On December 1, 2017, the Executive Board of the International Monetary Fund concluded the Article IV Consultation with Benin.

Benin showed mixed macroeconomic performance in 2016, with the economy weathering negative spillover stemming from a difficult external environment. Growth was about 4 percent, but a recovery is expected in 2017-18, owing to strong agricultural production, an increase in public investment, and a buoyant tertiary sector. Economic growth is accelerating and inflation remained negative in 2016 and through end-August 2017 but is forecasted to average 0.6 percent in 2017.

The medium-term outlook continues to show favorable signs, with high economic growth and low inflation. Cuts in recurrent spending have contributed to a smaller than programmed budget deficit of 6.0 percent of GDP in 2016 from 8.0 percent in 2015. The fiscal consolidation path foresees a further reduction of the deficit to 1.8 percent of GDP in 2019, below the West African Economic and Monetary Union convergence criterion of 3 percent of GDP.

Despite the favorable medium-term economic outlook, some challenges remain that need to be addressed going forward. These include prioritizing public expenditures to foster inclusive growth and to reduce poverty; accelerating the tax and customs administration reforms to mobilize more domestic resources; making public investment more efficient to sustain the expected growth over the medium term, addressing the rising burden of domestic debt service, and strengthening debt management to preserve public debt sustainability.

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Staff Report

Strengthening the Pillars for a Structural Transformation of the Economy

Inclusive growth has been elusive. Following a decade of mediocre economic performance, growth over the last 3 years (2013-15) averaged 5.2 percent, closing the gap with the sub-Saharan Africa (SSA) average in per capita GDP growth However, this solid macroeconomic performance did not translate in a meaningful reduction in poverty, which remains a major challenge calling for a higher and more inclusive growth over the medium term. Low and stagnant productivity in the agriculture sector is the primary cause of the limited poverty reduction in rural areas.

The government is committed to structurally transform Benin’s economy by scaling up investment and diversifying the economy. On April 7, the Board approved the authorities’ request for a three-year arrangement under the ECF. Executive Directors underscored the importance of adhering to policies that preserve macroeconomic stability and public debt sustainability. At the time of the 2017 IMF/World Bank Annual Meetings, Benin became a full participant in the G20 Compact with Africa (CWA) Initiative in the hope of bolstering private sector financing of the Government’s Action Program (GAP), 2016-21.

The government’s reform agenda suffered some setback but the authorities remained committed to it. In April, a revision of the Constitution aimed at fostering transparency and accountability by public office holders did not pass. Also, little progress is being made with reforms of audit institutions. Nonetheless, the authorities are developing strategies to ensure that the reform program will continue unabated, reiterating their commitment to improve governance and transparency and strengthened accountability for public office holders.

Recent Developments

GDP growth is recovering based on agriculture. Benin achieved an economic growth rate of 4.0 percent in 2016; up from 2.1 percent in 2015. Strong GDP growth in 2016 is mainly due to favorable weather conditions and better access to agricultural inputs. By contrast, the depreciation of the naira, coupled with the decline in 2016 of the activities related to cotton ginning, negatively impacted the secondary sector (2.6 percent growth in 2016 vs. 10.1 percent in 2015). Despite a difficult sub-regional context, the tertiary sector showed a 3.4 percent increase in value added compared to an initial forecast of 2.7 percent.

The current account deficit (including grants) is expected to remain elevated in 2017. After a brief improvement in 2016, it is projected to reach 9.1 percent of GDP, reflecting the investment scaling up in 2017 with imports of goods and services increasing by about 19 percent.

Policy Discussions

Discussions focused on how to: (i) accelerate reforms to create fiscal space; (ii) preserve debt sustainability; (iii) diversify the economy and promote inclusive growth, and (iv) promote good governance and transparency.

Promoting Diversification, Inclusive Growth, and Financial Deepening

Economic diversification and development of the financial sector are essential to enhance the inclusiveness of growth. Despite the agricultural sector’s strong contribution to economic growth over recent years, Benin faces critical challenges regarding export diversification and domestic production. Based on cross-country experiences, the Selected Issue Paper (SIP) prepared by staff on: Growth, Structural Transformation, and Export Diversification shows the type of structural reforms and economic diversification that could contribute to boost and sustain growth in Benin. These reforms should:

• aim at improving infrastructure and trade networks, reducing barriers to entry for new products, deepening financial markets, fostering more efficient financial intermediation and access to markets, and investing in human capital (Box 4);

• reinforce Benin’s relative good standing regarding the extent of foreign value added in its exports – traditionally referred to as backward integration, and

• focus more on sectoral policies such as developing high value added agro-commodity crops, promoting agro-processing, and developing the tourism sector – efforts to improve education outcomes, bolster governance and transparency in regulation should complement these sectoral policies.

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Box 4. Stages of Transformation and Diversification

Benin’s economy remains poorly diversified and there has been some de-industrialization with the output share of manufacturing falling from 22 percent in 2000 to 12 percent in 2012. Today, agriculture employs around 70 percent of Benin’s workforce and contributes approximately to 22 percent to its GDP. Benin is addressing de-industrialization with policies to boost value-added in agriculture and tourism. One of the pillars of the GAP is the structural transformation of the economy to create more value added in agriculture and tourism, both identified as key drivers of future growth. Specifically:

• Cross-cutting policies aimed at achieving efficiency gains in public investment, boosting private investment in energy and transport and strengthening education, skills, and human capital. Initiatives have been implemented to improve the business environment, although further progress in increasing access to electricity, facilitating paying taxes, and obtaining credit are needed.

• In the agricultural sector, the government has developed policies aimed at: (i) creating seven regional poles for agricultural development and promoting high value added sectors such as pineapples, cashew nuts, cotton, maize, cassava, and rice, (ii) evolving the processing industry through technological innovations, and (iii) boosting continental aquaculture.

• In the tourism sector, investment projects seek to: (i) build a tourist pole around Voodoo art, and (ii) recreate the historic city of Ouidah to make it the flagship destination of memorial tourism in Africa.

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Staff underscored the need to address weaknesses of the financial infrastructure and business environment to spur banks’ lending to the private sector. Although macroeconomic conditions in recent years have been favorable for financial stability, Benin’s financial sector remains under-developed and vulnerable, limiting its ability to support credit to the private sector and, ultimately, economic growth. The large number of unauthorized microfinance institutions (MFIs) raises stability risks. An SIP reviewed the financial sector’s contribution to sustainable economic growth, outlined stability concerns, and explored how to further improve financial inclusion.

Strengthening the Business Environment by Promoting Good Governance

A favorable business environment is critical for private sector-led growth. The authorities initiated several reforms aimed at improving the business and investment climate to support the process of economic diversification and improve the still weakly inclusive character of growth (MEFP ¶6). Heavy reliance on private investment to help address the infrastructure gap and Benin’s participation in the G20 CWA have heightened the importance of these reforms (MEFP ¶9). However, little progress is being made in: (i) strengthening audit institutions; (ii) addressing weaknesses in the doing business indicators; and (iii) addressing corruption and improving governance and transparency.

Ongoing reforms are expected to improve the business climate. Although Benin has continued to implement reforms, their ranking in the World Bank Doing Business Indicators has declined two positions in 2017. Benin ranks at 155 in 2017, with slight improvements on indicators covering the difficulty of starting a business, getting credit and protecting minority investors. The authorities plan to make progress regarding access to electricity, paying taxes, and enforcing contracts. Corruption has been identified in the 2017-2018 Global Competitiveness Index as one of the most problematic factor for doing business and some other third-party indicators suggest continued challenges for Benin. Additional steps should be taken to decisively tackle corruption, including through continued efforts towards establishing an effective AML/CFT regime to help deter, detect and prosecute the laundering of acts of corruption.

The authorities are committed to strengthen the AML/CFT and anticorruption frameworks. On November 2, 2017, the authorities approved for submission to the National Assembly a bill on AML/CFT, which coalesce existing legislation on the fight against money laundering with that on combating the financing of terrorism (MEFP ¶16). The authorities will further strengthen the framework for combating corruption, improve transparency, and proceed with a coherent implementation of the legislative and regulatory framework for AML/CFT.

Annex III. External Sector Assessment

The external sector assessment does not raise immediate concerns, but highlights the need to boost competitiveness. It found that the real effective exchange rate is broadly consistent with fundamentals although competitiveness remains weak. Benin’s current account deficit has improved in 2016 indicating significant export growth. However, this latter is projected to widen in 2017, reflecting scaling-up of investment. A gradual improvement of the current account deficit is expected from 2018 as investment and import growth stabilize.

Recent Developments of the Balance of Payments

The current account deficit excluding grants has improved in 2016. However, a widening of the current account is expected in 2017 due to the investment scaling up. From 2015 to 2016, the deficit of the current account narrowed from 8.2 percent of GDP to 7.5 percent of GDP. However, in 2017 the deficit is expected to widen and reach 9.4 percent of GDP. This evolution is mainly explained by higher imports of capital goods related to new investments. A gradual improvement of the current account deficit is expected from 2018 onwards as investment and import growth stabilize. By 2021, when the scaling-up of investment comes to an end, the current account deficit would narrow to 6.9 percent of GDP.

The external financing is mainly comprised of concessional financing and foreign direct investment (FDI). External financing of the current account deficit remained relatively stable over recent years. Short-term capital flows and medium- and long-term private loans were equivalent to 1 percent of GDP. Foreign direct investment inflows were equivalent to 1.5 of GDP in 2016 and are expected to reach 1.9 percent of GDP during 2017-21. Other capital flows, such as project loans, remained on average at 2.3 percent of GDP over the period 2014-2016 and are expected at 3 percent, on average during 2017-21.

Gross international reserve coverage in the WAEMU dropped sharply in 2016 and debt risks remain contained despite an increase in public debt led by high fiscal deficits. Gross international reserves coverage in WAEMU system declined substantially since 2010 when it stood at 6.6 month of imports, reserve coverage stabilized at around 4½ months of imports in 2013-14. In 2016, regional reserves in the WAEMU declined significantly by CFAF 1000 billion (about $2 billion) to stabilize at 3.7 months of imports. At end 2016, gross reserves covered about 55 percent of narrow money and 74 percent of short-term debt. International reserves increased by $2.7 billion in 2017, reaching 4.2 months of imports at end-September. Benin’s gross external debt is at 22.5 percent of GDP in 2016 (below the average WEAMU countries).

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Selected Issues Paper

This Selected Issues paper on Benin was prepared by a staff team of the IMF as background documentation for the periodic Article IV consultation with the member country. The following topics were covered: a) Growth, structural transformation, and export diversification; b) Financial inclusion and development; c) Efficiency of public investment in Benin: an empirical assessment; d) Macro-structural policies and inequality; and e) Fiscal incidence and inequality.

Growth, Structural Transformation, and Export Diversification

While Benin has delivered high economic growth over recent years, it faces critical challenges regarding export diversification and domestic production. Based on cross-country experiences, this note evaluates the type of structural reforms and economic diversification that could contribute to boost and sustain diversified growth in Benin, underscoring the need for improving infrastructure, trade networks, and market access, reducing barriers to entry for new products, deepening financial markets, and investing in human capital.

The Structure of the Beninese Economy

During the last decade, growth in Benin has been comparatively highly volatile. Per capita GDP growth however has been stagnating. Real economic growth rebounded to 4 percent in 2016 compared to 2015, where the growth rate slowed significantly to 2.1 percent due to weak agriculture output generated by unfavorable weather and negative spillovers from Nigeria. From 2006 to 2016, real GDP growth averaged 4.2 percent (with a maximum of 7.2 percent in 2013 and a minimum of 2.1 percent in 2010 and 2015), driven mainly by the services. Growth remains volatile, despite having strengthened in recent years. Per capita GDP growth has been stagnating and Benin has been lagging six fastest growing non-resource intensive SSA-economies. Inflation turned negative in 2016 after a moderate increase in 2015. The fiscal deficit grew from -0.4 percent of GDP in 2012 to -6.2 percent of GDP in 2016, with a maximum of -8.0 percent of GDP in 2015. The fiscal deficit growth was essentially driven by a net increase in current transfers, especially subsidies to the cotton and electricity sectors, as well as a higher wage bill, while tax revenues weakened. The external current account deficit dropped by 1.5 percentage points of GDP in 2016 compared to 2015 mainly due to continued strong export performance.

In addition, economic growth was not inclusive. Notwithstanding recent progress, Benin remains a low-income country with 11 million people and a per capita income of US$790 in 2015. Agriculture accounts for a quarter of GDP and 51 percent of the country's employment with cotton as its primary export commodity. The informal sector, including subsistence agriculture, contributes up to almost 60 percent of GDP and engages over 80 percent of the labor force. Re-export to Nigeria contributes up to a quarter of the government’s revenue. Nonetheless, rapid population growth – averaging 3.5 percent per year – led to a modest and unequal increase in household consumption. Poverty levels grew from 36.2 percent in 2011 to 40.1 percent in 2015. Due to its low productivity, growth was modest in agriculture, which employs almost half of the labor force. The economy remains poorly diversified and vulnerable to external shocks, underscoring the urgency to promote economic diversification. In particular:

• Poverty remains spread and it is characterized by significant regional disparities. Female-headed households have typically experienced lower poverty levels, divested of economic opportunities.

• There is a dichotomy between economic growth and poverty reduction. During the last five years, higher growth was mainly driven by more capital-intensive sectors like banking, telecommunications and maritime activities at the port of Cotonou. In contrast, agriculture, which is a main driver of poverty reduction, have grown, mostly, from expansion of cultivated land and the associated labor rather than increase in productivity.

• Rapid population growth further limited the growth in per capita income and its impact on poverty reduction. Furthermore, regional trade had a negative spillover from the Nigeria’s economic slowdown and policy changes. There were diminished opportunities in both goods and services between Benin and Nigeria affecting the broader sector of informal trade, where gas flows informally from Nigeria to Benin, and in the broader consumer goods sector, where rice, chicken, edible oil, used cars, used clothing etc., flow from Benin to Nigeria.

Diversification slowly advances led by the agriculture and service sectors. There has been relatively little evidence of structural change in Benin over time. The sectoral composition of output has remained remarkably stable and the level of diversification low. During the period 2010-2016, the primary sector contributed by 0.5 percent to the real GDP growth while the secondary and tertiary sectors agriculture accounted for around 1 percent and 2.2 percent respectively, shares that have changed little since 1990 for when data are first available. The level of output diversification – based on a Theil Index measure – is also low and has remained stagnant, in contrast to faster growing benchmark countries, which have witnessed sharp increases in diversification over time.

The agricultural sector in Benin is highly dependent on rainfall patterns and, mostly, on one major commodity (cotton). Despite its low productivity, agriculture remains one of the main sources of growth and employment in Benin. Nonetheless, to further contribute to economic growth and poverty reduction, the agriculture sector needs to buttress its productivity considerably. Specifically, agricultural production systems heavily rely on increases in cropped areas and family labor, with limited use of improved inputs, production methods, and farm equipment. Agricultural exports are concentrated on three groups of products: cotton, fruits (pineapple), and nuts (cashews) and oilseeds (soy and cottonseed). Nonetheless,

• to address the needs of a growing urban population, the country continues to import a large share of horticultural products from neighboring countries (mostly, Burkina Faso and Nigeria), rice from Asia, wheat, frozen meat and milk from Europe, and frozen poultry products from Brazil.

• the agricultural sector faces the triple challenges of diversifying exports (consolidating cotton exports and increasing export volume for pineapple and cashew nut), increasing food production, and sustainably increasing farm and post-harvest productivity – these challenges must be addressed by improving the structural vulnerability of the country’s agricultural production system to floods and occasional droughts; and

• access to financing is limited outside the cotton system. The country’s agricultural trade performance is generally weak, with a persistently negative agricultural trade balance.

Benin has experienced a modest de-industrialization, contrasting with a sharp industrial expansion in this sector among benchmark countries. The share of the manufacturing sector in output fell from 22 percent to 12 percent in Benin during the period going from 2000 to 2012 but increased from 10 percent to 16 percent in the Asian peer group between 1990 and 2012. Conversely, the share of the agricultural sector has declined across low-income countries over time but has remained elevated in Benin. During the decade 2000-2009, the share of the agricultural sector was estimated on average at 24 percent. It remained constant and has been valued at 22 percent during the period 2010-2016.

Benin has exhibited good performance regarding integration into value chains recently. The Regional Economic Study (2015) showed that integration into global value chains had indeed been accompanied by a pickup in income levels. To measure the depth of this integration, the REO relied on the extent of foreign value added in a country’s exports – traditionally referred to as backward integration. By this measure, rising depth of integration has been associated with rising income over time for developing and emerging market economies higher share of its exports enter as inputs for other countries’ exports, reflecting the still-predominant role of commodities in many countries’ exports in the region. By this metric, Benin is aligned with the rest of SSA.

Growth and Factor Inputs

Low human capital accumulation and total factor productivity appear to have driven volatile growth. A growth decomposition exercise suggests that two thirds of growth over the past two decades can be attributed to labor accumulation, while capital accumulation accounts for almost a third. In contrast, human capital and productivity appear to have been the main drivers of the mediocre growth performance, and are the factors in Benin lags most relative to other countries. These factor ‘gaps’ suggest that policies should target access and quality of education, public financial management (PFM) reforms to improve the efficiency of public investment, and key areas of the business environment, such as contract enforcement, access to credit and efficient electricity provision.

Benin’s competitiveness is impaired by structural bottlenecks and a challenging business climate. The 2016 Doing Business Indicators (DBI) report ranks Benin 155th (out of 189 countries), worse than most peer countries in the region. Indicators related to education, health, access to water, and infant mortality have improved in recent years but at a slow pace. Growth has been accompanied by a low level of job creation with widespread underemployment affecting especially women and the youth in urban areas. However, the participation of women in services has shown an improvement in the last decade. FDI is keeping its pace with SSA but more investment is needed.

Benin has maintained a steady sectoral share in the last decade. Notwithstanding the increase in overall participation recently, Benin was lagging almost half of the SSA countries in terms of its manufacturing and services as a share of GDP. Structural changes that followed the country after 2004 gradually brought the country to a much more favorable position today. Comparing Benin to SSA countries presently, the share of manufacturing and services is ahead of most of the SSA countries, reaching 75 percent of GDP. While its exports per capita remain lower than for most SSA countries, they improved a lot during this ten-year period.

Export Diversification

Export diversification has not taken place. African benchmark countries diversified quite strongly after 1990 and have caught up to Asian benchmark countries whose diversification levels were already comparatively high before that time. The number of export partners has increased on average, but the shares of the main export partners remain dominant. Cross-country experiences show that policies need to build on a country’s endowments and existing strengths and be tailored to tackle specific challenges to yield successful diversification.

Product diversification could yield growth gains. Further increasing product variety similar to diversification could yield further growth gains. Based on the estimates in IMF (2014a), a one standard deviation increase in LIC’s export diversification raises the growth rate by about 0.8 percentage points. For Benin, this translates into estimated growth gains of 0.2 percentage point if export diversification was raised to levels observed in comparators like Vietnam.

Conclusions

Benin’s competitiveness is impaired by structural bottlenecks. A challenging business climate, low productivity, and weak human capital. Low and stagnant productivity in the agriculture sector is perhaps a primary cause of the limited poverty reduction in rural areas.

Policies to promote structural transformation and diversification should focus on addressing weaknesses that hinder entry into new lines of economic activity. Further progress on strengthening the business climate, addressing electricity shortages, and increasing human capital could provide significant benefits.

In particular, measures that could help improve productivity in the short run includes:

• the support the promotion of large-scale adoption of improved technologies (production, postharvest, processing and storage), including climate-smart production systems, reduce vulnerability of farming activities to climate change and weather vagaries of farming activities;

• development of production and market infrastructure to enhance productivity through efficient water management, reduction of post-harvest losses and better access to market through warehouses and other facilities;

• support to value chain coordination and access to finance through sustainable use of the financial management instruments set up under the original project;

• institutional support to the Ministry of Agriculture and other stakeholders in the sector (civil society and producers’ organizations) with a particular focus on capacity building. Furthermore, measures to improve education and productivity could render significant impacts on the informal economy, which is estimated to be at more than half of GDP. Product diversification could yield higher growth rates.

Financial Inclusion and Development

While access to finance is improving, relatively to other sub-Saharan countries, a number of reforms could foster financial deepening and financial inclusion and complement efforts to promote the expansion of the private sector and employment creation.

Background

Benin’s financial sector is shallow, segmented, and with limited financial inclusion. Benin has a small and segmented financial sector in which 3 categories operate: the banking sectors, the microfinance institutions and other nonbank financial institutions. As of end-2016, there were 15 commercial banks, with 4 banks holding about 80 percent of credits to the banking system.

Banks’ capital adequacy has increased from 8.8 percent (end-June 2015) to 10.6 percent, above the 8 percent minimum but still below the WAEMU and SSA averages. The ratio of non-performing loans (NPLs) remains high when compared against peer countries in the WAEMU region. Other indicators are also lagging behind WAEMU averages, including the provisioning ratio for NPLs (12 percent of risk-weighted assets in 2014-15), the liquidity ratio, and profitability indicators.

Although the banking system remains stable, its depth has not improved. The banking sector is broadly sound but plays a limited role in financial inclusion. According to the BCEAO estimations (2010), there is a low level of access to banking service. More precisely, the number of deposit accounts in commercial banks relative to the active population is around 5 percent. In Benin, the banking services are targeting the high income urban population, the low population density and the large size of the informal sector limited the access to the banking services. In addition, the interbank market is no existent.

Financial Access and Development

The authorities are striving to enhance financial services delivery by addressing hindrances to financial inclusion and deepening, covering access, depth, and efficiency.

• Although the number of bank branches has been recently increasing, in particular in rural areas, there is room to further expand financial inclusion by strengthening the regulatory framework of agency banking. High documentation requirements to open, maintain, and close accounts and for loan applications could impede access to finance (participation costs).

• To further enhance credit culture and cover all, the authorities could consider setting a credit reporting bill to unify the collateral registration system, avoiding any potential fragmentation across registries. It could also be useful to strengthen the insolvency/bankruptcy procedure, and improve land titling, which can ease collaterals demanded by lenders. Further, improving contract enforcement in the judiciary sector could contribute to relax collateral constraints and addressing gaps in financial market infrastructure.

• Intermediation efficiency. Efficiency is generally associated with the state of competition and is reflected in interest spreads and banks’ overhead costs. Intermediation costs (i.e., high interest rates and fees) reflect asymmetries of information between borrowers and banks. Access to an account in Benin compares poorly with averages from low income countries.

Financial development has modestly improved in Benin over the past ten years. The composite index of financial development suggests that financial development in Benin has been lackluster over the past three decades. Relative to middle-income countries (Mauritius, Namibia, Seychelles, and South Africa), Benin shows a modest improvement in achieving higher rates of financial development and lacks behind the average for SSA countries and other regions.

Lastly, Benin is performing relatively well regarding access to finance and use of mobile banking but there is scope for further progress. Benin holds around 5 percent of the total volume of mobile transactions in the WAEMU region with a total number of subscription of 12 percent.

The benefits from developing financial institutions in Benin are large. Thus, an appropriate sequencing would emphasize developing institutions at early stages, with increasing attention to developing markets as income per capita rises. Benin could adapt regulation and infrastructure to make investment by private sector participants easier while allowing them to hedge risks and enabling capital to be efficiently channeled into investment projects.