EFFECTS OF EXTERNAL DEBT ON PRIVATE
INVESTMENT IN RWANDA
Oscar .^AASABO
NATIONS UNIES
AFRICAN INSTITUTE FOR ECONOMIC DEVELOPMENTAND PLANNING INSTITUT AFRICAIN DE DEVELOPPEMENT ECONOMIQUE ET DE
PLANIFICATION (IDEP)
<\
}^ /#)
(d;
UNITED MATIONS
Submitted in partial
fulfillment
of the requirements for theDegree
of Master of Arm in Economic
Policy
endManagement
ax the African institute of EconomieDevelopment
andPlanning (IDEP).
Dakar /
Senegal.
2003
africain institute
for economic development and planning
idep
This is to certify that
OSCAR AAASABO
Identification N'020704
has successfully defended the M.A. thesis entitled
EFFECTS OF EXTERNAL DEBTON PRIVATE INVESTMENT
INRWANDA
DEDICATION
Mrs.
Eugénie INGABIRE,
I know howfar you have suffered during my absence. Please consider this
work as your achievement. Tell our kids that this thesis is also the fruit of
their love and patience.
May God bless you all.
Eng. Albert BUTARE,
I know how much you are
involved in private initiative
and entrepreneurship. I also know that broadly, in Rwanda, private investorsface a number of constraints that are yet to be addressed. The latter
include the burden of the government external
debt
servicing.Please accept dedication
of
mythesis for
you toexplore
more.Indeed, this
serves as an expression of my indebtedness to you.
ACKNOWLEDGEMENTS
In the name ofthe
Almighty,
I am deeply thanking the following people andinstitutions for their invaluable support to undergo and complete my
training:
1. Prof. Aloysius A. Amin, my supervisor, for his invaluable involvement
and guidance in the framework of my research work
2. Dr. I. Hathie, Dr. M. Gaye, Dr. M. Diakhate and Mr. M. Diop for their qualitative contributions to my research
3. Mr. Th. Ntilivamunda for the cordial advices to achieve success of my studies and a good stay
in
Dakar4. Mrs. A. Kamara for her prompt assistance in the computer processing of my paper
5. The African Institute of Economic Development and Planning (IDEP)
for the outstanding training they provided me.
6. The Kigali Institute of Science, Technology and Management (KIST)
and the Government of Rwanda to have granted me the
scholarship.
Special gratitude needs to be extended to my family, particularly my spouse and kids, for the enormous sacrifices they underwent during my nineteen months of absence.
Thank you my dear colleagues and classmates for the
friendly and helpful
discussions we used to have together on various issues.
Thank you all and please, INVEST AS YOU EARN.
iii
ACRONYMS
ADB : African Development Bank
AFRITAC : African Regional Technical AssistanceCentre
AGOA : African Growth Opportunity Act
AIDS : Acquired Immuno-Deficiency Syndrome
BNR : Banque Nationale du Rwanda
CEEAC : Communauté Economique des Etatsd'Afrique Centrale
CEPGL : Communauté Economique des Pays des Grands Lacs
CD ROM : Compaq disc read only memory
COMESA : Common Market of Eastern and Southern Africa CPI : Consumerprice index
CSR : Caisse Sociale du Rwanda DRC : DemocraticRepublic of Congo ECM : Error correction model
ECT : Error correction term ELECTROGAZ: Electricité, eauet gaz
ESAF : Enhanced Structural AdjustmentFacility
FDI : Foreign direct investment
GATT : GeneralAgreementon Tariffs and Trade
GDP : Gross domesticproduct
GNP : Gross national product
HIPCs : Highly Indebted Poor Countries
HIV : Human Immunodeficiency Virus
ICOR : Incremental capital output ratio
IDA : International Development Agency
IMF : International MonetaryFund
KRB : Kagera River Bassin
LDCs : Leastdeveloped countries
MINECOFIN : Ministry of Finance and Economic Planning
NBR : National Bank of Rwanda
NEPAD : New Partnershipfor African Development
NPV : Net presentvalue
OCIR : Office desCultures Industrielles du Rwanda
OLS Ordinary leastsquare
PRSP Poverty Reduction Strategy Paper
RAR Régie des Aéroportsdu Rwanda
RIPA Rwanda Investment PromotionAgency
RITA Rwanda InformationTechnologyAgency
RWANDACELL: Rwanda CellularTelecommunications RWANDATEL : Office Rwandais deTélécommunications Rwf : Rwandafranc
SIDA : Syndrome ImmunoDéficitaireAcquis
SORWATHE : Société Rwandaise deThé SSA : Sub-SaharanAfrica
UNECA : United NationsEconomieCommissionfor Africa US : United States
WB : World Bank
V
RESUME
Cette recherche vise à examiner l'impact de la dette extérieure sur l'investissement privé au Rwanda. Nombre d'études ont montré un effet négatif
du fardeau de la dette sur l'investissement privé dans les pays à faible revenu.
En effet, les investisseurs privés voient le fardeau de la dette comme de futures
taxes confiscatoires sur la rentabilité de leurs projets. Ces taxes serviront à
financer les obligations du service de la dette.
Généralement, le poids excessif de la dette est défini comme une limite au-delà
de laquelle la dette devient insoutenable et cela au détriment de l'investissement (Krugman, 1989; Claessens et Diwan, 1989). Au Rwanda, le stock de la dette
extérieure et le service de la dette sont insoutenables et le niveau de l'investissement estfaible.
L'analyse empirique a montré l'effet d'éviction du ratio du service de la dette sur l'investissement privé, comme cela était attendu. Ceci signifie qu'une grande portion des rares ressources disponibles dans le pays esttransférée à l'extérieur
sous forme de paiements du service de la dette au lieu d'être affectée à
l'investissement productif. En plus, les estimations économétriques ont montré
que l'investissement public a des effets négatifs sur l'investissement privé. Le
résultat n'était pas attendu et ceci explique davantage le bas niveau de
l'investissement dans le pays.
EXECUTIVE SUMMARY
In the early 1970s, low-income countries received huge loans from abroad. But
their external debt became unsustainable over time. Some of these countries, like Mexico in August 1982, declared inability to meet their external obligations.
The oil shocks of 1973/74 and 1979/80 are said to have contributed more to the defaults than other factors (Ajayi, 1991).
At that period, the LDCs attracted very low investment, both public and private.
The adjustment programmes initiated by the IMF and the World Bank could not
reverse the trend. They put emphasis on foreign trade and neglected the private
investment aspects.
Various literature supports negative relationship between external debt overhang
and private investment. Krugman (1989) suggests that there is a limit to external
debt accumulation. Beyond such a threshold, the external debt becomes
detrimental to private investment (Elbadawi et al., 1996), and falls under the
condition of debt overhang.
Claessens and Diwan (1989) define a debt overhang as a condition where outstanding debt is so large that the investment will be hampered with no debt
service reduction. Thus, unsustainable external debt is regarded as a key
deterrent to private investment. In fact, private investors see the debt overhang
as future confiscatory taxes used to finance the government's external debt servicing. Under this circumstance, entrepreneurs would prefer to wait for the uncertainty to dissipate rather than make decisions to invest today (Rodrik, 1989).
In Rwanda, current external debt stock and debt service are unsustainable, and private investment is very low in the country. At the end of 2000, the debt-service
to export ratio was40.9% against the threshold of 15% (MINECOFIN, 2001). The
vii
external debt net present value to export ratio accounted for 523%, which is far beyond the threshold of 150% (MINECOFIN, 2001).
Exports are often used to compute the debt-sustainability indicators in indebted
countries. The debt-service-to-export ratio, for example, tells how much current export earnings are pre-empted by the debt service. In fact, the export sector is regarded as a lead driver for economic performance, and high level of export growth reveals the capacity ofa country toservice its external obligations.
The millennium development goals suggest investment of 35% of GDP for a HIPC country to achieve the target of 7% GDP growth per annum. In Rwanda,
gross domestic investment accounted for 15% in 2000. This would mean that an increase of 20 percentage points of GDP in additional investment is needed. The government's current economic policy assigns a key role to the private sector.
Thus, as for public-private partitioning of the additional investment of 20% of GDP, it is legitimate to expect the largest portion to be accounted for the private
sector. Yetprivate investment remains very lowin the country, only 9% of GDP at
the end of 2000.
The objective of the study is to investigate whether the Rwandan external debt
burden has contributed to weak private investment in the country. For this
purpose, two hypotheses need to be tested. First, the debt-service ratio is expected to have a negative effect on private investment. Second, public
investment is hypothesized to have positive effecton private investment.
The study is carried out using the OLS, and the time series data analyzed cover the period 1970 - 2000. Gross private investment (PRI) is specified as a function
of the debt-service ratio (DSR), gross public investment (PUI), terms of trade (TOT), total external debt stock (EDT), interest rate (IR), GDP lagged by one
period (Y-i), credit to private sector (CPS) and gross private investment lagged by one period (PRI(-1 )). A dummy variable was introduced to accommodate political stability (POST) in the model.
The empirical analysis reveals that the debt service ratio crowds out private
investment as hypothesized. This would mean that the scarce resources
available in the country are being used to meet the external debt obligations
instead of being allocated to productive investment. More surprisingly, public
investment has negative impact on private investment. While private investment
is said to contribute most to employment creation and general welfare, the government spending policy puts emphasis on social expenditure over time for poverty reduction. Consequently, public investment does not sufficiently complement private investment output, particularly in the areas of agriculture and
infrastructure. While social expenditure is badly needed in the context of Rwanda, its nearly exclusive focus on poverty reduction erodes the possibility of enhancing investment. Moreover, estimation results show negative relationship
between private investment and its lag. This would mean that the government
invests less in maintenance and operations of supportive services. There is a
need to reversethe trend.
All in all, the study concludes that the external debt burden crowds out private
investment in Rwanda. While the Government recognizes the private sector to be
the key engine of economic growth and poverty reduction, policy makers should
raise productivity of capital and increase the demand for the private sector output. To this effect, it is recommended that committed debt relief of US$ 452 millions (on NPV basis) should be provided. This would avail more resources for
new productive investments in the domestic economy. It is also suggested that
more resources should be allocated to the areas of agriculture and infrastructure.
These measures would help to enhance conditions meant to attract more private
investment in the country.
ix
TABLE OF CONTENTS
DEDICATION ii
ACKNOWLEDGEMENTS iii
ACRONYMS iv
RESUME vi
EXECUTIVE SUMMARY vii
GENERAL INTRODUCTION 1
1 Preview 1
2 Research Problem and Rationale 2
2.1 The Problem of the Study 2
2.2 The Rationale of the Study 4
3 Objective and Hypotheses 5
4 Organization ofthe Study 6
Chapter 1 THE PLACEOF DEBT IN RWANDA'S ECONOMY 7
1.1 Rwanda's Economic Performance 7
1.2 Rwanda's Debt Profile and Management 12
1.2.1 Historical Background of External Debt Accumulation and Crisis 12
1.2.2 Rwanda's Debt Stockand Composition 15
A Domestic Debt 16
B External Debt 16
1.2.3 Debt Service 18
1.2.4 DebtSustainability Analysis 18
1.2.5 The Enhanced HIPC Initiative 19
Chapter 2 PRIVATE INVESTMENT CLIMATE IN RWANDA 21
2.1 Openness to Private Investment 21
2.1.1 Rwanda Investment PromotionAgency (RIPA) 21
2.1.2 Privatization 22
2.2 Regulatory Environment 22
2.2.1 Financial System 22
2.2.2 Trade Regime 23
2.2.3 Labor Code 23
2.3 Opportunities 23
2.3.1 Coffee 23
2.3.2 Tea 23
2.3.3 Energy and Water 24
2.3.4 Telecommunications and Internet 24
2.3.5 Tourism 25
2.3.6 Pyrethrum 25
2.3.7 Other Investment Opportunities 25
2.4 Incentives 25
2.4.1 Exemption from Import Duties and Sales Taxes 25
2.4.2 Common Incentives 26
2.4.3 Work Permits and First Arrival Privileges 27
2.4.4 Additional Incentivesfor Free Export Economic Zones 27
2.5 Regional Integration 29
2.6 Partnerships 30
2.6.1 African Growth Opportunity Act (AGOA) 30
2.6.2 New Partnership for Africa's Development (NEPAD) 31 2.6.3 East Africa Regional Technical Assistance Center (AFRITAC) 32
2.7 Issue ofCorruption 32
2.8 Contribution and Limit of Private Investment to Poverty Reduction 33
2.8.1 Contribution of Private Investment to Poverty Alleviation 33
A General Welfare 33
B Economic Growth 34
C Job Creation and Technology Transfer 35
D Tax Revenue 36
2.8.2 AIDS: a Threatto Private Investment in Rwanda 36
Chapter 3 LITERATURE SURVEY ON DEBT OVERHANG AND PRIVATE
INVESTMENT 38
3.1 Theoretical Studies 38
xi
3.2 Empirical Studies 43
Chapter 4 METHODOLOGYAND REGRESSION ANALYSIS 49
4.1 Methodology 49
4.1.1 Theoretical Framework 49
4.1.2 Data Sources 51
4.1.3 Time Series Properties 51
4.2 Regression Analysis and Interpretation of the Results 53
4.3 Vector Error Correction Model (VECM) 54
4.4 Other Econometric Tests 56
4.4.1 Jarque-Bera Normality Test 56
4.4.2 Ramsey Reset Test 57
4.4.3 Breusch- Godfrey (BG) Serial Correlation LM Test 57
4.4.4 Unit Root Test on the Residual 58
4.4.5 White Heteroskedacistity Test 58
4.4.6 Cusum of Squares Test 58
Chapter 5 POLICY DISCUSSIONS AND RECOMMENDATIONS 60
5.1 Policy Discussions 60
5.1.1 The Debt Service 60
5.1.2 Debt Stock 62
5.1.3 Public Investment 63
5.1.4 Terms of Trade 65
5.1.5 Political Stability 65
5.1.6 Past Private Investment (PRI-1) 66
5.1.7 Interest Rate (IR) 66
5.1.8 GDP lagged by one period (Y.-i) 66
5.1.9 Credit to Private Sector(CPS) 67
5.2 Recommendations 67
5.2.1 Effective Debt Relief 67
5.2.2 Government Expenditure Reappraisal 67
CONCLUSION 69
REFERENCES 70
APPENDIX 77
LIST OF TABLES
Table 1: CoffeeProduction (tons) 9
Table 2: DomesticDebtStock(inBillions ofRwf) 16
Table 3: External DebtStock(in currentUS$ millions) 17 Table 4: Rwanda's DebtSustainabilityAnalysis, 2000 19 Table 5: Committed Debt Relief (NPV in millionsof US$) 20
Table 6: Prevalence of HIV(1997) 37
Table 7: PP Unit RootTestResults 52
Table 8: JohansenCointegrationTest 53
Table9: Estimation Results 53
Table 10:VectorErrorCorrection Estimates 55
Table 11: Jarque BeraTest 57
Table12: RamseyReset Test 57
Table 13: Breusch-GodfreySerial Correlation LMTest 58
Table 14: PP UnitRootTestonthe Residual 58
Table 15: WhiteHeteroskedacistityTest 58
Table 16: Final Consumption (% of GDP 67
Table 17: MacroeconomicData 77
LIST OF FIGURES
Figure 1: RealGDP Growth (%) 7
Figure 2: DebtLaffer Curve 40
Figure3: Responseof GPRI and GPUI tooneS.D. Innovations 56
Figure4: StabilityTest 59
Figure5: Exports of Goodsand Services (as %ofGDP) 62 Figure 6: Importsof Goods and Services(as %ofGDP) 64
Figure 7: Foreign Direct Investment (%of GDP) 65
Figure8: Publicand Private Investment(% ofGDP) 78 Figure9: ExternalDebt Evolution (US$ million) 78
Figure 10: Debt -ServicetoExport Ratio(%) 79
Figure 11: Terms ofTradeAdjusted(constantlocalcurrency) 79
Figure 12: Evolution of Interest Rate 79
Figure 13: CredittoPrivate Sector(%of GDP) 80
xiii
GENERAL INTRODUCTION
1 Preview
Over the last three decades from 1970, developing countries received very large
amounts of loans from abroad, which could boost their investment. But in the 1980s, they realized that repayment of their huge debt was not only an
obstacle
tothe
economic performance but alsovirtually impossible.
The onset of Mexico debt crisisin August 1982 revealed that the issue of external debt
has assumed critical importance and increased worldwide policymakers' attention.
According toAjayi (1991), the majorfactors of debt crisis are the oil shocks of 1973/74
and 1979/80. The oil price increases led to the deterioration in terms of trade leading
to balance of payments deficits. They contributed to a tremendous increase in the liquidity availability of international credit for developing countries at very low interest
rates. This encouraged oil-importing countries including Rwanda to borrow abroad to
pay the higher oil bills (Sachs and Larrain, 1995).
The adjustment programmes adopted in compliance with donorconditionality may also
have contributed to the slump in investment. It has been documented that these
programmes failed to reverse the declining trends in investment. The World Bank (1994:124) argued that Governments cut capital spending as part of their fiscal stabilization, while the private sector adopted a wait-and-see attitude during the early phases of adjustment mindful of the irreversibility of investment decisions and the reversibility of key policy changes.
Sustainable debt inflows are expected to have a positive effect on investment. In
traditional neoclassical models, the ability of a country to borrow increases growth through investment. Notwithstanding, the debt stock had kept increasing over time,
and has led to the situation of debt overhang, which has been identified as a key
deterrent to private investment. A debt overhang occurs when outstanding debt is so
large that it will dampen the investment unless the debt service is reduced (Claessens
and Diwan, 1989). Elbadawi et al (1996) confirm that there is a limit atwhich external
debtaccumulation stimulates investment. They argue that there is a threshold atwhich
more external debt is detrimental to investment, both publicand private.
Debt overhang is expected to discourage private investors as they anticipate
increased taxes to finance debt service in the future, hence reducing the expected
returns on projects. Furthermore, financing public investment through excessive foreign borrowing could crowd out private investment via its effecton inflation and debt accumulation, which render the business environment uncertain. Howevercrowding-in
effects of public investment would appear through the long run efficiency effects of its
infrastructural component on private investment.
Poor investment response in Sub-Saharan Africa is a particular disappointment to
those governments, which have reformed economic policy with the intention of creating an investor-friendly environment. The primary objective of these reforms is developmental, and private investment is regarded as fundamental element in
economic performance (Gardiner, 2000). Poverty is almost invariably linked to rural
and urban unemployment. Investment, particularly private investment, is essential for creating newjob opportunities in the economy.
Rwanda, a sub-Sahara African country, is plagued with its heavy external debt burden.
The debt crisis, compounded by massive poverty and structural weaknesses, has
made rapid and sustainable growth and development difficult in the country. One of
the major reasons is that private investment is very low in Rwanda. Theory reveals
that debt overhang significantly impinges on private investment. The main goal ofthe present study is to assessthe above assertion in Rwanda.
2 Research Problem and Rationale
2,1 The Problem of the Study
At the beginning ofthe 1980s, the debt crisis hit most ofthe least developed countries (LDCs). As a result, these countries experienced greatdifficulties to generate enough
resources to meet both theirdebt-service payment and investment needs. During that
2
period, the LDCs had to implement adjustment policies imposed by the World Bank
and the IMF. These programmes put emphasis on foreign trade and neglected private
investment aspects.
Nowadays, many economists and decision-makers recognize that the engine ofoutput growth is private investment. The economic policy currently pursued by Rwanda is explicitly intended to improve conditions for private investment through domestic
market liberalization, privatization, sound macroeconomic policies, good governance, etc. However, Rwanda has attracted less private investment than anticipated, in spite
of its explicitly investor-friendly macroeconomicframework.
The low level ofprivate investment in Rwanda constitutes a serious obstacle to growth
and employment creation. Of the total labor force of 4,479,090 in 1999, the MINECOFIN (2001) reports that 24,603 were employed with only 2,174 ofthese being
women. The resources that could have been allocated to investmentare instead being
transferred abroad in terms of debt-service payments. This may act as a strong
disincentive not only for the private sector to invest but also to partake in any
adjustment programme aimed at increasing growth. At the same time, few options
exist for the Government to finance development activities through domestic borrowing. In addition, the massive poverty prevailing in the country has hampered its
sustainable growth and development.
The existing research shows that large external debt burdens have a strong
disincentive effect on private investment and that poor international creditworthiness
reduces access to foreign savings (Faruquee, 1992). Furthermore, it is noted that low investment makes forms of poverty alleviation more difficult because rates of economic growth below the rate of increase in the population means that each year
more people are added to the ranks of the poor (ECA, 1995). It is also said that insufficient job opportunities result from inadequate levels of investment, both domestic and foreign (Gardiner, 2000).
The issue to address is whether the large debt burden in Rwanda is one of the major
factors lowering the level of private investment in the country. Debt overhang theory is
based on the premises that if debt exceeds the
country's repayment ability, expected
debt service is likely to take an increasing share
of
thecountry's output level. Thus,
some of the returns from investment in the domestic economy are effectively taxed
and private investment is discouraged (Claessens et
al, 1996; p17). In such
circumstances, the debtor country shares only partially any
increase in output and
exports because a fraction ofthat increase
will be used
toservice the external debt.
The NBR (2001) reports that Rwanda transferred 48% of GDP
in the form of debt-
service payment in 2000. The NBR (2001) states that this
ratio is
morethan the
expenditures allocated to education and health in 2000. Thisexample shows at most
that an important fraction of the country's output is being
used
to paythe external
debt-service obligations. In this way, debt acts as a marginal tax to private investment, lowering private business in the domesticeconomy.
2.2 The Rationale of the Study
A number of reasons help to justify the relevance of the present study. First of all, private investment has been found to have significantly stronger effect on economic growth than government investment. Second, the global development agenda is to
halve absolute poverty reduction by the year 2015 in poor countries. To achieve this goal, the World Bank suggests that these economies need to grow at least by 7% per
annum. Rwanda has agreed on the target through the poverty reduction strategy
paper (PRSP) completed in June 2002.
To this effect, it is indicated that a HIPC should invest about 35% of its GDP to achieve the targeted 7% GDP growth. Current gross domestic investment in Rwanda
accounts for 15%. This would mean an increase of 20 percentage points of GDP in
investment to reach the 2015 poverty reduction goal. And given the government
current economic policy of market-based strategies, the private sector has to play a
key role. Thus as for public - private partitioning of the additional (20% of GDP) investment, it is legitimate to expect the largest portion to be accounted forthe private
sector. Yet, private investment in Rwanda is very low, only 9% end of 2000.
Lastly, Rwanda's government of National Unity
has embarked
on a programmeof
comprehensive economic and social reforms
necessitated by the tragic genocide,
which broke out in the country in 1994. Recognizing that the
principal engine of
economic performance in Africa and elsewhere has been private sector,
Rwanda felt it
should not be left behind. Therefore, the country has put in place an ambitious privatization programme of state-owned enterprises. The Law
No 2 dated 11/3/96
established this programme. In addition, Rwanda has put in place the
"Rwanda
Investment Promotion Agency(RIPA)" established by the Law N° 14/98.
All these recent reforms are meant to encourage private investors and boost private
investment in the domestic economy. Our study would be a contribution within this
framework.
3 Objective
and Hypotheses
External borrowing constitutes large share of the resources meant to finance development plans in the LDCs including Rwanda. Development activities include,
among others, employment creation and poverty alleviation. Yet, external debt is not
free of charge and it is provided under certain constraints that lenders place on the
national economy. As a matter of fact, the structural adjustment programmes of the
World Bank and the IMF were initially meant to stimulate private investment.
According to the World Bank and the IMF, a reduced role of the Government in the
economy meant a reduction of barriers to private initiatives.
But these programmes have not brought out the expected results. Most economists
argue that government infrastructural spending was notaffected in the areas thatwere complementary to private investment. Others documented that the development projects were too ambitious and that they became the so-called "white elephants"
(Chhiberand Dailami, 1993).
In Rwanda like any other SSA country, private investment remains very low, and
external debt is considered as a key deterrent of private investment opportunities. The
main objective of the study is to assess the external debt overhang as a major
hindrance to private investment in Rwanda.
In this context, two hypotheses will be tested:
1. The debt-service ratio has a negative impact on private investment.
2. Public investment crowds in private investment.
4 Organization
of the Study
The paper consists of five chapters. Chapter one sheds some light on the place of
debt in Rwanda's economy. Chapter two highlights the private investment climate in
Rwanda. Chapter three surveys the literature on debt overhang and private
investment. Chapter four deals with the methodology and regression analysis. Chapter
five concentrates on policy discussions and recommendations. Finally, a conclusion
will be drawn.
Chapter 1 THE PLACE OF DEBT IN RWANDA'S ECONOMY
1.1 Rwanda's Economic Performance
Rwanda is a small, densely-populated and landlocked central African nation with
26340 square kilometers and a population of 8.1 million in 2002. The main structural challenges that Rwanda faces date back over the last 30 years. Some of these challenges include low agricultural productivity, low human resource development,
limited employment opportunities, high transport costs, high population density and growth. These problems gave rise to macroeconomic difficulties such as trade deficit, high vulnerability ofterms of trade shocks due tothe dependency on two export-crops, coffee and tea, structural imbalances between government revenues and expenditures, low savings and low level of private investment.
In Rwanda, GDP is estimated at US $ 1.8 billion (current prices) in 2002. Agriculture
contributes some 45% of GDP, 91% of employment and 72% of exports. There was considerable growth of the economy immediately after the genocide as a result of post-genocide recovery. Real GDP declined by 50 percent in 1994 and bounced back by 34 percent in 1995. Then it kept increasing: 16 percent in 1996, 13 percent in 1997
and 10 percent in 1998. Inflation measured by the CPI was 6 % in 1998 compared
with 17% atthe end of 1997.
Figure 1: Real GDP Growth(%)
The Rwanda franc depreciated in 1998 by 12% in nominal terms and by 18% in real
terms. But it appreciated by about 10% in the first half of 1999. The exchange rate is market-determined; with the NBR's intervention confined to meeting the net foreign
assets target and smoothing short-term exchange rate fluctuations. Since 1998, the
NBR has been controlling monetary aggregates and interest rates through indirect
instruments such asTreasury bill auctions.
Government revenues, as a percentage of GDP, rose from 6.9 percent in 1995 to 10.3 percent in 1997, and 10.4 percent in 1998. However, in 1998, the revenue
performancesuffered from a 20 percent drop in receipts from the import duties caused by a reduction in tariffs and decline in imports. Government expenditure declined from
5.2 percent in 1996 to 4.3 % and 4% in 1998 and 1999 respectively, while recurrent
social expenditure rose from 2.7 percent of GDP in 1997 to 3.7 % in 1998 and 5% of GDP respectively in 1999.
The impact ofthe 1994 genocide on Rwanda's economy was staggering. An estimated
8 to 10 percent of the population was killed. A quarterof the population was displaced.
Fields were deteriorated. The social fabric was torn. Violence disrupted production and, as a result, the economy collapsed. Poverty became rampant, and private foreign
investment dried up. Real GDP dropped by50 percent in 1994.
In 1995 Rwanda authorities focused on establishing peace and repatriating refugees.
GDP bounced back, but the apparently astonishing 34 percent growth rate was from the very low rate of economic activity in 1994 and was just the result of people returning to their fields.
In addition, the international community has provided substantial assistance of over
US$2 billion since 1994, for the reconstruction of Rwanda. The World Bank has provided an emergency grant (US$20 million) and two emergency credits of US$50
million yearly since 1994. The IMF approved a Post-Conflict Reconstruction Program
ofabout US$20.6 million in May 1997 to support Rwanda's emergency reconstruction
and economic recovery efforts. A three-year US$93 million Enhanced Structural
Adjustment Facility (ESAF) was approved by the IMF in June 1998, disbursements 8
have been made over the past three years. In December 2000, the World Bank, the
African Development Bank and the IMF approved US$450 million, on NPV basis, of
debt relief for Rwanda under the enhanced Highly Indebted Poor Country (HIPC)
Initiative. Reductions in Rwanda's international debt obligations have commenced, but
the full relief package is contingent on continuing compliance by Rwanda with
macroeconomic stability and poverty reduction agreements with the multilateral agencies.
The main export is coffee. In 1987 coffee production in Rwanda peaked at 46,000 tons, accounting for more than 80 percent of export earnings. However, following a
period of sharp decline in prices and the disruption of the civil war, production declined
to just 14,000 tons by 1994. In 1995, it increased to 21,952 tons but declined at
16.098 tons in 2000. Despite the drop in market value and production, coffee has
remained the country's largest export, accounting for more than 40 percent of export earnings in 1999.
Table 1: Coffee Production (tons)
1987 1994 1995 1996 1997 1998 1999 2000
46,000 14,000 21,952 15,285 14,830 14,268 18,817 16,098
Source: OCIR-Café
The NBR (1995) reports that the decline of coffee production and its value on the international market, the lack of economic diversification, corruption and appropriation
of economic resources for political ends, poor monetary policy, and poor financial policies all contributed to Rwanda's poor economic performance in the early 1990s.
There is significant evidence that dependence on agricultural and extractive export commodities, lack of economic opportunity and resulting low-income levels may have
been an important factor in setting off civil war in addition to the widely recognized sociopolitical explanations of state ideology, poor governance, ethnic heterogeneity
and political repression.
In 1996, recoverycontinued with a real GDP growth of 15.8 percent, as the agricultural
sector, though for subsistence, grew by 10 percent and livestock production by 27 percent. Manufacturing sector grew by 25 percent. Rwanda has
embarked
upon anambitious privatization program with the World Bank. The economy responded with
9.5 percent growth in real GDP in 1998 and 5.9 percent growth in 1999. Prolonged drought in 1999 resulted in extensive crop failures, reducing the economic growth rate
in 2000 to 5.2 percent.
The two greatest threats to continuing improvements in Rwanda's economic performance are insecurity in East of the Democratic Republic of the Congo (DRC)
and HIV/AIDS. The IMF has noted the impact of the DRC conflict involvement on coffee production in Rwanda. As related guerrilla activity in Rwanda prevents the replacement of aging Arabica trees with newer, high-yield trees, improvements in
coffee production probably await the end of thewar (IMF, 2002). In addition, Rwanda's
involvement in the war has increased spending on defense to more than four percent
of GDP, exacerbating an already large overall fiscal deficit of nearly 10 percent of
GDP at a time when government spending on poverty reduction is badly needed. An
estimated 11 percent of the rural population is already infected with the AIDS virus.
While the number of infected is growing rapidly, prevention and treatment programs remain inadequate. Rwanda may begin to feel the economic strains of health-related expenditure in a waythat has become all too common in neighboring nations.
Over the next several years, Rwanda badly needs to tame its "twin deficits" in the
current account and the government budget. The fiscal deficit and the current account deficit must be financed. That puts significant strain on an economy that is in urgent
need of strong, sustained private sector investment spending. The Rwanda Revenue Authority must be strengthened so that government revenue collection can be improved: spending 20 percent of GDP on government programs while collecting only
10 percent of GDP in revenues is not sustainable. An end to Rwandan military
involvement in the DRC would hopefully enable the government to reduce its defense expenditures. In addition, further debt-service relief will take further pressure off the
fiscal deficit, and will be most helpful in establishing longer-term debt sustainability and facilitating private investment in Rwanda.
Rwanda has historically run very large current account deficits, before official
transfers. The merchandise trade balance and the balances on services and on
international investment income have all been in deficit for many years as they currently are. The IMF estimates that in 2000, Rwanda's current account before government transfers would show a deficit of nearly US$300 million, nearly 17 percent
of GDP. With a land-locked, agricultural-commodity-based, and highly indebted
economy with no comparative advantage in providing international services, Rwanda
needs substantial outside help to pay its bills. Given its relative unattractiveness for private foreign investment, foreign direct investment has been negligible and thus
outside help is likely to be primarily official aid inthe foreseeable future.
Over the medium to longer term, it is essential to diversify the economy and to raise
the rate of productive investment in Rwanda. The slowdown in GDP growth in 1999
and 2000 has to be seriously addressed by raising investment. "In Rwanda's case, we must strive for GDP growth of at least 9% per year in order to achieve sustainable growth, provided this growth is equitably distributed. To achieve these objectives obviously requires a high level of investment of at least an ICOR of 4,4%"
(MINECOFIN, 2000; p17).
Unfortunately, private and government savingsto GDP ratios are negative orvery low.
In 1998 for example, overall savings were -1.2% of GDP compared to 7.7% for sub-
Saharan Africa excluding South Africa and Nigeria. The level of private investment is very law today, 9% of GDP, compared to the 35% needed each yearto halve poverty
in 2015. Obviously, the main boost ofdomestic savings and investment is the increase ofprivate sectoractivity.
To that extent, the Rwanda Investment Promotion Agency (RIPA) and the Private Sector Federation have been established. RIPA's mandate is to facilitate potential
investors and promote interest in investment in Rwanda. The RIPA is a one-stop
window to simplify the procedures facing investors in Rwanda. It will commission studies of constraints on competitiveness, and use these as a basis for regular discussions between the private sector and the government of Rwanda. It will also
develop a system for the transfer of information from the outside world and support marketing campaigns.
The Private Sector Federation provides a forum for the private sector to identify and organize actions to increase its competitiveness. It undertakes a study of sectors in
which Rwanda can develop a competitive advantage, using the cluster approach. It
will also set up a matching fund to support technical assistance to the private sector.
This fund is expected to prepare a study on the constraints facing small-scale enterprises in Rwanda.
1.2 Rwanda's Debt Profile and Management
1.2.1 Historical Background of External DebtAccumulation and Crisis
Between the Second World War and early 1970s, the world economy experienced
rather a long period of expansion. During that time, developed countries and some of
the LDCs had high rates of growth. Beside high rates of growth, they had low unemployment and inflation rates. Although there were some short sub-periods of slumps, the general characteristic of the period had not changed. In accordance with these, the volume of international trade was growing. Tariffs and other kinds of trade
barriers were abolished or reduced to facilitate the international movement of goods.
International organizations such as the GATT and the IMF tried to reduce the barriers
on international movementofcapital aswell.
Of course, not all the LDCs kept pace with these developments. While some countries like South Korea and Singapore exceeded the growth rates of the developed countries, some other LDCs like Brazil, Chile could notdo the same. The beneficiaries of this world order were the countries that have reached a certain level of industrial production. These countries usually produced more labor-intensive manufacturing products relative to the developed countries. They benefited from the growing import
demand of the developed countries and from the general reduction in tariffs.
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Labor-intensive production in some LDCs served two ends for the developed countries (Ndiaye A., 2002). First, LDCs earned considerable amount of foreign exchange that
in turn financed LDC imports from the developed countries. Second, developed
countries imported their needs for labor-intensive goods and therefore directed its
resources towards capital-intensive production. The latter curbed the rise in real
wages and keptthe profitrates at high levels in the developed countries.
Two other factors, namely multinational companies and the direct import of workforce by developed countries, contributed to these developments. Multinational companies
moved their labor-intensive production to LDCs where the wage rates were lower. By
this way, profit rates were kept at higher levels. Besides, the exports of LDCs by
means of these companies were increased. This parallelly increased the foreign exchange earnings of these countries (Krugman and Obstfeld, 2000). The import of
workforce by developed countries was another important factor in keeping the wage level under a certain level in developed countries. On the other hand such a workforce
movement decreased the unemployment rate and increased the workers' remittance earnings to LDCs.
During this period, developed countries accumulated a considerable amount of
savings, which exceeded their investment needs. These savings were then
transmitted to the LDCs in the form of long ormedium-term loans at relatively low level
of interest rates. This kind of capital movement, in turn, enabled the LDCs to invest
more than their savings would have allowed. An important factor behind the high growth rates in some LDCs during that time was the supply of such foreign finance.
Intensive public investment, which was usually financed by the foreign credit, became
the engine of fast growth and industrialization process in the LDCs. The use offoreign savings for the government investment expenditures was appropriate since it would
not crowd outthe private investment.
Furthermore, by use of the external sources, LDCs governments were able to preserve domestic consumption and investment patterns and carried on their political popularity (Benerbaiha, 2002). The government was able to offset some of the side effects of the adjustment policies, which would have undermined its popularity.
