Public Information Notice No. 05/158

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with the Central African Republic

November 29, 2005

On October 24, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Central African Republic.¹

Background

The Central African Republic has seen its economic and social conditions deteriorate seriously over the past decade due in part to poor economic management but also political and military disturbances that culminated in the March 2003 conflict. The country's physical and human capital suffered, its formal sector contracted significantly, and the production of cash crops almost ceased. Due to continued insecurity in rural areas and caution on the part of investors associated with the political transition, economic activity has yet to show signs of recovery from the sharp contraction associated with the 2003 conflict. Real GDP grew by 1 percent in 2004 as activity was stagnant in most sectors. While diamond production increased, activity in the forestry sector contracted due to heavy rainfall. The recent heavy rainfall in the capital Bangui caused some population displacement, although its impact on overall economic activity appears limited.

Price developments in the C.A.R. have by and large reflected food supply conditions. The average price level declined by about 2 percent in 2004 as stability returned to the agricultural sector, but has picked up moderately so far in 2005 in line with food prices.

Credit to the economy increased in 2004 reflecting a pick up in both private sector credit and net credit to government. The increase in private sector credit, largely associated with petroleum imports and several large loans in the forestry sector late in the year, has partly receded in 2005.

The external trade balance worsened in 2004 due to a terms of trade deterioration, a decline in timber exports, and a higher demand for petroleum product imports linked to election activities. The increase in donor support for carrying out the elections along with improvement in the services balance more than offset the deterioration in the trade balance. As a result, the current account deficit declined by ½ of one percent of GDP to 4⅓ percent of GDP. The C.A.R. is still not servicing its external debt except to the IMF and therefore external payment arrears continue to accumulate to both bilateral and multilateral creditors. The stock of external arrears at end-2004 is estimated at US$335 million (about 25 percent of GDP).

Serious weaknesses in public finances remain, and the large gap between expenditures and revenue continues to weigh heavily on the ability of the government to honor its current obligations and provide basic public services. While revenue increased in 2004, at around 8 percent of GDP it is still very low relative to other low-income African countries. Weaknesses in tax and customs administration, rooted partly in corruption, continue to hamper efforts to improve revenue performance. There has been a serious loss of control on expenditure, in particular over the wage bill, which has exacerbated the already difficult fiscal position. Although salaries have been frozen since 1985, the wage bill continues to increase because of the rapid expansion of allowances and benefits, the creation of high-level posts carrying salary premiums, and new recruitment paired with delays in retirements. The untenable fiscal position is reflected in the large build up of domestic payment arrears, including three months of new salary arrears accumulated so far in 2005.

Developments in the banking sector continue to be dominated by the government's heavy reliance on commercial banks' resources. Reflecting the difficult liquidity position of the banks, the regional central bank's (BEAC) temporary suspension of reserves requirements for C.A.R. banks remains in effect.

Social conditions in the country have worsened as a result of the political and military developments that led to the 2003 conflict. The C.A.R. has lost ground in terms of meeting the Millennium Development Goals. Health indicators, in particular, have deteriorated, with the incidence of HIV/AIDS rising, and life expectancy over the past decade declining by an average of six months every year.

Significant achievements have been made on the security front and in ensuring a smooth transition to democratic rule. The presidential and legislative elections were conducted peacefully and were generally free. The security situation has improved with the support of several hundred troops from the C.A.R.'s international partners. In addition to the ongoing efforts to train and better equip the armed forces, progress is being made in the implementation of the Disarmament, Demobilization, and Reintegration program. However, banditry remains a problem in rural areas.

Executive Board Assessment

Executive Directors commended the authorities of the Central African Republic for the recent peaceful completion of parliamentary and presidential elections and the continued improvement in the security situation. Directors believed that these positive developments bode well for reinforcing stability in the country and for deepening the economic reform program in the period ahead. They considered that the main challenges facing the country include further consolidating peace and security, establishing the conditions for strong economic growth, and reversing the deteriorating social conditions. Directors emphasized that this will require stabilizing public finances, more effectively delivering public services, and establishing an environment conducive to private sector activity.

Directors agreed that timely international assistance, including effective technical assistance, more support for social sectors, and substantial infrastructure investment, will have an important role to play in supporting the recovery. They emphasized that to be effective, this assistance should complement the authorities' own efforts. To this end, Directors urged the authorities to implement sound policies and improve the management of public resources, including by addressing recent policy slippages, particularly in the public finance area. Determined action by the authorities will send a strong signal to the international community of the authorities' ability to implement reforms, and should pave the way for greater international support, including further Emergency Post-Conflict Assistance from the Fund. Directors accordingly welcomed the authorities' recognition of the difficult challenges ahead, and their efforts to build consensus among the major stakeholders for the reform process.

Directors expressed concern about the persistence of severe weaknesses in the country's public finances, as manifested in the low level of government revenue, the difficulty in controlling expenditure, and the accumulation of domestic and external payment arrears. With monetary and exchange rate policy conducted at the regional level, sound fiscal policies will be critical for achieving macroeconomic stability. Directors accordingly called for urgent fiscal consolidation based on decisive actions both to contain expenditure and to boost revenues. These actions will be crucial for generating much-needed resources for social spending and public services.

Directors urged the authorities to move swiftly to bring the public sector wage bill under control, as containing the wage bill and paying salaries in a timely manner will be critical for establishing and maintaining financial stability. While acknowledging that this will be challenging in the context of a still fragile political environment, Directors encouraged the authorities to give serious consideration to staff proposals to reduce allowances, accelerate retirements, and introduce cuts in some high salary bands, while initiating a cleanup of the payroll files. Directors also encouraged the authorities to improve public expenditure management, including by strengthening expenditure procedures and monitoring. In this regard, they welcomed the recent introduction of the monthly treasury cash flow plan and improved identification of spending at the commitment level.

Directors expressed concern that the level of government revenue remains far below the needs of the country. They urged the authorities to strengthen tax collection and improve the customs and tax administration, in order to reduce corruption and enhance the ability of tax agencies to function effectively. Directors also saw an urgent need to widen the tax base by reducing exemptions, improving controls, and fighting fraudulent practices in the customs area—in line with the recommendations of the Fund's technical assistance.

Directors underscored their concern at the magnitude of the domestic arrears problem. They urged the authorities to put in place a realistic strategy for clearing the arrears, and noted the authorities' commitment to do so by early 2006. At the same time, Directors underscored the importance of timely payment of current obligations to avoid the further accumulation of arrears.

Directors observed that the regional monetary and exchange rate arrangement has provided a useful policy anchor in a difficult macroeconomic environment, and has helped keep inflation low. They encouraged the authorities to be vigilant in supervising commercial banks' compliance with prudential regulations and to act vigorously to find a lasting solution to the one problem bank having difficulty meeting prudential ratios. Directors called on the authorities to work with their partners to strengthen the microfinance sector with a view to broadening access to financial services.

Directors underscored the importance of improving the competitiveness of the C.A.R. economy. This will require rebuilding the infrastructure, enhancing security, and advancing on structural reforms. Improved infrastructure—especially for land and river transport—and better security in rural areas will be instrumental in reducing costs faced by agricultural producers and exporters. Directors also stressed the importance of flexibility in factor and product markets. Additional steps to strengthen the judiciary and improve property rights and contract enforcement should also contribute to reducing the cost of doing business in the C.A.R. and enhancing competitiveness.

Directors stressed that governance problems are at the heart of the weak management of public resources and the poor climate for private sector activity. While noting the need for international assistance in this area, Directors urged the authorities to demonstrate strong commitment in the fight against corruption. To this end, they encouraged them to equip the newly created unit within the Ministry of Justice adequately so that it can pursue corruption cases effectively. In addition, Directors welcomed the authorities' efforts to continue to enhance transparency, and emphasized the importance of widening these efforts, including in the areas of public expenditure and natural resources.

Directors noted that the C.A.R.'s debt situation is unsustainable. They urged the authorities to establish the necessary good track record of policy performance to be eligible for debt relief under the HIPC Initiative. Directors also encouraged the authorities to remain in close contact with their external creditors to work toward a plan to clear arrears. The importance of steps to improve the C.A.R.'s debt data was also noted.

Directors expressed concern about the C.A.R.'s very poor social indicators, and called for a concerted effort, in partnership with donors, to improve the delivery of social services. They also encouraged the authorities to continue making progress on the preparation of their PRSP.

Directors noted the vast technical assistance needs of the C.A.R. They welcomed the technical assistance provided by the Fund and strongly encouraged the international community to accelerate and better coordinate its support to the C.A.R. In the period ahead, priority should be accorded to improving public expenditure management, strengthening tax and customs administration, and upgrading the statistical database to enhance surveillance as well as program design and monitoring in the period ahead.