Republic of Congo: Selected Issues Paper
Author: International Monetary Fund
Publication Date:
18 Jun 2007
eISBN:
9781451808636
Language:
English
Keywords:
ISCR; CR; Congo; fiscal policy; authority; regime; expansionary fiscal policy path; crude oil type; prudent fiscal policy; permanently sustainable nonoil primary deficit; nonoil deficit; Oil; Oil production; gas and mining taxes; Oil prices; Sub-Saharan Africa
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This Selected Issues paper on the Republic of Congo analyzes the challenges of sustainable growth in the Republic of Congo. The paper highlights that it is paramount for the authorities to avoid repeating the experience of the 1980s, particularly in light of the projected decline in oil production over the next decade. It proposes a macroeconomic policy strategy that takes advantage of this unique opportunity to foster higher sustainable growth. The paper also provides a summary of various recent assessments of the quality of the Congo's public financial management system.

Abstract

This Selected Issues paper on the Republic of Congo analyzes the challenges of sustainable growth in the Republic of Congo. The paper highlights that it is paramount for the authorities to avoid repeating the experience of the 1980s, particularly in light of the projected decline in oil production over the next decade. It proposes a macroeconomic policy strategy that takes advantage of this unique opportunity to foster higher sustainable growth. The paper also provides a summary of various recent assessments of the quality of the Congo's public financial management system.

II. A Medium- Term Fiscal Strategy3

A. Introduction

16. Countries abundant in natural resources face a number of policy challenges, particularly in the fiscal area, relating to sustainability in the management of these resources. The volatility of commodity prices makes it particularly important that such countries pay attention to the debt dynamics of fiscal policy over the medium- to long-term. In addition, the limited amount of natural resources imposes another important challenge for fiscal policy over the medium- and long-term, namely to strike the right balance between spending now and saving for the future when natural resources will be depleted. This chapter examines these key policy issues in the context of the Republic of Congo.

17. Congo’s economic history since the 1970s illustrates the dangers of following a procyclical fiscal policy in a heavily oil-dependent economy, and not saving a sufficiently large share of current oil revenues to ensure the sustainability of fiscal policy in the medium- and long-run. The limited success of many oil-producing countries in using their oil resources wisely to improve living standards for the average citizen, including Congo’s experience in the 1980s, also underscores the importance of adopting a comprehensive medium-term fiscal strategy. The key challenge for Congo’s fiscal strategy is the accumulation of sufficient financial assets over time so as to prevent a decline in living standards as the country’s oil resources are depleted. This is especially important since oil production in Congo is projected to peak in 2010 and decline thereafter (Figure II.1). Given the existing weaknesses in Congo’s public expenditure management system, obtaining the maximum benefits from the utilization of the nation’s oil revenues will require that steps also be taken to significantly improve the quality of public spending (see Chapter III).

Figure II.1.
Figure II.1.

Republic of Congo: Oil production, 2000-12

(Thousands of barrels per day)

Citation: IMF Staff Country Reports 2007, 206; 10.5089/9781451808636.002.A002

Source: Congolese authorities data and projections.

18. This chapter is organized as follows. Section II provides some background on Congo’s past experience with the management of oil resources, including the crisis of the second half of the 1980s. The key elements of a medium-term fiscal strategy to avoid a repeat of such a crisis are outlined in Section III. Section IV concludes.

B. Background

19. Congo’s economic history since the 1970s illustrates the dangers for macroeconomic stability of following a procyclical fiscal policy in a heavily oil-dependent economy. The oil boom of the 1970s and early 1980s (Box II.1) encouraged the Congolese authorities to adopt in 1981 an ambitious Five-Year Economic and Social Development Plan, underlying which was an expansionary fiscal policy path (Table II.1, Figure II.2). Government investment rose by an average annual rate of 15 percent in the first half of the 1980s. Even though current expenditure was curtailed, the domestic financial imbalances, which had widened in the second half of the 1970s, continued to deteriorate in the first half of the 1980s. In addition, the country’s external indebtedness, which had already grown rapidly in the 1970s and early 1980s to finance domestic investment, doubled between 1980-84 and 1985-89, resulting in an unsustainable debt path.

Table II.1.

Republic of Congo: Key Fiscal Indicators, 1971-2005

(Percent of GDP, unless otherwise indicated)

article image
Source: Congolese authorities, and Fund staff estimates.
Figure II.2.
Figure II.2.

Republic of Congo: Key Fiscal Indicators, 1971-2005

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 206; 10.5089/9781451808636.002.A002

Source: Congolese authorities, Fund staff estimates and World Bank World Development Indicators.

20. The rapid rise in the public sector during the oil boom years of the early 1980s, including in the form of large public employment creation, partly provided the seeds for the subsequent long decline in output. The oil bonanza came to an end in the second half of the 1980s, when oil prices declined to an average of $18 per barrel during 1986-90 (from an average of $31 per barrel during 1981-85). In view of the associated significant decline in oil revenues, the government undertook some fiscal adjustment measures, including in the context of an IMF Stand-By Arrangement launched in August 1986. However, the government’s policy response to the terms of trade shock in the second half of the 1980s was slow and limited, relying mainly on cuts in government investment spending and limited structural reforms. As a result, economic activity stagnated, fiscal and external imbalances widened markedly, and the external public debt and debt-service burdens grew to unsustainable levels. In addition, large domestic and external payment arrears accumulated.

The Oil Sector in the Republic of Congo

Congo was in 2005 the sixth largest oil producer in sub-Saharan Africa, after Nigeria, Angola, Sudan, Equatorial Guinea and Gabon. This sector is today the country’s primary source of economic growth. The country is heavily dependent on its oil sector, which accounts for about half its GDP, and more than 80 percent of government revenues and merchandise exports. According to 2006 estimates by the Oil and Gas Journal (OGJ), Congo has 1.5 billion barrels of proven oil reserves, most of which are located offshore. One of the more recent oil discoveries in 2004 was the onshore M’ Boundi field, with proven reserves of 250 million barrels. Based on geological data, undiscovered reserves are estimated at 5.8 billion barrels on a risk-weighted basis. Congo’s crude oil types are typically medium and sweet.

Oil production in Congo commenced in the 1950s, and expanded rapidly in the 1980s and 1990s to reach a first peak in 2000. Production started in 1957 from the onshore Pointe Indienne field, which reached a peak output of about 2,500 barrels per day in the mid-1960s. During the 1980s and 1990s Congo’s crude production quadrupled, from 65,000 barrels per day in 1980 to an average of 280,000 barrels per day in 2000. Since then production has been falling, largely due to a decline in production at mature fields, and delays in bringing several new fields online. Crude oil production fell from an average of 265,000 barrels per day in 2000 to 224,000 barrels per day in 2004. However, oil production hast started to rebound and will continue to do so over the medium-term as new fields (including the M’Boundi field onshore, and the Moho-Bilondo field offshore starting from 2008) come online and offset declining output at more mature fields. Approximately 35 to 50 percent of the oil produced goes directly to the government and is mostly sold by the national oil company, the SNPC. The rest goes to the international oil partners, based on bilateral oil sharing contracts.

Oil production in Congo is expected to peak in 2010, at over 350,000 barrels per day, and may then fall at a fairly rapid pace thereafter—with important consequences for fiscal oil revenues. The authorities’ projections, however, assume annual oil production to be constant from 2012 onwards instead of declining, the assumption being that production from new oil fields could compensate for declining oil production from maturing fields. The authorities’ projections may be on the conservative side to the extent that a ‘prudence’ factor of $10 per barrel is deducted from the World Economic Outlook (WEO) oil price projections.

21. The fiscal imbalances of the late 1980s were followed by a large devaluation and a significant decline in per capita GDP. Given the magnitude of the macroeconomic imbalances in the late 1980s and early 1990s, it became clear by 1993 that fiscal adjustment alone would not be sufficient to restore external competitiveness because nominal domestic prices showed considerable downward rigidity. In addition, the onset of civil war in Congo in 1993-94 further complicated macroeconomic management. The CFA franc was devalued by 50 percent in January 1994 to restore competitiveness and boost exports. As a result, per capita GDP declined from its peak of US$1,390 in 1984 to about US$980 in 1995 (both in constant 2000 US dollars), resulting in a large increase in the incidence of poverty (see below). Over the following decade, successive economic programs supported by the IMF went off track, owing to further political instability, weak fiscal discipline, and insufficient resolve to implement structural reforms, especially in the oil sector.

22. In summary, Congo’s lack of a fiscal strategy in the 1980s consistent with the preservation of the nation’s oil wealth resulted in unsustainable growth, and an eventual sharp decline in living standards. Even though Congo’s human development index is higher than the average for sub-Saharan Africa and for both oil- and non-oil producing PRGF-eligible countries, it has been falling steadily since 1985 (Figure II.3). Moreover, poverty remains widespread: a recent household survey, completed in early 2006, shows that 42 percent of households and 51 percent of individuals live below the poverty line, and that pockets of poverty are equally distributed in urban and rural areas. Over the past decade Congo has also fallen significantly behind other developing countries, including oil-producing PRGF-eligible countries, in per capita GDP growth performance.

Figure II.3.
Figure II.3.

Republic of Congo: Human Development Index and Growth

Citation: IMF Staff Country Reports 2007, 206; 10.5089/9781451808636.002.A002

Sources: IMF, World Economic Outlook, and United Nations Development Program.1 Includes only countries for which data are available for all periods.

C. Key Elements of a Medium-Term Fiscal Strategy

Preserving Oil Wealth for Fiscal Sustainability

23. A key issue for an oil-producing country like Congo is not only whether a particular fiscal policy stance is sustainable in terms of its debt dynamics, but also whether it is sustainable in terms of preserving the nation’s oil wealth so as to prevent a decline in living standards when oil production declines. Using the ‘primary gap’ approach, a higher level of GDP growth will, ceteris paribus, automatically make a country’s fiscal position more sustainable. From a wider perspective, however, the opposite may be true if the higher output growth results from a faster rate of natural resource depletion which threatens the long-term sustainability of per capita real income (and, hence, living standards) in the future.

24. For oil-producing countries (OPCs) with large exhaustible oil resources, it is appropriate for the analysis to incorporate the following three considerations:

  • First, the projection period should be long enough to consider whether the debt-to-GDP ratio is expected to stabilize at a level that can be maintained indefinitely after oil resources are exhausted.

  • Second, the exhaustible nature of oil resources raises important intergenerational distributional issues, which can be best taken into account in expressing spending as a percentage of nonoil GDP, which reflects the increasing needs of the government in the context of a growing economy.

  • Third, the nonoil primary fiscal balance (that is, total nonoil revenue less nonoil non-interest expenditure) provides a clearer indicator of the fiscal policy stance for OPCs because it filters out fluctuations in revenue due to swings in international oil prices. 4

The analysis that follows incorporates these three considerations.

25. Based on this methodology developed by Leigh and Olters (2006) for Gabon, we propose the estimation of a sustainable primary balance expressed as a percentage of nonoil GDP that takes into account oil resources depletion and allows for progressive adjustment. Intertemporal optimization with habit formation lies at the core of the paper’s analysis. According to the permanent income hypothesis, the optimal policy is defined as a path of government spending that smoothes consumption over time and is consistent with the government intertemporal budget constraint. The optimal spending level depends on a number of factors, among them the future path of oil and non-oil tax revenues and the real interest rate. Expenditure is measured as a share of nonoil GDP.5

26. The analysis in this paper goes one step further and allows for the realistic possibility of negative growth-adjusted interest rates during a temporary period of rapid catch-up growth. This approach differs from a number of studies that assume that the real interest is always larger than the growth rate. Instead, we assume that the interest rate and the growth rate of nonoil GDP can vary over time, but that both rates are constant in the long-run and that the interest rate will be then over the growth rate.

27. Under these assumptions, the optimal policy is to set spending equal to permanent income, i.e., to the return on the present discounted value of all future oil and nonoil revenues. The full-fledged model underlying our simulations is presented in Carcillo, Leigh, and Villafuerte (2007). The calibration of the model is presented in Box II.2.

Results and Sensitivity tests

28. Three main results emerge from the simulation of the model, starting from the 2005 non-oil primary deficit level of 29 percent of non-oil GDP 6 (Table II.2 presents the results):

Table II.2.

Republic of Congo: Sensitivity Analysis

article image
Source: Fund staff projections.

The Congolese oil price is lower due to the quality discuount.

Long-run values, which hold from 2016 onwards.

  • First, the current level of the non-oil primary deficit is not sustainable. If the nonoil primary deficit is maintained at the 2005 level of 29 percent of nonoil GDP, debt will eventually explode. Under the baseline assumptions, the permanently sustainable nonoil primary deficit (PSNOPD) is estimated to be about 13 percent of nonoil GDP.

  • Second, the optimal path involves spreading the bulk of the adjustment over a period of five years. Under baseline parameters, the nonoil deficit would decline by 9 percentage points to 20 percent of non-oil GDP by 2011—close to 60 percent of the total adjustment required. Figure II.4 shows that the substantial overall primary surpluses that would materialize during this period—needed to pay off debt and accumulate sufficient financial assets. From a fraction of the returns on those assets, it then finances the non-oil deficit in the post-oil period. By contrast, a strategy of stabilizing net debt at a positive level would not be consistent with running a permanent deficit in the post-oil era. As oil reserves are exhausted, the primary surpluses decline and converge to the permanently sustainable level of 13 percent of GDP in 2026, some years before oil revenue is assumed to dry up.

  • Third, the level of the PSNOPD depends on the speed of adjustment. Figure II.5 shows how the estimated PSNOPD varies for different speeds of adjustment. For example, while the baseline scenario is consistent with completing more than 60 percent of the adjustment within 5 years, extending this period to 20 years would halve the PSNOPD to only 8 percent of nonoil GDP.

Figure II.4.
Figure II.4.

Republic of Congo: Optimal Fiscal Adjustment Path

(Baseline Assumptions, 2005-60)

Citation: IMF Staff Country Reports 2007, 206; 10.5089/9781451808636.002.A002

Source: Fund staff projections.
Figure II.5.
Figure II.5.

Republic of Congo: Tradeoff Between Adjustment Speed and Estimated PSNOPD

Citation: IMF Staff Country Reports 2007, 206; 10.5089/9781451808636.002.A002

Source: Fund staff projections.

Calibration of the model for the Republic of Congo

The following assumptions were made to establish the baseline projection for future real oil revenue:

  • The baseline projection for oil prices is based on the February 2007 World Economic Outlook (WEO) projections for 2007–12. Accordingly, the oil price is projected to average $64 per barrel over the 2008-12 period. In the long run, the price will stabilize at $63 per barrel.

  • As for future oil output, it as assumed that Congo has oil reserves of at least 2 billion barrels, somewhat higher than the current proven reserves. Annual oil production is expected to decline from its current level by about one-half in twenty years and to be exhausted in about thirty years (Figure II.3).

  • The paper assumes that the long-run oil tax rate will be 47 percent in the baseline scenario, 41 percent in the low price scenario, and 53 percent in the high price scenario, consistent with the average oil sharing contract for Congo. The non-oil tax rate is kept constant at the 2005 level of 18 percent.

  • It is also assumed that the long-run real interest rate equals 4 percent, below the current 4.4 percent paid on debt which is supposed to hold for another five years (2006-11).

  • The non-oil growth rate, γ, is set at 2 percent in the long-run, below the current 6.5 percent which reflects a catch-up period, and is supposed to hold during 2006-11, and decline to its long-run level over the following five years.

29. The result that the 2005 deficit is unsustainable is robust, even under the most favorable assumptions, based on a range of sensitivity tests on all the parameters in the model (Table II.2). For example, even if total reserves were to increase by 30 percent relative to the baseline, the sustainable nonoil deficit would rise to 16 percent of nonoil GDP, still well below the actual 2005 level. If the authorities succeeded in raising the tax take on oil GDP by 5 percentage points under the baseline assumptions, the PSNOPD would increase to 15 percent of nonoil GDP, also well below the current level.

30. Overall, the above analysis indicates that a larger share of oil revenues should be saved for future generations than is being contemplated at the present time. In this context, a prudent fiscal policy would target a steady rise in the nonoil primary balance, from a projected deficit of 44 percent of nonoil GDP in 2006, moving towards a deficit of about 15 percent by 2015, representing most of the adjustment required to reach the sustainable level of 13 percent of nonoil GDP by 2025.

31. A sensible fiscal policy would also require sound judgment regarding the absorptive capacity of the economy to accommodate higher government spending at the technical, institutional and infrastructural levels. Given the lack of infrastructure in the country, there is a need for productive investment in physical infrastructure, health, and education, particularly in the context of meeting the MDGs. At the same time, attention needs to be paid to technical, institutional, and infrastructural capacity constraints and bottlenecks that are likely to be faced in the context of a rapid and overambitious expansion of government spending in these sectors, thereby generating inflationary pressures. It is thus critical that efforts should continue to improve the quality and efficiency of capital expenditures, including through the adoption and implementation of a new public investment management system. As Takizawa et al (2004) note, when the efficiency of government spending increases over time, in countries such as Congo which suffer not only from poor infrastructure but also from weak institutions, there are likely to be greater advantages to postponing spending to when it can be used more effectively.

D. Conclusion

32. In assessing Congo’s fiscal-policy options during the remaining years of oil production, this paper reaches three main conclusions. First, Congo’s current non-oil primary deficit is not sustainable. The permanently sustainable non-oil primary deficit, estimated at 13 percent of nonoil GDP, is well below the level of 29 percent or 44 percent of nonoil GDP in 2005 and 2006, respectively. Second, the presence of habit formation implies that the optimal policy involves spreading the bulk of the adjustment over a number of years, rather than conducting the single, abrupt adjustment that standard permanent income models without habits prescribe. Third, there is a tradeoff between slower adjustment and a lower long-run sustainable nonoil deficit. Uncertainty regarding future economic conditions would provide a risk-averse policymaker with precautionary motives for front-loading the adjustment. Finally, the quality of public expenditure should improve over time as public financial management is enhanced and an appropriate growth and poverty-reduction strategy developed, providing greater assurance that government spending could generate adequate growth and social pay-offs.

References

  • Stéphane Carcillo, Daniel Leigh, and Mauricio Villafuerte, 2007, “Catch-Up Growth, Habits, Oil Depletion, and Fiscal Policy: Lessons from the Republic of Congo”, IMF Working Paper No. 07/80, International Monetary Fund, Washington, D.C., forthcoming.

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  • Daniel Leigh and Jan-Peter Olters, “Natural-Resource Depletion, Habit Formation, and Sustainable Foscal Policy: Lessons from Gabon”, IMF Working Paper WP/06/193, International Monetary Fund, Washington, D.C., August 2006.

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  • Hajime Takizawa, Edward Gardner, and Kenichi Ueda, “Are Developing Countries Better Off Spending Their Oil Wealth Upfront?”,”, IMF Working Paper WP/04/141, International Monetary Fund, Washington, D.C., 2004.

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3

Prepared by Stéphane Carcillo, based on Carcillo, Leigh and Villafuerte (2007).

4

As oil revenue is exhausted, the nonoil fiscal balance converges towards the overall primary balance used in traditional DSA analyses.

5

Choosing to measure expenditure in real terms instead of as a share of nonoil GDP would imply, under standard assumptions, a constant path of government spending in real terms out of net government wealth (whereas expenditure would increase in real terms when using the share-of-non-oil-to-GDP criterion). Assuming a positive rate of non-oil GDP growth, this criterion would also imply the need for a continuous adjustment in the non-oil primary deficit in percent of non-oil GDP until the oil wealth is depleted in real terms.

6

The nonoil primary deficit considered here includes foreign-financed capital investment, which is excluded instead in the definition in the accompanying Article IV staff report.

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Cover IMF Staff Country Reports
Republic of Congo: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2007: Issue 206
Publisher:
International Monetary Fund
ISBN:
9781451808636
ISSN:
1934-7685
Pages:
102
DOI:
https://doi.org/10.5089/9781451808636.002
  • View in gallery

    Republic of Congo: Oil production, 2000-12

    (Thousands of barrels per day)

  • View in gallery

    Republic of Congo: Key Fiscal Indicators, 1971-2005

    (Percent of GDP)

  • View in gallery

    Republic of Congo: Human Development Index and Growth

  • View in gallery

    Republic of Congo: Optimal Fiscal Adjustment Path

    (Baseline Assumptions, 2005-60)

  • View in gallery

    Republic of Congo: Tradeoff Between Adjustment Speed and Estimated PSNOPD

Republic of Congo: Oil production, 2000-12

(Thousands of barrels per day)

Republic of Congo: Key Fiscal Indicators, 1971-2005

(Percent of GDP)

Republic of Congo: Human Development Index and Growth

Republic of Congo: Optimal Fiscal Adjustment Path

(Baseline Assumptions, 2005-60)

Republic of Congo: Tradeoff Between Adjustment Speed and Estimated PSNOPD