III. ECONOMIC TRENDS OUTLOOK MAJOR TRENDS AND OUTLOOK Madagascar ranks among the poorest countries in the world. World Bank data places it twelfth-lowest globally in terms of real per capita gross domestic product (GDP). Between 1971 and 1991 real GDP per capita fell by forty percent. The 1980's were a decade of economic crisis in Madagascar as failed socialist policies, declining terms of trade and a growing external debt burden combined to cause a severe erosion in living standards of the Malagasy people. An attempt to implement a structural reform program during the 1988-1990 period produced encouraging results, but the political democratization process that began with the 1991 general strikes was accompanied by renewed economic decline. The present democratic Malagasy government has yet to reverse the downward trend. There are, however, some encouraging developments. Reforms in the agricultural sector have eliminated administered prices on all products except for vanilla. The privatization of some parastatals has been completed and others are planned. The banking sector has been opened to private companies and a duty free export processing zone program has attracted a significant number of manufacturing firms, primarily textile enterprises. The tourism and seafood industries show considerable growth potential. Finally, the recent expansion of commercial and political relations with South Africa offers the prospect of increased trade and investment in coming years. PRINCIPAL GROWTH SECTORS Madagascar has considerable unfulfilled growth potential. This island nation has ample resources: abundant, low cost and easily trained labor, a wide variety of soils and climates, economically significant mineral deposits and unique flora and fauna. Agriculture, food processing, aquaculture, mining, tourism and light manufacturing are the economic sectors that offer the best growth prospects over the near-term. In recent years weak prices and increasing competition from other producing countries have cut sharply into Madagascar's receipts for traditional agricultural exports such as vanilla, coffee and spices. As a result, investors and aid agencies are developing projects to encourage transformation of agricultural products before export. Some local producers have been successful in marketing fresh flowers and canned vegetables in Europe during the northern winter. Fishing in Malagasy territorial waters and shrimp farming has developed into sizable businesses in recent years, attracting several foreign investors. Madagascar has commercially significant reserves of several minerals, including chromite, graphite and titanium. Chromite and graphite deposits have been exploited for a number of years and development of a large ilmenite deposit in southeastern Madagascar is planned. Significant quantities of various precious and semiprecious stones are also found in Madagascar. Madagascar's unique flora and fauna is the basis for development of the tourism industry, although the decrepit state of the transportation and communications infrastructure on the island is slowing the growth of this sector. Major investments in other hotels and similar tourist facilities, will be required in order to realize continuing future growth. Political unrest caused a drop in the number of tourists in 1991 (from 53,000 in 1990 to 35,000) but arrivals recovered to 54,000 in 1992. Liberalization of the Malagasy air transport sector should boost tourism if more frequent flights to European cities and lower fares result. Light manufacturing, especially in the clothing and textile sectors, increased significantly since the establishment of a duty free export processing zone program in 1990. Clothing and textile producers migrated from Mauritius to take advantage of Madagascar's abundant labor resources, relatively low wages and less restrictive labor practices. GOVERNMENT ROLE IN THE ECONOMY In 1975 the Malagasy implemented a socialist economic policy that focused on the principle of national self-sufficiency. Large foreign enterprises were nationalized and bureaucratic controls on business were implemented. These controls included restrictions on imported goods, on the allocation of foreign exchange and on prices and profit margins. Structural reform negotiations with the Bretton Woods institutions which began in 1988 have focused on liberalization and privatization of key economic sectors to improve efficiency and competitiveness: air transport, petroleum, vanilla, telecommunications and banking. In the air transport sector, state-controlled Air Madagascar's monopoly in both domestic and external traffic is to be abolished with the privatization of this carrier also a possibility. The petroleum parastatal, SOLIMA has already lost its monopoly on the importation and distribution of non-motor fuel petroleum products. The IMF and World Bank are encouraging complete privatization of this sector. Vanilla is Madagascar's largest earner of foreign exchange and is the only remaining commodity subject to administered prices. In the telecommunications sector the government has already awarded contracts to private sector suppliers of cellular and international services, and a new administrative framework is being implemented that will recast the role of government from network operator to telecommunications regulator. Finally, in the banking sector, two state-controlled commercial banks are to be put under private management in late 1994 with the government's ownership stake reduced to a minority position. BALANCE OF PAYMENTS SITUATION Madagascar has run sizeable overall balance of payments deficits since the mid-1980's. The current account deficit as a percentage of GDP averaged in excess of six percent during the last half-dozen years and registered nearly seven percent in 1992. In the past, current account deficits have been financed by external borrowing, resulting in a heavy external debt burden. By the early 1980's these inflows began to dry up and arrears rose sharply. Madagascar's total external debt now stands at around USD 3.8 billion (about 113 percent of GDP) and total arrears are close to USD 400 million. In 1989 Madagascar was the beneficiary of debt cancellations by the governments of France, Germany and the United States. Madagascar will not be eligible for additional Paris club rescheduling of its debt burden until agreement is reached with the IMF on a new structural adjustment program (the last one expired in 1992). Negotiations with the IMF are ongoing but little progress has been made to date. TRADE AND INVESTMENT BARRIERS The inadequacy of the physical and institutional infrastructure in Madagascar constitutes the most significant barrier faced by potential investors. Madagascar's dilapidated transportation and communications networks impose significant costs on local firms, both in terms of direct expenses and diminished efficiency. The present legal and regulatory environment offers potential investors inadequate protection from the risks of arbitrary seizure or capricious decision-making by bureaucrats. Key figures in the political hierarchy exercise market power that can suppress competition. Corruption at all levels of government is widespread and payment of bribes is often required to secure necessary licenses and project approvals. The small size of the Malagasy market and generally low income levels limit the attractiveness of the market for many potential foreign exporters. The current unavailability of Eximbank coverage is also a significant handicap for potential U.S. exporters of capital goods. LABOR FORCE The labor force in Madagascar is generally literate and quickly trained and wage rates are among the lowest in the world. Although Madagascar's labor movement dates from the 1930's, organized labor is made up of over forty small, highly-localized unions which include less than fifteen percent of formal sector employees, who themselves number only about 400,000 in a population of over twelve million. The public sector in Madagascar accounts for 120,000 employees. The unions are generally ineffective. MAJOR LOCAL AND THIRD COUNTRY COMPETITORS IN SPECIFIC SECTORS In the agricultural sector, Madagascar competes with Indonesia for the small international vanilla market, and with South and East Asian countries for the spice market. In the light manufacturing sector Madagascar is competing with other developing countries for investors. With regards to tourism, Madagascar attracts only a fraction of the tourists now drawn to neighboring holiday destinations like Mauritius and the Seychelles. INFRASTRUCTURE SITUATION RE: GOODS/SERVICE DISTRIBUTION Madagascar's surface transportation network is in poor condition. Railroads cover only a small portion of the island and suffer from underinvestment and poor maintenance. The road network is more extensive but suffers as well from inadequate maintenance. During the rainy season (usually November until April) it is virtually impossible to reach some areas of the island by road. Domestic and international air transport services are unsatisfactory because of limited service and high cost. MAJOR INFRASTRUCTURE PROJECTS UNDERWAY The modernization of Madagascar's antiquated telecommunications system is the most significant infrastructure project now underway. The government has announced its intention to reduce its role to that of regulator in a restructured system and has signed contracts with private firms to provide cellular and international services. The estimated value of the system modernization is USD 200 million.