The IMF is working with Rwanda on its medium-term strategy

Saturday February 23 2013

By JOHN GAHAMANYI

Rwanda’s economy faces tough times due to suspension or delays in donor funding. This saw the government forced to cut spending by Rwf74 billion ($117 million) between July and December last year. 

The EastAfrican’s John Gahamanyi spoke to the IMF resident representative to Rwanda, Mitra Farahbaksh about the state of the country’s economy and what the government can do to deal with the potential risks and opportunities.---

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Rwanda’s domestic revenue is insufficient to fund government expenditure, meaning the country has to rely on donor aid.  What measures are required to boost domestic revenue? 

The government has to reduce its aid dependency through greater domestic resource mobilisation. At the request of the government, the Fund’s technical assistance mission visited Kigali late last year and made a number of recommendations for designing a medium-term strategy for significantly increasing the revenue-to-GDP ratio.

Specifically, it identified eight critical areas, where the focus must be to address weaknesses in tax policy and revenue administration.

These are improving taxpayer compliance, strengthening the tax policy unit, improving tax gap analysis, revising the investment code to reduce exemptions, complementing withholding taxes on dividends and interest by a capital gains tax at a similar rate; and reforming the VAT.

Specifically, when will these measures be implemented?

During the course of the next IMF mission to Kigali, in April, the Fund will discuss with the government the specific measures and the timing of their implementation as well as how much benefit each measure will yield in terms of increasing revenues.  

Rwanda is keen to look for other means of financing; one of them is issuing a Eurobond. Given the current macroeconomic conditions, how would you gauge Rwanda’s ability to raise money in the international debt market?

Typically, investors will look at a number of factors when deciding to purchase sovereign bonds. They will consider a country’s macroeconomic situation, the level of a country’s debt and the ability of the country to pay its debt.

Rwanda’s macroeconomic conditions have been very good. The economy grew by 8.6 per cent in the first six months of last year. Inflation has been declining.

The macroeconomic outlook remains generally favourable. The country’s debt is about 21 per cent of GDP, which is reasonable. However, there is uncertainty about donor aid and how it is going to affect the economy and its macroeconomic position.

The government has borrowed aggressively in recent years to finance strategic investments like the national carrier RwandAir and the multimillion-dollar Convention Centre. Are you concerned that this aggressive borrowing could affect the country’s current debt status, which according to you, is reasonable?

 The debt sustainability analysis prepared by the IMF and the World Bank shows that assuming that aid flows will resume in the first half of 2013, Rwanda’s debt remains sustainable over the medium term. As I said earlier, the debt to GDP ratio is about 21 per cent. It remains sustainable at this time.

What is the desirable level of debt to GDP ratio for Rwanda?

The desirable level of debt to GDP ratio depends on a number of factors. It depends on the growth rate of the economy, the terms and conditions of the debt (whether it is short or long term) as well as the value of debt in relation to export revenues.

Roughly, a ratio of debt to GDP below 30 per cent is considered reasonable. You also need to look at how this borrowing is being used. Thus far, the government’s borrowing has been for productive purposes, including investments in infrastructure and the service sector, which over time will help the economy grow.

Several of Rwanda’s development partners withdrew aid to the country. Could this affect foreign direct investment (FDI) flows to the country?

Investors come into a country because they think they can make a profit and because they think the business environment is good. Rwanda has been successful in improving its business environment.

One challenge though is that its market is small, but the government is trying very hard to reduce the cost of doing business and improve its infrastructure. Investors will have to compare the costs and benefits of investing in Rwanda versus the costs and benefits of investing in Uganda or Kenya.

The National Bank has maintained a tight monetary policy to contain inflationary pressures and foreign exchange volatility, which has maintained high borrowing rates. Deposit rates are climbing, which may translate into more expensive loans. How can the economy continue to grow with such tight liquidity conditions?

Credit to the economy in 2012 grew by 34 per cent. This is quite rapid and if you don’t have a tight monetary stance, this could lead to high inflation. Now, the recent increase in deposit rates is an indication of increased competition between banks.

They compete in raising resources so that they can increase their lending. This is a good thing because they are competing through market-based rates. At the same time, lending rates have not increased much, which means that the spread between the deposit and lending rate has been declining.

So what must the central bank do?

Going forward, the National Bank will need to look at government spending, inflation and exchange rate depreciation in order to make a decision on whether to maintain the key repo rate at 7.5 per cent or adjust it.

In general, the Fund has advised the National Bank to take a flexible approach to setting the repo rate in order to improve its signalling role. It has also advised it to strengthen its liquidity management framework, and reform its monetary instruments.

Going forward what do you see as potential risks to Rwanda’s macroeconomic stability? 

I would say the continuation of delays in donor aid is posing a real risk for Rwanda’s economy. Of course, the other risk is the global environment, but thus far Rwanda has been immune from global economic shocks.