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Country Commercial Guides for FY 2000: Madagascar Report prepared by U.S. Embassy Antananarivo, released July 1999

CHAPTER II:   ECONOMIC TRENDS AND OUTLOOK

MAJOR TRENDS AND OUTLOOK

Madagascar, the world's fourth-largest island, is located in the Indian Ocean off the coast of Mozambique. Though it is blessed with a unique ecosystem, its estimated population of 14.6 million people is among the poorest in the world, with GDP per capita income estimated at $262 in 1998 and 70 percent of the population living below a GOM baseline poverty level of $50 per year.

In spite of the poverty, there are some encouraging developments. The country has significant economic potential if it can put its socialist, inward-looking past behind it. In the long term, the potential stems from a very industrious, low-cost labor force and a variety of natural resources. In the short and medium terms, considerable economic growth can arise from greater efficiency in the allocation and use of these resources, chiefly through privatization and liberalization of the productive sector.

Implementation of conditionalities associated with the IMF's Enhanced Structural Adjustment Facility and the World Bank's Structural Adjustment Credit appears to be giving an economic boost to the country and is already beginning to attract foreign direct investment. Further proof is that the country's gross domestic product grew by an estimated 3.5 percent in 1997, 3.9 percent in 1998, outpacing the population growth rate for the first times since 1990. The macroeconomic environment has also improved: inflation was cut to 6.2 percent in 1998, from close to 45 percent only five years previously.

PRINCIPAL GROWTH SECTORS

With World Bank advice and support, the Government is seeking to move towards a market economy conducive to private sector development, openness to foreign investment, and withdrawal of the Government from productive activities. The Government's strategy recognizes that, notwithstanding significant inflows of official multilateral and bilateral assistance, the real engine of growth, will have to come from the private sector. According to the divestiture calendar fixed by the government in 1997, 45 state enterprises were supposed to have been privatized by the end of 1998, including the two state banks, BTM and BFV, the petroleum company SOLIMA and the airline company Air Madagascar. By mid-1999, despite the calendar, only 2 companies had been privatized. Nevertheless, as privatization is part of World Bank and IMF conditionalities, the Government intends to respect its commitments. As privatization takes place, there will be significant opportunities for foreign investors.

In recent years, weak export prices and increasing competition from other producing countries have cut sharply into Madagascar's earnings for traditional agriculture exports such as vanilla, coffee and spices. On the other hand, aquaculture, apparel manufacturing, mining, tourism, food processing and non-traditional agriculture are export sectors that have excellent growth prospects.

Many investors, for example, are now developing projects to encourage value-added processing of agricultural products before export, and diversifying into new products such as essential oils. Offshore fishing and shrimp farming have developed into the leading foreign exchange earners in recent years, attracting Japanese and European investors. Light manufacturing, especially in the textile and apparel sector, has increased significantly since the establishment of a duty free export processing zone program in 1991.

The country has commercially significant reserves of several minerals, including chromite, graphite, nickel, mica, and ilmenite. Gold and significant quantities of various precious and semi-precious stones are also found in Madagascar. The discovery of important deposits of sapphires in the north and the south of the country has attracted many foreign investors from the United States, Thailand, Indonesia, Israel and Europe, though unfortunately, much of the deposit lies inside the boundaries of national treasures-- Ankarana National Park in the north and Isalo Park in the south.

Madagascar's rich biodiversity and high level of endemism--plants and animals found nowhere else in the world-- is the basis for development of the ecotourism industry in places like the Ankarana. Major investments in hotels and other tourist facilities will be required for the industry to expand. Liberalization of the Malagasy air transport sector should boost tourism if more frequent flights to European cities and lower fares result.

GOVERNMENT ROLE IN THE ECONOMY

In 1975 the Government of Madagascar, or GOM, embarked on a socialist economic experiment focused on the principle of national self-sufficiency but also an opening towards the Soviet Union, the People's Republic of China and North Korea. The GOM nationalized large foreign enterprises and imposed rigid bureaucratic controls on business. These controls included restrictions on imported goods and control of the foreign exchange market, most prices and profit margins. The policies resulted in a sharp decline in productivity and a dramatic shrinking of the economy, with attendant increases in poverty levels.

Structural reform negotiations with the Bretton Woods institutions began in 1988 and have focused on liberalization and privatization of key economic sectors to improve efficiency and competitiveness. Substantial progress towards economic recovery was recorded under the programs supported by the IMF and the World Bank between 1987 and 1991; however, social unrest interrupted this trend in mid-1991, creating a climate of great uncertainty and wavering in the conduct of economic policy.

With a view to restoring confidence, the authorities in early 1994 defined, in collaboration with the IMF and the World Bank, a new policy framework paper, a strategy for liberalizing the economy, particularly the petroleum, transport, and telecommunication sectors, and for reforming the public sector, specifically by privatizing state-owned enterprises and banks. In a broad reform of the exchange market and the foreign trade system, the GOM allowed the Malagasy franc to float in an interbank foreign exchange market. It also lifted most import restrictions, increased exchange allocations for foreign travel for businesspersons and authorized residents and non-residents to open foreign exchange accounts for transfer from abroad.

BALANCE OF PAYMENTS AND MACROECONOMIC SITUATION

Madagascar has run sizeable balance of payments deficits since the mid-1980's. The current account deficit as a percentage of GDP averaged in excess of six percent during the last six years and registered nearly four percent in 1998. In the past, current account deficits have been financed by external borrowing, resulting in a heavy external debt burden. By the early 1980's these inflows began to dry up and arrears rose sharply. Notwithstanding the Paris Club's March 1997 approval of a 67 percent debt reduction, Madagascar's external debt now still stands at over USD 4.5 billion. Since many of the arrears were not covered by the Paris Club, the country's overall debt burden remains very high.

An optimistic high growth scenario is predicated on a recovery of private investor interest and a continuing drop in inflation. From 19.8 percent in 1996, the inflation rate dropped to 6.4 percent in 1998. The government intends to lower this further to 4 percent by the end of 1999. In 1998, real GDP growth stood at a moderate 3.9 percent, forecasted to accelerate to more than 4 percent in 1999-2000. The budget deficit was estimated at 4 percent of GDP in 1998. Tax rate has increased to over 10% of GDP in 1998 and in 1999-2000, the Government forecasts a rate approaching 11%. The 1999 budget will focus its priorities on education, health, environment and national security.

INFRASTRUCTURE

Madagascar's physical infrastructure is currently not up to the task of serving as a platform for development. The poor condition of roads, for example, inhibits the transportation of agricultural commodities from farm to market. This lowers farmgate prices, increases post-harvest spoilage and makes the supply of inputs irregular and expensive. Railroads cover only a small portion of the island and also suffer from under-investment and poor maintenance, both in terms of track and rolling stock. The port system has essentially been left untouched since independence in 1960. The recent liberalization of domestic and international air transport services is an improvement but the sector is still characterized by limited traffic and high costs.

The modernization of the telecommunications system is the most significant infrastructure project now underway. A private U.S.-based firm, financed by OPIC, has provided cellular phone services since 1994. The GOM has installed a new digital switching system thanks to a French and World Bank foreign assistance project, as part of a nationwide plan for upgrading the communications network.

Since 1997, three GSM providers were granted authorization by the Government to increase competition in the telecommunications sector and the Iridium system is already on sale in the country. Internet service has significantly improved since 1998, with the licensing of 10 Internet service providers.