2009 International Monetary Fund November 2009 IMF Country Report No. 09/320 January 8, 2009 January 28, 2009 xxxJanuary 29, 2001 xxxJanuary 29, 2001 January 28, 2009 Angola: Request for Stand-By-Arrangement The following documents have been released and are included in this package:  The staff report, prepared by a staff team of the IMF, following discussions that ended on September 30, 2009, with the officials of Angola on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on November 6, 2009. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.  Supplements to the staff report.  A Press Release  A statement by the Alternate Executive Director for Angola. The document(s) listed below will be separately released. Letter of Intent sent to the IMF by the authorities of Angola* Memorandum of Economic and Financial Policies by the authorities of Angola* Technical Memorandum of Understanding* *Also included in Staff Report The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information. Copies of this report are available to the public from International Monetary Fund  Publication Services 700 19th Street, N.W.  Washington, D.C. 20431 Telephone: (202) 623-7430  Telefax: (202) 623-7201 E-mail: [email protected] Internet: http://www.imf.org International Monetary Fund Washington, D.C. INTERNATIONAL MONETARY FUND ANGOLA Request for Stand-By Arrangement1 Prepared by the African Department (In consultation with other departments) Approved by Sean Nolan and Dhaneshwar Ghura November 6, 2009 Executive Summary: Angola’s First Fund Program Motivation: The global economic crisis, in particular the severe terms of trade shocks, has had a negative impact on Angola. By the time the crisis hit, expansionary fiscal and monetary policies, and more recently an overvalued exchange rate, had left Angola vulnerable. With oil revenues plunging, investor confidence declining, and heavy intervention by the National Bank of Angola (BNA) to sustain a tightly managed exchange rate, official reserves fell by one-third in the first half of 2009. Without a firm policy response backed by significant external financing support, the authorities could soon face a disruptive devaluation of the exchange rate with destabilizing social consequences; their immediate policy objective is to avoid that outcome. Program objectives: The authorities’ program, to be supported by a proposed 27-month Stand-By Arrangement of 300 percent of quota (SDR 858.9 million), aims to alleviate immediate liquidity pressures, boost market confidence, and restore a sustainable macroeconomic position. While the immediate goal is to mitigate the repercussions of the adverse terms of trade shocks, this program also includes a focused reform agenda aimed at medium-term structural issues on which long-term non-oil sector growth will ultimately depend. Key pillars of the program: Staff and the authorities agreed that, while the policy mix should consider all possible instruments geared towards achieving these objectives, fiscal policy should play the lead role in the policy package. Specifically, actions would be based on three pillars: • A determined fiscal effort embodied in a strong 2010 budget that still provides adequate resources for social spending and vital infrastructure projects. The program also emphasizes strengthening public financial management and enhancing fiscal transparency, especially in the oil sector. • An orderly exchange rate adjustment backed by tight monetary policy to normalize conditions in the foreign exchange market; and • Measures to safeguard the financial sector. 1 A staff team comprising L. Leigh (head), E. Castro, N. Klein, Y. Xiao (all AFR), R. Veyrune and F. Melo (both MCM) visited Luanda during August 3–7 and during September 22–30. The team held discussions with the Minister of Economy and head of the economic team, Minister of Finance, the Governor of the Central Bank, Chief Economic Advisor to the President and the other senior government officials, commercial banks, private sector representatives and donors. 2 Contents Page I. Context for Program Request................................................................................................3 II. Program Discussions............................................................................................................5 III. Program Modalities...........................................................................................................12 IV. Risks to the Program.........................................................................................................14 V. Staff Appraisal....................................................................................................................14 Tables 1. Selected Economic and Financial Indicators, 2006–14......................................................23 2a. Summary of Government Operation, 2006–11.................................................................24 2b. Summary of Government Operations, 2006–11...............................................................25 3. Monetary Survey, 2006–11................................................................................................26 4. Monetary Authorities, 2006–11.........................................................................................27 5. Balance of Payments, 2006–11..........................................................................................28 6. Banking System Financial Soundness Indicators, 2003–09..............................................29 7. External Financing Requirements and Sources, 2009–11..................................................30 8. Indicators of Capacity to Repay the Fund, 2009–16..........................................................31 9. Angola Reviews and Disbursements under the Proposed 27-Month Stand-By-Arrangement.....................................................................................................32 10. Progress on Public Finance Management and Fiscal Transparency.................................33 Figures 1. Angola in a Cross-Country Perspective, Based on Selected Group of Oil Exporting Countries......................................................................................................16 2. Recent Economic Trends....................................................................................................17 3. Angola and Comparators, Fiscal Balances..........................................................................21 4. Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2009–29..........................................................................................22 Boxes 1. Foreign Exchange Auction System.....................................................................................11 Appendices I. Letter of Intent.....................................................................................................................36 Attachment I. Memorandum of Economic and Financial Policies....................................37 Attachment II. Technical Memorandum of Understanding...............................................47 II. Debt Sustainability Update .……………………………………………………………54 Annexes I. Relations with the Fund ……………………...……………………………..……………69 II. World Bank-IMF Joint Management Plan …...……………………...………..…………72 III. Statistical Issues ………………………………………………………………..………..74 3 I. CONTEXT FOR PROGRAM REQUEST 1. Pre-crisis economic setting: Prior to the onset of the global economic crisis, Angola had recorded an extended period of rapid expansion, fueled by strong growth of oil revenues. Notwithstanding a heavily managed exchange rate with respect to the U.S. dollar, inflation had persisted at low double-digit levels, reflecting the strong pace of output expansion, significant inflation inertia, and continued supply bottlenecks. Fiscal policy had been strongly pro-cyclical, with the non-oil fiscal deficit increasing from 50 percent of non-oil GDP in 2006 to about 70 percent by 2008. Monetary and credit aggregates were expanding at an exceptionally rapid pace, with broad money growing by more than 90 percent in 2008 while bank credit expanded by about 70 percent. The economy was thus significantly exposed when oil exports suddenly plunged. 2. Nature of the shock: The global economic crisis and the resulting sharp drop of commodity prices have severely affected Angola’s economy. The spot price for crude oil fell from an average of US$97 a barrel in 2008 to Figure 1 - Angola: Usable international US$44 in the first quarter of 2009, while OPEC reserves and the oil exports receipts 5 22 cut its oil production quotas in response, reducing Angola’s quota by about 20 percent. D) 20 S 4 Diamond prices also fell substantially (Angola n U 18 SD) i3s. t h e wRorelsdu’slt finougr mth alcarrgoeescto pnroomduicc eirm).b alances: ort receipts (billio 23 111246 ves (billions of U Wthei tehc tohneo smhayr hpa dsr solpo wine odi ls hparricpelys ,a fnisdc rael vaenndu es, Oil exp 1 10 Reser external positions have weakened considerably, 0 8 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 the exchange rate has depreciated, and inflation Oil exports receipts International reserves has risen slightly: • Real GDP is projected to be broadly flat in 2009, reflecting a sizeable drop in oil production (-6 percent) and a sharp slowdown in the pace of non-oil growth (to 6 ¾ percent, down from 19 percent its average during 2005–08). Non-oil sector growth decelerated to 3 percent in the first half of 2009, largely reflecting a contraction of 8 percent of the oil-linked services sector and a zero growth of the manufacturing sector.2 Agriculture continues to register robust growth.3 2 The expectation is that as the oil sector recovers, economic activity in these non-oil sectors will also pick up. 3 The government has invested substantially in both small scale and large scale commercial farming in the past few years and this is beginning to bear dividend now. 4 • The plunge in oil revenues in the first half of 2009 has shifted the fiscal and external surpluses to substantial deficits. As a result, through June 2009, usable reserves fell by US$6 billion to US$10 billion (2¾ months of imports or a ratio of 1 to short-term liabilities), partly reflecting the National Spread Between Official and Parallel Market Bank of Angola’s (BNA) efforts to Exchange Rates (in percent) 30 stabilize the exchange rate and the government’s drawdown of its foreign 25 currency deposits at the BNA as deficit 20 financing became difficult. 15 10/9 10 • The official exchange rate has 5 depreciated in two distinct stages 0 (by 4 percent during the second quarter Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Source: National Bank of Angola. and then again by 10 percent in recent weeks, following the restoration of the foreign exchange auction), while the parallel rate has depreciated sharply, reaching a peak 25 percent premium vis-à-vis the official rate by end-September, although it has narrowed to about 12 percent in recent weeks. • Inflation has picked up to 14 percent in the 12 months through August, from an average level of 12.5 percent in 2008, despite the economic slowdown. Sales and Purchases of Foreign Exchange by the BNA Real and Nominal Effective Exchange Rates, January 2005-August 2009 (in millions of $US) 2000 78.0 280 11 Purchases Sales REER, (left scale) 1600 77.0 240 NEER, (right scale) 10 1200 76.0 Kwanza per $US, (right scale) 200 800 75.0 9 160 400 74.0 0 73.0 120 8 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Source: IMF, International Financial Statistics Statistics (IFS); and country authorities. Source: IMF, Information Notice System, (INS). 4. Authorities’ policy response: The authorities have responded to the collapse in oil revenues in an adaptive manner, relying first on the rundown of the government’s foreign currency deposits to finance the fiscal deficit and foreign exchange market intervention to maintain a stable exchange rate before moving to more activist responses as fiscal and balance of payments pressures intensified. • Fiscal policy was tightened considerably with the adoption of the 2009 supplementary budget in July 2009. The supplementary budget mandated a spending cut of 5 17 percent, mostly in capital expenditures. A moratorium was put on all new projects that had been included in the original 2009 capital budget, with the exception of energy and water projects in the rural areas. • Monetary policy was also tightened aggressively. The BNA raised reserve requirements for banks from 15 percent to 30 percent and increased its rediscount rate from 20 percent to 25 percent. • The BNA also shifted away from the foreign currency auction system to rationing, at a level that was substantially below the market demand. The loss of confidence in the kwanza led to increased currency substitution. 5. Remaining challenges: This piecemeal response to the macroeconomic imbalances, while containing important measures, did not restore market confidence in economic policies, as reflected in the large and widening spread between the official and parallel exchange rates and further pressure on reserves through September 2009. Although the fiscal deficit was contained through the supplementary budget, financing it domestically remained a challenge given the low demand for treasury bonds at prevailing interest rates. As a result, the government accumulated US$2½ billion of domestic arrears (3.6 percent of GDP) by September 2009. Moreover, while a tighter monetary stance has led to a significant moderation of credit growth, bank capital buffers remain vulnerable to deterioration in credit quality from slowdown in economic activity and the drop in the exchange rate.4 6. Program goal: The requested Stand-By Arrangement (SBA) aims to support orderly policy adjustments to restore macroeconomic balances and rebuild international reserves. While the immediate goal is to mitigate the repercussions of the adverse terms of trade shocks, this program also includes a focused reform agenda aimed at medium-term structural issues on which long-term non-oil sector growth will ultimately depend. II. PROGRAM DISCUSSIONS 7. Staff and the authorities agreed that, absent a comprehensive adjustment program, there is an imminent risk of a balance of payments crisis. While the authorities see Angola’s current financing needs as largely transitory given its richness in natural resources, the ongoing pressures on the balance of payments could soon produce a disruptive exchange rate devaluation and further erosion of market confidence. Without addressing the underlying economic imbalances, even with the recent recovery in oil prices, inflation is likely to pick up sharply as the kwanza continues to depreciate in the parallel market and inflationary expectations build. Growth would inevitably suffer against a backdrop of increasing macroeconomic turbulence. 4 With 60 percent of lending in foreign currency it is estimated that there is a large stock of loans to unhedged borrowers. 6 8. Outlook and key program objectives: The program aims to avoid this disorderly adjustment and envisages a modest recovery in non-oil GDP growth in 2010 as the impact of improvement in market confidence on aggregate demand (both investment and consumption) will more than offset that of policy tightening on economic activity. The projected improvement in oil revenues will return the current account to a surplus and, together with the normalization of conditions in the foreign exchange market, should reduce speculative- demand for foreign currency and contribute to reserve accumulation. 5 Inflation is expected to slightly increase in 2010 due to the exchange rate depreciation, but renew its declining path to a single digit level by the end of the program period (Table 1) reflecting continued fiscal tightening and the expected appreciation of the kwanza as the external position improves. The proposed policy mix aims to rebuild usable reserves to 3.2 months of imports in 2010 and to 3.8 months in 2011, with usable reserves in percent of short-term liabilities projected to return to 1.5 by 2010 (Table 5). 9. Highlights of the discussion: It was agreed that, while the policy mix should consider all possible instruments geared towards rebuilding reserves, fiscal policy should play the lead role in the policy package. Specifically, actions would be based on three pillars: • A determined fiscal effort embodied in a strong 2010 budget that provides adequate resources for social spending and vital infrastructure projects; • An orderly exchange rate adjustment backed by tight monetary policy to normalize conditions in the foreign exchange market; and • Measures to safeguard the financial sector. Fiscal policy: 10. The authorities are committed to making another forceful fiscal adjustment in 2010, augmenting the policy tightening in the 2009 supplementary budget. The fiscal program for 2010 envisages a return to a small surplus (1.5 percent of GDP) based on a recovery in oil revenues and a reduction of the non-oil primary fiscal deficit (program’s fiscal anchor) by 6 percentage points of non-oil GDP. 5 Oil production is projected to increase to an average of 1.9 million barrels per day in 2010 from 1.79 million barrels per day in 2009, in line with expected global economic recovery and increase in global oil demand. 7 Text Table 1. Angola: Selected Fiscal Indicators (as a percent of GDP; Unless otherwise indicated) 2009 2010 2011 Revenues 35.5 38.6 37.6 Of which: non-oil tax revenues 8.2 8.2 8.6 Expenditures 43.0 37.1 34.4 Of which: current spending 28.1 24.3 22.4 Of which: capital spending 14.9 12.8 12.1 Overall fiscal balance (accrual basis) -7.5 1.5 3.2 Non-oil primary deficit (percent of non-oil GDP) -53.0 -46.8 -40.7 • On the revenue side, oil revenues are expected to increase by nearly 20 percent in 2010 as a result of higher oil production and more favorable prices. • Expenditure restraint will be the cornerstone of the fiscal adjustment in 2010, with spending set to decline by 6 percentage points of GDP relative to 2009, reflecting a significant decline in current spending on goods and services (which has grown by an average of 18 percent in real terms during 2006-2008). 6 Social spending, (an indicative target under the program), will be kept at 30 percent of total see MEFP ¶9 expenditures, its average level in recent years. The wage bill will increase by 4 percent in real terms to accommodate employment increases in education, health, and other social sectors. The capital budget is set to remain constant in real terms with capital spending targeted mainly at infrastructure development. The budget provides for a gradual clearance of domestic arrears of US$2 ½ billion mostly to local suppliers.7 The authorities would need to conduct a mid-year review of budget performance and take corrective actions should there be significant deviations from the budget assumptions. Staff stressed that further fiscal consolidation will be needed in 2011 as part of an effort to put the non-oil primary balance on a sustainable trajectory. • On financing, the authorities are committed to observing the program’s nonconcessional borrowing limit of US$2 billion (2.4 percent of GDP).8 However, they noted that the ceiling may need to be recalibrated during program reviews if concessional funds to finance infrastructure projects falls below their see MEFP ¶10 expectations. Staff emphasized that Angola’s risk of debt distress remain 6 Angola’s fiscal adjustment in 2010 is ambitious compared to the fiscal effort in recent Stand-By Arrangements (Figure 3). 7 The government’s plans to clear these domestic arrears gradually on a monthly basis with the bulk expected to be cleared in the second half of 2010. 8 Given its natural resource richness and a per capita income of about $4,000 dollars, Angola’s access to concessional financing is relatively limited especially when compared to other countries in sub-Saharan Africa. 8 moderate and while steady progress is being made, there is room to further improve the capacity to manage public resources (debt management and public financial management-PFM) under the program. 9 Thus, further flexibility on the ceiling will take into account the progress made on debt management and PFM in line with the Fund’s new guidelines on debt limits. 11. From a medium-term perspective, further steps are needed to improve fiscal management by de-linking the fiscal stance from the volatile oil revenues and reforming the tax system. • To put a decisive break with past boom-bust fiscal cycles related to international oil price fluctuations and facilitate the convergence toward a sustainable fiscal position,10 the authorities agreed to develop an institutional framework that de-links the fiscal stance from short-term oil revenues, focusing instead on the non-oil see MEFP ¶11 primary fiscal balance, and ensures that greater proportion of windfall oil revenues is saved. In this context, the authorities have set up a task force to look into the modalities of a sovereign wealth fund (SWF)/oil fund which will serve both stabilization and savings purposes. The fund would be fully integrated into the budget process and its return would finance future non-oil fiscal deficits along the lines of the Norwegian oil fund. The action plan to set up the SWF will be initially sent to the cabinet for discussion and then implementation steps will be included in the program during SBA reviews. • Given the current distortions in the tax system,11 the authorities acknowledged the need to launch a major tax reform to lay a solid foundation for expanding the non-oil tax revenues. Their proposed tax reform strategy, which was reviewed by the Fund, is geared toward moving to a consumption-based tax system; it also envisages substantial simplification of the tax system to improve efficiency and reduce tax evasion. The strategy includes setting up an autonomous revenue authority and strengthening tax administration including by streamlining the generous tax exemptions so as to boost non-oil revenues. While the reform package identifies the major shortcomings of the tax system, and the strategy is appropriate, the proposals are very ambitious and are likely to be resource demanding and time consuming. The 9 The updated DSA shows that the confluence of nonconcessional borrowing that is significantly above the ceiling and an oil price path that is lower by 30 percent compared than in the World Economic Outlook baseline scenario is likely to push the present value of the debt-to-exports and debt service-to-exports ratios above their thresholds. 10 Based on the permanent income approach, the sustainable non-oil primary deficit in 2009 is around 25 percent of non-oil GDP. 11 The current tax system, whose features include a multi-rate cascading-type turnover tax, tax dichotomy between business profits and labor income and separate tax regimes for the oil and the diamond sectors, amplifies the tax burden and increase the incentives for tax evasion. 9 authorities will soon formally request Fund technical assistance to help flesh out further details of the reform package, with the aim of moving it through the government’s review process into a formally adopted policy. 12. The authorities continue to make steady progress in revamping their public financial management system (Table 10). They have recently see MEFP ¶12 decentralized budget execution to local governments, expanded the budget execution system (SIGFE), and for the first time produced the General Accounts of the state. Staff reiterated that these measures need to be complemented with reinforcement of internal controls, closer coordination of the current and capital budgets, and improvement of line ministry budgeting capacity, consistent with the recommendations of the 2006 fiscal ROSC. 13. Staff and the authorities agreed that steps need to be taken to improve fiscal transparency especially with regard to the activities of the state-owned oil company, Sonangol. Given the size of the oil sector and its impact on the economy, including government revenues, greater fiscal transparency see MEFP ¶13 and better oversight of Sonangol would help the authorities to monitor fiscal risks. A full audit of Sonangol’s accounts for 2008, including its quasi-fiscal operations, would be completed by Ernst & Young by mid-November 2009. A similar audit was conducted for 2007. The government is committed to publishing Sonangol’s audited financial statements. It will also publish the results of its fiscal operations quarterly and adopt a mechanism for the regular review of operational cash flows of major state-owned enterprises (SOEs) like Sonangol. The government will gradually phase out Sonangol’s quasi-fiscal operations.12 Staff’s assessment is that the authorities are taking significant steps toward their policies and commitment on resource revenue transparency. They have launched a campaign to place more documents of general interest in the public domain, including budget reports, while oil and diamond exports are now published on a monthly basis on the website of the Ministry of Finance. Exchange rate and monetary policies: 14. The authorities and staff agreed that exchange rate and monetary policies should be geared toward facilitating the normal functioning of the foreign exchange market. The system of foreign exchange rationing at a fixed exchange rate which was in place from April 21 to October 1 had proven to be both costly (to the BNA) and inefficient (yielding sizable spreads between the official, bank-client and parallel exchange markets), 12 The quasi-fiscal operations that are made by the state oil company, Sonangol, mainly include distribution and subsidy of oil. Sonangol also services part of the government’s debt. These expenditures are netted out from the oil revenues, which Sonangol has to transfer to the government, and they are budgeted within the ceilings on public spending. For 2009, Sonangol’s quasi-fiscal operations are projected at Kz. 295 billion (12 percent of total expenditures).