Democratic Republic of the Congo
Staff Report for the 2009 Article IV Consultation, Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility, and Request for Additional Interim Assistance Under the Enhanced Initiative for Heavily Indebted Poor Countries

This paper discusses a Request from Congo for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) program. Growth in Congo in 2008 was strong, but weakened by the onset of the global financial crisis during the second half of the year that resulted in a deterioration of the country’s terms of trade and large job losses in the mining sector. Macroeconomic policies for the rest of 2009 and 2010 aim at reducing inflation while mitigating the impact of the global financial sector on the economy.

Abstract

This paper discusses a Request from Congo for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) program. Growth in Congo in 2008 was strong, but weakened by the onset of the global financial crisis during the second half of the year that resulted in a deterioration of the country’s terms of trade and large job losses in the mining sector. Macroeconomic policies for the rest of 2009 and 2010 aim at reducing inflation while mitigating the impact of the global financial sector on the economy.

I. Background and context

1. Socioeconomic conditions in the DRC remain dire following a decade long conflict. The human cost and destruction of the country’s social and economic infrastructure were enormous. As a result, although rich in natural resources, the country’s per capita income and human development indicators remain amongst the lowest in Africa (Figure 1).

Figure 1a.
Figure 1a.

Democratic Republic of the Congo: Progress Toward Millennium Development Goals, 1990–2015

(Percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2010, 088; 10.5089/9781455203420.002.A001

Sources: World Bank, http://ddp-ext.worldbank.org; and United Nations, http://unstats.un.org.
Figure 1b.
Figure 1b.

Democratic Republic of the Congo: Social and Economic Indicators

Citation: IMF Staff Country Reports 2010, 088; 10.5089/9781455203420.002.A001

Sources: IMF, World Economic Outlook (2009), World Bank, Doing Business (2010), and Human Development Report, 2008-09.

2. The return of peace to most of the country in 2003 paved the way for political and economic stability. During 2003–06, the transitional government implemented prudent macroeconomic polices, restored confidence, brought hyperinflation under control, and laid the foundation for high levels of growth (Figure 2). This facilitated the installation of the new democratically elected government in March 2006.

Figure 2.
Figure 2.

Democratic Republic of the Congo: Economic Developments, 2002–08

Citation: IMF Staff Country Reports 2010, 088; 10.5089/9781455203420.002.A001

Sources: Congolese authorities; and IMF staff estimates.

3. The country’s dilapidated infrastructure constitutes one of the principal impediments to economic growth, private sector development, and poverty reduction. Given the huge infrastructure development needs and limited concessional resources available from traditional development partners, the authorities are pursuing nontraditional modes of financing to fill the gap, including resource-backed infrastructure development financing (Box 1).

4. The security situation in the eastern provinces remains fragile despite recent peacekeeping efforts. Attacks by armed militants continue to destabilize the eastern provinces. In 2008 and early 2009, this resulted in urgent spending requests outside the expenditure chain that placed pressure on scarce budgetary resources. In March 2009, the government and key rebel groups signed an agreement to integrate combatants into the national army. Disarmament and reintegration remains a key challenge with important budgetary implications.

5. The constitutionally mandated decentralization policy also poses significant budgetary and implementation challenges. The authorities are committed to transferring 40 percent of government revenues to the provinces, along with the responsibility for implementing social sector programs. Given existing constraints, however, they have decided to slow down the pace of implementation while strengthening capacity in PFM and project implementation at the provincial level.

6. The onset of the global financial crisis has aggravated economic conditions. The sudden and sharp drop in world commodity prices resulted in a marked deterioration in the country’s terms of trade—in the context of its narrow commodity export base—and a decline in foreign direct investment (FDI). This slowed economic activity, raised unemployment, and amplified macroeconomic imbalances. It also weakened fiscal performance, on top of an already low level of domestic revenue mobilization.

7. The DRC is in debt distress. The stock of external debt is about US$13.1 billion with debt service amounting to one-fourth of total expenditure. At end 2008, the present value of public and publicly guaranteed external debt is estimated at 93 percent of GDP, 150 percent of exports, and 502 percent of government revenue (excluding grants), well above the policy-based threshold levels.1 Given resource constraints, the country continues to accumulate arrears to bilateral (including Paris Club) and commercial creditors, but remains current on obligations to international financial institutions. The authorities continue to seek a settlement with the London Club and other bilateral creditors on outstanding loans. The World Bank is financing, through its Debt Reduction Facility, financial and legal technical assistance to the DRC to reach a settlement with its London Club creditors.

8. To address these challenges, the authorities are requesting a new three-year PRGF arrangement to support the implementation of their PRGS. The program aims to bolster macroeconomic stability, strengthen PFM, reinforce central bank independence, and improve the business climate. It is underpinned by an updated PRGS (2009–10) that bridges the period the authorities need to finalize their second generation PRGS (2011–16) by June 2010.

Democratic Republic of the Congo: The Sino-Congolese Cooperation Agreement (SCCA)

In April 2008, the DRC signed a cooperation agreement with a consortium of Chinese enterprises involving a US$3.2 billion mining project and a set of US$6 billion public infrastructure projects to be implemented in two phases. The Agreement was amended in October 2009 to exclude the second phase public infrastructure projects, leaving just a single phase totaling US$3 billion to be implemented over the period 2009–14. The amended agreement also limited the government guarantee to the financing of the infrastructure projects.

The Agreement calls for the creation of a joint venture (SICOMINES) between a Congolese parastatal mining enterprise (GECAMINES) and the consortium of Chinese enterprises. Paid-in capital of US$100 million gave GECAMINES a 32 percent equity share in the joint venture. SICOMINE will invest US$3.2 billion in the mining project financed by a US$1.1 billion interest-free loan and a US$2.1 billion loan with a fixed interest rate of 6.1 percent. The US$3 billion investment in public infrastructure is to be financed through a series of loans at a fixed interest rate of 4.4 percent. All loans are denominated in US dollars.

Operating profits from the mining project will be used to repay the mining and public infrastructure financing. The mine is expected to generate operating profits beginning in 2013. Initially, the net profits of SICOMINES will repay principal and capitalized interest on four priority public infrastructure projects (US$375 million). After this financing is fully repaid, 85 percent of the net operating profits will be used to repay the principal and capitalized interest on the mining loan. After the mining financing has been fully repaid, 85 percent of SICOMINES’ net operating profits will be used to repay the principal and capitalized interest on the remaining public infrastructure loans and the balance will be distributed as a dividend to the SICOMINES shareholders.

The grant element of the infrastructure financing is estimated at 42–46 percent, depending whether the US$250 million signing bonus is taken into account. This is based on the following assumptions: (i) the mining project does not generate any net income and the government guarantee is invoked after 25 years as provided for under the amended Agreement; (ii) accrued interest is compounded; and (iii) a fixed interest rate of 4.4 percent applies.

II. Recent Economic Developments

9. Macroeconomic policies were satisfactory during the first half of 2008. The fiscal balance (cash basis) recorded modest surpluses through end-June.2 Domestic revenue performance was robust and expenditures were kept in line with available resources. This allowed the central bank to contain the growth of monetary aggregates while keeping its policy rate unchanged at 28 percent.

10. The escalation of conflict weakened the fiscal position during the second half of 2008. An acceleration of security-related spending together with weak PFM shifted the underlying fiscal balance to a deficit in the last quarter and limited the surplus for the year as a whole to about 1 percent of GDP—about 1 percentage point below target (Figure 3). Under these circumstances, net credit to government (NCG) by the Central Bank of the Congo (BCC) was 2 percentage points of GDP above target at year-end. This boosted base money and eased liquidity conditions.

Figure 3.
Figure 3.

Democratic Republic of the Congo: Recent Economic Developments

Citation: IMF Staff Country Reports 2010, 088; 10.5089/9781455203420.002.A001

Sources: Congolese authorities; and IMF staff estimates.

11. Macroeconomic policies were mixed through September 2009.

  • During the first half of the year, underlying fiscal surpluses (on a cash basis) averaged 0.1 percent of GDP, as the government slowed spending. During the third quarter, modest improvements in domestic revenue (excluding the SCCA signing bonus) combined with the government’s success in containing expenditures kept the fiscal position in line with projections.

  • On monetary policy, the BCC raised its indicative interest rate in two steps from 40 percent to 65 percent in January and stepped up sales of central bank bills. However, increased lending by the BCC to distressed banks and the failure to mop up liquidity injections by government led to periodic accelerations of base money growth during the third quarter. In response, in October the BCC raised its indicative interest rate further to 70 percent, increased the reserve requirement ratio from 5 to 7 percent, and stepped up sales of central bank bills.

12. Against this background, macroeconomic outcomes were mixed.

  • Economic activity. In 2008, real GDP growth was about 6 percent instead of the projected 10 percent reflecting weaker exports in the face of the global financial crisis and supply bottlenecks (especially shortages in cement and electricity) that constrained construction and manufacturing activities (Table 1). It is projected to be 2.7 percent in 2009 owing to the effects of the global financial crisis.

  • Prices. There had been setbacks in containing inflation. After easing during the second half of 2008 thanks to the retrenchment of world fuel and food prices, inflation picked up in late 2008 and early 2009 owing mainly to government borrowing from the BCC. After a brief decline in May-August, inflation started to rise and reached 53 percent (year-on-year) at end-October in response to the periodic strong increases in base money and the depreciation of the Congolese franc. Under these circumstances, dollarization increased.

  • Current account and exchange rate. In 2008, the external current account deficit (including transfers) widened by some 14½ percentage points of GDP to about 16 percent of GDP owing to buoyant imports and the drop of export prices in second half of the year on account of the global financial crisis. The Congolese franc depreciated by 35 percent against the U.S. dollar between December 2008 and September 2009. The real exchange rate remained broadly stable over the past several years.

  • Gross official reserves. Reserves declined from US$180 million at end-2007 to about US$78 million (one week of nonaid imports) by end-2008 and further to a historically low level of US$30 million in February 2009. They reached US$894 million at end-September (10 weeks of nonaid import cover) following the disbursement of emergency assistance from the Fund and other development partners, the arrival of the first tranche of the SCCA signing bonus, and the general and special SDR allocations (SDR 424.5 million).

Table 1.

Democratic Republic of the Congo: Selected Economic and Financial Indicators, 2007–14

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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.

Includes investment financed by resources released under the enhanced HIPC Initiative.

End-of-period debt stock includes most of London Club debt (some US$1.2 billion in 2008), which is expected to be bought back with deep discount grants from IDA, and accumulated arrears.

Estimates and projections are based on the 2009 DSA and after HIPC Initiative interim relief assistance. 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; projections assume DRC reaches the HIPC completion point during the first half of 2010.

13. Banking system soundness and vulnerability. The health of the financial sector remains fragile (Text Table 1). At end September 2009, the capital-risk-weighted adequacy ratio averaged about 15 percent (compared with the required 10 percent), up from about 11 percent at the end of 2008. A large number of banks also have been unable to observe the required liquidity and net foreign exchange position ratios. Nonperforming loans increased significantly at the end of September 2009, reflecting in part recent improvements in the accuracy of the reporting system. The contagion effects of the global financial crisis have thus far had a limited direct impact on the banking system. Nevertheless, three local banks have shown signs of distress and urgently need to be recapitalized. The BCC is implementing a comprehensive strategy to address the issue, with technical assistance from the Fund and the World Bank. Specifically, it is strengthening on-site and off-site banking supervision and tightening and enforcing prudential regulations. It has also taken initial steps regarding the restructuring of one large bank.

Text Table 1.

Democratic Republic of the Congo: Financial Soundness Indicators, 2003–September 2009

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Source: Central Bank of the Congo (BCC), Directory of Bank Supervision

14. Performance under the program to date was satisfactory. All prior actions and indicative targets through end-September were observed and structural reforms remained on track (MEFP, Tables 1 and 2).

Table 2a.

Democratic Republic of the Congo: Central Government Financial Operations, 2007–12

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

Reflects revised calculation of HIPC Initiative assistance on the basis of the 2009 Debt Sustainability Analysis.

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

Underlying fiscal balance is defined as revenue (excluding signing bonus from the SCCA) minus expenditure (excluding interest on foreign debt, foreign-financed capital expenditure, and all exceptional spending).

The domestic fiscal balance is defined as revenue (excluding the signing bonus from the SCCA) minus total expenditure (excluding interest on foreign debt, foreign-financed capital and exceptional expenditure).

Table 2b.

Democratic Republic of the Congo: Central Government Financial Operations, 2007–12

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

Reflects revised calculation of HIPC Initiative assistance on the basis of 2009 Debt Sustainability Analysis.

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

Underlying fiscal balance is defined as revenue (excluding signing bonus from the SCCA) minus expenditure (excluding interest on foreign debt, foreign-financed capital, and all exceptional spending).

The domestic fiscal balance is defined as revenue (excluding the signing bonus from the SCCA) minus total expenditure (excluding interest on foreign debt, foreign-financed capital and exceptional expenditure).

III. Medium-term Outlook

15. Although short-term economic conditions remain weak, the medium-term outlook is positive. The deterioration in the country’s terms of trade and the decline in FDI on account of the global financial crisis are taking their toll on economic growth in 2009, particularly in the mining sector. Growth should pick up in 2010 and average 6.5 percent in 2010–12, supported by higher public and private investment and a recovery in the mining sector. However, it will remain below the 8 percent projected during the previous Article IV consultation (IMF Country Report No. 07/327). Inflation should decline to 48.7 percent by end-2009 and to single digits by 2012, supported by prudent fiscal and monetary policies. Given an expected gradual recovery in exports and large increases in investment-related imports, the current account deficit is expected to widen over the medium term, but will be financed in large part by capital and financial flows tied to infrastructure and mining projects. Gross reserves will remain to the equivalent of about 10 weeks of imports in 2012, in large part supported by the government’s decision to save the SDR allocations and maintain them in SDRs.

IV. Article IV Consultation and Policy Discussions

16. Drawing on the recommendations from the 2007 Article IV consultation (Box 2), the 2009 Article IV consultation discussions centered on three main themes: (i) fostering sustained and high economic growth; (ii) enhancing external sustainability; and (iii) strengthening institutional capacity for economic management.

Democratic Republic of the Congo: Main Recommendations of the 2007 Article IV Consultations

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A. Fostering Sustained and High Economic Growth

17. Sustained and high economic growth is critical to increasing per capita income and reducing poverty. The authorities agreed with staff that this requires bolstering macroeconomic stability, creating fiscal space for the provision of critical public goods, and advancing structural reforms to foster private sector development.

18. Moving toward macroeconomic stability. Given the country’s history of hyperinflation and uneven implementation of policies, staff believe that the fiscal policy rule of zero net bank credit to the government is critical to taming inflation and addressing fiscal dominance over monetary policy. The central bank would need to remain vigilant and mop up any excess liquidity, particularly those related to donor-financed public spending. The authorities agreed on the need to avoid recourse to central bank borrowing as this would reduce the burden on monetary policy in an environment where its effectiveness is already limited by the high degree of dollarization and underdeveloped financial markets. The authorities and staff also concurred that the reorganizing, restructuring, and recapitalizing the central bank is critical to enhancing its independence and capacity to conduct monetary and exchange rate policy.

19. Increasing fiscal space for priority spending. To create such space, the authorities need to mobilize domestic revenues and strengthen PFM. Staff noted the low levels of tax collection to date, particularly in the mineral sector, and the importance of increasing domestic revenues to address the country’s large reconstruction needs. The authorities agreed that bold reforms are needed to modernize and consolidate tax and customs management, streamline exemptions, and simplify the tax system, including introducing a VAT. They maintained, however, that this would need to be addressed over the medium term given capacity constraints. However, they have already begun taking steps to strengthen mining sector tax collection, including by reviewing exemptions and establishing a unit within the tax administration dedicated to this sector.

20. PFM. Poor budget planning, circumvention of budgetary procedures, and ineffective budget controls have weakened fiscal discipline and accountability. This, together with high levels of nondiscretionary spending, impedes progress in achieving the country’s poverty reduction objectives. Staff stressed the importance of realistic budgets, following proper budgetary procedures, strengthening controls, and improving priority expenditure tracking. Strengthening institutional capacity in PFM at the provincial level, with technical assistance from development partners, will also be important given the ongoing decentralization. The authorities concurred with the staff’s assessment and noted that progress on these fronts would also help allay concerns over governance. They stressed that the speed of PFM reforms should take into account the country’s post-conflict situation.

21. Improving the business climate. Staff urged the authorities to press ahead with reforms to reduce the cost of doing business and to diversify the economy. The authorities indicated that they are placing emphasis on restructuring public enterprises and privatizing the management of key public services (i.e., transport and utilities) as a first step toward privatization. They plan to submit to parliament a law that will allow the DRC to participate in the Organization for the Harmonization of Business Law in Africa (OHADA), which will help simplify procedures for business registration and strengthen legal protection of foreign investment. The authorities also noted that they established and staffed the office responsible for the implementation of the 2004 anti-money laundering and combating financing of terrorism legislation. Staff welcomed these efforts, but encouraged the authorities to advance reforms in the areas of banking supervision, credit information management, and the judiciary.

B. Enhancing External Sustainability

22. A flexible exchange rate regime is appropriate given the country’s low level of foreign reserves and vulnerability to exogenous shocks (Box 3). Staff noted that the exchange rate has broadly tracked economic fundamentals and appears appropriate assuming that donor flows continue and the DRC benefits from debt relief under the enhanced HIPC Initiative and Multilateral Debt Relief Initiative (MDRI). The authorities concurred, noting that the central bank intervenes in the foreign exchange market to achieve its reserve target and to smooth sharp fluctuations in the rate. Staff stressed that this could best be addressed by advancing reforms to reduce the cost of doing business.

The Democratic Republic of the Congo: An Assessment of the Exchange Rate Policy and External Competitiveness

The exchange rate of the Congo franc has been freely floating since the liberalization of the foreign exchange market and the unification of the exchange rate in 2001. Since then, BCC intervention in the foreign exchange market has been limited. Thus, the exchange rate appears to have been responsive to changes in macroeconomic policies and exogenous shocks. The nominal effective exchange rate of the Congo franc (NEER) depreciated by 10 percent a year on average over 2002–08 while the real effective exchange rate (REER) appreciated by 2 percent on average over the same period. Although assessing the equilibrium exchange rate is a complicated exercise, particularly in a post-conflict country with poor data and significant structural breaks, two approaches were used to assess the consistency of the real exchange rate with its equilibrium level.

  • 1. An estimation of the long-run trend of the real exchange rate by using standard smoothing filters—Five-year moving average of the REER and the Hodrik Prescott (HP) filter—to isolate the permanent component from the transient and short term shocks. The smoothed variable is then interpreted as the equilibrium real exchange rate. In 2002–08, the actual REER was below its equilibrium level most of the period, but appears to have converged to its equilibrium level at the end of the period.

uA01fig01

Democratic Republic of the Congo: Real Effective Exchange Rate: Actual, Moving Average, HP filter,

(Index, 2000=100)

Citation: IMF Staff Country Reports 2010, 088; 10.5089/9781455203420.002.A001

Sources: IMF, Information Notice System; and IMF staff calculations.
  • 2. An application of the macro-balance approach developed by the Consultative Group on Exchange Rate Issues. It consists of three steps. First, estimating an underlying current account (UCA) based on the medium term framework, excluding temporary factors. Second, computing a current account norm (CAN) based on the fundamentals. Third, deriving the adjustment in the REER necessary to close the gap between UCA and CAN, assuming import and export elasticities. Using different approaches, the UCA is estimated at a deficit of around 12 percent of GDP. The CAN is derived from variables and estimated coefficients on a panel of developing countries (see Isard and others (IMF Occasional Paper, 2001). Essentially driven by low level of net foreign assets and foreign aid, the CAN is estimated at about -8.4 percent. Using standard export and import elasticities, the analysis suggests the exchange rate would need to depreciate by about 9 percent to close the gap between the UCA and the CAN.

The above results do not suggest significant over or under valuation of the exchange rate. However, the inability by the DRC to fully service its debt (and thus accumulate arrears on its external debt) suggests that macroeconomic policies and structural reforms were insufficient to generate the growth and resources needed to fully meet debt service obligations. Nevertheless, the exchange rate level would be appropriate if foreign aid flows continue and the DRC benefits from debt relief from the enhanced HIPC initiative and the MDRI.

23. The DRC’s debt situation is unsustainable absent substantial debt relief. Debt burden indicators markedly exceed their policy-based thresholds.3 In the absence of debt relief from the enhanced HIPC Initiative and the MDRI, external debt burden indicators are projected to remain above policy-dependent thresholds over prolonged periods. The DRC will continue to be vulnerable to adverse exogenous shocks even after access to debt relief under the enhanced HIPC Initiative and MDRI reduces the country’s debt burden indicators below the thresholds. It is expected to reach the HIPC Completion point at earliest during the second quarter of 2010, assuming completion of the first review of the PRGF arrangement, indications that program implementation through end-March 2010 remains satisfactory, one-year satisfactory implementation of their PRGS, and observance of the HIPC triggers (Table 7). The authorities committed to adhere to a debt strategy that minimizes the risks of debt stress by relying strictly on grants or highly concessional loans. In this context, they have agreed with their partners to remove from the SCCA the second phase infrastructure projects and the government guarantee on the mining project.

Table 3a.

Democratic Republic of the Congo: Monetary Survey, 2007–10

(At current exchange rates)

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Sources: Congolese authorities; and IMF staff estimates and projections.
Table 3b.

Democratic Republic of the Congo: Accounts of the Central Bank of the Congo, 2007–10

(At current exchange rates)

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