MADAGASCAR: FIRST SEMESTER 2009 MACROECONOMIC REPORT

UNCLAS SECTION 01 OF 03 ANTANANARIVO 000573 SENSITIVE SIPDIS STATE FOR AF/E - MBEYZEROV STATE PLEASE PASS USTR USDOC FOR DESK OFFICER - BECKY ERKUL TREASURY FOR FBOYE E.O. 12958: N/A TAGS: ECON ETRD EAGR MA SUBJECT: MADAGASCAR: FIRST SEMESTER 2009 MACROECONOMIC REPORT ANTANANARI 00000573 001.2 OF 003 SUMMARY -------------- ¶1. (SBU) Unofficial GDP projections for 2009 are around negative four percent due to poor performance of the secondary and tertiary sectors resulting from the global slowdown and political instability in Madagascar. During the first half of 2009, inflation remained in check, while unemployment spiked. The government drastically cut expenditures, particularly public investment, due to falling revenues and foreign aid cuts, focusing on wages and debt payments during the second quarter. The government should be able to continue meeting wages and debt obligations for the remainder of the year. Domestic borrowing was down 35 percent during the first semester 2009 compared to the same period in 2008. Trade plummeted during the first semester, with exports declining by 47 percent compared with the previous year. Foreign reserves declined by 12 percent in the first half of the year due to the central bank's intervention to stabilize the exchange rate. Limited planting of counter-season rice, as well as risks to AGOA trade benefits and EU aid in the second half of the year, paint a grim economic outlook for the second semester and 2010. End summary. Negative GDP Outlook -------------- ¶2. (U) Official real GDP growth projections for 2009 are now 0.7 percent, but unofficial estimates of around negative 4 percent are more realistic, considering the ongoing decline of activity in the fishing/shrimping, agro-industry, garment, construction, tourism, and other sectors. The slowdown is the result of the global financial crisis, as well as local political unrest and instability. ¶3. (U) The secondary sector has been most affected. During April and May, electricity consumption declined by 55 percent in the textile sector and by 20 percent in the chemical industry. The decline continued in June, although at a lower pace (8 percent for the textile sector). Two-thirds of the government's investment budget was previously provided by foreign aid; aid cuts following the coup of March 17 led to a sharp decrease in construction and public works activities. The union of the companies in this sector estimated that their turnover has been reduced by 40 percent. This is also partly due to a decline in construction in the mining sector, due to entry into the exploitation phase by QMM. ¶4. (U) The tertiary sector has also been impacted due to a decline in transportation and tourism activities. Despite the beginning of the tourism high season, occupancy rates remain low. Several large hotels are planning to fire their employees, following months of temporary lay-offs. Poor performance in the commercial and industrial sectors has been partially offset by a bumper rice harvest (due to good weather and a strong second season harvest of 800,000 tons),an increase in logging, the start of ilmenite mining by QMM/Rio Tinto in southern Madagascar, and the lifting of the gemstone export ban this semester. Inflation Remains under Control -------------- ¶5. (U) In the first half of the year, the Consumer Prince Index increased by only 0.93 percent. This low level of inflation was due mainly to the fall in rice prices by 9.4 percent during the harvest period which began in February. However, during the first quarter, inflation reached 2.25 percent following the lootings of January which produced panic among consumers and traders as the ousted president's company TIKO, which had a quasi-monopoly on food products, lost a large quantity of its stock. ¶6. (U) Combined with the slowdown in economic activities, the reduction in credit given by the banking sector helped to control inflation. However, if the depreciation of the currency continues during the second semester, prices are expected to increase. The projection of average inflation for 2009 is 9.4 percent (compared to 9.2 percent in 2008). Unemployment Continues to Increase -------------- ¶7. (U) Following the lootings in January, 250 companies closed and approximately 20,000 employees lost their jobs. An additional 153 companies, 53 hotels, and 51 free zone companies were obliged to temporarily lay-off their employees. According to the current legislation, after several months of lay-offs, the workers must be definitively fired. Government Revenues Shrink -------------- ¶8. (U) The slowdown in economic activity and the quasi-paralysis of public administration have resulted in a significant decline in ANTANANARI 00000573 002.2 OF 003 domestic tax and customs revenues. During the first semester of 2009, tax revenue was 28 percent lower than the targets and amounted to USD 442.45 million (Ar 828.8 billion). During the same period in 2008, tax revenue amounted to USD 769.8 million (Ar 1,315.1 million). In local currency terms, the decrease was 37 percent compared to the first semester of 2008, owing mainly to the reduction in customs revenue (passing from USD 289.2 million to USD 169.5 million). However, in June, revenue collection improved due to the payment by a number of firms of tax arrears, and an unusually high level of oil imports (which accounted for one third of customs revenues collected in June). Customs revenues reached 86 percent of projections in June, because the power company Jirama imported a large quantity of oil. Because it had stocked up on oil in March for fear of shortages due to the political crisis, it did not import much oil in April or May, causing a decline in customs revenues for those months. Spending is Cut, but Wages are Still Paid -------------- ¶9. (U) The rapid and significant decline in public revenues due to the economic slowdown and the decision by many donors to cut aid following the March 17 coup d'etat, coupled with the lack of access to external financing, led to a severe adjustment of expenditures during the first semester. The cumulative execution rate of the overall budget was 20 percent at the end of June 2009, compared to 35 percent in June 2008. Most spending (around 80 percent) was concentrated on wages, debt repayment, and other priority current expenditures. For salary and wages, the budget execution rate is estimated at 27.9 percent for the first semester, whereas for other current expenditures and investment expenditure, it was respectively 27.9 percent and 6.3 percent. Thus, fiscal adjustment mainly impacted public investment. Wage Payments can be Sustained -------------- ¶10. (SBU) The government should be able to continue to pay salaries and pensions, which total around USD 26 million (Ar 49 billion) per month, going forward. Debt payments amount to around USD 18.6 million (Ar 35 billion) per month. From value added taxes, customs duties, and other taxes, the government should be able to collect USD 53 million (Ar 100 billion) per month easily, according to the IMF. While this is only 50 percent of original projections of USD 106.7 million (Ar 200 billion) per month, it is still enough to cover salaries and debt payments. Budget: Roughly Break Even -------------- ¶11. (SBU) The budget was roughly at a break even point for the first half of the year. The government is operating on a cash basis. The total expenditure figure of USD 359 million (Ar 673 billion) does not reflect the expenditures of January/February that were made to pay 2008 obligations. Usually, the government collects the majority of its revenues (about two-thirds) during the first semester, but does the majority of its spending (about two-thirds) during the second semester, so one would expect to see a deficit in the second semester. Education expenses will put pressure on the budget in September; about half of the education budget is generally expended that month as teachers relocate to their sites. Also, about 40 percent of primary school teachers will be affected by the suspension of the World Bank program that funded 30 percent of their salaries. Domestic Borrowing is Low -------------- ¶12. (U) Domestic borrowing was limited during the first half of the year. Treasury bonds auctioned amounted to USD 322.6 million during the first semester of 2009, compared to USD 567.8 million in the same period in 2008, a decrease of 35 percent. Despite this declining recourse to T-bills, the stock of domestic debt increased from USD 332.6 million in January 2009 to 379.5 million in June. Monetary Policy Seeks to Stimulate Growth -------------- ¶13. (U) Credit given by the banking sector amounted to USD 40.2 million during the first semester, compared to USD 126.8 million in 2008 despite falling interest rates, suggesting a decline in economic activities. To counter this trend, the central bank decreased its interest rate by 0.5 percentage points to stimulate demand. Significant Reduction in Trade -------------- ¶14. (U) Total exports decreased by 46.71 percent in value during the first semester of 2009 compared to the same time period in 2008. Traditional exports such as vanilla and coffee were ANTANANARI 00000573 003.2 OF 003 disproportionately affected, diminishing more than 90 percent. The shrimp sector also faced declining demand due to the impact of the global financial crisis. Competition from Asian countries with lower prices also led to a 56 percent reduction of shrimp exports. The textile sector registered a decline of 45 percent due to declining demand and for fear of non-satisfaction of the orders by Malagasy companies because of insecurity and political instability in Madagascar. ¶15. (U) Total imports decreased by 32.2 percent, due mainly to the decrease in oil products (57.1 percent of decrease) and inputs for the free zone companies (40.4 percent). Furthermore, imports of raw materials fell by 29.5 percent, confirming the slowdown in economic activities. However, imports of food and rice increased respectively by 33.2 and 34 percent. This increase was to substitute the supply of food that had been provided by the ousted president's company TIKO with imports from countries that are not traditional suppliers such as Malaysia, South Africa, and Mauritius. Depreciation and Declining Reserves -------------- ¶16. (U) During the first semester, the Ariary depreciated by 4.57 percent and 3.70 percent respectively against the Euro and the Dollar. In early May, depreciation reached 7.7 percent and 12.79 percent, but the exchange rate was stabilized during the last two months due to the central bank's interventions. As a result, the central bank's foreign reserves decreased from 3.2 months of imports in December 2008 to 2.6 months of imports in end-June (passing from USD 920.5 million to USD 808.3 million). Decline in Foreign Investment -------------- ¶17. (U) Foreign direct investment declined, passing from USD 257.8 million during the first semester of 2008 to USD 180.6 million in ¶2009. In May, visiting Saudi Arabian investors announced a USD 2 billion deal, but nothing concrete has resulted from this visit. The Ambatovy mining project plans to increase its investment from USD 3.4 billion as initially projected to USD 4.5 billion. If disbursed this year, this additional investment would help to compensate the balance of payments deficit. Comment: Future Challenges -------------- ¶18. (SBU) The annual food shortage period begins around October. Due to extremely low farm gate prices for rice, and the lack of incentive programs such as subsidized fertilizer and seed as given last year, farmers are not planting much counter-season rice, so next year's production will diminish. Importers are also unwilling to import rice for fear of shake-downs by the military. According to the director of the rice observatory, large traders have been racketed by the military, so are limiting their stockpiles. ¶19. (SBU) If Madagascar's political leaders can not manage to reach consensus, and the country remains isolated, the economic situation will continue to deteriorate. Madagascar risks losing eligibility for AGOA trade benefits if progress is not made to return to the rule of law, culminating in the potential loss of over 50,000 jobs and a reduction in export receipts. Furthermore, European Union aid could be definitively cut in November if the political situation does not improve. Harassment by the transition government also threatens to derail the USD 4.5 billion Ambatovy project, which would have enormous consequences for not only the Malagasy economy, but also the Japanese, Koreans, and Canadians who have invested heavily in the project. End comment. STROMAYER