Fiscal policy is priority as mineral exports boost Tanzania

Strong investment in Tanzania’s abundant natural resources has spurred a robust expansion in exports, while domestic policy buffers shielded the country from the worst effects of the global financial crisis. But, the IMF noted in its regular review of the east African nation’s economy, poverty affects one-third of the population and the country is dependent on foreign aid. Rapid population growth is putting pressure on the delivery of public services in the infrastructure and social areas, far outpacing the growth of domestic revenue and foreign aid. A combination of spending rationalization, tax policy reforms and enhanced public financial management will be called for to maintain fiscal balance.

The IMF’s executive board concluded May 6 its biennial consultation with Tanzania on the country’s medium-term economic developments and policies. It also completed its biannual review of Tanzania’s three-year Policy Support Instrument, a framework for low-income countries that may not need IMF financial assistance but still seek IMF advice on and endorsement of their policies.

The economic program of the authorities – supported by the IMF through the Policy Support Instrument – aims to reduce poverty within a stable macroeconomic environment. It also aims to create fiscal space for infrastructure investment – critical for accelerated growth – together with the consolidation of social sector gains, in line with the authorities’ new poverty-reduction strategy.

Tanzania’s tradition of peaceful elections has provided a solid basis for growth, which has averaged seven per cent a year since 2000. The country’s abundant natural resources have spurred a robust expansion in exports. The authorities have implemented wide-ranging policy reforms over the past decades, and policy buffers built up in previous years served Tanzania well during the global financial crisis.

However, Tanzania faces formidable hurdles. Per capita income is about $550, reflecting earlier decades of stagnation and high population growth. Poverty declined only slightly during the last decade and remains widespread, with one in three living below the poverty line. Tanzania is highly dependent on foreign aid, projected to peak at 10 per cent of GDP this year.

Following a projected slowdown in growth to six per cent in 2011 due to poor rainfall, the economy should rebound quickly with a return to normal weather and reach an annual growth rate of 7-7.5 per cent over the medium term. Consumer price inflation will likely spike above 7.5 per cent in 2011 due to higher food and energy prices, but return to the authorities’ medium-term inflation objective of around five per cent as international food and fuel price pressures ease.

Partly reflecting shifts in the composition and direction of global demand, commodity sectors are expected to further increase their weight in output and exports. The exploitation of Tanzania’s underground resources is accelerating and attracting potentially large flows of foreign direct investment.

Gold exports have increased from negligible levels 10 years ago to around $1.5 billion currently—a quarter of exports of goods and services. Considerable exploration has taken place in nickel, uranium, and gas, all of which are believed to have significant potential, with a large investment in uranium expected to move forward by mid-2012.

In spite of important progress over the past decade, Tanzania’s tax revenue collection, at around 15 per cent of GDP, is still below potential. The tax base could be expanded by scaling back widespread exemptions, aligning excise tax rates to the regional level, and exploring options regarding mining taxation.

Revenues from the (mostly gold) mining sector have remained small at about 0.5 per cent of GDP despite the sharp rise in the price of gold that has helped lift gold exports to seven per cent of GDP. They comprise mainly taxes on wages and some royalties, as existing agreements with mining companies have provided significant corporate income tax holidays. As a result, none of the existing gold projects have paid material income tax to date.

Stepped-up efforts to bring to resolution past—and highly contentious—tax disputes with existing gold mines, together with improvements in mining tax administration, could generate some additional revenue.

The authorities are committed to embark on a path of fiscal consolidation and more realistic budgets. Although an effective reform of tax and spending policies requires time, a signal to investors and donors of the authorities’ intentions should be provided at the time of the 2011/12 budget. An ambitious spending containment is required next year in view of the need to safeguard priority spending—all the more so if risks of donor aid shortfalls and higher international fuel prices were to materialize.

Increases in foreign direct investment and commodity exports highlight the need to address obstacles to growth. The foreign exchange inflows could lead to exchange rate appreciation and thereby reduce the competitiveness of sectors that compete with suppliers abroad, such as manufacturing. To boost the competitiveness of these sectors—and employment creation—forceful steps are needed to improve the business environment, which is by most measures poor.

The potential volatility of foreign investment flows into Tanzania’s relatively thin financial markets could also exacerbate exchange rate volatility. New instruments, such as currency swaps, and liquidity management policies could be developed to mitigate the disruptive impact of excessive volatility on exporters. Over the longer term, exchange rate and reserve management will need to be adapted to the shift from official to private sources of foreign exchange.

*  The author, Frank Lakwijk, works in the IMF African Department.

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