WP 98-04 May 1998 Working Paper Department of Agricultural, Resource, and Managerial Economics Cornell University, Ithaca, New York 14853-7801 USA ANGOLA: CURRENT SITUATION AND FUTURE PROSPECTS FOR THE MACROECONOMY Steven Kyle • ABSTRACT In spite of the improvement since 1992-1994, the economy of Angola remains far below levels achieved prior to independence with the exception of the oil sector, which has provided a huge foreign exchange windfall to the government amounting to about $2 billion per year. Periodic bouts of hyperinflation have contributed to the retreat of many from the money economy, particularly in rural areas, where many peasants have reverted to subsistence production and barter, and many others are newly resettled on lands they fled during the worst of the conflict. Many others remain in periurban areas, living on the fringes of the formal economy. © Steven Kyle, 1998 It is the Policy of Cornell University actively to support equality of educational and employment opportunity. No person shall be denied admission to any educational program or activity or be denied employment on the basis of any legally prohibited discrimination involving, but not limited to, such factors as race, color, creed, religion, national or ethnic origin. sex, age or , handicap. The University is committed to the maintenance of affirmative action programs which will assure the continuation of such equality of opportunity. l ." L Angola Current Situation and Future Prospects for the Macroeconomy April 1998 I. Introduction Angola's independence in 1975 after more than four hundred years of Portuguese rule was followed almost immediately by civil war, which reached unprecedented levels of death and destruction following UN sponsored elections in 1992. Angola's economy remains severely affected by the long war and the destruction resulting from it. However, it has begun the process of reactivation ofproduction now that hostilities have ceased and transport and communication routes have been reopened in many areas. While any economic data must be treated with caution, it is clear that there has been some improvement since the signing ofthe Lusaka Accord, though there continue to be severe problems with alternating cycles of inflation and control. In spite ofthe improvement since 1992-1994, the economy remains far below levels achieved prior to independence with the exception of the oil sector, which has provided a huge foreign exchange windfall to the government amounting to about $2 billion/year. Periodic bouts of hyperinflation have contributed to the retreat ofmany from the money economy, particularly in rural areas, where many peasants have reverted to subsistence production and barter, and many others are newly resettled on lands they fled during the worst ofthe conflict. Many others remain in periurban areas, living on the fringes ofthe formal economy. The massive inflow of oil receipts (amounting to more than half of GDP) has caused distortions typical of oil exporting economies, and commonly known as "Dutch Disease". This refers to the problems of exchange rate overvaluation and relative price distortions that result in • strong urban bias and stagnation of non-oil exports and import competing sectors. Diamonds constitute an additional factor exacerbating the already strong effects from oil. The activities most 2 adversely affected are those most exposed to comptetition from abroad, in this case, agriculture and light manufacturing and agro-processing sectors which have been virtually 100% replaced by imports in the large urban markets on the coast. Prior to independence Angola was the world's fourth largest coffee exporter and also exported more than 400,000 MT ofmaize a year. Exports of both of these crops are now near zero. The enclave nature of oil production is especially pronounced in Angola, where oil literally never touches the territory ofthe country apart from the Province ofCabinda which is separated from the bulk of the country by Congo. Offshore production is increasing with additional exploration continuing in order to expand output substantially over the next few years. (Production is expected to expand from a current level of approximately 750,000 barrels/day to 1 million barrels/day) Virtually all inputs used in production are imported by the concessionaires, including the majority ofoil company workers. The production enclave is matched by a consumption enclave in that oil receipts are used primarily to service foreign debt and to support the government budget which is expended mainly on defense, debt service and maintenance of the central government apparatus in Luanda. The resulting boom in spending has resulted in a higWy inflationary economy in Luanda in which many ofthe traditional links to productive areas in the interior have been broken. In effect, Angola has two economies, one reliant on imports at the official exchange rate financed by oil receipts, while the bulk ofthe population lives in an economy operating at parallel market prices, divorced from the official economy. In spite ofthe fact that most ofthe windfall has been spent on imports, and so has not directly affected the real exchange rate, enough of the additional demand has fallen on non­ traded sectors to create a chronic problem of overvaluation, which has proven particularly hard to deal with given the difficulties in reestablishing domestic productive capacity. Government expenditures have exceeded oil receipts, due both to large military expenditures .. necessitated by the war and more recently by the military expeditions sent to support factions in the conflicts in the two Congos, and the need to make payments on the external debt, which stood at 3 approximately $11 billion by the end of 1996. At present, oil production is almost entirely devoted to debt service, though there are new fields scheduled to enter into production in the near future. This will avoid a crisis in the near term by allowing financing gaps to be covered, but will merely postpone the inevitable adjustment to a later date at which time the gaps will be larger, the imbalances more severe, and the debt larger. The government enunciated a reform program in July 1995 designed to stabilize prices and achieve external balance, recognizing that the severe imbalances and distortions afflicting the economy were serious impediments to development and growth. In support of this program, the Government entered into discussions with the IMF in order to start the process leading eventually to a Fund approved ESAF together with structural adjustment lending by the World Bank. Unfortunately, it has proven more difficult than anticipated to adhere to the targets set by the Government in the Round Table document, and subsequent discussions with the Fund have proved unsuccessful. The failure ofthe stabilization program initiated in 1996, and the ensuing reemergence ofthe inflationary spiral of the preceding period underscored the need for a serious stabilization program. The program that was implemented (see below) has succeeded in containing inflation for some months at a time, but has gradually eroded as control measures have been unable to contain inflationary pressures. Failure to devalue the currency in line with rising prices has resulted in parallel market spreads over the official exchange rate of more than 70%. At the present time, the overall result of the program has been a reduction in open inflation, but at the cost of increased control and stagnation, and paralysis of many government functions. It is clear that the primary cause of the instability is the continuing deficit of the central government. The absence of unified budgeting and accounting procedures make it difficult to accurately assess the true size of the fiscal deficit, but it was approximately 24% of GDP in 1995, • and continued to remain highly in deficit last year in 1996 and then again in 1997, when the deficit .. amounted to 20% of GDP according to preliminary figures. 4 II. The Current Situation At the present time, Angola is in an unsustainable macroeconomic situation. After abandoning the liberalization program in June of 1996, the government retreated to what for Angola is by now the traditional situation of increased government control. However, this control has not, for the most part, been extended to prices themselves (apart from a few basic staple commodities) but has been based on stopgap measures designed to repress inflation in the short run. Faced with inflation approaching annual rates of 10,000% in June of 1996, largely due to uncontrolled government expenditures financed by money creation, the government took various measures to control the situation. Among these were: - Slowdown and then cessation of disbursements by the government, including payments to civil servants, including government functionaries, police and others, resulting in a huge decrease in money creation to fund these expenses. While this measure by itself succeeded in controlling inflation, it was obviously not sustainable since workers eventually have to be paid, or they will stop working. In fact, the government has paid up arrears periodically (generally from 4-6 months late) resulting in renewed bursts of inflation, most recently last December when the monthly rate topped 12%. - Reimposition of import licensing requirements. - Imposition ofcontrols on wholesale and retail margins - Reimposition of prior licensing requirements for purchase of large sums of foreign exchange. While there is no set rule for what amounts require prior permission, it is possible for individuals - to obtain amounts sufficient to pay for short trips abroad but attempts to purchase amounts as 5 $100,000 or more take a minimum of several weeks to be approved, if in fact the applications are not rejected. This policy has had the effect of strangling businesses which rely on imported inputs or which depend on ease of currency conversion. - Periodic sales offoreign exchange into the domestic economy, though this policy appears to have been abandoned early in 1997. Foreign exchange is now sold weekly to those chosen by the Central Bank (see below).