Public Disclosure Authorizeddocuments.worldbank.org/curated/en/... · report no. 73468-cv ....

Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 73468-CV

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR A PROPOSED DEVELOPMENT POLICY CREDIT

IN THE AMOUNT OF SDR 10.1 MILLION (US$15.5 MILLION EQUIVALENT)

TO THE

REPUBLIC OF CABO VERDE

FOR THE

EIGHTH POVERTY REDUCTION SUPPORT CREDIT (PRSC 8)

March 27, 2014

Poverty Reduction and Economic Management 4 Country Department AFCF1 Africa Region This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Bank’s policy on Access to Information.

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REPUBLIC OF CABO VERDE – FISCAL YEAR

January 1 – December 31

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of March 19, 2014)

Currency Unit = Cabo Verdean Escudo

US$1.00 = CVE79.22

ABBREVIATION AND ACRONYMS

AfDB African Development Bank AMP Port and Maritime Agency ALMP Active Labor Market Programs ANMCV National Association of Cabo Verdean Municipalities ASA Airport Security Administration (Agência de Segurança

Aeroportuária) ASYCUDA Automated System for Customs Data BCV Central Bank of Cabo Verde (Banco de Cabo Verde) BSG Budget Support Group CEM Country Economic Memorandum CVE Cabo Verdean Escudos DB DGA

Doing Business General Directorate of Environment

DGALF General Directorate of Customs DGCI Direção Geral de Impostos e Contribuições (General Directorate for

Taxes and Revenues) DNP National Directorate of Planning (Direção Nacional de

Planejamiento) DUC Single Collection Document EIA Environmental Impact Assessments ELECTRA Public Water and Electricity Company (Empresa de Electricidade e

Água) EMPROFAC ENAPOR

National Pharmaceuticals Company (Empresa Nacional de Produtos Farmacéuticos) National Port Authority (Empresa Nacional de Administração dos Portos)

FAMR Fundo Autónomo de Manutenção Rodoviária (Road Maintenance Fund)

FDI Foreign Direct Investment GDP Gross Domestic Product GNI Gross National Income GoCV Government of Cabo Verde GPRSP Growth and Poverty Reduction Strategy Paper

iii

IBRD International Bank for Reconstruction and Development ICA Investment Climate Assessment ID Import Duties IDA International Development Association IE Roads’ Management Agency (Instituto de Estradas) IEFP Employment and Professional Training Institute IFH Real Estate and Housing Fund (Imobiliária Fundiaria e Habitat) IFRS International Financial Reporting Standards IMF International Monetary Fund IMP Maritime Ports Agency (Instituto Maritimo Portuario) INE INMG

National Statitics Institute (Instituto Nacional de Estatística) National Meteorological and Geophysical Institute (Instituto Nacional de Meteorologia e Geofísica)

IT Information Technology IURPC Corporate Income Tax (Imposto Único de Renda para Pessoas

Colectivas) JSAN Joint Staff Advisory Note LDC Least-Developed Country LDP Letter of Development Policy LIC Low-Income Country LPRP Luxembourg Poverty Reduction Partnership Program M&E Monitoring and Evaluation MCC Millennium Challenge Corporation MDG Millennium Development Goal MoFP Ministry of Finance and Planning MIC Middle-income Country MoU Memorandum of Understanding MPD Movement for Democracy MTEF Medium-Term Expenditure Framework ODA Official Development Assistance PAICV African Party for the Independence of Cabo Verde PANA National Environmental Action Plan (Programa de Ação Nacional

para o Ambiente) PBMC Performance Based Maintenance contracts PDO Program Development Objective PEFA Public Expenditure and Financial Accountability Assessment PEMFAR Public Expenditure Management and Financial Accountability

Review PER Public Expenditure Review PFM Public Financial Management PIM Public Investment Management PIP Public Investment Program PPIAF Public-Private Infrastructure Advisory PRSC Poverty Reduction Support Credit PSI Policy Support Instrument RSRP Road Sector Reform Project

http://en.wikipedia.org/wiki/African_Party_for_the_Independence_of_Cape_Verde

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SDR Special Drawing Rights SIGOF Integrated Budget and Financial Management System (Sistema

Integrado de Gestão Orçamental e Financeira) SOE State-Owned Enterprises SPE State Services Participation (Serviço de Participações do Estado) SSA Sub-Saharan Africa TACV Cabo Verde Airlines (Transportes Aéreos de Cabo Verde) TBC Tax Benefits Code TdC Court of Accounts (Tribunal de Contas) TFS Trust Fund for Statistics TFSCB Trust Fund for Statistical Capacity Building TVET Technical and Vocational Education and Training UGA Procurement Management Unit (Unidade de Gestão de Aquisições) UN United Nations UNDP United Nations Development Programme VAT Value-Added Tax WEF World Economic Forum WTO World Trade Organization

Vice President: Country Director:

Sector Director: Sector Manager:

Task Team Leader:

Makhtar Diop Vera Songwe Marcelo Giugale Miria Pigato Fernando Blanco

v


EIGHTH POVERTY REDUCTION SUPPORT CREDIT (PRSC-8)

TABLE OF CONTENTS

1. INTRODUCTION AND COUNTRY CONTEXT ................................................................ 1

2. MACROECONOMIC POLICY FRAMEWORK ................................................................ 3

A. Recent Economic Developments ....................................................................................... 3 B. Macroeconomic Outlook and Debt Sustainability ............................................................. 8 C. IMF Relations .................................................................................................................... 11

3. THE GOVERNMENT’S PROGRAM ................................................................................... 11

4. THE PROPOSED PRSC 8 ...................................................................................................... 13

A. Links to the Government’s Program and Operational Description ................................... 13 B. Prior Actions, Results and Analytical Underpinnings ....................................................... 14 C. Links to the CPS and Other Bank Operations ................................................................... 28 D. Consultations and Collaboration with Development Partners ........................................... 29

5. OTHER DESIGN AND APPRAISAL ISSUES .................................................................... 29

A. Poverty and Social Impacts ............................................................................................... 29 B. Environmental Aspects ...................................................................................................... 30 C. PFM, Disbursement and Auditing Aspects ....................................................................... 30 D. Implementation, Monitoring and Evaluation ..................................................................... 31

6. SUMARY OF RISKS .............................................................................................................. 32

List of Annexes:

ANNEX 1: POLICY AND RESULTS MATRIX ....................................................................................... 34

ANNEX 2: LETTER OF DEVELOPMENT POLICY ................................................................................ 41

ANNEX 3: FUND RELATIONS ............................................................................................................. 48

ANNEX 4: COUNTRY MAP ................................................................................................................. 50

vi

List of Figures:

Figure 2.1 Distribution of the PIP ...................................................................................................... 3 Figure 2.2: Debt to GDP Ratio (% of GDP) ...................................................................................... 10 Figure 2.3: Gross Financing Needs (% of GDP) ............................................................................... 10 Figure 4.1: Structure of PRSCs series ................................................................................................ 14 Figure 4.2 The current and new fiscal diamonds ............................................................................... 15

List of Tables:

Table 2.1: Key Macroeconomic indicators ........................................................................................ 4 Table 2.2: Key Fiscal Indicators ........................................................................................................ 6 Table 4.1: Analytical Underpinnings and Prior Actions and Triggers ............................................... 28

The Eighth Poverty Reduction Support Credit (PRSC VIII) was prepared by a team led by Fernando Blanco (Lead Economist, LCSPE). The team included Alexandre Arrobbio (Sector Manager, SASGP), Kofi-Boateng Agyen (Senior Operations Officer, AFTFW), Marek Hanusch (Economist, AFTP4), Eric Brintet (Lead Financial Management Specialist, AFTMW), Faya Hayati (Economist, PRMED), Geraldo Martins (Senior Education Specialist, AFTED), Aline Couduel (Lead Social Protection Economist, AFTSP), Pierre Graftieaux (Lead Transport Sector Specialist, AFTTR), Fabrice Bertholet (Senior Financial Analyst, AFTG1), Ricardo Varsano (Consultant), Tanya Lisa Yudelman (Consultant, AFTN1), Sean Lothrop (Consultant), Christian Borja-Vega (Economist, TWIWP), Jose de Bettencourt (Consultant), Antonio Baptista (Consultant), Helen Edmundson (Country Economist, ECSP1), Andres Garcia (Senior Economist, AFTFE), Luz Meza-Bartrina (Senior Counsel, LEGAM), and Glaucia Ferreira (Program Assistant, AFTP4). Miria Pigato (Sector Manager, AFTP4) and Philip English (Lead Economist, AFTP4) provided guidance to the team.

vii

SUMMARY OF PROPOSED CREDIT AND PROGRAM


EIGHTH POVERTY REDUCTION SUPPORT CREDIT

Borrower: The Republic of Cabo Verde.

Implementing Agency: Ministry of Finance and Planning (MoFP).

Financing Data: IDA Credit, Standard IDA terms: 40-year maturity with a 10-year grace period.

Operation Type: Single-Tranche Operation of SDR 10.1 million (US$15.5million equivalent). First in a programmatic series of 3 operations.

Main Policy Pillars and Program Development Objective(s):

The proposed operation will cover two pillars: (i) Good Governance and Public Sector Efficiency; and (ii) Competitiveness, Private Sector Development and Labor Productivity. The development objectives of the first pillar include ensuring macro-fiscal stability and improving the efficiency of public expenditures. The development objectives of the second pillar are to improve the provision of infrastructure services and the investment climate, enhance labor force skills and the functioning of labor markets, and improve environmental protection.

Result Indicators: Baseline 2012/13

Target 2016

Total financing to GDP ratio (including on-lending to SOEs) (%)

13.5 lower than

10.0

Domestic revenue to GDP ratio (%) 21.0 24.0

Percentage of ministries and government entities in the Single Treasury Account (%)

80 100

Consolidated Balance of the 5 main SOEs (in million CVE)

-491.5 Positive

Percentage of new public investment projects financed by the budget appraised by the NIS (%)

0 higher than

50

Percentage of social protection programs using the Unified Registry of Beneficiaries (%)

0 75

Electra technical and commercial losses as a share of total energy generation (%)

26.2 lower than

20

Number of ports with Public Private Participation arrangements in place

0 3

ASA revenues (in million CVE) 648 higher than

750

TACV’s net result (in billion CVE) -3.2 higher than

-1.0

Time to import (days) 18 less than 15

Firing / Hiring Flexibility (1 worst–7 best) 3.4 4.5

Number of beneficiaries of TVET programs (in thousands) 1.5 higher than

5.0

Number of protected areas with legal boundaries and management plans defined

3 higher than

40

Overall risk rating: Moderate Operation ID: P127411

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IDA PROGRAM DOCUMENT FOR A

PROPOSED EIGHTH POVERTY REDUCTION SUPPORT CREDIT

TO THE REPUBLIC OF CABO VERDE

1. INTRODUCTION AND COUNTRY CONTEXT

1.1. The proposed Eighth Poverty Reduction Support Credit (PRSC 8) is the first operation in a new series of three one-year operations designed to support the implementation of the Government of Cabo Verde (GoCV)’s Third Growth and Poverty Reduction Strategy Paper (GPRSP 3) for 2012-2016. The GPRSP 3 encompasses a set of key structural reforms and priority programs designed to achieve the GoCV’s objective of "building a stable, dynamic and inclusive economy". In particular, the PRSC series will support GoCV’s efforts to enhance the country’s macroeconomic resilience to external shocks and to improve its competitiveness to promote sustainable poverty reduction and boost shared prosperity.

1.2. Over the past two decades Cabo Verde has achieved a remarkable record of economic growth. A country of half a million people spread over nine inhabited islands, with only 10 percent of its land suitable for cultivation and no natural resources aside from some modest fishing potential, Cabo Verde’s economy was able to grow at an average annual rate of six percent since 1990. Between 1990 and 2012 Cabo Verde’s GDP grew from US$0.3 billion to US$1.8 billion, while its per capita GNI (Atlas method) reached US$3,500 in 2012, more than four times what it was in 1990. In 2007 Cabo Verde became one of only three nations ever to graduate from the United Nations’ list of least-developed countries (LDCs).

1.3. A steadily expanding tourism sector and accelerated capital accumulation drove the country’s robust growth. Fueled by strong external demand tourism export receipts grew from US$40 million in 2000 to more than US$400 million in 2012, with an annual growth rate of 19 percent, much higher than the 6 percent observed for worldwide tourism in this period. The boom in tourism attracted large foreign direct investment (FDI) inflows, while the extensive utilization of Official Development Assistance (ODA) enabled the GoCV to increase public investment to about 15 percent of GDP over the last two decades. Consequently, Cabo Verde now has a relatively well developed stock of infrastructure assets. However, the evolution of productivity has been disappointing, and the country’s increasingly heavy reliance on the tourism industry and external financing deepened Cabo Verde’s dependence on the Eurozone economies, which are the main sources of FDI, ODA and tourism demand.

1.4. Cabo Verde’s strong growth performance has translated into considerable poverty reduction and boosted shared prosperity. The poverty rate dropped from 37 percent in 2001/2002 to 27 percent in 2010. The extreme-poverty rate dropped from 21 percent in 2002 to 12 percent in 2010, while the Gini coefficient fell from 0.57 to 0.47 over the same period. The income of the bottom 40 percent increased as a share of total income from 9.9 percent to 21 percent, and its share of consumption expenditures increased from 7 percent to 19 percent. The country has also made steady progress towards the achievement of the Millennium Development Goals (MDGs), and will likely fail to achieve only one by 2015.

1.5. Cabo Verde’s growth performance has slowed dramatically since 2009 due to the impact of the global economic crisis. This difficult macroeconomic situation is compounded by

2

a strong slowdown of economic activity, high indebtedness derived from counter-cyclical fiscal policies designed to mitigate the negative impact of the global crisis and an uncertain external environment. As a lower-middle-income country which mainly grew through capital and labor accumulation, Cabo Verde is experiencing a combination of declining competitiveness and an absence of new drivers of growth.

1.6. Cabo Verde needs to adapt its economic growth strategy to meet new challenges. To address them, the GPRSP 3 focuses on structural reforms to enhance productivity as the new source of growth, and to promote shared and more diverse growth. The GoCV recognizes that capital accumulation and tourism expansion cannot be expected to sustain high growth rates indefinitely, and that the positive external circumstances that contributed to strong growth in the past have now become significantly less favorable. Its strategy is focused on strengthening Cabo Verde’s macroeconomic resilience and improving productivity. Associated job gains and rising wages, partly supported by investment in human capital, better public infrastructure service quality, improved social protection systems, and enhanced focus on agricultural development in turn are expected to extend the benefits of growth across the nine islands and further reduce extreme poverty.

1.7. The proposed programmatic series supports the GoCV’s ambitious structural reform program spelled out in the GPRSP 3. Already in 2013, authorities have implemented broad structural reforms which have been the result of intense policy dialogue and technical assistance by the Bank and other development partners since the initial stages of preparation in mid-2012. While uncertainties surrounding the government’s macroeconomic framework have delayed the delivery of this operation for almost one year, they enabled the discussion, design and implementation of an impressive structural reform program supported by this series of operation.

1.8. The program supported by the proposed series is structured around two pillars: (i) Good Governance and Public Sector Efficiency; and (ii) Competitiveness, Private Sector Development and Labor Productivity. The first pillar will support the difficult but necessary process of macroeconomic adjustment and the implementation of critical public-sector management reforms. Due to the hard fiscal constraints and declining access to concessional financing, enhanced domestic-resource mobilization and more cost-effective spending will be increasingly vital. Pillar 1 addresses this complex challenge. It supports the authorities’ efforts to boost domestic resources and improve the public-investment system to ensure high-quality investment; a set of priority reforms focuses on the performance of state-owned enterprises (SOEs), which will reduce fiscal risks and improve service delivery.

1.9. The second pillar of the proposed series of operations supports the GoCV’s efforts to build a more competitive, shared and sustainable economy led by the private sector. Reforms supported under this pillar will help to establish a more transparent, fair and flexible investment climate by reducing administrative barriers to trade, rationalizing the tax-incentive system and deepening the domestic financial sector. In addition, this pillar supports improvements in the management of recently built infrastructure assets that are expected to ensure their positive contribution to growth. Raising productivity will require accelerating human-capital formation and a well-functioning labor market. Finally, conserving Cabo Verde’s natural assets is vital to maintaining the competitiveness and sustainability of the tourism industry. The proposed series of operations supports measures to ensure the appropriate management of protected areas throughout the archipelago, the efficient use of new public

3

resources allocated to the environmental sector, and the effective enforcement of environmental regulations to ensure the continuous development of the tourism industry and support the development of agriculture.

2. MACROECONOMIC POLICY FRAMEWORK

A. RECENT ECONOMIC DEVELOPMENTS

2.1 Real sector: The global financial crisis of 2008-09 followed by the European sovereign debt crisis of 2011 had a profound impact on the Cabo Verdean economy. After strong GDP growth that averaged 6.7 percent annually since 2000, Cabo Verde experienced a recession in 2009 as GDP contracted by 1.3 percent, and an anemic recovery by 1.5 percent in 2010. Growth rose to 4 percent in 2011, spurred by a strong investment program and by trade-diversion effects caused by severe political disruptions among Cabo Verde’s North African tourism competitors. Official national accounts data for 2012 and 2013 are not yet available. However, the fall in imports, domestic credit, FDI and business confidence, and increases in unemployment and nonperforming loans suggest that the double-dip recession in Europe has been mirrored in Cabo Verde. The IMF estimates GDP growth at 1 percent in 2012 and 0.5 percent in 2013. In 2014, growth is likely to accelerate somewhat as the external environment brightens.

2.2 Public investment helped cushion recession, partly compensating for collapsing private investment, especially FDI. In 2009, as the effects of the Eurozone crisis fully materialized, private investment—led by FDI—plummeted and has yet to recover. Financed at highly concessional terms, public investment began to increase in this period, partly filling the void of private investment, constituting a strong counter-cyclical policy response. Although this cushioned the effects of the crisis, all investment in Cabo Verde has high import content, limiting the multiplier effect of investment on domestic demand and economic activity in the short run.

2.3 More important, the expansion of public investment has represented a foundation for enhancing medium term growth. In 2008 the GoCV launched an ambitious public investment program (PIP) aimed at transforming the economy and eliminating infrastructure bottlenecks, while taking advantage of its last window of concessional aid following its graduation from the list of LDCs. Among the major projects undertaken were improvements in seaports, airports, roads and investments in energy, and water mobilization (dams and drip irrigation), thus all focusing on Cabo Verde’s binding infrastructure constraints yielding a growth dividend in the medium and long run (see Figure 2.1).

2.4 External sector: After the strong deterioration observed in 2009-11, external accounts improved substantially in 2012-13. While FDI, remittances and ODA all contracted during the global slowdown, resilient tourism exports, falling imports and robust migrant deposits improved the country’s external balances and international reserve position. FDI, remittances and ODA all suffered spillover effects from the euro zone crisis. Yet tourism—Cabo Verde’s single most

Figure 2.1 Distribution of the PIP

Source: Ministry of Finance. Note: Includes central government and SOEs via on-lending.

Agriculture and Water Manage-

ment

Ports Roads

Energy

Education

Poverty reduction

Other

4

important export—remained strong, growing at 26 and 21 percent in 2011 and 2012, respectively, though slowing down somewhat in 2013. Migrant deposits also continued to increase, spurred by considerable interest-rate spreads between Cabo Verdean and European deposits. Imports contracted in 2012 and remained depressed in 2013 as a result of slowing domestic growth. Thus, after a worrisome fall in 2011 international reserves recovered to 4.3 months by December 2013, well within the parameters recommended by the IMF.

Table 2.1: Key Macroeconomic indicators 2011 2012 e 2013 e 2014 p 2015 p 2016 p 2017 p

Real economy Annual percentage change, unless otherwise indicated GDP (nominal, local currency, bn) 147.9 153.9 159.4 166.8 175.8 186.2 197.5

Real GDP 4.0 1.0 0.5 3.0 3.5 4.0 4.0

Contributions

Consumption 1.6 -12.4 -6.7 6.3 1.7 0.1 -1.6

Investment 1.1 0.8 0.5 2.8 2.7 3.6 3.3

Net exports 1.3 12.6 6.7 -6.1 -0.9 0.4 2.4

Imports 17.9 -8.1 -7.9 14.1 7.8 7.5 7.6

Exports 17.3 7.2 4.3 6.8 9.8 10.4 10.4

Unemployment rate (ILO definition) 12.2 16.8 n.a n.a n.a n.a n.a

GDP deflator 2.7 3.0 3.0 1.6 1.8 1.8 1.8

CPI (eop) 3.6 4.1 0.1 2.0 2.0 2.0 2.0

Fiscal accounts Percent of GDP, unless otherwise indicated

Expenditures 33.3 32.6 31.0 33.9 31.9 31.4 30.4

Revenues 25.6 22.8 23.4 25.2 25.4 25.6 25.6

Overall Government Balance -7.7 -9.8 -7.7 -8.7 -6.6 -5.9 -4.8

Public Debt 78.5 88.8 95.0 103.1 106.7 109.0 108.4

NPV Debt 49.5 53.1 58.7 62.2 62.9 63.5 62.9

Selected monetary accounts Annual percentage change, unless otherwise indicated

Broad money 4.6 6.3 11.2 4.8 5.0 6.2 6.0

Credit to non-government 10.8 0.0 1.0 2.1 2.4 3.2 3.5 interest (key policy interest rate) 4.25 5.75 5.75 5.25 4.75 4.5 4.5

Balance of Payments Percent of GDP, unless otherwise indicated

Current account balance -16.3 -11.2 -5.6 -10.4 -10.3 -9.5 -8.6

Imports 73.9 65.2 58.0 63.3 64.7 65.6 66.6

Exports 42.3 43.5 43.9 44.8 46.7 48.6 50.6

Foreign Direct Investment 5.6 3.3 2.3 2.6 3.0 3.1 3.3

Gross Reserves (in US$ million, eop) 347.0 392.7 466.9 511.7 553.7 619.5 683.7

in months of next year imports 3.5 4.3 4.3 4.3 4.3 4.3 4.3

as % of short-term external debt 273.2 286.9 437.2 677.1 880.3 985.0 1,087.0

External debt 56.1 66.9 71.7 78.1 79.6 80.4 79.4

Terms of Trade (index 2011=100) 100.0 95.4 95.6 100.1 103.3 105.3 106.3

Exchange rate (average) 79.2 85.8 83.0 80.1 78.9 77.5 76.1 Memo items: GDP nominal in US$ (bn) 1.9 1.8 1.9 2.1 2.2 2.4 2.6

Source. IMF, Bank Staff

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2.5 Monetary policy, exchange rate, financial sector: Monetary policy in Cabo Verde is tasked primarily with maintaining the exchange rate peg of the escudo with the euro as a monetary anchor to keep inflation at low rates which has been critical for the attraction of FDI. In the context of the exchange rate peg, as net inflows of foreign exchange fell between 2009 and 2011, the central bank countered the drain on reserves by raising interest rates and reserve requirements and reducing domestic credit at the end of 2011. The monetary contraction aggravated the domestic economic slowdown but helped rebuild international reserves, strengthening the exchange rate peg to the euro. Credit growth stalled in 2012 and 2013. As a result of weak economic growth and positive international food and oil price developments, inflation slowed down to 0.1 percent in 2013.

2.6 Monetary easing began in the second part of 2013 and may be accelerated in 2014. As the international reserve coverage improved and inflation remained low, the central bank cautiously embarked on loosening monetary conditions since the second part of 2013. However, low capital adequacy in local banks, as a consequence of the weak economy, limits the transmission mechanisms of monetary policy. Bank lending was weak in 2013 and is likely to remain so in 2014.

2.7 Reflecting the countercyclical-investment-driven fiscal expansion, government deficits and debt rose substantially. The government’s overall deficit increased from an average of 1.3 percent of GDP in 2006-08 to 8.1 percent in 2009-13. Financing needs, including on-lending operations to SOEs through which the government executes part of the PIP, increased to an average of 10.3 percent during 2009-2013. The gross operating balance (revenues less current spending), however, has remained positive, confirming that the fiscal expansion was driven primarily by public investment, which in turn was financed by concessional lending. High deficits and low economic growth led to a jump in the debt to GDP ratio from 68 percent in 2009 to 95 percent in 2013. However, the concessional nature of the government’s borrowing strategy is reflected in an average debt maturity of 23 years and an average cost of 0.75 percent which helps ensure long-term solvency. Indeed, the NPV of the debt to GDP ratio was only 58.7 percent in 2013, reflecting the strongly concessional debt composition.

2.8 The fall in revenues, as a consequence of the economic slowdown, accounted for almost 40 percent of the deterioration of fiscal balances1. Due to the simultaneous drop in both tax revenues and donor grants, government revenues fell from an average of 28.7 percent of GDP in 2006-08 to an average of 25.2 percent in 2009-2013. Tax revenues fell from an average of 21.5 percent of GDP in 2006-08 to 18.6 percent in 2009-13. As a result of the economic crisis in Cabo Verde’s main development partners in Europe, external grants fell from an average of 4.9 percent of GDP in 2009-13 to 3.6 percent.

2.9 Increases in total spending, and in particular investment expenditures, have been responsible for the remaining 60 percent of the worsening fiscal balances. The authorities have pursued a strategy to control recurrent spending to open fiscal space to finance counterpart funds for their ambitious investment program, which has been mostly financed by concessional borrowing. The wage bill has remained stable around 11 percent of GDP. This level is comparable to that of other small economies, where economies of scale are not available. As a result of the recent elimination of energy subsidies, price supporting measures in Cabo Verde are

1 The CEM (2013) provides details on the contributing factors of the fiscal expansion 2009-13.

6

very low at less than one percent of GDP. Due to the concessional nature of most of its external borrowing and the government’s restrictions on domestic borrowing (domestic debt should not be higher than 20 percent of GDP), interest payments are also low at about two percent of GDP.

2.10 The high fiscal deficits and rising debt are primarily the consequence of the expansion of foreign-financed public investment in 2009-12 and this has two important

Table 2.2: Key Fiscal Indicators ( in percentage of GDP) 2011 2012 2013 2014 2015 2016 2017

Revenues 25.6 22.8 23.4 25.2 25.4 25.6 25.6 Domestic Revenue 22.8 21.0 21.1 22.3 23.6 24.0 24.3 Tax Revenues 20.1 17.9 17.6 18.7 19.6 19.9 20.2

Taxes on income and profit 5.9 5.6 5.4 5.7 5.7 5.7 5.8 Taxes on Goods& services 9.6 8.1 8.2 9.0 9.8 10.1 10.4 Taxes on international trade 4.0 3.8 3.6 3.6 3.6 3.6 3.6 Other taxes 0.7 0.4 0.4 0.5 0.5 0.4 0.4

Non-tax Revenues 2.7 3.1 3.5 3.6 4.0 4.1 4.1 Grants 2.8 1.8 2.3 3.1 1.7 1.5 1.2 Expenditures 33.3 32.6 31.0 33.9 31.9 31.4 30.4 Current Expenditures 23.1 22.2 22.1 25.1 24.5 24.1 23.3 Wages and Salaries 11.7 10.3 10.1 10.9 10.7 10.4 10.1 Of which related to the PIP 1.2 0.9 1.1 1.2 1.0 1.0 0.9 Goods and Services 3.8 2.9 2.8 5.0 4.4 4.2 3.8 Of which related to the PIP 1.5 1.2 1.5 2.7 2.2 2.0 1.7 Interest Payments 2.5 1.8 2.1 2.1 2.4 2.6 2.8 Subsidies 0.6 0.2 0.1 0.1 0.2 0.2 0.2 Transfers and Pensions 2.7 2.5 2.3 2.7 2.7 2.7 2.5 Other Current Expenditures 3.9 4.4 4.6 4.2 4.1 4.0 3.8 Gross Operating Balance 2.5 0.6 1.3 0.1 0.9 1.4 2.3 Accumulation of Non-Financial Assets 10.2 10.4 9.0 8.8 7.4 7.3 7.1 Primary Balance -5.2 -8.0 -5.5 -6.6 -4.2 -3.2 -2.0

Overall Balance (excl. net-lending) -7.7 -9.8 -7.7 -8.7 -6.6 -5.9 -4.8 Net Financing 7.7 9.8 7.7 8.7 6.6 5.9 4.8 Net External 6.0 7.5 4.9 5.9 2.9 3.0 2.8 Disbursements 7.3 8.6 6.1 7.1 4.0 4.1 3.9 Budget Support 2.1 1.3 1.5 1.4 1.0 1.0 0.9 Project Loans 5.2 7.3 4.5 5.7 3.0 3.2 3.0 Amortizations 1.2 1.1 1.1 1.2 1.2 1.1 1.1 Net Domestic 1.5 2.0 1.6 2.8 3.7 2.9 1.9 Statistical Discrepancy 0.2 0.3 1.2 0.0 0.0 0.0 0.0 On-Lending to SOEs 3.6 3.7 5.1 4.3 3.7 3.4 1.9 Total Financing (incl. On-lending) -11.3 -13.5 -12.8 -13.0 -10.3 -9.3 -6.6 Debt 78.5 88.8 95.0 103.1 106.7 109.0 108.4

NPV Debt 49.5 53.1 58.7 62.2 62.9 63.5 62.9 Source: MoFP and Bank Staff Estimations

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implications. First, the fiscal expansion was based on capital spending, which normally has more positive effects on medium to long term growth as compared to consumption spending. Second, as investment spending is more discretionary, the government has more scope to undertake adjustments in the level of spending if needed2.

2.11 In 2013, the government initiated a medium term fiscal adjustment trajectory. On the revenue side, the government adopted a bold tax reform which had two main objectives: (i) support the fiscal adjustment efforts in the short run and (ii) compensate the expected continuous fall in foreign aid in the medium term. To strengthen domestic revenue mobilization, the government adopted a tax package including an increase from 6 percent to 15 percent in the value-added tax (VAT) rate paid by hotels and restaurants, broadened the base of the VAT to include public utilities and oil, introduced a tourism fee of 2 euros per guest per night and a fee for the statistical registration of customs transactions, and expanded the base of the ecological tax on non-biodegradable imports. In addition, recent reforms have focused on improving tax administration. Collectively, these measures are beginning to yield results, and revenue has been edging up again since the third quarter of 2013. These measures supported by the proposed PRSC series are expected to generate additional revenue of 3 percentage points of GDP.

2.12 On the expenditure side, public investment spending began a gradual declining trajectory in 2013. This was offset by an increase in foreign-financed on-lending to state-owned enterprises in 2013 as progress accelerated on certain projects. Both the 2014 budget as well as the MTFF 2014-2017 indicate that the retrenchment of public investment and net lending has now commenced in earnest. Some large foreign-financed investments—including a social housing program, the expansion of the Praia airport, the renovation of the Boa Vista seaport and an energy project financed by IBRD—will keep investment spending relatively high until their completion. However, the number and total value of investment projects in the pipeline is falling.

2.13 In addition, in 2013, budget execution was managed carefully and progress was made towards fiscal consolidation. As the effect of the revenue enhancement measures did not appear in the first part of 2013, current and capital expenses were reprogrammed. Due to the cancellation of some investment projects against worse than expected revenue outturns, some delays in the implementation of investment projects, and the tight control on current spending, the fiscal deficit including on-lending to SOEs for 2013, is estimated to have declined moderately to 12.8 percent of GDP (0.7 percentage points lower than in 2012). Fiscal policy is expected to become less expansionary as the public investment program slows down, economic activity accelerates and new revenue measures take effect. Since the gross operating balance has been consistently positive, as investments decline, the overall balance will improve and gross financing needs will fall (see Figure 2.2).

2.14 The budget for 2014 indicates a higher deficit than that observed in 2013. The deficit for 2014 is expected to increase from 7.7 percent of GDP in 2013 to 8.7 percent. Some investment-related expenditure requires additional expenditures on personnel and goods and services which are booked on the central government’s accounts, while the introduction of a

2 Adding up current spending related to the PIP (personnel expenses and goods and services of Project Implementation Units) and investments (that are discretionary), total discretionary spending amounts around 13 percent of GDP or 37 percent of total spending, which implies a sizeable space of maneuver to make expenditure adjustments.

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single Treasury Account has increased both revenues and spending3. Thus, in 2014 there will be a temporary expansion in recurrent spending. Public investment is retrenching but space for further cuts in ongoing investment projects is limited because i) ongoing projects have high sunk costs, ii) delays increase the overall cost of projects, iii) incomplete investments have zero economic value, and iv) a more rapid withdrawal of fiscal stimulus may not be warranted, given the continued weak economy. However, the government has committed to keep constant the PIP envelope, which means that any additional investments to the PIP will need to be compensated by the exclusion of existing projects in the pipeline. Furthermore, authorities are committed to only implement investment projects that will be appraised and approved by the new National Investment System supported by this operation and World Bank TA and expected to be operational by 2016. In the medium run, by imposing a mandatory project life cycle ruled out by the new National Investment System it is expected more gradualism in government investments. Overall, the total financing including on-lending is expected to remain relatively stable in 2014, increasing by only 0.2 percentage points of GDP. This is based on more realistic revenue projections in the 2014 budget law than the ones set in previous years.4 The careful budget execution observed in 2013 which eventually led to a smaller than expected deficit suggests that the 2014 budget outturn may also be better than expected.

B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

2.15 The macroeconomic outlook is cautiously optimistic, as the global scenario brightens and both the PIP and ambitious structural reforms will yield economic returns. The Eurozone has emerged from recession and global markets are generally stabilizing despite the reduction of global liquidity, led by US monetary policy. The global recovery constitutes an important impulse for a small open economy like Cabo Verde. In addition, the government’s tremendous effort to upgrade key infrastructure has addressed important binding development constraints and thus increased the country’s growth potential. Finally, the government has pursued a transformative structural reform agenda, in energy, transportation, and other areas—partly with the support of the Bank. Further reforms to enhance the management of infrastructure, including Public Private Partnerships and a National Investment System (also partly supported by the Bank), are already ongoing. Against this backdrop, the prospects for the dynamism of Cabo Verde’s economy have improved considerably.

2.16 With respect to public debt, a stochastic Debt Sustainability Analysis (DSA) prepared by the Bank team indicates that the trajectory of public debt is sustainable, but

3 Part of the increase in goods and services and personnel reflects an accounting effect associated to the full operation of the single treasury account. The centralization of revenues in the treasury account also implies that expenses of all government agencies that previously had their own and separated accounting are now included in the central government accounts. Also, new revenue sources such as the touristic fee and the ecological tax generate additional spending as part of the resources collected by these contributions need to finance specific expenditures. In addition, spending that previously was considered investment has been reclassified as goods and services and personnel spending. In the budget 2014, this reclassification responds for about 4 percentage points of GDP or 15 percent of current spending. Finally, technical assistance projects associated to investment lending account for part of the increases in goods and services. All these changes explain at least 80 percent of the expected increases in goods and services and personnel spending in 2014. 4 Revenue projections tend to be overly optimistic because the authorities cannot by law exceed the level of spending approved by Parliament. This allows some flexibility in the event that revenue collection is successful, while typically requiring cuts in spending when revenues do not materialize as hoped.

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significant vulnerabilities will persist in the short term. Based on the authorities’ MTFF and Medium Term Debt Strategy (MTDS) for 2014-17, which were agreed by the Bank and authorities, the DSA indicates that the debt-to-GDP ratio is expected to reverse its increasing trend in 2016, when it will reach a peak of 109 percent of GDP. It is then expected to fall slowly to 105 percent of GDP by 2020 before reaching 85 percent of GDP by 2025.

2.17 This debt trajectory assumes a continuous fiscal consolidation from 2015 onwards, as well as a prudent debt strategy and the recovery of GDP growth to an annual average of 4.5 percent from 2016 to 2020. The fiscal framework indicates that an expansionary fiscal stance will support economic activity through 2014, and that a gradual reduction in deficits thereafter will be made possible through continued increases in domestic revenue and a smaller public investment program. The same borrowing strategy that Cabo Verde has pursued in recent years, under which roughly 75 percent of its gross financing needs are covered by external concessional borrowing, will still be possible through 2016. After that, the MTDS assumes realistically that the degree of concessionality of new external loans decreases over time. The scenario also assumes a gradual improvement in GDP growth to an average of 4.5 percent after 2016.

2.18 Under this scenario the public debt trajectory is sustainable in the long run, yet remains vulnerable to adverse shocks. Risks to GDP growth, the exchange rate, interest rates and SOE contingent liabilities have all been incorporated into the analysis. Under very adverse circumstances (a scenario with a probability of less than 10 percent) the public debt could reach 120 percent of GDP in 2016 remaining at 105 percent in 2020. In this scenario the probability of debt distress is around 15 percent.5 The reform of SOEs and the adoption of cost-recovery measures for the main infrastructure services (energy and transport) that are supported by this operation are expected to reduce fiscal risks arising from SOEs’ operations reducing the need for further capitalizations.6

2.19 While current and projected debt levels are high, other debt-sustainability indicators depict a more positive outlook. While public debt is high, its composition (highly concessional with long maturities) results in much lower net present values (NPV) which breaches debt ceilings only one time in the projection period and under very adverse and unlikely scenarios (i.e a 30-percent devaluation). Indeed, the latest Debt Sustainability Assessment (DSA) prepared by the Bank team in January 2014 confirms a moderate risk of debt distress. More importantly, gross financing needs (GFN) defined as the sum of the overall deficit and amortizations are expected to start declining in 2014, dropping from 20 percent of GDP in 2013 to 14 percent by 2020. Even in a very adverse scenario (massive materialization of SOE contingent liabilities), GFN should not exceed 16 percent of GDP. GFN are anticipated to fall due to the reduction of the primary deficit as the public investment program is moderated and amortization payments remain low (see Figure 2.3). This in turn accounts for the reduction in the debt-to-GDP ratio projected during the period.

2.20 Furthermore, the decomposition of GFN into its components—the primary deficit, on-lending operations for investments by SOEs, interest payments and amortization—

5 These probabilities are estimated taking into consideration specifics of Cabo Verde’s economy and governance structures. For more details see Cabo Verde’s Country Economic Memorandum. 6 Capitalizations of SOEs, in the magnitude of about 0.5-1 percent of GDP have been frequent in the past in Cabo Verde.

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indicates that medium term solvency is solid. A large part of the government’s ability to repay debt depends on the evolution of the primary balance (which in turn strongly depends on investments made by the central government) and on-lending operations that finance investments by SOEs. As described above, the government’s investment expenditures are largely discretionary at least in the short term, and increases in non-discretionary spending remain low and manageable; consequently the authorities will be able to reduce GFN, adapting its investment spending to economic conditions. Indeed, public investment and on-lending to SOEs are expected to fall from about 14.5 percent of GDP (their 2009-2013 average) to 9 percent of GDP by 2017. Amortization payments are expected to pick up in 2016, further reducing the debt-to-GDP ratio.

Figure 2.2: Debt to GDP Ratio (% of GDP) Figure 2.3: Gross Financing Needs (% of GDP)

Source: Bank Staff Source: Bank Staff

2.21 The challenge for fiscal policy is to strike the right balance between supporting growth and preserving macroeconomic and debt sustainability. Cabo Verdean policymakers are aware of the risks from heightened fiscal vulnerability, especially in an uncertain external environment, and have already adopted important measures to improve domestic revenue mobilization and scale back their investment program. The tax measures taken in 2013, the careful budget execution of 2013, the adoption of a more realistic MTFF for 2014-17 and the prudent medium-term borrowing strategy set forth in the MTDS demonstrate the authorities’ commitment to fiscal sustainability. The IMF has supported Cabo Verde’s strategy to benefit from concessional resources to finance high-productivity public investments. Such investments are boosting the country’s long-term growth potential, in traditional growth areas like tourism, but also in newer areas like agriculture. They have also played an important role in supporting domestic demand while external demand was depressed.

2.22 The fiscal adjustment required over the medium term to maintain debt sustainability is feasible. In addition, the GoCV’s infrastructure investments and the ongoing structural reform agenda, combined with significant new FDI in the tourism sector, are likely to yield a growth dividend that may accelerate the fall in the public debt-to-GDP ratio. Meanwhile, SOEs cost-recovery measures supported by the proposed PRSC series are expected to generate

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around 1.5 percentage points of GDP. Efforts to reduce risks from SOEs have yielded encouraging effects in Electra; unbundling and partially privatizing TACV, and privatization of port operations as currently pursued by the GoCV, would reduce the main source of risk stemming from Cabo Verde’s SOEs. In conclusion, despite its difficult external circumstances and high level of indebtedness, the government’s macroeconomic, fiscal and debt-management policies continue to provide an adequate basis for the proposed operation.

C. IMF RELATIONS

2.23 The IMF has not had a program with Cabo Verde since February 2012, when the country completed the second review under the Policy Support Instrument (PSI) program. While no new program has been requested by authorities, the GoCV and the IMF agreed in pursuing a strengthened Article IV surveillance through biannual missions. The latest Article IV mission was held on January 15 to 28, 2014 (see Statement at the Conclusion of the Mission in Annex 4). This proposed operation has been prepared in close collaboration with the IMF staff and benefitted from technical assistance on tax administration and public finance management provided by the IMF.

3. THE GOVERNMENT’S PROGRAM

3.1 The GPRSP 3 reflects a consistent and broad consensus on the country development strategy. This consensus has been spelled out in various documents including the long-term Economic Transformation Strategy (ETS), prepared in 2003, and the first and second Growth and Poverty Reduction Strategy Papers adopted between 2004 and 2012. These strategies have consistently identified seven economic clusters designed to broaden Cabo Verde’s economic base and strengthen the linkages of the prosperous tourism sector with the rest of the economy.

3.2 The seven clusters identified as priority areas for diversification are: (i) maritime activities (fishing, commercial port operations, and interisland transportation); (ii) air transportation and related activities (transport services for both passengers and cargo, air traffic control and information, and airplane maintenance and servicing); (iii) information and communication technologies (call centers, business-process outsourcing, etc.); (iv) financial services; (v) tourism; (vi) cultural products (historical preservation, music and arts); and (vii) agriculture (agribusiness and traditional rural development).

3.3 While preserving consistency with the GoCV’s long term development vision, the GPRSP 3 includes several important policy shifts from earlier strategies. The most important change is the greater emphasis on the structural reforms to foster productivity necessary for a more competitive and dynamic economy conducive to sustainable, inclusive and broad-based growth. Indeed, the GPRSP 3 sets out an ambitious agenda to improve the efficiency of public-sector investment and the management of SOEs, enhance the investment climate, enhance the functioning of the labor market and facilitate private-sector development.

3.4 A second remarkable shift is the focus on eliminating extreme poverty through the development and modernization of the agriculture and fisheries sectors and promoting sharing prosperity through strengthening the linkages of the tourism sector with these primary sectors. Because of the untapped potential of the agricultural sector, and, given the strong incidence of extreme poverty in rural areas, the GPRSP-III directs special attention to

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enhancing agricultural productivity and its linkages with the tourism sector. Efforts to increase water mobilization, agriculture productivity and interconnectivity between touristic islands and the agricultural ones in order to increase the demand for domestic agriculture products by the tourism sector. In addition, policies on human capital development, in particular fostering technical, vocational education and training (TVET), are deemed as priority areas to boost shared prosperity.

3.5 A third policy shift is the role of the private sector as the main protagonist of the new growth model. The GPRSP 3 recognizes that recent economic growth and the need to smooth the effects of the external crisis on economic activity have resulted in a greater participation of the public sector in the economy. Due to the hard financial constraints faced by the public sector and the need to increase efficiency, the GPRS 3 clearly indicates that the private sector is expected to be the new driver of economic growth in the upcoming years.

3.6 The GPRSP 3 supports the development of seven economic clusters through interventions organized under five axes:

(i) Infrastructure. Policies under this axis are designed to alleviate remaining infrastructure bottlenecks by completing the government’s public investment program in the areas of transportation, energy and irrigation networks, with an emphasis on interisland connectivity.

(ii) Human Capital. Objectives include: (a) to create a more competitive labor force, boosting employability and improving income distribution; (b) to strengthen competitiveness in technology-intensive industries; and (c) to enhance social protection policies.

(iii) Good Governance. The objective is to improve public financial management (PFM) by: (a) consolidating recent progress; and (b) supporting new initiatives in the national planning system, public investment management, monitoring and evaluation (M&E), development of statistical capacities and SOE reform.

(iv) Support to the Private Sector. The overarching goal of the GPRSP 3 is to shift the emphasis from public investment to private-sector growth through measures to enhance the business climate, expand trade openness and promote financial-sector stability and access to credit.

(v) Global Partnerships. In an environment of declining aid flows and reduced access to concessional financing, the GoCV has responded with a comprehensive plan to diversify its trade and development relationships to include new partners, such as China, Brazil, the Arab world and the West Africa Region.

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4. THE PROPOSED PRSC 8

A. LINKS TO THE GOVERNMENT’S PROGRAM AND OPERATIONAL DESCRIPTION

4.1 The proposed operation would be the first in a series of three one-year operations designed to support the implementation of the GoCV’s GPRSP 3. In accordance with GoCV priorities and the areas of intervention defined in the GPRSP 3, the new PRSC series focuses on two programmatic pillars: (i) Good Governance and Public Sector Efficiency, and (ii) Competitiveness, Private Sector Development and Labor Productivity. The development objectives of the first pillar include ensuring macro-fiscal stability and improving the efficiency of public expenditures. The development objectives of the second pillar are to improve the provision of infrastructure services and the investment climate, enhance labor force skills and the functioning of labor markets, and improve environmental protection. (Figure 4.1 shows the structure of the proposed series).

4.2 The first pillar aims at achieving two complementary objectives: bolster the country’s macroeconomic resilience to exogenous shocks and improve the efficiency of public spending, which are also the focus of the governance pillar of the GPRSP 3. This proposed operation is designed to support and reinforce Cabo Verde’s efforts to rebuild its macroeconomic buffers and strengthen its fiscal policy stance through the reduction of fiscal deficits and the improvement of domestic revenue mobilization. In addition, this pillar supports improvements in expenditure efficiency including the legal consolidation of public finance management improvements, the enhancing of public investment management and the strengthening of the oversight of State Owned Enterprises (SOEs). These improvements are critical not only to improve the efficiency of the public sector but to support the fiscal adjustment efforts as well. In addition, this series of operations aims at reducing poverty through more efficient social protection policies including better targeting, coverage and adequacy of social protection programs across the spectrum of social insurance and assistance.

4.3 The main objective of the second pillar of the proposed PRSC series is to enhance Cabo Verde’s competitiveness through actions in four dimensions. The first is the management of infrastructure assets in energy and transport sectors ensuring the cost recovery of the investments done by the government and a greater participation of the private sector on the service delivery of these assets. The second is the improvement of the overall investment climate including the reduction of non-tariff trade barriers and ensuring the stability of the financial sector as a necessary condition for financial deepening. The third dimension consists of the combination of improvements in labor force skills and in the functioning of the labor market to favor a better match between the labor-market supply and demand, the reduction of unemployment and informality. Finally, the fourth dimension is environmental protection, as Cabo Verde faces significant environmental vulnerabilities. Cabo Verdean tourism industry is fundamentally dependent on the natural assets of its islands, and consequently their conservation is a prerequisite to maintain its competitiveness and ensure sustainable growth.

4.4 The design of the PRSC 8 is based on a number of lessons learned from Cabo Verde’s experience with previous operations in the PRSC series. The ICR of the previous series (PRSC 5 to 7) prepared in FY13 highlighted the crucial importance of up-to-date analytical work on which to base policy dialogue, strong donor coordination to enhance leverage and reduce transaction costs to the government, and the need to provide technical assistance.

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Figure 4.1: Structure of PRSCs series

B. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS

Pillar 1: Good Governance and Public Sector Efficiency

4.5 This pillar supports measures designed to strengthen macroeconomic resilience, and increase the efficiency of service delivery. Reforms under this pillar aim at rebuilding macroeconomic buffers to absorb external shocks through the gradual reduction of fiscal deficits and debt, and enhancing the public sector’s efficiency by improving the quality of public investments and a better performance of SOEs. The “fiscal diamond” shown in Figure 4.2, below, presents a broad public-finance perspective on the macro-fiscal-stability and public-efficiency dimensions of this pillar. The authorities’ fiscal policies have been based on large-scale borrowing and strong donor support. While this strategy has enabled Cabo Verde to invest in critical public goods and alleviate binding infrastructure constraints, reliance on borrowing and external assistance cannot be sustained indefinitely. In this context, reducing deficits, increasing domestic-revenue mobilization and improving the efficiency of public expenditures not only have important short-term macroeconomic implications, but also are necessary conditions to ensure debt sustainability and improve the country’s growth performance. Results indicators under this pillar include fiscal deficits to GDP ratio, domestic revenue to GDP ratio, the financial balances of SOEs and quality of service delivery indicators.

1. Enhance Resilience 2. Improve Competitiveness

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Figure 4.2 The current and new fiscal diamonds

(a) Domestic revenue mobilization

4.6 Given (i) the limited ability to further reduce recurrent expenditures due their mandatory nature, (ii) the medium-term objective of rebuilding fiscal buffers against external shocks and (iii) the expected long-term decline in external grants, the PRSC 8 focuses on enhancing domestic revenue collection by supporting reforms in tax policy and tax administration.

Prior Action 1: Approval by the Parliament of the 2013 Budget Law No 23/VIII/2012 which contains measures to augment domestic revenues, including: (i) increasing the VAT rate applied to hotels and restaurants from 6 percent to the standard rate of 15 percent; (ii) increasing the VAT collection base for energy, water, communications and road-transportation services; (iii) expansion of the tax base of the Ecology Tax; (iv) establishing a “tourism fee” of €2 per guest-night; and (v) establishing a statistical fee for custom services.

4.7 Cabo Verde’s attractiveness to private investment has been enhanced by a generous system of fiscal incentives; however, this system has negative implications for fiscal revenues and distorts resource allocation in the economy. Fiscal incentives proliferated over time with no clear strategic objective, no ex post controls in place, without any assessment of their effectiveness and many of them were created to serve specific, temporary objectives that may be no longer relevant. Moreover, the fiscal incentive regime had a distortive effect on investment decisions as it skews resource allocation and attracts investments of dubious quality and sustainability. In addition, the selective use of fiscal incentives can favor certain investors over others, damaging the overall investment climate and fair competition.

4.8 The proposed PRSC series supports the GoCV’s efforts to reform the fiscal incentive system. Most of the existing fiscal incentives have been consolidated in a single code, the Tax Benefits Code (TBC), which centralizes the power to grant and monitor fiscal incentives and abolishes incentives that were granted under other legislation or that are not included in the TBC. Incentives under the corporate income tax (IURPC) will be now be in the form of investment tax credits, replacing the previous tax holiday policy of full exemptions for five years. This will ensure that incentives are granted ex-post and apply to actual investments, not merely promises of investments or job creation.

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Prior Action 2: Approval by Parliament of the Tax Benefit Code.

4.9 The tax-policy agenda for 2014-15 that will be supported by the PRSC 9 is also very ambitious. It includes the first trigger for the PRSC 9, which is the approval by Parliament of the General Tax Code, the Judicial Procedures for Taxation and the Tax Execution Code7. These codes are expected to enable the tax authority to expedite collection procedures, reduce tax evasion and accelerate the clearance of tax arrears. In addition, the second trigger for the PRSC 9 is the submission to Parliament of the reform of the Individual and Corporate Income Taxes, which will update, modernize and reduce loopholes in tax codes that date from the early 1990s.

4.10 The proposed PRSC series supports systemic improvements in tax administration. In 2012, with the support of the IMF’s Fiscal Affairs Department, the authorities adopted a strategic plan for 2013-15 to enhance the efficiency of tax administration. The plan encompasses the restructuring of the General Directorate for Taxes and Revenues (DGCI), the improvement and integration of taxpayer databases and the staffing of the DGCI. Substantive actions in this area are already being adopted, and preliminary results are encouraging. Therefore, the indicative first trigger for the PRSC 10 is the satisfactory implementation of this strategic plan. The revenue-enhancing measures are expected to increase domestic revenues from their current level at 21 percent of GDP to 24 percent by 2016.

(b) Public Financial Management 4.11 This component on public finance management (PFM), focuses on the consolidation of ongoing initiatives that were supported by the previous PRSC series. In particular, the focus of the PFM area under this new series is the legal confirmation of actions that have been already implemented and that require a legal framework to ensure their continuous operation. Following the consolidation of thousands of accounts from GoCV entities8, the operation of the single treasury account is expected to establish a unified framework for administering the treasury account, which will enable better cash management and generate important fiscal savings.

Prior Action 3: Approval by the Recipient’s Council of Ministers of Decree-Law No 20/2013, establishing the legal framework for the Single Treasury Account which introduces a unified document for the collection of taxes and non-tax revenues and consolidates all bank accounts held by different ministries and public agencies into a single account held by the Recipient’s General Directorate of the Treasury (DGT).

4.12 During the preparation of the GPRSP 3 authorities took advantage of the close coordination between the Directorates of Planning and Budgeting to establish, for the first time, a program-based budget for the 2013 fiscal year. Together with the monitoring and evaluation (M&E) system and the new budget-classification system, the establishment of program-based budgeting represents a major improvement in expenditure management. A more transparent allocation of expenditures clarifies the links between public spending and policy

7 These codes have been already approved by the Parliament in December 2013. Thus, this trigger is already met. 8 There were about 1,000 accounts opened by various ministries in commercial banks. They have all been closed and replaced by 400 new accounts, all of which are subaccounts of the single treasury account at the BCV.

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objectives, which are now closely monitored through the M&E system. The 2014 budget was also presented in a programmatic basis.

4.13 The PRSC series will support the consolidation of this major PFM reform, which still requires its legal foundation be approved by Parliament. The lack of approval of the Budget Framework Law could undermine efforts to properly and consistently implement program-based budgeting. The new law will contain a new budgetary classification and the guidelines for program-based budgeting. Therefore, the third trigger for the PRSC 9 will be the parliamentary approval of the revised Budget Framework Law. It is expected that all government entities will have their budget proposals prepared in a programmatic manner by 2016.

4.14 The PRSC series includes further measures to strengthen the public procurement system. Since 2005 the GoCV has taken a number of steps to improve the efficiency of public procurement. Supported by technical assistance from the Bank and other development partners, the GoCV reviewed and modernized the legal and institutional framework for procurement, organized large-scale capacity-building programs and introduced new tools to guide procurement procedures. Nevertheless, Cabo Verde’s procurement system still has important weaknesses, which will require further revisions to the legal framework, the extent of coverage and the system of controls and audits. Contradictions between the procurement code and other regulations as well as other loopholes are of particular concern. The indicative second trigger for the PRSC 10 will be the parliamentary approval of amendments to the GoCV’s procurement system legal framework, including the Public Procurement Law of 2007, the statutes of the Regulatory Authority for Public Acquisitions (ARAP), and roles for different procurement control agencies.

4.15 The PRSC series also supports the strengthening of the external-audit system. The mandate of the Court of Accounts (CoA) is not in line with international standards, and the limited scope of investigations represents a major risk. The control functions of the CoA are strictly limited; investment projects and operations by SOEs are outside of its authority. The approval of a new CoA law, to rectify these weaknesses is a top priority, and the indicative third trigger for the PRSC 10 is Parliamentary approval of the proposed CoA law9.

(c) SOEs Oversight and Service Delivery Quality 4.16 Cabo Verdean SOEs are responsible for providing nearly all basic infrastructure services and their performance affects the country’s competitiveness and fiscal sustainability. The efficient provision of public goods in small economies is challenging given their large fixed costs and limited economies of scale. In Cabo Verde this has resulted in the purely public provision of key infrastructure. Consequently, strengthening the operational and financial performance of SOEs is one of the top priorities of the GPRSP 3, and the SOE reform agenda is a key component of these programmatic series.

4.17 Cabo Verde’s five major SOEs have long been a source of contingent liabilities for the GoCV due to their generally weak commercial and financial performance.10 These five

9 The Government already submitted the draft law for the CoA. Parliament approved the draft in the first turn. The draft is now in the specialized commission which is expected to review and propose amendments by mid-2014. 10 The five major SOEs are: the National Airport Authority (ASA – Agência de Segurança Aeroportuária), the National Power and Water Utility (ELECTRA), the Port Authority (ENAPOR - Empresa Nacional de Portos), the

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SOEs account for 70 percent of state-owned capital and hold assets equivalent to 32 percent of GDP. Their total debt reached 26 percent of GDP in 2012. While SOE’s debt that is guaranteed by the state amounts to just 5 percent of GDP, the critical importance of the services they provide means that the state needs to lend them financial support even on their non-guaranteed obligations.

4.18 Over the past three years the GoCV has been working on the strengthening of the SOEs oversight. In 2009 the GoCV adopted a new law restructuring their legal and governance framework. It provides a precise definition for SOEs, confirms that they are subject to the commercial code, and includes extensive provisions related to governance requirements regarding public controls, reporting and disclosure requirements, and processes for composing boards of directors. In 2010 the GoCV adopted a decree-law establishing a code of conduct for SOEs managers, including rules for conflicts of interest and the tenure of directors.

4.19 However, the effectiveness of state oversight is hampered by the low capacity of the MoFP to exert a timely and effective control of its SOEs. The State Participations Service (SPE) at the General Directorate of the Treasury (DGT) is the responsible for the SOEs oversight. However, the actual ability of the SPE to exert oversight authority is limited, and the agency is not able to properly assist the MoFP in executing its SOE-related responsibilities. In addition, the SPE suffers from significant technical-capacity limitations. It lacks adequately qualified staff, a properly structured work environment, well-designed processes and procedures, and it has no automated system for collecting information from SOEs.

4.20 The PRSC 8 is designed to strengthen the institutional capacity of the SPE. The supported reforms will enable the SPE to verify SOEs’ reporting obligations and will enhance its technical capacity to estimate potential contingent liabilities arising from SOEs.

Prior Action 4: (a) Adoption by Council of Ministers of the Decree-Law No 37/2013 which expands the mandate of the Recipient’s State Participations Service (Servico de Participacoes do Estado (SPE); (b) issuance of the State Owned Enterprises (SOEs) Aggregate Contingent Liability Report of 2012; and (c) presentation of the 2012 audited financial statements of ASA, ELECTRA, ENAPOR, IFH and TACV.

4.21 To improve the quality of public service delivery the proposed PRSC series will support the preparation of result-based management contracts between the MoFP and the major SOEs. In 2011, with the support of the PRSC 7, the GoCV signed a results-based management contract with the national electricity and water utility, ELECTRA. The contract defines the responsibilities and obligations of ELECTRA Board and the MoFP. The contract also details the GoCV support necessary to achieve ELECTRA’s performance objectives as measured by time-bound indicators and targets. Results from this first experience are encouraging as reflected by the notable improvements in ELECTRA’s performance. The fourth trigger for the PRSC 9 is the signature of at least three additional result-based management contracts with the major SOEs. The indicative fourth trigger for the PRSC 10 will be the establishment of an M&E system at the SPE for monitoring SOEs’ financial, technical and service-delivery indicators. Expected results from these actions are improvements in the quality of service

government’s Real Estate Company (IFH – Imobiliária, Fundiária, e Habitat) and Cabo Verde Airlines (TACV – Transportes Aéreos de Cabo Verde).

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delivery and the shift in SOEs deficits of CVE490 million observed in 2012 to positive balances by 2016.

(d) National Investment System 4.22 The GPRSP 3 identifies the development of infrastructure as a necessary condition for improving conditions for economic growth, diversification and poverty reduction. Cabo Verde has taken significant steps to address its infrastructure deficiencies through high rates of public investment, which have largely been financed by an intense external-revenue mobilization effort. Strengthening the government’s national public investment system is critical to ensure that the public resources are allocated to the high return projects. Estimates based on a two-sector model prepared for the CEM reveal that at its current public-investment rate of 15 percent of GDP, an increase in the quality of public capital could increase the long-run per capita GDP growth rate from 4.4 percent to 4.6 percent.

4.23 The continuous improvements in PFM observed in recent years provide a solid basis for the development of a national public investment system. Cabo Verde has developed a strong administrative and managerial framework for budget execution and project implementation, a national monitoring and evaluation (M&E) system and the Medium-Term Expenditure Framework (MTEF). Finally, the introduction of program-based budgeting enables a better alignment of public investment projects into the GoCV’s national development strategies.

4.24 Despite these considerable advances, however, a diagnostic study of the government system prepared by the Bank team demonstrates that Cabo Verde’s current public investment system has a number of serious weaknesses. These include a lack of technical capacity in project appraisal, which negatively affects the project selection, independent review and ex post evaluation phases of the investment cycle, and the limited monitoring and maintenance of existing assets, which negatively impacts the productivity of public infrastructure.

4.25 The proposed PRSC series will support authorities’ efforts to enhance its national investment system (NIS). The study referred to above contains a detailed 3-year action plan covering key institutional, legal, technical and capacity-building activities. An Institutional Development Fund (IDF) grant is financing the implementation of this action plan. The fifth trigger for the PRSC 9 would be the submission to the Parliament of a new organic law for the government’s planning system that establishes the legal basis for the National Investment System. The indicative fifth trigger for the PRSC 10 will be establishment of a project appraisal unit at the National Directorate of Planning (DNP) which will be responsible for screening and selecting investment projects and the issuance of a public investment manual detailing standard practices for project appraisal. It is expected that by 2016, at least half of the new public investment projects financed by the state budget will be appraised and approved by the SNI.

(e) Social protection 4.26 The agenda of expenditure efficiency also encompasses the strengthening of social protection programs. Cabo Verde has a series of programs in place, mostly in terms of pensions (both contributory and non-contributory) and smaller, more fragmented social assistance programs. The country has made very significant progress over the past few years in

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strengthening its programs for greater efficiency and impact, in particular through the setting up of strong information systems for its pensions and through the elimination of duplications and overlap. Cabo Verde has also increasingly taken responsibility for the financing of its social protection programs, commensurate with the strengthening of its programs’ capacity. In the coming years, it will be important to consolidate social assistance programs, to ensure greater coverage, greater efficiency, avoid duplications and improve targeting and equity.

4.27 As a mechanism to increase the impact and the efficiency of public spending, the GoCV has developed the instruments for the implementation of a Unified Registry of Beneficiaries (URB). This registry will provide the basis for the targeting of social programs that aim at reaching the poorest. This instrument will contribute to addressing three key limitations of the existing system: (i) inefficiency (with each program collecting information on households to determine their eligibility); (ii) targeting the poorest; and (iii) overlaps or gaps in coverage. It will also help increase the programs’ impact on poverty and vulnerability, ensuring equitable coverage and seeking synergies between complementary interventions. 4.28 The proposed PRSC series will further support this effort. The indicative sixth trigger for the PRSC 10 will be the operationalization of the URB and the approval by the Parliament of a law that institutionalizes the registry, and the uploading of information on beneficiaries from the National Institute of Social Pension (INPS), the National Center of Social Protection (CNPS) and other social programs of the Ministry of Youth, Employment and Human Resource Development (MJEDRH) in the registry. The expected result in this area is to have all social protection programs supported by the URB which will prevent overlapping and coverage gaps, improving the targeting of government social spending.

Pillar 2: Competitiveness, Private Sector Development and Labor Productivity 4.29 This pillar supports the GPRSP-3 objectives of improving competitiveness and promoting more inclusive and sustainable growth through the resumption of the country’s structural reform agenda. This pillar consists of four policy areas: (i) infrastructure management; (ii) investment climate; (iii) skills development and labor market; and (iv) environmental sustainability. Results under this pillar are expected to be measured by infrastructure service delivery, labor market, business climate and environmental protection indicators.

(a) Infrastructure Management 4.30 Cabo Verde has taken significant steps to close its infrastructure deficits through high rates of public investment, which have largely been financed by an intense external revenue-mobilization effort. Cabo Verde now has a relatively well-developed stock of basic infrastructure. Nearly all of the nine inhabited islands have both marine and air access, and over 70 percent of the national road network is paved. The country has four international airports and four local airports, as well as nine seaports, seven of which have been modernized and expanded in the last five years. Its energy generation capacity is 156 MWs, of which almost 25 percent is renewable. In 2012, 95 percent and 60 percent of the population have access to electricity and running water services, respectively.

4.31 Cabo Verde now has an opportunity to build on these achievements by shifting focus from accelerated investment to improvements in the quality and efficiency of

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infrastructure and services. For example, while the national electrification rate is high, the most recent global competitiveness report produced by the World Economic Forum ranked the quality of Cabo Verde’s electricity and water supply as very poor with frequent and long duration. And whereas much of the transport infrastructure is graded and in good condition, inter-island connectivity is a major bottleneck for economic integration. Therefore, one of the most crucial challenges at this stage is to improve the management of the existing infrastructure stock.

4.32 The proposed PRSC series will support improvements in the management of the energy and transportation sectors through three sets of complementary measures. These are: (i) the adoption of cost-recovery tariffs for energy and transport services, (ii) improvements in the regulatory framework to foster increased private sector participation in the provision of utilities and (iii) managerial reforms in the energy and transportation agencies.

4.33 In the energy sector, since 2011 the GoCV has implemented the key elements of a comprehensive reform program for the electricity sector and the public electric and water utility, ELECTRA. A number of longstanding unresolved issues negatively affected both the operational and commercial performance of the sector, including: (i) insufficient investment in generation capacity, which resulted in chronic power and water shortages; (ii) non-cost-recovery electricity tariffs and inadequate pricing mechanisms; (iii) heavy reliance on imported oil products for power generation; and (iv) weak governance and management structure of ELECTRA.

4.34 Supported by the 3 previous PRSC operations in 2010-2012, the GoCV has worked to address these issues through: (i) a comprehensive investment program covering medium-term needs in the areas of power generation, electricity distribution, and water production; (ii) the establishment of improved tariff adjustment and indexing mechanisms to ensure ELECTRA’s financial viability; (iii) the development of new generation capacity to reduce generation costs and fostering the use of renewable domestic energy sources to diversify the country’s energy matrix and reduce dependence on imported oil; (iv) the managerial restructuring of ELECTRA and; (v) the signature of a result-based management contract between the MoFP and ELECTRA’s Board. Results in 2012-13 have been encouraging both in terms of financial and service delivery, but further actions to promote cost recovery are necessary to ensure ELECTRA’s financial viability. In particular, this new PRSC series is designed to help to improve ELECTRA’s commercial and technical losses from the current 26.2 percent to less than20 percent by 2016.11

Prior Action 5: Approval by Parliament of Law No 24/VIII/2013 establishing the Public Illumination Fee and regulations to facilitate the recovery of arrears to ELECTRA.

4.35 The development of a new regulatory framework for tariff adjustments and the payment of public illumination by municipal governments are essential to ELECTRA’s financial sustainability. In addition, the removal of legal obstacles to policing energy theft strengthening the legal recourse for infractions related to illegal energy consumption is critical for improving ELECTRA’s commercial and financial performance. In this regard, the sixth 11 In addition, the reduction of technical losses could be favored by the enactment of legislation punishing illegal connections which could be a follow up action to be supported by the forthcoming operations under this PRSC series.

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trigger for the PRSC 9 would be the enactment of legislation penalizing illegal connections to ELECTRA network.

4.36 In the transport sector, denser national economic integration and more comprehensive social and economic inclusion continue to be central development issues in Cabo Verde. Promoting greater market access by ensuring that the transportation network connects rural areas to urban centers around the country is crucial to Cabo Verde’s objectives for boosting shared prosperity. The GoCV has invested heavily in its transportation network, spending roughly US$400 million over the last ten years on its maritime and aviation infrastructure. Limited interisland connectivity is a major reason why the tourism industry, and the revenue it generates, is heavily concentrated in just a few islands, with relatively weak linkages to the rest of the economy.

4.37 Limited transportation services are due in part to an inadequate tariff system that results in insufficient cost recovery. The financing of transportation infrastructure through concessional borrowing has encouraged non-cost-reflective pricing policies. Both the maritime and air transportation sectors have greatly benefited over the past decade from the impressive growth of the country’s economy; however, marginal revenues have been declining due to insufficient tariff adjustment.

Prior Action 6: (a) Approval by the Recipient’s Maritime and Port Agency of the Deliberative Act No 12/CA/2013 establishing a new tariff policy for services provided by ENAPOR; (b) Approval by the Recipient’s Civil Aviation Agency of Regulation No1/2013, establishing a security fee of Euro 2 levied on domestic and international flights to be collected by ASA.

4.38 Expected results are increases in cost recovery by the SOEs in transport sector. The new tariff structure of ENAPOR is expected to increase its revenues by US$4 million (or 11 percent of its commercial revenues) while the ASA security fee will generate US$3 million (or 12 percent of revenues from passenger fees). Subsequent PRSC operations will support further efforts to recover costs. The seventh trigger for the PRSC 9 will be an upward review of airport fees and the adjustment of tariffs for regional flight information (FIR) services provided by ASA.

4.39 The PRCS series supports the introduction of performance-based management tools for the maintenance of the road network. Cabo Verde has a relatively dense network consisting of 1,350 kilometers (km) of road spread across its nine inhabited islands—334 km of road per thousand square km, compared to an average of just 81.5 km for Africa as a whole. With Bank support steady progress has been achieved in the institutional reform of the road sector. Key achievements include: (i) the creation of a road maintenance fund that generates approximately US$6 million annually; (ii) the establishment of a dedicated Roads Agency (Instituto de Estradas IE); and (iii) the introduction of a two-year performance-based maintenance contract (PBMC). The eighth trigger for the PRSC 9 will be the signature of at least four PBMCs between IE and its private contractors. The expected result is PBMC management covering at least 60 percent of the country’s paved road network.

4.40 An underlying transportation policy objective is to increase the participation of the private sector in the operation of seaports and the delivery of maritime services. In 2013 the GoCV reviewed and amended the legal framework governing the ports sector, including the 2010 Law of Ports. It adopted new regulations for the sector and revised the statutes governing the Maritime Ports Institute (IMP), which is now the economic and technical regulator of the

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sector, as well as restructuring ENAPOR to expand private port concessions and establishing a new legal base for concession contracts. Expected results are focused on the increased operation of seaports and airport services by private sector investors. In particular, it is expected that at least 3 ports will operate under PPP arrangements by 2016.

Prior Action 7: Approval by the Council of Ministers of the Legislative Decree No 1/ 2013 amending the Law of Ports approved on November 1, 2010, along with new statutes for the Maritime and Port Agency AMP and ENAPOR, a concession agreement between ENAPOR and the Ministry of Infrastructure and Maritime Economy (MIEM) and revised regulations for concessions in the port sector.

4.41 One of the most difficult challenges faced by the transportation sector is the air service delivery. At the core of these challenges is the difficult financial position of Cabo Verde’s national airline (TACV). Due to the unreliability of maritime transportation between islands, air services have become the dominant mode for the development of the tourism sector.

4.42 The weak financial, commercial and operational performance of TACV represents a source of fiscal risks, a constraint on the development of tourism and a threat to the stability of inter-island transportation. TACV’s financial solvency has been hampered for years by an array of managerial and structural issues, including inadequate assessment of route profitability, non-cost-reflective ticket pricing, high labor costs, revenue leakages, lack of appropriate reporting standards and financial controls. TACV not only lacks sufficient revenue to finance capital investments, but is also unable to cover its operating costs, and frequent recapitalizations from the Treasury generate fiscal pressures. TACV’s poor performance is also reflected in rising costs, frequent delays, irregular network connections and poor service quality. In 2011 and 2012 TACV ran deficits of US$18 million and US$30 million, respectively.

4.43 Recent reforms in TACV’s management, however, have been encouraging, and its financial outcomes for 2013 improved substantially. Regular reporting, the publication of audited financial statements, a better accounting system, resumed negotiations with creditors, halting service on certain unprofitable routes, and cost-reducing measures adopted in 2013 are all expected to improve TACV’s operational, financial and commercial performance.

Prior Action 8: Adoption by TACV Board of measures to improve the operational and commercial performance of TACV, including the: (a) closure of five unprofitable international routes; (b) approval of regulations limiting the concession of travel facilities; and (c) adoption of Act No 2/2013 by TACV’s General Assembly of Stakeholders approving the spin-off of TACV’s ground-handling services.

4.44 Given the precarious financial state of TACV a forceful approach to its reform is warranted. The Bank is providing technical assistance to support TACV’s financial recovery and pave the way for its eventual privatization. The ninth trigger for the PRSC 9 will be the approval of a 2-year recovery plan for TACV with an associated management contract signed by the SPE, the Ministry of Transport and Maritime Economy (MIEM) and the TACV Board of Directors. The continuous reform efforts to improve TACV’s operational and financial performance are expected to reduce financial losses from CVE3.2 billion (around 30 million Euros) experienced in 2012 to less than CV1 billion (or 10 million Euros) by 2016.

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(b) Investment Climate 4.45 The second policy area of the growth and competitiveness pillar supports actions designed to improve the investment climate. From 2010 to 2011 an aggressive reform agenda produced strong improvements in Cabo Verde’s business climate. In 2011 and 2012 the Doing Business (DB) report recognized Cabo Verde as one of the top 10 reformers worldwide. The 2014 DB shows a further improvement of 7 ranks, with the country moving from the 128th position to the 121st.

4.46 Following the approval of the investment code supported by the PRSC 7, which eliminated the distinction between domestic and foreign investors and the approval of the TBC (prior action 3 of this proposed operation), the GoCV plans to further simplify investment procedures. The tenth trigger for the PRSC 9 is the establishment of a “single window” system for investments, which will significantly expedite the registry and license of operations by foreign investors, and the concession of tax benefits, which with the new investment and tax benefit codes will also be applied to domestic investors.

4.47 Reduced transaction costs for international trade will improve Cabo Verde’s global competitiveness. Cabo Verde is heavily reliant on strategic imports (i.e. food and fuel). Strategic imports account for almost 30 percent of all imported merchandise. As an island nation with a relatively small consumer market, Cabo Verde faces high structural trade costs, which are exacerbated by administrative burdens.

4.48 After its accession to the World Trade Organization in 2008 the GoCV adopted a number of trade-facilitation measures. These included a reduction in tariffs rates, the elimination of non-tariff barriers, as well as the adoption of a new customs code in 2010, an intellectual property law in 2011 and a new investment code in 2012.

Prior Action 9: Adoption by the Council of Ministers of regulations related to the 2010 Customs Code designed to further streamline customs procedures.

4.49 The proposed PRSC series will support further progress on this agenda. The indicative seventh trigger for the PRSC 10 will be the establishment of a single window for international trade, integrating the port procedures of ENAPOR with the customs procedures of the General Directorate of Customs (DGALF). Consolidating these systems will produce important efficiency gains for both international trade firms and public administrative agencies. Expected results from these reforms include the reduction of days to import from 18 (registered by the 2014 DB Report) to less than 15 by 2016.

4.50 While Cabo Verde’s financial system has proven resilient to the effects of the global financial and euro-zone sovereign-debt crises, pressure on Cabo Verde’s banks has mounted. Investment opportunities diminished, while banks adopted more restrictive lending practices. Monetary tightening since 2012 has increased vulnerabilities of the financial sector. Credit growth has remained weak and financial-soundness indicators have deteriorated. The capital-adequacy ratio fell from 15.4 percent in December 2010 to 13.5 percent in June 2013 while nonperforming loans increased from 7 percent to 20 percent in the same period. The Central Bank of Cabo Verde (BCV) has undertaken important actions to address deteriorating bank performance, enhancing its supervision of commercial banks and issuing a strong recommendation that banks suspend dividend payments in order to build their capital buffers.

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4.51 In view of its financial-sector vulnerabilities, the proposed series will support the authorities’ efforts to strengthen banking oversight and regulation. The eleventh trigger for the PRSC 9 would be Parliamentary approval of the Financial Institutions Law and the Basic Financial System Law.12 The approval of these laws will expand the regulatory and supervisory powers of the BCV, limit BCV-financing of deposit insurance schemes to exceptional circumstances—on a temporary basis only and with adequate safeguards—and consolidate onshore and offshore banking regulations into a harmonized financial code. Strengthened financial regulations are expected to ensure a capital adequacy ratio superior to 12 percent, well above the Basel II suggested level of 8 percent.

4.52 The expansion of financial services remains an important strategic pillar for the development of the economy of Cabe Verde. Poor affordability of financial services, high spreads and reduced access to credit have been identified as major weaknesses of the overall investment climate. Competitiveness through enhanced financial services will be achieved, first, with stability and strength and, second, with efficiency in terms of financial access and costs. In this regard, authorities, with Bank support, have initiated the preparation of a Financial Sector Development Strategy. Therefore, the indicative eighth trigger for the PRSC 10 is the adoption by the government of the Financial Sector Development Strategy.

(c) Skills Development and Labor Market 4.53 This policy area focuses on the PRSC objectives of increasing resilience to shocks, boosting productivity and extending the returns to growth by accelerating human capital formation. As Cabo Verde transitions from a growth model predicated on physical-capital accumulation to one based on the productivity and human capital, flexible labor market institutions and investments in workforce skills are critical to the development of a diverse and competitive service sector.

4.54 In spite of its strong economic growth performance, high rate of net job creation, and the acceleration of human capital accumulation over the past decade, Cabo Verde continues to experience relatively high unemployment rates, especially among vulnerable groups such as women and youth. Informality is also prevalent, and workers in the informal sector typically face lower wages and reduced access to benefits such as pensions, healthcare and unemployment insurance. Although significant gains have been made in the education system, Cabo Verde still faces a number of important challenges in this area, particularly in terms of tailoring efforts to meet the needs of the domestic labor market.

4.55 This policy area supports the GoCV’ efforts to promote human-capital development and to increase the flexibility of the labor market. Cabo Verde has made important strides in promoting greater skills among its population. Illiteracy has been reduced from 63 percent in 1975 to less than 21 percent in 2010. Cabo Verde has reached universal enrollment in primary education, and its gross enrollment rate for secondary education is at 70 percent and tertiary enrollment reached 20 percent of the population. With the support of its development partners, the supply of Technical and Vocational Education and Training (TVET) has substantially increased. However, the World Bank’s most recent Enterprise Survey indicates that a large fraction of firms cite the lack of labor skills as a major constraint.

12 Parliament approved both laws in their generality (first round) in February, 2014. Their definitive approval (both in general and in detail) is expected for early-May.

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4.56 The reform agenda includes the consolidation of the Technical and Vocational Education and Training (TVET) sector. A first step in this agenda is the integration of education, training and employment policies that will enable a better coordination between the three line ministries involved in the sector (ministries of Education and Sports (MED); Youth, Employment and Development of Human Resources (MJEDRH); and Superior Education, Science and Innovation (MESCI)). A second step is the financing of the sector. External aid has played a major role in financing TVET, and guaranteeing the sustainability of the system will now require increased domestic financing, and cost-recovery mechanisms. Third is the effective use of the resources allocated to the sector through a clear definition of priorities and transparent distribution criteria.

Prior Action 10: (a) Adoption by the Council of Ministers of the Letter of Integrated Education, Training and Employment; (b) Capitalization of the Training Support Fund (TSF) approved in the 2013 Budget Law No 23/VIII/201; (c) Adoption by the Council of Ministers of a TSF operational manual.

4.57 High and persistent unemployment rates, substantial informality, and limited connectivity between labor supply and demand indicate a crucial lack of labor-market flexibility, which in turn can be traced to overly restrictive regulations. According to previous editions of the DB report, Cabo Verde’s labor market suffers from serious inefficiencies. The country ranking is the third lowest among small-island states, and 30th out of the 35 countries in Sub-Saharan Africa. The World Economic Forum (WEF) Competitiveness Report for 2012 identified Cabo Verde’s labor-market regulations as one of the most serious obstacles for doing business. Cabo Verde also ranks poorly on the WEF’s 2012 competitiveness index for labor-market efficiency (124th out of 142 countries), due largely to hiring and firing costs.

4.58 The GPRSP 3 contains a series of reforms aimed at removing some of the rigidities in the labor market. Properly balancing labor-market flexibility and worker protection is critical, and reform priorities should be established for labor markets’ most needed areas. Specific policies should include the enforcement of basic labor standards and the reform of contract regulations. As part of the compensation for removing worker protections, the GoCV is also exploring the option of introducing an unemployment program. While these reforms are likely to remove constraints to formality, robust private sector growth will remain critical to increase employment. In this direction, the indicative ninth trigger for the PRSC 10 is the approval by the Parliament of a labor code reform. Expected results from the support to the agenda of skills development and labor market reform are to increase the number of students attending TVET courses from the current 1,500 to more than 5,000 by 2016 and more flexible employment enrollment/dismissal rules reflected in the improvement of the hiring/firing flexibility index from the current 3.4 to 4.5 by 2016.

(d) Environmental Sustainability 4.59 Sustaining the competitiveness of Cabo Verde’s tourism sector and promoting agriculture requires protecting the integrity of its limited and extremely valuable natural capital. Coastal erosion, soil degradation, deforestation and the mismanagement of limited water resources all have a severely negative effect on the country’s growth prospects, and the cost of environmental damage will likely be borne most heavily by the poor. In addition, as a small-

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island nation Cabo Verde faces significant additional challenges associated with climate change, especially rising sea levels and the increased frequency of severe weather patterns, which may provoke increasing droughts and flooding.

4.60 Cabo Verde has established a number of important laws and regulations to control environmental degradation. Cabo Verde has made steady progress on improving its environmental framework, including issuing decrees that define protected areas and requiring environmental impact assessments to be completed for all public and private investment projects. However, weak enforcement capability, a lack of coordination among government entities, poor management of environmental issues and a lack of complementary regulations prevent the full application of the legal framework for environmental protection.

4.61 The proposed operation supports authorities’ efforts to address these gaps. A crucial but underdeveloped aspect of environmental protection is the definition of legal boundaries for protected areas. In 2003 the GoCV defined 47 protected areas that needed to have their legally recognized borders precisely established through complementary legislation. Due to competition between tourism-development zones and protected environmental areas there have been substantial delays in fixing the borders of protected areas. As of end-2012 only 3 protected areas out of the 47 had their legal borders defined. It is expected that at least 40 protected areas out of the 47 protected areas approved in 2003, will have their legal boundaries and managerial plans defined by 2016.

Prior Action 11: Approval by the Council of Ministers of the Regulatory Decrees No 4 through 17 defining the legal boundaries of 14 protected areas in the islands of Boa Vista, Sal, Santa Antao and Sao Vicente.

4.62 In addition, maintaining adequate financing for environmental protection is expected to become increasingly challenging in the coming years. A recent PEMFAR noted that while environmental spending had been relatively high, the drawdown in donor support put environmental spending at risk. The GoCV is taking important steps in this area. The reform of the Ecologic Tax approved in August 2012 represents a significant improvement over the previous law of 2010, and revenues generated by the tax will be allocated to the Environmental Fund, which finances environmental projects at the national and municipal levels. The twelfth trigger for the PRSC 9 will be the definition of the Environmental Fund’s project-selection procedural manual.

4.63 Weak enforcement capability and a lack of complementary regulations at the national level prevent the full application of the legal framework for environmental policy. As a result, unsustainable environmental practices such as illegal beach-sand extraction have been increasing, with negative impacts on tourism and agriculture (due to saline intrusion). The indicative tenth trigger for the PRSC 10 is the approval of the revised legal framework for environmental protection to strengthen enforcement.

4.64 The proposed operation is based on a number of analytical studies and technical assistance activities produced by the Bank over the last two years. These studies provide a solid analytical foundation for identifying prior actions and triggers supported by the PRSC series (see Table 4.1 below).

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Table 4.1: Analytical Underpinnings and Prior Actions and Triggers ESW, NLTA, Policy Notes Contribution to PRSC series and Accompanying

Program Document

Cabo Verde: Country Economic Memorandum (2013) Chapter 2 on Fiscal Sustainability, Chapter 4 on Tax Incentives, Chapter 6 on Labor Markets, Chapter 7 on Tourism and Environment

Overall program. PRSC8 prior actions 1, 2, 8 and 11, PRSC 9 triggers 1,2 and 12, PRSC 10 triggers 1, 9 and 10

Cabo Verde: A Diagnosis of Cabo Verde’s Public Investment Management System (2012)

PRSC 9 trigger 5, PRSC 10 trigger 5

Cabo Verde: Public Expenditure Management and Financial Accountability Review - PEMFAR (2012)

PRSC 8 prior actions 3, PRSC 9 trigger 4, PRSC10 trigger 2 and 3

ELECTRA: From Recovery to Sustainability Study –Public-Private Infrastructure Advisory Facility (PPIAF) (2011)

PRSC 8 prior action 5 PRSC 9 trigger 6

Policy Note on SOEs institutional arrangements (2012) PRSC8 prior action 4, PRSC 9 trigger 4, PRSC 10 trigger 4

Cabo Verde: Inter-island Transport Study (2011) PRSC 8 prior action 7, PRSC 9 trigger 7

Review of the air and port sectors in Cabo Verde (IFC), (2012) PRSC 8 prior action 6, PRSC 10 trigger 5

Cabo Verde: Shaping the Future: How Higher Education can Support the Economic and Social Transformation Agenda in Cabo Verde (2012)

PRSC 8 prior action 10

Non-Lending TA on Social Protection (2013) PRSC 10, trigger 6

Cabo Verde : Policy Note on Macro-Financial Sector Vulnerabilities (2013)

PRSC 9, trigger 11, PRSC 10 trigger 8

C. LINKS TO THE CPS AND OTHER BANK OPERATIONS

4.65 By supporting four of the five strategic axes of the GPRSP 3 the proposed PRSC VIII will be fully consistent with the forthcoming CPS for FY14-17. The CPS is focused on boosting economic productivity in order to eliminate extreme poverty and promote shared prosperity. The forthcoming CPS supports the GoCV’s structural reform agenda, which is designed to: (i) increase efficiency in public-service delivery and encourage responsible macroeconomic management by improving SOE oversight and maintaining fiscal sustainability in the face of recent and external shocks; (ii) strengthen economic competitiveness and the investment climate by supporting the efficient provision of economic infrastructure and services, particularly energy and transport, and enhancing labor skills and labor-market reforms.

4.66 This operation is closely related to three ongoing investment operations and technical assistance (TA) grants. The first is the IBRD’s Cabo Verde Recovery and Reform of the Electricity and Water Sectors Project (RREWSP) designed to support the comprehensive recovery of the energy sector. The second is the Cabo Verde Transport Sector Reform Project (TSRP) that provides TA to the GoCV for the design and implementation of improvements in the management of SOEs responsible for air and maritime transportation, as well as a set of reforms designed to increase the participation of the private sector in the delivery of transport services. The third is the Cabo Verde’s Small and Medium Enterprises Capacity Building and Economic Governance Project (SMECBEGP), which supports improvements in trade facilitation and the investment climate by financing the single-window systems for investments and trade, streamlining business and property registration. Last, the PRSC 8 benefitted from TA financed by trust funds including the Institutional Development Fund (IDF) and the Debt Management Facility (DMF).

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D. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS

Consultations

4.67 The GoCV’s medium-term development strategies are formulated through a consultative, participatory process. The GPRSP 3’s preparation process was led by the DNP at the MoFP, which worked in close coordination with the line ministries, agencies and SOEs. For the preparation of the GPRSP 3, the DNP organized four Consultative Forums (CF) with civil society groups, government agencies, private sector representatives and development partners. The fourth CF was held in November 2013 to assess the GPRSP 3 first-year’s results.

Collaboration with Development Partners

4.68 Cabo Verde’s major bilateral and multilateral donors have harmonized their budget support through a common policy matrix based on the GPRSP 3. Six donors comprise the Budget Support Group (BSG), which signed a Memorandum of Understanding (MoU) in 2006. Under this MoU, the “Partnership Framework between Budget Support Partners and the GoCV for the Provision of Budget Support”, the BSG supports the GPRSP 3 in ten policy areas. The BSG consists of the African Development Bank, the European Union, the Luxembourg Agency for Development Cooperation, the Government of Portugal, the Spanish Agency for International Development Cooperation and the World Bank. BSG members conduct joint reviews twice a year, which reduce transaction costs for the government and promote harmonization. The Bank is the current BSG coordinator and in the absence of an IMF program, the Bank has assumed the responsibility of providing macroeconomic assessments to the other BSG members.

5. OTHER DESIGN AND APPRAISAL ISSUES

A. POVERTY AND SOCIAL IMPACTS

5.1 The reform program supported by this operation is expected to have positive long-term impacts on poverty and social conditions in Cabo Verde. The reform program supported by the proposed operation is expected to reduce poverty and boost shared prosperity through increased productivity, improvements in labor-force skills and more employment opportunities for vulnerable groups, especially women and youth. Improving the efficiency of infrastructure and expanding social-service delivery is expected to benefit the poor through increased access to essential services, reduced transportation costs, lower import costs, and the economic integration of less-developed islands through improved inter-island transport services.

5.2 The proposed labor-market reforms are expected to have positive direct effects on poverty as they aim at boosting labor demand and promoting formality. Current labor market legislation is one of the major factors negatively affecting labor demand and the quality of jobs, which mostly affects the most vulnerable groups. Reduction of hiring and firing costs and less restrictive employment and contract rules are expected to reduce incentives for informality, which mainly affects young, less qualified workers and women. As any labor market reform, some workers protected by the existing legislation are expected to be worse-off. Of course, labor market reforms need to be complemented by policies designed to enhance labor skills, therefore, the proposed PRSC series also includes support for TVET to improve

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employability, boost labor productivity, increase labor income and reduce unemployment. Furthermore, it is worth to mention that the first pillar of this series also supports the streamline of social protection programs to improve targeting and adequacy of benefits and reduce gap coverage, improvements that could compensate probable negative effects of labor market reforms.

5.3 The broadening of the VAT tax on utilities and transportation is expected is to have a positive effect on income distribution because the regressive nature of the implicit subsidy to the consumption of these services generated by the partial exemption of the previous VAT regime. In any case, to mitigate the negative impact of the increase of the VAT tax base on the income of the poor, authorities excluded from the IVA reform the consumption of butane gas which is the main energy cost for the poor, this exclusion will attenuate negative distributional effects of the broadening of the VAT base.

B. ENVIRONMENTAL ASPECTS

5.4 The specific actions supported under the proposed PRSC VIII are likely to have positive effects on the country's environment, including the integrity of its agricultural land, forests, fisheries and other natural resources. In particular, the second pillar of the proposed PRSC VIII is expected to have positive impacts on the environment. Higher revenues generated by expanding the Ecology Tax and the enhanced management of these resources through the Environmental Fund are expected to improve the management and financial capacity of the environmental sector. Meanwhile, defining legal boundaries for protected areas will help to ensure the sustainability of the country’s most valuable natural asset, its natural beauty.

5.5 Improving evaluation mechanisms for public investment projects is expected to further enhance the preservation of natural assets. The NIS will include environmental impact assessments as an important criterion for public investment decisions. Environmental aspects of Cabo Verde’s economic development and policy reform agenda are part of the BSG’s consolidated matrix. This matrix identifies critical prior actions and establishes a set of results indicators, which are currently closely monitored. Following the interruption of budget support by the Spanish Cooperation in 2012 the Bank has assumed the leading role in the BSG dialogue with authorities on the country’s environmental agenda.

C. PFM, DISBURSEMENT AND AUDITING ASPECTS

5.6 PFM and procurement systems in Cabo Verde are generally sound. PFM was one of the core policy areas of the previous PRSC series, and improvements in this area have been highly satisfactory. A recent PEMFAR prepared in 2012 highlighted the substantial improvements that have been made in recent years and designed a reform plan for further improvements. The budget laws are timely published, fiscal reporting is regular and the coverage of the budget is reasonable. The successful implementation of the reform agenda defined in the 2004 Country Procurement Assessment Review and a major capacity-building program to train public-sector staff on new procurement procedures have been highly successful and the country has one of the most sophisticated and transparent procurement systems in the Africa region. However, performance in other critical areas, such as accounting, external audits and legislative oversight, still requires improvement. A recent IMF-Bank-EU joint mission in October 2013 prepared an action plan for a second generation PFM-reform program designed to address these

31

weaknesses. Indeed, the proposed PRSC series supports the adoption of budget programming, enhanced external controls (through the adoption of a new Court of Accounts Law) and the review of the procurement code. Technical Assistance by the Bank and other partners is being provided for the adoption of accrual accounting.

5.7 The IMF’s most recent assessment of the BCV was carried out in 2008. The assessment found that while the BCV has taken steps to strengthen its safeguard framework since the previous assessment. Further measures that have since been undertaken to strengthen the safeguard framework include the adoption of International Financial Reporting Standards (IFRS), the development of reserves-management procedures, the introduction of an internal audit function, and the rotation of external auditors. Notwithstanding these advancements safeguard challenges remain. The BCV adopted remedial actions to address these issues. Further fiduciary safeguards are not needed at this time.

5.8 Disbursement. The proposed operation would consist of a single tranche of SDR10.1 million (US$15.5 million equivalent) to be made available upon effectiveness and disbursed on the basis of a withdrawal application. The credit will follow the Bank’s disbursement procedures for development policy lending. The credit will be deposited with the BCV into a dedicated account that forms part of the country’s official foreign-exchange reserves. The Recipient shall ensure that upon the deposit of the credit into said account an equivalent amount in Cabo Verdean Escudos (CVE) is credited in the Recipient’s budget management system in a manner acceptable to IDA. The Recipient will report to the World Bank the amounts deposited in the foreign-currency account and credited to the budget-management system. Disbursement will not be linked to specific purchases. If the proceeds of the credit are used for the ineligible purposes, as defined in the Development Credit Agreement, IDA will require the Recipient to refund an amount equal to the amount of said payment to IDA promptly upon notice from IDA. Amounts refunded to the Bank upon request shall be cancelled.

5.9 Auditing. Through the MoFP the Recipient will: (i) report, within one week from the date of receipt, the exact sum received into the account; (ii) ensure that all withdrawals from the dedicated account are for budgeted public expenditures, excepting military expenditures or other items on IDA’s excluded expenditure list; and (iii) provide IDA with evidence that the Cabo Verdean currency (CVE) equivalent of the Credit proceeds were credited to the Single Treasury Account and that disbursements from that account were for budgeted public expenditures. The CoA is expected to provide IDA with its annual report to Parliament on the public accounts by the end of the year following the execution of the budget. IDA will reserve the right to request an audit of the dedicated account should the need arise. If an audit is requested, a legally registered audit firm will be contracted to perform the audit in accordance with terms of reference to be agreed upon with the Government. Audit costs will be met by the Government.

D. IMPLEMENTATION, MONITORING AND EVALUATION

5.10 The DNP at the MoFP will be responsible for the overall implementation of the proposed operation and for reporting on its progress. The Bank will vet the prior conditions for effectiveness and disbursement. It will be the responsibility of the DNP to present this information in a timely manner and in a format satisfactory to the Bank.

5.11 The M&E system that supports the implementation of the GPRSP 3 will be instrumental to assessing progress on the reforms included in the proposed PRSC series.

32

Since the previous PRSC series, the World Bank team has worked in close collaboration with the GoCV and its budget support partners to ensure adequate monitoring and evaluation. The GoCV and the BSG have agreed upon a matrix of indicators that is reviewed biannually to assess progress in the different policy areas supported by the group.

6. SUMARY OF RISKS

6.12 Risks can be classified under three main categories: external, domestic and operational. External risks are considered moderate as the global scenario remains uncertain but the recovery of the global economy seems to be underway. However, there are downside risks associated with major developed economies, especially the Eurozone. A further deterioration in external conditions would have detrimental effects on Cabo Verde’s growth trajectory and fiscal accounts, and the country’s exports, remittances and foreign direct investment flows. The macro-fiscal framework and reforms supported by this proposed operation are expected to enhance the country’s resilience to further adverse shocks.

6.13 Domestic risks associated with the macro-fiscal framework and the authorities’ policy stance are considered low. Renewed adverse shocks to economic activity would negatively impact revenues and may prompt further countercyclical policies, which would worsen fiscal revenues. However, authorities have demonstrated a strong commitment to fiscal adjustment that substantially mitigates this risk. Recent Bank TA has assisted the GoCV in setting up a credible MTFF to independently design regular MTDS’s and DSA’s. This allows for a close monitoring of costs and risks on future borrowing. Furthermore, the BCV’s commitment to maintaining sound monetary policies and the MoFP respect for the limits on domestic borrowing will attenuate risks of an exchange-rate crisis.

6.14 Risks related to the private sector’s ability and willingness to respond positively to the government’s structural reform agenda are considered high. A pivotal assumption behind the structural reforms supported by the PRSC series is that the private sector will become the country’s primary engine of economic growth as the government scales back its investment program. However, it is unknown whether the incentives created by the government’s strategy will be sufficient to induce the level of private-sector growth that the strategy envisions. The robustness of the structural reform agenda, the active participation of the private sector in the preparation of the GPRSP 3 and permanent dialogue between the government and private stakeholders mitigate partially these risks.

6.15 Political economy risks for sensitive reforms are considered moderate. Some of the reforms supported by the proposed series of operations which require Parliamentary approval are expected to find opposition, in particular the reforms of SOEs and labor market institutions. Nevertheless, the Government has been very effective in building consensus on the diagnosis of the country’s development challenges and the need for reforms during the preparation of the GPRSP 3. Given that the next national elections are not due until 2016, there is sufficient time to implement a strong program of structural reforms. The reform agenda to be supported by this proposed series in 2014 and 2015 is being accompanied by a communication and implementation strategy which has been reflected in the participatory nature of the preparation of the GPRSP 3 which involved representatives of the private sector, managers of the SOEs, civil servants and other stakeholders. Previous to the presentation of the draft labor code reform, the government

33

organized several consultative forums in order to reduce natural resistances to this critical reform.

6.16 Finally, operational risks are moderate. While by regional standards Cabo Verde’s institutional and technical capacity is remarkably strong, the limited number of technical staff in several core ministries poses some implementation risks. The reform of SOEs is particularly challenging, as it involves special processes that are not routine for the relevant agencies. To address this risk the BSG, and the Bank in particular, have made available a combination of capacity-building assistance, technical support and sector-specific investment operations, which will substantially improve prospects for success in the reform areas supported by this operation. In particular, as mentioned above, Verde Transport Sector Reform Project (TSRP) dedicates specific TA to the strengthening of the SOE unit at the MoFP which is expected to improve the ownership control of SOEs.

6.17 In summary, this risks assessment suggests a moderate level of risks surrounding the implementation of reforms supported by the proposed PRSC series.

34

ANNEX 1: POLICY AND RESULTS MATRIX

Component Prior Actions PRSC 8

Triggers PRSC 9

Indicative Triggers PRSC 10

Results Framework 2012 Baseline

2013 Baseline

2014 2015 2016 Target

Pillar 1: Good Governance and Public Sector Efficiency

Domestic Revenue Mobilization

Approval by the Recipient’s Parliament of the 2013 Budget Law No 23/VIII/2012 which contains measures to augment domestic revenues, including: (i) increasing the value added tax (VAT) rate applied to hotels and restaurants from 6 percent to the standard rate of 15 percent; (ii) increasing the VAT collection base for energy, water, communications and road-transportation services; (iii) expansion of the tax base of the Ecological Tax; (iv) establishing a “tourism fee” of Euro 2 per guest-night; and (v) establishing a statistical fee for custom services

Approval by Parliament of the Tax Benefit Code (TBC)

Approval by Parliament of the General Tax Code, the Judicial Procedures for Taxation and the Tax Execution Code*

Submission to Parliament of the reform of the Individual and Corporate Income Taxes

Satisfactory implementation of the tax administration strategic plan

Domestic revenue to GDP ratio (%)

Overall deficit to GDP ratio (%)

Total financing to GDP ratio (including on-lending to SOEs) (%)

21.0

9.8

13.5

21.1

7.7

12.8

24.0

lower than 6

lower than 10

35


Triggers PRSC 9



2013 Baseline

2014 2015 2016 Target

Public Financial Management

Approval by the Recipient’s Council of Ministers of Decree-Law No 20/2013, establishing the legal framework for the Single Treasury Account which introduces a unified document for the collection of taxes and non-tax revenues and consolidates all bank accounts held by different ministries and public agencies into a single account held by the Recipient’s General Directorate of the Treasury (DGT).

Parliamentary approval of the revised Budget Framework Law

Parliamentary approval of amendments to the GoCV’s procurement system legal framework

Parliamentary approval of the proposed CoA law

Percentage of ministries and government entities in the Single Treasury Account (%) Percentage of sector ministries implementing programmatic -based budgeting (%)

0

0

80

100

100

100

SOE’s Oversight and service delivery quality

(a) Adoption by Council of Ministers of the Decree-Law No 37/2013 which expands the mandate of the Recipient’s State Participations Service (Servico de Participacoes do Estado (SPE); (b) issuance of the State Owned Enterprises (SOEs)s Aggregate Contingent Liability Report of 2012; and (c) presentation of

The signature of at least three additional result-based management contracts with the major SOEs

Establishment of an M&E system at the SPE for monitoring SOEs’ financial, technical and service-delivery indicators

Consolidated net result of the 5 main SOEs (in million CVE) Contingent liabilities of SOEs (in billion CVE)

Number of SOEs with result-based management contracts

-491.5

18.2

1

Positive

lower than 15

5

36


Triggers PRSC 9



2013 Baseline

2014 2015 2016 Target

the 2012 audited financial statements of ASA, ELECTRA, ENAPOR, IFH and TACV.

National Investment System

Submission to the Parliament of a new organic law for the government’s planning system that establishes the legal basis for the National Investment System

Establishment of a project appraisal unit at the National Directorate of Planning (DNP) and the issuance of a public investment manual

Percentage of new public investment projects financed by the budget appraised by the NIS (%)

0

higher than 50 percent

Social protection

Operationalization of the URB and the approval by the government of a law it institutionalizes

Percentage of social protection programs using the URB (%)

0

75

37


Triggers PRSC 9



2013 Baseline

2014 2015 2016 Target

Pillar 2: Competitiveness, Private Sector Development and Labor Productivity

Infrastructure Management

Approval by Parliament of Law No 24/VIII/2013 establishing the Public Illumination Fee and regulations to facilitate the recovery of arrears to ELECTRA;

(a) Approval by the Recipient’s Maritime and Port Agency of the Deliberative Act No 12/CA/2013 establishing a new tariff policy for services provided by ENAPOR; (b) Approval by the Recipient’s Civil Aviation Agency of Regulation No1/2013, establishing a security fee of Euro 2 levied on domestic and international flights to be collected by ASA.

Approval by the Council of Ministers of the Legislative Decree No 1/ 2013 amending the Law of Ports approved on November 1, 2010, along with new statutes

Enactment of legislation penalizing illegal connections to ELECTRA network

Upward review of airport fees and the adjustment of tariffs for regional flight information (FIR) services provided by ASA

Signature of at least four PBMCs between IE and its private contractors

Electra net result (in million CVE)

Electra technical and commercial losses as a share of total energy generation (%)

Number of ports Public Private Participation arrangements in place

ASA Revenues (in million CVE)

Roads in good and fair condition as a share of total national roads (%)

-823.5

26.2

0

648

50

Positive

lower than 20

3 750

80

38


Triggers PRSC 9



2013 Baseline

2014 2015 2016 Target

for the Maritime and Port Agency AMP and ENAPOR, a concession agreement between ENAPOR and the Ministry of Infrastructure and Maritime economy (MIEM) and revised regulations for concessions in the port sector.

Adoption by TACV Board of measures to improve the operational and commercial performance of TACV, including the: (a) closure of five unprofitable international routes; (b) approval of regulations limiting the concession of travel facilities;; and (c) adoption of Act No 2/2013 by TACV’s General Assembly of Stakeholders approving the spin-off of TACV’s ground-handling services.

Approval of a 2-year recovery plan for TACV with associated management contract signed by the SPE, the Ministry of Transport and Maritime Economy (MIEM) and the TACV Board of Directors

TACV’s net result (in billion CVE)

TACV’s cabin factor (%)

-3.2

60

higher than -1.0

70

39


Triggers PRSC 9



2013 Baseline

2014 2015 2016 Target

Investment Climate

Adoption by the Council of Ministers of regulations related to the 2010 Customs Code designed to further streamline customs procedures.

Establishment of a “single window” system for investments

Parliamentary approval of the Financial Institutions Law and the Basic Financial System Law*

Establishment of a “single window” system for trade

Adoption by the government of the Financial Sector Development Strategy

Time to import (days)

Time to export (days)

Number of investment projects processed through the single window for investment

Capital adequacy ratio (Basel II) for the overall financial sector

Non-Performing Loans (NPL) as a share of total loans

18

19

0

13.5

20

less than 15 days

less than 12 days

30

higher than 12 percent

lower than 12

Skills Development and Labor Market

(a) Adoption by the Council of Ministers of the Letter of Integrated Education, Training and Employment as evidenced by the Boletim Oficial No 59, dated November 1, 2013; (b) Capitalization of the Training Support Fund (TSF) approved in the 2013 Budget Law No 23/VIII/201; (c)

Approval by the Parliament of a labor code reform

Rigidity of Employment (0 best–100 worst)

Firing / Hiring Flexibility (1 worst–7 best)

Number of beneficiaries of TVET programs (in thousands)

46

3.4

1.5

30

4.5

higher than 5.0

40


Triggers PRSC 9



2013 Baseline

2014 2015 2016 Target

Adoption by the Council of Ministers of a TSF operational manual.

Environmental Sustainability

Approval by the Council of Ministers of the Regulatory Decrees No 4 through 17 defining the legal boundaries of 14 protected areas in the islands of Boa Vista, Sal, Santa Antao and Sao Vicente.

Definition of the Environmental Fund’s project-selection procedural manual

Approval of revised legal framework for environmental protection to strengthen enforcement

Percentage of new projects with EIA audited by DGA

Number of protected areas with legal definition and management plans defined

10

3

70

higher than 40

* These triggers have been already met.

41

ANNEX 2: LETTER OF DEVELOPMENT POLICY

\\ \lllikar abral ( P•" JU, Prua Rt,lubh\-a dt( lilt..\ ll'fdt lrlf:1 B~t:t~o~~ou 4 !'0 1 lu: (•2.\StlOI ·c, B

IS'" November 2013

Topic: Letter of De•·elopmtnt Policy

\ir. Jim Yon2 Kim Pmiident of ihe World Bank 1818 H Stttt. NW Washington. DC 20433 us.

Dear Mr. Kim.

On behalf of the Government of Cabo Verde (GOCV), I am requesting a development policy credit in the amount of US$15 million from the International DeveiOI)tllcnt Association (IDA) to support our program of structural refomts included in our tCccnt Third Growth and Poverty Reduction Strategy Paper (GPRSP II() covering the rcriod 20 12· 16. :be aforemenrioncd development policy credit is the first operation of a •cries or 3 prug:rammali.; cJ&:H!IUj)IIU.:Ut jJUii'-)' Operations and \.\>ilJ help US CO mCCC f'inot~cing needs the GOCV faces for the implementation of our GPRSP II( in a conte<t of the global slo·.vdo"n that has been reflected in our country in declining GOP growth and impacting advet'S<?Iy govmunent re• emJeS.

This leuer briefly d=ribcs the mt1111 objectives of the GPRSP Ill, on;oing macroecooomic adjustment efforts and the structural reform agenda that "e arc implemen:ing.

The GPRSP !11.

Based on the assessment of Caho Verde's comparative advantages and rccognitirs the difficult cxtemaJ environment racing Cope Verde and the transition to middle-ircomc country (MIC) status, the GPRSP-111 nims at operationalizing through structural re,.orms and programs the government's objective of "building a dynamic, competitive and inclusive economy".

The GPRSP Ill is an instrument that implements the Agenda for Economic Transformation by structurina. in the multiannual framework. measures and actions for meeting the objectives laid do"n in Otc Go•·cmment Program of the 8"' Legislature for 2011-16. The main goal of the Agenda and the Program is to promote shared utd a more robt.st economic gro"1h "ith opportunities for all as the dri,er of poveny and inequaliry reduction. In this frame"ork, macroeconomic stability and good go•crr.ance, job crearion. impro'"ements in hum.an capital devclopmn1\ and an PnMnrNnt"fll rnle nf the pri\-att sector. "bich is e\peeted to become the ccooomy's main rngine. are ~ey pillars of the GPRSP.

42

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fa -~.

I A !\111\'JSTHA

Macroeconomic situation and government policies

On the macroeconomic front, the context of the uncertain international economic environment has taken a toll on the caboverdean economy and the budget policy that has been followed in the last four years has sought to compensate the impacts of the global economic and financial crisis. The recent historical GOP data disclosed by the National Institute of Statistics (INE), which reveals a more pronounced impact from the economic crisis on national output than had been previously estimated, has further added to the case for the use of counter cyclical stimulus to the economy. The Government's support to the economy through the investment program attempted to mitigate the negative impacts of the crisis on national demand and investment. Furthermore, the investment program is a necessary condition to increase competitiveness by alleviating chronic infrastructure bottlenecks and reducing the cost of factors in the medium-long term.

Furthermore, the Public Investment Program (PIP) is heavily connected with Cabo Verde's graduation from the United Nations (UN) Least Developed Countries ' list in 2008. By occasion of the transition to a Middle Income Country Status, development partners agreed in the establishment of a transition window that enabled the country to continue access concessional resources to fund infrastructure projects that would alleviate chronic bottlenecks to the development of Cabo Verde. This window also provided a fundamental and sustainable source of funding to adopt anti-cyclical measures to counter the effects of the international crisis on the caboverdean economy. The National Accounts published by the INE regarding the period from 2009 to 2011 demonstrate that these anti-cyclical measw·es were dully and t imely implemented and prevented the national economy from diving into a recessive wave.

Meanwhile, the global and domestic slowdown in economic activity led to a strong revenue fall that combined with our investment program resulted in high fiscal deficits and increasing indebtedness. To reverse this situation, since the beginning of 20 13 year, the GOCV has been adopting revenue enhancement measures including a broad tax reform on our Value Added Tax (VAT), establishment of a touristic fee, improvements on tax administration (technically supported by the fMF) and the increase of cost recovery measures for the services provided from our main State Owned Enterprises (SOEs). On the expenditures, tight controls on recurrent spending and the cancellation of some of our investment projects are expected to reduce total spending, resulting in the reduction of our overall deficit.

The 2014 budget and the mid-term programming (20 14-20 17), taking into account recent developments, reflect conservative estimates on revenue performance and a containment effort on the expenditure side in order to safeguard the principles of public debt sustainability and the alignment of the economic activity with the potential growth of the economy. The programming of revenues and expenditures has been discussed with the World Bank in a mission in August. The Bank team considered that estimates are realistic and that the phasing out of the public investment program should occur gradually in order to still mitigate potential negative effects on economic growth. The fiscal revenue is expected to reach 18.4% of GDP in 2014, a 0.6% percentage-points increase compared to the current year. In the midterm, it is expected that revenues might

43

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I ~~ z. ~ach 19.2% ofGDP by 2017 due to the imp:>et of theta.< administration reforms. the new tax sources, and the dynamic of the economy itself.

On the real economy front, some signals of recovery have been observed since the second quarter of 201 3. Positive results were noted in important economic sectors in 2012 reflecting the impact of a slight recovery in the economies of our main international pai1Jlers and the completion of some of our in'·esunent projects and structural reforms. \\'e highlight the e.xcellent performance of the tourism sector. Infrnstruetune improvements. repositioning of the counll) as an attracti' e destination, the promotion of ne" markets and the political stability had contributed to the growth of tOurism. In 2012 the number of tourists reached 533.877, an increase of 12.3 percent, overnights increased 17.9 percent. This positive evolution of the sector represented a rise in the tourism revenues of 21 percent and a 4 percent in the jobs creation. Data up to September indicates that these trends have been maintained and we expect to close the )eat ";tb an increase of at least 10 percent in the number of tourist and revenues of more than 15 per ccot.

In the agriculture sector investments focus on the increasing collect. storage and distribution of spring· fed and rain· fed water resources, enabling farmers to irrigate their fields trough new eflicient technologies which a re contributing to improve agricultural productivity and promoting agri-business. Extension of irrigated land and increasing watct· supply reliability Me lilcilitating a shill from low·valuc, rain-fed subsistence agriculture (such as com and beans) to high-value honicultural and fruit c rops. For example. the StOrage capacity in dikes retention/funding and reservoirs have increased noticeably by 99.8 percent in 2012 compared to 2010. irrigated areas with drip irri&atioo system 91.5 percent and total area ofh)dropooic production units 400 pen:ent.

The fisheries sector is performing well. It represents more than 800/o of good expons, the capture capacity is estimated between [36,000-44,000] ton/year and the cxpons over 1,000 container per year. In 2012 the incorporation o f national fisheries products in the industry of transformation activity increased 11 5 percent.

In the transport sector, '"e register a reco\'c:ry in passengers and containers flows in cabo,erdean ports. The national airports are recei,;ng more international flights. \Vith a 12 percent growth in 2012 and the number of passengers increased by 3 . 7 percent, reOecting the in' estrnent eapacit> impro,·ement in the transport sector.

Concerning the energy sector. Cabo Verde is striving to overcome one of its major development challenges - reduce dependence on fossi l fuel for energy generation, nevenheless the country has already attained its goal of 25% energy generation from renewable resources. Large investments in the sector resulted in an increased from 89 MW to 156M\V in 2012 and an increase in the coverage increased from 85 percent to 96 percent. Moreover. renewuble energies represent 25 percent of our installed electricity capacity. Last but 001 the least, institutional, regulatory and managerial reforms supponed by the World 8anJ.. in recent years are beginning to generate posithc results reOectcd in the improvement of the financial situation of our Electricity and Water utility ELECTRA which will enable to sustain the improvements described here.

Concerning the investment program specifica lly, it should be noted that major ne" projects will not be pursued in the near future considering the priorities of debt

44

' . '" ... ...

consolidation and susroinability. The current focus now is the conclusion of ongoing investments. Certain recemly commissioned projects such as the Praia international airport expansion or the technology park remain on the pipeline in the context of the development strategy and were considered in the debt sustainability analysis prepared by my team with the support of the World Onnk. In the near future we will put in place a national investment S)'Stem that will enable to improve the q uality of future investments opportunities. With the support of donors. the government is undertaking studies to determine the potential of new dams and will only mO\'e forward with new projects in this area once the strategy for the de,·elopmcnt of associated rural areas and agribusiness clusters is properly concti\ed and safeguarded.

ln tbc 2014 budget. the Go'emment \\ill continue to favor the maintenance of macroeconomic stability through a cautious fiscal and budget policy. lbe o'erall deficit is projected at 7.4% according to the lstest Mediwn Term Fiscal Frame"ork, total ~enues are projected to rise at a realistic 2.7% in 201-J laking into aceount in a consen'alive fashion both the ne\\ sources of revenue and the UL~ administration n:fonns now laking place. On the expenditure side, the effort to consolidate the public investment program will continue and capilal expenses "ill reach an expected 7.5% of GOP in 2014 doom from the 8.2% of the 2013 reprogramed budget. Due to the nature of the project cycles, now in a conclusion stage. and in accordance with debt sustainabil ity parameters, the public investmem program will reduce in volume durlng the next fiscal years. The Medium tern> Expenditure Framework also envisages a prudent framework put in place. The 2013 budget execution reprogranuning a lready pro,•ides examples of important measures of precautionary cuts specifically in: goods and services purchase (30%); fuel expenses (30%); travel and subsistence (40%); variable remuneration (10%); investments by public autonomous funds and services (between 30 and 50 depending on the entity) and freezing acquisitions of non-financial assets.

SlructuraJ reform agenda

The: Third Growth and Po,·ert)• Reduction Strateg) Paper (GPRSP 111) aims at accomplishing the goal of creating a dynamic. competitive and sustainable econom) in order to enable an en' ironment for inc lush c growth that "ill reduce povert). Considering its cross-sector nature, the GPRSP Ill imposes several simultaneous structural reforms that "'II aim to empower the development of the private sector nround the anchor sectors of competitiveness - agribusiness. tourism and the sea cluster. The agribusiness sector for example will open up opportunities to rural populations by interlinking the production capacity with tourisl'l'l demand for products and services, hence enabling the reduction of unemployment and poverty in areas traditionally hardest hit by lack of economic opportunities.

On tbe sea cluster, an important set of reforms is taking place on the fisheries sector seeking to leverage the good expon results in recent years. The strategy "ill seek 10

promote a national ,·aJue chain for competith c endemic species. Specific measures will include enhanced quality control and product certification: investments in modem~ freezer facilities (a competiti'e advanta£e in the sub-region): consolidation of the ongoing investments in modem ports facilities: attracting foreign and domesti

45

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companies, amongst others. The tourism sector, a defining anchor of the country's service economy as it is, ";n comprehend a broad SCI of measures seeking to diversify the tourism product into new high potential niches (rural. adventure, spons) and impro,·ing authorities' capaeity to conduct proper monitoring and evaluation of e\isting projects \\ith a strong focus on safeguarding environmental sustainability.

In effeet, the nature and substanCe of the public investment program elTon converges with the vision for competitiveness of the national economy. Furthermore. the investments will continue supporting key projects in enhancing the quality of education and health services and sponsoring cross sector reforms in the area of good governance (e-governance, state reform, and judicial system).

In simultaneous with competitiveness clusters specific reforms, the ovemll reform agenda "ill look to tackle and advance cross sector issues. The first great pillar of the agenda is the maintenance and enhancement of good macroeconomic go,·emance. In order to face the DC\\ challenges brought on by a more ' 'olatile international en,;ronment, it is important that SC\er&l ke> reforms ongoing in the area of public finance management be continued and complemented in order to increase the country's macro-fiscal resilience. The Government "ill continue adopting the necessaty measures for fiscal alignment, taking into account recommendations made by partners, and >Vbich will include the improvement of the efficiency o f tax collection (with advances already seen in the ongoing restructuring of the tax administration and its directorate general) and through the careful oversight o f the public investment program. Other important advances on the fiscal legislative front that are expected to increase revenue and ochieve a beuer fiscal balance arc the harmonization of the VAT in critical sectors such as towism as \\ell as the revision of the investment code and associated taX benefits diploma. The implementation of additional revenues sounces sueh as the tourism sun:harge and the statistical taX are expected to di\ersify the base of re' enue. Still on the legisloti\e dimension. the overhaul of major fiscal diplomas continues - e .a . C6digo Gert1l Trib1116rlo; C6digo de ExecufiJtJ Trlb111drlos: C6digo tk Proceuo Tributario and is now in n lina.l review by the Parliament.

Other key refonns in the public finance management area continue to advance ond will aim to increase the efficiency of resource planning at the central administrmion level according to the newly updated PEMFAR based reform action plan. The operation of the single treasuty account has already made significant advances in improving the Government's cash now management and predictability. In 2013. we introduced program-budaetina "hich represent a stron& impro,·ement in our public finance management. The consolida1ion of this process "iU be reOected in the submission of a new budget organic Ia" that \\ill make legal the changes in budget management that an: already in place. The o' emU debt management reform "ill seek to increase and broaden the marketability of government debt securities to domestic and international sa' ers and hence reduce the costs of indebtedness. The aspect of strengthening the in-house assessment and management of debt risks is a lso a priority (particularly those related to s tate owned enterprises). The area o f public procurement has seen noted advance in the regulatoty and legislative front and is now advancing toward e-procurcment solution that can further increase tmnsparcncy, reduce the costs of transactions and broaden scope of potential suppliers to the Government.

46

\\, .\mll,•r C o&bul ( P n~ .10, f'ull R~pUM•u ,1.-' tt- '- tr..t .. Ttlf ' 111 l-.1\: - ·111 ;•I

The es~ablishment of a ne" National Planning System (SNP) provides a more ample frameworl. to understand the full scope of public finance management reforms. The creation of a solid mechanism for policy =at ion. analysis and implementation remains a challenge that "ill "make or break- a successful implementation of the GPRSP Ill and the achievement of its vision. The SNP is made up for four subs)'stems. The first is monitoring and e\ aluation seeking to link the resource allocation to measures of physical execution and outcomes. The programmatic reform of the State Budget to include all GPRSP Ill programs. each with a logical framework for indicators and outcomes, is a significant step in thnt direction. Significant challenges remain considering tlte complexity of this reform, the associated in-house development of the necessary information technology platform, and the learning curve involved with all sectors. Secondly. the national im·estment system will seek to promote a comprehensive frameworl< for ~x ante cost benefit analysis and tx post impact as~ent of capital expenditure. This \\ill be essential in order to look for those projects which \\ill yield the highest return on in' cstment and ensure that scarcer public im·estment resourees are used to the highest possible utility to the populotion and economic agents. The system will also deal with the careful anal) sis of recum:nt costs associated with some of the major infrastructure projects and will examine new cost sharing mechanisms such as public privote partnerships. The third pillar, national statistics system, will a im to enhance the ti meliness and quality of output data across a range of socioeconomic domains. This is absolutely c ritical to ensure that policy makers and other economic agents, including donors and creditors, have access to the right information for decision making purposes - with a special focus on the essential monitoring and t\'llluation of the GPRSP Ill. Concrete actions are already being taken which include the institutional strengthening of INE and the timely pro,ision of the required national accounts dala outputs. Last but not least. the geographic information system will seek to le' erage information technologies to resolve the issue of territorial planning by creating an infonnation platfonn easily accessible to public. private and civil society stakeholders for issues of land usc. regulations and custody amongst others.

The refonns above mentioned in the area of overall macroeconomic and PFM will continue to r<!quire close support from our development partners. especially those in the Budget Support Group which is currently led by the World Bank. The GPRSP Ill furthers highlights as a pan of its reform agenda a critical area for improvement -ownership and control of state owned enterprises (SoEs) - that constitutes a multidimensional challenge spanning not only the management of the contingent fiscal risk but also the service IC\·el of these companies as key enablers of the cornpetitheness of the countT). The signature of performance management contracts \\ith ke> public utilities - Electm has been a key and successful step and we plan to replicate it to other SOEs. The overall broad refonn of the SoEs and strengthening of the Government's ownership and control capacity remains however a dense challenge and further measures are required. These companies mus1 be ublc to utilize and achieve returns on many of the public infrastructure projects recently concluded. Only then will a private sector driven economy around the above mentioned c lusters be possible.

In this sense. the transport and energy SoE infrastructure companies will receive heightened attention in these reform processes aiming to improve the associated

47

-\\, -\mll••r C uhrll CP n• JU, f'11111

Rtputlhn •I' ( 1ht> \ trolr Ttlf.. •.t II ln: :'"'1 efficiency and service delivery le,el. Specifically on lranSpOn. a series of measures recently published in a sector policy letter and the amendment of the Ia" on pons. which will enable concessions (including the restrUCturing of pon openuor ENAPOR). the re\'ie" of the pon authority. a tariff re•ision already executed by the pon operator. to foster the participation of the private sector. The focus on transpons will also prioritize the restructuring of the national airline TACV. The reorgani1.ation of the business units notably through the spin-off of the handling services is already underway and scheduled to be completed by June 2014. The energy sector will also sec significant changes, specifically in the ability of the util ity ELECTRA to collect and cut losses and increase the overall efliciency of energy and wncer production and distribution.

Additional critical areas of reform of noted imponance are those related \\ith the labor market. A series of recent diagnosis documents ha' c sho"n that the rigidity of the labor laws fa,ors informality and reduces the competotheness of the critical labor production factor. An appropriate balance mUst be sought bemeen the protection of the workers and the ability of firms to easily contract and manage their workforce tlCCording to principles of &ood performance and meritocracy. In this regard, the draft of a revision of the labor code was already been endorsed by the Council of Ministries and is in its public consultation period before its submission to the Parliament in early 2014.

Still in the scope of human capital, education is to remain an area of maximum priority. Over the past decade, Cabo Verde has made noted progress in expanding the coverage of its conventional education system nationwide under a banner of low cost universal access to all. The elTon was also noted in the unhcrsity higher education system. Howe,er, the paradigm is shifting towards the reinforcement of quality and the proper enabling of a techrtical and \'ocational education and training system that can provide skilled employees to service private sector operators especially in the areas of competith eness of the GPRSP III.

Conclusion

To conclude, it is in this scenario of imponant challenges that the Government of Cabo Verde reaffim'ls once again its commitment with Jiscal sustainability and a brond·band struc.tural reform agenda. In this sense we hope to continue receiving the important suppon of the World Bank through this development policy credit and the technical assistance which is critical for the implementation of our reform agenda The World Bank's suppon O\Cr the past years has been instrumental and remains a necessary condition to ensure a continuing transformation of Cape Verde during this difficult international en,ironmcnt .

. "'- .. . ..-..

48

ANNEX 3: FUND RELATIONS

Statement at the Conclusion of an IMF Mission to Cabo Verde

Press Release No. 14/27 January 28, 2014

An International Monetary Fund (IMF) mission, led by Ms. Andrea Richter Hume, visited Cabo Verde from January 15-28, 2014, to conduct discussions on the 2014 Article IV Consultation. The mission met with the Minister of Finance and Planning Cristina Duarte, Central Bank Governor Carlos de Burgo, other government officials, parliamentarians and representatives of civil society, development partners, and the private sector. The mission would like to thank the authorities for their excellent cooperation and hospitality.

At the conclusion of the mission, Ms. Richter Hume issued the following statement:

“Cabo Verde’s economy has continued to face significant headwinds, and the economy is estimated to have stagnated in 2013. Domestic demand remains weak, as reflected in depressed indicators of consumer and business confidence, a sharp drop in imports, sluggish credit growth, and high unemployment. On the external front, tourism—which accounts for about a fifth of Gross Domestic Product—has continued to do well. However, remittances fell, and foreign direct investment (FDI) has remained weak. As a result of these developments, the current account deficit is estimated to have declined in 2013. International reserves at end-2013 amounted to about 4.3 months of prospective imports. On the policy front, the fiscal stance was adjusted in light of the slowing economy, such that the government’s overall financing needs declined in 2013. An initial loosening of monetary conditions got underway in mid-2013 and liquidity in the banking system has improved, though this has not yet been reflected in higher lending. In 2014, a slight pick-up in growth is anticipated, reflecting improved conditions in key partner countries and an incipient recovery in domestic demand. Inflation is expected to remain modest. The overall balance of payments is projected to remain positive, with the international reserves cover of prospective imports holding steady. The exchange rate peg remains an appropriate monetary policy anchor.

“The 2014 budget is expansionary. Given high levels of public debt and downside risks to growth, the mission advises the authorities to rein in spending this year, and to adopt a more ambitious fiscal consolidation program over the medium term. At the same time, social spending for the most vulnerable should be protected. The mission sees scope for slowing the growth of current spending, and for adopting a somewhat less ambitious public investment program. As new capital spending is considered, it will be important that projects undergo careful review to ensure that they will deliver sufficiently higher returns. Improving the quality and efficiency of ongoing public investment will also be important.

“Cabo Verde is undertaking wide-ranging tax reforms, which are broadening the tax base and improving tax administration. The mission welcomes the harmonization of the Value Added Tax (VAT) rate, the rationalization of the incentives regime, the passage of three major tax codes, and the preparation of a new Income Tax Code. At the same time, it cautioned that a new

49

scheme for micro and small enterprises should be reviewed carefully to ensure that incentives set out in the scheme are in line with best practices for supporting micro and small enterprises.

“Given the improvement in the international reserves coverage of imports and the weak outlook for growth, the mission sees scope for easing monetary conditions further in order to encourage bank lending and support growth. The mission commends the Banco de Cabo Verde’s (BCV) ongoing efforts to improve financial supervision in light of the increase in non-performing loans. The recent passage of the long-awaited Basic Banking Law and Financial Institutions Law, which enhance the BCV’s powers to strengthen oversight (including of the offshore financial sector) and implement regulatory reforms, provides the BCV with critical tools to enhance financial stability.

“The mission welcomes continued efforts to improve the performance of state-owned enterprises (SOEs), which deliver essential infrastructure services to the economy. Improving their operational performance remains critical to restoring their financial health and reducing contingent fiscal liabilities. This includes introducing management contracts with SOEs, drawing lessons from the initial experience with such contracts at the national electricity and water provider (ELECTRA).

“As Cabo Verde seeks to diversify its economy and sustain long-term growth, investments that increase productivity will be essential. The public investment program has laid an important foundation for growth. Increasingly, reforms of the business climate and investment in human capital will be needed to boost growth, create jobs, and further reduce poverty. Export diversification both within and outside the tourism sector should be encouraged, with a focus on improving linkages to the domestic economy and pursuing opportunities for increasing employment and more inclusive growth.

“The Article IV consultation report of the mission is expected to be discussed by the IMF Executive Board in April 2014.”

São Domingo

Santa Catarina

Santa Maria

Espargos

Norte

Ribeira Brava

Povocão Velha

Lajes(1803 m)

Mt. Fogo(2,829 m)

BOA VISTA

BRAVA

MAIO

MOSTEIROS

PAÚL

PORTONOVO

TARRAFAL

SAL

SANTA CATARINASANTA CRUZ

SÃO MIGUEL

SÃO DOMINGOS

PRAIA

SÃO FILIPE

SÃO NICOLAU

SÃO VINCENTE

RIBEIRAGRANDE

RIBEIRA BRAVA

SANTA CATARINADO FOGO

SÃO LOURENÇODOS ÓRGÃOS

RIBEIRA GRANDEDE SANTIAGO

SÃO SALVADORDO MUNDO

Ribeira da Cruz

Ribeira GrandeVila das Pombas

Porto Novo

MadeiralCalhau

Tarrafal

Sal-Rei

Tarrafal

Santa CruzVila do Maio

São Domingo

Santa Catarina

SãoFilipe

Furna

Mosteiros Igreja

Santa Maria

Espargos

Norte

Ribeira Brava

Mindelo

São Pedro

Preguica

Povocão Velha

PRAIA

AT L A N T I C O C E A N

W I N D WA R D I S L A N D S

L E E WA R D I S L A N D S

Santo Antão

São Vicente

Ilhéu BrancoIlhéu Raso

Santa Luzia

São Nicolau

Sal

Boa Vista

MaioSão Tiago

Fogo

Brava

Ilhéus DoRombo

Lajes(1803 m)

Mt. Fogo(2,829 m)

17˚N

16˚N

17˚N

16˚N

15˚N15˚N

23˚W24˚W25˚W

23˚W24˚W25˚W

CABOVERDE

0 10 20

0 10 20 30 Miles

30 Kilometers

IBRD 33383R1

MAY 2013

CABO VERDECITIES AND TOWNS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

CONCELHO (MUNICIPALITY)BOUNDARIES

This map was produced by the Map Design Unit of The World Bank.The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

GSDPMMap Design Unit

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