Democratic Republic of the Congo
Review of the 2006 Staff-Monitored Program and a New Staff-Monitored Program for 2007: Staff Report; Staff Statement; Statement by the Executive Director for the Democratic Republic of the Congo

This paper reviews the 2006 Staff-Monitored Program (SMP) and a New Staff-Monitored Program for 2007 for the Democratic Republic of the Congo. Most quantitative and structural benchmarks under the SMP for April–December 2006 were not met; nevertheless, the SMP helped prevent major financial instability during the protracted electoral period. Cognizant of the need to reestablish macroeconomic stability, the government agreed on a policy framework for 2007 to be monitored by the IMF staff. Satisfactory performance under the SMP would open the way for discussions on a new arrangement under the Poverty Reduction and Growth Facility.

Abstract

This paper reviews the 2006 Staff-Monitored Program (SMP) and a New Staff-Monitored Program for 2007 for the Democratic Republic of the Congo. Most quantitative and structural benchmarks under the SMP for April–December 2006 were not met; nevertheless, the SMP helped prevent major financial instability during the protracted electoral period. Cognizant of the need to reestablish macroeconomic stability, the government agreed on a policy framework for 2007 to be monitored by the IMF staff. Satisfactory performance under the SMP would open the way for discussions on a new arrangement under the Poverty Reduction and Growth Facility.

I. Introduction

1. The protracted election period and security tensions made it difficult for the government to implement the staff monitored program in 2006. Key quantitative and structural benchmarks for end-September and end-December were missed (Appendix I, Tables 1 and 2).

Table 1.

Democratic Republic of the Congo: Selected Economic and Financial Indicators, 200407

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Sources: Congolese authorities and IMF staff estimates and projections.

Change in annual average. Minus sign indicates depreciation.

Includes interest due before debt relief and expenditure financed by HIPC resources.

Cash balance after debt relief on interest payments.

From 2003 onward, includes investment financed by resources released under the enhanced HIPC Initiative.

End-of-period debt stock includes accumulated arrears and reflects the arrears clearance arrangements concluded at the HIPC decision point. The increase in the projected stock-of-debt at end-2006 reflects the postponement of the HIPC completion point from 2006 to 2007.

Estimates and projections based on end-2002 DSA and after HIPC Initiative assistance assuming completion point in 2007, and includes assistance beyond the terms of the enhanced HIPC Initiative granted by some Paris Club creditors. Exports are on a three-year backward moving average.

Table 2.

Democratic Republic of the Congo: Central Government Financial Operations, 2004–07

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Sources: Congolese authorities and IMF staff estimates and projections.

Reflects revised calculation of HIPC Initiative assistance from 2002-based Debt Sustainability Analysis (DSA).

For 2004 and 2005, program figures reflect a change in classification of retirement allowances as part of exceptional spending.

For 2005, interest payments include rescheduling agreements with commercial creditors under the enhanced HIPC Initiative.

Exceptional expenditure includes spending for the Demobilization, Disarmament, and Reintegration (DDR) program, cost of the elections, payments for retirement allowances, repayments of domestic arrears, and payment for bank

For 2005, HIPC Initiative savings used for pro-poor wages and domestic investment were recorded under wages and domestic-financed investment.

Internal and external arrears.

Underlying fiscal balance is defined as revenue minus expenditure and excluding interest on foreign debt, foreign-financed capital expenditures, all exceptional spending and repayment of domestic arrears. Difference between estimated figure for 2005 and the one reported in IMF Country Report No. 05/347 reflects the change in definition to exclude all exceptional spending.

2. The new government prepared with Fund staff a policy framework for 2007 that is spelled out in the attached Letter of Intent (Appendix I) and will be monitored by staff. Progress in implementing this framework and meeting the quantitative and structural benchmarks for end-June 2007 would allow for the start of discussions on a medium-term program that could be supported by the Fund under a new PRGF arrangement. In turn, completion of the first review of the new PRGF arrangement would be one of the conditions for the DRC to reach the completion point and benefit from debt relief under the enhanced HIPC Initiative and the Multilateral Debt Relief Initiative (MDRI).

3. The SMP for 2007 is a first step toward implementing the program of the new government endorsed by the National Assembly in February 2007. The program, which draws on the PRSP adopted in July 2006, emphasizes five priority sectors to rebuild the country—infrastructure, employment, education, water, and electricity—and includes a compact to strengthen governance. The government is fully aware that implementing a strong set of policies is essential for meeting the population’s high expectations that the free and democratic elections would bring a rapid improvement in living conditions.

4. The first free and democratic elections in more than 40 years were a success. The elections of the President and the National Assembly ended three years of the political transition. A new government headed by Prime Minister Gizenga was confirmed by the National Assembly on February 23; it comprises 60 ministers and deputy ministers, representing a broad coalition supporting the President. Given the size of the government, however, policy coordination may remain a challenge. Furthermore, the armed confrontation that erupted in Kinshasa on March 22-23 demonstrates the fragility of the political and security situations and the need to strengthen them for the government to focus on stabilizing the economy.

II. Recent Developments and Performance Under the SMP

5. Macroeconomic performance fell short of objectives in 2006. By the end of last year, gross international reserves stood at US$150 million compared with the SMP target of US$247 million, the Congo franc had depreciated by 15 percent against the US dollar, and 12-month inflation had risen to 18.2 percent, compared with a target of 9.5 percent. The government also did not service its debt to official bilateral creditors amounting to US$58 million in the second half of 2006. Real GDP growth slowed slightly to 5.1 percent, owing to stagnating output in mining and manufacturing.

Figure 1.
Figure 1.

Democratic Republic of the Congo: Fiscal Developments, 2004–06

Citation: IMF Staff Country Reports 2007, 328; 10.5089/9781451808421.002.A001

Source: Congolese authorities and IMF staff estimates.

6. An easing of fiscal policy was mainly responsible for last year’s poor performance. The underlying fiscal surplus amounted to only ½ percent of GDP in 2006 compared with a target of 2.2 percent.1 As in the past, the government continued to have difficulties containing money financed current expenditure—especially for sovereignty and security. In addition, central bank losses were twice as large as anticipated (0.5 percent of GDP) mainly because of a large increase in operating expenses. Capital expenditure was much less than targeted, because the execution of foreign-financed projects slowed down during the elections. On a more positive note, an improvement in tax administration, achieved with Fund-supported technical assistance, led to a better-than-anticipated revenue performance.

7. A tightening of monetary policy in late 2006 was unable to mop up the excess liquidity resulting from money-financed government expenditure. The central bank increased interest rates by 16.5 percentage points to 45 percent and doubled reserve requirements to 4 percent in September-October 2006. While this led to an increase in the outstanding stock of central bank bonds to a modest 0.4 percent of GDP by end-2006, this was not sufficient to prevent broad money from expanding by 60 percent last year.

Figure 2.
Figure 2.

Democratic Republic of the Congo: Monetary Developments, 2004–06

Citation: IMF Staff Country Reports 2007, 328; 10.5089/9781451808421.002.A001

Source: Congolese authorities and IMF staff estimates.

8. The macroeconomic situation worsened in early 2007, before the formation of a new government. It took three months for the new government to be formed and approved by Parliament in late February. The resulting political vacuum led to further overspending that the Central Bank of the Congo (BCC) was unable to offset by increasing interest rates further to 50 percent. Hence, in the first two months of 2007, the Congo franc slid a further 12 percent, 12-month inflation rose to 21 percent, and international reserves dropped to about US$100 million or 1½ weeks of non-aid related imports. Preliminary budget reports also indicate that the government was unable to settle in the first months of 2007 all domestic payment orders issued toward the end of 2006, resulting in a possible accumulation of arrears.

9. Since March 2007, a tightening of policies has helped stabilize the economic situation. Better than anticipated government revenue and a tightening of government spending led to a reduction of ½ percent of GDP in net bank credit to the government. International reserves recovered to $160 million in April, from $100 million at end-February, as oil companies made large tax and royalty payments in US dollars. The exchange rate appreciated somewhat in March-April.

10. The DRC continued not to service its external debt owed to official bilateral creditors in the first quarter of 2007. The government communicated these difficulties to the Paris Club secretariat in April 2007. It reiterated its commitment to strengthen economic policy implementation, to prepare a medium-term program eligible for IMF financial support and to normalize the DRC’s relations with Paris Club creditors as soon as possible. In addition, the government indicated that it would continue to seek debt relief on comparable terms from all other external creditors.

III. The Program for 2007

11. With a democratically-elected President and Parliament, the DRC is entering a new era. Capitalizing on the mandate received from voters, the new government has an opportunity to demonstrate its determination to strengthen macroeconomic stability, fight corruption, and pursue structural reforms. The challenge is to strengthen macroeconomic management to set the stage for sustainable growth and poverty reduction. Improved public financial management, governance, and accountability are crucial for the government to balance high expectations of the population with tight resources, including limited external budget support.

A. Macroeconomic and Structural Policies

12. Macroeconomic targets for 2007 reflect continued recovery of the economy from a low base. Real GDP growth is expected to reach 6.5 percent on the back of a rebound in mining and manufacturing, and investments in infrastructure and social sectors. End-of-period inflation is projected to decline to 12 percent, assuming a tightening of fiscal policy. The international reserve target is set at 3 weeks of non-aid related imports, taking into account the low level of external budget support expected thus far.

13. The authorities agreed with the mission on the need to tighten fiscal policy. The key objective is to refrain from financing government spending through domestic bank credit for the rest of 2007 to reduce pressure on the Congo franc and inflation. This is a challenging objective, given limited scope for increasing government revenue in the short term, the lack of untied external budget support currently expected, projected debt service payments, and likely pressures to increase civil service salaries. In the draft budget for 2007, which the authorities intend to submit to the Parliament in May, the target for the underlying fiscal surplus (cash-basis) was set at 1.3 percent of GDP, compared with 0.5 percent of GDP achieved in 2006.2 Nevertheless, there remains a financing gap of US$85 million (0.9 percent of GDP) if arrears on external debt service and domestic bank financing of the budget are to be avoided in 2007. Staff emphasized the urgency of mobilizing donor funding and recommended that the government hold back on spending as much as possible until additional external support is mobilized.3 Staff also explained the difficult budget situation to donors and the risk that the DRC would be unable to service all external debt falling due in 2007 without additional support.

14. The mission urged the authorities to be cautious in setting an objective for government revenue in 2007. Initially, the new government believed it could increase revenue rapidly by combating corruption in tax administration. While recognizing that fighting corruption was essential, staff pointed out that improving tax administration was in general a slow process showing large benefit mostly over the medium term. It would also be a challenge to offset a drop in oil revenue, projected at 1.1 percent of GDP, resulting from lower international prices.4 Thus, the government agreed that an ambitious target would be to keep total government revenue unchanged in 2007 at 13¼ percent of GDP. The authorities expect that ongoing tax administration reforms, especially improved controls at the border, will increase government revenue by 0.8 percent of GDP. In addition, starting on July 1, 2007, the government will increase the main rate of the turnover tax from 13 percent to 15 percent, a measure anticipated to yield ½ percent of GDP on an annual basis.

15. The government aims at reducing non-interest current spending relative to GDP to 10 percent in 2007, bringing it back to its pre-election level. The bulk of the effort will come from tightening non wage and non-interest current spending, which is targeted to decline by 1.0 percentage points to 4.5 percent of GDP in 2007, largely through better control over spending for sovereignty (see below). At the same time, outlays for health and education are to increase to 2.9 percent of GDP in 2007. Exceptional spending—mainly foreign financed outlays for the elections—would decline by 3 percentage points of GDP, while spending on public investment would increase by 0.3 percentage points of GDP to a still moderate 3.7 percent of GDP.

16. The government has committed to keep the wage bill at 5.5 percent of GDP in 2007, as in 2006. To strengthen control over the size of the civil service, the government is determined to implement measures to strengthen the payroll, complete the civil service and military censuses, and standardize civil service enrollment procedures. The authorities are also assessing the possibility of incorporating previously unpaid teachers into the civil service and granting a moderate pay increase starting in July 2007, while observing the ceiling for the wage bill. The authorities have also started work on a broad reform of the civil service with the assistance of the World Bank. In addition, the government is committed to improving control over the military payroll with the support of the international community (Appendix I, paragraph 16).

17. The government agreed that strengthening of public financial management is a high priority. The objective is to enhance the efficiency of public spending through greater transparency. The government is committed to strictly observe spending ceilings included in the monthly spending commitment plan and cash flow plan, which are posted on the internet. Particular attention will be paid to controlling spending for sovereignty (security, the Parliament, the Presidency and cabinets of ministries), which accounted for most of overspending in the past. To be successful, however, this will require a strong commitment on the part of the government as well as an improved security situation. The mission also urged the authorities to enforce spending procedures and reduce cash advances, which often bypass procedures. Another important aspect is the strengthening of the management of government accounts at the central bank, with weaknesses in accounting and audit frameworks to be addressed in the coming months (benchmarks for end-June 2007).

18. The government is seeking assistance from the Fund and other donors to deal with the challenges created by the transfer of revenue in the context of devolution. Under the constitution, 40 percent of government revenue collected in a province is to be transferred to the provinces and an additional 10 percent is to finance an equalization fund for all the provinces. The government has drafted two laws specifying how devolution is to be implemented. Staff urged the authorities to implement such a reform over a long timeframe to avoid weakening public resource management. It emphasized the importance (i) for the central government to retain fiscal control and for provinces to implement budget procedures and monitoring mechanisms; and (ii) for higher revenue transfers to be commensurate with a transfer of spending responsibilities and improved local government capacity. The mission indicated that Fund staff was ready to work with the World Bank and other donors in assisting in the preparation of a framework for the devolution of revenue and expenditure responsibilities to provinces.

19. Reining in inflationary pressures through a tight monetary policy will remain a challenge for the BCC. The effectiveness of monetary policy is constrained by the high dollarization of the economy—90 percent of bank deposits are denominated in foreign currencies—an unstable demand for local currency, fiscal dominance, and thin financial markets. The conduct of monetary policy is further hindered by capacity constraints at the level of the central bank, including high operational costs, weak auditing and accounting frameworks, poor liquidity management, and insufficient forecasting capacity.

20. Against this backdrop, the BCC will maintain a proactive interest rate policy in combination with the use of central bank bonds to mop up commercial banks’ excess liquidity. To that effect, the BCC will work to improve its liquidity management and forecasting capacity, including through better coordination with the Ministry of Finance. In addition, it will seek to rebuild international reserves and observe the quarterly targets through foreign exchange intervention.

21. The central bank will continue strengthening its operations with the assistance of Fund technical experts. In particular, the BCC expects to complete the restructuring of the departments in charge of currency issuance, accounting, internal audit, and banking supervision in 2007. An audit of the BCC’s organization to be completed by end-May 2007 is to recommend additional measures to strengthen central bank operations while reducing their costs. In the meantime, the BCC will cut its operating deficit by more than one half to 0.2 percent of GDP (excluding the cost of monetary policy) by limiting expenditures.

22. The letter of intent includes structural measures that were not implemented under the SMP for 2006 as well as other new measures to improve transparency, including in the mining sector (see table). More complete discussions of structural reforms the government plans to implement will take place in the context of the discussions for the 2007 Article IV consultation and subsequent discussions on a new PRGF-supported program.

B. Program Monitoring

23. The government and staff will assess progress in implementing the SMP against quantitative and structural benchmarks (Appendix I, Tables 3 and 4). Test dates for the quantitative benchmarks are June 30, September 30 and December 31, 2007.

Table 3.

Democratic Republic of the Congo: Central Government Financial Operations, 2004–07

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Sources: Congolese authorities and IMF staff estimates and projections.

Reflects revised calculation of HIPC Initiative assistance from 2002-based Debt Sustainability Analysis (DSA).

For 2004 and 2005, program figures reflect a change in classification of retirement allowances as part of exceptional spending.

For 2005, interest payments include rescheduling agreements with commercial creditors under the enhanced HIPC Initiative.

Exceptional expenditure includes spending for the Demobilization, Disarmament, and Reintegration (DDR) program, cost of

For 2005, HIPC Initiative savings used for pro-poor wages and domestic investment were recorded under wages and domestic-financed investment.

Internal and external arrears.

Underlying fiscal balance is defined as revenue minus expenditure and excluding interest on foreign debt, foreign-financed capital expenditures, all exceptional spending and repayment of domestic arrears. Difference between estimated figure for 2005 and the one reported in IMF Country Report No. 05/347 reflects the change in definition to exclude all exceptional spending.

Table 4.

Democratic Republic of the Congo: Cumulative Cash-Flow Plan, Quarterly 2007 1

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Sources: Congolese authorities and IMF staff estimates and projections.

Excluding HIPC

Including domestic arrears and the balance of the BCC (for the latter, a minus sign corresponds to a surplus).

Exceptional expenditure include spending for the DDR program, cost of the elections, payments for retirement allowances, repayment of the domestic debt, and payment for bank restructuring.

Underlying fiscal balance is defined as revenue minus expenditure and excluding interest on foreign debt, foreign-financed capital expenditures, all exceptional spending and repayment of domestic arrears. Difference between estimated figure for 2005 and the one reported in IMF Country Report No. 05/347 reflects the change in definition to exclude all exceptional spending.

Net banking system credit to the government plus treasury balance of the Central Bank.

C. Risks

24. Implementing the SMP for 2007 presents the government with many challenges. First, insufficient external budget support to fill the US$85 million residual financing gap would lead to further accumulation of arrears on debt service to bilateral creditors. Second, the government may be unable to prevent a depreciation of the Congo franc in the face of exogenous shocks that could result if the political and security situation were to deteriorate. Third, the government will have to demonstrate a stronger commitment than in the past to observe extremely tight spending ceilings and avoid money financed overruns, especially for security; expectations raised by elections will make this extremely difficult. Fourth, the size of the government is likely to make it difficult to improve its decision making process and avoid recurrent delays in structural reforms (including those that were supposed to be implemented in 2006). Fifth, the government needs to work with trade unions to avoid social tensions and granting a large public sector pay increase. And sixth, a too rapid devolution of revenue and spending responsibilities to provinces could lead the central government to lose control over public financial management.

IV. Staff Appraisal

25. Recent slippages have put at risk the significant progress toward macroeconomic stability achieved during the 2002-2006 PRGF arrangement. With support from the Fund and donors, the DRC succeeded in reviving economic growth, bringing inflation to a manageable level and reducing exchange rate volatility. However, performance deteriorated starting late in 2005, as the focus of the transitional government shifted to the elections, which prevented the conclusion of the sixth review before the expiration of the PRGF arrangement and, later, the successful conclusion of the 2006 SMP.

26. With a democratically elected President and Parliament, the DRC has a great opportunity to rise to persistent challenges. Capitalizing on the mandate received from voters, the new government has an opportunity to make difficult decisions and demonstrate its determination to strengthen macroeconomic stability, achieve high and sustainable growth and reduce poverty. Improved governance and enhanced public financial management are critical to mobilizing the support of both the population and donors.

27. The 2007 SMP offers the new government an opportunity to demonstrate its determination to get away from the cycle of loose macroeconomic policies, resulting in a rapid depreciation of the currency and high inflation, followed by periods of policy tightening. Strong implementation of the SMP including a qualitative change in the conduct of macroeconomic management and policies would set a solid basis for discussions of a medium-term program that would warrant Fund support under a new PRGF arrangement and increased external assistance.

28. Tightening fiscal policy is central to restoring macroeconomic stability. The implementation of a realistic budget that is responsive to available external financing, with limited recourse to bank financing, is crucial. If the fragile security situation requires additional spending, this will have to be offset by cutting other expenditure to avoid pressure on the exchange rate and inflation. The new government needs to implement a prudent wage policy and resist granting a large pay increase that it could finance only through monetary creation.

29. The BCC should maintain a proactive monetary policy and improve its operations. Achieving the monetary policy objectives will require a dynamic interest rate policy, supported by improved liquidity forecasting and management. Prudent management of international reserves is also necessary for the central bank to meet its quarterly reserve targets. To improve transparency and contain its deficit, the BCC needs to accelerate key reforms, including implementing the new computerized accounting system and completing the audit of its organization.

30. Progress in other structural reforms is critical to the successful implementation of the economic program. These include improving the transparency and management of the mining sector; strengthening public financial management, especially observing ceilings on budget appropriations; and implementing a comprehensive civil service reform to contain the wage bill.

31. External financial assistance is essential to strengthen the macroeconomic environment, rebuild the economy, and improve living standards, and respond to expectations raised by the democratic process. Strong program implementation would help galvanize donor support that is necessary to cover the remaining financing gap of US$85 million in the 2007 budget. Lack of additional financial support would likely lead to a further accumulation of arrears on bilateral debt service.

32. The government will have to deal with many risks in implementing the staff-monitored program. These include overcoming the challenges associated with limited external financing and low international reserves, preserving security and containing related spending, increasing the focus of the large coalition government on macroeconomic policies, and implementing a reasonable wage bill while avoiding social tensions.

Table 5.

Democratic RepublicDemocratic Republic of the Congo: Monetary Survey, 2004-07

(At current exchange rates)

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Sources: Congolese authorities and IMF staff estimates and projections.
Table 6.

Democratic Republic of the Congo: Accounts of the Central Bank of the Congo, 2004–07

(At current exchange rates)

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Sources: Congolese authorities and IMF staff estimates and projections.
Table 7.

Democratic Republic of the Congo: Balance of Payments Summary, 2004–07

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Sources: Congolese authorities and IMF staff estimates and projections.

Including interest due to the IMF.

Excluding repayments to the IMF.

Adjusted from IMF Country Report No. 06/259, to reflect a shift to the 5th balance of payment manual. Current transfers and the current account balance have been adjusted accordingly.

Including unrecorded transactions. The latter may be substantial given the weak state of statistics.

Including US$58 million of arrears in 2006, on non reschedulable Paris Club debt service.