40311 INTERNATIONAL DEVELOPMENT ASSOCIATION INTERNATIONAL MONETARY FUND REPUBLIC OF CONGO DecisionPoint DocumentUnder the Enhanced HeavilyIndebtedPoor Countries(HIPC) Initiative Preparedby the Staffs o f the International Development Association and the International Monetary Fund Approved by Gobind T.Nankani and Danny Leipziger (IDA) and Anthony Boote and Thomas Krueger (IMF) March2. 2006 Contents Page IIntroduction............................................................................................................................ . 4 I1.Background and Assessment of Eligibility and Qualification for HIPC Initiative Assistance ..................................................................................................................... -5 A.PRGF and IDA Status............................................................................................... B Dimensions ofPoverty.............................................................................................. 5 5 6 D.Macroeconomic and Structural ReformRecord....................................................... C Recent Political and Security Developments ............................................................ .. 7 E Recent Performance Under the PRGF Arrangement............................................... . 13 I11 Medium-to-Long-TermStrategy for Poverty Reduction................................................... . 15 A. PRSP Formulation Process..................................................................................... 15 B.Macroeconomic Objectives..................................................................................... 16 C. Governance, 17 D. Social and Sectoral Policies.................................................................................... and Structural andInstitutional Reforms ........................................... 20 IV. Debt Sustainability Analysis and Possible HIPC Assistance ............................................ 21 21 B. Structure ofExternalDebt....................................................................................... A.Debt ReconciliationStatus...................................................................................... 22 -23 D Sensitivity Analysis.,............................................................................................... C. Debt Sustainability Analysis .................................................................................. . 24 E.Possible HIPC Initiative Assistance ........................................................................ 25 V Floating CompletionPoint.................................................................................................. . A. Triggers for the Floating CompletionPoint............................................................ 28 28 B. Monitoringthe Floating CompletionPoint Triggers .............................................. 31 C. Use and Monitoring o f Enhanced HIPC Initiative Debt Relief .............................. 31 D.Authorities' Views .................................................................................................. 32 VI.Issues for Discussion ......................................................................................................... 33 - 2 - Boxes 6 2. Steps to Strengthen Public Finance Management.............................................................. 1. SelectedPoverty and Living Standard Indicators................................................................ 11 12 4 External Arrears Clearance ................................................................................................ 3. Recent Reforms inthe Oil Sector ...................................................................................... . 27 6. ExpenditurePriorities ........................................................................................................ 32 5. Triggers for the Floating Completion Point....................................................................... 29 Figures 1. Net Present Value o f Outstanding Debt at end-2004 by Creditor Group 35 2 External Debt and Debt Service Indicators, 2004-24 ........................................................ Before Traditional Debt Relief Operations.................................................................. 36 3 .. Sensitivity Analysis after HIPC Initiative, 2005-24 .......................................................... 37 Tables . 7 2. Net Present Value o f External Debt, end-2004.................................................................. 1 SelectedEconomic and Social Performance Indicators, 1980-2004................................... 22 3 .. . External Indicators 2004 and 2005 .................................................................................... 24 4 Selected Economic and Financial Indicators, 2001-07 ..................................................... 38 5 Selected Indicators o f Long-Term Macroeconomic Projections, 2004-24 ........................ 39 6. Nominal andNet Present Value o f External Debtby Creditor Group 40 7 Net Present Value o f External Debt, 2004-24 ................................................................... at DecisionPoint, End-2004 ........................................................................................ 41 8 42 9 External Debt Service After FullImplementation ... External Debt Indicators, 2004-24 ..................................................................................... 43 10. Sensitivity Analysis, 2004-24 ............................................................................................ o f Debt-ReliefMechanisms, 2005-24 ......................................................................... 44 11 Enhanced HIPC Initiative: Assistance Levels Under a Proportional . Burden-Sharing Approach ........................................................................................... 45 12. Paris Club Creditors' Delivery o f Debt ReliefUnderBilateral Initiatives Beyondthe HIPC Initiative ......................................................................................... 46 13. Possible Delivery o f IMF Assistance Under the Enhanced HIPC Initiative, 2005-15 .............................................................................................. 47 14. Estimated Delivery o f IDA Assistance Under the Enhanced 48 15. Discount Rate and Exchange Rate Assumptions at end-2004 ........................................... HIPC Initiative, 2005-20.............................................................................................. 49 16. HIPC Initiative: Status o f Country Cases Considered Under the Initiative, end-October, 2005 ................................................................................. 50 Appendices I DebtSustainabilityAnalysisWithPreliminary . 52 I11.Debt Sustainability Analysis Usingthe Joint Framework for Low-Income Countries.....56 I1. National Oil Company FinancialObligations.................................................................... Updated Macroeconomic Framework.......................................................................... 58 - 3 - AbbreviationsandAcronyms AfDB African Development Bank BDEAC Banque de Diveloppement des Etats de 1'Afrique Centrale COBAC Commission Bancaire de 1'Afrique Centrale CORAF Congolaise de Raffinage DSA Debt Sustainability Analysis E M W Emergency Rehabilitation and Reconstruction Program GDP Gross Domestic Product HIPC Heavily IndebtedPoor Countries EITI Extractive IndustriesTransparency Initiative IBRD International Bank for Reconstruction andDevelopment IDA International Development Association IMF International Monetary Fund I-PRSP InterimPoverty ReductionStrategy Paper MDBs Multilateral Development Banks MDGs MillenniumDevelopment Goals MDRI MultilateralDebt Relief Initiative MONUC UnitedNations Organization Mission NPV Net PresentValue PRGF Poverty Reduction and Growth Facility PRSP Poverty Reduction Strategy Paper Congo Republic o f Congo SDR Special Drawing Rights SMP Staff-Monitored Program SNPC Societe Nationale des Petroles du Congo TSS Transitional Support Strategy UNDP UnitedNations Development Programme UNICEF UnitedNations Children's Fund - 4 - I.INTRODUCTION 1. This paper presents an assessmentof the eligibility ofthe Republic of Congo (hereafter "Congo") for assistanceunder the enhanced HIPC Initiative. The Executive Boards of the IMF and IDA discussed the preliminary HIPC document (IDA ReportNo. 33252-CG, August 2005; IMF Country Report No. 05/391, November 2005) for Congo on August 1 and 25,2005, respectively. On these occasions, ExecutiveDirectors made a preliminary determination that Congo could be eligible for assistanceunder the enhanced HIPC Initiative on the basis of its heavy debt burden, its track record of performance under IDA-andIMF- supported programs, and its status as an IDA-only and PRGF-eligible country. Directors generally agreed that Congo could reach its decision point by end-2005, providedthat policy implementation under the government's macroeconomic and structural program i s satisfactory. 2. The debt sustainability analysis (DSA) hereinindicates that Congo's external debt burdenwould remainabove the HIPC threshold even after applicationo ftraditional debt- relief mechanisms, with a ratio o f net presentvalue of debt to government fiscal revenues well above the threshold of 250 percent on the basis of end-2004 data.' Debt relief underthe enhancedHIPC Initiative would help accelerate progresstoward meetingthe Millennium Development Goals (MDGs). 3. Section I1provides background information on Congo's qualificationfor debt relief underthe enhancedHIPC Initiative, the dimensions ofpoverty, political and security developments, and the policy track record to date. Section I11discusses the Poverty Reduction Strategy Paper (PRSP) process, medium-to-long-term macroeconomic objectives, and the sectoral and structural reforms to be implementedbefore reaching the completion point. Section IV presents the key DSA results. Section V presents the floating completion point triggers, specifies how the enhancedHIPC Initiative assistance after the decision point will be usedandtracked, and reports the views of the authorities. Finally, Section VI proposes issues for discussion by Executive Directors. ~ Congo i s eligible for debt relief under the enhanced HIPC Initiative's fiscal window. In April 1997, the fiscal revenues and openness criteria were established to allow for the possibility that, for countries with a high export base, reaching the debt-to-export criteria targets may still leave the country with an unsustainable external debt burdenrelative to fiscal revenues. Inorder to qualify for this window, the country must have an export-to-GDP ratio of at least 30 percent, and a revenue-to-GDP ratio o f at least 15 percent, using an average of the last three years o f actual data. (See "Modifications to the Heavily Indebted Poor Countries (HIPC) Initiative, July 23, 1999 (IDNSecM99-475,and EBS/99/138)"). As of 2004, Congo's exports-to-GDP ratio was about 84.5 percent and its revenue-to-GDP ratio was about 32 percent. - 5 - 11. BACKGROUND AND ASSESSMENT ELIGIBILITYAND QUALIFICATION OF FOR HIPCINITIATIVE ASSISTANCE 4. Following the elections held in2002 and the relative stability that has ensued, Congo has been ina position to establish the prerequisites for reaching the decision point under the enhanced HIPC Initiative. It has made satisfactory progress inbuildinga track record o f macroeconomic stability and structural policy implementation, prepared an interim Poverty Reduction Strategy Paper (I-PRSP), and made significant progress innormalizing relations with creditors. This section discusses the achievement o fthese prerequisites ingreater detail. A. PRGF and IDA Status 5. Congo i s an IDA-only country, with a GNI per capita o f US$7702in2004 (Box l), and i s eligible to receive resources under the IMF's Poverty Reduction and Growth Facility (PRGF). Congo will continue to need concessional assistance from the international community and i s likely to remain an IDA-only country and eligible for PRGF resources for the foreseeable future. B. Dimensionsof Poverty 6. Once classified as a lower-middle-income economy, Congo experienced a continuous decline inper capita income from the mid-1980s to the late-1990s. This adverse trend coincided with the overvaluation o f the CFA franc inthe second half o f the 1980s,three armed conflicts inthe 1990s, and institutional weaknesses. Per capita real GDP in2004 was about 70 percent o f its 1984 level. As a result, poverty increased significantly, especially in the 1990s following the conflicts. 7. Successive and intense rounds o f civil wars (1993, 1997, and 1998-99) had significant negative socio-economic consequences (Box 1 and Table 1). It is estimated by the World Bank that 70 percent o f the population lives below the poverty line (defined as US$1 per day) compared to about 30 percent in 1993.The 2004 UnitedNations human development index ranked Congo 144th out o f a total o f 177countries. The pervasiveness o f poverty i s further reflected inlabor force statistics. Unemployment affects more than 50 percent o f the active population, with youth being particularly affected. Using World Bank's Atlas methodology - 6 - Box 1. Selected Poverty and Living Standard Indicators (Inpercent, unless otherwise specified) Sub-Saharan idicator Republic of Congo Africa Population (inmillions, 2004) 3.8 688 Population growth (in percent) 3.0 2.4 GNIper capita (U.S.dollars, 2004) 770 450 Life expectancy (inyears) 52 46 Infant mortality rate (per thousand) 81 105 Child under 5 mortality rate (per thousand, 2003) 108 ..I Maternal mortality rate (per 100,000 live births) 510 ... HIVIAIDS: Estimated prevalence rates (urban areas, 2003, inpercent) By gender: Male 3.8 Female 4.7 By age group: 15-19 1.2 .., 20-29 3.7 30-39 6.6 40-49 6.6 Illiteracy rate (percent o f population age 15+, latest single year available 1996-2002) 17 37 Gross primary enrollment rate (percent of school age population, latest single year available 1996-2002) 97 86 Of which: Male 101 92 Female 93 8C Impact o f conflicts in the 1990s Child soldiers 5,000 Displaced persons 1,000,000 Source: World Bank, Economic and Social Indicators database. C. Recent Political and Security Developments 8. Recent political developments are encouraging against the background o f recurrent conflicts inthe 1990s. Under the umbrella o f peace, Congo completed a four-year political transition period, held elections, and made significant progress inputting inplace democratic institutions requiredby the Constitution. Peace and security have improved since a new government was appointed following a constitutional referendumand presidential, legislative, local, and senatorial elections, all held during January-June 2002.3The The cabinet was reshuffledinearly January 2005. - 7 - government signed a peace accord with a hold-out rebel group and, over the past two years it has launched a program to demobilize former combatants. Nonetheless, the security situation remains fragile, as indicated by rebel attacks late last year which forced suspensionof services on the vital Brazzaville-Pointe Noire rail line, the rebel attack on a UNDP convoy in the PoolregioninApril 2005, and skirmishesthat eruptedinOctober 2005 ina suburbof Brazzaville. Table 1. Selected Economic and Social Performance Indicators, 1980-2004 I I 1980-84 1985-89 1990-94 1995-99 2000-04 Nationalaccounts (In percent, unless otherwise indicated) Per capitaGDP (in 1995 USdollars) 982 979 883 796 795 Real GDP growth 14.3 -0.7 -0.1 1.7 4.2 Oil 12.5 9.3 3.8 9.1 -3.3 Non-oil 14.9 -3.3 -1.7 -2.8 9.6 Consumer priceinflation 3.7 -2.8 9.0 7.4 1.9 , (In percent of GDP, unless otherwiseindicated) Fiscal accounts Total domestic revenue (excl.grants) 34.1 25.8 24.3 25.7 29.1 Primary expenditureand net lendingl / 24.3 22.9 26.4 21.6 22.4 Basic primary budget balance 9.8 2.9 -2.2 4.2 6.7 External sector Trade balance 23.3 25.6 24.3 40.1 53.3 Externaldebt 89.6 176.6 217.5 236.9 180.8 Real effective exchange rate (index, 1990=100) 96.7 98.8 92.7 79.3 80.8 Terms o ftrade (index, 1990=100) 179.6 125.8 84.1 78.0 127.4 Oil price (U.S.dollars per barrel) 33.3 18.7 19.2 17.4 28.9 Social indicators (Inunits indicated) Adult illiteracyratio (in percent of peopleages 15 and above) 46 38 30 23 19 Secondaryschool enrollment ratio21 74 75 54 53 42 Immunizationratio 3/ 50 70 67 33 31 Lifeexpectancyat birth (inyears) 50 51 51 51 51 Sources:Congolese authorities, and staffestimates and calculations. 1/ Noninterestcurrent expenditureplus domestically-financedinvestment. 2/ Inpercent o f the childreno f secondary schoolage. 3/ Inpercent of childrenunder 12 monthsfor immunizationagainst diphtheria,tetanus, andpolio. D. Macroeconomicand StructuralReform Record 9. Emerging from a conflict situation, and starting from a very low base, Congo has made significant progress inimplementingmacroeconomic, financial, and structural reforms. Large challenges remain, however, includingthe needto further enhance transparency inthe managementof Congo's natural resources, and strengthenbudget management, address widespread and primarily urbanpoverty, and continue to demobilize armed combatants. - 8 - 10. The overall improvingpolitical and security conditions allowed the authorities to make good progress toward restoring macroeconomic and financial stability. Since end-2002, the government has focused on the country's economic andsocial recovery withinthe framework o f its "Nouvelle Esperance" (New Hope) program. The government's efforts were supported by IMF, IDA, and donors: 0 On the IMF side, support was provided through an Emergency Post Conflict Assistance (EPCA) in2000 (inan amount equivalent to SDRlO.6 million) and close monitoring o f the authorities' efforts to strengthenthe framework for policy implementationthrough four staff-monitoredprograms (SMPs) during2001-04. Reform implementationhadbeen unevenunder the EPCA andthe first three SMPs, but significant progress was made in enhancing oil sector transparency andpublic finance management under the 2004 SMP (see below). On December 6,2004, the ExecutiveBoard o f the IMF approved a three- year arrangement under the PRGF for Congo inan amount equivalent to SDR 54.99 million (65 percent of quota) to support the government's economic program through 2007. 0 Support from IDA was providedthroughbalance-of-payments support consisting of a Post Conflict Economic Recovery Credit of US$37.6 million inJuly 2001 and an Economic Recovery Credit of US$30 millioninDecember 2004. The latter focuses on reforms inthe oil sector and improving performance with respect to public investment4. IDA also has several ongoing investmentprojects put inplace since the returnofpeaceto strengthen governance and social welfare. These include (i) a Transparency and Governance Capacity Building Project for US$7 million, which has focused mainly on improving transparency and governance inthe oil sector and inpublic sector financial management, and will continue to do so for the next few years; (ii) an Emergency Infrastructure Rehabilitation and Living Conditions project for US$40 million; (iii)an Emergency Recovery and Community Support Project for US$41 million; (iv) an This is atwo tranche operation, whose second and final tranche will be releasedwhen: (i) SNPCactionplan,drawnupinlightofthe1999-2001auditanddescribedingreater the detail inparagraph 30, i s deemedto have beenfully implemented; (ii) the following measureshave been undertaken with respect to public investment: a) completion and adoption of an action plan aimed at reformingthe management o f investmentprojects, b) the reviewand submission o f financial audit reports for investmentexpenditures for FY 2004, andc) satisfactory review and submission of a draft public investmentprogram for FY 2006- 07; and (iii)with respect to domestic debt: a) validation ofthe amount o farrearspertainingto the stock of domestic debt; b) a cut-off date has beenestablished after which claims by creditors can no longer be submittedor modified, c) an agreement has beenreached between the government and its creditors pertainingto a common discount factor, and (d) a commercial bank has beenappointed to effect payment to the entitled domestic creditors. - 9 - HIV/AIDS and Healthproject for US$19 million; and (v) a Support to Basic Education Project for US$20 million. 0 The African DevelopmentBank (AfDB), EuropeanUnion, andbilateral donors have also provided important assistance. Inaddition, an agreementwas reached on December 16, 2004, betweenParis Club creditors and Congo for a debt stock reduction and arrears rescheduling. 11. The onset ofpeace in 1999/2000 boosted economic activity and contributedto macroeconomic stability (Table 1 above), helped by enhancedmacroeconomic management and the significant rise inoil prices. Non-oil real GDP increased by about 9% percent per annum on average during 2000-04, propelledby improvements inagriculture, commerce, and transportation. The basic primary fiscal balance has improved since the late 1990s. Consumer price inflation declined significantly, helpedby the trend toward fiscal consolidation, a more reliable supply line from Pointe-Noire to Brazzaville, and a strengthening o f the euro (to which the CFA franc is tied) vis-a-vis the U.S. dollar. 12. Following repeated setbacks inthe implementation of economic reforms under the 2001-03 SMPs, a noticeable break with the past cycle o fpoor governance and weak economic management has beenobserved since late 2003: 0 The recent significant improvement inthe fiscal positionis attributable to tighter control of expenditure, highoil revenues, and mobilization o f non-oil revenues. Noteworthy, public finance reforms have beenundertaken with respect to the budgetframework, revenuemobilization, and expenditure and cashmanagement (Box 2). 0 The government placed strong emphasis on improvinggovernance, andespecially on enhancing oil sector management and transparency (Box 3). Nonetheless, more transparency has also brought to the fore remainingkey weaknesses inoil sector management (e.g., SNPC's accounting, internal control, management informationsystem, and marketing o f government oil). Yet, implementationo fthe actionplan aimed at remedying issues raised by the SNPC audits has beenslower than programmed, espeqially with respect to strengthening accounting, updating estimates o f petroleum assets, and defining responsibilities within the corporate structure. 0 Significant steps have beentaken to improve relations with creditors since the beginning of 2003, but with differing degrees o f success (see Section 1V.B). The government has contracted no new loans with maturity exceeding one year usingoil as collateral since October 2002. 13, Further structural and sectoral reforms are beingundertakenor have beeninitiatedas follows: 0 The privatizationof state-owned banks was successfully completed. Nonetheless, the government has temporarily taken over a bank incritical condition to protect depositors, allow an orderly restructuring, and prepare it for reprivatization. A restructuringplan, - 10- prepared with technical assistance from the regional supervisory agency (COBAC), was adopted by the bank's board inDecember 2004. This bank i s under intensive surveillance by the COBAC. 0 The government is improvingthe legal andregulatory framework as away to prepareor accompany liberalization, privatization, andprivate/public partnership, notably in telecommunications, electricity, water, and petroleum distribution. 0 The distribution of refinedoil products is being privatized, although the transfer of property titles i s not yet complete. 0 The government succeeded inattracting private operators inmobiletelecommunications, with improvements inquality andprice of service. The government significantly reducedthe rate of the tax on corporate profits andin parallel adopted an investment charter rationalizing tax holidays. 0 The government established a one-stop window to facilitate investment procedures. - 11- ~ Box 2. Steps to StrengthenPublic FinanceManagement Budgetframework a Centralization o f revenues and expenditures within the budget framework, including phasing out o f off-budget government spending by oil companies. Reduction o f delays inpreparing and submittingthe budgetto parliament. a Improvedcoordination between the Ministries of Finance and Planning on budget preparation. a Strengtheningof management and technical capacity at the FinanceMinistry. Revenuemobilization Quarterly certification, by an audit firm o f international reputation, that oil revenues due to the government by oil companies are consistent with proceeds registeredat the Treasury. Certification, by an audit firm of international reputation, o f the 2004 forestry tax revenues. Completion o f "cost oil" audits for the year 2003, by audit firms o f international reputation, for all production-sharing contracts. Adoption inMarch 2004 by the government o f a dividendpolicy for the SNPC, reserving at least 30 percent o f the 2003 net profits to the Treasury and 20 percent insubsequent years. Strengthening ofthe coverage of the territory by tax and customs administrationthrough the establishment of more provincial offices. Efficiency enhancement o f revenue-collecting agencies through the operational audit of the General Directorates o f Tax and Customs. Launching o f the computerization o f the systems at the General Directorates of Tax and Customs. Use o f a single taxpayer identification number (NN)to improve the tracking o f taxpayers and limit tax evasion. Expenditureand cash management a Preparationo f data tracking government spending at various stages o fthe expenditure circuit (commitment, issuance o f payment orders, cash payments). a Preparation o f regular data to track poverty-related spending. a Abstention by the government from contracting new oil-collateralized debt. Significant reduction o f exceptional spending procedures eaiementpar anticipation). a Preparationo f consolidatedtreasury accounts. - 12- Box 3. RecentReformsin the Oil Sector Considerable progress has been made in reforming the oil sector, and inparticular in improving oil sector transparency. Nevertheless, major weaknesses remain, especially with regardto SNPC's internal controls, management information system, and accounting (with auditors noting a lack o f access to adequate information), marketing o f government oil, and awarding concessions on government oil contracts. Key remaining weaknesses are to be addressed in the period ahead under the PRGFarrangement as well as under different World Bank programs. Past reforms were focused on the following areas: Ensuringfull mobilizationof governmentoil revenue 0 Creation in 2003 of the specialized Oil Monitoring Unit ( O W )inthe Ministry of Finance to (i) forecast oil revenues based on fiscal parameters inProduction Sharing Agreements (PSAs), (ii)compare forecasts with outcomes, and (iii) represent the Ministry's interests in oil-related transactions. Monitoring SNF'C activities Audit ofthe 1999-2001,2002, and 2003 SNPC financial accounts by an audit firm of international reputation. These covered the SNPC's financial consolidated statements, internal controls, and fiscal agency functions (notably oil sales, oil-based financing, and sovereignty expenditures). Audit, by an audit firm of international reputation and inaccordance with international standards on auditing, o f the 2002 financial accounts of the national oil refinery (CORAF). Adoption by the government in March 2004 of a plan to implementthe recommendations o f the 1999-2001 audit o f the SNPC with a view to improvingthe company's accounting, internal control, management information system, reporting and accountability. Preparationby the government o f a strategy aimed at ensuring that the SNPC focuses on core activities in the oil sector. Enhancingtransparency 0 Publication on official internet sites (www.mefb-cn.org) o f (i) 2003 SNPC audit, and the significant excerpts from the 1999-2001and 2002 audits; (ii) the planto reform the SNPC's operations; (iii)oil certification reports; (iv) PSAs; and (v) key oil-related data. 0 Organization by the government and SNPC o f seminars on the oil sector for parliamentarians in Brazzaville inNovember 2003, and for the public inPointe Noire in May 2004. 0 Public announcement by the government of its commitment to adhere to the Extractive IndustriesTransparency Initiative (EITI) (June 2004). - 1 3 - E. RecentPerformanceUnderthe PRGFArrangement 14. Since the issuance o f the preliminary document, indications are that performance underthe PRGF arrangement has remainedbroadly on track (see below). A full description o f performance will be undertaken inthe context o f the second review under the PRGF arrangement, planned for March 2006. 15. Preliminary indications are that eight o f the ten quantitative performance criteria for end-September 2005 under the program supported by the PRGF were met: (i) a ceiling on the change inthe net claims o f the banking system on the government; (ii) no new medium- or long-term nonconcessional borrowing; (iii) no new external debt (including leasing) with an initial maturity o f less than one year incurred or guaranteed by the government; (iv) no new oil-collateralized external debt by or on behalf o f the central government; (v) a ceiling on new nonconcessional external debt contracted by the SNPC; (vi) no new external payment arrears on nonreschedulable debt; (vii) a ceiling on domestic arrears payments; (viii) no new domestic payment arrears. However, the floor on the primary fiscal balance was missed by a large margin(see below), and the minimumpayment on external arrears was missedas the authorities adhered to the December 2004 Paris Club rescheduling agreement, entailing lower-than-programmed payments on post-cutoff-date arrears.' 16. Based on preliminary data, the primary fiscal surplus fell short o f its adjusted target6 by CFAF 113 billion (3.6 percent o f GDP) at end-September 2005 owing primarilyto exogenous factors and the authorities' response. First, with a view to protecting Congolese assets from litigating creditorsY7an amount o f CFAF 80.7 billion (2.6 percent o f GDP) in revenue from oil sales not transferred to the Congolese Treasury from abroad by end- September; these revenues, however, were repatriatedintheir entirety inearly November 2005. Second, an expenditure overrun equivalent to 0.6 percent o f GDP was incurred owing to (i) higher-than-projected transfers to CORAF to cover the company's higher losses inthe face of partial adjustment of fuel pump prices, and (ii) automatic payments to private oil The Paris Club debt agreement of December 16,2004 provided a more favorable schedule o f arrears clearance than envisaged under the PRGF-supportedprogram (IMF Country Report No. 05/39; February 2005). Inline with the technical memorandum o funderstanding attached to the PRGFarrangement (IMF Country Report No. 05/7, Appendix I,Attachment 111), the adjusted target reflects deviations from the program baseline intwo parameters: oil prices and shipments. About 10 percent o f total external debt stock (US$900 million) is owed to litigating creditors (Le., suppliers and commercial creditors, some o f whom bought Congolese debt on the secondary market at deep discounts, andhave beensuingactively incourts inFrance, the USandthe UKfor immediate and fullpayment oftheir claims, includingpenalty interest, by attachment o f the proceeds o f oil cargos or their payments). - 14- companies for their 2004 oil delivery to CORAF that had remained unpaid.' Third, although the world oil prices were higherthan programmed, raisingthe (adjusted) primaryfiscal surplus target under the program, the positive revenueimpact was offset to some extentby the sharp rise inthe discount on Congolese crude Inaddition, fees and commissions related to asset protection efforts noted above increased sharply. 17. The two structural performance criteria slated for the thirdquarter of 2005 were observed. First, the government adopted an action plan (including a timetable) for the introductiono f an automatic price adjustment mechanism for refinedpetroleumproducts. The plan envisages implementinga newprice structure in2006, following the completionof two studies, with World Bank technical assistance, to undertake a social impact analysis and an economic and strategic review o f the CORAF. Second, the certification o f forestry revenues in2004 by an audit firm of international reputation was completed and the report was submittedto the government. 18. Most structural benchmarks were also observed, including (i) adoption by the government o f a strategy to refocus the activities o f the SNPC on its core activities inthe oil sector along with an implementationtimetable; and (ii) certification o f oil revenues by an audit firm o f international reputation for the second quarter o f 2005 and the publicationof the related report on the Internet site. Nonetheless, the auditors for the oil revenue certification didnot have direct accessto treasury bank accounts for verifying oil revenues due to the government against cash receipts; inNovember, the government and the audit firm came to an understanding on direct information access for oil revenuecertification starting inthe last quarter of 2005. The benchmark on the adoption by the government of a comprehensive plan for the settlement of domestic arrears was missed, although the process for reaching an agreement with creditors was launched with IDA technical assistance from a private firm specializing inthis field. The treatment o f domestic arrears would include treatment o f social arrears, including the preparation in2006 o f a settlement plan for the latter. Some progress was made toward strengthening the banking system. First, an audit firm of international reputation completed an audit of the statement o f the loanportfolio as o f March 31,2005 o f a bank indifficulty. Second, with assistance from o f the Central African Banking Commission (COBAC), the government prepared an actionplanto further strengthen recovery of the banking system's nonperforming loans. 19. The Congolese authorities planto request waivers for the nonobservance ofthe two quantitative performance criteria noted above at the time o f the second review under the PRGF arrangement. Key issues for discussion with the authorities at the time o f the next 'Private oil companies can unilaterally activate guarantees provided by the government- . entailing direct deductions from payments o f tax obligationto the government-for unpaid bills by CORAF for its purchase o f crude oil. The price for lighter crude oil, such as Brent-a widely usedinternationalbenchmark-rose much faster than for heavy crude, such as the Congolese oil blend. - 1 5 - PRGF review would include management of oil revenues, strengthening o f the quarterly reconciliatiodcertification o f oil revenues, the marketing o f government oil by the national oil company, the awarding of contracts on oil concessions, governance and transparency in general, the schedule o f retail fuel price adjustment, and the status o f CORAF's losses. 111. MEDIUM-TO-LONG-TERM STRATEGYFORPOVERTY REDUCTION A. PRSPFormulationProcess 20. In2004, the government prepared anI-PRSP, basedon consultations withthecivil society and donors. The poverty reduction strategy proposed inthe I-PRSP presents a long- term vision of development based on five pillars: (i) consolidation o f peace and good governance; (ii) consolidation o f macroeconomic stability andpromotion o f key economic sectors; (iii) improving access to basic social services and social protection; (iv) improving access to infrastructure; and (v) strengthening the fight against HIV/AIDS. 21. The staffs of the IMF and IDA consider that the I-PRSP provides an appropriate framework for poverty reduction and use of resourcesthat could become available under the enhancedHIPC Initiative. The I-PRSP was analyzed inajoint staff advisory note (JSAN), which recommended (i) widening the participatory processto include a larger component o f civil society, (ii)improvingthe quality and availability o f data with a household expenditure survey, and (iii) continuing to focus on targeted areas o f interventionsuch as fiscal transparency, economic growth, public finance management, and the legal framework. 22. The government has begun the preparation of a full PRSP. With IDA assistance, a donors' meetinglowas organized inFebruary 2005 to evaluate the I-PRSP implementation process and to prepare the groundwork for a full PRSP. A key outcome o f the meeting was the creation of a donor coordinationbodyto support the PRSPprocess andto facilitate donor participation inthe formulation of activities. A full PRSP i s expected by late 2006. 23. The participationprocess for a full PRSPwill bebroadened and deepenedby including the input o f civil society early inthe design process. To enable an improved poverty diagnosis, a rapid poverty assessmentwas conducted inJune 2005, and a household survey, which i s underway, i s expectedto be completed by end-March 2006. The implementation o f the Core Welfare Indicators Questionnaire (CWIQ) will be an opportunity to reassess the level o f poverty inthe country and the main vulnerable groups, andto provide a benchmark assessmentof the state of social service delivery. Beyond the national household survey, steps will needto be taken to strengthen the country's monitoring and evaluation systemfor the full PRSP. loAside from the authorities, participants included the FrenchEmbassy, the French Cooperation Agency, UNDP, World Food Organization, UNICEF, European Union, WHO, UNIFEM, and IDA. - 16- B. Macroeconomic Objectives 24. Giventhat the decisionpoint is beingpresentedon a standalone basis, the macroeconomic projections usedare those discussed inthe preliminary HIPC document (Tables 4 and 5)." The forecasts are basedon assumptions o f continued progress on peace and reconciliation, sound macroeconomic policies, increased investment ininfrastructure and human capital, structural reforms that promote a business-friendlyenvironment, and policies that significantly enhance transparency and governance and promote sound institutions and the ruleof law. The baseline scenario assumesthat Congo benefitsfrom traditional debt relief mechanisms, with a significant downward impact on debt service. Inaddition, the compositiono f public expenditurei s expectedto shift infavor o f pro-poor capital outlays. More broadly, and inline with the authorities' I-PRSP, the projections assume that the share of pro-poor spending inoverall outlays will increase inorder to allow Congo to make progress toward the MDGs. 25. Reflectingthe above assumptions, real GDP growth i s projected at close to 5 percent per year during2005-24, with a rise ininvestment(Tables 4-5). Inview o f depletingoil production, the non-oil sector's importance i s projected to rise significantly over the long run.Oilproductionis expected to increaseuntil2010 as newoil fields come on stream, and thento decline over the following two years as this positiveeffect is offset bythe depletion of older oil fields. Non-oil real GDP growth, by contrast, i s projected to rise steadily over the period, largely on account of higher investment,reflectingthe positive impact o f structural reforms designedinparticular to promote greater private sector activity. The projected economic growth i s below that neededto halve the proportion o f the populationlivingbelow the poverty line (i.e,, about 8 percent per annum inthe non-oil sector), but it is considered realistic. As a point o f reference, non-oil real GDP growth has averaged about 3.3 percent per year during 1980-2004. 26. As a member of a monetary union, sound fiscal policy is the main domestic policy instrumentto securemacroeconomic stability. Inflationis projectedto averageabout 2 percent annually, mostly reflectinga prudent fiscal policy. The macroeconomic projections assume an improvement inthe non-oil basic primary fiscal balance from non-oil revenue mobilization and better expenditure management. A number o f recent measureshave been taken to widen the tax base and extend the reach of the central administration (Box 2). Medium-to -long-term measuresto enhancenon-oilrevenues include: the conduct ofregular tax audits; the establishment o f computerized links betweenthe various customs andtax administration offices; the use o f the singletaxpayer identification number; andthe streamlining of discretionary tax exemptions. It is expected that compliance by taxpayers l1The related forecasts are based on the Spring 2005 WorldEconomic Outlook (WEO). Appendix Iprovides a summary of the macroeconomic framework under the September2005 WEO; a key change is the significant rise inworld oil prices. - 17- would rise significantly on the basis o f improved government services. Thus, non-oil revenues are projected to rise steadily to reach about 16%percent o f GDP by 2024. 27. The overall budget balance is projectedto remain positive throughout the forecast period, but to decline significantly from 2012 onward reflectinga projected decline inoil revenues. The authorities are assumedto continue implementing a conservative fiscal rule regarding oil revenue projections; under the rule, oil revenues (and, consequently, expenditures) should be projected on the basis o f conservative oil price projections (IMF WE0 projectedpriceminus US$4 per barrel). 28. Export and import volumes are expectedto grow by 3% percent and 5 percent respectively per year on average during 2005-24. As a result, the external current account balance would move to a small deficit positionon average during this period (from a small average surplus position during 2000-04). Congo has an immediate balance-of-payments need stemming primarily from the needto settle large external arrears to commercial creditors amounting to some US$3.4 billion (74 percent o f 2004 GDP). Debtreliefwill be key to meeting these financing requirements.In2005, however, financing is assured, thanks to resources already committed by bilateral and multilateral donors, and financing assurances provided by Paris Club creditors. C. Governance,and StructuralandInstitutionalReforms 29. Inview ofCongo's heavy dependenceonoil, enhancing transparency inoil sector operations i s a key aim o f the government's reform program. To this end, the government has implementedanumber of reforms, supported inpart by the IDA-financed Governance and Transparency Capacity Building Project. This included audits o fthe SNPC's accounts (Box 3) while key recommendations o f the 1999-2001 audit were incorporated into an action plan, designed with the support o f IDA. 30. The SNPC action plan is being implemented, although with some delays, and, in order to improve implementation, the government has hireda private consulting firm to assist inthe process.An evaluation, undertakeninearly January2006, indicates that 9 out ofthe 20 actions have beencompleted, another 5 are near completion (including reinforcement o fthe Hydrocarbons unit inthe Ministry of Finance, establishment o f a humanresources and training strategy, reconciliation o f cross debts with the State for the period 1999-2003), leaving 6 which are far from completion at this time. These pertainto the study to model reserves and oil revenues (action l), the reform of the accounting system(action 6), the verification of partner accounts (action lo),the verification ofpast petroleumcosts (action 12), the study o f petroleum reserves (action 13), the elaboration o f operating procedures and manuals for SNPC departments (action 15), and the establishment o f a management information system (action 19).The government has stressed the need to improve the quarterly reconciliationo f revenues, to ensure that the marketing o f oil by SNPC, whether undertaken directly or indirectly, i s inline with best international practice as regards prices obtained, the fiscal take, and the timely transfer of revenues to the Treasury. To this end, it intendsto commission appropriate studies with the assistanceof the international financial community, inparticular IDA andthe IMF.These studies are expected to be completed and - 1 8 - their recommendations implemented before the completion point. Furthermore, the government intends to take all measures needed to permanently eliminate potential or actual conflicts o f interest, whereby senior SNPC officials are able to have interests incompanies with which SNPC has a business relationship. Ithas already taken a number o f steps to eliminate several such conflicts o f interest that have been made public during 2005. 31, The government publicly announced inJune 2004 its commitment to adhere to the Extractive Industries Transparency Initiative (EITI).l2While progress has been slow toward full participation inthis initiative, the following developments since the June 2004 announcement are noteworthy: The government reaffirmed its commitment to the EITIat a round table organized by Publish What You Pay, an NGO, inPointe Noire inFebruary 2005; this meeting was also attended by representatives from other NGOs, the national oil company (SNPC), and private oil companies operating in Congo. 0 Following the EITI conference inLondon inMarch2005, Congo was named ina press communique as one of nine countries that had made progress inimproving transparency inthe managementoftheir oil revenues. 0 InSeptember, the government convenedanEITIworkshop withcivil society andoil companies, during which a 25-member EITI Executive Committee was nominated. The authorities have also recently launched a website (www.mefb-cg.org/eiti) with information on EITI implementation in Congo. The next step will be the preparation o f the Committee's Action Plan. 32. With regard to public expenditure management, the government plans to (i) a adopt functional classification o f budget expenditure including for poverty related expenditures, with IMF and IDA technical assistance; (ii) streamline the spending chain inorder to strengthen the framework for tracking expenditures from commitment to payment stage; (iii)complete the computerization o f budget execution; and (iv) review the public procurement system, with IDA technical assistance. Inaddition, with technical assistance from IDA and IMF, the government plans to adopt a medium-term budget framework. Such a framework would enable improved management of both oil- and non-oil revenues and a better mapping o f expenditures with the priorities identified inthe PRSP, taking into account the sustainability o fthese expenditures. Bearing inmindthe importance of oil revenues in total government receipts, as well as the volatile and uncertain nature o f oil revenues, a regular update evaluating the level o f reserves and the trajectory o f oil production will be undertaken so as to obtain the best estimates over the medium-long term. 12TheEITIsupports improvedgovernance inresource-rich countries through the full publication and verification o f company payments and government revenues from oil, gas and mining. -19- 33. World Bank and IMF staffs will assist the authorities inthe evaluation of existing systems o f public finance management, and the identification of areas where reforms and technical assistance are needed. The World Bank expects to undertake a Country Integrated Financial Assessment inthe next few months, and to hold a seminar inMay/June 2006.13 This processwill help identify the key reforms neededwith respectto revenuemobilization andexpendituremanagement, control and auditing, as well as procurement reform. The Bank will conduct a Public Expenditureand Financial Accountability (PEFA) exercise. Subject to requests from the authorities, the IMF would provide technical assistancethrough the Fiscal Affairs Department, and the Bank through the Transparency and Governance Project, as well as the Emergency Recovery and Community Support Project. Through these actions, major reforms are expected to be designed and implementedbetweenthe decision and completion points, particularly as regards the efficiency o fpublic expenditure, especially those related to poverty reductionand public investment, as well as procurement. Onthe revenue side, further improvements are to beexpectedinthe certificationandreconciliationofoilrevenues and the mobilization o f non-oil revenues. 34. The forestry sector has a number of weaknesses, including modest transfer of receipts to the treasury, illegal logging, weak regulatory framework, and lack of transparency and competition inawarding concessions. Actions taken by the government to start enhancing forestry sector management include: (i) hosting, inFebruary 2005, a Summit o f Central Africa Heads o f States which focused largely on resource management and governance issues; (ii)auditing forestry sector revenuesfor 2004 by an independentauditor; and (iii) initiating, inOctober 2005, a three-month test project to strengthenthe control operations against illegal logging, with assistance from international observers. Looking ahead, with technical assistancefrom IDA, the government plans to undertake regulatory and institutional reforms, and adopt market-based instruments. 35. Private sector development is key to pro-poor growth, but Congo's external competitiveness suffers from the hi hcost o f doing business (see, for example, the World Bank's Doing Business database)."Actions underway to promotethe sector include reforming the legal andjudicial framework for business, with better guarantees of property rights and the independence of thejudiciary. Progresswith privatization inthe areas of refinedpetroleum products distribution, as well as banking andtelecommunications, are expected to be consolidated. Inparticular, the telecommunications sector i sjeopardized by ~~ ~~ I3A Country IntegratedFinancialAssessmentisacombined CountryFinancial Accountability Assessment (CFAA) which focuses on public financial management and Country Procurement Assessment and Review (CPAR) which focuses on the evaluation and reform of the procurement system. I4 The website is http://rru.worldbank.ora/DoinaBusiness/ExploreEconomies/BusinessClimateSnapshot.aspx? economyid=49. - 20 - regulatory bottlenecks and competitive restrictions that need to be addressed inorder to ensure open and fair access and a positive investment climate. Furthermore, the water and electricity utilities will be rehabilitated and their management upgraded inorder to improve service delivery and the prospects o f privatization. Efforts would also continue to complete the concession o f the vital Pointe Noire-Brazzaville railways link. 36. Finally, and more generally, the government intendsto adopt and implement the recommendations o f a diagnostic governance and anti-corruption study, to be undertaken by an independent group of internationally reputed experts, assisted by the national anti- corruption committee. D. Social and SectoralPolicies 37. Congo i s far from meeting the MDGs relating to mortality, health, and education. Public sector contribution to social services has beeninadequate to restore services that were diminishedor lost due to the effects o f conflict. The government plans to take a number o f actions to enable Congo to make significant progress inreaching the social MDGs. 38. Inthe education sector, the government haspreparedan "Education for All Action Plan" which aims to reach universal primary enrollment by 2015 by improving access, quality and efficiency. The efforts inthe short term are focused on rehabilitating facilities destroyed duringthe war and on improving the quality o f education, notably through: (i)decentralizingmanagementanddeliveryofservices, (ii) strengthening o f partnerships with civil society at the community and school level, (iii) training and hiringteachers, and (iv) enhancing efficiency and transparency o fthe system (inparticular eliminating fictitious teachers). The Ministry o f Education hasjoined the campaign against HIV/AIDS by educating teachers and students. Over the medium term, a key objective will be to improve access, quality, and relevance at secondary and higher education establishments by updating technical education and university curricula, improving efficiency, and introducing reforms inhigher education financing. 39. The health system i s severely damaged and cannot deliver minimumpreventive and curative services to the population. This is due to several factors, including the state o f disrepair o f many health facilities, the contraction o f personnel accompanied by their concentration in cities and l o w morale, and long standing problems inthe pharmaceutical sector which contribute to making access to health care too costly for the poor. The Ministry o f Health and Population has recently developed a National HealthDevelopment Plan, ratified inJune 2005, which i s to serve as a basis for reform. The Ministry has since started recruiting health personnel. Inaddition, the government has beennegotiating a health project with the EuropeanUnion. The objectives o fthis project are to provide support to the pharmaceutical sector, inparticular to establish an independent national drug agency with management autonomy, and to assist with service provision inthree sub-regions. The government also maintains an ongoing dialogue with IDA and intends to request its assistance to finance reforms inthe health sector. -21 - 40. With regard to HIV/AIDS, in2003 the government preparedaNational Strategic Plan for Combating HIV-AIDS for 2003-06 (CadreNational de Lutte contre le VIH-SIDA).The planwas basedon recommendations made during consultations throughout Congo during the secondhalf o f 2003, including the needfor prevention and changes inbehavior through counseling and early testing. In2004 the government obtained an IDA grant designedto finance the implementationo f the National Plan infive sub-regions (covering 82 percent of the population), including interventions to be carried out byNGOs. The sectoral plans included a strategy to inform and assist particular vulnerable groups by ministry (e.g., the Ministryof Defense has a strategy to inform, screenand assist soldiers, andthe Ministryof Education focuses on students and teachers). Recently Congo was granted funding from the Global Fund for HIV/AIDS, Malaria and Tuberculosis, which will make it possible to implementthe "National Strategic Planfor Combating HIV-AIDSfor 2003-06." Financing from IDA and Global Fund will ensure that the necessaryresources will be available to carry out the fight against HIV/AIDS over the next three years. During 2006, the National Commission for HIV/AIDS will evaluate the progress made since 2003 and develop a new national strategic plan for 2007-09. 41, Congo is highly urbanized, with about 70 percent o f the population residing inurban areas. Urban living conditions are characterized by an imbalance among inner-city neighborhoods, which are sparsely populated and have access to functioning infrastructure, and the peripheral neighborhoods, which are often densely populated and lack basic socio- economic amenities. During consultations heldwith civil society on urbanpoverty in June/July 2005, the government decided to focus on the following two constraints: (i) securing land ownership and tenure, and (ii) up o f financing mechanisms to setting improvethe supply o fhousingto the population. Addressingthese constraints would reduce the vulnerability of city dwellers. Iv. DEBTSUSTAINABILITY ANALYSISAND POSSIBLE HIPCASSISTANCE A. Debt Reconciliation Status 42. The DSApresentedbelow was preparedjointly by the authorities andthe staffs of IDA and IMF." It is based on loan-by-loan dataprovided by the authorities and creditors for outstanding external public and publicly guaranteed debt as o f end-December 2004. The debt reconciliation exercise was carried out by ajoint IDA-IMFmissionto Brazzaville in September2005. As of December 2004, about 80 percent of outstanding debt has been l5 The management capacity ofthe national debt management agency (CCA) was described inAppendix I1ofthe preliminary HIPC document (IMFCountry ReportNo. 05/391, November 2005; and IDA Report No. 33252-CGYAugust 2005). Debt management issues have remained unchanged since the discussion by the Executive Boards o fthe preliminary HIPC document. - 22 - reconciled with creditors.l6Financial obligations of the SNPC to private oil companies, amounting to US$ 941 million, do not constitute external debt.17Instaffs judgment, the data, including for the oil sector, underlyingthe debt sustainability analysis are reliable. B. Structure of ExternalDebt 43* Congo's public and publicly guaranteed external debt Table 2: Net Present Value o fExternal Debt, end-2004 i s estimated to be US$9.2 billion (Inunits indicated) innominalterms, or $9.0 billion NPVo fDebt innet present value (NPV) terms Million Percent o f as of end-December 2004, before U.S. dollars total considering the Paris Club debt Total 11 9,007 100 treatment (Table 2 and 6). Multilateral 363 4 l8 This 5,275 59 level of debt corresponds to an Official bilateral Paris Club 4,995 55 NPV of debt o f 661 percent of Other 280 3 fiscal revenues, and 252 percent Commercial 3,370 37 of exports as of end-2004. Memorandum items: I Total debt innominal terms 9,248 44. There are a number of ofwhich oil-collateralized debt 378 features o f the Congolese external NPV o fdebt after traditional debt relief21 5,176 debt that make it relatively unique among HIPCs; key features o f the Sources, Congolese authorities; and Fund and Bank staff estimates and debt structure (inNPV terms) at calculations 11Excluding potential debt o fthe SNPC. end-2004 are as follows (Figure 1, 21 AssumingNaples terms. Table 2): 0 Together, debt to multilateral and official bilateral creditors accounts for about 63 percent o f the total outstanding debt stock. Multilateral debt represents merely 4 percent o f the total stock, while official bilateral debt accounts for 59 percent. l 6 Multilateraldebt has been fully reconciled. Reconciliationdiscussions on Paris Club debt took place inthe context of the December 2004 Paris Club agreement. Commercial debt with the LondonClub group of creditors was fully reconciled. Debtwith other commercial creditors and non-Paris Club bilateral creditors has beenpartially reconciled, owing to incomplete response to requests for creditor statements within these two classes o f creditors. l7 Payments on these obligations are fully linkedto the existence o f oil revenues andno direct transfer from the government or state-owned enterprise takes place inthe absence of oil revenues. See Appendix 11. l 8 The NPV o f debt inCongo is close to its nominal face value; this is explained by the fact that most of the bilateral debt was contracted inthe 1970s and 1980sat near-commercial terms. - 23 - 0 The remaining 37 percent of the debt i s owed to commercial creditors. Ofthis amount, about 55 percent (or 22 percent of the total stock) is owed to non- litigating London Club creditors. The rest is owed to creditors o f oil-collateralized loans (4 percent of total stock) and litigatingcreditors (10 percent o f total stock). 45. Some of the same characteristics describedabove help to explain why financing assurances have been obtained for only 60 percent of the outstanding debt at the time of the decision point under the enhancedHIPC Initiative. Additional financial assurances-required to reachthe 70 percent threshold for the IMFto provide its interimdebt relief-are expected in2006. Indeed, as noted below, a debt deal withthe LondonClub inline withthe enhanced HIPC framework will allow financing assurances to exceed 80 percent (the minimum requiredat the completionpoint). The absence of financing assurancesto the tune of 70 percent at the time o f the decision point would not, however, prevent other multilateral creditors from providing interimdebt relief. 46. On December 16, 2004, Congo and its Paris Club creditors agreedto restructure the Congolesepublic external debt under Naples terms. Assuming comparable treatment from other bilateral and commercial creditors and clearance of multilateral arrears, the stock of outstanding external debt would then amount to US$5.2 billion inNPV terms as o f end-2004 (Table 6). Congo has either cleared, or put inplace plansto clear, all arrears. C. Debt SustainabilityAnalysis 47. The DSA analysis shows that in2004 Congo had significant debt inexcess ofthe enhancedHIPC Initiative fiscal revenuethreshold o f 250 percent, even after the application of traditional debt relief mechanisms.l9 After traditional bilateraldebt relief, Congo's debt burdenis projected to fall slightly below the threshold in2005 and subsequentlyto hover close to this level until2007. After the full delivery o f reliefunder the enhanced HIPC Initiative, the NPV of debt-to-revenue ratio (including new borrowing) i s estimated to fall from 250 percent at end-2004 (after traditional relief) to 162percent in2005 (Figure 2; Tables 3,7, and 8). Staff projections indicate that-assuming continued healthy GDP and export growth (5 percent and 9 percent a year respectively)-the ratio could be expectedto fall subsequently and to remainwell below the HIPC threshold o f 250 percent over the entire projectionperiod, reaching about 66 percent by 2024. l 9The assumptions underlying debt relief are provided inSection 1V.E. - 24 - 48. External debt Table 3: External Indicators2004 and 2005 1/ service as a ratio of (In percent) revenues after the full After traditional delivery of HIPC debt debt relief After enhanced HIPC assistance relief i s expected to fall mechanisms2/ sharply after 2009 and 2004 2005 2004 2005 remain below 10percent NPV of debt-to-revenueratio 31 370 248 250 162 thereafter (Figure 2; NPV of debt-to-exportsratio 41 173 138 117 90 Table 9). This ratio in NPV of debt-to-GDP ratio 119 94 80 61 Debt service-to-revenueratio 31 21 32 2005 is estimated at 32 Debt service-to-exportsratio 41 10 15 percent and projected to Memorandum items remain close to this level Governmentrevenueto GDP 31 32 38 32 38 untilend-2007, the Exports to GDP 41 69 68 69 68 completion point date Sources Congolese authorities assumedfor the purpose 11All debt indicators refer to public and publicly guaranteed(PPG) debt and are defined after O f the SimUkltiOn- Until rescheduling,unless otherwise indicated 21Reflect a hypothetical stock-of-debt operation on Naples terms at end-2004 for official bilateral and thispoint interimrelief3/ commercial creditors havea more limited Revenue is defined as central governmentrevenue, excluding grants effect on debt service. 4/ Exports of goods and services as defined in IMF, Balance ofPaymenfs Manual, 5th edition, 1993 Basedon a three-year average of exports on the previousyear 49. Since the issuance of the preliminary document, world oil prices have increased significantly-by a projected average of US$16,3O/barrel per year over the DSA simulation period. The DSA using a preliminary update of the macroeconomic framework confirms Congo's debt overhang problem in2004 (details are providedinAppendix I). This overhang would be significantly alleviated after the application o fthe traditional debt relief mechanisms, and Congo's debt profile would reach a comfortable level following relief underthe enhancedHIPC Initiative.The simulations also indicate that Congo's NPV-of- debt-to-revenue ratio would fall significantly below the 250 percent threshold starting in 2005 after the application o f the traditional debt reliefmechanism. D. SensitivityAnalysis 50. Two alternative scenarios were carried out to simulate the trajectory o f Congo's external debt burdenindicators after HIPC Initiative assistance (Figure 3; Table 10). These scenariosillustrate the vulnerability of the Congo's debt dynamics to various types of exogenous shocks. One scenario considers the sensitivity o f the projections to the effects of lower oil prices on exports and government revenues, assuming an unchanged level of external assistanceand investment.The international market price for oil i s assumedto be - 25 - 40 percent lower throughout the forecast periodrelative to the baseline, with the prudence factor unchanged at US$4/barrel; accompanying second-round effects on GDP growth are also accounted for.20The ratio of the NPV of external debt-to-revenue rises significantly; over the period 2005-14 the ratio is on average higher by about 30 percentagepoints per year relative to the baseline scenario. The second scenario considers the impact o f a three- percentagepoint lower non-oil GDP growth relative to the baseline throughout the projection period. The impact of this shock, while not as pronounced over the mediumterm as the oil- price effect, increases over time as the share o f the non-oil sector increases. The NPV of external debt-to-revenue over the period 2015-24 i s higher by about 25 percentagepoints per year relativeto the baseline scenario.Nevertheless, under both scenarios, the NPV o f debt-to- revenueratio remains below the 250 percent threshold over the simulationperiod. 51. Further debt sustainability analysis, following the methodology ofthe Joint Debt Sustainability Framework for Low Income Countries approved by the IMF and the World Bank in2005, and including the standardized stress tests of that framework, i s reported in Appendix 111. E. PossibleHIPC InitiativeAssistance 52. Debt reliefunderthe enhancedHIPC Initiative is expected to reduce Congo's external debt by about a third (after accounting for the impact o ftraditional debt relief mechanisms). The delivery o f traditional debt relief lowers the external debt-to-revenue ratio to about 370 percent; to reduce this ratio further to the HIPC target of 250 percent impliesa common reduction factor of 32.4 percent for all creditors.21This would be equivalent to enhancedHIPC debt relief inthe amount o f US$1,679 million inend-2004 NPV terms (Table 11).22 2o The resulting average oil price over the forecast period is inline with the historicalaverage over the period 1985-2004. 21 The commonreductionfactor is lower than inthe HIPC preliminary document owing to higher oil revenues (the preliminary document was based on end-2003 data). Fiscalrevenues expressed inU.S.dollars increased by 34 percent in2004. 22 InJuly 2005, the G8 group o f countries proposed the write-down o f all debt outstanding to the IMF,IDA, and AfDF for all HIPC completionpoint countries. Reaching the completion point will qualify Congo for debt reliefunder the HIPC Initiative and the Multilateral Debt Relief Initiative (MDRI). (See "The Multilateral Debt ReliefInitiative and its Implications for the Fund, November 1,2005, SM/05/353" and "The Chairman's Summing Up, November 16, 2005, BUFF/OS/l 88''). MDRIdebt relief will only cover credit outstanding as of end-2004 to the IMF, IDA and AfDF. Betweenend-2004 and attainment o f the completion point, Congo will continue to satisfy its obligations to these three institutions. The impact o f the MDRIis assessed inAppendix I11underthe LIC DSA analysis. Dueto the structure of Congolese debt, the MDRIwill have limitedimpact on Congolese debt sustainability. - 26 - 53. Out of total enhanced HIPC relief, multilateral creditors would contribute US$l18 millioninNPV terms, and Paris Club bilateral creditors US$913 million. Commercial creditors would be expected to provide a further US$590 million of reliefin NPV terms, and other official bilateral creditors US$58 million. Under the time profile and modalities laid out below, reliefwill translate into about US$2,906 millionof total debt service relief over time. The following assumptions were made inprojecting the time profile of possible enhanced HIPC Initiative assistance: For Paris Club bilateral creditors, there would be a flow rescheduling on Cologne terms-Le., a 90 percent NPV reduction-after reaching the decisionpoint, with delivery of the remaining assistance at the completionpoint through a stock-of-debt operation (Table 12). IMF assistancewould total US$8.08 million inNPV terms. IMFinterim assistance is assumedto be delivereda year after decision point approval, provided necessary financing assurances are inplace (Table 13). Giventhe Congo's debt structure-with loans from multilateral and Paris Club creditors comprising only 60 percent oftotal debt-reaching the 70 percent threshold for financing assurancesto allow the Fundto disburse its interimassistance will requireother creditors to participate inthe enhanced HIPC I n i t i a t i ~ ePrincipal repayments obligations on IMFPRGF loans will start falling . ~ ~ due in2010. Interimassistance from the Fundwill be applied, therefore, to cover IMF PRGF interest obligations falling due between2007 and end-2009. Most o fthe IMF's reliefwould be delivered following the completionpoint. IDA is assumedto provide total assistanceamounting to US$49 millioninNPV terms (Table 14). Immediately following the approval of the decisionpoint by the Boards o f IDA andthe IMF, IDA will beginto provide debt service reliefinthe form ofdebt- service reductionon debt outstanding and disbursed at end-2004. WhenCongo reaches the completionpoint, this debt service reliefwould become irrevocableand continue until 2021. AfDB Group assistance comes entirely inthe form ofthe arrears clearance operation under the framework for assisting post-conflictcountries (PCCF) (Box 4). The treatment for non-Paris Club official bilateraland commercialdebt is assumedto be inlinewith that ofthe Paris Club creditors. As notedabove, some commercialdebt (estimated to be 11percent o f the total NPV of debt outstanding) remains subject to legal action by creditors. However, it is expected that a deal with London Club creditors following the decision point would raise financing assurancesto over 80 percent (the minimumrequiredat the completionpoint). Nonetheless, reachingan 23The Congolese authorities planto make concrete proposals to London Club and other creditors once the framework o f the enhanced HIPC Initiative i s inplace. - 27 - Box 4. ExternalArrears Clearance The African DevelopmentBank Group (AfDB) approvedinJuly 2004 a framework for assisting post-conflictcountries (PCC) to clear their AfDB arrears. Underthis framework, the cost of clearing country arrears is sharedby the country, donors, andthe AfDB PCCFacility (PCCF).' The proportionof the cost coveredby eachparticipant is determinedcase by case. For Congo, the following framework was adopted:the country paidSDR34.3 millionto clear athird ofthe total SDRl00 million inarrears at end-2003; donors (France, Norway, andEuropeanCommission) pledgedSDR32.4 million; andthe AfDB approveda SDR33.3 milliongrant fromthe PPC facility to completethe arrears clearance plan. BADEA agreedon consolidatingUS$25.6million inarrears inOctober 2001. The arrears were to be repaidover 13 years on concessionalterms. Congo failedto respectthe agreementinitially, but it resumedpayments in2003. Uponreceiptof the overdue amounts, BADEA agreedthat the authorities couldmakethe remainingrepaymentsaccordingto the profile set inthe 2001 agreement. OPEC Fund arrears have beeneliminated via a Commodity ImportProgram(CIP) ofUS$13 million. The authorities have repaidall but US$12.1millioninarrears outstandingas of end-2003, andthe CIP financedpaymentofthese arrears duringthe calendaryear 2004. The CIP loan amount will be repaid over 9 years on concessional terms. Arrears to the European Uniontotaling some US$39.2millionhavebeenclearedwith a grant fkom the EUmostlythrough a reallocationofUS$38.2million fromthe EuropeanDevelopment Fund resourcesalready pledgedto Congo. In2003, Congo repaid SDR 2.9 million inarrears to IFAD andUS$1.5 millionto the Banquede Developpernentdes Etats de 1'AfriqueCentrale (BDEAC). Paris Club creditors restructuredthe Congo's public externaldebt onDecember 16,2004. A total o f US$3,020millionwas treated. The agreement treats, underNaples terms, bothaccumulated arrears at end-September2004 (including late interest) andcurrent maturities falling due during October 1, 2004 -September30, 2007. Pre-cutoff date ODA debts were rescheduledover 40 years, with 16years of grace. 67 percent of pre-cutoff-datecommercial credits were cancelled;the remaining amount was rescheduledover 23 years, with 6years of grace. Arrears onpost-cutoff-date debt and a part ofthe interest due under the reschedulingwere re-profiledover a periodo f 3 years (October 1,2004 - September30,2007).As o f September 2005, all bilateralagreementshavebeen signed. The authorities are indiscussions to settle arrears with non-Paris Club creditors Algeria, Angola, Kuwait, Libya, and SaudiArabia. The SaudiArabia Fundhas expressedwillingnessto discuss further reliefonce Congo reachesthe decisionpoint.The Kuwait Fundhas also expressed willingness to apply enhancedHIPC Initiativedebt reliefto its loansto Congo. The authorities expect to enter into discussions with the UnitedArab Emirates, China, France(Postal andHospital Services), andRomania inthe coming months. The governmenthas beenin discussionswith the London Club Steering Committee.Bothparties have agreedto negotiate the settlement of arrears following the decisionpoint. The government expects to settle arrears with other active commercial creditors onterms comparableto those under the enhanced HIPC Initiative. ' The PCC facility is a legal autonomous entity under the auspices of the African DevelopmentFund (AfDF) for the sole purpose of providing grant resourcesto assist qualifying PCCs clear their AfDB Group arrears. The facility is financed as follows: SDRlOO million from the AfDB net incomeallocations, SDRlOO million from ADF-IO resources, and SDR7 million from Nigeria Trust Fund income allocations. - 28 - agreement on debt restructuring and relief with litigating creditors may be challenging and could pose difficulties relative to uniformity o ftreatment issues. 0 All other creditors are assumed to provide debt-service reductionstarting at the decision point or the completion point, depending on creditor practices, untiltheir contributions meet the requirementunder the enhancedHIPC Initiative. V. FLOATING COMPLETIONPOINT A. Triggers for the FloatingCompletionPoint 54. IDA and IMF staffs have reachedunderstandings withthe authorities onthe completionpoint triggers, summarized inBox 5. The triggers incorporate the views expressedby executive directors during the discussions o fthe preliminary HIPC document and legitimate concerns expressedby other relevant stakeholders. Inaddition to standard triggers, sector specific triggers relate to: public finance management; natural resource (oil and forestry sector) management; telecommunications reform; and basic health and education reform. However, it was decided that successive annual audits would be requiredfor the governance and the oil sector triggers, which refer to triggers 5, 5(i), 5(ii), 5(iii). 0 As regards public finance management, the first trigger pertains to the establishment of a functional classificationfor expenditure, (including a sub-classification for poverty related outlays) and the presentation of the budget using it. This should ensure that all expenditures, inparticular those related to poverty expendituresprograms, are monitorablefrom commitment to payment. These objectives will be also furthered throughthe adoptiono f a medium-termframework for expenditure management. The public investmentrelated trigger has the objective o f improving economic and social returns o f the public investment program, especially that financed through the national budget (about 5-6 percent of GDP), which represents 80-90 percent of central government capital formation. This trigger i s complemented by that pertainingto the reform of the procurement system (legislation and institutions), neededto improve governance, competition, and transparency. 0 The governance trigger is to provide athorough and broadassessment of governance issues, with the authorities mindful o f the widespread perceptionthat corruption remains a major problem inCongo. The authorities concurred with the urgency to addressthis issue now, not least to ensure the appropriate use of reliefto be obtained underthe enhancedHIPC initiative (about US $2.9 billioninnominalterms). This trigger i s complemented by specific triggers relating to natural resource sectors, where poor governance and corruption are considered to be o f particular concern. Box 5: Triggers for the Floating Completion Point 1. PRSP: Preparationof afull PRSP through a participatory process and satisfactory implementationof its recommendedactions for at least one year, as evidencedby an Annual ProgressReport submittedby the government to the staffs of IDA and IMF. 2. Macroeconomic stability: Maintenanceof macroeconomic stability as evidencedby satisfactoryperformanceunder the PRGF-supportedprogramas well as any IMF successor program. 3. Public expenditure priorities: Alignment of public spending priorities in accordancewith the priorities identifiedinthe I-PRSP, and, when completed, the PRSP, reffecting emphasis on pro-poor growth. 4. Public finance management: (i) Establishmentof afunctional classificationsystem for governmentexpenditures, including povertyrelatedexpenditures consistentwith the IMF's Government Finance Statistics manual, and preparationof government budgets usingthis new classification;(ii)Implementation of a new public investment management system to provide rigorous selection, and efficient executionand monitoringof the projects; submission of draft public investment programsto IDA for review; (iii) Adoption and satisfactory implementationby the governmento fanew procurementcode (that promotes transparency and Competition), in line with internationalbest practice; (iv) Adoption by the government of amedium-termframeworkfor sustainable managemento f government expenditures and revenues, with technical assistance from IDA and IMF. 5. Governance and natural resource management Governance: Completion of a diagnosticgovernance and corruptionstudy by an independentgroup of internationally reputedexperts, assisted by a national anti-corruptioncommittee, basedon terms of reference preparedin consultation with IDA and IMF staffs.The terms ofreference and compositionofthe national anti-corruptioncommitteewill be satisfactoryto IDA and IMF staffs. Adoption by the government of an actionplan, preparedin consultationwith IDA and IMF staffs, to improve governance and reduce corruption,and sustainedimplementationof such action plan during the completionofthe audits referencedin subsections 5(i) and 5 (ii). Assessmentof the implementationof the action plan by IDA and IMF staffs on the basis of an independentreview by internationalexperts acceptableto IDA and the IMF. Oil sector: (i) Assessment by IDA and IMF staffs: basedon successiveannual audit opinions by an independentfirmof internationalreputation, and certified by the national anti-corruption committee, that SNPC's internal controls and accountingsystem are in line with international standardsand bestpractices; (ii) Preparation, by an independentfirm of international reputation, of adiagnostic study of the practices for the commercializationof oil by SNPC, basedor terms of reference prepared in consultationwith IDA and IMF staffs. Assessment by IDA and IMF staffs, based on successive audit opinions by an independentfirm of international reputation,that the commercializationof oil by SNPC has beenbrought into line with internationalbestpractice on the basis o fthe recommendationsofthe diagnosticstudy, and results in competitive and fair market values to Congo for the oil sold;' and (iii) Adoption and application by the Government, certified by the nationalanti-corruption committee, duringthe completion ofthe audits referencedin 5(i) and 5(ii), o f a legal text stipulating: compulsory declaration, to the NationalAuditing Office (Cour des Comptes), by the members of the Executive Board of SNPC andthose havinga managementmandatewithin SNPC and its subsidiaries, at the momentof their nomination and annually thereafter, oftheir participation or other interests in companies having businessrelationswith SNPC or its subsidiariesas well as the verification and annual publication of the aforementioned declarations by the National Auditing Office (Cour des Comptes). divestitureby the members of the Executive Board of SNPC and by those having managementresponsibilities within SNPC or any of its subsidiaries of such participationsand/or other interests, within atime period of 6 months after their nomination andprohibition ofthe taking of any interestin companieshaving businessrelationswith SNPC during the periodof their mandate. Forestry sector:Review of forestry sector managementand legislationwith IDA assistance;adoptionby the government of measuresrecommendedby the review to promote competition, transparency, and sustainable developmentinthis sector. 6. Structural reform: Review and adoptionof a regulatoryframework for the telecommunicationssector establishingcompetition at the level of internationalgateways and the wireless local loop. 7. Social sectors: Education: Implementation during 2006 of astrategy to eliminate fictitious workers from the education budget and increaseteacher staff by, at least, 1,000 each year in basic educationuntil 2007.Health:Increaseto, at least, 60 percent the shareo fgeneric drugs intotal expenditureson drugs by the central purchasing agency.HZV/AIDS: Increase inthe number of voluntary AIDS counselingandtesting centers with associatedmeasures(staff, equipment, and awarenesscampaign) from 4 at presentto, at least, 10 in 2006 and 15 in2007. 8. External debt management: (i) Publication of the quarterly external debt data and projections on a governmentwebsite; and (ii)Centralizationof all information on debt, including collateralized debt, in the government's debt agency (CCA). 'Internationalbest practice is understood to comprise arms-length market pricing, or where that is absent, reference to an establishedbenchmark crude oil price for Congolesecrude oils, with appropriate adjustmentsfor transport and quality differentials. - 30 - 0 The oil sector triggers pertain to (i) improving SNPC's accounting system and internal controls; (ii) improving its marketing practices; and (iii) reducing the scope for conflict of interest by Executive Directors and highlevel staff (with a management mandate) within SNPC and its subsidiaries. The trigger pertaining to accounting responds to, among others, the finding o f the external auditors that considered as "not auditable" the accounts o f SNPC, a company o f macroeconomic significance as it (i) monitors the oil sector and fiscal flows on behalf o f the State, and (ii) markets about two thirds o f the state share o f Congo's oil and about 40 percent o f the country's total oil revenues. The marketing trigger is designed, inparticular, to (i) the SNPC's marketing o f oil inline with best bring international practices so as to obtain competitive and fair prices after adjusting for transport costs and price premiumidiscount, and (ii) ensure that all revenues due to the State from SNPC and any private sector companies it employs are effectively remittedto SNPC and subsequently transferred to the Treasury. To this end, as a sign o f good faith, the authorities have agreed to provide to KPMG, as well as to IDA andIMF, the documentation that had beenrequested by KPMG while undertaking the 2004 oil revenue certification process. The third trigger seeks to ensure the removal o f recently identified conflicts o f interest, and the avoidance o f their resurgence. 0 The triggers inthe forestry sector, the second most important productive sector inthe economy and o fparticular importance from an environmental standpoint, have been retained as a result o f the studies and fiscal audits done inthe sector over the last few years (fiscal, institutional and revenue certification studies among others). Needs for improvement have been identified inthe following areas: enforcement o f mandatory managementplans to all production forests and sensitive buffer zones, coordination between the Ministries incharge o f Forests and Finance inmatters pertaining to the determination, collection and transfer o f forest taxes to Treasury; review and improvement o f the 2003 forest taxation regime and social responsibility clauses o f forest companies (cahiers de charges); enhancement o f the system for awarding forest contracts with more transparency and more prominent use o ffinancial criteria; improved control over illegal logging and poaching through the use o f third party observers. 0 The structural trigger pertains to the telecommunications sector, with the objective o f ensuringthat access to international telecommunications is no longer monopolized by a public or private operator, as is the case at the moment (the October 2004 - 466 Decree restored monopoly powers on international gateway and instituted bottlenecks in providing complete exclusivity on the WLL (Wireless Local Loop) market to Sotelco, the incumbent operator). The application o f the decree 466 would constrain the Congolese telecommunication sector to take a major step back incontradiction with all current worldwide regulatory practices. First, constraining mobile operators to physically and/or financially transit all their international traffic through Sotelco would dramatically imperiltheir economic sustainability. Second, setting up exclusivity on the WLL would originate strong disincentives on investments inthe sector. The social sector triggers address the most pressingprobIems inthe education sector, where there i s a crucial shortage o f teachers, which must be relieved inorder to expedite - 31 - the improvement o f educational outcomes. The objective inthe health sector is to increase the availability o f and access to low cost highquality generic drugs; and with respect to AIDS to ensure that those who wish to do so can know their serological status and be able to change their behavior so that they will not infect other people and be able to seek treatment ina timely manner. 0 Finally, the debt management trigger is intendedto improve the availability o f debt related information and an improvement in external debt management. These triggers are considered essential to the success o fthe enhanced HIPC Initiative in Congo. B. Monitoringthe FloatingCompletionPointTriggers 55. IDA and IMF staffs will work together closely to monitor the completion point triggers, with each institution leading on issues where its staff has primary competence, while also incorporating contributions o f the staff from the other institution. IMF staff will take the lead inmonitoring macroeconomic stability and budget control and management. IDA staff will take the lead inmonitoringprogress inthe preparation and implementation o fthe PRSP, as well as progress on sector-related triggers, includingthose pertaining to structural reforms, public expenditure management, and tracking of poverty-related expenditures. IMFand IDA staffs willjointly monitor those pertaining to transparency inthe oil sector and the forestry sector, and progress inimproving external debt management. C. Use and Monitoringof EnhancedHIPC InitiativeDebtRelief 56. The authorities are committed to ensuringthat HIPC assistance i s used to increase poverty-related spending. Securing the effective use of debt relief for pro-poor growth and spending, and the capacity to monitor a shift toward pro-poor expenditure, are key elements o f the HIPC Initiative. These objectives will require continued efforts to strengthen the programming, management, and control o f expenditures, andto improve service delivery in key sectors. Technical assistance on public expenditure management by IDA and the IMF will be essential to build adequate budget management capacity (Box 6). 57. Interimrelief i s discretionary on the part o f all creditors, and conditional uponthe maintenance o f satisfactory performance under both Bank- and Fund-supervised programs. Prior to completion point, to provide assurance of the effective use o f interim relief, spending o f interimassistance will be controlled through the use o f a special treasury account at the regional central bank (Banque Centrale des Etats d'Afique Centrale)where the interimdebt- service savings will be deposited. Expenditures from this account will be limited to agreed poverty-reducing categories, will be monitored by a committee comprising representatives in observer status from international donors and Congolese civil society, and subject to annual independent publishedaudits. Inthis regard, Congo currently uses a budget classification by economic category, which will initially guide the definition and monitoring o fpro-poor spending, This system would be improved once the government adopts a functional classification o f budget expenditure with IDA and IMFtechnical assistance. Rapid - 32 - introduction o f this functional expenditure classification, and stronger public investment management and procurement, would help ensure that debt relief assistance is focused on the priorities identified inthe I-PRSP and - once prepared - the PRSP. ~~ Box 6. ExpenditurePriorities Governance 0 Finance a results-based monitoring and evaluation system, as a management tool for efficient public resources utilization. 0 Financejudicial system reform. Social Protection 0 Resettle and reintegrate ex-combatants and civil strife victims. 0 Provide social safety nets linked to employment creation, especially for youth. InfrastructureRJrban 0 Rehabilitate roads, particularly rural access roads. 0 Rehabilitate and expand coverage of water supply systems. 0 Rehabilitatepower grids. Health 0 Intervene to control the spread o f HIVIAIDS. 0 Promote immunization, good hygiene, the use of oral hydration salts, and good nutrition practices; the use of bed nets to prevent malaria, and condoins to prevent unwanted pregnancies and sexually transmitted diseases. 0 Rehabilitatehealth infrastructure. Education 0 Raise significantly the share o f expenditures on primary education in total public expenditure. 0 Hireadditional teaching staff (for primary schools). Rural 0 Improve rural roads. ~ D. Authorities' Views 58. The authorities have emphasized that Congo's external debt remains unsustainably highand could further delay Congo's economic and social reformprograms. They have also noted that a significant share o f the population lives inpoverty, and lacks access to basic needs such as education, health, and safe water. A decade o f civil wzr resulted infurther economic decline and massive unemployment, fueling continued impoverishment. 59. The authorities have stressed that Congo has embarked since late 2002 o n an irreversible course to reinforce the framework for peace and political stability and implement - 3 - 3 policy reforms in order to set the country on a sustainable path o f growth and poverty reduction. While grateful for financial and technical assistance already obtained from the international community, the authorities now look forward to accessing debt relief under the enhanced HIPC Initiative as soon as feasible. The authorities planto settle arrears to all external private creditors in a way consistent with the framework o f the enhanced HIPC Initiative, Debt relief available under the enhanced HIPC Initiative would help to finance critical social and infrastructure programs, and allow the government to accelerate and intensify reconstruction efforts, as well as improve access to primary education, preventive health care, and urban and rural infrastructure. VI. ISSUES FOR DISCUSSION 60. This paper presents a decision point assessment o f Congo's eligibility for assistance under the enhanced HIPC Initiative, and seeks the Executive Boards' endorsement o fthis assessment. Inaddition, Executive Directors' views and guidance are sought on the following i ssues: 0 Eligibility and decisionpoint:Do Directors agree that Congo is eligible for reliefunder the enhanced HIPC Initiative, and do they recommend approvalof a decision point? 0 Amount and delivery of assistance: Inorder to reduce the NPV o f debt to revenues ratio to 250 percent, the total amount o f assistance under the enhanced HIPC Initiative i s estimated to amount to US$1,679 millioninNPV terms (Table 11). O fthis amount, US$48.9millioninNPV terms is to be provided by IDA and US$S.OS million by the IMF.The staff andmanagement recommendthat IDA and IMF(as soonas the 70 percent financing assurance threshold i s reached) consider providing interimassistance inline with existing guidelines. Do Directors agree? 0 Floatingcompletion point:Do Directors agree that the floating completion point would be reached when the triggers inBox 5 have been met and satisfactory assurances o f other creditors' participation under the enhanced HIPC Initiative have been received? - 34 - FIGURES,TABLES AND APPENDICES -35- Figure 1, Republic o f Congo: Net Present Value of OutstandingDebt at end-2004by Creditor Group before Traditional DebtRelief Operations Paris Club bilateral 56% NonPansClub bilateral 34'0 ilultila 40, Commercialcreditors 31% Sources: Congolese authorities; and staff estimates. Figure2. Republic o f Congo: ExternalDebt andDebt-ServiceIndicators,2004-24 (In percent) NPV o fdebt-to-revenue ratio 440 - -After - traditional debt relief After enhanced HIPC Initiative 400 - 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 50 45 40 35 30 -After - traditional debt relief After enhanced HIF'C Initiative 25 20 15 lo I 5 0 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 Sources: Congolese authorities; and staff estimates and projections. 1/ For 2005-07, it includes the arrears clearance of the Paris Club post cut-offdebt as agreed inthe December 2004 Naples flow agreement. Under this agreement the post cut-off arrears are repaid with less favorable terms than under the traditional relief mechanism. As a result, the debt service under traditional relief is lower than the one after eilliaiiced HIPC for the period 2005-07. - 3 7 - Figure 3. Republic of Congo: Sensitivity Analysis after HIPC Initiative, 2004-24 (Inpercent) 300 NPV o f debt-to-revenue ratio 250 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Threshold. . . . . . . . . . . . . . . . . !\\ ,* -Baseline scenario 200 \:\$. ,, . * \ - - - 40 percentdrop in internationaloil \ prices 3 percentage point drop in non-oil 150 - - - - - - L I - - - - - 100 50 0 I I I I I I I I I I I I I I I I I I l l 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 56 t Debt service-to-revenueratio -Baseline - - - scenario 40 percent drop in internationaloil pnces 3 , ,,,,,,>>3 percentage point drop in real non-oil GDP growth 36 - 1 8 ....:.. 32 - 28 - 24 - 20 - 16 - 12 - 8 - 4 0 , I I I I I I I I I I I I I I I I I I 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 Sources:Congoleseauthorities; and staff estimates and projections. - 38 - Table 4. Republico f Congo: SelectedEconomicand FinancialIndicators,2001-07 2001 2002 2003 2004 2005 2006 2007 Est. Prog. Est. Prog. Proj. Projections (Annual percentagechange) Production and prices GDP at constantprices 3.8 4.6 0.8 4.0 3.6 9.2 9.2 4.8 1.5 Oil -7.5 -1.5 -7.2 2.0 0.5 17.4 16.7 3.3 -6.3 Non-oil 12.5 8.5 5.4 5.0 5.2 5.1 5.5 5.6 5.6 GDP at cuiTent prices -10.7 2 8 -1.6 11.8 10.8 8.1 17.0 -0.2 -2.8 GDP deflator -13.9 -1.7 -2.4 7.5 6.9 -1.0 7.2 -4.8 -4.2 Consumer prices (period average) 0.8 3.1 1.5 2.0 3.6 2.0 2.0 2.0 2.0 External sector Exports, f.0.b. (CFA francs) -16.5 9.0 -4.8 20.2 18.8 9.0 15.4 -4.2 -7.6 Imports, f.0.b. (CFA francs) 17.8 -1.5 -4.4 18.2 21.1 9.3 7.4 3.9 0.7 Export volume -14.0 3.5 -5.5 8.3 8.6 15.2 14.9 3.1 -3.9 Import volume -10.1 34.7 2.9 13.1 16.7 9.1 11.6 5.4 1.5 Terns of trade (deterioration )- -10.7 -0.3 2.9 8.0 12.5 -4.5 4.7 -4.2 -4.0 Nominal effective exchangerate I.o 2.1 4.6 ... 1.8 ... ... ... Real effective excliange rate -0.4 3.5 2.2 ... 1.1 ... ... Central government tinances Total revenue(including grants) 3.7 -8.9 6.6 17.7 21.6 19.3 37.2 -11.2 -12.4 qfwhfch: oil revenue -7.6 -7.7 6.1 22.2 25.8 22.8 49.7 -17.6 -20.5 non-oil revenue 44.7 -11.7 4.4 11.1 14.1 8.5 5.7 9.0 8.7 Total expenditure 10.7 15.6 -18.8 0.3 8.3 8.7 -4.6 2.0 2.0 Current 30.4 27.8 -16.4 -1.4 5.3 4.2 .11.6 0.5 1.5 Capital 28.8 -10.7 -26 0 6.2 18.5 23.3 17.1 5.5 3.3 (In percento f beginning-of-period broad money) Money and credit Net domestic assets 14.5 8.8 8.5 2.7 -2.4 -3.0 -8.8 -6.4 -0.6 Domestic credit 3.0 -6.8 5.2 7.0 1.8 -3.0 -8.8 -6.4 -0.6 Central government 21.0 9.0 0.4 4.0 0.3 -5.0 -10.8 -8.3 -2.6 Credit to the economy -16.4 -16.5 5.3 1.9 1.2 2.0 1.9 2.0 2.0 Broad money -22.8 13.1 -2.4 6.4 17.4 6.9 7.6 7.7 7.7 Velocity o f broad money (non-oil) 3.0 3.6 3.6 3.6 3.5 3.6 3.3 3.3 3.3 (InpercentofGDP) Investment and saving Gross national saving 20.7 24.0 26.7 25.4 26.6 25.7 29.0 27.9 26.9 Gross investment 26.4 23.4 25.7 22.9 24.2 22.7 24.1 24.9 25.0 Ofwhich : public (domestically financed) 9.8 7.6 5.4 5.6 5.3 5.7 5.7 5.9 6.1 Central government finances Revenue and grants 30.8 27.3 29.6 31.2 32.5 34.4 38.1 33.9 30.6 Total expenditure 31.5 35.5 29.3 26.2 28.6 26.4 23.3 23.8 25.0 Overall balance(deficit -,commitment) I/ -0.7 -8.1 0.4 5.0 3.9 8.1 14.8 10.1 5.5 Primarybalance(deficit -) 2 i 6.8 1.2 6.7 10.1 10.5 13.2 17.7 12.6 8.1 Current account balance 31 -5.6 0.6 1.o 2.5 2.3 3.0 4.9 3.0 2.0 External public debt (end ofperiod) 195.8 180.3 200.5 ,,. 197.2 ... ... ... (Inpercentofexports ofgoods and services) External public debt service (before debt relief) 23.9 25.0 16.7 13.6 14.4 11.7 11.8 9.3 9.2 External public debt 252.9 22I.2 252.9 ... 233.4 ... ... ... ... (Inpercentoftotal governmentrevenueexcluding grants) Exteinal public debt service (before debt relief) 60.4 75.0 45.4 36.7 37.8 28.8 25.7 22.3 23.4 External public debt 638.4 663.7 687.9 ,.. 613.2 ... ... ... (Inbillions ofCFA francs, unless otherwise indicated) Gross official foreign reserves 53.6 22.2 20.5 24.2 60.4 39.8 101.3 149.9 182.2 In monthsof imports, c.i.f I.3 0.5 0.5 0.5 1.3 0.8 2.0 2.8 3.4 Noiiiinal GDP 2,048 2,105 2,072 2,316 2,294 2,503 2,685 2,679 2,604 World oil price (in U.S.dollars per barrel) 4/ 24.3 24.9 28.8 36.1 38.2 33.3 45.2 39.8 37.0 Oil production (in millions o f barrels) 89.6 88,O 81.7 83.3 82.1 97.9 94.7 97.9 92.6 Potential windfall oil fiscal revenue 5/ 0.0 0.0 0.0 9.8 0.0 144.3 82.8 121.8 106.5 Sources: Congoleseauthorities; and Fund staff estimates and projections. I/Includinggrants. 21Revenue (excluding grants) minus noninterest cumnt expenditure minus domestically financed capital expenditure and net lending. 31Including public transfers. 41From 2005 onward, world oil price forecasts incorporate a prudence factor. As a result, WE0 price forecasts are reduced by U S 4 per barrel. 5/ Additional revenuethat would be generated by using WE0 forecasts for world oil prices, that is, without applying the price rule. - 39 - Table 5 Republic of Congo Selected Indicators of Long-Tern MacroeconomicProjections, 2004-24 Averages 2004 2010 2015 2020 2024 2000-04 2005-14 2015-24 2005-24 (In units indicated) Real GDP growl1 (percent change) 3 6 5 8 4 5 5.1 5.5 4.1 4.5 s o 4 8 Oil 0 5 5 9 0 0 0.0 0 0 -3.3 2.I 0 0 I O Son-oil 5 2 5 7 6 0 6.3 65 9.4 5.7 6 3 6 0 Population (miliions) 3 2 3 8 4 3 4.9 5.4 3.0 3.7 4 9 4 3 Percentchange 2 9 2 9 2 8 2.6 2.5 2 9 2.9 2 6 2 7 CPI index (percent change) 3 6 2 0 2 0 2.0 2.0 1.9 2 0 2 0 2 0 (In percent o f GDP) Consumption 48 6 51 3 59 7 60 5 61 0 47 3 54 5 60 3 57 4 Government I 6 0 15 0 I6 7 16.7 I 6 3 154 15 6 16 6 16 I Private 32 6 36 3 42 9 43 8 44 7 31 9 38.8 43 7 41 2 Grass investment 24 2 25 7 32 8 33.2 33 0 24 3 21.3 33 I 30 2 Government 7 0 7 5 9 2 9.I 9 1 7 8 8.1 9 1 8 6 Private I7 2 18 2 23 6 24.2 23 9 16 5 19.3 24 0 21 7 Set exports ofpoodj and Services 27 2 23 0 7 s 6.3 6 0 28 2 18 2 6 6 I2 4 Exports 84 5 78 2 62 5 53.5 46 0 80 6 74.3 54 4 64 4 Ofwhich: crude 011 65 5 GO I 41 0 31.8 24 8 65 4 55.6 32 8 44 2 Imports 57 3 55 I 55 0 47.2 40 0 52 4 56.1 47 8 52 0 Gross natioiial saving 26 6 30 1 28 7 31.6 33 3 2s 7 28.0 31 3 29 7 total revenue, incl. grants 32 5 29 5 27 1 26.0 25 0 29 4 30.2 26 I 28 I Fiscal revenue 32 2 28 9 26 5 25.4 24 4 29 1 29.6 25 5 27 6 Ofii'hich' oil 23 I 19 2 13 0 9.9 7 7 20 I 192 I O 3 14 7 non-oil 9 0 9 7 I3 4 15.5 167 8 3 10.4 15 2 12 8 Total expenditure 28 6 24 7 27 6 26.8 26 2 30 1 25.8 26 9 26 3 Ofwhich Domestically-financed primary expenditures 21 6 20 9 24 2 24.0 23 7 22 3 22.1 24 0 23 0 Overall fiscal balance, iiicl grants (commitment basis) 3 9 4 7 -0 6 -0.8 -1 2 -0 7 4.4 4 8 1 8 Primary fiscal balance I O 5 8 0 2 2 I.4 0 7 6 7 7.5 I S 4 s Financing gap 0 0 -3 4 0 7 1.4 2 2 -0 3 -0.7 1 2 0 2 External current accouiit balance. incl grants (before HIPC debt relie0 2 3 4 4 -41 .I7 0 4 1 2 0.7 -I8 -0 6 Ofii,hri.h, Trade bnlaiice 53 4 48 7 30 1 23 2 0 4 52 0 43 7 22 3 33 0 Exports f 0.b 78 2 72 3 56 0 47.1 0 4 74 7 68.3 44 0 56 2 Ofivhich . inon-oil 12 7 12 2 15 0 15.3 15 0 9 3 128 15 2 I 4 0 Imports f0.b 24 8 23 6 25 9 23.8 0 4 22 8 24.6 21 8 23 2 Capital account balance 3s 7 0 6 0 7 0.6 0 4 8 1 0 6 0 6 0 6 Financial account balance -36 1 -0 5 4 2 1 2 0 4 -2 9 0 8 1 6 1 2 Overall external balance 1 9 4 5 0 7 0.I 0 4 0 2 2.1 a 4 1 2 Memorandum items (In percent of non-oil GDP) Son-oil revenue 19 1 194 20 3 20.9 20.9 18.8 19.3 20 7 20 0 Oil revenue 48 7 38 2 I 9 7 13.3 9.6 47.5 37.1 14 1 25 6 Nan-oil primary fiscal balance -25 3 -22 3 -16 3 -11.4 -8.7 -30 0 -21.6 -12 1 -16 9 (In units indicated) World oil price (US dollar per barrel) 38 2 34 8 34 8 34.8 34.8 28.9 36.6 34 8 35.7 Oil production (inillloiis of barrels) 82 I 126 4 94 5 94.5 94.5 87.7 102.5 94 5 98 5 Exportvolume ofgoods (percent change) 8 6 5 9 2 8 4.2 5.3 -1.4 3.2 4 0 3.6 Import volume of goods (percent change) 16 7 7 4 4 2 3.9 4.0 11.1 6.0 3 9 5.0 Gross foreign reserves (in months of imports of goods and services) 0 6 1 8 3 0 4.3 5.7 0.7 1.8 4 2 3.0 (In millionsof U.S. dollars) Soiniiial GDP 4,349 6,779 7,483 9,862 12,669 3,391 6, I76 9,779 7,977 Exports ofgoods and services 3,674 5,298 1,678 5,277 5,834 2,743 4,565 5,236 4,900 Imports of goods and services 2,492 3,736 $,I 16 4,656 5,069 1,786 3,467 4,596 4,032 Fiscal revenue, excluding grants 1,399 1,962 1,980 2,508 3,093 993 1,813 2,483 2,148 ~ Sources Congoleseauthorities, and staff estimates and projections - 40 - Table 6 Republic of Congo Nominal and Net Present Value of External Debt by Creditor Group at Decision Point, End-2004 1/ After waditional debt relief mechanismsU Nominal Debt NPV of Debt NPV o f Debt Percentof Percentof Percent .~..~~. US$inillion total US$million total US$million oftotal Total 9,248 100 9,007 100 5,176 100 Multilateral 524 6 363 4 363 7 Afiican Development Bank 138 I 121 1 121 2 African Developinent Fund 12 0 8 0 8 0 BADEA 21 0 16 0 16 0 EuropeanUiiion 40 0 29 0 29 1 IFAD 0 3 0 0.3 0 0 0 IDA 270 3 151 2 151 3 IMF 29 0 25 0 25 0 OPEC 13 0 13 0 13 0 Paris Club bilateial 3/ 5,048 55 4,995 55 2,815 54 Belgium 81 1 85 1 36 I Brazil 309 3 291 3 102 2 Canada 69 1 68 1 37 1 Denmark 2 0 1 0 0 0 France 2,942 32 3,002 33 1,129 33 Geimany 301 3 308 3 138 3 Ireland 0 0 0 0 0 0 Italy 255 3 256 3 142 3 Luxembourg I 0 1 0 0 0 Netherlands 0 4 0 0.2 0 0 0 Russia 159 2 I04 I 104 2 Spain 494 5 464 5 3 15 6 Switzerland 25 0 24 0 9 0 United Kingdom 346 4 332 4 164 3 United States 65 1 59 1 38 I Noli Paris Club bilateral 289 3 280 3 178 3 Algeria 20 0 20 0 6 0 Angols 60 1 60 1 20 0 Bulgaria 2 0 2 0 1 0 China 47 I 39 0 34 I Cuba 1 0 I 0 1 0 Saudi Arabia 64 I 64 1 51 1 Kuwait 49 1 49 1 41 1 Libya 28 0 28 0 9 0 Romania I 0 1 0 1 0 United Arab Emirates 17 0 17 0 15 0 Commercial 3,388 31 3,370 37 1,819 35 oftskicli: London Club 2,177 24 2,177 24 879 17 Sources:Congolese authorities; and staff estimates. I/FiguresarebasedondataasofendDecember2004,beforesigningofthebilateralagreementminutesfromtheDecember2004PansClubagreement, 21After a stock of debt operation on Naples tenns at end-2004 on official bilateral and commercial debt. 31EuropeanEconomic Commission loans administeredby IDA classified as multilateral loans in the preliminaly document have been reclassified as Pans Club bilateral loans at decision point. - 4 1 - - ffi Z ri W m 0 m "I m 10 P vi N m .u W m vi 0 0 0 0 -B h t I olor-vi- - m l n -- N m w m CI i 9- 0 0 N .-C .-0 e 0 \NDma m w -2g B m m m 9-loq 4 L 2;t: O l o Q loa2 Lo 28 9- 0 N 0 8 0 . - - 43 - - 44 - P! m m ri n. n. t, m m - 0 tr! m n --a PI 0 n n m o m 4 -" 3. 0. PI * m - m m m m ;i a a,r! --m PI o\ c r. ~ . ~ I P I m m -P! ." m m - 45 - Table 1 1. Republic of Congo: EnhancedHIPC Initiative: Assistance LevelsUnder a Proportional Burden-SharingApproach li (In inillions of US dollars in end-December2004 NPV terms; unless otherwiseindicated) 21 NPV of debt-to-revenuestarget (in percent) Total Multilaterals Bilaterals Commercial Common Creditors Reduction Factor 31 (Percent) 250 1679 118 971 590 32.4 Meinorandtiin [ems i NPV of debt at end-2004 4/ 5,176 Central governinent revenues at end-200451 1,399 NPV of debt-to-revenueratio (percent) 5/ 370 NPV of debt-to-revenuestarget (in percent) 250 Multilateral Creditors 363 Paris Club Creditors 2,815 of which pre-cut of date non-ODA 1,673 Non-Paris Club Bilateral Creditors 178 of which pre-cut of date non-ODA 36 Coininercinl Creditors 1,819 Sources Congoleseauthorities, and staff estimates and projections I/Asminesproportionalburden-sharingasdescribedin"HIPCInitiative:EstimatedCostsandBurden-SharingApproaches" (EBSi971127; 717197, and IDNSEC M97-306;717197). 21 Using six-inonth discount and end-of-period exchange rates as of end-December 2004. 3 i Eachcreditor's NPV reduction at tlie decision point after traditional debt relief in percent of its exposure at tlie decision point, 4/ After a hypothetical stock-of-debt operationon Naplesterms at end-December2004. 51Excludinggrants. - 46 - . c - 47- cr C r 0 DO 5 0 4 .-u 2P i - 49 - 0 d 0 -a c;' e, c e, Y - 50 - - 51 - In 0 0 N E i-1 6I C 'L 0 . m 0 U E J cU P D b Y E 0 U - 52 - APPENDIX I DEBTSUSTAINABILITY ANALYSISWITH PRELIMINARY UPDATED MACROECONOMIC FRAMEWORK 1. Since the issuance o f the preliminary document, world oil prices have increased significantly-by a projected average o f US$16.3O/barrel per year during 2005-24 (text table below). The staffheld preliminary discussions' in October 2006 with the authorities on the impact o f higher oil prices on the macroeconomic framework, including the 2006 budget, The authorities urged caution inupdating the macroeconomic framework, and suggested that the oil prices used for the forecast should be set at US$10 per barrel below the WE0 projections from 2006 onward (incontrast with US$4/barrel under the baseline scenario). In addition, the authorities have updated the projections for oil production, entailing an annual average production o f about 3.8 percent lower than under the baseline during 2005-24. 2. Inline withthe priorities underlying the PRGF-supportedprogram, use of additional resources would be on poverty-related spending, reduction o f external and domestic payment arrears, and reduction o f government net claims on the banking system. Inaddition, the authorities would seek assistance from the IMF and IDA to help with the establishment o f a framework for sustainable public finance management inthe presence of significant oil revenues. Congo: Key Macroeconomic Indicators, 2000-24 ilnunits indicated) 2000-04 Baseline Scenm'o Updated Scenario average 2005 2006 2005-24 2005 2006 2005-24 Real GDP growth (in percent) 4. I 9.2 4.8 4.8 9.2 5.2 5.5 Oil -3.3 16.7 3.3 1.o 16.7 3.3 0.5 Nonoil 9.4 5.5 5.6 6.0 5.5 6.3 6.5 Oil sector parameters Oil price (WEO, U.S.dollarsharrel) 28.9 47.5 43.8 39.7 54.4 61.8 56.0 Price rule (U S dollars/baid) I/ 28.9 45.2 39.8 35.7 52.4 51.8 46.0 Production (millions o f bairels) 87.7 94.7 97.9 98.5 92.3 101.5 94.8 Fiscal aggregates (in percent o f GDP) Domestic I-evenue 29.1 37.7 33.4 27.6 39.4 41.6 35.3 Priinaiy expenditures 22.4 20.I 20.8 23.0 17.9 20.0 22.0 In percent o fnonoil GDP 50.6 46.0 44.0 37.0 47.7 51.3 38.0 Priinaiy fiscal balance 2/ 6.7 17.6 12.6 4.5 21.4 21.6 13.2 Current account balance (incl. offical transfers) Inpercent ofGDP 1.2 4.9 3.0 -0.6 12.5 13.0 2.7 Memorandum items: Nominal GDP Total (in inillioiis of US dollars) 3391 5379 5364 7977 5960 6079 8786 Per capita (in US dollars) II30 1630 1625 1855 1806 1842 2043 Sources: Congolese iirithorities, and Fund staff estimates and projections. I/Theprojections~ncoi-porateaprudencefactor, sothattheWE0priceforecastisreducedafixeddollarvalueperbarrel. 2/ Revenue (escl. grants) iniiius noninterest current expenditure iiiinus doinestically-financed capital expenditure and net lending. ' These discussions-especially as regards their implications for the macroeconomic aggregates in2006 and 2007-will be finalized at the time o f the second review under the PRGF arrangement in early 2006. The staff will discuss MDG-related issues. - 53 - APPENDIX I 3. The higher oil revenue forecast creates room for higher spending. Nonetheless, in assessing the extent o f the increase in spending, due consideration needs to be given to absorptive and institutional capacity constraints, coherence o f a scaled-up investment budget with the priorities set out inthe I-PRSP, and risks o f inflationary pressures and "Dutch disease." A key concern for higher spending relates to capacity constraints-namely, shortage o f trained personnel inhealth and education, shortage of adequate basic physical infrastructure, and lack o f a functional classification for expenditure tracking. Inaddition, projects need to be rigorously selected and monitored. There are also risks o f inflationary pressures and Dutch disease from higher spending. Thus, a preliminary revised macroeconomic framework takes account o f the needfor prudence inthe use of additional oil revenues, while accommodating higher priority spending. 4. The authorities and staffreached preliminary understandings on broad budgetary targets for 2006. Domestically-financed capital and current spending in2006 would increase by about 40 percent and 13 percent respectively, a level that is likely to exhaust the country's absorptive capacities. Preliminary macroeconomic long-term changes-on a cumulative basis during 2005-24 and relative to the baseline scenario-are as follows (text table above): Domestic revenues are projected to be higher by about 7.7 percentage points o f GDP per year.2 Domestically-financed primary spending would be higher by about 1percentage point of non-oil GDP (but lower by 1 percentage point inrelation to total GDP, reflecting the oil price-related sharp increase innominal GDP). Primary fiscal surplus would be higher by about 8.7 percentage points o f GDP. The current account surplus is projected to improve by some 3.3 percentagepoints of GDP. Non-oil real GDP growth would be expected to be higher by about 1percentage point per year. The DSA results using this preliminaryupdated macroeconomic framework confirm the assessment provided inSection1V.D (Figure 1, Table 1). Withthe higher oil prices, Congo's debt burden falls to significantly below the 250 percent threshold starting in2005 after the application o f the traditional debt relief mechanism. Debt relief under the enhanced HIPC Initiative would allow Congo's external debt burden to drop considerably; the N P V o f debt-to-revenue ratio would fall to 140 percent in2005. This ratio would subsequently fall Government's oil tax receipts increase more-than-proportionately with rising international oil prices, and thus budgetary oil revenues grow at a higher rate than GDP. - 54 - APPENDIX I steadily and remain significantly below the HIPC threshold over the entire projectionperiod, reaching 44 percent by 2024. Figure 1. Republic of Congo: External Debt Indicators, 2004-24 (Inpercent) 400 360 320 280 240 200 160 120 80 40 Updated revenue projection 0 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 - 55 - APPENDIX I 8 Xn 8P yi nyi - 5 6 - APPENDIX I1 NATIONAL COMPANYFINANCIAL OBLIGATIONS OIL 1. The debt sustainability analysis (DSA) covered Congolese public and publicly guaranteed external debt accumulated as o f end-2004, including external liabilities transferred by the national oil company, SocietCNationale des PCtrolesdu Congo (SNPC) to the government (Le., the Caisse Congolaise d'Amortissement). No other SNPC liabilities were includedinthe analysis because (i) reportedno external liabilities as of end- SNPC 2004, and (ii) advance accounts heldby SNPC are not debt (discussed below). 2. The SNPC is the largest public enterprise inCongo. Ithas a special corporate governance structure that permits it to operate independently on a commercialbasis. The SNPC has also been entrustedwith important fiscal agency functions inthe oil sector, notably the management o f the state's oil assets and the marketing o f the state's in-kindoil revenue deriving from the production sharing agreements (PSAs). 3. The SNPC's assets-estimated at about US$1.2 billion at end-2004-largely consist of its participations inoil exploration and development joint ventures with private oil companies, with shares ranging from 15 to 50 percent. Assets are offset by large liabilities including balances inadvance accounts; these balances arise from the fact that the SNPC (and its predecessorHydroCongo) did not pay cash for its share inthe various joint ventures inwhich it participates with private oil companies. Instead, the funds are "advanced" to SNPC by its private partners to cover its share of explorationand development costs. Until there is sufficient production, exploration, development and interest costs continue to be debitedto the advance accounts. The so called "carried interest'' construction, standard practice inthe oil industry, i s intendedto facilitate the participationinoiljoint ventures of governments facing liquidity constraints. 4. At its creation in 1998,the SNPC took over eight of such accounts-together with all other assets and liabilities-from the state-oil company it replaced, Hydro-Congo. These accounts are governed by four joint-venture agreements, signedinthe early 1970sand late 1980s. The SNPC's advance accounts liabilities totaled US$941 million as of end-2004. The joint venture contracts stipulate that: (i) the advanceaccounts will bereimbursedfrom the SNPC's equity oil income once oil productionstarts, and (ii) reimbursement i s bounded to a fraction of the oil income to ensure SNPC obtains aminimumcash flow. 5. Based on the available informationIMF and IDA staffs obtained from authorities, advance account balances are not debt because: 0 Thejoint-ventureagreements that establish andregulate the advance accounts do not reflect the intention of the parties to establish a creditoddebtor relationship. 0 SNPC has no obligation to make any payment to thejoint venture participants based solely on the advance accounts. Any payment is fully linked to the existence of oil - 5 7 - APPENDIX I1 revenues and no direct transfer from the government or state-owned enterprise takes place inthe absence o f oil revenues. Advance accounts do not include current liabilities resulting from the provision o f assets or services. Joint-venture participants keep the right to participate inthe proceeds o f any sale which would otherwise be paid to SNPC and reduce the advance accounts balances "advanced" on behalf o f SNPC. e The "credit" aspect is not present.Reimbursements are expectedto take place immediately after the receipt o f sale proceeds. 6. The government has issueda written statement to the staffs confirming that the SNPC did nothave external debt with maturities exceeding 12months at end-2504, and had not provided any guarantees on external loans to third parties. ' As a general principle o f contractual law, parties to legal agreements are presumed to have intendedjust what their agreements set forth. - 58 - APPENDIX I11 DEBTSUSTAINABILITYANALYSISUSINGTHE JOINTFRAMEWORK LOW-INCOME FOR COUNTRIES 1. This annex provides an assessment o f Congo's debt dynamics based on the forward- looking approach of the debt sustainability framework for low-income countries (henceforth L I C DSA), using both the external and fiscal (including domestic) public debt templates.' The baseline macroeconomic scenario usedfor the analysis i s that described in Section 1II.B. 2. Although the framework used differs from the HIPC framework, the L I C DSA results confirm the assessment usingthe enhanced HIPC Initiative D S A template (see Section 1V.D). That is, inthe absence o f debt relief, Congo has debt ratios well above the thresholds indicative o f a risk of debt distress: most notably an NPV o f debt-to-GDP ratio in2005 well above the 30 percent indicative threshold and a total debt service-to-revenue ratio above 30 percent (Figures 1-2, Tables 1-4). HIPC Debt relief would significantly improve Congo's debt dynamics. 3. External debt dynamics are portrayed inFigure 1.Under the baseline scenario, debt- to-GDP falls below the indicative threshold o f 30 percent once the projected completion point i s attained and full HIPC debt relief comes on line in2008. The two debt-to-exports ratios are both comfortably below the thresholds taking into account HIPC debt relief. 4. Standard stress tests indicate some vulnerability of the debt-to-GDP ratio to exogenous and policy shoclts.* The greatest vulnerabilities relate to lower export growth, lower GDP growth, and depreciation o f the euro (to which the CFA franc is tied) against the US dollar. Under the "historical" scenario, which uses ten-year averages for macroeconomic parameters, debt-to-GDP goes below the indicative threshold only in2017, after peaking in 2011 as oil production declines. Note, however, that such a historical scenario covers a wartime period inthe case o f Congo when the economy contracted. 5. Figure 2 portrays debt dynamics including Congolese domestic debt and taking account o f projected fiscal deficits. The story i s broadly similar. HIPC debt relief brings all three debt ratios (in this case NPV debt to-GDP, N P V debt-to-revenue, debt service-to- revenue) sharply down to sustainable levels. Stress test show that the mainsources o f vulnerability are fiscal relapse (under a "no reform" historical scenario) and euro depreciation. However, even with these downside risks, the debt service-to-revenue ratio remains at modest levels over the simulation period. See "Interim Guidance on the Preparation o f Joint Fund-World Bank Debt Sustainability Assessments for Low-Income Countries,)' May 17,2005. Under the L I C DSA, (i) the "historical scenario" illustrates the dynamics o f the Congolese debt under the assumptionthat key variables (e.g., real GDP growth, current account balance, and foreign direct investment (FDI) inflows) are set at their historical average over ihe projection period; and (ii) "most severe" scenario captures the impact on debt of a the negative shock to FDI inflows. Under the fiscal DSA, (i) "most severe" scenario captures the the impact o f a one time 30 percent currency depreciation, and (ii) the "no reform" scenario illustrates the effects o f maintaining the primary fiscal balance at its historical level. - 5 9 - APPENDIX I11 Figure 1. Republic o f Congo: Indicators o f External Debt Under Alternative Scenarios, 2005-24 (In percent) 60 c NPV of debt-to-GDP ratio Threshold 10 - --- Historical scenario -Most extreme stress test MDRIscenario 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 120 IO0 Threshold - Baseline 80 ..... ,---4 . .. ---Historicalscenario Most extreme stress test 60 MDRIscenario 40 20 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 20 18 - Debt service-to-exportsratio --___----_----_______________________ - Threshold ---Historical Baseline scenario Mostextreme stress test 6 - / J-- _----_---------___ MDRIscenario 0 ----__ 4 - 2 - - ~, * _ U * " * s n * = = - J 0 . , I Source: Staff projections and simulations. - 60 - APPENDIX I11 Figure 2 : Republic o f Congo: Indicators o f Public Debt Under Alternative Scenarios, 2005-24 1/ IO0 90 N P V o f debt-to-GDP ratio -Baseline --- 80 -- No Reform Most extreme stress test 70 - -.. . 60 - -_------_ 50 - . 4 - - --\ -. 40 - \ 30 - 20 - I O- 0 350 N P V o f debt-to-revenue Ratio 2/ 300 -Baseline 250 Most extreme stress test 200 150 I00 50 2005 2006 2007 1008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 60 --- 30 - -__--_ -.- ---___ --- \ ..-- 20 - --- No Refonn 10 - Most extieine stress test Debt Service-to-revenue ratio 2/ 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source: Staff projections and simulations. 1/ Most extreme stress test is test that yields highest ratio in2015 2/ Reveiiue including grants. - 6 1 - APPENDIX I11 ? - ? l o r - - in - N PI N O in vm; d r j w VO,I m P - y 0, O B 'E p 'pB a e 5'PeP -62 - APPENDIX I11 Table 2 Republic o f Congo Sensitivity Analyses for Key Indicators o f Public and Publicly Guaranteed External Debt, 2005-24 (In percent) Estimate Projections 2005 2006 2007 2010 2015 2020 2024 NPV o f debt-to-GDP ratio Baseline 52 42 35 19 17 13 9 A. Alteriiative Sceuitrios AI Key variables at tlieir litstorical averages in 2006.25 I1 52 41 39 49 37 20 15 A?. New pubiic sector loans oii less Favorableterms in 2006-25 21 52 42 35 19 17 14 I O A3 MDRl scenario 50 41 33 I 1 16 I 2 9 B. Bound Tests BI.Real GDP groivtli at liistoricai average ininus one standarddeviation in 2006-01 52 44 31 20 18 14 10 B? Exponvalue yrowlli at liistorical averageminus one standard deviation in2006-07 31 52 46 44 26 23 16 II 03 US dollar GDP detlator at Iiistoricai average iiiinus one standard deviation in 2006-07 52 44 39 21 19 14 I O B4 Net non-debt creating flows at historical average ininus one standard deviation in 2006-07 41 52 52 55 35 30 20 12 B5. Coinbination oFBI-B4 using one-lialfstandard deviation shocks 52 36 I 2 0 2 5 5 06 One-time 30 percentnominal depreciation relative to the baseline iii 2006 51 52 62 51 21 2s 19 13 NPV ofdebt-to-exports ratio Baseline 63 53 46 24 21 24 20 A. Alterntttive Scenarios A I Uey variables at their liistoricai averages in 200b-25 i1 63 59 5 1 63 38 33 A2. New public sector loans on less favorable terms in 2006-25 21 63 53 46 24 i60a 26 22 A3 MOR1scenario 61 51 43 22 25 23 19 B. BoundTests 01 Real GDP growh at historical averageininus one standard deviation in 2006-07 63 53 46 24 27 24 20 B2. E S ~ Ovalue ytowih at iiistorical average minus oiie standarddeviation in 2006.01 31 K 63 61 61 35 39 32 25 B3 US dollar GDP deflator at historical average ininus one standard deviation in 2006-07 63 53 46 24 27 24 20 BJ Net iion-debt creating flows at lhistorical average ininus one standard deviation in 2006-01 41 63 65 11 44 41 3 1 21 85 Combination of Bi-Bd usingone-half standarddeviation shocks 63 42 13 0 3 1 I O 86 One-time 30 percent nominal depreciation relative to the baseline iii 2006 S I 63 53 46 24 21 24 20 Debt service ratio Baseline 14 16 14 2 I 2 2 A. Alternative Scenarios A I Uey variables at tlieir liistorical averages in 2006-25 I1 15 14 12 4 6 5 5 A2 New public sector loutis on less favorable terms in 2006-25 21 15 16 14 2 1 2 3 A3 MDRl scenario 15 16 14 2 1 I 1 8. Bound Tests BI Real GDP gt-owtliat liistorical average ininus one standard deviation in 2006-01 15 16 14 2 1 2 2 B2 Expon value growth at lhistorical average ininus one standarddeviation in 2006-0131 15 17 16 3 3 3 3 83 US dollar GDP deflator at lhistorical averageininus one standard deviation in 2006-07 I5 16 14 2 1 2 2 84. Net noii-debt creating flows at iiistoricai average minus one standard deviation in 2006-0141 I 5 16 15 5 4 5 4 B5 Combination ofB 1-84 using one-half standarddeviation shocks 15 15 II 0 -2 -I 0 06 One-time 30 percent nominal depreciation relative to the baseline in 2006 51 15 16 14 2 1 2 2 A,letllll,.nlllilmI IICtII. Grant eiement assumed on residual financtihy (i e , financing required above baseline) 61 0 0 0 0 0 0 0 Source: Staff projections aiid simulations I1 Variables include real GDP growth growth of GDP deflator (in U.S dollar terms), non-interest current account in percent of GDP, and non-debt creating flows. 21 Assumes tltat the intet-estrate on new borrowing is by 2 percentagepoints higher than in the baseline.,while grace and maturity periods are the same as in the baseline. 31 Expons values are assumed to reinaiii permanently at the lower level, but the current account as a share ofGDP is assumed to return to its baselinelevel after the shock (implicitly assuininy an offsetting iidjiistiincnt in import iei.elsj 41 Includes official aiid private transfers and FDI 51 Depreciarion is defined as perceiiraye decline iii doliarllocal currency rate, such that it never exceeds IO0 percent. 61Applies to ail stress sceiiarios except For A2 (less favorable financing) in which the terms on ail new financing are as specified in footnote 2. - 63 - APPENDIX I11 q 4m, m m, m m, j*,-m c r j 0 v, * PI T - 64 - APPENDIX I11 Table 4. Republic o f Congo. Sensitivity Analysis for Key Indicatorsof Public Debt, 2005-24 Estimate Projections 2005 2006 2007 2010 2015 2020 2024 NPV o f debt-to-GDP ratio Baseline 69 57 47 24 17 13 9 A. Alternative scennrios A I Real GDP growth and prmary balance are at liistorical averages 69 66 60 51 41 29 13 A2 Primary balance is unchanged from 2004 85 83 79 65 63 5 1 36 A3 Permanently lower CDP growth I1 69 57 48 27 29 41 50 B. Bound tests B I Real GDP growth is at liistoiical average minus one standard deviations in2006-2007 69 61 54 34 37 45 48 B2 Primary balance is at historical average minus one standard deviations in 2006-2007 69 70 69 43 40 39 36 B3 Combination of BI-B2 using one half standard deviation shocks 69 70 66 41 37 37 34 84 One-time 30 percent real depreciation in 2006 69 80 88 53 46 42 36 65 10percent of GDP increase 111other debt-creating flows in 2006 69 61 58 33 29 28 26 NPV of debt-to-revenue ratio 21 Baseline 182 I67 154 80 65 50 37 A. Alternative scenai 10s A I Real GDP growth and primary balance are `it historicdl averages I82 196 196 174 151 Ill 52 42 Primary balance is unchanged trom 2004 223 243 259 219 232 196 I43 43 Permanently lobser GDP growth I ' 182 I69 I58 92 107 156 198 B. Bound tests 61 Real GDP growth isat 111~toricaIaverage minus one standard deviations in 2006-2007 182 I80 176 1I 4 137 172 190 82 Primary balance is at liistorical average iniiius one standard deviations in2006-2007 182 205 225 146 147 151 144 83 Combinationof B1-52 using one half standard deviation shocks I82 205 217 139 138 I42 136 84 One-time 30 percent real depreciation in 2006 I82 235 286 I80 170 I60 145 65 10 percent of GDP increase in other debt-creatingflows in2006 I82 197 189 113 I06 109 103 Debt service-to-revenue ratio 21 Baseline 42 49 48 17 12 8 8 A. Alterniitive sceiiarios A I Real GDP growth and primary balance are at historical averages 42 50 50 24 25 18 13 A2 Primary balance is unchanged from 2004 42 51 52 28 33 28 22 A3 Perinanently lower GDP growth I/ 42 49 49 17 16 16 20 8. Bound tests 61 RealGDP growth is at historical average minus one standard dewations in2006-2007 42 51 51 19 19 19 21 82 Primary balance is at lhistorical average minus one standard deviations in2006-2007 42 49 50 23 22 19 18 B3 Combination of 6 1-82 using one half standard deviation shocks 42 50 51 23 21 18 17 B4 One-time 30 percent real depreciation 1112006 42 49 49 I 8 14 10 I O 65 I O percent of GDP increase in other debt-creating flows in 2006 42 49 50 20 17 14 I 2 Sources Congolese authorities, and Fund staff estimates and projections I/Assumes that real GDPyrowth IS at baseline minus onestandard deviation dividedby the squarerootof20(1 e, the lengthofthe projectionperiod) 21Revenues are defined iiiclusive of grants