Bangui, June 17 ,1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Camdessus:

On behalf of the government of the Central African Republic, I am pleased to forward herewith the memorandum of economic and financial policies for 1999. This Memorandum reviews progress in implementing the program supported by the first annual arrangement with the Fund under the Enhanced Structural Adjustment Facility, and describes the measures that the government plans to implement, especially in the context of the 1999 Finance Law.

As mentioned in paragraph 12 of the attached memorandum, one quantitative and two structural performance criteria at end-September 1998, as well as several benchmarks at end-September and end-December 1998, could not be met as expected. However, measures have been implemented to correct slippages in the structural reform program and improve performance in the area of public finances. Accordingly, the government requests waivers for the nonobservance of three performance criteria at end-September 1998: the floor on total government revenue, the closure of nonfinancial public enterprises that have ceased operations; and the completion of the privatization of the enterprise in charge of distributing of petroleum products.

The government of the Central African Republic believes that the economic and financial policies and structural reforms described in the attached memorandum are sufficient to attain the objectives of the program. The government will provide Fund staff with all information necessary to monitor the program and will take any additional measures that could be required to achieve the program's objectives.

1. In accordance with the terms of the first annual arrangement under the Enhanced Structural Adjustment Facility (ESAF), the C.A.R. authorities and the Fund staff have conducted the midterm review discussions of program developments. These discussions began at the time of the Annual Meetings in Washington, during the period October 5-8, 1998, and continued in Bangui during the period October 19-31, 1998, and February 16-26, 1999 and in Washington during the period April 26-30, 1999. The review discussions focused on recent economic and financial developments, the implementation of structural reforms, and the economic outlook and policies over the short and medium term. Although progress was made on several fronts, the implementation of the program ran into difficulties during the second half of 1998; since then, the authorities have implemented a series of measures to ensure that the program is brought back on track.

2. The objectives of the program for 1998 and the main elements of medium-term economic and financial policies were described in the memorandum of economic and financial policies for 1998 (June 18, 1998) and in the policy framework paper for 1998-2000 (May 29, 1998). The 1998 program aimed chiefly at achieving a lasting improvement in public finances, as well as establishing conditions conducive to sustainable economic growth, especially through revisions in the legal and regulatory framework and the privatization of public enterprises and financial institutions.

3. The economic adjustment and structural reform program is a component of the authorities' overall strategy to promote lasting social peace and economic development. Thanks in part to the support of the international community in the context of peacekeeping operations (MINURCA), the National Election Committee was in a position to organize legislative elections under fair conditions in November and December 1998. Moreover, the government has prepared a demobilization program in collaboration with the staff of the UNDP. This program is designed to facilitate the departure of about 800 soldiers, military policemen (gendarmes), and members of the Special Republican Guard. In addition, the government plans to restructure all defense forces soon, so as to transform them into a genuine national army respectful of democratic institutions.

Recent economic and financial developments

4. On the basis of preliminary data, real GDP in 1998 grew by about 4.7 percent, compared with the 5.5 percent projected initially. The index of consumer prices in Bangui fell by some 2 percent on average during 1998, whereas inflation had been projected at 2½ percent under the program. The slower rate of growth and the fall in prices reflected to some extent the impact of the Asian crisis, which translated into a smaller demand for exports and falling prices, especially for wood, cotton, and diamonds. In addition, poor weather conditions resulted in a smaller coffee crop. The effect of lower export prices was only partly offset by the fall in import prices for oil products. Overall, preliminary estimates suggest that the country recorded terms of trade losses of 0.3 percent in 1998, compared with gains of 0.4 percent projected under the program.

5. Regarding public finances, total revenue grew by some 25 percent in 1998, thanks to the economic recovery and, above all, the important efforts made by the collecting agencies. Nevertheless, government revenue totaled only CFAF 56 billion in 1998, compared with a program target of CFAF 62 billion. The revenue shortfall originated mainly at customs, as domestic taxation was broadly in line with expectations under the program. In addition to a weak administrative capacity and the persistent evasion of customs duties and import turnover taxes, the Customs Department faced serious difficulties in recovering taxes and duties in arrears, including from the enterprise in charge of distributing petroleum products (PETROCA). Furthermore, during the last few months of the year, attempts to increase customs revenue was hampered by important disturbances in regional trade (transport strikes in Cameroon, and civil wars in the Republic of Congo and the Democratic Republic of the Congo).

6. Overall, government expenditure on a commitment basis remained below the ceiling set under the program in 1998. However, the shortfall in revenue did not allow for the full settlement of expenditure commitments, which translated into a buildup of arrears. In particular, the government paid less than 11 months of wages and salaries to its employees, although the objective of the program was to begin reducing the stock of wage arrears as early as possible. In addition, financial constraints and weak administrative capacity in certain departments translated into low spending on health and education, as well as lower-than-expected domestically financed investment. Thus, the bulk of the upturn in public investment was financed through external sources. At the same time, the government provided the required local counterpart for the organization of the legislative elections (CFAF 400 million), out of total costs estimated at CFAF 2.3 billion.

7. In spite of a tight treasury cash position, the authorities have put a high priority on external debt servicing. In August 1998, the government settled its arrears to the World Bank and began reducing its arrears to the African Development Bank. It also settled its financial obligations vis-à-vis the Fund and paid interest arrears that had accumulated with the Bank of Central African States (BEAC). In September 1998, the Central African Republic benefited from debt relief on the part of Paris Club creditors, including on previously rescheduled debt, on very favorable terms (67 percent reduction in net present value terms). Owing to difficulties in financial management, however, the government was occasionally late in settling financial obligations vis-à-vis the Fund and the World Bank. As far as the settlement of domestic arrears is concerned, the Government decided to postpone the securitarization of the stock of domestic debt to 1999 because the evaluation of the total stock of domestic arrears had not been completed in time; in addition the tight treasury position impeded timely payment of wages and salaries.

8. Developments in 1998 with respect to money and credit and the balance of payments, were dominated by the adverse impact of the Asian crisis. In particular, the net foreign assets of the central bank declined substantially by CFAF 25 billion. In addition to the worsening of the current account deficit due to the drop in the value of exports, the fall in international reserves may have reflected an increase in short-term capital outflows related to uncertainties for some operators in the wake of the change in the CFA franc peg to the euro on January 1, 1999. Measures are currently under review in the context of the BEAC zone as a whole to tighten liquidity conditions in the money market and thereby fight the decline in the external reserves position of the central bank. In the Central African Republic, the monetary authorities have been particularly attentive to the amount of refinancing extended by the BEAC, as they have used the refinancing to slow the growth of domestic credit.

9. The drop in export prices since mid-1998 has had particularly serious consequences for the cotton sector, especially since the government had raised the producer price for cotton farmers from CFAF 155 to CFAF 170 per kilogram in April 1998. Barring adjustment measures, the projected deficit of the cotton sector (and, thus, the deficit of the mixed company, SOCOCA) might have been on the order of CFAF 4 billion. Accordingly, the government has decided to implement a series of measures designed to safeguard cotton producing activity, and to spread the burden of the required adjustment over all operators involved in the sector. Thus, the deficit of the cotton sector in 1998/99 has been reduced through expenditure-reduction measures at SOCOCA, including cuts in transportation costs and miscellaneous charges, and the suspension of indirect taxes (export taxes on cotton and turnover taxes on SOCOCA's imports). SOCOCA's residual financing need will be covered by a direct subsidy from the government (CFAF 1.5 billion) and a deferral of depreciation provisions. (Additional measures concerning the cotton sector are described in para. 27 below).

10. Concerning structural reforms, significant progress has been achieved despite delays in several areas. The privatization of the distribution of petroleum products has been launched in March 1999, with the signing of a draft memorandum of understanding for the sale of the retail distribution network to three private companies. These companies are in the process of setting up an assets-holding company (SOGAL) to manage imports and storage facilities, in which the government will hold no more than 10 percent of the capital. The parliament has approved the dissolution law and PETROCA is being liquidated. As planned under the program, the Prime Minister issued a directive on September 14, 1998 to clarify conditions for using resources at the Road Fund. Also, the process of validating domestic debt and arrears accumulated at end-1997 was completed in November 1998; and completion of the liquidation of seven nonfinancial public enterprises and four state banks that had ceased operations was achieved in May 1999. In addition, the government has preselected companies for the farming out of ENERCA, launched the merger of the two labor offices ONMO and ONIFOP, initiated the liquidation of the company SNE and the restructuring of SODECA (water distribution), and offered for sale its minority share in the tourism agency MANOVO.

11. Regarding bank restructuring and, in particular, the measures planned for the privatization of the two largest commercial banks (BICA and UBAC), the government's strategy had to be modified in several respects. For BICA, no tenders could be issued because a private investor decided to reactivate a memorandum of understanding that had been signed in March 1996, and BICA was privatized in December 1998. For UBAC, the government has called for bids for its full privatization. Concerning the third commercial bank (BPMC), the government had to postpone paying its share in the recapitalization because funds were not available. (Further actions in the area of bank restructuring are described in para. 30 below.)

12. The assessment of performance with respect to the program's objectives at end-September and end-December 1998 is summarized in the attached Tables 1–2. One quantitative performance criterion at end-September (the floor on total government revenue) and two structural performance criteria (the closure of all nonfinancial public enterprises that have ceased operation and the privatization of PETROCA) were not met. In addition, one of the quantitative benchmarks (the floor on total government revenue) at end-December 1998, as well as five structural benchmarks (the validation of domestic debt, finalization of the liquidation of commercial banks that have ceased activity, issuance of tenders for privatizing BICA, decision on the modalities for privatizing UBAC, and payment by the government of its share in the recapitalization of BPMC) were not met.

13. As indicated above, appropriate measures have been taken to make up for the delays in implementing structural reforms. Moreover, additional measures were implemented in late 1998 and in early 1999 in the context of the Finance Law to improve fiscal management and, in particular, increase government revenue collections significantly. As a result, government revenue during the first quarter of the year exceeded the target of CFAF 14 billion under the program, providing the basis for improved control over public finances in 1999.

Economic and financial policies in 1999

14. Although export price developments have resulted in a less favorable macroeconomic environment, the government's objectives remain ambitious, and the economic recovery that began in 1997 is expected to continue. Real GDP growth is projected at about 5 percent in 1999, and inflation at some 2½ percent, which would allow for sustained improvements in the standard of living of the population.

15. In line with the orientations set in the policy framework paper for 1998-2000, the government plans to continue its fiscal stabilization efforts in 1999. To this end, the Finance Law for 1999, which was approved by parliament in February 1999, aims at increasing government revenue substantially in order to fund priority outlays and mobilize a narrow primary surplus (i.e., excluding interest payments and foreign-financed investment) of about CFAF 7 billion, or 1 percent of GDP.

16. Budget revenue in 1999 is projected at CFAF 65 billion, or about CFAF 9 billion more than the 1998 estimated outcome. The Finance Law includes a number of discretionary measures, that aim in particular at broadening the tax and customs base—notably through strict controls over lawful exemptions and the elimination of all exemptions that do not have a legal basis—and improving administrative efficiency. These measures, derived in large part from the recommendations of the March 1998 technical assistance mission of the Fund, include the widening of the tax base for personal and corporate income; reductions in quotas for diplomatic exemptions under the Vienna Convention; increases in area fees for forestry companies; adoption of a floor turnover amount as basis for the taxation of diamond-purchasing bureaus; and strengthened efforts to collect arrears on taxes and real estate assessments. In addition, improved collection of customs duties will be ensured by a systematic checking of final customs forms; the monthly cross-checking of customs declarations with preshipment control certificates prepared by the private preshipment control agency; the monitoring of imports in transit from the port of Douala; and the comprehensive verification of wood exports. In order to complement and clarify the provisions of the Finance Law, a directive has been signed by the Prime Minister to ensure that no tax or custom exemption is granted unless it is authorized by law and approved by the Finance Minister.

17. Budget expenditures in 1999 are projected at CFAF 111 billion, or 16½ percent of GDP. Current primary expenditures, including the wage bill, are set to remain broadly unchanged in nominal terms. The number of government employees will remain under a ceiling of about 19,500. The budget includes allocations totaling CFAF 61 billion for investment, of which CFAF 44 billion is externally financed. The public investment program continues to place high priority on basic infrastructures, especially in the areas of transportation, health and education. In addition, large provisions have been made in the budget to ensure the proper maintenance of existing infrastructures.

18. In order to improve budget management and ensure the centralization of revenue at the Treasury, nearly all earmarking of resources has been discontinued, and the corresponding revenue sources have been consolidated in the budget. The sole earmarked revenue that has been maintained is for the Road Fund. More generally, the government will no longer allow the offsetting of expenditure against current receipts, nor any extrabudgetary operations. In addition, the 1999 Finance Law includes measures to strengthen expenditure control and expand support to the social sectors. The government will pay special attention to the effective use of budget allocations for education and health, whose share in budget expenditure will continue to increase. Spending on primary health care and on national education will account for at least 11.5 percent and 12.5 percent of noninterest current expenditure in 1999, respectively.

19. In spite of the debt relief obtained from Paris Club creditors and the debt relief expected from other bilateral creditors, external debt-service obligations remain heavy relative to government revenue. The government will nevertheless continue to place a high priority on current external debt service and the settlement of external payments arrears, especially with respect to multilateral and post-cutoff-date bilateral debt. The authorities are in contact with Paris Club creditors, and bilateral rescheduling agreements have already been concluded with six countries; agreements with the remaining three countries are expected to be concluded soon. A correspondence has been addressed to the Paris Club secretariat to request an extension of the deadline for completion of the bilateral agreements. Discussions have also begun with non-Paris Club bilateral creditors, with a view to securing concessional terms at least as favorable as those obtained from Paris Club creditors.

20. Based on an inventory at end-1997, the authorities intend to begin settling domestic arrears as soon as possible. Priority is to be given to the partial settlement of government wage arrears and the servicing of consolidated debt owed to commercial banks. Based on the treasury cash management plan drawn up in collaboration with Fund staff, cash payments to reduce wage arrears could reach CFAF 3 billion in 1999. Before the end of the year, when the treasury's cash position is genuinely under control, the government plans to clear other domestic arrears (minus any outstanding amounts due on account of subsidiary loan agreements or overdue taxes and duties) through the issuance of long-term securities carrying a below-market interest rate (e.g., 3 percent).

21. The overall government deficit on a commitment basis is estimated at CFAF 46 billion in 1999. Taking into account the clearance of external arrears and the partial settlement of domestic arrears, the cash deficit is projected at some CFAF 80 billion, or 12 percent of GDP. Apart from project financing and long-term security issues, covering this deficit will necessitate mobilizing program assistance from bilateral and multilateral sources, including the European Union, France, the World Bank, and the African Development Bank. To ensure the timely availability of funds, the government will make sure that all specific conditions, such as completion of the sale of PETROCA and the privatization of UBAC, are fulfilled as scheduled. The authorities, in collaboration with Fund staff, have prepared a monthly cash management plan, that provides for the regular servicing of external financial obligations, the early settlement of arrears vis-à-vis the World Bank, and the clearance of all external payments arrears by end-1999.

22. The authorities have updated the debt sustainability analysis in collaboration with the staffs of the Fund and the World Bank. This analysis suggests that, assuming sustained progress in economic and structural adjustment, the net present value of external public debt would decline to reach about 195 percent of exports of goods and services by 2001; by then, external debt service obligations would account for approximately 10 percent of exports of goods and services. Relative to government revenue, these ratios would be 340 percent and 17 percent, respectively. The authorities believe that the sustainability of the country's external debt position over the medium and long run hinges primarily on credible efforts to raise government revenue on a lasting basis.

23. After the large deterioration in the country's external position recorded in 1998, the authorities expect a reversal of this trend in 1999. With sustained economic growth and a restoration of confidence in the aftermath of the change in the CFA franc peg to the euro since January 1, 1999, broad money growth should return to the positive range. At the same time, the BEAC will maintain an appropriate interest rate policy, taking into consideration interest rates prevailing in the euro zone, to contain inflation at a moderate pace in the CEMAC member countries. Improvements in the current account balance, together with projected short-term capital inflows are expected to contribute to a replenishment of net foreign assets of the central bank.

24. To foster an expansion of external trade and capitalize on economic efficiency gains resulting from greater international openness, the C.A.R. authorities will continue simplifying and harmonizing the customs duty regime, in accordance with the timetable agreed under the Regional Reform Program. Once the treaty setting up the of Central African Economic and Monetary Community (CEMAC) has been ratified by all member states, and to improve policy coordination among member states following adoption of the euro peg, efforts will be made to develop an integrated financial programming framework.

Structural reforms

25. The government has begun putting in place a regulatory framework favorable to investment, designed in particular to reinforce investors' confidence. In this context, an information campaign has been launched to improve the awareness of economic operators of the provisions of the OHADA Treaty, which has been governing business law in the Central African Republic since its ratification. In addition, the Labor Code will be revised to facilitate job creation through greater flexibility in labor management and wage-setting arrangements. The Mining Code is being updated, with assistance from the World Bank, to incorporate international best practices in this area. Finally, the authorities intend to support regional initiatives to adopt an Investment Charter aimed at promoting private sector development and attracting private capital.

26. A law revising the civil service statute has been adopted by Parliament and promulgated. To improve staff management, the Ministry of Civil Service has begun a census of civil servants, which will complement the census of military personnel carried out in September 1998. Throughout 1999, the ceiling on the number of government employees will remain the same as in 1998. The government intends to pay its wage bill on a regular basis and, subject to satisfactory revenue collection performance, to begin reducing wage payments arrears. The government has also launched a restructuring of the armed forces. About 650 military staff who have reached retirement age should receive retirement grants and payments for wage arrears in 1999. Once the required funds can be mobilized, separation grants for voluntary departure will be offered to soldiers on active duty who have served for at least five years and are within five years of retirement. The demobilization program (PNDR), which has been prepared with technical assistance from the UNDP, aims at helping about 800 military personnel to return to civilian life, as a preamble for restructuring the various components of the C.A.R. armed forces.

27. After discussions with all partners involved in the cotton sector, the authorities have adopted a series of measures designed to halve the difference between overall costs and the sale price of cotton from the 1999/2000 crop year. The government will ensure cost-plus pricing for fertilizers and pesticides, while the cotton company (SOCOCA) will need to continue reducing its overall charges and improving productivity. In addition, further cost saving will be achieved through the closure of the least efficient ginnery and the issuance of tenders to contract out the transport of cotton fiber. Based on an analysis of the cotton sector to be carried out with financial and technical assistance from donors, a comprehensive reform of the management of the cotton sector will be adopted by end-1999, to be implemented by the 2000/01 crop year. This reform will aim at ensuring financial balance in the cotton sector in a sound and transparent framework, inter alia through the use of a flexible mechanism for setting producer prices. Finally, the authorities intend to prepare a reform program for the cotton sector, whereby the state would gradually abandon responsibility for overseeing the sector, and activities such as ginning and marketing would be opened up to competition.

28. As indicated above, the government has signed a draft memorandum of understanding with private operators for the sale of the retail distribution network of petroleum products and the law for the dissolution of the national petroleum company (PETROCA) has been approved by Parliament. The process of liquidating PETROCA should be completed by September 1999 at the latest. Meanwhile, the government will ensure a rapid winding up of PETROCA's operations—including selling its stock of petroleum products—with a view to settling separation grants for its employees, as well as outstanding balances of taxes and duties, which are presently estimated at about CFAF 1.5 billion (including amounts due to the Road Fund).

29. The farming out of the electricity company (ENERCA) has been delayed, principally because of a number of difficulties encountered in carrying out financial and technical assessments. Thus, even though a call for prequalification bids was issued at the end of 1998, the issuance of tenders for the farming out of the production and distribution of electricity in the Central African Republic has not yet been finalized. The authorities intend to undertake this soon, with technical assistance from the World Bank, and issue tenders in September, with a view to selecting a private operator by end-1999. Regarding the telecommunication sector, the private operator who holds 40 percent of the capital of the telephone company (SOCATEL) is no longer interested in purchasing the shares that the government offered for sale in 1998. Consequently, the government intends to reassess its strategy for privatizing this sector and, if necessary, call for bids for the sale of a majority stake to a new operator.

30. The restructuring of the banking sector has begun, with the sale of BICA to private operators and it is being pursued further in the context of discussions for the full privatization of UBAC. As a result of recent consultations, partners willing to take over this bank have been identified, and the authorities expect to conclude the negotiations by end-August 1999. Regarding the BPMC, the foreign partner has already paid up its share in the recapitalization, while the government is committed to settling its share by June 1999. Following the recapitalization of BICA, back in December 1998, and that of UBAC and BPMC, expected in the coming months, the health of the banking system in the Central African Republic is set to improve rapidly. A timetable will be drawn up in consultation with the management of these banks to ensure adherence that all prudential requirements set by the regional banking commission (COBAC). The bad debts still in the portfolios of BICA and UBAC will be converted into government debt, and the government will ensure its regular servicing. The collection of bad debts will be the responsibility of the two banks, which will retain a percentage of any amounts recovered.

31. As indicated in the policy framework paper for 1998-2000, the government intends to continue its structural reform program with respect to privatizing public enterprises and improving of the legal and regulatory framework for private sector activity. In the coming months, in particular, the government will develop plans for the sale of companies included in the second batch of public enterprises (ICA, SCET-Sofitel, SHDC-HC, BARC, SEGA, SOCATRAF, and ACCF), prepare a reform of the social security agency (OCSS) and an overhaul of social regulations, and revise the Mining and Forestry Codes. To these ends, clear and realistic timetables will be drawn up, and task forces responsible for implementing these reforms will be appointed through executive orders of the Prime Minister.

32. Privatization proceeds will be used primarily to settle indemnities and separation grants for laid-off employees, consistent with existing legal requirements, and any balance will accrue to the government budget. The authorities plan to allocate part of these funds for clearing wage arrears and developing basic social services for the poorest segment of the population.

Program monitoring

33. The authorities recognize that the design and implementation of the economic and financial adjustment program remains hampered by weaknesses in the statistical apparatus and a lack of administrative capacity. Strong efforts are needed to strengthen both the Technical Committee in charge of monitoring the program and the National Privatization Commission. Regarding statistical information, a study will be conducted with technical assistance from the Fund's Department of Statistics, which will serve as a basis to establish priorities before appropriate technical and financial assistance is sought.

34. The quantitative and structural benchmarks under the program have been updated, and new targets have been set for June 1999 (see attached Tables 1-2). In addition, to ensure a close monitoring of performance, the government has established monthly targets on a cash basis for revenue collection agencies, consistent with the aggregate budget revenue objective (Table 3). In the event that revenue falls short of the targeted level for two consecutive months, the authorities will in consultation with the Fund staff take corrective action with a view to meeting the annual revenue target. The authorities are aware that performance relative to the end-June 1999 and the realization of the monthly revenue targets will be important elements in the Executive Board's consideration of the Central African Republic's request for a second annual arrangement under the ESAF.