A fall in oil prices brought Angola to its knees two years ago. A deal with the IMF has helped the economy to stabilise and signs of growth can be seen in Luanda. But to avoid a repeat of the disaster, more structural reforms are needed to make the country attractive for business.

The more realistic among Angola’s commercial and financial leaders believe that, in the future, the fall in oil prices that brought the country’s spending boom to a grinding halt in 2009 will probably be seen as a blessing for the country’s economy.

It did not seem so at the time. The collapse in oil prices in the second half of 2008 and the first half of 2009 slashed revenue. The government was forced to cut capital spending, particularly on infrastructure, it was unable to pay its creditors, foreign exchange reserves were used to enable the country to function, while both the budget and current account plunged into the red.

This was an important lesson for ministers, who had been spending 13% to 15% of gross domestic product (GDP) a year on capital spending between 2006 and 2008, as it demonstrated to them that oil prices can plummet as well as soar. This not only brought about a more realistic approach from ministers, which has been evident in the past 18 months as oil prices have strengthened again, but forced the government to introduce structural changes which make it much less likely that spending will get out of control.

Indeed, risk analysts, looking at the way Angola's economy has recovered, are now even more well disposed to the country than they were when Angola received its first B+ rating only a year ago. There is a general assumption that the rating will rise, paving the way for a Eurobond issue in the fourth quarter of this year. This will not only give the government a further buffer of between $500m to $1bn to protect it against further oil price fluctuations, but also establish a benchmark and make it easier for the state-oil company Sonangol, and possibly the country's banks, to tap the market.

"Angola has overcome the effects of the financial crisis in 2008 and 2009 relatively quickly because of the strengthening of oil prices and the government's implementation of International Monetary Fund [IMF]-supported reforms on controlling the budget," says Veronica Kalema, director for sovereign and international public finance at Fitch Ratings. "The currency is now stable, growth has strengthened, payment arrears are eliminated and they are again building up substantial reserves."

Spending cuts

At Moody’s, Aurelien Mali, sovereign lead analyst for Angola, says the country is now in a much stronger position than before. "First, the recent improvements in the economy are sustainable based on the current oil prices and the accumulation of reserves. The government has done a good job in curbing spending over the past two years and the budget now balances on oil revenue of $65 a barrel; anything higher will lead to significant surpluses. Second, the arrears have been paid off, eliminating a constraint on the economy.”

The bare statistics make impressive reading. Growth in 2009 fell to 2.6% of GDP, last year it rebounded strongly to total 4.5% and this year analysts expect it to rise to at least 8%. The budget, which in 2009 had fallen to a deficit equivalent to 9% of GDP, registered a 5% surplus in 2010 and this year a 10% surplus is confidently predicted. What is more, this has been achieved while increasing capital spending to $8bn, which is thought to be well within the economy’s 'absorptive capacity'.

It has also been able to rebuild its reserves, having lost considerable sums in 2008 and 2009 – it lost one-third alone in an ultimately abortive attempt to defend the value of its currency. Reserves rose by $6bn last year and a further increase of $10bn this year should bring them back to $33bn, close to the level before the oil price crash. It is also now talking of putting some of its oil income into a sovereign wealth fund.

During this period the government repaid contract arrears that had climbed to $6.8bn during the economic crash. This was done by using accounts receivables from Sonangol and from cash reserves. The balance could have been paid off completely but an agreement was made with creditors to pay in the form of promissory notes that could be cashed this year. This was done to help the country’s cash management.

Oil boom

Clearly, oil made it possible to bring the country back on track so quickly. It is likely to continue underpinning the economy, with production expected to rise to about 2 million barrels a day this year as new fields come on stream and technical problems are resolved in some of the existing ones.

However, equally important, in this process of restoring the confidence of international markets and analysts, is that Angola, which last year paid off its Paris Club debt, has a stronger net external debt position than peer countries in Africa, giving it a considerable advantage.

Arguably, the most important factor has been the work done with the IMF on structural reform. The government took what was considered a brave decision at the time to ask for IMF help, and in November 2009 a 27-month standby arrangement was reached for $1.4bn, equivalent to 300% of its quota. What has impressed bankers the most is the way Angola has kept to the key pillars of the agreement.

These included paying off the arrears by March 2011, focusing monetary policy on reining in inflation (which is showing signs of success as the annual rate is falling from a high of 15% to nearer 13%) and pushing ahead with key financial management reforms.

It is in this final area that most progress appears to have been made. There is now a debt management office and a much more centralised and strengthened procurement process – some government departments were still issuing contracts in late 2008 when there was little chance of the money being available to finance them.

In its latest report on Angola, the IMF gave strong endorsement for the government’s record in delivering the necessary changes. “The authorities have achieved significant success with their stabilisation efforts to date, but now need to press ahead to rebuild policy buffers and to continue their reform and modernisation programme."

Risk analysts have also been impressed. "The new spending framework determined in talks with the IMF is much more sustainable," says Ms Kalema at Fitch. "It is now extremely unlikely that infrastructure spending will get out of control in the way that it did in the years up to 2008. Measures are being taken to reduce the non-oil primary deficit, procurement is being done much more professionally and approved on a centralised basis and there is now a proper debt management office."

Luanda regeneration

Signs of the increased confidence is now evident in the capital, Luanda. Work is once again moving ahead on buildings, including luxury blocks of flats – said to be selling at between $1m and $2bn depending on number of bedrooms – and new hotels, including a huge Intercontinental with accompanying casino.

Road projects are pressing ahead, bars and restaurants are full and the hotels are full of management consultants, oil workers and international bankers, who help make Luanda one of the most expensive cities in the world.

For it is no secret that Angola has huge natural resources. It is the world’s 12th largest oil producer, has reserves that at a conservative estimate total 10 billion barrels and could actually be twice that size according to some of the more ambitious estimates. Technology has now been introduced to harness and use the associated gas. Angola is also the world’s fourth largest diamond producer and there are substantial reserves of many other rare minerals.

However, there are still many challenges that need to be overcome if Angola is to reap the full benefits of the potential prosperity that oil will deliver. Many of its toughest problems stem from the 27-year civil war that began at independence in 1975 and did not end until the death of opposition Unita leader Jonas Savimbi in 2002.

The legacy of the war can be seen in the devastated infrastructure – there are few bridges left in the provinces, the capital is creaking under the strain of coping with half the country’s population, and the transport system can barely operate. It has also been a real challenge to rebuild institutions which simply could not operate in the war and it has taken a number of years to improve the quality of staff and the ability to deliver services.

Government success

The problems that remain today though should not obscure the very real successes of the Dos Santos government, which has fully embraced market economics. In the period between 2004 and 2008 when it implemented an extensive infrastructure programme, it achieved very strong economic growth (averaging 17.5%), reduced inflation to nearly 10%, stabilised the currency, achieved large fiscal and current account surpluses and built up extensive reserves.

It paid off most of its Paris Club debt arrears in 2006 and 2007 and completed the pay-off in 2010. In doing this, the government was given virtually no external assistance in terms of grants or debt relief. “Only $400m of penalties were forgiven," according to Standard & Poor’s.

This strong performance, which won international support, came to a halt with an oil price fall that not only ruined the government’s budget but made it even more challenging to redistribute wealth in the country.

Ministers are also wrestling with the challenge of closing the gap between the richest and poorest. Per capita GDP was estimated at $5103 in 2010 but this disguises huge income discrepancies, with some estimates stating that 70% of the population lives on less than $2 a day.

One of the keys to reducing poverty will be through rebuilding the professional middle class, many of whom left the country in the civil war. Entrepreneurs are starting to return, but although it is now easier to set up and run companies than in the past, the business environment remains weak. The country still needs more structural reforms to reduce the bureaucracy and regulatory constraints that are a consistent complaint of every corporate executive in Luanda.

Nor is there any doubt that this is deterring foreign investors, except for those with considerable experience of emerging markets, those from countries such as China with strong government bilateral links and banks from countries with historic national links. It is a constant complaint that Western companies are all too keen to sell goods to Angola but are reluctant to invest in the country.

However, the success of these entrepreneurs in developing new business, whether in industrial production or in agriculture, is central to the long-term goal of diversifying the economy. For as long as oil and liquefied petroleum gas dominate Angola's output, government revenue and merchandise exports, so will the economy be vulnerable to oil price fluctuations. Only when the conditions for a commercial private sector have been created will the economy really be protected from commodity prices.

Angola's GDP per capita/capital expenditure

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