Oil Wealth in Central Africa Policies for Inclusive Growth

EDITORS Bernardin Akitoby and Sharmini Coorey

INTERNATIONAL MONETARY FUND

Cover design: IMF Multimedia Services Division

Cataloging-in-Publication Data Joint Bank-Fund Library

Oil Wealth in Central Africa : policies for inclusive growth / editors, Bernardin Akitoby and Sharmini Coorey. — Washington, D.C. : International Monetary Fund, 2012. p. ; cm.

Includes bibliographical references. ISBN 978-1-61635-376-6

1. Petroleum industry and trade —Africa, Central. 2. Petroleum industry and trade— Africa, Central—Case studies. 3. Natural resources—Africa, Central—Management. 4. Natural resources—Africa, Central—Management—Case studies. 5. Economic development—Africa, Central. 6. Africa, Central—Economic policy. I. Akitoby, Bernardin. II. Coorey, Sharmini. III. International Monetary Fund.

HD9577.A352 O35 2012

Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its members.

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©International Monetary Fund. Not for Redistribution Contents

Foreword v Acknowledgments vii About the Authors ix Abbreviations xv Overview xvii Bernardin Akitoby and Sharmini Coorey (IMF)

Part I Macroeconomic and Growth Challenges

1 T he CEMAC’s Macroeconomic Challenges...... 3 Bernardin Akitoby and Sharmini Coorey (IMF)

2 Improving Surveillance Across the CEMAC Region...... 17 Robert York, Plamen Iossifov, Noriaki Kinoshita, Misa Takebe, and Zaijin Zhan (IMF)

3 d eterminants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?...... 39 Alexandra Tabova (Federal Reserve Board) and Carol Baker (IMF)

4 CE MAC‘s Infrastructure Gap: Issues and Policy Options...... 55 Rupa Ranganathan, Vivien Foster (World Bank), and Cecilia Briceño-Garmendia

Part II Management of Oil Wealth and Poverty Reduction

5 Managing Oil Windfalls in the CEMAC...... 89 Frederick van der Ploeg (Oxford University)

6 Government Failure and Poverty Reduction in the CEMAC...... 111 Shanta Devarajan and Raju Jan Singh (World Bank)

7 N atural Resource Endowments, Governance, and Domestic...... 125 Revenue Mobilization: Lessons for the CEMAC Region Sanjeev Gupta and Eva Jenkner (IMF)

8 T he Cyclicality of Fiscal Policies in the CEMAC Region...... 135 Gaston K. Mpatswe, Sampawende J.-A. Tapsoba, and Robert C. York (IMF)

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©International Monetary Fund. Not for Redistribution iv Contents

Part III Case Studies on Oil Wealth Management

9 Cameroon’s Oil Wealth: Transparency Matters...... 155 Bernard Gauthier (HEC, University of Montreal, Canada) and Albert Zeufack (Director of Research, Khazanah National Berhad, Malaysia)

10 Chad: Lessons from the Oil Years...... 171 Jean-Claude Nachega and Jaroslaw Wieczorek (IMF)

11 Congo’s Experience Managing Oil Wealth...... 183 Carol Baker and Oscar Melhado (IMF)

12 Gabon’s Experience Managing Oil Wealth...... 197 Cheikh Gueye (IMF)

Appendix. Introduction to the CEMAC Institutions...... 213 Salao Aboubakar (Advisor to the BEAC Governor)

©International Monetary Fund. Not for Redistribution Foreword

Overwhelming evidence shows that the Central African Economic and Monetary Community (CEMAC) oil exporters—five out of the six countries in the region—have not avoided the “resource curse.” Despite its abundant oil wealth, the region has grown more slowly, even compared with sub-Saharan African countries that have comparable levels of development. Ineffective fiscal management of volatile oil revenue has led to procyclical policies with “boom-and-bust” cycles that induce macroeconomic instability, thereby hurting investment and growth. The region also has some of the world’s lowest living standards and social indicators. Poverty and unemployment remain widespread, and a large proportion of the population still lacks access to basic power, safe drinking water, and improved sanitation. In other words, oil wealth has not led to more inclusive growth. Effective management of oil wealth remains on the IMF’s research agenda and is included in the policy dialogue with oil-rich countries. The IMF African Department recently launched an initiative to help countries strengthen the management of natural resources, sharpen our policy advice, and deepen our dialogue to promote more inclusive growth. As part of this initiative, this book is an excellent opportunity to focus our thoughts on the key challenges facing the CEMAC region and how they can be addressed. The overarching priority for these countries remains to seize the opportunity provided by oil wealth to foster strong, sustained, and inclusive economic growth, and to generate sufficient employment opportunities, particularly for their fast-growing youth populations. The related policy challenges range from breaking procyclical fiscal policies and improving governance and transparency of the oil sector to ensuring productive public investment and improving health and education spending. Drawing on the experiences of the CEMAC oil-exporting countries and new research on managing oil wealth, this book offers policy advice to address these challenges. First, it proposes a fiscal framework that recognizes the CEMAC’s large investment needs in physical infrastructure and human capital while reducing a bias toward procyclical fiscal policies. It underscores that public investment plans should be embedded in a realistic multiyear investment plan, and the related annual budgets should be cast within a medium-term fiscal framework consistent with macroeconomic stability and fiscal and external sustainability. Second, better investment appraisal, selection, and monitoring are needed to ensure spending quality. The pace of scaling up investment should be commensurate with the quality of public investment management systems. Finally, there is a pressing need to improve accountability and transparency in oil revenue management. Several contributions and case studies in this book propose measures to achieve this important objective.

©International Monetary Fund. Not for Redistribution vi Foreword

The likelihood that commodity prices will remain elevated by historical standards in the coming years gives CEMAC oil exporters strong incentives to strengthen their ability to maximize the benefits derived from exploitation of these resources. I hope this book provides a macroeconomic framework and policy advice to help CEMAC countries seize this opportunity to translate their oil wealth into inclusive and sustained growth. Antoinette M. Sayeh Director African Department International Monetary Fund

©International Monetary Fund. Not for Redistribution Acknowledgments

This book is part of the IMF African Department’s project to strengthen the management of natural resources and promote more inclusive growth. It brings together research work by a broad group of IMF economists and leading experts from the World Bank, academia, and one of Malaysia’s sovereign wealth funds. We would like to thank Antoinette M. Sayeh, Director of the IMF’s African Department, for her support for this initiative. We also owe thanks to many col- leagues at the IMF and the World Bank who read and commented on the papers included in this volume. Special thanks to Michael Atingi-Ego, Carol Baker, Andrew Berg, Dhaneshwar Ghura, Saul Lizondo, Paulo Mauro, Sean Nolan, Roger Nord, Catherine Pattillo, Raju Singh, and Mauricio Villafuerte. We are particularly grateful to Paul Collier (Oxford University), Shanta Devarajan (Chief Economist of the African Region at the World Bank), Sanjeev Gupta (Deputy Director of the IMF’s Fiscal Affairs Department), and Rick van der Ploeg (Oxford University) for useful advice. We also thank the CEMAC authorities for highly productive policy discussions over the past several years. We benefited from the technical and administrative support of many col- leagues. We gratefully acknowledge the excellent assistance of Cheryl Roberts in preparing the manuscripts. Particular thanks go to Atsushi Oshima and Mpumelelo Nxumalo for excellent research assistance; Jenny DiBiase, who edited some of the chapters; and Joe Procopio of the External Relations Department, who edited the book and coordinated its production. Finally, we are most grateful to our families for their unwavering support during the preparation of the book. The views expressed throughout this publication are those of the contributing authors and do not necessarily represent the position or policies of the IMF, the IMF Executive Directors, or the CEMAC authorities.

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©International Monetary Fund. Not for Redistribution About the Authors

Bernardin Akitoby, a national of Benin, is Division Chief in the African Department of the IMF. He also serves as the IMF Mission Chief for the Central African Economic and Monetary Community (CEMAC), the Bank of Central African States, and Gabon. Before joining the IMF, he worked in the World Bank’s Research Department and taught at the University of Montreal and the National University of Benin. He has published in academic journals, including Economic Journal, European Journal of Political Economy, Review of World Economics (Weltwirtschaftliches Archiv), Economie Appliquée, and Revue Economique. His research interests include real business cycles, growth, exchange rates, hyperinfla- tion, macroeconomic management of oil wealth, fiscal procyclicality, public investment and public-private partnerships, financial markets, economic institutions, and sovereign risk. He holds a PhD in economics from the University of Montreal and degrees in business administration, finance, and accounting.

Carol Baker is an Economist and Deputy Division Chief at the IMF currently assigned to the CEMAC region. Her recent research has spanned topics ranging from investment efficiency and growth to reserve adequacy. Before joining the African Department in 2010, she worked extensively in Southeast Asia on the dynamic economies of China, Malaysia, Singapore, and Vietnam. She holds a BA and an MA in economics from Boston University, and a PhD in economics from the University of Wisconsin-Madison.

Cecilia Briceño-Garmendia is Senior Economist in the Office of the Director for Sustainable Development in the Africa Region of the World Bank, where she co-led a major knowledge program known as the Africa Infrastructure Country Diagnostic. For more than 20 years, Ms. Briceño-Garmendia has dedicated her professional career to work and research on economic and policy issues pertain- ing to service provision and optimal functioning of infrastructure sectors. She has worked extensively on issues in the area of public financing of infrastructure, particularly on links between institutions and regulatory frameworks, and the efficiency of spending. She has spearheaded the use of spatial tools to help policymakers with infrastructure investment prioritization and with coordination of interventions across sectors and stakeholders. Her work at the World Bank involves both analytical and advisory services and economic input into the design and supervision of projects, with a focus on the financing of public infrastructure. Before joining the World Bank, she worked in software engineering and the design of information and organizational systems for both private and public sector enterprises in Venezuela. She holds a PhD in economics from Georgetown University and an MBA from the Instituto de Estudios Superiores en Administración.

©International Monetary Fund. Not for Redistribution x About the Authors

Sharmini Coorey, a national of Sri Lanka, is Director of the IMF Institute for Capacity Development. She was previously Deputy Director in the IMF’s African Department where her oversight and review responsibilities included the CEMAC region and Southern Africa. She has led IMF staff missions to South Africa, Zimbabwe, and Ireland, and headed the U.K. and Nordic country division. Her experience includes work on surveillance and IMF-supported programs in a range of industrial and emerging economies in Europe, Asia, and North and South America, as well as on various policy issues in the IMF’s Policy and Review Department. She has also served on the Editorial Committee of IMF Staff Papers and been a visiting researcher at George Washington University’s Elliot School for International Affairs. Ms. Coorey holds a PhD and a BA in economics from Harvard University. Her research interests include financial sector issues, macroeconomic stabilization, and growth, about which she published numerous works.

Shantayanan Devarajan is the Chief Economist of the World Bank’s Africa Region. Since joining the World Bank in 1991, he has been a Principal Economist and Research Manager for Public Economics in the Development Research Group, and Chief Economist of the Human Development Network and of the South Asia Region. He was the Director of the World Development Report 2004: Making Services Work for Poor People. Before joining the World Bank, he was on the faculty at Harvard University’s John F. Kennedy School of Government. The author and coauthor of more than 100 publications, Mr. Devarajan’s research covers public economics, trade policy, natural resources and the environment, and general equilibrium modeling of developing countries. Born in Sri Lanka, Mr. Devarajan received his BA in mathematics from Princeton University and his PhD in economics from the University of California, Berkeley.

Vivien Foster is Lead Economist in the Office of the Director for Sustainable Development in the Africa Region of the World Bank, where she has been responsible for coordinating a major knowledge program known as the Africa Infrastructure Country Diagnostic. Her work at the World Bank involves both analytical and advisory services, and economic input into the design and supervision of projects, with a focus on the effects of infrastructure reform and privatization on the poor. Before joining the World Bank, she was a Managing Consultant at Oxford Economic Research Associates Ltd in the United Kingdom, where she advised private and public sector clients in the water and energy industries, and worked with numerous Latin American governments on issues relating to water sector reform. She holds a PhD in economics from University College London.

Bernard Gauthier is Professor of Economics at the Institute of Applied Economics at HEC Montréal (the University of Montréal’s business school). He is also a visiting professor at Université de Paris 1, at Université de Paris 12, and at CEIS, Universitá degli Studi di Roma. His research interests include development economics, public finance, public sector economics, and the new economics of institutions. Since 2001, he has been involved in public sector micro-level

©International Monetary Fund. Not for Redistribution About the Authors xi surveys using Public Expenditure Tracking Surveys and Quantitative Service Delivery Surveys in various sectors. He has been a consultant for the African Economic Research Consortium, the World Bank, the United Nations Children’s Fund, the U.K. Department for International Development, and the Union Douanière et Économique de l’Afrique Centrale.

Cheikh Anta Gueye is a Senior Economist at the IMF and has wide experience in country policy issues. Before joining the IMF, he worked at the Central Bank for West African States based in Dakar, where he held successively the positions of Senior Economist and Head of the Department of Research and Statistics from 2003 to 2007. Before joining the Central Bank, he worked at the Senegalese Ministry of Economy and Finance. He holds an MBA from Southern Illinois University; an MPA from National School of Administration, Dakar, Senegal; and an MA in economics from University Cheikh Anta Diop, Dakar, Senegal.

Sanjeev Gupta is Deputy Director in the Fiscal Affairs Department of the IMF. He was previously Senior Advisor in the Fiscal Affairs Department and Assistant Director in the African Department. Mr. Gupta has published extensively on macroeconomic and fiscal issues.

Plamen Iossifov is an Economist in the European Department of the IMF. Before his current assignment on the Bosnia and Herzegovina country team, he worked extensively on countries in West and Central Africa—Equatorial Guinea, Sierra Leone, Gabon—and on CEMAC regional surveillance. Current research interests include credit growth, bank stress tests, and money demand.

Eva Jenkner has worked extensively on fiscal policy issues and public sector reform at the IMF, where she is a Senior Economist in the Fiscal Affairs Department. Her publications address a variety of fiscal policy topics, and include contributions on health and education expenditure and to IMF reports on Latin America, emerging Europe, and the Middle East. Apart from the IMF, she has worked as a Senior Economic Advisor to the government of Georgia and a Deputy Representative with United Nations Children’s Fund Malaysia. She has a BA from Cambridge University and an MA in Public Affairs from Princeton University’s Woodrow Wilson School of Public and International Affairs.

Noriaki Kinoshita, a Japanese national, is a Senior Economist in the African Department of the IMF. He holds a PhD in economics from the University of Cambridge and a BA in economics from the University of Tokyo. Before joining the African Department, where his responsibilities as a desk economist have included work for the Central African Republic and Ethiopia, Mr. Kinoshita worked for several years in the Fiscal Affairs Department. Before joining the IMF, Mr. Kinoshita led the international economics team at the Mitsubishi Research Institute in Tokyo.

©International Monetary Fund. Not for Redistribution xii About the Authors

Oscar Melhado is the IMF’s Resident Representative in Brazzaville, the Republic of Congo. He joined the IMF in 1999, working in the Western Hemisphere Department, and since 2003 in the African Department as desk economist for Gabon and Chad. Before joining the IMF, he worked as a consultant and taught at the Central American University of El Salvador.

Gaston Kagabo Mpatswe is an Economist in the African Department at the IMF, working on various countries’ economic programs supported under IMF arrangements. He also served as Advisor to the Executive Director for Africa. Before joining the IMF, he held senior positions in the Office of the President of Rwanda. He led and served on boards of directors of various public agencies and on high-level government committees in charge of designing and monitoring implementation of economic policies and reforms that were keystones to Rwanda’s successful postconflict recovery and ongoing economic development process. He started his economic career in academics at the National University of Rwanda. His research works relate to the effectiveness of foreign aid to sub- Saharan Africa, financial sector development, and economic reforms and development. He holds a graduate degree in quantitative development economics from the University of Warwick.

Jean-Claude Nachega is an Economist in the African Department of the IMF. In 2008–10, he worked as the Deputy Chief of Staff and Chief Economic Advisor to the Prime Minister of the Democratic Republic of Congo. He also previously worked as an economist at the International Finance Corporation (World Bank Group). He has published papers in the areas of monetary economics, public finance, and development economics.

Rupa Ranganathan is a core team member of the Africa Infrastructure Country Diagnostic. She has worked in a number of departments across the World Bank and International Finance Corporation. She is an economist and energy specialist. Ms. Ranganathan has an MA in public policy and is currently working toward her MBA.

Raju Jan Singh is the Lead Economist for Central Africa, based in Yaoundé, Cameroon. Before joining the World Bank, Mr. Singh held positions at the IMF in Washington, D.C., at the Swiss Ministry of Finance in Bern, and at Lombard Odier & Cie (private banking) in Geneva. He was also a consultant for the Swiss Agency for Development and Cooperation, working with the central banks of Rwanda and Tanzania, and taught at the Graduate Institute of International Studies in Geneva. Mr. Singh holds a PhD from the Graduate Institute of International Studies in Geneva, Switzerland.

Alexandra Tabova is an Economist in the Division of International Finance at the Board of Governors of the Federal Reserve in Washington, D.C. Her current work focuses on issues related to cross-border capital flows and implications for

©International Monetary Fund. Not for Redistribution About the Authors xiii the U.S. economy and the world. Her research focuses on international capital flows, portfolio choice, foreign direct investment, effects of risk exposure on economic growth, commodity price fluctuations, and growth in low-income countries. She previously worked in the Economic Policy and Debt Department and the Financial Resource Mobilization Department at the World Bank, and the African Department at the IMF. Ms. Tabova, a Bulgarian national, holds a PhD in economics from Duke University and an MSc from the Vrije Universiteit of Amsterdam.

Misa Takebe was a senior desk economist in the African Department of the IMF when her chapter was written. At the IMF, she has worked in the African Department, and in the Independent Evaluation Office where she focused on crisis cases in Latin America, Eastern Europe, and Asia. Ms Takebe was previously a regional strategist and economist for Asia at Nomura Asset Management. She is currently on leave from the IMF and is working at the Hong Kong Monetary Authority.

Sampawende J.-A. Tapsoba works as an Economist in the African Department at the IMF. Before the IMF, he was a research economist at the French Ministry of Finance and Economy and served as an assistant professor at the University of Auvergne. He holds a PhD and an MA in international economics from the Center for International Development Study and Research (France). He also received a degree in economics and management from the University of Ouagadougou.

Frederick van der Ploeg is currently a professor at the University of Oxford and codirector of the Oxford Centre for the Analysis of Resource Rich Economies, and senior research fellow at New College, Oxford. Before that, he held appoint- ments at Cambridge University, London School of Economics; Tilburg, Amsterdam; and the European University Institute, Florence. He has been a Member of Parliament and State Secretary of Education, Science and Culture in the Netherlands, and a member of the United Nations Educational, Scientific and Cultural Organization World Heritage Committee. Apart from his core interests in macroeconomics and public finance, his main research interests are development economics and environmental and resource economics. He has advised the European Union, the Organization for Economic Cooperation and Development, the African Development Bank, the Asian Development Bank, and the World Bank, and has taught a course on the economics of natural resources at the IMF Institute.

Jaroslaw Wieczorek, a Polish national, is a Deputy Division Chief in the Central I Division of the IMF’s African Department. He holds a PhD and an MA in international economics from the Graduate Institute of International Studies (GIIS) in Geneva, and MAs in economics and in philosophy from Warsaw University. He was also a George Soros scholar at Lincoln College, Oxford. Before joining the African Department, Mr. Wieczorek worked for several years in the

©International Monetary Fund. Not for Redistribution xiv About the Authors

IMF’s Middle East and Central Asia Department, in the Policy Department, and in the Review Department. Before joining the IMF, Mr. Wieczorek held teaching positions at Warsaw Polytechnic, Warsaw University, and GIIS, and worked as a consultant at the Centre de Recherche Entreprises et Sociétés in Geneva.

Robert C. York is a Deputy Division Chief in the IMF’s African Department. He has extensive experience in the CEMAC region, having participated in IMF missions to all CEMAC countries except Chad; he previously led missions to the Central African Republic and the Republic of Congo. Mr. York currently is the African Department’s mission chief for the Democratic Republic of Congo. He holds a BA and MA from the University of British Columbia and did doctoral studies in economics at Queen’s University.

Albert G. Zeufack is Director of Research and Investment Strategy in Khazanah Nasional Berhad, a Malaysian sovereign wealth fund, on leave from the World Bank. Before joining Khazanah, he was the World Bank’s Acting Lead Economist, Head of the Poverty Reduction and Economic Management Cluster, and Cluster Leader for Private Sector Development for Southeast Asia based in Bangkok, Thailand. Mr. Zeufack joined the World Bank as an Economist in 1997 through the Young Professionals Program. At the World Bank, he has worked both in Research and in Operations on Africa, Asia, and the Middle East, from Washington, D.C., and from field offices. Before starting his World Bank career, he taught economics and applied econometrics at the University of Clermont- Ferrand, where he received his PhD in economics with the highest distinction. Mr. Zeufack has worked extensively on micro-foundations of growth and competitiveness, and is author of a number of books and articles in academic journals. He is a renowned keynote speaker at international conferences.

Zaijin Zhan is a Senior Economist in the African Department of the IMF, where he served as desk economist for South Africa and Ethiopia. Before joining the African Department, Mr. Zhan worked for several years in the Strategy, Policy, and Review Department and Finance Department, focusing on IMF lending programs to various countries. Mr. Zhan has a PhD and an MA in economics from the University of Maryland and a BA in economics from the Beijing University, China.

©International Monetary Fund. Not for Redistribution Abbreviations

BEAC Bank of Central African States CAPP Central African Power Pool CEMAC Central African Economic and Monetary Community CFA Coopération Financière en Afrique Centrale CFAF CFA franc COBAC Central African Banking Commission COMESA Common Market for Eastern and Southern Africa EAC East African Community ECOWAS Economic Community of West African States EITI Extractive Industries Transparency Initiative GDP gross domestic product GMM generalized method of moments GNI gross national income ICT information and communications technology IMF International Monetary Fund IOC international oil company kwh kilowatt-hour LHS left-hand scale LIC low-income country MDG Millennium Development Goal MW megawatt NOGDP non-oil GDP NOPD non-oil primary deficit OECD Organization for Economic Cooperation and Development OLS ordinary least squares PIMI Public Investment Management Index PPP purchasing power parity PRMP Petroleum Revenue Management Program REER real effective exchange rate RER real exchange rate RHS right-hand scale SADC Southern African Development Community SNH Société Nationale des Hydrocarbures SOGARA Société Gabonaise de Raffinage SSA sub-Saharan Africa UEAC Central African Economic Union UMAC Central African Monetary Union WAEMU West African Economic and Monetary Union WEO World Economic Outlook

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©International Monetary Fund. Not for Redistribution Overview

The Central African Economic and Monetary Community (CEMAC) has earned significant revenue from oil production in past decades but faces substantial growth and development challenges. The region is lagging in non-oil growth and poverty reduction, even compared with sub-Saharan African (SSA) countries that have comparable levels of economic development. Inequality remains high, poverty and unemployment are widespread, and it is unlikely the region will meet the Millennium Development Goals. The overriding economic challenge for the CEMAC is how to seize the opportunity provided by oil wealth to achieve a significant and durable reduction in poverty through productive public investment in human and physical capital and employment generation in the non-oil sector. This book addresses the challenge of strengthening the management of oil wealth and promoting policies for inclusive growth. It is organized in three parts. The first part lays out the macroeconomic and growth challenges facing the region. The second part focuses on oil wealth management and its implications for poverty reduction. The third part consists of four case studies on the CEMAC countries’ experience with managing oil wealth and lessons learned.

Macroeconomic and Growth Challenges In Chapter 1, Akitoby and Coorey identify four primary macroeconomic challenges facing the CEMAC region: (i) ensuring fiscal and external sustainability, (ii) fostering stronger non-oil growth, (iii) reforming the financial sector, and (iv) promoting trade and regional integration. In discussing the first challenge, they argue that the permanent-income hypothesis model is not a suitable framework for capital-scarce developing countries like those in the CEMAC. Given their large investment needs in physical and social infrastructure, the focus should be on the quality and efficiency of public investment. Public investment needs to be embedded in a realistic multiyear investment plan, and related annual budgets should be cast within a medium- term macroeconomic framework consistent with fiscal and external sustainability. In addressing the challenge of raising non-oil growth, the authors underscore the need to strengthen the quality of health and education, improve the business climate, build basic infrastructure, and facilitate access to financing for small and medium enterprises. They emphasize that better investment project appraisal, selection, and monitoring are needed to ensure spending quality. Reforming the financial sector is another long-standing challenge facing the region. The authors highlight the urgen- cy of reforming the prudential and regulatory framework, and dealing with problems of systemically important banks. In discussing the challenge of promoting trade and regional integration, the authors note that trade barriers remain pervasive and intraregional trade is the lowest among regional trade groups in SSA. They call for the removal of internal and external trade barriers.

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©International Monetary Fund. Not for Redistribution xviii Overview

The next three chapters provide an in-depth discussion of the first two challenges identified in Chapter 1. Improving regional surveillance in the CEMAC is critical to safeguarding the currency union and the fixed exchange rate regime. In Chapter 2, York, Iossifov, Kinoshita, Takebe, and Zhan examine how surveillance in the currency union might be improved by broadening the current convergence criteria through alternative fiscal indicators. To start with, the authors note that the CEMAC convergence criterion in the fiscal area—nonnegative basic balance—has two main shortcomings. First, it fails to take into account the cyclical nature of each economy, thereby making countercyclical fiscal policies difficult to implement. Second, it does not recognize that the region’s economy is dominated by oil. To address these shortcomings, the authors propose that greater attention be given to non-oil fiscal balances in the design of the convergence criteria. They also suggest that the CEMAC might consider setting a minimum reserve level as a convergence criterion. Against the background of weak non-oil growth in the oil-producing countries of the Coopération Financière en Afrique Centrale (CFA) zone, Tabova and Baker (Chapter 3) investigate how the determinants of growth in these countries differ from other low-income countries. Using a panel regression and controlling for the real effective exchange rate, they do not detect any significant association between non-oil growth and the sizable public investment in the CFA zone oil producers. The authors advance two reasons to explain this striking finding. First, the quality of public investment may be questionable because of weak project selection, appraisal, implementation, and monitoring. Second, it is likely that the necessary conditions for public investment to spur private sector activity are not in place. Such conditions include basic infrastructure, an enabling business environment, and good governance. Non-oil growth has been constrained by poor physical infrastructure. For instance, despite abundant oil wealth, paved road density in the CEMAC is a fraction of already-low levels in West Africa. In Chapter 4, Ranganathan, Foster, and Briceño-Garmendia document the state of infrastructure in the region and discuss policy and financing options to close the infrastructure gap. Infrastructure indicators suggests that CEMAC countries are on par with other low-income countries in SSA, but they significantly lag resource-rich countries worldwide. Despite oil wealth, a large portion of the population still lacks access to basic power, safe drinking water, and improved sanitation. Moreover, new infrastructure costs are very high because of regulatory hurdles and insufficient and low- quality existing basic infrastructure. Governance challenges have hindered trans- lation of investment into productive infrastructure. What can be done to address the CEMAC region’s pressing infrastructure needs? To achieve the conservative objective of bringing CEMAC infrastructure in line with that of other developing countries, the authors estimate that, with efficiency and regulatory improvement, the funding gap will be manageable at 5 percent of the CEMAC region’s GDP. Establishing a proper investment climate will also help the region attract private financing for infrastructure.

©International Monetary Fund. Not for Redistribution Overview xix

Management of Oil Wealth and Poverty Reduction The four chapters in this section deal with the challenges of managing oil resources and transforming them into poverty reduction. In Chapter 5, van der Ploeg attempts to address the fundamental question facing the CEMAC oil exporters: how can oil wealth be successfully transformed into productive assets for economic development? Noting that the permanent-income hypothesis model is not optimal for capital-scarce developing countries, the author offers a different theoretical framework for harnessing oil revenue windfalls. He argues that there is a strong case for investing in both physical and human capital in the domestic economy rather than investing exclusively in a sovereign wealth fund. Given that developing countries often face absorptive capacity problems, the author calls for “investing to invest” to overcome these difficulties. Where absorptive capacity is very low, he suggests temporarily accumulating the oil windfall in a sovereign wealth fund. Devarajan and Singh (Chapter 6) investigate the CEMAC governments’ failure to transform significant revenue from natural resources into poverty reduction. They attempt to explain this apparent disconnect between money and results by predicating the analysis on four common themes. First, elites in the government captured oil revenue with little accountability to the population because this revenue accrued directly to the government. Second, potential or actual conflict within the country—often because different groups wanted to capture the resource rents—led to expenditure that was oriented toward maintaining political stability (or capturing political power) rather than fostering widespread development. Third, expenditure—on infrastructure, health, and education—was poorly targeted or used unproductively. Finally, the combination of conflict and economic distortions meant that private investment suffered, leading to slow growth and even slower poverty reduction. To address what they call “government failure” as the mirror image of “market failure,” Devarajan and Singh emphasize the need for a fundamental shift in citizens’ ability to hold governments accountable for spending natural resource revenue. Ensuring effective mobilization of domestic revenue is critical for long-term development in resource-rich countries. Recent studies emphasize that countries receiving large revenue from natural resource endowments typically raise less revenue from domestic taxation, thereby reducing the incentive for public scrutiny of government. Gupta and Jenkner (Chapter 7) examine disaggregated trends in revenue mobilization in the CEMAC and find that the data suggest disincentive effects on domestic revenue mobilization. The authors emphasize three reasons why the CEMAC region needs to strengthen the nonresource revenue base. First, because oil revenue is exhaustible, early development of alternative revenue sources will help minimize the cost of adjustment when oil runs out. Second, greater reliance on domestic revenue is likely to lead to increased public scrutiny and government accountability, thus strengthening governance and state institutions. Finally, high levels of corruption tend to coincide with low domestic revenue mobilization.

©International Monetary Fund. Not for Redistribution xx Overview

Volatile oil revenue has often led to procyclical policies with “boom-and- bust” cycles that induce macroeconomic instability. In Chapter 8, Mpatswe, Tapsoba, and York examine fiscal cyclicality in the CEMAC region. Using panel data analysis, they find that, as in other SSA countries, total public expenditure in the CEMAC is strongly procyclical. The procyclicality is most pronounced for public investment, which overreacts to lagged output growth with elasticity above 1. The factors driving the procyclical behavior include institutional weaknesses, the low level of economic development, and foreign aid. In contrast, the existence of an IMF-supported program can be a counterbalancing influence to attenuate this bias.

Case Studies on Oil Wealth Management Although they offer different perspectives, the four case studies point to common themes: procyclical fiscal policies with “boom-and-bust” cycles that induce macroeconomic volatility; slow non-oil growth that leads to fewer employment opportunities and less inclusiveness; poor quality of spending, especially investment spending; and weak institutions and accountability that result in poor management of oil wealth. Gauthier and Zeufack (Chapter 9) contrast Cameroon’s experience managing its oil wealth with that of Malaysia. Noting that both countries had strong simi- larities at independence (more than 50 years ago), the authors investigate why Malaysia harnessed oil wealth for broadly based economic development while Cameroon did not. They conclude that transparency and accountability in oil wealth management in Malaysia explain this divergence. They find that although transparency and accountability in Cameroon’s oil sector have improved somewhat during the past 30 years, evidence indicates that much remains to be done. They suggest that reforms along the lines of the Natural Resources Charter, especially those precepts aimed at empowering civil society in holding governments, firms, and capital markets accountable, would be most useful. Nachega and Wieczorek (Chapter 10) argue that Chad has struggled to translate oil wealth into productive public spending, faster growth, or reduced poverty. Moreover, oil resources have intensified security tensions. Chad also experienced “boom-and-bust” cycles from procyclical and unsustainable fiscal policies. The relatively short horizons of Chad’s oil fields call for some long-term saving of oil revenue and improved domestic revenue mobilization. The authors underscore the benefit of the Petroleum Revenue Management Program (PRMP) for revenue transparency and the need to build some basic institutions before oil revenue starts flowing. However, they note that the PRMP’s rigid mechanisms have complicated fiscal management and have stretched the country’s limited capacity. Baker and Melhado (Chapter 11) document the “boom-and-bust” cycles the Republic of Congo experienced during the past 50 years and emphasize the daunting challenge of maximizing the benefits of oil in a country with weak institutions. After a half century of oil production, much remains to be done to improve the life of the Congolese people and achieve inclusiveness. The authors

©International Monetary Fund. Not for Redistribution Overview xxi see the need to build on the recent progress made—in macroeconomic stability, the external financial position, and public financial management—to sustain the reform momentum in three areas: strengthening institutions, improving the governance and management of oil wealth, and fostering policies for private sector– led development. In his case study on Gabon (Chapter 12), Gueye notes that oil production during the past 40 years has transformed Gabon into a middle-income country; however, income inequality is high, and non-oil sectors are stagnant. Gabon is among the highest per capita GDP countries in Africa but ranks below the average of middle-income countries on human development indicators. In addition, government spending has often been inefficient, with past capital spending not translating into improved infrastructure or high and sustained non-oil growth. Oil revenue, channeled through government spending, is a main driver of economic activity, but volatile oil revenue and the government’s procyclical fiscal policy have caused “boom-and-bust” cycles. The author underscores the need to anchor fiscal policies and improve spending quality, further strengthen governance and transparency, and improve the business climate to encourage private sector development. Bernardin Akitoby and Sharmini Coorey

©International Monetary Fund. Not for Redistribution part I

Macroeconomic and Growth Challenges

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©International Monetary Fund. Not for Redistribution Chapter 1

The CEMAC’s Macroeconomic Challenges

Bernardin Akitoby and Sharmini Coorey

The Central African Economic and Monetary Community (CEMAC) has earned significant revenue from oil production in past decades, but faces substantial economic growth and development challenges (Figure 1.1). Five of the six CEMAC countries are oil producers; oil accounts for about 40 percent of regional GDP and 85 percent of total exports. Oil revenue, channeled through government spending, is the main driver of economic activity, but volatile oil prices and procyclical fiscal policy have caused boom-and-bust cycles that have been exacerbated at times by rapidly rising and downwardly inflexible wages in a fixed exchange rate regime. Spending out of oil wealth has not led to more inclusive growth. Against the backdrop of high inequality, poverty and unemployment remain widespread. In particular, youth employment is lower than in the West African Economic and Monetary Union (Table 1.1). The region is unlikely to meet the Millennium Development Goals by 2015 (see Table 1.5). The overriding challenge for the CEMAC, therefore, is to seize the opportunity provided by oil wealth to increase non-oil growth substantially and achieve a significant and durable reduction in poverty. Ensuring productive public investment, improving the business climate to strengthen competitiveness and stimulate private investment, and increasing labor market flexibility can make meaningful contributions to this effort. More fundamentally, high rates of poverty should be addressed by improving the quality of education and health spending and generating more employment opportunities in the non-oil sector. To lay the foundation for the CEMAC’s economic and social development, the CEMAC authorities need to address four key macroeconomic challenges: (i) ensuring fiscal and external sustainability, (ii) fostering stronger non-oil growth, (iii) reforming the financial sector, and (iv) promoting trade and regional integration.

Ensuring Fiscal Sustainability and External Competitiveness The non-oil primary deficit (NOPD) of the CEMAC area has widened in recent years, driven by public investment (Figure 1.2 and Table 1.2). The NOPD is projected to move closer to the sustainable level of about 5 percent of non-oil

©International Monetary Fund. Not for Redistribution Terms of Trade Change Real GDP Growth 4 30 8

25 CEMAC 7 20

15 SSA 6 10 SSA CEMAC

5 5

0 Percent Percent 2005 2006 2007 2008 2009 2010 -5 4

-10 WAEMU WAEMU 3 -15

-20 2 -25 2005 2006 2007 2008 2009 2010

Oil-Producing Countries, Real GDP Growth CEMAC: Real per Capita GDP Growth (Average 2005–10) 8 6 7 GCC countries1 5 6

5 4

4 3 Percent 3 Other SSA Percent oil exporters 2 2 CEMAC 1 1

0 0 2005 2006 2007 2008 2009 2010 n n C Chad Gabo African Congo, CEMA EquatorialGuinea CEMAC Oil Production Cameroo Republic Central Republic of 420 120 Oil output (left scale) UNDP Human Development Index, 2010 Petroleum spot price (right scale) (Index 0 = low, 1 = high) 400 100 0.7

) 380 80 0.6 s 0.5 360 60 0.4 US dollar Index

(Million barrels 340 40 0.3 0.2 320 20 0.1 300 0 0 2005 2006 2007 2008 2009 2010 n s Chad Gabon Africa CEMAC Cameroo African Rep.

Equatorial Guinea Central Congo, Republic of Sub-Saharan Middle-income countries Least developed countrie Figure 1.1 CEMAC: Growth and Development Challenges, 2005–10 Sources: IMF, World Economic Outlook database; and IMF staff estimates. Note: GCC 5 Gulf Cooperation Council; SSA 5 sub-Saharan Africa; WAEMU 5 West African Economic and Monetary Union. 1GCC countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.

Table 1.1 Social Indicators Life Expectancy Index Education Index Youth Employment1 (%) CEMAC 0.51 0.41 47 WAEMU 0.54 0.28 56 SSA 0.55 0.50 49

Sources: United Nations Development Programme and the World Bank. Note: CEMAC 5 Central African Economic and Monetary Community; SSA 5 sub-Saharan Africa; WAEMU 5 West African Economic and Monetary Union. 1Employment to population ratio, ages 15–24, total (%).

©International Monetary Fund. Not for Redistribution Akitoby and Coorey 5

-5

Percent of Non-Oil GDP -15

-25 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Non-oil primary balance Long-run sustainable norm NOPD (PIH) Public investment Figure 1.2 Fiscal Sustainability Sources: Staff estimates and projections. Note: NOPD 5 non-oil primary deficit; PIH 5 permanent income hypothesis.

GDP, derived from the permanent income hypothesis (PIH) model,1 as investment tapers off in the medium term. However, for assessing the fiscal stance of a natural resources producer investing in domestic physical capital, the PIH model is only relevant as a long-term benchmark, because it does not distinguish between capital and current expenditure and does not take into account development needs.2 For fiscal sustainability and optimality, public investment decisions need to be based on ensuring a rate

Table 1.2 Infrastructure Costs Cost Indicator CEMAC SSA Other Developing Countries Power tariffs 0.20 0.23 0.08 (US$ per kilowatt-hour) Port container handling charges 210 210 115 (US$ per TEU) Road freight tariffs 0.13 0.09 0.03 (US$ per ton-kilometer) Mobile telephony 15.1 11.8 9.9 (US$ per basket per month)

Source: World Bank Africa Infrastructure Country Diagnostic, 2008. Note: TEU 5 Twenty-foot equivalent unit. Figures represent midpoint of range across regions.

1The sustainable NOPD is based on IMF staff estimates and projections. For the analytics of the PIH model, see Chapter 5. 2See Chapter 5, and Collier and others, 2010.

©International Monetary Fund. Not for Redistribution 6 The CEMAC’s Macroeconomic Challenges

230 170 210 160 150 190 140 CEMAC WAEMU CEMAC WAEMU 170 130 150 120 130 110 100 110

Index, 2005=100 90 90 80 70 70 1990 1995 2000 2005 2010 1990 1995 2000 2005 2010 Figure 1.3 Exchange Rate Developments, 1990–2010 Sources: IMF World Economic Outlook database; and IMF African Department database. Note: CEMAC 5 Central African Economic and Monetary Community; WAEMU 5 West African Economic and Monetary Union.

of return at least equal to the rate on financial assets after allowing for differences in the risk profiles of the two types of investment. The government’s physical assets should yield, in risk-adjusted terms, at least the long-term real interest rate of investing in international financial assets (say, 2–3 percent) or an equivalent flow of social benefits to warrant consideration. The quality of investment, therefore, is critical. The risk that the governments may not realize adequate returns in the form of higher tax revenue or social benefits is significant in the CEMAC countries, because of poor governance and weak planning, implementation, monitoring, and maintenance of public investment projects (see “Accelerating Non-Oil Growth” below). The fiscal position has important implications for external competitiveness. Spending of oil revenue has led to the appreciation of the real effective exchange rate (REER) in the context of a fixed exchange rate regime (Figure 1.3 and Box 1.1 on inflation), thus eroding the competitiveness of the noncommodity sectors. In itself, the REER appreciation may not be a serious concern if public investment produces an adequate rate of return and boosts productivity in noncommodity sectors. However, given the poor rates of return on past public investment in the CEMAC countries, the REER appreciation has likely constrained noncommodity growth and hurt employment.

Policy and Reform Considerations The PIH model is not optimal for capital-scarce developing countries like the members of the CEMAC (see Chapter 5). Given their large investment needs in economic and social infrastructure, focus must be placed on the quality and efficiency of public investment. To this end, public investment needs to be embedded in a realistic multiyear investment plan and the related annual budgets cast within a medium-term macroeconomic framework consistent with fiscal and external sustainability. Moreover, public investment plans and execution should be scrutinized to ensure that they yield, in risk-adjusted terms, a real return at least equal to the long-term real interest rate on financial assets.

©International Monetary Fund. Not for Redistribution Akitoby and Coorey 7

Box 1.1

Inflation in the CEMAC Area One of the benefits of the monetary union and fixed exchange regime has been the generally low and stable inflation in the region, despite supply shocks and unbalanced fiscal positions. Caceres, Poplawski-Ribeiro, and Tartari (2011) use a data set including country-specific energy and food commodity indices to investigate inflation dynamics in four Central African Economic and Monetary Community (CEMAC) member countries (Cameroon, the Central African Republic, Gabon, and the Democratic Republic of Congo) and in the CEMAC-4 region as a whole.1 The objective was to analyze the impact of commodity prices on domestic inflation and to disentangle the dynamics and interactions between noncore (food and energy) and core (all items in the consumer price index basket excluding food and energy) components of inflation. The analysis suggests that the impact of commodity price shocks on inflation is significant. In most CEMAC countries, the largest effect of global food and fuel price movements occurs after four or five quarters in noncore inflation and then decays substantially over time. Second-round effects are significant only in Cameroon and to a lesser extent in the Republic of Congo. In Cameroon, the effects of a 1 percent increase in energy and food prices on core inflation are estimated to pass through and reach a peak at 0.32 percent after 10 quarters and at 0.14 percent after 14 quarters, respectively.

CEMAC: Core and Noncore CPI Inflation, 1996–2010

Core CPI Inflation (year over year) 20 CEMAC-4 Cameroon Central African Republic Republic of Congo

15 Gabon

5 Percentage change

-5

-10 1996 1998 2000 2002 2004 2006 2008 2010

Noncore CPI Inflation (year over year)

40 CEMAC-4 Cameroon 35 Central African Republic Republic of Congo 30 Gabon 25 20 15 10 Percentage change 5 0 -5 -10 1996 1998 2000 2002 2004 2006 2008 2010

Source: Cacere, Poplawski-Ribeiro, and Tartari, 2011. Note: CPI 5 consumer price index. 1Equatorial Guinea and Chad are excluded from the analysis because of a lack of data on consumer price index components.

©International Monetary Fund. Not for Redistribution 8 The CEMAC’s Macroeconomic Challenges

CEMAC WAEMU SSA oil exporters 14 12 10 8

Percent 6 4 2 2007 2008 2009 2010 Figure 1.4 Non-Oil GDP Growth Sources: IMF World Economic Outlook database; and IMF African Department database. Note: CEMAC 5 Central African Economic and Monetary Community; SSA 5 sub-Saharan Africa; WAEMU 5 West African Economic and Monetary Union.

Accelerating Non-Oil Growth Growth in the CEMAC’s non-oil sectors has been disappointing (Figure 1.4). Although the community has outperformed the West African Economic and Monetary Union, it has lagged behind sub-Saharan Africa (SSA) oil exporters. Non-oil growth’s downward trend has also led to fewer employment opportunities. Available evidence suggests that the CEMAC’s non-oil sector is constrained by inadequate infrastructure services (see Chapter 4). Costs associated with the use of infrastructure are very high because of insufficient and low-quality infrastructure and regulatory hurdles (Table 1.3). To accelerate non-oil growth, the oil- producing CEMAC countries have embarked on ambitious investment programs. However, given weak administrative capacity, rapid scaling up of investment has a high likelihood of compromising spending quality. The study in Chapter 3 suggests that in the past public investment has had low returns and little impact on economic growth in the region. A poor business environment and low-quality health and education services have also constrained growth. According to the World Bank’s 2011 Doing Business Indicators, the CEMAC’s average ranking is lower than the SSA average (172 compared with 137 out of 183 countries). The CEMAC countries ranked very low, with Chad and the Central African Republic having the lowest rankings

Table 1.3 CEMAC: Selected Partners' Trade Shares (Percent of total trade) Trade Partner 1995 2005 20101 European Union 49.0 31.5 32.2 United States 20.9 26.9 23.6 BRIC 2.8 17.3 21.2 China 2.1 14.7 16.4 India 0.2 0.9 3.0 Intra-CEMAC 2.4 1.1 1.2 Sources: IMF Direction of Trade Statistics; and IMF staff estimates. Note: BRIC 5 Brazil, Russia, India, and China 1Estimates.

©International Monetary Fund. Not for Redistribution Akitoby and Coorey 9 in the world, closely followed by the Republic of Congo.3 Areas in which member countries fared worst include starting a business, paying taxes, enforcing contracts, and trading across borders. Coupled with this unfriendly business environment, poor quality of health and education services has kept labor productivity low and explains the limited progress in raising human development indicators. Policy and Reform Considerations The following reforms appear critical to sustaining non-oil growth: • Refocusing public investment on key infrastructure that will help relieve major supply bottlenecks (e.g., electricity, trade-enabling roads, dams, ports). The authorities may want to seek technical assistance to strengthen the appraisal, selection, and monitoring of investment projects and the budgeting of operation and maintenance costs. Over the medium term, governments could explore the option of public-private partnerships to complement public investment, while containing the risk to public finances.4 • Pursuing reforms in the health and education sectors that would enhance labor productivity, generate employment, and alleviate poverty over time. • Improving the business climate by strengthening governance and streamlining administrative procedures. Priority should be given to removing regulatory hurdles that thwart the infrastructure sector and to addressing areas in which the CEMAC countries fared worst in the World Bank’s Doing Business survey. The authorities have taken a number of steps to ensure that public investment is prioritized and refocused on growth-enabling infrastructure. At the regional level, the Regional Economic Program5 is expected to make important contributions in this regard. At the national level, a number of countries have taken specific measures to strengthen public investment management. Notably, in Gabon, a national agency for major public works was set up and entrusted with the planning, management, and implementation of large public infrastructure projects. The U.S. engineering corporation Bechtel is providing the agency with technical expertise. A service agreement was also signed with the World Bank to enhance national capacities in this area. Similarly, in Cameroon, the authorities plan to establish a central unit for project feasibility studies and evaluation. Plans to improve the business environment have been in place in most CEMAC countries since 2007. The plans focus on streamlining administrative procedures and improving public-private dialogue. For instance, the Congolese authorities’ plan to improve the business climate includes improving public-private dialogue, streamlining the tax system, and ensuring investment security. In

3A similar conclusion can be drawn from other competitiveness indicators, such as the World Economic Forum’s Global Competitiveness Index and the World Bank’s Country Policy and Institutional Assessment rating for business regulatory environment. 4Lessons from an IMF cross-country pilot study can be drawn from Akitoby and others (2007). 5At the summit in Bangui in 2010, the heads of state of CEMAC countries agreed on a joint program called the Regional Economic Program. The objective of this program is to ensure that by 2025 the CEMAC becomes an integrated and emerging economic space.

©International Monetary Fund. Not for Redistribution 10 The CEMAC’s Macroeconomic Challenges

Equatorial Guinea, work is under way to establish a one-stop shop for investment. In Cameroon, time to start a business has been reduced from 12 to 3 days, procedures for paying taxes simplified, and delays in the provision of construction permits shortened.

Reforming the Financial Sector Reforming the financial sector is a priority for the CEMAC region from both stability and development points of view. Though some progress has been achieved, more remains to be done to safeguard financial stability and deepen the sector. Strengthening Financial Sector Stability and Supervision Some progress has been made in strengthening the financial stability framework since the 2006 Financial Sector Assessment Program6 report. The authorities have (i) harmonized and increased the minimum capital requirements for banks (Coopération Financière en Afrique Centrale franc [CFAF] 10 billion or US$20 million), (ii) strengthened corporate governance, and (iii) established a Financial Stability Committee to analyze financial sector vulnerabilities and advise on appropriate policy responses. The regional banking supervisor (the Central African Banking Commission, or COBAC) also introduced in 2009 a deposit insurance scheme, with the oversight of the Bank of Central African States and banking sector representatives. The insurance deposit, funded by fees from financial institutions, will insure deposits up to CFAF 5 million per account. However, the principal prudential regulations (on solvency, large exposures, connected lending) are out of line with international best practices and poorly enforced, thus encouraging excessive credit concentration and exposing the banking system to credit risk. To mitigate these risks, the prudential regulation could be amended in the following key areas: (i) solvency ratios and risk diversification; (ii) lending to shareholders, partners, executives, and directors; (iii) market risks; and (iv) consolidated supervision. Effective supervision is also hampered by an acute shortage of qualified staff at the COBAC. To safeguard the COBAC’s ability to foster financial stability, its staffing needs to be increased significantly and qualified commissioners appointed to the COBAC. With regard to the banking resolution framework, the protracted failure to resolve the financial problems of a systemically important regional banking group points to two weaknesses: an inadequate legal framework for dealing with banking crises, and shortcomings in cooperation among regional finance ministries. The longer the current situation in financially weak banks persists, the higher could become the costs to governments, to the credibility of supervisory institutions, and to reputational risks for the CEMAC’s financial sector. It would be important, therefore, to closely monitor liquidity conditions to avoid any suspension of payments by these banks, require full loss absorption by previous shareholders, and

6The Financial Sector Assessment Program, established by the IMF and the World Bank in 1999, is a comprehensive and in-depth analysis of a country’s financial sector. In developing and emerging market countries, Financial Sector Assessment Programs are conducted jointly by the IMF and the World Bank.

©International Monetary Fund. Not for Redistribution Akitoby and Coorey 11

80 SSA 70 WAEMU 60

40 CEMAC Percent of broad money 30 2004 2005 2006 2007 2008 2009 Figure 1.5 Credit to the Nonfinancial Private Sector Source: IMF World Economic Outlook database. Note: CEMAC 5 Central African Economic and Monetary Community; SSA 5 sub-Saharan Africa; WAEMU 5 West African Economic and Monetary Union. pursue maximum recovery of loans owed by related parties to minimize the financial costs to governments. A new regulation on the resolution of banking crises, which is planned to go into effect in 2012, is expected to allow the authorities to intervene early to resolve banking crises, define clearly the scope of judicial review, and prohibit questionable shareholders from participating in a bank restructuring. Financial Sector Deepening Access to credit in the CEMAC region is among the lowest in sub-Saharan Africa. The penetration rate is low (about 3 percent of the total population), and credit to the private sector is well below the average for SSA (Figure 1.5). Structural factors that explain this situation include high operating costs because of low population density, lack of credit information, and a weak institutional and legal framework. Given the limited role of microfinance institutions, most small and medium enterprises find it difficult to obtain credit. Improving the institutional framework, therefore, is critical for financial deepening (Akitoby, 2010; see Figure 1.6). Specific measures taken and actions in progress to deepen the financial sector include regular publication of lending costs

Registering property SSA CEMAC WAEMU

Enforcing contracts Protecting investors Figure 1.6 Investment Climate Indicators Source: World Bank, 2010. Note: Lines farther from the center represent a better relative outcome. CEMAC 5 Central African Economic and Monetary Community; SSA 5 sub-Saharan Africa; WAEMU 5 West African Economic and Monetary Union.

©International Monetary Fund. Not for Redistribution 12 The CEMAC’s Macroeconomic Challenges

and related fees to promote banking transparency and competition, as well as consumer protection; creation of a regional deposit insurance fund to protect small savers; creation of credit bureaus (with World Bank technical assistance); and establishment of a credit rating agency and a central registry of corporate balance sheets to reduce information asymmetry in credit activities. Going forward, institutional reforms should focus on improving the operations of land and commercial registries, streamlining the procedures for recording and enforcing guarantees, and strengthening creditor rights enforcement by improving the governance of the relevant courts. The recently established regional government securities market will also help manage excess liquidity and mobilize and better distribute savings. Microfinance could play a key role in broadening small and medium enterprise and private household access to financial services. Microfinance institutions have flourished since the introduction of the 2002 general regulation governing their activities. Transparency and consistent data reporting remain a challenge for microfinance institutions in the region, although progress has been made since the introduction in 2010 of a chart of accounts developed especially for them and the establishment of an information technology system to collect financial data automatically. Nevertheless, improvement of data reporting and supervision of microfinance institutions remain important challenges for the COBAC. Promoting Trade and Regional Integration The CEMAC trade patterns have shifted toward emerging markets. Notably, trade with Brazil, Russia, India, and China has grown significantly, displacing the European Union. Meanwhile, at less than 1½ percent of total trade, intraregional trade is the lowest among regional trade groups in SSA (Table 1.4 and Figure 1.7). Trade barriers remain a significant obstacle. The common external tariff is higher than in most other African regions (Table 1.5), yet some member states still impose additional surcharges and other fees. Regarding nontariff barriers, cross-country differences persist in import classification and valuation, exemp- tions rules, and implementation of rules of origin. Moreover, border procedures

Table 1.4 Common External Tariffs: Selected Regions (Percent) Indicator CEMAC WAEMU EAC COMESA Average 16 9 12 12 Maximum 30 20 25 25 Minimum 5 0 0 0 Number of rates 4 4 3 3

Source: Compiled from regional communities’ websites. Note: COMESA 5 Common Market for Eastern and Southern Africa; EAC 5 East African Community.

©International Monetary Fund. Not for Redistribution Akitoby and Coorey 13

20 18 1995 16 2010 14 12 10 8 6

Percentage of total trade 4 2 0 CEMAC WAEMU ECOWAS EAC COMESA SADC Figure 1.7 Selected Regions: Intraregional Trade Sources: IMF Direction of Trade Statistics and staff estimates. Note: CEMAC = Central African Economic and Monetary Community; COMESA = Common Market for Eastern and Southern Africa; EAC = East African Community; ECOWAS = Economic Community of West African States; SADC = Southern African Development Community; WAEMU = West African Economic and Monetary Union.

Table 1.5 CEMAC: Millenium Development Goals, 1990 and 2009 1990 2009 Goals and Measures CEMAC SSA CEMAC SSA Goal 1: Eradicate extreme poverty and hunger Employment to population ratio, 151, total (%) 64 64 65 64 Employment to population ratio, ages 15–24, total (%) 49 50 47 49 GDP per person employed (constant 1990 PPP $) . . . 2,493 ...... Income share held by lowest 20% ...... Malnutrition prevalence, weight for age (% of children under 5) 18 ...... 25 Poverty gap at $1.25 a day (PPP) (%) ...... Poverty headcount ratio at $1.25 a day (PPP) (% of population) . . . 58 . . . 51 Vulnerable employment, total (% of total employment) ...... Goal 2: Achieve universal primary education Literacy rate, youth female (% of females ages 15–24) 35 58 74 67 Literacy rate, youth male (% of males ages 15–24) 63 73 82 77 Persistence to last grade of primary, total (% of cohort) ...... 58 68 Primary completion rate, total (% of relevant age group) 44 51 53 64 Total enrollment, primary (% net) 65 . . . 77 76 Goal 3: Promote gender equality and empower women Proportion of seats held by women in national parliaments (%) 12 . . . 11 18 Ratio of female to male primary enrollment (%) 77 84 83 91 Ratio of female to male secondary enrollment (%) 52 76 61 79 Ratio of female to male tertiary enrollment (%) 18 . . . 43 68 Share of women employed in the nonagricultural sector (% of ...... total nonagricultural employment)

(continued)

©International Monetary Fund. Not for Redistribution 14 The CEMAC’s Macroeconomic Challenges

Table 1.5 CEMAC: Millenium Development Goals, 1990 and 2009 (continued) 1990 2009 Goals and Measures CEMAC SSA CEMAC SSA Goal 4: Reduce child mortality Immunization, measles (% of children ages 12–23 months) 68 57 57 68 Mortality rate, infant (per 1,000 live births) 97 109 92 81 Mortality rate, under-5 (per 1,000) 153 181 146 130 Goal 5: Improve maternal health Adolescent fertility rate (births per 1,000 women ages 15–19) ...... 119 116 Births attended by skilled health staff (% of total) 58 . . . 44 44 Contraceptive prevalence (% of women ages 15–49) . . . 15 . . . 21 Maternal mortality ratio (modeled estimate, per 100,000 763 870 628 650 live births) Pregnant women receiving prenatal care (%) ...... 69 71 Unmet need for contraception (% of married women ...... 13 24 ages 15–49) Goal 6: Combat HIV/AIDS, malaria, and other diseases Children with fever receiving antimalarial drugs (% of children ...... 54 34 under age 5 with fever) Condom use, population ages 15–24, female (%) ...... 14 19 Condom use, population ages 15–24, male (%) ...... 35 36 Incidence of tuberculosis (per 100,000 people) 126 180 298 350 Prevalence of HIV, female (% ages 15–24) ...... 4 3 Prevalence of HIV, male (% ages 15–24) ...... 1 1 Prevalence of HIV, total (% of population ages 15–49) 2 2 5 5 Tuberculosis case detection rate (all forms) 51 45 60 46 Goal 7: Ensure environmental sustainability CO2 emissions (kg per PPP $ of GDP) 0 1 0 0 CO2 emissions (metric tons per capita) 1 1 1 1 Forest area (% of land area) 53 29 49 26 Improved sanitation facilities (% of population with access) 21 27 31 31 Improved water source (% of population with access) 49 49 70 60 Marine protected areas (% of total surface area) ...... 2 0 Terrestrial protected areas (% of total surface area) ...... 14 12 Goal 8: Develop a global partnership for development Net ODA received per capita (current US$) 94 35 58 49 Debt service (PPG and IMF only, % of exports, excluding . . . 2 workers’ remittances) Internet users (per 100 people) 0 0 3 7 Mobile cellular subscriptions (per 100 people) 0 0 41 33 Telephone lines (per 100 people) 1 1 1 2 Other Fertility rate, total (births per woman) 6 6 5 5 GNI per capita, Atlas method (current US$) 665 577 1,635 1,126 GNI, Atlas method (current US$) (billions) 20 297 58 946 Gross capital formation (% of GDP) 15 18 26 21 Life expectancy at birth, total (years) 54 50 52 52 Literacy rate, adult total (% of people ages 15 and above) 34 53 69 62 Population, total (billions) . . . 1 . . . 1 Trade (% of GDP) 67 52 88 62

Source: World Bank, World Development Indicators database. Note: CEMAC 5 Central African Economic and Monetary Community; CO2 5 Carbon dioxide; GNI 5 Gross national income; HIV 5 Human immunodeficiency virus; ODA 5 Official development assistance; PPG 5 Public and publicly guaranteed; PPP 5 Purchasing power parity ; SSA = sub-Saharan Africa.

©International Monetary Fund. Not for Redistribution Akitoby and Coorey 15

Appendix Table 1.1 CEMAC: Selected Economic and Financial Indicators, 2005–10 Indicator 2005 2006 2007 2008 2009 2010 (Annual percent change) National income and prices GDP at constant prices 5.2 2.6 5.9 4.3 2.5 5.0 Oil GDP 21.0 20.9 22.7 20.9 26.0 21.4 Non-oil GDP 7.9 8.1 12.2 6.2 6.8 6.2 Consumer prices (average)1 2.7 4.2 1.1 5.7 4.8 2.5 Consumer prices (end of period)1 1.9 2.4 3.0 7.1 3.0 2.9 Nominal effective exchange rate1 20.9 20.2 3.1 3.2 20.1 24.1 Real effective exchange rate1 0.2 1.1 0.9 5.1 3.1 24.2 (Annual changes in percent of beginning- of-period broad money) Money and credit Net foreign assets 39.4 37.2 35.6 30.3 213.3 210.6 Net domestic assets 229.9 235.5 223.3 212.3 18.1 11.5 Broad money 16.8 19.1 13.9 17.8 6.6 23.2 (Percent of GDP, unless otherwise indicated) Gross national savings 16.1 18.4 17.3 17.9 10.3 9.0 Gross domestic investment 21.7 22.0 23.1 21.2 27.4 27.9 Of which public 4.4 7.1 7.9 8.7 13.6 12.0 Government financial operations Total revenue, excluding grants 24.2 28.3 27.8 30.5 26.0 25.6 Government expenditure 17.0 18.0 19.8 20.8 27.5 24.9 Primary basic fiscal balance2 12.3 14.4 9.7 11.7 1.1 3.2 Basic fiscal balance3 5.9 9.3 7.4 8.8 23.4 21.1 Overall fiscal balance, excluding grants 9.1 11.9 8.0 9.7 21.7 0.5 Non-oil overall fiscal balance, excluding 211.3 214.0 218.1 223.3 226.2 225.6 grants (percent of Non-oil GDP) Overall fiscal balance, including grants 9.8 22.1 8.8 10.2 20.6 1.3 External sector Exports of goods and nonfactor services 54.3 57.1 56.0 57.7 46.5 52.3 Imports of goods and nonfactor services 34.3 35.5 35.0 35.2 42.4 45.7 Balance on goods and nonfactor services 20.4 22.7 21.4 22.2 4.6 6.9 Current account, including grants 2.9 6.3 5.5 7.4 26.0 27.2 External public debt 40.2 26.5 25.1 16.2 17.1 12.7 Gross official reserves (end of period) In millions of U.S. dollars 5,143.9 8,888.6 11,937 15,662 14,354 13,658 In months of imports of goods and services 3.3 4.9 5.2 6.9 5.2 4.4 In percent of broad money 77.4 111.3 120.3 125.1 113.4 91.9 Memorandum items: Nominal GDP (billions of CFA francs) 24,676 27,507 29,559 35,326 30,231 35,985 CFA francs per U.S. dollar, average 527.5 522.9 479.3 447.8 472.2 495.3 Oil prices (in US$ per barrel) 53.4 64.3 71.1 97.0 61.8 79.0

Sources: IMF, World Economic Outlook database; and IMF staff estimates and projections. 1Using as weights the shares of member countries in CEMAC's GDP in purchasing power parity US$. 2Excluding grants and foreign-financed investment and interest payments. 3Excluding grants and foreign-financed investment.

©International Monetary Fund. Not for Redistribution 16 The CEMAC’s Macroeconomic Challenges

are cumbersome, and lack of coordination among customs administrations sometimes gives rise to double taxation of goods going to the hinterland. In addition, the lack of capacity and resources at the CEMAC Commission hampers its ability to enforce trade reforms and community rules. Notably, the community integration tax—the commission’s main source of financing—is not transferred in full by the member countries. Concerted action is needed to lower barriers to internal and external trade. The priorities are to expedite the intended lowering of the common external tariff, enforce the rules of origin, coordinate customs administrations, and strengthen the capacity of the CEMAC Commission, especially through the timely transfer of community integration tax revenue.

References Akitoby, Bernardin, 2010, “Seven Questions on How Institutions Shape Financial Markets,” IMF Research Bulletin, Vol. 11, No. 3, pp. 6–8. Akitoby, Bernardin, Richard Hemming, and Gerd Schwartz, 2007, “Public Investment and Public-Private Partnerships,” IMF Economic Issues, Vol. 40 (Washington: International Monetary Fund). Caceres, Carlos, M. Poplawski-Ribeiro, and D. Tartari, 2011, “Inflation Dynamics in the CEMAC Region,” IMF Working Paper 11/232 (Washington: International Monetary Fund). Collier, Paul, Rick van der Ploeg, Michael Spence, and Anthony J. Venables, 2010, “Managing Resource Revenues in Developing Countries,” IMF Staff Papers, Vol. 57, No. 1, pp. 84–118. World Bank, 2008, “Africa Infrastructure Country Diagnostic” (Washington). ———, 2010, Doing Business 2011: Making a Difference for Entrepreneurs (Washington).

©International Monetary Fund. Not for Redistribution Chapter 2

Improving Surveillance Across the CEMAC Region

Robert York, Plamen Iossifov, Noriaki Kinoshita, Misa Takebe, and Zaijin Zhan

This chapter considers the design of the fiscal criteria for surveillance in the Central African Economic and Monetary Community (CEMAC) with a view to ensuring they are consistent with internal and external sustainability.1 Sustainability is important within a monetary union because fiscal policy is the primary instrument through which national governments can influence macroeconomic performance. This chapter comments on the way in which surveillance might be improved by broadening the region’s current convergence criteria through alternative fiscal indicators and perhaps reserve coverage targets. As it stands, the CEMAC Commission’s focus on a narrow set of convergence criteria could give a misleading assessment of macroeconomic policy developments from both the short- and long-term perspectives.2 The chapter starts with an overview of the CEMAC structure in the first section. The second section assesses fiscal performance based on an alternative set of indicators that could be used by the CEMAC Commission to provide better insights into policy developments and to sharpen surveillance. The importance of external viability, which is critical to safeguarding the fixed exchange rate regime, is discussed in the third section, along with how better monitoring of fiscal and foreign reserves developments could help in this regard. The final section summarizes the results and offers policy implications.

Background and Features The CEMAC is a customs and monetary union of Cameroon, the Central African Republic, Chad, the Republic of Congo (Congo), Equatorial Guinea, and Gabon.

1This is a shortened version of IMF Working Paper 09/260 published in November 2009. A draft of that paper was presented in a seminar at the CEMAC’s regional central bank in Yaoundé, Cameroon, in September 2009. The authors would like to acknowledge the helpful advice and comments from Sharmini Coorey, John Wakeman-Linn, Tidiane Kinda, Oscar Melhado, and Marcos Poplawski-Ribeiro on that draft; and Paolo Mauro, Mauricio Villafuerte, and Li Zeng on this version. The authors are grateful to Anne Grant for editorial assistance. 2The CEMAC Commission is the body responsible for multilateral monitoring and the surveillance system, as well as for the quality and harmonization of the statistics of the member states.

©International Monetary Fund. Not for Redistribution 18 Improving Surveillance Across the CEMAC Region

The union was established in 1994 as part of a long process of economic integration in Central Africa, which is still in progress. The CEMAC’s objectives are to create a common market based on the free movement of goods and services, capital, and labor; and to harmonize business laws and coordinate economic policies. CEMAC members use a common currency, the Coopération Financière en Afrique Centrale (CFA) franc (CFAF), which is pegged to the euro at CFAF 656 per euro. The CFAF is issued by the regional central bank (the Bank of Central African States, or BEAC).

Monetary Policy The objective of monetary policy in the CEMAC is to guarantee the stability of the CFAF. The BEAC is entrusted with issuing the currency, formulating and conducting monetary and exchange rate policies, pooling and managing foreign exchange reserves (supported by a requirement that all export receipts be surrendered to the central bank), and keeping the region’s payment systems functioning well. Monetary policy is formulated by a committee that also manages the pooled foreign exchange reserves. Under the 1972 Convention on Monetary Cooperation between BEAC member states and France, France guarantees the convertibility of the CFAF at a given parity vis-à-vis the French franc and, since 1999, the euro. The parity rate can be changed after mutual consultation. In practice, CFAF convertibility is ensured through an operations account at the French Treasury with an unlimited over- draft, through which the BEAC effectuates most of its international payments. The BEAC is obligated to place in this account up to 50 percent of its foreign assets, net of the counterpart in foreign assets of government deposits of more than one year with the BEAC (i.e., Funds for Future Generations, which are remunerated accounts held in the BEAC) and the BEAC reserve position at the IMF. Capital mobility is, in principle, free within the CEMAC and between the CEMAC and France, but in practice it is limited by administrative hurdles. Given the overriding objective of exchange rate stability, the BEAC has adopted two monetary targets: low inflation and maintenance of an adequate foreign currency cover of the monetary base. For the region as a whole, the floor on net international reserves (NIR) coverage of the monetary base is set at 20 percent. If the floor is breached for three consecutive months, emergency measures are triggered (BEAC Statutes, Article 11). The BEAC also strives to keep the annual inflation rate below 3 percent. The instruments the BEAC uses to implement its monetary policy comprise country-specific ceilings on BEAC government credits, quantitative targets on BEAC refinancing of commercial banks, and required reserve ratios. The BEAC statutes limit (but do not prohibit) inflationary monetary financing of fiscal deficits of CEMAC members.3 In addition, the Monetary Policy Committee sets country-specific required reserve ratios and quarterly targets on BEAC refinancing of

3In June 2009, the Monetary Policy Committee decided to freeze the ceilings on statutory advances at 20 percent of CEMAC members’ 2008 domestic ordinary fungible fiscal revenue and to decrease them by 20 percent every year during 2010–15. Outstanding statutory advances in excess of the slid- ing ceilings must be repaid within 12 months.

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 19 commercial banks, to maintain the NIR coverage of base money in each CEMAC member within a desired range (between 75 and 100 percent). The consistency of the monetary policy instruments with BEAC monetary targets is ensured by a monetary programming exercise. However, because of excess liquidity in the banking system, existing instruments have not been effective in limiting money growth. The BEAC has thus been forced to rely, in part, on changes in the interest rates of its lending and deposit facilities to influence monetary outcomes. The continued use of country-specific monetary instruments reflects the reality that the product and factor markets of CEMAC members are not well integrated (Masson and Patillo, 2005).

Fiscal Policy Fiscal policies and public debt management are prerogatives of national governments. All six CEMAC members are exporters of nonrenewable resources (oil and diamonds) and primary commodities (logs and timber), and are at different stages of development and depletion of their resource endowments. The budgets of the oil exporters—Cameroon, Chad, Congo, Equatorial Guinea, and Gabon—are heavily influenced by oil revenue, which has characteristics similar to foreign grants, in that it should be considered transitory in formulating government policies for both the short and long terms. The countries’ budget balances swing widely with the volatility in world oil (and commodity and mineral) prices, which creates challenges for the smooth execution and planning of the budget. Several consequences follow from this: large swings in fiscal policy tend to be destabilizing, fiscal policies across CEMAC tend to have a procyclical bias, and focusing on the fiscal balance gives a misleading view of the fiscal stance. As a result of the stickiness of government spending, downturns in world oil prices have in the past also resulted in excessive government indebtedness to foreign investors, domestic banks, and suppliers. Moreover, government spending financed by oil revenue is inherently unsustainable in the long run because nonrenewable natural resources are exhaustible. The budget of the Central African Republic exhibits similar dynamics, with diamonds and external grants assuming the role of oil.

Policy Coordination and Surveillance The need for fiscal and monetary policy coordination in the CEMAC arises from the possibility of monetary financing of fiscal deficits and the impact of fiscal policies on the region’s competitiveness. From a theoretical point of view, the findings of the optimum currency area literature highlight the need for fiscal rules for monetary union members when fiscal policies follow political cycles and are not subject to the discipline imposed by sound debt markets (Tavlas, 1993; and McKinnon, 2004). Moreover, under the fixed exchange rate regime of a common currency, the impact of expansionary fiscal policies on domestic prices is a concern because of the potential for overvaluation of the real effective exchange rate and, over the long run, risks to the peg itself. Recognizing the need to coordinate fiscal and monetary policy, in 1994 CEMAC members adopted a regional surveillance framework. The overriding objective of surveillance, which is conducted by the CEMAC Commission, is to

©International Monetary Fund. Not for Redistribution 20 Improving Surveillance Across the CEMAC Region

prevent the occurrence of excessive fiscal deficits. A budget deficit is deemed excessive if it—particularly its financing—is incompatible with the objectives of monetary policy, such as the NIR coverage of base money (BEAC Statutes, Article 55). In 2001, the CEMAC refined the framework by adopting quantitative convergence criteria, and members were to comply with most of the criteria by end-2007. (The inflation criterion entered into force immediately; see Box 2.1.) The four main convergence criteria are complemented by several secondary criteria, as listed in Box 2.1, that aim to better capture policy efforts toward convergence by removing the effect of exogenous factors. Countries not in compliance with the four main criteria are required to adopt three-year adjustment programs to achieve convergence. However, this requirement has not been enforced in practice, and there are no sanctions for noncompliance. The adoption in 2008 of a new supplementary criterion on the basic non-oil fiscal balance was an important step in improving regional surveillance. Targeting a measure of fiscal deficits that abstracts from volatile and temporary oil revenue could improve the sustainability of fiscal policies and the CFAF peg. Such a measure should ideally exclude from its definition net interest payments (which are exogenous to current fiscal policy), and its target should be country-specific.

Box 2.1

Central African Economic and Monetary Community (CEMAC) Convergence Criteria The four main convergence criteria adopted by the CEMAC in 2001 are as follows: • Basic fiscal balance as a share of nominal GDP $ 0 percent. The basic fiscal balance is the difference between total revenue net of grants and total expenditure net of foreign-financed capital spending. In the 2008 evaluation of progress toward convergence, the CEMAC Commission used two supplementary criteria: (i) basic structural fiscal balance as a share of nominal GDP $ 0 percent—derived from the main criterion by replacing actual oil revenue with the three-year moving average; and (ii) the basic non-oil fiscal balance (as a share of non-oil GDP) $ 0. • Average annual inflation # 3 percent. This criterion is complemented by the adjusted indicator of the average annual underlying inflation of # 3 percent, which is obtained by stripping the overall consumer price index (CPI) of its most volatile component, the food subindex. • Stock of domestic and external debt as a share of nominal GDP # 70 percent. • Nonaccumulation of domestic and external payment arrears. In the 2008 evaluation of progress made toward convergence, the CEMAC Commission used the following secondary surveillance criteria, compliance with which is not obligatory: • Ratio of net international reserves to monetary base $ 20 percent. • Primary fiscal balance as share of nominal GDP $ 0 percent. • Non-oil fiscal revenue as share of nominal GDP $ 17 percent. • Ratio between the change in the public wage bill and the change in revenue # 1 percent. • Current account balance net of grants as share of nominal GDP $ 0 percent.

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 21

Improving the Measures of Fiscal Surveillance A government’s fiscal policy reflects a mix of objectives, among them control of aggregate demand, stabilization of public debt, and improvement of economic efficiency. Fiscal policy affects these objectives differently and to assess its impact a range of fiscal indicators is essential. Any single indicator—or criterion—is unlikely to comprehensively describe the impact of policy on the relevant objective. As noted by Blanchard (1990), the assessment of several aspects of fiscal policy would benefit from indicators that could provide insights into sustainability, the impact on aggregate demand, and microeconomic efficiency. Given these different facets of fiscal policy, there must be a trade-off in the selection of appropriate fiscal indicators between economic arguments on the one hand and ease of estimation and understanding on the other. In establishing criteria against which fiscal policy indicators could be judged, a few guiding principles must be kept in mind, such as the simplest possible formulation, positive rather than normative rules, comparable definitions and concepts across countries, and as few projections as feasible. This section considers a range of fiscal indicators, as well as the existing convergence criteria, with a view to clarifying the depiction of fiscal developments in the CEMAC region, and thereby improving fiscal policy surveillance and analysis. Attention is restricted to the indicators monitoring changes in fiscal policy and fiscal sustainability, the two areas emphasized by the CEMAC convergence criteria. The analysis first tries to interpret recent fiscal developments in the context of CEMAC’s convergence criteria, which proves difficult when world oil prices are relatively high. It then considers the usefulness of measures of the fiscal stance and the fiscal impulse in assessing policy changes and of two measures that could help shed light on sustainability. The range of fiscal indicators has been narrowed to those considered below, bearing in mind the principles that characterize a good indicator and the questions at hand.

CEMAC Convergence Criteria It has long been recognized that CEMAC’s convergence criteria may not provide an appropriate framework for fiscal policy surveillance, although the adoption of the non-oil basic fiscal balance as an additional criterion is a step in the right direction. The reason seems straightforward: with five of the six CEMAC members being oil producers, volatility in world oil prices and production could easily mask changes in fiscal policy. In the recent environment of oil-related surpluses, the traditional fiscal convergence criteria (basic fiscal balance, as defined in Box 2.1) and the complementary adjustment criteria (basic structural fiscal balance and, for oil producers the non-oil basic fiscal balance) could be giving a misleading signal of the “true” fiscal stance. For example, a temporary increase in oil-related revenue can lead to an expansionary fiscal policy that would not raise any alarms from the regional surveillance standpoint, if the increase in spending is smaller than the increase in revenue, even if this increased spending is not

©International Monetary Fund. Not for Redistribution 22 Improving Surveillance Across the CEMAC Region

sustainable. Although the introduction of the non-oil basic fiscal balance as an adjustment criterion offers some improvement, the target ($ 0) must take into account country-specific considerations about long-term fiscal sustainability, and the factors that influence it, to be relevant and effective. The difficulty in assessing CEMAC countries’ fiscal policy based on the existing convergence criteria has become increasingly evident with wide swings in world oil prices since 2004. The weakness in world prices in the latter part of the 1990s and the run-up in prices since early in the first decade of the 2000s had a profound, but perhaps predictable, impact on the fiscal position of all CEMAC countries, including the Central African Republic, which does not produce oil. Table 2.1 shows that the fiscal convergence criteria were missed by all or a majority of countries in 1998–2000, but only the Central African Republic, which did not directly benefit from the recent oil price hikes, has experienced a deficit since 2004 (when Chad joined the ranks of oil producers). Compared with the basic fiscal balance criteria, the overperformance was substantial, ranging from a basic fiscal surplus of 2.8 percent of GDP for Congo to 1.5 percent of GDP for Cameroon in 2008. Moreover, the fiscal surpluses as defined by the convergence criteria are misleading because (i) they masked very

Table 2.1 CEMAC: Fiscal Convergence Criteria, 1998–2008 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Basic Fiscal Balance1 (percent of nominal GDP)  0 Cameroon 22.4 21.0 2.0 3.3 0.8 1.1 0.0 3.5 5.4 3.9 1.5 Central African 28.7 28.6 26.5 24.1 24.2 24.4 25.2 28.2 24.0 22.5 23.0 Republic Chad 20.4 22.0 23.1 22.4 23.2 23.4 20.2 1.1 3.8 4.3 5.0 Congo, Republic of 219.9 25.8 1.5 6.4 0.5 1.0 4.6 15.9 17.1 11.1 26.8 Equatorial Guinea 27.7 20.2 22.5 14.4 16.9 11.8 12.3 20.6 23.5 17.8 15.3 Gabon 21.3 4.3 13.9 7.7 6.8 10.8 8.0 9.6 10.2 9.4 12.2 Supplementary Criterion I: Basic Structural Fiscal Balance2 (percent of nominal GDP) $ 0 Cameroon 21.6 22.7 20.1 3.7 1.0 1.4 0.2 2.7 3.5 3.3 0.4 Central African 29.4 29.6 26.8 24.4 25.7 22.6 24.2 28.6 25.4 23.9 24.0 Republic Chad 20.4 22.0 23.1 22.4 23.2 23.4 22.1 21.3 22.2 21.4 20.2 Congo, Republic of 213.1 28.5 26.1 4.5 2.2 0.8 1.4 4.6 4.6 11.0 17.0 Equatorial Guinea 214.7 23.5 28.6 4.5 11.2 8.5 3.5 8.2 12.5 13.3 8.1 Gabon 16.0 10.5 5.9 11.5 16.2 13.2 11.3 26.9 28.4 29.5 28.1 Supplementary Criterion II: Non-Oil Basic Fiscal Balance (percent of non-oil GDP) $ 0 Cameroon 24.7 26.3 25.2 21.6 24.3 23.1 24.1 21.6 21.6 22.7 27.1 Central African ...... Republic Chad 20.4 22.0 23.1 22.4 23.3 23.9 25.1 26.7 215.8 222.7 229.0 Congo, Republic of 250.3 253.2 254.7 233.6 239.5 239.4 239.1 244.2 266.1 262.9 253.3 Equatorial Guinea 273.5 252.6 285.1 235.6 224.1 247.7 268.5 263.9 266.1 261.4 275.7 Gabon 228.1 213.9 216.8 224.3 218.5 29.9 215.4 221.3 220.8 215.8 217.9

Sources: Country authorities; and authors’ estimates and projections. Note: . . . 5 Not applicable. The grey area indicates a period in which the criteria were not met. 1Defined as the difference between total revenue (less grants) and total expenditure (less foreign-financed capital outlays). 2Defined as the difference between total revenue (less grants), with current oil-revenue replaced by its three-year moving average and total expenditure (less foreign-financed outlays). For the Central African Republic, the three-year moving average is based on total revenue for comparison.

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 23 expansionary fiscal policy in the short term and (ii) they did not address the medium- term sustainability issues in oil-producing countries (both discussed below). A similar picture emerges for the basic structural fiscal balance (the first adjustment criterion), defined similarly to the basic fiscal balance but replacing current oil revenue with its three-year moving average. Except for Chad and the Central African Republic, all countries met this criterion because of high world oil prices over a relatively long period. In contrast, none of the oil producers met the second adjustment criterion of the non-oil basic fiscal balance during the period 1998–2008.

Fiscal Stance and Fiscal Impulse For improving fiscal surveillance in the CEMAC context, this analysis considers measures of the fiscal stance and the fiscal impulse that the IMF has used for its multilateral surveillance for the past several decades. The rationale for these measures is that the budget balance may be a misleading indicator of the thrust of policy because it is not clear whether changes in the actual balance are the cause or the result of economic activity. Ideally, an indicator would help distinguish between certain cyclical factors that may have a temporary effect on the budget balance and the effects of changes in the fiscal position due to policy or structural changes that may have a more lasting impact. Reflecting this need, the fiscal stance and fiscal impulse indicators attempt to measure the total stimulus to aggregate demand arising from fiscal policy from whatever source, whether discretionary or otherwise, during a given period (Heller, Haas, and Mansur, 1986).4 The indicators capture any change in the actual budget balance that is not transitory in a cyclical sense. Conceptually, the fiscal stance is the deviation of the budget balance from a “cyclically neutral budget balance.” The cyclically neutral budget balance is derived by (i) choosing a reference year in which actual and potential output are judged to be relatively similar; and (ii) projecting revenue and expenditure in the current year based on the assumption of unitary elasticities of revenue and expenditure with regard to actual and potential GDP, so as to account for the contribution to the fiscal stimulus of discretionary actions and the automatic stabilizers. The fiscal impulse defined here is simply the change in the fiscal stance from the previous year, which reflects the change in the government budget balance resulting only from changes in government expenditure and tax policies. The fiscal impulse indicator is useful for at least two purposes: monitoring the performance of fiscal authorities and making international comparisons of fiscal policy changes (Schinasi and Lutz, 1991). Because interest rates are not generally under the direct control of fiscal authorities, this analysis has been refined to focus on the primary fiscal balance; consequently, budgetary changes attributable to movements in debt payments are not viewed as discretionary or as imparting a fiscal thrust. For comparability between countries, this analysis has calculated the fiscal stance and fiscal impulse measures based on a

4Further details on the methodology, construction, and criticisms of the IMF’s fiscal impulse measure can be found in Chand (1992) and Schinasi and Lutz (1991). A different formulation of the fiscal impulse focuses on separating endogenous and exogenous elements of the budget balance, with a view to measuring discretionary changes in fiscal policy, compared with its thrust. This second formulation is used, for example, by the Organization for Economic Cooperation and Development.

©International Monetary Fund. Not for Redistribution 24 Improving Surveillance Across the CEMAC Region

common base year (2001) and estimated potential output using a Hodrick-Prescott filter with historical data and projections for the period 196522014 (IMF, 2009). These assumptions could, of course, be refined to reflect country-specific factors and more sophisticated modeling strategies (in particular, for potential output), although a parsimonious approach is sufficient to shed light on the issues of interest here. The measure of the fiscal stance suggests that the general thrust of fiscal policies in three of the six CEMAC member countries was expansionary from 2000 through 2008 (Table 2.2). This is a somewhat different message than provided by the overall fiscal balance (the region’s main fiscal indicator) alone, which shows fiscal surpluses

Table 2.2 Comparison of CEMAC Fiscal Indicators, 2000–08 (percent of GDP) 2000 2001 2002 2003 2004 2005 2006 2007 2008 Cameroon Basic fiscal balance 2.0 3.3 0.8 1.1 0.0 3.5 5.4 3.9 1.5 Primary balance 5.8 6.3 3.5 3.4 2.0 5.0 6.3 4.4 1.8 Primary fiscal stance 0.4 0.0 2.8 2.9 4.3 1.1 20.2 1.6 4.2 Primary fiscal impulse 22.2 20.4 2.8 0.1 1.4 23.2 21.4 1.9 2.6 Central African Republic Basic fiscal balance 26.5 24.1 24.2 24.4 25.2 28.2 24.0 22.5 23.0 Primary balance 24.8 22.7 22.6 23.2 24.0 27.3 23.1 21.4 21.1 Primary fiscal stance 2.2 0.0 20.3 20.9 20.2 3.1 20.9 22.6 23.7 Primary fiscal impulse 22.3 22.2 20.3 20.6 0.7 3.4 24.1 21.6 21.1 Chad Basic fiscal balance 23.1 22.4 23.2 23.4 20.2 1.1 3.8 4.3 5.0 Primary balance 22.0 21.6 22.3 22.8 0.2 1.4 4.3 4.7 5.3 Primary fiscal stance 0.1 0.0 0.7 1.7 0.4 20.8 24.0 24.8 25.7 Primary fiscal impulse 0.2 20.1 0.7 1.0 21.3 21.1 23.2 20.8 20.9 Congo, Republic of Basic fiscal balance 1.5 6.4 0.5 1.0 4.6 15.9 17.1 11.1 26.8 Primary balance 8.4 6.8 1.2 6.8 9.8 20.8 21.5 13.9 29.9 Primary fiscal stance 21.7 0.0 5.8 20.5 23.7 213.9 214.3 28.1 224.0 Primary fiscal impulse 21.5 1.7 5.8 26.3 23.2 210.2 20.3 6.1 215.9 Equatorial Guinea Basic fiscal balance 22.5 14.4 16.9 11.8 12.3 20.6 23.5 17.8 15.3 Primary balance 22.1 14.9 17.2 11.9 12.3 20.7 23.5 17.9 15.3 Primary fiscal stance 13.3 0.0 22.5 2.2 3.9 24.8 28.6 21.6 1.4 Primary fiscal impulse 1.5 213.3 22.5 4.7 1.7 28.7 23.9 7.0 3.0 Gabon Basic fiscal balance 13.9 7.7 6.8 10.8 8.0 9.6 10.2 9.4 12.2 Primary balance 19.8 16.5 11.2 14.8 12.0 12.4 12.5 11.5 14.0 Primary fiscal stance 23.5 0.0 5.1 1.7 4.4 4.2 4.0 5.6 3.1 Primary fiscal impulse 29.1 3.5 5.1 23.4 2.8 20.2 20.3 1.6 22.5 CEMAC Basic fiscal balance 4.8 3.8 2.0 3.2 2.8 5.7 7.5 4.9 6.9 Primary balance 9.1 7.3 4.4 5.8 5.1 7.5 9.0 5.9 7.9 Primary fiscal stance 22.3 0.0 2.8 1.3 2.6 0.2 21.6 1.7 20.2 Primary fiscal impulse 24.1 2.3 2.8 21.5 1.3 22.4 21.8 3.2 21.9

Sources: Country authorities; and authors’ estimates and projections. Note: CEMAC = Central African Economic and Monetary Community. The basic fiscal balance is defined according to the convergence criteria; primary balance is equal to the sum of basic fiscal balance and interest payments. The primary fiscal stance and primary fiscal impulse are described in detail in the text.

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 25 in all oil-producing countries. Measured by the fiscal stance, fiscal policy in the Central African Republic and more recently in Chad and Congo has been contractionary. This probably reflects the Central African Republic’s difficult financial environment and small resource envelope; for Chad and Congo, increased oil production widened primary surpluses. For all three, the point is further stressed by their contractionary (negative) fiscal impulse through most of the latter part of the period. The fiscal stance indicator suggests that the CEMAC region as a whole had a roughly neutral fiscal balance in 2008 after adjustments for cyclical factors, with a negative fiscal impulse indicating some policy tightening since 2007. It could be argued, however, that the apparent fiscal tightening in CEMAC oil-producing countries was misleading and largely caused by booming oil revenue (see below).

Fiscal Stance and Fiscal Impulse, Excluding Oil Revenue Following Barnett and Ossowski (2003), this analysis suggests that oil-producing CEMAC member countries should put more surveillance emphasis on the non- oil primary balance for a number of reasons: (i) in the management of oil resources, oil wealth defined by the discounted present value of future oil revenue is the key variable of interest, so fiscal proceeds from oil should be viewed as financing rather than income; (ii) the overall fiscal balance and the primary fiscal balance (including oil) are affected by oil price volatility, which is outside the control of the fiscal authorities, and movements in these indicators from changes in oil revenue do not directly affect domestic demand; (iii) it provides a measure of fiscal vulnerability and sustainability; and (iv) it is a better measure of the fiscal impulse consistent with medium-term sustainability. The measure of the fiscal stance excluding oil revenue presents an even more expansionary picture (Table 2.3). When oil revenue is stripped from the calculation, the thrust of fiscal policies in all of the oil producers seems strongly expansionary during 2005–08 (except for Gabon), including in Chad and Congo, whose fiscal stances were misjudged to be contractionary when oil revenue was included (see the preceding section). Consistent with the assessment for individual countries, the CEMAC members as a group have pursued expansionary fiscal policies since 2000, and the degree of expansion steadily increased in the last five years of the period. Consequently, relying on the convergence criteria (basic fiscal balance), or fiscal stance and fiscal impulse (including oil revenue), alone could provide a misleading signal about the direction of fiscal policies. When world oil prices peaked in 2008, only Congo started to reverse its fiscal stance as indicated by the negative fiscal impulse in Table 2.3. The measure of the non-oil fiscal impulse also demonstrates the procyclical nature of fiscal policies across most of the CEMAC countries. The estimated fiscal impulses are shown in Figure 2.1, along with the growth of non-oil real GDP. This juxtaposition is revealing; in many cases, the fiscal impulse moves more or less in line with the GDP growth rate. Although the fiscal stance and fiscal impulse are quantitatively easy to calcu- late, they are not free from criticism. Some authors question the justification for an indicator that is not model based (see Blanchard, 1990; and Buiter, 1983) and ask why actual growth in government expenditure should be tested against

©International Monetary Fund. Not for Redistribution 26 Improving Surveillance Across the CEMAC Region

Table 2.3 Comparison of CEMAC Fiscal Indicators, 2000–08 (percent of non-oil GDP) 2000 2001 2002 2003 2004 2005 2006 2007 2008 Cameroon Non-oil basic fiscal balance 25.2 21.6 24.3 23.1 24.1 21.6 21.6 22.7 27.1 Non-oil primary balance 20.9 1.6 21.5 20.7 22.0 0.0 20.6 22.2 26.7 Non-oil primary fiscal stance 2.4 0.0 3.2 2.4 3.8 1.7 2.1 3.6 8.2 Non-oil primary fiscal impulse 20.8 22.4 3.2 20.7 1.4 22.2 0.4 1.6 4.6 Chad Non-oil basic fiscal balance 23.1 22.4 23.3 23.9 25.1 26.7 215.8 222.7 229.0 Non-oil primary balance 22.0 21.7 22.4 23.2 24.3 26.0 215.0 222.0 228.4 Non-oil primary fiscal stance 20.1 0.0 0.9 1.9 2.7 4.9 13.8 20.7 27.1 Non-oil primary fiscal impulse 0.5 0.1 0.9 0.9 0.8 2.2 8.9 6.9 6.3 Congo, Republic of Non-oil basic fiscal balance 254.7 233.6 239.5 239.4 239.1 244.2 266.1 262.9 253.3 Non-oil primary balance 234.6 232.8 238.0 227.8 227.1 230.5 252.0 255.7 243.7 Non-oil primary fiscal stance 22.6 0.0 7.0 23.2 24.3 21.2 20.2 24.1 11.7 Non-oil primary fiscal impulse 13.2 2.6 7.0 210.2 21.2 3.1 21.4 3.9 212.4 Equatorial Guinea Non-oil basic fiscal balance 285.1 235.6 224.1 247.7 268.5 263.9 266.1 261.4 275.7 Non-oil primary balance 283.1 233.2 223.0 247.3 268.2 263.7 266.0 261.3 275.6 Non-oil primary fiscal stance 40.2 0.0 212.3 6.3 29.8 26.2 33.6 40.1 55.5 Non-oil primary fiscal impulse 40.9 240.2 212.3 18.6 23.4 23.6 7.4 6.5 15.4 Gabon Non-oil basic fiscal balance 216.8 224.3 218.5 29.9 215.4 221.3 220.8 215.8 217.9 Non-oil primary balance 25.4 29.1 211.0 23.0 28.2 215.4 216.0 211.6 214.3 Non-oil primary fiscal stance 24.7 0.0 1.2 27.3 22.2 5.4 6.4 2.8 5.5 Non-oil primary fiscal impulse 2.6 4.7 1.2 28.6 5.1 7.6 1.1 23.6 2.7 CEMAC Non-oil basic fiscal balance 212.3 29.0 29.8 28.6 211.5 212.1 215.8 217.1 222.4 Non-oil primary balance 26.1 24.3 26.7 25.1 28.1 29.1 213.3 215.4 220.7 Non-oil primary fiscal stance 1.3 0.0 2.4 0.6 3.5 4.6 8.8 11.3 16.5 Non-oil primary fiscal impulse 1.7 21.3 2.4 21.8 3.0 1.1 4.1 2.5 5.3

Sources: Country authorities; and authors’ estimates and projections. Note: CEMAC 5 Central African Economic and Monetary Community. The non-oil basic fiscal balance is defined as the difference between total non-oil revenue (less grants) and total expenditure (less foreign-financed capital outlays); the non-oil primary balance is equal to the sum of non-oil basic fiscal balance and interest payments. The non-oil primary fiscal stance and non-oil primary fiscal impulse are described in detail in the text.

potential output while actual growth in revenue is tested against actual output. In response, some authors have tried to provide a theoretical or model-based foundation for the fiscal impulse measure and suggested other technical improvements (see, e.g., Heller, Haas, and Mansur, 1986; Schinasi and Lutz, 1991; and Chand, 1992).

Indicators of Sustainability The CEMAC’s surveillance should also monitor countries’ fiscal sustainability and have indicators that could answer questions like the following: Can a country continue with its current fiscal policy, or will it have to increase tax rates, decrease spending, or consider more drastic measures to decrease its debt burden?

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 27

Real non-oil GDP growth (percentage change) Non-oil primary fiscal impulse (in percent of non-oil GDP)

10 10 Cameroon Central African Republic

5 5

0 0

–5 –5

–10 –10 1995 1997 1999 2001 2003 2005 2007 1995 1997 1999 2001 2003 2005 2007

15 20 Chad Congo, Rep. of 15 10 10

5 5

0 0 –5 –5 –10

–10 –15 1995 1997 1999 2001 2003 2005 2007 1995 1997 1999 2001 2003 2005 2007

60 Equatorial Guinea 15 Gabon 50 10 40 5 30

20 0 10 –5 0 –10 –10

–20 –15 –30 –20 –40 –50 –25 1995 1997 1999 2001 2003 2005 2007 1995 1997 1999 2001 2003 2005 2007 Figure 2.1 CEMAC Non-oil Real GDP Growth and the Fiscal Impluse, 1995–2008 Sources: Country authorities; and authors’ calculations.

Gap-based measures Blanchard (1990) suggests a simple indicator of sustainability, the primary gap. The primary gap is defined here as the change in the primary fiscal deficit needed to stabilize the debt ratio at its current level, given the current fiscal policy stance. Regardless of whether the government has built in future policy tightening (if the tax gap is negative) or loosening (if it is positive), the primary gap signals the need for a change in current policy settings. As Blanchard notes, this indicator is somewhat primitive because it does not take into account predictable changes in economic circumstances and economic policies. It is a static and backward- looking indicator, with the narrow goal of stabilizing the current debt ratio, which itself may not be sustainable or optimal to start with. The application of this

©International Monetary Fund. Not for Redistribution 28 Improving Surveillance Across the CEMAC Region

indicator in the CEMAC region faces an additional problem in that it ignores the exhaustibility of oil reserves. Nonetheless, the primary gap indicator has the advantage of being easily understood, and its estimation does not rely on forecasts or other extensive information. The results of this estimate of the primary gap for the six CEMAC members are plotted against external debt in Figure 2.2. These estimates are based on external rather than public debt because comprehensive data on public debt were not available. If domestic debt is significant, this estimate of the primary gap would be biased downward. Except for the Central African Republic, the estimated primary gaps show that during the years since 1998, fiscal policies have generally moved toward sustainable

Cameroon Primary gap (left scale) Central African Primary gap (left scale) Republic External debt (right scale) External debt (right scale) 8 100 7 10 120 80 6 5 60 5 60 4 0 0 Percent Percent 3 40 -5 -60 2 Percentage of GDP Percentage of GDP 20 -10 -120 1

0 0 -15 -180 1998 2000 2002 2004 2006 2008 1998 2000 2002 2004 2006 2008

Chad Primary gap (left scale) Congo, Rep. Primary gap (left scale) External debt (right scale) of External debt (right scale) 40 320 15 160

120 10 30 240 80 5 40 20 160 0 0 Percent

Percent 10 80 -40 -5 Percentage of GDP

-80 Percentage of GDP 0 0 -10 -120

-15 -160 -10 -80 1998 2000 2002 2004 2006 2008 1998 2000 2002 2004 2006 2008

Equatorial Primary gap (left scale) Gabon Primary gap (left scale) Guinea External debt (right scale) External debt (right scale) 35 100 20 30 80 15 80 25 10 20 60 40 5 15 Percent 40 0 Percent 0 10

Percentage of GDP -5 20 -40 Percentage of GDP 5 -10 -80 0 0 -15 1998 2000 2002 2004 2006 2008 1998 2000 2002 2004 2006 2008 Figure 2.2 External Debt and Primary Gap, 1998–2008 Sources: Country authorities; and authors’ calculations.

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 29 positions (positive primary gaps)—a view that is at odds with the generally expansionary thrust of policy during most of this period (see section on “Fiscal Stance and Fiscal Impulse,” above). This result highlights the design weakness in the primary gap measure and the impact of the favorable economic environment during the period. Recall that the primary gap is affected by two elements: actual primary balance and the difference between real growth and the real interest rate. In the early part of the 2000s, the fiscal positions in CEMAC oil-producing countries measured by the primary balance were generally improving because of sharply rising world oil prices, and real GDP growth, boosted by oil production, generally exceeded the real interest rate (the assumed nominal interest rate is 6 percent). These two elements combine to suggest that the primary surpluses being observed should have been more than sufficient to stabilize the external-debt-to-GDP ratio.5 This situation is exceptional, and it demonstrates the dangers in relying on a single short-term static indicator of sustainability. Indeed, the rules-based measures paint a different picture of developments. Rules-based measures A number of studies focus on the non-oil primary balance as the relevant indicator of the influence that initial conditions and resource endowments in oil-producing countries have on long-term sustainability in several different models of fiscal rules. Using the approach of York and Zhan (2009), the present analysis considers three models for long-term fiscal sustainability: (i) a conservative bird-in-hand rule, in which government would turn its oil resources into financial assets and commit to spend each year only the projected return on those assets; (ii) a spend- thrift balanced-budget rule, in which the government would adopt a balanced budget over the relevant time horizon and use up each year’s (projected) oil revenue in the process; and (iii) a constant-expenditure rule, based on Freidman’s (1957) notion of the permanent-income hypothesis, in which the government would spend only the permanent (annual) income from its oil-generated wealth, thus ensuring sustainability by maintaining a constant real expenditure path beyond the lifetime of oil reserves.6 Compared with the other approaches, the constant-expenditure rule has much to recommend it. By treating oil wealth as the present discounted value of future oil revenue, this approach highlights the importance of long-term sustainability and the challenge for fiscal policy in deciding how to allocate government oil wealth across generations. The bird-in-hand rule is very conservative and is tantamount to assuming that there would be no future oil revenue; at the same time, a balanced-budget rule is like “going on a binge.” The key long-term assumptions and projections for estimating these rules- based measures include oil (and gas) reserves, world oil prices, real GDP growth, inflation, real interest rates, and population growth (Table 2.4).

5The decline in the external-debt-to-GDP ratio in many of the CEMAC countries also reflects various debt rescheduling and relief initiatives, in particular, from the enhanced Heavily Indebted Poor Countries Initiative. 6Under the constant-expenditure rule, the analysis also considers the case of maintaining constant real per capita expenditure to demonstrate the impact of treating current and future generations equally.

©International Monetary Fund. Not for Redistribution 30 Improving Surveillance Across the CEMAC Region

Table 2.4 CEMAC Long-Term Macroeconomic Assumptions for Applying Rules-Based Measures (Percent, unless otherwise noted) Non-oil sector real growth rate 4 Real interest rate 4 Population growth (annual) 2.5 Starting balance of oil funds as of end-2008 (US$) 0 World oil prices (US$ per barrel) 2009–141 61.53–84.75 2015–48 Real prices are constant at the 2014 level Discount to world oil prices 10 Consumer Price Inflation in advanced economies 2009–141 0.35–1.64 2015–48 1.64

Sources: : IMF World Economic Outlook; and authors’ assumptions. Note: CEMAC 5 Central African Economic and Monetary Community. 1Based on the October 2009 IMF World Economic Outlook assumptions.

Based on a set of homogeneous assumptions for all the countries, the estimate under the baseline yields the following7: • As a group, the fiscal stance of the CEMAC countries in 2008 was far from being sustainable into the future, except under the balanced-budget rule, which is a comparatively extreme position and would imply drastic fiscal adjustments down the road when oil reserves are depleted (Figure 2.3 and Table 2.5). • Achieving a sustainable non-oil primary deficit (NOPD) for most CEMAC countries would require sizable adjustments, even in the short run. Comparing each country’s actual NOPD for 2008 with estimated sustainable levels for 2009–13 reveals that under a relatively conservative fiscal rule of maintaining constant per capita real oil wealth over time, none of the CEMAC oil-producing countries, either individually or collectively, has a sustainable NOPD. Under the fiscal rule of maintaining constant real oil wealth over time, only Gabon achieves sustainability. Cameroon and Congo are close, but Chad and Equatorial Guinea continue to be relatively far away. Chad’s NOPD was 28½ percent of non-oil GDP for 2008, the estimated sustainable deficit would be 10 percent using a constant real wealth rule based on the permanent income hypothesis, and Equatorial Guinea’s deficit of greater than 75 percent of non-oil GDP is very far from even a generous interpretation of fiscal sustainability (i.e., the balanced-budget rule). • Under the two more conservative fiscal rules, constant real per capita oil wealth, in which a government would ensure that current and future generations share oil wealth equally, and the bird-in-hand rule, in which a government spends as if there were no future oil revenue, no CEMAC oil-producing country’s, fiscal position is sustainable, either individually or as a group.

7These results differ from those of IMF country teams, which rely on country-specific assumptions and policy considerations, and possibly use different approaches to long-term sustainability from the approach used here.

©International Monetary Fund. Not for Redistribution 11 0 100 Bird in hand Balanced budget 90 Constant expenditure (real oil wealth) 80 Constant expenditure (per capita real oil wealth) 2008 actual NOPD 70 60 50 40 30 20

Non-oil primary deficit (percent of GDP) 1 0 CEMAC Cameroon Gabon Chad Congo, Equatorial Rep. of Guinea Figure 2.3 Sustainability of the Non-Oil Primary Deficit under Different Fiscal Rules, 2009–13 Source: Authors’ calculations. Note: CEMAC 5 Central African Economic and Monetary Community, including the Central African Republic; NOPD 5 non-oil primary deficit.

Table 2.5 CEMAC Average Sustainable Non-oil Primary Deficit Under Different Fiscal Rules, 2009–48 (percent of Non-oil GDP) 2009–13 2014–18 2024–28 2029–48 Cameroon Bird in hand 0.2 0.7 0.9 0.6 Balanced budget 3.1 2.1 0.8 0.0 Constant real oil wealth at 2008 levels 1.3 1.1 0.7 0.5 Constant real per capita oil wealth at 2008 levels 0.5 0.5 0.4 0.3 Gabon Bird in hand 2.7 7.9 11.7 10.5 Balanced budget 35.6 26.1 13.8 4.9 Constant real oil wealth at 2008 levels 20.4 16.7 11.3 7.1 Constant real per capita oil wealth at 2008 levels 8.0 7.4 6.4 5.4 Chad Bird in hand 2.2 6.0 6.7 4.8 Balanced budget 28.4 15.2 4.3 0.5 Constant real oil wealth at 2008 levels 10.1 8.3 5.6 3.5 Constant real per capita oil wealth at 2008 levels 4.0 3.7 3.2 2.7 Congo, Rep. of Bird in hand 7.2 22.0 26.1 17.8 Balanced budget 100.8 63.0 15.6 0.5 Constant real oil wealth at 2008 levels 37.9 31.1 21.0 13.2 Constant real per capita oil wealth at 2008 levels 14.9 13.9 12.0 10.0 Equatorial Guinea Bird in hand 4.8 13.0 14.1 9.4 Balanced budget 62.7 32.3 4.3 0.4 Constant real oil wealth at 2008 levels 20.7 17.0 11.5 7.2 Constant real per capita oil wealth at 2008 levels 8.1 7.6 6.5 5.5 CEMAC Bird in hand 2.0 5.8 7.1 7.1 Balanced budget 26.9 16.5 9.2 5.2 Constant real oil wealth at 2008 levels 11.0 9.1 7.4 6.1 Constant real per capita oil wealth at 2008 levels 4.3 4.0 3.7 3.5

Source: Authors’ calculations. Note: CEMAC = Central African Economic and Monetary Community.

©International Monetary Fund. Not for Redistribution 32 Improving Surveillance Across the CEMAC Region

80 75 Low-2: 50% discount from the baseline 70 Low-1: 20% discount from the baseline 65 Baseline prices 60 High-1: 20% permium over baseline 55 High-2: 50% premium over baseline 50 2008 actual 45 40 35 30 25 20 15 10 Non-oil primary deficit (percent of GDP) 5 0 CEMAC Cameroon GabonChad Congo, Equatorial Rep. of Guinea Figure 2.4 CEMAC Sensitivity of the Sustainable Non-Oil Primary Deficit to Oil Prices Under a Permanent Income Hypothesis, 2009–13 Source: Authors’ calculations. Note: CEMAC 5 Central African Economic and Monetary Community. CEMAC includes the data for Central African Republic.

• The above results are mostly robust with respect to different assumptions about world oil prices (Figure 2.4), even though higher (lower) world oil price assumptions would increase (reduce) the sustainable levels of the NOPD. Even with very optimistic assumptions about oil prices, say, 50 percent higher than the IMF’s October 2009 World Economic Outlook baseline, the NOPD in Cameroon, Chad, and Equatorial Guinea, as well as the CEMAC region as a whole, in 2008 appears unsustainable. With higher oil prices, Congo would cross the sustainable threshold under the fiscal rule of constant oil wealth. York and Zhan (2009) also demonstrate that these results would not change significantly with different assumptions about real interest rates and the introduction of oil price uncertainty. They also show that the results are unlikely to be affected by different definitions of the level of oil reserves, although a significant expansion would increase the long-term deficit that is consistent with sustainability, other things being equal. Nonetheless, some caveats about the results must be recognized. Allowing for variation, and presumably positive feedback in the growth of the non-oil sector in response to public investment, could materially affect the estimates. To the extent that higher and front-loaded public investment (in health, education, and economic infrastructure) could increase the rate of non-oil sector growth, running an NOPD above the long-term sustainable estimate might be appropriate. This point is emphasized by Collier and others (2009) and by van der Ploeg (Chapter 5 of this volume), who argue that resource- rich developing countries should invest more of their resource rents early on, when such investment is expected to have a high rate of return.

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 33

Implications for Fiscal Surveillance The CEMAC convergence criterion in the fiscal area—nonnegative basic balance—does not provide an appropriate benchmark against which to assess fiscal policy in each member country and in the region as a whole. It suffers from at least two shortcomings. First, it fails to take into account the cyclical nature of each economy and would make the implementation of countercyclical fiscal policies difficult. Second, it fails to recognize that five of the six CEMAC countries are oil producers and that oil revenue should be treated as financing instead of income, and should therefore be isolated from the fiscal balance for the current period. To improve fiscal surveillance in the CEMAC region, this chapter proposes that the member countries focus more on the fiscal stance and the fiscal impulse, excluding oil revenue, for judging the short-term direction of fiscal policy, and rely on the non-oil primary balance for assessing medium- to long-term fiscal sustainability. The recent adoption of the adjustment criterion on the non-oil basic fiscal balance is a step forward but could be further refined.

External Stability Considerations and Regional Surveillance This section argues that in light of the fixed exchange rate, the convergence criteria could also be extended to considerations of external stability.

Considering Fiscal Policy Effects on External Balance When setting a target for the fiscal criterion, fiscal policy effects on the external balance should be taken into consideration. Member countries do not have the option of nominal exchange rate or monetary policy adjustments to mitigate the impact on the external balance. And only fiscal policy is available (along with structural policies, which have an impact only over a longer time frame) to ensure external stability. Considerable evidence—including a high correlation coefficient—suggests that the fiscal policy stance affects the external position of the CEMAC (Figure 2.5). This is not surprising given that both the fiscal balance and the external balance are dominated by oil revenue and oil exports. The correlation between the overall fiscal balance and the external current account balance is 0.62, but the correlation between the non-oil fiscal balance and the non-oil current account balance is only 0.30. Among the six CEMAC countries, the correlation between the fiscal and external balance is highest in Gabon (0.90) and nonexistent in the Central African Republic. However, the oil-producing countries with higher oil revenue do not necessarily show a higher correlation between fiscal and external balances. The Central African Republic, the sole non-oil economy, shows no correlation between fiscal and external balances: it appears that its fiscal stance has little or no influence on its external balance. The more important channel through which fiscal policy affects the external position is changes in government deposits. In the CEMAC, official foreign exchange reserves are directly affected by member governments’ decisions about

©International Monetary Fund. Not for Redistribution 34 Improving Surveillance Across the CEMAC Region

20 Overall fiscal balance External current account balance

Percent of GDP 0

–5 Correlation = 0.62

–10

–15 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Figure 2.5 Central African Economic and Monetary Community Overall Fiscal Balance and External Current Account Balance Sources: Country authorities; and authors’ estimates.

how much to save. This result is clearly indicated in the relation between the foreign assets of the BEAC and member government deposits with the regional central bank (Figure 2.6). Although it is not possible to specify exactly what proportion of government deposits are in foreign exchange, a significant amount of oil receipts are supposedly denominated in foreign currency.

8000 60

7000 Foreign assets (left scale) 50 Government deposits (left scale) 6000 Government deposits as a proportion of ) foreign assets (right scale) 40 5000

4000 30 Percent

A francs (billions 3000

CF 20

2000

10 1000

0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Figure 2.6 BEAC: Foreign Assets and Government Deposits, 1995–2008 Source: BEAC; and authors’ estimates. Note: BEAC 5 Bank of Central African States; CEMAC 5 Central African Economic and Monetary Community; CFA 5 Coopération Financière en Afrique Centrale.

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Fiscal Policy Response to External Shocks An appropriate fiscal policy response to a deterioration in the terms of trade could be to tighten if the goal is external stability and to loosen if the goal is to stabilize economic activity (and internal balance). In reality, Adedeji and Williams (2007) show that the terms of trade affect the primary fiscal balance in the same direction. In other words, the primary fiscal balance improves when the terms of trade are favorable and deteriorates when they are unfavorable (presumably reflecting the importance of primary commodities, especially oil revenue, across CEMAC countries). Such a fiscal policy reaction may be desirable for stabilizing economic activity in the face of external shocks, although it could complicate efforts to achieve external sustainability, particularly by magnifying the downside risks to the external balance. One way to mitigate the problem is to accumulate a sufficient buffer of foreign reserves when external conditions are favorable.

The Desirability of a Foreign Reserves Target The BEAC statutes require members to maintain net foreign assets of at least 20 percent of short-term liabilities. This requirement raises two potential problems. The first is whether the ratio of reserves to sight liabilities (the currency cover ratio) is appropriate for assessing external stability. The second is that because the reserve ratio is not a convergence criterion, it could suffer from the free rider problem. Reserve adequacy can be assessed in several different ways. Based on the size of terms-of-trade shocks and other factors, Deléchat and Martijn (2008) recommend that CEMAC members have a reserve coverage of four months of goods and nonfactor service imports. Relative to these norms, the reserve level for the CEMAC region as a whole may seem adequate, but there is a large disparity among member countries: the reserve coverage in the Central African Republic, Chad, and Gabon has been relatively low while that in Cameroon, Congo, and Equatorial Guinea has been increasing (Table 2.6). One view would be that focusing on CEMAC reserves as a whole is the right approach for encouraging efficient pooling of the countries’ reserves. According to this view, each member’s reserve position would not—on its own—affect the external stability of the CEMAC, highlighting the benefits of pooled reserves. However, this view could pose a “free rider” problem because of the disparities between member countries’ reserve holdings. The size of these holdings is important because (i) there is a significant opportunity cost and (ii) wide disparities could weaken the cohesiveness of the monetary union. Therefore, the CEMAC might consider establishing a minimum reserve level—preferably using import cover—as a convergence criterion. Each member’s efforts toward preserving the external sustainability of the union and protecting its fixed exchange rate regime would be recognized. The adoption of the reserve cover of base money as a secondary criterion in the 2008 convergence evaluation was a positive step.

©International Monetary Fund. Not for Redistribution 36 Improving Surveillance Across the CEMAC Region

Table 2.6 CEMAC: Currency Cover Ratio and Gross Official Reserves, 2000–08 2000 2001 2002 2003 2004 2005 2006 2007 2008 Currency Cover Ratio1 (percent) CEMAC 71 65 68 66 75 88 96 98 103 Cameroon 28 39 50 47 52 67 78 89 93 Central African Rep. 99 99 99 97 87 81 75 62 68 Chad 78 80 88 74 70 64 91 90 93 Congo, Rep. of 63 35 22 18 31 77 92 90 102 Equatorial Guinea 61 98 102 100 100 100 100 97 98 Gabon 59 18 38 45 62 78 91 86 101 Gross Official Reserves (months of next year’s projected imports of goods and services) CEMAC 1.9 1.4 1.7 1.6 2.3 3.4 4.7 5.0 8.0 Cameroon 1.1 1.4 2.4 2.0 2.3 2.3 3.0 4.5 5.8 Central African Rep. 8.0 6.9 7.4 6.7 6.3 5.4 4.2 2.4 3.5 Chad 1.6 0.7 1.6 0.9 1.0 0.9 2.1 2.8 4.0 Congo, Rep. of 1.8 0.5 0.2 0.2 0.5 2.3 4.8 4.7 10.2 Equatorial Guinea 0.2 0.7 0.5 1.0 3.2 7.9 9.7 7.8 12.0 Gabon 1.5 0.1 0.9 1.1 2.2 2.7 3.5 3.2 6.4

Source: BEAC; and authors’ estimates. Note: CEMAC 5 Central African Economic and Monetary Community. 1Gross operations account official reserves (percentage of base money).

Summary and Policy Implications The CEMAC is undertaking a long-term process of regional integration with the intention of creating a common market based on the free movement of goods and services, of capital and labor, and of harmonizing business laws and coordinating economic policies. This worthwhile initiative should yield the benefits generally realized from closer integration in the context of a monetary union with a fixed exchange rate. Progress in moving forward with closer ties, however, has been slow. With regard to regional surveillance, the CEMAC’s convergence criteria could be usefully expanded given that the criteria currently provide an incomplete picture of whether policies are consistent with preserving the external stability of the monetary union and the fixed exchange rate. The CEMAC’s surveillance agenda could be sharpened in a number of ways. A separate problem facing the CEMAC not addressed in this chapter is the poor enforcement of the current criteria. The new and adjustment indicators proposed here are not expected to resolve this issue, but by making surveillance criteria more effective and relevant—and transparent— they could help to improve the enforceability of these criteria going forward. The main fiscal convergence criterion for the CEMAC region—a nonnegative basic balance—does not provide a reliable benchmark against which to judge short-term changes in fiscal policy or long-term fiscal sustainability in member countries. This criterion could be strengthened in at least two ways. First, it could recognize member countries’ cyclical fiscal positions and how these positions might affect adherence to the convergence criterion. Second, it could recognize explicitly that the majority of CEMAC countries are oil producers and that income from exhaustible oil resources should be treated as financing instead of revenue, from the point of view of good resource-wealth management.

©International Monetary Fund. Not for Redistribution York, Iossifov, Kinoshita, Takebe, and Zhan 37

An optimizing resource planner would choose to smooth consumption over time to maximize welfare. Although the majority of the CEMAC countries met the convergence criterion for the basic fiscal balance and one of the two associated adjustment criteria with comfortable margins, indicators of fiscal stance and fiscal impulse suggest that fiscal policies in all CEMAC countries were strongly expansionary during 2005–08 if cyclical fluctuations and oil revenue are appropriately removed. In addition, from the perspective of long-term sustainability, the majority of member countries’ NOPDs are far higher than the sustainable level under various fiscal rules. Fiscal surveillance at both the regional and individual-country levels should not rely entirely on the current convergence criteria. Instead, fiscal indicators excluding oil revenue should receive central attention. In this regard, the CEMAC Commission’s introduction of an adjustment criterion for the non-oil basic fiscal balance is welcome. This measure could be complemented by taking into consideration other variables, such as the non-oil fiscal balance, non-oil primary balance, and to the extent that a judgment can be made about the economy’s cyclical position, measures such as the non-oil fiscal stance and the non-oil fiscal impulse. With five of the six countries being oil producers, long-term fiscal sustainability is also a concern, and it could be monitored through analysis based on fiscal rules. CEMAC’s surveillance agenda will also need to take into account the impact of fiscal policy on external stability, especially under the fixed exchange rate regime. Building sufficient reserve coverage is important, especially in periods of high world oil prices resulting in windfall oil revenue. The existing minimum requirement as a non-obligatory secondary criterion on the currency coverage ratio (20 percent) is likely to be inadequate; this indicator may not be appropriate for defining reserve adequacy in the face of the external shocks buffeting the region. One clear possibility for addressing this concern is to reexamine reserve adequacy based on the ongoing work at the BEAC and to consider a relevant convergence criterion. When setting a reserve target level, consideration could be given to creating space for the fiscal stance to respond to changes in external (as well as domestic) conditions. To address long-term external stability, the regional surveillance exercise could include structural aspects of fiscal policy so that the tax and spending system would support capital accumulation and productivity gains in productive sectors. Ultimately, the external viability of the monetary union and its fixed exchange rate depends on the strength of its fiscal policies and on structural reform to build vibrant and viable non-oil sectors in the member countries. Only in this way will the union generate sufficient foreign exchange to finance the imports needed to maintain moderate levels of growth and real income.

References Adedeji, O., and O. Williams, 2007, “Fiscal Reaction Functions in the CFA Zone: An Analytical Perspective,” IMF Working Paper 07/232 (Washington: International Monetary Fund). Barnett, S., and R. Ossowski, 2003, “Operational Aspects of Fiscal Policy in Oil-Producing Countries,” in Fiscal Policy Formulation and Implementation in Oil-Producing Countries, ed. by J. Davis, R. Ossowski, and A. Fedelino (Washington: International Monetary Fund), pp. 45–81.

©International Monetary Fund. Not for Redistribution 38 Improving Surveillance Across the CEMAC Region

Blanchard, O., 1990, “Suggestions for a New Set of Fiscal Indicators,” OECD Economics Department Working Paper No. 79 (Paris: Organization for Economic Cooperation and Development). Buiter, W., 1983, “Measurement of the Public Sector Deficit and its Implications for Policy Evaluation and Design,” IMF Staff Papers, Vol. 30, No. 2, pp. 306–49. Chand, S.,1992, “Fiscal Impulses and their Fiscal Impact,” IMF Working Paper 92/38 (Washington: International Monetary Fund). Collier, P., F. van der Ploeg, M. Spence, and A. Venables, 2009, “Managing Resource Revenues in Developing Economies,” OxCarre Research Paper 15 (Oxford: Centre for the Analysis of Resource Rich Economies). Deléchat, C., and J. Kees Martijn, 2008, “Reserve Adequacy in the CFA Franc Zone,” in The CFA Franc Zone—Common Currency, Uncommon Challenges, ed. by M. Gulde and H. Tsangarides (Washington: International Monetary Fund) pp. 90–119. Friedman, M., 1957, A Theory of the Consumption Function (Princeton, New Jersey: Princeton University Press). Heller, P., R. Haas, and A. Mansur, 1986, A Review of the Fiscal Impulse Measure, IMF Occasional Paper No. 44 (Washington: International Monetary Fund). International Monetary Fund, 2009, World Economic Outlook: Sustaining the Recovery (Washington). Masson, P., and C. Patillo, 2005, The Monetary Geography of Africa (Washington: Brookings Institution Press). McKinnon, R., 2004, “Optimum Currency Areas and Key Currencies: Mundell I versus Mundell II,” Journal of Common Market Studies, Vol. 42, No. 4, pp. 689–715. Schinasi, G., and M. Lutz, 1991, “Fiscal Impulse,” IMF Working Paper 91/91 (Washington: International Monetary Fund). Tavlas, G., 1993, “The ‘New’ Theory of Optimum Currency Areas,” World Economy, Vol. 16, No. 6, pp. 663–85. York, R., and Z. Zhan, 2009, “Fiscal Vulnerability and Sustainability in Oil-Producing Sub- Saharan African Countries,” IMF Working Paper 09/174 (Washington: International Monetary Fund).

©International Monetary Fund. Not for Redistribution CHAPTER 3

Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

Alexandra Tabova and Carol Baker

Non-oil growth in the Coopération Financière en Afrique Centrale (CFA) zone oil-exporting countries has been lackluster despite the great natural resource wealth with which these countries are endowed. This is perhaps unsurprising given that only a few resource-rich countries have succeeded in diversifying their economies (Coxhead, 2007; and Gelb and Grasmann, 2010). This oft-cited “resource curse” is frequently attributed to three main factors: Dutch disease stemming from real exchange rate (RER) appreciation; the high volatility of oil- and mineral-related revenue; and institutional weaknesses, particularly in governance and transparency. This chapter reviews the central determinants of non-oil growth in the oil- producing countries of the CFA zone and explores to what extent these countries differ from countries with comparable levels of development that do not depend on nonrenewable resources. This comparison is made by extending existing growth models to capture key features of CFA zone oil exporters—large development needs, institutional weakness, and market imperfections. By incorporating government spending and the efficiency of public goods,1 the analysis derives a tractable general equilibrium model of a small open economy with an oil- exporting sector and two non-oil productive sectors in which public investment financed by oil revenue is growth enhancing while institutional weakness and market imperfections lower growth. Estimation results using a panel of 36 low-income countries (LICs) and CFA zone oil exporters are broadly in line with the theoretical predictions.2 Although RER appreciation is found to have negatively affected growth in all countries during the period 1985–2008, what distinguishes the oil producers of the CFA zone is the failure of public and private investment to boost non-oil growth.

1The analysis follows Barro (1990) and Barro and Sala-i-Martin (2004). 2The group of LICs includes Bangladesh, Benin, Burkina Faso, Burundi, Cambodia, the Central African Republic, Comoros, Ethiopia, The Gambia, Ghana, Guinea, Guinea-Bissau, Haiti, Kenya, Lao People’s Democratic Republic, Madagascar, Malawi, Mali, Mauritania, Mozambique, Niger, Rwanda, Senegal, Sierra Leone, Tajikistan, Tanzania, Togo, Uganda, Uzbekistan, Vietnam, and Zambia. The group of CFA oil exporters includes Cameroon, Chad, Republic of Congo, Côte d’Ivoire, and Gabon.

©International Monetary Fund. Not for Redistribution 40 Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

CFA Zone Oil Exporters: Wealth and Development Needs Despite their natural resource wealth, the oil-exporting countries of the CFA zone have large development needs. This disparity has widened since 2000, with provision of social services and basic infrastructure lagging far behind burgeoning oil wealth. Poverty is endemic, and social indicators are well below those of countries at the same level of income, and at times exacerbated by border and internal conflicts, which may also partly explain the widening infrastructure gap relative to a group of select LICs. Moreover, non-oil growth—a prerequisite for sustained poverty reduction—has not kept pace with that of comparator countries. Although non-oil growth in CFA oil exporters has been only modestly lower than that of the net oil importers in the CFA zone, it has been significantly lower than in LICs with comparable levels of development, consistent with the more challenging business climate. See Figure 3.1.

Literature Review Given the size of oil wealth relative to their non-oil economies, the countries of the Central African Economic and Monetary Community (CEMAC) are natural candidates to suffer from the “resource curse” phenomenon. The literature has documented that oil discoveries and oil price spikes lead to higher government spending, RER appreciation, and a loss of competitiveness in the non-oil tradable sector (e.g., Gelb, 1988; Everhart and Duval-Hernández, 2001). For LICs, one of the largest challenges associated with the study of Dutch disease is determining how large the tradables sector would have been in the absence of the natural resources. Empirical evidence on the role of the exchange rate generally suggests that substantial exchange rate overvaluation has a strong negative impact on growth (Razin and Collins, 1999; Aguirre and Calderón, 2005; Prasad, Rajan, and Subramanian, 2006). Rodrik (2008) and Berg and Miao (2010) stress the sym- metric association of the RER with economic growth. The evidence both studies present shows that overvaluation of the exchange rate is bad for growth, while undervaluation is growth-enhancing. Although there is a consensus in the literature on the role the RER plays for economic growth, it can more accurately be described as a facilitating condition rather than a fundamental determinant (see Eichengreen, 2008, for a detailed discussion).3 Apart from the issue of exchange rate appreciation, for less-developed resource- rich countries, the study of the determinants of economic growth should take into account the structural problems present before the discovery of the natural resource and that persist long after the start of its exploitation. In this vein, a large body of

3The facilitating role of the exchange rate refers to the fact that keeping the exchange rate competitive and avoiding excess volatility facilitates the growth-enhancing potential of the fundamentals. Eichengreen (2008) provides a detailed discussion of the link between the RER and growth, as well as of the potential and limitations of policy interventions.

©International Monetary Fund. Not for Redistribution Tabova and Baker 41 3.0 LICs 2.5 clean) ry ters 2.0 xpor upt, 10 = ve r 1.5 A non-oil e CF ters 1.0 s of xpor oire ter x (0 = highly cor p. LICs 1988–93 2000–05 Chad Gabon xpor , Re Inde A oil e Cameroon CF Côte d'Iv torial Guinea Congo 0 5

30 20 10 25 15 Equa

A non-oil e Percent CF b. Share of roads that are paved d. Corruption perceptions index, 2010 180 170 LICs 160 150 rst = 183) ters wo 140 A non-oil xpor e CF 130 ters ©International Monetary Fund. Not for Redistribution Rank (best = 1 to 120 1994–2002 2003–08 growth xpor ter of oire p. LICs Chad Gabon xpor A oil e CFA Zone Countries and Select Indicators Countries and Development LICs: Non-Oil Zone Growth CFA , Re CF Cameroon

Côte d'Iv torial Guinea

6 5 4 3 2 0

(percent) (percent) Congo

verage annual growth annual verage A A non-oil e Equa CF a. Real non-oil GDP c. Ease of doing business rank, 2010 Figure 3.1 Figure International. Transparency Bank, 2009; and World IMF staff calculations; Sources: country. LIC 5 low-income Centrale; en Afrique Financière 5 Coopération CFA Note: 42 Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

literature has been devoted to the way in which the wider institutional framework and its quality affect the growth outcomes of investment in developing countries. Theoretical and empirical work in this area has traditionally focused on investment quality, with more recent work incorporating the impacts of institutional weakness and market inefficiency on growth (Barro, 1990; Barro and Sala-i-Martin, 2004; Rodrik, 2008; and Chakraborty and Dabla-Norris, 2009). Rodrik (2008) and Chakraborty and Dabla-Norris (2009) incorporate market inefficiencies and institutional weaknesses in standard growth models and stress their growth-inhibiting effects. For example, Chakraborty and Dabla-Norris (2009) show how inefficient and corrupt bureaucracies interact with the provision of public investment, thereby diminishing the quality of public capital and private agents’ incentives to invest. Rodrik’s (2008) growth model allows for the study of the impact of market imperfections and institutional quality on GDP growth by incorporating in a standard growth model an “effective” tax rate on private investment and earnings. The assumption is that private investors and producers can retain only a portion of their investment returns and the value of producing the goods. The theoretical literature on endogenous growth models has stressed the importance of the efficiency and quality of investment (total investment, or disaggregated into private and public investment) for its growth impact. Barro (1990) and Barro and Sala-i-Martin (2004) demonstrate how productive public investment raises long-term growth by driving up the returns to other factors of production. To address the role of public services (e.g., publicly financed infrastructure, enactment of property rights, rule of law, and investment in human development), government purchases of goods and services enter the non-oil production function as productive public goods and complements to the private productive inputs. It is this productive role that can create a positive link between oil resources and economic growth. There is broad consensus in the empirical literature of the positive impact of public investment on GDP growth. For example, Easterly and Rebelo (1993) show that general government investment is consistently positively correlated with both growth and private investment. More importantly, using sector-specific investment data, the study indicates that the share of public investment in transport and communications is robustly correlated with growth. Following this earlier study, a large number of empirical studies have investigated the link between investment (or more specifically, public investment) and economic growth. A comprehensive survey of the empirical literature by Straub (2008) focuses on infrastructure investment and concludes that two-thirds of empirical studies published in the period 1990–2007 find a positive and significant link between infrastructure and growth.4 Studies using data on public capital stocks find a significant positive effect of public capital on economic growth (e.g., see Calderon and Serven, 2008).

4Straub (2008) surveys 64 articles in refereed journals in the period 1990–2007. Although two-thirds of the empirical studies find a positive and significant association between infrastructure investment and growth, certain questions regarding policy implications (such as the optimal spending levels at different stages of development, and the impact of infrastructure investment on development gaps in different regions within countries or between urban and rural areas) have been more difficult to answer.

©International Monetary Fund. Not for Redistribution Tabova and Baker 43

The Model To identify the factors affecting non-oil GDP growth, the present analysis developed a tractable model that reflects the production structure of the CFA oil- producing countries. The model is a general equilibrium model of a small, open economy with an oil-exporting sector and two non-oil productive sectors: a tradable and a nontradable sector. Oil production is modeled as exogenous. The analysis derives a closed-form solution for the non-oil GDP growth rate. To capture the role of public goods and services in enhancing non-oil growth, the model in Rodrik (2008) is extended in two ways: first, productive government spending is incorporated following Barro and Sala-i-Martin (2004) and Barro (1990), and second, the efficiency of public goods is added. The government receives income from oil and purchases goods and services that enter the non-oil production function as productive public goods that are complements to private productive inputs. This productive role of public goods creates a positive link between oil resources and economic growth. The model also allows for the study of the impact of market imperfections on non-oil GDP growth. These factors are incorporated into the model by the introduction of an effective tax rate on private investment and non-oil earnings. Specifically, it is assumed that private investors and producers can retain only a portion of their investment returns.

Consumption Households maximize their expected lifetime utility with preferences for a single final good that is produced by the non-oil sector using tradable and nontradable inputs: ∞ t max  b log(ct), (3.1) t50 where ct is consumption and b is the discount rate. Households supply capital k to firms and make investment decisions. The budget constraint is

ct 1 kt 1 1 5 (rt 1 1 2 d) kt , (3.2) in which r is the return on capital and d is the depreciation rate. Maximizing (3.1) subject to (3.2) leads to the familiar intertemporal optimality condition:

_ct 1 1 5 b (rt 1 1 1 1 2 d). (3.3) ct

Production The final consumption good is produced in the non-oil sector using tradable (T) T N and nontradable (N) inputs (y t and y t , respectively), under a constant-returns-to- scale Cobb-Douglas production function:

T a N 12a yt 5 (yt ) (yt ) , (3.4)

©International Monetary Fund. Not for Redistribution 44 Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

in which a denotes the share of tradable inputs in the final consumption good. T N Tradable and nontradable inputs are produced using private capital kt and kt , and public goods st:

T 5 T   1 2  5    1 2  yt AT (kt ) ( st) AT T kt ( st) (3.5) and N N  1 2    1 2  yt 5 AN (kt ) (st) 5 AN (1 2 T) kt (st) , (3.6)

in which T is the share of total private capital allocated to the production of tradables,  is the private capital share in the production of both tradable and nontradable inputs, and AN and AT are the levels of technology. The efficiency of public spending is captured by the parameter . The inclusion of public goods st in the production function follows Barro (1990) and Barro and Sala-i-Martin (2004). Public goods are defined in the broad sense to include physical infrastructure (roads and highways), communications and water systems, property rights, law and order, and contributions to human capital development. These goods and services are assumed to be provided by the government without charge and are not subject to congestion effects. The productive share of government spending that enters the production function is measured by the quantity of government purchases of goods and services. Conceptually, as outlined in detail in Barro (1990), this is equivalent to assuming that the government does not do any production on its own and does not own capital; rather, it buys a flow of output that it makes available to private producers. For the private producers, these purchases constitute inputs available for the production of goods. The tradable and nontradable goods are produced competitively. Given that public goods financed solely by oil revenue are provided without charge, and private sector use of public goods does not reduce the stock of available public services (no congestion), optimization is achieved by choosing the level of private capital while holding st fixed. As can be seen in equations (3.5) and (3.6), public goods produce externalities in the production of both tradable and nontradable goods—the production function specification generates endogenous growth. Following Barro and Sala-i- Martin (2004), it is assumed that the government chooses a constant ratio of its s productive purchases to GDP: _ s . When _ t is constant, the marginal product of y yt capital is invariant to the stock of capital kt . The constant marginal product of 5 capital delivers a standard AK-type growth model in which the growth rates of ct , kt , and yt are equal. This common growth rate can be determined from the expres- sion of consumption growth.

5An AK model is the simplest form of endogenous growth model in which Y 5 AKaL1 2 a has a set equal to 1.

©International Monetary Fund. Not for Redistribution Tabova and Baker 45

Using the first order conditions for the two sectors and the fact that in equilibrium the marginal productivities across sectors are equal, the non-oil GDP growth rate can be expressed as follows:

1 2  _ _a (1_ 2 a)  a 2 a g 5 b   _s A A   (1 2  )(1 ) 1 1 2  . (3.7) t [ ( y ) T N T T ] As is apparent from equation (3.7), the non-oil growth rate depends positively on the share of public goods in total output that is used for productive _s purposes y and on the efficiency of public spending . The productive use of _s public goods is growth enhancing. Moreover, g is monotonically increasing in y , _s because a higher y shifts upward the marginal product of capital. Because households do not pay taxes, households respond to the higher marginal product of capital by choosing a higher growth rate for consumption.

Market Imperfections Next, the analysis takes into account the market imperfections prevalent in the CEMAC member countries. These imperfections are modeled following Rodrik (2008) by assuming that firms can only retain a share (1 2 f ) of the value of the goods they produce, and similarly, households can only retain a share (1 2 k) of the income from their capital investment in the firms. Then f and k can be interpreted as the effective tax rates that firms and households face, respectively. For the purposes of the model, it is not important to distinguish between different types of market and institutional weaknesses. ~ The effective marginal product of capital rt can now be derived as ~ rt 5 (1 2 k )(1 2 f ) rt . (3.8)

Equation (3.8) shows that market imperfections lower the marginal product of capital. As a result, the growth equation can be written as

1 2  _ _a (1_ 2 a) s  a 2 a ~ 5 b 2  2    _t    2  (1 ) gt (1 k ) (1 f ) AT AN T (1 T) . (3.9) [ ( yt ) ] It is clear from equation (3.9) that the introduction of market imperfections leads to lower non-oil growth.

The Real Effective Exchange Rate Although the exchange rate does not enter directly into the growth equations, it nevertheless plays an indirect role. The analysis closely follows Rodrik (2008) to emphasize the role of the exchange rate. The relative price of the tradable goods pT R 5 _ is the index of the RER in the model. pN First, the analysis investigates how the exchange rate affects the allocation of capital across the two sectors by exploring the investment incentives in the intermediate sectors that produce the tradable and nontradable inputs. Equating the

©International Monetary Fund. Not for Redistribution 46 Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

marginal products of capital in the tradable and nontradable sectors gives the following relationship:

  2 1 A _T 5 _ 1 _ N . (3.10) ( 1 2 T ) R AT Equation (3.10) shows a positive relationship between the share of capital allocated to the tradable goods sector T and the RER R. This is the supply-side relationship between the exchange rate and T. Second, the analysis explores how the exchange rate affects the demand for the tradable and nontradable inputs in the production of the final good. From the demand for the two inputs in the production of the final good, the following relation can be derived:   _T 5 _a _1 _AN 2 a . (3.11) ( 1 2 T ) ( 1 ) R AT Equation (3.11) shows the negative relationship between the share of capital allocated to the tradable goods sector T and the RER R; an increase in R makes tradable goods more expensive and therefore reduces the demand for capital in the tradable goods sector T. This is the demand-side relationship. Rodrik (2008) shows that in equilibrium, the return to capital and growth are maximized when T 5 a, that is, when the share of capital allocated to the tradable goods intermediate sector equals the final good output elasticity of the tradable input.

Empirical Investigation The previous section showed that the productive use of public resources and the efficiency of investment are key ingredients for non-oil growth, and the RER affects growth indirectly through the role it plays in the allocation of capital across sectors. The discussion that follows tests these theoretical predictions for the CFA oil-exporting countries and explores the extent to which these countries differ from countries with comparable levels of development that are not highly dependent on oil or mineral resources. A growth equation is estimated using a panel with country and time fixed effects:

n CFA oil git 5 a0 1 a1 ln Rit 1 a2 Xit 1 a3 D Xit 1 at 1 ai 1 uit , (3.12)

n in which git is real non-oil GDP growth and Xit is a vector of standard growth determinants such as initial income, investment share of output, share of government consumption in output, terms of trade, and a measure of openness to trade. The term DCFA oil is a dummy variable for the CFA oil exporters.6 The interaction

6The direct impact of market weaknesses on growth is not estimated because, as the theoretical model shows, these will manifest themselves through the effectiveness of investment in spurring growth.

©International Monetary Fund. Not for Redistribution Tabova and Baker 47

CFA oil term D Xit captures whether and how CFA oil exporters differ from the rest of the sample with regard to the way the standard growth determinants affect non- oil growth. The net impact of Xit on growth for the CFA oil exporters is captured by a2 1 a3. The fixed-effects framework implies that the analysis uses changes in the explanatory variables to estimate changes in growth rates within countries. The time and country fixed effects are captured by the terms at and ai, respectively. In equation (3.12), Rit is a measure of the RER. Following Rodrik (2008) and Berg and Miao (2010), Rit is included directly in the non-oil GDP growth equation. Following Rodrik (2008), Delechat and others (2009), and Berg and Miao (2010), Rit is defined as the deviation of the actual RER from its purchasing power parity (PPP) value, adjusted for the effects of per capita income on the RER. The exchange ppp rate over- or undervaluation is then the residual  it in a regression of the RER on per capita income:

ppp ln RERit 5 a0 1 a1 ln yit 1 at 1 eit . (3.13) The advantage of this measure is that it is directly comparable across countries. The dependent variable RERit in equation (3.13) is the log of the ratio of the market exchange rate to the PPP conversion factor; the log of per capita GDP ln yit accounts for the Balassa-Samuelson effect. Subscript t denotes the three-year average period, and i denotes the country. The set of time fixed effects is captured by at. Following the literature, equation (3.13) is estimated for 181 countries for which data are available for the entire period (see Rodrik, 2008; and Delechat and others, 2009). Turning to the estimation of equation (3.12), the dependent variable is real non-oil GDP growth, measured as a log difference. Initial income, measured as the log of real GDP per capita in constant 2000 U.S. dollars, is included to control for the Balassa-Samuelson effect. Openness to trade is defined as (Exports 1 Imports)/ GDP, government consumption is measured as public consumption expenditure as a share of total GDP, and investment refers to gross fixed capital formation as a share of total GDP. The source of data is the IMF World Economic Outlook database, the time period covered is 1985–2008, and all variables are three-year averages, as is common in the literature to account for business cycle fluctuations. Ideally, the analysis would assess the role of the stock of capital on non-oil growth, which would be in line with the theoretical model presented in the previous section. Constructing capital stocks, however, is nontrivial, especially for low-income and post-conflict countries, and requires a number of important assumptions about initial capital stocks, and the level and time profile of depreciation rates and the depreciation method.7 Rather than constructing stocks of capital across countries, the analysis follows the empirical growth literature that uses investment rates (see, for example, Ramey and Ramey, 1995; and Berg and Miao, 2010). Consequently, these empirical estimates do not explicitly take into account the efficiency of converting investment into capital.

7See, for example, Klenow and Rodriguez-Clare’s (1997) analysis of the neoclassical growth model, in which they measure capital stocks by accumulating investment data in the Penn World Tables.

©International Monetary Fund. Not for Redistribution 48 Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

Table 3.1 Growth and Total Investment: Estimation Results (1) (2) (3) Non-oil growth (lagged) 0.007 20.005 20.010 (0.06) (0.06) (0.06) UNDERVAL (ln) 0.025** 0.025** 0.028*** (0.01) (0.01) (0.01) Initial income (ln) 20.078*** 20.078*** 20.081*** (0.02) (0.02) (0.02) Terms of trade (ln) 0.007 0.009 0.012 (0.01) (0.01) (0.01) Openness 0.004 0.007 0.003 (0.02) (0.02) (0.02) Investment 0.127*** 0.154*** 0.211*** (0.04) (0.05) (0.09) Gov. Consumption 20.076** 20.095** 20.134** (0.04) (0.04) (0.07) CFAoil * Investment 20.159*** 20.215*** (0.04) (0.08) CFAnon-oil * Investment 20.143* (0.09) Adjusted R2 0.28 0.29 0.30 Observations 270 270 270

Dependent variable: real non-oil GDP growth. Panel estimation with time and country fixed effects. Heteroscedasticity- consistent standard errors in parentheses. ***(1%), **(5%), *(10%).

As control groups to the CFA zone oil exporters, this inquiry uses (i) the CFA non-oil exporters and (ii) a sample of select LICs; in total, the final sample contains 36 countries (excluding Equatorial Guinea) and 270 observations.8 Although ppp Rit 5 eit is used for the baseline specifications, as a robustness check the log of the real effective exchange rate is used as an alternative measure of the exchange rate. As a starting point, Table 3.1, column 1, reports, for the entire sample of 36 countries, the results of a standard growth specification that does not distinguish among the three country groups. The specification is, therefore, a simplification CFA oil of equation (3.12) in which the interaction terms D Xit are ignored. It closely follows Berg and Miao (2010), and the results confirm their findings with regard to both magnitude and significance of the coefficients. The results of this analysis are also consistent with empirical studies documenting that for developing countries exchange rate overvaluations are associated with lower growth rates (Rodrik, 2008; and Berg and Miao, 2010). The estimates for the exchange rate measures suggest that a 10 percent overvaluation is associated with a 0.25 percentage point lower growth rate. The estimates for investment and government consumption

8The group of CFA oil exporters includes Cameroon, Chad, the Republic of Congo, Côte d’Ivoire, and Gabon. The group of CFA non-oil exporters includes Benin, Burkina Faso, the Central African Republic, Guinea-Bissau, Mali, Niger, Senegal, and Togo. The group of LICs includes Bangladesh, Burundi, Cambodia, Comoros, Ethiopia, The Gambia, Ghana, Guinea, Haiti, Kenya, Lao People’s Democratic Republic, Madagascar, Malawi, Mauritania, Mozambique, Rwanda, Sierra Leone, Tajikistan, Tanzania, Uganda, Uzbekistan, Vietnam, and Zambia.

©International Monetary Fund. Not for Redistribution Tabova and Baker 49 imply that a 1 percentage point increase in the share of investment in total GDP is associated with 0.127 percentage point higher growth, while a 1 percentage point increase in the share of government consumption in total GDP is associated with 0.076 percentage point lower growth. While it is common in the literature to include government consumption or investment shares in GDP growth regressions, the endogeneity problem can be nontrivial and results may reflect, to a certain extent, reverse causality (see, for example, Berg and Miao, 2010). The same issue applies to the inclusion of the RER in the growth regression. This concern might be addressed by a dynamic panel estimation using generalized method of moments (see Arellano and Bond, 1991). Reassured by findings for the panel as a whole that are consistent with the empirical findings in the literature, the analysis proceeds to investigate the factors that have led to lower non-oil growth in the CFA zone oil-exporting countries. The results in Table 3.1, column 2, imply that although on average investment is positively and significantly associated with growth for the sample as a whole, for the CFA oil exporters investment is not related to growth in a statistically significant way. The coefficient on the interaction term in column 2 shows that for the CFA oil-exporting countries the impact of investment as a share of GDP on non-oil growth differs significantly from the impact it has for the rest of the countries in the sample. The net impact for the CFA oil exporters (a2 1 a3) is 20.005, and a Wald test shows that this net coefficient is not statistically significant. The results in column 3 show that the lack of a significant relation between investment and non-oil growth for the CFA oil exporters is also evident when the analysis controls separately for the CFA non-oil countries. Similar to the results in column 2, the net effect of investment for the CFA oil exporters is 20.004, and a Wald test shows it is not statistically different from zero. Column 3 shows that for the group of CFA non-oil exporters the net effect of investment is positive and significant at the 1 percent level, although at 0.07 it is much lower than the estimate for the average LIC in the sample. Next, as a robustness check, the analysis uses the log of the real effective exchange rate REERit as a measure of the exchange rate. Table 3.2 shows that the results do not change and are therefore robust to alternative measures of the exchange rate. The estimates for the exchange rate measures suggest that a 10 percent overvaluation or a 10 percent increase in the REER are associated with a 0.3 percentage point lower growth rate. Turning to the composition of investment, because the oil revenue accrues to the governments of the oil-exporting countries in the CFA zone and public investment constitutes the majority of total investment in these countries, the analysis disaggregates investment into private and public investment as a share of GDP.9 The results are shown in Table 3.3.

9Public investment is gross public fixed capital formation as a share of total GDP; private investment is gross private fixed capital formation as a share of total GDP. During the estimation period, private investment in the CFA oil-exporting countries was mainly in the oil sector, while public investment was in infrastructure.

©International Monetary Fund. Not for Redistribution 50 Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

Table 3.2 Growth and Total Investment Robustness Check: Estimation Results Using the REER versus the PPP Undervaluation Index (1) (2) Non-oil growth (lagged) 20.024 20.010 (0.07) (0.06) REER (ln) 20.027*** (0.01) UNDERVAL (ln) 0.028*** (0.01) Initial income (ln) 20.080*** 20.081*** (0.02) (0.02) Terms of trade (ln) 0.010 0.012 (0.01) (0.01) Openness 0.001 0.003 (0.02) (0.02) Investment 0.206*** 0.211*** (0.07) (0.09) Gov. Consumption 20.131** 20.134** (0.05) (0.07) CFAoil * Investment 20.211*** 20.215*** (0.06) (0.08) CFAnon-oil * Investment 20.141* 20.143* (0.08) (0.09) Adjusted R2 0.31 0.30 Observations 270 270

Dependent variable: real non-oil GDP growth. Panel estimation with time and country fixed effects. Heteroscedasticity- consistent standard errors in parentheses. ***(1%), **(5%), *(10%). Note: CFA 5 Coopération Financière en Afrique Centrale; PPP 5 purchasing power parity; REER 5 real effective exchange rate.

For the sample as a whole, the positive association between both public and private investment and growth is preserved (Table 3.3, column 1). However, for the CFA oil exporters, the empirical analysis fails to detect any significant association between non-oil growth and either public or private investment: the net coefficients are 20.088 and 0.014, respectively, and a Wald test indicates that neither is statistically significant from zero (Table 3.4). The insignificant coefficient on the interaction term of the CFA non-oil exporters dummy with public investment means that the relation between public investment and growth in these countries does not differ from that found for the average LIC in the sample (0.19). To address the importance of the exchange rate for GDP growth in developing countries, as noted by the empirical literature, for all specifications the analysis includes an interaction term with either measure of the exchange rate (undervaluation index or the real effective exchange rate). This indicates whether the RER affects growth in the three country groups in a significantly different way. The results (not shown) indicate that there is no statistically significant difference in the way the RER is associated with GDP growth in the three country groups. Turning to investment efficiency, Dabla-Norris and others (2011) constructed an index of the efficiency of the public investment management process for 71 developing countries. The efficiency of public investment is proxied by aggregate indicators of the quality and efficiency of four crucial stages of the investment

©International Monetary Fund. Not for Redistribution Tabova and Baker 51

Table 3.3 Growth and Investment: Estimation Results When Investment Is Disaggregated into Public and Private Investment (1) (2) Non-oil growth (lagged) 20.002 20.018 (0.07) (0.07) UNDERVAL (ln) 0.026** 0.029** (0.01) (0.01) Initial income (ln) 20.078*** 20.081*** (0.02) (0.02) Terms of trade (ln) 0.008 0.013* (0.01) (0.01) Openness 0.003 0.003 (0.02) (0.02) Private Investment 0.129** 0.223* (0.05) (0.10) Public Investment 0.117* 0.191* (0.06) (0.10) Government. Consumption 20.078* 20.145* (0.04) (0.07) CFAoil * Private Investment 20.209** (0.09) CFAoil * Public Investment 20.279* (0.16) CFAnon-oil * Private Investment 20.206* (0.12) CFAnon-oil * Public Investment 20.011 (0.13) Adjusted R2 0.28 0.30 Observations 270 270

Dependent variable: real non-oil GDP growth. Panel with time and country fixed effects. Heteroscedasticity-consistent standard errors in parentheses. ***(1%), **(5%), *(10%). Note: CFA 5 Coopération Financière en Afrique Centrale.

Table 3.4 Impact of investment on non-oil growth

Total investment Public investment Private investment p-value p-value p-value Coefficient Coefficient Coefficient (Wald test) (Wald test) (Wald test)

0.211** 0.018 0.191* 0.069 0.223** 0.032 Select LICs positive and significant positive and significant positive and significant

CFA zone non- 0.068*** 0.008 0.180* 0.03 0.017 0.697 oil exporters positive and significant positive and significant positive but insignificant

CFA zone oil 20.004 0.899 20.088 0.516 0.014 0.612 exporters negative but insignificant negative but insignificant positive but insignificant

The reported coefficients are from the regressions that use UNDERVAL as dependant variable as a measure of the exchange rate. Note: CFA 5 Coopération Financière en Afrique Centrale.

©International Monetary Fund. Not for Redistribution 52 Determinants of Non-Oil Growth in the CFA Zone Oil-Producing Countries: How Do They Differ?

process: investment project appraisal, selection, implementation, and evaluation. Although the focus of this index is on the quality of the process for managing public investment and the index is not available for all countries in the present empirical investigation, it nevertheless provides a useful benchmark for these empirical findings. With regard to country comparisons, the results here are broadly in line with the rankings based on this index. Notably, all but one of the CFA oil-exporting countries for which the index is available rank among the weakest performers.

Conclusion Using a panel of 36 countries comprising LICs and CFA zone oil exporters, this inquiry finds that, controlling for the real effective exchange rate, investment by CFA zone oil-producing countries fails to spur growth. For LICs outside the CFA zone, private investment is found to have a fairly large, positive, and statistically significant effect on growth, while public investment has a somewhat weaker impact on growth. For CFA zone non-oil producers, the impact of public investment on growth is lower than in other LICs but positive and significant. In contrast, for CFA zone oil producers, the analysis fails to detect a significant association between non-oil growth and public investment. For both groups within the CFA zone, the impact of private investment is not statistically significant. Investment may not raise non-oil growth in the oil-exporting countries of the CFA zone for many reasons. First, investment itself may be less efficient as a result of project selection or capacity constraints related to project appraisal, implementation, and monitoring. Second, it is likely that the necessary conditions for public investment to spur private sector activity are not in place. Such conditions include basic infrastructure (greater than a required threshold level), an enabling business environment, and strong institutions and governance. These conclusions are supported by this theoretical model, which demonstrates that public goods are growth enhancing, while weak institutions and market imperfections impede growth.

References Aguirre, A., and C. Calderón, 2005, “Real Exchange Rate Misalignments and Economic Performance,” Working Paper 315, Central Bank of Chile, Economic Research Division. Arellano, M., and S. Bond, 1991, “Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations,” Review of Economic Studies, Vol. 58, No. 2, pp. 277–97. Barro, R.J., 1990, “Government Spending in a Simple Model of Endogenous Growth,” Journal of Political Economy, Vol. 98, No. 5, pp. 103–25. ———, and X. Sala-i-Martin, 2004, Economic Growth, 2nd edition (New York: McGraw-Hill). Berg, A., and Y. Miao, 2010, “The Real Exchange Rate and Growth Revisited: The Washington Consensus Strikes Back?” IMF Working Paper 10/58 (Washington: International Monetary Fund). Calderon, C., and L. Serven, 2008, “Infrastructure and Economic Development in Sub-Saharan Africa,” World Bank Policy Research Working Paper No. 4712 (Washington: World Bank).

©International Monetary Fund. Not for Redistribution Tabova and Baker 53

Chakraborty, S., and E. Dabla-Norris, 2009, “The Quality of Public Investment,” IMF Working Paper 09/154 (Washington: International Monetary Fund). Coxhead, I., 2007, “A New Resource Curse? Impacts of China’s Boom on Comparative Advantage and Resource Dependence in Southeast Asia,” World Development, Vol. 35, No. 7, pp. 1099–119. Dabla-Norris, E., J. Brumby, A. Kyobe, Z. Mills, and C. Papageorgiou, 2011, “Investing in Public Investment: An Index of Public Investment Efficiency,” IMF Working Paper 11/37 (Washington: International Monetary Fund). Delechat, C., G. Ramirez, S. Wang, and J. Wakeman-Linn, 2009, “Sub-Saharan Africa’s Integration in the Global Financial Markets,” IMF Working Paper 09/114 (Washington: International Monetary Fund). Easterly, W., and S. Rebelo, 1993, “Fiscal Policy and Economic Growth,” Journal of Monetary Economics, Vol. 32, No. 3, pp. 417–58. Eichengreen, B., 2008, “The Real Exchange Rate and Economic Growth,” Commission on Growth and Development, Working Paper No. 4 (Washington: World Bank). Everhart, S., and R. Duval-Hernández, 2001, “Management of Oil Windfalls in Mexico: Historical Experience and Policy Options for the Future,” Policy Research Working Paper No. 2592 (Washington: World Bank). Gelb, A., 1988, Oil Windfalls: Blessing or Curse (Oxford: Oxford University Press). ———, and S. Grasmann, 2010, “How Should Oil Exporters Spend Their Rents?” CGD Working Paper 221 (Washington: Center for Global Development). Klenow, P.J., and A. Rodríguez-Clare, 1997, “The Neoclassical Revival in Growth Economics: Has It Gone Too Far?” NBER Macroeconomics Annual 1997 (Cambridge, Mass: MIT Press). Prasad, E., R. Rajan, and A. Subramanian, 2006, “Foreign Capital and Economic Growth,” paper presented at a Federal Reserve Bank of Kansas City Conference, Jackson Hole, WY, August 25, 2006. Ramey, G., and V.A. Ramey, 1995, “Cross-Country Evidence on the Link Between Volatility and Growth,” American Economic Review, Vol. 85, No. 5, pp. 1138–51. Razin, O., and S.M. Collins, 1999, “Real-Exchange-Rate Misalignments and Growth,” in The Economics of Globalization: Policy Perspectives from Public Economics, ed. by A. Razin and E. Sadka (Cambridge, UK: Cambridge University Press). Rodrik, D., 2008, “The Real Exchange Rate and Economic Growth,” Brookings Papers on Economic Activity: Fall 2008 (Washington: Brookings Institution). Straub, S., 2008, “Infrastructure and Growth in Developing Countries: Recent Advances and Research Challenges,” World Bank Policy Research Working Paper No. 4460 (Washington: World Bank). World Bank, 2009, Doing Business 2010: Reforming through Difficult Times (Washington).

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©International Monetary Fund. Not for Redistribution Chapter 4

CEMAC’s Infrastructure Gap: Issues and Policy Options

Rupa Ranganathan, Vivien Foster, and Cecilia Briceño-Garmendia

The member countries of the Central African Economic and Monetary Commu nity (CEMAC) are extremely heterogeneous, with varying income levels, natural resource endowments, geography, and topography. The CEMAC comprises three low-income countries (Cameroon, Chad, and the Central African Republic), one lower-middle-income country (the Democratic Republic of Congo), one upper- middle-income country (Gabon), and a high-income country (Equatorial Guinea) that is not a member of the Organization for Economic Cooperation and Development (OECD). Geographically, CEMAC is composed of coastal nations (Cameroon, the Republic of Congo, and continental Equatorial Guinea and Gabon), islands (part of Equatorial Guinea), and isolated landlocked countries (Chad and the Central African Republic). The topography in the CEMAC region varies dramatically within and across countries, ranging from arid deserts to for ests and lush vegetation, lowlands, volcanic mountains, and islands. Rapidly rising oil incomes since the early 2000s have made the CEMAC coun tries more prosperous. All CEMAC nations except the Central African Republic are richly endowed with natural resources and oil and have benefited from increased oil exports and, consequently, fiscal revenue. Exploiting the recent dis covery of mineral deposits and some oil in the Central African Republic might enable it to join this league in the near future. In general, however, despite abun dant oil revenue, the standard of living for a large portion of the CEMAC popu lation has not improved. Much of the population lacks access to basic power, safe drinking water, and improved sanitation. Higher oil income presents CEMAC countries with both economic opportuni ties and challenges. Increased oil income can be expected to have positive repercus sions in the economy as a whole, but evidence across the world provides a mixed story. Most cases of increased oil wealth and dependence on natural resources have led to increased wealth disparities often resulting in political instability (Nigeria, Angola, and Bolivia provide clear examples) and a real economy overdependent in one sector at the detriment of other sectors. The term used for the phenomenon is Dutch disease (Adam and Bevan, 2006, and references therein). Higher oil revenue permits resource-rich countries, including CEMAC mem ber states, to undertake spending for infrastructure and social needs to bolster

©International Monetary Fund. Not for Redistribution 56 CEMAC’s Infrastructure Gap: Issues and Policy Options

2.5

h 2.0

1.5

1.0

0.5 Percentage-point change 0.0 in per capita economic growt Central West Southern East Asian Africa North East Western -0.5 Africa Africa Africa Tigers Africa Africa Europe

Stabilization policies Structural policies Infrastructure Figure 4.1 Changes in Growth per Capita Caused by Changes in Growth Fundamentals, 1990–2005 Source: Calderon, 2009

growth and attain the Millennium Development Goals (MDGs). The complex political and economic landscape in the region requires that the oil revenue be carefully managed and invested. The governance difficulties in resource-rich envi ronments have hindered the necessary investments that could transform natural resources wealth into productive infrastructure. Oil-endowed countries have experienced significant challenges in budget preparation, timing of budgets, and project preparation, and have been impeded by cumbersome procurement pro cesses. These issues have hindered capital budget execution. Capitalizing on oil revenue, particularly during boom periods, and making investments in non-oil sectors such as essential infrastructure should be an urgent priority. Adequate infrastructure is crucial for economic growth and competitiveness in Africa. Inadequate infrastructure prevents faster growth. This view, highlighted by the Commission for Africa (2005), is supported by a considerable volume of economic research. A key question for policymakers is the extent to which infra structure development, compared with other policy parameters, contributes to growth. One study found that across Africa, expanding and improving infrastruc ture contributed almost 1 percentage point to per capita economic growth per year from 1990 to 2005, compared with 0.8 percentage point for macroeco nomic stabilization and structural policies (Calderón, 2009) (Figure 4.1). Infrastructure improvements in Central Africa1 during 1995–2005, similar to what was found on the continent as a whole, boosted per capita growth rates by 1 percentage point, largely driven by the growth of mobile telephony in the region. Inadequate power infrastructure deterred growth. These trends are similar to what has been observed in Africa as a whole.

1Central Africa comprises Burundi, Cameroon, the Central African Republic, Chad, the Democratic Republic of Congo, Equatorial Guinea, Gabon, Rwanda, and São Tomé and Príncipe.

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 57

h 1.50

1.00

0.50

0.00 Percentage-point change

in per capita economic growt –0.50 n Chad Rep. Gabon Congo, African Central Republic Cameroo

Telephones ElectricityRoads Figure 4.2 Changes in Growth per Capita in CEMAC Countries Caused by Infrastructure Improvements, 1999–2005 Source: Calderon, 2009

Considerable differences exist at the country level (Figure 4.2). The historic impact of infrastructure on per capita growth varied from 0.6 percentage points in the Republic of Congo to 1.2 percentage points in Cameroon. Across the board, information and communications technology (ICT) improvements have made the largest contribution to economic growth. Power infrastructure has been a positive influence in some cases (notably the Central African Republic), but negative in others (Cameroon and the Democratic Republic of Congo). Infrastructure could contribute much more to growth than it has in the past. Simulations suggest that if Central Africa’s infrastructure could be upgraded to the level of Mauritius, the leading country in infrastructure provision in Africa, the impact on per capita economic growth would be on the order of 5 percent, with the power sector driving the largest change followed by roads and telecom (Figure 4.3). More-detailed microeconomic work on the relationship between infrastructure and the performance of firms consistently shows a strong relationship between infrastructure stock and the output, productivity, and investment behavior of firms. An exhaustive study analyzed the entire set of investment climate surveys in Africa (Escribano, Guasch, and Peña, 2008). The central finding was that in most African countries, particularly the low-income countries, infrastructure is a major constraint to doing business and depresses firm productivity by about 40 percent. Firms report that infrastructure contributed almost 50 percent to total factor productivity with 40 percent of the contribution coming from customs clearance and about 20 percent coming from power and water infrastructure. Inadequate infrastructure constrains firms’ business activities. Recent enter prise surveys indicate that between 60 and 75 percent of firms in Cameroon, Chad, the Republic of Congo, and Gabon identified power as a major impedi ment to doing business. Almost half the firms in Chad, the Republic of Congo, and Gabon cited inadequate transport as a hindrance to the effective undertaking of business activities.

©International Monetary Fund. Not for Redistribution 58 CEMAC’s Infrastructure Gap: Issues and Policy Options

h 5

in per capita economic growt 1 Potential percentage-point change

0 North West East Southern Central Africa Africa Africa Africa Africa Africa

Telecom PowerRoads Figure 4.3 Potential Growth per Capita Attributable to Improvements in Infrastructure Source: Calderon, 2009.

Infrastructure is also a key input for human development. Safe and convenient water supply arrests the spread of life-threatening diseases and prevents child mortality and malnutrition. Electricity powers health and education, and boosts business productivity. Transportation networks link local, regional, and global markets. ICT services democratize access to information, facilitate ease of com munication, and reduce transport costs by enabling transactions to be conducted remotely.

Benchmarking the CEMAC’s Infrastructure Despite strong growth and a surge in oil wealth in the early 2000s, CEMAC’s infrastructure performance has been lagging behind its peers. Overall, CEMAC countries display infrastructure indicators on par with other low-income coun tries in Africa but significantly behind benchmarks set by other resource-rich states. Installed electricity generation capacity and access to power are lower than all benchmarks. Mobile and mainline telephone subscriptions and access to sani tation, though marginally better than in low-income countries, are lower than resource-rich peers in other parts of Africa (Table 4.1).2

2Low income, nonfragile: Benin, Burkina Faso, Ethiopia, Ghana, Kenya, Madagascar, Malawi, Mali, Mozambique, Niger, Rwanda, Senegal, Tanzania, Uganda, and Zambia. Low income, fragile: Burundi, Central Africa Republic, Comoros, Democratic Republic of Congo, Côte d’Ivoire, Eritrea, The Gambia, Guinea, Guinea-Bissau, Liberia, São Tomé and Príncipe, Sierra Leone, Togo, and Zimbabwe. Middle income: Botswana, Cape Verde, Lesotho, Mauritius, Namibia, Seychelles, South Africa, and Swaziland. Resource rich: Angola, Cameroon, Chad, Republic of Congo, Equatorial Guinea, Gabon, Nigeria, and Sudan.

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 59

Table 4.1 Infrastructure Access in the CEMAC Region SSA Benchmarks Low- Resource- Middle- income rich income Indicator Units CEMAC countries countries countries Classified road network Km per 1,000 people 2.4 1.3 2.3 7.1 density Classified road network in percent 32 35 29 48 good condition Installed generation MW per million 16 20 43 799 capacity people Access to electricity percent of population 30 33 46 50 Internet subscribers per 100 people 2.8 5.69 11.8 8.94 Mobile telephone subscribers per 100 people 28.9 25.58 37.35 57.33 Main telephone lines per 100 people 0.7 0.8 0.83 4.78 Access to piped water percent population 12 10.5 12 52.1 Access to flush toilet or percent population 6 4.9 11.2 40.8 septic tank

Sources: Africa Infrastructure Country Diagnostic; US Department of Energy, 2005–8; World Bank Information and Communications for Development, 2009. Note: Roads and ICT data for 2008; energy and water data for 2004–05; electricity access for 2001. Benchmarks are for latest year available in the period 2000–05. CEMAC 5 Central African Economic and Monetary Community; ICT 5 information and communications technology; MW 5 megawatts; SSA 5 sub-Saharan Africa.

Consumers in CEMAC countries pay much higher prices for their infrastruc ture relative to African and global standards. Power prices and road freight tariffs are three times higher in CEMAC countries on average than in other developing regions. Internet dial-up access costs six times as much (Table 4.2). These high prices are driven by myriad factors that vary depending on the type of infrastructure. For example, in the power sector, costs of power generation are genuinely higher in many African countries because of the small scale of power systems and the reliance on expensive diesel-based generation technology, with costs that can run nearly three times as high as those of larger hydro-based power systems in other parts of Africa. The high cost of road transport in the CEMAC region is due to the presence of cartelization and restrictive regulation of the trucking industry leading to exceptionally high profit margins. The expensive

Table 4.2 Infrastructure Costs in the CEMAC Region Sub-Saharan Other Developing Service Costs CEMAC Africa Countries Power tariffs (US$ per kilowatt-hour) 0.10–0.30 0.03–0.43 0.05–0.10 Port container handling charges (US$ per TEU) 160–260 100–320 80–150* Road freight tariffs (US$ per ton-kilometer) 0.13 0.04–0.13 0.01–0.04 Mobile telephony (US$ per basket per month) 15.1 2.6–21 9.9 Internet dial-up service (US$ per month) 68 6.7–148 11

Sources: Banerjee and others, 2008; Eberhard and others, 2009; Minges and others, 2009; and Teravaninthorn and Raballand, 2009. Note: TEU 5 Twenty-foot equivalent unit. Ranges reflect prices in different countries and for various consumption levels. Prices for telephony and Internet represent worldwide developing regions, including Africa.

©International Monetary Fund. Not for Redistribution 60 CEMAC’s Infrastructure Gap: Issues and Policy Options

ICT services in the CEMAC region can be explained by the small number of countries that are connected to the submarine cable and the absence of competi tion in international gateways even where countries are connected.

A Sectoral Perspective on the CEMAC’s Infrastructure The suboptimal performance of infrastructure throughout the CEMAC region is consistent across sectors, although the challenges are different. This section takes a deeper look at some of the highlights of each sector.

Transport Infrastructure The common themes in road transport across all CEMAC countries are the low road density and low traffic volumes. All other facets of road transport vary widely across countries (Table 4.3). Classified road network3 density is signifi cantly lower than in low-income countries in Africa and comparable to that in African resource-rich peers. A sizable share of the road network is in good or fair condition except in the Republic of Congo, where the roads are in extremely poor condition, and in Cameroon, that with the largest road network density, had a relatively small proportion of roads in good condition. The unpaved network is quite poor, suggesting that accessibility along rural roads can be a challenge in the CEMAC region, given its low road densities. A small proportion of the rural population lives in close proximity to an all-season road. Traffic volumes overall are between a third and a half of what is typically observed in Africa’s resource- rich or low-income countries, and barely a fraction of the levels in middle-income countries. Cameroon, however, stands out in this regard because it has high vol umes (see Figure 4.4). Inadequate transport networks impede business. Almost half of the firms in Chad, the Republic of Congo, and Gabon indicate that transport is a major constraint compared with one-quarter of firms in low-income or resource-rich countries. Many African countries have introduced fuel levies as a mechanism for collecting road user charges to fund road maintenance. These levies are collected in road funds, which are important mechanisms that allow countries with weak institutions to protect resources for road maintenance to capture them in a way that bears some relationship to road usage. Even in countries in which institutions and public expenditure management systems are relatively mature, incentives exist to postpone maintenance as a way to offset short-run fiscal imbalances. While the effects of poor or non-maintenance are not perceivable immediately, this leads to a false economy creating significant medium-term liabilities for road rehabilitation and reconstruction.

3“Classified road network” generally refers to the roads that fall under the responsibility of the state to build and operate, and includes the sum of the primary, secondary, and tertiary networks.

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 61 27 25 61 64 26 38

1255

Countries Resource-Rich 5 75 88 58 32 278

3,798

Countries Middle-Income 24 39 56 81 23 88

1,341 (Nonfragile) Low-Income Countries Countries Low-Income 6 49 60 25 35 n.a.

977

Gabon 48 17 27 34 37 n.a.

655

Congo 46 26 34 78 24 22

562

Chad 14 20 80 58 28

200

Republic Central AfricanCentral 27 60 36 68 27 51

1,614 Cameroon

network ©International Monetary Fund. Not for Redistribution

% of firms that indicate % of firmsindicate that transport to as a constraint doing business annual average vehicles vehicles annual average per day annual average vehicles vehicles annual average per day percent of classified percent unpaved percent of classified percent network percent of rural population of rural percent within 2 km all-season from road km/1,000 sq km Units 4.3 e l Transport quality Transport Daily traffic, unpaved road road unpaved Daily traffic, network Daily traffic, paved primary paved Daily traffic, network road Classified unpaved road network road Classified unpaved in good or fair condition Road network in good or fair condition Rural accessibility Index accessibility Rural Indicator network densityClassified road Benchmarking Road Infrastructure Road Benchmarking Tab Sources: Gwillliam and others, 2009; and AICD road database, 2010. database, 2009; and AICD road Gwillliam and others, Sources: n.a. 5 Not available. Note: 62 CEMAC’s Infrastructure Gap: Issues and Policy Options

LIBYAAEEGYPTGYPT ALGERIA

MALI NIGER

CHAD SUDAN BURKINA FASO

BENIN NIGERIA TOGO GHANA ETHIOPIA

CENTRAL AFRICAN REPUBLIC CAMEROON

SÃO TOMÉ AND PRÍNCIPE EQUATORIAL GUINEA UGANDA CONGO CONGO, DEM REP GABON RWANDA Road Type & Condition Good Fair Poor Unknown BURUNDI Paved Unpaved TANZANIA

Figure 4.4 National Road Network Quality in CEMAC Countries Source: Foster and Briceño-Garmendia, 2009.

On average, countries with both road funds and road agencies4 have been able to maintain their roads better than those that lack either or both of these institutions. Four CEMAC countries—Cameroon, the Central African Republic, Chad, and the Republic of Congo—have taken the important policy measure of adopt ing fuel levies. Fuel levies in the region have been set between US$0.05 and US$0.10 per liter (Figure 4.5). Only in Cameroon is the fuel levy high enough to make a significant contribu tion to road maintenance funding. However, even adequate funding does not necessarily guarantee that roads will be satisfactorily maintained. For example, poor planning and implementation, or high local construction costs, can lead to insufficient maintenance. In Chad and the Republic of Congo, the fuel levy is barely one-third of the level needed to provide sustainable road maintenance funding. Chad, with its low

4“Most African countries have been moving toward an institutional model for the road sector that is based on the principle of road user charges. Under this approach, road users pay pseudo charges in the form of fuel levies and other surcharges that are transferred into a dedicated and ring-fenced road maintenance fund. Road works are implemented by an autonomous road agency. A series of institu tional indicators are collected to capture the extent to which this modern institutional model has been applied in each country” (Foster and Briceño-Garmendia, 2009).

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 63

10 US cents per liter

0 Cameroon Central African Chad Congo, Rep. of Republic

Existing fuel levy Optimal fuel levy for maintenance Figure 4.5 Fuel Levy in Select CEMAC Countries Source: Gwilliam and others, 2008. Note: CEMAC 5 Central African Economic and Monetary Community. traffic volumes spread across an extensive geographic area, highlights the difficulty of applying road user charging principles in the Central African context. The optimal fuel levy would be in excess of US$0.30 per liter, which is more than twice the highest fuel levy applied anywhere in Africa to date, and would likely prove prohibitive for road users. The deficiencies of the CEMAC’s national road networks are clearly reflected in its regional transit corridors, characterized by deficient infrastructure quality and very low traffic volumes. Freight travels at an effective velocity of only 6 kilo meters per hour—no faster than a horse and buggy. Less than half the transport corridors in the CEMAC are in good or fair condition, significantly worse than the next poorest performer, West Africa,5 where three-quarters of the roads are in good condition. The mobility barrier imposed by poor road quality is compound ed by the extremely high freight tariffs prevalent in the region. Road freight prices at $0.13 per ton-kilometer are among the highest in the world, more than double the prices in Southern Africa,6 which at $0.05 per ton-kilometer are the lowest in sub-Saharan Africa. Three major corridors traverse the CEMAC region, and a substantial share of the roadways in these corridors are unpaved and in poor condition (Table 4.4). In most cases, only about two-thirds of the length of the regional corridors is paved. Indeed, traffic volumes along two of the three corridors fall short of the typical economic threshold that justifies road paving. Some internal road links connecting CEMAC member states are missing. For example, no road connects the Republic of Congo with the Central African Republic.

5West Africa comprises Benin, Burkina Faso, Cape Verde, Côte d’Ivoire, The Gambia, and Ghana. 6Southern Arica comprises Angola, Botswana, Lesotho, Madagascar, Malawi, Mauritius, Mozambique, Namibia, South Africa, Swaziland, Zambia, and Zimbabwe.

©International Monetary Fund. Not for Redistribution 64 CEMAC’s Infrastructure Gap: Issues and Policy Options 1.2 5.6 0.0 0.0 0.0 0.0 0.0 93.9 62.1 Unknown 0.0 0.0 0.0 0.0 0.0 24.7 24.7 22.9 15.0 . 1,000 (percent) 6.1 19.3 24.1 11.3 49.4 49.4 13.5 24.0 20.4 300–1,000 Traffic Volumes (annual average daily traffic) (annual average Volumes Traffic 0.0 79.5 70.2 26.6 25.9 25.9 86.5 53.1 64.6 . 300 9.2 0.0 0.0 6.0 0.0 0.0 0.0 0.0 0.0 Unknown

Type Type 0.8 0.0 (percent) 62.8 25.2 32.7 32.7 47.9 31.4 100.0 Unpaved 0.0 27.9 99.2 68.8 67.3 67.3 52.1 68.6 Paved 100.0 9.0 1.0 6.0 7.0 0.0 0.0 0.0 0.0 0.0 Unknown

0.0 0.0 0.0 Poor 69.4 45.2 56.6 56.6 34.7 22.7 (percent) Condition Condition 0.0 0.0 Fair 21.3 38.8 18.9 24.5 24.5 35.7 23.4 0.0 99.2 55.6 29.1 18.9 18.9 29.6 53.9 Good 100.0 ©International Monetary Fund. Not for Redistribution 4.4 e l Republic of Congo Central African Republic African Central Cameroon Cameroon Central African Republic African Central Cameroon

Pointe Noire to Brazzaville to Bangui to Brazzaville to Noire Pointe

Douala to N'DjamenaDouala to

Corridors

Douala to Bangui Douala to Road Quality and Traffic for Key CEMAC Corridors Key CEMAC for Traffic Road Quality and Tab Source: AICD, http://www.infrastructureafrica.org/. AICD, Source: and Monetary Economic African Community. 5 Central CEMAC Note: Ranganathan, Foster, and Briceño-Garmendia 65

For landlocked countries like the Central African Republic, the regional corri dors are critical for integrating the country with the rest of the region and for access to ports. The Central African Republic has lightly paved just about the entire length of its corridors to the sea and keeps them in good condition. However, the connecting routes in Cameroon and the Republic of Congo are mostly inadequate. These countries seem to be neglecting strategic hinterland routes that are critical to Chad and the Central African Republic. In each of these cases, the problem seems to be the neglect of road quality by a coastal gateway country. The incentives for the coastal country to maintain hinterland road corridors do not appear to be strong—the coastal countries’ own economies are typically concentrated along the coast, thus rendering these upcountry segments regional public goods. Traversing the CEMAC’s regional corridors is costly and slow, hindering growth and productivity. It can take between 26 and 70 days, sometimes longer, to move freight from ports to landlocked capitals. Some 50 to 80 percent of this time is taken up by the inefficient operations of the ports serving Central Africa: Douala, Cameroon, and Pointe Noire, Republic of Congo (Figure 4.6a). Time- consuming regulatory processes related to customs clearance and technical con trols consume further time. Moving a metric ton of freight costs between $230 and $650 along intraregional corridors in the CEMAC region compared with between $120 and $270 in the Southern African Development Community region where distances are significantly longer. Expensive charges for road freight transport and port services account for the bulk of these costs (Figure 4.6b). Freight tariffs are high in the CEMAC region because regulation restricts mar ket entry and because of a lack of competition among trucking companies. The combination of self-regulation and national protection is particularly damaging. Both advance the interests of the incumbent national operator at the expense of the customer. The CEMAC region is notorious for strong trucking industry car tels. Powerful freight bureaus and transport associations influence the market, preventing truck operators from contracting directly with customers. As a result, trucking industry profit margins are rather high. Profit margins in West and

a. Total time b. Total costs

2,100 700 1,800 600 1,500 500 1,200 400 900 300 600 200 300 100 me to import goods (hours) Ti

0 Cost to import goods (US$/ton) 0 Douala to Douala to Pointe Noire Douala to Douala to Pointe Noire N’Djamena Bangui to Brazzaville N’Djamena Bangui to Brazzaville to Bangui to Bangui

Port Transport Border Administrative Port Transport Border Administrative Figure 4.6 Importing Freight by Road through Alternative Gateways Sources: Data collected from World Bank, 2008; AICD ports database; Teravaninthorn and Raballand, 2009. Note: Ports data are based on indicators from 2006–07.

©International Monetary Fund. Not for Redistribution 66 CEMAC’s Infrastructure Gap: Issues and Policy Options

Central Africa were found to be on the order of 80 percent, compared with 20–60 percent in Southern Africa. Along the route between Ngaundere, Cameroon, and Mondou, Chad, the profit margin is 163 percent compared with 18 percent between Lusaka, Zambia, and Durban, South Africa, in Southern Africa (Teravininthorn and Raballand, 2009). A coalition of interest groups that oppose change make breaking the regula tory status quo in the region a difficult proposition. Truckers exercise strong leverage over authorities because they have enough monopolistic power to block trade. Governance issues occur because some high-level authorities either super vise or control trucking companies and benefit from the status quo. Deregulating the trucking industry in the CEMAC region is more a political and social change than a technical one. The main concern for the economy is the potential reduc tion in number of trucks to match demand in road transport. A reduction could lead to a drop in trucking employment and profits, and some companies would disappear or shrink and the resulting social effects would need to be mitigated. It is possible that the cartels resisting the change might concede to reform if com pensation schemes pay part of the social costs. As is evident from Figure 4.6, inefficient ports add significant hurdles to trade logistics. Douala and Pointe Noire are the most significant ports in the CEMAC, with the former handling the bulk of the transit traffic from landlocked Chad and the Central African Republic. Pointe Noire is one of the best natural deep sea ports in Africa and used to play an important role in the subregion before the civil conflict in the Republic of Congo. However, since that time, the quality of the country’s road and rail surface transport links has deteriorated markedly, preventing transit cargo from being channeled through Pointe Noire. In the meantime, neighboring Gabon developed its own integrated rail and port infra structure, diverting traffic that would previously have gone to Pointe Noire. Performance of Central African ports does not compare favorably with the rest of Africa, let alone with global best practices. The services provided by Central African ports generally cost twice as much as those in other global ports. The ports score poorly on productivity measures—for example, crane productivity in Central African ports, as measured by either containers or weight, is less than half the international benchmark. The international standard dwell time is seven days or less, but in Central Africa, most containers spend more than two weeks in the terminal. Ineffective and inefficient performance of the rail network also constrains movement of goods in the CEMAC region. The railway network in Central Africa is by far the smallest in Africa, operating only 6,000 route-kilometers and carrying only 4,000 net ton-kilometers of freight annually. The railways in Cameroon and Gabon post relatively good productivity indicators for wagon, carriage, and labor productivity. Concessions in Cameroon and Gabon have boosted operational performance, efficiency, and traffic, so that labor and rolling stock productivity measures compare favorably with other rail concessions in the region and show substantially better performance than for CFCO, the region’s major publicly owned railway. Camrail carries about 60 percent of the nonmineral traffic from

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 67

Douala toward the borders with Cameroon and Chad, and it also compares favor ably with competing bus services on the route from Yaoundé to Ngaoundere, for which travel by unpaved road becomes difficult in the rainy season. Despite improved performance, the railways in Central Africa are very lightly used by global standards, carrying little more than moderately busy branch lines elsewhere. The resulting challenge is that such low traffic volumes do not generate the revenue needed to finance track rehabilitation and upgrading, leaving the future of the railways heavily dependent on public funding. River transport is cost-effective in parts of Central Africa and could be used to carry high-volume forestry products. However, upgrades are urgently needed to improve service. River transport by barge was widely used during the colonial period and remains a highly competitive transport option at US$0.05 per ton- kilometer. River transport is used for timber exports originating in the neighbor ing Democratic Republic of Congo and in the Central African Republic that travel along the main river and do not rely on the tributaries. Logs from the north are normally floated down the Oubangui and Congo Rivers to Kinshasa, where they are loaded onto trains for transport to the coast and exported. The lack of dredging on the Sangha and Oubangui tributaries of the Congo River, which service the Congolese forestry concessions, rules out this transport option for domestic forestry products. In addition, important stretches of the Congo River are not navigable during the dry season because of an absence of dredging. Lack of adequate investment in signaling and river port infrastructure also impedes navigability (Briceño-Garmendia and Foster, 2010).

Power Infrastructure CEMAC’s power infrastructure is still in an embryonic state (Figure 4.7). There are few large-scale power plants, and not one of the countries in the region has developed a national power grid, much less a regional grid. Insufficient power sup ply means that some 10 percent of effective power demand in the Central African Power Pool (CAPP)—CEMAC’s regional power trading arrangement—fails to be met. Installed capacity per million people varies across member countries but can be classified into three groups (Table 4.5). Capacity in Cameroon and the Republic of Congo is broadly comparable to the group of resource-rich countries. Gabon’s installed capacity—the greatest in the region at 300 megawatts (MW) per million people—is a fraction of that installed by its comparator group of middle-income countries. Finally, the Central African Republic’s and Chad’s dismal power indica tors are well behind the low-income peer group and among the worst in Africa. Limited installed capacity has translated to low access overall and chronic power problems in the CEMAC region, more so than in other parts of Africa. A staggering 50–75 percent of firms allude to power as a large impediment to business activity, resulting in significant losses in productivity and sales. Consumers in CEMAC countries pay very high prices for the limited supply of power that is available. Average prices range from US$0.11 per kilowatt-hour (kwh) in Cameroon to US$0.30/kwh in Chad (Table 4.6). The prices in Chad

©International Monetary Fund. Not for Redistribution 68 CEMAC’s Infrastructure Gap: Issues and Policy Options

POWER LIBYA EGYPT Power PlantsALGERIAType & Capacity (MW) HYDROTHERMAL OTHER > MW Planned power line ExistingMALI power line

ALGERIA NIGER

CHAD SUDAN BURKINA FASO

BENIN NIGERIA TOGO GHANA ETHIOPIA

CENTRAL AFRICAN REPUBLIC CAMEROON

SÃO TOMÉ AND PRÍNCIPE EQUATORIAL GUINEA UGANDA CONGO CONGO, DEM REP GABON RWANDA

BURUNDI

TANZANIA ANGOLA Figure 4.7 CEMAC’s Power Infrastructure Source: Foster and Briceño-Garmendia, 2009.

are about twice the average power tariff in sub-Saharan Africa of about US$0.14/ kwh, and about six times higher than typical power tariffs of about US$0.07/kwh elsewhere in the developing world (Figure 4.8). The Republic of Congo has lower prices but this is due to substantial underpricing. Despite high end-user prices, power generation costs are seldom recovered. The high costs are driven by the small scale of power production facilities. Each of the power systems in the Central African Republic, Chad, the Republic of Congo, and Equatorial Guinea range between 20 and 120 megawatts of installed capacity, which is well below the minimum efficient scale of about 200 megawatts for a single thermal generation plant. Many of these countries also rely heavily on expensive oil-based generation. The situation in Chad is extreme. Since the destruction of its import facilities for heavy fuel oil, Chad has relied on importing diesel fuel for power gen eration, resulting in power generation costs of US$0.33/kwh due to the compound effect of more inefficient power generation technologies and more expensive fuels. The long-run marginal costs of power for the region would be significantly lower, at US$0.10/kwh, if more cost-effective hydro generation capacity could be developed. Tariffs for power (as well as for water) are all too often set below cost-recovery levels. This practice results in a hidden transfer from producers to consumers and is a very inefficient way of providing generalized subsidies at the expense of the financial health of the utilities. These hidden transfers clearly create distortions in consumption

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 69 46 53 43 56 15 70 97 26

169 Countries Resource-Rich 6 0 50 50 31 91 85 10

799

Income Middle- Countries 33 86 20 52 10 92 89 24 69 Countries/ Countries/ Nonfragile Low-Income Low-Income 15 58 46 67 11 34 40

100

443 Fragile Countries/ Countries/ Low-Income Low-Income 75 61 58 40 n.a. n.a. n.a. n.a.

296

Gabon 35 51 29 71 39 91 80 47 86 Congo, Congo, Rep. of Rep. 4 3

75 40 83 91 33 22 Chad 3 10 40 66 68 48

101

167 Republic Central AfricanCentral 46 47 51 59 26 94 60 31 95 Cameroon ©International Monetary Fund. Not for Redistribution Units percent of population percent percent of population percent MW per million population percent of firms percent days/year percent of billing percent percent, historical percent, percent of generation percent percent of revenue percent 4.5 e and Foster, 2009. and Foster, l constraint for business for constraint Indicator (national) Access Access (urban) Access Installed capacity generation Firms that find power a find power that Firms Outages Collection rate Cost recovery ratio recovery Cost System losses System Total hidden costs hidden costs Total Benchmarking CEMAC’s Power Infrastructure Power Benchmarking CEMAC’s Data for urban access in the Central African Republic are for the capital city. for Republic African are in the Central urban access for Data Tab Sources: Eberhard and others, 2009; Rosnes and Vennemo, 2009; World Bank Enterprise Surveys, various years. Financial indicators were derived from financial accounts for utilities based on Briceño-Garmendia, for financial accounts from Smits, derived were indicators Financial various years. Surveys, Bank Enterprise World 2009; Vennemo, 2009; Rosnes and and others, Eberhard Sources: n.a. 5 Not available. Note: 1 70 CEMAC’s Infrastructure Gap: Issues and Policy Options

Table 4.6 Power Costs and Tariffs (U.S. cents per kilowatt-hour) Average Average Average Historic Average Average Long-Run Country Total Costs Capital Costs Operating Costs Revenue Effective Tariff Marginal Cost Cameroon 17.1 4.4 12.7 10.9 10.9 6.0 Central African 19.0 6.7 13.0 15.0 15.0 11.0 Republic Chad 33.2 4.2 29.0 30.0 30.0 11.0 Congo, Rep. of 20.1 6.7 13.4 12.8 16.0 7.0 Equatorial Guinea n.a. 7.4 n.a. n.a. n.a. 10.0 Gabon n.a. 5.7 n.a. n.a. 11.7 7.0

Sources: Derived from Eberhard and others, 2009. Note: n.a. 5 Not available.

and also benefit most those who are least in need of such support. At least half of all power consumers in the CEMAC countries, with the exception of Gabon, belong to the top quintile of the expenditure distribution. In some cases, power subsidies also benefit large industrial customers. For example, in Cameroon, tariffs mask generous cross-subsidies that are directed to the aluminum smelter, Alucam. The low and medium voltage consumer paid between $0.11 and $0.14 cents in 2009, whereas Alucam benefited from a tariff cap of 7 Coopération Financière en Afrique Centrale (CFA) francs/kwh (less than $0.02) until 2009, when tariff revisions took effect (Husband, McMahon, and van der Veen, 2009) (Box 4.1). Power utilities in the CEMAC region suffer large financial losses as the result of various inefficiencies or hidden costs. First, power tariffs only recover 60–80 percent of costs in CEMAC countries. Second, transmission and distribution losses range from 30–50 percent, compared with a best practice benchmark of 12 percent. And third, revenue collection ratios range from 65–90 percent, compared with a best practice benchmark of 100 percent. In addition, the utilities are further burdened by overstaffing that can siphon away up to 20 percent of revenue. All together, these

30 CEMAC country 25 20 15 10

U.S. cents per kwh 5 0 a a i erde Chad Kenya NigerBenin Africa Gabon Ghana MalawNigeriaZambia Ugand Senegal Rwand Namibia TanzaniaLesotho Ethiopia Cameroon Cape V MadagascarBurkina Faso Côte d'Ivoire SouthMozambique Congo, Rep. of African Republic

Central Figure 4.8 Average Tariffs in the CEMAC Region Sources: Adapted from Briceno-Garmendia and Shkaratam, 2011. Note: CEMAC 5 Central African Economic and Monetary Community.

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 71

Box 4.1

Electricity Subsidies for Aluminum in Cameroon Alucam is Cameroon’s largest electricity consumer, accounting for 35–40 percent of the power produced. Under a historic 30-year agreement that ended in 2009, Alucam benefited from extraordinarily low prices for electricity and a guaranteed supply of power. Alucam was guaranteed 145 milowatts (MW) of power during the dry season and 165 MW during the rainy season. A tariff cap of 7 Coopération Financière en Afrique Centrale (CFA) francs per kWh (about $0.017/kWh) applied until the end of 2009, compared with tariffs of $0.114/kWh and $0.136/kWh for medium- and low-voltage customers, respectively. Alucam’s prices were exceedingly low in the context of the chronic power problems throughout the country. Alucam has been seen as receiving an implicit power subsidy for decades. The overall subsidies are estimated to have been worth about $120 million per year, equivalent to 32 percent of AES Sonel’s (the power producer’s) revenue. Since the expiration of the agreement, Alucam’s power prices have been increased by 73 percent to 12.94 CFA francs per kWh, or $0.031/kWh. This price is above the global electricity tariff for aluminum companies, which averages about $0.0256/kWh. Even with the price increase, the rates paid by Alucam still fall well below operating costs of $0.13/kWh and total costs of $0.17/kWh, adding to AES Sonel’s cost-recovery woes.

Sources: Husband, McMahon, and van der Veen, 2009; and World Bank, 2011.

inefficiencies create a drain equivalent to 20–120 percent of utility revenue (Figure 4.9). The levels of inefficiency in the CEMAC region are greater than low- income countries overall and far exceed Africa’s best performer, South Africa. During the decade beginning in 2010, these challenges could be exacerbated because power demand is expected to double. To double electrification in the region from 35 percent to 53 percent of households, the CAPP needs to support

Resource-rich LIC-Nonfragile South Africa

Chad Cameroon Central African Republic Congo, Rep.

050 100 150 200 250

Hidden costs as a share of revenue

Unaccounted Losses Underpricing Collection Inefficiencies Figure 4.9 Inefficiencies in the Central African Economic and Monetary Community’s Power Utilities Source: Briceño-Garmendia, Smits, and Foster, 2009. Note: LIC 5 low-income country.

©International Monetary Fund. Not for Redistribution 72 CEMAC’s Infrastructure Gap: Issues and Policy Options

Table 4.7 Long-run Marginal Costs of Power Trade Expansion Trade Stagnation Scenario Scenario Pool or Country (US cents/kwh) (US cents/kwh) Absolute Differential Percentage Differential CAPP 7 9 22 222 EAPP 12 12 0 0 SAPP 6 7 21 214 WAPP 18 19 21 25 Cameroon 7 6 1 17 Central African 11 11 0 0 Republic Chad 7 11 24 236 Congo, Rep. of 6 8 22 225 Equatorial Guinea 8 10 22 220 Gabon 7 7 0 0

Source: Adapted from Rosnes and Vennemo, 2009 Note: EAPP 5 East Africa/Nile Basin Power Pool; SAPP 5 Southern African Power Pool; WAPP 5 West Africa Power Pool; CAPP 5 (Central African Power Pool). Each power pool represents the regional power trading arrangements for East, Southern, West, and Central Africa, respectively.

the development of 4,400 MW, or 2.5 times existing generation capacity, and refurbish half the existing power capacity, some 900 MW. Regional power trading could be a way to develop additional power generation and slash power costs. Power trading would consist of expanding cross-border trade to leverage lower-cost energy resources in the region as a whole and adding cross-border transmission capacity to facilitate the flow of power from production to consumption locations. A counterfactual scenario—trade stagnation—assumes that no cross-border interconnectors will be built and countries will meet incre mental power demands by expanding their domestic power sectors (Table 4.7). Using power trade to address the power needs of CEMAC countries would require harnessing Cameroon’s rich hydropower potential and reducing reliance on oil-based systems in other countries. Cameroon would need to develop 1,400 MW of additional hydropower capacity, largely dedicated to supplying power to neigh boring countries. All countries in the CAPP (except the Central African Republic) would need to invest in developing a total of 1,662 MW of new cross-border inter connectors to allow power to flow more readily around the region. The heaviest transmission investment would need to be made in Cameroon and the Republic of Congo, comprising 80 percent of the required cross-border investment. Figure 4.7 illustrates the existing regional power infrastructure and highlights the notable absence of transmission capacity for wheeling power across the region. Figure 4.10 illustrates the patterns that could emerge if CEMAC countries trade power. The Central African Republic is the only country in the CEMAC region that would apparently not benefit significantly from regional power trade. In all other countries, power trade has the potential to bring substantial benefits in three areas. First, power trade can save the CAPP as much as $160 million annually in energy costs. To harness trade, CEMAC countries would have to make an addi tional US$100 million investment annually in capital-intensive hydropower generation and development of cross-border transmission capacity, but these

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 73

CHAD

3 1.

CENTRAL AFRICAN REPUBLIC CAMEROON

1 0.

4.4 1 EQUATORIAL GUINEA

REPUBLIC of CONGO GABON CONGO, DEM REP

0.4

Figure 4.10 Potential Power Trading Patterns Source: Derived from Rosnes and Vennemo, 2009.

investments would be more than offset by reductions in the fuel bill as reliance on thermal generation is reduced. Chad and the Republic of Congo would achieve the largest savings in national energy costs through power trade (Figure 4.11). Cameroon, which would become the region’s major power exporter, would need to spend more on power under trade, but these investments would yield returns in the form of revenue from power trade. Second, trade expansion would reduce the long-run costs of power in the CAPP by as much as $0.02/kWh (a 22 percent savings overall). Because power is a key input in any economy, power cost savings will positively affect productivity and competitiveness. The savings accrue because of the shift from very small- scale, oil-based generation schemes to cheap hydropower from Cameroon. In particular, Chad, Equatorial Guinea, and the Republic of Congo could save between $0.02/kWh and $0.04/kWh, a percentage reduction in power costs of between 20 and 36 percent (Table 4.7). Only in Cameroon would the long-run marginal cost of power increase under trade, reflecting the need for it to develop additional energy resources for export. Third, trade expansion significantly increases the weight of hydropower in the regional generation portfolio from 83 percent to 97 percent, thereby reducing

©International Monetary Fund. Not for Redistribution 74 CEMAC’s Infrastructure Gap: Issues and Policy Options

8 P

Spending as a percent of GD 0 Equatorial GabonCameroon Chad Central Congo, Guinea African Rep. of Republic

Trade expansion Trade stagnation Figure 4.11 The Central African Economic and Monetary Community’s Spending Needs for Power at the Regional Level Source: Derived from Rosnes and Vennemo, 2009.

carbon dioxide emissions by 4 million tons per year and making energy production more environmentally sound.

Water Supply and Sanitation Access to safe water supply and sanitation is a key ingredient for human develop ment. Accordingly, one of the U.N. MDGs calls for halving the percentage of the population without access to improved water and sanitation by 2015. Gabon and Cameroon are both on track to meet the water-related MDG. Chad and the Central African Republic have made steady progress, but it is not sufficient to meet the tar gets by 2015. Meanwhile, the Republic of Congo and Equatorial Guinea are not likely to meet the MDGs. With regard to sanitation, the situation is less bright—the entire CEMAC region is seriously off course for meeting the sanitation MDG. Access to water varies widely across the CEMAC region, as shown by the per centage of the population with access to utility water, whether from private taps or public stand posts (Figure 4.12a). Gabon stands out as the regional leader, with piped water access greater than 70 percent and a further 10 percent having access to standposts. About half the populations of Cameroon and the Republic of Congo receive utility water, which is significantly better than the average for Africa’s low-income countries. The Central African Republic, Chad, and Equatorial Guinea lag far behind with only 10–20 percent of their populations benefiting from utility water. Large and arid regions and low population densities in the Central African Republic and Chad explain the limited reliance on water from utilities, with some two-thirds of the population in these countries relying on wells and boreholes. Equatorial Guinea is particularly worrisome, with more than half the population continuing to rely on unsafe surface water. A similar dichotomy can be seen in sanitation (Figure 4.12b). Chad and Equatorial Guinea present the most desperate situation, with 50–70 percent of their populations continuing to rely on open defecation, a highly insanitary practice. Elsewhere in the region, the practice of open defecation has been brought to less than

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 75

100 90 80 70 60 50 40 30

Percentage of population 20 10 0 a c Chad SSA Gabon CEMAC Cameroon Congo,Rep. of African Republi Equatorial Guine

Central

Surface water Wells and boreholes Standposts Piped water

100 90 80 n 70 60 50 40 30

Percentage of populatio 20

10 0 a n Chad SSA Gabon CEMAC Cameroo Congo,Rep. of African Republic Equatorial Guine

Central

Open defecation Traditional latrines Improved latrines Flush toilets and septic tanks Figure 4.12 Access to Water and Sanitation by Modality Sources: AICD calculations based on WHO/UNICEF Joint Monitoring Programme country reports 2010 (http://www.wssinfo.org/documents-links/documents/?tx_displaycontroller[type]=country_files). Note: CEMAC 5 Central African Economic and Monetary Community; SSA 5 sub-Saharan Africa.

©International Monetary Fund. Not for Redistribution 76 CEMAC’s Infrastructure Gap: Issues and Policy Options

Table 4.8 Benchmarking Performance of CEMAC’s Water Utilities SODECA, Low- Central SDNE, Low- Income Resource- Middle- SNEC, African Republic SEEG, Income Countries/ Rich Income Indicator Cameroon Republic of Congo Gabon Countries Fragile Countries Countries Collection ratio n.a. 86 91 n.a. 90 97 72 100 (% of billed) Connections n.a. 62 136 181 151 181 116 369 per employee Nonrevenue 37 51 28 18 37 32 41 27 water (%) Operating cost 79 64 82 101 97 81 100 82 recovery ratio (%)

Source: Derived from Briceño-Garmendia, Smits, and Foster, 2009. Note: n.a. 5 Not available.

20 percent. In the Republic of Congo and Gabon, the majority of the population is using traditional latrines that provide limited sanitary protection. Only in Cameroon and the Central African Republic do improved latrines reach a substantial share of the population. Across the region, flush toilets, and even septic tanks, are a rarity. With respect to operators, the limited evidence points to important differences in water utilities’ performance within the CEMAC region (Table 4.8). While utilities in Cameroon and the Republic of Congo suffer from relatively high distributional losses (nonrevenue water), Central African Republic’s losses are equivalent to half the water produced. Nonrevenue water in Gabon, however, is comparable to global standards. The operating costs for water production are higher than the revenue generated via tariffs in Cameroon, the Central African Republic, and the Republic of Congo. Cost recovery for both water and power is a challenge in African utilities. Although subsidies are often justified politically for making services affordable to the poor, the reality is that the poor are rarely connected to these services. Tariffs set at cost-recovery levels are typically affordable for the relatively well-off households that enjoy access. However, subsidies can be helpful in relation to system expansion. Targeted and trans parent subsidies to connections, capital investment (in-lending to utilities with a grace period), and well-designed tariff schemes in which cross subsidies are determined based on an affordability analysis are important policy options. The inefficiency issues arise when subsidies are hidden and nontransparent, which not only distorts con sumption but also severely hampers the financial health of providers, deters private investors from entering the industry, and stifles network expansion and maintenance. Aggressive increases in access to utility water passes through sector reforms targeting improvements in efficiency to fulfill basic water and sanitation needs in the region.

Information and Communications Technology Although mobile telephony has made major strides in the CEMAC region, the basic fiber optic backbone infrastructure necessary for providing adequate interna tional and Internet connectivity is conspicuous by its absence (Figure 4.13). Access

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 77

ICT ALGERIA LIBYA EGYPT Fiber (Existing) Fiber (Planned) ICT GSM Coverage

MALI NIGER

CHAD SUDAN BURKINA FASO

BENIN NIGERIA TOGO GHANA ETHOPIA

CENTRAL AFRICAN REPUBLIC CAMEROON

SÃO TOMÉ AND PRÍNCIPE EQUATORIAL GUINEA UGANDA REPUBLIC of CONGO GABON CONGO, DEM REP RWANDA

BURUNDI TANZANIA

ANGOLA Figure 4.13 ICT Backbone Infrastructure in the CEMAC Region Source: Foster and Briceño-Garmendia, 2009. to ICT services among CEMAC member states can be broadly categorized into two groups. Cameroon and Gabon, the first group, are leaders in access to ICT services across Internet, telephone, and mobile subscriptions. The Republic of Congo is not far behind with regard to mobile footprint, Internet users, and mainline and mobile telephone access; and Equatorial Guinea also demonstrates high access rates for mainline telephones and mobile telephones. At the other extreme, the Central African Republic and Chad have very low rates of access and are consistently behind the others in all aspects of ICT infrastructure. Mobile coverage and subscriptions in the Central African Republic are a fraction of those in the low-income peer group (Table 4.9). Despite relatively high internet bandwidth in Equatorial Guinea, usage of the service lags far behind similar income peers. The modest levels of access in the region are associated with the high costs for ICT services. Prices for mobile baskets of service, Internet access, and telephones are consistently and significantly higher than trends in resource-rich, low-income, and middle-income countries. Two major issues constrain ICT usage in the region: lack of regional roaming arrangements for mobile telephony and limited access to submarine cables. In other regions of Africa, high international fixed line calling rates are being circumvented through the widespread diffusion of preferential roaming arrange ments for mobile telephony—the preferred mode of communication in any case. These roaming arrangements are helpful because subscribers who belong to one of these networks can use their mobile handsets in the other countries without

©International Monetary Fund. Not for Redistribution 78 CEMAC’s Infrastructure Gap: Issues and Policy Options 7.58 2.78 4.78 8.94 42 10.10 25.44 57.33 95 Countries Middle-Income

3.50 3.01 0.80 5.69 13.15 56 11.03 25.58 42 Countries Low-Income Low-Income 9.24 3.48 8.19 2.04 0.83 41 37.4 11.80 59 Countries Resource-Rich 2.30 1.83 6.21 n.a. 13.70 89.77 80 Gabon 110 150.30

5.61 1.52 1.82 n.a. 97 18.60 35.12 52.49 30 Guinea Equatorial Equatorial 2.40 0.29 0.61 4.29 n.a. 85 18.80 49.98 80 Congo, Congo, Rep. of Rep. 4.56 0.64 0.12 1.19 Chad 12.70 16.00 16.58 50 105 1.83 0.44 0.28 3.55 0.44 12.90 13.70 20 African Central Central 130 Republic 1.80 1.04 3.8 14.30 48 14.40 10.94 32.28 80 Cameroon population ©International Monetary Fund. Not for Redistribution Unit US$ US$ US$ US$ Mbps per capita per 100 people per 100 people per 100 people percent of percent 4.9 e l Price of the fixed telephone basket telephone of the fixed Price Price of the 20-hour Internet basket Price Price of a three-minute the United call to Price States Prices basket price mobile monthly Prepaid Internet bandwidth Telephone lines Telephone Mobile subscriptions Internet users Indicator Access Mobile coverage Benchmarking ICT Infrastructure in the CEMAC Tab Source: Minges, and others, 2009. Minges, and others, Source: and Monetary Economic African Community; 5 Central ICT CEMAC technology;Note: and communications n.a. 5 Not available. 5 information Ranganathan, Foster, and Briceño-Garmendia 79

Table 4.10 Gaps in Intraregional Connectivity and Total Investment Required to Attain Minimum Levels of Regional Connectivity Country Gaps (km) Necessary investment (US$ million) Rep. of Congo 425 12 Central Africa Rep. 325 9 Gabon 1,418 38 Equatorial Guinea 89 2 Total 2,257 61

Source: AICD calculations. paying for incoming calls and paying only local rates for outgoing calls. Such arrangements have become widespread in West and East Africa, facilitated by a favorable regulatory environment as well as by the presence of panregional operators. In the CEMAC region, only the Republic of Congo and Gabon have made progress in promoting preferential interoperator roaming arrangements that are commonly available in other regions in Africa. Despite the presence of the SAT2/WASC undersea fiber optic cable skirting the entire CEMAC coastline on its way from Asia to Europe, only two coastal countries— Cameroon and Gabon—have made connections to this infrastructure (Figure 4.13). By contrast, the remaining coastal and landlocked countries are completely bypassed at present and lack even terrestrial fiber optic connections with neighboring countries connected to the cable, which might at least provide some form of indirect access. With a number of new submarine cables now being laid, there are plans for some CEMAC countries, such as the Republic of Congo, to connect. In addition, the Central Africa Backbone project will ensure fiber optic connectivity into landlocked Central African Republic and Chad. To develop the complete ICT regional backbone infrastructure, including connectivity to the submarine cables, CEMAC member countries will have to install almost 2,300 kilometers of new fiber optic links. However, the investments required are quite modest (Table 4.10). These developments will significantly increase bandwidth, lowering prices of Internet access in the region by as much as 75 percent. However, access to the submarine cable is a necessary but not a sufficient condition to lower prices of critical ICT services. Without competition for access to submarine infrastructure through multiple international gateways, the substantial cost reductions will be captured as monopoly rents rather than being passed on to consumers in the form of lower prices.

Financing the CEMAC’s Infrastructure Meeting the CEMAC region’s pressing infrastructure needs and catching up with developing regions in other parts of the world require rapid expansion of infra structure assets in key areas. For the purposes of this analysis, an illustrative package of infrastructure targets is used (Table 4.11). These are not intended to be norma tive, but are simply reasonable objectives that would help to bring the CEMAC’s

©International Monetary Fund. Not for Redistribution 80 CEMAC’s Infrastructure Gap: Issues and Policy Options

Table 4.11 Illustrative Investment Targets for Infrastructure in CEMAC Sector Economic Target Social Target ICT Install fiber optic links to Provide universal access to GSM signal and public neighboring capitals and broadband facilities submarine cable Power Develop interconnectors to Raise electrification to 84 percent urban and facilitate regional trade 19 percent rural (average 53 percent) based on national targets Transport Achieve regional (national) Provide rural road access to over half the highest- connectivity with good quality value agricultural land, and urban road access two-lane (one-lane) paved road. within 500 meters Water Supply n.a. Achieve Millennium Development Goals, clear and Sanitation sector rehabilitation backlog

Sources: Mayer and others, 2009; Rosnes and Vennemo, 2009; Carruthers, Krishnamani, and Murray, 2009; and You and others, 2009. Note: CEMAC 5 Central African Economic and Monetary Community; GSM 5 Global System for Mobile Communications; ICT 5 information and communications technology; n.a. 5 Not available.

infrastructure performance in line with other developing countries. An examina tion of the feasibility of funding a standardized infrastructure package makes pos sible meaningful cross-country comparisons of the feasibility of these objectives. Based on available information for Cameroon, Chad, the Central African Republic, the Republic of Congo, and Gabon, meeting these illustrative infra structure targets in the CEMAC region would cost US$4.6 billion per year over a decade (Table 4.12). Capital expenditure would account for 70 percent of this requirement. About 60 percent of the overall spending needs are associated with the power and transport sectors. These spending needs would absorb about 10 percent of the CEMAC region’s aggregate GDP. However, at the country level, the burden represented by infra structure spending needs varies widely. For Cameroon, Equatorial Guinea, and Gabon, infrastructure spending needs are well below 10 percent of GDP and should be affordable. For Chad, the Central African Republic, and the Republic of Congo, spending needs amount to 15–20 percent of GDP, comparable to what China has been investing annually to develop its infrastructure. However, this amount is well above historic spending trends in these countries (Figure 4.14).

Table 4.12 Large Infrastructure Spending Needs for the CEMAC Region, 2006–15 Capital Operating Capital Operating Expenditures Expenses Total Expenditures Expenses Total (US$ million (US$ million (US$ million (percent (percent (percent Sector per year) per year) per year) of GDP) of GDP) of GDP) ICT 254 244 498 0.54 0.52 1.06 Power 1,129 415 1,544 2.42 0.89 3.3 Transport (basic) 805 454 1,259 1.72 0.97 2.69 Water supply 680 254 935 1.46 0.54 2 and sanitation Total 3,190 1,371 4,562 6.82 2.93 9.76

Sources: Mayer and other 2009; Rosnes and Vennemo 2009; Carruthers, Krishnamani, and Murray, 2009; and You and others 2009. Note: Derived from models that are available online at http://www.infrastructureafrica.org/aicd/tools/models.

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 81

Low-income countries, fragile Low-income countries, nonfragile CEMAC Resource rich Middle-income countries

Congo, Rep. of Central African Republic Chad Cameroon Gabon Equatorial Guinea 0 5101520253035 40

Percentage of GDP

Capital expenditure Operational expenditure Figure 4.14 Infrastructure Spending Needs as a Share of GDP Source: Foster and Briceño-Garmenidia, 2009. Note: CEMAC 5 Central African Economic and Monetary Community.

During the period 2004–08, CEMAC countries spent an annual average of US$2.5 billion on infrastructure, equivalent to approximately 5 percent of GDP, split more or less equally between capital and operating expenditures (Table 4.13). Spending was strongly concentrated in the transport sector. Infrastructure spend ing in the CEMAC is generally consistent with what resource-rich countries elsewhere in Africa have been spending. Spending effort ranged from a low of about 3 percent of GDP in Chad to a high of almost 8 percent of GDP in the Republic of Congo (Figure 4.15) Thus, existing spending levels are approxi mately half the spending needs identified for the CEMAC region. The oil-rich countries should find it feasible to substantially step up infrastructure spending if petroleum royalties could be captured in government budgets. However, for the

Table 4.13 Public Sector Infrastructure Spending in CEMAC Countries, 2004–08 (US$ million per year) Operations and Maintenance Capital expenditure Public Non-OECD Total capital Total Sector Public sector sector ODA financiers PPI expenditures spending ICT 173 163 7 11 135 315 488 Power (nontrade) 434 85 31 34 60 210 644 Transport 443 334 134 51 39 558 1,001 Water supply and 122 102 64 3 29 199 321 sanitation1 Total 1,178 685 235 100 263 1,283 2,461

Sources: Mayer and others, 2009; Rosnes and Vennemo, 2009; Carruthers, Krishnamani, and Murray, 2009; and You and others, 2009. Note: CEMAC 5 Central African Economic and Monetary Community; ICT 5 information and communications technology; ODA 5 Official development assistance; OECD 5 Organization for Economic Cooperation and Development; PPI 5 Private participation in infrastracture. 1Includes irrigation.

©International Monetary Fund. Not for Redistribution 82 CEMAC’s Infrastructure Gap: Issues and Policy Options

SSA

Low-income countries, fragile CEMAC Middle-income countries Low-income countries, nonfragile Resource rich

Chad Cameroon Central African Republic Congo, Rep. of 0 246810 12

Spending as a share of GDP

Capital expenditure Operational expenditure Figure 4.15 Infrastructure Spending as a Share of GDP Source: Derived from Foster and Briceño-Garmendia, 2009. Note: CEMAC 5 Central African Economic and Monetary Community; SSA 5 sub-Saharan Africa.

Central African Republic, with its relatively large infrastructure needs and lack of resource revenue, closing the funding gap will be a far greater challenge. More than 75 percent of all recent infrastructure spending, including half of all capital expenditures, in CEMAC countries has been funded by the public sector (Figure 4.16). Even in the ICT sector, for which private funds are generally available, the public sector has financed about 50 percent of capital spending. Official develop ment assistance has also made a significant, though secondary, contribution to fund ing transport and water and sanitation investments. The external private sector has been a major financier of ICT infrastructure and has made a modest contribution to

1.4

1.2

0.8

0.6 Share of GDP 0.4

0.2

0 ICT Power (trade) TransportWater supply and sanitation Public Sector ODA Non-OECD Financiers PPI Figure 4.16 Sources of Investment Funding in the CEMAC Region Sources: Derived from Briceño-Garmendia , Smits, and Foster, 2009. Note: CEMAC 5 Central African Economic and Monetary Community; ICT 5 information and communications techonology; ODA 5 Official development assistance; OECD 5 Organization for Economic Cooperation and Development; PPI 5 private participation in infrastracture.

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 83

Table 4.14 Potential Gains from Tackling Infrastructure Inefficiencies (US$ million per year) Operational Inefficiencies Labor Under- Under- Capital Tariff Sector inefficiencies Losses collection maintenance Total Execution Recovery ICT 66 n.a. n.a. n.a. 66 0 n.a. Power 86 264 28 0 378 38 374 (non-trade) Transport n.a. n.a. 68 0 68 86 32 Water supply 19 14 7 0 40 8 137 and sanitation Total 172 278 102 0 551 132 544

Sources: Derived from Foster and Briceño-Garmendia, 2009. Note: n.a. 5 Not available. other areas of infrastructure. In contrast to other African countries, CEMAC mem bers have not benefited greatly from non-OECD financing for infrastructure, although there has been some investment in both transport and power. China is becoming an active financier of infrastructure projects in the CEMAC region, sup porting hydropower projects in Cameroon and Gabon, and modernizing water plants in Cameroon. China has also been involved in financing new rail construction projects linking Belinga iron ore mines to the port of Santa Clara in Gabon. Regardless of the secured financing sources, a major policy issue is that much more can be done within the existing resource envelope to meet infrastructure needs in the CEMAC region. This starts by tackling the inefficiencies across infrastructure sectors. Approximately US$1.2 billion per year can be recovered by addressing inef ficiencies (Table 4.14). The largest drain by far occurs in the power sector, with inefficiencies valued at US$790 million annually, deriving equally from underpric ing and operational deficiencies. The transport and water sectors each hemorrhage some US$185 million of resources annually. Underpricing is the key source of inefficiency in water. For transport, low capital budget execution is the major issue. Bringing the CEMAC’s infrastructure up to par comes with a substantial price tag of US$4.6 billion a year over a decade. The region already spends US$2.4 billion a year on infrastructure—but inefficiencies account for a staggering US$1.2 billion of that sum. If the region could correct these inefficiencies, the funding gap would drop to a manageable US$874 million a year (Table 4.15). This would amount to

Table 4.15 Tackling Inefficiencies to Reduce the Funding Gap (US$ million per year) Water Supply ICT Irrigation Power Transport and Sanitation Total Needs 2498 2326 21,544 21,259 2935 24,562 Spending traced to needs 427 4 625 1,001 321 2,378 Within sector reallocation 61 3 19 0 0 83 Potential efficiency gains 66 0 790 185 185 1,227 Gap or surplus 57 2318 2110 273 2429 2874

Source: Derived from Foster and Briceño-Garmendia, 2009.

©International Monetary Fund. Not for Redistribution 84 CEMAC’s Infrastructure Gap: Issues and Policy Options

Chad

Central African Republic

Congo, Rep. of

CEMAC

Gabon

Cameroon

024681012

Share of GDP Figure 4.17 Funding Gap as a Percentage of GDP Source: Foster and Briceño-Garmendia, 2009. Note: CEMAC 5 Central African Economic and Monetary Community.

about 5 percent of the region’s GDP (Figure 4.17). The largest funding gaps are in the water and sanitation (including irrigation) sectors. Despite the very high power spending needs, much of the requirement in this sector can be met from capturing internal inefficiencies; the resulting funding gap is relatively small. A number of policy choices relating to selection of technologies and regional approaches to infrastructure development could also contribute to reducing the funding gap by lowering the costs of meeting infrastructure targets. Adopting lower-cost technologies, such as standposts, boreholes, and latrines for meeting the MDGs in the water supply and sanitation sector, could save US$200 million annually. Adopting more appropriate standards for paved roads could shave almost US$400 million from the cost of achieving good road connectivity. Regional power trade, based on hydropower exports from Cameroon, could reduce the costs of energy supply by almost US$160 million. Measures such as these could potentially eliminate the infrastructure funding gap for power and transport, and almost halve it for water and sanitation. If all such measures were applied, the overall funding gap would fall to US$0.5 billion annually.

What Else Can Be Done? There are at least two other ways to close the remaining infrastructure gap: raise additional finance and set less ambitious timeframes for infrastructure development. The region’s oil boom could generate the necessary resources to finance infra structure. The extent to which resource royalties are channeled toward infrastruc ture is largely a political choice, and different examples exist across Africa. In Nigeria, for example, infrastructure spending actually declined during the oil boom of the early 2000s because the country chose to use the windfall to pay off accumulated debts. Angola and Sudan, however, seem to have channeled a sub stantial share of their oil wealth into infrastructure, leading to massive public investment programs in roads and power. Nevertheless, on average, resource-rich

©International Monetary Fund. Not for Redistribution Ranganathan, Foster, and Briceño-Garmendia 85

3.5

2.5

1.5 GD P share 1

0.5

0 a o a a e a go Mali Niger Chad To Keny Liberia Ghananzania BeninSudan Afric Uganda Nigeria Zambia Malawi GabonGuinea AngolaBurundi Senegal Rwanda Ta Lesoth Ethiopia Mauritius NamibiaComoros CameroonSeychelles MauritaniZimbabw BotswanSwaziland DRC Congo MozambiqueBurkina Faso MadagascarSierra Leone Côte d'Ivoire South Congo, Rep. Guinea-Bissau African Republic Equatorial Guinea

Central Figure 4.18 Private Investment for Infrastructure Source: AICD calculations. countries have spent less on infrastructure as a percentage of GDP than have low- and middle-income or even fragile states in Africa. The natural resource–endowed CEMAC countries could allocate more resources to financing infrastructure provision, as long as commensurate improvements in public expenditure manage ment systems are made to ensure that those resources are efficiently used. Attracting private investment for infrastructure is another possible source of financing. During the early 2000s, Cameroon, for example, captured private investment commitments worth about 0.9 percent of its GDP, even as the sub-Saharan African countries capturing the highest level of private investment reached about 1.5 percent of GDP in private investment (Figure 4.18). In other CEMAC countries, the volume of private finance is much lower (Gabon and the Republic of Congo) or almost nonexistent (the Central African Republic, Chad, and Equatorial Guinea). However, the challenges of the political economy and an uncompetitive invest ment climate need to be addressed to encourage large inflows of private financing for infrastructure in CEMAC member countries. Establishing a proper legal and institutional framework is a critical priority area for attracting private infrastruc ture financing as well as for managing fiscal risks from such engagements. Assuming that CEMAC member states do not raise any additional funding and do not implement the cost-saving policies described above, the only way to meet the infrastructure targets identified would be to take a longer time than the decade that was contemplated at the outset of this exercise. If the CEMAC region were able to correct the various inefficiencies identified above, and preserve overall spending at current levels, the targets would take 18 years to reach. Without tackling ineffi ciencies, attaining suitable levels of infrastructure seems an impossible proposition.

References Adam, Christopher, and David Bevan, 2006, “Aid and the Supply Side: Public Investment, Export Performance and the Dutch Disease,” World Bank Economic Review, Vol. 20, No. 2, pp. 261–90. Banerjee, Sudeshna, Vivien Foster, Yvonne Ying, Heather Skilling, and Quentin Wodon, 2009, “Cost Recovery, Equity, and Efficiency in Water Tariffs: Evidence from African Utilities,” AICD Working Paper 7 (Washington: World Bank).

©International Monetary Fund. Not for Redistribution 86 CEMAC’s Infrastructure Gap: Issues and Policy Options

Banerjee, Sudeshna, Heather Skilling, Vivien Foster, Cecilia Briceño-Garmendia, Elvira Morella, and Tarik Chfadi, 2008, “Ebbing Water, Surging Deficits: Urban Water Supply in Sub-Saharan Africa,” AICD Background Paper 12 (Washington: World Bank). Briceño-Garmedia, Cecilia, and Vivien Foster, 2010, “Republic of Congo, Prioritizing Infrastructure Investments: A Spatial Approach” (unpublished, Washington: World Bank). Briceño-Garmendia, Cecilia, Karlis Smits, and Vivien Foster, 2009, “Financing Public Infrastructure in Sub-Saharan Africa: Patterns and Emerging Issues,” AICD Background Paper 15 (Washington: World Bank). Briceño-Garmendia, C., and M. Shkaratam, 2011, “Power Tarrifs: Caught Between Cost Recovery and Affordability,” Working Paper 5904 (Washington: World Bank). Calderón, César, 2009, “Infrastructure and Growth in Africa,” Policy Research Working Paper No. 4914 (Washington: World Bank). Carruthers, Robin, Ranga Rajan Krishnamani, and Siobhan Murray, 2009, “Improving Connectivity: Investing in Transport Infrastructure in Sub-Saharan Africa,” AICD Background Paper 7 (Washington: World Bank). Commission for Africa, 2005, Our Common Interest, Report of the Commission for Africa, London. Eberhard, Anton, Vivien Foster, Cecilia Briceño-Garmendia, Fatimata Ouedraogo, Daniel Camos, and Maria Shkaratan, 2009, “Underpowered: The State of the Power Sector in Sub-Saharan Africa,” AICD Background Paper 6 (Washington: World Bank). Escribano, Alvaro, J. Luis Guasch, and Jorge Peña, 2010, “Assessing the Impact of Infrastructure Quality on Firm Productivity in Africa,” Policy Research Working Paper No. 5191 (Washington: World Bank). Foster, Vivien, and Cecilia Briceño-Garmendia, eds., 2009, Africa’s Infrastructure: A Time for Transformation (Paris and Washington: Agence Française de Développement and World Bank). Gwilliam, Ken, Vivien Foster, Rodrigo Archondo-Callao, Cecilia Briceño-Garmendia, Alberto Nogales, and Kavita Sethi, 2009, “The Burden of Maintenance: Roads in Sub-Saharan Africa,” AICD Background Paper 14 (Washington: World Bank). Husband, Charles, Gary McMahon, and Peter van der Veen, 2009, “The Aluminum Industry in West and Central Africa: Lessons Learned and Prospects for the Future,” Extractive Industries and Development Series No. 13 (Washington: World Bank). Mayer, Rebecca, Ken Figueredo, Mike Jensen, Tim Kelly, Richard Green, and Alvaro Federico Barra, 2009, “Connecting the Continent: Costing the Needs for Spending on ICT Infrastructure in Africa,” AICD Background Paper 3 (Washington: World Bank). Minges, Michael, Cecilia Briceño-Garmendia, Mark Williams, Mavis Ampah, Daniel Camos, and Maria Shkratan, 2009, “Information and Communications Technology in Sub-Saharan Africa: A Sector Review,” AICD Background Paper 10 (Washington: World Bank). Rosnes, Orvika, and Haakon Vennemo, 2009, “Powering Up: Costing Power Infrastructure Spending Needs in Sub-Saharan Africa,” AICD Background Paper 5 (Washington: World Bank). Teravaninthorn, Supee, and Gael Raballand, 2009, Transport Prices and Costs in Africa: A Review of the Main International Corridors (Washington: World Bank). United States International Trade Commission, 2009, Sub-Saharan Africa: Effects of Infrastructure Conditions on Export Competitiveness, Third Annual Report, USITC Publication 4071 (Washington). World Bank, 2008, Doing Business 2009: Comparing Regulation in 181 Economies (Washington). ———, 2009, Information and Communications for Development 2009: Extending Reach and Increasing Impact (Washington). ———, 2010, “Gabon Infrastructure Framework Review,” Public Private Infrastructure Advisory Facility (unpublished; Washington). You, L., C. Ringler, G. Nelson, U. Wood-Sichra, R. Robertson, S. Wood, G. Zhe, T. Zhu, and Y. Sun, 2009, “Torrents and Trickles: Irrigation Spending Needs in Africa,” AICD Background Paper 9 (Washington: World Bank).

©International Monetary Fund. Not for Redistribution part II

Management of Oil Wealth and Poverty Reduction

©International Monetary Fund. Not for Redistribution This page intentionally left blank

©International Monetary Fund. Not for Redistribution CHAPTER 5

Managing Oil Windfalls in the CEMAC

Frederick van der Ploeg

Natural resource rents worldwide exceed $4 trillion annually, amounting to some 7 percent of global GDP. Nonrenewable resource revenue is a dominant feature of 50 economies with a combined population of 1.4 billion. In 24 countries, resources make up more than three-quarters of exports. Resources account for at least 40 percent of GDP in 13 countries and more than half the fiscal revenue in 18 countries (IMF data 2000–05). Some countries (e.g., Botswana, Chile, and Malaysia) have grown fast on the basis of this revenue, but others (Nigeria and Cameroon, for instance) have not, and have been labeled as countries suffering from the “resources curse.” Turning attention to the Central African Economic and Monetary Community (CEMAC), Table 5.1 shows oil revenue as a percentage of GDP for each of the member countries. Oil revenue as a share of GDP ranges from zero for the Central African Republic to about 17 percent for Gabon, 23 percent for Chad, and 37 percent for the Republic of Congo in 2011. Figure 5.1 indicates that CEMAC oil production rose until 2005, dropped slightly through 2011, and is projected to fall rapidly during the next two decades. As a result of this oil depletion, Table 5.1 shows that CEMAC oil revenue as a percentage of GDP is anticipated to fall during the coming years, in sharp contrast to a country such as Iraq, whose oil revenue is projected to last well beyond the foreseeable future. From the point of view of the permanent-income hypothesis, Iraq should consume all of its oil windfall every year, while the countries of the CEMAC should save a certain portion to generate a sufficient return on sovereign wealth to finance a sustained increase in consumption. From a development perspective, however, investing in sovereign wealth (e.g., U.S. Treasury bills with a low rate of interest) seems unlikely to be better than using the oil revenue to pay off foreign debt (which typically carries a higher interest rate) or invest in domestic infrastructure, education, or health projects (with typically a much higher rate of return). Figure 5.2 shows that the CEMAC’s near-term economic prospects are not particularly good despite recent reserves accumulation. GDP growth is projected to be flat at very modest levels, and the share of investment in GDP gradually falls. The predictions for the CEMAC region suggest that very little of the windfall, which is forecast to continue until 2015–16, will be used for investment; instead, it will be used to maintain historically high government spending while keeping the burden of foreign debt as a percentage of GDP fairly low. Trade surpluses are expected to fall as oil revenue flattens out. Despite projected surpluses for the trade 89

©International Monetary Fund. Not for Redistribution 90 Managing Oil Windfalls in the CEMAC 5.0 0.0

2016

13.0 24.8 16.9 13.0 12.7 5.2 0.0

2015

14.4 27.1 18.6 13.8 13.9 6.0 0.0

2014

15.9 29.9 20.6 14.4 15.3 Projections 5.4 0.0

2013

16.3 34.1 22.1 15.2 16.5 5.2 0.0

2012

17.5 35.8 24.5 15.8 17.7 4.8 0.0

2011

22.7 37.4 25.9 17.1 19.1 4.5 0.0

2010

17.4 31.8 25.9 15.3 16.5 4.8 0.0 8.6

2009

20.7 37.1 16.2 15.6 7.6 0.0

2008

20.8 40.1 34.6 20.9 22.4 6.4 0.0

2007

16.8 32.1 33.9 17.3 18.6 6.8 0.0 0.0

2006

37.9 37.5 20.3 18.4 5.0 0.0 0.0 2005

31.8 31.7 19.8 15.2 3.9 0.0 0.0 2004

21.6 26.4 16.6 10.9 4.1 0.0 0.0 2003

20.8 23.2 17.5 10.1 ©International Monetary Fund. Not for Redistribution 4.9 0.0 0.0 2002

18.9 22.6 17.7 10.3 4.8 0.0 0.0 2001

21.0 22.5 21.8 11.5 5.8 0.0 0.0 2000

20.3 15.3 22.6 12.0 of 5.1 e bl Cameroon African Central Republic Chad Congo, Republic Congo, Equatorial Guinea Equatorial Gabon CEMAC a Oil Revenue in the CEMAC countries (Percent of GDP) (Percent countries in the CEMAC Oil Revenue T Central African Economic and Monetary Economic African Community. 5 Central CEMAC Note: van der Ploeg 91

450 400 Projected output 350

300 250 200 150 Millions of barrels 100 50 0 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 Figure 5.1 CEMAC Oil Production Sources: IMF African Department database; and IMF staff estimates. Note: CEMAC 5 Central African Economic and Monetary Community. balance and falling foreign debt, the current account will show modest deficits. Government budgets are also expected to stay in modest surplus. The crucial question is whether the CEMAC countries could have harnessed their oil windfalls better and whether they can do so more successfully as their streams of oil revenue decline. After all, controlling for initial income per capita, investments in physical and human capital, trade openness, and rule of law, natural resource dependence (measured by the ratio of natural resource exports to GDP) has a strong and significant negative effect on growth of GDP per capita (Table 5.2, column 1). All things equal, an increase in the ratio of resource exports to GDP of 10 percentage points depresses average growth of GDP per capita by 1.1 percent per year. However, empirical evidence supports the hypothesis that countries with good institutions receive a positive growth effect from resource dependence, while those with bad institutions are adversely affected. Increasing the ratio of natural resource exports to GDP by 10 percentage points increases average growth by a mere 0.1 percent per year in countries with good institutions (a weighted index of various indicators measured on a scale from zero to one) but decreases annual growth by 1.43 percent in countries with bad institutions (Table 5.2, column 2). The very small effect of windfalls on growth if institutions are good suggests that the effect of institutions on growth may well be asymmetric—windfalls hurt economic performance if institutions are poor but do not necessarily improve performance if institutions are good. It has also become clear that volatile commodity prices are a key driver of the natural resource curse; natural resource dependence, unrestricted international capital flows, being landlocked, and ethnic tensions boost the volatility of per capita growth and thus depress growth prospects (van der Ploeg and Poelhekke, 2010).1 The fundamental problem faced by the oil-rich economies of the CEMAC is how to transform their oil wealth into a portfolio of other assets—human capital (education and health), domestic physical capital (both private and public), and perhaps foreign

1A detailed survey of the evidence for and causes of the natural resource curse is given in van der Ploeg (2011).

©International Monetary Fund. Not for Redistribution 92 Managing Oil Windfalls in the CEMAC

25 Reserves 14 Real GDP growth 12

20 P 10 15 8 6

10 ent of GD

rc 4

5 Pe 2 0 0 2000 2002 2004 2006 2008 2010 2000 2002 2004 2006 2008 2010 2012 2014 2016

Total external debt Balance on current account 8 90 6 80 4 P 70 2 60 0 50 –2 40 ent of GD 30 rc –4 20 Pe –6 10 –8 0 –10 2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016

Trade balance Total investment 25 29 27

20 P 25 15 23 21 10 ent of GD

rc 19

5 Pe 17 0 15 2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016

General government balanceGeneral government total expenditure 25 29 27

20 P

P 25 15 23 21 10 ent of GD rc ent of GD 19 rc 5 Pe

Pe 17 0 15 2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016 –5 Figure 5.2 Macroeconomic Characteristics of the Central African Economic and Monetary Community Sources: IMF, International Financial Statistics; IMF, World Economic Outlook, April 2011; and IMF staff estimates.

financial assets—that yields a continuing and growing flow of income to their citizens. The World Bank’s (2006) estimates of adjusted net saving or genuine saving2 provide a measure of the extent to which many oil-rich countries have failed to do this, and the CEMAC countries do not appear to be an exception: the oil-rich Cameroon, Republic of Congo, and Equatorial Guinea have saving rates of 22.5 percent, 214.6 percent,

2These add to the usual definition of saving a measure of education spending to reflect investment in human capital and subtract depreciation of physical and human capital, the use of natural resources (making special allowances for renewable resources such as fish and forests), and the deterioration in environmental quality (mainly arising from carbon dioxide and fine particles pollution).

©International Monetary Fund. Not for Redistribution van der Ploeg 93

Table 5.2 Cross-Country Empirical Evidence for the Natural Resource Curse (Annual growth in real GDP per capita)

Sachs and Warner (1997) Mehlum, Moene, and Torvik (2006) Initial income 21.76 (8.56) 21.26 (6.70) Openness 1.33 (3.35) 1.66 (3.87) Resource dependence 210.57 (7.01) 214.34 (4.21) Rule of law 0.36 (3.54) n.a. Institutional quality n.a. 21.3 (1.13) Investments 1.02 (3.45) 0.16 (7.15) Interaction term n.a. 15.40 (2.40) Number of countries 71 87 Adjusted R2 0.72 0.71

Source: Author’s compilation. Note: n.a. 5 Not available. and 235.7 percent, respectively; the Central African Republic has no oil, but has a slightly positive genuine saving rate of 0.5 percent (World Bank, 2006). This suggests that the CEMAC countries were not effectively transforming their oil wealth into productive assets. A country successfully converting its oil reserves into physical, human, or financial capital or sovereign wealth does not run down its genuine natural wealth. The projections presented in Figure 5.1 suggest that the genuine saving rate may have become even more negative in recent years. Indeed, negative genuine saving rates have been persistent for large parts of sub-Saharan Africa, indicating that these countries have been running down their national wealth. The present analysis offers a theoretical framework for addressing the question of how the oil-rich CEMAC countries can successfully transform their oil wealth into productive assets and harness their oil windfalls for economic development.3 The chapter first discusses the benchmark that corresponds to the orthodox view of putting all the revenue from diminishing oil wealth into a sovereign wealth fund. It then argues that investment should be made in the domestic economy rather than exclusively in a sovereign wealth fund, because many developing economies face the twin problems of capital scarcity and declining efficiency as public investment in physical and human capital (i.e., infrastructure and health and education) is ramped up. The argument is then refined by making the case for “investing to invest,” which is necessary for overcoming the absorption problems resulting from Dutch disease and the difficulty of shunting private and public capital from the traded sectors to the nontraded sectors to release capital and other factors of production to make expansion of the latter sectors feasible. Because absorption problems may be most acute in the short run, temporarily parking some of the oil revenue in a sovereign wealth fund might be wise until the

3This analysis is based on earlier works (Collier and others, 2010; van der Ploeg and Venables, 2011a, 2011b, 2011c; and van der Ploeg, forthcoming).

©International Monetary Fund. Not for Redistribution 94 Managing Oil Windfalls in the CEMAC

economy has sufficient capacity to satisfy the increased demand for investment and consumption goods. Finally, the chapter summarizes a brief policy conclusion.

Benchmark: Put Oil Revenue in a Sovereign Wealth Fund The orthodox policy view has been to accumulate the windfall in a sovereign wealth fund and live off the interest from the fund afterward (e.g., Barnett and Ossowski, 2003). This view gives rise to the bird-in-hand policy, which presumes no increase in consumption ahead of the windfall and a gradual buildup of consumption during the windfall. After the windfall, the sovereign wealth fund is gradually depleted, which leads to a withering away of the earlier increases in consumption. If future oil revenue can be used as collateral for borrowing, the permanent-income policy comes into play, whereby borrowing occurs ahead of the windfall, then during the windfall the debt is paid off and sovereign wealth is accumulated sufficient to sustain a permanent increase in consumption. Although the bird-in-hand policy is often advo- cated on grounds of prudence, the volatility of consumption under that policy compared with under the permanent-income policy leads to large welfare losses. To illustrate the permanent-income rule and determine how much of the oil windfall to save and how much to consume, the analysis supposes that households receive exogenous production income Y and government transfers or citizen dividends T and have no access to the international capital market, so that their consumption is C 5 Y 1 T. All foreign assets A are held by the government and earn a return equal to the world interest rate r. The economy’s budget constraint is thus given by

A˙ 5 rA 1 N 1 Y 2 C 5 rA 1 N 2 T, A(0) 5 A0, (5.1) in which N is the size of the exogenous oil windfall. The first part of equation (5.1) says that the current account must equal the increase in assets of the nation; the second part indicates that the government surplus equals the increase in government assets. The size of the sovereign wealth fund of this economy is thus given by A. The present value of the oil windfall plus sovereign wealth should cover the present value of government transfers. Alternatively, we have

 1 1 5 2r (s2t ) YP(t ) NP(t ) rA(t ) r t e C (s)ds, (5.2)

 1 5 2r (s2t ) NP(t ) rA(t ) r t e T (s)ds,

where the permanent values of production income and the oil windfall are given 2r (s2t ) 2r (s2t ) by, respectively, YP (t )  r t e Y (s)ds and NP(t )  r t e N (s)ds. In situ oil wealth is NP/r. Private utility is

 1 2 1/ C(t ) 2 1 2  __ e t dt, (5.3) 0 1 2 1/

where r 5 r . 0 is the rate of time preference and s . 0 is the coefficient of intertemporal substitution. The government chooses the time paths of government

©International Monetary Fund. Not for Redistribution van der Ploeg 95 transfers and saving to maximize private utility (5.3) subject to the budget constraints (5.1) and (5.2). This yields optimal consumption and government transfers

C 5 YP 1 NP 1 rA, T 5 NP 1 rA 2 (Y 2 YP). (5.4)

Government transfers, and thus private consumption, respond to the permanent component (i.e., the annuity value of the stream of present and future natural resource revenue) and not the actual component of the oil windfall. This is achieved by borrowing ahead of a windfall, saving during the windfall, and using the interest on the accumulated sovereign wealth fund to finance the sustained increase in transfers and consumption after the windfall. The government surplus and current account thus respond to the temporary component of the windfall, A˙ 5 N 2 NP 1 Y 2 YP. The nonwindfall primary deficit (N 2 A˙) is driven by the permanent component of the windfall. If oil revenue declines exponentially at an annual rate of 10 percent and r 5 0.025 (as indicated by the “Windfall” line in the left panel of Figure 5.3), one-fifth of the windfall is the permanent component, which is consumed (“Consumption” in the left panel of Figure 5.3), and four-fifths is saved in sovereign wealth and shows up in temporary current account surpluses. It can also be seen that as oil wealth is depleted (“In situ resource wealth” in the right panel of Figure 5.3 or the falling permanent oil income line indicated by “Permanent oil income” in the left panel of Figure 5.3), the permanent-income rule builds up corresponding sovereign wealth (right panel of Figure 5.3) to leave total wealth unaffected. This ensures a sustained increase in citizens’ consumption. The orthodox bird-in-hand and permanent-income policy rules are popular and may be suited to the interests of mature, oil-rich economies, but they are wholly unsuitable for the countries of the CEMAC. In developing economies, the separation theorem, which states that domestic investment decisions should be completely independent of domestic saving and windfalls of foreign exchange, is simply not valid because these countries face capital scarcity and are not well integrated into world financial markets (van der Ploeg and Venables, forth coming). Developing economies thus need to depart from the partial equilibrium framework and confront the arduous task of harnessing oil revenue for growth and development. Before turning to that topic, the chapter discusses the problems of capital scarcity and the absorption problems that result from the inevitable inefficiencies that arise when ramping up public investment in physical and human capital in developing economies.

Two Obstacles: Capital Scarcity and Inefficiencies from Ramping Up Public Investment The CEMAC countries face two big obstacles to economic development, and any strategy for harnessing oil windfalls must tackle these obstacles. First, these countries are badly integrated into international capital markets. Borrowing for

©International Monetary Fund. Not for Redistribution 96 Managing Oil Windfalls in the CEMAC

1.0 0.9

P 0.8 Windfall, N 0.7 all GD 0.6 0.5 Current account 0.4 0.3 Consumpon acons of non-windf

Fr 0.2 0.1 Permanent oil income 0 0 510152025303540 Year

9 8 Total wealth P 7

all GD 6 5 4 3 In situ resource wealth

acons of non-windf 2 Fr Sovereign wealth fund 1 0 05 10 15 20 25 30 35 40 Year Figure 5.3 Permanent-Income Prescription for a Temporary Windfall Source: Author’s calcluations.

domestic investment typically requires payment of a much higher interest rate than the world interest rate. This is a pity, because many public investment projects, in both physical infrastructure and human capital such as education and health, could generate a much higher rate of return than the world interest rate. To capture the effects of this obstacle, the analysis draws on previous empirical work that finds that the interest premium increases with the degree of capital scarcity and decreases with the ability to pay as measured by the size of the oil windfall (Akitoby and Stratmann, 2008). A semi-elasticity of the natural log of the spread is estimated with respect to the debt-to-GNI ratio of 1.9. This implies that a 10 percentage point increase in the debt-to-GNI ratio pushes up the interest differential by 6.9 percentage points if the economy starts out with a debt-to-GNI ratio of 100 percent (or 1.3 percentage points if it starts off with no

©International Monetary Fund. Not for Redistribution van der Ploeg 97 foreign debt). To the extent that oil income is part of GNI, it becomes easier for the country to service its debt, so creditworthiness will be higher.4 This empirical finding suggests that it is necessary to depart from the permanent-income policy by increasing consumption less strongly, using the remainder of the windfall to alleviate capital scarcity and gradually boost investment in the domestic economy, and thus speed up the process of economic development (van der Ploeg and Venables, 2011b).5 The section on capital scarcity uses these ideas to examine the optimal public investment paths after an oil windfall in a framework that also deals with the second obstacle. The second obstacle to economic development is that absorption constraints limit the use of an oil windfall to rapidly scale up public investment. Capacity, institutional, legal, and training constraints lengthen the time it takes to implement public investment projects efficiently, both in infrastructure and in human capital. Given that public investment can be half or more of total investment in developing economies, this is a serious constraint on potential growth. It takes a long time to recognize, implement, and realize a public investment project, especially if it is large. For example, making a sizable parcel of land suitable for modern agriculture, which requires investment in large-scale irrigation, may involve many years of negotiation with local chiefs to get permission to use the land. Years might be needed for the bureaucracy, local government, and national government to agree to undertake a particular project. And sufficient capacity to supply the necessary investment goods might be lacking. For all these reasons, not all the money spent on public sector investment will result in increases in the public sector capital stock, and public investment will be more costly in the early stages of economic development when interest rates are high. Recent studies suggest that only 40 to 60 percent of spending on public investment gets delivered and leads to effective accumulation of public sector capital, and low-income countries such as most of those in the CEMAC are likely to be at the lower end of this range (Dabla-Norris and others, 2011). The public investment management index (PIMI) illustrates this problem. The PIMI is defined as the ratio of the part of public investment that yields effective public sector capital accumulation to total spending on public investment. PIMI data were obtained through surveys about the effectiveness of project appraisal, selection, implementation, and evaluation in many countries. The PIMIs that result from these detailed country-level data were then aggregated for 40 low-income, 31 middle-income, and then all 71 countries, and are presented in Table 5.3 for the period 2007–10. Table 5.3 indicates that, on average, only about half of public investment effort translates into productive public capital.

4The cross-country empirical evidence suggests a very weakly significant direct positive effect of natural resource exports on interest rate spreads, indicating, if anything, that resources worsen creditworthiness. This may be the result of the adverse impacts of resources on governance, political stability, and the risk of conflict. 5The oil windfalls of some CEMAC countries yield substantial revenue but are declining. Hence, the CEMAC oil windfalls are insufficient to pay off the whole external debt to remove the problem of capital scarcity altogether.

©International Monetary Fund. Not for Redistribution 98 Managing Oil Windfalls in the CEMAC

Table 5.3 Public Investment Management Index by Income Group, 2007–10

Country group PIMI Appraisal Selection Implementation Evaluation Low income (n 5 40) 0.47 0.21 0.28 0.30 0.20 Middle income (n 5 31) 0.57 0.21 0.30 0.28 0.22 All countries (n 5 71) 0.51 0.21 0.29 0.29 0.21

Sources: Dabla-Norris and others, 2011. Note: PIMI 5 public investment management index.

The PIMI captures the four stages of the project investment process: (i) appraisal, (ii) selection, (iii) implementation, and (iv) evaluation. The PIMI- adjusted measure of public capital is only 30 percent of GDP compared with 71 percent for the unadjusted measure in low-income countries (Dabla-Norris and others, 2011). The big declines in adjusted public capital in low-income countries are attributable to the low efficiency of new investments; in middle-income countries, the low efficiency of new investments has been offset by large investment efforts. These declines are in sharp contrast to the rise in the unadjusted measure of public capital. Despite the very high investment rates in much of sub-Saharan Africa, including the CEMAC countries, the projects have not delivered the expected growth and welfare results (e.g., Tabova and Baker, 2011). However, if the efficiency-adjusted measure of public sector capital is used, cross-country empirical evidence suggests that public capital is a significant determinant of economic growth (Gupta and others, 2011). In line with Table 5.3, the analysis here assumes that the PIMI is roughly 0.47. As the rate of public sector investment is ramped up, the efficiency of public investment deteriorates (Berg and others, 2011). Thus, the analysis introduces internal costs of adjustment for public investment and calibrates the adjustment cost coefficient in such a way that the economy replicates the investment rates and PIMI of the low-income countries. The internal costs of adjustment of public investment also capture the increasing costs incurred when rapidly scaling up public sector investment (van der Ploeg, forthcoming). The absorption problems that frustrate rapid economic development when scaling up public investment are thus captured. Use of the internal costs of adjustment and the PIMI also result in higher returns on public investment, and thus more realistically calibrate the model to developing economies. The next section shows the optimal way to harness a temporary windfall in a small economy suffering from capital scarcity.

Capital Scarcity: Use Oil Revenue to Boost Public Investment In the developing countries of the CEMAC, the separation theorem does not hold. Optimal public investment is, in fact, dependent on available finances and thus on the size of the oil windfall. Therefore, it would be a serious mistake for the CEMAC countries to put all oil revenue in a sovereign wealth fund when

©International Monetary Fund. Not for Redistribution van der Ploeg 99 domestic investment needs are so high. To illustrate the differences between a strategy designed to harness oil revenue for economic development and a permanent-income rule, this analysis offers several policy simulations for the same temporary oil windfall discussed in the “Benchmark” section above. These policy simulations assume that the world interest rate and discount rate are 2.5 percent; an annual depreciation rate of public investment of 2.5 percent (corresponding to an expected lifespan of public projects of 40 years); a production elasticity of public capital of 0.17 (the ballpark estimate reported in Bom and Ligthart, 2010); shares of labor and private capital in value added of 0.7 and 0.3, respectively; and an elasticity of intertemporal substitution s equal to 0.5. Furthermore, the policy simulations suppose a PIMI of 0.47 and a semi-elasticity for the debt-to-GNI ratio on the natural log of the interest spread of 1.9, as discussed in the “Two Obstacles” section. For the sake of concreteness, it is supposed that the economy starts off with an initial debt-to-GDP ratio of 100 percent and an initial public sector capital stock equal to 30 percent of GDP, and that the current size of the oil windfall is equal to current GDP. It is also assumed that all private capital is foreign direct investment for which the world interest rate is the main determinant. For public investment, the much higher domestic interest rate is the main determinant. The public investment rate is given by I/S 5 (q 2 1)/f, where I is public investment, S is the efficiency-adjusted stock of public capital, q is the value of public investment, and f 5 34.4 is the adjustment cost parameter, which is calibrated to fit a PIMI of 0.47. Total spending on public investment includes internal adjustment costs and is given by J 5 I 1 0.5 f I 2/S. In the steady state, the PIMI is I/J 5 1/(1 1 0.5fd) 5 0.70, but in the early stages of development only 47 percent of investment outlays are delivered because current public investment rates (I/S) are much higher. The value of public investment q follows from the arbitrage equation, which says that the increase in private output plus the reduction in internal adjustment costs resulting from a marginal increase in the efficiency-adjusted public capital must equal the rental charge plus the depreciation charge minus the expected rate of change in the value of public capital. Maximizing utility (5.3) subject. to the equations describing asset dynamics (5.1) and public capital dynamics, S 5 I 2 dS, yields the following two optimality conditions (see van der Ploeg, forthcoming, for more detail): . 5 s  _D 1  _D _D C C    , C(0) free, (5.5) [ ( ES 1 N ) ( ES 1 N ) ES 1 N ] . q 5 r* 1  _D 1  _D _D 1 d q (5.6) [ ( ES  1 N ) ( ES  1 N ) ES  1 N ]

 2  2 2 (1 2 )ES 1 2 _1 (q 2 1)2 2 ES 1 2

2  _D _D , q(0) free, ( ES  1 N )( ES  1 N )

©International Monetary Fund. Not for Redistribution 100 Managing Oil Windfalls in the CEMAC

and the reduced-form debt and public capital dynamics are given by . D 5 r* 1  _D D 1 C 1 _ 1 (q2 2 1) S (5.7) [ ( ES  1 N ) ] 2  2 ES 2 N, D(0) 5 D0, . S 5 _1 q 2 2 d S S 5 S [  ( 1) ] , (0) 0, (5.8) where non-oil output is given by the production function Y 5 E K  S , 0    0.3  1,   0.17  0, with K indicating private capital (FDI) or, equivalently, the reduced-form production function Y 5 ES  with  _ _ 1 1 2  1 2    E  E _ ,   _  , and m indicating the depreciation ( r 1  ) 1 2  rate of private capital. Equation (5.7) is the upward-sloping Keynes-Ramsey rule (also known as the Euler rule) in which growth in consumption responds to the gap between the social interest rate and the discount rate. Note that growth in consumption responds positively to the interest premium on debt, (D/Y ), 0, so that it is optimal to consume less and pay off debt. Of course, the interest premium on debt should not be taken too literally, but should be seen as a metaphor for capital scarcity.6 Equation (5.8) is the arbitrage equation for public investment, which states that the social user cost of public capital, consisting of the social interest charge plus the depreciation charge minus the expected rate of increase in the social value of public capital, must equal the marginal product of public capital plus the marginal reduction in adjustment costs. Equations (5.5) through (5.8) fully model capital scarcity, public investment, and windfall revenue management. They can be solved with a multiple shooting algorithm. The policy simulations can easily be done for each CEMAC country with the specific coefficients and parameters describing each country’s oil windfall, but the qualitative features will be like the ones discussed here. One caveat should be made: the simulations start with a relatively large government debt while the CEMAC countries have almost no government debt. The simulations are thus meant to be purely illustrative, with government debt not indicating so much the burden of government debt but rather the extent of the capital scarcity problem many developing countries face. A proper calibration to the CEMAC countries must be left for another occasion, or one should refer to the more care- ful empirically calibrated analysis of Berg and others (2011). Figure 5.4 presents the simulations and shows both the no-windfall paths and the paths with a temporary windfall. The difference between the lines indicates

6Using the empirical estimate of 1.9 for the semi-elasticity of the natural log of the spread with respect to the debt-to-GNI ratio (van der Ploeg and Venables, 2011b), we specify (d) 5 1024 exp(6.294) [exp(1.9d)21] for the interest spread schedule where 6.294 is the mean log of the spread. This implies that a 10 percentage point increase in the debt-to-GNI ratio pushes up the interest differential by 6.9 percentage points if the economy starts out with a debt-to-GNI ratio of 100 percent (or 1.3 percentage points if it starts off with zero foreign debt).

©International Monetary Fund. Not for Redistribution van der Ploeg 101

PIMI 0.59

0.57 No windfall 0.55

0.53

0.51

0.49 Opmal 0.47

0.45 05 10 15 20 25 30 35 40

Private consumpon, C 1.2 Opmal BIH 1.1

1.0 PIH 0.9

0.8 No windfall 0.7

0.6 0510 15 20 25 30 35 40

Public capital stock, S 1.6 1.4

1.2

1.0

0.8 Opmal No windfall 0.6

0.4

0.2

0 0510 15 20 25 30 35 40 Figure 5.4 Harnesing Windfall with Capital Scarcity and Rising Cost of Ramping Up Public Investment Source: Authors’ calculations. Note: "x" axis (horizontal) 5 years; BIH (dashes and dots) 5 Bird-in-hand policy; PIH (dots) 5 Permanent- income hypothesis policy; No windfall (dashes); Optimal policy (solid lines).

©International Monetary Fund. Not for Redistribution 102 Managing Oil Windfalls in the CEMAC

Value of public capital, q 3.4

3.2 Opmal 3.0

2.8

2.6 No windfall 2.4

2.2 0510 15 20 25 30 35 40

Sovereign debt, D 0.8

0.6

0.4 No windfall 0.2

–0.2 PIH BIH Opmal –0.4 0510 15 20 25 30 35 40

Government assets, q S – D 4.0

3.5

3.0

2.5 Opmal No windfall 2.0

1.5

1.0

0.5

–0.5 0510 15 20 25 30 35 40 Figure 5.4 (Continued)

©International Monetary Fund. Not for Redistribution van der Ploeg 103 the effects of the windfall. Figure 5.4 shows that the oil windfall speeds up the process of economic development, because the efficiency-adjusted public capital stock, and thus production, rise much more quickly toward their unchanged steady-state values. The temporary public sector investment boom is triggered by a temporary spike in the value of public sector capital fueled by the oil-induced boom in demand. This also leads to a temporary boost to consumption. The public investment boom has three noticeable features. First, on impact the social value of capital jumps and thus the rate of public investment rises modestly and the PIMI declines modestly.7 Second, ramping up public investment worsens absorption constraints and increases the inefficiency of public investment (see the substantial and persistent falls in the PIMI triggered by the windfall-induced investment boom in the upper left panel of the figure). Third, net government assets (i.e., the value of public capital, qS, minus sovereign debt) are not predeter- mined, because the shadow value of public capital jumps on impact from 2.36 to 3.19. Although the initial jump in the value of net government assets is small, the initial jump from 2.36 to 3.19 in the value of public capital is considerable. The boom in public sector investment is associated with bigger government surpluses. This results in more rapid and substantial drops in sovereign debt, which rapidly turn into sovereign wealth. Interest spreads and the cost of borrowing decline, which gives the government more scope to provide transfers to its citizens and to ramp up public sector capital despite the lower efficiency of public sector investment. An interesting feature of the no-windfall simulations reported in Figure 5.4 is that the shadow value of public capital, q, and thus the public sector investment rate, (q21)/f (which is thus proportional to q), and the PIMI overshoot. This reflects an initial phase in the development process in which the value of public capital and the investment rate rise, and the PIMI falls before these movements are reversed further along the development path. In the windfall simulations, private consumption overshoots as well, so that in the initial phases consumption is kept low and rises gradually to make room for a rapid rise in public investment.

The Advantages of Investing to Invest Oil windfalls can alleviate capital scarcity and thus boost public investment. This outcome is in sharp contrast to the separation result that prevails in the permanent-income rule discussed in the “Benchmark” section, which is most relevant for countries that are well integrated into world capital markets and do not suffer from capital scarcity. The permanent-income rule is a partial-equilibrium rule, given that no account is taken of the effects of the oil windfall on wages, prices, exchange rates, and quantity variables. The optimal policy rule does take account of general-equilibrium interactions—it is a one-sector model and thus

7If there are also adjustment costs associated with changing the rate of public investment (rather than adjustment costs for the stock of public capital), there would be no discrete jumps on impact in public investment or the PIMI.

©International Monetary Fund. Not for Redistribution 104 Managing Oil Windfalls in the CEMAC

only relative intertemporal prices (i.e., the interest rate) matter while relative intratemporal prices (such as the real exchange rate or the relative price of nontradables) do not play a role. (See the next section for a brief discussion of the effect of oil windfalls on relative intertemporal prices and Dutch disease effects.) Figure 5.4 also compares the optimal investing-to-invest rule with the permanent-income rule in the private consumption and sovereign debt panels. Under the permanent-income rule, the increment in private consumption equals the permanent value of the windfall at the time the windfall starts, that is, 0.144. Over time, the return on in situ oil wealth (i.e., the permanent value of the oil windfall) falls while the increase in interest income on the balance of the sovereign wealth fund rises by an equivalent amount until it has reached 0.144—see the right panel of Figure 5.3. However, the enormous boost to sovereign wealth under the permanent-income rule does not boost economic development because public capital, private capital inflows, and non-oil production are assumed to be exogenous under this application of the permanent-income rule. The oil windfall under the permanent-income rule does sustain a permanent boost to government transfers and thus to consumption, but fails to put oil funds into public investment. During the initial phases, the optimal strategy (see the solid lines in Figure 5.4) devotes much less to sovereign wealth or to paying off government debt and thus leads to a much bigger increase in private consumption than does the permanent- income rule (indicated by the steeply falling line in the left-bottom panel of Figure 5.4). After about 35 years, the consumption increment under the optimal strategy falls below that under the permanent-income rule. The optimal strategy thus permits much more consumption upfront and leads to a boost in public capital instead of parking that much-needed revenue in a sovereign wealth fund. Application of the permanent-income rule to developing countries such as those in the CEMAC is far from optimal, does not boost development, and does not serve the interests of citizens. The impacts on consumption and sovereign debt if the bird-in-hand rule is used (again, not taking account of general-equilibrium interactions) are also shown in Figure 5.4. Under this rule, all windfall revenue is accumulated into a sovereign wealth fund, and no transfers and resulting boosts to private consumption are allowed until sovereign wealth is accumulated. The withdrawal rate is set at 4 percent from the balance of the fund (as in Norway). Consumption does not jump on impact but rises only gradually. Eventually, consumption reaches a higher value than under the permanent-income rule before falling back to the no-windfall path in the very long run.8 The bird-in-hand rule performs even worse than the permanent-income rule. It does not offer any prospect for improved economic development and yields larger consumption increments than the permanent- income rule only after 10 years, and higher consumption increments than the optimal rule only after 23 years, before dropping off to zero in the very long run.

8This does not show up in Figure 5.4 because it takes a much longer time than the 40 periods indicated by the horizontal axis.

©International Monetary Fund. Not for Redistribution van der Ploeg 105

The celebrated Hartwick rule states that any depletion of subsoil oil assets must be exactly offset by accumulation of other assets such as sovereign wealth and public, private, or human capital (Hartwick, 1977). In other words, genuine saving must be zero. Indeed, for the permanent-income rule, Figure 5.3 indicates that the optimal accumulation of sovereign wealth exactly equals the decline in oil wealth, so that genuine saving is zero. In contrast, the bird-in- hand rule is more conservative than the permanent-income rule in that it only consumes a fraction of the stock of accumulated wealth. The bird-in-hand rule, therefore, leads to excessive accumulation of sovereign wealth, which gives rise to positive genuine saving increments. However, developing economies with capital scarcity and increasing costs associated with ramping up public investment require negative genuine saving increments to speed up the process of growth and development so that the positive increment in net assets (public capital minus sovereign debt) at each point in time is less than the negative increment in subsoil wealth. Another reason for negative genuine saving is anticipation of better times, which occurs if oil exporters anticipate either future reductions in the costs of extracting oil or future increases in the world oil price. It is then better to borrow on the international capital market and postpone oil depletion so that oil can be extracted more cheaply or fetch a higher price. Genuine dissaving then occurs equal to the sum of expected extraction cost reductions and expected capital losses on subsoil oil wealth. The simulations presented in Figure 5.4 are meant to be an illustration of the main qualitative policy message: an investing-to-invest policy is better than naively applying the permanent-income or bird-in-hand rule for developing countries facing capital scarcity and large domestic investment needs. To get a better quantitative understanding of the policy message for the CEMAC countries, at least three adjustments need to be made. First, it is better to take account of the country characteristics of each member state of the CEMAC when designing the optimal policy response; for example, the Central African Republic has no oil at all. Second, the size and duration of the windfall for each oil-rich CEMAC country may vary and will generally be smaller than the windfall reported in Figure 5.4 by a factor of about four. Although the effects on growth will be correspondingly smaller, the effects for the country will still be substantial. Third, and most important, a clear distinction must be made between capital scarcity and sovereign debt. Although Figure 5.2 indicates that the CEMAC countries have little sovereign debt, they still suffer from capital scarcity because the interest payments that have to be made on domestic investment projects—as well as the potential return on such projects—are typically much higher than world averages. Hence, the policy messages derived from Figure 5.4 also apply to a capital-scarce country with almost no sovereign debt. To capture this situation adequately, the functional specification of the interest rate premium is modified to    _D 1 D ,  0, where the constant D . 0 indicates capital ( Y 1 N ) scarcity reflected in an interest premium even in the absence of sovereign debt.

©International Monetary Fund. Not for Redistribution 106 Managing Oil Windfalls in the CEMAC

Absorption Problems and Dutch Disease: Temporarily Park Oil Revenue in a Fund No absorption problems arise if public capital can be imported from abroad or if airports, roads, and the like are delivered by foreigners (as Chinese firms have often done in Africa and Brazil). However, for most developing economies of the CEMAC, the majority of investment goods will have to be produced at home. Nurses are needed to train nurses, teachers to train teachers, roads to make further roads, and not all of these jobs can be accomplished by importing Chinese labor and capital. Furthermore, political pressure will be brought to bear to create jobs for local people. Thus, given that oil windfalls will be geared toward domestic consumption and investment, they will boost demand and put pressure on the nontradable sectors to expand and thus lead to hikes in the price of nontradables and to reallocation of labor and capital from the tradable to the nontradable sectors (Corden and Neary, 1982). The bird-in-hand policy and the permanent- income policy fail to deliver an optimal response to such Dutch disease effects because they are derived from a partial-equilibrium framework and do not take account of changes in the real interest rate or exchange rates. It may be optimal to smooth appreciation of the real exchange rate over time and thus have a small, long-lasting rather than a large, temporary decline in the tradable sectors. Persistence in preference allows for some “addiction” to high levels of public spending even after the windfall has ceased, and may help to explain the volatile behavior of real exchange rates. The optimal public investment and real exchange rate strategy in a fully specified, general-equilibrium, two- or three-sector model of a small, open economy must take into account capital scarcity and the rising cost of public investment. The optimal response should also take into account the need to “invest to invest.” Developing countries need teachers to train teachers, nurses to train nurses, and roads to make roads. Homegrown capital produced by the nontradable sector rather than imported from abroad is thus needed for successful economic development, but such capital takes time to deliver and leads to a different set of temporary absorption problems in the nontradable sector. In such a setting, it is optimal to temporarily invest some of the oil windfall in a sovereign wealth fund until the nontradable sector is able to deliver the investment goods necessary for economic development (van der Ploeg and Venables, 2011a). The inefficiency problem encountered when scaling up investment, as discussed in previous sections, implies that even more oil revenue has to be stored temporarily in a sovereign wealth fund. Detailed policy simulations are reported in van der Ploeg (forthcoming). These simulations show that the price of nontradables jumps on impact at the news of the oil bonanza. Over time, as labor shifts from the tradable to the nontradable sector, the capacity of the nontradable sector expands. The stock of public capital expands and, as the demand for nontradables is met, the initial appreciation of the real exchange rate is reversed. The absorption constraints resulting from Dutch disease are more severe if a greater part of consumption and public investment has to be produced at home. It then takes much longer for the

©International Monetary Fund. Not for Redistribution van der Ploeg 107 economy to move along its development path. Again, the efficiency of public investment is reduced considerably as public investment is ramped up, which aggravates the absorption constraints resulting from Dutch disease, and the windfall is also used to bring down sovereign debt more quickly. The oil bonanza increases consumption of both nontradables and tradables, but output of tradables falls considerably to make room for a boost in nontradables output. The oil windfall finances the resulting current account deficits and the more rapid reduction in sovereign debt. With a putty-clay technology for public capital, public investment can occur in either the nontradable or the tradable sector, but public capital cannot be shifted between sectors once installed. The only way the nontradable sector can expand if all capital is used in the tradable sector is for the tradable sector to gradually wind down its stock of public sector capital stock via wear and tear, thus bringing down its stock of private capital and releasing labor, which can then move to the nontradable sector. This adjustment mechanism also leads to a temporary appreciation of the real exchange rate and a gradual reallocation of workers from the tradable to the nontradable sector, but the root cause of this adjustment process is wholly different if public sector capital is only used in the nontradable sector, as in the simulations illustrated by Figure 5.4. Whether the Dutch disease dynamic is primarily driven by winding down capital in the tradable sector or by increases in the price of nontradables and sectoral reallocation depends on whether the tradable or the nontradable sector is more capital intensive. A detailed analysis of these two adjustment mechanisms to Dutch disease, that is, gradual accumulation of homegrown capital versus the gradual erosion of capital in the tradable sector, is much more fully analyzed within the comprehensive theoretical model in van der Ploeg and Venables (2011a).

Conclusion The oil-producing countries of the CEMAC would be unwise to follow either the permanent-income rule or the bird-in-hand rule and put their already declining oil windfalls into sovereign wealth funds. The main concern of the CEMAC countries is to boost economic development, not to engineer a sustained increase in consumption financed by interest earned on U.S. Treasury bills. The CEMAC countries’ main challenges are to deal with, on the one hand, capital scarcity, and on the other hand, declining inefficiency of investment projects in public infrastructure, health, and education as public investment projects are scaled up using what is left of the oil bonanza. It is far better for the CEMAC countries to use their oil windfall to steadily ramp up public investment, tolerate a temporary fall in the efficiency of public investment, and gradually boost the efficiency- adjusted stock of public capital and non-oil output. As a result of this strategy, wages and consumption would rise in the initial phases of economic development much more than they would under the permanent-income or the bird-in-hand rules. The optimal policy for harnessing the oil bonanza requires negative genuine saving so that the positive increment in net assets (public capital minus sovereign

©International Monetary Fund. Not for Redistribution 108 Managing Oil Windfalls in the CEMAC

debt) at each point in time is less than the negative increment in subsoil oil wealth. In practice, absorption constraints are aggravated because private demand and especially public sector demand are strongly biased toward nontradable products. This bias results in appreciation of the real exchange rate and Dutch disease. Nevertheless, the optimal harnessing strategy yields a sustained increase in private consumption and non-oil gross national product. The bigger the component of public capital that has to be homegrown, the bigger the absorption constraints. This is the challenge of “investing to invest.” Important inputs into the decision-making process can be obtained from financial programming models and from full-scale, empirically calibrated, dynamic stochastic general equilibrium models of oil-rich developing economies. Such models allow a richer derivation of optimal policy proposals for managing oil windfalls, especially with regard to how much of the windfall to consume upfront; how much sovereign debt to redeem or sovereign wealth to accumulate; and most important, how much investment in public infrastructure, health, and education to undertake, and how the optimal response is affected by changes in the real exchange rate and Dutch disease effects. The crucial point is that the prevalence of macroeconomic and microeconomic absorption constraints in ramping up investment in public infrastructure and human capital requires oil- rich, developing countries to temporarily park part of their oil windfalls in sovereign wealth funds.

References Akitoby, B., and T. Stratmann, 2008, “Fiscal Policy and Financial Markets,” Economic Journal, Vol. 118, No. 533, pp. 1971–85. Barnett, S., and R. Ossowski, 2003, “Operational Aspects of Fiscal Policy in Oil-Producing Countries,” in Fiscal Policy Formulation and Implementation in Oil-Producing Countries, ed. by J. Davis, R. Ossowski, and A. Fedelino (Washington: International Monetary Fund). Berg, A., R. Portillo, S.-C. S. Yang, and L.-F. Zanna, 2011, “Government Investment in Resource Abundant Low-Income Countries (unpublished, Washington: International Monetary Fund). Bom, P., and J.E. Ligthart, 2010, “What Have We Learned from Three Decades of Research on the Productivity of Public Capital?” Working Paper No. 2206 (Munich: CESifo). Cordon, W.M., and J.P. Neary, 1982, “Booming Sector and De-Industrialisation in a Small Open Economy,” Economic Journal, Vol. 92, No. 368, pp. 825–48. Collier, P., F. van der Ploeg, M. Spence, and A.J. Venables, 2010, “Managing Resource Revenues in Developing Economies,” IMF Staff Papers, Vol. 57, No. 1, pp. 84–118. Dabla-Norris, E., J. Brumby, A. Kyobe, Z. Mills, and C. Papageorgiou, 2011, “Investing in Public Investment: An Index of Public Investment Efficiency,” Working Paper 11/37 (Washington: International Monetary Fund). Gupta, S., A. Kangur, C. Papageorgiou, and A. Wane, 2011, “Efficiency-Adjusted Public Capital and Growth,” Working Paper 11/217 (Washington: International Monetary Fund). Hartwick, J.M., 1977, “Intergenerational Equity and the Investment of Rents from Exhaustible Resources,” American Economic Review, Vol. 67, No. 5, pp. 972–74. Mehlum, H., K. Moene, and R. Torvik, 2006, “Institutions and the Resource Curse,” Economic Journal, Vol. 160, No. 508, pp. 1–20.

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Sachs, J.D., and A.M. Warner, 1997, “Natural Resource Abundance and Economic Growth,” in Leading Issues in Economic Development, ed. by G. Meier and J. Rauch (Oxford: Oxford University Press). Tabova, A., and C. Baker, 2011, “Determinants of Non-Oil Growth in the CFA-Zone Oil- Producing Countries: How Do They Differ?” Working Paper 11/233 (Washington: International Monetary Fund). van der Ploeg, F., forthcoming, “Bottlenecks in Ramping Up Public Investment,” International Tax and Public Finance. ———, 2011, “Natural Resources: Curse or Blessing?” Journal of Economic Literature, Vol. 49, No. 2, pp. 366–420. ———, and S. Poelhekke, 2010, “Volatility and the Natural Resource Curse,” Oxford Economic Papers, Vol. 61, No. 4, pp. 727–60. van der Ploeg, F., and A.J. Venables, 2011a, “Absorbing a Windfall of Foreign Exchange: Dutch Disease Dynamics,” OxCarre Research Paper 52, (Oxford, UK: OxCarre). ———, 2011b, “Harnessing Windfall Revenues: Optimal Policies for Resource-Rich Developing Economies,” Economic Journal, Vol. 121, No. 551, pp. 1–31. ———, forthcoming, “Natural Resource Wealth: The Challenge of Managing a Windfall,” Annual Review of Economics. World Bank, 2006, Where is the Wealth of Nations? Measuring Capital for the 21st Century (Washington).

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©International Monetary Fund. Not for Redistribution Chapter 6

Government Failure and Poverty Reduction in the CEMAC

Shantayanan Devarajan and Raju Jan Singh

The countries composing the Economic and Monetary Community of Central Africa (CEMAC) have some of the lowest social indicators in the world (Table 6.1). Although the Republic of Congo (hereafter “Congo”), Equatorial Guinea, and Gabon are middle-income countries, Cameroon, the Central African Republic, and Chad are among the poorest countries. In Cameroon, poverty has increased over time, whereas the other two have remained at high levels of human deprivation. For instance, 55 percent of the population in Chad lives below the poverty line, with 36 percent in extreme poverty. Meanwhile, all six countries are rich in natural resources. Cameroon, Chad, Congo, Gabon, and Equatorial Guinea are oil producers, while diamonds are the Central African Republic’s major export. Congo is currently sub-Saharan Africa’s fourth largest oil producer, with an average daily output of 230,000 barrels.1 Although a small oil producer today, Cameroon experienced a rapid expansion in oil production starting in 1978, peaking at 180,000 barrels per day in 1985. Chad, which first shipped oil in October 2003, has about 1.5 billion barrels in proven reserves. Although reliable information on diamond activity in the Central African Republic is scarce, estimates indicate that the country produces between 350,000 and 400,000 carats per year, earning about $50 million in export revenue. How could these countries be so rich and yet so poor? This question, which has been posed about other resource-rich countries, has spawned a rich literature on various aspects of the “natural resources curse” (e.g., Gelb, 1988; and Sachs and Warner, 2001). This chapter explores whether one particular aspect of these countries’ natural resource endowments contributes to their persistent poverty. Specifically, has natural resource revenue undermined accountability mechanisms in these countries, making it difficult for governments to provide public goods and promote a more equitable distribution of income? This syndrome is dubbed “government failure,” as the mirror image of “market failure,” the situation in which private agents, acting in their own interests, give rise to an equilibrium that is suboptimal from society’s point of view. Government failure occurs when

1Unless otherwise stated, all data on Cameroon, Congo, and Chad are from World Bank (2010a, 2010b, 2010c).

111

©International Monetary Fund. Not for Redistribution 112 Government Failure and Poverty Reduction in the CEMAC

Table 6.1 Rank (out of 169) in the Human Development Index Gabon 93 Equatorial Guinea 117 Republic of Congo 126 Cameroon 131 Central African Republic 159 Chad 163

Source: UNDP Human Development Report, 2010.

individual government actors, responding to incentives created by existing accountability mechanisms, contribute to an equilibrium that is socially suboptimal. In turn, these government failures impede economic growth and poverty reduction. The Central African Republic, Chad, and Congo have also experienced civil conflict—an extreme form of government failure—which has exacerbated poverty. This analysis suggests that transforming these countries’ natural resources into sustainable growth will require more than technical approaches to strengthening public expenditure management systems (although that is important)—it will require a fundamental shift in citizens’ ability to hold governments accountable for spending natural resource revenue.

Common Features of the CEMAC Countries Although different in many respects, the six CEMAC countries share some common features that may have contributed to their similar outcomes for poverty and human development.

Natural Resource Endowments All six countries are richly endowed with natural resources, providing windfall revenues to the countries and their governments. In addition, they have many resources that remain to be exploited. For instance, the Central African Republic has largely unexploited natural resources in the form of gold, uranium, and oil deposits along the country’s northern border with Chad, while untapped resources in Cameroon include natural gas, bauxite, diamonds, gold, iron, and cobalt. As Collier (2010) has shown, Africa’s undiscovered mineral reserves are likely to be four times current reserves.

Diversity Sitting at the crossroads of the peoples of the desert, the savannah, and the forest, CEMAC countries are ethnically, linguistically, and religiously very diverse. This characteristic makes preservation of national unity challenging, and in some instances has led to decades of conflict, as in Chad. Cameroon was created as a political entity in the late nineteenth century, replacing numerous states and chiefdoms, each of which had its own history,

©International Monetary Fund. Not for Redistribution Devarajan and Singh 113 culture, economy, and government. Estimates identify anywhere from 230 to 280 different ethnic and linguistic groups broadly divided by the Adamawa Plateau into northern and southern regions (Neba, 1999). Religious differences add to this diversity. Similarly, more than 80 ethnic and linguistic groups inhabit the Central African Republic; there are 200 ethnic groups in Chad, 15 principal Bantu groups with more than 70 subgroups in Congo, and Gabon has at least 40 ethnic groups with separate languages and cultures. The majority of the people in Equatorial Guinea are of Bantu origin, but the Fang—the largest group— comprises about 70 clans. Living conditions also differ widely across regions within a country. Cameroon’s economic growth, for instance, has shown large regional disparity. The incidence of poverty in four regions (Adamawa, East, North, and Extreme North) increased significantly between 2001 and 2007 although the country’s overall poverty trend was steady. The two northern regions (North and Extreme North) saw the biggest poverty increases, of 13.6 and 9.6 percentage points, respectively. Similarly regional disparities are substantial in Chad, where the poverty rate is 50 percent in the rural parts of the north, but 70 percent in the rural south.

Historical Legacy The CEMAC countries have a common heritage of having been administered forcefully, often by private companies, during the colonial period. This may explain the distrust of the private sector. The reported financial successes of Leopold II’s concessionary companies in the Congo Free State in the latter half of the nineteenth century encouraged the French government to develop its Equatorial African territories by granting companies large concessions. Two dozen such concessions extended over large portions of present-day Central African Republic, Congo, and Gabon. The activities of the companies also affected Southern Chad. Similarly, in Cameroon the German Empire handed coloniza- tion to private companies, known as the Kolonialgesellschaften. In return for the exclusive right to exploit these lands by buying local products and selling European goods, the companies promised to pay rent to the colonial state and promote the development of their concessions. These private enterprises tended, however, to invest as little as possible in the development of the territories, while reaping as much short-term profit as they could from their natural resources, frequently using brutal methods to force Central Africans to work for them. At the turn of the twentieth century, public opinion in France and Germany revolted against the abuses of the system, leading to some changes. The traditional economies and societies of the African colonies, as well as the environment, had by then been severely disrupted (Coquery-Vidrovitch, 1972). One of the most striking consequences was the substantial demographic decline experienced in this region: from an estimated 10 million people at the beginning of the twentieth century, the population of French Equatorial Africa is thought to have declined to less than 5 million at the end of the colonial period in 1960 (Singh, 2008).

©International Monetary Fund. Not for Redistribution 114 Government Failure and Poverty Reduction in the CEMAC

Equatorial Guinea—a Spanish colony—is an extreme case of unequal development. On the main island, Biyogo, much of the indigenous population had been transformed into fairly prosperous farmers dependent upon migrant, especially Nigerian, labor. The island had the highest literacy rate in sub-Saharan Africa. In the mainland, Rio Muni, by contrast, from where the postcolonial leaders emerged, infrastructure and education services were rudimentary and Spanish military rule was often brutal (Sundiata, 1988). In sum, CEMAC countries are ethnically heterogeneous and mistrustful of the private sector as an engine of development. The discovery of oil, therefore, has provided an opportunity for governments to assert themselves as the main actors. It has also opened the possibility for disenfranchised groups to attempt to capture the oil revenue for their own groups. As shown below, these factors, combined with intrinsic aspects of natural resource revenue, have conspired to keep these countries from sustained growth and poverty reduction.

Elements of Government Failure The symptoms of the underlying problem in the CEMAC countries—government failure—can be illustrated by examining various aspects of their public finance.

Dependence on Resource Revenue The governments of the oil-producing countries depend heavily on oil revenue. This revenue needs relatively little administrative effort to collect compared with other revenue sources. Perhaps more important, they are much less costly politically because residents are spared the burden of heavy taxation. As a result, even compared with other oil-producing countries, CEMAC countries mobilize relatively little non-oil revenue (Figure 6.1).

Percent 30

0 CEMAC SudanKazahkstan Mexico Malaysia

Figure 6.1 Share of Oil Revenue in Total Revenue, Selected Oil-Producing Countries, Average 2007–09 Sources: Country authorities; and IMF staff calculations. Note: CEMAC 5 Central African Economic and Monetary Community.

©International Monetary Fund. Not for Redistribution Devarajan and Singh 115

However, heavy dependence on oil revenue complicates fiscal policy. These resources are typically volatile and uncertain. Linking public spending to resource revenue tends to lead to macroeconomic volatility and reduce the quality of public spending. Furthermore, because citizens do not directly contribute to this revenue, some evidence indicates that they exert less effort in holding the government accountable for its spending.

Lack of Transparency Despite years of technical assistance to improve public expenditure management, expenditure processes in Central Africa remain among the most opaque in the world according to the Open Budget Index (Figure 6.2). Overall governance indicators are also worse for these countries than for their Coopération Financière en Afrique Centrale (CFA) zone counterparts in West Africa and the rest of Africa (Figure 6.3). Because the population does not finance the bulk of public spending through their taxes, they do not feel as great a need to hold government accountable for the use of public money (Devarajan and others, 2011). The government, for its part, prefers to have discretion over its spending and therefore has little incentive to increase the non-oil revenue share. The combination of weak institutions and ethnic diversity has led to civil conflict in three of these countries. In the Central African Republic, where natural resources are not controlled and taxed by government, the possibility of earning diamond rents led to a winner-take-all mentality—in the absence of institutions for sharing the revenue—with different groups vying for the right to extract minerals. The resulting 30-year civil conflict meant that the country experienced low investment, slow growth, and increasing poverty. The Central African Republic illustrates what happens if none of the natural resource revenue flows to the government. The state becomes too weak to even provide basic public goods, such as security. The challenge in the Central African Republic is how to build state capacity and security to allow legitimate diamond mining, without jumping to the other extreme of state capture and weak accountability to the population. In Chad, rebel attacks in N’Djamena in 2006 and 2008 increased security demands on the government’s budget, crowding out much-needed social spending

45 40 ) 35 30 25 20 15

Index (max=100 10 5 0 CEMAC WAEMU Sub-Saharan World Africa Figure 6.2 Open Budget Index Scores, 2006–10 Sources: International Budget Partnership; and IMF staff calculations. Note: WAEMU 5 West African Economic and Monetary Union. CEMAC 5 Central African Economic and Monetary Community; WAEMU 5 West African Economic and Monetary Union.

©International Monetary Fund. Not for Redistribution 116 Government Failure and Poverty Reduction in the CEMAC

Business Freedom Trade Freedom 58 60

57 55 56 50 x x 55 45 Inde Inde 54 40

53 35 52 30 CEMAC WAEMU Non-CFA SSA CEMAC WAEMU Non-CFA SSA

Government Size Investment Freedom

95 50 90 49 85 48 80

x x 47 75 46 70 Inde Inde 45 65 60 44 55 43 50 42 CEMAC WAEMU Non-CFA SSA CEMAC WAEMU Non-CFA SSA

Property RightsFreedom from Corruption 45 30

40 25

x 35 x 20

Inde 30 Inde 15 25

20 10 CEMAC WAEMU Non-CFA SSA CEMAC WAEMU Non-CFA SSA

Figure 6.3 Selected Governance Indicators Sources: Heritage Foundation website; and World Bank staff calculations. Note: CEMAC 5 Central African Economic and Monetary Community; CFA 5 Coopération Financière en Afrique Centrale; SSA 5 sub-Saharan Africa; WAEMU 5 West African Economic and Monetary Union.

(see “Ineffective Allocation of Public Resources” section below). Likewise, Congo’s multiple ethnic groups were engaged in a civil war that left the economy at a much lower level than its resource base would predict. But the greatest difficulty facing all six countries is managing resource revenue, even in peaceful times. From the point of view of growth and poverty reduction, public spending in these countries has been particularly badly managed—at the aggregate, sectoral, and program levels.

Spending Booms As oil production increased rapidly in the late 1970s and early 1980s, Cameroon pursued an expansionary and unsustainable fiscal policy, eventually contributing to a deep economic crisis. From 1976 to 1985, inflation-adjusted public spending

©International Monetary Fund. Not for Redistribution Devarajan and Singh 117 rose by an average of 15 percent a year, contributing to strong economic growth. By the second half of the 1980s, however, oil production and international oil prices began to decline, bringing Cameroon’s oil boom to an end. In response, the government carried out fiscal adjustments (mainly cuts in investment) and pursued limited structural reforms. These measures were insufficient to prevent Cameroon from entering a deep recession, which lasted from 1987 until the mid-1990s. In that period, per capita income declined more than 40 percent, and Cameroon accumulated a large public debt, as well as payment arrears. By the early 1990s, it was clear that fiscal adjustment and structural reform alone could not restore competitiveness. In light of similar difficulties in neighboring countries, the CFA franc (CFAF) was devalued by 50 percent in early 1994. Similarly, Congo’s recent economic history clearly shows that rapid expansion of public spending—on loss-making public enterprises and a bloated public sector wage bill—financed by oil revenue can jeopardize macroeconomic stability. In the 1980s and 1990s, Congo displayed poor fiscal discipline, and its fiscal policy paid little attention to macroeconomic stability. As a consequence, economic growth could not be sustained and a large debt overhang accumulated. Since the restora- tion of peace in 2002, and especially since 2008, however, the Congolese economy has resumed economic growth, thanks to prudent macroeconomic policy, among other factors. Building on the oil boom of the early 2000s, the country has been running fiscal surpluses. In light of its massive infrastructure needs, Congo is planning large infrastructure investments. The challenge will be to ensure that these investments are properly managed and sequenced to avoid some of the boom-bust cycles experienced in the neighboring countries. As discussed in the “Overcoming Government Failure” section, one approach will be for citizens to demand strong government accountability for how the oil revenue is spent. In Chad, the government has relied heavily on oil revenue to finance a large expansion in public spending. Government revenue increased more than sixfold between 2003 and their peak in 2008, rising to CFAF 986 billion from CFAF 125 billion, reflecting increased oil production and high oil prices (Figures 6.4 and 6.5). As a result, public expenditure has increased significantly. Since 2003–04, public spending has substantially expanded across all catego- ries. The domestically financed budget increased from about CFAF 337 billion in 2004 to CFAF 905 billion in 2009 (from 14.4 percent of non-oil GDP to about 40 percent of non-oil GDP). The recurrent budget (net of debt-service payments) increased from CFAF 145 billion in 2004 to CFAF 612 billion in 2009 (from 10.2 percent of non-oil GDP to almost 30 percent of non-oil GDP): a threefold increase. The domestically financed investment budget experienced a similar expansion, increasing from 3.4 percent of non-oil GDP in 2004 to 9.4 percent of non-oil GDP in 2009. The decline in oil prices in 2008 and 2009 left Chad in an extremely vulnerable fiscal situation. Without appropriate savings, the country had to borrow. The government accumulated some deposits in its account at the Bank of Central African States (BEAC) when oil prices were high (Figure 6.6). However, these deposits proved insufficient when oil prices dropped in late 2008 and early 2009. Not only did domestically financed expenditures not adjust in accordance with

©International Monetary Fund. Not for Redistribution 118 Government Failure and Poverty Reduction in the CEMAC

1,200

1,000

AF 800

600

400 Billions of CF

200

0 1995 2000 2005 2010

Total revenues Oil revenues Expenditures Figure 6.4 Chad: Government Revenues and Expenditures, 1995–2010 Source: World Bank, 2011. Note: CFAF 5 Coopération Financière en Afrique Centrale franc.

lower revenue, they actually increased from 2008 to 2009 by 9.6 percent. As a result, the government had to drain its deposits at the BEAC, request advances to meet its financing needs, and turn to nonconcessional borrowing.

Ineffective Allocation of Public Resources In addition to mismanaging the aggregate levels of public spending out of oil revenue, these countries have misallocated resources across different uses. The discretion allowed by opaque public expenditure management practices and the need to deal with various demands from fragmented political constituencies have led to striking discrepancies between stated development objectives and actual executed public spending. Two cases in point are Cameroon and Chad.

160 140 133.87 120 100 84.98 80 60 54.3 40 Crude oil prices 41.58 (Brendt) $/barrel 20 0 7 1 01 M0 M07 M 2004M012004M072005M012005M072006M012006M072007M012007M072008M012008M02009 2009 2009 Figure 6.5 Evolution of Crude Oil Prices, 2004–10 Source: World Bank, 2011.

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350 120

300 100

250 80 AF 200 60 150 40 Price ($/bbl) Billion CF 100 50 20 0 0 Jan-08 Jul-08 Jan-09 Jul-09 Deposits Advances and credit Oil price, Doba field (to BEAC; left scale) (from BEAC; left scale) (right scale) Figure 6.6 Evolution of Chad’s Deposits and Advances at the BEAC Source: World Bank, 2011. Note: BEAC 5 Bank of Central African States.

In Cameroon, budget discipline has not always been strong, contributing to poor practices in budget preparation and execution, and allowing political interfer- ence in the budget process. Overall, poor planning and preparation of the budget, and the lack of broad participation by line ministries in the process, has lead to weak ownership and acceptance of the budget. Despite multiple controls in budget execution, the controllers are neither empowered to do their jobs without outside interfer- ence nor held accountable, further reducing the efficiency of budget execution. The social sectors, health and education in particular, along with agriculture and infrastructure, appear to constitute the pillars of the government’s investment strategy. The share of these four key sectors in the investment budget increased from about 42 percent in 2004 to about 68 percent in 2008. This expansion was driven mainly by the infrastructure sector, whose share more than doubled during these four years (from less than 20 percent in 2004 to more than 40 percent in 2008). However, these priority sectors represented a much smaller share of the treasury’s actual payments, declining from about 44 percent in 2006 to about 30 percent in 2008 (Figure 6.7 and 6.8). This decrease may reflect the difficulty of implementing projects in key sectors or a shift in the government’s priorities between the planning and payment stages. The infrastructure sector again saw the biggest changes: it represented 45 percent of the planned investment outlays in 2008, but only 19 percent of the payments. None of the government’s priority sectors differed from this pattern. In Chad, too, budget execution has not reflected strategic priorities. Budgetary appropriations more or less conform to the objectives spelled out in Chad’s Poverty Reduction Strategies (Figures 6.9 and 6.10). Actual spending in priority sectors, including but not limited to health and education, has fallen short of expectations because of problems in budget execution. Priority spending also seems to have been crowded out by unbudgeted expenditures, especially on the military.

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80 70 60 50 40 30 20 Percent of budget 10 0 2004 2005 2006 2007 2008 Figure 6.7 Budget Allocation to Priority Sectors in Cameroon, 2004-08 Sources: World Bank, 2010a.

80 70 60 50 40

Percent 30 20 10 0 2006 2007 2008 Priority sectors as share of budget Priority sectors as share of expenditures Figure 6.8 Budget versus Expenditure in Priority Sectors in Cameroon, 2006-08 Sources: World Bank, 2010a.

60 NPRS I Budgeted Execuon 50 et 40 30

ent of budg 20 rc

Pe 10 0 PrioritySecurityOther nonpriority Figure 6.9 Chad: Priority and Nonpriority Execution, NPRS I (2004–07) Sources: Country authorities; and IMF staff calculations. Note: NPRS 5 National Poverty Reduction Strategy.

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60 NPRS II Budgeted Execuon 50 et 40

ent of budg 20 rc Pe 10

0 PrioritySecurityOther nonpriority Figure 6.10 Chad: Priority and Nonpriority Execution, NPRS II (2008–10) Sources: Country authorities; and IMF staff calculations. Note: NPRS 5 National Poverty Reduction Strategy.

Low Value for Money Resources spent on priority sectors, such as infrastructure, agriculture, health, and education, have resulted in limited improvement in the services provided by these sectors. In Chad, the cost of constructing classrooms is the highest in Africa—and four times the next most expensive country. Despite providing “free” health care, Chad has one of the lowest immunization rates in the world. A leakage rate of 99 percent for nonsalary public spending in health in the country may be part of the explanation (Gauthier and Wane, 2009). Cameroon annually spends about $50 per capita on health, but has the epidemiological profile of countries that spend $10. Road maintenance costs in the country are twice the average for sub-Saharan Africa. Despite huge electricity needs, Congo’s electric utility suffers from 47 percent transmission losses (compared with an African average of 27 percent), overstaffing, low cost recovery (despite relatively high tariffs), and low collection rates. Finally, all these countries have used oil revenue to increase subsidies. In Chad, subsidies are provided to the cotton and electricity sectors; in Cameroon, to aluminum, fuel, and publicly owned enterprises. One reason for the low value for money in these countries is that, in all of them, most spending circumvents the public procurement system. In Cameroon, only about a quarter of contracts go through the procurement system. The figure in Congo was estimated to be about the same, although the share has increased since the country reached the completion point for the Highly Indebted Poor Countries initiative, with concrete, on-the-ground results from these reforms. The more general point is that there appear to be few incentives for using public revenue cost efficiently, possibly because citizen scrutiny of these spending decisions is minimal. That a sizable share of this revenue is spent on subsidies also indicates that it may be an instrument of political patronage.

Overcoming Government Failure The coexistence of natural resource rents and poor economic performance in the CEMAC countries is more than a coincidence. Poor performance stems from a

©International Monetary Fund. Not for Redistribution 122 Government Failure and Poverty Reduction in the CEMAC

fundamental feature of the revenue from mineral extraction. When the revenue accrues directly to the government without passing through the citizenry, as would revenue from taxation, citizen scrutiny—or even knowledge—of this resource revenue is weaker (Devarajan, 1999). Knowing this, government can exercise more discretion in public spending, leading to unsustainable fiscal deficits (as was the case in Cameroon in the early 1990s, and in Chad more recently), misallocation of resources away from priority sectors, and extremely low value for money. When the revenue does not accrue to the government, as with the Central African Republic’s diamonds, and the state’s capacity is weak, the “first-come, first-served” nature of natural resources extraction leads to civil conflict and an even further weakening of the state. What can be done in these situations? Broadly speaking, there are two catego- ries of actions. One is to strengthen governments’ capacity for taxation and public expenditure management. If governments employ a medium-term expenditure framework, they are more likely to see the future consequences of current expenditure patterns and, possibly, avoid running into debt problems. Similarly, if governments strengthen their capacity to evaluate public investment programs— including by using benchmark information to assess the costs of their investments— both the allocation of resources and value for money would improve. However, these “supply-side” interventions can only go so far when the per- vading problem is the government’s lack of accountability to its citizens for spending resource revenue. A second category of solutions, therefore, is to change the way resource revenue accrues to the government. Instead of having the revenue go directly from the oil company (for instance) to the government, it could be transferred directly to the citizens, who would then be taxed to finance public expenditures. Such a scheme is a variant on the direct distribution mechanisms already being practiced in, for instance, the state of Alaska in the United States, where a portion of oil revenue is transferred directly to citizens. As Devarajan and others (2011) show in an analytical model, such a scheme could lead to greater citizen scrutiny of government spending (even if that scrutiny is costly) and, ultimately, to better public expenditure decisions. To be sure, this approach would not work in a country such as the Central African Republic, where the problem is lack of government revenue (the Central African Republic has one of the lowest revenue-to-GDP ratios in Africa, and public services are virtually nonexistent outside the capital city). The challenge for that country is to strengthen the capacity to collect revenue from other sources so that the state can provide the basic public good of security, which would, in turn, allow for legal diamond mining. But even in this case, citizen feedback on how the state spends its additional tax revenue would be critical for sustaining that revenue. Direct distribution of resource revenue combined with taxation will also challenge the already weak implementation capacity of the CEMAC countries. Current tax administration is weak, and the governments lack effective means of distributing cash transfers to citizens. However, thanks to modern technology and an understanding of fiscal policy in low-income countries, both these problems

©International Monetary Fund. Not for Redistribution Devarajan and Singh 123 can be addressed. First, tax administration is weak in these countries because they have not had to rely on taxation for public revenue. Countries with comparable per capita income, such as Ghana and Kenya, have reasonably well-functioning tax systems. The CEMAC governments should be able to learn from Ghana and Kenya and develop their tax systems—especially if taxation becomes their only source of revenue. Second, although governments may now lack the means of transferring money to citizens, the enabling technology has improved so much that it should be possible in the near future. Low-income countries are already introducing personal debit cards (with verifiable anthropomorphic information, such as fingerprints embedded in the chip) to carry out various antipoverty schemes, such as India’s health insurance program (Gelb and Decker, 2011). With the advent of mobile banking, and the ubiquity of mobile phones in Central Africa, it will be possible to make these transfers by mobile phone, thereby reaching people in remote areas as well. No doubt, a proposal to transfer resource revenue directly to the public and then tax them will be resisted by governments that are accustomed to having discretion over public expenditures. But these are the same governments that have wielded this discretion poorly. The citizens of CEMAC countries have not benefited to the fullest extent from their countries’ rich natural resource base. They deserve better. With commodity prices expected to remain high through 2020 and the possibility of even more mineral discoveries in these countries, their citizens have an opportunity to launch their countries on a path of sustained economic growth and poverty reduction. The citizens of CEMAC countries— and indeed the international community—should ensure that natural resource revenue is not squandered in the future.

References Collier, Paul, 2010, The Plundered Planet (Oxford: Oxford University Press). Coquery-Vidrovitch, Catherine, 1972, Le Congo au temps des Grandes Compagnies Concessionaires 1898–1930 (Paris and The Hague: Mouton and Co.). Devarajan, Shantayanan, 1999, “Cameroon,” in Trade Shocks in Developing Countries: Volume I, Africa, ed. by D. Bevan, P. Collier, and J. Gunning (Oxford: Oxford University Press). ———, Hélène Ehrhart, Tuan Le, and Gael Raballand, 2011, “Direct Redistribution, Taxation and Accountability in Oil-Rich Economies: A Proposal,” Working Paper 281 (Washington: Center for Global Development). Gauthier, Bernard, and Waly Wane, 2009, “Leakage of Public Resources in the Health Sector: An Empirical Investigation of Chad,” Journal of African Economies, Vol. 18, No. 1, pp. 52–83. Gelb, Alan H., and Associates, 1988, Oil Windfalls: Blessing or Curse? (Oxford: Oxford University Press). Gelb, Alan, and Caroline Decker, 2011, “Cash at Your Fingertips: Technology for Identification and Payment in Resource-Rich Countries” (Washington: Center for Global Development). International Monetary Fund, 2009, Chad: Staff Report for the 2008 Article IV Consultation, IMF Country Report 09/68 (Washington). Neba, Aaron, 1999, Modern Geography of the Republic of Cameroon, 3rd ed. (Bamenda, Cameroon: Neba Publishers). Sachs, Jeffrey D., and Andrew M. Warner, 2001, “The Curse of Natural Resources,” European Economic Review, Vol. 45, No. 4-6, pp. 827–38.

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Singh, Daleep, 2008, Francophone Africa 1905–2005: A Century of Economic and Social Change (New Delhi: Allied Publishers Private Ltd). Sundiata, Ibrahim, 1988, “The Roots of African Despotism: The Question of Political Culture,” African Studies Review, Vol. 31, No. 1, pp. 9–31. United Nations Development Programme (UNDP), 2010, Human Development Report, The Real Wealth of Nations: Pathways to Human Development (New York, NY: UNDP). World Bank, 2010a, “Cameroon; Fiscal Policy for Growth and Development,” Report No. 48433-CM (Washington). ———, 2010b, “Republic of Chad: Public Expenditure Review Update,” Report No. 57654- TD (Washington). ———, 2010c, “Republic of Congo: Public Expenditure Review,” Report No. 54734-CG (Washington).

©International Monetary Fund. Not for Redistribution CHAPTER 7

Natural Resource Endowments, Governance, and Domestic Revenue Mobilization: Lessons for the CEMAC Region

Sanjeev Gupta and Eva Jenkner1

Financial flows to sub-Saharan Africa, spanning from aid and debt relief to remittances and foreign direct investment, have increased sharply since 1980, supporting higher public spending, including much-needed outlays on health and education. However, domestic revenue mobilization has been less successful, with revenue largely stagnating during 1980–2005 (Keen and Mansour, 2010). This has raised concerns about whether sub-Saharan Africa’s vast developmental requirements can be financed in a fiscally sustainable manner. A low, nonresource-based tax burden can, in principle, help to create a more diversified private sector. However, this chapter argues that it may not be the optimal strategy for many resource-rich countries. The reasons are manifold: In those instances in which natural resources are expected to be exhausted in the foreseeable future, the gradual development of a diversified tax base would be a rational strategy. And in countries that have not successfully dealt with volatility in resource revenue, a broadening of the revenue base can strengthen fiscal management. Furthermore, insufficient reliance on nonresource taxation fails to promote citizens’ involvement in scrutiny of the government’s operations and, therefore, in building of the state. Institutional weaknesses, in turn, affect a country’s ability to channel resources to their best uses. Thus, the advantages of a relatively low tax burden on the nonresource sector can easily be outweighed by the potential cost of stunted institutional development, which typically manifests itself in rent- seeking, corruption, and limited democratic accountability and legitimacy (Leite and Weidmann, 2002; Isham and others, 2003; Sala-i-Martin and Subramanian, 2003; Collier and Hoeffler, 2005; Moore, 2007; and Bräutigam, 2008). Dependence on foreign aid or natural resource revenue can create disincentives for countries to mobilize domestic revenue or nonresource revenue (Gupta and others 2004; and Bornhorst, Gupta, and Thornton, 2009). This chapter starts by exploring the links between natural resource revenue and efforts to mobilize nonresource

1We wish to thank Ben Clements, Sharmini Coorey, Katja Funke, Mario Mansour, Jean-Claude Nachega, Atsushi Oshima, Darlena Tartari Schwegler, and Abdel Senhaji for helpful comments and data; and Lilla Nemeth for excellent research assistance. 125

©International Monetary Fund. Not for Redistribution 126 Natural Resource Endowments, Governance, and Domestic Revenue Mobilization

revenue in the Central African Economic and Monetary Community (CEMAC) region. It then discusses the implications for governance and state-building of dependence on natural resource revenue. Conclusions are drawn in the final section.

The Impact of Natural Resource Endowments on Domestic Revenue Mobilization and the CEMAC Experience The traditional view has been that natural resource endowments can provide significant support to countries’ economic development and growth. Natural resources were seen as a capital endowment that would positively affect production and output (Viner, 1952; Lewis, 1955; and Rostow, 1960), and certainly industrial development in Europe was supported by the existence of energy sources such as coal. Subsequently, this view was challenged by a sizable literature that emphasized the potential negative consequences of natural resources, or the “resources curse.” However, discussion mainly focused on commodity prices and so-called Dutch disease. On the one hand, commodity prices were expected to fall over the long run as the result of greater competition in markets for primary goods (Prebisch, 1950; and Singer, 1950), and their great volatility was seen as undermining development through large swings in revenues and exports, complicating fiscal management and creating investment uncertainty (Micksell, 1997; and Auty, 1998). On the other hand, Dutch disease relates to a real appreciation of the exchange rate through capital inflows and high inflation fueled by strong domestic demand, which, in turn, undermines the development of other sectors of the economy. As a result, once resources are depleted, adjustment costs can be significant (Magud and Sosa, 2010). Recently, studies have added another dimension to the “resources curse” by exploring links between natural resource endowments and domestic revenue mobilization. Some scholars have argued that resource-rich governments have less of an incentive to mobilize revenue from domestic sources (Collier, 2007; and Moore, 2007), akin to a weakening of incentives in countries that rely heavily on external aid (Bauer, 1976; and Gupta and others, 2004). A first attempt was made by Bornhorst, Gupta, and Thornton (2009) to analyze empirically the impact of natural resource revenue on nonresource revenue for 30 hydrocarbon-producing countries. They found that nonresource revenue is lower by about 20 percent in these countries that rely on hydrocarbon-related revenue. A cursory examination of disaggregated trends in revenue mobilization in the CEMAC suggests that such disincentive effects are indeed prevalent in the region. Although overall revenue collection has increased in the CEMAC since 1980, and is comparable to other regional blocks in sub-Saharan Africa, higher resource revenue is the driving factor (Figure 7.1). Nonresource revenue as a share of GDP declined sharply because revenue from trade taxes fell by almost 5 percent of GDP and was only partially compensated for by indirect tax revenue such as the value-added tax and excise duties (Keen and Mansour, 2010). Income tax revenue also decreased marginally, by 0.5 percent of GDP. As a result, average nonresource revenue in relation to GDP in the CEMAC region was significantly lower than in all other regions during 2003–05.

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25 Other tax revenue Nonresource tax revenue

10 Percent of GDP

0 5 2 2 5 2 5 1980–822003–0 1980–822003–05 1980–82003–05 1980–82003–0 1980–82003–0 COMESA EAC SADC CEMAC WAEMU Figure 7.1 Sub-Saharan Africa: Total Tax Revenue by Regional Block Source: Keen and Mansour, 2010. Note: COMESA 5 Common Market for Eastern and Southern Africa; EAC 5 East African Community; SADC 5 Southern African Development Community; WAEMU 5 West African Economic and Monetary Union.

30 Total revenue (CEMAC countries) Total revenue (non-hydrocarbon producing African countries) 25 Nonhydrocarbon revenue (CEMAC countries)

Percent of GDP 10

0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Figure 7.2 Government Revenues from Hydrocarbon and Nonhydrocarbon Sources, 1992–2005 Sources: IMF staff estimates; and IMF staff calculations based on data from Bornhorst, Gupta, and Thornton, 2009. Note: Data for Chad are for 1994–2005. Nonhydrocarbon producing African countries are countries with no or insignificant hydrocarbon production: Burkina Faso, Burundi, Cape Verde, Comoros, The Gambia, Guinea-Bissau, Madagascar, Malawi, Mozambique, Namibia, Rwanda, Senegal, Seychelles, Sierra Leone, Swaziland, Tanzania, Togo, and Zambia. CEMAC 5 Central African Economic and Monetary Community/

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Cameroon Chad 30% 30% Total revenue (% of GDP) Total revenue (% of GDP) 25% Hydrocarbon revenue (% of GDP) 25% Hydrocarbon revenue (% of GDP) Nonhydrocarbon domestic revenue (% of GDP) Nonhydrocarbon domestic revenue (% of GDP) 20% 20%

15% 15%

10% 10%

5% 5%

0% 0% 9 6 5 9 03 993 995 997 1992 1993 1994 1995 1996 1997 1998 199 2000 2001 2002 2003 2004 2005 1992 1 1994 1 19 1 1998 1999 2000 2001 2002 20 2004 200 Congo, Republic of Equatorial Guinea Total revenue (% of GDP) Total revenue (% of GDP) 40% Hydrocarbon revenue (% of GDP) 40% Hydrocarbon revenue (% of GDP) 35% Nonhydrocarbon domestic revenue 35% Nonhydrocarbon domestic revenue (% of GDP) (% of GDP) 30% 30% 25% 25% 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% 3 3 05 994 1992 199 1994 1995 1996 1997 1998 1999 2000 2001 2002 200 2004 2005 1992 1993 1 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 20

Gabon 55% Total revenue (% of GDP) 45% Hydrocarbon revenue (% of GDP) Nonhydrocarbon domestic revenue (% of GDP) 35%

25%

15%

-5% 2 3 6 4 9 99 02 199 19 1994 1995 199 1997 1998 19 2000 2001 20 2003 200 2005 Figure 7.3 CEMAC: Revenue from Hydrocarbon and Nonhydrocarbon Sources, 1992–2005 Source: Bornhorst, Gupta, and Thornton, 2009. Note: Data for Chad are for 1994–2005.

Focusing specifically on revenue from hydrocarbons supports a similar conclusion. Although total revenue in CEMAC countries exceeds total revenue in nonhydrocarbon-producing African countries, the comparison is less favorable when revenue from hydrocarbon sources is excluded (Figure 7.2). Moreover, country data reveal that the decline in nonhydrocarbon revenue has been pronounced in Chad, Equatorial Guinea, and the Republic of Congo (Figure 7.3). Through 2005, nonhydrocarbon domestic revenue started to fall as hydrocarbon revenue grew in Equatorial Guinea and the Republic of Congo, and grew along with hydrocarbon income in Cameroon—a country whose hydrocarbon resources are projected to be exhausted by about 2030. This trend reverses when domestic revenue is estimated in relation to non hydrocarbon GDP (Figure 7.4).2 Specifically, revenue effort measured as a share of economic activity unrelated to hydrocarbons appears to have increased significantly

2Should hydrocarbon GDP increase sharply, nonhydrocarbon domestic revenue expressed as a share of total GDP may appear depressed. Measuring nonhydrocarbon revenue as a share of nonhydrocarbon GDP avoids this bias.

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–2

–4

Percent of GDP –6

–8

–10

–12 Cameroon Chad Congo Equatorial Gabon African Hydro- All hydro- Guinea hydrocarbon carbon carbon producers producers producers

4 Percent of nonhydrocarbon GDP 2

0 Cameroon Chad Congo Equatorial Gabon African Hydro- All hydro- Guinea hydrocarbon carbon carbon producers producers producers Figure 7.4 CEMAC: Change in Nonhydrocarbon Domestic Revenue, between 1992–95 and 2002–05 Source: IMF staff calculations based on data from Bornhorst, Gupta, and, Thornton, 2009. Note: Data for Chad are for 1994–2005. “Hydrocarbon producers” excludes Norway, Russia, and Kuwait. CEMAC 5 Central African Economic and Monetary Community. in all countries—in particular in Chad and Gabon—exceeding average rates for all 30 hydrocarbon-producing economies worldwide. However, this result should be interpreted with caution given the difficulties in estimating nonhydrocarbon GDP in these countries. Also, the estimation of nonhydrocarbon revenue may be biased upward by the inclusion of indirect hydrocarbon-related revenue (such as corporate income tax, value added tax receipts from upstream companies, or personal income tax on wage earnings in the hydrocarbon sector).

Natural Resource Endowments, State Building, and Governance A number of considerations underscore the need to strengthen the nonresource revenue base in the CEMAC region. First, CEMAC has a criterion on non-oil

©International Monetary Fund. Not for Redistribution 130 Natural Resource Endowments, Governance, and Domestic Revenue Mobilization

revenue as part of the fiscal convergence under which non-oil fiscal revenue should equal or exceed 17 percent of GDP (see Box 2.1 in Chapter 2). Admittedly, this is among the secondary surveillance criteria, and its compliance by member countries is not obligatory. Nevertheless, its existence is indicative of the desire of member countries to diversify their revenue base. Second, natural resources—and the associated revenue flows—are exhaustible. In the medium to long term, natural resource–producing states would need to develop alternative revenue streams to sustain their spending and to provide critical public services to the population (see Chapter 5 in this volume). Furthermore, diversification of the revenue base is also needed to offset the volatility associated with natural resource revenue.3 Although some resource-dependent economies, such as Chile, Mexico, and Norway, have managed revenue volatility by establishing large stabilization funds or by using hedging mechanisms, overreliance on natural resource income for most countries tends to translate into volatile income flows, which significantly complicate fiscal management. Inevitably, the institutional framework and capacity for raising domestic nonresource tax revenue will have to be developed, and the cost of moving to higher domestic taxation only after resources are depleted may be significant. Third, natural resource endowments encourage rent-seeking, and as a result, institutional development may be stunted (Isham and others, 2003; and Sala-i-Martin and Subramanian, 2003) and the probability of civil conflict and general waste and corruption can rise (Leite and Weidmann, 2002). In this regard, the structure of a country’s tax regime can affect the quality of its institutions and governance, with large resource endowments potentially having a detrimental impact on state- building. Consequently, greater reliance on domestic taxes could increase public scrutiny and accountability of governments in resource-rich countries, which, in turn, would help to strengthen governance and develop state institutions (Collier and Hoeffler, 2005; and Moore, 2007). Apart from building state capacity, the social contract and bargaining that surround taxation foster the legitimacy of the state and representative democracy (Bräutigam, 2008). However, should higher domestic taxation fail to instill greater accountability and transparency, augmented resources would only fuel public sector profligacy. It could also be argued that a reliance on natural resource taxation allows these countries to maintain low domestic taxation, which can help foster private sector activities and support much-needed diversification of the economy. Unfortunately, the limited analysis that has been carried out for developing countries finds no significant relationship between the level and composition of taxes on one hand and long-term growth on the other (Tanzi and Zee, 2000; Adams and Bevan, 2005; and Martinez-Vasquez, Vulovic, and Liu, 2009).4

3Ebeke and Ehrhart (2010) highlight the advantages of diversifying the revenue base for public investment. 4Lee and Gordon (2005) find that lower corporate income taxes are associated with faster growth, including in countries that are not members of the Organization for Economic Cooperation and Development, though other tax variables are insignificant. Easterly and Rebelo (1993) note that the effects of taxation on growth are difficult to isolate empirically.

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) 5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

Corruption index (0 = highly corrupt; 10 very clean 0 Nonhydrocarbon Hydrocarbon Nonhydrocarbon Hydrocarbon producers producers producers in producers in Africa Africa Figure 7.5 Perception of Corruption in Hydrocarbon-Producing and Nonhydrocarbon- Producing Countries, 2010 Source: Transparency International. Note: Corruption is measured as a perceptions-based index that assigns risk points on a scale from 0 (high) to 10 (low), according to the perceived amount of corruption. Classification of countries into hydrocarbon-and nonhydrocarbon-producing follows Bornhorst, Gupta, and Thornton (2009). Hydrocarbon producers include Algeria, Angola, Azerbaijan, Bahrain, Brunei, Cameroon, Chad, the Republic of Congo, Equador, Equatorial Guinea, Indonesia, the Islamic Republic of Iran, Kazakhstan, Kuwait, Libya, Mexico, Nigeria, Norway, Oman, Qatar, Russia, Saudi Arabia, Sudan, the Syrian Arab Republic, Trinidad and Tobago, the United Arab Emirates, Venezuela, Vietnam, and Yemen. Nonhydrocarbon producers include Albania, Bhutan, Burkina Faso, Burundi, Cape Verde, Comoros, Costa Rica, Cyprus, Djibouti, Dominica, the Dominican Republic, Eritrea, Estonia, Finland, France, The Gambia, Greece, Guinea-Bissau, Iceland, Israel, Jamaica, Japan, Jordan, the Republic of Korea, Kyrgyzstan, Latvia, Lebanon, Luxembourg, Madagascar, Maldives, Malawi, Mali, Malta, Mauritius, Moldova, Mongolia, Morocco, Mozambique, Namibia, Nicaragua, Panama, Paraguay, Portugal, Rwanda, Senegal, Seychelles, Sierra Leone, Singapore, Slovenia, Spain, Sri Lanka, Swaziland, Switzerland, Taiwan Province of China, Tanzania, Togo, Uganda, and Zambia.

Finally, corruption lowers tax revenue as resources are diverted, and tax collection is reduced through capture of tax inspectors (Tanzi and Davoodi, 2002). Transparency International’s Corruption Perceptions Index supports the general conclusion that corruption is higher in hydrocarbon-producing countries than in nonhydrocarbon-producing countries in Africa and worldwide (Figure 7.5). The index illustrates that poor governance is a particular concern among hydrocarbon- producing economies in Africa. Average perceived corruption in the CEMAC region is also found to be similarly high (Figure 7.6). This roughly corresponds to the finding that average nonhydrocarbon domestic revenue (10 percent of GDP) in the five CEMAC oil-producing countries is almost in line with the relatively low domestic revenue mobilization for all African hydrocarbon producers (9½ percent of GDP), although both corruption and domestic revenue mobilization are slightly above average in the CEMAC economies.

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4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5 Corruption index (0 = highly corrupt; 10 very clean) 0 Hydrocarbon Hydrocarbon Hydrocarbon CEMAC producers producers excluding producers in Norway, Russia, Kuwait Africa Figure 7.6 CEMAC: Perception of Corruption in Hydrocarbon-Producing Countries, 2010 Source: Transparency International. Note: CEMAC 5 Central African Economic and Monetary Community. Corruption is measured as a perceptions-based index that assigns risk points on a scale from 0 (high) to 10 (low), according to the perceived amount of corruption. Classification of hydrocarbon-producing countries follows Bornhorst, Gupta, and Thornton (2009). Hydrocarbon producers include Algeria, Angola, Azerbaijan, Bahrain, Brunei, Cameroon, Chad, the Republic of Congo, Equador, Equatorial Guinea, Indonesia, the Islamic Republic of Iran, Kazakhstan, Kuwait, Libya, Mexico, Nigeria, Norway, Oman, Qatar, Russia, Saudi Arabia, Sudan, the Syrian Arab Republic, Trinidad and Tobago, the United Arab Emirates, Venezuela, Vietnam, and Yemen.

The pattern is less clear-cut for the individual countries because of the many determinants of governance and the great divergence in resource revenues (Figure 7.7). Lack of data makes it impossible to conduct a thorough quantitative analysis. The country with the highest perception of corruption, Chad, also has the highest share of nonhydrocarbon revenue in total revenue, even above the share in the least-corrupt country, Gabon. However, hydrocarbon-related income was still low in Chad during 2000–05, and changes in governance will need to be monitored as reliance on resource revenue grows. Relatively high perceived corruption and very low domestic revenue mobilization coincided in Equatorial Guinea.

Conclusion The potential advantages of enhancing the nonresource revenue effort in natural resource–producing countries are many, including more stable and sustainable revenue flows, improved fiscal institutions, and a generally strengthened state with better governance. These gains would need to be weighed against the possible benefit of low nonresource taxation for development of the private sector. To enhance nonresource revenue, these countries need to broaden their tax bases, especially for value-added taxes and corporate income tax, as well as strengthen

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40 4.0 40 4.0 y Cameroon y Chad 35 3.5 35 3.5 NonhydrocarbonHydrocarbon NonhydrocarbonHydrocarbon 30 3.0 30 3.0 25 2.5 25 2.5 20 2.0 20 2.0 15 1.5 15 1.5

Percent of GDP 10 1.0 Percent of GDP 10 1.0 corrupt; 10 = very clean) 5 0.5 corrupt; 10 = very clean) 5 0.5 Corruption index (0 = highl Corruption index (0 = highl 0 0 0 0 Total tax revenue Corruption Total tax revenue Corruption (left scale) (right scale) (left scale) (right scale)

40 4.0 40 4.0 y Congo y Equatorial Guinea 35 3.5 35 NonhydrocarbonHydrocarbon NonhydrocarbonHydrocarbon 3.5 30 3.0 30 3.0 25 2.5 25 2.5 20 2.0 20 2.0 15 1.5 15 1.5

40 4.0 Gabon y 35 NonhydrocarbonHydrocarbon 3.5 30 3.0 25 2.5 20 2.0 15 1.5

Percent of GDP 10 1.0

5 0.5 corrupt; 10 = very clean) Corruption index (0 = highl 0 0 Total tax revenue Corruption (left scale) (right scale) Figure 7.7 CEMAC: Tax Revenue and Governance, 2000–05 AQ1 Sources: Bornhorst, Gupta, and Thornton, 2009; and Transparency International. Note: Corruption is measured as a perceptions-based index that assigns risk points on a scale from 0 (high) to 10 (low), according to the perceived amount of corruption. Figures refer to 2005. CEMAC 5 Central African Economic and Monetary Community.

revenue administration. Over the longer term, strong and stable domestic revenue and efficient expenditure allocations are critical for improved fiscal planning and management and the much-needed scaling-up of social spending in a fiscally sustainable manner. The presumption is that revenue diversification would contribute to institutional development and ensure that the resulting higher revenue would not be wasted. Finally, it is difficult to disentangle the revenue regime from the other complex determinants of governance simply by using superficial country snapshots. Governance indicators are a concern for most of the CEMAC region, in Chad and Equatorial Guinea in particular, and seem to coincide with decreases in nonresource revenue effort in those two countries.

References Adams, C.S., and D.L. Bevan, 2005, “Fiscal Deficits and Growth in Developing Countries,” Journal of Public Economics, Vol. 89, No. 4, pp 571–97. Auty, R.M., 1998, Resource Abundance and Economic Development: Improving the Performance of Resource-Rich Countries (Helsinki: United Nations World Institute for Development Economics). Bauer, P., 1976, Dissent on Development (Cambridge, Mass.: Harvard University Press).

©International Monetary Fund. Not for Redistribution 134 Natural Resource Endowments, Governance, and Domestic Revenue Mobilization

Bornhorst, F., S. Gupta, and J. Thornton, 2009, “Natural Resource Endowments and the Domestic Revenue Effort,” European Journal of Political Economy Vol. 25, No. 4, pp. 439–46. Bräutigam, D., 2008, “Introduction: Taxation and State-Building in Developing Countries,” in Taxation and State-Building in Developing Countries: Capacity and Consent, ed. by D. Bräutigam, O. Fjelstad, and M. Moore (Cambridge: Cambridge University Press). Collier, P., 2007, “Managing Commodity Booms: Lessons of International Experience,” African Economic Research Consortium (Oxford University). ———, and A. Hoeffler, 2005, “Democracy and Resource Rents,” Global Poverty Research Group Working Paper 016 (Oxford: Oxford University). Easterly, W., and S. Rebelo, 1993, “Fiscal Policy and Economic Growth: An Empirical Investigation,” Journal of Monetary Economics, Vol. 32, No. 3, pp 417–58. Ebeke, C., and H. Ehrhart, 2010, “Tax Revenue Instability in Sub-Saharan Africa: Consequences and Remedies,” CERDI Working Paper 201025 (Auvergne, France: CERDI). Gupta, S., B. Clements, A. Pivovarsky, and E. Tiongson, 2004, “Foreign Aid and Revenue Response: Does the Composition of Aid Matter?” in Helping Countries Develop: The Role of Fiscal Policy, ed. by S. Gupta, B. Clements, and G. Inchauste (Washington: International Monetary Fund). Isham, J., L. Pritchett, M. Woolcock, and G. Busby, 2003, “The Varieties of the Resource Experience: How Natural Resource Export Structures Affect the Political Economy of Economic Growth,” Working Paper 0308 (Middlebury, VT: Middlebury College, Department of Economics). Keen, M., and M. Mansour, 2010, “Revenue Mobilization in Sub-Saharan Africa: Challenges from Globalization I-Trade Reform,” Development Policy Review, Vol. 28, No. 5, 553–71. Lee, Y., and R.H. Gordon, 2005, “Tax Structure and Economic Growth,” Journal of Public Economics, Vol. 89, No. 5–6, pp. 1027–43. Leite, C., and J. Weidmann, 2002, “Does Mother Nature Corrupt? Natural Resources, Corruption, and Economic Growth,” in Governance, Corruption, and Economic Performance, ed. by G. Abed and S. Gupta (Washington: International Monetary Fund). Lewis, A., 1955, The Theory of Economic Growth (London: Allen & Unwin). Magud, N., and S. Sosa, 2010, “When and Why Worry About Real Exchange Rate Appreciation? The Missing Link Between Dutch Disease and Growth,” IMF Working Paper 10/271 (Washington: International Monetary Fund). Martinez-Vasquez, J., V. Vulovic, and Y. Liu, 2009, “Direct versus Indirect Taxation: Trends, Theory and Economic Significance,” International Studies Program, Working Paper 09-11 (Atlanta: Georgia State University). Micksell, R.F., 1997, “Explaining the Resource Curse, with Special Reference to Mineral- Exporting Countries,” Resources Policy, Vol. 23, No. 4, pp. 191–99. Moore, M., 2007, “How Does Taxation Affect the Quality of Governance,” IDS Working Paper 280 (Brighton, UK: Institute of Development Studies). Prebisch, R., 1950, The Economic Development of Latin America and Its Principal Problems (New York: United Nations). Rostow, W.W., 1960, The Stages of Economic Growth (Cambridge: Cambridge University Press). Sala-i-Martin, X., and A. Subramanian, 2003, “Addressing the Natural Resource Curse: An Illustration from Nigeria,” IMF Working Paper 03/139 (Washington: International Monetary Fund). Singer, H.W., 1950, “U.S. Foreign Investment in Underdeveloped Areas: The Distribution of Gains Between Investing and Borrowing Countries,” American Economic Review, Vol. 40, No. 2, pp. 473–85. Tanzi, V., and H. Davoodi, 2002, “Corruption, Growth and Public Finances,” in Governance, Corruption, and Economic Performance, ed. by G. Abed and S. Gupta (Washington: International Monetary Fund). Tanzi, V., and H. Zee, 2000, “Tax Policy for Emerging Markets: Developing Countries,” IMF Working Paper 00/35 (Washington: International Monetary Fund). Viner, J., 1952, International Trade and Economic Development (Glencoe, IL: Free Press).

©International Monetary Fund. Not for Redistribution CHAPTER 8

The Cyclicality of Fiscal Policies in the CEMAC Region

Gaston K. Mpatswe, Sampawende J.-A. Tapsoba, and Robert C. York

To promote and sustain the Coopération Financière en Afrique Centrale (CFA) franc–pegged exchange rate regime and enhance regional economic integration, Central African Economic and Monetary Community (CEMAC) member countries (Cameroon, the Central African Republic, Chad, Equatorial Guinea, Gabon, and the Republic of Congo) are called upon to support a number of policy objectives. These objectives are translated into convergence criteria, which include achieving a nonnegative basic fiscal balance, maintaining total debt of less than 70 percent of GDP, nonaccumulation of domestic and external arrears, and annual inflation of no more than 3 percent. The adequacy and effectiveness of fiscal convergence for supporting the fixed exchange rate and economic integration are frequently questioned, because member countries have rarely observed these criterion mainly because they are flawed in that they do not account for oil production in five of the six member countries and other factors (York and others, Chapter 2 of this volume). The convergence criteria also fail to recognize an important dimension of fiscal policy—the possibility of procyclicality. The CEMAC Commission’s narrow focus on a nonnegative fiscal balance could send misleading signals about fiscal policy performance in member countries because it does not prevent countries from spending windfall oil or commodity-export receipts when prices in these sectors rise. Such spending goes against good fiscal management, which suggests that expenditure not be influenced by temporary changes in oil (or other commodity) prices. Of course, if a price shock is permanent, a structural shift in the expenditure envelope could be prudent and consistent with long-term sustainability. Like others (Iossifov and others, 2009), this chapter argues that fiscal surveillance in the region and in individual CEMAC countries should not rely solely on the current convergence criteria but should also include fiscal indicators that consider cyclical factors, the fiscal impulse, and the behavior of non-oil aggregates and the non-oil primary balance. Yet the analysis remains cognizant of the broader concerns about procyclical fiscal policies, which can exacerbate economic fluctuations, hamper growth, and have long-term welfare implications (IMF, 2005). Also, if expansionary fiscal policies in good times are not fully offset in bad times, they may lead to large fiscal deficits and a buildup of debt and its associated problems, including possible default.

135

©International Monetary Fund. Not for Redistribution 136 The Cyclicality of Fiscal Policies in the CEMAC Region

The aim of this chapter is to shed further light on the nature of fiscal policies across the CEMAC, and in particular, to assess whether there is procyclical bias— an important question for the region, but one that has attracted little empirical interest. The analysis uses a panel data approach to address this question and assesses the cyclicality of fiscal policies of CEMAC countries during 1980–2008 as compared with other countries in the subregion. It examines the potential driving factors behind fiscal policies across the CEMAC and extends the empirical literature by employing a time-varying coefficient model to look at procyclicality coefficients over time. The next section reviews the empirical literature devoted to the CEMAC and is followed by a section that lays out the empirical model and its estimation. The final section draws conclusions and discusses policy implications. Overall, the findings support most existing literature demonstrating that fiscal policies are strongly procyclical across the region with significant evidence of persistence.

Review of the Empirical Literature Only a few empirical studies have investigated the cyclicality of fiscal policies in CEMAC member countries. The studies that do exist have followed the main- stream literature in focusing on comovements of various indicators of fiscal policy and output cycles. Although the various studies use different econometric techniques, the modeling strategy is generally similar. A fiscal reaction function of the following generic form is estimated by

gi,t    gi,t 2 1  yi,t  i,t   vi,t, (8.1)

in which i and t represent country and period, respectively; gi,t and yi,t are, respectively, indicators of fiscal policy (defined, for example, as a function of the fiscal balance as share of GDP or total government expenditure) and output cycles (which could be defined either as output gaps or growth rates); i,t represents a vector of control variables; and vi,t captures fiscal shocks. The disturbance term vi,t can be decomposed into three orthogonal components: a country-specific fixed effect i, period random terms ut , and an idiosyncratic fiscal shock it.The fiscal

shocks are thus expressed as (vi,t  i  ut  it). The cyclicality of fiscal policy is determined by looking at the sign and the size of the coefficient . When the indicator of fiscal policy is expressed in terms of government expenditure, procyclicality is inferred from the data if   0, that is, a cyclical upturn (downturn) is associated with an increase (decrease) in government spending; countercyclical if   0 and acyclical if   0. A few authors examine the fiscal balance in equation (8.1), but the majority of studies focus on the growth or level of public spending when testing for cyclicality, especially in low-income countries with limited data and in oil-producing countries (Box 8.1). Adedeji and Williams (2007) and Weigand (2004) are the only two studies that focus on CEMAC countries. Although their interests were not on investigat- ing fiscal cyclicality directly, the issue is raised in their analyses but the conclusions are not clear cut. Rather than government spending as the dependent

©International Monetary Fund. Not for Redistribution Mpatswe, Tapsoba, and York 137

Box 8.1

Fiscal Indicators and Economic Cycles A common methodology for determining whether a fiscal policy is expansionary or contractionary is to test comovements between changes in various summary indicators of the fiscal balance (often expressed in proportion to output) and cyclical changes in output. In this context, countercyclical fiscal policy is defined as running fiscal deficits in bad times and surplus in good times, whereas procyclical fiscal policy is defined as running fiscal deficits, or a surplus lower than what would otherwise have been achieved given the cycle of the economy, during good times. Reinhart, Kaminsky, and Végh (2004), among others, have questioned the accuracy of fiscal balance indicators in assessing the cyclicality of the fiscal stance, mainly on two grounds. First, the fiscal balance and other indicators like the revenue- and expenditure-to-GDP ratios reflect the outcomes of policy, and are affected only endogenously by the actions of policymakers. For this reason, the direction of comovements between these fiscal indicators and economic cycles might be ambiguous. Second, expressing fiscal variables as proportions of output could yield misleading results because the cyclical fiscal stance may be dominated by the cyclical behavior of output. The assessment of the fiscal stance of oil-producing countries is a particular case in point: for example, an expansion through increased spending is masked by an improvement in the overall fiscal balance resulting from rising oil revenue. Moreover, although devised to correct such volatility from biasing policy analysis, the applicability of indicators of discretionary policy—including cyclically adjusted fiscal balances and the fiscal impulse—has limitations in the case of oil-exporting countries. These indicators rely heavily on estimates of output gaps and the elasticity of the budget to changes in output, which could raise specific issues for oil producers because (i) they are subject to substantial and frequent terms-of-trade shocks, making it difficult to identify business cycles; and (ii) unlike most industrial non–oil-producing countries, in which output fluctuates around a relatively stable trend, shocks to trend growth are the primary source of fluctuations in oil-producing countries, blurring the simple distinction between trend and cycle (Aguir and Gopinath, 2004). Reinhart, Kaminsky, and Végh (2004) therefore advocate an approach that involves judging fiscal cyclicality by assessing the direction of comovements between fiscal policy instruments—tax rates and government spending—and economic cycles. They propose that governments pursue • countercyclical fiscal policy when they lower (raise) spending and raise (lower) tax rates in good (bad) times, because, for example, a reduction of spending and raising of tax rates tends to stabilize the business cycle; • procyclical fiscal policy when they raise (lower) spending and lower (raise) tax rates in good (bad) times; and • acyclical fiscal policy when spending and tax rates remain constant over the economic cycle—a pattern that will neither reinforce nor stabilize the business cycle. For many developing countries—including those in the Central African Economic and Monetary Community—the lack of comprehensive and systematic data on tax rates suggests that government spending is probably the most reliable indicator for judging fiscal cyclicality.

variable, Adedeji and Williams (2007) regress the basic fiscal balance on output, debt-to-GDP ratio, lagged dependent variable, and other control variables. Their model is estimated using both fixed effects and the difference and system generalized method of moments (GMM) estimators on annual panel data for the six countries covering 1990–2006. They find that the coefficient on the lagged basic primary fiscal balance is positive and significant, suggesting a high degree of persistence in fiscal policy. Because current fiscal performance is strongly determined by performance in the previous year, they conclude that exogenous shocks—in the absence of automatic stabilizers—would result in procyclical fiscal policies across the region (in other words, implying comovement between the policy stance and output, which is the essence of procyclicality). In his assessment of the fiscal convergence criteria in the CEMAC, Wiegand (2004) finds some contrary evidence. He computes the elasticity of the non-oil basic fiscal balance with respect to the CFA franc oil price over time to check whether procyclicality is a matter of concern. On this basis, no significant procyclicality is found over the period 1994–2001. Weigand (2004) suggests that large short-term changes in the non-oil balances are more closely aligned with political events than with oil price movements. Akitoby and others (2004) assess the short- and long-term behavior of government expenditure in 51 developing countries, including Cameroon and the Republic of Congo, during 1970–2002. Using an error-correction model, they find a positive short-term elasticity of government spending with regard to output and conclude that fiscal policy is procyclical in more than half the countries, including the two CEMAC members. Also, they show that output and government spending for most countries, and for at least one aggregate measure, are cointegrated, indicating a long-term relationship between them in line with “Wagner’s law” (see Akitoby and others, 2004). With government consumption responding more than proportionately to fluctuations in output in many cases (the mean across the region was 0.91, with a standard deviation of 0.39). For CEMAC countries, procyclicality is found to be significant and low for Chad and Gabon, and high for the Republic of Congo and Equatorial Guinea. Diallo (2008) investigates the impact of institutions on fiscal policy; he finds procyclical fiscal policies across the SSA region, but concludes these procyclical policies can be reversed by strong institutions. His empirical approach is slightly different from the generic equation (8.1), using instead a type of fiscal Taylor rule. He postulates that the fiscal stance can be captured by deviations of government spending from its trend; these deviations are themselves driven by deviations in output captured in exogenous shocks, which Diallo proxies by movements in the terms of trade from their (Hodrick-Prescott filtered) trend.1 He uses system

1In Diallo (2008), terms-of-trade shocks are taken as an explanatory variable in place of the deviations of real GDP from its long-run trend. His formulation is built on the argument that shocks, such as terms-of-trade volatility—which is among the most important sources of shocks with which African countries are confronted—negatively affect the design and implementation of sound economic policies.

GMM on a panel of 47 countries, including all six CEMAC members, during 1989–2002. Lledó, Yackovlev, and Gadenne (2009) use several methods (ordinary least squares [OLS], instrumental variables, and GMM) to estimate equation (8.1) for 174 countries, including 44 in sub-Saharan Africa (SSA) (and all six CEMAC members) during 1970–2008. Multiple methods were used to account for the possible reverse causality between growth in output and government spending. They find that b is positive and statistically significant for all developing countries and more pronounced for those in SSA, although the procyclicality bias declined over time, especially after the late 1990s. Carmignani (2010) looks at correlation coefficients between filtered real government spending and filtered real GDP growth for 37 African countries, including three from the CEMAC (Cameroon, Chad, and Gabon). He finds a statistically significant and positive relationship, which he concludes is evidence of procyclicality. CEMAC countries were classified among the procyclical countries. Finally, using measures of the fiscal stance and fiscal impulse (both including and excluding oil revenue), Iossifov and others (2009) suggest that procyclicality was a prominent feature of fiscal policies in the CEMAC region, particularly after 2000, coinciding with the run-up in world oil prices over nearly a decade. The study noted that the ripple effects of terms-of-trade and real effective exchange rate shocks on the business cycles in the region are potentially magnified through fiscal policies. In their assessment, procyclical policies may exaggerate these effects whereas countercyclical policies could potentially mitigate them.

Empirical Model To assess fiscal cyclicality, the ideal would be to estimate a fiscal reaction function in which real government expenditure responds to changes in real output cycles and other factors noted in the literature. A form of this reaction function is the Taylor-type rule without the inflation terms, as used by Diallo (2008). This reaction function assesses the direction and level of comovements between government spending and output deviations from their respective steady state trends:

(Gi,t 2 G*i,t ) 5    (Gi,t 2 1 2 G*i,t 2 1)   (Yi,t 2 Y *i,t )  X i,t   vi,t, (8.2) in which (Gi,t 2 G*i,t ) denotes the deviation of actual government spending from its long-run trend, and (Yi,t 2 Y *i,t ) is the deviation of output (or real GDP) from 2 its long-term trend. The terms Xi,t and vi,t are defined as in equation (8.1). As above, the cyclicality of fiscal policy is determined by the sign and size of the coefficient on output , which represents the short-run fiscal response to the

2The deviation terms could also be defined as spending gaps and output gaps, respectively, if related variables are expressed in logarithms or if the cyclical components are normalized onto the filtered trends.

economic cycle. Note that equation (8.2) is formulated with respect to comovements between spending and economic cycles, and not fiscal balance indicators. For the reasons outlined in Box 8.1, fiscal balance indicators may not be appropriate for judging cyclicality in low-income and oil-producing countries. To estimate this reaction function, adequate representations for the unob- served long-run values of government spending and output would be needed. One approach would be to use a filter to estimate these values and then run the model based on spending and output gaps (e.g., Diallo, 2008).3 Another approach would be to estimate a dynamic equation with the lagged values of these variables used as proxies for potential output and run the regression in first difference (e.g., Thornton, 2008)4:

LogGi,t    LogGi,t  1  LogYi,t  X i,t   vi,t, (8.3)

in which  is the first difference operator, Log is the logarithm, coefficient  would capture the short-term overall cyclical behavior of government spending without differentiating between discretionary fiscal actions and automatic responses to the economic cycle, and coefficient  would capture possible inertia effects or long-term mean reversion in government spending. This coefficient is expected to have a positive sign and be less than 1.5 Because automatic stabilizers are likely to be small in CEMAC countries, equation (8.3) is a reasonable approx- imation of discretionary fiscal policy. In addition, data to estimate equation (8.3) are easily available, thus avoiding the shortcomings of using the filtering approach to estimate potential output (Box 8.1). A consistent identification of  requires addressing the potential endogeneity bias stemming from two factors: (i) the reverse causality between public expenditure and output given that output is likely to be responsive to a fiscal stimulus; and (ii) the simultaneity bias caused by the fact that omitted variables, including country-specific factors, likely are correlated with government spending. Following the work of Lledó, Yackovlev, and Gadenne (2009), and others, the present analysis addresses the endogeneity problem by estimating equation (8.3) with GMM procedures (difference and systems) adapted for dynamic-panel estimation and fixed-effects estimators, which can control for country-specific factors. It should be noted that the lagged dependent variable will be correlated with the regression error when using fixed effects. To determine the consistency of the estimated coefficients, the results are reported in this chapter with and without the lagged dependent variable. Endogeneity is less a problem if the results do not change significantly. This analysis uses the two methods to improve on previous empirical work and to determine which leads to the most

3Box 8.1 highlights the difficulties of estimating output gaps, particularly for oil-exporting countries. 4This methodology differs slightly from Thornton (2008), however, because it uses the panel dimension of the data. 5 For a given time series process kt  kt  1 or equivalently kt  kt  1, mean reversion implies that 0    1. The series will either oscillate around the mean or drift away from the mean unless ||  1.

©International Monetary Fund. Not for Redistribution Mpatswe, Tapsoba, and York 141 robust results.6 Year-specific dummy variables are included in the estimates to control for the CEMAC’s covariant shocks, thus ensuring that the identified fiscal behavior is specific to fiscal authorities only. The estimation of equation (8.3) is carried out in two steps. The first step focuses solely on addressing the null hypothesis to determine whether fiscal policy is acyclical across the region (b 5 0). This coefficient is then allowed to be country specific and time varying, as specified in equation in (8.4)

LogGit    bitLogYi,t 1 it, (8.4) which is a modified form of equation (8.3), excluding the vector of control variables. Following Aghion and Marinescu (2008), the procedure estimates equation (8.4) using local Gaussian-weighted OLS. This technique determines the time-varying cyclicality coefficient ˆ it for country i at year t by using all observations and assigning greater weights to those observations closest to the reference year. This is achieved by giving a Gaussian-centered weight to the reference period. A 10-year rolling window approach is also applied to ensure that the cyclicality captured is a result of transitory discretionary fiscal policies. If t denotes the length of the rolling window, then the error term it follows a normal distribution 2  2 2 _  5 _1_ 2 (_ t)  2 1 function: 0, with Wt( ) exp 2 , (t 5, t 4). Wt(t) √ 2  ( 2 ) As suggested in Aghion and Marinescu (2008), the smoothing parameter s is arbitrarily set to 5 because the results are qualitatively robust to slight changes of this parameter.7 In the second step, the analysis pools the estimated time-varying cyclicality coefficients (ˆ it) and regresses them against the vector of control variables that are thought to be the main causes of cyclicality in developing countries (as noted in the literature review above). This is represented in equation (8.5)

 5  1 k k 1  ˆ it ( Z i,t ) it, (8.5)

k in which Z i,t denotes the explanatory variables and it is the classical error term encompassing a country-specific fixed effect and an idiosyncratic fiscal shock. The explanatory variables include political and institutional factors to capture rent- seeking behavior that could drive profligacy in public spending, weaknesses in governance (and corruption), and public financial management, election cycles, and financing constraints.8 This chapter proxies political institutional factors and

6The system and difference GMM procedure is particularly adapted for dynamic panels because it enables correction for any potential correlation between explanatory variables and country-specific factors. It does not require external instruments and uses lagged variables to address the endogeneity bias. The difference GMM yields similar results to the system GMM while imposing fewer restrictions on the correlations between the instruments and the error term. The within fixed-effects estimator only controls for country-specific factors and mitigates the simultaneity bias. It does not address problems such as reverse causality. 7The b coefficients without control variables would be biased upward. However, estimating the coefficients without control variables allows us to explain fiscal procyclicality using the control variables.

governance through an election variable (measuring a political or electoral cycle), Freedom House’s Civil Liberties and Political Rights indices (assessing the extent of democratization and the role of checks and balances on the fiscal authorities), and the World Bank’s Country Policy and Institutional Assessment index (measuring the quality of policies and institutions). Financing constraints are captured by aid-to-GDP ratios. Aid dependency is important and remains the main source of financing for developing countries when they are shut out of capital markets or during economic downturns. In addition to these usual factors, the analysis tests the potential influence of variables measuring fiscal space, which may affect a government’s ability to conduct active spending policy. Fiscal space is defined as the room to maneuver without jeopardizing fiscal sustainability.9 The role of IMF programs in creating such space is also explored. IMF-supported programs are viewed as policy anchors because they are generally accompanied by economic and structural reforms that could influence the conduct of fiscal policy. Accordingly, fiscal space is proxied by the current inflation rate, the lagged public-debt-to-GDP ratio, and IMF program status. Given the heterogeneity across member countries and the prominence of oil in the CEMAC region (five of the six countries are oil exporters), the analysis controls for terms-of-trade shocks and the level of development using real GDP per capita. These factors could strongly influence the ability of the countries in the region to implement countercyclical fiscal policies. Finally, a dummy variable is introduced among the regressors to take account of the effects of the 1994 devaluation of the CFA franc, with the value 1 for the subsequent period. The assumption is that structural adjustments that accompanied the devaluation—as well as the subsequent adoption of regional convergence criteria—might have imposed additional constraints on the fiscal authorities’ policy behavior.

Data Set The macroeconomic data for the six CEMAC countries and other SSA countries come from the IMF’s World Economic Outlook database and cover 1980–2008. Missing data caused an unbalanced panel of 164 observations. From this database are extracted general-government total expenditure (including the breakdown into consumption and investment),10 the GDP deflator, GDP per capita, the

8For instance, Tornell and Lane (1999) have shown that if there are no institutional controls to limit policy discretion, the risk of overspending the windfall revenue during good times is high. Such profligacy tends to be ubiquitous in volatile environments (Talvi and Végh, 2005), corrupted regimes (Alesina, Campante, and Tabellini, 2008), and where weak institutions prevail with fewer checks on the executive (Diallo, 2008). Also, developing countries’ lack of access to capital markets triggers fiscal profligacy during downturns as concerns increase about government creditworthiness and fiscal sustainability (Gavin and Perotti, 1997). 9Heller (2005) defines fiscal space as the availability of budgetary room that allows a government to provide resources for a desired purpose without any prejudice to the sustainability of a government’s financial position or the stability of the economy.

©International Monetary Fund. Not for Redistribution Mpatswe, Tapsoba, and York 143 consumer price index, trade shares, and terms-of-trade of goods and services. Fiscal data and explanatory variables are converted into real terms using the GDP deflator, when necessary, with 2000 as the base year. All indices are scaled to 2000 as well. Terms-of-trade shocks are specifically computed by weighting the unexpected change of the terms-of-trade variable—using the Hodrick-Prescott filter with the smoothing parameter set to 100—with trade shares. The intention is to model the exposure and vulnerability of each country to these shocks, especially ones arising from the volatility of oil prices. The other variables are taken from various sources. The election variable (taking the value 1 in an election year) is retrieved from the website African Elections Database (http://africanelections.tripod.com). The Freedom House Index (ranging between 1 and 7) is a measure of the average of the Civil Liberties and Political Rights subindices and comes from its website (http://www.freedom- house.org). A higher value of the index is associated with less civil and political liberty. The Country Policy and Institutional Assessment score is from the World Bank and was rescaled between 0 and 1 to make different years’ assessments comparable. A higher score corresponds to better-quality institutions and policies. The IMF program variable (taking the value 1 for countries under a program for a given year) and the public-debt-to-GDP ratio are compiled from other IMF databases.11 Finally, aid-to-GDP ratios are drawn from Organization for Economic Cooperation and Development data.

Estimation Results Table 8.1 reports the system and difference GMM estimates of the cyclicality of real public expenditure, consumption, and investment across SSA and the CEMAC region as specified in equation (8.4).12 The optimal lag structure of internal instruments in the regional data set is four. Based on the classical appraisal criteria, the GMM results are internally consistent for the SSA estimates but not for the CEMAC subregion alone. • For the SSA region as a whole, the results align with the empirical literature: there is strong evidence that fiscal policies are highly procyclical. The coefficient on output growth is close to 1 and is statistically significant at the 1 percent level. The analysis finds that procyclicality is also evident (and statistically significant at the 1 percent level) when considering public consumption and public investment as the dependent variables.13

10Across the CEMAC, data on general government mainly reflect the central government. 11In particular, debt data are taken from Abbas and others (2010). 12SSA includes 44 countries that are grouped in the IMF’s African Department. It does not include the countries in North Africa. 13An IMF staff paper (IMF, 2010) concluded that low-income countries, including those in SSA, were able to use built-up fiscal space to conduct countercyclical fiscal policies during the recent global financial crisis. This difference in conclusions from this chapter could reflect the data sample—the data for the present analysis runs only through 2008, just before the crisis.

©International Monetary Fund. Not for Redistribution 144 The Cyclicality of Fiscal Policies in the CEMAC Region 38 40 Yes 959 Public Public 2.088*** 0.235 0.000 0.783 (0.782) (0.490) (0.049) (0.046) 2 0.470 2 0.015 2 0.141*** Investment 38 40 0.152 0.464 0.013 0.397 0.006 Yes 959 (0.422) (0.344) (0.037) (0.057) Public Public 0.123 2 0.039 Consumption 38 40 Yes 943 0.954** 0.007 0.192 0.000 0.772 (0.412) (0.358) (0.037) (0.041) 2 0.005 2 0.055 Public Total Expenditure System GMM System 38 35 Yes 959 Public Public 1.925*** 0.254 0.000 0.626 (0.437) (0.049) (0.046) 2 0.011 2 0.141*** Investment Central African Economic and Monetary Economic African Community; Central 5 38 35 Yes 959 0.516** 0.011 0.387 0.006 0.395 Public Public (0.239) (0.035) (0.058) 2 0.038 Consumption 38 35 Yes 943 0.950*** 0.007 0.194 0.000 0.601 (0.238) (0.035) (0.041) 2 0.054 Public Total Expenditure 38 36 Yes 921 Public Public 2.102*** 0.253 0.000 0.736 (0.691) (0.484) (0.047) 2 0.402 2 0.138*** Investment 38 36 0.212 0.372 0.384 0.006 0.0843 Yes 921 (0.414) (0.369) (0.057) Public Public 2 0.038 Consumption 38 36 Yes 905 0.024 0.887** 0.139 0.000 0.472 (0.427) (0.372) Table 6.1 (0.043) 2 0.059 Public Total Rank (out of 169) in the Human Development Index Expenditure Gabon 93 Difference GMM Difference 38 32 Yes

Equatorial Guinea 117 921 Public Public 1.956*** 0.27 0.000 0.835 (0.419) (0.046)

Republic of Congo 126 2 0.137*** Investment

Camer oon 131 ©International Monetary Fund. Not for Redistribution Central African Republic 159 Chad 163 38 32 Yes 921 0.444* 0.366 0.006 0.293 Public Public (0.249) (0.057)

Source: UNDP Human Development Report, 2010 2 0.038 Consumption 38 32 Yes 905 0.893*** 0.142 0.000 0.331 (0.244) (0.044) 2 0.058 Public Total Expenditure

 Log 2 1 8.1 generalized method of moments. generalized G interacted Y interacted Y e 5 l with CEMAC GMM Estimates of Cyclical Fiscal Policy in Sub-Saharan Policy 1980–2008 Africa, Fiscal of Cyclical GMM Estimates ab  Log  Log

variable: variable: Dependent  Log Year dummies Year Constant Observations Countries Instruments AR(2) AR(1) Hansen T GMM Source: Authors’ estimates. Authors’ Source: CEMAC autocorrelation. order the first and second of Arellano-Bondfor the p values tests AR(1) and AR(2) denote in parentheses; errors Standard Note: ***significant at the 1 percent level. the 1 percent at ***significant level. the 5 percent at **significant level. the 10 percent at *significant Mpatswe, Tapsoba, and York 145

• The behavior of public consumption is less procyclical than public investment, which has an estimated coefficient on output growth of close to 2. This implies that investment is extremely responsive to economic cycles (i.e., a 1 percent increase in output growth leads to a 2 percent increase in the growth of public investment). • When CEMAC countries are identified separately in the regression (through a dummy variable LogY x CEMAC; the CEMAC dummy variable takes the value 1 for member countries and 0 otherwise), the results are similar. The corresponding coefficient—which approximates the difference in fiscal cyclicality—is not statistically significant. This implies that CEMAC countries’ fiscal policies also exhibit procyclicality over the sample period and that public investment is highly reactive to the economic cycle. In other words, governments in the CEMAC region tend to increase (cut) public investment rather than other types of spending during good (bad) times. • Consistent with most of the empirical literature cited above, the inertia effect captured by the coefficient on the lagged fiscal policy variable is negative and statistically significant for public investment. From the spending side of the budget, this provides some evidence that the behavior of fiscal policies is consistent with long-term sustainability, although not for public investment. The procedure also used the GMM for the CEMAC only; however, these results are not internally consistent. The inconsistency occurs because the number of internal instruments far exceeds the number of countries; consequently, the equation is overidentified and the validity of using GMM (to address the endogeneity bias) disappears.14 Instead, the analysis relies on the fixed-effects estimates for the CEMAC countries, which are reported in Table 8.2 for real public expenditure, consumption, and investment. These results mimic those from the GMM estimates over the entire SSA sample. The table also displays the results without the lagged dependent variable to assess the extent of the possible correlation with the error component. The results remained qualitatively robust in these different specifications, and the table reports those including the lagged dependent variable to address the notion of fiscal sustainability (or more correctly, inertia). • For the CEMAC, there is strong evidence of procyclicality because the coefficient on output growth is positive and statistically significant, with a magnitude similar to that of SSA (presented in Table 8.1). Once again, public investment is shown to be the most reactive to economic cycles, with elasticity above 1. Public consumption is also less responsive, in line with wider sample results.

14 Simply by being numerous, instruments overfit the instrumented variables, failing to expunge their endogenous components and biasing the coefficient estimates toward those from nonincremental estimators. As a consequence, the overidentification test is biased toward the null hypothesis of the validity of instruments. We found that the probability of the Hansen J-statistic test equals 1 in all cases. Moreover, the first- and second-order autocorrelation tests are also biased toward the null hypothesis of the presence of autocorrelation.

Table 8.2 Fixed Effects Estimates of Cyclical Fiscal Policy in the CEMAC, 1980–2008 Total Public Public Public Total Public Public Public Expenditure Consumption Investment Expenditure Consumption Investment Dependent Variable: DLogG With the Lagged Dependent Variable Without the Lagged Dependent Variable DLogY 0.932*** 0.652*** 1.105** 0.918*** 0.674*** 1.092** (0.133) (0.098) (0.356) (0.121) (0.111) (0.308)

DLogG21 20.200* 0.040 20.151 (0.090) (0.063) (0.145) Constant 20.049 20.011 20.137 0.255*** 0.123 0.041 (0.030) (0.065) (0.131) (0.016) (0.079) (0.195) Year dummies Yes Yes Yes Yes Yes Yes Observations 155 164 157 161 170 163 Countries 6 6 6 6 6 6 R2 0.333 0.298 0.154 0.322 0.298 0.138 Source: Authors’ estimates. Note: Standard errors in parentheses. CEMAC 5 Central African Economic and Monetary Community. ***significant at the 1 percent level. **significant at the 5 percent level. *significant at the 10 percent level.

• The coefficient on the lagged fiscal variable is negative, albeit weakly significant (at the 5 and 10 percent levels) for total expenditure; it is also negative but not statistically significant for public investment. This reveals the possibility of inertia and variability in public spending, but the effect could disappear over time (as is implied by the absolute value of the estimated coefficient of less than 1). York and Zhan (2009) reinforce the notion of persistence in government spending in considering the long-term sustainability of CEMAC oil-producing countries under a permanent-income framework. According to that study, public spending has driven the non-oil primary fiscal deficits too high, beyond levels consistent with the region’s proven oil reserves and the relatively short time horizon of future production (or long-term wealth, which is the discounted present value of the future stream of oil production). Equation (8.5) is used to shed light on the time-varying cyclicality coefficient by country and the OLS estimates for equation (8.4) to derive individual country coefficients. These coefficients are summarized in Table 8.3 and plotted in Figure 8.1. Both the coefficients15 and the figure show that CEMAC countries, except Chad, exhibit a high degree of procyclicality over a long period. There are, however, some significant cross-country differences in the cyclical behavior of fiscal policies. The cyclicality coefficient moves widely in the Central African Republic, the Republic of Congo, and Gabon, whereas Cameroon exhibits a sustained upward trend. The result for Chad was unexpected and requires future investigation. The estimates suggest that after 1994, all components of public spending tended to be countercyclical, while the empirical literature is ambiguous. For example, Carmignani (2010) estimates a negative but insignificant coefficient on government consumption during 1990–2007 (closer to the time frame of this chapter),

15 Individual country coefficients should be viewed as indicative only, given the limited time series and the use of OLS.

Table 8.3 Fiscal Cyclicality in the CEMAC Total Public Expenditure Public Consumption Public Investment Country estimates1 Cameroon 1.207** 1.306** 1.012*** Central African Republic 2.039* 1.036 5.741** Chad 20.480 20.665 20.129 Congo 0.569 0.718 0.748 Equatorial Guinea 0.861*** 0.736*** 0.880** Gabon 4.967*** 0.717** 9.099*** Time-varying estimates Mean 1.879 1.039 2.863 Standard deviation 1.789 1.101 3.621 Maximum 6.126 4.555 10.842 Minimum 21.008 21.531 21.092 Number of times   0 148 (92%) 155 (91%) 138 (85%) Number of times   1 83 (52%) 67 (39%) 103 (63%) Number of times   0 13 (8%) 15 (9%) 25 (15%) Total 161 170 163 Source: Authors’ estimates. Note: Percentage of total coefficients estimated in parentheses. 1Estimates include lagged dependent variable in right-hand side variables. ***significant at the 1 percent level. **significant at the 5 percent level. *significant at the 10 percent level. while Thornton (2008) finds strong evidence of procyclicality for Chadian expenditure over a longer time frame (1960–2003). Estimation of equation (8.5) also allows the factors driving the procyclicality of total government expenditure to be explored. Table 8.4 reports the results of the regression of six sets of variables that have been shown in the empirical literature to influence the cyclicality of public spending: political and institutional factors, financing constraints, fiscal space, the level of economic development, external shocks, and structural change. • Political and institutional factors. The investigation anticipated that elections would have a positive influence on the procyclicality of government spending and that higher-quality institutions would dampen profligacy, while political freedom would have an ambiguous effect. The prior expectations are only partially borne out by the data. The quality of institutions plays an important and quantitatively significant role in controlling total government expenditure and public investment in CEMAC countries, as does an improvement in political freedom. Election spending cycles are absent in the data, which is unexpected but not empirically significant. • Financing constraints. The impact of financing constraints (proxied by the foreign-aid-to-GDP ratio) on fiscal cyclicality is ambiguous. On the one hand, high dependency on aid for government spending heightens fiscal procyclicality because external assistance is empirically viewed as volatile, unpredictable, and overwhelmingly procyclical in many recipient countries (Pallage and Robe, 2001; and Bulir and Hamann, 2008). Disbursements

12 12 Central African Republic Cameroon 10 To tal 10 To tal Consumption Consumption 8 8 Investment Investment 6 6 ficient 4 ficient 4 Coef 2 Coef 2

0 0

–2 –2

–4 –4 1980 1984 1988 1992 1996 2000 2004 2008 1980 1984 1988 1992 1996 2000 2004 2008

12 12 Chad Congo, Rep. of 10 To tal 10 To tal Consumption Consumption 8 8 Investment Investment 6 6 ficient ficient 4 4 Coef Coef 2 2

0 0

–2 –2 1980 1984 1988 1992 1996 2000 2004 2008 1980 1984 1988 1992 1996 2000 2004 2008

12 12 Equatorial Guinea Gabon 10 To tal 10 To tal Consumption Consumption 8 8 Investment Investment 6 6 ficient ficient 4 4 Coef Coef 2 2

0 0

–2 –2 1980 1984 1988 1992 1996 2000 2004 2008 1980 1984 1988 1992 1996 2000 2004 2008 Figure 8.1 Time-Varying Fiscal Cyclicality Coefficients in the CEMAC, 1980–2008 Source: Authors’ estimates. Note: CEMAC 5 Central African Economic and Monetary Community.

increase during expansion episodes and may stop suddenly in downturns or during political instability and subsequent periods of slow growth or recession. Meanwhile, foreign aid is likely to become the only available financing for government spending during a sharp decline in commodity exports and could help the conduct of countercyclical policy by relaxing the financing constraint. As in Thornton (2008), this analysis finds that aid drives the procyclicality of total expenditure, especially public investment. The coefficients on these fiscal variables are strongly positive and statistically significant. The claim that foreign aid is itself procyclical and triggers the profligacy of public spending is, therefore, evident across the CEMAC region.

Table 8.4 Determinants of Cyclical Fiscal Policy in the CEMAC, 1980–2008 Estimator: Fixed Effects Dependent Variable: b-Coefficient in Equation (8.5) Total Public Expenditure Public Consumption Public Investment Political and institutional factors Election 20.263 20.222 20.197 20.221 20.243 20.047 (0.192) (0.207) (0.286) (0.267) (0.208) (0.502) Freedom House index 20.933*** 20.912*** 20.294 20.284 22.401** 22.344** (0.353) (0.312) (0.257) (0.278) (1.157) (1.010) CPIA score 23.544** 20.300 212.264** (1.675) (2.154) (5.004) Financing constraints Aid-to-GDP ratio 2.782** 4.526** 1.177 2.395 5.562 9.436*** (1.168) (1.818) (2.246) (2.647) (3.658) (3.124) Fiscal space Debt-to-GDP ratio (21) 0.420 0.065 0.556 0.456 20.391 21.474 (0.393) (0.307) (0.349) (0.288) (1.150) (1.132) Inflation 0.268 2.892 2.785 3.957 23.004 4.157 (2.472) (3.617) (1.824) (3.174) (6.236) (6.855) IMF program 21.006** 20.967* 21.699 (0.455) (0.561) (1.112) Level of development Log Y per capita 0.924* 1.337*** 0.489 0.673 0.262 1.387 (0.491) (0.501) (0.573) (0.603) (1.760) (1.509) External shocks Terms-of-trade shocks 0.278** 0.415* 0.288 0.444 0.301 0.482 (0.138) (0.212) (0.220) (0.325) (0.588) (0.685) Structural break Dummy 1994 0.063 0.334 20.061 0.346 0.681 0.473 (0.836) (0.979) (1.123) (1.746) (1.340) (1.591) Constant 25.350 28.410 24.518 26.324 13.226 6.130 (8.287) (7.609) (7.285) (7.368) (26.173) (21.839) Year dummies Yes Yes Yes Yes Yes Yes Observations 121 121 121 121 121 121 Countries 6 6 6 6 6 6 R2 0.506 0.589 0.296 0.366 0.381 0.484 Source: Authors’ estimates. Note: CPIA 5 Country Policy and Institutional Assessment. Standard errors in parentheses. ***significant at the 1 percent level. **significant at the 5 percent level. *significant at the 10 percent level.

• Fiscal space. The notion of fiscal space is accounted for through the debt-to- GDP ratio (lagged), inflation, and the existence of an IMF-supported program. The existence of an IMF-supported program was expected to dampen procyclicality, whereas lower inflation and debt might lead to the opposite effect. It was found that the debt-to-GDP ratio and inflation do not have an empirically significant impact on public spending when the analysis controls for the existence of an IMF-supported program. Indeed, the data show that an IMF-supported program encourages fiscal discipline and mitigates procyclical behavior, with a statistically significant impact on total expenditure and public consumption but not significant on public investment.

• Level of economic development. Following the conclusions of most of the previous empirical studies that fiscal policies are less procyclical in wealthier countries (especially advanced countries), both less procyclicality in richer CEMAC countries and a negative coefficient on GDP per capita would be expected. The data, however, reveal a positive and statistically significant relationship in the regression for total expenditure, suggesting that the wealthier CEMAC countries (notably Congo and Gabon in Figure 8.1) behave more procyclically. Perhaps this reflects their historical tendency to overspend oil windfall revenue, as noted in York and Zhan (2009). • External (terms-of-trade) shocks. Frequent and large terms-of-trade shocks stemming from oil price volatility would be expected to spur fiscal profligacy in CEMAC countries. This analysis finds that an expansion of public expenditure is heightened by unanticipated changes in terms of trade. This is inconsistent with the work of Talvi and Végh (2005), who postulate that under an unstable environment (i.e., one with frequent shocks) and institutional weakness, it might be optimal for budgetary authorities in developing oil-producing countries to spend the windfall revenue during the good times, partly in response to demands from different political and social groups. • Structural change. The impact of structural changes on the cyclicality of regional fiscal policies is ambiguous. The analysis introduces a dummy variable for the period after the 1994 devaluation of the CFA franc, with a value of 1 in the post-1994 period. The dummy variable is not statistically significant, as reported in Table 8.4. This finding is not consistent with suggestions from others (e.g., see Lledó, Yackovlev, and Gadenne, 2009) that after 1996 and during the recent global financial crisis, public spending has tended to be countercyclical across the SSA countries more generally.

Conclusions and Policy Implications The empirical analysis confirms the results of previous studies addressing the behavior of government spending over the economic cycle. The panel data for the six CEMAC countries—Cameroon, the Central African Republic, Chad, the Republic of Congo, Equatorial Guinea, and Gabon—during 1980–2008 provide strong evidence of procyclicality. This result is consistent with public spending behavior observed in other studies across the sub-Saharan region more generally, although this analysis provides further insights. The estimated cyclicality coefficients vary by country and over time—an interesting result that should be assessed more thor- oughly to deepen the understanding of fiscal policies across these six countries. For three of the six CEMAC countries, total public expenditure responds more than proportionately to fluctuations in output, with the reaction of the public investment component extremely high. This has probably amplified economic cycles across the subregion and prevented countercyclical fiscal policies from playing an important role in mitigating a decline in output caused by external shocks (Iossifov and others, 2009). In a region buffeted by frequent external shocks

stemming from volatility in the prices of oil and other commodities, this is cause for concern. The highly responsive behavior of public investment to output fluctuations suggests weaknesses in public financial management across the CEMAC. The tendency to use windfall revenue to boost such spending when oil prices rise may not be appropriate, given the importance of maintaining tight expenditure control over public investment programs, especially in light of the capacity and institutional constraints in the subregion. This ramped-up spending can easily be of poor quality and wasted, with adverse implications for building the physical and human capital needed to generate long-term wealth in a region endowed with considerable natural resources but burdened by relatively high poverty. This analysis shows that institutional weaknesses and poor governance partly explain the procyclicality of CEMAC fiscal policies, as does foreign aid, probably because of its own procyclical behavior. In contrast, the existence of an IMF- supported program could help provide a counterbalancing influence by attenuat- ing—but not totally eliminating—this procyclical bias. The level of debt is not found to be a statistically significant driver of procyclicality across the CEMAC region. However, the coefficient on the lagged dependent variable is negative, suggesting some concern about the persistence of and possible swings in government spending, which could have adverse consequences for the accumulation of public debt. Finally, the CEMAC Commission does not address the possibility of cyclicality in assessing its convergence criteria, which could send misleading signals about fiscal policy performance in member countries. As shown, the focus on a nonnegative fiscal balance alone can accommodate procyclical behavior because it does not prevent members from spending windfall oil or commodity-export receipts as prices rise. This violates principles of good fiscal management and fails to recognize the broader concerns about procyclical fiscal policies, including the potential for exacerbating economic volatility and hindering growth, and the policies’ long-term welfare implications.

References Abbas, A.S.M., N. Belhocine, A. ElGanainy, and M. Horton, 2010, “A Historical Public Debt Database,” IMF Working Paper 10/245 (Washington: International Monetary Fund). Adedeji, O., and O. Williams, 2007, “Fiscal Reaction Functions in the CFA Zone: An Analytical Perspective,” IMF Working Paper 07/232 (Washington: International Monetary Fund). Aghion, P., and I. Marinescu, 2008, “Cyclical Budgetary Policy and Economic Growth: What Do We Learn from OECD Panel Data?” NBER Macroeconomic Annual 2007, pp. 251–93. Aguir, M., and G. Gopinath, 2004, “Emerging Market Business Cycles: The Cycle is the Trend,” NBER Working Paper No. 10734 (Cambridge, Massachusetts: National Bureau of Economic Research). Akitoby, B., B. Clements, S. Gupta, and G. Inchauste, 2004, “The Cyclical and Long-Term Behavior of Government Expenditures in Developing Countries,” IMF Working Paper 04/202 (Washington: International Monetary Fund). Alesina, A., F. Campante, and G. Tabellini, 2008, “Why Is Fiscal Policy Often Procyclical?” Journal of the European Economic Association, Vol. 6. No. 5, pp. 1006–36. Bulir, A., and A. Hamann, 2008, “Volatility of Development Aid: From the Frying Pan into the Fire?” World Development, Vol. 36, No. 10, pp. 2048–66.

Carmignani, F., 2010, “Cyclical Fiscal Policy in Africa,” Journal of Policy Modeling, Vol. 32, No. 2, pp. 254–67. Diallo, O., 2008, “Tortuous Road Toward Countercyclical Fiscal Policy: Lessons From Democratized Sub-Saharan Africa,” Journal of Policy Modeling, Vol. 31, No. 1, pp. 36–50. Gavin, M., and R. Perotti, 1997, “Fiscal Policy in Latin America,” NBER Macroeconomics Annual, Vol. 12 (Cambridge, Massachusetts: MIT Press), pp. 11–71. Heller, P.S., 2005, “Understanding Fiscal Space,” IMF Policy Discussion Paper 05/4 (Washington: International Monetary Fund). International Monetary Fund, 2005, “Cyclicality of Fiscal Policy and Cyclically Adjusted Fiscal Balances,” SM/05/393 (Washington). ———, 2010, Emerging from the Global Crisis: Macroeconomic Challenges Facing Low-Income Countries (Washington). Iossifov, P., N. Kinoshita, M. Takebe, R. York, and Z. Zhan, 2009, “Improving Surveillance Across the CEMAC Region,” IMF Working Paper 09/260 (Washington: International Monetary Fund). Lledó, V., I. Yackovlev, and L. Gadenne, 2009, “Cyclical Patterns of Government Expenditures in Sub-Saharan Africa: Facts and Factors,” IMF Working Paper 09/274 (Washington: International Monetary Fund). Pallage, S., and M. Robe, 2001, “Foreign Aid and the Business Cycle,” Review of International Economics, Vol. 9, No. 4, pp. 641–72. Reinhart, C., G. Kaminsky, and C. Végh, 2004, “When It Rains It Pours: Procyclical Capital Flows and Macroeconomic Policies,” NBER Macroeconomics Annual 2004 (Cambridge, Massachusetts: National Bureau of Economic Research). Talvi, E., and C. Végh, 2005, “Tax Base Variability and Procyclical Fiscal Policy in Developing Countries,” Journal of Development Economics, Vol. 78, No. 1, pp. 156–90. Thornton, J., 2008, “Explaining Procyclical Fiscal Policy in African Countries,” Journal of African Economies, Vol. 17, No. 3, pp. 451–64. Tornell, A., and P. Lane, 1999, “The Voracity Effect,” American Economic Review, Vol. 89, No. 1, pp. 22–46. Weigand, J., 2004, “Fiscal Surveillance in a Petro Zone: The Case of the CEMAC,” IMF Working Paper 04/8 (Washington: International Monetary Fund). York, R., and Z. Zhan, 2009, “Fiscal Sustainability and Vulnerability in Oil-Producing Sub- Saharan African Countries,” IMF Working Paper 09/174 (Washington: International Monetary Fund).

Case Studies on Oil Wealth Management

Cameroon’s Oil Wealth: Transparency Matters

Bernard Gauthier and Albert Zeufack

Ample evidence indicates that natural resource revenue is more likely to lead to rent-seeking and corruption in countries that have not developed sufficient quality of governance before the natural resource discovery (Sala-i-Martin and Subramanian, 2003; and Karl, 2007). Cameroon is no exception. With its abundant natural resource base, varied climate, and diverse population, Cameroon has the potential to be one of the richest countries in sub-Saharan Africa. However, like many resource-rich countries, it has suffered from the natural resources curse. Using recently available data sets on oil production,1 Gauthier and Zeufack (2010) estimate the oil rent effectively captured by Cameroon since 1977, the beginning of commercial exploitation, and find that a large proportion was not properly accounted for in the budget. Using the World Bank’s Adjusted Net Saving series, the oil revenue gap is about US$5.9 billion for the 1977–2006 period. Using the national oil company’s (the Société Nationale des Hydrocarbures’s, or the SNH’s) own production data2 as a threshold, the difference between

This chapter draws heavily on a companion paper, “Governance and Oil Revenues in Cameroon,” in Collier and Venables, eds. (2011) Plundered Nations? Successes and Failures in Natural Resource Extraction, written as part of a project funded by the Revenue Watch Institute, which acknowledges the support of the Bill and Melinda Gates Foundation. The authors are particularly grateful to Paul Collier, Rick van der Ploeg, and Anthony Venables from Oxford University for valuable comments. They also thank Luc Désiré Omgba for research assistance and numerous staff from the World Bank for helpful discussions. The authors are indebted to the numerous people from civil society for sharing their invaluable insights during field visits in Cameroon. 1To estimate the oil revenue accruing to the country since the beginning of oil production, Gauthier and Zeufack (2010, 2011) make use of production data released by the World Bank’s Adjusted Net Saving project. This project estimates natural resource rents for a large number of countries, including Cameroon. The data set includes production data, prices, and costs over time. The Adjusted Net Saving production data are obtained from different independent sources, in particular British Petroleum’s “Statistical Review of World Energy” (various years); the International Energy Agency; International Petroleum Encyclopedia, 2001; and the United Nations “Monthly Bulletin of Statistics.” This data set has been used in empirical studies of the effects of natural resources revenue (e.g., Collier and Hoeffler, 2005). 2Oil production data was released by the SNH in 2008 as part of the Extractive Industries Transparency Initiative in Cameroon. These data comprise yearly physical production levels for the past three decades (Tamfu, 2008). The official data also comprise the country’s official budgetary data, part of the finance laws that present official oil revenue for most years during the period.

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Cameroon’s estimated oil revenue and reported oil revenue during the period is even higher—an impressive US$7 billion, or 35.2 percent, of the estimated total oil revenue that should have accrued to the government has not been accounted for.3 This chapter contrasts Cameroon’s development experience with that of Malaysia, a country with strong commonalities with Cameroon but that has managed to escape the “Dutch disease,” and argues that the lack of transparency and accountability in oil revenue management, including diversion of revenue away from the state budget, has significantly slowed the pace of development in Cameroon over the long run. Although transparency and accountability in the oil sector have improved somewhat during the past 30 years, evidence suggests that much remains to be done. Reforms along the lines of the Natural Resources Charter,4 especially reforms aiming at empowering civil society to hold governments, firms, and capital markets accountable, would be most useful. Specifically, the creation and operation of a truly independent energy regulatory agency, audit court, and anticorruption commission would help improve transparency in the oil sector in Cameroon. The next section discusses Cameroon’s lackluster development outcomes, contrasting these with the Malaysian experience. The subsequent sections link transparency and development outcomes, contrasting experiences from Malaysia and Cameroon, describe the oil sector in Cameroon and institutional arrangements governing the sector, and review the efforts to improve transparency in collaboration with the international community.

Oil and Development Outcomes in cameroon and malaysia: A Comparative Perspective Cameroon has experienced a stark deterioration in development outcomes despite growing oil exports. To put this situation in perspective, this analysis contrasts Cameroon’s experience with Malaysia, which shares many characteristics with Cameroon but has managed to escape Dutch disease. As highlighted by Collier (2010, p. 93), “Nowadays Malaysia is a highly successful middle-income country; at the time it established the state-owned oil company it was poor and struggling.” Cameroon and Malaysia are both small, tropical countries, with populations of 19 million and 27 million, respectively. Both countries have multi-ethnic populations and are former colonies, Malaysia gaining independence from the British in 1957, just three years before Cameroon.5 Both countries are rich in

3Using 2008 data, Gauthier and Zeufack found a gap of US$10.7 billion or 46 percent of total oil revenue. 4The Natural Resource Charter is a set of principles for governments and societies on how best to harness the opportunities created by natural resources for development. (See http://www.natural resourcecharter.org/.) 5Cameroon, a German colony, was divided after World War I into West and East Cameroon, administered by the British and the French, respectively, with a mandate from the League of Nations. East Cameroon acceded to independence on January 1, 1960, and West Cameroon became independent on October 1, 1961. The two Cameroons reunited on May 20, 1972.

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500

GNI per capita (constant 2000 US$) 0 1970 1975 1980 1985 1990 1995 2000 2005 2010

Cameroon Malaysia Figure 9.1 Real GNI per Capita, Cameroon and Malaysia, 1970–2010 Source: World Bank, World Development Indicators. Note: GNI 5 gross national income. natural resources, were agrarian economies in the 1960s, and still export commodities such as palm oil, rubber, and oil. However, as shown in Figure 9.1, in contrast to Malaysia, Cameroon did not harness its natural resources for sustained growth and development. Although the two countries were very similar at independence, Malaysia’s gross national income (GNI) per capita in constant US$ prices was twice Cameroon’s by 1970 and close to nine times greater in 2010. Cameroon’s annual GDP growth averaged 5.7 percent between 1972 and 1979, driven by the cocoa and coffee booms. Oil discovery and production began in 1977 (just before the second oil shock, in 1979), leading to a shift in the growth trajectory, with the country growing about 9.4 percent annually between 1977 and 1986. However, this high growth episode was short lived. A drop in the prices of commodities and oil coupled with inadequate policy responses plunged the country into a severe economic crisis. Between 1986 and 1993, GDP contracted by 5 percent per year on average, dropping per capita income in 1993 to half its 1986 level. The spell of negative growth culminated with the 50 percent devaluation of the Coopération Financière en Afrique Centrale franc in 1994. A set of accompa- nying measures were implemented, aimed at reforming public finances and the macroeconomic environment, including tax and commercial policies. The country’s positive growth rates resumed in 1995, but have not yet topped 5 percent. The slight rebound observed after the devaluation, mostly driven by a surge in timber exports—and forestry depletion—did not live up to expectations. Growth between 2001 and 2007 was 1 percentage point lower than the 4.5 percent achieved between 1995 and 2000, and Cameroon was poorer in 2007 than it was in 1985 as measured by GNI per capita. Malaysia, in contrast, posted an impressive growth performance in the 1970s right through the 1990s, raising GNI per capita to upper-middle-income status and reducing the poverty rate to less than 5 percent in 2007 from 50 percent in 1957. This performance was brought about by committed and far-sighted

leaders, macroeconomic stability, high rates of saving and investment, market- friendly policies, and openness to the world economy resulting in large inflows of foreign direct investment and economic diversification. In 2008, Malaysia was identified as 1 of only 13 countries in the world to have sustained growth of greater than 7 percent for more than 25 years since World War II (Growth Commission, 2008).6 Although the growth momentum has decelerated since the 1997 Asian financial crisis, and the 2001 bursting of the U.S. dot.com bubble, Malaysia’s real GDP growth still averaged 6 percent during 2003–07, against 9 percent in the 1987–97 period. By 2010, Malaysia had become the third most open economy in the world, with trade at 200 percent of its GDP (Azrai and Zeufack, 2011). Malaysia diversified its economy and exports. Exports of manufactures in particular increased significantly. In 2009, exports of manufactured goods represented 70 percent of the total value of Malaysian exports compared with only 3 percent in Cameroon. Oil accounted for only about 10 percent of Malaysian exports compared with about 41 percent in Cameroon. Strikingly, by 2009, 45 percent of Malaysia’s total exports were electrical and electronics components and products targeting the U.S. and European markets. About 90 percent of Dell laptops sold in the United States, for instance, were assembled in Penang, an island northwest of peninsular Malaysia. Infrastructure and other social outcomes also diverge dramatically between Cameroon and Malaysia. By 2009, Malaysia’s road network was about twice the length of Cameroon’s. Most important, 83 percent of roads in Malaysia are paved, but only 8 percent are in Cameroon. Malaysia has an extensive network of highways, including the 1,300-kilometer North-South highway that runs from South Thailand through Malaysia to Singapore. With regard to telecommunications infrastructure, while close to 56 percent of Malaysians have home access to the Internet, this proportion is only 4 percent in Cameroon. Social and human capital indicators have also deteriorated dramatically in Cameroon since the mid-1980s. Life expectancy dropped to 51 years from 53 between 1991 and 2009. The infant mortality rate steadily increased from 65 per 1,000 live births in 1991 to 84 in 2009, and the chronic child malnutrition rate remained at about 36 percent. During the same period in Malaysia, the infant mortality rate decreased from 16 per 1,000 live births to 6 and life expectancy increased to 74 years from 70. In 2008, while 100 percent of the Malaysian population had access to a clean water source, more than a quarter of the population of Cameroon was still without access to clean drinking water. Some 96 percent of Malaysians had access to sanitation facilities, whereas less than half of Cameroonians did. In 2007, the poverty headcount ratio was about 40 percent in Cameroon. Malaysia, however,

6The 13 countries identified by the commission, chaired by Nobel Laureate in economics Michael Spence, included Botswana, Brazil, China, Hong Kong Special Administrative Region, Indonesia, Japan, the Republic of Korea, Malaysia, Malta, Oman, Singapore, Taiwan Province of China, and Thailand.

©International Monetary Fund. Not for Redistribution Gauthier and Zeufack 159 has eliminated hardcore poverty in 50 years of independence. Only 3.6 percent of the Malaysian population was below the poverty line in 2008. The relatively high maternal mortality rate in Cameroon (600 per 100,000 live births) also carries a rural-poor bias. In 1998, fewer than one-third of women from the poorest quintile (29 percent) had deliveries attended by a medically trained person compared with 90 percent of women from the richest quintile. Also, roughly 60 percent of women from the poorest 20 percent of the population received antenatal care from a trained person compared with close to 100 percent of women from the richest 20 percent. These economic and social outcomes are not independent of oil revenue management policies implemented in each of the two countries, nor of political institutions. political institutions, Transparency in the oil sector, and Development Outcomes In The Plundered Planet, Paul Collier asks, “Why did Norway and Malaysia suc- ceed where most countries have failed?” His answer: “Both had honest leaders, and both had a cadre of public officials with a sense of national purpose” (Collier, 2010, pp. 93–94). Indeed, political leadership is fundamental to ensuring any successful development outcome. Most important, the relationship between oil and the economy cannot be understood outside the political economy realm. Malaysia’s successful diversification, for instance, was helped tremendously by political institutions, especially federalism,7 and a robust democratic system in the 1960s and 1970s that forced the multiple political parties to compete for solutions to voters’ main problem: unemployment. The electronics industry was introduced in Malaysia by the visionary Chief Minister of Penang State, the late Tun Dr. Lim Chong Eu, to tackle rising unemployment following Penang’s loss of free-port status. He created Malaysia’s first free trade zone in 1971 and aggres- sively recruited American and Japanese electronics firms to Penang. This example was subsequently replicated in other parts of Malaysia, especially in Greater Kuala Lumpur (Klang Valley) and in the southern state of Johor, bordering Singapore.8 This institutional setting contrasts starkly with Cameroon, where most political powers are centralized at the national level. Malaysia and Cameroon also have divergent institutional settings and strategies for oil revenue management. Both countries created national oil companies (Petronas in Malaysia in 1974 and the SNH in Cameroon in 1980), but their mandates were very different, and it is not surprising that they evolved in

7Malaysia is a federation, divided into 13 states and three federal territories. The 13 states are managed by elected chief ministers. Chief ministers enjoy considerable power, especially in economic policy. There is a clear delineation of powers between the federal, state, and local authorities. 8By 2009, Penang was home to more than 200 multinational companies and remained one of the 10 most successful industrial clusters in the world (United Nations Industrial Development Organization, 2009).

completely opposite directions. While Petronas was given a central role in production and in negotiation of technology transfer from multinationals, the SNH was created to manage the country’s interests in the oil sector and has therefore remained distant from direct production. As a consequence, in less than four decades, Petronas has built enough know-how to venture abroad and become a large, multinational, Fortune 500 company, successfully competing against all the other giants around the world and especially in Africa. One of the striking differences between these two countries is transparency in the oil sector. In contrast to Cameroon, information on the breakdown and time series of Malaysian federal government revenue from the oil sector is publicly available. Oil and gas revenue collected by the Malaysian federal government increased from US$154 million (7.8 percent of GDP) in 1975 to about US$16.1 billion (37.8 percent of GDP) in 2007 (Yusof, 2011). Data on direct taxes on oil and gas companies, indirect taxes (export duties on petroleum-related products), dividends from Petronas to the federal government, and royalties are published. Petronas’ profits are also published, even though it is not a publicly listed company. Access to information empowers civil society and enforces accountability. Petronas’ yearly contributions to the Malaysian federal budget are discussed at length in parliament and published. Transparency in oil revenue management has allowed the oil sector to become a central piece of Malaysia’s economic policy and development. Petronas’ rising profits were tracked and guided the design of the dividends policy. Dividends paid to the federal government by Petronas rose from US$374.5 million in 1985 to US$7 billion in 2007 (51.7 percent of the company’s 2007 profits). These transfers were used to finance Malaysia’s impressive social and physical infrastructure while keeping the budget deficit and debt in check. In stark contrast, because of the lack of transparency in Cameroon, the oil sector has remained an enclave and has not been engaged systematically in the medium- to long-term development planning for the country. Transparency is also critical in defining the rights of states and regions that produce oil. In Malaysia, the allocation rule between the oil-producing states and the federal government is publicly discussed and the states have the right to sue the federal government in case of wrongdoing. In Cameroon, this question is not publicly discussed. Transparency provides legal ways to voice concerns, an alternative to rebellion. The next section argues that the institutional arrangements governing the oil sector in Cameroon are confusing and complex, thus leading to nontransparency and a lack of accountability.

Institutional Arrangements in the Oil Sector in Cameroon Cameroon is a small oil producer on the world scene. It is also the smallest producer in Africa, far behind Nigeria, Africa’s largest oil producer, with about 4 percent of its northern neighbor’s oil output. Cameroon’s proven oil reserves are

©International Monetary Fund. Not for Redistribution Gauthier and Zeufack 161 also relatively small, estimated at about 540 million barrels, with an additional 960 million barrels of probable oil reserves (IMF, 2007).9 Despite being small by world standards, the oil sector plays a major role in production, exports, and government revenue in Cameroon. In 2009, the share of oil in total GDP was 4.8 percent, down from close to 30 percent at the peak of the oil boom in 1985. Crude oil products are the country’s main export, rep- resenting more than 41 percent of export revenue in 2009 (down from close to 80 percent in 1985), and far outweighing timber and wood products. The government’s revenue base is dominated by oil, which accounted for 26 percent of government revenue in 2009, down from almost 48 percent in 1985.10

Main Actors Oil exploration and production in Cameroon are carried out by international oil companies (IOCs), in a joint venture agreement (accord d’association) with the state, represented by the SNH. The SNH was created in 1980 as an autonomous public corporation, with a mandate to act as the government’s holding company for participation in joint ventures in the oil sector. It has overall responsibility for management of the sector, in behalf of the government. Its mandate includes (i) management of state interests in the oil sector; (ii) promotion, development, and monitoring of oil activities throughout the national territory; and (iii) com- mercialization of Cameroon’s share of crude oil production (SNH, 2008). While the SNH plays a vital role in the oil sector as regulator and joint-venture associate in all oil activities, two line ministries share some responsibilities over the sector: the Ministry of Energy and Water and the Ministry of Industry, Mines, and Technological Development, which is responsible for the issuance of mining titles for the extraction of oil. Responsibilities overlap between the two line ministries and other public agencies in the oil sector11 (World Bank, 2006). Notably, the delimitation between the SNH as a regulatory agency and as the party to an oil contract is insignificant. This lack of clarity leads to a very complex and quasi- opaque web of financial flows as shown in Figure 9.2.

Institutional Arrangements Until the adoption of the oil code in 1999, activities in the sector were governed by the 1964 Mining Law (Loi 64-LF-3) supplemented by the 1978 Law (Loi 78-14). Under that regime, oil taxation in Cameroon was based on a complex hybrid system combining production sharing and taxation as well as a guaranteed

9However, with the retrocession to Cameroon of the potentially oil- and gas-rich Bakassi peninsula by Nigeria in August 2008, new explorations have been registered and discoveries are expected to boost the Cameroon’s reserves considerably (Economist Intelligence Unit, 2008). 10In 2008, oil share of total GDP was 7.6 percent and oil accounted for 37 percent of government revenue (IMF, 2011). 11Other public agencies include the Société Nationale de Raffinage (the national refinery) and the Société Camerounaise de Depots Petroliers (the national petroleum storage company).

Crude oil Market Products of oil sale under the State mandate

Central Bank of Central Africa States (BEAC) Transfer on treasury account Sales

Dividends of the SNH SNH Contribution to Taxes on oil company profits (IS pétrolier) the budget Taxes on oil company profits, fix duties, SNH

Hydrocarbon Fix duties, area royalties Public Treasury (DGT) Department area royalties Tax Department (DGI) Dividends Taxes on oil company profits, fix duties, area royalties

Oil Companies Negative royalty, tendering funds, debt service

Signature bonuses, production bonuses, positive royalty

Ministries and other public Other transfers administrations Figure 9.2 Cameroon’s Oil Sector Financial Flows Source: Gauthier and Zeufack, 2010.

mining rent. State involvement in the oil sector took the form of a compulsory 20 percent SNH equity participation in the operating IOCs and a 50 percent share in joint venture arrangements with the same operators. This resulted in a 60 percent SNH equity share in all oil activities. In addition to the obligation to conclude production-sharing arrangements in accordance with the 1978 law, each IOC had to conclude a Convention of Establishment (convention d’établissement), part of the Investment Code that defined fiscal provisions. The Oil Code (Loi 99/013) adopted in 1999 sought to simplify the legislative and fiscal environment for IOCs, improve the incentive environment for exploration and extraction, and attract new investments in the sector (Extractive Industries Transparency Initiative [EITI] Cameroon, 2007). The code defines two types of contracts between which firms are free to choose: the concession contract and the production-sharing contract (Cameroon National Assembly, 1999). Despite the fact that several contracts have been signed under the new Oil Code, the two systems still coexist. In addition to a share of physical production, IOCs transfer to the SNH dividends as well as a series of taxes.12 In turn, the SNH is expected to remit to the treasury these payments as well as its benefits from oil sales and its own required fiscal contributions. The level of government revenue from oil production depends on the specific conditions agreed on between the SNH and the private IOCs, as defined in the production-sharing arrangements. The oil take also depends on production and transport costs. In Cameroon, a large share of the fixed costs is now amortized and transportation costs from off-shore platforms are low. The oil revenue accruing to the government is thus quite high relative to other oil-producing countries and amounts roughly to 67–70 percent of the value of oil exports (EITI Cameroon, 2007; and World Bank, 2006).

12These include taxes on profits, the proportional mining royalties, flat fees, land royalties, and royalties proportionate to production (EITI Cameroon, 2007).

Oil Revenue Transparency and the Role of Donors This section reviews the evolution of transparency in the management of oil revenue in Cameroon and the role played by the international community in promoting better governance in the sector. Secrecy has been the norm in the oil sector in Cameroon. Although the government has gradually provided more transparency over time in collaboration with donors, the situation is still far from full transparency and accountability. To analyze the evolution of transparency in the oil sector, the last three decades are segmented into five main periods.

First Period: 1977–79, Opaqueness of Oil Revenue Management When oil was discovered off the west coast of Cameroon and commercial production began in 1977, no specific state structure existed to regulate the sector or the relationship with IOCs. Responsibility for management of the sector, relationships with oil companies, and the use of oil revenue were directly assumed by the presidency. Full secrecy surrounded contractual arrangements with IOCs, and public oil revenue was deposited in accounts that were not transparently reported in the budget.13 Various authors have speculated about the destination of the oil revenue. Benjamin and Devarajan (1986) support the view that they were deposited outside the Cameroonian banking system, probably in U.S. banks. How much revenue accrued to these secret foreign accounts, and the uses to which they were put, have never been established.

Second Period: 1980–86, Creation of the National Oil Company and Continued Opaqueness of Revenue Management In 1980, the SNH was created to assume responsibility for the oil sector, in particular to oversee the relationships with IOCs and manage oil revenue. Despite the creation of this public corporation, the presidency did not abandon control over the sector. The SNH was placed under its direct authority with the SNH administrative board headed by the General Secretary of the Presidency and the SNH president appointed by the country’s president. Furthermore, the creation of the SNH did not diminish the opaqueness surrounding oil revenue. As during the first period, oil revenue transferred by IOCs or derived from SNH direct oil sales was deposited in bank accounts that were still not reported transparently in the budget (DeLancey, 1989). Citizens had virtually no information on the level or use of oil revenue. Indeed, during the economic upturn that accompanied the oil boom, very little information openly circulated in the country about oil sector activities.

13DeLancey (1989) called these accounts “ secret accounts.”

The population was also repeatedly told that the country’s oil reserves were very limited and would, at best, last a decade. These beliefs helped contain public spending pressures and reduce expectations about the importance of the oil bonanza, along with the need for public scrutiny. World Bank reports during the period conveyed the same message about oil revenue’s limited and transitory nature: “Proven oil reserves are expected to be exhausted within the next ten years, if not sooner . . .” (World Bank, 1987, p. i).

Third Period: 1987–90, Reporting of Oil Revenue in “Off-Budget Accounts” With activation of the first IMF stand-by agreement in 1988 and the first World Bank structural adjustment loan in 1989, oil revenue appeared for the first time in the state’s finance law. Oil revenue transfers under the heading Redevance pétrolières were reported as an off-budget account in the budget for the first time in 1987. This also led to more external scrutiny and estimates of Cameroonian oil revenue.

Fourth Period: 1991–99, More Transparency through “Partial SNH Audits” Another milestone in oil revenue transparency was reached in 1991, the year of Cameroon’s second stand-by agreement with the IMF. For the first time, some components of SNH activities were partially audited. That same year, the World Bank advised the authorities to (i) elaborate oil sector regulation and fiscal code distinct from the mining law, (ii) simplify contractual and legal arrangements in the sector, and (iii) redefine the role of the SNH. A decade after the first adjustment program was launched, a new generation of reforms was put forward. The IMF- and World Bank–supported reform program included measures dealing with governance and corruption issues, in particular (i) improvement of public finances and expenditure management, (ii) greater transparency in the management of public affairs, and (iii) anticorruption efforts. Despite progress in transparency, challenges remained. As a reminder, Transparency International’s Corruption Perceptions Index ranked Cameroon as the most corrupt country two years in a row.

Fifth Period: 2000–Present, Improved Transparency through the Heavily Indebted Poor Countries and Extractive Industry Transparency Initiatives The beginning of a new stage of oil revenue transparency can be pegged to 2000. The satisfactory completion of the 1997–2000 IMF lending program made Cameroon eligible for the Heavily Indebted Poor Countries (HIPC) facility, which would ultimately erase most of Cameroon’s external public debt. In exchange for debt alleviation, the government launched a new round of reforms to fight corruption and poor governance, and improve accountability and transparency, particularly in the oil sector (IMF, 2000). Specifically, the government adopted a five-year National Governance Program (Programme National de

Gouvernance), which was among the conditions for reaching the HIPC completion point. The program aimed at fighting corruption; strengthening public financial management, transparency, accountability, and civil participation in public affairs; and improving justice and human rights. Despite the implementation challenges that caused it to fall behind the initial timeline for HIPC completion, the government of Cameroon adopted a second National Governance Program in 2005 to prove its sustained commitment to good governance. Furthermore, in March 2005, in collaboration with donors, it announced its intention to join the EITI to signal its determination to improve governance in the oil sector. Finally, in 2006, the Bretton Woods institutions concluded that Cameroon had made sufficient progress in its reforms to reach the HIPC completion point.

Cameroon’s Commitments versus Actual Governance Reforms The government has made enthusiastic commitments to carry out governance reforms during the past 20 years, but with relatively modest results. For instance, in 2011 Cameroon still ranked 134 out of 182 countries on Transparency International’s Corruption Perceptions Index with a score of 2.5 on a scale of 0 to 10.14 In its September 2011 Article IV Consultation Report on Cameroon, the IMF states “Cameroon’s competitiveness remains clearly hampered by structural obstacles, mostly related to a weak business environment, corruption [emphasis added], and high costs of services” (IMF, 2011, p. 43). The overall state of governance in Cameroon is still considered poor according to most indexes of governance quality. For instance, in 2010, according to the World Bank’s World Governance Indicators, Cameroon ranked in the bottom quintile of countries for all six dimensions of governance, except political stability and regulatory quality, where it was in the bottom fourth (World Bank, 2011). It ranks below other middle-income and other African countries on all dimensions. Indexes of budget transparency also indicate opacity and poor governance in the country. The Open Budget Index of the International Budget Partnership, which evaluates clarity, scope, and availability of documents on public spending, found that Cameroon, with a score of 2 percent, is among the worst performers for meeting basic standards of transparency and accountability, ranking among the bottom 5 percent of the 94 countries surveyed in 2010 (IBP, 2010).15

14Cameroon was ranked the most corrupt country in the world twice in the last 20 years by Transparency International—85 out of 85 countries in 1998, and 98 out of 98 countries in 1999. 15Civil liberties and political rights, two fundamental components of democratic life and good governance, are also perceived as severely deficient in the country. According to the Freedom House index, which has evaluated the state of civil liberties and political rights around the world since 1973, Cameroon ranks very near the bottom. The overall ranking of countries along this index classifies countries as “free,” “partly free,” and “non-free.” Whereas before 1977 Cameroon was classified as partly free, the first year of oil production was marked by a worsening of civil liberties and political rights. Since that year, the country has been classified as non-free, a non-enviable status it has kept for the last 30 years (Freedom House, 2011).

When institutional reforms have taken place, they have been slowly enacted, and when put in practice, were often relatively inefficient at promoting better governance. For instance, in January 1996 the government announced the creation of an audit chamber (Cour des Comptes) to oversee external audits of government financial operations. The law creating the chamber, however, was not adopted until seven years later (World Bank, 2006), and the chamber became partly operational only in 2006. In 2010, only 19 magistrates were involved in reviewing government accounts, without the help of assistants and having access to a very limited share of government documents (IMF, 2010). A government plan to fight corruption was put forward in 1999 with the creation of a National Observatory. It later became the National Anti-Corruption Commission (Commission Nationale Anti-Corruption, or CONAC) in 2006. However, the commission lacks independence, as argued by van Hulten (2008b). Another example of ineffective institutions is the 2006 law prescribing that all high-level government officials, from the president down to the director level, must declare their assets at the beginning and end of terms of office. However, the commission that was expected to enforce the law was never created. The relative inefficiency of institutional reform in Cameroon is probably best exemplified by the SNH’s cash payment of off-budget expenditures. Donors’ documents frequently mention the problem of direct SNH payments, and calls for closing this tap became a recurring theme over the years. As early as 1991, this objective was put forward in World Bank– and IMF-supported programs as a required reform in the oil sector. Nearly 10 years later, the HIPC decision point document announced that these payments had stopped as a result of the efficiency of the reforms put in place. However, during the following years, some SNH direct payments of off-budget expenditures continued (Cossé, 2006; IMF, 2007; and Dynamique Citoyenne, 2008). Because of the slow pace of anticorruption and governance reform, a group of six bilateral donors supported by the United Nations Development Programme decided to put together a special anticorruption program, Change Habits, Oppose Corruption, to investigate the situation,—including the inefficiency of CONAC—and to propose improvements. Its first main report, published in June 2008, Change Habits, Oppose Corruption, headed by Dr. van Hulten—a former United Nations Development Programme staff member, a former senator, and member of the house and State Secretary for Transport in the Netherlands—casts serious doubt on CONAC’s capacity to perform its mandate, given its lack of independence from the presidency, and concludes that neither the government nor many donors showed sufficient willingness to fight, let alone to eradicate, corruption (van Hulten, 2008, 2010). The report attributes a direct role to oil and forestry companies in exacerbating corruption and further mentions that “national and expatriate companies fuel the corruption to maintain their position in the world markets (petrol, wood)” (van Hulten, 2008a, p. 1). Cameroon is currently a candidate country to EITI. To implement the disclo- sure process part of the initiative, an independent conciliator began in 2006 to collect and reconcile data on petroleum production, payments made by the oil companies to the government, and the corresponding receipts by the government

©International Monetary Fund. Not for Redistribution Gauthier and Zeufack 167 for the period 2001–04, 2005, and 2006–08. In October 2010, the EITI board estimated that sufficient progress had been made by Cameroon in implementing IETI criteria (14 out of 18 criteria met), and the country was declared “close to conformity.” To achieve “compliant” status, the country has been asked by the EITI Board to meet various requirements, including producing reconciliation oil reports for 2009 and 2010. In February 2012, the EITI Board granted Cameroon a final 18-month extension to complete the validation process. If the country has not achieved the “compliant status” by August 15, 2013, it will be de-listed from EITI (EITI, 2012). Despite this progress in transparency in the oil sector, Cameroon still has a long way to go to reach the standards of other middle-income countries with regard to public management transparency and accountability.

Conclusion Cameroon, potentially one of the richest countries in sub-Saharan Africa, has become another example of the natural resources curse. Building on Gauthier and Zeufack (2010, 2011), this chapter contrasts Cameroon’s development experience with that of Malaysia and argues that the lack of transparency and accountability in oil revenue management has significantly slowed the pace of development in Cameroon over the long run. The many efforts of the international community to help the authorities promote transparency in the oil sector in the country have yielded limited results. Clearly, these efforts have not been enough to fully inte- grate the oil sector with economic policymaking in the country. More needs to be done to engage the oil sector systematically in the medium- to long-term planning of Cameroon’s development, along the lines of the Natural Resources Charter developed under the direction of Paul Collier and Anthony Venables of Oxford University. Precept 11 of the charter, which deals with transparency, recommends that countries “develop benchmarks, checklists and metrics to empower civil society in holding governments, firms and capital markets accountable” (Natural Resource Charter, http://www.naturalresourcecharter.org/). This reform, combined with the creation and operation—beyond the symbolic level—of a truly independent energy regulatory agency, audit court, and anticorruption commission, is most needed to improve transparency in the oil sector in Cameroon.

References Azrai, E.M., and A.G. Zeufack, 2011, “Malaysia: Postcrisis Growth Prospects Depend on Restoring Fiscal Discipline and Private Investor Confidence,” in The Great Recession and Developing Countries: Economic Impact and Growth Prospects, ed. by Mustapha Nabli (Washington: World Bank), pp. 303–58. Benjamin, N.C., and S. Devarajan, 1986, “Oil Revenues and the Cameroonian Economy,” in The Political Economy of Cameroon: An SAIS Study on Africa, ed. by M.G. Schatzberg and W.I. Zartman (New York: Praeger Publishers). Cameroon National Assembly, 1999, Code Pétrolier Loi no. 99-013, December 1999 (Yaoundé, Cameroon: Cameroon National Assembly).

Collier, P., 2010, The Plundered Planet: How to Reconcile Prosperity With Nature (Oxford: Oxford University Press). ———, and A. Hoeffler, 2005, “Resource Rents, Governance, and Conflict,” Journal of Conflict Resolution, Vol. 49, No. 4, pp. 625–33. Collier, P., and T. Venables, eds., 2011, Plundered Nations? Successes and Failures in Natural Resource Extraction (London: Palgrave Macmillan). Cossé, S., 2006, “Strengthening Transparency in the Oil Sector in Cameroon: Why Does It Matter?” IMF Policy Discussion Paper 06/02 (Washington: International Monetary Fund). DeLancey, M., 1989, Cameroon: Dependence and Independence (Boulder, Colorado, and London: Westview Press). Dynamique Citoyenne, 2008, “Budget 2008: L’espérance du point d’achèvement n’est-elle qu’un mirage? ” Yaoundé, Cameroun. Extractive Industries Transparency Initiative Cameroon, 2007, “Reconciliation of the Financial and Physical Flows as Regards the Cameroon EITI for the Year 2005,” Committee for the follow-up to Cameroon Extractive Industries Transparency Initiative (EITI), Republic of Cameroon, Ministry of Economy and Finance, Mazars and Hart Group, March. http:// eitransparency.org/UserFiles/File/cameroon/2nd_cameroon_audit_report_french.pdf. ———, 2012, Cameroon: status of EITI Implementation, Extractive Industries Transparency Initiative, available at http://eiti.org/Cameroon, retrieved in March 2012. Economist Intelligence Unit, 2008, “Country Report: Cameroon” (London: Economist Intelligence Unit), August. Freedom House, 2011, Freedom in the World 2011: The Annual Survey of Political Rights and Civil Liberties (Washington). Gauthier, B., and A.G. Zeufack, 2010, “Governance and Oil Revenues in Cameroon,” OxCarre Research Paper No. 38 (Oxford, UK: OxCarre). ———, 2011, “Governance and Oil Revenues in Cameroon,” in Plundered Nations? Successes and Failures in Natural Resource Extraction, ed. by Paul Collier and Tony Venables (London: Palgrave Macmillan). Growth Commission, 2008, The Growth Report: Strategies for Sustained Growth and Inclusive Development (Washington: World Bank on behalf of the Growth Commission). International Budget Partnership, 2010, “Open Budgets Transform Lives: The Open Budget Survey 2010,” (Washington: International Budget Partnership). International Monetary Fund, 2000, Cameroon Article IV Statistical Appendix, IMF Country Report No. 00/80 (Washington). ———, 2007, Cameroon Selected Issues, IMF Country Report No. 07/287 (Washington). ———, 2010, Cameroon: Report on the Observance of Standards and Codes—Fiscal Transparency Module, IMF Country Report No. 10/264 (Washington). ———, 2011, Cameroon: 2011 - Article IV Consultation - Staff Report, IMF Country Report No. 11/266 (Washington). Karl, T.L., 2007, “Oil-Led Development: Social, Political, and Economic Consequences,” CDDRL Working Paper #80 (Stanford University). Sala-i-martin, X., and A. Subramanian, 2003, Addressing the Natural Resource Curse: An Illustration from Nigeria, NBER Working Paper Series 9804 (Cambridge, Massachusetts: National Bureau of Economic Research). Société Nationale des Hydrocarbures, 2008, “Presentation of the SNH,” Société Nationale des Hydrocarbures. Available at http://www.snh.cm/, accessed September 2008. Tamfu, S., 2008, “Perspectives for the Petroleum Extraction and Production Sector in Cameroon,” presented at the Cameroon EITI Workshop, September 22–23, Yaoundé, Cameroon. Transparency International, 2011, “Corruption Perceptions Index 2011” (Berlin, Germany: Transparency International). United Nations Industrial Development Organization, 2009, Breaking In and Moving Up: New Industrial Challenges for the Bottom Billion and the Middle-Income Countries, Industrial Development Report (Vienna: United Nations Industrial Development Organization).

©International Monetary Fund. Not for Redistribution Gauthier and Zeufack 169 van Hulten, M., 2008a, Three Months Cameroon: 1st Quarterly Report of the CHOC Project Based on the Annual Work Plan 2008 (Yaoundé, Cameroon: United Nations Development Programme). ———, 2008b, “Perception as a Cause of Corruption: The Cameroon Case,” Inaugural Lecture at SAXION Academy of Governance and Law, November 7. ———, 2010, “Power and Corruption in Cameroon in 2008,” presented at the Conference on Corruption in a Globalizing World: Challenge and Change, April 20–21, University of Surrey, Guildford, UK. World Bank, 2006, “A New Resolve to Sustain Reforms for Inclusive Growth,” Country Economic Memorandum, 29268-CM (Washington). ———, 2011, World Bank Governance Indicators (Washington). Yusof, Z.A., “The Developmental State: Malaysia,” in Plundered Nations? Successes and Failures in Natural Resource Extraction, ed. by Paul Collier and Tony Venables (London: Palgrave Macmillan).

Chad: Lessons from the Oil Years

Jean-Claude Nachega and Jaroslaw Wieczorek

Chad’s oil was developed in the uniquely difficult conditions of a landlocked nation with extremely low levels of human and physical capital, and in the virtual absence of basic infrastructure—which had to be created by the oil industry in the oil-producing region. Initial expectations at the industry level were modest; oil prices were particularly low when the development decision was made in 2000, and multiple difficulties were expected during the development phase (2000–03). Government revenue from oil was expected to be $45 million to $50 million per year, or equivalent to ¼ of annual donor assistance (including expected debt relief under the Highly Indebted Poor Countries Initiative). The World Bank’s participation in oil development and establishment of a transparent revenue-management system, including the institutional arrangements for using oil revenue for poverty reduction along with the resources provided by external donors, were unique to Chad. As a result of the surge in international oil prices in the second half of the decade, the revenue from oil vastly exceeded expectations, raising prospects for ending the country’s endemic poverty and laying the basis for creating a modern economy. However, this unexpected oil boom also complicated the politics of the country. It raised public expectations and created more competition for political control. In December 2005, a rebellion erupted with Sudanese support. The rebel threat peaked twice (in April 2006 and February 2008) when, on both occasions, the capital was nearly taken. In these circumstances, the carefully crafted oil revenue management system proved untenable. Resources were redirected toward security needs, and the development strategy changed. However, the transparent oil revenue collection system remained in place. The record of the oil years in Chad is mixed. The promise of a better future materialized to some extent, with visible progress in the development of infrastructure and urbanization, especially since 2009. At the high prices that have lasted into 2012, oil continues to attract new investors (notably, China) and— rather than only for exports—oil is also being used to broaden the country’s industrial base, including the oil refinery opened in June 2011 and related increased electricity generation capacity, and the cement factory inaugurated in February 2012. In addition, a number of industrial production facilities, including a fruit juice factory launched in July 2011, are being built in partnership with India. At the same time, Chad’s poverty indicators and progress toward the

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Millennium Development Goals have continued to lag behind many countries in sub-Saharan Africa (SSA) that operate without significant oil or other mineral resources. Chad has also been faced with important economic and political challenges stemming from oil production. Although no evidence indicates that Dutch disease has taken hold in Chad in the full sense of the term, oil rents have clearly reduced the incentive to reform the ailing cotton sector (Chad’s traditional export industry) and, more generally, to improve the business environment. Oil wealth has also been a factor in the spillover into Chad of violence from neighboring Darfur, which required major military and financial efforts to stop. The main challenge before Chad, though, is that its oil is expected to be exhausted in 20 years, and strong policies are needed to engineer a smooth transition into the post-oil era.

Oil Production and the Petroleum Revenue Management Program The development of the Doba project started the oil era and required the construction of the Chad-Cameroon pipeline, which was partly financed by the World Bank. Oil production began in October 2003. Owing to the small size of oil reserves in Chad, the expected trend in oil production is downward. The World Bank’s participation in oil development ensured the establishment of a transparent revenue-management system.

The Three Fields Project In 1988, Chad signed a convention with a consortium of oil companies led by ExxonMobil (the project operator), that (i) permitted exploration of three oil fields in the Doba basin (Miandoum, Kome, and Bolobo, or the “Three Fields”); (ii) regulated the processes for environmental protection, land acquisition and compensation, and royalties and tax payments; and (iii) granted a 30-year concession to develop, exploit, and commercialize the Three Fields. The construction of the Chad-Cameroon pipeline, indispensable for developing the Doba project, was the largest enterprise of its kind in SSA. In 2000–01, the consortium initiated the Chad-Cameroon Petroleum Development and Pipeline Project (in an amount of US$4.2 billion). Lack of direct access to the Atlantic Ocean meant that the consortium would have to construct a 1,070-kilometer underground pipeline to carry oil from the Doba basin to Kribi in Cameroon. The governments of Chad and Cameroon joined the consortium in setting up the Chad Oil Transportation Company and the Cameroon Oil Transportation Company; 85 percent of the length of the pipeline is located in Cameroon. The pipeline was completed in July 2003 and oil production began in October 2003.

Oil Production and Pricing Chad’s oil resources are small relative to those in other SSA countries and will not last long. Compared with Angola, Gabon, or Nigeria, Chad’s oil production started just recently and its reserves—estimated at 1.5 billion barrels (145 barrels per capita)—are expected to be depleted by about 2030 (Figure 10.1). After reaching a peak of 63 million barrels, or 172,000 barrels per day in 2005, oil output has been declining since, falling to 45 million barrels, or 123,000 barrels per day (2.3 percent of SSA production) in 2010. The expected trend in oil production is downward. Annual output from the Doba basin is projected to drop to about 30 million barrels in 2015 and to

Oil Production Profile

400 Equatorial Guinea 350 y)

300

Congo 250

and barrels per da 200

150 Chad 100 Gabon Production (thous 50 Cameroon

0 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Annual Oil Production and Exports, 2005–10 900 (period average) 25.0

800 22.5 Production (left scale) 20.0 700 Exports (right scale) 17.5 600

15.0

500 $ 12.5 400 10.0 Billions of US

Millions of barrel s 300 7.5

200 5.0

100 2.5

0 0.0 Nigeria Angola Equatorial Rep. of Congo Gabon Chad Cameroon Guinea Figure 10.1 Oil Production in Selected Sub-Saharan African Countries Source: IMF. Note: CEMAC 5 Central African Economic and Monetary Community.

10–15 million barrels per year thereafter, until about 2030. Doba crude sells at a variable discount with respect to Brent crude, as a result of its low quality and high unit transportation costs, which affect the implicit well-head price and the revenue base. The contribution of the new oil field near Bongor (developed by China National Petroleum Corporation), with production of 20,000 barrels per day starting in mid-2011, will not significantly alter the downward path of total production given that this field is only a third the size of the Doba field. A few other fields of similar size are being explored, but the production decision has not yet been reached in any of those cases.

Fiscal Regime for the Oil Sector Unlike most SSA countries—where production-sharing agreements are standard operating procedure—Chad relies on a concession contract system and a tax and royalty regime to govern the exploration, development, and exploitation of the Doba oil fields. Under this regime, the government is entitled to (i) signature bonuses and exploration permits, which were paid upfront when the concession contract was signed; (ii) dividends and share premiums, which are derived from Chad’s equity shares in Chad Oil Transportation Company and Cameroon Oil Transportation Company, and paid twice per year; (iii) royalties, which are paid monthly at a rate of 12.5 percent and on the basis of a “provisional quarterly well-head oil sale price”1; (iv) corporate income taxes, which are filed annually on tax liabilities of previous year’s profits plus an equal advance payment that can be credited against profit tax in the following year2; and (v) value-added taxes and custom duties, which are paid on non–oil-related purchases.

Petroleum Revenue Management Program The government took a loan from the World Bank to finance its stake in the pipeline project.3 The loan agreement provided for putting in place a petroleum revenue management program (PRMP) to ensure transparent use of oil revenue for priority sectors. Under the PRMP, all revenue from the project would pass through an offshore escrow account. The PRMP was the basis for the 1999 Petroleum Revenue Management Law, which specified the allocation of oil revenues. After deduction of debt service to the World Bank and the European Investment Bank, 10 percent of direct revenue (royalties and

1For a complete description of the pricing mechanism, see Daban and Lacoche (2007a and 2007b). 2The corporate income tax rate varies with the level of oil prices and rose to 60 percent in the high oil price environment of 2005–06. 3According to Ghazvinian (2007, p. 250), the World Bank was approached, at ExxonMobil’s insistence, for two main reasons: (i) covering for “political legitimacy”—the company did not want to “sink billions into a risky project whose commercial value was untested”; and (ii) covering for public relations (reputational) risk—the project had a potential environmental cost.

©International Monetary Fund. Not for Redistribution Nachega and Wieczorek 175 dividends) were earmarked for a future generations fund. The remaining 90 percent of post debt-service oil revenues were allocated as follows: 80 percent of royalties and dividends to priority sectors4; 5 percent of royalties to the Doba oil-producing region; and 15 percent of royalties and dividends to the general government budget. Furthermore, 42.6 percent of expenditure not financed by earmarked oil revenue (the “ordinary budget”) was to be allocated to priority spending to ensure “additionality” compared with the 2002 (pre-oil) budget. An autonomous joint government–civil society oversight body (the Collège) was to authorize and monitor oil-financed priority spending.

The Economic Impact of Oil Oil extraction was the main source of Chad’s economic growth during the development phase and the initial production phase, but this effect tapered off quickly. In 2000–05, oil investment and production pushed the average real GDP growth rate to 12.6 percent (9 percent in per capita terms). In 2006–10, however, real GDP growth dropped to 1.1 percent (21.4 percent in per capita terms)— one of the lowest rates in SSA—on account of declining oil output (as expected) and weak growth in non-oil GDP.

Structural Shift, Poverty Impact, and Political Economy Before the oil era, the economy was predominantly agrarian, with GDP per capita about US$205 in 2001–02—less than half the average in SSA. Chad’s traditional exports were cotton, which provides livelihoods to about one-third of Chad’s population, and cattle. A major structural shift occurred with the advent of oil production. In 2006–10, GDP per capita had risen to an average of US$750 with oil accounting for half of nominal GDP, 70 percent of government revenue (excluding grants), and 90 percent of merchandise exports. Despite the oil-driven increase in GDP per capita, Chad remains among the least-developed countries in the world, with a very high incidence of poverty.5 The bulk of the population still depends on livestock and agriculture. A 2003 consumption survey revealed that 55 percent of the population was affected by poverty and 36 percent by extreme poverty (World Bank, 2008). These indicators are to be reassessed by a new household consumption survey (to be completed in June 2012) but other measurements suggest that significant progress has yet to be made in poverty reduction. Chad ranks 163 out of 169 countries

4Priority sectors are health and social welfare, education, infrastructure (including energy), rural development (agriculture and livestock), environment, and water resources. 5According to the 2011 World Development Indicators data published by the World Bank, per capita gross national income rose from US$195 in 2001–02 to an annual average of US$548 (or about 55 percent of the US$1,006 middle-income threshold defined by the World Bank) during 2006–10.

in the United Nations 2010 Human Development Index and similarly poorly on indexes for rule of law, governance, business climate, and policy performance compiled by various organizations. Chad’s health indicators are particularly worrisome, with the maternal mortality indicator among the highest in the world, and recent reports pointing to a resurgence in previously eradicated diseases (notably, cholera and polio).6 Oil also complicated Chad’s political economy. The exploitation of oil wealth has exposed Chad to aspects of the “resources curse”: nonproductive public spending, corruption, weak external competitiveness, sharply rising public indebtedness, low non-oil taxation, rentier state behavior, and risk of conflict. The political dynamics were affected when a broad spectrum of political and military actors came to expect a significant share of oil-financed spending. Leaders believed that maintaining these flows was key to ensuring the stability and security of the state.

The Experience with the PRMP Government revenue from oil has been significantly higher than projected: $6.3 billion cumulatively through the end of 2010, nearly 20 times the amount initially expected in that period. With the surging price of oil outweighing declining production and enabling accelerated amortization of the development costs, government revenue from oil rose from 4.7 percent of non-oil GDP (33.3 percent of government revenue) in 2004 to 35 percent of non-oil GDP (76.2 percent of government revenue) in 2007–08 (Figure 10.2). In 2009–10, on account of the fall in oil prices (and changes in oil tax payment in 2008), oil revenue dropped to 19.5 percent of non-oil GDP (59.2 percent of government revenue). At the same time, however, the government was also subject to unforeseen spending pressures, mainly security related. In these circumstances, the PRMP turned out to be short-lived. Facing mounting security threats, the Chadian authorities modified the PRMP unilater- ally in December 2005 to divert a greater share of oil revenue to security and military spending and away from the future generations fund and agreed-on poverty-reducing spending. The government also revised the PRMP to change the definition of “priority sectors” (to include justice, territorial administration, and security) and to increase the share of non-earmarked oil revenue to 30 percent from 15 percent. The World Bank disagreed with these amendments to the PRMP, but renego- tiated the use of oil revenue. The 2007 budget would allocate at least 70 percent of all budgetary resources to a list of priority sectors, extended to include governance. However, in the face of increased rebel activity, the government was unable to adhere to the agreement. The rebels’ second attempt to take over the capital in

6According to the Millennium Development Goals Report 2010, only two Millennium Development Goals for Chad are within reach: primary education and fight against HIV/AIDS (United Nations, 2010).

Oil production radically improved goverment revenue... …financing a large increase in government spending ... P 120 60 Production (million barrels) 50 Oil revenue (percent of non-oil GDP) 100

WEO price ($/barrel) P 40 30 80 20 60 10 0 40 –10 Oil revenue

Percent of non-oil GD –20 Non-oil revenue 20 To tal spending –30 Non-oil primary balance 0 –40 Million barrels and Percent of non-oil GD 2003 2004 2005 2006 2007 2008 2009 2010 2003 2004 2005 2006 2007 200820092010

... including priority spending (for poverty reduction), but ...and a large share of spending bypassed normal also military spending, ... budget procedures 20 60 Share of domestically financed spending (excluding 18 wages and debt) executed by extraordinary budget 50 procedures (in percent)

P 16 14 40 12 10 30

8 Percent 20 6 Domestically financed priority Percent of non-oil GD 4 spending 10 2 Security spending 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2007 2008 2009 2010

The real effective exchange rate appreciated, as in other CEMAC countries...... while traditional exports declined. 11 5 80 100 Cotton Production (left scale) CEMAC Cotton Exports (right scale) ) 70 90 Chad

11 0 ) 60 80 50 105 70 40 60 100 30

Index (2005 = 100) 50

20 Export (US$ millions 95 Production (thousand tons 10 40

90 0 30 2003 2004 2005 2006 2007 2008 2009 2010 2003 2004 200520062007 2008 2009 2010 Figure 10.2 Oil Production, Fiscal Policy, and Public Financial Management, 2003–10 Sources: Country authorities; and IMF staff estimates. Note: CEMAC 5 Central African Economic and Monetary Community; WEO 5 World Economic Outlook.

February 2008 led to widespread damage, loss of life, and the evacuation of international agencies, including the World Bank, which closed its offices. In September 2008, the government fully repaid the loan balance on the pipeline and associated credits. The World Bank reopened its offices in January 2009 and resumed dialogue with the government about Chad’s development challenges outside the oil sector.7

7The International Finance Corporation remained involved in the pipeline program when the International Development Association and the International Bank for Reconstruction and Development (all members of the World Bank Group) exited from Chad’s oil sector; its loans to the pipeline companies remained in place and continued to be repaid as contractually scheduled. See World Bank (2011).

Even with the amendments, the PRMP ensured that Chad’s oil revenue flows were uniquely transparent and secured increased budgetary appropriations for priority spending.8 In nominal terms, priority sector expenditure increased by about 70 percent during 2004–06, albeit by less than overall spending—primary current expenditure rose from 10 percent of non-oil GDP to 29 percent, and domestically financed investment from 2 percent of non-oil GDP to 12 percent.9 Priority (nonsecurity) spending was later crowded out by exceptional security spending, which peaked at an annual 10 percent of non-oil GDP in 2006–08. The execution of priority spending was also hindered by procurement irregulari- ties (a lack of competitive bidding) and overpricing of goods and services.

Fiscal Policy Fiscal policy has been expansionary throughout the oil era. The oil revenue windfall fueled a spending spree, resulting in a sharp increase in the non-oil primary deficit (NOPD).10 With total expenditure (excluding interest payments and foreign financed investment) quadrupling (as a percentage of non-oil GDP) since 2003 and reaching about 40 percent of non-oil GDP in 2009–10, the NOPD (on a commitment basis) increased from 3 percent of non-oil GDP in 2003 to 30 percent in 2009–10. Both domestically financed capital and primary current spending have increased as a share of non-oil revenue beyond levels that could be sustained if oil revenue were to decline significantly. Domestically financed capital spending as a share of non-oil revenue increased from 23 percent in 2003 to 106 percent in 2008–10. Likewise, primary current spending as a share of non-oil revenue rose from the already high level of 112 percent in 2003 to 240 percent in 2008–10. In particular, the wage bill as a share of non-oil revenue increased from about 60 percent in 2003 to 75 percent in 2008–10. Meanwhile, traditional revenue sources have been neglected. In spite of moderate growth in non-oil GDP in the 2000s and significant growth in taxable imports, non-oil revenue effort has increased from 8.2 percent of non-oil GDP in 2000 to just over 12 percent in 2008–10 (a level below the average observed among other SSA oil exporters), and tax reforms have stalled. The oil-driven fiscal expansion strained absorptive capacity and public financial management, and raised governance concerns. The conjunction of fast growth of investment spending and neglect of the multiyear implications of

8Although the authorities no longer abide by the PRMP framework, they continue to adhere to the revenue transparency framework, which was created within its context. Information on oil revenue is published routinely. Also, the Collège publishes quarterly reports on the execution of oil-financed programs. 9Allocations in the ordinary budget were increased as stipulated by the additionality provisions, but actual priority spending accounted for less than the required 42.6 percent of expenditure in the ordinary budget. 10The NOPD is defined as total revenue excluding grants and oil revenue, minus total expenditure excluding net interest payments and foreign-financed investment.

©International Monetary Fund. Not for Redistribution Nachega and Wieczorek 179 investment decisions has prompted concerns about absorptive capacity.11 At the same time, allocations for recurrent spending on infrastructure maintenance, health, and education have remained insufficient. Public financial management issues relate to weak links between annual budgets and the poverty reduction strategy, and the limited role of line ministries in elaborating their budgets. Concerns about governance result mainly from weak procurement practices and the frequent bypassing of normal budget procedures; in 2007–10, about a third of domestically financed spending (excluding wages and debt) was executed using procedures normally reserved for emergency spending.

Debt Sustainability The fiscal expansion also called debt sustainability into question. The fall in oil prices in 2009 led to a large overall fiscal deficit (cash basis, including grants) of 10 percent of GDP (compared with a surplus of 3 percent of GDP on average in 2006– 08), which was financed by a drawdown of government deposits and borrowing from the central bank. Although the 2010 overall fiscal deficit was estimated to be lower, the government had to rely on nonconcessional external borrowing to finance it. As a result, the public sector debt-to-GDP ratio rose from 24 percent in 2008 to an estimated 33 percent in 2010. If the government were to stick to its 2010 fiscal stance (an NOPD of about 30 percent of non-oil GDP and an overall fiscal deficit [cash basis, including grants] of more than 4 percent of GDP), the resulting public debt and debt-service burden would quickly become unmanageable.

External Competitiveness: A Case of Dutch Disease? Evaluating Dutch disease symptoms in Chad is difficult because of data limitations and preexisting underdevelopment of the non-oil sector.12 The real effective exchange rate appreciated during the 2000s, largely reflecting the effect of a strong euro, but Melhado and Op de Beke (2009) and Kinda (2010) found no strong empirical evidence of overvaluation vis-à-vis fundamentals.13 Although the influence of oil cannot be ignored, Chad’s competitiveness appears to be affected more by preexisting constraints, such as low levels of human and physical capital and

11Kinda (2011) finds strong empirical links between public investment spending and inflation in Chad during the period 1983–2009, suggesting that absorptive capacity deserves serious consideration when programming new investments. 12Dutch disease emerges when an economy benefits suddenly from rents (such as mineral resources) or other external financing (such as foreign aid) that cause real exchange rate appreciation (by pushing up the price of nontradables in relation to tradables), which harms the traditional export sector. 13These results are also consistent with findings by Kinda (2011) indicating that rainfall, foreign prices, public investment, and exchange rate movements were the main determinants of consumer price inflation in Chad during 1983–2009. Shocks to rainfall were found to exert the most persistent impact on inflation, which has historically been moderate, averaging 4.2 percent during 1983–2010. During the oil years (2004–10), inflation averaged 2.2 percent, but exhibited sizable year-to-year fluctuations, also driven mostly by the impact of variable rainfall on agricultural output.

weak institutions and governance, than by oil-induced real exchange rate appreciation. The sharp decline in the production of cotton (along with livestock, Chad’s main exportable commodity before the oil boom) since its peak in 2004 could be consistent with Dutch disease, but could also have as much to do with weather conditions, international trade policy, state ownership, or Chadian regional politics as with the real exchange rate. Other non-oil exports were stagnant during the past decade, but they did not perform well in the pre-oil era, either. The endemic character of the problems underlying Chad’s weak competitiveness become apparent in a comparison with other SSA countries. Its indicators of human and physical capital remain below those of peer countries. Chad also ranks at the bottom of various measures of governance and business climate.14 Development of the oil sector has not translated into faster economic and human development, expanded employment opportunities, and sustainable economic growth. The direct impact of the petroleum sector on the rest of the economy has been limited, because the oil sector is not well integrated into the local economy. Also, the benefits of sizable oil-financed public investment spending have not yet produced a supply-side response in the non-oil sector, although, in theory, appropriately timed and well-designed public investment spending on infrastructure could alleviate supply-side constraints (without increasing inflation) and thus unequivocally strengthen external competitiveness.15

Lessons Learned and Policy Conclusions The arrival of oil opened a new chapter in Chad’s history, carrying a promise of a better future. However, Chad has struggled to turn oil wealth into productive public spending, faster growth, or poverty reduction. Moreover, the arrival of oil intensified security tensions and changed the country’s political economy. Chad’s experience with oil also illustrates the vulnerabilities stemming from a procyclical, volatile, and unsustainable fiscal policy in an oil-dependent economy. These vulnerabilities became particularly pronounced in the context of the 2008–09 global financial crisis, which affected Chad through the decline in oil prices, leading to a sharp deterioration in both the fiscal and the external positions. Poor budget discipline and weak administrative capacity were the main reasons that priority spending and its monitoring fell short of expectations. When facing cash flow constraints, the government borrowed from oil budget accounts (earmarked for priority spending) to finance the ordinary budget, leaving insufficient resources for priority social spending.

14Chad ranked last (183) in 2010 and 2011 on the World Bank’s Doing Business Index and on the World Economic Forum’s 2010–11 Global Competitiveness Index. It is near the bottom of Transparency International’s 2010 Corruption Perceptions 2010 Index (171 out of 178). 15Levy (2007) uses a computable general equilibrium model calibrated for Chad and shows that oil-financed public investment, in the form of roads and irrigation infrastructure, need not lead to Dutch disease (real exchange rate overvaluation and decline of traditional sectors) because it can be successfully mitigated by a strong agricultural output response.

However, Chad’s experience still offers some positive lessons for other oil-rich economies, mainly in the area of revenue transparency. All oil revenue flows are visible and captured well in the budget, although the distinction between the oil and non-oil parts of the budget no longer serves any useful purpose. The oil fiscal regime is relatively simple compared with other SSA oil producers and has worked for both the project operator and the government, notwithstanding large and rapid swings in oil prices. The PRMP helped to make the use of oil resources transparent, but it complicated fiscal management and made heavy claims on Chad’s weak administrative capacity.16 Persistent public financial management problems eroded the credibility of the PRMP and its efficacy in promoting priority spending. Also, spending pressures resulting from heightened security tensions rendered the PRMP untenable. If the PRMP is to regain its pivotal role, it must be redesigned with appropriate consideration for capacity constraints and must gain political ownership before it is implemented. Most important, it must remain sufficiently flexi- ble to deal with either an unexpected revenue windfall or expenditure pressure. The experience with the PRMP also shows the importance of designing frameworks that have comprehensive coverage. One way to generalize the positive experience with revenue transparency stemming from the PRMP would be to accelerate Chad’s accession to the Extractive Industries Transparency Initiative. Chad’s struggles after the collapse of oil prices and revenue in 2009 also vividly illustrates the need for a predictable multiyear budget and some level of precau- tionary saving, to smooth the public consumption path. The relatively short expected productive life of Chad’s oil fields supports the call for long-term saving of a portion of oil revenue in anticipation of full depletion, and for continued policy focus on improving the environment for non-oil investment and diversifying the revenue base.17 Otherwise, Chad faces a future of wide swings in revenue and expenditure and the risk of an unsustainable debt overhang at the end of its oil era. Chad must develop its non-oil economy to strengthen its competitiveness and ensure a successful transition to the post-oil era. Chad should use its oil revenue to make targeted improvements in physical infrastructure, develop human capital, and create a business-friendly environment. In particular, devising a clear strategy for agriculture and the cotton sector—to include encouraging increased domestic and foreign private sector participation in the transformation and marketing of cotton and other agricultural products—would help Chad diversify its export base and would endow it with a good measure of protection against the potential for oil-driven Dutch disease.

16See Daban and Lacoche (2007a and 2007b) for a comprehensive discussion of the experience with the PRMP. 17For instance, under a framework proposed by Daban and Hélis (2010), Chad could adopt a fiscal rule that delinks expenditure from oil revenue to ensure both fiscal and debt sustainability and the quality of spending, by treating oil revenue as a “source of financing” of the sustainable non-oil deficit. The government could then adhere to a spending path designed through a medium-term expenditure framework aligned with its poverty reduction strategy.

References Daban, T., and J.-L. Hélis, 2010, “A Public Financial Management Framework for Resource- Producing Countries,” Working Paper 10/72 (Washington: International Monetary Fund). Daban, T., and S. Lacoche, 2007a, “Fiscal Policy and Oil Revenues Management: The Case of Chad” (unpublished, Washington: International Monetary Fund). ———, 2007b, “Oil Revenues Management and Fiscal Policy: The Case of Chad,” in Chad: Selected Issues and Statistical Appendix, IMF Country Report No. 07/28 (Washington: International Monetary Fund). Ghazvinian, J., 2007, Untapped: The Scramble for Africa’s Oil (Orlando, Fla.: Harcourt, Inc.) International Monetary Fund, 2009, Chad: Selected Issues, IMF Country Report 09/67 (Washington). Kinda, T., 2010, “A Real Exchange Rate Assessment of Chad,” Africa Research Papers No. 10/03 (Washington: International Monetary Fund). ———, 2011, “Modeling Inflation in Chad,” IMF Working Paper 11/57 (Washington: International Monetary Fund). Levy, S., 2007, “Public Investment to Reverse Dutch Disease: The Case of Chad,” Journal of African Economies, Vol. 16, No. 3, pp. 439–84. Melhado, O., and A. Op de Beke, 2009, “Assessing Competitiveness in Tchad,” in Chad: Selected Issues, IMF Country Report 09/67 (Washington: International Monetary Fund). United Nations, 2010, The Millennium Development Goals Report 2010, New York. World Bank, 2008, “Chad: Poverty and Growth Strategy Paper for Chad” (Washington). ———, 2011, “Republic of Chad: Public Expenditure Review Update: Using Public Resources for Economic Growth and Poverty Reduction,” Report No. 57654-TD (Washington).

Congo’s Experience Managing Oil Wealth

Carol Baker and Oscar Melhado

The history of the Republic of Congo (Congo) is strongly linked to the production of oil, which began just before independence from France in 1960. From the time the first onshore field started pumping in 1957, the country has lived through periods of booms and busts, optimism and crisis, stability and war.1 Although per capita GDP returned to middle-income levels during the oil boom of the mid-2000s, social indicators have not kept pace—following a half-century of oil production, poverty rates are higher than in the early 1980s, human development indicators are in line with lower-income sub-Saharan African (SSA) countries, and infrastructure is severely lacking. The situation is now beginning to turn around, supported by high oil production and prices, and prospects are stronger than in recent memory. The newly stable macroeconomic and political environment has opened a window of opportunity to improve the lives of the 4 million Congolese people. This chapter offers reflections on lessons learned during more than 50 years of managing oil wealth, as well as on the current challenges.

Background and Context Congo is a young nation with a complex history in which the legacy of colonial- ism, deep-rooted socialism, and oil production are intertwined. To understand how oil production and revenue affected economic development, the country’s history and politics, the rise of oil production, the trajectory of global oil prices, and the fiscal oil revenue regime must first be briefly explored.

The Political Context—The Blending of Oil and Politics Shortly after independence from France, Congo adopted socialism2 and a cen- trally planned economic system, which would have a lasting impact on economic development. It was in this same period that oil production began. It started

1For the background to oil production in the Congo, see Bhattacharya and Ghura (2006). On political and economic developments in the early years of Congo, see World Bank economic reports, various years. 2The governments of Alphonse Massamba-Débat (1963–68) and Marien Ngouabi (1968–77) openly embraced socialism and became engaged in supporting insurgency in neighboring countries. President Ngouabi officially declared the Republic of Congo the first Marxist-Leninist country in Africa.

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modestly, then increased substantially in the 1970s after two offshore fields came onstream, generating the first oil boom and the belief that there were no serious constraints on government revenue and that oil proceeds would be available to finance the country’s needs for the foreseeable future. These beliefs have permeated the vision of policymakers throughout the postcolonial history of the country. This combination of socialism and perceived unlimited resources led to a bloated civil service and a rent-seeking culture. Volatile oil prices caused economic booms and busts, contributing to the early stages of Congo’s long-standing indebtedness. When the ideological 1970s gave way to the difficult 1980s, increasing rifts and inequities became apparent. As oil production and revenue rose, so did the incentives to capture oil rents, and the formerly outward-oriented armed conflicts shifted to the domestic arena in the 1990s. As a result, Congo endured civil war throughout the late 1990s. The conflict was deeply rooted in ethnic and geographical differences fueled by access to the resources generated by oil. Three periods of heavy confrontation during the 1990s destabilized the economy and nearly wiped out the incipient infrastructure built during the oil bonanza of previous years.3 With the negotiated end to the conflict, a period of peace and reunification began in 2000, but the political situation remained fragile. As the economic and political situation stabilized, incremental improvements in macroeconomic management and a shift toward more market-oriented policies occurred. However, only since 2009, after a couple of years of stable policies and a relatively uncon- tested presidential election, has the country experienced two situations virtually unknown in its turbulent history: macroeconomic and political stability.

The Rise of the Oil Economy—Developments in Oil Production and Prices Shortly after independence, Congo’s economy underwent a fundamental transformation from a relatively diversified economy to one dominated by oil.4 The initial jump in production coincided with the first global oil shock in 1973 (Figure 11.1), and from that moment on oil became Congo’s dominant export (Figure 11.2). From the time of the second global oil shock in 1979 through the civil war of the 1990s, oil production rose steadily to more than 150,000 barrels per day in 2000, despite lackluster prices from the mid-1980s through the 1990s. When global prices began a five-year surge in 2003, production rose again; in 2010 production surpassed 115 million barrels, making Congo the fourth-largest producer in SSA. Oil accounted for 70 percent of GDP, 85 percent of fiscal revenue, and 90 percent of exports in 2010.

3About a third of the population was displaced by the war, more than half of all health facilities were damaged or neglected, and service along the vital Pointe Noire-Brazzaville rail line was suspended for extended periods because of attacks on the line. 4The pre-oil economy was based on agriculture, exploitation of timber resources, transport, and public administration. The large public administration sector stems from Brazzaville’s years as the capital of French Equatorial Africa. Over time, regional administration was decentralized, but the legacy of a large bureaucracy persevered for at least three decades.

350 Production (left scale) 200 180 300 Oil price (right scale) 160 250 140 200 120 100 150 80 100 60

barrels per day) 40 50 20 Price index (2005 = 100) Production (thousand of 0 0 1972 1977 1982 1987 1992 1997 2002 2007 Figure 11.1 Oil Production and Prices, 1972–2010 Sources: IMF, World Economic Outlook database; and IMF staff estimates. Note: Crude oil price index is a simple average of spot prices of Dated Brent, West Texas Intermediate, and Dubai Fateh.

The Fiscal Oil Regime and Revenue Collection Oil production in Congo is carried out by private enterprises under contracts with the Congolese government. The first legal and fiscal oil framework was established in 1968, a quarter-century before the adoption of the current hydrocarbons code in 1994. The 1968 regime approved the contracts previously signed with two companies operating in the country and mandated government participation in both the capital and the management of the companies. Oil revenue to the government consisted of taxes on profits. This regime resulted in low fiscal revenue from oil, largely due to a lack of clarity about the revenue accruing to stakeholders, and was replaced by the current fiscal regime signed in 1994. The current, highly complex fiscal oil regime replaced the tax on profits with royalty payments and production sharing between the oil companies and the government. The royalty is set at 12–15 percent of production, while the share of production accruing to the government depends on the oil price. For prices greater than the base cap price (currently about $30 per barrel) the government and oil company split the value of production in excess of the cap. The share

90 s

30 Percent of

10 merchandise export 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 Primary and forestry Food Oil and minerals Figure 11.2 Congo’s Export Trends, 1970–80 Source: World Bank, World Development Indicators.

Oil revenue, 1989–2010 Oil production profile and projection, 2007–25 els) ) 5,000 50 Heavy crude oil 4,500 45 Light crude oil 4,000 40 P 3,500 35 100 Gas 3,000 30 2,500 25

2,000 20 ent of GD

1,500 15 rc 50 nue (US$ millions

1,000 10 Pe 500 5 Reve 0 0

oducon (millions of barr 0 1989 1992 1995 1998 2001 2004 2007 2010 2007 20112015 2019 2023 Oil revenue (left scale) Oil revenue (right scale) Pr Figure 11.3 Past Oil Revenue and Projected Production Source: IMF African Department database.

accruing to the government rises rapidly with price, topping out at 85 percent for the government and 15 percent to the operator. Partly offsetting this lopsided division, the oil companies are exempted from all import and income taxes. The 1994 regime was enacted when international oil prices were low and had been for some time. It is considered very favorable to the country, especially when international oil prices are high. Under this regime, oil revenue has increased significantly (Figure 11.3, left panel), to about 30 percent of GDP and 100 percent of non-oil GDP in 2010. During the decade 2001–10, oil production provided government coffers with revenue of $20 billion (185 percent of 2010 GDP). As of early 2012, work is under way to revise the fiscal regime to remove disincentives to new production. Cost recovery periods for oil companies operating in Congo are among the longest in the region, and the profit-sharing regime is especially unfavorable to exploitation in deep water, where production costs are higher. Without further exploration and production, Congo has a rapidly declining oil profile, with production in currently active fields projected to fall to less than 50 million barrels by 2020 (Figure 11.3, right panel).

Oil Wealth Management—The Absence of Institutions Despite Congo’s rising oil income and wealth, institutions for managing that wealth are weak at best. The national oil company (SNPC) was established in 1998 to oversee the country’s oil interests. However, oil continues to be perceived for the most part as a source of cash flow to finance spending rather than as wealth. No national oil strategy and no fiscal institutions govern the spending of oil wealth, and fiscal surpluses are saved as the equivalent of sight deposits at the regional central bank, earning low rates of return.

The Economic Impact of Oil Economic developments in Congo since 1970 can be broken into three periods, each largely driven by oil (Figure 11.4). The early period (1970–84) was characterized by output expansion and related boom and bust cycles. During this

1,500 1,400 Output 1,300 Output expansion Output collapse recovery 1,200 1,100 1,000 900 800

GD P per capita (constant 2000 US$) 700 1970 1975 1980 1985 1990 1995 2000 2005 Figure 11.4 GDP per capita, 1970–2008 Source: World Development Indicators.

period, structural and financial imbalances widened as a result of ineffective economic management under a socialist model and easy access to oil-induced financing. A prolonged period (1985–99) of output collapse and conflict followed—with falling per capita GDP, worsening poverty indicators, and an unsustainable buildup of debt, and finally, output recovery (2000–10).

Output Expansion under Boom and Bust Cycles: 1970–845 The First Global Oil Shock: 1974–78. In the early 1970s, Congo experienced a short-lived economic boom based on oil and mining (potash). Oil and mineral production rose, fostering rapid economic expansion, while oil prices shot up as an outcome of the 1973 Yom Kippur War and the oil embargo by the Organization of the Petroleum Exporting Countries (Figure 11.5). In the midst of a 20 percent increase in GDP in 1974 and highly optimistic assumptions about future production, the government launched an extensive capital expenditure program in areas for the most part not immediately productive (e.g., paving of streets in the capital). It also increased current expenditure by raising public sector wages and employment to such an extent that wages and salaries became the largest line item in the budget. However, in 1975, oil production declined and real prices slumped, coinciding with waning demand for forestry products as a result of the recession in Europe. These developments combined to dramatically alter the country’s financial situation. During the next two years, oil production stagnated and potash production ceased after flooding irreparably damaged the mine in 1977. Industrial production and construction also fell. As a result, real GDP declined by about 3½ percent per year in 1975–76, and a further 5 percent in 1977.

5For background on the early economic history of Congo see World Bank economic country reports for 1959, 1965, 1971, and 1979.

f 60 60 50 50 y) 40 40 30 30 x (2005 = 100) els per da 20 20

barr 10 10 oducon (thousands o Price inde Pr 0 0 1972 1973 1974 1975 1976 1977 1978 1979 Oil producon (le scale) Oil price (right scale) Figure 11.5 Oil Production and Prices, 1972–79 Sources: IMF, World Economic Outlook database; and IMF staff estimates. Note: Crude oil price index is a simple average of spot prices of Dated Brent, West Texas Intermediate, and Dubai Fateh.

The Congolese authorities maintained the expansionary fiscal policy adopted during the boom, believing that prices and production would recover. Domestic demand increased rapidly, pushing inflation into double digits and placing immense pressure on the external position.6 Large external borrowing, including suppliers’ credits, on increasingly worse terms raised public external debt to about 75 percent of GDP by end-1977, with debt service rising to about 25 percent of total revenue. While the debt stock (disbursed) continued to rise (Figure 11.6), domestic and external arrears continued to accumulate, even after debt rescheduling. After three years of declining real GDP, the economy expanded strongly in 1978 almost exclusively due to rising oil production. However, this recovery was insufficient to return GDP to pre-bust levels. The expansionary stance was maintained—large spending was carried over from the previous budget exercise and the wage bill increased a further 18 percent; the 1978 budget was passed in April of that year with a projected financing gap of about 4 percent of GDP (Figure 11.7). Spending continued unabated, and by year end the cash deficit amounted to 8 percent of GDP, with the stock of arrears, 85 percent of which was domestic, rising to an estimated 29 percent of GDP. The Second Global Oil Shock: 1979–84. The next great boom began in 1979, and was characterized by soaring oil production and record high oil prices after the Iranian Revolution that year. Despite continued stagnation in the agriculture and forestry sectors, Congo’s real GDP growth averaged 13 percent per year during 1979–81, with crude oil export receipts rising by 57 percent in 1979, only to double in 1980 and increase an additional 44 percent in 1981. However, while the trade balance rose, so did the current account deficit (greater than 25 percent of GDP in 1981), owing to large and increasing net services and transfers related to the oil sector and growing interest payments on external debt. With oil prospects improving, long-term public and private borrowing surged, sending debt higher but allowing the country to broadly clear

6Congo has had a fixed exchange rate since independence. As a member of the Coopération Financière en Afrique Centrale zone, convertibility of the currency is guaranteed by the French Treasury.

100

40 rcent of GDP

Pe 20

0 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 Figure 11.6 External Debt Stock, 1970–80 Source: World Bank, World Development Indicators.

60 50 40 30 20 10 rcent of GDP 0 Pe -10 -20 -30 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Balance Expenditure Revenue Figure 11.7 Budgetary Performance During the Boom and Bust Years, 1970–2003 Source: IMF African Department database.

1.00 0.90 0.80 s 0.70 0.60 0.50 0.40 0.30 Months of import 0.20 0.10 0.00 1978 1980 1982 1984 1986 1988 1990 Figure 11.8 Reserves, 1978–90 Source: World Bank, World Development Indicators.

external arrears. By end-1981, gross official reserves had risen from their very low levels of the previous bust, but had reached less than 1 month of rapidly rising imports (Figure 11.8). Despite substantial growth of oil resources, the 1979–80 fiscal position remained weak, mainly reflecting inadequate expenditure restraint, poor non-oil revenue collection, and the difficult financial positions of state-owned enterprises. The budget deficit was reduced but remained high at about 4 percent of GDP, and domestic arrears continued to accumulate. As a result, the objectives of the authorities’ stabilization program supported by the December 1978 one-year IMF stand-by arrangement were not met. The program was allowed to expire after two disbursements, marking the beginning of a quarter-century of failed economic programs. Despite this weak overall performance, the authorities stepped up efforts to improve non-oil revenue collection through improvements in tax administration. Despite a significant expansion of spending, the tax-collection efforts, together with increasing economic activity and oil revenue that had more than doubled, led to a turnaround of the fiscal situation in 1981. The fiscal surplus allowed the government to not only meet external debt-payment obligations, but also to pay back central bank advances and reduce domestic arrears by about 10 percent— misplaced fiscal exuberance was reborn. By end-1981, GDP had risen sharply and Congo’s external position had improved, but policy remained highly expansionary. Monetary aggregates grew rapidly, and credit to the economy rose by more than 60 percent that year. Fiscal spending was rising sharply. The resulting strong domestic demand coupled with the depreciation of the French franc led inflation to accelerate to 17 percent in 1981, from 7½ percent (average) during 1979–80. It was in this context of unfounded exuberance that the government adopted an ambitious and highly expansionary Five-Year Economic and Social Development Plan for 1982–86. Based on very optimistic assumptions, the plan envisaged total investment equivalent to nearly four times 1981 GDP, with the public sector accounting for more than half. The plan was to be financed by external borrowing. However, both oil production and prices came in significantly lower than anticipated, and external credit started to dry up, but the policy response was slow and limited. Non-oil GDP turned negative as state-owned enterprises were closed or suffered declining production due to mismanagement.7 Large external and internal imbalances quickly reemerged, and despite already- large subsidies, the government took over the rising debt obligations of financially strapped state-owned enterprises. With sustained current account deficits of more than 20 percent of GDP (Figure 11.9) and limited external capital inflows,

7By the early 1980s, the public sector’s role in the economy had risen to three-quarters of non-oil GDP, in overstaffed, inefficient, and poorly managed state-owned enterprises ranging from agriculture through manufacturing. Financial losses were significant and subsidies increased over time, in part due to inappropriate pricing policies and overstaffing. Even as its own financial position continued to deteriorate, the government sought not to close loss-making state-owned enterprises, preferring to rehabilitate them through externally financed modernization and capacity expansion, while taking on their debt obligations.

©International Monetary Fund. Not for Redistribution Baker and Melhado 191 1972 1974 1975 1977 1978 1980 1981 1982 1983 1984 0 –5 P –10 –15 –20 ent of GD

rc –25 Pe –30 –35 Figure 11.9 Current Account Balance, 1972–82 Source: World Bank World Development Indicators. Note: Data for 1973, 1976, and 1979 are not available. by end-1984—a mere three years after peaking—gross official foreign reserves had dropped to the equivalent of only a few days of imports. Output Collapse and Conflict: 1985–99 In this environment of large imbalances, the oil bonanza crashed to an end in the second half of the 1980s, with prices averaging only about half the level of the previous five years. As in the past, the policy response was slow and limited, and expenditures were reduced far less than the decline in available resources. Despite falling revenue, the government continued to raise agricultural producer prices and made transfers to weakly performing public enterprises, while assuming their debt obligations. Adjustment focused on slashing capital expenditure, with little structural reform. As a result, the economy started on a downward spiral. The budget deficit widened further in 1985–89, owing, in part, to the deflationary impact on the economy of the reduction in public investment. Real GDP declined by about 3 percent per year on average, public sector and external balances widened markedly, and the external public debt and debt-service burden grew to unsustainable levels—large payment arrears accumulated. It was during this period that the Coopération Financière en Afrique Centrale (CFA) franc became overvalued. By the time civil war erupted, macroeconomic stability had long fallen by the wayside. Per capita GDP was falling, and inflation was in double digits. The economy had become almost completely dependent on oil and subject to the vagaries of volatile oil prices. Despite rising oil production, the country ran acute fiscal and current account deficits, and international reserves fell to mere days of import coverage. The armed conflict exacerbated these trends. Agricultural production declined further, and fighting damaged or destroyed much of the infrastructure that had been built. With the country embroiled in conflict and given the magnitude of the imbalances, by the early 1990s it became increasingly clear that a strategy based on internal adjustment alone would be insufficient to restore external competitiveness. In January 1994, the CFA franc was devalued by 50 percent and the government adopted a 12-month IMF stand-by arrangement, which quickly went off

350 300 250 200 150

rcent of GDP 100 Pe 50 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Figure 11.10 External Debt Stock, 1970–2009 Source: World Bank, World Development Indicators.

track from policy slippages, weak management capacity, and conflict-induced disruptions of railroad transportation. Perversely, the 1994 devaluation of the CFA franc did not restore competitiveness but added to the country’s economic woes by driving inflation higher and by raising the domestic price of imports. The conflict raged on for nearly a decade, fueled and financed by rising oil production. Throughout the period, the government sought several times to place the economy back on the path to sustainable growth and poverty reduction, only to be derailed by flare-ups in the intermittent civil war, lack of fiscal discipline, and insufficient ownership of the structural reform agenda. By the end of 1999, the results of conflict and economic mismanagement were dishearteningly apparent: although oil production had risen to more than double its 1985 level (in excess of 80 million barrels per year), real GDP had fallen to a mere 70 percent of its 1984 level, about a third of the population had been displaced by the war, and much of the infrastructure built in the boom years had been damaged, destroyed, or neglected. Congo—once a middle-income country—had fallen back to low-income status with double the incidence of poverty and a debt burden exceeding 200 percent of GDP (Figure 11.10).

Output Recovery and Renewed Opportunities: 2000–10 In the early postconflict period, non-oil GDP growth surged to double digits and inflation decelerated as supply lines were restored. The government made several attempts to establish macroeconomic stability, including under IMF informal (i.e., staff-monitored) programs and formal arrangements. Early efforts met with limited success given the fragile political situation and entrenched culture of rent- seeking. Peace and security improved following a constitutional referendum and elections held during the course of the first half of 2002. A peace accord was signed and a program was launched to demobilize former combatants, but the situation remained fragile.8 In late 2002, the government launched an economic and social recovery plan in the context of an IMF staff–monitored program,

8As late as 2005, rebel groups carried out attacks on the rail line and a United Nations convoy in the southern region.

©International Monetary Fund. Not for Redistribution Baker and Melhado 193 although it would be another year before the cycle of poor governance and weak economic management would be broken.9 As oil production continued to rise and reforms started to take hold, Congo benefited at end-2003 when international oil prices embarked upon a five-year surge. In what initially appeared to be déjà vu, the government embarked once again on a National Development Plan to foster a dynamic non-oil sector and reduce poverty by using oil wealth to build up basic infrastructure, but this time the surge in oil prices and resulting windfalls proved sustained. Realizing that success would be hampered by poor economic management and the resulting burden of outstanding debt, the government vowed to start afresh. In the mid- 2000s, Congo began to work with development partners, including the IMF and the World Bank, not only to establish macroeconomic stability, but to use oil wealth more effectively by improving budgetary procedures, investment planning, and procurement procedures. After a somewhat rocky start, reforms began in earnest during a 2007–08 IMF staff–monitored program and continued throughout the subsequent three-year Poverty Reduction and Growth Facility arrangement signed in December 2008. Not until 2009, when the war-weary country established a climate of social peace, could policymakers begin to concentrate on economic development with a minimum of political noise. Momentum for change was fairly steady, if uneven, and the reforms and measures implemented as part of the IMF and World Bank arrangements allowed Congo to break free of an unsustainable debt burden by achieving the Heavily Indebted Poor Countries completion point in January 2010. Along the way, the government’s resolve was tested by the global downturn of 2008–09, during which oil prices plunged, but in contrast to the missteps of the 1970s and 1980s, the government demonstrated its desire to move ahead by maintaining an overall fiscal surplus and implementing the economic reform program. Macroeconomic stability has now been established, external debt has been reduced to a sustainable level, the current account is in surplus, and reserve coverage is ample. In July 2011, Congo successfully completed its first full IMF program (IMF, 2011). Although these achievements are but the first steps in the long process of institution building and oil wealth management, the stable environment has opened a long-closed window of opportunity.

9At the end of the civil war, the government put in place a policy framework entitled “Nouvelle Espérance” or New Hope, which was supported by the 2000 IMF Emergency Post-Conflict Assistance facility and four staff-monitored programs during 2001–04. Implementation of reforms under the programs through end-2003 was mixed. Performance improved, and in December 2004, the IMF Executive Board approved a three-year Poverty Reduction and Growth Facility arrangement, which went off-track after two reviews (for a summary of performance under IMF programs, see IMF, 2004, p. 13). The World Bank also provided assistance during this period through a 2001 Post-Conflict Economic Recovery Credit and a 2004 Economic Recovery Credit, as well as through projects in transparency, infrastructure rehabilitation and reconstruction, community support, health, and basic education.

Lessons and Challenges The Congolese experience highlights the difficulty of maximizing the benefits of oil in a country with weak institutions. After a half-century of oil production and some recent success in strengthening policy making, little progress has been made in improving the quality of life of the Congolese people—the majority of the population remains poor, social service provision falls well short of that in countries with similar per capita incomes, and the business environment is among the most difficult on the planet.10 To this day, institutional weakness continues to hold back economic development in Congo. The institutions executing the budget have not been effective in channeling resources from oil into pro-growth and pro-poor spending, in part because of pervasive rent-seeking but also because of lack of budgetary discipline and weak administrative capacity. The national oil company serves, in effect, as a source of budgetary financing and rents rather than gatekeeper of a well-defined national oil strategy. Therefore, perhaps it is unsurprising that governance and transparency of oil and oil wealth management are weak; only recently have transparency initiatives begun to partially disclose oil revenue and the spending of oil wealth. Yet, the government has control over the country’s destiny and has started to move in the right direction. Congo is in a privileged financial position relative to many SSA peers, and its oil wealth is being channeled to rebuilding infrastructure. Significant strides have been made to improve public investment, including through adoption of a new procurement code and better project appraisal, implementation, and monitoring, and the debt burden has been reduced to a sustainable level. With macroeconomic stability in place and a strong external position, Congo has arrived at a crossroads—it can continue to muddle through or it can take the necessary strides to move the country toward becoming a strong emerging market. At present, conditions are more supportive of change than at any time in the past four decades, and without decisive policy actions the risk of a return to past bad habits is high. The massive fiscal expansion in response to the March 4, 2012 munitions depot explosions bodes poorly for raising expenditure quality. To move ahead, the government must sustain momentum in three areas: strengthening institutions, improving the governance and management of oil wealth, and maintaining consistent and sustained policies to foster robust, private sector–led, non-oil growth. Critical steps include implementing full transparency in the oil sector, beginning with an international audit of the national oil company; ensuring that oil wealth is spent efficiently on pro-growth and pro-poor projects; and fully embracing and implementing the market-based reforms contained in the action plan to improve the business climate. To break the rent-seeking culture, both capacity and fiscal institutions will need to be built up, almost from scratch. Such reforms are not easy, but they are within the control of policymakers. The window of opportunity is open.

10In 2010, Congo ranked 129 of 172 countries on the United Nations Development Programme’s Human Development Index and ranks within the worst group in health indexes. In 2011, Congo ranked 181 of 183 countries on the World Bank’s Doing Business Indicators (World Bank, 2012).

References Bhattacharya, R., and D. Ghura, 2006, “Oil and Growth in the Republic of Congo,” IMF Working Paper 06/185 (Washington: International Monetary Fund). International Monetary Fund, 2004, Republic of Congo: Selected Issues and Statistical Appendix, IMF Country Report No. 04/231(Washington). ———, 2011, Republic of Congo: Fifth and Sixth Reviews Under the Three-Year Arrangement Under the Extended Credit Facility and Financing Assurances Review - Staff Report, IMF Country Report 11/255 (Washington). World Bank, 1959, Gabon and Congo – The Economy, Report No. EA99 (Washington). ———, 1965, Congo – The Economy, Report No. AF32 (Washington). ———, 1971, Congo – The Economy – Recent Evolution and Prospects, Report No. AW26 (Washington). ———, 1979, Congo – Economic Trends, Current Issues and Prospects, volumes I and II, Report No. 2213 (Washington). ———, 2012, Doing Business 2012: Doing Business in a More Transparent World (Washington).

Gabon’s Experience Managing Oil Wealth

Cheikh Gueye

Gabon is well endowed with natural resources, including timber, manganese, natural gas, and crude oil. Forests cover 85 percent of the country’s landmass, making it the second largest forest area in Africa, and Gabon accounts for nearly 25 percent of international trade in manganese. Proven natural gas reserves were estimated to be about 33 billion cubic meters in 2008. Despite this diversity of resources, since the mid-1970s the oil sector has been the mainstay of the economy. In the 10 years since 2000, oil accounted for, on average, 50 percent of GDP, 60 percent of all government revenue, and 80 percent of all export receipts. With oil reserves estimated in 2011 at 3.7 billion barrels, the seventh-largest volume of reserves in Africa, oil is expected to remain a key, albeit waning, sector for the foreseeable future. Since independence from France, Gabon has been fairly politically stable. In 1960, a single-party system of government was introduced, which prevailed until 1993. In that year, a multiparty political system was adopted, leading to open elections and formation of a broadly based coalition government. However, to this day the ruling Parti Démocratique Gabonais dominates the political arena, and the multiparty system has not translated into a genuine system of checks and balances with a meaningful participation of civil society. Yet, despite political stability, a rich resource base, and a small population, human development indicators are lagging. Although per capita income is at the level of an upper-middle-income country, Gabon’s social indicators are little better than in the rest of Africa. Headcount poverty increased from 27 percent in 1995 to 33 percent in 2005 and is estimated to have been 37 percent in 2010. This chapter analyzes oil wealth management in Gabon to understand why, with its ample natural resources, the country has not attained a level of social welfare commensurate with its income level. Mainly, Gabon needs to adjust its economic and social policies by stepping up its efforts to diversify the economy and strengthen its social infrastructure. To ensure that the country receives value for the investment these steps require, the government needs to build solid fiscal institutions to anchor fiscal policies, improve governance and transparency, and strengthen the business climate. The next section provides an overview of the oil sector. It is followed by a discussion of the economic policies under oil and the outcomes of policies under oil wealth management. The final section lays out lessons and strategic directions. 197

Overview of the Oil Sector This section explores production prospects, the legal framework of production, and the refinery and pricing system.

Historical Developments and Production Prospects Gabon is the fifth-largest crude oil producer in sub-Saharan Africa (SSA), with oil fields covering 253,557 square kilometers, more than three-quarters of which are offshore. Following discovery of the Ozouri field near Port-Gentil in 1956, production and exports rose steadily through the mid-1970s. Production reached 11.3 million tons (83 million barrels a year, or 225,000 barrels a day) in 1977 (Figure 12.1), before falling to less than 8 million tons in 1988, as existing oil fields were being depleted. With new fields coming onstream in the 1990s, production peaked at about 18 million tons in 1998 before declining to about 12 million tons a year in the latter half of the 2000s. Production in currently active fields has peaked, and prospects for new dis coveries are highly uncertain. At the current extraction rate and absent new discoveries, Gabon’s oil reserves may be depleted in about 40 years. Faced with declining reserves, the government is encouraging the optimization of production. Barring new discoveries, these policies aim to maintain daily output at the current level of 250,000 barrels a day by developing smaller, marginal oil fields and redeploying mature fields.

The Fiscal Regime Over the years, the fiscal oil regime has changed on various occasions. The 1962 mining code included provisions for oil activities. Terms of production were based on individual concession agreements, which awarded the beneficiary the exclusive right to explore and exploit oil. Under this regime, the company owned all assets and installations as well as the oil produced. The main payments to the government were royalties, calculated as a percentage of production valued at official prices, and income tax, calculated as a percentage of gross profits. The 1962 mining code also entitled the state to a 25 percent equity stake in any petroleum production venture.

) 20 18 16 14 12 10 8 6 4 2

Annual volume (million tons 0 1973 1978 1983 1988 1993 19982003 2008 2013 2018 2023 Figure 12.1 Gabon: Oil Production Volume, 1973–2025 Sources: Country authorities; and author’s calculations.

Income tax 20%

Dividends 3%

Oil profit 37%

Royalties 40% Figure 12.2 Gabon: Main Sources of Oil Revenues, Average 2005–10 Sources: Country authorities; and author’s calculations.

In 1982, a petroleum law based on production-sharing contracts was passed and remains broadly in place to this day.1 Under this regime, the government is the owner of all oil production; the company acts as a service provider, for which it is rewarded with a production share. After royalties are deducted, there is a split between “cost oil,” which goes to the contractor group to repay investment costs, and “profit oil,” which is divided between the state and the contractor companies. The production-sharing contracts enable a representative designated by the government of Gabon—currently the Direction Générale des Hydrocarbures—to participate in operational and accounting decisions and in the computation of the production shares. In 2000, revisions to the code were introduced to improve the terms of new licenses to remedy difficulties in attracting new investment and increased costs associated with greater water depths. Typical royalty levels are now 5–15 percent, compared with a previous average of 20 percent. The level of state participation has also been reduced, and exploration periods have been extended beyond the traditional 10 years. The cap on the cost-oil share for any given year was raised above the previous limit of 50 percent of production to 75 percent to allow oil companies to depreciate equipment more quickly. Under the two regimes concurrently prevailing in Gabon, state oil revenue comes from four main sources: profit oil, royalties, corporate income tax on petroleum companies and their subcontractors, and dividends (Figure 12.2). In 2011, nearly three-quarters of revenue came from profit oil and royalties. Despite changes to the fiscal regime implemented over the years, the existing agreements have a number of weaknesses that the government is considering changing.

1Contracts signed under the 1962 mining code remain under that regime. Some are still in effect.

These include the precedence of operating agreements (conventions d’établissement) over domestic law and the principle of nondiscrimination enjoyed by the oil companies.2 Any change to the fiscal regime will need to balance maximizing revenue to the state with providing incentives to producers to continue exploiting oil resources.

The Refinery and the Pricing System Gabon has a single refinery owned by public and private interests and managed by the Société Gabonaise de Raffinage (SOGARA).3 The refinery has an installed capacity of 1 million tons of crude oil a year. For the most part, output is sufficient to meet domestic demand, but SOGARA can also import refined petroleum products to sell to domestic consumers to address any supply shortfalls. Following the deterioration of SOGARA’s financial situation in 2007 and 2008, the government and private shareholders introduced reforms for the refinery in 2009. These reforms were meant to improve management and drastically reduce operating costs, which were higher than those of most refineries along the west coast of Africa, including Central African Economic and Monetary Community (CEMAC) countries such as Cameroon and the Republic of Congo.4 A retrench- ment plan was put in place, new investments (capital injections) made, and the government wrote off part of its claims on SOGARA. The domestic price-setting mechanism for petroleum products has gone through several rounds of reform. After two unsuccessful attempts in the 1990s, a price adjustment mechanism was finally adopted in 2007. However, its implementation was suspended in 2009 because of social tensions; as a result, estimated fuel subsidies have increased on average to about 3 percent of GDP in 2008 and 2009.5

Economic Policies during the Oil Era Gabon’s economic and financial performance since independence has experienced clear phases, largely reflecting the different cycles in world oil markets and domestic oil output. Before 1973, the Gabonese economy was dominated by services and primary and industrial products (Figure 12.3, left panel), and economic performance was relatively stable (Ministère de l’Economie et des Finances, et des Participations,

2The principle of nondiscrimination means that if one company considers a given clause in some other company’s operating agreement to be more advantageous, the first company is legally authorized to adopt this most favorable fiscal treatment. 3The government of Gabon holds a 25 percent stake. Private interests comprise TOTAL (43.8 percent), Shell International Exploration and Production Inc. (17 percent), ExxonMobil Corporation (11.7 percent), and Agip Exploration B.V. (2.5 percent). 4Ministère de l’Economie et des Finances, 2009, “Plan de Redressement de la Sogara,” Libreville, Gabon. 5Except for Equatorial Guinea, Gabon has the lowest retail fuel prices in the CEMAC region. Pump prices were last raised in February 2009 for kerosene (Coopération Financière en Afrique Centrale [CFA] franc 275/liter), August 2009 for super gasoline (CFA franc 530/liter), and April 2010 for diesel (CFA franc 470/liter).

Components of GDP, 1972 Components of GDP, 2000–10

Services Oil Services 28% 29% 33%

Oil 51%

Industry Industry Agriculture 8% 21% and forestry 14% Mining Agriculture Mining 3% and forestry 8% 5% Figure 12.3 Gabon: Components of GDP Sources: Country authorities; and author’s calculations.

Gabon, 1986). From 1973 onward, oil assumed a dominant role (Figure 12.3, right panel), accounting for about half of GDP (annual average, 2000–10). Government revenue increased sharply and services grew. At the same time, the rise of the oil economy increased the vulnerability of the overall economy to external shocks and the resulting large fluctuations in output and prices. Moreover, the distribution of oil rents favoring a narrow urban formal sector at the expense of rural areas contributed to a massive rural exodus and a widening of the gap in standards of living. The performance of Gabon’s oil-based economy exhibits four distinct phases: (i) oil-induced economic booms and busts, 1973–85, reflecting cycles in world oil markets that led to large imbalances; (ii) internal adjustment, 1986–93; (iii) external adjustment, including devaluation of the Coopération Financière en Afrique Centrale (CFA) franc, 1994; and (iv) postdevaluation policy changes and the rise of political cycles.

The Boom and Bust Period, 1973–85 With production surging and world oil prices rising in 1974 (Figure 12.4, top panel), fiscal revenue began to climb, and government policy shifted away from its early prudent position to an expansionary stance. The government embarked on a development agenda comprising a large investment program (Figure 12.4, middle panel) and the creation of state-owned enterprises, financed by oil revenue. The public sector grew rapidly. Public investment focused primarily on infrastructure projects aimed at accelerating economic growth through modernization and diversification of the economy. Infrastructure projects included the Trans-Gabon Railway and agro- industrial efforts. In addition to providing more regular transportation services, the Trans-Gabon Railway stimulated a number of economic activities, especially in connection with the exploitation of iron ore and manganese. However, shortcomings in project management—reflecting overall institutional weaknesses— caused the Trans-Gabon Railway project to be very costly, nearly bankrupting the government. The agro-industrial projects also became unprofitable because of serious weaknesses in both design and implementation. For instance, most agro- industrial projects—the linchpins of the diversification strategy—were in remote

Oil production (left scale) Oil price (right scale)

12 40 ) 10 35 30 8 25 6 20 4 15 10 (millions tons) 2 5 Annual production

0 0 Price (US$ per barrel 1973 1975 1977 1979 1981 1983 1985

Current spending (left scale) Capital spending (left scale) 800 Oil revenues (left scale) Non-oil revenues (left scale) 0

Non-oil deficit (right scale) –10 P 600 –20 –30 400 –40

200 –50

CFA francs (billions) –60 Percent of non-oil GD 0 –70 1973 1975 1977 1979 1981 1983 1985

70 External debt Domestic debt 60 P 50 40 30 20 Percent of GD 10 0 1973 1975 1977 1979 1981 1983 1985 Figure 12.4 Gabon: Fiscal Policies, 1973–85 Sources: Country authorities; and author’s calculations. Note: CFA 5 African Financial Community; NOGDP 5 non-oil GDP.

locations where labor was in short supply and transportation costs to and from urban centers exorbitant because of weak infrastructure. In contrast, resources allocated to priority social sectors were small. The share of health and education in the investment budget was about 8.7 percent in 1980, peaking at 15 percent in 1983 before leveling off to 8.8 percent in 1986. Meanwhile, money was flowing into the creation and expansion of public enterprises because the government used oil revenue to invest in most economic sectors. Once operational, however, the newly created state-owned enterprises proved ineffective. Performance was generally poor as a result of (i) lack of financial discipline; (ii) unqualified and surplus staff, along with shortages of skilled staff at critical levels; (iii) poor investment decisions; and (iv) inappropriate pricing and marketing policies. In addition, lack of accountability in management gave rise to a complex web of cross-debt and payments arrears. Under these circumstances, state-owned enterprises were not competitive. The government responded by protecting them with tariff barriers.

In the context of these expansionary policies, flat oil prices (1975–77) along with sharply lower public and private investment gave rise to a protracted recession. Economic activity contracted by 21 percent in 1977 and 28 percent in 1978 before bottoming out in 1979 ahead of the second oil price shock. The renewed high oil prices, however, could not compensate for declining oil production from aging fields (Figure 12.4, top panel). With spending rising anew, imbalances increased. During this period, the non-oil deficit as a share of non- oil GDP (NOGDP) increased from 7 percent in 1973 to 31 percent in 1975 and 65 percent in 1977 (Figure 12.4, middle panel), mostly reflecting capital spending (Figure 12.4, middle panel). The deficit was financed primarily by external debt. By end-1977, external debt had climbed to 40 percent of GDP (Figure 12.4, bottom panel). Against this backdrop, the Gabonese authorities adopted stabilization programs supported by IMF resources in 1978–82. These stabilization programs were geared toward (i) consolidating public finances to establish a sustainable fiscal position, (ii) improving transparency in the fiscal accounts, (iii) strengthening governance and oil revenue administration, (iv) privatizing state-owned enterprises, (v) improving administrative capacity through civil service reform, and (vi) improving debt management by strengthening capacity. Therefore, the program was mostly underpinned by restrictive fiscal and income policies and public enterprise reform. The program was broadly successful in stabilizing the fiscal position, and the government gradually reduced the external debt stock to less than 20 percent of GDP in 1984. However, oil production declined owing to the depletion of older fields, and average growth during 1980–85 never reached the levels of 1973–76.

The Internal Adjustment Strategy, 1986–93 An abrupt drop in world oil prices in 1986 ended relative economic stability and for the second time sent Gabon into a protracted economic crisis. The subsequent decline in oil revenue (Figure 12.5, top panel), lower government spending, and contraction of oil sector activity contributed to a downturn in overall economic activity.6 In response, the government embarked on an internal adjustment strategy. The strategy consisted of a number of economic reform measures supported by IMF resources and by structural adjustment loans from the World Bank and the African Development Bank. The main objectives of the reform efforts were to restore fiscal and external viability and to return to a more balanced growth path while promoting the diversification of the economy over the medium term. Policy implementation during the internal adjustment period was broadly ineffective, hampered by growing social discontent and continued low world oil prices. Although government revenue remained weak during most of the period, current

6GDP fell by almost 7 percent in 1986 and by a further 13 percent in 1987.

600 20 18 500 16 ) AF) 400 14 12 300 10 8 200 6

4 (In million of tons (In billions of CF 100 2 0 0 1986 1987 1988 1989 1990 1991 1992 1993 1994

Oil production Total revenues Oil revenues (right scale) (left scale) (left scale)

2,800 0 2,400 -10 AF) 2,000 1,600 -20

1,200 -30 800 -40

(In billions of CF 400 (In percent of NOGDP) 0 -50 1986 1988 1990 1992 1994

Current expenditures (left scale) Wages and salaries (left scale) Capital expenditures (left scale) External debt (left scale) Non-oil deficit in NOGDP (right scale) Figure 12.5 Gabon: Fiscal Policies, 1986–94 Sources: Gabonese authorities; and author’s calculations. Note: CFAF 5 African Financial Community Franc; NOGDP 5 non-oil GDP.

spending rose (Figure 12.5, bottom panel) owing primarily to overruns in the civil service wage bill, while capital spending bore the brunt of the government retrench- ment.7 As a result, the overall balance registered a deficit of about 6 percent of GDP in 1993 compared with 2 percent in 1991(non-oil deficit of about 20 percent of NOGDP), financed mostly by increasing external debt (Figure 12.5, bottom panel), which grew from about 50 percent of GDP in 1991 to 54 percent in 1993.

External Adjustment and the Devaluation of the CFA Franc in 1994 The rise in public consumption at the expense of investment, combined with sluggish implementation of structural reforms, resulted in rising wage costs and a further deterioration of competitiveness. The relatively small depreciation8 of the

7The investment budget was slashed from 34 percent of NOGDP in 1986 to a mere 7.4 percent in 1988, while current expenditure rose from 26 percent of NOGDP to 29 percent. Wage increases continued in the early 1990s in response to growing civil unrest. 8This depreciation was the result of the internal adjustment implemented in 1986–93.

120 11 0 100 90 80 70 60

Index, 1980 = 100 50 40 1980 1982 1984 1986 1988 1990 1992 1994 Real effective exchange rate Te rms of trade Figure 12.6 Gabon: External Sector Developments Sources: Country authorities; and author’s calculations. real exchange rate in1985–93 was not enough to restore competitiveness and stop the falling terms of trade (Figure 12.6). Therefore, despite a substantial increase in oil production, GDP growth decelerated because of large cuts in the government investment budget and a decline in private investment. After a decade of insufficient internal adjustment efforts in almost all countries in the CFA zone, economic policies in Gabon and in the rest of the zone countries moved forward with a drastic external adjustment measure. On January 12, 1994, the CFA franc was devalued by 50 percent against the French franc. This devaluation of the CFA franc was supported by restrictive fiscal, income, and credit policies. Moreover, a number of tax, price, and structural reforms were implemented in the stand-by arrangement concluded with the IMF (March 1994–March 1995). In contrast with past experience, Gabon’s performance under this stand-by arrangement was broadly satisfactory, aided, in part, by higher oil exports. Public finances improved markedly in 1995. The primary surplus as a ratio of GDP more than quadrupled from the 1992–94 average of 2.5 percent of GDP to 10.6 percent of GDP in 1995.9 The non-oil primary deficit fell from 15 percent of non-oil GDP in 1994 to 11 percent in 1995. Gabon appeared to be on its way to addressing its economic imbalances.

Economic Policies after the CFA Franc Devaluation and the Rise of Political Cycles Although satisfactory program performance in 1994–95 set the stage for a return to fiscal prudence, economic policies under the new multiparty system became increasingly influenced by politics, a situation that endured until the 2011 legislative elections, when election-related spending resulted in fiscal slippages. The first example of fiscal policy becoming mired in the political cycle was in the run-up to the 1998 presidential election. Despite rising global oil prices and domestic production, the deficit as a percentage of NOGDP rose significantly as

9Much of the improvement was due to the impact of the devaluation, as GDP and government oil revenue in CFA franc terms rose in proportion to the devaluation. Conversely, dollar-denominated debt stocks rose in CFA franc terms.

0 Presidential Legislative Presidential Political elections elections elections change -5 -10 -15 -20 -25 -30 Percent of NOGDP -35 -40 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Figure 12.7 Gabon: The Effect of Political Cycles on the Primary Balance Sources: Country authorities; and author’s calculations. Note: NOGDP 5 non-oil GDP.

the government adopted an expansionary fiscal stance (Figure 12.7). The late August 1997 supplementary budget provided for additional current spending amounting to about 3.5 percent of NOGDP; as a result, the non-oil deficit deteriorated to more than 20 percent of NOGDP. This deterioration continued in 1998, as weakened expenditure control and monitoring procedures and falling oil prices led to a widening of the non-oil primary deficit to about 35 percent of NOGDP. On the structural front, although legislation was approved in 1996 that allowed privatization of water and electricity services, implementation fell behind in the heated political environment. After the 1998 elections, momentum for structural reforms in the public sector and in debt management resumed. Commitment was strong initially, and the government designed an economic program for 2000–01 and requested an 18-month stand-by arrangement from the IMF. This economic program called for (i) consolidation of budget balances and (ii) progress in governance. The fiscal stance improved significantly at the outset, and progress was made in public service reforms, debt management, and oil revenue administration. Ultimately, however, political cycles prevailed, and governance reforms and privatization programs waned in the run-up to the December 2001 legislative election, only to resume again in 2002 with further support from rising oil prices in 2003. Lapses in reforms resumed ahead of the 2005 presidential election and the 2006 legislative poll when fiscal discipline proved difficult to maintain in view of record oil prices. The non-oil primary deficit widened to 17½ of NOGDP in 2005 and 18 percent in 2006. In the aftermath of the poll, the government once again formulated a comprehensive medium-term economic program aimed at reinvigorating structural reforms and reestablishing fiscal discipline. The key objective of the program was to seize the opportunity offered by high oil prices to place public finances on a sustainable footing and to prepare for the non-oil era. To support this program, the government requested a three-year stand-by arrangement with the IMF in May 2007. Policies implemented under this arrangement helped garner support from external creditors to reduce Gabon’s outstanding stock of debt. In a July 2007 agreement, Paris Club creditors consented to a buyback of Gabon’s private

120 35 100 30 25 80 20 60 15 40 10 Percent of GDP Percent of GDP 20 5 0 0 1990 1993 1996 1999 2002 2005 2008 2011

Gross external debt position (left scale) Total debt service (right scale) Figure 12.8 Gabon: Debt and Debt Service, 1990–2011 Sources: Country authorities; and author’s calculations.

development assistance debt at a 15 percent discount rate in net present value terms10 (Figure 12.8). Notwithstanding this major economic policy achievement, the three-year program began falling apart during the first half of 2009 because of political uncertainty created by the protracted illness and subsequent death of long-standing President Omar Bongo and slippages in current spending. This led to an increase in the non-oil primary deficit to 14 percent of NOGDP in 2009, well above the sustainable level estimated at 6.5 percent of NOGDP. In the last quarter of 2009, Gabon went through a political transition, and the new government embarked on an ambitious reform program. The objectives of this reform included (i) economic diversification through private sector development and increased domestic value added in key industries; (ii) improvements in the business environment, including through strengthened governance; and (iii) efforts to protect Gabon’s environment. A key element of this program was a large scaling-up of investment—the 2010 budget tripled capital expenditure.

Economic and Social Outcomes after the 40-Year Oil Era This section takes stock of economic policies in Gabon during the past 40 years that led to weak economic and social development outcomes. Past capital spending has not translated into improved infrastructure and high and sustained non- oil growth. Economic diversification has remained elusive. Oil wealth has not led to significant and durable poverty reduction. Why not?

10Creditors holding 86 percent of eligible claims—US$2.3 billion—participated. For this operation, Gabon issued a US$1 billion 10-year bullet bond on the international market with an 8.20 percent coupon. This buyback reduced the net present value of the corresponding debt by about 11 percent and was intended to smooth debt-service obligations, although the bullet payment meant a large payment at maturity. To calm markets’ fears about its capacity to repay, Gabon created an amortization fund at the World Bank.

9 8 7 6 5 SSA’s growth 4 3 Gabon’s non-oil growth 2 1 0 Percent change year-on-year -1 -2 2004 2005 2006 2007 2008 2009 2010 Figure 12.9 Gabon: Non-Oil Growth Compared with Growth in SSA, 2004–10 Sources: Country authorities; and author’s calculations. Note: SSA 5 sub-Saharan Africa.

Past capital spending has neither improved infrastructure nor resulted in high and sustained non-oil growth.11 Despite past public investment spending, non- oil growth picked up only moderately in the 2000s and still lags that of SSA as a whole (Figure 12.9). The major factor underlying this outcome is ineffective policy implementation owing to weak institutions—rentier states are generally characterized by a lack of strong institutions for revenue collection and expenditure monitoring.12 In Gabon, this deficiency is reflected in the poor execution of expenditure in priority sectors and in infrastructure because of lack of mana- gerial and administrative capacity and weaknesses in public financial management in general. Project appraisal and selection were centralized at the Ministry of Planning and Development until 2009, and line ministries charged with execution were barely involved. At the same time, funds intended for maintenance have occasionally been diverted to more costly rehabilitation projects and construction projects, and road projects were not always selected according to strict cost-benefit criteria. Funds committed to the Ministry of Infrastructure are always far higher than funds disbursed—investment budget execution averaged about 30 percent. The resulting infrastructure gap is a crucial element holding back non-oil growth. These institutional weaknesses were confirmed by the 2006 Public Expenditure and Financial Accountability exercise for Gabon (World Bank, 2006) and the country’s score on the 2011 Public Investment Management Index, which captures the institutional environment underpinning

11A national agency for major public works was set up in 2010, entrusted with the planning, management, and implementation of large public infrastructure projects. The American engineering corporation Bechtel is providing the agency with technical expertise. 12The tax system for non-oil revenue collection in Gabon is complex. In 1995 the value-added tax system replaced the turnover tax system, but even the value-added tax uses three rates (5 percent, 10 percent, 18 percent).

©International Monetary Fund. Not for Redistribution Gueye 209 public investment management across the different phases of project management.13 Another telling outcome is the lack of economic diversification and continued oil dominance. The diversification trend has improved since the 1990s, but oil continues to account for 80 percent of exports. The lack of diversification is partly due to the poor business climate, including Gabon’s rigid labor market. The tradable sector is constrained by high wages (the highest minimum wage in SSA) and lack of skilled labor. The structurally high wages were caused by the redistribution of rents through the high wage policy in the public sector during the oil booms and its spillovers to the private sector.14 With regard to the broader business climate, Gabon is lagging far behind in the overall 2012 World Bank Doing Business rankings, in particular in starting a business and enforcing contracts. Input costs are also elevated compared with other countries in the region. A recent study on competitiveness in the CEMAC ranked Gabon and Cameroon as having the most expensive input costs in the union.15 Another factor holding back diversification is that private sector activity, especially of small and medium enterprises, is constricted by the shallowness of the financial system (Figure 12.10). Windfall gains from natural resource abundance can lead to expansion of the nontradable goods sector and, therefore, to demand for financial services, including consumer credit. But the lack of a sound institutional framework, paramount for the development of any financial system, is hampering financial access in Gabon.16 Moreover, the number of depositors and borrowers has lagged behind the average of SSA and frontier market countries, reflecting weak capacity to allocate resources efficiently and mobilize savings. Credit to the private sector is well below the average in SSA’s oil-exporting countries. As a result of the failure of oil wealth to yield non-oil growth and diversification, natural resource abundance has not created a significant and durable reduction in poverty. The incidence of poverty increased from 27 percent in 1995 to 33 percent in 2005, and an estimated 37 percent in 2010. In addition, social outcomes are

13Among the Public Expenditure and Financial Accountability ratings from A (best) to D (worst), Gabon scored 17 C’s, 3 D’s, and 3 B’s on 23 indicators. On the evaluation of the level of financial risk based on 12 indicators of budget execution, 6 were rated “high,” 4 were rated “moderate,” and 2 were ranked “low.” Compared with 30 middle- and low-income countries, Gabon falls in the lowest of five performance brackets. On the Public Investment Management Index scale of 1 (low) to 4 (high), Gabon scores low. It is also in the lowest quintile of the 71 low- and middle-income countries in the sample. 14In addition, the labor market is hampered by the educational system’s failure to adapt its technical and vocational programs to the needs of labor markets, and the programs lack qualified teachers. The absence of qualified and trained workers weighs on factor costs and results in a lack of competitiveness in the Gabonese business environment. 15“Groupement Interpatronal du Cameroun (Gicam),” in L’Union (a daily newspaper in Gabon), May 23, 2011. 16The number of commercial bank branches per 100,000 adults increased from 3.67 to 4.69 between 2004 and 2009, surpassing the average for SSA and frontier market countries, reflecting a strengthening of financial infrastructure.

y SSA's oil exporting 60 countries

Percent of broad mone Gabon 45

40 2004 2005 2006 2007 2008 2009 Figure 12.10 Gabon: Claims on Nonfinancial Private Sector Source: IMF African Department Database. Note: SSA 5 sub-Saharan Africa.

disappointing, especially in the education and health sectors. The proportion of the budget allocated to health and education is lagging compared with middle-income countries. The share of Gabon’s budget allocated to education and health averaged 13 percent in 2008 and 5 percent in 2009, whereas middle-income countries averaged 20 percent and 11 percent in those two years, respectively (World Bank, 2011). Gabon also tends to underexecute budgeted priority social spending. As a result, despite Gabon’s relatively high per capita income, health indicators such as life expectancy and infant and child mortality have fallen behind those of middle- income countries (Figure 12.11) and are not significantly better than the average for SSA. The quality of education has been declining as shown by a rise in the share

120 y

100 Life expectancy

Child mortality

s 80

per 1,000 birth 40

Life expectancy (years) and child mortalit 0 GabonUpper-middle-income Gabon Upper-middle-income countries countries Figure 12.11 Gabon: Social Indicators Comparison, 2009 Sources: World Bank, World Development Indicators.

©International Monetary Fund. Not for Redistribution Gueye 211 of students repeating a grade, from 30 percent in 2006 to 38 percent in 2008, and life expectancy has stagnated at 62 years between 1990 and 2009, while life expectancy for the middle-income group has increased significantly.

Lessons and Strategic Directions Gabon needs to adjust its policies to increase economic diversification and to improve social indicators to reduce vulnerability and give the Gabonese people a quality of life commensurate with the nation’s income level. To ensure that the country gets value for money and returns to fiscal sustainability over the medium term, the government needs to build solid fiscal institutions to anchor fiscal policies, improve governance and transparency, and strengthen the business climate. Anchor fiscal policies and improve quality of spending. As demonstrated by the boom-bust fiscal cycles experienced during the past four decades, no reliable anchor has stabilized fiscal policies in Gabon. Fiscal policy needs to be rooted in a credible medium- to long-term strategy aimed at eliminating procyclicality and ensuring long-run fiscal sustainability, with near-term policies that address urgent development needs. Budget reforms should be accelerated, including the establishment of sectoral medium-term expenditure frameworks, allowing public investment plans to be embedded in a realistic multiyear investment plan. To that end, the government may explore the costs and benefits of implementing a fiscal rule. To be credible and effective, such a rule should be enshrined in higher legislation, with appropriately strong accountability procedures and enforcement mechanisms. Cross-country experiences offer many examples of anchoring rules for Gabon to explore, such as the oil budget price rule applied in Nigeria.17 Similarly, stepping up spending efficiency would help to strengthen any anchoring rule because it would ease the path to sustainability. Risk analysis of investment projects and fiscal plans should be enhanced. A global medium-term expenditure framework and sector strategies should be established to guide sector managers in selecting investment projects and planning expenditures. Further strengthen governance and transparency. Joining the Extractive Industries Transparency Initiative process in 2007 with the status of “close to compliant” was an important step toward instilling a culture of transparency in oil revenue management. However, more effort is needed, including an over- haul of the fiscal regime of the oil sector. A new petroleum code should align the fiscal regime with best practices, favoring a bidding process over the discretion that underpins the current code. In particular, the code should require (i) a published model contract, (ii) an allocation of blocks18 by an open bidding

17Every year in Nigeria, the government and the legislative branch—the national assembly—agree on budgeted revenues based on a given oil price (reference price) and an estimate of production volume. If actual revenues are more than budgeted revenue, the difference is saved and allocated based on predefined rules. 18A block in the context of the extraction of petroleum (and natural gas) is a subdivision of an underground petroleum reservoir.

process rather than direct negotiation, (iii) publication of signed contracts (a good transparency practice), and (iv) an obligation to disclose payments according to Extractive Industries Transparency Initiative standards. To further strengthen governance of oil revenue management, the creation of new extrabudgetary funds for managing oil revenue should be avoided. Extrabudgetary funds substantially increase the risk that governance and accountability will suffer. More generally, improved governance calls for genuine participation by civil society in the oil revenue management process. Therefore, an in-house participa- tory mechanism needs to be built into oil revenue management at all levels of Gabonese society, from the definition of strategic directions for the country to budget preparation and execution. Frequent and meaningful public participation would enhance the legitimacy of government actions in managing oil resources and support a collaborative dialogue. Improve the business climate to promote the private non-oil sector. Gabon has made headway in improving its business climate, moving up four places in its ranking on the World Bank’s 2012 Doing Business Index to 156 (of 183 countries), compared with the previous year. Improvements were made in access to credit (although not for small and medium enterprises), issuing construction permits, and time to resolve insolvency. However, given the country’s still-low rank, much remains to be done to streamline procedures to make the business environment friendlier and to abolish burdensome regulations involving lengthy procedures. Meanwhile, to enhance labor force productivity, further investment must be made in infrastructure and in human resources development. Since 1973, oil has played a dominant role in the Gabonese economy, creating the potential for splendid economic and social development for the well-being of all Gabonese. However, 40 years of policies in the oil era have so far resulted in weak social outcomes and an economy vulnerable to the swings of international commodity markets. Because oil is expected to be depleted sometime in the next 40 years, Gabon should prepare now for the post-oil era by diversifying its economy and investing in its social infrastructure to strengthen competitiveness. The country needs to build solid institutions to ensure effective implementation of economic policies, strengthen transparency and governance to make government institutions friendlier to business, and improve the business climate to promote domestic investment and to attract foreign direct investment.

References Ministère de l’Economie et des Finances, et des Participations, 1986, “25 ans de développement économique et social 1960/1985,” Libreville, Gabon. World Bank, 2006, “Gabon: Public Expenditure and Financial Accountability,” Report No. 35247-GA (Washington). ———, 2011, “Gabon: Revue des Dépenses Publiques” (Mieux gérer les finances publiques pour atteindre les objectifs du millénaire pour le développement) (Washington). ———, 2011, “Gabon: Ex-Post Assessment,” Gabon Team, AFR Department, (unpublished; Washington).

Introduction to the CEMAC Institutions

Salao Aboubakar Advisor to the BEAC Governor

The Central African Economic and Monetary Community (CEMAC) comprises six countries in Central Africa that have been engaging in various forms of economic and monetary cooperation with each other for more than a half century. Cameroon, the Central African Republic, Chad, the Republic of Congo, Equatorial Guinea, and Gabon established a formal framework for cooperation under the treaty signed in N’Djamena, Chad, on January 16, 1994. The CEMAC emerged as the successor to the Customs and Central African Economic Union, the initial framework for cooperation between the six countries, founded by the Brazzaville Treaty of December 1964. The population of the CEMAC region is estimated to be about 40 million inhabitants, spread over a surface area of 3,020 million square kilometers. Article 2 of the CEMAC treaty stipulates: “The main aim of the Community is to promote peace and the harmonious development of the Member States, through the institution of two Unions: an Economic Union and a Monetary Union.1 In each of these two areas, the Member States intend to move from the existing form of cooperation between them to the creation of a Union conducive to completing the process of economic and monetary integration.”

The Central African Monetary Union (UMAC) The UMAC manages all issues related to currency, finance, and banks. A central feature of the UMAC is the adoption of a common currency, the Coopération Financière en Afrique Centrale (CFA) franc, the issuance of which is entrusted to a common central bank known as the Bank of Central African States (BEAC). In general terms, the UMAC is responsible for • the management of the rules governing currency issuance; • the pooling of foreign currency reserves;

1The texts creating and governing the Central African Monetary Union (UMAC), the Central African Economic Union (UEAC), the Community Parliament, and the Court of Justice of the Community complement the treaty establishing the CEMAC.

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• the free circulation of banknotes and coins and freedom of transfers among the states of the union; • the preparation of measures aimed at the harmonization of monetary, banking, and financial legislation, and exchange arrangements; and • multilateral surveillance, in collaboration with Central African Economic Union (UEAC), through the coordination of economic policies and the establishment of national fiscal policies consistent with the common monetary policy of the union. To fulfill its multiple missions in the area of monetary integration, the UMAC comprises the following elements: • a common currency, the franc of Financial Cooperation in Central Africa, also known as the CFA franc; • a common central bank, the BEAC, which has the exclusive authority to issue bank notes and coins with legal tender in the six member states. The BEAC also manages the common pool of foreign currency reserves; • a common authority for banking supervision and microfinance activities, the Central African Banking Commission, which has extensive powers to regulate the banking system of member states. These include administrative powers (licensing of credit institutions and their managers, and the like), and regulatory and jurisdictional powers to sanction any noncompliance observed, with all six countries being subject to a single body of banking laws; • a common stock market, the Central African Stock Exchange; • a common body responsible for financial market supervision, the Central African Financial Oversight Commission; • a common body responsible for the management of means of payment, the Central African Electronic Banking Company; • a common body responsible for the regulation of means of payment, the Central African Electronic Banking Authority; • a common body responsible for combating money laundering and terrorist financing, the Task Force on Anti-Money Laundering and Combating the Financing of Terrorism in Central Africa; • a common body responsible for regulation of the insurance market, which also covers the member countries of the West African franc zone, the Inter- African Conference on Insurance Markets; • a common body responsible for the supervision of insurance companies, the Insurance Supervisory Commission; and • a common body of laws and accounting framework, which also covers the member countries of the West African franc zone, the Organization for the Harmonization of Business Law in Africa.

The Central African Economic Union (UEAC) The UEAC, in turn, is responsible for achieving the following objectives: • strengthening economic and financial competitiveness by harmonizing the rules conducive to improving the business environment, and regulating its functioning; • promoting convergence on sustainable growth through the coordination of economic policies and ensuring the consistency of national fiscal policies with the common monetary policy; • creating a common market based on the free movement of goods, services, capital, and people; and • fostering the coordination of national sectoral policies, implementation of common actions and adoption of common policies, particularly in the following areas: agriculture, livestock farming, fisheries, industry, commerce, tourism, transport, community land use planning and development and major infrastructural projects, telecommunications, information and communication technologies, social dialogue, gender issues, good governance and human rights, energy, the environment and natural resources, research, and education and vocational training. Several specialized institutions of the UEAC contribute to achieving these goals: the Central African Development Bank; the Economic Commission for Livestock; Meat; and Fisheries Resources; the Court of Justice of the Community; the Regional Hotel and Tourism School; the Central African School of Telecommunications; the Development Fund of the Community; the Institute of Economics and Finance; the Sub-regional Institute of Statistics and Applied Economics; the Sub-regional Multisectoral Institute of Applied Technology, Planning, and Project Evaluation; and the Organization for the Coordination and Control of Endemic Diseases in Central Africa.

[Page numbers followed by b, f, n or t refer to boxed text, figures, footnotes or tables, respectively.]

A Business climate/environment Cameroon’s, 10 Accountability and transparency Central African Republic’s, 9 in Cameroon’s oil wealth management, CFA zone, 41f xx, 156, 160, 163–67 current CEMAC ranking, 7–9 domestic revenue collection and, xix, 130 Gabon’s, 209, 212 government failure and, 111–12, infrastructure investment and, 57 115–16, 121–22 investment climate indicators, 12f in microfinance operations, 12–13 for private sector infrastructure rationale for non-oil revenue investment, 85 generation, 130–31 recent efforts to improve, 10 recommendations for Gabon, 211–12 regional comparison, 41f in Republic of Congo governance, 194 strategies for economic growth and strategies for financial sector poverty reduction, xvii, 3, 9, 10 deepening, 11–12 transport infrastructure and, 60 strategies for improving government oil wealth management, 122–23 C Alucam, 70, 71b Cameroon B accountability and transparency in oil wealth management, xx, 156, 160, Banking sector 163–67 capital requirements, 10–11 business environment, 10 central bank refinancing, 18–19 colonial legacy, 113 deposit insurance, 11, 12 commodity price movement, inflation excess liquidity, 19 and, 8b lending practices transparency, 11–12 corruption in, 164–65, 166–67 resolution framework, 11 current infrastructure improvement supervision, 11 efforts, 10 Bank of Central African States cyclical behavior of fiscal policies, 138, deposit insurance scheme, 11 146 foreign assets, 18–19, 33–34, 34f, 35 demographics, 156 operations account, 18 economic development experience, policy instruments, 18–19 156–59 responsibilities and authorities, 18 fiscal convergence criteria, 22 Bechtel, 10 fiscal policies, 116–17 Bird-in-hand model of economic windfall fiscal sustainability indicators, 30 management, 29, 30, 94, 95, future challenges and opportunities, 167 104–5, 106 governance quality, 165–66 BRIC countries, CEMAC trade with, 13 gross domestic product, 157

217

gross national income per capita, establishment, 18 157, 157f evidence of procyclical bias in fiscal health sector, 158, 159 policies, 136–39, 143–50, 146t, historical background, 112–13 147t, 148f information and communications fiscal balances and convergence criteria, infrastructure, 76, 79, 158 22–23, 22t infrastructure financing, 82, 84–85 fiscal policy outcomes, 24–26, 24t, infrastructure investment outcomes, 57 26t, 28, 28f, 30–32 infrastructure spending, 80 government revenues and expenditures, oil sector structure, 159–62, 163, 172 116–18, 118f oil wealth, 111, 160–61 historical infrastructure spending, policy and IMF arrangement, 164, 165 80–82, 80t, 81t political institutions, 159 historical legacy, 113–14 power infrastructure and service, 67, human development index, 111, 112t 70, 71b, 72, 73 inflation patterns, 8b public spending, 119, 121 information and communication saving rate, 92 infrastructure, 76–79 social indicators, 111, 113, 158–59 infrastructure investment outcomes, strategies for improving oil wealth 56–57, 56f, 57f management, xx, 156 membership, 17–18, 55 taxation, 161–162 monetary policy, 18–19 trade patterns, 158 natural resource endowments, 112 transport system, 60, 62, 65, 66–67, 158 objectives, 18, 36 unaccounted oil revenue, 155–56, oil wealth, 3, 55, 89, 90t, 111 166–67 poverty patterns and trends, 113 water supply, 74, 76, 158 power infrastructure and service, See also Central African Economic and 67–74 Monetary Community (CEMAC); rationale for strengthening nonresource CFA Zone oil-producing countries revenue base, 125, 129–32 Capital market obstacles to efficient use of recent economic and financial oil windfall, 95–97, 101–2f, 105 indicators, 6t, 56f Capital mobility, 18 reserves coverage among members of, CEMAC. See Central African Economic 35, 36t and Monetary Community resource curse phenomenon, 40, 111 CEMAC Commission, 13–14 sanitation infrastructure, 74–76 Central African Banking Commission saving rates, 92–93 deposit insurance scheme, 11 social indicators, 4t staffing, 11 surveillance rationale, xviii, 17 Central African Economic and Monetary trade patterns, 13, 13f Community (CEMAC) transport infrastructure, 60–67 case studies, xx–xxi. See also specific water supply and access, 74 country Central African Power Pool, 67, 71–72 current business environment, 7–9 Central African Republic demographic evolution, 113 business climate, 9 diversity among, 55, 112–13 civil conflict in, 115 domestic revenue collection, 126–29, colonial legacy, 113 127f, 128f cyclical behavior of fiscal policies, 146 economic challenges, xvii, xx, 3, 4f, diamond wealth, 19, 111, 115 55–56, 91–93, 95–98, 111 ethnic and linguistic diversity economic projections, 89–91, 91f, 92f within, 113

external current account balance, 33 infrastructure spending, 80 fiscal policy outcomes, 22, 25 lessons from oil resource experiences governance challenges, 115, 122 of, 180–81 information and communications non-oil economy, 178 infrastructure, 76, 79 oil revenues, 89, 111, 117, 119f, 128, infrastructure spending, 80, 81 171, 173–74, 173f, 176, 177f oil revenues, 89 oil sector development, 171, 172 power infrastructure and service, 67, oil sector fiscal regime, 174–75 68, 72 Petroleum Revenue Management recommendations for infrastructure Program, xx, 174–75, 176, investment, 79–80, 80t, 81f 178, 181 sanitation infrastructure, 74 political context of oil economy, 171, saving rate, 93 172, 176–77 social indicators, 111 poverty reduction, 175 transport system, 62, 65, 67 power infrastructure and service, water supply, 74–76 67–68, 73–74 CFA Zone oil-producing countries procyclical fiscal policies, 138, 146–47 business environment, 41f sanitation infrastructure, 74 corruption, 41f social indicators, 111, 171–72, 175–76 economic performance, 40 strategies for improving oil wealth infrastructure quality, 41f management, xx, 181 members, 39n, 39n. See also specific transport system, 60, 62–63, 65 country water supply, 74 modeling of non-oil growth factors See also Central African Economic and in, 43–52 Monetary Community (CEMAC); monetary policy, 18 CFA Zone oil-producing countries non-oil growth performance in, 39, China, 82 40, 41f Civil conflict private investment outcomes in non-oil in Central African Republic, 115 growth, 52 in Chad, 115–16, 171, 172, 176–77 public investment outcomes in non-oil in Congo, 116, 184, 191, 192 growth, xviii, 39, 52 Community integration tax, 14 Chad Congo, Republic of absorptive capacity, 178–79 accountability and transparency civil conflict in, 115–16, 171, 172, issues, 194 176–77 business environment, 10 current business environment, 9 civil conflict in, 116, 184, 191, 192 debt sustainability, 179 commodity price movement, inflation economic challenges, xx, 172 and, 8b economic development, 175, 180 cyclical behavior of fiscal policies, ethnic and linguistic diversity 138, 146 within, 113 economic development, 183–84, external competitiveness, 179–80 187f, 189f fiscal policy outcomes, 25, 178–79 ethnic and linguistic diversity within, 113 fiscal sustainability indicators, 30 fiscal convergence criteria, 22 government revenues and expenditures, fiscal policy outcomes, 25, 117 117–18, 176, 178 fiscal sustainability indicators, 30 health sector, 176 future prospects, 183, 186, 194 information and communications governance and institutional infrastructure, 76, 79 capacity, 194

information and communications as obstacle to growth, 42 infrastructure, 76, 77 perceptions index, 41f, 131, 131f, infrastructure investment outcomes, 57 132, 132f infrastructure spending, 80 Credit access, 11 lessons from economic development Customs administration, 13, 14 experience, 194 Cyclicality, fiscal oil production and revenues, 89, 111, challenges for CEMAC countries, xviii 128, 184, 185–86, 185f, 186f, 188f data sources for assessment of, oil sector and economic development, 142–43 186–93 determinants of, 147–50, 149t, 151 oil sector structure, 185 empirical model for assessment of, policy and IMF arrangement, 190, 139–42 191, 192, 193 evidence of procyclical bias, 136–39, political functioning, 184 145, 146, 147–50 power infrastructure and service, 67, findings from generalized method of 68, 72, 73–74 moments modeling, 143–50, 144t, public spending, 121 146t, 147t, 148f sanitation infrastructure, 74 fiscal impulse measurement and, 25 saving rate, 92 fiscal indicators of, 137b social indicators, 111, 183 fiscal stance measurement and, strategies for improving economic 23, 137b development, xx–xxi government failures in managing oil transport system, 60, 62, 67 wealth, 116–18 water supply, 74, 76 limitations of convergence criteria See also Central African Economic and as fiscal indicator, xviii, 21–23, Monetary Community (CEMAC); 135, 151 CFA Zone oil-producing countries oil revenue volatility and, xx, 3, 19 Consumer protection, 12 procyclical public investment, xx Convention on Monetary Cooperation, 18 recommended policy response, 150–51 Convergence criteria adoption of, 20 D cyclicality of fiscal policies and, 135 enforcement, 20, 36 Doing Business Indicators, 7–9 four main, 20, 20b Dutch disease, 39, 40, 55, 93, 106–7, limitations of, as fiscal indicator, xviii, 126, 156, 179–80 21–23, 25, 33, 36, 135, 151 minimum reserve level, xviii E non-oil fiscal revenue, 129–30 policy objectives, 135 Education recommendations for improving, xviii in Gabon, 210–11 reserve coverage, 35, 37 patterns in Africa, 4t secondary criteria, 20, 20b public spending, 119, 120 strategies for strengthening fiscal strategies for economic growth and surveillance, 36–37 poverty reduction, xvii, 3, 9 Corruption Employment. See Labor market in Cameroon, 164–65, 166–67 Equatorial Guinea domestic revenue mobilization and, business climate, 10 xix, 131–32 ethnic and linguistic diversity natural resource revenue and risk of, within, 113 131–32, 131f, 132f, 133f, 155 fiscal sustainability indicators, 30

information and communications fiscal stance and fiscal impulse infrastructure, 76–77 measures of, 23–26 infrastructure spending, 80 monetary policy coordination, 19 oil wealth, 128 objectives, 21 power infrastructure and service, 68, procyclical orientation, 25 73–74 recommendations for convergence procyclical fiscal policies, 138 criteria, xviii sanitation infrastructure, 74 recommendations for Gabon, 211 saving rate, 92 response to external shocks, 35 social indicators, 111, 114 sustainability goals, 17 water supply, 74 sustainability indicators, 26–32 Ethnic and linguistic diversity, 112–13 See also Oil wealth management; European Union, CEMAC trade with, 13 Surveillance, fiscal Exchange rate Fiscal stance and fiscal impulse effects on economic growth, 39, 40 measurement, 23–26, 37, 137b euro peg, 18 Fiscal sustainability indicators, 26–32 external competitiveness and, 5–7 Food prices, inflation and, 8b historical patterns, 7f Foreign exchange reserves, 18–19, 33–34, modeling of non-oil growth outcomes, 34f, 35, 37 45–46, 48–49 France, 18 need for fiscal and monetary policy Fuel prices coordination, 19 inflation and, 8b recommendations for CEMAC levies to support transport convergence criteria, xviii infrastructure improvement, 60–63, External current account balance, 33–34, 37 63f Extractive Industries Transparency power generation costs, 68 Initiative, 165, 166–67, 181, Funds for Future Generations, 18 211–12 G F Gabon Fiber optic infrastructure, 76, 77–79 business climate, 7–9, 209, 212 Financial sector current infrastructure improvement challenges for CEMAC countries, xvii efforts, 10 deepening, 11–13 cyclical behavior of fiscal policies, 146 strategies for improving economic economic and oil sector development, growth—, xvii, 10–13 198, 200–207, 201f, 204f See also Banking sector ethnic and linguistic diversity Financial Sector Assessment Program, 10 within, 113 Financial Stability Committee, 11 exchange rate development in 1990s, Fiscal policy 204–5, 205f Chad’s, 25, 178–79 external current account balance, 33 challenges for CEMAC countries, fiscal oil regime, 198–200, 202f xvii, 19 fiscal sustainability indicators, 30 comparison of findings from income inequality in, xxi surveillance indicators, 24–26, information and communications 24t, 26t infrastructure, 76, 77, 79 dependence on oil revenue, 114–15 infrastructure spending, 80, 82 evolution in Gabon, 198–200 natural resource wealth, 197 external balance outcomes, 33–34, 37 non-oil economy, 208, 208f, 212

oil wealth, 197, 198, 198f, 199f Heavily Indebted Poor Countries (HIPC) outcomes of oil wealth facility, 164–65 management, 207–11 Human Development Index, 111, policy and IMF arrangement, 203, 112t, 175–76 205, 206 political functioning, 197, 205–7, 206f I poverty reduction, 197, 209–10 private sector, 209, 210f Income distribution procyclical fiscal policies, 138 in CEMAC countries, 3 public investments, 201–2, 208–9, 210 in Gabon, xxi refinery operations, 200 Inflation, 8b sanitation infrastructure, 74 targets, 18 social indicators, 111, 197, 209–11, 210f Information and communications strategies for improving economic infrastructure development, xxi, 197, 211–12 costs, 59–60 transport system, 60, 66–67 current extent and quality, 58, 76–79, water supply, 74, 76 77f, 78t, 79t See also Central African Economic financing, 81–82 and Monetary Community future prospects, 79 (CEMAC); CFA Zone oil- investment outcomes, 57 producing countries Infrastructure, physical Generalized method of moments business environment and, 57 modeling, 140–41, 141n, 143–50 cost reduction strategies, 83–84 Ghana, 123 costs, xviii, 10t, 59–60 Government failure, xix economic growth and, xvii, 56–57, contributing factors, 111–12, 114–22 56f, 57f definition, 111 historical public sector spending, dependence on oil revenue and, 80–82, 81t 114–15, 130 human development and, 58 governance indicators, 115, 116f inefficiencies, 82–83 ineffective allocation of oil investment targets, 79, 80t revenues, 118–19 obstacles to non-oil sector growth, 7 lack of transparency and, 115–16, oil pipeline, 172 121–22 oil revenue financing for, xix, 84 in procurement, 121 potential growth outcomes from sources of civil conflict, 115 investment in, 57, 58f strategies for overcoming, 122–23 private sector investments, 84–85, 85f tax revenue and, 133f as productivity factor, 57 Government securities market, 12 public investment effects on growth, 42 H public spending, 119 recent efforts to improve, 9–10 Harwick rule, 105 recommendations for public and Health sector private investment, 79–80, 80t, Chad’s, 176 81f, 84f, 85 Gabon’s, 210–11 regional comparison, 41f public spending, 119, 120 shortcomings of CEMAC countries, strategies for economic growth and xviii, 58–60 poverty reduction, xvii, 3, 9 strategies for improving, xviii, 9

See also Information and Mobile phone technology, 76–77 communications infrastructure; Monetary policy Power infrastructure and service; fiscal policy coordination, 19 Transport instruments, 18–19 Interest rates international reserves coverage, 18–19 capital scarcity and domestic objectives, 18 investment in CEMAC, 95–97, Monetary Policy Committee, 18–19 101–2f, 105 primary gap measure of fiscal N sustainability and, 29 International Monetary Fund, xx, 151 Natural Resources Charter, xx Cameroon policies and arrangements, Non-oil economy 164, 165 Chad’s, 178 Congo policies and arrangements, 190, challenges for CEMAC countries, xvii, 3 191, 192, 193 current infrastructure shortcomings, 7 in creation of fiscal space, 142, 149 determinants of growth in oil- Gabon policies and arrangements, 203, producing countries, 39 205, 206 disincentives to taxation of, in Iraq, 89 resource-rich states, xix, 126–27 domestic revenue generation from, K 127f, 128–29, 128f, 129f external current account balance and, 33 Kenya, 123 fiscal balance surveillance criteria, 20, 37 fiscal impulse and, 25, 27f L fiscal surveillance, 25–26 Gabon’s, 208, 208f, 212 Labor market public investment outcomes, xviii, 5–7 employment patterns in Africa and recent performance, 3–5, 5f, 7, 9f, 39, 41f CEMAC, 3, 4t recommendations for convergence shift to nontradable sector, 106–7 criteria, xviii strategies for economic growth and strategies for raising growth in, xvii, 9–10 poverty reduction, 3 strategies for strengthening domestic Legal system, financial sector deepening revenue collection from, 132–33 and, 12 taxation rationale, 125, 129–32 Life expectancy patterns, 4t O M Official development assistance, 125 Macroeconomic policy and performance infrastructure financing, 81 challenges for CEMAC countries, xvii Oil wealth management fiscal sustainability and, 17 absorptive capacity problems, 93, medium-term framework, xvii 97–98, 106–7, 108 projections, 92f accumulation in sovereign wealth fund, spending boom outcomes in oil-rich 93, 94–95, 98–99, 104–5 states, 116–18 bird-in-hand rule, 29, 30, 94, 95, Malaysia, xx, 156–60 104–5, 106 Microfinance, 12–13 case studies, xx–xxi. See also specific Millennium Development Goals, 3, country 14–15t, 55–56, 74, 171–72 CEMAC revenues, 3, 89, 90t, 111

challenges, 39, 55–56, 89–93, 91f Political functioning consideration of individual country in Cameroon, 159 characteristics, 105 capture of oil revenues, xix corruption risk, 131–32, 131f, 132f, in Chad, 171, 176–77 133f, 155 in Gabon, 197, 205–7, 206f dependence on oil revenue, 114–15 ineffective allocation of oil revenues, disincentives to taxation of non-oil 118–19 economy, xix, 126–29 in Republic of Congo, 184 domestic investment for economic in road freight shipping costs, 66 growth, xix, 93, 99–103, 107–8 See also Corruption; Government failure economic growth and, 91 Poverty reduction external current account balance, 33 in Chad, 175 failure to reduce poverty, xix challenges for CEMAC countries, xvii, fiscal cyclicality and, xx, 3, 19 3, 111 fiscal surveillance indicators, 25–26, failures in effective use of oil revenues 36–37 for, xix global patterns, 89 in Gabon, 197, 209–10 governance capacity for, 56 oil wealth management and, 111 governance failure outcomes, 111–12, patterns and trends, 113 114–21, 130, 131 recommendations for CEMAC government revenues and expenditures countries, 3 and, 116–18, 118f Power infrastructure and service ineffective allocation of public business environment and, 57 resources, xix, 118–19, 121 costs, 59, 67–68, 70–71, 70t, 72t infrastructure financing, 84 current performance, 67, 69t investing to invest, xix, 93, 103–5, 108 future challenges, 71–72 limitations of convergence criteria as grid, 68f fiscal indicator of, xviii, 21–23, 33 growth outcomes from public oil price patterns, 118f investment, 57 permanent-income hypothesis model, human development and, 58 xvii, xix, 5, 7, 94–95, 96f, 103–4, inefficiencies, 70–71, 71f, 82 105, 106 regional power trading, 72–74, 73f, 84 political use of, xix tariffs and subsidies, 68–70, 70f, 71b poverty rate and, 111 Primary gap measure of fiscal resource curse phenomenon, 39, 40, sustainability, 27–29 55, 91, 126 Private sector rules-based measures of fiscal access to credit, 11 sustainability, 29–32 Gabon’s, 209, 210f structural obstacles to effectiveness in, historical distrust of, in CEMAC, 40–42, 91. See also Government 113, 114 failure infrastructure funding, 81–82, 84–85, 85f tax revenue, 127f, 128f investment disincentives, 42 Open Budget Index, 115, 115f lending patterns, 12f non-oil growth outcomes of P investment from, 50, 52 productivity outcomes of infrastructure Paris Club, 206–7 quality, 57 Permanent-income hypothesis model, xvii, structural determinants of investment xix, 5, 7, 94–95, 96f, 103–4, 105, 106 efficiency and quality, 42

See also Business climate; Small and power trading, 72–74 medium enterprises trade barriers, xvii, 13, 14t Procurement systems, 121 trade patterns, 13, 13f Property registration and transfer, 12 Regulatory and prudential framework Public investment current shortcomings, 11 absorptive capacity problems, xix, 93, recent financial sector reforms, 10–11 97–98, 106–7, 108 strategies for improving economic efficient use of oil windfalls for economic growth—, xvii, 11 development, xix, 93, 99–103 Road freight shipping costs, 63, 65–66 for fiscal sustainability, 5 Rules-based measures of fiscal as growth determinant, 42 sustainability, 29–32, 30t, 31f, 31t ineffective use of oil revenues, xix, 118–19, 121–22 S medium-term expenditure framework, 122 Sanitation infrastructure, 58, 74–76, modeling of non-oil growth outcomes, 75f, 83–84 43–45, 46–52 Saving rate, 92–93 non-oil primary deficit and, 3–5, 5f Small and medium enterprises obstacles to effectiveness in, 40–42, access to credit, 11 50–51, 52, 97 in Gabon, 209 outcomes in CFA Zone oil-producing strategies for financial sector countries, xviii, 39, 52 deepening, 12–13 private investment and, 42 strategies for improving economic process, 98 growth—, xvii procyclical, xx, 145, 146, 147–50 Sovereign wealth fund, xix, 89, 93, rate of return, 5–7 94–95, 98–99, 104–5 recommendations for physical Sub-Saharan Africa infrastructure spending, xviii, 9 evidence of procyclical bias in fiscal spending booms in resource-rich states, policies, 143–50 116–18 non-oil growth, 7, 9f strategies for economic growth and revenue collection shortcomings in, 125 poverty reduction, xvii, xviii, 3, 7, 9 Surveillance, fiscal strengthening governance capacity comparison of indicators, 24–26, for, 122–23 24t, 26t transport infrastructure fiscal stance and fiscal impulse improvement, 60–63 measures, 23–26 Public Investment Management Index, indicators, 21 97–98, 103, 208–9 non-oil fiscal balances, 20 of oil-producing countries, 25–26 R rationale, xviii, 17, 19–20 strategies for improving, 36–37 Rail network, 66–67 sustainability assessment, 26–32 Regional Economic Program, 9–10 See also Convergence criteria Regional relations CEMAC objectives, 18, 36 T challenges for CEMAC countries, xvii financial stability initiatives, 10–11 Taxation government securities market, 12 accountability and transparency in, infrastructure development, 9–10 xix, 130

Cameroon’s oil sector, 161–62 projections, 89–91 convergence criteria for non-oil regional road freight network and, revenue, 129–30 63–65, 65f corruption and, xix, 131, 133f trends, 13, 13f current revenue sources, 126–29, 127f, Trade policy 128f, 129f challenges for CEMAC countries, xvii disincentives in resource-rich countries, common external tariffs, 13–14, 14t xix, 125–26 fiscal policy response to external freight tariffs, 63, 65 shocks, 35 Gabon’s oil revenue, 199 intraregional trade barriers, xvii, information technology for, 123 13, 14t in oil-rich states, 114, 126–29 regional power trading, 72–74 power tariffs and subsidies, 68–70, strategies for improving economic 70f, 71b growth—, xvii, 14 public scrutiny of public spending See also Trade patterns and, xix Transparency. See Accountability and rationale for nonresource-based, 125 transparency rationale for strengthening nonresource Transport base, 129–32 as business environment factor, 60 revenue collection shortcomings in costs, 59, 65–66 sub-Saharan Africa, 125 current infrastructure quality, 60, 61t, strategies for strengthening non-oil 62f, 63–65, 64t revenue collection, 132–33 funding for infrastructure strengthening governance capacity for improvement, 60–63, 63f oil wealth management, 122–23 port operations, 66 for transport infrastructure rail network, 66–67 improvement, 60–63, 63f regional corridors, 63–65 water tariffs and subsidies, 76 by river, 67 Trade patterns road traffic volumes, 60 determinants of fiscal policy cyclicality, 150 W Dutch disease, 40 intraregional, 13, 13f Water supply, 74, 75f, 76t, 83–84 oil exports from CEMAC countries, 3 West African Economic and Monetary partners, 13, 13f Union, 3, 7 port operations, 66 World Bank, 10