Report No. 3287-ZR FIlE CohyZaire:Economic Memorandum

Recent Economic Developments and The Path to Recovery

May 20, 1981

Eastern Africa II

FOR OFFICIAL USE ONLY

Document of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may not otherwisebe disclosed without World F.ank authorization

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CURRENCY EQUIVALENTS AND UNITS

Currency Unit: Zaire (Z) Z 1.00 = 100 makuta

Exchange Rates 1/: January 2, 1979 - August 23, 1979 Z 1.00 = SDR 0.5US$1.00 = Z 1.56Z 1.00 = US$0.64

August 24, 1979 - February 22, 1980 Z 1.00 = SDR 0.375US$1.00 = Z 2.05Z 1.00 = US$0.49

Since February 22, 1980 Z 1.00 = SDR 0.2625US$1.00 = Z 2.92 2/Z 1.00 = US$0.34 2/

Weights and Measures: Metric System

Fiscal Year: January 1 - December 31.

1/ From March 12, 1976 to November 1, 1976 the zaire was pegged to theSDR at a rate of Z 1.00 = SDR 1.00. The zaire underwent to 50 percentdevaluation in 4 stages between November 1, 1978, and January 2, 1979.All conversions to US dollars in this memorandum have been made at theaverage exchange rate prevailing during the period covered.

2/ As of mid-November, 1980.

FOR OFFICIAL USE ONLY

Preface

The last economic report on Zaire covered develop-ments through 1978 and was issued in October 1979. This reportfocuses on developments in 1979-80 and is based on the findingsof an economic mission that visited Zaire in October 1980. Themission was composed of Bension Varon (mission chief), AlbertoEguren (economist), Ezzeddine Larbi (economist) and Ake Krantz(consultant). The report also incorporates the findings of anexternal debt mission carried out by William Grau in March 1980.The information was updated through a second mission, composedof Mr. Varon, that visited Zaire in early March 1981. The reportwas discussed with the Zairian Government during the same mission.Miriam Schneidman contributed to the preparation of the report.

The projections presented in the report are intendedsolely to highlight the constraints to Zaire's economic recoveryand the relevant policy issues; they do not constitute predictions.

This document has a restricted distribution and may be used by recipients only in the performanceof their oMcial duties. Its contents may not otherwise be disclosed without World Bank authorization.

ZAIRE

RECENT ECONOMIC DEVELOPMENTS AND THE PATH TO RECOVERY

TABLE OF CONTENTS

Page No.

SUMMARY AND CONCLUSIONS . ....................................... iii

INTRODUCTION ........................................................ v

I. RECENT DEVELOPMENTS, 1979-1980 ...... 1

A. Economic Developments 11. Economic Growth 1

2. Utilization of GDP. 3

3. Domestic Prices . ...... .......... 4

4. Public Finance. 45. Money and Credit 8 ......... 86. External Transactions 97. Social Cost ... .. .10

B. Institutional Developments and International Action 12C. Public Investment Program .. 14Do Overall Performance ..... 15

II. THE PATH TO RECOVERY ....... ......... 17

A. Government Finances and the Budgetary Process ........ 18B. The Foreign Exchange Markets ... o....... .. ..... 22C. The Credit Market ........................ 25D. The Goods and Services Market 26E. Gecamines ..... oo ......... ..... .. . 30

III. EXTERNAL TRADE, EXTERNAL DEBT AND CAPITAL REQUIREMENTS .... 35

A. Export Prospects ............ 35B. External Public Debt .... . . .36C. Capital Requirements ........... 38

IV. CONCLUSIONS ........ ......... o...oooo ............ 46

ANNEXES

I. External Public DebtII. Summary of Tax System, 1980III. Public and Private InvestmentIV. SOFIDE

STATISTICAL APPENDIX

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LIST OF TEXT TABLES

Table 1: Value Added in Constant 1970 Prices, 1977-79Table 2: Utilization of GDP in Constant 1970 PricesTable 3: Budgetary Revenues and Expenditures as a Percentage

of Commercialized GDP, 1977-79Table 4: Budgetary Operations, 1979 and 1980Table 5: Export Projections - Base and High Scenarios, 1981-85Table 6: Hypothetical Recovery Scenario: GDP, Investment and Imports in

Constant Prices, 1972 to 1985Table 7: Hypothetical Recovery Scenario: Projections of Capital Require-

ments, 1981-85

ANNEX I

Table I: Evolution of Outstanding Debt, 1974-1980Table II: Average Terms Structure of Commitments by Type of Financing,

1976-1979: Comparison of Zaire and Other Low-Income CountriesTable III: Disbursements by Type of Creditor, 1976-79Table IV: Undisbursed Balances on Loans and Credits at End 1979Table V: Principal and Interest Payments, 1976-79Table VI: Burden-Sharing, 1976-79 AverageTable VII: Net Transfers of Resources by Sources, 1976-1979Table VIII: Over-all Impact of Debt Reorganizations on 1980-1990 Projected

Debt Service at End 1980Table IX: Estimated Future Debt Service at end-1980 Eligible for

Rescheduling by the Paris Club in 1981, 1982 and 1983

ANNEX III

Table 1: Execution of 1979-81 PIPTable 2: Distribution of Total Public Investment Expenditures in 1979-80Table 3: Sectoral Distribution of PIP's for 1979-81 and 1981-83Table 4: Financing of the PIP for 1981-83, by Sector

ANNEX IV

Table I: SOFIDE's Operations: Loan Approvals, 1974-79

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SUMMARY AND CONCLUSIONS

1. Zaire plunged into a deep and protracted economic crisis in 1975,following an abrupt reversal in its terms of trade. During the period1975-78, the crisis was manifested in a sharp contraction of GDP and im-ports, large budgetary deficits, high inflation, a build-up of externaldebt arrears, and erosion of external confidence. The year 1978 proved theworst year of the crisis in every respect: commercialized GDP fell by nearly7 percent; merchandise imports were halved; and the budgetary deficit reacheda record level both in absolute terms and relative to GDP. Efforts to con-trol the crisis during this period were for the most part inadequate, timidand uncoordinated internally or externally. Both Zaire and the major donorswere slow to appreciate the severity and deep-rooted causes of the crisis.

2. As the nature and parameters of the crisis became more apparent, start-ing in late 1978, Zaire and its main partners embarked on better focused andmore coherent efforts to arrest the crisis and ushered in a period of activeintervention. For Zaire, the Mobutu Plan provided both the stimulus and theorientation for institutional and policy changes, many of which had been long-advocated by the donors. During this period, technical assistance teams wereinstalled at the Central Bank and the Ministry of Finance, existing institutions(e.g., the Customs Service) were revamped, new institutions (e.g., a CentralPay Directorate) were created, and several management reforms were introduced.Zaire also completed a three-year public investment program, which has recent-ly been updated, negotiated debt rescheduling agreements with the privatebanks and the Paris Club, and implemented a stabilization program in 1980,with the support of the IMF. In addition to debt rescheduling, the donors, ontheir part, provided humanitarian, emergency and technical assistance underthe aegis of three ad hoc conferences held in Brussels.

3. Thanks to these efforts and others, the contraction of the economydecelerated significantly in 1979 and was arrested in 1980. This period sawimproved fiscal performance in some areas, a major effort to respect thedebt rescheduling agreements, and an amelioration in the decision-makingprocess. A major fruit of this effort was the reduction of the inflationrate by half in 1980. The overall results, however, are anomalous in thefollowing sense: although the efforts made by Zaire have been considerable,and while the performance has improved as a consequence, its medium-termprospects have not improved commensurately, i.e., its external assistancerequirements remain as large as two years ago. There are two main reasonsfor this: (i) Zaire's export outlook has deteriorated considerably, due part-ly to the weakening of the world cobalt and coffee markets, and partly tothe major delay in the implementation of Gecamines' rehabilitation program;(ii) despite and, in a sense, because of the debt rescheduling agreements of1979/80, the debt service ratio of Zaire remains quite high (more than 30percent on average per year during 1981-83). Nevertheless, in the last two

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years, a momentum of change has been created and the road has beenpaved toward both a substantially greater use of IMF resources and amore comprehensive debt rescheduling.

4. In order to firmly embark upon and move along the path to re-covery, in addition to debt rescheduling, Zaire needs to give the high-est priority to rehabilitating Gecamines' production capacity. It alsoneeds to undertake simultaneously additional and coordinated policychanges. The three pillars of the needed changes are (i) to continue thepolicy of a flexible exchange rate, announced more than two years ago,more vigorously; (ii) to review and adjust interest rates periodically;and (iii) to remove price controls at all levels for most commodities.Zaire also needs to implement its public investment program for the years1981-83, although the improvement of the supply situation, which is high-ly dependent on external assistance, and the policy changes in the aboveareas and others will prove just as crucial in the medium term. Finally,Zaire should attack the problems of the agriculture sector more system-atically, in the context of a well-defined action program for the sector.

5. Although the external assistance requirements of Zaire for thenext five years are quite large compared to recent commitments, thefinancing gap for the outer years can be significantly moderated throughaction by either Zaire or the major donors. If Zaire acts vigorously andwithout delay in the policy areas noted above and if this results, in parti-cular, in the improved allocation of its resources,the gap can be significant-ly reduced. The gap can also be reduced if donors respond promptly, too,and with an appropriate blend of project and non-project assistance anddebt rescheduling. In short, the timing and quality of the decisions of allthe parties concerned in the immediate future will largely determine theprogress of Zaire and its assistance requirements in the longer run.

v

INTRODUCTION

1. Zaire became independent in 1960. After a protracted periodof political and economic turmoil, the Zairian economy grew at a rate ofabout 7 percent per annum between 1968 and 1974. During the first halfof this phase, the investment rate was high and so were government savings,deficit financing was negligible, the external current account was in surplus,and the debt service was low. The first signs of difficulty appeared in 1971;although the economy continued to grow and the investment rate remained highduring 1971-74, government revenues contracted relative to GDP, deficitfinancing increased markedly, as did external borrowing, and the currentaccount balance turned negative.

2. The Zairian economy plunged into a deep and uninterrupted crisisbeginning in 1975 following the downturn in commodity prices. The causes ofthe crisis went beyond the commodity cycle; they lay in the failure to start aprocess of development, the relative neglect of agriculture for more than adecade, the accentuation of the economy's dependence on mining, particularlycopper, the heavy dependence of the manufacturing industry on imported inputs,and poor or inexperienced economic management. Two policy actions in parti-cular proved very damaging to Zaire: (i) heavy external borrowing duringthe upswing of the commodity cycle, mostly for projects with long gestationperiods or uncertain economic benefits and at hard terms; and (ii) thezairianization/nationalization measures of 1973-74 which, though rescindedsince, have left scars to this day, such as the erosion of private sectorconfidence and the disruption of the transport and marketing networks. Tfrecollapse of the terms of trade in 1975 exposed these inherent weaknesses ofthe economy -- which was also burdened by the adverse consequences of theabove policies -- and it did so quickly: by the end of 1975 Zaire beganaccumulating external debt arrears and running larger and larger budgetarydeficits. Two stabilization programs,supported by the IMF, were adopted in1976 and 1977 with limited compliance; and two rescheduling agreements withthe Paris Club in the same years proved inadequate to relieve the debt burden.Zaire accumulated arrears on new debt service due and on the rescheduledamounts as well, with serious consequences on external confidence. Thedifficulties of the external sector, the misallocation of resources andthe delayed effects of the zairianization/nationalization measures combinedto bring about a severe across-the-board deterioration in the country'sproductive capacity and infrastructure, and Zaire soon changed from an agri-cultural exporter to an agricultural importer.

3. The causes, effects and implications of the crisis were examinedin detail in the last economic memorandum. 1/ The main conclusions ofthat memorandum were:

(i) Although Zaire needed to make a determined effort to improvethe mobilization and utilization of its own resources, it couldnot resolve the crisis alone, because the lack of foreign exchange

1/ The Zairian Economy: Current Situation and Constraints(Report No. 2518-ZR), October 19, 1979.

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was a major constraint to stabilization and recovery. Massiverescheduling of Zaire's external debt was essential but wouldnot be enough; substantial amounts of commodity assistance and/orbalance of payments support were needed to improve the supplysituation and to slow down the rate of inflation.

(ii) In order to expand the volume and accelerate the disbursementof external assistance, Zaire needed to improve its resourceabsorption capacity and to restore external confidence throughbold, coherent and well-executed economic policies. The moreeconomic policies relied on market forces, the less would be theneed to devise complex mechanisms for resource allocation and itsmonitoring and the greater the chance of restoring the profitabi-lity of the productive sectors.

(iii) The definition and execution of pragmatic policies required, onthe one hand, a continuous, institutionalized dialogue betweenthe Government and the private sector and, on the other, theestablishment of a planning framework -- in particular, aneconomic budgeting process -- as a precondition for implementinga medium-term recovery plan.

(iv) Although the restoration of economic activity deserved toppriority, Zaire needed to lay simultaneously the foundationfor a development pattern which, in the long run, would makeit less vulnerable to developments in the world economy. Zaire

and its major donors needed to cooperate toward that objective.

4. Although the economic difficulties have continued, since the secondhalf of 1978, Zaire and the international community have taken a number ofsteps to arrest and reverse the crisis. Among these are: the extension offresh commodity, humanitarian and technical assistance; the rescheduling ofexternal debt; the adoption of a stabilization program, which has been imple-mented in 1980; the preparation of a three-year (1979-81) public investmentprogram, which has been partially executed to date, and the completion of afollow-up program for 1981-83; the revamping of a number of institutions; andthe strengthening of the dialogue on economic issues both within Zaire andbetween Zaire and its major donors. Indeed, the last two years have been quiteeventful in terms of economic and institutional interventions. This memorandumaims to assess the impact of these interventions, the recent evolution of theeconomy, the remaining constraints, and the path to sustained recovery. Theanalysis focuses on the future. Chapter I presents, as background, a briefreview of economic and institutional developments in 1979-80, in order tosupplement and update the more comprehensive analysis provided in the lastmemorandum. Chapter II focuses on specific areas of decision-making; itprovides further elaboration on the recommendations made in the last memorandum,drawing on recent performance, recent policy measures and their lessons.Chapter III examines, on the basis of various hypotheses, the requirements forrecovery in order to highlight anew the indispensability of major external debtrelief, a significant expansion in external assistance and major policy changes.Finally, Chapter IV provides the main conclusions. A special focus of thereport is the public investment program. The main analysis of the experienceto date and the new program is presented in Annex III, although the principalfindings are summarized in the main text.

Page 1 of 2

ZAIRE - ECONOMIC INDICATORS

NATIONAL ACCOUNTS

Amount Share of GDP at Market Prices (%) Annual Growth Rates (%)

(million US$ at (at current prices) (at constant 1970 prices)current prices)

1979 1979 1977 1978 1979

Gross domestic product 6,267.3 100.0 -3.5 -5.8 0

Agriculture 2,023.6 32.3 -3.3 0.2 0.6

Industry 1,432.4 22.9 1.3 -8.3 -7.1

Services 2 659.1 42.4 -6.7 -7.0 2.8

Consumption 5,798.82/ 87.9_ -6.8 -12.8 n.a.Gross Investment 1,008.02/ 15.32/ 92.32' 43*72' n.a.Exports of GNFS 1,843.0 29.4 7.8 -9.0 n.a.Imports of GNFS 1,685.0 26.9 31.7 -33.2 n.a.

Gross national savings 1,013.02/ 16.2 5.0 5.7 n.a.

PUBLIC FINANCE-/ (Central Government) (million Z) % of GDPA c t u a 1 (at market prices)

1977 1978 1979 1977 1979

Current revenues 669.0 715.5 1,944.4 16.4 18.0

Current expenditures 847.2 1,161.5 2,391.9 20.8 22.0Deficit -178.2 -446.0 -447.5 -4.4 -4.0Capital expenditures 110.3 119.7 129.2 2.7 1.0

MONEY, CREDIT AND PRICES 1977 1978 1979(million Z outstanding end period)

Money and Quasi Money 1,153.9 1,854.5 2,575.5Bank Credit to Public Sector 1,054.8 1,578.3 1,928.3Bank Credit to Private Sector 537.0 644.9 987.7

(Percentages or Index Numbers)

Money and Quasi Money (as A of GDg - market prices) 28.4 33.6 24.2General Price Index (1969 = 100)- 804.4 1,274.0 2,517.6Annual percentage changes in:General Price Inde,5/ 62.9 58.4 97.6

Bank Credit to Public Sector 26.8 49.6 22.2Bank Credit to Private Sector 39.2 20.1 53.2

NOTE: The figures quoted in the text (e.g., on GDP and imports) may vary from theabove figures as they are based on staff estimates which are more reliable.Official figures have been used throughout this attachment in order toassure consistency among the various components.

All conversions to dollars in this table are at the average exchange rateprevailing during the period covered.

1/ At market prices; components are expressed at factor cost and will not adddue to exclusion of net indirect taxes and subsidies.

2/ 1978.

3/ Figures for 1977/78 are inconsistent with other trends in the economy andshould be used and interpreted with caution.

4/ Cash operations only; excludes foreign grants and expenditures financedby foreign sources.

5/ Consumer price index for the city of Kinshasa.

April 28, 1981

Page 2 of 2

ZAIRE - ECONOMIC INDICATORS

BALANCE OF PAYMENTS 1977 1978 1979(million US$ at current prices)

Exports of goods and services 1,293 1,638 1,843of which: Merchandise F.O.B. (1,228) (1,573) (1,773)

Imports of goods and services 1,784 1,490 1,685of which: Merchandise F.O.B. (1,248) (1,023) (1,160)

Net transfers -161 -163 -174Current Account Balance -652 -15 -16Capital account (net) 179 -198 -32Net errors + omissions -31 -116 -205SDR Allocation - - 20Net international reserves (- = increase) -69 -75 -48

EXCHANGE RATES:

January 2, 1979-August 23, 1979 B 1.00 = SDR 0.5August 24, 1979-February 22, 1980 X 1.00 - SDR 0.375Since February 28, 1980 B 1.00 - SDR 0.263

Average exchange rates

1978 US$ 1.00 = a 0.8361979 US$ 1.00 = X 1.729September 1980 US$ 1.00 = B 2.904

MERCHANDISE EXPORTS (1979) million US$ %

Mineralsl/ 1,344.2 76Others 428.8 24Total 1,773.0 100

EXTERNAL DEBT. December 31, 1979 (million US$)

Public Debt, incl. guaranteed 3,781.9Non-Guaranteed 300. OTotal outstanding & Disbursed 4,06i Y

DEBT SERVICE RATIO FOR 19793/ 7

Public Debt, incl. guaranteed 9.6Non-Guaranteed Private Debt n.a.

IBRD/IDA LENDING, October 31, 1980, million US$ IBRD IDA

Outstanding & Disbursed 37.44 161.37Undisbursed 0.16 141.84Outstanding, incl. Undisbursed 87.60 303.21

1/ Includes copper, cobalt and diamonds only.

2/ Estimated amounts incurred prior to 1978.

3/ Ratio of debt service to exports of goods and non-factor services.Represents actual payments.

April 28, 1981

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I. RECENT DEVELOPMENTS, 1979-1980

1. This chapter provides a broad overview of recent developments.A more problem-oriented analysis of developments in selected crucial areas(foreign exchange rate, credit, pricing and Gecamines) follows in Chapter II.

A. Economic Developments

1. Economic Growth

2. The national account estimates of Zaire have a number of shortcomingsand have been the subject of frequent revisions in the past. 1/ According tothe latest (mid-1980) revisions, commercialized GDP contracted by about 10percent during the period 1975-78 compared to the average for 1972-74 2/.During the same period the Zairian population grew by an estimated 15 percent.

3. Three events in 1978-79 had led to expectations of a return to posi-tive growth in 1979-80. These were: (i) the promise, by donors, at theSecond Brussels Conference (November 1978) of approximately US$225 million ofquick-disbursing, fresh assistance; 3/ (ii) the adoption -- partly on thestrength of that promise -- of a stabilization program, running from July 1,1979 to December 31, 1980 and supported by a Stand-by Arrangement for SDR 118million with the IMF; and (iii) the gains in copper and especially cobaltprices beginning in the last quarter of 1978. Although the expected recoverydid not materialize -- owing, in large measure, to the continued shortage ofimported raw materials and spare parts -- the decline of commercialized GDPdecelerated very significantly in 1979 and seems to have been arrested in 1980.

4. According to official statistics, in 1979 the decline in nearly allsectors slowed down markedly. The deceleration was particularly sharp in in-dustry. Gecamines' copper output, for example, fell by 5.4 percent comparedto 13.5 percent in 1978, the year of the second Shaba hostilities, and thecontraction of manufacturing output was more than halved -- from 12.7 percentto 6.0 percent. Only value added in construction and transport fell more thanin 1978, while commerce registered a moderate recovery after a sharp drop theyear before. According to the Bank of Zaire, which has the main responsibilityfor compiling the national accounts, the decline in aggregate commercializedGDP was kept to 0.16 percent, although the fall was probably close to 1.0percent -- still a major improvement over 1978, when commercialized GDP isestimated to have declined by 6.8 percent (Table 1). The slowdown in thedecline of aggregate production was made possible by a deceleration of thecontraction in imports: real imports declined by about 8 percent in 1979compared to about 50 percent in 1978, the worst year of the crisis in everyrespects.

1/ The shortcomings were highlighted in Report No. 2518-ZR, op.cit.,p. 10 and Annex I.

2/ The cumulative decline from the 1974 peak works out to 16.0 percent(Appendix Table 2.3).

3/ The first Brussels conference, in which Zaire and its major donorsparticipated, was held in June 1978 to review Zaire's efforts towardstabilization and recovery. Two more Brussels conferences were held inNovember 1978 and November 1979.

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Table 1: Value Added in Constant 1970 Prices, 1977-79(in millions of zaires)

Annual change %1977 1978 1979 a/ 1978/77 1979/78

Production of goods(including energy) 431.1 399.4 377.0 -7.3 -5.6

Production of services 458.7 425.5 413.3 -7.2 -2.8

Production of goodsand services 889.8 824.9 790.3 -7.3 -4.1

Indirect taxes 31.8 34.3 58.0 b/ +7.8 +69.1 b/

Commercialized GDP 921.6 859.2 848.2 -6.8 -1.3

a/ Preliminary.

b/ Mission estimates.

Source: Bank of Zaire and staff estimates.

5. In 1980, according to monthly inquiries carried out by the Commis-sariat General of Planning and other sources, agricultural production (non-food) was at about the same level as the year before. Gecamines' copperproduction recovered to about 433 thousand tons, 17 percent above the 1979level, while its cobalt output increased by 11 percent to reach 15.4 thousandtons -- the highest level since 1974. Cement production began recovering inthe second quarter of 1980. Available transport statistics for 1980 show adecidedly positive trend; the volume of domestically-transported goods may haveregistered an improvement of 6-7 percent over 1979, suggesting that economicactivity has been edging up. Overall, the change in commercialized GDP wasprobably around zero -- or even marginally positive -- due, in part, to someeasing of the supply situation. Although imports with officially acquiredresources declined in real terms, total imports cleared through customs mayhave registered a gain in volume. 1/

1/ This is due to the de facto liberalization of imports with foreignexchange which is not obtained from official sources (the domesticbanking system). While such imports were permitted in the past, theywere subject to Bank of Zaire authorization and limited to certaincategories of goods. Currently, such authorization is no longer neces-sary, i.e., importers who possess foreign exchange from sources otherthan the domestic banking system, no matter how acquired, can importany good provided that they pay customs duties. This has apparentlyinduced imports, albeit -- initially -- of consumer goods. Missioninterviews with the private sector confirm an amelioration in the supplysituation in 1980, even of spare parts and equipment.

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Table 2: Utilization of GDP in Constant 1970 Prices a/(millions of Zaires)

1973 1976 1977 1978

Private consumption 592.4 539.6 473.9 398.6Traditional sector 101.1 107.7 107.7 110.8Monetized sector 491.3 431.9 366.2 287.8

Public consumption 226.6 198.7 214.3 201.6Salary and wages 120.4 143.1 165.8 177.3Other 106.2 55.6 48.5 24.3

Gross fixed capital formation 298.3 244.4 470.0 b/ 264.5Change in stocks 53.4 27.6 51.7 17.8Net exports of goods and services -94.3 6.8 -180.6 87.5Gross domestic product 1,076.4 1,017.1 1,029.3 970.0

a/ Zaire's GDP is believed to be significantly underestimated; changesin the aggregates shown are more meaningful than their absolute values.

b/ Based on official estimates which are grossly exaggerated (see footnoteto Appendix Table 2.5).

Source: Appendix Table 2.5.

2. Utilization of GDP

6. Data on the utilization of GDP in 1979 are not yet available. Themost conspicuous development in this area during the period 1972-78 wasthe decrease of private consumption (monetized sector) in real terms and at anaccelerating rate (Table 2). Aggregate public consumption was relativelystable in real terms after 1975, but resources were constantly shifted to"salaries and wages" because of the constant expansion of government employ-ment. 1/ Accordingly, "other expenditures" endured a steady and substantialcontraction in real terms during that period: from an average of about Z 100million (in 1970 prices) in 1972-74 to 9 24 million in 1978. Gross fixedcapital formation has followed the direction of GDP during the crisis but hasfluctuated more widely; after declining by about 9 percent in 1979, it mayhave increased marginally in 1980. Overall, the consumer has constantly lostin the sharing of the resources, and the size of government employment hasbecome exorbitant compared to available resources.

1/ Government employment increased from about 300,000 people in January 1976to 433,400 in October 1980 (Appendix Table 1.1).

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3. Domestic Prices

7. The persistent imbalance between money demand and supply on thelocal market was sharply reflected in the development of prices in 1979. Thetwo devaluations of the local currency in January and August of about 34percent and 25 percent, respectively, automatically increased the local(zaire) cost of a unit of imported goods by about 100 percent. 1/ Becauseof continued shortages and the inefficacy of official price controls, theprices of certain imported goods rose even more (by about 160 percent), andprices of local products followed suit. According to official statistics, 2/consumer prices in the city of Kinshasa rose, on average, by 98 percentcompared to 1978 (Appendix Table 10.1). The price increase in the course ofthe year (December 1978 to December 1979) was less pronounced and limited to63 percent.

8. The rate of inflation slowed down significantly in 1980 when it averaged47 percent, due largely to the implementation of the stabilization program. Theslowdown was facilitated by the so-called demonetization measures implementedearly in the year (paragraph 15) and is attributable, in part, to the furthererosion of real income. According to preliminary estimates, consumer pricesin Kinshasa rose at a still lower annual rate, 40 percent, in the first quarterof 1981.

4. Public Finance 3/

9. The expected amelioration of public finances in 1979 did not fullymaterialize, although some progress in budgetary performance took place.The overall deficit amounted to Z 574 million (i 546 million, countingextrabudgetary operations), which corresponds to about 24 percent of totalexpenditures. The 76 percent coverage of expenditures by revenues represents aconsiderable improvement over the previous year (58 percent) and is the highestratio since 1973. Moreover, the deficit declined in real terms; its ratio tocommercialized GDP contracted from 13.2 percent in 1978 to 6.9 percent in1979.

10. Although budgetary performance improved in 1979, it fell short of theexpectations under the Stabilization Program. Of the total deficit of a 574million, F91 million were covered by external resources (the IMF Trust Fund)and 9 483 million by domestic bank credits. The latter exceeded the ceiling

1/ The cost of one SDR went up from E 1.31 on December 31, 1978 to9 2.66 by August 28, 1979.

2/ All inflation measures in this memorandum refer to the indices preparedby the National Institute of Statistics (INS).

3/ This section is based on Treasury budgetary statistics which, especiallywith respect to expenditures, can vary slightly from those of the Bankof Zaire.

under the IMF Stand-by by Z 133 million, despite the fact that debt servicepayments and investment expenditures were substantially lower -- in all, bysome E 300 million -- than was assumed in the Stabilization Program. 1/

11. The evolution of budget categories as a proportion of GDP over the lastthree years, instead of two, allows a more accurate assessment of recentbudgetary performance, as 1978 was an unusually bad year, especially withregard to revenue collection (Table 3). 2/ On the revenue side, the mostimportant increase in 1979 occurred in the export duties on copper and cobaltpaid by Gecamines; these amounted to 4.5 percent of commercialized GDP in1979, whereas practically none had been paid in 1977-78. There was also animprovement in the control and collection of personal income taxes (which arecollected at the source) and turnover taxes on exports. On the other hand,the collection of export duties on goods other than copper and cobalt and ofimport taxes was below their relative levels of 1977. 3/ The change in importtax proceeds fell short of the combined effects of higher import prices andthe devaluations. On the expenditures side, the most striking developmentswere the increase in debt payments and the decrease in investment expenditures.The latter accounted for a smaller share of a smaller pie, as real commercia-lized GDP contracted by about 8 percent between 1977 and 1979.

12. The development of public finances in 1980 has been quite erratic,with substantial monthly deficits alternating with important surpluses.On the whole, budgetary performance continued to improve, and the budgetaryperformance criteria set in the Stand-by Arrangement for December 31, 1980were met, although the detailed year-end picture is not available yet. 4/However, data for the first nine months suggest that new arrears on expendi-tures have been accumulated and that important taxpayers, particularlyGecamines, have more or less exhausted their cash resources. The deteriorationof Gecamines' cash flow had serious consequences for the execution of itsurgent rehabilitation program, as explained in Chapter II. Furthermore, whilecurrent expenditures have been kept in line with the Stabilization Program,their composition has diverged from it, with debt service payments falling

1/ Under the Stand-by Arrangement, Zaire was authorized to purchase SDR118 million in six roughly-equal installments. It purchased SDR 20million following approval of the Stand-by in August 1979, but it didnot make the following two purchases, because the performance criteriawere not met during the balance of the year. In February 1980, Zaireand the IMF negotiated performance criteria for 1980 and, on May 16,1980, they reached understandings regarding the circumstances in whichfurther purchases would be made.

2/ Although GDP is not the most appropriate basis of comparison for somebudget categories, it is a convenient if gross measure of performancein the case of Zaire where alternative comparisons are limited by dataconstraints.

3/ For a description of these taxes and the specific tax rates, see Annex II.

4/ Zaire has made all the purchases authorized under the Stand-by.

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Table 3: Budgetary Revenues and Expenditures as a Percentageof Commercialized GDP, 1977-79 a/

1977 1978 1979

Revenues1. Contributions 11.2 9.5 11.9

Company Tax 3.2 2.6 3.0Personal Income Tax 4.2 4.3 4.9Turnover Tax (on Exports) 1.3 0.4 1.7Other 2.5 2.2 2.3

2. Customs and Excise 7.4 5.5 9.9Export Duty on Copper and Cobalt 0.2 0.0 4.5Other Export Taxes b/ 1.9 0.9 0.9Import Taxes 4.0 3.3 3.1Other 1.3 1.3 1.4

3. Non-Tax Revenue 0.7 0.5 1.0

Total Revenue 19.3 15.5 22.8

Expenditures1. Current Expenditures 26.2 26.1 28.6

Dotations 2.8 2.8 2.6Public Debt 3.2 3.1 4.6Salaries and Wages 10.2 11.7 10.8Other c/ 10.0 8.5 10.6 c/

2. Investment Expenditures 3.0 2.7 1.5

Total Expenditures 29.2 28.8 30.1

Memo:Commercialized GDP (in millions

of current zaires) 3,404 4,474 8,350

a! Calculations based on Treasury statistics.

b/ Except turnover tax.

c/ The composition of this item in 1979 was as follows (share of GDPin parenthesis): subsidies to non-profit organizations, medicalorganizations and individuals (3.0 percent); centralized expenditures,e.g., electricity, gasoline, equipment and financial costs (2.2 percent);external expenditures (1.5 percent); other (3.9 percent).

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below the Program projections and the items "salaries and wages" and "otherexpenditures" exceeding them (Table 4).

Table 4: Budgetary Operations, 1979 and 1980(in millions of zaires)

Actual Stabil. Progr.Actual 9 months Projections1979 a/ 1980 1980 b/

Customs and Excise Duties 828 847 1,368of which: export tax on

copper & cobalt (375) (230) n.a.

"Contributions" c/ 996 1,505 2,055

of which: GECAMINES (507)Other Revenues 152 276 260

Total Revenues 1,976 2,628 3,683

Total Expenditures 2,522 3,055 4,222of which: investments 129 (175) (200)

debt service 385 (726) (1,342)salaries & wages 901 (969) (1,253)other 1,107 (1,185) (1,427)

Deficit -546 -427 -539

a! Figures according to Treasury statistics, including extrabudgetaryoperations.

b/ As revised in August 1980.c/ Income and property taxes, domestic turnover tax, and turnover tax on

exports.

13. Overall, in the last two years, the central government has continuedto operate under severe financial constraints, owing to the erosion of therevenue base during the crisis, the sheer size and inelasticity of certaincategories of expenditures (wages and salaries in particular), and growingdebt service payments, especially in 1980. Nevertheless, a beginning towardimproved fiscal performance was made in 1979 and this has continued in 1980.Existing taxes were raised selectively, new taxes were introduced and tax col-lection (though still inadequate) improved in some areas. On the expendituresside, a number of economy measures (such as an employment and wage freeze andrestrictions on external travel) were introduced, although the expenditures ofthe Presidency, the Army and the Ministry of Primary and Secondary Educationproved more difficult to control. 1/ The Government also increased electricityand water tariffs as well as petroleum prices sharply 2/ in order to increasethe self-financing and revenue generation capacity of the public corporations

1/ About 25,000 primary and secondary school teachers were added to the governmentpayroll during the year.

2/ See Appendix Table 10.5 and 10.7.

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concerned. The dividends paid by public corporations to the Ministry ofPortfolio increased from 9 1 million in 1976 to E 33 million in the firstnine months of 1980 when, for the first time in recent years, the Ministrytransferred Z 21 million to the Treasury.

14. According to preliminary information, a number of factors accentuatedthe budgetary imbalance in the first few months of 1981. These include: thedeteriorating tax payment capacity of Gecamines, due to the weakening of theworld cobalt market and given its urgent rehabilitation needs; large carry-over obligations from the previous year's budget; the approval of a 15 percentacross-the-board increase in government wages and salaries; and the continuedexpansion of the number of primary and secondary school teachers. The Govern-ment has recently announced a number of new measures to control the situation.Among these are: a freeze of total outlays for primary and secondary schoolteachers at their December 1980 level; major cuts in government imports, travelexpenditures, transfers to regions, and the budgets of decentralized agencies;an eight-fold increase in selected specific duties on imports; and majorincreases in the internal turnover tax and the income tax for expatriates.Additional measures are under study.

5. Money and Credit

15. The previous years' rapid increase in the money supply continuedthroughout the first 11 months of 1979 but was suddenly reversed in December,when the Government decided to demonetize the E 5 and i 10 notes. Thepurpose of this measure was to check the growth of inflation and to penalizehoarders of cash. The demonetized notes were withdrawn from circulation andonly partially replaced by new notes in the course of one week. Thus, thebanknotes in circulation were reduced by about Z 720 million by the end ofthe year. The operation was carried out inefficiently, gave way to abuses andhit the rural poor and those operating within the law hardest. In the courseof the first nine months of 1980 only some Z 80 million of additional oldnotes were exchanged for new ones. The stock of broad money did not regainthe level before the demonetization operation until the end of April 1980.In the interim, the insufficiency of liquidity restrained both private con-sumption and investments, which had a negative effect on economic activity ingeneral. The decrease in effective demand caused certain enterprises toreduce production, but it also had a mitigating effect on inflation.

16. The generally rapid increase in the money supply during the crisiswas mainly caused by the expansion of domestic credit, particularly to theGovernment in order to finance the budget deficits, although it was offsetsomewhat by the decline in the net external assets of the banking system.In the first nine months of 1980, banking system credit to the Governmentremained below the ceilings of the stabilization program; it expanded byjust 11 percent, compared to 30 percent during 1979. Credit to the non-government sector increased somewhat more than envisaged in the program dueprincipally to an expansion of the Bank of Zaire's rediscounting operationsand the fact that some commercial banks exceeded their credit ceilings becauseof their financing tied up in the coffee campaign. In order to correct thissituation, the authorities undertook efforts, inter alia, to reduce the redis-counting operations, to stop the exchange of demonetized notes, and to demandprompt payment for all foreign exchange allocated to the commercial sector.

These and other efforts have enabled Zaire to stay within the overall credit

ceiling for December 31, 1980 stipulated in the Stand by Arrangement. Indeed,the expansion of credit to the government was more than Z 100 million, or 30percent, lower than allowed under the Stand-by.

17. In 1979, as usual, private bank credits were mainly directed towardscommercial activities, particularly the commercialization of agriculturalproducts for export. Manufacturing activities received some 20 percent oftotal credits, compared to 17 percent in 1978. In 1980, commercial activitiesincreased their share, while the share of the manufacturing sector declined tosome 15 percent.

18. Recently, the Government announced a number of adjustments in interestrates. The rates paid by commercial banks on time deposits of 3-24 months wereincreased by up to 5 percentage points (to 8-30 percent per annum) and thosethat the commercial banks are allowed to charge were raised by 3.5-4 percentagepoints. The basic rediscount rate of the Bank of Zaire was also raised (to 15percent), and increases were announced in the Bank's other rates as well.

6. External Transactions

19. The evolution of international commodity prices in 1979 was veryfavorable to Zaire; its export price index rose by about 40 percent. Theimprovement was almost exclusively on the minerals side: the copper price wentup by 45 percent on the London Metal Exchange, and the producer price of cobaltmore than doubled. The price of coffee (New York) also rose: by 12 percentfor Robusta. Import prices increased by only half as much as export prices.As a result, the terms of trade improved by about 20 percent, although theindex was still less than half the level at the beginning of the decade, andthis remains at the root of the foreign exchange crisis which persists since1975.

20. The external accounts of Zaire had deteriorated dramatically in1977-78 when the rapid drying up of external credits, in the face of mountingexternal debt arrears, forced Zaire to restrain imports even more severely.Between 1976 and 1978, imports were cut by some 40 percent in real terms, thetrade balance changed from US$-368 million to US$+550 million, and the currentaccount deficit (nearly US$1 billion in 1976) practically disappeared.The improvement of the terms of trade in 1979 brought only partial relief, asthe volume of three of Zaire's four largest exports (copper, diamonds andcoffee) was down that year. Imports fell in real terms again (to 60 percentof the average level of 1972-74), the trade surplus exceeded US$600 million,and the current account balance was negative by only US$16 million. Moreover,the value of Zaire's oil imports went up by US$74 million more than the valueof its oil exports. 1/ Despite a 20 percent increase in debt service paymentsduring the year, at the end of 1979 Zaire had accumulated US$1 billion ofarrears on its long-term public debt alone and had additional arrears of about

1/ Zaire produces and exports oil (off-shore) which cannot be refinedlocally and imports crude oil and refined products. In 1979, its oil-trade balance changed from US$+18 million to US$-56 million.

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US$850 million on its short-term debt (less than one-year maturity) and itsprivate non-guaranteed debt. The fresh assistance promised at the Firstand Second Brussels Conferences (June and November 1978), though significantand helpful, proved incommensurate with needs. Disbursements of medium andlong-term capital fell by US$200 million to five-year low of US$300 million.Net transfers to Zaire (capital inflows minus debt service) dropped from aboutUS$350 million in 1978 to about US$50 million in 1979.

21. At the Third Brussels Conference, which was held in November 1979,donors promised fresh assistance of US$180-200 million for 1980; in December1979 Zaire negotiated the rescheduling of about US$1.3 billion of its debtwith the Paris Club; and in April 1980 the syndicated banks agreed to re-schedule their total outstanding credits to Zaire, amounting to about US$400million, over a ten-year period (see Annex I ). These actions have notpermitted yet a reversal of the crisis, although -- no doubt -- the situationwould have been more severe in their absence. A major reason is that thebehavior of international prices in 1980 was less favorable to Zaire than in1979. Although the copper price averaged 9 percent above a year ago, the trendin the second half of 1980 has been downward. The producer price of cobalt,though unchanged at US$25/lb, became increasingly hard to maintain, the spot(free market) price having fallen 20-25 percent below the producer price. 1/Moreover, only 35-40 percent of the cobalt output could be marketed--the resultof a policy of maintaining the producer price unchanged, despite the softeningof the market. 2/ The coffee market has been oversupplied, and consequentlyprices have declined sharply since June 1980. As a result of these trends,combined with the unabated increase in import prices, the terms of trade arelikely to have declined in 1980. In addition, disbursements of the aid promisedat the Third Brussels Conference are now estimated at less than half of theoriginal amount, due partly to administrative delays on both sides and to somedouble-counting. More importantly, public debt service payments jumped fromUS$168 million in 1979 to about US$330 million in 1980, the increment beingequivalent to nearly 90 percent of theestimated export gain for the year.

22. In short, whereas during the period 1975-77 Zaire was able tomitigate the impact of the crisis by accumulating external debt arrears andthanks to aid disbursements, which remained relatively high, beginning in 1978this no longer proved feasible to the same extent; disbursements began todecline, while debt service payments increased, private credits contractedsharply, and export performance was erratic. Consequently, in 1978-80,imports averaged about 60 percent of the pre-crisis (1972-74) level, andZaire ran a cumulative "forced" trade surplus of about US$1.8 billion.

7. Social Cost

23. In 1980, the inflation rate slowed down not because of a majorimprovement in supply but because of a further decline in effective demand.

1/ Both Zaire and Zambia reduced the producer price from US$25/lb to US$20/lbin March 1981.

2/ Zaire is reported to have accumulated stocks equivalent to nearly 1 1/2times its annual production and more than two-thirds of world annualconsumption.

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Increases in salaries and wages have not matched the increases in prices.Within the private sector, where salaries are higher than in the publicsector, the median salary of an unskilled worker in Kinshasa (including tran-sport and housing subsidies) was about Z 170 per month in September 1980,or less than half of the cost of feeding an average family of six people.(For comparison, the average price of meat was Z 30 per kg. in Kinshasa.)A decrease in consumption has been inevitable for some time, particularlyfor the low-income groups in urban areas.

24. Several recent studies bear out the emergence of malnutrition as aproblem in Zaire. 1/ Although the degree to which the problem is widespreadis uncertain, most studies confirm the aggravation of the problem in the areaswhere it has been identified. Moreover, while the causes of the problem arevaried -- and thephenomenon is not unusual for a country in Zaire's developmentstage -- all studies have established a link to the economic crisis. The studyon Kinshasa found that an important cause of the malnutrition observed was thedecreased supply and high prices of food products, i.e., "lack of quantityrather than quality". 2/ These recent studies have contributed to raising theZairian authorities' consciousness of the problem. They have dramatized inparticular the need for going beyond localized efforts to combatting malnutri-tion toward a general policy of promoting better nutrition -- the satisfactionof basic needs -- as part of an overall agricultural and development strategy.

25. The problem of shrinking real incomes has broader implications thanmalnutrition, however, as it affects the efficiency of the labor force and thepublic administration. In the early phase of the crisis the extended familysystem of Zaire had helped to cushion its effects for many. As the crisisdeepened, many of those holding a job were forced to engage in supplementaryactivities -- often neglecting their primary job -- in order to supportnot just themselves but also their "relatives". This phenomenon is notunusual worldwide but it is very widespread in Zaire.

1/ Preliminary Results of Nutrition Studies in Popokabaka, April 1979, andPreliminary Results of Nutritional Studies in Kinshasa with Recommendationsfor Interventions, June 1979. Both studies were carried out by the ZaireNutritional Planning Center with assistance from experts of Tulane Univer-sity, New Orleans. Three earlier studies were highlighted in the lastEconomic Memorandum, Report No. 2518-ZR, pp. 23-24.

2/ "The food consumption study showed a 200 percent increase in food pricesin local markets during the period August 1978 to February 1979. Aminimally acceptable diet (based on FAO Recommended Dietary Allowances)using locally-preferred foods (but no animal products because of the highprices) was calculated to cost 240 zaires for a family of four per month.This amount is certainly beyond the reach of most families whose averageincomes were estimated at about 100 zaires per month." (p. 86).

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B. Institutional Developments

26. In 1978, Zaire had started a process of institutional reform withthe abolition of inefficient commodity offices, the restructuring of themanagement of public enterprises, the establishment of an economic managementcommittee at the ministerial level, the installation of an IMF-financedtechnical assistance team to the central bank and the appointment of anexpatriate controller general (financed by the UNDP) at the Ministry ofFinance. This process of change has continued in the last few years, butthe results have been gradual because of (i) the weakness of the publicadministration at large, (ii) the resource constraints of the economy ingeneral and the public administration in particular, and (iii) the turnoverand delay in the arrival of some of the technical assistance teams. 1/

27. Most of the institutional changes were introduced as part of theMobutu Plan which was announced on November 25, 1977. The Mobutu Plan con-sisted of a three-year (1979-81) "recovery program" with three main objectives:(i) improvement of economic management at all levels, (ii) economic andfinancial stabilization, and (iii) recovery of production through a publicinvestment program (PIP), a program of priority import needs (Programme deBesoins Prioritaires) and a New Agricultural Strategy. 2/ Institutionalreforms were at the center of the first objective, namely, improved economicmanagement. Many of the ideas had been suggested earlier, either within Zaireor by its main partners, and stemmed in part from the experience with the 1976and 1977 efforts at stabilization.

28. The institutional reforms undertaken by Zaire in the last two yearsare essentially of three kinds: (i) Those designed to improve economicdecision-making and monitoring at a high level. The establishment of aShort-Term Economic Management Committee (Comite de Conjoncture) 3/ fallsin this category, as do the preparation of a medium-term public investmentprogram -- a major tool, in principle, for annual decisions on investmentexecution -- and the creation, in December 1980, of an External ResourcesCoordinating Committee. (ii) Those aimed at improving the functioning andthe administrative controls within key institutions. Among these are theappointment of high-level technical assistance teams to the Central Bankand the Ministry of Finance, the creation of a Central Pay Directorate and theestablishment of a new, semi-autonomous Customs Office called OFIDA. (iii)Those intended to gradually establish an investment approval, programming

1/ Because of recruitment problems, the controller general, who arrived inMay 1979, received the first of five authorized assistants only inSeptember 1980. The arrival of the team for Customs was delayed byseveral months because of housing problems.

2/ The Mobutu Plan was evaluated by the Bank staff in a paper titled "FromEconomic Stabilization to Recovery: An Evaluation of the Mobutu Plan",May 15, 1980, prepared for the Consultative Group.

3/ The Committee is chaired by the Prime Minister and is composed of thekey economic ministers and representatives of ANEZA (the enterpriseassociation) and UNTZA (the national labor union).

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and monitoring process. The centralization of these tasks in the CommissariatGeneral of Planning (CGP), the adoption of a new Investment Code and therevamping of the Investment Commission fall in that category. The measurescited are but a few of those being implemented; there are others concerningpublic corporations, education, agriculture, planning, project implementation,administration, etc. Only the progress under a few of the measures can bereviewed in this space.

29. In the high-level management and coordination sphere, the Comitede Conjoncture is increasingly becoming an economic policy-making body,advisory to the Executive Council. The Executive Council has not over-ruled the Committee to date. The Committee has also led to increased inter-ministerial and better government-private sector-labor cooperation, thanks to(i) the active and assertive role of the Prime Minister's Office in this area,and (ii) the addition of representatives of the enterprise sector and thenational labor union to the membership of the Committee. A problem whichremains unabated is insufficient vertical cooperation. Sometimes, agencyheads are not fully aware of what goes on in their own agencies or the tech-nical staff are not fully informed of decisions made at a higher level. Theestablishment of an External Resources Coordinating Committee responds to along-standing need for the follow-up of projects financed with external aid.The Committee, which met for the first time on January 31, 1981, is chairedby the Director of the Prime Minister's Office. Its members are the repre-sentatives of the Ministers of Finance and Foreign Affairs, the CGP, the Bankof Zaire, FED, the UNDP, and the World Bank. The Committee plans to inviterepresentative of other donors to present their problems or views, as needed.It also plans to establish a technical secretariat with assistance from theUNDP.

30. The creation of the Central Pay Directorate (CPD) and OFIDA are ofspecial interest because, together with the installation of experts at theBank of Zaire and the Ministry of Finance, they constitute the main pillars ofthe institutional reforms recommended by the donors at the First BrusselsConference (June 1978). Both organizations are off to a good start, althoughtheir tasks are quite difficult. CPD has succeeded in halting the expansionof government employees, with the exception of primary and secondary schoolteachers, the only category that expanded in 1980 (Appendix Tables 1.1 and1.3), and it has turned its attention to that category recently. OFIDAprojected an increase of Z 150 million in customs revenues in 1980 afterallowing for the impact of inflation. 1/ More importantly, it is in theprocess of putting in place pragmatic, problem and product-specific policiesto discourage underinvoicing, expand domestic supply and stimulate localprocessing. An important byproduct of its activities will be the productionin the next few months -- and for the first time in more than a decade -- of

1/ 9 150 million over 140 percent of revenues in 1979--40 percent beingthe assumed combined effect of devaluation and international inflation.

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accurate statistics on imports and exports (based on 100 percent of thedeclarations). Indeed, through the efforts of the CGP, OFIDA and otheragencies, the information base of Zaire has improved in some respects recently.

C. Public Investment Program

31. In the last few years, the Zairian Government has taken a numberof institutional and other measures to revitalize and improve the distri-bution of public and private investment. These include the adoption of athree-year public investment program (PIP), the diversification of the opera-tions of SOFIDE (Zaire's development bank), the adoption of a new InvestmentCode, the creation of Agricultural Recovery Funds, and others. These arereviewed and evaluated in Annex III. This section focuses only on the expe-rience with the public investment program.

32. In September 1979, Zaire completed a PIP for 1979-81 which coveredsix sectors -- agriculture, mining, energy, transport, education and health --and was presented in three tranches by priority. The total cost of the programwas estimated at Z 3.3 billion (or US$2.1 billion at the March 1979 rate ofexchange), of which one-third in local currency and two-thirds in foreignexchange. About half of the program was to be financed by the Government andthe parastatals concerned from their own funds, 30 percent through the projectpipeline and 20 percent through new project aid. Although the PIP containedsome projects of questionable merit or urgency, the amounts involved weresmall. The program responded, on the whole, to the priority needs of theeconomy, although it was too heavily weighted in favor of energy (20 percent),largely because of the burden of completing the investments associated with theInga-Shaba hydro-electricity complex. In addition, costs were for the mostpart underestimated and the execution schedules were optimistic. The prepara-tion of the program, nevertheless, represented a step forward, as the programwas reasonably well argued and documented, and the preparation process led tothe cancellation or consolidation of a number of projects.

33. The execution of the PIP to date has been constrained largely by (i)the shortage of resources, and (ii) the execution of certain on-going projectswhich had not been included in the PIP. Thus, only 40 percent of the three-year program was executed in 1979-80, compared to 63 percent foreseen underthe program. The lowest rate was recorded in agriculture (19 percent) andthe highest in mining (60 percent). The execution rate, however, appears tohave increased in 1980 (over 1979), as the authorities increased their effortsto fund the program, improve the cashflow of some of the parastatals concernedand remove implementation bottlenecks.

34. Recently, Zaire has completed a public investment program for theyears 1981-83, drawing on the experience with the first one. The new programincludes all projects under execution (only 36 of the 226 projects includedare new) and is presented in a single tranche. Its main objectives are therehabilitation of existing capacity and infrastructure (above all, Gecaminesand the voie nationale) and the completion of ongoing projects with largesunk costs. The total cost of the program is about E 6.9 billion (appro-ximately US$2.3 billion) of which about two-thirds are in foreign exchange.About one-fifth of the program cost is to be financed by the Government,14 percent through self-financing by the parastatals concerned and 27 percent

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through the project pipeline. Financing for the remaining 38 percent remainsto be found. A fuller description and an assessment of the program are includedin Annex III.

35. Overall, the new program responds to the priorities for Zaire andpromises to contribute measurably to Zaire's economic recovery. If merits,therefore, strong internal and external support, although the improvementof the supply situation and short- and medium-term economic policies will beeven more important. The new program is more realistic than the first in itscost estimates, implementation schedule and some of the financing components.While a large portion of the financing remains to be obtained, the prospectsfor its execution are more favorable than before for several reasons, outlinedin Annex III. These include the experience gained; measures, under implementa-tion or planned, to generate the domestic finance needed and accelerate externalaid disbursements; and fuller political support. On April 2, 1981, the Presi-dent issued a decree approving the PIP and urging its execution.

36. The preparation of the PIP should be viewed as a first step towardthe establishment of an investment programming and budgeting process in Zaire.This process has started, despite a weak manpower and data base, and is slowlyyielding some of the desired results: technical experience is slowly buildingup; programming and follow-up procedures are slowly being institutionalized;and the agencies whose cooperation is crucial to the process are slowly beingsensitized to the importance of this very cooperation. Expectations mustnevertheless be realistic and modest, because the task is, in many respects,vaster than the administration's human and financial resources allow.

D. Overall Performance

37. In the last two years, the strategy pursued by Zaire, in cooperationwith the major donors, to reverse the crisis comprised four concrete chronolo-gical steps: (i) strengthen or establish the institutions (Bank of Zaire,Ministry of Finance, CPD and OFIDA) which would have to play a key role in thestabilization efforts; (ii) secure the resources and debt relief necessary toachieve stabilization-with-modest-growth; (iii) implement a stabilizationprogram with assistance from the IMF; and (iv) prepare and execute a publicinvestment program, focused on rehabilitation, in order to start recovery.The strategy worked out as follows: the four main institutional changesforeseen are now in place, although some of them have been achieved with somedelay; the resource and debt relief provided has helped, but not as much asforeseen, partly because export volume declined in 1979 and the terms of tradedeteriorated in 1980; the stabilization program was implemented in 1980, butat a lower level of imports and economic activity than had been anticipated;and the public investment program became a reality but could be executedonly partially. At the same time,the financial situation of Gecamines hasdeteriorated and its investment program has fallen seriously behind schedule.The strategy had partial success; as a result, the crisis is not over, stabi-lization is not fully secured and recovery is yet to be assured. Neverthe-less, the degradation of the economy has probably been arrested, a momentum of

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change has been created, and the way has been paved toward both a greater useof IMF resources and a new, more substantive debt rescheduling agreement. 1/

38. The recent overall performance of Zaire must be seen against theperspective of resource availability. In 1980, the Government pursued astrategy of assigning top priority to the implementation of the stabilizationprogram and of avoiding non-compliance with the new debt rescheduling agreements.The resource crunch of the economy militated against orderly budgeting andallocation of domestic and foreign exchange resources despite efforts by theagencies concerned. For example, the central bank instituted monthly andquarterly foreign exchange budgeting in closer cooperation with the Ministryof Finance, Gecamines and Sozacom (the state-owned company marketing Gecamines'output). Yet, in practice, because of the shortage of resources, it wasforced to operate on the basis of ad hoc decisions literally week by week.The Ministry of Finance was under similar pressure and was forced to actsimilarly. Often both organizations had to cope with conflicting pressure oradvice from a variety of sources, including donors, technical advisors andconsultants.

39. The resource crunch was no doubt aggravated by the sluggishness of theexport sector and the inability to curtail the growth of curtain categories ofdomestic expenditures. In addition, donor response has been slow and has notmatched Zaire's perceived needs. For example, whereas Zaire requested aboutUS$450 million of balance of payments/commodity assistance support at theSecond Brussels Conference, it obtained promises of just US$350 million. 2/At the Third Brussels Conference, the request was for US$300 million and thepromise was for US$180-200 million. At the Paris Club, Zaire argued forrescheduling terms which would enable it to keep the debt service ratio at 17percent, and the outcome was about 26 percent. 3/ Part of the problem was thefragmented way in which the needs and remedies were considered.

40. Zaire's progress toward stabilization and recovery and its medium-term capital requirements were the main subject of attention at the meetingof the Consultative Group for Zaire which was held in May 1980. The donorsat the meeting expressed satisfaction with the reforms and measures whichZaire was implementing. They agreed with and affirmed their intentionto respect the priorities of the Mobutu Plan. They urged Zaire to continueits efforts, especially in the areas of decision-making, mobilization andallocation of domestic and foreign exchange resources, project implementation,investment budgeting, and agricultural policy. Most donors indicated that, if

progress continued, they would be prepared to increase their assistance toZaire.

1/ As of this writing, negotiations with the IMF on an Extended FundFacility are well advanced, and the Paris Club is expected to meet soon.

2/ Includes IMF resources.

3/ Projection for 1980 at the close of the Paris Club meeting. Actual debtservice in 1980 amounted to about 17 percent of export earnings due to thedelay in the signature of some of the bilateral agreements. The averagedebt service ratio in 1981-83 is more than 30 percent.

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II. THE PATH TO RECOVERY

41. Although the recovery of the Zairian economy will depend to a con-siderable degree on external factors, in particular, debt rescheduling andexport prices, the recovery may be short-lived if not carefully planned andexecuted. What Zaire needs and must embark upon without delay is to build amore diversified economy, increasingly based on the use of local resources.What stands in the way of such a transformation is not the behavior of oneeconomic or political group or another -- in fact, most groups would cooperatein the transformation -- but, rather, the configuration of current institu-tions and the interaction of current policies. After all, economic agents(farmers, firms, banks, households) act with a certain rationality under anyset of circumstances; Zaire is no exception in this regard, although thefunctioning of the economy does have characteristics peculiar to its struc-ture, institutions and history. While the Government has acted in a number ofpolicy areas, the actions have not taken sufficient note of what really goeson in the marketplace; they have been introduced with delay and in an abruptrather than gradual manner; and they do not constitute a coherent package.

42. This chapter focuses on five areas of decision-making: (i) mobili-zation, allocation and control of domestic financial resources, (ii) theforeign exchange rate, (iii) domestic credit, (iv) pricing of goods andservices, and (v) as a special case, Gecamines. It presents, under eachheading, a background containing a brief analysis of the current situation andsuggests some policy directions. The policy suggestions are illustrative andnot exhaustive. They are based on the following propositions which arefounded, in turn, on the conclusions of two earlier World Bank memoranda 1/and supported by the analysis in the rest of this chapter:

(i) the economy is subject to excessive regulations; theregulations either do not work as desired or benefitsectors or economic agents which do not contributeproportionately to the economy; they also impose aheavy administrative burden; there needs to take placea margin of improvement in the efficacy of the publicsector through a reduction in the number of inter-ventions and an increase in the effectiveness of eachremaining intervention;

(ii) resources need to be shifted from the service sectorsto the directly productive sectors;

I/ The Zairian Economy: Current Situation and Constraints (Report No.2518-ZR), October 19, 1979; and The Manufacturing Sector of Zaire (ReportNo. 2122-ZR), October 29, 1979.

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(iii) the administrative, structural, financial and socio-economic constraints of Zaire will remain significantfor some time; these would need to be taken into accountin considering the orientation, design and phasing ofpolicy changes;

(iv) as external and internal confidence has a major bearingon the prospects for recovery, policy changes -- evenif gradual -- must give clear signals, cover a broadfront and be clearly articulated.

43. The policy suggestions in the following pages are suited to thecurrent, in many respects abnormal, economic environment -- characterizedby severe shortages, gross underutilization of capacity, high inflation,speculation, weak private-sector confidence, and inadequate competition --which will take time to correct. When the situation normalizes, some of thepolicies would need to be reconsidered; in the interim, all would require closemonitoring of economic and financial trends.

A. Government Finances and the Budgetary Process

1. Background

44. Recent performance regarding the mobilization and allocationof domestic resources leads to the following observations and conclusions:

(i) The ratio of taxes to commercialized GDP has declined in thelast ten years despite the introduction of new taxes andefforts to improve tax collection. This suggests, and there isconsiderable evidence to demonstrate, that substantial taxevasion exists with respect to all categories of taxes, espe-cially income and profit taxes and within the real estate,commerce and industry sectors. For example, in 1979, approxi-mately 35 percent of the revenue from the personal income taxcame from Gecamines, which accounts for only 3-4 percent oftotal formal employment. The proceeds from the real estate incometax amounted to only Z 8.1 million, compared to a potential of9 40-50 million. The receipts from the tax on "liberal profes-sions" -- a mere i 123,000 -- was probably equivalent to whatone or two individuals alone could have been expected to pay.Neither tax receipts nor specific tax rates have increased withdomestic inflation. In 1979, import taxes (adjusted for importvolume) rose by less than the combined effects of the increasein import prices and the devaluations which took place duringthe year. There is a large difference between assessed customsduties and collection.

(ii) The compression of expenditures in real terms, which is welcome,has not been sufficiently selective, despite earnest efforts by theMinistry of Finance. (The limited "effective jurisdiction" of the

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Ministry over certain categories of expenditures, has imposed hardchoices on the staff). The reduction of the deficit as a proportionof GDP has been achieved at the expense of a substantial decline inreal government wages and salaries and in some of the operatingexpenditures essential for the proper functioning of the publicadministration. The present situation with respect to the govern-ment payroll is paradoxical in that, whereas total expenditures areexcessive, the level of wages and salaries is very low. The poorperformance of some government services is not the result of lackof staff; it is, on the contrary, a consequence of the super-fluousness of employees, many of whom are of questionable abilityand necessity, and the widespread lack of motivation and admini-strative discipline. Moreover, the proper functioning of theeconomy is hampered by the wornout state of the administrativemachinery -- the lack of maintenance and renewal of premises and ofoffice and transport equipment.

(iii) The elaboration of the budget, though subject to some guidelines,is not based on systematic projections based on clear goals,recent performance, means and a medium-term perspective. Wheregoals are stated, no adequate precision is given on how to reachthem. The conceptualization and formulation of the investmentbudget are deficient. For example, the expenditure side listsonly locally-financed, direct investments and, therefore, doesnot provide a complete picture of government investments; thejustification and cost breakdown of the proposals for financingis inadequate or not uniform in quality of presentation; andthe review process is too lengthy and takes too many officialsaway from their ordinary work. The preparation of the investmentbudget for 1981 shows improvement in the process, as explainedin Annex III; 1/ however, the effort needs to be intensified.

(iv) The budgetary control procedure has been satisfactory in designbut, traditionally, it has been applied to only a minor partof budgetary expenditures -- 15 to 20 percent of the total.Items traditionally not submitted to this control have been"dotations" (allocations to the Presidency) 2/, military

1/ Particularly noteworthy is that after completing its work on thedraft budget, the Sub-Commission responsible for it prepared for thehigher authorities a memorandum on the problems encountered duringthe work, with a view to correcting them next time. This is encouraging.

2/ Including auxiliary organizations, the Legislature, the Executive Council,etc.

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expenditures, public debt, financial costs 1/, subsidies,external expenditures, economic interventions 2/, and payments tothe regional administrations. With the establishment of OGEDEPand the Central Pay Directorate and with the installation of aController General (Ordonnateur Delegue-Principal), the coverageand application of control procedures may have increased (toprobably two-thirds of expenditures), but there is much room forimprovement.

2. Implications

45. A main objective of the budgetary process should be to include allgovernment revenue in the budget and to allocate it in a way that ensures

the most efficient use of resources. For example, all resources intendedfor investment should appear explicitly either in the current budget or inthe capital budget. No investment expenditures should be programmed or,preferably, approved without the technical evaluation or consent of theCommissariat General of Planning and the specialized ministries. This is thecurrent procedure; however, it requires clearer lines of coordination andgreater cooperation.

46. The mobilization, allocation and control of public resources isnot only a function of the fiscal, budgetary and related legislation, but itis also highly dependent on the organization, quality and efficiency of thepublic administration. The Zairian administration has some obvious short-comings. The rapid rejuvenation of the professional ranks and the frequenttransfers of qualified staff has led to an erosion of experience and speciali-zation. Moreover, the administration is continuing to suffer from conflicts ofcompetence and overlapping responsibilities. Some of the institutions thathave been created have often sought to enhance their importance by wideningtheir field of work. As a consequence, studies and statistics in the samefield are sometimes produced by several institutions, while some importantareas go unattended.

47. The institutional set-up of the public administration has undergonefrequent and sudden changes since independence, especially with the rapidwidening of the domain of direct government intervention. New institutionshave been created just because existing ones did not function adequately.In the case of institutions outside direct government control but exercisingtraditionally ministerial duties, the establishment of new ones has oftenbeen promoted by the staff concerned because of the greater independencegained with respect to salaries and operating expenditures. Consequently,such institutions have proven more costly. The frequent ad hoc changes inthe public administration have clouded administrative procedures as a wholeand responsibilities in particular. An overall review of the organization of,the public administration -- preferably by an outside agency -- is, therefore,needed.

1/ Commissions, interest to the Bank of Zaire, other bank fees.

2/ Loans, equity participation, tax rebates to economic agents.

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48. A number of measures could be considered to improve the mobilization,allocation, programming and control of domestic financial resources. Some ofthese are suggested below:

(a) Review the tax system with respect to administrative procedures,enforcement measures and penalties (establish specialized courtsto speed up the handling of violations, which could also have apreventive effect).

(b) Improve the resources -- human and administrative -- of the taxadministration, particularly the training of tax assessors.

(c) Simplify the tax system. The taxes applying to some transactionsor goods are too numerous and cumbersome.

(d) Collect all export taxes at the time of export (embarkation)rather than at the time of repatriation of the export revenue,which is now the practice in certain cases. 1/

(e) Make greater efforts to formulate the annual budget on the basis ofmedium-term plans (for two or more years) by the agencies concernedin order to permit evaluation of their requests in a longer timeperspective.

(f) In order to improve the investment programming and monitoringprocess: (i) achieve a better conciliation of the project files ofthe Ministry of Finance and CGP; (ii) undertake more systematic,on-the-spot inspection of execution, assign more specific responsi-bilities in this area and allocate sufficient funds for this purpose;(iii) introduce flexibility in the use of units of account (e.g.,US$ or another convertible currency) in the programming andmonitoring process (this is already taking place in the internalbidding or contracting for some goods or works); and (iv) continueto improve coordination among Ministries and between the CGPand the public corporations.

(g) Give higher priority to financing: (i) the minimum operatingexpenditures essential for the proper functioning of the admi-nistrative machinery, and (ii) recurrent or investment expendi-tures aimed at maintenance, rehabilitation or replacement ofinfrastructure or equipment; allocate any extrabudgetary orwindfall revenues, (e.g. income from government investments,royalties on crude oil production and aid counterpart funds) tothese two priority uses. The actual procedure for the allocationof counterpart funds is complicated and slow; it could be improvedand speeded up with the cooperation of the donors (See Annex III).

(h) Limit the number of government employees to a more reasonablelevel in order to generate the resources needed to bring salaries to

1/ Apparently, the Government has taken some action in that direction veryrecently, although the details are not available yet.

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more realistic levels--a process which will take time. The stepsinvolved (wiping out of payroll irregularities, retirement of staff,keeping new recruitment to a minimum, etc.) will be painful andrequire the cooperation of management on all levels.

B. The Foreign Exchange Markets

1. Background

49. The most disruptive market disequilibrium during the past few yearshas been that of the foreign exchange market, which has produced a largediscrepancy between the official exchange rate and the parallel (black market)rate. Since November 1978, the Bank of Zaire has carried out six devaluationsof the zairian currency -- the last one on February 22, 1980. Despite thesedevaluations, the gap between the two markets has remained considerable. In1979, the parallel market rate was, on average, 3.6 times the level of theofficial exchange rate. 1/ No economy can function properly with this type ofdisequilibrium, regardless of the efficiency of its banking and administrativesystems.

50. Since foreign exchange constitutes the scarcest good on the zairianmarket, its control provides innumerable opportunities for making exceptionalprofits, many of them illegal or speculative in nature. For example, manyexporters who, under foreign exchange regulations issued in early 1980, areauthorized to deposit with domestic banks (i.e., to keep for their own use)up to 15 percent of their export earnings in foreign exchange accounts,negotiate with local commercial banks the right to appoint the beneficiariesof the 55 percent which the banks are authorized to retain for financing therequirements of their clients. 2/ In turn, the beneficiaries either paythe exporters a premium for this right or sell their production to them atfavorable ex-factory or wholesale prices. The operating costs of firms areconsequently increased, which encourages illicit behavior or forces firms toincrease prices to reflect the effects of using the parallel market to supporttheir operations. This kind of behavior cannot be eradicated through adminis-trative controls, because the participating actors have enough resources toobtain favors, thanks to the high profits involved in these activities.

51. Speculative behavior and hoarding have also been indirectly encouragedby government policy. For example, exchange rate policy and its applicationhave prompted the conviction that the devaluations will give rise to sharpincreases in domestic prices and that a number of months will elapse betweenthe devaluations. The two devaluations of 1979 and that of early 1980 in-creased the value of the US dollar in terms of the local currency by 52.2percent, 32.7 percent and 44 percent, respectively. Producers and merchantsfelt that by hoarding goods up to the moment of a devaluation, they could

1/ The gap narrowed significantly in the first few months of 1980, partlyas a result of the demonetization measures, but has widened againsince then -- to nearly the 1979 level.

2/ The shortage of and competition for foreign exchange make the bankswilling negotiators.

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increase their prices by roughly these percentages. The adjustments in theforeign exchange rate, therefore, led to dislocations for protracted periodsdepending on the nature and resources of the specific firms. A recent exampleof speculative behavior is the coffee market, the main source of foreignexchange for Zaire's commercial banking system. By mid-October 1980, i.e.,about eight months after the last devaluation, and in the context of risingexpectations regarding the imminence of another important change in the parityof the Zairian currency, more than one-third of Zaire's coffee crop was held instock by firms reluctant to export through legal channels. In order to encouragethe evacuation of these stocks, the Bank of Zaire issued in October an instruc-tion authorizing certain coffee exporters (those engaged also in planting andprocessing) to deposit and retain up to 20 percent of their foreign exchangeearnings in the domestic commercial banks, in contrast to the 15 percentauthorized since early 1980 for all other exporters. Moreover, the so-called"taxe conjonturelle" on coffee exports was abolished. While the stocks wereeventually marketed, this was induced largely by the Central Bank's enforcementof the repayment of marketing credits rather than any disincentive to speculation.

52. Another factor which has encouraged illegal exports (smuggling orgrade falsification) is that after a devaluation, exporters -- with the notableexception of some mining and energy companies such as Gecamines and Gulf Oil --are authorized to preserve the purchasing power of neither the foreign exchangethey surrender to the Bank of Zaire (30 percent) and to the commercial banks(55 percent), nor the earnings which they are entitled to hold in the form offoreign exchange deposits (45 percent for Gecamines, 15 percent for otherexporters). Current regulations oblige banks to transfer the exchange ratedifferential in local zaires to the Bank of Zaire. (Such a policy contrastswith policies adopted by some countries, which -- particularly in periods ofrapidly increasing domestic and international costs -- systematically transferincome to the export sector in order to diversify their economies, createemployment opportunities and generate sufficient foreign exchange to sustaindevelopment efforts.) One more factor shaping expectations in Zaire's foreignexchange markets consists of the cyclical pattern followed by the differencebetween the parallel and the official exchange rates. During the last twoyears, after every major devaluation, the gap between the two rates declinedsignificantly, only to increase again after a few months. As a result,operators have learned that, although profit opportunities in the parallelmarket diminish considerably after a major devaluation, they will be restoreda few months later and that, therefore, they might as well continue operatingillegally and continue holding abroad as much foreign exchange as possible.

53. In the last two years, the Government has taken a number of stepstoward a policy of flexible exchange rates. First, the devaluations initiatedby Zaire in November 1978 have brought domestic prices more in line withinternational prices. (The increasingly narrowing gap between the two ratesafter each major devaluation seems to confirm this interpretation.) However,the persistence of a significant gap between the official and the parallelrates at the end of this period suggests that (i) factors other than dif-ferences in inflation rates -- in particular, all the complex factors affectingconfidence-- are dislocating the foreign exchange markets, and (ii) a reasonableequilibrium cannot be achieved unless expectations are drastically changed andthe official and parallel rates are brought more in line with each other by

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further devaluations. Another important measure consisted of granting, defacto, the right to import any good, without the authorization of the Bank ofZaire and without the purchase of foreign exchange from the domestic bankingsystem, provided that import duties are paid to OFIDA, the customs organization.Although statistical data on these transactions are not available, as noted inChapter I, the supply of ce