Cabo Verde: IMF Executive Board Concludes 2014 Article IV Consultation

On May 28, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the 2014 Article IV consultation with Cabo Verde.¹

The economy of Cabo Verde has continued to face significant headwinds due to the prolonged downturn in key trading partners in Europe and weak domestic demand. Output growth slowed from 4 percent in 2011 to 1.2 percent in 2012. Staff estimates that growth moderated further in 2013, to about 0.5 percent. While tourism performed well, remittances and private capital flows continued to decline, and domestic confidence declined further. The unemployment rate was 16 percent at end-2013, with the rate for youth twice as high. Consumer price inflation has fallen sharply, reaching 0.6 percent in March 2014. On the external front, the current account deficit is estimated to have narrowed sharply, contributing to a positive overall balance of payments and allowing international reserves to increase to roughly 4½ months of prospective imports.

Given weak economic conditions, and in the absence of imminent pressures on the balance of payments or consumer prices, the Banco de Cabo Verde (BCV) reduced its policy rate by 150 basis points in March 2014. While banks remain well-capitalized, financial stability has been weakened by the slowdown in economic growth. Non-performing loans have continued to rise, and by end-2013 accounted for 16 percent of total loans. This has contributed to a decline in bank profitability.

On the budgetary front, the fiscal deficit fell to 7¾ percent in GDP in 2013, about 2 percentage points less than the year before. However, total financing needs (including onlending to state-owned enterprises) remained very large, at 13 percent of GDP, causing total public debt to reach an estimated 98 percent of GDP by December 2013. The budget imbalance reflects the combination of weaker revenue performance and higher capital expenditure.

Staff projects Cabo Verde’s real GDP growth to pick up to 3 percent in 2014. Improving economic conditions in the euro area bode well for tourism, remittances, and Foreign Direct Investment (FDI). Domestically, consumer and investor confidence is expected to begin recovering, boosted by a more accommodative monetary policy stance. Inflation is expected to increase as activity picks up, but remain below 3 percent. The current account deficit should widen in 2014 as the demand for imports recovers, and is likely to remain high for a few more years, as the large-scale public investment program is gradually phased out. The principal near-term risks relate to a further delay in the European recovery, and to a resurfacing of financial stress in the euro area. Domestic risks are primarily fiscal in nature, given high public debt, though these risks are mitigated by the high concessionality and long maturity of this debt. Over the longer term, staff project growth of about 4 percent. The main risk to this outlook relates to Cabo Verde’s ability to implement the structural reforms needed to boost competitiveness and potential growth.

Executive Board Assessment²

Executive Directors commended Cabo Verde’s economic and social progress in the past decade, as well as the authorities’ skillful macroeconomic management amid a difficult external environment, which has helped strengthen foreign reserves and safeguard the exchange rate peg. At the same time, Directors noted that Cabo Verde is vulnerable to external shocks, and that its public debt, while mainly on concessional terms, is elevated. They encouraged fiscal consolidation to rebuild buffers, and structural reforms to bolster productivity and long-term growth and enhance resilience.

Directors welcomed the fiscal consolidation achieved in 2013 and the authorities’ plans to restrain spending in 2014 and beyond. At the same time, most Directors saw merit in faster deficit reduction, balanced with the need to protect growth, to help bring public debt on a downward path. Directors recommended safeguarding priority social spending and prioritizing strategic public investment projects while focusing on enhancing their efficiency. They welcomed efforts to bolster domestic revenue mobilization, and noted the role of Fund technical assistance in supporting the reform efforts. Directors also commended recent actions to strengthen the governance and financial performance of state-owned enterprises, and encouraged continued efforts to improve their efficiency.

Directors agreed that the recent loosening of monetary policy is appropriate, given the slowdown in private sector credit growth and absence of pressures on international reserves or prices. However, the weak monetary transmission mechanism undermines the effectiveness of monetary policy, and Directors called on the authorities to strengthen their liquidity management capacity, improve interbank market efficiency, and continue developing the government securities market. It will also be important to maintain a sufficient level of international reserve buffers.

Directors supported the efforts to safeguard financial stability and address non-performing loans, including more intense bank supervision and new laws that strengthen the supervisory and regulatory framework. They encouraged the authorities to implement the remaining recommendations of the 2009 Financial Sector Assessment Program.

Directors noted staff’s assessment that the escudo remains broadly aligned with fundamentals. In order to enhance the economy’s resilience to external shocks and diversify its sources of growth, they called for further progress on reforms to bolster competitiveness, create jobs, and deliver inclusive growth. Improving the business climate and increasing labor market efficiency and reducing skill mismatches will be particularly important. Directors also encouraged the authorities to prioritize the goals of the medium-term development plan with the highest potential economic and social returns.