72996 July 2012 | Edition No. 3 Leveraging Regional Integration Rwanda Economic Update Leveraging Regional Integration TABLE OF CONTENTS ACRONYMS .................................................................................................................................................. i PREAMBLE .................................................................................................................................................... ii EXECUTIVE SUMMARY ................................................................................................................................. iii PART 1: RECENT ECONOMIC DEVELOPMENTS ............................................................................................. 1 1.1 Global Economic Environment ......................................................................................................... 2 1.2 Rwanda’s Real Sector Trends ............................................................................................................ 2 1.3 Monetary Policy and Inflation Trends .............................................................................................. 8 1.4 Fiscal Trends ..................................................................................................................................... 12 1.5 External Sector Performance With a Regional Perspective .............................................................. 14 1.5.1 Overall Trends ............................................................................................................................. 14 1.5.2 Regional Exports Performance since the 2009 Crisis .................................................................. 15 1.5.3 Role of Private Inflows to the EAC .............................................................................................. 18 1.6 Outlook and Risks ............................................................................................................................. 19 1.6.1 Global Outlook ............................................................................................................................ 19 1.6.2 Rwanda’s Outlook ....................................................................................................................... 20 PART 2: MAKING THE MOST OF REGIONAL INTEGRATION FOR RWANDA ................................................ 23 2.1 Opportunities and Challenges of Increased East African Economic Integration .............................. 24 2.2 Rwanda’s Economic Geography and Regional Integration ............................................................... 27 2.2.1 Division and the Need for Thinner Borders ................................................................................. 28 2.2.2 Reducing Distance to Markets as a Way to Improve Access ....................................................... 31 2.2.3 Density and the Forces of Agglomeration ................................................................................... 34 2.3 Main Recommendations .................................................................................................................. 36 2.4 Conclusions ...................................................................................................................................... 38 REFERENCES ................................................................................................................................................. 47 LIST OF ANNEXES Annex 1: Consumer Price Index in Rwanda .................................................................................................. 41 Annex 2: The Taylor Rule .............................................................................................................................. 42 Annex 3: The 2009 Credit Crunch ................................................................................................................. 43 Annex 4: Forecasting Sectoral Growth .......................................................................................................... 44 LIST OF TABLES Table 1: Share and Growth in New Loans ..................................................................................................... 6 Table 2: Regionalized Banking Operations in the EAC ................................................................................... 7 Table 3: Rwanda’s Food Balance Sheet ......................................................................................................... 8 Table 4: Government Budget 2009/10 – 2012/13 (Percent of GDP) ............................................................. 13 Table 5: Growth Indicators, 2008-2013 ......................................................................................................... 20 Table 6: Rwanda's Trade Balance with Neighboring Countries (billion Rwf) ................................................ 30 LIST OF BOXES Box 1: Rwanda’s Construction Sector ........................................................................................................... 5 Box 2: Rwanda‘s Financial Sector as Part of the Regional Financial Market ................................................. 7 Box 3: Inflation Trends as a Result of Global Fuel and Food Price Trends .................................................... 9 Box 4: Exchange Rate Trends ........................................................................................................................ 12 Box 5: Rwanda’s Tourism Sector ................................................................................................................... 17 Box 6: Key Assumptions for the World Bank Growth Forecast for Rwanda .................................................. 22 Box 7: Overview of the EAC .......................................................................................................................... 26 Box 8: The Three Dimensions of Spatial Transformation .............................................................................. 28 Box 9: Rwanda’s Vibrant Informal Cross-Border Trade ................................................................................. 30 Box 10: Northern and Central Transport Corridors of East Africa ................................................................. 32 Box 11: Cross-border Infrastructure Challenges ........................................................................................... 33 LIST OF FIGURES Figure 1: Rwanda’s Growth Compared to the EAC and SSA, 2007-2012 ...................................................... iii Figure 2: Economic Growth in Rwanda was Robust in 2011 ......................................................................... 2 Figure 3: 2011 Growth Continued to be Strong due to Thriving Services, Construction and Mining ........... 3 Figure 4: Booming Mining and Construction Activities Carried Industrial Growth in 2011 .......................... 4 Figure 5: Agriculture Strongly Recovered in the Second Half of 2011 .......................................................... 6 Figure 6: Financial Depth in the EAC Region ................................................................................................. 7 Figure 7: Financial Inclusion in the EAC Region ............................................................................................ 7 Figure 8: Inflation Was Moderate Compared to Rwanda’s Neighbors, But at its Highest Level Since 2009 ......................................................................................................... 8 Figure 9: Domestic Retail Fuel Prices ............................................................................................................ 9 Figure 10: Prices for Locally Produced Foods Put Pressure on Food Inflation ............................................. 9 Figure 11: Core inflation Remained Above Headline Inflation until December 2011 ................................... 9 Figure 12: Historic Monetary Response to Inflationary Pressures ................................................................ 10 Figure 13: Deposit Rates and Short-term Interest Rates Were Negative in Real Terms ................................ 10 Figure 14: Interest Rate Spreads Only Varied by a Small Percentage During 2011 ....................................... 11 Figure 15: Money Market Operations ........................................................................................................... 11 Figure 16: The Rwf Appreciated in Real Terms .............................................................................................. 12 Figure 17: The Fiscal Deficit (incl. Grants) is Expected to Increase in 2012/13 ............................................. 13 Figure 18: Trends in External Balances ......................................................................................................... 14 Figure 19: Export Performance in 2011 Was Strong… .................................................................................. 15 Figure 20: … But Imports Continued to Outpace Export Growth Due to High Energy Prices ....................... 15 Figure 21: EAC Exports Rebounded After Being Deeply Impacted by the Global Downturn ........................ 16 Figure 22: EAC Export Value Trends .............................................................................................................. 16 Figure 23: EAC Exports as Percentage of GDP .............................................................................................. 16 Figure 24: Tourism is Becoming an Important Source of Export Earnings for Rwanda ................................. 17 Figure 25: Exports’ Basket Concentration in the EAC ................................................................................... 17 Figure 26: Rwanda’s Share of Tourism Receipts in the EAC Region Remains Low ........................................ 17 Figure 27: Rwanda’s Tourist Arrivals Originate Mainly from the EAC Region and the DRC .......................... 17 Figure 28: Overall, Remittances and FDI Inflows to the EAC are Still Low… ................................................. 18 Figure 29: Remittances and FDI to the EAC Region ...................................................................................... 18 Figure 30: Trends in EAC FDI Inflows ............................................................................................................ 19 Figure 31: FDI Inflows to Rwanda Rose Much in Recent Years ..................................................................... 19 Figure 32: EAC Trade by Destination ............................................................................................................. 24 Figure 33: Population Density in the EAC and Selected Comparator Countries, 1950–2050 ....................... 27 Figure 34: Trade Restrictions as a Barrier to Market Access ......................................................................... 28 Figure 35: Types of Informal Cross Border Exports ....................................................................................... 30 Figure 36: How Markets View the World ...................................................................................................... 30 Figure 37: Rwanda is Increasingly Diversifying its Export Market Towards other African Countries and Asia ........................................................................................................ 31 Figure 38: Economic Density in the EAC ....................................................................................................... 34 Figure 39: Remittances to Rwanda ............................................................................................................... 36 ACRONYMS ASEAN Association of Southeast Asian Nations BIF Burundian Franc BNR Banque Nationale du Rwanda (Central Bank of Rwanda) DRC Democratic Republic of Congo EAC East African Community EDPRS Economic Development and Poverty Reduction Strategy EICV Enquête intégrale sur les conditions de vie des ménages EU European Union GDP Gross Domestic Product FDI Foreign Direct Investments FY Fiscal Year HHI Herfindahl–Hirschman Index, KCB Kenya Commercial Bank KES Kenya Shilling KRR Key Repo Rate MINECOFIN Ministry of Finance and Economic Planning MINICOM Ministry of Trade and Industry NISR National Institute of Statistics of Rwanda NPLs Non-performing loans NTBs Non-Tariff Barriers Rwf Rwandan Franc SACCOs Saving and Credit Cooperatives SSA Sub-Saharan Africa SEZ Special Economic Zone TZS Tanzania Shilling UGS Uganda Shilling UNCTAD United Nations Conference on Trade and Development US United States VFR Visiting Friend and Relatives WDI World Development Indicators WDR World Development Report Y-O-Y Year-on-year i Rwanda Ecomomic Update | Edition No. 3 PREAMBLE T his Economic Update reports and synthesizes key economic developments in the past six months in Rwanda’s economy. It places them in a medium-term and regional context, and analyzes the implications of these developments and policies for the outlook of Rwanda’s economy. In this way, these reports contribute to the implementation of the Bank’s Africa Strategy. The Economic Update reports cover in each edition a special feature on a selected topic. It is intended for a wide audience, including policy makers, business leaders and other market participants, and the community of analysts, engaged in Rwanda’s economy. The Rwanda Economic Update was prepared and compiled by the Poverty Reduction and Economic Management team at the World Bank Country Office in Rwanda, under the leadership of Birgit Hansl (Senior Economist), with inputs from Peace Aimee Niyibizi (Economist) on the economic developments section and with inputs from Anton Dobronogov (Senior Economist) and John Bosco Kanyangoga (Consultant) on the economic geography and regional integration section, which synthesizes findings from the two World Bank reports: Reshaping Economic Geography of East Africa: from Regional to Global Integration (2012) and Defragmenting Africa (2012). Additional information: For more information about the World Bank and its activities in Rwanda, please visit: www.worldbank.org/rw. If you would like to be included in the email distribution list of this semi-annual series and related publications, please contact singabire@worldbank.org. For questions and comments related to this publication, please contact bhansl@worldbank.org. Rwanda Ecomomic Update | Edition No. 3 ii EXECUTIVE SUMMARY Another Banner Year as the Fastest Growing Rwanda’s stellar economic outcome in 2011 was EAC Economy substantially anchored by the performance of the industrial sector. Industrial growth doubled in 2011 R wanda grew at a rapid rate in the second half of 2011, exceeding 10 percent for the first time, since the 2009 global economic downturn. Overall, to 17.6 percent. Construction was the largest sub- sector, contributing 8.0 percent to total GDP, or 50.7 percent of industrial output in 2011. The public sector Rwanda achieved 8.6 percent growth in 2011, and continued to drive the high growth in construction. substantially exceeded the average growth for Sub- This was reflected by an increased share of capital Saharan Africa (SSA) of 5.0 percent. Rwanda also expenditures, which averaged more than 40 percent of grew fastest than all the countries in the East African total public expenditures, since 2008. More than half Community (EAC), which as a group reached 6.1 are funded by aid flows, mainly for schools, roads and percent in 2011 (Figure 1). Robust growth continued hospital construction, and irrigation works. Mining also in the first quarter of 2012, when Rwanda’s economy made a significant contribution to Rwanda’s industrial expanded at 7.7 percent. performance, as well as to overall economic growth. Overall, Rwanda’s mineral exports in 2011 more than Figure 1: Rwanda’s Growth Compared to the EAC doubled the value of the previous year. Part of this and SSA, 2007-2012 growth was a one-time-gain, as mineral exporters sold off substantial stocks in early 2011, before global regulations seeking to curb smuggling of minerals from conflict areas, were enforced. Manufacturing remained a minor contributor to industrial growth and Rwanda’s overall output. While the economy has expanded 8.2 percent over the recent five year period, manufacturing growth averaged only 5 percent, and its share of GDP remained at 6 percent. The services sector grew strongly at around 9 percent in 2011. Financial services led growth in services, expanding by 20.4 percent. Part of this growth can be attributed to a deepening of Rwanda’s financial infrastructure, Source: World Bank, Global Economic Prospects Report (June 2012). brought about by EAC-based institutions opening offices in Rwanda. Agricultural output rebounded in This remarkable performance was achieved against the second half of 2011, following good rains and a the backdrop of a deteriorating global economic bumper second harvest. environment in the second half of 2011, and recently, a dramatic worsening situation in the Euro zone. In the first quarter of 2012, industrial shrunk Uncertainty is heightened on how markets will dramatically to 1.1 percent, but services growth evolve over the medium-term, and global economic continued at a staggering 14.2 percent, compared conditions are expected to remain volatile and fragile. to the same period a year ago. In 2011 mining and This will require special monitoring and increased construction grew rapidly, but growth in these two vigilance in macroeconomic management, as the sub-sectors collapsed in the first quarter of 2012. country could become impacted by the weak fiscal Strong growth in services was grounded in stellar situation in Europe, and increased risk aversion in the performance in the sub-sectors of transport and global financial sector. communication, wholesale and retail trade, and iii Rwanda Ecomomic Update | Edition No. 3 Executive Summary public expenditure-led services (education, health Rwanda’s current account deficit widened in and public administration). The latter was a result of 2011, despite higher transfers. Although exports an 18.8 percent increase in Government consumption grew strongly, they were not sufficient to offset the expenditure. Agriculture output growth stood at 3.4 increased import bill. Rwanda’s traditional export percent in the first quarter of 2012 compared to a products (minerals, coffee and tea) increased in value year ago on account of a significant contraction in by 60 percent in 2011, reflecting high international growth for export crops. commodity prices. Another bright spot was the tourism sector, which continued to be the largest Like all countries in the EAC, Rwanda struggled to foreign exchange earner in Rwanda. Although contain inflation in 2011, although it experienced Rwanda’s exports have been increasing, they remain lower inflation than most. As a land-locked, fuel small as a share of GDP, especially when compared importer, Rwanda experienced high prices for to other EAC countries. Consumer goods remained imported petroleum products, but the Government’s the largest import expenditure, accounting for 27.2 decision to lower the excise tax on fuel in mid-2011, percent of all imports in 2011. Energy products were dampened some of the upward pressure on prices. the fastest growing import category, increasing by A review of the Rwanda Central Bank’s policies on more than 60 percent and accounting for 17 percent key interest rates, shows that the Key Repo Rate of the total import bill in 2011. Rwanda imports (KRR) was not as effectively used as it should have, significantly more products from EAC countries than to rein in inflation. Throughout the second part of it exports to them. Remittances to Rwanda are still 2011 when core inflation was on the rise, policy and relatively insignificant, amounting to US$166 million deposit rates became negative in real terms, leading or 1.7 percent of GDP in 2011. Kenya and Uganda to a surge in private credit growth, which peaked accounted for 95 percent of all remittances flowing at 31.0 percent in October 2011. This suggests that to the EAC in 2011, while Rwanda accounted for Central Bank should be vigilant, and could consider only 3.1 percent. With increased education levels, a more proactive monetary policy stance, consistent Rwanda’s stock of human capital may find attractive with tightening the KRR. In the first quarter of 2012, employment options within the EAC and beyond. headline inflation remained persistently high, around Foreign Direct Investment (FDI) remains extremely 7.9 percent, but core inflation eased off. low in Rwanda although it has been increasing in recent years. In the first quarter of 2012 export Rwanda continues to manage its fiscal account earnings continued to increase, but only on account prudently. It revised downward its spending of re-exported petroleum products to the Democratic commitment for capital projects under the 2011/12 Republic of Congo (DRC) while traditional export budget, resulting in an overall decline in its deficit products (minerals, coffee and tea) performed less from 2.6 percent of GDP to 2.2 percent. Revenues well. The import bill continued to expand in the remained robust with improved collection of taxes first quarter of 2012, but now capital goods and on goods and services. In particular, the Government intermediary goods overtook consumer goods as the received the equivalent of 0.7 percent of GDP from largest import expenditure. the sale of a new telecom license. The government is planning to increase public expenditure in Rwanda’s outlook for 2012 and 2013 remains 2012/2013, and is anticipating that revenues will positive, with the World Bank projecting growth not be sufficient to cover expenditures, resulting in rates of 7.4 percent and 7.7 percent respectively, a deficit of 2.9 percent of GDP, still well within global with considerable downside risks. Overall, benchmarks for prudent financial management. The agricultural growth should continue with new Government plans to finance the deficit largely with Government’s investments coming on stream, foreign financing, though it plans to tap the local but remain highly dependent on good weather capital markets, which are expected to have adequate conditions. The mineral sub-sector will likely see a liquidity. moderation in prices, as major western economies Rwanda Ecomomic Update | Edition No. 3 iv Executive Summary continue to adjust, dampening the demand for raw region’s competitiveness. Intraregional trade is also materials. It is assumed that for 2012, ongoing public inhibited by regulatory and administrative hurdles that sector investments in infrastructure will keep the inflate transport cost. There are numerous problems construction sub-sector growing. Growth in services affecting the smooth flow of goods from ports to will continue, on account of continuously high trade inland destinations, and vice versa. These include activity and high public and private consumption. inefficient port operations, unwarranted roadblocks and check points, and weighbridges along the regional The major risks facing Rwanda’s economic future transport routes, as well as delays at border crossings. relate to changes in the external outlook. Rwanda Freight costs per kilometer in the EAC are 30 percent could experience negative impacts due to a number higher than in Southern Africa. For Rwanda and the of factors: (i). increased inflationary pressures, which other landlocked countries, transport costs can be as could come in form of increased global energy and high as 75 percent of the value of exports. food prices; (ii). reduced commodity prices, especially for minerals; (iii). lower flows of remittances and This report has a special focus on the EAC, and FDI; and, (iv) decline in tourism, which could be will look at pathways which Rwanda could take in negatively impacted by a proposed increase in park order to unlock the benefits of regional integration. fees to view Rwanda’s gorillas, the main attraction of Currently, the EAC is a marginal player in global trade, tourists visiting from outside the EAC. Yet, the most accounting for a sliver of total activity. However, the substantial risk to Rwanda would be if donor financing “new EAC� is off to a good start, and is proceeding would diminish, given the precarious nature of the cautiously to avoid the pitfalls that led to the collapse economies of many traditional donors. This would of the previous EAC, which operated in the 1960s and require Rwanda to scale back on capital projects and early 70s. The new EAC is moving much slower than some recurrent expenditures. Offsetting this risk is its predecessor in developing community approaches Rwanda’s solid management of its economy, including and institutions. A customs union was phased in the effective use of donor funding, which will likely between 2005-2010, although numerous non-tariff give it high priority in receiving future financing. barriers to trade remain. Phasing in of a common market began in 2010, and talks are underway about Leveraging Regional Integration a monetary union. Political federation is a declared F objective, although it is still a long way off. or Rwanda to become an emerging middle- income economy, it will need to unleash its export potential, and integrate more with its EAC The framework of economic geography suggests neighbors. The country has a natural comparative that regional integration will work faster and better, advantage in services, including tourism, and can if it reduces the economic distance between the EAC serve as a gateway between the Anglophone East economy as a whole and the global core. The size of Africa and Francophone Central Africa. But Rwanda the EAC’s external markets vastly exceeds that of its can only develop these benefits, if it integrates with internal market, but jointly, EAC partner states are its neighbors. Until now, Africa’s fragmentation has more likely to successfully leverage global demand. held many countries back, as it hindered countries Unlike other economic communities, EAC currently to develop economies of scale through regional has a relatively high inland economic density, and integration. This fragmentation of Africa is explored it will need to compete with coastal parts of other in the recent World Bank report Defragmenting Africa regions such as East Asia, which already benefit (2012). from huge agglomeration effects. The framework of economic geography is applied in this report to the East Africa’s economic integration remains East African Community, based on the World Bank challenged by deficient regional infrastructure report titled Reshaping Economic Geography of East networks. High transport costs undermine the Africa: from Regional to Global Integration (2012). v Rwanda Ecomomic Update | Edition No. 3 Executive Summary This framework was first explored in the 2009 World are distributed as evenly as possible across partner Development Report. states. Finally, increasing labor mobility would help to generate important agglomeration effects in the Global and regional integration are complements, medium to long term, but also help to address critical not alternatives. Many European, American and Asian skills gaps, in selected EAC countries in the short-term. countries benefitted simultaneously from regional and global integration into the European Union (EU), Advances in East African integration are crucial, as it and Association of Southeast Asian Nations (ASEAN). has the potential for higher than usual benefits for The EAC countries could also use regional integration Burundi, Rwanda and Uganda, because for them the as a stepping stone for competing globally. The costs of being landlocked are very high. Successful EAC is now trading more with itself than with other integration would transform the five countries into regions of the World. Over the last five years, intra- a strong regional economy, slashing transport and EAC trade has risen sharply, more so in manufactured other costs. But the same fact of geography means goods such as food products, beverages, tobacco, and that integration policies for coastal versus landlocked cement. The greatest immediate benefits for closer economies will have asymmetric impacts. Firms EAC integration could be increased trade in agriculture tend to concentrate in the larger economies, and products which remain too expensive in many EAC often close to the coast. But given its location and countries and which could provide opportunities for size, Rwanda will lose most, if it does not integrate. farmers in food surplus economies such as Rwanda. However, a vibrant EAC will allow the development of “niche� markets, also in the smaller economies. Intra-EAC trade is expected to accelerate over the next years, and will generate opportunities for The main risk facing the EAC now is of a stalled form Rwanda and its EAC partners. As mentioned above, of integration in which a common market, although increased trade in agriculture would contribute existing on paper, still allows substantial barriers to to the region’s food security, and provide growth commerce in practice, an issue of particular concern opportunities for regional farmers. Increasingly, trade for the landlocked countries. These countries depend in basic manufactured goods and regional production on access to the coast through other states, and chains could create employment, and promote export the cost of doing this depends on both immutable, diversification. Intra-EAC trade in services could natural features (distance), as well as those that can offer new and dynamic opportunities for exports, be modified by policy (quality of infrastructure, and and enhance overall competitiveness of the EAC secure right of free passage). However, precisely economies.1 because the EAC is divided into multiple states, some landlocked and some coastal, coastal states do not Key recommendations for EAC policies to improve fully internalize the benefits of policy measures that regional integration include the regionalization improve coastal access for others. To keep politicians of connective infrastructure through effective (and their constituents) on board, the sequencing of joint-EAC transit management. This would help to policy measures has to be right. Parallel to removing overcome infrastructure bottlenecks, and decrease some of the non-tariff barriers and unofficial transport costs. The East African economy could obstacles, raising the quality of infrastructure and increasingly realize agglomeration benefits, with the social services, and establishing a coastal economic establishment of a regionally designed economic integration zone, EAC policy makers could consider integration zone. This could help to leverage global taking additional measures to enhance its outreach demand, and pilot future common institutions, to global markets. while ensuring at the same time, that some benefits 1 World Bank 2012, Defragmenting Africa. Rwanda Ecomomic Update | Edition No. 3 vi PART ONE Recent Economic Developments R enewed concerns over the global growth outlook and of the European debt crisis, might negatively affect Rwanda’s prospects in 2012/2013, and lead to a lower growth turn-out compared to 2011. First quarter growth in 2012 remained overall robust, but showed considerable weakness in the industry sector. This was in contrast to what was observed in the second half of 2011, when industrial growth led by buoyant construction, and mining activities pushed the sector to the top, ahead of services. In the second half of 2011, Rwanda’s growth momentum accelerated largely led by thriving non-tradable goods and services sectors while the manufacturing sector continued to be sluggish. The Rwandan economy expanded by 10.8 percent during the second half of 2011, but manufacturing only contributed 0.5 percentage points to this growth outcome. Agricultural output took a leap in the second half, mainly due to a very good second harvest season outcome. Overall, growth turn-out for 2011 stood at 8.6 percent, up from 7.2 percent in 2010. Inflationary pressures reappeared in tandem with high international food and fuel prices. The small policy response came with a delay, not enough to prevent core inflation reaching its highest level since mid-2009. Core inflation exceeded headline inflation for the whole second half of 2011. The current account deficit broadened in 2011. Rwanda’s export performed robustly, benefiting from high international prices, but could not keep up with the increasing import bill, leading to a further deterioration in the trade balance. For 2012, Rwanda’s economy is expected to continue to grow slower than it did in 2011, but at a healthy pace. The industrial sector is likely to expand less than in 2011 and growth in the services sector is expected to be more moderate, both on account of a more risky global environment. Recent Economic Developments 1.1 GLOBAL ECONOMIC ENVIRONMENT Nonetheless, risks to these forecasts remain tilted to the downside, as the global economy remains fragile R wanda continued to record the fastest growth rate in the EAC, increasing by 8.6 percent in 2011. Rwanda’s economic growth outpaced the and weaker growth in China could curtail growth in the resource dependent SSA’s economies. average growth rate for SSA of 5.6 percent and for Worldwide economic developments in 2011 EAC countries of 6.1 percent (Figure 2). Tanzania have been volatile, with large swings in investor recorded a healthy growth above the EAC average, sentiment, but periods of relative calm and but was slightly lower than in the previous year, due improving prospects. While output in the second half to slower fiscal expansion and the adverse impact of of 2011 was particularly weak, economic news during an energy crisis on private activities.2 The Kenyan the first four months of 2012 was generally positive. economy faced a number of challenges in 2011, Significant structural, fiscal and monetary policy steps including a severe drought in the Horn of Africa, and in high-income Europe during the fourth quarter high international commodity prices, resulting in a of 2011, and the first quarter of 2012, contributed growth outturn lower than the EAC average. to a significant improvement in market sentiment, and less constraining financial conditions. This Figure 2: Economic Growth in Rwanda was Robust in 2011 combined with monetary policy easing in developing countries, was reflected in a strengthening of real- side economic activity, in both low-income and high-income countries. Annualized growth rates for industrial production, import demand and capital goods sales returned to positive territory with low- income countries leading the rebound. Since May 2012, market tensions increased, sparked by fiscal slippage, banking downgrades, and political uncertainty in the Euro Area. The renewed market nervousness has caused the price of risk to spike upwards globally. Financial market indicators have Source: World Bank, Global Economic Prospects (June 2012). deteriorated, with low-income and high-income country stock markets facing increased volatility. Yields on high-spread economies were also driven Despite the turbulent global economic environment upwards, while those of safe-haven assets declined. in 2011, growth for SSA remained robust, notes the Virtually all low-income economy currencies have World Bank’s Global Economic Prospects report of depreciated against the US dollar, while industrial June 2012. Excluding South Africa, which accounts commodity prices such as oil and copper have fallen for over a third of the regions GDP, growth in the rest sharply. These renewed tensions will add to pre- of Sub-Saharan Africa was stronger at 5.6 percent in existing headwinds to keep GDP gains in 2012 modest. 2011, making it one of the fastest growing developing regions. Looking ahead, high commodity prices, ongoing investments in new mineral discoveries, policy 1.2 RWANDA’S REAL SECTOR TRENDS loosening in some countries, and lower inflation rates, should support robust domestic demand, with GDP growth projected at 5 percent in 2012—with a pick up R wanda’s growth in 2011 was led by booming non-tradable goods and services sectors. Similar to other economies with high foreign aid expected in 2013—as the global economy rebounds. inflows or strong natural resource sectors, growth in 2 After low 2010 rainfalls hydroelectric power generation was cut, leading to a 40 percent reduction in the national power supply. (IMF, Country Report No 12/13, January 2012). Rwanda Ecomomic Update | Edition No. 3 2 Recent Economic Developments manufacturing has lagged the overall growth trend. expenditure-led services reported a strong growth of While the economy expanded by 8.2 percent over the 14.2 percent (following an 18.8 percent increase in recent five years, manufacturing growth averaged a Government consumption expenditure). Agriculture much lower 5 percent and its GDP share accounted sector growth suffered from a weak performance for for only 6.0 percent. In the second half of 2011, the export crops, which saw growth for this sub-category Rwandan economy expanded by 10.8 percent, but contracting by 24.1 percent. manufacturing only contributed 0.5 percentage points to this growth outcome. Growth in services remained In 2011, growth in the industrial sector surpassed mainly fuelled by public expenditure-led services growth in services due to exceptional performance (public administrations, education, and health), as a of the mining and construction sub-sectors (Figure result of continued high level donor aid being injected 4). Industrial growth doubled in 2011 to 17.6 percent, to the budget. On an annual basis, agriculture and from 8.4 percent in 2010. After an impressive first services registered in 2011 similar growth as in 2010 half year growth of 14.7 percent, industrial growth (Figure 3). accelerated in the second half of 2011 to 20.4 percent, fueled by mining and construction. Growth Growth in the first quarter of 2012 remained at a in the mining sub-sector was a direct result of high healthy 7.7 percent compared to the first quarter international prices for tin, Rwanda’s main mineral a year ago. However, contrary to 2011, industrial export. International prices for Rwanda’s mineral growth was weak, at 1.1 percent. The two strongest exports increased to 54.7 percent in the second half growing industry sub-sectors of 2011—mining and of 2011 and 49.5 percent for the entire year. Growth construction—recorded a disappointing outturn of in the mining sector was more impressive in the zero, and negative 0.7 percent, respectively. Growth in first quarter of 2011 (112.5 percent) when mineral services stood at 14.2 percent as compared to the first exporters were assigned a short window of time quarter a year ago. The transport and communication to sell off their mineral stocks in response to new sector grew at 19.2 percent in the first quarter as a international anti-smuggling regulations. On April 1, result of an increase in mobile phone subscribers, and 2011, the Government’s bill prohibiting smuggling increased transport fares (due to high fuel prices). of minerals from conflict areas came into effect, in Other booming services sub-sectors benefited from response to a similar bill passed by the US Congress, strong private and public consumption: wholesale prohibiting mineral imports from conflict areas. and retail trade grew at 14.6 percent, and public Figure 3: 2011 Growth Continued to be Strong due to Thriving Services, Construction and Mining Source: National Institute of Statistics of Rwanda (NISR). 3 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments In 2011, Rwanda’s construction sector growth was In 2011, financial services led growth in services, instrumental for achieving the high growth outturn. expanding by 20.4 percent. Some of this growth Construction was the second most important driver of can be attributed to increased regional financial industrial growth (Figure 4). The construction sector sector integration, partly reflected in the increased grew in the second half of 2011 by 25.6 percent, and market presence of EAC banks in Rwanda (Box 2). In for the entire year by 23.6 percent. Construction’s 2011, the growth of the financial sector was driven contribution to overall GDP growth was higher than by both banking and insurance businesses. While from agriculture. Box 1 attempts to identify the both sectors’ profits increased, the banking sector drivers behind this strong sector growth and how it continues to dominate Rwanda’s financial sector, and spurred the rest of the economy. The public sector held more than 70 percent of financial assets, as of continued to be the key force behind construction December 2011. The banking sector saw its balance growth, reflected by high capital budget expenditures sheet expanding by 24.5 percent in assets mainly due which are funded largely by aid flows. Overall, the to new bank entrants into the market (one regional contribution of the private sector remained minimal, commercial bank, a military cooperative became a compared to the volume of new private loans for cooperative bank and two microfinance institutions construction in public capital spending. International upgraded to become microfinance banks),3 and the contractors dominate the market for the large public continued high growth of credit to the private sector. construction projects as private domestic construction Profit after tax increased by 42.4 percent in 2011. firms face size and capital constraints on their ability Credit to private sector rose by 28.6 percent in 2011, to compete for larger contracts. The outlook for compared to 11.1 percent in 2010, owing to a 29.2 construction of publicly financed projects remains percent increase in new loans. Loans for building and relatively optimistic, despite the disappointing first public works, registered the largest increase in the quarter result in the sub-sector. Government capital share in new loans (Table 1). Credit growth continued expenditures are projected to increase in the 2012/13 in 2012, and as of May 2012, credit to the private sector budget. Construction permits for large projects has expanded by 29.1 percent (y-o-y). However, new continue to be issued at a similar rate, compared to a loans took off dramatically in the first quarter of 2012, year ago. However, construction firms catering for the increasing by 92.2 percent (y-o-y). Some productive private market report sluggish demand, and expect to sectors like manufacturing, mining and agriculture operate at a lower capacity compared to 2011. continued to have less access to capital for expansion. Figure 4: Booming Mining and Construction Activities Carried Industrial Growth in 2011 Source: NISR. 3 Currently, Rwanda’s banking sector is composed by nine commercial banks, one development bank which merged with the housing bank in 2011, three microfinance banks and one cooperative bank. Rwanda Ecomomic Update | Edition No. 3 4 Recent Economic Developments Box 1: Rwanda’s Construction Sector C onstruction was the main contributor to industrial growth in 2011 (Figure 4). Growth in the construction sub- sector accelerated to 23.6 percent in 2011, from 8.8 percent in 2010. Construction is the largest industrial sub-sector contributing 8.0 percent to total GDP or 50.7 percent of industrial output in 2011. Construction growth has large spill-over effects, and spurs other activities such as financial services growth, and imports of construction materials. In 2011, 25.4 percent of new loans to the private sector were in the construction sector (up from 17.2 percent in 2010). Trade activities of construction materials surged with imports of construction materials increasing by 24.2 percent in volume (and by 27.1 percent in value) in 2011. The public sector continues to drive the high growth in construction. This is reflected by the increased share of capital expenditures which average more than 40 percent of total public expenditures since 2008. More than half are funded by aid flows, with these resources mostly used for schools, roads and hospital construction, and irrigation works. The contribution of the private sector remains small in comparison to construction activities undertaken by the public sector. The amount of new private loans for construction came to Rwf86.1 billion in 2011 compared with public capital expenditure estimated at Rwf447.9 billion in the same period. The majority of the large public construction and consultancy contracts, particularly for roads and office premises, are being executed exclusively by a few international contractors. Only a small number of local contractors are able to compete or work through joint ventures with these international contractors. However, the role of the private sector is slowly increasing. Recently, private real estate developers started to develop housing estates on a commercial basis. Additionally, associations of private investors started to develop commercial and industrial areas, using private funds, encouraged by a program of the Private Sector Federation developed in 2008. The Kigali City Market, a modern shopping complex, is one of the products of these formal business investment groups.4 For private domestic construction businesses, a number of factors constrain their expansion. Most domestic firms are small with a limited capital base, which affects their ability to post collateral for purchasing raw materials and equipment. There is a shortage of trained personnel on the local market, which pushes businesses to hire workers from neighboring countries. Another constraint is the high cost of construction raw materials, which are largely imported, with local producers unable to satisfy the demand. A large number of small and medium enterprises associated with the construction industry disappear, shortly after they are established. Apart from larger construction projects, the segment that supports private housing construction, which could provide opportunities for smaller enterprises, remains unregulated, and owners often build without technical expertise or recourse to local contractors. The outlook of the sector is mixed and depends on continued high levels of public capital expenditures. Larger construction firms with access to public contracts report an optimistic outlook. The size of Government capital expenditure is planned to increase in the 2012/2013 budget, and will likely continue to fuel construction growth in this market segment. The approval of construction permits continues to be high, and similar to the previous year. As of April 2012, the construction permit licensing for Kigali5 approved almost 40 percent of the number of construction permits cleared in 2011. However, smaller private operators expect to work at reduced capacity compared to 2011, based on the limited contracts in their books for 2012. Improving corporate governance combined with percent in 2009 to 8.0 percent in December 2011 (but deployment of better credit appraisal in some banks, still above the maximum target of 7 percent). contributed to the decrease in Non-performing Loans (NPLs) from the high levels observed in 2009. Financial services also continued to benefit from The NPLs/Gross loans ratio (NPL ratio) fell from 13.1 increased insurance activities, especially in the life 4 An association of traders was formed in 2000 with the objective of advocating for the interests of Kigali City traders. As Kigali City grew, the association mandate expanded to being part of the city’s development and the Kigali Investment Company was formed. 5 The One Stop Center was introduced in April 2010 by the City of Kigali, in effort to provide quick and better services to its clients, especially in the construction industry. The center deals with: (i) buildings with a capacity of receiving at least 100 people per day, (ii) projects covering an area equivalent or more than 4,000m2, (iii) constructions with a commercial, recreational usage and major residential developments and (iv) buildings with more than 2 floors. 5 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments Table 1: Share and Growth in New Loans Share of New Loans (in percent) Annual Growth (in percent) Sectors 2010 2011 Q1-2012 2010 2011 Q1-2012 Agriculture 2.1 3.5 1.8 44.4 120.6 -45.0 Mining industry 0.0 0.0 0.0 -16.7 0.0 0.0 Manufacturing industry 10.2 5.5 7.5 33.4 -30.2 246.5 Energy and water 0.5 0.2 0.1 -56.2 -60.6 400.0 Public works, building industry 17.2 25.4 27.1 23.0 90.8 122.5 Commerce, restaurant & hotels 42.6 36.4 38.9 53.1 10.4 118.5 Transport, warehousing & communications 8.6 5.4 6.0 -28.9 -19.7 170.3 O.F.I, insurances & other non-financial services 3.2 5.7 0.5 13.7 125.9 -91.4 Services provided to the community 3.7 2.8 2.0 109.2 -2.3 40.2 Not classified elsewhere 11.8 15.2 16.2 75.2 66.7 129.5 Grand total 100.0 100.0 100.0 32.2 29.2 92.2 Source: Banque Nationale du Rwanda (BNR). insurance segment. Increasing performance in the compared to a year ago. Growth for export crops non-life insurance segment can be partly attributed contracted significantly. Rwanda has also experienced to the implementation of the BNR regulation, on the delayed but heavy rains for season B, which are also separation of life and non-life insurance businesses6, likely to impact crop output adversely at the end of which eliminated the ability of companies to cross- season B. subsidize claims in non-life business, from life insurance premiums. Today, insurance businesses are Figure 5: Agriculture Strongly Recovered in the separated in most companies, and are both making Second Half of 2011 profit. Overall, the insurance sector’s profit increased by 64.3 percent in 2011, compared to 2010. Agriculture remains a mainstay of Rwanda’s growth. Starting from a low base in the first half of 2011, agriculture strongly rebounded in the second half of 2011 on account of a very good outcome for the harvest season B (Figure 7). The sector expanded by 8.6 percent in the second half of 2011, mainly led by food crops, which increased 9.6 percent in value. Export crops also picked up, rebounding from a 4.8 percent contraction in the first half, to increase Source: NISR. by 9.9 percent in the second half as a result of the Note: Others stands for Livestock, Forestry and Fisheries. strong coffee harvest and robust international prices. Overall, agriculture grew by 4.7 percent in 2011, Food security conditions continued to remain stable slightly lower than a 5.0 percent of 2010. For 2012 in 2011, but food prices were high. In 2011, Rwanda’s season A the volume of food crops rose only by 1.3 food balance sheet continued to improve, owing to percent compared to the same season in 2011.7 In the good production (Table 3). Food crops increased by first quarter of 2012, agriculture grew at 3.4 percent 10.6 percent in 2011—in volume—as a result of high 6 Regulations on licensing requirements and other requirements for carrying out insurance business, BNR May 2009. 7 Food Crop Assessment Report Season A 2012, Ministry of Agriculture. Rwanda Ecomomic Update | Edition No. 3 6 Recent Economic Developments Box 2: Rwanda‘s Financial Sector as Part of the Regional Financial Market T he banking sector in the EAC region has developed, but the region remains financially excluded, with Rwanda being among the most financially excluded. The financial Figure 6: Financial Depth in the EAC Region depth improved within the region, but to different degrees in the various countries (Figure 6). The average credit to GDP ratio for the five EAC countries rose from 17.6 percent in 2008, to 21.7 percent in 2011. Kenya remains the country with the highest ratio, on average 33.0 percent between 2008 and 2011, while Rwanda has the lowest ratio at around 12.7 percent over the same period. Large parts of the population in the region remain financially excluded, with less than a third of the population in Rwanda, Tanzanian and Uganda having access to formal financial system, and more than half of the population in Rwanda and Tanzania having no access to financial services at all. Even in countries with a high level of financial inclusion in the region, such as Kenya and Uganda, informal financial services dominate (Figure 7). Source: World Development Indicators (WDI). The financial services integration in Rwanda is led by Kenya- Figure 7: Financial Inclusion in the EAC Region based financial institutions. As of today, three Kenyan Percentage of adult population banks have branches in Rwanda (Table 2). FINA Bank began its regional expansion into Rwanda in 2004 after acquiring Kenya (2009) 23 18 27 33 BACAR. By the end of 2011, FINA Bank had ten branches. Kenya Commercial Bank (KCB) was the second Kenyan bank Uganda (2009) 21 7 42 30 to expand into Rwanda in December 2008. By the end of 2011, KCB had nine branches. In 2011, another Kenyan bank entered the Rwandan market: Equity Bank and started Rwanda (2008) 14 7 26 52 operating in early 2012. Beside these Kenyan-based banks, Ecobank, a regional West African banking group, joined the Tanzania (2009) 12 4 27 56 EAC through Rwanda in July 2007, after the acquisition of a 90 percent stake of Bank of Commerce Development and - 20 40 60 80 100 Industry. By the end of 2011, EcoBank had sixteen branches in Rwanda, and operated in all EAC states. Kenyan non-banking Formally included Informally included Informal Excluded financial institutions have also expanded into Rwanda. A Source: Various Countries FinAccess surveys. Kenyan based insurance company, Phoenix of East Africa, and several Kenyan stock broking firms have opened offices Table 2: Regionalized Banking Operations in the EAC in Rwanda. The integration of the EAC stock exchanges is planned, but at present only cross-listing of shares is already Tanzania Rwanda Burundi occurring: two Kenyan companies, KCB and National Media 2011 Uganda Kenya Group are listed on the Rwanda Stock Exchange and on other EAC stock exchanges. Barclays (UK) The effect of new regional entries into Rwanda’s financial Bank of Africa (Mali) system has so far been positive. The new entrance Citigroup (USA) energized the banking sector in rethinking their strategies Diamond Trust (Kenya) to retain market share, especially through: (i). improved communication; (ii). introducing new products; and, (iii). Ecobank (Togo) expanding their networks. Banks are transforming existing Equity (Kenya) business models through innovation in agency and mobile Fina Bank (Kenya) banking, in order to provide services to the currently under- Kenya Commercial Bank served population, and to reduce the cost of mobilizing retail (Kenya) deposits. The retail market is still largely served by Banque Standard/Stanbic Populaire de Rwanda, but it is beginning to be contested as (South Africa) competition has led banks to expand their branch networks. Source: Various Bank websites. 7 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments Table 3: Rwanda’s Food Balance Sheet is Positive 2010A 2010B 2011A 2011B 2012A I. AVAILABILITY = 1+2+3+4 1,379 1,404 1,418 1,547 1,390 1. Stock - 7 10 - - 2. Crop production 1,529 1,467 1,564 1,707 1,687 2. Expected Crop production C n.a. 81 n.a. n.a. n.a. 3. Animal production 79 81 79 95 40 4. Losses -229 -232 -235 -256 -337 II. NEEDS = 5 1,228 1,246 1,290 1,308 1,264 5. Consumption 1,228 1,246 1,290 1,308 1,264 III. Balance/Deficit = I-II 151 158 128 239 126 Source: Ministry of Agriculture. public expenditure through Government’s flagship percent. However, compared to other EAC countries, agriculture support programs, and beneficial rains it is modest (Figure 8a). Overall, headline inflation especially during the second agricultural season. climbed from 5.8 percent in June 2011 to 8.3 percent in However, food crop prices remained high throughout December 2011, from historic lows in the last quarter 2011, especially for cereals (being 20.5 percent of 2010. Average inflation also increased to 5.7 percent higher in December 2011, than December 2010). in 2011 compared to 2.3 percent in 2010. Inflationary This had likely eroded households’ purchasing power, pressure built up nearly uninterrupted in 2011 due to: particularly impacting vulnerable and low-income (i) steady increases in local food prices which pushed households, given their high reliance on food markets. up all food prices (ii) hikes in international fuel prices which led to increased domestic fuel prices (the latter 1.3 MONETARY POLICY AND INFLATION also reflecting the pass through effect of transport- related costs, (iii) rising core inflation as Central Bank TRENDS delayed the increase in its policy rate and continued Inflation tended up during 2011, amid the sharp increase in global food and oil prices. In the first quarter of 2012, it remained high at an average of 7.9 to finance the fiscal deficit through monetization (Box 3).8 However compared to its neighbors, inflation remained low and in single digits. Figure 8: Inflation Was Moderate Compared to Rwanda’s Neighbors, But at its Highest Level Since 2009 Overall inflation, percent Percentage point contributions to Inflation 35.0 10.0 9.0 8.3 8.3 8.2 7.8 7.9 7.8 8.0 7.5 7.4 7.2 6.9 7.1 25.0 6.6 7.0 6.1 5.9 5.6 5.8 5.9 5.7 6.0 5.7 5.0 5.0 5.0 4.5 4.5 15.0 4.2 4.1 4.0 3.0 2.7 2.5 2.6 3.0 2.1 2.0 2.0 1.5 5.0 1.1 1.0 0.2 0.2 0.2 0.0 M 11 M 12 Fe 1 No 10 Ju 0 Oc 1 11 12 M 10 Ja 1 Ap 0 Au 0 Ap 2 Se 9 M 10 10 Se 1 11 M 1 No 1 Ap 1 Ju 2 Fe 0 Au 1 Ju 1 Se 0 De 0 Oc 0 12 Au 9 No 9 De 9 Oc 9 Ja 9 Ja 0 M 12 1 -1 1 1 -1 l-1 -1 0 1 1 t-1 -1 -1 1 l-1 -1 1 1 1 l-0 t-0 0 0 0 1 r- b- n- t- p- n- n- b- c- g- r- n- g- v- b- n- g- v- p- n- v- p- c- c- r- ay ar ar ar ay ay Ju Ju Ju Fe De -5.0 Rwanda Kenya Uganda Tanzania Burundi Food Energy Others Headline Core inflation Source: EAC Statistics Offices and BNR. 8 Over the first nine months of 2011, the Government had to maintain high overdraft levels at Central Bank and also sell a large amount of domestic security instruments in order to cover priority expenditures. Rwanda Ecomomic Update | Edition No. 3 8 Recent Economic Developments Box 3: Inflation Trends as a Result of Global Fuel and Food Price Trends D omestic fuel prices have been frequently reviewed in 2011 (Figure 9). In the first half of 2011, prices were raised three times by a cumulative 11.3 percent, and 12.1 percent respectively for petrol and gasoline, in response to world oil market developments. In the second half, domestic fuel prices were revised downward, twice by a cumulative 5.7 percent, subsequent to the first cut of fuel excise taxes in July 2011. After the second cut, in January 2012, fuel prices were reduced by 6 percent, but this lasted only for one month. As of May 2012, fuel prices were revised upwards, twice, due to increases in international prices at the beginning of 2012. Food prices remained high in the second half of 2011, driven by local food inflation (Figure 10). This is partly due to the high weight of local food prices in the consumption basket. As at the end of 2011, food inflation stood at 11.2 percent, from negative 2.7 percent a year ago. Prices of locally produced foods were 10.4 percent higher than a year ago and prices of imported foods were up 15.9 percent. Overall, prices of cereals (mostly rice) were the major driver of food inflation in 2011. During the first three months of 2012, food prices continued to rise, and as of March, they stood at 15.4 percent, but eased off in April at 12.8 percent. Figure 10: Prices for Locally Produced Foods Put Figure 9: Domestic Retail Fuel Prices Pressure on Food Inflation Rwf/liter US$/bbl 1,200 120.0 16.0 12.0 1,100 110.0 8.0 Percent 4.0 1,000 100.0 0.0 900 90.0 -4.0 11 2 11 12 11 1 11 1 12 1 12 11 11 2 2 1 11 10 1 -1 -1 l-1 -1 r-1 -1 t-1 11 r-1 De 1 p- 1 No 1 n- n- Ap 2 10 n- M 2 g- Ju 1 b- n- 12 11 11 Ju 2 v- c- 11 M 2 Ap 1 11 12 1 b- c- 11 ar ay 1 ar ay l-1 t-1 -1 r-1 -1 Ju -1 1 -1 r-1 c- Au Ap Se Oc Ja Ja Ju De v- No Fe Ju De Ap Fe c- n- n- M g- p- b- n- n- M b- M ar ay M ay ar Ju Oc De Au Se Fe Ja Ja Fe M M Premium (Rwf) Diesel (Rwf) World average Price (US$/bbl) Local food Imported food Overall food Source: Ministry of Commerce and World Bank Development Economics Source: BNR. Note: In 2011, the annual average exchange rate was Rwf600.29/US$. Core inflation continued to rise in the second half of Figure 11: Core inflation Remained Above Headline Inflation until December 2011 2011 (Figure 11). Core inflation, which excludes fresh products and energy prices, rose from 5.8 percent in 10.0 June 2011 and peaked at 9.0 percent in September 2011 (Box 3). It exceeded headline inflation for the 8.0 whole second half of 2011 (Annex 1). By end-June 6.0 2011, the margin between the policy rate, the Key Percent Repo Rate (KRR) and core inflation was less than 4.0 0.5 percentage points and negative since July 2011 Core inflation exceeded headline inflation (Figure 13). By applying the Taylor Rule (Annex 2), a 2.0 retrospective review shows that the Central Bank— Banque Nationale du Rwanda (BNR)—might not have 0.0 Ap 2 11 Ju 1 11 12 11 11 Ap 1 12 1 De 1 12 11 Ju 2 M 2 M 1 1 0 M 1 -1 -1 -1 l-1 1 -1 r-1 1 t-1 -1 r-1 p- n- n- g- n- b- v- n- c- exhausted its potential policy space to rein in inflation b- ar ay ar ay c Ju Au Se Oc Ja Ja No Fe De Fe M Core inflation Headline inflation (Figure 12). Source: BNR. 9 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments Figure 12: Historic Monetary Response to Figure 13: Deposit Rates and Short-term Interest Rates Inflationary Pressures Were Negative in Real Terms Interest rates, percent 30.0 10.0 25.0 7.5 8.0 7.0 6.5 6.0 20.0 6.0 Percent 4.0 15.0 2.0 10.0 0.0 5.0 2.0 0.0 4.0 M 1 Ja 1 Ju 2 De 0 M 2 12 Ap 2 Ju 1 Se 1 11 De 1 Ja 0 M 1 Ap 1 11 Oc 1 M 2 No 1 r-1 12 1 1 -1 -1 1 -1 -1 1 1 1 1 -1 1 r-1 t-1 l-1 c- b- n- g- n- v- c- b- n- p- ay v n- ar ay ar No Au Fe Fe Ju Est. policy rate Actual Policy Core inflation Nominal KRR Real KRR Real tbills rate Real deposit rate Source: BNR and World Bank Staff calculations. Source: BNR. According to the Taylor rule, monetary policy in this period (February 2007 to May 2009) the policy the second half of 2011 should have been more rate was consistently lower than suggested by the responsive, and tightened more, in order to curb rising Taylor rule. This might also explain the reason for a inflation.9 By May 2011, the KRR became negative long period (26 months) of core inflation in double in real terms, but BNR only lifted it by a cumulative digits. Similarly, throughout the second part of 100 basis points, between October and December 2011, when core inflation was on the rise, policy and 2011 (Figure 13). But this delayed move was also not deposit rates became negative in real terms. Private sufficient, as the core inflation remained high, and credit expanded sharply, and credit growth peaked the KRR negative. Core inflation remained high due at 31.0 percent in October 2011. BNR also intensified to second-round effects of food and fuel prices hikes, money market operations (such as repos and treasury and ended the year at 8.3 percent, equaling headline bills sales), to withdraw the excess liquidity from inflation. Going into 2012, the only policy that had a the banking system, but credit to the private sector noticeable effect on core inflation was the second fuel continued to rise. To avoid a similar situation as tax cut. In January 2012, the Government reduced experienced in 2008-2009, BNR should be vigilant and fuel excise taxes by Rwf50 per liter for both petrol and consider a proactive monetary policy stance. gasoline, (following the first reduction in July 2011), as the second phase of a total of Rwf100 excise tax In 2011, interest rate spreads remained high, reduction called for in the 2011/12 budget. Core indicating robust profitability for commercial inflation eased off to 5.3 percent in March 2012, and banks. The level of banks’ interest rate spreads reached 3.7 percent in June 2012. was persistently high in 2011, and only retracted slightly during the course of the year (Figure 14). The In the second half of 2011, monetary indicators average spread by the end of 2011 was 9.0 percent, developed signs similar to the pre-2009 liquidity compared to 10.2 percent a year ago. Behind this crunch. The 2009 liquidity crisis occurred after small decrease lay increased competition among a prolonged period of loose credit conditions, commercial banks for loans. In addition, it reflected combined with double digit core inflation. This was the behavior of institutional depositors, who were exacerbated by the withdrawal of bank deposits by pushing commercial banks for higher returns on their large depositors in mid-2008, leading to a mismatch deposits citing rising inflation and the increased KRR. between credit and deposit growth (Annex 3). During 9 This was the case between May-December 2011 when the policy rate was consistently lower than the rate that would have been suggested by the Taylor rule as appropriate to curb inflationary pressures. Rwanda Ecomomic Update | Edition No. 3 10 Recent Economic Developments Figure 14: Interest Rate Spreads Only Varied by a Small percent higher than the level of December 2011, Percentage During 2011 and 18.6 percent higher than a year ago. New loans disbursed in the first quarter of 2012, almost doubled to Rwf117.1 billion compared to Rwf60.9 billion during the same period a year ago. Figure 15: Money Market Operations Source: BNR. The persistent dominance of commercial banks in money market securities also supports the notion of more room for monetary policy (Figure 15). The share of money market securities held by commercial banks increased to 98.8 percent as of December 2011 Source: BNR. (from 88.3 percent a year ago). At the same time, the share of securities with maturity greater than three Looking forward, it would be critical for BNR to be months increased too. In the second half, treasury proactive in mitigating inflationary risks which could bills with greater than three months maturity arise from high increases in international commodity averaged 32.7 percent, of total outstanding money prices, such as food and fuel prices. As of now, there market operations, compared to 25.1 percent in 2010. is limited room for a fiscal policy response—as part Overall, the stock of money market securities stood of the 2012/2013 budget—since the Government has at Rwf160.9 billion in December 2011, 18.9 percent already given up almost 0.7 percent of GDP in revenue higher than a year ago. This hints to ample domestic collection, due to fuel tax reduction measures taken liquidity in the financial sector which allowed banks to lower inflationary pressures in 2011/2012. In early to invest in longer term securities in addition to the May 2012, BNR raised the policy rate by 50 basis large increase in new private credits. New loans points, in view of continued high food and oil prices, increased by 29.2 percent to Rwf339.0 billion in 2011. declining prices for Rwanda’s main export products, In the first half of 2012, the financial sector continued and weak performances of domestic food production to experience plentiful domestic liquidity. As of June in Season A, following adverse weather conditions. 2012, the stock of money market securities was 33.6 11 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments Box 4: Exchange Rate Trends A fairly stable nominal exchange rate against the US dollar and rising inflation, led to a real appreciation of the Rwanda Franc in the second half of 2011 (Figure 16). The Rwandan franc (Rwf) remained reasonably stable against the US dollar in the second half of 2011, depreciating by only 0.3 percent. The Rwf continued to appreciate against other EAC currencies, except for the Burundian Franc, early in the second half of 2011, but the trend had reversed over the last two months of 2011. The Rwf started depreciating against all EAC currencies as inflationary pressures were easing off in these countries. However, the Rwf appreciated against other currencies of trading partners used in the computation of the real effective exchange rate. By December 2011, the weighted nominal bilateral exchange rate of ten major trading partners had slightly appreciated by 2.2 percent. Overall this resulted in an appreciated Rwf in real terms in the second half of 2011.In 2012, the Rwf continued to be stable against the US dollar and it depreciated slightly by 1.5 percent as of mid-July, 2012. Compared to other EAC currencies, the Rwf depreciated, except for the Burundian Franc. Figure 16: The Rwf Appreciated in Real Terms Jan 2005 = 100 105.0 Nominal Effective 100.0 95.0 90.0 85.0 Real Effective 80.0 75.0 1 12 11 2 11 2 11 2 11 12 11 1 1 11 11 1 1 10 -1 -1 r-1 -1 l-1 r-1 -1 t-1 n- b- n- g- p- b- c- n- v- ay c- ay ar ar Ju Ap Ap Oc Ja De Au Fe Ja No Se Fe Ju De M M M M Real Effective Nominal Effective Source: BNR and World Bank staff calculations. 1.4 FISCAL TRENDS expenditure to 48.4 percent of the 2012/13 budget from 46.0 percent in 2011/12. The domestically T he fiscal deficit of the fiscal year 2011/12 which concluded on June 30, 2012 was revised downward by 0.4 percentage points of GDP during financed component of the capital budget is expected to decline. Recurrent expenditures are projected to remain at almost the same level as in 2011/12, but the mid-term budget review. The revised budged with some changes within the envelope. Following was approved by Parliament in December 2011. The approval of the Government’s Pay and Retention overall expenditure envelope was revised downward. Policy in January 2012, wages and salaries are planned Total expenditures were projected to decline to 26.9 to increase by 0.7 percent of GDP, while the cost of percent of GDP, due to a delay in the execution of goods and services is projected to decline by 1.0 capital expenditures. On the revenue side, the loss percent of GDP. resulting from the fuel tax reduction is projected to be more than offset by one-off non-tax receipts from the The Government is planning on financing the fiscal sale of Government assets. deficit by increasing domestic borrowing following a permanent loss in non-tax revenues. Domestic The fiscal deficit is expected to widen in 2012/13 revenue collection is projected to increase with on account of increased capital expenditure (Table improved collection of taxes on goods and services. 4). Total expenditures including net lending are Non-tax Revenues are projected to decrease with projected to increase by 1.2 percentage points of GDP the permanent loss of dividends from Government to 28.1 percent of GDP. A major increase in projects assets sold in the previous fiscal year. Exceptionally funded by foreign capital is planned, pushing capital high levels of non-tax revenues during 2011/2012 Rwanda Ecomomic Update | Edition No. 3 12 Recent Economic Developments Table 4: Government Budget 2009/10 – 2012/13 (Percent of GDP) 2011/12 budget 2012/13 2009/10 2010/11 Original Revised Budget Revenue & Grants 25.1 25.0 25.0 25.1 25.4 Domestic Revenue 12.6 14.0 13.6 13.8 14.0 Tax revenue 12.1 13.4 12.9 12.7 13.5 Direct taxes 4.8 5.2 5.4 5.0 5.4 Taxes on goods and services 6.3 7.1 6.4 6.6 7.1 Taxes on international trade 1.0 1.1 1.2 1.0 0.9 Nontax revenue 0.5 0.6 0.7 1.1 0.5 Grants 13.2 11.0 11.4 11.3 11.4 Budgetary grants 9.1 6.2 6.7 6.8 6.2 Capital/Projects grants 4.1 4.7 4.7 4.5 5.1 Total expenditure 25.9 27.9 27.1 26.9 28.1 Current expenditure 14.8 14.9 14.6 14.5 14.3 Wages and salaries 3.4 3.5 3.3 3.2 3.8 Purchase of goods and services 3.4 3.5 3.6 3.6 2.7 Interest payments 0.5 0.4 0.4 0.4 0.4 Transfers 5.8 5.6 5.6 5.5 5.6 Exceptional expenditures 1.7 1.9 1.7 1.9 1.8 Capital expenditure 10.2 12.4 12.6 12.4 13.6 Domestic 5.1 6.2 6.1 6.1 5.8 Foreign 5.1 6.2 6.5 6.3 7.8 Net Lending 0.9 0.5 0.0 0.0 0.2 Change in arrears -0.4 -0.3 -0.2 -0.3 -0.2 Overall deficit -0.5 -3.2 -2.6 -2.2 -2.9 Note: Fiscal data presented in this table differs from the Government budget posting on the MINECOFIN website (http://minecofin.gov.rw/library/budgetfinalversion/) in the following ways: starting 2012/13 the budget law proposes to reclassify receipts from the UN Peace Keeping Operations as non-tax revenues, compared to donor grants previously. This reclassification would lead to a projected increase in domestic revenues to 15.2 percent in 2012/13. Grants would be projected to decrease to 10.4 percent of GDP in 2012/13. Source: Rwandan Authorities and IMF staff estimates. Figure 17: The Fiscal Deficit (incl. Grants) is Expected to were the result of one-off non-tax receipts from the Increase in 2012/13 sale of Government assets (including a new telecom Percent of GDP 4.0 license which brought in the equivalent of 0.7 percent of GDP). Grants are projected to remain at the same 3.0 levels as in 2011/12. However, there are some shifts 2.0 planned in the composition: an increase equivalent 1.0 to 0.6 percent of GDP is expected in capital/project 0.0 - 0.5 grants, while budgetary grants are projected to 1.0 -2.2 -2.6 -2.9 -3.8 decline by roughly the same amount in 2012/2013. 2.0 The planned increase in total revenues will not be 3.0 enough to cover the expansion of public expenditure, 4.0 2009/10 2010/11 2011/12 2011/12 2012/13 thus widening the fiscal deficit from 2.2 percent of original revised budget budget budget GDP to 2.9 percent in 2012/2013 (Figure 17). Fiscal balance Net Foreign Financing Net Domestic Financing Source: Ministry of Finance and Economic Planning (MINECOFIN). 13 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments In order to sustain the level of capital spending needed 1.5 EXTERNAL SECTOR PERFORMANCE WITH for supporting economic growth, the Government A REGIONAL PERSPECTIVE will need to raise higher domestic revenues and carefully plan recurrent expenditure, including the roll- 1.5.1 OVERALL TRENDS T out of the Pay and Retention Policy. As a result of the he current account deficit broadened in 2011, introduction of EAC Common External Tariff in 2009, despite higher transfers and strong growth in an increasing share of Rwanda’s imports, especially of exports (Figure 18). Strong growth in exports was not consumer goods, is coming from EAC countries. This enough to cover an increase in the import bill, leading led to a decline in international trade taxes to about to a deteriorating trade balance of 17.4 percent in 0.9 of GDP. Which means that other tax sources have 2011 from 14.1 percent in 2010. Due to rising tourism to be developed to make up for this permanent loss receipts and a large one-off license fee payment for in trade taxes. For 2012/2013, the Government is a new mobile operator, net services and income planning the implementation of a number of new decreased to negative 3.9 percent in 2011. The current tax policy measures: (i). introduce a gaming tax; (ii). account deficit was largely financed by net transfers increase tax rates for imported construction materials in the amount of US$880.6 million. However, these by five percent on average import duties, VAT and higher transfers were not sufficient and the current excise duties; and, (iii). streamline exemptions under account deficit, after transfers, widened to 7.3 percent the investment code. As a result of the increase in in 2011, from 5.9 percent of GDP in 2010. public sector wages and salaries, income tax revenues are also expected to increase. Revenue administration Figure 18: Trends in External Balances measures (i.e. introducing electronic sales registers to Percent of GDP 25.0 limit VAT evasion) are also expected to increase tax 20.0 6.3 3.8 7.7 revenues. These are expected to bolster domestic 15.0 2.3 4.5 3.8 3.5 1.2 revenue by some 0.2 percent points of GDP, to around 10.0 13.3 13.9 14 percent of GDP. In 2012/2013, there will also be 5.0 11.0 11.5 0.0 a new tax regime for small and medium enterprises, -5.0 which is expected to be revenue neutral.10 Other -10.0 medium-term tax policy plans include the broadening -15.0 -13.1 -2.9 -14.7 -14.1 -17.4 of the tax base and introducing a flat personal and -20.0 -4.2 -5.2 -3.9 corporate income tax. -25.0 2008 2009 2010 2011 Trade balance Net Services Net Current transfers Capital account The 2012/2013 budget and the medium-term Financial account Current account balance Overall BoP macroeconomic framework are adequate to support Source: BNR. the Government’s development program. Overall, the Rwanda’s Balance of Payments surplus slightly 2012/2013 budget follows a prudent fiscal strategy, increased in 2011 (Figure 18). The surplus is estimated carefully balancing the need for capital investment to have reached 3.8 percent of GDP (from 1.3 percent with increased efforts in revenue mobilization. The in 2010) on account of higher net current transfers, current 2012/13 budget was approved by Parliament due to increased budgetary grants from donors and on June 27, 2012 and was promptly published on the long term borrowing. Budgetary grants represent web-page of the Ministry of Finance.11 84.1 percent of net transfers, or 9.9 percent of GDP. 10 The new policy groups all SMEs into two categories and applies new rates as follows: (i) a flat tax rate of 3 percent for SMEs with a turnover of Rwf12 to 50million and (ii) annual flat amount for SMEs with a turnover of lesser than Rwf12 million (classified into four bands). 11 The Executive Budget Proposal is presented to Parliament (after Cabinet approval) as part of the Budget Framework Paper, drafts of which are discussed before with Development Partners that provide budget support. The legislative approval and enactment period for both documents is in June. Gazetting as well as web-posting happens on the Ministry of Finance’s external website before the start of the new fiscal year, on July 1. Rwanda Ecomomic Update | Edition No. 3 14 Recent Economic Developments Overall, net current transfers are estimated to have total import bill in 2011. The costs of freight and reached 13.9 percent of GDP in 2011, about 1.5 transportation services further increased, and as a percent higher than the average of the past five years. result, Rwanda remained a net service importer. The Net remittances recovered from the low levels of 2009 overall import bill was equivalent to 34.5 percent of and expanded by 69.2 percent to US$110.2 million in GDP. The import bill continued to expand in the first 2011, from US$65.1 million in 2010. Nevertheless, quarter of 2012, with an increase of 30.5 percent, the overall contribution of net remittances remains compared to the same period a year ago. Contrary to low, about 1.7 percent of GDP in 2011. 2011, in the first quarter of 2012 capital goods were the largest import type (32.2 percent), followed by Export earnings in the first quarter of 2012 increased intermediary goods (28.1 percent) while the share of by almost 30 percent compared to the same period consumer goods declined from 32.0 percent to nearly in 2011, but traditional export products (minerals, 23 percent. Energy goods remained at around 17 coffee and tea) performed less well. Their export percent of total imports. value decreased by 1.2 percent compared to the same period a year ago. Although global coffee prices Figure 19: Export Performance in 2011 Was Strong… declined in the first quarter of 2012, Rwandan coffee Export earnings, million US$ featured higher prices compared to the same period 1000.0 in 2011. This pushed coffee export values up by more 800.0 than 50 percent while, at the same time, exported volume increased only by 3.7 percent. Tin mineral 600.0 export values dropped off by 25.1 percent due to lower global tin prices compared to the same period 400.0 in 2011. Mineral export earnings declined by 3.5 200.0 percent in the first quarter of 2012 as compared to Q1 2011. Tea export values decreased by 6.7 percent 0.0 compared to the same period in 2011 as a result of 2008 2009 2010 2011 lower prices at the Mombasa Auctions and lower Tourism Minerals Coffee & Tea Other services Other goods exported volume in the first quarter of 2012. Overall Source: BNR. export earnings increased on account of re-exported petroleum products to the DRC. Earnings from re- Figure 20: … But Imports Continued to Outpace Export Growth Due to High Energy Prices exported products accounted for 17.1 percent of the Import bill, million US$ value of good exports in the first quarter of 2012; its 1,600.0 share was 1.7 percent in the same period a year ago. 1,400.0 1,200.0 Driven by energy products Rwanda’s import bill 1,000.0 expanded by nearly 50 percent in 2011 (Figure 800.0 20). Consumer goods remained the largest import 600.0 expenditure with 27.1 percent in 2011, albeit declining from 2010. Intermediary goods and capital goods 400.0 continued to be the next largest import categories 200.0 by value, with 25.9 and 22.9 percent of total goods 0.0 2008 2009 2010 2011 imports respectively. But the fastest growing import Capital goods Intermediate goods Energy products Consumer goods Adjustement Tot. good imports category was energy products, which increased Source: BNR. by 66.2 percent and accounted for 17 percent of 15 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments 1.5.2 REGIONAL EXPORTS PERFORMANCE export crops, and the recovery in tourism, which was SINCE THE 2009 CRISIS adversely impacted by the global downturn. In 2010 and 2011, Rwanda registered an average increase of E xport earnings in the EAC region have been on the rise over the last decade, but were deeply impacted by the 2009 global crisis. After registering 26.6 percent in exports earnings, compared to 15.7 percent for the whole EAC region. record increases in export earnings in 2008, all EAC The value of Rwanda’s exports increased substantially states, apart from Uganda, saw their export growth following the 2009 crisis, but remained small as a slip into negative territory during 2009 (Figure 21). share of GDP, especially when compared to other On average, the total export earnings declined by EAC countries. Rwanda’s exports rose by 29.5 percent 6.9 percent, with Rwanda taking the second place from 2008 to 2011, sustained by high demand and (after Burundi) with a 20.4 percent decline. Since high commodity prices for its key export products 2010, exports have rebounded and increased by (Figure 22). However, the percentage of GDP exports 12.8 percent as a result of high international prices remain one of the lowest levels in the EAC region for key export products, such as minerals and certain (Figure 23). Figure 21: EAC Exports Rebounded After Being Deeply The tourism sector is an important source of foreign Impacted by the Global Downturn exchange earnings in the EAC region, and of growing Percent growth, Export earnings importance for Rwanda (Figure 24). In 2011, the 90.0 EAC tourism sector generated almost US$3.5 billion, contributing to more than 15 percent of EAC’s total 60.0 export earnings. Rwanda’s contribution of 29.8 percent was the highest, followed by Uganda (23.4 30.0 percent) and Tanzania (20.1 percent). In Kenya, the tourism sector generated around 9 percent of total 0.0 exports, while transport remained the main service earner (about 15 percent of total export values). In -30.0 Burundi Kenya Rwanda Tanzania Uganda EAC Burundi the tourism sector’s contribution to total 2001 - 07 2008 2009 2010 2011 exports is still low at around 1 percent in 2011. But compared to its neighbors in the region, Rwanda’s Source: United Nations Conference on Trade and Development (UNCTAD). share of EAC tourism receipts is modest (Box 5). Figure 22: EAC Export Value Trends Figure 23: EAC Exports as Percentage of GDP Annual average change, percent Export values, percent of GDP 35.0 30.0 30.0 25.0 25.0 20.0 20.0 15.0 15.0 10.0 10.0 5.0 5.0 0.0 - Burundi Kenya Rwanda Tanzania Uganda EAC Burundi Kenya Rwanda Tanzania Uganda EAC 2001-07 2008-11 2001- 07 2008 -11 Source: UNCTAD. Source: UNCTAD Rwanda Ecomomic Update | Edition No. 3 16 Recent Economic Developments Figure 24: Tourism is Becoming an Important Source of Export Earnings for Rwanda Figure 25: Exports’ Basket Concentration in the EAC Pecent contributions to Exports earnings Her�ndahl-Hirschman Index (HHI) 100 0.8 80 0.7 0.6 60 Percent 0.5 40 0.4 0.3 20 0.2 0 0.1 2001-07 2008-11 2001-07 2008-11 2001-07 2008 -11 2001-07 2008-11 2001-07 2008-11 - Burundi Kenya Uganda Tanzania Rwanda 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Goods Transport Tourism Other commercial services Gov. services Burundi Kenya Rwanda Uganda Tanzania Source: UNCTAD. Source: UNCTAD. Box 5: Rwanda’s Tourism Sector T he tourism sector in Rwanda continued to be the leading export earner in 2011 (Figure 19). Tourism receipts increased in 2011 by 24.9 percent to US$251.8 million, mainly on account of large (18.1 percent) growth in the leisure segment. In 2011, the second export earner was other services, with almost 20 percent of total export value, as a result of the license fee of a new mobile operator, Bharti airtel. The introduction of a single tourism visa within the EAC region could provide Rwanda with a significant increase in leisure tourism. Between 2008 and 2011, Rwanda’s share of EAC region tourism receipts was 7.0 percent, while hosting 18.0 percent of tourism arrivals in the EAC region (Figure 26). Tanzania accounts for the lion share of EAC tourism receipts, 43.3 percent, followed by Kenya and Uganda. Most tourist arrivals in Rwanda originate from the EAC region (38.8 percent) and the DRC (42.7 percent) and come primarily for the purpose of business or visiting friends and relatives (VFR) (Figure 27). Only 4.5 percent of arrivals from the EAC region and the DRC come for leisure. At the same time, leisure tourists generated more than 45 percent of tourism receipts in Rwanda. Figure 26: Rwanda’s Share of Tourism Receipts in Figure 27: Rwanda’s Tourist Arrivals Originate Mainly from the the EAC Region Remains Low EAC Region and the DRC Tourism receipts, average percent share of EAC region (2008-11) Arrivals by Region EAC & DRC, arrivals by purpose 100 100 Rwanda Burundi 7.0% 0.1% 80 80 Kenya 60 60 26.3% Tanzania 43.3% Percent Percent 40 40 20 20 0 0 Uganda 23.4% 2009 2010 2011 2009 2010 2011 EAC DRC Europe Americas Others Leisure Business VFR Others Source: BNR and EAC website. Source: Rwanda Development Board (RDB). 17 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments Rwanda has one of the highest concentrations of its were the main destination countries for remittances export (goods) basket in the EAC region. Measuring within the EAC, averaging more than 95 percent of Rwanda’s export basket concentration with the total inflows. Rwanda accounted for only 3.2 percent Herfindahl-Hirschmann Index (HHI)12 shows that it in total EAC remittances, and 4.4 percent of total FDI has averaged 0.4 between 2008 and 2011 (Figure 25). in the region. It is noteworthy that by 2011, the level Rwanda’s export basket is dominated by traditional of FDI to the EAC exceeded the pre-2008 global crisis exports crops (coffee and tea), and minerals (tin, level (6.6 percent higher than 2007 levels). coltan and wolfram). The category of other goods became a significant export earner in 2011, generating Figure 28: Overall, Remittances and FDI Inflows to the EAC are Still Low… 19.5 percent of the value of total exports, comprising Inflows, percent mainly of informal cross border trade and re-exported 16.0 products (Box 9).13 In total, informal cross border 14.0 trade accounted for 41.0 percent of other exported 12.0 goods and 8 percent of total exports by value in 2011. 10.0 8.0 6.0 1.5.3 ROLE OF PRIVATE INFLOWS TO THE EAC 4.0 R 2.0 emittances and Foreign Direct Investment (FDI) - are still relatively low in the EAC region (Figure (2.0) 28). In 2008-2011, remittances flowing to the EAC 2006 2007 2008 2009 2010 2011 region averaged 13.1 percent of total remittances Remittances EAC/SSA FDI EAC/SSA Remittances EAC/World FDI EAC/World flowing to SSA, and constituted less than 1.0 percent of world-wide remittances. Over the same period, Source: UNCTAD. FDI to the EAC averaged almost 6 percent of total FDI inflows to SSA, and less than 1 percent of the FDI levels in Rwanda are extremely low compared to world-wide FDI. Uganda and Tanzania were the main other EAC countries, although they are an increasing destinations for FDI in the EAC region, averaging more source of investment. From 2006 to 2009, FDI inflows than 85 percent of the EAC total. Kenya and Uganda increased by more than 70 percent per annum, from Figure 29: Remittances and FDI to the EAC Region … and Rwanda’s share is very small compared to its EAC peers FDI inflows, percent share (2007 - 2011) Remittance inflows, percent share (2008-2011) Burundi Burundi Kenya 0.1% 0.1% 8.7% Rwanda 4.4% Uganda Uganda 29.9% 34.9% Tanzania 0.8% Kenya 65.9% Rwanda 3.2% Tanzania 51.9% Source: UNCTAD. 12 The HHI is calculated by taking the square of export shares of all categories in the market: HHI = ƩSi 2 ; i = 1,2, …, n. This index gives greater weight to the larger export categories and reaches a value of unity when the country exports only one commodity or service. 13 Since 2009, the Ministry of Commerce, Central Bank and NISR have been conducting surveys on informal cross border trading. With these survey results, new export products have emerged, such as beans, wheat flour, malt beers, mineral water and livestock. Rwanda Ecomomic Update | Edition No. 3 18 Recent Economic Developments US$30.6 million in 2006 to US$118.7 million in 2009. In 1.6 OUTLOOK AND RISKS 2010 FDI slumped back to US$42.3 million as a result 1.6.1 GLOBAL OUTLOOK of the global economic uncertainty, following the 2009 crisis. In 2011, FDI recovered from the low level of 2010, by more than doubling to US$106.2 million. Over the recent five years, FDI inflows to Rwanda T he World Bank’s Global Economic Prospects report of June 2012 projects global GDP to increase 2.5 percent in 2012, with growth accelerating to 3.0 averaged 1.9 percent of GDP, with the highest level of percent in 2013. Output in the Euro Area is projected 2.3 percent of GDP in 2009 (Figure 30). Measured as a to contract in 2012, reflecting both weak carry over share of Gross Fixed Capital Formation, Rwanda is the and increased precautionary saving by firms and only EAC country where inflows increased from 2008 households, in response to renewed uncertainty. to 2010 (Figure 31). Overall, high-income GDP is expected to expand by only 1.4 percent this year, weighed down by the banking-sector deleveraging, and ongoing fiscal Figure 30: Trends in EAC FDI Inflows consolidation. As these pressures ease in 2013, high- FDI inflows, percent of GDP income country GDP growth is projected to firm to 7.0 what will still be a modest 1.9 in 2013. GDP in low- 6.0 income countries is projected to expand by 5.3 percent 5.0 in 2012. These drags on growth are expected to ease as global growth strengthens in 2013. However, both 4.0 low-income countries’ and high-income countries’ 3.0 GDP will grow less compared to the pre-crisis years 2.0 of this century. 1.0 In the immediate term, tensions emanating from 0.0 2006 2007 2008 2009 2010 2011 the Euro Area are the most serious potential risk. Rwanda Burundi Kenya Tanzania Uganda Assuming that conditions in high-income Europe do not deteriorate significantly, the increase in tensions Source: UNCTAD. is going to mainly affect growth in the Euro Area Figure 31: FDI Inflows to Rwanda Rose Much in 2012. The direct effect on low-income country in Recent Years growth will be minor (in part because there has been less contagion), but increased market uncertainty, FDI inflows, percent of Gross Fixed Investment Formation reduced capital inflows, high-income fiscal and UGA banking-sector consolidation are expected to keep growth weak in 2012. If conditions in high-income TZA Europe deteriorate sharply such that one or more RWA countries find themselves frozen out of financial markets, growth prospects in low-income countries KEN would be dampened. In a relatively orderly crisis BDI that is limited to a few small Euro Area economies, the impact on GDP growth in low-income countries - 5.0 10.0 15.0 20.0 25.0 30.0 would be relatively contained, but were there to 2008 -10 2005 - 07 2000 -04 be a disorderly crisis that extended to several Euro Area countries then the deceleration in low-income Source: UNCTAD and WDI. country GDP growth would be stronger. 19 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments A second downside risk is low commodity prices; A return to more neutral macroeconomic policies with potentially serious consequences for exporting would help low-income countries to reduce their countries which depend on revenues to finance a large vulnerabilities to external shocks, by rebuilding share of their imports and government expenditures. fiscal space, reducing short-term debt exposures, and The recent decline in commodity prices (oil and recreating the kinds of buffers that allowed them to metals are down to 8.4 percent and 4.7 percent in the react so resiliently to the 2008/09 crisis. Currently, last month) attests to the possibility that commodity low-income country fiscal deficits are on average prices could come down sharply in the near future. 2.5 percent of GDP higher than in 2007, and current Such a decline in commodity prices could raise trade account deficits 2.8 percent of GDP higher. And short- deficits and increase Balance of Payments imbalances, term debt exceeds 50 percent of currency reserves in which could dampen growth in respective countries. 11 low-income countries. Should global conditions deteriorate, low-income 1.6.2 RWANDA’S OUTLOOK countries would be hit—making the replenishment of depleted macroeconomic cushions a priority. The resurgence of tensions in high-income countries is a R wanda’s outlook for 2012 and 2013 remains promising: the World Bank projects a growth rate of 7.4 percent in 2012 and 7.7 percent in 2013 reminder that the after effects of the 2008/2009 crisis have not yet played themselves out fully. Although the (Table 5). The main assumptions for the World resolution of tensions is still the most likely outcome, Bank growth forecast are summarized in Box 6. The a sharp deterioration of conditions cannot be ruled outlook for agricultural growth remains positive, out. While the precise nature of such a scenario is due to ongoing prioritized public investments, which not known in advance, low-income countries could allow for continued realization of higher productivity be expected to take a large hit. Low-income countries in the sector. The outlook for the industrial sector is with strong reliance on commodities, tourism, more cautious, as sustaining the growth of the past remittances, or with high levels of short-term debt or year requires continued high mineral export prices, medium term financing requirements, are likely to be an unlikely event, given the growth forecasts in the hardest hit. industrialized economies. On the other hand, ongoing Table 5: Growth Indicators, 2008-2013 (Percent) 2008 2009 2010 2011 2012* 2013* GDP 11.1 6.2 7.2 8.6 7.4 7.7 Agriculture 6.4 7.7 5.0 4.7 3.7 4.5 Food crops 6.2 9.4 4.9 5.0 3.3 4.8 Export crops 28.9 -15.1 14.2 2.7 20.1 1.5 Industry 15.1 1.3 8.4 17.6 12.4 11.4 Manufacturing 5.6 2.9 9.3 8.0 6.3 6.3 Construction 28.1 1.4 8.8 23.6 16.8 14.5 Services 13.8 6.3 9.0 8.9 8.5 8.8 Public expenditure led services 6.6 11.8 12.1 14.4 10.3 11.0 Other services 16.2 4.5 7.9 7.0 7.8 8.0 *Projections Source: NISR and World Bank Staff calculations for 2012 and 2013. Rwanda Ecomomic Update | Edition No. 3 20 Recent Economic Developments public investments in roads and other construction demand for Rwandan goods and services (mainly for activities are expected to continue to contribute tourism, coffee and mineral exports) and a slump positively to growth in construction. Services growth in commodity prices, particularly for minerals; and is expected to be slightly lower than it was in 2011, (iii) lower financial inflows in the form of Foreign as public expenditure-led services are anticipated to Direct Investment (FDI) and remittances. According experience moderate growth. Financial sector services to the recent World Bank’s Commodity Markets are also expected to grow at a slightly slower pace, Review (June 11, 2012), the prices of Rwanda’s main after experiencing dramatic expansion in the previous export products (tin, coffee and tea) have shown a year. Growth in trade and retail services is expected downward trend in the first quarter of 2012 while oil to be more buoyant in 2012 and 2013, on account of and food prices increased. Furthermore, with regard higher consumption, resulting from increased wages to tourism receipts, the planned 50 percent increase and salaries for public servants projected for the in gorilla park fees effective from June 1, 2012, could current and the following budget years. jeopardize revenues in this sector.14 Inflation prospects for 2012 continue to be moderate. The most substantial risk for Rwanda is that its However, the Central Bank needs to be more proactive budget is still heavily reliant on grant financing. While in mitigating inflation trends, and tightening monetary in the previous crisis donors came around to provide policy if needed. Although Rwanda was not directly extra budget support, this is unlikely to happen in affected by the drought in the Horn of Africa in 2011, the current crisis, as many donor countries face fiscal food inflation will need to be carefully monitored as tightening. This would leave the country with limited inflationary pressures in 2011 were mostly driven by and sub-optimal alternative financing options. It domestic food prices. could be argued that high aid flows, as Rwanda has experienced to date, could have an adverse impact on The external outlook is becoming more uncertain. macroeconomic outcomes and inhibit export growth, Rwanda’s experience with the past crisis showed especially if it leads to currency overvaluation. In that it is impacted by global trends through the the past, Rwanda has managed aid flows well by following channels: (i) increased inflationary channeling it to productive public investment and pressures; (ii) a trade shock, due to declining external public services, thus mitigating the risks. 14 Charges for foreign non-residents will increase to US$750 from US50, whereas foreigners residing in Rwanda will be charged US$375 instead of US$250 to trek the gorillas. Rwandan nationals will be charged US$50 up from US$33. 21 Rwanda Ecomomic Update | Edition No. 3 Recent Economic Developments Box 6: Key Assumptions for the World Bank Growth Forecast for Rwanda T he World Bank Rwanda country forecast is based on a sectoral bottom-up approach of projecting growth for 2012 and 2013. This approach differs from the approach used for the joint macro-framework the Government, International Monetary Fund and the Bank discuss and agree on periodically. Information in Annex 4 provides a brief description of the forecasting approach. Agriculture growth is expected to be positive and follow in 2012 and 2013 the trends of previous years. Agriculture is rain fed and Rwanda has experienced delayed but abnormal heavy rains and floods between January and May 2012 which will likely impact crop output adversely at the end of season B. However, substantial past and ongoing public investments in the sector, including in irrigation improvements and productivity increases, are expected to continue to positively impact the growth path. High Government expenditures in the sector are expected to be sustained through continued donor financing of several successful sector projects. Based on these assumptions, an overall positive, but lower than 2011 sector outcome, is projected which would also help ease pressure on domestic food prices. For export crops, it is forecasted that growth will be slowing down, mainly reflecting on the natural two-year coffee cycle and also the likelihood that global commodity prices will retreat from their current record levels, as the global economic environment cools down. Industrial growth is forecasted to remain relatively strong in 2012 and 2013, but with a slightly more cautious outlook. A projected slight slowdown is based on the assumption of retreating mineral prices as global economic activities cool off. It is expected that construction activities for 2012 will remain substantial due to still large ongoing public infrastructure investments, but declining slightly in 2013. Manufacturing is projected to slow down in 2012 due to the impact of high energy and input prices, before starting to benefit from improved global conditions in 2013 and internal infrastructure improvements. As an influencing factor of industrial activity, it is also expected that credit growth will decelerate in 2012 and 2013, which started in the last quarter of 2011, as further tightening of monetary policy is expected to rein in inflation. Growth in the services sector is projected to slightly slow down to more moderate levels in 2012 and 2013. Growth is expected to slightly slow down as public expenditure-led services, which positively impacted economic growth in previous years, are expected to grow at a lower pace. Transport services are likely to be adversely impacted if global fuel prices continue to remain high or increase again. Trade and wholesale services are expected to continue to grow at similar levels as observed in the second half of 2011, when higher income from a good agriculture outturn positively affected growth in this sub-sector. This assumption is based on the implementation of plans for an overall increase in wages and salaries for public servants, (adopted in January 2012) that is likely to impact 2012 and 2013 the most. Previous high growth in the financial sector is expected to slightly slow down, as the sector expanded substantially in recent years and might head for consolidation. Rwanda Ecomomic Update | Edition No. 3 22 Executive Summary PART TWO MAKING THE MOST OF REGIONAL INTEGRATION FOR RWANDA R egional integration can bring about substantive benefits to EAC countries. But will progress on the regional integration front affect all countries in a similar fashion? For example, will integration create the same opportunities and challenges for member countries? It seems like the answer to these questions is no, taking into account the differences among the EAC countries. Three countries are landlocked (Burundi, Rwanda, and Uganda), and two are coastal (Kenya and Tanzania), which in turn impacts the cost of accessing international markets. Size-wise, Kenya’s GDP (Purchasing Power Parity) is similar to Tanzania’s, but is five times that of Rwanda, and almost twenty times that of Burundi. Tanzania has a population density of around 50 people per sq. km, while Burundi’s and Rwanda’s are 325 and 430 respectively. Some countries have important oil (Uganda), and gas reserves (Tanzania), while others are mainly importers (Rwanda). Given these scenarios, it is obvious that the challenges and opportunities created by the regional integration process are diverse for the member countries. Asymmetric benefits will imply that the complementary agenda that countries should follow to maximize the impact of those opportunities, and minimize the challenges of the integration process, should also be different. This part of the Rwanda Economic Update looks into these issues, and gives a focus on how Rwanda can lean on the EAC in order to unlock the benefits of increased regional integration, and perhaps, globalization. It draws on the two World Bank’s reports of Reshaping Economic Geography of East Africa: from Regional to Global Integration (2012) and Defragmenting Africa (2012). 22 Edition No. 3 | June 2012 Making The Most of Regional Integration For Rwanda 2.1 OPPORTUNITIES AND CHALLENGES to Europe, the rest of Africa, or the combination of OF INCREASED EAST AFRICAN ECONOMIC East Asia, South Asia and China (Figure 32). INTEGRATION Figure 32: EAC Trade by Destination T he EAC is the fastest growing economic community in the world. It has grown faster than any other economic community in the last decade, 2.50 EAC Exports to... closely followed by the Association of Southeast 2.00 Asian Nations (ASEAN). The EAC grew at an average of 5.9 percent per year over the last decade, with each 1.50 US$ Billion member country more than doubling its own GDP. 1.00 The EAC also experienced unprecedented population growth – the region grew by 25 percent from 110 0.50 million people in 2002 to 138 million people in 2010, and will reach 200 million people by 2030. The - Intra - EAC Europe Rest of Africa South and East Asia Rest of World region’s high population growth has been close to 3 2008 2010 percent per year over the last two decades, compared Source: WDI 2012. with Sub-Saharan Africa’s average of 2.6 percent. However, significant intra-regional country variations An expansion of intra-EAC trade would generate exist. notable opportunities for the EAC partners:15 Within the EAC, growth has been unevenly • Intra-EAC trade in agriculture would contribute distributed with Tanzania, Uganda and Rwanda to the region’s food security. The production of growing at an average of over 7 percent per year food staples for growing urban markets and food between 2002 and 2010, compared to Kenya and deficit rural areas represents the largest growth Burundi’s 3 and 4 percent respectively. Kenya is the opportunity for regional farmers. Given population largest economy with a GDP of approximately US$ growth and increased urbanization, Africa’s 32 billion in 2010, followed by Tanzania, Uganda and demand for food staples will grow dramatically Rwanda, and finally Burundi with a GDP of only US$ in the coming decade. Indeed, demand in Africa 1.6 billion in 2010. is expected to double by 2020, primarily in cities. But agricultural resources are not allocated equally Total EAC exports are increasing, and so are intra- across EAC countries, or even within them, so regional exports as a proportion of total exports. Total borders often artificially demarcate food surplus exports from EAC partner states grew at an average of areas from food deficit ones. Regional trade 16 percent annually, from US$ 6 billion in 2002 to US$ integration can have a substantial impact by better 20 billion in 2010. Kenya, Tanzania, and Uganda (the linking farmers to consumers across borders, and founding members of the EAC) are the main sources in ameliorating the effects of periodic national food of such growth, in intra-regional exports. However, shortages and increasing global food prices. At the next three years are expected to also witness an this stage, however, regional trade in food staples acceleration of Rwanda and Burundi export growth remains far from free, despite efforts for policy in the EAC (albeit from relatively low levels), and and regulatory harmonization. The arbitrary and both countries are expected to see export growth erratic imposition of barriers (undermines private exceed import growth from 2015 onwards (East Africa sector confidence to invest and distorts incentives Corridor Diagnostic Study, 2011). Intra-EAC trade towards cash crop production away from food (about US$2.2 billion) is currently higher than trade staples. 15 World Bank 2012, Defragmenting Africa. Rwanda Ecomomic Update | Edition No. 3 24 Making The Most of Regional Integration For Rwanda • Intra-EAC trade in basic manufactured goods too many graveled roads that are poorly maintained, and regional production chains would reduce overloaded, and badly managed. Years of very weak unemployment. Trade in basic manufactured goods operating performance due to poor governance, such as plastics, chemicals, paints and cosmetics, organizational deficiencies, revenue inadequacy, construction materials and pharmaceuticals is and underinvestment have led to deficient and in beginning to materialize in East Africa, but high some cases what are, in effect, decapitalized regional transport costs and non-tariff barriers are currently infrastructure networks. Such deficiencies seriously limiting such opportunities. Similarly, prospects for undermine the region’s competitiveness. Freight regional production chains driven by trade in parts costs per kilometer are estimated to be 60–70 percent higher than in the United States and Europe, and components (“trade in tasks�) remain limited and 30 percent higher than in Southern Africa. For the due to trade and regulatory barriers that raise landlocked countries, transport costs can be as high transaction costs and increase uncertainty. The as 75 percent of the value of exports. removal of such barriers would encourage vertical specialization, and the emergence of regional Intraregional trade is also inhibited by regulatory production chains that create employment and and administrative hurdles that inflate transport promote export diversification. cost, causing long delays for freight movements along • Intra-EAC trade in services could have significant the region’s transport corridors. Such movements economy-wide benefits for all EAC countries. suffer from serious delays due to informal stops and Despite significant measurement problems, checkpoints—formal or informal. Trucks are forced to go over weighbridges, either mobile or grounded, to opportunities for expanding trade in services in ensure their compliance with regional axle load and East Africa are becoming increasingly apparent. gross vehicle weight standards. The lack of proper For example, Kenyan firms have become successful equipment and design problems in weighbridges exporters of business, financial and distribution causes congestion and delays. Most often, trucks are services to the region, and Uganda is exporting stuck in long lines. Weighbridges should normally education services to East Africa and beyond. require three minutes for transit. However, according Services offer new and dynamic opportunities to the East Africa Business Climate Index 2008 survey for exports. Services are also important for the of the East African Business Council, trucks on average competitiveness of all sectors including agriculture spend 92 minutes, and some weighbridges occupy and manufacturing given that they provide critical trucks for up to five hours. inputs for most economic activities. Policy makers are beginning to realize the limitations of their High transport costs make East Africa also more services sectors, and the need to open them up distant to the world’s major markets, or “global to imports and foreign direct investment, in order core,� but such distance is not insurmountable as the to increase competition and efficiency. Deeper experience of East Asia’s export success shows. Over regional integration cannot be achieved without the last few years, East Africa has made progress in services liberalization and reform. reshaping its economic geography. The EAC is at the moment one of the most dynamic and advanced But East Africa is still facing challenges to economic regional integration communities in Sub-Saharan integration, especially due to high transport costs. Africa (Box 7). The EAC was reestablished16 by Kenya, Regional connectivity is being hampered by ports Tanzania, and Uganda in 1999 following a gradual with high berth and yard congestion, slow customs institutional convergence that was helped by global clearance, and excessive dwell times for ships; economic and political trends. Burundi and Rwanda limited compatibility of rail systems, poor service joined in 2007. Rwanda considers regional integration reliability (especially at transfer and locomotive as a crucial pillar in its vision 2020, viewing EAC as an exchange points), and low operating efficiency; and opportunity to ease access to the sea in its efforts to 16 A predecessor collapsed in the 1970s, as the partner states diverged in their political and economic paths. 25 Rwanda Ecomomic Update | Edition No. 3 Making The Most of Regional Integration For Rwanda Box 7: Overview of the EAC Kenya, Tanzania and Uganda have a long history of successive regional integration arrangements: • 1927: Customs Union between Kenya, Tanzania and Uganda • 1948-1961: East African High Commission • 1961-1967: East African Common Services Organization • 1967-1977: East African Community • 1993-2000: East African Co-operation • 1993: East African Co-operation • 2000: East African Community The Treaty for establishment of the EAC was signed on 30 November 1999 and entered into force on 7 July 2000 following its ratification by the original three partner states – Kenya, Uganda and Tanzania. Rwanda and Burundi acceded to the EAC Treaty on 18 June 2007, and became full members of the EAC from 1 July 2007. The EAC today is a regional intergovernmental organization of Kenya, Uganda, Tanzania, Rwanda and Burundi with headquarters, and a Secretariat, in Arusha, Tanzania. South Sudan has made an application to join the EAC which is ongoing. The collapse of the EAC in 1977 can be attributed to a number of reasons; including governance challenges, economic imbalances (in part arising from the socialist system in Tanzania and capitalist system in Kenya), political disagreements and an extremely limited dissemination of information. Two reasons stand out, first, the relatively low engagement of stakeholders in civil society, the private sector and amongst EAC citizens in the decision-making and management processes of community integration. And, second, a lack of a dispute resolution process for sharing the costs and benefits arising out of EAC integration. Since 1977, steps have been taken to address some of these problems, including a Mediation Agreement (1984) for determining and diving EAC assets and liabilities, and the agreement for the establishment of the Permanent Tripartite Commission for East African Cooperation (1993). Nonetheless, a number of the above problems remain, and citizen engagement, knowledge sharing, consensus building and economic integration are and will continue to be key components for the success of the EAC today. The EAC, the smallest economic community in Africa, has already made progress. Out of the four planned stages of EAC integration – customs union, common market, monetary union and political federation—the EAC has successfully reduced tariffs on intraregional trade, enlarged to five members and established the customs union with a common external tariff. The common market commenced in July 2010 and will ultimately allow all factors of production to move freely within the region. All five partner states have made commitments to open up and create regional markets in several services sectors and have accepted to remove restrictions on the free movement of workers and on the right of establishment, and to pursue mutual recognition of academic and professional qualifications. An ambitious objective has been set of agreeing a protocol on monetary union in 2012 and a common currency in 2015. Source: EAC Integration Process & Enabling Peace and Security Architecture, Hon. Beatrice B. Kiraso (2009); EAC Secretariat, World Bank (2011) cut transport costs for both exports and imports, and Yet, the EAC is a very heterogeneous group and to reduce high transport costs which impinge on the integration will have asymmetric effects. Several Rwandan competitiveness. economic and social indicators vary substantially within the EAC, for example, the three landlocked The region has advanced the regional integration countries of the EAC (Burundi, Rwanda, Uganda) agenda and is trying to address existing bottlenecks are much more densely populated than the coastal such as: (i). the existence of important non- ones (Figure 33). The next section reflects on these tariff barriers; (ii). the region’s underdeveloped asymmetries and what they imply to Rwanda, in infrastructure; (iii). the lack of harmonized regulations; terms of development policies. and, (iv). the limits to labor mobility in the region. Rwanda Ecomomic Update | Edition No. 3 26 Making The Most of Regional Integration For Rwanda Figure 33: Population Density in the EAC and Selected Comparator Countries, 1950–2050 Population density 900 800 700 600 People per sq km 500 400 300 200 100 0 Burundi Kenya Rwanda Tanzania Uganda China India US Western Europe Source: UN 2011 (medium fertility scenario for 2010–2050). 2.2 RWANDA’S ECONOMIC GEOGRAPHY AND Taking into account that logistic costs can represent REGIONAL INTEGRATION in some cases even 50 percent of the shelf price of the products, would the person set-up business in E conomic geography is the branch of economics which focuses on the location, distribution and spatial organization of economic activities, and was Rwanda, a landlocked country, or settle close to Mombasa (the main port of the EAC) to minimize costs and hence be globally competitive? Clearly, the focus of the Bank’s World Development Report the answer to these questions depends on the type (WDR) 2009. In the context of asymmetric regional of products that the person has in mind (e.g. how integration processes, the 2009 WDR analytical important are transport costs relative to the ease of framework appears particularly appealing as country doing business?), but it should not be a surprise that differences may affect the geography of economic in an integrated EAC, firm location dynamics differ activity in an integrated supranational entity. For from what can be expected in a fragmentized EAC. example, some places like cities, coastal areas, and To a large extent market access is affected by the connected countries-are favored by producers. Thus integration process. to the extent that economic integration contributes to transforming a set of more or less isolated economies According to the WDR market access across into a single economic unit may have dramatic geographic scales (international, national, and local) implications. will determine where economic activity can thrive and thus where firms will locate and generate spatial Consider the case of a Rwandan entrepreneur who transformation. Going one step forward the WDR wants to start a company which aims to satisfy the emphasized three dimensions of markets access EAC market and imagine that borders are not an division, distance, and density (Box 8). issue. Where would the person locate? In Rwanda, where the World Bank’s Doing Business indicators Following this framework, policies within the EAC suggests that opening and running a firm is relatively should consider three elements: easier than in other EAC countries? Or rather, should the person consider locating closer to Nairobi (one of • regionalizing connective infrastructure may help the biggest markets in the EAC) and from there export to reduce economic divisions within the region to the rest of the EAC including Rwanda? Perhaps if it helps the EAC countries to allocate costs and more dramatically, consider the case of another benefits of connectivity more equitably among entrepreneur who aims to export to global markets? themselves; 27 Rwanda Ecomomic Update | Edition No. 3 Making The Most of Regional Integration For Rwanda Box 8: The Three Dimensions of Spatial Transformation Division is the most important dimension internationally. Given the relatively small size of internal markets in many African countries (such as Rwanda), economic integration is critical for achieving economies of scale and generating the agglomeration effects that the continent’s firms need to leverage global demand. Economic production is concentrated in a few world regions—North America, Northeast Asia, and Western Europe—that are also the most integrated. Other regions, by contrast, are divided. Divisions associated with the impermeability of borders and differences in institutions, regulations, and currencies are major constraints to economic activity. Distance matters internationally the most for access to world markets. Distance between areas where economic activity is concentrated and areas that lag is important too. The policy challenge is helping firms and workers reduce their distance from density. The main mechanisms are the mobility of labor and the reduction of transport costs through infrastructure investments. A large and dynamic economy in the neighborhood can help smaller countries, especially in regions distant from major world markets, by reducing their distance to markets. Density of economic activity has been increasing worldwide not only at local and national, but also at international level. There is no good reason to expect economic growth to spread smoothly across space. The experience of successful developers shows that production becomes more concentrated spatially. Similar concentration of economic mass has occurred internationally. Today, a quarter of the world’s GDP can fit into an area the size of Cameroon, and half into the size of Algeria. The policy challenge is getting density right—harnessing market forces to encourage concentration and promote convergence in living standards. Source: WDR 2009. • developing joint targeted interventions, such as Kenya and Uganda), the rest of the bilateral borders establishing economic integration zones (e.g. in have potential to become more accessible. But it coastal areas) may help the East African economy is important to keep in mind that thinner borders to leverage global demand, and to pilot future common institutions in places where they Figure 34: Trade Restrictions as a Barrier to Market Access have a high chance of success. • increasing labor mobility would help to generate important agglomeration effects in the medium to long-term, but also help address critical skill gaps in selected EAC countries in the short-term; 2.2.1 DIVISION AND THE NEED FOR THINNER BORDERS Division refers to market opportunities related to size. To the extent that regional integration is used to start exploiting economies of scale and become more efficient, it can also be used as a bridge to access even bigger markets. Today, there are few very integrated regions with high economic production. But many regions, including in Africa, remain divided. For example, Figure 34 presents a map where the thickness of the borders between countries represents the trade restrictions between these two countries, and while it is apparent that some of the EAC countries have relatively thin borders (e.g. Source: WDR 2009. Rwanda Ecomomic Update | Edition No. 3 28 Making The Most of Regional Integration For Rwanda operate in two directions. Trade facilitation measures from the possibility of specialization. Regional that create opportunities for domestic firms to gain integration can bring about challenges. Take into access to other markets and increase exports, tend account the diverse economic geography of the EAC, to be accompanied by opportunities created for which perhaps is not very favorable for Rwanda. But foreign firms to compete in the local market and in at the same time, autarky for a country like Rwanda some cases (particularly when foreign firms are more is not an option not only because of the need to relay efficient) displace local firms. While in a spatial context on imports for a significant share of the country’s efficiency needs to be seen not only as productive consumed and invested goods, but also because efficiency but also as logistical efficiency, it may be without economies of scale is very difficult become worth considering where firms may have incentives efficient. Regional markets play an important role in to locate. supporting export diversification—one of Rwanda’s key trade policy objectives. Unlike EAC exports The EAC customs union has removed obstacles to outside the region, which are mainly commodities, moving goods within the the region, but non-tariff the bulk of intra-regional exports are manufactured barriers (NTBs) remain, such as discrimination against goods (food products, beverages, cement, etc.)—and landlocked countries’ exports and imports in the ports, some of these could be good candidates for Rwanda’s and police roadblocks on the main land—from land export diversification. locked countries to the ports. Tariffs in the EAC have been reduced dramatically, and the tariffs currently Rwanda’s beneficial climate conditions and recent in force amongst partner states are set out in the success in increasing agriculture productivity Common External Tariff 2007. For effective regional provides it with a good opportunity to become a integration, policy makers must address the border regional food exporter. To dat, informal cross-border barriers. The EAC countries have made progress on trade is dominated by agricultural products (Box reducing NTBs such as quotas or restrictive import 9). A vibrant informal cross-border trade indicates licensing requirements, but other categories of NTBs opportunities for Rwanda, and potential benefits remain. EAC countries need to increase collaboration which could be multiplied with intensified attempts on minimizing the trade restrictiveness of specific non- to facilitate trade by making borders thinner. tariff measures, such as sanitary and phytosanitary measures that address safety and health concerns, However, a more globalized vision of the world and advance the harmonization of standards, as these would dwarf the economic weight of the EAC and measures continue to constrain the daily operations bring a different perspective on the importance of of ordinary producers and traders. size. Figure 36 borrows from the WDR 2009 to show how markets view the World.17 The map suggests NTBs are one of the main obstacles to effective that Africa, perhaps with the exception of South regional integration. Regional efforts would need Africa, currently appears as a very small player, to create incentives for the removal of (selected) and what can make a difference in developing an NTBs, which in turn would not only encourage economy is tapping access in to the big European, US the emergence of regional production chains and or Asian markets. Indeed to the extent that the global productive infrastructure in landlocked countries but and regional integrations are seen as complements, would also facilitate access to the coast, and thus not alternatives, many of the location forces could global markets. be mitigated. Many European, American and Asian countries benefitted simultaneously from regional As a landlocked country of modest size, Rwanda and global integration into the EU and ASEAN. Thus needs to rely on regional integration to start to the EAC countries can also use regional integration as exploit economies of scale and potentially benefit a stepping stone for competing globally. 17 The cartogram was developed using a method developed by Gastner and Newman (2004). The map shows the countries that have the most wealth when GDP is compared using currency exchange rate. This indicates international purchasing power–what someone’s money is worth if spent in another country. 29 Rwanda Ecomomic Update | Edition No. 3 Making The Most of Regional Integration For Rwanda Box 9: Rwanda’s Vibrant Informal Cross-Border Trade Informal cross-border trade constitutes a major component of Rwanda’s export base. In 2009, the Government of Rwanda initiated a survey of informal cross border trade at Table 6: Rwanda Trade Balance with Neighboring Countries (billion Rwf) Trade 53 formal and informal border crossings. On monthly basis, Year Type Exports Imports Balance the survey takes place led by the BNR. The surveys indicate Formal 14.5 133.0 -118.5 that informal cross border trade is a significant and growing component of Rwanda’s export base. In 2011, informal cross 2010 Informal 28.0 25.0 3.0 border exports accounted for 15 percent of total exports, Total 2010 42.5 158.0 -115.5 higher than tea exports (Rwanda’s third largest export). Formal 31.6 162.0 -130.4 2011 Informal 33.0 11.5 21.5 Informal cross-border trade makes an important contribution to reducing Rwanda’s trade deficit. While Total 2011 64.6 173.5 -108.9 Rwanda ran a formal trade deficit with its four neighbors Source: MINICOM, Draft Cross-Border Trade Strategy. (DRC, Burundi, Uganda and Tanzania) in both 2010 and Figure 35: Types of Informal Cross Border Exports 2011, informal trade Rwanda ran a trade surplus in 2010 and Clothing Other in 2011 (Table 6) and combining formal trade with informal Machinery 4% 4% Contruction 1% 4% cross-border trade shows a reduction in the trade deficit for 2011. Over 50 percent of total informal cross border exports are traded with the DRC because of big bordering urban Livestock cities (Goma and Bukavu) with over 800,000 people living in 24% each city and nearest to Rwanda. Agricultural products represent the large share of Rwanda’s informal cross border exports (Figure 35). Agricultural products account 51 percent, followed by livestock (24 Food & Beverage percent) and re-exports of paraffin (11 percent). Locally Fuel 51% produced foods and beverage are mostly traded goods with 12% the DRC, Burundi and Uganda, predominately composed of agricultural products. Source: MINICOM, Draft Cross-Border Trade Strategy. Figure 36: How Markets View the World Source: WDR 2009. Rwanda Ecomomic Update | Edition No. 3 30 Making The Most of Regional Integration For Rwanda It might seem that if the EAC is considered as an 2.2.2 REDUCING DISTANCE TO MARKETS AS A isolated entity, the division dimension of economic WAY OF IMPROVING ACCESS transformation may not play to the advantages of Rwanda. Yet, a broader view of development forces Distance, understood in economic terms as the cost which put the EAC in a global context may qualify the of moving goods and services, complements the previous assertion, particularly for firms with a global discussion on division in the previous section. For vocation. Moreover, the possibilities of thriving in example, it costs US$4,800 to transport a container isolation for a small land locked economy appears to from Mombasa to Kigali by road (East Africa Corridor be very limited. Diagnostic Study, 2011), compared to the US$ 1,000 which is the cost of transporting the original Indeed, Rwanda is already diversifying its export container from Japan to Mombasa. Thus regardless market away from the EAC region and traditional of the kilometric distance between Kenya and Japan, European markets (Figure 37). In 2001-2007 about and Kenya and Burundi, in economic terms Kenya is 40 percent of Rwanda’s exports were destined to the closer to the Asian country than to the EAC partner. EAC region, but by 2008-2010, exports to the EAC Not surprising, a key policy challenge for the EAC is accounted for only 25 percent. The proportion of to help firms to reduce their distances to markets, exports to the EAC market has been declining with and this would call for a reduction of transport costs the expansion into other markets, such as Asia and through infrastructure investments, in particular, other African countries. However, Kenya remains the along the two main transport corridors to the ports main destination for Rwanda’s exports, due to the of Mombasa and Dar-se-Salam (Box 10). However, fact that one of Rwanda’s main export crops, tea, is better infrastructure and regional interconnectivity sold at the Mombasa Auctions. Tea export earnings is unlikely to benefit all EAC partners in a similar averaged almost 20 percent of Rwanda export values fashion, nor will it resolve all NTBs’ challenges (see in 2008-2011. On the import side, the EAC region previous section). For Rwanda, good infrastructure continues to constitute a large source of Rwanda’s and connectivity alone may not necessarily attract imports. Since 2007, imports (in value) from the EAC major manufacturing industries, but the country region have been steadily increasing, and are now could greatly benefit from cheaper imported goods second to imports from Asia. While Rwanda’s imports for consumers and inputs for potentially smaller from Burundi and Tanzania are mainly food and live supplier industries. animals, Rwanda’s imports from Kenya and Uganda are dominated by manufactured products. Infrastructure connectivity is particularly critical for Figure 37: Rwanda is Increasingly Diversifying its Export the landlocked countries of the EAC, as both trade Market Towards other African Countries and Asia flows within the EAC and with external markets Export market, percent EAC are affected. Rwanda has a much greater economic 40.0 distance compared to the coastal countries to major global markets, because transport by sea is much less Others Africa, others expensive than by land or air. The coastal countries 20.0 are responsible for investments in infrastructure facilities used by firms in landlocked countries, which - partly explains why, despite recent improvements, there is underinvestment and poor physical quality Americas Asia of connective, or cross-border, infrastructure. One reason which partner states do not always honor their obligations, is that officials have few incentives to delegate responsibilities to the EAC, even when it is Europe, others Euro Zone in the common interests of all the states. No regional 2003- 07 share 2008-10 share entities have the authority to compel officials: these Source: UN COMTRADE and World Bank staff calculations. 31 Rwanda Ecomomic Update | Edition No. 3 Making The Most of Regional Integration For Rwanda Box 10: Northern and Central Transport Corridors of East Africa T here are two main transport corridors in East Africa which link the main land and the two major ports at the Indian Ocean. The Northern Corridor (anchored by the port of Mombasa in Kenya) and the Central Corridor (anchored by the port of Dar-es-Salaam in Tanzania) are the principal transport routes for national, regional and international trade for the EAC. The Northern Corridor is the busiest and most important transport route, providing a link through Kenya to the landlocked economies of Uganda, Rwanda, Burundi and DRC. An alternative transport network serving the landlocked Great Lakes Region is the Central Corridor through Tanzania. The 1,400 km-long corridor uses lake transport on the Lake Tanganyika to Kigoma in Tanzania, and then road or rail to Dar- Es-Salaam. A third option - through the DRC from the Angola port of Lobito is currently non operational. Another option is the Deep South route, through Zambia, Zimbabwe and South Africa. This corridor uses lake transport on the Lake Tanganyika to Mpulungu in Zambia, and then road transport, or a mix of rail and road transport, to Durban in South Africa. This option is too far from the Great Lakes countries. The EAC has corridor authorities, one for the Northern and another for the Central corridor, to address issues on transport regulation and policy harmonization, but they are not fully effective. Transport corridor operations in East Africa are still characterized by long transit times and high costs, making transport cost a high share of the value of exports. Modernization of transport infrastructure and removal of non-tariff barriers along these corridors is critical for trade expansion, economic growth, increased regional integration in East Africa, but also better connectivity between East Africa and the rest of the World. Source: www.eastafricancorridors.org bodies are weak, without enforcement mechanisms. noncore to their global activities. Individual countries In addition, institutional capacity in partner states in East Africa may well be below this threshold size, is below the global average (according to the World for attracting the interest of foreign utilities and other Bank’s Governance Indicators), though it has generally investors. improved over the last decade. This makes it difficult to remove critical economic divisions discussed in the The region’s infrastructure as a whole may help to previous section. overcome the national size disadvantage. Cross- border infrastructure may therefore yield investment Infrastructure networks exhibit significant benefits which go beyond exploiting economies of economies of scale and scope. Such economies could scale and scope in production. Every strategy for be more fully exploited if the market boundaries of addressing the issue of infrastructure bottlenecks these industries were expanded beyond national should consider the region a single entity, and seek to borders. But in the face of global financial instability facilitate investments on regional rather than national and retrenchment, many multinational utilities lines. Yet benefits from better connectivity through are rationalizing their operations, and are leaving cross-border infrastructure tend to be indirect and countries with small infrastructure markets that are long term, as well as asymmetric across countries. Rwanda Ecomomic Update | Edition No. 3 32 Making The Most of Regional Integration For Rwanda Costs, though, tend to be incurred immediately. the risk of coordination failures (Box 11). The role This mismatch makes it hard for countries to agree of supranational institutions is especially important on the appropriate allocation of costs, especially for when the distribution of the investment burden large projects. Consequently, there is a tendency differs substantially from the distribution of expected for individual governments to under-invest in such benefits. Regional institutions can analyze economic an infrastructure. In addition, because cross-border and financial feasibility, as well as the distributional infrastructure typically extends over several countries, consequences of cross-border infrastructure projects, it also gives rise to potentially important coordination in a non-partisan manner. Thus they could facilitate problems. (In fact, “missing links� in major cross- regional agreements and compensation schemes. border roads are common). Such problems are Regionalizing regulation may therefore help to exacerbated if the project has asymmetric country enhance policy credibility and commitment, and to effects. overcome constraints in technical capacity. Effective joint-EAC transit management, including for Regional special economic zones (SEZ) located cross-border infrastructure will be important, given along the coast would facilitate the partner states the inadequacy of infrastructure networks designed to maximize their potential comparative and for national markets in the face of growing integration, competitive advantages. In particular, coastal SEZs potential underinvestment due to spillovers, and with an objective of making manufacturing more Box 11: Cross-border Infrastructure Challenges L ack of policy harmonization holds back cross-border infrastructure in promoting intraregional trade. Cross- border infrastructure helps to promote intraregional trade only when supported by harmonized regulatory frameworks and administrative procedures—still a work in process in East Africa. Regulations on vehicle dimensions, axle-load limits, road transit charges, highway codes have yet to be harmonized. Even common definitions of road classes and route numbers are missing. Similarly, rail connectivity is gummed up with minimal integration of national technical standards, such as those for building and maintaining railway facilities. Shipping on inland waterways and lakes needs a set of common regulations on ship registration as well as safety standards, including those pertaining to periodic ship surveys, staffing requirements, and aids to navigation and radio communication. Many border crossings have antiquated infrastructure, inadequate coordination between the countries, and congestion. The key problems that plague border crossings have been extensively documented and include excessive documentary requirements and anachronistic official procedures; insufficient use of information and communications technology systems; questionable due process—lack of transparency, predictability, and consistency in customs activities and determinations; unclear demarcation of responsibilities; and lack of efficient cooperation among a country’s customs and other governmental agencies. There are also frequent unwarranted roadblocks and checkpoints. Inspections are notorious for their lack of procedural transparency. Officials regularly deviate from agreed inspection procedures and subject drivers to administrative harassment and extortion. According to the 2008 EAC Business Climate Index Survey, 172,236 days are lost each year as a result of delays at weighbridges, roadblocks, and customs offices, and US$9.8 million is paid in bribes.18 18 The survey comprised interviews with 240 business leaders: Uganda (25 percent), Kenya (21 percent), Tanzania (20 percent), Rwanda (18 percent) and Burundi (15 percent); 140 truck drivers through self completion diaries (collected at the point of exit from the country of departure) and 187 Clearing and Forwarding Agents. 33 Rwanda Ecomomic Update | Edition No. 3 Making The Most of Regional Integration For Rwanda competitive globally, would be helpful for landlocked offering the EAC an opportunity to implement basic partner states like Rwanda to help to reduce their high principles it can learn from the regional integration costs of production and transport, and with relevant successes in other parts of the world (such as the incentives, could in turn attract more investors. This European Union or the East Asian countries) in ways coastal economic integration zone—on or near the which fits the local context. coast, with a port, governed and taxed jointly by the EAC partner states, and with some functions privately 2.2.3 DENSITY AND THE FORCES OF run—could offer prospects of improving the EAC’s AGGLOMERATION business climate and infrastructure. For example, a large fiscal gap faced by Rwanda (and currently Density of economic activity has been increasing covered by donors) is in part due to the fact that it worldwide There is a long tradition in the economic is difficult to attract industries exhibiting substantial literature going back to Adam Smith and Alfred economies of scale (and potentially producing large Marshall which recognizes that areas with a high tax revenues) to a land-locked country. This is because density of firms and workers tend to be more such industries achieve scale by serving large markets, productive. There are several possible arguments and this is much easier to do from the coast. that may explain this observation: (i) sharing facilities: once for example specific infrastructure has been A commercially focused, regionally designed SEZ provisioned there may be a tendency for firms relying could help to ensure that some of the benefits of on this infrastructure to create density in a specific agglomeration are distributed as evenly as possible point; (ii) sharing suppliers: final producers may benefit across partner states. This regional and coastal SEZ from sharing a large common base of suppliers; (iii) could be designed in line with the “wide area� SEZs sharing the gains from individual specialization: larger which generally occupy a surface area greater than markets could contribute to worker specialization and 10,000 hectares, with mixed-use Figure 38: Economic Density in the EAC developments (including industrial, commercial, and real estate), and normally with a resident population. It would function as a new city or municipality. The SEZ would have similarities to two recent economic policy concepts—charter cities19 and early reform zones. The creation of a regional SEZ would help to concentrate many firms in one area. Benefits for the firms would include cutting down transport costs, inter-linkages, providing each other with industrial inputs, leveraging and sharing technology, infrastructure and utilities among others. The key benefit for the EAC partner states is that coastal SEZ would help them to jointly leverage global demand, Source: World Bank staff estimates. 19 Charter cities aim to use unoccupied land to establish a new city that operates outside the existing arrangements of the country, establishing their own tax regimes and legal structures. In this concept, countries can act as host, source, or guarantor: the host country provides the land, source countries provide the residents, and guarantor countries ensure that the charter is enforced. Honduras, for example, recently amended its constitution to allow for charter cities. Rwanda Ecomomic Update | Edition No. 3 34 Making The Most of Regional Integration For Rwanda productivity; (iv) sharing a labor pool: larger markets firm location in the US state of Maine established that may make easier to fill vacancies including through industry agglomeration encourages business location better matching of employers and employees; in 17 out of 54 industries analyzed.20 (v) sharing customers: tapping a bigger customer base that a single firm could face; and (vi) learning: Increasing labor mobility to support agglomeration higher densities can increase the possibilities to effects and to address skills gaps is of particular exchange ideas. Economic density in the EAC tends importance, when considering East Africa’s to concentrate around the Nairobi and Dar Es Salaam aspiration to become a leader in the services areas and to a lesser extent Kampala. Figure 38 shows industry. Services offer not only new and dynamic where economic activity is located in the EAC. The opportunities for exports, but they are also important map also indicates that economic density in Rwanda for the competitiveness of all sectors of economic is quite low (though population density is quite activities, to which they provide critical inputs. high). In this context, and to the extent that density Services have the potential to become an important complements the forces which division and distance source of future growth and agglomeration for creates on a firm’s location, Rwanda may be facing land-locked countries, as they are less impacted by an additional challenge of attracting firms, since they other infrastructure constraints which contribute to have a tendency of locating to high density areas. distance and division. Over the past decade, exports of services from non-oil exporting land-locked countries Economic density can be viewed as economic in Africa have increased, at a rate of more than three opportunity, and to the extent that individuals want times their exports of goods. to get a part of the wealth, they will be ready to migrate closer to it. At the same time, high economic Presently, Rwanda is an important migrant-receiving density areas will also act as attractors of the labor country to develop its rapidly growing services force, to further exploit the benefits of agglomeration. sector (for example, Ugandan health professionals, or It is likely that the EAC will experience in the future, Kenyan and Ugandan financial specialists, engineers important migration flows, between areas of varying and accountants). These inflow of highly skilled EAC economic and population density. professionals, currently addresses important skills shortages and skills mismatches in Rwanda. In the International labor mobility partly depends on formal long-run, Rwanda is likely to be an important source of agreements among countries and on the number migrants, and would benefit from higher labor mobility of borders within a region, but even to a greater in form of reduced labor-market pressures at home, extent, on economic incentives and endowments. suggesting higher wages and lower unemployment Internationally mobile workers go typically to (or both), as well as greater remittances. richer, larger, better educated countries. Educated people are more mobile and more employable, Remittances of Rwandan migrants abroad are allowing all countries in the medium to long term, already becoming a significant source of household to benefit from lower spatial disparities in provision income in Rwanda. According to preliminary results of education and other social services, as well as in of the recent Households Living Conditions Survey human development outcomes. This suggests that (EICV3), the share of private transfers has grown by governments should facilitate labor mobility, and 1.9 percentage points from 4.4 percent in 2005/06 to encourage remittances. In parallel, efforts should also 6.3 percent in 2010/11. Among these private transfers been undertaken to promote the development of are remittances from households who have relatives selected activities, where agglomeration effects (and living abroad. In 2011, inward remittances to Rwanda hence the pull factor behind economic density forces) stood at US$166.2 million, representing 1.8 percent are not that important. For example, a recent study of of GDP. Over the past five years, remittance inflows 20 See http://nercrd.psu.edu/Industry_Targeting/ResearchPapersandSlides/IndCluster.Gabe.pdf 35 Rwanda Ecomomic Update | Edition No. 3 Making The Most of Regional Integration For Rwanda increased by more than 70 percent per annum from 2.3 MAIN RECOMMENDATIONS US$25 million in 2006 to US$166.2 million in 2011. The EAC region is the top source of remittances to U sing the framework of economic geography, this section presents key recommendations for EAC policies for improved regional integration to Rwanda. According to the World Bank, Migration and Remittances Factbook 2011, the largest share (46.3 address challenges with the region’s underdeveloped percent) of remittance inflows in 2010 came from the infrastructure, persisting non-tariff barriers, and EAC region, followed by Europe and North America the lack of harmonized regulations. It also suggests (Figure 39). This corresponds with the fact that most potential benefits to increased labor mobility in the Rwandan emigrants live in EAC countries. By 2010, region. an estimated of 263,641 Rwandans were living out of the country, representing around 2.6 percent of First, regionalizing connective infrastructure may the Rwandan population (World Bank, 2010). The top help to reduce economic divisions within the region, destination countries in Africa for Rwandan emigrants as it contributes to a more equitably allocation were Uganda, Tanzania and Burundi, which accounted of costs and benefits of connectivity among EAC for nearly 80 percent of all Rwandan emigrants. countries. Regionalizing infrastructure should include The main destinations outside Africa were Belgium, two strategic pillars: Canada, France, the United Kingdom, and the United (i) eliminating cross-border infrastructure States. bottlenecks; and, (ii) promoting regional policy harmonization The EAC could increasingly provide institutional (alongside institutional capacity building). support and leadership, to enable labor mobility and to facilitate services liberalization, reform and trade. Obtaining consensus from all governments in One sign of increased regional integration is the East Africa for a regional infrastructure policy and example of Rwanda and Kenya, which have removed regulation, might be problematic due to different work visa restrictions under the Common Market attitudes and commitments toward reform, as Protocol. Yet despite signs of progress, the movement well as concerns about national sovereignty. It of skilled labor and open international competition, will require more cooperation and trust between remains politically sensitive. countries. Initially, regionalization efforts could Figure 39: Remittances to Rwanda The EAC region is the main source of Remittances to Rwanda… … with most Rwandan emigrants living in the EAC NLD, 1.8% Others, 13.2% EAC Emigrants Destination, percent DEU, 1.8% 100 EAC, 46.3% 10.5 7.9 9.7 10.0 19.5 ITA, 2.3% 80 28.9 USA, 4.0% 60 Percent 24.4 78.5 56.1 76.8 83.6 40 BGR, 4.0% 20 38.8 10.1 2.5 4.7 1.7 14.3 FRA, 4.2% 9.3 8.6 0 4.2 Burundi Kenya Rwanda Tanzania Uganda CAN, 5.5% BEL, 16.8% Europe Americas EAC Others Source: World Bank, Migration and Remittances Factbook 2011. Rwanda Ecomomic Update | Edition No. 3 36 Making The Most of Regional Integration For Rwanda focus on promoting regional regulatory cooperation, broad categories. First, commercial and financial as a more realistic option for alleviating scarce mechanisms can establish an effective incentive country regulatory expertise and resources. At the system from the outset, enabling trust. Second, formal start, regional regulatory entities in roads, rail, and institutional approaches to ensure commitment are energy could be established, to facilitate information largely related to legal constraints, and enforcement exchange and offer non-binding advice on technical mechanisms through which to bind parties to matters. Consensus for regional regulatory agencies commitments. Finally, there are informal approaches could then increase as more countries reform, as to align the mutual interests of stakeholders. These gains from regional policy coordination and trade approaches are by no means mutually exclusive— become more apparent, and as countries confront indeed, overcoming the commitment challenge likely the costs and staffing challenges of creating and relies on using all three. maintaining national regulators. Further, both returns and political feasibility of regional infrastructure Finally, increasing labor mobility would help to projects might be improved, if these projects help the generate important agglomeration effects in the coastal economies to improve their access to markets medium to long term, but also help to address and natural resources of inland countries, beyond the critical skills gaps in selected EAC countries in the EAC such as the DRC or Southern Sudan. short term. As noted in the 2009 WDR, the ability of people to move is a good gage of their economic Second, developing joint targeted interventions, potential, and the willingness to migrate appears to such as establishing economic integration zones in be a measure of their desire for advancement. While coastal areas may help the East African economy the government should support labor mobility and to leverage global demand, and to pilot future remittances, this should not be taken as an excuse common institutions in a place where they have a to not facilitate the country’s industrialization. The high chance of success. The report supports a coastal facilitation of development of activities would need to SEZ which would allow all partner states to benefit follow a selective approach to the types of industries from concentrated economic activity, even outside whose development may have important payoffs in their territory. Unlike the EAC, countries or regions countries with low economic density, and where for that leverage global demand for goods generally use a number of reasons, the economic geography is not coastal areas for production, because they are less favorable. Policy makers should take into account that economically distant from the global core, given the not all industries appear to react in the same way to much lower costs of water transport. But there are agglomeration effects. For example, Rwanda appears some risks associated with a transnational SEZ. A big to have a natural comparative advance in services, challenge is in maintaining the commitment of the including tourism, and can serve as a gateway between host government(s) and other partners over the long the Anglophone East Africa and Francophone Central term. This is the challenge of managing the investment Africa. But in order to use this opportunity to become risk—the issue of credible commitment. A government a more service-oriented economy, Rwanda would could, for example, reclaim sovereignty over the zone need to develop over time, the right skills mix in its or put up barriers to the interaction between the zone population, and support agglomeration of services and the national economy. This could be triggered in Rwanda. In the short-run, Rwanda can gain much by political, social, or economic issues in the host from better movement of labor, through the import country, including fiscal crisis, economic or political of service sector skills from the EAC. In the medium nationalism, and elections and subsequent policy and long term, once education and human capital instability. Potential approaches to overcoming the constraints are better addressed, it could become an commitment challenge for the regional SEZ, given the important source of qualified labor migration for the likely asymmetric distribution of gains, fall into three EAC. 37 Rwanda Ecomomic Update | Edition No. 3 Making The Most of Regional Integration For Rwanda 2.4 CONCLUSIONS for three reasons—(i). convergence in economic policies and institutions; (ii). outward orientation of F or Rwanda to make the best of regional integration, it will be important to take into account how division, distance, and density can influence firm economic policies of the landlocked partner states; and, (iii). common security interests—but risks of its integration stalling are greater. location within the EAC. As a small, high density, landlocked country, Rwanda has all the incentives to Convergence in economic (and political) institutions favor an aggressive regional integration process to was among the factors helping to re-establish exploit the opportunities of economies of scale, and the EAC. It is also helping to sustain it: having specialization that can be created by a significantly common institutions and more deeply integrated larger market than the Rwandan. Yet there are also economies, may help to further promote institutional challenges in this strategy, as regional integration convergence, which in turn cements the Community. may lead to a concentration of economic activity in After Kenya, Tanzania, and Uganda attained their the EAC coastal states. In this regard, Rwanda may political independence, the perception that Kenya need to focus on sectors such as services, where was benefiting disproportionately from the regional infrastructure plays a less important role in the trade arrangements became a major stumbling assessment of distance, especially for industries block. Today, an outward shift in priorities toward where agglomeration effects are not that relevant. the greater importance of global markets makes a difference. For the three landlocked countries, access The EAC governments will want to choose integration to international markets depends on transit via policies that are implementable with their national Kenya and (less so) Tanzania. Under these conditions, (and regional) institutions, and gradually scale even if a future Ugandan government, for example, up as capacity and confidence improve. The first thought that Kenya was benefiting too much from the embodiment of the EAC collapsed partly because it trade arrangements, the idea of going it alone would was too ambitious.21 More recently, launching the become much less appealing. customs union before national and regional bodies were ready to remove non-tariff barriers has proven Risks of stalled integration are higher because to be difficult. If integration helps to gradually increase of asymmetric impacts of integration policies. the institutional capacity of the EAC, it would make Economic concentration in the coastal states, and the next steps easier. the consequent reforms to level the playing field in the landlocked partners have asymmetric—and Getting sequencing right will be key for success, but sometimes opposite—impacts. The same issues which also a challenge, because international experience led to the EAC’s collapse in the 1970s—including does not offer any blueprints on regional economic failure to agree to larger redistributive transfers—can integration for the EAC’s circumstances. Limited slow integration, even if they are unlikely to cause capacity in public institutions makes it hard to follow the current Community to disintegrate. The main the European model, and the asymmetry of coastal risk now is of a stalled form of integration in which and landlocked partner states dims the allure of the a common market, although existing on paper, still East Asian model. Optimal sequencing of economic allows substantial barriers to commerce in practice, integration, and design of the safeguards ensuring the an issue of particular concern for the landlocked sequencing’s political sustainability, depend not only countries. These countries depend on access to on the substance of the integration policies, but also the coast through other states, and the cost of this on the risks that the overall process faces. At this stage access depends on both immutable, natural features of integration, risks of the EAC collapsing are limited (distance), as well as those that can be modified by 21 It was predominantly government-driven, while the new EAC expressly confirmed the crucial role of the private sector and civil society: the principles that govern the objectives of the community shall be “people-centred and market-driven� (Article 7 of the EAC Treaty). Rwanda Ecomomic Update | Edition No. 3 38 Making The Most of Regional Integration For Rwanda policy (quality of infrastructure, and secure right of activities exhibiting increasing returns to scale, free passage). However, because African regions are such as high-end manufacturing, are unlikely to divided into multiple states, some landlocked and concentrate in the landlocked countries, some some coastal, coastal states do not fully internalize others, such as agricultural processing, certainly the benefits of policy measures, that improve coastal can—and demand for their output is likely to access for others. To address this problem, the EAC increase, if the coastal economies grow faster. must chart its own course. To facilitate their development, donors—and eventually the EAC itself—can help to invest Development Partners may play a role mitigating in connective and productive infrastructure. some of the asymmetries through some fiscal Investment in the infrastructure helping agricultural compensation. Potentially, the World Bank (and processing in Rwanda and other landlocked EAC others) can facilitate integration, and make it more partner states, should be complemented by politically sustainable by emulating and encouraging enhancing regional specialization in agricultural fiscal pooling in their lending practices. It can do this research, enhancing collaboration in agriculture through policy lending and investment lending. training and technology dissemination and facilitating increased transfer of agricultural • Policy lending to implement the integration policies technology, information, and knowledge across with asymmetric impact on partner states. national boundaries. Potentially, any policy removing economic divisions between the EAC partner states, such as removing • Investment lending for provision of social services. obstacles to labor mobility, regionalizing cross- Incomes per capita and demographic dynamics of border infrastructure, establishing one-stop border the landlocked countries, and reducing disparities posts, or establishing regional payment systems, in provision of social services would mean greater may qualify. This would partially substitute for fiscal investments in landlocked countries. Since a fiscal pooling and help to achieve some of its objectives. pool large enough to reduce disparities in human capital investment per student is unlikely in the • Investment lending for connective and productive short to medium term, development partners may infrastructure of landlocked countries. While need to step up their support. 39 Rwanda Ecomomic Update | Edition No. 3 ANNEXES Annex 1 Annex 1: Consumer Price Index in Rwanda Methodology: The Consumer Price Index (Headline CPI) and the core consumer price (core CPI) are published by the National Institute of Statistics of Rwanda (NISR) and of the Central Bank of Rwanda (BNR) on monthly basis, and are usually released every month by the fifteenth. The core CPI is defined as the CPI excluding fresh food and energy prices. The CPI uses a Modified Laspeyres formula to calculate the index. The reference population for the CPI consists of all households, urban and rural, living in Rwanda. The index reference, or base, for the CPI is February 2009. The household basket includes 1,136 products observed in many places spread all over the administrative centers of all provinces in Rwanda. All kinds of places of observation are selected: shops, markets, services etc. More than 29,200 prices are collected every month, by enumerators of the National Institute of Statistics of Rwanda and of the National Bank of Rwanda. The weights used for the index are the result of the Household Living Conditions Survey (EICV II) conducted in 2005-2006 with a sample of 6,900 households. Table A 1: Disaggregated components in the CPI and the core CPI Weights (percent) Components CPI Core 1. Food and non-alcoholic beverages 35.38 2. Alcoholic beverages and tobacco 2.40 3. Clothing and footwear 3.77 4. Housing, water, electricity, gas and other fuels 22.04 5. Furnishing, household equipment and routine 4.57 household maintenance 6. Health 1.63 7. Transport 11.89 8. Communication 2.88 9. Recreation and culture 2.56 10. Education 3.31 11. Restaurants and hotels 5.58 12. Miscellaneous goods and services 4.00 Total 100.00 78.29 The overall CPI basket can also be classified into three categories: fresh food, energy items and core CPI with the weights of 14.03 percent, 7.67 percent and 78.29 percent respectively. Fresh food category consist of: cereals not transformed and flour, fresh or frozen fish, banana (for fruits, cooking and for beer), bean, fruits and vegetables, potatoes, cassava, tarot, salt, spices and culinary herbs. Energy includes: electricity, gas, liquid and solid fuels and lubricants. 41 Rwanda Ecomomic Update | Edition No. 3 Annex 2 Annex 2: The Taylor Rule Being proposed as a monetary policy for the USA by John Taylor, the Taylor rule exhibits how a central bank should systematically arrange the interest rate as a policy instrument within its macroeconomic activities and during the development of inflation. The rule systematizes the reaction of the monetary policy against prevailing trends of inflation and economic conditions, by using the money market short interest rates as a monetary policy instrument. The Taylor rule calls for a higher setting of the policy rate when inflation is (or is expected to be) high and/or the output is high relative to capacity. Theoretically, the increase/decrease in the policy rate is generally thought of as representing a move toward more restrictive/loosening policy stance, one that tends to reduce/ increase aggregate demand. Taylor rule proposes a simple model that provides the key instrument to the central banks to focus on. it = rt* + πt-1 + α(πt-πt*) + β(yt – yt*) In this equation, while - it: is the nominal federal funds rate (the policy rate), - rt*: stands for the real interest rate (2 percent) - πt the inflation rate, - πt* is the targeted inflation rate, - yt the real gross domestic product (real gdp) yt* is the potential GDP growth. - α and β stands for the responses importance that a central bank gives respectively to inflation and economic conditions while setting the policy rate. Taylor took both as equal (0.5). The sources of Data used for this exercise are: (i) IMF country report for targeted inflation proxied by the period average consumer prices (Selected Economic indicators); (ii) BNR website: monthly inflation and policy rate and (iii) National Institute of Statistics for the GDP growth. The GDP trend was estimated based on the actual GDP. Rwanda Ecomomic Update | Edition No. 3 42 Annex 3 Annex 3: The 2009 Credit Crunch Beginning 2005, the banking sector in Rwanda experienced an excess liquidity position, following the recapitalization of two banks, which were in financial difficulties, and the reduction of the Government’s financing of the budget, through overdraft and commercial bank borrowing (because of higher external funding support since 2004). Banks also still limited lending to the private sector, as they preferred lending to the Government, which led to a limited absorption of prevailing liquidity. As a result BNR had to intervene massively on the money market, with money market and Treasury bill rates decreasing to historic low levels in the first quarter of 2005. In August 2005, BNR introduced the reference rate for money market operations, set at 9 percent and replaced it in August 2008 with the KRR. In August 2005, growth of credit to the private sector was above 30 percent year-on-year and the core inflation was still in single digits. By March 2006, the policy rate had become negative in real terms as core inflation was rising, but high growth in credit to the private sector was continuing. In July 2008 growth of bank deposits declined sharply after the withdrawal of around Rwf8 billion by large depositors in an attempt to diversify their asset portfolio (from savings deposits to more attractive investment outlets such as real estate, government bonds, etc.). Prior to this, a large domestic cooperative network graduated to a commercial bank status in early 2008, and withdrew about Rwf6 billion as deposits from other commercial banks. Growth in credit to the private sector peaked at 37.1 percent year-on-year in November 2008, when the core inflation was at its historic highs, at 22.7 percent. At the same time BNR kept the KRR constant (Figure 12). As a result of the deposit to credit mismatch, deposit rates increased and the market for credit dried up. 43 Rwanda Ecomomic Update | Edition No. 3 Annex 4 Annex 4: Forecasting Sectoral Growth This annex describes the methodology used by the World Bank’s country economic team in Kigali in making a GDP forecast for Rwanda for the next few years. Three important elements were crucial for putting together the GDP forecast. First, a fairly comprehensive database was assembled from available information from the National Institute of Statistics of Rwanda. Second, a large number of indicators relevant in explaining sectoral growth were also compiled. Third, attempts were made to select a set of behavioral relations, that would facilitate forecasting in the short-run. The forecast is based on the national accounts data published by the National Institute of Statistics of Rwanda for past years, which is traditionally presented for a substantial breakdown by sub-sectors. For example, the Rwanda national accounts show five different sub-sectors for agriculture, four sub-sectors for industry, and nine sub-sectors for services. It should also be noted that under industry, manufacturing is further sub-divided into seven sub-sectors. The aggregate national accounts data for the country thus shows nineteen sub-sectors in the published tables. In consideration of the volume of work involved in incorporating forecasts for all these nineteen sub-sectors, it was decided to focus attention on the most important sub-set. Thus, taking into account the weight of each sub-sector in the overall GDP, it was decided to limit the analysis to the following ten sub-sectors: food crops, export crops, manufacturing and construction, wholesale and retail trade, transport, storage and communications, real estate and business services, public administration, education, and other personal services. An important element of the exercise had been to assemble appropriate databases to determine any empirical regularities that can be discovered in each of the ten sectors under study. Thus, a considerable volume of data had been gathered on various indicators closely correlated with developments in a given sector. This body of data can be considered as “leading indicators� of the sectors in question. The other key methodological element in the current exercise had been to capture as far as possible, what may be considered as important regularities in the behavior of the selected sectors of the economy. These regularities (which are largely historical because of the use of time series for the recent past) are assumed to be informative about the future, especially in the short run. However, things could turn out to be quite different from prior expectations. Thus, the methodology relies on a probabilistic approach. While it would have been appropriate and useful to present the forecasts with confidence intervals, the results of the exercise are presented as point estimates purely from the perspective of convenience. The estimation of a number of relationships explaining the behavior of value added in each of the selected sectors was performed. These estimates have to be treated as indicative for several reasons. First, it has not been possible to assemble reliable time series on several key variables. Second, the quality of the assembled data still needs improvement. Third, it has not been possible to conduct the usual tests of the time series properties of the data. Fourth, due consideration has to be taken of technical issues such as omitted variables bias in the estimated equations, and the issue of simultaneity in the system as a whole. The team hopes nevertheless, that a foundation for future work has been laid with the approach taken in the current exercise. Forecasting is rather complex because the future is largely unpredictable. This is more so in the current uncertain global environment brought about by the economic crisis in the major developed countries since 2008, including the US and the Euro zone. As more experience is gained in building information about “leading indicators� for Rwanda and estimation and use of empirical relationships, it is hoped that the present exercise could be improved in the next rounds. Rwanda Ecomomic Update | Edition No. 3 44 Annex 4 1. Agriculture Food Crops projection: The methodology is based on a two-step procedure, from estimates of volumes of crop production to sector GDP. First, volumes of crop production have been estimated. Agriculture is rain fed and in the first half of 2012, Rwanda has experienced delayed but abnormal heavy rains and floods, and this has likely impacted crop output adversely at the end of season B. However, given substantial past and ongoing public investments in the sector, it was estimated that the production will not be too much affected. Therefore, the production of the season B was estimated by using trend extrapolations. For the year 2013, volumes of production were also estimated by using trend extrapolations. With the volume of crops issue sorted out, the next step was to link that to GDP in the crops sector. In contrast, lumping together crops production data for the two agricultural seasons may not make sense as it creates a methodological issue for the projections part of the exercise. The reason is that the two seasons may be influenced by different factors. The degree of disaggregation to be considered has been an important issue in view of data and other considerations. A manageable number of sub-sectors was considered to be around five, at best. This means only five types of crops: cereals, pulses, bananas, tubers and vegetables were used. While a great deal of details are available for the above five sub-sectors, it has been found convenient to limit the analysis to one “food crops� sector. A more detailed sub-sector classification should be considered only for the next round. Export Crops: The methodology is based on first estimating the volume of exports and then using that to arrive at value added in export crops production. An estimate of world commodity price movements in the near future was obtained. The nuance of the method is to avoid judgments about the volume movements (either from trends or other means). Rwanda’s key export crops are tea and coffee. According to past trend production, especially for coffee, one year with low production is followed by one year with high production (the natural coffee cycle). 2011 was a year with a low production, and 2012 is expected to be a year with higher production. For tea, every three years of increasing production are followed by a decrease in tea production. This leads us to project a decline in production of tea in 2012. Furthermore, the experience in the past years showed that with an increased coffee production, overall export values are expected also to increase. Although the global price of coffee is projected to decline on international markets, it was expected that this will be balanced by a high coffee production in 2012. 2. Industry The most important industries in Rwanda are mining, manufacturing, electricity and water, and construction sectors. Of these, manufacturing and construction account for 95 percent of industrial activities. In the manufacturing sector, well over 65 percent of the output can be attributed to food processing and beverages and tobacco processing. Thus, it has been attempted to capture the growth of manufacturing (with emphasis on food processing), and construction sub-sectors. For construction sub-sector, the main assumption was based on large ongoing public infrastructure investments, but at a slower pace. For the other sub-sectors, trend extrapolations for projections have been used. 3. Services An attempt was made to explicitly account for all the major services sub-sectors in the Rwandan economy. Particular attention was devoted to the following sub-sectors: wholesale and retail trade, transport and communications, real estate and business services, public administration and education. In the current analysis the following sub- sectors have been grouped into “other services�: hotels and restaurants, finance and insurance, and health and other personal services. It has to be noted that this aggregation is somewhat arbitrary, and any of the above sub- sectors can be separately highlighted as there are separate value added figures available for each of those sectors in the national accounts. 45 Rwanda Ecomomic Update | Edition No. 3 Annex 4 Wholesale and Retail Trade: The volume of wholesale and retails trade is closely related to the volume of imports and the domestic transactions in the non-traded sectors. The latter variable however could pose a problem since one of the key aspects of the whole exercise is also to get a forecast of the domestic economy. For simplicity, only the volume of imports variable has been used in the analysis. Transport and Communications: Transport and communications are closely related to what happens in the wholesale and retail trade. Thus, in explaining the behavior of value added in this sector, two key proxy variables that have been used are, the volume of imports and exports. The estimated equation has a reasonably good fit for quarterly data. Real Estate, Business Services: Real estate and business services cover a wide variety of services, which makes it not always easy to identify few explanatory variables. However, it has been conjectured that perhaps the degree of urbanization may be a relevant variable to capture the behavior of the sector. Indeed the simple regression of value added in this sector on the degree of urbanization (represented by the share of urban population to total) shows that 86 percent of the variations in value added in the sector can be explained by the urbanization variable. Public Administration: Perhaps the most relevant explanatory variable for value added in public administration is the total expenditure of government in a given year. The simple regression estimated shows that 94 percent of the variations in value added in public administration can be explained by the variations in total public expenditures. The latter explanatory variable turns out to be highly significant. Education: Enrolments in primary and secondary education are assumed to be reasonably good indicators of the volume of transactions in the education sector. The regression results show that almost 98 percent of the variations in the value added in the education sector can be explained by the two enrolment variables. The elasticity of value added in education with respect to primary enrolment is estimated to be around 0.9 while for secondary enrolments it is around 0.7. Both estimated coefficients are significant, as indicated by the t-ratios. Other services (incl. health, other personal services, hotels and restaurants): Several sub-sectors are included in this category of “other services�. These are: hotels and restaurants, health and other personal services). The projections for these sectors are largely based on recent trends. Rwanda Ecomomic Update | Edition No. 3 46 References REFERENCES BNR. (2012). 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Resilience in the Face of Economic Adversity. Policies for Growth with a Focus on Household Enterprises. Rwanda Economic Update 2. 47 Rwanda Ecomomic Update | Edition No. 3 Produced by Poverty Reduction and Economic Management Unit Africa Region. Photo credits: © Rogers Kayihura, World Bank Communications Officer. Design by: Robert Waiharo.