Public Information Notice No. 05/85

Public Information Notice: IMF Executive Board Concludes 2004 Article IV Consultation with Angola

July 6, 2005

On March 4, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with Angola.¹

Background

Since the end of violent conflict in April 2002, about 4 million displaced Angolans have returned to their communities, supported by a government-led initiative to provide emergency food aid and humanitarian assistance, involving UN agencies and other donors. Nevertheless, poverty remains widespread. Income is highly concentrated, and health and social indicators are poor, although prevalence rates for HIV/AIDS are lower than in most of southern Africa. The physical infrastructure has been largely destroyed. In addition, the legacy of civil conflict includes sizable short-term external debt, a large public sector payroll, and state institutions that hold dominant positions in critical areas of the economy with limited accountability.

GDP grew by 11 percent in 2004, following a slowdown in growth in 2003, largely reflecting the profile of oil production, which now accounts for half of GDP. The economy outside the extractive sector is currently estimated to be growing by about 9 percent. Despite extensive landmines and devastated infrastructure, which continue to restrict the availability of seed and fertilizer and impede marketing, agricultural production (largely by households) has recently begun to recover. The other principal identified sources of growth are construction and services.

Inflation has declined substantially, to a 12-month rate of 31 percent in December 2004, following a major change in macroeconomic policy implementation in September 2003, known as the "hard kwanza" policy, which has largely stabilized the nominal exchange rate. This has involved liberalization of the foreign exchange market, and active absorption of domestic liquidity by central bank sales of foreign currency, to support a tightening in monetary policy based on improvements in fiscal control and domestic debt sales. The growth rate of reserve money fell from 160 percent in the 12 months to September 2003 to 19 percent one year later.

Initial estimates indicate a substantial decline in the fiscal deficit between 2003 and 2004, reflecting the rise in oil prices, lower real spending on goods and services, and policies to reduce fuel subsidies, which raised gasoline prices to about US$1.50 per gallon by November 2004.

After a widening of the external current account deficit in 2003, caused in part by higher imports and services related to investments in the oil sector, Angola moved into significant surplus in 2004 as oil prices rose. Nevertheless, heavy gross external borrowing equivalent to 12 percent a year was undertaken by the public sector in 2003-04. A total of US$3.4 billion was raised from commercial banks in oil-backed loans and over US$0.5 billion was drawn from bilateral oil-backed credit lines. As a result, despite the substantial sales of foreign currency by the central bank, gross international reserves are estimated to have increased from US$0.4 billion at end-2002 to about US$2.2 billion at end-2004 (two months of imports), including an estimated US$660 million accumulated in foreign currency accounts managed by Sonangol on behalf of the government. Angola's external debt was estimated at US$9.5 billion at end-June 2004 (equivalent to about 49 percent of GDP) including late interest and arrears.

Important improvements have been made in the last two years in the fiscal accounts and the transparency of oil transactions. However, the independent oil diagnostic study published by the government in May 2004 indicated significant weakness in the governance of the oil sector, mainly reflecting continuing conflicts of interest as Sonangol, which acts as government concessionaire and regulator, is also a major operator in oil extraction and a provider of services to the industry. Sonangol's spending on behalf of the government also remains outside effective central government control and monitoring. The national diamond company Endiama also continues to act under conflicts of interest and, despite some reforms in the sector, transparency remains very limited.

Progress on structural reform and the implementation of policies to deal systematically with poverty reduction has been limited. The state continues to exercise a heavy influence in many sectors. Noncompetitive practices, privileged access, and costly bureaucratic procedures hamper the growth of the non-oil private sector and contribute to high margins in domestic prices. The privatization process appears to have stalled. The draft Poverty Reduction Strategy Paper (PRSP) distributed in December 2003 has not yet been finalized.

Angola's statistical system remains weak.

Executive Board Assessment

Executive Directors welcomed the restoration of peace in Angola starting in April 2002 and commended the authorities for successfully tackling the ambitious post-war humanitarian and resettlement program. Equally, Directors commended the authorities for the improvements in macroeconomic management since the peace agreement. Noting the sharp reduction in inflation over the past year, Directors observed that a decisive break appears to have been made from the previous record of large fiscal and quasi-fiscal deficits, money creation, and high inflation. They also welcomed the initial steps to improve transparency, including budget unification, the increased use of independent auditors, and strengthening of data collection.

Looking ahead, Directors observed that Angola has considerable medium-term potential but faces substantial challenges. Directors agreed that Angola will be in a strong position to achieve a high average income level and a sustainable fiscal and external position if it carefully husbands the wealth from its abundant natural resources and forcibly addresses the outstanding governance issues. In the short term, Angola will need to address the challenges that reflect the legacy of many years of civil war—widespread poverty and low human development indicators; a sizable short-term external debt; a large public payroll; poor infrastructure; and the need to strengthen the accountability of many state institutions.

Directors called for sustained progress in three priority areas to help Angola achieve its medium-term potential: macroeconomic management; transparency and governance; and structural reform. They noted, first, the importance of developing and implementing a macroeconomic framework directed at the achievement and maintenance of low inflation. This will require firm establishment of fiscal discipline, to orient fiscal policy to the medium term in the face of uncertain oil revenues. Second, Directors underscored that Angola should further strengthen transparency with regard to the management of its vast oil and other resources, as well as fiscal operations in general. Third, Directors emphasized the need for structural reform measures, focused on improving competition, to develop the non-oil private sector, including agriculture.

Directors welcomed the authorities' decision to formulate the 2005 budget on the basis of a conservative oil price, and their indications that any additional revenues from higher prices will be saved in the first instance in an oil reserve account. They urged the authorities to build on these principles and develop an explicit and formalized medium-term fiscal framework, which will promote fiscal discipline, provide a comprehensive strategy for judicious investment of oil revenues, and minimize the risk of procyclical spending as oil prices vary.

Directors supported the authorities' goal of increasing public spending on much-needed infrastructure and provision of social services. However, in light of the already high level of public spending, some Directors recommended that the authorities should prioritize reallocation from other spending, including from the large government payroll for administrative and military personnel. Directors welcomed the authorities' intention to eliminate fuel subsidies in Angola, noting that they are inefficient and regressive, and stressed the importance of accompanying such measures with appropriate protection for low-income households.

Directors highlighted the importance of further strengthening fiscal management, through effective budget planning, monitoring, and control. In particular, they called for the full and speedy operation of the SIGFE management information system, and the strengthening of administrative capacity, noting the technical assistance offered in these areas by the international community. More generally, Directors welcomed the authorities' intention to implement many of the recommendations for improving the budgetary process made in the World Bank's Public Expenditure Management and Financial Review, including the application of conventional budgetary arrangements to the remaining services provided by the national oil company, Sonangol.

Directors commended the authorities for their commitment to lowering inflation further in 2005-06. Nevertheless, and taking into consideration the current propitious fiscal climate resulting from high oil revenues, some Directors encouraged the authorities to adopt more explicitly ambitious inflation objectives in the short term. This will call for a flexibly managed money-based stabilization, underpinned by fiscal restraint. Policy will need to continue to pay due regard to the exchange rate, but most Directors advised against a formal exchange rate target, as this can entail substantial risks in the face of uncertain oil prices, uncertain fiscal control, and a low level of foreign exchange reserves.

Directors welcomed the slowing of monetary growth rates during 2004, secured in part by the termination of the central government's reliance on domestic finance. Most Directors advised, nonetheless, against further external commercial borrowing by the central government, particular in respect of oil-backed loans. Directors noted the continuation of large operating deficits of the central bank and urged the authorities to avoid further deficits. Several Directors recommended that the authorities consider recapitalizing and restructuring the central bank. To increase the effectiveness of monetary control, Directors suggested that the authorities continue to extend the range of domestic debt instruments. Directors also noted that both monetary and fiscal transparency and management will be improved by transferring all government holdings of foreign exchange to the central bank, within international reserves.

Directors welcomed the authorities' commitment to improving governance and transparency in resource management. They strongly encouraged the authorities to implement, as planned, the main recommendations of the oil diagnostic study, and to consider comparable measures in the diamond sector. Key steps in this regard include the transfer of Sonangol's functions as regulator and government concessionaire to other agencies, and establishing a government oil revenue management unit. In a similar vein, Directors observed the advantages of separating regulatory and licensing functions in the diamonds sector from Endiama's commercial operations. Directors welcomed the authorities' interest in participating in the Extractive Industry Transparency Initiative.

Directors observed that the envisaged improvements in resource management will facilitate greater fiscal transparency. It was also noted that the unification of the budget, the publication of oil revenue information, and the increased use of independent auditors have helped to establish a good basis for more reliable fiscal information. Directors were of the view that further progress in macroeconomic management will require building on these achievements to produce comprehensive and timely data, not only in the fiscal area, but also, under the General Data Dissemination System (GDDS), on the external accounts and the real economy.

Directors urged the authorities to take steps to create a liberalized and competitive climate in order to improve medium-term prospects for private sector investment and growth. Facilitating contract enforcement will be one key element. Directors also encouraged the government to formulate a systematic program to reduce bureaucratic costs and delays and promote effective competition in the private sector. They welcomed the recent elimination of export tariffs and reduction of import tariffs, which should help improve competitiveness, and suggested that the privatization process be accelerated.

Directors stressed that, despite the recent rapid economic expansion, poverty remains widespread in Angola. They considered that poverty reduction efforts will be greatly aided by a clearly-articulated and effective poverty reduction strategy, and looked forward to the completion of the PRSP in the coming months. Directors suggested that the PRSP be informed by a broad-based consultative process and include a medium-term expenditure framework carefully linked to the overall budget plans.

Directors noted that an agreement on a Fund staff-monitored program can help Angola establish a track record of performance, which can prepare the ground for future use of Fund resources and the provision of donor financial assistance, including debt rescheduling.