Public Information Notice No. 06/07

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Guinea

January 27, 2006

On December 23, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guinea.¹

Background

Guinea's economic performance deteriorated in recent years, largely as a result of a weak policy framework and against a background of mounting regional insecurity and low prices for its main commodity exports. Having averaged 4.7 percent in the late 1990s, economic growth since 2000 has slowed to an average of about 2.5 percent, inflation accelerated to almost 30 percent, international reserves fell to less than one month of imports, and the external public debt rose to almost 100 percent of GDP and is unsustainable.

Real GDP growth is expected to recover moderately in 2005 but little progress is expected in reducing inflation. The modest improvement in output growth to 3 percent reflects a rebound in agricultural activity as well as stronger growth in the construction and mining sectors. Inflation, while edging down, is expected to be nearly 28 percent at end-2005, well above the government's objective of less than 19 percent. Gross international reserves are expected to edge up from 0.8 to 1.3 months of import cover during 2005.

The improvement in economic performance in 2005 followed the tightening of fiscal and monetary policy early in the year and the implementation of the first steps to unify and liberalize the foreign exchange market. Reflecting a significant contraction of expenditures, the overall fiscal deficit (excluding grants) came down from 6 percent of GDP in 2004 to 0.2 percent of GDP by June 2005. As a result, net central bank credit to the government increased by just over 1 percent of reserve money in the first half of 2005, compared with 10 percent of reserve money in the same period of 2004. At the same time, the recent nominal depreciation of the Guinean franc, amounting to about 38 percent since end-February 2005, has brought the real exchange rate close to its underlying equilibrium rate.

The authorities are taking steps to enhance the business environment for the private sector, by implementing structural reforms, improving investment conditions in the mining sector, and strengthening governance and the judicial system. On the structural front, they have adopted plans to improve the quality and availability of electricity and water services, and are carrying out a program of privatization of government assets (including a substantial reduction of the government's stake in the largest commercial bank).

In support of the authorities' efforts, IMF management approved a staff-monitored program (SMP) covering April 2005-March 2006. The SMP aims to restore macroeconomic stability and, through structural reform, to lay the basis for renewed growth, debt sustainability, and poverty reduction. Guinea met all end-June and end-September indicative quantitative targets and structural benchmarks under the SMP, except for the end-June accumulation of central bank net foreign assets and the introduction of a new multiple currency practice.

Executive Board Assessment

Executive Directors welcomed the commitment of the new economic team—which took charge in late 2004—to implementing prudent economic policies and advancing structural reforms in order to address Guinea's macroeconomic imbalances, boost economic growth, and fight the pervasive poverty. They commended the actions taken in 2005, including the tightening of fiscal and monetary policies, the unification and liberalization of the foreign exchange market, and the efforts to improve the environment for private sector development. Directors were disappointed at the slippages in policy implementation toward the end of the year, but welcomed the corrective measures being taken. They noted that the overall strengthening of policies in 2005 has led to a decline in inflation in the last few months, a narrowing of the external current account deficit, and a small rebound in economic growth. Directors considered that these developments bode well for Guinea's economic future.

Directors emphasized, however, that much more needs to be done to achieve lasting progress toward macroeconomic stability and the Millennium Development Goals. Despite the recent progress, inflation remains high, the public debt unsustainable, the external position weak, and economic activity narrow-based and subdued. Directors therefore urged the authorities to implement promptly and vigorously the measures adopted in their economic program agreed with Fund staff, and to put in place an efficient policy coordination and monitoring mechanism to ensure that fiscal and monetary policies are implemented in a consistent way. This will also enable Guinea to build the track record that would allow it to move eventually to an IMF-supported arrangement, and subsequently to reach the completion point under the enhanced Heavily Indebted Poor Country Initiative and to benefit from the Multilateral Debt Relief Initiative.

Directors stressed that fiscal consolidation is a key requirement for Guinea's return to higher and sustained economic growth and to a sustainable debt level. In this regard, they underscored the importance of adopting a prudent 2006 budget, consistent with the authorities' stabilization objectives. Key measures will be to continue to improve tax and customs administration and widen the tax base, control the growth of government outlays while promoting priority expenditures, deepen public expenditure management, intensify reform of the public utilities, and address institutional and capacity constraints to policy design, implementation and monitoring. Directors also advised that domestic prices of petroleum products be allowed to move in line with international prices.

Directors encouraged the authorities to take action to strengthen monetary control, including through institutional and operational strengthening of the central bank and further progress on financial sector reform. They urged the authorities to avoid central bank financing of budget operations, and to instead issue government securities such as treasury bills, which should help develop domestic capital markets. Directors recommended that interest rates be liberalized to help reverse recent dollarization, allow interest rates to send a clear signal of the stance of monetary policy, and promote a more efficient allocation of resources. While Directors were encouraged by the improvement in financial sector soundness indicators, they expressed concern at the high level of non-performing loans and concentration of credit, and called for continued reinforcement of banking supervision and for vigilant prudential oversight. Directors also encouraged the authorities to address as soon as possible the shortcomings identified in the audit of the central bank's 2004 accounts and foreign exchange position.

Directors encouraged the central bank to calculate the reference exchange rate on the basis of a weighted average of intra-day market transactions and to publish it daily. This will further unify and liberalize the foreign exchange market, make the exchange rate fully flexible and market-determined, and help eliminate the remaining multiple currency practice. Directors also supported the planned reorganization of the foreign exchange department of the central bank.

Directors commended the progress on structural reform and strengthening governance. In particular, they noted that the water and electricity sector reforms and the privatization of state-owned enterprises will be crucial for stimulating private sector-led growth and improving social conditions. They welcomed the steps taken to combat corruption and improve the justice system, and Guinea's participation in the Extractive Industries Transparency Initiative, and urged the authorities to accelerate efforts to combat money laundering and terrorism financing. Directors also stressed the need to diversify the export base in order to reduce Guinea's vulnerability to external shocks, and in this regard they commended the authorities' decision to adopt the WAEMU common external tariff and remove non-tariff barriers.

Directors welcomed the authorities' decision to stay current on their external debt payments, and, in particular, the measures taken to ensure that timely payments are made to the Fund. They encouraged the authorities to remain in close contact with their external creditors to work toward a plan to clear arrears.

Directors welcomed the authorities' progress in implementing their poverty reduction strategy. They underscored the importance of orienting public expenditure toward the social sectors, consistent with the framework of the Poverty Reduction Strategy Paper (PRSP). In this regard, they encouraged the authorities to keep their PRSP under review, and to ensure that the investment plans of the different government agencies reflect the priorities set out in the PRSP. Directors also underscored the importance of strengthening the statistical system, and encouraged the incorporation of an overall strategy for statistics development into the PRSP framework.