Rapid Budget Analysis 2012

Rapid Budget Analysis 2012

Synoptic Note

DRAFT

November 18, 2012

The Rapid Budget Analysis is now a programmatic feature of Tanzania’s budget calendar. It is produced by PER-Macro group involving close donor-Ministry of Finance collaboration. The Ministry of Finance has provided prompt access to detailed information on the 2012/13 approved budget data and the pre-audited actual spending data for 2011/12. The Synoptic Note was produced by World Bank staff, with inputs from IMF, while the background notes were produced by staff and consultants from Japan, Norway, Sweden, UNICEF, EC, Denmark, Belgium, Canada, KfW, AfDB, USAID, Ireland, UK, and the World Bank. The RBA 2012 will be discussed with the Budget Guidelines committee chaired jointly by the MoF and the POPC will constitute key input for dialogue with stakeholders during the GBS Annual Review 2012.

Main messages

• Macro and fiscal framework. Tanzania continues to be a top performer with rapid and constant GDP growth, with external and fiscal deficits under control, and declining (but still high) inflation.

• Fiscal policy. For the first time since 2008 global financial crisis, the Government was able to reduce the fiscal deficit, from 6.6 to 5.0 percent of GDP. This adjustment, higher than agreed in the IMF PSI program, was the result of the good performance in tax collection and significant cuts in recurrent expenditures. At the same time, the authorities increased the allocation of public resources toward roads and energy with the objective to close the existing gap in infrastructure.

• In spite of the recent good performance, there a number of emerging fiscal issues that will require the close attention of the authorities in the years to come:

1. Planning vs. execution: Over the past few years, the gap between approved and executed expenditures has been increasing, reaching as high as 15 percent in 2011/12 (against 10 percent percentin average over the 2007/08-2010/11 period.). Such an increasing gap has had significantly implications on the alignment of the budget to national priorities because cuts have been unequal across sectors. Economic, social, and infrastructure ministries have proportionally suffered more than ‘administrative’ ministries.

1. Shift toward new infrastructure. The growing attention given by the authorities to infrastructure is welcomed given the existing shortages in Tanzania. However, this shift requires (i) capacity to select and implement the optimal projects; (ii) maintaining the right balance with the needs of social sectors; and (iii) a close attention to maintenance. On these three fronts, the authorities need to improve with a sense of urgency and their multi-year planning capacity.

1. New sources of funding: Since 2008/9, the Government has increased its use of concessional financing and borrowed non-concessionally on oth from domestic and international markets. As a result, the public debt to GDP ratio jumped from 28 to 40 percent in the past four years with a corresponding increase in debt service payments. While fiscal and debt sustainability are not yet at risk, a closer attention to debt management is warranted, including of contingent liabilities in parastatals and other public entities. Such monitoring should also include the possible accumulation of arrears, especially in the energy (TANESCO) and road sectors.

1. Off- budget expenses: An increasing share of public money is managed outside of the central government. The pipeline project implemented under the responsibility of TPDC accounts for approximately 10 percent of total public expenditures. Similarly, the deterioration of the financial situation in TANESCO poses a major quasi-fiscal risk. Comprehensive monitoring and reporting is particularly vital for the energy sector, given the projected level of gas revenues and the uncertainty surrounding the financial situation of the public agency, TANESCO. This basic principle of good governance recommended by the IMF manual on fiscal transparency and by OECD governance guidelines has been implemented by many Latin American countries, including Costa Rica and El Salvador, as well as many Asian countries including Malaysia and the Philippines.

1. Tax exemptions. The authorities have set up ambitious targets in terms of fiscal revenues over the next few years. However, the main explanatory factor of growth in the 2012/12 budget is the introduction of new taxes and increases in existing tax rates (notably excise taxes). Such strategy has its own limit. The authorities will need to address the use of tax exemptions, which contribute to almost 4 percent of GDP in tax revenues losses in 2011/12.

1. The public pension system is "eating its assets." It spends more than it receives in contributions. In absence of reforms, three pension funds will be bankrupt by 2015. Their survival will then require injection of a minimum of US$ 100 million per year. The Government plans to adopt a new policy (reducing benefits and paying its debt) but progress has been slow, partly because such reform is difficult to sell politically and partly because it will force the Government to pay upfront a large amount of money (in the range of USD 600 million). However, the long term cost of inaction will be much higher and could potentially destabilize the overall budget by the beginning of next decade.

1. Local Government Authorities. Today the transfers to LGAs account about one quarter of central government expenditures. There are at least three main issues that affects the effectiveness of the current system: (i) the amount and the allocation of those transfers to LGAs is not clearly defined (in spite of formula) and are heavily influenced by ‘number of staff and facilities’ rather economic factors; (ii) the payments of those transfers are late (albeit improving) but, above all, was much lower than initially planned in the 2011/12 budget (the gap was as high as 47.4 percent for development); and (iii) there is little monitoring and control on how there transfers are spent on the grounds.

1. Introduction

1.This note presents an overview of the main findings and key messages of the various sector and thematic reports carried out as part of the Rapid Budget Analysis (RBA) 2012. The analysis for FY11/12 uses actual expenditures data, while the analysis for FY12/13 uses budget estimates approved by parliament (original estimates). As much as possible, the analysis is cast in a medium-term perspective.

2.The key focus of this note is to assess the alignment of the budget to the MKUKUTA, the National Growth and Poverty Reduction Strategy of Tanzania, Five Year Development Plan (FYDP) and sectors priority objectives. In other words, the key question addressed by the RBA is: “to what extent is the national budget an effective financial instrument to implement the policies and achieve the objectives of the MKUKUTA and FYDP?”

3.To respond to this question, the RBA is organized as follows. First, it examines recent macroeconomic developments since a sustainable economic environment is by itself an important ingredient in achieving the MKUKUTA and FYDP objectives. In this respect, the note discusses the impact of the budget on key macroeconomic variables such as the inflation rate, the GDP growth rate, and the internal and external balance. Second, it reviews the allocation of public expenditures among different MKUKUTA clusters and sectors and also at how the budget is composed in terms of economic nature of spending such as wages, current expenditures, maintenance, and infrastructure investment. This analysis is carried out both with respect to the actual spending in FY11/12 and of the approved budget estimates of the FY12/13. Third, it gives a special emphasis to the public spending within strategic ministries/sectors. The last section contains a summary and highlights a number of potential fiscal issues that should receive special attention from policy policymakers in both the short and longer terms.

1. Macro-fiscal framework and Outlook

1. Macroeconomic Context

4.Tanzania’s GPD growth continues to be relatively high. Driven by mining and services sectors, real GDP growth reached 6.5 percent in 2011/12 despite the energy crisis which faced the country (Table 1). The surge in FDI into the mining sector has helpedto increase mining production and exports, especially in gold. Service sector (especially financial services and communication) has also seen high growth of above 8 percent. As a result, Tanzania continues to be a top performer, growing faster than world and regional trends (Figure 1).

5.Inflation remained high but has slowly declined since January 2012, reaching 13.5 percent in September 2012 and projected to decline further. During 2011/12 headline inflation increased significantly reaching a peak of almost 20 percent in November 2011 on account of significant increase in energy and food prices (Figure 2). The increase in international prices of energy and food together with reduced production of food energy in the country due to drought contributed to increased inflation rate. Electricity production was cut by almost 40 percent due to the drought (and other factors) and hence reliance expensive thermal generated electricity which also required a tariff adjustment of 40 percent in January 2012. However since December 2011 inflation has been gradually declining and reaching 13.5 percent in September 2012 on account of slightly better food supply and tighter monetary policy implemented by the Government.

Table 1: Key macroeconomic indicators

Source: Tanzania authorities, IMF and World Bank preliminary estimates

6.Monetary policy remained tight consistent with objectives of containing inflation. The growth in broad money (M3) was restricted in 2011/12. Monetary expansion (M3) has fallen from more than 25 percent to 9.0 in August 2012 driven by slowdown in growth of rates of Net Foreign Assets (NFA) and Net Domestic Assets (NDA). Liquidity squeeze experienced by the banks increased most of money markets interest rates that affected negatively growth rate of credit to private sector which declined to 16.8 percent in August 2012.

7.The deterioration in the current account deficit by an equivalent 4 percent of GDP was balanced by higher capital inflows, resulting in stable international reserves over the past year. However, this apparent stability masks a series of movements that may become a source of concern for the authorities. The trade deficit worsened significantly over the past year mainly as a result of the increased level of imports(up by 30 percent). The surge in the value of energy imports, which increased by 66 percent, was necessary to offset the decline in output from hydropower. Concurrently, capital inflows increased from USD 2.1 billion to more than USD 3 billion in the period from 2010/11 to 2011/12. Encouraged by recent discoveries, private companies operating in the mining and gas/oil sectors have increased their level of investment to approximately USD 1.5 billion. The Government has also increasingly borrowed from foreign banks, with the value of these loans up by USD 630 million in the period from 2010/11 to 2011/12.

8.As described in the next section, fiscal deficit was also brought under control for the first time since global financial crisis.

Macroeconomic Outlook

9.The Tanzanian economy is expected to continue to expand at the rate of approximately 6.5 to 7 percent in the next few years, which is consistent with its performance over the past decade. As in recent years, fiscal policy will remain the main instrument to stimulate economic growth (see more details in the next section).

10.The private sector will continue to expand over the next 2 to 3 years. However, growth will be concentrated in capital intensive rather than labor intensive sectors. In particular, driven by increased demand and improved technologies, the telecommunications and banking sectors should continue to grow at a relatively rapid pace. With interest from foreign investors and with the expectation that mineral prices will remain high on global markets, the mining sector should also continue to expand. The construction boom is expected to continue given the rapid and ongoing urbanization, particularly in Dares Salaam, and with the Government’s commitment to increased expenditure on infrastructure. The agricultural and manufacturing (to a less extent) sectors employ approximately 80 percent of the total labor force in Tanzania.However it is not expected that these two labor-intensive sectors will record an increased rate of growth in the near future. While there are some incipient indications of trends that may lead to increased growth in the future, particularly the use of new technologies and agglomeration effects resulting from urbanization and regional integration, their impact on Tanzania’s economy is likely to only become apparent in the medium term future.[1]

11.The Central Bank’s commitment to reducing inflation is strong. Despite this commitment, it is likely that only a gradual decline in inflation will be achieved.Food prices have again jumped on international markets, increasing by approximately 25 to 30 percent in the period from June to August 2012. The impact of these increases will be transmitted to local markets in the next few months. Energy prices have remained volatile on world markets, increasing by approximately 10 percent at the end of August 2012. Domestically, upward pressures on prices have become apparent in the cost of restaurant meals, clothing and leisure activities. There has also been growing demand from public servants in the education and health sectors for increased wages. All these factors may make it difficult for the Government to achieve its goal of a single digit inflation rate by the end of 2012/13.

12.The external balance is expected to remain under control, with the current account deficit in the range of a value equivalent to 16 percent of GDP. The main uncertainty relates to imports whose prices are directly impacted by energy prices. In terms of exports, the manufacturing sector is likely to recover and record improved performance as a result of increased regional demand and the stabilization of the real exchange rate. The volume of other exports is expected to increase in line with recent trends, barring major changes in commodity prices especially gold prices. Capital inflows will increase as a result of a gradual increase in FDI inflow and a higher level of public borrowing on foreign markets. While substantial investments in the gas sector are expected, the timing of these investments remains uncertain. In any case, most of the increase in FDI will have a neutral impact on the balance of payments. For each dollar of FDI, it is estimated that approximately USD 0.8 to 0.9 will be used to finance imports, especially in the early stages of large mining projects.

B.Fiscal-frame and outlook

Recent fiscal developments

13.Fiscal deficit: Fiscal adjustments implemented by the Government in 2011/12 reduced fiscal deficit to around 5.0 percent of GDP. This is a major reversal since the financial global crisis when the government adopted expansionary fiscal policies and increasing fiscal deficit. This fiscal consolidation was achieved through significant cuts in non-priority current spending, slightly higher domestic revenue collection and lower than planned development spending (but higher than in 2010/11) (Figure 3 and Table 2).

Table 2: Fiscal trends (in percent of GDP)

Source: Tanzania authorities, IMF and World Bank

14.The Government improved the sustainability of fiscal policy by: i) reducing the level of recurrent expenditures as a proportion of the budget; and ii) increasing the level of expenditure on development, particularly infrastructure. The strength of fiscal accounts is generally measured by: (i) the ratio between domestic revenues and recurrent expenditures; and (ii) the ratio between recurrent expenditures and development expenditures. The first indicator captures the golden rule that borrowing should only be used to finance investment spending, while the second indicator measures the Government’s contribution to the accumulation of physical capital in the country. These two ratios improved in Tanzania during 2011/12, in contrast with the trend observed between 2008/9 and 2010/11 (Figure 4). The rate of expansion in development expenditures (56 percent in nominal terms) was three times faster than in recurrent expenditures (16.8 percent in nominal terms).

15.In 2011/12, the allocation of expenditures shifted from recurrent to development expenditures, confirming the Government’s strategic shift toward infrastructure (Table 3). The share of development expenditures exceeded 35 percent of the total budget, up by 6 percentage points compared to 2010-11, and back to the level observed in 2007/8. In percentage of GDP, the share of the development expenditures was equal to 9.2 percent, which is the highest ratio reported since 2007/8. It is however important to underscore that not all developing spending is spent on capital since “true capital expenditures’ were equivalent to about ¾ of development expenditures in the approved 2011/12 budget.[2]

Table 3: Decomposition of spending