Mission Concluding Statement 

Angola -- 2006 Article IV Consultations, Preliminary Conclusions of the IMF Mission

March 29, 2006

1. An IMF mission conducted discussions in Luanda with the Angolan authorities for the 2006 Article IV consultations during March 15-29, 2006.

2. The recovery of the Angolan economy is now becoming more firmly established. Since the 2002 peace settlement, about 4 million displaced persons, including former combatants, have been resettled, and the output of agricultural smallholdings has been growing strongly. Rapidly rising production and revenues from the oil sector have been the main driving forces behind the improvements in overall economic activity and in macroeconomic conditions. Extensive demining has been undertaken and reconstruction of the physical infrastructure, most of which was destroyed during the civil war, is now under way. Nevertheless, commercial activity outside oil, construction, distribution, and diamonds is extremely limited. Poverty remains widespread.

Economic conditions continue to improve

3. The macroeconomic position strengthened during 2005. GDP grew by about 18 percent, largely reflecting rising oil production. By end-2005, oil output exceeded 1.4 million barrels per day (bpd). There were also clear signs of buoyancy in the construction sector and sustained growth in agriculture. At the same time, inflation declined steadily. The 12-month CPI inflation rate fell to18.5 percent in December 2005 (compared to a target of 15 percent) from 31 percent a year earlier (and has since declined below 16 percent). Net international reserves, including all the deposits recently transferred to the central bank from offshore oil escrow accounts, rose to the equivalent of 4.3 months of non-oil-related imports (US$ 4.1 billion) by end-2005, while nearly US$600 million from outstanding commercial oil-backed loans was paid off.

Although the government's accounts moved into surplus in 2005, monetary growth was higher than planned. The mission estimated a fiscal surplus of about 7 percent of GDP (US$2.2 billion) in 2005, resulting primarily from a rise in government oil revenues to US$10 billion in 2005 from US$ 5.6 billion a year earlier. Nevertheless, boosted by a surge in liquidity at the end of the year associated with a larger than usual end-year concentration of government spending, base money rose by 66 percent in the 12-months to end-December 2005, presenting some risks to inflation in the coming months. The exchange rate rose sharply against the US dollar towards the end of 2005, following increased foreign exchange sales by the central bank. The real effective exchange rate at end-2005 was over 40 percent above its level two years previously.4.

Economic prospects are favorable if a focus is maintained on macroeconomic stabilization and the development of the private sector.

5. With more oil production scheduled to come on-stream from existing discoveries, prospects are promising for continued economic growth and strong public finances for the remainder of this decade. Recent projections suggest that oil output will surpass 2 million bpd during 2007 and will be 90 percent above 2005 levels by 2010. This would imply GDP growth of about 15 percent in 2006 and average annual GDP growth rates of over 13 percent between 2007 and 2010. Government oil revenues would nearly double in US dollar terms between 2005 and 2010, even after allowing for a fall in oil prices towards their long-term trend. This increased revenue could create room for a substantial increase in public spending while maintaining comfortable overall fiscal surpluses. On this basis, there would also be a steady decline in the ratio of public debt to GDP, perhaps to below 20 percent by the end of the decade.

6. The outlook is however subject to significant risks, which must be addressed by government actions. In an uncertain environment for oil production and prices, public expenditure growth needs to be set in a medium-term context to avoid the boom and bust cycles that have undermined stability and development in some other oil-producing countries. At the same time, given limited administrative and absorptive capacity, a careful assessment of rising public expenditure is needed to assess its value for money and yield and to minimize potentially adverse macroeconomic consequences. In addition, the authorities should specify a clear monetary anchor, with responsibilities for executing monetary policy defined for the National Bank of Angola (BNA), to maintain the downward trend in inflation even in the face of external shocks. To allow the private sector to take advantage of the new opportunities, the pace of structural reform must accelerate sharply, accompanied by sustained improvements in transparency.

Economic policies should be framed within a longer time perspective

7. A medium-term economic framework should guide economic policy. At present, the horizon for decisions affecting macroeconomic policy is, at most, two years ahead; spending programs in annual budgets are determined only by revenue prospects for the coming year. Although a conservative approach is taken towards specifying the oil price on which the revenue projections are based, this approach can still yield sharp cycles in spending and levels of spending which can prove unsustainable in the long run. A sounder approach would be to base annual ceilings for public expenditure on medium term revenue prospects, evaluated at a long-run oil price. The objective would be to deliver consistent fiscal surpluses over time, so that financial reserves could be built up during the years of peak oil output (or cyclically high prices) to sustain incomes when oil revenues eventually fall. The level of the non-oil fiscal balance during this period would provide a useful indicator of the sustainability of fiscal policy; and changes in the non-oil fiscal balance would monitor its direct impact on the domestic economy.

8. Public spending plans should be cast within a medium-term strategy for poverty reduction, and for achieving the Millennium Development Goals (MDGs). An updated and extended Estrategia de Combate a Pobreza.(ECP) would help determine medium-term priorities. The quantitative projections in the draft ECP, produced in 2003, were not able to reflect the considerable increases in resources, which are now being made available to the budget. An extended ECP could also provide a stimulus for the development of indicators to measure and track income and non-income dimensions of poverty. In this regard, a useful supplementary interim approach would be to track resource inputs by the government on priority sectors (such as education and health), complemented by a series of relatively low-cost Public Expenditure Tracking Surveys (PETS) in selected sectors to assess effectiveness.

9. In view of the improvement in Angola's fiscal position, the authorities should aim to reduce Angola's public external debt, while also building up foreign exchange reserves. A priority should be to initiate clearance of external debt arrears, which currently exceed US$2 billion, in addition to late interest. A useful first step in this regard would be to resume payments falling due. Other important considerations in rebalancing the overall foreign exchange portfolio to maximize returns to Angola would be to eliminate the government's reliance as soon as possible on expensive oil-backed loans from commercial banks and to minimize recourse to external debt to finance public investment in the future. It is understood, however, that part of the improvement will be used to create a dedicated `oil reserve account' of the Ministry of Finance at the BNA to help in fiscal stabilization. The rules governing this reserve account should clearly establish the basis under which transfers will be made and how the funds will be invested. Elimination of Angola's remaining exchange restrictions would clear the path for acceptance of obligations under IMF Article VIII.

Some adjustments in economic policies should be considered

10. Given limited administrative capacity, the planned increases in public expenditure in the 2006 budget pose considerable risks for the economy. Capital expenditure is budgeted to rise to US$ 7.9 billion in the current year, from an estimated execution of about US$ 1.5 billion in 2005. While commendable, in the light of post-conflict needs and pervasive poverty, such an increase would place an intense burden on the administrative resources required to process the projects. In addition, execution of the projects would put immense strain on the absorptive capacity of the economy. There will be a need for particular vigilance against inefficiency and weak governance, as a substantial part of the program apparently involves the use of military forces and directly contracted labor rather than competitive contracts. A better approach would be to mitigate the potentially adverse macroeconomic consequences on prices and the exchange rate through a transparent execution process and maintaining a high import content. At the same time, the further increases planned in the public payroll should be carefully monitored in the light of domestic capacity constraints and the need to prevent further unproductive spending, including on additional `ghost workers'. Angola already has an unusually large public payroll, relative to GDP, compared with other countries in the region.

11. The government should resume its policy of reducing petroleum subsidies and allocate some of the resources saved to poverty-reducing spending. The prices of domestic petroleum products would then increase towards levels elsewhere in the region. While the cost of subsidies on petroleum products is likely to be about 3 percent of GDP (US$ 1.2) billion this year, much of this spending benefits the better-off . Poverty alleviation measures could focus on support for transport services and welfare provision. Alternatively, part of the resources saved could contribute to a strengthening of the overall fiscal position and thus reduce the vulnerability of the budget to shocks.

12. The calculations used to determine payments to Sonangol from the government should be revisited. The formulas which set the reimbursements to Sonangol for the costs of refining and delivering petroleum products, and for acting as the government's concessionaire, need to be updated to reflect the changing relationship between costs and prices in the oil sector. Sonangol would appear to have received substantial windfall gains from the government since oil prices began to rise in 2003.

13. Achievement of the authorities' 10 percent inflation target for 2006 will require a tightening of monetary policy this year, including a possible appreciation of the nominal exchange rate. Excess liquidity created by the overshooting of the monetary base target last year has not yet been drained from the banking system, while interest rates on government securities are now negative in real terms. The scaling up of public spending is likely also to exert additional pressure on the domestic price level. In these circumstances, with swiftly rising foreign exchange reserves, both sales of foreign currency and new issues of government securities should be used by the BNA to help mop-up excess liquidity. While not a policy objective, an appreciation of the nominal exchange rate should not be resisted as it will contribute to the downwards pressure on inflation.

More transparent management of public resources and an improved business climate are essential

14. An urgent priority for Angola is to improve its capacity to plan, scrutinize, execute, and monitor public expenditure. In particular, greater consideration should be given to potential returns when choosing investment projects, bearing in mind that accumulation of financial assets provides a secure alternative use of available funds. Many of the weaknesses identified in the 2004 Public Expenditure Management and Financial Accountability Review (PEMFAR) by the World Bank remain to be addressed and some of these could usefully be followed up this year in a Public Expenditure Review (PER). Until the Integrated Financial Management Information System, SIGFE (Sistema Integrado de Gestao das Financas do Estado), is operating effectively, and has comprehensive coverage, it will be important to focus attention on making operational the new fiscal programming unit in the Ministry of Finance in order to expeditiously improve public expenditure monitoring. Fiscal data remain extremely weak.

15. The authorities should further strengthen the transparency of government revenue and fiscal accounts and systematically address the serious deficiencies that remain in the governance of the oil and diamond sectors. There is a large outstanding agenda from the `Oil Diagnostic Study' issued in May 2004, to which the government has not yet made a comprehensive response. Items identified in the study include: the separation of Sonangol's regulatory functions from its commercial interests; improved oil revenue management; regular publication of oil data and analysis; the development and use of a forecasting model for oil revenues; and bringing under budget scrutiny Sonangol's quasi-fiscal spending on petroleum delivery, oil subsidies, and miscellaneous services, which are currently netted out of their oil payments. Timely publication of the audits of Sonangol's financial statements would also be fruitful. Similarly, in the diamond sector, there is a need for a transparent licensing, regulatory, and tax structure that would avoid conflicts of interest and privileged access to development rights. Meanwhile, the request by the government to the IMF Fiscal Affairs Department for completion of a Report on the Observance of Standards and Codes (ROSC) in the area of Fiscal Transparency, including on resource revenue, will provide an effective framework for further improvements in transparency and provide recognition for the advances that have already been made. Participation in the Extractive Industries Transparency Initiative (EITI) would also contribute positively to this process.

16. The authorities should quickly implement measures under consideration that would reduce bureaucracy, limit graft, enforce contracts and property rights, and reduce privileged access; and should revitalize the privatization program in a transparent and fair manner. The climate for doing business in Angola--whether for residents or foreign companies--is still perceived as one of the least conducive in the world. Implementation of pro-business measures would enable companies to compete more effectively in an open market, which has also been promoted by the recent reduction in external tariffs. The alternative path of increasing protection to selected sectors by raising barriers to external trade would promote inefficiency and raise prices and be subject to serious governance risks. Similarly, the proposed establishment of a development bank, which will seek to direct up to 5 percent of the government's oil revenues for subsidized lending to the private sector without collateral or an adequate equity stake, is a retrograde step. The evidence from other countries (and of past experiences in Angola) is that such institutions are prone to poor governance, including privileged access and to emergence of non-performing loans, and that they promote inefficiency and moral hazard. There are more effective ways to address the problems of inadequate finance for micro, small and medium-size businesses including through microfinance, venture capital, and supportive action on contract enforcement. An improvement in the overall business climate is critical for the development of the private sector.

17. The authorities need urgently to address data weaknesses. In particular, data on the fiscal sector and the real economy contain serious deficiencies. Additional technical assistance is available from the Fund and the international community to improve data collection and analysis.