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The In­ter­na­tional Mon­e­tary Fund reports this week that de­spite that Swazi­land has a mid­dle-in­come sta­tus, struc­tural im­ped­i­ments have hin­dered pri­vate in­vest­ment and kept un­em­ploy­ment high, con­tribut­ing to persistently el­e­vated poverty and in­come in­equal­ity. Macroe­co­nomic con­di­tions have re­cently de­te­ri­o­rated. In 2016, two shocks – a pro­longed drought and a sharp de­cline in South­ern African Cus­toms Union (SACU) re­ceipts – se­verely hit the econ­omy, while an ex­pan­sion­ary fis­cal pol­icy wors­ened fis­cal and ex­ter­nal bal­ances. Growth in 2016 stag­nated, as agri­cul­tural pro­duc­tions de­clined, and head­line in­fla­tion in­creased sharply, mostly due to ris­ing food prices. Gov­ern­ment’s pol­icy of in­creas­ing pub­lic ex­pen­di­ture, while SACU rev­enues de­clined, widened the FY16/17 deficit to about 10½ per cent of GDP. Pub­lic debt rose and do­mes­tic ar­rears ac­cu­mu­lated, while the cur­rent ac­count de­te­ri­o­rated and in­ter­na­tional re­serve cov­er­age de­clined be­low three months of im­ports.

The eco­nomic slow­down and gov­ern­ment’s do­mes­tic ar­rears have started hav­ing ad­verse ef­fects on the bank­ing sec­tor’s as­set qual­ity, with non-per­form­ing loans (NPLs) ris­ing. Fis­cal pol­icy re­mains on an ex­pan­sion­ary course, while the mon­e­tary stance has tight­ened. De­spite a pickup in SACU rev­enue, the 2017 bud­get en­vis­ages a con­tin­u­a­tion of large fis­cal deficits, and fur­ther in­crease in pub­lic debt. In the con­text of the peg to the South African rand, in early 2017 the Cen­tral Bank of Swazi­land raised its pol­icy rate above South African Re­serve Bank’s rate.

On Septem­ber 1, the Ex­ec­u­tive Board of the In­ter­na­tional Mon­e­tary Fund (IMF) con­cluded Ar­ti­cle IV con­sul­ta­tion1 with the King­dom of Swazi­land. Since the 2010 fis­cal cri­sis, Swazi­land has ex­pe­ri­enced a pe­riod of macroe­co­nomic sta­bil­ity and re­cov­ery. A re­bound in SACU rev­enues, ex­pan­sion­ary poli­cies and the peg to the South African rand have contributed to the re­build­ing of buf­fers and sup­ported a growth re­cov­ery. The out­look is frag­ile, with an un­sus­tain­able fis­cal pol­icy. Growth is pro­jected to pick up in 2017 due to the end of the drought and in­creas­ing SACU rev­enue, and turn neg­a­tive there­after as fis­cal and ex­ter­nal po­si­tions weaken. The large fis­cal deficit would con­trib­ute to fur­ther re­duce in­ter­na­tional re­serves and bring pub­lic debt above sus­tain­abil­ity thresh­olds. Down­side risks dom­i­nate the out­look. The main risk stems from fur­ther tight­en­ing in bud­get fi­nanc­ing. Ad­di­tional risks arise from de­te­ri­o­rat­ing banks’ as­set qual­ity, lower SACU rev­enue and de­mand for key ex­ports. With a frag­ile out­look, the ma­te­ri­al­i­sa­tion of risks could trig­ger abrupt fis­cal ad­just­ment. Link­ages be­tween do­mes­tic fi­nan­cial in­sti­tu­tions and the gov­ern­ment could fur­ther am­plify the neg­a­tive im­pact of shocks on the econ­omy.

Ex­ec­u­tive Di­rec­tors noted that while Swazi­land had ex­pe­ri­enced sus­tained growth and macroe­co­nomic sta­bil­ity in re­cent years, the coun­try is now fac­ing for­mi­da­ble chal­lenges.

A pro­longed drought, and a sharp de­cline in SACU rev­enues have re­cently hit the econ­omy. An ex­pan­sion­ary fis­cal pol­icy has fur­ther wors­ened fis­cal im­bal­ances and cre­ated tighter links be­tween the gov­ern­ment and do­mes­tic fi­nan­cial in­sti­tu­tions, con­tribut­ing to the frag­ile eco­nomic sit­u­a­tion.

In ad­di­tion, Di­rec­tors noted that struc­tural im­ped­i­ments have kept growth rel­a­tively low. They em­pha­sised that im­ple­men­ta­tion of sound poli­cies and struc­tural re­forms will be key to man­ag­ing the ris­ing risks, main­tain­ing macroe­co­nomic and fi­nan­cial sta­bil­ity, and gen­er­at­ing stronger growth to re­duce poverty and in­come in­equal­ity.

Di­rec­tors em­pha­sised that sig­nif­i­cant fis­cal ad­just­ment is needed to en­sure macroe­co­nomic sta­bil­ity and debt sus­tain­abil­ity. They stressed that, with tight­en­ing bud­get fi­nanc­ing, ad­just­ment ef­forts should be spread over time and fo­cus on both rev­enue and ex­pen­di­ture mea­sures that can sup­port long-term growth. Di­rec­tors un­der­scored that steps to con­tain the pub­lic wage bill, pri­ori­tise cap­i­tal out­lays, re­duce trans­fers to ex­tra-bud­getary en­ti­ties, and boost tax rev­enues will be crit­i­cal to the ad­just­ment ef­fort. They en­cour­aged the au­thor­i­ties to im­prove bud­get for­mu­la­tion and ex­pen­di­ture con­trols, and strengthen the gov­er­nance of ex­tra-bud­getary en­ti­ties to en­sure the cred­i­bil­ity of con­sol­i­da­tion plans. Di­rec­tors noted that strong fis­cal ad­just­ment will help re­lease pres­sures on mon­e­tary pol­icy. They un­der­scored that the Cen­tral Bank of Swazi­land (CBS) should re­frain from ad­di­tional bud­get fi­nanc­ing and, in the con­text of the peg with the South African rand, the CBS should main­tain the pol­icy rate at a pos­i­tive spread with the South African Re­serve Bank’s rate.

Di­rec­tors wel­comed the au­thor­i­ties’ plans to amend the CBS Act to bol­ster the cen­tral bank man­date and in­de­pen­dence and strengthen its su­per­vi­sory struc­ture. They stressed the im­por­tance of mon­i­tor­ing and as­sess­ing fi­nan­cial sta­bil­ity and macro-fi­nan­cial risks aris­ing from tight link­ages be­tween gov­ern­ment and the fi­nan­cial sec­tor, and sys­tem­i­cally large non-bank fi­nan­cial in­sti­tu­tions. In this con­text, Di­rec­tors rec­om­mended to ac­cel­er­ate plans to cre­ate a fi­nan­cial reg­u­la­tory ar­chi­tec­ture and en­hance the CBS’s ca­pac­ity to as­sess macro-fi­nan­cial risks and ex­er­cise

Di­rec­tors em­pha­sised that bolder struc­tural re­forms are needed to foster stronger and more in­clu­sive growth. They high­lighted that the re­form ef­fort should fo­cus on re­duc­ing skill mis­matches through im­prov­ing ac­cess and qual­ity of higher ed­u­ca­tion, align­ing wage and pro­duc­tiv­ity dy­nam­ics, in­clud­ing by con­tain­ing pub­lic sec­tor wages, and sim­pli­fy­ing busi­ness reg­u­la­tions and im­prov­ing the in­sti­tu­tional en­vi­ron­ment. Di­rec­tors wel­comed the au­thor­i­ties’ re­cent in­crease of cash as­sis­tance pro­grammes and sug­gested fur­ther scal­ing up and bet­ter tar­get­ing to ad­dress ex­treme poverty.

Swazi­land is a small mid­dle-in­come econ­omy par­tic­u­larly ex­posed to ex­ter­nal shocks and with sig­nif­i­cant struc­tural chal­lenges. Af­ter a sharp de­cline in rev­enue from the SACU in 2010 that prompted a fis­cal cri­sis, rev­enue bounced back, fis­cal and ex­ter­nal bal­ances im­proved, and buf­fers were re­built. The peg to the South African rand contributed to mod­er­ate in­fla­tion, and growth re­cov­ered. How­ever, growth has been low com­pared to the pre-cri­sis pe­riod and other mid­dle-in­come coun­tries.

The cur­rent ac­count re­mains heav­ily de­pen­dent on SACU rev­enue and ex­ports con­cen­trated on a few prod­ucts. More re­cently, an ex­pan­sion­ary fis­cal pol­icy has de­pleted buf­fers, leav­ing in­ter­na­tional re­serve cov­er­age be­low ad­e­quate lev­els and prompt­ing a rapid in­crease in pub­lic debt. More­over, de­spite its mid­dle-in­come sta­tus, Swazi­land faces wide­spread poverty and a high HIV preva­lence rate. Un­em­ploy­ment re­mains high and lit­tle re­spon­sive to growth, con­tribut­ing to el­e­vated in­come in­equal­ity. In 2016, a pro­longed drought and a sharp de­cline in SACU rev­enue se­verely hit the econ­omy. Real GDP stag­nated (1.1 per cent in 2015) as agri­cul­ture and hy­dro-power pro­duc­tion de­clined be­cause of the drought, with neg­a­tive ef­fects on other sec­tors of the econ­omy. De­clin­ing pri­vate de­mand largely off­set the im­pact of an ex­pan­sion­ary fis­cal pol­icy. The de­cline in SACU trans­fers (about 4¼ per cent of GDP), cou­pled with strong de­mand for im­ports and lower ex­ports (par­tic­u­larly for agri­cul­tural prod­ucts), re­duced the cur­rent ac­count sur­plus to ¾ per cent of GDP (10.8 per cent of GDP in 2015). On the pos­i­tive side, the net in­ter­na­tional in­vest­ment po­si­tion im­proved some­what, al­though mainly re­flect­ing short-term trade credit as­sets. How­ever, other buf­fers have thinned, and end-year in­ter­na­tional re­serve Swazi­land, with Le­sotho, Namibia and South Africa, is mem­ber of the Com­mon Mon­e­tary Area (CMA), and its cur­rency is pegged at par with the South African rand. CMA mem­bers and Botswana con­sti­tute the SACU. In re­cent years, growth in agri­cul­ture, man­u­fac­tur­ing and some ser­vices has slowed down. On the ex­ter­nal side, ex­ports of soft drink con­cen­trates, caramel colour, sugar, and tex­tile con­sti­tute about 70 per cent of to­tal ex­ports and are mainly di­rected to South Africa. Low Real GDP Growth (per cent) cov­er­age de­clined to be­low three months of pro­jected im­ports. More re­cently, re­serve cov­er­age has fallen fur­ther to 2.6 months of im­ports (May 2017).

Gov­ern­ment’s pol­icy of in­creas­ing pub­lic ex­pen­di­ture, against de­clin­ing SACU rev­enue, widened the fis­cal deficit and cre­ated bud­get fi­nanc­ing short­falls. The FY16/17 deficit widened to 10½ per cent of GDP (4.6 per cent in FY15/16) as SACU rev­enue de­clined and, on the spend­ing side, a salary re­view in­creased wage costs and trans­fers and cap­i­tal out­lays reached the high­est level since 2010, largely un­do­ing the ad­just­ment achieved dur­ing the 2010 fis­cal cri­sis.

Gross fi­nanc­ing needs in­creased to 21¾ per cent of GDP. The gov­ern­ment in­creas­ingly tapped do­mes­tic mar­kets and, in ad­di­tion, re­sorted to cen­tral bank fi­nanc­ing and ac­cu­mu­lated do­mes­tic ar­rears (about 5⅓ per cent of GDP at end March 2017). While still rel­a­tively low, pub­lic debt jumped to 25⅓ per cent of GDP (from 18.7 per cent), in­clud­ing do­mes­tic ar­rears. Against these de­vel­op­ments, mar­ket pres­sures in­ten­si­fied, re­sult­ing in de­clin­ing cov­er­age ra­tios and ris­ing yields for gov­ern­ment se­cu­ri­ties.

Eco­nomic slow­down and gov­ern­ment’s fi­nanc­ing short­falls have started ad­versely af­fect­ing the bank­ing sec­tor.

Since 2012, credit growth to the pri­vate sec­tor has av­er­aged 11½ per cent, but de­cel­er­ated to 7½ per cent in 2016 as cor­po­rate lend­ing growth turned neg­a­tive (Fig­ure 5).

How­ever, credit to house­holds for mort­gages and durables re­mained buoy­ant, con­tribut­ing to in­crease house­hold in­debt­ed­ness. At the same time, banks’ as­set qual­ity de­te­ri­o­rated, with NPL ris­ing rapidly and ex­ceed­ing 10 per cent of to­tal loans (end-March 2017).

As gov­ern­ment’s fi­nanc­ing needs in­creased, banks’ di­rect ex­po­sure to the pub­lic sec­tor rose and hold­ings of gov­ern­ment se­cu­ri­ties reached about 11 per cent of banks’ as­sets.

Against this back­ground, in­fla­tion picked up and mon­e­tary pol­icy stayed on a tight­en­ing course. Af­ter av­er­ag­ing five per cent in 2015, head­line in­fla­tion reached 8.7 per cent in since FY13/14, SACU rev­enues have been on a de­clin­ing trend. The sharp de­cline in FY16/17 com­pared to the pre­vi­ous year re­flected past trends and an ad­just­ment to off­set over­pay­ments in pre­vi­ous years.

In 2016, in­ter­na­tional re­serves were boosted by two cur­rency swap oper­a­tions that in April 2017 amounted to about US 18 mil­lion.

The 2016 salary re­view re­formed, among others, civil ser­vant grades, re­sult­ing in ad­di­tional an­nual wage costs of about two per cent of GDP. Do­mes­tic ar­rears are es­ti­mated as the dif­fer­ence be­tween above the line ac­crual spend­ing and be­low the line cash fi­nanc­ing, ac­count­ing for an av­er­age end-year float of due pay­ments.

As end-March 2017, au­thor­i­ties’ sys­tems iden­ti­fied pend­ing bills, ex­ceed­ing 30 days, above four per cent of GDP. Given the volatil­ity of credit se­ries, credit growth refers to 12month av­er­age. In July 2016, the Swazi­land Cen­tral Bank in­creased liq­uid­ity re­quire­ments (from 20 to 25 per cent of do­mes­tic li­a­bil­i­ties to the pub­lic), cre­at­ing an ad­di­tional in­cen­tive for banks to in­vest in do­mes­tic se­cu­ri­ties.

In 2017, in­fla­tion started slowly de­clin­ing as the ef­fect of the drought faded away. In the con­text of the peg with the South African Rand, the CBS raised the pol­icy rate in 2016, and again in Jan­uary 2017 to reach 7.25 per cent, for the first time in years, above the South Africa Re­serve Bank (SARB)’s rate, cit­ing el­e­vated risks . Aware of the long-term chal­lenges, au­thor­i­ties have adopted plans to boost growth and foster so­cial and eco­nomic trans­for­ma­tion, but re­sults have been mixed. In the con­text of their 2022 vi­sion, au­thor­i­ties have in­creased pub­lic in­vest­ment, and de­ployed in­cen­tives to boost pri­vate in­vest­ment and eco­nomic di­ver­si­fi­ca­tion. How­ever, the im­pact of these ini­tia­tives has been lim­ited, par­tic­u­larly on pri­vate in­vest­ment, em­ploy­ment and eco­nomic di­ver­si­fi­ca­tion.

On the pos­i­tive side, macroe­co­nomic sta­bil­ity has been main­tained. How­ever, im­ple­men­ta­tion of re­cent staff’s ad­vice has been un­even, es­pe­cially in the fis­cal area, and new chal­lenges are ris­ing.

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