MADAGASCAR AND IMF DISAGREE ON INVESTMENT LAW

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TAGS: EFIN ECON EAID EINV PREL IMF MA
SUBJECT: MADAGASCAR AND IMF DISAGREE ON INVESTMENT LAW


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1. (SBU) SUMMARY. A September 20-October 4 Mission from the
International Monetary Fund (IMF) found Madagascar largely compliant
with the terms of its Poverty Reduction and Growth Facility (PRGF)
and praised the Government of Madagascar (GOM) for appropriate use
of its debt relief windfall. The GOM agreed to trim spending in a
revised budget to compensate for reduced imports leading to
below-forecast customs collections. However the IMF and the GOM
clashed over a proposed investment law; the IMF claimed the tax
incentives would so distort the revenue picture as to invalidate the
basis of the PRGF, while the GOM claimed that the incentives would
attract investment spurring sufficient economic growth to offset the
revenue losses. It appears the investment law will be modified to
meet IMF concerns, but GOM officials have told us privately they
felt they had been "blackmailed" into accepting the change. END
SUMMARY.


2. (U) The IMF Mission, led by Brain Ames and composed of three
economists and the IMF Resident Representative, had three main
objectives: 1) To conduct a first review of the PRGF program by
analyzing Madagascar's performance, accomplishments, and the
macroeconomic indicators as of the end of July 2006; 2) To discuss
the economic situation to determine whether there might be a need to
adjust economic policy for the achievement of the objectives for
2006 as projected; and, 3) To discuss the 2007 program, in
particular the 2007 budget and its accompanying macroeconomic
framework and policies, the new investment code, and financial
sector reforms. On October 4, Ames briefed the donor community on
the outcome of the visit.

THE GOOD NEWS FIRST: LARGELY MEETING TARGETS
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3. (U) Ames began by noting that the GOM is meeting or respecting
all realization criteria and indicators under the PRGF. For the
period September to December 2006, the projected tax revenue (as
forecast in May 2006) is expected to fall short by some 30 billion
Ariary (approx. USD 14 million),mainly due to a decline in imports
lowering customs revenue. The Minister of Finance, with concurrence
from President Ravalomanana, agreed to reduce expenditures by this
amount and presented a belt-tightening budget amendment in the
National Assembly on October 4. The average inflation target for
2006 was revised down by half a point to 10.8 per cent, mainly
because of the decline in rice and oil prices.


4. (U) Looking ahead to 2007, the GOM and the IMF reduced the tax
revenue target by 0.3 points to 11.2 per cent of GDP. Ames said
they agreed it was better to set an achievable target than to fall
short of an ambitious one. The level of expenditures will be
revised accordingly.


5. (U) Ames cited one other highly positive result of the IMF
Mission's analysis. Some donors have criticized the GOM for
misallocating the debt service windfall arising from Madagascar's
debt relief through the Heavily Indebted Poor Countries Initiative
(HIPC) and the Multilateral Debt Relief Initiative (MDRI). Ames
contradicted this view, stating that the increase in poverty
reduction priority spending from 2005 to 2006 and budgeted into 2007
exceeds the sum of the additional funds obtained through HIPC and
MDRI.

SOME CONCERNS: PUBLIC UTILITY, CENTRAL BANK, MANAGEMENT
-------------- --------------


6. (SBU) The IMF expressed concern that the budgeted operating
subsidy to the water and electricity utility, JIRAMA, was 25 billion
Ariary (just under USD 12 Million) whereas independent assessments
(confirmed in the meeting by other donor representatives) suggested
the true shortfall to be double that amount. Ames wondered what
this would mean in terms of power outages and corresponding
constraints on economic growth.


7. (U) The IMF also stressed the need to recapitalize the Central
Bank to make it profitable. This is expected to strengthen its
independence and to provide it with the resources necessary to carry
out effective monetary policy. The GOM is discussing a
recapitalization plan with the IMF that is expected to be
implemented in March 2007 and included in the 2007 Budget Law.


8. (U) The GOM's management of public finance was the third concern
the IMF raised. This was a problem in 2005, and the World Bank is
funding four French visiting experts to audit and explain the
reasons for the overrun in expenditures, in order to prevent the
problem from recurring. In the meantime the GOM, encouraged by the
IMF, will introduce a monthly tracking system, tied to quarterly
targets, to better calibrate revenue with expenses
ministry-by-ministry.

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9. (SBU) On this subject, the EU interjected to express concern over
the delay in budget execution, particularly fund disbursement in the
social sectors. If not addressed properly, this would affect their
indicators, which in turn regulate the disbursement of their
budgetary support. The resultant delay could then have a negative
impact on the GOM's budget.

THE BIGGEST CONCERN OF ALL: THE INVESTMENT CODE
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10. (SBU) Ames acknowledged that the only really contentious
discussion had centered on the GOM's proposed new investment code.
This is a centerpiece of President Ravalomanana's Madagascar Action
Plan (MAP),his five-year program to accelerate the country's
development beginning in 2007. The MAP targets double-digit
economic growth, to be achieved in large measure through dramatic
expansion in foreign direct investment (FDI) in the order of USD
500-800 million per year. The FDI would be channeled through a new
facilitating institution, the Economic Development Board of
Madagascar (EDBM). The EDBM proposed a new law that would provide
up to 200 billion Ariary (approx. 93 million USD) in fiscal
incentives including a two-year exemption in the profit tax and a
reduction in the profit tax rate from 30 to 20 per cent.


11. (SBU) Ames expressed strong support for investment promotion and
facilitation, but was skeptical that the fiscal incentives would
achieve anything other than to throw the budget severely out of
balance. He supported simplification of the tax and customs laws as
helpful to attract investment, as well as being intrinsically
desirable, but argued strongly that such simplification should be
carefully studied and modeled in advance so as to be strictly
revenue neutral. Should the GOM agree to follow this path, with a
goal of launching the new laws in October 2007 for the 2008 budget,
he had offered IMF and other donor technical assistance in carrying
out such studies.


12. (SBU) The GOM, however, was pushing for fast solutions, Ames
said, expressing frustration that the investment team within the
Presidency was looking only at investment and not considering the
implications for revenue, poverty reduction, or anything else. He
had finally told the GOM that if the investment law were passed
unchanged then the IMF would have to withdraw the PRGF. This was
not a threat, according to Ames, but a reality, because it would
change all of the parameters upon which the PRGF had been based.

THE GOM FEELS ITS ARM TWISTED
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13. (SBU) Meeting separately with the Ambassador on October 6, Dr.
Prega Ramsamy, the Mauritian selected by President Ravalomanana to
head the EDBM, reflected the GOM's frustration at the IMF's
position. Ramsamy suggested the IMF was merely "balancing the
books" and performing static analysis in a fluid situation. They
were not including the economic benefits, including government
revenues, which will accrue once the investment arrives. The GOM
and IMF agreed on the need for investment promotion and
facilitation, as well as assistance in securing safe title to land
for investment, but diverged sharply on fiscal incentives. He
pointed out that Madagascar "is not the easiest country to do
business in" and therefore, if nearby countries with better
infrastructure such as Mauritius offer fiscal incentives, then
Madagascar's offer must be a little sweeter. According to Ramsamy,
the IMF initially proposed an extended budget impact study to be
concluded in 2010. The GOM felt "blackmailed" since it feared a
donor backlash if the PRGF were to be withdrawn, so it agreed to the
study but accelerated it to mid-2007. Ramsamy asked whether the USG
could offer any economic modeling assistance to the GOM so that it
could also do its own studies of this issue.

COMMENT: TOO RUSHED, OR TOO MEASURED?
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14. (SBU) COMMENT: Post sees merit on both sides of the investment
argument, but is perhaps slightly more sympathetic to the GOM
position. For one thing, Madagascar tends to be a highly
traditional, conservative society; it is refreshing to hear them
accused of rushing into anything. This urgency reflects several
realities: Madagascar is woefully short of FDI, its GDP growth
barely exceeds its population growth, and the process of
globalization has tended to reward the more nimble and fast-reacting
countries in the competition for investment. This leads the GOM to
fear it will miss the train while the IMF forces it to examine the
timetable. Perhaps, for a country as poor as Madagascar, missing
the train altogether is a greater danger than boarding the wrong
one, the danger the IMF seems to fear. In any case, this dispute

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has strained relations between the IMF and the GOM and has
overshadowed the generally positive report the IMF issued regarding
the GOM's performance. END COMMENT.

SIBLEY