Statement by Damian Ondo Mañe, Executive Director for Chad February 16, 2005

This paper analyzes requests from Chad authorities for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) and Additional Interim Assistance Under the Enhanced Heavily Indebted Poor Countries (HIPC) Initiative. The authorities made progress in implementing structural reforms in 2004. In particular, they took corrective measures for the two structural benchmarks missed under the sixth review of the previous PRGF arrangement. They also continued efforts to meet structural conditions for the completion point under the enhanced HIPC Initiative.

Abstract

This paper analyzes requests from Chad authorities for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) and Additional Interim Assistance Under the Enhanced Heavily Indebted Poor Countries (HIPC) Initiative. The authorities made progress in implementing structural reforms in 2004. In particular, they took corrective measures for the two structural benchmarks missed under the sixth review of the previous PRGF arrangement. They also continued efforts to meet structural conditions for the completion point under the enhanced HIPC Initiative.

We would like to thank staff for the comprehensive and well-balanced report on Chad, which provides a thorough description of the country’s economic situation and the challenges it faces. We are appreciative of their continued advice to the Chadian authorities in meeting these challenges. For its part, the government is fully committed to pursuing sound economic and financial policies and structural reforms aimed at strengthening the country’s economy, improving growth and reducing poverty in a sustained manner.

The ex post assessment discussed at the Board last March highlighted progress achieved by Chad in many economic areas under Fund-supported programs, but it also revealed the many challenges the country has to address to achieve sustainable and lasting poverty reduction, notably the need to strengthen administrative capacity and physical infrastructure, improve human capital, consolidate security, enhance budget and cash management, increase access to financial services, and cope with exogenous shocks such as droughts and low international prices of agricultural products. Since the ex post assessment, other adverse shocks have been evident, notably the desert locust infestation and the Darfur situation, which has humanitarian consequences and budgetary implications for Chad. Among other constraints to sustained growth is the low and unpredictable external aid flows to Chad.

To address these numerous problems, the assistance of the international community is most needed. As the petroleum era may be short-lived and the contribution of oil revenue to the government budget has not been very significant so far, there is a need to not be overoptimistic about the oil factor. The resources from the HIPC Initiative debt relief carries much weight. My authorities are making efforts to tackle the problems the country faces. They commit to a close implementation of the program set forth in their PRGF, and stand ready to take any further measures if and when necessary. They call on all donors to support their efforts.

I. Overview of Chad’s Economic Situation and Recent Policies

A landlocked country with partly semi-arid and mostly desertic climate, Chad faces the combined effects of poverty-related problems and frequent droughts that contribute to make this country one of the most impoverished countries in the world. While the petroleum era has commenced, most of Chad’s oil revenue is earmarked for expenditures in priority sectors (education, health and social affairs, infrastructure, rural development, environment and water resources) and part is saved offshore in a Fund for Future Generations (FFG). Immediate social needs remain daunting and infrastructure deficient in many areas, including social sectors, transportation, energy and telecommunications, leading to difficulties in sustaining appropriate policy implementation and structural reform agenda. The country’s limited institutional and administrative capacities add to the difficulties, highlighting the crucial need for financial and technical support.

Faced with such uneasy environment, my authorities have engaged in policies to maintain macroeconomic stability and they have initiated the implementation of a national strategy to reduce poverty. Economic developments in 2004 have been largely driven by the strength of the oil production while non-oil sector growth (1.9%), especially agriculture, was hampered by low rainfall and desert locust infestation. Real GDP has grown by 31 percent, while inflation declined on account of increased food supply from the previous year and the strengthening of the euro to which the CFA franc is pegged. The last two years of the previous PRGF-supported program that expired in January 2004 have seen the achievement of the fiscal deficit targets, while efforts in 2004 have further improved the basic fiscal balance, bringing Chad in compliance with this criterion for CEMAC regional macroeconomic convergence. This was attained despite capacity constraints that hamper revenue collection. Efforts are being made to remedy the revenue collection problem, including action plans in the customs area and the setting up of institutional arrangements for the management of oil revenue to avoid delays in oil revenue accruing to the budget. Also, the approval of a new PRGF-supported program would resume aid flows that have sharply fell after the expiration of the previous arrangement.

On the expenditure side, my Chadian authorities have made significant downward adjustments in 2004 to compensate for the lower-than-expected budget resources. Cuts covered mostly current expenditures and domestically financed investment. However, my authorities remain committed to the improvement in the execution of prioritized expenditures. During the discussion of the ex post assessment, my Chadian authorities acknowledged the need to improve the composition of fiscal spending towards increased outlays in priority sectors. They have since made efforts in this direction, and spending in priority sectors is estimated to have increased by 20 percent in 2004.

The shortfalls in non-oil revenue and external budget support have also led to occurrences of payment arrears. Disagreements between the authorities and the petroleum consortium exploiting oil in Chad have led to delays in royalties payments and donor disbursements, contributing to arrears of payments to the Fund. While the authorities have made strong efforts to bring the country current on its obligations to the Fund, they had to accumulate domestic arrears accumulate in 2004. However, more than 56 percent of the stock of domestic debt has been verified, and understandings on a repayment schedule were reached with some creditors.

On the monetary and financial front, credit to the economy rose slightly in 2004, reflecting low economic activity. The banking system remains broadly sound, with most banks complying with the main prudential ratios of the regional banking supervision commission, COBAC.

Chad has made progress in implementing structural reforms. There have been broad and deep reforms in the area of transparency and governance in resource and expenditure management (para. 10 and 13 of the authorities’ MEFP). In particular, the authorities have completed the computerization of the expenditure circuit and prepared a treasury cash-flow table, which will allow close monitoring of budget execution along the expenditure chain. Actions were also taken to avoid the re-emergence of arrears to the Fund, that of setting up a mechanism through which Chad’s SDR holdings account will be used to repay the Fund. The authorities have also decided to establish an integrated system for the administrative and financial management of the civil service; established a budget discipline court in charge of enforcing civil servants’ accountability; and published a wide range of reports, including on the 2002 and 2003 budget laws, the use of HIPC funds, the procedural manual of the CCSRP, the customs services action plan, and the implementation decrees for the new procurement code.

In the oil sector, a set of mechanisms have been designed and adopted to ensure transparency in, and appropriate use of, oil resources. The governing Law on Petroleum Revenue Management (LPRM) comprises stabilization and sterilization mechanisms, additionality of spending in the priority sectors financed by oil proceeds, the FFG, and a resource allocation system to ensure the development of the oil-producing region. LPRM, which has also established a supervisory body, the Collège de Contrôle et de Surveillance des Ressources Pétrolières (CCSRP), is viewed as a pioneering law in the region and puts Chad at the forefront of many oil producing developing countries in efforts towards oil sector transparency and governance. As stated above, most of the institutional arrangements for the proper management of oil resources have been set, and the last two decrees of implementation (on the FFG and the oil-producing region) have been issued.

The cotton sector, an important non-oil segment of the Chadian economy, continues to experience difficulties. The financial situation of the publicly-owned cotton company, Cotontchad, has deteriorated further in 2004, owing to the decline in world prices, the weakening of the US dollar, the increase in producer prices decided to support this population group, and decreased financial support on the part of the state, which itself lacks resources. Sectoral actions have been taken in 2004, including workshops intended to producers and potential investors. In the quest to privatize the company, two scenarios (sale of equities and sale of ginneries) have been selected out of nine and were discussed at the workshops.

My authorities are fully aware that, despite these substantial achievements, much remains to be done, especially on the structural front, to improve non-oil sector growth prospects and significantly reduce poverty. They are appreciative of the technical assistance from the Fund, and they expect to benefit from additional assistance, especially in the areas of budget preparation, execution and monitoring; governance strengthening; and fiscal agency coordination.

II. The Economic Program

My authorities will build on the progress achieved thus far to prepare further Chad to cope with the many challenges ahead, including those related to the petroleum era. In so doing, they are hopeful that the international community will be supportive of their efforts, particularly in helping to close the expected medium-term financing gaps. The Fund will play a crucial role in sending signal to donors and creditors by endorsing their policy and reform program.

The 2005-07 Medium-Term Program

The government’s Poverty Reduction Strategy Paper is the main guide of its economic program. Over the medium-term, the latter will rest on six economic, social and environmental pillars: (i) promoting good governance, (ii) ensuring strong and sustained growth, (iii) developing human capital, (iv) improving the living conditions of the poor, (v) restoring and safeguarding ecosystems, and (vi) monitoring and periodically evaluating the implementation of the poverty reduction strategy. To help establish the linkage between the objectives of the PRSP and the effective use of budget resources, the authorities have prepared, in collaboration with the Fund, a Medium-Term Expenditure Framework (MTEF) for 2005-07. In the process, based on lessons learned from MTEFs for priority sectors for the past two years, the government will improve the quality of the MTEF and link it more closely with the objectives of the PRSP.

The program emphasizes macroeconomic policies and structural reforms aimed at maintaining a stable environment conducive to investment and the development of the private sector. The MTEF, which prudently assumes no new investments for prospective oil fields, envisages that growth in the petroleum sector will be at around 27 percent in 2005 before slowing in the next two years. However, aware of the risks of Dutch disease and crowding-out of yet weak non-petroleum activities, my authorities seek to strengthen the non-oil sector, which growth will be driven by agriculture and services. The non-oil sector should expand by about 5.5 percent annually over the three-year period, owing to important productivity gains to be achieved through reforms in the energy and cotton sectors as well as further investment in infrastructure.

On fiscal management, my authorities seek to improve non-oil revenue collection through measures to combat tax evasion, improve efficiency in revenue-collecting agencies, and reduce tax exemptions. The level of revenue achieved by 2007, coupled with anticipated budgetary assistance, will allow the authorities to meet their obligations to domestic and external creditors. Nevertheless, as the authorities have often faced the daunting prioritization choice between domestic obligations (payments of civil service salaries) and external debt servicing, more predictable external financing would alleviate these difficulties and reduce the risks associated with the closing of recurrent financial gaps. In the same vein, rigidities have been observed in the implementation of the LPRM, which have favored late payments of obligations to the Fund. These rigidities, which lead to the lack of flexibility in cash management and increased fragmentation of budget management systems, need to be removed. While committed to manage oil revenue effectively and transparently, my authorities, following a year or two of implementation, are willing to make adjustments to the LPRM scheme in this direction.

My authorities have also expressed the desire to improve the composition of expenditures, effectively continuing to give more weight to the priority sectors, with the view to reduce poverty and make progress towards the Millennium Development Goals. In this endeavor, fiscal policy sustainability and debt relief provided under the HIPC Initiative will carry weight. The Chadian authorities understand that the sustainability and steadiness of the pro-poor and other expenditures that are key to the program success will depend on their ability to circumvent the effects of international oil price volatility. Thus, the government will pursue the provision of the stabilization account to smooth out these expenditures should unexpected and adverse oil market events occur.

Policies and structural measures envisaged in 2005

The economic program for 2005 focuses on reinforcing fiscal management (enhancement of non-oil revenue collection and strengthening expenditure management) and transparency, and on addressing impediments to growth through renewed momentum to the structural reform agenda. Institutional arrangements under the LPRM will also be completed. The recovery in cotton sector, along with oil-related activities, will spur economic growth in 2005. The non-oil sector growth should reach 6.4 percent, inflation be subdued to 3 percent, and the current account deficit improved further to 8.4 percent of GDP.

The fiscal policy is aimed at reinforcing macroeconomic stability. The expected overall budget deficit (11.2 percent of non-oil GDP) will be financed with external budgetary assistance, including debt relief under the HIPC Initiative. However, my authorities stand ready to make downward adjustments to nonpriority expenditure in the event of lower-than-anticipated budget resources, so as to avoid an accumulation of payments arrears.

On the revenue side, efforts to strengthen collection will include increases in human resources and computerization in the customs and tax agencies; better coordination and taxpayer information sharing between these two administrations; improved use of the import preshipment inspection certificate; and improved ex post controls and computerization of exemptions by the collection administrations. These efforts would bring the total revenue-to-non-oil GDP ratio to 19.2 percent this year, from 14.5 percent in 2004. As regards expenditures, the planned 36 percent rise primarily reflects investment and spending in priority sectors that is financed with earmarked oil revenue. Poverty reducing spending will amount to 10.4 percent of non-oil GDP. While the government intends to hire about 2,931 people, most of whom (90 percent) will be in the priority sectors, it will not grant a general wage increase for the civil service in 2005.

Domestic debt will continue to be settled. Restructuring arrangements will permit payments to some creditors. The stock of unpaid treasury arrears at end-2003 will be inventoried and verified, and the authorities will request financial support from donors for the implementation of an action plan prepared by end-2005 that will eliminate these arrears.

As regards the monetary and financial sector, monetary policy, which is conducted at the regional level, will remain prudent, consistent with the CFA franc peg to the euro. It should be noted that the government has planned to reduce its liabilities to the banking system. The Chadian authorities will also pay off the costly exceptional advances granted by the BEAC in 2003-04 by using the additional margin that will be provided by the increase in the country’ statutory advances from the central bank.

Turning to structural reforms, the government of Chad is committed to press forward reforms in the sectors of cotton, energy, expenditure and cash management, and good governance and transparency in resource management. As regards the cotton sector, the government will hold in early 2005 consultations with the World Bank and other donors on the current sectoral crisis, which is caused by the decline in international prices and the unfair competition stemming from the large subsidies granted by advanced countries to their producers. These consultations will allow the authorities to prepare a strategy for the sector.

This strategy will take into account the feedbacks from the workshops organized for producers and potential investors. Other measures envisaged for 2005-06 include a broad range of actions, in particular: the completion of the ex-ante Poverty and Social Impact Analysis (PSIA) for which the first stage of qualitative and quantitative analyses has already been completed; a decision on how to rehabilitate the company or assume its debts, depending on the choice of privatization scenario; specifying the market regulation and access to credit for the cotton sector after privatization is completed; clarifying the producer price-setting mechanism; boosting productivity and efficiency by the training of cotton farmers on production and selling techniques as well as information to them about market conditions and inputs; improving the rural road network in cotton-producing areas; and launching an ex-post PSIA after privatization of Cotontchad.

In the energy sector, the authorities’ focus will be two-fold: (i) increasing production immediately and its capacity later on, and (ii) improving the financial situation of the public water and power company, STEE. In the short run, the government will boost power supply by reconditioning old generators and purchasing three new ones to meet the current demand. However, given the high costs of fuel used by the generators, the government plans to build in the medium term a new power plant at Farcha to improve power production capacity, while reducing the costs. On the second point, that of addressing the financial difficulties of STEE, an action plan with the assistance of the World Bank is already underway.

Efforts at strengthening expenditure and cash-flow management as well as good governance and transparency in resource management will be pursued. As noted above, the government will need additional technical assistance from the Fund, in particular to strengthen budgetary procedures, address the fragmentation of cash management through the setting of a treasury single account, and prepare the implementation of all other actions recommended by Fund’s FAD. Also planned is the connection of priority ministries to the Integrated Financial Management Information System, the codification of poverty-reducing spending, and the submission to the parliament of the 2004 settlement law. The update of the 2000 civil service census, the strengthening of personnel management through payroll computerization and personnel management systems, the recruitment of qualified staff, and the provision of training to ensure proper implementation of the new procurement code, all will contribute to enhance good governance and transparency in resource management.

Finally, in the oil sector, the quarterly reports prepared by the supervisory board, CCSRP, will continue to be published; the investment strategy for the resources allocated to the FFG through a separate offshore account will be finalized by end-June 2005; and a working group will be set up by May 2005 to prepare the required actions for implementing the Extractive Industries Transparency Initiative (EITI) to which the Chadian government has decided to adhere.

III. HIPC Initiative and PRSP Implementation

My authorities are implementing the national strategy of poverty reduction, which was endorsed by the Board of the Fund in November 2003. The PRSP monitoring mechanism has been finalized, and the first PRSP progress report which provides a review of specific measures needed to achieve the PRSP objectives and highlights the key poverty reduction issues with insufficient attention, was completed in late December 2004.

As regards the HIPC Initiative, my authorities are confident that they will meet the Completion point conditions in 2005. In light of their encouraging actions and results, it would be useful to free more resources for poverty reduction. The substantial budgetary support that the country would receive through debt relief at the Completion point will be very helpful, and my authorities will work to implement the necessary structural measures, all of which are in progress and some completed. In particular, as Table 12 of Staff Report indicates, substantial achievements have been made in the priority sectors of health, education, and basic infrastructure.

Conclusion

The progress achieved thus far remain fragile. The commencement of the petroleum era in Chad, which has created high expectations amongst the population, would not suffice to get the country out of widespread poverty, in view of the relatively small contribution of oil revenue to the government budget thus far and in light of the daunting social needs of the population. Assistance from the international community will remain critical to support the efforts of Chad, which ranks among the poorest countries in the world. An illustration of the critical need for external assistance is the exponentially-growing priority sector expenditure in contrast to the abrupt decline in oil revenues after 2009 based on currently available oil fields.

As for the Fund’s highly needed and catalytic contribution, a new PRGF arrangement is best-suited to not only reinforce incentives for sound policies and reforms, but also enable Chad to meet the expected financial needs necessary for the strengthening of its capacities, make progress towards substantial debt relief under the HIPC Initiative, ensure the preparation of the post-oil era, allow the sustained implementation of the country’s national strategy of poverty reduction, and prepare the long road to development. The new Chadian government is also requesting an additional interim assistance under the HIPC Initiative, which will help to fully finance, along with resources from other multilateral donors, the 2005 program.