Guinea -- Conclusions of the IMF Article IV Consultation Mission
May 10, 2003
Guinea—Conclusions of the IMF Article IV Consultation Mission
Conakry, May 10, 2003
To hold consultations under Article IV of the Fund's Articles of Agreement for 2003, an IMF mission, headed by Mr. Pierre van den Boogaerde, visited Conakry from April 28 to May 11, 2003. A World Bank team led by Mr. Ezzeddine Larbi, and staff from the European Union, took part in the talks.
The government team led by S.E.M. Cheick Ahmadou CAMARA, Minister of Economy and Finance, with the participation of the Governor of the Central Bank of the Republic of Guinea (BCRG), Mr. Ibrahima Cherif BAH, discussed with the mission the macroeconomic situation and structural reforms implemented in 2002, as well as the economic policies and structural measures planned for 2003 and for the medium term. In the context of its sectoral meetings, the mission had constructive discussions with Mr. Niankoye Sagno, Minister of Planning, El-hadj Oumar Kouyaté, Minister of Fisheries and Fish Farming, Mr. Alpha Mady Soumah, Minister of Mines and Geology, Mr. Mamadou Sylla, Minister of Justice, the departments of agriculture and livestock, industry and commerce, and other ministries responsible for priority sectors on the implementation of Guinea's Poverty Reduction Strategy (PRS). Finally, the mission discussed the campaign against corruption with the National Anti-Corruption Committee (CNLC). The mission sincerely thanks the authorities for their warm welcome, the quality and candor of the discussions, which has characterized its work.
The economic situation in Guinea in 2002 was severely affected by the slow growth of the world economy and its negative impact on the prices of bauxite and other products that Guinea exports, the insecurity of the southern borders, uncertainty created by the events in Côte-d'Ivoire since September 2002, and the lack of external assistance. However, the rate of growth of the economy was 4.2 percent, as projected, mainly because of good agricultural output and sustained activity in the secondary sector. The abundant harvest also helped keep the inflation rate measured by the consumer price index down to an average of 3 percent but, as a result of strong money supply growth, the inflation rate on a year-on-year basis accelerated in the second semester to reach 6.1 percent at end-December. The current account deficit (excluding transfers) worsened from 3.8 percent of GDP in 2001 to 7.5 percent of GDP in 2002, due to a slight deterioration in the terms of trade and a strong increase in imports, particularly imports of oil products.
On the fiscal side, exogenous factors—;the effect of capital losses on the contribution of mining companies to government revenue and, especially, unplanned expenditure on security—;put heavy pressure on national budget implementation. In contrast to its weak performance in recent years, government revenue in 2002 amounted to 12 percent of GDP, a substantial increase over the 11.3 percent of GDP of 2001. This revenue comprises mining and nonmining receipts, which amounted to 2.3 percent and 9.7 percent of GDP, respectively. Primary current expenditure exceeded projections by some GNF 100 billion (1.6 percent of GDP). Half of this overrun was due to unforeseen expenditure on security, and the balance comprised unexpected election spending, expenditure linked to the installation of national satellite coverage, and other expenses resulting from poor monitoring of budget execution. It should be noted that all outlays on priority social sectors, public external debt, and payments for electricity, water, and telephone charges were paid on schedule. As a result of these developments, the primary balance was 1.9 percent of GDP below estimate. The overall budget deficit on a cash basis for the full year was 7.1 percent of GDP, twice as high as projected, as a result of significant shortfalls in foreign aid disbursements (more than 1 percent of GDP), large transfers to other government administration departments, and a sharp reduction in domestic arrears through debt securitization.
Monetary policy in 2002 was characterized by a steep decline in the BCRG's foreign assets, a sharp increase in net domestic assets owing to the government's considerable indebtedness to the banking system and a significant expansion of the monetary base resulting in excess liquidity. The decline in foreign assets from US$60.7 million at end-2001 to US$26.4 million at end-2002 was mostly a result of the failure to mobilize external assistance and unplanned expenditure on security. The BCRG's net domestic assets increased by more than 50 percent, mainly due to the monetary financing of the budget deficit; overall, net bank credit to the government increased by 3.6 percent of GDP. Contrary to what had been discussed, the BCRG issued insufficient sterilization bills (TRMs) to mop up excess liquidity. As a result, the money supply increased by 19.2 percent in 2002, double the expected growth rate. Growth of credit to the private sector was 7.5 percent in 2002.
Exchange rate policy continued to be implemented through monthly BCRG auctions on the foreign exchange auction market. In 2002, the nominal value of the Guinean franc remained practically stable vis-à-vis the U.S. dollar, indicating an implicit policy of pegging the official nominal exchange rate to the U.S. dollar, while it depreciated by some 13 percent against the euro and by about 5 percent in real effective terms. The differential between the official and parallel market rates remained around 2 percent. However, the mission noted that disintermediation had become more pronounced as a growing volume of number of imports was financed with deposits held abroad.
Structural reform progressed well. In the fiscal area, the Treasury's accounts were linked to the computerized expenditure chain and a database was created for the Surveys and Research Division of the National Tax Directorate. In the monetary area, instructions and rules were issued to align prudential regulations with the core principles of the Basel Committee, the draft of the new banking law was submitted for comment and opinions, and the rules for auditing microfinance agencies were established. Eight public enterprises were privatized or liquidated. Concerning the anticorruption effort, the public trial, broadcast in the media, of the cases of misappropriation of public funds forwarded by the National Anti-Corruption Committee (CNLC) to the judicial authorities began in November 2002, but the process of reviewing the cases has been moving very slowly.
The economic outlook for 2003 may be characterized as one of slow growth, higher inflation, and pressures on the exchange rate of the Guinean franc. The mission discussed the sources of growth, exchange rate policy, and the policies necessary to bring down inflation and foster robust and sustained growth in the medium term in line with the objectives of the Poverty Reduction Strategy.
The Guinean economy has experienced annual real GDP growth of about 4 percent since 1996, with the exception of 2000 because of the impact of the border conflicts. This has resulted in an increase in per capita income of about 1 percent per year, a level insufficient to reduce poverty significantly. As a result, the Poverty Reduction Strategy Paper (PRSP) was premised on faster growth and on a better distribution of its benefits. However, the initial estimated growth of 4.9 percent for 2003 cannot be attained. In spite of the good prospects for the crop season, the numerous power outages are a drawback to the manufacturing sector and to commercial activity, and projected GDP growth was revised downward to 3.6 percent. The mission held numerous discussions on the sources of growth and the measures needed to accelerate the growth rate on a sustainable basis, including restoring economic and financial stability, further developing agriculture, improving basic infrastructure (in particular electricity, water, and transportation), strengthening the institutional, legal, and regulatory environment, better financial intermediation, and progress in structural reforms. Continued uninterrupted efforts in these areas should make it possible to achieve a growth rate of more than 5.5 percent over the medium term, in line with PRSP projections. The mission also presented a low-case scenario of lax fiscal discipline and governance, an accomodating monetary policy, and a somewhat less favorable external environment, particularly in terms of mineral prices. In that scenario, growth would remain around 3.4 percent on average in the medium term and would prevent achievement of the goals of poverty reduction.
Guinea's greatest economic achievement in the last decade is to have kept inflation under control. However, the rapidly expanding money supply since the second quarter of 2002 fueled inflation considerably, pushing it up to 10.4 percent year-on-year at end-March 2003. This inflationary spurt may continue until the middle of the year, also as a result of the rise in fuel prices in March, and might then taper off if the money supply shrinks. The mission estimates that average inflation for 2003 would be close to 6.2 percent (9.6 percent in the low-case scenario). To reduce inflation in the medium term, strict discipline will be required to ensure that growth in money supply is contained.
The main problem in the fiscal area is low levels of revenue resulting in insufficient resources for investment and essential public services, including in the social sectors. Revenue mobilization has been less than 12 percent of GDP in recent years, well below the average of about 18 percent for the countries of the subregion and the 20-percent target established in the convergence criteria of ECOWAS's second monetary zone. This low level of mobilization is essentially due to a very wide range of exemptions, the decline in mining sector revenue, institutional weaknesses in the tax and customs administrations, and fraud. Yet major strides are beginning to be made. In 2002, nonmining revenue amounted to 9.7 percent of GDP, 1.2 percent higher than in 2001. The estimated level for 2003 is 10.6 percent, a further increase of 0.9 percent of GDP. Further improvements in the level of nontax revenue should result from the willingness to broaden the tax base and reforms in the revenue administrations to compensate for the losses in mining revenue resulting from the recent drop in international prices. The mission discussed pursuing these reforms, particularly the adoption of prior actions to the introduction of the WAEMU common external tariff (CET) and the continued strengthening of the tax and customs administrations.
Progress in expenditure management was mixed in recent years. Public expenditure is now conducted in a medium-term framework and administered through a computerized tracking system, and increased budgetary decentralization to improve the impact of public expenditure. The share allotted to the social sectors has increased notably. However, this progress did not prevent significant overruns in 2001 and 2002. As a result, the mission discussed additional efforts to control expenditure levels, including the processing of all public expenditure through the computerized tracking system, and the improvement of budget decentralization and expenditure tracking, in particular by reinforcing the medium-term framework. It also insisted on the need to continue giving preference to social expenditure.
Steadily increasing revenue and better expenditure control will make it possible to gradually improve the basic balance and reduce the overall deficit and the government's indebtedness to the banking system. To limit the creation of money, the financing needs of the government must be met essentially by issuing treasury bills and, eventually, by government bond borrowing from the nonbank financial sector and the public.
Monetary and exchange policy
Monetary policy had been relatively stable over the past five years, despite some slippages in 2000. In particular, increases in the money supply were moderate, borrowing by the government from the banking system was controlled, and the level of net foreign assets was generally adequate, resulting in a subdued inflation rate. These achievements are now threatened by the slippages observed since the second quarter of 2002, namely a sharp increase in credit to the government, and in base and broad money; a substantial decline in net foreign assets; and a return to year-on-year double-digit inflation. The monetary policy lessons to be learned from these slippages are: (i) liquidity management must be more proactive; (ii) better conditions must be created for bank intermediation and private sector financing; and (iii) exchange rate policy must be market-based.
The mission noted that monetary policy should seek to stabilize monetary aggregates in the medium term, in particular through a gradual reduction in government debt to the banking system and proactive liquidity management. For this to work, it is essential that the central bank adopt sound ways to finance the government's financing needs by using treasury bills and avoiding financing with central bank credit, as it has in recent times. Furthermore, a reduction in the government's debt vis-à-vis the BCRG would enable the central bank to rebuild its gross foreign assets. The money supply should expand in line with nominal GDP growth, keeping velocity of circulation constant. To this end, the central bank must actively use its main monetary policy instrument, sterilization bills. Lastly, the reduction in credit to the government should result in a significantly increase in credit to the private sector to meet the development needs of the economy.
In the area of exchange rate policy, during the first quarter of 2003, the rate of the Guinean franc to the U.S. dollar in the monthly auctions on the foreign exchange auction market remained steady. However, the differential between the official and parallel market rates gradually increased to over 5 percent in March 2003, thereby becoming an exchange restriction under the terms of Article VIII of the Fund's Articles of Agreement. The mission pointed out that the exchange rate might already be structurally overvalued in light of the poor response of exportable goods to changes in the rate. Further overvaluation would harm the economy's competitiveness and call for a large devaluation later on, which would have destabilizing effects on the economy. Liberalization of the process of establishing rates on the official market would be by far the best solution. The authorities responded that some control of the official rate was necessary given its immediate impact on price levels and the fact that depreciation had little effect on export supply, owing to structural problems. The mission countered that argument by pointing out that the reference exchange rate for price formation is the parallel market rate, in light of the small volume of transactions on the official market, and that maintaining an overvalued rate would only increase the inelasticity of exports to the exchange rate.
Monetary policy must be accompanied by a number of structural measures to enhance the effectiveness and stability of the financial system in Guinea. The bank chart of accounts is being automated and, at end-March 2003, the BCRG instituted an anti-money laundering mechanism. The regulatory framework of the banking system will also be strengthened by the passing of the new banking law in the parliament and by the strengthening of prudential standards. The banking environment seems relatively sound. The banks generally observe prudential ratios and the rules on exchange rate positions and internal controls. The only remaining problem bank should be recapitalized by end-June 2003. Microfinance has also been progressively rehabilitated. The liquidation of the Crédit Mutuel de Guinée and the compensation paid to its depositors should be completed in July 2003. The Crédit Rural de Guinée, the largest microfinance institution in the country, is running well and other private entities have begun to operate in that market. An appropriate legal and regulatory framework for the sector was put in place and off-site and on-site audits have been started.
Liquidity management at the BCRG continues to improve, supported by technical assistance from the IMF. Following up on the recommendations of the IMF safeguards assessment mission in May 2002, the BCRG adopted the international accounting standards (IAS) as the framework for presenting its financial statements starting FY 2003. Three other important measures will be implemented on schedule: creation of an audit committee, special audit of the exchange reserves, and audit of the BCRG's financial statements.
Guinea enjoys a large number of external trade advantages, in particular its strategic location vis-à-vis its landlocked neighbors. Despite this, the growth of external trade in Guinea is significantly lower than GDP growth, mainly because of the numerous administrative drawbacks. Since the beginning of 2003, the government has been committed to removing some of these obstacles, particularly the roadblocks and the 17 checkpoints at the port of Conakry, and intends to continue its efforts.
In the medium term, the average annual growth rate of exports is estimated to be about 3 percent in volume, which is still below GDP growth, reflecting the continued preponderance of mining products and the lack of any significant diversification. Imports are expected to increase by about 6 percent on average per year. As a result, there would be a slight deterioration in the current account balance (including grants) from 5 ¼ percent of GDP in 2003 to about 6 percent in 2008. In terms of months of imports of goods and nonfactor services, gross foreign assets are expected to amount to 5 months of imports in 2008, as opposed to 2 months in 2003.
Debt management capacity has been strengthened, in particular with the assistance of Debt Relief International (DRI) that started in June 2002. Debt agreements are being compiled and the database updated in Excel; data entry forms for new agreements have been prepared; computer equipment and software have been purchased; and staff has been trained. The result is an improvement in the procedure for debt service payments and a greater capacity to monitor debt sustainability. The indicators of debt sustainability worsened in comparison with the calculations made at the decision point of the HIPC Initiative, reflecting mainly a decrease in the value of exports (an annual average decline of 20 percent) and of tax revenue.
The numerous water shortages and power outages since the second quarter of 2002 signal the urgent need for public enterprise restructuring and privatization, in particular in the area of infrastructure (water, energy, telecommunications), for strengthening regulatory frameworks, and for improving the collection of consumption charges. Without a radical reform of these sectors, the Guinean economy will not be able to embark on the path to sustainable growth. In the water sector, the government's goal is to turn over the management of operations to a private operator, under an improved outsourcing contract. Regarding electricity, the government continues its efforts to raise the output rate and outsource the operation of this service to a private concession.
The mission was pleased to note the willingness of the authorities to improve the functioning of the judicial system. Projects include, among others, redefining the role of magistrates, attributing a special status to the magistracy, regulating the profession of attorneys to ensure the independence of the bar, effectively applying the texts implementing the OHADA treaty, and better enforcement of judicial decisions. The scourge of corruption continues to permeate Guinean society and retards growth and poverty reduction. Corruption imposes extra costs and reduces the competitiveness of exporting companies, discourages investment—;both domestic and foreign, diminishes the tax revenue collected, and affects the quality of public services, as well as their access, in particular for the poor. The CNLC began its sociological surveys, covering the entire territory, to establish a national anticorruption strategy and will continue its investigations into corruption cases. The Ministry of Justice has also set up a joint committee to define procedures and functional relations between the CNLC and the Chancery.
IV. Poverty Reduction Strategy Paper
The implementation of Guinea's poverty reduction strategy, as presented in its PRSP, has made possible a fair amount of improvement in the living conditions of the population in the last two years. This progress is significant in the areas of primary and technical education, health, village waterworks, urban sanitation, and rural roads. In particular, in the education sector, the gross primary school enrollment rate moved from 56 percent in 1999 to 62 percent in 2001 and to 71 percent in 2002, with the rate for girls rising from 40 percent in 1999 to 51 percent in 2001 and 61 percent in 2002. In the health sector, the immunization rate (DTP3) of infants under one year old rose from 45 percent in 2000 to 50 percent in 2001 and to 55 percent in 2002. Resource allocation in the 2003 budget was deconcentrated on the basis of the priorities defined by the local population and written into the PRSP. Great efforts to execute the budget for the social sectors were made in 2003 and this work is expected to continue.
After holding consultation workshops throughout the country, the government has started preparing regional poverty reduction strategies and drawing up the first progress report on PRSP implementation, which will present a rigorous assessment that will serve as the basis for updating the strategy.