Abstract
Tanzania’s fiscal policy has been tightened owing to the deteriorating financing climate and rising inflation. The Bank of Tanzania has tightened its reserve money program for 2011/12, and domestic interest rates have risen sharply since mid-2011. The authorities are expanding Tanzania’s electric power generation capacity and raising electricity tariffs. Tanzania has good prospects as a major producer of natural gas by the end of the decade. The authorities will identify the critical macroeconomic policies and institutions to successfully manage future gas wealth.
1. My Tanzanian authorities remain determined to persevere with prudent and sound macroeconomic policies in spite of the challenges emanating from the second round of heightened global economic uncertainties coupled with repetitive drought-related demand and supply shocks for food in the greater East African region. They remain committed to deepen further their structural reform agenda and strengthen the country’s macroeconomic fundamentals and policy framework to further shore up the economy’s broad-based and inclusive growth. With their policy stance and unrelenting support from the international community and policy guidance from the Fund, my authorities are confident that they stand a good chance of mitigating the strong headwinds emanating from the current round of commodity price surges and the fallout from the heightening global economic uncertainty.
2. My authorities are appreciative of the Fund’s constructive engagement and support under the PSI. They thank staff for the candid policy dialogue and advice under the program and for the related technical assistance packages. Going forward, the authorities are determined to further strengthen Tanzania’s macroeconomic fundamentals and policies, persevere with the reform effort including laying a good foundation for the management of the new gas economy, strengthen their engagement with the Fund and their development partners, and achieve key national and regional objectives set out in their respective policy guidelines and protocols.
3. To this end, and in view of the strong performance under the program—with all but two end-June 2011 quantitative performance/assessment criteria observed with good margins, and implementation of structural reforms on track—they request Directors’ support for the completion of the third review of the PSI. With corrective actions in place, they also request the waivers for the nonobservance of end-June assessment criteria on net domestic financing and on net international reserves; and Directors’ support for the modification of the end-December 2011 assessment criteria for net international reserves and external debt.
Recent economic developments and respective policy environment
4. Tanzania’s strengthened economic fundamentals have helped the economy maintain a strong growth momentum despite the successive rounds of global economic downturns. That notwithstanding, the heightened global economic uncertainties and region-specific shocks have generated new sets of challenges that may further dampen economic activity. Consequently, real GDP that had recovered from 6.0 percent in 2009 to 7.4 percent in 2010 is now projected to ease to 6.0 percent in 2011, mainly due to the deterioration in the external environment coupled with weather-induced power shortages. However, prospects for medium term growth remain positive. The coming on stream of government’s investments in additional power generation including the new gas pipeline coupled with stronger investment in key economic and social sectors will augur well for economic growth in the medium term. In addition, the coming on stream of the new gas extraction, improvement of the external economic environment and normalization of the weather conditions are also expected to support and raise Tanzania’s economic growth trajectory in the medium term.
5. The protracted high global food and fuel prices, the repetitive regional drought conditions, an increase in domestic power tariffs and the recent exchange rate volatility continue to exert pressure on domestic inflation. Reemergence of inflationary pressures has raised new concerns and, in this regard, the Bank of Tanzania (BoT) has adopted a tightened monetary policy stance to forestall the inflationary challenges. Additionally, the BoT is strengthening the operation of its policy instruments for sterilization of liquidity and broadening of its monetary policy transparency. The authorities remain committed to maintaining the flexible exchange rate regime which they reaffirm has served the country well and has boosted export diversification.
6. The external balances weakened slightly in 2010/2011 mainly due to a sharp rise in the Import costs (mainly fuel) while exports recorded a double digit growth reflecting strong performance in traditional and manufactured exports and favorable commodity prices, especially of gold. Official gross reserves by end-September 2011are estimated to decline to USD 3.5 billion equivalent to about 3.7 months of import of goods and services (down from 4.4 months of import cover at end-June 2011). This was also due to delays in donor disbursements and non-concessional borrowing, as well as negative valuation effects on reserves held in euros and sterling when these currencies depreciated against the dollar.
7. My authorities’ fiscal policy in FY 2010/2011 broadly remained within the PSI targets, mainly due to a proactive management of spending and significant improvement in revenue performance. The authorities’ cash-budgeting system helped contain monthly expenditure within available resources and meet the domestic financing target. The overall deficit of 6.9 percent of GDP was marginally above the program goal of 6.5 percent of GDP. On the revenue front, the 2010/2011 performance was well above program target by 0.4 percent of GDP reflecting the authorities’ perseverance with their enhanced revenue collection efforts and related reforms.
8. Reflecting the growing development financing needs especially with respect to education, health and infrastructure, the 2011/12 budget was approved to support the authorities’ efforts to meet these needs. However, with downside risks emanating from uncertainties in external financing and rising inflationary pressures, my authorities, through a broad-based expenditure savings and strict application of cash management coupled with enhanced revenue collection efforts, have revised downwards the projected fiscal deficit to 6.6 percent of GDP. They are, however, keenly mindful of the need to sustain spending on social sectors and infrastructure consistent with their broad-based and inclusive growth objectives. Data as of end-December 2011 further indicates continued improvement in domestic revenue collection and the full year performance is projected to exceed the program target. The authorities are confident that the downside risks emanating from the impact of the protracted power shortages on corporate activity and profits on the level of revenue collections will in the near term abate as new power generation capacities come on line. The recent electricity tariff adjustment will also enhance revenue for the power utility and thereby reduce potential subsidies. They are aware of the difficulties entailed in modifying the mining sector tax regime in light of the existing agreements, nonetheless they remain focused on broadening the tax base, and strengthening customs and tax administration. They view the continued Fund TA support in tax administration as valuable inputs into their reform effort.
9. The government has made progress in raising funds from external non-concessional borrowing strictly within the PSI targets. Negotiations are in progress with various banks and institutions for an amount of up to US$575 million for the current financial year as per the program targets. The authorities are confident that they will make use of the entire non-concessional borrowing window for this financial year.
10. The banking system remains sound and continues to weather the impact of the global economic headwinds well, supported by a strong capital base. The upturn in the level of non-performing loans (NPLs) has reversed. Nevertheless, the authorities continue to monitor these aggregates carefully. The authorities are aware that the key challenge facing Tanzania’s financial sector today is to ensure that the pension funds are strong, and managed professionally, in the interests of the existing and prospective pensioners. In that regard, they have attached high priority to strengthen the operations of the new regulator, the Social Security Regulation Authority, with, inter alia, publication of the investment guidelines for the social security funds.
Medium-term policy framework and reforms
Fiscal policy and related reforms
11. My authorities’ fiscal policy, going forward, will strive to strike and maintain an appropriate balance between the objective of stimulating economic growth and maintaining macroeconomic stability. To achieve these objectives, the authorities intend to implement further measures to reduce the overall fiscal deficit through expenditure restraint and revenue enhancing measures. On the expenditure restraint, the authorities intend to contain recurrent spending especially on the wage bill and create the fiscal space necessary for sustained budgetary spending levels for priority services, and modest scaling-up of investment in infrastructure and primary sectors to shore-up economic growth. Deepening of structural reforms to improve budget execution and efficiency will continue to be prioritized.
12. To maintain spending in these priority areas while embarking on a fiscal consolidation path, the authorities will continue to strengthen domestic and concessional resource mobilization in the medium term. The authorities have embarked on further revenue enhancing reforms with the view of raising the revenue yield. Among the key revenue reform measures, the scope of tax expenditures will be streamlined substantially and tax holidays eliminated. The VAT base will be enlarged drawing on the planned comprehensive review of the VAT regime with the support of the Fund TA. Internal control systems will be strengthened further and risk management strategies developed for all spending agencies. Cognizant of the overall resource limitations, the authorities intend to facilitate greater inflows of FDI and private sector participation through PPPs, and fully utilize this year’s non-concessional financing window of US$575 million. They will especially remain vigilant of the contingent liabilities arising from greater use of FDI and PPPs, and debt sustainability implications of non-concessional funding. To that end, they are building capacities in these areas, and with the help of the Fund and the World Bank they have adopted the Medium Term Debt Strategy (MTDS) tool and published its results in June 2011.
Monetary and exchange rate policies
13. My authorities will continue with the tight monetary policy stance with the objective to bring down inflation to the BoT’s policy target of 5 percent in the medium term. The authorities will remain vigilant and closely monitor risks to inflation, especially those arising from the protracted high global commodity prices and regional supply shocks. To achieve the objective of anchoring its monetary policy on low and stable inflation, while supporting growth through maintaining sufficient liquidity in the financial system, the BoT will set its policy rate consistent with its disinflationary path. The BoT will further bolster its monetary policy instruments, rely substantially on foreign exchange sales for sterilization of liquidity, and continue to improve liquidity forecasting. The BoT is committed to improve the transparency of its policy stance and promote orderly financial markets.
14. On the exchange rate, the BoT reaffirms its commitment to a market determined exchange rate, and continue to see this as the first line of defense against external shocks. In this regard, the BoT will continue to participate in the foreign exchange market for liquidity management purposes and to smooth out short-term fluctuations in the exchange rate. Additionally, the BoT will enforce the existing restrictions on non-residents’ access to credit facilities and other sources of the Tanzania shilling funding, where these are not backed by underlying economic activities. The authorities will also seek to make progress in the preparation for and negotiations of the East African Monetary Union. To that end, they and other EAC partners continue to appreciate the Fund’s support in key areas of the preparations and, going forward, welcome further structural support.
Financial sector stability
15. Financial soundness indicators at end-September 2011 indicate that the banking system remains sound, profitable and liquid, and adequately capitalized, and NPLs have declined reflecting improved quality of loan portfolios. The BoT will continue to strengthen its financial stability monitoring tools and arrangements to ensure stability and soundness of the financial system. To that end, a financial regulators’ forum will be launched shortly to assume joint responsibility for safeguarding the stability of the financial system and to coordinate crisis management and resolution. Thanks to the Fund’s support, the BoT’s framework for financial monitoring and reporting has taken root with the second Financial Stability Report to be published during the first quarter of 2012. Following the full operationalization of the Social Security Regulatory Authority for the pension sector, the investment guidelines prepared by the BoT will be issued in the near term.
Energy policies and the new gas economy
16. At the time of the second review the authorities indicated their intention to commission, on an emergency basis, additional power generation capacity to meet the acute shortage of electricity in the tune of 300 MW. They have since implemented their Emergency Power Plan (EPP) that has added an additional 217.5 MW to the power grid. Though this new capacity has considerably mitigated the power crisis, it is based on expensive hydrocarbons the supply of which is constrained but also has significant implications on the import bill and the government budget. In this regard, the authorities have embarked on a system of periodic tariff adjustment and measures to enhance productivity improvements in power generation. On the later, the authorities intend to commission shortly the construction of a 520km gas pipeline, the financing of which is well within the PSI targets, to supply natural gas for power generation and other uses. It is envisaged that the new sources of energy will substantially improve the supply of electricity and other sources of energy for industrial, services and household use at a much lower cost than current.
17. The authorities have recorded substantive natural gas exploration results. When fully confirmed the new natural gas economy is envisaged to emerge with a potential multi-billion dollar investments over the medium term with a correspondingly large export and budget revenue flows. To best take advantage of this potential natural resource wealth, the authorities are embarking on the preparation of a Natural Gas Master Plan to be finalized later this year. They are aware that in a macroeconomic and budget management context, considerable work will be needed also to position the country to manage the new natural gas economy as well as mitigate the related Dutch disease effects. They, in this regard, request Fund’s comprehensive TA support under the Topical Trust Fund for Managing Natural Resources Wealth (MNRW-TTF).
Conclusion
18. The authorities’ macroeconomic fundamentals and continued commitment to strong and sound policies helped the economy to sustain a growth momentum despite the heightened global economic uncertainties. They are aware of the build-up of new risks and are, therefore, prepared to take appropriate measures to protect the gains in the country’s macroeconomic stability. In the near term, and notwithstanding the need for fiscal consolidation, the authorities are determined to ensure that the program focuses on sustaining macroeconomic stability, enhancing domestic resource mobilization, promoting broad-based and pro-poor growth, and creating fiscal space for increased investment in infrastructure, primary sectors and core MDG clusters. They are starting to focus on the future opportunities and challenges arising from the new natural gas economy. Going forward, they request continued support from the Fund, other international financial institutions and development partners in their efforts to strengthen macroeconomic stability, exploit new growth drivers, and achieve their development goals.