Central African Republic: Staff Report for the 2005 Article IV Consultation
Author: International Monetary Fund
Publication Date:
02 Dec 2005
eISBN:
9781451806625
Language:
English
Keywords:
ISCR; CR; authority; CAR economy; wage bill; C.A.R. economy; exchange rate; revenue performance; CFA franc; broad money; ability to pay; Arrears
Download PDF (518.5 KB)

The staff report for the 2005 Article IV Consultation on the Central African Republic (CAR) highlights economic developments and performance. Revenue performance was disappointing, and there were sizable expenditure overruns, particularly on the wage bill. The authorities and IMF staff agreed on the importance of raising government revenue to ensure that sufficient resources are available for basic government functions. Key reforms will include efforts to combat fraud in customs and improve domestic tax administration through increased controls and verification procedures.

Abstract

The staff report for the 2005 Article IV Consultation on the Central African Republic (CAR) highlights economic developments and performance. Revenue performance was disappointing, and there were sizable expenditure overruns, particularly on the wage bill. The authorities and IMF staff agreed on the importance of raising government revenue to ensure that sufficient resources are available for basic government functions. Key reforms will include efforts to combat fraud in customs and improve domestic tax administration through increased controls and verification procedures.

I. Introduction

1. The Central African Republic (C.A.R.) has seen a considerable deterioration in its economic and social conditions over the past decade. The country is endowed with sizable natural resources and arable land, but intermittent political and military disturbances and weak governance have led to a degradation of the country’s capital stock, a collapse of the private formal sector, and a steady erosion of living standards.

2. Poor management of public finances has been a central feature of this decline, and presents a major challenge as the C.A.R. authorities try to rehabilitate the economy and restore public services. Government revenue now stands at about 8 percent of GDP, which is very low by both African and international standards, and insufficient for financing the core functions of the state, including social services. At the same time, weak expenditure control has led to unproductive spending and a very large and growing public sector wage bill. The wage bill now far exceeds the authorities’ ability to pay salaries with their own financial resources and diverts scarce resources from priority social spending.

3. In this setting, the C.A.R. continues to accumulate external and domestic arrears—at end-2004, external arrears totaled 25 percent of GDP and domestic arrears amounted to roughly 30 percent of GDP. A durable resolution will require reaching agreement with creditors and putting public finances on a sustainable footing to prevent the accumulation of new arrears.

4. Weak institutions and pervasive corruption have accompanied and contributed to the economic decline and poor public finance management. Weaknesses in the judicial sector and a heavy regulatory burden, in the context of widespread public corruption and poor public services, have created an extremely difficult climate for private sector activity. Moreover, on top of being a land-locked country, the C.A.R. has seen little investment in and maintenance of the infrastructure network. Combined with banditry in many parts of the country, this has resulted in some of the highest per unit transport costs in the world and contributed to the decline of key export activities, notably in the agriculture sector. Addressing these shortcomings will be essential to support private sector development.

5. The 2005 Article IV consultation provides a useful opportunity—ahead of a possible request for further assistance under the Fund’s Emergency Post-Conflict Assistance (EPCA) policy—to take stock of the progress to date and challenges ahead. The discussions with the authorities focused on these challenges and on the steps that would foster a rebound in economic activity and an improvement in living standards.

II. Political and security developments

6. The political situation has settled since the March 2003 coup, and the transition to democratic rule culminated in peaceful presidential and legislative elections during March-May 2005. According to most observers, the elections were generally free, despite logistical constraints and some allegations of fraud. The incumbent, President Bozizé, won in the second round, and a coalition supporting him has a majority in the National Assembly. Despite these developments, the political situation remains fragile largely because of the population’s deepening impatience with the difficult economic situation, including the recurrent problem of public sector wage arrears.

7. The security situation has generally remained calm in the capital, Bangui, but banditry continues in the rural areas. While some demonstrations took place around the elections, little political violence was reported. Several hundred troops from France and the Central African Economic and Monetary Community (CEMAC) continue to be stationed in the C.A.R. to support the peace process. In addition, the first two phases of the disarmament, demobilization, and reintegration program of ex-combatants (DDR) are expected to be concluded by the end of this year, while the reintegration phase will likely take two years to complete. Efforts are also under way to train and better equip the armed forces. Nonetheless, rural areas remain beset by armed bands harassing local populations and robbing passing vehicles. The C.A.R. armed forces are undertaking operations to dismantle those bands.

III. Recent economic developments and program performance

A. Weak Signs of Recovery

8. Economic activity in 2004-05 has yet to recover from the sharp contraction associated with the 2003 conflict (Table 1). Real GDP grew by only about 1 percent in 2004, resulting in a further deterioration in per capita income. A number of factors have hindered a rebound in the economy, including capacity constraints resulting from the accumulated destruction of the capital base; continued insecurity in rural areas which mutes any significant upturn in agriculture production; and the political uncertainty of the transition period, which made economic operators cautious, notably about investment. In this setting, a contraction of output in the forestry sector as a result of heavy rainfall further depressed real GDP growth, and was only partly offset by some increase in diamond production. Initial indications through mid-2005 offer little suggestion of an uptick in growth. Recent heavy rainfall in Bangui displaced a number of people from their homes, but it appears to have had little impact on overall economic activity.

Table 1.

Central African Republic: Selected Economic and Financial Indicators, 2001—08

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Sources: C.A.R. authorities; and IMF staff estimates and projections.

Refers to the 2004 EPCA program targets.

Revised on the basis of an October 2004 staff visit.

In percent of broad money at beginning of the period.

For 2005, average of 12-month period ending June 2005.

In line with the 2004 EPCA program, the projections for 2004 include 1 percent of GDP in priority spending financed by grants.

Excludes interest payments, foreign-financed investment, and grants.

Excludes foreign-financed investment and grants.

In percent of exports of goods and services.

Key Macroeconomic Indicators, 2001-05

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Sources: C.A.R. authorities; and IMF staff estimates.

9. The average price level fell by about 2 percent in 2004 but has picked up moderately in 2005. These developments were driven by a decline in food prices in 2004 induced by more stable conditions in the agricultural sector, followed by a modest upturn in food prices during the first half of 2005. The real effective exchange rate has remained broadly flat since 1995, one year after the devaluation of the CFAF franc, in large part reflecting the low inflation over this entire period.

uA01fig01

Consumer price index, 2000-05

(Average annual percent change)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

uA01fig02

Effective Exchange Rates, January 1993—June 2005

(1990=100)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

10. The external current account deficit narrowed by about ½ of 1 percent of GDP to 4⅓ percent of GDP in 2004 and is expected to decline by a similar amount in 2005. The deterioration in the trade balance in 2004—largely caused by a worsening terms of trade, the decline in timber exports, and a higher demand for petroleum products for election-related activities—was more than offset by an increase in current transfers, partly reflecting donor support for carrying out the elections, and some improvement in the services balance.

uA01fig03

Money Aggregates, March 2003-June 2005

(In billions of CFA francs)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source: C.A.R. authorities.

11. Regarding monetary developments, net credit to the government and private sector credit picked up in 2004, although the increase in private sector credit—linked to petroleum imports and several large loans in the forestry sector—partly receded in the first half of 2005.

B. Uneven Program Performance

12. The C.A.R.’s performance under the EPCA program was uneven, with some progress on structural reforms but also serious fiscal slippages (Tables 2-4).1 The outturn for the narrow primary deficit in 2004 was more than 1 percent of GDP higher than targeted.2 In the first half of 2005, the narrow primary deficit exceeded the target by 1 percent of annual GDP; on a cash basis it exceeded the target only slightly because of the accumulation of additional salary arrears, which restrained cash outlays.

Table 2.

Central African Republic: Central Government Operations, 2001-08

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Sources: C.A.R. authorities; and IMF staff estimates and projections.

In line with the 2004 EPCA program, the projection for 2004 includes 1 percent of GDP in priority spending financed by grants.

Revised on the basis of an October 2004 staff visit.

United Nations Mission in C.A.R.

Excludes interest payments, foreign-financed investment, and grants.

Excludes foreign-financed investment and grants.

Table 3.

Central African Republic: Authorities’ Indicative Targets, January 1—December 31, 2004

(In billions of CFA francs; cumulative from January 1, 2004; ceilings, unless otherwise indicated)

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Including withholding taxes on government salaries, earmarked revenue, and taxes and duties on project-related imports.

Including withholding taxes on government salaries.

The narrow primary balance compares revenue on a cash basis (that is, excluding withholding taxes on government salaries, earmarked revenue, and taxes and duties on project-related imports) with total expenditure, excluding interest payments and foreign-financed investment. Objectives for end-September and end-December have been adjusted by CFAF 3.4 billion and CFAF 7.7. billion, respectively, to reflect 1 percent of GDP grant-financed priority expenditure envisaged under the 2004 EPCA program.

Contracted or guaranteed by the government.

Table 4.

Central African Republic: Authorities1 Indicative Targets, March 1–December 31, 2005

(In billions of CFA francs; cumulative from January 1, 2005; ceilings, unless otherwise indicated)

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Including withholding taxes on government salaries, earmarked revenue, and taxes and duties on project-related imports.

Including withholding taxes on government salaries.

The narrow primary balance compares revenue on a cash basis (that is, excluding withholding taxes on government salaries, earmarked revenue, and taxes and duties on project-related imports) with total expenditure on a cash basis, excluding interest payments and foreign-financed investment and including treasury operations. Targets will be adj usted downward if external grants allocated to priority spending are above the projected amounts.

Contracted or guaranteed by the government.

The narrow primary balance compares revenue on a cash basis (that is, excluding withholding taxes on government salaries, earmarked revenue, and taxes and duties on project-related imports) with total expenditure on a commitment basis, excluding interest payments and foreign-financed investment and including treasury operations. Targets will be adj usted downward if external grants allocated to priority spending are above the projected amounts.

Arrears on goods and services include unpaid spending commitments vis-à-vis suppliers as well as deposit accounts of enterprises at the Treasury.

13. Overall revenue performance has been disappointing. Initial shortfalls in 2004 were partially corrected, and the target for end-2004 was met. However, revenue weaknesses continued in the first half of 2005, and the end-June target was missed by about ¼ of 1 percent of annual GDP. Customs performance, in particular, has been weak, because of a low level of taxable imports, but also because of persistent and pervasive corruption. The average effective tariff—import tax receipts as a share of total imports—is about 9 percent, against a weighted statutory tariff estimated at 15 percent, suggesting that there is room to significantly increase customs receipts through eliminating fraud and exemptions (see para. 42 for a description of the trade regime).

14. The authorities’ control over payroll management slipped considerably in 2004-05, and was marked by a worrisome rise in the wage bill and a further accumulation of wage arrears (Box 1). Public sector wage commitments exceeded the budget envelope by 0.8 percent of GDP in 2004, and are projected to exceed the 2005 budget envelope by over 1 percent of GDP. As a result, the wage bill far surpasses the authorities’ ability to pay salaries, and about 1½months and three months of additional salary arrears have been accumulated, respectively, in 2004 and thus far in 2005.3 There were also some overruns on other current public spending in both 2004 and early 2005, linked in part to the elections.

15. The authorities made progress on fiscal structural measures (Table 5), although the reform momentum slowed considerably as the electoral process got underway, and the impact of the measures on the fiscal situation has been limited. Regarding the domestic tax administration, measures were implemented to improve value-added tax (VAT) collections and strengthen performance of the Large Taxpayer’s Unit. These measures enabled the domestic tax administration to improve collections in 2004 over 2003. At customs, the authorities introduced measures to better control smuggling, although progress has been slow and efforts to reduce fraudulent CEMAC labeling of imported goods have so far proved ineffective, with the result that customs receipts have remained stagnant. The authorities also made some progress on public expenditure management, including the introduction of a monthly treasury cash flow plan, and better identifying spending at the commitment stage.

Table 5.

Structural Reform Measures under the 2004 Emergency Post-Conflict Program

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Corrective measures identified during October 2004 and February 2005 staff visits.

The Wage Bill

The government wage bill (on a commitment basis, which includes wages paid plus new arrears) is projected at 5.8 percent of GDP for 2005, about 1 percent of GDP more than in the 2005 budget. This follows slippages of about 0.8 percent of GDP in 2004 as measures1 adopted in the 2004 budget to contain commitments on wage spending were not effective. Although base salaries have been frozen since 1985, the wage bill continues to increase because of the rapid expansion of allowances and benefits, the creation of high-level posts carrying salary premiums, and delays in retirements. Commitments on wage spending now represent close to 100 percent of government cash revenue (excluding offsets, earmarked revenue, withholding taxes on government salaries, and taxes and duties on project-related imports), and have resulted in further salary arrears being accumulated.

Wage Bill in the CEMAC

(In percent of GDP)

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Net recruitment also accounts for part of the increase in the wage bill. The largest percentage increase was in the defense ministry (armed forces and gendarmerie).

Evolution of the Components of the Wage Bill, 2003-04

(In percent)

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Size of the Public Administration

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Sources: Central African authorities; and WETA database
1 Most notably, a 25 to 30 percent reduction of annual salaries in excess of CFAF 300,000 (about US$550).

16. The government also made some advances on governance issues. A new organizational structure for the Ministry of Justice, including a financial unit, was introduced in mid-2005 after some delays. The financial unit is expected to strengthen the government’s ability to prosecute corruption cases, and defend the financial interests of the state in legal disputes, both areas where the authorities have acknowledged weaknesses in the past. Transparency has also been enhanced through wider and regular publication of information on fiscal revenue and expenditure, as well as on the allocation of permits in the mining and forestry sector, with the latter being allocated in a competitive bidding process.

IV. Macroeconomic Outlook: Modest Rebound Under the Baseline Scenario

17. The C.A.R.’s short-term outlook is predicated on a modest increase of real GDP of 2¼ percent in 2005. Project financing from donors has started to pick up, which should accelerate infrastructure spending, and diamond mining and agricultural activity are projected to rise. Consistent with developments through July 2005, inflation is expected to return to its historical range of 2–3 percent, in line with the CEMAC trend level. The trade balance is expected to remain largely unchanged in 2005 as both imports and exports pick up, with the projected reduction of ½a percentage point of GDP in the external current account deficit (to 4 percent of GDP) reflecting in particular a mild increase in remittances and some improvement in the services account.

18. The medium-term outlook for the economy is clouded by a number of factors:

  • Destruction of the physical capital base. The long legacy of conflict has led to the destruction of much of the country’s physical capital and the disappearance of most of the industrial sector.4 The resulting capacity constraints suggest a limited near-term growth potential for industry.

  • High transport costs. The continued banditry in rural areas, coupled with the terrible state of infrastructure, have raised transport costs and hampered the recovery of trade, undermining the development of markets in food products and dampening the recovery of cash crop production. Infrastructure improvements will be crucial, but the gains would only be realized gradually over time.

  • Deterioration of human capital. The country’s history of poor governance, ineffective public spending, and disruptions in the educational system have undermined human capital, and led to a deterioration in institutional capacity and educational achievement. An additional obstacle is the high and rising prevalence of HIV/AIDS. These factors have had an immense human cost and also seriously weakened public administration and prevented the development of a skilled labor force.

19. Given those circumstances, economic growth in the C.A.R. is expected to reach 3½ percent in 2006 and remain in the range of 3½-4 percent over the medium term. This baseline scenario represents a more muted recovery than that observed in many other post-conflict countries and, as outlined below, hinges on the country’s making steady progress in reforming the economy and enhancing security, both of which are critical for improving the environment for private sector activity and, hence, for increasing investment and savings. The balance of payments is expected to remain broadly unchanged over the medium term, with higher investment-related imports offsetting a gradual rebound in exports (Table 7). The forestry sector has been a key growth area, but is expected to reach the limit on sustainable harvesting within four to five years, underlining that other sectors will need to pick up the slack. Consistent with a return to stability of public finances, fiscal policy would aim at a reduction in the overall deficit, including grants, of about 1 percent of GDP over the 2005-08 period, predicated on a gradual improvement in revenue and restraint on spending not financed by donors. The annual financing gap over the medium term is projected at around 3 percent of GDP and corresponds to external debt service due and is anticipated to be financed by the accumulation of external arrears except to the Fund.5

uA01fig04

Growth Performance in Post Conflict African Countries

(t=year conflict ended)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source: IMF staff estimates.1/ for the C.A.R.t=2003.

20. There are risks to the baseline scenario. A high-case scenario based on an acceleration of the reforms discussed below shows a sizable increase in investment—higher donor support paired with a “crowding in” of private investment—and an improvement in public finances, which would permit a boost in priority spending. As a result, growth would accelerate to 5½ percent in 2006 and beyond, resulting in per capita income growth of close to 3 percent. In a low—case scenario, poor policy performance would result in a further drop in investment levels. Weaker revenue collection combined with lower donor assistance would result in a deteriorated public finance position as well as lower priority spending. Domestic arrears would increase rapidly. Real GDP growth would hover around 1 percent, implying a further erosion in people’s standards of living and greater uncertainty about political stability.

uA01fig05

Alternative Macroeconomic Scenarios, 2005-08

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source: IMF staff estimates and projections.

V. Policy Discussions

21. The authorities underlined that, with the electoral process complete, they could focus their attention on rehabilitating the economy. They highlighted the significant achievements made on the security front and in concluding the electoral process, to which they had given priority up to May 2005. But these activities weighed heavily on the authorities’ ability to advance the economic reform agenda and achieve concrete results under the EPCA program.

22. The views of the authorities and the staff diverged on the appropriate timing of greater international support and policy reforms. The authorities—and civil society—fully anticipated a sizable increase in international assistance following the elections. They considered increased aid essential to jump-starting the economy, rehabilitating public finances, and improving the performance of the administration, which would, in turn, engender greater domestic political support for subsequent economic reforms. The authorities generally shared the staff’s view on the medium-term outlook but considered it fully conditioned on the level of international support, including an early move to a program supported by the Poverty Reduction and Growth Facility (PRGF).

23. The staff welcomed the authorities’ greater focus on economic issues but stressed the urgency of implementing sound policies to address the country’s tremendous difficulties and attract international support. The staff agreed that significant international support was necessary to accompany the recovery, and noted that the significant delays in the provision of technical assistance due to procedural obstacles on the part of donors were one reason why the results of the EPCA program were not more encouraging. Nonetheless, without action by the authorities to place public finances on a sustainable footing and firmly confront governance issues, international aid—including from the IMF—would be lower and most likely ineffective.

24. In this context, the discussions focused on the actions the C.A.R. should take in the near term to stabilize the fiscal situation; the reforms needed to fight corruption and improve the private sector climate; and the possibility of future IMF support.

A. Macroeconomic and Financial Policies

Fiscal policy: Bridging the gap between current spending and revenue

25. The authorities recognized that the severe weaknesses in public finances were at the heart of the country’s economic ills. Poor or nonexistent public services, a very narrow tax base that squeezes the formal sector, and sizable arrears to civil servants and domestic suppliers are the legacy of a long period of poor public finance management and have contributed to the C.A.R.’s intermittent political instability.

26. The overall deficit on a commitment basis (including grants) is projected to widen to 2¾ percent of GDP in 2005. Total expenditure commitments are expected to be 1 percentage point of GDP lower than in 2004, even accounting for the higher wage bill commitments. However, a decline of almost 2 percent of GDP in donor budgetary grants paired with only a small increase in revenue (about 0.2 percent of GDP) implies the deficit will rise. The authorities are trying to identify additional grants that would obviate the need for additional bank financing or the further accumulation of arrears. The staff noted that the projected deficit for 2005 is now almost 1½ percent of GDP higher than the objective agreed with staff earlier in the year, and which was reflected in the 2005 budget. Moreover, the nonsalary expenditure envelope was extremely tight and that further salary arrears were likely if additional financing did not materialize.

uA01fig06

Revenue and Expenditures, 2000-05

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Sources: C.A.R. authorities; and IMF staff.

27. The staff stressed that the public sector wage bill has dominated public finance policy. The authorities are now confronted with the dilemma that the timely payment of wages is their principal policy priority, but this goal has become increasingly difficult to achieve as the wage bill continues to rise while revenue stagnates. The staff stressed that reductions of about 1 percent of GDP on an annual basis in the wage bill were needed to bring it in line with the government’s resources and assure that a minimum amount of resources is available to finance essential non-salary spending. The staff proposed immediate measures to reduce allowances, accelerate retirements,6 and introduce cuts in some of the higher salary bands not subject to reductions in 2004, while urging the authorities to initiate the time-consuming task of cleaning up the payroll files. The staff noted that the full-year impact of many of these measures would only be realized in 2006, and thus the target on the wage bill for 2005 was likely to be exceeded by a wide margin.

28. While underlining their commitment to reduce the inflated wage bill, the authorities expressed concern about political fragilities. Citing the disruptions prompted by the moderate salary reduction adopted in early 2004, they noted that drastic measures to cut salary expenditures could be politically destabilizing. Their preference has been to undertake a census of civil servants as a means of identifying anomalies in the payroll files. This work is ongoing and although a number of anomalies have been identified, possible savings remain unclear. The staff welcomed this initiative, but noted that similar efforts had not proved successful in the past. The authorities have also started to accelerate retirements, and indicated their intention to freeze recruitment for at least one year.7 The authorities are examining ways of strengthening payroll management. One option they are considering is to transfer the management of the computerized payroll database to a private operator; corruption in the public agency responsible for managing this database has reportedly been a key source of anomalies in the payroll.

29. Raising public revenue remains a critical challenge for the authorities. At about 8 percent, the C.A.R.’s revenue-to-GDP ratio ranks among the lowest in Sub-Saharan Africa, mainly because of the contraction of the formal sector, weak administration, and corruption and fraud. Given the weak revenue outturn through the first semester of 2005, achieving the targeted increase in the revenue-to-GDP ratio for the entire year will require a concerted effort. The authorities acknowledged that these problems were chronic, but cited gains, including some progress in controlling customs fraud. Their progress is partly attributable to the implementation, albeit delayed, of a number of measures in the EPCA program. In addition, the authorities are curtailing tax exemptions and exceptional customs clearance procedures, and are considering measures to address revenue shortfalls linked to widespread smuggling by the informal sector. However, even with better controls, smuggling is expected to remain a serious challenge as economic operators attempt to evade tariffs that rise to 30 percent for consumption goods (see para. 42). On domestic tax administration, improvements will continue to focus, in line with the FAD technical assistance recommendations, on boosting controls and tightening verification procedures.

uA01fig07

Fiscal Revenue as Share of GDP, 2004

(Excluding grants)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source: IMF, WEO/Economic Trends in Africa database, 2005.

30. The authorities agreed with the staff that using petroleum tax reductions to limit a pass-through of world oil prices had undermined the revenue base.8 While acknowledging the sensitivity of this issue, the staff encouraged the authorities to examine ways to mitigate this effect, notably by raising retail prices. The staff noted that the impact on the poor could be mitigated by containing any increase in the price for kerosene, a key household good of the poor.

31. On public expenditure management, the staff underlined that expenditure controls and monitoring remained very weak. As a result, the authorities have often exercised spending restraint through cash rationing. They have been working closely with an FAD expert to reform the system and ensure that most spending will have a corresponding budgetary allocation and be in compliance with regulated expenditure procedures.

32. The authorities recognized the importance of finding a lasting solution to all government domestic arrears, including to civil servants and suppliers. An ongoing investigation, with the assistance of a World Bank consultant, is identifying the government’s domestic arrears, which preliminary estimates suggest amounted to about 30 percent of GDP at end-2004.9 The authorities are committed to finalizing a strategy in early 2006 for eliminating the stock of domestic arrears and will seek assistance from donors to clear them. This strategy could include a significant discount on the payment of many of these claims.

Continuity in monetary policy and reducing strains in the banking sector

33. Monetary and exchange rate policy is conducted at the regional level by the BEAC, whose main objective is price stability. The authorities and the staff agreed that the institutional arrangement has proved helpful in maintaining low inflation and providing some policy certainty in an otherwise difficult macroeconomic situation (see para. 45 for a discussion of real exchange rate and competitiveness issues).

34. The authorities are currently negotiating an exceptional central bank advance to help them meet current obligations. They negotiated a similar advance of 1½of GDP last year.10 The staff expressed strong reservations about this operation, urging the authorities to exhaust all possibilities of grant financing from donors and regional partners before contracting such expensive debt. To this end, the staff strongly encouraged the authorities to use any available foreign budgetary grants to reimburse this advance.

35. The staff noted that due to the government’s dependence on commercial banks’ resources, the liquidity situation in the banking sector remained tight. As a result, the monetary authorities have maintained the suspension of reserve requirements for Central African banks introduced in mid-2003. The staff encouraged the authorities to limit further strain on banks’ liquidity so as to prevent a crowding out of private sector credit. The staff also encouraged the authorities to be vigilant in supervising banks’ compliance with prudential regulations. The authorities acknowledged the delay in recapitalizing one problem bank, which met only one of the nine prudential ratios in the CEMAC, but underlined their intention to address this issue.

36. Access to financial services in the C.A.R. is very limited, with total bank deposits representing only 4 percent of GDP. The authorities indicated their intention to improve the population’s access to financial services, in particular by strengthening the microfinance sector, in partnership with donors.

uA01fig08

Deposits in Banks to GDP, 2004 1/

(In percent)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Sources: BEAC; and IMF staff est imates.1/ Fgures are preliminary.

B. Governance and Structural Reforms: Improving the Effectiveness of the State and the Climate for the Private Sector

Tackling corruption

37. The authorities recognize that the economic revival of the country hinges on improving the functioning of the state and the climate for private sector investment, and progress in both these areas depends, in turn, on more effectively fighting corruption. while agreeing that this would take time, the staff emphasized that the need for progress was urgent and encouraged the authorities, in particular, to strengthen the judiciary and enhance transparency. The authorities indicated their intention to adequately staff and equip the newly-created specialized financial units within the Ministry of Justice. They underlined the dire lack of resources and technical expertise at the ministry and were seeking appropriate donor assistance. The staff welcomed the authorities’ publication of revenue and aggregate expenditure data, and encouraged them to widen this information to include, for example, data on the composition of expenditure, which could foster greater accountability of public officials responsible for key expenditure items.

38. The authorities have also committed to reforming weak public procurement practices, which potentially engender corrupt practices. The staff welcomed the authorities’ initiative to seek World Bank expertise in identifying reform measures in line with international best practices. The objective is to enhance the transparency and predictability of public procurement and reduce the discretionary power of the state.

Improving the business climate

39. The staff encouraged the authorities to consider ways to reduce the cost of doing business in the country. Aside from poor governance, the C.A.R. rates very poorly in the World Bank’s Doing Business report, notably regarding labor market flexibility, the time needed to set up a business, and the cost of enforcing contracts.11 The staff underlined that recent work by the World Bank’s Foreign Investment Advisory Service emphasized that advancing private sector development reforms in tandem with—rather than following—capacity-building efforts would enhance the prospects for a strong economic recovery following a conflict.

uA01fig09

Cost of Enforcing Contracts

(In percent of debt)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source: World Bank, Doing Business

40. The authorities will continue to reform the natural resource sectors. In the forestry sector, they are now expanding inspections—carried out by an independent inspection agency—of logging activities to deter smuggling and improve the payment of stumpage fees and taxes. The authorities will also widen the information published on the sector to include export activities and taxes paid. They are hopeful that, with the renewed interest of foreign companies, the medium term prospects of the mining sector will improve. With regard to the chronic problem of tax evasion in the sector, the authorities are determined to strengthen the capacity of the office of diamond and gold valuation and control to value diamonds more accurately and fight smuggling. They will continue to abide by the certification requirements of the Kimberley Process.

41. The authorities agreed with the staff on the need to address public enterprises’ severe financial and operational difficulties. Toward this end, they are considering privatizing the billing and collection services of the electricity and water utilities. Each company bills only half of total production to consumers because of theft and losses, and collects only about half its billings in payments. The combined losses of the three largest public enterprises—the electricity and water companies, plus the telecommunications company—represented about 0.7 percent of GDP in 2003.12

C. Boosting Trade and Enhancing Competitiveness

42. As a member of the CEMAC, the C.A.R. applies a common external tariff to imports from countries outside the zone. Four rates are applied—5 percent for essential goods, 10 percent for raw materials and investment goods, 20 percent for intermediate goods, and 30 percent for consumer goods—and the weighted average tariff is estimated at about 15 percent.13 Imports of goods produced in CEMAC countries are not subject to tariffs. A few quantitative restrictions remain, the most important being on the import of sugar.

43. The authorities agreed with the staff on the importance of trade liberalization and regional integration in the context of the CEMAC. The staff underscored the potential benefits to the C.A.R. of a reduction in the region’s common external tariff (CET) and stressed that the authorities needed to renew their efforts to strengthen the application of regional trade regulations, including on the classification and attribution of goods to the relevant tariff categories. The authorities noted that they are well aware of the distortions introduced by a preferential regime for regional trade, and that a drop in the CET would provide important economic benefits, although they expressed some concern about the possible decline in fiscal revenue should the CEMAC lower its external tariff.

44. The authorities recognize that high transport costs represent a major obstacle for exporters in their efforts to access regional and international markets. In particular, the quality of the C.A.R.’s roads as measured by, for example, the ratio of paved to total roads, is very low compared to other African countries. The staff underscored that, if transport costs are not lowered, economic recovery is likely to be muted. With a view to facilitating trade, including in the traditional export sectors (Box 2), the staff encouraged the authorities to seek further donor support and collaborate with their CEMAC neighbors to rehabilitate land and river transport infrastructure.14

uA01fig10

Quality of Roads in Selected African Landlocked Countries

(Index, Botswana=1)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source: Faye, McArthuir, Sachs, and Snow, Journal of Human Development, 2004.
uA01fig11

Estimated Unit Road Transport Cost per Container for selected African Routes and the United States

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source:Review of Maritime Transport, UNCTAD 2003.

Cost Structure in the Cotton Sector

The cotton sector in the C.A.R. has all but disappeared in recent years. After exceeding 40,000 tons in 1998, cotton production bottomed at about 1,500 tons in 2003, in part because of the various conflicts, but also because of low international prices, high transport costs, and an inefficient parastatal. The sector had previously played an important role in boosting cash incomes in rural areas, and the authorities consider it to be an important potential contributor to economic growth and poverty reduction.

The staff noted that the sector was currently uncompetitive, and counseled prudence if the authorities were to consider committing public resources to the rehabilitation of the sector. Losses are inevitable at current world prices and taking into account the C.A.R.’s high transport costs. As illustrated by the cost structure for the 2003/04 season (production level of 1,500 tons), at low production levels, the average unit cost far exceeds the export price. The resulting losses have been absorbed by the now-bankrupt cotton parastatal and through nonpayment to farmers. While many ginning and other costs are fixed and will decline significantly as production increases, transport costs are very large and mostly variable.

C.A.R. Cotton Cost Structure 2003/04 1/ (In CFAF per kilogram)

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Sources: C.A.R. authorities.

On the basis of a production level of 1,500 tons

With 0.425 ginning productivity

Includes international and domestic land transport as well as minor transaction costs

45. The authorities and the staff agreed on the importance of improving the competitiveness of the C.A.R. economy. The C.A.R.’s real effective exchange rate remains 25 percent below its level prior to the 1994 devaluation of the CFA franc, although a continuation of the decline in the terms of trade observed in recent years could eventually pose overvaluation concerns. In light of the fixed exchange rate regime, the staff stressed the need for flexibility in labor and product markets—including easing rules on hiring and firing and reducing licensing requirements—to enable them to better adjust to shocks and maintain competitiveness. Strengthened security, as well as structural reforms to reduce input costs faced by producers, will also be essential.

uA01fig12

Real Effective Exchange Rate and Terms of Trade, 2001—05

(1991 = 100)

Citation: IMF Staff Country Reports 2005, 424; 10.5089/9781451806625.002.A001

Source: IMF, IFS database.

D. External Debt and Arrears

46. Given its difficult fiscal position, the C.A.R. has not been servicing its external debt, except to the IMF,15 since 2001 and has thus continued to accumulate external arrears to both bilateral and multilateral creditors. The stock of external arrears at end-2004 is estimated at about US$335 million (25 percent of GDP). Normalization of relations with external creditors will require a comprehensive arrears clearance plan, including with the World Bank and the African Development Bank (AfDB). The authorities have, as a first step, started to verify with their creditors the stock of debt outstanding and of arrears at end-2004. They also have exchanged views with some creditors on the possible profile of arrears clearance operations. The authorities agreed with the staff that all external financing should be in the form of grants, although they have recently contracted some interest-free loans. The staff urged the authorities to seek more support to improve their debt data management.16

External Debt Indicators, end-December, 2004

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Sources: C.A.R. authorities; and IMF staff estimates.

47. The debt sustainability analysis in Appendix IV clearly shows that the C.A.R.’s external debt situation is unsustainable. for end-2005, the net present value (NPV) of the ratio of its debt to exports is projected at about 480 percent and would decrease only marginally to 435 percent under the assumption of traditional debt-relief mechanisms (Appendix IV, Table 3). All key debt ratios in both the baseline and alternative scenarios are above the policy-dependent indicative thresholds17 and as such, the country can be classified as “in debt distress” as further evidenced by the accumulation of external arrears. The C.A.R. could be eligible for debt relief under the Highly-Indebted Poor Country (HIPC) initiative but would have to establish a good track record of policy performance and make satisfactory progress in its poverty reduction strategy.

E. Future Fund Support: Creating the Necessary Conditions

48. In this setting, a key theme of the discussions was the conditions necessary for additional Fund financial support. The staff indicated that given the C.A.R.’s continued weak administrative and institutional capacity, further support under the Fund’s EPCA policy would be more appropriate at this stage than a PRGF-supported program.18 The staff underlined that addressing the fiscal slippages and implementing key governance and structural reforms, including those measures outstanding from the first EPCA program (Table 6) would be necessary to proceed with another post-conflict program. Specifically on public finances, given that corrective measures were only being implemented in the latter part of the year, several of the end-year fiscal targets for 2005 were not likely to be achieved. Thus, staff indicated that satisfactory progress would entail meeting the revenue target—which would require additional revenue measures, including on petroleum prices and tax exemptions; maintaining restraint on non-salary spending; and introducing measures that will yield savings on the wage bill of 1 percent of GDP on an annual basis. Looking further ahead, the staff emphasized that the C.A.R. should establish a good track record of policy implementation and improve capacity to be able to move ahead with a PRGF-supported program. In addition, the C.A.R. would need to avoid accumulating domestic arrears, reduce the delays in the implementation of structural reforms, make progress on a draft poverty reduction strategy paper (PRSP), normalize relations with its external creditors, and finalize a strategy to settle its domestic arrears.19 The staff underlined the importance of the authorities continuing to meet their obligations to the Fund in a timely manner.

Table 6.

Priority Actions of the C.A.R. Authorities for the Remainder of 2005

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VI. Social Sectors and the PRSP

49. Despite some improvement over the past year, the social sectors are in a dire condition with services absent in many parts of the country. In recent years, the C.A.R. has lost ground in terms of meeting the Millennium Development Goals (MDGs—Table 10). Health indicators, in particular, have deteriorated, with life expectancy over the past decade declining by an average of six months every year. The authorities have expressed a strong commitment to reverse this situation, including by extending the fight against HIV/AIDS with the support of donors. Also, they are determined to provide the appropriate incentives for qualified education and health personnel to relocate to the provinces.

Table 7.

Central African Republic: Balance of Payments, 2001-08

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Sources: C.A.R. authorities; and IMF staff estimates and projections.

Refers to the 2004 EPCA program targets.

Revised on the basis of October 2004 review of EPCA program.

A portion of project grants is included under current transfers.

Based on definitions consistent with the IMF’s Balance of Payments Manual (5th ed.).

Includes debt relief under the 1998 Paris Club rescheduling agreement, as well as agreements reached with other creditors in 1999.