Report No. 35362-AO Angola Country Economic Memorandum Oil, Broad-Based Growth, and Equity October 2, 2006 Africa Region Macroeconomics I Document of the World Bank Table of Contents EXECUTIVESUMMARY. ....................................................................................................... i THEREPORT'S MAINMESSAGES ................................................................................... I TheRoad Ahead Involves Risks ................................................................................. iii SOCIO-ECONOMIC 111 A World Class Oil and Diamond Producer ............................................................... REALITIES...................................................................................... iii Daunting Poverty and Welfare Indicators................................................................. iv A ChallengingBusiness Environment........................................................................ iv MACROECONOMIC REFORMAGENDA ........................................................................... V TangibleProgress and Promising Opportunities........................................................ v Aligning Economic Policy with Macroeconomic Realities.,...................................... vi Institutional Options to Manage the Windfall .......................................................... vii STRENGTHENING GOVERNANCE TRANSPARENCY AND VI11 Dealing with Conflicts of Interest .............................................................................. .............................................. ix Reassessing the Role of Sonangol.............................................................................. ix Addressing Governance and Transparency Issues...................................................... x TacklingIssues in the Diamond Sector..................................................................... xii HOW TO STRENGTHEN THE PRIVATE SECTOR ........................................................... XI11 OPTIONS TO REVAMPAGRICULTURE ......................................................................... XIV IMPROVINGWELFARE THROUGH SERVICE DELIVERY ............................................... XV Reaching the Poor with Social Services .................................................................... xv Using Fiscal Savings to Improve Service Delivery.................................................... xv CHAPTERS INTHE MAINTEXT I. COUNTRYBACKGROUND: SOCIO-ECONOMIC REALITIESBEFORE AFTER AND INDEPENDENCE ................................................................................................................... 4 SOCIO-GEOGRAPHIC CHARACTERISTICS ...................................................................... 4 LIVINGSTANDARDS INDICATORS .................................................................................. 6 THETRANSITIONTO INDEPENDENCE.......................................................................... 10 POLICY CHOICES AND STRUCTURAL CHANGES .......................................................... 12 11. MACROECONOMIC PERFORMANCE INA TIME OF TRANSITIONS ....................... 16 THETRANSITIONTO A MARKET ECONOMY ............................................................... 16 Macroeconomic Instability and Dollarization in the 1990s..................................... I 8 MORE REVENUES AND LESS INFLATION ..................................................................... 19 Bringing Inflation Down with Success...................................................................... 22 26 THETENSIONS TRANSITION................................................................................... TheExternal Sector: Oil is Well that Ends Well....................................................... OF 27 Maintaining Fiscal Discipline .................................................................................. 27 Developing the Interior and the Cities in Tandem.................................................... 29 Dealing with Dutch-Disease Related Phenomena .................................................... 30 Consolidating the Transition to a Multi-Party Democracy...................................... 31 111 . OILWEALTH: POLICY OPTIONS TO MANAGE WINDFALL..........................THE 33 THECHARACTERISTICS OFTHE PETROLEUMSECTOR .............................................. 33 THELEGAL ................................................ 37 The Organization of Fiscal Administration .............................................................. FRAMEWORK GOVERNING THE SECTOR 40 GOVERNANCE, TRANSPARENCYINSTITUTIONAL CAPACITY .............................. AND 41 TheRole of Sonangol ................................................................................................ 42 OILGovernance HowMUCH FORHowLONG? WEALTH:and Transparency ................................................................................. 44 AND .................................................... 47 Oil Revenues under Different Scenarios................................................................... 49 INTERGENERATIONAL CONSIDERATIONS.................................................................... 53 POLICY OPTIONS T O MANAGE WINDFALL THE .......................................................... 54 Institutional Options to Manage the Windfall .................................... The Way Forward: Five Steps to Manage the Windfall ........................................... ..,....................56 57 IV. THEDIAMONDSECTOR: A POTENTIALUNDEREXPLOITED ................................ 61 THECHARACTERISTICS OFTHE DIAMONDSECTOR................................................... 61 GOVERNANCE: OPAQUEAND UNSTABLE LEGISLATION ............................................. 63 THEBUSINESS ENVIRONMENT: COMPETITIVE ENOUGH NOT .................................... 65 A THREE-PRONGED STRATEGY TO UNLEASH ............................................................. 69 THE POTENTIAL OF THESECTOR ................................................................................ 69 Improving Transparency and Governance ............................................................... 69 Improving the Business Environment ....................................................................... 70 Strengthening the Social Contribution of Diamond Mining..................................... 71 v. PRIVATE SECTOR DEVELOPMENTAND THE BUSINESS ENVIRONMENT., ............74 THEPRIVATE SECTORINANGOLA.............................................................................. 74 The Business Environment........................................................................................ The Quality of Infrastructure .................................................................................... 74 76 The Cost of Capital................................................................................................... 78 A Bimodal Private Sector.......................................................................................... 79 TRADEPATTERNS TariffStructure.......................................................................................................... AND REGIONAL INTEGRATION ...................................................... 80 80 TariffDispersion and Averages ................................................................................ 81 TradePartners.......................................................................................................... 82 RECENT ACTIONSTO IMPROVETHE BUSINESS ENVIRONMENT ................................. 85 THEWAYFORWARD A Phased Approach to Improve the Business Environment...................................... .................................................................................................... 88 89 What Should be Done in the Short Term .................................................................. 89 What Should be Done in the Medium and Long Terms ............................................ 90 VI . REMOVINGOBSTACLESTO AGRICULTURE AND RURAL DEVELOPMENT., 94 .......... A SECTORFACINGDAUNTING CHALLENGES .............................................................. 94 REMOVING OBSTACLES OUTPUTGROWTH TO ........................................................... 97 97 Increase the Importance of Agriculture in the Budget.............................................. Reduce Costs............................................................................................................. 98 Improve the Effectiveness of MINADER................................................................. 101 STIMULATING COMPETITIVENESSTHROUGHBETTER INCENTIVES ......................... 103 Improve the Regulatory Environment ..................................................................... 103 Rehabilitate Rural-Urban Commercial Circuits .................................................... 103 VI1. SUPPORTINGLIVELIHOODS IMPROVINGSERVICEDELIVERY AND ...................111 SUPPORTING LIVELIHOOD 111 Oil. diamonds and livelihoods ................................................................................ STRATEGIES .................................................................... 112 Subsistencefarming ................................................................................................ 112 Non-farm livelihoods .............................................................................................. 113 Urban livelihoods.................................................................................................... 113 Children andyouth ................................................................................................. 114 Access to land and livelihoods................................................................................ 114 STRENGTHENING EXISTINGSOCIAL PROGRAMS 116 SERVICES ........................................................ ...................................................... REACHING THE POORWITH SOCIAL 119 Recent Progress in Service Delivery....................................................................... 123 USINGFISCAL ...................................... 124 Phase Out Subsidies to Obtain Fiscal Savings ....................................................... SAVINGS TO IMPROVE SERVICEDELIVERY 124 How to Manage Political Costs.............................................................................. 125 Palliative Measures, Monitoring and Evaluation................................................... 126 LISTOFTABLES EXECUTIVE .. E.l A Scorecard to Assess Governance andTransparency inthe Oil Sector ............x11 SUMMARY E.2 Summaryof Diagnostics and Recommendations .............................................. xviii ... CHAPTER 1 1.1 Basic Poverty and Social Indicators ........................................................................ 7 1.2 Composition o f GDP by Sector, 1966-2004.......................................................... 12 CHAPTER 2.1 Macroeconomic Stabilization and Programs Adopted between 1989 and 2000 ...17 2 2.2 Macroeconomic Framework, 2003-2007............................................................... 20 CHAPTER 3 3.1 UnitCost Comparisons for SelectedCountries..................................................... 35 3.2 Fiscal Terms for Petroleum Exploration Contracts inAngola............................... 38 3.3 A scorecard to Assess governance and Transparency inthe Oil Sector ................45 Sonagol Tax andProfit Oil liabilities to the Government o f Angola .................... 39 3.4 3.5 Angola's Petroleum Wealth under Different Price Scenarios ............................... 47 3.6 Gross RevenueScenarios....................................................................................... 49 3.7 Total Governance Revenues ................................................................................. S O 3.8 Permanent ExpenditurePer Capita at DifferentAssumptions.............................. -53 CHAPTER Fiscal Regimes for DiamondMining..................................................................... 4 4.1 67 CHAPTER 5 5.1 Government Policies and Behaviors and Investment Decisions............................ 74 5.2 75 83 Destination o f Angolan Exports............................................................................. Trends inMerchandizeTrade ................................................................................ SADC Infrastructure Indicators ............................................................................. 5.3 5.4 . . 83 5.5 Sources o f Imports ................................................................................................. 84 CHAPTER Production o f selected farm products intons and inkg/per capita (1961-2003) ...95 6 6.1 CHAPTER7 7.1 Public Services According to their Perceived Importance .................................. 125 7.2 Satisfactionrates with Public Services ................................................................ 125 LISTOFFIGURES E.1 EXECUTIVE Association between Resource Concentration and Conflicts ................................ SUMMARY ... 111 E.2 Curbing Inflation...................................................................................................... v E.3 Government Revenues from Oil under DifferentPrice Scenarios.,....................... vi CHAPTER1 1.1 Gini Coefficients -Angola and Oil ProducingCountries ....................................... 8 1.2 Evolution of Angola's Real GDP Per Capita, 1960-2004..................................... 13 1.3 14 Total Government expenditure as a percent o f GDP ............................................. Composition of Domestic Expenditure, 1960-2004 .............................................. 1.4 15 CHAPTER2 2.1 A Snapshot of Inflation and Dollarization............................................................. 18 2.2 21 22 Foreign Exchange Interventions ............................................................................ Curbing Inflation.................................................................................................... Progress inMacroeconomic Indicators.................................................................. 2.3 2.4 23 2.5 Tradable and non-tradable Inflation Rates............................................................. 25 2.6 Angola - Gross InternationalReserves 2.7 Association between Resource Concentration and Conflict .................................. 28 CHAPTER 33 Angola Oil Production........................................................................................... Oil Reserves: Selected Countries.......................................................................... 3 3.1 3.2 33 3.3 Total Costs for Selected Project............................................................................. 35 3.4 Comparison of Government Take in Selected Countries ...................................... 37 3.5 Brentnorth Sea Oil Price Scenario ........................................................................ 48 3.6 49 Government Revenue Scenarios ............................................................................ Gross Revenue Scenarios....................................................................................... 3.7 40 3.8 Sonangol Revenues................................................................................................ 51 3.9 Sonangol Expenditures .......................................................................................... 51 3.10 Permanent Expenditure Per Capita ........................................................................ 53 CHAPTER Angola's Official Diamond Exports...................................................................... 4 4.1 61 4.2 Diamond Tax Revenues (1995-2004) .................................................................... 65 CHAPTER Importance of informal employment inthe urban economy ................................. 5 5.1 78 5.2 Breakdown of Applied MFNDuties, 2005 ............................................................ 81 5.3 Governance and Transparency............................................................................... 85 CHAPTER Estimated historical production of major crops inthousand tones (1961-2003) ...95 6 6.1 CHAPTER 120 Annual per capita Expenditure inHealth............................................................. Annual Expendituresper capita inEducation by Provinces................................ 7 7.1 7.2 121 LISTOFBOXES EXECUTIVESUMMARY E.1 Elementso fa Revenue Management Framework for Angola............................. viii ... CHAPTER 3.1 Petroleum Sector Data ........................................................................................... 34 3 3.2 Legal and Contractual Framework......................................................................... 36 3.3 The PetroleumTax cycle inAngola ...................................................................... 40 3.4 The Paradox andPlenty andthe Case of Angola................................................... 41 3.5 48 Elements o f a RevenueManagement Framework for Angola............................... The Quality o fAngolan Crude Oil ........................................................................ 3.6 58 CHAPTER 63 The InternationalExperienceon RegulatingDiamondProduction....................... Certificates o f origin and the Kimberley process .................................................. 4 4.1 4.2 66 4.3 Corporate Social Responsibility inthe Diamond Sector ....................................... 71 CHAPTER5 5.1 A Scorecard for Tackling Governance and Corruption......................................... 92 CHAPTER6 6.1 Decentralization Matters: the Mozambican "Proagri" .......................................... 99 6.2 ShrinkingState Intervention and Soaring Productivity -The Case o fBrazil.....102 CHAPTER7 7.1 Existing National Programs Addressing PRS Objectives.................................... 118 AfDB African Development Bank AGOA Africa Growth and Opportunity Act ANlP Agencia Nacional de Investimentos Privados ASCORP Angola Selling Corporation AUPEC Aberdeen University Petroleum EconomicsConsultancy BNA Banco Nacional de Angola CABOG Cabinda Gulf Oil Company CPi Consumer price index DFlD UK Departmentfor International Development DNI Directoria Nacionalde lmpostos EBA Everything ButArms ECP Estratkgia de Combate Pobreza EDEL Empresade Distribuigo de Electricidadede Luanda ElTl Extractive industries Transparency Initiative ENDIAMA Empresade Diamantes de Angola ENE Empresa Nacional de Electricidade EPA Economic PartnershipAgreement EPAL Empresa Publica de Aguas de'luanda FA0 Food and Agriculture Organization FAS Fundo de AcMo Social FDES Fundo de DesenvolvimentoEconomico e Social FDI Foreign direct investment FLEC Frente para a Libertago do Enclave de Cabinda FNLA Frente Nacionalde Libertaqaode Angola GARE Gabinete de RedimensionamentoEmpresarial GDP Gross domestic product GOA Government of Angola HDI Human Development Indicators IDR lnquerito de Despesas e Receitas IFi International Financial Institutions IMF International Monetary Fund INE lnstituto Nacional de Estatisticas LPG Liquified petroleumgas LUPP Luanda Urban Poverty Program MBD Million barrels per day MFN Most favored nation MlCS Multiple Indicator Cluster Survey MINADER Ministryof Agriculture and Rural Development MOF Ministryof Finance MOP Ministry of Petroleum MPLA Movimento Popular para a Libertago de Angola MTFF Medium-Term Fiscal Framework NEPAD The New Partnershipfor Africa's Development OECD Organizationfor Economic Developmentand Cooperation OPEC Organizationof Petroleum Exporting Countries PDV Present DiscountedValue PIP Public investment program PIT Petroleum income tax PSA Production SharingAgreement PTT Petroleumtransaction tax SADC Southern African Development Community SiGFE Sistema lntegrado para a Gestao das FinanFasdo Estado SODIAM Sociedade de Comercializaqaode Diamantes SSA Sub-saharanAfrica UNDP United Nations Development Program uUNITA Uniao Nacional para a IndependenciaTotal de Angola xo Unexplodedordinance WHO World Health Organization Angola: CountryData Area (ThousandSq. Km.) Population Density 1,246.7 14.5 million (mid 2005) 11.6 per square km. Growthrate: 3.0 % (average 1998-2005) MilleniumDevelopmentGoals:SelectedIndicators Latestvear available Sub-Sahara between 1998-2005 Africa GNIper capita (Atlas method) 1,350 600 Net primary schoolenrollment(% age group) 61 64 Ratio of girls to boysineducation 84.1 83 Under 5 mortality rate (per 1,000 livebirths) 260 168 Life expectancyat birth (years) 47 47 Access to improve water sources 38 58 HIV Prevalencerate, female (% age 15-24) 3.9 9.4 Gross DomesticProductin 2005 GovernmentFinancesas percent of GDP (%) . . US$Million - % 2002-04 - 2005 GDPmp 32,810 100.0 Current revenue 37.5 38.0 Investment 2,473 7.5 Current expenditure 33.2 25.2 Gross domestic savings 10,759 32.8 Currentbalance 4.3 12.8 Resource balance 8,286 25.3 Capital andother Exportsof goods andservices 24,120 73.5 expenditures 8.6 6.0 Importsof goods and services 15,834 48.3 Overallbalance (accrualbasis) -4.3 6.8 Annual rate of growth of GDP at constant 1997prices(YO) ~~~ 2000-2001 2002-2003 2004-2005 3.1 8.9 15.9 Moneyand Credit Inbillions of Kwanza 2 0 0 1 -2002 2003 2004 2005 Netforeignassets 18.0 46.0 60.1 123.8 185.3 Domesticcredit 12.3 28.0 38.2 10.0 -14.3 MoneyandQuasi-money 25.5 65.6 70.9 66.7 146.6 Other net liabilities M2IGDP (%) 21.0 21.5 17.1 14.8 13.7 Inflation and exchange rate 2 0 0 1 -2002 2003 2004 - 2005 Periodaverage inflation (%) 152.6 108.9 98.3 43.6 23.0 Kz perUS$ 22.1 43.7 74.6 83.4 87.2 US$per Kz 0.0453 0.0229 0.0134 0.0120 0.0115 Balance of payments Million US$ 2001 2002 - - - 2003 2004 2005 Exports, f.0.b. 6645 8166 9515 13474 23724 Imports, f.0.b. 3179 3760 5480 5832 8667 Services (net) -3316 -3115 -3120 -4480 -6770 Income (net) -1561 -1635 -1726 -2484 -4075 Current transfers (net) 91 32 99 7 30 Financial and capital account Capital transfers (net) 4 10 0 11 6 Direct investments (net) 2146 1643 1652 1414 1639 Medium- and long-term loans -618 -162 178 906 1408 Other capital (net, incl. errors and -985 -1742 -1005 -1970 -5512 omissions) Overall balance Net international reserves (- increase) 440 229 -443 -1233 -2117 Exceptional financing 334 334 330 187 335 Merchandise exports 2002-04 - 2005 % - % Total 10385.0 100.0 23723.7 100.0 Crude oil 9453.1 39.8 22307.7 94.0 Refined oil products 145.9 0.6 245.0 1.o and gas Diamonds 738.8 3.1 1089.2 4.6 Other 47.2 0.2 81.9 0.3 ExternalDebt in billionof US$(end period) Debt service to net export ratio (%) 2005 2005 Total outstanding and disbursed 12.6 10.5 Acknowledgements This Country Economic Memorandum i s the result o f collaboration between the World Bankandthe Government o fAngola with the support o fthe BritishGovernment between 2004 and 2005. A formal discussion of the main findings and recommendations o f the report was held in Luanda on May 11, 2006 with representatives o f the Ministry o f Planning, the Ministry o f Finance, and the Central Bank. The counterpart team in the Government o f Angola was led by the Ministryo f Planning under the guidance of Ms.Ana Dias Lourenqo, Minister o f Planning, and the leadership o f Mr.Pedro Luis Fonseca, Director o f Studies and Planning with the support o f Messrs. Alcino Izata Conceiqgo, Lando Teta, and Pedro Kiala. They have provided enormous support and encouragement to the C E M team and contributed useful comments and suggestions throughout the concept and implementation stages o f the report. In the Ministry of Finance, especial thanks are due to Mr. Jose Pedro de Morais, Minister of Finance, and Messrs. Eduardo Severim de Morais and Job Graga, Vice-Ministers o f Finance, for their support. Mr. Manuel Net0 da Costa, Director o f the Office o f Studies and Foreign Relations o f the Ministry o f Finance (GEREI) led the discussions on behalf o f the Ministryo f Finance and his constant feedback was instrumental for the success o f the task. The team is also grateful for the support offered by senior and technical staff in the Ministry o f Agriculture, Ministryo f Industry and Commerce, Ministry o f Petroleum, Ministry of Geology and Mines, BNA, Sonangol, Endiama, EPAL, EDEL, and INE in the provision o f the necessary information and data requiredto produce the CEM. On the World Bank side, the Country Economic Memorandum was managed by Francisco Carneiro (Sr. Country Economist, AFTP1). The team included Maria Teresa Benito-Spinetto (Research Analyst, AFTPl), Fahrettin Yagci (Lead Economist, AFTPl), Nelvina Lutucuta (Economic Analyst, AFMAO), Sonia Sanchez (Consultant, AFTPl), Louise Fox (Lead Specialist, AFTPM), Charles McPherson (Sr. Advisor, COPCO), Paulo de Sa (Lead Operations Officer, LCCSC), Charles Husband (Lead Mining Specialist, COPCO), Gilbert0 de Barros (Sr. Private Sector Development Specialist, AFTPS), Eduardo Luis Lea0 de Sousa (Sr. Economist, AFTSl), Estanislao GacitukMari6 (Sr. Social Scientist, AFTS3), Hakon Nordang (Junior Professional Associate, SDV), and Sigrun Aaslund (Operations Analyst, AFTS3). The consultants financed by the British Government through the British Embassy in Angola and DfID were Prof. Steven Kyle (Cornel1 University, USA), Prof. Richard Auty (University o f Lancaster, UK), and Prof. Emilson Silva (Tulane University,USA). The financial and intellectual support to the task offered by the former British Ambassador to Angola, Mr. John Thompson, renewed by his successor the current BritishAmbassador, Mr.Ralph Publicover, is gratefully acknowledged. Especial thanks also go to Messrs. Harry Hagan and Martin Johnston from DfID.The BritishGovernment financed background work on the impacts o f phasing out fuel and price subsidies in Angola, and a Country Social Analysis (CSA). Both the subsidies study and the CSA involved a substantial effort to generate new data through a series o f surveys in Luanda and other provinces in Angola and were very important inputs to the C E M and contributed to inform ongoing government policies. Advice and comments were also received from the donor community, civil society, academia, and think tanks in Angola through a serious o f consultations on specific sections o f the report that were held in Luanda during preparation o f the Country Economic Memorandum. Their extensive knowledge o f economic and social issues in Angola was extremely valuable. Valuable comments and suggestions at different stages were also offered by Jon Shields, Alfred0 Torrez, and Alexander Kyei (IMF). The peer reviewers Jeni Klugman (Lead Economist, AFTP2), and Robert Bacon (Consultant, COPCO) provided valuable comments and suggestions. Laurence Clarke (Country Manager at the time o f writing, AFMAO) and Olivier Lambert (Sr. Country Officer, AFMAO) provided invaluable support throughout the process by reading, commenting, and seeking feedback from key stakeholders in Luanda on earlier drafts o f individual chapters. Peter Nicholas (Country Program Coordinator, AFC02) contributed useful insights to several draft chapters and reviewed an earlier version o f the full report. Emmanuel Akpa (Sector Manager, AFTP1) offered conceptual guidance, provided analytical advice and ensured quality control. Michael Baxter (Country Director, AFC02) read a previous draft, provided comments, and supported the whole process. Superb assistance with communication, budget management, and logistical arrangements was provided Domingas Pegado and Margarida Mendes (AFMAO). Ligia Murphy (AFTP 1) showed outstanding commitment and provided impeccable assistance in formatting and editingthe report. MAP ANGOLA OF PREFACIO Esta versso do Memorando Econ6mico para o Pais sobre Angola incorpora comentarios e sugestaes recebidas das autoridades angolanas durante a reuniso para apresentaqgo e discuss50 do relatorio, que aconteceu no dia 11 de Maio de 2006, no MinistCrio do Planeamento, em Luanda, corn a presenqa de representantes do Ministbrio do Planeamento, MinistCrio das Finanqas, e do Banco Nacional de Angola. 0 Banco Mundial recebeu ainda comentarios por escrito enviados pel0 Gabinete de Estudos e Relaqaes Internacionais do MinistCrio das Finanqas. Umbreve resumo dos principais t6picos discutidos durante a reuniso do dia 11de maio bem como dos assuntos ventilados nos comentarios do Ministkrio das Finanqas C apresentado a seguir. Constrangimentos Externos: A existsncia de constrangimentos externos, alheios ao control0 do governo, que podem afectar o desempenho da economia e das politicas econ6micas, sendo que o principal destes constrangimentos C o pr6prio preqo do petr6leo. Papel do Sector Anricola: Enquanto reconhece-se que o sector agricola tem papel fundamental na economia, ha uma limitaq5o para avaliar-se qual C exatamente o grau de competitividade do sector devido a falta de uma noqso Clara sobre a estrutura de custos de produqso. Para alCm disso, o sector enfrenta outros constrangimentos tais como a qualidade das terras, que impedea reproduq5o das culturas produzidas na era colonial. Apoio ti Anricultura: Quanto ao apoio a prestar A agricultura, as autoridades comentaram que o MINADER e os Governos provinciais deveriam prestar o apoio institucional e os serviqos necessarios. Mas adicionaram que sera necessario incitar as empresas agro-industriais e de exportaq5o a instalarem-se em determinadas areas. Os financiamentos aos pequenos produtores deveriam ser fornecidos atravks de bancos/instituiqdes locais de micro-crtdito com o objectivo de introduzir uma certa competitividade nesse sector. Industria Transformadora:A actual configuraq5o da balanqa de pagamentos de Angola implica por s i s6 na valorizaq5o da moeda. A moeda valorizada funciona como um forte constrangimento para a competitividade da industria local. Esta situaqso gera a necessidade de se procurar reduzir os custos de produq5o em relaq5o aos paises vizinhos. Apreciacilo da Taxa de Cgmbio: Foi ressaltada a aparente contradiqgo entre a necessidade de se reduzir a inflaqso, o que demandaria evitar tentar combater a tendsncia a apreciaqgo da taxa de ciimbio em face do volume de divisas que sera acumulado em anos futuros, e a necessidade de se diversificar a economia e se promover um aumento da competitividade dos sectores n5o-minerais. Diante disso, ressaltou-se que ha a necessidade de se procurar reduzir os custos domCsticos atravCs da reparagso das infraestruturas e da identificaqso de outros factores constrangedores que possam ser eliminados, assumindo o constrangimento de uma taxa de ciimbio apreciada como inevitbvel em anos futuros. Investimento na Capacitacfio: As autoridades enfatizaram que o governo tem estado a investir significativamente em capacitaqtio nas mais diversas areas, uma vez que reconhece-se que o sistema de ensino actual ntio contribui de maneira efectiva para gerar m80 de obra qualificada com a urgencia que se precisa. Transiciio para a Demoracia: N a apresentaq8o da principal mensagem do memorando, o documento justifica a necessidade de completar a transiq8o para a democracia multipartidaria com a necessidade de acomodar as tensdes Ctnicas. As autoridades sugeriram que seria necessario mencionar que a democracia ajudaria ainda a amenizar tensdes sociais. Composicfio das Despesas Publicas: 0 govemo enfatizou que a adopq8o de preqos conservadores para o barril do petroleo na elaboraqtio do orqamento representa uma boa opq20. Com base nesta opqtio, portanto, dever-se-a ter um limite de despesa publica baseada nas perspectivas de mCdio prazo das receitas avaliadas com base nos preqos projectados de longo prazo. N o entanto, as autoridades sugerem que os excedentes constituiriam reservas que deveriam ser aplicadas em mercadoshnvestimentos internacionais que serviriam de colateral para eventuais emprkstimos destinados a financiar os investimentos internos. Desse modo, os juros sobre os emprkstimos seriam compensados pelos juros e dividendos das aplicaqdes internacionais. Reforco do Sector Privado: 0 fortalecimento do sector privado requer que o Estado, ao mesmo tempo que deva se preocupar pelas infraestruturas, govemanqa e ambiente de negocios, deva tambCm contemplar, nas suas politicas de compensaq2o dos custos de ajustamento, a requalificaqtio da m2o-de-obraYpois o investimento privado tem tendencia a exigir cada vez maiores qualificaqdes da m8o-de-obra. Fazer passar as pessoas de n8o qualificadas para semi-qualificadas, a qualificadas e a altamente qualificadas exige um empenho do governo, particularmente nos paises em desenvolvimento como Angola. A decis2o de investimento privado dependera muito disso tambCm. Outros assuntos que foram object0 de discuss80 envolveram (i)a quest80 da legislaq8o do petroleo (que n8o mudou e ntio alterou, portanto, contractos existentes); e (ii)a necessidade de se gerar informaq8o confihvel sobre custos unitarios nas areas da educaq8o e da saude para aumentar o grau de eficiencia dos investimentos neste sectores. Em suma, o Memorando foi considerado como um conjunto de consideraqdes e recomendaqdes gerais que procuram ajudar o Govern0 na definiqgo e implementaq8o de politicas de modo a que as receitas petroliferas sejam bem aproveitadas. ANGOLA OIL,BROAD-BASED GROWTH, AND EQUITY COUNTRYECONOMICMEMORANDUM EXECUTIVESUMMARY i. This Country Economic Memorandum identifies six core areas where a strategic approach for the development of a broad-based growth strategy is required. Indesigning a sustainable development strategy for the country, the authorities will need to address a number of issues in six major areas which have been found to constrain growth and equitable development in Angola: (i) the incomplete transition to a market economy; (ii) macroeconomic management; (iii) governance and transparency in the management o fthe mineral wealth; (iv) the business environment; (v) agriculture; and (vi) public service deliveryto the poor. The recommendedstrategic approach to each one o f these areas i s summarized below. The subsequent sections o f this executive summary highlight the broader conclusions and the main recommendations o f the Country Economic Memorandum. & First, Angola needs to complete the transition to a market economy. With the advent o f Independence in 1975, the Angolan government opted for a centralized economic system which today i s believed to have contributed, together with the growing dependence on oil, to constrain the development o f sound institutions that foster the appearance o f a vibrant private sector. The transition to a full market economy system will require political commitment at the highest levels since entrenched vested interests will have to be dismantled. Additionally, the country will also needto complete the transition to a multi-party democracy which will help to accommodate social and ethnic tensions that permeated and fueled civil conflict in Angola in the past and which remain latent in the present. These points are treated inChapters 1 and 2. P Second, on the macroeconomic front, continuing deficiencies in policy design and implementation, especially at the aggregate level, still need to be addressed. Recent progress in the management o f the economy i s encouraging, most notably the success in reducing inflation and strengtheningthe government's fiscal position. However, these have been largely influenced by rather favorable developments in the oil sector. To guarantee the sustainability o f the recently achieved macroeconomic stabilization Angola needs to put in place a sound economic policy mix with a focus on better public expenditure management and administer some tensions that are common to economies that are transitioning from war to peace and from a command setting to a market economy. Chapters 2 and 3 presentadvice on macroeconomic policy options. >Third, a clearer strategy to manage the country's growing oil and diamond wealth based on sound governance and transparency principles must be defined.The Angolan economy will experience a massive oil revenue windfall with a concomitant fiscal gain over the next two decades or so. Diamond production i s also projected to grow strongly. The derived gains from increased production, however, represent the depletion o f the country's oil and diamond reserves. This raises the question o f how to use the incomes from non-renewable resources to create income sources into the future, including for future generations. Sound governance and transparency principles should guide the establishment o f any natural resource management strategy inAngola. Issues and options on this area are discussed indetail in Chapters 3 and 4. P Fourth, and related to the point above, there is a real urgency to improve the business environment and the investment climate in Angola. The business environment in the country i s one o f the least favorable in the world. If the authorities want to promote a broad-based economic recovery o f the country, with morejobs and higher incomes for the average Angolan, then pro-business measures that can enable companies to compete more effectively in an open economy needto be implemented fast and social programs targeting the most vulnerable population and insulating them from adjustment costs should be put in place. Otherwise, the Angolan economy will continue to be highly dependent on mineral resource exploitation and the majority o f the population will continue untouched by the mineral wealth. Chapter 5 focuses on the challenges and opportunities associated with the development o f the non-mineral private sector inAngola. > Fifth, considering areas of potential outside the mineral sectors, the importance of agriculture as a source of employment and incomes should not be neglected.Angola i s a natural food and cash crop producer and agriculture holds the potential to contribute for further economic growth in the years to come. Government policies should support the development o f smallholders but, at the same time, foster a conducive environment to encourage investmentsin the private commercial sector. Chapter 6 outlines a strategy to increase agriculture output and improve the incentives that can contribute to higher competitiveness inthe sector. > Finally, as part of the peace dividend to the Angolan population, the quality and supply of public services, especially to the poor, must improve.As a post- conflict country, Angola faces a huge challenge to improve the welfare o f its population, including the poorest. The country stands a very good chance o f meeting this challenge owing to the increasing resources available from the exploitation o f its natural resources. Feasible options to improve the welfare o f the majority o f the Angolan people are discussed inChapter 7. .. 11 11. The road aheadinvolves .I political risks which will be Figure E.l: Association between Resource difficult to address. Ample Concentration and Conflicts empirical evidence has shown that natural resource dependence i s particularly problematic, since it is easily captured by the ruling elite, removing the incentive for the government to actively engage its citizenry. This destroys both the capacity and the legitimacy o f the state, exacerbating social divisions and even leading to direct conflict over the resource itself. Research at the World Bank and elsewhere points to resource dependence as one o f the most important causes o f civil wars (see Figure E.l).' In the case o f Angola, moving forward with the reform agenda - Source Bannon and Collier (2003) in the areas of governance, transparency, public finance management, business environment, and public service delivery will be politically challenging, but the risks o f not reforming at all or wait too long to take action can be devastating given the huge gaps that the country needs to fill. Notwithstanding, while an increase in natural resource revenues can potentially increase rent-seeking behavior and give governments an excuse to delay reform, it can also allow reform-minded governments to implement changes. Angola has now a real opportunity to use its natural resource wealth to mitigate tensions and adopt the difficult measures that can put the economy on a path o f sustainable development. The World Bank stands ready to support the government inthat endeavor. iii. Onceoneoftheworld'slargeststaplefoodproducers,Angolaisnowknown as a major oil exporter. Prior to independence, Angola was better known as a coffee exporter than as an oil exporter. Angola was not only the world's fourth largest coffee exporter, but also exported over 400,000 MT o f maize annually, making it one o f the largest staple food exporters in Sub-Saharan Africa. The structure o f the economy then changed substantially after 1973 as the miningand service sectors increased their share in the compositiono f GDP. The country is now the second largest oil producer inAfrica. ' Violent secessionist movements can often be traced to oil. Examples include Aceh in Indonesia, Biafra in Nigeria, conflicts inSudan, Chad, Congo Brazzaville, and inAngola itself(see Busby et al., 2002). ... 111 iv. Angola is also the world's fourth largest producer of rough diamonds in terms of value, with the potential to become one of the leading global diamond producers. The country has close to 12% o f the share o f the world market and a high proportion o f its production i s o f gem quality. Diamond reserves were estimated in 2000 at 40 million carats in alluvial deposits, and 50 million carats in kimberlite pipes, which are just now beginning to be exploited. Around 700 kimberlites o f varying sizes (10-190 hectares) and shapes are known in Angola, aligned along a SW to NE trend across the country and into the Democratic Republic of the Congo. v. In addition to oil and diamonds, the country is well endowed with agricultural resources which remain mostly untapped. Staple crops range from cassava in the humid north and northeast to maize in the central highlands and sorghudmillet in the dryer southern provinces. Potatoes are an important crop in the central plateau and rice i s also grown over large areas in the north. Cattle i s raised over broad areas in the central plateau but are particularly important in the southern provinces o f Cunene, Huila, and Namibe where there are an estimated 3 million heads o f cattle. Coffee, the most important cash crop during colonial times, grows well in the highlands from Uige and Malange through Kuanza Norte and as far south as Huambo and Bie. It i s also important to note that some two thirds o f the Angolan population live in rural areas and earn their living from agriculture, which currently accounts for less than 10% o f GDP and receives less than 1% o f all budget outlays. vi. Despitethe country's significantnaturalwealth, existingsocial indicatorsstill reflectlow livingstandards.According to boththe 2001 IDR(Income and Expenditures Survey) and the 2002 MICS (Multi Indicator Cluster Survey), approximately 70% o f the population lives on less than 2 dollars a day and the majority o f the Angolans lack access to basic healthcare. About one in four Angolan children die before their fifth birthday, 90% o f whom perishdue to malaria, diarrhea or respiratory tract infections, the maternal mortality rate (at 1,800 per 100,000 births) i s one o f the highest in SSA, and three in five people do not have access to safe water or sanitation. The HIV/AIDS prevalence rate is, according to official statistics, relatively low, affecting an estimated 3.9% o f adults.2 In terms o f education, primary school enrollment i s very low at 56%, and suffers from late entries into school and high repetition and drop out rates. Some 33% o f the population i s currently illiterate, thoughinrural areas this climbs to as many as 50%. vii. The business environment in Angola is challenging. According to the 2006 Doing Business survey of the World Bank, establishing a company in Angola takes an average o f 146 days, more than twice the regional average. Licensing i s a time- consuming and costly procedure. The time to comply with all licensing and permit requirements i s estimated at 326 days -almost one year. Registering property also takes about 11 months and costs more than 11percent o f the property value. Investor Low estimatesare 1.9% and highestimates are 9.4% (UNAIDS, 2004). iv protection i s not high when compared to similar countries and obtaining credit i s equally difficult. The average import requires 10 documents, 28 signatures, and 64 days. It i s equally difficult to enforce a contract -incalendar days, it takes 1,011 days to resolve a dispute starting from the moment a plaintiff files a lawsuit in court until settlement or payment. Dispute resolution among Angola's neighbors and potential competitors takes much less time -inZambia 274 days; inNamibia, 270; and inBotswana, 154. viii. ... Besides having a difficult business environment, Angola ranks amongst countrieswith the worst corruptionperceptionindices.Inthe rankings established by Transparency International's widely referenced Corruption Perceptions Index, petroleum exporting developing countries find themselves in the bottom one third o f the countries listed.Angola's rank inthe most recent release o f the CPIwas 151, numbernine from the bottom. This i s a particularly serious finding because corruption i s recognized as one o f the largest single inhibitingfactors to private sector investment and growth. ix. More recently, government's efforts to reduce inflation have been Figure E.2: Curbing Inflation successful.Between 1999 and the peace agreement o f 2002, annual consumer price inflation fell from around 300% to around 100% (see Figure E.2). .` 450 - Following the adoption o f a stabilization 400 program in September 2003, inflation 350 - fell sharply again and by December 2004 300 . the 12-month inflation rate had declined 250 to 31%. The improvement was largely 200 - due to the government's avoidance of 150 100. money creation for deficit finance 50 together with smaller fiscal deficits. In 2005, the cumulative rate o f inflation dropped to 18.5% and the projection for 2006 i s of an annual rate o f 10%. X. Despite the recent progress, there should be a stronger emphasis on the continuing deficiencies in policy design and implementation. The stabilization obtained so far needs to be strengthened with improved coordination o f the fiscal policy with monetary and exchange rate policies. These policies need to spell out a consistent strategy to absorb the upcoming oil windfall without inhibiting growth outside the mineral sectors. A first step in the right direction would be to reduce public expenditures on consumption and increase spending on productive investments (e.g., infrastructure) o f the sort that will have the effect of lowering domestic costs for the entire economy. To a certain extent, this strategy i s already being followed by the authorities, but there are areas inwhich complementary measures are requiredandthese are discussed below. V xi. Instruments to smooth out the impact of the oil cycles should be adopted. The combination o f fiscal, financial, trade, and monetary policies must care about stimulating private investments to increase the size and sophistication o f non-extractive sectors. This will require (i)prudence in the management o f aggregate demand (Le., avoid rapid expansion in public spending or credit, which can lead to macroeconomic imbalances); and (ii) the use o f a medium-term economic framework to guide economic policy decisions. Instruments to smooth out the impact o f the oil cycles in the economy and create a desirable pace o f non-oil industrialization include: ' 0 A prudent fiscal envelope for the coming years. It is Figure E.3: Government Revenues from Oil under Different Price important to remember the Scenarios and in the Absence of New Discoveries hump-shaped profile o f oil- related fiscal revenues and the fact that they will decline A rapidly during the next 50000 I \ \ Highprice decade, inthe absence o f new 1 I discoveries (see Figure E.3). 40000 / / \\ Such a path would require running substantial surpluses when the rapid extraction of 30000 oil reserves takes place over E the rest o f this decade and = 20000 v) most o f the next decade. However, this may not be politically feasible. In 1~000 addition, expectations about future growth in the non-oil 0 1 1 1 1 1 1 I ' I ' I I I 1 1 1 1 - sector may fail to materialize ~ ~ ' 1 ~ 1 1~ 1 ~ I ~ ' altogether, while the present 1990 1995 2000 2005 2010 2015 2020 2025 2030 discounted value (PDV) o f the future oil wealth i s uncertain and subject to oil price volatility. Therefore, although there may be ample room for public expenditure increases, the above-mentioned concerns call for a conservative fiscal envelope. 0 A medium-term economic framework. Currently, the horizon for decisions that affect macroeconomic policy is, at most, two years ahead as spending programs in annual budgets are determined only by revenue prospects for the coming year. Despite the fact that the government has been adopting a conservative approach towards specifying the oil price on which revenue projections are based, this approach can still yield sharp cycles inspending which can prove unsustainable inthe long run. A preferred approach would be to base annual ceilings for public expenditure on medium-term revenue prospects, evaluated at a long-run oil price. Under this approach, the recommendation o f the previous paragraph o f generating consistent fiscal surpluses could be accomplished over time so that financial reserves vi could be accumulated during the years o f peak oil production to sustain spending when oil revenues eventually fall. Anti-cyclical fiscal policies in relation to oil prices. The pro-cyclicality of fiscal expenditures and oil prices i s dangerous and can transmit volatility to the rest o f the economy. A key policy objective for Angola should be to pursue fiscal strategies aimed at breaking the procyclical response o f expenditures to volatile oil prices. In this sense, the approach currently usedby the authorities of adopting a conservative oil price in the preparation o f the budget i s welcome, but with the remark that it should be complemented with the recommendations o f the previous paragraphs. 0 Rapid and bold improvements in procurement practices. In simple terms, the level of spending should be determinedtaking into account its likely quality and the capacity o f the administration to execute it efficiently. In this regard, an abrupt enlargement o f expenditureprograms associated with oil windfalls carries important risks. A hasty public spending program may exceed the government's planning, implementation, and management capacity, with the result that it may be difficult to prevent wasteful spending. xii. An institutionalframework will be required in order to effectively manage Angola's oil wealth. Regardless o f whether or not Angola adopts the above recommendations, the Government must develop the institutional capacity required to manage future revenue. The recent announcement o f the creation o f an oil reserve account at the Central Bank that would accumulate part o f the oil revenue windfall, and the use o f an oil revenue forecasting model by the Ministry o f Finance are welcome developments which needto be complementedby additional arrangements. xiii. The establishment of rules for the oil reserve account should draw on the successes and failures of past experience in other oil producing countries. As the Government o f Angola i s considering the establishment o f an oil reserve account, the following features, which are based on other models now being developed and implemented in other countries, might be considered useful on the way forward (a summary o f these features inpresentedinbox E.1below): > The oil reserve account should be the designated recipient of petroleum windfall revenues.Partial capture of oil revenues by various ministries or state- owned entities would make it difficult to obtain efficient and sustainable management o f the revenues. > Transfers to the budget should be based on the agreed savingdexpenditure rule. Without clear rules, transfers risk becoming increasingly dependent on short-term economic and political cycles, which would critically undermine the account's function. vii T h e BYh should be desi Cettrraf Batik. There must b e sz oil reserve account, and the viii factors that can affect the quality o f governance. This will require further efforts in the following 4 broad areas. xv. The relationship between Sonangol, the national oil company, and the Government creates conflicts of interest and is against good practice in the management of public finances. Sonangol performs multiple roles vis 2 vis the Government, including activities which would normally be performed by the Treasury and the Central Bank. It i s a taxpayer, it carries out quasi-fiscal activities, it invests public funds, and, as concessionaire, it is a sector regulator. This multifarious work program creates conflicts o f interest and characterizes a complex relationship between Sonangol and the government that weakens the formal budgetary process and creates uncertainty as regards the actual fiscal stance o f the state. xvi. A similar concern is associated with the operations of Endiama, the national diamond company. The Ministry of Geology and Mines is responsible for the implementation o f the legal and regulatory framework for the sector, for issuing mineral rights, and for the geologic survey, while the mandate to approve kimberlite concessions i s o f the Council o f Ministers. Endiama i s by law the largest shareholder in all new diamond ventures and also has regulatory functions over the selection o f companies that are to be granted new diamond mineral rights, the negotiation o f mining contracts, and the monitoring and control of activities of diamond ventures. The company is, therefore, both an operator and a regulator inthe diamond industry. xvii. There is, thus, a needfor institutionalreformsinthe oil and diamondsectors. Inthe oil sector, the role of Sonangol shouldbereassessedwith a view to eliminate the conflict o f interest and improve the quality and effectiveness o f public finance management in Angola. In the diamond sector, it will be necessary to introduce a transparent licensing, regulatory, and tax structure that would avoid conflicts o f interest and privileged access to development rights.These issues are discussed separately below. xviii. M o r e needs to be done to phase out the dual role o f Sonangol. Although there have been initiatives to add transparency in the relations between Sonangol and the Government, the current procedures have several disadvantages, in addition to that o f recording fiscal activities outside the budget where they belong: a) as affirmed above, it i s not transparent; b) it leads to frequent disputes; and c) it misrepresents Sonangol's position on taxes. The GOAi s now moving to reflect quasi-fiscal activities in the budget, and Sonangol i s taking steps in its external audit to identify and audit all such activities undertaken on behalf o f the Government. Both o f these measures are welcome. However, the offsetting mechanism is still very much a current practice and concrete efforts to phase it out have yet to materialize. xix. Sonangolcan contribute more effectively to the development of the country by focusing on its core business. It is a recognized fact that the activities performed by i x Sonangol on behalf o f the government create an additional administrative and operational burden on the company. If these were relinquished and Sonangol focused exclusively on its core business, the company could contribute even more to the development o f the country. A few examples o f areas where the increased intervention o f Sonangol could make a difference include: (a) investments to increase fuel storage capabilities; (b) investments to improve fuel distribution to the interior o f the country; (c) training o f Angolan labor force to work inthe IOCs; and (d) investments in social projects. xx. There has been some progressin improvinggovernance and transparencyin the petroleum sector since 2002. A number o f recommendations made by the Bank in the past, both in the Oil Diagnostic Study and in the PEMFAR have been adopted and these are summarized below: P The governmenthas been publishingdetails of oil payments received(by block, by type o f payment, with annual summaries by company) on the Ministry o f Finance website, although with a significant lag o f 6 months on average. P The audits of the petroleum sector are being conducted. The financial statements o f companies inthe Sonangol group were audited comprehensively for the first time, by Ernst & Young, in 2003. The 2004 audit was recently completed. The auditors' reports, however, have yet to be published. P Recent audits have followed acceptable accounting rules. The audits mentioned above applied Angola's recently issued accounting legislation where appropriate, and IAS rules where the new legislation does not apply. By end-2006 Sonangol expects to have moved fully to IAS standards. P The roll out of the Angolan IFMS (SIGFE) is progressing steadily. Progress towards the implementation and full roll out o f the Angolan IFMS (Integrated Financial Management System) has been steady and currently most o f the expenditure side o f the government accounts i s registered in the system. However, progress in the inclusion o f revenue data into the system remains very weak. P The governmentis usinga modelfor oil revenueforecasting.The Ministry o f Finance has signed a contract with AUPEC, Aberdeen University Petroleum Economic Consultancy, to implement an oil revenue forecasting model and advise DNIon strengthening its capacity with respect to petroleum taxation. xxi. But progress has been slow in addressingother equally importantstructural financialmanagementissues. The Government has started to strengthen the capacity o f the Ministry of Finance to control expenditures with the roll out o f the SIGFE and the setting up o f a fiscal programming unit. An initiative to gain some oversight over the X operations o f Sonangol on behalf o f the Treasury by registering them ex-post in the SIGFE i s also inplace. But more needs to be done to arrive at a point o f "normalization". Other suggested improvements in public financial management that remain to be addressedinclude: > Sonangol's quasi-fiscal operations: Sonangol's quasi-fiscal operations are currently reflected in the budget (with a lag), but there i s no clear indication about a timeframe for phasing them out. > Separation of concessionaire and operator roles of Sonangol. The Government and Sonangol have both indicated that there will be no change on this configuration at least until 2010 under the justification that there are institutional and technical limitations in the Ministry o f Finance and in the Ministryof Petroleumthat prevent faster progress. > Updating of the Ministry of Finance website. Detailed information was provided to the Bank and Fund in March 2006 about oil exports, oil prices, and profit oil from the Tax Directorate o f the Ministry o f Finance for 2005, butthe information on the website continues outdated. > Engagement with civil society on public finance management issues. The MOF has asked the World Bank to organize high level workshops on petroleum revenue management. This i s a welcome initiative that needs to be complemented with more perennial actions o f engagement with civil society. P Formal endorsement of the EITI criteria. Angola has been cautious about announcing formal adherence to the principles and objectives o f the Extractive Industries Transparency Initiative (EITI), despite the encouragement of the Bank, IMF andbilaterals. xi xxii. A scorecard of actions taken and targets to be met spotlights required further actions. Table E.1 describes areas where progress has been made and where further actions are required to meet objective governance and transparency criteria which are considered good practice: Resolveconflict of interest potential Sonangol is ring-fencing Subject to credible institutional (Sonangol as concessionaire) concessionaire activities capacity, transfer concessionaire role to Ministry of Petroleum Introduceadequate Government MOFlMOP have little capacity to Engage qualified consultant support. oversight of Sonangol provide oversight Build capacity. Reconcilelinclude Sonangol financial Sonangol ring-fencing and auditing Bring Sonangol quasi-fiscal and own flows with budget quasi-fiscal activities. Own expenditures into budget and comply expenditures are still outside budget. with budget procedures without Quasi-fiscal expenditures comply delays. with budget procedures with a 90-day lag/ Create adequate institutional capacity Seriously under-resourced. Strengthen technical capacity in DNI. in key ministrieslagencies Inadequate skills. Salaries low. Build or transfer capacity to MOP. Ministry of Finance now using oil Resolve salary issue. revenue forecasting model developed by AUPEC. Performqualified, independent audit Annual industrv cost and fiscal audits Take notice and act according with of payments made and revenues by experience4 international auditors. the auditors' recommendations. This received Auditor reconciles tax filings with will allow a comparison of payments revised tax assessments and with made by industry and revenues payments made, and identifies received by the federal and provincial discrepancies. governments. Audit revenues received by MOF, Cabinda and Zaire; include Sonangol, and clear arrears. Publicationof audit results in Current detailed publication of Add audit results. Improve accessibleform company payments on MOF website. accessibility of website. Consider Audit results not yet published. broader media publication. Audit exercise should apply to all Current practice, but Sonangol data Sonangol to provide data directly to companies, including Sonangol derived from block operator. MOF. Publication of Sonangol corporate audits Engagecivil society in revenue No current engagement Topical workshops to include civil management and transparency society. Establish independent public process information center Introduceclarity on legal, contractual Legal drafts and texts difficult to Compile and publish legal texts, and fiscal frameworklprocedures access. DNI preparing tax manual procedures. tax manual. DeveloD time-bound. funded, action No current plan, although individual Prepare and publish explicit plan planfo; implementation of ' components have been scheduled transparency agenda xxiii. Successful development of the diamond sector led by the private sector in Angola will require change. There are a lot of improvements possible in the diamond sector that, to a large extent, remains secretive and victim of patronizing. The most xii important areas where improvements are called for include: (i)predictable and transparent legal framework that adequately defines investors' rights and obligations; (ii) a fiscal package that i s competitive and at the same time equitable for the concerned stakeholders; (iii) security o f tenure o f miningpermits; (iv) strengthened capacity o f the Government to monitor and regulate the sector; and (v) a firm commitment towards marketing liberalization. xxiv. Whatever the strategy selected by the authorities to promote the diamond sector, an integrative approach should be pursued. Over the medium term, the interventions for improving the artisanal and small scale mining sub-sector should focus on: a) improving the quality o f life o f those living and working in diamond fields; b) rehabilitating the environment and improving agricultural productivity; c) upgrading regional infrastructure; d) improving miningproductivity and safety; and e) encouraging general economic growth via multiplier effect o f mining activity and infrastructure improvement. Additional emphasis should also be given to: (i) continued implementation o f the Kimberley Process; and (ii) the harmonization o f the domestic policies with those o f competing and neighboring countries (namely the Democratic Republic of the Congo), to discourage smugglingand encourage trading through official channels. xxv. There is a world of opportunities for investment in Angola both in the mineral and non-mineraleconomies that can be realized by removing barriers and constraintsto the investmentclimate.With the advent of peace since 2002 the country now faces the daunting challenge o f channeling its huge resource endowment into reconstruction o f its infrastructure and into poverty reduction activities. However, improvements in the competitiveness of the local industry and efforts to diversify the economy remain hampered by inadequate infrastructure, poor governance indicators and less than adequate businessenvironment. Inorder to address these issues there are 5 areas that will require attention: 9 Structurea dialoguebetweenthe public and the privatesectors. Inthe very short term, the establishment o f a consultation mechanism between the government and the private sector i s a critical element to secure a private-sector-led growth agenda. The private sector and the authorities should then determine together the sequencing and prioritization o f the necessary reforms. > Reduce the number of unnecessary regulations and procedures. Despite some recent progress in lessening bureaucratization, more needs to be done in that area. A good way to start a second phase o f effective reforms could be by carrying out a systematic inventory o f existing rules and regulations which affect the country's investmentclimate. > Ease restrictions on property and land registration.It is critical that property and land registration be facilitated. The authorities could facilitate the formal registration o f land by reducingboth the time and the cost required to register it. xiii Reviselabor regulationsto introducedynamismin the labor market. InAngola, when an employer decides for operational reasons that s/he needs to dismiss an employee, actually doing so requires a highdegree o f persistence and patience. It i s a costly, time consuming and cumbersome process. However, it i s important that the cost o f dismissal be reduced while still ensuringthe protection o f workers' rights. Maintain government commitment to improve governance and adopt anti- corruption actions. The World Bank estimates that a country that improves its governance from a relatively low level to an average level could almost triple the income per capita o f its population in the long term, and similarly reduce infant mortality and illiteracy. In the case o f corruption, research suggests that it i s equivalent to a major tax that increases costs and reduces efficiency. xxvi. Assess productions costs with a view to reduce them. In the face of an overvalued real exchange rate, the country should explore possibilities for reducing agricultural unit costs. The country has a better rainfall than many o f its neighbors, has substantially lower yields, and has been cut o f f from technological advances in new varieties or other areas for decades. The key question, however, i s whether productivity gains can be large enough to offset the disadvantages posed by the strong currency and high transportation costs. As there is no clear indication as to what is the actual cost structure o f production in Angola, this question can only be answered through a case by case accurate crop budget analysis. xxvii. Increase the importance of agriculture in the budget. Increasing the priority given to agriculture and rural development through budget allocation will be an important measure to strengthen the sector. Budget allocations to the Ministry o f Agriculture and Rural Development (MINADER) in 2004 reached AKZ 2.3 billion (approximately US$25 million). This represents only 0.64% o f the national total budget. xxviii. Move gradually towards greater decentralization. Administrative decentralization should be encouraged as agriculture is perhaps the prototypical example of an activity that is not best managed from a capital city. The move towards expendituredecentralization, however, should be conducted gradually to avoid waste and inefficiency. Equally important concerns exist with regard to the capacity o f local government structures to establish and operate the necessary administrative and budgetary mechanisms that decentralizationwould require. xxix. Develop and support a market-orientedenvironment. There should also be a shgt in policy towards further market deregulation. In the short term, this would represent adjusting and/or phasing out food aid programs to avoid unfair competition with the emerging domestic production o f cereals. In the area o f marketing and distribution the government i s still inthe businesso f settingwholesale and retail margins. Government controls have demonstrated in Angola and elsewhere that they result in a poorly developed trading network and poorly serviced farmers. xiv xxx. Improve the effectiveness of MINADER. In order to function properly and effectively contribute to the development of the agricultural sector, MINADER needs to undergo performance-enhancing changes. To increase its effectiveness, the Ministry would benefit from measures aimed at: (i)identifying redundant and unproductive positions with a view to eliminate them; (ii)reforming its structure to strengthen its extension and research services; (iii) creating a high level policy analysis unit; and (iv) strengthening the ministry's existing statistical unit. xxxi. Create better incentives to stimulate competitiveness.The development of the sector will require investments in infrastructure and a better regulatory environment. A realistic vision o f the future for Angolan agriculture should include a mix o f commercial and familiar farms. Both need improved transport infrastructure, a modem marketing system and a conducive regulatory environment. MINADER and provincial governments should be equipped to provide the necessary institutional support to new projects. xxxii. A number of official social programshave had some success, but more needs to be done to reach the most remote and most needy areas of the country. Although existing national programs administrated by the government and the private sector suggest that the intendedobjectives are beingmet, the majority o f them lacks capacity to fully respond to the poor given that the demand far outstrips the supply. To increase the effectiveness o f current and new social programs, the authorities should: (i)adopt mechanisms to consult the poor on how to allocate public funds; and (ii)use fiscal savings to improve service delivery. These two options are discussed below. xxxiii. Mechanisms to consult the poor on how and where to allocate public funds can be very helpful.Angola's experience with FAS is a very good example of this mode o f operation. Mechanisms to automatically consult the poor inregards to decision-making on public investment should be put in place in addition to accountability channels in order to ensure quality control and civic engagement. xxxiv. Subsidies to fuel and utility prices should be phased out gradually and the savings redirected to improve the quality of public services and to compensate the poor. Ina first stage, the authorities will need to announce a comprehensive program to deal with subsidies in a phased strategy beginningin 2006. In a second stage, the current pricing mechanism used by Sonangol should be reassessed and the adjusted level o f subsidies phased out gradually while the compensation program designed in the first stage continues to be implemented. At any point intime, the program should be adjusted incasethere is a crash ininternational oil prices. xv xxxv. The authorities should not neglect the policy's political costs. International evidence demonstrates that fuel price hikesunaccompaniedo f a set o f palliative measures typically leads to public protests and may trigger violence and social unrest. The experience o f other countries demonstrates that any program to reallocate fiscal spending should pay close attention to the following broad principles: Political attractiveness: Off-setting, politically attractive expenditure programs are key to the political and social sustainability o f a subsidy removal. A high visibility and credible announcement o f compensating measures i s an indispensable feature o f the package. Pro-poor and effective targeting: Measures should ideally be those that maximize development and poverty reduction impact. "Compensation" programs should be targeted to benefit the poor and possibly other key losers o f the subsidy removal as well. They needto be seen to do so as well. Speed of spending and impact on households: The speed at which programs are designed and money is spent i s important for macroeconomic reasons, while the speed at which programs impact poor households is important for compensatory and political economy reasons. xxxvi. One of the palliative measures that may bring large benefitsto the poor is a water and sanitation policy. The welfare analysis carried out in the World Bank-UK- sponsored study on the impacts o f phasing out subsidies indicates that changes in water price will bring about a much larger marginal social impact than changes in fuel prices. Given the precarious state of affairs in water infrastructure, management and service delivery, there appears to be ample room for reform in the public water sector with the goals of making it more efficient, expanding water supply to the population and improving water quality. The finds needed to finance such a large venture could come from funds saved with the gradual phase out of fuel subsidies and from private sector participation. xxxvii. Other palliative policies that can be implementedare as follows: 9 Public Education Policy: Promotion of voucher systems, conditional cash transfers and school meals in order to offer incentives to parents to send their children to school and incentives for children to stay inschool; 9 Health Care Provision Policy: Promote infrastructure investment, offer preventive care and mobile clinics to expand health care service access; 9 PublicTransportationPolicy:Creationofa social passwhich can be used in buses and vans interchangeably, cost subsidization o f van service based on utilization rates, implement employer-sponsored passes. xxxviii. A successfulpackageto phase out subsidies inAngola will demandpolitical commitment and a good implementation and monitoring strategy. In order to successfully implement the package the GOA will need to form teams and attribute xvi responsibilities. The teams should cover the following main areas: (i)macroeconomic and fiscal issues; (ii)expenditure programming (social protection and compensatory expenditure, and other development and poverty reducing expenditures); and (iii) socialization o f savings.. xxxix. Finally, in order to know if a poverty reduction strategy is effective in reducingpoverty,it is necessaryto set inplace a poverty monitoringsystem to track key indicators over time and space. In Angola, there is still a dearth o f knowledge on the livelihoods o fthe poor. Overall, it is difficult to have a full assessment ofthe existing safety net programs given that these do no have at the outset an expected number o f beneficiaries. This failure comes from the lack o f reliable data on poverty to which programs could refer to in order to assess appropriateness and effectiveness in their targeting and the impact o f their activities. A sensible way o f tackling this limitation would be to strengthen the National Statistical Institute (INE) and establish a program o f annual monitoring o f poverty and indicators and disseminate these to the public at large. xl. Summary of recommendationsand next steps. The following Table outlines priority areas for action and suggestednext steps (see Table E.2). Some recommendations are already under implementation, in some cases with World Bank support. xvii Table E.2: Sun 4ddresscontinuing deficiencies in 4dopt a prudentfiscal envelope for the coming years and avoid rapid increases in public macroeconomicpolicy design and sxpenditure.Continueadopting conservativeoil price in the budget. #mplementation. Preparean MTFF. Calculateannual ceilings for public expenditure based on medium-termrevenue forecasts evaluatedat a long-runoil price. Move gradually towards an MTEF. Create clear fiscal rules for the recentlyannounced oil reserve account based on solid governance and transparencyprinciples.Adopt a cap ex-ante limiting the volume of resourcesto be accumulated, Avoid pro-cyclicalityof fiscal spending. Generate fiscal surpluses when oil prices are risingto sustainspendingwhen revenues eventuallyfall. Use oil revenuesfor productive investmentsand not consumption (increase productivecapacity)to reduce costs to the entire economy. Adopt a clear monetaryanchor, use foreign exchange sales to mop liquidity and keepthe downward pressureon inflation,and do not resist likely appreciation of the currency. Build up foreign exchangereserves and reduce the external debt. Modernize policiesand institutionsfor procurement, financial management,and program evaluation. Dealwith conflictsof interest in Sonangol Pursue adequategovernment oversight of Sonangol and Endiama. and Endiama. Separate the activitiesof Sonangoland Endiama as operators and regulators in their respective sectors by transferring regulatory responsibilitiesto appropriate ministries. Improvegovernance and transparency in Support the petroleumrevenue management unit in the Ministry of Finance and train staff to work the oil and diamond sectors. with the oil revenueforecasting model. Publish Sonangol's and Endiama's corporate audits. Define a plan and a timeframeto phase out completely Sonangol's quasi-fiscal operations. Update informationon oil exports, oil prices,and profit oil without delays on the website of MINFIN. Endorseformallythe ElTl criteria Compile and publishlegal texts, procedures,and tax manual on fiscalllegal framework in the oil sector. Enact transparentand stable legislation under a new diamond law. Commissionan updatingof the 2003 Diamond Diagnostic Study. Review and regularizeexisting mineral rights (exploration and mining). Improve the businessenvironment in the Produce bettergeological informationand disseminate it. diamond sector. Liberalizediamondsales: identify and assess options for free market trading of diamonds; pilot test selected optionsfor free market trading of diamonds. Raise awarenessand disseminate rulesof the game locally and internationally. Reinforce implementationof the Certificationof Origin Scheme xviii Remove barriers and constraintsto the Structure a dialogue between the public and the privatesectors businessenvironment. Reducethe number of unnecessaryregulationsand procedures. Ease restrictionson propertyand land registrationsand reduce the associated costs. Revise labor regulationsto introducedynamism in the labor market. Maintaingovernment commitmentto improve governance and adopt anti-corruption actions. Use trade as a yardstickfor measuring Resist protectionist pressures that will emerge as the exchange rate appreciates. success in diversification. Develop export incentive systemswhere there are comparative advantages. Improvetrade facilitation and strengthen trade capacity. Take advantage of trade agreements and participateactively in regional and global negotiations. Introducewin-win schemesto foster Preparesector development strategies. interaction between oil companiesand local suppliers. Invest in training for Angolan workers. Promotejoint ventures. Improve business environment,competition, and exit mechanisms. Increasecompetitivenessin agriculture. Reviewagricultural support policies (trade and fiscal) with a view of fonulating a clear strategy to increasethe competitivenessof the sector. Support smallholders and resistthe temptationto engage in public production or market activities Repair roads in rural areas to facilitate accessto markets. Removeobstacles to output growth Preparea detailed analysis of actual cost structures per crop with a view to reduce productioncosts. Increasethe importance of agriculture in the budget. Movegradually towards administrativeand spending decentralization. Developand support a market-orientedenvironmentfor the sector; review existing marketing controls; phase out existing government involvementin production and marketing activities; review the current policy of distribution and subsidized sales of fertilizers, Improve the effectivenessof MINADER Performan overall manpower study of MINADER with a view to identify redundant and unproductive positionsand formulate a plan for their elimination. Reformthe structure of MINADER to strengthen its extension and research services. Create a high level policy analysis unit in the Ministry capable of analyzing policy alternatives and appraising projects. Improvethe existing statistical unit in the Ministrythat should liaise with the National Institute of Statisticsand the Ministryof Planningto design a nationalagricultural survey. xix Design a phased publicworks program. Target publicworksjobs program for the low skilled labor force. Increasejob opportunitiesfor the labor Revise labor legislationto introduce dynamism in the labor market (but respectworkers' rights). force. Support the organizationof small business into cooperatives. Encouragegreater community participation Adopt best practice mechanismsto consultthe poor in regards to decision-making on public in the design and implementationof social investment. service investments. Increase scope and coverage of the FAS. Promotea higher degree of coordinationamong development partners and the government (local and provincial). Use savingswith subsidies phase out to Prepare a phased programto eliminatefuel and utility price subsidies. Adopt a two-prongedstrategy improve service delivery to: (i) bring fuel pricessubsidies bill in line with the oil price implicit in the 2006 budget;and (ii) revise Sonangol's pricing mechanismto phaseout completely fuel subsidization and liberalizedistribution. Use fiscal savings to compensatethe poor and the losers with the elimination of the subsidies by investing in infrastructurerehabilitationin the water sector: public education; health care provision; and publictransportation. Create an inter-agencyteam to preparethe package. The team should look at the following areas in designing the package: macroeconomicand fiscal issues; expenditure programming (social protection and compensatoryspending):and socializationof savings. Establisha programof annual monitoring of Strengthen the National Statistics Institute(INE) with better physical and human capital. Higher poverty and social indicators wages may be necessaryto attract skilled labor. Revise the nationalstatistics plan and give a higher priority to poverly monitoring. After adequate support is in place, conduct and disseminate annual labor force surveys. Frame publicspending planswithin a medium-termstrategy for poverty reduction and for achieving the MillenniumDevelopmentGoals (MDGs). xx INTRODUCTION The one and only Country Economic Memorandum about Angola was prepared and discussed with the authorities in June 1990 (World Bank Report No. 8906-ANGYJune 1990). At that time, the Bank's diagnostic about the Angolan economy identified three main factors that contributed to slow economic growth and to continuous economic instability since Independence in 1975: 0 First, the violent conflict that erupted with Independence and that contributed to the destruction o f infrastructure and to the exodus o f a hugenumber o f people into the cities. The conflict disrupted internal transportation, imposed a heavy burden on the budget (with defense accounting for more than 40% o f government expenditures at the time), absorbed a large proportion o f the limited supply o f technicians and skilled manpower, and created enormous suffering and deprivation among the population. 0 Second, the massive exodus during the period o f transition to Independence o f about 300,000 Portuguese settlers (90% o f the total) who held practically all administrative, managerial and skilledjobs, which created a situation o f chaos in the economy. Few Angolans had the professional qualifications to run the enterprises which were abandoned or to fill thejobs which had been left. Third, the inefficient economic management and inadequate economic policies which prevailed after Independence which, along with the previous two factors, contributed to the decline in aggregate production, scarcities in the supply o f consumer goods and inputs for the industry, and distortions in the distribution o f income. The Bank's advice to the authorities to put the economy back on a path o f macroeconomic stability and equitable development reinforced the current economic policy thinking at the time, which was based on the Government's own reform agenda in the form o f a Program o f Economic and Financial Restructuring (designated as SEF, Programa de Saneamento Econdmico e Financeiro). The main recommendations were oriented towards the following two main broad objectives: i.Stabilization of the financial situation, by reducing internal and external disequilibria, which were reflected in inflationary pressures, large budgetary deficits, excessive losses and indebtedness o f many enterprises, serious deterioration o f the financial situation o f the banking system, accumulation o f arrears inforeign payments, and difficulties inservicing the external debt; ii.Introduction and implementation of structural reforms, in order to increase productivity, improve the allocation o f resources and create the conditions for a faster rate o f economic growth and equitable development inthe future. Some 15 years later, the main issues confronting the Angolan authorities in their efforts to consolidate macroeconomic stability on a sustainable basis and in promoting an improvement in the welfare o f the Angolan citizens do not seem to differ significantly from those addressed in the 1990 report. Therefore, in the current Country Economic Memorandum, the Bank reassesses some o f the key issues that remain relevant nowadays and that should help the Angolan economy reach a path o f sustainable economic development. The analysis in this report centers around the following four core issues: (i) taking stock of socio-economic realities; (ii) the options available for the management of the country s mineral wealth without deleterious macroeconomic consequences; (iii) the main constraints to economic diversijkation away from the mineral sectors; and (iv) the challenges and opportunities to improve the welfare of thepopulation. Each o f these core issues forms the building blocks that provide an overview o f the current situation and a possible solution to Angola's structural problems in the short to the medium term. The report thus plays an informative role and offers policy recommendations. The rationale behind the core issues and how they fit in the structure o f the report is briefly outlined below. Taking Stock ofSocio-Economic Realities. The report starts by taking stock o f socio- economic realities in the country that may help to understand how its institutions developed and how the Government has handled macroeconomic management since Independence. It traces the link betweenthe recent history o f conflict, weak institutional capacities, and the difficulties in achieving macroeconomic stability after Independence. This is done in Chapters 1 and 2. InChapter 1, the analysis starts with a brief discussion o f socio-economic realities in the country. In Chapter 2, a comprehensive macroeconomic assessment i s presentedhighlighting major past features, the country's constant search for stability, and recent successes inthe macroeconomic front. Options to Manage the Mineral Wealth. With rising international oil prices and the prospects o f a doubling in oil production in the near future, Angola will benefit from a sizable revenue windfall. The prospects inthe diamond sector are equally promising. The significant additional revenue and the speed with which the government will have access to it poses challenges o f macroeconomic management and raises intergenerational considerations and expectations about how the mineral wealth can contribute to improve the welfare o f the poor and o f the vulnerable inAngola. These questions are addressed in Chapters 3 and 4. InChapter 3, the report discusses the structure o f the petroleum sector, the future production profile, the size o f the oil wealth, and policy options to manage the revenue windfall. Chapter 4 focuses on the diamond sector, its structure, legal and fiscal framework, and explores ways in which the sector can improve its contribution to social development. Constraints to Economic Diversification. Despite the favorable outlook in terms o f mineral wealth, the Angolan economy will not enter a path o f sustainable shared growth without some necessary structural reforms. Because o f the long civil war and o f the effects o f the strong dependence on oil and diamond revenues, the private sector has not evolved outside o f the mineral sectors and the quality o f the country's institutions remains low. The combination o f this state o f affairs creates constraints to private sector development and for the diversification o f the economy. Options to overcome these 2 structural issues are discussed in Chapters 5 and 6. In Chapter 5, the report assesses the quality o f the business environment and the opportunities to improve the investment climate. Chapter 6 discusses alternatives to unleash the potential o f the agricultural sector ingenerating employment outside ofthe mineral sectors. Challenges and Opportunities to Improve the Welfare of the Population. Finally, the report acknowledges that it will take some time before the required structural reforms can start to yield concrete results. In this instance, the authorities will need to worry about mitigating measures to improve the welfare o f the population until the Angolan economy reaches a path o f sustainable development. In Chapter 7, the analysis focuses on how to improve the livelihoods o f the poor and o f the vulnerable with recommendations on how to use the mineral wealth to improve public service delivery targeted to the poor. The analysis in Chapter 7 i s complemented by an additional study on the welfare impacts o f phasingout fuel andutility price subsidies and on how to use the derived fiscal savings to improve service delivery in Angola. This study, that was managed by the World Bank, fundedby the BritishGovernment, and prepared inthe context of this Country Economic Memorandum, i s publishedseparately. As policy reform in an economy in transition (from war to peace, from a colonial economy to an independent market system, and from Marxist centralization to a multi- party democracy) i s by definition politically difficult and requires a piecemeal approach, the report presents policy options that range from the modest to the radical. The recommendations include institutional reform but, recognizing that this will be difficult and time-consuming, other alternatives are suggested. To guide policymakers, the report also attempts to determine priorities and sequencing. This i s an issue that surfaces in all chapters when policy recommendations are offered. A note o fcaution is necessary inrelation to the quality and completeness o fthe data used in the preparation o f this report. The reader is alerted that in many occasions the necessary information was either not available, or when available was o f limited coverage, quality and usefulness. A great deal o f this i s associated with the impacts o f the conflict in the capacity to generate data. The Government now has a long-term plan to address this problem and it i s hoped that data quality and coverage in Angola will improve substantially inthe near future. 3 I. COUNTRYBACKGROUND:SOCIO-ECONOMICREALITIES BEFOREAND AFTERINDEPENDENCE Angola is a country blessed with vast stocks of natural resources, of which oil and diamonds alone account for more than half of the countryS gross domestic product andfor over 90% of its exports. The economic concentration on oil and diamonds, together with the deleterious effects of a violent war that plagued the country for nearly three decades, has left a difJicult legacy. The potential to develop a thriving diversi3ed economy outside the mineral sector is large, but so are the obstacles that have to befaced before the country can take advantage of the favorable moment. This Chapter takes stock of the socio-geographic characteristics of the country and of the structural changes that have taken place since Independence and sets the stage for the analysis that follows which will deal with the challenges of achieving sustainable macroeconomic stability whilepromoting shared-growth. 1. The Republic of Angola is, after the Democratic Republic of Congo and Sudan, the third largestnationsouth of the Sahara.Ithas an area o f 1,276,700 sq. km (including the 7,270 sq. km o f the oil-rich Cabinda enclave) and i s the largest Portuguese speaking African country. Angola i s located on the West Coast o f Africa bordering Namibia, the Democratic Republic o f the Congo, and Zambia. Without considering Cabinda province (an exclave in the Northwest separated from the rest of the national territory), Angola has a roughly square shape, measuring 1,277 km from North to South and 1,236 km from West to East (from the mouth o f the Cunene river to the Zambia border). Angola's capital, Luanda, lies on the Atlantic coast in the northwest o f the country. Plateaus, averaging altitudes between 1,050 and 1,350 meters, account for about two thirds o f the Angolan territory. The Angolan coast, with an extension o f 1,609 km, i s mountainous to the North of the mouth o f the Kwanza river, and quite flat with occasional cliffs to the South. The coastal plains are separated from the inland plateau by a score o f irregular "terraces" that form a subplateau. The most important rivers in the country originate in the plateau regions and flow in three directions: east-west to the Atlantic, south-southeast, and northeast. Most rivers, however, do not provide easy access to the interior regions as they are not navigable. Nevertheless, they offer energy and irrigation potential. The main rivers o f Angola include the Kwanza (with an extension o f 960 km, 200 o f which are navigable by small watercraft), and the Cunene (945 km long andbordering Namibia to the south). 2. The country's relativeclimaticdiversityrepresentsan advantageand hintsat huge potentialfor agriculturaldevelopment.Angola's location inthe intertropical and subtropical zones o f the Southern hemisphere, its proximity to the sea and the cold Benguela stream, and its topographical characteristics are the factors which create two 4 distinct climate regions with two seasons: the dry and cool season (from June to September) and the hot and humid season (from October to May). The northern region from Cabinda to Ambriz has a humid tropical climate with heavy rainfall, while the region from Luanda to Namibe (Mogamedes) has a moderate tropical climate, with the rainfall reduced on the coast by the Benguela wind stream. The southern strip between the plateau and Namibia has a desert climate, given the proximity to the Kalahari, with irregular rainfall between 600 and 1000 mm. annually. Temperatures average 23 degrees C inthe north and the coastal areas, and 19 degrees C inthe interior. The relative climatic diversity, due to variations o f altitudes across the country, allows for the growth o f crops from bothtropical andrelatively more temperate zones. 3. The vast and diverse territory hosts a large concealed economic potential. Among the abundant natural resources there i s plenty o f water that provides for hydroelectric power plants and irrigation; amid mineral resources there are abundant oil, diamonds, iron, quartz, ornamental stones and phosphates. In the Cabinda region, very dense forests predominate (Maiombe forests) with economically important timbers such as black wood, ebony, African sandalwood, and ironwood. With a coastline o f 1,650 km, Angola's waters are rich in fish, mollusks, and crustaceans. The main petroleum basins under exploration are located near the coast o f Cabinda and Zaire provinces. The main diamond producing area i s located inthe Lunda Norte province. Unfortunately, due to the nonexistence o f proper and comprehensive geological surveys, the whole mineral potential o f Angola is, to this date, vastly ~ n k n o w n . ~ 4. The Angolan population is young and i s growing rapidly. Recent population figures are difficult to obtain due to the lack o f a full national census. A limited census was carried out in the province o f Luanda in 1983, which was extended to the provinces o f Cabinda, Namibe and Zaire in 1984. War-related problems made it impossible to carry out a national census. It took 70 years for the population to double from 2.7 million in 1900 to 5.9 million in 1970, with the rate o f growth accelerating in the 1940-70 period, due to significant Portuguese immigration. In 1980, according to official estimates, the population reached 7.7 million, implying an annual average growth rate o f 3.2% for the previous decade. Though data i s scanty, the population was projected to grow at an annual rate o f 2.9% during the 1980s and 1 9 9 0 ~reaching about 13 million in 2003. ~ Estimates by the US Census Bureau suggest that in 2000 some 6.5 million people or about 62% o f the Angolan population were under the age o f 24 and that by 2025 that segment of the population would be o f approximately 10.8 millionpeople, or around 60% o f the population. With a population growth rate o f approximately 2.9%, the absolute numbers and the proportion of youth will continue to be extremely highover the next 50 years. 5. Population density is low and ethno-linguistic groups are geographically separated. Population density (8.6 inhabitants per Km2)i s very low, with the most populous provinces being Huambo, Luanda, Bie, Malange, and Huila, which together account for more than half o f the total population. About three-quarters o f the population See Araujo and Costa (1997) and Alves da Rocha (2001) for a detailed description o f Angola's natural resource endowments. 5 come from three ethno-linguistic groups: the Ovimbundu (37%) in the Central plateau region, the Kimbundu(25%) living in a belt extending from Luanda to the East, and the Bakongo (13%) in the Northwest. In addition, mestiqos (Angolans o f mixed European and African family origins) amount to about 2%, with a small population of whites, mainly ethnically Portuguese. Portuguese i s both the official language and predominant language, spoken in the homes o f about two-thirds o f the population, and as a secondary language by many more. 6. The historical ethnic divide influenced the anti-colonial resistance and the formation of the post-colonial state. The Ovimbundu are, by far, the largest ethno- linguistic group. They dominate the areas with the highest population density in the country - the central plateau provinces of Benguela, Bie and Huambo. As argued by Malaquias (2000), their cultural, linguistic and economic domination in central part o f Angola i s such that they have been regarded in the past as "a nation rather than an assembly o f tribes." Awareness o f this ethnic diversity i s crucial to understanding the politics and society inAngola, both during colonial times and as a post-colonial state. For example, in the past, the Portuguese were able to impose colonial rule because the nature o f anti-colonial resistance was so fractured. Although sporadic military resistance persisted during Portugal's presence in Angola, the various kingdoms and chiefdoms threatened by colonial domination were not able to create a united front. From this perspective, the disunity that characterized the anti-colonial movement and the inability to establish an inclusive political system after independence have long historical antecedents. 7. There i s a dearth of information on poverty and social indicators and most of the existing surveys are dated and curtailed in terms of coverage. The most recent household income and expenditure survey (IDR) i s from 2001 and covers only 8 provinces, about 50% o f the population. The survey covers rural and urban households, but owing to the provinces covered, 86% o f the sample lived in urban areas. Although Angola was highly urbanized at this time, as many households fled the countryside and moved into displaced person camps in urban areas, this sample i s considered to have an urban bias. Female headed households are also likely to have been undercounted, as only 20% of households were female headed inthe sample, but owing to the effects o f the war, the proportion is believed to be higher. In 2002, a Multiple Indicators Cluster Survey (MICS) was conducted and collected data on household assets, health and education status, and access to and use o f social services. This survey covered 19 provinces, approximately 90% o f the country. This sample i s considered more reliable. The MICS results show that 61% o f sample households reported living in urban areas, but this probably still undercounts the rural areas. 8. The existing social indicators still reflect conditions prevailing during the war period. According to both the 2001 IDR and the 2002 MICS, approximately 70% o f the population live on less than 2 dollars a day and the majority o f the Angolans lacks access to basic healthcare. About one in four Angolan children die before their fifth birthday, 90% o f whom perishdue to malaria, diarrhea or respiratory tract infections, the maternal 6 mortality rate (at 1,800 per 100,000 births) i s one o f the highest in SSA, and three in five people do not have access to safe water or sanitation. The HIV/AIDS prevalence rate is, according to official statistics, relatively low, affecting an estimated 3.9% o f adult^.^ However, lack o f statistical information and a limited number o f surveillance centers suggest that the true prevalence rate may be much higher. Interms o f education, primary school enrollment i s very low at 56%, and suffers from late entries into school and high repetition and drop out rates. Some 33% o f the population i s currently illiterate, though in rural areas this climbs to as many as 50% (see Table 1.1). Population (million) 14.7 Population I20 years 60% Population below poverty line 68% Life expectancy at birth 42.4 Under-five mortality (per 1000 live births) 250 HlVlAlDS prevalence 3.9% Populationwho know where to get an HIV test 23% Population correctly stating 3 main ways to avoid HIV 17% infection Adult illiteracy rate 33% Maternal mortality rate 1800 Net primary school attendance rate (1-4m grade) 56% HDI rank (out of 177countries) 166 GDPlcapita rank (out of 177 countries) 128 Gini coefficient (income, 1995) 0.54 Gini coefficient (income, 2001) 0.62 Source: IDR (200011); UNICEF (2003); UNAIDS (2004); UNI3P (20051, 5). 9. Livingstandards have shown some improvement recently, but they continue to be considered low by international standards. The crude birth rate o f 52 per thousand estimated for 2000-05 i s the second highest in the world after Nigeria and reflects a high total fertility rate (6.8) combined with a large proportion o f women o f fertile age. The crude mortality rate o f 25.9 per thousand for 2000-05 i s influenced by malnutrition, precarious sanitary conditions, a large proportion o f illiterate mothers, and inadequate health facilities. Infant mortality i s very high, although precise information i s still difficult to obtain, ranging from 191 to 250 per thousand for the period 2000-05. Life expectancy has increased from 35 years in 1960-70 to 42.4 years in 2000-05, but remains very low. The rapid growth o f the population, together with a relatively low life expectancy, i s a clear indicator o f a young population. The proportion o f the population under 20 years o f age is 60%, whereas those 65 years or older represent only 2.8%. As a result, the dependency rate is extremely high. Additionally, according to the UNDP's 2005 Human Development Report, Angola i s among the group o f least developed countries inthe world with a human development index (HDI) o f 0.445, which ranks it at 166 out o f 177 countries. The vast majority o f the population (68% in 2001, according to UNAIDS(2004). Low estimates are 1.9% andhighestimates are 9.4%. 7 official data) lives below the poverty line. Furthermore, the household budget survey (IDR) o f 2001 shows that income inequality in fact rose throughout the 1990s, from a Gini coefficient o f 0.54 to 0.62, makingAngola one o f the most unequal countries inthe world, interms o f income distribution (see Figure 1.l).5 Figure 1.1: Gini Coefficients -Angola and Oil Producing Countries Angola I Turkmenistan Trinidad and Tobag Russian Federation 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Source: 2005 World Development Indicators 10. Inequalityis highin terms of asset holdingswhich are mostlyfound in urban rather than in rural areas. Using the asset scale estimated with using the MICS data (the MICS did not collect information on consumption or income), assets are found to be highly concentrated inurban areas - only 8% o f the population in urbanareas was found inthe lowest quintile accordingto asset and durable goods holdings, but 44% o fthe rural population was in this q ~ i n t i l e .Likewise, only 2% o f the rural population was in the ~ upper quintile. Households with larger asset holdings are much more likely to be found inthe capital region, followed by the Western and Southern regions, although the latter region also has one o fthe highestconcentrations o f low asset holders. This region i s very heterogeneous, as Cunene province has 41% o f its population inthe lowest group, while Namibehas the same amount inthe highestquintile. The assetsmost likely to beheldare 5A recent study by Adauta de Sousa et a1(2003: 38) estimates that the national Gini coefficient is actually higher than the 0.62 recorded for Luanda. 6Evidence presented in the 2006 World Development Report suggests that higher initial inequality means that growth reduces poverty by a lesser amount as it would otherwise do in the absence o f income inequality (p. 86). 7Unequal access to assets and services is an important to constraint market efficiency, as failures in the market for credit, insurance, land and human capital result in underinvestment by the poor, overinvestment bythe rich and a less efficient economy (see WDR, 2006, Chapter 5). 8 radios (76% in Luanda, 28% in rural areas) and bicycles (9-10'70 outside o f Luanda). Few have cars outside o f Luanda. 11. Inequality of opportunities i s also stark. Data from the 2002 MICS survey suggest that the ability to gain access to basic social services i s directly influenced by the household's income level. Access to primary education, for example, i s only 35% for the poorest quintile, while for the richest quintile it i s more than double that, at 77%.8 Literacy rates compare at 62% for the poorest quintile and 95% for the richest quintile. Gender disparity i s also apparent, with female literacy rates within the poorest quintile o f 27% compared with 62% for men, and 86% and 95% within the richest quintile, respe~tively.~Government data from 2002 show that overall completion rates for primary education for girls are estimated at 41.3% compared with 56.8% o f boys." 12. General living conditions are far from ideal, even for the middle class, but they are especially dire for the poor. The long period o f civil war destroyed much o f the infrastructure. Most Angolans, even in urban areas, do not have reliable access to safe water - only 20% inurban areas outside o f Luanda have access to it, according to the MICS data. Again the inequality i s stark. l1 InLuanda, virtually no one inthe two lower assets quintiles reported access to safe water, while 40% in the highest quintile reported access. For example, in the comuna o f Hoji ya Henda, o f 580,000 people, only about 15% o f the people are connected to pipedwater while the rest o f the population relies on 18 public water points, 14 o f which are functioning. Electricity also i s primarily available to the rich, most o f whom rely on generators given the poorly functioning infrastructure and frequent power outages, In Luanda, 82% o f the highest quintile reported having electricity, but no one inthe bottom 60% reported having any. 13. Publicdelivery of social services is also skewed in favor of the urban rich. For example, inurban areas in 2002, 50% o f women reported receiving some form o f trained pregnancy assistance, and this percentage only dropped to 40% in the bottom quintile. However, only 24% inrural areas reported receiving this assistance, with only 16% inthe poorest 20% o f the population. An estimated 17% o f (surviving) children under the age Conditional cash transfers (CCTs) have been used in many countries to induce poor parents to enroll their children in school. CCTs make payments to poor families, typically mothers, o n the condition that children attend school regularly. The programs can be seen as compensating for the opportunity cost o f schooling for poor families and represent one approach to addressing failures in credit markets and the imperfect agency o f parents. The biggest programs o f this kindare Oportunidades (formerly PROGRESA) inMexico, the Bolsa Escola inBrazil, and the Food for Education Program inBangladesh (see WDR, 2006, p. 137). The 2006 World Development Report argues that gender inequity directly affects the well-being o f women and decisions in the home, affecting investments in children and household welfare (p. 51). Econometric evidence cited in the report confirms that an increase in a woman's relative worth and an improvement in her fallback options have positive effects on the children (p. 53). lo Progress report on MDGs (2005: 24). Gender inequities are also reflected at the government and national political level, where women only account for 11 of 70 ministers and vice-ministers and only 14% o f the national assembly. A t the Provincial level, there are currently no female Governors or Vice-Governors. ' IAccording to a recent survey conducted by Development Workshop in Luanda, about 30% o f the interviewed households did not have access to basic infrastructure (e.g. pipedsafe water and electricity), as well as to basic services such as health and education in the vicinity. About 56% have access to some level o f infrastructure and services. Only 13% have access to a relatively high provision o f infrastructure and services (Development Workshop, 2003: 44). 9 o f 5 had not received any childhood vaccinations at all in 2002. Access to education i s poor as well. Only 44% o f rural children o f primary school age (gradesl-4) are reported to be in school, and 60% o f urban children. This i s partly because about one third o f children start school 1-2 years late, either because the walk to schools i s long, or the family cannot afford the fees12, or they are needed to work at home, or the quality is viewed as poor so parents do not value the child's education very highly, or the parents simply want to keepthe children at home for an extra year. O fthose who start, only 46% complete primary school and enroll infifth grade. 14. Rapid economic growth developed after WWII and was largely based on agricultural exports. In the early decades of the 20th century, there had been some development of the modern sector o f the Angolan economy based on railway building, diamond mining, plantation agriculture and trade. However, rapid economic growth began only after the Second World War. The initial stimulus came from the coffee boom. Coffee production rose from 14,000 tons in 1940 to around 100,000 tons in the early 1960s. In 1950, coffee was already the most important o f Angolan exports, accounting for 30% o f total foreign currency earnings. Widening economic opportunities contributed to an increase inthe population o f Portuguese settlers, from 44,000 in 1940 to 172,000 in 1960. However, most Angolans continued to live in extremely difficult conditions, many o f them became employed in the plantations and mines, either on a voluntary basis (at very low wage levels), or under the so-called system o f contract labor, which imposed forced labor on about 350,000 workers by the mid-1950s and that was only abolished in 1961. 15. Heavy public investment in economic infrastructure boosted economic growth between 1960 and 1974. Economic growth accelerated considerably in the period 1960-74, despite the anti-colonial war o f independence that started in 1961. Public investment in economic infrastructure increased significantly, restrictive investment laws were liberalized in 1965 to encourage foreign investment and the Portuguese authorities also encouraged the immigration o f Portuguese settlers. Duringthe period 1960-74, GDP rose at an annual growth rate o f almost 7% inreal terms, one of the highest inAfrica. The volume o f annual coffee production doubled to 210,000 tons and by the early 1970s Angola ranked fourth among the world's coffee producers. Besides coffee, several other cash crops (such as sisal, sugar, tobacco, and cotton) contributed to foreign exchange earnings. In the early 1970s, Angola was also the fourth largest producer o f diamonds (over 2 million carats a year), and the production o f iron ore, which was negligiblein the 1960s, exceeded 6 million tons per year in 1970-73. The most spectacular development, however, was that o f oil production. The first commercial discovery o f oil resources was made in 1955 and production rose rapidly in subsequent years, particularly after 1969. In 1973, output was already in the order o f 144,000 barrels per day and, following the price increases in that year, oil overtook coffee as the leading export commodity, accounting for more 30% o f total export revenues. l2Inthe 2001 IDR, 25% of parentsreported that their children were not in school owing to lack of money to pay fees. 10 16. Economic development under colonial rule did not necessarily benefit the bulk of the Angolan population.Insome areas, the best land was taken away from the Angolans and given to Portuguese settlers, and the compulsory relocation o f large numbers o f African peasants into protected villages (as a counter-insurgency measure) was also very disruptive o f traditional African agriculture. Educational standards were very low and Africans were deniedaccess to education. As a result, native Angolans were not only absent in managerial, professional, and technical employment, but due to the influx o f poorly educated Portuguese settlers, almost all semi-skilled jobs and a high proportion o f low skilledjobs were reserved for European immigrants. 17. The armed struggle for independence of Angola from Portuguese colonial rule began in 1961. The hostilities started in 1961 and were conducted by three rival movements: the M P L A (Movirnento Popular para a Libertaqiio de Angola), the FNLA (Frente Nacional de LibertaGiio de Angola) and UNITA (Uniiio Nacional para a Independ5ncia Total de Angola). A separatist movement also appeared in the Cabinda region (Frente para a Libertaqio do Enclave de Cabinda - FLEC). A number o f commentators sustain that UNITA emerged because o f a perceived dominance o f the M P L A and the FNLA by mixed-race intellectuals from the coastal cities.13 UNITA leaders claimed to represent the "real Africans", sons o f the soil, living in the bush, fighting against a wealthy, cosmopolitan, better-educated urban elite. 18. Ethnic tensions permeatedthe conflict for liberationfrom colonial rule and fueled a civil war after independence. Although other important dividing factors, including class and race, were superimposed by colonialism on Angolan society, the perceived gap dividing different ethnic groups proved to be both enduring and difficult to bridge. Not surprisingly, the anti-colonial struggle reflected these ethnic differences, as the three major liberation movements -MPLA, UNITA, and FNLA - represented almost exclusively the Mbundu, Ovimbundu, and Bacongo ethnic groups, respectively. As argued by Malaquias (2000), even in the face o f their common enemy, Portuguese colonialism, these three nationalist groups were unable to overcome their differences in the form of a united front. The independence of Angola was officially proclaimed on November 11, 1975, with the M P L A in control o f the government. Despite the proclamation o f independence, UNITA maintained a guerrilla war in the South, with the military support o f South Africa and others. This war was enlarged in subsequent years creating extremelysevere disruptions to the economy. 19. The war caused the demise of the rural economy and the subsequent sharp rise in urbanizationdue to the arrival of rural refugees.More than 1 million lost their lives during the civil war, 3 million fledto the cities and 400,000 crossed the borders into neighboring countries. Upwards o f 45% o f the population became concentrated in urban areas, with more than half o f them in Luanda (Adauta de Sousa, 2003). Furthermore, the current population growth at 2.9% per annum has almost doubled the population since 1980, which i s now estimated at 14 million. Cross-continental transportation links, which served landlocked neighbors as well as the domestic economy, have atrophied. l3 for example, the discussionoftherootsofthe Angolanwar inthebookbyDietrichandCilliers See, (2000). 11 Infrastructurehas also deteriorated inthe cities, partly through warfare and partly because inefficiencies in most parastatal companies and price control policies depress public utility revenues, which fail to recover costs inmost services. An estimated $4 billion may be requiredjust to restore the road and bridgenetwork, without which little rural activity i s feasible. 20. The structure of the economy changed significantly and the country is now highly dependent on oil. As a colony o f Portugal, for nearly 500 years Angola served the needs of Portugal. The cycles o fthe colonial economy were determined by exports- first slaves, then primary commodities such as rubber and coffee. Before Until 1975, the country was known as an agricultural producer, not an oil exporter. It was the world's fourth-largest exporter o f coffee and one o f the largest exporters o f staple foods in sub- Saharan Africa-exporting more than 400,000 metric tons o f maize annually. These grain exports were produced almost exclusively by smallholders usingtraditional technologies. Oil had not yet achieved the high production levels o f the 1980s and thereafter. Today, the economy is heavily dependent on oil, a capital-intensive sector with few linkages to other parts o f the economy and little impact on employment. After 1973, the structure o f the economy changed substantially as the miningand service sectors increased their share in GDP (Table 1.2). To this date, the Angola economy remains heavily dependent on the oil sector, a capital-intensive sector with very few linkages to other sectors o f the economy and little impact on employment. Agriculture, Forestry and Fishery 14.2 9.0 12.6 7.0 9.1 industry 22.2 29.6 57.5 67.8 58.1 Mining 6.3 10.7 51.0 61.2 49.8 Manufacturing 8.7 10.7 3.7 3.4 4.2 Electruicity and water 0.9 0.9 0.3 0.0 0.0 Construction 6.3 7.3 2.5 3.1 4.0 Services 63.6 61.4 29.9 25.2 32.8 Transport and communications 6.3 5.9 2.7 0 0 Commerce 34.0 30.3 7.2 15.0 15.4 Other services 23.3 25.2 20.0 10.1 17.5 Sources:IV Plano de Foment0 1974-1979,Angola; Perfil Estatistico, 1988-1991;"Angola: An IntroductoryReview",TheWorld Bank,January 1991;data proviced by Angolan authoritiesto IMF and WB. 21. Important structural changes have taken place in Angola since Independence.Over the last 40 years or so, the Angolan economy sufferedwith adverse shocks associated with changes in international oil prices and with the consequences o f the war that, together with the political orientation chosenby the Government since 1975, help to explain the structural changes which the economy has experienced since Indpendence. Following the end o f the colonial period, for example, there was an almost immediate shift in public-private roles in the economy which implied in changes in the political governance and administration systems. This shift preceded changes in the 12 composition o f production and inthe structure o f trade. In addition, with the focus on the role o f the state as the engine o f growth, there was a structural change inthe composition of public outlays after 1975. The next paragraphs explore these structural changes in more detail. 22. The economy experienceda great deal of ups and downs in its growth path during the last four decades.From 1960 to 1973, GDP per capita at 1996 international prices grew steadily, but collapsed by more than 35% after independence (see Figure 1.2). The period between 1974 and 1976 and the events associated with the fight for independence had a profound impact on Angola's economy insofar as skilled labor fled the country and organizational capacity deranged. From 1975 to 1997, the economy sufferedseveral shocks, the biggest o fthembeingthe restart o f the war at the endo f 1992 which caused another major drop of roughly 39% in GDP per capita in 1993. In addition, changes in oil prices provoked economic contractions during that period when GDP per capita declined at an average rate o f 2% per annum. From 1997 to 2004, GDP per capita grew at an average rate o f 4.2 % per annum with the biggest increase observed in 2002 (about 13%). In mid-2002 gradualist economic policies were adopted and by 2004 the government managed to bring inflation down and become relatively more transparent in the oil and fiscal sectors. Currently, the level o f GDP per capita stands at US$ 1,784, which is still half o f the level observed in 1973. Figure 1.2: Evolution of Angola's Real GDP Per Capita, 1960 2004 - 23. The shift to a commandeconomy right after Independenceled to changes in the way resources were allocated in the economy. Before 1974, total government consumption was less than 20% o f GDP with private consumption at about 70% o f GDP (see Figure 1.3). After Independence, these proportions changed substantially and today public consumption is about 28% of GDP while private consumption accounts for 44% o f GDP. The shift from a market economy in 1974 to a command economy in 1975 meant inpractice a structural change inthe way resources were allocated in the economy. One 13 o f the important changes was in the economy's price system as the government introduced (i) price controls for a large number o f goods and services, (ii) ceilings price for some products, and (iii) guaranteed minimum prices for agricultural and livestock, thus misaligningrelativeprices anddistortingprice signalingmechanisms. Figure 1.3: Composition of Domestic Expenditure, 1960 2004- 120 40 20 Primte ConsurnptionlGDP 24. In the period of strong centralization, practically all prices of goods and services in the official market were controlled by,the Government. The policy o f controlled prices was administered by the National Planning Office (Direcqiio Nacional de Preqos, now Direcqio Nacional de Preqos e Concorrincia). The Ministry o f Finance and other sectoral Ministries were also often involved in price control decisions and the responsibility for monitoring and supervising controlled prices belonged to the Office for Inspection o f Economic Activities (Direcqio Nacional de Inspecqio e Investigaqio das Actividades Econdmicas), a Department o f the Ministry o f the Interior. The artificial stability imposed by price controls and the rapid increases in cash balances held by consumers ledto large and increasing gaps between the supply and demand o f practically all goods and services inthe official market. 25. With the optionfor centralization,the importanceof the public sector in the Angolan economy grew and is now considered high by international standards. Before independence, government expenditures as a share o f GDP averaged less than 15% at current international prices. Between 1974 and 1975, the ratio augmented to 25% o f GDP and since then has remained amongst the highest in Africa and elsewhere (see Figure 2.3). The highest share was registered in 1999 reflecting the scaling-up o f the government's war efforts against the armed opposition movement UNITA. With the end o f the conflict in 2002, this ratio has been declining steadily, reaching 37.5% of GDP in 2004, which i s still highby international standards. The large size o f the public sector has led to monetization o f fiscal deficits in the past which contributed to high inflation, macroeconomic instability, and vulnerability to external shocks. 14 Figure 1.4: Total Government expenditure as a percent of GDP for selected countries Sao Tome and Prlnclpe Sa0 Tome and Princlpe Angola Eritrea Entre. Angola Seychelles Portugal Portugal Brazil UK Seychelles Congo, Rep. of UK Brazil Nlgeria South Africa Malawi Argentina Maurltanla Equatonal Guinea Mozamblque Mauritania Congo, Rep. of Chile South Africa Malawi Argentina Mexico Chile Gabon Mexico Mozambique Chad - USA Gabon Chad Indonesia Thailand USA Cameroon Cameroon Thailand Indonesia Equatorial Guinea Nigeria 0 10 20 50 40 SO 60 70 80 0 10 20 30 40 SO 60 70 80 Total Expenditures as %of GDP 1996 - Total Expendlturer as %of GDP. 2003 26. The next Chapter assesses progress towards macroeconomic stability in a time of transitions. As discussed in this opening Chapter, the prolonged war, the rapid development o f the oil sector and the policies pursued after Independence, have left the Angolan economy in a unique situation, characterized by very uneven indicators o f development. For example, Angola's substantial oil production leads to a per capita GDP (approximately US$1,800 in 2004) that would place it among lower middle income countries. The Chapter also highlighted that the transition to a market economy was initiated in the mid-1980s and has yet to be fully completed. The next Chapter explains what has failed and what i s working well in the search for macroeconomic stability and discusses the likely tensions that the government will have to face and manage to complete the transition not only to a market economy but to a viable democracy that can secure sustainable development. These tensions include the need to maintain fiscal discipline in a context of rapidly increasing oil revenues, the development o f the interior in tandem with the cities, dealing with Dutch-disease related phenomena (such as exchange rate appreciation, corruption and waste o f public funds), and consolidating the transition to a multi-party democracy. 15 11. MACROECONOMIC PERFORMANCE INA TIME OF TRANSITIONS After Independence, Angola embarked on a system of centralized economic and political management that only in the mid-1980s started to be reviewed. The transition to a market economy took impetus with an ambitious reform program introduced in 1987 that aimed at stabilizing the economy, securing j s c a l discipline, encouraging the development of the private sector, and abandoning the system of administered prices. Progress on this agenda has been sluggish and only after the early 2000s, aided by the fortuitous role played by growing oil revenues, the government succeeded in curbing inflation and achieving an incipient macroeconomic stability. I n theface of a favorable external outlook, the country now has the opportunity to consolidate not only the transition to a market economy but also the transition to a multi- party democracy. This Chapter looks into the progress in terms of macroeconomic performance and outlines some of the tensions that will need to be addressed to secure the recently achieved macroeconomic stabilization and the consolidation of a viable democracy - both of which are of key importancefor the overall objective of apeaceful reconstruction. 27. A transition to a market economy was initiated in the mid-1980s with an ambitious program of reforms. As described in Chapter 1, the Angolan economy functioned under Marxist principles and a centralized planning system after Independence. The transition to a market economy initiated in the mid-1980s when the government adopted in 1987 an ambitious program o f Economic and Financial Restructuring, designated as SEF (Programa de Saneamento Econdmico e Financeiro), and oriented towards the following two main objectives: iii. Stabilization of the financial situation, by reducing internal and external disequilibria, which were reflected in inflationary pressures, large budgetary deficits, excessive losses and indebtedness o f many enterprises, serious deterioration o f the financial situation o f the banking system, accumulation o f arrears in foreign payments, and difficulties inservicing the external debt; iv. Reform of the economic system, inorder to increase productivity, improve the allocation o f resources and create the conditions for a faster rate o f economic growth and equitable development inthe future. 28. The reforms ranged from budgetary discipline to rescheduling of the external debt and adjustmentsto the planning system. At the beginning of 1989, the authorities approved a "Program o f Economic Recovery" (Programa de RecuperaGlo Econdmica - PRE) oriented to the two main objectives o f starting the process o f 16 macroeconomic adjustment and o f promoting the rapid recovery o f production. The PRE initiated the implementation o f the economic reforms announced in the SEF, which included the following: (1) the reduction o f the budget deficit o f the state budget; (2) the adoption o f new solutions to finance the budget deficit; (3) the restructuring o f the financial situation of public enterprises; (4) the reform o f domestic credit policies; (5) the rescheduling of external debts; (6) adjustments o f controlled prices; and (7) adjustments inthe exchange rate. 29. On the structuralside, the reforms aimed at increasingthe role of the private sector and at graduallyreducingthe importanceof the state in the economy. Inwhat i s concerned with structural reforms to increase the efficiency o f the productive system, the SEF envisaged a more important role for the private sector, more autonomy for public enterprises, a revision o f the law on foreign investment and improvements inthe planning system. The SEF explicitly admittedthat smaller public enterprises should be transferred to the private sector and that state ownership should remain concentrated largely in key, enterprises with strategic roles. As regards improvements in the planning system, the SEF envisaged to achieve better coordination between the Annual Plans, the State Budget, and the Foreign Exchange Budget, and more decentralization o f planning activities from the Planning Ministryto the planning organizations at regional levels. Table 2.1: Macroeconomic Stabilization Programs Adopted between 1989 and 2000 1990 (May) I PAG- Programa de Acq8o do Governo 8 Program of Government Action 1991 PN Plano Nacional National Plan 12 1992 PN Plano Nacional National Plan -- -- 7 1993 PEE - Programa de Estabilizaqao Economica 3 Program of Economic Stabilization 1993 (March) PEG- Programade Emergencia do Governo a Program of Emergency of the Government 1994 PES Programa Economico e Social - 12 1997 1 PES - Proclrama Economico e Social I 12 I Economic and Social Program 1998-2000 IIPERE- Programa de Estabilizacao e Recuperacao Economica I 12 1999-2000 IIEstrategia Global para a Saida da Crise 15 Global Strategy to'Exit the Crisis Source: Alves da Rocha (2001), p. 64. 30. Despitethe appropriate focus, the reformsdid not yield the expected results. Government efforts to implement the SEF and the PRE proved unsuccessful and between 1989 and 2000 some 12 different macroeconomic stabilization programs were introduced 17 with equally frustrating results. On average, there were 1.2 programs per year and each o f the programs lasted for a period o f 10.6 months (see Table 2.1). The main obstacles to the lasting and effective stabilization o f the economy continued to be throughout this period the lack o f fiscal discipline, the excessive centralization in the planning system and the resultingbureaucratization o f the economy, and the inefficiency o f the state inpromoting the growth o f productivity. Fiscal deficits remained high during the 1990s making it difficult for the authorities to reduce inflation, the oil economy remained as the main source of revenues to the state without productive links with the other sectors of the economy, and the priorities of the war continued to condition government expenditures which focused primarily on consumption and military expenditures and neglected social and development spending (notably on health, education, and infrastructure). 31. In the context of failed stabilization attempts, Angola struggled for years with stop-go cycles of inflation and devaluation coupled with extremely low confidencein the domestic currency. As discussed above, a succession of failed or only partially successful stabilization plans marked the country's economic policy history since its first major attempts to stabilize in 1987. Duringthe period up to mid-1996, there were successive inflationary peaks that would be temporarily brought down by the adoption o f a plan, only to be followed by an even higher peak after some months (see Figure3.1). In 1997, there was a "structural break" on the inflation rate time series as the Government introduced the so-called "Nova Vida" Plan. Up untilthen, inflation was not only four digits, but also very volatile, due to continuous adoption of new (and unsuccessful) plans. With the "Nova Vida" Plan, and the introduction o f a fixed exchange rate (to the dollar), inflation was halted for a while, but crept up again in 1997 as it became clear that fiscal adjustment was again being postponed. However, since the introduction o f the "Nova Vida" Plan, the connection between dollarization (as measured by the share of foreign currency deposits to M2) and inflationbecame much closer. Figure 2.1: A Snapshot of Inflation and Dollarization 400% 350% 150% 100% 50% 0% : P W U 32. Responding to macroeconomic instability, the phenomenon of dollarization appeared as a result of financial adaptation in the economy. To a certain extent, dollarization can be seen as an endogenous process triggered by macroeconomic 18 instability, high inflation, and the resulting lack o f confidence in the domestic currency. Countries that display these characteristics can either facilitate financial adaptation when they allow residents to hold financial assets indexed to a foreign currency or to some other stable unit of account, or they can stifle the adaptation when they impose additional distortions that lead to financial disintermediation and capital flight. These are some o f the options governments have at their disposal to try to minimize the adverse effects of macroeconomic instability. They are all second-best, and they all entail costs. Theory and evidence suggests that the latter option i s probably the most costly and, in this sense, Angola i s on the right track. 33. More recently,the government's economic policy has yieldedpositiveresults, but sustainability will demand further reforms.As discussed inthe following section, with the implementation o f a more rigorous monetary policy, the restriction o f monetary financing o f the budget deficit since 2002, and the implementation o f an active exchange rate policy since September 2003, inflation has been significantly reduced. However, the outlook i s subject to significant risks, which must be addressed by government actions. Most importantly, in an uncertain environment for oil production and prices, public expenditure growth needs to be set in a medium-term context to avoid the boom and bust cycles that have undermined stability and development in other oil-producing countries. The following paragraphs highlight progress obtained so far and the tensions that will need to be managed to complete the transition to a market economy and to a viable democracy. 34. The economic outlook in Angola has been transformed by the peace agreement of 2002 and by positive developmentsin the oil sector. With the end o f violent conflict and the return of more than 4 million IDP to their original communities since 2002, agricultural production has picked up and the non-oil economy has shown signs o f a vigorous recovery in Angola. Although official and detailed data on the non- mineral economy i s scant, the lively and vibrant informal economy that i s now seen inthe streets o f Luanda i s a visible leading indicator o f strong economic performance. There have also been encouraging signs o f recovery in public services, construction, and infrastructure rehabilitation. Oil production, which currently accounts for 55% o f GDP i s expected to double to 2 million barrels per day by 2007. Largely as a result of increasing oil production combined with rising international oil prices, real GDP i s estimated to have grown by 20% in 2005, while the economy outside the mineral sectors is estimated to have grown at an annual rate o f roughly 10% over the last 3 years. Current projections indicate that GDP i s expected to grow by 15% inreal terms in 2006 and by 30% in 2007, one o f the highest growth rates inthe world. 19 Table 2.2: MacroeconomicFramework,2003 2007 - 2003 2004 2005 2006 2007 Est. Proj. Proj. (Percentage change, except where indicated) National income and prices Real GDP 3.3 11.2 20.6 14.6 30.2 Oil sector -2.2 13.1 26.0 15.0 40.9 Non-oil sector 10.3 9.0 14.1 13.8 13.7 GDP per capita (in US. dollars) 959 1,322 2,129 2,780 3,614 GNDl per capita (in US. dollars) 848 1,157 1,866 2,449 3,082 Consumer price index (annual average) 98 44 23 13 8 Consumer price index (endof period) 77 31 19 10 7 Money and credit (endof period) Net domestic assets 12 -97 -9 -102 -52 Broad money 21 67 50 60 43 29 M2 velocity (non-oil GDPlaverage M2) 3.35 3.55 3.33 2.92 2.65 Base Money in real terms (percentchange) -0.5 19.1 40.2 30.0 16.0 (Percentage of GDP, except where indicated) Fiscal accounts Total revenue 37.9 36.9 38.0 38.0 37.9 Of which : oil 27.9 28.4 30.1 30.0 30.5 grants 0.8 0.5 0.2 0.3 0.2 Total expenditures 44.3 38.5 31.2 35.7 32.5 Overall balance (accrual basis) -6.4 -1.6 6.8 2.2 5.4 Non-oil fiscal balance (accrual basis) -35.1 -30.4 -23.6 -28.0 -25.3 Overall balance (cash basis) -5.6 -3.7 6.0 1.6 3.1 External sector Current account balance (includingtransfers: deficit -) -5.1 3.5 12.9 8.8 12.4 Externaldebt (in billions of US.dollars) 10.2 10.8 12.6 15.0 16.3 External debt-to-GDP ratio 73.1 54.5 38.5 34.1 27.7 Debt service-to-net-exportratio 31 16.5 16.4 10.5 4.8 6.4 (In millions of US. dollars, except where indicated) Net internationalreserves (end of period) 41 790 2,023 4,140 9,252 13,920 Gross internationalreserves (end of period) 4/ 800 2,034 4,147 9,261 13,927 Memorandum items: Gross domestic product (in millions of US$) 13,956 19,800 32,810 44,103 59,019 Official exchange rate (kwanzas per US. dollar: end-of-period) 79.1 85.6 80.8 ... ... Gross domestic product (in billions of kwanzas) 1,041 1,652 2,860 3,539 4,839 Oil production (thousandsof barrels per day) 875 989 1,247 1,434 2,019 Price of Angola's oil (US. dollars per barrel) 28.2 36.4 50.1 56.6 57.4 Non-oil fiscal balancelGNDl -38.8 -34.3 -26.6 -31.5 -29.4 Sources: Angolan authorities and IMF and World Bank staff estimates and projections. '/ End of period. A positive sign denotes appreciation. "As percentage of beginning-of-periodM3. In % of exports net of oil-related expenses such as oil-related imp. of goods and services and oil companies' remittances. 4/ Includes governmentdeposits in overseas accounts. 35. The macroeconomicframework for 2006 and 2007 is highly favorable and accommodates significant changes on the revenue and spending sides. Table 2.2 presents a hypothetical scenario for the next two years on the basis of preliminary assumptions about economic growth, oil production, evolution o f world oil prices, and revenue capability. The figures are based on information as o f March 2006 and reflect the 20 macroeconomic framework agreed between the authorities and the Fundduring the 2006 Article IV consultations. In our estimates, total government revenues are expected to remain at a level close to 38% o f GDP until 2007. On the expenditure side, spending i s estimated to decline from 38.5% o f GDP in2004 to 35.7% o f GDP in2005. Inthe pursuit o f long-term fiscal sustainability, spending should gradually decline in 2006 and 2007 as a share o f GDP.14 Such gradual decline in public spending as a share o f GDP i s not politically unrealistic insofar as real GDP i s estimated to have grown by 20% in2005 and to grow by an average 24% in 2006-2007 supported by strong performance in the oil sector and steady recovery o f the non-oil economy. Figure 2.2: Progress in Macroeconomic Indicators Angola: Oil Production -Actual (2001-2004) and Angola: External Debt as a Share of GDP Projected (2005-07) 180, . . ... .. . ... ... .... .... ... . .. .. . . .... .... . " 'I 160 700 140 600 120 f 600 I 0 0 ap 8 400 80 = 8 so 3 300 40 200 20 I00 0 0 1998 1899 2000 2001 2002 2003 2004 2001 2002 2003 2004 2006 200% 2007 Angola: Non-Oil Fiscal Deficit as a Share of Non-Oil Angola: Twelve-Month Growth Rates of GDP Monetary Indicators I I ap F 1 r i M 3 IReserve Money 1 14 In the draft 2006 budget recently finalized by the Government, the authorities are projecting a fiscal deficit o f 6.9% o f GDP in 2006 and an annual inflation rate o f 10%. The fiscal numbers in our macroeconomic framework are different from those presented by the Government in the 2006 budget because our estimates use higher oil prices for 2006 ($56/barrel) than those used by the Government in their 2006 budget ($45/barrel). 21 36. There have been commendable successes towards macroeconomic stabilization,but there should be a stronger emphasis on the continuingdeficiencies in policy design and implementation. Figure 2.2 shows progress on a number o f macroeconomic variables since the year 2000, including oil production. The stabilization obtained so far, however, needs to be strengthened with improved coordination o f the fiscal policy with monetary and exchange rate policies. These policies need to spell out a consistent strategy to absorb the upcoming oil windfall without inhibiting growth outside the mineral sectors. To avoid the boom and bust that have undermined stability and development in some other oil-producing countries, new public spending in the future should be set in a medium-term context. In addition, the authorities should consider the adoption o f a monetary anchor, with the responsibilities for executing monetary policy defined for the Central Bank in order to guarantee a downward trend in inflation even in the face ofan external shock. These issues are discussed indepthinthe next Chapter. 37. The root cause of past inflationaryepisodes in Angola was the monetization of itsfiscal deficits.Angola's main source o f fiscal revenueis through the taxation of the oil sector, including the state-owned oil company Sonangol. As a result, fiscal revenues have been excessively vulnerable to international crude oil price volatility and have not always been able to keep pace with expenditures. The insufficient control o f public spending, including notably large extra budgetary expenditures and the sizeable operational deficit o f BNA, have induced large increases in base money. Additionally, in the past, favored interest groups, including Sonangol, have used arbitrage and other tactics to benefit from high inflation, for example, by delaying payments in domestic currency for oil and other sales received in hard currency." Until 2002, this combination o f affairs had actually created positive incentives for high inflation.l6 38. M o r e recently, government's efforts to reduceinflation have been successful. Between 1999 and the peace agreement o f 2002, annual 450 -` - consumer price inflation fell from 400 350 - around 300% to around 100% (see 300 - Figure 2.3). Following the adoption o f 250 - a stabilization program in September i 200 . 150 - 2003, inflation fell sharply again and --. 100. I by December 2004 the 12-month 50 - 0, , , 15A detailed discussionof public finance management issues can be found inthe Bank's PEMFAR report, published inFebruary2005 (see World Bank, 2005). l6 From a political economy point of view, a centralized economic system that functions based on controlling markets encourages the development of a wealthy elite which tends to create mechanisms to guarantee the appropriation of profits irrespective of exchange rate and price swings so they are largely indifferent to macroeconomic shocks and the need to stabilize the economy. In fact, the wealthy can lose from economic reform to the extent that competitive markets and transparent public finances shrink the scope for rent extraction. Some commentators argue that this was actually one of the reasons beyond the war situation that couldbe usedto explain why reform stalled through the 1990s(Aguilar, 2001). 22 inflation rate had declined to 31%. The improvement was largely due to the government's avoidance o f money creation for deficit finance purposes together with smaller fiscal deficits in 2003 and 2004 (that dropped from 6.5% o f GDP in 2003 to 1.5% o f GDP in 2004, on a commitment basis) and an estimated fiscal surplus o f 6.8% o f GDP in 2005. Since 2003, government spending has been increasingly funded with resources obtained through direct sales o f foreign exchange in excess o f $2 billion in 2003 and 2004, respectively, which has increased Angola's external liabilities.l7 The non-oil fiscal deficit as a share of non-oil GDP has also declined substantially since 2000 from around 130% to close to 63% in 2005. In 2005, the cumulative rate o f inflation dropped to 18.5% and the projection for 2006 i s of an annual rate o f 10%. 39. Monetary aggregates have been kept under control contributing to lower inflation. Inthe past, the Central Bank o f Angola traditionally accommodated unplanned, extra-budgetary expenditures and followed a practice o f monetizing the fiscal deficit. Such policy was responsible for rapid money supply growth and high inflation and has been discontinued in recent years, and this i s a welcome development. Since 2003, reduced reliance on the domestic banking sector to fund the public sector has contributed to a considerable fall in the growth rate o f the monetary aggregates. In the 2004 Article IV consultation, the IMF reported a substantial fall inreserve money growth from 160% inthe 12-monthperiod prior to September 2003 (thebeginningo f the Government's so- called "hard kwanza" stabilization policy) to 26% one year later, while the growth in broad money fell from 125% to 50%. In 2005, the situation remained encouraging with reserve money growing by less than 30% up to June while broad money expanded by 33% in the 12-month period up to September. The slow growth in reserve money can be attributed to net foreign currency intervention in this period, which exceeded US$1.2 billion, using proceeds from external borrowing and higher sales o f government securities." "A detaileddescription ofthe kinds and magnitudes of intervention in the foreign exchange market in Angola is available inthe 2004 Angola Economic Report published by the Center of Studies and Scientific Investigation of the Catholic University of Angola - see CEIC (2004). l8Additionally, the IMF reports strengtheningof domestic open market operations from July 2003 through the introduction of treasury bills with maturities of between 28 and 182 days. Longer-term bonds (2 to 7 years) were also issued to clear arrears to domestic suppliers. With the deepening of the domestic debt market, commercial banks developed new instruments, including repurchase agreements and bankers' acceptances whose holdings are included inbroad money (M3) which is dominated by deposits in foreign currency. 23 Figure2.4: ForeignExchange Interventions Angola: Sales of Foreign Exchange, 2000 2005 - 350.000 300.000 250.000 200.000 150,000 100.000 50.000 0.000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec [2000 EZOOI 02002 ~12003m2004 m20051 Source: National Bank o f Angola. 40. There are clearly beneficial consequences associated with the current policy to combat inflation. First, removal o f excess liquidity from circulation reduces the inflationary pressures deriving from money expansion permitting a decline in the rate o f inflation. Second, the use o f foreign exchange for the purpose o f mopping up liquidity contributes to stabilize the exchange rate. Third, keeping the exchange rate stable implies in a corresponding constancy in the prices o f imported goods, eliminating inflationary pressures from this source. Finally, avoiding a policy that requires an immediate fiscal adjustment in favor o f one which yields price stability while postponing cuts in expenditures generates an immediate and visible success in economic management. These effects combined may help the government to build the necessary political capital for the future, when expenditures will invariably have to be cut down. 41. The continuity of such policy, however, must be weighed against the costs of keeping it unchanged. The authorities have managed to bring inflation down in Angola without having to promote an upfront fiscal adjustment, but the international experience reveals that it i s questionable whether this kind o f policy i s sustainable without stronger efforts towards a balanced fiscal budget. The main factor that distinguishes success from failure in a sample o f countries which have adopted similar price stabilization attempts i s the extent to which governments pursued fiscal contraction in support o f their stabilization efforts (see Table 2.3). Countries that did not reduce expenditures, as for example Argentina, Brazil, and Mexico, ended their stabilization attempts with renewed inflation, low confidence in the local currency, and severe drawbacks to investment and 24 gr~wth.'~ the current juncture, in which massive oil windfall revenues are likely to At accumulate in a relatively short period o f time (see next Chapter), the authorities should consider the adoption o f a policy mix that allows for a conservative increase in government spending without sacrificing fiscal discipline. This would require complementing the current anti-inflation policy with the setting up o f a medium-term fiscal framework that could yield a balanced budget and that could incorporate the spending needs to repay the peace dividend to the Angolan people in line with the expected increase in oil revenues. The costs o f doing otherwise could be too highto bear. Israel Jun 85 - Sept 86 Fixed,Crawling Peg 1128.9 50.1 Yes Brazil Feb86 - Nov 86 Fixed 286.0 76.2 No Mexico Dec 87 - Dec 94 Fixed,Crawling Peg 159.0 6,7 No Peru Aug 90- Dec 99 Monetary anchorldirty float 12378.0 10.2 Yes DominicanRep. Aug 90 - Dec99 ER unification andfloating 60.0 2.5 Yes Argentina Apr 91 - Dec 01 Currency Board 267.0 -0.3 No Source: Gasha and Pastor (2004). 42. Achieving sustainable inflationary stability i s also essential to harness the growth of the non-oil economy. It i s a well established fact that the inflation component o f market-oriented reform policies should be expected to be growth-enhancing. In the case of Angola, this i s particularly relevant for the non-oil economy, given the insulation o f the oil-economy due to its enclave nature. This i s so because highrates o f inflation can be expected to reduce economic growth through a variety o f mechanisms which can influence both the rate of capital accumulation and the rate o f growth of total factor productivity. One o f such mechanisms i s that high inflation means unstable inflation and volatile relative prices, which reduces the information content o f price signals and distorts the efficiency o f resource allocation thus harming the growth o f total factor productivity over extendedperiods. Furthermore, governments that tolerate highinflation have lost macroeconomic control, and this circumstance i s likely to deter domestic investment inphysical capital.20 19 Calvo and Vegh (1999) argue that lasting stabilization programs are characterized by a significant fiscal adjustment, independently o f the monetary arrangements. AgCnor and Montiel (1999) review a variety o f stabilization attempts in several countries and point to the need to a permanent fiscal adjustment in any serious disinflation program. 2o Barro (1997) presents cross-country evidence on the negative relationship between inflation and growth for a sample o f 100 countries with annual observations on macroeconomic data for the period 1960-90. His central finding is that, other things equal, a 10% increase inthe rate o f inflation reduces long-run growth by about 0.025% per year. 25 43. Beyond the fiscal sphere, there are important Figure 2.5: Tradable and Nontradable Inflation Rates concerns associated with the - virtual stabilization o f the Inflation Rates, January 2003 July 2005 (Annual percentage change) nominal exchange rate that the current policy has generated. 40 As noted above, exchange rate stability may be seen as a beneficial consequence o f this policy by working as a major factor limiting price increases o f tradable goods. However, the growth o f the monetary aggregates in Angola, while slowing, has been faster than would be consistent with the 0 4 , , , , , . . . . . . . . . . . . . . . . . . . . . . . . achievement o f the inflation objective, with the consequence that the real exchange rate has appreciated significantly. The implication o f this is that the policy has been much less effective in reducing the inflation o f the non-tradables (see Figure 2.5). In addition, the scaling up o f public spending is likely to exert pressure on the domestic price level. To counter that effect and keep the declining trend in inflation, the authorities should resort to both sales of foreign currency and new issues of government bonds to help mop up excess liquidity. Inthis context, an appreciation o f the nominal exchange rate should be not be resisted as it will contribute to reduce inflation. 44. The external outlook i s positive as a result of rising international oil prices and domestic oil production. The external accounts have moved into a significant surplus in 2005 (12.9% o f GDP) after a widening o f the current account deficit in 2003 (5.1% o f GDP) which was attributed to higher imports o f goods and services related to investments in the oil sector. Despite substantial interventions in the foreign exchange market, the monetary authorities were able to increase its gross official reserves from US$400 million in 2002 to US$4.1 billion in 2005, which i s sufficient to pay for 6 months of non-oil imports (see Figure2.6). The authorities estimate that in2006 the level o f their net international reserves will increase to some US$9 billion level. At the same time, Angola's external debt as a share o f GDP has been declining since the late 1990s because o f a strong growth rate in the economy's oil production value. In monetary terms, the country's external debt increased from US$8.7 billion in 2002 (more than 60% o f GDP) to US$12.6 billion in 2005 (38.5% o f GDP). The external debt-over-GDP ratio i s expected to decline to 34% in2006 given the expected rapid growth in GDP. 26 Figure2.6: Angola Gross International Reserves - 4,000 - - 3,500 - - 3,000 - - US$ Mlllior 2,500 - - 2,000 - - 1,500 - 1,000 - - 500 - - 0 - - 1998 1999 2000 2001 2002 2003 2004 2005 Source: National Bank of Angola. 45. Angola still has to overcome tensions that are inherent to a country which is in transition. Entrenched interests undermine structural reforms in several areas which are considered key to a stronger involvement o f the international community in the reconstructionprocess (OECD, 2005). This tension betweenthe government and the IFIs actually reflects an inner issue inAngola that i s rooted ina non-transparent conflict inside the ruling MPLA betweenthe so-called reformers, who seem to favor a stronger market- oriented approach in the management o f the economy, and the so-called non-reformers, who seem to place a higher value to the role o f the state in paving the way for the country's economic development. In order to embark on a long-term sustainable development path, Angola will need to manage these differing views and other tensions associated with conflicting interests arising between the coast versus the interior o f the country, rural areas versus urban areas, Dutch-disease related phenomena (notably real exchange rate appreciation), and the normal tensions that accompany the transition from a centralized political systemto a muti-party democracy. 46. Although there may be ample room for public expenditure increases in Angola, capacity constraintsand concerns associated with the paradox of plentycall for prudence in defining the public expenditure envelope for the next years. While the consensus interms of the role ofthe state inthe economy is not settled, policy makers will continue to face the difficulties associated with maintaining macroeconomic stability 27 inthe presence o f large, petroleum-related foreign exchange inflows. The mainproblems resulting from a large and volatile oil windfall are discussed indetail inthe next Chapter but are typically manifested in excessive real appreciation o f the exchange rate and a structural shift toward non-tradable sectors. In the context o f low absorptive capacity, rapid spending o f the oil windfall may also leadto a "waste" o f petroleum wealth through unproductive public expenditure. There is always the risk that rapid spending may lead to a rent-seekingbehavior to garner the windfall, and this may occur in an environment that i s weak institutionally and i s thus less able to filter out all o f the requests.21 All o f these issues are relevant for Angola and a solution to these problems will require an accelerated pace to structural reforms in the areas o f governance, private sector development, and human capital formation, without which larger public spending may not yield the expected outcomes. 47. The solutions while straightforward in principle are Figure 2.7: Association between Resource Concentration and Conflict politically complicated. Ample empirical evidence has shown that natural resource dependence is particularly problematic, since it i s 30 30% easily captured by the ruling elite, removing the incentive for the government to actively engage its citizenry. This destroys both the capacity and the legitimacy o f the state, exacerbating social divisions and even leading to direct conflict 10 over the resource itself. Research at the World Bank and elsewhere points to resource dependence as one ct o f the most important causes o f civil wars (see Figure 2.7). 22 But while an increase in oil revenues increases rent-seeking behavior and gives Source: Bannonand Collier (2003) governments an excuse to delay - reform, it also allows reform-minded governments to implement changes. When oil prices are high, resource constraints get relaxed, allowing governments to pay o f f debt or invest in infrastructure and the social sectors-provided fiscal institutions and the commitment to reform are strong. Angola has now a real opportunity to use its oil wealth to mitigate tensions and put the economy on a path o f sustainable development. ~~ '' 21 For example, McMahon (1997), cited in Sarraf and Jiwanji (2001), provides examples of excessive investment in the under-developednon-traded sector during resource booms, due in part to political ressureto prop up ailing industries. Violent secessionistmovementscan often be tracedto oil. Examplesinclude Aceh inIndonesia,Biafrain Nigeria, conflicts inSudan, Chad, Congo Brazzaville, andinAngola itself(see Busbyet. al., 2002). 28 48. Diversification of the economy outside the mineral sectors and equitable development will require the reconnection of the interior of the country to the coastal areas. Inany part o f the world, including Angola, those who control coastal areas andor ports exercise a degree o f control over interior landlocked areas by virtue o f their ability to control or charge for access to outside markets. There i s a real economic foundation for this: whoever controls access to outside markets can charge a price for the privilege.23The same logic applies to landlocked areas within a country, particularly when the country in question i s composed of provinces which have some degree of de facto autonomy, or the central government apparatus uses control o f ports to generate revenuefor its own use. This is no different inAngola than it i s elsewhere, with the major ports o f Luanda and Lobito/Benguela playing the most important role, but also to some extent the lesser ports o f Namibe, Port0 Amboim, Ambriz and others. In colonial times as well as more recently, the central government (be it Portuguese or Angolan) has explicitly and implicitly taxed both agricultural exports (particularly coffee through the government marketing board) and imports through tariffs and import quotas. In order to diversify the economy outside the mineral sectors, the authorities need to create incentives for domestic production enhancement (such as incentives for irrigation, demining, agricultural research, and the strengthening o f smallholder agriculture) and invest in infrastructure to reconnect the interior to the coast and thus make the main markets accessible to the poorest. 49. Infrastructure reconstruction in the cities will need to be done in tandem with the strengthening of the agricultural sector. Even in countries where the alignment o f coast with citieshndustries and interior with agriculture does not exist one can observe a similar type o f tension between agricultural interests versus urbadindustrial ones by virtue o f the fact that what one party buys, the other one sells and vice versa. InAngola, the coast i s not only a gatekeeper, but it i s also the location o f the major urbadindustrial centers, particularly Luanda, while the interior is also the location o f the most productive agricultural areas, particularly the central planalto where the principal grain supplies o f the country are (or could potentially be) grown.24 The observation that the principal geographical location o f agricultural comparative advantage lies in the interior has a very important corollary: in order to maximize the return to this comparative advantage it will be necessary to invest in this area. These investment needs have the potential to be contentious since at first blush the money would be going to one area o f the country seemingly at the expense o f other zones. However, the experience o f many other countries has demonstrated that to attempt to pursue industrialization without investing in increased agricultural productivity is a self limiting strategy. A possible way of preempting such type of conflict could be through the adoption o f a spatial approach for economic development that would link coastal 23The importance o f free access to a port has been shown empirically by Bloom and Sachs (1998) who analyzed the growth records o f Sub-Saharan African countries and found that geographical access to a port was a significant determinant of growth prospects. 24 Iti s from this area that pre-independence grain export surpluses were taken, and where most o f agricultural GDP originates (see Kyle, 1997, and World Bank, 1994). 29 areas with promising areas in the interior o f the count$'. The World Bank could help the authorities to identify these areas and develop further a spatial approach for economic development inAngola. 50. The authoritieswill need to act firmly to preempt rent-seeking. The Angolan authorities need to be aware o f and take serious actions to combat a very common problem associated with the so-called resource curse that i s materialized inthe propensity o f mineral (and especially oil) dependent economies to develop problems o f rent seeking and corruption.26 The argument i s that the existence o f oil income results in a scramble for these rents rather than efforts to engage in more productive activities. In addition, these effects can cause institutions to become weak, which will itself have a detrimental effect on In the case of Angola, where already fragile institutions became weaker because o f a prolonged civil war, it i s extremelyimportant to improve governance to avoid corruption and waste. Specific recommendations on that area are offered in the next two Chapters. 51. Successful management of mineral income will require improvements in institutions.Inwhat concerns the handling of oil windfall revenues, the case o f Nigeria offers a cautionary example. The recent experience o f Nigeria i s perhaps the most directly relevant to the Angolan case as corruption and institutional weakness have been found to have a more important effect on the economy than has distortion o f the real exchange rate. Recent empirical evidence suggests that even though Nigeria invested a large proportion o f their windfall, the weakness o f their institutions resulted in "bad" investments with very low returns.28 52. The exchange rate is likely to appreciate in real terms and the problems associated with this appreciation will have to be dealt with. Given the size of the windfall revenues to be accumulated over the next few years in Angola, which can reach up to US$266 billion innet present value, the authorities will have very little margin of maneuver to manage the exchange rate, which i s expected to appreciate inreal terms. An overvalued real exchange rate creates disincentives for domestic production as it reduces the competitiveness of domestic goods vis ci vis imported ones. In the case o f Angola, where there is an urgent needto diversify the economy away from the mineral sectors to create employment and reduce poverty, the authorities will have to deal with this issue 2sMellor (1995) argues that the contribution o f agriculture to economic development takes place through (i)apre-conditioning stage, whenimprovedinfrastructurecombineswiththestrengtheningofmarketsto encourage technological change that triggers expanding productivity; and (ii)a follow-up stage where agriculture plays a decisively constructive role in supporting the structural change o f the economy. Furthermore, Mellor notes that where a sound macro policy is combined with effective institutions and an improved transportation system (so that crop specialization for trade becomes possible) then the steady diffusion o f technology can sustain an agricultural growth rate o f 4-6% per annum. Based on data for fourteen Asian countries during 1960-86, Mellor (1995) calculates the agricultural multiplier at 1.5 that implies that agricultural growth can drive GDP growth rates to 7.5% per annum. 26See for example, Mauro (1995), Leite and Weidmann (1999). "Ishametal.(2004) find such a relationship ina cross section o fcountries. 28 See, for example, Sala-i-Martin and Subramanian (2003) o n the case o f Nigeria. 30 diligently. Some of the policy options available involve (i) creation o f a short-term the strategy to absorb the windfall, which has to be respected by both the budgetary authorities and the central bank; (ii)an improvement in the coordination between the fiscal policy and the exchange rate policy; and (iii) adoption o f prudent fiscal policies the to complement the windfall absorption strategy. These are issues that are discussed in depthinthe next Chapter. 53. Angola has started a welcome transitionto a multi-party democracy.The last Presidential elections in Angola were held in September 1992 with inconclusive results that led to the resurgence o f armed conflicts. A government o f national unity was formed in April 1997, comprising the ruling MPLA, UNITA and four other opposition parties. Since then, the Government has been structured around a strong presidentialist regime which i s supported by the MPLA. In August 2004, a 14-point timetable was established to guide preparations for the next electoral process, which included elections for the National Assembly in 2006 and for the Presidency in 2007. This timetable provided for the preparation and adoption o f a new constitution and an electoral law, as well as the appointment of members o f the National Electoral Council in2005. The exact date o f the elections will be determinedby the President and the candidates must be approvedby the Supreme Court. An Interministerial Committee for the preparation o f elections was established in January 2005, but so far the dates o f the two polls have not yet been publicly announced. 54. Old ethnic tensions remain as a latent source of concern.UNITA is grouped around the Ovimbundu ethnic group that comprises 37% o f the population and has traditionally practiced agriculture on the relatively fertile central west planalto, around Huambo. Duringthe civil war this faction used diamond rents to fund its campaign. The end of the civil war saw the collapse o f UNITA, which left its coastal rival, the MPLA in control o f the Luanda oil enclave within a war-ravaged rural economy. The victorious MPLA's main support i s the coastal Mbundu ethnic group, which comprises one-quarter o f the Angolan population (FA0 2004b, 12). Inthe 1992 elections, the M P L A carried its coastal heartland provinces and some provinces in which the Mbundu were in the minority (Kyle, 2002). In contrast, UNITA carried its planalto heartland provinces but few provinces where the Ovimbundu were in a minority. In the absence o f a unifying development plan to integrate the country and develop the interior, tensions between the two main political parties are not likely to decrease without political dissent. The strengthening o f democracy in the country should contribute to reduce both ethnic and social tensions that remain latent as post-conflict wounds inAngola. 55. Some form of politicalaccommodationwill be required to maintain a viable democracy. Entirely apart from ideological or geopolitical concerns, the political issues inherent in the transition to a multi-party democracy are fundamental to any long term view o f the Angolan political situation. A core issue is the need for maintaining a viable democracy in a situation where the two main parties have such a strong regional base. In the next elections, any victory at the national level by one side or the other must be carefully managed to avoid it being seen by the loser as a "conquest" as much as an 31 electoral Inthis context, a possible recipe for longterm political accommodation in Angola involves some sort of federalism, where a great deal of power is devolved to the provincial level. Although constraints associated with the lack o f institutional capacity to implement a fully fledged fiscal decentralization program are non-negligible in Angola, the government should learn with the experience o f the sub-programs supported by the FAS project and set up a plan to gradually expand its reach and its scope as a way to cede budgetary authority to lower levels o f government. This was actually one o f the objectives of the SEF program discussed earlier, and which has not yet been institutionalizedinAngola. 56. While there are huge challenges to achieving the objectives of a peaceful and sustainable recovery of the Angolan economy, there are also options available to accomplish them. It i s often said that Angola i s a resource-rich but policy poor country. As discussed in the very next Chapter, the Angolans, as a nation, are about to become evenricher. But will the oil and diamond wealth be usedwisely to heal the wounds o fthe war, to help rescuing many trapped by poverty and to pave the way to shared and inclusive growth? This report addresses a number o f issues that should be the object o f thorough reflection by the Angolans in their quest for a peaceful reconstruction anchored on broad-based and equitable economic growth. The following Chapters will help to show the way toward the path o f prosperity based on the understanding on how the Angolan economy has gotten to where it i s today with the hope that this understanding will expose the way forward. After an analysis of the options available regarding the management o f the oil windfall, the report takes a closer look at the microeconomic underpinnings of shared growth in Angola by addressing private sector development constraints and opportunities, the potential o f the diamond and agricultural sectors in the near future, andhow to improve the welfare o f the poor. 29 Empirical research suggests that, on average, there is an improvement in growth performance once stable democracy is established in a country. Furthermore, growth under democratic regimes tends to be much more stable than under authoritarians regimes. Stronger democratic institutions tend to restrain corruption and this has the effect o f stimulating technological change and hence economic growth (see, Rivera-Batiz, 2003, and Shen, 2002). 32 111. OILWEALTH: POLICYOPTIONSTO MANAGE THE WINDFALL The Angolan economy will experience a massive windfall with a concomitant fiscal gain during the second half of this decade and throughout the next decade. Thefiscal gain, however, is a result of the exploration of the country's oil reserves. Long-term sustainability requires that part of the resource rents be reinvested productively, to compensate for this reduction in natural resource capital by the accumulation of other forms of assets. Since oil rents are to a large part concentrated in the public sector, the question of how the oil revenue should be spent and distributed across present and future generations becomes key to any economic development strategy. This Chapter deals with this question, discusses governance and transparency issues in the oil sector, estimates optimal levels of consumption and investment under different production and oil price scenarios, and offers policy options for managing the oil windfall revenues. 57. The governmentbecame directly involvedin oil productionin Angola in the 1970s with the creation of a national oil companythat i s now a major operator and the sole concessionairefor exploration and production. Oil began to be explored in Angola in the mid 1950s in the onshore Kwanza Basin while the main expansion of the upstream (exploration and production) industry occurred inthe 1960swhen Cabinda Gulf Oil Company (CABOG), now ChevronTexaco, discovered oil offshore the Angolan enclave of Cabinda. In 1973, oil became Angola's principal export. The government became directly involved in oil exploration in the mid 1970s when, in 1976, Sonangol, the national oil company, was created to manage the oil industry on behalf o f the government. In 1978, Sonangol acquired a 51% interest in Cabinda and in all onshore concessions and was made sole concessionaire for exploration and production, although operatorship remained with the international companies. In the 1990s, Sonangol invited bids for exploration licenses in deep water (over 200 meters), where there have been several major oil finds in recent years, and subsequently licensed a number o f ultra- deepwater blocks. 58. Angola is now a well-established petroleum producer, with an enviable record of explorationsuccess and associated rapid reserve and production growth, and significant remaining petroleumpotential. Most of the premier international oil companies have acquired interests in Angola, including ChevronTexaco, ExxonMobil, British Petroleum (BP), Total, Shell, and Agip. New entrants include some smaller companies, such as Devon, CNR, and ROC. Other possible new entrants include the Chinese oil companies. Proven reserves, currently estimated at 8.8 billion barrels, have 33 quadrupled in the 10 years from 1995 to 2005, with the promise o f more to come, depending on the level o f exploration activity. Angola currently holds 0.75 YOo f world reserves, or 1.9% of reserves outside the Middle East, and i s Sub-Saharan Africa's second largest oil producer after Nigeria currently producing 1.3 MBD, an increase o f 70% over 2000 production levels. Production i s expected to increase by another 90 % to 2.6 MBD over the next five years. Overall, production will have increased by 225 % between 2000 and 2010 (see Figures 3.1 and 3.2). Figure3.1: Oil Reserves:Selected Countries World proved oil reserves (Year end 2004) Nigeria 35 26 United States China Canada Mexico $80 Brazil Noway Angola Azerbaijan Sudan India Ecuador Indonesia United Kingdom Malaysia 5 00 1000 15 00 20 00 25 00 30 00 35 00 40 00 Billion barrels Figure3.2: Angolan Oil Production 3,000 2,500 2,000 1,500 1,000 500 34 35 deepwater blocks where costs, as Table 3.1 suggests, are significant. Even if the pace o f new licensing were not to slow exploration and development activity, these considerations might. 61. In addition to oil, Angola has substantial natural gas reserves. Current estimates suggest that natural gas reserves in Angola total 1.6 trillion cubic feet (TCF). New discoveries could push Angolan proven reserves to 10 TCF and possibly as high as 25 TCF. Approximately 85% o f the natural gas produced in Angola is produced in conjunction with oil, and i s flared into the atmosphere. The remainder i s re-injected into the producing reservoir to aid oil recovery, and/or processed into liquefied petroleum products. ChevronTexaco, Sonangol, and other international petroleum companies in Angola are developing a project to convert natural gas from offshore oil fields into liquefied natural gas (LNG) for international markets. The LNG facility will be located at Soyo and should add more than US$1 billion a year to exports by the end o f the decade. Table 3.1: Unit Cost ComDarisonsfor Selected Countries Deep Water Exploration Costs Angola Deep 3.43 2.79 Brazil Deep 2.96 3.71 Nigeria Deep 2.69 2.56 Norway Deep 2.64 6.12 USA (Gulf) Deep 3.14 2.71 Equatorial Guinea Deep/Shallow 4.13 2.84 Shallow Water Exploration Costs Angola Shallow 4.05 4.60 Brazil Shallow 2.51 3.45 Congo Shallow 4.42 3.64 Malaysia Shallow 1.27 1.47 Nigeria Shallow 2.70 2.03 Figure 3.3: Total Costs for Selected Project 7,000.00 6,000.00 L - clOperatingcosts 5,000.00 5-4,000.00 8 3,000.00 'E 3 2,000.00 1,000.00 36 37 sharing scales may differ among contracts within the same vintage. The PIT also differs between concession agreements and PSAs. The cost and complexity o f administering such a regime can be very burdensome. A significant level of skilled resources is required to administer the regime effectively. The fact that each PSA is negotiated individually i s time consuming and costly. The burden o f fiscal administration falls primarily on Sonangol and the regulating ministries-the Ministry of Petroleum and the Ministry of Finance. Measures to ensure adequate institutional capacity in this area deserve to be assigned very high priority. With an estimated $15 billion in fiscal revenues due in2005 alone, effective fiscal administration i s critical. Figure 3.4: Comparisonof Government Take in Selected Countries 100% I 80% 60% 40% 20% 0Yo 64. The structure of fiscal terms appears to create incentives in favor of contractors, but it also implies in the concentration of cost recovery, which can result in lower annual rates of government take over time. The structure o f fiscal terms described in Table 3.2 implies that the production allowances, investment uplifts, and generous cost recovery provisions, will tend to "front-load" cash flow in favor of the contractor. This i s desirable in so far as it provides an incentive to the contractor to invest by reducing perceived risks and protecting marginal projects against the very high marginal rates o f take that apply. At the same time, such terms create a need to manage expectations in those situations where a "bunching" o f cost recovery in the sector may result in annual rates o f government take that appear low relative to when full cycle 38 calculations o f take would show. When production sharing i s based on cumulative production, as it i s for the early PSAs, this can create disincentives to investment in often important rehabilitation or secondary recovery projects late in a field's life. Under the cumulative production formula, the contractor may at this point have passed the highest production threshold and be facing the highest rate o f government take. Furthermore, the exclusion o f exploration costs from fiscal ring fencing provisions i s attractive as an incentive to explore, but it limits that incentive, i.e., early tax write-off o f exploration expenses, to those companies that are already "players" in the sector, namely those with already established production income. Table 3.2: Fiscal Terms for Petroleum Exdoration Contracts in Anaola 20 % royalty. A negotiable signature bonus. The cost recovery allowance A Petroleum Transactions Tax Early payments were relatively has been increased to 55 % in (PTT) charged at a 70 % rate on modest (less than $10 million). particularly deepwater. income subject to the Petroleum A provision for early recovery of Signature bonuses vary widely. Income Tax (PIT), except with cost or cost oil up to a ceiling of Early deepwater blocks no deduction for either royalty or 50 % of the value of gross attracted relatively modest ($20 interest paymen1. Two production. Recoverable costs million) bonuses, while highly additional items are, however, include an uplift on capital prospective deepwater blocks deductible (a) a petroleum expenditures of 33 % to 40 %. awarded later have attracted allowance of $4.00 per barrel in Sharing of remaining production, bonuses in excess of $200 1982, escalated annually at 7 %; or profit oil, between the million. Bonuses are neither and (b) an investment Government and contractor as a cost recoverable nor deductible allowance, or uplift, or 50 % on function of cumulative for PIT purposes. capital invested. Both of these production. The negotiable Profit oil is shared between the allowances are deducted once share typically varied between Government and contractor as a the contractor has achieved a an initial 40 % to the function of the contractor's threshold rate of return (23 %). Government, increasing to 90 % achieved after-tax rate of return. PIT at a rate of 65.75 % on final over 100 million barrels of In a typical PSA, the profit after deduction of all costs, production. Government share increased in including royalty, interest, and A price cap set at $20 per barrel tranches from 25 % at a PIT. in 1984 and escalated with contractor return of less than 15 Production areas are ring- inflation above which all revenue %, to 90 % where the contractor fenced for tax purposes, Le., goes to the Government. return exceeds 40 %. costs incurred with respect to PIT at a rate of 50 % applied to one development cannot be the contractors profit oil after offset against taxable income deduction of the price-cap fee. from another area, with the Ring fencing of fields for cost exception of exploration costs. recovery and PIT purposes, except for exploration costs, which can be consolidated within a block. An uplift on capital expenditures of 40 % for cost recovery DurDoses. 30Slightly different terms apply to different areas within the concession, and to the onshore Congo and Kwanze concessions. 39 65. Current roles in fiscal administration are shared by the Ministry of Finance, the Ministry of Petroleum, and Sonangol. Their individual roles can be briefly described as follows: Ministry of Finance (MOF). The DNI (National Tax Inspectorate) in the MOF is responsible for the assessment and collection o f royalties and taxes. The office i s very small (three to four professionals) and while it does a good job given its resources, it must rely heavily on outside auditors in performance o f its assessment function. The DNI engages qualified international auditors through international competitive tender every three to four years. Current auditors are Deloitte Touche. Estimated taxes are paid monthly, 30 days after the end o f the month in question. Once the annual audit i s complete, a final adjustment i s made for any over- or under- payment inMarch following the end o f the tax year. DNIi s responsible for recording all tax transactions and regularly publishes tax assessments in considerable detail on its web site (www.minfin.gv.ao). Details o f the petroleum tax cycle and procedures are shown inBox 3.3. Ministry of Petroleum(MOP). The MOP is responsible for determiningthe prices to be used for fiscal purposes. Procedures are set out in each concession decree. Contractors provide price information on their own transactions to the MOP. On the basis o f these submissions, the MOP determines a market price (MOP) for the period (quarter) in question. In the event o f disagreement, the Concession Decree provides for recourse to an independent expert opinion, which the minister must take into account in making a final decision. The system i s generally regarded as working well, resultinginprices reflective o f arm's lengthmarket prices. Sonangol. As concessionaire, Sonangol oversees taxpayer cost recovery claims, engaging qualified external auditors to do this, much as the DNIcontracts out its tax assessment functions. At the moment, cost audits are conducted by Ernst and Young (others are engaged where conflict o f interest situations arise). As concessionaire, Sonangol i s also responsible for determining profit oil due to the government, for its marketing on behalf o f the State and for payment o f the proceeds thereof to the M O F (see Table 3.3). Table 3.3: SonaneolTax andProfit OilLiabilitiesto the Government of Angola 2000: 1190 2001: 721 2002: 642 2003: 821 2004: 994 Source: Sonangol's own assessment as reported by the IMF. Includes upstream activities only. 40 le roles vis & t i v the Gov 42 national oil company by Government include: a) supply o f petroleum products to the internal market at subsidized prices; b) product deliveries below cost to public services (military, hospitals, etc.) and in remote areas; c) management and servicing of public debt; d) the performance o f various sector regulator roles; and e) marketing o f the Government's share o f crude oil accruing to Government under PSAs. This gives the company a largely independent role in the economy which could be justified in a war period, but not inthe context o f peace. 68. This complicated relationship between the Government and Sonangol has resulted in payment arrears to the Government and in the appearance of a dual spending system. At the same time that Sonangol performs all o f the operations described above, it i s also subject to the taxes and other payment obligations, including production shares, as any other oil company in Angola. Sonangol's record, however, i s one o f underpayment o f taxes and substantial arrears to the Government. This i s because the company is often not reimbursedfor the cost o f carrying out these tasks and, inlieu o f reimbursement, the company has offset or claimed credit against its tax liabilities by the amount of such costs. The practice has resultedin a dual spending system associated with the spending executed by Sonangol and by the National Treasury.31Inan ideal situation, Sonangol should have to transfer to Government what it owes to Government, and the Government would be the one responsible for undertaking many o f the quasi-fiscal expenditureswhich are currently performedby Sonangol. 69. Independently of how organized these non-conventional mechanisms have become, they violate the existing financial legislation. While during 2002 the compensation process described above seemed to be rather haphazard, since 2003 it has become more organized and predictable. This in itself presents the additional danger o f creating an artificial "functionality" that could lead to the perpetuation of a mechanism that violates basic legislation and ultimately weakens the Ministry o f Finance as the chief fiscal institution in Angola. In addition, the existence o f a significant amount o f expenditures which are not timely recorded according to the current procedures followed by other spending units in the government weakens the budgetary process and creates uncertainty as regards the actual fiscal stance o f the Government. It also weakens transparency and accountability, and impairs planning. 70. More needs to be done to phase out the dualspendingsystem. Although there have been initiatives to add transparency in the relations between Sonangol and the Government, the current procedures have several disadvantages, in addition to that o f recording fiscal activities outside the budget where they belong: a) as affirmed above, it i s not transparent; b) it leads to frequent disputes; and c) it misrepresents Sonangol's position on taxes. The GOAi s now moving to reflect quasi-fiscal activities in the budget, and Sonangol i s taking steps in its external audit to identify and audit all such activities undertaken on behalf o f the Government with a view to resolving tax disputes as well as clarifying the financial results for its core activities. Both o f these measures are welcome. 31 A detailed assessment o f this offsetting mechanism is described in the World Bank's PEMFAR report publishedinFebruary2005. 43 However, the offsetting mechanism i s still very much a current practice and concrete efforts to phase it out have yet to materialize. 71. Sonangol can contribute more effectively to the development of the country by focusing on its own business. It is a recognized fact that the activities performedby Sonangolon behalf o f the government create an additional administrative and operational burdenon the company. Ifthese were relinquishedand Sonangol focused exclusively on its own business, the company could contribute even more to the development o f the country. A few examples o f areas where the increased intervention o f Sonangol could make a difference include: (a) investments to increase fuel storage capabilities; (b) investments to improve fuel distribution to the interior o f the country; (c) training o f Angolan labor force to work inthe IOCs; and (d) investmentsinsocial projects. 72. There has been some progress in improvinggovernance and transparencyin the petroleumsector since 2002. A number of recommendations made by the Bank and the Fund, both inthe Oil Diagnostic Study and in the PEMFAR, have been adopted and these are summarizedbelow. k The government has been regularly publishing details of oil payments received (by block, by type o fpayment, with annual summaries by company) on the Ministry o f Finance website, with a lag o f 6 months. This level o f publisheddetail is virtually unique among oil producing countries. k The audits of the petroleum sector have been conducted on a regular basis. The financial statements o f companies in the Sonangol group were audited comprehensively for the first time, by Ernst & Young, in 2003, with only minor audit qualifications o f exploration and production operations (where most o f the money is). The less important downstream operations did, however, attract numerous audit qualifications, but Sonangol has invited Accenture to help clean up irregularities. The auditors' reports, however, have yet to bepublished. k Recent audits have followed acceptable accounting rules. The audits mentioned above applied Angola's recently issued accounting legislation where appropriate, and IAS rules where the new legislation does not apply. The new audit legislation i s already regarded as a major step towards IAS accounting. By end-2006 Sonangol expects to have moved fully to IAS standards. The 2004 audit was recently completed. k The rollout oftheIFMS(SIGFE)isprogressingsteadily.Progress towards the implementation and full roll out of the Angolan IFMS (Integrated Financial Management System) has been steady and currently most o f the expenditureside o f the government accounts is registeredinthe system.There are delays associated with the inclusion o f all revenues in the system, but the Ministry of Finance has a clear plan to address the constraints andthe full roll out o f the system i s expected to take place by 2008. 44 > A model is being used for oil revenue forecasting. The Ministryof Finance has a signed a contract with AUPEC, Aberdeen University Petroleum Economic Consultancy, to implement an oil revenue forecasting model and advise DNI on strengthening its capacity with respect to petroleum taxation. The work started on April 1, 2006 and Ministrystaff are being trained on how to use the model. 73. Other structural financial management issues are being addressed, but progress has been slow. The Government has started to strengthen the capacity o f the Ministry of Finance to control expenditures through the roll out of the SIGFE and ring- fencing the operations o f Sonangol on behalf o f the Treasury. But more needs to be done to arrive at a point o f "normalization". Other suggested improvements inpublic financial management that remain to be addressed include: > Sonangol's quasi-fiscal operations: Sonangol's quasi-fiscal operations are currently reflected in the budget, but there i s no clear indication about a timeframe for phasing them out. The Ministry o f Finance has confirmed that the expenditures performed by Sonangol on behalf o f the government comply with the formal budgetary procedures, but that this is currently happeningwith a lag o f 90 days. The National Directorate o f Accounting (DNC) has confirmed to the staffs o f the Bank and the Fundthat their goal i s to eliminate this lag completely bythe endo f2006. 9 Separation of concessionaire and operator roles of Sonangol. The Government and Sonangol have both indicatedthat there will be no change on this configuration at least until 2010 under the justification that there are institutional and technical limitations in the Ministry o f Finance and in the Ministry of Petroleum that prevent faster progress. The Oil Revenue Diagnostic Study jointly funded by the Bank and the Government recommended transfer o f the regulatory functions away from Sonangol. > Updating of the Ministry of Finance website. Detailed information was provided to the Bank and Fund in March 2006 about oil exports, oil prices, and profit oil from the Tax Directorate o f the Ministry o f Finance for 2005, but the information on the website continues outdated (reflecting the situation inthe first quarter o f 2005 only when the accounts for 2005 have already been closed). > Engagement with civil society on public finances management issues. The M O F has asked the World Bank to organize two high level workshops on petroleum revenue management - one for senior Government officials, followed by a second for industry and civil society. These workshops were successfully held in mid-May, 2006. Other outreach activities for civil society should be organized inthe future. > Formal endorsement of the EITI criteria. Angola has been cautious about announcing formal adherence to the principles and objectives o f the Extractive Industries Transparency Initiative (EITI), despite the encouragement o f the 45 Bank, IMF and bilaterals. Nonetheless, the government has made some progress towards addressing the criteria o f the EITI and the authorities should seriously consider joining the initiative. 74. A scorecard of actions taken and targets to be met spotlights required further actions. Table 3.4 describes areas where progress has been made and where further actions are requiredto meet objective governance and transparency criteria which are considered good practice: Table 3.4: A Scorecard to Assess Governance and Trani Resolve conflict of interest potential Sonangol is ring-fencing Subject to credible institutional (Sonangol as concessionaire) concessionaire activities capacity, transfer concessionaire role to Ministry of Petroleum Adequate Government oversight of MOFlMOP have little capacity to Engage qualified consultant support. Sonangol provide oversight Build capacity. Reconcilelinclude Sonangol financial Sonangol ring-fencing and auditing Bring Sonangol quasi-fiscal and own flows with budget quasi-fiscal activities. Own expenditures into budget and comply expenditures are still outside budget. with budget procedures without Quasi-fiscal expenditures comply delays. with budget procedures with a 90-day lag/ Qualified, independent audit of Annual industry cost and fiscal audits Take notice and act according with payments made and revenues by experienced international auditors the auditors' recommendations. This received will allow a comparison of payments made by industry and revenues received by the federal and provincial governments. Audit revenues received by MOF, Cabinda and Zaire provinces. Publicationof audit results in Current detailed publication of Add audit results. Improve accessible form company payments on MOF website. accessibility of website. Consider Audit results not yet published. broader media publication. Audit exercise applies to all Current practice, but Sonangol data Sonangol to provide data directly to companies, including Sonangol derived from block operator. MOF. Publication of Sonangol corporate audits Engage civil society in revenue No current engagement Topical workshops to include civil management and transparency society. Establish independent public process information center Clarity on legal, contractual and fiscal Legal drafts and texts difficult to Compile and publish legal texts, frameworklprocedures access. DNI preparing tax manual procedures. tax manual. Develop time-bound, funded, action No current plan, although individual Prepare and publish explicit plan plan for implementation of components have been scheduled transparency agenda 75. Despite recent progress, there are critical outstandingitems that remain to be addressed. The Government acknowledges that there are limitations and constraints to moving on a few areas, and has asked the Bank to provide advice on how to overcome them. While discussions on a definitive list ofperformance criteria are ongoing, a number o f key areas where the government will needto be proactive are summarized below: 46 Formal endorsement o f EITI and agreement on an action plan for its implementation. Clearing o f tax arrears by Sonangol. Verification o f all Sonangol liabilities and payments. Publication o f audits o f financial statements and tax audits. Extension o f the audit o f company results to audit o f the "flip side", Le., o f revenues receivedby federal andprovincial governments. More accessible, user-friendly website for oil data, with additional datdinformational enhancements (e.g., tax-payers manual). Publication o f the Sonangol auditors' reports. Outreach informational events for civil society. Public Information Centre with objective information on the oil industry. 76. Besides addressing governance and transparency issues, it is equally important to assess how much oil wealth will be accumulated and how long it is likely to last. Gaining a good understanding o f the size o f the oil wealth that the country will accumulate in the years to come i s essential to plan for the future and to define a strategy to improve the lives o f the Angolan people. The report now turns the focus to these issues and to policy options available to the authorities on how to manage their rapidly growing oil revenues. 77. Inthe computationof Angola's oil wealth, three referenceprice scenarios are considered - a base case, a high case, and a low case. Benchmark price scenarios were developed by the World Bank's Commodities Department and are illustrated in Figure 3.5. The benchmark used i s the widely referenced price o f Brent North Sea oil, which applies to Angola. It is also worth noting that the price of Angolan oil varies with the quality o f the oil extracted inthe different blocks (see Box 3.5). The rationale for each o f one o f the different scenarios i s as follows: i. Inthebasecasescenario,thethinkingisthatoilpricesareexpectedtoremain elevated in the near- to medium-term due to capacity constraints, moderately strong demand growth, and OPEC production discipline. High oil prices are expected to have some impact on demand, and non-OPEC supplies outside o f the Former Soviet Union, which have beenflat the last few years, are expected to rise from such areas as the Caspian, West Africa, deepwater, and Canada. Output in Russia i s also expected to rebound. New capacity i s expected from most OPEC countries such that surplus capacity will rise modestly and exert downward pressure on prices. However, OPEC will be in a fairly strong position to set a reasonable floor underprices. 47 .. 11. The high case scenario assumes stronger growth in demand, particularly in China and India, and continued supply disappointments that keep the market balance tight. High prices ultimately have a negative impact on demand and a positive impact on supply such that prices fall over the forecast period. However, OPEC i s ina strong position to keep prices above $50 per barrel. ... 111. The low case scenario assumes that demand weakens from already high prices and structural changes in demand going forward. Supplies grow rapidly in both OPEC and non-OPEC countries, exerting significant downside pressure on prices. OPEC takes a less aggressive stance with respect to prices to maintain market share, but i s able to secure a price much higher than in the past at around $30 per barrel in nominal terms. Angolan crude oils sell at a discount off Brent prices due to locational disadvantages and, insome cases, quality disadvantages. 78. Angola's future oil revenues are substantial and estimates show that they can reach close to US$266 billion in present value terms. The present value of that asset, discounting future revenue flows at a 10% rate, results in estimates ranging from $119 billion to $266 billion, depending on the production and price scenarios assumed (see Table 3.5). These figures translate into per capita petroleum wealth ranging from $8,500 to $19,000, based on an estimated population o f 14 million. While large, these figures are perhaps lower than many policy makers might have expected. This i s because o f the discounting and the relatively short-lived peak o f production, even in the extended production case. In what follows, the report looks into the future path o f oil production and its impacts on government revenues under different scenarios.32 The reserve, production, cost, and fiscal scenarios used to project oil revenues are those described in preceding sections. The recurring critical component i s price. Current proven and probable assets 118,597 145,718 253,310 Current assets adding Block 31SE and 32 123,378 150,657 266,027 Note: Assets discounted at 10% and reported in $ million 32 Our projections do take into account new discoveries. In fact, a new bidding round for exploration o f existing fields has been announced, but any significant new discovery, should one be made, could not be expectedto impact revenues positively for at least 5 to 7 years. 48 Figure3,5, Brent North Sea Oil Price Scenario 82.00 tow 54.00 4000 3944 3889 3833 3'778 37 production decreases. The fall m a y be deferred by bringing the pending development projects in Block 31 and 32 onto production, but this would extend the period of high revenues by no more than two to three years. While all revenues are significant, a comparison of the three scenarios illustrates their dramatic volatility in the face o f not unrealistic future price scenarios. Figure 3.6 Gross Revenue Scenarios A 50000 / \ I \ Highprice ~ \ 40000 1/ 1990 1995 2000 2005 2010 2015 2020 2025 2030 Table 3.6: Gross Revenue Scenarios 1990 1994 17,340 17,340 17,340 1995 1999 -- 22,026 22,026 22,026 2000 - 2004 43,884 43,884 43,884 2005 - 2009 156,052 210,063 129,852 2010 - 2014 148,768 226,698 143,266 2015 2019 73,388 115,324 73,388 2020 2024 35,152 55,239 35,152 2025 2029 --- 11,018 17,314 11,018 80. The share of the government in total oil revenues is also expected to grow quickly and then decline steeply in the near future in the absence of new discoveries. The past and expected future behavior of government revenues is illustrated in Figure 3.7 and Table 3.7. Government revenue closely tracks gross revenues with a slight lag reflecting early recovery o f costs by contractors and a consequent deferral of payments to government. Also, as might be expected, based on the fiscal regimes described earlier, government revenues increase as a percentage of project net cash flow (gross revenues minus cost) in later years following cost recovery by the contractors. They also increase as prices increase, e.g., they are higher as a percentage of project cash flow in the high price case than inthe low price case. 50 Figure 3.7: Government Revenue Scenarios 35000 / \ \ Highprice 30000 r/ \ Table 3.7: Total Government Revenues I Total Government Revenues (US$ million) I 1990 1994 - 10,247 1995 1999 - 12,119 2000 2004 - 24,251 Base Price High Price Low Price 2005 - 2009 99,930 152.358 74,301 2010 2014 - 95,016 175,672 86,805 2015 2019 - 50,239 94,850 48,232 2020 2024 - 21,556 41,922 21,256 2025 - 2029 5,772 11,748 5,714 81. Government revenues will also vary in line with Sonangol's revenues and expenditures. The measures o f government revenue shown above do not include the after-tax revenues accruing to Sonangol. Since Sonangol i s 100% state-owned, these are public revenues and should be considered together with other revenues indescribing total revenue flows to government from the sector. Sonangol revenues expected under each o f the three assumed price scenarios are described in Figure 3.8. The revenues comprise equity returns from both concession areas and PSAs in the form o f after-tax cash flow and contractor production shares, respectively, and the 10% of government production 51 shares allocated to Sonangol to cover costs incurred in discharging its duties as concessionaire. Sonangol not only receives significant public revenues, but it also spends public funds, reducing government's net revenues from the oil sector. Sonangol's expenditures are expected to grow inthe near term as its commitments to fund its annual share o f deepwater development projects become effective, as shown inFigure 3.9. Figure 3.8. Sonangol Revenues lCompanyISonangoi1 3000.00 2500.00 2000.00 1500.00 1000.00 500.00 0.00 1 -500.00 Regime Data ~Conoasrionr~ Sum of Company Cash Flow SM ~Concesrlonr Sum of Gov Share Angola Profn 011(10%) $M . OPSC Sum of Company Cash Flow SM . OPSC Sum of Gov Share Angola Profit011(10%) SM . Figure 3.9 :Sonangol Expenditures 800.00 700.00 600.00 - 500.00 2c `E 400.00 3 300.00 Lent Abandonm 200.00 100.00 0.00 1990 1995 2000 2005 2010 2015 2020 2025 2030 52 82. With the massive increasein fiscal revenuesassociated with the upcomingoil boom lies the question of how to allocate the proceeds of the oil windfall in an intertemporalperspective.That is, what is the optimal annual level of consumption out o f Angolan oil income now and in the future? The answer depends on both the size o f the revenue that can be expected from oil in the future, the rate at which one discounts these values to the present, and the relative weights one attaches to future vs. present generations. Past attempts inoil-rich countries to address these intergenerationalconcerns have almost uniformly run into difficulties. Problems have occurred at the political level -itishardforpoliticiansto"sell" the idea o f transferring resources to future generations when the needs o f the current generation are manifestly great. Additional problems have had their origin in the weak governance and institutional capacity traceable to the Paradox o f Plenty. 83. To guarantee the well-being of future generations, part of Angola's oil revenues should be saved. Based on the current reserves and development activity described in previous sections, the current oil boom in Angola i s likely to last for about two decades in the absence of new discoveries. During this period the economy will experience high economic growth, driven by the oil sector, and a massive windfall with concomitant fiscal gains. Provided the serious issues associated with the Paradox o f Plenty (see Box 3.4) are adequately addressed, the fiscal gain should go a considerable way towards alleviating Angola's widespread poverty, contribute to growth and economic diversification, and increase the general standard o f living. However, given the expected decline inproduction from peak boom levels and the eventual exhaustion o f oil resources, long term sustainability o f these benefits requires that a part o f the coming revenue windfall be saved to provide for the economic and social well-being o f future generations. 84. An option to make the oil wealth last longer is to convert part of it into financial assets that can yield returns well beyond the depletion of oil reserves. In order to transform the revenue boom into a permanent income per capita, Angola can convert oil revenues into financial assets at a rate that allows the return on those financial assets to take over as a source o f income in the long run. In such a scenario, Angola would invest, as oil revenues come in, the amount required for interest income to equal oil revenues per capita at the end o f the oil boom. For sustainable expenditure policy, this representation o f oil wealth i s more realistic than the absolute numbers, as reported in Figure3.10. 85. Future government revenues and expenditures under this approach would vary with the rate at which financial assets are remunerated. Based on projected future revenue flows, the permanent sustainable expenditure per capita i s $169 per year. This means that each Angolan citizen could spend an additional $169 per year in perpetuity if Angola saves all oil revenues that exceed this amount for as long as oil revenues are coming in. In calculating this number, we assume an annual population growth o f 2.9%, the base price scenario in Figure 3.10, an annual yield o f 5% on financial assets, and we discount future revenue flows by 10% per year in order to include 53 uncertainty into the calculation. Different assumptions give different results: if w e discount future revenues by 15% and assume a low price scenario, the sustainable permanent expenditure is $107 per capita. If w e discount revenues by 5% and assume a high price scenario, the best case sustainable permanent expenditure is $385 per capita (see Table 3.8). Figure3.10: Permanent ExpenditurePer Capita Assumptions: Base price scenario Population grows at 2.9% annually. Financial assets yield 5% annually. Adjusted government revenue is discounted at 10%. -Adjusted --Projectedgovernment revenue per capita -Interest on accumulated savings per capita government revenue per capita - - Permanent Expenditure per capita Table 3.8: PermanentExpenditurePer Capita at DifferentAssumptions DiscountRate PriceScenarios 5yo 10% 15% I Low 182 136 107 Base 220 169 136 High 385 292 232 86. Fiscal policies will be of central importance in managing looming revenue shocks. As revenues are expected to increase significantly under all likely scenarios, policy objectives should include dealing with Dutch Disease risks (ie., avoiding overheating o f the economy inresponse to massive revenue inflows and consequent price inflation, dealing with the unavoidablereal exchange rate appreciation and likely erosion o f the competitiveness of non-oil export activities), avoiding damaging pro-cyclical expenditures inresponse to expected revenue swings, and providing for expected declines 54 in production and revenues, and ultimately exhaustion o f Angola's oil resources. In Angola, the desirable fiscal policy should attempt to insulate the economy from the volatility o f oil revenues, because frequent upward or downward adjustment o f fiscal expenditures are costly and hurt the economy through uncertainty about aggregate demand and through costs associated with factor reallocation^.^^ 87. Econometric estimates for the case of Angola show that controlling oil revenues seems to be essential to effectively control the growth of government spending and insulate the economy from oil price volatility. A detailed econometric analysis on the relationship between oil revenues, government expenditures, and gross domestic output in Angola34shows that following an increase in oil taxes, government spending temporarily increases and then fades away quickly after the shock. Inthe same token, GDP responds positively to an increase in oil revenues but this effect i s not sustainable in time. In this context, in which government spending and GDP vary in the same direction as oil revenues, the introduction o f some sort o f stabilization fund to insulate the economy from the volatility associated with the oil sector could be warranted35.As argued by Barnett and Ossowski (2003), a key policy objective in such situation should be to pursue a fiscal strategy aimed at breaking the pro-cyclicality response o f the fiscal policy to volatile oil prices. This would involve eliminating expansionary fiscal policy biases intimes o f oil booms. 88. Up to now, the enclave nature of the Angolan economy has meant that GDP has responded more to changes in oil revenues than to changes in government spending. The econometric estimates also show that oil revenues and GDP do not respond significantly to increases in government spending inthe short run.36One possible reason why short-term changes in government spending do not affect GDP could be that government spending simply leaks out through the trade balance due to the non-existence o f idle capacity which makes domestic supply inelastic. That is, if all the government i s doing with its additional expenditures i s financing imports then one would not see GDP changing. The finding i s notjust consistent with the enclave nature o f the oil sector inthe Angolan economy and the prevailing Dutch-disease situation that plagues Angola and other resource-rich countries37,but could also be seen as a consequence o f the prolonged civil war that plaguedthe country for over 27 years (see Collier, 1999)38. 33 See Katz et al. (2004) for a generalization o f this point. 34 See Carneiro (2005) background paper for this Country Economic Memorandum. - 35 There are certain pre-conditions that must be observed for a successful implementation o f a petroleum revenue fund and an assessment as to whether these are present or not inAngola i s beyond the scope o f this paper. For a thorough discussion o f this subject, please refer to Davis et al. (2003) and Katz et al. (2004). 36A result which has also been found for the case o fMexico (Tijerina-Guajardo and Pagan, 2003). 37 For an assessment o f different ways in which the Dutch disease can operate in the economy, see Hausmann and Rigobon (2003). 38 Iti s reasonable to assume that if government demand i s channeled to the domestic economy by means o f increased investments in infrastructure and human resources, then the non-oil domestic sector will in the medium to the long runeventually respond, leading to increases inGDP. 55 89. There are five important issues that deserve attention. A crucial question behindthe extraction of naturalresources that are exhaustible is how to manage a sudden increase in government revenues derived from windfall gains. In the case o f Angola, there are five associated issues that call for careful consideration by the authorities. 90. First,the authorities should strive to improvethe investmentclimateand the business environment in Angola to foster the gradual and sustainable growth and diversification of the non-oil economy. The extraction o f the country's oil reserves by definition represents a depletion o f its natural resource endowment that will affect not only the current generation. Clearly, the country receives something in return, but from a long-term sustainability point o f view, this reduction should ideally be compensated by the accumulation o f other asset forms such as physical and human capital. The decision on the fraction o f oil revenues to be saved as financial assets, therefore, requires that policymakers make explicit decisions about the intergenerationaldistribution o f revenues related to the extraction o f exhaustible oil resources. Inparticular, future generations will be worse off ifthe oil-related revenues are spent too quickly, without leadingto improved long term non-oil growth prospects. Thus, the authorities should strive to create the conducive business environment in Angola that will support sustainable growth and the diversification o f the non-oil economy. Options available on that front are discussed in detail inChapter 5. 91. Second, the fiscal envelope for the coming years should be based on a medium-term economic framework. Currently, the horizon for decisions that affect macroeconomic policy is, at mot, two years ahead as spending programs in annual budgets are determined only by revenue prospects for the coming year. Despite the fact that the government has beenadoptinga conservative approach towards specifying the oil price on which revenueprojections are based, this approach can still yield sharp cycles in spendingwhich can prove unsustainable inthe long run. A preferredapproach would be to base annual ceilings for public expenditure on medium-term revenue prospects, evaluated at a long-run oil price. Under this approach, consistent fiscal surpluses could be generated over time so that financial reserves could be accumulated during the years o f peak oil production to sustain incomes when oil revenues eventually fall. 92. Third, fiscal policy should be anti-cyclical in relation to oil prices. The pro- cyclicality o f fiscal expenditures and oil prices i s dangerous and can transmit volatility to the rest of the economy. In countries that have not been cautious, the resulting fiscal deficits have been financed with external and/or domestic borrowing. The former type o f borrowing has rendered many borrowers vulnerable to increases in the interest rate on foreign loans, as well as to the drying up o f new loans as sustainability concerns set in, while the latter has often been inflationary or has crowded out private sector access to credit. The joint result could well mean that the government will be forced to adopt belated, costly, and disorderly expenditure cuts in the future, often involving the suspension or abandonment o f investment programs. The bottom line for these governments i s that in periods of oil price downturns the authorities would be forced to adopt sharp and disruptive fiscal contraction measures when the economy can least afford 56 them. 39 Therefore, a key policy objective in this context should be to pursue fiscal strategies aimed at breaking the pro-cyclical response o f expenditures to volatile oil prices. In this sense, the approach o f using a conservative oil price in the preparation o f the budget that the authorities are already adopting i s welcome, but this approach should be complementedwith the recommendationo fthe previous paragraph. 93. Fourth,the authorities shouldbuildup foreign exchange reserves and reduce the country's public external debt. In view o f the improvements in Angola's fiscal position, there i s considerable scope to reduce the country's public external debt while also building up international reserves. Part o f the windfall gains that i s accruing to the government can be usedto clear external debt arrears, which currently add up to close to US$2 billion dollars plus late interest, and an important first step in that direction could be the resumption o f payments falling due. The authorities should also consider rebalancing the overall foreign exchange portfolio with a view to maximize returns to Angola and eliminate the government's reliance on expensive oil-backed loans from commercial banks and to minimize recourse to external debt to finance public investment inthe future. 94. Finally, expenditures should not rise faster than transparent and careful procurement practices allow. Massive institutional and legal reforms are necessary to develop a thriving businessenvironment and inAngola these reforms have started but are ina very early stage. Insimple terms, the level o f spendingshould be determined taking into account its likely quality and the capacity o f the administration to execute it efficiently. Inthis regard, an abrupt enlargement o f expenditureprograms associated with oil windfalls carries important risks. A hasty public spending program may exceed the government's planning, implementation, and management capacity, with the result that it may be difficult to prevent wasteful spending. For instance, the criteria for the selection o f capital projects may become lax, leading to suboptimal choices; the costs o f new projects may also increase due to bottlenecks in the supply o f some inputs; and a large- scale capital expenditure program can also be a fertile ground for governance problems. 95. An institutional framework will be required in order to effectively manage Angola's oil wealth. Regardless o f whether or not Angola adopts this guide to fiscal policy, the Government should have the institutional capacity requiredto generate future revenue scenarios. Considerable progress has already been made in this direction in the form o f the Oil Revenue Diagnostic Model prepared by AUPEC for the MOF, but additional arrangements are still required such as, for example, in opening up the dialogue with civil society and in establishing a formal and transparent mechanism to administer the windfall. 96. Popular support for saving a share of oil wealth can be gained through an open dialogue with civil society. The permanent expenditure approach to fiscal policy 39For a discussion of procyclical fiscal policies in Nigeria and Venezuela, for example, see Hausmann, Powell, and Rigobon (1993), and Garcia et al. (1997). 57 discussed above i s likely to encounter significant popular/political opposition because o f the substantial early savingddeferred expenditures it implies inyears when the perceived need for public expenditures i s high. To gain popular support, however, the authorities need to strengthen the dialogue on oil revenue management options with civil society and make the case that the permanent expenditure approach establishes a benchmark that investments must meet inorder to convert the oil boom into sustainable wealth. 97. The establishment of the savings and expenditure rules for the oil reserve account should draw on the success and failure of past experience in other oil producing countries. The authorities have announced that part o f the improvement in the country's fiscal position will be used to create a dedicated oil reserve account o f the Ministry o f Finance at the BNA to help in fiscal stabilization. Past experiences with similar initiatives in a variety o f countries have not been encouraging. However, learning from past failures, new promising approaches are being adopted around the world. As the Government o f Angola i s considering the establishment o f an oil reserve account, the following features, which are based on other models now being developed and implemented in other countries, mightbe considered useful on the way forward: i. Theoilreserveaccountshouldbethedesignatedrecipientofpetroleumwindfall revenues. Partial capture o f oil revenuesby various ministries or state-owned entities would make it difficult to obtain efficient and sustainable management o f the revenues. .. 11. Transfers to the budget should be based on the agreed savings/expenditure rule. Without clear rules, transfers risk becoming increasingly dependent on short-term economic and political cycles, which would critically undermine the account's function. ... 111. The BNA should be designated as the operational (day-to-day) manager for the account. An efficient, transparent, and rule-bound management requires dedicated andneutral staff, placed within the Central Bank. iv. The rules for investing the account's assets (e.g. low risk overseas treasury instruments)mustbeclear, agreed and published. V. A high level oversight committee (key ministriesplus qualified external advisers) mustbeestablished. vi. There must be annual, professional audits of the oil reserve account. vii. The oil reserve account, its management, and guidelines must be subject to rigorous transparency requirements. 98. In addition to savings and expenditure rules, the Government will have to choose investment rules for the saved funds. In determining these rules, it will be important to keep in mind that only investments matching the return on financial assets 58 it is clue, the tax 55) 100. A similar set of issues applies to the case of the diamond sector in Angola. The next Chapter provides an assessment of that sector, which alike the petroleum sector has traditionally been controlled by the Government. But governance in the diamond sector has been considered significantly opaque whereas the legal framework has been considered unstable. The potential of the sector to contribute more to the development o f the country is huge, but more needs to be done so that this potential can be realized. The main challenges for the diamond sector are associated with problems related to governance, the business environment and the social contribution o f diamond mining. 60 IV. THEDIAMONDSECTOR:POTENTIALUNDEREXPLOITED A Angola is currently thefourth world's largest producer of diamonds with the potential to become one of the leading global producers. The industry has been traditionally controlled by the Government which has experienced dijjculties to introduce in the diamond sector the same level of institutional and economic maturity observed in the oil sector. Partly due to the way the sector was affected by the civil war, frequent changes in the legal and regulatory framework concerned with the diamond industry and excessive government interference have prevented the major players in the global industry to contribute effectively to the sector's full growth. The main challenges that must be addressed by the authorities are related to problems with governance, the business environment, and the social contribution of diamond mining. This Chapter looks at these challenges and presents a reform strategy to unleash thepotential of the diamond sector in Angola. 101. Angola became one of the world's major diamond producers in the 1970s, but quickly lost its dominance due to the independence war and a violent civil conflict. The start of diamond production in Angola dates back to 1912 in the Northern province of Lunda. This was and i s the part of Angola where alluvial diamonds are most abundant. At that time, the sector was exploited by Diamang, ajoint venture between De Beers, the Portuguese state and international miningfinance interests, which was granted a monopoly over all diamond related activities in the country. Very quickly, diamonds became Angola's most valuable exports, and by 1971 Angola was producing 2.4 million carats a year, placing it among the world's major diamond producers. However, the war for independenceand ensuing civil war severely disruptedminingand Angola dropped to seventh place in world production with diamond output falling to 750,000 carats in 1975 and350,000 in 1977.40 102. Many years of instability and the alluvial nature of production have contributedto the structuralgrowth of illegal miningactivities in the country.Illicit diamond production increased markedly in the late 1970s, resulting in the Movimento Popular para a LibertaqCo de Angola (MPLA) government dividing the Lunda province into north and south sections in 1978 to restrict population movements. The M P L A also nationalized the control of the industry and, in the mid-1980s, a new state mining company, Endiama, took over Diamang's monopoly and operations with the purpose o f revamping production. But output continued to decline dropping to less than 100,000 40See Dietrich and Cilliers (2000), and Pearce (2004) for a detailed account of the history of diamond production inAngola. 61 carats by the end of the decade. The government liberalized the industry in the early 1990s in an effort to reverse the decline in production, but the main result of this policy was the rapid development of artisanal mining. The situation got worse during the civil war, when a large part of diamond production was in the hands of the rebel group UNITA. The result was a tremendous increase inillegal diamond output, reaching nearly US$ 600 million in 1992. 103. Most of the current formal and informal production comes from secondary alluvial deposits. Presently, the only kimberlite pipe exploited at commercial levels is Catoca, located inthe Lunda Sul province. As of 2003, its output amounted to 3.2 million carats, equivalent to 65% of the total formal sector production by volume (see Figure 4.1). Catoca i s currently inthe process of doubling is productioncapacity, while a second kimberliteproject, Luo, is expectedto be commissioned in2005. As a result of Catoca's expansion and the commissioning of new projects, Angola's formal exports in 2005 are expected to reach about 10 million carats, worth US$ 1 billion. The production of diamonds by project in2003 is presentedinAnnex 2. In2004, reported diamond exports totaled 6.63 million carats, worth US$ 763 million (see Annex 1). Angola's diamond exports represent about 95 % of the country's non-oil exports and about 10 % of non-oil GDP. Figure 4.1: Angola's Official Diamond Exports ~ 6,000,000 -~ 800 -- 700 , 5,000,000 -- US$nillion Carats 600 4,000,000 -- 500 3,000,000 -- 400 ~- 300 2,000,000 200 ~~ 1,000,000 -- 100 0 - 0 I Year : 1991 2004 - 1II -eUS$million Carats 1 104. Currently, Angola is the world's fourth largest producer of rough diamonds in terms of value, with the potential to become one of the leading global diamond producers.The country has close to 12% of the share of the world market and a high proportionof its production is of gem quality. Diamond reserves were estimated in 2000 at 40 million carats in alluvial deposits, and 50 million carats in kimberlite pipes, which are just now beginning to be exploited. Around 700 kimberlites of varying sizes (10-190 hectares) and shapes are known in Angola, aligned along a SW to NE trend across the country and into the Democratic Republic of the Congo. But in order to unleash the full 62 potential o f the sector, underlying governance problems and the ensuing less than adequatebusiness environment have to be tackled. 105. There is little competition and a large element of discretion involvedin the concession of miningrights in Angola. The concession of mininglicenses i s granted as follows: (i) interested companies send to the Ministry o f Geology and Mines a letter of intent explaining what sort of minerals they want to extract and outlining their technical and financial profiles; (ii) the Ministry evaluates the proposal and checks the availability o f concessions and the final decision i s made by the Minister; (iii) after approval o f the concession, a contract i s negotiated with ENDIAMA - the Ministry charges a premium and a deposit which are also negotiable, and royalties which are payable once production starts; there i s also an industrial tax o f 35% on the net profit o f the company; (iv) the maximum dimension o f a concession i s o f 3,000 km2. A more competitive and transparent bidding system for new licenses should encourage all potential operators and generate an increase in state revenues. 106. The legal structure is not very clear about the roles of operator and regulatingagencies in the sector.The Ministryo f Geology and Mines is responsible for the implementation of the legal and regulatory framework for the sector, for issuing mineral rights, and for the geologic survey, while the mandate to approve kimberlite concessions i s o f the Council o f Ministers. Endiama i s by law the largest shareholder in all new diamond ventures and also has regulatory functions over the selection o f companies that are to be granted new diamond mineral rights, the negotiation o f mining contracts, and the monitoring and control o f activities o f diamond ventures. The company i s therefore both an operator and a regulator in the diamond industry. In order to avoid potential conflicts o f interests and to allow Endiama to exploit its commercial potential, its licensing, regulatory, marketing and advisory functions might be transferred to other agencies or to the current regulating ministry. 107. Due to developments associated with the lasting civil war, the government became at the same time a monopolist and a monopsonist in the sector. In 2000, Endiama transferred its exclusive marketing rights to a newly created subsidiary called Sociedade de Comercializaqiio de Diamantes (SODIAM). Two basic reasons were put forward to justify the introduction o f a monopoly in the commercialization o f diamonds: (i) improvecollectionoftaxrevenuesfromthecompaniesoperatinginthesector;and to (ii)to reduce smugglingand minimize the problem of the "conflict diamonds", as SODIAM would be issuing certificates o f origins for the diamonds it traded, in conformity with the implementation o f the Kimberly process (see Box 4.1). SODIAM was, however, faced with two issues at its inception: (i) its lack o f comparative advantage intrading diamonds inkey markets such as Antwerp; and(ii) financial inability to deal its with cyclical downturns in the diamond markets. To this end, SODIAM engaged in a joint venture with the Lev Leviev Group to form ASCorp, a single official 63 UCCJ in an arbitrage process, an average and consensual price i s fixed. SODIAM then imposes a discount on the average price. This discount i s supposed to allow SODIAM to trade inthe international market at competitive prices, but the practice has been criticized based on concerns about special and privilegedtreatments. 109. The implementationof the Kimberley Process has been relatively successful in Angola, but more could be done to improve the efficiency of the system. Angola was the first country to implement a full certificate o f origin for diamond exports in2000, and although implementation has been successful, a lot more could be done to improve the overall efficiency o f the system. Apart from lack o f field inspections by Kimberley Process officials, and some delays in reporting obligations, the most obvious problem i s that there i s no system to determine the origin o f the diamonds from the informal sector beyond the records kept by the buying offices. To the extent that it i s possible, it would be desirable to move toward the optimization and development o f market efficiency and better incentives for a free market inthe sector. 110. The current set of diamond policies and institutions is producing mixed results in terms of the development of the country's huge diamond potential. The current business environment does not seem adequate to attract the type o f investors that possess the financial resources and the technology needed to develop the existing kimberlite deposits. Large western mining corporations, when considering to invest in Angola, have expressed concern with relation to: (i) excessive Government discretion and lack o f transparency on decision making, (ii)weak legal and regulatory framework, subject to fundamental abrupt changes in the rules o f the game (namely in terms o f ownership rights); (iii) poor definition o f the key institutional roles and lack o f powerful regulatory institutions; (iv) trade monopoly by SODIAM; (v) no clear rules for investment agreements with Endiama, with very strict articles o f association (limited periods, no transferability, etc.); (vi) lack o f accountability o f Endiama management and poor disclosure of information; (vii) lack o f security in mining areas; and (viii) lack o f a clear framework for the sharing o f revenues with the affected communities. 111. The performance of the fiscal revenues generated by the sector has been uneven. The fiscal contribution from the sector has improved dramatically since 2000, reaching US$44.6 million in 2002, and US$ 112 million in 2003, of which more than two thirds came from two projects (Catoca and SDM). However, preliminary figures for 2004 point to a sharp reduction in tax revenues to US$69.5 million (see Figure 4.2). From a fiscal point o f view, taxes from the diamond sector have traditionally provided just 1-2% of total budgetary revenue.42The small contribution can be explained by the fact that the nature o f the artisanal production o f alluvial diamonds has traditionally made 42The logic for collecting taxes is as strong for diamonds as it is for tropical hard woods, but the most efficient way of doing it differs because diamonds are much easier to smuggle than logs. Export taxes on diamonds vary from 2.5% to 3.5% in most diamond producing countries. The proceeds lost by lowering export taxes could be offset by raising license fees, but the trade-off between the two would depend on local conditions (Goreux, 2001). 65 it very difficult to control production and trade, while facilitating smuggling activitie~~~. On the large scale mining side, the government provides generous tax breaks and holidays to industrial projects in a proactive effort to share the potential benefits o f the industry with the local private sector. Moreover, revenue from dividends of the government's participation in Endiama and the various diamond joint ventures are virtually nil. I Figure 4.2: Diamond Tax Revenues (1995-2004) 800 200 700 600 150 500 400 100 300 50 0 I 1995199619971998199920002001200220032004 112. The applicable fiscal regime for mining is not very complex. There are two main taxes: a corporate rate at 35%, and a capital income tax at 10%. Mining equipment and supplies are exempt from import duties. Fixedassets and exploration investedbenefit from accelerated depreciation (50% inthe year they are incurred, 30% inthe second year, and 20% on the third). Inaddition, diamond production inAngola is also subject to three specific taxes: Taxes on surface rights o f mineral permits are between US$1 and US$3 per hectare and per year and US$3 per hectare and per year upon renewal o f the license. A bonus is payable on the award o fmineral rights, based on the size and value o fthe project. Royalties for miningventures are currently o f 5 YOon the gross value o f diamonds produced. 0 Export duties are leviedat a currently reported rate o f 2.5 %. 113. The fiscal burden on diamond production in Angola per se does not seem excessive when compared to other major producingcountries,but the unstable and non-transparentlegal framework reduces the sector's competitiveness.The limited 43 First, diamonds have very high value to weight and volume ratios facilitating their illegal trade. In addition, the mining sites are usually widespread and easy to work with simple technologies, making it difficult for Government to monitor the trade flows. Finally, the economic and social organization in the artisanal areas involves many actors, intricate divisions of labor, and informal businessrelationships. 66 transparency o f the sector makes an assessment o f the current taxation arrangements difficult. It i s also difficult to assess how onerous or fairly applied i s the current tax regime, as information on the margins earned by SODIAM and ASCORP and payments for mineral rights are not published. Moreover, Endiama takes a substantial free-carried interest in all ventures. Although these equity participations are seen by the foreign investors as a fiscal burden, reflected by the potential flow o f payments to Endiama, they do not translate into fiscal revenues, neither in the form of dividends paid by Endiama, nor as signature bonus or any other form o f quasi-fiscal revenue. Furthermore, the ambiguity and instability o f the regulatory framework adds to the perception o f Angola as a high-risk location and continues to deter investors. An international comparative assessment o f the sector's fiscal regime i s presentedinTable 4.1. 114. Successful mineral development led by the private sector in Angola will require change. There are a lot of improvements possible in a sector that, to a large extent, remains secretive and victim o f patronizing from the high instances of Government. Some o f the critical issues involve: (i)continued peace and stability; (ii) stable macroeconomic environment; (iii)sound trade policies; (iv) predictable and transparent legal framework that adequately define investors' rights and obligations; (v) a fiscal package that i s competitive and at the same time equitable for the concerned stakeholders; (vi) security o f tenure o f mining permits; (vii) strengthenedcapacity o f the Government to monitor and regulate the sector; and (viii) a firm commitment towards marketing liberalization. The international experience suggests that there i s scope for improvements inthe legal framework currently inuse inAngola (see Box 4.2). Researchand Prospection There is no standardpracticeon this area Parties should negotiate details of the contract regarding the work plan, calendars, budget, M&E systems, auditing and reporting Exploitation There is no standardpracticeon this area The example from the petroleum industry should be used in the diamond industry because in the oil industry,these contractsare common and usually includethe following: Joint OperatingAgreement Project definition Costing of the project Calendars for operation and production Terms and conditions for payment to partners Sharing agreements Operating committee Reporting Dispute resolution Treatment of residuals Royalties There is no standard method to determine These are usually negotiated among the royalties parties Reserves The diamond market is highly sensitive as to A "standard" and acceptable model to define the definition of reserves and there are reserves should be adopted. Different rules international rdes on this fixed by the lSCs should be used for the alluvial (USGS) and the and their respectivetechnicalcommittees kimberlite (OSC and AuslMM) deposits. 67 I s s s 2 s 4l E8 i 4 115. In order to improve the overall contribution of diamonds to the country, three sets of issuesremainto be addressed: 0 Governanceand Transparency:Should Endiama keep both its functions of operator and regulator o f the industry?What institutional reforms are needed both at Endiama and at the mining administration levels to improve governance in the sector? What else can be done to improve transparency in the sector? 0 Investment Climate:How can the current investmentclimate be improved in order to attract and retain credible national and international investors to Angola's diamond sector? 0 Social Development:How to increase the contribution o f diamond mining to social development? 116. The diamond sector in Angola has been notoriouslyopaque underminingthe full potentialof the industry. Although Government intervention was instrumental to increase production and tax revenues from the sector, the overlapping o f several functions inside Endiama - grantor o f concessions, direct producer (both directly and indirectly, through its joints ventures), and exclusive marketer - imposes constraints to transparency, accountability, and impairs planning. 117. Regulatoryand institutionalreformsare needed, both at Endiama and at the mining administration levels. A priority task would be to enact transparent and stable legislation under a the new diamond law, providing a clear separation between regulators and operating companies, a simple and transparent managementsystem o f mining rights, ensured consistency in taxation and marketing arrangements, and defined objective criteria and minimumrequirements for private investments, clearly indicating that special privilegeswould not be accorded to individual citizens or companies. 118. The authorities should reflect as to whether Endiama should keep both its functions of operator and regulator of the industry. Similarly to the case o f the national oil company, discussed inthe previous Chapter, there i s a clear potential conflict o f interest in the exercise o f Endiama's operations as negotiator o f every concession agreement, shareholder in every project, producer on its own account, and purchaser o f all production from the country. To avoid conflicts o f interest, and to permit ENDIAMA to exploit its commercial potential, Government should consider transferring its licensing, regulatory, marketing, and advisory functions to the Ministry o f Geology and Mines Mines (as it was the case before the position of Minister was given to an UNITA representative), while Endiama would keep its prominent position as a commercial 69 e n t e r p r i ~ e ~Its.role as a passive shareholder might also be separated from its active ~ operational roles. 119. Financialoversight over the company should also be improved,with a more active role to be played by the Ministry of Finance. As a state-owned company, Endiama both generates and spends public funds on a massive scale. As several major projects are currently under consideration, investment requirements should increase considerably inthe near future. These investmentswill have a substantial macroeconomic significance and need to be discussed in the context o f a budget debate. The oversight over Endiama's operations requires an update o f the first phase diagnostic o f the diamond sector and financial audits o f Endiama, carried out by PricewaterhouseCoopers for the 5 years prior to 2003. Both the diagnostic study and the audit reports should be published and made available to the public. 120. The updateddiagnosis study should be followedby an effort to improve data collection, coordination, analysis, and decision making in the sector. This would involve the set up o f an independent, transparent data collection system to monitor the sector, the improvement o f data collection from artisanal areas, and o f record keeping and information management across the sector. This could be a preparatory step for Angola to join the EITIfor diamonds 121. Initial requisites to improve the business environment involve not only clearer rules for the sector but also better geological information. The long war meantthat most of Angola has not beenexplored usingmodern techniques and only 40% o f the country has been covered by basic geological surveys. The country i s now considered to be one o f the most promising diamond areas in the world with over 600 kimberlite pipes identified, most of which await more detailed geological evaluation. However, due to the marketing monopoly, lack o f transparency in the grant o f mineral rights, and overall country risk issues, few international world class investors have invested in the sector. This has delayed the development o f several promising new projects. 122. The policy to share the benefits of the diamond sector with the domestic privatesector also requires improvements.Under its current form, the policy could be compared to a sale o f "lottery tickets" to the private sector, providing them with an opportunity to try to attract foreign sponsors with the financial resources to develop these properties. Given the uncertainty o f the investmentclimate and lack o f reliable geological information, most o f the foreign investors that accept to play the game are relatively small companies without the financial resources or the technical skills needed to develop efficient mining projects. They are attracted by the possibility o f making quick gains by raising equity through private placements or in the international capital markets, to finance the minimum amount o f work requiredto eventually "flip" these concessions to 44The new diamond law is expected to clarify the relationship and the specific roles of the Ministry of Geology and Mines and Endiama. 70 more reliable mining companies. Efforts to move towards the liberalization o f the market should be considered along with the necessary legal and institutional reforms requiredfor achieving this objective. 123. Despite the attractiveness of existing alluvial deposits, the cost structure of diamond production in Angola is still higher than in neighboring countries. Although the alluvial deposits represent easy targets for entering the industry, as their high grades, low-risk technical profile, and short commissioning period allow for almost immediate cash flow generation, the cost structure for diamond production in Angola i s significantly higher than in neighboring countries like South Africa. Efforts to engage domestic private companies in the diamond sector are commendable but, given the low value added brought by the Angola counterpart to the venture, they represent in practical terms an additional level o f taxation for foreign investors, refraining the development o f the industry. 124. The formalization and re-organizationof artisanal and small-scale mining could be enhanced as a source of legitimate non-farm income generating opportunities, while promoting more socially and environmentally responsible miningpractices.As it is practicedtoday, artisanal miningbrings little economic benefit to the local communities. The bulk o f the profits remains concentrated at the level o f the traders while most o f the diggers receive only a fraction o f the sales price o f the stones they extract. The "patrocinador", or middlemen, many o f them from foreign countries, is often responsible for funding the operations, and providing rudimentary equipment, buying in exchange all the production from the diggers, mainly from Angola and DRC. Diggers are engaged on the basis o f receiving subsistence from the artisanal mining license holder duringthe period o f work. They are financially rewarded with fifty percent o f any eventual diamond sales, over and above the working costs incurred by the license holder. 125. The authorities should consider adopting measures aimed at improving the overall standard of living of the communities linked to the mining activity. The government's current strategy to reduce smuggling o f diamonds aims at curbing informal artisanal production by having the diggers absorbed by licensed companies that will use more efficient extraction methods, ensure safety standards, pay taxes, and provide social services to their local community. Most o f the social initiatives in the diamond areas are left to the companies without a clear framework for the engagement o f the mining communities and little support from the government (see Box 4.3). For this policy to succeed, the government should complement it with measures aiming to improve the overall standard o f living o f the involved communities, through the pursuit o f multiple goals. A few priority areas to be considered by the authorities include: (i)improvement o f artisanal mining rights and security o f tenure; (ii) ensure that mineral wealth supports sustainable economic and social development o f the communities; and (iii) providing a level playing field for the license holders as well as diggers through training to enhance their product evaluating capabilities. 71 ** 5 1 ased rent-leaseof free markettrading of diamonds 72 128. Shared-growthand sustainable development in Angola will demand a better investment climate and improvements in the business environment. Along with the petroleum and the agriculture sectors, the diamond sector hosts the hopes for sustainable development based on equitable and shared-growth in Angola. However, none o f these sectors will meet the challenge o f providing a better life to the Angolan people if the factors that inhibit private sector development and the sharing o f the country's mineral wealth are not removed. As discussed in the previous Chapter, in the case of the petroleum sector, the key issue i s associated with the impact o f the oil windfall revenues on macroeconomic stability and the quality o f institutions. Inthe case o f diamonds, there are equal constraints associated with governance, the business environment, and the potential o f the sector to contribute for the increase of the welfare of the population. In the case of agriculture, to be discussed in depth in Chapter 6, the challenge is how to increase productivity in the presence o f an overvalued real exchange rate. However, in order to create the conditions for the development o f a thriving private sector that can interact with and benefit from the mineral sectors, a number o f issues related with the quality o f the business environment in Angola must be addressed. The next Chapter addresses these issues. 73 v.PRIVATESECTOR DEVELOPMENT THE BUSINESS AND ENVIRONMENT While most of the world is suffering from some form of `Betro pessimism", Angola is amongst a handful of countries that could derive benefits out of the current international scenario of high and rising oil prices. This raises the expectations on the speed with which the `Beace dividend" could be shared with the Angolan population. However, a rapid economic recovery, with more jobs and incomefor the average Angolan, will be difJicult to achieve without the necessary commitment to structural reforms. The climate for doing business in Angola - whether for residents or foreign companies - is perceived as one of the least conducive in the world and any strategy to promote private sector development in the country will need to rest on pro- business measures that can enable companies to compete more effectively in an open economy. This Chapter discusses options and priorities to remove barriers and improve the investment climate in Angola. 129. The business environment in Angola is challenging. According to the 2006 Doing Business survey o f the World Bank, establishing a company in Angola takes an average o f 146 days, more than twice the regional average. Licensing i s a time- consuming and costly procedure. The time to comply with all licensing and permit requirements i s estimated at 326 days -almost one year. Registeringproperty also takes about 11 months and costs more than 11percent o f the property value. Investor protection i s not highwhen compared to similar countries and obtaining credit i s equally difficult. The average import requires 10 documents, 28 signatures, and 64 days. It i s equally difficult to enforce a contract -incalendar days, it takes 1,O 11days to resolve a dispute starting from the moment a plaintiff files a lawsuit in court until settlement or payment. Dispute resolution among Angola's neighbors and potential competitors takes much less time -inZambia 274 days; inNamibia, 270; and inBotswana, 154. 130. Restrictive laws and business practices hamper the development of an appropriateinvestmentclimate.Angola ranks below many other sub-Saharan countries on manymeasures of the ease o f operating in the private sector, and ranks last out o f 155 countries surveyed by the World Bank in its 2006 Doing Business report. Cumbersome property registration procedures and a costly and insecure business environment are common features o f the private sector in Angola. Other key investment climate constraints include: (i)labor market rigidities; (ii) time and cost to start up a business; (iii) toandcostoffinance; and(iv)contractenforcement. Alloftheseconstraints access hamper entry and competition in the formal economy, encourage informality, and feed rent-seeking practices. The challenge facing Angola in creating an encouraging 74 environment for private sector investment i s summarized in Table 5.1 and reflects its poor scores on indicators describing the ease o f doing business. 131. The challenging business environment creates additional costs, increases risks, and imposes barriers to competition. These are the factors that can influence profitability and job creation. The opportunities and incentives firms have to invest productively, create jobs, and expand can be traced through their impact on expected profitability. And profitability i s influenced by the costs, risks, and barriers to competition associated with particular ~pportunities.~~Each factor matters independently, and all three are interrelated. Some risks can be mitigated, for example, by incurring greater costs. High costs or risks can be barriers to competition. And barriers to competition can reduce risks for some firms but deny opportunities and increase costs for others. Governments have more decisive influence over many aspects o f the investment climate, such as the security o f property rights, approaches to regulation and taxation, the adequacy o f infrastructure, and the functioning of finance and labor markets. As outlined inTable 5.1,these are the areas inwhich Angola needs a dramatic improvement inorder to create a better investment climate. Tabli 5.1: Government Policiesand Behaviorsand Investment Decisions pe Opportunities and lncent es for Firmsto Invest costs Corruption Marrtet-aetermined prces Corruption rank: 151out of 155 Taxes of inpJts countries (Transparency Regulatory burden D stance to n p J and International) Infrastructureand finance o,tpJt marrtets Doing Business Indicators: costs Econornles of sca e and Ease of Doing Business: 135 Labor market regulation scope assodated w'th Starting a Business: 155 panicdlar tecnno og es Hiring and Firing: 117 Dealing with Licenses: 122 Paying taxes: 79 Getting credit: 77 Risks Policy predictability and Consumer and competitor Recent progress on credibility responses macroeconomic stability Macroeconomic stability External shocks Doina Business Indicators: Rights to property Natural disasters Registering Property: 145 Contract enforcement Supplier reliability Enforcing Contracts: 122 Expropriation Protecting Investors: 48 Barriers to Regulatory barriers to Market size and distance It takes 146 days to start up a Competition entry and exit to input and output company and 335 days to register Competition law and policy markets a property in Angola. Functioning finance Economies of scale and Commercial code dates back to markets scope in particular 1888. Infrastructure activities Infrastructuredestroyed during war and still in the process of reconstruction. Source:World Developmei ieport 2005 (Table 1.l), Doing E 2006 iiness Report. 45 These points are developed further in the World Bank's 2005 World Development Report, A Better Investment Climatefor Everyone, Chapter 1. 75 132. Besides the difficultbusiness environment, corruptionis often a realityin oil rich countries and Angola ranks amongst countries with the worst corruption perception indices. Oil revenues provide governments with a source of revenue independentof its citizens, diminishing the need for accountability, and diminishingthe incentive to pursue the components o f good governance listed above. Oil wealth may actually encourage the opposite behavior, and at the same time increase government's ability to buy off or intimidate opposition to such behavior. Those with ulterior motives o f political or personal gain can be very successful at making the petroleum industry and its revenue flows opaque. In the rankings established by Transparency International's widely referenced Corruption Perceptions Lndex, petroleum exporting developing countries find themselves inthe bottom one third o f the countries listed. Angola's rank in the most recent release of the CPI was 151, number nine from the bottom. This is a particularly serious finding because corruption i s recognized as one o f the largest single inhibitingfactors to private sector investment and growth. 133. In additionto corruption and an unfavorablebusiness environment, another important inhibitor of private sector development in Angola is the lack of appropriate infrastructure. Since independence, infrastructure provision has been almost a monopoly o f the public sector be it in the form o f Government departments, or o f state-owned enterprises. And with the long war and inefficient management o f public companies, the country's infrastructurei s in a parlous state, negatively impacting both the quality o f life o f the people and the operation o f almost all economic activities. Many state industrial and manufacturing enterprises record substantial losses, which have in many cases depleted working capital. In comparison with the SADC countries, many o f which are not highly developed, Angola scores at or close to the very bottom for most infrastructure indicators, such as access to safe water and sanitation, electricity, and telephones (see Table 5.2). Table 5.2: SADC Infrastructure Indicators High (1) 47 Seychelles 235 320 555 Medium(7) 67 Mauritius 235 151 386 107 South Africa 70 99 87 80 92 87 3,587 114 190 304 122 Namibia 71 100 83 20 93 62 1,022 63 47 110 125 Swaziland 576 32 33 65 126 Botswana 88 100 90 41 91 55 755 93 123 216 128 Zimbabwe 69 99 79 32 96 52 715 18 23 41 132 Lesotho 57 91 62 35 56 38 188 10 10 20 Low (6) 151 Tanzania 58 92 66 83 98 86 45 5 5 10 153 Zambia 10 81 38 57 94 71 609 8 9 17 155 DRC 26 89 42 6 53 18 163 Malawi 40 95 47 1 18 9 Source: SADC, Compiledfrom World Bank (2005), County FrameworkReport- Private Solutions for Infrastructure in Angola. 170 Mozambique 63 543 71 40 44 52 6 134. There are difficultieswith infrastructurethat are spread across different key sectors that range from transport to telecommunications. The road system is in a shocking state o f disrepair, making several provinces all but inaccessible by road. In 76 many areas, roads have been mined, and at least 300 bridges have been destroyed. The three railways systems at their height carried 9.3 million metric tons o f freight to the Atlantic ports, but this has now fallen to insignificant levels. On the 1,340 km Benguela line, for example, services are now limited to the 30 km stretch between Lobito and Benguela, and it i s mainly passengers rather than freight been carried (see World Bank, 2005, CFR). Urban infrastructure also has dramatically deteriorated, the streets in most urban areas are in a state o f virtual collapse, and there are essentially no functioning sewerage or drainage systems. The fixed-line telephone systemi s antiquated, very limited in coverage, and prone to service interruptions, while the two small cellular networks, largely servicing the capital, are unable to meet fast growing demand. Out o f some 160 Angolan municipalities, as o f 2003, only 40 were connected to the fixed public telephone network. 135. There have been efforts to repair the road network after the end of the war. The classified road network consists o f 72,323 km o f roads: 7,777 km of paved roads; 28,018 km o f gravel roads; and 36,528 km o f earth roads. Much o f it has received little or no maintenance because many roads are in former war zones and have carried little or no traffic. In 2002 the government approved a program o f emergency repair and reconstruction o f roads. During the first phase, from 2002 until September 2004, basic repairs were to create the minimum conditions for traffic at a cost o f US$55 million (US$45 million for roads and US$10 million for bridges). The second phase, which i s underway now, envisages improving regional connections with the main roads and i s budgeted at US$171 million. The General Government Program 2005-2006 emphasizes the needs of transport infrastructure, identifying4,194 km of roads for rehabilitation, the construction o f 2,000 m o f bridges, and the rehabilitation o f 17 bridges. Projects rehabilitating international road links to the Democratic Republic o f Congo and Zambia were submitted to the COMESA Secretariat in 2003-2004 for feasibility studies. China also supports the rehabilitation o f the road network. In addition, the World Bank has started an Emergency Multisector Recovery Project in six provinces, which includes a component devoted to roads. 136. The precarious road conditions inflate transportation costs which impact negatively on competitiveness. Though traffic has increased from the near-zero level o f the war years, long-distance road transport i s still an arduous, costly, and time-consuming undertaking. An 18 wheel truck that transports goods 1,250 km from Luanda to Dundo in the northeast o f the country cannot make the round-trip in seven days, and will have no backload from Dundo to Luanda. The truck has to take 1,250 liters o f fuel from Luanda because gas supply along the road i s unreliable. It i s not surprising that the cost o f this type o f transport i s high: US$3,500 (down from US$5,500 in 2002/2003 because o f heavy competition). A 423 kmtrip from Luanda to Malange costs US$2,500. 137. Inefficiency in service provision by state-owned enterprises is also widespread. At present, most infrastructure service providers are forced to make do with inadequate prices and therefore operate at a loss. Costs overwhelm revenues and enterprises depend on subsidies from central government. Subsidies generally cover varying proportions o f both capital and operating expenses, are not targeted, and do not provide any sort o f incentive to enterprise managers to improve efficiency. A recent 77 household survey commissioned by the World Bank to investigate the incidence o f subsidies and the satisfaction o f the population with the public services showed a dismal picture, whereby large percentages o f the population surveyed responded that the services provided are of minimal satisfaction. More than 50% o f the households surveyed declared to be minimally satisfied with roads and sewage while some 30% o f the respondents were minimally satisfied with schools, electricity provision, health center services, home tap water service and public transportation. In sum, relatively few households enjoy the key services provided by public authorities, even though, relatively many households agree that these services are o f maximal importance. 138. The experience of involvingthe private sector in infrastructurerebuildingso far has been limited. As discussed in the Bank's Country Framework Report o f 2005, the most highprofile of these is the mobile phone license issued to Unite1inApril 2001. Telecommunications i s also the only infrastructure sector for which a regulatory body has beenestablished. Insome other sectors there have been management contracts, which are considered to have been reasonably successful (water supply in Soyo and Caxito, solid waste collection in Luanda, terminal operations in the port o f Luanda, and ground handling services in Luanda airport). New concession contracts are being formulated for solid waste collection and terminal operations inthe port, while in the electricity sector a concession was recently awarded to Alrosa, and in the telecommunications sector four new fixed line licenses are beingissued. 139. Another constraint to privatesector developmentlies in the financial sector. There is no stock market, the money market has very few tradable instruments, the insurance sector i s dominated by two state companies, and there are no institutions specializing in housing finance. The banking sector consists o f nine commercial banks, one merchant bank, four representative offices o f foreign banks, and a few institutions providing loans to small-scale enterprises. Among the commercial banks, three are foreign-owned and two are state banks, BPC and BCI. The three larger banks (BPC, BFA, and BAI) handle some 82% of the turnover of the entire system. However, the three private banks recently established (BTA, BESA, and BCA) are the first to have offered banking products denominated in dollars, and have began to win a significant market share because o f better quality service and a breakthrough in banking marketing. The state banks account for about 45% o f commercial bank assets in the country. The Central Bank has recently created a division specialized in micro-finance in anticipation o f an appropriate legal framework in response to growing demand by commercial banks to offer this service. 140. And as in many other African countries,the cost of capitalin Angola is high. With a short term inter bank interest rate at 96% in 2003, loans made out to clients by commercial banks carried, on average, annual interest rates above 100%. The cost o f capital is expected to remain high in the short term. The Economist Intelligence Unit estimates that short term interbank interest rate will average 94% and 96% in 2005 and 2006, respectively. Therefore, the cost o f finance remains an important constraint to the development o f the Angolan private sector and smaller businesses are likely to be 78 constrained the most. Individually and combined, these factors have constrained the ability o f businesses to undertake investments, including in technology and skills development, a factor which has hamperedtheir productivity and competitiveness. 141. The private sector in Angola is bimodal and the two major poles are quite distinct from one another. On the one hand there is a thriving informal sector while on the other end there is a highly sophisticated sector linked to the oil economy. As portrayed by Grion (2004), in one extreme there i s a segment o f companies that operate under a legal and fiscal framework that is controlled by the state. These companies are usually foreign-owned, use sophisticated technology, and operate incompetitive markets. Inthe other extreme, there is a myriad o fmicro enterprises that operate ina less dynamic market, using outdated technology that i s intensiveinunskilledlabor, and trading mostly in the informal market. In the latter segment, the logic is more one of survival than entrepreneurship.The gap between the top and the bottom of this bimodal distribution - the so-called missing middle -is hugeinAngola and there is scope for it to be filled with small and medium enterprises, which in the case o f Angola have not yet reached a significant number. As shown in Figure 5.1,approximately 65% o f business activities in urban areas in Angola are done through the informal sector. Self employment leads the informal categories, with 43% o f the economic activity.46 Figure5.1: Importanceof informalemployment inthe urban economy Source: Cain (2004). 46Research on the causes o f growth o f the informal sector points to excessive bureaucracy and government interventions in the market as two o f the most important factors encouraging informality. Loayza et al. (2005), for example, argue that a heavier regulatory burden, particularly in product and labor markets, reduces growth and increases informality. The authors conclude, however, that these effects can be mitigated as the overall institutional framework improves. 79 142. The most dynamic pole of the economy is concentrated in Luanda.The only source o f information on the private sector inAngola i s a recent enterprise census carried out by INE in 2002 and made available publicly in 2004. Based on that census, there were 19,119 private sector firms employing some 340,000 people in 2002. O f those, 14,484 firms (75%) employ between 1-9 employees. The largest density o f businesses i s concentrated in Luanda, which abridges 55% o f the total number o f firms in the country, followed by the provinces o f Benguela, Kwanza-Sul, Huila, Cabinda, and Huambo which together account for only 26.6% o f the total. The remaining 12 provinces host the other 30% o f the existing companies in Angola, but they are virtually disconnected from the most dynamic markets o f Luanda and Benguela by the virtual lack o f any real linkages beyond these large economic poles. 143. With several constraints to private sector participationin the economy, it is not surprising that Angola exports mostly oil and diamonds and imports almost everything. Angola's exports, 72% of its GDP, are heavily dependent on oil and diamonds, which in recent years have amounted to an average o f about 93% and 6% o f total merchandize exports, respectively (Table 5.3). Items such as stones, sand, fish, etc make up the remaining one percent. With limited refining capacity, almost all exported oil i s crude On the other hand, Angola imports almost everything, including products that the country has a comparative advantage. Merchandize imports being about 30% o f GDP, the trade account generates a large surplus averaging 40% o f GDP. This i s offset by payments for services related to investment in the oil sector and interest charges on large short-term external debt. The current account generates a deficit or surplus dependingon the price o f oil. 144. Angola appliesMFNtreatment to all its trading partners.Angola's tariff, like its import system overall, has been considerably revised and liberalized since M a y 1999, when a new tariff code (Pauta Aduaneira) based on the Harmonized System (1996 version) was introduced. At that time, the maximum duty rate was cut from 135% to 35%. The latest tariff schedule for imports and exports, based on HS 2002, with a maximumrate of 30%, was introduced in2005 under Decree-Law No. 2/05.48According to the authorities, the objectives o f the new tariff schedule are to: 0 Align the tariff structure with that of the HS 2002, according to the requirements o f the WTO and the World Customs Organization; 0 Revise duties to protect national production without harming the interests o f consumers and guarantee the supply o f essential goods at competitive prices; 47Oil i s exported largely under long-term contracts with particular countries. This i s usually done with oil- backedloans which commit oil production to the repayment of the loans. 48The2005 tariff is available at the following website: http://www.ita.doc.gov/td/tic/ tariff/ country-tariff-info.htm#Angola. 80 Protect national industry from dumpingpractices; promote, as a strategy and with comparative advantage as a guide, a gradual process o f substitution for imports of essential goods and to relaunch exports from non-oil sectors; Grant tariff benefits to the productive sectors o f the economy and create fiscal equity. 145. The new tariff structure i s oriented towards strengthening of the domestic production. Specifically, the new tariff structure seeks to reduce tariff rates that affect imports o f raw materials; maintain or slightly increase tariffs on finished goods that can be acquired locally inacceptable quantity and quality; impose minimumrates on essential goods and intermediate products that are not produced locally or whose production levels do not satisfy local needs; and impose maximum rates on used goods not incorporated in local products.49 146. The tax system is straightforward, but tax rates are relatively high compared to other SADC countries. The principal legislation i s the Law on Taxation Policy and Levels (Law No. 5/99). There i s a series o f other laws for specific taxes. Rates can only be changed by amendments being passed to the relevant laws. Corporate profits are taxed at 35% while profits on agriculture, forestry, or cattle-raising attract the only concessional corporate tax rate o f 20%. Public enterprises are subject to taxation o f profits at the corporate rate (35%) as well as other taxes. A tax on contracts i s levied at the rate o f 3.5% for construction, improvement, and repair o f fixed assets and at 2.5% for all other contracts. Personal income tax rates on salaries and wages, bonuses, and benefits range from 4 to 15%. Contributions to social security are compulsory and total 11%. The employee contribution i s 3% and the employer contribution i s 8%. 147. There are no quantitative restrictions on international trade and no incentives to exports. Licensing i s required for all trade activities but they are granted almost automatically. Importation o f certainproducts (transmitters, receivers, explosives, plants, fruits, seeds, drugs, etc) require ministerial permit. In 2001, the Government introduced a Customs Expansion and Modernization Project to improve customs administration. The Project has been implemented in collaboration with the Crown Agent, a consulting company. Most products require pre-shipment inspection that is provided by BIVAC standards. There i s no export incentives system in place (duty drawback, bonded warehousing, export processing zones, etc.) but investment goods in the oil and miningsectors are exempted from import duties. 148. Angola's applied tariff has six bands o f 2%, 5%, lo%, 15%, 20% and 30%. There are no duty-free lines. The tariff follows the HS at the 8-digit level. Out o f the 5,384 tariff lines in the schedule, 66% (3,570 lines) are rated at 2% or 5%; 38.5% (2,074 lines) are at 2% and classifiable as "nuisance rates," which are likely to cost more to raise than they yield. The two highest rates o f 20% and 30% jointly apply to 10.5% o f tariff 49 Information supplied by the Angolan authorities. 81 lines, or 565 lines. The simple average MFN applied tariff in 2005 was 7.4%, by major sector (WTO definition), the average tariff on agricultural goods i s 10% (compared with a bound average o f 52.6%), and that on nonagricultural goods 6.9% (compared with 60.1% boundaverage - see Figure 5.2). Figure5.2: Breakdownof Applied MFNDuties, 2005 Numberof tariff lines Percentage 2,500 2,000 1,500 1,000 500 0 0 2% 5% 10% 15% 20% 30% Note: Angola has 5,384 tariff lines; the figures inparentheses correspond to the percentage o f total lines Source: WTO Secretariat calculations, based on data provided by the Angolan authorities. 149. Overall, the Angolan tariff is likely to providedomestic producersin selected sectors with high levels of effective pr~tection.~' Most tariffs on industrial inputs, capital goods, and equipment are low, or at "nuisance" levels (2% or 5%). In addition, substantial duty-free concessions are available to investors inpriority zones, as well as to the oil and miningindustries.The combination o f low tariffs and concessions means that most investors pay little or no customs duty on inputs, equipment, and capital goods for at least the initial period (up to 10 years) of their activities, and in the oil and mining industries for the duration o f their activities. At the other extreme, a number o f sensitive domestic final goods, including certain construction goods, are taxed at relatively high nominal duty rates o f 20% or 30% . Because o f the low duties and tariff concessions on goods usedin production, the effective protection o f added value is, in these areas, likely to be many times higher than the nominal rates o f duty on the final goods would imply. 150. Angola participates in a number of trade agreements, but has not benefited from any preferential arrangements due to its lack of capacity to produce and lack of competitiveness. It i s a member o f the Southern African Development Community (SADC), but it does not participate in SADC's Trade Protocol. It also benefits from non- 50 Effective protection i s a measure o f the protection provided to an industry by the entire structure of tariffs, taking into account the effects o f duties on inputs as well as on outputs. See Corden, W. Max (1966). 82 reciprocal preferential treatment from many industrialized countries under the Generalized System o f Preferences (GSP) including the EU's Everything But Arms (EBA) Initiative and the US'SAfrica Growth and Opportunity Act (AGOA).Angola is a signatory to the Cotonou Agreement and, together with some SADC members, it i s also negotiating a reciprocal Economic Partnership Agreement (EPA) with the EU which will replace the Cotonou agreement. Angola has not been able to take advantage o f any o f these preferential arrangements because o f its lack o f capacity to produce and its lack o f competitiveness. It i s essential therefore to remove the supply-side constraints to be able to fully benefit from these preferential .arrangements, although this i s likely to take some time. 151. Almost half of Angola's exports are shipped to the US and a quarter to China (all crude oil). China seems to be gaining some o f the market share that until 1999 belonged to the US. The EU accounts for about 20% o f total merchandize exports (Table 5.4). With regard to the sources o f imports, the EU has the largest share at about 50% (Table 5.5), followed by South Africa (13%) and the U S A (10%). Exports o f both oil and diamonds are projected to increase substantially in the coming years. Such increase may not be translated into overall growth and poverty reduction unless the export revenue i s used more productively and the policy environment i s improved significantly to assist the economy to diversify. 152. Foreign direct investment in the oil and mining sectors is growing fast, but linkageswith the rest of the economy have yet to be developed.In2003, Angola was Africa's third largest recipient o f foreign direct investment in Africa (with US$1,415 billion5'), following Morocco and Equatorial Guinea. According to a recent report by the OECD52,three related phenomena - the discovery o f new oil fields, the increasing cost- effectiveness o f deep-water exploration in a context o f high oil prices, and the strategic interest o f American businessand non-traditional OECD partners such as China and India inthe energypotential o f the South Atlantic -are driving FDIactivity. Chevron Texaco, inparticular, has earmarked $11billion for investmentover the next five years. Despite their positive contribution to GDP and exports, oilprojects have veryhighimport content and very few linkages with local business. Although the number o f backward and forward linkages has started to grow - foreign companies have ad hoc programs to increase local content - the integration between the domestic and foreign businesses remains limited to very low-skilled activities such as catering and cleaning services. The rest o f the economy, however, continues to attract very little FDI due to several constraints to the businessenvironment. 153. Strengthening of the non-mineral private sector and diversification of the economy will require improvementsin the legal and regulatoryframework. Recent improvements in trade volumes, private sector development, and rising FDI levels are encouraging, but there i s an urgent need for deeper and further reform in the legal and regulatory framework. All o f these examples are important in demonstrating that the private sector can thrive in Angola, but in view o f the long history o f centralized control See UnitedNationsConferenceon Trade andDevelopment (UNCTAD, 2004). 52See OECD (2005). 83 o f the economy, a number of constraints to private sector development have yet to be removed. A number of such constraints i s discussed inthe following section. Table 5.3: Trends in Merchandize Trade us$ (000) Total Exports 3753 4993 4768 3825 4829 7927 6881 8030 9486 Total Imports 1734 1930 2316 2047 2055 2023 3238 2886 4161 Trade Balance 2019 3063 2452 1778 2774 5904 3643 5144 5325 Percent of GDP Total Exports 74.5 66.3 62.1 59.3 79.3 89.5 72.6 71.4 71.9 Total Imports 34.4 25.6 30.2 31.8 33.7 22.8 34.2 25.7 31.5 Trade Balance 40.1 40.7 31.9 27.5 45.6 66.7 38.4 45.7 40.4 Composition of Exports (percent) Crude Oil 90.4 91.1 89.2 85.9 85.1 88.9 88.9 90.5 94.0 Refined Oil 3.1 2.2 1.5 2.0 1.9 2.1 1.7 1.7 1.9 Diamonds 4.4 5.1 6.9 9.2 11.5 7.7 8.2 6.3 3.2 Others 2.1 1.6 2.4 2.9 1.5 1.3 1.2 1.5 0.9 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Table 5.4: Destination of Angolan Exports (percent) EuropeanUnion 21.6 19.3 14.3 17.0 17.0 17.7 26.3 26.4 13.4 France 2.4 2.9 3.8 2.9 2.0 4.7 9.7 7.9 7.3 NorthAmerica 64.0 59.9 62.2 64.4 53.2 46.0 48.1 40.8 47.5 LatinAmerica 3.0 5.3 3.8 2.3 1.5 2.4 3.6 1.4 2.4 Brazil 1.1 3.1 0.8 0.6 0.6 0.4 2.8 0.2 0.1 Asia 10.8 12.9 18.6 15.9 27.3 33.3 21.3 30.5 36.0 Sub-SaharanAfrica 0.5 1.4 1.3 0.3 0.9 0.6 0.8 0.9 0.7 South Africa 0.0 1.1 0.9 0.1 0.7 0.5 0.6 0.5 0.6 Others 0.0 1.1 0.9 0.1 0.7 0.5 0.6 0.5 0.6 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 84 Table 5.5: Sourcesof Imports (percent) European Union 60.4 50.0 29.1 31.8 44.9 46.2 37.9 45.8 51.6 Portugal 19.8 20.6 19.9 20.0 14.3 16.8 13.8 18.7 17.7 NorthAmerica 15.2 14.1 12.4 17.6 12.7 11.6 8.6 13.1 12.2 USA 15.0 13.9 12.1 17.3 12.3 10.8 8.5 12.9 11.8 LatinAmerica 2.3 3.9 3.7 6.7 3.5 5.9 5.0 8.2 7.4 Brazil 1.2 1.8 3.5 5.9 3.1 5.2 4.4 6.9 5.6 Asia 9.4 9.0 19.9 9.2 19.5 9.5 28.0 8.7 11.1 China 1.2 1.5 1.3 1.8 0.8 1.7 1.4 2.1 3.5 Sub-SaharanAfrica 10.7 21.6 6.1 7.8 12.3 20.8 16.2 18.7 14.9 South Africa 8.6 19.7 4.7 6.1 10.3 16.8 12.9 15.7 13.2 Others 2.0 1.5 28.8 26.9 7.2 6.0 4.2 5.4 2.8 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: IMF Direction of Trade 154. Many of the problems faced by businesses outside the mineral economy in Angola are associated with the level of developmentof its institutions.As argued in previous Chapters, the appreciation o f the real exchange rate and other phenomena associated with the Paradox of Plenty are per se hard to deal with when the objective i s to foster broad-based growth, but recent research on the drivers o f growth and economic development reveals that institutions also matter a lot.53Broadly speaking, institutions include the various checks and balances that underpin democracy, the laws o f contract and property, and the regulatory mechanisms that underpin the market economy. In a country with weak institutions, the absence o f checks and balances leaves corruption unrestrained, and corruption impedes economic development by generating inefficiencies that block entry and competition. Angola performs poorly in an international comparison o f institutional quality amongst oil-rich countries and has therefore a daunting challenge to promote growth outside the mineral economy (see Figure 5.3). 53 See Collier and Hoeffler (2005); Hausmann and Velasco (2005); Fosu O'Connell (2005); Rodrick, Subramanianand Trebbi (2002); and Rodrick (1999). 85 155. There have been encouraging initial steps to streamline and reform the regulatory framework. To consolidate its pro-market economic policy stance, the government committed itself in2002-03 to overhaul the legislative framework for private sector activity in Angola, which was heavily based on Portuguese commercial codes that date back to 1888. O f the nine main laws, supplemented by various decrees, which constitute the overall legal framework for private investment in infrastructure inAngola, one was revised in 2002 and four are new legislative instruments, which were passed in 2003. These are the Law on the Delimitation o f the Sectors of Economic Activity (revised in May 2002), the Private Investment Law, the National Private Investment Agency Law, the Law on Tax and Customs Incentives for Private Investment, and the Voluntary Arbitration Law (all passed in April 2003). In addition, a Land Tenure Law was passed in2004 with the aim o f clarifying property rights and customary tenure. Figure5.3 ' - kerbailan Weak Governance 160 Countries Strong governance -+ So-rce for aala ,.g t. I % A ? !*>!: ?,o ir?Q..'~ r cr ~ ~ x ~ : ~ O ~ Tn~sicnansnohsestmalesofconlro ofcorr.pl onfor 160co-nrr esa dng I:., : . 2000 01, w in se eciea co,n!r es .no c a m for sirat ve pcrpases Tne vema oars snow me. &ey range of Governance na cators ana tne m apo nis of I lnese oars snow me most I%ey va "e for eacn co.nlry. Tne engln of lnese ranges varies w in me amo-nl of nformalon ava a0.e for eacn co-nlry Co OR are ass gnea accora ng 10 lne fo. ow ng cnlena. Rea. ess inan 30% of overa Icornlries ran*. (Yorse:Ye OH. between 30%and 70%: Green. over 70% .CoLnlrfes' re.alwe pos Ions tn no hay renecl tne offc,a v ews of me norla Ban6 or lne nlernaltona Monetary F.nd 156. Despite these promising efforts there are still significant risks for investors. The main investor risk arises from the provision in the sectoral laws which enable the state to nationalize assets when it deems it inthe nation's interests to do so. However, the Constitution, the Private Investment Law and the sectoral framework laws do guarantee the foreign investor the right to compensation if this occurs, in accordance with international law and international dispute resolution procedures. At this point, there i s also a high level o f regulatory risk in that regulatory frameworks are largely underdeveloped. The only stand-alone infrastructure regulatory body presently in operation (telecommunications sector) does not have an adequate degree o f autonomy 86 from government. Without a more robust legal framework for infrastructure regulation, there i s a high risk o f political intervention in the granting o f licenses and concessions and the determination o f prices. 157. There have been encouraging measures to improve access to credit, but resultshaveyet to materialize.A recent report by the OECD and the AfDB quotes that Novobanco, a micro-finance bank also active in other Southern African countries, has developed financial instruments and a system o f credit lines that bypass red tape hampering access to finance for established businesses. According to the report, in the three months since its opening in Luanda in September 2004, the bank had already extendedmore than 120 credit lines in a total amount o f $600,000 (the average loan was for $5,000, maturing in 3-5 years, at a monthly interest rate o f 4%), almost entirely to clients operating in the trade sector. Such a successful uptake was made possible by the flexible formula offered to small entrepreneurs,which includes a no-fees account with no minimum balance, informal guarantees (house assets and a guarantor) and an ongoing relationship with loan officers. A network o f such officers i s responsible for assessing portfolio quality and monitoring clients, for which they are paid performance-related salaries. The report notes, however, that the USAID-financed scheme lacks a technical assistance component, which i s considered one o f the main requirements for small business de~elopment.~~ 158. Other equally encouraging initiatives have been launched to foster private sector development. As previously discussed, these include a new investment law that provides equal treatment to foreign and Angolan firms (with exceptions); a new commercial code enacted in early 2004 to replace the 1888 commercial code and the 1901 law on limited-liability companies; the establishment o f the National Private Investment Agency (ANIP); and the creation o f a one-stop registration office for companies (the so-called Guichk Unico). One o f constraints that this new office faces i s concerned with delays in the publication o f new firms by the Didrio da Repziblica due to lack o f representatives from the national official press in the Guichk Unico. Additional provisions will be required before the new commercial code becomes fully effective while the one-stop registration office has yet to show practical results. 159. There have been positive initiatives to reduce barriers to competition, but these are still strong. The telecommunications sector i s the only sector for which a regulatory body has been established and significant challenges remain to be addressed on that front. Despite the move towards liberalization, additional progress can be made in introducing competition by removing barriers to entry and in particular by licensing additional mobile service providers. Angola Telecom remains a dominant monopoly provider in many areas, as new entrants who could make a difference face in practice numerous obstacles such as the non - transparency o f tariffs or the inability to obtain timely and cost-effective interconnection. These obstacles further result in lack of competition, high prices, and a communications infrastructure limited mainly to 54The OECD/AfDB report also highlights that, recently, other initiatives have combined lines o f credit to small businesses with training and technical assistance. Inparticular, a local bank, Banco Sol, has gradually started financing individual businesses from its traditional clientele, requiring informal collateral and relying on international NGOs for monitoring and assistance to the clients. 87 businesses and government, and to major urban centers. Additionally, there are some constraints in the legal and regulatory framework. There remain overlapping responsibility areas between INACOM, the regulator, and the Ministry o f Post and Telecommunications, and the regulator has only a limited measure o f autonomy. As o f 2003 private investment was not authorized in the basic network infrastructure and it i s therefore unclear which services are left to the newly licensed public fixed line operators. The telecommunications sector inAngola is hinderedby the lack o f a clear, effective and transparent regulatory framework. INACOMfurther faces difficulties with lack o f skilled staff. 160. A number of privatizationshave taken place, but the privatizationprogram needs to be revamped. In 1989, a public agency, GARE (Gabinete de Redimensionamento Empresarial / Cabinet of Enterprise Redimensioning), was created to co-ordinate and execute the privatization program o f State companies. The program was divided into two phases. Phase 1 was implemented in the period o f 1990-2000 and accounted for the restructuring and privatization (global and partial) o f 409 companies yielding some US$lOOmillion to the Government. In 2001, the government launched phase 2 of the privatization program covering the period 2001-2005. This program involved about 90 public companies, most o f them being from the previous program. Those companies are part o f the following sectors: fishing, trade, hotels and tourism, transport, agriculture, manufacturing, oil, geology and mining, electricity and water, communication and financial. Official data indicates that the biggest volume o f revenue inthis phasewas reached in2002, whenprivatizationhadraisedabout US$14million. In the first six months o f the current year, the State collected US$2.5 million from the privatization o f 8 companies. Total revenues o f US$ 20.5 million have been collected since the second phase o f the privatization program was launched in 2001. By The privatization o f 4 beer companies (CUCA, NOCAL, N'GOLA and EKA) i s expected to be completedbefore the end o f 2006. 161. The creation of a nationaldevelopment bank of Angola will not help private sector developmentif the business environmentdoes not change. The authorities have announced the establishment o f a national development bank which will direct some 5% o f the government's oil revenues for subsidized lending to the private sector without collateral or an adequate equity stake. Several countries have tried the same route and failed, including Angola in the past. The international evidence suggests that such institutions promote inefficiency and moral hazard and that they are prone to governance problems, including elite capture o f subsidized capital and the emergence o f non- performing loans. More effective ways to improve access to finance for micro, small and medium-size businesses include microcredit, venture capital, and supportive action on contract enforcement. But none o f these options will be successful in promoting private sector development ifthe overall business environment inAngola does not improve soon. 162. There is a world of opportunities for investment in Angola both in the mineral and non-mineral economies that can be realized by removingbarriers and constraints to the investment climate. As described in Chapter 1, Angola is blessed 88 with natural resources, profuse climatic diversity, and a hibernating market economy. With the advent of peace since 2002 the country now faces the daunting challenge of channeling its huge resource endowment into reconstruction o f its infrastructure and into poverty reduction activities. However, inthe aftermath o f the civil war, improvements in the competitiveness o f the local industry and efforts to diversify the economy away from the mineral sectors remain hampered by inadequate infrastructure, poor governance indicators and a less than adequate business environment. In what follows, a few suggestions on how to address these issues are discussed. 163. A first step to improve the business environment is the definition of a clear set of priorities. Improvements in the investment climate in Angola will require reduction in unjustifiedcosts, risks, and barriers to competition. Inpractice, costs, risks, and barriers to competition are a function o f government policies and behaviors that play out through a wide range o f specific policy areas. But where should Angola begin?No reform o f any kind can be successful if a clear and consistent list o f priorities i s defined. In defining the priorities for reform, the authorities need to consider the current conditions inthe country, the potential benefits from improvement, the links with broader national and regional goals, and implementation constraints. A good way o f starting this priority setting exercise in Angola could be through the structuring of a dialogue mechanism between the public and private sectors. The establishment o f a consultation mechanism between the government and the private sector i s a critical element to secure a private-sector-led growth agenda. 164. Effective prioritization and sequencing can be done through formal consultations with the private sector. To accomplish this, it is first necessary to institutionalize such mechanism and the first step inthat direction could be the realization o f an annual private sector conference. To be effective, this meeting would require the presence o f senior Cabinet members. In some countries, such as Senegal, Malaysia, Mozambique, and Zambia to name a few, the Head o f State presides over the meeting. The private sector and the authorities should then determine together the sequencing and prioritization o f the necessary reforms. In that instance, starting up with "quick wins", such as the adoption o f the reduction in the time and cost for the registration o f a business55,necessary adjustments in labor market legislation, among others, seem to be ~ a r r a n t e d . ~ ~ 165. In parallel to consultation with the private sector, the authorities can also carry out an inventory of the regulatory environment in Angola in the very short term. The authorities should carry out a systematic inventory of existing rules and 55For example, there is a need to reduce the minimumcapital requirement for the establishment o f a limited liability company which i s currently set at $20,000 and the requirement for a down payment o f at least $6,000 that must be paid inbefore an enterprise i s established. 56Additional details regarding the structure and operation of this mechanism could be developed through a specific study on this topic, which would also be based on additional consultation with stakeholders. 89 regulations which affect the country's investment climate. This should not only include an analysis o f general restrictions for how to setup a business, but also sectoral analysis. Such a review could be done by an independent and professional team o f consultants, with the participation o f the private sector. The objective o f the comprehensive review i s to identifythe existing investment climate constraints in a systematic manner. Once these constraints are identified, a time-bound action plan to revoke and/or simplify rules and regulations that cannot bejustified or are cumbersome would be drawn up. Initiatives to that effective could be taken also inthe very short term. The World Bank could assist the authorities on this regard through its Investment Climate Assessment (ICA) report. 166. Another short-term action is concerned with the reduction of the time requiredto register businesses in Angola. Inorder to address this issue, it will also be necessary to streamline the requirements for business registration and integrate the operations o f all institutions involved in this process. The three institutions involved, namely the Notary Office, the Public Commercial Registry (Conservatdria de Registos Comercial) andthe State's Printing Office, (Imprensa Nacional) should be merged into a joint Management Information System (MIS) so that the relevant public officials from any one o f them can retrieve the information entered by another institution, process it and make it available for processing by yet another institution involved in the registration. Under such an MIS, the Notary Public would prepare and make available the public deed o f incorporation in an electronic version. Moreover, on the same day, the Consewatdria de Registo Comercial will be able to record extracts o f the public deed o f incorporation and register the company. The same electronic document would then be made available to Imprensa Nacional for publication, while other necessary steps, such as the various inspections o f the enterprise, are being carried out. Naturally, incorporation o f business would needto be centralized at the country level so as to avoid different registries issuing the same name for differententerprises. 167. In the medium term, reforms that can enhance the potential benefits of changes that can be introducedin the short term should be favored. The impact o f any policy improvement will depend on how it addresses a constraint that i s actually bindingon firms. For example, clarifying rights to land can help ease access to credit by f i r m s and households - but only when it i s relatively straightfonvard to start a business and register property. Another example i s that reducing barriers to competition will not deliver its full potential ifweak bankruptcy laws slow the exit o f less efficient firms, or if labor market policies limit the ability o f firms to adjust production processes to respond to a more competitive environment. Similarly, efforts to encourage local R&D can be hobbled by shortages o f skilled workers, limited competition, or weak intellectual property rights. 168. Improvementsin trade facilitationshould ease some of the constraints to the investment climate. An efficient transport system, customs administration, and health and safety standards infrastructure are essential to developing a cost-effective trade network. The Government has already initiated steps to reform customs administration. The program should include upgrading equipment and infrastructure, integrating border 90 agencies, reducing border clearance time, and training staff. Angola will also need to develop a standards infrastructure and testing services to be able to export agricultural products in the future. As a country with a lengthy coastal line and a number of neighboring land-locked countries, Angola has the potential to provide port and transit services to its neighbors. To realize this potential, it i s necessary to develop a transit strategy and to harmonize customs procedures in collaboration with neighboring countries and SADC. 169. To complementthe reformsassociatedwith the regulatoryburdeninAngola, restrictions to property and land registration should be eased. As a first step, it is critical that land registration be facilitated. As mentioned above, it currently takes 335 days to register property with a cost equivalent to 11% o f the property's cost. The Angolan authorities could facilitate the formal registration o f land by reducing both the time and cost required to register it. Additionally, the government could scale up the allocation o f land to private investors, who could then develop the area. This approach has the dual advantage o f generating the funds necessary for infrastructure development and decreasing the price o f formal land. Relaxing tenant laws, zoning restrictions and buildingcodes is also a relatively easy and quick way to increase formal land availability. 170. It will also be necessary to revise labor regulationsto introducedynamismin the labor market.InAngola, when an employer decides for operational reasons that s/he needs to dismiss an employee, actually doing so requires a highdegree o f persistence and patience. The terms and conditions for employment termination are costly, time consuming and cumbersome. It i s important to note that from an investor's perspective a barrier to firing i s also a barrier to hiring. Therefore, it i s important that the cost o f dismissal be reduced, but this has to be done while still ensuring the protection o f workers' rights. A revision o f the Labor Law should be guided by the principle o f adequately balancing the flexibility o f firms to adjust their work forces in response to market forces and the need to protect workers' rights. It i s equally important to ensure that the amount o f severance payments and the limitations on working hours need to be brought inline with Angola's competitors and international best practice. 171. To realize the potential benefits of policy reforms, the authorities need to introducemeasures that can catalyze changes. Change tends to occur when something shifts the incentives for maintaining the status quo. International experience illustrates how a diverse range o f factors can trigger policy change even inthe face o f resistance by beneficiaries o f the status quo. Those triggers can include external shocks and crises, technological change, new opportunities, new information and institutional competition, political change, and the initiative o f policy entrepreneurs. In Angola, the potential benefits o f policy reforms can only be realized if the bottlenecks to improved productivity and productive capacity in the nontradable sector of the economy can be removed. These bottlenecks are usually associated with the Paradox o f Plenty and are concerned with physical and human capital limitations that constrain the expansion o f the supply ofnontradables. 172. To promote the expansion of the supply of nontradables and thus act in a catalyst way, it will be necessary to strengthen governance institutions, invest in 91 physical and human capital development. The government is already promoting investments in roads, ports, telecommunications, energy transmission, and training of skilled workers. In what concerns the development o f human capital, the authorities should consider ways to attract skilled diaspora Angolans. As discussed earlier, the lack o f human capital i s a severe constraint, especially in the public sector. At the same time, there i s a large pool o f highly educated Angolans outside the country. A major obstacle to their return is that the cost o f an equivalent lifestyle is so much higher inAngola than in Europe or in the Americas. As oil wealth grows, one possible use for it would be to subsidize the return o f key diaspora Angolans, perhaps through upfront grants for housing and education. There would obviously be costs in terms o f divisiveness, but similar exercises have been successful in other countries such as Guinea-Bissau, Afghanistan, and Georgia, for example. In addition, it i s important to be aware that improvements in the business environment will bring about the destruction o f some jobs and the creation o f new ones. This will require compensatory policies that target the most vulnerable groups with social programs (see Chapter 7 for a proposed approach). 173. The authoritiesalso need to establish a long-term strategy to take advantage of trade agreements. Angola needs to determine its long-term trade interests and participate actively inregional and global trade negotiations to ensure that its interests are adequately reflected in future outcomes. Regional markets are important for Angola for non-mineral exports. It i s advisable that Angola explores the terms upon which it might enter the SADC FTA. Maintaining market access to the EU market does not require Angola to sign an EPA unless it offers benefits beyond those provided by the EBA Initiative. To be beneficial to Angola, it is essential that an eventual EPA contains (a) improvements in the EBA and the Cotonou rules o f origin (ROO), (b) increased financial assistance to address supply side bottlenecks and to offset the revenue loss from lower tariffs on imports from the EU, and (c) adequate flexibility in EPA design to accommodate differing conditions among the countries within the SADC group. The Cotonou Agreement recognizes the need for developmental support from the EU to the signatories. Therefore, a successfully negotiated EPA would enable Angola to receive financial support from the EUto improve the production capacity. When the production capacity improves, Angola would be in a position to export particularly, agricultural commodities, to the neighboring SADC members duty- and quota-free under the SADC Trade Protocol. 174. Improvements in governance and anti-corruption actions are also required to unleash the full potentialof private-sectorled growth. Governance and corruption remain a sensitive and misunderstood topic that i s usually avoided in policy dialogues, but it is not by avoiding the problem that it will go away. Recent research has extensively examinedthe impact o f governance and corruption on development. The empirical results generally show that countries can derive a very large "development dividend" from better governance. The World Bank estimates that a country that improves its governance from a relatively low level to an average level could almost triple the income per capita o f its population in the long term, and similarly reduce infant mortality and illitera~y.~' Governance also matters for a country's competitiveness and for income distribution. In 57See, inter alia, Bellver and Kaufmann (2005); and Kaufmann et al. (2005). 92 VI. REMOVINGOBSTACLESTOAGRICULTUREAND RURAL DEVELOPMENT Angola is a natural food and cash crop producer where agriculture can play an important role to support growth outside the mineral economy, provided that macroeconomic issues and agricultural policies are appropriately addressed. On the macroeconomic side, there is a high risk that the impact of an overvalued exchange rate can rapidly undermine agricultural competitiveness while at the same time budget execution rates for the agricultural sector remain extremely low. A realistic vision of thefuture for Angolan agriculture should include a mix of commercial and familiar farms. I n this context, public agricultural policies should primarily focus on the development of smallholders but, at the same time,foster a conducive environment to encourage investments in theprivate commercial sector. This Chapter revisits these issues while also addressing the need to promote institutional reforms, including the strengthening of recent decentralization efforts, the revision of investment allocations and the role of the Ministry of Agriculture and Rural Development - MINADER - in the development of the agricultural sector. 176. In line with the current reality in Africa, the large majority of the poor in Angola lives in rural areas. Inthe whole o f Africa, roughly 80% o f the poor are in rural areas, and even those who are not will depend heavily on increasing agricultural productivity to lift them out poverty. As producers, 70% o f all Africans (and nearly 90% o f their poor) work primarily in Agriculture. As consumers, all o f Africa's poor (both rural and urban) count heavily on the efficiency o f the continent's farmers, since farm productivity and production costs are fundamental determinants o f the prices o f basic foodstuffs which account for 60-70% o f total consumption expenditure by low income groups.58 In Angola, between 60% and 70% o f Angolans earn their living from agriculture, which currently accounts for less than 10% o f GDP. According to the "Inquerito aos Agregados Familiares sobre Despesas e Receitas" (2000/200 l), 94% o f rural households were poor, compared with 57% inurban areas, due to the isolation from essential services and markets, and the destruction o f their crops and livestock. 177. Agro-climactic conditions in Angola vary widely and there are large sparsely populated areas which are underutilized. The central highlands contain large areas with good rainfall (1500-2000 mdyear), relatively moderate temperatures, and are also the region with the highest population density. It is estimated that more than 2/3 o f the rural population live in this area. Soils, though adequate in some micro regions, are generally depleted o f at least some macronutrients and require fertilization for sustained cultivation. The coastal and southern areas are far dryer, with average rainfall o f less than 100 mdyear in southwestern desert areas and between 500 and 1000 mdyear in the four southern provinces of Namibe, Huila, Cunene and Cuando Cubango. Irrigation i s essential to production in these zones, and fortunately there are 58See Gabre-MadhinandHaggblade(2003), andWorld Bank (2000). 94 abundant surface and subsurface sources, many o f which have been developed to some degree. While population is densest in the high potential areas o f the central plateau (Bie, Huambo, Kuanza Norte, Malange, Uige and parts o f Benguela and Kuanza Norte), there are large sparsely populated areas, especially in the east, which are capable o f supporting much larger populations than at the presenttime. 178. The successful performance as an exporter of agricultural products vanished with the war. The country was once the world's third largest exporter coffee. Maize was also a major export in the 1 9 7 0 ' ~amounting to more than 400,000 MT in its peak year, almost all o f which ~ was produced by smallholders. Cotton, sugar cane, sisal, bananas and wood also used to be important cash exportable crops. After independence, most o f the settlers left the country and many o f the former commercial farms and plantations were converted into state farms, which have now been privatized. A large number of rural inhabitants either fled or reverted to subsistence production. Moreover, infrastructure suffered greatly with widespread destruction o f roads, bridges and warehouses together with the presence o f thousands o f land mines in rural areas resulting ina virtual collapse o f the marketed production. 179. The country is well endowed with agricultural resources which remain mostly untapped. Staple crops range from cassava in the humid north and northeast to maize in the central highlands and sorghudmillet in the dryer southern provinces. Potatoes are an important crop in the central plateau and rice i s also grown over large areas in the north. Cattle i s raised over broad areas in the central plateau but are particularly important in the southern provinces o f Cunene, Huila, and Namibe where there are an estimated 3 million heads o f cattle. Coffee, the most important cash crop during colonial times, grows well in the highlands from Uige and Malange through Kuanza Norte and as far south as Huambo and Bie. 180. Recent increases in agricultural production are encouraging, but yields still are remarkably low. Cassava has experienced the largest increase in production since the cease fire agreement and the current production amounts up to 6 million tondyear. In the case o f maize, production has reached pre-war levels over the last 2 years, averaging 600 thousand tondyear. Coffee production, however, i s reduced to one tenth when compared to levels registered 30 years ago (see Figure 6.1). Accounting for population growth over the last 40 years, there has been a reduction o f roughly 60% inper capita terms inthe production o f cereals whose consumption has beenpartially substituted byroots andtubers - whose production per capita has increasedbymore than 70% (see Table 6.1). Furthermore, Angola still presents remarkably low yields when compared to other African countries. The only exception i s cassava, whose yield i s very close to the average (see Table 6.2). Although there is substantial room for improvement a doubling o f yields would still leave Angola in the lower ranks o f the range o f yields found in comparator countries. In the authorities' view, large investments to improve the quality o f the soil will be requiredbefore large scale agricultural production can contribute again in a significant way to the country's economic output. 95 Figure6.1: Estimatedhistoricalproduction of major crops,in thousandtones (1961-2003) ..~......"......I...... ...... ." .....ll.l...".l." l."l ".""l..l "..I" ..... "I I ....... 7,000 6,000 5.000 4,000 E 8 F e 8 300 -- 8 3,000 2,000 1,000 0 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 Source: FAOSTAT year Table 6.1. Production of selected farm products,intones and in kg/per capita (1961-2003) Maize All Cereals Roots and Tubers Coffee Per Per Per Per Popn Capita Capita Capita Capita Year (000) Total (ton) (kg) Total (ton) (kg) Total (ton) (kg) Total (ton) (kg) 1961 4,890 430,000.00 879.00 540,000.00 1,112.00 1,355,000.00 2,771.00 168,000.00 344.00 96 Table 6.2: ComparativeYields for Key Crops, 2003 Cassava 8 835 8 850 100 Millet 703 350 50 Groundnut 855 390 46 Beans (dry) 608 220 36 Coffee (green) 448 19 4 a/FAOSTAT ADril2004. b'FAOlWFP Clop and Food Supply Assessment Mission to Angola, 2003 (exceptcoffee, from FAOSTAT). 181. The inevitable overvaluation of the real exchange rate in Angola will remain as a key constraint to the competitiveness of agricultural products. The typical overvaluation o f the currency in real terms observed in oil-rich countries can be a major disaster for the agricultural sector. In Angola, for example, every farmer wishing to produce maize for the coastal urban market has been effectively taxed by the real appreciation o f the Kwanza, especially over the past 2 years. Casual evidence indicates that they may not be competitive with imports at current exchange rates, but that they enjoy some de facto protection in the interior due to the extremely poor roads. It i s thus clear that once the logistical infrastructure i s rehabilitated, the rural farm production will have to compete with cheap imported goods and tradable commodities, such as cereals. Inthis case, a possible way to prevent widespread depression in the agricultural sector i s byrapidly increasingits competitiveness. 182. In the face of an overvalued real exchange rate, the country should explore possibilities for reducing agricultural unit costs. The country has a better rainfall than many o f its neighbors, has substantially lower yields, and has been cut off from technological advances in new varieties or other areas for decades. Cutting costs may take time and so further tariff reductions for agricultural trade should be implemented only as productivity improvements are realized. The key question, however, i s whether productivity gains can be large enough to offset the disadvantages posed by the strong currency and hightransportation costs. As there i s no clear indication as to what i s the actual cost structure o f production in Angola, this question can only be answered through a case by case accurate crop budgetanalysis. 183. The recent experience of Nigeria can be relevant for Angola' Due to competition from artificially cheap food imports, made possible by the appreciation o f the real exchange rate, producers in the major agricultural regions could buy imported food at the farmgate at prices below their own production costs. The result was a collapse in domestic production and a conversion o f what had been one o f Africa's largest agricultural exporters into one o f its largest importers. Another important consequence o f the oil boom and the ensuing overvaluation o f the domestic currency in Nigeria was that the agricultural GDP fell on a higher level than that 97 observed for agricultural employment while more than 60% o f the country's arable land remained idle.59 184. Increasingthe priority given to agriculture and rural development through budget allocation will be an important measure to strengthen the sector. Budget allocations to the Ministry o f Agriculture and Rural Development (MINADER) in 2004 reached AKZ 2.3 billion (approximately US$25 million). This represents only 0.64 percent o f the national total budget. Capital allocations to the agricultural sector have been somewhat better, at just under 2% o f the Public Investment Programme (PIP), or AKZ 1.5 billion. Some AKZ 5.9 million were also budgeted for irrigation development in the separate 2004 Infrastructure Rehabilitation Programme (PRINF) controlled by the Ministry o f Public Works. It should be noted that a considerable portion o f the PIP - over 40% - was allocated to provincial governments in 2004. O f this amount, an analysis o f provincial expenditure budgets indicates that a total o f 8.2% (approximately AKZ 4 billion) were assigned to agriculture and other rural purposes; 2.3% (AKZ 1.65 billion) were purely for agriculture, mostly in the form o f irrigation rehabilitation. Non- irrigation infrastructure absorbed the majority o f provincial capital expenditures. 185. But budget allocations alone do not suffice as it is the actual budget execution that counts - and in this area serious improvementsare needed in Angola. A common feature of the budget cycle in Angola i s that the inclusion o f expenditures in the State budget does not automatically guarantee that the funds are made available to the Ministry in question. Specific expenditure authorization has to be obtained from the Ministry o f Finance and this is granted in tranches during the financial year, with a percentage heldback for contingencies. Therefore, it i s not necessarily the case that all budgeted expenditures are, in fact incurred. According to MINADER officials a significant, but not quantified, proportion of the budget has not been authorized over the last years, thus reducing expenditures below the budget figures. As a result, almost the entire disbursed budget i s destinedto personnel costs, penalizing current costs, such as fuel for the extension workers to visit farmers. 186. Much of the institutional apparatus of the Angolan government is unchanged from its command-economy structure of the past and needs to be revised. Decentralization of services, through the support o f rehabilitation and capacity building at the provincial and local levels i s critical. Despite the approval o f a National Strategy for Decentralization in 2001, many aspects o f the proposed decentralization policy remain undecided and it i s still unclear which level o f Government will have authority over different activities, and from where they will obtain the necessary financial resources. The absence o f a clear decentralizationpolicy has increasedthe difficulty o f rehabilitating and maintaining rural infrastructure and services. In particular, extension services are located at the municipality level and it i s there that assistance should have the greatest impact on target populations. 59 The Nigeria case has been exhaustively studied both within the World Bank and outside of it. Major studies include those by Gelb et. al. and Lele et al. in the 1980's and Schiff and Valdes in the 199O's, which document the evolution of the real exchange rate and its effects on agricultural production inthe interior of the country. 98 with the.emerging domestic production of cereals. The lack of adjustment on such programs has been an important deterrent to domestic production in some countries facing post-conflict situations. An illustrative example o f this market distortion was identifiedin the beginning o f the 1990's in Mozambique. It was noted that local prices for maize were highly correlated with shipments o f food aid in the post-conflict period, demonstrating the ability of large food aid shipmentsto depress localprices, andpenalizing domestic production.60 190. Existing marketing controls need to be reviewed. In the area o f marketing and distribution the government has long ago ceased to set prices centrally, but it i s still in the businesso f setting wholesale and retail margins. These regulations are stated as limits o f 25% on each o f three market levels: producer or importer to wholesaler, wholesaler to retailer, and retailer to consumer. Though these laws are only sporadically enforced, they remain a distinct barrier to progress in the area o f marketing. The standard prescription for exploitative marketing and trading (if it i s occurring) i s some combination o f two strategies. One i s to promote the entry o f more traders into the market to provide competition. The other is to provide farmers with some measure o f countervailing power through the development o f producer associations. Government controls have demonstrated in Angola and in many other countries that they result in a poorly developed trading network and poorly serviced farmers. See Box 6.2 for a glance at the case o f Brazil. 191. The government should not engage in public productionor market activities. While the government has divesteditself of many o f its large state runoperations inthe sector, there is still a tendency to look to the government for things which in the past were done by parastatal organizations. Perhaps the most obvious o f these i s the state agricultural machinery company, MECANAGRO, which i s now re-extending itself into rural areas after decades o f virtual total absence. Recently, MECANAGRO has started to offer subsidized sales o f seed and other inputs, undercutting possible private sector development. A standard rule o f thumb would be that the government would not be responsible for any activities inside the farmgate, nor would it be responsible for any marketing services on the input or output side.6' 192. There is scope to revise the current policy of distribution and subsidized sales of fertilizers. The distribution of subsidized fertilizer by the government i s extremely detrimental to market development since a viable fertilizer supply system will depend on demand from commercial farmers as well as small farmers to be viable. As an interimmeasure to deal with the market's inability to overcome risks associated with input markets, the Government could auction donated or other fertilizer imports inprovincial capitals. In the longer term, consider guarantees to support financing o f private sector imports and consider the feasibility o f domestic production. To stimulate demand, implementation o f a targeted fertilizer voucher program similar to that used inMalawicould also beconsidered. This has the virtues o fbothstimulating demand andreducing risk for the private sector while keepingthe government out ofthe businesso f direct distribution. This is an option that should be studied extremely carefully before going ahead given the very 6oSee Dunovan (1996). 61 Another example i s INCER (National Institute o f Cereals) that remains the owner o f various warehouses in varying states o f disrepair in grain producing zones and along transport routes. The example o f Mozambique is useful inthis regard, where the government grain board rented or sold such facilities to the private sector in order to promote private sector marketing development. Clarification o f INCER's mission in the future would be a useful step. 100 large optimal scale o f fertilizer plants and the less than stellar record o f such facilities in developing countries. Nevertheless, the ready availability o f raw materials in Angola makes it at least a viable candidate for a feasibility study. 193. In order to function properly and effectively contribute to the development of the agricultural sector, it will be necessary to promote performance-enhancingchanges in MINADER. Currently, MINADER is responsible for agriculture, irrigation, forestry, food security, issuance o f rural land titles (although it has recently lost its role in cadastral and land registration to the Ministry o f Urban Affairs), agricultural research and agricultural extension. To improve its effectiveness the Ministrywould benefit from: > Performing an overall manpower study of MINADER in order to identify redundant or unproductive positions and formulate a plan for their elimination. > Reforming the structure of MINADER to strengthen the extension and research services, and pursue a unified management with the explicit mission of improving conditions o f smallholder agriculture. This could be accomplished through a joint researcWextension committee with oversight responsibility staffed with representatives from the research institutes, the extension system, the university faculty o f agriculture, and farmer associations. P Creating a high level policy analysis unit in MINADER capable of analyzing policy alternatives and appraising projects according to commonly accepted standards. This would require, at least, (i)adequate training and education for existing staff; and (ii) recruitment o f new staff trained ineconomics. > Improving the existing statistical unit within MINADER that would liaise with the National Institute o f Statistics and the Ministry of Planning to design a national agricultural survey to establish baseline data regarding areas planted and amounts harvested (to be carried out by INE). 101 194. The agricultural sector in Angola faces several constraints to competitiveness.A scorecard was prepared by World Bank staff based on existing information about four main categories of factors that affect competitiveness in agriculture: (i) macroeconomic environment; (ii) structural issues; (iii) natural resource endowments; and (iv) vulnerability and risk. The full details o f the scorecard are attached in the annex to this Chapter. The scorecard findings indicate great potentiality in expanding agricultural activities once structural issues concerned with the quality of infrastructure and institutions are resolved. Major challenges involve the management of the real exchange rate and improvements inthe allocation o f funds and betterbudget execution rates for the agricultural sector. 195. The developmentof the sector will requireinvestmentsin infrastructureand a better regulatoryenvironment.A realistic vision o fthe future for Angolan agriculture should include a mix of commercial and familiar farms. This is an important debate in the country and it should influence the types o f approaches and the priorities adopted in channeling support to the agricultural sector. Both need improved transport infrastructure, a modem marketing system and a conducive regulatory environment. The large smallholder sector in Angola i s accustomed to producing for the market and has demonstrated a large capacity o f responsiveness to market incentives, which can be seen as a natural comparative advantage inrelation to other sectors. 196. In order to build on comparative advantages, obstacles to the development of the smallholder sector should be removed.There are excellent reasons to emphasize assistance to smallholders. The main reason i s that these households, constituting a majority of the Angolan population, are less able to make needed investments than larger farmers. There are also compelling reasons at both the micro and macro levels for such an emphasis. At the micro level the need for an emphasis on aid to smallholders can be summarized as economic efficiency, poverty reduction, social cohesion, and political reconciliation. At the macro level, such an effort i s critically important for the following reasons: potential food deficits (about half of Angola's grain needs are currently met through imports, much o f these free or concessional), long term development, and impact o f oil economy. 197. A key goal to be pursued is the reactivation of rural-urban commercial circuits which can generate a self-sustaininggrowth dynamics.Ruralproducers, both large and small, need assistance in realizing the country's underlying comparative advantage in agricultural production. Producing for already existing food markets in cities as well as supplying newly reactivated manufacturingwill ensure integration o f rural areas into the economy on the output side. On the input side agricultural development will increasingly rely on purchased inputs while risingincomes will generate demand for manufacturedconsumer goods. The most striking gap in many areas is the near total destruction of rural marketing institutions and infrastructure. Without 103 outlets for their produce, smallholder development at the farm level will be for naught. Among the mostpressingneeds for promotion the smallholder development are: P Road, bridge and rail rehabilitation and demining: Many villages live in near total isolation. Improving market access and rehabilitating roads to the point where vehicles can easily pass will go far toward promoting market activity. It i s estimated that some 80 percent o f the road network i s in very bad conditions, and most o f the rail network i s closed apart from a few short-haul services near the ports. The end o f civil war has opened the way for a large increase in road transport, and about 50 percent o f the primary road network has beenreopened to traffic according to government estimates; considering the relative weight of the transport on the final value o f farm products and food, the rehabilitation o f roads will provide a major benefit to both the agricultural sector and to the consumers, notably those who live in the interior areas o f the country and cannot benefit from the cheaper prices o f the imported food close to the ports. P Strengthening of farmer associations: Producer associations have proven effective in the Angolan context in supporting marketing by smallholders as well as providing a way to mediate support efforts interms o f credit, extension, and input purchase. P Incentives for irrigation: Despite the dominance o f rainfed agriculture in Angola62, irrigation can be important to maintain year-round production o f food and vegetables. The sharp and rapid transition between the coastal plain and the plateau provides a great number o fpotential sites to establish reservoirs and major diversion structures to regulate flows and to irrigate the extensive lower floodplains. The morphologies o f the central highlands and eastern zone presenta highpotential for small river diversion structures and small storage tanks. But care needs to exercised in promoting irrigation to avoid uncontrolled and unbalanced expenditures that will not reach smallholders. P Address land issues: The institutions responsible for land tenure, cadastre and registration to ensure greater transparency and protection for the rights o f smallholders should be reformed. Special attention should be given to the finalization o f the legal framework surrounding land titling based on a participatory process. Current donor efforts are piloting approaches in land reform, which need to be evaluated for potential duplication and support inadditional areas o f the country. P Decentralized Extension Services: The Government has recently announced a general plan to decentralize government functions; this deserves a further assessment and financial support at the decentralized level as well as assistance in defining the relationship between extension, farmers and the central government. 62Three main types o f irrigation prevail in the country: (i) to medium scale irrigation schemes fully or partly large equipped with water control works; (ii) small scale gravity or pumped schemes; and (iii) lands and depressions low utilizing water conservation farming practices. According to the available data, there were around 100,000 ha o f land that are irrigated in large/medium scheme, o f which roughly 39,750 ha are reported to be "operational" in 2004 and less than 20,000 ha for small scale model (against more than 300,000 ha in the pre-war period). 104 > Agricultural Research: The principal agricultural research institutions, IIA and IVA, were almost completely destroyed by the war. Reconstitutingthese as institutions directly responsible to their client population o f small farmers i s a key element in promoting improved farm technologies; technical cooperation between Minader and other key players in the research o f tropical crops, such as IARS, CGIARs andor the Brazilian Embrapa would also make it possible important improvements and quick gains to the system. Sustainablemanagementof naturalresources: Angola has a tremendous natural resource base in land and water, biodiversity, forestry and fisheries which are critical assets to support sustainable livelihoods and poverty reduction inthe country. However, there i s a severe limitation o f data and information which currently relies on occasional technical studies, selected and deficient government statistics, mostly financed by donors, and thus not necessarily systematized and incorporated in government planning. As the majority o f the population in Angola i s alienated from the oil and diamonds economy, the sustainable use o f natural resources basically means the survival o f present and future generations. It i s therefore extremely urgent the generation o f baseline information about the country's natural resources so that they can be actually managed. 198. The next Chapter discusses palliative measures to improve the welfare of the poor. The recommendations o fthis Country Economic Memorandum so far have focused on: (i) to how manage appropriately the mineral wealth; (ii)how to improve the business environment to facilitate the diversification o f the economy outside o f the oil sector; and (iii) to unleash the how potential o f the agricultural sector. Addressing all o f these issues would bring the Angolan economy close to a path o f sustainable and equitable growth. But this will not happen with the speed and the amplitude that many would have hoped, as structural reforms take time to yield concrete visible results. The next Chapter discusses instances in which the Government can use palliative measures to improve the welfare and the livelihoods o f the poor while the economy moves to a path o f sustainable development. 105 Annex 1 Customs tariffs and consumer taxes applicableto importedagriculturaland relatedgoods Current kes (%) New rate ' (%) Item Merchandise Import Export Import Export Consumer tax (%I Live animals (cow, pork, goats) 5 2 10 -purerace reproducers 2 0 0 Milkand derivatives (butter & 5 5 5 cheese) Roots (potatoes, onions, garlic), 5 1 2 10 beans Fruits(freshand dry) 5 10 10 -banana 10 15 Coffee (green or roasted) - tea 35 30 30 5 5 < Cereals (wheat, maize, rice, 2 1 2 1 2 sorghum) Flour (maize, wheat, rice) 10 15 1 10 Seeds (oilseeds, grains) 5 1 2 1 2 bulk 5 refin 10 non-ref Crude animal & vegetal oil 5 1 2 1 2 (pork, soya olive, sunflower) -refined inbulk 5 1 5 1 5 -refined and bottled 5 1 10 1 10 Canned meat (beef, pork) 20 2 20 2 15 -fishand seafood 20 1 20 1 15 Refined sugar (cane & other) 5 1 1 "10 -non-refined 5 5" Canned fruits and vegetables 10 1 10 1 10 Extracts, essences, spices, 30 2 5 1 0 raw mat. sauces 10 -yeast 5 5 5 Drinks(water, ethyl alcohol) - alcoholic 30 2 30 2 20 drinks 35 30 2 30 Fertilizers 2 2" " 2 2 Soaps 5 < 10 Farming implements (machetes, 5 1 2 1 2 scissors) Equipment and machinery - water pumps -coldrooms 2 2 2 -scales 10 10 2 -earthworks 2 2 -plows, grades, discs, 2 2 cultivators, sprayers 2 2 -tractors 2 2 Merchandises imported are, inaddition, SI Isubjecttothefollowing charges:a .valorem stamptax (0.05%); custom service dity (5%); port charges (EP14 & EP17) estimated at 3%; transport charges (10%). 1/ The new tariff rates were approved as o f March 1,2004. Consumer tax rates remain unchanged. 106 ;e 2 3 r E e a, n E P E m a, c E c i m c e! m 2 B a, X E e 3 - 4 a, E n n h m w z3 .- s v) c W c a 0 L 3 2 -0 m c r m r H e c m k E 2% 05 r cu cu m 2 3 c-4 v) $3 dw c v) e! LL 0 0cu VII. SUPPORTINGLIVELIHOODS IMPROVINGSERVICE AND DELIVERY As a post-conflict country, Angola faces a huge challenge to improve the welfare of its population, including the poorest. Angola stands a very good chance of meeting this challenge owing to the increasing resources available from the exploitation of natural resources. I n order to succeed on thatfront, the Government needs to pursue three complementary objectives: (a) support livelihood options and strategies available to people; (e) increase the access of thepoor to better quality of social and economic services; and (c) usefiscal savings to improve the quality of public service delivery to the poor. This strategy would support an improved living standard by raising incomes and assets of thepoor through theprovision of capital, technology, and economic services. It would support the equitable development and maintenance of social and human capital through a community based approach to the provision of social services. This Chapter discusses options available to meet these objectives. 201. Promotingsustainable pro-poor growth in a resource-based economy is not easy, but is possible. The record of low income mineral-exporting countries inachieving pro-poor growth i s fairly dismal, especially in Africa. Nonetheless, the example o f Indonesia shows that it can be done. Key elements in Indonesia's success, are embedded in the recommendations offered elsewhere in this report, including managing inflow of foreign currency to ensure a competitive domestic sector (avoiding "Dutch disease"), supporting rural infrastructure and the rural non-farm sector by using oil-revenues to finance labor-intensive infrastructure projects in rural areas, supporting a better business environment for urban micro-enterprises and the provision o f infrastructure and social services to the poor areas as well as the upper income or industrial areas63. 202. Different livelihood strategies have been used by the poor to survive in difficult times. People's livelihoods depend on the opportunities and assets (natural, physical, financial, human and social) available to them. The war not only destroyed the assets o f people, ruined infrastructure, and harmed and displaced millions o f people. It also significantly impacted the livelihood options and strategies available to people. It ruined the agricultural base o f the country, by limiting access to inputs, reducing available labor, and by entirely isolating certain parts o f rural Angola. This section o f the report discusses different livelihood strategies that have been used by Angolans to survive during difficult times and suggests ways to strengthen the options that have worked well so far. 63See Timer (2005) for an elaboration o f these points. 111 203. The oil economy is an enclave with limited impact on livelihood strategies, but the same is not true of the diamond economy. While Angola has recently experienced rapid growth, this has been dominated by the oil sector which has very few forward or backward linkages to the rest o f the economy, having therefore few impacts on the livelihood strategies and opportunities available to ordinary Angolans. The diamond sector, on the other hand, has since the 1990s - when UNITA began its occupation o f the mines - been highly labor-intensive, and has played an increasingly important role for the livelihoods o f many informal, artisanal miners, the garimpeiros. A majority o f Angolans, however, rely on livelihood strategies that fall outside o f the miningsectors. 204. Due to lack of opportunities for most Angolans in the mineral sectors, more than two-thirds of the country's workforce find employment in farming, livestock and artisanal fishing.64Indeed, while the last four decades have seen what could arguably be called a rural exodus towards urban and peri-urban areas, an estimated 60% o f Angola's population still resides in rural areas and more than 70% depend on agriculture and rural activities as their principal source o f income and food. As i s also true in urban areas, however, large numbers o f people have lost their assets during the conflict and have had few opportunities for replacing them, and therefore lack sufficient food stocks, seeds, tools and livestock. Without assistance in gaining access to such crucial assets they remain unable to resume normal agricultural production, with little chance o f feeding themselves. The Provinces o f Huambo, Bie, Huila - where the largest number of returnees, demobilized soldiers and their families are found - are particularly vulnerable to food security, as are the remote Provinces o f Kuando Kubango and Moxico. 205. Subsistence farming remains the main livelihood strategy for a majority of rural Angolans. Both women and men tend to be involved, with women frequently doing more o f the cultivation, helped by children, while men are more involved in the clearing and preparation o f land. However, small-scale farming faces significant difficulties in most areas, such as the lack o f inputs - which for the most vulnerable includes labor - as well as difficult access to markets. In almost all cases, farmers are only cultivating a small part o f their potential land and yields are low. Perhaps one o f the most important assets to the rural poor i s access to land, which has beenput increasingly under pressure since the war as IDPs, demobilized soldiers and other returnees are enteringthe market for land. 206. The presence of a significant amount of landmines and other unexploded ordnances (UXOs), however, is a serious threat. Angola is considered to be one o f the 64 In terms o f fishing, Angola's coast is very favorable, with a lot o f potential both for artisanal and industrial fishing. At independence, Angola was the second-ranked fish exporter in Africa, and even in 1985 produced a total of 400,000 tons. Over-fishing, mainly due to illegal and unregulated fishing by large foreign fishing vessels, has resulted in a rapid depletion o f stocks, and put the livelihoods o f many coastal villages at riskUNDP (2005: 17). 112 countries most affected by UXOs. Estimates for the amount o f landmines that litter the country are in the millions, although information on the exact extent o f landmine contamination in the country remains limited and unclear. This i s exacerbated by the numerous parties involved in mine-laying and the lack of credible records. According to Government figures, however, as many as 4,200 areas are reported to contain or suspected to contain landmines, and are spread across all o f the 18 provinces in Angola.65 Based on a survey conducted from 1996 to 1998 - prior to the last military offensive - as much as 35% o f Angola's 1,254,000 square kilometers i s contaminatedby landmines.66 207. The difficulties in makinga livingfrom peasant agriculture meanthat there i s a tendency for peoplein rural areas to also develop other livelihoodsand survival strategies. As in urban areas, large numbers o f people survive through casual labor, biscatos, of various types, including working on other people's fields, transportation of mud(adobe) or other buildingmaterials for construction purposes (mainly carried out by children), etc. Many people also depend on access to, and extraction of, other natural resources. The collection o f wood for sale, or for transformation into charcoal and subsequent sale, i s a common livelihood strategy, especially inareas near towns or larger roads, or where there i s some transport available to urban areas. This practice has led to environmental degradation and depletion o f woodlands in these areas. Income from sale o f wood or charcoal appears to be low, as barriers to entry to this occupation are low and many families include it in their livelihood strategy, leading to abundant supply and low prices. However, most rural people do not have access to a sustainable income base outside o f agriculture, although the coping mechanisms provided through casual labor and collection o f firewood remain important complementary strategies. There i s thus an urgent needto diversity and expand the agricultural and the non-agricultural base o f rural households. 208. There are desperateneedsin urbanareas that need constant attention.While it is important to design an effective and inclusive rural development strategy, inpartjust to reduce the incentives for urbanization, there are also desperate needs to be filled inthe urban areas that cannot be neglected. Approximately 40% o f Angola's population currently lives in urban areas, o f which about 60% - or 20-25% o f the total population - lives inLuanda. According to UNstatistics, the overall urban population i s likely to grow to 44% by 2015 and to 53% by 2030.67The rapid urbanization can be explained by both push and pull factors: the war, and dismal livelihoods in rural areas pushed people towards urban zones less affected by the conflict, and the perception o f better 65 Government of Angola (2004) "Article 7 Report, Form C", submitted to the Secretary-General of the United Nations on 14 September 2004, in compliance with the Convention on the Prohibition of the Use, Stockpiling, Production and Transfer o f Anti-Personnel Mines and on their Destruction (the Ottawa Convention). These figures differ from those providedby the National Institute of Demining (INAD) which indicatesthat Angola has atotal of 4,000 minefields. 66 United Nations Mine Action Service (2005) "Angola Country Overview", available at http:/lwww.mineaction.org. 113 opportunities, peace and - for some - anonymity - were some o f the reasons people were pulled towards the cities. Most o f the new residents have settled in the peri-urban musseques and occupy a significant part o f what used to be mostly industrial and farmin areas. Living conditions are extremely poor: people live in overcrowded settlements, 4 with no sanitation or solid waste management. Inequalities in access to services are the source o f considerable frustration among inhabitants, inparticular poor sectors o f society. 209. Angola is a young country and as such special attention should be devotedto children and the youth. Currently in Angola, about 67% of the population is less than 25. A majority o f those who migrated or were displaced to urban centers were youth, making it likely that the percentage o f people under the age o f 25 living in Luanda and other cities i s much higher than the national average. Children and youth growing up duringthe war find themselves at a particular disadvantage, having had no or little access to basic education and health facilities, key protective factors preventing risky behavior and obviously limiting employment opportunities and social mobility. As a result o f increasing pressure on livelihoods opportunities, some youth are turning to criminal activities. An estimated 30% o f children aged 5-14 years are also currently working (UNICEF, 2003). Families often try to improve their livelihoods by putting various family members, including children, to work, either inside the home (thereby sometimes allowing women to work outside the home) or outside. 210. Equitable and regulated access to land for agriculture, livestock breeding, and settlement is crucial for economic development in Angola. Control over and access to land i s affected by displacement and return, landmines, and by existing regulations and institutions. Risks relate to the appropriateness and implementation capacity o f the new land law and its regulations, impact o f landmines, and different types o f local land conflicts by livelihood. Potential for land conflicts and marginalization relate to settlements in urban areas, agriculture and division o f territories in densely populated or mined rural areas, and access to water wells for livestock in the south. Without addressing these issues, it i s difficult to visualize a sustainable and successful effort to promote poverty reduction through agricultural growth inAngola. 211. A new LandBillhas become effective,but there are lingeringconcerns about its impacts. The bill was passed in August 2004, and published in November 2004, becoming effective in February 2005. The new law replaces old legislation from 1992. In essence, the Law: (i)grants the right to private property in urban, but not rural areas, 67Cited inJenkins et a1(2002: section2.2). According to the survey conducted by Development Workshop, 55% of households across Luanda reported over 3 people to a room and 30% reported between 2 and 3 people to a room. For Huambo city, 66% o f households reported more than 3 people to a room, and 16% between 2 and 3 people to a room (Development Workshop, 2003: 44,49). 114 where right is limited to `superficio '; (ii)formally recognizes collectively controlled community land, regulated through traditional power structures and community level and good for collateral for community loans; (iii) allows expropriation in cases o f existence o f natural resources or due to inefficient use o f the allocated land; and (iv) imposes requirements on the efficient use o f land and conditions on capacity to cultivate. There are concerns, however, that the new legislation focused mainly on increasing the power o f state officials to manage land and determine who gets land and on what terms (Development Workshop, 2005). 212. Traditionalpower structures and its implicationsfor land managementare a potentialsource of concern. First, the power granted to traditional authorities - or the so-called sobas - may undermine the rights o f women. While the law grants equal hereditary rights to men and women, local customs vary. In many communities, a deceased husband's property i s seen as belonging to his brothers and nephews. Second, the juridical personality o f the communal land i s not clear. If it i s assigned as individual property to the soba, some fear he may be subject to manipulation, or he himself being tempted to manipulate these powers. Third, there are risks o f marginalization o f other social groups. With the return o f refugees, IDPs, ex-combatants and other memberso f the rebel forces, community compositions are changing. For those returning to their community o f origin, disputes over land will normally be resolved by the soba, who represents the community memory. In other cases, often ex-combatants and abductees do not return to their community o f origin but to other communities. Some are too far away, others are inhibitedby the stigma or trauma the war has inflicted upon them. Community structures are based on a composition o f families. Unless they have family members in their new community, they tend to have difficulties being integrated. Fourth, the institutional setup for the formalization o f land rights remains to be specified. Fifth, community ownership i s not a concept shared by all provinces and even all communities within provinces. 115 213. The Government's policy instrument in place to improve the living conditions of the poor is the Estratkgia de Combate ii Pobreza - ECP. The ECP was developed by a group o f public officers from the main social ministries under the coordination o f the Ministry o f Planning, with external technical assistance provided by the World Bank and UNDP.69 The ECP's specific objective is to consolidate peace and national unity through sustainable improvement of living conditions o f the most vulnerable groups. To this effect, the ECP has defined ten priorities. These are (i) Resettlement/Social reinsertion; (ii) De-mining; (iii) security; (iv) (HIV/AIDS); (v) Food Education; (vi) Health; (vii) Rehabilitation o f basic infrastructures; (viii) Employment and vocational training; (ix) Governance; (x) Economic management. The ECP budget i s $3.2 billion for a period o f five years (2003-2006) but does not reflect the considerable increases in resources which are now being made available to the budget. Inrevising the ECP to take into account the larger fiscal envelope with the recent windfall gains, the authorities should also cast the associated public spending plans within a medium-term strategy for poverty reduction and for achieving the Millennium Development Goals (MDGs) 214. The Government efforts to tackle the needs of the poor and vulnerable groups are beingaddressed in nationalprogrammes.These are in the areas o f Social Reintegration (ADRP); HIV/AIDS (HAMSET); Reconstruction and Institutional Support (PAR); ReconstructiodRehabilitation (FAS). A summary o f all o f these programs can be found in Box 7.1 and a detailed description o f the ECP's priorities as well as an assessment o f the performance o f the national programmes (which i s beyond the scope of this report) is presentedinthe Country SocialAnalysis for Angola, which is abackground report to the Country Economic Memorandum. 215. Other social programs that are neither nationwide nor being administrated by Governmententities are also relevant.These are beingfunded bybilateral agencies, United Nations Agencies, and the private sector, and are implemented by international NGOs. 216. The mainprogramfunded by a bilateralagency is the Luanda Urban Poverty Program (LUPP). The LUUP benefits from a grant from the Development Fund for International Development (DFID), and was created in 1998. It i s being implemented by a consortium o f international NGOs (Development Workshop, Save the Children UK and Care International). The main objective i s to contribute to poverty reduction in Luanda peri-urban areas while testing best practices for participatory local governance, through multi-sectoral approaches through education, water and sanitation and good governance. The province o f intervention is Luanda and its peri-urban areas (Sambizanda, Kilamba Kiaxi, H o Yi Ha Henda). The budget for the first phase (1998-2003) and second phase (2003-2007) i s o f E 9 million respectively. 69The Ministriesinvolvedwere the Ministry of Planning, Social Affairs, Women and Family, Agriculture and Rural Development, Health, Education and Culture, Energy and Water, Fisheries and Environment, Public Works andTransport. 116 217. The private sector i s also supporting social programs. These are small scale but do complement other actors' activities inthe sector of agriculture andthe provision o f microcredit. Chevron-Texaco Corporation, a multinational oil company, along with other partners such as USAID, i s contributing to the agricultural sector through an integrated development programme called Angola Partnership Initiative (API) that aims at: (i) promoting rural development through food relief, re-integration o f internally displaced persons, ex-combatants, refugees, food production, seed multiplication, rehabilitation o f basic infrastructure, and rural credit; (ii) promoting the development o f rural small and medium enterprises through microfinance, vocational training and business development; and (iii)supporting the rehabilitation effort o f the education sector. The program i s estimated at USD 58 million and i s being implemented by international and local agencies and NGOs specialized in agriculture and rural development projects, such as CARE, World Vision and ADRA. The provinces of intervention are Huambo, Bie, Kwanza Sul and Huila. The program has duration o f four years (2003-07). 218. There are also a plethora of international NGOs that are active in the delivery of basic social services. A leading project in the area o f micro finance i s the NOVO BANCO project. Its main objective i s to create a sustainable, profitable commercial microfinance institution to provide credit and other financial services to micro, small and medium sized businesses. NOVO BANCO targets enterprises and entrepreneurs in the trade, services and production sectors working in urban and peri- urban communities. The project i s being implementedby Frontier International in the province o f Luanda with the intention to expand to other provinces. The project has a capital o f USD 4.9 million and a total fund o f USD 7.9 million. 219. Local NGOs have difficulties to implement large-scale development programs given the donor-driven nature of their operations. Moreover, the majority o f NGOs have limitedexperience in sustainable development activities given the fact that they have only been engaged so far in the delivery of humanitarian assistance in an emergency context. Although the scope o f their programmes i s now adapting to the transition to the rehabilitation and reconstruction, the majority have sustainability problems and therefore can only operate with external funds. 117 220. Churches also play a very important role in providing services to the poor. Both the Catholic and Protestant Church have the largest number of adherents, given that 118 there are over 80 per cent o f Christians in Angola. These Churches are active in responding to the social needs o f its membership through a national network o f Caritas offices that operates in the provinces, and departments that promote community development and social programmes. The four Protestant churches and church-related organisations that seem to most actively promote these types o f programmes are the Igreja Kibanguista, the Igreja Batista, the AssociacGo Evangelica de Angola and the Conselho de Igrejas Cristas. 221. All of these programmes have had some success, but more needs to be done to reach the most remote and most needy areas of the country. Although existing national programs administrated by the government and the private sector suggest that the intended objectives are being implemented with some degree o f success, the majority lack capacity to fully respond to the poor given that the demand far outstrip the supply. However, it i s also evident that the limited access to more remote areas o f the country due to communication constraints and mines have contributed to the fact that over eight provinces such as Lunda Norte, Lunda Sul, Moxico, Kwando Kubango, Uige, Kwanza Norte, Zaire and Malange have limited or non-existing presence o f activities by these programmes. 222. One of the surest ways to use oil revenues to improve the welfare of the poorest is to reduce the overall social service deficit. Limited information available suggests that this will require a restructuring o f the budget, and possibly some changes in the budget process. In terms o f expenditure by sector, Angola still spent 40% of its budget on defense and national security in 2004. This limits the amount available for sectors such as health, education and infrastructure (water supply, roads, etc.) As a result, Angola spent only 14% o f the budget on education, 13% on health and social assistance, and less than 5% on roads, water and sanitation, and urban infrastructure. By contrast, in the same year, Uganda (which faces significant security problems in the northern districts, as well as a high debt burden), spent 19% on education (down from 21% inthe previous year), 12% on health, 8% on roads and works and 3% on rural water supply. Uganda achieved this by reducing security (including defense) expenditures to 11% o f the budget. This expenditure i s still high compared with its neighbors, but as noted above, the conflict inthe north has taken a large toll, both human and fiscal. Within expenditure categories, Uganda has been able to direct expenditures toward basic services, especially inunder served areas. In2003/4, 60% o f the education budget goes to primary education, compared to 11% o f non-wage education expenditures to primary education inAngola in2004. 223. To improve equity in the provision of social services, budget allocations should be based on unit costs and more spending autonomy extended to provincial governments. In terms o f non-defense expenditure by province, Angola also has wide gaps. As there is no data on, for example, how many children in each province go to school, one cannot calculate average education spending levels per child. In addition, data i s only available on expenditures for the portion which i s delegated to the province to spend (86% o f the total). By calculating expenditures per capita for a few provinces 119 one can find quite a gap (see Figure 7.1). The variance in education appears to be 10 times higher than the average. This i s quite high given that the province is already a fairly large agregation. Inhealth, the proportion delegated to the provinces i s much less (only 48%). This may be why the expenditures on health appear more equally distributed (see Figure 7.2). Countries such as Tanzania and Uganda have reduced these regional gaps substantially by allocating more expenditure authority to local governments, and by allocating funds on a per enrolled child basis. This not only ensures a more equitable distribution, but it also encourages teachers and principals to maximize enrollment o f children inthe area. Figure7.1: AnnualExpendituresper capitainEducationby Provinces PerCapita6qmdiiure inWucation 80.M) ..". I .I...." ....."... I.._.I....." " ....... ..I......" ""l.l"...""" .... ""-..l .... ....ll.-lll..""l"..."l.".~ l."...l.." ............. I "" " """ Note: excludes wages and other central government expenditures 120 Figure7.2: Annualper capita ExpenditureinHealth Annual per capita expenditure in Health 14.00 12.00 10.00 2 8.00 8 ' 6.00 4.00 2.00 Benguela Bie Huambo Huila KuandoKubango Kunene Luanda Malanje Moxiw Note: excludes wages and other central government expenditures 224. Mechanisms to consult the poor on how and where to allocate public funds can be very helpful. African countries have also found that increased community participation inthe design and implementation o f social service investments as well as in operation and maintenance results in more efficient and effective public spending on social infrastructure. Angola's experience with FAS i s a very good example o f this mode o f operation. As part o f its ongoing decentralization process, Angola may wish to consider incorporating elements o f this delegation o f responsibility in its programs. Mechanisms to automatically consult the poor in regards to decision-making on public investmentshouldbeput inplace inadditionto accountability channels inorder to ensure quality control and civic engagement. The poor quality o f services offered, has led to the lack o f trust in the institutions by the poor and the over reliance on the informal sector for social services. However, evidence indicate that this option i s not always cheaper and/or o f better quality. 225. Effective social sector spending requires predictable resources available to spending units, especially in the labor-intensive sectors such as health, education, and social assistance. Angola has not yet achieved this goal. While detailed budgeting i s done every year, only 72% o f what was allocated in the budget was made available to spending units in 2004. The discrepancy between budget allocation and what was received by spending units also varies substantially by province. In Uige, Zaire and Luanda Norte, the amount spent was less than 40% o f the budget allocation. Other provinces did much better as in Benguela, 68% o f the budget allocation was spent. As a result, employees such as teachers often face arrears in pay, and are forced to take a secondjob, sometimes resultingin absences form the classroom. As the economy settles 121 down and revenues become more stable and predictable (especially oil revenues, the main revenue source for the Government), the Government could set targets toward more realistic budgeting. An oil revenues stabilization fund may help inthis process. 226. To increase the effectiveness of current activities, a higher degree of coordination among development partners and the government should be put in place. Activities implementedby national programs are providing many opportunities for consolidating partnerships to improve the livelihoods o f the poor and vulnerable. However, their implementation i s hampered by the lack o f a national coordination mechanism. The majority o f national programs do not report systematically on their lessons learnt among themselves and partnerships are therefore taking place mostly at the local level and on a project basis without the umbrella o f a national coordinating agency to ensure that the implemented activities respond to the ECP. In the long run, this could create a situation in which the overall impact o f the several existing programs happens in an isolated fashion to the detriment o f the strengtheningo f social protection measures and the design o f well informed policies. To address this problem, the government should create a coordinating agency and encourage the establishment o f a mechanism for information sharing inview of informing policies. 227. Inequality of opportunities causes certain groups of Angolans to face greater barriers to access basic services than others. Data from the 2002 MICS survey suggest that the ability to gain access to basic social services i s directly influenced by the household's income level. Access to primary education, for example, i s only 35% for the poorest quintile, while for the richest quintile it i s more than double that, at 77%." Literacy rates compare at 62% for the poorest quintile and 95% for the richest quintile. Gender disparity is also apparent, with female literacy rates within the poorest quintile of 27% compared with 62% for men, and 86% and 95% within the richest quintile, respectively." Government data from 2002 show that overall completion rates for primary education for girls are estimated at 41.3% compared with 56.8% o f boys.72 228. Another equally important challenge is how to offer basic social services to all at accessible costs. Not everybody in Angola i s able to go to a hospital without experiencing tremendous difficulties. In the eastern Provinces, for example, where the humanitarian needs are perhaps the most striking, distances to the nearest hospitals can 70Conditional cash transfers (CCTs) have been used in many countries to induce poor parents to enroll their children in school. CCTs make payments to poor families, typically mothers, o n the condition that children attend school regularly. The programs can be seen as compensating for the opportunity cost o f schooling for poor families and represent one approach to addressing failures in credit markets and the imperfect agency o f parents. The biggest programs o f this kind are Oportunidades (formerly PROGRESA) in Mexico, the Bolsa Escola in Brazil, and the Food for Education Program in Bangladesh (see WDR, 2006, p. 137). 71The 2006 World Development Report argues that gender inequity directly affects the well-being o f women and decisions in the home, affecting investments in children and household welfare (p. 51). Econometric evidence cited in the report confirms that an increase in a woman's relative worth and an improvement in her fallback options have positive effects on the children (p. 53). 72Progress report on MDGs (2005: 24). Gender inequities are also reflected at the government and national political level, where women only account for 11 o f 70 ministers and vice-ministers and only 14% o f the national assembly. At the Provincial level, there are currently no female Governors or Vice-Governors. 122 sometimes be more than lOOkms, and roads are not always there to make matters worse.73 Access to healthcare i s also prohibitively expensive. Again, in Hoji ya Henda, treatment at a public hospital can cost from 500Kz to 1,500Kz (roughly US$6 to US$18), many times the daily income for most of Luanda's pop~lation.Public school places in ~ ~ Luanda, moreover, tend to be limited.A range o f private schools or classes are emerging to fill the vacuum, some legal some not, both more expensive than the state school system. 229. A carefully designed and phasedpublic works programscan potentiallyhelp to support agriculturalgrowth and thus contributeto poverty alleviation.To support the rural economy to get back on its feet, the Government may wish to consider complementing an agricultural support package (which should increase productivity and reduce co-variate risk) with an explicitly targeted public works jobs program for the low skilledlabor force. Targets for the program would include return migrants, who may have trouble getting land or integrating into the farming sector as they have been away from farming for such a longperiod o f time. Farmers would also want to participate duringthe off-season. In countries such as Tanzania, Senegal and Malawi, these programs have been implemented through social fund structures, drawing donor support in to help finance the programs. In South Asia, where local government structures are more developed, these programs have been implemented through Government structures with some success. Once the rural economy has stabilized inan area, programs to support non- farm micro and small enterprises can be introduced and thejobs programs phased out. 230. All things considered, improvementsin social indicators should be the main objective of any public policy in Angola. Child mortality is one o f the highest in the world as one out o f every four children i s expected to die before the age o f 5. This estimate does not vary much between rural and urban areas. Nutrition indicators are equally poor: 30% o f children are moderately underweight, and 8% were found to be severely underweight. Likewise, 45% suffer from moderate stunting (low height per age) and 22% suffer from severe stunting, a very high level. Inthe lowest asset quintile, these numbers are double the ratio for the highest quintile, but even inthe highest quintile the numbers are high: 13% severe stunting. By comparison, Mozambique in2003 recorded a slightly lower level o fmoderate stunting, but a muchlower percentage o f severe stunting. 231. Despite difficultieswith logistics, there has been some limitedprogress in the areas of education, health, and resettling of displaced people. Reportedly, some 29,000 additional teachers have been recruited, and one million more children are apparently now in school. Polio i s fast getting closer to polio-free status and towards its goal o f reducing child mortality rates. Interms o f access to populations in remote areas, dozens o f bridges and nearly 1,000 km o f roads have been reconstructed and rehabilitated. And although more than a million Angolans still require food aid, almost half a million more hectares o f land have been cultivated since the peace. Logistics have 73Robson(2005). 74Yngstrom (ibid). 123 hampered most efforts to improve services in rural areas. The Government, supported by international assistance and NGOs, i s resettling displaced persons and ex-combatants back to their home areas, resulting in a migration out o f Luanda and other large cities. This may help to improve the subsistence level o f the poor compared with living in IDP camps if farmers can earn an adequate subsistence off the land, but it may also increase exclusion and the rural urban-gap owing to the difficulties Angola faces in improving services inpoor areas. 232. Recent efforts to improve service delivery have yet to reach the most remote areas. In 2004, the government budget was approved with significant increases in allocations towards health, education and welfare services (an increase of 9% compared to the previous year). Provincial Governments, however, still lack sufficient funds and technical capacity to improve service delivery without external assistance. With limited capacity o f the Government to deliver services, the main providers o f basic social services, humanitarian relief and development resources have since the early 1990s been non-governmental organizations (NGOs), supported by international donors (Pacheco, 2005). In urban areas some services have also been provided by the private sector (mainly water). Nevertheless, NGOs have so far tended to concentrate inparticular areas o f the country - and not necessarily the ones with the greatest needs - and are very rarely sufficient to meet local needs. Logistics continue to create difficulties for improving access to services in remote areas. As a result, there i s a risk that the low level o f services in these areas will continue accentuating the inequalities between areas and between social groups. 233. Eliminating fuel and utility subsidies can be a viable option to improve service delivery and the welfare of the poor. The government i s considering a gradual eliminationo f fuel prices to be followed by the phasing out o f subsidies to public utilities. The Bank, with the support of the UK Embassy in Angola, commissioned a study to assess the welfare impacts o f such policy. The conclusions o f this study are very telling. Inthe first place, the population ranks very highly the types o f service provided by the population to be o f minimal quality (see Tables 7.1 and 7.2).7 In the second place, government, but the quality o f these services i s considered b 7 the majority of the subsidy provision in Angola does not target the poor who are most likely to be excluded from both public service provision and consumption. Therefore, the marginal negative social impacts o f removing fuel and utility price subsidies will likely be small. 234. The phase out of fuel and utility price subsidies represents an extra opportunity to improve spending in poverty reduction and development programs. Subsidy expenditure was the main source o f expenditure within the umbrella of 75 In the authorities' view, the school system in Angola has been a major priority for the government as it remains highly ineffective and incapable o f forming skilled labor in the pace which would be required to satisfy the current demand for good education by both households and emerging businesses. 124 governmental transfer payments. O f total transfer payments, subsidy expenditure accounted for 66.57% in 2001, 74.09% in 2002, 67.31% in 2003 and 76.86% in 2004. Between 2001 and 2004, subsidy expenditure expanded by 377%. As subsidy expenditure amounted to US$1.286 billion in 2004, the savings to be had with the complete elimination o f subsidies are tremendous. Clearly, there would be enough resources to compensate poor households for increased burdens associated with higher fuel prices. Table 7.1: Public ServicesAccording to their Perceived Importance Schools 92.29 3.15 1.82 0.77 0.70 0.35 0.91 Electricity 82.84 6.93 3.43 2.59 1.40 0.91 1.89 Roads 68.19 9.39 9.18 3.50 1.40 1.12 7.22 Health Center 86.19 7.01 2.80 2.10 0.56 0.70 0.63 Sewage 72.48 6.65 7.21 3.64 1.75 2.10 6.16 Home Tap Water 83.31 8.63 3.16 1.61 1.05 0.98 1.26 Pub. Transportation 76.30 7.10 2.70 2.34 1.77 2.27 7.52 Table 7.2: Satisfaction Rateswith Public Services Schools 19.55 10.16 16.82 8.27 4.70 7.57 32.94 Electricihr 12.46 6.72 9.10 12.46 6.02 9.87 43.35 Roads 6.74 3.58 4.28 9.89 8.42 11.16 55.93 Health Center 15.16 9.54 14.11 12.42 7.58 10.46 30.74 Sewage 8.63 2.18 5.89 8.91 5.89 7.16 61.33 Home Tap Water 18.79 5.89 6.10 11.43 5.12 9.05 43.62 Pub. Transportation 15.33 6.53 9.01 9.87 6.39 13.20 39.67 235. Subsidies to fuel and utility prices should be phased out gradually and the savings redirectedto improve the quality of public services and to compensate the poor. In a first stage, the authorities will need to announce a comprehensive program to deal with subsidies in a phased strategy beginning in 2006. Some limited increase to show intent would be a good way to start the program, but the announcement of the program would have to state clearly that the initial objective is, for example, to align fuel prices with the 2006 budget's implicit oil price (US$45harrel). A larger increase could be introduced in mid-2006 matched with a program to spend the funds saved through a compensation program and on neededinfrastructure at the same overall fiscal deficit. Ina second stage, the current pricing mechanism used by Sonangol should be reassessedand the adjusted level o f subsidies phased out gradually while the compensation program designed inthe first stage continues to be implemented. At any point intime, the program should be adjusted in case there i s a crash in international oil prices. 236. In contemplating the implementation of a policy of gradually and periodicallyadjustingfuel and utility prices,Angolan authorities should not neglect the policy's politicalcosts. This i s particularly true now inthe eave o f major elections. 125 International evidence demonstrates that fuel price hikes unaccompanied o f a set o f palliative measures typically leads to public protests and may trigger violence and social unrest, even at times following elections. The incentives o f political contestants of generating public debate and criticism o f fuel and utility price increases at times preceding elections are heightened. Incumbents anticipate this and thus know that ifthey support fuel price increases, they may end up losing high numbers o f votes to their competitors. The experience o f other countries demonstrates that any program to reallocate fiscal spendingshould pay close attention to the following broad principles: > Political attractiveness: Off-setting, politically attractive expenditure programs are key to the political and social sustainability o f a subsidy removal. A high visibility and credible announcement of compensating measures is an indispensable feature o f the package. > Pro-poor and effective targeting: Measures should ideally be those that maximize development and poverty reduction impact. "Compensation" programs should be targeted to benefitthe poor and possibly other key losers o f the subsidy removal as well. They needto be seen to do so as well. > Speed of spending and impact on households: The speed at which programs are designed and money i s spent i s important for macroeconomic reasons, while the speed at which programs impact poor households is important for compensatory and political economy reasons. 237. One of the palliative measures that may bring large benefits to the poor is a water and sanitation policy intended to provide access to higher quality water and sanitation services. The welfare analysis carried out in the World Bank-UK-sponsored study on the impacts o f phasing out subsidies indicates that changes in water price will bring about a much larger marginal social impact than changes in fuel prices. Given the precarious state o f affairs in water infrastructure, management and service delivery, there appears to be ample room for public policy makers to reform the public water sector with the goals of making it more efficient, expanding water supply to the population and improving water quality. Such a reform, if successful, will naturally lead to a substantial reduction inthe water.price faced by the average consumer in Luanda. The funds needed to finance such a large venture could come from funds saved with the gradual phase out o f fuel subsidies and from private sector participation. 238. Other palliativepoliciesthat can be implementedare as follows: P Public Education Policy: Promotion of voucher systems, conditional cash transfers and school meals in order to offer incentives to parents to send their children to school and incentives for children to stay in school; P Health Care Provision Policy: Promote infrastructure investment, offer preventive care andmobile clinics to expand health care service access; P Public Transportation Policy:Creation of a social pass which can be used in buses and vans interchangeably, cost subsidization o f van service based on utilization rates, implement employer-sponsored passes. 126 239. A successful package to phase out subsidies in Angola will demand political commitment and a good implementation and monitoring strategy. In order to successfully implement the package the GOA will need to form teams and attribute responsibilities. The teams should cover the following main areas: (i)macroeconomic and fiscal issues; (ii)expenditure programming (social protection and compensatory expenditure, and other development and poverty reducing expenditures); and (iii) socialization o f savings. They would have to work together and consult each other in order to develop initial proposals based on their own experience and on the findings o f the Bank-UK sponsored subsidies study. 240. Finally, in order to know if a poverty reduction strategy is effective in reducingpoverty,it is necessary to set in place a poverty monitoringsystem to track key indicators over time and space. InAngola, there is still a dearth o f knowledge on the livelihoods of the poor. Overall, it is difficult to have a full assessment of the existing safety nets programs given that these do no have at the outset an expected number o f beneficiaries. 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World Bank (2005), Managing Angola's Oil Wealth, Background Paper for the Country Economic Memorandum, Washington, D.C. 132 STATISTICAL APPENDIX 133 Angola - Key Economic Indicators Actual Estimated Projected Indicator 1999 2000 2001 2002 2003 2004 2005 2006 Kational accounts(as YOof GDP) Gross domesticproducta 100 100 100 100 100 100 100 100 Agriculture 6 6 8 8 8 9 7 9 Indusky 73 72 65 68 61 66 74 72 Services 21 22 27 24 24 25 19 19 Total Consumption 79 58 85 76 81 75 67 65 Gross domestic fixed investment 29 15 13 13 13 9 8 14 Governmentinvestment 13 6 6 7 8 5 5 12 Privateinvestment 16 9 7 6 5 4 3 2 ~xports(GNFS)~ 86 90 77 74 70 70 74 70 Imports(GNFS) 93 63 75 62 63 54 48 49 Gross domestic savings 21 42 15 24 19 25 33 35 Gross nationalsavings' -1 24 -1 10 8 13 20 23 Memorandum items Gross domesticproduct 6153 9135 8936 11386 13956 19800 32810 44103 (US$ million at current prices) GNP per capita(US$,Atlas method) 450 480 540 720 770 960 1350 1980 Realannualgrowthrates (%, calculatedfrom 1997prices) Gross domesticproduct at marketprices 3.2 3.0 3.1 14.5 3.3 11.2 20.6 14.6 Gross DomesticIncome 21.2 48.0 -7.7 14.4 6.6 21.3 52.0 26.5 Realannualper capita growthrates (%, calculatedfrom 1997 prices) Gross domestic product at marketprices 0.6 0.2 0.2 11.2 0.2 7.7 16.5 11.6 Total consumption 2.1 9.6 17.5 -3.8 5.0 7.0 25.7 -13.6 Balanceof Payments(US%millions) ~xports(GNFS)~ 5310 8187 6848 8373 9716 13797 24120 30785 MerchandiseFOB 5157 7920 6645 8166 9515 13474 23724 30335 Imports(GNFS)~ 5704 5739 6697 7082 8801 10635 15834 21640 MerchandiseFOB 3109 3040 3179 3760 5480 5832 8667 12514 Resourcebalance -394 2448 150 1291 915 3162 8286 9145 Net currenttransfers 56 28 91 32 99 7 30 28 Current account balance -1710 795 -1320 -312 -713 685 4242 3896 Net private foreign direct investment 2472 879 2146 1643 1652 1414 1639 2237 Long-termloans (net) -291 -766 -618 -162 178 906 1408 2397 Other capital(net, incl. errors & omissions 59 -276 -647 -1398 -675 -1772 -5172 -3419 Changeinreservesd -530 -631 440 229 -443 -1233 -2117 -5112 Memorandum items Resourcebalance(% of GDP) -6.4 26.8 1.7 11.3 6.6 16.0 25.3 20.7 Real annualgrowthrates ( YR97 prices) Merchandiseexports (FOB) 1.4 2.0 -0.9 21.3 -2.7 14.1 28.5 13.2 Merchandiseimports(CIF) 55.3 4.8 7.9 15.4 -.- 29.2 -3.7 43.5 .. 45.5 (Continued) 134 Angola Key Economic Indicators - (Continued) Actual Estimated Projected Indicator 1999 2000 2001 2002 2003 2004 2005 2006 Public finance (as YOof GDP at market prices)e Current revenuesand grants 46.4 50.2 45.1 38.3 37.9 36.9 38.0 38.0 Current expenditures 50.6 43.5 35.6 35.0 36.3 30.6 25.2 23.4 Current account surplus (+) or deficit (-) -4.2 6.7 9.5 3.3 1.6 6.3 12.8 14.5 Capitaland other expenditure 31.1 15.1 13.1 12.3 8.0 7.9 6.0 12.3 Total expenditures 81.7 58.6 48.7 47.3 44.3 38.5 31.2 35.7 OverallBalance(accrualbasis) -35.4 -8.4 -3.6 -8.9 -6.4 -1.6 6.8 2.2 Monetary indicators M2iGDP 22.8 17.3 21.0 21.5 17.1 14.8 13.7 15.8 Growth of M2(%) 680.9 303.7 161.2 158.5 66.3 37.5 60.0 43.2 Priceindices( YR97 =loo) Merchandiseexport price index 99.0 149.2 126.2 127.9 153.2 190.0 260.3 294.2 Merchandise import price index 92.7 86.5 83.8 86.0 97.0 107.1 111.0 110.2 Merchandiseterms oftrade index 106.8 172.4 150.6 148.8 157.9 177.4 234.6 267.1 Realeffectiveexchange rate (US$/LCU)' 71.0 85.3 96.4 98.1 116.1 139.1 173.3 Consumer price index (% change) 248.2 325.0 152.6 108.9 98.3 43.6 23.0 12.9 GDP deflator(%change) 556.9 418.2 108.5 120.5 102.5 42.7 43.5 8.0 External debt External debt inbillions o fUS dollars 10.3 9.4 9.2 9.2 9.7 10.6 12.6 14.8 External debt to GDP ratio 167.4 102.9 103.0 80.8 69.5 53.6 38.4 33.6 Sources: Angolan authorities and IMF and World Bankestimates. a. GDP at marketprices b. "GNFS" denotes "goods andnonfactor services." c. Includes net unrequitedtransfers excludingofficial capital grants. d. Includesuseof IMF resources. e. Consolidatedcentral government. f. "LCU" denotes "local currencyunits." An increaseinUSWLCUdenotes appreciation. 135 Angola NationalAccounts - Part A: Current PriceData (inbillions of local currency units) Atlas GNP per capita:US$1,350 (2005) Vidyear population 14 5 million (ZOOS) Actual Estimated Projected 1999 2000 2001 2002 2003 2004 2005 2006 Grossdomestic productat market prices 17.2 91.7 197.1 497.6 1041.2 1652.0 2859.7 3538.9 Net indirecttaxes 0.6 1.8 3.0 25.2 3.6 -34.9 -6.6 20.1 GDP at factor cost 16.6 89.9 194.1 472.4 1037.6 1687.0 2866.4 3518.7 Agriculture 1.1 5.2 16.1 39.1 86.7 142.5 206.8 322.9 Industry, o fwhich 12.5 66.1 127.9 339.3 701.7 1092.0 2117.0 2552.3 Manufacturing 0.6 2.6 7.6 18.2 40.4 66.1 102.3 131.1 Services 3.6 20.4 53.1 119.2 252.7 417.5 535 9 663.7 Resourcebalance -1.1 24.6 3.3 56.4 68.3 263.9 722.2 733.8 Exports(GNFS) 14.8 82.2 151.0 365.9 724.9 1151.2 2102.3 2470.2 Imports(GNFS) 15.9 57.6 147.7 309.5 656.6 887.3 1380.1 1736.4 Total expenditure 18,3 67.1 193.8 441.2 973.0 1388.2 2137.5 2805.0 Consumptionexpenditures 13.6 53.3 167.4 378.7 841.1 1237.7 1922.0 2307.8 Government 10.3 39.0 68.1 174.3 350.5 501.1 688.5 774.4 Private 3.4 14.3 99.2 204.3 490.6 736.6 1233.5 1533.4 Gross domestic investment 4.7 13.8 26.4 62.5 131.9 150.5 215.5 497.3 T O ~ Agovernmentinvestment 2.2 5.6 12.5 33.6 79.0 80.8 134.7 409.5 Total private investment ' 2.5 8.2 13.9 28.9 52.8 69.7 80.8 87.8 Total fixed investment 4.9 13.8 26.4 62.5 131.9 150.5 215.5 497.3 Total changes in stocks -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Domesticsavings 3.6 38.4 29.7 119.0 200.1 414.4 937.8 1231.1 + Net factor income -3.8 -16.9 -34.4 -71.4 -128.8 -207.2 -355.2 -423.4 +Net currenttransfers 0.2 0.3 2.0 1.4 7.4 0.5 2.6 2.2 = Nationalsavings -0.1 21.8 -2.7 48.9 78.7 207.7 585.2 809.9 Gross nationalproduct 13.3 74.8 162.7 426.2 912.4 1444.8 2504.6 3115.5 Gross nationaldisposable income 13.5 75.1 164.7 427.6 919.8 1445.4 2507.2 3117.7 a. "GNFS" denotes "goods andnonfactorservices." b. Gross domestic fixed capital formation only. c. Derivedas a residual; includesincreasein stocks. d. Total net unrequitedtransfers excludingofficial capital grants 136 Angola NationalAccounts (continued) - Part B: Shares of Gross DomesticProduct (percentagescalculated using current price data) Acutal Estimated Projected 1999 2000 2001 2002 2003 2004 2005 2006 Grossdomej[lc product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Net indirecttaxes 3.2 2.0 1.5 5.1 0.3 -2.1 -0.2 0.6 Agriculturevalue added 6.3 5.7 8.2 7.9 8.3 8.6 7.2 9.1 Industry value added, of which 72.7 72.1 64.9 68.2 67.4 66.1 74.0 72.1 Manufacturing 3.2 2.9 3.9 3.7 3.9 4.0 3.6 3.7 Services value added 21.0 22.2 27.0 24.0 24.3 25.3 18.7 18.8 Resourcebalance(X-M) -6.4 26.8 1.7 11.3 6.6 16.0 25.3 20.7 Exports(GNFS) ' 86.3 89.6 76.6 73.5 69.6 69.7 73.5 69.8 Imports (GNFS) 92.7 62.8 74.9 62.2 63.1 53.7 48.3 49.1 Total expenditure 106.4 73.2 98.3 88.7 93.4 84.0 74.7 79.3 Governmentconsumption 59.7 42.5 34.6 35.0 33.7 30.3 24.1 21.9 Privateconsumption 19.5 15.6 50.3 41.1 47.1 44.6 43.1 43.3 Governmentinvestment 12.8 6.1 6.4 6.8 7.6 4.9 4.7 11.6 Privateinvestment 14.4 8.9 7.1 5.8 5.1 4.2 2.8 2.5 Gross domestic savings 20.7 41.8 15.1 23.9 19.2 25.1 32.8 34.8 Grossnationalsavings -0.7 23.8 -1.4 9.8 7.6 12.6 20.5 22.9 Memorandumitems GDP deflator 888.9 4606.8 9604.4 21178.3 42894.1 61212.3 87851.3 94893.4 Consumerprice index 722.4 3070.3 7755.1 16199.7 32130.9 46126.8 56717.9 64049.8 Total GDP (million currentUS$) 6152.9 9135.1 8936,l 11386.3 13956.3 19799.5 32810.4 44102.7 Per capita gross national product 440.0 480.0 520.0 680.0 770.0 960.0 1350.0 1980.0 (Atlas method: inUS$) a. "GNFS" denotes "goods and nonfactorservices." 137 Angola NationalAccounts (continued) - PartC: ConstantPriceData (in billionslocal currency, constant 1997prices) GDP at marketprices 1.9 2 0 2 1 2 3 2 4 -L.-I 3.3 3.7 GDP at factor cost 1 9 2.0 2.1 2.3 2.4 2.7 3.3 3.7 Agriculture 0.2 0.2 0.2 0.2 0.3 0.3 0.4 0.4 Industry, of which 1.2 1.3 1.3 1.5 1.6 1.8 2.2 2.6 Manufacturing 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.2 Services 0.5 0.5 0.5 0.6 0.6 0.6 0.7 0.7 Resourcebalance 0.1 0.0 -0.3 -0.1 -0.3 -0.2 -0.6 -1.4 Exports(GNFS) 1.4 1.3 1.3 1.6 1.5 1.7 2.2 2.5 Imports(GNFS) 1.2 1.3 1.6 1.6 1.8 2.0 2.8 3.9 Total expenditure 1.8 2.0 2.3 2.4 2.7 2.9 3.9 5.1 Consumption 1.3 1.5 1.8 1.8 2.0 2.2 2.8 2.5 Government 1.9 1.6 1.2 1.5 1.7 1.8 2.2 2.5 Private -0.6 -0.1 0.6 0.3 0.3 0.3 0.6 0.1 Gross domestic investment 0.5 0.5 0.5 0.6 0.7 0.8 1.0 2.6 Total governmentinvestment 0.2 0.2 0.2 0.3 0.4 0.4 0.7 2.1 Total privateinvestment 0.3 0.3 0.3 0.3 0.3 0.4 0.4 0.5 Total fixed investment 0.5 0.5 0.5 0.6 0.7 0.8 1.0 2.6 Total changesin stocks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Terms-of-trade(TT) effect -0.2 0.6 0.3 0.4 0.5 0.8 2.1 3.0 Gross domestic income 1.7 2.6 2.4 2.7 2.9 3.5 5.3 6.7 Domesticsaving (TT adjusted) 0.4 1.1 0.5 0.9 0.9 1.3 2.5 4.2 Net factor income -0.3 -0.4 -0.4 .n 4 -0.4 -0.5 -0.8 -1.1 GNP at market prices 1 6 1.. 1 7 6 2 0 2 1 2 2 2 4 2 7 a "GNFS" denotes"goods andnonfactorservices " 138 Angola NationalAccounts (continued) - Part D:Annual Growth Rate (calculated from data in constant 1997prices) Actual Estimated Projected 1999 2000 2001 2002 2003 2004 2005 2006 GDP at market prices 3.2 3.0 3.1 14.5 3.3 11.2 20.6 14.6 Agriculture 1.3 9.3 18.0 12.1 12.1 14.1 17.0 14.5 Industry, of which 6.5 3.5 4.1 14.5 3.8 10.6 23.4 17.4 Manufacturing 7.2 8.9 9.8 10.1 12.0 13.5 24.9 13.5 Services -3.3 -0.3 -4.6 15.4 -1.7 11.3 14.3 5.8 Exports (GNFS) 3.4 -3.7 -1.2 20.7 -3.1 14.4 27.6 12.9 Imports(GNFS) 11.1 6.0 19.1 3.1 10.1 9.4 43.7 37.7 Total expenditure 8.4 10.1 16.5 3.4 12.0 8.2 31.9 32.3 Consumption 4.8 12.7 21.0 -1.0 8.2 10.5 30.1 -11.3 Investment 19.8 2.7 2.7 19.5 23.5 2.1 37.1 150.6 Gross domestic income 21.2 48.0 -7.7 14.4 6.6 21.3 52.0 26.5 Gross domestic saving -0.2 -19.2 -53.9 144.5 -13.3 14.1 -18.5 184.1 a. "GNFS" denotes "goods and nonfactorservices,'' Part E:PeriodAverage Indicators Estimate Projection 1995-2000 2000-2005 Marginal national saving rate 11.1% 44.8% Incremental capital-output ratio 4.1 2.5 lmuort elasticitv 0.4 1.4 Sources: Angolan authorities and IMF and World Bank estimates. 139 Angola Exports and Imports - Aclual Estimated Projected 1999 2000 2001 2002 2003 2004 2005 2006 A. Value incurrentprices(US$millions) Total merchandiseexports (FOB) 5157 7920 6645 8166 9515 13474 23724 30335 Principalprimaryproducts 5048 7727 6510 8035 9337 13261 23441 29988 Crudeoil 4406 6951 5801 7386 8533 12441 22308 28501 Diamonds 629 738 689 638 788 790 1089 1431 Coffee 4 1 0 0 1 0 0 1 Gas 9 37 20 10 16 30 43 55 Refinedpetroleumproducts 75 132 93 95 139 148 202 258 Other goods 33 61 42 36 39 65 81 90 Total merchandiseimports(CIF) 3109 3040 3179 3760 5480 5832 8667 12514 Memorandumitems Exportvolume growthrate 1.4 2.0 -0.9 21.3 -2.7 14.1 28.5 13.2 Importvolumegrowthrate 55.3 4.8 7.9 15.4 29.2 -3.7 43.5 45.5 B.PriceIndices(YR97 = 100) Merchandiseexport 99.0 149.2 126.2 127.9 153.2 190.0 260.3 294.2 Merchandiseimport 92.7 86.5 83.8 86.0 97.0 107.1 111.0 110.2 Merchandiseterms oftrade 106.8 172.4 150.6 148.8 157.9 177.4 234.6 267.1 Sources: Angolan authoritiesandIMF and World Bank estimates. 140 Angola Balance of Payments - (US%millions at currentprices) Actual Estimated Projected 1999 2000 2001 ZOOZ 2003 2004 2005 2006 Total exports ofGNFS" 5310 8187 6848 8373 9716 I3797 24120 30785 Merchandise(FOB) 5157 7920 6645 8166 9515 13474 23724 30335 Nonfactor services 153 267 203 207 201 323 397 450 Total Imports of GNFS 5704 5739 6697 7082 8801 10635 15834 21640 Merchandise(FOB) 3109 3040 3179 3760 5480 5832 8667 12514 Nonfactor services 2595 2699 3518 3322 3321 4803 7167 9126 Resourcebalance -394 2448 150 1291 915 3162 8286 9145 Net factor income -1372 -1681 -1561 -1635 -1726 -2484 -4075 -5277 Factorreceipts 41 46 49 18 12 33 41 45 Factorpayments 1413 1726 1610 1653 1739 2517 4116 5322 Interest (scheduled) 569 597 539 354 243 399 459 688 Total interestpaid 569 597 539 354 243 399 459 688 Net adjustments to scheduledinterest 0 0 0 0 0 0 0 0 Other factor payments 844 1130 1071 1299 1495 2118 3657 4634 Netprivate currenttransfers 110 126 137 -110 -87 -118 -120 -122 Current receipts, ofwhich 193 186 198 0 0 0 0 0 Workers' remittances 193 186 198 0 0 0 0 0 Current payments 83 60 61 110 87 118 120 122 Net official current transfers -54 -99 -46 142 186 124 150 150 Currentaccount balance -1710 795 -1320 -312 -713 685 4242 3896 Officialcapital grants 7 18 4 10 0 11 6 0 Private investment (net) 2472 879 2146 1643 1652 1414 1639 2237 Direct foreign investment 2472 879 2146 1643 1652 1414 1639 2237 Portfolio investnmts 0 0 0 0 0 0 0 0 Net Official LT borrowing -291 -766 -618 -162 178 906 1408 2397 Disbursements (incl. Gap) 1610 1619 2764 3484 3211 Repayments (scheduledj 1501 1279 1539 1791 2376 2237 1441 1359 1857 2076 792 a Goods and non-factor services b Refersto oil bonus 141 Angola Balance of Payments (continued) - (US$ millions at current prices) Base-case (most IikelvJ uroiection ., ' I ACYUal Estimated Projected 1999 2000 2001 2002 2003 2004 2005 2006' Adjustments to scheduled debt service (Exceptional financing) 791 336 334 334 330 187 335 201 Other capital flows incl. mors and omissions -739 -630 -985 -1742 -1005 -1970 -5512 -3619 Change in net international reserves (incl.Net IMF) -530 -631 440 229 -443 -1233 -2117 -5112 (- indicates increase in assets) Memorandum items Total gross reserves 496 1198 766 399 800 2034 4147 9261 Total gross reserves (in nunths' imports G&S") 0.8 1.9 1.1 0.5 0.9 1.9 2.5 4.1 Exchangerates Annual average (LCUILISS)~ 2.8 10.0 22.1 43.7 74.6 83.4 87.2 At endyear (LCUiVSS) 5.6 16.8 31.9 58.7 79.1 85.6 80.8 Current Account Balance as % GDP -27.8 8.7 -14.8 -2.7 -5.1 3.5 12.9 8.8 Sources: Angolan authorities and IMF and World Bank estimtes. c. "G & S" denotes "goods and services." d. "LCU" denotes "local currency units." 142 Angola Public Finance - (at current prices and exchange rates) Actual Estimated Projected 1999 2000 2001 2002 2003 2U04 2005 2006 Governmentbudget(billions LCUs) ' Total current revenuesandgrants 8.0 46.0 88.9 190.8 394.9 609.7 1085.8 1343.0 Direct taxes 7.4 43.0 78.0 163.6 328.9 522.8 941.2 1160.3 Indirecttaxes 0.6 2.8 ,10.2 25.2 53.1 73.8 109.1 138.4 On domestic goods and services 0.3 1.6 5.8 14.6 30.1 41.9 61.9 78.5 On internationaltrade 0.2 1.2 4.4 10.6 23.0 31.9 47.2 59.9 Nontaxreceipts 0.0 0.2 0.7 2.0 12.9 13.1 35.5 44.3 Total Expenditures 14.0 53.7 96.0 235.2 461.5 635.7 891.8 1264.1 Total Current Expenditures 8.7 39.9 70.1 174.2 378.1 505.6 720.1 828.5 Interestonexternal debt 1.6 5.0 9.8 15.5 18.1 31.1 34.8 38.4 Intereston domestic debt 0.0 0.0 0.0 0.0 0.9 6.7 13.8 15.7 Transfersto private sector 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Transfersto other NFPSb 1.8 4.9 3.6 12.5 16.8 32.4 64.0 15.5 Subsidies 0.0 1.0 7.2 0.0 49.5 108.7 115.7 118.3 Consumption 5.3 28.9 49.6 146.2 292.8 326.6 491.8 580.6 Wages and salaries 0.7 5.2 14.9 51.3 125.0 167.0 238.0 3 14.0 Other consumption 4.6 23.7 34.7 94.9 167.8 159.6 253.8 266.6 BudgetarySavings -0.7 6.2 18.7 16.6 16.8 104.1 365.8 514.5 Capital Revenues 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total Capital Expendituresand other 5.3 13.8 25.8 61.0 83.4 130.1 171.7 435.7 Budgetary fixed investment 2.2 5.6 12.5 33.6 79.0 80.8 134.7 409.5 Other incl. unclassifiedexpenditures 3.2 8.2 13.3 27.4 4.3 49.3 37.0 26.2 Overallbalance (- = deficit accrual basis) -6.1 -7.7 -7.1 -44.4 -66.6 -26.0 194.1 78.9 Changes in arrears net) 1.8 23.3 -2.3 36.8 8.0 -35.0 -23.5 -22.3 Overall balance(-= deficit cash basis) -4.2 15.7 -9.4 -7.6 -58.6 -61.0 170.6 56.6 Sources o f financing (+) 4.2 -15.7 9.4 7.6 58.6 61.0 -170.6 -56.6 Net externalborrowing 0.3 -4.3 -10.3 -24.2 36.2 89.6 -91.1 216.7 Net domestic financing 1.3 -11.4 15.4 18.1 22.4 -46.0 -79.4 -433.8 Other 2.6 0.0 4.3 13.6 0.0 17.4 0.0 160.5 Shares of GDP (%) Currentrevenues 46.4 50.2 45.1 38.3 37.9 36.9 38.0 38.0 Currentexpenditures 50.6 43.5 35.6 35.0 36.3 30.6 25.2 23.4 Budgetarysavings -4.2 6.7 9.5 3.3 1.6 6.3 12.8 14.5 Capital revenues 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total Capital Expendituresand other 31.1 15.1 13.1 12.3 8.0 7.9 6.0 12.3 OverallBalanceaccrualbasis (- = deficit) -35.4 -8.4 -3.6 -8.9 -6.4 -1.6 6.8 2.2 Sources: Angolan authoritiesand IMF andWorld Bank estimates, a. "LCU" denotes "local currency unit." b. "NFPS" denotes "nonfinancial public sector." 143 Angola -,Monetary Survey (in billions of local currency units) Actual Estimated Projected 1999 2000 2001 2002 2003 2004 2005 2006 A. Annual Flows: Netforeign assets 5.6 24.7 18.0 46.0 60.1 123.8 185.3 625.1 Net internationalreserves 1.5 6.3 -9.7 -10.0 33.0 102.9 184.5 410.2 Other net foreignassets 4.1 18.4 27.7 56.0 27.1 20.9 0.8 214.9 Domestic credit 0.8 -14.8 12.3 28.0 38.2 10.0 -14.3 -488.0 To government 0.4 -16.4 6.3 11.5 4.9 -27.2 -68.9 -534.4 To rest of the economy 0.4 1.7 6.0 16.4 33.3 37.2 54.6 46.3 Total assets = liabilities 6.4 10.0 30.3 74.0 98.4 133.8 171.0 137.1 Money and quasimoney 3.4 11.9 25.5 65.6 70.9 66.7 146.6 169.2 Netother liabilities 3.0 -1.9 4.8 8.4 27.4 67.1 24.3 -32.1 B.Endof Year Stocks: Net foreign assets 5.8 30.5 48.5 94.5 154.7 278.4 463.7 1088.8 Net internationalreserves 2.8 20.1 24.5 23.4 63.3 174.1 335.0 751.2 Other net foreign assets 3.0 10.4 24.0 71.1 91.4 104.4 128.8 337.6 Domestic credit 1.2 -13.5 -1.2 26.8 65.0 75.0 60.7 -427.3 To government (NFPS) a 0.7 -15.7 -9.4 2.1 7.0 -20.2 -89.0 -623.4 Governmentbudget Other NFPS To rest ofthe economy 0.5 2.2 8.2 24.7 58.0 95.2 149.7 196.1 Private sector 0.5 2.2 8.2 24.7 58.0 95.2 149.7 196.1 Other financial institutions 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total assets = liabilities 7.0 17.0 47.3 121.3 219.7 353.4 524.4 661.5 Money and quasimoney 3.9 15.8 41.4 107.0 177.9 244.6 391.2 560.4 Net other liabilities 3.1 1.2 5.9 14.3 41.8 108.8 133.2 101.1 C. Factors accounting for monetary expansion(as % MQMb) Net foreign assets 147.0 192.6 117.3 88.4 86.9 113.8 118.5 194.3 Credit to government (NFPS) 17.9 -99.2 -22.8 2.0 3.9 -8.2 -22.8 -111.2 Credit to rest o f the economy 13.6 13.8 19.9 23.1 32.6 38.9 38.3 35.0 Netother liabilities (-) 78.6 7.3 14.3 13.4 23.5 44.5 34.0 18.0 D.Money, credit andprices M2/GDP 22.8 17.3 21.0 21.5 17.1 14.8 13.7 15.8 Annual growth rate MQM 680.9 303.7 161.2 158.5 66.3 37.5 60.0 43.2 Annual growth rate privatecredit 477.4 308.8 275.9 199.9 135.0 64.1 57.4 31.0 Sources: Angolan authorities and IMF and World Bank estimates. a. "NFPS" denotes "nonfinancialpublic sector." b. "MQM" denotes "money and quasi money." 144