Mr. Rodrigo de Rato
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. de Rato:

1. This letter describes economic and financial developments during the first half of 2004, as well as the policies that the government intends to implement over the rest of the year to meet the objectives of the program supported by the Stand-By Arrangement.

Developments during the first half of 2004 and economic outlook for the remainder of the year

2. Economic and financial developments in Gabon during the first half of 2004 were generally in line with program objectives. In the public finance area, all key targets were met even though growth in the non-oil sector was somewhat lower than envisaged. All the end-June performance criteria were met, as well as all the indicative targets, except for a small shortfall in non-oil revenues.

3. Oil production was close to the level of 2003, and a decrease of only 1.5 percent to 13.3 million metric tons is expected for the full year. Investment in the sector remains robust, boosted by high world prices. In the non-oil sector, real growth is stronger than in 2003, but it is expected not to exceed about 2.3 percent, below the 3 percent program target. Good performance was recorded in mining, particularly in manganese, where extraction could rise by 20 percent over the year. Logging of secondary species also performed well, rising by over 10 percent. However, this was accompanied by a fall in the logging of okoumé, the main timber species, so that total timber cutting over the year is expected to be stable. In the secondary sector, the growth in value added in the wood-processing industry continues to be strong (15 percent on an annual basis), while value-added in other industries and trade is expected to rise by less than 2 percent.

4. The 12-month rate of increase in the consumer price index at end-June was 1.7 percent, in line with the annual program target for 2004 (2 percent year-on-year).

5. Developments in the external current account were much more favorable than expected, due to the higher price of oil exports, and greater manganese exports both in volume and value. This led to a sharp increase in Gabon's contributions to the Bank of Central African States (BEAC) net foreign assets. For the year as a whole, the current account surplus is expected to reach the equivalent of 11.6 percent of GDP, compared with 5.8 percent initially forecast, with an increase in BEAC net foreign assets attributable to Gabon of about CFAF 122 billion (3.3 percent of GDP).

6. The rescheduling of Gabon's debt towards the Paris Club creditors, agreed in early June, was broadly in line with the program estimates. Of the CFAF 342 billion of arrears as at end-April 2004, CFAF 45 billion is to be repaid in two equal tranches before mid-September and mid-December 2004, respectively; this was decided because of the upward revision in the oil tax revenue estimates for the year. During the first half of 2004, the oil revenues surplus was CFAF 37 billion. A rescheduling agreement with South Korea was signed in July, and the agreement with the London Club creditors is currently being negotiated.

7. With regard to budgetary developments, in the first semester the target for the primary fiscal surplus, excluding grants and foreign-financed capital expenditures, and adjusted for the oil revenue surplus, was met with a comfortable margin. Non-oil revenues were broadly in line with the program, while expenditures were lower than expected. On the revenue side, a strong performance was recorded by nontax revenues and the revenue from the tax on income from financial assets (IRVM). Indirect tax revenue was very close to target, while direct tax revenue was lower than targeted by about CFAF 5 billion (0.1 percent of GDP). The latter is expected to pick up because of significant amounts owed by mobile telephone operators and tax arrears to be recovered through assessments. Revenues from forestry taxation (area tax and stumpage fee) were well below target, partly owing to the late publication of the 2004 budget law that defined the tax obligations, but collections accelerated in July and August, including on back taxes owed for the 2002 and 2003 fiscal years.

8. Current expenditures remained within program limits, even though transfers and subsidies were slightly above the program estimates. Capital expenditures were less than programmed by about CFAF 10.3 billion (0.3 percent of GDP). Nevertheless, the execution rate is higher than that observed for the same period in 2003.

9. In the first semester, the treasury float (difference between payment orders received and actual payments) was reduced by substantially more than envisaged in the program (CFAF 39.9 billion, compared with CFAF 12 billion programmed). This was due to the government decision to normalize its relations with domestic creditors. Thus, the treasury repaid all claims of less than CFAF 5 million, and is in the process of clearing those between CFAF 5 and CFAF 50 million, according to seniority. In addition, an agreement was reached in April with a group of domestic creditors, called the Libreville Club, which is open to all creditors with claims exceeding CFAF 50 million, and provides for settlement over an 18-month term. The claims presented to the Libreville Club amount to CFAF 38.9 billion, including about CFAF 30 billion previously in the treasury float; the remainder is constituted of arrears on the domestic debt obligations recorded at the Directorate General of Public Accounting (DGCP). The repayment schedule provides for payments of CFAF 2.2 billion a month, including CFAF 1.6 billion related to the treasury float. The treasury intends to reopen membership of the Club in the next few weeks, and to encourage the remaining eligible creditors to join.

10. The arrears on domestic debt obligations, which amounted to CFAF 21.2 billion at end-2003, were reduced to CFAF 5.5 billion at end-June 2004, well below the program target, as a result of actual payments and the Libreville Club rescheduling agreement, which covered CFAF 10.1 billion of arrears; of these, CFAF 1.8 billion were already settled by end-June. No external payment arrears were incurred during the program period.

11. The end-June performance criterion on net credit to government by the banking system was met. The sharp rise in net foreign assets of the banking system during the first six months of the year contributed to a 5.6 percent increase in money supply (5 percent in the 12 months to end-June 2004), following a fall of 1.2 percent in 2003. Credit to the economy decreased by 12.6 percent, as the high level of repayment of treasury float and domestic arrears strengthened the liquidity of the private sector.

Policies for the second half of 2004

12. The government remains committed to achieve the program's fiscal targets for 2004 and to implement the reforms envisaged in the fiscal and structural areas. A major change in the outlook for the second half of the year is the much higher oil revenue presently projected, as discussed in paragraph 5 above. The allocation of these resources is discussed below.

Public finance

13. In the fiscal area, the government is focusing on measures to strengthen revenue collection and enhance efficiency in budgetary programming and execution, in a framework consistent with the medium-term objectives of the PRSP.

14. After repaying Paris Club arrears, the excess oil revenue, now estimated at CFAF 110 billion for the year, equivalent to 3.3 percent of GDP, will be used in part to increase the resources of the Fund for Future Generations (CFAF 50 billion, equivalent to 1.4 percent of GDP); the remainder will be used to reduce the treasury float and domestic debt arrears in excess of the original program's targets. Accordingly, we request that the performance criteria on net credit to government by the banking system and on the stock of arrears on domestic debt of the central government for end-September and end-December 2004 be modified, as indicated in attached Table 1.

15. The main tax reforms measures being implemented are the following: (i) establishing the Large Enterprise Directorate (DGE), (ii) updating the taxpayer roster, (iii) strengthening collection of back taxes, in particular from the mobile telephone companies and the forestry industry, (iv) establishing an updated land registry to increase the yield of real estate taxes, and (v) securing forestry revenues. The draft decree establishing the DGE has been prepared. The turnover threshold for coverage by the DGE has been set at CFAF 1.5 billion, so that about 310 enterprises be covered. Given the status of the preparatory work, the DGE is expected to be operational from the beginning of 2005. Significant work to review the taxpayers' registration system has started, as the current roster is not reliable. The replacement of enrollment procedure by the issuance of tax collection notices is expected to lead to efficiency gains by improving taxpayer monitoring, rapid follow-up of delinquent taxpayers, and faster collection. This reform requires, however, that the General Tax Directorate (DGI) be adequately staffed; the establishment of the DGE, which is an essential part of this reform, should help considerably. The identification of the staff to be assigned to the DGE and the definition of its procedures, which will be thoroughly explained to the public, are already under way.

16. Regarding the VAT, the higher rate (25 percent) introduced in the 2004 budget law, which is applied to important services, such as telecommunications and banking operations, and to luxury goods, could constitute an obstacle to economic development. Also, the taxation of luxury goods could be more effectively achieved through an appropriate excise tax. For these reasons, the government will examine the possibility of reducing the higher rate to 18 percent in the 2005 budget law, after conducting an impact analysis.

17. Regarding real estate taxation, the timetable for establishing a new land registry provides for (i) the legal provisions on real estate taxes to be amended by end-December 2004; (ii) assessment lists for Libreville and Port-Gentil to be issued by end-December 2004; and (iii) accelerating procedures for automatic registration of land developed for housing construction during 2005.

18. On forestry taxation, the procedure of withdrawing permits from holders who do not comply with the tax obligations will continue to be applied rigorously. For payment of the stumpage fee, the principle of joint liability of the permit holder, the logger, and the timber trader will be strictly applied.

19. For the second half of the year, the government will ensure that current expenditures continue to be kept within the program limits, except for an allocation of CFAF 1 billion for (i) conducting the audit of the Road Maintenance Fund (FER) arrears and the regional investment expenditures related to the independence day celebrations, and (ii) securing technical assistance needed for applying the new budgetary classification also to the investment budget. A higher investment expenditure execution rate is expected in the second semester. Given the lower-than-projected non-oil growth, the ratio of the primary non-oil deficit to non-oil GDP will be slightly higher than programmed (7.6 percent of GDP instead of 7.5 percent). We therefore request that the target for the primary fiscal balance of the central government be revised to take into account the higher spending and higher oil revenue, as per Table 1 attached.

20. The wage bill is expected to remain within the program limits (CFAF 226 billion, or 6.2 percent of GDP) as a result of the measures adopted last April. These involve specifically (i) the strict observance of the retirement age limit; (ii) a careful check of contractual staff effectively in service; (iii) the rigorous audit of the payment of managerial allowances to ensure that they are allocated only to those entitled; (iv) a compression of the range of managerial allowances, with limits on increases based on seniority; (v) the limitation of the size of the ministerial cabinets; and (vi) payment of the air service allowance only to those strictly entitled. In addition, a new system for allowances for staff training abroad will be adopted by the government before end-2004, to rationalize trainee benefits.

21. Concerning expenditures for water and electricity, the efforts to contain consumption have not yet yielded significant results, in part because the required associated investments have not been made. Thus, the actual consumption in 2003 has exceeded the budgetary allocation by about CFAF 3 billion, which will be paid by the treasury before end-year. For 2004, an assessment of actual consumption will be prepared before end-September, and, if needed, the budgetary allocation will be revised upwards in the supplementary budget law; this adjustment will be offset by savings in other expenditures for goods and services or capital expenditures.

22. The Road Maintenance Fund (FER) is executing on schedule its 2004 budget, for which the program envisages total outlays of CFAF 24 billion, of which CFAF 18 billion related to the current budget year, and CFAF 6 billion for work undertaken in 2003 and not yet paid. The treasury will settle this amount within the allocation for float reduction.

23. Draft laws on the organization of government services and on the civil servants' statutes are expected to be approved by parliament during its September-December 2004 session. The preparation of the new civil service organizational chart will be completed by end-December 2004. In addition, the harmonization of the rosters of the civil service and the payroll office has progressed well and should be completed by end-December 2004, as programmed. Although significant progress has been made in preparing the computerized civil service management project (ANITA), actual implementation will take place during 2005, due to the technical complexities encountered.

24. With regard to the scholarship program, the Directorate for Scholarship and Training is conducting a study on how to enhance its effectiveness, inter alia by targeting specializations, better following students' progress, and reducing overall costs. The savings achieved will be used to strengthen the country's educational system. The government will submit this study to the World Bank for review.

Expenditure management and preparation of the PRSP

25. The government has taken measures to improve the transparency and efficiency of budgetary management. In this context, an audit mission was carried out in June 2004 to assess the physical and financial execution of a sample of priority investment projects in all provinces of the country. The mission helped identify the main reasons for the poor investment budget execution rate, including weaknesses both in preparation and in implementation and tracking of projects. The roundtable government discussions on the 2005 budget, which started in July, are taking the execution rate of projects into account in deciding budgetary allocations, and are giving priority to completion of projects under way.

26. The government will ensure that projects to be included in the investment budget for 2005 and the public investment program (PIP) for 2005-07 are consistent with the needs identified in the PRSP for the priority sectors. For example, the ministries of health and education will take into account the urgent needs revealed by the new national health map and by the last educational statistics yearbook. The focal points and the PRSP tracking units in the various government departments were involved in the process of selecting the priority projects. We are relying on the assistance of the World Bank in preparing the medium-term expenditure frameworks for these sectors. A Bank mission for this purpose, which will include other donors and lenders, is planned for end-September/ early October.

27. To speed up the preparation of the PRSP, which is expected to be finalized in early 2005, the government has allocated the necessary budgetary resources to conduct a rapid survey (core welfare indicators questionnaire, CWIQ), which will benefit from significant support from donors and lenders. This survey will allow the updating of both the poverty indicators and the other social indicators; it has started in August, and is expected to be completed by year-end. The results of the General Census of Population and Housing are currently under review, with the assistance of donors and lenders. In addition, a wide consultative process has begun in July, starting with Libreville.

28. The government has decided to carry out audits of the Road Maintenance Fund (FER) arrears and of the regional investment expenditures relating to the independence celebrations (fêtes tournantes) for the fiscal years 2003 and 2004. To this end, invitations to bid have been launched in early September for the FER arrears audit and will be launched in early October for the regional investment expenditures. These audits are expected to be completed by end-February and end-March, respectively.

29. The recently established General Directorate of Government Procurement (DGMP) is monitoring that all contracts are awarded in conformity with the provisions of the public procurement code. In this context, it has already rejected a large number of contracts that did not comply with the prescribed procedures. According to the code, all projects over CFAF 30 million must be approved by the DGMP. Firm instructions have been given to the General Budget Directorate not to issue any payments order for projects that do not comply with the procurement code.

30. A key objective for the 2005 investment budget is to ensure its rapid execution as soon as it is adopted. To this end, the detailed breakdown of appropriations needed for executing the budget will be attached to the draft budget submitted to parliament. In addition, the government is in the process of preparing the functional classification of budget expenditures; this is expected to be finalized during 2005 to be used for the 2006 budget, with a view to facilitating the tracking of expenditures in the PRSP's priority sectors.

Local government and social security funds

31. A commission set up by the government with the participation of the Senate and the Audit Office (Cour des Comptes) is currently carrying out a study to review local government finances, and identify measures to ensure their financial viability. These will probably include a strengthening of real estate taxation and greater rigor in personnel management. The study is proceeding on schedule, and the commission's report will be finalized and presented to the government by end-October, as planned.

32. The government has started introducing corrective measures for the National Social Guarantee Fund (CNGS), which provides old age and medical insurance and family allowances to government contractual staff and self-employed individuals. The CNGS budget presents a structural deficit because the payroll tax paid by the government as employer, together with a government annual budgetary subsidy, are insufficient to cover the costs of the benefits and of the funds' operations. To cover this deficit, which will amount to about CFAF 1.5 billion in 2004, during the second semester the government will increase its subsidy to the fund by CFAF 1.5 billion, through a corresponding appropriation in the supplementary budget for 2004. A draft performance contract to reduce operating costs and to improve the fund's efficiency is being prepared and will be finalized by end-September. In the interest of maximum transparency, the CNGS accounts will be presented in an annex to the government budget starting with the 2005 budget. The salary base for the payroll tax and the 7 percent tax rate will have to be revised upward to achieve equilibrium in the insurance scheme. To that end, a study will be launched by year-end.

33. With regard to the National Social Security Fund (CNSS), the updating of its data base of insured workers and their employers was completed in August. Using this database, the actuarial study carried out by the ILO will be completed in the first quarter of 2005. A specialized private operator has been managing the CNSS hospitals since March, to increase their efficiency.

Other structural reforms

Investment climate

34. Improving the investment climate to foster the diversification of the Gabonese economy is one of the main program objectives. Last May, a team from the foreign investment advisory unit of the International Finance Corporation (IFC) conducted an initial mission to evaluate the business climate; it will present a report to the government in September, which will provide the basis for establishing a plan of reforms. In the first quarter of 2005, further studies may be conducted on administrative barriers and on the tax and incentive system.

35. The government is aware that a recovery of the housing sector, where major social needs remain unmet, could significantly improve the living conditions of the population. In this context, the procedures for allocating lots for housing will be simplified, and the land development methods will be reviewed to give a greater role to the private sector. The land registry staffing will be reinforced, to speed up land registration.

36. To foster microfinance activity, which is still inadequately developed in Gabon, the government is looking into the advisability of revising the Development and Expansion Fund (FODEX) statutes, to enable it to operate in this sector in conformity with the prudential regulations for microfinance activities established by the Central African Banking Commission (COBAC).

Forestry sector and mining

37. In the forestry sector, the national forestry company (SNBG) has continued its program of cost reduction; this is all the more urgent given the depressed level of okoumé exports, in which the company has a monopoly, and which is showing no signs of recovery; export volumes fell by 28 percent in the first semester from one year before, while exports of other types of timber rose by 13 percent by volume, due to the strengthening of demand in China for high quality timber used in construction and decoration. Consequently, the company decided to cut wages in a 5 to 15 percent range according to wage levels. A study on the role of the SNBG by an internationally recognized consultant is under way and is expected to be completed by end-October, as scheduled in the program.

38. Following the government's adoption on May 18 of the letter of development policy for the forestry, fishery, and environmental sector, prepared in consultation with the World Bank, steps must be taken to implement the main actions provided for in the letter, including the launching of a pilot test for the allocation of forestry concessions by auction, and the publication of the list of all forestry permits. To this end, a decree establishing a moratorium on the allocation of new forestry permits and introducing the pilot auction project was issued on August 9, 2004.

39. The mining sector offers significant growth potential. The implementing regulations of the mining code will be approved by end-December 2004. In addition, the standard concession agreement, which will define the taxation applicable to investors, is currently under preparation. The government intends to submit it to the Fund Fiscal Affairs Department for review.

Public enterprises' privatization

40. The privatization program for Gabon Telecom is near conclusion, despite the delays in preparing the information memorandum for potential buyers. However, the government intends to increase the amount offered for sale from the 35 percent initially envisaged; this could delay the selection of the successful bidder to January 2005. In the postal sector, the consulting firm preparing a plan to restructure Gabon Poste is expected to submit its report by end-October 2004.

41. Concerning Air Gabon, the government decided last May to strengthen the management team by appointing a new director general. The provisional accounts for 2003 show a higher-than-expected operating loss. The new management has already adopted a series of cost-cutting measures, including the redeployment of the fleet to increase the load factors and achieve fuel savings. This has improved the cash flow in recent months, so that debts to suppliers were reduced. Nevertheless, the 2004 target of a balanced operating result before depreciation appears out of reach. In addition, the government has decided to start the process of partially privatizing the company; a call for expressions of interest was launched on July 19. As the Central African Economic and Monetary Community (CEMAC) member states have launched a study to create a regional airline (Air CEMAC), decisions on this option will have implications for the future course of the company.

42. The placement of the ports of Owendo and Port-Gentil under concession with the specialized port and harbor management company SIGEPRAG for a 25-year period, starting from April 2004, with the obligation to operate, rehabilitate, and expand the infrastructure, has already led to major rehabilitation work and an improvement in the quality of service.

Price liberalization and trade policy

43. The government remains committed to price deregulation. The new General Directorate of Competition and Consumption, which replaced the Directorate of Prices, is currently defining its work program. With regard to petroleum product prices, the government is determined to restore, at the latest by end-March 2005, the automatic price adjustment mechanism to reflect changes in international prices. Although retail prices have remained unchanged since August 2002, despite an increase in the CFA franc crude oil price of about 6 percent, the reintroduction of the price formula is not expected to lead necessarily to a rise in retail prices, as the initial price structure included a large margin for the refinery, which was to be temporary, to enable it to carry out the plant's rehabilitation.

44. The government is determined to eliminate tariff surtaxes on eggs and cigarettes by end-2004, in line with the program. Regarding sugar, following the expiration in June 2004 of the agreement with the private company SUCAF, which took over the state-owned company in 1998, and which was granted a monopoly status, the government will propose at the next interministerial meeting of CEMAC to start consultations on the adoption of a common policy to promote regional competition.

Good governance

45. The government remains committed to improve governance. In this context, the decree setting the procedures for wealth declaration by government officials was adopted in April 2004. Nevertheless, on May 4, 2004, the Constitutional Court decided that various provisions of the decree were unconstitutional. The government has drafted a new version that addresses the court's concerns. It will continue to rely on the technical assistance of the Fund staff to assist the work of the National Commission Against Illicit Enrichment.

46. The government has indicated to the World Bank that it wishes to comply with the Extractive Industries Transparency Initiative. To this end, it has received the relevant questionnaires for 2003, which it will complete speedily. If necessary, it may request the assistance of the Fund Fiscal Affairs Department to that end.

47. The government of Gabon is confident that the policies spelled out in this letter are adequate to achieve the program's objectives. It stands ready, in consultation with the Fund, to take any additional measure that may prove necessary to that end. In addition, the government notes that until the external arrears towards the banks of the London Club will have been rescheduled, or paid, each purchase under the arrangement will be subject to a financing assurances review in accordance with the Fund's lending into arrears policy.

Amendment to the Technical Memorandum of Understanding Under the Program Supported by the Stand-By Arrangement

The following sentence is added at the end of paragraph 1:

1. (...). The key assumptions of the initial program, in particular those related to oil revenue, have been modified by the letter of the Minister of Economy, Finance, Budget, and Privatization of September 8, 2004. The adjusters for the quantitative performance criteria have also been modified slightly.

The following sentence is added at the end of paragraph 11:

11. (...). For 2005, the net reduction of the treasury float is defined as the reduction in the float existing at end-2004, excluding the accumulation of new float during 2005.

The following sentence replaces the penultimate sentence of paragraph 20:

20. (...). The cumulative ceilings to the adjustor are CFAF 17.0 billion for end-June, CFAF 25.5 billion for end-September, and CFAF 45.0 billion for end-December 2004.

Paragraphs 21 and 23 have been deleted.

Paragraph 22 has been modified as follows:

22. The program also includes (downward/upward) adjusters for the benchmarks on net credit from the banking system to the central government for (i) lower/higher-than programmed external debt service effectively paid¹ (net of nonproject external financing disbursements); and (ii) lower/higher-than-programmed net reduction of domestic arrears.²

Paragraph 26 has been modified as follows:

26. The main assumptions of the program are the following: