On December 9, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Swaziland.

Swaziland’s growth has been recovering since the 2010-11 fiscal crisis, albeit at a slower pace recently. Growth recovery following the fiscal crisis was broadly supported by the manufacturing and service sectors. In 2015, however, growth is expected to slow, owing to adverse weather conditions and a slowdown in tourism and transport sectors. Swaziland continues to face significant development challenges, with high unemployment and poverty, and prevalence of HIV. Inflation has stayed modest (4.5 percent in September 2015), reflecting low international commodity prices.

Fiscal policy has become expansionary in recent years. Domestic revenue collection improved with stepped-up administration efforts. Expenditures expanded even further since the crisis, owing to increased recurrent spending (with fast growth in public sector wages) and a revival of capital expenditures. Subsequently, after running surplus for two years, the fiscal balance turned into a deficit in 2014/15. The deficit is expected to further increase in 2015/16 to 5 percent of GDP due to lower Southern African Customs Union (SACU) revenues, wage adjustments, and the supplementary budget. As a result, public debt is projected to grow fast in 2015, with heavy reliance on short-term debt creating high rollover risks.

While international reserves have strengthened since the crisis, they have not reached an adequate level. A current account surplus was recorded in 2014, supported by robust SACU revenues and exports (e.g., wood pulp, textile); there were financial account outflows in light of limited domestic investment opportunities. International reserves stayed at 3½ months of imports in September 2015, below the authorities’ medium-term target of 5-7 months of imports.

Swaziland’s growth outlook is projected to remain subdued over the medium term, while it is clouded with downside risks. Growth is expected to slow in 2016/17, followed by a modest recovery in the following years. SACU revenues are expected to decline markedly in 2016/17, putting pressures on fiscal and external balance. Furthermore, tighter or more volatile global financial conditions and weaker growth in South Africa could have negative spillovers to Swaziland. The recent weakening of the South African economy, together with the expected revision to the revenue sharing formula, point to downside risks for SACU revenues.

IMF Staff Report: Key issues

Swaziland’s growth has been recovering since the 2010-11 fiscal crisis, albeit at a slower pace recently, and its significant development challenges continue, with high unemployment and poverty. Over the past three years, Swaziland has shifted toward an expansionary fiscal policy, while revenues from the Southern African Customs Union (SACU) have declined in percentage of GDP since 2013/14. Hence, after running surpluses for two years, fiscal balance turned into a deficit in 2014/15. International reserves stood at 3½ months of imports as of end-September 2015.

Emerging shock and risks

Swaziland’s economy faces new challenges. The recent weakening of the regional economic outlook is likely to have adverse impacts on Swaziland through trade and financial channels. The SACU revenues, in particular, are projected to decline significantly in the coming years, raising concerns for fiscal and external sustainability. These challenges, unless properly addressed, could weaken growth and adversely affect financial sector stability.

Strengthening international reserve buffer

Maintaining sufficient international reserves is important to ensure the confidence in the economy. To this end, fiscal consolidation is needed over the medium term, while protecting spending for critical social and development needs. Enhanced fiscal reforms – strengthening public financial (and investment) management and domestic revenue collection – are critical policy agendas.

Safeguarding financial stability

Financial soundness indicators point to generally sound banking system. A dominant size of the nonbank financial sector – which grew fast in recent years – calls for strengthening of supervision and regulation for the sector.

Raising inclusive growth

To address social and economic challenges, it is essential to raise Swaziland’s potential for inclusive growth, while the loss of the Africa Growth Opportunity Act (AGOA) eligibility points the importance of enhancing economic diversification and competitiveness. Stepped-up policy efforts in multiple areas are needed: including improving business climate and export diversification.

Past advice

There is broad agreement with the authorities on macroeconomic policies and structural reform priorities, but the implementation of past advice has been uneven. Specifically, although the authorities acknowledge the need to pursue a prudent fiscal policy stance and rein in current spending, there have been no major policy changes since the last consultation. Progress on structural reforms (including improving business climate and accelerating land reforms) has also been modest.

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Selected Issues paper

Assessing Swaziland’s export diversification and quality

Swaziland’s exports are relatively diversified with good quality index compared with its peers. However, diversification and product quality have declined in recent years, while the expiration of the access to AGOA calls for enhanced efforts in this area. Improving education and training, strengthen institutional framework, and further developing the financial market will help improve export diversification and quality upgrading.

This note analyzes Swaziland’s export diversification and product quality. A more diversified export base would make export performance more resilient to idiosyncratic shocks. This is particularly important for small open economies such as Swaziland. IMF finds that higher diversification in exports and in domestic production and upgrading the quality of existing product have been conducive to faster economic growth and greater macroeconomic stability in developing countries.

Existing references on Swaziland’s export diversification point to somewhat conflicting conclusion. The Economic Recovery Strategy cites an undiversified export base as one of the factors contributing to Swaziland’s slow growth. On the other hand, the World Bank (2015) and Edwards et al. (2013) find that Swaziland’s export base is quite diversified relative to peers, as measured by the Herfindahl-Hirschman Index.

Swaziland’s export structure has experienced sizable changes over the past 15 years. The share of textile exports has halved, and the expiration of trade benefits under AGOA implies that the share of textile exports would decline further. In contrast, the importance of sugar exports have increased substantially, and also (though to a lesser extent) for miscellaneous edibles (which includes the allimportant Coca-Cola concentrates). Relatedly, E.U.’s share of Swaziland’s exports has increased and the U.S. market’s share has declined. At the same time, the overall export-to-GDP ratio has declined from 56 percent in 2000 to 43 percent in 2014.

Macro-financial risks in Swaziland’s banking sector associated with the SACU revenue fall

The fall in the revenues from the Southern African Customs Union (SACU) could have serious macroeconomic consequences. In addition to adverse impacts on fiscal and external balances, financial sector would also be affected. This section focuses on the likely impacts of prospective SACU revenue shock on the financial sector. Specifically, staff analysis demonstrates that the SACU revenue fall would increase sovereign spread and reduce private credit growth, while the government itself may face liquidity problem and run arrears (as experienced in the 2010-11 fiscal crisis). These developments would also affect borrowers’ payment capacity and eventually worsen bank’s asset quality, possibly resulting in further negative feedback to the economy

Swaziland’s banking system currently functions well with sufficient capital buffer (Table 7 of the Article IV staff report), though it is vulnerable to exogenous shocks. Capital ratios of commercial banks are above the regulatory minimum, and their profitability is high. The banking sector, however, is highly exposed to exogenous shocks, reflecting the economy’s vulnerability (e.g., a small open economy and heavy reliance on the SACU revenues). Furthermore, the high level of concentration on the balance sheets and the almost unitary business model of three of the banks pose additional structural weaknesses which would augment the negative impact of various shocks (in particular, the high volatility in the SACU revenues).

In view of the expected fall in the SACU revenues in coming years, this note explores the impact (stress) of the prospective fiscal shock on the stability of the banking system and its feedback effect on the real economy.

The stress testing exercise is carried out in the following three stages:

1. Exploring the macro-financial links from stress event (SACU revenue shock) to macroeconomic variables using a vector auto-regression (VAR) model,

2. Mapping the macroeconomic shocks to banks’ asset quality (i.e., NPL ratio) using cross-country panel regression, accounting for the feedback effect of banks’ credit risk on the real economy, and

3. Stress testing based on the calibrated NPL shock and the stress-testing model developed in the recent MCM TA (IMF, 2015), based on the standard macro stress-testing framework (Čihák, 2007).