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C O N F I D E N T I A L ASMARA 000516 
 
SIPDIS 
 
SIPDIS 
 
LONDON FOR AFRICA WATCHER 
PARIS FOR AFRICA WATCHER 
 
E.O. 12958: DECL: 6/15/2016 
TAGS: ECON EAID EFIN PREL ER
SUBJECT: Dire Economic Conditions Compel GSE to Court 
IMF; Donors Doubt ItQs a Match That Will Last 
 
CLASSIFIED BY:  AMB Scott H. DeLisi, for reasons 1.4 (b) 
and (d). 
 
 
¶1. (C) Summary: After two weeks of consultation, the IMF 
mission team presented a hopeful image for the future as 
GSE officials offered assurance of GSE interest and 
commitment to a staff monitored program(SMP) as the first 
step toward HIPC support for Eritrea.  GSE interest is, 
of course, tempered with concerns about requiring 
monetary policy changes such as exchange rate adjustments 
and opening the import market.  Moreover, implementation 
is fraught with tension both within the GSE and between 
the donors and the GSE.  DonorQs expressed heavy 
skepticism about the GSEQs commitment and about its 
willingness to transition to transparency. With the GSE 
shutting out donors and withdrawing from bilateral 
partnership with the US and other western nations over 
the past year donor skepticism is unsurprising.  Still, a 
last chance to regain donor support for HIPC debt relief 
may be a powerful incentive for the GSE to reengage and 
consider compliance with IMF reforms.  We are doubtful it 
will happen, but given the GSEQs dire economic situation, 
we expect the GSE to play out its dialogue a bit further 
in hope that donors may still join the IMF in saving the 
GSE from itself.  End Summary. 
 
COMPONENTS OF THE SMP 
--------------------- 
 
¶2.  (C) With the sunset clause for HIPC support rapidly 
approaching in December 2006, the pressure is on the GSE 
to implement an IMF staff monitored program in hope of a 
full program being approved by yearQs end.  IMF staff, in 
interim and final outbriefings with donors, reported that 
macroeconomic stabilization - combining fiscal adjustments 
with supportive monetary conditions - would be the 
foundation of the SMP.  The SMP monthly targets will 
focus on: severe restrictions on domestic lending, 
increasing net international reserves, controlling the 
balance of payments, reducing government expenditures, 
increasing tax revenue, and reducing the fiscal 
deficit(primarily the domestic balance.)  Measurement of 
these targets would need to be completed by the end of 
October in order to allow the IMF time to prepare for the 
December board meeting.  (Note: In the best case 
scenario(and possibly unrealistic one), presuming 
agreement and initiation by June 30, this would allow for 
4 months of data.) 
 
¶3.   (C)Meeting the monthly targets is important, however, 
these accomplishments alone will not be enough. The SMP 
will also  require increasing transparency in the 
financial sector and regarding government budgetary 
practices, including the publishing of a budgetary 
framework and dialogue with donors.   The IMF expects 
that economic data such as the Consumer Price Index and 
the fiscal data of the GSE will be made available. 
Furthermore, the IMF requires that action plans be 
implemented to address such issues as weaknesses in the 
banking system.  Finally, the IMF anticipates the World 
Bank funded public expenditure review on the health and 
education sectors will be completed in a timely manner. 
All of these steps, according to the IMF team leader, 
will demonstrate the GSE commitment to reform and show 
that "they [the GSE] have a vision." 
 
TIMING IS EVERYTHING 
-------------------- 
 
¶4. (C) Of greatest concern to the GSE, according to the 
IMF staff, is the impact and timing of the monetary 
policy changes; namely devaluation of the currency and 
reopening/liberalization of the import market.  Devaluing 
the currency 15 to 19 nakfa to the dollar (which is the 
IMF recommendation) will, with the current level of debt 
and without donor support, lead to greater inflation. 
With inflation reported to the IMF at 12%, but in reality 
 
 
probably higher, the risk of inflation concerns the GSE. 
The GSE is also reluctant to liberalize imports, another 
IMF recommendation.  With no exports to speak of there 
will be little gain on that front from devaluation which 
could offset the increased costs of imports.  The effect 
on the balance of payments and international reserves 
will, as a result, likely be severe.   (Comment:  The GSE 
currently uses currency controls and other mechanisms to 
restrict private sector imports and those imports that 
are allowed are destined for companies controlled by 
government through its political party, the PeopleQs 
Front for Democracy and Justice.   Keenly aware as well 
that increased economic freedom can lead to challenges to 
political restrictions, the government has multiple 
reasons to want to go slow on both devaluation and trade 
liberalization.  If they do proceed, it will be an 
indication of just how dire the GSEQs economic situation 
has become.  End Comment.) 
 
MEETING THE DEADLINE: WHAT REMAINS TO BE DONE 
----------------------------------------- 
 
¶5. (C) According to the IMF team the GSE has agreed to 
these measures "in principle," however no agreement 
exists on the data points.  What is still missing?  A 
three year macroeconomic framework, the selection and 
agreement on the actual numbers for five or six fiscal 
benchmarks for monitoring and an action plan for 
interaction with stakeholders, such as civil society and 
the donors.  Moreover, there is no agreement yet on the 
timing of devaluation or on what actions will be taken 
when in regard to trade liberalization.  Although the 
"theory" of a staff-monitored program is agreed, the IMF 
team acknowledged that they departed on June 10 with a 
lot of oral commitments but nothing in writing. 
 
 
IT ALL SOUNDS GOOD: DOES THE GSE REALLY WANT IT? 
----------------------------------------- 
 
¶6. (C) While the IMF team leader praised the cooperation 
of the Ministry of National Development and Minister 
WoldaiQs understanding and commitment to reform, the team 
leader did share with the Ambassador the reluctance of 
the Ministry of Finance to engage.  During the first week 
of the visit, the Ministry of Finance, including the 
Minister, refused to meet with the IMF team.  Reportedly, 
Minister Woldai traveled down to Massawa to ask President 
Isaias to direct the Minister of Finance to cooperate. 
This effort resulted in the IMF being able to obtain what 
it needed from the Ministry of Finance.  Noting these 
differences within the GSE during his outbrief for 
donors, the IMF team leader suggested that donor support 
for an IMF program with the GSE might also support and 
strengthen the position of "the more progressive actors 
within the GSE."  The IMF team noted as well that the GSE 
had indicated that without assurances of donor support 
there were certain steps that it could not take, 
including action on currency devaluation and 
liberalization of trade policy.  Under any circumstance, 
however, the GSE indicated that it would, in fact, want 
to delay these two measures as long as possible. 
 
WILL THE DONORS HELP? 
--------------------- 
 
¶7. (C) Donor response throughout the IMF teamsQ visit was 
widely skeptical reflecting a considerable lack of trust 
in the GSEQs professed commitment to reform.  Many 
donors, especially the Dutch, also discounted the 
significance the IMF attached to the prospect of Minister 
Woldai signing an agreement with the Fund.  Noting the 
GSEQs readiness to abrogate and completely disregard 
contracts and agreements regarding food aid, the Dutch 
Deputy Chief of Mission dismissed any signed document by 
the GSE as being meaningless.  He also noted that his 
government would be unwilling to offer any sort of 
support until the GSE takes irreversible and solid steps 
 
toward reform.  The European Commission indicated that 
while donor support for an IMF program was planned for 
2007 and beyond, the trust level was extremely low and 
the monies at this point unlikely to be released. 
 
COMMENT 
------- 
 
¶8. (C) Comment:  We fully share the skepticism about the 
GSEQs willingness to ultimately proceed with an IMF staff 
monitored program and, if it does proceed, remain 
doubtful that it will ultimately enact promised reforms. 
Nonetheless, we are struck by the extent of the GSE 
engagement with the IMF and the fact that the GSE invited 
the Fund back for these discussions and claims to be 
committed in principle to a SMP has surprised us all.  It 
may be a hopeful sign that at least on economic issues 
the GSE is rethinking its disastrous insistence on 
control. More likely, however, it reflects a growing 
realization for the GSE that the problems associated with 
high debt, virtually no exports and negligible hard 
currency reserves has brought the economy near collapse. 
If so, it may perhaps offer donors a degree of leverage 
with the GSE, and pledges of economic support in 
conjunction with efforts to reach agreement on border 
demarcation and normalization, could be an important 
incentive to elicit GSE cooperation. 
 
¶9.  (C) Comment continued.  That said, we question whether 
the senior leadership of the GSE will ultimately accept 
participation in a SMP, knowing it would be tantamount to 
admitting they are in deep trouble.  The Minister for 
National Development in fact, within days of the IMF 
teamQs departure, told one international visitor that 
"current conditions and national requirements" (i.e. the 
border conflict) would make it very difficult for the GSE 
to enact the required reforms. The GSE knows as well that 
donors -- who are still reeling from the GSEQs travel 
restrictions, seizure of food aid, and expulsion of many 
partner NGOs are likely to be reluctant to offer 
support absent truly meaningful reform.  As a result, we 
would not be surprised to see the GSE play out its 
dialogue with the IMF and then, when it decides the 
reforms are too much to accept, turn the blame on donors 
claiming that yet again they were abandoned by an 
international community that unhesitatingly provides 
abundant support to arch-rival Ethiopia. End Comment. 
 
DeLisi