Abstract
This Selected Issues and Statistical Appendix paper outlines the recent developments in the political and security situation in Congo. It reviews economic performance during 1970–2003, including in the context of IMF-supported programs. The paper also reviews recent developments in public finance management, and examines the constraints on growth and poverty reduction. The sources of economic growth during 1970–2003 are analyzed. The paper also discusses the feasibility of an oil fiscal rule, and notes some key lessons and challenges for the Congo.
VII. Prudent Management of Oil Wealth16
52. As noted in Section V, the Republic of Congo (hereafter “the Congo”) exhibits one of the highest rates of dependence on a nonrenewable resource in the world, with approximately 90 percent of merchandise exports and 70 percent of fiscal revenues derived directly from sales of crude oil. Such dependence has been shown to be theoretically and empirically associated with lower rates of long-run economic growth through (i) economic channels (for example, a loss of competitiveness in tradable sectors), (ii) institutional channels (for example, an increase in the incidence of corruption or rent seeking), and (iii) political channels (an increase in the probability of civil conflicts). Moreover, periodic reversals in oil prices and the nonrenewable nature of oil reserves present ongoing challenges for policymakers.
53. Over the past two decades, the Congo has experienced firsthand most of the hazards associated with extreme dependence on petroleum. The massive increase in oil production in the late 1970s and early 1980s was accompanied by decreases in other tradable sectors, including coffee and cocoa. Corruption is now considered endemic in the country, and the quality of institutions is evaluated as below average within sub-Saharan Africa (see Section V). Outbreaks of civil conflict throughout the 1990s inflicted considerable human and physical damage, particularly in the administrative capital, Brazzaville (see Section II). Finally, the protracted economic slump that originated in the second half of the 1980s was triggered by the failure of policymakers to adjust to a sudden drop in oil prices (see Section III).
54. Recent Fund-supported programs have emphasized the need for substantial improvements in governance and transparency in the oil sector in order to begin to lay the groundwork for more economically sound public policies, enhanced political stability, and sustained private sector development. Within this framework, one of the key challenges facing Congolese policymakers is ensuring policy sustainability, particularly in light of the current levels of reliance on the oil sector. In this section, the precepts of the permanent income theory are used to evaluate the sustainability of the fiscal policy stance. 17
A. Fiscal Sustainability
55. The litany of economic hazards associated with a high degree of reliance on natural resources implies that using the conventional measures to assess the sustainability of the fiscal stance can be misleading for countries highly dependent on nonrenewable resources. 18 Aside from the problems of slower growth noted above, these countries have unique characteristics because resource extraction implies a change in national wealth whose value is not typically recorded in the national accounts, whose size is subject to considerable uncertainty, and whose price has been historically volatile. Therefore, an assessment of fiscal policy sustainability must explicitly account for the nonrenewable nature of the asset-generating fiscal oil revenues and the volatility in its assessed economic value. For forwardlooking policymakers, the crucial issue can be framed in the form of a portfolio problem: what level of total assets, and which combination of oil reserves or other assets (principally, financial wealth or higher productive capacity) should future generations be endowed with?
56. In these cases, the permanent income theory provides a useful rule of thumb: the government should consume at most the annuity value of its total wealth (instead of setting the level of expenditures on the basis of current resources). Therefore, the sustainable level of government consumption is no higher than this rent, and over time, other assets should substitute oil resources as the latter diminish in value. Without such restraints on fiscal spending, the value of total wealth can be eroded over time if resource extraction is too high or financial wealth accumulation too low. This policy prescription is consistent with an objective of maintaining the level of national (oil) wealth constant forever (i.e., intergenerational equity) and ensuring that governments can deliver to future generations a constant level of per capita services. 19
57. A measure of government consumption that is consistent with the notions of the permanent income theory, as applied to the case of oil producers, is the non-oil current fiscal balance. The appeal of this measure derives from the fact that, in abstracting from the volatility of oil prices and revenue, it provides a better indicator of underlying fiscal trends. Under this measure, capital expenditures are considered investments, and all current expenditures, including spending on education and health, are considered consumption. 20
B. Fiscal Policy in the Congo
58. The present value of the Congo’s public wealth at end-2002 is estimated at about US$28.8 billion (equivalent to 950 percent of GDP), composed mainly of oil wealth of US$36.1 billion and public external debt of US$7.4 billion. The estimate of oil wealth is based on the following key assumptions:
oil reserves of 7.3 billion barrels, 21
international oil prices similar to projections under the World Economic Outlook,
a discount rate of 3.5 percent per annum,
extraction costs of US$5 per barrel, and
production levels rising from the 2003 level of roughly 210,000 barrels per day to just over 290,000 barrels per day by 2008 and stabilizing thereafter (as new field production begins to offset reduced output at more mature fields).
59. Table VII.1 below presents the base case, with oil prices and reserves as outlined above, and two alternative scenarios: (i) lower oil prices in the outer years, and (ii) lower initial oil reserves. Columns labeled as “Target” indicate the maximum level of non-oil current fiscal deficit compatible with the permanent income hypothesis.
Republic of Congo: Fiscal Sustainability Approach Based on Intergenerational Objectives, 2003-13 1/ 2/
(In percent of GDP)
Holding constant the level of total wealth per capita; where total wealth includes present value of oil wealth, stock of public external debt and net financial assets.
For 2003-08 and 2009-12, data shown are period averages (except oil reserves which are estimates for beginning of period). “Target” indicates the maximum level of non-oil current fiscal deficit compatible with the permanent income hypothesis.
Non-oil revenue less non-oil current expenditures.
World oil price beyond 2014 estimated at US$ 21.50 per barrel.
Beginning of period; for 2002, proven reserves of 1,500 million barrels and risk-weighted mean estimate of undiscovered reserves of 5,800 million barrels.
World oil price for 2004 is the same as the base case (US$ 25.5 per barrel); for 2005 and beyond, price drops to US$ 20.00 per barrel.
Republic of Congo: Fiscal Sustainability Approach Based on Intergenerational Objectives, 2003-13 1/ 2/
(In percent of GDP)
| 2003 | 2004-2008 | 2009-2013 | ||||||
|---|---|---|---|---|---|---|---|---|
| Est. | Target | Proj. | Target | Proj. | Target | |||
| I. Base case | ||||||||
| Non-oil current fiscal deficit 3/ | 12.0 | 8.4 | 8.5 | 7.5 | 5.3 | 5.4 | ||
| Parameters: | ||||||||
| World oil price (U.S. dollars per barrel) 4/ | 28.5 | 28.5 | 22.8 | 22.8 | 21.5 | 21.5 | ||
| Oil reserves (millions of barrels) 5/ | … | 7,216 | 7,138 | 7,138 | 6,656 | 6,656 | ||
| II. Sensitivity analysis | ||||||||
| Scenario A | ||||||||
| Non-oil current fiscal deficit | … | 8.2 | … | 7.2 | … | 4.8 | ||
| Parameter changes from base case: | ||||||||
| World oil price (U.S. dollars per barrel) 6/ | … | … | … | 21.1 | … | 20.0 | ||
| Scenario B | ||||||||
| Non-oil current fiscal deficit | … | 7.2 | … | 6.2 | … | 3.4 | ||
| Parameter changes from base case: | ||||||||
| Oil reserves (millions of barrels) | … | 1412.0 | … | 1330.3 | … | 837.9 | ||
| Scenario C | ||||||||
| Non-oil current fiscal deficit | … | 8.0 | … | 7.5 | … | 5.7 | ||
| Parameter changes from base case: | ||||||||
| Extraction costs (U.S. dollars per barrel) | … | 8.0 | … | 8.0 | … | 8.0 | ||
| Memorandum item: | ||||||||
| Oil production (millions of barrels) | 81.7 | 81.7 | 98.5 | 98.5 | 110.0 | 110.0 | ||
Holding constant the level of total wealth per capita; where total wealth includes present value of oil wealth, stock of public external debt and net financial assets.
For 2003-08 and 2009-12, data shown are period averages (except oil reserves which are estimates for beginning of period). “Target” indicates the maximum level of non-oil current fiscal deficit compatible with the permanent income hypothesis.
Non-oil revenue less non-oil current expenditures.
World oil price beyond 2014 estimated at US$ 21.50 per barrel.
Beginning of period; for 2002, proven reserves of 1,500 million barrels and risk-weighted mean estimate of undiscovered reserves of 5,800 million barrels.
World oil price for 2004 is the same as the base case (US$ 25.5 per barrel); for 2005 and beyond, price drops to US$ 20.00 per barrel.
Republic of Congo: Fiscal Sustainability Approach Based on Intergenerational Objectives, 2003-13 1/ 2/
(In percent of GDP)
| 2003 | 2004-2008 | 2009-2013 | ||||||
|---|---|---|---|---|---|---|---|---|
| Est. | Target | Proj. | Target | Proj. | Target | |||
| I. Base case | ||||||||
| Non-oil current fiscal deficit 3/ | 12.0 | 8.4 | 8.5 | 7.5 | 5.3 | 5.4 | ||
| Parameters: | ||||||||
| World oil price (U.S. dollars per barrel) 4/ | 28.5 | 28.5 | 22.8 | 22.8 | 21.5 | 21.5 | ||
| Oil reserves (millions of barrels) 5/ | … | 7,216 | 7,138 | 7,138 | 6,656 | 6,656 | ||
| II. Sensitivity analysis | ||||||||
| Scenario A | ||||||||
| Non-oil current fiscal deficit | … | 8.2 | … | 7.2 | … | 4.8 | ||
| Parameter changes from base case: | ||||||||
| World oil price (U.S. dollars per barrel) 6/ | … | … | … | 21.1 | … | 20.0 | ||
| Scenario B | ||||||||
| Non-oil current fiscal deficit | … | 7.2 | … | 6.2 | … | 3.4 | ||
| Parameter changes from base case: | ||||||||
| Oil reserves (millions of barrels) | … | 1412.0 | … | 1330.3 | … | 837.9 | ||
| Scenario C | ||||||||
| Non-oil current fiscal deficit | … | 8.0 | … | 7.5 | … | 5.7 | ||
| Parameter changes from base case: | ||||||||
| Extraction costs (U.S. dollars per barrel) | … | 8.0 | … | 8.0 | … | 8.0 | ||
| Memorandum item: | ||||||||
| Oil production (millions of barrels) | 81.7 | 81.7 | 98.5 | 98.5 | 110.0 | 110.0 | ||
Holding constant the level of total wealth per capita; where total wealth includes present value of oil wealth, stock of public external debt and net financial assets.
For 2003-08 and 2009-12, data shown are period averages (except oil reserves which are estimates for beginning of period). “Target” indicates the maximum level of non-oil current fiscal deficit compatible with the permanent income hypothesis.
Non-oil revenue less non-oil current expenditures.
World oil price beyond 2014 estimated at US$ 21.50 per barrel.
Beginning of period; for 2002, proven reserves of 1,500 million barrels and risk-weighted mean estimate of undiscovered reserves of 5,800 million barrels.
World oil price for 2004 is the same as the base case (US$ 25.5 per barrel); for 2005 and beyond, price drops to US$ 20.00 per barrel.
60. Under the base case, the non-oil current fiscal deficits for 2003 exceeded the level compatible with prudent management of oil reserves, 22 but the macroeconomic scenario projected by the staff over the period 2004–08 (see column labeled as “Proj”) is broadly consistent with the guidelines from the permanent income hypothesis. 23
61. However, the high degree of vulnerability to oil sector shocks is clearly illustrated by the alternative scenarios. A relatively small decrease in the outlook for oil prices (essentially a drop of US$1.50 per barrel, starting in 2005) or a reduction in estimated reserves (in this case, using only the figure for proven reserves) necessitates substantial fiscal adjustment in order to ensure prudent management of oil resources.
62. In conclusion, it is worth emphasizing the following:
The high degree of vulnerability to external shocks indicates that precautionary saving, in addition to the level of saving implied by the permanent income theory, may be advisable.
Ensuring that the financial savings from a prudently designed fiscal policy are adequately managed requires a transparent institutional framework with strong safeguards. The experience of 2003, when the budget was based on a conservative oil price but the windfall revenues were used on unbudgeted outlays, is a reminder of the importance of this point.
Public investments must earn at least the real rate of return on financial savings in order to be economically rational. Notwithstanding the urgency of the task of national reconstruction, the current level of absorption of the Congolese economy is likely to be low, a situation that calls for caution in projection selection.
The exhaustible nature of oil resources implies that sustainable economic growth ultimately requires that current and future generations adopt policies geared to ensuring a sustained rise in the productivity of the non-oil economy.
This section was prepared by Carlos Leite.
This analysis does not explicitly account for feedback effects between fiscal policy and the response by the private sector.
Typically, fiscal policy sustainability is assessed on the basis of a country’s explicit debt \burden and its projected dynamics over the medium term.
Trivially, an increase in non-oil revenue will raise the level of sustainable current expenditures. The caveat is that consistency with intergenerational equity requires that such increases in revenue result from economic growth rather than a heavier tax burden.
In this analysis, no allowance is made for depreciation of capital stock. Additionally, investing in financial assets is considered equivalent to capital expenditures. The usual caveat applies: physical investments should generate an economic rate of return at least equal to the real rate of return on financial assets.
Publicly available data estimates proven reserves at 1.5 billion barrels (unchanged since 1996 despite significant discoveries in the intervening period). Based on geological data, undiscovered reserves are estimated at 5.8 billion barrels on a risk-weighted basis (www.eia.doe.gov). The national oil company (SNPC), claims that the Congo’s reserves are approximately 23 billion barrels. For this analysis, current reserves are estimated at 7.3 billion barrels (proven plus undiscovered sources) with no additional discoveries projected during the forecast period. Such an assumption is equivalent to starting with the lower publicly-available estimate and then projecting increases in reserves (as happened in early 2004 with an onshore field operated by Maurel & Prom, for example); the economic valuation is based on the production profile and not on reserves available at a particular point in time.
Depreciation costs on existing capital stock are not included in current expenditures.
Current projections do not include the net fiscal impact of HIPC Initiative-related expenditures (which would have the tendency to increase the fiscal deficit).