Outlook for 2011-12

The risk of serious political instability will be high at least until presidential and parliamentary elections are held. Long-running disputes between the opposition and the unelected transitional government, Haute autorité de la transition (HAT), mean that polls are unlikely to be held before late 2011, with further delays a distinct possibility. Another major threat to stability is posed by increasing popular exasperation at the economic toll that the political crisis has exacted on the country. In view of delays to the electoral timetable, a fiscal deficit equivalent to 0.9% is now forecast in 2011 (compared with a surplus of 0.4% of GDP previously). Assuming aid flows resume in 2012 and royalties from the Ambatovy nickel-cobalt mine start to flow, a surplus of 1.2% of GDP is forecast in 2012 (previously 2.7%). After shrinking by an estimated 2% in 2010, the economy is forecast to grow by 2% in 2011, largely on the back of mining activity. The Economist Intelligence Unit expects real GDP growth of 6% in 2012, again driven by the minerals sector, although political uncertainty poses severe downside risks to this optimistic outlook. The current-account deficit is expected to shrink to US$1.8bn in 2011 (equivalent to 19% of GDP), before narrowing to US$1.6bn in 2012 (13.1% of GDP).

The political scene

The prime minister of the HAT, Camille Vital, resigned in March to comply with the "roadmap" back to democratic government. However, he was swiftly reinstated by the HAT president, Andry Rajoelina-a move that angered the opposition. The new transitional government includes four army generals and several defectors from the opposition. A failed assassination attempt on Mr Rajoelina in March underlined the strong risk of political violence in the country.

Economic policy

The government has postponed indefinitely an auction of 225 hydrocarbon exploration blocks in the country's territorial waters in the Indian Ocean.

The domestic economy

The combined impact of the domestic political crisis and high global prices for food and fuel has increased hardship for much of the population. The government's rice monitoring unit says that the retail price of this basic staple has doubled over the past two years.

Foreign trade and payments

Total aid to Madagascar has been falling, owing to the near total freeze on general budgetary support. However, aid to social sectors has actually increased substantially, reaching US$256m in 2010, compared with just US$180m in 2008.

Land area

592,000 sq km

Population

19.5m (World Gazetteer 2010 estimate)

Main towns

Population, 2010 (World Gazetteer estimates)

Antananarivo (conurbation): 1.7m

Toamasina: 225,000

Antsirabé: 197,000

Fianarantsoa: 184,000

Mahajanga: 166,000

Toliara: 123,000

Antsiranana: 88,000

Climate

Tropical; cooler in the highlands

Weather in Antananarivo (altitude 1,370 metres): hottest month, December, 16-27°C; coldest month, July, 9-20°C; driest month, June, 8 mm average rainfall; wettest month, January, 300 mm average rainfall

Languages

Malagasy, French

Measures

Metric system

Currency

Ariary (AR)-the ariary officially replaced the Malagasy franc in August 2004

Fiscal year

April-March

Time

Three hours ahead of GMT

Public holidays

January 1st; March 29th (commemoration of the 1947 rebellion); Easter; May 1st (Labour Day); Ascension Day; Whitsun; May 25th (Organisation of African Unity Day); June 26th (Independence Day); August 15th (Assumption); November 1st (All Saints' Day); December 25th, December 30th (Republic Day)

Official name

Republic of Madagascar

Form of state

Unitary republic

Legal system

Based on the Napoleonic Code, the 1992 constitution and traditional local additions

National legislature

In October 2010 a bicameral transitional legislature was appointed as part of the political accord signed in August in Ivato; its lower house is a 256-member congress and its upper chamber a 90-member higher council; the major signatories to the accord, including the transitional authority, Haute autorité pour la transition (HAT), were each given the right to nominate members; a new, permanent parliament is due to be established under the new constitution approved by referendum in November

National elections

December 2006 (presidential), September 2007 (legislative); legislative and presidential polls have been repeatedly delayed and are unlikely to take place before late 2011; however, the major political parties are yet to agree on the modalities of the elections, so this timetable may well change

Head of state

Marc Ravalomanana was re-elected as president in December 2006 but was forced to resign in March 2009; the de facto head of state is Andry Rajoelina

National government

Following the ousting of Mr Ravalomanana in March 2009 the HAT was created, with the former mayor of Antananarivo, Mr Rajoelina, as its president; an agreement on the formation of a new transitional government was made in Maputo, Mozambique in August 2009 and in Addis Ababa, Ethiopia, in November 2009; however, Mr Rajoelina subsequently reneged on his commitment to share power and has continued to appoint ministers of his own choosing; Mr Rajoelina reshuffled his cabinet in late May 2010

Main political parties

The former ruling party, Tiako-I-Madagasikara (TIM), which had 105 seats in the National Assembly, appears to be disintegrating after its leader, Mr Ravalomanana, was forced into exile; Mr Rajoelina's supporters have yet to develop into a national party; five other opposition parties- Tanora malaGasy vonona (TGV), the Union of Democratic Republicans for Change (UDR Fanovana), Fanjava Velogno, Leader-Fanilo and Liaraike-are of national importance and have given their support to the HAT

President of the HAT: Andry Nirina Rajoelina

Prime minister: Albert Camille Vital

Key ministers

Agriculture: Vyvato Rakotovao

Armed forces: André Rakotoarimasy

Economy & industry: Pierrot Rajaonarivelo

Education: Jean Jacques Rabenirina

Energy: Elysée Ratsiraka

Environment & forestry: Herilanto Raveloarison

Finance & budget: Hery Rajaonarimampianina

Foreign affairs: Yvette Sylla

Gendarmerie: Randrianazary

Health: Pascal Rajaonarison

Interior: Florent Rakotoarisoa

Justice: Christine Razanamahasoa

Mines & hydrocarbons: Mamy Ratovomalala

Telecommunications, post & new technology: Ny Hasina Andriamanjato

Trade: Rinarisoa Razafimandimby

Central Bank governor

Frédéric Rasamoely

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Please see graphic below

The risk of serious political instability will be high at least until presidential and parliamentary elections are held. Long-running disputes between the opposition and the unelected transitional government, Haute autorité de la transition (HAT), mean that polls are unlikely to be held before late 2011, with further delays a distinct possibility. Moreover, there is a strong risk that instability will persist even after elections are held, as the losers are likely to contest the validity of the vote. Furthermore, although it was easily suppressed, the failed coup attempt in November 2010 and the failed assassination attempt against the HAT's leader, Andry Rajoelina, in March 2011 underline the risk that he could be overthrown by disaffected members of the security services. This risk will grow if Mr Rajoelina continues to be viewed as obstructing the return of democracy and jeopardising the country's economic prospects.

Another major threat to stability is posed by increasing popular exasperation at the economic toll that the political crisis has exacted on the country. The livelihoods of the urban poor-particularly those in the capital, Antananarivo-have suffered as a result of the political crisis and international sanctions imposed on the country. Thus, a popular uprising against the HAT cannot be discounted, particularly in the light of well-publicised recent revolutions against undemocratic regimes in North Africa. However, despite increasing hardship, there have been markedly few mass demonstrations to date and no figurehead who could mobilise popular discontent has yet emerged. On balance, the Economist Intelligence Unit tentatively forecasts that stability will improve in 2012, although this rests on the assumption that democracy is successfully restored in 2011, which is by no means guaranteed.

The deadline for polls in the first half of 2011 is now untenable. The end of the year now appears to be the earliest that they could be held. The HAT is keen to gather as much domestic and international backing as possible for its "roadmap" back to democracy in advance of holding elections. Yet even if opposition groups do agree to participate in the polls when they are eventually held, levels of trust are so low that they are likely to cry foul if they lose.

Constitutional reforms that would allow Mr Rajoelina to run for the presidency were approved in a referendum that was boycotted by the three main opposition parties. So his candidacy, which looks increasingly likely despite his earlier pledges not to stand, will remain a major obstacle to political normalisation. However, if he does stand as we expect, his chances will be helped by the strong national endorsement of his referendum proposal and his conspicuous largesse to the electorate since commandeering much of the budget for discretionary spending. Although loyalists of the ousted previous president, Marc Ravalomanana, will denounce the poll as illegitimate if, as is likely, he is excluded from it, emerging splits in the opposition mean that some of his former allies and other opposition factions may agree to take part. Mr Ravalomanana cannot run himself, owing to a conviction in absentia relating to the deaths of protestors while he was in office. However, if he decides instead to back the candidacy of an ally, his considerable financial resources and influence among Protestant groups would pose a threat to Mr Rajoelina's electoral chances.

Given that the HAT apparently continues to have the backing of much of the country, parties allied to it could win a parliamentary majority at legislative polls (with Mr Rajoelina possibly becoming prime minister if he does in fact honour his pledge not to run for the presidency). Although not our core forecast, another highly plausible scenario is that either no polls are held in 2011-12 or they are boycotted altogether by the opposition. In either event the political impasse would persist. The decision to postpone indefinitely the municipal elections that were due to be held before the end of 2010 indicates that the HAT is prepared to abandon electoral timetables if it believes its interests are best served by doing so.

The mainly anglophone Southern African Development Community (SADC), from which Madagascar has been suspended, is set to soften its hitherto hardline stance against Mr Rajoelina's adminstration, having come to acknowledge the persistent strength of his popular support. However, if SADC leaders believe that he is not honouring his commitments under the roadmap, which the organisation backs, they may withdraw their endorsement of it. Assuming that most of the opposition can be convinced to participate in the upcoming polls, and that they are held in a credible manner, Mr Rajoelina would probably receive international recognition as president if he stood successfully. French and South African firms will remain key players in the economy, and China's economic ties to Madagascar are set to increase, particularly in the mining sector.

The government will broadly continue to target fiscal stability and discipline as the most effective means of coping with the loss of budgetary support from donors, which may be restored in 2012 if elections with broad legitimacy are held in 2011 as we tentatively forecast. However, we nonetheless expect the HAT to resort increasingly to populist measures as it tries to protect living standards and garner support ahead of the polls. The freeze on capital investment applied in most of 2009-10 is set to end as the HAT announces vote-courting initiatives such as new roads, schools and hospitals. A shift in the balance of spending power away from sector ministries in favour of the presidency is a sign of this increased politicisation of expenditure decisions.

Looking beyond the immediate post-crisis economic reconstruction that is likely to dominate the agenda in 2012 (assuming that the country returns to constitutional rule by then), Madagascar will need to develop a strategy for more effective growth and development over the long term. Tourism, minerals, agriculture and labour-intensive industries such as textiles are likely to receive most government investment. To boost the country's long-term growth potential, heavy investment in health, education, infrastructure and telecommunications is expected. We expect a rapid return to close co-operation with the IMF and the World Bank, both of which would favour strengthening the monetary policy independence of the central bank, Banque centrale de Madagascar (BCM).

The budget for 2011 marks a return to capital spending, which had been all but frozen in 2009-10 in response to the loss of general budgetary support from donors. Health, education and infrastructure are set to be the main beneficiaries, although more initiatives are likely to be announced than are actually realised. These projects and election-related costs mean that total spending is expected to be up by around 20% in nominal terms on the total in the revised budget for 2010. The government is banking on a sharp rise in receipts from the mining sector to fund its spending plans. Global demand for the country's mineral exports is expected to ease in 2012, but this should be more than offset by extra investment in mining, so receipts from this sector should remain high. On the tentative assumption that democracy is restored in 2011, the consequent resumption of general budgetary aid in 2012 will result in even quicker growth in spending, of around 25%. In view of delays to the electoral timetable, we now expect a deficit equivalent to 0.9% in 2011 (compared with a surplus of 0.4% of GDP previously). Assuming aid flows resume in 2012 and royalties from the Ambatovy nickel-cobalt mine start to flow into the public coffers, we forecast a surplus of 1.2% of GDP in 2012 (previously 2.7%).

The independence and credibility of the BCM is set to remain strong, although the HAT may exert influence on it to draw on the bank's foreign-exchange reserves, which it has held steady at just over US$1bn in recent months, to fund pre-election largesse and subsidise staples amid rising global commodity prices. In an effort to restrain inflation, the bank's policy interest rate is forecast to increase slightly from its current level of 9.5%. However, given the lack of financial depth in Madagascar, monetary policy has only limited ability to slow inflation, which is largely determined by fluctuations in local agricultural output and world commodity prices.

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Economic performance will be highly dependent on the uncertain political scene. A return to constitutional rule with broad domestic and international acceptance would restart inflows of aid and investment, upon which the economy depended before the political crisis. After shrinking by an estimated 2% in 2010, the economy is forecast to grow by 2% in 2011, largely on the back of sharply increased mining activity, particularly at the Ambatovy nickel and cobalt mine. In 2012 minerals will continue to drive growth, which should be further bolstered by the expected return of aid inflows. We expect real GDP growth of 6% in that year, although political uncertainty poses severe downside risks to this optimistic outlook.

The decision by the US to suspend Madagascar's trade privileges under the African Growth and Opportunity Act may have dealt a devastating blow to the island's textile and garments industry, which seems to be in terminal decline. Tourism is due to pick up slightly, in line with the likely improvement in political stability, although arrivals will remain below the levels recorded prior to the crisis. Moreover, the external situation increases the risks to our forecast. The ailing euro zone economies are traditionally major sources of tourists and investment.

In 2011 the outlook for sharp rises in global commodity prices, combined with lower local agricultural output owing to drought, means that prices are set to rise at an even faster rate of 12.8%. The inflation rate should ease to 6.3% in 2012, in line with world commodity prices and assuming a return to normal local agricultural output from recent lows.

The central bank has intervened in recent months to keep the exchange rate at around AR2,000:US$1. However, the BCM is expected to allow the currency to slide slightly in 2011 to an average of AR2,050 rather than let the country's foreign-reserves cushion shrink. Assuming that legitimate elections are held in 2011, the consequent increase in aid inflows and inward foreign direct investment should put upward pressure on the ariary. We expect the exchange rate to average AR1,900:US$1 in 2012.

In view of the upward revision to our global commodity price forecast since the last report, we now expect goods exports to pick up to US$1.7bn in 2011 (previously US$1.6bn), driven by growth in minerals exports. Assuming that the political situation improves, export growth should be more rapid in 2012 as investors return and mining projects continue to proliferate. Meanwhile, imports are expected to increase briskly in 2011-12 as incomes rise and the demand for capital goods increases. Overall, we expect the trade deficit to be equivalent to 17.6% of GDP on average in 2011-12. We forecast that the services deficit will shrink from an estimated 1.2% of GDP in 2010 to just 0.1% of GDP in 2011 and 2% of GDP in 2012. This trend will be driven by the expected return of tourists to the island. In dollar terms the income deficit will grow slightly, in line with increased profit repatriation by foreign-owned mining firms, but will remain broadly steady as a proportion of GDP, averaging 1.1% in 2011-12. The transfer surplus is expected to rise to 2.9% of GDP in 2012 assuming aid flows return. Overall, the current-account deficit is expected to shrink to US$1.8bn in 2011 (equivalent to 19% of GDP), before narrowing to US$1.6bn in 2012 (13.1% of GDP).

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On March 10th Camille Vital-the prime minister of the transitional government, Haute autorité pour la transition (HAT)-resigned. This was in compliance with the "roadmap" to fresh elections, which was put forward by the transitional government and has been endorsed by Leonardo Simão, the mediator for Madagascar of the regional grouping, Southern African Development Community (SADC). Mr Simão apparently backed the plan in the hope that a new broad-based administration would provide a counterweight to the transitional president and coup-leader, Andry Rajoelina. A change at the top of government was supposed to herald a new consensus-based administration to manage the transition. The roadmap also envisages an enlarged and more inclusive parliament and electoral commission.

In principle, the plan provided a credible basis for a return to democratic government. However, it specified that the new prime minister should be proposed by the political parties that have signed the plan. This in effect excludes loyalists of three former presidents-Albert Zafy, Didier Ratsiraka and Marc Ravalomanana-who boycotted the process and are the main opposition groups. Nonetheless, Mamy Rakotoarivelo who represents the exiled Mr Ravalomanana in Madagascar, stated that his party, Tiako-y-Madagasikara (TIM) would consider signing up to the plan but was opposed to Mr Rajoelina remaining as transitional president with powers to choose the premier and the membership of the transitional assembly. Mr Rakotoarivelo suggested that, for the sake of balance, the Ravalomanana camp should choose the new prime minister. However, Mr Simão was reluctant to let the roadmap fall victim to squabbles between political factions, suggesting that SADC would not support changes to the original plan that might jeopardise its success. Mr Rajoelina was quick to take advantage of Mr Simão's reluctance to allow revisions to the plan. On March 16th the HAT leader announced that he had reappointed Mr Vital as prime minister. He indicated that he had considered other possible contenders but had ultimately concluded that Mr Vital was the best candidate for the post.

Mr Rajoelina thereby secured a tactical victory: he has a prime minister who shares his agenda, and yet who complies with the wording of the roadmap, which specifies that the premier must come from a region and a political party that are not those of the president. Mr Vital, a former general, has always declared himself to be a politically neutral figure, and he comes from the south-east of Madagascar, whereas Mr Rajoelina is a highland Merina. However, in strategic terms the decision to reappoint Mr Vital may yet prove to be a mistake, as it breaks the spirit, if not the letter, of the political transition deal. It risks reviving the SADC leaders' mistrust of the HAT regime. Moreover, Mr Rajoelina's opponents did not regard the premier as a genuinely neutral figure. The appointment has, therefore, undermined the chances of persuading Mr Ravalomanana, who was ousted as president by the coup of 2009, to sign up for the roadmap.

A new government was formed on March 26th, ten days after the reappointment of the prime minister. Its composition was broad-based and was presented by Mr Rajoelina as a government of national unity. The administration comprises 32 ministers, of whom 23 are new arrivals. Including Mr Vital, a total of four former or serving army generals were given posts, indicating Mr Rajoelina's continuing dependence on the support of the military for his political survival.

Notably, some of the ministers were co-opted from Mr Ravalomanana's TIM party, including its secretary-general, Vyvato Rakotovao, who was given the agriculture portfolio. Another key appointment was that of Yves Aimé Rakotoarisoa, a former senior TIM parliamentarian who had broken with Mr Ravalomanana and signed up to the SADC roadmap. He has taken on the constitutionally important portfolio for relations with other state institutions, with the senior title of minister of state. The appointment of TIM members to the government indicates the ambivalence of the party towards the roadmap and may signal splits; Mr Ravalomanana has himself refused to sign the political transition plan.

Also notable was the appointment as minister of foreign affairs of Yvette Sylla, the widow of the late Jacques Sylla, who served as Mr Ravalomanana's first prime minister, but then joined the Rajoelina camp during the 2009 political crisis. Mr Rajoelina succeeded in persuading his former foreign minister, Ny Hasina Andriamanjato, to rejoin the cabinet, as minister for telecommunications. Mr Andriamanjato is a figurehead of moderate politics who had quit the HAT in early 2010 in protest at Mr Rajoelina's failure to form a more inclusive government.

Perhaps the most significant nomination was that of Pierrot Rajaonarivelo, a former close ally of Mr Ratsiraka, as state minister for economics and industry. Mr Rajaonarivelo was national secretary of Mr Ratsiraka's Alliance pour la Renaissance de Madagascar (Arema) party from 1997 to 2009. He was the leading light of the party's modernising tendency, but lost influence as Mr Ratsiraka took a more active role in Arema affairs. By early 2010 he had found a new berth, in the small Mouvement pour la démocratie. Meanwhile, Elysée Ratsiraka, a younger brother of the former president, became minister for energy; but it is unclear how far his participation represents a rapprochement between the two camps.

Although the more inclusive transitional government has gone some way towards normalising political relations, deep hostilities persist between elements of the opposition and Mr Rajoelina's camp. For example, in early March Mr Rakotoarivelo of the TIM was arrested in connection with an unsuccessful attempt to blow up Mr Rajoelina's car. A homemade bomb was set off by a roadside in the capital, Antananarivo, as the HAT leader's convoy drove past. No one was hurt and no serious damage was done.

The incident was reminiscent of previous incidents of political violence or alleged plots that arise occasionally in Madagascar. Such occurrences sometimes remain unexplained and they have rarely developed into serious threats. For example, in late April the government suggested that sabotage may have been behind a technical fault on the private jet taking Mr Rajoelina to Zambia, but little evidence emerged to support the claim. Mr Rakotoarivelo was detained for two weeks before being released at the end of March. His arrest will be interpreted by the Ravalomanana camp as a politically motivated abuse of the judicial process, and will serve to deepen its antipathy towards the HAT.

The interim government, Haute autorité pour la transition (HAT), has continued to keep the wheels of state turning, but only through tight spending controls that have brought an almost total halt to public capital investment. This policy has so far proven effective. In its latest edition of its Regional Economic Outlook for Africa, the IMF estimates that the fiscal deficit in 2010 was a mere 1.7% of GDP (the Economist Intelligence Unit estimates the deficit at 2.1%, by contrast). There is little room for flexibility, however. Until there is a political settlement that restores Madagascar's access to budget aid the authorities have little choice but to continue this hand-to-mouth strategy.

Moreover, the financial pressures are intensifying: the IMF forecasts that the deficit will grow to 2.4% of GDP in 2011 and 6.4% next year. This trend is in line with many other Sub-Saharan African countries, but with the crucial difference that most of them have access to external budget support, and it is this that renders such large deficits sustainable. By contrast, we forecast a more positive fiscal performance, on the assumption of a return to political normality by the end of 2011. We expect the deficit to shrink to 0.9% of GDP in 2011 and to turn to a surplus of 1.2% of GDP in 2012. If a solution to the political crisis is achieved, the taps of international aid are likely to reopen and private investment should increase in response to stability.

Following protracted negotiations, the government and fuel distribution companies agreed in April to raise fuel prices by AR50 (US$0.025) a litre. Fuel prices are a sensitive issue in Madagascar, as in other poor countries, and particularly so at a time when living standards are squeezed by public spending cuts. The rise in world hydrocarbon prices left the authorities with little choice but to acquiesce to the suppliers' pressure for permission to increase prices. The government demanded that the increase be small and apply to all oil derivatives. The distributors eventually agreed. The increase will affect not only the cost of public transport but also business costs and, in particular, the key transport links between rural food-producing areas and the capital, Antananarivo. The rise therefore threatens to push up the cost of food, further eroding the living standards of urban workers, who have already been hit hard by the problems in textiles and other urban-centred economic sectors.

The government has postponed indefinitely an auction of 225 hydrocarbon exploration blocks in the country's territorial waters in the Indian Ocean. This is probably in large measure a consequence of the damage caused to investor confidence by the authorities' treatment of a US-owned firm, Madagascar Oil. The transitional government has threatened the firm with the expropriation of all its permits except for Block 2 (Bemolanga), which is operated by a French major, Total, after it acquired a 60% stake from the US company. In March Madagascar Oil declared force majeure on four production-sharing contracts relating to on-shore blocks 3104-3107. Block 3104 includes the important Tsimiroro project. Subsequently, trading of the company's shares on the London stockmarket was suspended. Madagascar Oil has since been subjected to an official audit to ensure it meets all the conditions of the contracts, the results of which have not yet been published.

The HAT's threat to revoke the firm's exploration rights may be related to the apparently generous nature of its contract, which reportedly entitles Madagascar Oil to 99% of the revenue during the first ten years of production, dropping to 80% for the next ten and 70% for the following decade. However, contracts are often structured to allow an investor to recoup much of its development costs before a project moves to long-term profitability. The fact that heavy oil is typically more expensive to develop than higher-grade crude oils may have resulted in a contract structure that appears unusually generous to the investor by oil industry standards. The government may also be motivated by concerns about the serious environmental impact of exploiting tar sands.

Madagascar Oil may offer to renegotiate the contract to give the government a higher share of revenue during the first ten years of production to resolve the dispute. However, this is far from certain. In early May the company instigated international arbitration proceedings against the government, although the firm's chief executive, Laurie Hunter, told a UK newspaper, the Financial Times, that Madagascar Oil still hoped to reach a negotiated settlement with the Malagasy authorities. According to the Financial Times, the HAT has offered the company about US$100m to buy back its assets, despite the fact that the firm claims to have spent US$215m developing the fields.

Investors may see Madagascar Oil as a special case that does not signal a further deterioration of the business environment. After all, other minerals projects are moving ahead. For example, the Ambatovy cobalt and nickel mine operated by a Canadian-listed firm, Sherritt, is set to enter production later this year, while an Australian company, Cluff Resources Pacific, is developing an open-pit gold mine. Meanwhile, another Canadian firm, Silvore Fox Minerals, has announced a US$10m joint venture in the copper sector, and China's Wuhan Iron & Steel (WISCO) is starting iron ore exploration in the Soalala region, for which it made a US$100m rights payment last year. Yet despite the apparent buoyancy of interest of investors in Madagascar's mineral resources, a prolonged dispute with Madagascar Oil will damage the already weak image of the country's business environment, which the World Bank ranks 140th globally in terms of ease.

The combined impact of the domestic political crisis and high global prices for food and fuel has increased hardship for much of the population. The government's rice monitoring unit says the retail price of this basic staple has doubled over the past two years. In February prices for the staple had reached nearly AR2,000 (US$1)/kg in the capital, Antananarivo. Unemployment has risen, notably in the textile sector, which has suffered from the suspension of Madagascar's access to the US market access privileges under the African Growth and Opportunity Act. The squeeze on the public finances has also made itself felt, as the slowdown in capital spending has reduced work opportunities in construction.

A recent official survey of household incomes confirms the impact of these trends: 77% of Malagasy households lived in poverty in 2010, some 9 percentage points more than in 2005. The squeeze on public-service support is reflected in declining public services: net primary school enrolment fell from 83% in 2005 to just 73% in 2010, while the proportion of births attended by skilled health workers declined from 51% in 2006 to 44% in 2009. In 2008-10 non-wage and capital spending by the Ministries of Education and Health were cut sharply as these two departments concentrated resources on salaries, the bill for which rose rapidly, at the expense of maintenance and investment. The combined health and education wage bill climbed from AR352bn (US$207m) in 2008 to AR366bn the following year and AR440bn in 2010, according to data from the Ministry of Finance and the prime minister's office. Meanwhile, capital investment in health and education has slipped sharply, from AR67bn a year in 2008-09 to just AR19bn in 2010. Other non-wage spending rose, from AR168bn in 2008 to AR188bn the following year before plunging to AR139bn last year.

One factor that has helped to mitigate the human impact of the squeeze on the state finances has been donors' willingness to adjust their strategy to provide extra support for key social sectors. Aid to Madagascar has been falling, owing to the near total freeze on general budgetary support.

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Aid to social sectors has, however, actually increased substantially, reaching US$256m in 2010, compared with just US$180m in 2008, according to World Bank figures (which exclude aid from China, India and Arab states, for which comprehensive data are not available). Aid for health has risen by 75% over the past two years, while funding for social protection is up by 42%. The extra social spending comes despite a drop of about US$200m per year in total donor support, compared with pre-crisis levels. As is normally the case in countries whose governments are not recognised as legitimate by donors, aid is mainly channelled through non-governmental organisations, rather than central government structures. Last year less than 10% of aid for social sectors was delivered through the central government ministries of health and education.

There is deep concern that, despite the extra aid for social spending, social indicators in Madagascar are worsening. However, this probably does not indicate that aid is ineffective, or that programmes are poorly managed. It is more likely that the extra aid cannot compensate for the sheer scale of the economic crisis, particularly for urban households suffering job losses. Indeed, the extra aid money has been critical in preventing the outright collapse of services. For example, with the state increasingly unable to pay salaries and running costs, many health centres are now donor-funded and many teachers' salaries are paid directly by the UN Children's Fund. Similarly, measures to deal with child malnutrition or the aftermath of climatic problems are now funded heavily by external aid. The number of donor-funded social sector projects has doubled, to 102, over the past two years. However, these tend to be smaller than the sort of major projects that would be undertaken in more normal times.

Tourism income and foreign-exchange earnings have been threatened by serious new problems facing the national carrier, Air Madagascar. The EU has banned the airline from serving its two European destinations, Paris and Marseille, with its two leased Boeing 767 aircraft, which have been deemed no longer compliant with EU safety standards. The company insists that the two planes remain in working order and can be reallocated to other routes, such as Guangzhou, in China. However, it admits that they no longer satisfy the more stringent safety requirements of the EU. The ban applies only to these two aircraft, so if Air Madagascar is able to lease other planes it will be able to continue serving Europe, a key source of tourists for Madagascar. In the longer term, other carriers may take up the slack left by the disruption to the company's flights, but the short-term impact on tourism flows may be significant.