Abstract
The Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility of Rwanda explains macroeconomic challenges. Indicative limits on domestic debt have been established. If these limits are exceeded or inflation is rekindled, the domestic component of fiscal spending must be released more gradually. On the structural side, the focus remains on public financial management (PFM) and the financial sector. The authorities’ financial sector development plan is a sound basis for building long-term financial markets.
June 25, 2007
I - Introduction
My Rwandese authorities would like to express their appreciation to staff for the well written set of papers and for the fruitful dialogue they had during the discussions held in Kigali on the second review under the Poverty Reduction and Growth Facility (PRGF). They are in broad agreement with the thrust of issues identified in the staff’s report and have consented to the Fund’s publication of the report.
My Rwandese authorities would also like to thank the Executive Board and Management for their continued support and advice. Mr. Portugal’s visit to Rwanda early last May gave to my authorities the great opportunity to reaffirm their strong commitment to reforms and adequate Fund-supported programs. This visit has also enabled the Deputy Managing Director to gain first-hand experience, not only the achievements made on economic and political fronts, but also of the daunting challenges facing Rwanda in its efforts to sustain growth and fight poverty. Exchanges with representatives of the private sector, civil society organizations, mass media and donors highlighted progress made by Rwanda since the genocide and underscored the strong support to authorities’ economic program and reform agenda.
Since June 2006, Rwanda is successfully implementing a three-year PRGF arrangement, in order to continue addressing challenges in achieving higher economic growth and reducing poverty. In line with program objectives, Rwanda’s macroeconomic performance continues to be strong, with growth rate higher than expected, inflation declined through April 2007, international reserves substantially exceeded program target in covering 5.5 months of imports at end-2006 and fiscal realizations in line with the targets. As a result, the program and structural reforms remain broadly on track. Indeed, all quantitative performance criteria set for end-2006 were met, except for the limit on net credit to government, due to delays in reimbursements from the African Union for Rwanda’s peacekeeping in Darfur. Two structural benchmarks related to issuing accounting instructions and publication of a fertilizer strategy were implemented with delays, owing to capacity constraints and technical difficulties beyond the authorities’ control. The third structural benchmark pertaining to the review of the wage structure has been converted into a new benchmark set for September 2007, as technical assistance is needed in carrying out this exercise.
In view of the overall satisfactory program performance and strong resolve to speed up the implementation of structural reforms, my Rwandese authorities request the completion of the second review under the PRGF arrangement and the waiver for the nonobservance of the quantitative performance criterion on net credit to government which was implemented with delay due to capacity constraints and modification of performance criteria due to further TA needs. My authorities are determined to achieve the objectives set out in the program meant to preserve macroeconomic stability, advance in reforms, boost growth and strengthen competitiveness.
II - Performance under the Program
The continued implementation of reforms has led to positive and significant macroeconomic developments in Rwanda. In 2006, despite adverse weather conditions on agricultural sector, economic growth was higher than estimated, reaching more than 5 percent thanks to buoyant activity in the manufacturing and services sectors.
In the fiscal area, performance was strong, reflecting the authorities’ determination to implement the fiscal program. The end-2006 target on the domestic fiscal balance was achieved with revenue mobilization higher than anticipated, due mostly to one-off VAT collections and non tax receipts. On the expenditure side, priority spending substantially exceeded the target with additional outlays for schools, water project and export promotion. In order to enhance public financial management, the authorities organized workshops to facilitate the implementation of the Organic Budget Law. They also decentralized the authority to effect expenditure commitments and transfers to budget agencies. In addition, the public procurement code was passed by the parliament and intergovernmental fiscal relations unit was established, with a view to report on local government finances. The audit of the peace keeping activities was also completed. Determined to avoid any delay in the reimbursements from the AU and comply with the limits on net credit to government, the authorities agreed on an appropriate payments’ timetable. They stand ready to cut other current expenditure to meet the target in the case of any delay in the reimbursements.
On the monetary front, inflation declined to 10 percent in April 2007 from 12 at end-2006. The international reserves substantially increased to exceed five months of imports. The real exchange rate appreciated by 4 percent and the authorities are concerned about the impact of a strong appreciation on exports. To prevent further appreciation, the authorities issued domestic papers, which helped to bring reserve money within the target set for end-2006. Regarding the current account position, the deficit narrowed more than expected, following continued good policy performances that encouraged private sector’s transfers and increase in export receipts.
On the structural front, the authorities have put emphasis on public finance management, poverty reduction, financial sector reform and private sector development. In this regard, it is worth noting that a national fertilizer strategy was developed and published in February aiming at increasing agricultural productivity to improve food security and reduce poverty in rural areas. A financial sector development plan was prepared and presented to donors for financing. The foreign exchange regulations were revised in addition to relaxing the auctions rules, in order to promote the foreign exchange market.
III - Outlook and Policies for 2007
The macroeconomic policy framework for 2007 remains consistent with the authorities’ objectives over the medium-term, namely ensuring broad-based economic growth to sustain poverty reduction and enhance Rwanda’s external competitiveness. As stated in the staff report, prospects for scaling up of aid are positive. The authorities are committed to the most productive use of resources with a view to preserve macroeconomic stability, accelerate growth and sustain poverty reduction.
In 2007, economic growth is projected to be in the range of 4.5 and 6.5 percent. Inflation is expected to decline to 5 percent, while international reserves would cover about 5 months of imports. The authorities intend to press ahead with their enhancement of public finance management and remove obstacles to private sector.
Fiscal Policy
The Rwandese authorities are strongly committed to implement prudent fiscal policy, notably in the context of substantial fiscal expansion resulting from a scaling up of aid. They will focus on preventing a crowding out of the private sector as well as building up of onerous domestic debt and rekindling inflation. In this regard, indicators on domestic fiscal balance and net credit to government will be closely monitored. On the revenue side, the revenue-to- GDP ratio will be maintained at 14.7 percent. In the case of revenue shortfalls, the authorities stand ready to increase the petroleum excise. As for expenditure, all new spending is for priority sectors, notably education, food security, Lake Kivu methane gas pilot project, infrastructure repairs and emergency assistance to flood victims. The action plan for the medium-term public financial management will be completed by end-2007. This plan designed to ensure full implementation of the organic budget law and financial regulations includes measures to improve on public accounts, budget preparation, budget execution and capacity building in the office of the Auditor General and the Internal Audit Department, through the technical assistance from the World Bank and AFRITAC. The diagnostic review of the Medium-Term Expenditure Framework covers the integration of the development and recurrent budget.
Monetary Policy and Financial Sector Reform
Monetary policy will continue to aim at achieving the inflation objective set for 2007. To this end, reserve money will remain the operational target and monetary management will be improved. The authorities intend to rebase the reserve money program and monitor its developments on a monthly basis. The growth of money reserve will be limited to 13 percent and further room for an expansion of credit to private sector. The management of excess reserves of banks will be tightened through the sales of foreign exchange to encourage a stronger interbank market. With these measures, inflation is expected to be reduced at 5 percent. In their efforts to enhance the exchange rate’s flexibility, the authorities will engage with banks in the preparations for an exit from the current auction system toward a fully-fledged interbank market.
The authorities will continue to enhance progress made in the financial sector reform. To improve banks’ capital base and tighten the licensing criteria, the minimum capital requirement for banks will be increased as of January 2008. Disinvestment of the Banque of Kigali is underway and during the transition period, an interim management was established. Moreover, the Financial Sector Development Plan (FSDP) includes strengthening the NBR’s supervisory functions, expanding access to credit and financial services, notably outside the capital, developing long-term finance and capital markets, consolidating regulation and supervision for nonbank financial institutions namely insurance companies and pension funds. Regarding the modernization of the payments system, the authorities aim at developing a national strategy on payments and establishing an automated clearing house. On the Anti- Money Laundering front, the authorities will establish a Financial Intelligence Unit to enforce the law, following its adoption by the Parliament.
Structural Reforms and Competitiveness
My Rwandese authorities are aware of the challenges facing the economy and the need to pursue implementation of their reform agenda. Sustaining economic growth and improving the country’s competitiveness require in particular boosting the agricultural productivity, finding lasting solution to the energy difficulties and improving the conditions of the private sector development. Remarkable progress has been achieved with regard to the public finance management and financial sector reform. The authorities are exploring various options to increase the electricity supply, including the Lake Kivu methane gas pilot project and a heavy-fuel oil generator. Electrogaz’s management was strengthened and its financial situation is expected to improve in the medium-term. A structured tariff has been introduced and further adjustments are scheduled. Reforms in the Justice and land sectors were accelerated, in order to improve the business environment. In this respect, a three-year project in partnership with the private sector was launched last May, with a view to address legal and regulatory constraints facing investors and businesses. In the same vein, the authorities will speed up their efforts to invest in infrastructure and promote new information technologies and communication networks to further attract private investment.
As regards the regional trade and integration, the Rwandese authorities are developing an implementation roadmap for joining by June 2009 the East African Community’s Customs Union Protocol.
With regard to poverty reduction, my authorities are reviewing policies and outcome indicators in updating the PRSP. They will intensify their efforts to tackle extreme poverty by improving food security and fostering job creation. The revised strategy will focus on schemes to raise agricultural productivity and address population issues, including growth rate. As poverty remains concentrated in rural areas, increasing agricultural productivity is crucial. Accordingly, the agricultural strategy will be finalized in time to enable its implementation with the 2008 budget.
On debt sustainability, the authorities remain committed to pursuing prudent debt management.
IV - Conclusion
My Rwandese authorities have continued to demonstrate their strong commitment to implementing sound policies and reforms, which have resulted in appreciable economic performances. Based on the satisfactory program implementation, I would appreciate Directors support of my authorities’ request for the completion of the second review under the PRGF arrangement and waiver of nonobservance of performance criterion and modification performance criteria. The Rwandese authorities thank the international community and the Fund for their continued assistance. They remain committed to achieve the objectives and implement policies set forth under the PRGF arrangement.