Gabon seeks to diversify its economy as oil revenues decline
Hit hard by the recent oil price decline, Gabon can build resilience and revive growth by continuing to diversify its economy, says the IMF.
In its annual assessment of the economy, the IMF also welcomed the government’s plan to improve the level and quality of infrastructure, and raise the quality of human capital – the key constraints to economic growth.
A challenging economic environment
Despite progress in implementing its transformation plan, Gabon is still oil-dependent and therefore highly vulnerable to the recent oil price shock. After a decade of lackluster economic growth, in 2010 the government embarked on the Plan Stratégique Gabon Emergent (PSGE), which aims to diversify its economy by 2025. In its first phase (2010-14), high oil revenues funded a scaling up of public investment that helped propel overall growth to nearly 6 percent on average, led by construction and services. While there are initial promising signs of diversification, structural transformation is a gradual process, and as of 2014 oil still accounted for roughly 40 percent of GDP, 45 percent of government revenues, and nearly 85 percent of exports. The low oil price outlook and secularly declining oil production will reduce available financing for the second phase of the PSGE (2016–20). As part of the oil-dependent CEMAC monetary union, Gabon’s success in adjusting to oil price shocks also hinges on the ability of other member countries to appropriately implement fiscal adjustments and their own diversification agenda.
Economic activity has significantly decelerated in 2015. Statistical data through September 2015 indicate higher-than-expected oil production (thanks to the introduction of new wells and performance improvements), mining (manganese), and agriculture (due to a large, ongoing international agribusiness joint venture). However, the sharp fall in oil prices has prompted the government to slow capital spending, and oil companies to rein in operating and development expenditures. This reduced domestic demand led to significant contractions in large non-oil sectors, including construction, transportation, commerce, and services. At the same time, broad money and credit to the economy are contracting.
Despite significant fiscal adjustment since the second half of 2014 and delays in the implementation of the capital spending, fiscal buffers are contracting rapidly. Since 2012, public debt has more than doubled from 20 to 43 percent of GDP (above the 35 percent indicative ceiling of the government), in part due to US$1.5 billion and US$500 million Eurobond issuances in December 2013 and June 2015, respectively. About two-thirds of the increase in the debt-to-GDP ratio since 2014 is due to the depreciation of the CFA franc and the decline in the oil GDP deflator. Moreover, between December 2014 and October 2015, government deposits at the BEAC (net of Eurobond receipts) declined by 57 percent, and gross international reserves by 30 percent. Foreign financing has become increasingly costly, as rating agencies have downgraded the sovereign debt of oil exporters, including Gabon, contributing to a significant increase in spreads in recent months.
Presidential and parliamentary elections are expected in the second half of 2016. No official election dates have been announced, but the process of electoral list revision began in January 2016. Opposition parties boycotted the 2009 parliamentary elections, and the governing Parti Démocratique Gabonais won 113 of the 120 seats in the National Assembly. The run-up to the elections is likely to be accompanied by heightened social and political tensions. As a result, some politically tough economic policy decisions may be delayed.
POLICY DISCUSSIONS: CONTAINING THE IMPACT OF THE OIL PRICE SHOCK
The principal theme of the 2015 Article IV consultations was the impact of lower oil prices on the economy, especially on the budget and the financial sector. Another key issue was how to reassess and reprioritize the PSGE so that it can be sustainably financed. Staff also assessed progress on other important issues and recommendations discussed during the 2014 Article IV consultations, including on the PSGE, structural reforms, and economic data shortcomings. As indicated in Annex II, there has been an improvement in the implementation of previous Article IV recommendations.
Fully Adjusting to a New Oil Price Outlook
The continued drawdown of fiscal buffers increases the risks to fiscal sustainability and the adequate financing of needed investment. While there was a slowdown in the execution of the 2015 budget (only 62 percent of budgeted capital spending was executed by September), non-oil revenue was lower than in 2014 and the government repaid large domestic arrears and temporary external arrears. Financing pressures likely persisted in the last quarter considering the expected acceleration in spending. Taking into account these developments and the 2015 amended budget, the staff projects a fiscal deficit on a commitment basis of 3½ percent and on a cash basis of 9 percent of non-oil GDP (including large reimbursements of VAT-related and other arrears).
Staff welcomes the authorities’ aim to continue fiscal consolidation, as outlined in the 2016 budget draft and in the Medium Term Fiscal Framework (MTFF), but has substantial reservations on the underlying assumptions. While the assumed US$42 per barrel of Gabonese oil was conservative when the budget was prepared, the acceleration of the decline in international oil prices suggests there is a need to amend the budget accordingly. Furthermore, the 2016 initial budget optimistically assumes a 20 percent increase in non-oil revenues relative to the authorities’ 2015 projection. It also proposes a small 3.5 percent increase in current spending, which will be politically difficult in an election environment and crowds out much-needed productive public investment by including two stadia to host the 2017 African Cup of Nations, which account for 15 percent of total capital spending. The 2016-18 MTFF proposes spending paths that imply a freeze in current spending in nominal terms and a reduction in capital spending by 8 percent between 2015 and 2018. Under these assumptions the government expects that the overall fiscal deficit would gradually decline and reach a small surplus in 2018.
The staff baseline scenario proposes a more substantial adjustment to preserve fiscal sustainability. Staff proposes that the non-oil revenue base be widened over time with the elimination of overly generous tax exemptions; wages and salaries would grow at 2 percent per year in nominal terms throughout the period; and other main current spending items and capital spending grow in nominal terms but at a rate significantly below non-oil GDP growth. Under those assumptions, a debt sustainability analysis (DSA) shows Gabon’s projected debt level peaking at 50.1 percent of GDP in 2016, and decline slowly from 2019. That said, shocks considered in the DSA could lead to much higher debt-to-GDP ratios, and a growth shock could propel debt significantly above the CEMAC ceiling (70 percent of GDP) by 2021. Given the large proportion of US dollar-denominated debt, exchange rate fluctuations constitute a significant risk to Gabon’s external debt sustainability.
Adjusting to the unfavorable oil price outlook while ensuring the financing of the government’s diversification plan requires a wide range of strong measures. The authorities need to:
Foster non-oil revenues by widening the tax base, mainly by reducing tax exemptions and improving tax administration. In a fiscally-challenging environment, it is hard to justify the recent elimination of taxes and fees for over 171 products as part of the so-called “policies against high living costs”, and the prohibition of importation of vehicles over three years old, which represent a revenue loss of 0.7 percent of GDP in 2015. A review of these policies is urgently needed, especially in the context of rapidly rising real public wages. More generally, staff recommends a thorough review and reform of the tax policy regime.
Prepare a revised budget for 2016, given the worsening growth and oil price outlook, to preempt unfavorable public debt dynamics and avoid the accumulation of arrears.
Further enhance tax administration, drawing on extensive IMF and AFRITAC technical assistance by implementing measures such as formalizing the collaboration between tax and customs directorates, moving the collection of customs revenues from the Treasury to the customs department, modernizing customs drawback system, and adopting a risk-based approach to VAT reimbursements.
There is also a critical need to curb inefficient and/or poorly targeted current spending, while protecting social spending. Most importantly, the public wage bill needs to grow below inflation in the medium term.
With public investment considerably lower than in recent years, private sector participation for infrastructure construction should be encouraged by accelerating development of an appropriate Public Private Partnership (PPP) framework. Key projects under the PSGE should be reviewed and reprioritized while minimizing projects with limited long-term economic payoff such as sports infrastructure.
Staff recommends anchoring medium-term fiscal policy by targeting a steady reduction in the debt to non-oil GDP ratio through a progressive strengthening of the nonoil primary deficit, which would allow the authorities to rebuild fiscal buffers. Throughout the adjustment, and financing permitting, annual reductions in the non-oil primary deficit should not exceed 2 percent of non-oil GDP so as to limit the negative fiscal impulse.
The implementation of the BOP should continue, taking into account recent recommendations by IMF technical assistance, emphasizing measures to improve treasury management and to avoid further accumulation of arrears, especially external arrears.
Promoting Non-oil Growth under Tighter Budget Constraints
The recent decline in oil prices is proving a stark reminder of Gabon’s oil dependence, underscoring the need to foster non-oil growth and employment. Econometric evidence presented in the 2015 CEMAC regional consultation staff report shows that shocks like the recent decline in oil prices could lead to negative non-oil GDP growth in Gabon, with effects from both fiscal pro-cyclicality and from direct linkages between the oil and non-oil economies. The current strong fiscal response of the authorities and increased non-oil production is expected to soften the impact during the current oil price slump. Still, the ongoing deceleration and vulnerable fiscal outlook highlights the importance of the authorities’ PSGE, which seeks better stewardship of natural resources, infrastructure and human resource development, and moving up along the value chain.
The authorities have been able to attract foreign non-oil investment, but partly relying on costly schemes. As part of the PSGE, the government has appropriately allocated a portion of the oil windfall to strength the country’s transport and energy infrastructure. The authorities have embarked on a major rehabilitation of the Trans-gabonais railway line with the support of the IFC. This should significantly remove bottlenecks for wood-related and mineral exports. Gabon has also partnered with Olam International in one of the largest agri-business investments currently underway in sub-Saharan Africa. The government has provided a land bank to Olam of 300,000 hectares, of which over one-sixth is already under oil palm and rubber cultivation. To date, Olam’s foreign direct investment in Gabon has totaled US$1.5 billion, including plantations and the development of the Special Economic Zone and port capacity. Further impetus is expected to come from the GRAINE14 program, a joint venture of Olam and the government to address food security and rural income issues in Gabon. These investments will increase both cash crop and subsistence farming, boosting real growth by one percentage point, although the tradeoff is government financing for related infrastructure and foregone revenue in the form of a long tax holiday.
There is substantial room to implement more cost-efficient reforms to attract additional investment. The focus should be on improving the business climate, especially considering that Gabon’s standing in the World Bank’s Doing Business report and in other rankings is very low, below comparator countries, as well as undertaking additional horizontal structural reforms aimed at reducing factor costs.
With the oil price shock weighing on private sector activity, PSGE growth and diversification objectives need to be protected and structural reforms accelerated. In the present tight budgetary context, the authorities should aim to maximize the return on limited resources.
Investor tax incentives should be avoided, as these undermine revenue generation and are unlikely to trigger a self-sustaining process of economic diversification.
Investment should be reprioritized to focus on transport and energy projects with potential growth spillovers.
In the same vein, priority should be on horizontal structural reforms aimed at raising economic competitiveness and productivity, notably in the areas of education, infrastructure, and institutions.
Even prior to adopting a road map for Phase 2 of the PSGE, business climate reform should be accelerated, notably improving labor market legislation, strengthening anti-corruption efforts and the AML/CFT framework, and cutting red tape, as recommended in an action plan developed with the IFC.
Deeper regional integration in CEMAC and more trade openness of the region would facilitate economic diversification in Gabon. Gabon should take a lead role in taking the necessary regional reforms forward. Similarly, Gabon should review its investment program against projects already underway in neighboring countries to ensure that possible synergies at the regional level are fully exploited.