AID AND REFORM THE CASE OF THE DEMOCRATIC REPUBLIC OF CONGO Public Disclosure Authorized TABLE OF CONTENTS Page Abstract 2 Introduction 3 Part One: Economic Policy and Performance 3 The chaotic years following independence 3 The early Mobutu years 4 Public Disclosure Authorized The shocks of 1973-75 4 The recession years and early attempts at reform 5 The 1983 reform 5 Renewed fiscal laxity 5 The promise of structural reforms 6 The last attempt 7 Part Two: Aid and Reform 9 Financial flows and reform 9 Adequacy of the reform agenda 10 Public resource management 12 Public Disclosure Authorized The political dimension of reform 13 Conclusion 14 This paper is a contribution to the research project initiated by the Development Research Group of the World Bank on Aid and Reform in Africa. The objective of the study is to arrive at a better understanding of the causes of policy reforms and the foreign aid-reform link. The study is to focus on the real causes of reform and if and how aid in practice has encouraged, generated, influenced, supported or retarded reforms. A series of country case studies were launched to achieve the objective of the research project. The Democratic Republic of Congo (DRC) was selected among nine other countries in Africa. The case study has been conducted by a team of two researchers, including Public Disclosure Authorized Gilbert Kiakwama, who was Congo’s Minister of Finance in 1983-85, and Jerome Chevallier. AID AND REFORM The case of the Democratic Republic of Congo ABSTRACT. i) During its first years of independence, the Democratic Republic of the Congo plunged into anarchy and became a hot spot in the cold war between the Soviet Union and the West. In 1965, President Mobutu took power in a bloodless coup supported by western governments. A stabilization plan was prepared in 1967 with the help of the IMF. With favorable terms of trade, restoration of private sector confidence, and sound macroeconomic management, the country (renamed Zaire) enjoyed a few years of solid growth. Four shocks, two external (oil prices increase in 1973-74 and copper price decline in 1975), and two self-administered (“Zairianization” of all economic activities in 1973 and heavy debt financing of non viable projects in 1973-74) led to a period of steady decline and arrears accumulation. ii) After several unsuccessful attempts at financial stabilization, Zaire implemented a comprehensive and far-reaching reform program in 1983-85. The economy recovered. It is unfortunate, however, that during this period the international community did not find ways to help Zaire address its heavy debt burden. Fiscal discipline in the face of negative net transfers in favor of bilateral lenders became increasingly difficult to justify. In 1986 the reform program stalled. Fiscal management further deteriorated in 1987 and 1988, despite strong support from the international community. A last attempt at reform was made in 1989. It was a short-lived one, however, and the World Bank decided to discontinue support to adjustment in early 1990. Lack of control over public expenditure led the country into hyperinflation. iii) While the responsibility for the failure of the Democratic Republic of the Congo as a state lies squarely with the political elite under President Mobutu, which ruled the country until 1997, it is clear also that the interaction with the international donor community has not been as helpful as it could have been. The major donors were also the major creditors. By financing non viable projects under commercial credit conditions in the early 1970s, and not providing appropriate debt relief ten years later when the country was in the process of reforming, they contributed to making adjustment difficult to sustain. Aid and Reform: The case of the Democratic Republic of Congo 3 INTRODUCTION 1. This study is in two parts. The first part presents the economic performance of DRC and the reform programs from independence in 1960 to the end of the Mobutu era in 1997. The second discusses some key issues in the interaction between the donor community and the attempts at reform in DRC. PART ONE: ECONOMIC POLICY AND PERFORMANCE 2. The chaotic years following independence. Independence of the Congo in June 1960 was followed by a long period of political instability and civil strife. The country was ill prepared for independence, with only a handful of university graduates available. Together with Cuba and Vietnam, Congo had the dubious privilege of being a hot spot in the conflict between the Soviet Union and the West during the Cold War. Its vast resources, particularly in the mining sector, its huge size and its strategic location at the center of the continent made it a coveted prize in the east-west conflict. 3. The central instruments of a seemingly all-powerful colonial state decomposed rapidly. Anarchy prevailed after the breakdown of authority in 1960-61. Provincial fragmentation in 1962-63 led to armed rebellions in 1964-65. The economic toll of the first five years of independence was high. While mineral production, the mainstay of the economy, remained stable (copper production in 1965 stood at 282 thousands tons, compared to 282 thousands tons in 1959), commercial agriculture and the transportation network suffered from the pervasive lack of security. Their output was reduced by about one third. Inflation, fueled by monetary financing of the budget deficit, soared to an annual average of 31 percent during the five-year period. 4. The early Mobutu years. On November 24, 1965, with the support of Western governments, Mobutu seized power in a bloodless coup. A new Constitution was enacted in 1967 and the name of the country was subsequently changed to Zaire to make a symbolic break with the recent past (in this note Zaire will be used, as the country was known during the Mobutu years, which lasted until 1997). A stabilization program prepared by the Central Bank with support from the IMF was announced in June 1967. It included a 300 percent devaluation and the replacement of the Congo franc by the Zaire, the elimination of the dual exchange rate, a steep increase in export and import tariffs, the removal of import licensing, and the freeing of profit remittances. The stabilization plan was a success. The inflation rate declined rapidly to 2.5 percent in 1968, and economic growth resumed. The 1967-74 period was a favorable one for the economy, with steady growth supported by strong private investment and favorable terms of trade. 5. A generous investment code was enacted in 1969, offering exemption from import duties on capital equipment and a five-year corporate and real estate tax holiday. It triggered a strong wave of private investment, mostly in import substitution industries, including two vehicle assembly plants, a tire factory and a flour mill. These industries relied heavily on imported inputs and protection from competing imports. Aid and Reform: The case of the Democratic Republic of Congo 4 6. The shocks of 1973-75. Two external shocks and two self-administered ones brought this period of economic expansion to an end. As an oil-importing country, Zaire suffered from the 1973-74 oil shock. To make things worse, in 1975 the price of copper, its main export, fell dramatically, resulting in a 40 percent decline in its terms of trade. The self-administered shocks included the contracting of a large debt on commercial terms for the financing of non-viable projects in 1972-73, and the government decision in late 1973 to transfer all economic activities to Zairian nationals. This policy was a major blunder. It sapped private sector confidence. Its consequences were catastrophic, and by late 1975-early 1976 the Government had to abandon it in stages. 7. In 1972 the Government launched two large projects, with an estimated cost of about US$250 million each, to make use of cheap energy produced at Inga, a site with a huge hydro-electric potential on the Zaire river west of Kinshasa. A steel mill was built with Italian financing, but never operated at more than 10 percent of its capacity. The other project was the construction of the Inga-Shaba power line, partly financed by the Export-Import Bank of the USA. The objective of the project was to supply power from the Inga dam to the mining industry in Shaba, 1800 km. away. Cheaper alternatives were available locally, but the project was launched for purely political purposes, as a means for the central authorities to keep control over the secession-prone province. Implementation of the project took much longer than expected, and its final cost escalated to an estimated US$1.5 billion. For the following two decades, the debt for the Inga- Shaba project has remained by far the largest part of Zaire’s debt burden. 8. The recession years and early attempts at reform. By 1975, Zaire was unable to service its debt. A prolonged period of economic decline ensued. It was aggravated in 1977 and 1978 by rebel incursions in the Shaba region. Between 1975 and 1978, GDP declined at an annual average rate of 3.5 percent. The inflation rate reached on average 57 percent during this period. In 1978, the external current account deficit was the equivalent of 16 percent of GDP. Arrears on the external debt accumulated to US$1.2 billion at the end of 1978. With the objective of correcting growing imbalances, the Government reinforced a number of controls across the economy. Most prices, including interest rates, were administratively set, the trade regime became highly restrictive, and the allocation of scarce foreign exchange was under the tight control of the Central Bank.