Conakry, Guinea
March 20, 1998

1.    The objectives of Guinea's program of economic and financial adjustment for the three-year period 1998-2000 are set out in the updated policy framework paper prepared in close collaboration with the staffs of the Fund and the World Bank, which is being transmitted to you under separate cover.

2.    The attached memorandum of economic and financial policies, based on the policy framework paper referred to above, sets out the objectives and policies that the Government of Guinea intends to pursue during 1998. In support of these objectives and policies, the Government hereby requests the second annual arrangement under the enhanced structural adjustment facility (ESAF) in an amount equivalent to SDR 23.6 million (30 percent of quota).

3.    The Government of Guinea 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.

4.    The Government of Guinea believes that the policies and measures set out in the attached memorandum are adequate to achieve the objectives of its program; it will take any further measures that may become appropriate for this purpose. During the period of the second annual ESAF arrangement, the Government will consult with the Managing Director on the adoption of any measures that could be appropriate, at the initiative of the Government or whenever the Managing Director requests such a consultation. Moreover, after the period of the second annual ESAF arrangement and while Guinea has outstanding financial obligations to the Fund arising from loans under the arrangement, the Government will consult with the Fund from time to time, at the initiative of the Government or whenever the Managing Director requests consultation on Guinea's economic and financial policies.

5.    The Government of Guinea will conduct with the Fund a midterm review of its program supported by the second annual arrangement not later than September 30, 1998.

Attachment


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

Conakry, Guinea
March 20, 1998

I. INTRODUCTION

1. This memorandum reviews economic developments and policy implementation in Guinea during 1997 and describes the principal objectives and policies envisaged by the government for 1998. The program for 1998, in support of which the government requests the second annual arrangement under the Fund's enhanced structural adjustment facility (ESAF), has been cast within a medium-term framework outlined in the updated policy framework paper (PFP) for 1998-2000. The program continues to aim at establishing the conditions for high and sustained economic growth, low inflation, and a viable balance of payments, based on sound financial policies and productivity-enhancing structural reforms. The government believes that strong financial support from the international community is critical for the sustainability of Guinea's adjustment effort, and that such support is warranted by the present program.

II. ECONOMIC PERFORMANCE IN 1997 AND EARLY 1998

2. Policy implementation through mid-1997 was discussed in detail in the government's letter to the Managing Director of July 31, 1997. Since then, policy implementation has remained strong, and the quantitative benchmarks concerning the primary budget balance and net bank credit to the government at end-December 1997 as well as most of the structural benchmarks were observed. However, a number of other benchmarks could not be attained, including those related to external arrears and net foreign assets. In particular, in view of the negotiations in progress, debt service obligations to non-Paris Club creditors could not be entirely fulfilled. The response of economic activity to the improved environment remains below expectations, owing, among other things, to continuing weaknesses in the country's financial and legal systems. Real GDP growth for 1997 is estimated to have been in the vicinity of 5 percent, similar to 1996, and inflation remained low, averaging less than 2 percent.

3. The government made particularly strong efforts to observe the key target relating to the domestic primary balance. The projected surplus of 2.6 percent of GDP was even exceeded. The government wage bill was scaled down owing to better control of employment in the civil service, the elimination of unjustified bonuses, and the suspension of those still needing to be verified.

4. The troubling financial position of four banks led the government in November 1997 to propose measures to restore normal operating conditions in the banking system. Unable to reach agreement with its private partner in the Banque Internationale pour l'Afrique en Guinée (BIAG), the government had no choice but to close the bank. The cash reimbursement of small depositors proceeded smoothly and is now nearly completed. Large depositors will be reimbursed in government securities, the terms of which were recently defined. The three other banks in difficulties were asked to increase their capital, the government having made known its intention to contribute its share. Regarding the Banque Populaire Maroco-Guinéenne (BPMG), in which the government is a shareholder along with a foreign bank, a recent draft audit report revealed serious operating irregularities. As soon as the final audit report becomes available (around end-March), the foreign shareholder will be informed of the options available to correct the deficiencies observed, including the possible closing of the bank. The plan should be finalized by end-May 1998.

5. As for the Banque Islamique de Guinée (BIG), which is privately owned, the government notified shareholders in early February of the precise conditions for its intervention, according to a plan which guarantees the credibility of the restructuring program and protects the government's interests as fully as possible. The government offered its support in the light of the recent finding by the BIG's external auditor that the measures adopted since August 1997 were in line with the recommendations of their previous audit report. The shareholders are to make their opinion known by end-May 1998 and are to sign an agreement in due and proper form with the government.

6. Lastly, the Union Internationale de Banques en Guinée (UIBG), which is controlled by its majority shareholder, a French public bank, was informed in early February 1998 that a shareholder contribution of GF 2 billion was essential to raise its capital base to a level compatible with the continuance of its operations. The shareholders are held to announce their position in the coming weeks so that an agreement could be signed by end-May 1998.

7. Preliminary estimates show that export receipts increased by at least 10 percent while imports grew by 7 percent. The external current account deficit declined somewhat, and the overall balance showed a surplus; the latter improved with respect not only to 1996 but also to the 1997 program objective. This performance is explained by the significant financial assistance of the World Bank (US$54 million), the African Development Bank (US$8 million), the European Union (US$8 million), and Kuwait (US$4 million). The Fund disbursed the equivalent of US$34 million under the first annual ESAF arrangement.

8. External arrears, as defined under the program, were not fully eliminated in 1997, but remained at US$17 million at the end of that year. Net foreign assets, at US$135 million at end-December 1997 (before valuation change), fell short of the adjusted target of US$141 million. The government has made progress in negotiating bilateral agreements with Paris Club creditors who agreed to extend to end-March 1998 the deadline for concluding the remaining agreements. In addition, the government has invited Russia and non-Paris Club bilateral creditors to initiate discussions to solve Guinea's external debt problem. Russia has expressed agreement in principle to defer any payments until after 1998. The debt owed to the former Czechoslovakia (US$20 million) was eliminated through debt conversion. With assistance from the World Bank and bilateral donors, Guinea is in the process of buying back a significant share of its commercial debt at 13 percent of face value.

III. ECONOMIC PROGRAM FOR 1998

9. The implementation of tight financial policies over the past 18 months has helped to keep inflationary pressures under control. However, the mobilization of government revenue continues to challenge economic policy. The poor social indicators in Guinea confirm the urgency of bolstering priority expenditures for the social sectors and for physical infrastructure. Private sector confidence in the economy remains dependent on the government's ability to address the deficiencies in the economic and institutional environment. To ameliorate the conditions for private sector activity, the government intends to ensure greater transparency of its actions, simplify business procedures, improve the enforceability of contracts, and enhance the functioning of markets. It also plans to organize a national forum to promote private sector development.

10. The principal macroeconomic objectives for the medium term remain broadly as envisaged in the original program-keeping inflation below 4 percent, containing the external current account deficit (excluding grants) at less than 8 percent of GDP, and raising gross international reserves to about 3 1/2 months of imports. Exports are expected to benefit from structural reforms enhancing external competitiveness in the context of a flexible exchange rate. The domestic primary surplus is expected to increase to 3 percent of GDP, a level that will free financial resources for private sector development and the provision of adequate infrastructure, while still permitting necessary increases in spending on health and education.

A. Fiscal Policy and Budgetary Management

11. To ensure a durable improvement in revenue performance and to strengthen the efficiency of government management, the government's recent actions included: (i) finalizing decrees for the application of laws on the value-added tax (VAT) to mining companies and their subcontractors; (ii) entrusting the customs inspection company with the responsibility of controlling all imports of mining companies and assessing the corresponding VAT and customs duty obligations; (iii) completing the list of domestic payments arrears outstanding;¹ (iv) revoking ad hoc exemptions from the VAT granted since its introduction; (v) lowering the VAT threshold for businesses in the services industry; (vi) creating a tax appeal commission; (vii) finalizing the update of the files of government pensioners in the Conakry and Kindia areas; (viii) implementing a first round of rehabilitation measures for the National Social Security Fund (CNSS), based on the recommendations of the recent audit report; (ix) preparing a computerized system of monthly expenditure reporting; (x) designating the head and staff of the department of financial control and starting its operation; (xi) beginning a revision of the customs tariff to bring it gradually into line with tariffs in force in the subregion; and (xii) adopting a unified real estate tax. The government has made significant strides in combating fraud and corruption. These efforts will be pursued further, in particular through a series of controls aimed at ending the corruption of certain public officials and their misappropriation of funds in collusion with the private sector.

12. For 1998, the program aims at increasing the domestic primary surplus to almost 3 percent, eliminating remaining external arrears, and reducing government domestic arrears and indebtedness to the banking system. To attain this objective, budget revenue is expected to reach 11.6 percent of GDP, compared with an estimated 11.1 percent in 1997, reflecting the full-year impact of actions implemented in 1997 and early 1998, and the strengthening of customs and tax administration.

13. Expenditure will be raised by almost 7 percent in real terms to meet the needs of the priority sectors² and contribute to the restructuring of the ailing banks. The government wage bill will be contained at GF 185 billion. This represents an increase of 8 percent in nominal terms from 1997, even in the absence of any general wage increase, because it reflects the full-year impact of the 8 percent pay raise granted in September 1997, the resumption of payments on suspended bonuses that have been found justified, and new hiring in the education and health sectors. In relation to total revenue, however, the wage bill will decrease slightly.

14. Structural reforms for 1998 in the budgetary area will include measures to improve non-mining revenue and strengthen budget implementation and control. On the revenue side, the unified real estate tax will be introduced, while field offices of the national tax department (DNI) will be reorganized along the lines of the unit in charge of large enterprises. The DNI will be provided with sufficient resources to carry out this reorganization. The tax audit function will be streamlined and strengthened. The efficiency of the customs department will be enhanced through the rehabilitation of the ASYCUDA system, the reassignment of personnel, and the reinforcement of the program to combat fraud. On the expenditure side, computerization of the expenditure chain from commitment to payment order, including strict compliance with government contracting procedures, is about to become operational, and will be gradually extended to more ministries to provide improved access to information. Budgetary procedures have been streamlined and financial control overhauled. These measures are aimed at introducing greater transparency in the budgetary process, to allow for a gradual return to standard budget execution procedures, while at the same time minimizing the risks of embezzlement. Strict enforcement will be ensured by the controls already in place. In addition, the new budget classification, which is used in the 1998 budget law, should facilitate the functional analysis of expenditure.

15. The government pension system, which imposes an increasingly heavy burden on the budget owing to the age pyramid of civil servants, will be reformed. At the same time, the CNSS will be restructured in accordance with the recommendations of the recent operational audit, beginning with a financial audit of the CNSS's position at end-1997, to be completed by an independent firm by end-June 1998.

B. Monetary Policy and Financial System Reform

16. Monetary policy, supported by fiscal restraint, will aim at keeping inflation low while protecting external reserves. The monetary program allows for an expansion in the money supply of 9 percent during 1998 and an increase in the net foreign assets of the BCRG to US$143 million. Given the surplus programmed for the government's domestic primary operations, these targets will permit appreciable growth in bank credit to the private sector.

17. In implementing monetary policy, the BCRG will focus on achieving stable growth in reserve money, relying on market-related instruments. Given the considerable decline of inflation in recent years, the minimum deposit interest rate was recently lowered from 9 percent to 6 percent.

18. The government will take steps to ensure a better harmonization of public debt management and monetary policy, and will coordinate the issuance of treasury bills with the BCRG. Central bank advances to the government will be kept strictly within the statutory limit, and their interest rate has been raised from 5 percent to the market rate with effect from March 1, 1998. The terms governing treasury bill auctions have deviated somewhat from the regulatory provisions in force. To correct this, the joint BCRG-Ministry of Finance committee is now conducting Dutch auctions in order to promote competition and lower the costs to the government of these issues. Moreover, the BCRG will encourage insurance and other companies to participate in the auctions, and, to this end, has reduced minimum bids for treasury bills from GF 100 million to GF 20 million. Finally, in June 1998, the central bank will start issuing on behalf of the government small-denomination treasury bills for budget financing purposes.

19. The central bank will focus on reinforcing the supervision of the banking system and strictly ensuring that the prudential standards are observed by all financial institutions. The government is committed to performing an analysis of banking supervision against the background of the core principles of effective banking supervision developed by the Basle Committee and approved by the international community at the annual meetings of the IMF and the World Bank in October 1997. Adhering to a timetable to be established by end-June 1998, the government will then correct any weaknesses revealed by this analysis. The authorities will act on the violations committed by applying the penalties provided for in the banking law, without ruling out the possibility of closing banks, particularly those whose shareholders do not respond to the directives issued by the BCRG in connection with the current restructuring plans. Among other measures designed to strengthen the prudential regulations, the BCRG will, by mid-1998, tighten the rules on solvency and will thoroughly examine the responsibilities of both shareholders and auditors whose performance needs to be improved to enhance the security of banking operations.

C. Other Structural Reforms

20. In the past, the government successfully implemented a far-reaching privatization program. Building on that experience, the government plans to identify new entities to be privatized and, by end-June 1998, to establish a timetable for government withdrawal. It will also prepare a plan for the settlement of cross debts between the government and public enterprises. This plan is not expected to have any budgetary implication for 1998.

21. Regarding the taxation of petroleum products, effective January 1, 1998, the government adopted a new, more realistic price structure that includes all costs and provides for monthly receipt of the tax on petroleum products (TSPP) on a net basis. It has also decided to audit the accounts of the transport-equalization and stabilization funds during the first half of the year, as part of its program to combat fraud.

22. In parallel with the restructuring of the banking sector, the BCRG will define balance sheet items in the new accounting plan for commercial banks and will take all steps needed to ensure that commercial banks prepare their end-1999 accounts in accordance with the rules of the new accounting plan. To improve the legal environment for business activity, following the approval of a related law, the government will create an arbitration court and will make the necessary arrangements for its smooth functioning. It will also establish collegiality, starting at the trial court level, in judgments on commercial matters, train judges in business law, and recruit qualified experts in the field of commercial litigation.

23. Moreover, the government will begin classifying goods with a view to harmonizing import taxes and duties with those in force in the subregion. Aware of the unsatisfactory status of available economic data, the government intends to improve their quality. Accordingly, it is actively seeking financial and technical assistance, particularly for the preparation of a preliminary version of the national accounts for 1995-96. Rehabilitation of the ASYCUDA system should permit the production of up-to-date foreign trade statistics.

D. External Sector

24. The government is determined to clear outstanding external arrears and remain current on its external obligations. To this end, it will eliminate all nonreschedulable arrears to the Paris Club and to multilateral organizations before end-March 1998. It will also pursue its efforts to conclude bilateral agreements with Russia and non-Paris Club creditors, on terms at least comparable to those accorded by Paris Club creditors in February 1997. A total of US$688 million in external arrears will be paid or rescheduled in 1998. To limit Guinea's external debt burden, the government intends to contract new loans only on concessional terms.

25. The authorities remain committed to market determination of the exchange rate. Aware of the deficiencies hindering the free functioning of the interbank foreign exchange market, the BCRG has reaffirmed its commitment to a strict enforcement of the agreed provisions on the method of calculation and daily announcement of the weighted average exchange rate. It recently established procedures to monitor the compliance of banks and exchange bureaus with these provisions. It also replaced the notion of an official exchange rate with that of a reference rate. To no longer disadvantage banks relative to the informal sector, the BCRG eliminated at end-February 1998 the 0.25 percent commission that it levied on exchange operations carried out by banks. At the same time, the BCRG, in cooperation with the Ministry of Mines, will be working to create a gold market, on which transactions will be in foreign currencies. This market will give local production easier access to the international market. It will also help supply the economy with foreign exchange and allow for better integration of both formal and informal foreign exchange markets.

26. Given the wait-and-see attitude likely to be adopted by the business community during an election year, external performance May not improve in 1998. Thus, the current account deficit (excluding transfers) is projected to remain near 8 percent of GDP. The financing gap of US$794 million is expected to be covered by debt relief of US$673 million and financial assistance from donors of US$121 million.

E. Performance Criteria, Benchmarks, and Review

27. Implementation of the program will be monitored through quantitative performance criteria for end-June 1998, as well as benchmarks for end-March 1998 and indicative benchmarks for end-September and end-December 1998 (Table 1). Definitive quantitative benchmarks for the latter dates will be set at the time of the midterm review. Structural performance criteria and benchmarks have also been identified and are shown in Table 2. The nonaccumulation of new external payments arrears will also constitute a performance criterion, applying on a continuous basis. The implementation of the program and Guinea's economic performance in light of the program objectives will be the subject of a mid-term review by the Fund under the second annual arrangement. The availability of the second disbursement under the second annual arrangement will be conditional upon observance of the quantitative and structural performance criteria for end-June 1998 and completion of the midterm review by end-September 1998.

28. During the period of the second annual ESAF arrangement, the government will not, without Fund approval, introduce new or intensify existing exchange restrictions, nor permit any multiple currency practice, or introduce import restrictions for balance of payments reasons.

An asterisk (*) indicates a performance criterion.