Careful decision making vital to tempering Djibouti's rapid expansion

Djibouti’s economic strategy, as outlined under the Djibouti Vision 2035 plan, is in large part dependent on growth led by construction activity and infrastructure spending. While much of the $14bn worth of ongoing or planned projects is being financed directly by overseas investors, a large percentage is also being funded from the government’s budget, or with financing assistance from development institutions. This is having an impact on the state’s fiscal sustainability, with the budget now operating in the red, as well putting absorptive capacity – the ability to implement projects in a timely fashion and spend the full envelope of funds – under pressure.

To finance the gap, the country is turning towards a number of multilateral lenders, but this is leading to an increase in financing and interest payments, which is prompting the government to improve revenues and address bottlenecks for higher tax collections. Total expenditure is set to reach DJF153bn ($858.8m) in 2015, according to IMF projections, up from DJF89.4bn ($500.6m) in 2012.

Spending-LED Growth

Relatively robust economic growth – at an average of between 5% and 6% over the past two years and with forecasts of up to 7% for the next two years – has allowed the country to attract a wave of inbound investment and spark activity in the construction and transport sectors, which comprise the largest parts of the secondary and tertiary sectors respectively.

Capital Investment

However, much of this headline growth has come on the back of capital spending. In total, aggregate investment, both public and private, hit 53% of GDP in 2015, roughly double the volume two years prior. Nearly half of that – 25% of GDP – comes from the public coffers.

Closer attention to how expenditure programmes are implemented can also help manage the situation. In its Article IV consultation with Djiboutian authorities, the IMF put an emphasis on the country’s need to ensure that spending allocated to infrastructure projects be accompanied by cost-benefit analysis. The fund also recommended a strengthening of the public sector’s management capability of the spending programme.

Revenues 

As a result of the high volume of spending, ensuring a stable and sustainable source of revenues is crucial. Djibouti has traditionally outperformed the African average in terms of tax collection, with tax revenues equal to around 20% of GDP on average – well above countries like Nigeria, Ghana or Kenya, which are often in the low to mid-teens. A number of pending tax reforms (see overview) that are due to be unveiled in 2016 should help to ensure that number inches up further. In June 2015 Djibouti held a high-level tax conference as a prelude to passing much needed tax reform, which is set to take five years to implement.

Djibouti also benefits from a stream of revenues from the leasing of military bases to countries like the US and China. In 2014 Djibouti successfully raised the rent for the US military base from $38m to $63m a year, which will provide a boon for the treasury, while China’s planned base is expected to bring in around $100m a year.

A number of one-off measures will also help to expand revenues over the next couple of years, including a $50m grant from the Gulf Cooperation Council for debt service and capital spending, and the remnants of the funds raised from the partial privatisation of the ports in 2013.

Bottlenecks

Structural aspects of the country’s economy will, nonetheless, contribute to a challenging environment in terms of revenue collection. A still largely undiversified economy, reliant on transport services, and a weight of informal activities has made it hard for the government to increase tax revenues. On top of this, the large dependence on imports impacts the cost-of-living and makes the country vulnerable to external shocks. It also has the effect of leaving the country will a structural trade deficit.

Equally importantly, according to the IMF, revenues may actually decline as a percentage of GDP over the next few years. Part of this is a result of the high level of GDP growth, and the fact that expanding the tax base at the same pace may prove difficult. Similarly, many of the activities – such as trade and transport – that are contributing to growth are tax-exempt, which means that higher headline figures will not translate into a jump in revenues. The IMF also pointed out in its December 2015 report that rents for the military bases are fixed in nominal terms, which will means that they will decline in relation to GDP. The payment of tax arrears in 2013 and 2014 has also helped stabilise fiscal revenues but with most arrears now cleared, that will fall.

Handling Debt

So far, to maintain capital spending levels, and to bridge the gap between revenues and expenditures – which on a commitment basis should more than double from 5.9% in 2013 to 13.8% in 2015 – the government has turned to external lending. According to the IMF, the stock of publicly guaranteed debt as a percentage of GDP will rise sharply, from 48.4% of GDP in 2013 to 65.7% of GDP by 2015. The country’s position is expected to become even more critical, with external public and publicly-guaranteed debt peaking at 81.5% in 2017, although it should begin to decrease to 68.6% of GDP by 2020, according to December 2015 projections by the fund.

Much of this growth in debt is a direct result of financing for the major infrastructure projects. The projects that are expected to represent a larger amount of debt are the multipurpose sea port, the water pipeline link to Ethiopia, and the railway connection. The loans for those projects will be handled by the central government, until they are operational and revenue-generating, and thus can be transferred to the public companies in charge of those projects. According to the World Trade Organisation (WTO), the majority of Djibouti’s external debt, at 66%, is owed to multilateral lenders, according to 2013 figures.

The servicing of debt was made more burdensome in light of the country’s classification as a middle-income country, according to the Djiboutian authorities. On top of the existing debt, the government of Djibouti signed two additional loan deals in 2013 with China Exim Bank, linked to some of the large-scale infrastructure projects currently under way, although the conditions of these loans have been kept confidential, according to the African Development Bank’s (AfDB) “2015 African Economic Outlook” report.

The heavy debt burden has nonetheless been compensated by an increase in the country’s foreign direct investment stock, which increased to over $1.5bn in 2014, according to international media reports. In 2013 foreign direct investment reached a record 18.6% of GDP. This was largely influenced by the government’s decision to sell 23.5% of the Port of Djibouti to Chinese investors for $185m. According to the AfDB, 40% of the funds collected by the government was used to payback arrears, invest in other infrastructure projects and replenish reserves at the Central Bank of Djibouti.

Taking in large amounts of debt can be a gamble for an economy as small and exposed as Djibouti’s. However, the infrastructure investments are expected to pay-off in the long run, by helping to make the economy run more efficiently and allowing the country to capitalise on its unique position in the realm of international commerce. In the meantime, however, a measure of fiscal discipline will be needed in order to ensure future stability. If the appropriate measures are taken it is likely that Djibouti will continue to see its economy grow.