Bissau, November 24, 1999

Mr. Camdessus:

1.  The present government of Guinea-Bissau which took office on February 20, 1999, following a period of severe armed conflict, that was very costly in terms of destruction and loss of human lives, has started to implement with determination an emergency program aimed at reconstruction and economic recovery in a climate of political and financial stability. This program has received the support of the donors at the roundtable that took place on May 4 and 5, 1999, and that of the IMF in the form of a first disbursement under the emergency post-conflict assistance policy, approved by the Fund's Executive Board on September 14, 1999. Disbursements of external aid for the program have picked up in the last few months, after initial delays.

2.  Favorable developments in agriculture, and in particular in the production and exports of cashew nuts, have helped the recovery of output and made it possible to exceed the end-September program target for tax revenue. Meanwhile primary current expenditure was kept within limits, and credit to government was below target; however, as external aid fell short of expectations, it was not possible to meet the end-September external arrears settlement objective.

3.  The government has made substantial efforts to restore effectively the functioning of the tax and customs administrations, carried out the most urgent rehabilitation of administrative infrastructure and of social services, and strengthened the organizational frame-work of the armed forces to reinforce discipline. However, urgent tasks remain to be accomplished; three priority areas command immediate attention. First, a number of schools and health centers need to be rebuilt, the administrative infrastructure strengthened, and electricity and telecommunications services need to be improved. Second, the private sector, which experienced heavy losses during the period of the conflict, requires an injection of resources to rebuild its capital and working balances, which could be facilitated through the settlement of the government arrears. Third, the restructuring and demobilization of the armed forces must proceed expeditiously and in an orderly manner. Accordingly, the program of the government for the coming months aims at concentrating efforts in these key areas, with the financial and technical assistance support of foreign donors. The budget for the year 2000, presently under preparation, is intended to serve as the principal tool to achieve these objectives. The main lines of the budget are described in the attached memorandum of economic and financial policies, which also presents the macroeconomic framework for the year 2000 and the actions in the area of public enterprises, civil service and banking reform.

4.  To support the program in the coming months, the government hereby requests a second purchase from the Fund under the emergency post-conflict assistance policy for an amount of SDR 1.42 million, equivalent to 10 percent of quota. The government expects Fund support to catalyze aid, notably from the World Bank, the European Union, and bilateral donors. The action plan for the next few months will lay the groundwork for the preparation of a comprehensive three-year program aimed at promoting economic growth and reducing poverty, for which Fund support will be requested under the Poverty Reduction and Growth Facility. To that end, the government is starting the preparation of a comprehensive poverty reduction strategy.

5.  The government of Guinea-Bissau will consult with the Fund on the adoption of any additional measure that may prove necessary to implement the program and will provide the Fund with any information that it may request in connection with the implementation of the program.

Sincerely yours,

Attachment: Memorandum of Economic and Financial Policies

Bissau, November 24, 1999

1.   Since taking office on February 20, 1999, the government of national unity has concentrated on the key priorities of maintaining peace, reconstructing destroyed or damaged infrastructure and housing, stimulating the economy, and restoring national unity. The government has carried out with determination the emergency program it submitted to donors at the round table held in Geneva on May 4–5, 1999. This program covers the country's priority needs in the following areas: (i) reconstruction of housing and basic infrastructure destroyed during the conflict; (ii) return of displaced persons; (iii) troop demobilization and reunification and improvement of housing for soldiers; (iv) removal of land 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 respect of the rule of law. The financing requirement of the emergency program, which will amount to a total of US$138 mil-lion over several years, has been assured by donors' commitments. The first tranche of the program, covering 1999 and including the cost of the elections, was included in the 1999 budget approved by parliament in September 1999.

2.   Consistent with the emergency program, the government prepared in consultation with IMF staff a macroeconomic framework for 1999 that served as a basis for the program supported by the emergency post-conflict assistance approved by the Fund Executive Board on September 14, 1999. The macroeconomic framework assumed an economic growth rate of 7.5 percent in 1999, based on a marked increase in investment related to the reconstruction program, as well as in exports and private consumption. It envisaged a deterioration in the external current account deficit, excluding official grants other than fishing licenses, to 33 percent of GDP, given the expected sharp increase in imports. The 1999 budget was based on a gradual increase in tax and nontax revenue as tax offices began to operate efficiently again, and provided for an allocation of sufficient resources for essential government services. It also provided for a reduction in the domestic arrears accumulated in 1998, with the help of external budgetary assistance; resources available through the Multilateral Assistance Fund enabled the payment in April 1999 of the arrears accumulated in 1998 toward the World Bank.

3.   The government has endeavored to implement the emergency program despite a number of difficulties in key areas. A number of positive results were achieved. These include the return of most of the displaced persons, the consolidation of social peace with the signing in July 1999 of the Political Transition Pact by the government, the 14 political parties, and the military junta, and the preparation of legislative and presidential elections, which took place as scheduled on November 28, 1999. Thanks to strong support from a number of nongovernmental organizations, more than half of the 5,000 houses damaged during the conflict were restored before the onset of the rainy season. As for the administrative infrastructure and social services (schools and health facilities), implementa-tion of the government's reconstruction program has been adversely affected by delays in the disbursement of external assistance related to the time required by the donors to reestablish normal operations and finalize project. The government was thus forced to use its own resources to finance the rehabilitation of essential infrastructure, including military housing, buildings for the judicial system, and offices for the various ministerial departments. At end-September, however, an agreement was concluded with the European Union for emergency assistance to rehabilitate the urban infrastructure and social and administrative facilities. The World Bank has also released resources for strengthening equipment and infrastructure in various areas of government administration, pending the finalization of an economic rehabilitation and recovery credit (ERRC) in the amount of US$25 mil-lion. This credit will finance, inter alia, the cost of the demobilization program, the reinsertion of independence war veterans, and the reduction of arrears. Overall, public investment is expected to total CFAF 12 billion for 1999 (8.8 percent), compared with an initial estimate of CFAF 26 billion. This amount will be insufficient to cover all the urgent needs, notably the reconstruction of the schools and health centers that were destroyed during the period of the conflict.

4.   Concerning the armed forces—whose staff amounted to 11,000 at the end of the conflict compared with 2,500 before the war—the government, with World Bank support, has defined an action plan for the preparation of a demobilization program. The first stage of this program includes a survey of personnel, which was expected to have been completed by end-November. An initial pilot demobilization phase is scheduled to take place by October 2000.

5.   Economic activity in the agricultural sector was favorable during the first nine months of 1999, as rain was plentiful and the displaced population was involved in the production of various crops, including cashew nuts. The production of cashew nuts, the principal export product, reached an estimated 64,000 metric tons, or 20 percent more than expected, while cereal and food production rose by an estimated 10 percent. Activity in the service sector has picked up steadily, especially in the areas of commerce and transportation. In the banking sector, the commercial banks that reopened in June 1999 have resumed their operations, but banking activity is being hampered by the difficult financial situation faced by the International Bank for Guinea-Bissau (BIGB) (see below). In the circumstances, real GDP growth in 1999 is estimated to reach about 8.7 percent. Despite these encouraging signs, the private sector continues to suffer from the heavy losses it sustained during the conflict. The government is aware that in order to contribute to the rehabilitation of the private sector, it must quickly begin repaying domestic payments arrears and find an equitable solution to the losses incurred during the conflict.

6.   Inflation has declined considerably in recent months; the Bissau consumer price index, which had risen by 19 percent between January and November 1998, fell by 13 percent between November 1998 and May 1999, mainly owing to the improvement in the food supply that followed the end of the conflict. Prices have stabilized over the past few months, with the consumer price index at end-September 1999 standing at 4 percent below the level at end-December 1998. The price index is therefore expected to decline by 1 percent, on an annual average, during 1999. As import growth was lower than expected, owing to delays in the public investment program, and export growth exceeded projections, the current account deficit (excluding official transfers other than fishing licenses) is currently estimated at 14 percent of GDP, against the initially projected 33 percent of GDP.

7.   In the area of public finance, encouraging results were achieved over the first nine months of the year. Budgetary revenue exceeded the target by the equivalent of 4 percent of GDP because of the satisfactory results in the collection of the taxes on goods and services and income taxes, including the equivalent of 1.8 percent of GDP on taxes due in 1998. At the same time, current expenditure was in line with the targets, although the cost of feeding the armed forces was lower than initially projected because of the available food stocks. However, the budgetary contribution to investment exceeded the target, mainly because of the need to rehabilitate housing facilities of the armed forces and a number of administrative buildings.

8.   The reduction of domestic arrears in the first nine months of the year was in line with program targets. Wage and pension arrears accumulated during the second half of 1998 to approximately CFAF 5 billion, but payments under these headings totaled CFAF 0.9 billion at end-September 1999 and CFAF 1.6 billion at end-October 1999. These payments are expected to reach CFAF 2 billion by end-1999. With regard to external arrears, because of delays in disbursements of external budgetary assistance, payments were limited to clearing arrears toward the World Bank. Debt service on current obligations was also lower than projected, as it was limited to the servicing of obligations to the World Bank and the Fund. Thus, additional arrears were accumulated during the year vis-à-vis the African Development Bank (AfDB) and other multilateral institutions, in the amount of approximately CFAF 7 billion.

9.   Reflecting the good revenue performance, and also the lower-than-expected external debt payments during the first nine months of the year, the government's net position toward the central bank improved by CFAF 1.6 billion during this period, whereas the program envisaged, as a performance indicator, a deterioration not to exceed CFAF 6.6 billion.

10.   Based on end-October figures,¹ tax receipts at year's end are expected to reach CFAF 20.5 billion (15  percent of GDP), compared with an initial target of CFAF 16 billion (11.7 percent of GDP ). Excluding taxes due for 1998, the ratio of revenue to GDP is expected to reach 13.3 percent. Expenditure increased sharply in October, owing in particular to investment outlays for rehabilitating government administrative buildings and military barracks, which the government financed with its own resources. Thus, the government net position vis-à-vis the central bank worsened in October by CFAF 2.1 billion. In addition, the authorities are currently drawing down the amount of CFAF 3 billion that has been deposited since end-1998 at the central bank by the European Union in order to fund priority investments, including the rehabilitation of government and educational and health services buildings. In all, the domestic contribution to the capital budget is projected therefore to reach CFAF 4.5 billion, against the CFAF 3 billion initially estimated. As a result, the primary deficit (excluding foreign-financed investment) is expected to reach CFAF 1.1 billion (0.8 percent of GDP), compared with an initial projection of CFAF 5.7 billion (4.2 percent of GDP). The current primary balance is projected to record a surplus equivalent to 2.5 percent of GDP, compared with a program target of a 1.9 percent deficit.

11.   The initial projections for external budgetary assistance were revised downward from CFAF 14.3 billion to CFAF 1.9 billion (US$3.2 million), primarily because the first tranche of the World Bank credit, initially scheduled for disbursement in the fourth quarter of 1999, will now be available only during the first quarter of 2000. In light of this delay and of the projected level of revenue and expenditure during the fourth quarter of 1999, the government intends to use, during this quarter, a sizable portion of the deposits accumulated at the central bank as of end-September and part of the central bank's statutory advance. Accordingly, during the period January-December, the government's net position vis-à-vis the central bank is expected to decline by about CFAF 6.1 billion, which is still less than the CFAF 7.3 billion initially targeted.

12.   Considerable progress has been made over the past few months in strengthening fiscal management and tax administration. Tax collection offices have become more efficient, two decentralized collection offices have been opened in Bissau, and measures have been taken to centralize revenue and reduce tax evasion, especially at customs. In particular, 11 tax comptrollers have been installed in the decentralized administrations, such as the port, the forestry fund, the road fund, the passport office, and the civil courts. The Ministry of Finance has reestablished the system of prior authorizations for all expenditure commitments. As regards the restructuring of public enterprises, the government has, as programmed, approved the law on electricity, providing for the separation of electricity production and distribution into two legally distinct corporations. This law will be submitted to the new parliament to be appointed after the elections. Concerning the recapitalization of the main commercial bank, the BIGB, the adoption of an action plan has been somewhat delayed, for reasons described in paragraph 21, but a well-focused program of work to strengthen the bank is under way.

13.   Macroeconomic projections for 2000 are predicated on strong growth in public investment, mostly foreign financed (which will more than double from the compressed level of 1999), sustained growth in private investment and consumption, and a modest increase in the volume of exports from the high level reached in 1999 (exports of cashew nuts are expected to stabilize at around 64,000 metric tons). Imports of goods and services are expected to rise by about 55 percent in value as a result of the reconstruction effort and the growth in investment. GDP is projected to grow by about 7.6  percent in real terms. Because of the stability in the level of exports and the strong recovery of imports, the current account deficit, excluding official transfers other than fishing licenses, is projected to reach 29 percent of GDP, as against 14 percent in 1999. The annual average inflation rate is expected to be about 3 percent.

14.   The budget for 2000, which is to be submitted to parliament after the elections, is being finalized. It relies on the continuation of the actions already under way to ensure efficient tax administration and broaden the tax base, and takes into account the need to maintain the overall deficit needs to remain within the limits of the external financing available for investment spending and budgetary assistance. The draft budget reflects the impact of measures adopted to (i) strengthen the administration of the general sales tax (IGV) with Fund technical assistance, in particular by increasing the number of registered taxpayers; (ii) improve collection of the property tax; and (iii) renegotiate a number of fishing licenses. The government is preparing, with West African Economic and Monetary Union (WAEMU) assistance, a revised external tariff and categorization of imports, consistent with the WAEMU common external tariff (CET). As these tasks will take several months to complete, the new tariff, which includes a maximum rate of 20 percent, will enter into force only in the second half of 2000. Based on provisional estimates, the transition to the WAEMU CET should not cause any revenue shortfall, as the CET rates for many imports are higher than the present ones.

15.   In 2000, budgetary revenue is projected to reach CFAF 21.1 billion, equivalent to 14 percent of GDP, as against 13.3 percent of GDP in 1999, excluding back taxes. Tax revenue is projected to reach CFAF 11.8 billion (or 7.8 percent of GDP), with a strong rise of consumption tax (IEC) and sales tax (IGV) receipts from the 1999 level. Revenue from the profits tax and real estate taxes should also increase significantly. Customs revenue is projected to reach CFAF 6.5 billion (4.3 percent of GDP), compared with CFAF 5.7 billion (4.2 percent of GDP) when back taxes are excluded.² Nontax revenue is projected at CFAF 9.3 billion (6.2 percent of GDP), less than in 1999 (CFAF 10.1 billion ), a year in which the European Union fishing licenses payments have also included the amount due for 1998.

16.   On the expenditure side, the government has taken into account: (i) the need to reduce military spending by promoting the reinsertion of military personnel into civil society through the demobilization program; and (ii) to raise wages, which are very low in comparison with the other WAEMU countries, while reactivating the civil service reform started in 1998. Based on a 20 percent wage increase to be paid in two steps, the wage bill is projected to increase by 20 percent to reach CFAF 8.4 billion (40 percent of projected revenue and 5.6 percent of GDP). Expenditure on goods and services would rise by 40 percent, reflecting a number of nonrecurrent factors, such as: (i) government operations were practically at a standstill during the first months of 1999; (ii) the cost of feeding the armed forces will rise temporarily as the food inventories built up in the past have been run down and need to be replenished; this cost is, however, expected to decline in 2001 as demobilization proceeds; (iii) spending in the social sectors will rise sharply in order to rehabilitate schools and hospitals. On this basis, primary current expenditure is projected at CFAF 22.5 billion in 2000, or 15 percent of GDP, as against 12.6 percent of GDP in 1999. The primary deficit, excluding foreign-financed investment, is projected to reach CFAF 5.8 billion (3.8 percent of GDP), compared with 0.8 percent of GDP in 1999. The annexed table contains the quarterly budgetary indicators for the first half of 2000.

17.   The government is about to complete an inventory of domestic arrears, which will have to be submitted to a rigorous auditing process. These arrears concern: (i) wages and pensions for the second half of 1998; (ii) obligations for purchases of goods and services through end-May 1998; (iii) obligations for purchases of supplies during the conflict period; and (iv) the debts to be recognized in connection with the losses sustained during the conflict. The arrears will be verified by a commission already appointed by the Prime Minister, and payments will be made after offsetting government debt with its claims on economic agents on several accounts (taxes, debt to the liquidated government-owned Banco de Credito Nacional (BCN), and other bank debts). The work of this commission will be completed by March 2000. Settlements of arrears will be phased over 2000-01, on the basis of a schedule that will treat all creditors equitably. Regarding conflict-related losses, a commission has been established within the Chamber of Commerce to collect data from economic agents; this work will be completed by early 2000. Bilateral donors have established concessional credit facilities for private businesses affected by the war, so as to promote the recovery of business activity. The World Bank will earmark some of the resources released under the ERRC for the settlement of domestic arrears to the private sector; assistance from the European Union is also expected to that end, and similar support will be sought from other donors.

18.   Regarding external debt service, the government will service during the year 2000 all current debt-service obligations to multilateral creditors, amounting to the equivalent of US$12.5 million. For this purpose, further contributions from the bilateral creditors to the Multilateral Debt Fund have been requested. In order to regularize the substantial arrears toward multilateral institutions, the government is seeking to reach agreements with these institutions providing adequate refinancing on concessional terms. Furthermore, the government has requested from the Paris Club the rescheduling of arrears at end-1999 and payments falling due in 2000 on highly concessional terms. The government hopes to be able to reach the decision point for the Initiative for Heavily Indebted Poor Countries (HIPC Initiative) toward mid-2000, at the time when it intends to finalize a new three-year program with the Fund. This would make it possible to start benefiting in the second half of the year from relief on debt obligations to the multilateral institutions.

19.   Investment spending is now projected to reach CFAF 33 billion (21.8 percent of GDP), comprising CFAF 28.5 billion financed externally and CFAF 4.4 billion financed through the government's domestic budget. These projections are based on the evaluation of the pace of implementation reviewed by the World Bank. They take into account the start of an important road project financed by the European Union and large disbursements for health infrastructure projects that have also recently resumed. Investments for education and health are expected to represent a significant part of this total (about 30 percent). In addition, the demobilization program, which is to be financed by donors, is expected to cost CFAF 9 billion (US$15 mil-lion), with disbursements over a three-year period, including an amount of CFAF 3 billion in 2000. The World Bank ERRC is expected to cover about half of this program. The government expects to mobilize the other half through meetings with donors in the first half of 2000, under the aegis of the World Bank.

20.   The financing gap in 2000 is estimated at about CFAF 123 billion. Of this total, about CFAF 99 billion could be covered, in the context of a new PRGF, by debt relief from creditors on current maturities and external arrears. The balance will be covered by already identified assistance from various donors, including the World Bank under the ERRC (CFAF 12 billion), the Fund under a new three-year agreement, the European Union in an amount of about CFAF 2.4 billion, the AfDB (CFAF 3.6 billion), and bilateral donors (for approximately CFAF 2.2 billion), partly to finance the demobilization program, and the multilateral debt fund.

21.   One of the government's priorities is to strengthen the banking system, through the recapitalization of the largest bank in the country, the BIGB, whose financial situation is weak. The Banking Commission's audit of the bank's portfolio, which began in 1997-98 and was interrupted by the war, will be completed shortly. The Portuguese majority shareholders are committed to recapitalizing the bank in a few months' time, after the elections. For its part, the government will pay the debts toward the bank owed by the public enterprises in liquidation; appropriate solutions will have to be negotiated for the loans that cannot be recovered because of losses sustained by the borrowers as a result of the conflict. The government will recruit an expert to assist in designing the strategy for the government's divestment of its shares in the bank; the divestiture will take place at the time of the prospective recapitalization. The banking system will be strengthened by the opening, in December 1999, of a new bank, the Banco de Africa Occidental (BAO), with the majority of its capital controlled by foreign investors.

22.   In 2000, credit to the economy is expected to be mainly seasonal in nature, linked to the harvesting and exporting of cashew nuts and of other agricultural products; some credit expansion is also needed to finance the economic recovery. In all, credit to the economy is expected to grow by 9 percent. Credit to the government is projected to remain broadly stable. During 2000, net foreign assets of the banking system are projected to rise by CFAF 9 billion (US$15 mil-lion). Money supply, after a 6.9 percent increase in 1999, is projected to grow by 14 percent in 2000.

23.   In 2000, the government intends to pursue, with World Bank assistance, its policy of deregulation of the telecommunications sector, as well as the restructuring of the port of Bissau. It will also continue to divest from the hotel sector. In the telecommunications sector, the government will establish a regulatory framework, introduce better frequency-band management, take steps to facilitate telephone access to the rural areas, modify the concessions contract with Guiné-Telecom (the sole operator on the market), and sell the government's minority stake in the company. The precise time frame is in the process of being defined in consultation with the World Bank. Regarding the port, the concession agreement with Guiport has been cancelled, and a new operator will be sought through a call for bids. During the year 2000, the process of selling off a number of state corporations, which was already under way in early 1998 (SOCOTRAM (timber), Guinave (shipyards), Cerâmica de Bafatá (pottery)), will be completed. Concerning the demobilization program, the authorities will promulgate, before end-February 2000, the decree under preparation defining the institutional framework for the demobilization and reinsertion program of ex-combatants. This will constitute a structural indicator under the program.

24.   The government's action plan for the coming months in the area of public finance, demobilization, and structural reform is essential for laying the groundwork for a comprehensive program of structural adjustment and poverty reduction for which the authorities intend to request Fund support under the Poverty Reduction and Growth Facility.

25.   The government is aware that the new three-year program will have to formulate in a clear manner the main objectives of its poverty reduction effort, the strategies to be pursued to that end, and the resource and indicators that will have to be monitored on an annual basis. The main impact indicators will include, inter alia, the number of schools and health centers, the rate of primary school enrollment for boys and girls, the repetition rate at primary schools, the number of books available to schoolchildren, and the vaccination rate. The resource indicators will include, inter alia, the ratio of health and education spending to total expenditure, the number of operational health centers that meet the minimum medical staff and drug requirements, and the number of qualified teachers in urban and rural areas. The choice of indicators will be finalized in the coming months, with the assistance of World Bank experts. The government is determined to involve the parliament and civil society extensively in the formulation of the poverty reduction program, including local communities, producer organizations, trade unions, and nongovernmental organizations. To this end, it has started the preparation of a detailed program of work that will be submitted to the Fund and Bank before end-1999; this will focus, in the first stage, on the most urgent actions to strengthen the education and health sectors, and to improve the overall poverty assessment. In particular, the government will initiate, with World Bank assistance, a house-hold survey in the first months of 2000, so that updated poverty data will be available by the end of that year. Using these data, the government is committed to preparing a full Poverty Reduction Strategy Paper in a participatory manner by mid-2001.