Republic of Congo
2007 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Congo
Author: International Monetary Fund
Publication Date:
18 Jun 2007
eISBN:
9781451808629
ISBN:
9781451808629
Language:
English
Keywords:
ISCR; CR; oil GDP growth; growth; deficit; government policy priority; debt relief; rate of return; government effectiveness; government capital expenditure
Download PDF (484.1 KB)

This 2007 Article IV Consultation highlights that the implementation of the Poverty Reduction and Growth Facility (PRGF)-supported program was broadly satisfactory for Congo in 2004–05. However, expenditure overruns and delays in structural reforms pushed the program off track in 2006. Discussions are continuing on an IMF staff-monitored program aimed at establishing a solid track record that could pave the way for resuming discussions on the PRGF-supported program. Macroeconomic performance was mixed in 2006. Real GDP growth is estimated at 6.1 percent in 2006. The outlook for 2007 and the medium term is uncertain.

Abstract

This 2007 Article IV Consultation highlights that the implementation of the Poverty Reduction and Growth Facility (PRGF)-supported program was broadly satisfactory for Congo in 2004–05. However, expenditure overruns and delays in structural reforms pushed the program off track in 2006. Discussions are continuing on an IMF staff-monitored program aimed at establishing a solid track record that could pave the way for resuming discussions on the PRGF-supported program. Macroeconomic performance was mixed in 2006. Real GDP growth is estimated at 6.1 percent in 2006. The outlook for 2007 and the medium term is uncertain.

I. Introduction

1. Past Fund advice centered on the need to improve fiscal management, adopt a medium term framework, strengthen transparency and good governance, and create an environment favorable to private sector activity. The authorities have made some progress on transparency and governance, but fiscal and other structural reforms are lagging.

2. The political debate is focused on the June/July 2007 parliamentary elections. Pressure for higher government spending is mounting. Relations between the government and civil society have deteriorated with the trial of two oil transparency activists.

3. After two years of satisfactory performance, expenditure overruns and delays in structural reforms in 2006 have derailed the PRGF-supported program. Discussions continue on an SMP to establish the track record needed to resume discussions on the PRGF-supported program.

II. Recent Economic Developments and Performance Under the PRGF

4. Macroeconomic performance was strong in 2004-05, but weakened in 2006. Growth eased in 2006 as oil growth moderated from its rapid pace in 2005. Solid non oil growth helped keep overall GDP growth above the average of the Communauté Économique et Monétaire de l’Afrique Centrale (CEMAC) region (Figures 1 and 2). Inflation accelerated in 2006, reaching the highest level in the CEMAC in December (8.2 percent year-on-year), fueled by expansionary fiscal policy and transportation disruptions (Figures 3 and 4). The external current account registered large surpluses in 2005–06 because of higher oil export receipts.

Figure 1.
Figure 1.

Republic of Congo: Oil Prices, Exports, and Real GDP Growth, 2001-06 1

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Sources: Congolese authorities and Fund staff estimates.1 Price differentials fluctuate due to various factors, including shifts in regional supply-demand balances for each main crude oil category. Price differentials have varied considerably over time. The gap between Congolese blend price and the Brent price widened sharply during the second half of 2004 and early 2005, rising from about $2.10 a barrel in June 2004 to $5.30 in December 2006 with a peak of $8.50 a barrel in December 2004. This partly reflected the strong growth in world demand for light oil blends, and increases in freight costs, notably in 2004-2005, which producers of heavy fuels were only partly able to pass on to their customers.
Figure 2.
Figure 2.

Real GDP Growth, 2001-06

(Percent)

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Source: Congolese authorities; and Fund staff estimates.
Figure 3.
Figure 3.

Congo: Monthly Inflation, 2005-06

(Percent)

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Source: Congolese authorities, and Fund staff estimates.
Figure 4.
Figure 4.

Inflation in the CEMAC, 2005-06

(End-of-period, percent)

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Source: Fund staff estimates.

5. Broad money expanded rapidly in 2005-06, mainly reflecting increases in net foreign assets stemming from higher oil prices. Gross foreign assets soared to 26 percent of GDP in 2006 (15 months of imports), from 13 percent in 2005, a significant part of which was not sterilized. Credit to the private sector remained sluggish, reflecting: (i) limited lending opportunities; (ii) the high cost of credit; and (iii) legal and institutional constraints in recovering collateral.

6. The health of the banking system is improving, partly reflecting the recapitalization and privatization of one troubled bank. The cost of privatizing the bank to the government budget was CFAF 14 billion (0.4 percent of GDP), given the negative net worth of the bank. Nonetheless, the privatization process was not transparent and could cost the government budget at least CFAF 6 billion (0.2 percent of GDP) more than the value of the bank, according to an independent consultant. 1 The buyer also has the option until September 2007 to transfer additional assets deemed non-performing to the government, which could push up further the budgetary cost. Under the regional rating system, three banks were found in good condition at end-December 2005, while the fourth one was reported to be in a fragile situation.

7. New borrowing has eroded some of the recent improvement in external debt indicators. The debt cancellation of about $1,7 billion and the rescheduling of outstanding arrears done in the context of the 2004 Paris Club agreement have cut the public debt burden from 213 percent of GDP in 2004 to an estimated 78 percent of GDP in 2006. Since the March 2006 Paris Club agreement, the authorities have signed bilateral agreements with 8 Paris Club creditors. The last phase of the Paris Club agreement has not been activated as it hinges upon satisfactory implementation of the PRGF arrangement. Most of the new external borrowing was contracted with China—primarily for the electricity sector and partly on nonconcessional terms—with commitments totaling $829 million (12 percent of GDP) at end-2006. The authorities also signed a framework agreement with China in June 2006 for cooperation in the areas of oil exploration, infrastructure, and social development, though its financial terms are not yet available. The authorities have reached a tentative agreement with London Club creditors on debt relief consistent with the enhanced Heavily Indebted Poor Countries (HIPC) Initiative.

Text Table.

Republic of Congo: Fiscal Performance in 2006

(Percent of GDP)

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Source: Congolese authorities; and Fund staff estimates.

Excluding interest payments and foreign-financed investment.

Preliminary estimate; the program originally projected GDP of CFAF 3,411 billion for 2006.

Percent of nonoil GDP.

8. The PRGF-supported program went off-track in 2006 owing to large expenditures overruns. Oil and non oil revenues were higher than programmed (text table). The authorities, however, missed the June 2006 performance criterion on the adjusted primary fiscal balance by 2.7 percent of GDP. Additional spending authorized by the October 2006 revised budget without prior consultation with Fund staff brought the expenditure slippages to an estimated 5 percent of GDP at the end of 2006. Transfers to the refinery (CORAF) more than doubled in 2006, reaching CFAF 65.7 billion (1.7 percent of GDP). The non oil primary deficit surged to an estimated 44 percent of non oil GDP in 2006 (up from 27 percent in 2005).

9. The authorities have not yet provided comprehensive fiscal data for 2006 to allow Bank and Fund staff to assess the quality of investment spending. Limited available data suggests that spending overruns were mostly in non-priority areas. Furthermore, the authorities did not meet the conditions for the CFAF 50 billion adjuster on additional investment spending authorized by the Board at the time of the second PRGF review: the relevant projects were not approved by the World Bank and not awarded through transparent and competitive procurement procedures.

10. There were significant delays on the structural front, mainly reflecting political concerns, capacity weaknesses, and limited donor assistance. The divestiture of other business interests by both management and the executive board of the SNPC was met (end-September 2006 structural performance criterion). However, the other performance criterion on the diagnostic study of the commercialization of the SNPC and most other structural benchmarks were missed. The audit covering the awarding of the Marine XI oil concessions was published with a delay (Box 1).

Key Findings and Recommendations of the Marine XI Audit 2

The audit identified: (i) the weaknesses and limitations of government institutions involved in the awarding process; (ii) the lack of regulations to implement the existing Code des Hydrocarbures, in particular the lack of procedures for the awarding of contracts under competitive conditions; (iii) the absence of clarity regarding the role that SNPC should play as holder of mining rights in the process of negotiation of new contracts and its participation in setting up of associations with private operators; (iv) the lack of regulations governing the selection process in awarding contracts to local and foreign operators; (v) the potential conflicts of interest between the oil sector and SNPC management; (vi) the lack of effective controls; and (vii) the deficiencies in the Code of Penal Law as it does not cover conflicts of interest in the oil sector.

The report recommends immediate measures to clarify the role that SNPC, issue a decree that all new contracts are subject to an open international competitive bidding, and establish a registry of qualified firms. Over the next few months, the authorities should also consider establishing: (i) a new institutional framework that provides a clear separation of responsibilities between the sector authorities and the national oil company SNPC; (ii) a regulatory framework and implementation procedures to enhance current control mechanisms, including those related to control, filing, data management and information-related procedures; and (iii) the adoption of regulations to implement the existing Code des Hydrocarbures.

11. Progress on the triggers for the HIPC completion point has been slow. As detailed in the accompanying joint Bank-Fund report, the authorities have made progress on the triggers in the forestry and social sectors. Progress otherwise has been slower than envisaged in the action plan agreed to in August 2006.

III. Article IV Consultation Discussions

12. The Article IV Consultation discussions took place against the backdrop of large fiscal slippages in 2006 and pressures to increase spending in the run-up to the upcoming elections. They centered on a strategy to increase sustainable growth while preserving fiscal and external sustainability (see the selected issues papers (SIP) accompanying this report).

A. Medium-Term Scenarios and Debt Sustainability Analysis (DSA)

13. The medium-term outlook hinges on strong oil prices and production. Oil production is expected to rise until 2010. The non oil growth rate is projected to remain at the current level over the medium term. Inflation would gradually decline as the fiscal stimulus is removed in the adjustment scenario. The external current account would continue to record large surpluses in the next few years, contributing to a large build-up of international reserves.

14. Congo’s fiscal stance is not sustainable. Without fiscal adjustment, external debt ratios would exceed sustainability thresholds by 2011 (Figure 5). The authorities did not favor an immediate fiscal adjustment, as they anticipate increased growth, higher oil revenues, and larger current account balances from potential new oil discoveries.

Figure 5.
Figure 5.

Congo: Baseline vs. Adjustment Scenario, 2005-15

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Source: Fund staff estimates and projections.

15. Congo’s debt would become sustainable only after fiscal adjustment and full delivery of debt relief under the HIPC Initiative (Appendix I). The non-adjustment scenario and stress tests signal significant vulnerability to shocks, especially without changes to bolster fiscal policy, raise growth, and increase foreign direct investment. In contrast, in the adjustment scenario, the ratio of total public debt (external and domestic) to revenue is projected to be sustainable for the next 20 years. The recently contracted new loans also highlight the need to limit new borrowing, given their impact on the debt ratios over the next decade.

16. Based on this analysis, the discussions centered on an adjustment scenario to achieve fiscal sustainability that allows room for priority spending.

17. External competitiveness is key to developing the non oil sector and increasing sustainable growth. Non oil exports (excluding wood) make up a small share of exports and the real effective exchange rate (REER) appreciated by 8.4 percent in 2006, reflecting higher inflation. Estimates of the equilibrium real exchange rate confirm that expansionary fiscal policy in 2006 led to an overvaluation of the REER (Figure 6). A continuation of this trend could slow non oil economic growth and further compromise fiscal and debt sustainability.3

Figure 6.
Figure 6.

Real vs. Estimated Equilibrium Real Effective Exchange Rate, 1990-2006

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Sources: INS Database; and Chudik and Mongardini (IMF WP/07/90).

B. Policy Discussions

18. The discussions centered around much-needed reforms to create the conditions for higher growth and progress toward the Millennium Development Goals (MDGs). In particular, the authorities must avoid the procyclical spending of the 1980s, which together with the civil war, contributed to increasing the overall deficit and debt burden and lowered living standards (Figure 7). Staff proposed a strategy for sustainable growth that calls for (i) a medium-term fiscal strategy aimed at moving toward fiscal sustainability in the long run; (ii) reforms to improve the quality of public spending and increase transparency in budgeting and the oil sector; and (iii) measures to reduce the cost of doing business to promote private sector investment and higher non oil growth.

Figure 7.
Figure 7.

Republic of Congo: Key Fiscal Indicators, 1971-2005

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Sources: Congolese authorities; Fund staff estimates; and World Development Indicators.

Anchoring fiscal policy to a medium-term fiscal strategy (MTFS)

19. Congo has one of the highest non oil fiscal deficits in sub-Saharan Africa (Figure 8) and limited oil resources. The non oil primary balance has also deteriorated since 2003. Such high deficits are clearly unsustainable given that oil production is expected to peak in 2010 and be exhausted in about 20 years. The authorities attributed the slippages in 2006 in part to higher outlays for security (owing to conflicts in neighboring countries), the presidency of the African Union, and urgent priority investments.

Figure 8.
Figure 8.

Oil Producing Countries: Non Oil Primary Balance, 2002-06

(Percent of non oil GDP)

Citation: IMF Staff Country Reports 2007, 205; 10.5089/9781451808629.002.A001

Source: Fund staff estimates.
Text Table.

Republic of Congo: Sustainable Nonoil Primary Deficit with Habit Formation and Catch up Period, 2005-55

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Source: Fund staff projections based on Carcillo, Leigh, and Villafuerte (forthcoming).

The baseline parameters are 6.5 percent growth rate and 4.4 percent real interest rate for 2006-10, and 2 percent growth rate and 4 percent real interest rate after 2016.

Same as baseline, except a 2 percent growth rate and a 3 percent real interest rate after 2016.

Same as baseline, except a 3 percent growth rate and a 4 percent real interest rate after 2016.

20. The mission highlighted the need for an MTFS that explicitly addresses both the country’s limited oil resources and its development needs. Staff favored anchoring the MTFS to a permanently sustainable non oil primary fiscal balance (Chapter II of the SIP). This strategy would keep government spending as a percent of GDP constant, even after oil resources are depleted, as new financial assets would yield enough interest income to finance higher spending. The sustainable non oil primary deficit is estimated at around 13 percent of non oil GDP, well below the 27 percent of 2005 and the 44 percent in 2006 (text table).4 Given the size of the deficit, fiscal policy should seek to reach sustainable deficits gradually over the next 15 years, while allowing room for priority spending.

Text Table.

Republic of Congo: Government Capital Expenditure, 2005-07

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Source: Congolese Authorities, and Fund staff estimates.

21. For 2007, staff urged the authorities to pass a budget consistent with restoring macroeconomic stability. Oil revenue would decline because of slowing production from maturing oil fields and lower international prices. The staff proposed current primary expenditures decline marginally on account of lower transfers to the oil refinery, while capital spending increase to about 12 percent of GDP. The non oil primary balance would thus decline by about 5½ percentage points to 38.6 percent of non oil GDP. While this drop would reduce inflationary pressures, it would, nonetheless, loosen the non oil primary balance by 10 percent of non oil GDP, compared with the program target for the second review.

22. The authorities agreed there is a need for prudent fiscal policy in the long run, but argued for flexibility within each budget year for priority investments. For 2007, they argued that the social rate of return on railway, electricity, water, and sanitation projects outweighed the negative return on financial assets held at the BEAC. The authorities therefore originally proposed capital spending of 15 percent of GDP. While acknowledging the need to strike a balance between sustainability considerations and the country’s development needs, staff noted that the authorities’ proposed fiscal stance was unsustainable. The mission emphasized the need to undertake a fiscal adjustment starting in 2007 to move towards a sustainable non oil primary deficit. The authorities subsequently presented a budget in line with staff’s recommendation but indicated their wish to discuss additional capital spending for a possible supplementary budget, once improvements in public financial management had been implemented. In this context, the mission also underscored the need to accelerate implementation of public financial management (PFM) reforms to improve the transparency of oil revenue management and the quality of spending. Finally, given the envisaged increase in the government’s net asset position associated with the MTFS, the mission urged the authorities to seek ways to increase the rate of return on financial assets. The recent agreement to change the investment policies at the BEAC to increase the remuneration of reserves could help in this regard.

23. The authorities agreed on a policy of no new non-concessional external borrowing. They however did not share the staff’s recommendation that concessional loans should be contracted only if they do not jeopardize debt sustainability and are consistent with Congo’s strategy to enhance transparency and good governance. The mission urged the authorities to continue negotiating with all creditors (including litigating creditors) on terms consistent with the enhanced HIPC initiative.

Improving public financial management

24. The composition and quality of public spending in 2006 deteriorated sharply. Investment spending in health and education only accounted for 15 percent of total capital spending. In addition, subsidies to the national oil refinery were significantly higher than spending on primary education. A large portion of current expenditure was executed using exceptional spending procedures, and many public investment contracts were awarded without transparent procurement and open competitive bidding. For 2007, in the absence of adequate information, staff could not evaluate the authorities’ proposal to increase capital spending. The authorities shared staff’s advice to strengthen public finance management (PFM) (Box 2 and SIP, Chapter III). With assistance from the World Bank, they subsequently drafted a PFM action plan. Bank and Fund staff are of the view that this action plan is a good start but still requires improvements, including details on each action, as well as an extension to cover the reform of the expenditure chain and the management of public investment projects.

Staff Recommendations to Improve Public Financial Management

In cooperation with World Bank staff, the mission advised the authorities to

  • Implement a new functional classification of the budget to improve transparency and track poverty-related expenditures. The Fund is providing technical assistance, but progress so far has been slow.

  • Comply with the organic budget law, particularly in delineating responsibilities between the Ministry of Finance and the Ministry of Planning on investment spending.

  • Limit the recourse to exceptional spending procedures, consistent with the organic budget law.

  • Streamline current transfers, including by rapidly eliminating subsidies to the domestic refined petroleum products, to increase pro-poor and infrastructure spending.

  • Implement a new public investment management system, with World Bank assistance, to better align investment spending to the priorities in the PRSP.

  • Establish a new procurement code in line with best international standards.

  • Strengthen customs administration and the fight against tax fraud and corruption on the revenue side.

  • Improve the monitoring of the expenditure chain and control, with technical assistance from the Fund.

Reducing the cost of doing business

25. Congo ranks as one of the lowest countries in the world in terms of the ease of doing business. According to the World Bank database, the cost of starting a business, constraining labor legislation, difficulties in registering property and enforcing contracts, limited access to credit, and restrictions on border trade are particular concerns (Table 13). The mission underscored the importance of reforms that liberalize the price of energy and basic commodities, strengthen governance, develop the financial sector, and promote external trade (SIP, Chapters IV-VI).

Table 1.

Republic of Congo: Selected Economic and Financial Indicators, 2004–121

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Sources: Congolese authorities; and Fund staff estimates and projections.

In view of the structural shift in GDP starting in 2005 stemming from significantly higher oil prices, some of the ratios to GDP may not be comparable to past levels.

Projections for the GDP deflator are based on terms of trade projections, which include a prudence factor, with oil price projections reduced by US$10/barrel relative to weo price forecasts.

The large decline in net domestic assets for the projection period reflects an important buildup of assets in the oil revenue stabilization account.

Including grants.

Revenue (excluding grants) minus noninterest current expenditure minus domestically-financed capital expenditure and net lending.

Including public transfers.

From 2006 onward, oil revenue forecasts incorporate a prudence factor, with oil price projections reduced by US$10/barrel relative to WEO price forecasts.

Additional revenue that would be generated by using WEO forecasts for world oil prices, that is, without applying the prudence factor.

Table 2.

Republic of Congo: Central Government Operations, 2004–12

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Sources: Ministry of Economy, Finance, and the Budget; and Fund staff estimates and projections.

Excess oil revenue (which arises when operating costs of oil companies are lower than the limits stipulated in production-sharing agreements) is partly assigned automatically to cover an existing liability (HydroCongo).

Revenue (excluding grants) minus noninterest current expenditure minus domestically financed capital expenditure and net lending.

Including grants.

Excluding investment income.

From 2006 onward, oil revenue forecasts incorporate a prudence factor, with oil price projections reduced by US$10/barrel relative to WEO price forecasts.

Table 3.

Republic of Congo: Monetary Survey, 2004–07

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Sources: BEAC; and Fund staff calculations and projections.
Table 4.

Republic of Congo: Balance of Payments, 2004–12

(Billions of CFA francs, unless otherwise indicated)

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Sources: BEAC; and Fund staff estimates and projections.

Includes debt relief from Paris Club.

Percent of GDP.