IMF Country Report No. 13/292 CAPE VERDE, NAMIBIA, AND KINGDOM OF SWAZILAND SELECTED ISSUES PAPER ON THE CHALLENGES OF SMALL September 2013 MIDDLE-INCOME COUNTRIES IN SUB-SAHARAN AFRICA This selected issues paper on Cape Verde, Namibia, and Kingdom of Swaziland was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member countries. It is based on the information available at the time it was completed on January 23, 2013. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the governments of Cape Verde, Namibia, and Kingdom of Swaziland or the Executive Board of the IMF. The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information. Copies of this report are available to the public from International Monetary Fund Publication Services 700 19th Street, N.W. Washington, D.C. 20431 Telephone: (202) 623-7430 Telefax: (202) 623-7201 E-mail: [email protected] Internet: http://www.imf.org Price: $18.00 a copy International Monetary Fund Washington, D.C. ©2013 International Monetary Fund ©International Monetary Fund. Not for Redistribution CAPE VERDE, NAMIBIA, AND KINGDOM OF SWAZILAND SELECTED ISSUES PAPER ON THE CHALLENGES OF SMALL January 23, 2013 MIDDLE-INCOME COUNTRIES IN SUB-SAHARAN AFRICA KEY POINTS Small middle-income countries (MICs) in sub-Saharan Africa (SSA) share broadly similar policy challenges. A cross-country clustered look should provide an opportunity to discuss the common policy challenges facing them and to facilitate peer learning. Thus, this background paper associated with the 2012 Article IV consultations with Cape Verde, Namibia and Kingdom of Swaziland (hereinafter “Swaziland”) summarizes the analytic underpinnings that support the staff’s advice on policies to strengthen macroeconomic stability, foster more inclusive growth, and enhance the resilience of their financial systems. Among the key policy lessons for small MICs in SSA that could be drawn from the analytic work in this background paper are the following: Macroeconomic policies should aim to rebuild policy buffers to help cushion against large external shocks especially given the prevalence of pegged exchange rate regimes in these economies. Although growth has continued to benefit majority of their populations, it has become less inclusive in recent years. Policies that target income inequalities at their sources have the potential to lead to significant gains in terms of increasing the duration of growth spells. Small MICs cannot grow their way out of their enormous unemployment challenge; putting a significant dent on their high level of unemployment would require carefully designed structural and wage policies. Financial sector policies need to be cognizant of the concentration risks for banks, regulatory risks for nonbanks given weaknesses in their supervisory frameworks, and potential vulnerabilities owing to cross-linkages between banks and nonbanks. ©International Monetary Fund. Not for Redistribution CAPE VERDE, NAMIBIA, AND KINGDOM OF SWAZILAND Approved By Prepared by a team led by Lamin Leigh and comprising Anne-Marie Gulde-Wolf Ara Stepanyan, Antonio David, Rodrigo Garcia-Verdu, Floris Fleermuys, Patrick Gitton, Seok Gil Park, Marcio Ronci, Yibin Mu, Olivier Basdevant, Borislava Mircheva, and Farayi Gwenhamo. Andrew Jonelis and Breda Robertson provided excellent research and editorial assistance, respectively, to the drafting of this report. CONTENTS CAPE VERDE, NAMIBIA, AND KINGDOM OF SWAZILAND _____________________________________ 1 EXECUTIVE SUMMARY ___________________________________________________________________________ 4 I. MACROECONOMIC VULNERABILITY IN SMALL MIDDLE-INCOME COUNTRIES IN SUB- SAHARAN AFRICA—RESERVE ADEQUACY AND FISCAL POLICY ______________________________ 6 A. Introduction _____________________________________________________________________________________ 6 B. Empirical Analysis ________________________________________________________________________________ 7 C. Conclusions ___________________________________________________________________________________ 13 References _______________________________________________________________________________________ 15 II. ENHANCING INCLUSIVE GROWTH AND EMPLOYMENT IN SMALL MIDDLE-INCOME COUNTRIES _____________________________________________________________________________________ 16 A. Introduction ___________________________________________________________________________________ 16 B. Empirical Analysis ______________________________________________________________________________ 16 C. Conclusions ___________________________________________________________________________________ 34 References _______________________________________________________________________________________ 39 III. FINANCIAL STABILITY ISSUES IN SMALL MIDDLE-INCOME COUNTRIES IN SUB- SAHARAN AFRICA _____________________________________________________________________________ 41 A. Introduction ___________________________________________________________________________________ 41 B. The Structure of the Financial Systems and Potential Source of Vulnerabilities _______________ 41 C. Conclusions ___________________________________________________________________________________ 44 References _______________________________________________________________________________________ 50 BOXES I.1. Standard and Modern Approaches for Estimating Reserve Adequacy _________________________ 9 II.1. Botswana and Chile: What Explains the Divergent Unemployment Rates ___________________ 35 2 INTERNATIONAL MONETARY FUND ©International Monetary Fund. Not for Redistribution CAPE VERDE, NAMIBIA, AND KINGDOM OF SWAZILAND II.2. Cape Verde: Unemployment, Education, and Labor Market Institutions _____________________ 36 II.3. Mauritius: Unemployment Issues ____________________________________________________________ 38 III.1. Botswana: Structure and Performance of the Financial Sector ______________________________ 46 III.2. Cape Verde: Structure and Performance of the Financial Sector ____________________________ 47 III.3. Namibia: Structure and Performance of the Financial Sector _______________________________ 48 III.4. Swaziland: Structure and Performance of the Financial Sector ______________________________ 49 FIGURES I.1. Selected Middle-Income Countries in SSA: Reserve Adequacy, 2012 __________________________ 7 I.2. Swaziland: Actual and Adequate Level of Reserves ___________________________________________ 12 I.3. Middle-Income Countries in Sub-Saharan Africa and the Eastern Caribbean Currency Union (ECCU): and Emerging Markets Average: Cross-Country Comparison ________________ 14 II.1. Selected Small MICs—Growth Drivers _______________________________________________________ 19 II.2. Selected Middle-Income Countries in SSA: Traditional Solow-Growth Accounting __________ 20 II.3. Evolution of per capita GDP (PPP terms) _____________________________________________________ 21 II.4. Namibia: Growth Incidence Curve of Real Consumption per capita: 1993/1994–2003/2004 _______________________________________________________________________ 25 II.5. Namibia: Growth Incidence Curve of Real Consumption per capita: 2003/2004–2009/2010 _______________________________________________________________________ 25 II.6. Mauritius: Growth Incidence Curves for per capita Household Expenditures ________________ 26 II.7. Employment-Output Elasticity, Job Creation, and the Effective Cost of Capital ______________ 30 II.8. Unemployment Rates and Labor Market Indicators-Correlation Analysis ___________________ 31 II.9. Cape Verde: Unemployment and Education _________________________________________________ 37 III.1. Namibia: Financial Sector Indicators ________________________________________________________ 45 TABLES I.1 Middle-Income Countries in SSA: Adequacy of International Reserves _________________________ 7 I.2. Cape Verde: Summary of the Results of Reserve Adequacy Estimates _______________________ 11 II.1. Contributing Factors to the End of Growth Spells in the SACU Region _____________________ 27 III.1. Key Banking Sector Indicators across Small Middle-Income Countries _____________________ 42 INTERNATIONAL MONETARY FUND 3 ©International Monetary Fund. Not for Redistribution CAPE VERDE, NAMIBIA, AND KINGDOM OF SWAZILAND 1 EXECUTIVE SUMMARY This background paper associated with the 2012 Article IV consultations with Cape Verde, Namibia and Swaziland aims to highlight the policy commonalities and the potential for synergy among the small middle-income countries (MICs) in sub-Saharan Africa (SSA). The paper distills the key lessons that can be drawn from the critical common policy challenges facing these economies with a view to strengthen Fund policy advice and make it more focused and issues oriented. The economy of a small MIC in sub-Saharan Africa (SSA) is often characterized by the following features: (i) low population (ii) per capita income in the range of $3000–$10,000 (PPP basis); (iii) somewhat undiversified; and (iv) structural and institutional weaknesses that often resemble those of low-income countries (LICs). Beyond the narrow criteria of per capita income level, there are a number of areas including macroeconomic policy implementation capacity, where small MICs in SSA are a lot stronger than the low-income countries in the region and are in fact closer to large MICs elsewhere. This selected issues