Directors agreed that a prudent 2011/12 budget would be an important first step toward strengthening public finances. While recognizing that high fuel prices, weather-related supply shocks, and shortfalls in donor aid could complicate near-term fiscal management, they encouraged the authorities to continue to streamline current spending by trimming the wage bill, aligning spending more closely with available resources, and tightening existing commitment controls to help prevent the reemergence of arrears. At the same time, it will be important to safeguard essential social spending and high-yielding infrastructure investment.

Directors stressed the importance of broadening the tax base, reducing tax exemptions, and strengthening public financial management. They considered that strengthening value-added tax (VAT) compliance and enhancing the taxation of the mining sector will be key to boosting revenue mobilization.

Directors encouraged the authorities to expeditiously complete their debt management strategy and maintain a cautious approach to non-concessional borrowing to ensure debt sustainability over the medium term. In this context, they stressed the need to carefully select projects financed with nonconcessional borrowing through rigorous cost-benefit analysis.

Directors urged the authorities to monitor inflation developments closely and stand ready to further tighten monetary policy as needed. They noted the staff’s assessment that the exchange rate appears broadly in line with fundamentals. Directors welcomed the overall soundness of the financial sector and the authorities’ reform efforts, in line with the 2010 Financial Sector Assessment Program recommendations. They emphasized the importance of continued vigilance regarding credit quality, given the recent rise in non-performing loans and lending.

Directors stressed the importance of reinvigorating structural reforms and improving governance and the business environment. Further progress in these areas is critical to bolstering private sector confidence, increasing economic diversification, and preserving the competitiveness of non-commodity sectors, including emerging manufacturing exports.

Background

The economy has performed strongly over the past decade with average growth of 7 percent, a robust expansion in exports, and progress towards the Millennium Development Goals (MDGs). The authorities have implemented wide-ranging policy reforms over several decades and recently were able to use the fiscal space accumulated in better years to mitigate the impact of the global financial crisis. Nonetheless, challenges remain. Per capita income is about US$550 and poverty remains widespread, with one in three living below the poverty line. Tanzania is highly dependent on foreign aid, projected to peak at 10 percent of gross domestic product (GDP) this year.

Tanzania weathered the adverse shocks of recent years relatively well. Activity slowed in the aftermath of the global financial crisis but rebounded in the second half of 2009, thanks in part to supportive fiscal and monetary policies. Consumer price inflation fell into single digits as good harvests pushed down food prices and fuel prices were subdued. Financial market indicators remained sound overall.

The economic rebound has now leveled off. Growth in 2010 is estimated at 7 percent with continued strong performance in manufacturing, construction, and communications and a more subdued expansion in agriculture and gold mining. In recent months, power shortages after below-normal rainfalls have been taking a toll on activity. Growth is expected to decline to 6 percent in 2011 but rebound quickly once the weather situation normalizes. Consumer price inflation rose in early 2011 largely due to higher energy and food prices—the latter mainly weather-related.

The medium-term outlook is favorable but could raise significant policy challenges. Large projected investments in the commodity sectors could weigh on overall competitiveness and pose challenges for exchange rate management. It also needs to be ensured that these investments benefit other sectors of the economy. Rapid population growth will continue to put pressure on the delivery of public services, far outpacing the growth of domestic revenue or foreign aid.

The near-term fiscal situation is already challenging: revenue collection for 2010/11 (July-June) is falling short of ambitious budget targets due in part to the adverse weather situation, constraining public spending and contributing to the emergence of arrears. Spending was cut in the context of the mid-year budget review, and steps were taken to tighten commitment controls, but more spending restraint is likely to be needed.

Monetary policy has become less accommodative, and the exchange rate has been stable in recent months reflecting relatively modest inflation differentials and rising domestic interest rates. Non-performing loans remained at manageable levels after growing considerably in the second half of 2010, largely reflecting deterioration in personal loans, which expanded significantly in recent years.