Sustaining growth by building on emerging export opportunities

Rwanda’s economic growth has been slowing down since mid-2016 resulting in a 6 percent growth in 2016 and in 4.2 percent annualized growth in the first quarter of 2017. This slowdown was mainly due to a combination of the drought, weak export prices and construction activities following the completion of large investment projects in 2016.

However, the growth is expected to peak up in the second half of 2017, according to the 10th edition of the World Bank Rwanda Economic Update, Sustaining Growth by Building on Emerging Export Opportunities, launched on 6 September 2017.

The report also noted improvement in macro-economic policy environment in 2017 with inflation decelerating to below 5 percent by June 2017 down from the peak of more than 8 percent recorded in February. Depreciation of the exchange rate has also alleviated the pressure on foreign exchange reserves and is expected to contribute to narrowing of external imbalances.

Analyzing the export sector performance as a special topic, the Rwanda Economic Update noted that exports increased from just $400 million in 2007 to $1.6 billion in 2016. Non-traditional exports have emerged as an important driver of that growth, thus laying the foundations for export-led growth in Rwanda. Exports to the region, and especially to the Democratic Republic of Congo and to the East African Community (EAC) countries, mainly as re-exports and through small-scale cross-border trade contributed the bulk of export growth.

“Although Rwanda’s export sector is still small, the progress made in the past decade sends a clear message that an export-led growth is within reach for Rwanda, and country’s long-term growth strategy should continue focusing on strengthening economy’s capacity to produce exportable goods and services,” said Aghassi Mkrtchyan, World Bank Senior Economist.

To ensure sustainable export growth, the Rwanda Economic Update highlights some policy considerations including maintaining a competitive real exchange rate by avoiding exchange rate misalignment, focusing on agriculture as a strategic sector that provides raw materials for emerging agribusiness, and continued engagement at the regional level to identify and remove non-tariff barriers within the EAC region.

Returning to a higher growth trajectory in 2018 is attainable, although there are risks, according to the report. In the medium term, economic activity will benefit from the expected recovery of prices of traditional exports, including minerals, tea, and coffee. But the key for sustaining growth at the rates in line with Rwanda’s historical average is private sector investment activity, especially in the tradable and export oriented sectors.

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Introduction

The tenth Economic Update comes at an important juncture for Rwanda. The country has entered the third decade of uninterrupted economic growth and social progress. Rwanda’s global income ranking improved from the seventh poorest in 2000 to the 20th in 2015, on the back of Rwanda’s strong commitment to good governance, the principles of market economy and openness.

The growth, however, has been slowing down recently and is expected to remain subdued in 2017. Going forward, achieving Rwanda’s ambition of attaining middle-income status requires sustaining the average growth rate of the past two decades in the years to come. The Vision 2050, and the new EDPRS, currently under preparation will provide the roadmap for adapting the economy to the evolving regional and global context and maintaining a growth rate that delivers poverty reduction and prosperity.

In addition to presenting recent macroeconomic developments, this update also discusses the longer term patterns of productivity and structural transformation and derives some broad lessons for growth strategy. As a special topic for this edition, the update presents an analysis of Rwanda’s export sector performance, an important issue for Rwanda in the light of the centrality of exports for Rwanda’s long-term growth strategy.

Productivity and structural transformation patterns

The growth slowdown of 2016 and 2017 driven by the drought, weak export prices and fiscal restraint to address growing external imbalances can be seen as a temporary phenomenon. At the same time, long-term productivity patterns examined in this report point to several factors that, if not addressed, may depress Rwanda’s growth potential.

Structural transformation, characterised by an inter-sectoral movement of labour from subsistence agriculture mostly to the service sector, has been the main driver of growth since the early 2000s. The growth in productivity within economic sectors played a smaller role. Service sector has contributed to the growth in productivity as it absorbed labor from agriculture and most of the entrants to the job market. Within-sector productivity growth in non-tradable services was not high, highlighting the limits of these services in driving the long-term growth. While manufacturing sector demonstrated high productivity growth in recent years, it attracted a negligible fraction of the total increase in the labour force. Creating enabling environment for a greater labour absorption capacity in manufacturing, coupled with an improved productivity in agriculture, will be key for sustaining growth in the medium to long-term.

With respect to the patterns in total factor productivity (TFP), it appears that TFP growth has slowed recently with capital accumulation becoming the main driver of growth. In this context, the surge in public investment of 2013- 2015 helped to maintain a high growth rate. The recent slowdown underscores the dependence of the economy on government-led investment. There is only limited scope to further increase public investment as it can lead to debt accumulation and thus cannot be sustainable in long-term. This highlights the importance of the more efficient use of available investment resources to underpin strong TFP and, ultimately, economic growth. For the private investment, evidence points that allocation of capital investment to housing, hotels and restaurants where the expected payoffs are yet to materialise could be one of the factors behind the slowdown in TFP growth. Going forward, creating conditions that encourage the private sector to channel investment resources to the tradable sector where the potential for productivity growth is high will be key for sustaining a high growth rate in long run.

Analysis of export sector performance

From a very low base, Rwanda’s exports have increased four-fold in the last decade from just US$400 million in 2007 to US$1.6 billion in 2016. Rwanda’s exports are more diversified with the growth of services, re-exports and small-scale cross-border trade. Exports to the region, and especially to the DRC and to the EAC countries, mainly as re-exports and through small-scale cross-border trade contributed the bulk of export growth for Rwanda. However, non-tariff barriers including cumbersome customs procedures, export bans and roadblocks continue to impede the growth of intra-regional trade.

Traditional agricultural exports – tea, coffee, and minerals – are still important export earners but overall performance has been mixed in recent years. Traditional exports currently generate less than half of the total exports earnings, while a decade ago Rwanda’s exports exclusively consisted of these traditional goods. Export volumes of coffee have been stagnant while the volume of tea production has nearly doubled, although with muted economic impact given low value addition. Declining prices and low production of traditional minerals has also substantially affected export earnings.

Non-traditional merchandise exports have emerged in Rwanda, offsetting mixed performance of traditional sectors. Other minerals, agriculture, and manufacturing, that generated only US$4 million in 2004 reached US$155 million in 2016. Re-exports and small-scale exports mainly to DRC and to the EAC region also made a substantial contribution to export growth. Although re-exports do not generate substantial value added and jobs, they enable local clusters of economic activity that can be built upon.

Services exports are concentrated in traditional sectors of tourism and transport but exports in high-productivity ICT and financial services have started. Continued efforts to diversity tourism products will help to reduce the risk of over-dependence on traditional tourism which currently accounts for 29 percent of total exports.

Firm-level analysis of exporters in Rwanda reveals that the number of exporters has increased but the size of exporting firms is smaller than those in regional peer countries. Exports are concentrated in a few exporters but such concentration is similar to the levels found in countries with the same level of development. Rwandan exporting firms are on average less diversified, both in terms of the number of exported products as well as the number of destination markets. Over 50 percent of exporting firms export only a single product to a single destination. The majority of firms serve only the regional-market (EAC and DRC) and the average value of exports per exporter to regional markets is much smaller than that of firms who export to the rest of the world.

The challenges of small exporting firms are survival and growth in the export markets. There is a high degree of churning of firms with high entry and exit rates. Exporting firms that import intermediate inputs are on average more diversified in terms of both export product as well as destinations than pure exporters.

This emphasizes the need for continued efforts to reduce barriers to imports and improve trade logistics. For Rwanda, facilitating imports of inputs, including through effective management of exchange rate policy, is a key element in promoting export diversification. The analysis also reveals that growth of exports is driven by incumbent firms that have managed to proceed past the initial survival stage. This suggests that measures that assist new exporters to survive will have longer-term pay-offs in terms of greater export growth.

This update also highlights several policy considerations that are important for ensuring sustained export growth:

• Maintain a competitive real exchange rate by avoiding exchange rate misalignment to encourage investments in tradable sectors.

• Facilitate access to affordable and reliable inputs and raw materials using measures such as the Duty Remission Scheme under the EAC Common External Tariff.

• Focus on agriculture as a strategic sector that provides raw materials for emerging agribusiness, an important source of future export growth with strong impacts on poverty reduction.

• Continue to engage at the regional level to identify and remove non-tariff barriers within the EAC region.

• Improve trade logistics through needsbased infrastructure development, stronger institutional coordination and capacity building of logistics service providers

• Implement programs to reduce variable costs related on exporting with emphasis on SMEs and large exporting firms.

• Continue to implement measures that make Rwanda attractive as a location for FDI that is seeking to exploit opportunities for goods and services in the regional market as well as under the EBA and AGOA trade preference schemes.

The 10th edition of the REU was jointly prepared by the Rwanda Macroeconomics and Fiscal Management Global Practice team and the Trade and Competitiveness Practice team at the World Bank.