Article

Madagascar: Crafting Comprehensive Reforms

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1991
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As it sought to overcome the constraints of the socialist economic structure that it had introduced in the 1970s, Madagascar began implementing a series of reforms from the mid-1980s, with help from the IMF and the World Bank

S. Rajcoomar

The heavy weight of administrative controls, extensive nationalization, and a poorly coordinated investment program that added to the burden of external debt—this list of obstacles to sustainable growth and financial stability is only a partial litany of the misguided policies pursued in Madagascar during most of the past two decades. The results were slow economic growth, a decline in real per capita GDP, and substantial imbalances in external and domestic accounts. Recent efforts by the Malagasy authorities provide strong evidence of the gains that can be made by moving to a stable and more open economic order, provided the political will to attack fundamental problems exists, and domestic efforts are supported by international assistance.

Madagascar initially focused on the attainment of financial stabilization, with complementary measures to open up the economy to competition. It also tried to reform and restructure the public enterprise sector, formulate a new social policy, and institute a strict public expenditure control program. As a result, the external current account deficit was reduced significantly, reflecting in large part a sharp cut in the fiscal deficit, while gross international reserves rose markedly. Meanwhile, the authorities followed a prudent monetary policy, initiated the structural reform process, and removed some of the distortions between traded and nontraded goods. Helping this process were substantial inflows of capital and several debt reschedulings by the Paris Club and other official creditors and by commercial banks, as well as a significant amount of bilateral debt cancellation. Both the IMF and the World Bank assisted the Malagasy authorities to help change the economic course of the country over the 1980s, with a series of arrangements and loans.

While a number of structural problems remain and self-sustained growth is not yet assured, the nature of the reforms undertaken by Madagascar over the past few years reflects the importance of comprehensive change and long-term commitment. In this case, the move from a socialist planned economy to a competitive market-oriented one has been phased over a relatively short period, despite the deeply rooted problems of the previous economic regime. Eventual success, however, will depend on how well these policies are maintained over time and on external conditions.

Background

In attempting to introduce a Malagasy-style socialism, the Government, in the mid-1970s, adopted the Charter of the Revolution. Madagascar withdrew from the Franc Zone and imposed administrative controls in most areas of the economy, involving the nationalization of several sectors, including the banking system. As a result, the economy grew at a slow pace, with real GDP rising at an average annual rate of less than 2 percent, implying a steady decline in real per capita GDP.

To accelerate the growth rate, a large-scale investment program was implemented between 1978 and 1980. Given the absence of proper coordination, and an efficient system of project implementation, this had little lasting impact on the country’s productive capacity, but ended up quadrupling its external debt. At the same time, the Government pursued an expansionary financial policy that was aggravated by unfavorable movements in its terms of trade. Quantitative restrictions on trade were intensified, resulting in substantial external and domestic disequilibria, pronounced distortions in relative prices, and an accumulation of external payments arrears.

Against this background, since the early 1980s, the authorities have implemented several economic adjustment programs, supported by the IMF and the World Bank, aimed at reducing domestic and external financial imbalances (Table 1). These programs, which were designed to open the economy to competition, included far-reaching structural reforms in the areas of internal and external trade, the financial sector, public enterprises, social policy, and public expenditure programming. Meanwhile, the authorities implemented a prudent demand management policy. By the end of the 1980s, Madagascar had achieved considerable progress on the macroeconomic front: the external current account deficit was reduced significantly, owing largely to the improvement in the overall fiscal position, the pursuit of prudent monetary policy, and a narrowing of distortions in relative prices between traded and nontraded goods (see chart and Table 2). At the same time, the authorities accorded a greater priority to the social and environmental aspects of adjustment.

Table 1.IMF arrangements and World Bank adjustment operations with Madagascar, 1980-89
Type of arrangement/facilityDate approvedApproved

amount
(In millions

of SDRs)
IMF arrangement and special facilities
Stand-by (2 years)June 27, 198064.5
Compensatory financing facilityJuly 15, 198029.2
Stand-by (14 months)Apr. 13, 1981109.0
Stand-by (1 year)July 9, 198251.0
Compensatory financing facilityJuly 9, 198221.8
Stand-by (1 year)Apr. 10, 198433.0
Compensatory financing facilityJune 27, 198414.4
Stand-by (1 year)Apr. 23, 198529.5
Compensatory financing facilityMay 28, 198616.1
Emergency assistanceMay 28, 198616.6
Stand-by (18 months)Sept. 17, 198630.0
Structural adjustment facilityAug. 31, 198746.5
Stand-by (10 months)Sept. 2, 1988113.3
Enhanced structural adjustment facilityMay 15, 198976.9
Bank adjustment operations(In millions of

US dollars)
Industrial sector adjustment creditJan. 15, 198560.0
Agricultural sector adjustment creditAug, 5, 198660.0
Industry and trade adjustment creditJune 30, 1987100.0
Public sector adjustment creditJune 29, 1988127.6
Sources: IMF, Treasurers Department, and World Bank. Statement of Development Credits, December 1990.
Sources: IMF, Treasurers Department, and World Bank. Statement of Development Credits, December 1990.
Table 2.Madagascar: financial indicators, 1980—89
198019851986196719881989
(In percent of GDP)
External current account balance−14.0−8.7−2.9−6.0−5.7−3.5
Domestic savings−1.40.96.24.97.29.1
Overall budget deficit14.33.83.33.53.54.2
Debt service ratio118.188.689.898.6105.1100.0

In percent of exports of goods and services, before rescheduling.

In percent of exports of goods and services, before rescheduling.

Structural changes

External reform. Although the Government was initially reluctant to adjust the exchange rate to a realistic level, it became evident by 1982 that the widening external current account deficit and difficulties in obtaining adequate external assistance would require substantial remedial action. Over 1982-87, the exchange rate was devalued on several occasions in the context of successive stand-by arrangements with the IMF, lowering the value of the Malagasy franc (FMG) by a cumulative total of 80 percent against the basket of currencies to which the currency was pegged. A mechanism was also set up to regularly adjust the exchange rate in light of the differences in the relative inflation rates vis-à-vis Madagascar’s trading partners. The currency’s exchange rate declined to the equivalent of FMG 2,014 per SDR at the end of 1989 from FMG 335 at the end of 1981.

Despite some initial resistance, the authorities took comprehensive measures in 1987-89 to reduce administrative barriers to exports and to eliminate government export monopolies and export licensing requirements. A new export law allowed exporters to export freely all their products (with the exception of vanilla) at prices negotiated directly with foreign importers, while the state export monopolies in pepper, cloves, and coffee were abolished. Moreover, the complex system of export taxation was simplified considerably and replaced by ad valorem taxes on traditional exports, involving a substantial reduction in the rates.

On the import side, a liberalized import regime was introduced in 1987, covering 25 percent of imports. This import regime was subsequently replaced by an open general license system for all imports, thereby eliminating the discretionary system of foreign exchange allocation. The Government also abandoned the requirement that importers provide domestic currency to cover 100 percent of the value of imports, allowing commercial banks to decide on the need for such guarantees, which in no case could exceed 20 percent of the value of imports. A comprehensive reform of the tariff system was begun in 1988 to promote efficient import substitution and export industries within the mixed public/private sectors. The aim was to reduce the effective rate of protection significantly, to 35 percent over four years, and to decrease sharply the dispersion of tariffs by limiting the range eventually to 10-50 percent. Progress in this area has been encouraging, and the program is expected to be completed on schedule. In the meantime, a significant liberalization of invisible transactions has taken place, with an emphasis on incentives for investment and exports.

Madagascar: selected economic indicators, 1980-89

(Annual percentage change)

Sources Central Bank of Madagascar; Ministry of Economy and Planning; and IMF staff estimates

Public enterprise reform. In 1988, with the assistance of the World Bank, the Government formulated a three-year program to rehabilitate the public enterprise sector and to reduce its predominance in the economy. After full implementation of the process of liquidation, divestiture, or restructuring, the public enterprise sector was expected to be cut to about half its initial size by 1991, while all the remaining public enterprises were to be reorganized or financially rehabilitated. Although some progress was made in several areas, the privatization and rehabilitation program was delayed, and a central entity was established only in late 1990 to coordinate the overall reform program. The Government adopted a number of measures to limit the financial burden of public enterprises on the budget. A moratorium was imposed on the creation of new public enterprises in 1988, while the level of bank credit and budgetary transfers to 22 unviable public enterprises has been limited to the 1987 amounts. An overall ceiling on credit to public enterprises was also fixed under successive IMF supported programs (including no credit to a few unviable enterprises).

Financial sector reform. In order to further establish a dynamic and competitive financial system, thereby helping to stimulate private saving, in 1988, the Government embarked on a program of restructuring the state-owned domestic banking system by opening it to private domestic and foreign investors. A critical element of this operation was the restructuring of the portfolios of all three banks. This involved the liquidation of all non-performing and doubtful assets, followed by the partial privatization of two banks (with the participation of foreign partners).

Along with the reorganization and deregulation of the financial system, the monetary authorities were able to gradually reduce reliance on direct credit control in favor of indirect instruments of monetary control. This involved the modification of policies relating to minimum reserve requirements, the removal of the ceilings on credit for individual banks, and the phasing out of the system of prior credit authorizations. The authorities took initial steps to broaden the recently introduced money market, improve the mobilization of small savings, and widen the array of financial services offered by banks, including export financing.

Fiscal reforms. The Government’s fiscal strategy has been geared toward generating additional saving, reinforcing the incentive framework through tax reform, and contributing to the rehabilitation and expansion of the productive capacity of the economy. In addition to withdrawing progressively from directly productive activities, the authorities assigned a higher priority to improving essential public services—notably social services and infrastructure—and enhancing the administrative capacity of the most critical institutions. This reorientation of priorities of the public sector demanded a prudent fiscal policy, with a gradual improvement in revenue performance and strict control on expenditure; this allowed the Government to repay a substantial proportion of its borrowing from the central bank.

On the revenue side, the main focus was on a continuation of the rationalization of the tax and tariff structures and a broadening of the tax base. The monitoring and control of the financial operations of the Central Government were also enhanced, and the structure of public spending improved. The Government initiated the reform of budgetary and management procedures on the basis of an IMF technical assistance report. Regarding capital expenditures, the system of annual formulation of a three-year rolling public investment program was improved, with the plan elaborated each year by August 31. Public investment policy has rightly placed strong emphasis on the rehabilitation and development of the country’s economic and social infrastructure, thereby providing essential support for private sector productive activities.

Sectoral reforms. While the initial adjustment effort centered around financial stabilization, the Government formulated various sectoral programs to stimulate domestic production, particularly in the area of liberalization of trade in agricultural products. The strategy involved a sharp reduction in administrative controls and the streamlining and simplification of the regulatory and legal framework. With the liberalization of the internal marketing of all agricultural products, the Government began to remove controls from virtually all agricultural producer prices, consumer prices, and profit margins. It approved a new investment code and enacted legislation to establish industrial free trade zones; by the end of 1990, more than 100 franchises had been awarded under these two codes.

Lessons and prospects

Although the Malagasy economy has recorded substantial improvements in recent years in the context of successive adjustment programs supported by the IMF and the World Bank, many structural, institutional, and financial problems continue to constrain the prospects for growth. The Government will need to consolidate the gains obtained to date, while accelerating the pace of fundamental reforms. Given Madagascar’s vulnerability to external shocks and heavy reliance on foreign assistance, unfavorable exogenous developments are likely to have an immediate adverse impact on the economy. The fragility of the economic and financial recovery was clearly exposed in 1990, when the country’s international reserves declined to their lowest level in several years as the terms of trade deteriorated further.

With the experience of several countries confirming that progress in structural reform is a slow process, Madagascar must transform its economy more rapidly to enhance its flexibility and resilience in dealing with such shocks. In this regard, the immediate priorities should include quicker reform of the public enterprise sector, improvement of the public investment program, and streamlining of the institutional, legal, and regulatory procedures that have played a major role in constraining output.

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