Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street NW
Washington, D.C. 20431
Dear Mr. Köhler:
The government is determined to continue to execute its economic and financial structural adjustment program, as it is described in its memorandum of December 7, 1999. This execution for the rest of the program period will take place along the lines agreed with the Fund, and the government will make all efforts to achieve the objectives it has adopted.
The government will provide the Fund with such information as the Fund requests in connection with the progress made in implementing the economic and financial policies and achieving the objectives of the program described in the attached memorandum.
The government believes that the policies and measures set out in the attached memorandum are adequate to achieve the objectives of its program, and it will take any further measures that will become appropriate for this purpose.
Memorandum of Economic and Financial Policies
for the Balance of the Third Annual Arrangement
Under the Poverty Reduction and Growth Facility
December 6, 2000
I. Introduction
1. Implementation of the program supported by the third annual arrangement under the Poverty Reduction and Growth Facility (PRGF) during the period October 1, 1999-March 31, 2000 was seriously complicated by unfavorable exogenous developments, such as the deterioration of the terms of trade resulting from the sharp increase in international oil prices since December 1999; the absence of external financial aid; and the worsening security situation at the country's borders, which led to substantial unprogrammed military outlays.
2. In light of this situation, the Guinean government took steps during the first quarter of 2000 to reduce public expenditure and strengthen domestic revenue mobilization. By reducing expenditure, it was possible to attain the program objectives for net bank credit and base money at end-March 2000; however, the budget situation at end-March proved difficult to sustain because of the very low level of expenditure commitments in the priority sectors and for consumption of key public services, as well as the persistent weakness in revenue mobilization, despite the ad hoc measures that had been taken. Further, the central bank's net foreign assets fell short of the programmed level, primarily as a result of the absence of external aid and the need to finance unavoidable military expenditure and external debt service payments in foreign exchange. There were also substantial delays in implementing the structural reform program, and new external payments arrears were accumulated. As a result, two of the six quantitative performance criteria and two of the quantitative benchmarks for end-March 2000, as well as two of the seven structural performance criteria (for end-December 1999 and end-March 2000), were not observed
(Tables 1 and 2).
3. In consultation with the May 2000 mission of the International Monetary Fund (IMF), the Guinean government decided to defer the conclusion of the first review under the third annual PRGF arrangement, and established monthly budget and monetary targets to correct the shortfalls observed and ensure that the initial revenue and expenditure targets would be met by the end of the year. Domestic revenues were to be increased, inter alia, by adjusting retail prices for petroleum products to reflect the increase in oil prices on the international market; expenditure execution in the priority sectors was to be accelerated, so as to reach the initially budgeted level; and domestic bank financing during the second half of the year was revised upward to reflect the delays in mobilizing external aid. Additional structural measures were also planned in the areas of governance (start-up of the anticorruption committee); public enterprise reform (implementation of an action plan for reform of the National Agency for the Development of Mining Infrastructure (ANAIM) and completion of the tax audit of four major public enterprises); government finances (audit of customs operations, implementation of the computerized system for the expenditure process, and revision of the adjustment mechanism for prices of petroleum products); and the banking sector (completion of the audit of the central bank). This memorandum describes the progress made in implementing the revised program for 2000 and the financial policy orientations to the end of the current program period, as well as the main thrust of the budget for 2001. It also takes stock of the process of drafting the interim poverty reduction strategy paper, and preparations for reaching the decision point under the Heavily Indebted Poor Countries (HIPC) Initiative.
II. Results at end-September 2000
4. Implementation of the monthly program for the period June-September 2000 was generally satisfactory, despite the further deterioration of the country's security situation during the summer. These developments led to a larger-than-projected increase in military expenditure to protect Guinea's borders against incursions of armed rebel troops from neighboring countries, although the government did not benefit from any financial aid from external partners.
5. In the fiscal area, revenue was lower than projected at end-September, primarily as a result of a shortfall in petroleum tax revenues—the authorities raised petroleum prices by 60 percent at end-August, i.e., almost two months later than projected. The government used this period to conduct a public awareness campaign on the need for the price increase. Collection of the value-added tax (VAT) from certain major public enterprises and of nontax revenue also fell somewhat short of expectations. By contrast, delays in commitments for priority expenditure, pensions, and water and electricity consumption were fully made up by end-September; domestic arrears were lower than programmed; and external debt service was paid consistent with the terms of the 1997 Paris Club rescheduling agreement, notwith-standing the higher military expenditure to address the increasingly frequent attacks at Guinea's borders and the absence of any external budgetary assistance. The authorities also reduced nonpriority current and capital expenditure. The primary surplus therefore amounted to GF 127.8 billion at end-September, and the overall deficit (on a cash basis) was GF 137.5 billion, thus meeting the targets.
6. Fiscal discipline made it possible to meet the targets for net bank credit to the government and reserve money for end-September. However, the central bank's reserve position continued to deteriorate, reflecting the use of foreign exchange for the additional military expenditure and external debt service, which resulted in a negative cumulative net transfer to the rest of the world of GF 121 billion (2.3 percent of GDP) for the first nine months of the year. In addition, owing to the shortage in the supply of foreign exchange, the central bank found it necessary to sell a portion of its reserves on the local foreign exchange market.
7. Substantial progress was made in the area of structural reform, especially in the management of government finances. The computerization of the public expenditure process, encompassing all budget and treasury operations, was completed on July 10, 2000; a decree establishing the general public accounting regulations was signed on August 9, 2000; and a reorganization of customs was undertaken on September 1, 2000. To facilitate proper budget execution, the authorities have, since February 2000, been preparing a forward-looking monthly cash flow plan that compares monthly revenue projections, including external resources, with expenditure. This cash-flow plan, which is updated weekly, makes it possible to adjust expenditure to reflect priorities and available resources. Three of the four tax audits of major public enterprises were carried out. A review of the audit reports—for SOGEL (electricity), SEEG (water) and PAC (port authority)—indicates the need for a tax adjustment for all the enterprises audited, as a result of the underestimation of the assessment bases and underreporting on tax returns. Moreover, the application by some of these enterprises of VAT rates well below the legal rate had led to lost VAT revenue. The government has commented on the provisional report on the audit of customs tax invoices (borderaux de taxation) and is awaiting submission of the final report. Finally, the audit of the central bank was completed in a timely manner, and the authorities have adopted an action plan for implementing the recommendations of the audit, which entails primarily strengthening the accounting units.
8. The national anticorruption committee (CNLC), which started operations in June 2000, submitted an interim action plan on July 7, 2000, and will prepare a final action plan for its activities by January 2001. Moreover, the CNLC collaborates closely with the government oversight agencies (Inspection Générale d'Etat, Inspection Générale des Finances, and Direction Nationale du Contrôle Financier). These collaborative efforts have already led to the identification of misappropriations of funds in the public treasury and the fisheries sector, which, when corrected, can be expected to secure substantial revenues—including in foreign
exchange—for the government. The CNLC will also monitor the implementation of the recommendations of the tax audit reports for public enterprises which it has recently received.
9. In the area of public enterprise reform, a decision was taken on August 18, 2000 to remove the senior management and board of directors of ANAIM, and to establish a committee to manage its personnel, and real and movable property, as well as ANAIM's contracts and agreements, during the transition period. Revenues and proceeds from its assets are paid regularly into a treasury account with the central bank. Eight more public enterprises have been placed in liquidation, and the government's shares in seven others were offered for sale on September 28, 2000. Furthermore, a reform strategy for the public enterprises was adopted by the Council of Ministers on October 24. Reform of the National Social Security Fund (Caisse Nationale de Sécurité Sociale) is continuing with the implementation of the recommendations of a technical assistance firm.
III. Economic and Financial Policy to the End of the Program
10. There is a risk that Guinea's economic situation may be seriously affected in the coming months by the continued aggression at its borders, which has clearly already led economic agents to adopt a wait-and-see approach and resulted in displacements of the population of the agricultural areas affected by the attacks. The economic slowdown, particularly in the transportation and agricultural sectors, is a major obstacle to the flow of supplies to hundreds of thousands of refugees living on Guinean territory. In addition, food security problems and related additional expenses will certainly have an adverse effect on government finances. As a result of the crisis, the government must maintain a level of military expenditure that is much higher than desired, aggravating its fiscal problems and exerting great pressure on the foreign exchange market, which is also suffering from the adverse effects of the considerable deterioration in the terms of trade. Finally, it now seems unlikely that external budgetary assistance can be mobilized by the end of the year, as initially programmed. This substantially complicates the financing of the budget deficit and the government's efforts to pursue monetary restraint in order to limit the pressures on domestic prices and the exchange rate.
11. Despite this very difficult context, the Guinean government will continue to implement the budgetary program established in May 2000 until completion of the PRGF-supported program, and beyond. During this period, government finances will be managed on the basis of the detailed monthly cash-flow plan to ensure that unavoidable priority expenditures—including external debt service—are covered. The government will also resolutely pursue its structural reform program.
Fiscal situation
12. Total revenue at end-2000 should reach GF 623 billion (11.6 percent of GDP), a shortfall of GF 15 billion relative to the revised program objectives, as a result of lost taxes on petroleum products prior to the domestic price adjustment and the impact of the frequent aggressions. The revenue situation may be improved by the collection of some unpaid duties and taxes from certain importers, and from the major public enterprises identified in the tax audits.
13. Expenditure will be limited to the additional military outlays required for the defense of the national territory, priority expenditure set forth in the budget law, and other expenditure that cannot be reduced, such as wages, domestic and external debt service, and consumption of public utilities. At the same time, to minimize the deficit to be financed, the government will further reduce nonpriority current expenditure and will slow the rate of investment expenditure financed with own revenue during the last quarter. Total expenditure is thus projected at GF 909 billion, or 17 percent of GDP. Further, it will not be possible to hold the volume of outstanding domestic payments arrears at the low level attained at end-September, owing to the government's cash-flow problems, which will result in a smaller reduction of arrears than that projected in the revised program. The primary surplus will thus be GF 154 billion (2.9 percent of GDP), which is lower than the target revised in May (3.1 percent of GDP) but slightly higher than the initially programmed level (2.7 percent of GDP), while the overall cash-basis deficit of GF 185 billion will not exceed the revised target.
14. However, budget projections indicate a financing requirement for the last quarter of GF 45.5 billion, after taking into account project loans and external debt amortization payments due, including a US$1 million payment on the Russian debt under an agreement reached with this key partner. This financing requirement is roughly the same as the amount of external nonproject support initially envisaged for this year, and will be covered on an exceptional and temporary basis by borrowing from the domestic banking system. The government's net borrowing from the central bank increased by GF 47 billion between end-September and end-October 2000 to a level of GF 238.5 billion, which already exceeds significantly the limit set by the Central Bank Act (a net current account position of the treasury at the central bank equivalent to no more than 20 percent of total revenues of the previous year). The authorities intend to refrain from additional recourse to central bank financing and to lower gradually the indebtedness to the central bank to below the legal limit in 2001. In order to avoid any additional recourse to central bank credit, the government intends to issue new treasury bills, at a higher rate of interest that that of bills already in circulation. It is expected that these bills will be absorbed in large part by the commercial banks, using resources released by the reduction in the reserve requirement from 11 percent to 5.5 percent of eligible deposits effective December 1, 2000, announced by the central bank in late November 2000. Based on this assumption, the recourse to net bank credit will increase from GF 46 billion at end-September to GF 92 billion at end-December, rather than declining as initially programmed. However, the supplementary monetary financing should be absorbed during the first quarter of 2001, immediately after the programmed budgetary assistance is disbursed. The authorities will attempt, to the extent possible, to place treasury bills with private enterprises in a comfortable liquidity position, which would reduce the requirement of additional bank financing. In addition, the Guinean authorities intend to ask Paris Club donors and lenders to defer the payment due in December by 30 to 60 days.
Monetary policy
15. The need to finance the budget deficit with an increase in domestic credit will require rigorous monetary management to minimize the impact on the exchange rate and domestic inflation. Reserve money will increase by 17.1 percent during 2000, rather than the 14.5 percent provided in the revised program, and the money supply will grow by 20.9 percent rather than 17.2 percent. The central bank's foreign assets will decrease further during the last quarter as the result of reduced inflows of external aid and substantial capital outflows to cover external debt service and expenditure in connection with the security effort. By contrast, relative to beginning-of-period broad money, net domestic assets will increase by 24.0 percent, primarily reflecting the increase in credit to government. As regards exchange rate developments, the shortage of foreign exchange on the auction market has caused the Guinean franc to depreciate against the U.S. dollar by approximately 12 percent since July 2000, and this trend may continue until the end of the year, notwithstanding the new measures taken by the authorities to enhance the integration of the informal exchange market into the official market (see below).
16. Monetary policy between now and the end of the program, and during the first few months of 2001, will emphasize the implementation of the recommendations of the central bank audit to strengthen its accounting and financial oversight procedures; the pursuit of the bank restructuring effort; and reforms in exchange market management and the conduct of monetary policy recommended by the IMF technical assistance missions. In the area of bank restructuring, the central bank will complete the harmonization of the licensing agreements for local banks by the end of the year. It has agreed with the World Bank on the treatment of Crédit Mutuel de la Guinée, either by the transfer of its operations to an existing structure, or by the creation of a new structure. The central bank intends to resolve the issue of the financial participation of the foreign partner in the recapitalization of one of the commercial banks in difficulty by end-December, and to decide the future of another bank after examining the various options.
17. The monetary authorities discussed with the last IMF technical assistance mission the conclusions of its report on the operation of the foreign exchange market and will adopt by the end of the year an action plan for implementing the recommendations. This plan will specify the respective roles of the commercial banks and their customers in the foreign exchange auction market (MED), and encourage automatic stipulation of purchase and sale orders as "at the market" or "limit" orders. By end-November, the central bank will also issue a new regulation for exchange bureaus, which will, inter alia, resolve the issue of the appropriate procedure for providing bond, and should facilitate their participation in the foreign exchange auction market through the commercial banks. Last, by end-November, the central bank will liberalize the conditions for foreign exchange accounts of the exchange bureaus held at commercial banks. This liberalization will, in particular, allow cash deposits and withdrawals, and the receipt of transfers in foreign exchange from abroad. For other holders of foreign exchange accounts, the liberalization will take place in March 2001.
18. Before receiving the final report from the IMF technical assistance mission on monetary policy, the central bank decided to implement some of the proposed measures—in particular, starting in November 2000, the issuance of very short-term central bank bonds to regulate bank liquidity, more effective projections of bank liquidity, as well as the lowering of the required reserve ratio from its present level of 11 percent to 5.5 percent. The central bank intends to adopt an action plan to implement the other recommendations, in step with the reduction of the exceptional increase in bank credit to the government at end-2000 and the attendant additional expansion of liquidity in the banking system. The authorities intend to discuss their liquidity management plans for 2001 with the Fund staff early next year in the context of the discussions on a new three-year PRGF arrangement.
Structural measures
19. The government will ensure full implementation of all the structural measures foreseen in the program for end-2000, with emphasis on the reforms required to facilitate external aid disbursement, particularly the fourth structural adjustment credit (SAC IV) from the World Bank.
20. In the public enterprise sector, having already adopted the public enterprise reform strategy, the Council of Ministers will establish by the end of the year an independent unit responsible for the privatization of enterprises with the potential to become profitable and attract the interest of private investors. Further, a review of the regulatory framework for infrastructure was conducted with support from the World Bank, with a view to improving conditions for private investment in the water, electricity, transportation, and telecommunications sectors. An action plan for restructuring the energy sector should be prepared by the end of the year, under which the liquidation of the electricity company (ENELGUI) will be launched.
21. With regard to the implementation of the recommendations of the tax audits of the three enterprises for which the audit reports are available, reexamination of the VAT assessment base will make it possible to identify by the end of the year the definitive amount of tax adjustments required. A strengthened action plan will be adopted for these three enterprises by end-November to correct the problems identified in the audit reports and to establish a schedule for payment of the unpaid taxes. It was also decided that, beginning in 2001, SEEG, SOGEL, and SOTELGUI (telecommunications) would be subject to VAT from the billing phase. The action plan for SOTELGUI should be adopted by end-December 2000. With regard to the audit of the tax invoices (bordereaux de taxation—BDT), a listing of unpaid BDT balances by importer and type of tax will be prepared by end-December, using the computerized system of the Société Générale de Surveillance (SGS). The importers involved will be asked to submit by mid-December proof of any payments made, and a schedule for the repayment of the definitive amounts to be paid will be established by end-December.
22. An international consultant has submitted a proposed automatic adjustment mechanism for petroleum product prices to the authorities; the proposal also includes a review of the domestic price structure. It will be discussed with the participants in the sector in the coming months, with a view to taking a final decision and effectively introducing this new mechanism no later than March 31, 2001.
IV. 2001 Budget
23. A full macroeconomic framework for 2001-03, and the details of structural reforms to be implemented in 2001 in support of this framework, will be established in February 2001 in the context of discussions with Fund staff on a new three-year PRGF arrangement. The main orientation of the draft 2001 budget aims at continuing fiscal consolidation while reflecting the need to defend the national territory and to implement the national poverty reduction strategy in the context of effective delegation of authority and enhanced decentralization. The expected availability of official development assistance from external partners will certainly facilitate proper budget execution. However, considering the major difficulties that occurred in 1999-2000 as a result of delays in mobilizing this assistance, as well as the need to reverse the larger recourse to domestic bank financing during the last quarter of 2000 in the first months of 2001, the execution of the 2001 budget during the first quarter will be based on a monthly cash-flow plan prepared with IMF staff.
24. The draft budget law provides for certain changes in the tax system in 2001, designed to enhance revenue mobilization. The lower limit for the fixed minimum tax (impôt minimum forfaitaire) will be raised from GF 2 million to GF 3 million, and the upper limit increased from GF 20 million to GF 40 million, thus inciting a larger number of enterprises to make profit tax declarations, and the rate of the fixed levy (prélèvement forfaitaire) applied at customs will be increased from 3 to 5 percent. In addition, the withholding tax at the source on local purchases by enterprises not subject to the VAT will be expanded to cover more enterprises. In the area of tax administration, the management of the single tax on vehicles (taxe unique sur les véhicules—TUV) will be computerized for more effective tracking of taxpayers; a specialized investigation bureau to monitor and collect taxes in large enterprises will be established to enhance the effectiveness of tax audits; and a tax office will be established in Customs to improve monitoring of the application of the fixed levy and minimize abuse of the fixed rate system by importers subject to the VAT. All of these new measures combined should generate additional revenue of GF 5-6 billion for the year as a whole.
25. In the area of import duties and taxes, the assessment-processing fee (redevance de traitement et de liquidation—RTL) will be applied at the rate of 2 percent to all presently exempt mining company imports not directly used in the production process. Public works equipment temporarily admitted to Guinea should be subject to normal pro rata temporis taxation. Finally, temporarily admitted vehicles will be subject to an annual RTL payment on their residual value. These measures should generate approximately GF 4 billion in supplementary revenue.
26. In 2001, the government will undertake a re-examination of the system of customs exemptions under the Mining Code, the Investment Code, and the special tax agreements and letters of establishment. It will prepare a plan to phase out this category of exemptions by renegotiating existing agreements and not renewing those that expire. It will also ensure that all new investments comply with the existing codes. With the improvements in the VAT assessment base, the tax adjustments resulting from the audits discussed above, and the effect of the ongoing customs reform and new airport customs clearance procedures, total revenue for 2001 is projected at GF 770 billion (13 percent of GDP), an increase of 23 percent over the level expected in 2000.
27. The budget law will also provide for an increase in the financial resources of local governments so as to involve them to a greater extent in providing public services, thus enabling them to play a more important role in the implementation of the poverty reduction strategy. Accordingly, effective in the 2001 budget year, 80 percent of the proceeds from the single professional tax (taxe professionnelle unique—TPU) and the single property tax (contribution foncière
unique—CFU) will be transferred to the local governments, along with 50 percent of the TUV.
28. In the area of expenditure, the government will continue its policy of promoting the priority sectors—education, health, and agriculture. Current expenditure in each of these sectors will be maintained or increased in real terms, and the share of these outlays in the total non defense-related current expenditure, excluding interest, will remain stable at 48 percent in 2001. Capital expenditure will also emphasize projects in the priority sectors. The government will begin in 2001 to recruit qualified personnel in the priority sectors. To this end, the draft budget provides for an increase of GF 4.4 billion for these recruitments (as part of the wage bill) and for salary increases according to the merit principle. The government will begin a study on the reform of the civil service in 2001. Total expenditure in 2001 is projected at GF 1,009 billion (17 percent of GDP). The primary surplus will therefore increase to GF 216 billion (3.7 percent of GDP).
29. The government will clearly specify in the budget law for 2001 how the additional resources from interim assistance under the enhanced HIPC Initiative will be used, on which agreement was reached with Fund and Bank staff. This will be based on detailed estimates of the costs of the various measures recommended in the context of the poverty reduction strategy. This additional spending has been integrated into the baseline budget before its approval by the government on December 5 (a prior condition for the review), and the integrated budget will be submitted to the National Assembly.
V. Poverty Reduction Strategy Paper (PRSP) Process and HIPC Initiative
30. Following consultation with its development partners and civil society, and in cooperation with the latter, the government has prepared the interim national poverty reduction strategy paper (interim PRSP). This document will soon be submitted to the Executive Boards of the IMF and World Bank, and the government sincerely hopes to reach the decision point under the enhanced HIPC initiative before end-2000. In consultation with the staffs of the Bretton Woods institutions, it also adopted a number of performance indicators in the areas of education, health, government finances, and good governance. These indicators will serve as conditions for the HIPC Initiative completion point. The interim PRSP presents a timetable and detailed budget for the participatory process of preparing the full PRSP, which will be completed by end-2001. The government will also involve its development partners in this process and intends to seek their technical and financial assistance to ensure that the process transpires smoothly.
31. With regard to the external debt sustainability analysis, the authorities have reconciled data on the stock of external debt with the support of experts from the World Bank and IMF. This exercise was carried out for the debt to multilateral institutions and bilateral Paris Club creditors, and will be completed for debt to other creditors by end-November 2000.
32. Despite efforts to keep the program supported by the third annual PRGF arrangement on track, two of six quantitative performance criteria and two quantitative benchmarks, as well as two of the seven structural performance criteria (one for end-December 1999), foreseen under the program were not observed at end-March 2000. However, the implementation of the interim program through September has brought the program back on track. The government therefore requests that the Executive Board of the IMF grant waivers for the performance criteria that were not observed at the test dates.
