Introduction

1. Our Somali authorities appreciate staff’s continued engagement and candid policy discussions on the combined second and third reviews of the Extended Credit Facility (ECF) Arrangement. They broadly share staff’s appraisal of key policy priorities.

2. The past couple of years have been especially challenging. The country faced multiple shocks amidst very limited fiscal scope. The global pandemic and worsening drought conditions have, together with global supply disruptions, led to a severe food crisis, with a third of the population facing acute food insecurity amidst deteriorating humanitarian conditions. This crisis was exacerbated by security challenges. Nevertheless Somalia has continued to make substantial progress in rebuilding government and economic institutions with help from the IMF and other international development partners. This is reflected in robust program performance. While varied shocks threatened to setback reform progress, the authorities remained steadfast, sustaining prudent economic management to meet their ECF program targets and preserve macroeconomic stability, while continuing to pursue the Ninth National Development Plan (NDP9) priorities. The NDP9 and ECF prioritize strengthening economic institutions, public finance management, domestic revenue mobilization and creating a conducive environment for sustained and inclusive growth.

3. The country currently faces a looming humanitarian crisis. A joint UN agencies report released on June 6, 2022 indicates that in the wake of drought with four failed rainy seasons, the Somali population faces catastrophic hunger and severe food insecurity. The report estimates that nearly 50 percent of the population will experience food insecurity or worse through September 2022 and possibly, beyond. The crisis is further exacerbated by high food inflation which has impacted vulnerable households the most, as they spend a significant share of their income on food. With a weak social safety net and limited fiscal space, Somalia continues to rely heavily on external donor support to help reduce the risk of famine. We appeal to development partners to redouble their support to the country to help avert a humanitarian crisis and save lives.

Recent Economic Developments and Outlook

4. The economy grew by 2 percent in 2021 following contraction in 2020. The modest recovery reflected some recovery in exports and household consumption. was buttressed by higher remittances The economy is expected to grow by 2.7 percent in 2022, however, the outlook is clouded by the prolonged and severe drought, on-going security challenges, higher fuel and food prices, and the risk of COVID-19 resurgence due to very low vaccination rates. Nevertheless in the medium-term, GDP growth is projected at 4.1 percent supported by higher private investment, public spending, and on-going reforms.

5. Inflation recorded at 4.6 percent in 2021, is expected to accelerate to 8.5 percent in 2022, as food and energy prices continue to rise reflecting spillovers from the war in Ukraine alongside the prolonged and severe drought. Inflation is projected to moderate to less than 4 percent in 2023 and beyond.

6. Despite strong exports and increased remittance flows, the current account deficit widened from 10.8 percent of GDP in 2020 to 15.0 percent in 2021 reflecting a higher import bill and decline in donor support. The current account deficit is projected to remain elevated in the medium term and is expected to be financed through remittances and foreign direct investment, and in the medium-term, by modest concessional loans.

7. Since the beginning of the global health crisis, Somalia has experienced multiple COVID-19 waves. Inadequate vaccine access and limited capacity to administer particularly outside major urban areas have resulted in extremely low vaccination rates.

As of June 9, 2022, less than 9 percent of the population were fully vaccinated.

Program Performance

8. Given the strong performance under the ECF arrangement amidst especially challenging conditions, the authorities seek Executive Directors’ support for the completion of the second and third reviews of the program and for associated waivers and modifications. As the timing of budget support disbursements is uncertain, the authorities request the use of an adjustor on the floor for the fiscal balance to reflect this. They are also requesting rephasing of access and the extension of the ECF arrangement to end-2023 to adjust for delays in the second and third reviews. They seek disbursement of the third tranche of interim HIPC assistance of SDR 680,000 to cover debt service to the Fund falling due through June 2023.

9. All quantitative performance criteria and all indicative targets from December 2020 to September 2021 were met except for the floors on domestic revenue and the fiscal balance, as the authorities could not prevent pandemic-induced shortfalls in revenue or the pause in budget support in response to delayed elections. The authorities have committed to taking corrective actions to address revenue shortfalls including through the introduction of new tax measures in the 2022 budget as well as revenue administrations reforms. The recent successful elections are also expected to unlock donor budget support.

10. The authorities have also met all structural benchmarks on time except one on the Targeted Financial Sanctions Law. While Cabinet had approved the law and it was submitted to the previous Parliament, it did not move forward because Parliament was not in session during the elections period. The authorities intend to resubmit the bill to the new Parliament for approval in June 2022. They are also making steady progress in implementing HIPC Completion Point triggers with a view to reaching the Completion Point by early 2023.

Fiscal Policy

11. Despite substantial spending pressures fueled by severe drought, the pandemic, security challenges, and an election cycle, the authorities have exercised remarkable restraint and pursued prudent expenditure management. The suspension of donor budget support alongside pandemic impacts also contributed to the significant revenue shortfall. Judicious use of the SDR allocation, strategic advances from the Central Bank of Somalia (CBS), and effective and careful expenditure management helped preserve macroeconomic stability and allowed the authorities to meet critical expenditures while limiting the negative cash balance to 0.3 percent of GDP. Moving forward, they remain committed to effective expenditure control and domestic revenue mobilization anchored by the medium-term fiscal framework supporting NDP9 implementation. Continued support from development partners will however remain essential at the center of the authorities’ medium-term fiscal framework. In the short run should donor support fail to materialize in time to meet critical spending and mitigate liquidity risks, the authorities have contingencies in place including temporary advances from the CBS, expenditure reprioritization and acceleration of revenue measures. However, given the severe humanitarian challenges the country faces, timely donor support is critical as sustained austerity has significant risks.

12. The authorities will boost domestic revenue collection by broadening the tax base and improving the efficiency of tax administration. New tax measures in the 2022 budget and resumption of donor support are expected to ease pressures in 2022 and beyond and to support spending priorities including critical higher social spending. Starting in 2023, more revenues are expected from the telecom sector with the application of an effective tax rate consistent with those in other countries in the region, and fair spectrum fees which the authorities plan to introduce by July 2022. In addition, the deployment of point-of-sale machines is being prioritized to improve accuracy of sales data and increase sales tax collection from large taxpayers. The current outdated income tax law will also be updated with the submission of a new modern income tax law to Parliament. The authorities will develop an integrated tax administration system by the end of this year as well as draft the regulations for the Revenue Management Law, to enhance tax administration efficiency. They have also prioritized modernizing and improving the efficiency of customs administration. They intend to shift to an ad valorem tariff structure across all ports of entry of the Federal Republic of Somalia and its member states. They will issue customs regulations on valuation and declarations and enact the law specifying the ad valorem tariff schedule this year. They will also operationalize the Customs Administration System at ports and airports as part of the infrastructure for ad valorem customs valuation.

13. On expenditure, the authorities will implement payroll reforms. The integrated payroll system will capture all compensation of employees (including the share currently outside the payroll process) in the Somalia financial management information system (SFMIS). Cabinet will approve a new pay and grade policy that will codify salary scales and allowances in support of this process. In the short run, nominal wages will be frozen, and growth of public sector employees limited to new recruitments in the security sector. The authorities will also improve budget execution and the treasury management process. They plan to develop invoice tracking and efficient budget management functionality under the SFMIS. The functionality of the commitment control module in the SFMIS has been operationalized to strengthen expenditure management and is already contributing to more effective cash and other expenditure management.

14. The authorities continue to strengthen public financial management (PFM), building on previous reforms. They published audited annual financial statements of the Federal Government of Somalia (FGS) for 2019, and 2020 and 2021 statements will be released after their consideration by the new parliament. In 2021, the authorities published the aggregate comprehensive budget of the FGS, federal member states plus and Banadir Regional Administration for the first time. In May 2022 the stalled 2018 PFM Act regulations including provisions on debt, public investments, and natural resource management were issued and implementation will commence immediately. This is an important step towards building a strong foundation for more effective and cooperative intergovernmental fiscal relations. In addition, the authorities are stepping up the implementation of the Public Procurement Law and regulations as well as building capacity for public sector employees to ensure they fully understand the legislation and associated regulations. To boost transparency, the authorities launched the public procurement portal that will serve as a one stop repository of all procurement related information.

15. Since reaching the HIPC Decision point, the authorities have been in active negotiations with all their creditors to secure the required level of debt relief and ensure debt sustainability at HIPC Completion Point. As a result, agreements have been reached with all Paris Club members except Russia as well as with the Kuwait Fund for Arab Economic Development. Negotiations are on-going with the remaining creditors, as the authorities seek and hope for their cooperation. The authorities have substantially improved their debt management capacity with the adoption of the Commonwealth Meridian debt recording management system. As a result, the Debt Management Unit has been able to publish accurate quarterly public debt reports since 2020Q4.

Monetary and Financial Sector Policies

16. The authorities remain committed to strengthening monetary policy. The central bank has limited policy levers to mitigate current high inflation given that the economy is de facto dollarized. Although the currency exchange project which will replace counterfeit currency in circulation and usher in full currency reform in the future remains a high priority, the authorities are taking a careful and considered approach to ensure successful implementation. They will endeavor to have in place operational, security and financial requirements as well as basic monetary policy instruments and capacity before this critical reform is operationalized. The authorities will also seek the support of development partners to secure the required financial resources and technical support, in this regard.

17. The authorities have prioritized rebuilding the capacity of the central bank by creating a function-based organizational structure and executive committee to improve decision making efficiency. The full implementation of the IMF safeguards recommendations, which cover external and internal audit, legal, reporting and controls, in line with the Central Bank of Somalia’s (CBS) strategic plan, remains a priority. Significant progress has been made in the implementation of these recommendations. The authorities have also taken steps to improve the CBS’s internal operations such as accounting practices, and for the first time in FY2020, the CBS’s financial statements received an unqualified audit opinion, with no material weaknesses or significant deficiencies cited. The audit was conducted by a reputable international independent certified public accounting company. The CBS is also in the process of modernizing its legal framework. In this regard, the draft National Payment System Bill and revised Financial Institutions Law and Insurance Bills are now under final technical and legal reviews and will be submitted to Cabinet in October 2022.

18. Somalia’s banking sector has remained resilient to shocks benefitting from ample capital and liquidity buffers. Nevertheless, regulations on banking institutions’ capital adequacy and liquidity risk management are being updated to comply with Basel committee recommendations. With support from the Fund, the CBS supervision department has also taken concrete steps to build technical capacity and improve the regulation of the banking sector, including Islamic banks, including with a tailored training plan for supervisory staff. Guidance has also been issued on both Islamic bank financial reporting and the governance framework. Concerted efforts to improve the accounting practices and develop the capacity of accounting staff with support from international development partners including the IMF are bearing fruit. The CBS has also issued modern mobile money regulations and gave mobile money operators 24 months to meet the regulatory requirements. Licenses were issued to two large mobile money operators that were compliant with all the requirements.

Together they account for nearly 80 percent of all mobile transactions. Two additional licenses are currently under consideration.

Structural Reforms and Governance

19. Addressing governance weaknesses and fighting corruption remains a high priority. An independent Anti-Corruption Commission was established, and the national anticorruption strategy published. The authorities note the importance of developing an action plan for the anti-corruption strategy once ongoing outreach to stakeholders is concluded. Somalia’s August 2021 accession to the UN Convention Against Corruption set the stage and an implementation action plan is being developed. The authorities also ratified the African Union and Arab League anti-corruption conventions. On the AML/CFT front, the authorities have completed a comprehensive National Risk Assessment with support from the World Bank. The assessment highlights areas for improvement that will inform the development and implementation of a new National Strategy on AML/CFT to address identified shortcomings before the MENA-FAFT Mutual Evaluation Assessment in 2024.

20. Our authorities intend to create a strong social safety net to support vulnerable households. With the support of the World Bank, the Shock Responsive Safety Net for Human Capital Project (Baxnaano) which is based on the World Food Program system was launched in April 2020 and has played a critical role in supporting drought and COVID-19 affected households. A national registry system will also be established along with the necessary regulations including those addressing data privacy and data protection protocols. The most vulnerable households will be targeted for support. The authorities are also making progress towards a national ID to support financial intermediation and delivery of government services, including social programs.

21. Somalia has the potential to become an important oil and gas producer in the region. To ensure the country derives maximum benefit from any future exploration and that proceeds from production of oil and gas accrue to the people of Somalia, the Inter-Ministerial Concession Committee approved a model oil and gas production sharing agreement (PSA). The Extractive Industries Income Tax (EIIT) Bill has been revised to make it internally consistent with the PSA. The authorities also plan to adopt a strong tender protocol in line with IMF recommendations and international best practice, to promote competitive bidding for petroleum exploration contracts. On the advice of the IMF, the authorities will refrain from issuing exploration licenses before regulatory building blocks including the Petroleum Act, EIIT, and the model PSA and associated PFM regulations are in place.

22. Our Somali authorities recognize the increasing urgency of climate change adaptation and its importance to protect growth and food security and reduce climate-induced poverty. The authorities are concerned at the increasing impact of the climate change and are keen to implement pertinent reforms for adaptation and resilience. The increasing frequency and severity of droughts and floods and resultant food insecurity is a concern but to date the authorities have been constrained by the lack of resources to adapt. Somali authorities appreciate the continued support of their international partners to deepen reforms to adapt to climate change.

Conclusion

23. The Somali authorities remain committed to implementing difficult reforms notwithstanding the extremely challenging environment. They value their engagement with IMF staff and the substantial technical assistance and capacity development support they receive. They look forward to the support of Executive Directors towards the completion of the second and third reviews of the ECF program.