Public Information Notice No. 12/115

Public Information Notice: IMF Executive Board Concludes 2012 Article IV Consultation with the Democratic Republic of the Congo

September 27, 2012

On September 24, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the 2012 Article IV consultation with the Democratic Republic of the Congo (DRC).¹

Background

In the past few years, economic performance in the DRC has shown marked improvement although progress in alleviating poverty and meeting the Millennium Development Goals has lagged. Prudent macroeconomic policies and structural reforms have underpinned this performance and led to the DRC receiving debt relief under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative in mid-2010.

The DRC’s weak financial linkages with the euro area countries have largely shielded it from the turmoil there, allowing real gross domestic product (GDP) growth to expand by about 7 percent in 2010–11. Strong trade and investment inflows from non-European countries, driven mainly by the mining sector, have provided the main impetus to growth. Inflation was well above the single-digit target of the Central Bank of the Congo (BCC) in 2011 largely because of external factors, but has recently slowed to about 10 percent through July 2012.

The external sector improved significantly as a result of HIPC debt relief but the DRC remains at high risk of debt distress because of its vulnerability to the volatile terms of trade, high import dependency on food and capital goods, and a narrow export base. Weak debt management also increases the risk of again accumulating an unsustainable level of debt. The current account deficit widened in 2011 to about 11½ percent of GDP as commodity prices weakened from their high levels in 2010 and the value of imports increased, especially for food, fuel, and capital goods.

Macroeconomic policies have provided strong support to recent performance, with the DRC having rebuilt many of its buffers. In particular, fiscal dominance has been reduced over the past few years, owing to the government’s expenditure discipline and commitment to zero (net) financing of the budget from the BCC. This has helped break a vicious inflation-exchange rate depreciation cycle and brought the domestic fiscal deficit down from 2½ percent of GDP in 2009 to a projected deficit of 0.9 percent of GDP in 2012. Strong expenditure discipline has been an essential element in the authorities’ efforts to achieve consolidation, which was necessary in the context of the limited external financial support to the DRC—reflecting donors concerns over governance, especially in the natural resource sector—and slow progress in raising more domestic revenue. Recently, however, weaknesses in the budget process, inflated revenue projections, and a corresponding large expenditure envelope pose a risk to fiscal credibility and point to the need to bolster and better entrench public financial management reforms.

The improvement in the fiscal situation has also helped the BCC control liquidity and fight inflation. The BCC aims at containing inflation through the issuance of central bank bills but data and capacity problems as well as political pressures have made it hesitant at times to proactively tighten monetary policy.

Although progress in structural reform has been mixed, some reforms in key areas are supportive of better economic performance. These include efforts to improve public financial management, strengthen governance and transparency in the natural resource sector, and enhance the BCC’s independence and financial stability and development of the financial sector more generally. Still, other reforms have lagged and new issues have emerged, including weaknesses in external debt management (emergence of external payments arrears) and accountability and transparency in the operations of state-owned enterprises (SOEs) in extractive industries. These weaknesses could undermine recent progress and have contributed to the delay in completing the fourth and fifth reviews under the authorities’ Extended Credit Facility arrangement.

Executive Board Assessment

Executive Directors welcomed the authorities’ improved macroeconomic management, which contributed to higher growth, lower inflation, and a stronger external position. However, poverty remains widespread, the economy is vulnerable to domestic and external risks, and program delays are cause for concern. Directors called for steadfast efforts to preserve fiscal credibility, strengthen the monetary policy framework, and improve the governance of extractive industries.

Directors commended the authorities’ progress in consolidating the fiscal position, supported by the commitment to forgo financing of the fiscal deficit from the central bank. They encouraged the authorities to maintain this fiscal anchor but expressed concern that the 2012 budget threatened hard-won credibility gains. Accordingly, they called for monitoring budget execution rigorously, reducing discretionary spending if revenue projections fail to materialize, and making further efforts to increase domestic revenues, particularly from extractive industries. Directors also encouraged the authorities to strengthen debt management and consider external borrowing only at highly concessional terms.

Directors encouraged the central bank to manage liquidity tightly to further dampen inflation expectations and guard against second-round effects from the recent increase in global food and fuel prices. They also agreed that completion of recapitalization, divestment of non-core activities, and greater operational transparency would strengthen central bank independence and improve the effectiveness of monetary policy.

Directors considered that the current monetary framework and floating exchange rate regime remain appropriate. However, given the high level of dollarization and the central bank’s limited ability to act as lender of last resort in the event of a deposit run, a further build up of international reserves is warranted. While the external sector has improved recently, the country remains vulnerable to external shocks due to its narrow export base and lack of access to international capital markets.

Directors noted that the financial sector is underdeveloped, limiting financial intermediation and the transmission mechanism of monetary policy. They advised the authorities to improve bank supervision, enforcement of prudential requirements, data quality, and the central bank’s analytical capacity. Directors welcomed the authorities’ request to participate in the Financial Sector Assessment Program.

Directors emphasized that efforts to improve governance and transparency in extractive industries, and the business climate more generally, must be stepped up if the country is to maximize the benefits of its vast natural resource wealth. In particular, the authorities must move quickly to address gaps recently exposed by the commercialization of state-owned enterprises in the natural resource sector.