On July 12, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the 2017 Article IV consultation with Rwanda and completed the seventh review of Rwanda’s performance under the Policy Support Instrument (PSI) and the second review of the arrangement under the Standby Credit Facility (SCF).

Following the Executive Board discussion, Mr. Tao Zhang, Deputy Managing Director and Acting Chair, made the following statement:

“Rwanda has made notable progress in the past two decades, anchored by its carefully-considered development strategy. This includes steady progress on structural transformation, high and inclusive growth, reduced poverty and gender inequality and attractive business environment. This has been reinforced by strong macroeconomic policy management, characterized by strategic public investment in growth-enhancing infrastructure, maintenance of low inflation, and measures to bolster domestic revenue mobilization.

“Responding to adverse global conditions, the authorities took decisive steps to address external imbalances, thereby safeguarding macroeconomic stability and growth over the longer term. Exchange rate flexibility has been the central tool of policy adjustment, with structural reforms to bolster domestic production. These policies have already made progress in reducing the deficit in goods and services trade, and should place external balances on a more sustainable path over the medium term. Performance under the SCF arrangement and PSI-supported program has been strong, with almost all program targets and structural measures set through end-March achieved.

“Growth slowed in 2016, due to an extended drought, completion of large investment projects, and adjustment policies. It is expected to recover over 2017-18, with balanced risks to the outlook. Inflation spiked in early 2017 due to a food supply shock, but is now abating.

“Despite the notable achievements, the Rwandan economy remains vulnerable to external shocks. It will be important to rebuild foreign exchange reserve buffers to enhance the country’s resilience. Similarly, to support continued growth-enhancing public investment, the government should ensure that recently-introduced tax incentives to boost domestic production are well-targeted and do not unduly weaken the tax base. To reach the goal of upper middle income status, it will be important to boost the role for the private sector to serve increasingly as the main engine for growth and investment in Rwanda.”

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Staff Report

Context

Rwanda has implemented an ambitious development program over the past two decades. Its policies have resulted in high and inclusive growth, poverty reduction, improved living standards, and sharpened competitiveness. These policies were implemented in the context of a 20-year “Vision 2020” strategy that envisages the country moving to middleincome status by 2020. This has been implemented through 5-year policies under successive “Economic Development and Poverty Reduction Strategies”. Under these strategies, the government has channeled significant public investment into programs to improve social outcomes, increase agricultural productivity and transform the economy to higher value added activities, improve gender equality, and foster financial inclusion, among other things.

High and inclusive growth has increased incomes and reduced poverty. In the past decade, the sustained focus on high and inclusive growth, combined with maintenance of macroeconomic stability, has achieved tangible results: growth rates have averaged around 7½ percent per year, close to doubling per capita income. At the same time, concerted policies have reduced gender inequality to the lowest level in Sub-Saharan Africa (SSA), reduced poverty from around 60 percent to under 40 percent, and lowered income inequality, with the Gini coefficient dropping from 0.52 in 2005 to 0.45 in 2014.

At the same time, policies have been implemented to improve the business environment and competitiveness. The 2017 World Bank’s Doing Business survey ranks Rwanda ranks 56 out of 190 countries, #2 in Africa after Mauritius. For example, online business registration has reduced the time to start a new business down to 4 days, and an electronic case management system for judges and lawyers helped reduce the time for contract enforcement to 230 days, shorter than many more advanced economies. For competitiveness and productivity, the 2016/17 World Economic Forum’s Global Competitiveness Index ranks Rwanda as the fourth most improved country in Africa compared to two years earlier, garnering the highest scores for improving its institutional quality and labor market efficiency while diversifying the economy. Rwanda is currently ranked at 52 out of 138 countries, outperforming SSA averages in all pillars except for market size.

Rwanda has boosted domestic revenues to reduce donor reliance. Rwanda’s past achievements have relied substantially on official development assistance. However, faced with declining aid flows to finance its investment strategy, Rwanda has taken numerous tax policy and revenue administrative measures to boost domestic revenues, which increased some 6 percentage points of GDP from 2010 to 2016.

Box 2. Rwanda: Domestic Revenue Collection

Rwanda has made significant strides in raising tax revenues through better administration and tax policy measures. In the past decade, domestic revenue collection has grown by more than 6 percentage points of GDP. Increasing domestic revenues has been a key feature of the current PSI-supported program.

Gains in recent years have been primarily a result of improvements in revenue administration, including the collection of local taxes at the central level, improvements in auditing procedures, and closer scrutiny of large taxpayers. Tax policy measures have included VAT on mobile airtime, royalty taxes on mining, and taxes for special petroleum and infrastructure funds. Following the use of a Tax Administration Diagnostic Assessment Tool (TADAT) in 2015, the Rwandan Revenue Authority (RRA) is implementing a work program focused on strengthening taxpayer registries and electronic filing, and reducing outstanding stock of arrears more efficiently.

In recent years IMF technical assistance (TA) has focused mining and property taxation and analyzing the VAT gap. The authorities have used this advice to formulate royalty taxes and the long-awaited revised Fixed Asset Tax legislation, which provides for new rates and a property valuation system based on market prices. Both taxes provide an upside risk to revenue projections over the medium term. On VAT, amendments have been associated with narrowing various incentive schemes to strategic sectors e.g. exports, manufacturing, energy, ICT, financial services, construction, and agriculture.

Policy discussions

Discussions focused on key areas for sustaining high and inclusive growth, while maintaining macroeconomic stability and advancing EAC integration. Staff also prepared analytical work on structural transformation, gender inclusion, and macro-financial stability and development. Discussions included: redoubling efforts on revenue mobilization; improving fiscal transparency; and setting the path toward a price-based monetary policy framework, supported by a flexible exchange rate regime and vibrant interbank markets and central bank instruments. Informed by an updated external assessment and debt sustainability analysis, the authorities and staff also discussed fiscal and monetary policy stances for the remainder of 2017, within the context of various challenges to the ever-important agriculture sector. The authorities explained their “Made in Rwanda” campaign, originally intended to address external imbalances, but now expanded to promote more domestic production through strengthened supply chains and higher productivity. Finally, authorities and development partners worked together on preparation for Rwanda’s participation as one of the first five countries in the G-20 Compact with Africa.

External Sector – Rebuilding Reserve Buffers

External imbalances remain, but are falling. The deterioration of the current account deficit and reserve buffers since 2012 reflected temporary factors affecting the trade balance – including the commodity price shock and large investment projects – as well as a structural reduction in official development assistance. Adjustment policies undertaken since have begun to reverse external imbalances and stem the loss of official reserves. The pace of Rwandan franc depreciation has slowed in 2017, suggesting that the external position is more in line with fundamentals, as indicated by various external analysis metrics (Annex IIII). Accumulation of official reserves through end-2017 is expected to be slightly less than earlier projected, however, this is based on the authorities’ revised projections for foreign direct investment which reflect recent information on 2015 outcomes. Staff expressed the view that the authorities’ projections for FDI may be conservative: Foreign direct investment outturns in 2015 may have been depressed by temporary factors including the commodity price decline, and various initiatives are underway to stimulate private investment.

The authorities have gone beyond macroeconomic adjustment policies to address external imbalances. The “Made in Rwanda” campaign, launched in 2016, originally focused on strategic interventions for import substitution. However, the campaign has been expanded to promote domestic production more generally. While acknowledging the initiative, staff emphasized that continued exchange rate flexibility will be important both for sustainable external balances and for the transition to inflation-targeting.

Box 8. “Made in Rwanda” Campaign

To reduce structural trade deficits and stimulate growth, the government formulated a “Made in Rwanda” (MIR) initiative over the course of 2016. Initially the policy was intended to identify promising sectors for import substitution, e.g. cement, light manufacturing (garments), agriculture (sugar, rice). Targeted interventions already underway include investment in the publicly-owned cement company to expand production potential. The policy has since been expanded to provide incentives to deepen domestic supply chains and product quality, including through:

• A communication campaign to encourage purchase of domestically-produced goods;

• Public procurement laws which give preference to domestically-produced goods;

• Certification changes to increase quality of domestically-produced goods;

• New VAT exemptions on inputs for strategic sectors to reduce the cost of production;

• Sector-specific action plans for strategic sectors to strengthen domestic supply chains to boost the domestic content of products, including meat, sugar, steel, detergents, and pharmaceuticals.

As of July 1, 2016, the government also implemented an EAC policy to hike import tariffs on used clothing/shoes, primarily to stimulate domestic clothing production. From July 2016-March 2017, imports of used clothes/shoes declined by 86 percent, and domestic production has picked up sharply. Over the same period, inflation related to clothing/shoes has remained lower than other categories, suggesting there has not been an adverse welfare effect.

With the larger MIR initiative in its nascent stages, it is too early to assess its broader impact on domestic production, external balances, and consumer welfare.

Rebuilding reserve buffers remains important. Staff assess that, given the risks Rwanda faces, official foreign exchange reserves covering 4-5 months of prospective imports would be optimal. This is also in line with the need to reach and maintain reserve coverage ratio of at least 4.5 months of imports to meet the EAC convergence criteria. The current account position is expected to gradually improve as the trade deficit narrows because of adjustment policies, commodity price stabilization, and returns from public investment in tourism, which should also allow an opportunity to rebuild reserves over the medium term, but projections for FDI in 2017 have been revised downward based on a new survey for 2015. This implies that, despite faster-than-expected improvement in the current account balance, reserve levels will be rebuilt somewhat more gradually than foreseen in the original program. A sustainable external position and ample reserves are important considering the unique risks Rwanda faces, particularly, continued dependence on relatively large official development assistance, a still-narrow export base, large import needs, and expensive overland access to ports.

Box 9. Rwanda: G-20 Compact with Africa

The G-20, under German leadership established a “Compact with Africa (CWA)” in February 2017. The basic idea of the CWA is that progress can be achieved in fostering private investment in Africa by identifying specific obstacles and/or market failures in host and potential investor countries. The Compact focuses on: the macro environment and supporting public infrastructure; the business environment and the government’s capacity to handle public-private partnerships; and the financing environment, including the availability of risk mitigation instruments provided by multilateral and bilateral development partners, access to domestic debt instruments, and potential support from institutional investors in advanced markets.

Based on its strong track record of performance, the authorities expressed hope that the Compact could have good potential to leverage existing work to attract and increase private investment in strategic sectors of the economy. The Rwandan government has identified strategic areas for private investment, including agriculture, light manufacturing in industrial parks, affordable housing, information technology, and infrastructure. Working together with development partners, the government articulated the advantages of working in Rwanda, incentive schemes for investors, and potential obstacles to investment. The “Compact” will be presented to the G-20 and potential private investors at various high-level events in 2017.

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Selected Issues paper

Investment strategy to foster structural transformation in Rwanda

Over the past 15 years, Rwanda has transformed its economy by moving workers out of agriculture into mostly services and some industry. This has been accomplished through strong public investment flows and efficient public investment management. Going forward, the challenge is whether the private sector can complement the infrastructure assets put in place by the public sector and maintain economic momentum. It will also require continued effort by the government in raising education standards, better matching qualifications offered to students to those most in demand by employers, and lowering electricity and transportation costs. If these challenges are met, Rwanda stands a good chance of maintaining its historically high growth rate and attain middle income status within 20 years.

State of Structural Transformation in Rwanda Sector Analysis

In SSA countries, over the 2000-10 decade, workers moved out of agriculture, where relative productivity levels are low, into the services and manufacturing sectors. This picture documented by Fox et al. (2013) reverses McMillan and Rodrik (2011) who analyzed developments in SSA during an earlier period (up to 2000) and found workers moving into lower-productivity sectors. The updated labor productivity calculations were based on combining sectoral output levels with corresponding trends in sectoral employment levels based on household survey data. Figure 1 plots average annual changes in employment shares over the 2000-10 period against relative productivity levels for agriculture, industry, and the services sector in 2000. During this decade of high growth, almost all SSA countries showed a pronounced shift in employment toward higher value added sectors. The only sub-Saharan African countries that did not, due to increases in the share of employment in agriculture, were Cote d’Ivoire and Mozambique.

For Rwanda, the shift of employment toward higher value-added sectors has been comparatively rapid. In a cross-country comparison, through 2010, Rwanda experienced a large shift in the share of employment from agriculture to services. Interestingly, over the most recent three-year period, 2011-14, while the annual decline in the share of employment in agriculture remained about 1 percent per annum, more of the jobs created over this period occurred in industry (0.66 percent) rather than services (0.33 percent). In Rwanda, as elsewhere, industry/manufacturing output has the highest value added.

Industry, and more particularly manufacturing, plays a smaller role in the Rwanda economy than elsewhere in Sub-Saharan Africa. Manufacturing is considerably below other East African countries although its importance is closing in on the average LIC. There is a general recognition of the difficulty in stimulating manufacturing in a landlocked country such as Rwanda which is why the focus of its investment strategy has been on agriculture and services.

Total Factor Productivity Analysis

An alternative way of looking at economic transformation is through “total factor productivity.” Looking at the whole economy, this analysis estimates the contribution to growth from increases in productivity (i.e. more output per input via, e.g. more sophisticated machines, use of information technology) vs. increases in inputs (e.g. more labor, machines). In the figures below the standard analysis is presented using the number of workers and combining the number of workers with a measure of educational attainment (average number of years of education) to give a quality-adjusted labor series.

In considering a few high-growth, non-resource-rich economies, the data suggests that growth has been largely dependent upon increases in inputs rather than increases in productivity, especially during the most recent five-year period. While growth has averaged between 5-7 percent over the 2010-14 period, growth in productivity was low in most cases. The exception is Kenya, which had higher productivity growth. This may relate to the size and greater sophistication of its economy, with mobile banking providing access to capital to a much wider population. For Rwanda, despite a relatively constant growth rate over the period, growth in productivity contributed far more in the earlier 2000-10 period than in the last five years. A challenge going forward will be to maintain the momentum for productivity growth.

Role of Investment in Rwanda to Foster Structural Transformation

Rwanda is a small landlocked country far from the sea, and it is extremely difficult to achieve economies of scale from the industrial sector. The country is therefore focusing on the development of services through establishing itself as a business tourism hub and improving agricultural productivity. Rwanda’s attractiveness is based on its cleanliness, security, good transportation and IT infrastructure and tourism opportunities. The authorities also recognize that some industry is needed to supplement export earnings and is focusing on light manufacturing (garments, shoes) and mining. It is also developing a policy of import substitution to conserve on foreign exchange needs and has identified cement, basic clothing, rice and sugar as products with the most potential of displacing imports.

Rwanda’s economic plan is contained in the most recent poverty reduction strategy plan (EDPRS2) covering the period 2013-18. True to the country’s comparative advantage, the plan focuses on improving agricultural productivity through increased irrigation, seed and fertilizer investment and promotion of services exports through large infrastructure investment. The plan aims to reduce poverty to 20 percent or below by 2020, and to increase foreign exchange earnings to place external balances on a sustainable basis, as external donor assistance is forecast to decline gradually in the future.

Macrofinancial dimensions in Rwanda: stability, inclusion, and development

Rwanda’s financial development may have been just as impressive as its economic growth plane over the past decade. But many experts and practitioners are skeptical about “financial growth success stories” in a low-income country context – more often than not have such episodes benefited only a narrow share of the population, while ending in tears for the country (and shattered public finances). Hence, did Rwanda’s financial growth coincide with actual improvements in the population’s access to financial services? Did financial stability suffer from the extraordinary growth of the past years? How can the public sector strike the appropriate balance between encouraging financial innovation and maintaining safeguards through proper regulation and supervision? These questions cannot be conclusively answered in this paper, but we wish to support their public discussion by providing a few facts and observations on Rwanda’s financial sector.

Financial Inclusion and Innovation in Rwanda

Sustained growth in microfinance and mobile financial services have contributed to more financial inclusion in Rwanda. Total assets of microfinance institutions almost doubled from end-2013 to 2016, while deposits increased by 65 percent over the same period. The rapid increase in microfinance activities, in particular through Umurenge SACCOs, has been one of the drivers of financial inclusion in Rwanda. The 2016 FINSCOPE survey indicates a significant overall increase in financial access of the adult population over the past four years, overwhelmingly on behalf of access to formal financial services (which includes microfinance).

There has also been a significant diffusion of mobile financial services in recent years, with Rwanda following a similar trend as its EAC peers. As of end 2016, more than 9.7 million users had subscribed to mobile payment systems, and nearly one million users had subscribed for mobile banking services, and the value of total e-payments rose to more than 30 percent of GDP within five years. Financial services innovation is an important driver of financial inclusion, and the rapid diffusion of money mobile transactions, pioneered by Kenya over the past decade, has caught on across the EAC.

The emergence of new alternative financing models could become the next frontier of financial innovation, with potential to further enhance financial inclusion in Rwanda. A recent report by the University of Cambridge has documented a doubling in the value of financial transactions through innovative online funding and lending platforms from 2013 to 2015. While the total amount raised in 2015 through such portals (US$4 million) is still only one thousandth of the overall financial system’s assets, the potential of the technology to reach projects and customers not served by traditional funding mechanisms is significant. Fast recent growth indicates that these new portals meet the needs of both suppliers and customers.

Rwanda is among the leaders in the region in creating an enabling regulatory environment for financial inclusion. The Economist Intelligence Unit’s 2016 Global Microscope rates Rwanda at the 8th position of all countries. Remarkably, Rwanda leapfrogged in the ranking by eight positions within one year, the third-highest observed relative improvement, mainly explained by significant capacity building in operating and supervising municipal savings and credit cooperatives. Compared to a total of thirteen surveyed SSA countries, Rwanda’s performance was bested only by Tanzania and Kenya, and it exceeded the regional average in seven out of twelve sub-indicators.

Rwanda also compares well with the EAC in the World Bank’s Financial Inclusion Index. For the first time, the 2014 FINDEX survey included access to microfinance and mobile financial services, and the remarkable progress compared to 2011 may reflect that. The results also confirm a picture of consistent and rapid improvements in financial inclusion. Interestingly, nearly all EAC countries exceed both the composite SSA and the frontier LICs inclusion index, and Kenya even exceeds the average index for emerging market economies.

Financial Development

When measured against the IMF’s financial development index, Rwanda’s performance appears less favorable than it probably is. The IMF has developed a database capturing financial development across depth, access, and efficiency, measured across institutions and markets. Within this framework, Rwanda’s performance is distinguished by the high quality of its financial institutions, but dragged down by its unsophisticated securities markets. However, recalling Rwanda’s recent advancements in financial access and inclusion, it seems likely that the country’s state of financial development is understated by the index, because it does not include data on microfinance or mobile financial services – the access parameters for institutions (number of mortar-and-brick branches; ATMs) may even be misleading in an innovative world that moves toward low-cost mobile payment and banking solutions.

The index suggests that Rwanda’s financial system has improved over the past decade, but is held back by size and scale limitations. Developments are much in line with regional peers, but the overall level of the index is lagging other EAC countries. It appears that this mainly reflects the limitations of a tiny national securities market: It is very difficult for smaller countries to score well on an index that measures market efficiency per absolute number of transactions. A long-term strategy for gradual regional integration of financial markets within the EAC may present the best available chances for overcoming these size and efficiency issues.