Haiti Second PRGF Review

© 2008 International Monetary Fund March 2008 IMF Country Report No. 08/ 117 Haiti: Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility and Request for Waiver of Nonobservance of Performance Criteria—Staff Report; Staff Statement on the Executive Board Discussion; and Statement by the Executive Director for Haiti In the context of the second review under the three-year arrangement under the Poverty Reduction and Growth Facility, and request for a waiver of nonobservance of performance criteria, the following documents have been released and are included in this package: • The staff report for the Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility and Request for Waiver of Nonobservance of Performance Criteria, prepared by a staff team of the IMF, following discussions that ended on November 15, 2007, with the officials of Haiti on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on February 5, 2008. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF. • A staff supplement on the joint IMF/Word Bank debt sustainability analysis. • A staff statement of February 29, 2008 updating information on recent developments. • A Press Release summarizing the views of the Executive Board as expressed during its February 29, 2008 discussion of the staff report that completed the request and review. • A statement by the Executive Director for Haiti. The documents listed below have been or will be separately released. Joint Staff Advisory Note of the Poverty Reduction Strategy Paper Letter of Intent sent to the IMF by the authorities of Haiti* Memorandum of Economic and Financial Policies by the authorities of Haiti* Poverty Reduction Strategy Paper Technical Memorandum of Understanding* *Also included in Staff Report The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information. Copies of this report are available to the public from International Monetary Fund • Publication Services 700 19 th Street, N.W. • Washington, D.C. 20431 Telephone: (202) 623-7430 • Telefax: (202) 623-7201 E-mail: publications@imf.org • Internet: http://www.imf.org Price: $18.00 a copy International Monetary Fund Washington, D.C. INTERNATIONAL MONETARY FUND HAITI Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility and Request for Waiver of Nonobservance of Performance Criteria Prepared by the Western Hemisphere Department (In consultation with other departments) Approved by Caroline Atkinson and Mark Plant February 5, 2008 • Arrangement. In November 2006, a three-year PRGF arrangement was approved in an amount of 90 percent of quota (SDR73.71 million), along with Haiti’s decision point under the enhanced HIPC Initiative. The first program review was completed in July 2007. Upon completion of the second review a disbursement of SDR 7.6 million will become available to the authorities. • Discussions. Second review discussions were held in Port-au-Prince from November 5-16, 2007. The mission consisted of Messrs. Bauer (Head), Martin, Callegari, and Ms. Redifer (all WHD), Ms. Funke (FAD), and Mr. Barnichon (PDR), and was supported by Mr. Fasano (Resident Representative). Ms. Florestal (OED) and World Bank staff participated in the policy discussions. Mr. Blancher (MCM) joined the mission briefly to discuss the FSAP aide-memoire. The mission met with Minister of the Economy and Finance Dorsainvil, Central Bank Governor Castel, Minister of Planning Bellerive, Minister of Public Works Verella, other government officials, and representatives of the donor, civil society, and business communities. • Program status. The PRGF-supported program is on track. In the attached LOI and MEFP, the authorities describe their policies for the second year of the program and request completion of the second review and waivers for the nonobservance of two end-September PCs. The authorities intend to implement both PCs as prior actions for the review. 2 Contents Page I. Recent Developments and Performance Under the Program ........................................5 II. Economic and Financial Policies for the Second Program Year...................................9 A. Macroeconomic Framework .....................................................................................9 B. Fiscal Policy............................................................................................................10 C. Monetary and Financial Sector Policies..................................................................11 D. Program Financing and Monitoring........................................................................13 III. Debt Sustainability, Capacity to Repay, and Program Risks.......................................13 IV. Staff Appraisal .............................................................................................................14 Tables 1. Indicative Targets and Quantitative Performance Criteria .........................................16 2. Structural Performance Criteria and Benchmarks ......................................................17 3. Selected Economic and Financial Indicators..............................................................19 4a. Central Government Operations (in millions of gourdes) ..........................................20 4b. Central Government Operations (in percent of GDP) ................................................21 5. Summary Accounts of the Banking System ...............................................................22 6. Balance of Payments...................................................................................................23 7. Medium-Term Scenario..............................................................................................24 8. Indicators of Fund Credit............................................................................................25 9. Budgetary Financing by Donor and Type...................................................................26 10. Indicators of External Vulnerability ...........................................................................27 11. Financial Soundness Indicators of the Banking System.............................................28 12. Proposed Schedule of Disbursements.........................................................................29 13. Millennium Development Goals.................................................................................30 Figures 1. Economic Performance at a Glance..............................................................................8 Boxes 1. Increasing Expenditure Execution Capacity................................................................11 2. Key FSAP Findings and Recommendations................................................................12 Attachments I. Summary of Annexes..................................................................................................31 II. Letter of Intent ............................................................................................................32 III. Memorandum of Economic and Financial Policies....................................................34 IV. Technical Memorandum of Understanding ................................................................44 3 L IST OF ACRONYMS BRH Bank of the Republic of Haiti DGI General Tax Directorate DSA Debt Sustainability Analysis EU European Union EUNIDA European Network of Implementing Development Agencies FAD Fiscal Affairs Department FDI Foreign Direct Investment FSAP Financial Sector Assessment Program FY Fiscal Year GDDS General Data Dissemination System GDP Gross Domestic Product HIPC Heavily Indebted Poor Countries HOPE Haitian Hemispheric Opportunity through Partnership Encouragement Act IDA International Development Association IDB Inter-American Development Bank IFRS International Financial Reporting Standards LIC Low-income Country LOI Letter of Intent (Attachment II) MCM Monetary and Capital Markets Department MDRI Multilateral Debt Relief Initiative MEFP Memorandum of Economic and Financial Policies (Attachment III) NDA Net Domestic Assets NIR Net International Reserves NPV Net Present Value OED Office of the Executive Director PC Performance Criterion PDR Policy Development and Review Department PEMFAR Public Expenditure Management and Financial Accountability Review PRGF Poverty Reduction and Growth Facility PRSP Poverty Reduction Strategy Paper SDR Special Drawing Rights STA Statistics Department TA Technical assistance TMU Technical Memorandum of Understanding (Attachment IV) UN United Nations WHD Western Hemisphere Department Y-o-Y Year-on-Year 4 E XECUTIVE SUMMARY Background • The macroeconomic goals of the first program year were largely met, although growth accelerated somewhat less than expected. • Quantitative PCs and indicative targets for the second review were met with ample margins and most structural conditionality was implemented on time. Two PCs (a report on IFRS implementation by the BRH and commencement of an assessment of state bank BNC's recapitalization needs) are delayed because of difficulties in identifying and hiring foreign experts. The authorities intend to implement these as prior actions for the review. • Key goals for the second program year (FY2008) are to create conditions for higher growth and consolidate stabilization gains achieved so far. The macroeconomic framework foresees real GDP growth of 3.7 percent and end-year inflation of 9 percent. Structural conditionality includes measures to strengthen revenue generation, increase budget execution capacity, enhance the monetary policy regime, and further develop the financial sector. • A joint Bank-Fund external DSA indicates that Haiti’s risk of debt distress remains high, but would decline substantially after the HIPC Initiative completion point. Staff appraisal • Macroeconomic performance and program implementation are on track. • The key challenges for fiscal policy in the second program year will be to accelerate budget execution, while safeguarding expenditure quality and ensuring resource sufficiency. • Monetary policy implementation will have to be cautious, given uncertainty about the extent of commodity price and other external shocks, and weak monetary policy transmission. • Strong focus on implementing the PRSP and HIPC triggers in coming months will be important to achieve the HIPC Initiative completion point as soon as possible. • Staff supports the requested conclusion of the second program review and two waivers, subject to implementation of the two outstanding structural PCs as prior actions. 5 I. R ECENT DEVELOPMENTS AND PERFORMANCE UNDER THE PROGRAM 1. Security improved markedly throughout 2007. In Port-au-Prince, a reduction in gang-related violence and crime has contributed to a visible increase in street activity and vehicle traffic. Still, the situation remains fragile, as illustrated by an uptick in kidnappings during the recent holiday season. In October 2007, the UN Security Council extended the mandate for its stabilization mission by one year, and widened it to enable UN troops to patrol borders. This should help combat arms and drug trafficking. 2. Despite periodic political tension, democratic institutions are being strengthened. Parliament has passed key legislation, including a supplementary budget for 2007, the 2008 budget, and judicial reforms. In December 2007, the government forged a difficult agreement to replace the provisional electoral council, which had been mired in internal disputes. It is hoped that this will allow delayed elections to proceed, to renew one-third of the Senate. President Preval has continued his forceful drive to improve governance and combat corruption. 3. The macroeconomic goals of the first program year were largely met, although growth accelerated somewhat less than expected. Based on preliminary data, real GDP is estimated to have risen by 3.2 percent in FY2007 (October–September), almost one percentage point more than in FY2006 but below the original program objective of 4 percent (Figure 1). Growth was driven by private consumption, which benefited from the more stable environment and strong remittances. Public investment also contributed to growth, even though underexecution of the budget meant that fiscal stimulus was considerably less than originally envisaged. In contrast, private investment appears to have contracted, following a large investment in telecommunications in FY2006. Inflation declined to 7.9 percent, in line with the program, aided by 10 percent nominal appreciation of the gourde against the U.S. dollar. 2006 2007 Prog. Rev.Prog. Prel. Real GDP 2.3 4.0 3.5 3.2 Consumption 6.3 9.4 0.6 2.4 Private Consumption 5.7 9.3 4.4 2.2 Public Consumption 0.6 0.0 -3.8 0.2 Gross Domestic Investment 0.8 6.9 5.2 1.1 Private Investment -0.6 2.6 2.4 -1.2 Public Investment 1.3 4.3 2.8 2.2 External Sector -4.8 -12.4 -2.3 -0.2 Exports 1.1 2.4 2.8 -0.6 Imports -5.9 -14.7 -5.1 0.4 Source: IMF Staff estimates based on data from the Haiti Statistical Institute and the Ministry of Economy and Finance Haiti - Real GDP growth, sectoral contribution (in percent) Haiti: Real Effective Exchange Rate Index 90 95 100 105 110 115 120 125 130 135 Sep-05 Dec-05 Ma r-06 Jun-06 S ep- 06 Dec- 06 Mar-07 Jun-07 Sep-07 6 4. Performance against targets under the PRGF-supported program was strong. As in the first program review, quantitative PCs and indicative targets for the second review (end-September 2007 test date) were met with ample margins (Table 1). • Fiscal revenues performed well, but expenditure execution fell short of expectations (Table 4). Domestic revenues for FY2007 exceeded estimates at program approval (original budget) by 0.6 percent of GDP, reflecting the expansion of the economy and improved revenue administration. However, revenue did not reach the ambitious target set at the time of the first review (linked to the supplementary budget), partly because currency appreciation reduced revenues collected at the border. Public expenditures rose significantly, but execution on a cash basis was lower than both the ambitious supplementary budget and the original budget. As a result, the overall balance (excluding grants and foreign-financed projects) for FY 2007 was close to zero, compared with a deficit of 1.3–1.4 percent of GDP envisaged at program approval and the first review. Commitments for budget support were higher than expected, but in light of the underexecution of expenditure some grants were shifted from FY2007 to FY2008. Late passage of the supplementary budget resulted in a surge of expenditure commitments that were not executed before the end of the fiscal year. • Base money growth remained within the indicative program target (Table 5). The accumulation of government deposits—because of budget underexecution— facilitated base money control, together with sterilization of foreign exchange purchases through central bank (BRH) bond issuances. In July, the BRH took an important step toward a quantity-based policy framework, by allowing competitive bidding in its bond auction, which led benchmark interest rates to decline from 13 percent to less than 5 percent. However, this decline did not translate into much reduction of commercial bank lending rates, and credit growth in gourdes remained flat throughout FY2007, reflecting both structural factors constraining supply and weak demand from businesses. Growth of dollar-denominated credit was more dynamic, but reportedly concentrated in a few specific sectors (e.g., exports, telecommunications). Anecdotal evidence indicates activity in the microcredit sector has remained vibrant. • Improvements in both the current and capital account allowed for a strengthening of international reserves well beyond program targets (Table 6). The increase in reserves was made possible by robust inflows from transfers, net lending and FDI, along with debt relief and IMF net disbursements. Overall, NIR rose by US$162 million (including letters of credit, guarantees, and earmarked project accounts) against an original program floor of US$30 million. 7 5. Following an orderly consolidation of the banking sector, financial soundness indicators remained broadly stable throughout FY2007 (Table 10). Most banks reported positive earnings and high capitalization. The absorption of ailing Socabank by the state commercial bank BNC took place ahead of schedule in mid-2007. 6. Structural conditionality was met, except for two end-September PCs (Table 2). A detailed modernization plan for the DGI was prepared, domestic arrears were cleared, quarterly limits for budget allocations were observed, and oversight of program monitoring data was improved. However, the end-September PCs on commencing an assessment of BNC recapitalization needs and producing a report on IFRS implementation by the BRH were delayed because of difficulties in finding and hiring foreign experts for these tasks. 1 The authorities intend to complete these PCs as prior actions for the review and request waivers. 7. The PRSP was completed through a participative process and formally submitted to the IMF and World Bank on November 30, 2007. 2 It focuses on promoting growth through sectoral strategies for agriculture and rural development, tourism, infrastructure rehabilitation, and science and technology; and seeks to widen access to basic services such as electricity, water and sanitation, health and education. Improvements in institutional infrastructure, including a better functioning justice and penal system, are also planned. The PRSP’s macroeconomic policy framework is broadly consistent with the PRGF-supported program. However, the aggregate costs of the sectoral strategies for the next three years go beyond what is foreseen in the macroeconomic framework, and far exceed historical rates of budget execution and financing. Consultations to develop the PRSP were extensive. The authorities intend to hold a donors’ conference in the coming months to reprogram committed resources for FY2008 in line with PRSP spending priorities. 8. Progress in implementing HIPC Initiative completion point triggers has been mixed. 3 Several measures have been taken or are underway, such as tracking poverty- reducing spending; passing the public procurement law; extending customs control to the provinces; increasing immunization rates; extending use of the central taxpayer file; and establishing a national HIV/AIDS plan. However, progress on a number of other triggers is less advanced, including establishing a centralized debt database; passing a law on asset declaration; and submitting audits of government accounts within legally-established timeframes. 1 The IFRS implementation report has two main components: a description of current accounting practices of the BRH, and a qualitative assessment of how these practices deviate from IFRS. The second component requires support from a foreign expert, since domestic audit firms are unfamiliar with IFRS. 2 See www.imf.org for Haiti’s “National Strategy for Growth and Poverty Reduction (in french: Document de Stratégie Nationale pour la Croissance et la Réduction de la Pauvreté―available at www.mpce.gouv.ht)) and www.imf.org for the IMF-World Bank Joint Staff Advisory Note (JSAN) of the PRSP. 3 See IMF Country Report No. 06/440 for a complete list of triggers. 8 Figure 1. Haiti - Economic Performance at a Glance Sources: Ministry of Economy and Finance; Bank of the Republic of Haiti; and Fund staff estimates. Growth reached 3.2 percent in FY 2007, sustained by private consumption and public investment. Inflation dropped to single digit levels, helped by exchange rate appreciation... …and a cautious monetary stance, with base money growing less than nominal GDP. Higher than expected revenue and lower spending led to a fiscal surplus. Both the current and capital account improved... …cont ributing to faster than expected accumulation of official reserves. 0 50 100 150 200 250 300 350 2002 2003 2004 2005 2006 2007 0 0.5 1 1.5 2 2.5 3 Gross international reserves (right scale) Net international reserves millions of US$ months of imports US $/ HTG Exchange Rate (left scale) 34 35 36 37 38 39 40 41 42 43 44 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 0 2 4 6 8 10 12 14 16 18 Y-o-y inflation (right scale) Food inflation (right scale) 0 5 10 15 20 25 30 35 2004 2005 2006 2007 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 Total revenues excl. grants (left scale) Total expenditure excl. externally-financed proj. (left scale) billions of gourdes Overall balance (right scale) -2,000 -1,500 -1,000 -500 0 500 1,000 1,500 2,000 2,500 2002 2003 2004 2005 2006 2007 -100 -50 0 50 100 150 200 Trade balance Current transfers Current account (right scale) Capital account (right scale) millions of US$ -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 2003 2004 2005 2006 2007 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 External Sector Investment Consumption Real GDP growth (right scale) Contributions to Real GDP (in percent) 0 2 4 6 8 10 12 14 16 18 Oct-06 Jan-07 Apr-07 Jul-07 -1 0 1 2 3 4 5 6 7 Base Money (left scale) Y-o-Y percentage change BRH real bond rates ( right scale) Y-o-Y percentage Nominal GDP 9 II. E CONOMIC AND FINANCIAL POLICIES FOR THE SECOND PROGRAM YEAR 9. Key goals for the second program year (FY2008) are to create conditions for higher growth and consolidate stabilization gains achieved so far. Despite the progress already made, Haiti’s economy remains in a state of transition. Large-scale investment in human and physical capital is needed for higher growth and employment creation, both vital for ensuring better living conditions and durable social peace. Maintaining a stable macroeconomic and financial environment remains important in this context, to bolster private sector confidence and ensure sustainability. The program balances the need for growth and stability through a macroeconomic framework that provides room to raise priority expenditures and absorb external price shocks, while still ensuring internal and external stability. 10. Structural conditionality will be more parsimonious, acknowledging the need to focus limited capacity on implementation of the PRSP and HIPC Initiative completion point triggers. The program includes measures to strengthen revenue generation and budget execution capacity, enhance the monetary policy regime, and further develop the financial sector (MEFP Table 2). A. Macroeconomic Framework 11. The macroeconomic framework for FY2008 foresees real GDP growth of 3.7 percent and end-year inflation of 9 percent. Projected growth was lowered from 4.5 percent at the time of the first review, reflecting the adverse impact of Hurricane Noel on agricultural output, and reduced expectations of the likely impact of the HOPE Act on apparel export growth to the U.S.. The projection implies substantial stimulus from public consumption and investment, as reflected in the authorities’ budget. Private investment is also expected to pick up as confidence rises. Haiti will face substantially higher international food and oil prices in FY2008. The inflation target was revised upward from an earlier goal of 7.5 percent to leave room for absorbing these price increases, but a cautious monetary stance should prevent them from translating into broader inflationary pressures. The program’s monetary goals will continue to be supported by a zero annual ceiling on net central bank financing to the government. In light of the sizeable overperformance in FY2007, the floor for NIR accumulation for FY2008 was set at US$40 million, increasing gross reserves coverage slightly further to 2.7 months of imports. Haiti - Real GDP gro wth in 2008 (Contribution to growth, in percent) 3.7 2.0 1. 0 3.7 1. 4 -4.5 -5-4-3-2-10 12345 Private Co nsumptio n P ublic Co nsumptio n Private Investment P ublic Investment Net Exports Real GDP gro wth 10 Average Real Salary at Ministry of Finance (1999=100) 0 20 40 60 80 100 120 1999 2004 2005 2006 2007 B. Fiscal Policy 12. The authorities’ fiscal program focuses on further accelerating expenditure execution, supported by a substantial domestic revenue effort (Table 4). Expenditures (excluding foreign-financed projects) are budgeted to increase by 2.8 percent of GDP, while domestic revenues should rise 1.8 percent of GDP. This leaves an overall deficit (excluding grants and foreign-financed projects) of 1.1 percent of GDP, to be covered by external budget support. • Higher expenditures will be effected through almost doubling domestically- financed investment on basic infrastructure and substantially increasing the wage bill (MEFP para. 14). The FY 2008 budget accommodates civil service salary increases of 20–35 percent to allow partial recovery of past real-wage losses, as well as further hiring for social sectors and the police. Measures are underway to raise expenditure execution capacity, some of which are incorporated into program conditionality (Box 1 and MEFP para.15). The share of poverty-reducing spending in the FY2008 budget is estimated at 56 percent, up from 43 percent in FY2007. • Increased revenues are expected through implementing action plans to strengthen customs and tax administration (MEFP para. 12). Program conditionality contains elements of these plans, including collection of delinquent taxes and new customs posts (Benchmarks for end-March and end-September 2008). The projected further acceleration of growth and stepped up efforts to control the border should also help boost revenues. 13. In light of higher-than-usual carryover of expenditure commitments from FY2007, the authorities are dedicated to careful budget implementation. Expenditure commitments that carry over into FY2008 are estimated at 2.2 percent of GDP. To ensure resources are available, the government has identified 60 top priority investment projects for an amount of 3 billion gourdes, with lower priority project expenditures being only initiated as resources are realized (MEFP para. 11). 11 Box 1. Increasing Expenditure Execution Capacity Budget execution was constrained by (i) limited project formulation and implementation capacity of spending ministries, (ii) lack of familiarity with the new procurement law; and (iii) limited capacity of local firms to handle larger construction projects. Drawing on findings from the World Bank-IDB PEMFAR report and a EUNIDA diagnostic mission, the government is taking several steps: • Programming units of key spending ministries will be strengthened through deploying trained experts in project formulation and implementation (PC for end-March, 2008); • Internal control processes will be facilitated through the deployment of public accountants and budget comptrollers to key line ministries (Benchmark for end-March, 2008); • Implementation of the procurement law will be reviewed and, if necessary, revised by a recently created working group; and • Participation of foreign firms in public tenders is being encouraged. C. Monetary and Financial Sector Policies 14. Monetary policy will focus on quantity management, with a market-determined policy interest rate. The indicative FY2008 target for base money growth (9.6 percent) remains below projected nominal GDP growth to help ensure that higher oil and food prices do not translate into broader inflation. The authorities remain committed to maintaining a flexible exchange rate regime, limiting exchange market intervention to smoothing operations (MEFP para. 17). 15. The authorities plan to further strengthen their monetary policy framework (MEFP paras. 18–19). Participation in BRH bond auctions will be broadened to include non-bank financial institutions (PC for end-March 2008) and a plan developed to improve liquidity forecasting (Benchmark for end-September 2008). Moreover, the BRH will institute formal communications to convey its monetary policy intentions and actions to the public (Benchmark for end-September 2008). The authorities are developing—with Fund TA—a recapitalization plan for the BRH, and—with IFC support—a plan to divest BRH ownership in the state telecommunications company (PCs for end-March 2008). Implementation of these plans should further strengthen independence in monetary policy making, important given Haiti’s history of fiscal dominance. 12 16. Steps to foster financial sector stability and development are planned, following recommendations from the recently concluded FSAP (Box 2 and MEFP paras. 21–22). 4 These include completing an independent assessment of an additional systemically important bank (PC for end-September 2008) and improving the regulatory framework and supervision of credit unions (Benchmark for end-September 2008). The authorities also intend to remove obstacles constraining credit and private sector activity, such as reducing fees on real estate transactions, allowing co-ownership of property, and expanding collateral guarantees. Box 2. Key FSAP Findings and Recommendations Haiti’s financial system faces a number of stability and development challenges. Three banks hold almost 80 percent of all bank assets, and total credit represents 11 percent of GDP—well below other countries in the region. Key FSAP conclusions and recommendations include: • Banking soundness: Indicators of bank soundness are relatively favorable, but concentrated loan portfolios remain vulnerable to a deterioration in credit quality. The capacity of the largest public bank to manage a newly-acquired, largely non-performing loan portfolio requires careful monitoring. • Credit growth and access to credit: High intermediation spreads reflect primarily weaknesses in the legal and institutional frameworks, including the accounting and auditing, and insolvency and creditor rights regimes. The security situation, low competition among banks, poor governance, high reserve requirement ratios, absence of a credit registry, and crowding out by BRH bonds also weigh on the financial sector’s ability to effectively support growth. • Monetary policy: Effectiveness of monetary policy has been hampered by dollarization, excess liquidity, underdeveloped money markets, and uncompetitive BRH bond auctions. Allowing BRH bond interest rates to be market determined, opening up auction participation to nonbank institutions, and strengthening the framework for forecasting systemic liquidity are priorities. • BRH financial independence: Accumulated quasi-fiscal deficits have eroded the BRH’s capital base and need to be addressed to avoid risks for monetary control. A comprehensive plan to rehabilitate the BRH balance sheet is being developed under the PRGF-supported program. • Financial regulation and supervision. The new draft banking law addresses the major weaknesses in banking supervision. Its implementation will require upgrading prudential regulations and enhancing BRH independence. Basic regulatory and supervisory frameworks for nonbank financial institutions need to be introduced or strengthened. The authorities welcomed the FSAP findings and indicated that they intend to implement most of the recommendations, including partly as conditionality under the PRGF-supported program. 4 See www.imf.org for the complete Financial Sector Stability Assessment (FSSA). 13 D. Program Financing and Monitoring 17. The program for FY 2008 is fully financed. Total external financing for the budget is projected at US$134.2 million or US$44.1 million after debt service payments (Table 9). 5 Potential resources from Venezuela’s PetroCaribe initiative are not yet reflected in program financing, since oil deliveries continue to be delayed by logistical obstacles. If these are overcome, any use of the resulting financing will be transparently channeled through the budget (MEFP para.13). 18. The current program monitoring framework remains in place. The program will be monitored on a quarterly basis, with test dates at end- March and end-September 2008 for NIR, NDA, central bank financing, concessionality of external debt, and arrears accumulation (MEFP Table 1). Minor definitional changes have been made to NIR and central bank financing (see the TMU). III. D EBT SUSTAINABILITY, CAPACITY TO REPAY, AND PROGRAM RISKS 19. A joint Bank-Fund external DSA indicates that Haiti’s risk of debt distress remains high, but would decline substantially with a HIPC completion point. 6 Under the baseline scenario (before post-completion point stock of debt relief), the NPV of external debt-to-exports ratio remains above the indicative threshold of 100 percent in the medium term, while other debt ratios do not surpass thresholds. However, after HIPC and MDRI stock reductions of debt (including from the IDB), the NPV of external debt-to-exports ratio would fall to 44 percent. Because of Haiti’s very low level of domestic debt, these conclusions also hold for the fiscal DSA. Overall, the DSA suggests room for scaled-up external financing after HIPC/MDRI debt relief. However, a careful approach would still remain advisable, given that debt indicators deteriorate rapidly in scenarios with large volumes of additional concessional borrowing (for example through the PetroCaribe initiative) or financing on less concessional terms. 5 Firm donor commitments have been received. A small remainder of $2.4 million (0.05 percent of GDP) is to be covered by miscellaneous budget support inflows, which staff fully expect to materialize in the course of the fiscal year in line with past experience (MEFP para.11). 6 The DSA analysis can be found in Supplement 1 to this report. Prospective Debt Rescheduling (incl. Paris Club) 3.6 115.8 32.5 13.0 8.0 27.5 2.7 13.7 6.7 9.2 2.4 14.8 1/ Excluding potential financing under the PetroCaribe initiative Other Interim HIPC assistance Haiti - Budget Support in FY2008 (in millions of US dollars) France Spain Canada Venezuela 1/ IDB WB US EU Total External Financing 134.2 Budget Support 14 20. Haiti’s capacity to repay the Fund has improved slightly since the arrangement was approved. Higher-than-expected reserves accumulation, exports, and nominal GDP have helped lower indebtedness ratios (Table 8). Outstanding obligations to the Fund are projected to peak at SDR 74 million in 2010, or about 11 percent of exports of goods and services. 21. Risks remain significant, but the authorities’ evident commitment to the program and strong track record speak in their favor. The growth outlook could weaken because of security backlashes, political tensions, continued budget underexecution, and negative consequences for exports and remittances from a U.S. economic slowdown. Shortfalls in revenue targets or programmed donor support could create pressure to resort to central bank financing, damaging private sector confidence, and undermining inflation objectives. Even with growth, employment creation, the restoration of basic services, and social progress may be painfully slow, and could trigger social conflict. While these are real risks, the likelihood of macroeconomic imbalances from policy shortcomings appears more limited, given the authorities demonstrated commitment to prudent fiscal and monetary policies, and their proven capacity to implement structural reforms under difficult conditions. Also, risks on the fiscal side appear relatively balanced, as shortfalls could occur on both the revenue and expenditure sides. While data limitations make program development and monitoring quite difficult, data provision has been improving, including as a result of IMF TA. The authorities have decided to participate in the GDDS, which could be achieved by end-March 2008. IV. S TAFF APPRAISAL 22. Macroeconomic performance and program implementation are on track. Growth has accelerated for the third year in a row, albeit somewhat less than hoped for, and inflation has declined to single digits. Quantitative targets for the second review were again met by large margins, although this partly reflected slower-than-expected government spending. Implementation of structural reforms was also satisfactory, despite some delays. The authorities’ program for FY2008 focuses appropriately on creating conditions for higher economic growth, while keeping inflation in check. Net private Transfers to Haiti and US business cycle indicators -10 0 10 20 30 40 50 60 70 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Percentage 0 1 2 3 4 5 6 7 8 Percentage Private transf ers (net) (Def lated by US GDP deflator) - Grow th (left scale) U.S. GDP, constant prices - Y -o-Y Grow th (right scale) U.S. private consumption expenditure, constant prices - Y -oY Grow th (right scale) 15 23. The key challenges for fiscal policy in the second program year will be to accelerate budget execution, while safeguarding expenditure quality and ensuring resource sufficiency. Improving the provision of basic public goods and services is essential to stimulate private sector activity and improve social conditions. Staff thus strongly supports the steps that are being taken to overcome existing bottlenecks in budget execution. At the same time, given the large carryover of expenditure commitments from the previous fiscal year, availability of resources will have to be monitored closely. Modernization plans for customs and the DGI should be diligently implemented to meet revenue targets, and donor conditions fulfilled in a timely manner to avoid delays in budget support disbursements. 24. Monetary policy implementation will have to be cautious, given uncertainty about the impact of commodity price shocks and weak monetary policy transmission. Staff welcomes the steps underway to strengthen the monetary policy framework, which include a stronger focus on quantity management and more policy communication with the public. The indicative target for base money growth, below nominal GDP growth, appears appropriate. However, the BRH will have to remain vigilant, monitoring liquidity conditions closely to ensure that international food and oil price increases do not lead to a broader acceleration of inflation. Staff welcomes the authorities’ commitment to strengthen the financial health of the BRH, and implement key FSAP recommendations. 25. Strong focus on implementing the PRSP and HIPC triggers in coming months will be important to achieve an early HIPC completion point. Given the timing of the submission of the PRSP, a completion point could be reached by end-2008, provided that all conditions are met. However, progress on completion point triggers has been uneven, and their timely implementation will require a concerted and well-coordinated effort by all ministries involved. 26. Staff supports the requested conclusion of the second program review and waivers, subject to the implementation of the two outstanding structural PCs as prior actions. Macroeconomic policies contained in the program are consistent with the central objective to boost growth while maintaining economic stability, and committed structural reforms will help further solidify economic institutions. Program risks remain significant, as the multifaceted strategy to maintain security, build infrastructure, provide basic services, fight corruption and bring about sustained growth will strain Haiti’s limited capacity. However, the authorities have shown extraordinary commitment to their program of reform, and established a track record for implementing difficult policies. 16 Actual stock at end- Sep-06 Prog. with adjustor Actual Deviation from prog w/adjustor Prog. with adjustor Actual Deviation from prog w/adjustor Prog. with adjustor Actual Deviation from prog w/adjustor Prog. with adjustor Prel. Deviation from prog w/adjustor Performance criteria Net central bank credit to the NFPS (in millions of gourdes) 21,002 211 -581 -792 333 -1,845 -2,178 -1,031 -2,208 -1,177 1,446 -1,097 -2,542 Of which: Central Government21,176 211 -327 -538 333 -1,452 -1,784 -634 -2,002 -1,368 1,446 -961 -2,407 Rest of NFPS-174 0 -254 -254 0 -394 -394 -398 -206 191 0 -135 -135 Net domestic banking sector credit to the nonfinancial public sector 20,118 -50 -747 -697 333 -2,031 -2,363 -1,316 -2,394 -1,078 1,446 -1,403 -2,848 (in millions of gourdes) Net domestic assets of the central bank (in millions of gourdes) - ceiling 1/ 5,685 1,288 -1,497 -2,785 740 -3,819 -4,559 -3,344 -5,258 -1,913 -2,833 -6,054 -3,221 Domestic arrears accumulation of the central government 2/ 0 0 0 0 0 0 0 0 0 0 0 0 0 New contracting or guaranteeing by the central government or the BRH of nonconcessional external debt 2/ 3/ 4/ (In millions of U.S. dollars) Up to and including one year000000 0 00 0000 Over one-year maturity000000 0 00 0000 Net international reserves of central bank (in millions of U.S. dollars) - floor 5/ 130 4 65 61 -1 92 94 97 129 32 99 162 63 External arrears accumulation (in millions of U.S. dollars) 4/ 0 0 0 0 0 0 0 0 0 0 0 0 0 Indicative target: Change in base money 23,172 1,609 1,502 -107 1,164 922 -242 1,239 1,278 39 2,294 1,758 -536 Memorandum items: Change in currency in circulation 11,159 1,451 1,213 -238 693 58 -635 261 -96 -357 859 412 -448 Government total revenue, excl. grants (in millions of gourdes) … 5,945 5,847 -98 11,364 11,736 372 18,318 17,360 -957 25,000 23,197 -1,803 Government total expenditure, excl. ext-fin investment (in millions of gourdes) … 6,534 5,694 -840 12,245 10,336 -1,908 18,988 16,411 -2,577 28,078 23,112 -4,966 Sources: Ministry of Finance, Central Bank of Haiti, and Fund staff estimates. 1/ For program monitoring purposes, NDA is defined as currency in circulation minus NIR in gourde terms. Program exchange rate of G42/$ through end-March and G40/$ through end-Sept. 2/ On a continuous basis. 3/ Excludes guarantees granted to the electricity sector in the form of credit/guarantee letters. 4/ Includes foreign currency denominated debt. 5/ Including letters of credit, guarantees, and earmarked project accounts Sep-07 Dec-06 Table 1. Haiti: Indicative Targets and Quantitative Performance Criteria for FY 2007 Jun-07 Mar-07 Cumulative Flows since September 2006 17 Table 2. Haiti: Structural Performance Criteria and Benchmarks for the First and Second Program Reviews Measures Date (Month-end) Status 1. Structural performance criteria • Approve a comprehensive plan to establish customs control in the provinces. December 2006 Met • Start implementing the plan based on an agreed timetable. March 2007 Met • Expand use of the central taxpayer file to include all taxpayers identified in the Delmas and Croix-des-Bouquets tax centers. March 2007 Met • Implementation on schedule of approved plan, referred to in prior actions, to deal with banking system weaknesses. March 2007 Met • Implement the key recommendations on safeguards in accordance with the action plan. March 2007 Met • Continue to limit spending executed through current accounts to below 10 percent of budget appropriations for nonwage current expenditures as defined in paragraph 18 of the TMU. Quarterly Met • Submit to parliament a draft banking law consistent with international standards, as described in the TMU. March 2007 Met with delay, waiver granted. • The BRH will cease certain nonessential activities related, in particular, to its participation in the management of and/or shareholding in the BPH, TÉLÉCO, and SONAPI, in the following phases: • Adopt a strategy for discontinuing BRH involvement in BPH management; • Formulate draft laws amending the APN and SONAPI organic laws to, inter alia, change the composition of the Boards of both institutions; • Submit to parliament for approval the draft law on the option adopted with respect to discontinuing involvement with the BPH; • Submit to parliament for approval amendments to the laws on the APN and SONAPI changing the composition of the boards of both institutions. March 2007 March 2007 June 2007 June 2007 Met Met Met Met • Adopt a strategy for discontinuing BRH involvement with TÉLÉCO June 2007 Moved to March 2008 • Prepare a plan to recapitalize the central bank. September 2007 Moved to March 2008 18 Measures Date (Month-end) Status • Begin independent assessment of possible recapitalization needs and required financial and operational restructuring of BNC. September 2007 Not met, prior action for 2 nd review • Complete a review of implementation issues for the adoption of IFRS by the BRH September 2007 Not met, prior action for 2 nd review • Adopt detailed implementation plan for modernization of the DGI. September 2007 Met 2. Structural benchmarks • Submit the new draft customs code to parliament. March 2007 Met with delay • The Minister of the Economy and Finance will approve a medium-term strategic plan for the DGI, setting out the corporate vision, mission, values, goals, and objectives. March 2007 Met • Based on the existing expenditure classification, adopt a mechanism for tracking expenditure allocated to poverty reduction and produce quarterly reports on these expenditures. March 2007 Met • Formulate a plan for the settlement of domestic arrears. March 2007 Met with delay • Expand the TOFE coverage by including in it the ministries’ and deconcentrated agencies’ own resources and related expenditure. March 2007 Met • Every three months, conduct an independent confirmation audit of the mechanism for monitoring the subsidy to the Ed’H. March 2007 Met with delay • Complete the payment of wage and nonwage arrears. September 2007 Met • Set quarterly limits on the expenditure of each ministry and ensure, within the ministries, that all recruitment and promotion proposals are within budget appropriations. September 2007 Met • Monthly monetary program data to be signed off by the Central Bank’s interdepartmental and steering committees Monthly, starting August 2007 Met [... middle sections omitted for long document ...] 2 The aforementioned capacity constraint has been particularly hurtful in the public works sector. Several projects have been delayed because local firms had reached maximum capacity and/or foreign firms did not find the bids profitable enough to justify a start-up investment in Haiti. Efforts to garner investors’ interests and to reach out to non traditional investors have borne their fruits. New investors particularly from Latin America and the Caribbean have become increasingly interested in doing business in Haiti often in partnership with local firms. By the end of the last fiscal year, this had improved the pace of implementation of public investment projects, which are crucial in achieving growth and poverty reduction goals. Improving coordination and efficiency on both the Government and donor side is also critical. Better knowledge by the international community of the administrative and legal constraints as well as enhanced efforts to encourage national ownership is important in increasing absorptive capacity. Had these conditions prevailed in 2007, Haiti could have better used the long time spent trying to accommodate the World Bank’s and some donors’ insistence to have grant agreements ratified by the Haitian Parliament despite the fact that the constitution does not bestow such authority upon Parliament. Downside Risks Responsible and prudent policies have helped maintain stabilization gains. The macroeconomic framework is continuously being strengthened, and measures to improve governance, maintain political stability and enhance security are designed to help restore investor confidence. An important reduction of inflation has been achieved in recent periods owing to the strong fiscal position and the appreciation of the national currency. However, more recently, international food and petroleum price hikes have led to considerable inflationary pressures in the domestic market. Despite growing political pressures, the authorities remain committed to maintaining macroeconomic stability and to refrain from taking short-term ad hoc measures to counter price inflation, as these measures may jeopardize fiscal consolidation and long-term growth. They are considering the adoption of policies that would allow the relaxation of the supply constraint in the medium and long run, such as investment in agriculture, while bringing some alleviation to the hardships of the most vulnerable sections of the population in the short run. At the political level, the government is pursuing its efforts to garner consensus and encourage participation in finding solutions to Haiti’s numerous problems. This spirit of consensus building has allowed them to reach an agreement on the roadmap to the renewal of a third of the Senate whose term expired the second Monday of January 2008. Reaching the consensus needed to form the new electoral council took more time than projected and elections could not be organized prior to the expiration date. Nonetheless, it has finally been agreed by all parties that the ten senators would leave office as soon as the new electoral 3 decree is approved by Parliament. On February 21, 2008 a draft of the electoral decree has been officially transmitted to Parliament. Strengthening the Central Bank’s Financial Position We thank the Fund for the support received to move forward with the plan to redress the Central Bank’s financial situation. The strategies envisaged in the “fact finding” mission’s report are a valued input in the authorities’ decision-making process. The comparative advantage of the alternative strategies (front-loaded versus gradual approach and high versus low recapitalization schemes) are being assessed internally. The urgency of addressing the deteriorating position of the Central Bank, particularly in order to safeguard the effectiveness of monetary policy and maintain price stability, is being weighted against the fiscal effort implied for the short run and the time needed to make the appropriate administrative and legal changes to implement the recapitalization plan. This plan, in our authorities’ view, is intrinsically linked to achieving complete financial independence of the Central Bank and thus implies the complete removal of the possibility of a return to fiscal dominance. Thus, as underscored in the aforementioned TA report, one of the most important elements of the action plan is the development by the Central Government of the permanent capacity to finance itself without recourse to monetary financing. This goal will be achieved through increased fiscal revenues, the creation of Treasury Bonds and the development of a local capital market. The divestment by the central bank of the state telecom company (TELECO) is also instrumental in the recapitalization process. This divestment will also relieve the central bank of duties that take time away from the central bank in achieving its core functions. Our authorities are appreciative of the assistance of the IFC in this process. On Growth and Poverty Reduction Achieving positive real per capita GDP growth after several years of decline is definitely a step forward in the fight against poverty. Nevertheless, the actual pace of growth is insufficient to ensure a significant progress towards achieving the MDGs. To promote higher levels of growth and alleviate poverty, massive investments are needed particularly in infrastructure. However, both the resource and capacity constraints are binding. Thus, the key challenges the authorities face for the implementation of the PRSP include the ability to mobilize adequate levels of domestic and international resources and that of increasing absorptive capacity. Efforts to increase fiscal revenues have already brought satisfactory results. The authorities are committed to maintaining the course and to enhancing further tax collection through sustained efforts to strengthen the fiscal administrations and curb smuggling and tax evasion. To decrease backlogs and improve the services offered by customs, starting this month, the 4 working week of the customs office has been extended to Saturdays with the possibility of it being called upon to work on Sundays in case of an emergency. Besides the lack of adequate availability of expert services, institutional weaknesses have also hampered a better implementation of investment projects. Personnel are being recruited to strengthen the programming units of line ministries particularly that of public works, agriculture, justice, education and health. Announcements have been launched to that effect and candidates’ records are being reviewed. Public accountants and budget comptrollers are also being progressively deployed in all central government administrations to ensure the respect of transparent and efficient public management practices. The implementation and monitoring structures of the PRSP, which benefited considerably from inputs from the Public Expenditure Management and Financial Accountability Review (PEMFAR) exercise led with support from the World Bank and the IDB, will allow prompt identification of bottlenecks and other factors delaying project implementation. The scarce supply and high cost of electricity represents an important impediment to business activity. The authorities are pleased to have been able to conclude a power generation and distribution contract with a new domestic firm that will both increase significantly electricity generation and reduce users’ costs. In the meantime, with the support of several donors, efforts are being made to increase the efficiency of the state electricity company (EDH) through better controls, reduction in technical losses and the gradual modernization of the plant’s equipment. The IDB is also preparing with the authorities a program for the financing of the hydroelectric dam of Peligre. The operation is scheduled to be approved by the IDB Board during the fall of 2008. Monetary Policy and Financial Sector Strengthening The authorities welcome the findings and recommendations of the FSAP report as they are helpful in their efforts to strengthen the financial sector, which has withstood well the risks caused by the three banks that had been in difficulty two years ago. Nevertheless, as underlined in the FSAP report, the financial system still faces a number of challenges. The authorities look forward to the approval by Parliament of the new banking law that addresses many of the shortcomings of the existing prudential regulation and supervision of the banking institutions particularly those pertaining to insolvency procedures. The authorities are also committed to moving promptly with the supervision and regulation of credit unions, microfinance institutions, insurance companies and pension funds. On the monetary policy front to enhance the policy framework, the Central Bank has formally adopted a monetary aggregate target and top priorities include increasing competition in and the effectiveness of its bond auction system through the broadening of participants and the improvement of liquidity forecasting. In the long run, the Central Bank hopes to diversify the use of its instruments and reduce its reliance on reserve requirements. 5 Progress on this front has been temporarily upset by recent inflationary pressures and speculative behavior. Nonetheless, the significant recent reduction of interest rates on Central Bank paper should encourage in the medium run an upturn in private domestic credit. Prudential regulations to reduce foreign exchange exposure have recently been tightened. The existing ceiling on the net open FX position of banks was not binding at 8 percent and has been reduced to 1 percent. Completion Point Triggers and Debt Management Progress has been made towards achieving completion point triggers particularly with the conclusion of the drafting of the PRSP and, more recently, with the voting of the law on asset declaration by both chambers of Parliament. The donors’ meeting to be held in Port-au- Prince next April is crucial for the mobilization of additional resources for the implementation of the PRSP. Revisions introduced in the existing procurement law have been transmitted to the highest level of Government for review pending its submission to Parliament. The debt management capacities of the Ministry of Economy and Finance and the Central Bank are being reinforced with the assistance of UNCTAD, which has recently produced the evaluation report for the implementation of the centralized debt management database with the adoption of SYGADE ( Système de gestion et d’analyse de la dette) by both institutions. The TA from UNCTAD includes staff training and institutional strengthening of debt management structures. The authorities are convinced of the need to give quasi exclusive preference to external support in the form of grants in order to safeguard debt sustainability, and Haiti is appreciative of the financial support that is being awarded through the HIPC, Paris Club and MDRI debt relief mechanisms. In view of the vast needs of the country, while the authorities are wary of any engagement, which would jeopardize long-term debt sustainability, they are thankful for the opportunities offered by the Petro Caribe agreement, which has a 50 percent grant element. They are committed to implementing the latter in a self-sustaining manner and are pleased that the first and second shipment of petroleum products are programmed to take place in March and April. Conclusion Haiti is still, and probably will be for a while longer, going through a difficult period and our authorities stand ready to acknowledge that the political and security situation could reasonably be perceived as lacking sufficient sturdiness even with the significant progress made on these fronts with the assistance of the United Nations Stabilization Mission in Haiti (MINUSTAH) and the international community at large. Nonetheless, the persistent 6 categorization of Haiti with the most troubled post/in-conflict nations of the world by part of foreign media is unjustifiable, unfair and potentially very damaging to the work the Fund and other donors are trying to achieve with the Haitian authorities. This negative publicity is repeatedly being circulated even if often based on questionable facts. Hence, the Fund, the World Bank and other donors are encouraged to be ever more proactive in spreading the information they hold on Haiti’s countless achievements notwithstanding the prevailing capacity constraints and recurring external shocks. Our colleagues at the Board are also invited to be the echo of the favorable assessment of Haiti’s performance under the PRGF and, in the case of donor countries, of the accounts we presume they are receiving from their countries’ representatives of the improved situation on the ground. Finally, our authorities would like us to commend the management and staff of the IMF for understanding the need to keep conditionality under the program at a minimum and to focus on PRSP and HIPC Initiative completion point triggers. They look forward to the up scaling and timely delivery of technical and financial support from the international community for the achievement of the goals set out in the PRGF and PRSP.