On February 26, 2018, the Executive Board of the International Monetary Fund concluded the Article IV consultation with Namibia.

Since 2010, Namibia has experienced a period of exceptional growth. Growth was partly attributable to temporary factors. An expansionary fiscal policy, the construction of large mines and buoyant credit supported growth and better living standards. However, robust growth masked rising macroeconomic vulnerabilities and deteriorating productivity performance. Moreover, structural impediments have contributed to keep unemployment and income inequality unacceptably high.

With temporary expansionary factors ending, the economy has reached a turning point. GDP sharply decelerated in 2016 and contracted in 2017 as construction in the mining sector came to an end and the government began consolidating. With the economy contracting and Southern Africa Customs Union (SACU)’s receipts temporarily increasing, the current account balance improved significantly. However, despite significant fiscal adjustment, the public debt ratio continued to increase and almost doubled over the last four years, exceeding in 2017 the median of the countries at the lowest tier of investment grade.

The outlook remains positive with considerable vulnerabilities and risks. Growth is projected to resume in 2018, as mining production ramps up, construction activity stabilizes and manufacturing recovers, before converging to a long-term rate of about 3½ percent, below the average of recent years. Inflation is anticipated to remain below 6 percent. However, as SACU revenues are expected to decline, in the absence of policy action, the fiscal deficit would remain large and public debt would continue rising and approach 70 percent of GDP by 2022. On the positive side, the current account deficit is expected to narrow on average to around 6 percent of GDP on the back of larger mining exports, but international reserve coverage is projected to gradually decline.

Downside risks dominate the outlook. They stem mainly from possible fiscal slippages that could undermine policy credibility, lower demand for key exports, further declines in SACU revenue, and slower recovery in mining and construction activities. Extensive macro-financial linkages could amplify the negative impact of shocks.

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Staff Report

Context: Economy at a turning point

Since 2010, Namibia has experienced a period of exceptional growth fueled in part by temporary factors, while vulnerabilities have risen and structural challenges remain. Despite being a small commodity-dependent economy exposed to external shocks, between 2010-2015, Namibia’s annual GDP growth averaged 5½ percent and living standards improved. This strong performance was in part due to the construction of large mines and an expansionary fiscal policy that temporarily boosted investment. The peg with the South African rand contributed to contain inflation. However, strong growth masked a deteriorating productivity performance, that negatively contributed to the recent growth dynamics, while macroeconomic vulnerabilities rose. Large fiscal deficits led to a sharp increase in public debt. The current account deficit widened, and international reserve coverage fell below adequate levels. Rapid credit growth financed the economic expansion, but also fueled fast-rising house prices and elevated private sector indebtedness. Yet, unemployment has remained high and inequality, although declining, is among the highest in the world.

In 2016, the economy reached a turning point and sharply decelerated and began contracting in 2017. The engines that temporarily boosted growth grounded to a halt and set off a complex adjustment process.

• Real GDP growth decelerated in 2016 to 1.1 percent, as construction in the mining sector came to an end and the government began consolidating. Public and private investment declined, and consumption decelerated as unemployment rose. The weak performance continued in 2017, with the economy contracting in the first three quarters of the year as construction and retail and wholesale activities declined further.

• Despite weak domestic demand, the 2016 current account deficit remained large and wider than justified by macroeconomic fundamentals (Annex I). Lower imports and improved exports reduced the trade deficit. However, the current account deficit remained unchanged at 14.1 percent of GDP, as SACU receipts declined and income flows deteriorated. Moreover, external vulnerabilities built up. External public and private debt increased to 60.2 percent of GDP (48.2 percent in 2015), and the net international investment position turned negative. On the positive side, international reserve coverage improved to 3.7 months of projected imports, partly sustained by Bank of Namibia (BoN)’s swap operations. With the economy contracting, in the first three quarters of 2017, the trade deficit narrowed further driven by import compression and the current account balance sharply improved because of a temporary increase in SACU receipts.

The government began implementing a medium-term consolidation plan to bring public finances on a sustainable path, and contributed to the economic slowdown. Despite a sharp decline in SACU revenue (3 percent of GDP), the FY16/17 deficit only increased by about ¾ percentage point of GDP to 11.1 percent of GDP (10⅓ percent in FY15/16), as the authorities implemented substantial reductions in non-wage expenses and capital outlays. However, most of the spending reductions were introduced late in the fiscal year, prompting a sudden policy correction that led to the accumulation of about N$3.9 billion in domestic arrears (2.4 percent of GDP) and weighed heavily on the 2017 growth. As the fiscal deficit remained large, public debt increased to 44.3 percent of GDP (including domestic arrears), above the median of the countries at the lowest tier of investment grade. Gross financing needs remained high (about 18 percent of GDP) and, as the authorities increasingly tapped domestic markets, yields on government debt rose. Against this background, Moody’s and Fitch lowered the sovereign credit rating to below investment grade.

With the economy adjusting, credit to the private sector and housing prices growth decelerated amid still elevated household indebtedness. After averaging 14 percent between 2010-15, private sector credit growth started declining in 2016 and reached 4.5 percent at end 2017. The deceleration reflected both banks’ tight funding constraints and low demand from a highly leveraged private sector. Against this background, both corporate and household lending (including individuals’ mortgage loans) decelerated, contributing to contain the annual increase in house prices to 7 percent (9 percent on average over the last five years). However, household and corporate leverage remained high and close to the level of more advanced economies. At the same time, banks’ asset quality showed signs of deterioration, with NPLs increasing, albeit from very low levels. As government’s financing needs remained high, banks’ direct exposure to the public sector rose, and holdings of government securities reached about 10 percent of banks’ assets.

Against this background, headline inflation has recently declined and the central bank has eased the monetary stance. After averaging 7.3 percent in 2016, headline inflation peaked to 8.2 percent in January 2017, mostly because of high food prices, reflecting a prolonged drought and increases in administrative prices. Since then, inflation has rapidly declined and reached 5.2 percent in December 2017, reflecting better crop yields and economic slack. In the context of the currency peg, the BoN followed the South African Reserve Bank (SARB), and in August reduced its policy rate to 6.75 percent, citing lower projected inflation.

Authorities are adjusting their macroeconomic and developmental policies to deal with the new economic realities. They have recently issued a new national development plan (NDP) emphasizing private sector financing of large infrastructure projects, and prioritized the implementation of high impact projects and policies in the social sectors. Broadly following staff’s past advice, they have also embarked on medium-term fiscal adjustment plans, and adopted LTV ratio limits for non-primary residential houses to manage fast-rising real estate market prices. With the economy decelerating, and in preparation of the FY18/19 budget, they have recently revised their fiscal adjustment plans to better consider the economic cycle.

In 2016, the economy reached a turning point and sharply decelerated and began contracting in 2017. The engines that temporarily boosted growth grounded to a halt and set off a complex adjustment process

• Real GDP growth decelerated in 2016 to 1.1 percent, as construction in the mining sector came to an end and the government began consolidating. Public and private investment declined, and consumption decelerated as unemployment rose. The weak performance continued in 2017, with the economy contracting in the first three quarters of the year as construction and retail and wholesale activities declined further.

• Despite weak domestic demand, the 2016 current account deficit remained large and wider than justified by macroeconomic fundamentals. Lower imports and improved exports reduced the trade deficit. However, the current account deficit remained unchanged at 14.1 percent of GDP, as SACU receipts declined and income flows deteriorated. Moreover, external vulnerabilities built up. External public and private debt increased to 60.2 percent of GDP (48.2 percent in 2015), and the net international investment position turned negative. On the positive side, international reserve coverage improved to 3.7 months of projected imports, partly sustained by Bank of Namibia (BoN)’s swap operations. With the economy contracting, in the first three quarters of 2017, the trade deficit narrowed further driven by import compression and the current account balance sharply improved because of a temporary increase in SACU receipts.

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Policy discussions

Discussions focused on the policies to manage the ongoing adjustment process and preserve macroeconomic stability by: (i) implementing credible fiscal adjustment plans to contain public debt dynamics and support long-term growth; (ii) managing macro-financial risks from a large and interconnected financial sector; and (iii) advancing structural reforms to leverage the growth benefits from the ongoing demographic transition and reduce unemployment and income inequality.

Leveraging the Demographic Transition

Structural impediments are keeping unemployment high and could limit the benefits from the upcoming demographic changes and the capacity to deliver more inclusive growth. Namibia is going through a major demographic transformation with more than 65 percent of the population, or about 3 million people, expected to be in the working age group by 2050. Experience in other countries shows that similar transitions may boost potential growth but, if not managed properly, lead to long-term stagnation, inequities, and less inclusive growth. The potential benefits from demographic changes in Namibia could be substantial, with per capita income being potentially 25-50 percent higher. Key to a successful transition is the ability to create enough high-productivity jobs. However, this raises potential challenges in Namibia. The country has a low employment elasticity to growth and could be unable to generate enough jobs to reap the benefits of demographic changes even with sustained growth, risking instead rising unemployment. Increasing the elasticity of employment to growth is therefore critical to the country development and to deliver more inclusive growth. Analysis shows that, compared to other countries, structural factors limit the capacity of the Namibian economy to create new jobs including: (i) low education outcomes, particularly for higher education skills; (ii) weaknesses in the business environment, including for starting businesses and obtaining labor permits; (iii) wage dynamics in excess of productivity trends; and, (iv) employment still concentrated in less dynamic economic sectors (e.g., agriculture).

The authorities’ strategy of supporting infrastructure investment and providing incentives to labor-intensive sectors has had limited impact, and new initiatives are planned. The recent increase in public investment has supported domestic demand, but has so far failed to crowd in non-mining private investment. Despite high social spending, health and education attainments remain relatively poor compared to other upper-middle income countries. In addition, programs to support employment and tax incentive schemes have had limited impact on employment and export diversification. In addition, the authorities have recently issued a new national development plan (NDP5) and, with the Harambee Prosperity Plan, they have prioritized the implementation of high impact policies in the infrastructure, education and social sectors.

Policies targeted at improving the entrance in the labor market and the business environment could boost job creation and help reap the benefits of demographic changes. Considering the tight fiscal constraints, reforms in two areas could potentially improve employment dynamics:

• Human capital and skill mismatches. Improving educational attainment, especially for higher education, would reduce skill mismatches in the labor market and boost the capacity to absorb new workers. This requires improving both access and quality of secondary and higher education, and strengthening technical and vocational training programs to better align skills to job needs. Strengthening the existing programs to acquire on-the-job training would facilitate the transition from school to work.

• Wage dynamics and business conditions. Reducing the gap between wage and productivity dynamics (e.g., containing public wages) has the potential to boost the elasticity of employment to growth. Moreover, streamlining business regulations (e.g., starting businesses, registering property and land) and the functioning of the labor market (e.g., increased labor permits for skilled workers, efficient dispute resolution processes) would contribute to reduce unemployment. Reforms in these areas might also boost development in labor-intensive sectors, e.g., manufacturing, further improving employment absorption.

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Annex I. External Sector Assessment

In 2016, Namibia’s external position was substantially weaker than suggested by fundamentals, mostly because of large one-off events linked to the construction of new mines. During the first three quarters of 2017, the trade balance sharply improved as the construction of large mines came to an end and imports declined, while mining exports began increasing. These developments are permanent in nature and will likely lead to a change in the assessment of Namibia’s external position to moderately weaker than suggested by fundamentals. Given the expected decline in SACU receipts, and a still large fiscal deficit, further fiscal adjustment, as recommended by staff, would help bring the external position broadly in line with fundamentals.

Recent Trends

Namibia’s current account (CA) and net international investment position (NIIP) deteriorated further in 2016. Since 2006, the CA has been deteriorating, turning from positive to negative, until reaching a deficit of 14.1 percent in 2016. This trend is largely attributable to a surge in imports as a share of GDP during the global financial crisis, and a subsequent expansionary fiscal stance and the construction of new mines. The trade balance followed a similar trend, but in 2016 it took a different direction and improved due to both higher exports (from the recovery in the global diamond markets, and higher production from some new mines) and lower imports (as the construction of new mines came to an end and the economy sharply deteriorated). However, an abrupt decline in SACU receipts and larger income and service deficits offset the improvement in the trade balance in 2016, leaving the current account deficit substantially unchanged compared to 2015. A savings and investment decomposition suggests that the main driver of the CA deterioration has been the decline in the public balance resulting from an expansionary fiscal stance. At the same time, the NIIP has been deteriorating since 2009 and in 2016, the net foreign position turned negative to -14½ percent of GDP (1 percent of GDP in 2015). In general, the deterioration in the NIIP is attributed to the sharp increase in external liabilities from both the government and nonbank corporates.

The CA deficit is mostly financed with FDI and other investments, while portfolio investments have generally registered net outflows. In the early 2000s, the net portfolio investment was positive due to large investments abroad by non-bank financial institutions, mostly the public pension fund. However, the issuance of Eurobonds in 2011 and 2015 generated large offsetting portfolio inflows. At the same time, in 2015 FDI increased while other investments fell as loans from parent mining companies were transformed into equity. Apart from these temporary changes, in 2016, financial flows returned to the composition observed pre-2015. The gross external financing requirements have continuously increased to about 32 percent of GDP, with about half corresponding to short term debt.

The Namibian dollar is pegged at par to the South African rand and developments in the real exchange rate largely follow the rand. Namibia’s real effective exchange rate (REER) has experienced large fluctuations over the past decade. Between 2010-2015, it depreciated by 30 percent, but appreciated by 20 percent thereafter. In June 2017, the REER returned to its ten-year average, although it depreciated by about 5 percent in the second half of the year.

The stock of international reserves has fluctuated around 10-15 percent of GDP over the past ten years. At end 2016 reserves stood at 14.7 percent of GDP (3.7 months of projected imports), reflecting an increase in 2015 due to the issuance of the Eurobond and some swap operations by the BoN. In November 2017, reserves further increased to about 4.1 months of imports, reflecting the disbursement of an AfDB budget support loan and an improving current account.

Conclusions

Namibia’s current account deteriorated over the past decade, but is expected to improve in 2017 and, over time, stabilize at a deficit of about 6 percent of GDP. Despite the expected improvement, international reserves coverage is below adequate levels and is projected to decline over the coming years. However, the implementation of the advised fiscal consolidation would help curb domestic demand and reduce the external imbalance, bringing the CA account better in line with fundamentals, while increasing international reserves to adequate levels (under staff’s reform scenario, the current account deficit would stabilize at a deficit of about 2 percent of GDP, largely due to the lower imports from fiscal consolidation, and international reserves would reach 20 percent of GDP by the end of the projection).

Annex V. Containing Public Wage Bill Dynamics: Policies and Benefits

With several countries embarking on fiscal consolidation efforts, the public wage bill has come under increasing scrutiny as it accounts for a substantial portion of total public spending and, over the past decade, has increased in many countries. Evidence shows that SACU countries, and especially Namibia, have some of the highest public wage bills in the world and that public sector salaries are well above those in the private sector. The impact of such wage premium is likely to raise workers’ reservation wages, appreciate the real exchange rate, and reduce the economy’s ability to absorb foreign shocks. Moreover, except for South Africa, the public sector premium in SACU countries falls along the income distribution, which might exacerbate the brain drain for highly skilled labor.

SACU countries have some of the highest public wage bills in the world. Looking at 2016 worldwide data, on average countries spend about 8 percent of GDP on public wages, with European countries being on the higher side and Asian countries on the lower side, and wage costs increasing with countries’ income levels. In sub-Saharan Africa, East African countries record the lowest wage bill while Southern African countries, particularly SACU countries, register much higher wage spending (about 14 percent on average). Public wages also absorb a significant share of budget revenue. Countries worldwide spend on average about a 1/3 of their revenues in wages, with the share increasing to 35 percent in subSaharan African countries, and further rising to 40 percent in Southern Africa and 45 percent in SACU countries.

Within SACU and small-middle income countries, Namibia has large and fast-growing public wage costs. In FY 16/17, public wage costs for central government employees reached 16.4 percent of GDP (42 percent of primary spending), almost 5 percentage points of GDP higher than in FY12/13. They absorbed about 55 percent of tax revenue, 10 percentage points of GDP higher than in FY12/13 and 80 percent of its domestic revenue (excluding SACU) on its wage bill. Notwithstanding the already high spending, the public wage spending bill is expected to further increase and reach about 17 percent of GDP in FY17/18.

The rapidly rising public wage bill in Namibia is largely the result of fast-increasing public sector salaries. Using government’s payroll data, staff estimate that about 2/3 of the increase in the wage bill over the period FY12/13-16/17 reflected wage increases, while new hires only accounted for a third of the increase. More specifically, over the period FY12/13-16/17, on average, government wages increased in real terms by about 7 percent per year, well above the average inflation rate of 5.2 percent, while the number of employees increased by about 4 percent per year. Although the annual increase in real wages seems to be moderating over time, the increase remains extremely high when compared to the limited growth registered over the same period in total factor productivity (TFP) for the whole economy (about 0.5 percent).

Yet, the high wage bill does not translate into better public services. The elevated wage bill in Namibia reflects relatively high spending in health and education compared to other middle-high income countries and countries in the region (as a share of GDP). However, the higher spending in these sectors does not always deliver better outcomes. Key health and education outcomes in Namibia (e.g., maternal and child mortality, availability of hospital beds and physicians, pupil-teacher ratio, expected years of schooling) are substantially below the standards prevailing in middle-high income countries, although better than in countries in the region. This suggests that there is room to improve the efficiency of public spending in health and education and make savings, without affecting the quality or access to these services.

However, rising salaries have led to public sector workers being paid more than similar workers in the private sector, in some cases by a wide margin. Using traditional Mincer equations (see Appendix), staff estimate that in all SACU countries, public workers have a premium compared to private workers with similar characteristics. The estimated premia are about 10 percent in South Africa, to 15 percent in Namibia, 40 percent in Swaziland, and 50 percent in Lesotho and Botswana. It is worth noticing that these premia are lower-bound estimates as they do not account for public workers’ greater job stability, and non-cash benefits commonly used in most SACU countries.

Except for South Africa, public sector wage premia are particularly high for low-skilled workers, contributing to possible brain drain in BLNS countries. A typical argument made in the region to justify high salaries is the need to address shortages of doctors and teachers, which force governments to pay higher wages for these professionals to avoid losing them to South Africa (which on average pays higher wages as the country is more developed). To assess the validity of this argument, staff ran quantile regressions of the Mincer equation for each country (see technical note) and the results show quite the contrary. The public premium is very high for low skilled workers and falls along the income distribution. Differently from BLNS, however, in South Africa the premium tends to increase along the income distribution. Taken together these results might explain the scarcity of skilled labor in the BLNS, as these workers might be tempted to work in South Africa where their abilities are better rewarded.

Containing the public wage bill is critical for fiscal adjustment and could correct macroeconomic imbalances with positive effects on long-term growth and employment. Empirical evidence for low and middle income countries suggests that wage increases above productivity gains are associated with higher unemployment rates. In the case of Namibia, staff’s analysis suggests that public sector’s wage dynamics, and most likely private sector wage increases, have widely exceeded changes in labor productivity, which tend to be associated with high unemployment. Moreover, empirical evidence for small-middle income countries shows that creating public jobs does not necessarily reduce unemployment and, in some cases, may increase it by creating pressures on the labor market. Accordingly, controlling Namibia’s public wage dynamics would bring wage increases closer to productivity trends, thus potentially boosting long-term growth and reducing unemployment.

Reducing the public wage bill and controlling salary dynamics require a combination of short and medium-term measures. Short-term measures are needed to correct the expected increase in the wage bill under current policies and start containing real salary dynamics. However, cross-country experience suggests that short-term measures are not sustainable, and tend to distort wage and employment structures. Therefore, more permanent policies are needed to preserve initial gains and contain dynamics over time.

• Short-term measures. Experience from other countries suggests that several short-term measures are effective in bringing the wage bill under control, including maintaining salary increases below inflation trends and suspending automatic salary increase, e.g., “notch” increases for workers not yet at the highest point-value of their pay grade; introducing temporary hiring rules to reduce public employment (e.g., retirement replacement ratios); and reducing temporary and contractual positions as feasible.

• Medium-term measures. Over the medium term, there is considerable scope to improve the wage bill management. Specifically, it is important to link pay to some indicator of performance, and align job requirements with compensation while ensuring public and private sector compensation for workers with similar skills is comparable. In addition, strengthening human resource management (e.g., review presence of ghost workers), and improving wage bill controls (e.g., through biometric technologies, enhanced controls for the hiring of low-skilled workers) could deliver long-term savings. Finally, comprehensive organizational and functional reviews of ministries, departments, and agencies can produce tangible savings over the medium term by identifying areas of overlap or duplication.

Controlling the wage bill dynamics and real salary dynamics is important not only for fiscal reasons but also for their positive macroeconomic effects. The rapid rise in real wages tends to increase worker’s reservation wages, appreciate the real exchange rate and reduce the economy’s competitiveness and ability to absorb foreign shocks. For these reasons, the increases in real wages that were observed in the past five years are not sustainable from a macroeconomic point of view and are introducing a whole range of economic distortions. Thus, better linking pay dynamics to productivity and ensuring similar compensation for public and private workers with comparable skills would help bring the economy on a more sustainable development path.

Annex VI. Mobilizing Tax Revenue in Namibia: Challenges and Reforms

Improving domestic revenue mobilization is critical to the government’s fiscal adjustment plans and the country’s future economic development. The tax revenue-to-GDP ratio in Namibia (29.2 percent in FY16/17) is relatively high compared to peers, but about a third of such revenues are shared receipts from the Southern African Customs Union (SACU). Instead, domestic tax revenues over the last four years only averaged about 19 percent of GDP, somewhat less than the average in emergency market economies and other small middle income African countries. Combined with narrowed tax bases (see below), this signals some room to improve domestic revenue and collection efficiency. In addition to relatively low domestic revenue, the current dependency on volatile SACU revenue exposes the budget to significant shocks. The dependency also poses significant risks as SACU revenues are expected to remain low over the next years as growth in South Africa, the main contributor to the revenue pool, is expected to remain sluggish. Moreover, these revenues will likely decline over the long-term as trade liberalization in the region deepens.

Reforms to broaden the tax base and avoid base erosion would greatly strengthen the efficiency of the Namibia’s tax system and improve domestic revenue.

• The tax base could be broadened by eliminating special tax regimes under the corporate tax, removing some VAT zero-rating provisions, and making foreign investment income of Namibian residents taxable. Preferential corporate tax rates and inefficient tax allowances create separated tax regimes with different effective tax rates. The different effective rates can be exploited by shifting taxable profits and deductions across entities to minimize the tax liability. Moreover, the VAT tax base could be broadened by removing some unnecessary zero-rating of certain goods and services (e.g., residential property, residential utilities, fuel products, telecommunications). Finally, many residents have bank accounts and investments abroad that produce income that is currently not taxable in Namibia.

• There is room to curtail a variety of tax base erosion opportunities and strengthen the integrity of the tax system. These include, for example, ring-fencing business losses (i.e. curtailing the possibility to offset losses and profits across different types of businesses); avoiding to treat construction workers as self-employed (rather than employees); eliminating exemptions for real property companies from capital gains taxation; and, finally, introducing earnings stripping rules to limit deductibility of interest expense as currently there is no limit.

Despite progress in some areas, there remains significant room to improve key tax administration functions. The most recent assessment of tax administration in Namibia took place in 2016 through the Tax Administration Diagnostic Assessment Tool (TADAT). The TADAT assessment identified a number of weaknesses in basic functions compared to international good practices. These include: inadequate data integrity and an inaccurate taxpayer register – critical to managing return filing, payment and the management of tax arrears; absence of documented processes and procedures; a lack of service delivery standards; and, limited control over taxpayer compliance.

Creating and reaping the benefits of a semi-autonomous revenue authority can take time and, in the process, significant operational improvements are needed. The authorities are moving ahead with the creation of a semi-autonomous revenue authority, planned to be operative in 2019. This is a positive step, but it does not eliminate the need for immediate operational improvements. Specifically, in the near term, it is important to develop further the capacity to conduct in-house audits for large taxpayers, design a specific strategy to manage medium-sized taxpayers and introduce a presumptive regime for smaller ones. Authorities should also avoid new tax amnesties on tax arrears that, particularly in the absence of a strong administration, are likely to reduce tax compliance.