CABO VERDE ENHANCING FISCAL SUSTAINABILITY IN THE FACE OF SHOCKS Abbreviations and Acronyms V TABLE OF CONTENTS Acknowledgements VII Executive Summary VIII Chapter 01. Chapter 03. Understanding Recalibrating Towards The Macro-Fiscal Context Growth-Enhancing Expenditure 1.1. Recent Macro-Fiscal Developments 25 3.1. Expenditure Trends And Budget Rigidity 106 1.2. Macro-Fiscal Challenges And Risks 29 3.2. Efforts Towards Growth-Enhancing Public Spending 123 1.3. Fiscal Policy: Past And Present 39 3.3. Policy Recommendations 140 1.4. Policy Recommendations 50 Chapter 04. Chapter 02. Accelerating The SOE Reform Improving Domestic Revenue Agenda To Reduce Fiscal Risks Mobilization In Cabo Verde 4.1. The Soe Landscape In Cabo Verde 146 2.1. Revenue Trends, Potential And Effort 56 4.2. Corporate Governance And Accountability Mechanisms 153 2.2. The Efficiency Of Cabo Verde’s Tax System 60 4.3. State Footprint And Effects On Markets 158 2.3. Is There Scope To Simplify The Tax System? 72 4.4. Assessment Of Fiscal Costs And Risks From The Soe Sector 161 2.4. Is Cabo Verde’s Tax Regime Effective 4.5. Policy Recommendations 183 At Correcting For Externalities? 88 2.5. Policy Recommendations 99 Annexes Public Finance Review - Page 3 List of Figures FIGURE 1.1. Economic growth decelerated after the global financial crisis... 27 FIGURE 1.2. ...and has been more volatile than in most peer countries (2000−2022) 27 FIGURE 1.3. Recovery has been mostly driven by service exports and private consumption 28 FIGURE 1.4. Deficits in the current account and fiscal balance have narrowed 28 FIGURE 1.5. Cabo Verde trails peers on some economic, climate and social development indicators 31 FIGURE 1.6. Although improving, gender gaps in labor force participation persist 31 FIGURE 1.7. One-off revenues, the wage bill freeze, and low capital spending reduced the fiscal deficit 33 FIGURE 1.8. Cabo Verde has limited fiscal space... 33 FIGURE 1.9. ...and public debt remains elevated 34 FIGURE 1.10. Public debt is concessional with favorable conditions… 34 FIGURE 1.11. ...though debt servicing pressures are considerable for the medium-term 35 FIGURE 1.12. Growth remains key for public debt reduction 35 FIGURE 1.13. Fiscal risks from SOEs have been increasing 38 FIGURE 1.14. Cabo Verde is highly vulnerable to climate change 38 FIGURE 1.15. Capital expenditures have borne the brunt of the expenditure adjustment in the last decade… 41 FIGURE 1.16. ...and are significantly lower than for peers 41 FIGURE 1.17. Government capital expenditure has negatively contributed to growth 42 FIGURE 1.18. Income tax productivity is lower than in peer countries 42 FIGURE 1.19. Cabo Verde’s most recent fiscal consolidation occurred from 2014−2017 44 FIGURE 1.20. Fiscal policy has generally been procyclical in the last decade 46 FIGURE 1.21. Expenditure has generally accompanied the cycle 46 FIGURE 1.22. Expenditure procyclicality has been among the highest of peers (2000−2023)... 47 FIGURE 1.23. ...and was even stronger until the pandemic (2000−2019) 47 FIGURE 2.1. Total tax revenues are increasing, but are yet to match levels of aspirational peers 58 FIGURE 2.2. The share of tax revenues in total revenues is comparable with regional and aspirational peers 58 FIGURE 2.3. Tax collection levels are stagnant 59 FIGURE 2.4. Despite Cabo Verde’s tax collection levels, there is scope to improve its tax effort 59 FIGURE 2.5. PIT revenues are in decline 63 Public Finance Review - Page 4 List of Figures FIGURE 2.6. Cabo Verde’s PIT productivity could be higher 64 FIGURE 2.7. Revenues are highly dependent on indirect taxes – highlighting concerns about progressivity 64 FIGURE 2.8 VAT revenue has been volatile 66 FIGURE 2.9 The efficiency of the VAT system is above average 66 FIGURE 2.10 CIT revenues have been declining 69 FIGURE 2.11 CIT productivity is well below average 69 FIGURE 2.12 Cabo Verde’s foregone tax revenues surpass all comparators 73 FIGURE 2.13 Tax expenditures have been declining recently 74 FIGURE 2.14 VAT exemptions comprise the largest share of tax expenditures 75 FIGURE 2.15 VAT-exempted essential goods contributed to tax expenditures worth nearly 3% of GDP 75 FIGURE 2.16 Investment tax credits account for a large share of DGCI’s CIT expenditures 76 FIGURE 2.17 Most investment tax credits occur in the tourism sector 76 FIGURE 2.18 Exemptions on import duty and VAT make up the largest share of DGA’s tax expenditures 77 FIGURE 2.19 The largest tax expenditures by DGA are linked to exemptions in the tourist sector 78 FIGURE 2.20 VAT-linked exemptions make up a large share of revenue foregone 79 FIGURE 2.21 A large share of poorer households’ consumption basket benefits from exemptions or reduced rates… 80 FIGURE 2.22 …but poorer households have a higher level of consumption informality 80 FIGURE 2.23 Eliminating VAT exemptions would have welfare implications if not accompanied by mitigation actions 82 FIGURE 2.24 Firms benefiting from contractual incentives, on average, create low-paying jobs 87 FIGURE 2.25 Mortality and morbidity due to alcohol, tobacco and SSBs are rising in Cabo Verde 89 FIGURE 2.26 Increasing taxes have made Cabo Verde’s most-sold brand of cigarettes less affordable 91 FIGURE 2.27 Alcohol taxes contribute the most to revenue 91 FIGURE 2.28 Carbon prices vary by fuel type 95 FIGURE 2.29 Residential and power sectors have lower carbon prices than transport and industry 95 FIGURE 2.30 There is a large gap between fuel import duties/excise taxes and an efficient carbon price of CVE 10,500 97 FIGURE 3.1 Public expenditure in Cabo Verde is declining and is lower than peers 109 FIGURE 3.2 Highly rigid components have accounted for a larger share of spending 110 FIGURE 3.3 Budget rigidity is higher than for international peers 110 Public Finance Review - Page 5 List of Figures FIGURE 3.4 Public investment has played a negligible role in driving growth 111 FIGURE 3.5 Cabo Verde’s wage bill is higher than aspirational peers and aligns with structural ones… 112 FIGURE 3.6 …although public employment does not stand out from aspirational comparators 112 FIGURE 3.7 Public wages only differ from the global mean for some occupations 113 FIGURE 3.8 The wage bill is mostly concentrated in public service delivery 113 FIGURE 3.9 Income redistribution spending has expanded in the context of strengthened social benefits 117 FIGURE 3.10 Public expenditure contraction has mostly affected the economic affairs sector 117 FIGURE 3.11 Social assistance has been increasing 119 FIGURE 3.12 Benefit coverage of the most vulnerable was on the rise before the pandemic 119 FIGURE 3.13 Public expenditure targeting gender equality has increased by 30% since 2018 120 FIGURE 3.14 The PNIG has clear strategic objectives 121 FIGURE 3.15 Capital spending reductions are driven by a decline in foreign financing 125 FIGURE 3.16 Budget execution difficulties may be driving foreign financing declines 125 FIGURE 3.17 Public spending efficiency in infrastructure quality could be improved for ports, roads and transport 127 / 128 FIGURE 3.18 Cabo Verde could enhance the quality of infrastructure by eliminating inefficiencies 129 FIGURE 3.19 Cabo Verde’s public spending efficiency in education trails some peers 133 FIGURE 3.20 Eliminating inefficiencies could see improved outcomes in secondary education 134 FIGURE 3.21 Cabo Verde compares well with peers for public health spending efficiency 136 / 137 FIGURE 3.22 Improving public spending efficiency could bring notable gains in life expectancy 138 FIGURE 4.1 The wage bill for the six largest SOEs is declining 148 FIGURE 4.2 TACV’s labor costs per available seat-kilometer have risen 149 FIGURE 4.3 Substantial transactions have been made to reduce NewCo’s liabilities, 2019–2023 (CVE million) 166 FIGURE 4.4 Spending on SOEs is equivalent to a significant amount of spending in priority sectors 167 FIGURE 4.5 Four scenarios are modelled for ASA’s dividend payout policy 174 / 175 FIGURE 4.6 Three scenarios are modelled for ENAPOR’s operations 177 / 178 FIGURE 4.7 Four scenarios are modelled for TACV’s operations 180 / 181 Public Finance Review - Page 6 List of Tables and Boxes TABLE E.1 Potential fiscal gains from domestic revenue mobilization and expenditure reforms 21 TABLE E.2 Additional measures to support the consolidation agenda 22 TABLE 1.1 Important macro-fiscal reforms to support sustainable fiscal consolidation 52 TABLE 2.1 Number of firms under different tax regimes 61 TABLE 2.2 Special tax regime for micro and small-sized companies 67 TABLE 2.3 The effects of contractual incentives on firms’ key outcome variables 84 TABLE 2.4 The effects of the contractual incentives over time 85 TABLE 2.5 Excise tax rates have evolved over time 90 TABLE 2.6 Effective alcohol tax rates in 2023 and 2024 92 TABLE 2.7 Cabo Verde’s excise tax rates are lower than in similar peer countries 93 TABLE 2.8 Potential fiscal gains from domestic revenue mobilization measures 100 TABLE 3.1 Potential fiscal gains from expenditure measures 142 TABLE 4.1 Total assets of SOEs by economic sector (thousand USD) 150 TABLE 4.2 Transactions between SOEs and the GoCV budget (percent of GDP) 164 TABLE 4.3 SOEs have liabilities with varying degrees of risk 168 TABLE 4.4 Overview of Cabo Verde’s six main SOEs, US$ millions (2023) 172 TABLE 4.5 Fiscal costs of Cabo Verde’s six main SOEs relative to the budget (percent) 172 TABLE 4.6 Priority reforms for the SOE sector 186 BOX 1.1 How successful have previous fiscal consolidation efforts been in Cabo Verde? 43 BOX 1.2 Fiscal Frameworks In Small Island Developing States (Sids) – Can Cabo Verde Do More? 48 BOX 2.1 Women-led businesses and the REMPE 68 BOX 2.2 Cabo Verde’s progress on implementing international tax standards and next steps 70 BOX 3.1 The reform of the public service regime in Cabo Verde 115 BOX 3.2 Gender expenditure: a step towards promoting gender equality 120 BOX 3.3 Improving Cabo Verde’s disaster risk management and adaptation 130 BOX 3.4 How effective health service costing can strengthen policy making 139 BOX 4.1 Status of Cabo Verde’s 2022−2026 SOE reform agenda 145 BOX 4.2 The SOE wage bill has fallen, but operational efficiency could be improved 148 BOX 4.3 Framework for transactions between the state and SOEs in Cabo Verde 162 BOX 4.4 NewCo and its continued fiscal costs 166 BOX 4.5 Addressing the fiscal cost of electricity and water services 169 BOX 4.6 The fiscal cost of maritime travel 171 Public Finance Review - Page 7 Abbreviations and Acronyms ASPIRE Atlas of Social Protection Indicators of Resilience and Equity HIPCs Heavily Indebted Poor Countries AETR Average Effective Tax Rate HRMIS Human Resources Management Information System BEPS Base Erosion and Profit Shifting IFI International Financial Institution BOS Business of the State IMF International Monetary Fund CAMA Computer-Aided Mass Appraisal IMTT Intermediate Monetary Transaction Tax CBF Tax Benefits Code IRPC Corporate Income Tax (Portuguese acronym) CCDR Country Climate and Development Report iSOEF Integrated State-Owned Enterprise Framework CDRM Climate and Disaster Risk Management IRPS Personal Income tax (Portuguese acronym) CET Composite Efficiency Score ISORA International Survey on Revenue Administration CIT Corporate Income Tax ISPMIS Integrated Social Protection Management Information System CPI Consumer Price Index LMIC Lower middle-income country CVE Cabo Verde Escudo MAPS Methodology for Assessing Procurement Systems DALYs Disability Adjusted Life Years MDAs Ministries, Departments and Agencies DGA Customs Directorate General MFN Most-favored Nation DGCI Directorate General of Taxation MNEs Multinational Enterprises DRM Domestic Revenue Mobilization OPC Office of the President and Cabinet ECOWAS Economic Community of West African States OSR Own-Source Revenue e-GP e-Government Procurement QFO Quasi-Fiscal Operation EFDs Electronic Fiscal Devices PCFR Plano de Carreiras Funções e Remunerações do Regime Geral [Plan for Careers, EIB European Investment Bank Functions and Remuneration of the General Regime] ETR Effective Tax Rate PEDS Strategic Sustainable Development Plan FDMS Fiscalization Data Management System PER Public Expenditure Review G&S Goods and Services PFM Public Finance Management GDP Gross Domestic Product PFR Public Finance Review GoCV Government of Cabo Verde PIM Public Investment Management GRB Gender Responsive Budgeting PIT Personal Income Tax Public Finance Review - Page 8 Abbreviations and Acronyms PNIG Plano Nacional de Igualidade do Genero [National Gender Equality Plan 2021−2025] PPP Purchasing Power Parity PSO Public Service Obligation RBM Results-Based Management REMPE Regime Juridico das Micro e Pequenas Empresas [Legal Framework for Micro and Small Enterprises] RSI Social Inclusion Income RTGS Real Time Gross Settlement SDP Structured Dialogue Platform SEZ Special Economic Zone SMEs Small and Medium Enterprises SOE State-Owned Enterprise SSA Sub-Saharan Africa SSB Sugar-Sweetened Beverage SST Single Special Tax TACV Transporte Aéreos de Cabo Verde TADAT Tax Administration Diagnostic Assessment Tool TaRMS Tax and Revenue Administration System UASE Unidade de Acompanhamento do Setor Empresarial do Estado [State Business Sector Monitoring Unit] UMIC Upper middle-income country US$ United States Dollar VAT Value-Added Tax WB World Bank WHO World Health Organization WHT Withholding Tax Public Finance Review - Page 9 Acknowledgements This Public Finance Review, covering performance until 2023, was prepared by a dedicated team of staff, whom we gratefully acknowledge. Overall guidance was provided by Keiko Miwa (Division Director, AWCF1), Abebe Adugna Dadi (Regional Practice Director, EAWDR) and Hans Anand Beck (Practice Manager, EAWM1). The overall task of drafting and synthesizing the report was led by Anna Carlotta Allen Massingue (Senior Economist, EAWM1) and Ibrahim Saeed Chowdhury (Senior Economist, EMFTX). The report was strengthened by insightful comments and suggestions from Daniela Marotta (Lead Economist, EAWM1), Fernando Blanco (Lead Economist, EMFTX) and Alastair Thomas (Lead Economist, EMFTX) as well as from peer reviewers, Melanie Simone Trost (Senior Economist, EECM2), Pui Shen Yoong (Senior Economist, ELCMU), Tihomir Stucka (Senior Economist, EEADR) and Daniel Carvalho Cunha (Economist, IMF). On the Government’s side, the team benefitted from the collaboration of key representatives of the Ministry of Finance, including Gilson Gomes Pina (National Director of Planning), Jose Luis Semedo (National Director of Budget and Public Accounting), Recilete Joia (Director of Public Accounting Services), Mirizaida Almeida Santos (Director of Budget Services) and Sandeney Fernandes (SOE Oversight Unit Coordinator). The team is also grateful for the data, inputs, and support from all the staff in the Ministry of Finance, as well as various other sectoral ministries, departments, and agencies. Chapter 1 on macro-fiscal context included Daniela Vanina Dborkin, with inputs from Luciana De la Flor Guiffra, John Nana Darko Francois and Tomas Agustin Picca. Chapter 2 on opportunities for domestic revenue mobilization included Silver Namunane, Waewnet Sukkasem (tax revenue trends, PIT, VAT and CIT productivity analysis), Eduardo Malasquez and Daniel Valderrama (distributional effects of removing VAT exemptions), Hitomi Komatsu (gender and tax), Evan Harold Blecher (health excise taxes), Alexandra Andrea Maite Campmas and Sahil Gill (environmental taxes). Chapter 3 on opportunities for expenditure rationalization included Daniela Vanina Dborkin (expenditure trends, composition, rigidity), Eduardo Malasquez and Gabriela Paczko Bozko Cecchini (public sector wage bill premium), John Nana Darko Francois (efficiency analysis), Luciana De la Flor Giuffra (gender-responsive budgeting), Oscar Ishizawa, Alex Giron Gordillo and Rafael van der Borght (climate and disaster risk management), Emily Elaine Gardner (education) and Jorge Baretto (health). Chapter 4 on accelerating the SOE reform agenda drew on the analysis prepared under the integrated SOE framework, was led by a multi-sectoral Bank team including Marc-Anton Pruefer, Immanuel Steinhilper, Anna Carlotta Allen Massingue, and Dennis Sanchez Navarro. The team included Philippe Neves, Dusko Vasiljevic, and Guilherme Kono. Laurent Mehdi Brito and Raluca Georgiana Golumbeanu contributed valuable technical insights to select sections. The team would like to thank Micky Ananth, Theresa Adobea Bampoe, Pedro Soares and Vania Lopes for providing logistic and administrative support, Marco Medina Silva for communications support, Fiona Hinchcliffe for editorial support, Djalita Fialho for the translation to Portuguese and Christian de Rosa for the design and layout of the report. Public Finance Review - Page 10 Executive Summary How can Cabo Verde create fiscal space to tackle persistent challenges that Moreover, continued capitalization of underperforming SOEs (which averaged 1 include high debt and rigid budgets, while allowing this small, open, but percent of GDP over the last five years) adds to the fiscal burden, compounded vulnerable archipelagic economy to develop sustainably? Cabo Verde has by risks such as rolling over guarantees and the de facto servicing of on-lent made a strong recovery from recent shocks: robust growth and improved debt, while increasing climate change impacts further strain public finances. revenue mobilization have contributed to reduce fiscal deficits and lower public debt1. However, persisting fiscal challenges need to be urgently addressed to Addressing these challenges calls for urgent strategic fiscal reforms - some of support long-term fiscal sustainability. First, public debt remains high compared which the authorities have already started to implement. In the aftermath of to historical levels and debt servicing is absorbing over a third of revenues. the pandemic, the Government of Cabo Verde (GoCV) is pursuing a renewed Although the risk of external debt distress has improved (to moderate in 2022), fiscal consolidation agenda aimed at putting public debt as a share of GDP on a debt sustainability rests on economic growth remaining above the cost of decisive downward trajectory. Anchored in the Strategic Plan for Sustainable borrowing – an increasingly challenging prospect amid reduced access to Development (PEDS II) for 2022–2026, the fiscal strategy sets ambitious concessional financing and vulnerability to exogenous shocks. Second, the targets: reducing central government public debt to below 100 percent of GDP budget has become highly rigid over the last decade, limiting room for fiscal by 2026 (estimated at 109.6 percent of GDP in 2024, excluding SOE debt) and maneuver. Third, domestic revenue mobilization has consistently fallen short of eliminating the primary fiscal deficit by 2026, with a modest surplus (of around 1 spending needs. Notable reforms are ongoing, but further action is warranted – percent of GDP) expected in the near term. While lower public debt levels and including reducing revenues foregone from tax incentives – to ensure fiscal fiscal deficits suggest ongoing efforts are bearing fruit, more is warranted to sustainability. Finally, state-owned enterprises (SOEs) remain a source of fiscal ensure that fiscal reforms are implemented effectively, are sustainable and pressure and risk. promote a growth-friendly consolidation strategy2. The latter is particularly important as growth in Cabo Verde tends to be driven by exogenous factors Despite positive developments, several structural challenges continue to (tourism demand) and investments in key infrastructure are needed to propel constrain Cabo Verde’s fiscal space. Cabo Verde’s economy faces high service activity in the remainder of the economy. costs driven by connectivity and infrastructure deficits, a heavy reliance on an all-inclusive tourism model, and limited linkages between foreign direct investment (FDI) and the broader economy. Post-pandemic growth has been buoyed by tourism and improvements in revenue collection. However, seventy percent of Cabo Verde’s budget is considered rigid (for instance, together, interest and wage bill spending alone account for over 40 percent of total spending). This is very high by international standards, and reduces room for fiscal maneuver, which is much needed for expenditure rebalancing. 1Growth averaged 9.5 percent between 2021 and 2023, with revenues at almost 24 percent over the same period. 2Growth-friendly fiscal consolidation involves managing government finances in such a way that reduces fiscal deficits and public debt while minimizing negative impacts on growth. Public Finance Review - Page 11 Executive Summary While there has been some uptake of recommendations from the previous The report includes recommendations that could lead to a potential fiscal gain of Public Expenditure Review (PER, 2019), the outcome has been mixed. In part, 3.65−4.15 percent of GDP (see Table E.1), which would be supported by this is reflective of the challenging context created by exogenous shocks such additional public finance measures to support the consolidation agenda (see as the pandemic. For instance, while there have been revisions to the Tax Benefits Table E.2). In the midst of heightened global uncertainty, including regarding Code (in 2020), these have fallen short of addressing key sources of fiscal sources of external financing, the proposed actions are crucial to enhance Cabo leakages. Similarly, adjustments to the application of VAT on imported goods has Verde’s fiscal sustainability in the face of shocks. contributed to reduce foregone revenues but the planned comprehensive revision of the VAT Code and exemptions list has been delayed given concerns STRENGTHEN REVENUE MOBILIZATION FOR FISCAL SUSTAINABILITY about the socio-economic impact of these at a time of considerable uncertainty (i.e. 2020−2022). On the spending side, efforts have been made to safeguard Reducing the tax gap and raising the tax effort remain critical for generating social spending and ensure equity in access to public services – as is the case of fiscal space in a sustainable manner. Revenue performance in recent years has the elimination of secondary school feeds. However, spending efficiency benefitted from windfall collection from SOE restructuring (e.g. capital gains in remains a concerns and key drivers of spending pressures– e.g. goods and 2023), however the one-off nature of these means they are not sustainable. services - persist. Instead, efforts ought to remain focused on enhancing tax revenue collection instead to support spending needs. While total tax revenue increased from 16.9 Given the above, this Public Finance Review (PFR) offers concrete policy percent of GDP in 2012 to 19.3 percent in 2023, it remains below peer country options and measures to create additional fiscal space of up to 4.15 percent of averages of around 20 percent. While shares for value added tax (VAT), taxes on GDP to support the Government of Cabo Verde’s (GoCV) ongoing fiscal international trade and personal income tax (PIT) are comparable to peers, consolidation efforts. The PFR draws on outcomes from earlier expenditure corporate income tax (CIT) and excises are below peers – in part reflecting reviews and provides additional policy recommendations aimed at enhancing generous investment incentives that undermine revenue collection. In fact, the revenue mobilization (chapter 2), strengthening expenditure efficiency, heavy reliance on indirect taxes suggests there is some scope to improve the cementing budget credibility by improving planning and execution of public progressivity of the tax system. The analysis in this report indicates that Cabo investment projects (both chapter 3), and accelerating the SOE reform agenda Verde’s tax potential is around 30 percent of GDP – implying an overall tax gap of (chapter 4)3. Together, these measures are designed to identify additional fiscal about 11 percentage points. This highlights significant untapped potential, with space needed to support critical growth-enhancing investments, reduce the need to focus on reforms to strengthen tax administration, reduce excessive vulnerabilities, and promote long-term economic and fiscal resilience in Cabo tax exemptions, and ensure a more progressive and efficient tax structure. Verde. 3 The previous Public Expenditure Review (PER), spanning 2004−2017, was completed in 2019. Recommendations from that review are presented in Annex 1.3. Public Finance Review - Page 12 Executive Summary Cabo Verde's tax potential has increased over the past decade, emphasizing room for Differences in the headline CIT rate and top marginal PIT rate might explain the added fiscal gains lower PIT collections as individuals opt to incorporate businesses because of the lower CIT rates. 35 0,70 Accelerating efforts to streamline tax incentives – particularly VAT-linked 30 0,68 ones – is critical to reduce revenue leakages. Numerous tax incentives across the main tax instruments have resulted in large shares of revenues forgone, 25 0,66 averaging 5.8 percent of GDP between 2018 and 2022. For example, while VAT 20 0,64 remains the largest contributor to tax revenues, accounting for about 40 percent of total revenue collected, there is room for improvement. Streamlining 15 0,62 VAT-exempt and zero-rated supplies could generate additional fiscal space of 1−1.5 percent of GDP while also reducing enforcement costs. While the current 10 0,60 practice of exemptions is largely regressive, implementing complementary policy measures to strengthen the social protection system and safety nets will 5 0,58 be important to mitigate any potential impact on the most vulnerable households. - 0,56 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Tax gap - left axis Tax collection - left axis Tax effort - right axis Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool, 2024. A critical challenge is the underperformance of personal income tax (PIT) collections. While PIT revenue grew from 2.8 percent of GDP in 2013 to 3.6 percent in 2017, it has since declined, apart from a brief increase in 2020. The average PIT productivity for Cabo Verde was estimated at 0.119 during 2018−2022, which is higher than for LMIC peers (0.098), but lower than averages for SSA (0.134) and UMICs (0.140)4. 4 PIT productivity, measured as the ratio of the PIT as a share of GDP to PITs top marginal tax rate, captures how much of the potential tax base is in the tax net. Public Finance Review - Page 13 Executive Summary Streamlining tax incentives, which represent a large source of lost revenues, is key ... ...particularly those VAT linked incentives 7 3,5 2,95 Percent of GDP, 2019−2022 avg Percent of GDP, 2019−2022 avg 5,8 3,0 6 5,1 5 2,5 4 2,0 3 1,5 2,4 2,1 2 1,0 1 0,5 0,24 0,18 0,14 0,20 0 0,0 Cabo Verde Regional Structural Aspirational IRPC/CIT VAT - Domestic REMPE - IRPC REMPE - VAT IRPS/PIT Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool, 2024. PFR tool, 2024. Public Finance Review - Page 14 Executive Summary Addressing investment incentives is also important. Reviewing and ultimately below European Union minimums. Reforming and increasing excise taxes on eliminating contractual conventions would enhance the fairness of the tax tobacco and alcohol could help strengthen revenue collection, discourage system, improve tax productivity, and prevent government subsidization of harmful consumption, and improve public health outcomes. Estimates suggest low-wage employment. This could yield gains of at least 0.2 percent of GDP. that a recalibration of ad valorem and specific rates on tobacco and alcohol Should there be a need to take a phased approach, the government should products could result in modest fiscal gains of 0.15 percent of GDP. repeal provisions that allow firms to enjoy reduced rates after four years of receiving contractual incentives, as the economic benefits are not substantial Aligning fuel taxes with carbon content would have important revenue impact though beyond this period. More broadly, eliminating tax exemptions—including those sectoral and welfare impacts need to be mitigated not in use—is critical to reduce potential leakages. Tax gap CVE per liter CVE per liter, equivalent to a CVE 10500 carbon tax Environmental taxation, especially with regards to fuels, could bring important fiscal gains – though implementation needs to consider ongoing sectoral reforms. A well-designed carbon tax has the potential to achieve a 30 double dividend by reducing emissions while supporting economic growth CVE per liter through strategic revenue recycling. IMF analysis shows that a modest carbon tax would allow for emissions mitigation alongside considerable 20 revenue-generating potential – amounting to near 1 percent of GDP by 2035. Similarly, revisit existing fuel taxes and duties to ensure these are applied based on carbon content is important. For example, a careful, and phased, upward revision of carbon prices in particular applied to diesel fuels in the power sector – 10 considering ongoing sector reforms – could drive investment in renewable energy and energy efficiency improvements, while also contributing to higher revenues. 0 S uper gasoline Regular gasoline Kerosene (illuminating oil) Diesel Domestic fuel oil Light fuel oil Heavy fuel oil I Heavy fuel oil II Liquefied butanes Another area of untapped potential is health taxation. Compared to peer countries, Cabo Verde’s tobacco and alcohol taxes are relatively low, particularly for wine and spirits. Effective tax rates on wine and spirits being lower than on beer may encourage substitution, undermining tax policy effectiveness. Source: World Bank staff estimates based on official data. Energy prices for January 2025 are used and are available here. Similarly, while cigarette taxes exceed ECOWAS levels, they remain significantly Public Finance Review - Page 15 Executive Summary Additional measures could be implemented to strengthen tax administration Public investments have played a negligible role in spurring growth... efforts. This includes assessing the implementation of Pillar 2 of the 2021 OECD/G20 Inclusive Framework on BEPS by analyzing the potential impact of the global minimum tax and the policy implications, including the possible 20 introduction of a domestic top-up tax. Cabo Verde should also consider Contribution to overall growth (percent) 15 implementing the Subject to Tax Rule to ensure that profits are taxed where 10 economic activities generating the profits are performed, and where value is created. Strengthening transfer pricing auditing capacity is crucial to monitor 5 and regulate intra-group transactions effectively, thereby preventing base 0 erosion and profit shifting. 2015 2016 2017 2018 2019 2020 2021 2022 2023 -5 ENHANCE FISCAL EFFICIENCY TO SUPPORT SUSTAINABLE GROWTH -10 Achieving the ambitious goal of a growth-friendly fiscal consolidation -15 trajectory requires identifying opportunities for efficiency savings that could -20 be re-allocated productively to pursue economic development objectives. Public spending in Cabo Verde is constrained by high budget rigidity and -25 inefficiencies. While public spending is below both structural and aspirational peers and has remained relatively stable in terms of GDP over the last decade (around 28 percent), it has become increasingly skewed towards current Contribution of other factors Contribution of government capital spending, driven by the wage bill, goods and services, social benefits and subsidies. A relatively high level of overall budget execution over the past five Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool, 2024. years masks lagging in key spending components including public investment, which dampens growth. Public spending also exhibits high procyclicality, which undermines the effectiveness of expenditure policy as a stabilization tool. Public Finance Review - Page 16 Executive Summary ...in part reflecting low spending and execution levels sustainability. The PCFR benefits include clearer career paths and reduced wage disparities but adds budget rigidity. Simulations using wage bill data can assess the impact and feasibility of the new remuneration table on the fiscal balance, 14 providing implementation alternatives. 12 Revisiting the way subsidies are provided, including to private entities operating concessions, is also key. Given the rapid increase in subsidies paid 10 over the past decade – from 0.1 percent of GDP in 2018 to 1 percent in 2023 – a Percent of GDP thorough review of the drivers and rationale for their provision is important. The 8 authorities have already taken important steps to address the weaknesses of the 6 inter-island maritime concession contract, but are encouraged to further review the use of subsidies to support the operations of private concessionaires. Policy 4 recommendations linked to SOEs are discussed in more detail in Chapter 4, which highlights the increasing support to such entities through below-the-line 2 operations. 0 Optimizing goods and services (G&S) spending for greater efficiency in public 2015 2016 2017 2018 2019 2020 2021 2022 2023 spending. Spending on G&S continues to rise, up 14 percent in real terms from 2019 to 2023. Health, general public services, and economic affairs account for Cabo Verde Scructural Aspirational 60 percent of this spending, with much of non-health spending linked to travel, accommodation, and technical assistance. The discretionary nature of this Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank spending suggests potential short-term gains from tighter controls, as PFR tool, 2024. highlighted in the previous public expenditure review (2019). Improving Cabo Addressing wage bill pressures to ensure fiscal sustainability. The wage bill is Verde’s procurement system could yield significant savings. Tighter controls higher than aspirational peers – and spending pressures are rising. It consumes and a more effective procurement system, and gradually reducing spending on 35 percent of Cabo Verde’s budget and 43 percent of revenues, more than in technical assistance and professional contracts to the 2018−2022 average, peer countries. While public employment levels are similar to structural peers, could see cumulative fiscal gains of 0.6 percent of GDP over three years. the new public administration career and remuneration plan (Plano de Carreiras, Funções e Remunerações, PCFR) needs thorough assessment for fiscal 5 Extreme poverty (under the $2.15 international poverty line, PPP2017) is estimated to have reached 2.3 percent in 2023. https://ine.cv/wp-content/uploads/2024/10/nota-de-imprensafinal-resultados-da-estimativa-de-pobreza-2022−swift-002.pdf Public Finance Review - Page 17 Executive Summary Ensuring sustainability of social protection reforms. Important reforms to the extent been constrained by the early phase of the project cycle, evidence points social protection system have improved the progressivity of expenditure. to weaknesses in planning. Strengthening PIM systems to improve the planning However, it needs to be sustainable. Social protection spending has increased of public investment according to the project budget cycle is key to increase from an average of 2.5 percent of GDP in 2012−2017 to an average of 3.4 percent budget credibility as well as resource allocations. in 2022−2023, reflecting system improvements and enhanced benefits. With the GoCV’s target to eradicate extreme poverty by 20265, ensuring the More efficient and climate-conscious spending should have positive long-term sustainability of these expenditures is crucial for both fiscal contributions on growth. Cabo Verde’s capital stock lags behind sustainability and human development. This includes accelerating the peers—including infrastructure quality. There are significant inefficiencies in diversification of financing sources for the Fundo Mais, which reduces public investment in roads, ports, and transport infrastructure more broadly. dependency on tourism receipts to safeguard the budget from exogenous Analysis shows that scaled up public investment needs to be accompanied by shocks. reforms to eradicate sources of inefficiencies: had Cabo Verde eliminated all inefficiencies between 2017 and 2019, it could have reduced its investment Enhancing efficiency in human capital spending. While spending on human spending by an average of 40 percent. By eliminating all inefficiencies today, its capital has been safeguarded over the past decade, more efficient spending is infrastructure quality could be enhanced by nearly 20 percentage points (pp) on critical and can be achieved using cost-effectiveness analyses. Spending on current average quality levels of 54 percent. Addressing inefficiencies also education has averaged about 5 percent of GDP, above peers, while health includes strengthening the disaster and climate resilience of public investments, spending increased from 1.9 percent of GDP in 2012 to 3 percent in 2023. which will ease the impact of shocks on public finance and safeguard fiscal Although education and health outcomes are generally better than for structural space in the face of elevated climate vulnerabilities. and aspirational peers, addressing inefficiencies in both sectors could provide additional fiscal space for human capital investment. Identifying inefficiencies in secondary education and conducting comprehensive costing of health services are crucial for budget planning and new health system investments, especially as spending pressures continue and resources are constrained. Improving public investment management (PIM) is important for better budget predictability and execution. Public investment spending has plummeted over the last decade (from around 10 percent of GDP in 2013 to 1.7 percent in 2023), reflecting not only fiscal consolidation efforts but also planning and implementation challenges. While public investment execution has to an Public Finance Review - Page 18 Executive Summary Improving public spending efficiency could bring notable gains in education and health outcomes 100 100 90 90 Gains in Units of Education Outcome Gains in Units of Health Outcome 80 18,36 80 70 70 71,30 60 16,59 60 50 50 53,33 40 40 30 30 20 20 10 10 0 0 Level of Education Secundary School Infant Survival Rate Life Expectancy Immunization Measles Immunization DPT Actual Education Outcome (Average: 2015-2019) Health Outcome (Average: 2015-2019) Potential Full Gains in School Enrollment (Net) Potential Full Gains in Health Outcome Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool, 2024. PFR tool, 2024. Public Finance Review - Page 19 Executive Summary STRENGTHEN SOE REFORMS TO ENHANCE FISCAL SUSTAINABILITY Spending on SOEs is comparable to an increasing share of priority spending AND ECONOMIC EFFICIENCY 6 90% SOEs have played a significant role in Cabo Verde’s development trajectory, 80% 5 but are a growing source of fiscal risks. While direct budgetary support to SOEs 70% remains relatively low, below-the-line transactions, including capitalizations and on-lending, averaged 2.2 percent of GDP between 2018 and 2023. SOEs’ total 4 60% liabilities for the 35 companies under the portfolio of the SOE oversight unit 50% (Unidade de Acompanhamento do Setor Empresarial do Estado, UASE) reached 3 50.6 percent of GDP in 2023, up 7.2 percent from 2020. The bulk of liabilities are 40% concentrated in a few non-performing entities such as ELECTRA (electricity and 2 30% water), TACV (air transport), IFH (housing), SDTIBM (tourism), and CVT (telecommunications). These entities rely heavily on explicit and implicit 20% 1 government support, increasing fiscal vulnerabilities. To create additional fiscal 10% space and transition towards more productive spending, accelerating the SOE - 0% reform agenda—particularly for poor-performing entities in the transport 2019 2020 2021 2022 2023 sector—is essential. Expenditures on SOEs, Share of health Share of education excluding guarantees (CVE bn) expenditure (RHS) expenditure(RHS) Persistent fiscal risks from SOEs require comprehensive reform measures. Despite past restructuring efforts, SOEs continue to receive significant public Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank support, with spending on SOEs in 2019–2023 averaging 2 percent of GDP, PFR tool, 2024. equivalent to more than half of the share spent on health. Moreover, the high exposure of commercial banks to sovereign debt raises concerns about A key priority is enhancing transparency and fiscal risk management. While financial stability, as many SOEs carry guaranteed loans that pose potential fiscal SOE transparency in Cabo Verde is relatively strong, ensuring the timely risks. Addressing these challenges requires a comprehensive strategy that publication of SOE annual and audit reports is essential, particularly for TACV, includes enhancing transparency, enforcing financial discipline, restructuring whose reports have not been published in recent years, deviating from non-performing SOEs, and strengthening governance. international good practices. Strengthening reporting on transactions between SOEs and the government, especially for on-lent loans, would provide a clearer picture of potential fiscal costs and identify cascading arrears risks. Additionally, Public Finance Review - Page 20 Executive Summary improving disclosure of non-financial information, including environmental, core business. This would help enhance operational efficiency and overall social, and governance (ESG) and climate-related risks, would offer a more performance, and ensure that ASA remains focused on its core business of holistic view of SOE performance and their broader economic impact. managing airport infrastructure and air traffic navigation while enhancing revenues for the state. Accelerating the implementation and application of guarantee fees to all sovereign guarantees (including retroactively) is critical. This would help Finally, a careful approach is required to operationalize Parpública. The reflect the true fiscal risks associated with SOEs, as mandated by Decree-Law creation of Parpública has the potential to further strengthen the SOE ownership 42/2018 and Ministerial Order 96/2022. Ensuring that interest rates on function in Cabo Verde – but only if well implemented. However, SOE holding guaranteed debt—which are often twice as high as those on treasury structures come with their own set of challenges that will require careful issuances—are properly priced to reflect sovereign risk is also critical. Moreover, preparation and management. For instance, it is crucial to define a clear division the Treasury should play a more active role in SOE financing negotiations to of responsibilities and carefully manage any overlap in roles and functions of prevent excessive fiscal exposure and ensure that the costs of guarantees are Parpública with UASE and other existing structures to avoid duplication and accurately accounted for. ensure efficient coordination. A well-defined governance structure for Parpública that appropriately balances necessary management autonomy with Restructuring and deleveraging non-performing SOEs is another critical step. strong accountability to the state and the public is essential. Exchanging For example, deleveraging TACV’s legacy debt by converting it into government knowledge and experiences with other centralized SOE ownership institutions, equity would help improve the company’s financial position, while allowing the including SOE holding companies, and exchanges with other SOE oversight GoCV to renegotiate loan terms under more favorable conditions. However, this entities on the overall institutional setup and specific technical issues could be should be tied to strict performance targets to prevent further fiscal drain. helpful. Additionally, it is essential to avoid repeating past mistakes, such as expanding TACV’s capacity and routes without a proven profitable business model – such By strengthening governance, enforcing financial discipline, and restructuring expansions have historically contributed to financial instability in the airline liabilities, Cabo Verde can reduce fiscal risks, improve SOE performance, and sector. free up resources for more productive spending. Additionally, exchanging knowledge and best practices with countries that have successfully reformed Promoting and enforcing better SOE capital discipline is important. This their SOE oversight frameworks could provide valuable insights to support these applies to the airports and air safety company (ASA), for example. Although ASA efforts. has a robust cash generation profile and minimal investment requirements, promoting and enforcing better capital discipline will ensure that its balance sheet is not used for investing in unprofitable ventures or activities outside its Public Finance Review - Page 21 Executive Summary TABLE E.1. POTENTIAL FISCAL GAINS FROM DOMESTIC REVENUE MOBILIZATION AND EXPENDITURE REFORMS Time frame/ Impact Impact Policy area Policy action Fiscal impact (estimate, percent of GDP) feasibility on efficiency on equity Revenue mobilization VAT exemptions and Streamline the list of exempt and reduced-rate goods6 ST 1.0 - 1.5% + -/+ zero-rating Review ZEET incentives to minimize VAT leakage ST Implement mandatory turnover threshold Potential unclear (reduces cost VAT (other) MT + TBC for VAT registration of administration) Trade taxes Proceed with full implementation of ECOWAS CET 1% MT + TBC Contractual convention Eliminate contractual incentives At least 0.2% ST + + + (longer Health excise tax Raise tobacco and alcohol excise 1.5% ST + lifespan) Expenditure Gradually review professional contracts and Goods and services technical assistance, reverting in three years to 0.6% MT + -/+ spending average 2018-2022 Wage bill Align PCFR reform with a sustainable fiscal path Work ongoing MT + -/+ Public investment Proceed with full implementation of ECOWAS CET 1% ST + + management Total potential fiscal gain 3.65-4.15% 6 Estimated fiscal gains do not factor in costs of compensatory social transfers that would be introduced to shield most vulnerable households from the impact of removing the VAT. Public Finance Review - Page 22 Executive Summary TABLE E.2. ADDITIONAL MEASURES TO SUPPORT THE CONSOLIDATION AGENDA Time Frame Policy area Policy action Feasibility Revenue mobilization Strategic framework Leverage important fiscal planning tools – such as the Medium-Term Revenue Strategy – to support the revenue mobilization agenda ST International taxes Assess the implementation of Pillar 2 of the 2021 OECD/G20 Inclusive Framework on BEPS ST-MT Improve the productivity of corporate income tax and minimize tax planning behavior by both professionals and firms that claim Direct taxes ST to create more jobs, Expenditure Budget credibility Enhance budget credibility through strengthened multi-phased year budgeting ST Spending efficiency Analyze the cost-effectiveness of spending in key sectors—such as education and health—as a key tool for decision making ST-MT Debt management Prepare and publish a comprehensive Medium-Term Debt Strategy, and accompanying annual borrowing plans ST Fiscal frameworks Explore the use of fiscal rules, including (i) a binding debt/GDP rule and (ii) cap on wage bill spending, to support fiscal sustainability ST SOE corporate governance Ownership and oversight function Carefully approach the operationalization of Parpública as a new SOE portfolio holding company ST Ensure complete and timely publication of SOE annual and audit reports – including as a priority for TACV, as well as aggregate Transparency and reporting MT portfolio reports, encouraging inclusion of key non-financial information. Assessing and addressing fiscal risks Fiscal risks from guarantees Accelerate the implementation of Ministerial Order 96/2022 and apply guarantee fees to all sovereign guarantees (including retroactively) ST Ensure adequate costing for Through MoF involvement, ensure reduction of interest rates on SOE borrowing under government guarantees ST government guarantees TACV legacy debt Consider deleveraging legacy debt from TACV, with a view to improving the company’s financial position and reduce costs to GoCV. ST TACV operations and future Prioritize TACV’s profitable routes, eliminate, or reduce unprofitable routes, and restrain capacity growth until an operational MT business model break-even point is clearly indicated. Energy sector unbundling Clearly define parameters for how the newly created entities will interact with each other. MT 1. MACRO-FISCAL CONTEXT Public Finance Review - Page 24 Understanding The Macro-Fiscal Context 1. Cabo Verde has long been a story of economic success, but growth decelerated in the last decade and has become more volatile – with implications for fiscal performance. Economic growth and social indicators improved significantly after the country’s independence from Portugal in 1975, driven by the tourism sector, remittances, and foreign direct investment. Annual average GDP growth hovered near 7 percent between 1993 and 2008. However, the global financial crisis significantly affected previous achievements, slowing growth to an average of 1.1 percent between 2009 and 2015 (Figure 1.1 and Figure 1.2), with limited productivity gains. Excluding the recent response to the pandemic, the country has struggled to implement countercyclical fiscal policies due to high debt levels, a narrow revenue base and high susceptibility to external shocks. Weak automatic stabilizers and rigid public expenditure structures generally impede quick fiscal adjustments, and institutional limitations can delay policy responses. Structural challenges include a heavy reliance on the all-inclusive tourism model, strong state presence in the economy and limited linkages between sectors benefiting from foreign direct investment (FDI) and the broader economy. 2. This chapter reviews Cabo Verde’s recent macroeconomic developments and considers their impacts on public finances. It begins by outlining recent macro-fiscal developments, with a focus on the real, fiscal and external sectors – including monetary policy. Section 2 discusses key macro-fiscal challenges, including limited economic diversification and heavy reliance on tourism, climate-related shocks, and constraints to female labor force participation. The section also discusses challenges to fiscal sustainability, including budget rigidities and the risks arising from state-owned enterprises (SOEs). Section 3 takes a deeper look at fiscal policy to date, highlighting important limitations. The chapter concludes with policy recommendations—highlighting opportunities for potential medium-term gains from macro-fiscal reforms. 1.1 MACRO-FISCAL DEVELOPMENTS Public Finance Review - Page 26 Recent Macro-Fiscal Developments 3. The pandemic exposed Cabo Verde’s vulnerabilities and halted previous The Central Bank of Cabo Verde (Banco de Cabo Verde, BCV) has tightened its fiscal consolidation efforts. Real GDP growth average of 4.9 percent between monetary policy stance as part of its broader strategy to narrow the interest rate 2016 and 2019, driven primarily by infrastructure investment and private gap with the Eurozone, thereby mitigating capital outflow risks. The BCV raised consumption. However, the pandemic dealt a severe blow to the economy, the policy rate in November 2023 - from 1 percent to 1.5 percent - with three leading to a near 21 percent growth contraction in 2020 due to a sharp reduction additional hikes in 2024, reaching 2.25 percent in December. in tourism activity (see Annex 1.1). The crisis highlighted key structural vulnerabilities, such as strong dependence on the all-inclusive tourism model, 5. Near-term prospects are favorable, but subject to downside risks. absence of buffers to shocks, and the poor performance of SOEs. It also eroded Improvements in air connectivity and sustained growth in tourist arrivals, along previous fiscal gains, turning a primary surplus of 0.8 percent of GDP in 2019 into with continued implementation of structural reforms aimed at improving public a deficit of 6.6 percent in 2020; and raised public debt – including SOE sector efficiency and the business environment, will keep growth stable at guaranteed debt – to a record high of 157.7 percent of GDP in 2021. around 5 percent over the medium term. The overall fiscal deficit widened to an estimated 1.1 percent of GDP in 2024, reflecting higher public investments 4. Cabo Verde’s economy is recovering well from these shocks, largely execution, one-off expenditures related to local elections, and enhancements thanks to increased tourist arrivals and capacity. Growth averaged 9.5 percent to social programs, coupled with lower non-tax revenues. However, the overall between 2021 and 2023, which includes a sharp rebound in 2022 (15.8 percent). deficit is expected to narrow to below 1 percent over the medium term, On the demand side, the main drivers of the post-pandemic recovery were supported by robust revenue collection. Nonetheless, the outlook is subject to exports and private consumption (Figure 1.3), while sectors linked to the tourism downside risks, primarily related to SOE performance, global uncertainties and sector supported the economy from the supply side. Continued strengthening climate. While public debt is on a downward path, and mostly concessional, in tourism activity, along with a gradual recovery in agriculture, suggest growth servicing costs account for over a third of revenues and pose an additional exceeded 7 percent in 2024. The rebound in tourism, and general easing of source of risk. international food and fuel prices, has also allowed the current account deficit to narrow. Financing of the external position relies primarily on FDI and concessional loans. Gross international reserves now cover over 5 months of prospective imports, well above the level of 3.6 months recommended by the International Monetary Fund’s 2024 External Stability Assessment (ESA)7. Headline inflation – which had accelerated sharply to 7.9 percent in 2022 on the back of rising international commodity prices in the context of the global geopolitical tensions and global supply chain disruptions – moderated in 2023 to 3.7 percent, and fell further to 1 percent in 2024. 7 https://www.imf.org/en/Publications/CR/Issues/2024/07/30/Cabo-Verde-Fourth-Review-of-the-Arrangement-Under-the-Extended-Credit-Facility-and-First-552798 Public Finance Review - Page 27 Recent Macro-Fiscal Developments FIGURE 1.1. FIGURE 1.2. ECONOMIC GROWTH DECELERATED AFTER … AND HAS BEEN MORE VOLATILE THAN IN THE GLOBAL FINANCIAL CRISIS... MOST PEER COUNTRIES (2000-2022). GDP Growth Standard Deviation of GDP Growth Percentage Percentage Points 20 14 15 12 10 10 5 0 8 -5 6 -10 4 -15 2 -20 -25 0 Cabo Verde Structural Aspirational 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021P 2022P 2023P Source: World Bank staff estimates based on World Economic Outlook and National Institute of Source: World Economic Outlook. Note: dots represent countries within each group. Structural Statistics (INE) peers: Bhutan, São Tomé and Príncipe, Samoa and Vanuatu. Aspirational peers: Maldives, Mauritius, Seychelles, St. Kitts and Nevis and St. Lucia. Public Finance Review - Page 28 Recent Macro-Fiscal Developments FIGURE 1.3. FIGURE 1.4. RECOVERY HAS BEEN MOSTLY DRIVEN BY DEFICITS IN THE CURRENT ACCOUNT SERVICE EXPORTS AND PRIVATE CONSUMPTION AND FISCAL BALANCE HAVE NARROWED Contribution to GDP Growth Fiscal balance and Current Account Balance Percent and Percentage Points Percent of GDP 20 2 15 0 -2 10 -4 5 Percent of GDP -6 0 -8 -5 -10 -10 -12 -15 -14 -20 -16 -25 -18 2018 2019 2020 2021P 2022P 2023P 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 Private Consumption Government Consumption Investment Net Exports GDP (real) Fiscal balance Current account balance Source: World Bank Staff Estimates based on INE Source: World Bank Staff estimates based on GoCV Data. 1.2 MACRO-FISCAL CHALLENGES AND RISKS Public Finance Review - Page 30 Macro-Fiscal Challenges and Risks LIMITED DIVERSIFICATION, VULNERABILITY TO SHOCKS 8. The country’s vulnerability to climate-related shocks adds to existing AND STUBBORNLY HIGH INEQUALITY ARE KEY CHALLENGES headwinds to achieving long-term development goals. Efforts to strengthen linkages between the tourism sector and the rest of the economy, improve inter-island connectivity, and enable greater private sector participation, are 6. Reducing dependence on the traditional all-inclusive tourism offering, important. However, the country’s geographic characteristics and location while addressing persistent poverty and inequality, are priorities for the make it highly exposed to natural disasters, and climate change risks have the growth agenda. While the tourism sector plays a key role in the country’s potential to derail Cabo Verde’s achievements and hinder further progress. development, it is highly concentrated and exposes the country to external According to the recent Country Economic Memorandum (CEM), over the last shocks. Despite strong institutional performance (Figure 1.5), Cabo Verde decade, economic losses from disaster and climate-related shocks have continues to face challenges in economic and social outcomes, including higher increased, with annual average losses estimated at one percent of GDP—mainly unemployment rates than its structural peers8, and persistent poverty. While due to climate-related events. About a third of the population are engaged in poverty rates have declined since the pandemic, continued efforts to activities potentially affected by climate change. As such, increasing the strengthen social protection are key to protect the most vulnerable. The resilience of the existing growth model is crucial for sustainable and government is implementing the second Strategic Sustainable Development climate-resilient development, and to protect the most vulnerable14. Plan 2022−2026 (PEDS II), aiming to diversify the economy and enhance resilience. PEDS II also seeks to tackle extreme poverty, particularly in rural areas and among women9, and to reduce moderate poverty and inequality10. 7. Gender gaps in the labor market and the lack of economic diversification are other critical issues. Although the gender gap in labor force participation (LFP) has narrowed, female LFP still lags behind men’s by 13 percentage points (69 percent versus 82 percent). Many women hold vulnerable, informal jobs without social protection, increasing their risk of slipping into poverty11. Efforts to diversify the economy by developing the blue and digital sectors could help reduce economic concentration and create more equitable opportunities. However, the tourism sector still poses challenges for environmental sustainability12 and women's economic participation13. 8 Annex 1.2 describes Cabo Verde’s peer countries used for this assessment. Structural peers: Bhutan, São Tomé and Príncipe, Samoa and Vanuatu. Aspirational peers: Maldives, Mauritius, Seychelles, St. Kitts and Nevis and St. Lucia. 9 According to PEDS II, the extreme poverty rate in rural areas is 20.3 percent, compared to 5.3 percent in urban areas. 10 The most recent Gini coefficient was 42.4 (in 2015)—higher than both structural peers (36.2) and aspirational peers (39.4). (World Development Indicators). 11 The Women, Business, and the Law 2024 report (World Bank, 2024c) indicates low scores for Cabo Verde in critical areas such as childcare support, workplace conditions and pay equality. 12 This includes the overdevelopment of some islands, protection of biodiversity, pressures on natural resources, and threats to coastal and marine ecosystems (World Bank, 2024b). 13 Despite comprising 60 percent of the workforce in accommodation and restaurant sectors, women earn 50 percent less than men, with many on informal, short-term contracts. Women-owned businesses represent 30% of all businesses, but the women behind these businesses face barriers in education, training, and childcare (World Bank, 2023b). 14 World Bank (2023a). Public Finance Review - Page 31 Macro-Fiscal Challenges and Risks FIGURE 1.5. FIGURE 1.6. CABO VERDE TRAILS PEERS ON SOME ECONOMIC, ALTHOUGH IMPROVING, GENDER GAPS IN CLIMATE AND SOCIAL DEVELOPMENT INDICATORS LABOR FORCE PARTICIPATION PERSIST Selected development indicators Labor force participation Index, 0−100 (the best) Percent of population +15 GDP per capita 100 100 Control of corruption Economic growth 75 50 Government effectiveness 0 Low unemployment 50 Low CO2 emissions per Female labor participation 25 GDP unit Low climate risck Low poverty 0 1990 1995 2000 2005 2010 2015 2020 2025 Cabo Verde Scructural Aspirational female male Source: World Bank PFR tool, Climate-driven INFORM Risk. Note: all indicators are standardized from Source: World Bank Gender Data Portal 1 to 100, where a higher value indicates better performance. Average 2016−2022. Public Finance Review - Page 32 Macro-Fiscal Challenges and Risks LIMITED FISCAL SPACE AND ELEVATED DEBT LEVELS Strong growth and prudent borrowing policies have since reduced public debt REDUCE ROOM FOR MANEUVER to 124.7 percent of GDP in 2023 (central government and SOE guarantees)15, though it remains above pre-pandemic levels. At 80.2 percent of GDP in 2023, the central government’s external debt is mostly concessional (Figure 1.10) with 9. Cabo Verde's limited fiscal space calls for strategic fiscal reforms and long maturities and low interest rates. growth-focused consolidation. The combination of low capital expenditure execution and one-off proceeds from SOE restructuring operations 11. This said, the share of costlier domestic debt has picked up in recent years. contributed to reduce the overall deficit in 2023 (Figure 1.7). However, spending While central government’s domestic debt has fallen as a share of GDP, from pressures remain. Cabo Verde has the least fiscal space amongst its peers 52.3 percent in 2021 to 44.5 percent in 2023, its share of total debt has slightly (Figure 1.8), which means there is little room for maneuver in the face of shocks. increased—from 29.5 percent before the pandemic to 36.3 percent in 2023— Budget rigidities—about 70 percent of total spending, are also high by given the reliance on the domestic market to meet the government’s financing international standards, adding to the challenges of expenditure rebalancing. To needs in 2020 and 2021. The average interest rate on domestic financing address important structural challenges, fiscal policy needs to adopt a instruments is 3 percent (higher than the average 1.6 percent on external debt), growth-friendly consolidation strategy that reduces the fiscal deficit and places and maturities average 3.8 years (versus concessional loans of 21 years). This public debt on a downward trajectory, while still accommodating public poses risks of maturity concentration (near 15 percent of GDP during the period investment needs and safeguarding social and human capital spending. This will 2026−2028; Figure 1.11). Amortization of domestic debt accounted for 5 percent require addressing key structural issues, including identifying new sources of of GDP in 2024, with the increasing trend suggesting the need for close domestic revenue, rebalancing public expenditure, improving spending monitoring and prudent debt management. efficiency, and reducing fiscal risks from SOE performance. 12. Significant reliance on debt financing means fiscal space is further 10. Public debt levels are elevated, reflecting past and recent economic constrained by debt servicing obligations. Cabo Verde’s risk of external debt pressures, but are sustainable given the largely favorable borrowing distress is moderate, but the overall risk of debt distress remains high. The most conditions. The pandemic halted efforts to reduce the debt burden, already recently published debt sustainability analysis (DSA; January 2025) shows that strained by debt-financed countercyclical fiscal policies following the global liquidity indicators (debt service to revenue and to export ratios) remain below financial crisis. These policies failed to restore the country to its previous growth their respective thresholds under the baseline, mainly due to the significantly trajectory and led to a rapid increase in central government public debt, peaking concessional characteristics of Cabo Verde’s external debt. 16This said, debt at 115.6 percent of GDP in 2015, from 66 percent in 2010 (Figure 1.9). The fiscal service pressures have picked up in recent years, with debt service payments consolidation program launched in 2016 was reversed by the pandemic, which absorbing over a third of revenues in 2023. pushed public debt to a record 148 percent of GDP in 2021, or 157.7 percent when including SOE guarantees. 15 Much of this increase was driven by the growth contraction in 2020, elevated fiscal deficits, and support to some SOEs, notably CVA and ELECTRA. 16 World Bank (2023c). Public Finance Review - Page 33 Macro-Fiscal Challenges and Risks FIGURE 1.7. FIGURE 1.8. ONE-OFF REVENUES, THE WAGE BILL FREEZE, CABO VERDE HAS LIMITED FISCAL SPACE ... AND LOW CAPITAL SPENDING REDUCED THE FISCAL DEFICIT Change in main fiscal aggregates, 2022−2023 Fiscal space, Average 2018−2023 Percent of GDP Percent of GDP 0,0 85 -0,5 Low debt High debt Fiscal balance, percent of GDP 45 Low fiscal Low fiscal -1,0 Stress Stress -1,5 65 -2,0 -2,5 75 -3,0 5 -3,5 -4,0 375 -4,5 Low debt High debt 365 Balance Tax Revenues Other Revenues Wages and Salaries Goods and Services Interest Payments Capital Expenditures Other Expenditures Balance High fiscal High fiscal Stress Stress 345 5 95 755 795 655 695 455 Public debt, percent of GDP 2022 Revenues Expenditures 2023 Other Aspirational Structural Cabo Verde Source: World Bank staff, based on GoCV data. Source: World Economic Outlook Note: light blue represents a positive contribution to fiscal deficit reduction while orange means a Note: the dashed lines represents the first and third quartiles. negative contribution. Public Finance Review - Page 34 Macro-Fiscal Challenges and Risks FIGURE 1.9. FIGURE 1.10. ... AND PUBLIC DEBT REMAINS ELEVATED FIGURE 1.10. PUBLIC DEBT IS CONCESSIONAL WITH FAVORABLE CONDITIONS ... Public Debt Composition of public debt Percent of GDP Percent of total debt 160.0 Domestic T- External IMF; 3,4 140.0 Bills; 0,9 External World 120.0 Bank; 20,2 Domestic Percent of GDP 100.0 Bonds; 29,3 80.0 60.0 40.0 External ADB; 9 20.0 - 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 External External Other Commercial multilaterals; 7,7 Public debt Average 2000-2004 Average 2005-2009 creditors; 15,4 Average 2015-2019 Average 2020-2023 Average 2010-2014 External Bilateral creditors; 12,6 Source: World Bank and IMF staff estimates. Source: World Bank staff and IMF estimates. Public Finance Review - Page 35 Macro-Fiscal Challenges and Risks FIGURE 1.11. FIGURE 1.12. ... THOUGH DEBT SERVICING PRESSURES ARE GROWTH REMAINS KEY FOR PUBLIC DEBT REDUCTION CONSIDERABLE FOR THE MEDIUM-TERM Central Government debt service Debt-creating flows Percent of GDP Percent of GDP 16 40 14 30 12 20 10 10 8 0 6 -10 4 -20 2 -30 0 -40 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 5- year historical change 5- year projected change IMF World Bank Other Multilaterals Paris Club Primary deficit Real GDP growth Other debt creating flows Changebin Non-Paris Club Commercial Domestic Real interest rate Real Exchange rate depreciation Residual debt Source: World Bank (2023c), Cabo Verde: Joint World Bank-IMF Debt Sustainability Analysis. Source: World Bank (2023c), Cabo Verde: Joint World Bank-IMF Debt Sustainability Analysis. Public Finance Review - Page 36 Macro-Fiscal Challenges and Risks 13. Notwithstanding the 2024 overall deficit expansion, the GoCV remains FISCAL RISKS ARISE FROM STATE-OWNED ENTERPRISES AND committed to fiscal consolidation over the medium term and to placing the NATURAL HAZARDS debt-to-GDP ratio decisively on a downward trend. Fiscal policy is anchored by a primary balance consistent with putting debt on a downward path. Fiscal 15. As discussed in detail in Chapter 4, SOEs’ liabilities pose significant fiscal consolidation will be supported by (i) improving the efficiency of the tax system risks and are largely concentrated in non-performing entities. Data for the 35 and broadening the tax base; (ii) keeping the wage bill below the historical companies under UASE’s (Unidade de Acompanhamento do Setor Empresarial average of 10.2 percent of GDP; and (iii) the ongoing restructuring of the SOE do Estado) portfolio shows total liabilities reached 46 percent of GDP19, with sector, which foresees fiscal gains from privatizations and concessions of about almost two-thirds of these liabilities held by five companies. The budget faces 0.6 percent of GDP in 2024 and 2.1 percent in 2025. 17The authorities are also considerable direct exposure to SOEs’ liabilities, with the stock of guaranteed exploring new modalities for investment financing, in partnership with the private SOE debt at about 8.6 in 2023 (up from 6.4 percent in 2019, Figure 1.13). sector; and debt-swap transactions to support key investments in climate and Below-the-line financing remains high—for example, capitalizations to SOEs environment action. They remain committed to maintaining a low level of totaled CVE 9.16 billion between 2019 and 2023, almost 30 percent higher than domestic borrowing, which will contribute to supporting monetary policy in the average annual amount spent on the health sector during the same period.20 safeguarding the currency peg. As of end 2023, about 19 percent of total SOE liabilities represented debt outstanding for on-lending agreements. This figure increases to 24 percent 14. Strengthening shortcomings in the public financial management (PFM) when accounting for SOEs’ other direct obligations to the state or public entities system is equally important to support fiscal reforms. Although Cabo Verde’s (such as VAT, social security taxes and payroll taxes). most recent Public Expenditure and Financial Transparency Assessment (PEFA) was completed in 2016, many of its findings remain relevant today. 18The 16. SOEs also hold liabilities that can be considered an implicit risk for the assessment recognized strengths, including improvements in budget scope, state. Total SOE liabilities are made up of amounts owed to: (i) suppliers; (ii) the transparency, and policy-based budget formulation, but noted ongoing GoCV and other public entities; (iii) commercial banks; (iv) on-lending; and (v) weaknesses in budget credibility and predictability. These weaknesses remain. other liabilities. When excluding on-lending and guaranteed loans from the For example, transparency in the reallocation of budget funds during the fiscal banking sector, total liabilities amounted to about 28 percent of GDP in 2023. year requires strengthening, and emergency procedures are used occasionally Within this amount, there is a portion that is likely linked to public entities as well without adequate justification. Moreover, while key fiscal policy instruments as suppliers, making it challenging to disentangle. If this amount is not such as the Medium-Term Fiscal Framework (MTFF) and Medium-Term Debt considered, SOEs have liabilities worth about 20.1 percent of GDP that are not Strategy (MTDS) have been prepared, they are for internal consumption and not guaranteed and that could pose a fiscal risk. made publicly available. 17 Amounts are based on expected dividends, fees from concession contracts and privatizations—including partial divestment from Caixa Ecónomica (commercial bank) in 2024, privatization of the pharmaceutical SOE (Emprofac), and the payment of the second tranche of the upfront fee for the airport concession in 2025. 18 PEFA (2016). 19 Government of Cabo Verde - UASE Relatório de Desempenho SPE 2023 4ºT. 20 This refers to financial transactions that are recorded separately from the government's regular revenue and expenditure, typically involving the government's financial assets and liabilities, like investments in other entities or large capital injections, which are considered "exceptional" and not part of the standard budget operations. Public Finance Review - Page 37 Macro-Fiscal Challenges and Risks While the banking sector is well capitalized, it is highly exposed to SOE debt, economic growth tends to decline following a disaster, leading to reduced tax which could be a source of risk. The BCV’s stress tests point to high exposure of revenues and increased expenditure needs. Limited fiscal space and budget commercial banks to sovereign debt as a source of vulnerability or a risk to rigidities (see Section 1.3 and Chapter 3) constrain Cabo Verde’s ability to financial stability. mobilize resources quickly—often resulting in ad hoc emergency measures (such as the 0.5 percent VAT increase after the Fogo volcanic eruption in 17. The GoCV is making progress on the SOE reform agenda. This includes 2014−2015) —or to meet recovery needs, thereby prolonging the disruptive steps to restructure nine SOEs through full or partial divestments, concessions, effects of such shocks. Additionally, climate-related shocks severely impact and public-private partnerships (PPPs) – currently at various stages of poor and vulnerable populations. For example, droughts reduce agricultural implementation. Additionally, in October 2023, authorities launched the SOE output, particularly affecting poor rural households that rely on rainfed farming.24 Manager database, a platform to monitor and evaluate sector performance, enhancing transparency and contributing to better sector reform design. As highlighted in the recent joint World Bank-IMF DSA21, ongoing improvements in SOEs’ risk assessment and fiscal transparency are crucial for mitigating risks from this sector (see Chapter 4 for a detailed assessment of the SOEs). 18. Cabo Verde’s high exposure to natural hazards and climate-related shocks heightens the fiscal, economic, and social risks. While the country is only a small contributor to global greenhouse gas (GHG) emissions22, it suffers from the consequences of natural hazards – including those linked to climate change. An assessment of climate-driven hazard risks23 shows that Cabo Verde is more vulnerable than its aspirational peers, though its vulnerability is similar to its structural comparators’ (Figure 1.14). Cabo Verde has recently been affected by seven consecutive years of drought, while extreme rainfall events have caused floods, negatively affecting livelihoods and key economic sectors like tourism and transport. Without adaptation efforts, the negative impacts of climate change and associated losses are expected to worsen as climate change progresses.Climate-related hazards also pose significant fiscal risks, as 21 World Bank (2023c). 22 At less than 1 million tons of carbon dioxide equivalent (mtCO2e), Cabo Verde’s emissions per capita are aligned with other small islands developing states (SIDS) of similar income level (IMF 2023a). 23 The IMF’s climate driven INFORM Risk Indicator has three dimensions: (i) climate driven hazard and exposure; (ii) vulnerability; and (iii) lack of coping capacity. The first indicator reflects the probability of physical exposure associated with specific climate-driven hazards; the second represents the economic, political and social characteristics of the community that can be destabilized in case of a hazard event; and the third reflects ability to cope with disasters in terms of formal, organized activities and the effort of the country’s government, as well as existing infrastructure which helps to reduce disaster risk (https://climatedata.imf.org/datasets/7cae02f84ed547fbbd6210d90da19879_0/about). 24 On average, between 2007 and 2020, a one standard deviation decrease in annual precipitation was associated with a 3.11 percentage point reduction in the agricultural output growth rate, while a one degree increase in temperature was associated with a further decrease in growth rate of 4.15 percentage points (World Bank 2023a). Public Finance Review - Page 38 Macro-Fiscal Challenges and Risks FIGURE 1.13. FIGURE 1.14. FISCAL RISKS FROM SOES HAVE BEEN INCREASING CABO VERDE IS HIGHLY VULNERABLE TO CLIMATE CHANGE Stock of SOEs guaranteed debt Climate-driven INFORM Risk Index 0−100 (the best) Percent of GDP 12 Risk Indicator 100 10 80 60 8 40 20 6 Hazard & Lack of coping 0 Exposure capacity 4 2 Vulnerability 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 Domestic debt External Debt Cabo Verde Scructural Aspirational Source: World Bank (2023c), Cabo Verde: Joint World Bank-IMF Debt Sustainability Analysis Source: IMF Climate-driven INFORM Risk. Note: higher value indicates better performance. Average 2016−2022. 1.3 FISCAL POLICY: PAST AND PRESENT Public Finance Review - Page 40 Fiscal Policy: Past and Present LIMITED PUBLIC INVESTMENT AND RIGID SPENDING Additionally, the nature of these rigidities has evolved: rigidity linked to UNDERSCORE THE NEED FOR STRONGER DOMESTIC donor-funded capital investment has fallen, but has increased for recurrent expenses such as wages and pensions.28 The high degree of budget rigidity has RESOURCE MOBILIZATION limited fiscal flexibility, forcing the government to rely on cuts to the investment budget, as previously mentioned. 19. Cabo Verde has embarked on ambitious fiscal strategies to address since the GFC, but with mixed outcomes. Capital expenditures have borne the brunt 21. Revenue mobilization has been central to Cabo Verde’s fiscal of the expenditure adjustment over the last decade, with a dampening impact consolidation effort to date, but significant gaps remain.29 While potential on growth. Historically, expenditure reduction efforts have primarily targeted proceeds from SOE restructuring remain important to the budget, enhancing capital expenditure, which contracted from near 10 percent of GDP in 2013 to a revenue mobilization through tax policy and tax administration is critical for fiscal mere 1.7 percent in 2023 (Figure 1.15), leaving Cabo Verde with the lowest capital sustainability. The country’s tax gap is estimated at 11 percent of GDP, far expenditure among peers (Figure 1.16, and Box 1.1). Notably, capital expenditure exceeding peers, with tax expenditures averaging 5.8 percent of GDP from has been significantly under-executed, averaging 44.3 percent of the initial 2019–2022, primarily due to foregone VAT revenues.While VAT productivity has budget since 2020. While lower spending has contributed to improvements in improved and remains higher than peers, income tax productivity, especially for the fiscal balance in recent years, such temporary fiscal gains mask significant corporate taxes, lags behind and has not recovered to pre-pandemic levels structural challenges and raise questions around the adequacy of the fiscal (Figure 1.18).30 Current efforts focus on tax administration reforms, reducing tax stance in supporting growth. An assessment of growth drivers from 2014 to expenditures, and aligning with the ECOWAS Common External Tariff (CET). 2022 shows that government investments have contributed minimally25, if not Developing a Medium-Term Revenue Strategy will be key to consolidating negatively, to growth, particularly since 2016 (Figure 1.17). Recalibrating spending reforms and improving efficiency in tax collection. is thus critical to support the PEDS II and Cabo Verde Ambition 203026 goals of accelerating growth-enhancing public investments. 20. High budget rigidity further complicates fiscal consolidation efforts. Budget rigidities arise from various expenditure items (wages, pensions, and interest payments, among others).27 Cabo Verde stands out for its notably high degree of budget rigidity, averaging near 74 percent between 2018 and 2022, much higher than that of aspirational and structural peers. 25 World Bank (2023c). 26 Government of Cabo Verde (2020). 27 “High rigidity expenditures” by economic classification include the public wage bill, spending on employment contracts, spending on basic services, interest payments, social protections, pensions, non-pension social benefits, transfers to subnational governments, and other rigid expenditures. 28 Please refer to Chapter 3 for an in-depth budget rigidity analysis. 29 See Chapter 2 for a detailed analysis of revenues. 30 In the case of CIT, productivity is estimated as the ratio between revenue collection in terms of GDP and the standard tax rate, while for PIT it is estimated using the highest marginal tax rate. VAT efficiency is measured by the C-efficiency ratio, which shows the ratio of actual VAT collections to the theoretical revenues under a perfectly enforced tax levied at the standard rate on all final consumption without any exemption. Public Finance Review - Page 41 Fiscal Policy: Past and Present FIGURE 1.15. FIGURE 1.16. CAPITAL EXPENDITURES HAVE BORNE THE BRUNT OF ... AND ARE SIGNIFICANTLY LOWER THAN FOR PEERS THE EXPENDITURE ADJUSTMENT IN THE LAST DECADE ... Expenditure composition Capital expenditure Percent of total Percent of GDP 100 14 90 12 80 70 10 60 8 50 6 40 30 4 20 2 10 0 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023* 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Wage bill Capital expenditure Other Cabo Verde Scructural Aspirational Source:World Bank staff estimates. Source: World Bank staff estimates. Public Finance Review - Page 42 Fiscal Policy: Past and Present FIGURE 1.17. FIGURE 1.18. GOVERNMENT CAPITAL EXPENDITURE HAS NEGATIVELY INCOME TAX PRODUCTIVITY IS LOWER CONTRIBUTED TO GROWTH THAN IN PEER COUNTRIES Contribution to real GDP growth PIT and CIT productivity ratios 6 6 0,16 5 0,14 5 0,12 4 Percentage points 4 0.1 3 Percent 3 0.08 2 0.06 2 1 0.04 0 1 -1 0 0 AV. 2014-2015 AV. 2016-2019 AV. 2020-2022 AV. 2014-2022 PIT Productivity CIT Productivity Contribution of other factors Contribution of Government Capital to Growth Real GDP Growth (RHA) Cabo Verde Regional LMICs UMICs Source:World Bank (2023c), Cabo Verde: Joint World Bank-IMF Debt Sustainability Analysis. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance and World Bank PFR tool. Note: Due to limitations in data availability for peer countries within the structural and aspirational groups, LMICs (lower middle-income countries) and UMICs (upper middle-income countries) are used for comparison purposes. Public Finance Review - Page 43 Fiscal Policy: Past and Present BOX 1.1. HOW SUCCESSFUL HAVE PREVIOUS FISCAL CONSOLIDATION EFFORTS BEEN IN CABO VERDE? Fiscal consolidation has become increasingly important in developing countries given elevated debt levels. The World Bank has developed a tool to analyze episodes of fiscal consolidation with the aim of informing policy strategies. Fiscal consolidation is assumed to consider periods that last three years and where the primary balance has improved by at least 0.5 percent of GDP. The tool allows for setting of parameters defining consolidation episodes and to determine their success. Importantly, it allows for country specific analysis, to evaluate previous consolidation processes. In general, results from implementing fiscal consolidation have been mixed. Successful episodes are those where (i) countries experienced an improvement in the primary balance as a share of GDP; (ii) the debt-to-GDP level was not higher than the year prior to consolidation; and (iii) gaps with debt stabilizing primary balance were eliminated. Only 16 of the 60 episodes observed achieved these goals; with the number reducing to 11 if protecting per capita GDP growth is added. Cabo Verde’s most recent fiscal consolidation episode (2014−17) was not entirely successful (Figure 1.19). According to the tool, the previous consolidation episode occurred between 2014 and 2017. While the primary balance improved from -6.9 to -0.3 percent of GDP, fiscal consolidation was not successful in terms of debt reduction. This episode involved a front-load fiscal consolidation (at least 55 percent of the adjustment was made at the beginning of the process), driven initially by expenditure (through cuts to the investment budget) and later by revenue. Public Finance Review - Page 44 Fiscal Policy: Past and Present FIGURE 1.19. CABO VERDE’S MOST RECENT FISCAL CONSOLIDATION OCCURRED FROM 2014-2017 Debt-creating flows Drivers of changes in the overall balance 40 8 30 6 Percent GDP 20 4 ∆ D/GDP 2 10 0 0 -2 -10 -4 -20 -6 -30 -8 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Primary Deficit Real GDP growth Nominal interest rate contribution ∆ Compensation ∆ Use of G&S ∆ Social benefits ∆ Subsidies Exchange rate depreciation Inflation Other (residual) ∆ Interest ∆ Grants ∆ Other ∆ Consum. fixed ∆ total D/GDP ∆ Net invest. nonfin. ∆ Expenditure capital Drivers of expenditure Drivers of revenue 8 6 6 4 4 Percent GDP Percent GDP 2 2 0 0 -2 -4 -2 -6 -4 -8 -10 -6 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 ∆ primary revenue primary expenditure ∆ net interest expense ∆ overall balance ∆ PIT ∆ CIT ∆ Property ∆ VAT ∆ Excise ∆ Trade taxes ∆ Other taxes ∆ Grants ∆ SSCs ∆ Other revenue ∆ Total revenue Public Finance Review - Page 45 Fiscal Policy: Past and Present PROCYCLICAL FISCAL POLICY UNDERSCORES THE NEED FOR AUTOMATIC STABILIZERS 22. Fiscal policy has largely been procyclical—except during the pandemic—highlighting the need to reinforce automatic stabilizers. Over the past decade, fiscal policy has tended to align with the business cycle, failing to act in a countercyclical way. This has often resulted in fiscal loosening during economic expansions (procyclical loosening, top-left quadrant in Figure 1.20) and fiscal tightening during downturns (procyclical tightening, bottom-right quadrant). The cyclically adjusted primary balance (CAPB) has usually improved when the economy is growing below potential, and deteriorated during economic booms. The notable exception was in 2020, when fiscal policy took a countercyclical approach, primarily driven by increased spending during the pandemic. 23. Expenditure has also shown procyclical behavior over the last two decades. From 2000 to 2023, expenditure exhibited a positive correlation with GDP (0.19), showing procyclical behavior (Figure 1.21) that is more pronounced than most peers, except for the Maldives, Mauritius and St. Kitts and Nevis (Figure 1.22). When examining the period up to 2019, results show the correlation was higher (0.42), indicating even stronger procyclicality prior to the pandemic (Figure 1.23). 24. Cabo Verde has struggled to implement countercyclical fiscal policies due to several constraints. High public debt levels limit fiscal space, while dependence on external sources like tourism reduce the government’s capacity to generate income during downturns. The country’s susceptibility to external shocks, and limited access to affordable financing, further restrict its ability to engage in expansionary policies without jeopardizing fiscal health. Weak automatic stabilizers impede quick fiscal adjustments, and institutional limitations can delay policy responses. These factors collectively push Cabo Verde toward procyclical measures instead of countercyclical ones. Exploring actions to strengthen the existing fiscal framework should therefore be considered (see examples presented in Box 1.2). Public Finance Review - Page 46 Fiscal Policy: Past and Present FIGURE 1.20. FIGURE 1.21. FISCAL POLICY HAS GENERALLY BEEN EXPENDITURE HAS GENERALLY PROCYCLICAL IN THE LAST DECADE ACCOMPANIED THE CYCLE Output gap Cyclical componenets of total expenditure and GDP Percent of potential GDP Constant local currency units 10 Procyclical 30 Fiscal 2019 Countercyclical loosening Fical tightening 5 2018 20 2017 0 2023 10 2022 2016 2014 2015 -5 0 -10 -10 2021 -15 Procyclical -20 Fiscal Countercyclical tightening Fical loosening -20 -30 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 -2 -1 0 1 2 3 4 Change in cyclically adjusted primary balance, percent of GDP Expenditure GDP Source: World Bank staff estimates. Source: World Bank staff estimates. Note: estimated using the Hodrick-Prescott filter Note: estimated using the Hodrick-Prescott filter Public Finance Review - Page 47 Fiscal Policy: Past and Present FIGURE 1.22. FIGURE 1.23. EXPENDITURE PROCYCLICALITY HAS BEEN ... AND WAS EVEN STRONGER UNTIL THE AMONG THE HIGHEST OF PEERS... (2000-2023) PANDEMIC (2000-2019) Correlation between GDP and public spending cyclical components Correlation between GDP and public spending cyclical components -1 to 1 (the highest cyclicality) -1 to 1 (the highest cyclicality) 0,6 0,8 0,4 0,6 0,4 0,2 0,2 0 0 -0,2 -0,2 -0,4 -0,4 -0,6 -0,6 São Tomé and Principe Bhutan Vanuatu Maldives Samoa Seychelles St. Lucia Cabo Verde Mauritius St. Kitts and Nevis São Tomé and Principe Bhutan Vanuatu Maldives Samoa Seychelles St. Lucia Cabo Verde Mauritius St. Kitts and Nevis Correlation Cabo Verde Correlation Cabo Verde Source: World Bank staff estimates. Source: World Bank staff estimates. Note: estimated using the Hodrick-Prescott filter Note: estimated using the Hodrick-Prescott filter Public Finance Review - Page 48 Fiscal Policy: Past and Present BOX 1.2 For example, escape clauses can be crucial for providing flexibility in FISCAL FRAMEWORKS IN SMALL ISLAND DEVELOPING unpredictable scenarios, particularly those related to natural disasters. MTFFs provide credible "forward guidance" on how fiscal targets will be STATES (SIDS) – CAN CABO VERDE DO MORE? achieved, with key components including medium-term projections of macroeconomic variables, a fiscal strategy, and a comprehensive SIDS face unique challenges due to their small size, openness to external assessment of risks. Several SIDS have made progressed in strengthening shocks, and limited fiscal space. Heavy reliance on trade, remittances, and their fiscal frameworks. For example, Mauritius and Seychelles have foreign investment make them highly vulnerable; while limited economic comprehensive MTFFs, which are annually reassessed and updated to adapt diversification typically means economies lack scale. Large government to changing conditions. Moreover, Mauritius established a sovereign wealth presence and fixed exchange rates may further constrain policy flexibility. fund – the Mauritius Investment Corporation – to support the economy during Moreover, their characteristics means frequent natural disasters cause the COVID-19 pandemic and to invest in strategic sectors to ensure significant economic disruptions. Fiscal policy that ensures a well-designed long-term economic stability and growth. Other SIDS like Tonga have fiscal fiscal framework is critical for achieving the dual policy goal of economic rules that include a domestic revenue floor and public wage bill ceiling to help resilience and sustainable development. It should target four key objectives: manage revenues and expenditures, respectively. 1. Fiscal sustainability, which involves ensuring long-term solvency and Is there scope for Cabo Verde to do more? Ensuring debt sustainability, addressing pressures related to high costs of public goods and services. managing risks, strengthening DRM, and stabilizing output require a 2. Output stabilization, which aims to reduce fiscal procyclicality and comprehensive fiscal framework with well-designed fiscal rules. Cabo Verde volatility to mitigate the impact of economic shocks. currently has a binding rule on domestic debt (i.e., for any given year, 3. Risk management, which focuses on building fiscal buffers and domestic borrowing to meet the fiscal deficit is capped at 3 percent GDP), implementing risk transfer mechanisms to address exogenous shocks aiming to, amongst others, ensure that government borrowing does not such as natural disasters. crowd out private investment activities. However, while the debt-to-GDP 4. Growth diversification, which seeks to create fiscal space and promote ratio remains high (109 percent in 2024, excluding SOE debt), there exists no investment efficiency to support long-term development needs. binding debt/GDP rule to ensure fiscal sustainability beyond government strategic directives. As such, extending the domestic debt rule to overall How can key fiscal policy objectives be achieved in SIDS? Fiscal debt could help to maintain sustainability. A complementary action would be frameworks should encompass fiscal rules, escape clauses, automatic to consider an expenditure rule, or more specifically a wage bill rule as in correction mechanisms, risk management strategies and buffers, and a Tonga. medium-term fiscal framework (MTFF). Public Finance Review - Page 49 Fiscal Policy: Past and Present (cont.) This will help with macroeconomic stabilization while providing clear operational guidance. Combined with the strong DRM in Cabo Verde, an expenditure rule can help provide guidance for stabilizing debt. Similarly, a fiscal framework that has an in-built guidance on how windfalls are managed can indirectly support debt sustainability and potentially attenuate procyclical and volatile spending. Indeed, with rising non-tax revenues from SOE restructuring processes, embedding clear guidelines—such as allocating funds to a rainy-day fund—could help buffer fiscal risks from contingent liabilities. The consideration of these rules should however be tailored to align with policy objectives, and if adopted, should be binding to ensure their effectiveness. 1.4 POLICY RECOMMENDATIONS Public Finance Review - Page 51 Policy Recommendations 25. Cabo Verde is recovering well from recent shocks, but is faced with elevated debt levels, limited fiscal space, and fiscal risks from SOEs and climate change. Despite strong post-pandemic growth buoyed by tourism performance and improved revenue collection, high budget rigidity constrains the fiscal space available for growth-enhancing investments. The fiscal position is also made vulnerable by poor-performing SOEs—requiring continued capitalization, rolling over of guarantees and de facto servicing of on-lent debt—as well as from rising climate change impacts. 26. Leveraging planning fiscal tools to support the consolidation agenda is thus critical. While Cabo Verde has a tax administration strategy, this falls short of an overarching framework to guide the fiscal consolidation agenda. As such, investing in Medium-Term Revenue Strategy (MTRS), which provides a comprehensive approach for undertaking effective tax systems reform for boosting tax revenues and improving the tax system over the medium term, is key. Preparing and publishing a comprehensive Medium-Term Debt Strategy is equally important to strengthen the credibility and transparency of debt management. Similarly, re-establishing the annual borrowing plan as a tool to guide financing decisions is of equal importance. 27. Equally important, is the need to cement budget credibility through improved planning and execution of public investment projects. Weaknesses in budget credibility and predictability identified in the last PEFA (2016) remain—particularly under-execution of public investment spending. While some of this is linked to the early stage of project preparation, improvements to planning are warranted, including: (i) multi-year/phased budgeting; and (ii) efforts to streamline the project preparation phase. These, together with efficiency gains in goods and services spending, and containing growth in the public sector beyond the planned increases to address the lengthy wage freeze, could yield medium-term gains of up to 1.3 percent of GDP (see chapter 3). 28. Accelerating the SOE reform agenda and reassess support to SOEs also plays an important role in creating additional fiscal space. While above-the-line spending on SOEs is relatively low, transactions below the line (including on-lending and capitalizations) have averaged 2.2 percent of GDP between 2018 and 2023. Taking decisive action to restructure SOEs is critical for a gradual transition towards more productive spending (see Chapter 4 for more on SOEs reforms). 29. Finally, ensuring the use of a comprehensive fiscal framework with well-designed fiscal rules will be key to support fiscal sustainability and economic resilience. Several SIDS have made progress in strengthening their fiscal frameworks through Medium-Term Fiscal Frameworks (MTFFs) and fiscal rules, with important lessons for Cabo Verde as it seeks to ensure fiscal sustainability. Considerations include a broader debt rule and a cap on wage spending – both of which would contribute to this objective. Public Finance Review - Page 52 Policy Recommendations TABLE 1.1. IMPORTANT MACRO-FISCAL REFORMS TO SUPPORT SUSTAINABLE FISCAL CONSOLIDATION Policy area Policy action Timeline Revenue mobilization Leverage important fiscal planning tools – such as the Medium-Term Revenue Strategy – to support the revenue mobilization agenda ST Debt management Prepare and publish a comprehensive Medium-Term Debt Strategy, and accompanying annual borrowing plans ST Fiscal frameworks Explore the use of fiscal rules, including (i) a binding debt/GDP rule and (ii) cap on wage bill spending, to support fiscal sustainability ST-MT Enhance budget credibility through strengthened multi-phased year budgeting Budget credibility Review and streamline public investment management ST Source: World Bank Staff Public Finance Review - Page 53 Policy Recommendations REFERENCES World Bank (2023b). Gender-Responsive Tourism in Cabo Verde. Ensuring better, safe, and more jobs for women. Washington, DC.: World Bank Group, Government of Cabo Verde (2020). “Cabo Verde Ambição 2030. Agenda April 2023. Estratégica de Desenvolvimento Sustentável de Cabo Verde”, Government of Cabo Verde, 2020. World Bank (2023c). Cabo Verde: Joint World Bank-IMF Debt Sustainability Analysis, Washington, DC.: World Bank Group, June 2023. IMF (2023a). “Cabo Verde Climate Policy Diagnosis”, Technical Assistance Report, Washington, DC.: IMF, September 2023. World Bank (2024a). Blue Economy: The Latent Potential of Fisheries and Aquaculture in Cabo Verde, Cabo Verde Economic Update. Washington, DC.: IMF (2023b). Cabo Verde—Third Review Under the Extended Credit Facility World Bank Group, June 2024. Arrangement, Washington, DC.: IMF, December 2023. World Bank (2024b). Creating Markets in Cabo Verde. An Archipelago of PEFA (2016) “Avaliação do Desempenho da Gestão de Finanças Públicas em Opportunity: Pathways to Foster Sustainable Private Sector–Led Growth, Cabo Verde – 2015”, Public Expenditure and Financial Accountability Country Private Sector Diagnosis, Washington, DC: IFC-World Bank Group, Assessment, May 2016, https://www.pefa.org/country/cabo-verde March 2024. World Bank (2018). Republic of Cabo Verde. Adjusting the Development Model World Bank (2024c), Women, Business, and the Law 2024. Washington, DC: to Revive Growth and Strengthen Social Inclusion, Systematic Country World Bank Group. Diagnostic (SCD). Washington, DC.: World Bank Group, 2018. World Bank (2019). Revisiting the Efficiency of Public Spending to Reduce Debt and Improve Education and Health Outcomes, Republic of Cabo Verde Public Expenditure Review, Washington, DC.: World Bank Group, February 2019. World Bank (2023a). Sailing Rough Seas. Accelerating Growth and Fostering Resilience to Climate Change in Cabo Verde. Country Economic Memorandum, Washington, DC.: World Bank Group, June 2023. 2. DOMESTIC REVENUE MOBILIZATION Public Finance Review - Page 55 Improving Domestic Revenue Mobilization in Cabo Verde 30. Cabo Verde’s fiscal sustainability requires significant efforts to increase and enhance domestic revenue mobilization. While important, grant financing has accounted for only about 1.3 percent of GDP – or 5 percent of total revenues – over the past years. This, along with increasing uncertainty around global financing flows suggests a broad package of reforms to tax policy and tax administration are needed to meet financing needs – and enhance self-sufficiency. Careful tax design can help minimize tax-induced economic distortions by broadening tax bases and simplifying the tax system, making taxes easier to both administer and comply with, while reducing opportunities for tax avoidance and evasion. Additionally, targeted efforts to improve tax progressivity can increase the equity and efficiency of the tax system. 31. This chapter outlines Cabo Verde’s performance on revenue collection, and the potential to mobilize additional domestic revenue. It starts by reviewing historical tax revenue trends since the last Public Expenditure Review, i.e. the period 2017−2023, and assesses Cabo Verde’s tax potential. Section 2 then explores the efficiency of Cabo Verde’s tax system—focusing on income taxes as well as VAT. This section also presents progress made on implementing international tax standards, and discusses important reform options for consideration. Section 3 explores how Cabo Verde can simplify the tax system by revising and eliminating existing tax incentives, with a particular focus on VAT-linked exemptions and those provided to investments benefiting from contractual conventions.31 Section 4 assesses opportunities for raising health excise taxes related to alcohol and tobacco, as well as the transition to carbon-content linked environmental taxation. The final section provides some recommendations for going forward. 31 Contractual conventions allow firms that (i) have investments exceeding US$30 million; (ii) create at least 20 jobs; and (iii) accelerate economic development, to benefit from reduced rates across various taxes for 15 years, with the first 5 years being blanket exemptions. 2.1 REVENUE TRENDS POTENTIAL AND EFFORT Public Finance Review - Page 57 Revenue Trends, Potential and Effort 32. Cabo Verde’s domestic revenue mobilization levels are stable, but lag behind aspirational peer countries.32 Total revenues—which include tax revenues, social contributions, grants, and other non-tax revenue streams—have increased from an average of 22.8 percent of GDP between 2012−2016 to 24.7 percent of GDP between 2017−2023. Some of the most recent increase is driven by non-tax revenues linked to earnings from restructuring SOEs. Despite this positive trend, Cabo Verde's domestic tax revenues have on average trailed aspirational peers by about 1.5 percentage points of GDP, though are slightly above those of structural and regional peers (Figure 2.1). 33. Tax revenues remain the largest contributor to total revenues, with value added tax (VAT) and taxes on international trade accounting for the highest shares. Tax revenues accounted an average for 76.1 percent of total revenue between 2017 and 2023, while other revenues – which include earnings from property rental and sales of goods and services – accounted for 15.9 percent, grants 8.8 percent, and social contributions only 0.1 percent. The large share of tax revenues in total revenues is comparable with regional and aspirational peers, whose averages were 72.9 percent and 76.8 percent respectively over the same period (Figure 2.2). The share of VAT (39.3 percent), taxes on international trade (20.7 percent), and personal income tax (17.8 percent) in total taxes is higher than peers, however, and the country lags behind peers for the amounts raised by corporate income tax and excise tax revenue. In part, this reflects the country’s fewer excisable goods and lower effective excise rates. In addition, overly generous investment incentives undermine the performance of corporate income tax, and domestic revenue mobilization in general. A more detailed analysis of this can be found in Section 3. 34. Cabo Verde’s tax potential is estimated at about 30 percent of GDP; an increase from 25.6 percent of GDP in 2012. However, actual tax revenue collections have grown at a slower pace, increasing by only 1.4 percentage points of GDP over the same period (Figure 2.3). Despite the higher tax potential, the country faces an overall tax gap of about 11 percent. 35. The average tax effort in Cabo Verde is relatively low and declining. With a value of 0.63, tax effort lags behind the estimated averages for SSA, lower middle-income, and upper middle-income countries, which are about 0.72, 0.67, and 0.72 respectively (Figure 2.4). This low and consistently declining tax effort highlights the need for strengthening tax administration and streamlining overly generous tax exemptions. These measures will help minimize leakages in tax revenues and bolster domestic revenue mobilization. 32 For details of Cabo Verde’s structural and aspirational peers see Annex 1.2. Public Finance Review - Page 58 Revenue Trends, Potential and Effort FIGURE 2.1. FIGURE 2.2. TOTAL TAX REVENUES ARE INCREASING, BUT ARE YET THE SHARE OF TAX REVENUES IN TOTAL REVENUES IS TO MATCH LEVELS OF ASPIRATIONAL PEERS COMPARABLE WITH REGIONAL AND ASPIRATIONAL PEERS Fiscal revenues Tax revenues Percent of GDP Percent of GDP 35 100 30 80 25 20 60 15 40 10 20 5 0 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Cabo Verde Regional Structural Aspirational 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Cabo Verde Regional Structural Aspirational Other taxes Corporate income tax VAT Total tax revenues Social contributions Other revenues Grants Excise taxes Taxes on international trade Personal income tax Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and Government Finance Statistics (GFS) database Note: Data refer to Central Government. Structural peers: Bhutan, Samoa, São Tomé and Principe and Vanuatu. Aspirational peers: Mauritius, Seychelles, St. Kitts and Nevis, St. Lucia, and Maldives. Peer data averaged over 2017−2022. Separate grant data for peers is not available. Public Finance Review - Page 59 Revenue Trends, Potential and Effort FIGURE 2.3. FIGURE 2.4. TAX COLLECTION LEVELS ARE STAGNANT DESPITE CABO VERDE’S TAX COLLECTION LEVELS, THERE IS SCOPE TO IMPROVE ITS TAX EFFORT Tax collection and gap (percent of GDP) and tax effort ratio, 2012−21 Tax collection and gap (percent of GDP) and tax effort ratio 35 0,70 35 0,70 30 0,68 30 0,68 25 0,66 25 0,66 Percent of GDP Percent of GDP 20 0,64 20 0,64 Tax effort 15 0,62 15 0,62 10 0,60 10 0,60 5 0,58 5 0,58 - 0,56 - 0,56 Sub-Saharan Lower middle Upper middle Cabo Verde 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Africa income income Tax gap - left axis Tax effort - right axis Tax collection - left axis Tax revenues Tax gap Tax Effort Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool, 2024 2.2 THE EFFICIENCY OF CABO VERDE’S TAX SYSTEM Public Finance Review - Page 61 The Efficiency of Cabo Verde’s Tax System 36. Taxes are generally applied on personal income, corporate income, and TABLE 2.1. NUMBER OF FIRMS UNDER DIFFERENT TAX REGIMES consumption; however, the top marginal tax rates on personal and corporate income are not aligned. Cabo Verde applies a standard VAT rate of 15 percent – Year General regime Tax exemption Fiscal transparency Reduced rates Total which is aligned with peers – but does not apply an exemption threshold. The 2016 3,119 25 33 12 3,189 headline corporate income tax (CIT) rate is 21 percent (down from 22 percent in 2017 3,260 28 29 10 3,327 January 2024), which is lower than regional and aspirational peers, but higher than structural peers. The top marginal personal income tax (PIT) rate is 27.5 2018 3,492 29 26 17 3,564 percent. Differences in the headline CIT rate and top marginal PIT rate tend to 2019 3,685 22 30 21 3,758 influence whether people chose to file taxes as a corporate entity or as an 2020 3,737 16 36 22 3,811 individual, especially professionals.33 However, Cabo Verde has implemented a “fiscal transparency” regime which taxes professionals’ corporate profits at the 2021 3,914 13 39 23 3,989 individual level. Whereas professionals face a higher marginal tax rate, other 2022 3,923 11 39 25 3,998 corporate entities tend to benefit not just from the lower CIT rate, but also from Total 25,130 144 232 130 25,636 reduced rates conditional on the number of jobs created. Table 2.1 shows that the number of businesses benefiting from reduced rates has increased from 12 Source: Author’s analysis from Cabo Verde’s Model 1B. firms in 2016 to 25 firms in 2022. On the other hand, the number of firms under the “fiscal transparency” regime continues to grow. Even though the number of firms Note: Entities licensed at the Cabo Verde International Business Centre (CIN) benefit from reduced benefiting from incentives has decreased over time, multiple regimes with corporate tax (IRPC) rates on income from industrial, commercial, and related activities, including services. These tax benefits, valid until 2030, are contingent on job creation relative to the business's differentiated tax rates are problematic for tax administration and create size and nature. The minimum job requirement is ten in the International Industry Centre (IIC) and the leakages in the tax system. As such, there is potential to raise more revenue and International Trade Centre (CIC). The reduced tax rates are as follows: 5 percent for businesses with simplify tax administration by ensuring that the tax system taxes all forms of ten or more employees, 3.5 percent for those with twenty or more employees, and 2.5 percent for income in similar ways. businesses with fifty or more employees. Firms under the general regime face the regular statutory CIT rate of 21 percent, Exempt firms are beneficiaries from Cabo Verde’s contractual conventions while the “fiscal transparency” regime provides for taxation of professionals’ corporate profits at the individual level. 33 The differences in rates mean that professionals in Cabo Verde might opt to have their income taxed as part of corporate income since the top CIT rate is lower than the PIT rate. Public Finance Review - Page 62 The Efficiency of Cabo Verde’s Tax System PERSONAL INCOME TAX REVENUES HAVE DECLINED, AND PRODUCTIVITY IS LAGGING 37. Cabo Verde’s tax resident individuals are liable to pay personal income tax (PIT) (Imposto sobre o Rendimento das Pessoas Singulares, or IRPS, in Portuguese) on their worldwide income. The PIT system in Cabo Verde is designed to capture all forms of personal income of all its residents. This means that resident individuals are required to pay tax on all income earned within Cabo Verdean territory and abroad. While taxpayers have the option to include employment and pension income (Category A income) in their annual tax return, it is mandatory to also declare income from Category B (business and professional income with organized accounting) and rental income (Category C in Table A1 in Annex 1). Non-resident individuals, on the other hand, are subject to PIT only on Cabo Verdean-sourced income, and at flat tax rates that are the same as those applicable for resident taxpayers. 38. Employment income, as defined in the PIT Code, includes all payments related to work under an employment contract. This encompasses salaries, bonuses, commissions, pensions, allowances – such as cost-of-living and housing allowances – and benefits in kind – such as company cars – regardless of the payment's origin. The PIT rates follow a progressive schedule, ranging from 16.5 percent to 27.5 percent, with an annual exemption threshold of up to CVE 220,000. There are several exemptions from the PIT, including per diems for national and international trips, within the limits set for public services; lunch allowance of up to CVE 250 per day; use of a personal car of up to CVE 120,000 per year; cash shortage allowance, up to 15 percent of the monthly salary; family allowance, up to CVE 500 per month for each dependent; redundancy payments, taxable only on the portion exceeding one and a half times the average remuneration of the last months of employment, multiplied by the number of years of employment; and pension income below CVE 960,000. 39. Individuals in Cabo Verde can be subject to taxation through two different methods: the declarative method (self-assessment) and the final withholding method. The declarative method requires the following taxpayers to report their annual income: those with business, professional, or rental income; resident workers with foreign income; or non-residents earning in Cabo Verde. This method is also optional for employed residents. The taxes of employed residents who do not file an income statement are collected through final withholding. Public Finance Review - Page 63 The Efficiency of Cabo Verde’s Tax System 40. Revenues from PIT have decreased since the pandemic, and tax FIGURE 2.5. productivity lags behind both regional and aspirational peers.34 Having PIT REVENUES ARE IN DECLINE increased steadily between 2013 and 2017, from 2.8 percent of GDP to 3.6 percent (Figure 2.5), PIT collection has since experienced a continuous decline (reaching an average of only 2.6 percent of GDP between 2022 and 2023). The PIT revenues average PIT productivity for Cabo Verde was estimated at 0.119 during Percent of GDP 2018−2022 (Figure 2.6), which is higher than for LMIC peers (0.098), but lower 4,0 than averages for SSA (0.134) and UMICs (0.140). This lower productivity is partly explained by the fact that individuals’ dividend income benefits from full tax relief, undermining productivity. Moreover, business entities are fully exempt on 3,5 dividends, unless they are already benefiting from a reduced rate. Differences in the headline CIT rate and top marginal PIT rate might explain the lower PIT collections, as individuals opt to incorporate businesses because of the lower CIT rates. Given this, designing the tax system such that the effective tax rates 3,0 are equalized regardless of institutional form (individual or corporate entity) will be important to improve revenues from PIT. Furthermore, simplifying the PIT tax filing mechanism may ease the compliance burden and encourage formalization 2,5 (Coelho et al., 2023). 3,02 3,06 2,84 3,43 3,36 2,95 3,62 3,26 3,73 2,75 3,31 2,51 41. While PIT rates follow a progressive schedule, reliance on indirect taxes 2,0 suggests there is room to improve the broader progressivity of the tax system. 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Conceptually, a higher share of revenue from direct taxes would suggest a more progressive tax system, given that these are inherently designed in a progressive manner (including in Cabo Verde). However, Cabo Verde slightly lags behind aspirational and regional peers when it comes to direct taxes as a share of Note: The PIT top rate dropped from 35% to 27.5% in 2014. revenues, which suggests there could be room to improve the progressivity of Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data the tax system. One design feature in the tax system that may improve progressivity, or improve revenues from direct taxes, would be to introduce a tax on dividends, which are currently exempt. 34 PIT productivity is calculated as the ratio of the PIT as share of GDP to PIT’s top marginal tax rate. Note that PIT productivity estimates are only indicators, since they ignore the progressive PIT schedule. Countries are not always trying to raise all their revenue from the top rate, the degree of progressivity varies across countries depending on equity preferences. Public Finance Review - Page 64 The Efficiency of Cabo Verde’s Tax System FIGURE 2.6. FIGURE 2.7. CABO VERDE’S PIT PRODUCTIVITY COULD BE HIGHER REVENUES ARE HIGHLY DEPENDENT ON INDIRECT TAXES HIGHLIGHTING CONCERNS ABOUT PROGRESSIVITY PIT productivity ratio, 2018−2022 Direct taxes Percent of GDP and of tax revenues 0,15 40 7 0,140 0,14 35 6 0,134 30 0,13 5 0,119 25 0,12 4 20 0,11 3 15 0,098 0,10 2 10 0,09 5 1 0,08 0 0 Cabo Verde Regional LMICs UMICs Cabo Verde Regional Aspirational Percent of tax revenues (RHS) Percent of GDP (LHS) Note: Data refer to Central Government. Due to limited data availability for peer countries within the Note: 5−year average (2018 – 2023) Source: GFS structural and aspirational groups, LMICs and UMICs are used for comparison purposes. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool Public Finance Review - Page 65 The Efficiency of Cabo Verde’s Tax System THE VAT SYSTEM COULD BE MORE STREAMLINED Nevertheless, the DNRE is still encountering obstacles, especially in hiring IT system developers to expedite crucial IT projects aimed at tax crime prevention and to improve the process for VAT auditing. This largely reflects the DNRE’s 42. At about 7.8 percent of GDP in 2023, VAT is Cabo Verde’s largest source of institutional set up and lack of autonomy on decisions, including human tax revenue (roughly 40 percent of total revenues). The VAT was introduced in resourcing.36 The ongoing efforts to create a Revenue Authority, which have 2004, and a standard rate of 15 percent is applied to most goods and services, benefited from IMF technical assistance, may provide a solution to some of including imports. Private consumers also benefit from a lower VAT rate for these constraints. electricity and water, at 8 percent. The standard rate was temporarily raised to 15.5 percent in 2015, as the authorities sought to increase financing in response to the Fogo volcano eruption. While VAT collections have exhibited considerable 45. The efficiency of Cabo Verde’s VAT system is above average, but has seen volatility over the years (Figure 2.8), they have always accounted for the largest some fluctuation in recent years – resulting in considerable tax gaps. The share of revenues, which highlights the reliance on indirect taxes. While VAT C-efficiency is the ratio of actual VAT collections to the theoretical revenues collections decreased to 6.8 percent of GDP in 2021 because of the scaring under a perfectly enforced tax levied at the standard rate on all final effects of the pandemic,35 they have since recovered, and reached 7.8 percent consumption without any exemptions. Cabo Verde’s average C-efficiency ratio of GDP in 2023. is estimated at about 0.701, which is higher than the regional average of 0.343, the LMIC average of 0.465, and the UMIC average of 0.522. While VAT collection has picked up from 10 years ago, it has experienced some fluctuation since 2017 43. While the VAT rate in Cabo Verde is comparable to those of its peers, it – which could reflect the VAT exemptions provided. lacks a registration threshold. There is currently no turnover threshold for VAT registration in Cabo Verde. This means that all businesses must register and are able to reclaim VAT on their inputs. While having no threshold could maximize 46. Addressing loopholes in the VAT regime by streamlining VAT-exempt and revenue and minimize distortion along the supply chain, it may also lead to high zero-rated supplies is critical to improve VAT collection. Exemptions in Cabo administrative costs. Setting a threshold is thus advisable to reduce such costs, Verde extend beyond the standard exemptions for financial services, basic even if it results in some revenue loss (Keen and Mintz, 2004). health care, and education, to include the supply of goods and services related to non-profit organizations; the supply of copyright and art objects by the original creators or their heirs; the supply of certain cultural, educational, 44. The authorities are taking important steps to strengthen tax technical, and recreational services; garbage removal services, etc.37 While administration, though further revisions to the institutional set are warranted. zero-rating is generally the preserve of exports, the supply of meat, fish, and milk The National Directorate of State Revenue (DNRE) is making progress with digital among others are included as zero-rated supplies. Streamlining exempt and initiatives, such as electronic invoicing and audit systems, to improve VAT zero-rated supplies will not only improve revenue mobilization, it will also reduce declaration. The VAT electronic audit system alone has the potential to boost the cost of enforcement. revenue collections by as much as 1 percent of GDP over the medium-term. 35 The COVID-19 pandemic significantly dampened VAT revenue collections in 2020 and 2021. The decrease was largely driven by the downturn in the tourism industry, which limited companies' ability to pay their taxes, as well as the tax relief measures provided – including moratoria, and reduced rates on tourism (VAT narrowed to 10 percent). 36 IMF (2024). 37 See Coelho et al., 2023 for an in-depth discussion. Public Finance Review - Page 66 The Efficiency of Cabo Verde’s Tax System FIGURE 2.8. FIGURE 2.9. VAT REVENUE HAS BEEN VOLATILE THE EFFICIENCY OF THE VAT SYSTEM IS ABOVE AVERAGE VAT revenues VAT C-efficiency ratio, 2018−2022 Percent of GDP 8 1,2 0,8 0,701 1,0 7 0,6 0,522 0,8 0,465 6 0,6 0,4 0,343 0,4 5 0,2 0,2 6,3 6,2 6,0 6,5 6,5 6,8 7,9 7,5 7,4 7,0 7,6 7,8 4 0,0 0,0 Cabo Verde Regional LMICs UMICs 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Note: A 15.5% standard VAT rate was a temporary measure introduced from 1 January 2015 to 31 Note: Data refer to Central Government. Due to limited data availability for peer countries within the December 2015. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance structural and aspirational groups, LMICs and UMICs are used for comparison purposes. data. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool Public Finance Review - Page 67 The Efficiency of Cabo Verde’s Tax System CORPORATE INCOME TAX PRODUCTIVITY IS UNDERMINED BY INVESTMENT INCENTIVES 47. Corporate income tax (CIT) is applied to the profits of Cabo Verde’s resident companies, and of the permanent establishments of non-resident companies. The standard CIT rate was reduced from 25 percent to 22 percent in 2019 and cut further to 21 percent in January 2024. Additionally, a surcharge, known as Taxa de Incêndio, is applied at a rate of 2 percent on the tax due, resulting in a final tax rate of 21.42 percent. This surcharge is enforced in the municipalities of Praia (Santiago) and Mindelo (São Vicente). As in other tax jurisdictions, Cabo Verde has a special regime for micro and small-sized companies, known as the Regime Juridico das Micro e Pequenas Empresas (REMPE). Micro and small-sized companies (defined in Table 2.2) are subject to a single special tax (SST) of 4 percent, levied on the gross amount of sales obtained in each taxable year, and payable quarterly (see Box 2.1 for an example). Non-resident companies without a permanent establishment are subject to withholding tax (WHT), with rates ranging between 1 percent and 20 percent. TABLE 2.2. SPECIAL TAX REGIME FOR MICRO AND SMALL-SIZED COMPANIES Size Employees Base Annual turnover Micro-sized company <= 5 Gross income without deductions Below CVE 5 million Small-sized company 6-10 Gross income without deductions Between CVE 5 million and CVE 10 million Importers whose customs value of imported goods does not exceed their annual turnover qualify Micro and small importers N/A Gross income without deductions for the simplified scheme for micro and small-sized companies. Source: PwC Worldwide Tax Summaries (https://taxsummaries.pwc.com/cabo-verde) Public Finance Review - Page 68 The Efficiency of Cabo Verde’s Tax System BOX 2.1. WOMEN-LED BUSINESSES AND THE REMPE The REMPE was introduced to promote the formalization and productivity of micro and small businesses. Registered business owners are subject to a single special tax of 4 percent levied on gross sales, and are exempt from paying VAT, CIT, the employers’ social security contribution, and customs duties and VAT on imported vehicles. Businesses with a turnover of less than CVE 1 million are exempt from SST. Small business owners gain access to social security coverage and benefits, including health insurance and pensions. Registration with REMPE also qualifies business owners for access to subsidized credit.38 The REMPE has played a key role in formalizing women-led businesses. The number of small businesses registered under the REMPE regime has steadily increased since its introduction. Many women-led businesses have become formalized: out of 25,177 individuals registered in the social security system in 2023, close to 50% were women.39 Reassessing the REMPE regime to identify areas for reform—including streamlining tax exemptions—is important to ensure its efficiency. This could assess who has benefited (disaggregated by gender if data is available), the types of benefits received (for example, tax exemptions and/or access to subsidized credit), and whether the support is well-targeted. 48. CIT collection has declined, and its tax productivity is lagging behind peers. The legislative changes in 2015, which included the breakdown of the single income tax into personal income tax (IRPS) and corporate income tax (IRPC), along with comprehensive revenue administration reforms, resulted in a significant increase in CIT revenues, from 1.6 percent of GDP in 2014 to 2.5 percent of GDP in 2015 (Figure 2.10). However, to mitigate the effects of the pandemic on businesses, fiscal relief measures were introduced—such as the postponement of corporate income tax payments—which undermined collection. Revenues have not returned to pre-pandemic levels, with collection at 1.4 percent of GDP in 2022 and 2.15 percent in 2023. Furthermore, over the period 2018−2022, average CIT productivity stood at 0.087—trailing behind the averages for Sub-Saharan Africa (0.11) as well as the LMIC (0.141) and UMIC (0.149) groups (Figure 2.11). The productivity of CIT is further undermined by the numerous incentives granted. Therefore reviewing the scope and type of incentives—as discusses in the section below—will go a long way toward improving CIT revenues. 38 Rizza Ferraz (2023). 39 Cruz (2024). Public Finance Review - Page 69 The Efficiency of Cabo Verde’s Tax System FIGURE 2.10. FIGURE 2.11. CIT REVENUES HAVE BEEN DECLINING CIT PRODUCTIVITY IS WELL BELOW AVERAGE CIT revenues CIT productivity ratio, 2018−2022 Percent of GDP 3,0 0,16 0,149 0,15 0,141 2,5 0,14 0,13 2,0 0,12 0,110 1,5 0,11 0,10 1,0 0,087 0,09 0,08 0,5 2,50 2,02 2,26 2,47 0,07 2,14 1,93 1,36 2,19 1,62 2,61 1,47 2,17 - 0,06 Cabo Verde Regional LMICs UMICs 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Note: CIT rate dropped from 25% to 22% in 2019 and from 22% to 21% since 1 Jan 2024. Source: Note: Data refer to Central Government. Due to limitations in data availability for peer countries World Bank staff calculations based on Cabo Verde Ministry of Finance Data. within the structural and aspirational groups, LMICs (lower middle-income countries) and UMICs (upper middle-income countries) are used for comparison and presentation purposes. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank PFR tool Public Finance Review - Page 70 The Efficiency of Cabo Verde’s Tax System 49. Cabo Verde has demonstrated its commitment to international tax standards, but the country is yet to implement a global minimum tax (GMT).40 Cabo Verde has partially implemented the Base Erosion and Profit Shifting (BEPS) minimum standards and is committed to the Two-Pillar Solution to address tax challenges from the digital economy. While the country meets the minimum standard for BEPS Action 5 on harmful tax practices, it is yet to fully implement other actions, such as Country-by-Country Reporting and the Mutual Agreement Procedure. Although it has not committed to the Common Reporting Standard, the country has taken steps to improve its exchange of information for tax purposes and is preparing for an Exchange of Information on Request (EOIR) peer review. Box 2.2 summarizes progress made toward implementing international tax standards. 50. The World Bank is supporting the country with the practicalities and policy implications of implementing the global minimum tax (GMT). The country is evaluating the possible impact of the GMT and considering implementing a domestic minimum top-up tax. The number of entities within the scope of the GMT is estimated to be 50, and therefore implementing it has the potential to improve Cabo Verde’s CIT productivity and tax revenues. BOX 2.2. CABO VERDE’S PROGRESS ON IMPLEMENTING INTERNATIONAL TAX STANDARDS AND NEXT STEPS BEPS minimum standards have been partially implemented. Cabo Verde’s implementation of BEPS Action 5, on harmful tax practices, meets the minimum standard, both on information gathering and on information exchange. However, it received a recommendation for exchanging information on the tax rulings in accordance with the form and timelines under the transparency framework.41 When it comes to preventing tax treaty abuse (BEPS Action 6), the country is not a signatory of the BEPS Multilateral Instrument (MLI), and the implementation of the minimum standard is currently done through bilateral renegotiations. Cabo Verde is implementing the BEPS Action 6 minimum standard through the inclusion of the preamble statement and the Principal Purpose Test. It has not yet implemented Country-by-Country (CbC) Reporting (BEPS Action 13). As such, there is no local filing, no notification, and no reciprocity, as the CbC Multilateral Competent Authority Agreement has not yet been signed.42 Cabo Verde has committed to the Mutual Agreement Procedure (MAP) minimum standards (BEPS 14), but has not yet made the MAP fully effective as it is still working on implementing the necessary frameworks and procedures. Assessment of the implementation is deferred.43 40 The GMT ensures that large multinational enterprises pay a minimum level of tax on their income in each jurisdiction in which they operate, thereby reducing the incentive for profit shifting and placing a floor under tax competition, bringing an end to the race to the bottom on corporate tax rates. 41 OECD (2023). 42 OECD (no date). 43 OECD, “Action 14 Mutual Agreement Procedure,” https://www.oecd.org/tax/beps/beps-actions/action14/. Public Finance Review - Page 71 The Efficiency of Cabo Verde’s Tax System Additional efforts are being made on broader international tax matters. The Corporate Income Tax Code already includes special anti-avoidance rules. These include Controlled Foreign Company rules and interest deduction limitation rules, with a General Anti-Avoidance Rule being included in the General Tax Code. Moreover, in 2023, Cabo Verde implemented the OECD Value-Added Tax standards for e-commerce supplies (for e-services but not yet for low-value goods).44 The country also implemented transfer pricing rules in January 2016,45 and the Bank is set to provide support in applying and improving audit capabilities effectively for transfer pricing. Despite this progress, there is room to further improve implementation. First, Cabo Verde should continue efforts to develop a process to complete the templates for all relevant rulings and to ensure that the exchanges of information on rulings occur in accordance with the form and timelines under the transparency framework. Reform of existing tax incentives, such as the CIT credit of up to 20 percent of eligible investments, is warranted if these lead to an effective tax rate of less than 15 percent. Second, implementing the remaining BEPS minimum standards—including signing the CbC MCAA and implementing the MAP—is key. Cabo Verde can take steps to extend the VAT e-commerce regime (online sales) to sales of low-value goods (as exists in many countries globally). Finally, continued efforts to improve the legal and regulatory framework and practices to bring these in line with the Exchange of Information on Request (EOIR) standard, ahead of the launch of the EOIR peer review, will be important. 44 2023 State Budget Law Cabo Verde: https://kiosk.incv.cv/V/2022/12/30/1.1.125.4568/,page 18 45 Order No. 75/2015, dated 31 December 2015, of the Ministry of Finance and Planning. 2.3 IS THERE SCOPE TO SIMPLIFY THE TAX SYSTEM? Public Finance Review - Page 73 The Efficiency of Cabo Verde’s Tax System TAX INCENTIVES REPRESENT A CONSIDERABLE FISCAL DRAIN FIGURE 2.12. CABO VERDE’S FOREGONE TAX REVENUES SURPASS 51. Cabo Verde uses numerous tax incentives (essentially tax expenditure ALL COMPARATORS measures) across its main tax instruments, which have seen it forgo revenue. These measures—introduced to encourage investment and promote the Revenues foregone due to tax expenditures, average 2019−2022 development of priority sectors—include preferential tax treatments such as Percent of GDP exemptions, deductions, credits, reduced tax rates, and other special tax treatments. The foregone revenue from tax incentives is considered a tax 7 expenditure, akin to public spending in many respects. Since 2014, Cabo Verde 5,8 has consolidated its tax and customs incentives under a single piece of 6 legislation known as the Código de Benefícios Fiscais (Tax Benefits Code) 5,1 (CBF).46 The CBF has undergone several adjustments as the authorities work to 5 refine the concessions granted. The authorities are committed to streamlining 4 tax expenditures, including the development and publication of an action plan aimed at reducing them.47 3 2,4 2,1 52. Tax expenditures in Cabo Verde surpass those of its peers. Between 2019 2 and 2022, Cabo Verde’s tax expenditures averaged 5.8 percent of GDP, slightly exceeding those of its aspirational peers (5.1 percent), and more than double 1 those of regional and structural peers, which stood at 2.4 percent and 2.1 percent of GDP, respectively (Figure 2.12). Between 2019 and 2022, 66 percent 0 Cabo Verde Regional Structural Aspirational of tax expenditures were on internal revenue, under the Directorate-General of Internal Revenue (DGCI), while 35 percent originated from customs, under the National Directorate of Customs (DGA) (Figure 2.13). While elevated, tax Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data and World Bank expenditures have been on a downward trend since 2021, in part due to slower PFR tool . economic activity resulting from the pandemic. 46 European Union (2018). 47 IMF (2023). Public Finance Review - Page 74 The Efficiency of Cabo Verde’s Tax System FIGURE 2.13. 53. Tax expenditures linked to VAT account for the largest share of revenue TAX EXPENDITURES HAVE BEEN DECLINING RECENTLY foregone for the DGCI. During 2019−2023, roughly 77.2 percent of tax expenditures, averaging 2.95 percent of GDP, originated from domestic VAT (Figure 2.14). This figure increases to 3.09 percent of GDP if VAT exemptions Tax expenditures, 2019−2023 under the REMPE are considered. The dominance of amounts foregone from VAT Percent of GDP reflects the use of exemptions on goods, as well as varying rates applied on domestic goods and services.48 About 84.2 percent of total tax expenditures, or 8 2.9 percent of GDP, are attributed to the increase in consumption of essential 7 goods,49 which are VAT exempt (Figure 2.15). This increase was particularly notable in 2020 and 2021 during the pandemic. 6 5 54. Though not as significant as VAT, preferential treatments in corporate income tax payments are also a source of foregone revenue. IRPC-linked 4 foregone revenues accounted for 8.3 percent of DGCI’s tax expenditure 3 between 2019 and 2023, or 0.24 percent of GDP. Nearly half of the tax expenditures under the IRPC at the DGCI stem from investment tax credits, 2 constituting 0.133 percent of GDP and equivalent to the combined impact of measures such as full exemption and rate reduction (Figure 2.16). Investment tax 1 credits are available to all corporate taxpayers, although the majority originate 0 from the tourism sector (58.3 percent of tax expenditure or 0.185 percent of 2019 2020 2021 2022 2023 GDP). DGCI - Internal revenue DGA - National directorate of customs Total Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data 48 These are 0 percent for essential goods, 2.5 percent for butane gas, 8 percent for electricity and water, and 10 percent for tourism sector (e.g., accommodation and catering). In 2022, the latter was increased to 15 percent reflecting an unwinding of measures in response to the pandemic. 49 Education supplies and services, medical care and basic medicines, and food staples. Public Finance Review - Page 75 The Efficiency of Cabo Verde’s Tax System FIGURE 2.14. FIGURE 2.15. VAT EXEMPTIONS COMPRISE THE LARGEST VAT-EXEMPTED ESSENTIAL GOODS CONTRIBUTED TO SHARE OF TAX EXPENDITURES TAX EXPENDITURES WORTH NEARLY 3% OF GDP Tax expenditures under DGCI, average 2019−2023 DGCI’s tax expenditures under VAT – domestic by regime, average 2019−2022 Percent of GDP Percent of GDP 3,5 3,5 2,95 2,95 3,0 3,0 2,5 2,5 2,0 2,0 1,5 1,5 1.0 1.0 0.5 0,24 0.5 0,24 0,18 0,14 0,20 0,11 0,13 0,02 0,03 0,0 0,0 IRPC/CIT VAT - Domestic REMPE - IRPC REMPE - VAT IRPS/PIT Full Special Reduced Reduced Simple VAT exemptio rate rate rate exemptio refund n (0%) (2,5%) (8%) (10%) n Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data. Note: In 2023, data disaggregated by regime is not available. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data Public Finance Review - Page 76 The Efficiency of Cabo Verde’s Tax System FIGURE 2.16. FIGURE 2.17. INVESTMENT TAX CREDITS ACCOUNT FOR A MOST INVESTMENT TAX CREDITS OCCUR IN LARGE SHARE OF DGCI’S CIT EXPENDITURES THE TOURISM SECTOR DGCI’s tax expenditures under IRPC/CIT by regime, average 2019−2022 DGCI’s tax expenditures under IRPC/CIT by sector, average 2019−2021 Percent of GDP Percent of GDP 0,18 0,20 0,185 0,16 0,18 0,14 0,133 0,16 0,14 0,12 0,12 0,10 0,10 0,08 0,065 0,061 0,08 0,06 0,06 0,048 0,042 0,04 0,04 0,019 0,022 0,02 0,012 0,02 0,007 0,001 0,003 0,00 0,00 Full Rate Investment Sponsorship Others Tourism Industry Financial Energy Business Transport Others exemption reduction tax credit and other cost increases Note: data disaggregated by regime not available for 2023. Note: data disaggregated by sector is not available for 2022−2023. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data Public Finance Review - Page 77 The Efficiency of Cabo Verde’s Tax System 55. The prominence of VAT-linked tax expenditures is also evident in FIGURE 2.18. foregone revenue for the DGA, along with import duties. Together, these EXEMPTIONS ON IMPORT DUTY AND VAT MAKE accounted for 83 percent of the DGA’s tax expenditures over 2019−2023, resulting in revenue foregone equivalent to 1.6 percent of GDP (Figure 2.18). UP THE LARGEST SHARE OF DGA’S TAX EXPENDITURES While tax expenditures derived from import VAT declined by about 30 percent in Tax expenditures under DGA, average 2019−2023 2021 compared to 2020, and by 55 percent in 2022 compared to 2021, it Percent of GDP remained the highest share of tax expenditure (49.4 percent), or 1.1 percent of GDP, during 2019−2021. Since 2022, exemptions on import duties have gained 1,2 prominence and account for the largest share of tax expenditure (48.6 percent) or 0.6 percent of GDP. 1,0 56. The tourism sector is the primary recipient of customs exemptions, 0,76 0,80 accounting for revenue foregone of approximately 0.55 percent of GDP over 0,8 2019−2021 (Figure 2.19). A large share of customs exemptions applies to imports of intermediate goods used in the tourism industry.50 Between 2019 and 0,6 2020, special tax provisions provided to the tourism sector represented about one-third of total tax expenditures, accounting for 0.7 percent of GDP. 0,4 However, there has since been a gradual shift in beneficiaries following the 0,26 granting of returned non-resident status (NRRD) at the DGA,51 resulting in the 0,2 highest share of tax expenditures for this category, at 28 percent in 2021, 0,02 equivalent to 0.6 percent of GDP. 0,0 Import duties Community tax Excise duties (ICE) Import VAT Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data 50 European Union (2018). There are concerns about the inadequate monitoring system for exemptions at customs throughout the duration of an exempted project. This limitation, which could potentially result in the resale of exempted products on the domestic market, particularly building materials for tourism projects related to tourism (European Union, 2018). 51 For the purpose of customs exemptions, Cabo Verdean nationals are considered NRRDs if they reside abroad for more than four consecutive years. Public Finance Review - Page 78 The Efficiency of Cabo Verde’s Tax System FIGURE 2.19. 57. Measuring the percentage of revenue foregone relative to total tax THE LARGEST TAX EXPENDITURES BY DGA ARE revenue is crucial for assessing the impact of tax expenditures. Foregone revenue represented 37 percent of the total revenue collected in 2020−2021. LINKED TO EXEMPTIONS IN THE TOURIST SECTOR The figure for foregone taxes from VAT-linked incentives is significantly higher, representing on average 144.8 percent of VAT revenues in 2020−2021. In part, DGA’s tax expenditures by sector, average 2019−2021 the elevated share reflects exceptional fiscal measures to mitigate the effect of Percent of GDP the pandemic on the economy—including revisions to the VAT rates applied. While overall foregone revenues have fallen to about 18 percent of total revenue 0,6 0,555 collected in 2023, the figure for VAT-linked exemptions remains high (Figure 2.20), suggesting that revisiting the framework for VAT incentives is warranted. 0,5 0,403 0,4 0,344 0,305 0,3 0,2 0,182 0,147 0,106 0,095 0,093 0,1 0,0 Tourism NRRD Industry AJD - public works projects Others AJD - public service Health Development aid Others Note: data disaggregated by regime not available for 2023. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data Public Finance Review - Page 79 The Efficiency of Cabo Verde’s Tax System FIGURE 2.20. RETHINKING VAT-LINKED INCENTIVES IS CRITICAL52 VAT-LINKED EXEMPTIONS MAKE UP A LARGE SHARE OF REVENUE FOREGONE 58. Broadly speaking, VAT-linked incentives aim to preserve the purchasing power of poor households, but their downside is foregone tax revenues. Share of revenue foregone relative to revenue collected, 2019−2023 Reduced or exempted VAT in Cabo Verde applies to products that represent Percent about one-third of poor households’ overall consumption and one-quarter of consumption by households in the wealthiest quintile (Figure 2.21).53 The primary beneficiaries of these tax exemptions are supposed to be the poorest 12,8 households, as most exemptions are applied to food products (which form a 28,9 significant part of their consumption basket). However, the lack of targeting of 15,5 19,0 17,1 these exemptions means they also provide significant benefits to richer 20,6 households, making them an inefficient way of providing support to poorer 14,7 25,9 23,0 households. Instead, direct mechanisms such as targeted transferred should be 8,0 36,9 22,3 considered (Thomas, 2024). 25,7 9,6 14,9 24,4 27,2 176,0 7,1 16,1 59. Informality further weakness the case for using VAT expenditures to 8,1 support poorer households. In Cabo Verde, Valderrama et al. (2024) estimate 113,6 78,2 74,1 59,4 that around 67 percent of the consumption of the poorest households is informal,54 versus 44 percent for the richest quintile (Figure 2.22). This implies that the tax base protected by VAT expenditures is low for poorer households and 23,6 16,5 5,1 21,8 17,4 there is little case for keeping those exemptions on the basis of redistribution. 2019 2020 2021 2022 2023 The prevalence of consumption informality on food items highlights the IRPC/CIT (inclusing SRSMC) Import duties VAT - DGA potentially overlooked importance of eliminating exemptions on education and VAT - DGCI (including SRSMC) Community tax Excise taxes health to increase tax revenue. Note: data disaggregated by regime not available for 2023. Source: World Bank staff calculations based on Cabo Verde Ministry of Finance data 52 This section is based on “A note on the incidence of VAT in Cabo Verde. Background Note for the Cabo Verde PFR” prepared by Valderrama et al. (2024). 53 These include food items, books, medications and medical equipment, farming inputs and items for fishing activities. 54 Informal consumption is measure by purchases from traditional retailers: street stalls and public markets, corner stores, gifts and home production (Bachas et al. 2024) Public Finance Review - Page 80 The Efficiency of Cabo Verde’s Tax System FIGURE 2.21. FIGURE 2.22. A LARGE SHARE OF POORER HOUSEHOLDS’ CONSUMPTION ... BUT POORER HOUSEHOLDS HAVE A HIGHER LEVEL BASKET BENEFITS FROM EXEMPTIONS OR REDUCED RATES OF CONSUMPTION INFORMALITY 100 100 80 80 Percentage of consumption Percentage of consumption 60 60 40 40 20 20 0 0 Poorest 2 3 4 Richest Poorest 2 3 4 Richest quintile Quintiles of consumption per-capita quintile quintile Quintiles of consumption per-capita quintile Standart rate Exempted or reduced rate Source: Author’s calculations based on the III Demographic Household Survey (Inquérito às Depsesas e Receitas Familiáres, IDRF-III) and 2013 Tax code. Public Finance Review - Page 81 The Efficiency of Cabo Verde’s Tax System 60. The VAT reduces the purchasing power of both poor and rich households, 63. Removing existing VAT exemptions will bring fiscal gains; but but its impact varies with consumption informality levels. Valderrama et al. complementary policy measures to mitigate potential impacts on the more (2024) indicate that, without informality, the tax rate would be fairly flat: 10% for vulnerable households are warranted. The existing VAT system – accounting for the richest and 9.2% for the poorest households. This slight progressivity is due the non-exempt goods - increases the poverty headcount, measured by the to the richer spending more on non-food items. However, effective tax rates are national poverty line, by between 2 and 5.3 percentage points depending on the lower and more progressive because poorer households more often buy from informality assumption. A VAT system with a uniform tax rate and no exemptions informal stores and rely on non-market purchases. The richest face a tax rate 1.5 would result in higher levels of fiscal impoverishments, with poverty increasing times that of the poorest, making VAT more progressive than statutory rates by 7.9 percentage points where no informality is assumed, and by 2.9 suggest. percentage points where informality is present. Inequality is in general expected to decline (by less than one Gini point) in all scenarios and models, with stronger 61. VAT revenues mostly come from the wealthiest households. About half of declines when VAT expenditures are eliminated and consumption informality is all VAT revenues come from the top quintile of consumption, with similar values present (Figure 2.23, right-hand graph). Ensuring fiscal gains are directed to shown for a model that assumes consumption informality (54 percent) and a strengthening the social protection system and providing safety nets to most model that assumes no consumption informality (48 percent). The contributions vulnerable households is key to mitigate these impacts. To identify these of the poor to indirect taxes are estimated to be at most 6 percent for both types households, Cabo Verde could leverage its Unified Social Register (Cadastro of models. Social Único, CSU), which is currently used by 12 social programs to identify beneficiaries, to target cash transfers funded by fiscal gains resulting from the 62. Likewise, revenue gains from eliminating exemptions and reduced rates removal of VAT exemptions. are also expected to be mostly sourced from the wealthiest Cabo Verdeans.55 Between 42 and 52 percent of the additional revenues will come from households in the top quintile, while the poorest quintile will contribute at most 7 percent of the expected revenues. Eliminating VAT exemptions is expected to reduce consumption by poor households by between 1.2 and 4.3 percent, depending on consumption informality; this range is expected to be between 2.2 and 3.6 percent for the wealthiest households. The lower relative burden for wealthier households is explained by exemptions being largely directed towards food. 55 While some elements of the exemptions might not be progressive according to Coelho et al (2023), it is important to highlight that the analysis does not account for informality in consumption which has an impact on household consumption. Public Finance Review - Page 82 The Efficiency of Cabo Verde’s Tax System FIGURE 2.23. ELIMINATING VAT EXEMPTIONS WOULD HAVE WELFARE IMPLICATIONS IF NOT ACCOMPANIED BY MITIGATION ACTIONS Percentage increase in poverty headcount Impact on inequality 10 -0,2 7,9 8 0,04 -0,0 Percentage points 6 5,3 Gini points 4 -0,2 2,9 2,0 -0,23 2 -0,4 0 -0,44 -2 -0,6 -0,56 Status quo Eliminating exemptions Status quo Eliminating exemptions No informality Informality No informality Informality Source: Author’s calculations based on IDRF-III and 2013 Tax code. Public Finance Review - Page 83 The Efficiency of Cabo Verde’s Tax System ARE INCENTIVES FROM CONTRACTUAL CONVENTIONS 66. The firm outcome variables chosen for the analysis are based on the MEETING THEIR INTENDED OBJECTIVES?56 objectives for granting the contractual incentives, listed above. These can be assessed through the following measures: 64. Incentives under contractual conventions have been part of Cabo Verde’s legislation for several years, though with some recent modifications. • Gross value added: indicates a firm’s contribution to economic activity. This These incentives, specified in Article 16 of Cabo Verde’s CBF, are designed to helps to assess the extent to which the incentives contribute to accelerated exempt firms from several taxes, such as import duty, CIT, property tax and growth. stamp duty, and are granted by the Council of Ministers on condition that the • Sales revenues: an increase is indicative of within-firm growth. beneficiaries meet the following conditions: (i) an investment of at least CVE 3 • Depreciation: although the level of investment is not directly observable in billion (following a downward revision in 2016 from the CVE 10 billion specified in tax return declarations, they do show whether firms are deducting the 2013 legislation); (ii) an investment relevant for accelerating the depreciation and amortization expenses from their gross earnings. This can development of the national economy; and (iii) at least 100 direct jobs to be be used as a proxy for the level of investment in physical/depreciable assets. created within three years. Regulatory changes in 2016 relaxed the eligibility • Expenses on wages and salaries: indicate the level of employment created conditions and expanded the coverage of applicable municipalities for these by the firm, either in terms of quality (better pay), or quantity (number of investments.57 people employed). 65. While these measures aim to encourage investment, promote the 67. The effects of the contractual incentives on these measures are estimated development of priority sectors and areas, and support other public policy using tax returns data from 2015 to 2022. Standard difference in differences goals, they ultimately lead to a decrease in government revenue, (DID) and DID with matching estimation techniques were both applied59,60 , to understanding their economic and social impact is therefore key. To estimate estimate the impacts of the contractual incentives on firm outcomes by the effect on firm outcomes of the revised eligibility criteria for these incentives, comparing how the outcome variables for benefiting firms changed over time we compare the changes in the outcome variables of treated firms (those that compared to the non-benefiting firms. The assumption, commonly referred to became beneficiaries after the changes in 2016 )58 with a group of relatively as the “parallel trends assumption”, suggests that in the absence of the similar non-benefiting firms (the comparison group). contractual incentives, the changes in the outcome variables of the treated firms would have been the same as those of the non-benefiting firms (see Annex 2.3 for more detail on the methodology and the estimation equation). 56 This section is based on “Tax incentives in Cabo Verde: Are Cabo Verde’s Contractual Incentives Meeting the intended objectives?”, a background note for the Cabo Verde PFR by Namunane, S. (2024). 57 In 2016, eligibility conditions were relaxed by 50 percent for beneficiaries with businesses located in São Vicente, Maio and São Nicolau; and reduced by 75 percent for investment projects carried out in the municipalities of São Filipe, Santa Catarina do Fogo, Mosteiros, Brava, Porto Novo, Paul, Ribeira Grande de Santo Antão, São Lourenço dos Órgãos, São Salvador do Mundo, Tarrafal, Santa Cruz, Santa Catarina de Santiago, São Domingos, São Miguel and Ribeira Grande de Santiago. 58 Initial beneficiaries are excluded from the analysis because it is not possible to observe their gross value added, sales revenues, depreciation and amortization expenses, and wages and salaries (outcome variables) in periods before the incentive was granted (i.e. prior to 2016). 59 The difference-in-differences (DID) technique is used to assess the causal effect of an event by comparing the change in the outcomes of a set of units where the event happened (treatment group) in relation to the outcomes of those units where the event did not happen (control group). 60 Matching is a statistical technique used to evaluate the impact of a treatment by comparing treated and non-treated units in an observational study. However, in this study propensity score matching is used to ensure that the comparison group is more like treated firms in pretreated outcomes. Public Finance Review - Page 84 The Efficiency of Cabo Verde’s Tax System 68. While firms benefiting from contractual incentives saw greater increases in gross value added and sales revenues than non-benefiting firms, the incentives had no effect on either investment in depreciable assets or wage growth. This implies that although beneficiaries contributed more to economic activity and registered higher within-firm growth than non-benefiting firms, they are not investing in more depreciable assets, employing more people or paying higher wages than the non-benefiting firms. Gross value added and sales revenues for benefiting firms were, on average, higher by 23.9 percent and 34.5 percent respectively than for the non-beneficiaries (Table 2.3). These results are statistically significant at the 10 percent and 5 percent levels respectively. While the depreciation and amortization expense is about 12 percent higher for benefiting firms, and the wages and salaries paid by beneficiaries are about 14.6 percent higher than for the comparison group firms, these effects are not statistically significant (Table 2.3). Contractual incentives also have a significant positive effect on gross value added and firm sales revenues when the comparison group is restricted to only firms that are similar in pre-incentive outcomes, though results for investment and jobs proxies are barely statistically significant (see Table A3.2 in Annex 2.3).61 TABLE 2.3. THE EFFECTS OF CONTRACTUAL INCENTIVES ON FIRMS’ KEY OUTCOME VARIABLES (1) (2) (3) (4) Log Gross Log Sales Log Depreciation and Log wages Value Added Revenues Amortization expenses and salaries Beneficiaries * after 2015 0.239* 0.345** 0.120 0.146 (0.131) (0.162) (0.274) (0.173) Time trend 0.008 -0.002 0.038*** 0.053*** (0.008) (0.010) (0.010) (0.008) Firm-level fixed effects Yes Yes Yes Yes Dummy for last year (t=8) in sample Yes Yes Yes Yes Observations 17,725 21,214 17,084 19,169 R-squared 0.002 0.001 0.005 0.010 Number of firms 4,340 4,908 3,953 4,394 Note: Robust standard errors in parentheses and clustered at a firm level. ***, **, and * denote the significance at the 1, 5 and 10 percent levels, respectively. 61 Initial results may be subject to bias because the non-benefiting firms may not necessarily be comparable to the beneficiaries. To address these concerns, we exploit the larger size of non-benefiting firms and generate a propensity score that is used to match beneficiaries to non-beneficiaries that are similar in the propensity score (Blundell et al., 2004; Glewwe and Todd, 2022). Table A3.2 shows that the gross value added and sales revenues for benefiting firms increased by 37.4 percent and 33.9 percent respectively relative to the comparison group. These effects are statistically significant at the 1 percent level. Similarly, the depreciation and amortization expenses and wages and salaries increased by 29.9 percent and 15.5 percent, though results are barely statistically significant. Public Finance Review - Page 85 The Efficiency of Cabo Verde’s Tax System 69. While useful in initial years, there are no observable gains in firm outcomes after the fourth year of the provision of incentives. The results discussed above assume that the effect of granting the contractual incentives on firm outcomes is constant over time. However, further analysis shows that the effects of granting contractual incentives vary over time and are generally not statistically significant after the fourth year of provision of the incentive (Table 2.4). For example, there is no difference between how benefiting firms and the comparison group contribute to the level of economic activity in the 5th and 6th years post-incentive. Similarly, there are no significant impacts observed on sales revenues after year 4. Results also show that benefiting firms are not investing in physical assets in ways that are significantly different from the comparison group. Lastly, while estimates show that benefiting firms’ wages increased by 42.9 percent in the 4th year post-incentives relative to the comparison group, this result is partly explained by the design of the pre-qualifying conditions in Article 16 of the CBF, which requires firms to create at least 100 direct jobs within a maximum of three years. This may have encouraged firms to work towards attaining the intended objectives in the earlier years of becoming beneficiaries; however, there is no evidence that the gains from the contractual incentives are sustained after the first four years. TABLE 2.4. THE EFFECTS OF THE CONTRACTUAL INCENTIVES OVER TIME (1) (2) (3) (4) Log Gross Log Sales Log Depreciation and Log wages Value Added Revenues Amortization expenses and salaries Exempt firm * One year post exemption (t=2) 0.031 -0.019 -0.128 -0.204 (0.144) (0.205) (0.261) (0.292) Exempt firm * Two years post exemption (t=3) 0.294 0.390** 0.101 0.299 (0.195) (0.182) (0.300) (0.210) Exempt firm * Three years post exemption (t=4) 0.548*** 0.595*** 0.321 0.416* (0.146) (0.185) (0.295) (0.216) Exempt firm * Four years post exemption (t=5) 0.510*** 0.659*** 0.179 0.429** (0.155) (0.186) (0.357) (0.202) Exempt firm * Five years post exemption (t=6) 0.110 0.398 0.228 0.077 (0.401) (0.363) (0.336) (0.227) Exempt firm * six years post exemption (t=7) -0.180 0.124 0.205 -0.071 (0.372) (0.366) (0.328) (0.280) Exempt firm * Seven years post exemption (t=8) 0.513*** 0.469 0.104 0.177 (0.197) (0.312) (0.312) (0.282) Time trend 0.009 -0.003 0.037*** 0.053*** (0.008) (0.010) (0.010) (0.008) Firm-level fixed effects Yes Yes Yes Yes Dummy for last year (t=8) in sample Yes Yes Yes Yes Observations 17,725 21,214 17,084 19,169 R-squared 0.002 0.001 0.005 0.010 Number of firms 4,340 4,908 3,953 4,394 Note: Robust standard errors in parentheses and clustered at a firm level. ***, **, and * denote the significance at the 1, 5 and 10 percent levels, respectively. Public Finance Review - Page 86 The Efficiency of Cabo Verde’s Tax System 70. While the incentives are partly designed to encourage job creation, the results from the empirical analysis point to a relative weak impact on wage growth. Changes in firms’ expenses on wages and salaries are either driven by a change in the wage rate or the number of employees. We further investigate whether the changes in wages and salary expenses are driven by lower employment numbers or lower compensation offered by benefiting firms. 71. Notably, the jobs created by the firms benefiting from contractual incentives are, on average, less well-paid than those created by comparison group firms. Empirical analysis of monthly employee level data suggests that while the number of employees in benefiting firms has increased relative to the comparison group (Figure 2.24, left graph), the average wage rates paid by the benefiting firms have remained low and have decreased in recent years (Figure 2.24, right graph). These results suggest that benefiting firms are creating relatively low paying jobs relative to the comparison group firms in Cabo Verde. Creating jobs alone is not enough, especially when the process is subsidized; the jobs must be remunerated at the same level as those created by firms paying the full taxes. 72. In conclusion, the GoCV should consider eliminating contractual conventions given that there is little evidence to suggest that beneficiaries invest more than non-beneficiaries, and that the jobs created are often of low quality. This would enhance the fairness of the tax system, improve tax productivity, ease tax administration, and prevent government subsidization of low-wage employment. Should benefits under contractual conventions be maintained, there is scope to streamline them – including by repealing provisions that allow for reduced rates after exemptions expire, as economic benefits after the initial four years are not substantial. Reassessing the scope of taxes eligible for exemption under contractual incentives is also important, given the mixed outcomes on economic gains observed from such broad-based tax benefits. Public Finance Review - Page 87 The Efficiency of Cabo Verde’s Tax System FIGURE 2.24. FIRMS BENEFITING FROM CONTRACTUAL INCENTIVES, ON AVERAGE, CREATE LOW-PAYING JOBS No. of employees Salary levels 6 9,4 Log average employee compensation Comparison firms 9,2 Log number of employees 5 9 4 8,8 3 8,6 Benefiting firms 8,4 -2 2015 2016 2017 2018 2019 2020 2021 2022 2015 2016 2017 2018 2019 2020 2021 2022 Note: Anonymized monthly employee level data and the respective wage rates were received to disaggregate the effects of contractual incentives on firm wage growth. Employees for firms that are benefiting from other CIT incentives are excluded from the comparison group as they would bias the estimates. Other Incentives are granted to some firms in the financial sector, and in special economic zones. Source: World Bank staff estimates based on Cabo Verde Ministry of Finance data. 2.4 IS CABO VERDE’S TAX REGIME EFFECTIVE AT CORRECTING FOR EXTERNALITIES? Public Finance Review - Page 89 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? HEALTH-RELATED TAXES HAVE SCOPE FOR INCREASES FIGURE 2.25. MORTALITY AND MORBIDITY DUE TO ALCOHOL, 73. Cabo Verde applies excise taxes on alcohol, tobacco, and some TOBACCO AND SSBS ARE RISING non-alcoholic beverages, which are designed to target the negative externalities and internalities generated by their consumption. Well-designed Disability-adjusted life years (DALYs) lost health taxes increase the prices of targeted products, reducing their consumption and the burden of mortality and morbidity, while simultaneously increasing tax revenues. Trends in disability-adjusted life years (DALYs) lost in Percentage of all DALYs (alcohol and tobacco) 6% 0,40% Cabo Verde due to alcohol, tobacco and sugar-sweetened beverages (SSBs) show an increasing burden of disease over the last three decades (Figure 2.25), 5% Percentage of all DALYs (SSBs) underscoring the importance of health taxes. 0,30% 4% 74. Health taxes are influenced by Cabo Verde’s membership of ECOWAS, which implements a harmonized excise tax directive that defines both tax 0,20% 3% structures and minimum tax rates on tobacco, alcohol and non-alcoholic beverages. The directive was reformed in 2017, increasing minimum tax rates, 2% but more importantly implementing specific taxes on tobacco for the first time.62 0,10% ECOWAS member states are required to implement a minimum ad valorem tax of 50 percent and a specific tax of US$ 0.40 per pack (US$ 0.02 per stick). To this 1% end, in 2019 Cabo Verde raised the ad valorem rate from 30 to 50 percent and introduced a specific tax of CVE 20 per pack (US$ 0.20) (Table 2.5). Subsequent 0% 0,00% increases in specific taxes resulted in a specific tax equivalent to US$ 1.18 per 1990 1994 1998 2002 2006 2010 2014 2018 pack in 2024, well above the ECOWAS minimum requirement. Increases in tobacco taxes have had a meaningful impact on cigarette prices. Between 2018 Alcohol Tobacco SSBs and 2022, the price of the most sold brand of cigarettes increased by 51 percent in real terms, following a decline of 11 percent in the preceding decade (Figure Source: GBD (2019), Global Burden of Diseases Results Tool 2.26). 62 Excise taxes can be implemented as specific or ad valorem taxes. Specific taxes apply to the volume of the product (i.e., number of cigarettes or liters of beer), while ad valorem taxes apply to the value of the product (i.e., CIF value). Generally for health taxes, specific taxes are preferred to ad valorem taxes since the negative externalities of the products do not correlate with the value (i.e., a cheaper cigarette or beer is not less harmful than a more expensive cigarette or beer). Furthermore, specific taxes have a more meaningful impact on reducing consumption by increasing the prices of cheaper products by more, thereby reducing incentives to trade-down to cheaper products. Specific taxes are also easier to administer, resulting in greater scope for increases in tax revenues (WHO, 2021). Their most significant weakness is their inability to automatically adjust for inflation; however, indexation of specific tax rates helps overcome this (World Bank, 2023a; World Bank, 2023b). Public Finance Review - Page 90 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? 75. While not required by the ECOWAS directive, Cabo Verde began The higher magnitude of tobacco tax increases resulted in larger relative implementing specific taxes on alcohol in 2022. Tax rates have increased over increases in tobacco excise tax revenues (335 percent in real terms between time; however, the ad valorem rate was reduced from 50 to 40 percent in 2024. 2017 and 2023). Notably, alcohol accounted for 80 percent of revenues in 2023, A challenge in applying both specific and ad valorem taxes (the mixed system) is indicating a larger consumption base; however, this was down from 93 percent in the relative impact of the two components, which is analysed in more detail 2017, indicating the slower increase in tax rates.64 Reforms have increased excise below. tax collection from 0.67 percent of GDP in 2017 to 0.90 percent in 2023, reflecting the buoyancy of health taxes and the meaningful impact on fiscal TABLE 2.5. EXCISE TAX RATES HAVE EVOLVED OVER TIME space.65 Product Excise type 2018 2019 2020 2021 2021 2022 2023 2024 Tobacco Ad valorem 30% 50% 50% 50% 50% 50% 50% 50% Specific (CVE per pack) 20 20 40 40 70 90 120 Alcohol Ad valorem 50% 50% 50% 50% 50% 50% 50% 40% Beer Specific (CVE per L) 15 20 40 Wine 30 35 60 Whiskey 150 180 200 Other spirits 100 130 200 Note: The tax base for specific tax is a pack of 20 cigarettes and one litre of beverage. In 2024, the specific tax increase on alcohol was accompanied by a reduction in the rates on domestically produced alcohol to half the rate of imported products. 76. The tax reforms and increases have had a significant impact on excise tax revenues. Alcohol excise tax revenues increased by 30 percent in real terms between 2017 and 2023, with much of the increase in 2022 after the implementation of the specific tax (Figure 2.27).63 63 Tax revenues declined in 2020 and 2021 due to the COVID-19 pandemic; however, the average revenue over 2022−2023 was 28 percent higher than over 2017−2019. 64 Non-alcoholic beverages accounted for a negligible amount of tax revenue (0.4 percent of total health tax revenue in 2023). 65 See World Bank (2023) for a broader discussion. Public Finance Review - Page 91 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? FIGURE 2.26. FIGURE 2.27. INCREASING TAXES HAVE MADE CABO VERDE’S ALCOHOL TAXES CONTRIBUTE THE MOST TO REVENUE MOST-SOLD BRAND OF CIGARETTES LESS AFFORDABLE 2008−2022 (constant 2022 prices) Alcohol and tobacco excise tax revenue, 2017−2023 350 2,5 1,0% CVE (billions, constant 2023 prices) Percent of GDP, 2019−2022 avg 300 2,0 0,8% 250 1,5 0,6% 200 150 0,4% 1,0 100 0,5 0,2% 50 0 0,0 0,0% 2008 2010 2012 2014 2016 2018 2020 2022 2017 2018 2019 2020 2021 2022 2023 Net-of-tax VAT/Sales tax Customs duties Specific Ad valorem Alcohol Tobacco Percentage of GDP Note: World Bank GTP estimates using WHO (2023), WHO Report on the Global Tobacco Epidemic, Note: World Bank GTP estimates using WHO (2023), WHO Report on the Global Tobacco Epidemic, 2023: Protect people from tobacco smoke; and World Development Indicators data. 2023: Protect people from tobacco smoke; and World Development Indicators data. Public Finance Review - Page 92 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? 77. Assessing the effectiveness of excise taxes involves considering the TABLE 2.6. EFFECTIVE ALCOHOL TAX RATES IN 2023 AND 2024 relative contribution of ad valorem and specific tax components. For example, in 2022 the specific tax on cigarettes was CVE 70 per pack, while the value of the Specific Ad valorem Total excise Specific share ad valorem tax of 50 percent on each pack of the most sold brand (i.e., effective tax per pack) was approximately CVE 14 per pack. This made the specific tax a Per L Per L Per L Per LAA Percent significantly larger component of the total excise tax, accounting for 83 percent 2023 of the total excise tax in 2022. Conversely, specific taxes account for significantly smaller shares of the total excise tax on alcoholic beverages, Beer 20 84 104 2,080 19 although there is also substantial variation between beer, wine, and sprits (Table 2.6). While continued application of the specific tax is important given its impact Wine 35 57 92 708 38 on health and tax revenue, the relatively higher effective ad valorem tax on spirits Other spirits 130 332 462 1,155 28 means that the base value of the specific tax may be insufficient. Whiskey 180 495 675 1,688 27 78. Health taxes in Cabo Verde are still relatively low compared to peer 2024 2024 2024 2024 2024 2024 countries. While cigarette taxes are higher than other ECOWAS countries and significantly above the minimum tax rate, taxes are still lower than other countries 2024 in Africa, with the peer countries of Mauritius and Seychelles especially highlighted since they are also small island economies with significant Beer 40 68 108 2,152 37 dependence on tourism. Furthermore, effective tax rates in Cabo Verde are Wine 60 45 105 809 57 significantly lower than the minimum excise in the European Union (US$ 1.96 per pack), where most tourists are normally resident. Alcohol taxes show a greater Other spirits 200 266 466 1,165 43 degree of variation. While beer taxes in Cabo Verde are more aligned with peer countries, wine and spirits taxes are significantly lower than most peer countries Whiskey 200 396 596 1,490 34 (Table 2.7). Note: Assumed alcohol strength of 5%, 13% and 40% for beer, wine, and spirits when converting volumetric tax to litres of absolute alcohol (LAA). Source: World Bank Global Tax Program (GTP) estimates using Ministry of Finance data. Public Finance Review - Page 93 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? TABLE 2.7. CABO VERDE’S EXCISE TAX RATES ARE LOWER 79. This suggests there is still scope for future increases and reforms in THAN IN SIMILAR PEER COUNTRIES tobacco tax policy. While tobacco tax rates are at the higher end of peer country comparisons, there is still room to increase taxes, particularly to ensure that the value of taxes and tax revenues are protected in real terms. Further Cigarettes Beer Wine Spirits analytic work is required to ensure taxes on other tobacco products, including shisha and novel tobacco products such as heated tobacco and electronic Per pack Per L Per L Per L cigarettes, are applied and in line with existing taxes. With improved data availability, future engagement could consider appropriate tax rates and Cabo Verde* 1.18 1.07 1.04 4.83 structures to achieve both health and fiscal goals. Kenya 0.44−0.61 1.07 1.83 2.68 80. Alcohol taxes require further attention as current rates may encourage Mauritius 3.04 1.18−1.63 3.15−5.51 6.46−19.94** substitution between products and undermine the effectiveness of the tax policy. While tax reforms are commendable, the tax structure—including the Seychelles 5.65 1.78 3.30 12.20−20.67 balance between specific and ad valorem taxes, the relative tax rates of different beverages, and the different treatment of domestic and imported South Africa 1.20 0.38** 0.30−0.88 6.06** products—requires attention. Effective tax rates on wine and spirits are significantly lower than on beer, which may encourage substitution from beer to Note: * Taxes in Cabo Verde reflect the estimated effective tax; ** these taxes are levied on the wine and spirits, undermining the effectiveness of tax policy in discouraging alcohol content and converted to volumetric taxes using same method as Table 2.4. consumption. Furthermore, as tax rates are lower than in peer countries, there is scope for increases. Since the alcohol market is very heterogeneous, further analysis, including of prices and the effect of taxes on prices and volumes, should be considered. Public Finance Review - Page 94 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? CARBON PRICING CAN BE MADE MORE EFFECTIVE 81. At present, Cabo Verde has no formal carbon pricing mechanism, such as a carbon tax or cap-and-trade system; instead, carbon is priced indirectly through multiple fuel taxes and VAT differentials. An analysis of total carbon price (TCP) shows that the price of carbon varies between fuel type (Figure 2.28). For example, LPG exhibits a net negative carbon price due to a lower applicable VAT on butane. Diesel has benefited from a lower TCP in recent years due to both lower prices compared to gasoline as well as VAT exemptions applied in 2022 and 2023. The difference in pricing is also evident across sectors, with carbon being priced lower in the residential and power sectors than in the transport and industrial sectors (Figure 2.29). 82. Although its emissions are relatively low, Cabo Verde is keen to align tax policy reforms with environmental commitments. Cabo Verde has made a commitment to reduce emissions by 18 percent from business-as-usual (BAU) by 2030, while also aspiring to achieve net-zero emissions by 2050. However, an assessment carried out by the IMF (2023a) using the Climate Policy Assessment Tool (CPAT) shows that the country’s emissions trajectory is not aligned with the objectives outlined in its Nationally Determined Contribution (NDC). The tool was also applied to understand the effects of a proposed carbon tax in Cabo Verde.66 66 The CPAT is a diagnostic tool jointly developed by the World Bank and the IMF, to assess the environmental and socio-economic impacts of various carbon pricing and non-carbon pricing policies, using country-specific assumptions about energy prices, economic growth, and other socio-economic variables. Public Finance Review - Page 95 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? FIGURE 2.28. FIGURE 2.29. CARBON PRICES VARY BY FUEL TYPE RESIDENTIAL AND POWER SECTORS HAVE LOWER CARBON PRICES THAN TRANSPORT AND INDUSTRY Total carbon price by fuel type (2023) Total carbon price by sector (2023) 100 150 Constant USD per TCO2 Constant USD per TCO2 100 50 50 0 0 -50 -50 LPG Diesel Gasoline Overall TCP Residential Power Transport Industrial Overall TCP Carbon Taxes Emissions Trading Fuel Excises Carbon Taxes Emissions Trading Fuel Excises TCP component TCP component Fuel Subsidy (est.) VAT Differentials Fuel Subsidy (est.) VAT Differentials Note: Calculations are based on fossil fuel price data provided by the International Monetary Fund (IMF), which relies on the price gap approach to estimate net energy taxes or net fuel subsidies. The legend displays all TCP components although some of them do not apply in Cabo Verde. Source: TCP tool using IMF Energy Price database Public Finance Review - Page 96 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? 83. A modest carbon tax would allow for emissions mitigation alongside 85. Cabo Verde can harmonize the TCP across different sectors and link considerable revenue-generating potential. The IMF analysis of a potential existing fuel taxes and duties to carbon content – rather than relying on varied carbon tax in Cabo Verde suggests that starting the tax at US$ 10/tCO2e in 2024 import duties and excise tax exemptions for certain fuels. Inconsistencies in and increasing it to US$ 35 by 2035 would lead to a 6.02% reduction in GHG carbon pricing across sectors create economic distortions, reduce efficiency, emissions by 2030 relative to a business-as-usual scenario (IMF, 2023a). The and weaken incentives for decarbonization. Where sectors with lower carbon power sector is anticipated to be the primary contributor to these reductions prices continue to emit at a higher rate, this undermines mitigation efforts. given its significant reliance on fossil fuels. Additionally, the tax is projected to Competitive imbalances may arise, leading to market inefficiencies. A careful, generate substantial government revenue, potentially amounting to 1 percent of and phased, upward revision of carbon prices—especially applied to diesel fuels GDP by 2035, and cumulatively up to US$ 280 million between 2024 and 2035. in the power sector, considering ongoing sector reforms—could drive investment in renewable energy and energy efficiency improvements (Figure 84. A well-designed carbon tax has the potential to achieve a double 2.30). Similarly, the current taxation structure based on fuel volume or value (ad dividend by reducing emissions while supporting economic growth through valorem) does not directly incentivize emissions reduction. As such, Cabo Verde strategic revenue recycling. Upstream carbon taxation can have lower impacts is encouraged to revisit existing fuel taxes and duties to ensure these are applied on economic growth than conventional taxes. Covering large informal sectors based on carbon content. As well as promoting use of low-carbon products, this and using the revenues to substitute formal-sector taxes creates opportunities approach also reduces the impact of price fluctuations on tax revenue stability to boost output. Despite the CPAT analysis showing that the potential carbon tax as ad-valorem taxes/duties depend on fuel market prices. could have a modest negative impact on economic growth, the broad tax base allows carbon taxation to raise revenues more efficiently, with less negative impact on output compared to conventional taxes.67 Upward pressure on energy prices and increased output prices – including in transportation – could be mitigated through growth-enhancing revenue recycling options. For example, channelling proceeds to targeted cash transfers and public investment such as in health, education, and infrastructure can deliver high returns to economic welfare.68 67 See, for example, evidence for Côte d’Ivoire (Timilsina et al., 2023), Ghana (Elmaleh et al., 2021), Pakistan (Burns et al., 2021), China and India (Carson et al., 2021), Iran (Mirhosseini et al., 2017), Spain (Markandya et al., 2013), Eastern Europe (Skrok et al., 2022, p. 48f), the EU (Barrios et al., 2013), and globally (Bento et al., 2018, Schoder, 2023). 68 Plante (2014). Public Finance Review - Page 97 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? FIGURE 2.30. THERE IS A LARGE GAP BETWEEN FUEL IMPORT DUTIES/EXCISE TAXES AND AN EFFICIENT CARBON PRICE OF CVE 10,500 Selected development indicators Labor force participation Index, 0−100 (the best) Percent of population +15 Tax gap CVE per liter CVE per liter, equivalent to a CVE 10500 carbon tax Tax gap Existing CVE per ton CO2e CVE 10350 carbon tax 35000.00 10500.00 30000.00 8500.00 CVE per ton CO2e CVE per liter 25000.00 6500.00 20000.00 15000.00 4500.00 10000.00 2500.00 5000.00 0 500.00 Super gasoline Regular gasoline Kerosene (illuminating oil) Diesel Domestic fuel oil Light fuel oil Heavy fuel oil I Heavy fuel oil II Liquefied butanes Super gasoline Regular gasoline Kerosene Diesel Domestic fuel oil Light fuel oil Heavy fuel oil I Heavy fuel oil II Liquefied butanes -1500.00 Source: World Bank staff estimates based on official data. Energy prices for January 2021 are used and are available here Public Finance Review - Page 98 Is Cabo Verde’s Tax Regime Effective at Correcting for Externalities? TAXES ON INTERNATIONAL TRADE ARE 88. To increase revenue from trade taxes, Cabo Verde is taking steps to align AN IMPORTANT RESOURCE its customs tariff with the ECOWAS Common External Tariff (CET) Schedule. The adoption of the ECOWAS CET, initially postponed due to the pandemic, is being introduced in a phased manner starting in 2024. The reform is expected to 86. Taxes on international trade are a major source of government income, increase revenues by about 1 percent of GDP over the medium term.69 A full second only to VAT. Between 2012 and 2023, they accounted for about 3.7 implementation of the CET would result in a notable decrease in tariff percent of GDP, or 20.7 percent of total tax revenue. From 2018 to 2022, Cabo dispersion,70 with the highest rate dropping from 50 percent to 35 percent, and Verde's performance in collecting trade taxes surpassed the averages for the proportion of goods with zero-duty MFN rates significantly reduced from 44 Sub-Saharan Africa (SSA), structural peers, and aspirational peers alike, who percent to 1.4 percent, based on World Trade Organization (WTO) data from accumulated trade taxes of 2.6 percent, 3.3 percent, and 3.4 percent of GDP, 2015.71,72 respectively. 87. While Cabo Verde’s trade is mainly with non-African countries, it actively engages in the ECOWAS Trade Liberalization Scheme (ETLS), which promotes free trade within the region for certain goods. The ETLS is designed to streamline the ECOWAS Free Trade Area (FTA) and enable the unrestricted movement of specific qualifying goods throughout the region. Under this scheme, all qualifying goods sourced from approved producers in other ECOWAS member states can be imported into Cabo Verde duty-free. However, goods imported from other regions of Africa are subject to the most-favored-nation (MFN) applied duty. 69 IMF (2022). 70 The ECOWAS CET is organized into five tariff bands depending on the type of good: 0 percent for essential social goods; 5 percent for goods of primary necessity, raw materials, and capital goods; 10 percent for intermediate goods and inputs; 20 percent for final consumption goods or finished products; and 35 percent for specific goods. 71 Lisazo (2022). 72 Cabo Verde’s MFN applied tariff comprises 12 tariff bands, ranging from low (duty-free, 1 percent, 2 percent, 3 percent and 5 percent) to medium (10 percent and 15 percent) and to high (20 percent, 25 percent, 30 percent, 40 percent and 50 percent). Most goods are imported at a 5 percent duty. These products include liquefied butanes, motorboats, coffee, and sawn tropical, mahogany and Sapelli wood. A 10 percent import duty is applied on imports of certain goods vehicles, while a 20 percent duty is levied on imports of cooked pasta and certain goods vehicles. High tariffs are applicable to imports of passenger vehicles, pneumatic tires, certain food preparations (30 percent import duty each) and uncooked pasta (40 percent import duty) (Tralac, 2018). 2.5 POLICY RECOMMENDATIONS Public Finance Review - Page 100 Policy Recommendations 89. This chapter has shown that tax revenue collection in Cabo Verde has increased gradually over the last decade, but remains below potential. Tax revenue has increased from 16.7 percent of GDP in 2012 to about 19.3 percent in 2023. However, most comparable aspirational peer countries collected on average 20 percent of GDP between 2018−2022. Perhaps more importantly, the analysis indicates that Cabo Verde has a tax effort of 0.63, which implies an overall tax gap of about 11 percentage points. 90. To bridge the considerable tax gap, and ensure continued fiscal sustainability, the chapter provides a range of options for boosting domestic revenue mobilization in a way that improves efficiency and is pro-poor. A conservative estimate suggests that implementing the policy actions listed in Table 2.8 could structurally raise tax collection by around 2.35−2.85 percent of GDP. TABLE 2.8. POTENTIAL FISCAL GAINS FROM DOMESTIC REVENUE MOBILIZATION MEASURES Time frame/ Impact Impact Policy area Policy action Fiscal impact (estimate, percent of GDP) feasibility on efficiency on equity VAT exemptions and Streamline the list of exempt and reduced-rate goods ST 1.0 - 1.5% + -/+ zero-rating Review ZEET incentives to minimize VAT leakage ST Potential unclear (reduces cost of VAT (other) Implement a turnover threshold for VAT registration MT + TBC administration) Trade taxes Proceed with full implementation of ECOWAS CET 1% MT + TBC Contractual convention Eliminate contractual incentives At least 0.2% ST + + + (longer Health excise tax Raise tobacco and alcohol excise 0.15% ST-MT + lifespan) Total potential fiscal gain 2.35-2.85% Source: World Bank staff estimates. Notes: ST = 1−2 years; MT = 2−5 years Public Finance Review - Page 101 Policy Recommendations 91. Additional measures could be implemented to strengthen tax administration efforts: • Assess the implementation of Pillar 2 of the 2021 OECD/G20 Inclusive Framework on BEPS. This could be done by analyzing the potential impact of the global minimum tax and the policy implications, including the possible introduction of a domestic top-up tax. Cabo Verde should also consider implementing the Subject to Tax Rule to ensure that profits are taxed where economic activities generating the profits are performed, and where value is created. Strengthening transfer pricing auditing capacity is crucial to monitor and regulate intra-group transactions effectively, thereby preventing base erosion and profit shifting. • Improve the productivity of corporate income tax and minimize tax planning behavior by both professionals and firms that claim to create more jobs, Cabo Verde should also explore aligning the headline CIT rate with the top marginal PIT rate. In addition, the country should eliminate reduced rates for job creation – allowing the tax system to be neutral regardless of institutional form. • Accelerate efforts to streamline tax incentives. Reviewing and ultimately eliminating contractual conventions would enhance the fairness of the tax system, improve tax productivity, and prevent government subsidization of low-wage employment. Should there be a need to take a phased approach, the government should repeal provisions that allow firms to enjoy reduced rates after four years of receiving contractual incentives, as the economic benefits are not substantial beyond this period. More broadly, eliminating tax exemptions—including those not in use—is critical to reduce potential leakages. Public Finance Review - Page 102 Policy Recommendations REFERENCES Cruz, J. (2024). National Director for State Modernization. "Presentation to the World Bank: Cabo Verde Entrepreneurship Ecosystem." 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Addressing Informality through Simplified Enterprise Forms and a Special Legal Status; Research Report. Donor Committee for Lane C, Blecher E, Ozer C, Bloom D, Prinz D (2023a) Health taxes and inflation. Enterprise Development. World Bank Global Tax Program Health Taxes Knowledge Note Series No. 2. Washington DC: World Bank. Skrok et al. (2022). Green Fiscal Reforms: Part Two of Strengthening Inclusion and Facilitating the Green Transition. Lisazo, T. (2022). Cape Verde in the ECOWAS: From a Free Trade Agreement to a Customs Union. A CGE analysis at the product level (HS6). University of San Timilsina, G. R., Dissou, Y., Toman, M., & Heine, D. (2024). How can a carbon tax Andrés. October 17, 2022. benefit developing economies with informality? A CGE analysis for Côte d’Ivoire. Climate Policy, 24(1), 71−86. Markandya, A., González-Eguino, M., & Escapa, M. (2013). From shadow to green: Linking environmental fiscal reforms and the informal economy. Energy Tralac (2018). Cape Verde: Intra-Africa trade and tariff profile – 2018. Tralac Trade Economics, 40, S108−S118. Law Centre. No. 16/2019. August 2019. Mirhosseini, S. S., Mahmoudi, N., & Pourali Valokolaie, S. N. (2017). Investigating Valderrama, D., and Malazquez Eduardo (2024). A note on the incidence of VAT in the relationship between green tax reforms and shadow economy using a CGE Cabo Verde. Background Note for the Cabo Verde PFR. model-A case study in Iran. Iranian Economic Review, 21(1), 153−167. WHO (2021). Technical Manual on Tobacco Tax Policy and Administration. OECD (2023). Harmful Tax Practices – 2022 Peer Review Reports on the Geneva: World Health Organization. Exchange of Information on Tax Rulings: Inclusive Framework on BEPS: Action 5− Cabo Verde, OECD/G20 Base Erosion and Profit Shifting Project, OECD WHO (2023). WHO Report on the Global Tobacco Epidemic, 2023: Protect Publishing, Paris, https://doi.org/10.1787/22bbeacc-en. people from tobacco smoke. Geneva: World Health Organization. OECD (no date). “Activated exchange relationships for Country-by-Country reporting”,https://www.oecd.org/tax/beps/country-by-country-exchange-re lationships.htm. 3. RECALIBRATING TOWARDS GROWTH-ENHANCING EXPENDITURE Public Finance Review - Page 105 Recalibrating Towards Growth-Enhancing Expenditure 92. Achieving the ambitious goal of a growth-friendly fiscal consolidation trajectory requires identifying opportunities for efficiency savings that could be re-allocated productively to pursue economic development objectives. To address this need, this chapter starts with an analysis of public spending, including composition and execution, comparing Cabo Verde to peer countries. Given the high level of budget rigidity, including pressures from recent wage bill reforms, the chapter then considers opportunities for greater spending efficiencies—including goods and services, and public investment management (PIM). Next, the chapter assesses spending from a sectoral angle—with a focus on education and health— and identifies avenues for greater spending efficiency. Finally, the chapter concludes with a summary of policy recommendations and their potential fiscal gains. 3.1 EXPENDITURE TRENDS AND BUDGET RIGIDITY Public Finance Review - Page 107 Recalibrating Towards Growth-Enhancing Expenditure 93. Over the last decade, public expenditure in Cabo Verde has remained Spending on goods and services (G&S) and social benefits has almost doubled relatively stable as a share of GDP, but has become increasingly skewed as a share of total spending over the past decade, increasing in real terms and as towards current spending. Total expenditure averaged 28.8 percent of GDP in a share of GDP (continuing the rising trends highlighted in the previous PER). the five years prior to the pandemic and has fallen further since the crisis While interest payments have remained constant as a share of GDP, they now (averaging 26 percent over 2022−2023, Figure 3.1). Despite this, public account for almost 9 percent of total expenditure, up from 6.5 percent a decade expenditure in 2023 was 9 percent higher than in 2013 in real terms, driven by ago, reflecting higher servicing costs—particularly given reliance on short-term current expenditure. The composition of spending has shifted away from public domestic financing in the wake of the pandemic. Finally, subsidies have recently investment, which represented over 30 percent of the total a decade ago, and gained weight in the budget—in part driven by support to the maritime only 7 percent in 2023. Indeed, while public expenditure in Cabo Verde is below interisland transport concession, as well to SOEs.73 Subsidies to SOEs—partly that of both aspirational and structural peer countries, notable differences exist related to the energy and water sectors—have increased in the last two years as when examining expenditure composition. Current spending is 1.2 pp of GDP the authorities introduced compensatory mechanisms to implement the social higher than structural peers (average 2018−2022). It is also higher than both tariff for targeted vulnerable households. As a result, subsidies reached 1 comparison groups as a share of total expenditure (90 percent in Cabo Verde vs percent of GDP in 2023 (from near 0.1 percent of GDP before the pandemic). A 76 percent in structural peers and 86 percent in aspirational ones, average dedicated discussion on support to SOEs, including potential fiscal risks, is 2018−2022). Similarly, Cabo Verde’s wage bill as a share of total spending (35 found in Chapter 4. percent) is above structural (32 percent) and aspirational peers (28 percent), though, on average, non-wage bill related current spending is aligned with 95. Changes in expenditure composition have made the budget increasingly aspirational peers. rigid.74 An evaluation of the budget based on economic classification shows high rigid expenditure components, increasing from less than 50 percent of 94. The increases in current spending are driven by the wage bill, goods and total expenditure in 2012 to 67 percent by 2023 (Figure 3.2) because of the services, social benefits and subsidies. The wage bill increased 30 percent in increasing weight of the wage bill, pensions and interest payments in overall real terms between 2012 and 2021, driving the growth in current spending. A spending. When foreign-financed capital expenditure is considered, overall wage freeze kept wage spending subdued since 2022 but, going forward, the rigidity reached 70 percent of total expenditure in 2023 (still down from the 74 introduction of the new Plan for Careers, Functions and Remuneration of the percent average between 2018−2022). As such, the sources of budget rigidity General Regime (Plano de Carreiras Funções e Remunerações do Regime Geral, have shifted in line with greater inflexibility arising from the weight of wages, PCFR) (see Box 3.1) which initiated in 2024 will create additional spending interest rates and pensions in the budget, as well as a reduction in international pressures. financing earmarked to capital spending. 73 Interisland maritime travel has largely been covered by Cabo Verde Interilhas (CVI), who operates under a 20−year concession contract with the GoCV. See Box 4.3 in Chapter 4 for a discussion on the fiscal costs associated to the concession contract. 74 Fiscal rigidities are constraints that limit the ability to change the level or structure of public budgets in a specified period. Such constraints may include various legal, contractual and institutional public-sector obligations that have budgetary impact (Cetrángolo 2010). High rigidity items include wage bill and employment contracts, basic services, pensions and other social benefits, interest payments and transfers to subnational governments. Rigidity can also arise from the financing side, as earmarked taxes or loans also introduce inflexibilities into the budget. Public Finance Review - Page 108 Recalibrating Towards Growth-Enhancing Expenditure Importantly, Cabo Verde’s public spending is more rigid than both structural and According to the authorities, key factors affecting execution include budget aspirational peers (Figure 3.3), highlighting one of the main challenges the planning challenges, limited human resources coupled with high staff turnover budget presents for any recalibration towards growth-friendly expenditure. rates, and cumbersome procurement procedures—in part arising from a large share of donor financed projects. The later section on the efficiency in public 96. Over the last five years, around 84 percent of the budget has been investment spending provides additional analysis on execution dynamics and executed—although this masks variation across spending components and key challenges. lags behind peers. An analysis of execution by spending components shows that the most rigid expenditure items have had the highest execution rates, while others—such as capital expenditure—have seen the lowest spending. This low execution significantly trails that of peer countries over the 2018−2022 period, as does execution of G&S spending. Lower execution rates have played a significant role in driving budgetary changes within each year, which could signal difficulties in budget planning. 97. Low execution of the capital budget has contributed to declining levels of spending, which has translated into government investment having a very marginal impact on growth. Declining public investment in part reflects expenditure restraint following the rapid debt build up in the early 2010s. More recently, it is a symptom of persistent under-execution of the capital budget.75 Budget execution reached an all-time low, at 40 percent, in 2022−2023. Tellingly, the contribution of public investment to growth has been marginal, mostly driven by its reduction and its effect on aggregate demand since 2015 (Figure 3.4). Moreover, the low multiplier for public investment is in line with the substantial import content of capital spending, as well as persistently low execution rates. While comparator countries have also faced a reduction in their capital spending as a share of total spending, the contraction has been more pronounced in Cabo Verde.76 Unlike Cabo Verde, countries like Bhutan and the Maldives have seen public investment contribute positively to growth.77 75 Measured as the ratio between executed expenditure and initial budget. 76 Capital expenditure decreased for structural peers from 30 percent of the total on average over 2012−2017 to 25 percent of total over 2018−2022. Likewise, aspirational peers decreased their capital expenditure from 16 to14 percent over these two periods. In contrast, Cabo Verde’s capital expenditure share was cut by half, from 22 to 11 percent. 77 Based on estimates from debt sustainability analyses of Bhutan, Samoa, Maldives and São Tomé and Príncipe. Public Finance Review - Page 109 Recalibrating Towards Growth-Enhancing Expenditure FIGURE 3.1. PUBLIC EXPENDITURE IN CABO VERDE IS DECLINING AND IS LOWER THAN PEERS Economic classification of public expenditure Execution ratios, average 2018−2022 Percent of approval amounts 40 160 120 35 140 30 120 100 25 100 Percent of total revenues 20 80 15 60 80 Percent of GDP 10 40 5 20 60 0 - 40 Average 2012 - 2017 2018 2019 2020 2021 2022 2023* Cabo Verde Structural Aspirational 20 Average Cabo Verde 0 2018 - 2022 Total Wage Bill Goods Interest Social Subsidies Capital Wage Bill Other Social Benefits Expenditure and Services Payments Benefits Expenditure Goods and Services Total Expenditure (% revenues) Capital Expenditure Subsidies Interest Total Expenditure (% GDP) Cabo Verde Structural Aspirational Source: World Bank’s BOOST database78 based on GoCV data. * Preliminary data 78 https://www.worldbank.org/en/programs/boost-portal Public Finance Review - Page 110 Recalibrating Towards Growth-Enhancing Expenditure FIGURE 3.2. FIGURE 3.3. HIGHLY RIGID COMPONENTS HAVE ACCOUNTED FOR A LARGER BUDGET RIGIDITY IS HIGHER THAN FOR INTERNATIONAL PEERS SHARE OF SPENDING Selected development indicators Public expenditure rigidity, average 2018−2022 Index, 0−100 (the best) Percent of total expenditure 100 100 90 90 Percentage of total expenditure 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Cabo Verde Structural Aspirational High rigidity (economic classification) High rigidity - foreign financed CAPEX Medium rigidity Low rigidity High rigidity Medium rigidity Low rigidity Source: World Bank’s BOOST database. Note: High rigidity includes wage bill, employment contracts, basic services, pensions and other social benefits; interest payments and transfers to subnational governments; and capital expenditure financed by foreign funds. Medium rigidity: Goods and services in health and education (other than those included as high rigid); and subsidies and domestic-financed capital expenditure in health and education. Low rigidity: other domestic financed capital spending, other goods and services, other expenditure. Public Finance Review - Page 111 Recalibrating Towards Growth-Enhancing Expenditure FIGURE 3.4. THE WAGE BILL IS HIGHER THAN PEERS, PUBLIC INVESTMENT HAS PLAYED A NEGLIGIBLE ROLE AND SPENDING PRESSURES ARE PICKING UP IN DRIVING GROWTH 98. Cabo Verde’s wage bill remains the highest among aspirational peers, Contribution of government capital and other factors to growth despite lower employment levels. The wage bill, both as a share of GDP and of total expenditure, is in line with structural peers but higher than aspirational ones and consumes more of Cabo Verde’s revenues (around 43 percent) (Figure 3.5). 20 Cabo Verde’s share of public employment in overall employment is similar to 15 structural peers and much lower than aspirational ones (Figure 3.6). However, available data suggest salaries in Cabo Verde are higher than in structural peers 10 for most occupations (Figure 3.7), although not for aspirational ones. 5 0 Percent 2015 2016 2017 2018 2019 2020 2021 2022 2023 -5 -10 -15 -20 -25 Contribution of other factors Contribution of government capital Source: Adapted from World Bank (forthcoming), Cabo Verde: Joint World Bank-IMF Debt Sustainability Analysis. Public Finance Review - Page 112 Recalibrating Towards Growth-Enhancing Expenditure FIGURE 3.5. FIGURE 3.6. CABO VERDE’S WAGE BILL IS HIGHER THAN ASPIRATIONAL …ALTHOUGH PUBLIC EMPLOYMENT DOES NOT STAND OUT PEERS AND ALIGNS WITH STRUCTURAL ONES… FROM ASPIRATIONAL COMPARATORS Public wage bill Public employment Percent of GDP / of expenditures and revenues Percent of total 12 45 40 40 35 10 35 30 8 30 25 25 6 20 20 15 4 15 10 10 2 5 5 0 0 0 Cabo Verde Structural Aspirational Cabo Verde Structural Aspirational Percent of GDP Percent of public revenues (rhs) Percent of public expenditure (rhs) All Male Female Source: World Bank Macro-Fiscal Model (MFMOD). Source: International Labor Organization (ILO) Public Finance Review - Page 113 Recalibrating Towards Growth-Enhancing Expenditure FIGURE 3.7. FIGURE 3.8. PUBLIC WAGES ONLY DIFFER FROM THE GLOBAL MEAN THE WAGE BILL IS MOSTLY CONCENTRATED FOR SOME OCCUPATIONS IN PUBLIC SERVICE DELIVERY Cross-country public sector pay compression ratio Public wages composition, average 2018−2022 (relative to the global mean) Percent of total expenditure 1.4 Cabo Verde Structural Aspirational 100 90 1.2 80 1 70 60 0.8 50 0.6 40 0.4 30 20 0.2 10 0 0 Cabo Verde Structural Aspirational Universaty teacher Senior official Secundary school teacher Primary school teacher Police officer Judge Hospital nurse Hospital doctor Government economist Judiciary Public safety Education Health Other Source: World Bank Bureaucracy Database (WWBD). Note: The pay comparison ratio compares pay Source:World Bank’s BOOST database in selected occupations with the global mean (measured in 2017 PPP). Of the structural peers, the WWBD only includes São Tomé and Principe (all occupations) and Bhutan (primary and secondary teachers, nurses and doctors). Public Finance Review - Page 114 Recalibrating Towards Growth-Enhancing Expenditure 99. Much of the country’s wage bill spending is concentrated in functions 101. Wage bill pressures are expected to increase with ongoing reforms of the related to service delivery – including education, public safety, health and public service, which include redefining core functions. Having expanded judiciary functions. These sectors account for more than 70 percent of gradually in real terms until 2021, the wage bill contracted since 2022 to 2018 spending, higher than in peer countries, particularly for education, where the levels due to the nominal freezing of salaries and rising inflation. Still, it is share of the wage bill is almost double (Figure 3.8). When general public services expected to rise 9 percent of GDP by 2025. This reflects the ongoing are added, spending reaches 80 percent of total wages in 2023. These implementation of a new career plan that is redefining core functions, shifting functions were also the main drivers of real growth of the wage bill until 2021.79 fixed-term contracts towards opened-ended ones, and increasing wages to Contractual and temporary workers account for a significant share of the wage match inflation (Box 3.1). Analysis of microdata on wage bill spending is critical to bill (20 percent), although it has been declining (down from 30 percent over the simulate the impact of these changes on fiscal sustainability.82 last decade). This is consistent with the implementation of the new PCFR, which seeks to transition workers currently under fixed-term contracts to open-ended positions, where applicable.80 100. Preliminary analysis suggests that a significant wage gap exists between public and private sector workers.81 An analysis of wage compensation between public sector workers (individuals who work for the public administration or SOEs) and private sector workers, using the Inquerito Multi-Objetivo Continuo survey from 2023, suggests that the average private sector worker earns up to 47 percent less per hour than the average public sector worker. This wage disparity persists even when accounting for differences in observable characteristics among both groups. The analysis shows that, on average, public sector employees tend to be older, possess more years of experience in their current positions and have higher levels of education. In addition, public sector workers generally work fewer hours, are more frequently women, and are likely to be in service-oriented roles. Interestingly, when SOE employees are excluded (about 15 percent of the sample), the observed wage gap between public sector and private formal sector workers decreases (to about 40 percent). 79 Accordingly, the wage bill represents a higher share of total spending in education (more than 75 percent), public safety and defense (more than 60 percent each) and health (50 percent). 80 See https://www.mf.gov.cv/web/dnap/-/quadro-comum-da-administra%C3%A7%C3%A3o-p%C3%BAblica-dotado-de-um-novo-plano-de-carreias-fun%C3%A7%C3%B5es-e-remunera%C3%A7%C3%B5es-pcfr-2. 81 An econometric analysis suggests that half of the wage gap is driven by worker characteristics, while the remainder is unexplained. Education is a significant contributor. 82 The Government Analytics Handbook (Rogger and Schuster, 2023) provides an analysis of how wage bill microdata can support governments to improve workforce and fiscal planning jointly and in a coordinated way (chapter 10). Specifically, microdata can help human resources planning by identifying sectorial needs and staff characteristics to better allocate resources, and it also allows to have a better understanding of hiring needs and forecast retires, which influence the budget. Still, this analysis needs to be framed in the context of small states staffing challenges, which as Carroll et al (2024) explains, includes diseconomies of scale arising from minimum amount of staffing needed to administer a country and provide public services as well as limited labor pool and brain drain, which complicates staffing in government (notably for skilled positions). Public Finance Review - Page 115 Recalibrating Towards Growth-Enhancing Expenditure BOX 3.1. THE REFORM OF THE PUBLIC SERVICE REGIME IN CABO VERDE83 In 2024, Cabo Verde started implementing a new public service regime for the public administration, the PCFR Plano de Carreiras Funções e Remunerações do Regime Geral [Plan for Careers, Functions and Remuneration of the General Regime, PCFR]. This reform aims at improving working conditions for public employees and overcoming key challenges of the previous 2013 Job, Career and Salary Plan (Plano de Carreiras e Salários, PCCS), including (i) a high share of employees under fixed-term contracts; and (ii) wide variation in salaries across entities and regimes. The PCFR establishes new principles, rules and criteria for the organization, structure and professional development of public servants under the general public employment regime. Key innovations include the introduction of a new set of “functions”, rather than positions, and the implementation of a Single Remuneration Table (Table Unica de Remuneração, TUR) that harmonizes remuneration practices, thus increasing transparency. Moreover, the PCFR regularizes the employment status of all operational support and technical assistant staff currently employed under fixed-term contracts, allowing them to be linked to a career regime with professional development opportunities. Government estimates suggest that, of a total of 6,869 employees, 70 percent are contracted personnel who will be covered by the employment regularization program. The PCFR emphasizes the use of performance evaluation for promotions, rather than training or academic degrees, as mandatory for progression. The new TUR provides wage increases of 27 percent for operational support staff, 11 percent for technical assistance staff and 8 percent for technical staff (relative to 2013 PCCS tables). Wage increases for general staff and the regularization program as well as the implementation of the PCFR for special regimes (e.g. education, health), which are expected to be approved in 2025, will create additional costs of near 1 percent of GDP in 2025. 83 This box is based on the Plano de Carreiras Funções e Remunerações do Regime Geral. https://www.mf.gov.cv/documents/89129/4199801/Plano+de+Carreiras+Fun%C3%A7%C3%B5es+e+Remunera%C3%A7%C3%B5es.pdf/aabf5b6b-6db9−9436−5e2f-b4d70ca308c9?t=1707322983231 Public Finance Review - Page 116 Recalibrating Towards Growth-Enhancing Expenditure SPENDING ON GOODS AND SERVICES CONTINUES TO RISE 104. Efforts to improve the effectiveness of Cabo Verde’s procurement system could bring important savings for G&S spending. The recent 102. Goods and services (G&S) spending is not high when compared to Methodology for Assessing Procurement Systems (MAPS) assessment,84 peers, but continues to increase. Unforeseen spending during the pandemic, completed in 2024, highlights the following gaps in effective procurement: (i) mainly on medical inputs and vaccines, increased G&S spending to an average the lack of economic analysis of procurement efficiency, including quantified of 5.8 percent of GDP in 2020−2021. While G&S spending has since narrowed, to objectives and targets for performance assessment; and (ii) a general lack of 4.6 percent of GDP in 2023, it is still above the 3 percent recorded in 2012. It also market analysis and research for guiding acquisitions. Amongst other represents a higher share of total expenditure (18 percent in 2023) and is higher recommendations, the assessment emphasizes the need to promote a than pre-pandemic levels. Notably, G&S spending in 2023 was 14 percent higher comprehensive approach that tackles technical, legal, and political aspects of in real terms than 2019. The relatively discretionary nature of this category public procurement system reform, aiming for a more efficient and transparent suggests there could be short-term gains from tighter controls – as already system and promoting market and performance orientation.85 highlighted in the previous Public Expenditure Review (World Bank, 2019). HUMAN CAPITAL SPENDING HAS BEEN PROTECTED AND 103. Health, general public services and economic affairs account for the SOCIAL SPENDING ENHANCED bulk of G&S spending. Taken together, these functions represent almost 60 percent of all G&S spending. While health expenditure is mostly related to 105. Human capital (health and education) spending and income medicines and other medical inputs, general public services and economic redistribution (social protection) have largely been safeguarded over the affairs spending is mostly associated with travel and accommodation; and past decade. The strengthening of social benefits has increased the income technical assistance to residents and non-residents. Within economic affairs, redistribution function86 (Figure 3.9). Education spending (averaged around 5 technical assistance represents more than half of G&S spending and was one of percent of GDP between 2013−2023) was shielded from fiscal consolidation the drivers of the sharp increase of G&S in 2023. Employment contracts efforts before pandemic, and health spending was reinforced even before the registered under G&S spending have picked up over the last decade (driven by COVID-19 crisis. However, overall public spending on improving resource general services, health, education and economic affairs), emphasizing the need allocation87 (including not only health and education but also spending related to for robust controls. economic affairs functions88) has contracted, mainly driven by the fall in public investment (see section 3.2). Cabo Verde has also taken important steps to promote gender equality by adopting gender budget tagging, although programs with a specific gender component are only a minor share of the budget (see Box 3.2). 84 Methodology for Assessing Procurement Systems (https://www.mapsinitiative.org/methodology/). 85 African Development Bank (2024). 86 The share of the social protection function rose from 9.5 percent in 2013 to near 18 percent in 2023, almost doubling its weight on the budget. 87 Including functions of economic affairs, environment, housing, health, recreation and education. 88 The economic affairs function comprises expenditure on agriculture, electricity, transport, and construction, among others. Public Finance Review - Page 117 Recalibrating Towards Growth-Enhancing Expenditure FIGURE 3.9. FIGURE 3.10. INCOME REDISTRIBUTION SPENDING HAS EXPANDED IN THE PUBLIC EXPENDITURE CONTRACTION HAS MOSTLY AFFECTED CONTEXT OF STRENGTHENED SOCIAL BENEFITS THE ECONOMIC AFFAIRS SECTOR Functional expenditure Functional expenditure Percent of GDP Percent of GDP 100% 35 90% 13% 30 17% 80% 25 70% 20 15 60% 52% 45% 10 50% 5 40% - 30% Average 2012-2017 2018 2019 2020 2021 2022 2023* Cabo Verde Structural Aspirational 20% 38% 35% 10% Average 0% Cabo Verde 2018 - 2022 Average 2012-2017 Average 2018-2023* General services Defense Public safety Economic affairs Environment Basic functions of state Allocation of resources Income redistribution Housing Health Recreation Education Social Protection Source: World Bank’s BOOST database, based on Government of Cabo Verde data. * Preliminary Source: World Bank’s BOOST database, based on Government of Cabo Verde data. * Preliminary data data Public Finance Review - Page 118 Recalibrating Towards Growth-Enhancing Expenditure 106. Cabo Verde’s functional composition is largely aligned with that of The implementation, since 2018, of the Unified Social Registry (USR) has aspirational peers (Figure 3.10). The share of spending on basic state functions contributed to improved targeting and implementation of the RSI and the (General services, Defense, Public safety) is similar to peer countries. emergency RSI.94,95 The country has also implemented unemployment insurance Importantly, since the last PER (World Bank, 2019) Cabo Verde’s efforts have for formal workers since 2016,96 financed through contributions by both brought spending income redistribution in line with aspirational peers. Notably, employers and workers. Despite this, high informality rates (around 50 percent) social protection spending has picked up from an average of 12 percent of total mean that most workers are not reached by this insurance.97 The Government of spending in 2012−2017 to 17 percent in 2018−2022.89 Spending on resource Cabo Verde has also created the Fundo Mais—partially financed through a allocation90 is also similar to aspirational peers, though well below structural tourism receipts—aiming at raising funds to support efforts to eliminate extreme ones, mostly explained by the public investment contraction in Cabo Verde. poverty by 2026. Within these functions, Cabo Verde’s education spending has been higher than for both comparator groups, while health expenditure expansion has allowed 108. Spending on social protection is likely to continue increasing as the Cabo Verde to narrow the gap with its peers.91 An analysis of key trends for the authorities implement the National Strategy for Eradication of Extreme education and health sectors, and efficiency challenges, is outlined in Section Poverty. The poverty rate (measured at US$ 3.65 a day, 2017 PPP) has fallen from 3.2. 19.3 percent in 2015 to an estimated 16.2 percent in 2023. However, it remains higher than for in most aspirational countries, as well as Bhutan, though lower 107. While pensions represent the bulk of social benefits, the weight of the than in São Tomé and Principe.98 Inequality—measured by the Gini index using the non-contributive pillar has gradually increased. Both pensions and social latest data (2015)—also remains higher than for most peer countries (except St. assistance benefits had been on the rise prior to the pandemic, as well as the Lucia). To address these, the Government’s National Strategy for the Eradication coverage of the vulnerable population for receiving non-contributive cash of Extreme Poverty (Estratégia Nacional para Eradicação da Pobreza Extrema, benefits (Figure 3.11 and Figure 3.12). This trend reflects the development of the ENEPE) aims at to strengthening the social protection system to reduce extreme non-contributive pension system (the social basic pension,92 which is mainly poverty by increasing coverage of the RSI and promoting productive inclusion directed towards the elderly, children in vulnerable households and people with programs; improving the links among social policies; and strengthening a disability). It also reflects the implementation of the Rendimento Social de institutional, technical, and financial capacities to enable the planned expansion Inclusão (RSI; Social Inclusion Income) cash transfer program, for which the and its M&E.99 benefit value is in line with other cash transfer programs in the region.93 89 For structural peers, this ratio went up from 15 to 16 percent between the two periods. 90 Including functions of economic affairs, environment, housing, health, recreation and education. 91 Although health spending as a share of GDP remains lower than for comparator groups, its share in total expenditure has been more aligned with peers on average over 2018−2022 (above 11 percent), up from 7 percent on average between 2012 and 2017. 92 Analysis of the adequacy of this benefit estimates it represented 43 percent of the minimum wage and 102 percent of the international extreme poverty line (US$ 1.9 per day) in 2023 (GoCV and ILO, 2024). 93 The RSI benefit represents 27 percent of the average household consumption for extreme poor families with children under 15 (World Bank, 2018). 94 The emergency component expanded coverage to all first quintile households, and to households with children under 15 in the second quintile. 95 World Bank (2023a). 96 Decree-Law 15/2016. 97 Government of Cabo Verde (2022). 98 No comparable data for Samoa, Vanuatu, and St. Kitts and Navis. 99 World Bank (2023a). Public Finance Review - Page 119 Recalibrating Towards Growth-Enhancing Expenditure FIGURE 3.11. FIGURE 3.12. SOCIAL ASSISTANCE HAS BEEN INCREASING BENEFIT COVERAGE OF THE MOST VULNERABLE WAS ON THE RISE BEFORE THE PANDEMIC Social benefits by type Coverage of vulnerable population 5.0 50 4.5 45 Percent of poor and extreme 4.0 40 3.5 35 poor population Percent of GDP 3.0 30 2.5 25 2.0 20 1.5 15 1.0 10 0.5 5 0.0 0 Average 2018 2019 2020 2021 2022 2023 2016 2017 2018 2019 2020 2022 2012-217 Social assistance Pensions Share of poor population Share of extreme poor population Source: World Bank’s BOOST database, based on GoCV data. Note: *Preliminary data Source: Boletim Estatístico sobre Proteção Social em Cabo Verde, 2016−2020 and 2021–2023, GoCV and ILO (2024). Note: data refers to the proportion of people in poverty or extreme poverty receiving at least one cash benefit from CNPS. Data for 2021 not available. Public Finance Review - Page 120 Recalibrating Towards Growth-Enhancing Expenditure BOX 3.2. FIGURE 3.13. GENDER EXPENDITURE: PUBLIC EXPENDITURE TARGETING GENDER EQUALITY HAS A STEP TOWARDS PROMOTING GENDER EQUALITY INCREASED BY 30% SINCE 2018 Cabo Verde has adopted budget gender tagging to identify spending on Public expenditure by gender classification promoting gender equality. The methodology, applied since 2018, classifies budget programs and projects into four different groups: (i) projects that do 1,8% 2,4% 2,1% 3,5% 0,9% 2,3% not yet integrate gender aspects (G0); (ii) projects with some intervention to 100% promote gender equality, which at least include some product, activity, or 90% 13% 12% Percent of total expenditure 17% 25% 25% indicator (G1); (iii) projects that, while not having the promotion of gender 80% 24% equality as their main objective, include a component that directly 70% contributes to it (G2); and (iv) projects whose main objective is to promote gender equality, directly contributing to gender priorities (G3).100 60% 51% 54% 49% 41% 44% 42% 50% While projects directly targeting gender priorities represent a minor share 40% of the budget, those with at least one component have been increasing. 30% Public expenditure classified as G3 (main objective to promote gender equality) accounted for a mere 2 percent of total expenditure in 2023 (Figure 20% 29% 33% 32% 31% 30% 31% 3.13), and was allocated to the Ministry of the Family, Inclusion and Social 10% Development and the Ministry of Justice. While minor, this budget has 0% increased by over 30 percent in real terms between 2018 and 2023. The 2018 2019 2020 2021 2022 2023 budget has also seen a shift from G1 to G2 spending, with a greater portion of the budget now having a specific gender component, at almost a quarter of G0 G1 G2 G3 Not identified the total budget in 2023 (up from 17 percent in 2018, or 39 percent higher in real terms). The share of the budget not integrating gender related aspects Source: Government of Cabo Verde. Note: G0: projects not yet integrating gender; G1: projects with some intervention to promote gender equality; G2: projects with a specific component to remains stable at 30 percent. promote gender equality; G3: projects that directly promote gender equality. 100 Coello Cremades (2017). Public Finance Review - Page 121 Recalibrating Towards Growth-Enhancing Expenditure The Government of Cabo Verde’s National Gender Equality Plan 2021−2025 (Plano Nacional de Igualidade do Genero, PNIG) guides the implementation of gender equality measures and actions. The plan—structured around economic, physical, and decision-making autonomy—serves as a reference for formulating and implementing policies and programs promoting gender equality, and facilitating the monitoring and evaluation of gender equality goals. Focus areas and strategic objectives are shown in Figure 3.14. FIGURE 3.14. THE PNIG HAS CLEAR STRATEGIC OBJECTIVES 1.INCREASED 2.BODY 3.DECISION PRODUCTIVITY AND AUTONOMY MAKING ECONOMIC THE BASIS OF AUTONOMY EMPOWERMENT OF EMANCIPATION DEEPENING WOMEN DEMOCRACY 1.1. Ensure the 1.2. Monitor the 1.3. Promote full 2.1. Strengthen 2.2. Strengthen 2.3. Include in 3.1. Strengthen 3.2. Promote full integration implementation institutional interventions actions to the national the the increase in of women of a care commitmentto with a gender combat political implementation women's accelerating system, gender approach in the gender-based agenda of actions participation in the country's promote equality. health sector. violence (GBV). objectives promoting leadership in economic shared aimed at positive public growth. responsibility in eliminating changes in the administration family care. discrimination exercise of and decision affecting the power in private making in the LGBTIQ and public private sector population. spaces. and CSOs. Public Finance Review - Page 122 Recalibrating Towards Growth-Enhancing Expenditure Ensuring the alignment of gender-tagged programs with the PNIG is crucial. As a preliminary exercise, three G3 programs (directly contributing to gender priorities) were analyzed and compared to the PNIG: • The Fundo Mais (Fund More) program aims to combat extreme poverty by 2026 through increased social income transfer programs, providing monthly support to families in extreme poverty. Beneficiaries, including poor households, female-headed families, and victims of gender-based violence, use these funds for small businesses, housing improvements, education, and health. This initiative aligns with the PNIG by supporting women’s economic empowerment (Objective 1.1), improving health services (Objective 2.1), and enhancing gender-based violence prevention (Objective 2.2). • The Fundo de Apoio às Vítimas de Crimes (The Crime Victims Support Fund) provides immediate assistance to victims of gender-based violence, offering financial support for urgent expenses and maintaining shelters and support centers. By targeting women and vulnerable groups, the fund provides social, psychological, medical, and legal assistance for victims, and prevention programs for aggressors. This aligns with the PNIG by combating gender-based violence (Objective 2.2), improving access to services for women and girls (Objective 2.1), and ensuring a supportive framework for victims (Objective 2.3). • The Apoio Integrado À Família (Integrated Family Support) addresses transformations in household composition and disrupted care networks, targeting families struggling with poverty and social inequalities. It improves access to essential services such as education, health, and sanitation, enhancing family dynamics and community integration through guidance and support. The program aligns with the PNIG by supporting women's economic empowerment (Objective 1.1), reducing care burdens (Objective 1.2), and enhancing women's decision-making influence (Objective 3.1), indirectly supporting leadership roles within families and communities (Objective 3.2). While this initial analysis shows strong alignment between gender-tagged programs and the National Gender Equality Plan, further evaluations are necessary to determine if the entire portfolio meets gender equality objectives and supports the expenditure targets. A comprehensive assessment will ensure the system effectively addresses the country's gender priorities and continues to promote equality across all sectors. Assessments should be conducted periodically to ensure continued monitoring of program implementation and associated outcomes—and provide opportunities for further improvements, as needed. 3.2 EFFORTS TOWARDS GROWTH-ENHANCING PUBLIC SPENDING Public Finance Review - Page 124 Efforts Towards Growth-Enhancing Public Spending EFFICIENCY CHALLENGES IN PUBLIC INVESTMENTS 111. Gaps in procurement processes, as well as planning weaknesses, seem to be playing a role in low execution rates. Gaps highlighted in the MAPS 109. Public investment spending has plummeted over the last decade, assessment include procurement entities’ persistent failure to publish Annual reflecting not only fiscal consolidation efforts but also planning and Procurement Plans. These—and their alignment with budget proposals—would implementation challenges. Following the sharp increase in debt levels after the ensure greater coherence between budgeting and planning, and lead to more global financial crisis, capital expenditure was rationalized to support fiscal efficient resource utilization. A more thorough assessment of project execution consolidation. Public investment spending has since continued to fall, and suggests that the planning of public investment could be an issue. For example, reached the lowest levels for the decade in 2023. Notably, the reduction in sizable projects that represented 40 percent of the overall unexecuted amounts capital spending was driven by a decline in foreign financing, which fell from in 2023 were also included in 2021 and 2022 budgets, for similar or higher almost 11 percent of GDP in 2012 to 0.5 percent in 2023 (Figure 3.15). Despite amounts, with execution being significantly low in those years.101 this, an analysis of approved budgets shows the fall in foreign-financed capital expenditure is lower, which suggests issues with budget execution rather than the absence of availability of funds (Figure 3.16). 110. Despite this general decline, the share of investment in social protection and human capital has remained broadly unchanged, and housing and transport investments have also been protected. Investments in social protection, education and health have increased from an average of 0.5 percent of GDP between 2012−2017 (when public investment was concentrated mostly in economic sectors) to 1.9 between 2018−2021, before reverting in the post-pandemic period to previous decade minimums in terms of GDP, though with higher shares of overall investment (19 percent in 2022/2023 vs 10 percent in 2012−2017). Social protection investments have mainly gone towards constructing social housing, while health and education investments are mainly in general hospital infrastructure and equipment, and tertiary education. Recently, in 2022 and 2023, housing and transport investment jointly represented nearly half of all capital expenditure. 101 For example, this includes a transport project that was budgeted at about CVE 2 billion in 2023, and was also included in the 2021 budget for a similar amount but had near zero execution then. Similarly, a water project featured in the 2021 and 2022 budgets with a similar budget and an average execution rate of 2 percent. While the project’s budget was halved in 2023, the execution rate was a mere 3 percent. Public Finance Review - Page 125 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.15. FIGURE 3.16. CAPITAL SPENDING REDUCTIONS ARE DRIVEN BY BUDGET EXECUTION DIFFICULTIES MAY BE DRIVING A DECLINE IN FOREIGN FINANCING FOREIGN FINANCING DECLINES Capital expenditure (CAPEX) by source of financing Approved and executed foreign financed capital expenditure Percent of GDP 14 12 140% 12 120% 10 Percent of approved capital 10 100% 8 Percent of GDP Percent of GDP expenditure 8 80% 6 6 60% 4 4 40% 2 2 20% - - 0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023* 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023* Foreign financed Foreign financed Execution rate Foreign financed Treasury Total CAPEX approved CAPEX executed CAPEX foreign financed CAPEX (RHS) Source: World Bank’s BOOST database, based on GoCV data. Note: *Preliminary data Source: Boletim Estatístico sobre Proteção Social em Cabo Verde, 2016−2020 and 2021–2023, GoCV and ILO (2024). Note: data refers to the proportion of people in poverty or extreme poverty receiving at least one cash benefit from CNPS. Data for 2021 not available. Public Finance Review - Page 126 Efforts Towards Growth-Enhancing Public Spending 112. Cabo Verde’s capital stock lags behind peers—including for Given this, any scale up of public investment needs to be accompanied by infrastructure quality. Since independence, the country’s per capita capital reforms to identify and eradicate sources of inefficiencies in order to increase stock has been falling behind peers, leaving the country with fewer “factor value for money. endowments” that can contribute to economic growth.102 The introduction of reforms in 2005 to promote private investment and increase public capital 114. Addressing these inefficiencies also requires strengthening the disaster expenditure accelerated growth in capital stock (Annex 3.2, Figure B1). Despite and climate resilience of public investments, which will ease the impact of this, recent data shows a plateauing in the level of capital stock—suggesting shocks on public finance and safeguard fiscal space in the face of elevated reforms have not been enough to close the gap with peer countries. The quality climate vulnerabilities. Recent weather-related shocks have had a negative of infrastructure in Cabo Verde, proxied by the Quality of Infrastructure Index, impact on public finances through two channels—lower revenue collection due has averaged 54 points over 2017−2020, lower than Mauritius and Seychelles to reduced economic activity, and higher spending resulting from post-disaster (68.4 and 65.3, respectively). Exploring the detail behind the overall index shows recovery and reconstruction efforts. Estimates suggest an increase in future challenges for port infrastructure, which is crucial for commerce and losses if climate change adaptation measures are not implemented quickly.104 connectivity in this archipelagic nation (Annex 3.2, Figure B2). Investing in climate-resilient critical infrastructure is thus key to ensure business continuity and protect the most vulnerable. It also contributes to a quick and 113. There are significant inefficiencies in public investment in roads, ports, robust economic recovery, mitigating potential negative spillovers from the and transport infrastructure more broadly. When analyzing spending on public initial shock. However, a deeper analysis of the budget shows minimal public investment efficiency across countries, while Cabo Verde performs well in spending on climate and disaster risk management (Box 3.3). subsectors like electricity (Figure 3.13, Panel A),103 there are very large inefficiencies in public investment related to roads, ports, and transport infrastructure (Figure 3.17, Panels B, C and D), suggesting that scaling up public investment in these sectors alone would not necessarily improve their quality. To illustrate, if inefficiencies had been eliminated, Cabo Verde could have reduced its investment spending by 1.3 percent of GDP on average between 2017−2019 to obtain the same level of output (equivalent to near 40 percent of total public investment in those years). Conversely, estimates suggest that within the same spending levels Cabo Verde could enhance the quality of infrastructure by nearly 20 pp if all inefficiencies were eliminated (Figure 3.18, Panel A), and by nearly 16 pp with partial efficiency improvements (to levels comparable to countries in the 90th percentile of efficiency performance) (Figure 3.18, Panel B). 102 World Bank (2023b). 103 It is worth mentioning that while efforts to expand access to electricity, especially in rural areas, is ongoing, challenges such as geographic isolation and limited resources tend to impact the pace of electrification initiatives. 104 For example, under a high-warming scenario, almost 32 percent of the coastal population could be exposed to coastal floods by 2050. Public Finance Review - Page 127 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.17. PUBLIC SPENDING EFFICIENCY IN INFRASTRUCTURE QUALITY COULD BE IMPROVED FOR PORTS, ROADS AND TRANSPORT Panel A: Quality of electricity Panel B: Quality of ports 0,97 0,98 0,96 1 1 Efficiency scores (Quality of Ports) Efficiency scores (Quality .8 .8 of Electricity supply) .6 .6 0,46 .4 .4 0,35 0,22 .2 .2 0 0 CPV MUS SYC CPV MUS SYC Public Finance Review - Page 128 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.17. PUBLIC SPENDING EFFICIENCY IN INFRASTRUCTURE QUALITY COULD BE IMPROVED FOR PORTS, ROADS AND TRANSPORT Panel C: Quality of roads Panel D: Quality of transport 1 1 Efficiency scores (Quality of Roads) Efficiency scores (Quality .8 .8 of Transportation) 0,61 0,60 0,60 .6 .6 0,51 0,47 0,42 .4 .4 .2 .2 0 0 CPV MUS SYC CPV MUS SYC Source: World Bank Staff calculations. Note: MUS: Mauritius and SYC: Seychelles. The efficiency analysis is based on the composite efficiency score (CES), which is a simple average of the efficiency score from five different methodologies (i.e., Data Envelope Analysis, Free Disposal Hull, DEA-Bootstrap, FDH-Bootstrap, and the Stochastic Frontier Analysis). The CES score ranges from 0 to 1, where 0 represents complete inefficiency and 1 represents full efficiency. The public investment efficiency analysis spans the period 2017−2019 and uses the Quality of Infrastructure Index, which ranges from 0−100. The efficiency scores for public investment reported in the section are output-oriented efficiency scores, which capture the gains Cabo Verde can accrue in its infrastructure quality by removing inefficiencies and without scaling up public investment. Public Finance Review - Page 129 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.18. CABO VERDE COULD ENHANCE THE QUALITY OF INFRASTRUCTURE BY ELIMINATING INEFFICIENCIES Panel A: Full efficiency gains Panel B: Partial efficiency gains 100 100 2,92 1,27 90 96,37 90 96,37 80 80 Infrastructure Quality Index Infrastructure Quality Index 70 19,93 70 15,82 60 22,47 60 17,82 50 54,03 50 54,03 18,33 40 40 14,55 42,67 42,67 30 16,29 30 31,98 11,46 31,38 20 20 20,98 20,98 10 10 0 0 Ports Transport Road Overall Electricity Ports Transport Road Overall Electricity Quality Quality Quality Infrastructure Quality Quality Quality Quality Infrastructure Quality Actual Infrastructure Score (Average: 2017-2019) Potential Full Gains in Infrastructure Quality Actual Infrastructure Score (Average: 2017-2019) Potential Full Gains in Infrastructure Quality Source: World Bank staff calculations Public Finance Review - Page 130 Efforts Towards Growth-Enhancing Public Spending BOX 3.3. IMPROVING CABO VERDE’S DISASTER RISK MANAGEMENT AND ADAPTATION Assessing climate and disaster risk management (CDRM) efforts in public finance provides an initial understanding of government expenditures on building resilience to and reducing risks posed by climate change. Analysis using the BOOST database examined expenditures supporting or contributing to strengthening disaster and climate resilience. These CDRM expenditures – which are often cross-sectoral and embedded in broader budget programs – include activities such as risk identification, risk reduction and climate adaptation investments and projects, emergency preparedness and response, financial protection and recovery, as well as post-disaster reconstruction efforts. Public expenditure on CDRM represents only a small fraction of Cabo Verde’s budget, and there is limited integration of CDRM considerations across the budget. The analysis of expenditure between 2018 and 2023 shows that only 3.5 percent of all budget programs can be identified as CDRM-related expenditures, with nearly 80 percent concentrated under two entities: Ministry of Agriculture and Environment (MAE; 68 percent), and Ministry of Internal Affairs, in charge of the Civil Protection System (11 percent). Key stakeholders with an institutional mandate for implementing disaster risk management and climate resilience activities have been allocated very limited funding. The Ministry of Infrastructure, Spatial Planning and Housing (MIOT) and Ministry of Maritime Economy (MEM), critical to ensure resilient territorial planning and promote a blue economy, have less than 8 percent of their budget allocated to CDRM-related expenditures. Similarly, consistent with findings from the IMF’s Climate Diagnostic Report (2023), public expenditure on CDRM is heavily focused on response to disasters and climate-related shocks and conservation and environmental protection projects – rather than mitigation efforts.105 Public expenditure on understanding and assessing disaster and climate risk has also been very limited. The significant gap in knowledge about disaster and climate risks and potential impacts inherently reduces the government’s ability to effectively identify and implement appropriate risk reduction and climate change investments and projects. For example, the National Risk Assessment program, which should develop targeted information on disaster and climate risks, received approximately CVE 0.8 million (0.1 percent of CDRM related expenditure) on average during 2018 and 2023. CRDM expenditures mirror broad budget trends – with capital expenditure accounting for only a fraction. Between 2018 and 2023, about 50 percent involved transfers to other actors, including municipalities (27 percent), while only 15 percent went to capital expenditure. This underscores the crucial role of subnational governments, which are often on the frontline of emergency preparedness, response efforts, and climate change adaptation. Strengthening their capacity and resources is essential for effectively addressing these challenges. 105 CDRM expenditure is scattered across various functional classifications in the budget, diluting the effectiveness of long-term resilience efforts. Public Finance Review - Page 131 Efforts Towards Growth-Enhancing Public Spending Looking ahead, an in-depth review of Cabo Verde’s Climate Action and Resilience (CAR) budgetary program's objectives and results framework could be a critical opportunity to refocus government spending on disaster and climate resilience. To date the CAR program106 has received limited allocations, averaging just 0.99% of total expenditures between 2023 and 2024. This is largely due to the program’s narrow focus on environmental outcomes rather than on long-term disaster and climate resilience objectives. By ensuring more targeted and strategic investments, the government can support cost-efficient, long-term resilience-building efforts. Building on the recent Country Climate and Development Report (CCDR),107 the analysis provides targeted recommendations to strengthen CDRM monitoring and investments: • Develop adequate and targeted information on disaster and climate risks. This is a prerequisite to quantify the potential benefits arising from risk reduction and climate adaptation investment opportunities (e.g. in terms of avoided losses) and is required in order to prioritize the most cost-effective public investments. Enhanced awareness of the range of activities that public sector entities can undertake to strengthen resilience is also important to broaden the scope of public entities in charge of building long-term resilience to disaster and climate risks. Risk information will notably help to identify investment opportunities to reduce risk and adapt to climate change in key sectors managing infrastructure (e.g. roads, ports, airports), as well as in critical sectors (e.g. health, territorial planning and coastal and urban development management). • Clearly define climate adaptation objectives and outcomes in infrastructure and critical sectors and prioritize budget allocation accordingly. The recent creation of a National Secretariat on Climate Action (SNAC) within the MAE could be an important step to strengthen the policy framework for climate adaptation in these sectors. The mid-term review of the PEDS, planned for 2025, provides a unique opportunity for the MoF to work directly with prioritized sectors and translate the renewed policy vision into a budgetary framework and associated results framework that defines clear disaster and climate resilience outputs. This will enable these sectors to align their budgeting processes towards these objectives and outcomes. A budget tagging system would also enhance capacity to measure the contribution of public spending on Cabo Verde’s climate objectives. • Evaluate the efficiency and impact of climate-related policies and programs. The progressive generation of data on disaster and climate resilient public spending will help assess whether public investments achieve desired CDRM outcomes – helping to enhance efficiency in the allocation of public resources. 106 Since the Base Law of the National Planning System and the introduction of program-based budgeting (Law 72/VIII/2014), budgetary programs are linked to planning objectives. These budgetary programs should be maintained through the 5-year duration of the PEDS, and adjustments could be introduced in the mid-term review planned for 2025. 107 World Bank Group (2025). Public Finance Review - Page 132 Efforts Towards Growth-Enhancing Public Spending EDUCATION EXPENDITURE COULD BE MORE 117. Cabo Verde outperforms some structural peers on public spending EFFICIENT IN SECONDARY EDUCATION efficiency in education, but lags behind aspirational peers. Education expenditure efficiency was analyzed by looking at the outcomes of secondary 115. Education spending has been shielded from fiscal consolidation efforts, school education, proxied by net secondary school enrollment and the level of though it has declined recently. Education expenditure averaged around 5 education.108 Efficiency in public spending related to net secondary school percent of GDP between 2013−2023, and its share of in total spending enrollment in Cabo Verde stands at 0.74 (Figure 3.19, Panel A), outperforming fluctuated between 17 and 20 percent over the same period. However, data for structural peers like São Tomé and Principe (0.59) and Vanuatu (0.55), but below 2023 points to a reduction in education spending to below pre-pandemic levels Samoa and all aspirational peers. For the level of education indicator, Panel B (4.3 percent of GDP). This was driven by the freeze of the wage bill, which shows a lower public spending efficiency score (0.62) in Cabo Verde than in accounts for the largest share of spending in the sector. Cabo Verde has spent Mauritius and Seychelles (0.86).109 The efficiency scores related to public more on education than its peers, both in terms of GDP as well as share of total spending in these indicators suggest an output shortfall in Cabo Verde of 26% spending. Despite this, the composition of spending by education level differs, and 31%, respectively. as Cabo Verde spends slightly higher amounts on primary education, while aspirational peers spend more on secondary education, on average. 118. At current public spending levels, Cabo Verde could improve education outcomes by eliminating some or all inefficiencies in its public spending.110 116. Cabo Verde has fared well on key primary education indicators, but lags Based on a counterfactual analysis, Figure 3.20 shows that if all inefficiencies behind peers on secondary education outcomes. At an average of 93 percent, were eliminated (Panel A), Cabo Verde could increase secondary school Cabo Verde’s net primary school enrollment competes strongly with enrollment and education levels by 18.4 pp and 16.6 pp respectively, while international standards. However, for secondary school education, the story is keeping spending at current levels.111 If partial improvements were made to raise starkly different. While Cabo Verde’s net secondary school enrollment stands at efficiency levels to the 90th percentile of developing countries in the sample 71.3 percent and outperforms structural peers like São Tomé and Principe and (Panel B), Cabo Verde could still see 13.4 pp and 13.1 pp increases in net Vanuatu, there are large gaps when compared to aspirational peers (see Annex secondary school enrollment and education levels (Panel B) 3.2, Figure B3). 108 The analysis uses the World Bank’s PFR Public Spending Efficiency Tool, which advocates and recommends for the use of a composite efficiency score (CES). The CES takes the simple average of 5 different methodologies (i.e., Data Envelope Analysis, Free Disposal Hull, DEA-Bootstrap, FDH-Bootstrap, and the Stochastic Frontier Analysis). The CES score ranges from 0 to 1, where 0 represents complete inefficiency and a value of 1 represents full efficiency. The analysis period is 2010-2019. The scores reported in the section are output-oriented efficiency scores, which measure the output shortfall in efficiency—i.e., it measures how a country in question can attain more in the economic outcome (i.e., education outcomes) without scaling up expenditure. 109 Data on the other peers are unavailable for this indicator. 110 For example, higher execution of the education budget is identified to be a strong predictor of enhanced government spending efficiency in education (Figure B, Annex B). However, budget overruns diminish government spending efficiency in education. Cabo Verde budget execution rate (i.e., actual executed budget divided by approved budget) averages 93%, suggesting a gap of 7pps. Closing this budget execution gap to achieve full budget execution rate can partly help eliminate government spending inefficiencies in Cabo Verde’s education sector. 111 This confirms findings in the previous PER, which also pointed to potential efficiency gains, mostly in secondary education. Public Finance Review - Page 133 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.19. CABO VERDE’S PUBLIC SPENDING EFFICIENCY IN EDUCATION TRAILS SOME PEERS Panel A: Secondary school enrollment Panel B: Level of education 1 0,95 1 Efficiency scores (Level of Education) 0,86 0,86 Efficiency scores (Sec. School 0,84 0,86 0,79 Enrollment (Percent Net) .8 .8 0,77 0,74 0,69 0,59 .6 0,55 .6 .4 .4 .2 .2 0 0 CPV KNA LCA MUS STP SYC VUT WSM CPV MUS SYC Source: World Bank staff calculations Public Finance Review - Page 134 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.20. ELIMINATING INEFFICIENCIES COULD SEE IMPROVED OUTCOMES IN SECONDARY EDUCATION Panel A: Full efficiency gains Panel B: Partial efficiency gains 100 100 Gains in Units of Education Outcome 90 90 Gains in Units of Education Outcome 80 18,36 80 13,42 70 70 71,30 71,30 60 16,59 60 13,15 50 50 53,33 53,33 40 40 30 30 20 20 10 10 0 0 Level of Education Secundary School Level of Education Secundary School Actual Education Outcome (Average: 2015-2019) Potential Full Gains in School Enrollment (Net) Actual School Enrollment (Average: 2015-2019) Potential Partial Gains in School Enrollment (Net) Source: World Bank staff calculations Public Finance Review - Page 135 Efforts Towards Growth-Enhancing Public Spending HEALTH EXPENDITURE IS ROBUST, 121. Recent country-level data shows that Cabo Verde’s health outcomes are BUT BETTER COSTING WOULD STRENGTHEN IT FURTHER comparable to aspirational peers and, in some cases, outperform both aspirational and structural groups. Despite a recent slowdown in key health 119. Health spending was on the rise even before the pandemic, and the health outcomes (such as vaccination rates), results are still favorable in the system has been strengthened. Cabo Verde allocates a significant portion of its international context. At 74.1 years, life expectancy in Cabo Verde is higher than budget to healthcare (10 percent in 2023). Spending was reinforced during the for all aspirational and structural peers, and it has the lowest infant mortality rate pandemic, with external financing playing a crucial role in the rapid access to per 1000 of life births (Annex 3.2, Figure B4). Moreover, immunization rates in vaccines that led the country to be among the Sub-Saharan countries with the Cabo Verde are largely comparable to aspirational peers, and the country highest vaccination rates. In this context, health public spending grew from 1.9 outperforms its structural peers on most of the selected health indicators. percent in 2012 to 3 percent of GDP in 2019, and has remained at this level after the pandemic. This increase in public health expenditure, both in terms of GDP 122. Remaining challenges include limited financial resources, geographical and total spending, has moved Cabo Verde closer to its structural and barriers to health service delivery in this archipelagic country, and the impact aspirational peers. of climate change on public health. These challenges were exacerbated by the pandemic in 2020, with the country registering a fall in key health indicators like 120. Primary and secondary health services spending has been reinforced. life expectancy, as well as a slowdown in immunization rates post-2020. Spending on basic and general services has increased as a share of total health Moreover, deaths caused by non-communicable diseases have been rising spending, from an average of 33 percent in 2012−2017 to an average of 39 steadily—from 62.2 percent of total deaths in 2010 to 70.1 percent in 2019.112 percent in 2018−2023. Tertiary and quaternary services—the more specialized services—have followed the opposite trend. In this context, Cabo Verde has 123. Given these challenges, the efficient use of public spending is critical, made progress in strengthening its healthcare system through initiatives to and should include better costing of health services. An efficiency of health expand access to primary healthcare services, train healthcare workers, and spending analysis done for this report focuses on selected health outcomes: life invest in medical infrastructure. The government has prioritized disease expectancy; infant survival rates; diphtheria, pertussis (whooping cough), and prevention and health promotion strategies, including efforts to improve tetanus (DPT) immunization rates; and measles immunization rates.113 maternal and child health outcomes, as well as strategies to combat malnutrition. 112 Cause of death refers to the share of all deaths for all ages by underlying causes. Non-communicable diseases include cancer, diabetes mellitus, cardiovascular diseases, digestive diseases, skin diseases, musculoskeletal diseases, and congenital anomalies. 113 The analysis uses the World Bank’s PFR Public Spending Efficiency Tool, which advocates for and recommends the use of a CES. Conditional on comprehensive data availability, input and output variables for computing efficiency scores for the health sector are selected based on Grigoli and Kaspoli (2018). We include up to a maximum of 9 inputs in computing the public spending efficiency score: public expenditure per capita PPP, private expenditure per capita, PPP, adult literacy rate, population density, alcohol consumption, access to basic sanitation, access to basic water, Tuberculosis diffusion, and HIV diffusion. While the selection of the inputs does not address all the limitations faced when estimating public spending efficiency in health, it does account for key socioeconomic factors that may affect health outcomes, as well as private/household funding of health care. The analysis period is 2010-2019. The scores reported are output-oriented efficiency scores, which measure the output shortfall in efficiency—i.e., it measures how a country can attain more in health outcome without scaling up expenditure. The composite SFA scores incorporate the specified input variables, whereas non-parametric methods are limited to include a single input: orthogonalized public investment per capita. Public Finance Review - Page 136 Efforts Towards Growth-Enhancing Public Spending While the analysis suggests public spending is more efficient in Cabo Verde than in structural peers, and marginally below aspirational peers (Figure 3.21), there is still room for improvement. A counterfactual analysis shows that by improving public efficiency, Cabo Verde could benefit from relatively sizeable gains in health outcomes. If all inefficiencies in public spending in health were eliminated (Figure 3.22, Panel A), the infant survival rate could increase from 4.8 to 5.3; and measles and DPT immunization rates could rise from 95.6 to 99.7 and 95.8 to 99.8, respectively. These gains translate into 7.7 years of life expectancy. Even when only partially eliminating inefficiencies, by attaining levels that match the 90th percentile efficiency score for developing countries, Cabo Verde could still gain approximately 5.6 years in life expectancy, 0.37 units in infant survival rate, and 2.44 and 2.56 in measles and DPT immunization rates, respectively. This calls for a deeper look at the potential sources of inefficiencies and corrective measures, including better costing of health care services (see Box 3.4). FIGURE 3.21: CABO VERDE COMPARES WELL WITH PEERS FOR PUBLIC HEALTH SPENDING EFFICIENCY Panel A: Life expectancy Panel B: Infant survival rate Efficiency scores (Infant Survival Rate) 1 0,95 1 0,94 0,92 Efficiency scores (Life Expectancy) 0,90 0,90 0,90 0,89 0,91 0,88 0,91 0,89 0,86 0,87 0,85 0,85 .8 .8 .6 .6 .4 .4 .2 .2 0 0 CPV LCA MUS STP SYC VUT WSM CPV KNA LCA MUS STP SYC VUT WSM Source: World Bank staff calculations Public Finance Review - Page 137 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.21 CABO VERDE COMPARES WELL WITH PEERS FOR PUBLIC HEALTH SPENDING EFFICIENCY Panel C: Immunization, DPT Panel D: Immunization, measles 0,96 0,97 0,98 0,97 0,98 0,96 0,96 0,97 0,98 1 0,94 1 0,94 Efficiency scores (Immunization DPT) Efficiency scores (Immunization DPT) 0,93 0,84 0,80 .8 0,74 .8 0,72 .6 .6 .4 .4 .2 .2 0 0 CPV KNA LCA MUS STP SYC VUT WSM CPV KNA LCA MUS STP SYC VUT WSM Source: World Bank staff calculations Public Finance Review - Page 138 Efforts Towards Growth-Enhancing Public Spending FIGURE 3.22. IMPROVING PUBLIC SPENDING EFFICIENCY COULD BRING NOTABLE GAINS IN LIFE EXPECTANCY Panel A: Full efficiency gains Panel B: Partial efficiency gains 100 100 90 90 Gains in Units of Health Outcome Gains in Units of Health Outcome 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Infant Survival Life Immunization Immunization Infant Survival Life Immunization Immunization Rate Expectancy Measles DPT Rate Expectancy Measles DPT Health Outcome (Average: 2015-2019) Potential Full Gains in Health Outcome Health Outcome (Average: 2015-2019) Potential Full Gains in Health Outcome Source: World Bank staff calculations Public Finance Review - Page 139 Efforts Towards Growth-Enhancing Public Spending BOX 3.4. HOW EFFECTIVE HEALTH SERVICE COSTING CAN STRENGTHEN POLICY MAKING Effective costing of health services is critical to inform policy making and increase the efficiency and effectiveness of scarce public resources. Knowing the cost of treating diseases, including the costs related to healthcare workers, key services, interventions and medical goods beyond medicines, is important to help policymakers understand the full economic impact of diseases and traumas on healthcare system financing. This is particularly important when considering Cabo Verde’s limited fiscal space—and given the country’s increased share of the elderly in the population, who require different healthcare services. The lack of such information can compromise the sector’s ability to allocate resources more efficiently for more effective results. While Cabo Verde’s health sector is governed by well-defined strategies, detailed costing information is not available. Cabo Verde has made important technological advances in healthcare. This, along with the growing need for providing healthcare services locally that are typically more expensive—such as cancer treatments, stroke treatment, treatments for heart disease, trauma, and surgical interventions—underline the importance of undertaking an in-depth assessment of the real cost of treating these health conditions. More broadly, an in-depth assessment of health expenses is critical to better understand which areas consume most funds and whether there are opportunities for savings and redistribution of internal funds with a view to improve health care provision. Finally, healthcare costing plays a central role in strengthening planning—including for the forthcoming investments in new hospital facilities to provide a local response to the main causes of medical evacuation to Portugal—and allows for better reference cost values when negotiating with private suppliers. 3.3 POLICY RECOMMENDATIONS Public Finance Review - Page 141 Policy Recommendations 124. This chapter has shown that while public expenditure has been relatively • Address challenges in public investment management—including contained, the structure of spending has been skewed towards current planning—to improve budget predictability and ultimately execution. spending. The budget has become increasingly rigid and spending pressures While public investment execution has to an extent been constrained by the linked to these items—including the wage bill—persist. The shift away from early phase of the project cycle, evidence points to weaknesses in planning. public investment has not been conducive to support growth, in part because of Strengthening PIM systems to improve public investment planning the significantly low level of spending, as well as the high import content of according to the project budget cycle is key to increase budget credibility capital spending. Infrastructure challenges are a concern, with Cabo Verde and resource allocations. This, along with efforts to improve the quality of lagging behind peers on key quality indicators, as well as on per capita capital infrastructure—including climate resilience—will play an important role in stock. While continuing to protect the most vulnerable and maintaining the gains supporting long-term growth. recently achieved by the social protection system are key, additional fiscal space is needed for growth-enhancing spending—including climate-resilient • Analyze the cost-effectiveness of spending in key sectors—such as and sustainable public investment. This can be achieved through the following education and health—as a key tool for decision making. Key areas of recommendations: analysis include identifying sources of inefficiency in the provision of secondary education, where the lowest efficiency levels have been • Ensure the sustainability of wage bill reforms to achieve fiscal recorded, and carrying out a comprehensive costing of health services to sustainability. This includes aligning ongoing public administration inform budget planning—including for new investments in health system employment and wage reforms with the fiscal path. While the PCFR brings capacity. More broadly, along with the interventions in social protection, benefits in the form of clearer professional paths, increased transparency ensuring the long-term sustainability of these expenditures is important not and reduced wage disparities remain important, as does keeping the wage only for fiscal sustainability, but also for human development and, ultimately, bill contained, as it already represents a high share of the budget, and has for growth. For example, diversifying financing sources for the Fundo Mais so been a source of high rigidity. Simulations using wage bill micro data can be it is not solely dependent on tourism receipts will help to safeguard the carried out to assess the impact and feasibility of the new renumeration table budget from exogenous shocks. on the wage bill and the fiscal balance—providing alternatives for implementation. Strengthening fiscal oversight of the wage bill will also be 125. Additional fiscal gains of up to 1.3 percent of GDP can be achieved paramount. This includes establishing a wage bill monitoring committee to through greater spending efficiency (Table 3.1). This includes addressing track spending trends and report regularly to decision-makers; and inefficiencies related to public investments, which could yield fiscal gains of up introducing multi-year wage bill projections. to 0.7 percent of GDP.114 Moreover, accelerating the procurement process reforms outlined in the recent MAPS assessment, and comprehensively revising goods and services spending will identify potential savings. 114 This estimate is based on efficiency gains detected in the period 2017-2019 as share of total investment of that period (40 percent). Public Finance Review - Page 142 Policy Recommendations For example, reviewing and gradually reverting technical assistance and professional contracts (which almost doubled in 2023) to their 2018−2022 average in real terms over a three-year period would imply an annual reduction in G&S spending of 5 percent – equivalent to savings of nearly 0.2 percent of GDP annually (0.6 percent of GDP in total). TABLE 3.1. POTENTIAL FISCAL GAINS FROM EXPENDITURE MEASURES Time frame/ Impact Impact Policy area Policy action Fiscal impact (estimate, percent of GDP) feasibility on efficiency on equity Gradually review professional contracts and technical Goods and services assistance, reverting in three years to their 2018-2022 0.6% (over 3 years) MT + +/- spending average Wage bill Align PCFR reform with fiscal path Analysis ongoing MT + +/- Public investment Revise PIM processes to improve budget planning 0.7% MT + + management according to project cycles Total potential fiscal gain 1.3% Source: World Bank staff estimates. Note: ST = 1−2 years; MT = 2−5 years Public Finance Review - Page 143 Policy Recommendations REFERENCES Grigoli, F. and J. Kapsoli (2018), “Waste not, want not: The efficiency of health expenditure in emerging and developing economies,” Review of Development African Development Bank and Government of Cabo Verde (2024). “Assessment Economics, Vol. 22 (No. 1), pp. 384– 403. of Cabo Verde public procurement system”, September 2024. Rogger, Daniel, and Christian Schuster, eds. (2023). The Government Analytics Caroll, N., Thévenot, C., Walker, S. (2024). “How to Manage Government Handbook: Leveraging Data to Strengthen Public Administration. Washington, Compensation and Employment Effectively in Small States”, July DC: World Bank 2024Cetrángolo, O., Jimenez, J.P and Ruiz del Castillo, R (2010). “Rigidities and fiscal space in Latin America: a comparative case study”, Economic Commission World Bank (2018), Social Inclusion Project. Social Protection and Jobs Global for Latin America and the Caribbean (ECLAC), Santiago: Chile. Practice, Western and Central Africa Region, Washington, D.C.: World Bank Group, November 2018. Coello Cremades, R. (2017) “Proposta de sistema de marcadores para orçamentação sensível ao género no SIGOF, Cabo Verde”. Projecto para World Bank (2019), Public Expenditure Review. Revisiting the Efficiency of Public Reforço das Competências Técnicas e Funcionais das Instituições Superiores Spending to Reduce Debt and Improve Education and Health Outcomes, de Controlo (ISC), Parlamentos Nacionais e Sociedade Civil para o controlo das February 2019, Washington, D.C.: World Bank Group. finanças públicas nos PALOP e em Timor-Leste (Pro PALOP-TL ISC),115 draft 15−June-2017 World Bank (2023a), Implementation and Completion Report (ICR) of the Social Inclusion Project. Social Protection and Jobs Global Practice, Western and Cooper, J., & Pattanayak (2011). Chart of Accounts: A Critical Element of the Central Africa Region, Washington, D.C.: World Bank Group, October 2023. Public Financial Management Framework. Washington, DC: Fiscal Affairs Department, International Monetary Fund. World Bank (2023b). Sailing Rough Seas. Accelerating Growth and Fostering Resilience to Climate Change in Cabo Verde. Country Economic Memorandum, GoCV and ILO (2024), Boletim Estatístico sobre Proteção Social em Cabo Washington, DC.: World Bank Group, June 2023. Verde, 2021–2023. World Bank (2025). Cabo Verde Country Climate and Development Report. Government of Cabo Verde and ILO (2022), Boletim Estatístico do Sistema de CCDR Series. Washington, DC: World Bank Group. Proteção Social em Cabo Verde 2016−2020.116 World Bank and IMF (2024), Joint World Bank-IMF Debt Sustainability Analysis, Washington, D.C.: World Bank Group. 115 “Proposal for a marker system for gender-sensitive budgeting at SIGOF, Cape Verde”. Project to Strengthen the Technical and Functional Skills of Higher Control Institutions (ISC), National Parliaments and Civil Society for the control of public finances in the PALOP and Timor-Leste 116 Statistical Bulletin of the Social Protection System in Cabo Verde 2016-2020 4. ACCELERATING THE SOE REFORM AGENDA TO REDUCE FISCAL RISKS Public Finance Review - Page 145 Accelerating the SOE Reform Agenda to Reduce Fiscal Risks 117 126. State-owned enterprises have played a significant role in Cabo Verde’s development trajectory, but have become a growing source of fiscal risks. BOX 4.1. Following independence in 1975, SOEs were essential for economic STATUS OF CABO VERDE’S 2022-2026 SOE REFORM AGENDA development, particularly in transport, utilities, and telecommunications, as the government stepped in to provide critical services due to limited private sector In 2022, Cabo Verde adopted a new SOE reform agenda for 2022−2026, capacity. While SOEs became a significant part of the economy in the 1990s, aiming to reduce dependency on the state and attract private sector they struggled with inefficiency and financial strain partly due to political participation. The agenda involves various degrees of privatization for nine interference and monopolies. There followed several privatization efforts, SOEs in the electricity, water, transport, telecommunication, and other including the most recent plan approved for the 2022−2026 period (Box 4.1) as sectors. Modalities range from partial to full privatization, concessions, and the state transitions from an ownership role to one of regulator. Despite these public private partnerships (PPPs). The status of reforms as of September efforts, support to SOEs has continued, with average spending between 2024 is presented below: 2019−2023 equal to over half of expenditures on health. Moreover, SOE liabilities are concentrated in non-performing entities that rely heavily on explicit and Entity Type of Restructuring Business and Asset Evaluation Feasibility Study Documents for Restructuring Date of Restructuring implicit support from the government to remain operational. CABNAVE PPP / Privatization Concluded N/A Concluded TBD CAIXA Económica Partial divestiture Concluded Concluded Concluded Concluded – 2024 127. Reviewing the role of the state in SOEs is critical to mitigate fiscal risks CV Handling CV Telecom Privatization Partial divestiture Concluded TBD N/A TBD Concluded TBD Q1 2025 TBD and limit their impact on fiscal sustainability. This chapter applies the World ELECTRA / AEB Privatization Concluded N/A Concluded Q3 2025 Bank Group’s integrated State-Owned Enterprise Framework (iSOEF) to provide EMPROFAC/INPHARMA Privatization Concluded N/A Concluded Q3 2025 a comprehensive assessment of Cabo Verde’s SOE sector and current reform ENAPOR Sub-concession Concluded N/A Concluded Q3 2025 trends. The analysis draws on multiple data sources to provide an overview of the TACV TBC TBD TBD TBD TBD key issues.118 The chapter starts with an overview of the SOEs. It then briefly Source: World Bank staff estimates. Note: ST = 1−2 years; MT = 2−5 years discusses corporate governance and accountability mechanisms and challenges, and the state’s footprint and effects on markets, focusing on how these impact fiscal risks. Next, the chapter assesses fiscal costs and risks from the SOE sector analysis, including a deep dive analysis of three key SOEs which have significant fiscal impact in Cabo Verde. The chapter concludes with policy recommendations that aim to reduce SOEs’ fiscal impact, presented in Table 4.5 and expanded in Annex 4.2. 117 This chapter draws from the forthcoming Cabo Verde Integrated SOE Framework (iSOEF) assessment. 118 Overall, SOE data availability in Cabo Verde is robust compared to most countries in the sub-region, reflecting significant prior investments in SOE transparency, strengthening of the SOE ownership function, and more recently, a digital SOE monitoring system, the SOE Manager. Full-year data used for this report was available through 2022. The fiscal risk analysis relied on additional company-specific data. 4.1 THE SOE LANDSCAPE IN CABO VERDE Public Finance Review - Page 147 The SOE landscape in Cabo Verde 128. Cabo Verde’s SOEs are legally defined and categorized under the 2016 In 2016, the revised State Enterprise Sector Law introduced reforms to enhance State Enterprise Sector Law, which distinguishes four types: public SOE oversight further, introducing debt management requirements and stricter companies, participated companies, firms with permanent participation, and reporting obligations, and defined the UASE as the monitoring unit within the public companies managing services of general interest. These categories Ministry of Finance to oversee SOE operations and guide privatization efforts. vary based on ownership, control, and government influence, allowing the state to have either direct or indirect control. Public companies are fully or 131. The COVID-19 pandemic in 2020 heavily impacted the SOE sector, predominantly owned by the state, while participated companies have partial exacerbating existing financial vulnerabilities and halting many ongoing government ownership without dominant influence. Firms with permanent privatization efforts. With tourism and transport sectors severely affected, participation involve state investment but no influence on management, and SOEs required substantial government support, leading to rising debt levels. This public companies managing general interest services are mandated to ensure crisis highlighted the importance of SOE fiscal management, and the service universality and consumer protection. The government SOE oversight government introduced additional measures for fiscal transparency and risk agency UASE (Unidade de Acompanhamento do Sector Empresarial do control. However, progress toward privatization slowed considerably, with the Estado)119 is responsible for overseeing this sector, including reporting on flagship airline even being renationalized in 2021. operations and publishing an annual list of SOEs. CABO VERDE’S CURRENT SOE PORTFOLIO 129. The first wave of privatizations began in 1992, driven by structural adjustment programs and economic reforms. Over a decade 27 SOEs were 132. In 2022, Cabo Verde’s SOE portfolio comprised 35 companies, privatized, including major utilities and banks, with the intent to improve operating across key economic sectors. Based on their legal status, Cabo efficiency and attract foreign investment. While some privatizations attracted Verde’s SOEs can be classified into two groups: (i) 28 joint stock companies foreign capital, others also led to monopolies, higher prices, and regulatory (Sociedade Anónima - S.A.), including 16 fully, 5 majority, and 7 minority challenges in utilities, telecom, and the maritime sector, where a consortium of state-owned entities; and (ii) 7 non-corporatized public entities that are fully smaller companies with outdated fleets secured the sector concession. state-owned (Entidades Públicas Empresariais E.P.E). Total SOE sector assets were equivalent to 53.9 percent of GDP. They employed 5,494 people, 130. After the 2008−2009 financial crisis, Cabo Verde undertook governance representing 3.1 percent of total employment, and 14 percent of public sector reforms to modernize the SOE sector, including introducing performance employment. Overall, SOE wage bill costs have been declining, though this is not contracts, board and management accountability, and clearer financial necessarily indicative of greater efficiency (see Box 4.2). control measures to address inefficiencies. Although these changes led to improved corporate governance, limitations in institutional and technical capacity hindered their full implementation. 119 State Business Sector Monitoring Unit. Public Finance Review - Page 148 The SOE landscape in Cabo Verde BOX 4.2. FIGURE 4.1. THE SOE WAGE BILL HAS FALLEN, BUT OPERATIONAL THE WAGE BILL FOR THE SIX LARGEST SOES IS DECLINING EFFICIENCY COULD BE IMPROVED Wage bill Percent of GDP Despite its significant size, there has been a notable decline in the wage bill for the six largest SOEs, outpacing the reduction in the public sector wage 2.5% bill as a percentage of GDP. In 2023, wages and social security contributions for these entities accounted for 1.2 percent of GDP, down by about half when compared to 2016 (Figure 4.1). This decline is mostly driven by two SOEs: (i) 2.0% ASA (Empresa Nacional de Aeroportos e Segurança Aérea), as the new concessionaire responsible for managing all airports in Cabo Verde retained 1.5% over 50 percent of ASA’s existing workforce; and (ii) TACV (Transporte Aereos de Cabo Verde), which has downsized its operations significantly (a near 58 percent reduction in its wage bill) over this period. Should the planned ports 1.0% concession proceed as anticipated, the SOE wage bill is projected to fall below 1 percent of GDP by 2025, assuming the new port concessionaire 0.5% retains about 60 percent of ENAPOR’s current workforce. 0.0% 2016 2017 2018 2019 2020 2021 2022 2023 6 Largest SOEs 6 Largest SOEs (Adj. by ENAPOR) Source: UASE, World Bank. Note: During 2021 TACV was not operational due to COVID-19. Public Finance Review - Page 149 The SOE landscape in Cabo Verde FIGURE 4.2. While a reduced wage bill is important, this trend does not inherently reflect TACV’S LABOR COSTS PER AVAILABLE improved efficiency within the SOE sector. While the strategy of increasing private sector participation in key areas of Cabo Verde’s economy presents SEAT-KILOMETER HAVE RISEN an opportunity to reduce government labor costs while enhancing efficiency TACV's Labor Cost per ASK and service quality in certain sectors, this outcome is not consistently observed across all sources of labor cost reduction. For example, in the case 7.00 of TACV’s operational downsizing, the labor cost per ASK (available seat-kilometer) has risen significantly compared to previous levels (Figure 6.00 4.2). This suggests that, despite the overall reduction in labor costs, the level of service delivered in relation to the decreased expenditure has declined 5.00 considerably. 4.00 3.00 2.00 1.00 0.00 2016 2017 2018 2019 2020 2021 2022 2023 Source: UASE, World Bank. Note: During 2021 TACV was not operational due to COVID-19. Public Finance Review - Page 150 The SOE landscape in Cabo Verde 133. Cabo Verde’s SOE portfolio is highly concentrated in natural monopoly sectors, reflecting its geographic characteristics as a small island state. Together the top three sectors (“Energy, water, and sewerage”, “Transport, logistics and post”, and “Engineering, construction, and infrastructure”) account for 73.5 percent of total SOE assets (Table 4.1). TABLE 4.1 TOTAL ASSETS OF SOES BY ECONOMIC SECTOR (THOUSAND USD) Sector 2020 2021 2022 % of total assets 2022 Energy, water, and sewerage 327,745 336,788 353,676 28% Transport, logistics and post 349,879 323,779 297,954 24% Engineering, construction, and infrastructure 307,607 298,487 262,922 21% Technology, media, and telecom 204,384 222,416 198,910 16% Financial 93,655 99,832 85,540 7% Pharmaceuticals 32,026 25,400 25,558 2% Service 19,929 20,748 18,252 1% Industry 776 762 683 0% TOTAL 1,336,001 1,328,211 1,243,496 100% Source: World Bank staff consolidation based on UASE annual report. Public Finance Review - Page 151 The SOE landscape in Cabo Verde RECENT PERFORMANCE OF THE SOE SECTOR 137. Cabo Verde’s largest SOEs face severe financial challenges, creating a FINANCIAL PERFORMANCE IS STILL OF CONCERN cycle of debt accumulation that poses systemic fiscal risks. High fiscal deficits in 2020 and 2021 pushed public debt from 109 percent of GDP in 2019 to 148 134. The financial performance of Cabo Verde's SOEs is polarized, with some percent in 2021. While public debt decreased to126.7 percent of GDP in 2022, entities generating profits while the majority incur high deficits. Between 2019 thanks to strong nominal growth in that year, the contribution of SOE debt and 2022, the overall SOE portfolio generated a reported net loss of around US$ remained significant at around 29 percent of GDP in 2022. Around a third of this 130.3 million—heavily influenced by Transporte Aereos de Cabo Verde (TACV) debt (9 percent of GDP) is guaranteed, and mainly held by TACV, ELECTRA, and and Empresa de Electricidade e Aguas (ELECTRA). While losses in the sector NewCo, the special purpose vehicle created to liquidate TACV’s earlier financial have been falling recently, with about 36 percent of the SOEs reporting a obligations. Additionally, declining profitability makes servicing of this debt combined net income of US$29.53 million in 2022 (1.3 percent of GDP), this increasingly challenging and often results in the rollover of SOE debt, creating improvement was not enough to outweigh losses recorded in the remainder of additional fiscal risks. the portfolio. As a result, overall losses reached US$ 11.24 million (0.5 percent of GDP), reflecting persistent economic and financial challenges to be addressed SERVICE DELIVERY PERFORMANCE IS POSITIVE to improve the viability of the portfolio. 138. Public service coverage and access is generally good, especially by 135. Companies that were profitable in 2019, prior to the pandemic, managed subregional standards and considering the challenges Cabo Verde faces as a to regain a positive financial outlook by 2022. While the overall portfolio still small island developing state. Coverage and access to key public services in recorded a net loss, some SOEs successfully recovered from the operational Cabo Verde are much more akin to the European Union (EU) average than the SSA challenges brought on by the pandemic. Among these, Empresa Nacional de average. Moreover, the often striking rural-urban divide observed in other Aeroportos e Segurança Aérea (ASA) stood out as the most profitable, countries of the subregion is much less pronounced. Service delivery generating US$ 15.1 million in profits (0.7 percent of GDP). performance, however, could be improved by increasing operational efficiency. 136. Conversely, SOEs that were already incurring losses pre-pandemic, 139. Cabo Verde has nearly achieved universal electricity access (96 experienced further deterioration of their financial results and are still facing percent), but struggles with high tariffs, service reliability, and significant financial losses, highlighting structural challenges. The inflationary surge in raw system losses. Additionally, the grid relies heavily on fossil fuels (83 percent), material costs driven by COVID-19 impacts and Russia’s invasion of Ukraine making the system vulnerable to fuel price shocks. To address these issues, the worsened operational cost structures for SOEs, highlighted the obsolescence government plans to increase renewable energy’s share to 50 percent by 2030 of some existing business models, and underscored the need for strategic and 100 percent by 2040. restructuring to sustain financial viability. Public Finance Review - Page 152 The SOE landscape in Cabo Verde Given limited public resources, the government is turning to private investment Efforts are underway to address these challenges. In 2023, a 40−year to support this ambitious agenda—including through the unbundling of concession contract was signed with Vinci Partners for the management of ELECTRA and opening energy generation and distribution to private capital. A Cabo Verde’s airports, while the port concession process is nearing its final good regulatory framework will be important to support this, including rules on stages. In 2024, the authorities created a new domestic airline – Linhas Aéreas de access to networks and cost-reflective tariffs, as well as ensuring competitive Cabo Verde (LACV) – in a bid to enhance inter-island connectivity in a market that neutrality. is potentially more operationally viable than the international one. Steps to operationalize LACV are ongoing. 140. In water and sanitation, close to 90 percent of the population have basic drinking water access, with urban areas having better coverage than rural 142. Cabo Verde’s ICT sector is among the strongest in the region. Internet ones. As in the electricity sector, system losses represent the greatest challenge access is at 69.8 percent and mobile coverage is nearly universal. The and vary greatly across the territory—from as much as 50 percent on São government’s Digital Economy Development Strategy aims to further promote Vincente, to 3 percent on Santiago. Improving water supply and sewerage ICT usage by 2030. services, while ensuring acceptable tariffs for consumers, is thus a strategic priority for the GoCV, prompting a focus on improving efficiency and accessibility. 141. The transport sector faces challenges from geographic dispersion, and operational issues in air and maritime transport. TACV was renationalized in 2021, following a brief privatization, and since early 2024 has also covered domestic flights after Bestfly terminated its services. The company has recorded consecutive losses, and relies heavily on state support for its operations. Recent capitalizations have supported an international market-orientated business model with inherent financing risks. Maritime transport also struggles with the private inter-island operator (CV Inter Ilhas), relying on state subsidies to cover its operational inefficiencies. Port operations are hampered by limited equipment, storage, and logistics, leading to low volumes and lack of necessary operational scale. 4.2 CORPORATE GOVERNANCE AND ACCOUNTABILITY MECHANISMS Public Finance Review - Page 154 Corporate Governance and Accountability Mechanisms 143. Cabo Verde has recently enhanced its corporate governance A tighter control on borrowing allows the GoCV to better manage potential environment for SOEs, but further improvements are needed to help mitigate sector risks. Second, when reporting on their operation, SOEs are now required fiscal risks. SOE corporate governance refers to the legal and regulatory to distinguish between commercial and non-commercial functions. This framework, internal governance structures, shareholder relations, state promotes more transparency in company management and ensures state oversight, and transparency. Recent reforms – such as a centralized ownership financing is only provided to support public service provision rather than poorly function at the MoF, annual aggregate portfolio reports, and the "SOE Manager" performing companies or SOE commercial activities. Third, SOEs are required to digital monitoring tool – provide a strong foundation. Despite this, additional develop and maintain internal risk control measures. To this end, they are improvements to mitigate fiscal risks include greater transparency and reporting required to prepare and approve an annual risk management report which (i) of specific SOEs’ operations, strengthening the conditions for appointment of provides a diagnostic of strategic, operational, economic, fiscal and financial SOE boards, and general sector governance. These are discussed below. risks; and (ii) outlines measures for managing, reporting and monitoring of those risks. Finally, SOEs are also required to have a separate environmental and THE LEGAL AND REGULATORY FRAMEWORK IS BEING climate sustainability report, which includes (i) a diagnosis of social, climate and environmental risks; (ii) measures and investments to mitigate them; and (iii) STRENGTHENED information on entities’ resilience to climate risks, especially climate-related physical risks. 144. Cabo Verde’s SOE legal framework is based on the State Enterprise Sector Law, the Public Manager Statute, and the Principles of Good OWNERSHIP AND OVERSIGHT ARE IN TRANSITION, BUT Governance for SOEs. The State Enterprise Sector Law sets governance rules for SOEs, including state ownership, board responsibilities, and transparency, CAREFUL DESIGN IS NEEDED with the Ministry of Finance as the shareholder representative. The law also mandates SOEs to follow competition rules, performance contracts, and 146. Cabo Verde has centralized and increasingly strengthened its SOE financial controls. Complementary laws, like the Public Manager Statute ownership function through a dedicated unit at the Ministry of Finance. (Decreto-Lei nº 6/2010) and Good Governance Principles (Resolução nº Established in 2016, UASE oversees the SOE portfolio, facilitates restructurings 26/2010), further define board duties and management standards. and privatizations, monitors PPPs, and tracks independent regulatory agencies. UASE is one of the strongest SOE ownership units in the subregion and performs 145. To further strengthen the regulatory framework, the 2024 revision of the several key functions of a centralized SOE ownership institution. It has compiled State Enterprise Sector Law has introduced new instruments and rules to an SOE database and, since 2016, has regularly published annual aggregate SOE promote SOE corporate governance and mitigate fiscal risks from the sector. portfolio reports on the Ministry of Finance website. The unit also advises on First, all long-term financing not included in SOEs’ annual budgets or investment revisions to the SOE legal framework and helps prepare and monitor SOE plans must be approved by the GoCV. restructuring and privatization processes and concessions. Public Finance Review - Page 155 Corporate Governance and Accountability Mechanisms 147. Despite this, its centralized ownership function remains incomplete 150. The Ministry of Finance’s oversight role for Parpública and the reporting when it comes to board selection and performance management, with line obligations of the new holding company need to be clearly defined. While it is ministries continuing to exercise significant influence. Line ministries handle essential to grant Parpública sufficient autonomy to enhance portfolio technical oversight of SOEs in Cabo Verde, with UASE’s role currently limited. performance, the new structure must also delineate oversight, transparency, Such limitations prevent a consistent approach across the portfolio and increase and accountability mechanisms. In this context, the strategic oversight by the the risk of interference. Ministry of Finance and the performance and reporting requirements for Parpública should be further developed as part of the operationalization 148. Cabo Verde is reforming its SOE oversight and plans to transition to an process. Specifically, the new institutional set up could weaken fiscal SOE holding company. In 2020, it established Parpública CV, S.A.,120 a accountability if the holding company’s decisions are less transparent or state-owned public company designed to enhance governance and prioritize operational survival over financial sustainability. Failure to do so could performance in managing SOE ownership, privatizations, and PPPs, with the lead to increased exposure to fiscal risks. authority to issue bonds in both domestic and foreign markets.121 However, Parpública has yet to be operationalized. While UASE currently manages SOE 151. Establishing an SOE ownership policy or strategy could be vital for oversight, the government aims to operationalize Parpública in the near future, guiding Cabo Verde’s new SOE ownership function moving forward. While the allowing it to assume UASE's responsibilities for SOE and PPP oversight.122 legal framework and ownership function are well established, an explicit ownership policy could enhance clarity. This policy should outline the country's 149. Transitioning to a new SOE ownership model based on a holding long-term strategic objectives and rationale for SOEs across different sectors, company is a significant reform that necessitates careful design of the as well as criteria for their creation, ownership, and divestment, thereby institutional structure and management of potential risks. It is crucial to replacing previous ad-hoc approaches to SOE reform. understand that merely shifting oversight from UASE to Parpública will not inherently improve the performance or fiscal risks associated with the SOE portfolio. Therefore, Parpública should not be seen as a quick fix for addressing the underlying challenges of SOE reform. Additionally, the new model may introduce new risks and practical challenges that will require thorough consideration and management. For example, while establishing the holding structure will enable positive earnings to be redirected from certain companies to loss-making ones, which could shield the budget, this would reduce dividend receipts and impact the primary balance. 120 Through Decree-Law no. 28/2020 of March 23, 2020. 121 This move looks to transform the role of the state as a shareholder that monitors and issues general guidelines for the activity of public companies, to that of a shareholder that conducts the corporate life in an in-depth and specialized manner, monitoring all the developments of the companies, in order to ensure that companies fulfill their mission, their management is guided by high levels of performance and in line with best practices in terms of quality, efficiency and effectiveness, as well as risk. 122 In turn, UASE’s responsibilities for independent regulatory entities would be transferred to the Treasury Department. Public Finance Review - Page 156 Corporate Governance and Accountability Mechanisms PERFORMANCE MONITORING AND THE ROLE OF BOARDS OF 155. Oversight of SOE boards and management is conducted by the general DIRECTORS NEED SOME STRENGTHENING assembly or UASE, following pre-established directives, but lacks specific performance indicators. The Public Managers’ Statute links management 152. The SOE framework law mandates performance agreements with contracts to service objectives. Base pay for public managers, SOE board targets and management contracts for SOEs, led by the Ministry of Finance members, and regulators is standardized, with a variable component based on with sector-specific input from line ministries. Despite the existence of target achievement, approved by the general assembly following UASE performance agreements in key sectors like energy and water, implementation evaluations. The GoCV plans to clarify performance criteria in a future statute has faced challenges, including inconsistent reporting and limited enforcement revision. of non-performance penalties. To address these issues, future agreements will need stronger technical oversight and a better monitoring framework. The 156. It will be key to strengthen the compliance of SOEs’ annual reports with ongoing review of the Public Managers’ Statute provides an important legal transparency requirements for information to be made public about opportunity to strengthen performance monitoring. boards of directors. There is a lack of transparency on SOE board roles, selection of independent directors, meeting details, and remuneration 153. Boards of directors govern all SOEs in Cabo Verde but lack explicit methods. Systematic data collection on board composition could improve quality criteria for members. Boards typically comprise three members123 as governance. defined in their statutes, and the board nomination process and strategic oversight function are delimited by the state.124 The lack of explicit quality criteria TRANSPARENCY, REPORTING AND DISCLOSURE ARE for board members can undermine balanced representation, and there are GENERALLY STRONG currently few independent directors. 157. While SOE financial reporting and disclosure is strong, and national 154. Public officials are generally excluded from SOE boards, with the state accounting standards are anchored in international financial reporting required to have a non-executive representative. If no non-executive standards (IFRS),125 there are notable exceptions. SOEs are required to members are present, state representation must occur within the fiscal regularly prepare and publish financial statements, and most prepare monthly, council. The legal framework mandates the fiscal council to ensure legal quarterly, and annual financial statements, often audited by external compliance, regularity, and sound financial and asset management. Other independent firms.126 Annual statements and audit reports are typically governance bodies are rarely included in the governance structures of SOEs. published on the respective SOE and the MoF websites by the required deadlines. Accurate and timely financial reporting is essential for government decision makers, as it provides a better understanding of the financial health of 123 The Commercial Companies Code requires boards to have an odd number of directors. It also allows a single executive to replace the board in specific cases. The State Enterprise Sector Law defers to this code on board size. 124 Decreto-lei nº 76/2021: Estabelece a estrutura, a organização e as normas de funcionamento do Ministério das Finanças e do Fomento Empresarial. 125 The SNCRF are based on IFRS, incorporating adapted International Accounting and Financial Reporting Standards into national law 126 Artigo 17 Lei n.º 104/VIII/2016, alterada pela Lei n.º 58/IX/2019, Minister of Finance Decree (Portaria n.º 48/2021). Public Finance Review - Page 157 Corporate Governance and Accountability Mechanisms This said, there are notable exceptions to this practice of reporting. For example, no financial statements have been published for TACV since 2020 due to the ongoing company restructuring. 158. At portfolio level, Cabo Verde has become a leader in the subregion for aggregate portfolio reporting. It is one of the few countries in West Africa that regularly prepares aggregate annual portfolio reports and publishes them on the MoF website. The reports provide a comprehensive picture of SOE portfolio performance, outlining current trends and challenges. 159. Cabo Verde is also one of the few countries to introduce a digital SOE performance monitoring system, the partially public SOE Manager platform. It aggregates performance data, generating dashboards and graphs that support SOE performance management, in line with OECD SOE Governance Guidelines and WBG iSOEF best practices. Ensuring timely completion and publication of audited reports for all SOEs will be key for maintaining the SOE Manager’s credibility and utility as a tool for decision making. 4.3 STATE FOOTPRINT AND EFFECTS ON MARKETS Public Finance Review - Page 159 State Footprint and Effects on Markets 160. Cabo Verde's competitive environment is hampered by structural 162. While state participation in markets can address market failures like challenges stemming from its geographic isolation and small market size. The natural monopolies and public goods, it also risks hindering private sector small size and fragmentation of this island economy limit the customer base and growth and distorting market performance, especially in commercially viable potential economies of scale, resulting in higher production costs and reduced sectors. Nearly half of Cabo Verde’s BOS operate in sectors where private competition in certain industries.127 Consequently, the state often plays a competition could be feasible, but this is not occurring. significant role in addressing market failures and providing essential goods and services. However, state ownership can introduce some market distortions, 163. The overall performance of Cabo Verde’s state-owned enterprises using especially in sectors dominated by a few providers. Moreover, subsidies and the broader (BOS) definition reflects a cumulative net loss, mainly driven by SOE budget allocations can also create an uneven playing field for private firms, BOS in competitive and partially contestable sectors. As of 2022, BOS as well as creating potential fiscal risks.128 For this reason, reviewing the state’s reported an overall net loss of US$ 10.1 million (0.4 percent of GDP). The participation in markets is critical to level the playing field, foster market entry, performance in partially contestable sectors is especially weak. Fifteen of these enhance dynamism, and, ultimately, mitigate fiscal risks. BOSs jointly generated revenues of US$209 million (9.3 percent of GDP) in 2022 (accounting for 51 percent of total BOS revenues and 41 percent of THE STATE’S FOOTPRINT IN THE MARKET IS STILL LARGE IN employment), but in aggregate they still recorded US$ 21 million (0.8 percent of CABO VERDE GDP) in losses, primarily attributed to TACV and ELECTRA; other firms from this group, such as Cabo Verde Telecom and Sociedade Interbancária Sistema 161. Identifying Cabo Verde’s state footprint requires looking beyond SOEs to Pagamento (SISP) were profitable, but not sufficiently to offset the negative include all entities with at least 10 percent state participation (referred to as performance of the overall group. Additionally, profit margins in competitive "businesses of the state" (BOS).129 This section examines the broader policy and sectors remain low (e.g. state firms in tourism and transportation), with nearly 60 fiscal impact of state involvement in the market, focusing on entities with at least percent of these BOSs either operating at a loss or barely breaking even. Only 14 10 percent state ownership, directly or indirectly, that engage in market percent of companies reported profit margins above 7 percent, highlighting production for financial gain. Since 2017, the GoCV has embarked on a new challenges in generating adequate returns and in funding essential investments. strategy to bring in private participation in key sectors in Cabo Verde, and reduce SOE-related fiscal risks. While the GoCV is exploring alternatives – ranging from 164. Nine BOS firms operate in natural monopoly sectors, where economies privatization to divestitures, concessions and PPPs – the state continues to of scale favor a single provider, including postal services, airport operate as a key market player in 12 different sectors. management, and utilities. These sectors generated US$ 128 million in revenue and net profits of US$ 12 million in 2022. While not all need to be state-owned, public service obligations may warrant state involvement. 127 World Bank Group (2024). 128 IMF (2023). 129 Dall'Olio, et al. (2022a). Public Finance Review - Page 160 State Footprint and Effects on Markets THE STATE’S FOOTPRINT RAISES POTENTIAL RISKS TO (iii) introduce targets for commercial rates of return as key performance COMPETITION indicators to benchmark and incentivize better performance of BOS vis-à-vis private peers when they operate in competitive sectors; (iv) reduce the use of subsidies and concessional loans to BOS on a preferential and discretionary 165. While state market participation is not inherently harmful to competition, basis, which effectively means that (some) SOEs operate with soft budget policies linked to BOS or SOEs can distort markets and affect private sector constraints, and lack incentives to improve performance; and (v) strengthen viability and profitability. Policies that favor certain market players, such as by institutions to conduct proper market surveillance and enforce competition and distinguishing between state-owned and private firms, create unfair advantages sectoral regulation, while also promoting ex-ante assessments of potential and impede private sector growth. A high state presence often correlates with market distortions through state support or preferential regulatory treatment. reduced firm entry, increased market concentration, and resource misallocation.130 In addition, when state presence includes preferential treatment for SOEs, it distorts market competition further. 166. Competitive neutrality analysis can assess the fairness of the playing field between state-participating firms and private competitors. This assessment is critical, especially in Cabo Verde, where nearly half of BOS operate in fully competitive sectors suitable for private participation. Competitive neutrality principles—both at the firm and systemic levels—help determine if SOEs benefit from market rules that could distort competition, deter private entry, and weaken market performance. 167. The analysis identifies opportunities to level the playing field between SOEs, BOS, and private firms, fostering market entry, enhancing dynamism, and mitigating fiscal risks (see Annex 4.1). This suggests the following priority actions: (i) implement the subsidiarity principle as an economic tool to assess whether state ownership is deemed necessary; (ii) separate commercial and non-commercial functions with discrete accounting, proper disclosure of costs and prompt compensation by the state for fulfilling public service obligations (PSOs); 130 World Bank, 2023. 4.4 ASSESSMENT OF FISCAL COSTS AND RISKS FROM THE SOE SECTOR Public Finance Review - Page 162 Assessment of Fiscal Costs and Risks from the SOE Sector 168. Despite their importance for supporting Cabo Verde’s economic development over the years, SOEs continue to rely on the government to support their operations through subsidies, transfers, capitalizations, and guarantees, amongst others (Box 4.3). Efforts have been made to strengthen corporate governance and accountability mechanisms and level the playing field between SOEs, BOS and the private sector. These are important foundations, but perhaps more important is the ability to assess and quantify potential fiscal risks associated with SOE operations with a view to enhancing mitigation measures. This section presents the fiscal costs and risks posed by the SOE sector in Cabo Verde and explores the potential fiscal impacts of key SOEs under different operational scenarios. It also includes a deep dive analysis of the fiscal implications of three key SOEs with significant impact. BOX 4.3. FRAMEWORK FOR TRANSACTIONS BETWEEN THE STATE AND SOES IN CABO VERDE Government support to SOEs is defined through various laws and accompanying regulations – with the Framework Law for the State’s Budget providing guiding principles, and the annual Budget Law outlining limits on transactions. Key aspects are described below: 1. Subsidies. Entities providing PSOs are eligible for compensation through the budget to subsidize costs that are not covered by the income generated from activities linked to public services. 2. Transfers. Transfers are provided to utility companies as a compensation mechanism for providing a social tariff, and to the inter-island maritime transport operator. 3. Guarantees. Decree Law 42/2018 outlines the process for awarding guarantees, including limits, terms, eligibility, conditions, and collateral. Annual guarantee limits for SOEs, municipalities, and the private sector are approved through the Budget Law, excluding restructured guaranteed loans and those linked to food aid. 4. On-lending. Contract exists between the Treasury and the SOE for amounts. While measures to encourage SOEs to stay current on their debt servicing obligations exist, renegotiated with the Treasury is possible. 5. Capitalizations. Capitalization amounts for SOEs are included in the annual Budget Law, determined by a financial needs assessment from UASE using firm-provided data, and awarded according to the established regime. Public Finance Review - Page 163 Assessment of Fiscal Costs and Risks from the SOE Sector SOES’ FISCAL COSTS ARE SIGNIFICANT 172. More recently, the reform agenda has started to see some positive impact on the budget through higher concession earnings, though much of 169. SOEs’ fiscal costs are assessed by quantifying transactions between the this progress is linked to contributions from ASA's airport concession government and SOEs. Direct transfers from the government to SOEs include payment. While SOE revenues reached 2.6 percent of GDP in 2023, about 1.5 subsidies, transfers, and equity injections (capitalizations). Indirect state support percent came solely from ASA's first upfront fee payment. This concession will includes deferred taxes, tax credits or tax arrears, non-payment of dividends and continue to provide crucial support, with another vital injection of 1.8 percent of any other kind of preferential treatment. The authorities have indicated there is GDP expected in 2025 from the final payment. In the absence of these no preferential treatment or specific tax regime for SOEs. Like other entities, substantial ASA payments, the fiscal position would be considerably more income taxes are paid on positive earnings. strained, even with the gradual recovery of tax revenues. Further revenues are anticipated from privatization processes, though these are expected to yield 170. In Cabo Verde, transactions between the state budget and SOEs occur modest amounts: about 0.5 percent of GDP in both 2024 (from CECV) and 2025 through both above- and below-the-line operations. Above-the-line (from EMPROFAC and INFARMA). operations include revenues from SOEs and spending on subsidies and transfers. Although the net position for SOE transactions is positive (around 0.9 173. Above-the-line support to SOEs through explicit subsidies and transfers percent of GDP from 2019−2022), this excludes GoCV's servicing of on-lent has picked up in recent years. Preliminary data for 2023 points to subsidies and loans (averaging 0.6 percent of GDP). Importantly, it also masks substantial transfers to SOEs of about 1 percent of GDP (Table 4.2), up from 0.2 percent in support to SOEs through below-the-line transactions, such as capitalizations 2019. This increase is explained by compensation payments to (i) the inter-island and on-lending, as well as sovereign guarantees. transportation company (CV Interilhas) ; and (ii) the energy/water SOEs, for social tariffs targeted to poor households. 171. At an average of 1.4 percent of GDP over 2019−2022 (about 6.2 percent of revenues), SOEs’ contribution to budget revenues has been modest, in part reflecting their poor financial performance and the impact of the pandemic. Direct flows to the budget – tax revenues, earnings from concession contracts and dividends – narrowed from almost 2 percent of GDP in 2019 to 0.7 percent in 2022. Tax revenues, which reached 1.2 percent of GDP in 2019, have not fully recovered since the pandemic.131 The same applies to dividends, which saw a significant reduction as some SOEs that were profitable pre-pandemic have not seen their performance bounce back. 131 Tax revenues collected from SOEs include VAT payments, corporate income tax, and payroll taxes (withholding tax), which accounted for 35, 28 and 36 percent of overall payments respectively (between 2019 and 2023). Public Finance Review - Page 164 Assessment of Fiscal Costs and Risks from the SOE Sector TABLE 4.2. TRANSACTIONS BETWEEN SOES AND THE GOCV BUDGET (PERCENT OF GDP) Sector 2019 2020 2021 2022 2023p A. Revenues 1.95 1.56 1.32 0.67 2.59 Taxes 1.23 1.06 0.82 0.65 0.83 Rent from concessions 0.10 0.02 0.02 0.01 1.48 Dividends 0.62 0.49 0.47 0.02 0.29 B. Expenditures 0.99 0.67 1.71 0.79 1.19 Subsidies 0.04 0.35 0.36 0.57 0.89 Transfers 0.17 0.15 0.10 0.14 0.19 Servicing on on-lent loans 0.78 0.17 1.26 0.08 0.11 C. Overall balance (A-B) 0.96 0.89 -0.39 -0.12 1.40 D. Financing 3.57 2.71 2.53 2.89 2.39 Capitalizations 1.44 0.44 0.40 0.92 0.83 Guarantees 2.13 2.28 2.13 1.97 1.55 E. Net budgetary flows (C-D) -2.61 -1.83 -2.92 -3.01 -0.98 F. Stock of contingent liabilities 18.13 23.92 22.82 18.92 17.47 Guaranteed debt 6.8 9.1 10.4 9.0 8.4 On-lending 11.32 14.78 12.42 9.91 9.05 Source: Ministry of Finance – UASE and DGT. Note: p=preliminary; Items in section A reflect flows from SOEs to budget, while items in section B and D indicate support to SOEs. Public Finance Review - Page 165 Assessment of Fiscal Costs and Risks from the SOE Sector 174. Servicing of on-lent external financing to SOEs represents a steady cost to the GoCV’s budget. In 2023, the stock of external loans on-lent to SOEs reached CVE 23.9 billion (about 9 percent of GDP), with 58 percent held by ELECTRA, 36 percent by IFH, and 6 percent by ENAPOR. From 2019 to 2023, the GoCV's annual servicing cost for on-lent loans averaged CVE 985 million – equivalent to nearly three-quarters of Cabo Verde's 2023 health expenditures – and making up about 22 percent of total external debt payments. 175. The brunt of SOEs’ fiscal cost is attributed to capitalizations, which have added to overall fiscal financing needs. Capitalizations of SOEs totaled CVE 9.16 billion between 2019 and 2023 (about 3.6 percent of GDP), almost 30 percent higher than the average annual amount spent on the health sector during the same period. Capitalizations of NewCo (see Box 4.4),132 and TACV accounted for the largest share, reaching 91 percent of the total capital disbursed in 2023. Capitalizations largely reflect amounts used to address liabilities in non-performing companies, rather than operational expansion. 132 NewCo (Reclamação e Resolução de Créditos, Sociedade Unipessoal, SA.) is a special purpose vehicle (SPV) that was established by the GoCV in 2019 with the exclusive purpose to hold, resolve and liquidate selected transferred liabilities from TACV. Public Finance Review - Page 166 Assessment of Fiscal Costs and Risks from the SOE Sector BOX 4.4. FIGURE 4.3. NEWCO AND ITS CONTINUED FISCAL COSTS SUBSTANTIAL TRANSACTIONS HAVE BEEN MADE TO REDUCE NEWCO’S LIABILITIES In 2019, NewCo was created to offload TACV’s debt, enabling a private partner to take control and revitalize operations without legacy liabilities. Transactions About US$98 million were transferred to NewCo, with creditors agreeing to CVE million debt haircuts, reduced interest rates, and extended repayment terms. NewCo does not engage in operational activities, relying entirely on transfers 120000,0 from the GoCV to meet its debt obligations. From 2019 to 2023, the GoCV 100000,0 injected roughly US$45 million into NewCo, aiming to reduce its liabilities and 80000,0 to cover financial expenses on the outstanding balance (Figure 4.3). Total outstanding liabilities amounted to US$59 million at the end of 2023. 60000,0 40000,0 NewCo is expected to represent a steady fiscal cost in the near term. All 20000,0 things unchanged, and following the current repayment schedule, the GoCV ,0 is expected to inject a total of US$81.6 million into NewCo by 2032. Of this, Transf. Liabilities Capitalization 2019 Fin. Exp 2019 Others 2019 Cash Cons. 2019 Capitalization 2020 Fin. Exp 2020 Others 2020 Cash Cons. 2020 Transf. Liabilities 2021 Capitalization 2021 Fin. Exp 2021 Others 2021 Cash Cons. 2021 Capitalization 2022 Fin. Exp 2022 Others 2022 Cash Cons. 2022 Capitalization 2023 Fin. Exp 2023 US$48.2 million relates to debt amortization and US$13.4 million to interest expenses. There is an additional US$20 million for non-interest-bearing liabilities, including to the social security agency and other public and private entities. Increase Decrease Total Source: NewCo balance sheet, UASE. Public Finance Review - Page 167 Assessment of Fiscal Costs and Risks from the SOE Sector 176. Notably, the aggregate fiscal cost of SOEs is significant when compared FIGURE 4.4. to spending on the priority sectors of health and education – with TACV SPENDING ON SOES IS EQUIVALENT TO A SIGNIFICANT representing an average 50 percent of such costs.133 On average, over 2019 to 2023, budget resources spent on, or on behalf of, SOEs was equivalent to more AMOUNT OF SPENDING IN PRIORITY SECTORS than half of government spending on health and over a third of spending on Expenditure on SOEs and priority sectors education over the same period (Figure 4.4). While SOEs have contributed to revenues, with an uptick in 2023, support to SOEs could be crowding out 6.0 100.0% spending on priority sectors in a context of constrained fiscal space. 5.0 80.0% 4.0 60.0% 3.0 40.0% 2.0 20.0% 1.0 0.0 0.0% 2019 2020 2021 2022 2023 Expenditures on SOEs, Share of health Share of education excluding guarantees (CVE bn) expenditure (RHS) expenditure Source: Authors’ calculations based on UASE, DGT and CGE data 133 This amount includes fiscal costs arising from TACV and NewCo, given that the latter holds TACV’s former debt. Public Finance Review - Page 168 Assessment of Fiscal Costs and Risks from the SOE Sector SOES’ FISCAL RISKS ARE ALSO SIGNIFICANT 178. SOEs’ liabilities are significant and are largely concentrated in non-performing entities. Data for the 35 companies under UASE’s portfolio 177. SOE’s fiscal risks can be classified into different types depending on the shows total liabilities reached CVE 119 billion (50.6 percent of GDP) in 2022, an degree of contractual obligation by the state. Table 4.3 classifies risks as direct increase of 7.2 percent from 2020. This increase in SOEs’ liabilities is mostly or contingent, and explicit or implicit. Direct risks involve liabilities impacting the driven by operating losses and higher cost of debt, and nearly two-thirds of budget, while contingent risks depend on future events, like debt repayment. these liabilities are held by only five companies.134 Explicit liabilities are legally obligated, while implicit ones may be covered by the government for social or political reasons, despite no legal obligation to do so. 179. The budget faces considerable direct exposure to SOEs’ liabilities. By the end of 2022, on-lending debt accounted for about 20 percent of total SOE TABLE 4.3. liabilities, rising to 25 percent when including other unpaid obligations to the SOES HAVE LIABILITIES WITH VARYING DEGREES OF RISK state, such as VAT, social security, and payroll taxes. From 2019 to 2023, delayed SOE amortization payments to the Treasury grew significantly, reaching nearly 90 Liabilities Direct Contingent percent, largely due to defaults by ELECTRA SA and IFH. ELECTRA’s inability to meet any scheduled on-lending amortization over the past five years Explicit External debt contracted by government and Debt contracted by SOEs and guaranteed by on-lent to SOEs– 9.3 percent of GDP government – 8.6 percent of GDP contributed to the GoCV’s recent decision to convert all on-lending stock into equity (as part of the broader sector reform, with liabilities for energy and water Implicit Provision of social services – e.g. inter-island Operating losses of SOEs transport, subsidized utility tariffs, etc. transferred to Electra SA; see Box 4.5). For IFH, an alternative debt servicing Debt contracted by SOEs not guaranteed by method has been implemented, which consists of the transfer of IFH assets, government – 12.2 percent of GDP specifically residential buildings, to the GoCV as a form of debt amortization. This SOE arrears to other entities, private sector and government supports the conclusion that the government’s external liabilities on these loans are likely mostly serviced from general budget resources rather than SOEs’ loan Banking sector exposure/wage bill repayments to the budget. PPPs / concessions 180. At 8.6 percent of GDP in 2023, guaranteed SOE debt represents an Source: Application of World Bank iSOEF matrix for fiscal risk assessment, data based on end 2023 explicit contingent fiscal risk. The stock of guaranteed debt reached CVE 22.2 billion in 2023 , up by almost 70 percent from the amount in 2017. Nearly 71 percent of this guaranteed debt is held by ELECTRA, TACV and NewCo. While history suggests that the likelihood of guarantees being called is minimal, this significant stock of guaranteed debt is an important source of fiscal risk. 134 TACV, ELECTRA, IFH, SDTIBM and CVT. Public Finance Review - Page 169 Assessment of Fiscal Costs and Risks from the SOE Sector BOX 4.5. ADDRESSING THE FISCAL COST OF ELECTRICITY AND WATER SERVICES Cabo Verde’s energy and water utility SOE has faced significant financial challenges with considerable fiscal implications. Until recently, ELECTRA S.A. was the public utility concessionaire responsible for electricity and water services. ELECTRA is the largest SOE in terms of assets (US$ 203 million by the end of 2023) and has posted recurrent losses, leading to a negative shareholders’ capital of US$74 million by the end of 2023. Consequently, its loans amount reached US$ 203 million, all of which were either on-lending or backed by sovereign guarantees. In addition, ELECTRA is facing liquidity issues, aggravated by a spike in oil prices (over 80 percent of the energy mix relies on fossil fuels), which led to delayed payments to suppliers that reached around US$ 5.5 million by the end of 2023. To address this, the GoCV has approved the unbundling of ELECTRA into four entities: EPEC (thermal generation), EDEC (distribution and retail), ONSEC (system operator), and the new water utility (New ELECTRA). This restructuring aims to improve transparency and service quality, and attract private capital, while advancing the energy transition. The New ELECTRA will focus solely on water services once the restructuring is complete. The government is also developing a new energy sector framework to attract private investment and reduce tariffs, targeting 54 percent renewable energy by 2030. Despite these efforts, the transition could bring other sources of fiscal risks. The government has transferred ELECTRA’s legacy liabilities to the new water company and converted on-lent loan debt into equity, giving the new entity US$ 35 million in shareholder capital. However, given that water services used to account for 15 percent of ELECTRA's revenue, the New ELECTRA’s cashflow may struggle to cover liabilities or generate profit, posing ongoing fiscal challenges. The speed of the reform will influence the scale of these risks, with operational difficulties expected until private sector involvement takes full effect. 181. The maturity profile and the elevated cost of guarantees are key concerns for the state’s exposure, including for the banking sector. Most recent loans were issued at rates above 10 percent and with maturities below two years. Such high-cost loans associated with high refinance risk pose a potential additional indirect cost to the budget. In fact, the Central Bank’s Bulletin on Financial Stability, published in April 2024, points to the high exposure of commercial banks to sovereign debt as a source of vulnerability or risk to financial stability. Meanwhile, having been on a downward trajectory since 2021, non-performing loans increased to 10 percent in July 2024, reflecting challenges in the air transportation sector. Public Finance Review - Page 170 Assessment of Fiscal Costs and Risks from the SOE Sector 182. While Cabo Verde has introduced important measures to shield the 185. PPPs and concession contracts may also represent a source of fiscal risk budget from contingent liability risks, namely the use of guarantee fees, especially if not well designed. The recent experience of a concession contract accelerating implementation is critical. Decree-Law 42/2018 requires the for providing maritime travel services has highlighted the importance of ensuring government to collect fees from beneficiaries of guarantees and to constitute a the provision of essential services does not come at an unsustainable cost to the reserve fund to cover potential defaults. Ministerial Order 96/2022 sets out government (see Box 4.6). Important reforms have recently been implemented guidelines for its application and drawing of funds. The Treasury started charging to strengthen the appraisal framework for PPPs, and the authorities plan to SOEs the guarantee fee in the second half of 2024, including on guarantees broaden the coverage of fiscal risk analysis and reporting to include PPPs, provided since the issuance of Ministerial Order 96/2022. However anecdotal supported through the ongoing program under the IMF’s Extended Credit data suggests no payments had been made by end November 2024. It is also Facility. unclear what amounts the authorities expected to obtain – although a quick analysis of guarantees issued in 2022−2023 suggests this could be up to US$ 2 million, equivalent to 0.1 percent of GDP. 183. SOEs also hold liabilities worth about 12.2 percent of GDP that can be considered an implicit contingent risk for the state (Table 4.3). The GoCV may assume responsibility for liabilities with commercial creditors to prevent operational disruptions or mitigate moral hazard with private investors (as with TACV and ELECTRA), and may also choose to cover SOEs’ arrears with other public entities through the budget to avoid a cascade effect on institutions. 184. Implicit contingent obligations include the government’s social and economic obligations to ensure that SOEs can maintain essential services. These obligations are contingent because the magnitude of fiscal resources required is uncertain and dependent upon future events. The impacts of the COVID-19 pandemic and the Russian invasion of Ukraine on the economy are clear examples of how such liabilities can quickly materialize and cause the government to intervene. Public Finance Review - Page 171 Assessment of Fiscal Costs and Risks from the SOE Sector FUTURE SOE FISCAL IMPACTS AND RISKS CAN BE MITIGATED BOX 4.6. THE FISCAL COST OF MARITIME TRAVEL 186. An in-depth analysis of the fiscal impact of three focus SOEs – ASA, Interisland maritime travel has largely been covered by Cabo Verde ENAPOR, and TACV – offers recommendations for reducing costs and Interilhas (CVI), which operates under a 20−year concession contract with mitigating risk. These companies are three of the GoCV’s six main state-owned the GoCV. Established in 2019, CVI was founded by a consortium of enterprises (Table 4.4). TACV was chosen due to its significant liabilities (second shipowners (11 national and 1 Portuguese), with the ultimate objective of only to ELECTRA) and poor operational performance, which have led to recurrent reorganizing and integrating transportation services across the Cabo Verdean government support. ASA and ENAPOR were selected based on their asset sizes archipelago. and advancement along the concession process. Both the airport concession contract signed in 2023, and the ports sub-concession contract anticipated for The initial concession contract proved to be costly for the GoCV and lacked 2025 are part of the GoCV program to attract private investment to improve incentives for efficiency. The 2019 contract allowed CVI to lease vessels to efficiency, mitigate fiscal risks and generate stable revenues.135 manage Cabo Verde's transportation network, with the GoCV committed to covering any eligible costs exceeding CVI’s revenues to ensure breakeven. 187. The fiscal impact of each company’s performance is presented using Furthermore, as part of its concessionaire remuneration, CVI was entitled to various scenarios, which have been discussed with the authorities. For all receive an additional payment from the GoCV equivalent to 10 percent of the companies, the status quo is based on the most recently available financial total sales of the services provided. This setup undermined motivation to statements. The alternative scenarios presented reflect ongoing sector reforms implement cost-saving measures, ultimately leading to inefficiencies in the or company business plans. They also follow discussions with UASE as well as the system. As a result, CVI benefited from subsidies averaging US$ 10 million in management of the three companies. 2020−2022. Recurrent pressures on the budget led to renegotiation of the contract in 2023 with the GoCV intervention moving from annual payments to investments in assets. Subsidies are now capped at approximately US$ 7 million. Moreover, the GoCV has acquired vessels and made them available to CVI, thus reducing leasing costs. ELECTRA, the largest SOE in Cape Verde in terms of assets, was not selected for this initial assessment given the ongoing corporate restructuring process that will transform both the electricity sector and the company's operations (see Box 4.5). 135 This restructuring is expected to reach a more mature phase by late 2024, making it a more suitable time to analyze the potential fiscal risks of the newly created entities. EMPROFAC and IFH were not included in this first phase of the study due to their smaller size, and relatively stable financial condition, as well as time constraints, and incomplete data. Public Finance Review - Page 172 Assessment of Fiscal Costs and Risks from the SOE Sector TABLE 4.4. OVERVIEW OF CABO VERDE’S SIX MAIN SOES, US$ MILLIONS (2023) C (A-B) F (B/C) A B Net worth D E G H Company Debt to equity Total assets Total liabilities (shareholders’ equity) Net income Adjusted debt Direct subsidies Dividends ratio ASA 188,430 74,790 113,640 14,749 60,429 66% 0 22 ELECTRA 193,521 262,156 -68,635 -7,506 189,338 -382% 1,465 0 EMPROFAC 25,683 14,478 11,204 1,351 6,753 129% 0 0 ENAPOR 61,541 36,432 25,109 2,457 24,773 145% 63 0 IFH 126,555 97,912 28,643 402 88,132 342% 0 0 TACV 5,777 120,006 -114,229 -19,729 53,108 -105% 0 0 % of SOE sector 48% 53% 12% 5% TABLE 4.5. FISCAL COSTS OF CABO VERDE’S SIX MAIN SOES RELATIVE TO THE BUDGET (PERCENT) Sector 2019 2020 2021 2022 2023 A. Revenues 1.8 1.5 1.3 0.6 2.5 B. Expenditures 0.8 0.2 1.3 0.3 0.4 C. Overall balance (A-B) 1.1 1.4 0.0 0.4 2.1 D. Financing 1.3 1.6 1.0 1.5 1.2 E. Net budgetary flows (C-D) -0.3 -0.2 -0.9 -1.1 0.9 F. Stock of contingent liabilities 17.1 22.2 17.3 13.9 13.6 Guaranteed debt 5.8 7.4 4.9 4.0 4.5 On-lending 11.3 14.8 12.4 9.9 9.1 Public Finance Review - Page 173 Assessment of Fiscal Costs and Risks from the SOE Sector ASA (EMPRESA NACIONAL DE AEROPORTOS E SEGURANÇA 191. A scenario analysis estimates potential fiscal gains in four different AÉREA) payout policies combined with a capital reduction: Scenario 1 assumes a US$ 40 million capital reduction with a 50 percent dividend payout rate (status quo). 188. ASA is a fully owned SOE with the mandate to manage the air traffic Scenario 2 involves a US$ 81 million capital reduction and a 99 percent payout navigation system in Cabo Verde; it has gone through significant reform in rate. Scenario 3 has a US$ 40 million reduction but a 99 percent payout rate, recent years. In 2022, a joint venture (JV) between Vinci Airports and Aeroportos while Scenario 4 features a US$ 81 million reduction with a 70 percent payout de Portugal signed a 40−year concession contract with the GoCV for all airport rate. Notably, the capital reduction in all scenarios has no cash-flow implications, services in Cabo Verde, becoming the operator of the country’s airport as it offsets assets ASA expects to receive from the GoCV. infrastructure as of July 2023. The JV paid an upfront fee of US$ 35 million to the GoCV, with an additional US$ 45 million expected for 2025. With the concession 192. Results suggest that implementing a higher dividend payout policy in place, ASA's operational revenues now come from aeronautical fees, which would be beneficial to both ASA and the GoCV (Figure 4.5). For ASA, optimizing are much more predictable. In 2023, approximately 92 percent of these fees its capital structure with a high dividend payout would signal confidence in its were generated from flights transiting Cabo Verde’s airspace. ASA also owns profitability and operational stability, enhancing its reputation and aiding 100 percent of CV Handling S.A. and a 20 percent stake in CV Telecom S.A. negotiations with banks and partners. This approach would also promote capital discipline, preventing investment in unprofitable ventures outside its core 189. With a strong balance sheet, high cash generation, and steady cash business.136 Additionally, distributing dividends would provide a stable revenue flows, ASA is expected to contribute significantly to the GoCV budget. World source for the GoCV, bolstering the government's financial position and Bank projections estimate annual operating income will average around US$ 23 supporting economic stability and development initiatives. million from 2024 to 2028, assuming current operational conditions persist. Additionally, the divestment of up to 61 percent of CV Handling's share capital could translate into further fiscal gains through higher dividend payout and increased liquidity for ASA. 190. ASA's strong income generation suggests a need to reconsider its dividend policy. The GoCV and ASA have agreed that ASA will withhold 50 percent of future dividends until ASA repays approximately CVE 4 billion in loans contracted to airport investments. While this strengthens ASA's balance sheet, it may create a sub-optimal capital structure due to excess cash. 136 In 2023, ASA reported the acquisition of an aircraft and other security equipment intended for lease to the Coastguard. This acquisition was financed through bank loans totaling US$ 12.3 million at an interest rate of 5.5 percent, backed by a sovereign guarantee. 137 Since estimating an upfront fee for the right to use port terminals is challenging at this stage, this scenario assumes that any upfront fee paid would be entirely directed to the government, thus not impacting the company cashflow. Public Finance Review - Page 174 Assessment of Fiscal Costs and Risks from the SOE Sector FIGURE 4.5. FOUR SCENARIOS ARE MODELLED FOR ASA’S DIVIDEND PAYOUT POLICY Net debt Net debt/EBITDA CVE million 4,000,000 1.5x 1.0x 2,000,000 0.5x 0 0.0x 2023 2024 2025 2026 2027 2028 2023 2024 2025 2026 2027 2028 -2,000,000 -0.5x -1.0x -4,000,000 -1.5x -6,000,000 -2.0x -8,000,000 -2.5x Scen 1 Scen 2 Scen 3 Scen 4 Scen 1 Scen 2 Scen 3 Scen 4 Source: Authors’ estimates based on company financial statements. Note: EBITDA=earnings before interest, taxes, depreciation, and amortization. Public Finance Review - Page 175 Assessment of Fiscal Costs and Risks from the SOE Sector FIGURE 4.5. FOUR SCENARIOS ARE MODELLED FOR ASA’S DIVIDEND PAYOUT POLICY Return on equity (ROE) Net budgetary flow Percent of GDP 60% 1.60% 55% 1.40% 50% 1.20% 45% 1.00% 40% 35% 0.80% 30% 0.60% 25% 0.40% 20% 0.20% 15% 10% 0.00% 2023 2024 2025 2026 2027 2028 2024 2025 2026 2027 2028 Scen 1 Scen 2 Scen 3 Scen 4 Scen 1 Scen 2 Scen 3 Scen 4 Source: Authors’ estimates based on company financial statements. Note: EBITDA=earnings before interest, taxes, depreciation, and amortization. Public Finance Review - Page 176 Assessment of Fiscal Costs and Risks from the SOE Sector ENAPOR (EMPRESA NACIONAL DE ADMINISTRAÇÃO DOS 196. The fiscal impact of ENAPOR’s operations is evaluated under three PORTOS, S.A.) scenarios: Scenario 1 assumes no operational improvements from 2023, with labor costs rising with inflation. Scenario 2 follows ENAPOR’s Interim Business Plan, projecting a 5 percent volume growth and a better mix favoring 193. ENAPOR, Cabo Verde’s port concessionaire, is entirely owned by the international traffic. Scenario 3 determines the minimum fee ENAPOR needs GoCV and oversees the administration, management, and economic from a potential sub-concessionaire to break even in cash flow.137 utilization of ports, terminals, and jurisdiction zones. It ensures conservation, planning, and development while exercising port authority competencies. 197. Results indicate that the sub-concession process could significantly enhance ENAPOR’s financial performance both in the short term and 194. ENAPOR’s financial position has weakened since 2018, with a net sustainably over the medium to long term (Figure 4.6). Engaging a private debt/EBITDA ratio of around 3.2× and a liquidity ratio of 1.1×. Though not operator could provide an immediate financial boost through an upfront fee, immediately concerning, ENAPOR’s high fixed costs and reliance on large while variable fees tied to volume growth—leveraging the operator's volumes to dilute costs limit its ability to achieve satisfactory investment returns. international expertise—could further optimize returns. The World Bank Since its peak operational result in 2019, total goods volume has decreased by 6 estimates that ENAPOR would need to collect an annual fee of US$2.5 million for percent, with long-haul goods—more profitable than domestic ones—dropping cashflow to break even. Additionally, ENAPOR should maximize handling by 25 percent. This trend raises concerns that ENAPOR may shift from being a volumes and optimize costs. Given the company’s high fixed costs and the budget contributor to a potential cost burden as its contributions to the GoCV capital intensity of port services, maximizing volume is crucial for achieving budget through income taxes and dividends have been declining since before operational leverage and improving financial results. the pandemic. 195. The authorities have embarked on a process to sub-concession port services across all nine ports within the country. The concession will allow a private operator the right to deliver, under a public service framework, various cargo handling activities. Notably, ENAPOR will retain responsibility for passenger handling services and may also assume a regulatory role within the sector. 137 Since estimating an upfront fee for the right to use port terminals is challenging at this stage, this scenario assumes that any upfront fee paid would be entirely directed to the government, thus not impacting the company cashflow. Public Finance Review - Page 177 Assessment of Fiscal Costs and Risks from the SOE Sector FIGURE 4.6. THREE SCENARIOS ARE MODELLED FOR ENAPOR’S OPERATIONS Net debt (CVE million) Net debt/EBITDA 3,500,000 10.0x 9.0x 3,000,000 8.0x 2,500,000 7.0x 6.0x 2,000,000 5.0x 1,500,000 4.0x 1,000,000 3.0x 2.0x 500,000 1.0x 0 0.0x 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Scen 1 Scen 2 Scen 3 Scen 1 Scen 2 Scen 3 Source: Authors’ estimates based on company financial statements. Note: EBITDA=earnings before interest, taxes, depreciation, and amortization. Public Finance Review - Page 178 Assessment of Fiscal Costs and Risks from the SOE Sector FIGURE 4.6. THREE SCENARIOS ARE MODELLED FOR ENAPOR’S OPERATIONS Current ratio (current assets / current liabilities) Net budgetary flows (percent of GDP) 1.8x 0.25% 1.6x 1.4x 0.20% 1.2x 0.15% 1.0x 0.8x 0.10% 0.6x 0.4x 0.05% 0.2x 0.0x 0.00% 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2024 2025 2026 2027 2028 Scen 1 Scen 2 Scen 3 Scen 1 Scen 2 Scen 3 Source: Authors’ estimates based on company financial statements. Note: EBITDA=earnings before interest, taxes, depreciation, and amortization. Public Finance Review - Page 179 Assessment of Fiscal Costs and Risks from the SOE Sector TACV/CVA (TRANSPORTES AÉREOS DE CABO VERDE 202. TACV presents significant fiscal risks on multiple fronts. The company CABO VERDE AIRLINES) has accrued tax arrears and withheld employee social security contributions, with estimated liabilities to INPS (Cabo Verde’s social security agency) and DNRE (Revenue Directorate) totaling nearly US$ 5 million (0.2 percent of GDP) as of 198. TACV is Cabo Verde’s flagship airline. TACV was majority-owned by the 2023. Additionally, TACV has been receiving annual capitalizations of US$ 1 GoCV until 2019, when Loftleidir Cabo Verde acquired a 51 percent stake. As part million from the GoCV to maintain operations, with a total of US$ 3 million of the deal, most of TACV’s longstanding liabilities were transferred to a new disbursed from 2022 to 2024. The company also relies on loans from the banking special purpose vehicle, NewCo (see Box 4.4). Operations were suspended sector backed by sovereign guarantees. from early 2020 to late 2021 due to COVID-19, and the partnership with Icelandair ended in 2021, leading to TACV’s renationalization. 203. Scenario analysis indicates that the agreed capitalizations are insufficient to close the cash gap created by TACV's underperformance, 199. At the time of writing, TACV was operating only two aircraft, limiting its potentially leading to further costs for the budget. If capitalizations are frequency and destinations, while financial constraints restrict operational disbursed as planned, arrears to the government cease, and no operational leverage. The company primarily focuses on international routes, serving as an improvements occur, TACV is estimated to require an additional average of US$ alternative to other carriers. As of June 2023, its only regular route was 47 million annually from 2024 to 2028 to meet its debt service and maintain Praia-Lisbon, as delays in settling payables to the IATA clearing house and BSP operations. This amount is equivalent to nearly 20 percent of the GoCV’s have severely limited access to key distribution channels, constraining demand. spending on priority sectors (health, education, social security) in 2023. 200. Historically, TACV has operated with compressed margins due to low 204. TACV has developed an ambitious turnaround plan focused on load factors and weak yields. In 2019, before the COVID-19 pandemic, TACV expanding international travel, which comes with high risk. The 2023 Interim increased available seat kilometers (ASK) by 53 percent, but this led to a 4.3 Business Plan projects138 increased supply, better occupancy rates, higher percent yield decline and a load factor of only 59.8 percent, below the 71.7 yields, and fleet growth to four aircraft by 2026. However, if these assumptions percent average for African airlines and the global average of 83 percent. fall short—such as supply growth not followed by higher load factors and yields—TACV’s financial position could deteriorate further. 201. TACV has posted negative shareholders’ equity since before 2016. As of December 2023, TACV reported a debt position of US$ 63 million (roughly 2.6 205. Scenario analysis indicates the need for bold decisions: Scenario 1 percent of GDP), all of which is backed by GoCV guarantees. Moreover, the maintains the status quo; Scenario 2 adds an annual CVE 1 billion cash injection surge in TACV’s cost of debt to above 8 percent has resulted in substantial through 2028; Scenario 3 incorporates improvements from the 2023 Interim financial expenses and accentuates cash pressure. Business Plan but without fleet expansion; and Scenario 4 is similar to Scenario 3 138 The Interim Business Plan was prepared with support from Kroll Advisory Portugal Unipessoal, Lda. but with all guaranteed debt assumed by the GoCV (Figure 4.7). Public Finance Review - Page 180 Assessment of Fiscal Costs and Risks from the SOE Sector FIGURE 4.7. FOUR SCENARIOS ARE MODELLED FOR TACV’S OPERATIONS Adjusted net debt Operating cashflow CVE million CVE million 30,000,000 0 -500,000 25,000,000 -1,000,000 20,000,000 -1,500,000 -2,000,000 15,000,000 -2,500,000 10,000,000 -3,000,000 -3,500,000 5,000,000 -4,000,000 0 -4,500,000 2023 2024 2025 2026 2027 2028 2024 2025 2026 2027 2028 Scen 1 Scen 2 Scen 3 Scen 4 Scen 1 Scen 2 Scen 3 Scen 4 Source: Authors’ estimates based on company financial statements. Note: EBITDA=earnings before interest, taxes, depreciation, and amortization. Public Finance Review - Page 181 Assessment of Fiscal Costs and Risks from the SOE Sector FIGURE 4.7. FOUR SCENARIOS ARE MODELLED FOR TACV’S OPERATIONS Adjusted net debt/EBITDA Net budgetary flows Percent of GDP 50.0x 0.0% 40.0x -0.2% -0.4% 30.0x -0.6% 20.0x -0.8% 10.0x -1.0% 0.0x -1.2% 2023 2024 2025 2026 2027 2028 -10.0x -1.4% 2024 2025 2026 2027 2028 Scen 1 Scen 2 Scen 3 Scen 4 Scen 1 Scen 2 Scen 3 Scen 4 Source: Authors’ estimates based on company financial statements. Note: EBITDA=earnings before interest, taxes, depreciation, and amortization. Public Finance Review - Page 182 Assessment of Fiscal Costs and Risks from the SOE Sector 206. The analysis suggests that even with operational improvements TACV 210. TACV may also consider focusing on the domestic market and relying will not be able to reduce its debt to manageable levels. Such results highlight less on highly competitive international routes. Previous analyses suggest that the need for a de-leveraging exercise for TACV to improve its financial situation there may be an acceptable level of demand for air travel between the islands, and to rationalize government expenses. One approach, similar to the one taken both as final destinations and as feeders into international destinations. during the creation of NewCo in 2019, would be for TACV’s high-cost guaranteed debt to be assumed by the government and converted into equity. The main rationale for this is that the government is better positioned to negotiate with lenders, leading to lower financial expenses and longer maturity. 207. A highly leveraged TACV tends to elevate costs for the budget. If TACV maintains a highly leveraged balance sheet, it may continue to struggle to service and refinance its debt. In such a scenario, lenders may execute sovereign guarantees, forcing the GoCV to assume all TACV loans. If this scenario materializes in 2025, likely leading TACV to bankruptcy, it could cost the GoCV up to US$ 160 million in TACV liabilities. 208. To support TACV’s de-leveraging, robust corporate governance should limit further borrowing. De-leveraging aims to reduce GoCV’s financial burden, not to enable TACV’s expansion, which could risk taking the company back to the current financial challenges. 209. To improve operational results, TACV should focus on profitable routes and limit capacity growth until it achieves operational break-even. Historically, TACV's load factor has not exceeded 66 percent, meaning that expanding capacity without a proven profitable model could exacerbate losses. Scenario analysis indicates that following the 2023 Interim Business Plan without operational improvements could raise TACV's annual cash needs from an average of US$47 million to US$105 million. 4.5 POLICY RECOMMENDATIONS Public Finance Review - Page 184 Policy Recommendations 211. This chapter provides actionable recommendations for Cabo Verde’s • Improve management of SOE borrowing and financing needs, including by SOE reform, emphasizing a strategic, integrated approach to improve accelerating the implementation of Ministerial Order 96/2022 and governance, performance, and competitiveness while managing fiscal risks. applying guarantee fees to all sovereign guarantees (including Priority reform measures that can contribute to mitigate fiscal risks are proposed retroactively). Decree-Law 42/2018 mandates the government to collect below (a broader set of recommendations are outlined in Annex 4.2): fees from beneficiaries of guarantees and establish a reserve fund to cover potential defaults. Accelerating its implementation by applying Ministerial • Improve transparency and accountability by ensuring complete and Order 96/2022 and imposing guarantee fees retroactively could help timely publication of SOE annual and audit reports (especially by TACV), as mitigate the fiscal risk associated with guaranteed SOE debt. This could help well as aggregate portfolio reports, and encouraging inclusion of key create a financial buffer for the GoCV in case of defaults and encourage non-financial information. While SOE transparency in Cabo Verde is SOEs to manage their finances more responsibly. relatively high, annual and audit reports for TACV have not been published in recent years, which is a clear deviation from international good practice. • Ensure the fiscal risk being borne by the GoCV from guarantees is Encouraging the inclusion of key non-financial information, including ESG adequately costed by creditors. The analysis shows that the interest rate on (environmental, social and governance) and climate aspects, is crucial for guaranteed debt is at least twice as high as on Treasury issuances, if not enhancing transparency and providing stakeholders with a more higher (in the case of TACV). The Treasury is encouraged to take a more active comprehensive understanding of SOE performance. role in negotiating SOE financing to ensure costing reflects the risk that is being taken by the sovereign. • Enhance reporting on transactions between SOEs and GoCV for on-lent loans, as well as transactions between SOEs, to better assess their • De-leverage legacy debt from TACV to improve the company’s financial potential fiscal costs. The GoCV provides on-lending to SOEs, with position and reduce costs to GoCV. TACV has a significant debt burden and repayment guaranteed by the beneficiary through a banking institution. has been in a state of technical default since before 2016. De-leveraging Greater transparency around these transactions would allow for a more TACV’s legacy debt by assuming it into government equity would improve accurate assessment of fiscal costs associated with on-lending, enabling the company's financial position and reduce costs. This would allow the better decision-making regarding future on-lending practices. Similarly, GoCV to renegotiate loan terms as a sovereign entity, potentially securing reporting on transactions between the government and SOEs and between lower financial expenses and longer maturities. This could be done in SOEs would provide a more comprehensive overview of the SOE sector's exchange for strict future performance targets for the company. financial landscape. This would strengthen fiscal risk oversight by identifying potential cascading effects of arrears and enabling proactive measures to mitigate these risks. Public Finance Review - Page 185 Policy Recommendations • Implement the above step in tandem with prioritizing profitable routes for • Importantly, take a careful approach to the operationalization of TACV and restraining capacity growth until an operational break-even Parpública. If well implemented, the creation of Parpública has the potential point is achieved. This will ensure that TACV focuses on reducing losses and to further strengthen the SOE ownership function in Cabo Verde. However, achieving sustainable growth, thus avoiding repeating past mistakes of SOE holding structures come with their own set of challenges that will expanding capacity or routes without a proven profitable business model. require careful preparation and management. For instance, it is crucial to Balancing the desired level of service provision with costs to the state will be define a clear division of responsibilities and carefully manage any overlap in critical in this regard. The process would include defining essential routes roles and functions of Parpública with UASE and other existing structures to and the minimum amount of flights to ensure essential connectivity, avoid duplication and ensure efficient co-ordination. This structure may also transparently calculating and accounting for the cost of PSOs, setting a weaken fiscal accountability if the holding company’s decisions are less maximum overall amount, and ensuring their timely reimbursement. transparent or prioritize operational survival over financial sustainability. A well-defined governance structure for Parpública that appropriately • Define clear parameters for how the new entities created in the energy and balances necessary management autonomy with strong accountability to water sector will interact with each other. Being clear about how these four the state and the public is therefore essential. Enhanced oversight new entities (EPEC, EDEC, ONSEC, and the New ELECTRA) will interact with mechanisms, such as dual reporting lines to the MoF and Parliament, or each other is paramount for ensuring a smooth transition and preventing mandatory external audits of the holding company’s operations, may be potential conflicts or inefficiencies. This will also help to mitigate fiscal risks considered. Exchanging knowledge and experiences with other centralized associated with the restructuring process. SOE ownership institutions, including SOE holding companies, and exchanges with other SOE oversight entities on the overall institutional setup • Promote and enforce better capital discipline in ASA to avoid investments and specific technical issues could be helpful. Importantly, while in unprofitable ventures or activities outside its core business. This could establishing the holding structure will enable positive earnings from some help enhance operational efficiency and overall performance, and ensure companies to be redirected to loss making ones, which could shield the that ASA remains focused on its core business of managing airport budget, it will reduce dividend receipts, with impacts on the primary balance infrastructure and air traffic navigation while enhancing revenues for the and overall fiscal space. state. • Prioritize efforts for ENAPOR to increase handling volumes to their full potential. In 2023, the total volume of goods handled (in tons) was still 6% lower than before the onset of the Covid-19 pandemic. Given the relevant fixed cost structure and capital intensity of port services, maximizing volume is essential to achieving operational leverage and improving financial results. Public Finance Review - Page 186 Policy Recommendations TABLE 4.6. PRIORITY REFORMS FOR THE SOE SECTOR Time Frame Policy area Policy action Feasibility Ownership and oversight Carefully approach the operationalization of Parpública as a new SOE portfolio holding company ST function Ensure complete and timely publication of SOE annual and audit reports – including as a priority for TACV, as well as aggregate Transparency and reporting MT portfolio reports, encouraging inclusion of key non-financial information. Accelerate the implementation of Ministerial Order 96/2022 and apply guarantee fees to all sovereign guarantees Fiscal risks from guarantees ST (including retroactively) Ensure adequate costing for Through MoF involvement, ensure reduction of interest rates on SOE borrowing under government guarantees ST government guarantees TACV legacy debt Consider deleveraging legacy debt from TACV, with a view to improving the company’s financial position and reduce costs to GoCV. ST TACV operations and future Prioritize TACV’s profitable routes, eliminate, or reduce unprofitable routes, and restrain capacity growth until an operational MT business model break-even point is clearly indicated. Energy sector unbundling Clearly define parameters for how the newly created entities will interact with each other. MT