Evolution of Somalia’s Fiscal Sector: Modernizing Revenue Collection and Tax Administration

Policy Briefs June 2025

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Evolution of Somalia’s Fiscal Sector: A Journey Towards Modernization and Optimization of Revenue Collection and Tax Administration Policy Research & Analysis Division Research and Statistics Department Monetary, Financial, Regulatory Policy Group Central Bank of Somalia June 2025

Policy Brief, June 2025 2 Executive Summary Somalia’s fiscal sector is undergoing a significant transition, marked by reforms in tax policy, digitization of business processes, and public financial management. These significant strides in reforming the fiscal system have strengthened domestic revenue performance aimed to reduce over-reliance on external grants. After reaching the Heavily Indebted Poor Countries (HIPC) Completion Point in December 2023, the Federal Government of Somalia (FGS) accelerated tax mobilization initiatives through customs modernization, broader sales tax, and better tax administration. Most of the reform was driven by enhanced collection of income tax and sales tax. In September 2024, the FGS widened the sales tax base by working with firms in the telecommunications sector to introduce a digital mechanism to collect a 5 percent sales tax from businesses using merchant accounts. The main benefits of this reform were seen in the fourth quarter of 2024, assisted by digital tools like the Electronic Tax Administration System (ETAS) and Invoice Tracking System (ITS). These efforts led to domestic revenue growth, from US$262.8 million in 2022 to US$369.4 million in 2024. Yet, Somalia’s revenue-to-GDP ratio remains low at 3.0 percent, well below the East African Community’s 25 percent target. Although Somalia’s Ministry of Finance (MoF) developed a Medium-Term Revenue Roadmap (MTRR) in 2024, which sets out the FGS’s revenue mobilization strategy for 2025–27. The core target is for the FGS to be able to cover all operating expenses from domestic revenues by 2027. Although tax collection has improved, it has not kept up with the FGS spending needs. In 2024, FGS collected US$369.4 million but spent over US$485 million on operating costs (excluding donor funded projects), resulting in a fiscal gap of over US$116 million. Most of this spending goes to operational costs including salaries and other non-income generating expenditures, leaving little for capital expenditure. Encouragingly, digital sales tax collection and outsourced rental income management have boosted revenues in Mogadishu, showing what is possible when reforms are well implemented. To move forward, Somalia needs to broaden the tax base and enhance taxpayer compliance by adopting the Medium-Term Revenue Roadmap-2024-2027 strategy, bringing informal sectors into the system, fully digitizing tax processes, de￾escalating political tensions, and improving coordination between the FGS and FMS fiscal reforms. Equally important is aligning spending with actual revenue, increasing transparency, and building public trust in the system. With sustained commitment and targeted reforms, Somalia can create a fair, more effective, and self-reliant fiscal policy. The paper outlines three strategic policy recommendations:

1. Improve Tax Policy and Broaden the Revenue Base: The FGS should implement the 2025–2027 Medium-Term Revenue Roadmap by enforcing the new Income Tax Law, expanding the tax net to informal and under-taxed sectors, and reducing exemptions. Strengthening legal frameworks and tax policy is critical to achieving the 4% revenue-to-GDP target by 2027 and reducing fiscal dependency.
2. Establish a Solid and Digitally Enabled Tax Administration: The FGS should scale up investment in digital systems such as ETAS, RITS, ITS, and SOMCAS to improve compliance, audit capacity, automate collection, enhance taxpayer registration, and improve real-time monitoring, especially in high-volume sectors like telecom and trade in goods and services.
3. Promote Fiscal Federalism and Customs Harmonization: Enhancing coordination of fiscal governance between the FGS and FMS is vital to unify tax policy, reduce fragmentation, establish a fair revenue-sharing formula, and establish a functioning Somali Revenue Authority. Scaling up customs reform, especially the nationwide rollout of SOMCAS at key ports will strengthen cross-border enforcement and support sustained domestic revenue growth.

3 Evolution of Somalia’s Fiscal Sector: A Journey Towards Modernization and Optimization of Revenue Collection and Tax Administration

1. Introduction and Context Somalia’s fiscal sector is entering a critical phase of transformation following the achievement of debt relief under the Heavily Indebted Poor Countries (HIPC) initiative in 2023. With the launch of the National Transformation Plan (NTP 2025–2029) and the ambition of Centennial Vision 2060, the Federal Government of Somalia (FGS) is prioritizing domestic resource mobilization as the backbone of state affordability, legitimacy, and resilience. However, the country’s revenue￾to-GDP ratio remains among the lowest globally and regionally, currently standing at just 3 percent of GDP. In response, Somalia’s Ministry of Finance (MoF) developed a Medium-Term Revenue Roadmap (MTRR) in 2024, outlining the FGS’s revenue mobilization strategy for 2025–2027. The aim for the roadmap is to increase domestic revenues by 0.3 percent of GDP annually, with the goal of reaching US$602 million by 2027, equivalent to 4 percent of GDP. At the same time, Somalia’s fiscal reform efforts are critical to achieving macroeconomic stabilization, enhancing domestic resource mobilization, and progressing toward budgetary self-reliance. In response, the FGS introduced a set of tax policies and administrative reforms between 2023 and 2025 to modernize Somalia’s strategic fiscal framework, improve compliance, and reduce dependency on foreign aid by expanding the domestic revenue base. These reforms included the introduction of the Turnover Tax regime in 2023, the launch of a 5 percent electronic transaction tax (sales tax on digital payments) in 2024, and the enactment of the Income Tax Law in 2025. Simultaneously, the government rolled out the Somalia Customs Automation System (SOMCAS) at both the Mogadishu and Kismayo ports and airports, along with an Invoice Tracking System, aimed at enhancing tax compliance, audit capacity, and taxpayer registration. 1 Republic of Kenya. National Tax Policy. Nairobi: The National Treasury and Economic Planning, 2024. https://www. treasury.go.ke/wp-content/uploads/2024/05/7.05.-2024-National-Tax-Policy.pdf. Over the last five years, cumulative domestic revenue has surpassed US$1.4 billion, consistently exceeding targets in the past three years. In 2024 alone, the government achieved a revenue performance rate of 106.7%, domestic fiscal receipts registered US$369.4 million, a 12 percent increase from the previous year. Despite this progress, the revenue-to-GDP ratio has stagnated at just 3.0 percent in both 2023 and 2024, well below the East African Community’s benchmark of 25 percent1 . This highlights the structural challenges within Somalia’s fiscal system and underscores the urgent need to modernize and optimize the various revenue streams. The MTRR (2025–2027) sets an ambitious target of increasing the revenue-to-GDP ratio to 4 percent by 2027, with the aim of enabling the Federal Government of Somalia to fully finance its operational expenses through domestic resources. Achieving this goal will require the implementation of a comprehensive package of tax policy and institutional reforms. Key priorities include expediting the establishment of the National Revenue Authority, ensuring effective enforcement of the newly enacted Income Tax Law, enhancing administrative capacity, harmonizing customs systems, and investing in digital infrastructure to strengthen compliance and expand the tax base. This policy brief provides an in-depth analysis of key strategies for strengthening Somalia’s fiscal foundation. It emphasizes the critical need to enhance domestic revenue generation through diversified tax systems and improved collection mechanisms. The brief also highlights the importance of ensuring equity in resource allocation to address disparities across regions and communities, thereby fostering social cohesion and economic stability. Additionally, it argues for the alignment of fiscal governance structures with systemic reforms that promote transparency, accountability, and citizen participation. By implementing these strategies, Somalia can create a more sustainable fiscal environment that supports long-term development and economic resilience.

Policy Brief, June 2025 4 1.1 Somalia’s Revenue Mobilization Gap: Regional Lag and Structural Challenges Somalia remains significantly behind its East African Community (EAC) counterparts in domestic revenue mobilization. While EAC countries such as Rwanda, Burundi, and Kenya consistently collect between 15% and 22% of GDP in government revenue, Somalia’s revenue-to-GDP ratio has remained extremely low—rising only from 2.3% in 2018 to 3.0% in 2024. This substantial gap highlights the urgent need for Somalia to strengthen its revenue generation and optimization strategies. By prioritizing reforms in tax policy, enforcement, and digital systems, Somalia can work toward closing this gap and fostering sustainable economic growth and fiscal resilience. Table 1: Government Revenue, Percentage of GDP in EAC (2018-2024) Year Burundi Uganda Rwanda Tanzania Kenya Somalia 2018 19.4 13.2 23.8 15.3 17.5 2.3 2019 22.4 13.5 23.1 15.2 17.0 2.7 2020 23.1 13.7 23.9 14.9 16.7 2.4 2021 25.1 14.0 24.6 14.9 16.8 2.4 2022 23.0 14.2 23.9 15.2 17.1 2.6 2023 20.7 14.3 22.3 15.5 16.9 3.0 2024 20.7 14.2 22.4 14.9 16.8 3.0 Source: IMF Portal, 2025 The above table shows that FGS’s recorded a revenue-to-GDP ratio (excluding grants) of just 3 percent in 2024 significantly lower than regional peers such as Rwanda (22.4), Kenya (16.8%) and Uganda (14.2%). This relatively low ratio reflects Somalia’s continued dependence on external grants and highlights the urgent need to expand the domestic tax base. A narrow revenue base constrains the government’s capacity to fund development priorities, sustain essential public services, and manage fiscal risks effectively. On the expenditure side, reforms targeted payroll efficiency through the Civil Servant Law and the Public Service Pension and Gratuity Act (2024). Despite these initiatives, expenditure remains skewed toward recurrent costs, with limited allocations for capital investment. Intergovernmental fiscal coordination also remains a challenge. While most of the Federal Member States (FMS) have aligned with national tax frameworks, some are yet to integrate fully, complicating harmonization and equitable revenue sharing. 2. Key Domestic Revenue Mobilization Reforms Improving domestic revenue mobilization remains a core fiscal priority for the FGS. In 2024, total domestic revenue reached over US$369 million, representing a 12 percent increase from US$329 million in 2023. Despite this growth, the revenue-to-GDP ratio remained unchanged at 3.0 percent, underscoring the need for deeper tax base expansion and efficiency gains. Significant improvements in the mobilization of domestic revenue have been made by the federal government. The FGS has implemented new tax measures, including a turnover tax that was previously absent, as well as the extension of sales tax to the service sector. Additionally, there are plans to modernize the income tax law to better align with the country’s current economic realities. These new taxes and improved tax administration are expected to raise domestic revenue in 2025 to US$430.3 million, equivalent to 3.18 percent of GDP.

5 There are also increased automation efforts in tax collection. The Somali Customs Automated System (SOMCAS) is operationalized in Mogadishu and Kismayo ports and Airports, thus facilitating the implementation of tariffs. The custom taxes collected in 2024 were US$168.88 million against a target of US$164.52 million2 , implying that the automation had increased efficiency. The FGS is formulating a comprehensive revenue strategy, supported by the IMF, to guide revenue collection over the next three years with a target of getting the revenue to GDP ratio to over 4 percent by 2027. This includes implementing a new Income Tax Law to replace the outdated 1966 income tax legislation. The revenue growth was largely due to improved income and sales tax collection. In early 2024, the FGS outsourced the collection of rental income tax on public properties in Mogadishu to a private contractor. The contractor introduced an electronic database of rental properties and stepped-up enforcement that saw rental income rise tremendously by Q3 2024 (Figure 5). The corporate and personal 2 3 income tax compliance improved, as more firms were registered and complied with income tax requirements. In Q3 2024, the government collaborated with telecommunications companies to introduce a digital system that automated sales tax collection via merchant accounts, significantly boosting sales tax receipts in Q4. Additionally, utility providers, including electricity and water companies, were integrated into the digital sales tax system, broadening the tax base further. Despite these gains, revenue estimates remained insufficient to finance operations fully. While over US$369 million collected in 2024 was enough to cover FGS salary obligations (Figure 1), it fell short of covering operational expenditure, which stood at US$485 million. The resulting fiscal gap of US$116 million3 highlights the persistent mismatch between domestic revenue performance and expenditure needs, reinforcing the urgency of continued reform and improved budget discipline. Source: MoF, 2025 2 FGS, 2024 End-Year Budget Performance Report, 16 March 2025. https://mof.gov.so/sites/default/files/ Publications/2024%20END%20YEAR%20BUDGET%20PERFORMANCE%20REPORT_0.pdf 3 Federal Government of Somalia. Somalia Financial Governance Report 2024: Strengthening Petroleum Revenue Sharing for State Building and Economic Development. Mogadishu: Ministry of Finance, April 2025. https://mof. gov.so/sites/default/files/Publications/Somalia%20Financial%20Governance%20Report%20%20 2024%20.pdf Figure 1: FGS Domestic Revenues, Salaries, and Total Operational Costs,2020–2024 Evolution of Somalia’s Fiscal Sector: A Journey Towards Modernization and Optimization of Revenue Collection and Tax Administration

Policy Brief, June 2025 6 3. Recent Developments in FGS Domestic Revenue Trends (2018–2024) Somalia’s domestic revenue mobilization exhibited notable and consistent growth in domestic revenue mobilization over the past seven years, cumulative domestic revenue has surpassed US$1.8 billion, consistently exceeding targets. This progress reflects the impact of ongoing fiscal policy reforms focused on expanding the tax base, improving taxpayer compliance, and strengthening public financial management systems. Source: MoF, 2025 Figure 2 presents annual domestic revenue collected by the FGS during this period. In 2018, actual domestic revenue stood at approximately US$183.4 million, surpassing the initial budget estimate of US$156 million. The upward momentum continued into 2019, with revenue reaching around US$230.3 million. In 2020, collections declined to US$211.2 million, primarily due to the adverse economic effects of the COVID-19 pandemic. Despite this temporary setback, the recovery was swift: domestic revenue rebounded in 2021 and has continued on a rising trend through 2024. By 2024, total revenue collections reached an all-time high of US$369.4 million, exceeding the budget estimate by over US$23 million. Notably, both 2023 and 2024 saw actual revenues outperform projections, signaling improved forecasting, enforcement, and revenue mobilization efforts. Overall, the strong performance in recent years demonstrates Somalia’s growing fiscal capacity and lays a solid foundation for achieving the medium￾term goals outlined in the National Tax Plan and broader public finance reform agenda. 4. FGS Rental Income and Sales Tax Trends Table 3 presents the Federal Government of Somalia’s (FGS) quarterly rental income and sales tax performance from 2022Q1 to 2024Q4. The data highlights a steady increase in rental income collection and a dramatic surge in sales tax revenue beginning in late 2023. Figure 2: Domestic Revenue Trends (2018–2024) with YTD Performance

7 Table 3: Quarterly Rental Income and Sales Tax Trends (2022Q1-2024Q4) Year Quarter Rental Income Sales Tax Total 2022 Q1 $ 168,675 $ - $ 168,675 2022 Q2 $ 136,539 $ - $ 136,539 2022 Q3 $ 162,077 $ - $ 162,077 2022 Q4 $ 163,989 $ - $ 163,989 2023 Q1 $ 211,779 $ - $ 211,779 2023 Q2 $ 275,351 $ - $ 275,351 2023 Q3 $ 403,846 $ - $ 403,846 2023 Q4 $ 279,996 $ 214,738 $ 494,734 2024 Q1 $ 937,963 $ 160,435 $ 1,098,398 2024 Q2 $ 1,842,219 $ 219,075 $ 2,061,294 2024 Q3 $ 2,069,831 $ 93,883 $ 2,163,714 2024 Q4 $ 1,815,424 $3,851,666 $ 5,667,090 Source: MoF, 2025 The data illustrates a significant upward trajectory in both rental income and sales tax collections throughout 2024, with sales tax revenue peaking in Q4 at nearly US$4 million. Between 2022 and 2023, revenue was primarily driven by rental income, while sales tax remained uncollected until Q4 of 2023, highlighting its phased rollout. A notable turning point occurred in Q4 of 2024, coinciding with the formal launch of the 5 percent electronic transaction tax, targeting digital payments. This policy shift led to a dramatic increase in tax revenue, with total collections in 2024Q4 reaching over US$5.6 million. This growth was significantly enabled by the deployment of digital tax administration systems, namely the Rental Income Tax System (RITS) and the Electronic Tax Administration System (ETAS). While RITS facilitated streamlined rental income collections, ETAS played a transformative role by enabling the government to monitor real-time sales through merchant accounts and automatically deduct applicable taxes directly into government accounts. These two systems collectively enhanced compliance, transparency, and efficiency in revenue mobilization. This growth in tax revenue can be attributed to three key drivers:

1. Digitalization of Tax Administration: Tools such as ETAS and RITS significantly enhanced taxpayer registration, monitoring, and compliance enforcement.
2. Policy Enforcement: The notable revenue jump in 2024 indicates stronger enforcement of tax policy, including digital invoicing, and the successful onboarding of vendors into the formal tax net.
3. Urban Tax Base Development: Rental income has shown consistent year-on￾year growth, positioning it as a stable and scalable source of domestic revenue tied to Somalia’s urban development. The overall trend underscores Somalia’s transition toward a more formalized and tech￾enabled fiscal environment. The exponential growth in sales tax revenue underscores the untapped potential of digital taxation, particularly in urban and service sectors, while the consistent rise in rental income signals a stable and scalable base for urban-focused fiscal policy. Evolution of Somalia’s Fiscal Sector: A Journey Towards Modernization and Optimization of Revenue Collection and Tax Administration

Policy Brief, June 2025 8 This evolution in revenue performance marks a pivotal moment in Somalia’s public finance trajectory, laying the groundwork for greater fiscal self-reliance, improved domestic resource mobilization, and more sustainable public service delivery. 5. Key Notable Issues Somalia’s low domestic revenue is largely a consequence of several interrelated factors. First and foremost, institutional deficiencies play a critical role; many government institutions lack the capacity, resources, and transparency necessary to collect and manage revenue effectively. Additionally, the country struggles with a fragile governance system, which undermines public trust, leading to poor compliance with tax regulations. The presence of a significant informal sector further exacerbates the issue. Many businesses operate outside the formal economy, making it difficult for the government to tax them and capture potential revenue. This informal economy provides livelihoods for many, yet its lack of regulation hinders economic growth and the state’s ability to generate income. Finally, ongoing security concerns also contribute to Somalia’s revenue mobilization challenges. The instability caused by persistent conflict and the threat of violence undermines both domestic and foreign investment, weakens the government’s capacity to increase its fiscal base. Together, these factors create a complex environment that severely limits the effectiveness of domestic revenue generation efforts in Somalia A) Improving Tax Policy and Revenue Mobilization: Expanding the tax base, strengthening fiscal sustainability, and improving revenue design

1. Low Revenue-to-GDP Ratio • Despite steady growth in domestic revenue—from US$262.8 million in 2022 to US$369.4 million in 2024—Somalia’s revenue-to-GDP ratio remains critically low at just 3.0 percent. This is far below the East African Community benchmark of 25 percent and well behind regional peers such as Rwanda (22.4%), Kenya (16.9%), and Uganda (14.3%). The persistent underperformance of the domestic tax base has left the government heavily reliant on external grants.
2. Persistent Fiscal Gap In 2024, while domestic revenue reached US$369.4 million, the Federal Government’s operational expenditure (excluding donor￾funded projects) totaled US$485 million, resulting in a fiscal deficit of over US$116 million. Revenue growth has not kept pace with the government’s expenditure needs, particularly for non-wage recurrent expenses and essential capital investments.
3. Limited Impact of Revenue Growth on Fiscal Space • Although income and sales tax revenues have improved, driven largely by digital tax initiatives, Somalia’s broader fiscal space remains constrained. Untapped tax streams and continued tax avoidance undermine fiscal sustainability. Most of the revenue gains have been absorbed by wage payments, limiting investment in public service delivery and infrastructure.
4. Skewed Expenditure Toward Recurrent Costs • Reforming Public Expenditure and Tax Instruments. Despite the launch of civil service and pension reforms, the government’s budget remains dominated by recurrent spending, especially public sector wages. This imbalance continues to crowd out allocations for development projects and infrastructure, which are essential for long-term growth and state￾building.
5. Underutilized Tax Instruments and Compliance Systems • Revenue from rental income and electronic sales tax has shown encouraging growth following the digitization of business processes. However, full implementation

9 and enforcement remain at an early stage, especially across informal and rural economies, limiting the revenue potential of these tax streams. Weak compliance systems also hamper the effectiveness of existing tax instruments. B) Establishing Solid and Cohesive Tax Administration: Institutional capacity, automation, taxpayer compliance, and operational efficiency: 6. Delays in Establishing the Somali Revenue Authority and Revenue Allocation Committee • Although the creation of the Somali Revenue Authority (SRA) and Revenue Allocation Committee was agreed in principle at the March 2023 National Consultative Council (NCC), both institutions remain non-operational. Progress has stalled due to the absence of clear legal, institutional, and governance frameworks. These entities are critical for enhancing federal revenue collection and ensuring transparent and predictable intergovernmental fiscal transfers. The absence of enabling legislation and weak institutional coordination undermines trust and slows progress on nationally integrated revenue systems. 7. Multiple Taxation and Jurisdictional Overlaps • Inconsistent tax policies and a limited Customs harmonization across Federal Member States (FMS) create significant challenges for businesses and taxpayers. The resulting duplication and jurisdictional confusion reduce tax compliance and increase administrative costs. C) Harmonization through Fiscal Federalism and Customs Reform: Federal-member state alignment, intergovernmental trust, and customs coordination. 8. Delayed SOMCAS Rollout • The SOMCAS has not been fully rolled out across all FMS. • The absence of a standardized valuation framework and inconsistent application of ad valorem tariffs undermines customs efficiency. • Several FMS have implemented turnover taxes targeting Small and Medium-sized Enterprises (SMEs), but poor coordination with the Federal Government tax system leads to duplication and disincentivizes business formalization. • The politicized resistance stems from concerns over FGS overreach and potential loss of revenue control by FMS. 6. Policy Recommendations A) Improving Tax Policy and Broadening the Revenue Base

1. Expedite Implementation and Enforcement of the New Income Tax Law • Implement regulations for the 2025 Income Tax Law, ensuring uniform implementation across all federal member states (FMS). • Strengthen income tax collection from corporate entities and high-potential sectors.
2. Strengthen Budget Discipline and Align Expenditures with Revenue Capacity • Implement a Medium-Term Expenditure Framework (MTEF) to ensure that public spending is based on credible, multi-year revenue projections, in line with the targets set in the Medium-Term Revenue Roadmap (MTRR). • Re-balance expenditure priorities by gradually increasing allocations to capital investments while introducing controls to curb the growth of recurrent expenditures, especially non￾essential administrative costs. Evolution of Somalia’s Fiscal Sector: A Journey Towards Modernization and Optimization of Revenue Collection and Tax Administration

Policy Brief, June 2025 10 B) Establishing a Solid and Digitally Enabled Tax Administration 3. Modernize and Digitize the Administration of Taxes • Implementing technology-driven tax administration systems across all sectors will reduce human errors and increase efficiency in tax administration. The FGS should scale up ETAS and Invoice Tracking System (ITS) across all economic sectors, including utilities, transport, wholesale/ retail, and telecoms. Ensure adoption of common digital tax tools by all FMS to harmonize systems and reduce evasion. 4. Improve Taxpayer Compliance and Public Trust • Increase taxpayer education programs, especially targeting SMEs and informal operators. • Launch comprehensive anti-corruption and audit reforms to ensure transparent use of tax revenues and reduce resistance to taxation. 5. Strengthen Legal and Institutional Frameworks • Establish an independent tax appeals tribunal to handle disputes, ensuring fairness of the tax system and due process. This will build the confidence of the taxpayers in the tax system and enhance overall compliance. C) Harmonization through Fiscal Federalism and Customs Reform 6. Strengthen and Improve Customs Administration • The new customs laws have attempted to standardize customs across all ports; however, this requires effective enforcement to ensure compliance. Ensure that all entry points, including those operated by Federal Member States (FMS), apply the same customs laws and tariffs. • The Federal Government should expand the use of SOMCAS and risk-based inspections. Full deployment of the Somali Customs Automated System (SOMCAS) across all ports and border entry posts is necessary to maximize revenue collection from customs. 7. Establish a Somali Revenue Authority (NRA), and the Independent Revenue Allocation Committee, Promptly • Accelerate efforts to establish and operationalize the Somali Revenue Authority, as endorsed by the National Consultative Council (NCC) in the Baidoa Agreement of March 2023. • Enact enabling legislation and Institutional Frameworks for the National Revenue Authority with clear roles, transparency, and intergovernmental oversight mechanisms. • Establish a transparent, legally binding framework to clarify revenue assignments and administration roles between FGS and FMS. 8. Strengthen IGFF Mandate, Coordination, and Accountability • Empower the Intergovernmental Fiscal Forum (IGFF) to lead the development and enforcement of a federal tax administration code, with defined dispute resolution mechanisms. • Institutionalize regular technical working groups and reporting frameworks to improve coordination and mutual accountability between FGS and FMS. • Enact a legally binding framework for fiscal federalism, with a clearly defined revenue￾sharing formula, and compliance incentives to foster cooperation and predictability in intergovernmental transfers.

11 References CEIC Data (2025). “Kenya Tax Revenue: % of GDP”, CEICDATA.com. https://www.ceicdata.com/ en/indicator/kenya/tax-revenue--of-gdp. Federal Government of Somalia (2024), “2025 Budget Policy Framework Paper.” Ministry of Finance. https://mof.gov.so/sites/default/files/Publications/FGS%20Budget%20Framework%20 Paper%20for%20FY%202025%20revisedv15.pdf Federal Government of Somalia. Somalia Financial Governance Report 2024: Strengthening Petroleum Revenue Sharing for State Building and Economic Development. Mogadishu: Ministry of Finance, April 2025. Accessed May 30, 2025. https://mof.gov.so/sites/default/files/Publications/ Somalia%20Financial%20Governance%20Report%20%202024%20.pdf FGS (2025). “2024 End-Year Budget Performance Report.” Ministry of Finance. https://mof.gov.so/ sites/default/files/Publications/2024%20END%20YEAR%20BUDGET%20PERFORMANCE%20 REPORT_0.pdf IMF (2023). “IMF and World Bank Announce US$4.5 billion in Debt Relief for Somalia.” International Monetary Fund. https://www.imf.org/en/News/Articles/2023/12/13/pr23438-imf-and-world￾bank-announce-us-4-5-billion-in-debt-relief-for-somalia IMF (2024), “Statement by Mr. Mahmoud Mohieldin, Mr. Ali Alhosani, and Mr. Abdulqafar Abdullahi on Somalia.” International Monetary Fund. https://www.elibrary.imf.org/view/ journals/002/2024/158/article-A004-en.xml Republic of Kenya (2024). “National Tax Policy. Nairobi: The National Treasury and Economic Planning, 2024.” The National Treasury. https://www.treasury.go.ke/wp-content/uploads/2024/05/7.05.- 2024-National-Tax-Policy.pdf. Trading Economics (2024). “Uganda - Tax Revenue (% of GDP) - 2023 Data.” Trading Economics. com. https://tradingeconomics.com/uganda/tax-revenue-percent-of-gdp-wb-data.html. Evolution of Somalia’s Fiscal Sector: A Journey Towards Modernization and Optimization of Revenue Collection and Tax Administration

Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis Policy Research & Analysis Division Research and Statistics Department Monetary, Financial, Regulatory Policy Group Central Bank of Somalia June 2025

13 Executive Summary Somalia achieved a major milestone on December 13, 2023, by attaining the completion point under heavily indebted poor countries initiative, drastically reducing its external debt from $5.3 billion (64% of GDP) in 2018 to $0.6 billion (under 6% of GDP) by end-2023. This marked a turning point in Somalia’s economic recovery, resulting from a decade-long effort of structural reforms, improved governance, and international cooperation particularly under the IMF-supported ECF. However, this debt relief is not an endpoint but a foundation for a new fiscal phase focused on maintaining debt sustainability while advancing inclusive and resilient development. In the post-HIPC era, the Somali government has implemented robust public financial management and revenue mobilization reforms. Despite these efforts, domestic revenues remain exceptionally low below 3% of GDP placing Somalia among the least fiscally mobilized economies in Africa. Recurrent expenditures, especially the public wage bill and security costs, exceed domestic revenue, and 65% of the government budget dependent on donor support. Under the New ECF Program (2023–2026), the IMF and the FGS reached a staff-level agreement on economic and financial reforms of three years (Dec 2023 to Dec 2026) in post￾HIPC policies. These include tax policy reform, payroll integration, debt policy regulation, PPP legislation, and strengthened central bank operations. Most of these benchmarks have been achieved or are in progress, indicating steady reform commitment. Debt sustainability analysis (DSA) indicates that Somalia’s debt levels are currently low and within all sustainability thresholds. External public debt is around 6.0% of GDP, with debt service obligations below IMF-set thresholds. However, Somalia remains categorized as a “moderate” debt distress risk due to vulnerability to external shocks and limited institutional capacity. Under adverse scenarios, such as reduced export earnings or donor support, debt service-to￾revenue ratios could breach sustainability thresholds. Somalia’s debt-carrying capacity remains low, with a Composite Indicator (CI) score of 1.58 classified as “weak” under the Low-Income Country – Debt Sustainability Framework “LIC-DSF” framework. This means Somalia must adopt a conservative borrowing strategy, focused on concessional financing and strict fiscal management, until significant progress is made in revenue generation and institutional strengthening. The paper identifies eight core challenges threatening post-HIPC fiscal sustainability: low revenue mobilization, high recurrent expenditure, excessive aid dependence, weak debt management institutions, underdeveloped natural resource governance, vulnerability to external shocks and climate disasters, and persistent political and security instability. These factors, if left unaddressed, could compromise Somalia’s hard-won debt relief gains. The paper outlines five strategic policy recommendations:

1. Advance Fiscal Sustainability: Somalia must urgently expand its tax base and control spending. Achieving the target of 4% revenue-to-GDP by 2027 is critical.
2. Reduce Aid Dependence: The FGS must prepare for declining grants by assuming donor-funded costs and building fiscal buffers.
3. Strengthen Debt Management: Institutionalize a medium-term debt strategy and limit non-concessional borrowing.
4. Govern Natural Resource Revenues Wisely: Finalize petroleum legal framework, establish a sovereign wealth fund, and prevent premature borrowing against unproven resource income.
5. Prioritize Climate Adaptation: Integrate climate risks into development planning and build national capacity to withstand natural disasters. Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 14

1. Introduction On December 13, 2023, Somalia achieved a historic milestone by reaching the Completion Point under the Heavily Indebted Poor Countries (HIPC) Initiative. This accomplishment marks a significant turning point in Somalia’s economic journey, lowering its external public debt from US$5.3 billion (64 percent of GDP) in 2018 to just US$0.6 billion (less than 6 percent of GDP) by the end of 2023. This substantial progress not only indicates debt cancellation but also signifies a broader shift toward macroeconomic stability and structural reforms following decades of conflict, institutional collapse, and international isolation. The HIPC Completion Point was not an isolated policy achievement, but the result of a sustained, multi-year effort led by the Federal Government of Somalia (FGS), in collaboration with development partners. The process required implementing widespread reforms in public financial management, domestic revenue collection, governance, and the legal and regulatory framework for economic governance. Somalia’s successful track record under the IMF-supported Extended Credit Facility (ECF) between 2020 and 2023 was vital in reaching this milestone. Yet, debt relief is not an endpoint. Instead, it marks a transition to a new phase of economic policymaking, one centered around safeguarding debt sustainability while advancing inclusive growth. Somalia has now entered the post-HIPC era with a renewed focus on long-term fiscal discipline, domestic resource mobilization, and the institutional foundations needed to sustain access to concessional financing. The 2023–2026 ECF￾supporting reform program builds on this momentum, targeting improved resilience to shocks, inclusive development, and reduced reliance on external grants. Despite notable 1 SNBS, Somalia gross domestic product (GDP) 2024. https://nbs.gov.so/somalia-gross-domestic-product-gdp-2024/ gains, Somalia’s post-debt relief landscape remains fraught with challenges. Security risks, political uncertainty, and escalating climate shocks all significantly impact economic prospects. While real GDP growth is expected to rise to 4.1 percent in 20241 . This pace remains insufficient to significantly reduce poverty, which still affects over 54 percent of the population. The cornerstone of Somalia’s post-HIPC economic strategy is the pursuit of debt sustainability within a framework of concessional financing and prudent fiscal policy. The FGS has committed to maintaining a low risk of debt distress by avoiding non￾concessional borrowing and limiting fiscal deficits to manageable levels. At the same time, FGS is working to strengthen domestic revenue mobilization capacity through reforms such as the implementation of a new income tax law and customs modernization and to improve public financial management systems, including payroll integration and expenditure controls. This paper examines Somalia’s post-debt relief reforms through the lens of debt sustainability. It assesses how the government’s fiscal policy, financing choices, and institutional reforms are shaping the sustainability of its debt path in the medium and long term. Using official Ministry of Finance, IMF-WB DSAs, macroeconomic data, and policy documentation. The paper critically reviews the progress to date, recent reforms, and key issues, and discusses policy options to ensure that Somalia remains on a sustainable fiscal path while addressing pressing development needs. The paper is organized into six sections: (1) Introduction, (2) One Year After HIPC: Policy Reforms, (3) Debt Restructuring and Current Composition, (4) Debt Sustainability Analysis, (5) Key Notable Issues, and (6) Policy Recommendations.

15 2. One Year After HIPC: Policy Reforms In the post-HIPC era, the FGS implemented transformative reforms to strengthen financial governance and improve public financial management systems, including payroll integration and expenditure controls. As part of these efforts, the Ministry of Finance is driving domestic revenue mobilization reforms. Recently, the Government implemented the sales tax electronic system, which has significantly streamlined tax collection processes, improving efficiency and transparency in revenue generation. The ministry has introduced a set of tax policies and administrative reforms between 2023 and 2025, which included the Income Tax Law, the Turnover Tax regime, and the launch of a 5 percent electronic transaction tax in September 2024. Simultaneously, the rollout Invoice Tracking System aimed to improve tax compliance, audit capacity, and taxpayer registration. Over the last five years, cumulative domestic revenue has surpassed US$1.4 billion, consistently exceeding targets in the past three years. In 2024 alone, domestic revenue increased by 12 percent, reaching US$369 million in 2024. Domestic revenues covered compensation costs of employees for the third consecutive year, although they remain insufficient to cover the government’s recurrent expenditures. Somalia’s domestic revenue remains the lowest in Africa, particularly among East African economies, with a tax revenue-to-GDP ratio of less than 3 percent, contrasting sharply with Africa’s average of 15 percent (Volz et al., 2020). Moreover, external grants cover nearly 65 percent of total government revenue. Figure 1: FGS Domestic Revenues and Total Operational Costs, 2020–2024 Source: MoF, 2025 Figure 1: FGS Domestic Revenues and Total Operational Costs, 2020–2024 Source: MoF, 2025 Figure 2: Comparison of Revenue to GDP (excluding grants) as % of GDP In East Africa Region (2022) Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 16 Post-HIPC Priorities Somalia is now focused on: • Building fiscal resilience and expanding the tax base • Continuing reforms at the Central Bank • Aligning development with long-term strategies with the National Transformation Plan 2025–29 and other long-term strategies. Challenges Ahead • Foreign aid cuts in 2025 threaten growth momentum. • Somalia must double down on domestic revenue mobilization and private sector development to sustain progress. Figure 2: Comparison of Revenue to GDP (excluding grants) as % of GDP In East Africa Region (2024) Source: IMF Portal, 2025 © Microsoft, OpenStreetMap Powered by Bing 20.7 14.2 22.4 14.9 16.8 3.0 3.0 22.4 Series1

17 Box 1: Natural Resource Revenue: Its Future Impact on Government Revenue Somalia’s oil and gas sector is nascent but holds significant promise. The country is believed to have sizable hydrocarbon prospects offshore and onshore (though there are no proven reserves yet). In a bid to attract investment, FGS has signed 16 production sharing agreements (PSAs) with international oil companies since 2022. Most of these were concluded in 2024, including several blocks awarded under a cooperation deal with Türkiye. As of 2024, no oil production has begun. These PSAs are for exploration, so there are no resource revenues flowing to the government yet. If and when commercial oil is discovered, the fiscal stakes will be enormous: even a moderate oilfield could yield hundreds of millions of dollars in annual government revenue, far exceeding with current US$370 million domestic revenue base. On other side, Somalia also has rich fisheries resources along its 3,300 km coastline the longest in Africa. Starting in 2018, the Ministry of Fisheries issued tuna fishing licenses to international fleets, and by 2024 these licenses had yielded a total of just over US$6 million in fees. On the revenue sharing mechanisms, the Baidoa Agreement (2018), enshrined in the Petroleum Act, outlines a derivation-based sharing model. For onshore oil, 50 percent of revenues go to the producing FMS and its district, 30 percent to the Federal Government, and the rest is divided among non-producing FMS. For offshore resources, the FGS receives a higher share (up to 55%)2 . While much depends on exploration outcomes, the fiscal upside of natural resources in Somalia is potentially very large. If oil production begins later this decade, government revenues from petroleum could quickly climb into the hundreds of millions of dollars per year – a several-fold increase over today’s domestic revenue. In a high-case scenario of a major oilfield, annual oil revenues might even approach or exceed $1 billion, fundamentally reshaping Somalia’s budget. For perspective, Somalia’s Medium-Term Revenue Roadmap (2024-2027) targets steady non￾resource revenue growth of about 0.3 percent of GDP per year any sizeable oil or gas income would be a windfall on top of these baseline gains3 . If used wisely, resource revenues could help Somalia cover its financing needs domestically and reduce reliance on foreign aid. The government’s goal of funding all core operating costs from domestic revenue by 2027 would become more attainable with natural resource income contributing. On front of the financial sector, CBS has introduced key legislation to align regulatory frameworks with international best practices, expand supervisory scope, and build a more resilient financial sector with robust risk management practices. Major initiatives include the enactment of the Takaful Act, the amendments to the Financial Institutions Law and the Revised Anti-money laundering and counter￾terrorist financing Act. As of December 2024, Somalia’s financial sector includes thirteen domestic commercial banks, one foreign bank branch, fifteen money transfer businesses, and five mobile money service providers. Additionally, the sector has 12 registered non-life insurance companies, 22 non￾deposit-taking microfinance institutions, and 6 money exchange bureaus4. Somalia’s banking sector has undergone significant transformation, driven by efforts to modernize financial systems, enhance regulatory frameworks, and promote financial inclusion. 2 MoF, Somalia Financial Governance Report 2024. https://mof.gov.so/index.php/publications/somali-financial-governance-report 3 MoF, Somali Medium Term, Revenue Road Map 2024-27. https://mof.gov.so/publications/somali-medium-term-revenu-road￾map-2024-27 4 CBS, Quarterly Economic Review (2024Q4). https://centralbank.gov.so/wp-content/uploads/2025/06/Quarterly-Economic-Report_ Q4_2024.pdf Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 18 The sector continues to play a vital role in supporting economic growth, building trust in formal financial institutions, and expanding access to banking and non-banking services. Key collaborations between government agencies, financial institutions, and international partners have been instrumental in advancing reforms, improving governance, and integrating Somalia into the global financial system. The total assets of the banking sector have been increasing continuously, reflecting a significant rise in public trust in banks. The total assets of the banking sector in 2024 reached over US$2 billion5 . So far, CBS has completed institutionally all the critical actions/ benchmarks laid out by the currency reform roadmap. The Central Bank of Somalia adopted a currency board arrangement and intends to reintroduce the Somalia Shilling (SOS). 5 CBS, Quarterly Economic Review (2024Q4). https://centralbank.gov.so/wp-content/uploads/2025/06/Quarterly-Economic￾Report_Q4_2024.pdf The new SOS notes will provide an important liquidity function by facilitating payments for small value transactions and promoting financial inclusion for the most vulnerable and low-income people. To sustain these critical reforms for Somalia’s economic and social development, the IMF and the FGS reached a staff-level agreement on economic and financial reforms of three years (Dec 2023 to Dec 2026) in post-HIPC policies, providing about US$100 million under the Extended Credit Facility (ECF). The agreement aims to advance reforms that strengthen vital economic institutions and foster inclusive & sustainable growth, in line with Somalia’s national development plan and the government’s long-term vision, with below benchmarks. Figure 3: Financial Sector Landscape in Somalia Source: CBS, 2024 Source: World Bank Database, 2025 Figure 3: Financial Sector Landscape in Somalia Source: CBS, 2024 Figure 4: Somalia’s External Debt-to-GDP Ratio, Before and after debt relief Source: MoF and IMF, 2024 Source: World Bank Database, 2025 Figure 3: Financial Sector Landscape in Somalia Source: CBS, 2024 Figure 4: Somalia’s External Debt-to-GDP Ratio, Before and after debt relief Source: MoF and IMF, 2024

19 Table 1. Structural Benchmarks Under the ECF, March 2024-November 2025 Benchmarks Target/ Proposed Data Sector/ FGS Agency Rational Status Publish a Tax Policy and Revenue Administration Roadmap approved by the Minister of Finance, in line with IMF staff recommendations. End-June 2024 MOF Support domestic revenue generation and revenue administration. Met Submit the Income Tax Bill to Parliament End-June 2024 MOF Support domestic revenue generation and revenue administration. Met, implemented with delay on July 9, 2024. Ensure full payroll integration of FGS employees in the SFMIS payroll module by reducing the ratio of non-payroll compensation of employee payments to total compensation of employees to less than 1 percent. End-June 2024 PFM / MOF NCSC MOLSA Strengthen payroll integrity, expenditure controls, and governance. Met (1) Issue a Prime Ministerial Decree that articulates the key parameters for debt policy and establishes the procedures to be followed for entering into new borrowing and issuing sovereign guarantees, in line with IMF staff recommendations; (2) amend the PFM regulations to include a clear definition of “other financial liabilities” that are considered guarantees as per Article 37 (6) of the PFM Act, in line with IMF staff recommendations. End-June 2024 MOF Define debt policy and strengthen debt management framework and capacity, in order to preserve fiscal sustainability. Met, implemented with delay on July 15, 2024. Submit the PPP Bill to Parliament with a framework that adequately manages fiscal risks and establishes a gateway process managed by the Ministry of Finance. End-June 2024 MOF Reduce fiscal risks and contingent liabilities/ Strengthen governance and reduce corruption risks. Met, implemented with delay on August 12, 2024. Develop an action plan to improve the quality of data submitted by commercial banks, in line with IMF recommendations, and communicate the action plan to commercial banks. End-July 2024 CBS Improve risk-based financial supervision. Met Develop a roadmap to implement the Pay and Grade policy, which would include as elements (i) a plan and timeline for the development of a strategy to align the salaries of temporary workers with the pay scale of permanent workers and (ii) a plan and timeline for conducting a costing exercise to understand the fiscal implications of the proposed shift of permanent and temporary workers to a new pay scale. End￾February 2025 PFM / MOF NCSC MOLSA Strengthen payroll integrity, expenditure controls, and governance. Ongoing (i) Publish the updated PFM regulations relating to digital signatures for the purchase order to payment process; and (ii) implement the digital signatures in the SFMIS. End-June 2025 PFM/MOF Strengthen expenditure controls and improve transparency and accountability. Ongoing Submit to Parliament amendments to the CBS Law, including to cover the currency board arrangement, in line with IMF recommendations. End￾December 2025 CBS Enhance central bank operations and independence under the currency board arrangement. Ongoing Source: IMF Country Report, December 2024 Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 20 3. Debt Restructuring and Current Composition In the post-HIPC era, the FGS actively engaged with its creditors to restructure and settle outstanding debts as part of its broader economic recovery and fiscal sustainability efforts. As part of wider economic reform agenda, the Ministry of Finance undertook significant steps in 2024 to implement the debt relief terms outlined in the “Paris Club Agreed Minutes” signed on March 13, 2024, and the common reduction factor established in the Decision and Completion Point Document under the HIPC Initiative. One of the significant achievements during this period was the Ministry’s successful conclusion of debt cancellation agreements with nearly all Paris Club creditor countries. The only exception was Spain, with whom negotiations remained ongoing by the end of 2024. In parallel, the Ministry intensified its efforts to communicate with non-Paris Club and multilateral creditors to pursue comparable debt treatment, consistent with the Paris Club framework. These engagements reflected Somalia’s continued efforts to secure equitable and sustainable debt resolutions across all creditor groups. 6 MoF, Annual Debt Management Report of 2024. https://mof.gov.so/publications/debt-management-reports 7 MoF, Annual Debt Management Report of 2024. https://mof.gov.so/publications/debt-management-reports Key milestones achieved during high-level international forums. On June 25, 2024, the Ministry signed a US$36 million debt relief agreement with the OPEC Fund during the OPEC Fund Development Forum, supported by a bridge loan from the Kingdom of Saudi Arabia. Subsequently, on July 16, 2024, the Ministry finalized a separate agreement with the Islamic Development Bank, successfully resolving a US$28 million debt stock, further reinforcing Somalia’s progress in settling multilateral debt obligations. At the end of 2024, Somalia’s total external public debt stock stood at US$1.5 billion. Multilateral creditors accounted for the largest share, representing 45.5 percent of the total debt, or approximately US$685.10 million. Within this category, the largest creditors were the Arab Monetary Fund (AMF), the Arab Fund for Economic and Social Development (AFESD), and the International Monetary Fund (IMF). Non￾Paris Club creditors made up nearly 39 percent of the total debt portfolio. The principal lenders in this group included the Abu Dhabi Fund, the Government of Iraq, the Kuwait Fund for Arab Economic Development (KFAED), and the Saudi Fund for Development (SFD). In addition, Somalia retained a single commercial loan with a Serbian company, amounting to US$2.67 million6 . Table 2: Somalia Stock of debt at the end of 2024 in Millions of US Dollars Creditor Category / Creditor Name Face Value Interest Arrears Other Fee Arrears Total Stock GRAND TOTAL 749.55 654.08 111.72 1,515.35 Commercial 1.51 1.16 - 2.67 Government of Serbia 1.51 1.16 - 2.67 Multilateral 311.33 373.72 0.05 685.10 Arab Fund for Economic and Social Dev. 74.56 127.00 0.05 201.61 Arab Monetary Fund 58.20 246.72 - 304.92 Int. Fund for Agricultural Development 2.05 - - 2.05 International Monetary Fund 113.46 - - 113.46 Islamic Development Bank 26.67 - - 26.67 OPEC Fund for Int. Dev. 36.39 - - 36.39 Non-Paris Club 388.45 279.20 111.67 779.32 Abu Dhabi Fund for Development 94.22 172.48 0.02 266.72 Government of Algeria 0.90 0.66 - 1.56 Government of Bulgaria 5.53 5.96 - 11.49 Government of Iraq 31.22 69.70 111.65 212.57 Government of Libya 11.75 30.15 - 41.90 Government of Romania 123.70 - - 123.70 Saudi Fund for Development 118.86 - - 118.86 Paris Club 48.26 - - 48.26 Government of Russia 7.36 - - 7.36 Government of Spain 40.90 - - 40.90 Source: MoF, 20247

21 4. Debt Sustainability Analysis Since achieving debt relief in 2023, Somalia’s public debt landscape has remained significantly streamlined. The government holds no guaranteed debt, and there are no identified liabilities from state-owned enterprises (SOEs), subnational governments, or public-private partnerships (PPPs). Furthermore, there is no domestic public debt issuance apart from legacy central government wage arrears. Somalia’s public debt burden has fallen dramatically following HIPC debt relief. The external public debt-to-GDP ratio declined from about 64 percent of GDP in 2018 to just 6.0 percent by the end of 20238 , reflecting the cancellation and restructuring of most legacy obligations. Total public debt (almost entirely 8 MoF, Annual Debt Management Report of 2024. https://mof.gov.so/publications/debt-management-reports 9 IMF & World Bank, Joint Debt Sustainability Analysis (2024). https://documents.worldbank.org/pt/publication/documents￾reports/documentdetail/099121924162519492/bosib168995492026196c31d3bba0e27f03 10 World Bank, Fiscal Vulnerabilities in Low-Income Countries: Evolution, Drivers, and Policies (2025) http://worldbank.org/en/ research/publication/fiscal-vulnerabilities external) stood at an estimated US$766.3 million (6.4% of GDP) at the end of 20249 . This is exceptionally low by international standards – for context, government debt in low-income countries averages around 72 percent of GDP as of 202310, giving Somalia a much-improved starting position. Subsector of the Public Sector Sub-Sectors Covered 1 Central Government X 2 State and Local Government 3 Other elements in the government 4 Guarantees (to other entities in the public and private sector) X 5 Central Bank (Borrowed on behalf of the government) X 6 Non-Guaranteed SOE debt X 1 The country’s Coverage of Public debt The central government, central bank, government-guaranteed debt, non￾guaranteed SOE debt Default Used for the analysis Reasons for deviations from the default setting 2 Other elements of general government were not captured in 1. 0 percent of GDP 0.0 3 SoE’s debt (Guaranteed and not guaranteed by the government in 1. 2 percent of GDP 0.0 No government guarantee or non￾guaranteed SOE debt in Somalia 4 PPP 35 percent of GDP 0.0 No PPPs exist in Somalia 5 Financial Markets (the default value of 5 percent of GDP is the minimum value) Total (in percent of GDP) 5 percent of GDP 5.0 Table 3: Somalia: Public Debt Coverage Sources: IMF, 2024 Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 22 In the baseline scenario, Somalia’s PV of external debt-to-GDP is only around 4 percent, versus the 30% threshold for weak economies11. The present value of external debt￾to-exports is around 21-22 percent, extremely low relative to the 140 percent threshold. Debt service is also modest at present: external debt service in 2024 is about 0.9 percent of exports and 5.9 percent of government revenue, fall significantly by nearly half of the DSF limits (10% and 14% respectively)12. Furthermore, the PV of total public debt-to￾GDP (including the domestic debt) is only 5 11 IMF & World Bank, Joint Debt Sustainability Analysis (2024). https://documents.worldbank.org/pt/publication/documents￾reports/documentdetail/099121924162519492/bosib168995492026196c31d3bba0e27f03 12 IMF & World Bank, Joint Debt Sustainability Analysis (2024). https://documents.worldbank.org/pt/publication/documents￾reports/documentdetail/099121924162519492/bosib168995492026196c31d3bba0e27f03 13 IMF & World Bank, Joint Debt Sustainability Analysis (2024). https://documents.worldbank.org/pt/publication/documents￾reports/documentdetail/099121924162519492/bosib168995492026196c31d3bba0e27f03 14 CBS, Somalia’s Post-HIPCS Priorities: Economic Prospects and Debt Sustainability. https://centralbank.gov.so/wp-content/ uploads/2024/09/CBS-Policy-Brief_June-2024_007.pdf percent, vs a 35 percent benchmark13. These figures illustrate that, following debt relief, Somalia’s debt burden indicators are well within sustainable ranges. In other words, Somalia currently has substantial borrowing space before approaching any DSF debt stock thresholds, a fortunate position that many post-HIPC countries did not maintain for long14. Figure 4: Somalia’s External Debt-to-GDP Ratio, Before and after debt relief Source: MoF and IMF, 2024 Source: World Bank Database, 2025 Figure 3: Financial Sector Landscape in Somalia Source: CBS, 2024 Figure 4: Somalia’s External Debt-to-GDP Ratio, Before and after debt relief Source: MoF and IMF, 2024

23 Table 4: Sensitivity of Debt Sustainability Indicators to Changes in GDP (Percentage of GDP, Unless Otherwise Indicated), Using GDP Figures in the Current LIC-DSA, 2023-2024 Sustainability Indicators 2023 2024 Total public debt-to-GDP ratio 6.4 6.4 PPG external debt-to-GDP ratio 6.4 5.9 PV of total public debt-to-GDP ratio 5.1 4.9 PV of PPG external debt-to-GDP ratio 4.4 4.3 PV of PPG external debt-to-exports ratio 22.5 21.0 PPG external debt service-to-exports ratio 0.7 0.9 Debt Indicator (Percent) DSF Threshold (Weak Capacity) 2024 (Baseline) PV of external public debt / GDP 30 4.3 (well below threshold) PV of external public debt / Exports 140 21.0 (well below threshold) External public debt Service / Exports 10 0.9 (below threshold) External public debt Service / Revenue 14 5.9 (below threshold in baseline) PV of total public debt / GDP (overall debt benchmark) 35 5.0 (well below benchmark) Source: IMF, 2024 In Somalia’s case, while all debt indicators stay comfortably below their thresholds in the baseline, the external debt service-to-revenue ratio would breach its 14 percent threshold under a severe shock scenario. Specifically, if the country were hit by adverse shocks (such as a sharp drop in exports and weaker growth), the standardized stress test, the annual debt service burden could temporarily rise above the indicative ceiling once initial grace periods on new loans end. This prospective threshold breach under stress is what drives the moderate risk rating (as opposed to a “low” risk rating which would require no breaches even under stress). At the same time, Somalia’s capacity to absorb severe shocks remains limited by its broader vulnerabilities. The country faces persistent risks from political and governance challenges, global commodity price swings, and climate-related disasters (e.g. droughts and floods), which can derail exports, growth, and revenues. Somalia also remains highly dependent on external grants financing to fund its budget. These factors mean that even with “space” under the debt indicators, a major shock or lapse in donor support could rapidly strain the fiscal position. The DSA emphasizes that Somalia’s apparent headroom should not lead to complacency, underscoring the importance of strengthening domestic revenue mobilization, building fiscal buffers, and enhancing debt management capacity to handle shocks. 4.1 Debt Sustainability Analysis Methodology This policy papers follows the World Bank￾IMF Low-Income Country Debt Sustainability Framework (LIC DSF). This framework assesses a country’s ability to meet its external debt obligations based on current economic indicators. It links debt thresholds to a country’s debt-carrying capacity, which is measured by a Composite Indicator (CI) derived from institutional quality and macroeconomic fundamentals. Each country’s CI score is used to classify it into one of three categories: Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 24 Table 5: CI score Classification CI Category Score Range Classification Weak CI ≤ 2.69 Low debt-carrying capacity Medium 2.69 < CI < 3.05 Moderate capacity Strong CI ≥ 3.05 High debt-carrying capacity Source: World Bank, 202515 Debt burden indicators are evaluated against external debt thresholds that vary by a country’s Composite Indicator (CI) classification, with key metrics including the Present Value (PV) of External Debt-to-GDP, PV of Debt-to-Exports, Debt Service-to-Exports, and Debt Service-to￾Revenue each serving as critical benchmarks for assessing debt sustainability under the World Bank-IMF framework. Table 6: Global Thresholds and Benchmarks PPG External Debt Debt Indicator Weak Capacity Medium Capacity Strong Capacity PV of External Debt-to-GDP (%) 30 40 55 PV of Debt-to-Exports (%) 140 180 240 Debt Service-to-Exports (%) 10 15 21 Debt Service-to-Revenue (%) 14 18 23 Source: World Bank, 202516 4.2 Debt-Carrying Capacity and Composite Indicator Somalia is currently classified as a “weak” capacity country under the LIC-DSF17, with a Composite Indicator (CI) score of 1.58 which is well below the 2.69 (Typically, a CI below around 2.69 corresponds to weak capacity)18. This rating reflects continued challenges, including low-income levels, limited fiscal and external buffers, and institutional fragility following prolonged conflict and state collapse. Although Somalia’s debt indicators remain comfortably within the thresholds for weak-capacity countries, the classification underscores its limited ability to manage higher debt burdens. Maintaining a conservative debt path is essential unless significant progress is made in macroeconomic performance and institutional capacity. 15 World Bank- Debt-Carrying Capacity, https://www.worldbank.org/content/dam/LIC%20DSF/Site%20File/station4. html#:~:text=WEAK 16 World Bank- Debt-Carrying Capacity, https://www.worldbank.org/content/dam/LIC%20DSF/Site%20File/station4. html#:~:text=WEAK 17 The Score based on factors like GDP growth, international reserves, remittances, and institutional quality (CPIA score). 18 World Bank- Debt-Carrying Capacity, https://www.worldbank.org/content/dam/LIC%20DSF/Site%20File/station4. html#:~:text=WEAK

25 5. Key Notable Issues Somalia is currently assessed to be at a moderate risk of debt distress, implying it has some room to borrow for development, yet remains vulnerable to shocks. Before accumulating new loans, Somalia must tackle a range of underlying issues to ensure that borrowing is sustainable and contributes to growth. In particular, three strategic priorities are crucial: scaling up domestic revenue, ensuring the state’s future affordability, and maximizing value for money in public spending. The following eight critical issues spanning economic, fiscal, governance, legal, and institutional domains – need to be addressed to strengthen Somalia’s fiscal resilience and mitigate risks prior to incurring new debt.

1. Low Domestic Revenue Mobilization: Somalia’s government revenues are extremely low by global standards, which undermines its ability to fund essential services and repay debt. After the state’s collapse in 1991, formal taxation virtually ceased, and domestic revenues hover around just 2.6 percent of GDP, among the lowest in Sub-Saharan Africa. Over 2012–2023 the FGS slowly rebuilt its 19 IMF Country Report, Somalia: Staff report for the sixth review under the Extended Credit Facility arrangement and request for a three-year arrangement under the Extended Credit Facility. https://www.imf.org/en/Publications/CR/Issues/2023/12/20/ Somalia-Staff-Report-for-the-Sixth-Review-Under-the-Extended-Credit-Facility-ECF-542834 20 MoF, Somalia Financial Governance Report 2024. https://mof.gov.so/index.php/publications/somali-financial-governance￾report revenue system, customs duties, a sales tax in Mogadishu, and some income and telecom taxes, but progress has been modest. Domestic revenues increased only by about 0.4 percent of GDP during the 2020–2023, far below initial targets19. A significant portion of Somalia’s economy operates informally or outside the tax system. As a result, Somalia relies heavily on donors for basic expenses.
2. High Recurrent Expenditure and Wage Bill Pressures: The “affordability of the state” is a major concern; FGS faces high recurrent expenditures (especially wages and security costs) that currently outstrip its revenues. Rebuilding Somalia’s civil service and security forces after decades of conflict has led to a rapidly rising wage bill. By 2024, security salaries alone accounted for 48 percent of the total government payroll, and overall security spending equated to about 64 percent of domestic revenues20. This leaves very little fiscal space for other services or development. In 2024, domestic revenues could cover the FGS employee compensation, However, the domestic receipts were insufficient to fully cover the government’s recurrent expenditure, which Table 7: Somalia: Composite indicate and Threshold Debt Carrying Capacity Weak Final Classification based on current vintage Classification based on the previous vintage Classification based on the two previous vintages Weak Weak 1.58 Weak 1.57 Weak 1.57 APPLICABLE External debt burden thresholds PV of debt in % of GDP 30 Exports 140 Debt Service in % of Exports 10 Revenue 14 APPLICABLE Total public debt benchmark PV of total public in percentage of GDP 35 Source: IMF, 2024 Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 26 amounted to approximately US$876.7 million and forces the government to seek external financing to cover the resulting budget deficit. As Somalia assumes more responsibility for security (e.g. as AU peacekeepers draw down) and hires more teachers, health workers, etc., the pressure on the budget grows. Unchecked expansion of recurrent costs could force Somalia to borrow to pay salaries, a dangerous path that led to past arrears. 3. Dependence on External Aid and Grants: Somalia’s fiscal survival has long depended on aid from international partners. This aid dependency poses risks: donor grants can be unpredictable or may wane now that Somalia’s debt relief is achieved. In 2024, donors disbursed US$543 million to the FGS, including US$185 million in direct budget support that was essential for filling the government’s financing gap. Notably, over 80 percent of donor assistance remains off￾budget (channeled through UN agencies, NGOs, etc.), meaning the government cannot fully direct or predict these funds21. Post-HIPC, Somalia’s classification as moderate debt risk means multilateral aid is shifting from grants to loans. This transition could sharply increase Somalia’s debt if it continues relying on external financing for basic expenditures. A sudden reduction in grants (due to global priorities or Somalia’s governance concerns) would leave a financing gap that Somalia might fill by borrowing or by cutting essential services. 4. Limited Institutional Capacity for Debt Management and Framework: Until recently, Somalia had no experience managing external borrowing, having been cut off from new credit for 30 years and in default on old debts. Post-HIPC, a coherent debt management framework, is urgently needed to avoid repeating past mistakes. While the Ministry of Finance established a Debt Management Unit (DMU) in 2015, institutional capacity remains 21 MoF, Somalia Financial Governance Report 2024. https://mof.gov.so/index.php/publications/somali-financial-governance￾report 22 CBS, Quarterly Economic Review (2024Q4). https://centralbank.gov.so/wp-content/uploads/2025/06/Quarterly-Economic￾Report_Q4_2024.pdf constrained. Somalia lacks a comprehensive Medium-Term Debt Management Strategy (MTDS), and its legal framework for borrowing is incomplete. This raises the risk of ad-hoc borrowing or contracting loans on unfavorable terms. As Somalia gains access to new lenders and financial instruments, its debt management institutions risk being outpaced, potentially resulting in poor decision-making. 5. Petroleum Sector Governance and Revenue Management: Somalia’s offshore oil and gas potential has long been seen as a possible game-changer for the economy; petroleum revenues could eventually dwarf all other sources of fiscal revenue . However, this “resource hope” comes with high stakes and risks. The petroleum sector is still in its early stages – currently limited to exploration only- but the government has signed 16 PSAs with foreign companies as of 2024. Without robust governance, Somalia risks falling into the “resource curse,” where oil revenues fuel conflict and macroeconomic instability rather than fostering sustainable development. A particularly concerning scenario would involve premature borrowing against projected future revenue; if those revenues fail to materialize as expected – or delayed- Somalia could face sever fiscal imbalances and heightened debt vulnerabilities. 6. External Economic Shocks and Commodity Dependence: Somalia’s economy is highly exposed to external economic shocks, given its dependence on imported commodities and a narrow export base. Two prime examples are global food and fuel prices. Somalia imports the majority of its food (27% of total imports in 2024) 22 and virtually all of its petroleum fuels; thus, spikes in global prices (like those induced by the Conflict in Ukraine in 2022) directly translate into domestic inflation and strain on households. The government often has a limited ability to respond, and it can

27 barely afford subsidies. As a result, high prices simply cause economic pain and, occasionally, pressure for the government to reduce or forego import taxes to ease costs, which then impacts revenue. On the export side, Somalia primarily exports livestock and some crops. Any slowdown in global demand or trade, or bans (such as past livestock import bans by Gulf states due to disease concerns), can sharply reduce export earnings. Remittances, while relatively steady, could be affected by downturns in host countries’ economies or exchange rate shifts. In addition, Somalia is vulnerable to shifts in donor economies (as it shifts, e.g., USAID), if there is a global recession or new crises elsewhere, aid flows to Somalia could diminish. All these external factors are largely outside Somalia’s control, yet they can cause budget volatility or balance￾of-payments pressure. For instance, a surge in oil prices would increase costs for electricity (many businesses rely on diesel generators) and transport, slowing growth and potentially prompting higher security or salary costs (if cost of living rises), thus widening deficits. Without shock absorbers, Somalia could be forced to seek additional borrowing to cover import bills or emergency needs arising from such global shocks. 7. Climate Change and Natural Disaster Vulnerability: Somalia is extremely vulnerable to climate-related shocks – notably droughts and floods – which regularly derail economic activity and strain public finances. In the past decade, Somalia has suffered repeated droughts (including an unprecedented sequence of failed rainy seasons from 2020–2022) that caused crop failures, mass livestock deaths, and humanitarian crises23. These droughts cut GDP growth sharply (e.g. growth was only 2.7% in 2022 due in part to drought)24. They also force the government to redirect funds to emergency relief or rely on international aid, 23 CBS, Quarterly Economic Review (2022Q2). https://centralbank.gov.so/wp-content/uploads/2023/06/CBS-QER-2022Q2-. pdf 24 SNBS, Somalia gross domestic product (GDP) 2024. https://nbs.gov.so/somalia-gross-domestic-product-gdp-2024/. while reducing the tax base (as livestock and crop export revenue fall). Similarly, periodic floods (such as riverine flooding in southern Somalia) wipe out infrastructure and require spending. Climate change is expected to increase the frequency and severity of these events. Each shock adds to fiscal risk: for example, a drought can cause food insecurity, requiring emergency imports and humanitarian aid appeals, and if aid is insufficient, the government might need to borrow or shift budget resources. Without buffers, these shocks lead to crisis-driven spending spikes and revenue shortfalls. Furthermore, disaster responses often depend on external grants; if those ever lag, the pressure to take loans (even expensive ones) in a pinch could rise. Over time, the economic losses from climate shocks also keep Somalia’s GDP and revenues lower than they would otherwise be, meaning less capacity to carry debt. 8. Political Instability and Security Challenges: Somalia’s ongoing conflict and political instability undermine both economic performance and fiscal sustainability. Security consumes a significant share of resources, around 64 percent of domestic revenue is allocated to security-related spending, leaving limited fiscal space for development. Persistent insecurity disrupts economic activity, deters investment, and weakens revenue generation. Politically, Somalia’s federal system remains fragile. Tensions between the federal government and member states, coupled with an incomplete constitutional framework, create uncertainty. These political uncertainties can delay reforms, undermine fiscal planning, and risk suspension of external financing if successive governments do not uphold agreements. Without sustained peace and stable governance, Somalia’s economic recovery and debt sustainability remain at risk. Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 28 9. Maintaining Debt Sustainability and Prudent Borrowing Post-HIPC: Following its hard-won debt relief under the HIPC initiative, Somalia faces the critical challenge of safeguarding long-term debt sustainability and avoiding a relapse into debt distress. With debt now at a low level (around 6% of GDP)25, there may be temptations or pressures to borrow for the many needs the country has. However, Somalia’s debt carrying capacity is still rated “weak” (1.58), meaning it can only handle limited debt safely26. The latest DSA projects Somalia’s risk of debt distress as moderate, and crucially, it shows that in stress scenarios (e.g., if growth falters or concessional financing declines) Somalia could breach debt service thresholds in the long term once grace periods on new loans expire27. In other words, the current low debt metrics mask future risks if borrowing is not carefully managed. Additionally, as noted, Somalia’s shift from grants to loans (especially from IDA) will gradually increase debt stock. The government has set a fiscal anchor of keeping deficits below 3.5 percent of GDP, primarily financed by highly concessional loans28. Sticking to this is vital. If Somalia were to accumulate debt too quickly, even if each loan is concessional, it could face a repayment hump in the 2030s or 2040s that its revenue base cannot support. The experience of other post-HIPC countries underscores the risk of debt re-accumulation due to non-concessional borrowing and weak fiscal consolidation. Somalia must embed debt discipline now to safeguard its hard-won gains and ensure fiscal sustainability. 25 IMF Country Report, Somalia: 2024 Article IV consultation and second review under the Extended Credit Facility. https:// www.imf.org/en/Publications/CR/Issues/2024/12/17/Somalia-2024-Article-IV-Consultation-and-Second-Review-Under-the￾Extended-Credit-Facility-559663 26 IMF Country Report, Somalia: 2024 Article IV consultation and second review under the Extended Credit Facility. https:// www.imf.org/en/Publications/CR/Issues/2024/12/17/Somalia-2024-Article-IV-Consultation-and-Second-Review-Under-the￾Extended-Credit-Facility-559663 27 IMF & World Bank, Joint Debt Sustainability Analysis (2024). https://documents.worldbank.org/pt/publication/documents￾reports/documentdetail/099121924162519492/bosib168995492026196c31d3bba0e27f03 28 IMF Country Report, Somalia: Staff report for the sixth review under the Extended Credit Facility arrangement and request for a three-year arrangement under the Extended Credit Facility. https://www.imf.org/en/Publications/CR/Issues/2023/12/20/ Somalia-Staff-Report-for-the-Sixth-Review-Under-the-Extended-Credit-Facility-ECF-542834 29 MoF, Somali Medium Term, Revenue Road Map 2024-27. https://mof.gov.so/publications/somali-medium-term-revenu-road￾map-2024-27 6. POLICY RECOMMENDATIONS Somalia’s post-debt relief fiscal landscape presents both opportunity and vulnerability: while the country’s debt burden has been significantly reduced, sustaining this trajectory requires disciplined governance, institutional resilience, and strategic borrowing. To avoid reaccumulating unsustainable debt, Somalia must prioritize domestic revenue mobilization, strengthen public financial management and debt oversight, and ensure that any new borrowing is transparent, concessional, and aligned with national development priorities. Sound fiscal federalism, institution building, and improved resilience to climate and economic shocks are essential pillars for preserving debt sustainability and securing inclusive, long-term growth. I. Advance Fiscal Sustainability (Revenue and Expenditure) A dual strategy of increasing domestic revenue and exercising strict expenditure control before taking on any new debt. On the revenue side, the government’s 2024 Medium-Term Revenue Roadmap aims to raise revenues to 4 percent of GDP by 202729 Improving revenue is perhaps the most critical step for Somalia’s debt sustainability. With revenues of 4 percent of GDP, even highly concessional loans can strain repayment capacity. In short, without stronger revenues, new borrowing would quickly become unsustainable for Somalia. At the same time, implement tight expenditure controls in operational costs through frugal budgeting and procurement savings. Reducing the mismatch between

29 revenues and expenses is vital for avoiding excessive borrowing. Currently, the gap between domestic revenue and operating expenses is about US$116 million (0.7% of GDP), which has been bridged by donor budget support. Together, more substantial revenue and spending discipline will reduce fiscal risks, support debt sustainability, and give Somalia the fiscal space to fund development without falling back into debt distress. II. Redirecting Aid Towards Productive Sectors and National Priorities in Somalia To enhance the long-term effectiveness and sustainability of aid, Somalia must transition from aid-driven development to investment in productive sectors aligned with national priorities. Aid should be redirected to critical areas such as agriculture, fisheries, energy, infrastructure, and small-scale manufacturing sectors with strong multiplier effects on employment, livelihoods, and domestic revenue generation. III.Strengthening Debt Management and Framework: The government should develop a comprehensive debt management strategy aligned with national economic goals to ensure debt sustainability. Commercial or non-concessional borrowing should be strictly limited; ideally, Somalia should avoid market-based borrowing until the economy grows stronger. Maintaining debt sustainability requires broader reforms in revenue mobilization and expenditure control. The government must be prepared to reject unfavorable loans, including supplier credits or politically motivated offers. For large investments, grants or public-private partnerships should be prioritized. A fiscal anchor keeping the deficit below 3.5 percent of GDP and ensuring at least half of financing is concessional should be codified in regulation or debt legislation and monitored through the budget process. A public debt strategy should guide borrowing, enhance transparency, and be shared with Parliament and development partners. IV.Strengthen Natural Resource Revenue Management and Governance Strengthening governance in the petroleum sector by finalizing and enforcing a complete legal and regulatory framework. This includes clear rules for PSAs, environmental safeguards, revenue sharing, and transparency. At the same time, develop a plan for managing future oil revenues. Establishing a sovereign wealth or stabilization fund can help smooth spending and avoid boom-bust cycles. A fair revenue-sharing formula with Federal Member States must be agreed upon before production begins to prevent future disputes. Effective governance will reduce the risk of reckless borrowing tied to overly optimistic resource projections. Avoiding the pre-spending of anticipated oil income through debt will help Somalia escape the mistakes of other resource-rich countries. V. Prioritize climate adaptation by strengthening coordination and institutional capacity. Somalia should place greater emphasis on medium- to long-term climate adaptation rather than mitigation by enhancing national coordination mechanisms, strengthening institutional capacity, and securing sustainable climate financing. Climate adaptation must be integrated into development planning at all levels. Empowering key institutions and mobilizing both domestic and international finance will boost Somalia’s resilience to climate shocks, reduce fiscal and economic vulnerabilities, and support sustainable development. Post-Debt Relief Reforms in Somalia: Keeping an Eye on International Monetary Fund’s Debt Sustainability Analysis

Policy Brief, June 2025 30 Reference Central Bank of Somalia [CBS]. (2022). Quarterly economic review (2022Q2). Mogadishu, Somalia. https://centralbank.gov.so/wp-content/uploads/2023/06/CBS-QER-2022Q2-.pdf Central Bank of Somalia [CBS]. (2023). Annual report 2022. Mogadishu, Somalia. https://centralbank. gov.so/wp-content/uploads/2024/02/Annual-Report-Year-2022.pdf Central Bank of Somalia [CBS]. (2024). Quarterly economic review (2024Q4). https://centralbank. gov.so/wp-content/uploads/2025/06/Quarterly-Economic-Report_Q4_2024.pdf Central Bank of Somalia [CBS]. (2024). Somalia’s post-HIPCS priorities: Economic prospects and debt sustainability. https://centralbank.gov.so/wp-content/uploads/2024/09/CBS-Policy-Brief_June￾2024_007.pdf International Monetary Fund [IMF]. (2023). Somalia: Staff report for the sixth review under the Extended Credit Facility arrangement and request for a three-year arrangement under the Extended Credit Facility. https://www.imf.org/en/Publications/CR/Issues/2023/12/20/Somalia-Staff-Report￾for-the-Sixth-Review-Under-the-Extended-Credit-Facility-ECF-542834 International Monetary Fund [IMF]. (2024). Somalia: 2024 Article IV consultation and second review under the Extended Credit Facility. https://www.imf.org/en/Publications/CR/Issues/2024/12/17/ Somalia-2024-Article-IV-Consultation-and-Second-Review-Under-the-Extended-Credit-Facility-559663 International Monetary Fund [IMF] & World Bank. (2024). Somalia: Joint Bank-Fund debt sustainability analysis. https://www.imf.org/en/Publications/CR/Issues/2024/12/17/Somalia-2024- Article-IV-Consultation-and-Second-Review-Under-the-Extended-Credit-Facility-559663 Mawejje, J. (2025). Fiscal vulnerabilities in low-income countries: Evolution, drivers, and policies. Washington, DC: World Bank. https://doi.org/10.1596/978-1-4648-1968-1 Ministry of Finance [MoF]. (2024). Somali medium-term revenue roadmap 2024–2027. https:// mof.gov.so/publications/somali-medium-term-revenu-road-map-2024-27 Ministry of Finance [MoF]. (2025). Annual debt management report of 2024. Mogadishu, Somalia. https://mof.gov.so/publications/fy2024-annaul-debt-management-report Ministry of Finance [MoF]. (2025). Somalia financial governance report 2024. https://mof.gov.so/ sites/default/files/Publications/Somalia%20Financial%20Governance%20Report%20%202024%20.pdf Somali National Bureau of Statistics. (2025). Somalia gross domestic product (GDP) 2024. https:// nbs.gov.so/somalia-gross-domestic-product-gdp-2024/ Volz, U., Akhtar, S., Gallagher, K. P., Griffith-Jones, S., Haas, J., & Kraemer, M. (2020). Debt Relief for a Green and Inclusive Recovery: A Proposal. Center for Sustainable Finance. https://drgr.org/ files/2021/01/DRGR-report.pdf

Strengthening Somalia’s Financial Sector: The Emerging Role of Non-Bank Financial Institutions Policy Research & Analysis Division Research and Statistics Department Monetary, Financial, Regulatory Policy Group Central Bank of Somalia June 2025

Policy Brief, June 2025 32 Executive Summary Somalia’s financial sector has undergone substantial transformation in recent years, driven by progressive reforms from the CBS to improve stability, financial inclusion, and regulatory oversight. Central to this transformation is the emergence and expansion of NBFIs, including MFIs, insurance companies, money transfer operators, and mobile money service providers. These entities play a growing role in enhancing financial accessibility, particularly for underserved communities, women, youth, and small businesses. The CBS has led several landmark reforms including the introduction of a national payments system, IBAN implementation, a digital eKYC framework, the adoption of the SOMQR code standards and the launch of the Somali Instant Payment System (SIPS). Complementary legislative reforms was enacted such as the Takaful Act 2025and amendments to the Financial Institutions Law 2025 reflect Somalia’s alignment with global standards and its commitment to financial resilience. The National Payment Bill is currently under the parliament review and will be enacted soon, Microfinance institutions have expanded significantly, offering tailored financial products and services, particularly to low-income populations. However, challenges persist, including high operational costs, credit risk due to lack of collateral, and limited financial literacy. The insurance sector, while nascent, has shown promise, particularly through the adoption of Sharia-compliant Takaful insurance. The number of licensed providers has grown to twelve by 2024, expanding services in health, construction, and livestock insurance. While the sector remains underdeveloped, initiatives like the Takaful Act and increasing diaspora investment signal its growing relevance. A regional comparison with East African Community (EAC) countries shows Somalia lagging behind in regulatory sophistication and market development. Unlike peers like Kenya and Rwanda, Somalia was lacking robust frameworks for NBFIs and continued to rely heavily on informal mechanisms. Despite recent legislative progress, Somalia’s NBFI sector still faces several key challenges, including limited credit infrastructure due to the absence of credit bureaus and asset registries, weak KYC/AML enforcement due to the slow rollout of the national identification, absence of capital market compounded by high lending cost; underdeveloped insurance and remittance integration frameworks;, and low levels of financial literacy across all demographic groups. The policy recommendations from the study emphasize the need for regulatory enhancement through risk-based supervision, tiered KYC frameworks, and strengthened regulatory capacity; development of financial infrastructure, including a national credit bureau and interoperable payment systems; support for microfinance and SME lending via community-based models and digital credit scoring; acceleration of currency reform alongside public education on the new Somali Shilling; development of the insurance sector with a focus on rural outreach and Sharia￾compliant products; improved remittance oversight to integrate diaspora flows into formal financial systems; and nationwide financial literacy campaigns targeting youth and women.

1. Introduction Somalia’s financial sector has made remarkable progress in recent years, moving towards greater stability, inclusiveness, and integration into the global economy. The Central Bank of Somalia (CBS) is at the forefront of this transformation, demonstrating a strong commitment to rebuilding and modernizing the country’s financial infrastructure. This commitment includes a multifaceted approach focused on strengthening regulatory frameworks, enhancing financial stability, and improving the overall resilience of the financial system. To promote financial inclusion, the CBS is implementing a series of reforms designed to empower individuals and small businesses, particularly those in underserved communities.

33 These efforts are beginning to yield positive outcomes, as evidenced by increased public trust in financial institutions and a noticeable rise in private sector access to credit. By facilitating access to necessary financial resources, the CBS aims to stimulate economic activities and foster entrepreneurship, which are vital for the nation’s growth. The CBS actively collaborates with various stakeholders to catalyze financial development, including government agencies, private financial institutions, and international partners. This collaborative approach aims to enhance the overall economic infrastructure through innovative solutions and technology integration, fostering a more efficient and accessible financial ecosystem1 . Such partnerships also help leverage global best practices, ensuring that Somalia can benefit from the lessons learned by other nations. Through these comprehensive initiatives, the Central Bank of Somalia is working to stabilize the financial system and lay the groundwork for a more inclusive economy that supports sustainable development and improves the livelihoods of its citizens. This study aims to provide a comprehensive review of significant developments in the financial sector over recent years. It will explore various aspects such as technological advancements, regulatory changes, shifts in consumer behavior, and the impact of global economic trends. By examining these areas, the study seeks to offer a detailed understanding of how these factors have shaped the landscape of finance, influencing both institutional practices and individual financial decision-making. The paper is organized into eight sections: The introduction sets the context for strengthening Somalia’s financial sector through NBFIs. Recent reforms 1 CBS, Quarterly Economic Review (2024 Q3). https://centralbank.gov.so/wp-content/uploads/2025/03/Quarterly-Economic￾Report_Q3_2024.pdf 2 CBS, Quarterly Economic Review (2024 Q3). https://centralbank.gov.so/wp-content/uploads/2025/03/Quarterly-Economic￾Report_Q3_2024.pdf 3 CBS, Quarterly Economic Review (2024 Q4). https://centralbank.gov.so/wp-content/uploads/2025/06/Quarterly-Economic￾Report_Q4_2024.pdf highlight regulatory progress. The growth of microfinance and insurance services shows expanding financial access and risk protection. Currency exchange and remittances underscore their vital role in liquidity and household support. A regional comparison offers lessons from EAC countries. The paper ends with key issues and policy recommendations to enhance NBFI development. 2. Recent Development In recent years, CBS has achieved several significant milestones, including introducing a national payments system, regulating and supervising the mobile money sector, implementing International Bank Account Numbers (IBAN), and adopting an AML/ CFT compliance module and SOMQR Code standardization guideline. These efforts demonstrate Somalia’s progress in revitalizing its financial services sector and paving the way for a more inclusive and prosperous economy. One key aspect of Somalia’s financial sector development was the continued expansion of mobile banking and digital financial services. With the increasing penetration of mobile phones nationwide, mobile money platforms played a crucial role in improving access to financial services, especially in rural areas. This trend facilitated transactions and promoted financial inclusion among underserved populations2 . As of December 2024, Somalia’s financial sector includes thirteen domestic commercial banks, one foreign bank branch, fifteen money transfer businesses, and five mobile money service providers. Additionally, the sector has 12 registered non-life insurance companies, 22 non-deposit-taking microfinance institutions, and six money exchange bureaus3 . Strengthening Somalia’s Financial Sector: The Emerging Role of Non￾Bank Financial Institutions

Policy Brief, June 2025 34 Somalia’s banking sector has undergone significant transformation, driven by efforts to modernize financial systems, enhance regulatory frameworks, and promote financial inclusion. The sector play a vital role in supporting economic growth, building trust in formal financial institutions, and expanding access to banking services. Key collaborations between government agencies, financial institutions, and international partners have been instrumental in advancing reforms, improving governance, and integrating Somalia into the global financial system. The total assets of the banking sector have been increasing continuously, reflecting a significant rise in public trust in banks. The total assets of the banking sector in 2024 reached over US$2 billion4. 2.1 Recent Reforms in the Financial Sector Over the past decade, CBS has been actively rebuilding the country’s financial infrastructure through a series of strategic reforms to strengthen the financial sector and promote financial inclusion. In recent years, CBS has introduced key legislation to align regulatory 4 CBS, Quarterly Economic Review (2024 Q4). https://centralbank.gov.so/wp-content/uploads/2025/06/Quarterly-Economic￾Report_Q4_2024.pdf frameworks with international best practices, expand supervisory scope, and build a more resilient financial sector with robust risk management practices. Significant initiatives include of the Takaful Act, the amendments to the Financial Institutions Law and the Revised Anti-money Laundering and Counter-terrorist Financing Act. To further promote financial sector integrity. In late 2024, the CBS Board approved the Electronic Know Your Customer (e-KYC) regulation, standardizing KYC procedures and enabling financial institutions to digitally verify customer identities, improving operational efficiency and regulatory compliance. In partnership with the National Identification and Registration Authority (NIRA), CBS has integrated e-KYC into the national identification system, the Memorandum of Understanding (MOU) between CBS and NIRA as well the MOU between NIRA and Somali Bankers Association on electronic verification through Hubiye platform further strengthening the integrity and security of the financial system. CBS has also revolutionized Somalia’s payment ecosystem by implementing the Somali Instant Figure 1: Structure of Financial Sector in Somalia Sources: CBS 2024 Figure 1: Structure of Financial Sector in Somalia Sources: CBS 2024 Figure 2: Number of Microfinance Institutions Registered (Cummulative) Figure 1: Structure of Financial Sector in Somalia Sources: CBS 2024 Figure 2: Number of Microfinance Institutions Registered (Cummulative)

35 Payment System (SIPS), facilitating real-time transactions and significantly expanding access to banking services for both urban and rural populations. In its commitment to supporting Islamic finance and broader financial inclusion, CBS has become a member of international organizations such as the Islamic Financial Services Board (IFSB) and the Alliance for Financial Inclusion (AFI). These memberships enhance CBS’s ability to align with global standards and promote inclusive growth. Another critical milestone is CBS’s joining the World Bank’s Reserve Advisory and Management Partnership (RAMP). This partnership equips CBS with essential technical expertise to improve the management of foreign exchange reserves, enhance liquidity oversight, and mitigate financial risks, all of which are vital for stabilizing the monetary system. The collective reforms currently underway are particularly timely and essential as Somalia prepares to reintroduce the Somali Shilling (SOS). This significant move represents a crucial step toward achieving long-term economic stability in a country that has faced prolonged fiscal challenges. With CBS implementing a currency board arrangement, the introduction of the new shilling will serve a vital liquidity function. They will facilitate everyday transactions, particularly for small-value payments, thereby enhancing the efficiency of financial exchanges within local communities. Furthermore, this reform is expected to encourage financial inclusion, especially for Somalia’s most vulnerable populations, including low-income individuals and those who have traditionally been marginalized from formal financial systems. By increasing access to a stable currency, the CBS aims to empower these groups, enabling them to participate more fully in the economy and improve their overall livelihoods. Overall, the reintroduction of the SOS not only symbolizes a return to a more stable monetary system but also reflects a broader commitment to fostering economic resilience and social equity in Somalia. 3. Growth of Microfinance Institutions Microfinance institutions (MFIs) have experienced remarkable growth in recent years, expanding their services beyond small￾scale loans to include savings products and financial literacy programs. These institutions primarily target underserved populations, with a particular emphasis on empowering women and youth. By doing so, they play a pivotal role in fostering entrepreneurship, reducing poverty, and stimulating local business growth. Financial inclusion remains central to their mission. MFIs have developed targeted programs designed to enhance access to essential financial services for various demographic groups, including youth, women, small enterprises, and rural communities. Such inclusivity enables greater participation in the economy and contributes to a more equitable society. Mobile banking has further transformed the microfinance landscape. With the widespread adoption of mobile phones, MFIs have leveraged technology to facilitate greater access to financial services, enabling individuals in remote or underserved areas to access the financial services more easily. This technological advancement has been instrumental in increasing participation rates among populations that historically faced barriers to financial access. In addition to enhancing individual financial capabilities, CBS has made it a priority to support small and medium-sized enterprises (SMEs). This commitment includes improving access to credit for these businesses, fostering job creation, and driving economic growth. By providing the necessary resources and support, CBS aims to cultivate a vibrant ecosystem for SMEs, which are essential for overall economic stability and development. Strengthening Somalia’s Financial Sector: The Emerging Role of Non￾Bank Financial Institutions

Policy Brief, June 2025 36 The microfinance sector in Somalia plays a vital role in fostering economic development by offering financial services to individuals and small businesses that are often excluded from traditional banking systems. Despite its importance, the sector faces several significant challenges that impede its growth and overall effectiveness. One of the foremost obstacles is the limited rollout of the National identification, which restricts the ability of many potential clients to access essential financial services. Without official identification, individuals may find it difficult to open accounts, request financing, or engage in formal financial transactions. In addition to identification issues, the microfinance sector in Somalia grapples with other critical challenges. These include limited financial literacy among potential borrowers, which can lead to poor financial decision-making and high default rates. To address these challenges, Central Bank of Somalia has issued the Non-Deposit Taking Microfinance Licensing Regulation in May 2025. Prior to that, National Identification and Registration Authority (NIRA) was established, and the ID process was rolled out. As of June 2025, ten (10) licensed commercial banks have been fully integrated and tested in this platform, remaining banks and other financial institutions will be integrated in the fourth quarter of 2025. In addition, to support an effective implementation of the eKYC regulation, NIRA has introduced online verification platform – Hubiye Platform, that has been integrated with financial institution systems. Additionally, the ongoing instability and insecurity in the region present logistical challenges, making it difficult for microfinance institutions to operate effectively and reach underserved populations. The lack of infrastructure, such as credit information sharing, collateral registry and affordable technology, further compounds these difficulties. In summary, while the microfinance sector in Somalia can empower individuals and stimulate economic growth, addressing these multifaceted challenges is crucial for unlocking its full potential and creating a more inclusive financial landscape. Additional key challenges currently facing the microfinance sector in the country include: Figure 2: Number of Microfinance Institutions Registered (Cummulative) Source: CBS, 2024 Figure 1: Structure of Financial Sector in Somalia Sources: CBS 2024 Figure 2: Number of Microfinance Institutions Registered (Cummulative)

37

1. Operational Costs The sector faces significant operational expenses, including staff salaries, administrative overhead, and outreach activities required to serve remote or underserved communities. However, high operational costs with limited financial resources often constrain their capacity to scale services and reach more vulnerable populations.
2. High Credit Risk and Loan Defaults The informal nature of many businesses in Somalia makes it challenging to assess creditworthiness. Borrowers often lack collateral, increasing the risk of loan defaults and financial losses.
3. Low levels of financial literacy Low levels of financial literacy among the population pose a significant challenge. Many potential clients often face difficulties in accessing affordable and sustainable funding sources.
4. Complex application requirements Complex application requirements, such as the need for guarantors and collateral, create significant barriers to microfinance adoption. BOX 1: IMPACT OF MICROFINANCE FUND The CBS microfinance fund originated from a $3 million donation by the State of Kuwait (Kuwait Fund for Arab Economic Development) to the Federal Government of Somalia in 2013. This fund was designated to promote financial inclusion and support small-scale investors. Building on this opportunity, CBS launched a microfinance project in January 2017, introducing a free loan scheme distributed through licensed commercial banks. Acting on behalf of CBS, these banks were tasked with distributing small-scale loans to individual entrepreneurs and small and medium-sized enterprises (SMEs). Implemented in five phases, the microfinance project demonstrated significant outreach and impact. With a total of 11,040 direct beneficiaries and considering Somalia's average household size of five, the initiative indirectly benefited approximately 55,200 individuals. The fund targets vulnerable groups such as unemployed individuals, small entrepreneurs, and farmers, who often face barriers to formal financial services due to collateral requirements and low-income levels. The initiative notably promoted financial inclusion, economic empowerment, and self-employment, especially among youth and women. Of the direct beneficiaries, 66% were women and 34% were men. Young adults aged 30 and below accounted for 33% of recipients, those aged 31–40 at 30%, and the 41–45 age group at 23%. These figures underscore the fund's role in empowering individuals across various life stages, strongly emphasizing support for emerging entrepreneurs and those in their most productive working years. Beyond individual impact, the fund played a pivotal role in fostering entrepreneurship and sustaining small businesses, thereby contributing to local economic development. A survey of beneficiaries revealed that all respondents used the funds either to expand existing businesses or to launch new ventures. Specifically, 70% of recipients used the funds to grow their current businesses, while 30% used them to start new ones. The fund supported a diverse range of sectors, including SMEs, service providers, small livestock traders, as well as agricultural and health centers across all Somali federal member states. A sectoral breakdown of microfinance fund utilization shows that SMEs accounted for the largest share at 75%, followed by Food & Restaurants (13%), Agriculture (5%), Health Sector (3%), Livestock (2%), Fishing (1%), and other categories (1%). This distribution highlights the fund's wide-reaching impact across critical economic sectors, demonstrating its importance in supporting both business development and broader socio-economic resilience. Strengthening Somalia’s Financial Sector: The Emerging Role of Non￾Bank Financial Institutions

Policy Brief, June 2025 38 4. Emergence of Insurance Services The insurance industry in Somalia is gradually evolving and demonstrates promising growth potential despite being in its nascent stages. Over recent years, several new insurance companies have entered the market, introducing a diverse portfolio of products aimed at meeting the unique needs of the Somali population. These offerings include health insurance, construction insurance, and livestock insurance, reflecting the country’s economic activities and cultural practices. To foster this expansion and safeguard consumer interests, regulatory frameworks are being developed to ensure that the industry operates with integrity and transparency. By 2024, the number of registered insurance companies in Somalia is expected to reach twelve, marking a significant increase as more businesses recognize the value of insurance as a financial service. A major milestone in this progress was the introduction of the Takaful Act in 2025. This legislation, designed to promote Sharia￾compliant insurance practices. The passage of the Takaful Act not only reflects an effort to diversify insurance offerings but also aims to build trust and encourage participation among communities that have previously been hesitant to engage with conventional insurance products. This development is positioned to transform the landscape of insurance in Somalia, creating a solid foundation for its future growth. Aspect Details Origin $3 million grant by the State of Kuwait to the Federal Government of Somalia in 2013 Purpose Promote financial inclusion and support small-scale investors Launch Date January 2017 Loan Scheme Free loan scheme distributed through licensed commercial banks Direct Beneficiaries 11,040 Indirect Beneficiaries Approximately 55,200 Target Groups Vulnerable groups such as unemployed individuals, small entrepreneurs, and farmers Gender Distribution 66% women, 34% men Age Distribution 30 and below: 33%, 31-40: 30%, 41-45: 23% Fund Usage 70% to expand existing businesses, 30% to start new ones Sectoral Breakdown SMEs: 75%, Food & Restaurants: 13%, Agriculture: 5%, Health Sector: 3%, Livestock: 2%, Fishing: 1%, Other: 1% Figure 3: Number of Registered (licensed) Insurance Companies Source: CBS, 2024 Source: CBS, 2024 Figure 3: Number of Registered (licensed) Insurance Companies Source: CBS, 2024

39 Despite ongoing challenges, the sector holds significant potential for growth. The increasing demand for risk management, driven by personal and business needs, presents a significant growth potential. Additionally, the Somali diaspora, which has shown considerable investment interest, could play a vital role in supporting the development of the insurance market. The rise in digital financial services offers new avenues for expanding insurance coverage, particularly in underserved areas. Furthermore, the potential for Sharia-compliant insurance products, such as Takaful, aligns with cultural and religious preferences, offering a pathway to increase insurance uptake. Similar to other segment of the financial sector, the insurance industry remains in its infancy. Following the collapse of the state in 1991, Somalia was left without any formal insurance system for nearly three decades. In recent years, however, the sector has begun to re-emerge, largely through Islamic insurance models known as Takaful5 . Under this cooperative system, participants contribute to a shared pool to protect one another against loss or damage. Takaful operations were introduced in Somalia for the first time in early 2018, and the first insurance company was officially registered with the Central Bank of Somalia that same year. 5. Currency Exchange Services CBS has initiated a series of comprehensive reforms designed to stabilize the exchange rate market, focusing on the unification of exchange rate management and the restoration of confidence in the foreign exchange sector. Since 2018, CBS has taken significant steps by registering six money exchange bureaus, a move intended to formalize and regulate a sector that has historically operated in a largely unregulated environment. The revised Financial Institutions Law 2025 gives clear mandate for CBS to regulate and supervise the sector. In the 5 Chepngeno, S., Karanja, D., & Abrar, Y. “Enhancing opportunities for non-banking financial institutions and approaches in Somalia,” May 2022. 6 CBS. Annual report 2023. https://centralbank.gov.so/wp-content/uploads/2024/11/CBS-Annual-Report_2023.pdf current economic landscape, the economy is highly dollarized, and most exchange bureaus in Somalia primarily facilitate transactions in US dollars. This situation arises from the fact that CBS has not issued any currency since 1991, resulting in the country effectively becoming a dollarized economy, where the U.S. dollar is frequently used for everyday transactions and savings. This lack of a national currency has posed challenges for economic policy and financial stability. Recognizing the importance of monetary control, CBS has prioritized currency reform as a key objective. The bank has made substantial progress in this area and has reportedly completed most of the critical actions and benchmarks established in its currency reform roadmap. These steps are crucial for fostering a more stable economic environment and restoring the functionality of the national currency in the future6 . 6. The Role of Remittances in Shaping Somalia’s Financial Sector While remittances themselves are not classified as NBFIs, but rather a payment platform, their critical role in Somalia’s economy and financial landscape warrants attention in any analysis of financial sector development. Remittances play a vital role in bolstering Somalia’s economic stability, serving not only as a financial lifeline for countless households but also as a significant catalyst for broader economic growth. These monetary inflows support millions of families, enabling them to access essential goods and services, which are crucial for their daily survival. Additionally, remittances encourage entrepreneurship and create job opportunities, thereby fostering a culture of self-sufficiency and innovation within communities. The impact of remittances extends beyond individual households; they contribute substantially to the national economy by infusing much-needed foreign currency. This influx of funds boosts consumer Strengthening Somalia’s Financial Sector: The Emerging Role of Non￾Bank Financial Institutions

Policy Brief, June 2025 40 spending, which is essential for stimulating local markets and enhancing overall financial resilience in a challenging economic landscape. In 2024, Somalia witnessed total inward transfers reaching an impressive US$6.23 billion, highlighting the critical importance of remittances in the country’s financial architecture. Individual remittance alone surged to US$2,7191 million, reflecting a growing trend among the diaspora to support their families back home. Business transfers also saw a robust increase, totaling US$2,3152 million, underscoring the reliance on remittances to fund local enterprises and economic activities. Moreover, transfers from non-governmental organizations (NGOs) increased steadily, reaching US$1,0072 million, which shows these entities’ essential role in providing humanitarian assistance and development support. Overall, the steady growth of remittance inflows highlights their critical function in improving the living standards of Somali families, stabilizing the economy, and fostering a more resilient financial future for the country. This rise indicates more substantial financial support from the Somali diaspora, increased business activity, and improvements in remittance processing channels. The consistent increase in remittances indicates its significance in the economy, supporting household incomes, investments, and overall financial stability. Advancements in Somalia’s financial sector have further amplified the positive impact of remittances. Improved access to mobile money services, enhanced regulatory oversight, and increasing financial inclusion have made transferring funds through formal channels easier and more secure. This has helped to build trust in the financial system and align remittance flows with Somalia’s broader financial sector development goals. Table 1: Remittance Inflows in Millions of US Dollars (2019-2024) Inflow 2019 2020 2021 2022 2023 2024 Individual Remittance 1,339.3 1,642 2,101.8 2,150.9 2,181.3 2,719.1 Business 779.7 911.4 1,021.3 984.5 1,085.8 2,315.2 Grants 502.7 620.7 757.4 943.6 1,068.6 1,007.2 Other Swift Transfers 172.4 271.1 402 667.1 1,334.1 188.5 Total 2,794.2 3,445.2 4,282.6 4,746.1 5,669.8 6,230 Source: CBS, 2024 7. Regional Comparative Perspective: EAC NBFIs are increasingly recognized as vital pillars of inclusive financial systems across East Africa. Countries within the East African Community (EAC), including Kenya, Rwanda, Uganda, and Tanzania, have actively developed regulatory frameworks, institutional arrangements, and policy innovations to formalize and expand the role of NBFIs. In contrast, Somalia’s NBFI sector is still in a formative stage, characterized by fragmented regulation, limited supervisory capacity, and informal service delivery channels. While mobile money services and microfinance institutions are expanding rapidly, Somalia has yet to develop a cohesive legal and regulatory structure that supports their growth and integration into the broader financial sector.

41 Table 2: Comparative Overview of the East African Region (EAC) Country Legal Framework NBFI Categories Covered Key Innovations Supervisory Body Kenya Microfinance Act (2006); SACCO Societies Act (2008) MFIs, SACCOs, digital lenders M-PESA integration, SASRA oversight, and digital credit licensing Central Bank of Kenya; SASRA Rwanda Law on Microfinance Institutions (2008, revised 2018) MFIs, cooperatives, e-wallets Digitization of Umurenge SACCOs, interoperable digital finance National Bank of Rwanda Uganda Financial Institutions Act (2004); Tiered regulation MFIs (Tier 3 & 4), SACCOs, mobile money Tiered licensing, agent banking Bank of Uganda Tanzania Microfinance Act (2018) MFIs, community banks, mobile lenders Agency banking, financial inclusion strategy Bank of Tanzania Somalia Financial Institutions Law (2025), with Non-Deposit Taking Microfinance Licensing Regulation 2025 Takaful Insurance, Microfinance and Money Transfer Businesses Mobile Money, Instant Payment Systems, Agent banking and other financial institutions and electronic customer verification. Central Bank of Somalia 8. Key Notable Issues in NBFI Somalia’s NBFIs face several systemic and structural challenges that hinder their effectiveness and outreach. Key issues include:

1. Credit Risk in Microfinance Due to the absence of traditional collateral and most clients limited or non-existent credit history, MFIs face elevated credit risk. This restricts loan disbursements and increases default rates, making sustainable lending difficult in the long term.
2. Lack of Credit Market Infrastructure Somalia lacks essential credit market infrastructure such as an asset registry, credit bureau, or collateral verification systems. As a result, lenders rely on informal risk assessments and impose high collateral requirements, severely limiting access to finance for micro and small enterprises.
3. KYC (Know Your Customer) and Security Challenges Many clients lack formal identification documents or possess minimal identification. This poses a significant hurdle for compliance with Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) regulations, making onboarding and monitoring of clients difficult for MFIs and other NBFIs.
4. Unregulated Foreign Exchange Practices The absence of a formal, centralized foreign exchange market and reliance on informal money changers has led to fragmentation. Without a regulated and transparent exchange rate framework, it is challenging to maintain investor confidence or facilitate effective cross-border trade.
5. Absence National Currency in Circulation The lack of a widely accepted, national currency undermines the foreign exchange market. Most transactions occur in U.S. dollars or old Somali shillings, weakening the effectiveness of the foreign exchange market and limiting the central bank’s influence over the NBFI sector.
6. Nascent Insurance Sector Somalia’s insurance sector remains underdeveloped, with limited formal providers and low market penetration. Key regulatory frameworks, including those for Takaful (Islamic insurance), are still being finalized, creating uncertainty and limiting sector growth. This lack of risk-mitigation instruments, especially for agriculture, property, and life, exposes individuals and enterprises to high financial vulnerability. Strengthening Somalia’s Financial Sector: The Emerging Role of Non￾Bank Financial Institutions

Policy Brief, June 2025 42 7. Limited financial literacy While NBFIs have increased access to financial services, financial literacy among the users remains low. Many customers are unaware of their rights, service terms, or risk exposure when entering into financial contracts or micro-loans to access financial services. 8. Gaps in Remittance Regulation and Integration While remittances are a primary source of income for Somali households and an essential part of the economy, the sector has limited prudential policies to strengthen regulatory oversight and link remittance flows with formal financial products. This limits the potential of remittances to contribute more effectively to financial inclusion and sector stability. 9. Policy Recommendations

1. Regulatory and Supervisory Reform • The CBS should be strengthened to effectively regulate Non-Bank Financial Institutions (NBFIs) by providing the necessary technical and financial support. This includes enhancing its capabilities for licensing, advancing risk-based supervision, and monitoring regulatory compliance throughout the NBFI sector. • The CBS should intensify collaboration with NIRA to leveraging digital identity systems, biometric verification, and community￾based referencing models to improve client onboarding while maintaining AML/CFT compliance.
2. Financial Infrastructure Development • Integrate NBFIs and banks into a centralized, interoperable payment system to ensure efficiency, security, and inclusion. • Create a National Credit Information Bureau to enable better credit assessment, reduce loan defaults, and facilitate lending between NBFIs and SMEs.
3. Manage risks to reduce defaults • Encourage solidarity group lending models and peer-guaranteed microloans to reduce default risks and leverage community accountability to get creditors to pay. • Implement innovative credit assessment tools using mobile phone usage, transaction history, and behavioral analytics.
4. Expedite the national currency project and encourage its usage • Accelerate the printing and distribution of new Somali shillings Educate citizens and businesses on the benefits of the new Somali shilling to build confidence and encourage uptake. • CBS, in collaboration with NBFIs, civil society organizations, and educational institutions, should roll out community-based digital financial education programs tailored to women, youth, and other vulnerable groups. These efforts will improve understanding of economic rights, service terms, and risk management.
5. Encourage the development of the insurance sector • Provide tax breaks or technical grants for insurers to develop micro insurance, agricultural, property, and life insurance products. • Collaborate with civil society and religious leaders to demystify insurance and promote uptake, particularly in rural and agri￾dependent communities.
6. Strengthen Remittance Oversight and Integration with Formal Financial Services • The Central Bank of Somalia should enhance regulatory oversight and digital infrastructure for remittance service providers, including digital uplifiting and improving interoperability with other payment plaforms.

43 Reference Central Bank of Somalia. (2024, Annual report 2023). https://centralbank.gov.so/wp-content/uploads/2024/11/ CBS-Annual-Report_2023.pd Central Bank of Somalia. (2024). Quarterly economic review (2024 Q3). Mogadishu, Somalia. https:// centralbank.gov.so/wp-content/uploads/2025/03/Quarterly-Economic-Report_Q3_2024.pdf Central Bank of Somalia. (2024). Quarterly economic review (2024 Q4). Mogadishu, Somalia. https:// centralbank.gov.so/wp-content/uploads/2025/06/Quarterly-Economic-Report_Q4_2024.pdf Chepngeno, S., Karanja, D., & Abrar, Y. (2022, May 31). Enhancing opportunities for non-banking financial institutions and approaches in Somalia. Support to Policy Dialogue for Investment Climate in Somalia, EU Service Contract: T05.EUTF-HOA-So-57-12. https://dai-assets.s3.amazonaws.com/projects/NBFI%20 Study%20_book_WEB%20%281%29.pdf Strengthening Somalia’s Financial Sector: The Emerging Role of Non￾Bank Financial Institutions

CENTRAL BANK OF SOMALIA info@centralbank.gov.so www.centralbank.gov.so @CBSsomalia Central Bank of Somalia