Angola--2007 Article IV Consultation, Preliminary Conclusions of the Mission, Luanda

June 6, 2007

Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

Preliminary Conclusions of the Mission
June 6, 2007

1. The IMF mission that visited Luanda from May 24-June 6, 2007 conducted discussions with the Angolan authorities for the 2007 Article IV consultations. This concluding statement summarizes the mission's preliminary findings. The mission would like to thank Mr. de Morais, Minister of Finance, Mr. Mauricio, Governor of the National Bank of Angola, other ministers, and senior government officials for their cooperation in facilitating the mission's work.

I. Recent Developments and Medium-Term Outlook

2. Angola's recent macroeconomic performance has been good. Output growth has been robust since 2001 both in the oil and diamond sectors, and in the nonextractive sectors (especially in manufacturing, processing, construction, and services). Real growth in 2006 reached 18.6 percent, supported by double-digit growth in both the oil and non-oil sectors. Angola has made impressive progress in reducing inflation in recent years, with inflation at the end of 2006 falling to about 12 percent compared to almost 19 percent in 2005. This inflation outcome was, however, short of the government's target of 10 percent. High oil prices together with rising oil export volumes provided a significant boost to government revenues in 2006 that more than offset the rise in public spending (which was pegged at a lower price for oil). As a result, the overall fiscal surplus in 2006 amounted to 16.5 percent of GDP, more than twice the outturn in the previous year. Rapidly growing oil and diamond exports in 2006 also led to the further increase of the external current account surplus in 2006. International reserves more than doubled during the year, reaching US$8.5 billion (almost 6 months of imports of non-oil goods and services).

3. Near-term and medium-term economic prospects remain positive. Several indicators suggest that real growth will remain robust, and the external environment is expected to be broadly positive. Real GDP growth is projected in 2007 at about 31 percent, reflecting the coming into production of new oil fields, while robust growth in agriculture, manufacturing, construction, and the power sector is expected to boost non-oil GDP. For the period 2008-12, growth is expected to average 7.5 percent. However, the mission projects that the external current account surplus will taper off over the medium term and move to a deficit as the oil sector matures. Inflation is projected to decline to the single digits during the medium term.

4. The Angolan authorities have been implementing a broad economic program to address the consequences of the long civil war. They maintain that a rapid increase in infrastructure and social sector spending is needed to reduce poverty, achieve the Millennium Development Goals, and enhance efficiency and competitiveness of the economy. The mission fully concurs with the authorities' policy objectives and the need to address social and economic inequalities in the country. The mission believes that the current benign external environment provides Angola with a unique opportunity to make significant inroads into poverty reduction.

5. Nonetheless, Angola faces a volatile market for its main export crude oil. Large shifts in international oil prices will have important effects on the country's external current account and fiscal balance. While Angola would be able to weather an oil price shock in the short run, thanks to its comfortable cushion of international reserves, and its external and domestic debt levels are relatively low, a permanent reduction in international oil prices would require adjustments in macroeconomic policies to ensure that fiscal and external sector positions remain sustainable. In view of these risks, the authorities are encouraged to design and implement fiscal policies with a medium term focus to avoid boom-bust cycles and vigorously pursue appropriate structural reforms to support the development of the non-oil/non-extractive sectors.

6. In sum, the IMF mission sees three key medium-term challenges facing the authorities: (1) management of the oil wealth over the limited period before oil production matures to ensure long-term fiscal and debt sustainability; (2) improvement of the competitiveness of the economy; and (3) development of the non-oil/nonextractive economy. Supportive structural reforms would enhance implementation capacity and efficiency of the public sector, particularly in the area of public financial management. The strengthening of private sector competitiveness will be important to offset the impact of real exchange rate appreciation.

II. Macroeconomic Policies

Fiscal policies

7. In 2006, the non-oil primary fiscal balance as a share of non-oil GDP improved much more than envisioned, largely due to the government's inability to execute fully the capital budget. The non-oil primary fiscal deficit moved from 61.5 percent of non-oil GDP in 2005 to 50.8 percent of non-oil GDP in 2006. In particular, the execution of the public investment program in 2006 was less than 50 percent of the budgeted target, which reflected implementation capacity constraints. Furthermore, imports, including capital goods, were slowed down by significant congestion at the ports. Capital spending was budgeted to increase from about 6 percent of GDP in 2005 to around 21 percent of GDP in 2006, with a significant portion of the increased spending to be financed through lines of credit from China as well as from other bilateral sources. The government's implementation of the recurrent budget and expenditure on social services was also constrained because of difficulties in the recruitment of qualified personnel. The government continued in 2006 to incur substantial outlays on fuel subsidies (about 3.6 percent of GDP).

8. The mission recommends that the government adopt the non-oil primary fiscal balance1 as the anchor for assessing its fiscal stance. Further, the mission supports the government's recent practice of adopting a conservative oil-price rule in the budget to guide expenditures. Fiscal policies should be formulated around a clear declining trend for the non-oil primary deficit (as a percent of non-oil GDP), consistent with the medium-term fiscal and debt sustainability. An expansive fiscal policy jeopardizes macroeconomic stability, as well as the effective utilization of oil revenues because Angola's fiscal institutions are not yet sufficiently strong. When the budget is framed in a medium-term context, an oil-price fiscal rule helps govern the intertemporal allocation of finite oil revenues. The fiscal rule would also indicate how to set expenditure targets at levels to cope with oil revenue volatility and unpredictability. Room for significant up-front post-conflict infrastructure and social sector spending would still be provided for by a gradual transition to a sustainable non-oil primary fiscal position. In staff's view, medium-term fiscal sustainability suggest that the non-oil primary fiscal deficit should narrow by about 50 percent by 2012 from 51 percent of non-oil GDP in 2006.

9. The budget for 2007, if fully implemented, would result in a notable worsening of the non-oil primary balance compared to 2006. The mission believes that in order to be consistent with the above-mentioned fiscal rule, and also help bring inflation down further this year, the authorities should contain the non-oil primary deficit at below 60 percent of non-oil GDP. This is larger than the outturn for 2006, but it maintains the momentum of reducing the non-oil fiscal deficit over time. In the mission's view, this is feasible, since it is again unlikely that the authorities will be able to scale up spending in real terms by 36 percent as budgeted, in part through a planned increase of investment spending of US$7.5 billion (14.5 percent of GDP). In addition, since the fuel subsidy largely benefit higher income groups, the mission urges that its cost be contained by targeting those population groups in need of the subsidy.

10. Angola could draw on the extensive experiences of other countries in developing its oil saving mechanisms, such as oil funds and budgetary oil price rules. These mechanisms have already been adopted by several oil-producing countries but with mixed results. The Council of Ministers adopted in 2007 a reserve fund for oil where the difference between the world price for Angola's oil and the budgeted oil price (US$45 in 2007) is automatically channeled. Setting a specific oil price in the budget is attractive because it is easy to explain to the public, and it provides an effective and transparent way of limiting policy-makers' discretion. However, empirical evidence suggests that it is difficult to specify with any degree of confidence the long-run prices and assess whether an oil price shock is permanent or temporary. An oil fund to improve fiscal management needs to be consistent with the fiscal framework adopted by the authorities. It might be used to target fiscally responsible levels of non-oil primary deficits, based on well-defined procedural and transparency rules. It would also promote the strengthening of public financial management systems. The authorities may wish to seek technical assistance, including from the Fund, in this area.

Monetary and external sector policies

11. Staff supports the monetary authorities' recent policy tightening to contain the rise in consumer prices. The National Bank of Angola (BNA) raised its rediscount rate from 14 to 18 percent in May 2007 and revised the assets eligible for required reserves (within unchanged total required reserves). These measures have led to higher commercial bank interest rates and facilitated the appreciation of the kwanza. In support of these policies, the BNA has continued active sterilization operations in 2007.

12. The mission is in agreement with the BNA's decision to use a monetary target to anchor its inflation objective. The mission also agrees that there is analytical support for targeting a narrow measure of money to reduce inflation. However, due to extensive dollarization of the economy, and the unstable velocity of money, the choice of the intermediate policy target would need to be evaluated on a continuous basis to ensure its relevance. In the mission's view, it would be more appropriate for the BNA to set a target range for such a monetary aggregate rather than target a single absolute value. The central bank should also monitor a broad set of inflation indicators to support its monetary target range. The mission agrees that it is premature to adopt the interest rate as an operating variable, which would be more effective once the financial markets become deeper and more efficient. The presence of excess liquidity and rigidities in the Angolan economy could complicate the use of interest rates as operating targets. To complement their efforts to reduce inflation, the monetary authorities could allow the appreciation of the kwanza, which is suggested by Angola's faster real growth compared to its trading partners. A more flexible exchange rate would also be useful against negative shocks (such as a fall in the price of oil).

13. The IMF mission urges the authorities to work with Paris Club creditors to reach a solution on the issue of Angola's arrears. The mission commends the authorities for their efforts to normalize relations with Paris Club creditors. The authorities recently paid creditors US$2.3 billion to settle principal and interest arrears. It is the mission's understanding that the bulk of the remaining arrears relate to penalty interest (about US$1.5 billion). The authorities noted that once the government has completed its work on reconciling debt data, it will propose a strategy to the Paris Club on how to settle the interest penalties. Angola is also making payments to Paris Club creditors on amounts falling due.

14. The authorities are encouraged to use part of the windfall of oil revenues to bring down Angola's external debt, thus ensuring external debt sustainability even in the face of adverse shocks. Achieving a sustainable fiscal position would also facilitate debt sustainability. Looking ahead, it is imperative to develop a comprehensive strategy to manage Angola's external current account and it's financing through non-debt-creating capital inflows to further ensure external debt sustainability. As part of this strategy, the authorities could explore alternatives to costly external borrowing, including using existing reserves to pay off outstanding debt while phasing out expensive oil-backed loans.

15. The authorities should consider eliminating the remaining restrictions subject to Article XIV, and the multiple currency practice subject to Article VIII under the IMF's Articles of Agreement before accepting the obligations under Article VIII, Sections 2 and 3. The mission supports the authorities' strategy to develop a comprehensive plan to liberalize Angola's exchange system, with the view of controlling risks and ensuring that the changes do not undermine the collection of external sector statistics.

III. Structural Policies

Public financial management

16. Following recent improvements, further strengthening of the public financial management system is needed to ensure effective management of Angola's growing mineral wealth. Measures could be considered to strengthen budget formulation, including budget classification, and the coordination between the current and capital budgets. The dialogue between the Ministry of Finance and line ministries on budget issues could be improved while budgeting and programming capacity at the sectoral level is strengthened. In addition, the public financial management information system's (SIGFE's) effectiveness needs to be further boosted by strengthening internal controls. The recording of Sonangol's large quasi-fiscal activities and projects financed by lines of credit, which are budgeted for, are recorded and reconciled with a delay because they are not part of the on-line system.

17. The current bi-annual public investment program is not always observed, and should be replaced by a multi-year fiscal framework. Fiscal policy formulation within a full-fledged medium-term fiscal framework (MTF) would reorient budget formulation and implementation away from annual targets and toward the attainment of long-term fiscal goals. Furthermore, it will assist in tailoring the pace of public spending to Angola's macroeconomic and administrative absorptive capacity and the large social and infrastructure needs. Together with an enhanced functional budget classification, the MTF would help guide discussions with line ministries on how to prioritize spending requests over the medium-term. It would also help identify the future implications of present policy decisions (such as the possible recurrent costs of capital spending). By doing this, the MTF will assist in striking the right balance between consumption, investing in physical assets (infrastructure and human development), and accumulation of net financial assets (the net between accumulated oil revenue deposits and outstanding debt).

18. A prudent management of Angola's natural resources requires that priority is given to measures to strengthen governance and transparency in the oil and diamond sectors. This would further enhance macroeconomic management. The authorities have implemented some of the measures contained in the Oil Diagnostic Study issued in 2004. However, since the issuance of the study, the oil sector has evolved, and there is a need to continually assess further steps that may be required to strengthen governance. The World Bank's Public Expenditure Management and Financial Accountability Review and the IMF's fiscal ROSC offer suggestions on how to improve transparency in these industries. The participation in the Extractive Industries Transparency Initiative is also encouraged, as it would bring international recognition to government's efforts to enhance transparency in the extractive sectors.

Improvement of the business climate

19. The authorities could place more emphasis on improving the business climate in Angola. The non-oil sector must be more competitive if it is to become the source of sustained high real growth. At present, the authorities seem to have focused on infrastructure investment to facilitate the development of the non-oil sector. Carefully targeted investment would help address supply-side bottlenecks. However, it is critical that the cost of doing business is reduced, including the streamlining of costly and time-consuming registration requirements. Strengthening the legal and regulatory framework for business, contract enforcement, and property rights would also be necessary to encourage business activity.

IV. Other Issues

Statistical issues

20. The authorities acknowledge that Angola's statistical system needs to be improved further. They have made progress in strengthening the quality, coverage, and timeliness of economic statistics, including with technical assistance from the IMF and the World Bank. Several surveys have been conducted to produce data on social indicators and household expenditure patterns, with financing from the World Bank. Nevertheless, there remain significant deficiencies in key macroeconomic statistics. Progress in these areas would support economic analysis and provide information for policy implementation (for instance, assessing the impact of poverty spending).

Dialogue with the Fund

21. The mission welcomes the authorities' interest in seeking a closer engagement with Fund staff on policy issues. Such an engagement could provide opportunities for more frequent exchanges of views on macroeconomic and structural issues to support the authorities' policy design and implementation. If the authorities agree, Fund staff could return to Luanda in the fall of 2007 to provide input into the 2008 budget. The Fund also stands ready to support Angola strengthen its institutional and administrative capacity through technical assistance, including through the support of long-term resident advisors. The mission and the authorities agreed to explore other options for a strengthened relationship.

1 Defined as non-oil revenue minus total expenditure excluding interest outlays.


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