Report No. 32167-MG Madagascar Development Policy Review Sustaining Growth for Enhanced Poverty Reduction (In Two Volumes) Volume I: Main Report May 16, 2005 PREM I Southern Africa Africa Region Document of the World Bank IMF InternationalMonetary Fund INSTAT InstitutNationalde la Statistique IT InformationTechnology ITC InternationalTrade Center ITQ InformationTechnologyQuality IUCN World ConservationUnion JIRAMA Jirosy Ran0Malagasy(Energy Company) LIC Letter of Credit LDI LandscapeDevelopmentInterventions LPDR Lettrede Politiquede DCveloppement Rural M&E MonitoringandEvaluation MDG Millenium DevelopmentGoals MFA Multi FiberAgreement MFI MicrofinanceInstitution MIGA MultilateralInvestmentGuarantee Agency MSC MarineStewardshipCouncil MTM Maisondu Tourisme de Madagascar NEAP NationalEnvironmental Action Plan NERICA New Ricefor Africa NGO NonGovernmentalOrganization NRB NaturalResourceBase- ODA Official DevelopmentAssistance ONE NationalEnvironment Office ONTM Office NationalduTourisme Malgache ORT Office RegionalduTourisme PA ProtectedArea PADR Programme d'Action pour le DCveloppement Rural PER PublicExpenditureReview PES Payment for EnvironmentalServices PNRA ProjetNationalpour laRecherche Agricole PNVA ProjetNationalde VulgarisationAgricole PPP Public-Private-Partnership PRSP PovertyReductionStrategyPaper RFT Rberve FoncihreTouristique RTA RegionalTradeAgreement SAC StructuralAdjustment Credit SIRAMA SiramamyMalagasy SLA Structural Adjustment Loan SSA Sub-SaharanAfrica T&A Textiles andApparel TEV Total Economic Value TELMA Telecom Malagasy UNIDO UnitedNationsIndustrialDevelopment Organization USAJSA UnitedStates of America USAID UnitedStates Agency for InternationalDevelopment VAT Value Added Tax wco World Customs Organization WTO World Trade Organization WWF World Wildlife Fund - 11- IThis report was prepared by a team led by Luc Razafimandimby with an overall guidance from Jaime de Melo and advice from Kathie Krummand BenuBidani.The peer reviewers are Vandana Chandra, Manuela Ferro and Albert Zufack. Major contributors to the report were Jaime de Melo; Guenter Heidenhof, D.Randriamanampisoa, (Governance); Ganesh Rasagam (Private Sector Development); Jacob H. Bregman, Maria Eugenia Bonilla-Chacin, Patrick Ramanantoanina and Alessandro Nicita (Labor Market and Education); Susanne Holste, Noroarisoa Rabefaniraka, Patrice Rakotoniaina (Infrastructure); Jean Christophe Carret, Bienvenu Rajaonson (Environment); Jean Christophe Carret (Shrimp sector); Bart Minten, Martien Van Nieuwkoop (Agriculture); Adam Schwartzman, Robert Keyfitz, Aurelien Kruse, Pave1 Lukyantsau (Macroeconomics); Paul0 de Sa (Mining); Korotoumou Ouattara (Microfinance). Administrative support was provided by Cecile Wodon, Risseme Gabdibe and Emma Fabienne Raharinjanahary. The Malagasy research center (CREAM) in Antananarivo provided statistics and a background paper on the chronological order o f major events occurring inthe Malagasy economy and the links between major economic indicators. The MinistryofEconomy inMadagascar contributed to themacroeconomicprojections. -... 111- TABLE OF CONTENTS EXECUTIVE SUMMARY ............................................................................................... vii 1 1 2.. INTRODUCTION ................................................................................................... ASSESSMENT OF DEVELOPMENT OUTCOMES ............................................ 3 The Inheritance o f Reforms ....................................................................................... Two Decades o f Reforms for Development: An Overview o f the Major Outcomes....3 6 The Challenge: BuildingPolicies for Sustained and Shared Growth ........................ 10 3. POLICY AND INSTITUTIONAL AGENDA ...................................................... 19 StrengtheningState Effectiveness............................................................................ 19 A More Effective Partnership with the Private Sector .................................. 19 Measures to Improve Governance................................................................ 20 More Effective Public Sector ...................................................................... 24 Improved Delivery of Infrastructure Services.,............................................. 28 Addressing Key Constraints inthe Factor Markets .................................................. 34 Challenges in the Marketsfor Labor ............................................................ 34 The Challengesfor Education Policy The Banking Sector and Microfinance ......................................................... ........................................................... 36 38 Supporting the Growth Poles................................................................................... Adapting EPZManufacturing to theNew CompetitiveEnvironment ............42 42 The Tourism Sector ..................................................................................... 46' TheMining Sector........................................................................................ 49 ........................................................................................ Growth for the Many -Rural Development............................................................. The Shrimp Sector 51 55 Rural Development...................................................................................... 55 Protecting the Environment ......................................................................... 63 4. MEDIUMOUTLOOKAND RISKS .................................................................... 67 Macro-Economic Projections, 2004-2008 ................................................................ 67 Risks .................................................................................................................... Poverty Simulations ................................................................................................ 74 Knowledge Gaps ..................................................................................................... 75 77 Boxes 6 Box 3.1: The IntegratedGrowth Pole Project (IGPP) .......................................................... Box 2.1: Growth o f GDP and growth o f exports.................................................................... Box 3.2: Growth Accounting inMauritius over the Recent Period ...................................... 20 36 Box 3.3: FERHA ................................................................................................................ 59 Box 3.4: The benefits o f agri-business and accessto foreign markets: the case o f Lecofruit 61 Box 3.6: The National Environmental Action Plan (NEAP)................................................ Box 3.5: Trends inforest conversion and fragmentation...................................................... 63 64 .iv- Tables Table 2.1: Poverty profile by sector of employment .............................................................. Table 2.2: Selected sectoral employment growth (1997-2001) ............................................... 9 9 Table 2.3: Headcount Trends by Region and by Rural-Urban area (%) ................................ Table 3.1: Comparative Analysis of Factor Costs................................................................ 10 Table 3.2: Effect o f remoteness on agriculturalpractices andpoverty, by commune............29 29 Table 3.3: Urbanlabor demand projections: 2004-08 .......................................................... 35 Table 3.4: Selected Comparisons betweenPoor and Non-Poor Households with respect to Education (2001) ......................................................................................................... 35 Table 3.5: Selected Performance Indicators for Madagascar's Savings and LoanAssociations Table 3.6: U S Clothing Imports: Madagascar's Share vis-&vis sub SaharanAfrica.............41 inMicrofinance, as ofDecember 31, 2003 .................................................................. ......................................................... 43 Table 3.9: Public expenditures on agriculture, inthe Budget Law (1997- 2004) ..................56 Table 3.8: Annual household income inrural areas (HH2001) ............................................ Table 3.7: Recent Performanceofthe Tourism Sector 46 57 Table 3.10: Impact o f different investment strategies based on simulations with the general ............................................................................... 58 Table 4.1: Selected indicators o f real sector activity, 1997 -2008 ....................................... equilibriummodelofMadagascar 69 Table 4.2: Key public sector developments, 1997-2008 (inpercent o f GDP) ....................... Table 4.3: The effects o f economic growth on poverty ........................................................ 74 75 Figures Figure2.1:Per capita GDP andmain Economics events........................................................ 4 Figure2.2: VariationinGDP Poverty Growth and inPoverty Headcounts ............................ 8 ............................................................................. Figure2.4: The evolution o f Madagascar's stock o finfrastructureon a comparativebasis . 15 Figure2.3:Investment Climate concems . 13 ........................................................ Figure 4.1: Developments on the balance ofpayments, 2003 - 2008 ................................... Figure 3.1: Shrimp production and exports 1994-2003 52 70 Annexes Table A. 1. Gross Domestic Expenditureand Product (current prices)................................. Table A. 3. Gross Domestic Product by Expenditure, National Income and Savings............79 Table A.2. Gross Domestic Expenditureand Product ......................................................... 79 Table A. 4.Annual growth rates ofNational Income and Product at constant prices............80 80 Table A. 5. Prices................................................................................................................ Table A. 6. Public Sector Finance ....................................................................................... 81 81 Table A. 8 Table A. 7. Public Sector Finance ....................................................................................... 82 Table A. 9. Balance o f Payments......................................................................................... .Banking Survey and Interest Rates.................................................................... 83 Table A. 10. Trade .............................................................................................................. 84 Table A. 11.External Debt and Debt Service ...................................................................... 85 Table A. 12.Financial Sector Indicators .............................................................................. 85 Table A. 13. Millenium Development Goals Indicators....................................................... 85 Table A. 14. GDP incurrent prices ..................................................................................... 86 87 Table A. 16. Government Finance....................................................................................... Table A. 15. GDP incurrent prices (share o f GDP) ............................................................. 88 89 Table A. 17. Government Finance (share o f GDP) .............................................................. 90 .v- Table A. 18. Monetary Survey ............................................................................................ 91 92 Table A.20. Balance of Payments (share of GDP) .............................................................. Table A. 19. Balance of Payments....................................................................................... Table A.21. Real Sectoral Growth, const. 1984 .................................................................. 94 Table A.22. Sectoral Contribution to GDP inconstant prices, 1984 .................................... 96 97 .vi- EXECUTIVE SUMMARY Recent Economic Development and the Inheritance of Reforms 1. Madagascar has experienced a long economic decline from the 1970s until the second half of the 1990s despite a significant economic potential, an abundant and diversified natural resource base offering strong potential for growth for agriculture, fisheries, mining and tourism. The poor economic performance was mainly due to the failure o f an inward-looking, import substitution and a state-led development strategy characterized by pervasive price distortions'. The policy stance was associated with poor govemance inthe forms o f state capture, which led to deeply rooted rent-seeking and vested interests. As a result, Madagascar's annual economic growth had averaged 0.5 percent over this period against a population growth rate of about 2.8 percent. Reflecting this decline, consumption per capita has more than halved, from US$473 in 1970 to about US$230 in 2003 and GDP, and is now less than half that o f the LDC average, making Madagascar one o f the poorest countries inthe world. 2. Major structural changes have taken place gradually from the second half of the 1980s. However, it was only in the end of the 1990s that the long economic decline was reversed. Inthe face o f the growing failure over the 1970s and the 1980s, Madagascar has gradually reformed its economy towards more pragmatic policy stance. The policy undertaken comprised : (i)sound pricing policy including, the abolition o f administered prices and the adoption o f a flexible exchange rate policy ;(ii) trade liberalization including the removal of quantitative import restriction and export licensing, the abolition of export taxes and the reduction o f customs tariff peak; (iii) liberalization o f the economy through state divestiture from key sectors such as mining, fishing, and the launching privatization of the major state-owned companies, including the state-owned banks; (iv) creation o f a more conducive business environment with the establishment o f a long-term land lease for foreign investors (99 years) and the facilitation o f visa for tourists; (v) establishment o f the Export Processing Zone (EPZ). 3. The compound effect of the preferential trade opportunities, namely the AGOA, and the reforms spurred an export, private sector-led growth from 1995 onwards. Growth rate averaged 4,6 percent over the 1997-2001 period and reached 6 percent in 2001, as opposed to an average o f 0.4 percent over the 1980s. The growth experience over this periodwas marked by the development o f a few export oriented sub-sectors inmanufacturing and services - textiles and clothing grew at an average rate of 24.5 percent; tourism grew at an average rate o f 11percent; banking and construction grew twice as much as the economy. Exports have increased significantly and accounted for 24 percent o f GDP in 2001, as opposed to 13 percent o f GDP in 1980, with an increasing share o f manufacturing goods and non-traditional exports: mining, shrimp, tourism, textiles accounted for 50 percent o f exports on average over the second half o f the 1990s. This period has also seen a surge in private investment, which increased from 3.5 percent of GDP on average over the 1980s to 9.7 'Price was administered by the State. Import taxes were high and exports were penalizedby heavy taxation. The exchangerate remained overvalued for many years. - vii- percent in 2001. Inparticular FDI in the growing sectors increased from almost zero in the 1980s to 2.1 percent o f GDP in2001. 4. Growth over the second half of the 1990s was accompaniedby an improvement in macroeconomic management. Despite transitory exogenous shocks (oil and cyclone shocks), the rate of consumer price inflation on a year-on-year basis deceased steadily from 65 percent in 1994 to 4.8 percent in 2001. Despite significant import constraints as in many increase in FDI and the strong export performance. The trade balance deficit - excluding small economies, the balance of payments developments were favorable thanks to the net grants - decreased from 7 percent o f GDP on average during the second half of the 1990s to 2 percent o f GDP in2001. Net foreign assets o f the banking system increased substantially and external reserves improved, rising from 9.8 to 14.4 weeks of imports between 1999 and 2001. However, with respect to revenue policy, success i s less evident. Although Government's revenues increased over the second half o f the 1990s, Madagascar's performance remained very low with tax revenues averaging 9 percent o f GDP, hamstringing the government's ability to provide key public services as fiscal consolidation had been made by lowering expenditure. Shortfall inrevenuewas mainly due to weaknesses incustoms administration. 5. But the pattern of growth revealed a two-track economy, marked by the poor performance of agriculture and the absence of linkagesbetweenthe growing sectors and agriculture. Madagascar is an agricultural base economy with most o fthe population earning their living from agriculture and living in rural areas. Agriculture is the main sector in the economy with significant employment (76 percent in2001) and GDP shares (14.8 percent in 2004). However, incontrast to manufacturing and services, the outcomes inagriculture have been disappointing. The sector has been growing at an annual rate o f 1.2 percent since the 1980s and of 1.8 percent between 1997 and 2001, well below the population growth rate of about 2.8 percent. The availability o f rice, the main staple food, measured in kilograms per persodyear, fell from 144 kg in 1981 to 112 kg. in 2001, pointing to an increasing food insecurity. Although agricultural exports still account for a significant share o f total foreign exchange earnings, with vanilla and cloves alone accounting for 27 percent o f export revenues in 2001, exports proceeds from traditional products such as coffee, vanilla, cloves and pepper have decreased sharply since the mid-1980s2. The share o f non-traditional agricultural exports such as vegetables, fruit and essential oil has increased but remains small. 6. Several factors accountedfor the weak performance of the agricultural sector in the past. In general, very low on-farm productivity, due to poor water management conditions and modest adoption o f modern agricultural technologies, features among the major factors that account for the low growth inagriculture. Very low market access - due to the absence o f large scale private investment, such as in agri-business, and the concentration on highly self-consumed primary products, inparticular rice3- is also among the reasons that hampered the development o f agriculture. Finally, the compound effect o f decreasing resources and weak institutional coordination, due to a centralized system, led to public investment inefficiency and a failure to take into account the immense variation and heterogeneity o f Madagascar's agricultural assets. These constraints hampered the design o f an appropriate policy response to the constraints facing the differentiated agricultural clusters. While several o f Madagascar's traditional agricultural exports have been reduced in recent years by the sharp reduction in their international prices, a sharp reduction in the volumes o f these exports both preceded and continuedthroughthis period o f price declines. Two thirds o fthe rice production is auto-consumed by agricultural households. About 85 percent of farmers grow rice and income o f rice makes up a little over one third of the monetary agricultural income o f farmers. - viii- 7. Growth has allowed to reduce poverty over the 1997-2001 period. However, the vast majority of the populations were excluded from its benefits. During this period, poverty headcounts decreased from 73 percent to 69 percent. However, just as the growth poles have been growth enclaves, the distribution of the growth benefits was also uneven with poverty reduction mainly attributable to within-sector poverty reduction in manufacturing and services. Poverty headcounts in manufacturing and services decreased from 54.3 percent to 42 percent and from 44 percent to 36 percent respectively, while poverty headcounts in agriculture and rural areas averaged 75 percent over the 1980s and the 199Os, irrespective of the overall economic performance. Against this backdrop, poverty headcounts inurbanareas decreasedsubstantially. Inparticular, poverty headcounts inthe Capital, where the development of manufacturing and services took place, decreased from 66.4 percent to 49.3 percent over the 1997-2001 period while it has increased inthe other provinces. 8. If the persistentlow growth in agriculture is one the factors accountingfor the persistent poverty in agriculture and in rural areas, the pattern of growth also revealed a number of issues that should be taken into account if poverty is to be reduced significantly. First, growth in sectors with strong potential such as the EPZ and tourism needs to be sustained and accelerated. Evidence from the labor market dynamics suggests that their development was instrumental in reducing poverty. Real earnings and employment growth rates in manufacturing and services were high as opposed to a stagnation in the agricultural sector. However, employment in EPZ represented only 1,4 percent of the active labor force in 2001 and was not significant enough to absorb a significant share o f the population, in particular from the rural labor force. Second, the movement o f the labor force from agriculture to the modem sector did not play a major role. There are few contacts between urban and rural labor markets as there i s little temporary or permanent migration from rural to urban areas. Third, findings suggest a significant skill mismatch, with the educational attainment in the growing sectors averaging 8 years as opposed to 4 years in all farm activities, which mighthave partly accounted for the small integration o f the labor force from rural areas into the growing sectors. 9. As spelled out in the PRSP, Madagascar's objective is to achieve high and shared growth. In the aftermath of a political crisis in 2002, the new Government has launched a series o f reform aiming at achieving this objective. The prospects for growth are undeniably brighter given the structural changes that havetaken place and Madagascar has arguably broken the vicious circle of low growth rates.Despite a severe contraction of the economy due to a political crisis in 2002, recovery has taken place with a growth rate of 9.8 percent in2003 and a projected 5.3 percent in2004. 10. However, the redistribution of the growth benefits, hence poverty reduction remains a concern. Due to the impact of the crisis, poverty headcounts were as high as 80 percent in 2002 and are estimated at 73 percent now. The development strategy for Madagascar needs to be geared towards measures and reforms aiming at further supporting sectors with high potential and at the same time integrating the rural population into the growth process. Achieving Madagascar's Development Objectives 11. Given the limited internal demand and import constraints, a private sector, export-led growth is the most sensible way to sustain the recent good growth performance.Lessons from the recent growthperiodinMadagascar and from the East Asian experience highlight the conditions for the success o f a private sector, export-led growth - ix- strategy, including, among others : (i)credible, open and close government-business cooperation with the private sector, facilitating consensus-building on economic growth, associated with openness to foreign direct investment; (ii)emphasizing efficient infrastructure development to strengthenexport competitiveness; (iii) giving highpriority to building human capital (in education); (iv) adoption of a conscious export push strategy, aggressively promoting non-traditional export development; (v) sound macro-economic policies, including pro-trade exchange rate policies and fiscal discipline as well as low inflationfacilitating highdomestic savings and investment. 12. Pursuing a course of shared growth that is from the outset ensuring broad participationin the growth process is a more difficult challenge.Not only will it require prolonged growth and the implementation of the broad conditions mentioned in the above paragraph, but it will also requiremeasures to address the identified structural weaknesses in the preceding paragraphs that hampered a broader distribution of the benefits of growth. More importantly, as spelled out in the new development strategy of Madagascar, Madagascar Naturellement, it will require a re orientation o f the development strategy towards a focus on rural development, aiming at making the agricultural sector one of the engines o f exports and growth, and towards an integrated policy development emphasizing the linkages betweenagriculture with the rest of the economy. 13, Indeed, although the recent development o f manufacturing and services, and in particular the EPZ-led growth, indicated the presence o f linkages, the opportunities that these sectors offer are not likely to be sufficient to lift a significant number o f the population out of poverty, at least inthe medium-term.Evenas backwards linkages are encouraged; even as the government implements policies to enable more people to participate in growth through interventions infactor markets, a growth strategy concentrated on a few small, fast-expending sectors inmanufacturing and services is still likely to bypass the majority o f the population if growth does not include agriculture. 14. Most of the reforms under the government's agenda are geared towards the completion of these conditions and were initiated over the last two years. Some have been successful but other planned measures needto move into higher gear. They are regrouped as the followings. entailsreforms spanningfour broad areas... 15. Enhanced Government effectiveness for stronger competitiveness and increasing private investment. Private investment has played a key role in driving growth inthe recent past, increasing from an average level o f 3.5 percent o f GDP in the 1980s to 8,5 percent of GDP over the 1997-2001 period. However, compared to an average level o f private investment o f about 20 percent o f GDP inthe East Asian highperforming countries (HPEs), it still remains low. Private investment has to increase significantly to support an accelerated growth given the low level o f tax revenue collection, even compared to levels elsewhere in Africa4. In particular, FDI i s key in order to bring technology and to ensure international market access. While the recent growth period has shown the considerable role of FDI and the strong potential o f Madagascar to attract FDI, the basis for sustained flows o f FDI remains fragile. The current level o f FDI i s about 1 percent o f GDP, decreasing from 2.1 With a projected 11.2percent of GDP in 2004, tax revenue collection remains low, in comparison to a selected list of developing countries (18 percent of GDP) Mauritius average tax collection rate was 16 percent over the recent past. I M F-Mauritius- Selected Issues and Statistical Appendix, Country report N02/144. - x- percent of GDP in 2001. Therefore, implementing a critical mass o f policy reforms to consolidate the private sector's confidence and considerably expand private investment i s the key to Madagascar's growth prospects. 16. A first area of the government's focus is the implementation of the strategic partnership with the private sector. In private sector development, effort to bring the private sector onboardi s beingdeepened with the commitment to public-private partnerships (PPP) in the restructuring o f the major public enterprises. The state-owned companies in cotton and sugar were respectively privatized and under management contract. Emphasis is also being put on effort to bring the private sector into key policy discussions for private sector related issues with the creation o f a platform for discussion between the private and public sectors (CAPE). The PPP initiative i s accompanied by direct intervention to facilitate private investment. A one-stop shop (GUIDE) was created in 2002 to streamline business procedures. Another intervention planned to start in 2005 i s the Integrated Growth Pole Project (IGPP), comprising a combination o f mutually reinforcing priority infrastructure investments and actions inthe growth poles considered sources o f growth - textiles, tourism, mining, and fishing. The idea underpinningthe IGPP is based on the experience that the development o f the EPZ in the Capital has showed the existence o f linkages with a strong poverty effect. While the GUIDE has been successful in providing support and adequate services to the private sector, the CAPE needs to be strengthened to be an effective tool o f dialogue. 17. A secondarea of relevance is the emergence of the awareness about the necessity to fight corruption. An anti-corruption framework was developed and followed by the creation o f an independent anti-corruption bureau. Similarly, reforms to improve justice and customs, which are seen as widely corrupt and inefficient were initiated. In customs, steps were taken to simplify customs clearance procedures with the creation o f a one-stop shop in two major ports, the processing o f payments of the customs duties through the banking system, the implementation of an automated system data processing system (SYDONIAtl-) and the simplification of tariffs'. Customs duties credit and the immunity o f customs agents from enquiries and prosecution were also abolished and the Government will establish a new action plan to address the remaining binding constraints to better and efficient customs services as revenue generator and trade facilitator. Inparticular, the establishment o f service standards to establish performance indicators will be at the heart o f the new action plan. In justice, effective legal remedies for settling commercial disputes, the setting up o f the financial and administrative court and an effective oversight o f the judicial services are among the priorities. However, so far, no tangible reforms have been adopted. In a country where perception o f state capture and clientelism was very strong in the past, addressing issues inthese two areas i s critical intwo ways by: (i) providing a better investment climate through reduced uncertainty and costs to productions, and (ii)further strengthening government's credibility. 18. A third area in which a comprehensive reform program has started is infrastructure.Inthe past, the public sector was absent where it should have beenpresent to create the public goods that will not be provided by the private sector: building, upgrading and maintaining transport infrastructure (roads, railways, ports, airports). On the other hand, the State was intervening where it should not, in transport services and/or infrastructure management through public enterprises which would be better managed by private enterprises. Inturn, the weak management was the reflection o f predatory behavior creeping The Governmenthasmergedcustoms and importtaxes into a single tax - xi- in as governance was progressively deteriorating. Deteriorating infrastructure has disadvantaged the economy by adding significant costs to production and by severing linkages between the growth poles and the rest o f the economy. Some estimates suggest that ifMadagascar's infrastructure hadbeenmaintained to the levels of other poor countries, the volume o f trade may have beenup to 20 percent higher. 19. The Government has recently carried-out a number o f major institutional reforms to overcome Madagascar's enormous infrastructure backlog vis-&vis both levels that existed at independence, and other developing countries. The role o f the State is being redefined towards the functions of planning, regulation and coordination and supervisory agencies have been created for each sub-sectof. A significant progress has been made to increase the participation o f the private sector in the development, management, maintenance and rehabilitation o f industrial infrastructure. 20. Completed reforms comprised the management contract of the airline company (Air Madagascar), following the liberalization o f the sector inthe end o f the 1 9 9 0 ~ ~ the recent and implementation of the open-sky policy. The completion o f the concessioning o f the railways networks is under way. The telecommunications sector was liberalized and the state-owned company (TELMA) operating in the sector was privatized. In energy, the water and electricity state-owned company (JIRAMA) was recently put under management contract, The concessioning o f the main airports and the ports is the next reform o f the agenda o f the Government. It i s expected to be completed in 2005. On road transportation, the physical progress in road rehabilitation i s quite impressive with about 1,850km of roads rehabilitated in2003, athree-fold increase over the 2001/2002levels. 21. Despite the recent progress, a number o f issues need to be addressed to move the infrastructure restructuring program forward. In energy, the priority actions relate to the design and the implementation o f an action plan for the redress o f the national water and electricity company (JIRAMA) including an improvement in financial management and the definition o f the operational aspect o f the management of JIRAMA to be implementedinthe medium-term.A range o f institutional reforms are planned inthe medium-term to meet the growing demand in energy, including rural electrification, that the JIRAMA alone i s not likely to provide due to insufficient resources. For the other infrastructure components, the followingpoints need to be addressed: (i) a sustainable financing mechanism for road maintenance given the growing maintenance need; (ii) the definitionof an exit strategy inthe air transport sector with the phasing out o f the management contract o f the national airline company in 2006; (iii) the completion o f the setting up o f regulatory and supervisory agencies and their strengthening. This is particularly relevant for antitrust supervision and competition policy issues (dominant position and pricing policy) in sectors where a limited number o f operators conduct infrastructure activities, e.g. intelecommunications, energy and air transport. Overall, the strategy will help improve the quality o f services butwhether it will helpdecreasethe cost ofinfrastructureremainsto be seen. 22. Finally, the growthpath will entail significant increase in public investment and require improved state capability, covering the areas of public expenditures management, decentralizationand civil service reforms.Public service delivery is being addressed with reforms aiming at improving the efficiency o f public resources in a These includes: OMERT, for the telecommunications; ACM, for air transport; APMF, for ports and maritime transport. The Land Transport Agency, ATT, should have been set up almost two years ago, and is now expectedto be operationalin2005. - xii- transparent manner. Several measures to rationalize and modemize public expenditure management are under way and need to be continued. Measures include improvement in budget execution, the establishment of a new procurement code and an oversight institution, and improved accountability with the strengthening o f the internal and external control mechanisms. In addition to public expenditure management, public sector reforms include civil service reforms. The latter reform has been on the agenda o f the Government for many years but many implementation difficulties have slowed down its pace. In the context o f decentralization, despite the process set into motion to empower the communes in the early 1990s, Madagascar still remains a highly centralized country, both administratively and fiscally. Commune competencies are still limited to the basic function o f administrative services and waste management, and some co-financing o f social services through conditional grants. With the enactment o f the 2004/001 law empowering the regions as o f June 17, 2004, the decentralization process is being reshaped. They have been assigned significant roles consisting in enforcing administrative rules, coordinating the development programs o f the communes and supervising the development program o f the deconcentrated agencies. Clarifying the new set up with the creation o f the regions, while securing the resources o f the communes, shouldbe the priority o f the Govemment inthe short-term. 23. Factor markets. A key area in which the Government is putting emphasis is education. Education is a key factor to the objective o f sustained and shared growth intwo ways by: (i) allowing the poor to benefit from the labor demand incase of a strong growth in the growing sectors, and; (ii) enabling the Malagasy economy and labor force to respond to the demand o f the fast growing sectors. For instance, evidence suggests a possible demand shortage o f the semi-skilled laborers needed for the enterprises working inEPZ and other fast growing sectors such as tourism. 24. Significant progress has been made in education with the Education for All (EFA) but the challenge also spans all levels, in particular in secondary education and vocationaltraining. The EFA allowed to increase the net enrollment rate inprimary schools from 67 per cent in 2001 to more than 90 percent now. However, given the importance of illiteracy rate in Madagascar, the difference between the needed average educational attainment to support the growing sectors and the skills available, and the outcomes o f the 1997-2001 growth period in the labor markets, two reforms emerged as priority areas in the short, medium-term : (i) to revamp vocational trainings in order to respond to the growing needs o f the driving sectors, including the establishment o f a partnership between the training providers, be it the State or the private sector and firms; (ii) to increase the completion rate in primary and secondary schools. An assessment o f the adequacy o f the skills delivered by highereducation to the labor market demand is also needed. 25. A second area of concern in factor markets is the financial sector, regarding particularly a broader access to credit. If the health o f the financial sector has been restored since the privatization o f the state-owned banks, the challenge i s to address the lack of long-term credit which i s clearly a constraint on investment, with the majority o f firms dependent almost exclusively on retained earnings to finance capital formation. With only seven banks, the Malagasy banking system i s highly concentrated, even by the standards of Sub SaharanAfrica. Inmicrofinance, although still low, the penetrationrate grew rapidly and reached 5 percent (150,000 clients) o f the active population o f Madagascar in 2003, compared to only 1.4 percent in 1998. However, access to credit i s skewed to the wealthiest. Not only i s the challenge to improve the depth and outreach but also to provide better access to credit to poor households. The Government i s inthe process o f establishing a proper legal - x111- ... and regulatory framework to build viable Micro Finance Institutions (MFIs) and ensure a sustained growth o f microfinance by encouraging financial competition and efficiency, protecting depositors and maintaining the integrity o f the payment system. A Bank-IMF mission i s expected inthe first 2005 to do an in-depth assessment o f the financial sector and provide clear recommendations on several issues raised inthe DPR. 26. Sectoral Policies for Growth Poles and export development. To complement the measures addressing the identified cross cutting constraints, a number of sectoral reforms have been undertaken or under review to unleash the potential in sectors considered sources of an export-led growth - mining, shrimp, tourism, textiles, these four sectors having accounted for 53 per cent and 60 percent of total exports respectively in 2003 and 2004. The challenges that the government faces in sustaining or nurturingthe performance ofthese sectors areregroupedas follow : 0 intextiles, the strengthening ofthe sector's competitiveness inview ofthe phasingout of the Multi Fiber Agreement i s crucial, with measures spanning labor productivity, the strengthening o f the linkages in the sector and the costs and availability o f industrial facilities. So far, the measure taken by the Government consists in the privatization o f the state-owned cotton company (HASYMA). Itholds promises for the redress o f the identified inefficiencies to meet cost, quantity and quality requirements for yarn and fabric to supply the garment exporters. The IGPP i s expected to helpmake industrial facilities available at an affordable cost; 0 in tourism, lifting supply response constraints related to infrastructure and accommodation features among the priority actions. While the open sky policy i s expected to reduce air transportation costs, initiatives to improve the quality of accommodation have been initiated with the on-going restructuring o f the state-owned hotels and the targeted interventions to take place within the IGPP and the development of Risewes foncigres touristiques clusters where investment in ecotourism and resort areas can be undertakento - resolve the problem o f making land available to tourism investors. In addition, the promotion o f Madagascar has been reinforced with the creation o f the Ofice National du Tourisme Malgache (ONTM). If progress in infrastructure has been significant, reforms relatedto accommodation were slow andneedto move into higher gear; 0 in fishing, the main issues relate to the regulation of over-fishing inshrimp fisheries and the strengthening o f the competitiveness o f shrimp farming, while ensuring that future growth o f the latter sector i s environmentally viable and the risk o f disease i s mitigated. To this end, analytical work has been carried out by the Government and the association of the private sector to identify the regulatory mechanisms to address over fishing and to strengthen the competitiveness o f the shrimp farming sector. These studies will provide insightsinto the needed reforms inthese two areas; 8 in mining, the Government is currently launching a second generation of sector reforms to : (i) reduce smugglingo f rou,gh gemstones in order to increase the contribution o f Madagascar's miningto government's revenues and exports, and; (ii) strengthenthe capacity o f the institutions to better enforce the legal and regulatory framework inthe sector'. To this 'The liberalization o f the sector undertaken in the late 1990s was instrumental in the emergence of the mining sector. Among the key reforms are a new mining code that puts all investors on the same base, irrespective of their origin or their capital ownership; environmental regulations for mining, publishedjointly by the Ministry of Environment and the Ministry of Energy and Mines; a special law for large-scale mining investments, - xiv- end, the Government has started to decentralize the miningadministration with the creation of the Agence de Promotion du Secteur Minier (APSM) at the levels o f provinces. Measures aiming at redirecting to formal channels the transactions were also adopted with the creation of a one stop-shop (the Comptoir des Pierres) and the mechanism o f tax collection i s being revised. Inaddition, the Gemeology Institute of Madagascar (GIM) was created to set down norms and provide certification for gemstone cutting with the aim to increase demand o f gemstones with higher value added. The GIM will also promote gemstone cutting and polishing and provide institutional support to small artisans to facilitate their access to imported equipments for polishing activities. Large projects - representing planned investments of more than US$ 1 billion - have moved into feasibility stage, with decisions expected in2005/2006. Inthe short-term, the priority o f the Government should be to finalize the planned investment, address administration weaknesses in revenue collection and strengthen the APSM. 27, Not only does Madagascar need to strengthen incentives to the growing sectors, but it also has to diversify its export base. Despite the promisingexport performance with the existing export base, as a catching up country, it will be difficult for Madagascar to compete with Asian countries in areas that require intensive technology, in particular in a more liberalized trade environment. For instance, although textiles represent a potential for export development and growth, the expiration o f the MFA may weaken the foundations o f its recent development giventhe strong competitiveness of countries such as China or India. 28. Given the structure of the economy, most important is the focus on products with higher value added derived from agriculture. Although the majority o f manufacturing EPZ exports consist o f textiles products (more than 90 percent), several non-textile EPZ sub- sectors have the potential for exports, including furniture manufacturing, wood processing, precision medical instruments, optics and clocks and leather items and footwear as well as ICT firms. In addition, a list o f additional activities under the EPZ regime has been published: software development, telecommunications and off shore banks. These possibilities should be explored. Most importantly, Madagascar needs to explore ways to increase the contribution o f non traditional agricultural products to exports, for which the country has strong comparative advantage - such as hit, vegetables, essential oil, etc -. This can be done mainly by developing agri-business. But there i s little analysis for these potentials and additional analytical work i s needed to gather relevant information and build knowledge inthese areas. 29. sector, both interms o f contribution to GDP - and therefore to its capacity to ignite growth - Rural Development and Environment. Given the importance o f the agricultural and percentage o f population, as well as interms o f the number o f the poor inthe sector, the challenge for Madagascar relates to the quest for a significant growth in agriculture. The development strategy entitled Muduguscur Nuturellement aims at making the sector one o f the engines o f growth and exports inthe medium-term. Reaching this objective entails three sets o f actions and reforms : (i) address the identified constraints in agriculture; (ii) to to adopt policies aiming at the development o f the identified sources o f growth with possible linkages to agriculture, in particular agri-business and; (iii) to establish or strengthen the linkages between the driving sectors and agriculture. Emphasis i s particularly put on the need to further develop agri-business. The rural development strategy (PADR) o f the Government elaborates on policies and reforms aiming at achieving two o f these objectives - to address defining an attractive special investment regime for FDI; and the establishment of a non-discretionary and transparent systemto grant, manage and cancel mining permits with the creation of the Mining Cadastre. - xv- the identified constraints in agriculture and to establish or strengthen the linkages between agriculture and agri-business. 30. series of inter-linkedfactors in agriculture : (i) provision o f infrastructure - rural roads Priority measures falling into the following broad areas are proposed to lift a the through the current road program, irrigation with an investment program under review (FERHA) and the expansion of micro credit; (ii) institutional reforms to improve on-farm productivity through measures aiming at improving agricultural extension and research; (iii) establishing a dynamic agricultural sector through the strengtheningof partnership between the peasants/producer organizations and the private sector in agri-business. Not only will such partnerships improve market access by reducing price risks, diversifying agricultural activities towards products with higher value added, but it will also reduce uncertain input delivery and therefore mitigate the costs for transformation activities falling into the private sector. 31. The success of the Government's policy in rural development will also require institutionalreforms towards a more organized ruralsector:first, measures to strengthen the deconcentrated and decentralized levels. It i s a pre requisite to any improved service delivery and efficient public expenditures since to bring tangible results, the reforms need to take into account the agro-ecological specificity, the comparative advantage of the regions and the type o f households involved in agricultural activities ;second, measures towards the multiplication and the strengthening o f producer organizations. Effective producer organizations will strengthen the bargaining power o f peasants, thereby will reduce price risks and improve input provision, including credit. At the same time, it will facilitate effective partnership betweenpeasantsand the private sector. 32. Apart fromthe infrastructureprogram,the above reforms are beingdesigned or under review. Their implementation is challenging as they will require strong institutional coordination and broader range o f reforms. For instance, the development o f agri-business will require a conducive business environment and improved rural infrastructure - among others, rural electrification and energy. For firms in agri-business to gain broader international market access, it i s required to expand market knowledge through improved technical and vocational training, and through better access to informationrelated to product and market issues. 33. Environment protection is among the priorities of Madagascar with actions aiming at expanding the protected areas network and strengthening institutional coordination for enhanced conservation system. Apart from the benefits arising from biodiversity conservation, protecting the environment also helps capture most o f the economic services derived from ecosystems (tourism, dams, irrigation system and water supply). Various measures are being implemented to this end : (i) expanding the protected areas network and establishing conservation sites in natural forests; (ii) transferring forest management responsibilities to communities to allow for increasing participation o f local stakeholders; (iii)measures to mainstream environmental concerns , and (iv) improving transparency, accountability inthe sector by regulating cutting permits and the monitoring of forest resources. Another challenge relates to the setting up o f sustainable financing mechanisms to protect ecosystem inthe long-term. Further analysis i s needed to establish an effective resource mobilization. - xvi- Meeting the objectives would require a strong commitment, vigilance and an adequate assistance 34. The preceding sections have presented the government's agenda of policy and institutional reforms aiming at supporting an accelerated and shared private sector, export-led growth. None o f the areas under the Government's reform program could lead itself to the expected growth and poverty outcomes. They are complementary and only their combined effect would allow Madagascar to achieve its objectives, consistent with the PRSP goals. 35. Based on the structural changes observed recently and the on-going reforms, the DPR macroeconomicprojectionsforecast an annual average growth of 6.6 percent over the 2004-2008 period. The projected growth performance will require strong export and investment performance. Exports are projected to average 23 percent o f GDP over the forecast period. Investment i s projected to grow rapidly, reaching 25 percent o f GDP, compared with 18.5 percent at the height o f the 1997-2001 growth episode. Private investment i s expected to reach 12 percent o f GDP on average, with the average o f FDI reaching the pre crisis level o f 2,l percent o f GDP over the forecast period. All sectors o f the economy are expected to improve their performance in comparison with the growth episode o f 1997-2001. Growth will be mainly driven by the major export sub-sectors: textiles, mining; shrimp,tourism andrelatedactivities such a construction. 36. The major risksto the success of the current strategy are a slippageinachieving political stability, a prolongeddownturn in world growth and a slow implementation of the policy reforms.However, most o f these risks can be mitigated. First, the popularity o f the Government mitigates the risk o f another political instability although there are some perceived tensions. Second, although Madagascar is a small country and i s not insulated against exogenous shocks, evidence suggests that the economic performance o f the country shows resilience to exogenous shocks when international support i s adequate. Third, the commitment o f the Government, as witnessed by the number o f reforms undertaken in a relatively short-term, lessens the risks o f significant slippages in the pace of reform implementation. However, there are some key areas where discussionhas outstripped actions and for which effort should be made to implement key reforms in order to deepen the structural changes implemented inthe past. 37. There are also signs that the economy is vulnerable and the recovery is still fragile, pointing to a little room for maneuver in macroeconomic management. First, Madagascar's development needs have led to en increase in public expenditures, from 17.2 percent o f GDP on average over the 1997-200 1periodto 23.1 percent o f GDP in2004 while tax revenues have remained roughly the same with a projected level o f 11.2 percent in 2004. To support in a sustainable manner the investment needed to achieve its development objective, Madagascar needs to increase significantly the level o f tax collection. Second, uncertainty among the private sector was raised by concerns about the macroeconomic instability during the year 2004. For instance, a law enacted in the last quarter of 2003 abolished all taxes on a range o f investment and consumption goods, spurred a strong increase in imports and partly led to a sharp depreciation o f the local currency o f about 50 percent in real terms which contributed to rising inflation, with a 2004 projected end o f period inflation o f about 27 percent'. The depreciation was accompanied by a strong `The impact of the law on imports was compounded by exogenous shocks such as a net increase in oil prices. - xvii- volatility o f the exchange rate due to inconsistent interventions o f the Central Bank in the foreign exchange market. Third, another sign o f fragility relates to the post-crisis export performance, which has not caught up with its pre-crisis level yet due to a sharp decrease in international price o f vanillag. Although increasing, textiles could have probably better performed without the uncertainty raised by the expiration o f the MFA. As result o f these developments, the current account deficit, including net official transfers, has deteriorated from 2003 onwards, reaching 6 percent of GDP in2002 and 2003 and a projected 8.6 percent o f GDP in 2004. The outcomes o f balance o f payments during the growth period were reversed. SubstantialPovertyReductionRemainsa Dijj7cult Challenge 38. Poverty remains a concern. The estimated annual average growth of 6.6 percent over the period 2004-2008, i s expected to reduce poverty headcounts to 67 percent at the end o f the forecast period, down from 73 percent in2004. A series o f simulations o f the impact of growth on poverty show that: (i) growth i s a strong vehicle o f poverty reduction and inorder to further reduce poverty, Madagascar has to do better than during the recent growth period; (ii) shapeofgrowthwillimpactonpovertyreduction.Thesimulationsareillustrativeto the what extent agricultural growth i s key to poverty reduction. But they also highlight the difficulties in achieving this objective given the many implementation difficulties Madagascar needs to overcome to achieve strong rural growth. TheNeedfor an AdequatePrioritization and Sequencing 39. To bring tangible results, the development strategy outlined in the DPR will require appropriate sequencing and prioritizationin all of the areas revisited in the document.Giventhe breadth of the reform agenda and the many implementation difficulties that have to be overcome, a good balance has to be struck. However, many o f the components o f the policy reforms are intrinsically inter-related. Therefore, the Government should identifythe most bindingconstraints, adequately sequence andprioritize the reforms and stay the course in order to bring tangible results. It will also require discipline, perseverance and strong political commitment to the necessary policy and institutional reforms. 40. Along this line, the DPR explores the reform program o f the Government, recognizes areas o f success, identifies issues that need hrther attention and attempts to establish a sequencing andprioritization for the components o f the Government development strategy. Total exportsin2001 amountedto SDR757.9 million in2001 and SDR621.2million in2004. Source: Sixth review ofthe PRGF-2004. - xviii- .YX I I Ym a B 5e Y -0 W 8 E Y 8 M 2 E 8 3 -0 C cd I E - 0 O B .n 5 2 e, .z C, 8 8f Y s2aa 8 1. INTRODUCTION 1.1 Inthe second half of the 1990s, Madagascar had emerged from a period ofover forty years o f precipitously declining incomes, impoverishment and economic mismanagement associated with poor governance and weak institutions as evidenced by the deteriorating quality o f public services in infrastructure and the social sector. Real per capita income almost halved over the period, and close to three out of four Malagasy found themselves below the poverty line. The seeds o f a recovery were sewn inthe late 1980s and 1 9 9 0 ~ ~with the onset o f structural reforms that resulted in sustained and strong growth over a significant growth-episode, spanning 1997-2001,and the beginnings o f a reversal o f poverty rates by the end o f the millennium. 1.2 At the beginning of 2002, Madagascar plunged into a political crisis, following the contested first round of elections on December 16, 2002, when the two major candidates, the then-incumbent president Didier Ratsiraka and the mayor o f the capital Antananarivo, Marc Ravalomanana, disagreed on the outcome of the elections With the victory o f Marc Ravalomanana leading to the resolution o f the 2002 political crisis, the new government assumed office, with a strong commitment to growth andpoverty reduction. 1.3 The country's approach to poverty reduction i s outlined in the 2003 Poverty Reduction Strategy Paper, and draws on a development approach in which growth and poverty reduction are mutually reinforcing. Three areas o f focus are identified in the PRSP: (i)restoration of law and improvements ingovernance; (ii) promotion o f broad-based growth; and (iii)promotion o f systems for establishinghuman and material security. 1.4 The DPR presents Madagascar's development policy agenda in an integrated framework within which issues of policy consistency, priorities, and sequencing could be addressed. This DPR focuses on growth and growth strategy. It highlightsthe main structural and institutional impediments to achieving sustained growth and the factors constraining the ability o f the poor to participate in economic growth. Emphasis is put on issues and sectors that contribute directly to growth: private sector development issues, including the availability o f credit; elements of competitiveness such as infrastructure and education; and issues in sectors considered sources o f growth. While the impact o f government policy on poverty i s most directly felt through public expenditure and service delivery, these are dealt with in great detail in the accompanying PER, and will only be touched upon here in the context o f government's growth strategy. Finally, the DPR identifies the main sources o f vulnerability o f the country. 1.5 The DPR evaluates the government policies and points to areas of success and room for improvement. It also provides an opportunity to consider the manner in which growth, and the distribution o f its benefits, i s likely to play out in the future, given the manner in which it has played out in the past and points to the need to sharpen the strategic policy orientation to substantially reduce poverty. - 1 - 1.6 The remainder of the DPR: (i) assesses the development outcomes inthe recent past. The DPR traces in broad terms Madagascar's development history since Independence and links it to the economic outcomes. Particularly emphasis i s given to the growth episode of 1997-2001, here and throughout the DPR, which provides important insights into the structure of the Malagasy economy, and the manner inwhich the benefits of growth are likely to be distributedin the future; (ii) discusses, evaluates the government's policy agenda and highlights room for improvement, and; (iii) establishes a medium-term outlook with its likely impact on poverty and evaluates the risks associated with the development strategy. - 2 - 2. ASSESSMENT OF DEVELOPMENTOUTCOMES TWO DECADESREFORMS FORDEVELOPMENT:OVERVIEW OF THE MAJOR OF AN OUTCOMES 2.1 Madagascar i s an agricultural base economy, endowed with a rich and wide range o f natural resource, a situation reflected in the sectoral contribution to GDP, sectoral employment share and Madagascar's foreign exchange earnings". The country's economic and human development has seen a period o f relative promise in the 1960s when it was among the better off African countries, with an educated elite, comparatively strong institutions and infrastructure, and an income per capita above the average for developing countries - a position it maintained during the 1960s when it enjoyed a favorable trend in its terms-of-trade. Misguided policy during the 1970s and most o f the 1980s gave way to sustained decline untilthe first halfo f the 1990s. 2.2 But the impact of a range reforms undertaken from the second half of the 1980s contributed to a reversal o f the economic decline in the end o f the 1990s. Despite a political crisis which brought about a short-lived, but severe contraction in 2002, good growth performance has since been restored. However, given the long period o f decline, Madagascar's GDP per capita i s now less than half that o f the Least Developed Countries (LDCs) average and poverty is widespread. Estimated to have been around 30 percent at independence, poverty worsened steadily over the period o f decline, averaging 70 percent over the 1980sand the 1990s, with an improvement over 1997-2001. A period of misguidedpolicy and economic declinefrom the 1960s... 2.3 Madagascar has experienced a long economic decline and increasing poverty which became sharper from 1970 onwards and lasted through the 1970s into the first half o f the 1990s. This period o f decline has seen Madagascar loosing ground against other developing countries (Figure 2.1). loIn2001, the primary sector representedabout 30 percent GDP with an employment share of 76 percent. Cloves and vanilla export proceeds accountedfor 27 percent of total exports in 2001. - 3 - 500 450 400 350 300 250 200 $50 100 50 0 I ty dtity on imports. - 4 - 2.6 Misguidedpolicies and poor governance reflected inthe economic performance over the 1980s. Growth averaged 0.4 percent and most economic indicators were disappointing. Trade development was constrained by the overvaluation of the exchange rate and the heavy tax on exports. As a result, exports of good and services were as low as 14percent o f GDP on average from the 1980s until the first half o f the 1990s. Overall investment remained at around 9 percent o f GDP on average and average private investment was as low as 3.5 percent o f GDP as the private sector saw their competitiveness eroded, bearing the costs o f high prices for some traded inputs and many non-traded service inputs delivered by state monopolies. Foreign direct investment remained absent until the late 1980s. Most importantly, the feeling o f uncertainty resulting from the manner in which policy had been enunciated significantly discouraged the private sector. ...withperiods of reforms and sporadic recoveriesfrom the late 1980s, inparticular in the second half of the 1990s 2.7 Inthe face of growing failure, Madagascar adopted more pragmatic policies geared toward the liberalization of the economy from the mid-1980s onwards with the first o f a number o f substantial economic reforms to alter incentives. Quantitative import restrictions were removed, export licensing and state export monopolies were abolished, and peak customs duty rates were reduced. Controls on prices were lifted gradually; the exchange rate, that remained overvalued until the mid-l990s, was floated after a series o f devaluation inthe 1980s and export taxes were abolished. Foremost was the establishment o f a two-track approach with the Export Processing Zone (EPZ), which was instrumental in the rapid development o f the textile and shrimpindustries inthe late 1990s. 2.8 Reforms resumedin the second half o f the 1990s, subsequent to a period o f political instability over the first half o f the 1990s. Key measures aimed at deepening the liberalization o f the economy undertakeninthe late 1980s and included liberalization inkey sectors such as miningand fishery with the establishment of a transparent, competitive and non-discretionary license delivery system. The reforms also included some other notable measures such as the liberalization o f the petroleum, energy, air transport and telecommunications sectors and the launching o f the privatization o f the major state-owned companies operating in these areas13 as well as the establishment o f supervision and regulatory frameworks. Finally, additional measures to open up the country were implemented, including the facilitation o f visa and work permit issuance as well as the possibility to lease land for foreigners. 2.9 The reforms sent strong signals o f a change inapproach to the private sector and they were successful ininitiatinga private sector, export-led growth by the end o f the 1990s. The growth rate rose consistently every year between 1997 and 2001, with an average o f 4.6 percent, reaching 6 percent at the end o f the period. Private investment increased from 3,5 per cent o f GDP inthe 1980s to 9,7 per cent o f GDP in 2001, with net FDI increasing from $US 14 million in 1997 to $US 100 million in 2001 (2,l percent o f GDP). Exports developed rapidly, inpart due to preferential access to external markets, mainly the AGOA. The share o f the exports in GDP increased from 13 percent in 1980 to 16.6 percent in 1990 and to 24.7 percent o f GDP in 2001 with an increasing share o f manufacturing goods and a declining exposure to external shocks. However, despite a decreasing share of exports proceeds from traditional products such as coffee, vanilla, cloves and pepper since the mid-1980~~ l3These includethe bankingsystem in 2000. - 5 - agricultural exports still account for a significant share of total exports proceeds, with vanilla and cloves alone accounting for 27 percent o f export revenues in200114. Box 2.1: Growth of GDP and growth of exports :ngeneral, the evolutionofexports s accompanied by a similar trend of Madagascar, GDP Growth Rateand ExportGrowth 3DP growth. After beingnegative Rate :inyearly average), GDP growthrate mdexports performedbetter during 15.00 he reform periods. 10.00 (1) State-led development (2) First generation o f Structural Adjustment 5.00 (3) Period of hesitant reforms (4) Structural AdjustmentIand 0.00 I1 -5.00 -10.00 1966-1975 1976-1985 1986-1990 1991-1995 1996-2001 I E! GDParowth rate W EX DO^^ Growth rateI source: Africa World Bank Database 2.10 The absence o f major macroeconomic instability under the IMF programs (ESAF- PRGF) over this period also played a key role in nurturing growth. Inflation on a year-on- year basis deceased steadily, down from 65 percent in 1994 to 15 percent in 1999 and 5 percent in 2001; the balance of payments developments were favorable due to the surge in exports and improved capital account supported by FDI; net foreign assets o f the banking system increased substantially and external reserves improved, increasing from 9.8 to 14.4 weeks o f imports between 1999 and 2001. THEINHERITANCEOFREFORMS Madagascar arguably broke the vicious circle of low growth rates 2.11 Although gradual and piecemeal, the reforms implemented over the past two decades arguably helped Madagascar break the vicious circle of low growth and lay the ground for better development outcomes. The pattern o f the economy has been reshaped drastically compared to the legacy o f the state-led development strategy during most o f the 1970s and the 1980s, with the opening up and the liberalization o f the economy, includingthe financial sector; the expansion o f private investment, inparticular, the significant increase in FDI; the diversification o f the economy in the form o f the emergence o f non-traditional export sectors as major sources o f growth and the relating trade expansion. In the aftermath of the 2002 l4While several of Madagascar's traditional agricultural exports have been reduced in recent years by the sharp reduction in their international prices, a sharp reduction in the volumes o f these exports both preceded and continuedthrough this period of price declines. - 6 - political crisis, recovery from the crisis has taken place. The economy reboundedremarkably fast with economic growth reaching 9.8 percent in2003 and a projected 5.3 percent in2004. But sectoralperformance trendsrevealed a two-track economy 2.12 The sectoral performance was not homogenous and was dominated by the impact of economic reforms: (i) that have experienced market liberalization have enjoyed rapid sectors expansion. Exports in sectors such as mining and shrimp increased with shrimp exports increasing from USD56 million to USD155 million from 1995 to 2001, accounting for an increasing share of Malagasy export proceeds; (ii) with the improvement of the business environment and the trade opportunities (AGOA), textiles activities in EPZ have expanded considerably with an average growthrate o f 20 percent over 1996-2001 period and estimated 110,000 employments. Madagascar is now the fourth largest exporter to the US among AGOA suppliers and garments exports increased from SDR136 million in 1996 to SDR267 million in 2001; (iii) tourism, and related activities such as construction, benefited from the liberalization o f the air transport and the overall business environment. Tourism grew at an average rate of 11 percent over the growth period, accounting for a large portion o f the foreign exchange earnings, and with its potential, represents a strong vehicle for growth for Madagascar. 2.13 But the recent development also highlighted the challenge the country is facing in bringing about growth that would benefit the majority o f the Malagasy population. With about 75 percent of the population living inrural areas and 76 percent o f employment share, agriculture remains the most important sector. The sector's contribution to GDP was 14,8 percent in 2004 and agriculture is a powerful leverage for economic owth. However, despite strong potential, as evidencedby a variety o f agricultural productsl'and a favourable climate, the agricultural performance has been very weak over the past two decades and characterized by increasing food insecurity16. The sector has only been growing at an annual rate of 1.2 percent since the 1980s and grew by o f 1.8 percent between 1997 and 2001, well below the population growthrate o f about 2.8 percent. , ..with uneven distribution of thegrowth benefits 2.14 Growth has relatively done well inreducingpoverty with poverty headcounts from 73 percent to 69 percent over the 1997-2001 period. Low levels o f growth in the period leading up to the 1997-2001 growth episode were consistently accompanied by worsening poverty outcomes. Only with the comparatively higher growth rates, i s economic growth associated with improvedpoverty outcomes as shown inthe figure below (Figure 2.2). Agricultural products comprise food crops such as rice, maize, cassava; staple crops such as coffee, vanilla, cloves; and industrial crops such as sugar cane and cotton. l6 Rice is the main staple crop. Rice availability per year and per headhas decreasedfrom 144 k g in 1981to 112 kgin2001 - 7 - Figure 2.2: Variation in GDP PovertyGrowth and in Poverty Headcounts )ata Source: Ministryo f Finance, INSTAT; Madagascar. 2.15 However, just as the sources of growth in the 1997-2001 episode were unevenly distributed across the economy, so too was the distribution o f its benefits. Madagascar's development appears to be characterized by a high degree o f geographical and sectoral enclavement, with the vast majority of the population excluded from the generation and benefits o f growth. 2.16 First, poverty reduction has beenmore attributable to within-sector poverty reduction inmanufacturing and services. For instance, between 1997 and 2001, inmanufacturing and services - excluding the public sector - poverty headcounts decreased from 54.3 percent to 42 percent and from 44 percent to 36 percent respectively while poverty in agriculture has stagnated irrespective o f the economic situation with on average 76 percent o f agricultural households being poor over the last decade. The poor performance o f agriculture accounts for a large part o f the persistent poverty in the sector (Table 2.1). But difference in wages and employment growth over the same period also account for the difference. In particular, in manufacturing, annual employment growth was estimated at 20 percent and annual change in real earnings was about 8 percent compared with a stagnation in wages and employment in the farm sector (Table 2.2). Finally, the movement o f the ruralpoor into fast growing sectors has not been significant (Romani 2003)17. 2.17 As a result of these developments, poverty was also regionally biased. As shown by the household data from 1997, 1999 and 2001, poverty reduction has been concentrated in urban areas, and inthe province o f Antananarivo inparticular, where the development o f EPZ manufacturing and services took place. Being inherently an agricultural phenomenon, poverty i s rural in nature with poverty headcounts in rural consistently very high. It reached 80,l percent in2003 compared to 51,8 percent inurban areas'*. At the same time, three out o f five provinces outside o f Antananarivo saw overall increases inpoverty (Table 2.3)". Although the share of population in manufacturing and service increased against a reduction of rural population's share between 1999 and 2001 as indicated intable 2.2, the role o f migration picked up by the inter- sectoral effects is somewhat limited due to very low mobility. Source : Madagascar PRSP progress report 2004. - A full assessment of the determinants of poverty in each province requires a comprehensive analysis for which the absence of data on regional on growth and growth accounting, for instance, does not allow to understand the linkages between poverty and growth inthe provinces. - 8 - 2.18 Second, evidence suggests that there seems to be a significant gap for the needed average educational attainment in those sectors manufacturing and services - and all farm - activities, The average educational attainment in all farm activities where most o f the population and the poor earn their living, i s 4 years as opposed to 8 years for the manufacturing and services (Table 2.2). This difference ineducational attainment could have partly accounted for the uneven distribution of the growth benefits and the weakness o f linkages to the ruralpopulation. Table 2.1: Povertyprofileby sector of employment Index Percent pop . . Index percentpop - - Agriculture Headcount 76.5 84.0 Povertygap 36.59 79 37.9 76 Manufacturing Headcount 54.3 42.0 Povertygap 19.81 6 15.4 8 Services Headcount 44.0 36.5 Povertygap 15.3 10 13.6 12 Public sector Headcount 52.1 36.0 Povertygap 19.2 5.00 9.4 4 Total 100 100 Source: Romani -2003, basedon HH-2001 I Table 2.2: Selectedsectoralemploymentgrowth (1997-2001) All FarmActivities 76 54 4.2 3 0 Agriculture 96 55 4.2 3 0 Fishing 1 24 6.8 11 0 All Manufacturing 8 44 8.6 20 8 Food Industry 13 61 6.9 4 8 Mining 3 18 7.8 15 8 Textiles 36 79 8.8 35 8 Wood and Handicrafts 12 13 8.1 25 8 ConstructionMaterials 9 47 7.8 12 8 All Services 16 47 8.8 5 7 Tourism 6 62 8.4 7 7 Private Services 35 44 8.5 3 7 Public Administration 16 32 12.0 5 7 Source: HH-2001. Average yearly growth over 1997-01. * **Estimatedlabor force in 2001: 8,710 million. - 9 - Table 2.3: HeadcountTrends by Regionand by Rural-Urban area (YO) Total UrbanRuralTotalUrbanRuralTotalUrbanRural National 73.3 63.2 76.0 71.3 52.1 76.7 70.1 48.1 76.5 Slight Improvement(Urban) Antananarivo 66.4 52.0 72.1 61.7 43.3 69.3 49.3 29.2 57.5 HugeImprovement (Especially Urban) Fianarantsoa 75.1 83.1 73.6 81.1 55.8 85.9 83.3 59.4 87.8 Worsening (Urban and Rural) Toamasina 79.8 76.3 80.8 71.3 52.6 76.4 83.1 61.1 89.1 Large Worsening(UrbanandRural) Mahajanga 73.8 68.2 75.1 76.0 65.2 78.8 72.6 50.2 78.5 Improvement (Urban) Improvement (Urban) Worsening Toliara 82.0 69.1 84.9 71.6 66.5 73.1 75.9 50.2 83.4 (Rural) Antsiranana 62.3 27.0 69.5 72.6 31.3 80.6 69.7 27.9 79.3 Slight Improvement(Urban) Source: HH-2001- Madagascar The recent developmentalso highlightedthe vulnerability of the economy 2.19 Despite the positive outlook and hope for the future, the recovery i s fragile. First, the year 2004 was marked by a significant macroeconomic instability. The exchange rate depreciated by about 50 percent inreal terms and was characterized by a sharp volatility, A number o f factors triggered the exchange rate developments: (i)imports have increased significantly during the last quarter o f 2003 and the first quarter o f 2004 following tax and tariff exemptions on a range o f capital and consumption goods for a period o f two years; (ii) international price of oil have increased sharply over the same period. The volatility o f the exchange was rate largely due to erratic interventions o f the Central Bank in the foreign exchange market to prevent a significant depreciation o f the local currency. As a result, macroeconomic indicators worsened in2004. Inparticular, the end o f period inflation was 27 percent against 1 percent in2003. 2.20 Second, exports as a share of GDP have not caught up with their pre-crisis levels yet, First, despite the renewal o f the AGOA, the prospects for textiles EPZ, the main source of growth over the recent period, are unclear with the phasing out o f the Multi-Fiber Agreement (MFA). Second, exports proceeds from vanilla have decreased drastically from SDRl61 millionin2003 to SDR79 millionin2004 due to a sharp decrease ininternational prices2'. As a result, exports decreased from 21 percent of GDP in 2001 to 15 and a projected 19 percent o f GDP respectively in 2003 and 2004. The current account balance (including grants) deteriorated from 1.3 percent o f GDP in2001 to a projected 8.6 percent of GDP in2004. 2.21 Finally, FDI has decreased to a level as low as 0.3 percent o f GDP in 2003 and 1 percent o f GDP in 2004, far below its level in 2001- 2.1 percent o f GDP. Although the overall investment increased from an average level o f 15 percent over the 1997-2001period to 23 percent in 2004, the increase was mainly driven by public investment, which saw its level increasing from 7.1 percent to 11.5 percent over the same period. THECHALLENGE: BUILDINGPOLICIESFORSUSTAINEDAND SHARED GROWTH 2.22 As spelled out in the PRSP, Madagascar's objective is to sustain high and shared growth. As will be developed inthis document, inthe aftermath of the political crisis in2002, the Government has engaged in a vast structural reform program to achieve this goal (see Chapter 3). *'Source: INSTAT-Madagascar. - 10- 2.23 Based on the observed structural changes in the recent past and the assumptions that the programmed reforms move into higher gear and all the difficulties inimplementation are overcome, the DPR projects an annual average growth o f 6.6 percent over the 2004-2008 period. It i s a highhest case outcome, slightly higher than the IMF base case and lower than the PRSP macroeconomic framework. All sectors o f the economy are expected to improve their performance in comparison with the growth episode o f 1997-2001. The projected growth performance will require strong private investment and exports. Exports are projected to average 23 percent o f GDP over the forecast period. Investment i s projected to grow rapidly, reaching 25 percent o f GDP at the end o f the forecast period, compared with 18.5 percent at the height o f the 1997-2001 growth episode. Over the same period, private investment i s expected to average 12 percent, with FDI reaching the pre crisis level o f 2,l percent o f GDP. The projected growth performance i s expected to lead to a reduction o f poverty headcounts to 67 percent in 2008, compared to 80 percent in 2002 and 73 percent in 2003, below the 69 percent level in2001 (see Chapter 4). What is required to achieve thisperformance in the medium-term? 2.24 First, a prolonged growth is necessary to allow for a significant poverty reduction to take place. For growth purpose, given the limitedinternal demand and import constraints, and as evidenced by the recent growth experience, a private sector, export-led growth is the most sensible way to sustain the good growth performance. 2.25 Findings over the recent growth period in Madagascar and lessons from East Asian experience highlight the conditions for the success o f a private sector, export-led growth strategy, including, among others : (i)credible, open and close government-business cooperation, facilitating consensus-building on economic growth, associated with openness to technology and foreign direct investment; (ii)emphasizing efficient infrastructure development to enhance export competitiveness; (iii) giving highpriority to buildinghuman capital (in education); (iv) adoption o f a conscious export push strategy aggressively promoting nontraditional export development; (v) sound macro-economic policies, including pro-trade exchange rate policies and fiscal discipline as well as low inflation facilitating high domestic savings and investment. 2.26 Second, Madagascar needs to lay the foundation for a shared growth, which i s from the outset, ensuring a broad participation in the growth process. Not only will it require measures to implement the above recommendations to achieve sustained growth but it will also require measures to address the identified structural weaknesses that hampereda broader distribution o f the benefits o f growth. More importantly, as spelled out in the new development strategy o f Madagascar, Madagascar Naturellement, it will require a re orientation o f the development strategy towards a focus on rural development, aiming at making the agricultural sector one o f the engine o f exports and growth, and towards an integrated policy development emphasizing the linkages between agriculture and the rest of the economy. 2.27 Indeed, although the recent development o f manufacturing and services, and in particular the EPZ-led growth, indicated the presence o f linkages, employment in EPZ only represented 1.4 percent in 2001 and the employment opportunities that these sectors offer are insufficient to lift a significant number o f the population out o f poverty, at least in the medium-term. Even as backwards linkages are encouraged; even as the government implements policies to enable more people to participate in growth through interventions in factor markets, a growth strategy concentrated on a few small, fast-expending sectors in - 11- manufacturing and services i s still likely to bypass the majority of the population if growth does not include agriculture. A strategyfor shared,private sector, export-led growth ... 2.28 Most o f the reforms under the Government's agenda are geared towards the completion o f these conditions and were initiated over the last two years. The following paragraphs will elaborate on issues relevant to each o f the above recommendations in the Malagasy economy andthe implications on the current reformprogram. ...impliesno roomfor maneuver in macroeconomic management 2.29 The latest InvestmentClimate surveys reported that a stable macroeconomic situation i s among the major factors accounting for the lack o f confidence among the private sector (figure 2.3). Inorder to understand why there i s so little room for maneuver, it i s necessary to consider Madagascar's economic status. First, Madagascar spending has been modest compared to the needs to develop the economy and gift poverty. For instance, government expenditure on investment, goods and services i s only two thirds that o f the average for sub- Saharan Africa2'. Despite this, revenue mobilization has been very weak and fiscal consolidation has always been made to the detriment o f expenditures.Although projected to reach 11 percent in 2004, Madagascar's tax collection rate i s very low, even by African standard, with an average o f 9 percent o f GDP over the recent period. Second, as a small economy, the country i s exposed to frequent shocks - natural disaster and external shocks - which often result inmacroeconomic imbalances. The 2004 experience i s illustrative to what extent Madagascar needs a prudentmacroeconomic policy. Third, although Madagascar has reached the HIPC completion point in October 2004, the sensitivity analyses point to the vulnerability o f debt sustainability, which requires sustained sound macroeconomic policy22. 2.30 However, transforming the response o f the private sector will require more than macroeconomic effort and stability. The recent development points at the need to further strengthen the private sector confidence and for rapid implementation o f a critical mass o f policy reforms to reduce policy uncertainty and the business environment, an outcome borne by the same surveys. The key dimensions of this aspect of reforms are the subject of the following paragraphs. "Ofthe49Africancountriesforwhichcomparabledataisavailableovertheperiod1998to2001Madagascar '*See i s 41st in terms of its non-interestexpenditure, in percentageGDP terms. :HIPC Completion Point Document-World Bank 2004. - - 12- Figure2.3: InvestmentClimate concerns Finance \li. Eectricity Skills 2% a i m Corruption 4% uncertainty 10% -l 28% Regulation- 10% Tax 19% Macroeconomic instability 23% Source: World Bank Investment Climate Surveys ...and will require a more conducive environment to theprivate sector broad domain - from contract enforcement, business regulation and taxation, labor market 2.3 1 Government policies and behavior shaping private sector development play out over a regulation, property rights, etc. and involve more than one off ``strokeof thepen reforms, " 2.32 However, the recent experience in Madagascar and in other countries23suggests that to ignite significant growth does not need perfection. The key to success i s to address important constraints in a way that strengthens firms' confidence to invest, by reducing uncertainty. 2.33 The current conditions in Madagascar show that there are potential dividends from improvements in priority areas requiring a significant strengthening o f the capacity o f the administration. A first area relates broadly to the quality o f institutions in which Madagascar has scored poorly on a comparative basis24.The predictability and enforceability o f rules in justice are still weak, which results in lack of uniformity in the application of laws and regulations. Incustoms, the constraints imposed by excessive use o f physical inspections and devannings slow down the clearance process and offset the comparative advantage of Madagascar. These institutional distortions foster corruption and increase the cost o f doing business; perpetrate elite capture and rent extraction, and eventually, limitbetter prospects for private investment. In a country where state capture, rent-seeking, arbitrariness as well as 23A Better Investment Climatefor Everyone; World Development Report -2005; The World Bank. 24Largely due to a poor scoring on indices o f governance and institutional quality, in 2000, Madagascar ranked last out of 24 countries on an index o f global competitiveness proposed by the World Economic Forum (WEF), though it ranked higher in the Transparency International Corruption Perception index in 2003 (88" out o f 133 countries). The latest Corruption Perception Index o f Transparency International in 2004 shows an improvement for Madagascar with the country ranking 86' out o f 146 countries. - 13 - clientelism were seen as an extended practice and the State seen as a predatory one, reforms to combat corruption, inparticular inthese areas feature among the priorities. 2.34 A second area relates to reducing unnecessary uncertainty which is an effective approachto stimulate investment, including about the government policy. Inorder to enhance the predictability and transparency o f reforms, policy consistency and consistent dialogue with the private sector needto be enhanced. An example relates to the recent rice crisis over the last quarter of 2004. Compound effects o f the depreciation o f the local currency and the increase ininternational prices have led to a sharp increase inrice price inthe markets. Early announcements o f state intervention in case o f a steep increase in rice price led the private sector to reduce rice imports. As a result, if in the previous year, Madagascar's rice imports estimates were about 150 000 tons inthe middle of the year, in2004, only 59 000 tons were imported, reducing rice availability sharply, fueling speculation and leading to a sharp increase o f rice price inretail markets and further fueling inflation. Eventually, a partnership between the Government with the rivate sector allowed to import rice from Thailand at a retail price well below local prices2! As international prices and the population expectations remain high, uncertainty remains for the private sector whether the Government still intends to renew the operation. Whether private operators sector will engage in rice imports also remains to be seen. 2.35 Reducing uncertainty also requires the provision o f stronger direct incentive to the private sector. Regarding FDI, Madagascar i s a catching up country due to decades of isolation from world markets and needs to provide tangible incentives. Access to land, streamlining o f business procedures are areas inwhich the country needs to performbetter. ...including an improvedfinancial sector, 2.36 Access to credit i s clearly a constraint to the development o f local firms, Madagascar's Gross Domestic Savings Rate i s low, averaging 8 percent o f GDP over the last 8 years and the banking system i s undersized relative to the credit and investment needs for accelerated private sector, export-led growth. The financial system i s shallow and financial intermediation i s weak. For instance, the depth o f the financial system (M2/GDP) o f 24 percent remains limited and a sizeable share of the population do not have access to formal sector financial services; less than 15 percent of the economically active population in Madagascar i s estimated to have access to basic financial services. One indication, to achieve 6.6 percent growth over the medium-term, credit for the private sector need to reach 11.4 percent o f GDP compared to an average of 8 percent o f GDP over the recent past. Meanwhile, despite being a largely rural subsistence economy, informal and semi-financial financial institutions, such as credit unions and savings and loan associations, are still embryonic with an outreach o f 5 percent in2004. Reforms to enhance state capability, which in turn, will strengthen competitiveness, are key 2.37 Another area relates to the strengthening o f state capability to improve the delivery of key public services, notably education and infrastructure, which play a key role in strengthening competitivenessandreducing poverty. 25 It consisted in selling imported rice at a price (3500 Fmg/kgversus 7500 Fmg/kgat the domestic market or from commercial imports) guaranteed by a compensation through grants donated by bilateral partners and expected in2005. It required important financial asset to support the losses before the grants reach the importers and excluded commercial imports due to the price difference. - 14- 2.38 Madagascar's stock o f infrastructure - telephone, roads and railways - has seen a significant decline since independence (Figure 2.4). Weak institutions and scarce resources led to the deterioration of infrastructure in the past. The public sector was absent where it should have been present to create the public goods that will not be provided by the private sector: building, upgrading and maintaining transport infrastructure (roads, railways, ports, airports). On the other hand, the State was intervening where it should not, in transport services and/or infrastructure management through public enterprises which would be better managed by private enterprises. In turn, the weak management was the reflection o f predatory behavior creeping inas governance was progressively deteriorating. Figure 2.4: The evolution of Madagascar's stock of infrastructure on a comparative basis26 250 , A1 225 200 175 -MDG +Wodd 150 *DC 125 -n-P-P 100 75 50 1962 1966 1970 1974 1978 1982 1986 1990 1994 Source: Calculations from Brunet al (2003). 2.39 As a result, Madagascar still lacks adequate industrial infrastructure such as modern ports and airports; the cost o f air transport, energy and telecommunications are high and roads are poorly maintained, resulting in losses o f thousands of kilometers o f paved roads. Madagascar producers incur greater costs than their competitors. Some estimates suggest that ifMadagascar's infrastructure hadbeenmaintainedto the levels of other poor countries, the volume o f trade may have beenup to 20 percent higher 27. 2.40 In education, growing anecdotal evidence suggests that the education system, includingthe existing training providers, be it public or private, has not been able to meet the 26 Infrastructure index, built using 4 variables taken from the data base constructed by Canning (1996): number of kilometres o f roads, o f paved roads, o frailways, and number of telephone setsllines per capita. The first three variables are in ratio to the surface area (WB, 1999) to obtain a density. Each variable, thus obtained, i s normalized to have a mean equal to one. An arithmetic average is then calculated over the four variables. The final year o f the database i s 1996. Evolution: base 100 in 1962 for each group. World= total sample of 130 countries (over 1962-1996); DC=all Developing countries; P-P=The sample is broken down into three equal- sized groups with selection according to the income per capita of each bilateral trade partner so that "P-P" is bilateral trade between the poorest (richest) tercile o f countries in each time period; MDG=Madagascar. 27 Carrtre and de Melo (2004) gave the estimates o f a gravity trade model inwhich the volume o f bilateraltrade depends on country size, distance, the quality o f infrastructure and other control variables. When estimated for Madagascar over the period 1962-196, it tracks approximately the volume of bilateral trade with Madagascar's 50 most important trading partners. Coefficients estimates are then used to simulate the loss in trade volume associated with the deterioration in infrastructure. Results suggest that if Madagascar's infrastructure had maintained itself to the levels of other poor countries (the lowest tercile in terms of income per capita in the sample) the volume o f trade would have been 20 percent higher. - 15- demand from the expanding sectors. Against this backdrop, there i s a need to accommodate the labor demand from the fast growing sectors in the medium-term. A study o f the urban labor market in Madagascar (Glick et al., 2003) found that the average year o f schooling of Antananarivo's EPZ workers decreased from 9.4 in 1995 to 7.8 in 2001, while the self- reported occupational or skill status increased in the same period. This suggests a possible demand shortage o f the semi-skilled laborers needed for the enterprises working in EPZ. In 1995 not only most o f these enterprises were just starting, but the country was still facing the effects o f the depressedeconomy that had characterized it inthe early 1990s. At that stage the EPZswere able to select the most skilledworkers among the unemployed or underemployed, but once these firms started to grow and neededmore workers, the limited number of semi- skilledworkers available forced them to employ workers with less skill and train them. This made the average schooling o f these workers decrease while their occupational or skill status increased. Anecdotal evidence based on firm interviews from the EPZs (Nasir, 2003) also shows that the lack o f trained workers has beena critical challenge for the clothing and textile industryand it is starting to become an issue intourism and the handicraft industry. 2.41 Similarly, the integration o f the majority o f the population inthe growth process will need an increase in the level o f the average educational attainment in Madagascar, in particular for the labor force in rural areas as evidenced by the gap between the average educational attainment infarm activities and the needed average educational attainment inthe modem sector. In2001, nearly half o f the population was illiterate (48 percent) with a rural contribution o f 61 percent; 60 percent of the pupils inurban areas complete the primary cycle schooling against only 12 percent of those living in rural areas. If, in urban areas the percentage of population having reached higher education i s as low as 5.2 percent, the percentage represents only 0.8 percent for rural population. These issues highlight the challenge ineducation. 2.42 Reforms in education and infrastructure require broader public sector reforms which entail significant redefinition o f the roles o f the State, greater private participation in the provision o f the services and measures to improve public expenditure management, including the decentralizationof service delivery and improvement inthe quality of civil service. Beyond setting the scene, specijk actions are required.. . 2.43 The DPR also revisits the sectoral policies that complement the reforms aiming at addressing cross cuttings constraints. Those policies aim at sustaining or nurturingthe recent performance o f the sources o f an export, private sector-led growth that are likely to play a key role in driving overall growth and exports performance in the future. This i s even more the case because major shifts or instability in world market demand for Madagascar's traditional exports since the mid-1980s - coffee, vanilla, cloves. Many o f them are untapped and have strong comparative advantage, such as tourism, fishing and mining and need to be strengthened. Textiles are still benefiting from the AGOA. These four sectors accounted for 53 percent and 60 percent o f total exports value, respectively in2003 and 2004. ...to allowfor strong non-traditional exportperformance ... 2.44 In textiles, inview of the phasing out of the Multi-Fiber Agreement as of January 1, 2005, Madagascar will need to strengthen its competitiveness by improving labor productivity, providing adequate industrial infrastructure and utilities, and improve the efficiency o f the sector through effective backward and forward linkages. In tourism, better supply response entails addressing constraints related to infrastructure, be it the cost of - 16- international air transport or the quality o f internal transportation. Lack of accommodation i s also an issue as only a few hotels meet international standards as evidencedby the scarcity of hotels in peak seasons. The shrimp sector holds strong promises, but regulating the fishing volume in the shrimp fisheries and establishing clear policy to provide incentives for the development o f the shrimp farming i s key to sustained growth o f the sector. Similarly, although the prospects for the miningsector seem brighter, institutional reforms to improve the enforcement o f the mining code, particularly in gemstones, and relaxing cumbersome procedures that reduced exports and increased the risk o f corruption and smuggling are much needed. 2.45 export base given the recent development in exports - uncertainty about the impact o f the However, Madagascar should gear its policy towards enhanced diversification o f its MFA, and the instabilityof traditional exports prices. Other possibilities should be explored or expanded such as the non-garments EPZ sectors, non-traditional agricultural exports - fruit, vegetables, essential oil, etc. Not only does this approach rely on products for which Madagascar has a strong comparative advantage but it also helps include agriculture in the growth process. ...and achieve successful ruralgrowthfor the many 2.46 and therefore to its capacity to ignite growth - and percentage o f population, as well as in Given the importance o f the agricultural sector, both interms o f contribution to GDP - terms o f the number o f the poor in the sector, the challenge for Madagascar relates to the quest for a significant growth in agriculture.Many obstacles have impededthe development o f the sector. Weak market access and very low on-farm productivity feature among the weaknesses o f Malagasy agriculture. Deteriorating irrigation and low use o f modern inputs - chemical fertilizers, pesticides, high yielding varieties - due to inefficient extension and research services are among the major constraints inagriculture. Market segmentation due to poor road conditions, the low degree o f agricultural activities diversification towards products with high value added, high consumption rate, and the absence o f strong linkages between agriculture and the rest o f the economy, inparticular the absence o f a developedagri-business network, account for very low market access inagriculture28.Finally, inefficient institutional coordination did not allow to tailor appropriate and integrated policy response to the specific problems inthe different zones and sub-sectors, and to take advantage o f the rich agricultural endowment, mainly due to the weaknesses o f the deconcentrated and decentralized agencies. These are the challenges related to the improvement of the agricultural performance and the life of the majority o f the population. 2.47 The protection of important services derived from the environment by means o f actions to prevent the deterioration o f ecological systems that sustain many aspects o f rural activity and its direct impact on agricultural activities - irrigation and soil fertility - i s also needed. Large scale ecosystem degradation in Madagascar over the last few decades has resulted in substantial environmental damage and has threatened the natural resources from which important services are derived - freshwater, food, timber - and biodiversity; as well as ecological systems such as nutrient cycling and soil fertility, waste processing and detoxification, climate and natural hazards regulation. In addition to direct losses o f **Rice is the single most importantcrop. It is the backbone of the rural economy as it is estimated that over 10 million people one way or the other are involved in the productionof rice in Madagascar.Revenues from rice account for one-thirdof agricultural households' revenues. However, two thirds of the rice production is auto- consumedby agriculturalhouseholds - 17- biodiversity, tourism revenues, timber, fuelwood, and fodder, forest destruction also leads to soil degradation and erosion, flooding, and siltation of downstream infrastructure - including dams, irrigation systems and domestic water supply facilities. The major effects o f deforestation inupstream watersheds are mainly felt indownstream irrigatedpaddy fields and indownstreamdrinkingwater supply. Overview of the remainder of the report 2.48 The remainder o f the DPR will discuss and describe in details the Government's reform program and the challenges they entail: (i)Governance reforms and strategic enhancement of state effectiveness to fbrther strengthen state capability in public service delivery, including reforms in infrastructure; (ii)Measures in factor markets to address the skills mismatch between the labor market supply and demand. The DPR also deals with unavailability o f credit from the financial sector which i s a constraint on capital accumulation; (iii) Measures required to nurture growth inthe identified sources o f growth - textiles in EPZ; shrimp fisheries and farming; mining and tourism; (iii) Measures for an integrated rural development. None o f these actions i s sufficient in itself but they are each necessary ingredient and together would be instrumental in achieving Madagascar's objectives. 2.49 A macroeconomic framework will be developedto illustrate a highcase, based on the assumptions that the implementation o f the reform program moves into higher gear, no major shocks interruptthe pace of growth and a sound macroeconomic policy i s adopted. The DPR will also evaluate the manner inwhich growth, andthe distribution o f its benefits, is likely to play out, given the manner in which it has played out in the recent past, in particular over between 1997 and 2001. - 1 8 - 3. POLICY AND INSTITUTIONAL AGENDA STRENGTHENING STATE EFFECTIVENESS 3.1 The answer to government failure was seen as state withdrawal in the 1990s by replacing state discretion with market mechanisms. However, in many other areas, the appropriate response i s not necessarily withdrawal, but enhancement o f the state effectiveness. 3.2 Inthis chapter the focus is on four key areas inwhich the Government has not been effective enough inthe past and where shortcomings in this respect have negatively impacted on economic activity and poverty reduction. Three o f these priority areas fall under the rubric o f governance, an area of enormous significance to long term development outcomes: the effectiveness of government's partnership with the private sector; public sector reforms including public expenditure management, decentralizationand civil service reforms, and; the fight against corruption, particularly in customs and justice. The fourth area relates to the institutional reforms aiming at improving service delivery in one crucial area for both competitiveness and poverty reduction, that o f infrastructure provision. In many cases government reforms are already well underway. Inothers, additional measures are necessary. A More Effective Partnership with thePrivate Sector 3.3 The government i s seeking greater partnership and co-ordination with the private sector as a key element o f its institutional agenda. Reforms undertaken inthe late 1980s have already laid the foundation for a private sector-led growth during the 1997-2001 period and introduced greater flexibility into the domestic economy. ...through the Integrated Growth Poles Project ... 3.4 The government's Integrated Growth Pole project (IGPP) seeks to replicate the success o f the EPZ and to support accelerated growth in selected regions and sectors with highpotential by providing a minimuminfrastructure platform based on the needs expressed by the private sector, andby seekingto remove the mainbottlenecks to investment. The IGPP i s also expect to balance the regional and sectoral redistribution of growth. Investment i s expected to start by end-2005. ...greater private sector consultation, ... 3.5 At the same time the Government is seeking to bringthe private sector into processes and policy discussions that affect its ability to generate wealth and drive growth. The year 2002 saw the creation o f CAPE, a platform between the public and private sectors aimed at enhancing the participation of the private sector in discussion on private sector related issues such as the budget law (Loi des Finances), the government's private sector development strategy, reform o f business law, financing issues and land tenure. In February 2005, the Government has issued a decree to expand the CAPE at the regional levels. The success o f this forum is likely to play an important role in the effectiveness of government policy towards private sector development. At the very least, it should help strengthen the - 19- confidence that i s needed for the private sector to react to reforms when they are announced, by adjustingrather thanby lobbying for policy reversals. Box3.1: The IntegratedGrowth PoleProject(IGPP) The IGPP comprises a combination of mutually reinforcing priority infrastructure investments and actions to improve the business environment to facilitate public-privatepartnerships. Three potential growth poles have been identified as follows: (i)Antananarivo for export-ledgrowth (ii)Nosy Be for tourism-ledgrowth and (iii) Fort Dauphin for mining and tourism-led growth. In all three growth poles, there are on-going or proposed economic activitieswith clear prospects for expansion of private investments.The three selected growth poles were identified based on (a) their specific economic growth potential (based on comparative advantages/resource endowments for productive sectors), (b) identified prospects and existing private investment in the short and medium term (interest and needs expressed by private sector) and (c) the identification of infrastructuregaps as abottleneck for the realizationofthe regions' growthpotential. Inaddition, there will be cross-cuttingprojectsinall three growthpolesas follows: I Establishing a separate policy and regulatory regime in the growth poles through special legislation to enhance the investmentconditions (special zone status) prior to projectimplementation; Strengthening capacity of existing institutions (GUIDE, CAPE) for investment promotion, regulation and management at bothnationalandregionallevel; Establishclear backwardlinkagesto agribusiness Complementingplannedregulatoryreforms intelecommunications, power and customs; Enhancing institutional capacity for tourism promotion and management and for land reform and improvinglandadministrationinthethree growthpoles; Facilitateoutreachto the localandinternationalprivate sector; Improving the business environment for private enterprise, especially MSMEs, in areas such as business registration, contract enforcement, commercial arbitration, equipment leasing, lowering corruption, improvingair accessibility, reductionof logisticsand other costs. Source: World Bank-2004 ...and directprivate sector developmentinterventions 3.6 A number of more direct measures to facilitate private sector development have also been taken. Among the most important measures to facilitate businesses in Madagascar, for both domestic and foreign firms is the creation o f a one-stop shop (GUIDE) in September 2002 in the capital and Toamasina. The GUIDE aimed at further streamlining administrative procedures relating to visa and work permits issuance, free Zone Agreements and all issues relating to tourism and land leases. Nine o f the 10 departments involved in procedures for enterprise creation have been located in one office. The time to set up a firm has been reduced to less than 20 days in 1999 to 3 days in 200429.In 1999, long-term (99 years) land lease to foreigners was authorized. Foreigners' access to land was deepened with the law givingrights for land ownership by foreigners passingin2003. 3.7 Butthe government also needs to address other key elements contributingto lowering the cost o f doing business and effectively improving the environment for the private sector state credibility. These are described below. Measures to Improve Governance 3.8 Good governance and the fight against corruption i s a cornerstone o f the government's political agenda, with improvement in the administration's transparency, 29Source : PRSPprogress report-2004. - 20 - accountability and efficiency defined as key objectives. The establishment o f the Anti- corruption Commission (Conseil SupCrieur de Lutte contre la Corruption, - CSLCC) under the authority o f the President, i s an important step in addressing corruption on a systematic level but needs to be followed by actions. The specific measures to be taken by the Government in customs administration and the justice system need to move into higher gear, given the particularly negative consequences of corruption in these spheres for investment and trade. ...include theAnti-Corruption Commission,. . 3.9 The fight against corruption was formalized with a legislative text which passed the Parliament in 2002. The text requires all ministers, senior officials, and judges to regularly declare their assets and those o f their close relatives. It was followed by the establishment o f the CSLCC whose main function i s to advise government on a viable anti-corruption strategy and coordinate all governance and anti-corruption efforts. An anti-corruption law which passed by the Parliament strengthens the regulatory framework to fight corruption by consolidating the existing legislation. It includes improved regulations for investigation, prosecution and sanctions. The CSLCC has also prepared the regulatory and procedural framework for the independent Anti-Corruption Bureau (Bureau Indkpendant Anti- corruption, BIANCO) which i s now operational with the appointment o f its head, as o f October 2004. The main role o f BIANCO will be to coordinate government activities in the fight against corruption. 3.10 The effectiveness o f the fight against corruption will need to be translated into actions. So far, the declaration of assets has not been effective as only a few officials have abided by the rules. To translate the recent setting up o f the BIANCO into actual changes will require a radical change in the administration and in the mentality in general. In that, it constitutes a major challenge for the government and will be determinant in improving business environment. The design o f the anti-corruption strategy i s the priority o f the BIANCO inthe fight against corruption. ...and specific measures in customs administration.. . 3.11 The Malagasy customs administration has been widely regarded as being corrupt. According to a perception survey conducted by Transparency International in 2002, 95 percent o f the formal and 76 percent o f informal sector thought that the customs services were corrupt. Inroughly 52 percent o f the interactions with customs `non official' payments were demanded3'. Carriers, brokers and importers unanimously characterize the behavior o f customs officials as arbitrary and complain that unofficial payments are necessary to get goods through. In spite o f technical assistance and investment in technology for over a decade, customs still seemedto be characterizedby excessive use o f physical inspections and devannings, compounded by red tape. At the same time, significant trans-shipment and under-valuation seemedto go largely unchecked. 3.12 Under the general guidance of the Secretariat to the World Customs Organization (WCO), the government has clearly stated a long-term commitment to improve the performance o f customs. An ambitious program o f restructuring customs services was developed in April 2003. Its objective i s to build capacity (through modernization, 30Transparency International, Etude Nationale Sur L'IntCgritC; Enquste Auprbs du Secteur PrivC, Avril 2002. -21 - computerization, training and accountability) for the customs administration, to enable it to fulfill its role as a transparent revenue collector and facilitator oftrade. 3.13 At the technical level, a contract was signed in February 2003, forming a strategic partnership with a service provider. The contract strengthens the existing system o f Pre- Shipping Inspections with the objective o f focusing inspections over time on high-risk importers and on goods from countries that have a low compliance rate and for which fraud might lead to substantial revenue losses. It will thus eliminate repetitive inspections for companies having a high degree o f compliance and appropriate systems for management o f imports and exports. Within the new framework for import procedures, the minimum value required for a pre-shipping inspection us US$3,000. Goods valued at between US$l,OOO and US$3,000 may be subjected to inspection at their destination place. Exemption and warehousing schemes are also followed up by the contractor with the aim o f expanding the risk analysis database (Profiler). It is envisaged that inspection rates progressively decrease from 100 percent to 10 percent over 37 months. The new contract also provides assistance in the application ofregulations regardingthe transaction value, tariffclassification, andrules of origin, Inaddition, after beingdelayed for many years, the automated custom data processing system (SYDONIA-H) will be operational on April 1'' 2005 inthe main port o f Madagascar (Toamasina) to improve operational efficiency. It will be linked to the storage warehouse in order to speed up customs clearance. This system aims at simplifying and streamlining procedures for importers and reduces discretion o f customs agents. Finally, a one stop shop was set up inthe mainports to streamline customs clearance. 3.14 At the procedural level, customs regulations will need to be further simplified and brought inline with international standards to improve transparency and reduce discretionary authority and arbitrary decision making, which are often based on unclear or non-transparent rules and regulations. Customs administration should be subjected to clear and transparent service standards derived from international experience, on issues such as delays in customs clearance, the frequency o f inspections (especially devanning) and trends in revenues3'. To this end, the Government plans to establish a new action plan to modernize customs administration from the second semester o f the year 2005, aiming inparticular at establishing service standards for customs operations. 3.15 SYDONIA ++ and the one stop-shop. Most encouraging has been the further simplification In general, there was a progress in reforming customs with the setting up of o f the tariff schedule to four rates (ranging from 3 to 33 percent) which i s likely to bring several gains: (i) opportunity for tariff reclassification by customs; (ii) time and less less resources wasted intrying to obtain a better rate. Additional actions were adopted along the lines o f these ideas. The Government has merged the customs and import taxes into a single tax; customs duties credit was eliminated; payments of the customs duties through the banking system will be mandatory fkom April 4,2005; the immunity o f customs agents from enquiries and prosecution was abolished. However, much needs to be done to bringtangible results: (i) the results of the programmed actions with the pre-inspection service should be monitored on a regular basis and an action plan should be derived accordingly; (ii) new the action plan should address the binding constraints to better and efficient customs services as 31Customs' performancein dealingwith manufacturersunder the Africa Growth and Opportunity Act (AGOA) is particularly problematic: AGOA has been well received by government and business community in Madagascar as an engine promoting economic growth and development. Yet, while improvements have been significant under the new government, interviews suggest that the respective controlsby customs are intensive andintrusive. - 22 - revenue generator and trade facilitator. In particular, the establishment o f the service standards needs to be sequenced and needto match internationalpractices. ...and thejustice system 3.16 According to the same perception survey mentioned above, 82 percent o f the formal and 85 percent o f the informal sector thought the judiciary to be corrupt. In its PRSP the government recognizes failures in the judicial system - lack o f access, impartiality, slowness indecision-making-which places a significant constraint oninvestment and growththrough the insecurity o f property rights and weak enforceability o f contracts. Among the identified broad priority areas which form the basis for a reform strategy are: (i) the fight against corruption, (ii) the expedition o f proceedings, (iii) refgorm o f business laws. the 3.17 Little progress has been made injustice and actual changes have not taken place. To reduce the existing backlog o f cases (22,000 inAntananarivo alone) the government recruited a task-force; the work o f this group has reduced the number o f open cases to 14,000 in2005. The short-term specific measures that would help strengthen the credibility o f the government's reform program include: first, the strengthening of the commercial section o f the lower courts. Second the government could seek to revive and foster the application of alternative conflict resolution mechanisms to meet the growing demands of the private sector. Inmany other countries these mechanisms are the preferred instruments to solve conflicts, in particular incommercial matters. The arbitration and mediation centre (Centre d'arbitrage et de mediation, CAMM) established in2000, put inplace the recommendations o f Commercial Law Reform Commission (Commission de riforme du droit des aflaires, CRDA), was an important step inthis direction. However, the fact that smaller businesses are prevented from using this mechanism due to excessive costs is a shortcoming that requires redress. Finally, an important measure would be to ensure effective oversight and combat corruption by improving the operational efficiency of the internal control cadre o f the Ministry o f Justice and the Judicial Services Inspectorate and by introducing service standards and evaluation methods to increase andmonitor case loads handledby the various magistrates. The needfor an adequate sequencing andprioritization 3.18 Inconclusion, despite a number of initiatives adopted to provide stronger incentives to the private sector and improve business environment, more needs to be done to effectively eliminate uncertainty and give impulseto a net increase o f private investment. 3.19 Some initiatives were successful such as the GUIDE in facilitating and streamlining business procedures. But some measures are in the process o f being implemented and some others need to be improved in order to bring tangible results. Inparticular, the elimination of the sources ofthe private sector concerns anduncertainty inareas such as customs andjustice - improving law enforcement, speeding up proceedings o f commercial courts and establishing effective ways o f solving commercial conflicts - is key. Consistent and constructive dialogue needs to be effective and guide the government's approach to improve private sector related issues. As a result, the challenge i s also to strengthen and make all the institutional arrangements, such as the CAPE, fully effective, not just as platform for debate, and the GUIDE fully operational at the national level. Inhindsight, the law giving rights to foreign investors i s too restrictive inmany aspects and so far, not many interest have been expressed : the investment requirement is US500 OOO$, the authorized land size varies from 5.000 to 10.000 m2, depending on the sector. In addition, while land registration takes a day in Mauritius, it takes at least three months inMadagascar. - 23 - 3.20 As regards the IGPP, the investmenthas not started yet. Inaddition, to materialize the expressed interests by the private sector will require significant infrastructure rehabilitation and its implementation needs a wide range o f complementary actions, requires a significant institutional improvement inseveral areas and a strong coordination capacity. 3.21 Inview ofthe large governance reformagenda, the key challenge for the government will be to adequately prioritize and sequence its interventions to allow for a private sector-led growth. The reforms should pursue an integrative approach - addressing the relevant institutional and proceduralbottlenecks as well as policy deficiencies and capacity constraints in a consistent and effective manner. The Government should stay the course and bring visible and tangible results by completing as planned the initiated and announced reforms. A coordination o f the actions o f Madagascar' partner i s much needed to facilitate the implementation o f the large institutional agenda, inparticular incustoms andjustice. 3.22 A systematic investment climate assessment needs to be carried out to guide the govemment's effort ina constantly changing environment. Itwill help narrow down the focus and address effectively the private sector's concerns. More Effective Public Sector ... 3.23 Effective growth and poverty reduction are highly dependent on the presence of effective and efficient services for which Government i s fully or partly responsible. For instance, adequate services are needed for the poor to be able to take better advantage o f economic possibilities: rural roads will help connect markets while basic services such as water, sanitation and electricity and education and health provision as well as security will improve the living conditions directly. These require well-functioning institutions. 3.24 Three broad areas inwhich reforms have the potential to improve state capability and allow local institutions to play this role are set out below. These are public expenditure management, decentralization and civil service reforms. They have been on the agenda for many years but implementation has been slow. ...through enhanced Public ExpenditureManagement, ... 3.25 The challenge for Madagascar in the short- and medium-term i s to maximize the return o f the available envelope and improve the efficiency o f expenditures. Indeed, tax revenues have been somewhat limited and a net increase i s expected to take place gradually due to the structure o f the economy - highly dominated by the agricultural sector - and the major institutional reforms to be undertaken to improve revenue c ~ l l e c t i o nHowever, to ~ ~ . sustain the growth and poverty reduction objectives, the Government's revenues have to increase inline with the expectedincrease inthe level o f expenditures inthe medium-term. 3.26 The recently completed Country Financial Accountability Assessment (CFAA) and the Country Procurement Assessment Review (CPAR) issued recommendationsto rationalize and modernize budget and public expenditure management, and to improve accountability and transparency o f the government's operations. Better, more accountable management o f public expenditures are critical to reduced corruption, waste and to improving quantity and quality o f public services. The companion PER presents a detailed analysis o f Madagascar's 32See the section on macroeconomic projections inthe medium-term outlook chapter. - 24 - public financial management capacity. Only the main aspects o f public expenditure management reforms are revisitedbelow. 3.27 Efforts to better align budget with priorities through the integration o f elements o f a medium term expenditure framework into the budgetingsystem are already at an early stage with the adoption of the organic law, and requirestrengthening. The Government has started the revision o f a fixed calendar to define the different stages o f the budget process and implementing greater integration o f the cabinet and sector ministries as well as the private sector into budgetpreparation. 3.28 To address the lack o f transparency o f expenditure management, the Government has updated the existing legal, procedural, and institutional framework governing the control mechanisms, both internal and external, to conform international standards33 and new procedural manuals have been published accordingly. Staffing for the National Audit Court (Chambre des Comptes), the Directorate for Expenditure Commitment Control (CDE) and the State Inspectorate General (IGE) has been strengthened, and the different offices have been modernized to enhance the operational efficiency. A new internal control cadre in the Ministryo fFinance, the General Inspectorate for Finances(IGF),hadalso beenintroducedin 2003 and became operational in June 2004. Issues remain however in clarifying the conflicting competencies between the IGF and the IGEwhich are called to exercise the same roles and functions. 3.29 The Government has also adopted reforms to address weaknesses34in the public procurement system based on the recommendations of the CPAR. A new institutional set up i s under way, a new procurement code was adopted and new procedural manuals are being prepared. Institutionalization of these reforms, however, will be a challenge, requiring comprehensivetraining and capacity buildingprograms. 3.30 Finally, the realization o f the objectives o f the government's ambitious plans will require steps to enhance the effectiveness of the budget as a management tool. The effectiveness o f policy implementation should be measurable, with outcomes assessed in terms o f the delivery on programs and their objectives. This i s particularly so as the Government will start implementing a budget program in 2005. Such framework requires both improved financial reporting and strengthening o f the results orientation of the public sector. 3.3 1 On reporting, shortcomings inproducing final accounts o f the Treasury on time were addressed through the creation o f a consolidation unit at the Treasury to pave the way for the National Audit Court to submit audited accounts to Parliament and initiate parliamentary approval on the basis o f the annual budgetary execution law35.But the National Audit Court will also have to submit on time their audit to the Parliament in order to initiate relevant discussions and debates about the orientation o f the budget as a tool for economic development. On results orientation, the Government has already started designing its 33 A series of legislative texts hadpassedthe parliament andpromulgated betweenJuly and October 2004. 34 These include an outdate regular framework, the lack o f standardizedbidding, contractual documents and relatedmanuals, a weak institutional framework combined with low operational efficiency o ftender boards, a lack o f service standards, low transparency and inefficient control mechanisms, and limitedcapacity inthe area of public procurement in administration. 35 As a result of the work of this unit, general balance sheets for the years 1999to 2003 have been established and will be submittedto National Auditor Office (Chambre des Comptes). - 25 - business plan which underpins the PRSP. The process should be streamlined by the introduction o f service standards at the level o f line ministries. 3.32 While significant progress has been made, further effort i s needed to translate the program into actions and actual changes. The PER provides the details o f the priorities in reforming public financial management and makes recommendations across a wide range of areas. Among the priorities are : (i) sustaining effort to provide reliable macroeconomic and fiscal framework, including revenue forecasting for better cash management; (ii) better aligning the budget to the PRSP priorities, including addressing the concentration of resources at the central level and revisingthe envelope allocation ifnecessary; (iii) improving budget execution, including the simplification of disbursement procedures and the settingup o f an effective mechanism to systematically track implementation o f the reform program. A number o f initiatives have already started in this area but would need to be strengthened. Periodic reports to monitor execution rates for six ministries (education, health, agriculture and fishery, forestry, environment andjustice) have beenproduced since 2003 but it has to be extended to other line ministries; effort in setting up the integrated financial management should be continuedto improve the timeliness and reliability of budget execution, .,, resolution of important aspects of the decentralization program 3.33 The Malagasy territorial administration comprises five main levels: provinces, regions, districts, communes and villages. Despite reform effort, the decentralization process set into motion to empower the communes inthe early 1990s has stalled and Madagascar still remains a highly centralizedcountry, both administratively and fiscally. 3.34 Commune competencies are still limited to the basic function o f administrative services and waste management, and some co-financing o f social services through conditional grants. Social sector ministries have been partially deconcentrated and discretion over personnel and budget management remains limited. The revenues o f the decentralized layers remain low at the same time. Fiscal centralization i s higher than in most other low- income countries, with 97 percent of revenues collected at the central level, and 88 percent o f expenditure executed by central government. 3.35 With the enactment of the 2004/001 law empowering the regions as of June 17, 2004, and the recent nomination of the Heads o f the regions, the decentralization process i s being reshaped. Among the decentralized layers, the regions have been assigned significant roles consisting in enforcing administrative rules, coordinating the development programs o f the communes and supervisingthe development program o f the deconcentrated agencies. 3.36 A policy of radical decentralization would be difficult ina country like Madagascar, which still lacks the required financial and administrative foundations. Currently, a number o f issues remain unclear and may cause confusion among the actors, thus impact on the efficiency o f the development programs at the decentralized levels, if not tackled by the government ina relatively short time. 3.37 Recommendations will be : (i)Jirst, to clarify the exact extent o f the competencies and the nature o f the inter-relations between the decentralized layers and their relation with the central government; (ii) to clarify the financing mechanisms and the restructuring second, o f the previous fiscal assignment framework, and the nature of the transfer from the central government; (iii) third, to clarify the inter-relation between, and competencies o f the regions and the deconcentrated line ministries. - 26 - 3.38 While implementing these prior actions, broad recommendations at the initial stage are to limit the roles o f the regions to the legal control and the coordination as well as the facilitation o f communes' developmentprogram. Inthe meantime, the Government could: (i) preserve communes' revenues and transfer; (ii) improve the efficiency and accountability in revenue collection; (iii) strengthen commune's executive competencies; (iv) strengthen the control and monitoring systems, and improve accountability at the commune and regional level. ...and civil service reformsJ6 3.39 While the Malagasy civil service i s relatively small by developing country standards, and its growth in recent years has been moderate, its composition and structure pose a number o f problems. Repeated reform attempts over the 1990s have largely been unsuccessful, and the public sector remains deficient due to a number o f important problems. 3.40 The inability o f the civil service to attract sufficient numbers o f skilled staff i s perhaps its greatest challenge. As in many other developing countries, the Malagasy civil service employs a relatively high number o f support staff - over 60 percent o f the state agents - while the intermediate level that comprises technical specialists on whom the design and execution o f government programs largely depends, account for only 30 percent o f the total number. This situation prevails despite the leap inrecruitment in 2002, inwhich the number o f teachers was increased by 7 percent in the primary education sector, and employment in the health sector increasedby 6 percent. 3.41 One o f the most important factors behind this outcome is a remuneration system that favors support staff, and makes it difficult to attract executives. Despite efforts to reform the salary scale, the compression rate between the lowest and highest salary in the civil service salary scale was 6.69 in2004, compared with 11.66 inthe 1960s which i s generally regarded as a healthy rate. 3.42 This staffing mismatch is similarly reflected in a highdegree o f centralization -both geographically, and interms o f decision making. Over 44 percent o f civil servants are based in ministries in Antananarivo. Similarly, personnel management is centralized. Despite a decree in July 2003 to devolve routine management responsibilities regarding recruitment and promotion to line ministries, responsibility for the management o f staff has generally remained at the level o f centralministries. 3.43 Performance orientation has still to be introduced inmost areas. Objective-basedjob descriptions and service standards are for the most part lacking, and while the government intends to introduce performance contracts, at present there exists no form o f systematic and transparent evaluation procedure for civil servants. At the same time, decision making i s frequently overly complex and bureaucratic, extremely hierarchical, and often characterized by discretionary authority that is one of the key sources ofmismanagement and corruption. 3.44 Comprehensive civil service reforms are difficult to implement and sustain. The PER describes in details mechanisms to attract qualified staff at technical and managerial level are strong candidates as `quick win' interventions. These could include : (i) a special scheme for key positions in the administration, that would make provision for comparatively higher levels o f remuneration - for instance, by extending the current postes c l b system, or 36This sectionis developedcomprehensively inthe PER. - 27 - recruiting highly needed personnel on a contractual basis; (ii) decompression of the existing salary scale infavor o f higher levels would be an important interim step; (iii) other short-term measures might include requiring ministriesand departments to completejob descriptions for every `poste budgdtaire' and to develop performancetargets for organizationunits, as well as the introduction of measures to systematically sanction absenteeism and informal behavior that i s not inline with the regulations o f the administration. 3.45 Inconclusion, while civil service reforms may take time and be politically difficult, priority actions could be focused on the completion o f the planned reforms on public expenditure management and the setting up o f a clear decentralization strategy. Improved Delivery of Infrastructure Services 3.46 Madagascar's enormous infrastructure backlog vis-his both levels that existed at independence, and other developing countries, disadvantages the economy in two important ways: (i) by effectively severing linkages between growthpoles and the rest o fthe economy, and thus contributing to the country's pattern o f enclavement development, and (ii)by adding significant costs to production. 3.47 Madagascar i s a vast island and transport appears to be the state's most pressing priority. Real and immediate benefits will be gained through reforms in the transport sector given the losses in competitiveness. However, the government's programs also cover the other infrastructure components, inparticular inthe energy sector. Current status andframework in infrastructure 3.48 The damage done to competitiveness by the poor provision o f infrastructure extends to almost every key input, including telephone, internet and electricity charges. This i s particularly so for transportation costs. For example, intextile, comparing children's clothes coming from Sri Lanka with those coming from Madagascar (both destined for Paris) indicates a transport cost about a third higher for those originating from Madagascar, inspite o f a lower shipment value. The cost from Hong Kong, the better-connected location, i s less than half the cost from Madagascar even though the distance i s about the same between both sources37. Teleuhone and Internet charges. The cost of local calls in Madagascar i s very high and Madagascar i s the most expensive country after Kenya. International calls cost more than twice as much to make a 3-minute call to the U S in Madagascar than in Mauritius and more than 4 times as muchthan inSouthAfrica. Water. The water costs in Madagascar are very competitive in the region - they are at par with tariffs in Mauritius and lower than Kenya or Sri Lanka. However, the World Business Environment Survey, 2000 paints a different picture. However, more than 60 percent o f firms surveyed consider the quality o f the water supply to be bad, compared to only 7 percent in Botswana and 6 percent in SouthAfrica. Electricitv. Madagascar based manufacturers are faced with the highest industrial energy costs in the region. The per kilo-watt hour cost o f US$O.O9 i s three times that o f Botswana and South Africa and i s only exceeded by Kenya. Apart from the cost, the lack o f reliable 37Source: Economic Sector Work on Textiles - World Bank2003. - 28 - industrial electricity supply i s also an obstacle. Even inAntananarivo, power fluctuations are becoming more frequent. Table 3.1: ComparativeAnalysis of Factor Costs Africa Electricity (Per Kwhof 0.05 0.09 0.03 0.10 0.07 0.05 0.03 industrialuse) Water (per cubic meter 0.29 0.34 0.43 N/A 0.36 NIA of industrialuse) Cost of local call per 3 0.03 0.08 0.02 0.04 0.01 0.04 0.09 mins Cost of call to USper 4.00 8.98 3.60 7.35 NIA 3.05 1.98 3 mins Internet:Monthly 22.9 66.5 14.7 65.6 12.3 6.5 8.5 Service Charge Internet:Telephone 0.38 0.44 0.14 0.46 0.17 0.05 0.33 Usageper minute Source:World Bank, Interviewswith EPZ manufacturers andgovernment agencies 3.49 Not only does poor infrastructure affect those parts o f the economy that compete in international markets, but it also impacts adversely on the poorest segments o f the population, who face problems as simple as the absence o f roads. About 80 percent o f the rural population has no reliable transport services due to poor road conditions, and o f this one third has no road access at all. The time taken to reach the nearest urbancentre -unfeasibly highin many rural areas with highly degraded roads - i s strongly correlated with low production and poverty. Table 3.2: Effect of remotenesson agriculturalpracticesand poverty,by commune Remotenessquintile National 4 1 4 2 43 4 4 Q5 Time to get to the closest urban 11 3 5 10 18 22 center (inhours) Poverty (headcount) 77 48 75 86 90 87 Yields-(ton/ha)Rice 2.2 3.5 2.5 1.9 1.7 1.7 Source: Stifel et al. (2003) Measuresfor an efficient Infrastructure and Transportsystem include 3.50 It is only recently that a concerted effort for infrastructure improvement has beenput in place and the Government has carried-out a number of major institutional reforms accordingly. The approach underpinningthe current reforms has three major axes. ...a strengtheningof thePublic Private Partnership 3.5 1 First, with the liberalization o f the air transport, telecommunications and energy sectors initiated from the second half o f the 1990s3', significant effort has been undertaken to further focus the government's role inthe functions of planning, regulation and coordination. Productive activities, which range from construction to ancillary services, such as 38This programwas initiatedfrom 1997 under StructuralAdjustment Iand 11. - 29 - laboratories for material testing will be commercialized or liquidated, depending on their capacity to meet market needs. 3.52 Second, priority has been placed on creating autonomous regulation agenciesj9, in partnership with the private sector to promote technical, transparent and independent decision-making, based on their respective technical and economic regulations, and ensure safe competition among the carriers or operators. 3.53 Third, recognizing that public funding alone is not sufficient to finance all required infrastructure investments, and that the Government does not have the adequate capacity to operate efficiently such activities, private sector participation i s encouraged in the management and operation of key infrastructure nodes modes. For instance, the national airline company, the railways networks (South and North) and the water and energy company are now under management contract; the telecommunications company was privatized. The recent reforms will undeniably contribute to an improvement o f the quality o f services. Whether they will help decrease the cost o f industrial infrastructure remains to be seen. ...addressingpressing issues in the transport sub-sectors Roads rehabilitationandmaintenance 3.54 The country has lost an average of 1,OOOkm roads per year during the last 20 years; mainly because of the lack of maintenance policy and the lack of financing (the budget allocatedby the Government to road maintenance was erratic). 3.55 The Government's strategy includes a $1 billionroad rehabilitation program, with the objective to rehabilitate 60 percent of the total network (Le. 14,OOOkm) in 2008. The rehabilitation program is ambitious and the following problems need to be addressed: (i) the technical capacity of the ministry to implement this program needs to be strengthened (bid launching, work supervision), given the scarcity o f skilled personnel; (ii) absorptive the capacity of local firms is weak which may slow down the implementation o f the program; (iii) adequate institutional arrangements to plan, manage and maintain the road network should also be set up. 3.56 Inorder to improve the capacity within the administration, it is planned to redeploy staffs according to their competence. Another adoptedmeasure relates to the resolution of the limited absorptive capacity. The Parliament has approved the creation o f leasing companies that would lease equipments to both local and (new) international companies. 39The regulatory agency intelecommunications (OMERT) and in energy (ORE) have been operational since the end of the 1990s. In the transport sector, there are three regulatory Agencies: APMF (Agence Portuaire Maritime et Fluviale) for maritime and river Ports, which began its activity in 2004; A C M (Aviation Civile Malgache) for air transport, which has been operational since 2000; and ATT (Agence de Transport Terrestre) for roads and railways: the establishment of ATT has been delayed, together with the creation o f the Road Agency (AR AutoritC Routikre), which will be responsible for (i)the research and definition o f technical standardsregarding roadconstruction; (ii)the elaboration of a road data bank for a better knowledge and follow- up ofthe sub-sector; (iii) planningof road development, rehabilitation, andmaintenance operations; and, (iv) the the procurement of goods, work, and services relatedto the implementation o f these operations. Both ATT and AR are now expected to be operational in 2005 according to an action plan agreed between the Government and the main donors (IDA, EU, andADB). - 3 0 - 3.57 On maintenance, the Road Maintenance Fund (RMF) i s financing the program elaborated by the Ministry in charge o f Transport and Public Works4'. The RMF's challenge i s to secure sufficient resources to finance road maintenance by increasing the amount o f resources which do not transit through the Treasury. As a result, Road Users Fees (RUR) on petrol and oil products which are directly collected by the oil companies and repaid to the RMFwill be the bulkofthe RMF's resources inaddition to fees derivedfrom the application o f axle load fees. A decree was issued to this end. To complement this reform, recommendations will be: (i)to develop the relationships between the RMF and the associations o f road users; (ii) to perceive tolls from road users, following rehabilitation, and; (iii)encourageNGOstoinvestinruralroadrehabilitationandmaintenance. to As the Government's role is refocused on the functions o f strategic planning and sector oversight and coordination, regulatory agencies - the Roads and Railways Agency 3.58 (Agence des Transports Terrestres, ATT) and the Road Authority (Autoritk Routi&-e, AR) - were programmed to be created. These entities would be responsible for regulatory issues, road rehabilitation and maintenance planning and road management. However, their creation has been delayed. An action plan has been recently agreed between the main donors and the Government to make sure that these entities are operational in2005. Railways 3.59 The rail network of Madagascar consists o f two networks: the Northern and Southern Railways. The Northern railway, connecting the country's main port in Toamasina with the capital Antananarivo and Antsirabe, with a network o f 732 km was concessioned to a private operator (MADARAIL) inJuly 2003. The line has significant commercial potential but i s in need o f major infrastructure rehabilitation and renewal o f rolling stock. The concessionaire plans a five-year US$35 millioninvestment program to modernize the railway and to provide a competitive transport alternative to the road. 3.60 However, serious financial problems arose from increasing costs, including the impact o f the depreciation o f the local currency, further degradation o f the railway infrastructure due to the delay in investment4' and overcapacity o f transport domestic supply due to fierce competition with road transport. Inresponse to the difficulty, the Government has decided to take over the infrastructure rehabilitation inrailways. A particular effort need to be made to establish a clearer policy for railways and a competition between roads and railways, especially, ifit is envisaged as an alternative to the roadtransport. 3.61 The Southernrailway, with a track lengtho f 163km and connecting Fianarantsoa with the port o f Manakara, i s planned to be concessioned in mid-2005, jointly with the port o f Manakara, to private operators. The challenge i s more important here, as this network has 40 The RMF was created in 1999, but the maintenanceworks and the financing issues remained unsolved, as transparent procedures for its management were not set up, and its resources were still dependent on the Government's Budget and procedures. Thus, in 2001, a second generation RMF, with more autonomous financing was created. Its main resources come essentially from Road Users Fees (RUR) on petrol and oil products, and are directly collectedby the oil companies and repaidto the RMF. Besides, its management is regularly audited. 4' For instance, financial projection over 10 years shows negative results if urgent corrective measures are not taken, such as the payment of the government's financial contribution as contained in the Concessioning Agreement, t6 contributeto the infrastructureandrollingstock investments. - 31 - limited commercial viability, but plays a key role inthe corridor's environmental protection42 and in serving the 1,000,000 people in the region. Substantial public investment (US$17 million) i s plannedthrough government funding, supported by various donors. Portsand maritimetransport 3.62 Along the lines of the principles adopted for the restructuringo f the transport sector as a whole, the Government has created a Ports, Maritime and River Agency (Agence Portuaire, Maritime et Fluviale,APMF) and has adopted a legal framework for the regulation o f the ports and maritime transport. The law allows individual concessioning o f large ports (Ports ri Gestion Autonome), and grouped concessions for medium-sized ports, while the small commercially nonviable ports will be managed directly by APMF or fully transferred to local communities. For each port, the government's strategy will be to create a company with 51 percent state ownership (consisting mainly in a contribution in kind, with the physical infrastructure). Most of the operating and development costs o f the sector will be financed through port and maritime user fees. These companies will act as port authorities, to manage the facility and sign concession agreements with other private operators for commercial activities (stevedoring, warehousing, towing, pilotage, boatage). The Government will naturally retain its role in discharging functions pertaining to planning and oversight, safety, environmental protection, and security. Air transport 3.63 The air transport sector i s crucial to promote tourism (Government i s aiming at 500,000 tourists by 2008) and manufacturing exports, two sectors targeted for their growth potential. The Government plans to ensure an efficient grid network throughout the country for trade and communications from urban centers to remote towns domestically and outside the great island of Madagascar. To achieve these goals, the Government endorsed an air transport liberalization policy, by establishing the principles o f multiple designation, free capacity and pricing (except for dumping and excessive price practices) to improve quality and accessto air services, and reduce costs. The most urgent action relates to the definition o f the next step to be taken after the management contract of the national airline company will phase out in2006. ....including regulationissues 3.64 Some regulatory agencies have been set up since the reform engaged inthe late 1990s but they need to be ~trengthened~~.The challenges faced by these agencies relate to the followings: Jirst, a culture of transparency should be applied: procedures and rules needto be published and easily available to the public, to avoid arbitrary decisions; second, staffs are not trained to effectively control operators' compliance with the regulation requirements; third, there is, arguably, a need to strengthen oversight regarding antitrust supervision and competition-policy issues (dominant positions and pricing). It i s suggested that the consultative process in drafting an updating competition law should be resuscitated and supported by a diversified group o f local and international experts on legal, economic and 42Iftherailwayweretoceaseoperations,thelastremainingprimaryforestwouldbegravelythreatenedbecause the people living along the line could no longer rely on their export crop and would resort to slash and burn farming. 43In general, staffs working inthese agencies are former civil servants from Ministries with adequate technical background.These includes: OMERT, for the telecommunications; ACM, for air transport; APMF, for ports and maritimetransport. - 32 - institutional issues. Key elements o f any new legislation should include: transparency in the decision making process, rights of defense, access to legal recourse, preservation o f confidentiality of information supplied to regulators as part o f an investigation, an independent appeals mechanism and a "rule o f reason" approach. It i s recommended that the priority actions be taken in the oil, telecommunications and air transport sectors where the liberalization has brought about a number of competitors. ...addressingissues in the energy sector 3.65 The most urgent action in energy is the design and the implementation o f an action plan for the redress o f the national water and electricity company (JIRAMA). The objectives are to define performance indicators in order to improve the quality o f services; improve the financial management of the firm, including the setting up o f new tariffs; and define the operational aspect of the management o f the firm to be implemented from January 2006 onwards. 3.66 But the Government is also in the process of adopting its reform program inenergy for the medi~m-term~~.The strategy aims at strengthening the liberalization o f the sector with the introduction o f competition and regulation o f activities related to the provision o f energy45as the capacity and resources in the public sector are not likely to meet the growing demand. For instance, rural electrification rate i s less than 3 percent; between 1996 and 2003, annual demand has increased by about 7.5 per cent and i s expected to increase by about 8 per cent per year in the coming ten years. To this end, the Govemment plans to strengthen the supervisory and regulatory agency I'OfJice de Re`gulation de 1'Electricite` (ORE) and make it hlly effective : (i) ensure regulation andmonitoring of activities relatedto the provision o f to electricity; (ii) to ensure that prices meet all the standards as spelled out in the regulatory framework; (iii) to promote the participation o f the private sector inthe sector; (iv) to ensure that regulation i s properly met by all operators inthe sector. 3.67 The Government also plans to take actions for the effectiveness o f the Fonds National de I'Electricite` (FNE), created by the Law No2002-001 o f October 7, 2002 to support rural electrification through subsidies to rural electrification providers, which will not exceed 70 percent of total investment. The Agence pour le De`veloppement de 1'Electrijkation Rurale (ADER) will promote services provision, includingrural electrificationby the private sector; supervise and finance rural electrification through the FNE, and; monitor the environmental impact o f projects. About 150 rural electrification projects are expected to be completed on an annual basis with the support o f the FNEand ADER. 3.68 In the medium-term, the establishment of new hydro-electric power plants with the participation o f the private sector i s planned to increase the absorptive capacity o f Madagascar. In addition, studies aiming at exploring the sources o f renewable energies will be launched. Conclusion 3.69 Inconclusion, significant progress hasbeenmade ininfrastructure. The public private partnership has been accelerated to improve quality services in telecommunications, water 44Politique du Secteur de 1'Energie Ci Madagascar. Sector Policy of Energy, Draft. Ministry of Energy- 2005. 45 Activities in the sector were liberalized in 1999 (Law No98-032; January 20, 1999). The objective is to introduce competition in the medium-term through the breakdown of electricity provision (production, transport-distribution). - 3 3 - and energy, air transport and inrailway. The concessioning o f the mainports and airports will complete the series o f partnership to improve the quality o f infrastructure inMadagascar and the implementation o f the open sky to further liberalize the air transport sector i s expected to support the growing sectors such as tourism. The physical progress in road rehabilitation i s quite impressive with about 1,850km of roads rehabilitatedin2003, athree-fold increase over the levels in2001/2002. 3.70 However, some pressing issues need to be addressed and the followings features among the priority reforms : (i) a sustainable financing mechanism o f the FER should be implemented quickly in order to ensure a proper road maintenance given the growing maintenance need, including rural roads; (ii) the effectiveness and the strengtheningo f the regulatory agencies should not be further delayed in order to ensure a coherent infrastructure program, including policies regarding pricing policy; (iii) the completion o f the strategy in energy inorder to define an action plan for the short-and medium- term; (iv) the definition o f the strategy o f state disengagement inthe air transport sector. ADDRESSINGKEY CONSTRAINTSINTHE FACTOR MARKETS 3.71 For many Malagasy, escape from a subsistence existence through employment inthe growing manufacturing and services sectors i s one potential channel out o f poverty and into wealth generation. Developments in the Malagasy labor markets, the skills base, and the availability o f capital for investment will have a crucial bearing on the scale and nature of future economic growth, and the distribution of its benefits. Inthe absence o f interventions in the education sector, low educational attainment among the poor will cut off many o f these opportunities, while placing a binding constraint on economic growth. So too will the unavailability o f credit from the banking system, which limits the ability o f all but a few foreign multinational companies to investinlabor intensive productive activity, Challenges in the Marketsfor Labor Labor demand and the skills mismatch 3.72 The macroeconomic projections for the period 2004-2008 suggest that the labor demand i s likely to outstrip the labor supply by approximately 8 percent. This shortfall in supply was already suggestedby anecdotal evidence from the EPZ and tourism sectors46and i s likely to impact adversely on the competitiveness o f Madagascar. Based on the characteristics drawn from the 2001 household surveys and the projected growth, estimates o f labor demand, broken down b worker education level, will lead to upwards o f 318 000jobs against 293,500 labor supply4 7. 46 See Glick et al., 2003 andNasir,2003 47 The methodologyto simulateurban labor demandis explainedinVolume 11. - 34 - Table 3.3: Urban labor demand projections: 2004-08 Labor Supp ducation lev Labor Demand(#workers (#workers No Education 20,300 51,900 Primary 49,300 66,800 Low Sec. 111,600 107,300 4,300 HighSec. 118,600 61,100 57,500 University 18,200 6,400 11,800 Total 318,000 293,500 Staff estimates basedonthe HH2001 3.73 Up to 80 percent of the deficit in labor supply will be related to skills equivalent to higher secondary education and to the growing sectors that require skilled individuals (at least 8 years o f education), where the employment growth rates and change in real earnings have been the highest. This compares with the Malagasy adult average o f 4.4 years, less than the five years needed to complete primary education, and for example with the Mauritian average o f 9 years. It suggests that, in addition to the lost opportunity of potential jobs, the current low educational attainment might further make it difficult for the labor demand to reachmost o f the poor48. 3.74 Reforms in education are crucial. First, a strategy that would seek to develop the growing sectors and absorb the excess rural labor force is a viable pro-poor option inview o f the low growth inagriculture and the large percentage o f the poor inthe sector. However, this strategy needs to be supported by policy aiming at creating a pool o f available skilled workers from rural areas. Second, even inthe event o f a strong rural growth, reforms aiming at providing the skills to the poor in rural areas via formal or technical education are o f considerable importance for poverty reduction as the percentage o f non poor increases with the level o f educational attainment (Table 3.4). Failure to address skills mismatch i s likely to replicate the pattern o f the redistribution of growth over the 1997-2001 period, with most o f the benefits accruing to those at the top o f the distribution, ifthe labor demand is met4'. Table 3.4: SelectedComparisonsbetween Poor and Non-Poor Householdswith respectto Education (2001) Education(years) 4 8 Technicaleducation( percent) 1 9 Primaryeducation( percent) 22 14 Secondary Education( percent) 21 55 TertiaryEducation( percent) 1 11 SubsistenceHH( percent) 44 12 Monthly per householdsexp. (FMG) 508,235 2,162,090 Source: HH-2001 48 The average educational attainment in farm activities where most of the population and the poor earn their living i s 4.2 years as opposedto an average of abit higher than 8 years inthe growing sectors. 49As employmentgrowthwould likely greatlyreducepovertyinurbanareas as was the case overthe recent growthperiod. - 35 - 3.75 One of the medium- longer term outcomes o f an unmet demand o f the growing sectors in industry and services may be an upwardpressure on wages and a capital deepening, as has been the case in Mauritius, with the prospect o f a structural unemployment problem and its adverse impact on poverty, and the likely impact on the competitiveness o f Madagascar. Box 3.2: Growth Accounting in Mauritius over the Recent Period In Mauritius, there seems to be a change toward a capital deepening and a decline of labor's share in growth accounting. For the economy as a whole, economic growth has been driven by inputs, capital in particular, facilitatedby the rents accruingto investorsfrom the sustainedhighgrowthof the past.The recent upwardtrend of the level of MFPmight have occurred from the adoptionof more advancedproductiontechniques resultingin dynamic gains in efficiency. The share of labor in growth accounting is decreasing and there has been an increasing number of unemployed, estimated at 9,2 percent of the population in 2001. While there has been heavy capital investment in Mauritius, at present, a significant gap in educational attainment and vocational training, compounded by the rigidity of the labor market, contributedto an increasingrate of unemployment, andencouragedresortingto foreignworkers. 1983-1989 5.71 48.34 47,48 4.17 1990-2000 5.69 11.43 69.04 19.52 Source: Ministryof EconomyandDevelopment, Mauritius.MFT:Multi-factorproductivity The challengesfor Education Policy.. . 3.76 Against this background, education policy has an important role to play in strengthening the competitiveness o f Madagascar and enabling the Malagasy labor force to respond to the demand for skilled workers that may accompany growth in the future. Three main objectives arise: (i) to increase enrollment and completion rates in primary and post- primary school levels, at least to junior secondary level; (ii) to adapt the existing skill supply to the demand of the labor market; and (iii) promote private participation, both as a to financing mechanism, and as a means o f ensuring the appropriateness o f skills development to market demand. 3.77 These objectives require measures across all levels o f the education system -primary, secondary and tertiary education, as well as vocational training. However, objectives (ii) and (iii) tomoveintohighergearintheshort-andmediumterm, giventheloweducational need attainment among the adults and the labor force. Inthis reform effort, ensuring access o f the poor to education services shouldremaina priority. ...span primary and secondary school reforms.. . 3.78 The Government has made primary education reform one of the main focuses o f its poverty reduction strategy, notably through the Education for All (EFA) policy as expressed inthe Strategic Plan for the Reform and Development ofthe Education Sector. The objective o f the govemment's strategy i s to ensure that all children o f school age are enrolled and are able to complete the five years o f primary school by 2015, already with some positive result^.^' To improve the quality o f education, further actions are required to address: (i)the unequal distribution o f teachers across schools and the student-teacher ratio which remains For instance, enrolment rate in primary schools increased from 67 percent to 82 percent between 2001 and 2003. It is reportedthat enrolment reacheda level around 90 percent in 2004. - 36 - high, above 50 inmost rural areas; (ii) repetition of about 30 percent and drop out rates high and the implementationo f the compulsory 9 years education. 3.79 Most important is the need to extend these measures to secondary education, particularly to the junior secondary level. Increasing enrollment in primary education alone will not produce an equal increase in enrollment in the lower secondary level, as the cohort survival rates in secondary education i s also low. However, not much has been done to reform secondary education despite the objective o f targeting compulsory `Basic Education', with five years of primary education and four additional years of lower secondary. The goal i s to be reached by 2015 but analytical work will be much needed to determine the best policy options to achieve that goal5'. ...technical and vocational secondary education.. . 3.80 Vocational training is key to the provision o f the necessary skills to the labor demand to match labor supply. Currently, the sector i s characterized by increasing and unregulated private provision (currently accounting for 60 percent o f enrollments) for which very little information is available5*. Vocational training and technical education have beentraditionally offered by the public system, but public institutions have not been successful inprovidingthe skills demanded by the private sector in a cost-effective manner: (i) public provision o f the this type of education is highly fragmented, concentrated invery few provinces, and offering very few options, with most o f them only offering two or three topics; (ii) studentlteacher and studentlnon-teaching staff ratios are very low. As a result, the unit costs in these schools are high, almost twice as large as similar schools inother developing countriess3;(iii) few very students graduate from these institutions (only 40 percent of those enrolled inthe Centres de Formation Professionnelle (CFP), and 30percent o f those enrolled in Lycies Technique Professionnelles (LTP). 3.81 A review of vocational and technical education and training in the region (Johanson and van Adams, 2004) concluded that the public sector should "complement" the private sector and not duplicate its efforts. To better respond to the labor demand, among government's options to be explored are the following actions: (i) to strengthenthe existing training providers by promoting and establishing stronger links with firms in the growing sectors, which will also help cover more options. It i s a pre-requisite before expanding the network coverage; (ii) to finance vocational training through contracts with private providers, and; (iii) to create incentives for the firms, inthe growing sectors, to offer adequate skills and training to worked4. 3.82 The government could start by regulating the sector as quality variations in the provision o f professional and technical educationtend to be larger inthe private sector. More specifically, the role o f the govemment should be directed towards the following areas: (i) "Recentdatasuggestthat bottlenecksbetweenprimaryandsecondaryremainhigh(seeVol 11).A morein- depth study to examine the effect o f not only individual and household variables affecting the demand at this level, but also the effect o f school fees, distance to school, and quality of education is needed to determine the best policy options to increase enrollments inpost-primary levels. 52 See Vol I1for a list of the inefficiencies for the students enrolled inpublic-sector vocational schools. Administrative data indicates that in the school year 2002-2003, the studentkeacher ratio in public CFPs, Centres de Formation Professionnelle, was about 8.6 while in LTPs, ,Lyce`es Technique Professionnelles, was about 17.6 (MINESEB2004). 54 Hart, Schleifer and Vishny (QJE, 1997) discuss the appropriate break up inthe supply o f services betweenthe private and public sector. - 37 - setting standards and assuring quality; (ii) developing curriculums and instructional materials; (iii)providing information on the private sector services and on labor market requirements; (iv) financing training only for disadvantaged groups that otherwise would not be able to afford it; (v) and directly providing services only when the private sector cannot or would not offer these services, such as in some geographical areas or in skills that are two costly to provide, ...as well as tertiary education 3.83 Tertiary education in Madagascar i s provided mostly by the public sector through autonomous universities, although some private providers have started to offer programs to a very limited number o f students. Although assuring that a large proportion o f the population masters the basic skills needed to perform inthe labor market i s important, higher education should not be disregarded. For instance, the creation o f highly skilled labor can on itself create comparative advantages in the export o f certain services, such as in IT industry. Although evidences suggest that there are constraints in the supply o f higher skilled workers", at the moment there is not enough informationto determine whether the education offered by tertiary institutions in Madagascar is attuned with the demands o f the labor market. Policy aiming at improving the links between education and the labor market that goes beyond the basic skills provided by primary education and secondary higher education will needto be based onmore detailedinformation than is currently available. 3.84 Inconclusion, significantprogresshasbeenmade ineducationwiththe net increase in primary school enrollment rate which i s now more than 90 percent. However, given the importance o f illiteracy rate in Madagascar, the difference between the needed average educational attainment to support the growing sectors and the skills available, two reforms emerged as priority inthe short-term : (i) to revamp vocational trainings inorder to respond to the growing needs o f the growing sectors, including the establishment o f a partnership between the training providers be it the State or the private sector with firms; (ii) to increase the completion rate in primary and secondary schools. In addition, an assessment o f the adequacy o f the skills deliveredby higher education to the skills requiredby the labor market needs to be conducted. The Banking Sector and Microj?nances6 A healthy but uncompetitivebanking system 3.85 Ifthe health of the financial sector has been improved since the privatization of the state-owned banks, the challenge i s to address the lack o f long-term credit which i s clearly a constraint on investment. Duringyears subsequent to the privatization of the banking sector in the late 199Os, return on assets and equity, and liquidity assets have increased. Non performing loans and capital at risk have decreased although remaining at a fairly high level. Nonetheless, the regulatory capital to risk-weighted average remains above the ratio Cooke for all banks and adherence to the Basel Core Principles i s moderately satisfactory with capital adequacy ratio inline with Basel Irequirements (see Fifthreview o f the IMFprogram - October 2004). The overall supervision framework has been improved following technical assistance provided by the IMF in 1999 and 2002 but needs to be further strengthened. 55 Anecdotal evidence from the textile industry shows that most of the managerial, quality control experts, supervisors, andtechniciansworking on them are expatriates. 56Most of the remarkson commercialbanks are drawn from IF, vol. I,section4.3.2. - 38 - Quality o f risk management in financial institutions i s moderately satisfactory with three level internal control system regularly reviewed by the supervisory agency (CSBF). 3.86 Financial intermediation remains relatively poor. Credit to the private sector as a proportiono f GDP i s still low, at 9 percent as o f 2003. The lack o f long-term credit, except to foreign multinationals, i s clearly a constraint on investment. The majority o f firms are dependent almost exclusively on retained earnings to finance capital formation and sizeable share o f the population, including SMEs, does not have access to formal sector financial services yet. With only seven banks, very limited access to external financing for the private sector, the Malagasy banking system i s highly concentrated, even by the standards of Sub Saharan Africa and 57. Most o f the banks make their largest profits through investment in Treasury Bills.The banking system i s highlyliquid with highlevel liquid assets to total assets (50.5 percent) and o f liquid assets to short-term liabilities (74.5 percent) in 2003, keepingan upwardtrend over the years, denoting at the same time a conservative credit policy. 3.87 A number of factors account for this outcome. First, the regulatory framework does not cover adequately the risks banks are facing: availability and seizure o f collateral, and bankruptcy law are inadequate. Although decreasing after the privatization o f the state-owned primary banks, non performing loans (NPLs) have been fairly high, inparticular subsequent to the 2002 crisis5*.Second, against the alternative o f almost riskless investment in Treasury bonds (BTA), albeit at relatively low interest rates, the private sector finds it difficult to comfortable rents. Intermediation margins have beenhovering for years around 8 percent - 10 compete for the attention of bankers59. Third, the Malagasy banking sector enjoys percent in 2003 and 2004 - and reflect substantial interest-rate spreads between loans and deposits. There are also very profitable operations on the foreign-exchange market, which i s the main profit center for Banks (IMF 2000), and high fees for a number o f transactions.60 Fourth, six out of the seven banks are foreign-owned and restricted by exposure limits imposedby head .,.requires several measures to support investment 3.88 Reforms in the banking sector have been more focused on measures related to the strengthening of supervision and risk management o f the financial sector6* by developing an early warning system for bank fragility and establishing closer cooperation with the supervisory agencies incommercial banks' home countries. 3.89 Inresponse to the lack oflong-term credit, a couple ofinitiatives have beenlaunched. With the assistance of donors, the authorities have established the procedures for the use of the Loan Guarantee Fundin2003 and intended to streamline the procedures for coverage of more loans. A recent amendment o f the Property Act aims at alleviating the collateral problem, but its full impact will only be realized once an appropriate land registry system i s "Withcloseto2.5millioninhabitantsperbank,Madagascarinfactranksatthebottomofasampleof12SSA countries surveyed in 1999. '*NPLs to total gross loansdecreasedfrom 21 to 10percent in2001. Dueto the crisis, NPLs haveincreased significantly, reaching 19percentin2002. Currently, the rate is amountingto 16percent. Source: Fifth review ofthe IMFprogram- October 2004. "`Primarybanksarethemostimportanttreasurybillsholdersdetainingabout62,4 percentofTreasurybills detainedin end-2001. 6oSee the exampleson the cost of banking fees reportedin IF, section4.3.2. "FourthReviewoftheIMFprogram `*Most -March2003. ofthe measures aimedat improvingthe conformity of the Malagasyfinancial system to the Base1Core Principles. - 3 9 - inplace. Madagascar is currently one of three pilot countries for the establishment of a new International Financial Corporation (IFC) delivery platform to provide an integrated package o f services and financing to SMEs (SME Solutions Centers), officially open on June 14, 2004 and operational since end-October 2004. To date the SSC has received approximately 300 requests for support. Business Partners, a South African SME Finance company, will manage the financing component ofthe SSC. Commercialbanks, namely BOA-Madagascar and BNI- CrCdit Lyonnais, in which IFC has equity investment, have also expressed interests in providing support inthis area. 3.90 While banking soundness has been on the agenda o f the Government subsequent to the privatization, the challenge relating to enlarging the outreach i s at an early stage and has been more difficult to address. It requires a comprehensive set o f policies, ranging from the diversification o f the types of credit instruments to the strengthening o f risk management. In addition, the government could also improve incentives by strengthening the judicial system (which implies, notably fightingcorruption) and encouraging entry into the banking sector. A joint IMF-Bank mission i s expected to take place in the first semester o f the year 2005 to conduct a full assessment o f the financial sector. Measuresfor viable and sustainable microfinance institutions 3.91 As in many low-income countries, basic deposit, payments and credit services have remainedbeyond reach o f the majority o f the population. This arises for a number of reasons, including the inability o f commercial banks to reach the poor due to the poor state of roads and communications, low population density, highrisks farming activities, lack of collateral by low-income clients, and high information collection and transaction costs that make clients inrural areas less attractive to banks. 3.92 The Government has implemented a 15-year microfinance development program which started inthe early 1990s with the help o f international donors and, divided inthree 5- year phases. Phase 1, aiming to establish savings and loan associations (SLAs) or mutuelles networks has been extended untilend-2005. Phase 2 and 3 o f the program aim to consolidate and strengthen microfinance network and expandtheir reach to more than 500,000 clients. 3.93 Mutualist Micro Finance Institutions (MFI), membership-based organizations are serving 86 percent o f the existing market and operate 84 percent o f financial activities (savings collected and loans distributed). Non mutualists MFI are not regulated by any financial institutions. They put greater emphasis on credit distribution than on savings mobilization. Although still low, the penetration rate o f microfinance in Madagascar grew rapidly and reached 5 percent (150,000 clients) o f the active population o f Madagascar in 2003, comparedto only 1.4 percent in 1998. MFIprograms, mostly made up o f mutuelles, are now present in77 out o f 118 districd3.Average savings and loan size for clients have been increasing over the years. 3.94 However, access to credit i s skewed to the wealthiest. Analysis o f the household surveys in 2001 reported that assets o f households that reported to have obtained credit exceeded the average assets o f poor households by a factor 10. Most o f the MFIs are located 63 A World Bank microfinance project which became effective in 1999, established savings and loan associations (SLAs) or mutuelles networks, the most common type of MFIs in Madagascar in four out of six provinces. Today these mutuelles mobilize up to 63 percent of all savings inmicrofinance. - 4 0 - in relatively rich areas where they would rapidly reach operational and financial sustainability, leaving poor areas ~nderserved~~. 3.95 The challenge o f microfinance is, not only to improve the depth and outreach but also, to provide better access to credit to poor households. The Central Bank i s only involved in the regulation and supervision of mutualist MFIs. As a result, the Government i s conducting studies to develop a supervision and prudential regulation framework for non mutualist MFIs which mobilize public savings to allow them to expand their activities. The objective is to build viable M F I s and ensure a sustained growth of microfinance by encouraging financial competition and efficiency, protecting depositors and maintaining the integrity o f the payment system. The setting up o f active supervisory services and a legal framework that allows for effective enforcement o f financial contracts to legally repossess clients' assets when they fail to repay a loan are the main challenges to be addressed. Finally, inorder to be able to reach the poor a better knowledge o f the size and needs o f the potential market for micro finance services inMadagascar i s much needed, without which it i s difficult for MFIs and donors to establish clear objectives both in terms o f geographical establishments and financial services to be provided. Table 3.5: SelectedPerformanceIndicatorsfor Madagascar's Savings and LoanAssociations in Microfinance,as of December31,2003 Start date 31/03/99 31/03/99 28/10/99 30/06/00 01/06/01 -_ Numberof SLAs 38 12 36 31 13 130 Total Nb. Of 37,500 12,204 13,580 26,000 9,411 98,695 membersklients Total Savings 21,952 9,176 5,900 14,270 8,740 60,038 deposits(million FMG) Average savings 585 752 434 549 929 608 amount(`000 FMG) Total 12,092 8,642 5,037 4,401 3,473 33,645 outstanding LoanPortfolio (million FMG) Average Loan 2,829 4,023 1,777 4,433 3,277 -_ amount (`000 FMG) Operational self- 65 92 77 68 93 _ _ sufficiency (percent) Source: World Bank Microfinance Project Agence d'Extcution duProjetMicrofinance - 64See RuralDevelopmentand Environment Economic Sector Work. Madagascar - World Bank 2003. -41 - SUPPORTING THE GROWTH POLES 3.96 In its development strategy the government has placed high priority on policies to nurture the development o f the growth poles and support export performance. Inthis respect, four sectors have received particular attention: the EPZ sector, which i s dominated by textiles; tourism; mining; and shrimp farming, inparticular through the growth pole project (IGPP). They clearly have the potential to drive an export-led growth. Duringthe 1997-2001 growth period these sectors accounted for approximately one fifth of output, and well over 50 percent o f export earnings. They represented 53 per cent and 60 per cent o f total exports, respectively in2003 and 200465. 3.97 These sectors also have the potential to balance regional growth and poverty: while textiles remain centered in the highlands, (and already accounts for the country's major growth pole), mining potential is mainly in Southern Madagascar. Shrimp farming and tourism have the largest potential on the west coast and in the north, respectively. However, growth in these sectors needs to be accelerated to benefit a larger share o f the population. While the rate o f employment creation in these sectors is likely to be high, they nonetheless accounted for little over 3 percent o f total direct employment in 2001 or roughly 275 000 jobs66.The degree to which there canbe a broader sharing o f the benefits o f growth generated by these sectors will also depend on the strength of linkages between the poles and the surrounding economy. 3.98 However, while nontraditional exports have expanded rapidly in the recent past - shrimp, tourism, some minerals andEPZ exports of garments -, exports have decreasedinthe aftermath of the crisis and have not resumed to their pre-crisis levels in 2004. In 2001, total exports amounted to SDR757.7 million versus a projected SDR621.2 million in 2004. If tourism receipts have almost doubled between 2003 and 2004, accounting for an increasing share o f foreign exchange earnings (8 percent in2003 and 18 percent in 2004), and are well above that of 2001, the impact of the political instability in 2002, late confirmation o f the renewal o f the AGOA in2004, and the uncertainprospects for the post-MFA intextiles may have slowed down textiles' growth, although textiles exports still account for the largest share in terms of foreign exchange earnings (26 percent of total foreign exchange earnings). In addition, the sharp decrease invanilla price has hurt Madagascar's exports. 3.99 This trend points to the vulnerability o f the current export base o f Madagascar and the necessity to adopt a more aggressive export push policy and to diversify rapidly the export base with a focus on products for which Madagascar has a comparative advantage. Adapting EPZManufacturing to the New CompetitiveEnvironment A recent history of significant growth ... 3.100 The EPZ sector, although small, is by far the fastest growing part o f the Malagasy economy. Comprising 1.7 percent o f the GDP and about 10 percent o f the secondary sector in 2004, it grew at an average annual rate o f 21 percent over the 1997-2001 growth period. The sector has also shown considerable resilience in the face o f the 2002 political crisis, with employment and exports now havingreturnedto pre-crisis levels. 65Basedon national account data for the EPZ sector, miningand fisheries. National accounts data is not available ontourism as a sector, and so estimates are based on staff calculations. 66Staff estimatesbased on the 2001 household survey. - 42 - 3.101 While a range o f activities fall under the EPZ regime, the sector is dominated by the textiles and garment industries, which comprise 94 percent o f activity - o f this, the garment sector accounts for 40 percent o f production, and 60 percent o f output. Garment sector provided direct employment to 110 000 workers in 2001. On average, textiles exports accounted for 26 per cent o f Malagasy exports in 2003 and 200467,and Madagascar is now the fourth largest exporter to the US among AGOA suppliers. Madagascar's comparatively low labor costs and preferential access to US markets through the Africa Growth and Opportunity Act (AGOA) have beeninstrumental indriving the success of textiles firms. Table 3.6: US Clothing Imports:Madagascar'sShare vis-his sub Saharan Africa 2001 percentof 2002 percentof 2003 percentof (miliion$) TotalImports(million$) Total Imports(million $) Total Imports Madagascar 178 18.3 89 7.9 196 12.8 Lesotho 215 22.1 321 28.7 393 25.6 Kenya 65 6.7 126 11.3 188 12.2 Mauritius 238 24.4 255 22.8 269 17.5 SouthAfrica 195 20.0 200 17.9 253 16.5 Rest of SSA 84 8.6 129 11.5 236 15.4 Total: Sub-SaharanAfrica 975 100.0 1,120 100.0 1,535 100.0 Source: Office of TextilesandApparel, US Dept. of Commerceand staffs calculations ...now challenged by a significantly more competitive external environment.. . 3.102 Inthe short term, however, the sector will face significant challenges that put at risk much o f its output, and the jobs dependent on it. While the AGOA was renewed, the expiry o f the MFA inJanuary 2005 will bring about the elimination o f all quantitative restrictions on imports from specific origins. This will effectively remove the quota cost advantage that made Madagascar an attractive destination for many o f those firms that invested in the EPZ sector to take advantage o f Madagascar's unusedquotas. The reliance inthe past on displaced manufactures from quota-bound countries, which led to narrow product concentration, will make the industryhighly vulnerable to competition, now that quotas are removed68. 3.103 This i s compounded by increasing price competition from countries negotiating free trade agreements with the US, such as Mexico, Jordan and others, that might erode the 17 percent price competitiveness Madagascar enjoys for wool and cotton garments due to its duty-free access. Similar price competition can be expected by cheaper EUexporters putting Madagascar's competitivenessat stake. 3.104 Madagascar's challenge i s to take advantage o f the renewal o f the AGOA which grants Madagascar with a quota at preferential rates. It should be viewed as a window of opportunity to strengthen the competitiveness of the sector and challenge the likely impact o f the MFA. 3.105 This challenge raises three cross-cutting priorities. These are labor productivity; availability, quality and cost o f industrial infrastructure and utilities; and fostering backwards and forwards linkages within the domestic economy. 67Source :INSTAT - Madagascar 68USAID Study, September 2003 and ITC Study, December 2003. - 4 3 - ...requiring improvementsin labor productivity.. . 3.106 Although Madagascar i s competitive interms o f labor costs, with the low wage rates, labor productivity i s affected by high turnover o f 15-17 percent (attributed to poaching o f trained workers by new firms) and high absenteeism rates (12-15 per~ent)~'.Although, it i s unclear how this problem affects the competitiveness o f Madagascar, a review o f the labor legislation i s probably needed to lessen the impact of such issue. 3.107 In addition, in the medium-term, there is a risk o f skilled workers shortage at the supervisory and middle management level as explained in the chapter covering the labor market analysis. A strengtheningand an expansion o f the technical and vocational training to supply the skills needs of the industry through the promotion of a collaboration between the firms and the Government (such as a levy grant scheme or fiscal incentives in other countries) to promote enterprise-based training is a priority action inthis area. ...and industrial infrastructure, ... 3.108 Another priority i s to address the availability, quality and cost of industrial infrastructure and utilities. Although most o f infrastructure issues are covered in the chapter on Infrastructure in this DPR, it i s worth noting that the high cost o f land and air freight transport and the lack of logistics facilities such as inland container depot facilities coupled with inefficientport operations are major factors affecting the competitiveness o f the industry inMadagascar. A comparison of industrial rents acrossthe region also reveals that industrial rents inAntananarivo, where the EPZ firms intextile are concentrated, are almost double that in Mauritius or Botswana, ranging between US$3.50 and US$ 4.00 per square meter, compared with US$1.50 per square meter incompetitor countries. Although there are private industrial parks, these tend to be poorly sited, do not have adequate facilities and do not enjoy EPZ status. The investment in the railway network under management contract, ports and airports, and the EPZ component of the government Growth Poles project should go some way to addressing these shortcomings. ...integration into international supply chains and more developedbackwards and forwards linkages ... 3.109 Third, addressing constraints to the development o f backwards and forwards linkages inthe sector comprises a final priority. Interviewswith firms suggest growinginterest insub- contracting work from the EPZ firms to local operators for basic cut-and-trim and sewing activities. There is also scope for local firms to supply packaging materials, hangars and other accessories to the EPZ firms. However, the EPZ law on movement of goods from EPZ firms to non-EPZ firms i s not conducive to support the growth o f the sub-contracting industry. The VAT payment requirement for domestic inputshinders the development of domestic linkages and the creation o f a domestic accessories supply industry. Policies aiming at lifting the regulatory obstacles to the establishment of supplier and sub-contracting relationships betweenEPZ firms and EPZ and non-EPZ firms should be explored. 3.110 Part o f the reasons why Malagasy firms' products were not diversified is also due to the fact that the regional and international production supply chains, into which firms in the garment industry tend to belong, were very poorly integrated into the Malagasy economy. Significant quantities o f fabrics were importeddue to the poor quality o f the locally produced 69UNIDO, 2001. - 44 - fabrics. The inefficiencies o f the state-owned cotton company (HASYMA) led to unutilized ginning capacity and declining fiber production. The contract for the privatization o f HASYMA was signed recently. The privatization of the HASYMA, holds promise for the redress o f the identified inefficiencies to meet cost, quantity and quality requirements for yam and fabric to supply the garment exporters. Closer attention should be paid to the variety o f fiber to meet various intemational standards. 3.111 A diversification o f the quality o f fiber can also help diversify textile products and reduce reliance on quota bound products if the variety o f inputs i s available. More than 85 percent o f Madagascar garment exports to the U S consists o f cotton-based apparel and there i s evidence o f increasing specialization in specific product categories particularly in women'dgirl's slacks and men'shoy's knit shirts which are considered as "hot quota " items7'. 3.112 In conclusion, although textiles used to be a strong vehicle for growth and foreign exchange earnings and employment creation, the expiration o f the MFA raises uncertainty about the near future. Inthe medium-term, if the AGO expires, the strong competitiveness of Madagascar i s likely to be weakened and it will be difficult for Madagascar to compete with countries such as China and India for example. This i s why this AGOA period should be viewed as an opportunity to address the main issues hampering stronger competitiveness o f textiles. Apart from cross-cutting constraints such as the cost o f transport and investment climate, the most specific constraints are related to: (i) the availability and costs o f industrial facilities; (ii)policies that aim at developing backward and forward linkages and diversifying textile products. Such policies include the diversification o f HASYMA products and the revision o f the tax law governing the transactions between EPZ and non EPZ firms; (iii) the provision o f skills through a closer collaboration between the Government and the firms operating inthe sector. Prospectsfor non garments EPZ manufacturing 3.113 For the strengthening o f the Malagasy export base, the development of non-garment EPZ which have not been explored or supported so far i s as important as the strengthening of the textile EPZ7'. 3.114 Handicraft i s among the promising sectors with a potential for poverty reduction due to the linkages between the mainstream handicraft exporters and the small, informal suppliers and s~b-contractors~~. The Integrated Framework (IF) reported that while the growth prospects for the handicrafts sector are good, support should be provided to address : (i) the lack o f technical knowledge on product design and development, quality control and scaling up productionto commercial scales ;(ii) lack o f technical training and skills development the programs to support the industry, (iii) the lack o f market information and knowledge o f exporting requirements; (iv) fragmented institutional structure with many different institutions having overlapping responsibilities to support the development o f handicrafts (v) the weak supply chain resulting inunreliable supply of raw material inputsboth interms of quantity and quality73. In addition, unlike the garment firms, the handicraft firms are reportedly unable to enjoy the full export incentives of the EPZ regime because o f their small 70 USAIDStudy, September 2003 and ITC Study, December 2003. 71 Other EPZ manufacturingactivities include furniture manufacturing; wood processing; handicrafts; precision medical instruments,optics and clocks; leather items and footwear; shrimp rearing/processingand ICT firms. 72 A study on the sector i s beingfinalized. 73 Findingsfrom an on-goingstudy by Sud Conseil StratCgie- Madagasar. - 4 5 - size and significance as well as the perceived complexity o f getting the necessary approvals for operating under EPZ status. The Tourism Sector 74 Vast tourismpotential.. . 3.115 Given the wonderful flora and fauna and its highendemism, Madagascar i s primarily an ecotourism de~tination~~.The tourism sector grew at an average rate o f 11 percent, saw increasing tourist visits by 70 percent and provided a bit less than US$250 million over the recent growth period(1999-2001). Tourism reboundedafter the crisis and grew at a rate o f 13 percent, after faltering to 35 percent in2002, with most o f indicators improving dramatically, in particular tourism receipts which are projected to double from 2003 to 2004 with an increasing share in total exports from 8 to 18 percent o f total exports (Table 3.7). In 2004, estimates for nonresidents arrival were 228 784. The country's assets suggest that the current small size o f the sector reflects substantial unrealizedpotential. 3.116 Tourism can be a potent tool for development. Because the assets extend over the island, tourism creates pockets of economic growth in regions that have no alternative sources o f income and employment. In remote regions, tourism helps alleviate poverty by diversifying income sources. An example o f such a Pro-Poor Tourism policy, developed with the Executive Agency o f Environment Policy (ANGAP), seeks to bring those living near natural parks into the preservation of flora and fauna, with half the entrance fees collected in the national parks shared with the local communities. Ifproperly managed, tourism can also help preserve the environment, whether for ecotourism or for resort-based tourism. The realization o f this potential will require measuresto address a number o f constraints. Table 3.7: RecentPerformanceofthe TourismSector Tourism 44.6 52.9 65.5 72.9 91.9 81.6 27.8 54.0 104,3 receipts (US$ millions) Number of 82,681 100,762 121,207 138,253 160,071 170,208 61,674 139,230 228,784 visitors Source: TourismEconomic Sector Work, 2002 (World Bank) - Ministry ofTourism and Culture ...constrainedmainly bypoor infrastructure and accommodationprovision 3.117 A number o f factors have been hampering significant development o f the tourism sector. They are mostly supply constraints. The most important o f these is the inadequacy o f the country's infrastructure. International access i s inconvenient for all tourists except residents o f France (and South Africa) because o f the few gateway cities in tourist supplier markets77.The scheduled carriers, Air France, Corsair and Air Madagascar, dominate travel 74This section summarizes the mainfindings ofthe TourismEconomic Sector Work (World Bank, 2002). 75It is reportedinthe Tourism Economic Sector Work (2003) that 55 percent oftourists are ecotourists. 76 These estimates do not take account of employment generated by tourism in agriculture, fishing, ago- industries and manufacturingintransport and other tourism-relatedservices (such as scuba diving, guides, etc), andinthe handicrafts sector. 77and Italy is the only other gatewayinEurope.These figures were taken from the Economic Sector Work on Tourismproducedin2002. - 46 - from Paris to Madagascar with code share arrangements. Because of lack of competition among the few air carriers that serve Madagascar, airfares are prohibitive and weigh heavily inthe total tourist package (at least 50 percent). There are also constraints relatedto lack of quality andreliability o f internal transportation, due primarily to the country's weak road network (see chapter on Infrastructure) and the absence o f adequate health facilities in most cities78. 3.118 Similarly, despite the country's extraordinary asset base, only a few destinations benefit from tourism because o f the poor quality o f available accommodation. Even in the main destinations, there i s evidence o f scarcity o f quality lodging inthe peak season. Only a small number o f hotels meet acceptable standards and the majority o f existing accommodations are designed for relatively low-income international tourists. Among the several difficulties facing hotel (and other) investors in Madagascar, the most frequently mentioned i s that o f acquiring title to land. Inthe recent past, to obtain a long-term lease to unregistered state land, the application had to be submitted repeatedly for the approval o f the surrounding community, a non-transparent process that can lead to delays o f several years or more. Most importantly, because o f potentially undiscovered claimants, investors face lack of security o f tenure. 3.119 Infrastructure problems were compounded by lack of effective promotion o f Madagascar by either the public or private sectors which restricts its access to supplier markets. Inturn, it has contributed to the absence o f brand name hotels. Thegovernment's Tourism Master Plan provides the basisfor a response... 3.120 Inthe recent past, the surge intourism was mainly due to the overall strategy aiming at opening up the country and the development o f the private sector that ensued. Inhindsight, there was a lack o f clear strategy to develop the sector. 3.121 Currently, the Government i s in the process of producing a Tourism Master Plan which will lay the foundation for interventions in two key policy areas. The first i s the initiation and the development o f Rksewes fonci2re.s touristiques - clusters where tourism investment in ecotourism and resort areas can be undertaken to resolve the problem o f making land available to tourism investors. The second area addressed in the Master Plan i s the development of policies to encourage Pro-Poor Tourism. The Government has integrated the pro-poor aspects o f tourism in its planning. Several initiatives aim at developing ecotourism and incorporating local communities in the protection o f identified areas to enhance economic gains for the poor. ...accompaniedby the growth pole and other investmentinitiatives.. . 3.122 At the same time, the government has undertaken a range o f initiatives to address supply side constraints in the sector. As part o f the government's Integrated Growth Poles Project (IGPP), the island o f Nosy Be has been identifiedas a sight for targeted interventions to boost the tourism industry. The proposed intervention comprises a number of measures : the formulation o f a tourism and urban development plan to regulate and manage existing development and plan new initiatives; upgrading o f the road, water and sewerage, power, and telecommunications network, as well as medical amenities; refurbishing cultural heritage sites, such as Hellville; enhancing institutional capacity at commune level for planning, See Economic Sector Work on EPZ- World Bank 2003. - 47 - administration and provision of urban services; the creation o f a regional development committee for the island; and supporting industry-led skills development programs for the sector. 3.123 IFC i s also actively engaging in the development of a chain o f five hotels to be located in Antananarivo and in other regional capital cities. In order to take advantage o f Madagascar unique bio-diversity, IFC i s also actively seeking a world-class sponsor for the development o f a network o f Eco-lodges to be established beside the national parks. This identification exercise i s conducted jointly with the WWF. ...and a range of measures to improve the institutional environment 3.124 The planned investment i s complemented by a series o f institutional measures. First, the implementation of GUIDE aims at facilitating private investmentinthe sector while the enactment o f the law allowing foreigners to buy and own land complements the RFT policy. Second, the promotion o f Madagascar has been reinforced with the creation o f the Ofice National du TourismeMalguche (ONTM). The ONTM is an agency that regroups the private and public sectors, operating with regional branches -Ofice Rigional du Tourisme (ORT) - to promote and highlight regional comparative advantages. Third, the restructuring o f the state-owned hotels has been scheduled to take place from 2004 onwards. This program aims at improving the management o f the state-owned hotels, raising the standard o f the accommodation in Madagascar and attracting foreign investors. Finally, new gateway cities intourist supplier marketswere openedrecently, inMilanandBangkok. A number of areas requirefurther attention 3.125 In conclusion, tourism i s probably the sector that has the strongest potential for foreign exchange earnings and linkages with the rest o f the economy. The expected impact of tourism on growth and poverty development can only be achieved through an increase of the number of tourists. Therefore, the sequencing of policy should address the most binding factors constraining this objective. 3.126 The abolition o f many infrastructures such as accommodation and transport costs problems appear among the priorities. The open skies policy, expected to lead to an increase inthe numberof gateway cities and to cheaper air transportation costs, has been initiated. In the area of accommodation, the restructuringof the state-owned hotels and the RFT initiative be streamlined andprioritized. With several actions inparallel with different procedures - the has been slow and has not yet brought out concrete results. Accommodation policy needs to IGPP being under an EPZ-type law, the RFTs and the privatization o f the state-owned hotels being under the common law -, the strategy needs to be clarified to avoid conflicting messagesthat may arise with the different existing incentives. 3.127 To provide adequate promotion o f Madagascar, careful coordination will be needed between the ONTM and the Maison du Tourisme and an adequate financing mechanism to support their activities will need to be establishedto set up a more aggressive promotion policy for Madagascar as tourism destination. 3.128 The Pro Poor Tourism (PPT) initiatives policies would benefit from the existence of collated information to enhance their effectiveness. A number o f pro poor tourism initiatives are taking place. Some o f these projects were undertaken with the assistance from different technical agencies like LDI, WWF and Conservation International (CI) among others. If the - 4 8 - informationwere centralized, it would assist the Government and, principally, the Ministry o f Tourism to analyze the experiences and develop policies for PPT. TheMining Sector A significant potentialfor growth and linkages to the domestic economy 3.129 Since 1996, official mining exports have increased from US$16 million to US$37 million and annual investmentexpenditures increased from about US$ 10 millionto US$ 40- 50 million today. At present, the extractive industries reflect 0.2 percent o f GDP, while mineral exports represent 3 percent o f total exports. 3.130 Given Madagascar's extensive natural endowment o f mineral resources, relatively cheap labor costs, the ongoing sector reforms and the current exploration boom, a significant expansion o f the sector i s likely. Large projects - representing planned investments o f more than US$ 1billion-have moved into feasibility stage, with decisions expected in2005/2006. Mineral exports are expected to increase to about US$lOO to US$lSO million per year over the nextten years7'. 3.131 The mining sector also offers significant opportunity for diversification o f non-farm rural income. About 2 300 operators are active in rural areas, providing direct and stable employment estimated at about 100 000 persons. An additional half-million seasonaljobs are estimated to be linked to the sector. Forward linkages, in the form of gem polishing and cutting, hold significant potential for job creation and additional domestically-addedvalue. Despite afirstgeneration of reforms in the late 1990s... 3.132 The liberalization o f the sector undertaken in the late 1990s was instrumental in the emergence o f the mining sector. Among the key reforms are a new mining code that puts all investors on the same base, irrespective of their origin or their capital ownership; environmental regulations for mining, publishedjointly by the Ministry o f Environment and the Ministry o f Energyand Mines; a special law for large-scale mininginvestments, defining an attractive special investment regime for FDI; and the establishment of a non-discretionary and transparent system to grant, manage and cancel miningpermits with the creation o f the MiningCadastre. ...significant problems in the administration remain 3.133 A number of challenges still exist to the harnessing o f the sector into an effective growth strategy. First, weak enforcement o f the mining code, in gemstones in particular, diverts the artisanal mining outside the formal channels, with insufficient linkages to the rest ''QIT MADAGASCAR MINERALS S.A. (QMM) is ajoint venture company held at 80 percentby QIT-FER, a subsidiary of RIO TINT0 (Great Britain and Australia) and at 20 percent by the Malagasy State, aimingto develop ilmenite deposits in Fort-Dauphin, Toliary. The deposit contains 67 million tons of high quality ilmenite, a world class deposit. Total investment i s put at US$350 million, for a total annual production of 750,000 tons at full capacity. The investment decision is expectedin 2005. DYNATEC/ PHELPS DODGE i s a joint venture company held by Dynatec at 53 percent and Phelps Dodge at 47 percent, for the mining of nickel in the region of Moramanga. The deposit contains 210 million tons of minerals with nickel content of 1.10 percent and cobalt of 0.10 percent. Expected production is 60,000 tons of nickel and 4,000 tons of cobalt per year for more than 20 years. US$ 20 millions are being invested in the preparation of a feasibility study, expected to be concluded by June 2004. Total investment is put at more than US$500 million, including a metallurgicalplantnear Toamasinafor the processingofthe ore. - 49 - of the economy, generating a substantial loss of fiscal revenues and causing damage to the environment". Second, the current export licenses mechanisms provide substantial leeway for redtape and corruption and at the same time, reduce the prospects for formal exports. The foreign exchange restrictions (obligation o f repatriation) lower incentives for exporters and gemstone purchases by tourists are subjected to the discretion o f the authorities. Third, thresholds on the special investmentregime are reported to be inappropriately high (US$200 million). 3.134 Another problem relates to the weakness in the administration and reflects in the collection o f the mining royalty. The contribution o f Madagascar's mining to government's revenues i s small even when measured against the modest size o f the sector. For instance, the mining royalty (redevance mini8re) due by the mining operators in 2002 totaled US$ 1.9 million. But due to cumbersome procedures and lack o f cooperation between the miningand the tax administrations, only about 10percent of this amount was effectively collected. Inthe beginning o f 2004 many mining companies, and not the smallest ones, were still negotiating the amount of royalties due for 2000. Another problem relates to the collection o f the sector specific tax through the laissez-passer system, which i s slow complex and inefficient". For instance, there i s little control on the declared production (on which royalties are based) and no follow-up on those that fail to declare. New measures aim atformalizing mining operation in thegemstone sector ... 3.135 In response to many o f these challenges, the Government i s currently launching a second generation o f sector reforms aiming to improve the performance o f the mining sector, provide opportunities to the small operators to benefit from the development o f the sector and strengthen the capacity o f the mininginstitutions. 3.136 Formalizing mining operations and improving transparency and governance in the gemstone sector are seenby Govemment as the preferential route to reduce the smuggling o f rough gemstones and increase the contribution o f mining to the economy. Among the government's most significant institutional reforms i s the creation o f the Gemological Institute o f Madagascar (GIM). It aims to disseminate information on Malagasy gemstones, set down noms for gemstone cutting and provide certification which will allow for increasing demand o f more valued added gemstones. But the GIM will also provide : (i) institutional support to small artisans and develop forward linkages inthe gemstone sector by promoting gemstone cutting and polishing and (ii) support to facilitate the access o f small artisans to imported equipments for polishing activities. In addition, marketing and commercialization mechanisms will also be revampedto further formalize miningoperations, with the establishment o fthe Comptoir dePierre for gemstone transactions inAntananarivo. 3.137 To allow the government to capture most o f the value o f the sector, a new royalty's mechanism on gemstone tax collection i s under consideration, with annual declarations to be replaced by retention at the source and with no gemstones allowed to leave the country without proof of previous payment o f all taxes due. For instance, rushes in gemstones do not fall systematically under the legislation. As a result, value added from mining escaped the country due to smuggling of precious stones out of Madagascar. Illegal exports are estimatedat US$200million per year, or 5 percent o f GDP. The operators declare the quantity of the first transaction on the basis of a laissez-passer on which the Government levies an estimated amount o f the tax due. - 50 - 3.138 Finally, to increase the participation o f domestic operators in mining, the administrative procedures to facilitate the access o f small artisans to miningtitles will also be simplified to provide equal opportunity and formal access to mineral resources to small miners. .,.andfocus on decentralization 3.139 To better enforce the mining code, the Government i s decentralizing the mining authorities based on the recognition that due to the immense variation o f Madagascar's geological and environmental conditions, a sustainable development o f mining cannot be achieved without a decentralized administration and a deep involvement o f the communities. The Agence de Promotion du Secteur Minier (APSM) was created to this end. It i s funded through a contribution o f 5 percent o f the royalties collected in the sector. The APSM will ensure an appropriate enforcement o f the law on large scale mining investments in the provinces, decentralize mineral resources management and provide support to small-scale and artisanal miners to access commercial channels. Inaddition, the Government is planning to open Mining Cadastre Office at the regional levels and set up itinerant cadastre office in areas o f production to provide better flexibility in administrative procedures for mining operations. 3.140 In conclusion, the mining sector holds a lot o f promises but the realization of the potential will require significant institutional reforms to strengthen the capacity o f the administration. First, although a public and transparent information system on granting o f licenses (beneficiary list, geographical zone, amount) in the sector has been implemented, a proper miningroyalties mechanism collection needs to be set up. The laissez-passer system also needs to be revamped to better reflect the value of the transactions in the sector, in particular at the export level. Failure to do so will weaken the revenue collection system and put the APSM activities at stake. Second,the implementation o f the APSM calls for a strong capacity building program of the deconcentrated and/or mining administration, with the establishment of a better alignment between core central public sector functions. Third, to significantly increase the value o f exports, the priority for Madagascar i s to make sure that the FDIexpected to start in2005/2006 inthe sector is finalized. Fourth, setting clear rules for gemstone purchase by tourists might help reduce the heavy control on exports and reduce leeway for corruption. Not only will it, reduce the risk o f smuggling, but it will also provide more opportunities for increasing activities inthe sector. Such measures will complement and take advantage of the GIM and the setting up o f the Comptoir de Pierre in the effort to formalize miningoperations and integrate small artisans into the formal channels. The Shrimp Sector Recentperformance attributable to strong growth in thefarming sub-sector 3.141 The shrimp sector comprises two sub-sectors: shrimp farming and shrimp fisheries, Shrimp exports are destined mainly for Europeanand Japanese markets inwhich Madagascar benefits from a premiumprice inniche export markets, particularly with the EU, as a result o f medium densityfarming practices and the stringent quality control adopted by large corporate firms. Shrimp exports have seen a steady increase in the recent period, driven mainly by shrimp farming. The volume of exported farmed shrimphas increased from 400 tons in 1994 to 6 500 tons in 2003, while biological limits have maintained shrimp fishing at a constant level o f 12 000 tons (Figure 3.1). It i s generally agreed that the production from aquaculture will soon exceed the total shrimp catch and expected that the aquaculture production would - 51 - reach 20 000 tons a year in the next 5-10 years, reflecting the growing tendency o f aquaculture development inthe international markets. 3.142 Foreign exchange earnings from shrimp now account for more than two thirds o f export proceeds earned through fish exports, and have increased from $US 56 million in 1997 to $US 155 millionin 2003, despite a significant decrease in white shrimp prices inthe last four yearsx2.With a projected farm production o f about 20 000 tons infive years, foreign exchange eamings will be twofold the current levels. The prospects for job creation inshrimp farming i s promising with estimated additional 10 000 direct jobs -corresponding to the projected increase in shrimp farming production inthe next five yearsx3. Figure 3.1: Shrimp productionand exports 1994-2003 (,OOO tomes) 20 18 16 14 12 10 8 6 4 2 0 Source: Statistical data compilation, World Bank staff. 2004. Priority in the sector relates to the limitation of over-exploitation in shrimpfisheries., 3.143 The most important concern in shrimp fisheries i s the risk of over-exploitation. The recent review of the biological fishery data indicates a trend that the Madagascar shrimp fishery i s at, or possibly just above, the maximum sustainable exploitation levels. Evidences suggest that the size of the shrimps captured in the recent past seems to be slightly smaller compared to that of the early years. While it may be that the fishery season is open too early to allow shrimp to grow, the shrimp size could also be an indication o f over-fishing and increasing levels of fishing effort, resulting in decreasing yields, although there were good catches in 2002 and 2003. Although there i s no immediate threat o f collapse in Madagascar, there are many examples of collapse of shrimp fisheries as a result o f over-fishing all over the world. 3.144 While traditional fishery still remains unregulated, the Government has started addressing the sustainability o f shrimp fisheries in artisanal and industrial fisheries in 2000. New management measures (decree 2002-415) consisted in limiting fishing effort by means o f inputrestriction through control o f vessel license issued-the vessel license i s based on the Internationalpriceshave decreasedfrom $ 7 to $3.5 per kilo over the last four years (2000-2004) - Urner Barry UUIndex. 83Basedon 60 directjobs for a production 100tons of shrimps. - 5 2 - type o f boat, the horsepower and the zone in which it fishedg4.However, the current input control system does not place a significant constraint on the amount o f fish that licenses may catch, and may fail to prevent over-fishing. 3.145 The govemment i s currently investigating in a co-management approach with the private sector mechanisms to regulate increasing industrial and artisanal effort fishing, including an appropriate monitoringsystem o f technological advances. A restructuring policy i s being discussed among the stakeholders, based on the recommendations from an analytical study aiming to assess the feasibility of a regulatory framework based on the transferable right approachg5.The study offers several options on the basis o f a co-management approach betweenthe Government, the fishery association (GAPCM) and other stakeholders. 3.146 Measures to protect fishery habitats and juvenile spawning stocks through the regulation o f traditional fisheries also require investigation. Traditional fishery has increased substantially over the years due to migration towards the coastal areas and the expansion of activities such as mining, and due to the increasingpoverty inmost provinces. The traditional shrimp fisheries can be regulated by making the seasonal closures effective to protect both juvenile animals and spawning stock. Two approaches can be simultaneously promoted: (i) fisheries Concerted Management Zones (ZAC) can be used as an experimental tool for resolving resource allocation problems and conflicts between fishing sectors; (ii)financial incentives such as Payment for Environmental Services (PES) can also be used to refrain exploitation o f the resources during lean seasons. Additional measures aiming to monitor by- catches area also needed. For instance, the GAPCM has established a program aiming to reduce by-catches usingthe TurtleExcluder Device (TED) and By-catches Reduction Device (BW. ...and theprovision of incentivesfor theprivate sector in shrimpfarming 3.147 Although shrimp farming has experienced a boom over the last ten years, the key constraint to further development o f the sector i s the lack o f a clear policy to provide incentives for the development o f the sector. It is reported that although the sector i s under the EPZ regime, the benefits in the sector do not outweigh investment cost due to, among others, tax burden on the sectorg6.A study on the shrimp farming sector i s being conducted to re assess the efficiency o f the incentives in the sector and will provide detailed insights into the constraints indeveloping shrimp farming. 3.148 Another possible constraint, in the medium-term, relates to the management o f environmental externalities, the risk o f disease, and ensuring the profitable market value o f Malagasy shrimp. In the medium-term, the government's challenge i s therefore to develop regulation and undertake research to assure good environmental stewardship by shrimp 84 The primary purpose o f the license/unitisation system was to measure and control the payment o f fees to the Government. To limit fishing effort and capacity in the fishery through a formal system of fishing rights was therefore easier with a freeze. 85 Systems based on individual transferable rights are likely to provide better flexibility and secured fishing rights.They can be a quota (ITQ), boat days allocation or gear units restriction and applied to both the industrial and the artisanal fleet as a whole. Individual decisions to buy, sell or lease unit are market based, and can be reduced or increased when adjustment i s needed. The technical aspects and options o f the Individual Transferable Rights are described in detail in "Scoping Study on the Implementation of Transferable Effort UnitdFishing Rights in the Madagascan Wild Caught ShrimpFishey"Annie Jarret, 2004. 86 A survey reported that the sector incurred aggregated losses from 2001 to 2003. Source: Observatoire Economique de la Filihe Crevettikre -Rapport n9,tome 3, Avril2004. - 53 - producers and to address potential shrimp disease. Madagascar currently enjoys a major production advantage due to lack of epidemic viral diseases in its shrimp stock. To maintain this advantage requires a focus on capacity building and expertise for effective disease surveillance and monitoring program. 3.149 The possibility of certification of the Madagascar shrimp farming industry on the basis o f good environmental practices should also be investigated. The fact that the sector i s based on semi-intensive as opposed to intensive cultivation practices i s an excellent starting point. The GAPCM and WWF are investigating ways to ensure a certification mechanism relevant to the benefits o f the sector. 3.150 In conclusion, in the current context, the priority i s to finalize the studies on the competitiveness o f the shrimp farming which holds a lot o f promises in terms o f foreign exchange earnings and employment creation. An action plan should be derived from this analysis to provide clear recommendations on how to achieve a high growth rate in shrimp farming. The analysis o f shrimp fisheries should also be finalized to provide effective recommendations on the appropriate way of limitingeffort fishing. Finally, different ways to limittraditional effort fishingneedto beexplored. Conclusion 3.151 The bulk o f foreign exchange earnings are derived from these sectors - textiles, tourism, mining, fisheries and export performance in the near future depend on their performance. However, as witnessed by the impact o f the decrease invanilla price, and given the uncertainty raisedby the expiration of the MFA, the diversification ofthe export base and the strengthening ofthe current export-oriented sectors are the priorities for Madagascar. 3.152 In this context, tourism appears to be one very strong source o f potential. Not only, does it have extraordinary assets but its performance also has rebounded quickly and outpaced that in2001. Ithas a strong potential for poverty reduction with the development o f the pro-poor initiatives in ecotourism while offering a potential for environment protection. In addition, it has strong linkages with related activities such as construction. Reforms expected to take place in the air transport sector and aiming at improving the quality o f accommodation are the priority actions in the sector. The shrimp sector farming i s another source o f substantial foreign exchange earnings for which Madagascar has a strong comparative advantage. The lifting o f constraints inshrimp farming appears to be the priority in the sector. Although at an early stage, mining holds strong promises for the Malagasy exports development. The realization of the potential depends on the ability o f the Government to formalize mining operations, which requires the implementation o f the reforms aiming at lifting the identified administrative weaknesses. Another key element is the completion o f the negotiation o f the expected investment inthe sector by multinational firms. Finally, textiles represent another potential for export development. However, the expiration o f the MFA may shake the foundations o f the recent growth in textiles. The AGOA can help maintain the recent pace o f exports and growth in the sector, at least over the medium-term and its extension should be viewed as an opportunity to address the identified constraints. Unless these constraints are lifted quickly, the long-term development o f textiles in Madagascar will be hamperedby countries such as China or India. 3.153 The diversification o f the export base i s critical. Several non-textile EPZ sub-sectors have the potential for exports, including furniture manufacturing, wood processing, precision medical instruments, optics and clocks and leather items and footwear as well as ICT firms. - 54- Inaddition, a list of additionalactivities under the EPZregime hasbeenpublished: software development, telecommunications and off shore banks. 3,154 Given the structure of the economy, most important i s the focus on products with higher value added derived from agriculture for which Madagascar has a strong comparative advantage such as fruit, vegetables, essential oil, etc. But there is little analysis for these potentials and additional analytical work i s needed to gather relevant information and build knowledge inthese areas. GROWTH FORTHE MANY RURAL- DEVELOPMENT 3.155 This chapter outlines the components o f a strategy for rural growth, and for the protection o f the environmental assets on which rural growth is partly dependent. It first looks at factors accounting for the decline in agriculture and identifies the elements of a strategy to improve welfare and income growth o f agricultural households. The second part o f the chapter discusses measures required to protect important services derived from the terrestrial ecosystem and to prevent the deterioration o f ecological systems that sustain many aspects o f rural activities. Rural Development Ruralpoverty is closely linked tofailures in the agricultural sector 3,156 Agriculture accounts for a considerable portion o f the rural sector and has the largest share interms o f GDP contribution (14.8 percent o f GDP) but has barely grown over the last tow decades. Growth in the agricultural sector i s therefore a powerful leverage to achieve strong growth rate. However, growth rate in the sector amounted to 1.8 percent during the 1997-2001 growth period, compared with 4.6 percent for the economy as a whole. Besides, the majority o f the Malagasy populations live inrural areas, where dependence on agriculture i s strong, and economic opportunity i s limited. More than three quarters of the rural population are poor. Among those in the rural areas who earn their living from agricultural activities (approximately eight out o f ten people), over 87 percent are poor, an outcome considerably worse than those o f other sectors and urban areas. Therefore, achieving agricultural growth and creating economic opportunities for those living in rural areas are clearly o f prime importance, ifthe government's poverty reduction and growth objectives are to be met. 3.157 Poverty in rural areas i s closely, but not exclusively, linked to failures in the agricultural sector, with poorer families largely dependent on agricultural income. Three features characterize poverty in agriculture. First, about 63 percent o f the agricultural households are small farmers with a poverty contribution o f about 77 percent. Second, the lack o f diversification and the prominence o f rice in the economy partly accounts for the weak performance o f the agricultural sector and poverty among agricultural households. About 50 percent o f the value added inagriculture i s accounted for by rice. About 85 percent of farmers grow rice and income of rice makes up a little over one third o f the monetary agricultural income o f farmers. Despite favorable initial conditions, rice performance has stagnated. Between the 1960s and 2000, yields have increased from 1.8 tons / ha to only 2 tons / ha, compared with Mali, where yields have increase from 1.0 tons / ha to 2.3 ton / ha; or Indonesia, where it has increased from 1.7 tons / ha to 4.4 tons / ha. As a result, agricultural households who diversify their agricultural activities and who rely more on off farm activities are muchbetter off with higher revenues. - 55 - Table 3.8: Annual householdincome in rural areas (HH2001) Consumptionquintile National Q1 42 4 3 4 4 Q5 Total income (1000 Ariary) 747 434 631 723 785 1,158 Agricultural income as percent of 57 64 71 66 63 34 total income Off-farm income as percent of 43 36 29 34 37 66 total income Percent of agr. Hhsthat grow rice 86 86 86 84 88 86 Agr. Diversificationindex* 41 36 36 40 44 49 Q1= the poorest quintile; Q5 =the richest quintile; *: basedon HH 1993 ...due to very low market access andproductivity 3.158 Very low market access features among the major factors that account for low agricultural growth. For instance, two thirds o f the rice production i s self-consumed by agricultural households. High self-consumption rate i s compounded by low producer prices, due to the very segmented nature ofmarket, which inturn, is due to the sharp deterioration of rural roads and the resulting monopsonic settings87.For instance, the results o f the commune census o f 2001 show that rice prices in Madagascar vary from 1 to 20 over space and time duringa one year period with the lowest prices inremote areas. Finally, insufficient linkages with large private investment inagri-business contribute to low market access and the lack of diversification of activities to higher value agricultural products. 3.159 Low productivity i s another factor accounting for the poor performance o f the agricultural sector. First, the adoption o f modem agricultural technologies i s modest: 94 percent o f the agricultural households do not use chemical fertilizer; only 18 percent uses the in line rice transplanting technique which has been shown to dramatically increase production. As a result, 63 percent and 65 percent of representative focus groups inMalagasy communes stated in 2001 that the fertility of lowland and upland land respectively has degraded over the last ten years (Minten et al., 2003). Second, at the national level, there are about 700 000 ha o f lowlands affected by poor water management conditions. This situation exists against the background of apparent ineffective public investments that have beenmade in the past, which focused particularly on hardware requirements of large-scale irrigation schemes. As a result o f these problems, more than 80 percent o f the increase in rice output has come from area expansion by small farmers, mainly inthe form o f gradual expansion o f cultivated acreage up hillsides, exacerbating productivity problems and accelerating environmental degradation88. ...owing to the inability of the State to deal with institutional constraints 3.160 The poor performance o f the agricultural sector - and o f rural areas ingeneral - i s also explained by a multitude o f inter-linked non-agricultural factors. Among those factors are a poor institutional coordination, the reduction in public investments and a declining investment efficiency8'. ''''''Source: Source: RuralDevelopmentandEnvironmentEconomic Sector Work (World Bank2003). Ibid. In a review of the agricultural sector, the World Bank (1998) stated that projects lacked cohesiveness and focus, were undertakenacross severalministriesand covered different themes, subsectors and geographic areas without attention to synergy. Problems included duplication, conflicting policy approaches and blurred - 56 - 3.161 Success in achieving the program's objectives in the agricultural sector has been limited, due to lack of appropriate priority-setting andproper regionalplanning, which was in turn triggered by weak institutional coordination. It was planned in the government's rural development strategy that most of the decision power would be transferred to 20 decentralized Groupe de Travail pour le Diveloppement Rural (GTDR) whose role was to design and implement rural development policy, taking into account respective assets and constraints in the regions. While the immense variation and heterogeneity o f Madagascar's agricultural assets, climate and environmental conditions implies that specificities are likely to influence agricultural and rural policy, until now, it i s still unclear how the decentralized bodies will function institutionally and financially. 3.162 Compound effect o f inadequate funding and investment inefficiency is another factor accounting for the low institutional performance that impacted adversely on agriculture, Despite the importance o f agriculture in the economy, the allocation to the sector has decreased from $US70 million to $US40 million fiom 1997 to 2003 and the bulk o f the budget is still handled at the central level. This adds ups to a growing inefficiency o f public investment. For instance, investment to support the development o f irrigation schemes inthe past has failed, leading to a sharp deterioration o f water management over the last two decades (World Bank, 2003). Past errors inthe implementation o f irrigationprojects included overemphasizing construction; neglect of institutional issues (including the needto strengthen water user associations); unclear maintenance arrangements; neglect of environmental problems; and ineffective extension services. Exacerbated by the inefficiency in extension services, these problems have worsened on-farm productivity. Extension services have failed due to lack of funds, skilled personnel, as well as poor linkage and coordination between extension services and research (World Bank, 2003), which explained in part the very low use o f modern techniques and inputs.Extension service programs have now almost come to a standstill. Table 3.9: Publicexpenditures on agriculture,inthe Budget Law (1997- 2004) (inmillion$) Year Total agricultural budget Projectfunds Administration funds YOof centralbudget 1997 70.8 58.3 12.5 88 1998 69.9 51.3 12.5 88 1999 68.5 56.3 12.3 89 2000 65.0 55.0 10.0 79 2001 56.8 45.2 11.6 75 2002 56.8 44.3 12.6 75 2003 40.6 29.2 11.3 66 Source: staff estimates based on data from the Ministryo f Agriculture. Measures to invigorate the government's rural developmentstrategy 3.163 Achieving welfare and income growth in rural areas requires a set o f integrated policies to take into account the inter-linked factors accounting for the heterogeneous living conditions o f the rural population. A simulation using a recently developed Computable General Equilibrium (CGE) model (Dorosh et al., 2003), shows that a more dynamic commercial sector - through a better market access - can have a significant impact on growth and provide large benefits to the rural poor. Equally important i s an increaseintotal responsibilities which lowered the quality of basic services in rural areas - such as extension, education, monitoring and evaluation, and rural security - inthe last decade. - 57 - factor productivity in staple crops. To a lesser extent, off-farm investments in rural areas and an increase incash crops productivity can also contribute to rural poverty alleviationg0. Table 3.10: Impact of differentinvestmentstrategies basedon simulationswith the generalequilibrium modelof Madagascar Investment Measures of impact (percent) Staple crops Cash crops Lower commercial Tourism (inpercent) (inpercent) margins(inpercent) (inpercent) Choc +30 +30 +20 +loo GDP +3.7 +0.7 +3.9 +1.9 Real Consumption Small cultivators, Highlands +2.3 +0.6 +5.3 +1.5 Large cultivators, Highlands +0.3 +o. 1 t6.3 1-1.4 Small cultivators, East coast +1.6 +1.1 +7.7 +0.9 Large cultivators, East coast +2.2 +3.4 +7.1 -0.3 Small cultivators, South +4.7 +0.5 +10.5 +1.6 Large cultivators, South +6.3 +1.0 +18.8 +3.0 Small cultivators, West +1.9 +0.2 +7.8 +1.2 Large cultivators, West +0.7 +0.4 +6.5 +1.0 Source: Dorosh et al. (2003) and author's calculations 3.164 These results are in accordance with the findings that : (i)the majority of the agricultural households are involvedinstaple crops, rice inparticular, and an improvement in on-farm productivity will improve the welfare o f most o f the peasants and; (ii) agriculture i s little geared towards markets and a better market access i s key to rural growth. 3.165 In order to take the Government's rural development policy, forward, priority measures falling into four broad areas are proposed, addressing these two problematic. These four areas comprise the provision of basic infrastructure and services; an improvement in information dissemination for enhanced use of technology; the development of a more diversij?ed and more dynamic commercial agricultural sector, including the strengthening o f partnershipsbetween peasantsand the private sector. Emphasis i s particularly put on the need to further develop ago-business as recently developed in a document elaborating on the new vision o f an integratedrural development strategy -Madagascar Naturellement, and; a better organized rural sector. 3.166 The above recommendations are largely taken over into the PRSP, the PADR (Programme d'Action pour le Diveloppement Rural- PADR) developed in 1999 91 and the recent Lettre de Politique de Developpement Rural (LPDR) which establishes the sector policy. The program has been complemented by a number o f other plans over the last years (Business Plan and Master Plan for Agriculture) as well as sectoral plans (rice, livestock, fisheries). While simulations ofthis sort can be criticized due to its static nature, they are illustrativeto what extent all o f these strategies might affect the rural sector and how they all have a role to play in rural income growth and poverty alleviation. Four types of impacts are shown: (i)growth of 30% in total factor productivity in staple food production; (ii)growth of 30% in total factor productivity in cash crop/commercial agriculture; (iii) reduction by 20% of the commercial margins (due to road building and more competitive practices); (iv) ''increasePADR o f activities inthe off-farm sector, inthis case doubling o fthe tourism sector. The objectives were first, a better management o f the rural sector through institutional reform; second, expanding and promoting agricultural productionthrough optimal use of resources; third, ensuring food security inall regions; andforth, developing social infrastructure to ensure accessto social services. - 58 - Building block 1: Provision of key infrastructure and services 3.167 Inthe absence of basic infrastructure and services -inparticular rural roads, irrigation and credit -the development o f the rural economy and the benefits o f specialization and trade will be limited. The benefits o f the current rural road network program would be substantial for the rural areas with improved market access and market integration, through the reduction o f price variability and monopsonic settings, while facilitating the provisiono f inputs.Due, in part, to increased competition, triggeredby the recent road rehabilitation and maintenance, it was reported that paddy price at farm level has doubled in 2004 compared to its level in 200392. 3.168 Water management is another key infrastructure affecting agriculture's performance. Madagascar's vast irrigation infrastructure i s a tremendous capital asset that could be the starting point for accelerated growth. It i s necessary that an approach be established that defines the roles o f all stakeholders (state, private sector and farmers) in the operation and maintenance o f irrigation systems. The plannedWatershed Project could be a step inthe right direction. It includes the setting up o f the Fonds d'Entretien pour 1'Infrastructure Hydro- Agrologique (FERHA) that will provide a sustainable financing mechanism including all beneficiaries, while experience with sustainable soil and water managementpractices will be scaled up.The investment program i s expected to start in2005. Box 3.3: FERHA Following the example o f the road maintenance fund (FER), the Council of Ministers has decreed the establishment o f a Fonds d'Entretien des Rkseaux Hydro-Agricoles (FERHA) which requires a sizeable allocation of public resources. The fund is to receive and manage funds for maintenance of non-transferable irrigation infrastructure, typically infrastructure that is of a strategic nature, or that is too large to be maintained by irrigation water users. In many countries, responsibility o f management and maintenance o f smaller infrastructure has been handed over to farmers organizations, but full cost recovery has remained elusive. Maintenance of other, larger infrastructure has often remained a govemment responsibility, but insufficient public funds are allocated. Inadequate maintenance ultimately leads to serious damage and to the need for expensive donor funded rehabilitation programs. Calls for a more rational use o f public resources have made it imperative to find innovative solutions for financing of O&M costs. The establishment o f FERHA should be seen against this background. Source: World Bank 3.169 A well-functioning rural financial market plays a critical role in both agriculture and rural development by financing production activity and investments, and aiding consumption smoothing in response to production and other risks. Although credit use in Madagascar remains very limited, it is improving with efforts to expand the penetration o f micro-finance institutions in rural areas (see chapter on microfinance). But the government can also reinforce informal credit setting that has been successful. An important success story on which to build i s that of the Greniers Communautaires villageoises - a project that provides small credit to groups of farmers to help them build storage facilities and stock, part o f their production in order to ensure food security in lean seasons and therefore as consumers, to "Data for 2001 point a producer price of paddy o f about FMG I,OOO/kg. In 2004, the producer price o f paddy reportedly was at around FMG 1,500 kg at the start o f the harvesting season in June 2004 and now stand at around FMG 2,000 per kg. The sharp increase in producer price was also due to the impact o f the depreciation of the FMG, compounded by the increase in international price. Rice prices on the intemational markets have increased significantly from $USl4O/ton in March 2003 (Thai AlSuper, f.0.b Bangkok) to US$225/ton in March 2004. - 59 - avoid the impact o f increasing price. Programs o f this kind could be usefully expanded to help farmers' better deal with large seasonal swings. Building block 2: Information disseminationto improve on-farm productivity 3.170 Given that over 80 percent o f Madagascar's rice i s grown under irrigated conditions, the application o f Green Revolution type technologies in association with an accepted level of water management should be considered the key driving force for successful systems intensification inMadagascar. Improved cultivation, including double cropping to reduce the increasing pressure on land and to alleviate seasonal stress; introduction of better seeds and enhanced use o f fertilizers are key. For instance, recent evidence from Madagascar shows that communes that have higher rice yields are characterized by higher real agricultural wages (on which poor people rely), lower levels o f food insecurity and shorter leanperiodsg3. 3.171 Enhanced use o f moderntechnology and inputswill require both efficient agricultural extension and research at the same time and the required technology directions should be integrated inthe country's agricultural research agenda. First, there i s a needto tailor the type o f productivity enhancingtechnologies to the particular needs o f the differentiated clusters o f agricultural-based farming systems. It requires a strengtheningo f adaptive research in order to assess the viability and relevance o f proposed technological innovations at the farm level. Second, linkages between the research community and the extension services have to be strengthened. Extension services play a particularly important role as far as low-external input technologies are concerned, which tend to be highly knowledge intensive. Both recommendations will require a more active coordinating role o f the Government in extension, through partnerships with NGOs, private enterprises and farmer organizations, Third, to better tap into the advances of strategic research elsewhere, FOFIFA, the Malagasy research center should continue to strengthen its alliances with the international agricultural research community. The experience of some rice producing countries might be more relevant for Madagascar than others, entailing the establishment o f a strategic partnership at the bilateral level ina south-south context (e.g. Vietnam). Building Block 3: A more diversified agriculture and more dynamic commercial agricultural sector 3.172 Increasing productivity i s necessary but not sufficient for rural development. A dynamic commercial agricultural sector, inparticular through the integration between farmers and down-and upstream processors, i s key to increasing employment and rural growth - directly, by absorbing wage labor; and indirectly, via growth o f the down-and upstream processing sectors. In addition to general improvement in the country's business environment, priority actions include the diversification o f agricultural products, the development o f producer/operator partnerships, and an improved marketing to gain broader access to international markets. 3.173 A first pre requisite to rural growth i s the diversification o f agricultural activities towards high value added products. Possible drivers for the identification o f opportunities include economies o f scale in downstream processing activities. Tomatoes, potatoes, sugarcane and cotton are examples o f crops where some form o f vertical integration is taking place. Specifically, promotion o f high value niche export crops (e.g., organic rice, essential oils, and flowers) should be considered, and targeted support could be provided to bring 93RuralDevelopmentandEnvironmentEconomicSector Work. Madagascar.WorldBank-2003. - 60 - producer organizations, exporters and international demand together. At the same time, while some o f the best economic potential may be embodied in specific rural products, their inherent instability and novelty make them also quite risky for the development o f stable partnerships. Therefore as a start prospect for rural development, partnerships should not rule out well established food crops inlocaldemand such as maize, manioc, potatoes etc. 3,174 The development o f the partnership between farmers and downstream operators i s a key element o f any approach seeking to increase production and establish a more dynamic and diversified commercial sector. Producer / operator partnerships can deliver many benefits to producers including assured business and improved incomes by reducing price risk, thereby lowering peasants' aversion to adopt a more aggressive commercial approach. This i s especially so inthe Malagasy environment where production decisions are made by poor and liquidity constrained peasants. They are also key in reducing uncertain input delivery and thusmitigate the costs for transformationactivities falling to the private sector (ARD, 2002). 3.175 The development o f pilot projects, based on the success stories such as that embodied by Lecofruit, may be one useful step inthe development of producer/operator partnerships, the resulting diversification o f agricultural activities and the benefits accruing to the peasants and the expectedexpansion o f agribusiness inMadagascar. 3.176 For the firms in agri-business to gain broader access to markets, it i s necessary to expand market knowledge through expanded technical and vocational training, and through better accessto information related to product and market issues. Specific training on sanitary norms, grades, standards and sizes, quality control and verification, packaging and labeling i s necessary and can be expanded, which require collaboration and partnerships between the government and the private sector. Box 3.4: The benefitsof agri-business and access to foreign markets:the case of Lecofruit Inthe early 1990s Lecofruit was a Malagasy company producinggherkins in small quantities from cucumbers sourcedfrom approximately 100 small farmers. Later on, it linked up with the Frenchcompany, Segma Maille, which assured regular outlets for its products in Europe. Today Lecofruit is firmly established in Madagascar, and produces, among others, string beans, snow peas, asparagus and mini vegetables. The company buys the production from thousands of farmers, regrouped within different associations, with which it has contractual arrangements on inputs and outputs. The company also employs hundredsof permanent and seasonal workers, and day laborers.Becausethe companyis able to take the risk of investment in agriculturalproductionon itself, it is able to increase agricultural production and improve the livelihoods of small farmers. Without these linkages with Lecofruit, small risk averse farmers would not be willing to take up these new opportunities themselves. Building Block 4: A more organized rural sector 3.177 Most o f the agricultural households are small farmers, with weak bargaining power and the vast majority o f producers inMadagascar are fragmented and weakly organized when dealing with processing intermediaries further up the commodity chain. But organizational weakness also impacts on the accessto inputsand technologies. 3.178 In Madagascar, only half o f the rural communes report the existence of a farmers' organization within their boundaries. The policy orientation inthe agricultural sector can put emphasis on the strengthening o f producer organizations which represent a source o f better information on market prices, alternative sources o f credit and self-development or empowerment. The Rural and Environment Sector Review, provides an insight into a number - 61 - o f legal issues hampering the development o f producer organizations: the status of non-profit association (law 60-133), still the most used form, i s unsuitedto commercial operations; the NGO status, which must be non-profit and i s inpractice difficult to comply with, and most so-called NGO's are associations under law 60-133; for cooperatives, there remains an ambiguity in the finance law which requires `sociktks coopkratives' to pay tax in the same way as companies whereas the law on cooperatives excuses them o f tax. The main recommendations aim at reforming the law o f associations (cooperatives, associations and NGOs), introducing favorable fiscal status for cooperatives and developing capacity building programs. All of which require institutionalstrengthening 3.179 The most important challenge Madagascar faces is the setting up o f an effective institutional coordination for an adequate implementation o f the rural development strategy. Efficient information dissemination would require the development o f partnership between the private and the public sectors, between peasants and operators. Effort in infrastructure rehabilitation (roads, irrigation) aiming at improvingproductivity and market access will also need stronger state capability. 3.180 In particular, policies need to be geared towards a tailored, an integrated and a targeted approach that takes into account the variety and diversity o f the agro-ecological zone, regional assets and constraints. As shown in, policy response has different impact on the poor depending on their location. Inthis respect, the strengthening o f the deconcentrated agencies, the regional competencies (GTDR) and the decentralization structure with the empowerment o f the regions i s key, both in terms o f resources and capacity building. However, many o f the institutional arrangements have only recently been established and the role o f local policy-making and implementing bodies' vis-&-vis national-level actors i s unclear at present. An effective implementation o f the rural development strategy will needto bepreceded by institutional measures inthis direction. 3.181 More resources need to be allocated to the sector given the magnitude o f the necessary actions and the prominence o f agriculture in the economy. An analysis o f the budget allocation and expenditures that was carried out as part of the Rural Development and Environment sector work (World Bank, 2003) confirmed that budget allocation should be better brought in line with the PADR and that better provisions should be made to cover the recurrent costs o f initiatives launched byprojects andprograms. 3.182 The Rural Development and Environment sector work (World Bank 2003) provides the following recommendations (i) allocate more operational budget to decentralized services (especially secondary regions), the amounts varying according to each region's specific needs; (ii) provide more financial assistance to activities that relate agricultural production with optimal use and sustainable management o f resources and infrastructures; (iii) more effortdfunds should be put into strengtheninglencouraging the participation o f and collaboration with private entities; (iv) promote/encourage activities that develop a supply chain approach and those which promote the professionalizationo fproducers. 3,183 In conclusion, the rural development strategies adopted so far have not been able to unleash the potential in agriculture. The identified constraints are complex and difficult to overcome. Several ingredients as described in this section are necessary but not sufficient. Only their combination can contribute to rural growth. - 62 - 3.184 Key reforms include a better market access - with the development o f the road particular in agri-business, and the diversification o f agricultural products - and the program, the establishment of partnership between the producers and the operators, in improvement of on-farm productivity. Such an approach will require an increase in the resources allocated to the sector. But the reforms need to take into account the agro- ecological specificity, the comparative advantage of the regions and the type o f households involved in agricultural activities. It i s a pre requisite to any increase in budget for the ministry of agriculture. For instance, for the majority, who are small producers, food security i s the priority while for the others involved in marketing; agriculture i s a means to generate revenues. The two objectives mightneed different measures, sequencing andprioritization. 3.185 In this context, institutional strengthening at the deconcentrated and decentralized levels is a pre requisite to any sound policy design, improved service delivery and efficient public expenditures. The strengthening o f producer organizations i s also key to enhanced bargaining power o f peasants, reduced price risks, improved input provision, including credit, and successful demand driven extension services. At the same time, it will help facilitate and implement effective partnershipbetween peasants and the private sector. These elements will help improve on-farm productivity and orient gradually agriculture towards a more diversified and dynamic one while promoting the professionalizationo f producers. Protecting theEnvironment Madagascar has experienced a significant environmental degradation. 3,186 Madagascar's terrestrial, coastal and marine eco-systems provide valuable services at the local, national and global levels. Loss o f natural forest i s the principal environmental problem in Madagascar. One third o f the natural forest area has been converted by slash and burn agriculture since the 1950's and the remaining forest area is now highly fragmented. The main reasons for forest loss i s agricultural expansion due to a combination of low agricultural productivity and rapidly expanding rural population growth; and weak property right enforcement, which accounts for many failures inthe forestprotection. Box 3.5: Trends inforest conversion and fragmentation An assessmentbased on aerial photography from 1949producedan estimate of 17 million hectares of total forest in the 1950's. Satellite-basedestimates of forest and woodland clearance for the entire islandshows that the current forest andwoodland cover i s within the rangeof 8.8 millions hectares with a yearlyaverage deforestation rate of 1percent duringthe last ten years. By 1990, the forests and woodlands of Madagascar were already heavily fragmentedwith patches of 20 h2 or less or within 1 !aof anon-forestededge and connectedareas of viable habitat shrinkrapidly with deforestation and some key species populationsthe 45 species of lemurs that are endemic to Madagascar. Noble but slow-growingtrees like the rosewood -- will not quickly recover or recover at all from conversion. Source: SteiningerandAl., 2002. 3.187 Large scale ecosystem degradation in Madagascar over the last few decades has also resulted in substantial environmental damage and has threatened the natural resources from which important services are derived - freshwater, food, timber - and biodiversity; as well as ecological systems such as nutrient cycling and soil fertility, waste processing and detoxification, climate and natural hazards regulation. - 63 - ...with implicationfor economic activities 3,188 The island's biodiversity has been a key factor inthe growth o f ecotourism in recent years, with 55 percent of tourists to the island reported to be eco-tourists. Madagascar's protected areas have established themselves among the main tourist attractions o f the island. Ten protected areas actively contribute to the development o f tourism in Madagascar, attracting a growing number o f tourists. Five other protected areas have significant untapped eco-tourism potential. 3,189 In addition to direct losses of biodiversity, tourism revenues, timber, fuelwood and fodder, forest destruction also leads to soil degradation and erosion, flooding, and siltation o f downstream infrastructure - including dams, irrigation systems and domestic water supply facilities. The major effects of deforestation in upstream watersheds are mainly felt in downstream irrigated paddy fields and in downstream drinking water supply. For farmers usingirrigationwater, upland forests protect soils onthe steepest slopes, and therefore reduce silt loads that damage irrigation systems. Maintaining forest cover in headwaters provides several basic services to downstream water users. For town-dwellers relying on rivers for potable water, upstream forests help filter water, reduce siltation, and contribute to water storage, thereby increasingthe regularity o f stream flows. Strengthening of eco-system conservation is key ... 3.190 Eco-system conservation requires on the one hand, the strengthening o f the institutions that protect natural assets and the expansion o f conservationprograms, and on the other hand, the creation o f financing mechanisms that allow specialized agencies to capture eco-system rents for the purpose of conservation. The National Environmental Action Plan (NEAP) i s the cornerstone o f Madagascar's response to the challenges posed by ecosystem conservation. Box 3.6: The NationalEnvironmentalAction Plan(NEAP) The (NEAP) was adoptedby the Government of Madagascar in 1989, and given legal force by the National Environment Charter and the National Environmental Policy in 1990. It was designed from its inception as a fifteen year investment program divided into three five-year phases. The first five year phase aimed at creating a policy, regulatory and institutional framework. The second phase of the NEAP aimed at reversing degradation and integrating environment into other sectoral policies. The third phase, which is currently under preparation, is focused on consolidating the past efforts and establishing sustainable financing mechanisms for the environment. Implementation started in 1991 with the support of a broad coalition of bilateral donors, international agencies and NGOs. The Plan recognizes the link between environmental protection and economic development and includes six elements: (i) protecting and managing the national heritage of biodiversity, with a special emphasis on parks, reserves and gazettednatural forests, in conjunction with the sustainable development of their surrounding areas; (ii)improving the living conditions of the population through the protection and management of natural resources in rural areas with emphasis on watershed protection, reforestation and ago-forestry; in urban areas this involves improving water supply and sanitation, waste management and pollution control; (iii)promoting environmental education, training and communication; (iv) developing mapping and remote sensing tools to meet the demand for natural resources management: (v) developing environmental research on terrestrial, coastal and marine ecosystems; and (vi) establishing mechanismsfor managing and monitoring the environment. Source: World Bank (Project Appraisal Development - EP3) 3.191 areas - covering today roughly 1.6 millions hectares o f forests, or 3 percent of the country's One o f the NEAP most important achievements has been the creation o f 46 protected - 64 - total area, and 15 percent o f its existing natural forests. Deforestationrates have been slowed, while deforestationhas beenvirtually eliminatedinprotectedarea systems. 3.192 The NEAP i s currently in its third phase. Among the most important planned measures inthe current phase are: (i) expanding the protected areas network and establishing conservation sites in natural forests. Six million hectares of natural forests and marine ecosystem will be preserved, representing Madagascar's entire different forest ecosystem. The area represents about 10 percent o f Madagascar's territory, thereby bringing the country inline with International Union for Conservation of Nature and Natural Resources (IUCN) conservation norms; (ii) transferring forest management responsibilities to communities to allow for increasing participation o f local stakeholders through joint decision-making between communities and ANGAP, and a conservation-compatible means o f assuring local livelihoods. 3.193 Institutional measures were adopted to mainstream environmental concerns and further develop conservation program. Land use planning, transport and public works were integrated into a single ministry to allow for an integrated approach to national spatial development planning and to incorporate environmental dimension into national planning. Water and Forest ministries were merged with Environment into a single ministry to orient forests sector to conservation. The approach will also help coordinate and establish a clearer division o f responsibilities between agencies involved in conservation. Additional institutional measures aim at improving transparency and accountability in the sector by regulating cutting permits and improving the monitoring o f forest resources. ...and should be accompanied by sustainablefinancing of environmental protection 3.194 One o f the most pressing challenges i s the setting up o f mechanisms for sustainable financing o f environmental protection. Financing o f the operational costs o f protecting Madagascar's ecosystem has relied on foreign assistance in the past indeed, The third phase o f the NEAP raises as an important policy issue the sustainability o f how the ecosystem i s managed, especially the 6 millionhectares that should be put under conservation. 3.195 The establishment o f the Malagasy Foundation for Protected Areas and Biodiversity i s the centerpiece o f the NEAP third stage approach to sustainable financing o f the environment. The foundation i s expected to total $50 millionby the completion of NEAP in 2008. Assuming a 6 percent interest rate and 10 percent operating costs a year, this endowment fund would ensure sustainable financing o f up to $2.5 million a year after NEAP thirdphase completion. 3.196 Several ways can be explored to address this issue. Tapping global willingness to finance conservation o f the country's unique assets may provide an additional source o f finance. Capture of tourism rents may provide another funding mechanism. One target is the park entrance fee for foreign tourists, which surveys suggest could be doubled. The other obvious target i s the hotel tax, which i s extremely low by international standards (FMG 3000 or $0.50 per night). The scope for systems o f payments for environmental services in watersheds i s also worth exploring, although it i s likely to be limited by the highlevel o f rural poverty. - 65 - 3.197 In conclusion, at the current stage, meeting the objective o f enhanced conservation system i s a priority. Several institutional arrangements still need to be designed and implemented. Ensuring sustainable financing mechanisms for the outer years subsequent to the NEAPthird phase will require further analysis to achieve effective resource mobilization. - 66 - 4. MEDIUMOUTLOOKAND RISKS 4.1 T h i s final chapter simulates the possible poverty reduction effects o f a medium-term growth trajectory, based on the structural features identifiedinchapter 2, and progress in the realization o f the measures set out in chapters 3. Poverty reduction outcomes are estimated usinga World Bank-developedmodel PovStat. - 4.2 Debt sustainability i s not analyzed in the DPR. Madagascar reached the HIPC completion point on October 21, 2004 and Madagascar exits from the enhanced HIPC Initiative with improved chances to maintain debt ~ustainability~~ The HIPC completion point paper provides a comprehensive analysis of debt sustainability. MACRO-ECONOMICPROJECTIONS,2004-2008 4.3 The medium-term economic framework has been developedjointly with the Malagasy authorities, reflecting a number o f the features o f the 1997-2001 growth period, and differing inothers, It is a "highhestcase" outcome, slightly higher than the IMFbase case and lower than the PRSP macroeconomic framework. Most economic indicators in2004 are assumed to be the same as inthe IMFbase. 4.4 The realization of the macroeconomic projections represents a challenge for Madagascar and its partners ina rather difficult context with several shocks, both internal and external, impacting adversely on the economy in 2004 and a sharper international competition with the phasing out o f the MFA in textiles, one o f the engines o f growth and poverty reduction. 4.5 The message associated with the high case outcome i s that the projected growth can be achievedifthe implementations ofthe government's program moves into highgear, all the many difficult problems inimplementation are overcome; no major event disruptsthe pace o f growth and Madagascar benefits from adequate assistance. The following paragraphs elaborate on the basis o f the highgrowth over the forecast period. Averagegrowth, at 6.6percent, surpasses that of the 1997-2001 episode ... 4.6 Over the medium term, growth i s expected to reach an annual average o f 6.6 percent, slightly above its highestpoint during the growth episode o f 1997-2001, o f 6 percent and the IMFbase case with an average o f 6.3 percent over the forecast period.'Ifgrowth is expected to be the same as inthe IMFbase case in2004, the DPR projects slightly higher growth from 2005 onwards. All sectors o f the economy are expected to improve their performance in comparison with the growth episode o f 1997-2001. The most dramatic increases are projected for the secondary sector, which will replace the services sector as the fastest growing part o f the economy. 94The NPV of Madagascar's debt at end-2003, after full application o f traditional debt relief mechanisms, is estimated at US$3,053 million, equivalent to 284 percent o f the exports of goods and non-factor services. After assuming full delivery of the revised HIPC debt relief, the NPV o f external debt would be reduced to US$2,079 million, equivalent to 194 percent of exports. Finally, after taking into account additional bilateral debt relief, the NPV of extemal debt would be reduced to US$1,467 million, equivalent to 137 percent o f exports and is expected to decrease gradually to 65.8 percent by2023. - 67 - 4.7 The reforms revisitedinthe DPR are expected to support the projected growth. Inthe medium-term, the competitiveness o f the Malagasy economy i s expected to be stronger. With the road program; the concessioning o f the railways network, ports and airports; the privatization of the water and energy and the telecommunications companies, and; the open skies policy, the infrastructure program will provide reliable services and decrease infrastructure costs, in particular in transport. The investment climate is expected to improve with a sound macroeconomic policy, a consistent dialogue between the State and the private sector and an improved environment in the judiciary and customs. The growth poles project will play a key role in nurturing growth in key sectors with readily available industrial infrastructure and services such as the GUIDEas described inBox 3.1. 4.8 Within the manufacturing sector, although the Multi Fiber Agreement will expire, Madagascar i s expected to take advantage o f its price competitiveness and consolidate its increasing market share in the US markets with the AGOA. The sector would grow at 25 percent on average over the forecast period, a slightly higher rate compared to the 1997-2001 period. In mining, the GIM - whose objective i s to disseminate information on Malagasy gemstones, set down norms and for gemstone cutting, provide certification, facilitate access to imported equipments for the trade -and the recent institutional measures (transaction through the one-stop shop; introduction o f the o f APSM) i s expected to re direct mining operations inthe formal sector gradually, and increase the value added o f the sector. With the beginning o f the large scale investment inthe sector, miningwill grow by 15 percent by the end ofthe forecast period. Agri-business will expandat an average rate of 10percent. 4.9 Growth in the tertiary sector will be driven by construction, which will grow at an annual rate o f 18,5 percent over the forecast period, with the investment inroads, school and hotel construction. Tourism also will expand, thanks to a combination of initiatives such as the growth pole project, the restructuring policy aiming at increasing the quality of accommodation - the privatization o f state-owned hotels, the RFTs and investment in ecotourism accommodation as well as other private initiatives -; an improved internal transport with the road program and an increased opening and competition in the airline sector. Other sub-sectors in the tertiary sector such as telecommunications will continue to grow with the recent privatization o f the national telecommunications company and the related investment to expand the telephone network. Banks will maintain high grow as a result o f growing activities and the measures to ensure the stability and the efficiency of the sector. - 68 - Table 4.1: Selected indicatorsof real sector activity, 1997-2008 GDP growth 4.6 -12.4 9.8 5.3 7.0 7.0 7.0 7.0 6.6 Primary 2.5 -1.3 1.3 3.1 3.6 4.3 4.5 4.5 4.0 ,..ofwhich agriculture 1.8 0.8 2.6 3.5 4.0 5.0 5.0 5.0 4.5 Secondary 5.8 -20.7 14.5 6.5 11.8 9.9 10.0 10.1 9.7 , 22.9 -40.0 75.8 25.0 45.0 20.2 19.2 17.7 25.0 ,.... ofwhich EPZ ofwhich mining -5.5 -34.2 10.2 7.7 5.7 15.0 15.0 15.0 11.6 Tertiary ....of which construction 5.3 -15.0 10.6 6.0 7.5 7.5 7.1 7.0 7.0 10.1 -36.3 22.9 29.0 18.5 18.5 18.5 18.5 20.6 ...of which telecommunications which banking 7.5 4.9 12.6 5.0 8.4 7.0 6.5 5.8 6.5 of 9.3 -5.7 8.4 5.0 6.7 7.0 6.0 5.4 6.0 Investment (percent GDP) 15.3 14.3 17.9 23.7 22.6 23.4 24.2 24.9 23.8 Public 7.1 4.8 7.811.5 10.811.3 11.7 11.9 11.4 Private 8.1 9.5 10.1 12.2 11.8 12.2 12.6 12.9 12.3 of which FDI 1.2 0.2 0.3 1.0 1.8 2.7 2.5 2.3 2.1 Source: staffestimates 4.10 While the primary sector will continue to lag the rest o f the economy, expanding at an annual average o f 4.5 percent, this represents a significant improvement over the annual average o f 2.5 percent during the 1997-2001 growth period. Agriculture will grow at 3,5 percent in 2004 and an average o f 4.5 percent over the forecast period. Increasing resources to support investments inirrigation (FERHA) underthe watershed program, the impact o f the road program on productivity and producer prices at the farm level account for the increased contribution o f the agricultural sector. These investments are expected to be supported by stronger producer organizations, an effective partnership between the producers and the operators and the growth o f agri-business which will allow for a more dynamic agriculture and the diversification o f agricultural activities towards products with higher value added. Fisheries will expand at an average rate o f 4 percent, thanks to the regulation o f over-fishing inshrimpfisheries and a stable progressionof shrimp farming, further boostedbythe AGOA and incentives to strengthen the competitiveness o f the sector based on the recommendations issuedby the currentjoint analysis o f the Government and the private sector. Re-establishment of healthy balance ofpayments andforeign reserves ... 4.11 Duringthe 1997-2001 period, as a result o f the surging exportsg5,the current account balance deficit, includinggrants, narrowed from 5,6 percent o f GDP in 1997 to 1,3 percent o f GDP in 2001. Privatization receipts and surging FDI - which increased almost ten-fold between 1997 and 2001 mainly toward the EPZ firms - strengthened the capital and financial account. Supported by adequate external assistance inflowsg6, the balance o f payments developments were favorable, net foreign assets o f the banking system increased substantiallyg7and gross official reserves rose to 13.2 weeks o f imports o f goods and non- factor services. 4.12 The balance o f payments outcomes in the recent past were reversed. The impact o f negative terms o f trade shock driven by the increase in oil and rice prices and the decline in vanilla price, compounded by a significant increase in imports - following a full tax 95 Between 1997 and 2001 merchandiseexport volumes grew by an annual average of 11,8 percent and export earnings doubled.Earningsfrom manufacturedexports, includingthe output ofthe EPZs, grew by 78,5 percent. 96 Externalbudgetaryandbalanceof paymentssupport amountedto 1,3 percentof GDP in2001. 97Net foreignassets increasedfrom SDR -58,9 million in 1994to SDR 801,9 million bythe end of 2001. - 69 - exem tion on a list o f goods - led to a widening o f the current account deficit in 2003 and 2004 ?*.Exports value has decreasedfrom 21percent of GDP to 15,6 percent o f GDP between 2001 and 2003. In 2004, it i s not expected to reach the levels o f the 2001 exports yet. The current account deficit, including net official transfers, deteriorated from 2003 onwards, reaching 6 percent in2002 and 2003 and a projected 8.6 percent in2004. Inaddition, a series o f interventions o f the Central Bank inthe foreign exchange market inan attempt to mitigate a depreciation o f the exchange rate in the first semester o f 2004 led to a decline in foreign reserves to a projected level of three (3) months of exports by end-2004. Figure4.1: Developmentson the balanceof payments,2003 -2008 (percent GDP, months of imports) ~~ 20.0, I 6.0 ~ 15.0 4.0 = 10.0 s n 0 5.0 2.0 (3 2 CI c 0.0 0.0 .E Q -10.0 - - - - - .. - = * OO*I...l........~ E -15.0 - - - - * * = - -4.0 0 E Source: Central Bank; IMF. ...will be supported by stronger exports and adequateforeign assistance 4.13 Inthe medium term, the current account balance, includingnet official transfers, is expected to decrease at 6.2 percent of GDP in 2008, with the trade account registering 9.5 percent o f GDP thanks to a resumption o f the exports performance supported by the development of the mining,tourism, fisheries and the textile sectors. Exports are projected to grow at an average rate o f 12 percent, and average 23 percent of GDP over the forecast periodwhile imports would grow at an average rate o f 8.8 percent with an average level o f 28 percent o f GDP. 4.14 The capital and financial account i s also expected to improve. With the investment in the IGPP, mining and industrial infrastructure, FDI would more than triple in the same period, from $USD 40 million in 2004 to $USD 140 million in 2008, reaching the pre crisis Inearly 2004 several developments affected the current account balance: (i)an increase in oil and rice prices and the full tax exemptions, includingVAT, on a range of capital and consumption goods under a law enacted in the second semester of 2003. As a result, imports in 2004 are expected to increase from SDR838 million to SDR880 million; (ii)two cyclones that affected shellfish and vanilla, two major sources o f foreign exchange earnings. Vanilla export value decreased from SDR139 million in 2003 to a projected SDR69 million in 2004. Exports would be decreasing from SDR611 million in 2003 to a projected SDR596 million against SDR757 million in 2001. - 70 - level o f 2,l percent of GDP. Increase in FDI will be supported by the management contract and/or privatization in infrastructure - airports, ports, railway, telecommunications, electricity and water -,the privatization o f the Cotton Company and direct investment in tourism, mining and textiles. If Madagascar benefits from considerable donor support, total foreign assistance in terms o f capital grants, current transfers and government borrowing would amount to 9.0 percent o f GDP in 2008, although down from a level o f 12 percent in 200499. The balance o f payments will experience a net improvement. The level o f international reserves is expected to recover gradually and reach the equivalent o f 193 weeks o f GNFS imports (43 months) at the end o f the forecast period. ...andflexible exchange rate management 4.15 While the impact o f the political crisis accounted for the losses in exports, there has also been an appreciation o f the exchange rate during several years before the 2002 political crisis1oo.As reported inthe fifthreview o f the IMFprogram (PRGF) inOctober 2004, the real exchange rate had largely recovered its competitiveness to the level o f late 1999/early 2000, following a depreciation o f the Malagasy franc by almost 50 percent in the first semester o f 2004. The exchange rate has now stabilized but the question remains whether this depreciation was in fact merely a correction o f a previous over-evaluation or a combination o f factors such as: surging imports after the detuxation laws o f September 2003, higher government expenditures in2003 or higherpetroleum and rice prices as o f 2004. 4.16 The extent to which overall exports respond to the exchange rate depends, not only on the competitiveness o f the exchange rate, but also on several determinants. Madagascar needs to diversify its export base and reduce its reliance on primary agricultural products, for which elasticity could be low. Raising the performance o f the sources o f growth, increasing the production capacity, decreasing the cost o f doing business and achieving the planned infrastructure program with the different reforms set out inthe Government's program i s key inenhancingexportperformance. 4.17 Nonetheless, to achieve the balance of payments and foreign reserves objectives, Madagascar needs to ensure exchange rate stability and competitiveness. This i s particularly relevant today as several trade preferential agreements will soon be coming to term. To maintain a competitive real exchange rate and secure adequate levels o f the international reserves: (i) centralbankwillissueguidelineforinterventioninthemarketwiththeassistanceof the the IMF in 2005 aiming to direct central bank interventions to achieve its foreign assets objectives and dampen sharp swings that would create uncertainty"'. The recent opening o f a continued interbank foreign exchange with an electronic trading system i s expected to provide accurate information to the operators and reduce the volatility o f the exchange rate. However, the recent interdiction o f Bank transfers between foreign currencies denominated accountslo2 could have ambiguous effects and trigger a flight o f foreign currency from the 99Over the forecast period, grants will amount to 6 percent. loo Between 1997 and 2003, the Malagasy Franc has been depreciating nominally against the currencies o f most of its trading partners, except those of Indonesia, Mauritius, and South Africa. lo' Indeed, 2004 the Central Bank reduced considerably its international reserves to the equivalent 2,8 months o f imports as opposed to 4 months in 2002 and 3,3 months in2001, inan attempt to stabilize the nominal exchange rate. lo' The decree 2004-694 of July 6 2004 allows foreign currency transfers only between nonresidents. - 71 - Banking sector - in the form of foreign currency retention on cross border deposits by Malagasy exporters. (ii) authorities will implement sound monetary policy geared toward securing the the competitiveness o f the exchange rate. Because of inflation, the Malagasy franc has in fact appreciated in real terms against all partner currencies, with the exception o f the Indonesian Rupiah. Inflation shocks to work themselvesthrough the economy.. . 4.18 factors - agricultural production, exogenous shocks such as natural disasters, international Ingeneral, several factors affect inflationinMadagascar. First, several non-monetary prices o f products such as rice or oil and the evolution o f the exchange rate - influence the primary state-owned banks was a major factor inavoiding inflationary money rea at ion''^. inflation. Second, monetary policy: the increasing use o f treasury bills and the privatization of When necessary, prudent and tight monetary policy such as increasing minimum reserve requirements andhigherinterest rates also helped contain credit to the economy. 4.19 For the coming years, shocks are expected to be mitigated and work their way through the economy, and the inflation rate i s expected to decrease to 4.9 percent in 2008. Improved performance o f the agricultural sector entailing good rice harvest combined with a monetary policy aiming at controlling inflation while remaining supportive of private sector's needs should lower inflation. Following the strong inflation performance of 2003, in which prices increased by 1percent, end o f period inflation reached 27 percent by the end o f 2004, due to the exchange rate depreciation of the first semester of 2004, lower export performance and the money demand that it brought about, as well as the intemational spike in oil and rice prices. ....with decreasinggovernment borrowing to allowfor strongprivate sector credit extension 4.20 Credit to the overall economy will decrease over the forecast period - from 19.2 percent o f GDP in2003, to 16.5 percent o f GDP in2004 and to 14.9 percent o f GDP by 2008 -largely at the expense o f govemment. Credit to the government i s projected to decrease steadily from 9.0 percent o f GDP in 2003, to 2.9 percent of GDP in 2008, as government accesses resources`through increases in foreign assistance. Credit to the private sector would increase gradually with an average growth rate o f 7 percent, to reach 11.4 percent o f GDP in 2008. Broad money will increase at an annual average o f 12.5 percent, in line with the projected growth rates. Increase in tax revenue i s also expected to lower Government's domestic financing. A decliningfiscal deficit will be supportedby an increase in tax revenues.. . 4.21 The overall deficit, on a commitment basis and excluding grants, i s expected to decrease from 11.1 percent of GDP in 2004, to 9.2 percent in 2008 (or 3.7 percent on average, including grants). The reductioni s projected to arise mainly from an improvement in domestically raised revenues, which have been historically low by intemational and developing country standards. I O 3Treasury bills operations, onwhich primarybanksheavilyinvested, playedakeyrole inthe recent past as their refinancingtook placeat the secondary market, not throughthe central bankandwith preferencegivento short-termoperation(3 months). - 72 - 4.22 Although projected to reach 11.2 percent o f GDP in 2004, Madagascar's tax collection rate i s very low, even by African standard, with an average o f 9 percent o f GDP over the recent period. The main issues include a narrow tax base and a high degree o f evasion, due to widespread corruption and the proliferation of exemptions and partial adjustment^"^. In particular, customs revenue collection remains significantly below its potential due to corruption and inefficiency (see chapter on governance). The tax system i s also highly concentrated with 8 percent of customs taxes and 28 percent o f inland revenue derived from the five largest contributors to each category o f tax. Similarly, tax receipts are highly concentrated with respect to taxation instruments, with two taxes - the VAT and import taxes - accounting for 70 percent o f the country's total tax receipts. 4.23 To a lesser extent, exogenous factors also accounted for the low level o f the government revenues. Ingeneral, natural resources, most notably mining, continue to operate largely outside of the formal economy; illegal logging (or the provision o f non-regular licenses) in the forestry sector has also been a major concern. Other factors such as the streamlining o f tariffs in line with the Cross-Border Initiative/Regional Integration also accounted for the loss inrevenues105. ...ifthe planned reforms aiming to increase domestic revenues are successful. ... 4.24 The government has started to implement a number o f actions to increase tax revenues gradually, with the goal o f reaching 13 percent o f GDP in 2008. Inthe short-term, the Government will address tax administration weaknesses and broaden the tax base. Customs' reform will be at the core. 4.25 The government rescinded the VAT on the previously VAT-exempted consumption goods. A committee overseeing tax administration and tax policy was created in2O03lo6.The role o f the committee i s to design, monitor and implement reforms intax administration for a two-year period. Major reforms under way include actions: (i) to strengthen o f the Service des Grundes Entreprises (SGE) collecting tax from large enterprises; (ii) close loopholes to that reduce tax collections and to recover arrears and amount indispute; (iii) to rationalize the tax and tariff structure; (iv) to install one-stop shop in the main ports to speed up customs clearance. While in the past, collection o f taxes on petroleum products took 45 days as they were collected only prior to distribution, since the second semester o f 2004, taxes on petroleum products have been collected at arrival instead o f to improve the predictability of tax revenues. In addition, concrete actions were adopted in the line o f these ideas in early 2005. The Government has already merged the customs and import taxes into a single tax; customs duties credit was eliminated; payments of the customs duties through the banking systemwill be mandatory from April 4,2005; the immunityo f customs agents from enquiries and prosecutionwas abolished. ....and will support increasing expenditures 4.26 Increase in tax collection i s necessary to support fiscal consolidation without imposing limitations on the required levels o f expenditures in relation to the growth and I O 4The VAT rate inMadagascar, for instance -at 20 percent of value added -is among the highest inthe world. However, at 4,2 percent of GDP, Madagascar's VAT take i s approximately half of its full-collection level. `Os IMF article IV in November 2001 estimated at 0,5 percent of GDP the shortfall in revenue due to the appreciation of the M g f ,the lower petroleum imports and the tariff cut from 30 to 25percent on a large number of products inthe context ofthe Cross Border Initiative over the first half o f 2001. See "Madagascar : Vers la Rationalisation du Systkme Fiscal (( ))- IMF-August 2003. - 73 - poverty reduction objectives. The level o f government expenditure i s expected to rise significantly over the forecast period, to an average o f approximately 22 percent o f GDP, a rise o f approximately 5 percent over the growth period o f 1997-2001, capital expenditure accounting for approximately half o f the outlay. Interest payments will decrease from 3.0 percent o f GDPin2004, to 1.9 percent of GDP in2008 after the HIPC completion point. Table 4.2: Key publicsector developments,1997-2008 (in percentof GDP) 1997-2001 2002 2003 2004 2005 2006 2007 2008 2004-2008 Total expenditure 17.2 15.2 19.2 23.1 21.8 22.1 22.5 22.7 22.4 ,, 14.7 13.0 17.0 20.1 19.4 19.9 20.5 20.8 20.1 , ... oofwhich investment f which non-interest 7.1 4.8 7.8 11.5 10.8 11.3 11.7 11.9 11.4 Revenue 14.7 10.2 15.4 19.9 18.1 18.4 ...tax revenues. 18.8 19.1 18.9 10.2 7.7 10.0 11.2 11.6 12.1 12.6 13 12.1 Grants 4.0 2.2 5.1 7.9 5.9 5.8 5.7 5.6 6.2 Deficit commt basis - excl grants* -7.6 -7.7 -9.3 -11.2 -9.5 -9.5 -9.4 -9.2 -9.8 ., ,with a stronger public sector investment ~omponent''~ 4.27 Growth will be stimulated by an increasing investment rate. Investmenti s projected to grow rapidly, reaching 25 percent of GDP by the end o f the forecast period, compared with 18.5 percent at the height o f the 1997-2001 growth episode. The public sector will play a much stronger role in driving investment than it has in the past, representing 48 percent o f total investment on average over the forecast period- as opposed to 40 percent in2001. With the support o f donor funds and the debt service savings from the HIPC relief, government capital expenditure i s projected to increase by close to $800 million over the five years to 2008. The increase reflects investment in infrastructure - roads, energy, water and sanitation and additional infrastructure supporting the growth pole project and the watershed program (FERHA) - and education. This public sector investment drive is projected to crowd in private sector investment, in the textiles, tourism, and mining sectors, and give impulse to agricultural growth. Private investment will increase, reaching 12 percent at the end o f the forecast period, with a significant contribution o f FDI. Reforms undertaken to modernize public expenditure management in the Priority Action Plan o f the Government based on the CFAA and the CPAR are expected to improve budget execution and efficiency. R I S K S 4.28 The major risks to the success of the current Government's strategy are a slippage in achieving political stability, the impact o f exogenous shocks andor a prolonged downturn in world growth and a slow implementation of the reforms. First, the risk o f political instability i s less although some tensions are perceived. Second, the country i s exposed to a multitude o f shocks over which it has no control. For instance, the impact o f the oil shock and the uncertain7 about the evolution of commodity prices are likely to challenge the growth objective' '. However, the experiences in 2001 and 2004 (cyclone and oil shocks)'0g IO7 The fiscal implications of the investment inkey sectors inanalyzed inthe PER. lo' Preliminary estimates point at particular concern about the adverse impact on low-income oil-importing developing countries. While detailed country data are weak and must be interpretedwith some caution, for low- income oil importers as a group (excluding India), an estimated $10 increase in the average price of oil would translate into a 6 percent fall in their terms of trade, corresponding to an income loss o f 1.3 percent o f GDP (with substantial variation around the average). The adverse movement offsets much o f the improved terms of trade that many non-oil commodity exporters had experienced the last few years. Ref. Oil Market Update and Implicationsfor Developing Countries -World Bank, September 22, 2004. - 74 - demonstrate that a sound macroeconomic policy and an adequate level o f assistance can help the country smoothout the impact ofexternal shocks andmaintainhighgrowthperformance. 4.29 But this DPR also highlightedthe need for caution ina number of areas over which the Government has control: (i) necessity to adopt a sound macroeconomic policy; (ii) the the need for enhanced transparency in policymaking. The DPR argues therefore that the main challenge for Madagascar lies in the capacity o f the administration to implement the reform program. Given the breadth of the reforms and the relatively weak capacity within the administration, there i s a risk that the pace o f the implementation of the reforms i s slow although the far reaching reforms implemented since 2002 and their nature point at potential for improvement. The Government should sequence, prioritize and address the most binding constraints by focusing on reforms that are likely to bring tangible results and enhance its credibility. One o f the lessons from the 1990s i s "that there is a need to get away from formulae and realize that economic policies and institutional reforms need to address whatever is the binding constraint on growth, at the right time, in the right manner, and in the right sequence, instead of addressingany constraint at any time"110. POVERTY SIMULATIONS 4.30 How the expected growth over the forecast period would translate into poverty reduction? Using a World Bank Projection Toolkit (PovStat) with the macroeconomic framework in the DPR and the characteristics and data o f the 1997-2001 period, poverty i s expected to be reduced to 67 percent, down from 73 percent over the forecast period (2004- 2008) and below the poverty headcounts in 2001 (69.3 percent)"'. Poverty gaps decrease pointing to an improvement inextreme poverty. Table 4.3: The effects of economicgrowthon poverty Base Case Projections 2005 2006 2007 2008 GDP Growth 7.0 7.0 7.0 7.0 Foster-Greer-ThorbeckeIndices HeadcountIndex 73.16 71.25 69.58 67.75 PovertyGap Index 38.18 36.59 35.01 33.44 Number of Poor (thousands) 12,47 12,48 12,53 12,54 Case 1: Overallgrowth remains the same with lower agriculturalgrowth Pro,jections 2005 2006 2007 2008 GDP Growth 7.0 7.0 7.0 7.0 Foster-Greer-ThorbeckeIndices HeadcountIndex 73.8 72.9 71.9 71.08 PovertyGap Index 39.02 37.76 36.80 36.30 Number of Poor (thousands) 12,58 12,78 12,95 13.16 Case 2: Overallgrowth remains the same with higher agricultural growth and a lower growth in industry GDP Growth 7.0 7.0 7.0 7.0 logThe two exogenous shocks were: (i) sharp increase in oil prices in 2000 which caused increases in the oil a bill (by 78 percent) and in transportation costs (by 40 percent), leadingto an estimated loss of 2.5 percent of GDP; (ii)a series of cyclones which hit the North of Madagascar in 2000, resultingin important social needs and serious damagesto infrastructureand a fall inexports proceedsdropped. `loEconomic Growthinthe 1990s- Learningfrom aDecade of Reform-The World Bank-2004. ``IThe mainassumptions are the following: populationgrowthrate, the sectoralemployment creation elasticity to GDP: sector share/GDP arethe same that in2001. - 75 - Base Case Projections 2005 2006 2007 2008 Foster-Greer-ThorbeckeIndices HeadcountIndex 73.6 71.7 69.7 67.8 Poverty Gap Index 38.5 36.7 34.8 33.1 Number of Poor (thousands) 12.55 12.56 12.56 12.57 Case3: Overall and agriculturalgrowth decrease Projections 2005 2006 2007 2008 GDP Growth 4.6 4.6 4.6 4.6 Foster-Greer-ThorbeckeIndices HeadcountIndex 74.38 73.54 72.66 71.95 Poverty Gap Index 39.53 38.61 37.72 36.88 Number of Poor (thousands) 12,69 12.88 13,09 13,31 Source: Staffs' calculation using RMSM- PovStatprojections and HH2001. 4.31 Overall economic growth in the past has helped decrease poverty. However, growth over the recent period did not translate into equal increase in income for all households. The additional income was distributed mainly within industry and services, with people making their living from agriculture left aside. A negative average per capita growth over the same periodinagriculture accounts for the stagnation o f poverty inagriculture. 4.32 The following simulations show that: (i) growth matters to poverty reduction and in order to further reduce poverty, Madagascar has do to better than during the recent growth period; (ii) the nature o f sectoral growth impacts on the shape o f poverty reduction and poverty gaps. For instance, higher agricultural growth is likely to lead to a more significant poverty reduction. 4.33 Case 1: GDP remains the same with lower agricultural growth. Another simulation shows that inspite of strong growth o f about 7 percent and with a stronger growth inindustryand services of 12percent and 8 percent on average respectively, a contraction of the agricultural sector to an average level o f 2 percent will lead to a less significant poverty reduction than inthe base case. Poverty rate will be 71 percent, higher o f about 4 percentage points than the base case and with additional 570,000 people below the poverty line at the end o f the forecast period - 2008. Poverty gaps will be higher than in the base case as agriculture lags behindthe other sectors. 4.34 Case 2: Overall growth remains the same with higher agricultural growth and lower growth in industry. Agriculture will grow by 7 percent on average (a 3.5 percentage point increase compared to the base case), industry will grow by 2 percent, a 6 percentage point decrease compared to the base case while services will observe the same average base case - 67 percent growth as in the base case. In this projection, poverty reduction will be the same as in the - pointing to a stronger impact o f agricultural growth on poverty reduction despite a significant decrease in industrial growth. Poverty gap will decrease to the level o f the base case, a lower level than in Case I,as agriculture catches up with the other sectors. 4.35 Case 3: overall growth remains at the 1997-2001 (4.5 percent) with all sectors observing the same average growth over the recent period - agriculture 2.5 percent; industry 5.8 percent and services 5.3 percent. A number o freasons may account for the lower agricultural growth: a strong exposure to natural disaster or the failure to address productivity and market access constraints in the sector. This projection also assumes a lower growth in - 76 - industry that may arise from the risk borne by the phasing out of the MFA or the failure to address the identified issues in competitiveness and investment climate; the failure to implement the institutional reforms in mining. In services, the lower performance may be resultingfrom the failure to address the accommodation issues intourism or the costs o f air transportation with a resulting slower growth inthe number o f tourists. It can also stem from a slow implementation o f the programmed public investment, including the growth poles projects or road infrastructure for example. In this projection, poverty will only decrease to 71 percent, the same as in Case 1. However, the absolute number o f poor will increase by 770, 000 compared to the base case. KNOWLEDGE GAPS 4.36 Not only does a substantial poverty reduction require a prolonged growth, but it also has to benefit the majority of the population. The simulations on poverty indicate that if the pattern o f growth does not include the agricultural sector and the rural areas, the likely poverty outcomes will be uneven as it was during the 1997-2001 period, with the vast majority o f the population excluded from the generation and benefits o f growth. 4.37 As a result, a strategic balance has to be struck in the Madagascar development strategy at least for two reasons: (i) Madagascar needto maintain high growthperformance in industryand services as a rapideconomic growth is not likely to come from agriculture inthe short-term. Ifthis approach will help attract migrants and release the pressure on land, a rapid absorption o f the rural labor force will not happen over night; (ii) at the same time, given the magnitude of poverty in rural areas, the importance o f the labor force and the rural population, poverty reduction will not occur without strong rural growth. 4.38 Currently, a series o f analytical work is being conducted to build knowledge in key areas in order to sustain growth' '*.However, some aspects of the economy remain unknown and a consensus on a strategic approach to turn the economy structurally in a different direction onto a higher and more integrated growth trajectory with substantial poverty reduction impact i s necessary. Among the most important i s the strengthening o f linkages between agriculture and the modern sectors to achieve the objective o f making agriculture one o f the engines o f growth and a strong vehicle for poverty reduction as spelled out inthe Madagascar Naturellement. Inparticular, analytical study needs to be carried out on how to develop agri-business and tap the potential in agriculture; what are the products for which Madagascar holds strong comparative advantage in the world market and what are the prospects for their development. 4.39 Similarly, the linkages between some growing sectors and the rural areas need to be explored. In tourism, as indicated in the Tourism Economic Sector Work o f the World Bank (2003), a supply chain analysis for a group o f hotels indifferent geographic regions will help determine the potential for linkages o f the sector to the domestic economy : which products comprise the chief inputs into local hotels, which are produced locally and which are imported; an analysis o f the reasons for importing rather than purchasing locally, where this i s feasible, could identify some constraints that are capable o f resolution. I n EPZ, there i s An investment climate assessment is being conducted to provide a comprehensive understanding of issues the private sector faces; a study on the handicraft sector, as part ofthe EPZ sector is being finalized; a study on the regulation of the exploitation o f shrimp fisheries and on issues related to the competitiveness of shrimp farming are beingfinalized. - 7 7 - little analysis o f the potential of growth and exports in non garments EPZ manufacturing. Most o f them may also have linkages with agriculture. 4.40 Some aspects regarding the provision o f key assets to the population and the poor in particular need to be explored. In education, the Government would need to explore options to improve the quality o f vocational training with the aim to establish stronger links with firms in the growing sectors and create incentives for those firms to offer adequate training. I n thefinancial sector, it i s necessary to have a better knowledge o f the size and needs o f the potential market for micro finance services, to avoid a regressive pattern as it seems to be the case (see section on microfinance). 4.41 Finally, Madagascar seems to be characterized by a strong regional disparity. An analysis o f the constraints to migration, the potential for and constraints to regional growth as well as the factors underlying regionalpoverty would also provide insightsinto the resolution o f the regional disparity. - 78 - Annexes Table A. 1. GrossDomesticExpenditureand Product (current prices) (billions of LCU) 1995 1996 1997 $998 1999 2000 2001 2002 2003 A. GDP bv Exwndltureand Income 1. Finalconsumption 13.025.1 15.230.7 17.198.7 18,914.3 21,683.2 24,216.3 25,261.2 27,729.4 31,244.2 a) Generalgovernment 904.2 1,583.7 1.411.3 1,592.3 1,682.2 1,790.3 2,469.8 2,449.8 3.108.0 b) Private 12,120.8 13.647.0 15.787.5 17,322.0 20,001.0 22,426.1 22,791.4 25,279.6 28.136.2 2 Gross capitalformation 1,474.9 1,888.0 2.313.0 3.007.0 3.485.3 3,948.1 5.520.9 4.284.8 6,064.5 a) Grossfixed capita formation 1,474.9 1,688.0 2.313.0 3.007.0 3.485.3 3,948.1 5,520 9 4.284.8 6,064.5 i) Government 779.9 1,081.8 1.177.0 1,612.0 1,616.0 1,766.1 2,180.9 1,445.8 2,657.4 ii) Privatesector and parastatals 695.0 806.2 1,136.0 1,395.0 1,869.3 2.182.0 3.340.0 2,839.0 3,407.1 b) Changein inventories 0 0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. TotalAbsorption (1+2) 14,499.9 17,118.7 19,511.7 21,921.3 25.168.5 28,164.4 30.802.1 32,014.2 37,308.7 4. Resourcebalance -1,021.3 -894.3 -1,461.O -1,578.0 -1,809.0 -1,922.6 -959.1 -1.972.4 -3,415.5 a) Exportsof goods & services 3,253.0 3,324.8 3.947.0 4,378.0 5.715.0 8,051.3 8,678.0 4,809.2 7.284.5 b) importsof goods & Services 4.274.3 4,219.1 5,408.0 5.956.0 7.524.0 9,973.9 9.637.1 6.781.6 10,699.9 5. Statistical discrepancy 0.0 0.0 -0.6 -1.6 24.4 0.3 0.1 0.0 0.0 6 Gross domestic product(3+4+5) 13.478.7 16,224.4 18,050.1 20,341.7 23.383.9 26,242.1 29.843.1 30,041.9 33,893.2 7. Net incomefrom abroad -674.7 -641.0 -465.7 -402.3 -264.3 -477.1 -391.7 -469.7 -494.6 8 Gross nat ona ncome (6*7) 12803 9 15,583.4 17.584.4 19,939.5 23,119.6 25,764.9 29,451.4 29,572.1 33,398.6 910her c-rrent transfers from aoroao 268 7 645.7 926.5 465.0 812.8 918.7 961.8 651.1 1,876.4 Gross nanonaldlSpOSa0te ncome (8-9) 13.072 6 16,229.1 18,510.9 20,404.5 23.932.4 26.683.7 30,413.1 30,223.3 35,274.9 11.Nationaisavinas(10-1) 47.6 998.5 1.312.2 1,490.2 2,249.3 2,467.3 5.132.0 2,493.9 4,030.7 E. GDP by Industrial origln 1,Agriculture 4,109.3 4,807.5 5.266.2 5.716.8 6.422.9 6.945.4 7.679.2 8,962.6 9,073.4 2. industry 1,716.9 2,046.6 2.243.8 2.542.6 2,860.4 3,384.2 4,014.9 4,077.6 4,776.7 ConstruCtion 46.9 54.1 80.3 84.3 95.2 118.8 152.2 137.6 132.9 Gas,electricity,water 159.3 206.0 245.6 262.0 304.5 395.0 422.4 360.7 334.9 Manufacturing 1,510.7 1,786.6 1.917.9 2,196.4 2.460.7 2,870.3 3,440.4 3,579.3 4.308.8 3. Services 6,699.3 8,2541 9.181.5 10.444.4 11,918.2 13,407.8 15.837.1 15.225.1 17i272.3 Transportation 2.447.8 2.800.3 3k38.0 3.657.7 4,020.9 4,400.1 5,032.2 4.562.2 4.870.0 Trade 1.359.0 2,086.4 2.229 3 2,3849 2.631.6 2,835.1 3,335.8 3.554.6 3.909.2 Dwellings 1703 220.8 232.5 296.4 357.2 430.8 524.3 552.3 651.7 Bankingand Rnance 147.4 211.9 162 1 199.7 259.4 226.9 196.2 164.8 190.0 Publicadministration 573.7 678.6 884.0 1,057.6 1.268.7 1,450.7 1.722.0 1,640.9 2,173.2 ~~ ~ Other 2,001.1 2,256.1 2,435.6 2,848.0 3,380.5 4,064.1 5,026.5 4,750.3 5.478.1 4 indirect(import)taxes 953.2 1,116.2 1.358.6 1,637.9 2,182.5 2.504.7 2,311.9 1,776.6 2,770.9 5. Totalvalue addedat marketprices 13,478.7 16,224.5 18,050.1 20.341.7 23,383.9 26.242.1 29.843.1 30.041.9 33.893.2 Table A. 2. GrossDomestic Expenditureand Product (Shares based on current price data) 1995 1996 1997 I 998 1999 2000 2001 2002 2005 A. GDP bv Exoendlture and Income 1 Final c&umption 96 6 93.9 95.3 93.0 92.7 92.3 84.7 92.3 92.2 a) General government 6.7 9.8 7.8 7.8 7.2 6.8 8.3 8.2 9.2 b) Private 89.9 84.1 87.5 85.2 85.5 85.5 76.4 84.1 83.0 2. Gross capital formation 10.9 11.6 12.8 14.8 14.9 15.0 18.5 14.3 17.9 a) Gross fixed capital formation 10.9 11.6 12.8 14.8 14.9 15.0 18.5 14.3 17.9 i) Government 5.8 6.7 6.5 7.9 6.9 6.7 7.3 4.8 7.8 ii) Private sector and parastatals 5.2 5.0 6.3 6.9 8.0 8.3 11.2 9.5 10.1 b) Change in inventories 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Total Absorption (1+2) 107.6 105.5 108.1 107.8 107.6 107.3 103.2 106.6 110.1 4. Resource balance -7.6 -5.5 -8.1 -7.8 -7.7 -7.3 -3.2 -6.6 -10.1 a) Exports of goods &services 24.1 20.5 21.9 21.5 24.4 30.7 29.1 16.0 21.5 b) imports of goods 8 services 31.7 26.0 30.0 29.3 32.2 38.0 32.3 22.6 31.6 5. Statistical discrepancy 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 6. Gross domestic product (3+4+5) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 7. Net income from abroad -5.0 -4.0 -2.6 -2.0 -1.l -1.8 -1.3 -1.6 -1.5 8. Gross national income (6+7) 95.0 96.0 97.4 98.0 98.9 98.2 98.7 98.4 98.5 9. Net current transfers from abroad 2.0 4.0 5.1 2.3 3.5 3.5 3.2 2.2 5.5 I O . Gross national disposable income (8+9) 97.0 100.0 102.6 100.3 102.3 101.7 101.9 100.6 104.1 11. National savings (10-1) 0.4 6.2 7.3 7.3 9.6 9.4 17.2 8.3 11.9 B. GDP by Industrial orlgln 1.Agriculture 30.5 29.6 29.2 28.1 27.5 26.5 25.7 29.8 26.8 2. Industry 12.7 12.6 12.4 12.5 12.2 12.9 13.5 13.6 14.1 Construction 0.3 0.3 0.4 0.4 0.4 0.5 0.5 0.5 0.4 Gas, electricity, water 1.2 1.3 1.4 1.3 1.3 1.5 1.4 1.2 1.o Manufacturing 11.2 11.0 10.6 10.8 10.5 10.9 11.5 11.9 12.7 3. Services 49.7 50.9 50.9 51.3 51.O 51.1 53.1 50.7 51.O Transportation 18.2 17.3 17.9 18.0 17.2 16.8 16.9 15.2 14.4 Trade 10.1 12.9 12.4 11.7 11.3 10.8 11.2 11.8 11.5 Dwellings 1.3 1.4 1.3 1.5 1.5 1.8 1.8 1.8 I.9 Banking and finance 1.I I.3 0.9 1.o 1.I 0.9 0.7 0.5 0.6 Public administration 4.3 4.2 4.9 5.2 5.4 5.5 5.8 5.5 6.4 Other 14.8 13.9 13.5 14.0 14.5 15.5 16.8 15.8 16.2 4 Indirect (import) taxes 7.1 6.9 7.5 8.1 9.3 9.5 7.7 5.9 8.2 5.Total value added at market prices 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 - 79 - Table A. 3. Gross Domestic Productby Expenditure,National Income and Savings (billionsof 1984LCU) 1995 1996 1997 1998 1999 2000 2001 2002 2003 A. GDP by Expendlture and Income 1. Finalconsumption/1 1,727.1 1,742.2 1.842.1 1,913.1 1,983.0 2.079.5 2.176.9 2,016.0 2,223.8 a) Generalgovernment 157.8 151.8 174.3 170.2 164.7 172.0 195.7 171.7 221.2 b) Private 1,569.3 1,590.4 1.667.8 1,742.6 1,818.8 1,907.9 1,978.2 1,844.3 2002.6 2. Gross capitalformation 194.8 219.1 231.6 274.0 277.8 319.0 391.2 268.2 421.6 a) Grossfixed capitalformation 194.8 219.1 231.6 274.0 277.8 319.0 391.2 268.2 421.6 i)ii)Government 103.0 122.4 115.8 143.5 123.9 121.6 146.5 78.7 183.5 Privatesector and parastatals 91.8 96.7 115.8 130.5 153.9 197.4 244.7 189.5 238.1 b) Change in inventories 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. TotalAbsorption (1+2) 1,921.9 1,961.3 2,073.7 2,187.1 2,260.8 2.398.5 2.568.1 2,284.2 2645.4 4. Resourcebalance 9.4 11.5 -28.1 -61.3 -35.1 -67.1 -100.1 -127.2 -277.2 a) Exportsof goods 8 services 336.5 351.5 338.3 323.2 372.9 430.4 456.0 256.7 566.9 b) Importsof goods 8 servlces 327.2 340.0 366.4 384.5 408.0 497.5 556.1 384.0 844.1 5. Gross domestic product(3+4) 1,931.3 1,972.8 2,045.6 2,126.1 2,225.1 2,331.1 2,470.9 2,157.0 2368.2 6. Terms of trade adjustment -87.5 -89.5 -99.2 -78.6 -53.0 -88.8 -31.O 24.8 23.6 7. RealGrossdomestic income(5+6) 1,843.7 1,883.3 1,946.4 2,047.5 2,172.2 2,242.3 2,439.9 2,181.8 2391.8 8. Netincomefrom abroad -89.0 -75.1 -49.3 -39.3 -23.5 -39.4 -32.3 -33.1 -32.6 9. RealGrossnational income(7+8) 1,754.7 1,808.2 1.897.1 2,008.2 2,148.7 2,202.8 2,407.6 2,148.7 2359.1 10.Netcurrent transfers from abroad 35.4 75.6 98.0 45.4 72.2 76.0 79.4 46.4 49.0 11.RealGross national disposableincome(9110) 1,790.2 1,883.9 1,995.1 2,053.6 2,220.9 2,278.8 2,486.9 2,195.1 2408.2 12.Real Gross nationalsavings (11-1) 63.1 141.6 153.0 140.6 238.0 199.3 310.0 179.1 184.4 6.GDP byIndustrial origin 1. Agriculture 667.3 684.0 696.9 711.8 736.0 741.8 771.5 759.5 769.3 2. Industry 225.4 229.8 240.5 253.3 264.0 278.7 299.9 237.5 272.1 Construction 5.1 5.0 7.2 7.4 7.6 8.1 8.6 5.5 6.7 Gas, electricity,water 34.1 36.9 43.3 42.6 44.3 46.5 43.6 30.1 33.9 Manufacturing 186.2 187.9 190.0 203.3 212.1 224.0 247.7 202.0 231.5 3. Services 874.4 893.2 935.6 980.7 1,034.3 1,106.3 1,173.6 992.5 1,086.9 Transportation 294.0 309.8 336.2 351.8 366.0 377.0 396.0 308.3 287.9 Trade 212.8 219.8 225.9 232.3 240.7 247.4 259.0 239.4 248.9 Dwellings 26.3 28.1 29.4 33.3 37.2 42.8 48.6 41.2 51.7 Banking 25.7 26.1 26.6 29.8 31.7 34.6 37.4 39.3 44.2 Publicadministration 105.7 108.1 108.1 108.2 108.2 108.2 110.3 112.6 119.3 Other 209.9 201.3 209.5 225.3 250.5 296.3 322.2 251.7 334.8 5. Total value addedat basicprices 1,767.1 1,807.0 1,873.0 1,945.7 2,034.3 2,126.9 2,245.1 1,989.5 2128.3 6. Indirecttaxes (import duties) 164.2 165.8 172.6 180.4 190.8 204.2 225.8 167.5 239.9 7. GDPat market prices (5+6) 1,931.3 1,972.8 2,045.6 2,126.1 2,225.1 2,331.1 2,470.9 2,157.0 2368.2 I/l includesstatisticaldiscrepancy Table A. 4. Annual growth rates of National Income and Product at constant prices (percentages) 1995 1996 1997 I998 1999 2000 2001 2002 2003 A. GDP by Expenditure and Income 1.Finalconsumption I.7 0.9 5.7 3.9 3.7 4.9 4.7 -7.4 10.3 a) General government 2.7 -3.8 14.8 -2.4 -3.2 4.4 13.8 -12.3 28.8 b) Private 1.5 1.3 4.9 4.5 4.4 4.9 3.7 -6.8 8.6 2. Gross capital formation 1.6 12.4 5.7 18.3 1.4 14.8 22.6 -31.4 57.2 a) Gross fixed capital formation 1.6 12.4 5.7 18.3 1.4 14.8 22.6 -31.4 57.2 i) Government -5.4 18.8 -5.4 23.9 -13.7 -1.8 20.5 -46.3 133.2 ii) Private sector and parastatals 10.9 5.3 19.8 12.7 18.0 28.3 23.9 -22.6 25.6 3. Total Absorption (1+2) 1.7 2.0 5.7 5.5 3.4 6.1 7.1 -11.1 15.8 4. Resource balance 15.0 22.5 -344.8 117.9 -42.8 91.3 49.2 27.1 117.9 a) Exports of goods & services 3.3 4.4 -3.8 -4.4 15.4 15.4 6.0 -43.7 120.8 b) Imports of goods & services 3.0 3.9 7.8 5.0 6.1 21.9 11.8 -31.0 119.8 5. Gross domestic product (3+4) 1.7 2.1 3.7 3.9 4.7 4.8 6.0 -12.7 9.8 6. Terms of trade adjustment -2.0 2.2 10.8 -20.8 -32.6 67.6 -65.0 -179.9 -5.0 7. Real Gross domestic income (5+6) 1.9 2.1 3.3 5.2 6.1 3.2 8.8 -10.6 9.6 8. Net income from abroad 2.7 -15.7 -34.3 -20.3 -40.2 68.0 -18.1 2.5 -1.5 9. Real Gross nationalincome (7+8) 1.9 3.0 4.9 5.9 7.0 2.5 9.3 -10.8 9.8 io. Net current transfers from abroad -33.7 113.4 29.7 -53.7 59.2 5.2 4.5 -41.5 5.6 11,Real Gross nationaldisposable income ( 0.8 5.2 5.9 2.9 8.1 2.6 9.1 -11.7 9.7 12. Real Gross nationalsavings (11-1) -18.4 124.3 8.I -8.2 69.3 -16.2 55.6 -42.2 3.0 B. GDP by industrial origin I, Agriculture 1.9 2.5 1.9 2.1 3.4 0.8 4.0 -1.6 1.3 2. Industry 1.8 2.0 4.7 5.3 4.2 5.6 7.6 -20.6 14.5 Construction 10.9 -3.0 45.0 1.8 3.1 6.6 6.2 -36.3 22.9 Gas, electricity, water 8.1 8.4 17.2 -1.6 4.1 5.0 -6.3 -31.1 12.6 Manufacturing 0.4 0.9 1.1 7.0 4.3 5.6 10.6 -18.5 14.6 3. Services 1.5 2.1 4.8 4.8 5.5 7.0 6.1 -15.4 9.5 Transportation 1.6 5.4 8.5 4.6 4.1 3.0 5.0 -22.1 -6.6 Trade 1.8 3.3 2.8 2.9 3.6 2.8 4.7 -7.6 4.0 Dwellings 14.5 7.0 4.7 13.3 11.6 15.0 13.5 -15.1 25.5 Banking 1.5 1.5 2.0 12.0 6.4 9.4 8.1 4.9 12.6 Public administration -2.2 2.3 0.0 0.1 0.0 0.0 2.0 2.0 6.0 Other 1.7 -4.1 4.1 7.5 11.2 18.3 8.8 -21.9 33.0 5. Total value added at basic prices 1.7 2.3 3.7 3.9 4.6 4.5 5.6 -11.4 7.0 6. Indirect taxes (import duties) 1.9 1.o 4.1 4.5 5.8 7.0 10.6 -25.8 43.2 7. GDP at mark& prices (5+6). 1 7 ... 2.1 3.7 3.9 A 7 ... 4.8 6.0 -12.7 9.8 - 80 - Table A. 5. Prices 1995 1996 1997 I998 1999 2000 2001 2002 2003 Exchange Rates (LCU per US$) Nominalofficial average exchangerate (rf, iMF) 4267.91 4054.56 5090.90 5441.40 6283.80 6787.23 6588.50 6832.00 6191.60 Real effectiveexchangerate (depreciation,%,IMF -9.21 27.12 -10.09 0.99 -2.78 10.19 10.31 8.03 5.00 Price Indices Wholesaleprice index (1987=100) Consumer Price Index (1980-100) 436.2 522.4 545.9 579.8 637.2 713.0 765.5 886.7 879.6 CPI (% change) 49.0 19.8 4.5 6.2 9.9 11.9 7.4 15.8 -0.8 Index of RealWages Manuf.Exp.Unit Value Index (1987-100) 128.8 122.5 113.9 109.6 109.3 107.1 105.6 106.1 107.1 Implicit Deflators (1986.100) Grossdomestic productat marketprices 697.9 822.4 882.4 956.8 1050.9 1125.8 1207.8 1392.8 1431.2 Exports of goods and services 617.6 966.6 946.0 1166.9 1354.5 1532.5 1670.6 1902.9 1873.3 Imports of goods and services 851.1 1306.5 1241.0 1476.1 1548.9 1844.1 2004.8 1732.8 1766.2 Terms of trade Index 72.6 74.0 76.2 79.1 87.4 83.1 93.3 109.8 106.1 TableA. 6. PublicSector Finance (inbillions ofLCU) 1997 1998 1999 2000 2001 2002 2003 Overall balance. incl. current grants -1012.7 -1919.0 -1321.0 -1504.8 -2029.0 -2051.1 -2288.1 Total Revenues,.incl. current Grants 2,124.4 2,137.0 2,839.6 3,246.6 3,456.7 2,652.7 4,353.8 Expendituresand Net Lending 3,137.1 4,056.0 4,160.6 4,751.4 5,485.7 4,703.7 6,641.9 Overall balanceexcl. capital Grants -1,012.7 -1,919.0 -1,321.0 -1,504.8 -2,029.0 -2,051.1 -2,288.1 Overall balance inci. all grants (curr. & capital) -433.9 -1,271.0 -650.4 -737.0 -1,295.1 -1,650.6 -1,417.1 Current RevenuelExpenditure Current Budget Balance,incl. currentGrants 164.2 -245.8 294.9 261.4 151.9 -450.9 475.8 Total Current Revenues,incl.current Grants 2,124.4 2,137.0 2,839.6 3,246.6 3,456.7 2,652.7 4,353.8 Current revenue,excludinggrants 1,746.8 2,077.2 2,667.7 3,067.7 3,029.0 2,403.0 3,494.5 Direct Taxes 329.3 339.6 398.0 467.4 594.5 527.6 570.9 IndirectTaxes 1,317.2 1,608.1 2,143.0 2,455.9 2,256.4 1,733.3 2,750.2 On domestic goods & services 369.6 411.1 661.6 865.0 804.2 689.7 1,037.1 On internationaltrade 947.6 1,197.0 1,481.4 1,590.8 1.452.1 1,043.6 1,713.2 Nontax Receipts 58.9 92.4 87.3 95.6 122.6 98.9 102.2 Grants, current 377.7 59.8 171.9 178.9 427.7 249.6 859.3 Unclassifiedrevenue 41.4 37.1 39.4 48.8 55.5 43.3 71.2 Total Current Expenditures 1,960.2 2,382.8 2,544.7 2,985.2 3,304.8 3,103.5 3,878.0 Intereston ExternalDebt 503.5 466.5 325.0 371.2 349.1 407.7 302.8 Intereston Domestic Debt 45.4 87.3 167.8 241.1 242.8 251.8 447.5 Subsidies 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Consumption 1,411.3 1,592.3 1,682.2 1,790.3 2.489.8 2.449.8 3,108.0 Wages and Salaries 669.6 826.4 1,000.6 1,042.4 11337.6 1;380.0 1,887.9 UnclassifiedExpenditure 0.0 236.7 369.7 582.7 223.1 -5.8 19.7 Total Capital Expendituresand Net Lending 1,176.9 1,673.1 1,615.9 1,766.1 2,180.9 1,600.2 2,763.9 CapitalTransfers and Net Lending 0.0 0.0 0.0 0.0 0.0 154.4 106.5 BudgetaryInvestment 1,176.9 1,673.1 1,615.9 ,766.1 2,180.9 1,445.8 2,657.4 Other capital items Total Deficit Financing 1,012.7 1,919.0 1,321.O ,504.8 2,029.0 2,051.1 2,288.1 ExternalCapitalGrants 578.8 648.0 . 670.6 767.8 733.9 400.5 871.0 External Borrowing (net) 6,152.0 290.8 284.9 704.7 637.0 1,094.2 957.8 MonetarySystem Credit (net) -146.0 741.2 167.1 3.1 468.4 722.1 43.9 PrivatizationproceedsI sale of assets 0.0 4.4 51.8 46.3 104.1 46.5 83.5 Other items, incl.arrears and discrepancy(net) -5.572.1 234.5 146.6 -17.2 85.5 -212.1 331.9 Debt (at end year) Total Government Debt 35,103.4 35,400.8 External Debt, incl.Arrears 30,867.0 30,698.0 DomesticDebt 4,236.4 4,702.9 Banks 3,663.9 3,707.8 Non-banks 572.5 995.1 Other Series Primary Balance, after grants 115.1 -717.1 -157.6 -124.7 -703.2 -991.1 -666.7 InterestPayments 548.9 553.8 492.8 612.3 591.9 659.5 750.4 - 81 - TableA. 7. PublicSector Finance (in% ofGDP) ::::- 1995 1996 1997 1998 1999 2000 2001 2002 2003 Overaii balance, inci. current Brants veraii balance, inci. curr -8. - .61 -9.4 - - .8 -6.83 - . Total Revenues, inci. current Grants ?eta Revenues,inci. currei 8.:; Ii.77 10.5: 1::;; 1:.5: 8.83 l;.g Expendituresand Net Lending Expendituresand Net Lend 17.61 17.77 17.38 19.94 1;::;17.79 18.11 18.38 15.66 19.60 Overaii balance exci. current Giants Overaii balanceexcl. capita -8.63 -8.25 -5.61 -9.43 -5.65 -5.73 -6.80 -6.83 -6.75 Overaii balance inci all grants (curr. &capital) Overail balanceinci. ail grai -5.95 -4.75 -2 40 -6.25 -2.78 -2 81 -4.34 -5.49 -4.18 Current RevenueExpenditure Current RevenueiExpenditure Current Budget Balance, incl. current Giants Current Budget Balance,in, -2.32 -098 091 -1 21 126 100 051 -1 50 140 Total Current Revenues, incl. current Grants Total Current Revenues.in1 8.98 Current revenue, excluding grants Current revenue, excluding 8.75 Direct Taxes DirectTaxes 1.24 indirect Taxes indirect Taxes 7.07 On domestic goods &Services On domesucgoods 2.37 225 205 202 283 330 6.06 269 4.87 2 30 306 ~~~ ~~~ ~~ ~ ~~ On intemationai trade On internationaltrac 4.70 4.62 5.25 5.88 6.34 3.47 5.05 Nontax Receipts Nontax Receipts 0.43 0.19 0.33 0.45 0.37 0.36 0.41 0.33 0.30 Grants, current Grants, current 0.23 0.72 2.09 0.29 0.74 0.68 1.43 0.83 2.54 Unclassified revenue Unclassifiedrevenue 0.00 0.15 0.23 0.18 0.17 0.19 0.19 0.14 0.21 Total Current Expenditures Total Current Expenditures 11.30 10.50 10.86 11.71 10.88 11.38 11.07 10.33 11.44 Interest on Extemai Debt interest on Extemai Dc 4.63 Interest on Domestic Debt interest on Domestic C 0.47 Subsidies (direct) Subsidies 0.00 Consumotion Consumotion 6.20 Wages and Salaries Wages and Saiarie 3.30 322 371 406 428 397 448 459 557 Unclassified Expenditure Unclassified Expenditi 0.00 000 000 116 158 222 075 -002 006 Total Capital Expenditures and Net Lending Total Capital Expendituresi 6.31 CapitalTransfers and Net Lending Capita Transfen and NE 3.17 Budgetary investment BudgetaryInvestment 3.14 Other capital items Other capital items 0.00 Total Deficit Financing Total Deficit Financing 8.63 8.25 5.61 9.43 5.65 5.73 6.80 6.83 6.75 ExternalCapital Grants ExternalCapita Grants 2.68 350 321 319 287 293 246 133 257 External Borrowing(net) ExternalBorrowing(net) -3.68 -1 69 3408 143 122 2 69 2 13 3 64 283 MonetarySystem Credit (net) MonetarySystem Credit -0.32 -028 -081 364 071 001 157 240 013 Privatizationproceeds i sale of assets Privatizationproceeds/ s 0.00 000 000 002 022 018 035 015 025 Other items, incl. arrears & discrepanc)1(net Other items, inci. arreai 9.95 672 -3087 115 063 -007 029 -071 098 Debt (at end year) Debt (at end year) Total Government Debt Total Government Debt 116.85 104.45 External Debt, inci. Arrears External Debt, inci. Arrears 102.75 90.57 Domestic Debt Domestic Debt 14.10 13.88 Banks Banks 12.20 10.94 Non-banks Non-banks 1.91 2.94 Other Series Other Series Primary Balance,after grants Primary Balance.aftergran -0.85 -0.07 0.64 -3.53 -0.67 -0.48 -2.36 -3.30 -1.97 interest Payments Interest Payments 5.10 4.68 3.04 2.72 2.11 2.33 1.98 220 2.21 - 82 - Table A. 8. BankingSurvey and Interest Rates (billions of LCU) 1997 1998 1999 2000 2001 2002 2003 I. Banking Survey A) Millions of LCU, end-year stock Net foreign assets 1,489.3 960.8 1,450.5 1,777.1 2,306.9 2,158.6 2,479.3 Domestic credit 2,494.2 3,410.8 3,668.4 4,271.O 5,305.1 5,952.4 6,509.5 Claims on government 584.3 1,455.3 1,560.7 1,563.3 2,047.9 2,706.8 3,078.4 Claims on parastatals 110.9 143.7 170.2 404.4 756.4 811.1 456.7 Claims on private sector 1,799.0 1,811.8 1,937.5 2,303.3 2,500.8 2,434.5 2,974.5 Claims on other financial institutions 0.0 0.0 0.0 0.0 0.0 8,111.o 0.0 0.0 Total assets (= total liabilities) 3,983.5 4,371.6 5,118.9 6,048.O 7,612.0 8,988.9 Liquid Liabilities 3,846.2 4,159.4 4,959.0 5,915.0 7,357.3 7,877.0 8,522.8 o/w Money + Quasimoney 3,846.2 4,159.4 4,959.0 5,915.0 7,357.3 7,877.0 8,522.8 Moneymarket instruments 2.0 3.0 4.0 5.0 6.0 7.0 8.0 All other net 137.3 212.2 159.9 133.0 254.7 234.0 466.1 B) Shares of GDP (%) Net foreign assets 8.3 4.7 6.2 6.8 7.7 7.2 7.3 Domesticcredit 13.8 16.8 15.7 16.3 17.8 19.8 19.2 Claims on government 3.2 7.2 6.7 6.0 6.9 9.0 9.1 Claims on parastatals 0.6 0.7 0.7 1.5 2.5 2.7 1.3 Claims on private sector 10.0 8.9 8.3 8.8 8.4 8.1 8.8 Claims on other financial institutions 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total assets (= total liabilities) 22.1 21.5 21.9 23.0 25.5 27.0 26.5 Liquid Liabilities 21.3 20.4 21.2 22.5 24.7 26.2 25.1 o/w Money + Quasimoney 21.3 20.4 21.2 22.5 24.7 26.2 25.1 Money market instruments 0.0 0.0 0.0 0.0 0.0 0.0 0.0 All other net 0.8 1.o 0.7 0.5 0.9 0.8 1.4 C) Annual growth rates in excess of GDP (%) Net foreign assets 55.4 -42.8 31.3 9.2 14.2 -7.0 1.8 Domesticcredit -8.6 21.3 -6.4 3.7 9.2 11.5 -3.1 Claims on government -34.2 121.0 -6.7 -10.7 15.2 31.3 0.8 Claims on parastatals 45.9 15.0 3.0 111.7 64.5 6.5 -50.1 Claimson private sector 2.0 -10.6 -7.0 5.9 -4.5 -3.3 8.3 Claims on otherfinancial institutions Money 7.7 -4.0 3.7 6.3 9.4 6.4 -4.1 Other, net 246.7 37.1 -34.4 -25.9 68.5 -8.8 76.6 111. Interest rates (%) Treasury bill rate CBM Discountrate (temporaryadvances) Deposit rate 14.4 8.0 15.3 15.0 12.0 12.0 11.5 Lendingrate 30.0 27.0 28.0 26.5 25.3 25.3 24.3 Realdeposit rate 9 5 1 7 ... 4 Q 2.8 4.1 -3.3 12.4 Real lendingrate 27.0 22.4 15.5 14.4 17.8 8.1 26.3 - 83 - Table A. 9. Balanceof Payments (USmillions) 1997 1998 1999 2000 2001 2002 2003 Prelim. Current Account Exports of goods & services 774.1 804.6 910.1 1,186.2 1,316.5 729.5 ,171.O Exports of goods 507.1 522.3 584.0 828.9 964.8 499.1 852.0 Exports of services 267.1 282.3 326.1 357.3 351.7 230.4 319.0 Imports of goods & services 1,060.6 1,094.6 1,I98.2 1,469.5 1,462.0 1,028.7 ,720.0 imports of goods, f.0.b. 682.0 672.2 742.5 932.5 950.0 619.6 ,104.8 Imports of services 378.7 422.4 455.8 537.0 512.0 409.1 615.2 Net trade in goods & services -286.5 -290.0 -288.1 -283.3 -145.5 -299.2 649.0 Income receipts 19.8 24.0 20.6 21.9 23.8 26.8 16.3 Income payments 111.2 97.9 62.7 92.2 83.2 98.0 95.8 Total interest due (PPG) 99.2 86.0 52.0 53.9 56.5 62.2 65.1 Other income payments 12.0 11.9 10.7 38.3 26.7 35.8 30.8 Net income from abroad -91.4 -73.9 -42.1 -70.3 -59.4 -71.3 -79.5 Net private current transfers 102.2 68.4 94.1 101.7 99.2 18.8 159.4 Net official current transfers 79.5 17.1 35.3 33.6 46.7 80.0 142.2 Current Account Balance -196.1 -278.5 -200.9 -218.2 -59.0 -271.7 -326.9 Capital 8 FinancialAccount Net total private investment inflows 13.8 16.1 58.4 69.8 93.1 8.5 12.7 Net LT borrowing & capital grants -45.3 28.6 215.9 127.4 87.1 121.0 136.3 Adjustments to scheduled debt service 34.0 67.3 60.9 86.3 73.0 78.5 53.4 Other capitalflows, net 234.2 79.8 -90.6 -12.0 -95.3 101.0 149.9 Net short-term capital -25.6 23.4 3.3 -33.0 4.8 -28.1 -22.7 Capital flows n.e.i. 235.7 79.1 -103.7 87.4 44.8 81.5 22.6 Errors and omissions 24.1 -22.8 9.7 -66.5 -144.9 47.5 150.0 Net Reserves,change -40.5 86.6 -43.7 -53.2 -98.9 -37.3 -25.4 (negative sign indicates increase) Other Series Gross reserves. months of imuorts 2.4 1.3 1.6 1.8 2.6 4.1 2.7 GDP (millions of US) 4,229.3 5,017.0 4,593.3 4,822.7 4,749.2 4,426.2 5,144.3 - 84 - Table A. 10. Trade 1997 1998 1999 2000 2001 2002 2003 A. EXPORTS (FOB, US m) Total PrimaryCommodities 119.1 134.3 153.0 191.5 355.7 243.6 281.9 Commodity 1 (Coffee) 33 40 30 8 3 3 4 Commodity2 (Vanilla) 10 16 28 58 164 120 195 Commodity3 (Cloves ) 12 9 16 45 96 30 29 Commodity4 (Shrimp) 64 69 79 80 92 90 54 Manufactures 346 356 398 608 572 227 551 Other Exports 41.5 32.4 33.1 29.3 37.1 28.4 19.0 Total Merchandise Exports 507.1 522.3 584.0 828.9 964.8 499.1 852.0 B.IMPORTS (CIF, US m) Food 48.6 54.1 46.0 77.0 83.6 61.5 115.6 Consumer Goods 353.1 386.5 416.9 479.4 571.1 258.6 563.1 POL and other Energy 116.8 101.5 124.0 211.5 167.8 216.7 184.2 IntermediateGoods 137.5 110.9 133.2 162.3 131.3 100.7 219.8 Capital Goods 146.2 138.0 139.8 166.9 163.9 91.5 217.1 Total Merchandise imports 802.2 791.O 859.9 1,097.1 1,117.7 728.9 1,299.8 C. INDICES (Vol 1987 = 100) C1. Volume Indices Merchandise Exports 154.1 158.7 177.5 251.9 293.2 151.7 259.0 Merchandise Imports 196.1 193.4 210.2 268.2 273.2 178.2 317.8 C2. Price Indices Merchandise export price index 93.4 94.8 90.2 95.4 113.4 111.1 118.3 Merchandise import price index 115.7 101.0 107.3 122.2 108.8 116.2 143.0 Merchandise Terms of Trade 0.8 0.9 0.8 0.8 1.o 1.o 0.8 Table A. 11.External Debt and Debt Service 1997 I998 1999 2000 2001 2002 2003 I. (millions of USdollars) A. Debt Outstandingand disbursed TotalPublic longterm Privateand pub. guaranteed 3,875.0 4,106.4 4,368.9 4,295.3 3,793.4 4,136.7 4,249.0 non-guaranteed 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Shortterm 164.6 229.6 323.6 301.4 239.2 231.4 119.0 iMF 694 580 629 1042 1274 1496 1720 Total DOD 4,109 1 4,3940 4,755 3 4,700 9 4,160 0 4,517 7 49580 6. DebtService Interest 94.0 53.4 83.1 37.9 32.6 34.2 32.0 Amortizations 118.0 72.0 76.2 78.8 34.6 38.7 34.0 Total 212.0 125.4 159.2 116.7 67.2 72.9 66.0 II.Ratios (%) Total DOD to GDP 81.9 95.7 98.6 99.0 94.0 87.8 85.9 DOD to exportsof goods and services 530.8 546.1 522.5 396.3 316.0 619.3 423.4 Public debt service to exports of goods and services 27.4 15.6 17.5 9.8 5.1 10.0 5.6 Table A. 12. Financial Sector Indicators 1999 2000 2001 2002 2003 A. Banking System 1. Depth and Structure Total domestic credit (% of GDP) 15.7 16.3 17.8 19.8 19.2 of which private credit (% of GDP) 8.3 8.8 8.4 8.1 8.8 Number of banks Share of foreign-owned (%) 5-bank concentration ratio (%) 2. Efficiency and Strength Domestic interest spread (deposit rate-lending rate), % -12.67 -11.50 -13.25 -13.25 -12.75 Spread over LIBOR (lending rate- LIBOR), %* 21.46 21.81 21.46 21.19 21.52 Non-performing loans as % of total Return on equity B. Stock Market * For foreign currency-denominated loans - 85 - TableA. 13. MilleniumDevelopmentGoals Indicators lYLl0 1YY3 zuou ZUOl zuuz ZUOJ 20w 1 Eradlcate extreme DOVWtY and hUnQer 2015 target halve 1990 S I a dav Dovertv and malnutrition rates .. . Population below $1 aday (%) 49.1 Povertygap at $1 a day (%) (Availableindicator,Gini Coefft) 18.3 Percentage share of income or consumptionheld bypoorest20% Prevalence of chiid malnutrition (% of childrenunder 5) 40.9 34.1 33.1 Population below minimum levelof dietaryenergy consumption(%) 35 40 36 2 Achieve universal prlmary education 2015 target = net enrollment to 100 Gross primary enrollment ratio (% of relevant age group) 60 6 72.9 67 70 82 &1 Percentageof cohort reaching grade 5 (%)(estimated) 21.5 39.7 33.6 Youth literacy rate (% ages 1524) 3 Promote gender equality 2005 target =education ratlo l o 100 Ratio of girls to boys in primaryand Secondaryeducation(%) 98.9 99.2 Ratio of young literate females to male (% ages 15-24) 85.6 88 8 92.1 92 5 Share of women employed in the nonagriculturalsector (%) 26 48 8 Proportionof seats held by women in nationalparliament(%) 4 4 Reduce child mortality 2015 target reduce 1990 under 5 mortality by two-thlrds Under 5 mortality rate (per 1.000) 168 156.0 139 136 141 Infant mortality rate (per 1,000 live births) 103 95 86 84 Immunization,measles (% of childrenunder 12 months) 47 55.0 55 61 Maternal mortality ratio (modeled estimate, per 100,000 live births) 550 421 353 Births attended by skilled healthstaff (% of total) 57 47.3 46.2 5 Combat HIWAIDS, malaria and other diseases 2015 target - halt, and begin to reverse, ADS Prevalenceof HiV, female (%ages 1524) 0.2 1.1 Contraceptive premlence rate (% of women ages 15-49) 16.7 19.4 19 Number of children orphaned by HIVIAIDS 6300 incidence of tuberculosis (per 100,000 people) 251 233 Tuberculosis cases detected under DOTS (%) 65 60 61.6 6 Ensure environmental sustainability 2015 target Forest area (X of total land area) 22.2 20.4 20.4 Nationallyprotected areas (% of total landarea) 1.9 2 10.2 GDP per unit of energy use (PPP $ per kg oil eauivalent) C02 emissions (metric tons per capita) Access to an improved water source (% of population)(treatedwater) 44 47.0 Access to improved sanitation (%of population) 36 42.0 7 Develop a Global Parinerrhlpfor Development 2015 target Youth unempioynent rate (% of total laborforce ages 1524) 7 1 Fixed line and mobile telephones (per 1,000 people) 2.8 3 133 226 233 Personalcomputers (per 1,000people)(% hhs equipped) 1 5 2 4 4 4 - 86 - Table A. 14. GDP incurrent prices (inbillion LCU) 2004 2005 2006 2007 2008 GDP at market prices 39,445.5 45,582.4 51,425.8 57,871.9 65,077.1 Net Indirect Taxes 3,670.6 4,536.6 4,852.4 5,485.6 5,935.5 GDP factor cost 35,774.9 41,045.8 46,573.4 52,386.3 59,141.6 Primary Sector 10,325.0 11,553.9 12,677.0 13,934.9 15,307.0 Secondary Sector 5,850.4 7,066.9 8,196.4 9,487.9 10,993.5 O.W. Manufacturing 4,680.3 5,653.5 6,557.1 7,590.3 8,794.8 Tertiary Sector 19,599.5 22,425.0 25,700.0 28,963.6 32,841.1 Net Imports of Goods and Non Factor Services 5,886.4 5,459.5 5,088.5 5,705.4 6,208.3 Imports of Goods and Non Factor Services 17,077.1 19,416.1 21,645.3 24,457.9 27,536.9 Exports of Goods and Non Factor Services 11,190.7 13,956.6 16,556.7 18,752.5 21,328.6 Total Available Resources 45,331.9 51,041.9 56,514.3 63,577.3 71,285.4 Domestic Absorption 45,331.9 51,041.9 56,514.3 63,577.3 71,285.4 Total Consumption 35,964.8 40,756.8 44,461.4 49,560.9 55,089.3 Government 3,374.7 3,913.2 4,447.9 5,097.3 5,766.3 Non-Government 32,590.1 36,843.6 40,013.5 44,463.6 49,323.0 Investment 9,367.1 10,285.1 12,052.9 14,016.4 16,196.1 Government 4,553.2 4,912.3 5,792.0 6,745.0 7,776.3 Non-Government 4,813.9 5,372.8 6,260.9 7,271.4 8,419.8 Total Savings 9,367.1 10,285.1 12,052.9 14,016.4 16,196.1 Foreign Savings 3,408.3 3,612.0 3,116.6 3,599.2 4,005.0 Gross National Savings 5,958.8 6,673.1 8,936.3 10,417.1 12,191.1 Monetary Savings 0.0 0.0 0.0 0.0 0.0 Government Savings 1,581.3 1,460.3 1,920.3 2,410.5 3,000.0 Private Savings 4,377.5 5,212.8 7,016.0 8,006.7 9,191.1 Memorandum Items: Net Factor Income -545.2 -770.1 -919.3 -1,087.9 -1,326.1 Gross National Product 38,900.3 44,812.3 50,506.5 56,784.0 63,751.0 Net Transfer Income 3,023.3 2,617.6 2,891.2 3,194.1 3,529.3 Gross National disposable Income 41,923.6 47,429.9 53,397.7 59,978.1 67,280.4 Exchange rate 13,055.6 13,520.4 14,001.7 14,500.2 15,016.4 '000 FMGISDR p.a 13.1 13.5 14.0 14.5 15.0 '000 FMG/US$ p.a 9.4 9.7 10.0 10.4 10.8 Inflation CPI (p.a) 10.1% 7.6% 5.0% 4.9% 4.9% CPI (e.0.p) 14.9% 5.0% 5.0% 4.9% 4.9% GDP (in million of US$) 4,211.0 4,698.9 5,119.0 5,562.6 6,040.2 - 87 - Table A. 15. GDP in current prices (share of GDP) 2004 2005 2006 2007 2008 GDP at Market Prices 100.0 100.0 100.0 100.0 100.0 Net Imports of Goods and Non Factor Services 14.9 12.0 9.9 9.9 9.5 Total Available Resources 114.9 112.0 109.9 109.9 109.5 Consumption 91.2 89.4 86.5 85.6 84.7 Government 11.6 11.0 10.9 10.8 10.7 Non-Government 79.6 78.4 75.6 74.8 73.9 Investment 23.7 22.6 23.4 24.2 24.9 Government 11.5 10.8 11.3 11.7 11.9 Non-Government 12.2 11.8 12.2 12.6 12.9 Gross Domestic Savings 8.8 10.6 13.5 14.4 15.3 Government 0.4 1.2 1.8 2.3 2.7 Non-Government 8.4 9.4 11.7 12.1 12.6 Current Account (excluding grant) -12.7 -10.2 -8.3 -8.4 -8.3 (including grant) -8.6 -7.9 -6.1 -6.2 -6.2 Gross National Savings 15.1 14.6 17.4 18.0 18.7 Government 4.4 3.5 4.0 4.4 4.8 Non-Government 10.7 11.2 13.4 13.6 13.9 Memorandum Items Private Transferts 3.6 3.5 3.4 3.4 3.3 Net Factor Income -1.4 -1.7 -1.8 -1.9 -2.0 Current Offical Grants 4.0 2.3 2.2 2.1 2.1 Total 6.3 4.1 3.8 3.6 3.4 - 88 - Table A. 16. GovernmentFinance 2004 2005 2006 2007 2008 Total Revenues and Grants 7,846.3 8,259.8 9,485.2 10,877.6 12,405.7 Total Revenues 4,722.6 5,577.3 6,512.8 7,583.9 8,756.0 Budgetary Revenue 4,722.6 5,577.3 6,512.8 7,583.9 8,756.0 Tax Revenue 4,417.9 5,287.6 6,222.5 7,291.9 8,460.0 Income Tax 747.3 750.9 1,370.1 1,806.3 2,524.5 Taxes on Goods and Services 1,505.7 1,556.8 1,756.3 1,976.5 2,222.6 Taxes on International Trade 2,072.3 2,869.0 2,965.7 3,356.3 3,535.6 Others 92.6 110.8 130.4 152.8 177.3 Non-Tax Revenue 304.7 289.8 290.2 292.0 295.9 Grants 3,123.7 2,682.4 2,972.4 3,293.7 3,649.7 Current Grants 1,464.2 897.8 994.8 1,102.3 1,221.5 Total Expenditures 9,115.9 9,927.1 11,379.3 13,020.8 14,753.7 Current Expenditures 4,562.8 5,014.8 5,587.2 6,275.7 6,977.5 Consumption 3,374.7 3,913.2 4,447.9 5,097.3 5,766.3 Salaries and Wages 1,931.3 2,232.9 2,443.4 2,717.5 3,012.4 Other Consumption 166.3 103.0 103.0 103.0 103.0 Other Non-Interest Expenditures 1,277.1 1,577.3 1,901.6 2,276.8 2,650.9 Interest Payments 1,188.1 1,101.6 1,139.3 1,178.4 1,211.2 Foreign Interest Obligations 560.7 670.3 706.1 749.9 790.6 Domestic Interest Obligations 627.4 431.3 433.2 428.6 420.6 Capital Expenditures 4,553.2 4,912.3 5,792.0 6,745.0 7,776.3 Domestically Financed 1,200.0 1,566.1 1,881.6 3,354.8 2,492.1 Foreign'Financed 3,353.2 3,346.2 3,910.4 3,390.2 5,284.2 Balance Balance, including grants -1,269.7 -1,667.3 -1,894.1 -2,143.2 -2,348.0 Balance, excluding grants -4,393.3 -4,349.7 -4,866.5 -5,436.9 -5,997.8 Net Cost of Structural Reforms -42.7 0.0 0.0 0.0 0.0 Exceptional Revenue 7.3 0.0 0.0 0.0 0.0 Cost of Structural Reforms 50.0 0.0 0.0 0.0 0.0 Balance (Including net cost of structural reforms) Balance, including grants -1,312.4 -1,667.3 -1,894.1 -2,143.2 -2,348.0 Balance, excluding grants -4,436.0 4,349.7 -4,866.5 -5,436.9 -5,997.8 Domestic Arrears -347.3 -150.0 -100.0 -50.0 -50.0 Overall Balance -1,659.7 -1,817.3 -1,994.1 -2,193.2 -2,398.0 Financing 1,659.7 1,817.3 1,994.1 2,193.2 2,398.0 External (net) 2,005.8 2,173.5 1,758.8 1,942.2 2,049.6 Internal (net) -479.6 -356.2 235.3 251.O 348.5 Privatization Receipts 133.5 0.0 0.0 0.0 0.0 - 8 9 - Table A. 17. GovernmentFinance (share of GDP) 2004 2005 2006 2007 2008 Total Revenues and Grants 19.9 18.1 18.4 18.8 19.1 Total Revenues 12.0 12.2 12.7 13.1 13.5 BudgetaryRevenue 12.0 12.2 12.7 13.1 13.5 Tax Revenue 11.2 11.6 12.1 12.6 13.0 IncomeTax 1.9 1.6 2.7 3.1 3.9 Taxes on Goods and Services 3.8 3.4 3.4 3.4 3.4 Taxes on InternationalTrade 5.3 6.3 5.8 5.8 5.4 Others 0.2 0.2 0.3 0.3 0.3 Non-Tax Revenue 0.8 0.6 0.6 0.5 0.5 Grants 7.9 5.9 5.8 5.7 5.6 Current Grants 3.7 2.0 1.9 1.9 1.9 Total Expenditures 23.1 21.8 22.1 22.5 22.7 Current Expenditures 11.6 11.o 10.9 10.8 10.7 Consumption 8.6 8.6 8.6 8.8 8.9 Salaries and Wages 4.9 4.9 4.8 4.7 4.6 Other Consumption 0.4 0.2 0.2 0.2 0.2 Other Non-Interest Expenditures 3.2 3.5 3.7 3.9 4.1 Interest Payments 3.0 2.4 2.2 2.0 1.9 Foreign Interest Obligations 1.4 1.5 1.4 1.3 1.2 Domestic InterestObligations 1.6 0.9 0.8 0.7 0.6 Capital Expenditures 11.5 10.8 11.3 11.7 11.9 Domestically Financed 3.0 3.4 3.7 5.8 3.8 Foreign Financed 8.5 7.3 7.6 5.9 8.1 Balance Balance, including grants -3.2 -3.7 -3.7 -3.7 -3.6 Balance,excluding grants -11.1 -9.5 -9.5 -9.4 -9.2 Net Cost of Structural Reforms -0.1 0.0 0.0 0.0 0.0 ExceptionalRevenue 0.0 0.0 0.0 0.0 0.0 Cost of Structural Reforms 0.1 0.0 0.0 0.0 0.0 Balance (Including net cost of structural reforms) Balance, including grants -3.3 -3.7 -3.7 -3.7 -3.6 Balance,excludinggrants -11.2 -9.5 -9.5 -9.4 -9.2 DomesticArrears -0.9 -0.3 -0.2 -0.1 -0.1 Overall Balance -4.2 -4.0 -3.9 -3.8 -3.7 Financing 4.2 4.0 3.9 3.8 3.7 External(net) 5.1 4.8 3.4 3.4 3.1 Internal(net) -1.2 -0.8 0.5 0.4 0.5 PrivatizationReceipts 0.3 0.0 0.0 0.0 0.0 - 90 - Table A. 18. Monetary Survey (inbillions ofMalagasyFrancs, endofperiod) 2004 2005 2006 2007 2008 Net foreign assets 4139.7 5131.1 7081.2 9056.5 11055.0 Central Bank 2441.7 3525.6 5370.5 7180.3 8979.5 Commercial Bank 1698.0 1605.5 1710.7 1876.2 2075.5 Net Domestic Assets 5454.8 6264.5 5775.3 5411.5 5214.3 Total Domestic Credit 6394.5 6718.3 7526.8 8455.0 9682.8 Net Credit to Government 2781.2 2581.2 2464.9 2367.9 2295.8 Net Claims on Government 2358.4 2158.3 2042.0 1945.1 1873.0 Central Bank 1068.9 868.9 752.6 655.7 583.5 Commercial Bank 1289.5 1289.5 1289.5 1289.5 1289.5 Other Claims 422.8 422.8 422.8 422.8 422.8 Credit to the Economy 3613.3 4137.2 5062.0 6087.0 7387.0 Credit to the Economy 3613.3 4137.2 5062.0 6087.0 7387.0 Central Bank 66.2 66.2 66.2 66.2 66.2 Commercial Bank 3547.1 4071.0 4995.8 6020.8 7320.8 Other Claims 0.0 0.0 0.0 0.0 0.0 Other Items -939.8 -453.8 -1751.6 -3043.5 -4468.5 TOTAL ASSETS 9594.5 11395.6 12856.5 14468.0 16269.3 Stock of Money 9594.5 11395.6 12856.5 14468.0 16269.3 Currency in Circulation 2590.5 3076.8 3471.2 3906.4 4392.7 Demand Depositsof PS 4114.5 4886.9 5513.3 6204.4 6976.9 Quasi Money 2889.5 3431.9 3871.9 4357.2 4899.7 TOTAL LIABILITIES 9594.5 11395.6 12856.5 14468.0 16269.3 Memorandumitems ForeignAssets incl Gold (in SDR) 458.8 536.5 642.7 741.1 833.1 Gross Res of the Mon.Auth. incl. Gold (in SDR) 335.2 410.2 513.1 604.4 , 687.7 IMF -134.1 -136.3 -118.6 -100.2 -82.4 ForeignAssets of Commercial Banks 123.6 126.2 129.6 136.7 145.4 - 91 - Table A. 19. Balanceof Payments (inmillionsUSD) 2004 2005 2006 2007 2008 Current account -363.8 -372.3 -310.2 -346.0 -371.7 Goods and services -628.4 -562.8 -506.5 -548.4 -576.2 Trade balance -391.1 -298.2 -240.9 -252.8 -258.0 Exports 837.7 1,033.8 1,200.1 1,332.2 1,485.4 Imports -1,228.9 -1,332.0 -1,441.O -1,585.0 -1,743.4 Net services -237.3 -264.6 -265.6 -295.6 -318.2 Services, receipts 356.9 404.9 447.9 470.3 494.3 Transportation 69.7 75.7 81.8 87.9 94.6 Travel 109.3 138.9 162.5 173.8 186.0 Business and personelservices 117.5 125.8 134.6 134.6 134.6 Governmentservices, n.i.e. 60.3 64.6 69.1 73.9 79.1 Services, payments -594.2 -669.5 -713.6 -765.8 -812.5 Freight & insuranceon goods -183.6 -235.1 -254.3 -279.7 -307.7 Transportation -53.5 -57.3 -61.3 -65.6 -70.1 Travel -69.7 -74.6 -79.8 -85.4 -91.3 Businessand personelservices -153.3 -164.0 -175.5 -187.8 -193.4 Governmentservices, n.i.e. -134.1 -138.6 -142.7 -147.4 -149.9 Income -58.2 -79.4 -91.5 -104.6 -123.1 Receipts 30.7 28.0 28.8 31.9 34.4 Investment income 10.0 10.7 10.5 12.5 13.8 Other 20.6 17.3 18.3 19.4 20.6 Payments -88.9 -107.4 -120.3 -136.5 -157.5 Dividendes -26.2 -35.6 -47.7 -63.2 -83.2 Interest -62.7 -71.8 -72.6 -73.3 -74.3 Of which: government interest -59.1 -69.1 -70.3 -72.1 -73.4 Current transfers 322.8 269.8 287.8 307.0 327.6 Govemment 169.4 105.8 112.3 119.2 126.6 Budgetaid 154.9 92.5 99.0 106.0 113.4 Of which: HlPC relief I/ 30.9 0.0 0.0 0.0 0.0 Of which: Grants 124.1 92.5 99.0 106.0 113.4 Other (net) 14.5 13.2 13.2 13.2 13.2 Private 153.3 164.0 175.5 187.8 201.o Capital and financial account 338.9 399.6 446.8 467.7 487.1 Capital transfers 173.5 184.0 196.9 210.6 225.4 Government 173.5 184.0 196.9 210.6 225.4 Project grants 173.5 184.0 196.9 210.6 225.4 Other 0.0 0.0 0.0 0.0 0.0 Private sector 0.0 0.0 0.0 0.0 0.0 Financialaccount 167.4 215.6 250.0 257.1 261.8 Directinvestment 41.8 84.5 139.4 139.4 139.4 Portfolioinvestments 0.0 0.0 0.0 0.0 0.0 Other 125.6 131.2 110.6 117.7 122.4 Government 144.4 149.9 143.5 155.6 164.7 Monetary Sector 0.0 0.0 0.0 0.0 0.0 PrivateSector -10.9 -15.0 -28.2 -28.0 -30.2 Banks, net -7.9 -3.7 -4.7 -9.9 -12.1 Other -1.4 0.0 0.0 0.0 0.0 Errors& omissions 0.0 0.0 0.0 0.0 0.0 Overall balance -24.9 27.2 136.6 121.7 115.4 (continued) - 92 - 2004 2005 2006 2007 2008 Financing 24.9 -101.3 -168.2 -152.9 -140.9 Netforeign assets (increase -) -29.2 -101.3 -168.2 -152.9 -140.9 Use of Fund credit (net) 41.1 3.1 -24.8 -25.6 -24.9 Purchase 48.7 15.8 0.0 0.0 0.0 Repurchases -7.6 -12.7 -24.8 -25.6 -24.9 Other assets (Reserves BCM), net (increase-) -70.3 -104.5 -143.4 -127.3 -116.0 Net change in arrears (excl. CBM) 0.0 0.0 0.0 0.0 0.0 Arrears accumulation 0.0 0.0 0.0 0.0 0.0 Repayment of arrears 0.0 0.0 0.0 0.0 0.0 Rescheduling of arrears 0.0 0.0 0.0 0.0 0.0 Debt relief and cancellation 54.1 0.0 0.0 0.0 0.0 Current maturities 54.1 0.0 0.0 0.0 0.0 Arrears 0.0 0.0 0.0 0.0 0.0 Residualfinancing gap 0.0 -74.1 -31.5 -31.1 -25.5 Of which: Paris Club 0.0 0.0 0.0 0.0 0.0 Of which: HlPC relief 0.0 0.0 0.0 0.0 0.0 Memorandumitems: Exchange Rate Malagasyfrancs/SDR (periodeaverage) 13,056 13,520 14,002 14,500 15,016 Malagasyfrancs/US$ (periodeaverage) 9,367 9,701 10,046 10,404 10,774 GDP (in billionsof FMG) 39,445.5 45,582.4 51,425.8 57,871.9 65,077.1 GDP (in millions of USD) 4,211.0 4,698.9 5,119.0 5,562.6 6,040.2 I / Interim relief is expectedto be providedby multilateralorganizationsfor 2003-04. - 93 - TableA. 20. Balance of Payments (shareof GDP) 2004 2005 2006 2007 2008 Current account -8.6 -7.9 -6.1 -6.2 -6.2 Goods and services -14.9 -12.0 -9.9 -9.9 -9.5 Trade balance -9.3 -6.3 -4.7 -4.5 -4.3 Exports 19.9 22.0 23.4 23.9 24.6 Imports -29.2 -28.3 -28.2 -28.5 -28.9 Net services -5.6 -5.6 -5.2 -5.3 -5.3 Services, receipts 8.5 8.6 8.8 8.5 8.2 Transportation 1.7 1.6 1.6 1.6 1.6 Travel 2.6 3.0 3.2 3.1 3.1 Business and personei services 2.8 2.7 2.6 2.4 2.2 Government services, n.i.e. 1.4 1.4 1.3 1.3 1.3 Services, payments -14.1 -14.2 -13.9 -13.8 -13.5 Freight & insurance on goods -4.4 -5.0 -5.0 -5.0 -5.1 Transportation -1.3 -1.2 -1.2 -1.2 -1.2 Travel -1.7 -1.6 -1.6 -1.5 -1.5 Business and personel services -3.6 -3.5 -3.4 -3.4 -3.2 Government services, n.i.e. -3.2 -2.9 -2.8 -2.6 -2.5 Income -1.4 -1.7 -1.8 -1.9 -2.0 Receipts 0.7 0.6 0.6 0.6 0.6 Investment income 0.2 0.2 0.2 0.2 0.2 Other 0.5 0.4 0.4 0.3 0.3 Payments -2.1 -2.3 -2.3 -2.5 -2.6 Dividendes -0.6 -0.8 -0.9 -1.1 -1.4 Interest -1.5 -1.5 -1.4 -1.3 -1.2 Of which: governmentinterest -1.4 -1.5 -1.4 -1.3 -1.2 Current transfers 7.7 5.7 5.6 5.5 5.4 Government 4.0 2.3 2.2 2.1 2.1 Budget aid 3.7 2.0 1.9 1.9 1.9 Of which: HlPC relief I / 0.7 0.0 0.0 0.0 0.0 Of which: Grants 2.9 2.0 1.9 1.9 1.9 Other (net) 0.3 0.3 0.3 0.2 0.2 Private 3.6 3.5 3.4 3.4 3.3 Capital and financial account 8.0 8.5 8.7 8.4 8.1 Capital transfers 4.1 3.9 3.8 3.8 3.7 Government 4.1 3.9 3.8 3.8 3.7 Project grants 4.1 3.9 3.8 3.8 3.7 Other 0.0 0.0 0.0 0.0 0.0 Private sector 0.0 0.0 0.0 0.0 0.0 Financial account 4.0 4.6 4.9 4.6 4.3 Direct investment 1.o 1.8 2.7 2.5 2.3 Portfolio investments 0.0 0.0 0.0 0.0 0.0 Other 3.0 2.8 2.2 2.1 2.0 Government 3.4 3.2 2.8 2.8 2.7 MonetarySector 0.0 0.0 0.0 0.0 0.0 Private Sector -0.3 -0.3 -0.6 -0.5 -0.5 Banks, net -0.2 -0.1 -0.1 -0.2 -0.2 Other 0.0 0.0 0.0 0.0 0.0 Errors & omissions 0.0 0.0 0.0 0.0 0.0 Overall balance -0.6 0.6 2.7 2.2 1.9 (continued) - 94 - J 2004 2005 2006 2007 2008 Financing 0.6 -2.2 -3.3 -2.7 -2.3 Net foreign assets (increase-) -0.7 -2.2 -3.3 -2.7 -2.3 Use of Fund credit (net) 1.o 0.1 -0.5 -0.5 -0.4 Purchase 1.2 0.3 0.0 0.0 0.0 Repurchases -0.2 -0.3 -0.5 -0.5 -0.4 Other assets (ReservesBCM), net (increase-) -1.7 -2.2 -2.8 -2.3 -1.9 Net change in arrears (excl. CBM) 0.0 0.0 0.0 0.0 0.0 Arrears accumulation 0.0 0.0 0.0 0.0 0.0 Repayment of arrears 0.0 0.0 0.0 0.0 0.0 Rescheduling of arrears 0.0 0.0 0.0 0.0 0.0 Debt relief and cancellation 1.3 0.0 0.0 0.0 0.0 Current maturities 1.3 0.0 0.0 0.0 0.0 Arrears 0.0 0.0 0.0 0.0 0.0 Residualfinancing gap 0.0 -1.6 -0.6 -0.6 -0.4 Of which: Paris Club 0.0 0.0 0.0 0.0 0.0 Of which: HlPC relief 0.0 0.0 0.0 0.0 0.0 - 95 - TableA. 21. RealSectoralGrowth,const. 1984 (percent change) 2004 2005 2006 2007 2008 2009 Primary Sector 3.1 3.6 4.3 4.5 4.5 4.5 Agriculture 3.5 4.0 5.0 5.0 5.0 5.0 Fisheries 3.3 3.5 4.0 4.5 4.5 4.5 Forestry 0.0 2.0 2.0 2.0 2.0 2.0 Secondary Sector 6.5 11.8 9.9 10.0 10.1 10.3 Secondary Sector (excl. EPZ) 4.0 6.4 7.6 7.7 8.1 8.1 Agroindustry 0.0 5.0 10.0 10.0 10.0 10.0 Indus. Other 7.7 5.7 15.0 15.0 15.0 15.0 Energy 6.0 6.3 10.0 10.0 10.0 10.0 Food 3.0 6.3 10.0 10.0 10.0 10.0 Beverages 4.5 7.5 8.0 8.5 10.0 10.0 Tobacco 3.0 3.9 1.5 1.3 1.2 1.o Fats and Oil 2.5 5.7 3.0 2.6 2.3 2.0 Pharmaceuticals 3.1 4.5 2.0 1.o 0.9 0.8 Textiles 6.0 9.4 4.9 4.3 3.8 3.3 Leather 3.0 6.3 3.5 3.1 2.7 2.3 Wood 3.0 6.3 5.0 4.4 3.9 3.3 Construction Mat. 7.8 7.5 5.5 4.8 4.3 3.7 Metal Industry 6.7 2.2 2.0 1.5 1.3 1.I Goods Transport 0.8 8.9 6.0 5.0 4.5 3.8 Electrical Components 2.5 9.8 10.0 10.0 10.0 10.0 Paper 2.0 7.9 4.5 3.5 3.1 3.0 Other 4.8 5.0 8.0 8.0 10.0 10.0 Export Processing Zones 25.0 45.0 20.2 19.2 17.7 17.7 Tertiary Sector 6.0 7.5 7.5 7.1 7.0 6.8 Construction 29.0 18.5 18.5 18.5 18.5 18.5 MerchandiseTransportation 5.6 8.9 8.1 7.0 7.0 7.0 PassengerTransportation 6.3 9.4 7.5 6.0 5.8 5.0 Transportation, Other 5.4 7.5 7.5 6.0 5.4 4.6 Telecommunications 5.0 6.7 7.0 6.0 5.4 4.6 Commerce 3.4 6.4 7.0 8.5 8.5 8.5 Banks 5.0 8.4 7.0 6.5 5.8 5.0 Insurance 4.0 6.7 7.0 6.0 5.4 4.6 Businessand Household Services 6.5 6.3 6.5 5.0 4.5 3.8 Management 1.6 3.0 3.0 3.0 3.0 3.0 Non Imputablecharges 5.0 8.4 7.0 6.5 5.8 5.0 GDP at factor cost, COnSt. 1984 5.0 6.7 6.7 6.6 6.7 6.6 IndirectTaxes 7.5 9.6 9.5 9.6 9.5 9.8 - 96 - I Table A. 22. SectoralContributionto GDPin constant prices,1984 (percent change) 2004 2005 2006 2007 2008 Primary Sector 32.0 31.O 30.2 29.5 28.8 AgricuIture 14.8 14.3 14.1 13.8 13.6 Fisheries 14.4 13.9 13.5 13.2 12.9 Forestry 2.9 2.8 2.6 2.5 2.4 SecondarySector 11.8 12.3 12.7 13.0 13.4 Secondary Sector (excl. EPZ) 10.1 10.1 10.1 10.2 10.3 Agro-industry 0.3 0.3 0.3 0.3 0.3 Indus.Other 0.2 0.2 0.2 0.3 0.3 Energy 1.4 1.4 1.5 1.5 1.6 Food 2.1 2.1 2.2 2.2 2.3 Beverages 2.2 2.2 2.2 2.2 2.3 Tobacco 0.7 0.7 0.7 0.6 0.6 Fats and Oil 0.3 0.3 0.3 0.3 0.3.- Pharmaceuticals 0.4 0.4 0.4 0.4 0.4 Textiles 0.2 0.2 0.2 0.2 0.2 Leather 0.0 0.0 0.0 0.0 0.0 Wood 0.3 0.3 0.3 0.3 0.3 Construction Mat. 0.3 0.3 0.3 0.3 0.3 Metal Industry 0.4 0.4 0.4 0.4 0.4 Goods Transport 0.2 0.2 0.2 0.2 0.2 ElectricalComponents 0.7 0.7 0.7 0.7 0.7 Paper 0.1 0.1 0.1 0.1 0.1 Other 0.2 0.2 0.2 0.2 0.2 Export ProcessingZones 1.7 2.2 2.5 2.8 3.1 Tertiary Sector 47.7 48.0 48.2 48.2 48.2 Construction 2.7 3.0 3.3 3.6 4.0 MerchandiseTransportation 9.5 9.6 9.7 9.7 9.7 PassengerTransportation 2.7 2.8 2.8 2.8 2.8 Transportation,Other 2.5 2.6 2.6 2.5 2.5 Telecommunications 1.7 1.7 1.7 1.7 1.6 Commerce 10.3 10.3 10.3 10.4 10.6 Banks 1.9 1.9 1.9 1.9 1.9 Insurance 0.0 0.0 0.0 0.0 0.0 Businessand HouseholdServices . 11.6 11.5 11.4 11.2 11.0 Management 4.9 4.7 4.5 4.3 4.2 Non Imputablecharges -2.3 -2.3 -2.3 -2.3 -2.3 GDP at factor cost, const. 1984 89.2 88.9 88.7 88.4 88.1 IndirectTaxes 10.8 11.1 11.3 11.6 11.9 Total 100.0 100.0 100.0 100.0 100.0 - 97 - Bibliography Alston, J.M., Chan-Kang, C., Marra, M.C., Pardey, P., Wyatt, T.J., A meta analysis of rates o f return to agricultural R&D : Expede herculem ?, IFPRIresearch report 113, IFPRI, Washington DC, 2000 Andrew Cooke, Onesime Ratomahenina, Eulalie RanaivosonandHaja Razafindrainibe. 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