Document o f The World Bank FOR OFFICIAL USE ONLY Report No. 50217 - SC INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED L O A N IN THE AMOUNT OF EURO 6.4 MILLION (US$9.0 Million Equivalent) TO THE REPUBLIC OF SEYCHELLES FOR A DEVELOPMENT POLICY LOAN October 5,2009 Poverty Reduction and Economic Management Unit 2 Country Management Unit Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. I t s contents may not otherwise be disclosed without World - Bank authorization. REPUBLIC OF SEYCHELLES Government Fiscal Year: January-December Currency Equivalents (Exchange Rate Effective as o f September 1,2009) Currency unit Seychelles Rupee US$1-00 12.767 SR 1.00 0.078 Weights and Measures: Metric System ABBREVIATIONS AND ACRONYMS AfDB African Development Bank COMESA Common Market o f Eastern and Southern Africa DPL Development Policy Loan EU European Union FIAS Foreign Investment Advisory Service GDP Gross Domestic Product GFS Government Finance Statistics GST Goods and Services Tax IBRD International Bank for Reconstruction and Development IMF International Monetary Fund OECD Organization for Economic Co-operation and Development PEFA Public Expenditureand Financial Accountability PER Public ExpenditureReview SMB Seychelles Marketing Board STC Seychelles Trading Company Ltd. Vice President: Obiageli Ezekwesili Country Director: Johannes Zutt Sector Director: Sudhir Shetty Sector Manager: Kathie Krumm Task Team Leader: Tracey Lane (formerly Cevdet Denizer) .. 11 CONTENTS 1 . INTRODUCTION ....................................................................................................... 3 2 . Country Context .......................................................................................................... 5 A . Recent Economic Developments ........................................................................... 6 B. Macroeconomic Outlook and Debt Sustainability ............................................... 10 3 . GOVERNMENT'S PROGRAM AND PARTICIPATORY PROCESSES .........13 A . Public Financial Management Reforms ............................................................... 16 B. Public Sector Reforms ......................................................................................... 17 C . Social Sectors and Social Protection Policies ...................................................... 23 4 . Bank Suppport to the Government's Program ...................................................... 24 A . Linkages to the Interim Country Assistance Strategy .......................................... 24 B. Collaboration with the IMF and Other Donors .................................................... 25 C . Lessons Learned................................................................................................... 26 D. Analytical Underpinnings .................................................................................... 27 5 . Proposed Operation ................................................................................................... 28 A . Description o f the Operation................................................................................ 28 B. Objectives, Themes, and Policy Areas ................................................................. 28 6 . Operation Implementation ....................................................................................... 32 A . Poverty and Social Impact ................................................................................... 32 B. Environmental Aspects ........................................................................................ 34 C . Implementation. Monitoring. and Evaluation ...................................................... 34 D. Fiduciary Aspects ................................................................................................. 34 E. Disbursement and Auditing ................................................................................. 35 F. Risks and Risk Mitigation.................................................................................... 35 Boxes Box 1: Former Seychelles Marketing Board ..................................................................... 21 Box 2: Good Practice Principles on Conditionality .......................................................... 27 Figures Figure 1: Bound Tests for Baseline Scenario (Paris Club Restructuring and Non- concessional Refinancing) ................................................................. 13 Figure 2: Bound Tests for Alternative Scenario (assuming comparability o f treatment for other creditors), 2003-19 .................................................................. 13 Tables Table 1: Social Indicators for Seychelles and Comparators. 2007 ........................................ 5 Table 2: Macroeconomic Indicators and Medium Term Outlook 2008-12 .......................... 8 Table 3 : External Debt ......................................................................................................... 12 Table 4: Eliminated Direct and Indirect Subsidies .............................................................. 15 Table 5: Revenue-Raising Measures in the Macroeconomic Reform Program 2008 ......... 16 Table 6: Estimates of Wage-Bill Savings Measures............................................................ 19 Table 7: DPL supported policy actions................................................................................ 28 ... 111 Annexes Annex 1: Letter o f Development Policy ................................................................................38 Annex 2: Seychelles Development Policy Loan Policy Matrix ............................................ 47 Annex 3: Joint World Bank-IMF Work Program ................................................................. 49 Annex 4: IMF Press Release on the Completion o f the Second Review Under Seychelles' Stand-By Arrangement .......................................................................................... 5 1 Annex 5: Debt Sustainbility Analysis ................................................................................... 52 Annex 6: Country at a Glance ............................................................................................... 65 The proposed Development Policy Loan was prepared by an IBRD team led by Cevdet A. Denizer (Lead Economist) until September 1 and by Tracey Lane (Senior Economist) from September 1, and comprising Tony Verheijen (Senior Public Sector Specialist), Pia Schneider (Senior Health Economist), Csaba Feher (Senior Economist), Nightingale Rukuba-Ngaiza (Senior Counsel), Luis Schwarz (Senior Finance Officer), Peter Moock (Consultant), Wendy Ayres (Consultant), Henry Amuguni (Financial Management Specialist), Patrick Umah Tete (Senior Financial Management Specialist) and Dahir Warsame (Senior Procurement Specialist). Peer reviewers included Roland Clarke and Vivek Suri. The team benefited from the inputs and guidance o f Kathie Krumm and Sudhir Shetty. The team gratefully acknowledges the excellent close collaboration o f the Seychelles authorities and development partners, as well as the support and guidance o f Johannes Zutt, Michel Wormser, Sudhir Shetty, Harold Bedoya, and Marie-HCl&ne Bricknell. Rosemary Otieno and Dora Harris assisted the team with the preparation o f the program document. iv SEYCHELLES Development Policy Operation Summary Recipient Government o f the Seychelles ImplementingAgency Ministry o f Finance Financing data Amount 6.4 million (US$9.0 million equivalent) IBRD Loan, fixed-spread loan in Euro, with 25.5 years maturity and a 10 year grace period. Operation Type Stand-alone single tranche operation. Standard International Bank for Reconstruction and Development terms. Main policy areas The proposed Development Policy Loan supports strengthened budget management, improved governance and accountability in public procurement, creation o f a more efficient civil service and public administration, establishment o f a targeted social safety net to protect the poorest, and reduction in the role o f the state in the economy. Key outcome Primary balance rises from -2.0 percent o f GDP in 2008 to indicators exceed the original 6.2 percent o f GDP primary surplus target for 2009 envisaged in the program. 0 National Tender Board established and fully functioning. 0 Staff o f the public administration falls by 15 percent. 0 Public sector wage bill falls from 10.2 percent o f GDP in 2007 to 7.5 percent o f GDP in 2009. 0 Social Welfare Agency established and fully functioning. Overall subsidies o f the government to parastatals fall. Program development The objective o f the proposed operation i s to help the objectives and Seychelles establish a stable macroeconomic environment and contribution to sustainable fiscal framework. This will be achieved through Interim Strategy fiscal adjustment underpinned by public administration and civil service reforms and a reduction o f the role o f the state in commercial activities. The operation also supports establishment o f a targeted social safety net. By providing foreign exchange in a timely manner, the operation will directly contribute to stabilization o f the economy during a period o f global slowdown and will help i n building public support for the reform process. R i s k s and risk The operation faces five main risks. The first source o f risk mitigation arises from external shocks generally and in particular that o f the global economic slowdown which could make sound macro and fiscal management more challenging. The second risk i s that the government's commitment to reforms may weaken if reform outcomes do not deliver results. Related to both these risks. i s the risk that external arrears will subsequently build-up if the fiscal and macroeconomic reform program goes o f f track. However, the results o f reforms are showing that the immediate effects o f the shock have been absorbed and are n o w starting to stabilize (although there i s still a significant shock to the real sector this year, with unemployment levels remaining below 5 percent). Nonetheless, government commitment to the program remains firm and, it i s highly unlikely that there will be serious policy reform reversals. T o some extent the risk i s also being mitigated by the government's strategy to work closely with development partners that have made technical and financial commitments to support the government as these reform policies are implemented. The recent Paris Club debt relief agreement has also yielded tangible results that the government i s able to demonstrate to the public, and this has added to the credibility o f the reform process. This risk i s limited by the focus o f the proposed operation o n fiscal and public sector reforms, where the main policy actions have already been implemented and reform reversal risk i s minimal. The measures supported by the operation help achieve fiscal sustainability, including debt sustainability. The third risk is the fiduciary risks related to auditing capacity weaknesses, which i s being mitigated by closely working with the IMF technical capacity team o n the issues. The fourth risk i s the sporadic piracy attacks o n tuna fishing vessels using Seychelles' territorial waters. This reduced tuna exports earlier in the year. This risk is being mitigated by working closely with other countries (such as the United States and France) that are providing enhanced protection and assistance to Seychelles' coast guard. Operation ID Number P I 14822 2 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED DEVELOPMENT POLICY LOAN TO REPUBLIC OF SEYCHELLES 1. INTRODUCTION 1. This program document describes a development policy loan (DPL) designed to support the adjustment and reform strategy o f the Government of the Seychelles. The proposed operation involves a single tranche o f 6.4 million (US$9 million equivalent) and i s conceived as a one-time operation supporting structural reforms to put the Seychelles on a sustainable development path. The objective o f the proposed operation i s to help the Seychelles establish a stable macroeconomic environment and sustainable fiscal framework. This will be achieved through fiscal adjustment underpinned by public administration and civil service reforms and a reduction o f the role o f the state in commercial activities. The operation also supports establishment o f a targeted social safety net. By providing foreign exchange in a timely manner, the operation will directly contribute to stabilization o f the economy during a period o f global slowdown and will help in building public support for the reform process. The proposed DPL i s expected to achieve substantial measurable outcomes during 2009 and 2010 and to contribute to the achievement o f restoring internal and external balances with the assistance o f the international financial institutions and development partners. 2. I n late 2008, after many years of pursuing an unsustainablefiscal policy and managing a distorted and overvalued foreign exchange regime, the Government of the Seychelles embarked upon a fundamental economic reform program. This program aims to put the economy on a path toward macroeconomic stability, and to redefine the role o f the state in the economy to give the private sector the major role in operating commercial enterprises. The Seychelles faced acute economic difficulties in 2008 as a result o f past economic mismanagement exacerbated by high global o i l and food prices and the downturn in the global economy. This resulted in missed debt- service payments in mid-2008 and the subsequent downgrading o f i t s credit rating by Standard & Poor's. Faced with these difficulties and the fact that Seychelles would not achieve external debt sustainability without a sizeable reduction in the present value o f i t s debt, the authorities responded quickly by adopting in November 2008 a comprehensive reform program supported under a two-year Stand-By Arrangement with the International Monetary Fund (IMF). At the same time the authorities initiated debt restructuring negotiations with the Paris Club creditors and other private and official creditors. Following the successful completion o f the first review o f the Stand-By Arrangement, the Paris Club in mid-April 2009 granted exceptional debt relief to the Seychelles, providing an opportunity for the country to attain fiscal and external debt sustainability. The IMF in June completed its second review o f the Stand-By Arrangement, noting that all quantitative performance criteria were observed and that the structural reform program was on track. A further disbursement o f SDR 0.88 million (about US$1.4 million) was 3 approved by the IMF Board on 25 September. An IMF team plans to travel to the Seychelles in late October to discuss a follow-up arrangement under the Extended Fund Facility. 3. The proposed DPL i s based on the government's reform program as articulated in the detailed policy statements of the Ministry of Finance to the parliament for the 2008 and 2009 budgets and in the president's speech to the nation in late February 2009. Both the 2008 and 2009 budgets aimed at achieving upfront strong fiscal adjustment with sizeable primary surpluses in both years despite the global crisis. Policy statements for 2008 and 2009 presented to the parliament specify how these targets would be achieved (for details see section 3 o f this document). Policy measures supported by this operation directly focus on these areas. The current reform program i s in line with the government's commitments under the IMF supported Stand By Arrangement. The long t e r m vision for development in Seychelles ("Strategy 2017") i s currently under review to reflect the current realities and the economic reform program. To support the development o f a fully articulated medium-term plan, the Bank prepared a Public Expenditure Review (PER).' The PER helped the government to identify key fiscal reforms and develop a public sector reform roadmap, and the government has already implemented many o f its recommendations. The PER i s also providing the Bank and other donors with the analytical basis for potential financial support. 4. The Seychelles reform package includes measures to protect vulnerable groups and to expand employment in the private sector to cushion expected job losses due to downsizing o f the public sector. As the foreign exchange depreciation has passed through to domestic inflation prices, real incomes and household consumption have been adversely affected. Although this effect has proved to be a one-off adjustment, the government introduced a new social welfare system to protect the most vulnerable. A new Social Welfare Agency Act was enacted in October 2008, establishing a new Social Welfare Agency and a new means-tested social welfare benefit. By August 2009, some 3,000 households were receiving benefits from the new agency. The new system replaces a system based on universal subsidies, which was both costly and inefficient. The authorities have also been implementing policy reforms to support the creation of new jobs in the fishing, tourism, and banking sectors. This is particularly important since the .on-going public administration reforms are leading to staff reductions in the public sector. Flotation o f the Seychelles Rupee, liberalization o f domestic prices, and elimination o f state monopolies are expected to boost private sector activities and hence generate new employment. The government expects these reforms will foster dynamic private sector led growth over the next decade. 1 "Seychelles Public Expenditure Review," Report 49273-SC, Poverty Reduction and Economic Management 2, Africa Region, World Bank, June 25, 2009. 4 2. COUNTRY CONTEXT 5. The Seychelles i s a remote, small island-state with middle-income country characteristics. The estimated population o f the Seychelles is 86,000 (2008). The per capita income o f US$10,290 (2008) i s among the highest o f the middle-income countries group.* As with other island-states, the overall size o f the economy is small (US$833 million GDP in 2008) and i s predominantly service based, with tourism and transportation and the fishing industry important contributors to economic output. The Seychelles enjoys an exclusive economic zone o f almost 1.4 million square kilometers in one o f the world's major tuna fishing grounds. However, the limited land, capital, and human resources restrict the country's ability to benefit from economies o f scale in production and economic diver~ification.~ Unemployment has been l o w over the years, estimated at 5.5 percent in 2007. The Seychelles also has good quality-of-life indicators with l i f e expectancy at Organization for Economic Co-operation and Development (OECD) levels o f 73 years (see Table l).4 An open economy, with trade accounting for 250 percent o f GDP, the Seychelles i s naturally vulnerable to global shocks and terms-of- trade shocks, particularly those which affect tourist arrivals (notably from Europe). Furthermore, the Seychelles relies on imports for almost all raw materials, products, and specialized service^.^ Table 1: Social Indicators for Seychelles and Comparators, 2007 s -3 a 2 Q) % ; tl .- 2 .I 3 a 2 r $ .2 e s z z a- 3 & e o !3 mQ g G 'E k c3 3 L i f e expectancy (years) 77 73 72 71 70 69 68 Under-five mortality per 1,000 13 13 15 32 35 18 30 Births per 1,000 11 18 14 24 15 21 23 Primary completion rate (%): Boys 94 111 92 84 98 90 131 Girls 95 118 95 88 102 90 127 Source: World Development Indicators 2009. Calculated using the World Bank Atlas method. Note the GDP per capita in US$ was calculated before the effects o f the exchange rate devaluation in November 2008 were felt. The Seychelles comprises 115 tropical islands spread over 1.374 million square kilometers in the western Indian Ocean, covering 455.3 square kilometers in land area. Only 2.2 percent o f the land area i s arable, and about 10 percent o f the 60 square kilometers o f potential agricultural land i s in use. The mountainous terrain and low soil fertility are an impediment to agricultural productivity. Some 87 percent o f the country i s forested, and 50 percent i s a forest preserve. About 90 percent o f the population o f the Seychelles lives on the largest island, MahC, where the capital, Victoria, and the main fishing port are located. Data in this paragraph are from the World Development Indicators database. The Seychelles belongs to the Common Market o f Eastern and Southern Africa, the Indian Ocean Commission, and the Southern African Development Community regional groups, and i t s major trading partners are the China, France, Italy, Japan, the Netherlands, Saudi Arabia, Singapore, South Africa, Spain, Taiwan, Thailand, United Kingdom, and the United States . 5 6. The Seychelles i s a multiparty democracy and has had seven presidential elections since independence from the United Kingdom in 1976. A year after independence, a coup d'etat established a one-party socialist state which lasted until December 1991, when President France Albert Rene o f the Seychelles People's Progressive Front announced a shift to multi-party pluralism. President Rene won the first multiparty presidential elections in 1993 after the adoption o f a new constitution. H e `governed Seychelles until April 2004 when he stepped down and appointed James Alix Michel as the interim president. President appointee Michel was elected in 2006 for a five-year t e r m in a close race with majority opposition leader Wave1 Ramkalawan o f the Seychelles National Party. Since his election, President Michel has taken a robust approach towards good governance in the management o f the country's political economy. The main thrust o f the economic reform was to redefine the role o f the government in the economy and society in a paradigm shift, which recognizes the need for political, economic, and social reforms. Under his leadership, the government i s pursuing a sound policy framework which encourages entrepreneurship, proposes to dismantle an inefficient regulatory framework and make appropriate infrastructure investments, and attempts to attract new foreign direct investment. In this pursuit, President Michel has additionally accepted to engage in open and active discussions with the opposition parties, civil society organizations and the public in general, and has appeared regularly o n television and in public addresses to demonstrate his commitment to the reform program. 7. The Seychelles has two principal natural endowments, which are its comparative advantage. The f i r s t is a physical environment that i s largely pristine, with a tropical and hurricane-free climate. The second i s an extensive maritime environment. As a result, the economy i s predominantly service based and largely depends on tourism, and to a lesser extent fisheries, and off-shore services. Tourism accounts for 26 percent o f GDP.6 The relatively small agricultural sector has continued to decline. The Seychelles has the second-largest tuna cannery in the world; which a recent report estimated contributed 3.5 percent o f GDP. However, its share o f employment, GDP and foreign exchange generation has declined in recent years.' Bunkering, (the re-export o f fuel) and the storage o f fuel are profitable activities taking advantage o f Seychelles geographic position in the middle o f the Indian Ocean. Also a Seychelles parastatal company runs a successful international freighter service enterprise. Offshore business and financial services had been developing in the years prior to the onset o f the global economic crisis. A. Recent Economic Developments 8. During the 1990s, the Seychelles managed an unsustainable fiscal situation, which was funded by domestic and external borrowing. The emphasis on state-led development policies emphasized rapid capital accumulation, economic self-sufficiency, and the establishment o f a generous welfare system to improve the well-being o f the country's small population. The government sought to achieve these economic and social goals through central planning and public ownership o f productive resources. N o t Seychelles National Statistics Bureau, national income accounts. ' Oceanic Development Benchmark Tuna Process in Seychelles, 2008. 6 only did the government play a dominant role in the economy through extensive controls and regulations, but it also intervened directly in manufacturing, distribution, trade, and other economic activities through parastatals. Although this strategy resulted in impressive achievements in the social sectors, and the economy grew by an average o f 5 it also led to an accumulation o f unsustainable domestic and percent during the 1 9 9 0 ~ ~ external imbalances. Current account deficits were high throughout the 1990s and reached 23 percent o f GDP by 2001. 9. The government attempted to bring high public spending and unsustainable deficits under control in 2003, but these efforts were short-lived. Fiscal deficits remained high and reached almost 18 percent o f GDP in 2002, before the government responded with a fiscal consolidation program. Public debt stock accumulated over the period, and reached about 150 percent o f GDP by 2008/9. GDP declined by 5.3 percent in 2003, and it was clear that the state-led development strategy pursued for more than a quarter century had reached i t s limits and become unsustainable. Although the government introduced a macroeconomic reform program in mid-2003, implementation was short-lived and significant internal and external imbalances persisted well into 2007. Despite the stop-go fiscal policy, economic growth during this period was strong, with real GDP growth averaging 8.5 percent between 2005 and 2007 (see Table 2). 7 Table 2: MacroeconomicIndicators and Medium Term Outlook 2008-12 2005 2006 2007 2008 2009 2010 2011 2012 Actual Actual Actual Est. Proj. Proj. Proj. Proj. National income and prices % change Nominal GDP (SR millions) 5,043 5,628 6,877 8,756 10,280 11,066 11,901 12,882 Real GDP (Percent change) 6.6 9.3 9.7 -0.9 -10.7 3.5 5.0 5.0 CPI (Annual average) 0.6 -1.9 5.3 37.0 35.1 4.1 2.5 3.2 GDP deflator average 0.8 2.1 11.4 28.4 31.4 4.0 2.4 3.1 Money and credit YOchange Net claims on private sector 1.9 0.4 9.3 58.4 24.3 20.2 Broad Money (M2) 1.7 6.1 -7.6 27.2 5.6 20.5 Reserve Money (% change) 3.4 32.7 -23.1 0.6 20.6 19.4 Savings and investment % o f GDP Gross national savings 14.1 13.5 8.0 -13.7 -1.8 -3.8 1.6 8.0 Ofwhrch: government savings 5.8 0.4 4.4 4.2 1.0 4.5 5.2 8.1 Gross investment 33.1 26.6 28.8 31.9 27.9 29.3 31.8 32.1 Ofwhrch: government investment 5.1 7.7 5.5 2.1 4.3 5.0 6.9 7.3 Government budget % o f GDP Total Revenue and Grants 40.6 41.2 32.2 36.4 35.6 34.3 33.6 33.7 O f which Tax revenues 31.1 29.9 27.6 28.1 29.8 28.5 28.7 28.8 Total Expenditure and Net Lending 38.9 47.0 40.9 39.8 35.6 32.9 35.1 32.8 I.Current expenditures 33.8 39.4 36.3 28.6 34.2 29.6 28.2 25.5 Wages and salaries 11.1 11.6 10.2 7.9 7.5 6.2 6.1 6.1 Goods and services 8.2 7.1 7.3 5.6 6.4 6.8 6.8 7.1 Interest payments 5.4 5.3 6.6 7.2 11.4 8.4 6.9 3.9 Foreign interest 1.3 1.4 3.2 3.9 5.3 3.9 3.6 1.1 Domestic interest 4.2 3.9 3.4 3.3 6.2 4.4 3.3 2.8 Transfers 8.9 15.3 12.1 7.9 8.6 8.2 8.4 8.4 Social programs and SSF 3.9 7.1 6.7 5.4 6.2 6.8 7.2 7.3 To rest o f public sector 5.0 8.1 5.5 2.5 2.4 1.4 1.2 1.2 2. Capital expenditure 5.1 7.7 5.5 2.1 4.3 5.0 6.9 7.3 3. Net Lending -0.1 -0.9 9.1 -3.9 -2.6 0.0 0.0 4. Contingency 1.0 0.9 0.0 0.0 Overall balance, including grants 1.6 -5.9 -8.7 -3.3 0.0 1.4 -1.5 0.9 Primary balance 7.1 -0.5 -2.0 3.8 11.4 9.8 5.4 4.8 Total public debt 141.8 132.4 129.8 139.4 149.7 121.7 84.1 76.9 Domestic 96.9 81.4 65.8 52.3 41.8 30.5 26.3 21.6 External 44.9 51.0 63.9 87.1 108.0 91.2 57.8 55.3 External sector Current account balance after official transfers -19.0 -13.2 -20.8 -45.6 -29.7 -33.0 -30.3 -24.1 Total stock o f arrears ($ millions) 184.0 123.5 160.4 97.8 133.6 Total external debt outstanding (% o f GDP) 53.0 51.1 69.2 87.1 108.0 91.2 - Terms o f trade (= deterioration) 4.4 -0.2 -1.2 0.7 -2.1 Real effective exchange rate (end o f period) 2.7 -9.7 -25.4 -1 8,:4 Gross official reserves (US$ millions end o f year) 56.1 112.7 9.8 50.9 108.4 158.4 208.4 258.4 In months o f imports 0.0 1.3 0.1 0.7 1.3 1.8 2.3 2.6 Exchange rate Seychelles rupees per U S 1 (end o f period) 5.5 5.8 8.0 16.6 16.0 Seychelles rupees per US$1 (period average) 5.5 5.5 6.7 9.5 16.0 Source: IMF August 2009. 10. Funded by new external borrowing, fiscal deficits widened to 8.7 percent of GDP in 2007, and both the fiscal and external debt sustainability situation worsened. In 2007, the overall fiscal deficit was about 8.7 percent o f GDP, compared with the start o f the year's target o f a fiscal surplus o f 5 percent, as expenditures were not 8 contained. Despite the efforts with fiscal reforms at the beginning o f the decade, public spending remained high and above that o f other small island comparator countries. Already relatively high, spending for social services and safety nets increased further between 2005 and 2007. Social security spending-which averaged 29.8 percent o f expenditures, or 8 percent o f GDP, during 2000-05-is on a par with that o f European countries, and at the top end o f middle-income countries, as well as higher than a comparator group o f small island-states' averages. As shown by the 2009 PER, average spending between 2000 and 2005 remained 6.6 percentage points o f GDP above comparator countries. In fact, average primary spending in the Seychelles during 2000- 05 was higher than that o f two-thirds o f OECD nations.' Wages and salaries accounted for more than 10 percent o f GDP-high by international standards-and reforming the public sector had not (until recently) been on the agenda. N e t transfers to public enterprises, which account for 30 percent o f GDP and employ 41 percent o f the labor force, steadily increased and reached 5.5 percent o f GDP in 2007. With limited recourse to other finances, largely non-concessional external borrowing funded these deficits. In 2006, Seychelles borrowed US$230 million and in 2007, an additional 54.7 million and US$30 million bringing i t s total external debt stock to about 64 percent o f GDP (up from 44.6 percent o f GDP in 2004), and total public sector debt to 130 percent o f GDP by the end o f 2007. 11. These growing imbalances proved unmanageable and in 2008 Seychelles defaulted on its debt and faced a severe foreign debt and balance-of-payments crisis. After many years o f managing an unsustainable fiscal and external debt situation, the Seychelles faced a foreign exchange shortage, which disrupted output in real sectors. The situation was aggravated by the oil and food crises which brought the unsustainable debt situation to a head. As a result, economic growth dropped sharply from 9.7 percent o f GDP in 2007 to -0.9 percent in 2008. Inflation also was considerably higher in 2008, particularly after flotation o f the Seychelles Rupee. At the end o f 2008, annual average inflation was about 37 percent and end-of-period inflation about 63 percent compared with 5.3 percent in 2007. (though the official consumer price index may have understated true inflation in 2007 because o f controls on prices that s t i l l existed then). Exacerbated by rising food and particularly energy prices, current account deficits widened considerably in 2008 and reached about -45.6 percent o f GDP, from -20.8 percent in 2007. As a result reserves declined rapidly, and by mid 2008 the Seychelles was practically out o f reserves as import coverage f e l l to less than one month. External transactions were increasingly financed by arrears accumulation. The external environment continued to deteriorate as the global credit crisis impacted tourism in the last quarter o f 2008. In September 2008, the authorities announced that they would not be able to make a coupon payment on the US$230 million bond. The government approached the IMF and in November 2008 successfully negotiated a two year Stand-By Arrangement. Soon thereafter, the authorities initiated debt restructuring discussions with the Paris Club and other official and private creditors. The Paris Club creditors in April 2009 granted a face value reduction o f 45 percent. * The IMF's Fiscal Affairs Department recently conducted a similar exercise using a different small island-state comparator group and found that in 2007 primary spending in the Seychelles was 20 percent of GDP higher than the average. IMF 2008. "Strategy for Strengthening Budget management," Fiscal Affairs Department, IMF, 2008. 9 12. The government's decisive implementation o f the macro stabilization program and swift introduction o f structural reforms successfully stabilized the economy by the end o f first quarter o f 2009. Critically, the Government moved to float the Rupee in November 2008. The Rupee immediately depreciated by about 50 percent against the U dollar, where it broadly stabilized by early 2009. The currency S has appreciated since April and it appears that the market i s now fully functioning, with regular transactions taking place in the newly created inter-bank foreign exchange market. Notably, the parallel foreign exchange market has disappeared. Interest rate controls were also lifted and while rates initially rose sharply to 30 percent, by May they were back down to 15 percent, in line with falling inflation. The initial depreciation in November was passed through to prices, and inflation jumped by 24 percent in that month and finished the year at 63 percent on a year-on-year basis, but this proved to be a one-off adjustment, as expected and inflation i s n o w expected to stay in the l o w single digits. With the tightening o f monetary policy since the floatation o f the Rupee and fiscal adjustment efforts as described below, inflation declined sharply to the l o w single digits, where it i s expected to remain, in line with major trading partners' inflation. This indicates that the current macroeconomic framework is appropriate. 13. Strong fiscal adjustment underpinned by structural reforms has been the main factor in stabilizing the economy. The Government initiated several far reaching fiscal policy reforms in late 2008. I t reduced current and capital expenditures sharply, including 3.8 percent reduction o f public investment spending, mostly on new housing construction as well as wage restraint and tighter controls on spending. It enacted a new Procurement A c t and tightened financial controls, which helped contain outlays on goods and services. The elimination o f direct and indirect subsidies reduced expenditures by 1.5 percentage points. The wage bill reduction due to public administration and civil service reforms generated additional savings o f about 1.5-2.0 percent o f GDP in 2009. The downsizing o f the civil service i s greater than initially targeted, and some 2,500 staff had left the public service by April 2009, representing15 percent o f the April 2008 public sector workforce. Subsidies to state enterprises were cut from 5.5 percent o f GDP in 2007 to 2.1 percent in 2008 and onlending to the sector was eliminated in 2009. The non-use o f the contingency fund (about 1 percent o f GDP) for possible bank recapitalizations has also helped contain expenditures. Revenue performance mobilization o f external grants at about 3 percent o f GDP (Abu Dhabi, China, and South Africa for a total o f US$19.9 million) has helped to soften adjustment. These measures have led to projections o f a primary surplus o f 11.4 percent o f GDP in 2009. B. Macroeconomic Outlook and Debt Sustainability 14. The global recession has hit the Seychelles hard and GDP i s expected to decline by around 10 percent in 2009 and to recover to only 3.5 percent growth in 2010. The global slowdown began to affect tourism revenues in the fourth quarter o f 2008. Although tourism arrivals recovered in the second quarter o f 2009, there i s a 15 percent fall in tourism revenues anticipated for the year as a whole. Given the share o f tourism in the economy, this will contribute to an expected real GDP decline o f around 10.7 percent, the largest in the history o f the Seychelles since independence. The initial rebound will depend upon the recovery in the tourism sector, which has been a traditional 10 driver o f growth. In the medium term, a positive reaction from the private sector i s expected as the government's role in commercial activities is reduced and the playing field i s leveled between the public and private sectors. Given the stable macroeconomic outlook with l o w projected inflation the rebound will also depend on the speed with which service based small and medium-sized enterprises respond to the improved fundamentals. Provided that tourism sector goes back to i t s traditional performance and with improved global economic conditions attaining average economic growth rates o f 5 percent would seem to be within reach. 15. External accounts are expected to improve in the next couple o f years, but only gradually, on account o f the global crisis. The current account situation has deteriorated in 2009 as the global downturn and piracy are expected to constrain exports and tourism earnings in 2009 and 2010. Based on the first six months o f 2009, growth in the tourism sector i s expected to decline by 15 percent, while tuna exports are projected to decline by about 20.5 percent in 2009 over 2008 and by a further 6.9 percent in 2010. Over the medium term, tourism growth i s expected to recover and register around 10-1 1 percent annual growth by 2012, but projections depend on the rate and extent o f recovery in the global economic environment. Tuna exports are expected to grow by about 4.5 percent between 2010 and 2011. Imports are projected to have contracted by about 40 percent in 2009 and are expected to recover slowly, with 11 percent growth in 2010. Over the medium term, net foreign direct investment i s projected to stabilize at around 25 percent o f GDP over 201 1-14. Reserve build-up i s expected to continue in 2009 reaching 2 months o f import cover by 201 1. Given these projections, the current account deficit i s projected to reach 30 percent o f GDP in 2009 depending on reaching an agreement with private creditors as interest payments will be large if a deal cannot be reached. Even if a deal i s reached, current account deficits are not likely to fall below 25 percent during the 2009- 12, 16. The restructuring agreement o f Paris Club debt was an important step in the achievement o f debt sustainability. O n April 16, 2009 Paris Club creditors granted Seychelles exceptional treatment under the Evian approach, recognizing the strong commitment o f the government to reforms and the limited debt repayment capacity o f the country.' A total o f US$140 million o f arrears were normalized. Under the agreement nominal claims are reduced by 45 percent in two tranches (July 2009 and 2010) following the second review o f the current Stand-By Arrangement and the first review o f the successor arrangement in June 2010. The remainder i s rescheduled over 18 years with five years grace, with graduated payments. The Paris Club agreement i s not tenable on i t s own, since a formal requirement for the effectiveness o f the agreement i s securing comparability o f treatment from other creditors. The government i s in advanced negotiations with non-Paris Club bilateral and private creditors (the majority o f which are the holders o f a US$230 million bond and a 55 million (face value) amortizing note) and it i s expected that most agreements will be reached by end December 2009. The agreement covered all debt to Paris Club. South Africa, a significant non-Paris Club creditor participated in the meeting and was a signatory o f the minutes. 11 1 Table 3: External Debt End-2008 External debt stock2 802.2 Multilateral 57.0 Bilateral 267.4 Paris Club 151.7 Non-Paris Club 115.8 Commercial 477.7 External debt arrears 333.5 Multilateral 0.0 Bilateral 184.5 Paris Club 124.2 Non-Paris Club 60.4 Commercial 149.0 1 Preliminary and subject to reconciliationwith creditors. Includes central bank external debt. 2 Includes arrears Source: IMF 17. The debt sustainability analysis, based on the Paris Club deal results in a significant reduction in debt ratios, but without further restructuring from other creditors on comparable terms, public debt remains unsustainable. Based on macroeconomic projections related to the main indicators, a debt sustainability analysis has been completed by the Fund (Annex 5). The first scenario assumes Paris Club restructuring for Paris Club debt and no restructuring for private debt, with the additional assumption that this non-restructured debt (including arrears) i s serviced and the financing gaps are closed by a flow rescheduling on market terms. The result is that by 2017 the external debt ratio would increase steadily to 259.9 percent o f GDP (Figure 1) and to 326.2 percent o f GDP by 2019. Despite strong fiscal adjustment, the analysis also shows that overall public sector debt would also rise, and reach 278.7 percent o f GDP by 2017. The second scenario assumes that public external debt (using debt stock at end 2008) i s restructured o n comparable cash-flow terms. External debt would then decline steadily to 48.9 percent o f GDP by 2017 (Figure 2) and remain under 50 percent o f GDP through 2019. Total public debt, including domestic debt, would decline to 62.5 percent o f GDP over the same period. The analysis also shows that Seychelles's public debt i s particularly exposed to current account and interest rate shocks, which put a premium on prudent economic management. 12 Figure 1: Bound Tests for Baseline Scenario (Paris Club Figure 2: Bound Tests for Alternative Scenario Restructuring and Non-concessional Refinancing)" (assuming comparability of treatment for other creditors), 2003-19 1 280 BaselineZgl (left I 190 170 150 -I Historica t 230 150 scale) ; 130 50 180 110 90 90 I2O 130 M 70, , 80 50 30 30 10 6o 30 2003200520072009201 1201320152017 20032005200720092011201320152017 Source: IMF Debt Sustainability Analysis 18. Negotiations with non-Paris Club bilateral and commercial creditors for debt to be restructured on comparable terms are well advanced. Before the end o f 2009 the government i s expected to make a formal tender offer to bondholders to exchange outstanding bonds for a new bond on restructured terms. Successfully completing the tender will raise the country's creditworthiness, and allow it to potentially benefit from a proposed second World Bank-financed Development Policy Loan in the second half o f 2010. 3. GOVERNMENT'S P R O G R A M AND PARTICIPATORY PROCESSES 19. The government's program i s based on a strong political consensus for a new development strategy that emerged in mid 2008, i s heavily frontloaded and deals with the underlying causes o f the crisis. President James Michel's popular mandate and endorsement o f reforms by the opposition and civil society, including labor unions, have given the government the support needed to break with the past. An initial assessment o f the effects o f reforms was made by the government during the Seychelles Forum in May 2009, which brought together development partners, multilateral institutions, civil society members, and the opposition. There was a broad endorsement o f the new development strategy and results achieved so far, and the president asked for continued donor support, noting that debt relief provided by the Paris Club enhanced the credibility o f reforms. The IMF and the government had successfully concluded the second review o f the Stand-By Arrangement prior to the forum. During the event, the lo External financing gap i s assumed to be closed by external borrowing at LIBOR plus 1300bps, with 3 year maturity. Shaded areas represent actual data. Individual shocks are permanent one standard deviation shocks (two standard deviations for growth shock). Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable i s also shown. 13 Bank presented the main elements o f i t s Interim Strategy Note, which i s being submitted to the Bank's Board along with this operation. 20. The government i s consulting widely with the public on the reform program with meetings held in all 25 electoral districts. The president, all ministers present in the country, numerous principal secretaries, member o f parliament and chief executive officers o f parastatals, travel to district administration offices to explain the objectives o f the program and the measures that the government i s taking to ease its short-term impact. The president and ministers answer questions. The principal secretaries and parastatal chiefs are expected to follow up o n issues raised and to meet with citizens after the meetings. The meetings generally last 90-1 50 minutes. The story is regularly broadcast o n local media, two or three days after the event and is reported in The Nation newspaper the following day. State House also issues a monthly newsletter which summarizes the government's priority reforms and outcomes so far. The newsletter also presents the main issues discussed by the cabinet during the month. The newsletter is distributed to all government ministries and agencies and i s available o n the state house website. These measures are proving effective in building consensus among citizens for reform, as demonstrated by the lack o f organized public resistance to the changes. 21. The reform program, as presented to parliament for the 2008 and 2009 budgets, aimed at stabilizing the economy, and contained well-sequenced structural reform measures to foster a market-oriented economy. The Government i s o n track to achieving i t s goal to create a stable macroeconomic environment and transform the role o f the state to a provider o f public goods, thereby allowing the private sector to take the lead role in commercial production activities. By liberalizing the foreign exchange market fully and by eliminating price controls and some o f the most obvious constraints on economic activity, the authorities aimed to boost employment in the private sector- particularly in tourism, banking, and the fishing industry-and to enhance real incomes. The reform program included the following elements: 0 Liberalization o f the exchange rate regime, elimination o f all restrictions, and flotation o f the Rupee, tight fiscal policy backed by public employment reforms and a reduction o f direct and indirect subsidies; 0 Social sector reforms and improved targeting o f the social safety net; 0 Reduction o f the state in the economy through further privatization and improvement o f the investment climate; 0 Review o f the tax regime and elimination o f exemptions; and e Reform o f the monetary policy framework to focus o n liquidity management based o n indirect instruments. 22. Many o f these reforms were initiated in 2008, others were undertaken in 2009, and others are s t i l l under way. Starting with the formulation o f the 2009 budget, fiscal consolidation measures that began in 2008 continued. Actual outturn o f the 2008 14 budget shows that the government was able to maintain fiscal discipline, following two years o f budget overruns. Public enterprises are now required to operate with limited or no direct subsidies. Downsizing in the core public sector will continue as the reform program i s being implemented. The government has already initiated welfare reform and established a better targeted safety net and a reduction in abuse o f the current system. The government has also reformed the monetary policy framework and laid the foundation to create a financial system in which policies are implemented with indirect instruments. 23. During 2008, the government initiated several efforts to reduce the number of employees on i t s payroll, such as an early retirement scheme, a voluntary departure scheme, and a new hiring freeze. The Bank's PER indicated potential to achieve a wage-bill target o f 6.5 percent o f GDP in 2010 without undermining proper public sector management. The implementation o f the first phase o f reforms has been impressive and has demonstrated government's commitment to reform the public sector. Table 4: Eliminated Direct and Indirect Subsidies Action Timing Abolish fishermen's fuel subsidy coupons. October 1,2008 Eliminate indirect universal product subsidies and replace them with a targeted November 1,2008 social safety net by enacting the Welfare Agency Act. Eliminate S 90 per month electricity rebate for households. R January 1,2009 Raise and maintain Seychelles Public Transportation Company bus fare at January 1,2009 operating cost recovery levels. Eliminate implicit and explicit subsidies for Agro Industries, Hatcheries, January 1,2009 Seychelles Trading Company, and Coetivy Prawns. Eliminate liquefiedpetroleum gas subsidy by the state-owned Seychelles January 1,2009 Petroleum Company (about SR 3 per kilogram). Source: Memorandumo f Economic and Financial Policies 2008-9, Government o f Seychelles. 24. Recent fiscal reforms also included revenue-raising measures and removed distortionary exemptions. To boost its fiscal position, the government announced a number o f measures, which are summarized in Table 4 and Table 5. Given the global environment, tax revenues are expected to be affected by the growth slowdown, and lower tourism revenues. Reviewing tax policy options and ensuring a tax regime that i s both consistent with fiscal targets and supportive o f business climate reforms to help the private sector during the transition and downturn in global economic activity have become even more urgent. The authorities launched a fundamental tax reform in June. The medium-term strategy involves a modernization o f the tax regime to eliminate sectoral preferences and exemptions, harmonize tax rates, and remove distortions and inefficiencies. A new business tax code and a personal income tax will be introduced in 2010, followed by a VAT by 2012. Major upgrades to tax administration are also in process, supported by continued technical assistance from the IMF. The IMF will be assisting the authorities by undertaking a detailed review o f key issues and proposing 15 policy measures to deal with them. The Government continues to be on track with the implementation o f all fiscal measures as documented in the IMF's first and second reviews o f the Stand-By Arrangements. Table 5: Revenue-Raising Measures in the Macroeconomic Reform Program 2008 Action Timing Raise and harmonize taxes on local and imported cigarettes to SR 500 October 1,2008 per 200 cigarettes. Introduce 10% withholding tax on interest income for residents. October 1,2008 Extend goods and services tax (GST) to all telecommunications October 1,2008 companies. Announce the introduction o f 15 percent GST on residential rental October 10, 2008 income, effective January 1, 2009. Announce the removal o f the exemption on interest income to November 1,2008 companies (Tax Act), effective January 1,2009. Reintroduce GST on locally produced soft drinks. November 1,2008. Raise GST on tourism services from 7 percent to 10 percent. November 1,2008 Raise specific taxes and excise tax rates for locally manufactured and November 1,2008 imported alcohol to adjust for inflation. Raise the environmental l e v y to SR 25 from SR 10 per month per January 1,2009 household. Adjust fees, fines, charges, and rents and royalties for inflation. January 1,2009 Reinstate GST on liquefied petroleum gas. January 1,2009 Raise GST on tourism services from 10 percent to 12 percent. November 1,2009 Repeal all provisions for discretionary exemptions in the Trade Tax January 1,2009 and Business Tax Acts. Source: Memorandum o f Economic and Financial Policies 2008-9, Government o f Seychelles. A. Public Financial Management Reforms 25. Because budget credibility has been weak in the past, the government i s strengthening the public financial management framework. Budget outturns have tended to exceed the approved appropriation at the start o f the fiscal year by an average o f 22 percent per year during 2005-07. With the exception o f spending on wages and salaries in very recent years, the budget was exceeded across the board. A key reason was that the macroeconomic assumptions underpinning fiscal policy analysis and budget 16 preparation are not prepared systematically or used consistently.'' A s a result, the macroeconomic framework and budget framework are internally inconsistent, and various revenue and expenditure items are not prepared using consistent macroeconomic assumptions. Another major reason has been that past budgets did not include sector ceilings, and ministries often exceeded their allocations. 26. I n addition to changing i t s budgetary processes, the government has created a new unit that will b e responsible for producing internally consistent projections o f main macroeconomic aggregates for budget preparation. Previously, no unit had central responsibility for preparing projections o f relevant macroeconomic variables, such as GDP growth, inflation rates, exchange rate, interest rates, or unemployment. The new unit i s responsible for providing binding inputs to the 2010 budget formulation process. The 2009 budget has been consistent with the macroeconomic program and includes binding sector ceilings to ensure that the country's fiscal consolidation will be sustained. The government i s continuing to consolidate the budget consistent with the definitions in the IMF's Government Finance Statistics Manual and the recommendations o f the IMF. B. Public Sector Reforms 27. Public sector reforms aim to transform in an efficient manner the role o f the state to one o f provider o f public services and goods and to improve governance. Public sector reforms underpin the economic reform program and are critical in achieving fiscal stability. O f priority is the reform o f public administration and c i v i l service. Given the nature o f the adjustment needed, a two-pronged approach i s being followed: (a) transition from across-the-board retrenchment programs to a more strategic approach that takes into account the functions undertaken by the state and the way in which these functions are provided, and (b) wage system reform to ensure the public sector retains qualified and competent staff. The second component i s the reduction o f the role o f the state in the economy. This goal will be achieved by first o f all improving the government's oversight o f the parastatals and by privatizing government's holdings in commercially-oriented enterprises to enable the private sector to assume the lead role in the economy. Reforms in this area are necessary to achieve fiscal sustainability and limit contingent liabilities from the public sector. They include policies to better exercise the ownership o f the state. The third component i s the improvement o f overall governance. Although the country's overall ratings based o n Transparency International Corruption Perceptions Index are at levels comparable to Greece and Italy, a recent assessment by the United Nations and the IMF's Safeguards Assessment found some important weaknesses. The government i s now addressing these (for details, see paragraph 41, below). 28. T h e government recognizes the need to safeguard the impressive development outcomes that the Seychelles has already achieved; and to ensure that the most vulnerable are protected during the transition. A targeted social safety net has therefore been established. The policies to balance out any short-term adverse '' The first Public Expenditure and Financial Accountability (PEFA) assessment assigned a "D' rating for Seychelles' budget execution patterns. The Bank's 2009 PER identify additional reasons for this outcome. 17 impacts o f the public sector reform program and how to improve delivery o f services in health and education within a sustainable fiscal envelope are discussed in Section C. 29. The government is. committed to gradually reducing the size o f the public administration in line with fiscal consolidation targets. As shown by the PER, the public sector in the Seychelles i s large even by small-state standards (about 40 percent o f total employment), and government involvement in economic activity has crowded out the private sector. In collaboration with the private sector, the authorities have started a retraining initiative, actively seeking to identify jobs where former public sector employees could be hired. O f those employed in the private sector, about 26 percent work in the hotel and restaurant industry, 21 percent in construction, and 16.5 percent in manufacturing. The fishing and financial sectors are currently not significant employers, with 0.9 percent and 2.0 percent o f total employment, respectively. The Seychelles also imports labor, predominantly in the private sector-in the hotel and construction industries and in the tuna-canning factory. Hence, these sectors have considerable capacity to employ local Seychellois. Indeed, private sector employment has increased from 24,000 in April 2008 to 27,000 in April 2009.12 30. Public service reforms initiated in 2008 have already brought about wage-bill savings. As an initial step to curb projected wage-bill growth, a manpower budgeting exercise was conducted at the end o f the first quarter o f 2008. The exercise included a cross-comparison o f payroll and nominal roll data, including a review o f supplements and allowances, self-assessments conducted by public sector organizations, and projected establishments o f new posts. The objective o f the exercise was to reduce the projected wage-bill "overrun" o f SR 17.8 million (3 percent o f the 2008 budgeted wage bill). R Following the exercise, a projected "deficit" o f only S 4 million, or 0.62 percent o f the wage bill, remained.13 In 2009, the manpower budgeting exercise will be replaced with a strategic review o f functions, which the Department o f Public Administration will lead. The review is expected to generate additional savings in 2009 to 201 1. 31. The early retirement and voluntary departure schemes were introduced to bring about a more efficient public sector. The early retirement scheme was introduced at the beginning o f 2008 for civil servants over 55 years o f age and will remain open until December 2009. Those eligible can apply for the scheme, which pays 40 percent o f salary until the official retirement age o f 63 years. The voluntary departure scheme offered a voluntary redundancy payout in two installments, the first at the end o f December 2008 and the second in mid-2009. In total, the early retirement and voluntary departure schemes have reduced the number o f staff members in post by more than the targeted 12.5 percent - the total number o f public sector employees f e l l from 16,615 to 14,075 from April 2008 to April 2009, a reduction o f 15 percent from 2008 levels. A preliminary review by the Department o f Public Administration, estimated potential total wage-bill savings from the early retirement and voluntary departure schemes at R approximately S 100 million for 2009, or approximately 14.7 percent o f the total wage 12 National Bureau o f Statistics employment data. l3 This figure compares to an execution ratio o f 99 percent in 2007 and 110 percent in 2006. 18 bill (2008 budget). The longer-term effect o f the voluntary departure scheme in particular will be higher because part o f the redundancy payout for staff members who accepted the offer in 2008 i s paid from the 2009 budget. Current estimates project the wage bill to fall from 10.2 percent o f GDP to 7.5 percent o f GDP from 2007 to 2009. 32. The government, with the assistance of the Bank, i s developing a framework to achieve the medium-term rationalization objectives so that the Seychelles will be able to modernize its public administration without compromising its quality. This framework includes taking measures to rationalize the structure o f line ministries, outsourcing certain service functions (and stimulating the development o f the private sector to take over those functions), and considering alternative service provision methods. In addition, reforms to the public sector wage system are planned to enhance transparency and to better integrate performance elements in the wage system. Initial reviews o f eight ministries were undertaken from October to December 2008 to (a) identify potential efficiency gains and (b) identify functions that could be transferred to the private sector or to nongovernmental organizations. The methodology and results o f these reviews are documented in the 2009 PER. In a summary report, the Department o f Public Administration highlighted that the government has begun implementing a significant number o f the proposed PER recommendations. Where organizational changes have already been made, staff members have generally taken the voluntary departure option. Table 6 reflects the cumulative effect o f the rationalization efforts so far. Continuing the implementation o f organizational reforms i s important, including effectively changing the status o f organizations that will fall under alternative service delivery arrangements. As noted, although several key changes have been introduced, status changes o f other organizations will require additional time and effort. Table 6: Estimates o f Wage-Bill Savings Measures Savingsfrom voluntary departure scheme (including Savingsfrom Manpower Savingsfrom early the effect o ongoing f budgeting exercise retiremenf rationalization efforts) Year SR million % o wage bill f SR million % o wage bill f SR million % o wage bill f 2008 13.8 2.3 0 -1 1.5 -2.0 2009 0 0 14.4 1.9 86.0 12.8 2010 0 0 14.4 1.9 101.0 15.0 Source: World Bank staff estimates based on 2008 wage-bill levels, Ministry o f Finance data. a. Based on Department o f Public Administration data, received in January 2009, on uptake o f the voluntary departure scheme. 33. I n this context, the government has issued a clear policy document on further public administrationreforms. The Memorandum o f Action Public Administration and Public Sector Reforms outlines the principles o f review o f functions, the rationale for seeking alternative service delivery mechanisms, and the way in which these mechanisms will be managed, as well as what type o f functions will be considered for private provision. In the latter case, this effort relates both to internal service functions (cleaning, cooking, security guard services, and the like) and to service delivery 19 functions. These reforms would ensure the reform process goes beyond a one-time set o f measures and instills a new way o f management in the public sector. It would also allow the Department o f Public Administration and the Ministry o f Finance to manage and track reforms more easily and effectively. 34. Fundamental reforms o f public sector pay are planned. To ensure that the remaining posts in the public sector can attract and retain qualified staff, the government i s developing policies to reform the current system, which lacks transparency in wage setting because multiple allowance schemes are used, such as periodic allowances and public service supplements. A s a result, the wage system i s neither efficient nor transparent. It i s not a competitive wage system that attracts and retains qualified senior staff. In short, these features arise from (a) including a large number o f categories o f staff; (b) setting artificially l o w base-wage levels for senior staff members, usually to give the impression o f egalitarianism; and (c) fragmenting pay composition. Such wage systems typically lack transparency, are costly to administer (because payroll needs to take into account 10 or more components), are open to abuse, and make pay levels unpredictable for staff members. The compression ratio for current real salary levels (lowest paid staff to the average permanent secretary) i s approximately 1:6, which i s at the lower end o f what would constitute an acceptable compression ratio in international comparative terms. The government i s revising the wage grid following a fiscal impact assessment to ensure that this ratio i s feasible in the near future. The current plan i s to redesign the wage grid and other allowances and benefits in 2009. 35. The Seychelles i s taking measures to increase the market orientation of the economy and to support private sector development. Although the Seychelles undertook some reforms in the mid-1990s to increase the market orientation o f the economy, government controls continued to be widespread and parastatals dominated a number o f sectors. The government i s n o w moving in two main areas to reduce the state's role and t o enable the private sector to take the lead in the economy. First, the government i s accelerating i t s privatization program. Second, the government i s taking measures to move from direct controls t o transparent regulation and to improve the business environment. Considerable progress has occurred in privatization o f parastatals, and the government in 2009 will continue executing its privatization program. Although some measures have already been implemented to improve the investment climate, fully achieving this objective i s possible only in the medium term, pending the determination o f key constraints to private sector development. The government has requested assistance, and the Bank in mid-2009 prepared the "Administrative Barriers to Private Sector Development and Business Environment in the Seychelles." 20 Box 1: Former Seychelles Marketing Board An act o f parliament founded the Seychelles Marketing Board (SMB) in 1984 to assure a steady supply o f essential commodities at stable prices. I t s chairman was the president o f Seychelles. Until recently, i t s managing director doubled as the economic advisor to the president. Over the years, the SMB acquired growing monopoly powers and branched into other activities. SMB was a conglomerate with more than 1800 employees and consisted of: Import and distribution o f "essential commodities" under a monopoly concession from the government. The definition o f "essential commodities" encompasses some 48 goods including different categories o f rice, edible oils, sugar, flour, meat and vegetables. Most o f them had not been changed since the mid 1980s. SMB has developed long term relationships with a number o f producers including Unilever, Gillate, Nestld, and Smith Klein. To fulfill i t s mission o f providing secure long term supplies o f essential goods, SMB had priority access to foreign exchange from the central bank. Imports and distribution o f commodities in competition with the private sector, such as imports o f building materials, retail outlets and franchises. SMB's manufactured product lines included consumers goods (liquid long-life milk, h i t juices, h i t yogurt, tomato and other sauces, orange squash, jams and honey, processed meats, broiled chicken, prawns, and tea and coffee products); and producer goods (livestock feeds, shrimp feeds, and day- old chicks). The manufacturing division had six separate units: (1) poultry hatchery (broiler and layer day- old chicks); (2) Animal feed factory; (3) abattoirs (poultry and red meat), (4) Foodpro (processed meat); (5) Agro industries (long-life packaging and bottling); (6) Bois de Rose factory (water, snacks, soap, pasta). In addition the division had a quality assurance supporting unit and a joint venture, Kreolor, that manufactures gold jewelry and crafts) with an Italian entrepreneur. The criteria for deciding to manufacture in the Seychelles through SMB include (1) food security; (2) quality; (3) foreign exchange saving^;'^ (4) value adding; (5) introduction o f new technology in the country; (6) skills that can easily be mastered; and (7) job creation. Exports, in particular export o f prawns. SMB had an agricultural division that produced hydroponic vegetables and flowers and imported and repackaged coffee. It exported some tea. SMB had a management unit, a finance division, a marketing division, and a human resources division and a support services section for the entire group. SMB had two large warehouses with 18 chillers o f different size. Well before the introduction o f the IMF-supported reforms, the government decided to dismantle SMB. As a first step, assets formerly belonging to SMB were transferred to four separate new companies: Coetivy Prawns Limited, Seychelles Agro Industries Limited, Seychelles Hatcheries and Feeds Limited, Seychelles Trading Company Limited (STC). The liabilities o f SMB were absorbed by the government. The second phase o f this process involved the sale or liquidation o f the new entities. Coetivy Prawns Limited was liquidated in November 2008. Seychelles Agro Industries Limited was sold to local investors n in early 2009, whilst Seychelles Hatcheries and Feeds Limited were sold to a farmers' cooperative, also i late 2008. STC has taken over a reduced role in the importation of food, and remains in state hands. l4 If foreign exchange savings were achieved by importing the parts rather than the manufactured product, notwithstanding the Rupee costs associated with manufacturing in the Seychelles, the decision was made to manufacture it locally. 21 36. Governance o f public enterprises i s being improved, and a medium-term plan f o r the sale o f remaining large enterprises i s being developed. The Bank will be supporting the government with analytical work and technical assistance in identifying solutions. Initial reviews found a complex group o f 44 enterprises with varying degrees o f government involvement, exposure, and oversight. The sector has received increasing transfers from the budget in recent years (about 4 percent o f GDP), while dividends back to the government have decreased over the same period. In line with the Bank's recommendations, the government i s adopting a standardized approach to governance and accountability relations. This would mean one body for agency-type institutions (regulatory and inspection functions), one for non-commercial state enterprises, one for commercial state enterprises with over 50 percent government ownership, and one for commercial state enterprises where the government has a minority shareholding, until government shares in these enterprises were divested. These reforms would significantly reduce government exposure to risks and contingent liabilities and facilitate a more systematic approach to reforming the sector. The government plans to establish this framework by mid-2009. Audits now being carried out o n the largest f i r m s including those o f several state-owned enterprises that will strengthen the Ministry o f Finance's ability to address concerns. 37. The privatization o f parastatals and publicly-owned banks accelerated in 2007 and 2008. The government initially started transferring public assets to the private sector in 2005 with the sale o f State Assurance Corporation o f Seychelles in June 2006 to a strategic investor and to the public. In 2007, the Government began a public information campaign and made efforts to build consensus for privatizing large public enterprises. Current government plans give priority to those state-owned enterprises that have a distortionary effect on the economy and those that are causing a net fiscal drain. One such parastatal is the former Seychelles Marketing Board (SMB), a state trading conglomerate and supplier o f basic consumer goods, which was restructured in March 2008 by discontinuing some o f the operations and separating the rest o f the activities into separate entities. Eight profitable business units o f the former SMB were privatized and all loss-making units were liquidated in 2008. The government still owns the Seychelles Trading Company, which operates eight business units on fully commercial basis. The government i s committed to privatizing these units in 2009. 38. The Seychelles has made significant progress on governance-related matters in 2008 and in early 2009. In August 2008, the government adopted the Public Officers Ethics Act, which provides for a code o f conduct and ethics for all civil servants, requiring financial declarations and prohibiting conflicts o f interest. In November, the president and each member o f the cabinet signed and submitted declarations o f their assets to the ethics commission as required by the newly enacted law. Based on Bank advice, the government prepared the Public Procurement Act modeled on the COMESA standard, which is a major reform supported by this operation. Parliament approved the act in December 2008. The law standardizes procurement procedures within the government by modernizing and harmonizing regulations and procedures. Transparency, competitiveness, and efficiency have been enhanced, and tender procedures now ensure 22 competitive bidding through strict and uniform requirements regarding minimum number o f bidders and public disclosure o f all bills. In December 2008, a new Public Debt A c t established procedures and defined roles and responsibilities o f agencies involved in debt contracting and management. The law authorizes the Ministry o f Finance as the only body to contract debt. The deficiency in the previous law contributed to building debt to unsustainable levels. C. Social Sectors and Social Protection Policies 39. A key reform objective o f the government in the health and education sectors i s improving efficiency without undermining the achievements o f the past. Reviews undertaken by government agencies and the Bank's PER show considerable potential to improve efficiency in both health and education. This improvement can be achieved by reducing spending o n service delivery areas that are underused and by reducing expenditures on cash transfers that are not well targeted. However, achieving expenditure savings within the sector would not automatically imply a reduction in overall sector spending because a healthy and well-educated labor force i s critical for long-run growth. The authorities are aware that low value for money o f investments in these sectors, particularly in education, must be addressed for the Seychelles to develop and achieve its developmental aspirations. The government i s planning, therefore, to invest any savings beyond the wage bill savings generated by reforms in improving outcomes in both o f these sectors. 40. Reforms are being introduced to substantially reduce the health sector wage bill by identifying and releasing staff members in areas o f low productivity. H a l f o f government health spending is for wages and salaries, which i s high, especially considering that expensive tertiary-level care (with highly paid medical staff) i s not provided in the country. The number o f health sector employees has been increasing, as has the share o f ancillary staff members (which i s also high compared to other countries). Additionally, average monthly incomes for public workers in the health sector are high compared with those o f workers in the rest o f the public sector. In some cases, the medical staff i s not working at full capacity; for example, physicians in public hospitals see on average four hospitalized patients per week. The government i s planning to both (a) contract out core services and (b) reduce staff in unproductive positions. Preliminary analysis conducted for the PER suggests staff reductions could reduce the health sector wage bill by almost SR 13 million per year, reflecting 6.4 percent o f 2007 total government health spending. 41. Low use rates, comparable to European levels, characterize the health sector, and new measures are being adopted to rationalize facilities. The share o f the total health budget spent o n hospital care (46 percent) i s very high, especially when compared with that o f European countries with more sophisticated hospital care. The Seychelles has an oversupply o f health care facilities and more hospitals and beds per capita than other middle-income countries. I t has more hospital beds than needed, as evidenced by extremely l o w occupancy rates in hospitals o f f M h Island and in wards within the main ae hospital in Victoria. T o increase the average acute care occupancy rate in hospitals to 80 percent, the government i s advised to close about 50 beds initially. In addition, the 23 government plans to contract specialized secondary and tertiary care in the country, including open heart surgery, renal transplantation, hemodialysis, and cosmetic surgery, thereby reducing spending on overseas treatment. The Ministry o f Health and the Department o f Public Administration are undertaking a review o f facilities and staffing needed. 42. Reforms in education aim to reallocate resources to generate savings that will be used to improve quality and results without cutting the overall spending envelope. Recent reviews o f the education sector have raised concerns about quality and examination results. Many candidates do not pass and are particularly unsuccessful in mathematics. Given the relatively modest-and recently declining-government expenditures on education, government spending on education will not be cut. Instead, expenditure improvements will be largely reinvested in sector reforms aimed at increasing quality o f education and education outcomes. As i s typical, public education spending i s principally on personal emoluments for school-based staff members. This area i s also where there is the most potential to improve efficiency o f spending by removing unproductive posts. Strategic staffing reductions will be introduced, and core and non-core services will be contracted out. The government has already reduced office staff in the Ministry o f Education, and by contracting out school cleaning and meal provision, it has been able to reach the target o f a 12.5 percent reduction o f the wage bill. Savings generated from these reforms will be spent on measures to improve the quality o f education, and the Ministry o f Education will focus on results. I t i s in the process o f developing a new strategy. 43. A well-targeted social safety net i s replacing the costly and inefficient direct and indirect product subsidies. Over the past 20 years, the government has provided a generous and broad-based social safety net through universal subsidies that proved to be inefficient. Such subsidies also have been a disincentive to sustainable employment in the private sector. Because the initial effects o f reforms and exchange rate adjustment resulted in higher prices, real incomes are expected to decline on a one-time basis. To protect the poor, the government has designed a new, targeted social protection system. A new Social Welfare Agency A c t was enacted in October 2008, and the government has R issued the eligibility criteria. It will provide about S 1,300 per month, or about US$3.40 per day per single individual. For households with children, a formula-based system is being used. The approach i s to protect the most vulnerable with monetary assistance and to go beyond financial transfers to also provide assistance in the form o f incentive-to-work schemes. The agency i s already assisting people who l e f t the public sector. Applicants receive a response within ten days. 4. BANK SUPPPORT TO THE GOVERNMENT'S PROGRAM A. Linkages to the Interim Country Assistance Strategy 44. The proposed DPL i s a key component o f the two-year Interim Strategy Note that covers the World Bank's program in the Seychelles for fiscal 2009-11. The Interim Strategy Note aims to support the government's macroeconomic stabilization program in the short run and to initiate the structural reform process in line with the 24 Seychelles longer-term economic recovery strategy. The proposed D P L i s fully consistent with this objective and is the first Bank lending operation after 2002, when the Seychelles fell to suspension status because o f payment arrears to the International Bank for Reconstruction and Development (IBRD). All payment arrears were cleared in October 2006. By initiating policy dialogue on main reform issues, the D P L will contribute to development o f a longer-term World Bank engagement, perhaps through a four-year Country Assistance Strategy. B. Collaborationwith the IMF and Other Donors 45. The World Bank has been working very closely with the IMF. A Joint Management Action Plan guides the joint collaboration o f the Bank and the IMF and seeks to prevent duplication o f efforts, but it also points to the Bank's independent view o f macroeconomic and fiscal policy issues emerging from i t s own analytic work. Evidence o f successful IMF program reviews will be used to judge and determine developments in the reform program. The Bank has been participating in IMF missions, and close cooperation exists at all levels o f the two institutions. A joint World Bank IMF mission will take place at the end o f October 2009 as the intension i s to put in place a three year Extended Fund Facility program in late 2009. 46. A number of donors operate in the Seychelles, and they have capacity- building programs. Because o f the external debt arrears situation, the European Union (EU) engagement has been limited. The only EU member states with a diplomatic presence in the Seychelles are France and the United Kingdom. The French government cooperates in the environmental, educational, and cultural fields and provides long-term technical assistance, particularly in the fisheries sector. The Seychelles signed a regional cooperation agreement with Reunion Island (France) that will allow sharing o f a wide range o f technical expertise in areas such as health, training, environment, and natural disaster management. UmeA University in Sweden has signed a memorandum o f understanding with the Seychelles to enable students, teachers, and in-service personnel from the Seychelles to benefit from studies and training in Sweden, while Germany, Greece, the Netherlands, and Spain have been providing scholarships to Seychelles citizens. Other donors are involved in grants and soft loans in housing finance. The Bank team has had discussions with the EU representatives in the Seychelles and briefed them about the DPL. China has a number o f capacity-building programs. A fisheries agreement with China was signed in June 2006. India has had longstanding technical and financial cooperation with the Seychelles, and the Seychelles has a number o f scholarships and exchanges with Indian universities. Through the Pan African Network System, India i s establishing a satellite terminal station to facilitate telemedicine. Cuba and Nigeria have bilateral cooperation agreements, and Australia and Japan provided assistance in the context o f the 2004 tsunami. There has been an increase in Australian technical assistance provided in the last few months in support o f the economic reform program. 47. The African Development Bank (AfDB) i s an important partner. The AfDB approved a 1 5 million economic governance reform program loan, signed into effect on August 25, 2009. The AfDB began operating in Seychelles in 1978 and has since 25 approved 19 operations comprising 14 projects, one study, three lines o f credit, and one emergency assistance operation, amounting to 85.6 million units o f a c c o ~ n t . ' ~N o approvals occurred between 2001 and November 2006, when the country was under sanctions, except for an emergency assistance operation worth US$500,000 that was granted in January 2005 to deal with the tsunami. Cumulative approvals net o f cancellations as at March 13, 2008, amounted to unit o f account 65.23 million, o f which 67 percent was from the AfDB window, 16 percent from the Nigeria Trust Fund window, and the remaining 14 percent from the African Development Fund window. The D P L team has been working closely with the AfDB, and there i s discussion o f developing a joint reform program. C. Lessons Learned 48. This first DPL benefits from the lessons captured by past evaluations of the Bank's development policy lending experience by its International Evaluation Group. In particular, (a) multi-tranching contributes to slow program implementation, particularly if it makes the operation overly complex; (b) classic ex-post conditionality weakens reform ownership; and (c) rapidly changing policy environments are difficult to anticipate in loan design. These lessons, as well as the latest thinking on DPLs for well- performing middle-income countries, have influenced the design o f this operation. Hence, particular attention has been paid to two main factors. The first is up-front action instead o f ex-post conditionality. This D P L i s based on prior actions, and the government has demonstrated its commitment to reform by fulfilling policy reforms supported by this operation. The second i s the provision o f support to a reform program instead o f specific conditionality. This D P L supports the government's reform program that was presented to parliament for the 2008 and 2009 budgets. 49. Useful lessons also arise from the AfDB Group interventions in the country. Although operations, particularly in the social sectors, had made important contributions in helping the government to achieve the impressive results registered in education and health, a 1998 Country Portfolio Review revealed that macroeconomic imbalances adversely affected the AfDB's operations in the country, mainly because o f the shortage o f foreign exchange. As a result, some AfDB-financed projects had difficulties obtaining imported inputs. Moreover, some projects incurred cost overruns because o f delays in obtaining foreign exchange approvals from the central bank. The major lesson emerging from this experience i s that a stable macroeconomic environment i s crucial for the success o f project implementation. In addition, the review highlighted the problem o f the country's. capacity to timely execute projects. Several projects had been adversely affected by the shortage o f adequately trained personnel in the country. Another issue was the need for better coordination o f AfDB projects among the Ministry o f Foreign Affairs, technical line ministries, and executing agencies, which was further compounded by the shared oversight responsibility for AfDB projects between the ministries o f foreign affairs and finance. IS Unit o f account 1 = US$1.51678as at January 5, 2005. 26 Box 2: Good Practice Principles on Conditionality Principle 1: Reinforce ownership The proposed operation i s based o n the Government's aspirations t o resolve the unsustainable macroeconomic imbalances o f the 1990s and create an environment for a private sector led economy. Moreover, the president's consultation campaign being carried out throughout the country demonstrates clear commitment o f the Government t o the reforms. The successful implementation o f the IMF-supported Stand-By Arrangement and interest o f the government in a follow-on program under the Extended Fund Facility i s h r t h e r evidence o f commitment t o the reform agenda. Principle 2: Agree upfront with the government and other financial partners on a coordinated accountability framework The D P L program is summarized in an agreed policy matrix in annex 2 . The matrix contains both policy actions and indicators o f expected outcomes. The Ministry o f Finance i s responsible for monitoring progress with the agreed reform program and for coordinating the actions o f the other agencies and ministries involved. The Bank consults regularly with other development partners in the Seychelles to ensure that aid is as effective as possible. Principle 3: Customize the accountability framework and modalities o f Bank support to country circumstances The accountability framework is based o n the 2009 Bank Public Expenditure Review, a report by IMF's Fiscal Affairs Department o n budget management, and the I M F ' s staff reports related t o the Stand-By Arrangement, and the central bank's safeguards assessment. The accountability framework has also been influenced by the 2008 PEFA assessment. Principle 4: Choose only actions critical for achieving results as conditions for disbursement The proposed DPL operation contains only six agreed prior actions and 8 milestones. All are focused o n achieving critical improvements in fiscal management and policy. Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial support Progress reviews o f the policy actions in specific areas and o f the operation as a whole are held regularly with government officials from ministries and agencies participating in the project. These reviews allow the Bank t o update the matrix o n the basis o f actual and expected performance and t o communicate to the government what i s essential t o enable the approval o f the operation. As a one-off single tranche operation, there will be a review o f performance presented in the Implementation Completion and Results Report. Monitoring indicators and outcomes were discussed and agreed with the government and draw o n the government's o w n monitoring and evaluation efforts. D. Analytical Underpinnings 50. A number o f recently produced studies supported this operation. The Bank prepared an initial PER in 2009 on the basis o f fieldwork in 2008 and 2009. The Bank also benefited from the EU-funded PEFA assessment which was prepared in 2008. The Bank produced a policy note "Administrative Barriers to Private Sector Development and Business Environment in the Seychelles" in 2009. This updated the 2006 Investment Climate Review prepared by the Foreign Investment Advisory Service. The Cabinet has endorsed the document and a high level task force has been established to ensure the implementation o f the recommendations o f the policy note. The Bank team also benefited from the IMF's work, including staff reports related to the Stand-By Arrangement, the first and second reviews o f the arrangement, the central bank's safeguards assessment, and a report by IMF's Fiscal Affairs Department on budget 27 management. The Bank and Fund staffs have regularly updated debt sustainability analyses during 2008 and 2009 as the debt situation evolved. 5. PROPOSED OPERATION A. Description of the Operation 5 1. The proposed DPL i s a one-tranche operation supporting the implementation of the initial phase o f the Seychelles government's comprehensive stabilization and structural reform program. This loan i s conceived as a one-time operation, based on passage and implementation o f fiscal stabilization and public financial management reforms that will achieve substantial measurable outcomes by the end o f 2009. It i s also designed to facilitate policy dialogue with the Seychelles authorities and establish a framework that may eventually be followed up by future DPLs under a programmatic framework. The borrower would be the Government o f the Seychelles, and the total proposed amount o f the loan is US$9.0 million equivalent, to be made available when the loan becomes effective. B. Objectives, Themes, and Policy Areas 52. The objective of the proposed operation i s to help the Seychelles establish a stable macroeconomic environment and sustainable fiscal framework. This will be achieved through fiscal adjustment underpinned by public administration and civil service reforms and a reduction o f the role o f the state in commercial activities. The operation also supports establishment o f a targeted social safety net. By providing foreign exchange in a timely manner, the operation will directly contribute to stabilization o f the economy during a period o f global slowdown and will help in building public support for the reform process. These measures are integral to ensuring sustainable private sector employment and broad-based growth in the Seychelles. Table 7 presents the specific measures undertaken as prior actions for presenting the DPL to the IBRD Board o f Directors. Annex 2 presents the development policy loan matrix with expected operation outcomes. Table 7: DPL supported policy actions Policy objectives Policy action Strengthen budget management The Borrower has adopted the Government Finance Statistics classification for preparing the budget and for monitoring budget performance, thereby enhancing the credibility of budget execution Ministry o f Finance established binding ministerial expenditure ceilings to prepare the budget, starting in 2008. 0 Fiscal monitoring reports issued quarterly startine in 2008. 28 Improve governance and accountability of public 0 The Borrower has enacted the Public procurement Procurement Act, 2008, modernizing and harmonizing procurement regulations and procedures, enhancing transparency, competitiveness and efficiency, and introducing strict and uniform requirements governing competitive bidding procedures. 0 National Tender Board established January 29,2009. Create amore efficient civil service and public 0 The Borrower has through a combination administration o f early departure and voluntary retirement schemes met the 12.5 percent target for reducing employment in the public sector. 0 The Borrower has secured cabinet approval o f the Memorandum o f Action on Public Administration and Public Sector Reform Policies, the objective o f which is t o b r i n g about a modern and efficient administration, consolidate public sector reforms and roll-back the role o f the government in commercial activities. Establish a well-targeted social safety net 0 The Borrower has enacted the Social Welfare Agency A c t 2008, introducing a simple and effective program to provide targeted cash assistance to vulnerable segments o f the population, and establishing the Social Welfare Agency to administer the program. 0 Simple and effective targeting mechanism in use starting in 2008 to provide assistance to those who lost their jobs and other vulnerable people. Reduce the role of the state in commercial areas of the 0 The Borrower has restructured the economy Seychelles M a r k e t i n g Board, discontinuing some of i t s operations and separating the rest to be managed as separate units, privatizing the profitable business units and liquidating the loss- making ones. 0 Eight profitable business units of the former n SMB privatized i 2008. 0 All loss making units of the former SMB liquidated in 2008. Subsidies to public enterprises reduced. 53. The measures supported in this operation represent important steps toward achieving the medium-term program objectives that the government has defined for itself. These are summarized in the Statement o f Development Policies submitted to the Bank in support o f this DPL and are explained in more detail in the government's economic policy frameworks and policy submissions to parliament in support o f the 2008 and 2009 budgets. Policy reforms supported by this D P L are expected to contribute to 29 achieving macroeconomic stabilization in the short run by ensuring that fiscal policies are consistent with the IMF program. Additional measures are likely to be needed to reach those objectives over the medium term, and obtaining debt relief from the private creditors at similar terms to the recent Paris Club deal will be critical for debt sustainability. In the near term, success o f the reforms supported by this loan will be evaluated o n the basis o f outcomes measurable at the end o f 2009 and 2010. 54. Strengthening budget management involves introducing principles of sound fiscal management and bringing fiscal budgeting and accounting in line with international best practices. The Government faces a number o f challenges, namely: (i) strengthening adherence to the existing legislative requirements within a traditionally weak financial management framework; and (ii)improving budget management practices. To date the government has strengthened budget credibility by adopting standard Government Finance Statistics (GFS) classification for preparing and monitoring budget performance. Timely, quarterly reports are now being prepared t o allow the government to monitor budgetary outcomes and ensure consistency with the macroeconomic framework. Nascent macroeconomic modeling has started with a team from the Ministry o f Finance, the Revenue Commission and the central bank. 55. Further work i s planned to improve consolidation o f extra-budgetary funds with the Social Security Fund expected to be brought into the 2010 budget. Next steps also include better coordination between capital budget plans and recurrent cost implications. In budget execution progress has been made with improved cash management and the setting up o f a Treasury Single Account. Anticipated results from improved public financial management are achieving the primary fiscal surpluses set out in the Government's reform program, consistent with improving the macroeconomic stability and debt sustainability objectives. 56. I n the area o f public administration and civil service reform, the government's objective i s to bring about a modern and efficient administration without undermining the capabilities of the state and without causing sharp increases in the overall unemployment situation. To improve efficiency in the public sector, the government has implemented several programs to deal with excess staff such as the voluntary departure and early retirement schemes. These programs have already achieved 12.5 percent targeted public service staff reductions. Non-core state functions such as provision o f school cleaning and maintenance services have already been outsourced to the private sector and standard bidding documents to roll-out the contracting-out approach have been developed. The government has undertaken a review o f core State functions, and as per the prior policy action approved an action plan for implementing the results o f these functional reviews. 57. Next steps include contracting out all cleaning and security services and school meal provision in 2010. There have also been on-going reform efforts to develop a revised wage grid. This would ensure greater transparency in public sector wages and result in a compression ratio consistent with attracting and retaining qualified staff at senior levels o f the civil service. The government has developed several active-labor market policies aimed at assisting former public sector workers with retraining and 30 redeployment in the private sector, especially the tourism sector. T o date 115 people have applied and 85 attended such training courses. Policy reforms launched to date are expected to lead to rapid growth o f the private sector and hence employment opportunities for those who have left the public sector. To date an additional 3,000 jobs in the private sector have been registered in April 2009 over April 2008. 58. The privatization program aims at reducing government's contingent liabilities, rolling back the State from commercial activities and increasing the role o f the private sector to lead economic growth. To date reforms have largely centered around improving governance and monitoring o f the public enterprise sector through more effective oversight mechanisms and effective Board membership. The principle o f removing the State from commercial activity i s accepted, and to this end the government has restructured the Seychelles Marketing Board into 16 commercial units. Eight commercially viable units have already been sold, and all non-viable units have been liquidated. The remaining units have been combined in an umbrella company s t i l l with government ownership called Seychelles Trading Corporation. Since the beginning o f 2009 STC has been successfully, commercially managed without government subsidy. 59. M o r e broadly, the government i s developing a strategy for dealing with the public enterprise sector including commercial and regulatory bodies in which government has full o r partial ownership. The Public Enterprise Monitoring Unit has already been established and has developed a strategic plan. The next steps for SMB/STC are to transfer the remaining commercial entities o f STC to the private sector. The government proposes to assess the effectiveness o f the public enterprise reform program by measuring the size o f the private sector in GDP; and the reduction in subventions to the broader public sector. Furthermore, the elimination o f subsidies and privileges to the government-owned commercial interests was creating a distortion and hampering private sector activity. The reduction o f government subsidies has helped to level the playing field for the private sector. Anticipated results are a more vibrant private sector as indicated by the private sector contribution to GDP referred to above. 60. I n the social protection area, the government has already established a new Social Welfare Agency, which has been fully operational since January 2009. From an initial 900 households receiving welfare payments, there are as o f June 2009 3150 households receiving the targeted cash assistance. Already, the Agency has developed robust verification systems to check claimant's information and has access to a variety o f other government department databases for validation purposes. The Agency adopted a formula-based means test that is simple and transparent. The average household on R welfare i s receiving S 1,300 per month. Next steps are to review the efficiency and effectiveness o f the new welfare program. While the impressive ability to verify claimant's information gives policy-makers little concern that there are fraudulent cases, there i s some concern to ensure that all eligible households are indeed receiving their entitlements. The World Bank under the second PER i s proposing to assist with this analytical work. 61. The government i s committed to implementing the next steps in the reforms o f the policy areas supported by the DPL. Maintaining momentum on reforms in four 31 key policy areas would be important: (a) public financial management; (b) public administration; (c) public enterprise reform and privatization and (d) administrative barriers that hamper the investment climate. 62. All these policy areas are under consideration by the government who are planning next steps in the reforms, and are areas where both the World Bank and the IMF have planned to provide analytical support. In public financial management, the necessary next steps are based on analysis developed by the IMF's Fiscal Affairs Department and include strengthening the process by which the sector ceilings are developed based on existing and new policies, rather than current year's actual spending. In public administration reform, implementation o f the Memorandum o f Action will be key, including the important step o f contracting out non-core government functions. In public enterprise reform, steps continue to be taken to strengthen the governance and monitoring o f the government's state-owned enterprises and parastatals and further work 1 to assist the authorities i s planned under the Public Expenditure Review 1 . Furthermore, the PER I1 is also expected to assist with a review o f the effectiveness o f the new social protection system to ensure that all eligible households are receiving support. N e w policies targeting improvements in the business climate are also needed and are on the government's radar. World Bank and Foreign Investment Advisory Service (FIAS) advice on next steps i s planned for October 2009. 6. OPERATION IMPLEMENTATION A. Poverty and Social Impact 63. The impact on real incomes and hence household consumption are likely to be negative in the very short run, although the stabilization o f the Rupee and rapidly falling inflation has begun to mitigate such effects. Real wages have fallen between October 2008 and June 2009 due to high inflation caused by the devaluation, and as households cope with the immediate foreign exchange adjustment resulting in higher food costs. As noted this impact has been a one-time adjustment because households initially have Rupee-denominated incomes and predominantly import-related expenditures. The appreciation o f the Rupee since April 2009 and the fall in inflation to single digits during 2009 are both indications that the initial impact o f the reforms is now behind the Seychellois. C i v i l society members and other development partners attending the Seychelles Forum held in May 2009 welcomed this development. Official data however do show that there has been an increase in the number o f private sector jobs from 24,000 to 27,000 between April 2008 and April 2009. 64. The welfare impact on households in the near term i s being mitigated with a well-targeted social safety net, government assistance to place the unemployed, and retraining. A s previously noted, the government has designed a new means-tested welfare system to mitigate the impact o f the reforms o n the poorest. Social security contributions will continue to fund statutory benefit schemes detailed in the Social Security Act. About h a l f o f the former staff o f the public service has found new employment. The government i s actively involved in placing people, and a task force headed by the Minister o f Employment and including the principal secretary o f the 32 Ministry o f Employment, the principal secretary o f the Department o f Public Administration, and the chief executive officer o f the National Human Resources Development Council reports to the cabinet weekly and briefs the minister o f employment about the employment situation. The Ministry o f Employment i s coordinating this work. It has contacted most o f the people who became unemployed and explained h o w they may apply to the new welfare agency. Along with the National Human Resources Development Council, the ministry is coordinating the retraining program currently run by the Seychelles Institute o f Management and the Seychelles Tourism Academy. As o f the end o f M a y 2009, the program had more than 250 trainees. The ministry i s also planning to work with the Seychelles Investment Bureau to train people for attracting foreign investments and for the financial services industry. 65. The most recent draft report on the household income/expenditure survey for 2007 indicate that less than 1 percent of the population lives on less than US$2 per day and less than 7 percent live on less than US$3.5 per day. However, when using the national thresholds for the share o f population able to afford a balanced diet or the national food poverty line, the 2007 household budget survey shows that 18 percent o f the population i s estimated to be living below the national food poverty line o f SR 38.9 per adult per day. This estimate i s roughly equivalent to US$6.00 per day. When factoring food and non-food basics (including shelter and non-replaceable utilities) into what i s called the national basic needs poverty line, the survey shows that an adult needed SR 50 per day or around US$7.5 per day. These are very high thresholds for international standards. The latest poverty assessment done on Seychelles, the 1994 World Bank report entitled "Poverty in Paradise" (Report No. 12423 SEY), characterized the poor in four groups: (a) single women-headed households, (b) households headed by a school drop-out; (c) households headed by people without marketable skills, and (d) households headed by retired people on limited pensions. The distribution o f income i s also unequal with a Gini Coefficient o f 0.40 in 2007, roughly similar to Mauritius and Ghana, both with Gini o f 0.39. The Gini, however, has declined overtime from 0.47 in 1984. The government may consider a new household survey with support from the World Bank given the new price structure and evolving earnings situation. Findings are expected to be compiled in an updated poverty assessment report which will allow the authorities to better assess the impact o f reforms and contribute to possible improvements to the social-safety net. 66. Although the downturn in economic growth and civil service reform are likely to affect employment, one of the positive features of the current situation i s the very low rate of unemployment in the country. The total number o f employees in the formal sector increased by 5.2 percent from 2006 to 2007, and by a further 3.7 percent in the first quarter o f 2008. Employment increased in the private, parastatal, and government sectors from 2006 to 2007 but f e l l in government and parastatal sectors during the first quarter o f 2008. Although the private sector accounts for about two thirds o f GDP, it employs only 59 percent o f employees; 15 percent are in the parastatal sector and 27 percent in the government. The labor force profile in the private sector also includes a large number o f non-Seychellois, which could adjust to absorb increased Seychellois participation. Stimulating private sector employment i s one o f the dimensions covered in the Bank's investment climate work. 33 B. EnvironmentalAspects 67. Policy actions supported by this D P L are not expected to have significant impacts the environment, forests, or other natural resources. C. Implementation, Monitoring, and Evaluation 68. Executing agency. The Ministry o f Finance i s the executing agency. Other line agencies and decentralized institutions will support the ministry. The Ministry o f Finance and the Bank have agreed to monitor progress in the program supported by the D P L in the context o f the Implementation Completion Report for this loan and preparations o f a new country assistance strategy (programmed for fiscal 2012). The Ministry o f Finance i s charged with collecting from the appropriate sources the data necessary to assess implementation progress. Reviews by the Ministry o f Finance and the Bank team will aim to identify the main strengths and weaknesses o f the reform program, to identify possible assistance needs to sustain the forward momentum toward the government's planned medium-term outcomes, and to address possible downside risks. 69. Monitoring and evaluation. Bank staff has regularly monitored implementation o f the policy reform program laid out in table 7. Country capacity for monitoring i s strengthened through a grant from the Bank-managed Statistical Capacity Building Trust Fund. An implementation completion report will be issued within six months following the closing date o f the operation. D. Fiduciary Aspects 70. The government i s addressing identified fiduciary issues. A s noted earlier, the Bank has recently prepared a PER, and a PEFA assessment has been supported by the EU. The IMF has prepared a safeguards report and considered the adequacy o f central bank's financial management practices. The report found a number o f deficiencies pointing to risks in the central bank's safeguards framework. The authorities have already taken remedial measures with respect to some o f the issues raised by the IMF. These measures included signing a new contract with external auditors in 2008 and bringing accounts in compliance with international accounting standards. The Ministry o f Finance and the Central Bank o f Seychelles signed a memorandum o f understanding in December 2008 to strengthen and formalize the terms and conditions under which the central bank transacts o n behalf o f the government. The government will be implementing measures to deal with the rest o f the deficiencies identified in the safeguards assessment during 2009. The new Central Bank o f Seychelles Act was approved by the National Assembly April 28, 2009 and came into effect in early May. The new financial institutions law was signed by the President on July 9, 2009. This was a condition for completion o f the first Stand-By Arrangement review. A s noted already, the Seychelles enacted a modern procurement law in December 2008, which was a structural benchmark under the IMF standby program. 34 E. Disbursement and Auditing 71. The Bank would make the single loan disbursement to a Designated Account in the Central Bank of Seychelles denominated in Euros. The central bank will credit the Seychelles Rupee equivalent amount to the Ministry of Finance's Treasury Single Account. The Treasury Single Account centralizes government expenditures and revenues for financing o f public spending. Upon its deposit the D P L disbursement will become available to finance budgeted expenditures. The funds will be audited to confirm that they have been received into the Treasury Single Account. The audit will be undertaken by an independent auditor using international auditing standards. The audit report will be submitted to the Bank as soon as available but no later than four months after the date o f the Bank's request for the audit through a letter submitted to the Minister o f Finance. F. Risks and Risk Mitigation 72. External shock vulnerability and the global economic slowdown continue to threaten macroeconomic performance, which may delay the reform program should Government waiver in putting in place a program that can be supported with international financial assistance. The global economic slowdown could be worse than anticipated, with adverse effects on tourism, growth prospects, and-to a lesser extent- solvency o f the banking sector. External financing availability may prove more difficult to mobilize than has been anticipated, and the global financial turbulence may increase the risk o f protracted discussions with private creditors, thus compromising IMF, AmB, and IBRD program financing and debt sustainability (Annex 5). Moreover Paris Club creditors have made the full implementation o f their o w n treatment conditional on the respect o f the comparability o f treatment with non Paris Club creditors. The risk to the stabilization and reform program i s limited in the proposed operation by the focus on fiscal and public sector reforms, where the main policy actions have already been implemented and reform reversal risk i s minimal. The measures supported by the operation help achieve fiscal sustainability, including external debt sustainability. The authorities have shown strong commitment to implementing the stabilization program, as demonstrated by the up-front measures already taken and measures outlined in the president's 2009 budget speech. Meanwhile, the risks o f debt unsustainability related to delays or unsatisfactory negotiations with non Paris Club creditors are addressed through the ongoing efforts o f the authorities to secure debt restructurings with their external creditors and progress already made with some non Paris Club creditors. The two DPLs envisaged under the Interim Strategy Note are linked to the IMF quarterly and yearly reviews and the second D P L will also require evidence o f an agreement with private creditors, including bondholders, on a debt restructuring program. This will also provide some assurances o f program commitment and debt sustainability before extending further IBRD financing. 73. Erosion o f political support and delayed policy reforms caused by social dissatisfaction may occur. The government's stabilization program supported by the IMF will adversely affect some groups and may result in social tensions if not managed carefully. Although the government has made a major effort to inform the public about 35 the necessity and possible effects o f reforms, delayed positive outcomes may affect the process o f transforming the economy o f the Seychelles. In particular, policy reforms may halt or even reverse, leading to slower economic recovery and failure to lift the reform `process beyond the first year and into the medium term. The government i s addressing potential income disparities and intends to target the most vulnerable populations through a social safety net, a comprehensive communications strategy, and interventions in key islands and communities. In parallel, the government i s taking complementary measures to remove constraints to private sector growth and employment, which are critical to mitigating social tensions. The Bank will assist the government with technical capacity on the design o f a medium-term economic reform program to ensure greater inter- ministerial coordination on the reform program as well as support private sector development from the overall World Bank Group. 74. Associated with the first two risks, i s the possibility o f external arrears building up once again if the macroeconomic program goes off-track. The Bank i s engaging with Seychelles only now that a determined reform effort over the last 12 months has been implemented, which through fiscal consolidation has improved the debt sustainability outlook considerably. After four years in suspension status, Seychelles repaid both loans to the IBRD in full and currently has no outstanding obligations to IBRD. Seychelles went into non-accrual status in August 2002 for violating the negative pledge clause and not meeting its debt payment obligations to IBRD. Seychelles cleared all payment arrears (US$770,000) in October 2006. Seychelles subsequently prepaid in full i t s small outstanding balance to IBRD and cleared remaining issues with the negative pledge clause. Mitigation measures include working very closely with other development partners who are supporting .the reform efforts such as the IMF, the European Commission and the AfDB. This enables active supervision and monitoring o f the reform efforts and ensures a consistent message to the authorities to assist them in staying on track with the reform program. Timely, and predictable financial support through adjustment operations will also assist the authorities manage the challenges o f an adverse external environment; and at the same time a possible second IBRD D P L will only be prepared following progress with debt restructuring negotiations with non-Paris Club bilateral and private creditors. 75, Fiduciary risks could delay program implementation. There are several weaknesses in the fiduciary framework that are being addressed. Given the lack o f Bank engagement for many years, analysis o f the country's public financial management i s planned to take place during the implementation o f the Interim Strategy Note 2009-1 1. A financial management assessment in 2008 concluded that capacity constraints faced by the internal audit department related to insufficient staff in the Ministry o f Finance to monitor compliance with internal control systems and procedures in ministries. The Auditor General's Office also faces staffing constraints in conducting project audits; and does not have the legal mandate to audit all government institutions. The IMF's most recent safeguards assessment o f the Central Bank o f Seychelles, also found some weaknesses o f accounting and auditing and these risks are being mitigated with technical support o f the IMF. The first and second review o f the IMF's Standby Arrangement has shown that the central bank has made good progress toward dealing with the deficiencies identified earlier. 36 76. Finally, piracy activities in Seychelles territorial waters may require additional fiscal resources, and may lower economic growth prospects. During the second quarter o f 2009 there was a threat o f piracy attacks o n tuna fishing vessels and the Government has had to request a supplementary budgetary allocation from the Parliament to support the operations o f its coast guard. While such expenses are not yet likely to undermine fiscal adjustment efforts o f the government piracy attacks may have an impact o n export revenues. The Government has n o w negotiated assistance programs from a number o f countries (including the United States and France) who are providing personnel and equipment to bolster the resources o f the Seychelles coast guard. 37 The President STATE HOUSE, VICTORIA, MAHE REPUBLIC OF SEYCHELLES I6* September 2009 I I In mid 2008. the global slowdown and knock-oncffccts o f the sharp food and fuel price increases o f ZOO? k d cmly 2008 brought longstanding wlnembilities in Seychelles to a head. Although wc had sought to gradually address imbalances from the 199Os, o w cfforts were insufficient: reliance an external b o n ~ w i n gto fvnd infiastnrcture investments progressively weakened public finances; govcmment intervention in key sectors limited #e adjwtment o f tlie ccorvomy to new global conditions; foreign exchange restrictions only accelerated our loss of competitiveness and capital flight. With reserves n w rock bottom, arrears spreading across all categories of creditors, and financing impossible to abtilin. we launched a truly dramatic refom program. On 33 October I announced the reforms in an address to the nation, on 1 Novlembx we allowed the cwrency to flea W l y (it losa half its value in the day), and in November and December we reduced ow public sector workforce by 17%. We also cut subsidies to our bloated state enterprises, and instead began providing targeted subsidies to those who needed help afttr the devOI1ua~ion most. the 2. Our rcforms have achieved broad based support. As we designed the program, we carefully consulted with our partners in civil society, &e opposition, and business. Despite a healthy difference o f views among parties, every single reform hs been a a uanraimously approved in Parlimcnt. This domestic consensus h s been blstered by 38 .. ....- _. . ... . . ..... ... . . _I_ . ` , . . . ..I ___.."I __..I _._l__..l_.-.... . The President ' international cornrnunity, which has long played ;3n important role E our country. I n n April 2009, the Paris Club group o f creditors provided a 45% debt cancellation and 18 year defeml o f maturities-an exceptional treatment for a middle income country. The Club's willingness to h n t lotad. assistance was due in part to the ste;ldi"ast prise we have received h r n the h t e m t i o n d Monetary Fund, which has provided us our first ever borrowing probpm, a SElR 17.6 million Stand By Arrangcrncnt. 3. Early SUCC~SSES of refom implementation are becoming apparent though Seychelles has not been spared the deterioratjon in the global economy. Supported by tigbt f j s d and monetary policies, the nominal exchange rate stabilized in late 2008 and has slowly appreciatcd against the US dollar since Ql 2009. As o f thc end o f August, priccs have actually declined since the beginnhg o f the year-a remarkablerevenal from last year's average inflation o f 37%. External rescmc accumulation has been well abave targct throughout our IMF program, while reserve money was contained by over performance on the fiscal side. Yet our economy depends on tourism, and the global downturn has brought a startling slowdown. Afler contracting by 0.9% in 2008, our economy i s expected to decline by 11.7% this y e a due in large part to a decline in tourism spcnding of 25%. 4. A key component o f our reform program is placing our public sector debt on a sustaimble footing, Since late 2008 we have engaged our external creditors in &dliscussio~lsabout h e nature of` the problems in the economy and public fimnces as well as thc severe financing ~hortfklls face over the next decade. Although the Pais Club we agmment has provided a important benchmark, i t covered only h u t a third af the debt n stock that must be restructured. We anticipate that holders o f capital market instruments will be asked to provide relief through an cxchangc for new bonds in Q4; cornniercinl banks arid nun-Paris Club bilateral creditors me cxpcctcd ta sign bilateral loan stnenchncnts in Q4 or early 2010, Although the mtnicturing discussions haw been challenging given the rnabailude o f relief required to achieve sustninability, we are encouraged by the long temi view takcn by many o f our creditors. Assuming. we obtain comparable treatment Ersm them we expect that OUT remailling fmancing gaps wouId be closed. 5, I t is in this coniiection we are sccking the assistance of thc World Bank for ensuring tbnt we continue to irnplerncnt our reform progranl with dctcrmhation and there are no financing gaps wfrich could undermine the credibility o f the reform process. The objective o f this Letter of Development Policy (LDP) is to present policy reforms we implemented in 2008 and 2009 which arc based on our economic policy frameworks that The accompanied 2008 and 20013 budget submissions to our P~~iarnent. measures we implemented in 2008 md in early 2009 are fhlly in line with our "Seychelles 2017" approved by our government in March 2007, a brwad based 10 year refom strategy which aims at doubling o f per-capita income in ten years and a reduction o f public debt from 145 pcmnt o f GDP to 60 pcrccnt. During my spccch to the p o p l c o f Seychelles on our National Day o f 18 Jmc, 2009 Istated that achieving our reform has been one of 39 \ The President the greatest challenges that our country has ever faced. Iam convinced that we are now headd in thc right direction and have encouragcd the Government to embark on additional round o f rcfonns under a successor arrangement with &e I&@.this Fat purposc, we have requested that the W provide an hzcnded Fund Facility to ensure that we have a medium to long term outlook in our policy focus. 1 SEYCFIELLES REFORM PROGRAM . 1.1 Overview 6. Over the past two decades Seychelles h s successfully prornotlcd social a development. In Afdca, Seychdlas leads in h m n development with a life expectancy u a o f 72.2 years and high litcrncy rate o f 96.6 percent. I t i s mkcd 50th on hc 2007 United t th Nations Development Program H m n Development index, a level campamble ta many u a OECD countries. Howcvcr, since the mid-1990s these achievements haw been put increasingly at risk due to persistent macroeconomic imbalances, cxtenial shocks and long-standing structural problems. C m n t C ~ C C Q U ~ ~ deficits were: high throughout the 1990s m reached 23 pcrcent by 2001. Fiscal deficits also rcrnlxined high and reached d about 20 pcrcent o f CDP in 2002; the external debt stock reached alrnost 85 percent of CDP and Seychelles fell into arrears with some of its creditors. GDP declined by 5.3 percent in 20103 signaling that domestic and external imbalances were having a negative impact on the economy and welfare, 7. Recopking these challenges, in 2003 we beyan a rcfonn and modmiration dhrt and introduced a Macro Economic ReSorm P m p m (MEW) in June 2003. W P ,R emphasizcd w. large irnmediatc tiscal adjuslment through a combination o f mvenue increases and expenditure reducing rneasurrss. I t also included liberalization measures such as a privalizition program. As a result the economy started to recover in the Iattcr half o f 2005 driven by a sharp increasc in tourist anivais, a construction sector boom financcd by record-high foreign direct investment inflows as well as short-term high public spending (during the 2006 election year and in 2007 as election promises were implernonted). Red GDP gmw by 6.3 percent in 2007. However, the fiscal adjustment was not sustained, and significmrort intern& and external imbalances remained. AAer a brief period o f a near-bdmwd budget between 2003 and 2005, fiscal pcrfommce deteriorated in 2006 and 2007, partly as a result OF spending associated with the presidential and pwliamentmy elections. While then were step devaluations and the R exchange rate moved from S 5.5 la SR 8 per US$l, in the absence o f fmdamcntal liberalkation of the regirnc pmlPel markets continucd to flourish with rates o f SR 12 or 13 to LJS$I. Plicc controls and restrictive regulatory framework remained in effixt which hindered private sector growth. 40 The President ' 8. The maintenance o f a pegged exchange rate, which was not compatible with fiscal and monetary policy, together with pervasive forcign cxctzimgc restrictions has led to an overvaluation of the Seychelles rupee, a g ~ ~ i pmaJle1 market, and persistent foreign n g exchange shortagcs. This in turn hers increasingly hampered competitiveness and economic growth. hi 2007-08, the global oil and fond fice shack hit the Seychelles economy particularly hard given its dependence on basic imports, with inflation rising sharply to 38percent (year-on-year) by August 2008. Notwithstandixlg gradual adjustment o f the exchange rite from 5 to 8 N Q ~ ~to the US dollar between October S 2006 and October 2007, fhe currency remain& ovcrvducd, exchange shortages persisted, and official external rcserves were virtually exhutitid. These imbalances Came to a head in July 2008 when we missed B payment duc on a privately-placed extcmal dcbt issue. In Octobcr 2008, wc were unable to make a coupon payment on our outstanding Eurobond. As of the end of June 2009, Seychelies' public sector debt had risen to roughly 150% o f CDP, a levcl that i s clearly not sustainable. XI. MAIN ELEMENTS OF POLiCY REFORMS 9. l%is situation called for a radical bmak with past financial und economic policies. n I early November we introduced the following set o f fundammtal reforms: Full liberalization o f the f o r c i p exchange regime by floating the Rupee 0 Tight fiscal policy backed by public sector reforms and a reduction in direct and indircct subsidies, and public financial management measures. Social scctor refoms and improved tclrfieting o f &e social sdcty net 0 A reform o f the rolc o f government and a reduction o f the state in the economy thmugb further privatizationand improving Lht: investment climate. + Reform o f monetary policy forniulation process and the banking system n. IForeign ExchsngeRqhe IO. Fallowing the float o f thc rupee in early November the exchmge rate lost ahout 60 pcmnt o f i t s vdue against the US. dollar, and it has nomindly appwiated since QI. Monetary policy has been tightened to support thc fw-x floatation o f the currency. In addition to thc exchange mte the trends in othcr monetary aggregates have showed very encomging movements, notably the intcmst rates, which wikr initially rising strongly- T-bill rates mse to over 29percent in late December-have fallen `ta wound 12% in August. We have now achieved 1 1 1 convdbility of the Rupee and we are confident that 41 The President this major regime ctrange wi11 have a positive impact on prhate sector development in gencwl. [I. Fiscal Rclarms and Fiscal Palicy Framwark 2 11. Strong fiscal adjustment has been and is central to the achieverncut nf debt sustainability and sound public finances. We are committed to implementing a large and sustained fiscal adjustment that Will help both anchor the move to a floating exchange rate regime and allow For a gradual reduction in public debt. In 2008 our primary surplus \vas over 9 percent o f GDP-well over the program target OF 6.2 percent. These objectives have been achieved through a cofnbinatian o f expenditure restraint, including h e elimination o f subsidies and a reduction o f the wage bill in real terms [from about 9.1 pcrcent o f GDP in 2008 to 6.4 percent o f GDP in 20 10) as part of our plan to reduce h e size o f the public sector, tax policy measures including the removal o f exemptions, strengthened lax administration and public financial management, public scctor reform, and furlher privatizatil~n f public enterprises. To consolidate reform, exceptionally high o primary surpluses of about 20 percent of icDP will be mahtahed in 2009-10, easing gradually over the medium term. 12. Wc have introduced m w m s to reinforce fiscal rcvenue and results to date have been encouraging. We havc applied the goods and services tax (GS'I') ta dl IocaUy- mmmufacturcd and imported goods, except for E3 basic food itcms, and removed discretinnary powers to grant exemptions. The followiuing rcvenue mcasclres have h e n introduced in the fourth quarter of 2008 as per the schedule bclow. Table 1 Revenue Kabing Messures Agreed la the MEW, 2008 : Action Timing b i s e and harmonia taxes an local and imported cigarettes toSR 500 Octokr 1,2008 pcr 200 Clgqwttes. lntrnduce 10 percent witkhaidingtax on interest income for residents. , October I 2608 Extend OST to all teleccirn cornpanit%. October I,2008 Announce the introduction oTUw GST of 15 percent on residential October 10,2008 rcntal income. cffmive January 1,2009. Announce the removal o f the exemption on interest income by Novcmber 1,2008 companies (Tax Act) eflective Jmuary 1,2009. Reintroduce GST QI locally produced soft' drinks. November I, 2008. Raise GST on tourism services from 7 percent to 10 perccnt Navember 1,2008 Raise specific tsxeslexcise tax tales for both lacally nimulhctured nnd November I, 2008 importled alcohol to adjust for inflation. Raiw cnvironmcnlal levy to SR 25 from SR 10 pcr month per Jwuaury 1,2009 household. bdjrist fees, fines, cherps and rents md royalties for inflation. Iaiiivary I, 2009 Reinstate GS'I' 011 LPG. January 1,2009 Raise GST on tourism services from 10 percent to 12 percent. November 1,21109 Repeal all provisions for discretionary exemptions in the Tradc Tax Januasy 1,2009 and Business Tarc Acts 42 The President As part of the 2009 budget, we have introduced lhe following revenue meaures: 13. More frequent adjustments toward cost-recovery levels for watm and electricity prices arc reducing government subsidies to the public utility company, and petrolcum product prices &I% now adjusted monthly to reflect international prices. Despite I idlathnary pressures, primary spending has dso been contained due to low public sector wage rises and tighter spending controls. Increasedtruc on fuel and a new i m p r l levy on automobiles have more than made up for a shortfall OR goods and scrviccs tax (GST) due to the elimination o f GS'I' on 13 basic food items and cooking gas (LPG). ET. 3 Budget Credibility and Public Financial Management Reforms 14. Strengthening the public financial managcment framework and the budgetary process; i s one of our key objectives. hi the past the credibility of our budget has been low as budget outcomes have tended to exceed thc approved appropriations approved by the Parliament at thc beginning o f the fiscal by a large margin, BS much as 22 percent on average between 20052007. This was in part due to the fact that ow budgetary process and budget classification systems were outdated and international standards wcrc not wed. In order to deal with this issue we have strenb$hened the budget fomuiation and exccution process by adopting the IMPS GFS classification system and esabiished spending limits for line ministries. We have also strengthened the budget preparation, implementation and monitoring processes, including through the preparation o f a comistent medium-term macroeconomic fnmcwork by creaking a aew unil within the Ministry of Finance. These refoms enabled us to better monitor fiscal outturns and improved our budget execution rate which in turn allowed us and to achieve our primary surplus targets as indicated above. 11. 4 Public Sector Reforms and Reforming the Role o f the State 15. Our main objective in this area i s to transform the role o f the State to one of provider o f ef'ficient public administration and public goods and services. This required action in three areas. First, Seychelles needcd to rcdum the size o f its public administration and our analysis o f the situation h s sbowi that this was critical for a attaining fiscal sustainability. Prior to reforms public administration accounted fir over 40 percent o f total employmcnt, a large figure by small island standards. The Manpower 43 The President Budgeting Exercisc ( M E ) we carried out in 2008 h s shown that there was considerable a scope for public sector employment rationdimtion. We Rimed to r d w x the number of government employees by 12.5 percent by early 2009 and by mid 2009 this target was more than achieved. This objective was achieved through three %hemes. First, under the W E we reduced the projected wage bill overrun from S 17.8 million to 4 million. R Second, an early retirement scheme was dso introduced at the beginning of2008 for civil servants over the age of 55. The scheme has remained open for the remainder o f 2001). Third, a voluntary departure scheme has been conducted in Uctobrhlovcmber 2008, and this was followed by a fteeze in non-essential vacancies. Reductions in public employment cut the wage bill from 9.8 percent of GDP to 6.8 percent in 2009 thus generating the budgetary savings in part to attain our primary surplus targets. Those who left government have been provided with a separation package and have bccn eligible to seek assistance from the newly cremd Sacid Wclfarc Agency as explained in paragraph 19 below. A strategic plan to modernize our public administration was endorsed by cabinet in August and implemcntatian i s aiready underway. 16. Privatizing conunercially oriented enterprises with a view to enable the private sector i o wsme the lead role in the economy i s the second iey of our broader public sector reforms. Reforms in this particular area also include polices to better exercise the ownership o f the State and me necessary to achieve fixd sustclinability. Wc have initially started our privatization program by sclling the State Assumce Corporation of Seychelles (SAGOS) in June 2006 to a strategic investor and to the public. In 2008 we have focused state owned enterprises that have a distortionary impact on the economy and &me that are causing a net fiscal drain. One such parastatal was the former State Marketing Board, a State trading conglomerate and supplier o f basic collsumer goods, which was closed in Fobmary 2008. The former SMI3 was unbundled in March 2008 and five new different companies were created and some ofthc assets have been sold in 2008 and the government i s committed to complete the sale o f former SMB in 2001). Our privatization progrmi will continue over the next year with the divestiture of the Seychdlm Savings Bank and Nouvobmq Going forward we intend to avoid &ning minority stakes in the tirrns we privatize. 17. We are committed to enforce the highest standards o f msparency and ility in the public and private sectors. A new Public Dc6t Mumgment Act wm encated in Decemhcr 2008 establishing procedures and defining roles and responsibilitics o f agencies involved in debt contracting and management. T&c Law authorizes the Ministry oFFirrance us the only body to contract debt. T h e deficiency in the previous law n contributed to the build-up in debt to unsustainabla levels. I August 2008 wc enacted the Public OlJicr?rs 8 M c . ~Act, which provides for a code of conduct and ethics far civil servants, requiring financial declarations and prohibiting conflicts o f interest. The Public Pracurem&ni Acr, modeled 011 the C O M M A standard, was enacted in December 2008. The objectivc o f the act i s to standardize procurement proccdures within the govemmcnt by modernizing and harmonizing regulations and procedwcs. Transparency, 44 The President comptitiveness, and efficiency will be e n h c c d as tender procedures Will cnsure competitive bidding through strict and uniform requirements regarding minimum number o f bidders and public disclosure o f all bids. In July 3,008, wc amended the Anti-Money Laundering ( r v ) A d to establish a Fhmcid Intelligence Unit with powen of CY i L investigation and sanction, and to strengthen the proper enforcement of AML regulations by enabling the Supreme Court to order civil proceedings for the preservation and disposal o f promds o f criminal conduct under the Act, 1 1 . 5 Rcforaning Social Sectors and Improving Health and Education 18. Our main objective in health and education sectors i s to improve efflfficiency and maintain the standards we attained since independence. We have undertaken reviews in both Sectors With the ssistance of the Bank and found that there w s and there i s stiZl a considerable potential to make considerable improvements to efficiency in both health and education. This can be achieved by reducing spcndhng on service delivery areas that are underutilized and reducing expenditures on cash transfers that are not well targeted. In the health sector reforms have been introduced to substantially reduce the h d t h sector wage bill by identifying and rcleasing staff in areas o f low productivity. The health sector i s characterized by low utilization rates comparable to Europertn fevcls and new measures are being adopted to rationalize facilities. A facilities and staffing review i s being undertaken by hfOH and Department o f Public Administration and based on this review we will begin to mtiodixe our hcaltb facilities, 19. Improving eFficiency and generating savings without reducing overall education spending is one of the mdn goals o f our government. Recent reviews, both by the government a d our development partners have shown that quality and examinations results are issucs as many candidates do not pass exams. Wc will not reduce budgetary allocation to this sector but instead expenditure rovements will be largely re-invested k~ sector reforms aimed at hxeasing quality o f educalion and education outcomes. Most public education spending is pn'ncipdly on wages and solarics and this is also where most potential to impmvc efficiency of spending by removing unproductive posts. Wc hive carried out strategic stafing reductions and reduced office staff in MOE and by contracting out school cleaning and mcal provkiun has been able to reach the target of 12.5 percent reduction of the wage bill. Savings generated from these reforms i s being spent on measures to improve the quality of education and the MUE Will focus on results and i s in the process o f developing a new strategy. 20. We have replaced costly and inefficient direct and indirect product subsidies with a well-targeted social safety nct. The universal subsidy scheme our government provided over the past two decades was too generous and it proved to be ineficient. We have 45 The President for Agro ,Industries, Hatcheries, I January 1,2009 Seychelles Trading Comp;ul$ {STC). and Coetivy &wns. I I Eliminate LPG subsidy by the statc oil company (SEPEC) @ h u i SR 3 per January I, 2009 The agency will protect the most vulnerable segments of our population that have been hard hit by t h rise in inflation, particularly increased food prices, as well those who lefl he thcir jobs in the public sector. Applicants reeeivc a response within 3-7 days and ow initial msasment is that the agency is working reasonably wcll as i t has been able to provide assistarm to tIiosc who Icft the public scctor. Cnnclusion As the abave indicate, the government o f the Republic o f Seychcllcs i s strongly committed to undertaking necessary reforms actions to promote economic growth and niodcrnize our cowtry. In this context, the support o f the. World Bank through approval o f Ehu Second Programmatic Development Policy Finance would be important to succcssful implcnicntationof the govcrnnent's rcfonn agenda. Accordingly, the givernment o f the Republic of Seychelles requests that this first Development Policy Loan be approved. 46 Annex 2: Seychelles Development Policy L o a n Policy M a t r i x Policy objectives Policy action Outcomes (end 2009) Strengthenbudget The Borrower has adopted the P r i m a r y balance rises f r o m -2.0 percent o f management Government Finance Statistics GDP in 2008 to exceed the original 6.2 classification for preparing the percent of GDP p r i m a r y surplus target for budget and for monitoring 2009 envisaged in the program. budget performance, thereby Source: Ministry o f Finance. enhancing the credibility o f budget execution. Ministry o f Finance established binding ministerial expenditure ceilings to prepare the budget, starting in 2008. Fiscal monitoring reports issued auarterlv starting in 2008. Improve governance The Borrower has enacted the National Tender B o a r d established and fully and accountability Public Procurement Act, 2008, functioning (46 contracts have been subject to o f public modernizing and harmonizing National Tender Board procedures since its procurement procurement regulations and establishment, o f which 39 were approved and procedures, enhancing 7 returned for retender). Source; National transparency, competitiveness Tender Board. and efficiency, and introducing strict and uniform requirements governing competitive bidding procedures. National Tender Board established January 29,2009. Create a more The Borrower has through a Staff o f the public administration falls b y 15 efficient civil combination o f early departure percent (from 16,6 15 civil servants and service and public and voluntary retirement parastatal employees in April 2008 to 14,075 administration schemes met the 12.5 percent in April 2009). Source: National Statistics target f o r reducing employment Bureau employment data. in the public sector. The Borrower has secured The public sector wage bill falls in relation cabinet approval o f the t o GDP (from 10.2 percent o f GDP in 2007 to Memorandum o f Action on 7.5 percent o f GDP in 2009). Source: Ministry Public Administration and of Finance. Public Sector Reform Policies, the objective o f which i s to bring about a modern and efficient administration, consolidate public sector reforms and roll- back the role o f the government in commercial activities. 47 Establish a well- The Borrower has enacted the I Social Welfare Agency established and fully targeted social Social Welfare Agency Act 2008, functioning in all 25 districts of the safety net introducing a simple and Seychelles. effective program to provide targeted cash assistance to Social Welfare Agency drawing on relevant vulnerable segments of the government databases to establish eligibility population, and establishing the of claimants, as provided for in the Social Social Welfare Agency to Welfare Agency Act. administer the program. 0 Simple and effective targeting Claimants receive response from Social mechanism in use starting in 2008 Welfare Agency within 10 days. to provide assistance to those who lost their jobs and other vulnerable Source: Social Welfare Agency. neode. Reduce the role o f The Borrower has restructured Overall subsidies of the government to the state in the Seychelles Marketing Board, former S M B falls (fi-om SR 68 million in commercial areas o f discontinuing some of its 2007 to zero in 2009). the economy operations and separating the rest to be managed as separate Overall subsidies of the government to state units, privatizing the profitable owned enterprises falls (from S 239 million R business units and liquidating the in 2007 to S 78.5 million in 2008). R loss-making ones. 0 Eight profitable business units o f Source: Ministry o f Finance. the former SMB privatized in 2008. 0 All loss making units o f the former SMB liquidated in 2008. 0 Subsidies to public enterprises reduced. 48 Annex 3: Joint World Bank-IMF Work Program, 2009 W e ]Products ITiming of mission IDelivery date A. Mutual Information on Relevant Work Programs !ank IA. Strategy and analytical work P Interim Strategy Note- ovember 2008 and ovember 2009 February 2009 Public Expenditure Review October 2008 Public Expenditure Review Phase 2 October 2009 Update to FIAS report (improving the business environment October 2009 and private sector development) Joint Country Procurement Assessment Report and Country Ongoing Identification Ongoing Financial Accountability Assessment mission: November 2008 B. Ongoing and new projects Global Environment Fund grant implementation (tsunami Identification mission: April-May 2009 reconstruction, disaster management, fisheries capacity) November 2009 Development Policy Loan May 2009 November 2009 Development Policy Loan 2 March 20 10 October 2010 'und Program and surveillance work 1. Article I V consultation and approval o f 2-year Stand-By November 14,2009 Arrangement 2. Quarterly program and financing assurances reviews under the Stand-By Arrangement March 27,2009 First review February 2009 June 2009 Second review May 2009 September 2009 Third review August 2009 December 2009 Fourth review (if needed) October 2009 December 2009 3. Discussion on medium-term structural reform agenda that October 2009 could be supported by a successor arrangement under the Extended Fund Facility. Technical assistance and capacity building March 2009 1. Fiscal Affairs Department technical assistance mission on February 2009 tax policy and revenue administration review. July 2009 2. Fiscal Affairs Department technical assistance mission on June 2009 Public Financial Management. Ongoing 3. Monetary and Capital Markets Department technical Ongoing assistance on reforming the monetary policy framework (long-term monetary advisor, automation o f interbank market, reserve money management) strengthening bank supervision, and Central Bank Seychelles governance. March 2009 4. Monetary and Capital Markets Department technical Ongoing assistance on public debt management. 49 Title IProducts /Timing of mission IDelivery date B. Requests for Work Program inputs 1. Medium-term macro-economic and fiscal framework to n.a. Ongoing request to inform Public Expenditure Reviews Debt Sustainability Analysis n.a. March 2009 2 . Assessment o f the poverty impact o f Rupee float and To be determined October 2009 request to strategy on strengthening the social safety net and enhancing targeting o f social assistance. 3. Policy note on parastatal reform and privatization. October 2009 December 2009 4. Strategy on improving business environment and October 2009 December 2009 promoting private sector investment 5. New wage grid proposal for public sector October 2009 December 2009 Joint Joint mission to discuss a medium-term structural reform October 2009 December 2009 products agenda focusing on: social safety net targeting; civil service (preliminary) reform, parastatal reform; and promoting private sector investment 50 Annex 4: IMF Press Release on the Completion o f the Second Review U n d e r Seychelles' Stand-By Arrangement IMF Executive B o a r d Completes the Second Review U n d e r Seychelles' Stand-By Arrangement and Approves US$1.4 M i l l i o n Disbursement Press Release No.09/246 June 30,2009 The Executive Board o f the International Monetary Fund (IMF) today completed the second review o f Seychelles' economic performance under its two-year Stand-by Arrangement, and completed the latest quarterly financing assurances review. The Board's decision enables Seychelles to receive a disbursement in an amount equivalent to SDR 0.88 million (about US$1.4 million). The Executive Board also approved the modification o f quarterly quantitative performance criteria, and agreed to establish a schedule o f semi-annual program reviews, while maintaining quarterly quantitative performance criteria, and financing assurances reviews. The two-year SDR 17.6 million (about US$27.3 million) Stand-By Arrangement for Seychelles was approved on November 14,2008 (see Press Release N o . 08/282). Following the Executive Board discussion, Mr. Takatoshi Kato, Deputy Managing Director and Acting Chair, stated: "Seychelles' commitment to reform and prudent financial policies has brought about rapid progress o n macroeconomic stabilization. The significant fiscal consolidation effort, backed by the new market-based monetary policy, has restored confidence in the Rupee and helped bring inflation down rapidly. "Economic policies are geared toward consolidating this progress. The fiscal stance aims to support the disinflation objective and contribute to public debt sustainability, while preserving priority social spending. The market-based floating exchange rate regime i s serving the economy well, and monetary policy should aim to maintain interest rates positive in real terms in order to anchor price stability. Efforts should continue to expand monetary policy instruments and modernize the legal and institutional framework for the financial sector. "Structural reforms are needed to lay a firm foundation for sustained recovery. The authorities have strengthened tax administration and launched a fundamental tax policy reform, which are key to improving the investment climate, reducing economic distortions, and securing fiscal sustainability. Progress has also been made in strengthening public financial management and expenditure control. Further efforts in this direction, including to reinforce financial discipline and accountability in public enterprises, will be essential to ensuring fiscal sustainability and raising productivity. "Good progress i s being made with public external debt restructuring. Following the favorable agreement with the Paris Club, the authorities have shown good faith efforts to normalize relations with all creditor groups. In view o f the high public debt level, the authorities are pursuing a debt restructuring with non-Paris Club creditors that i s consistent with Seychelles' limited payments capacity. The authorities should reinforce their debt management capacity, supported by Fund technical assistance," said Mr. Kato. 51 Annex 5: Debt Sustainability Analysis The debt sustainability analysis confirms that public debt in Seychelles remains unsustainable even after restructuring o Paris Club debt in April 2009. The highly concessional restructuring f agreement with Paris Club creditors in mid-April 2009, which recognized Seychelles' limited payments capacity, was an important step toward achieving sustainability. However, even with the strong and sustained fiscal adjustment assumed under the program, a further signijkant reduction f o the external debt burden is required to restore longer-term sustainability. Against this background, engagement in good-faith discussions with all external creditors to achieve a restructuring on comparable terms is critical. Macroeconomic assumptions The debt sustainability analysis is based on the macroeconomic framework presented in the present staff report: Near-term economic growth outlook has been revised downwards on account o f the global recession, with real GDP expected to s h r i n k by about 10.7 percent in 2009. Growth i s expected to recover only gradually from 2010 onwards, supported by resumption o f foreign direct investment-financed projects and recovery o f tourism, and stabilize at around 5 percent a year in the long term. Supported by tight fiscal and monetary policy, inflation has declined sharply and i s expected to remain in the l o w single digits for the remainder o f 2009, aided by sharp declines in world food and fuel prices. It i s assumed to remain at around 3 percent going forward in line with major trading partners' inflation. The near-term current account outlook has worsened from the previous analysis (done at the time o f the first review) as piracy and the global economic crisis are expected to restrain exports and tourism earnings in 2009-10. The tourism forecasts for 2009 have been revised to a 22 percent drop, from the originally projected 25 percent decline, while tuna exports are expected decline by 21 percent and by a further 6 percent in 2010. Nevertheless, over the medium-term, tourism growth i s expected to recover, peaking at 10.6 percent in 2013 and moderating to a long-run steady rate o f around 8 percent a year. Given i t s comparative advantage, tuna exports are expected to revive by 4.5 percent in 201 1. Net foreign direct investment inflows are expected to decline sharply in 2009 to 27 percent o f GDP, as a number o f large hotel projects have been postponed or slowed. This reflects tighter credit conditions and lower near-term outlook for tourism inflows. Foreign direct investment flows are expected to recover from 2010 and stabilize at 26 percent o f GDP over the long-run. Official foreign exchange reserves are targeted to build-up gradually to about 3.8 months o f imports by 2019, a necessary recovery from the depleted levels o f 2008. 52 Evolution of the debt stock and debt burden Public external debt is estimated at US$802.2 million (87.1 percent o f GDP) at end-2008 (table 1). About 60 percent o f the debt was owed to commercial creditors, while the Paris Club countries account for about 19 percent o f the total. Seychelles has no arrears with multilateral creditors. At end-2008 some 42 percent o f the debt stock was in arrears (US$333.5 million). 0 In April 2009, Paris Club creditors granted exceptional treatment to Seychelles under the Evian approach.' US$140 million o f arrears were normalized (including South Africa). The restructuring o f Seychelles debt will involve both flow and stock rescheduling with the debt stock reduced by 45 percent in two tranches and the remaining amounts rescheduled over 18 years including a five-year grace. N o repayments will be made in 2009 other than a "goodwill" payment o f US$1 million by end-June, with very limited payments due in the next few years as moratorium interest i s partially deferred. Despite the Paris Club debt restructuring, the stock o f public external debt i s expected to rise to 108 percent o f GDP by end 2009, primarily reflecting disbursements from multilateral agencies and the depreciation o f the Rupee. Baseline Scenario The Paris Club agreement leads to a significant reduction in the debt ratios but without further restructuring from other creditors on a comparable basis public debt remains unsustainable(Tables 2, 2a). However, the Paris Club agreement i s not tenable on i t s own, since a formal requirement for the effectiveness o f the agreement is securing comparability o f treatment from other creditors. This scenario assumes that the non-restructured debt (including arrears) is serviced and that the financing gaps are closed, as assumed in earlier analyses, by a flow rescheduling on market terms at L I B O R plus 1300 basis points and with a three-year maturity.2 Over the next ten years, the public external debt ratio would rise steadily to around 326 percent o f GDP (310.5 percent o f exports) in 2019. Furthermore, the bound tests highlight that the external debt i s extremely sensitive to the underlying assumptions, with even moderate shocks triggering dramatic explosive dynamics (Figure 1a). Notwithstanding the strong fiscal adjustment (Table 2b and Figure lb), the analysis indicates a similar unsustainable profile for overall public sector debt over the medium run, at 342.7 percent o f GDP, driven by dynamics o f external debt. The agreement covered all the debt to Paris Club. South Africa, a significant non-Paris Club creditor, participated in the meeting and was a signatory of the minute. 2 The assumed risk premium i s designed to mimic the current level o f EMBI spreads on sovereign external debt o f other highly indebted countries with significant vulnerabilities, for which trading o f debt securities i s more active. 53 Alternative Scenario Under this scenario, public external debt at end-2008 i s restructured on comparable cash flow terms with the Paris Club agreement (the agreement with Paris Club creditors requires Seychelles to seek promptly from all other external commercial and bilateral creditors debt restructuring on comparable terms). Public external debt would decline steadily to 60.4 percent in 2014 and remain under 60 percent through 2019 (Table 3a and Figure 2a). Total public debt (including domestic debt) would decline to 62.5 percent o f GDP by 2019 (Table 3b, Figure 2b). However, assuming key variables are at their historical averages the external debt ratio would rise steadily to 104.9 percent o f GDP, pointing to the vulnerability o f the outlook. Standardized bound tests show that Seychelles's public debt i s particularly exposed to current account shocks and interest rate shocks. Assuming a h a l f standard deviation shocks to the current account (8.3 percent increase in the deficit); the debt stock would increase to 493.2 percent (baseline scenario) in 20 19 and 118.7 percent (alternative scenario). Table 1. External Debt 1 End-2008 External debt stock 2 802.2 Multilateral 57.0 Bilateral 267.4 Paris Club 151.7 Non-Paris Club 115.8 Commercial 477.7 External debt arrears 333.5 Multilateral 0.0 Bilateral 184.5 Paris Club 124.2 Non-Paris Club 60.4 Commercial 149.0 1Preliminary and subject to reconciliation with creditors. Includes Central Bank o f Seychelles external debt. 2 Includes arrears. This hypothetical scenario i s included for illustrative purposes only. It i s based on technical assumptions regarding the restructuring o f debts to all other non-Paris Club creditors on terms comparable to those agreed with Paris Club creditors, without pre-judging the terms o f such a restructuring. 54 Figure l a . External DSA: Bound Tests for Baseline Scenario (PC Restructuring and Nonconcessional Refinancing)'(External debt in percent of GDP) Baseline and historical scenarios Interest rate shock (percent) 280 1 Gross financing need under baseline Baseline 2 9 1 n (lee ::: 366, / 230 150 /' 130 rate shock 0 180 230 110 90 180 130 70 Baseline 130 80 50 30 30 IO 30 I M I , 2003 2005 2007 2009 2011 2013 2015 2017 2003 2005 2007 2009 2011 2013 2015 2017 Growth shock Non-interest current account balance (percent per year) shock ( percent of GDP) 1 Scenario: Scenario: 280 account 380 230 330 shock, / :ll w a s ; i n e , 280 230 180 130 80 80 30 30 2003 2005 2007 2009 2011 2013 2015 2017 2003 2005 2007 2009 2011 2013 2015 2017 Combined shock Real depreciation shock 8 /,I /i 351 280 330 380 280 , Combined shock 230 230 #' 291 180 180 130 130 80 80 30 2003 2005 2007 2009 2011 2013 2015 2017 2003 2005 2007 2009 2011 2013 2015 2017 Sources: International Monetary Fund, Country desk data, and staff estimates. ' External financing gap is assumed to be closed by external borrowing at LIBOR plus 1300bps, with three year maturity. Shaded areas represent actual data. Individual shocks are permanent one standard deviation shocks (two standard deviations for growth shock). Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown. Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance. One-time real depreciation of additional 15 percent occurs in 2009. 57 58 8 'E 0 u) f z E B z a Figure 1b. Public DSA: Bound Tests for Baseline Scenario (PC Restructuring and Nonconcessional Refinancing of Private Sector Creditors (Public debt in percent of GDP) Baseline and historical scenarios Interest rate shock (percent) 500 500 416.1 /' 400 1' - 400 -Baseline: . 1.5 - 153 Scenario: 5.0 300 Historical: 2.4 200 100 1 1 2001 2004 2007 2010 2013 2016 2019 2001 2004 2007 2010 2013 2016 2019 Primary balance shock and no policy change Growth shock (in percent per year) scenarios (constant primary balance) 700 M t Scenario: 500 Historical: -0.4 6oo 500 385.2// 4oo / No policy change 400 - Baseline: 3.3 Growth *, __Scenario: -4.5 shock / 300 300 . Historical: 16.0 200 - 200 100 " I " ' 2004 2010 2013 2016 2019 2001 2004 2007 2010 2013 2016 2019 Combined shock 700 I I 600 42?/ 400 /* 15 % 500 / /* 400 Combined / # 300 200 100 2001 2004 2007 2010 2013 2016 20192OOl 2004 2007 2010 2013 2016 2019 Sources: International Monetary Fund, Country desk data, and staff estimates. 'Shaded areas represent actual data. Individual shocks are permanent one standard deviation shocks (two s.d. for growth). Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown. Permanent 114 standard deviation shocks applied to real interest rate, growth rate, and primary balance. One-time additional real depreciation of 15 percent in 2009, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator). 59 f 60 61 rc m x P ; 2 n I 9 a - m n I c9 W N 8 m m w o 1 W x W rc ? i 2 IC - 0 m 2 W 2 W 3 E a C G 0 1 E c g i! I J a . - 0 E 2 W Figure 2a. External DSA: Bound Tests for Alternative Scenario (Assuming Comparibility of Treatment for other Creditors), 200349' (External debt in percent of GDP) Baseline and historical scenarios Interest rate shock (percent) Gross financing need under Historical baseline Scenario: 120 (right scale) scale) 120 Historical: 90 40 90 - Interest rate shock 30 60 20 45 30 10 "" 2003 2005 2007 2009 2011 2013 2015 2017 2003 2005 2007 2009 2011 2013 2015 2017 1 ;,1 Growth shock Non-interest current account balance (percent per year) shock ( percent of GDP) 150 t Basetine: Baseline: -21.4 Scenario: Scenario: -27.0 Historical: 120 - Historical: -12.7 110 I4O 90 - balance 45 L" ~~ ~ 2003 2005 2007 2009 2011 2013 2015 2017 2003 2005 2007 2009 2011 2013 2015 2017 Combined shock Real depreciation shock 150 130 117 110 1.i I * 90 70 50 15% depreciation '. 30 '. ' 25 10 2003 2005 2007 2009 2011 2013 2015 2017 2003 2005 2007 2009 2011 2013 2015 2017 Sources: International Monetary Fund, Country desk data, and staff estimates. ' External financing gap is assumed to be closed by external borrowing at LIBOR plus 1300bps, with 3 year maturity. Shaded areas represent actual data. Individual shocks are permanent one standard deviation shocks (two standard deviations for growth shock). Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown. Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance. One-time real depreciation of additional 15 percent occurs in 2009. 62 200 b 0 0 / - 0 . - 210 Historical - 220 150 - 160 Baseline: 0.7 GFN (rhs) Scenario: 4.2 110 "Historical: ,2.4 .A i-rate shock 100 ae Bnil : 60 - - - . - _ _- . 120 102 . 50 I I II I I II .>. 10 ' 67 ~ 20 Growth shock (in percent per year) I 730 630 t- 530 Scenario: Growth 430 - Historical: 18.0 shock 330 - 230 1 I 67 2001 2004 2007 2010 2013 20167 2019 2001 2004 2007 2010 2013 2016 2019 Combined shock Real depreciation Combined shock 145 .- - . Baseiine -- 144- 45 '"'''''''10 2001 2004 2007 2010 2013 2016 20192001 2004 2007 2010 2013 2016 2019 Sources: International Monetary Fund, Country desk data, and staff estimates. 'Shaded areas represent actual data. Individual shocks are permanent one standard deviation shocks (two s.d. for growth). Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown. Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance. One-time additional real depreciation of 15 percent in 2009, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator). 64 Annex 6: Country at a Glance (includes country map) Seychelles a t a glance 9f24108 sub- Upw Saharan mook A h -m Agt distribution. 2007 FWch I BOP le23 2 4 242 4 1 487 :4 08 3e 75 762 6 750 052 d 987 15 1 BTO 1 1 0hB 112 58 O P O l I I 37 51 pcrtent 53 Under-5 mentali rat4 Iprr 1,000) 72 '50 PI 17 70 -- 3- 1_, 09 pi 50 P2 P9 ltZ a8 100 58 D.5 31 e3 N i t Aid Flows igeo I998 2080 Zb07 22 O 1 I 30 1 13 5 18 0 2 0 14 4 3 2 7 Gmwih af GDP and GDP per erpitr 1%) IC !5 1 1PO 3.1 l.P m9 3 211 t &5 c 334 13 b 35 0.3 1 11 8 22 0 51 1.3 7 3 84 53 E.7 87 aa t 00 191 1980-90 1990-2000 2 0 W 7 :,"-go 1IIIIU.l gmMn ?e} 01 0 1 0.1 01 0 0 I S 07 147 3ea e1 5 728 37 45 4 2 Ips ofGDPl 00 18 311 30 -1 1 03 51 15 B rl*3 290 za 4 4 3 18 e l.8 74 101 102 $7 0 61 b3 4 2 775 78 9 e8 a 58 e 1 9 27 -1 3 442 cia 53.9 79 e 4s t C $9 2E 7 27 7 24 2 21 E 49 17 5t 38 3 14 a 252 41 E 10 3 10 5 34 68 0 ezs 78 2 138 4 19 3 68 72 79 1 Be7 E11 IBO 4 I60 io5 100 217 172 -33 65 SeycheNes 2000 2007 Gcvtmm=s m d i u b n . 20800 and 2007 795 oa 5 3.11 51P -1 E -32 1 2 4 D1Q -45 -303 -1 3 -413 43 78 h9 4 40 4 5t 4 3e 1 41 0 45 5 2000 200T -13 0 .3 4 846 960 57 115 00 3 1 304 305 :i 1& - 49 4 1168 1 4 20 B 11 t 46 70 66 0 0 Cbmparitibn bff lata1 artrmrl dcbc 2006 3 0 0 0 1 0 0 D 0 0 0 D 2000 2009 0 0 - 39 - E3 12 P - 33 12 D 7 0 2000 2007 3 0 MIDA oms* *rperun N w guaranttes 66 Millennium Development Goals Seychelles With selecfed targets fo achieve between 1990and 20.I5 jesbmac k date t h w n , +.I- 2yemi Coal 4; reduce undcrd mortllitv by h v - t h d s Under-5 mortal& nu t p r I.WO, 10 16 15 13 Infant rnaruMy rate I per 1.000 )Ne bimr I 17 14 13 12 Measius immunaamn mmpormn of meyear 010s immunlred $0 a8 07 97 99 Goat 5 : mducc matrrnrl monTallcV by thrw-fouTths Uatpmal mortaUyrato lmodelW estimate. per 100 000 INC billhr) Goal 8 %dswlop a globalparmershlpfor dwvplopment 12 4 174 15 4 24 2 0.0 01 32 0 90 9 o.a 07 74 37 a 13 6 21 2 h1 67 MAP SECTION 50°E 52°E 54°E 56°E SEY C HELLES Bird I. Denis I. 4°S 4°S SELECTED CITIES AND TOWNS NATIONAL CAPITAL INNER MAIN ROADS (GRANITIC) VICTORIA ISLANDS African Banks 48°E For Detail, AMIRANTE See Inset Below GROUP St. Joseph Atoll Étoile I. Desroches I. Poivre Boudeuse I. Atoll Platte I. SEYCHELLES 6°S 6°S Desnoeufs I. Marie Louise I. I N D I A N O C E A N E ) I S L A N D I N S L O ALPHONSE Alphonse I. R GROUP S. François I. Coetivy I. A C 54°E 56°E ( 8°S 8°S SEYCHELLES R Inner (Granitic) Aride I. E 4°15'S Curieuse I. T Islands West Sister I. East Sister I. Félécite U Grand' Anse Praslin I. I. Marie Anne I. O North I. La Digue I. ALDABRA Providence I. INDIAN OCEAN Aldabra St. Pierre I. Atoll GROUP Bancs Providence Silhouette I. Mamelle I. Cosmolédo Is. Assomption I. FARQUHAR Frigate I. 10°S GROUP 10°S De Quincy Village Recif I. Astove I. Belle Ombre L'Îlot I. Farquhar Atoll VICTORIA Conception I. Cascade Thérèse I. Anse Boileau Mahé I. This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information 0 50 100 150 Kilometers 4°45'S Anse Royale shown on this map do not imply, on the part of The World Bank 0 5 10 Kilometers IBRD 33477 Takamaka MARCH 2005 Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. 0 50 100 150 Miles 0 5 10 Miles 48°E 50°E 52°E 55°15'E 55°30'E 55°45'E