Bissau, August 13, 1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Camdessus:

1.  In June 1998, an armed conflict broke out in Guinea-Bissau. It caused widespread destruction, loss of human life, and displacement of populations, and it disrupted economic activity. Since taking office on February 20, 1999, the national unity government has undertaken the massive task of reconstruction and economic recovery in an environment of relative domestic stability and gradual troop demobilization.

2.  With the assistance of the United Nations and bilateral donors, the government has prepared an emergency plan, which was well received by donors at a roundtable in Geneva on May 4 and 5, 1999. The aim of the plan is to restore private sector activity, return displaced persons to their homes, rebuild residential areas and infrastructure, rehabilitate the social sectors, demobilize troops, and organize elections. The government immediately adopted measures to reconstitute a functioning civil service and prepare a budget for 1999 to serve as framework for the emergency program. In addition, with the assistance of staff of the International Monetary Fund, it prepared a macroeconomic and structural program for 1999 that was consistent with the medium-term objectives already contained in the last program supported by the Enhanced Structural Adjustment Facility (ESAF) and in the policy framework paper for 1997-2000. In support of this program, the government wishes to obtain assistance from the Fund under the emergency post-conflict assistance policy in the amount of SDR 3.55 million, equivalent to 25 percent of the quota, to be accessed in two drawings of SDR 2.13 million (15 percent of quota) and SDR 1.42 million (10 percent of quota), respectively. The satisfactory completion of this program should make it possible for the government formed after the upcoming elections to start on a firm foundation and formulate a comprehensive, three-year macroeconomic and structural adjustment program that could be supported by a new ESAF arrangement.

3.  The program for 1999 is presented in detail in the attached memorandum of economic and financial policies. Its aim is to promote economic recovery in the context of the fiscal discipline that is required for implementation of the emergency investment plan, to rehabilitate the tax and budgetary system with external technical assistance, to consolidate the banking system, and to resume the public enterprise restructuring program. The government is expecting broad support from the international community for its 1999 program, both to finance emergency investment projects and to cover the financing gaps. Quantitative and structural performance indicators will make it possible to monitor implementation of the program, which will also be subject to a comprehensive review by end-December 1999.

4.  The government of Guinea-Bissau considers that the economic and financial policies presented in the memorandum are appropriate to confront the current serious difficulties and meet the program objectives. It will consult with the Fund on the adoption of any additional measures that may prove necessary during the program period and provide the Fund with any information that it may request in connection with the implementation of the program.

Sincerely yours,

/s/

Abubacar Demba Dahaba
Minister of Economy and Finance
Bissau
Republic of Guinea-Bissau

1.  In January 1995, the government of Guinea-Bissau undertook a three-year economic reform program supported by the IMF's Enhanced Structural Adjustment Facility (ESAF). When this program ended, a new three-year program supported by ESAF arrangements for the period 1998-2001 was negotiated in April 1998, with the first annual arrangement thereunder covering the period July 1998-June 1999. However, the armed domestic conflict that broke out in June 1998 interrupted Guinea-Bissau's ongoing economic and financial adjustment. The record of program implementation had been generally satisfactory and the reform effort sustained until that time, despite certain difficulties in containing expenditure and in the centralization of revenue. During the period between 1995 and mid-1998, economic growth had resumed, financial imbalances had been reduced, competitiveness had improved, and inflation had fallen substantially. Major reforms had been undertaken to strengthen budget management, rehabilitate the banking system, and privatize public enterprises. These reforms had made it possible for Guinea-Bissau to accede to the West African Economic and Monetary Union (WAEMU) at the beginning of 1997, which helped secure the benefits of exchange rate and price stability. The macroeconomic program developed for the period July 1998-June 1999 was to focus primarily on continuing to strengthen government finance and implement tax reforms. Important measures were planned for reforming the civil service, privatizing state-owned enterprises, and strengthening social services. In addition, efforts were under way to conclude external debt-relief agreements with all lenders with which Guinea-Bissau had payments arrears.

2.  In the event, the envisaged program was not finalized owing to the armed conflict that began on June 7, 1998. A cease-fire was reached in August 1998, and negotiations under the aegis of the Economic Community of West African States (ECOWAS) led to an agreement signed by the parties involved at Abuja on November 1, 1998. This agreement provided for the formation of a transitional national unity government, the deployment of an ECOMOG peacekeeping force and observers, the withdrawal of foreign intervention forces, and the organization of legislative and presidential elections by end-March 1999. Under the Abuja agreement, Francisco Fadul was appointed Prime Minister on December 2, 1998. The government, appointed on January 11, 1999, took office on February 20, 1999, following the deployment of the ECOMOG forces. The government contacted bilateral and multilateral donors and lenders to mobilize emergency relief, and prepared an assessment of Guinea-Bissau's requirements, which was presented to donors and lenders during a roundtable organized under the auspices of the UN in Geneva in early May.

3.  The conflict has resulted in considerable damage: in Bissau, more than 5,000 homes and numerous government, school, and hospital buildings were destroyed or severely damaged, as well as computer and transportation equipment, and the industrial infrastructure. Thousands of land mines were also laid. The airport and banks were closed, and the production capacity of the Bissau power station was greatly reduced, owing to insufficient maintenance in the midst of the conflict. Production declined sharply during the second half of 1998, and Guinea-Bissau's economy contracted sharply; the population of the capital fled, the airport, central bank, and commercial banks were closed, and road transportation and communications were impaired. This caused considerable flow of displaced persons to neighboring provinces and countries. Most of these persons have since returned, although the process has been difficult, especially because of the damage sustained in residential areas.

4.  The decline in real GDP in 1998 is estimated at 28 percent. According to recent estimates, agricultural production declined by 17 percent, owing to the negative effects of the displacement of the population. Cashew nut production is estimated to have declined by 30 percent to approximately 35,000 tons, and the conflict seriously impeded the transportation of the crop to the port of Bissau, which was in the combat zone. As a result, large quantities of cashews were exported through informal channels. Industrial and commercial sector activity came to a standstill for several months. In particular, electricity production declined to half of the normal level during the second half of the year, while financial services were suspended and the central government administration ground to a halt.

5.  Inflation accelerated during the period from July through November 1998; however, prices declined in December. For the entire year, the inflation rate reached 8 percent on average, as well as for the 12-month period ended December. During the first three months of 1999, the price index increased by 4 percent. For 1999 as a whole, demand pressures resulting from the return of the population to Bissau and the resumption of wage payments could lead to a 12-month inflation rate of about 6 percent. The cashew harvest is expected to be favorable in 1999, as the plantations have apparently not sustained damage. With a stock of 5,000 tons left over from the previous crop year, cashew exports could reach 50,000 tons. By mid-July, 41,000 tons had already been exported. Despite the growth in exports, the trade deficit is expected to increase sharply as a result of the high level of imports required for reconstruction, which is expected to be financed mostly by external assistance.

6.  The national unity government, which took office on February 20, 1999, is determined to tackle the problems concerning reconstruction, the return of displaced persons, the rehabilitation of the government administrative machinery, the unification of the armed forces, and demobilization, and the reactivation of social services. The government must at the same time prepare for legislative and presidential elections, consolidate democracy, and ensure law and order. While aware of the magnitude of this task, the government is confident that it can be accomplished with the support of all segments of the population and of the external partners. The government is also aware of the private sector's central role in economic recovery and is committed to ensuring the restoration of domestic order, effective law enforcement, and free and open domestic and international trade, as these are essential for strengthening security and confidence, and for stimulating economic activity.

7.  The priority in the agricultural sector is to ensure that sufficient seed is available to start the cereal crop year, and that the private sector imports a sufficient quantity of rice to cover urban consumption and the rural needs connected with the commercialization of cashew exports. Private sector imports are expected to cover urban rice consumption. The restoration of the airport infrastructure is now in progress, and the port of Bissau is already completely operational. External financing is expected to be available soon for the rehabilitation of the power plants. Although the new school year began at end-March 1999, much remains to be done to rehabilitate the schools that were used as barracks during the conflict, and to reconstruct those that were damaged. Funding from the development partners has been requested to repair and reconstruct hospitals and laboratories. In the residential sector, the government is determined to assist families whose homes were destroyed or damaged. To that end, the government has began a housing survey, and the European Union has decided to provide an emergency allocation of funds, to be supplemented by other donors and lenders, for an urban housing program that is now in preparation.

8.  Private economic agents sustained considerable losses during the conflict. Accordingly, the government is asking donors and lenders to make funding available to the private sector at highly concessional rates, so as to promote the recovery of business activity. The government will accelerate the settlement of its payments arrears outstanding as of mid-1998 to suppliers of goods and services. The government also envisages an accelerated schedule for reimbursement of the obligations contracted to procure goods and services during the conflict.

9.  Considerable arrears, estimated at CFAF 4.4 billion, were also accumulated during the second half of 1998 on payments of wages and pensions to government workers. The payment of wages and pensions for the first two months of 1999 was started only in April. In the framework of the 1999 budget, the government aims at a rapid regularization of wage and pension payments for 1999, and a gradual absorption of the arrears from 1998.

10.  The government recognizes that the economic reconstruction and recovery efforts require a stable macroeconomic framework, as well as the maintenance of rigor and transparency in government finances, and in budgeted expenditure procedures. The government is finalizing the 1999 budget for presentation to the People's National Assembly. It is determined to maintain strict control over expenditure and to observe the procedures introduced in 1997, which call for ex ante authorization of commitments by the Ministry of Finance. The government will contain nonessential expenditure, such as travel abroad and spending on embassies, and it has already taken austerity measures in this regard. The budget and treasury directorates are being strengthened with support from donors and lenders. Assistance has been requested from the IMF to implement the new budget nomenclature adopted by the WAEMU, and to enhance the efficiency of expenditure, verification, and authorization procedures. World Bank assistance has been requested for the implementation of new and more rigorous government contracting procedures. The government is also determined to centralize all revenue of the autonomous funds and government agencies in the treasury, as this is an area in which supervision difficulties have been encountered in the past.

11.  The customs and tax administrations have deteriorated seriously, with a considerable loss of equipment that must be replaced rapidly. The customs directorate has been diligent in resuming its activity, albeit with weakened resources. With World Bank assistance, the ASYCUDA computer system for customs data will be restored shortly; vehicles for border control will be procured; and customs clearance procedures will be simplified and improved, with a view to increasing efficiency. The tax and contributions directorate (DGCI) is also being strengthened with the provision of adequate computer equipment. The collection of the general sales tax (IGV), which was not possible during the conflict period, was resumed in May, and the computer system will soon start functioning again.

12.  The government is determined to resume the structural reform program. The intent is to complete the privatization of a number of public enterprises—a process that was well under way prior to June 1998. These include Ceramica de Bafatá (ceramics), SOCOTRAM (timber), and GUINAVE (shipyard), and the semi-industrial fisheries complex (so as to expand fish-processing activities). The water and electricity company, EAGB, will be split by the end of the year into a state-owned assets management company and a private operating company.

13.  A key government concern is the strengthening of the banking sector and ensuring of full compliance with the prudential criteria established by the central bank. Guinea-Bissau's largest bank, the Banco Internacional de Guiné-Bissau (BIGB), is taking action to strengthen its capital and liquidity, and the government is making an effort to reimburse the debts accumulated toward the bank during the second half of 1998 by a number of public enterprises.

14.  The authorities presented the priority needs for an emergency program in the base document for the emergency roundtable conference in Geneva on May 4-5, 1999. These requirements were estimated at a total amount of US$138 million. They would cover the costs involved in the (i) reconstruction of residential housing and basic infrastructure; (ii) return of displaced persons; (iii) demobilization and reunification of the armed forces, and improvement of their housing; (iv) removal of mines; (v) rehabilitation of the social sectors; (vi) support for the private sector; (vii) repayment of arrears; and (viii) organization of elections, consolidation of democracy, and establishment of law and order.

15.  The government is aware that the funds to cover these requirements will have to be raised over several years. The first annual tranche of the emergency program was included in the 1999 investment budget and has been evaluated at US$75 million (CFAF 45 billion). This includes the cost of the elections scheduled for the end of the year. An estimated US$63 million (CFAF 38 billion) in external financing is required for this program, and discussions with donors and lenders have already started. The pace of implementation of the annual program for 1999 will depend on the release of funds and the capacity to implement various projects.

16.  In March 1999, the joint military commission estimated the size of armed forces in the two camps at 10,850, while before the conflict the police and armed forces, not including civilian staff in the ministries of defense and the interior, numbered 5,000. The government is preparing a demobilization and social and economic rehabilitation plan, which should also provide an equitable solution for veterans of the war of independence. In preparing this plan, the authorities expect to receive assistance from donors and lenders with considerable relevant experience, including the World Bank. An initial mission of experts to assist the government in this task is expected by end-August 1999. The implementation will require substantial foreign resources.

17.  Macroeconomic projections for 1999 are based on an increase in exports of approximately 52 percent in value, a doubling in the value of public and private sector investments, up from the very low 1998 level, and an increase in consumption in real terms of approximately 6 percent. Cashew exports could reach 50,000 tons, up from about 34,000 tons in 1998, of which 24,000 tons through official channels. Imports of goods and services are projected to increase by approximately 51 percent in value as a result of the recovery of investment and reconstruction activities. Overall, real GDP could increase by approximately 7 percent, taking account of the low level of activity during the early months of the year. A stronger GDP growth can be expected in 2000.

18.  The external current account deficit, excluding grants, other than fishing licenses, is projected to widen in 1999 as a result of the sharp recovery of imports to about 32.5 percent of GDP. The financing requirement is expected to be covered by the external budgetary support (see below).

19.  The 1999 budget was prepared on the basis of an expected pickup in tax and nontax revenue owing to restored efficiency in the tax services. The primary deficit is targeted at CFAF 5.6 billion (4.1 percent of GDP), up from 4.2 percent of GDP in 1997. Budgetary revenue is projected to reach CFAF 15.9 billion, equivalent to 11.5 percent of GDP, as against 15.3 percent in 1997, the last normal year in terms of economic activity. Tax revenue is projected to amount to CFAF 6.8 billion (5 percent of GDP), primarily based on revenue generated by cashew nut exports, customs duties, consumption taxes (IEC) on beverages and petroleum products, and the IGV. Income tax revenue should be low as a result of the 1998 conflict. Nontax revenue in 1999 can be expected to amount to CFAF 9 billion (6.5 percent of GDP). Of this total, fishing licenses and related compensation from the European Union are projected at CFAF 7.6 billion (5.5 percent of GDP). Current budget expenditures have been set in line with those of the 1998 budget.

20.  Primary current expenditure in 1999 is set at CFAF 18.6 billion, equivalent to 13.5 percent of GDP, as against 9.9 percent of a higher GDP in 1997; this amount is close to that envisaged in the 1998 budget, except that a larger amount is provided for maintenance of the armed forces in light of the increase in its size pending implementation of the demobilization process. Adequate appropriations have been made for public utility consumption. The domestic contribution to the investment budget will amount to CFAF 3 billion (2.1 percent of GDP).

21.  Based on provisional estimates, payments arrears accumulated during the period June-December 1998 with regard to wages, pensions, and transfers amount to CFAF 4.4 billion, including approximately CFAF 3 billion on wages. Arrears on goods and services are provisionally estimated at CFAF 2 billion, pending completion of a survey in progress. A survey of domestic arrears at end-1997 was completed by May 1998. An audit to verify these arrears will be conducted shortly with external technical assistance; these arrears will be partly offset against the government's claims for past taxes and for debt contracted with the liquidated Banco de Crédito Nacional (BCN), with commercial banks, and with the Japanese-financed KR2 Fund. Multilateral donors and creditors have indicated their willingness to finance the settlement of these arrears in 1999, in the framework of the clearance of debts to the tax administration and the banking system.

22.  Concerning external debt service, the government has settled in April 1999 the payment arrears toward the World Bank and, in July 1999, has paid a part of its arrears to the African Development Bank. The government will settle during 1999 all its current obligations toward multilateral creditors, amounting to US$10.5 million. To ensure this debt service, new contributions by bilateral partners to the Multilateral Debt Fund have been requested.

23.  Taking account of the expenditure required to settle domestic arrears (approximately CFAF 4 billion) and arrears to the World Bank and the African Development Bank at end-1998 (US$1.9 million and US$1.6 million, respectively), the overall financing requirement, excluding financing for the investment budget, is estimated at CFAF 22.4 billion in 1999. Of this amount, approximately CFAF 5.6 billion will be secured from the use of government deposits at the central bank constituted with European Union (EU) assistance in 1997 and 1998 (CFAF 3.6 billion), and with previous disbursements for the Multilateral Debt Fund (CFAF 2 billion). Net use of Fund resources is projected at CFAF 2.4 billion. The remaining CFAF 14.4 billion (US$23 million) is expected to be covered as follows: CFAF 12.3 billion (US$20 million) in economic rehabilitation assistance from the World Bank; and CFAF 2 billion (US$3 million) from bilateral donors, including in the form of contributions to the Multilateral Debt Fund.

24.  Monetary policy and bank supervision are conducted within the framework of the WAEMU. Under the direction of the Central Bank of West African States (BCEAO), monetary policy in 1999 will continue to aim at strengthening the Union's external reserves and limiting inflation to levels in line with the euro area. The bulk of credit to the economy will be of a seasonal nature in connection with the cashew crop year and exporting activities; in all, such credit should remain broadly stable during the year. Bank credit to the government will consist of the counterpart of EU assistance and contributions to the Multilateral Debt Fund; the latter will be use for the repayment of debt arrears. Net foreign assets of the banking system could decrease by CFAF 3 billion (US$1.5 million). The money supply is projected to increase by 10.5 percent in 1999 after a 7.5 percent decline in 1998.

25.  The strengthening of the banking system is essential for the economic recovery. The country's two commercial banks remained closed during the conflict and did not reopen until May 1999. When the BIGB reopened in May 1999, it shored up its weak liquidity position by arranging substantial interbank lines of credit, so as to be able to finance the new cashew crop. An audit of the bank by the regional banking commission will be concluded shortly, and, on the basis of its recommendations, an increase in capital is likely to be necessary. The government, which holds 26 percent shares in BIGB, is committed to reducing substantially its participation in the bank in connection with the expected capital increase. The government will shortly request BCEAO and World Bank technical assistance to advise on the approach to be taken in the divestiture of its interest in the BIGB; following this divestiture, management of the bank will be entirely in the hands of the private sector. An action plan on the recapitalization of the bank will be adopted by end-November 1999.

26.  The reforms that the government is implementing focus on strengthening budget procedures and tax and customs administration, as described above, rehabilitating the banking system, and resuming the privatization of a number of enterprises that was under way in 1998. With regard to the restructuring of the civil service and the armed forces, the objective is a gradual reduction of staff to increase efficiency and improve remuneration. In 1999, this effort will focus on the preparation of an action plan, with technical assistance from the World Bank and other donors, for demobilizing troops, introducing a more effective targeting of veterans of the war of independence in need of financial support, and defining the modalities for such support.

27.  In the area of public enterprise restructuring and privatization, priority is given to the restructuring of the energy and water company, EAGB; for that purpose, a state-controlled assets management company will be established, and a long-term management contract will be concluded with a private company during the first quarter of 2000. The government has sought external assistance for rehabilitating the power stations and the entire grid, and some work has already started. The government will adopt a draft law on electricity by the end of November 1999 to define the institutional framework for the sector.

28.  The government is aware of the importance of restructuring the telecommunications sector and the port of Bissau; in both areas, private agents operate under concession arrangements that need to be reviewed to improve management efficiency. To that end, the government intends to initiate studies in the coming months, with foreign technical assistance.

29.  In the next few months, the government intends to complete the privatization of GUINAVE (ship repair) and SOCOTRAM (timber), which was negotiated before the outbreak of the conflict. The government also plans to initiate procedures to privatize the Complexo Semi-industrial de Pesca de Bissau, which could play an important role in developing the country's capacity for processing fish products.

30.  The government has requested assistance from the International Monetary Fund in strengthening budget procedures and ensuring full implementation of the IGV. It has also requested assistance from the World Bank, the European Union, and bilateral donors and creditors in order to strengthen the customs administration, the budget directorate, and the treasury directorate. The authorities also wish to receive assistance from the IMF and other donors and lenders for correcting weaknesses in preparation of the economic statistics, in particular, in the area of the national accounts. Various donors and creditors, especially the European Union, support the unit in charge of monitoring economic policy in the context of multilateral surveillance within the WAEMU. Assistance has also been requested from the WAEMU to facilitate implementation of a number of community laws and directives in the area of government finance. The terms of a troop demobilization program and the infrastructure reform program will also be defined with external technical assistance.

31.  As the cashew plantations sustained only limited damage, the medium-term balance of payments outlook presented in the 1997-2000 policy framework paper remains valid. Exports can be expected to increase by approximately 13 percent in 2000, while growth of imports should be limited, owing to the rapid recovery expected in 1999. The external current account deficit, excluding government transfers other than those in connection with fishing licenses, which was estimated at 18.3 percent of GDP in 1997, the last normal year in terms of economic activity, is projected to amount to 25 percent of GDP in 2000. This deficit can be expected to decline thereafter as a result of sustained growth and the diversification of exports, supported by a resurgence of external investment as confidence is restored in the country's potential. This resurgence will make it possible to gradually reduce the balance of payments financing requirements.

32.  External debt-service arrears have been incurred in 1998 and 1999 with Paris Club creditors, other bilateral creditors, and multilateral organizations. A rescheduling of arrears and of current maturities falling due on highly concessional terms will be requested from the Paris Club creditors and other bilateral creditors at the beginning of 2000, when a new three-year ESAF-supported program is expected to be finalized. In 1999, the authorities will place priority on the payment of current debt service to multilateral creditors; total debt service for current obligations is estimated at US$10.5 million for the year. In addition, US$3.9 million of end-1998 arrears will be repaid during 1999. To help cover this service, further contributions of about US$2 million from bilateral donors to the Multilateral Debt Fund are expected. At mid-1999, the external debt situation, including arrears, remains substantially as described in the March 1998 preliminary document prepared for the Initiative for Heavily Indebted Poor Countries (HIPC Initiative), which estimated the debt at approximately US$900 million. The government hopes that the HIPC Initiative decision point can be reached in early 2000, with the adoption of a new program supported by the ESAF; it also wishes to benefit from a shortening of the period between the HIPC decision and completion points, with a view to reaching the latter in 2001.

33.  To ensure proper program execution, prior actions will be implemented before the program is submitted to the IMF Executive Board. These actions include (i) restoration of normal ex ante control procedures for expenditure commitments by the Minister of Finance, as well as for expenditure verification and authorization; (ii) restoration of normal customs control procedures for clearance of merchandise; (iii) resumed collection of the IGV from major taxpayers; (iv) preparation of a survey of the government's arrears on wages, pensions, and procurement of goods and services during the conflict period; and (v) adoption of an action plan and timetable for the preparation of a troop demobilization plan, with assistance from the World Bank.

34.  The monitoring of the emergency program in 1999 will be based on quarterly quantitative indicators for end-June, end-September, and end-December 1999 and the structural benchmarks indicated in the attached table. The quantitative indicators include (i) budget revenue; (ii) primary current budget expenditure; (iii) primary current budget balance; (iv) net bank credit to the government; (v) reduction of domestic arrears; (vi) the payment of current debt-service obligations; and (vii) the payment of a minimum amount of arrears on external debt. In addition, the government will not contract or guarantee any nonconcessional loans during the program period. Quantitative indicators for end-March 2000 for the same aggregates will be established during the midterm review, to be completed by end-December 1999. Structural benchmarks include (i) the adoption by end-November 1999 of an action plan for the recapitalization of the BIGB, and the reduction of government participation in the bank; (ii) the government's adoption of a draft law on electricity by end-November 1999; and (iii) the transfer of electricity and water management to a private company by end-March 2000. The program review will focus on execution of the emergency program in 1999 and the budget for 2000.

Quantitative indicators

External debt service on arrears (minimum amount)