The global economic situation is still volatile although there are signs of recovery with price indices rebounding from their low levels of December 2011. There are still some risks relating to the debt crisis in the Euro zone, persistent high fuel prices, declining prices of key export commodities and high food prices. On the regional scene, inflationary pressures remain high, although declining, while food production on the local market is not as good as expected.  DMITRY GERSHERSON, the Resident Representative of the International Monetary Fund (IMF) talked to our Business Editor  JOHN GAHAMANYI about Rwanda’s economic prospects amidst these challenges. Below are excerptsQuestion. The IMF mission was recently in the country where they met different officials from government and the private sector. What are the key issues that were discussed?That was a mission to conduct the fourth review under the Policy support Instrument (PSI), a macroeconomic programme supported by the IMF—which doesn’t involve financing.  The team is now in Washington, they are preparing the report. The IMF board will meet to discuss the report in June.There are several major themes that emerged from that mission;  One thing is that there are no big surprises; Rwanda is doing well, the economy has been growing strongly last year, at 8.6 per cent, and it is expected to grow also quite strongly this year, at 7.7 per cent.Inflation was at 8.3 per cent last year and it is expected to drop to 7.5 per cent in 2012. This is despite some volatility in the region, especially last year when inflation was so high in neighbouring countries where the foreign exchange rate fluctuations were also quite strong. The forecast of the global economic situation (by IMF) is also quite positive but there are still lots of risks. So, the discussion during the mission’s visit was how those risks may affect Rwanda and what needs to be done to mitigate those risks. The agreement was that if there is any impact it shouldn’t be large.  Although there will be a need to do more if problems arise due to global uncertainty.The main elements of the programme (PSI) are;The fiscal side, the pillar of the PSI is to increase domestic revenue collection. The target set out two years ago was to increase domestic revenues to 14 per cent of Gross Domestic Product (GDP) and that is where we expect to get next year (fiscal year 2012/13). Still on the fiscal side there will be a small increase in the fiscal deficit, largely due to foreign financing of capital projects. There will be an increase in public sector wages, which were frozen for a number of years and the money for that increase will come from reduced purchases of goods and services.Basically, government shifts resources from goods to wages. Government will increase domestic borrowing. It will borrow a little bit, not much, about 0.3 per cent of GDP. On the monetary side we agreed on a slight monetary tightening to keep inflation were it is.  The (central bank) policy rate is going up (It is currently at 7.5 per cent). It is the right thing to do. (April figures shows inflation cooled to 6.95 per cent Last year inflation in Rwanda was much lower than in neighbouring countries to some extent because food prices were low due to good harvests.  Now, harvests are not as good as expected. This is pushing inflation up. We saw a bit of that in the data for March. There was quite a bit of substantial increase in inflation (it was 8.18%). The important point to note is that food makes up one third of the Consumer Price Index basket. Well, the central bank’s policy decision may possibly be effective in controlling inflation but don’t you think it is being done at the expense of economic growth?I don’t think so because in theory, what can affect growth is if you really tighten up liquidity conditions for the banks. From our discussions, commercial banks have enough liquidity. Another way to look at it is, the key repo rate going from 7 to 7.5 per cent is an increase but inflation is already at 8 per cent. So if you compare the policy rate with inflation, the difference is negative. I don’t think it would impact on growth. What about in real terms?    You can think of interest rate as the price of money. The higher interest rate is (i.e. the more expensive money is), the more difficult (costly) it becomes to consume and to invest, which in turn serves as a brake on economic growth. That’s why we say that higher interest rates result in slower growth. There are several ways to measure interest rates. We can talk about nominal rates, i.e. the rates that the banks pay on deposits and charge for loans. We can also talk about real rates, which are nominal rates minus inflation. The real interest rate is the real price of money.Let’s say I borrow Rwf100,000 at 7 per cent interest, and inflation is 8 percent. Next year, I will repay the loan in full – Rwf107,000. But the Rwf107,000 at next year’s prices is equivalent to Rwf107,000/1.08 = Rwf99,000 at today’s prices. In other words, I will pay back less in real terms than I originally borrowed. Given these numbers, it makes sense to borrow as much as possible, because the repayment is lower in real terms than the amount of the loan. That is what happens when the real interest rate is negative. That’s why I said that as long as the interest rates are negative, money is effectively free, and the policy rate does not serve as a brake on economic growth. Neither does it serve as a brake on inflation, and we have to be mindful of that. Fuel prices are going up on the local market yet the buffer that the government had set up in form of tax subsidies is no longer there. Going forward, what kind of threat does it pose to inflation and the economy in general? The taxes (on fuel) were reduced last year for two reasons. One was to harmonise Rwanda’s taxes with EAC taxes. Second, it was to remove the inflationary pressures because fuel feeds into everything; so fuel prices have a strong impact on inflation. The conventional prescription that we advocate is that if there’s a price shock (increase in oil prices) there’s not much that Rwanda can do. So you allow for this price increase to filter in. But what you don’t want is to allow the so-called second order effects. What it means is that if the price of fuel goes up and the price of transport accordingly goes up, you allow for this. But what you don’t want is the next step when people say; the price of transport goes up so am going to increase the price of vegetables.  It is a fine line, easy to prescribe but not easy to implement. The way to do it is to increase interest rates. I am not saying that central bank can control prices directly but what they can do is reduce inflationary pressures by raising the interest rates. Commercial banks’ lending to the economy is not evenly distributed. For instance in the first quarter of this year outstanding credit to agriculture, where most Rwandans are employed was Rwf9.1 billion compared to Manufacturing, mortgage industry, commercial & hotels which received Rwf25.5b, Rwf47.6b and Rwf88.8b respectively. Is this something that you are concerned about as IMF?Our primary concern is whether the financial sector is well capitalised and stable. If you look at it from the point of view of financial stability, the joint IMF/World Bank report last year pointed out that the banking sector in this country is in good shape and can survive potential shocks.In terms of the facts mentioned, let me try to explain without passing judgment on activities in   particular sectors, because this is not something that we do. The banks, understandably, like financing commercial enterprises that have a steady revenue stream. The difficulty in extending credit to agriculture in Rwanda is that most of the people engaged in agriculture are subsistence farmers and as a subsistence farmer you don’t have a stream of income because much of what you are producing is for own consumption. If you are a cooperative that sells potatoes or coffee that generates consistent stream of income, the banks are more likely to finance that. As for the subsistence farmers income is difficult. It’s not to say that the banks shouldn’t try to think of products that could be useful to the farmers but it is very difficult here. There has to be a business model that generates income. The world economy is volatile with weak demand and low commodity prices that might hurt Rwanda’s export revenues. What policy measures should the country pursue in order to control its widening trade deficit in the wake of this volatility in the global economy?Rwanda is particularly vulnerable because when you look at the export base, it’s largely tea, coffee, minerals and tourism. All of those things are volatile because tea, coffee and minerals depend on prices, which of course you don’t control. For now we don’t see any major problems on that side but of course anything can happen. Tourism is volatile in a sense that if there’s a major slowdown in advanced economies, where the tourists come from, then Rwanda will receive fewer tourists. What needs to be done in the long run, export base needs to be diversified but that is in 10 to 20 years. And that is something that government is aiming at in the export strategy. In the short term we just have to be cautious and right now the country has substantial reserves, five months of imports.  There’s nothing the country can do in the short term to avoid the risk, because due to their structure Rwandan exports are inherently vulnerable to shocks.With the current regional and economic outlook, how confident are you that Rwanda will maintain a high growth rate?When you talk about projections, this always an assumption and we (Government and the IMF) are trying to be cautious not to assume something that is unlikely to happen because if you put your growth targets too high and the growth is in reality low the monetary program will be too expansionary and that can lead to high inflation. If you assume your growth you have to basically develop the monetary and fiscal program depending on the gowth assumptions.  So we are trying to be prudent. We believe 7.7% is a reasonable assumption. Are there other policy objectives that you feel government should be pursuing to sustain the high economic growth rate? Government is thinking about how to increase growth. This is a very difficult thing to do in general. In economics there is a lot of academic papers about growth experience in different countries and what needs to be done to increase growth rates and how it can be sustained, but there is no consensus. In some cases certain things work and others don’t. So it’s very difficult to say if we do this, then our growth will be that.  What government is doing is to make doing business easier and strengthening the role of the private sector. That is where the growth usually comes from.