From: Biniam Haile \(SWE\) (eritrea.lave@comhem.se)
Date: Fri Dec 11 2009 - 15:48:43 EST
IMF Executive Board Concludes 2009 Article IV Consultation with the
State of Eritrea
Public Information Notice (PIN) No. 09/133
December 11, 2009
On December 7, 2009, the Executive Board of the International Monetary
Fund (IMF) concluded the Article IV consultation with the State of
Eritrea.1
Background
Eritrea’s economic performance has weakened since the last consultation
discussions held in January 2008. A series of exogenous shocks have
taken a heavy toll on an already stretched economy. First, Eritrea
experienced a severe drought in 2008, which resulted in a harvest that
was one-fourth of that of the previous year, and necessitated emergency
imports of food. Second, as a net importer of food and oil products,
Eritrea was hard hit the same year by the international food and oil
price crises. Finally, while the global financial crisis has so far
bypassed Eritrea, the world-wide recession is likely to dampen the
possible revival of remittances from the diaspora.
In spite of these adverse developments, the authorities have endeavored
to protect the most vulnerable segments of the population and to
implement their long-term development policies. They maintain an
extensive social safety net, and are investing in three priority areas:
(i) food security and agricultural production; (ii) infrastructure
development; and (iii) human resources development.
As a result of the exogenous shocks, the economy sharply contracted in
2008, and inflation surged to double digits. To mitigate the impact of
the shocks on the population, the authorities increased social subsidies
and transfers. The ensuing fiscal deficit further burdened an already
fragile domestic banking system. With the return of rains in 2009,
agriculture is expected to rebound, and growth is projected to reach an
estimated 3½ percent. Though the budget deficit is projected to improve
in 2009, it will remain excessive, and inflation is forecast to hold in
the double digits.
Monetary policy has continued to accommodate the budget deficit. The
reliance on monetary financing of the budget deficit has resulted in a
rapid expansion of broad money and has fueled inflation. Shortages of
foreign exchange, falling remittances, and heavy government borrowing
from the banking sector have hindered private sector activity. Negative
real interest rates have stymied financial intermediation and weakened
the stability of banks. IMF staff analysis suggests that the exchange
rate is overvalued, indirectly confirmed by a growing parallel market
exchange rate. Domestic and external debt levels are deemed
unsustainable.
The medium-term outlook presents development challenges and may entail
risks. In spite of progress toward certain Millennium Development Goals,
poverty reduction has been thwarted by subdued growth and high
inflation. Continued fiscal and domestic imbalances under current
policies would impose an increased burden on the population. Conversely,
the coming on stream of a major mine and of a cement factory in 2010
will have positive contributions to economic performance over the medium
term.
Executive Board Assessment
Executive Directors noted that Eritrea’s economic performance weakened
in 2008 in the wake of international food and oil price hikes, a severe
drought, and the global economic crisis. They commended the authorities’
efforts to mitigate the impact on the most vulnerable segments of the
population. Real growth is expected to rebound in 2009, but inflation is
projected to remain high. Directors noted that low growth and high
inflation have undermined poverty reduction in Eritrea—despite
commendable progress toward the Millennium Development Goals in primary
education and health, as well as in infrastructure development. They
encouraged the authorities to take decisive and prompt actions to arrest
the weak economic performance, to address large financial imbalances,
and to place the economy on a path of sustained growth with poverty
reduction.
Directors called on the authorities to reduce the large fiscal deficits
that have been at the root of economic instability in Eritrea. They
encouraged the authorities to implement comprehensive fiscal and
structural reforms, and welcomed the authorities’ interest in requesting
technical assistance from the IMF to improve public financial management
and revenue administration, and adopt a medium-term expenditure
framework. A few Directors recommended further reductions in defense
spending to strengthen the fiscal position and release resources for
development.
Directors expressed concern that the latest debt sustainability
assessment shows Eritrea to be in external debt distress, accompanied by
a very high level of domestic debt. They advised the authorities to
reduce the need for further borrowing and to re-engage with the donor
community, seeking grant or highly concessional external financing. Such
renewed relationships will help provide the assistance—including debt
relief under the enhanced Heavily Indebted Poor Countries Initiative and
the Multilateral Debt Relief Initiative—necessary to help restore debt
sustainability. A few Directors recommended using part of the revenue
from the Bisha mine toward reducing domestic debt.
Directors regretted that the conduct of monetary policy continues to be
dominated by the government’s large financing needs, fueling inflation,
and curtailing credit to the private sector. Restoring the independence
of monetary policy was viewed as critical, along with efforts to
strengthen the banking sector and reduce distortions in financial
intermediation. A few Directors encouraged the authorities to pass and
implement Anti Money Laundering/Combating the Financing of Terrorism
legislation.
Directors underscored the importance of liberalizing the exchange and
trade systems to mitigate the foreign currency shortage, revive
remittances, and reinvigorate private sector activity. They recommended
reinstating the franco-valuta scheme. Directors noted the staff’s
assessment that the real exchange rate is significantly overvalued,
while also noting the deficiencies in data and assessment methodologies.
They generally concurred that a gradual correction in the misalignment
should be part of a comprehensive reform plan.
Directors encouraged the authorities to publish the budget and
macroeconomic data to bolster transparency and economic accountability,
utilizing technical assistance from the Fund, including from East
African Regional Technical Assistance Center (AFRITAC). They also
encouraged the authorities to address the serious data shortcomings that
hamper Fund surveillance.
Eritrea: Selected Economic and Financial Indicators, 2005–09
http://www.imf.org/external/np/sec/pn/2009/pn09133.htm
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