Public Information Notice No. 02/104

Corrected Public Information Notice: IMF Concludes 2002 Article IV Consultation with Rwanda

September 20, 2002

On July 24, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Rwanda.¹

Background

Since the end of the war and genocide in 1994, Rwanda has made substantial progress in rebuilding the country's economic and social infrastructure, despite institutional capacity constraints. After the immediate post-conflict recovery period, Rwanda's economic performance has remained strong. Real GDP grew 6.7 percent in 2001, as favorable weather conditions stimulated agricultural output and external transfers, equivalent to 11.5 percent of GDP, spurred manufacturing, construction, and transportation and communication activities. The current account deficit (excluding grants) in 2001—at 16.4 percent of GDP roughly unchanged from 2002—was financed by continuing large external aid inflows. Consumer price inflation declined to 3.4 percent in 2001 from 3.9 percent in 2000, helped by the favorable impact of increased food supply on prices for agricultural products. Broad money growth in 2001, at 10 percent, was largely fueled by foreign currency inflows. Helped by larger-than-anticipated foreign aid inflows, the National Bank of Rwanda (NBR) increased its level of gross reserves to cover 5.7 months of imports of goods and nonfactor services.

The fiscal performance in 2001 was encouraging. With stepped-up efforts in revenue collection, the revenue-to-GDP ratio rose to 11.4 percent in 2001 from 9.7 percent in 2000. Reflecting a lower-than-envisaged implementation rate of foreign-financed capital projects, the deficit was limited to 9.5 percent (excluding grants), nearly one percentage point lower than targeted.

The government initiated a number of structural reforms in 2001. Among major achievements were the development of a system for the monitoring of poverty-reducing spending, the introduction of a value-added tax, the start of weekly foreign exchange auctions of the NBR, and the strengthening of the Office of the Auditor General. However, partly due to capacity constraints, some actions remain to be taken.

In 2002, the government will limit the overall fiscal deficit to below 9.9 percent of GDP. Programmed spending includes outlays for demobilization and reintegration of army soldiers and ex-combatants, stepped-up efforts at fiscal decentralization, and jurisdiction of genocide-related trials. In order to accommodate these exceptional expenditures, revenue measures—including an increase in the value-added tax rate to 18 percent from 15, and a harmonization of the customs tariff structure to proposals for a common external tariff under the Common Market for Eastern and Southern Africa (COMESA)—are being implemented. At the same time, the corporate income tax is being reduced in an effort to harmonize the tax system with neighboring countries.

Rwanda's medium-term macroeconomic strategy is to gradually reduce the fiscal and current account deficits, and to arrest the deterioration of the debt sustainability indicators. While increasing macroeconomic stability, these policies are expected to also improve private sector confidence, which will be critical to improving economic growth and reducing poverty. For 2003 and 2004, the government plans to limit the fiscal deficit to 9.4 and 8.0 percent of GDP, respectively. During this period, expenditure in priority areas will continue to grow substantially, while growth in other spending will be moderated. Revenue measures, such as the introduction of an excise tax on cars and a reform of the personal income tax, will accompany the package. The external current account deficit is projected to decline to 13.6 percent of GDP by 2004.

Rwanda's economic program also contains a comprehensive structural reform agenda, including substantial improvements in the administration of public finances, the promotion of governmental transparency and accountability, and the strengthening of the financial sector and its supervision.

Rwanda's program is backed by its first full Poverty Reduction Strategy Paper (PRSP), issued in June 2002, which builds on a broad-based consultative process. In the PRSP, Rwanda lays out in detail its strategy for substantially reducing poverty. Rwanda can reach the completion point under the enhanced HIPC Initiative in 2003.

Executive Board Assessment

Executive Directors commended the authorities' progress, over the past year, in laying the foundations for robust growth and poverty reduction under difficult conditions. Directors cited in this connection the major reintegration effort, the safety nets for survivors of the 1994 genocide, the elections for local government, work on a new constitution, and the training of judges.

Directors stressed, equally, that sustained growth and enduring poverty reduction depend crucially on a just and durable security settlement in Rwanda and more widely in the Great Lakes region. Only in that setting can critically-needed advances in regional economic integration be realized, and domestic resources in Rwanda be freed for productive use. Directors therefore urged the authorities to pursue peace relentlessly. This would be crucial also, in parallel with strong policy performance, to catalyze investor and donor support and assure the financing of Rwanda's program.

Directors laid particular emphasis on the need for fiscal transparency, including on defense expenditures. They urged prompt action to establish effective expenditure tracking and financial reporting systems, to be developed with direct World Bank engagement, so that the demobilization and reintegration program would be subject to adequate monitoring and accounting systems.

Directors noted that the progress achieved by the authorities over the past three years has taken place in a setting of macroeconomic stability, and a progressive strengthening in administrative capacity, under the PRGF programs. They viewed performance in 2001 as broadly encouraging, with growth strong, inflation moderate—partly due to climatic conditions—and an above-target rise in official reserves. Progress has been made with structural reforms—such as the revised fees for public services; improved performance at the Rwanda Revenue Authority (RRA); the auditing of public accounts transactions and of key ministries, as well as a strengthening of the Office of the Auditor-General; a new civil service structure and code; and strengthening of the national tender board. Taken together, these measures lay a strong basis for moving forward.

Most Directors welcomed the authorities' program for 2002-03 as underpinning the growth and poverty reduction goals of the PRSP. A number of Directors, however, expressed strong reservations as to whether the preconditions for a sustainable program were yet in place—referring notably to risks arising from the security situation, and Rwanda's implementation capacity.

Directors stressed that macroeconomic stability is crucial for the attainment of sustained growth and poverty reduction. A prudent fiscal stance is thus essential, to avoid a deterioration in debt sustainability indicators beyond the projected levels. In this connection, most Directors were encouraged by the limited rise in the deficit on domestic fiscal operations projected in 2002, and the commitment to reverse this from 2003 onward.

Directors viewed success in the revenue effort under the program as critical—in this key phase of nation-building—to secure financing consistent with continued stability. Recent increases in the VAT rate to the regional average, and the adjustment of tariff rates in line with preliminary COMESA proposals, were seen as contributing substantially to meeting revenue targets, although further improvements to the capacity of the RRA remain essential.

Directors praised the authorities' expenditure program, which encompasses fully the priority actions needed for social, political, and economic transformation. In this regard, they pointed to constitutional reform, government decentralization, and the strengthening of governance as bold steps toward a sustainable and efficient foundation for the economy. Spending on local (gacaca) courts and on demobilization and reintegration, as well as assistance to genocide victims, support critical poverty reduction goals in the PRSP, Directors noted. They laid particular emphasis on the importance of reducing unproductive expenditure. Some Directors questioned whether, in present circumstances, the authorities would be in a position to fully implement these expenditure plans.

Directors stressed the need to continue strengthening public financial administration—which is crucial for the appropriate and efficient use of resources in support of program goals. They commended new eligibility guidelines for domestic liability claims, improved processes for establishing and monitoring government bank accounts, and the incorporation of off-budget accounts. They noted also the importance of continued reinforcement of the Office of the Auditor-General, publication of audit reports and data on government financial operations, and inclusion of the demobilization and reintegration accounts for 2002 in the program of the Auditor-General's Office.

Directors considered that the current floating exchange rate regime continues to serve Rwanda well. They welcomed the authorities' continuing commitment to establishing low inflation as a norm. Directors urged the National Bank of Rwanda (NBR) to monitor closely liquidity developments, and to tighten policy aggressively when needed.

Noting Rwanda's extremely narrow export base, continued dependence on external financing, and vulnerability to external shocks, Directors stressed that capital inflows and shifts in relative prices must not be allowed to undermine market incentives for productive activities and diversification of the economy. Directors also urged the authorities to strengthen their debt management system. Several Directors stressed concerns about the lengthy period over which Rwanda's debt ratios are projected to decline to sustainable levels, and some emphasized that the international community must continue to provide adequate financial assistance.

Directors expressed concern about the precarious health of the banking sector and urged prompt action to deal with underlying issues. They called for a timely action plan, in consultation with World Bank and Fund staff, to address problems in a commercial bank now under provisional control of the NBR — to safeguard assets and limit the potential fiscal burden. They welcomed the authorities' interest in participating in the FSAP program.

Directors encouraged resolute movement forward with measures to combat money laundering and financing for terrorism. They welcomed the authorities' commitment to develop, with the assistance of anti-money laundering experts, a road map setting out required technical assistance and major milestones.

Directors noted that Rwanda's macroeconomic statistics suffer from many weaknesses, especially in the areas of national accounts, government finance, and balance of payments. While recognizing that some initial steps to address identified issues had been taken, they stated that further strengthening remains a priority and advised the authorities to take advantage of available technical assistance, including from the Fund, in the effort.