Public Information Notice No. 04/115

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Guinea

October 3, 2004

On August, 27, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guinea.¹

Background

In 2003, Guinea's economic situation deteriorated on account of exogenous conditions, as well as poor macroeconomic management and the lack of progress in key structural areas. Annual real GDP growth slowed down from 4.2 percent in 2002 to an estimated 1.2 percent, owing mostly to a reduction in manufacturing output caused by frequent outages in the supply of electricity and water, a reduction in construction, and a poor crop season caused by unfavorable rainfalls. With the ensuing pressures on food prices, the 12-month rate of inflation (CPI-based) reached 14.8 percent in December 2003 (from 6.1 percent in December 2002), owing to a combination of lax liquidity management and excessive bank financing of a higher-than-projected government deficit. The overall fiscal deficit (excluding grants) widened to 7.9 percent from 6.2 percent of GDP in 2002, reflecting weaknesses in revenue mobilization and expenditure overruns, notwithstanding a 0.5 percent of GDP shortfall in social spending. The wider deficit coupled with the lack of external budgetary assistance led to an accumulation of payment arrears both domestic and external. The external current account deficit (excluding official transfers) declined by over 1½  percentage points of GDP mostly because imports of intermediate and capital goods were subdued by an unfavorable investment climate associated with uncertainties during the run up to the December 2003 presidential elections and continued institutional weaknesses.

The government continued its de facto fixing of the exchange rate, keeping the Guinean franc/US dollar exchange rate broadly stable notwithstanding rising inflation. Market pressures were reflected in a widening of the parallel market premium to over 20 percent, from roughly 2 percent in 2002. The scarcity of foreign exchange in official channels exacerbated. This, coupled with the lack of external budgetary assistance, led to a decline in Guinea's gross official reserves to 1½ months of imports, from 2.3 months of imports in 2002.

In the structural reform area, progress was mixed. On the fiscal front, the authorities took actions that strengthened treasury management and implemented some of the preparatory measures for the adoption of the common external tariff of the West African Economic and Monetary Union. In the monetary area, there were further delays in the submission to parliament of the draft banking and microfinance laws. There were further delays also in implementing key measures meant to strengthen the central bank reporting and audit systems and improve the transparency of its operations. In the public enterprise area, there was no progress toward the urgently needed reform of the public utilities, whose poor operations continue to adversely affect economic activity.

The outlook for 2004 is plagued by poor performance in the first quarter of the year and by important downside risks, exogenous as well as policy-related. Assuming no deterioration in exogenous conditions—terms of trade, climate, and security—economic performance will be contingent upon the government's resolve to implement the emergency recovery program it adopted in March 2004. Under the assumption that this program will be implemented, real GDP growth is projected to accelerate somewhat to 2.6 percent, owing mostly to improved agricultural output and a slight pick up in the secondary sector. However, the annual average rate of inflation is projected to increase further to almost 16½ percent as the government's reliance on the banking system to finance its cash deficit would lead to a further monetary expansion.

As part of the Article IV consultation, an assessment of the Fund's longer-term program engagement in Guinea was prepared by the staff and discussed with the authorities.² The assessment concludes that under the last two arrangements covering 1997-2004, Guinea made very limited progress. It highlights that the programs' objectives of reducing financial imbalances and promoting higher private sector-led growth have not been attained and that Guinea's performance has been well below the country's great potential. It underscores the importance of strengthening ownership and commitment to programs' objectives so as to sustain a steady implementation of good macroeconomic policies and implement key structural measures to unlock the country's growth potential and reduce poverty.

Executive Board Assessment

Executive Directors welcomed the emergency economic recovery program adopted by the authorities in March 2004 following the serious deterioration of Guinea's economic situation in 2003. However, Directors considered that this package alone would not be sufficient to put the economy back onto a solid growth trajectory, bring about a significant reduction in inflation, and restore foreign exchange rey stressed that initiating a staff-monitored program would require evidence theserves. While recognizing the difficulty in realizing the needed short-term fiscal adjustments, that the emergency program is restoring fiscal and monetary discipline, as well as the adoption of a floating exchange rate system, the implementation of the long delayed recommendations of the 2002 safeguards assessment mission, and the initiation of urgently needed structural reforms.

Directors emphasized that fiscal consolidation remains the cornerstone to improving macroeconomic performance and reducing domestic debt. They indicated that achieving a sound fiscal policy will depend critically on improving revenue performance, containing defense spending, and keeping nonproductive outlays to a strict minimum to free up resources to bolster domestically financed investment and social outlays.

Directors agreed that the central bank should stop accommodating the expansionary policies of the government, and should instead focus monetary policy on its primary objective of containing inflation. They emphasized that the sizeable monetary overhang calls for much more proactive liquidity management, including open market operations to contain money supply growth and limit inflationary pressures. They also advised that treasury bills should replace central bank advances as the preferred instrument of budget financing. Directors noted that financial indicators suggest that good progress has been achieved in improving the soundness of the banking sector. However, they encouraged the authorities to continue strengthening bank supervision and to push for the adoption of the revised banking and microfinance laws.

Directors expressed concern that the de facto pegging of the Guinean franc to the US dollar since late 2002 and the administrative allocation of foreign exchange had introduced substantial distortions in the economy. They regretted the multiple currency practice arising from the absence of a mechanism to prevent the rates in the official and parallel exchange markets from diverging by more than two percent. Directors welcomed the depreciation of the official rate that took place since July 2004, and the authorities' objective of adopting a floating exchange rate determined through interbank trading to eliminate the multiple currency practice. They encouraged the authorities to make effective use of technical assistance to help achieve this objective as soon as possible.

Directors underlined that economic reform over the medium term in Guinea faces serious risks and challenges. Political instability and regional insecurity, lack of economic diversification, possible shortfalls in donors' support, and a growing domestic debt were of particular concern. Directors emphasized that strong political will to adopt and steadily pursue a sound, pro-growth, and poverty reducing reform agenda will be critical to help achieve the Millennium Development Goals. They urged the authorities to accelerate the pace of reforms in the public enterprise sector, including through privatization. Efforts to boost private sector opportunities by improving the business climate and diversifying the economy were also favored. In particular, Directors stressed the need to rapidly restructure the public utility enterprises to alleviate shortages in electricity and water supply, and tackle operational difficulties in the mining sector. In addition, they urged the authorities to rapidly and forcefully step up the fight against corruption and show determination in reforming the judicial system. In this regard, Directors stressed the importance of ensuring the independence of the Anti-Corruption Commission.

Directors underlined the importance of trade diversification to improve the external accounts over the medium term. In that regard, they welcomed the authorities' commitment to regional integration and the steps taken to prepare for the introduction of the common external tariff (CET) of the West African Economic and Monetary Union, noting that the CET would simplify Guinea's tariff system and enhance trade liberalization. However, Directors noted that progress toward joining the West African Monetary Zone (WAMZ) is hindered by the lack of economic convergence with other WAMZ member countries and Guinea's vulnerability to asymmetric shocks.

Directors expressed serious concerns over the difficulties Guinea has experienced in servicing its external debt and over the country's heavy external debt burden, noting the suspension of interim debt relief under the HIPC Initiative and Guinea's limited foreign exchange reserves. They urged the authorities to eliminate external debt arrears and normalize relationships with creditors, and in this regard they welcomed in particular the renewed dialogue with the EU. Directors also stressed that decisive action is needed to reverse the recurring pattern of late payments to the Fund. Further, they underlined the importance for the government to pursue its reform efforts to eventually regain access to the HIPC Initiative relief it qualified for at the decision point in 2000.

Directors commended the efforts to advance the poverty reduction agenda notwithstanding the difficult economic environment, as discussed in Guinea's first annual progress report of its Poverty Reduction Strategy Paper (PRSP-PR). However, the urgent correction of macroeconomic imbalances is needed to achieve sustained poverty reduction and to shield the social sector from budgetary cuts. They also called for using more recent poverty data to update social indicators and supported the finalization of the integrated household survey.

Directors observed that, notwithstanding the efforts made in recent years to improve Guinea's statistical apparatus, data deficiencies remain in the areas of public finance, the real sector, balance of payments, and external debt statistics. They encouraged close collaboration with the international donor community, including the IMF's West Africa Technical Assistance Center, to strengthen the statistical database and, more broadly, to address capacity-building needs.

Directors welcomed the opportunity to review Guinea's performance under Fund-supported programs since 1986 by means of an Ex Post Assessment of Longer-Term Program Engagement. Despite progress in stabilizing the economy during the decade through 1995, subsequent economic performance was undermined by domestic policy weaknesses, political uncertainty, and regional instability. Going forward, Directors noted that the ongoing macroeconomic imbalances and structural problems in the core areas of the Fund's expertise warranted continued Fund engagement. However, they considered that any discussion on a new PRGF-supported program should be preceded by successful adherence to a staff-monitored program, building on the authorities' emergency economic recovery program. These reform efforts should address the current macroeconomic imbalances and advance structural reforms in key areas in close cooperation with the World Bank. Directors stressed the need to ensure ownership and commitment at the highest political level, to base any future program on realistic assumptions of growth, revenue, and official finance, and to include ex-ante contingency plans to ease adjustment should key assumptions turn out to be overly optimistic.