Sierra Leone - Economic memorandum

RESTRICTED FILE COPY Report No. AF-66a This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION ECONOMIC MEMORANDUM ON SIERRA LEONE November 21, 1967 Africa Department  CURRENCY ECtUIVALENTS US $1. 00 = Leone 0. 714 Leone 1. 00 = US $1. 40 Le 1 million = US $1. 4 million  TABLE OF COflTETS Page No. BASIC DATA................................ SUMMARY AND CONCLUSIONS........................ i THE 1967/68 BUDGET a..........3.... a...... a a. 3 PUBLIC CORPORATIONS ..................... 6 MONEY, CREDIT AND PRICES...*#********......... 7 BALANCE OF PAYMENeTS.......................... .. 8 CONCLUSIONS ..................... .... .,. 9 STATISTICAL APPENDIX This memorandum reviews specifically recent fin- ancial developments in the public sector, since the report "Economic Position and Prospects of Sierra Leone" (AF-52a of October 31, 1966) had stressed the need for improved fiscal performance as an importanit factor affecting long- term growth. That report is the frame of reference for this memorandum, and therefore it should be consulted for a more detailed background or for any aspects of Sierra Leone's economic performance and development prospects not discussed herein. This memorandum is based on information gathered by an observer, Mr Wlerner Hammel, attached to an International Monetary Fund Mission which visited Sierra Leone in June 1967.  BASIC DATA. AREA 27,925 square miles POPULATION Total (1967) 2.3 million Rate of Growth 1.3-1.5% per year GROSS NATIONAL PRODUCT PER CAPITA at current market prices, 1965/66 US$ 157.6 GROSS DOMESTIC PRODUCT at current market prices (1965/66) Le 260.8 million Annual average real growth rate (1963/6h-1965/66) 5.7 per cent long term (estimated) 3 per cent Distribution by sector (%) Agriculture 31.3 Mining and quarrying 19.2 Manufacturing 6.3 Construction 3.6 Transport and communication 7.7 Wholesale and retail trade 15.0 Other sectors 16.9 INVESTMENT AND DOMESTIC SAVING (% of GDP at current market prices - 1965/66) Gross domestic investnm;nt 15.3 Gross domestic savings 11.4 Domestic resource gap 3.9  -2- CENTRAL GOVERNMENT FINANCES (Le mill=oiV Rate of Change per annum 1966/67 1960/61-1966/67 Current Revenue 39.4 9.2 Current Expenditure 34.7 8.0 Debt service 7.0 40.0 Capital expenditures 7.5 0.1 Capital receipts 2.0 -8.7 I/ Overall deficit 7.8 8.2 BALANCE OF PAYMENTS IS - million) Rate of Change per annum 1966 1963 - 1966 Exports 77.6 2.3 Imports 86.3 5.3 Services (net) -18.3 negligible Transfer payments (net) 6.0 31.0 Current account -21.1 7.2 Commodity concentration of exports (diamonds) 1966: 58.6% Net foreign exchange reserves (end of 1966): US$ 13.3 million EXTERNAL PUBLIC DEBT As of June 30, 1967 US$ 65.3 million Debt service ratio (1966): 9.5% CONSUMER PRICE INDEC (1961=100) 1965: 116.5 1966: 121.6 I/ These trends are of limited significance since the level of Central Government investments and their financing vary considerably from year to year with individual projects.  - i - SUMMARY AND COTirCLUSIONS The last economic report (AF-52a of October 31, 1966) concluded that in view of the scale and duration of Sierra Leone's external capital requirements and its only moderate export prospects, a consider- able portion of external assistance should be on concessional terms even though its present debt burden would allow some additional borrowing on conventional terms. While the report was basically optimistic about the country's long-term growth prospects, in view of its mineral wealth and agricultural potentials, it expressed concern about deteriorating fiscal performance which had forced the Government to resort increas- ingly to deficit financing. This in turn had caused total foreign exchange reserves to drop from Le 20 million at the beginning of 1965 to Le 11 million (US$l5 million) in May 1966, which was then the equiva- lent of two months' imports. In 1966 the Gbvernment called on the International Monetary Fund which devised a stabilizaltion program center- ing around improvements of fiscal performance. This program was incor- porated into a $7.5 million stand-by arrangement which became effective on November 1, 1966. However, in the ixmediate future following the conclusion of the agreement the then Government found it difficult to implement the stabilization measures recommended by the IDF. It was facing elections in early 1967 and claimed that unpopular measures would unduly impair its chances. In the meantime public finances continued to deteriorate. In particular the deficit of the largest public corporation, the Sierra Leone Produce Marketing Board. (SLPMB) grew behond expectation, mainly on account of politically motivated marketing practices and ven- tures in plantation development, and in December 1966 the Fund had to agree to raise the credit ceiling for public corporations. The Government in turn indicated that after the election victory it would do everything to implement the stand-by agreement and to improve the country's public finances. 2. In March 1967, in the wake of considerable confusion about the election outcome, the army and police took over the Government of Sierra Leone. They formed a National Reformation Council (NRC) of eight officers with Brig.Juxon-Smith as Chairman. With its own first budget, introduced on July 1, 1967, and a variety of significant steps to improve the finances of public corporations, the new Government has demonstrated its determina- tion to cope with Sierra Leone's economic difficulties, despite the fact that reduced public expenditures and the resulting increase in unemploy- ment have seriously affected its popularity. For the future, however, its more responsible attitude toward public finances has established good prospects for improved economic performance as well as for continued assistance from the IMF. This in turn has strengthened Sierra Leone's creditworthiness even though exports in 1966 did not develop as favorably as anticipated in the last economic report. Service on external debt is  - ii - now estimated to reach its peak in 1968, at about 12.2% of current account earnings and, since additional medium-term borrowing has been curbed under the arrangement with the IMF, a further deterioration of the external debt structure is unlikely. Sierra Leone can., therefore, incur some additional debt on conventional terms. However, a long-term judgment on terms and volume of lending to Sierra Leone will require a reassessment of the country's economic performance and prospects after the new Government has had sufficient time to demonstrate its ability to implement and strengthen its new economic policies.  ECONOMIC MEMORANDUM ON SIERRA LEONE BACKGROUND 1. The Government of Sierra Leone which became independent in 1961, inherited an unbalanced economy. Although growth rates in real terms are believed to have been about 3% between 1955 and 1964 and more than 5% between 1964-1966, resulting in a GNP per capita of US$158 in 1965/66, overall investment rates, output and exports were heavily dependent on foreign private investment in the mining sector (see Table 3). Almost twenty percent of GDP is derived from mining, notably of diamonds, iron ore and, more recently, of bauxite and nrtile compared to 31.3% from agriculture (see Table 4). Furthermore, real average growth rates over the last seven years have originated largely from diamonds, and to a lesser extent, iron mining. Aside from participation of indigenous diggers in alluvial diamond mining since the late 1950's, the bulk of mining output has originated from foreign firms: of combined mining exports, foreign firms contributed 100% in 1950, 41% in 1960, the high point of diamond digger activity, and 58% in 1966 (see Table 7). The importance of mineral output in GD? is also reflected in exports, of which minerals now account for 80% of total exports. 2. The share of agriculture in GDp dropped to 31.3% in 1965 and there is evidence that this sector, though certainly not the economy as a whole, suffered from the speculative attractions of the diamond boom which caused tens of thousands of upland farmers to leave their farms and seek their fortune in diamond digging. At the peak of this boom in 1959/60 imports of rice, Sierra Leone's major staple food, reached a record level of 43,000 tons after decades of self-sufficiency. tith the diamond digging boom slowly fading the situation improved somewhat and imports of foodstuffs were almost constant through 1964. Ever since the trend is rising again. In 1966 Rood amounted for 20% of total imports (see Table 8), a level only reached in the diamond boom year, 1959. In 1966 rice imports were up to 34,50n tons again. Even though conclusive agricultural statistics are not yet available, indications are that growth of agricultural production iwas not commensurate with increasing per capita income and a population growth estimated at 1.3-1.5% per year. Efforts to improve the food balance have not yet had an appreciable impact which is especially regrettable in view of Sierra Leone's con- siderable agricultural potentials. 3. The importance of foreign-operated mining in GDP and exports has been reflected in savings and investment trends; both increases and varia- tions in gross domestic investment are largely attributable to annual changes in foreign private investment. As illustrated in the table below, increased gross domestic investment between 1963/64-1965/66 resulted from foreign private investment, in this case .Ln bauxite and rutile mining. Completion of these latter investments wi:Ll probably result in a decrease  - 2 - of the investment rate in the short term. Since most of these increased investments were finarLced from private capital inflow, the share of total investment covered by domestic savings dropped proportionally. Furthermore, national savings have been considerably below domestic sav- ings, since the level of savings retained in the country is affected by sizeable remittances of investment income abroad. Saving and Investment (at currentprice7 1963/64 1964/65 1965/66 Gross domestic savings as % of GDP 10.4 9.3 11.4 Gross national savings as % of GNP 8.1 6.9 8.4 Gross domestic investment as % of GDP 10.9 11.9 15.3 Gross domestic savings as % of Gross Investment 95.7 78.7 74.3 4. An effective development strategy for Sierra Leone in the 1960's called for policies directed at solving three overriding problems: alloca- ting investments to diversify the structure of output; maintaining an adequate infrastructure to attract and complement further private invest- ment; and mobilizing financing for public investments in a w-ay that would not threaten the conditions necessary tc operate an open mixed economy with an important private mining industry. The Government rightly saw consider- able scope for development in agriculture and forestry, and largely through the Sierra Leone Produce Marketing Board (SLP~M), undertook numerous invest- ments in agriculture, but they were ill conceived and failed to generate an appreciable growth impact. The resulting deficits exacerbated the fiscal problem. Efforts to expand infrastructure services, except for power and w2ter. were inhibited by inadequate administrative ability and public finance for development. The failure to improve on investment allocation and manage- ment, combined with inadequate public savings, frustrated attempts to attract long-term external assistance which could have contributed to solv- ing both the problems of new directionsin investment and inadequate develop- ment finance. 5. With foreign private investment concentrated in mining and long- term external assistance to the public sector scarce, the development problem became one of mobilizing additiconal public sector savings. The Central Government strived to increase revenues and in fact succeeded in raising current receipts from Le 23.3 million in 1960/61 to Le 39.4 million in 1966/67 or by 9.2% per annum, which reflects a remarkable effort. It even succeeded in keeping the growth of current expenditures (8% per annum) below that of current revenues but due to imprudent medium-term borrowing from suppliers annual debt service increased rapidly, thus leaving a small  srrplus for development expenditures in only two years during this period. Central Bank borrowing started to appear in 1963/64 and increased gradually to Le 2.9 million in 1965/66. Therefore, with the exceptions mentioned above, domestic funds for development were virtually not available and the Government was limited to deficit financing and some long-term aid which came mainly from the UK and because of Glovernment's economic performance was not readily forthcoming. Not surprisingly, it resorted to supplier's and contractor's financing and since in these cases initiative and project selection -as with the financiers, Sierra Leone's past development effort gives an incoherent and aimless appearance9 Planned development is still in its infancy and was discouraged by the lack of funds. The net result was to create pressures on external reserves which began to threaten the conditions for an open economy in which foreign private investment has been the main source of growth thus far,. 6. When the IMF considered Sierra Leone's request for stand-by assist- ance in 1966, the 1966/67 budget showe(d an uncovered deficit of Le 19.3 million mainly on account of a development budget which bore little rela- tionship to available resources. Under the IM stand-by arrangement this deficit was cut to Le 7.2 million mainly by reducing development expendi- tures from Le 18.9 to 9.9 million and cuarrent expenditures by Le 0.9 million. Revenues wfere to be increased by Le 1.6 million by new taxes and improved collection techniques. The remaining deficit was to be covered by counterpart funds from the DMF drawings of Le 3.8 million and Bank borrowing of Le 3.L million. However, the Government showed only limited determination to implement this stabilization program, and particularly, as will be seen, to improve the operations of the SLPMB. It was at this time preparing for elections and tried to avoid unpopular economic measures. The fiscal year 1966/67 which ended in June under a new military Government closed with an estimated deficit of Le '78 million or Le 0.6 million more than envisaged under the revised stand-by estimates. Even this result required special efforts on the part of the new military Government which took powTer in Mlarch 1967. To finance the deficit the Central Government had to borrow a record Le 3.5 million from the banking system, and still ended with unpaid arrears of Le 0.5 million. It should be added that these estimates are still subject to changes pending final accounts. Central Government accounting is still in a poor state and delays and uncertainties are frequent. THE 1967/68 BUDGET 7. The DMF mission which reviewed Sierra Leone's performance under the stand-by arrangement was confronted with a budget proposal for 1967/68, which, compared with the estimated actual outcome for 1966/67, showed an overall deficit exceeding the 1966/67 level by Le 2.3 million or 28%. It was pointed out to the authorities that such a budget would only accelerate the deterioration of public finances and foreign exchange reserves and as such would not be consistent with a stand-by program. It was stressed that  - h - the availability of IF counterpart funds for fiscal use was not neces- sarily the rule and that a marked reduction of Bank borrowing was called for in order to prevent a further reduction in foreign exchange reserves. The authorities were impressively receptive to these representations. They embarked on a thorough budget review, in the process of which: a. estimated recurrent expenditures were reduced by Le 3 million to a level which is 5% below the estimated actual expenditures for 1966/67. Cuts will affect all sectors of the economy including military expenditures which are now estimated at about the 1966/67 level; b. development expenditures were reduced to Le 9.8 million, a level largely determined by contractual obligations. This reduced program would require a net contribution from the Government's own resources of Le 3.7 million. The difference of Le 6.1 million is covered by disburse- ments from supplier's credits contracted before the stand-by arrangement, two long-term loans from the UK and the Federal Republic of Germany and a variety of grants from miscellaneous sources, includirig a once and for all levy on diamond dealers (Le 0.5 million); and c. revenue estimates were raised by Le2.1 fmillion which reflects tax increases put into effect during the mission's stay. Tax measures include increases in turnover and some excise taxes, a surtax on both corporate and personal income, increased import duties on various goods and higher export duty for diamonds. 8. The combined effect of these measures is now estimated to yield a current surplus of Le 10.3 million and after debt service a surplus for development of Le 1.5 million. The overall deficit is reduced to Le 2.2 million, which can be covered by counterpart funds from the last drawing under the existing stand-by arrangement and by borrowing from the Central Bank of Le 0.8 million. This budget was formally accepted by the NRC and announced by its Chairman on June 30, 1967. He stressed his Government's sincerity and determination to support this stabilization budget. The IMF in turn assured the Government that it was prepared to consider formally Sierra Leone's request for a second stand-by arrangement this fall. The new 1967/68 budget compared to previous years is summarized in the table below:  - 5 - Central Government Fir