Republic of Congo: Selected Issues
Author: International Monetary Fund
Publication Date:
25 Feb 2009
eISBN:
9781451951967
ISBN:
9781451951967
Language:
English
Keywords:
ISCR; CR; price; cost; export; GDP; across-the-board price; quintile bear; fuel price subsidy; quintile's share; income household; Oil; Inflation
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This Selected Issues Paper for the Republic of Congo discusses economic development and policies. Domestic prices of refined petroleum products are administratively set by the authorities below import parity. Non-oil revenue in 2007 has remained about 20 percent of non-oil GDP, compared with overall fuel subsidies of about 8.3 percent of non-oil GDP. The fuel pricing policy and subsidy scheme have been established by the authorities to protect low-income households from rising energy prices.

Abstract

This Selected Issues Paper for the Republic of Congo discusses economic development and policies. Domestic prices of refined petroleum products are administratively set by the authorities below import parity. Non-oil revenue in 2007 has remained about 20 percent of non-oil GDP, compared with overall fuel subsidies of about 8.3 percent of non-oil GDP. The fuel pricing policy and subsidy scheme have been established by the authorities to protect low-income households from rising energy prices.

I. Fiscal Costs and Distributional Impact of Oil Subsidies1

A. Introduction

1. A key objective of the Congolese authorities’ fiscal policies is to increase priority spending on pro-poor and growth-enhancing programs. The current composition of spending is moving in this direction, although there is scope for improvement, especially in reducing low-priority outlays such as for fuel subsidies. These subsidies are more than twice as large as outlays for health and addressing HIV/AIDS.

2. This paper assesses the fiscal costs and distributional impact of fuel subsidies. It draws on the analysis conducted by the Fiscal Affairs Department in the context of a Policy and Social Impact Assessment.2 In recent years, while international oil prices kept rising domestic fuel prices remained broadly unchanged, pushing fuel subsidies to very high levels. To understand these subsidies better, we make a clear separation between (i) those borne by the budget, (ii) arising from the inefficiency of the state-owned oil refinery (CORAF), (iii) those required to cover losses stemming from regulated retail prices that are below import-parity, and (iv) budgetary transfers intended to clear payments arrears accumulated by crude oil suppliers to CORAF. Also, the paper quantifies the incidence of fuel subsidies on household welfare using household survey data, to show that these subsidies are not well targeted.3

3. The paper has three main findings:

  • Until more recently, fuel subsidies have weighed heavily on the budget. The total fiscal cost of these subsidies rose to as high as 8.3 percent of non-oil GDP last year, compared with total current expenditures of 56.3 percent of non-oil GDP.

  • Higher income households benefit most from the fuel subsidies, contrary to the pro-poor objective of the government’s fuel pricing policy. The top 20 percent of the population received about 40 percent of the subsidies for gasoline and diesel. For kerosene (consumed disproportionately by lower income households), however, the top two quintiles receive 42 percent of the benefits while the bottom two quintiles receive 35 percent of the subsidies. Consequently, fuel price subsidies do not adequately protect the real incomes of the poor.

  • The authorities’ policies to mitigate the adverse impact of rising fuel prices earlier this year were well intended, but were not sufficiently targeted to benefit the poor. The various public expenditures that were made probably did not alter the pattern of the welfare distribution. We judge that the lowest quintiles of the welfare distribution only receive about one third of the benefits from these measures.

4. The paper is organized as follows. Section B briefly describes the fuel pricing policy currently in effect and evaluates the fiscal cost of the subsidies, while Section C quantifies their distributional impact. Section D discusses the fuel price increases and the impact of the mitigating measures implemented by the authorities in early 2008 to help offset them. Section E offers some conclusions.

B. Current Petroleum Products Pricing Policy and Fuel Subsidies

5. Domestic prices of refined petroleum products are administratively set by the authorities below import parity. Prices are set according to a formula established by Presidential Decree 2005-699.4 This formula first establishes an ex-refinery price for the various domestic petroleum products by adding customs duties, VAT, and an “economic adjustment” factor (ajustement économique) to the c.i.f. world market price. To compute the pump price, the formula adds various costs to the ex-refinery price, including transportation, distribution margins for wholesalers and retailers, financing and inventory costs, and an environmental audit tax. Despite recent adjustments, domestic prices of refined petroleum products remain below import parity.

6. Domestic petroleum products benefit from substantial subsidies. At the heart of the aggregate subsidies are the price subsidies which compensate for the structural mismatch between administered selling prices and import-parity levels. By end-2007, against a background of rising world prices, these price subsidies represented an estimated 3.2 percent of non-oil GDP (45 percent of overall subsidy). Reflecting these subsidies, end-2007 pump prices of diesel, kerosene and jet oil were at 40-70 percent of an estimated free market reference price. Super gasoline also had a small subsidy of about CFAF 27 per liter. Subsidies to offset the operating and technical losses of CORAF (20 percent of overall subsidy) and to clear payments arrears accumulated vis-à-vis crude oil suppliers (“the guarantee provision”) by CORAF reached the equivalent of 5.1 percent of non-oil GDP. Total subsidies for 2007 reached CFAF 115 billion (equivalent to 8.3 percent of non-oil GDP). Reflecting higher domestic prices, the overall subsidies for 2008 are projected to come down to CFAF 75 billion or 4.8 percent of non-oil GDP (Table 1).

Table 1.

Republic of Congo: Transfers to CORAF, 2007-2008 In billions CFA francs

article image
Source: Congolese authorities; and Fund staff projections.

7. Price subsidies encourage consumption of petroleum products and contribute to a misallocation of scarce budgetary resources. Non-oil revenue in 2007 was about 20 percent of non-oil GDP, compared with overall fuel subsidies of about 8.3 percent of non-oil GDP. In 2008, they are expected to decline, but they still consume a substantial share of domestic resources.

C. Distributional Impact of the Subsidies

8. The fuel pricing policy and subsidy scheme were established by the authorities to protect low-income households from rising energy prices. However, these policies have not been effective, as we demonstrate below through a simulation of the impact of removing the subsidies on households’ real incomes across the income distribution. The incidence of subsidies is quantified using ECOM 2005. The simulation involves raising retail prices to reach import-parity levels to capture the effect on each group’s real income.

9. The impact of the subsidy program is evaluated by examining two components. The first component is the quintile’s share of the benefit from the overall subsidy; and the second takes into account the share of petroleum products in total household consumption. The former indicates the efficiency—defined as how much of the total subsidies accrue to the low income groups—of a given subsidy reaching a given quintile, while the latter captures the overall effect of the subsidy on that income group.5

10. We use household per capita consumption as an indicator of welfare. Data from ECOM 2005 indicate that more than 70 percent of the population lives below the poverty line of US$ 2 per day, including all households in quintiles one to three (Table 2). In addition, the bottom 60 percent of the fourth quintile lives on less than US$ 2 a day. The mean welfare of the top quintile is 11.4 times higher than that of the bottom quintile; the second quintile is 1.8 times higher; and the third 2.7 times higher. Data show that there is also significant variation in welfare among the poorest quintiles. Accordingly, all but 30 percent of households are living in poverty. The bottom top quintile lives in extreme poverty.

Table 2.

Republic of Congo: Distribution of Household Welfare1

article image
Source: IMF staff estimtates based on ECOM, 2005.

Welfare groups are based on household consumption per capita.

11. On average, all energy expenses accounted for 2.85 percent of household expenditures, with low variation across income groups (Table 3). Urban households spend the highest share (3 percent) on energy products, compared with semi-urban (2.5 percent) and rural (2.7 percent).

Table 3.

Republic of Congo: Household Budget Shares for Energy

(In percent)

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Source: IMF staff calculations based on ECOM 2005.

12. High income households consume the majority of all fuel types other than kerosene (Table 4). The top two quintiles represent 95.4 percent of gasoline and diesel expenditures. Kerosene dominates fuel expenditure for the poorer quintiles. The poorest 60 percent of the population account for 57.7 percent of all kerosene expenditure but only

Table 4.

Republic of Congo: Distribution of Total Household Energy Consumption

(Percent)

article image
Source: IMF staff calculations based on ECOM, 2005.

5.2 percent of gasoline and diesel fuels. This suggest that a subsidy on all oil products, while helping the poor up to an equivalent of about 2.8 percent of their income, aids mostly the top income quintiles, up to about 2.9 percent of their significantly larger income. The burden of a subsidy removal would fall mostly on these upper quintiles.

13. The question arises as to who benefits from the subsidies. The distribution of subsidies is computed by simulating the impact of the elimination of subsidies on households’ real income across the income distribution using data from ECOM 2005. The price increase needed to eliminate subsidies for domestic petroleum products will affect the household real income directly and indirectly. By end-2007, this implied a 125 percent increase in kerosene prices, a 60 percent increase in diesel prices, and only a 6 percent increase in super gasoline prices (Table 5). The prices of goods in other sectors that use petroleum products as inputs (for example, textiles) are also impacted. The oil sector was shocked with a 55 percent price increase in 2007 and all indirect effects are calculated from that shock. On average, it is estimated that an increase of 55 percent is necessary for all products.

Table 5.

Republic of Congo: Price Increases to Eliminate Subsidy1

(Percent)

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Source: Congolese authorities; and IMF staff calculations.

Increases based on 2007 average oil prices.

14. From the above distributional analysis, we can draw the following conclusions:

  • Most of the subsidies benefit higher-income households. Hence, fuel subsidies are not a cost-effective way to protect the real incomes of poor households. A high proportion (40 percent) of total fuel subsidies benefits the richest 20 percent of the population who consume the highest share of gasoline and diesel. In contrast, a kerosene subsidy would largely benefit the poorer quintiles. Therefore, in addition to being politically difficult to implement, the elimination of subsidies can have a significant adverse impact on the real incomes of poor households.

  • The total (direct and indirect) impact of increasing fuel prices to import parity levels would be an average of 5.9 percent of real per capita income (Table 6). On average, household real incomes decrease by 5.86 percent, ranging from 6.1 percent for the second and third quintiles to 4.76 percent for the top. This would significantly depress the budgets of low and middle-income households that already face difficulties covering basic expenditures. The impact is associated to an average price increase of 55 percent.

Table 6.

Republic of Congo: Estimated Budgetary Impact of a Complete Subsidy Elimination

(Percent of Budget)

article image
Source: ECOM 2005, SNPC, Congolese authorities, and staff estimates.

  • Although all income groups experience a substantial decrease in real incomes, the poor feel the largest effect, as a percent of their total budget. Table 7 indicates that the top-income quintile bears about 40 percent of the total burden and the poorest quintile 8 percent. On average, a household in the top quintile would lose CFAF 11,082 per month in subsidies and the lowest quintile currently receives just CFAF 2293.5 per month.

Table 7.

Republic of Congo: Share of the Burden by Income Groups

(In percent)

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Source: ECOM 2005, SNPC, Congolese authorities, and staff estimates.

D. Impact of the January 2008 Policy Changes

15. Domestic petroleum prices were adjusted in January 2008 (and again in October), to help reduce the rising level of fuel subsidies. This price adjustment was accompanied by a few mitigating measures. The January across-the-board price increases were projected to reduce fuel subsides by an estimated CFAF 21.1 billion. In addition, the reduction in margins for transportation and distribution operators expected to produce additional savings of about CFAF 7.1 billion; combined, the net annualized savings would be CFAF 30.1 billion. The authorities targeted a price increase on all products to spread the burden of the removal of the subsidies across various market participants and to avoid problems with substitution.

16. The mitigating measures in early 2008 involved various public expenditures amounting to about CFAF 20 billion (about 1.5 percent of non-oil GDP) (Table 8). They included (i) a 12.5 percent increase in the base salary for civil servants; (ii) a tax exoneration for public transportation (taxis and buses); iii) the elimination of fees for public primary, secondary, and technical schools; (iv) free school supplies (books and manuals) for students in public schools; and (v) medium-term investments in health, water, and electricity.

Table 8.

Republic of Congo: Compensatory Measures, January 2008

(Billions of CFA Francs)

article image
Source: Congolese authorities; and IMF staff estimates.

Includes expenditure on HIV/AIDS and malaria treatment, free diesel for rural generators, solar energy incentives, and increased access to water.

These measures have not been individually costed.

17. Using the model, we simulate the impact of these mitigating measures on the income distribution to gauge their effect. Unfortunately, the support to the poor for these measures is mixed. While the measures related to the elimination of public school fees and provision of free school supplies are well targeted, the civil service pay increase and reduction in transportation taxes disproportionately benefits relatively well-to-do households, with an estimated two-thirds of the benefits from each accruing to households in the top two quintiles. Thus households in the bottom two quintiles would receive an estimated 35 percent of the benefits, compared with those in the top two quintiles who would receive an estimated 46 percent (Table 9). In addition, they do not fully compensate lower income households for resources lost to higher petroleum prices.

Table 9.

Republic of Congo: Estimated Budgetary Impact of Implemented Measures

(CFA Francs)

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Source: 2005 Household Survey, SNPC, authorities, and staff estimates.

E. Conclusion

18. The Congolese authorities’ efforts to cushion the impact of rising fuel prices are well intended, but come with a high cost to the budget and are not well targeted. We estimate that the top 20 percent of the income distribution benefit from more than 40 percent of the total subsidy. In this regard, the government’s intention to establish a new fuel pricing policy is welcome.

References

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1

Prepared by Abdelrahmi Bessaha, with assistance from Dale Manning.

2

Gillingham, R., S. Lacoche, D. Manning, 2008, “Republic of Congo: Reforming Fuel Subsidies While Protecting the Poor,” Fiscal Affairs Department, IMF.

3

The household survey was conducted by the Centre National de la Statistique et des Études Économiques in 2005. Enqûete Congolaise des Ménages pour l’Evaluation de la Pauvreté (ECON) 2005 provided socioeconomic data for 4,985 households in Brazzaville, Pointe Noire, and rural areas. For analytical purposes, this paper also uses a 2005 input-output table for Congo, based on detailed cost structures for 18 economic sectors and industries.

4

The main fuel products are super gasoline, diesel, kerosene, jet fuel, and propane.

5

Higher domestic prices for petroleum products would affect real income through two channels: (i) directly from an increase in the prices paid by households for their direct consumption of petroleum products; and (ii) indirectly from increases in prices of other goods and services (e.g., higher prices for food and transportation) consumed by households as producers pass on the higher costs for fuel inputs.

Appendix I

Figure 1.
Figure 1.

Republic of Congo: REER and Fundamental Determinants, 1969-20071

Citation: IMF Staff Country Reports 2009, 072; 10.5089/9781451951967.002.A001

Source: WEO; and Fund staff estimates.1 All sreries are expressed in natural logarithms.
Table 1.

ADF Statistics Unit Root Test

article image
Table 2.

Misspecification Tests

(Chi-squared test statistics)

article image

The null hypothesis is that of residuals with no skeweness, no kurtosis and normal.

Ortogonalization is based on Cholesky (Lutkepohl) test; skewness and kurtosis is based on joint chi-square test; normality is based on joint Jarque-Bera test.

B. VAR Residual Serial Correlation LM Tests1

(Chi-squared test statistic)

article image

The null hypothesis is that of no serial correlation at lag order h.

C. VEC Lag Exclusion Wald Test1, 2

article image

The null hypothesis is that the coefficients of the lags

Numbers in [] are probabilities

Table 3.

Test Statistics for the Cointegrating Rank1

article image

The unrestricted VAR was estimated with 2 lags following the results from the Wald test.

denotes rejection of the null hypothesis and 5 percent significance level.

Table 4.

Selected Results of the VECM

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6

Prepared by Izabela Karpowicz.

7

The poor performance of lower-income countries, particularly in the CEMAC region, has been documented in a number of studies on exchange rates, evolution of exports, and institution. See, for instance, IMF Country Report 07/206 Selected Issues Paper on Governance, Tsangarides on REER and on competitiveness in Working Papers 06/236 and 7/212; Di Bella, Lewis and Martin (2007) on competitiveness and REER misalignment.

8

Oil exports are the primary source of government revenue, and Congolese consumers rely heavily on imports of food, machinery, transportation equipment, medicines, and other goods.

9

In contrast, CEMAC trade increased to 100 percent of GDP in 2007, while SSA exports and imports reached slightly more than 70 percent of GDP.

10

Large annual variations somewhat distort the annual average.

11

The REER indices were constructed following IMF methodology (Zannello and Desruelle, 1997). The REER is a geometric average of prices (consumer prices, export and import unit values, GDP deflator) and the US dollar exchange rates based on bilateral trade weights. A total of 19 trading partners are included in the index, where trading partners belonging to the euro area together have a weight of 44 percent. The series are spliced backwards to account for changes in INS weights introduced in 2000.

12

In 2007, for instance, the change in terms of trade for Congo was unfavorable.

13

This index is constructed along the lines of Lipschitz and McDonald (1991). It is calculated as the ratio of ULC-REER to the GDP deflator-REER. A rise in the index is associated with a loss in competitiveness and a worsening in the trade balance because the share of labor costs in value-added rises relative to competitors. Unlike the ULC index, this indicator captures the loss in competitiveness resulting from a rise in the price of an intermediate input.

14

Normality tests for the two specifications indicate that the hypothesis of normality of the residuals is rejected. However, Paruolo (1997) shows that where normality is rejected due to excess kurtosis rather than skewedness, as here, the Johansen cointegration results are not affected.

15

The error correction term is negative and significantly different from zero, an indication that the REER follows a stable mean-reverting process. The short-run effects are mostly insignificant across the estimate. Only the term representing the devaluation is found to be significant and bears the expected negative sign.

16

It is not clear whether changes in monetary policy have a long-run effect on the equilibrium rate.

17

As reported in the CEMAC Staff Report on Common Policies of Member Countries (July 2008), the CEMAC REER does not appear to be fundamentally misaligned, despite continuous appreciation.

18

Chudik and Mongardini (2007) have highlighted the weaknesses of single-country time series estimations for low-income countries. Based on the coefficients estimated from their model on a panel of 7 oil-exporting SSA countries, Congo’s REER was overvalued in 2007 by 14 percent. However, the estimated country-specific long-run elasticity of real oil price for Congo is very small in this model, possibly understating the equilibrium value of the REER in recent years.

19

Qureshi (2008) finds that the weakness on non-oil exports in oil-producing African countries is closely linked to the quality of their institutions.

21

The poor governance record of CEMAC countries has been deteriorating; the CEMAC lags behind WAEMU, EAC, and SACU (Oliva and Moussa, 2007).

23

Heritage Foundation, http://www.heritage.org/Index/.

26

For example, the ratio of private credit to GDP is only 2.1 percent (SSA average: 17.4 percent), and the share of the population with a formal bank account is less than 3 percent (regional average: 26.8 percent). The loan/deposit ratio is about 22 percent in Congo, 80 percent for WAEMU countries, and 48 percent for the CEMAC.

27

The triggers for enhanced HIPC debt relief have also identified measures for improving governance in Congo. See http://www.imf.org/external/pubs/cat/longres.cfm?sk=19163.0.

28

The Poverty Reduction Strategy paper was submitted to the Executive Board in August 2008, along with the Joint Staff Advisory Note on the PRS.

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Cover IMF Staff Country Reports
Republic of Congo: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2009: Issue 072
Publisher:
International Monetary Fund
ISBN:
9781451951967
ISSN:
1934-7685
Pages:
36
DOI:
https://doi.org/10.5089/9781451951967.002

Republic of Congo: REER and Fundamental Determinants, 1969-20071