Republic of Congo
2010 Article IV Consultation and Fourth Review Under the Three-Year Arrangement Under the Extended Credit Facility, and Request for Modification of Performance Criteria—Staff Report; Staff Supplement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Congo.
Author: International Monetary Fund
Publication Date:
15 Mar 2011
eISBN:
9781455223022
Language:
English
Keywords:
ISCR; CR; ECF arrangement; authority; downturn well; management; oil revenue; private sector; government asset; cash basis; return on assets; Oil; gas and mining taxes
Download PDF (840.8 KB)

In this study, economic performance remained robust throughout the global downturn, and shows signs of further strengthening. In 2010, the external position improved significantly, as fiscal surpluses raised official foreign assets, and the Highly Indebted Poor Countries (HIPC) debt relief significantly reduced external liabilities. Macroeconomic stability is well established, and the external position has improved. Private sector development has reduced oil dependence and is assuring sustained poverty-reducing growth. Efforts should be supported by policies to increase the private sector’s access to credit, and deepen financial intermediation to improve the financial performance of state-owned enterprises.

Abstract

In this study, economic performance remained robust throughout the global downturn, and shows signs of further strengthening. In 2010, the external position improved significantly, as fiscal surpluses raised official foreign assets, and the Highly Indebted Poor Countries (HIPC) debt relief significantly reduced external liabilities. Macroeconomic stability is well established, and the external position has improved. Private sector development has reduced oil dependence and is assuring sustained poverty-reducing growth. Efforts should be supported by policies to increase the private sector’s access to credit, and deepen financial intermediation to improve the financial performance of state-owned enterprises.

I. The Economic Agenda

1. The road leading to the HIPC completion point was long, with a pronounced period of adjustment during which the poor did not perceive an increase in welfare in line with Congo’s burgeoning oil wealth. Yet, through this process, the authorities began to address policy challenges and economic fragilities, making strides toward macroeconomic stability and fiscal sustainability. They also made progress on improving public financial management and took some initial steps to strengthen institutions. As a result, the economy has become more resilient and policy making and transparency in the management of oil resources have improved.

2. With HIPC behind them, the authorities aim to address challenges posed by still-high poverty and oil dominance, setting their sights on the next phase of development—fostering a dynamic non-oil sector. And, building on gains in macroeconomic and external stability, they plan to redouble efforts to reduce poverty and bring the benefits of stability and oil wealth to the people. Their three-pronged approach focuses on (a) investing in basic infrastructure and human capital, (b) raising pro-poor spending, and (c) supporting growth of the non-oil economy. At the outset, key public infrastructure will be completed to ease bottlenecks in transportation and public utilities which have held back non-oil activity, while upgrading and constructing new health and education buildings.

3. Discussions focused on the authorities’ shift in policy direction. Key issues included striking a balance between development needs and safeguarding stability and sustainability; the steps the government could begin to take to strengthen the business climate; as well as the need for greater focus on improving health and education services.

II. Progress Toward Achieving Policy Objectives

Despite the global downturn, developments since the last Article IV have been positive and Congo is reaping the benefits of sustained policy implementation and HIPC debt relief. Yet, progress to date in social areas such as health and education has been disappointing.

4. Economic resilience has increased markedly since 2008, despite oil dominance.

  • Macroeconomic stability is now well established. Economic activity remained robust as the global economy faltered, buoyed by rising oil production and sustained non-oil growth in construction, telecommunication and transport, which more than offset the hard-hit timber market. Inflation returned to the low single digits.

  • The external position improved significantly despite the massive terms of trade shock in 2009. Official foreign assets were buoyed by overall fiscal surpluses, while HIPC debt relief reduced external liabilities. The real effective exchange rate strengthened.

uA01fig01

Contribution of Oil and Non Oil Sectors to the GDP Growth

(percent)

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

uA01fig02

Gross Foreign Reserves and Debt Stock, 2007–11

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

uA01fig03

Real Effective Exchange Rate

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

5. Fiscal consolidation through June 2010 progressed somewhat faster than envisioned at the time of the last Article IV consultation, but spending pressures began to mount in the third quarter.

  • As oil revenues plummeted in 2009, the authorities slashed current expenditure while modestly raising non-oil revenue collection to register a consolidation of the basic non-oil primary deficit (BNOPD) of 8½ percentage points of non-oil GDP.

  • Consolidation continued in the first half of 2010, with revenue over performance and under execution of capital projects more than offsetting a tick up in current expenditure across spending categories. The authorities observed the end-June BNOPD program target.

  • Preliminary data indicate that current spending pressures intensified in the third quarter, rising to 93 percent of annual budget allocation by end-September. About half of the increase is estimated to be due to the need for the government to respond with increasing public resources to the refugee crisis in the North of the country and a move toward a pay-for-use system for some public utility services.1,2 Part was also due to overruns associated with the Fiftieth Anniversary of Congo’s Independence celebrated in August. A recent severe outbreak of polio has necessitated a mass vaccination campaign, placing further strains on government finances.

uA01fig04

2010 Expenditure as share of budget

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

6. Liquidity conditions remain ample and the underdeveloped banking sector appears generally sound. Entry of two new banks has increased competition and pushed lending rates down slightly, but total outstanding credit to the private sector remains small at less than 4 percent of GDP, and excess reserve and cash holdings are large. While financial sector soundness indicators do not raise red flags, problems have been identified in one small non-systemic bank accounting for about 3 percent of total banking sector assets. Under the action plan the bank has until end December 2010 to meet prudential ratios or be liquidated.

7. Progress was made in addressing institutional weaknesses in the context of the HIPC process. The authorities took steps to strengthen public financial management through establishing a functional classification of expenditure, integrating public investment into the 2010 budget process through the medium term expenditure framework (MTEF), and rationalizing budget execution procedures. They also adopted and have implemented a new procurement code, which supports transparency and competition. Oil sector transparency and governance has been improved through quarterly certification of oil revenues and transfer of oil receipts to the treasury within 45 days of shipment (structural benchmarks).

uA01fig05

Bank Reserves and Credit as Share of Deposits

(percent)

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

8. At the same time, tangible improvement in key social areas such as the provision of health and education services has yet to become apparent.3 While the 2011 draft budget contains higher spending, less than 5 percent of the overall budget is allocated to health and education, much of which is targeted toward infrastructure not service provision, and strategies to place doctors and teachers in rural areas face challenges.4

III. Prospects and Risks in the Post-HIPC Era

9. The outlook is favorable, despite continued high dependence on oil. Oil production in currently operational fields is expected to peak in 2011, but new contracts may be signed following the change in the oil taxation regime underway leading to new fields coming on stream by 2015. Prospects for the non-oil economy depend on the success of public investment in basic infrastructure and improvements in the business climate in raising future growth. In the near term, growth will be supported by strong activity in the construction, telecoms and transport sectors related in large part to the scaling up of public investment, but looking ahead activity will need to increasingly rely on private sector participation in the economy. There are strong indications that economic activity is accelerating, and growth is forecast to reach 9 percent in 2010. Under the baseline scenario, non-oil growth is expected to pickup markedly over the medium term (from a low base) as infrastructure projects are completed, but oil dominance would remain. Inflation would remain somewhat higher than trading partners over the near term, as bottlenecks in transportation limit the supply of consumption and investment goods in the capital city, but decline steadily as projects to increase rail and road capacity are completed. In the absence of new oil fields coming on stream, the current account would return to deficit by the end of the medium term. However, debt sustainability would further strengthen given the appreciable decline in the net external debt ratio as gross official foreign assets rise to above 135 percent of GDP in 2015.

uA01fig06

Oil production profile and extrapolation, 2007-25

(Million of barrels)

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

uA01fig07

Current Account, Oil Production and Non-oil Exports, 2007-2015

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

10. The outlook is subject to domestic as well as external risks. In addition to risks stemming from oil price volatility or lower oil production, downside risks center around uncertainties about the ability of public investment and structural reform to raise future growth, deliver promised poverty reduction and strengthen social cohesion. Risks to fiscal sustainability and policy credibility are heightened by ambitious planned revenue and expenditure measures. New oil discoveries are an upside risk.

Republic of Congo: Medium Term Macroeconomic Framework 1/

(in percent of GDP unless otherwise indicated)

article image

The baseline scenario is based on the staff’s medium-term projection.

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

IV. Balancing Development Needs and Fiscal Sustainability

Formidable development challenges remain in both basic infrastructure and social service provision. With the country on a stronger economic footing, the authorities plan to step up efforts to reduce infrastructure bottlenecks. Discussions focused on striking an appropriate balance between scaling up expenditure and fiscal sustainability.

Fiscal policy

11. The authorities are taking measures to solidify 2010 consolidation efforts. As previously noted, the authorities experienced spending pressures in the third quarter, some related to unforeseen humanitarian and utility costs, but also overruns attributable mainly to the Fifty-year Independence celebration, with little pro-growth impact. Aided by the seasonal drop off in spending in the fourth quarter, they are taking measures to rein in current spending while building on over performance in non-oil revenue by strengthening customs collection and ensuring that dividends from profitable public enterprises are collected. Allowing for additional humanitarian and immunization spending and the change in the utility billing system, the authorities expect a consolidation in 2010 of 1.3 percentage points of non-oil GDP in 2010, bringing consolidation over the first two years under the three-year ECF arrangement to 9.6 percentage points of GDP. The authorities noted that such an adjustment is broadly equivalent to the three year adjustment contained in the original program (IMF Country Report No. 09/74), and could justify a slower pace of consolidation in order to address development challenges which are holding back non-oil growth and poverty reduction.

12. With HIPC behind them and ample policy buffers, starting with the 2011 budget the authorities plan to scale up public investment, while continuing to save a large share of oil revenue.5 They pointed to paved road density in Congo that is one-quarter that of Sub-Saharan Africa and the country’s insufficient and unreliable electricity supply.6 They stressed that frontloading public investment will lay the foundation for future growth, which is key for job creation and poverty reduction as oil production declines, and rebuffed the validity of anchoring policy strictly on a permanent income model that does not differential between consumption and investment spending.

13. That said, the authorities reiterated their commitment to fiscal sustainability and investment efficiency. Their 2011 BNOPD target of CFAF 753 billion (34.5 percent of non-oil GDP) is consistent with the consolidation envisioned in the original program. They plan to achieve this target through further efforts to strengthen non-oil revenue collection and restrain current expenditure to make space for a 37 percent increase in domestically financed public investment, while continuing to save a large share of oil revenue. Specific actions the authorities intend to take include:

  • Non-oil revenue: measures to broaden the tax base (payment of forestry and telecoms royalties to the treasury, taxation of transactions related to public contracts); reduce exonerations; and improve administration, with particular emphasis on customs appraisal and control. The expected net gain is 1 percentage point of non-oil GDP.

  • Current expenditure: continue efforts begun in early 2009 to reduce current expenditure, focusing on bringing transfers and spending on materials and supplies down from the high levels experienced in 2010 due to one-off events. The expected reduction in non-wage primary current expenditure is 2.9 percentage points of non-oil GDP. While appearing ambitious relative to the high base of 2010, compared to 2009 the decline mostly reflects lower transfers to loss-making state enterprises.

  • Domestically financed capital expenditure: carry out the necessary investment for growth and poverty reduction taking into account capacity constraints. While continuing to pursue additional sources of non-oil revenue, in the event these fail to materialize, cap domestically financed capital expenditure (excluding the use of HIPC interim assistance funds) at CFAF 650 billion through project prioritization and use of strict measures to ensure project quality. While somewhat lower than that envisioned in the 2011 draft budget, this envelope is sufficiently ample to cover execution of all projects currently in train and the launch of new priority projects.7 The authorities will continue to finance investment mostly out of their own resources, with some highly concessional foreign co-funding.

14. The authorities are conscious of the risks that ongoing current expenditure pressures place on their deficit target, and stand ready to take measures. Pressures may emanate from an unresolved refugee crisis, the impact of inflation on spending on materials and supplies, higher transfers to compensate for royalties being paid into the treasury, the need for more healthcare and education professionals, and rising operations and maintenance costs as infrastructure projects are completed. A preliminary costing of the planned three-year phase-in of the civil service reform which takes effect in January 2011 does not appear to put undue pressure on public finances.8 The authorities will remain vigilant and reduce non-priority current outlays to meet the deficit target while protecting social spending, which appears feasible given still-high total current spending.

15. Over the medium term the authorities will continue efforts toward achieving fiscal sustainability. Ongoing efforts to boost non-oil revenue will be redoubled through a planned tax reform aimed at broadening the tax base and reducing complexity (with FAD technical assistance), and significant efforts to strengthen tax administration. On expenditure, current spending will be streamlined to make space for increased social service provision and operations and maintenance costs, and while investment expenditure is expected to remain elevated over the near term, it will come down as major projects are completed. (Box 1)

Structural fiscal measures

16. Despite progress on PFM, the authorities recognize that there is still work to be done on addressing weaknesses in budgetary control and treasury operations. They are increasing vigilance over the length of the budgetary chain, and plan to work with development partners to strengthen treasury operations.

17. The authorities plan to redouble efforts to safeguard public investment quality by more fully employing the toolkit developed as part of the HIPC process. Beginning with the appraisal process, the authorities will ensure that all projects have a feasibility study and are aligned with the MTEF, and re-enforce budget execution procedures and controls at the commitment stage of the expenditure chain. They will also complement competitive bidding under the procurement code with increased coordination among agencies involved in the investment process, and prepare a procurement plan for 2011 with quarterly monitoring reports, in collaboration with the World Bank.

V. Supporting Economic Diversification

The authorities are in the process of developing a second generation Poverty Reduction Strategy for 2011–16. Identified motors of growth include agriculture and agro-industry, and transportation through development of a transit corridor to central Africa. Discussions focused on putting in place the necessary conditions for private sector-led non-oil growth.

18. The authorities have taken some measures to increase banking sector credit to the private sector, but large challenges remain. They have allowed greater competition through the entry of new banks; begun eliminating ceilings on lending rates; and pushed for greater transparency of loan conditions, including publication of the complete costs of loan offerings, including fees and charges. They have also had some success in increasing the use of banking services by paying some wages and pensions through direct deposit, eliminating account fees, and closing the postal bank, although the latter has reduced financial service coverage in rural areas. Despite these efforts, credit to the private sector has increased only modestly, reflecting the low capacity of SMEs to produce financial statements and business plans, the lack of quality projects, and the high cost of collateral.

Update on Fiscal Sustainability

Congo has achieved significant fiscal consolidation over the course of the current ECF program (Country Report No. 09/74), with a projected reduction in the basic non-oil primary balance of almost 10 percent of non-oil GDP over 2008 and 2010. Despite this sizeable progress, further consolidation efforts are needed to ensure fiscal sustainability.

Key variables affecting the sustainable fiscal deficit are now projected to be more favorable than at the beginning of the ECF program, notably the oil and growth profiles. Oil revenues (in cumulative terms) over 2008–28 are projected to be 18 percent higher (Figure 1; left panel), mostly due to larger expected oil production (12 percent higher). Projected nominal GDP growth is also higher, mostly reflecting growth-enhancing public investment.

Figure 1:
Figure 1:

Current projections and the projections at the beginning of the three-year ECF program

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

Source: IMF staff calculations.

To illustrate possible adjustment paths we consider three scenarios: a baseline in which sustainability is reached by the time oil is exhausted in 2028 (a 1.8 percentage point average consolidation per year); a “good” scenario with a faster rate of consolidation; and a “bad” scenario with a slower pace of consolidation. Under the baseline net government assets amounting to around 96 percent of GDP are accumulated by the end of the oil period, implying a sustainable long-term primary deficit of 1.8 percent of GDP annually. Under the “good” scenario, fiscal sustainability is attained earlier (by 2022), and a net asset accumulation of 128 percent of GDP could sustain a long-term primary deficit of 2.4 percent of GDP. Conversely, under slower consolidation, a significant fiscal adjustment would be needed at the end of the oil period to reach a sustainable long-term primary deficit of 0.5 percent of GDP.

Figure 2:
Figure 2:

Fiscal sustainability—scenario analysis

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

Source: IMF staff calculations.

19. The authorities have recently adopted an action plan to improve the business climate. The near-term priorities contained in the comprehensive plan include improving public-private dialogue; simplifying and making the tax system more business friendly; ensuring investment security; and addressing issues related to land use and tenure, such as the use of long-term leasing. With the help of development partners, the council for public private dialogue is operational, while work is already in train to establish an agency for investment promotion, an industrial standard setting agency, as well as an office for the protection of intellectual property.

VI. Other Surveillance Issues

20. The exchange rate regime has anchored macrostability in Congo, and the real effective exchange rate is broadly in line with policy dependant medium term fundamentals given the uncertainty surrounding such estimates.9 However, external stability in the CEMAC region requires regionally lower public expenditure and structural reforms to bring the real effective exchange rate in line with medium-term fundamentals.

uA01fig08

Current account balance, 2010–2016

in percent of GDP

Citation: IMF Staff Country Reports 2011, 067; 10.5089/9781455223022.002.A001

VII. The Fourth Review Under the ECF—Growth Oriented Policies

21. Program implementation through June was satisfactory. All quantitative performance criteria and structural benchmarks were met, including the strategic study of the oil sector (end-September structural benchmark) (Table 6). Net domestic financing was higher, reflecting in part lower oil revenue.

Table 1.

Republic of Congo: Selected Economic and Financial Indicators, 2008–15

article image
Sources: Congolese authorities; and Fund staff estimates and projections.

Country Report No. 10/54.

Including public transfers.

Including grants.

Primary revenue (excluding interest income and grants) minus non-interest current expenditure minus domestically financed capital expenditure and net lending.

HIPC completion point reached in January 2010. In March 2010, the Paris Club granted 100 percent debt relief.

Table 2.

Republic of Congo: Medium Term Balance of Payments, 2008–15

article image
Sources: BEAC; and Fund staff estimates and projections.

Country Report No. 10/54.

Includes stock debt relief of the HIPC completion point.

Includes HIPC and MDRI debt relief (2010) and assumed disbursements under the ECF.

Includes flow debt relief from Paris Club and London Club, and payments to litigating creditors.

Table 3a.

Republic of Congo: Central Government Operations, 2008–15

article image
Sources: Congolese authorities; and Fund staff estimates and projections.

Country Report No. 10/54.

From the HIPC interim relief trust fund.

Primary revenue (excluding interest income and grants) minus noninterest current expenditure minus domestically finance capital expenditure (excluding HIPC-financed capital expenditure) and net lending.

HIPC completion point reached in January 2010. In March 2010, the Paris Club granted 100 percent debt relief.

Table 3b.

Republic of Congo: Central Government Operations, 2008–15

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

Country Report No. 10/54.

Primary revenue (excluding interest income and grants) minus noninterest current expenditure minus domestically financed capital expenditure (excluding HIPC-financed capital expenditure) and net lending.

HIPC completion point reached in January 2010. In March 2010, the Paris Club granted 100 percent debt relief.

Table 4.

Republic of Congo: Monetary Survey, 2008–11

article image
Sources: BEAC; and Fund staff estimates and projections.

Country Report No. 10/54.