Abstract
This Selected Issues paper and Statistical Appendix investigates the sources of growth in the Democratic Republic of the Congo (DRC) and evaluates the relative importance of productivity growth and factor accumulation. The analysis is extended to the key sectors of the economy: agriculture, mining, and transport. The paper assesses the DRC’s medium-term growth prospects and compares them with both the post-conflict growth experience to date and the growth objectives of the Poverty Reduction and Growth Facility-supported program. The paper also suggests a simple, yet powerful, methodology for projecting the real GDP growth rate.
II. Challenges in Developing Financial Intermediation in the Democratic Republic of the Congo 14
Summary
Despite the significant progress made in macroeconomic stabilization, the dollarization of the economy and the financial system have remained high, and financial intermediation has not resumed in the Democratic Republic of the Congo (DRC). The commercial banks (which comprise the bulk of the financial sector) continue to play a limited role in the payments system and in providing credit to the economy. If the private sector is to become the engine of growth, financial intermediation must be revived.
Discontinuing reliance on the rationing of currency by the Central Bank of the Congo (BCC) as a monetary policy instrument, which has resulted in nonfungibility between the components of base money, is a necessary initial condition for reviving financial intermediation.
As the BCC discontinues reliance on the rationing of currency, it will need to rely on monetary instruments to sterilize any injection of liquidity in the financial system that is not consistent with the monetary program. Following recommendations by Fund staff, in December 2002, the BCC started offering short-term bills to the banks (and through them to their customers) to adjust overall liquidity in the system. However, until financial intermediation has deepened, the ability of monetary policy to compensate for even temporary fiscal imbalances in a timely fashion may be limited. Therefore, the execution of the cash plan at the Ministry of Finance needs to be closely coordinated with the liquidity forecasting exercise undertaken by the BCC.
Further progress in centralizing all financial operations of the government sector, broadly defined, into the budget would facilitate the conduct of monetary policy, as would enhancing the quality of financial data. Progress in these areas, by facilitating a timely identification of the sources of public sector outflows, will enhance the coordination of monetary and fiscal policies, and facilitate liquidity management by the BCC.
Should financial intermediation deepen, further dollarization of bank assets could increase credit risks for the banks and limit the role of the BCC as lender of last resort. The BCC must, therefore, avoid taking any actions that would further reinforce the possìbìlìty of additional dollarìzatìon. In this context, the BCC should continue its policy of not intervening to set the exchange rate. The greater role of the commercial banks in the payments system to be expected from the fungibility between the components of base money will support the use of the Congo franc for transaction purposes, as would the issuance by the BCC of large-denomination Congo franc banknotes.
A. Introduction
45. For a number of years, the financial system (including the Central Bank of the Congio—BCC) in the Democratic Republic of the Congo (DRC) has operated in a climate of uncertainty owing to political instability, fiscal mismanagement, and limited resources. This has resulted in major dysfunctions and evident weaknesses. In particular, the financial system has become irrelevant in mobilizing savings and providing credit to the economy. Along with the promulgation of the new law for the central bank enshrining its independence, and of the new Banking Law, the BCC has taken measures to remedy these weaknesses and help create the conditions that would pave the way for a revival of financial intermediation in the DRC.
46. While prospects have clearly improved, the challenges ahead are enormous. Human resource and technical needs are already considerable, and are likely to increase as the DRC reunifies. The fields of BCC activity where capacity building is most urgently needed are in the areas of foreign exchange operations, accounting and internal audit, and monetary policy (including cash management). Up until now, these are the areas on which Fund technical assistance has focused, with banking supervision being added in the most recent period. Looking forward, it is clear that external assistance will continue to be necessary if the BCC wants to implement the strategy required to develop financial intermediation, acquire the information technology needed, and remodel internal structures.
47. It is also important to recognize that monetary policy implementation has a cost that must be borne by the budget until the BCC can generate sufficient revenues from its operations. Such a cost needs to be weighed against the expected benefits, in particular, financial stabilization.
48. This section discusses the challenges the BCC faces at this juncture to help create the initial conditions for a resumption of financial intermediation. It draws on the findings and conclusions of the Fund technical assistance mission, which overlapped in Kinshasa with the Fund mission to conduct the Article IV consultation and the first review under the PRGF-arrangement during the period October 29 to November 12, 2002. The technical assistance mission focused on analyzing the causes of the low level of financial intermediation in the DRC and identifying measures that the BCC would need to implement to create the initial conditions for promoting a greater use of the local currency and reviving financial intermediation.
B. Recent Developments in the Financial System
The banking system
49. Despite the significant progress made in macroeconomic stabilization, financial intermediation has not yet resumed in the DRC, reflecting the continued low public confidence in the banking system. Following several years of hyperinflation, accompanied by a free fall of the exchange rate, it may take time for confidence in the Congo franc to return. Consequently, the banking sector, which forms the bulk of the formal financial sector, has played a limited role in the economy since the late 1980s. For instance, on October 18, 2002, the balance sheet total of the banks amounted to CGF 91 billion (Table II.1), which is less than 5 percent of GDP.15
DRC: Consolidated Balance Sheet for the Commercial Banking System
(As of October 18, 2002; in billions of Congo francs)
Including balances with correspondent banks abroad.
DRC: Consolidated Balance Sheet for the Commercial Banking System
(As of October 18, 2002; in billions of Congo francs)
| Assets | Congo francs | Foreign Exchange | Total | Congo francs | Foreign Exchange | Total | Liabilities | |
|---|---|---|---|---|---|---|---|---|
| BCC and interbank | 8.73 | 41.36 | 50.09 | 0.04 | 3.89 | 3.93 | BCC and interbank | |
| Currency | 2.60 | 7.68 | 10.28 | |||||
| Reserves at BCC | 5.76 | 0.00 | 5.76 | 0.01 | 1.02 | 1.03 | BCC lending | |
| Interbank market | 0.37 | 33.681/ | 34.05 | 0.03 | 2.87 | 2.90 | Interbank market | |
| Customer operations | 8.03 | 7.13 | 15.16 | 12.83 | 43.06 | 55.89 | Customer operations | |
| Credit to public sector | 0.44 | 0.00 | 0.44 | 1.48 | 0.04 | 1.52 | Deposits by public sector | |
| Credit to private sector | 7.59 | 7.13 | 14.72 | 11.35 | 43.02 | 54.37 | Deposit by private sector | |
| (nonperforming loans) | (0.51) | (0.75) | (1.26) | |||||
| Other | 7.98 | 12.47 | 20.45 | 7.32 | 12.02 | 19.34 | Other | |
| Fixed assets | 5.30 | 0.00 | 5.30 | 8.03 | 2.35 | 10.38 | Capital | |
| 1.46 | 0.00 | 1.46 | Retained earnings | |||||
| Total | 30.04 | 60.96 | 91.00 | 28.22 | 61.32 | 91.00 | Total | |
Including balances with correspondent banks abroad.
DRC: Consolidated Balance Sheet for the Commercial Banking System
(As of October 18, 2002; in billions of Congo francs)
| Assets | Congo francs | Foreign Exchange | Total | Congo francs | Foreign Exchange | Total | Liabilities | |
|---|---|---|---|---|---|---|---|---|
| BCC and interbank | 8.73 | 41.36 | 50.09 | 0.04 | 3.89 | 3.93 | BCC and interbank | |
| Currency | 2.60 | 7.68 | 10.28 | |||||
| Reserves at BCC | 5.76 | 0.00 | 5.76 | 0.01 | 1.02 | 1.03 | BCC lending | |
| Interbank market | 0.37 | 33.681/ | 34.05 | 0.03 | 2.87 | 2.90 | Interbank market | |
| Customer operations | 8.03 | 7.13 | 15.16 | 12.83 | 43.06 | 55.89 | Customer operations | |
| Credit to public sector | 0.44 | 0.00 | 0.44 | 1.48 | 0.04 | 1.52 | Deposits by public sector | |
| Credit to private sector | 7.59 | 7.13 | 14.72 | 11.35 | 43.02 | 54.37 | Deposit by private sector | |
| (nonperforming loans) | (0.51) | (0.75) | (1.26) | |||||
| Other | 7.98 | 12.47 | 20.45 | 7.32 | 12.02 | 19.34 | Other | |
| Fixed assets | 5.30 | 0.00 | 5.30 | 8.03 | 2.35 | 10.38 | Capital | |
| 1.46 | 0.00 | 1.46 | Retained earnings | |||||
| Total | 30.04 | 60.96 | 91.00 | 28.22 | 61.32 | 91.00 | Total | |
Including balances with correspondent banks abroad.
50. The rate of financial penetration is very low. The DRC, with a population of about 54 million, has only 35,000 bank accounts, of which almost half are held by businesses. The settlement of transactions that go through the banking system is limited due to the prevalence of the informal sector, which operates mostly in cash—resulting in Congo franc bank deposits representing only 22 percent of the money supply in Congo francs.
51. The contribution of the banking system to money creation is marginal. The volume of credit denominated in Congo francs accounts for only 8.7 percent of the total bank balance sheet (Table II.1). Almost this entire amount (99.1 percent) represents short-term loans to finance a few local enterprises. For the most part, the activity of commercial banks is limited to their role in collecting government taxes and paying government expenditures, as well as opening letters of credit for the financing of exports. Since the commercial banks grant little or no credit to the private sector, money creation has taken place mainly through the issuance of BCC currency.
52. There is still a strong preference for foreign exchange as a vehicle for savings, and for the settlement of large transactions. The former is a consequence of currency instability in the past; the latter is due to the absence of large-denomination banknotes in local currency (the largest banknote in Congo francs is equivalent to US$0.30) in a context of a virtually nonexistent payments system other than cash. The dollarization of the economy is reflected in the balance sheets of banks, two-thirds of which are in foreign currencies. Most interbank activity is in foreign currencies (99.1 percent of sources and 98.9 percent of uses of funds), as are most transactions with customers (77 percent of deposits and 47 percent of lending).
53. Financial intermediation has also suffered from weaknesses in policy implementation at the BCC. For a number of years, the BCC has not enjoyed adequate operational autonomy, and has had limited resources. Moreover, the low level of financial intermediation has made the use of conventional monetary policy instruments more difficult. This has resulted in major dysfunctions and evident weaknesses, which have seriously limited the capacity of the commercial banks to provide financial services. In particular, at times the BCC has not allowed banks to use their free reserves to obtain currency, resulting in nonfungibility between the components of base money.16 In turn, currency rationing and the associated nonfungibility of base money has led to the discounting of Congo franc deposits in commercial banks, with Congo franc bank deposits trading against Congo franc currency at a discount (décote). In the past, the use of currency rationing had been prompted by the apparent inability of the BCC to produce sufficient quantities of banknotes. However, during the recent period it would appear that the BCC has relied on currency rationing as a substitute for conventional liquidity mopping-up operations, which the low level of financial intermediation has made difficult or costly to undertake.
The Central Bank of the Congo
54. With the support of Fund technical assistance, progress has been made in strengthening the BCC’s institutional capacity.17 During the course of 2002, key financial legislation was enacted that reflects international best practices in its respective areas and provides a sound framework for the DRC’s strengthening of the financial sector.
55. Good progress was also made in strengthening the BCC’s operational capacity (see Annex). In particular, the BCC put in place key components of a framework to program currency issues; the net income position of the BCC was consolidated in the government’s accounts; the central bank created a Consultative Group on Monetary Policy to strengthen policy design and implementation; and, at the same time, it adjusted interest rates to bring them in line with downward price developments, while maintaining them at a positive level in real terms.
56. However, the long-standing problem of nonfungibility between the components of base money has remained. In practice, the BCC has not been able to guarantee the convertibility in currency of the banks’ free reserves, and the rate of the discount (décote) has been very volatile and at times high (up to 40 percent) in response to changes in the balance between the supply and demand for bank money.
57. The BCC has not been able to rely on conventional monetary instruments, due to the low level of financial intermediation, and it has frequently resorted to the practice of rationing currency. Data provided in Table II.2 illustrate the difficulties the BCC has had to face in the regulation of currency in circulation, which is the main component of broad money. For the first six months of 2002, the BCC did not provide currency to the commercial banks, and all currency issues were allocated to the payment of the government’s expenses (“Treasury” outflows in Table II.2) and that of the BCC (“BCC” outflows in Table II.2). This policy was modified beginning in July, under pressure from banks that could not provide payments services to government (mostly the payment of public sector salaries that have to be paid in cash), even though they had positive balances with the BCC. However, during the January–October 2002 period, most of the currency outflows from the BCC were to the DRC Treasury or to pay for BCC’s own expenses.
DRC: Sources of Currency Flows at the BCC, January–October, 2002
(In billions of Congo francs)
DRC: Sources of Currency Flows at the BCC, January–October, 2002
(In billions of Congo francs)
| Inflows | Outflows | |||||
|---|---|---|---|---|---|---|
| Banknotes taken from market | 8.6 | Treasury | 13.7 | |||
| Net foreign exchange sales | 4.8 | BCC | 5.0 | |||
| Net repayments of CDs | −2.3 | Banks | 3.1 | |||
| Special arrangements (décote) | 6.1 | |||||
| New issues | 14.7 | |||||
| Change in cash balance | −1.6 | |||||
| Total | 21.7 | Total | 21.7 | |||
DRC: Sources of Currency Flows at the BCC, January–October, 2002
(In billions of Congo francs)
| Inflows | Outflows | |||||
|---|---|---|---|---|---|---|
| Banknotes taken from market | 8.6 | Treasury | 13.7 | |||
| Net foreign exchange sales | 4.8 | BCC | 5.0 | |||
| Net repayments of CDs | −2.3 | Banks | 3.1 | |||
| Special arrangements (décote) | 6.1 | |||||
| New issues | 14.7 | |||||
| Change in cash balance | −1.6 | |||||
| Total | 21.7 | Total | 21.7 | |||
58. Some of the monetary instruments used by the BCC to regulate overall liquidity in the system have caused distortions or have been costly:
Until the end of 2002, certificates of deposits (CDs) had been used to “buy” currency from the market.18 However, as their remuneration was brought in line with inflation (from 25 percent per month at the beginning of the year to 0.7 percent since May 2002), demand for CDs evaporated, since their rate of return no longer incorporated the implicit cost of the décote. Consequently, since the beginning of the year, CD operations have led to net liquidity injections.
Special arrangements have involved operations of the BCC on the décote market, whereby the BCC was receiving Congo franc notes against Congo franc bank money.19 These operations proved to be costly (30 percent on average). In addition, they resulted in an increase of banks’ reserves with the BCC (CGF 6 billion at end-May) and the correlated increase in the rate of the décote (Figure II.1). The rate of the décote dropped in July as the BCC started to “liquefy” banks’ reserves. Recourse to décote operations in September–October led again to a sharp increase in the décote rate.
While currency issues would have been less costly than décote operations, the BCC indicated that it did not have the foreign exchange to pay for the related expenses. In addition, currency issues could have led to additional demand for foreign exchange, while the décote operations resulted in the injection of bank money that could only be used for the payment of taxes. Therefore, currency issues would have needed to be supplemented with sterilization operations. One cannot rule out that the two operations combined could have generated costs in line with those of the décote operations.
DRC: Décote Rate and BCC Operations on the Décote Market, 2002
Citation: IMF Staff Country Reports 2003, 175; 10.5089/9781451841152.002.A002
Sources: BCC; and staff estimates on the basis of information provided by market sources.59. The analysis of the distribution of the BCC’s currency operations among new issues and net purchases of notes on the market during the period from January 2001 to October 2002 clearly shows the complementarity of these two types of mechanisms in balancing the offer and demand of banknotes (Figure II.2). It illustrates the constraints the BCC was under, given the narrow room for maneuvering because of a structural deficit of its operating account and the alleged shortage of foreign exchange to meet currency issue costs. In this context, it is important to recognize that the cost of monetary policy implementation must be borne by the budget until the BCC can generate sufficient revenues from its operations. Such a cost needs to be weighed against the expected benefits, particularly financial stabilization. Other costs that are unavoidable for any central bank but which the BCC has been unable to cover are those related to the manufacturing or buying of banknotes.
DRC: New Issues and Purchases of Notes by the BCC, 2001–02
(In millions of Congo francs)
Citation: IMF Staff Country Reports 2003, 175; 10.5089/9781451841152.002.A002
Source: BCC.C. Initial Conditions to Support Financial Intermediation
60. This subsection analyzes the effects of the décote on the financial system; it argues that the return to the fungibility of base money is a necessary initial condition to develop financial intermediation in the DRC. It also offers some preliminary considerations on the linkages between dollarization and financial intermediation.
Nonfungibility of base money and décote
61. The nonfungibility of base money has had adverse consequences at the macroeconomic level of financial intermediation. Commercial banks need to make a distinction between customers’ deposits made in cash (cash deposits), and customers’ deposits resulting from transfers through the payments system (bank money deposits), the counterpart of which is reserves with the BCC. Therefore, three payment instruments in local currency circulate in the DRC: currency, cash deposits, and bank money deposits. While currency and cash deposits are traded at par (provided that the former are placed with a solvent bank), at times, bank money deposits are traded at a discount (décote), compared with currency or cash deposits. The level of the décote varies depending on the supply (payments in bank money made by the BCC) and demand for bank money deposits (capacity of taxpayers to settle their taxes in bank money).
62. The nonfungibility of base money has also had adverse consequences at the macroeconomic level of financial intermediation. First, it has acted as a barrier to the provision by the commercial banks of payments services—for instance, checks are not accepted unless the beneficiary is willing to take the risk of having to pay the décote to obtain currency. Moreover, it is a barrier to banks’ provision of credit to the economy. Currently, currency is the principal medium of settlement of economic transactions. The inaccessibility of banks’ free reserves imposes an additional liquidity constraint, since commercial banks cannot guarantee at all times and upon request the availability of currency to the beneficiary of a loan, even if they have free reserves with the BCC. In this context, arbitrage activity between cash and bank money may become a lucrative business.
63. In the Congolese context, the activities of the financial system are limited to the provision of payments services. The bulk of Congo franc transactions that are intermediated by the financial system are related to government receipts and expenditures. Therefore, any imbalance between the supply and demand of Congo franc banknotes reflects imbalances in the public sector that are not covered by the issuance of banknotes by the BCC; hence, the décote.20 Indeed, in the context of a balanced budget for the public sector, the BCC should not need to have recourse to the rationing of currency. The BCC should be in a position to meet all payments requested by the government. However, the BCC has had to resort to currency issues to meet essential government expenditures (Table II.2), and it has not issued currency to meet the demands of commercial banks, with the result that free reserves at the BCC have accumulated (reinforcing the nonfungibility of base money) and the décote has reached 40 percent in September 2002 (Figure II.1).
64. The imbalances in the public sector may originate from three sources. First, some payments executed by the BCC on behalf of the government are not reflected in the budget. Second, not all of the operating losses of the BCC are accounted for in the budget in a timely manner. Third, financial institutions that participate in the collection of taxes have retained part of the government’s revenues to cover expenditures that are not recorded in the budget. The weaknesses in the information systems at the BCC, in the financial institutions, and in the public sector (comptabilité publique) have prevented an assessment of the size of these outflows.
Establishing the initial conditions21
65. A revival of financial intermediation is critical to the success of the reform agenda currently being implemented by the authorities. First, it is necessary to relax some of the constraints that the BCC faces in the implementation of monetary policy, in particular with regard to the control of overall liquidity conditions in the economy. Second, if the private sector is to become the engine of growth, it will need the support of the banking system.
66. To enable banks to increase their role in payments systems, the décote must be eliminated. This is a necessary condition for the smooth operation between solvent banks of the payments systems. It is also a necessary (but not sufficient) precondition for resuming money creation (i.e., the provision of credit to the private sector) in local currency.
67. Following the corrective measures implemented by the authorities in November 2002, the décote was virtually eliminated.22 In order to prevent the décote from appearing again in the future, the BCC needs to be prepared to provide banknotes on demand to the banks that have positive reserve balances. As the BCC discontinues reliance on the rationing of currency, it will need to rely on a monetary instrument to sterilize any injection of liquidity in the system that is not consistent with the monetary program. The introduction in December 2002 of BCC short-term bills, as recommended by the Fund, will provide the BCC with such a monetary instrument (Box II.1).
Monetary Instruments of the BCC
Short-term foreign exchange swaps: to be used at the discretion of the BCC for the supply of reserves to banks on a temporary basis (one to two weeks).
Short-term BCC bills: to be issued at the discretion of the BCC for mopping up excess reserves from banks and, through the banks, from a wide range of investors. The BCC should offer a more competitive rate of remuneration than investments in foreign currency at equivalent terms, taking into account interest rates on the dollar and inflationary expectations.
Reserve requirements: set at 2 percent of deposits in local currency. This instrument has had a limited impact in the past, given the low level of deposits and the size of banks’ free reserves. Deposits in foreign currency should be subject to reserve requirements to avoid a bias in favor of dollarization.
68. In the context of the current policy framework, where fiscal consolidation is one of the cornerstones of the program, strict adherence to the monthly treasury cash-flow plan should prevent the buildup of imbalances in the system. This is particularly important since, at least until financial intermediation has deepened, the ability of monetary policy to compensate for fiscal imbalances, even temporary ones, in a timely fashion may be limited. Therefore, the execution of the cash plan at the Ministry of Finance needs to be closely coordinated with the liquidity-forecasting exercise undertaken by the BCC.23 This is particularly important because there is a high probability that excess liquidity in the system will put downward pressures on the exchange rate, with direct repercussions for inflation owing to the high level of pass-through.24
69. Better identification and quantification of the causes of the imbalances in the public sector will facilitate the coordination of monetary and fiscal policies by allowing the monetary and fiscal authorities to identify early in the process deviations from the monetary program, so that they are in a position to decide on corrective measures in a timely and coordinated fashion. This requires action in three areas: (a) completion of the ongoing efforts to rehabilitate the accounts of the BCC in order to better assess its financial position; (b) strengthening of banking supervision in order to assess potential sources of outflows through the financial institutions participating in the collection of public sector revenues; and (iii) strengthening of public accounting procedures (comptabilité publique) to enable the Ministry of Finance to monitor more effectively the government’s accounts on the books of the BCC.
70. The return to fungibility of base money will result in an increase of deposits for transactions purposes, thereby allowing the banks to resume their participation in money creation. In such a context, the BCC will be able to use the range of refinancing instruments already at its disposal. In particular, within the target for base money provided for in the monetary program, the BCC will be able to supply banks with reserves through short-term foreign exchange swaps (Box II.2).25 In the future, the range of collateral in support of the BCC’s refinancing operations may be broadened to include assets in local currency, once the process of reintermediation has resulted in the accumulation of such assets by the commercial banks.
71. The restoration of the fungibility between the components of base money will involve shifting from the currency programming framework currently in place to a base money programming framework. In order to expand the current monetary programming framework, the BCC will need to strengthen the lines of communication among the various operational BCC directorates, and between the BCC and the Ministry of Finance. Such a framework will allow the BCC to analyze the autonomous sources of demand for and supply of base money, and to decide on the discretionary monetary operations needed to keep base money in line with assumptions in the monetary program. Such a framework can also be utilized for ex post analysis of actual flows, thereby enabling the BCC to understand past trends and decide on corrective actions to be taken as required in the future.
D. Financial Intermediation and Dollarization
72. Past macroeconomic instability and weak BCC policies have not only marginalized the banking sector but also led to the development of multiple forms of dollarization in the DRC (Box II.2). Bank deposits represent only about 2 percent of GDP, 80 percent of which is denominated in foreign currencies.26 Total bank reserves of Congo francs with the BCC exceeded the level of loans in Congo francs (Table II.1), and bank money in Congo francs is for the most part used in the context of the operations on behalf of the government. Transactions in the economy are also highly dollarized: they are either executed in dollars or indexed to the dollar. Accordingly, any excess supply of local currency, in light of the limited demand, has a direct inflationary impact owing to the high pass-through of exchange rate changes into prices, given that such excess supply results in an additional demand for foreign exchange in the market.
Forms of Dollarization
Dollarization may be partial (the local currency is the legal tender but financial or real transactions can be denominated in dollars) or total (another currency—typically but not necessarily the U.S. dollar—is the predominant or exclusive legal tender). Within partial dollarization, one can distinguish the following: payments dollarization (or currency substitution), that is, the use of foreign currency for transaction purposes; financial dollarization (or asset substitution), that is, residents’ holding of financial assets or liabilities in foreign currency; and real dollarization, that is, the indexing, formally or de facto, of local prices and wages to a foreign currency.
While data on residents’ holdings of currency in foreign currency are not always available, dollarization can be assessed by analyzing the balance sheets of domestic banks via the ratio of onshore foreign currency deposits to total onshore deposits. Loan dollarization reflects deposit dollarization but is often less intense, owing to banks’ large holdings of liquid dollar assets.
Source: “Financial Stability in Dollarized Economies,” IMF, (forthcoming).73. Deposits have been dollarized mostly through unremunerated foreign currency-denominated demand deposits. These deposits reflect a reluctance to hold balances in domestic currency for transaction purposes because of high inflation, rather than interest rate arbitrage. As they are converted into Congo francs, they can be utilized in the settlement of transactions.27
74. In a context of limited financial intermediation, the dollarization of large transactions is also encouraged by the low purchasing value of Congo franc banknotes. This is because the face value of banknotes in Congo francs was not adjusted according to the evolution of prices in the economy. For instance, the note with the highest face value (CGF 100) is equivalent to less than US$0.30; it was equivalent to US$70 when it was introduced back in 1998.
75. As financial intermediation is developed, it is important to be aware of the costs and risks that increased dollarization could bring to the financial system. First, dollarization reduces the seigniorage base that is associated with the issuance of domestic currency. Second, there is evidence that dollarized financial systems are increasingly vulnerable to solvency and liquidity risks, as the degree of financial dollarization increases, while real dollarization lags behind. In particular, greater dollarization of banks’ loans could increase the risk of deterioration in the quality of bank portfolios as loans would not necessarily be issued to borrowers with foreign exchange income. Dollarization also imposes limits on the central bank’s lender-of-last-resort function. Therefore, as financial intermediation is developed, it is important to avoid certain actions that might further reinforce dollarization in the DRC and take measures supportive of a reintermediation in local currency.
76. Monetary policy may affect the degree of financial dollarization through the interest rate spread between currencies. The authorities should, however, resist using interest rates to prop up the exchange rate. Such a strategy could generate difficulties in the long run. In particular, it would increase the lending rate for domestic currency, thus encouraging the dollarization of loans, with unfavorable consequences for the vulnerability of the financial sector to sudden exchange rate fluctuations, as indicated above. Therefore, monetary policy should continue to be guided by price stability objectives.
77. In low-income countries, like the DRC, most of the deposits in commercial banks are demand deposits, maintained primarily for transaction purposes. Therefore, a reintermediation in local currency will need to be supported by the development of an efficient payments and settlement infrastructure for local currency-denominated transactions. In addition, as the DRC consolidates the gains made in stabilizing the macroeconomic framework, the demand for savings instruments in local currency will rise. In such a context, the offer by the BCC of a short-term instrument, as discussed above, will help the process of reintermediation in local currency by restoring parity between the Congo franc and the dollar at a given inflation rate and in light of the anticipated devaluation of the exchange rate.
78. Regarding currency in circulation, the face value of Congo franc banknotes must be reevaluated, with a view to ensuring a better match with the needs that arise for transaction purposes. Banknotes of larger denominations than are currently available should be introduced as soon as possible, so as to allow the use of the Congo franc in large transactions. At the same time, the BCC will need to provide banknotes of smaller denominations, which are still in use by a large fraction of the population.
79. Finally, it is important to recognize that the capacity to find outlets for stable demand deposits and to generate revenue will also depend on the environment in which credit activity is carried out. Accordingly, it is essential that the DRC authorities make every effort to build the pillars of sound banking activity by complementing the new banking law that has been promulgated with the following measures: (a) complete the bank restructuring; (b) establish prudential regulation and bank supervision processes in line with international standards; (c) complete the public enterprise sector reform; (d) create a business environment conducive to the development of an efficient private sector; and (e) promote an appropriate legal framework governing contracts and efficient judicial administration.
ANNEX: Progress Accomplished in Strengthening the BCC’s Operational Capacity
80. Fund technical assistance in monetary and exchange rate policy areas was based on a multitopic diagnosis mission led by AFR in early 2001 before the implementation of the interim government program monitored by the Fund staff. This multitopic mission resulted in the design of a clear road map of policy measures, as well as sequenced technical assistance, fully taking into account the administrative capacity in the DRC. This road map was updated during the review of the staff-monitored program (SMP) and implementation of the successor three-year government economic program supported by an arrangement under the IMF’s Poverty Reduction and Growth Facility (PRGF). It began in early 2001 with a visit of a Fund short-term expert to assist the authorities in the unification and floating of the exchange rate in the context of the SMP. Then, a Fund technical assistance mission took place later, in October 2001, and when the macroeconomic framework had already been stabilized under the SMP, following greater budgetary discipline and the successful unification and floating of the exchange rate. At the time of the technical assistance mission, exchange arrangements for international transactions had been liberalized for the most part. The objective of the mission was to support the capacity-building efforts at the BCC so that these initial achievements could be sustained. The mission focused its work on monetary management, the foreign exchange market and operations, and central bank accounting and audit operations. During the course of 2002, Fund short-term experts made several follow-up visits to assist the BCC in the implementation of Fund recommendations, and a Fund Resident Advisor to the BCC Governor was appointed. In parallel, the World Bank took a leading role in the restructuring of the banking sector, in particular in overseeing the liquidation of insolvent banks.
81. During the course of 2002, key financial legislation was enacted. First, a central bank law was enacted that provides for its independence; second, a Banking Law was enacted that establishes bank licensing, liquidation, and supervisory frameworks. The Banking Law specifically gives the BCC full responsibility for the supervision of the financial sector and spells out the conditions under which credit unions are organized and supervised, and can operate; and third, a new legal framework was established for the restructuring of the banking system, so as to extend a special restructuring regime that had been in place since 1998 but had expired on December 31, 2001.28 The central bank law and the Banking Law, which benefited from comments by Fund staff, reflect best international practices in their respective areas and provide a sound framework for strengthening the financial sector.
82. The October 2001 Fund technical assistance mission found that monetary management was constrained by several factors: a weak framework for liquidity forecasting; a need for better coordination of monetary management and government operations; the absence of any adjustment of official interest rates, in view of the downward trend for inflation; and nonfungibility between bank reserves at the central bank and currency. To address these shortcomings, and consistent with the recommendation of the October 2001 mission, the following measures were implemented:
The BCC put in place key components of a framework to program currency issues. In particular, the BCC’s Treasury Directorate (DT) started, at the beginning of 2002, to monitor the counterparts of currency inflows and outflows, thereby allowing the BCC to track the factors that had led to net injections of currency in the system. The BCC has also already started to use this tool to forecast the net demand for currency.
Further progress was made in centralizing all public sector expenses with the consolidation of the net income position of the BCC in the government’s position in order to avoid the inflationary consequences of BCC losses, which had been a problem previously.
In September 2002, to facilitate coordination of fiscal and monetary policies, the BCC created a Consultative Group on Monetary Policy, composed of eight members (six from key BCC departments and two from the Ministry of Finance), who now meet at least twice a month. The committee will report to the senior management at the BCC and the Minister of Finance.
The monetary authorities have adjusted the BCC refinance rate and the rate of remuneration on CDs to bring them in line with downward price developments, while keeping their levels positive in real terms.
83. Since the unification of the multiple exchange rates and the floating of the currency in May 2001, the foreign exchange market has continued to function satisfactorily. The spread between the formal and informal markets has never exceeded 2 percent, on average; the collection and dissemination by the BCC of the market exchange rate has functioned well overall; and the published rate has become a reference rate in the market.
84. The October 2001 mission noted that short-term foreign exchange swaps could be used by the BCC to inject liquidity in the system, given the lack of adequate collateral in domestic currency that could be used. While preliminary assistance was provided for their introduction, these swaps did not materialize because refinancing needs for the banking sector did not emerge at the time.
85. Work in the area of reserve management started in the context of a visit by a Fund short-term expert early in 2002. Broad reform areas were identified, including the need for a new organization of the reserve management function, the creation of front-office and back-office functions in the operations division, the reform of accounting practices, and the production of a procedures manual. Subsequently, staff involved in reserve management made a study tour to a neighboring central bank that had just reformed its reserve management function with the support of a Fund technical assistance program. Recommendations were also formulated for the consolidation of the numerous accounts in one main correspondent account.
86. The October 2001 Fund technical assistance mission found weaknesses in the accounting framework at the BCC. Subsequently, the external audits of the 2000 and 2001 accounts of the BCC have been finalized, but not certified, pointing to lapses in both accounting procedures and transparency, and casting doubts on the real financial position of the BCC. In response, the BCC created an Account Reconciliation Committee (Comité d’Assainissement des Comptes—CAC), with the Fund Resident Advisor as its chair, to clean up its balance sheet and implement transparent accounting procedures. Furthermore, in September 2002 the BCC drafted terms of reference for an overhaul of these systems by an international firm. In this context, the BCC intends to adopt a new accounting framework consistent with international standards.
87. Regarding the internal audit function, which was also identified as an area calling for urgent action, the BCC issued an audit charter in September 2002 (following the establishment in 2000 of an Internal Audit Directorate (DAI)), which defined the objectives, responsibilities, powers, and methods of operation of the DAI. This measure is an important element in the BCC’s efforts to implement best international practices in this area.
This paper was prepared by Bernard Laurens and Abdourahmane Sarr (both MAE), with inputs from Olivier d’Ambriéres (Fund Resident Advisor to the Governor of the BCC) and experts who participated in the November 2002 MAE advisory mission, which overlapped with the AFR mission to conduct the Article IV consultation and the first review under the PRGF arrangement.
The banking sector consists of 14 banks, 5 financial institutions, a network of credit unions, and 27 microfinance institutions (MFIs). Of the 14 banks, only 11 are active. No reliable data are available on the consolidated balance sheet of the nonbank financial institutions.
In this note, the components of base money include currency in circulation and banks’ free reserves.
See the Annex to this section for a review of Fund technical assistance to the BCC.
CDs were issued to finance the budget. However, they could only be purchased with cash, thus allowing the BCC, in its capacity as fiscal agent, to “buy” currency from the market that could be used for the payment of the government’s expenses.
The BCC’s operations on the décote market involved purchases of foreign currency or Congo franc banknotes against payments in Congo franc bank money at a premium.
Here, “public sector” encompasses the government budget, the BCC, and all other government entities that utilize, in some way or another, the payments systems.
It is important to note that financial intermediation is also conditional on a number of additional policies, including an appropriate legal framework governing contracts, efficient judicial administration, and the presence of sound and effective financial institutions. These policies are not discussed in this section.
The corrective measures taken by the authorities to keep the program on track are described in the staff report for the 2003 Article IV consultation and first review under the PRGF arrangement (EBS/03/12, 2/4/03).
In September 2002, the BCC created a Consultative Group on Monetary Policy to facilitate the coordination of fiscal and monetary policies (see Annex).
As there is no comprehensive indexing mechanism (in particular, regarding wages), this variability in inflation has significant real effects.
The liquidity-providing foreign exchange swaps are operations where the BCC buys foreign exchange against Congo francs on the spot market and, at the same time, sells it back forward at a specified repurchase date and rate. Such operations amount to a BCC loan to financial institutions that is collateralized with foreign exchange. Changes in the spot Congo francs exchange rate during the life of the swap have no implications on the settlement of the transaction at the due date.
At the end of 2001, the ratio of average foreign currency deposits to total deposits in Africa reached 33.2 percent (see “Financial Stability in Dollarized Economies,” IMF, forthcoming Working Paper).
At the end of October 2002, demand deposits represented 95 percent of total bank deposits, with 80 percent of these deposits composed of demand deposits in dollars.
The new framework allows the BCC to decide to bring any institution under the regime, whereas the previous regime was voluntary. At the time of the Fund technical assistance mission, seven banks out of eleven active banks operated outside of the regime, and four private banks were in liquidation.
