Guinea - Medium Term Macro - Econonic Framework : Special Study

Document of RETURN To The World Bank RPRSDS REPORTS DESK FOR OFFICIAL USE ONLY WITHIN ONE WEEK CONFIDENTI Report No. 1621-GUI FILE COPY GUINEA MEDIUM TERM MACRO-ECONOMIC FRAMEWORK Special Study May 31, 1977 Western Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENT 1. Currency unit: Syll 2. The following rate has been used in this report: 1 US$ M 19.65 Sylis WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet 1 kilometer (km) . 0.62 miles 1 hectare (ha) . 2.47 acres 1 square kilometer (km2) - 0.386 square miles 1 kilogram (kg) = 2.205 pounds 1 ton (t) . 2,205 pounds 1 liter (1) - 0.26 gallons Fiscal year of the Government - October 1 to September 30 FOR OFFICIAL USE ONLY CONFIDENTIAL This report is based on the findings of an IBRD mission which visited Guinea in April 1976. The mission consisted of the following: Heinz Bachmann Chief of Mission Raymond Rabeharisoa Loan Officer Ggrard Boulch Economist Naguib Abu-Zobaa Financial Analyst Mathias 'Meyer Education Economist R. Berthillot Education Specialist G. Duff Port Engineer R. Knighton Transport Consultant S. Lang Secretary This cumnthaartedtributio and may be med by mcipiet only ian thepedftmanc of thir offcial duties. Its contents may not oherwise be disclosed without WorM Bank authonD. TABLE OF CONTENTS Page MAP INTRODUCTION SUMMARY AND CONCLUSIONS PART I - PAST ECONOMIC DEVELOPMENTS AND PERFORMANCE 1 A. Political Situation 2 B. Past Economic Developments (1958-1972) 3 C. Recent Economic Developments and Performance (1972-1975) 6 - Overall Assessment 6 - Foreign Trade and Balance of Payments 9 - Monetary Policy 11 - Public Finance and Public Investments 13 - Public Enterprises 18 - Foreign Debt Management 18 PART II - THE MEDIUM TEIM OUTLOOK FOR ECONOMIC GROWTH 20 A. Introduction 20 B. Growth of Production 21 C. Growth and the Use of Foreign Exchange Resources 26 D. Savings and the Financing of Public Investments 37 - Macro-Ecconomic,Aspects 37 - Public Finance Aspects 39 - Financing of Public Investments 41 E. Sensitivity Analysis and Policy Conclusions 44 IBRD 12848 S E N E GL AE LIBYA Youkounkoun A L r KDundare- SE - MALl GER -__ f ' Lebékere NIGERIU A GAOUA G INE EP OFKourémokt iIAT/TIOCEAN 2ARE \ \Al R O THa .rISE -ta T erjD ProjuFRIGUIAner Bss igkr noojnrMandn> ana 00 A tFnstic -S~~~ ~S ubueirba Fraa O v0 co Sik.n CONAKeToFrkeseego S' E E A LE0 Projctd Rosnd Fs g h o t .. r. R ad rpse fsor MaSintnac unerScod2ihwyPrjetTorewnR PU U O G INE 2 A S \ 10p CUD r darfo SaC nFiltryCopaTA SP RTN TW R MainMEtDevelopment Poles '~ R Ricc Pojetn Proose Bauxit Mmingse -g FrstCat-- gry- R ad s 0 20 40 Hig80ay00 P20 14 160- - n, --- Roads under ons ruct Hi wa KILOMET ERS,a an ar -Iad Prop o wd Trens--Guine a R neirod .iginnay Pr•o20j40e6,0 T International Airpont MLES I CuB E R IAn i . + Regularly s4eiced Airfioteds RiversOR NETMBA Toop-1~ Fn.Bel -. Ieern taltodrO The ,<ciaes ihano B-his mapd Inoni. In 5O t Ser 'iDa Ahirpr MILES 1 1 B E.R I A mply s jorJselt y accepanøjed byAeL WorlBanandis afinaes.Monrviaj ? AP.I L 19?71 INTRODUCTION The objectives of this report are limited to the study of the macro-economic framework of the Guinean economy during recent years and projections for the five to ten years to come. The particular system that governs the Guinean economy is therefore discussed only in general terms, and sectoral priorities and policies are not covered explicitly. The emphasis is placed on the evolution of the main economic aggregates and part:.cularly on those that concern the balance of payments. Furthermore, the lack of statistical data has prevented a comprehensive presentation of historical trends. The projections are used not in the sense of a forecast but rather to describe the conditions for economic development assuming various feasible scenarios. In particular, we try to evaluate the effects of transition from a situation in which the lack of foreign exchange constitutes one of the most serious bottlenecks to development, to a s:ituation in which - because of the implementation of large scale mining projects - foreign exchange earnings would be much greater. The report also emphasizes the special problems that are created by the magnitude of the amount of money in circulation at the present time. SUMMARY AND CONCLUSIONS i. The main purpose of this report is to provide a basis for evaluat- ing prospective macro-economic developments in Guinea during the 1975-1985 decade, including their impact on the balance of payments, public debt, and public finance; this will provide a framework for foreign aid management, such as size and conditions of foreign lending and creditworthiness. It deals only marginally with sector issues, awaiting the outcome of two detailed studies on one of the country's key sectors, the rural economy. Draft sector papers are available for transport, education, mining and manufacturing industries. ii. Economic growth from the date of Independence in late 1958 through 1972 has been very unsatisfactory, particularly considering the country's great economic potential, which is among the largest in West Africa, in min- ing as well as in the rural sector. GNP at constant prices seems to have increased less than 2.3 percent p.a. during those 14 years, and by 1972, GDP per capita had fallen by more than 10% below its 1960 level in real terms. The way the country gained its Independence had a lot to do with these unsatis- factory developments; in addition, however, Government performance also contributed to slow economic growth. Particularly the financing of successive years of central government and public enterprise deficits by central bank credit created a huge excess of liquidity in the country, which, combined with inadequate growth in supplies of intermediate and consumer goods, caused a wide and growing differential between the domestic and international price levels, the emergence of parallel markets, and of barter trade as Guineans became more and more reluctant to hold domestic currency. In addition foreign debt increased rapidly, exceeding the debt servicing capacity of the country so that foreign debt arrears became more and more important. iii. With the start of production of two major mining enterprises, economic growth has substantially accelerated over the 1972-1975 period and balance of payments constraints have considerably eased. At the same time, Government performance has markedly improved; it has made very responsible use of the considerable additional foreign exchange resources accruing from the two mining enterprises. Conservative monetary policies have brought to an end further inflationary pressures and even resulted in some reduction of the accumulated money overhang; budget surpluses have substantially increased and the foreign debt burden declined in relation to exports. These are all positive trends that augur well for future growth and performance. iv. However, this change for the better will need time to take effect on the economy. It has not yet been enough to overcome the country's funda- mental problems and the situation remains difficult. The money overhang, while somewhat reduced, persists and so does the parallel market with all the distor- tions that go with it; the lack of imported inputs and consumer goods remains a major bottleneck for more rapid growth in the rural sector and manufacturing; and foreign debt arrears are still very high indeed. At the same time, the Government's recent policy changes concerning rural production and trade give rise for concern. -ii - v. The more rapid economic growth of the last three years is likely to continue over the next ten years, with GNP in real terms expected to expand by 6.5-7.5 % p.a. Even more importantly, however, will be the proj- ected increase in exports and thus in import capacity, that might well average 11-14% per annum in real terms over the 1975-1985 period. In conse- quence the past serious foreign exchange constraint could be expected to ease considerably; while recent Government performance can be taken as an indica- tion that Government will follow appropriate policies to take better advantage of the improving foreign exchange situation. Thus conditions seem to be ripe to give the country for the first time in over a decade a real chance for more rapid economic development. vi. In the short term, i.e. during the remainder of the 1970s, the foreign exchange situation is likely to remain very tight, because a high proportion of the rapidly growing export proceeds will be needed to cover the foreign exchange costs of the mining ventures themselves; furthermore, foreign debt service requirements will remain a heavy burden. Thus, during these years, Government will enjoy very little flexibility to carry out more liberal import policies; even by keeping imports at a minimum, foreign debt arrears are likely to further increase until about 1980, except if foreign aid donors were willing to provide considerable amounts of balance of payments support, not tied to the financing of the foreign cost of new investments. vii. Beyond 1980 economic growth will depend very strongly on the speed at which Guinea will be able to further expand its mining sector. If all the mining projects presently under active consideration are completed by 1985 (including Nimba and Aye-Koye), the country will likely have overcome its foreign exchange constraints by the mid-1980's and could be expected to experience continuing rapid economic growth thereafter, with financing prob- lems having ceased to be a serious constraint. However, should one of the two major mining projects mentioned above not be undertaken before 1985, there is a serious danger that Guinea wil not be out of balance of payments problems by that time, and foreign exchange constraints will continue to hamper faster economic growth. Thus, Government performance in developing the country's mining resources is of overwhelming importance for Guinea's longer term growth. viii. The detailed projections have another important bearing on future Government policies; they indicate quite clearly that for the next five years, continuing very careful foreign exchange management will be imperative in order to make the best possible use of limited foreign exchange resources. There will be no room for spectacular increases of imports, which makes it all the more important to establish import priorities carefully; imports of rural inputs as well as of consumer goods for the rural sectors ought to figure high on this priority list as should inputs for the manufacturing sector. Implementation of a monetary reform would make it much easier to stick to these priorities, as it would reduce the excessive amount of pur- chasing power accumulated in urban areas. ix. For foreign aid donors, the recommendations deriving from the detailed projections are quite obvious. Up to about 1980, a substantial - iii - portion of foreign aid ought to be on concessional terms to finance invest- ments in the non-mining sector; in addition, all foreign lending should have grace periods extending up to at least 1980. Under these conditions, the country is creditworthy for foreign public project borrowing, projected to increase four times from US$70 million in 1977 to US$280 million in 1983. Furthermore, foreign sources of capital should provide substantial additional aid over and above the financing of the foreign cost of new investments (local cost financing, program loans, balance of payments support) averaging about US$45-50 million per annum during the 1977-79 period, or an equivalent amount of debt rescheduling. The country is creditworthy also for these additional borrowings. After 1980, the situation will have to be reassessed in light of developments in the mining sector up to that date. PART I PAST ECONOMIC DEVELOPMENTS AND PERFORMANCE 1.1 Guinuea is potentially one of the richest countries in West Africa, endowed with substantial natural resources in the rural sector, in mining, and to a lesser extent in hydroelectric power. Rural potential is very diver- sified, reflecting the country's different climatic zones, ranging from the sub-saharan north to sub-tropical mountain areas in the center, and tropical forest in the south. At the time of Independence, in late 1958, Guinea had been the leading African exporter of bananas (approximately 100,000 tons) and in addition exported sizeable quantities of coffee, pineapples, and palm oil. Furthermore, the country is particularly well suited for irrigated rice pro- duction and livestock herding; before 1960, it was able to cover most of its basic foodstuff requirements and it has the potential to become a sizeable exporter of rice and cattle. More recent is the discovery of the extraor- dinarily rich mining potential. Guinea's bauxite deposits are tentatively estimated at 4-5 billion tons or nearly half of the free world's total reserves, while readily exploitable high grade iron ore deposits are esti- mated at over one billion tons. 1.2 In spite of this outstanding resource endowment, past economic growth has been disappointingly slow. While lack of data prevent a detailed assessment, GNP at constant prices has certainly increased by less than 2.5% per year since Independence, or less than population growth (2.8% per annum). Thus, real per capita incomes have slightly declined. In 1974/75, GDP was estimated at sylis 16.4 billion ($837 million) 1/ and per capita income at $186.2/ A major 1/ A rate of exchange of syli 19.65 per US$ is used throughout this report, or close to the official rate of syli 21 per US*. The pro- found distortions resulting from a decade of highly inflationary policies have virtually split Guinea's economy into two basically different segments, - the official and the parallel sector - where prices for the same goods might differ by as much as 1:10 (para. 1.9); these price differentials are reflected also in the exchange rate, with the Syli exchanged in the parallel market at little more than one tenth of its official exchange rate. Under these circum- stances, national. accounts figures are even more approximate than usual in West Africa. All macro-economic figures used in this re- port are mission estimates that have been put on an official price basis; to be consistent, they have to be changed into $ at the ex- change rate used in the official sector. 2/ There are two different estimates concerning Guinea's total popula- tion. After the December 1972 census, an official decree put total population at 5.14 million for end-1972. However, based on likely population growth determined by this census and on a series of demo- graphic data collected during the 1960's, a figure of about 4.2 million seems much more likely. All population data, including per capita GDP, are based on this latter figure. -2- bottleneck for satisfactory growth has been the balance of payments which has remained under heavy pressure since the early 1960's with exports stagnating, imports declining, and foreign debt service reaching unmanageable proportions. A. Political Situation 1.3 Low economic growth cannot be dissociated from Guinea's political background. The country became independent suddenly and unexpectedly in the fall of 1958 as the only French territory in Africa to vote against joining the French Union. This created a confrontation with France, resulting in the immediate recall of all French civil servants, the end of technical aid, and the abolition of preferential treatment of imports from Guinea. In 1960, partly for nationalistic reasons and partly to control increasing capital flights, Guinea withdrew from the French controlled West African Monetary Union, and created its own currency, the Guinean franc, renamed syli in October 1972. Unable to obtain large amounts of foreign aid from Western countries, the new regime turned towards the communist world in its search for assistance and export markets; however, this aid often was ill adapted to Guinea's needs and did little to improve the unsatisfactory economic sit- uation. Despite its heavy reliance on communist aid, the country never integrated into the communist world, but always tried to strike a balance between East and West. Thus, American and German aid were quite substantial and in the mining sector reliance on Western private and public capital and know-how is the rule. 1.4 The desire to avoid too much dependence on any group of countries reflects the Party's basic political option of achieving self-sufficiency and independence, political as well as economic, based on a vaguely,marxist ideology. To achieve this goal, the Government decided to build up an entirely state-controlled economy, with virtually all economic decisions to be made by the bureaucracy, and with trade, banking, and manufacturing handled almost exclusively by state enterprises. However, Guinea did not have the necessary administrative skills to implement such comprehensive economic planning and to carry out these plans; thus, planning was replaced by impro- visation, project preparation was highly deficient, and the many public enterprises were badly managed. This had particularly dramatic consequences for local and foreign trade; the hasty take-over by inexperienced public enterprises resulted in serious disruptions in the trade network; a major reason for the unsatisfactory growth of rural production. More generally, the lack of leadership and control seriously hampered the necessary coordin- ation between different ministries and between central and regional admini- strations, with the regions enjoying considerable de facto independence. It has also created a widening gap between the Government's intentions and decisions and what was really going on in the country. This was particularly true for the rural sector that has continually received priority in Government declarations while in fact past policies have largely favored urban interests. 1.5 Manufacturing and banking are entirely Government controlled while mining remained almost fully private until very recently when it was declared 3- a "mixed sector" with Government and private foreign companies closely working together. The IBRD-finaanced Boke project was the first implemented according to this new formula starting in 1968. It serves as an example for all future mining developments. Official trade is entirely controlled by the Government but much trading is carried out in the parallel market, including exports and imports. In the rural sector, limited administrative capability has hampered the Government's desire for full control and repeated attempts to introduce official production cooperatives and communal type production schemes have failed. As a consequence, the rural economy operates largely outside the official trade network. B. Past Economic Developments (1958-1972) 1/ 1.6 A brief assessment of economic events during the first five years after Independence is important to understand the present economic situation. Developments during that short period profoundly affected Guinea's economy, while since 1964, only limited changes have occurred that have not fundamen- tally altered the situation. 1.7 At the time of Independence Guinea was largely a rural economy with the bulk of population engaged in traditional smallholding agriculture and livestock, paticularly the production of rice, cassava, and cattle, the country's basic foodstuffs. The modern sector of the economy comprised the foreign and Guinean owned banana plantations as well as considerable bauxite, iron ore, and diamond mining while manufacturing industries were virtually non-existent. Modern sector activities occupied less than 10% of the active population, but provided over half of exports and most public revenues. Con- struction of the Friguia alumina mining and processing plant started shortly before Independence. Owned by a consortium of international aluminum com- panies, this enterprise was soon to become the country's major source of foreign exchange; it was carefully shielded by the Government from the effects of the serious economic problems soon to encompass most other sectors of the economy. 1.8 Soon after Independence, the Government embarked on an ambitious development program giving major emphasis to manufacturing industries and transport infrastructure. State trading companies were created to replace the old established French trading firms. Financing of the large public investment program, of increasing working capital requirements of public enterprises, and of the heavy current deficits of these enterprises by far exceeded budgetary savings and foreign aid. The shortfall was covered by 11 An economic report covering the period 1958-1966 was issued by the Bank in 1967 [AF-63b, Sept. 1, 1967]. central bank advances, a policy that soon led to serious balance of pay- ments difficulties. Precipitated by a sharp fall in exports after the break- down of most mining activities, the foreign trade deficit.more than quadrupled within four years with exports covering little more than 40% of imports. By 1963, Guinea had virtually exhausted its foreign exchange reserves, created a galloping internal inflation, and accumulated a foreign debt of nearly 50% of GDP, about one-third of it at short term. To make things worse, many of the new public enterprises financed through this foreign borrowing were badly conceived and managed. Their contribution to GDP, to the balance of payments, and to public savings remained marginal at best. Furthermore, Guinea's export capacity was severely curtailed by the collapse of iron ore, bauxite, and diamond mining that had accounted for almost 36% of export proceeds in 1960. Text table I/1: KEY ECONOMIC DEVELOPMENTS, 1956-1967 (in millions US$ at current prices) 1956/57 1960 1962/63 1965/66-1966/67 Exports 1/ 22.7 48.0 30.4 31.7 Imports 34.8 70.5 79.3 53.3 Trade deficit 1/ -12.1 -22.5 -48.9 -21.6 Foreign exchange reserves 2/ n.a. 40.7 3.1 1.1 Monetary circulation 2/ n.a. 62.8 110.8 192.9 Foreign debt 2/ 3/ 6.5 n.a. 143.7 239.0 1/ Net of mining induced transfers and debt amortization. 2/ End of period. 3/ Including net drawings on bilateral trade agreements. Source: See detailed statistics in the Annex. 1.9 Under these conditions, a sharp cutback of imports became un- avoidable beginning in 1964 and since then the lack of foreign exchange has been the biggest single botteneck to Guinea's economic growth. In this situation the establishing of import priorities became a major policy in- strument to influence the economy. This tool was not used very efficiently which led inter alia to a decline of rural production during the second half of the 1960's through a chain of events composed of several links. First, the administrative shortcoming mentioned above often resulted in ad hoc decisions that ran contrary to the Government's own stated long-term goals, and that often discriminated against the rural sector. Second, while total imports were cut back sharply, the ill-prepared public development program was continued almost unabated, syphoning off a large part of the scarce foreign exchange and this requiring particularly high cuts in other imports such as raw materials, spare parts, and consumer goods. Thirdly, and most impor- tantly, the Government did not adapt local prices and the foreign exchange rate to the high inflationary pressures. On the contrary, it required all public enterprises, including trading companies, to operate at artificially low controlled prices, thus creating a widening gap between the sharply reduced offer of consumer goods and the highly inflated local demand. This .- 5 - disequilibrium led to the appearance of a black market, while most goods disappeared from official trade channels. Eventually, Guinea's economy was split into two clearly separated segments, operating in two completely dif- ferent ways, and at price levels sometimes as much as ten times different from each other; this split still hampers economic development to date. 1.10 In urban areas, to protect wage earners whose salaries remained largely unchanged, the Government imposed a rationing system for basic com- modities based on ration cards very much the way it was done in Europe during the War but distribution of other consumer goods was done in a rather hap- hazard way. The bulk of the scarce imported consumer goods never went beyond Conakry. This caused increasing discrimination against the rural sector which could find its only supplies in the black market at sharply increasing prices. Nevertheless, offical farmgate prices were not raised -- or if so, only belatedly and insufficiently -- so that terms of trade in the official sector turned very rapidly against the rural producer. Some farmers, particularly those located near major consumption centers or living not too far from Guinea's borders were able to regain acceptable terms of trade through selling in the parallel market or smuggling into neighboring coun- tries. However, the bulk of Guinea's farming population got more and more squeezed and as a result, lost interest in producing beyond their own sub- sistence needs. This in turn created an increasing shortage of basic food- stuffs in urban centers to the point that they had to be supplied mostly through imports, which further reduced the possibility of imported inter- mediate and durable consumer goods. In addition, banana production and exports came to a virtual standstill. Thus, a vicious cycle was closed that has not yet been broken. 1.11 For most of the period, after 1963, export earnings as well as im- ports stagnated at low levels except for Plan related imports financed through foreign borrowing. During these years, the share of exports in GNP declined from about 20% to under 15%, a low performance indeed considering that GNP itself was stagnating and for a country with such great export potential. Even though the shortage of consumer goods imports was compensated to some extent by unrecorded imports there can be no doubt that Guinea was suffering from a growing shortage of imported goods of all kinds, that hampered economic growth in all sectors. 1.12 The split of the economy worsened the situation for public enter- prises in two ways. A priori, the selection of these enterprises was very reasonable, as most of them were designed to process local raw materials, like tomatoes, cotton, cattle, and timber. Operating in the official sector of the economy, they were forced to sell their output at low official prices and to pay no more than the official producer prices for their local inputs. Ob- viously, at these prices, they were unable to purchase sufficient raw mate- rials. Furthermore, low priority was given to the import of spare parts and raw materials, which created another serious bottleneck to their operations. Last .but not least, they were generally not well managed. Consequently, most public enterprises never operated at more than 10-40% of capacity, so that -6- they only marginally satisfied local demand and consistently required addi- tional advances from the Central Bank, further fueling inflationary money creation. C. Recent Economic Developments and Performance (1972-1975) Overall Assessment 1.13 Even though the fundamental problems and shortcomings in Guinea's economic system have not been overcome the last three years, there have been quite considerable improvements in overall economic growth as well as in Government performance; these are briefly assessed in this chapter. The main purpose is to derive a judgement on recent Government performance as a basis for projecting likely Government performance over the next decade. To this end, recent Government performance will be analysed concerning overall eco- nomic policy, foreign trade management, monetary policies, public finance and public investments, management of public enterprises and of the public debt. 1.14 Summarizing this analysis, one can say that Government performance has improved in many respects, but not yet enough to solve Guinea's funda- mental problems; thus, while the trend is in the right direction, the situ- ation remains difficult. Government has been very responsible in the use of the large amounts of additional foreign exchange that have started to accrue from the two new mining projects. A large part was used to step up imports of durable consumer goods and industrial inputs, which are crucial to improve incentives in the rural sector and to stimulate manufacturing production. Part was used to increase foreign exchange reserves and at the same time to slow down expansion of money circulation well below the growth of GDP. While this was far from sufficient to do away with the large money overhang, it did somewhat reduce the fundamental disequilibrium between supply and demand. There was no excessive growth in current budget expenditures; resource allo- cation has improved and so has the overall budgetary situation. While the performance of public enterprises is still highly unsatisfactory, Government has taken steps to improve the situation by closing down the most hopeless cases and pursuing a program of rehabilitation and improvement for the others. It has resisted the temptation to use present and expected future increases in foreign exchange earnings to start a massive program of new investments financed by increasing foreign borrowing; while rural sector investments have increased, total public investments have actually declined and highest priority was given to better use the productive potential that already exists in the country. As a consequence, foreign indebtedness, while still excessively high, has declined in relation to exports. These trends augur well for the future, even though some major question marks remain, particularly concerning Government policies in the rural sector (collectivisation of rural production, nationalisation of all rural trade) that do not seem to be a successful step toward stimulating rural output. 1.15 The three year period 1972/73 - 1974/75 has shown a marked accel- eration in Guinea's overall economic growth. Indeed, after 14 years of - 7 - slow economic expansion, averaging less than 1.3% per annum in real terms (and never exceeding 4.5% in any one three year period during this time), real GDP at factor costs increased by an annual average of 7% between 1971/72 and 1974/75. This reflects the start of exploitation in two major bauxite mines, the Boke mine, financed by the World Bank and a consortium of international aluminium companies, and the Soviet financed OBK mine near Kindia; nearly three-fourths of the incremental growth of GDP over these three years is directly attributable to these two projets. The remainder resulted primarily from a substantial expansion of rural output, as agricultural production was recovering from the exceptionally unfavorable rainfall conditions in 1971/72 and from widespread cassava sickness; to a minor extent it was due to an expansion of high sea fishing after introduction of modern fishing equipment. Thus, most of this satisfactory growth in rural output represents simply a recovery to previous production levels after an exceptionally bad number of years, while the longer term rural growth trend remained low (less than 2% p.a. between 1969/70 and 1974/75), reflecting the continuing serious problem of lack of incentives for rural producers. With contruction coming to an end at the two large mining projects, activity in that sector sharply declined, creating unemployment problems in the modern sector; while Government had hoped to have a new mining project ready for construction by the time the Boke and OBK projects were completed, several factors prevented such a smooth transition, creating an interlude of several years with very little construc- tion activity. Public administration hardly expanded (in real terms) during the three year period, while manufacturing expanded quite substantially, with several new enterprises starting production; however, this sector remains too small to have a major impact on overall economic growth, particularly as long as its many fundamental problems are not solved (see paragraph 1.39 on public enteprises). 1.16 Despite this rapid economic growth during the last three years real GDP per capita has not yet fully reached its pre-independence level; GDP reached nearly $190 in 1974/75, and GNP about $180, still low figures in view of the economic potential of the country. Rough approximations suggest that per capita revenues of the urban population are still substantially below the 1960 level, while rural incomes are very close; in consequence, the urban- rural income differential has narrowed considerably from about 17:1 in 1960 to about 11:1 in 1974/75. However, considering the two completely - different economies in which these segments of the population live such a comparison is of little significance in the case of Guinea. Nevertheless it is in line with the many observations made in Guinea recently to the effect that the least favored segments of the population to date are probably the lowest paid employees in towns. .- 8 - Text Table 1/2: REAL GROWTH OF GDP AT FACTOR COSTS 1971/72-1974/75 (in billions sylis at 1974/75 prices) Average Annual 1971/72 1974/75 Growth Rural Sector 5.53 6.37 4.8% Mining 1.04 3.11 44.0% Manufacturing, power 0.63 0.85 10.3% Construction 0.91 0.39 -24.5% Services 1.94 2.10 2.7% Public administration 2.33 2.35 0.3% 12.38 15.17 7.0% Source: Mission Estimates. 1.17 During the 1971/72 - 1974/75 period, there have been two major policy changes bearing on overall economic growth, particularly in the rural sector. First, the Government has made another attempt to organize rural production along non-individual lines, by creating rural brigades, partially mechanized, partially using animal traction. This project will be assessed briefly in the discussion of the public investment program below (see paragraph 1.36). 1.18 The other important change in policy concerns the complete take-over of all trade by the public trading system. Public trading companies were organized and supplemented not only on the national level but also on the regional and local level with a public wholesale agency in each region and a store in each village. This new system has completely replaced rural private trade, including the traditional vegetable and fruit markets in each urban center. If past experience can provide any guidance, it seems very doubtful indeed whether this elaborate and cumbersome system can market all rural produce and supply the Guinean farmer in a satisfactory way with all the goods he is interested in, to provide the necessary incentives for him to increase production and to sell his produce in the official market. Much will depend on the amount of imported consumer goods that will in fact be channeled to the regional local trading companies and on their ability to transport these goods to the hinterland for distribution, once they have received them. In both respects bottlenecks have already occurred. 1.19 This particular policy change notwithstanding, there can be no doubt that improved management of Guinea's economy has improved over time reflecting evolution in quality of the medium and higher level civil service. The severe economic problems Guinea had to face over the last 15 years provided a unique opportunity for the country's managers to become experienced in the handling of economic problems, even though progress involved a difficult and costly process of trials and errors. This has resulted in the emergence of an increasing number of well trained and experienced civil servants who are more apt to take decisions in rational ways than in the past, and who are becoming increasingly more influential even though decision making is still highly centralized. In addition, the substantial efforts made in the past in education and training are beginning to show results. -9- Foreign Trade and Balance of Payments 1.20 For foreign trade and the balance of payments, which constituted the most serious bottlenecks to satisfactory economic development in the past, the year 1972/73 was a major turning point. Although it marked the worst perfor- mance over a decade, 1972/73 also appears to have ended a trend of deterior- ation that started in L962. There has been substantial improvement since then. 1.21 Export performance up to 1972 was characterized by a gradual overall decline in real terms with slight growth in mineral exports being more than offset by the continuous deterioraton in exports of rural products, parti- cularly bananas. 1/ The negative trend of rural exports continued unabated after 1972 but in 1973/74 with the beginning of production at Boke and OBK, bauxite exports more than made up the difference. From zero in 1972/73, bauxite exports increased to nearly 55% of total exports in 1974/75, which led to a doubling of the share of total exports from 11 to 22% of GDP. It ought to be pointed out that the simultaneous completion of two large mining pro- jects without major delays is itself evidence of good performance. Even though foreign financial aid and foreign know-how played a very important role indeed, the Government's contribution to the smooth implementation of these undertakings augurs well for the execution of further large projects. 1.22 The sharp increase in foreign exchange resources was used in three different ways: first. a very substantial part went to cover the direct for- eign exchange costs of the two mining operations; second it was used to increase imports and third it served to increase Guinea's foreign exchange reserves. For many years, it has been argued that the lack of general imports (i.e. imports other than related investment goods and mining inputs) consti- tuted one of the main bottlenecks for faster economic growth in Guinea and this for two reasons: first, insufficient imports for raw materials and spare parts severely hampered production of local manufacturing enterprises, which operated almost entirely at a small fraction of their capacity; second, insufficient imports of durable consumer goods, textiles, etc., was largely responsible for limited supplies of these products in rural areas and thus for the lack of farmers' incentives to produce more than their own needs. Thus, the stagnation in manufacturing as well as in rural production resulted largely from insufficient imports of products other than investment goods. As shown in the Chart, such imports have more than doubled in real terms between 1972/73-1974/75, reaching their highest level since 1963; in 1974/75 they accounted for 45% of all non-mining related imports. 1.23 This substantial increase was achieved through special import programs undertaken by the Government, designed to help satisfy the observed excess demand in the country, to reintegrate the rural sector into the modern sector of the economy, and to stimulated rural output. However, as discussed in more detail in 1/ From a peak of nearly 100,000 tons in the early 1960's, banana exports declined to virtually nil by 1972. GUINEA: MAIN TRENDS IN FOREIGN TRADE: 1956 - 1975 MILLION SYLIS IN 1974/75 PRICES 3,000, I* II 0 -Total gross exports /** 2,000 I"*... Imports of general merchandise excl. food, fuel and investment goods 1,000 I I I 0 I | | n|-73C 1956 1958 1960 1962 1964 1966/67 1968/69 1970/71 1972/73 1974/75 Wornd Sank-17301 - 10 - the section on monetary policies, it is not at all certain whether without supplementary monetary measures, additional imports can close the enormous gap between supply and demand. In addition, it is difficult to judge what part of this additional supply has indeed reached the rural population, where it is most urgently needed. The sharp increase in general imports was accompanied and facilitated by declining imports of foodstuff reflecting better rainfall conditions in Guinea, and by much lower imports of investment goods. Text Table 1/3: CONSUMPTION, INVESTMENTS AND SAVINGS (in billion sylis at 1974/75 prices) 1971/72 1974/75 sylis % 1/ sylis % 1/ Consumption: private 11.86 81.5 11.73 71.4 public 2.60 17.9 2.95 17.9 Total 14.46 99.4 14.68 89.3 Investments 2.81 19.3 2.01 12.2 Balance of goods and services -2.73 -18.7 -0.25 -1.5 GDP (at market prices) 14.54 100% 16.44 100% Domestic savings 0.08 0.6 1.76 10.7 National savings -0.58 -3.9 0.97 5.9 National savings gap -3.39 120.6 1/ -1.04 51.7 1/ 1/ In percent of GDP, except for the national savings gap which is expressed in percent of investments. Source: Mission estimates. 1.24 Lack of reliable balance of payments data precludes a detailed assessment of the effect of the increasing foreign exchange proceeds on the foreign exchange situation in general. Movements in foreign exchange reserves are assessed in the context of overall monetary policies; they show a marked improvement up to March 1975 but a substantial decline thereafter, so that total net foreign exchange holdings have only slightly improved between 1972 and 1975. A rough balance of payments estimate for 1974/75 is provided below: - 11 - Text Table 1/4: ESTIMATED BALANCE OF PAYMENTS - 1974/75 (in billions sylis at current prices) Current Account: Imports -3.81 Exports 3.86 Services (net) -0.30 Balance of goods and services -0.25 Transfers (net) -0.79 Total current account -1.04 Capital Accounts: Private capital (net) 0.50 Public capital (net) 0.43 Total capital account 0.93 Errors and Omissions -0.01 Decline in reserves 0.12 Monetary Policy 1.25 The Government has also moved in the right direction on monetary policy, but the question still remains whether continuation of this policy is by itself enough to achieve - within a reasonable time period - the desired results. In October 1972, the Guinean Franc was replaced by the Syli in a proportion of GF 10 to Syli 1. The main goal of this operation - which was similar to the 1956 introduction of the "Nouveau Franc" in France - was to better control money circulation, particularly the outflow of bank notes to neighboring countries, and thus to reduce smuggling; in addition it resulted in a slight reduction of money supply. Since then, Government followed Text Table 1/4: MONETARY STATISTICS 1971-1975 (in billions sylis, end of month) 1971 1972 1973 1974 1975 Sept Sept Sept Sept Sept Dec Net foreign exchange reserves -1.97 -1.29 -0.66 -0.82 -0.70 -1.15 Credit to the economy: - central 2.67 2.06 2.19 2.02 0.61 0.89 - other 7.12 7.65 8.18 9.37 11.14 11.86 Money: - currency in circulation 3.50 3.88 3.29 3.99 3.96 3.64 - demand deposits 3.75 3.55 4.18 5.16 4.99 5.69 Other deposits 0.91 1.27 1.58 1.99 2.34 2.43 Miscellaneous -0.34 -0.28 0.66 -0.57 -0.24 -0.16 GUINEA: MAIN MONETARY TRENDS (ANNUAL FLOWS) 3 YEAR AVERAGES IN MILLION SYLIS 1,000 - 00 Total credits to the economy 750 500.**** * Increase in money supply 250] ' ..7 -2500 1 / ,w I Changes in net foreign assets (minus =increase in foreign assets) 1962 1963/64 1965/66 1967/68 1069/70 1971/72 1973/74 World Bank-17297 - 12 - policies that were markedly less expansionist than during any period since Independence. Credits to the economy as well as money circulation expanded at a lower rate than total GDP and their relation to GDP improved. At the same time the net foreign exchange position became less negative up to September 1975 but worsened again during the last quarter of 1975. 1.26 Total credit to the economy expanded at an annual average rate of 6.6% as compared to 15.2% for GDP at current prices so that its share in total GDP declined from 90% in September 1972 to 71.5% in September 1975, (78% in December 1975). This slow-down was due to a sharp fall in Central Bank advances to the Central Government from sylis 2 billion to 0.6 billion reflecting the increasing budget surpluses after mining revenues rose sharply in 1974. Since 1974, the Government very consciously followed conservative budget policies, giving high priority to reduce its debt towards the Central Bank, as a means to reduce monetary circulation. However, credit to public enterprises increased nearly as fast as GDP and substantially faster than in the past (14.2% p.a. during 1972-75 as compared to 10.5% p.a. during 1966- 1972). In consequence, there has been a marked shift in the composition of outstanding credit. Clearly, public enterprises account for the major part of credit expansion in Guinea; their growing needs still constitute a major weakness in overall economic performance. The divergence in trends between credit to the public enterprises and credit to the Central Government reflects the Government's point of view that only credit to the Government is infla- tionary while credits to public enterprises are not, as they create not only increasing demand but also the necessary supply to satisfy that demand. This, unfortunately, has not been the case since the financing of current public enterprises deficits has not produced any additional supplies, while credit for public enterprise investments has provided additional goods only after a considerable time lag, if at all. 1.27 Money supply expanded even slightly less than total credits, namely by 6.4% p.a. as compared to 11-15% p.a during the 1960-72 period, and declined as a proportion of GDP from 69% in September 1972 to 54% in September 1975 (56.7% in December 1975). In spite of this recent improvement, however, Guinea's money supply is still way above countries with comparable economies. For example as a general rule in West Africa money supply averages no more than 20-25% of GDP. Applying this yardstick to Guinea in 1975, money in circulation would not have exceeded a maximum of sylis 4.0 billion, or 2-3 times less than the sylis 9.3 billion actually attained. Consequently, while the money overhang has no doubt been reduced considerably over the last three years, it is far from having been fully absorbed, and the dual economy still exists as a major factor hampering future economic developments. 1.28 Two conclusions can be reached from the changes in the monetary situation briefly described above: (i) the Government is no doubt determined to improve the monetary situation, to correct the results of past GUINEA: LOCAL BANK LENDING TO THE PUBLIC SECTOR (ANNUAL FLOWS) 3 YEAR MOVING AVERAGES IN MILLION SYLIS 1,000 Total lending to the public sector 500 -- Lending to Government 0• Lending to public enterprises -500 -1,000 1961 62 63 1964/5 1967/8 1970/1 World Bank-17295 - 13 - overly expansionary policies, and to do away with the profound disequilibrium between supply and demand (at official prices), the flourishing parallel market and the rationing of basic consumer goods in towns; this is very much in line with the position the Bank has taken for a long time; (ii) while policies have moved in the right direction, the limited results achieved so far indicate that additional measures may be needed. The policy implemented since 1974 consists basically of using a substantial part of new mining revenue to increase the supply of imported consumer goods and thus to satisfy more of the huge surplus demand created by a decade of inflationary money expansion. However, an enormous gap still exists between supply and demand, considering the need to use government mining revenues primarily for development purposes (to increase current budget expenditures for maintenance, agriculture, education and health, or to step up public investment) rather than to mop up excess demand. Guinea could still derive major advantages from a monetary reform. Such a measure would aim to narrow the gap not only by increasing supply, but by reducing nominal demand especially in urban areas through a reduction in money supply. This possibility ought to be assessed carefully, based on an objective analysis of its advantages and drawbacks, and is briefly discussed at the end of the second part of this report [paragraph 2.48]. Public Finance and Public Investments 1.29 Guinea's public finance situation has improved considerably since 1972/73. Budgetary revenues increased by some 22% p.a.; current budget expenditures by nearly 15% (slightly less than GDP); and the net current budgetary position swung from a deficit of 2% of total revenues in 1972/73 to an expected comfortable surplus of nearly 14% of revenues in 1975/76. This improvement was achieved mainly by the Government not using the sharply increased revenues from mining to go on a spending spree, but to reduce its indebtednes vis-a-vis the Central Bank. .- 14 - Text Table 1/6: CURRENT BUDGET: SUMMARY ACCOUNTS (in billions sylis at current prices) 1963 1971/2 1972/3 1973/4 1974/5 1975/6 lb Current revenues 2.36 2.35 2.77 3.05 4.25 Current expenditures Ll 2.24 2.40 2.77 2.96 3.66 Net results +0.12 -0.05 - +0.09 +0.59 Current revenue in % of GDP at factor costs: 22.6% 25.2% n.a. n.a. 20.0% 25.4% /a Before debt service b Preliminary 1.30 Government revenues have averaged well above 20% of GDP at factor costs for many years. In 1974/75 the share of the revenues in GDP was low due to the fact that tax revenues from mining lagged somewhat behind the fast increases in mining production. However, tax revenue rose again in 1975/76, which contributed considerably to the substantial improvement in the net current budget surplus. -15 - Text Table 1/7: CURRENT BUDGET EXPENDITURES BY MAJOR SECTORS (in percent) 1970/71 1971/72 1972/73 1973/74 1974/75 Economic Services Rural development 0.6 1.6 1.5 3.6 2.0 Industry 0.6 0.9 0.6 2.5 0.7 Transport, public works 10.0 11.8 12.6 10.1 11.2 Total economic services: 11.2 14.3 14.7 16.2 13.9 Social Services 34.7 34.6 33.3 32.7 32.7 Social Security 4.4 5.2 7.4 7.6 5.4 Other Current Expenditures /a /b 49.7 45.9 44.6 43.5 48.0 Total Current Expenditures /a 100.0 100.0 100.0 100.0 100.0 1964- 1966- 1968- 1970- 1971- 1972- 1973- 1974- 1975- 65 67 69 71 72 73 74 75 76 Wages and Salaries 67 68 71 71 74 68 74 68 68 Materials, Maintenance 28 29 28 25 26 30 25 31 30 Other Current Expenditures /a /b 5 3 1 4 - 2 1 1 2 Total Current Expenditures /a 100 100 100 100 100 100 100 100 100 /a Excluding debt service. /b No further breakdown available. 1.31 Between 1971/72, and 1974/75 current expenditures have increased almost in line GDP, i.e. by some 15% p.a. in current prices and 5.2% p.a. in real terms. At the same time, the structure of current expenditures changed as shown in Text Table 1/6. The share of wages and salaries, which had reached a peak of 74% of total current outlays in the early 1970's, declined again to about 68% in 1974/75 and 1975/76, while that of expenditures for materials and maintenance increased from 25 to 30%, resulting in a nearly 18% p.a. growth of such expenditures during the 1972/75 period. As a result, the severe lack of material that had seriously hampered functioning of the public - 16 - administration has somewhat subsided, even though the share of materials and maintenance remains rather low. Thus, while the trend is in the right direc- tion, additional changes in priority ought to be implemented over the coming years. 1.32 However, the improved overall budgetary performance, as reflected in the current budget surplus, could only be achieved by (a) compressing expendi- ture on economic services (rural, industry, transport), the share of which has even slightly declined since 1971/72 to a very low 13.9% of total current budget outlays in 1974/75. In a country with over 85% of total population living in the rural sector, the allocation of only 2% of current budget out- lays to agriculture, livestock and fisheries seems excessively low; (b) by failing to meet public debt service obligations. This problem is discussed in more detail below. 1.33 In Guinea, public investment is tantamount to total investment. The only sector where private investments are still important is the rural economy; but these investments are outside the money economy and are not recorded in the national accounts either as investment or savings. In addition, there is a limited amount of private housing construction going on in towns. Mining investments are considered public investments in this analysis even though majority held foreign private companies finance and implement a substantial part of it. 1.34 Public investments are mostly carried out in the framework of Development Plans. Three such plans have been formulated since Independence. The second one, a seven-year plan, ended in 1971; while the third, a five- year plan covering the period 1973-78 came into effect in October 1973. It foresees total investments of some syli 59.4 billion, or nearly 12 billion per year, of which somewhat over one third is to be implemented by the Gov- ernment and the remainder by the semi-public sector, primarily for mining development including infrastructure. Thus, mining and related projects account for close to two thirds of the plan total, while the share of rural investments is less than 5%. However, this plan does not fully reflect Government priorities; since its publication, Government declarations and actions reflect more emphasis on rural development. 1.35 During 1972-75 the overall investment volume fell nearly 50% after completion of the two large mining projects, while rural investments increased quite substantially, reaching a level in real terms never attained before. As a result, the share of rural development outlays increased from an average of 7% of total Plan outlays through 1972/73 to 26% and nearly 50% in 1973/74 and 1974/75 respectively. - 17 - Text Table I/8: PLAN INVESTMENTS (Annual averages in billion sylis at 1974/75 prices) 1960- 1964- 1966- 1968- 1969- 1970- 1970- 1972- 1973- 1974- 63 66 68 69 70 71 71 73 74 75 Industry, Mining 0.44 0.33 0.91 0.49 0.09 1.90 1.14 1.42 0.19 0.21 Rural 0.34 0.06 0.21 0.16 0.33 0.07 0.08 0.04 0.22 0.56 Other Sectors 1.83 1.39 1.89 1.90 0.71 0.60 1.31 0.74 0.42 0.36 TOTAL: 2.61 1.78 3.01 2.55 1.13 2.57 2.53 2.20 0.83 1.13 1.36 The large increase in the volume of rural public investments is a positive element in the Government's recent performance; however, the quality and appropriateness of these investments is a different issue con- sidering that the largest part of the increased rural outlays consisted of the purchase of several thousand tractors to equip the newly created mechanized rural brigades. This report does not seek to assess in detail the present situation in the rural sector which should become much clearer once the results of the two sector studies on rice and livestock undertaken in the framework of the Bank's Daboya pineapple project have been completed. How- ever, it might be observed generally, that Guinea has attempted more than once to organize its rural sector along collectivistic lines, with no lasting success; it has also tried to introduce tractors in the past with no positive results. It is difficult, therefore, to believe that a combination of the two unsuccessful approaches would result in a more positive outcome, parti- cularly as long as the fundamental problems of incentives for the rural producer are not satisfctorily solved. Even then, it would seem more prudent and more promising to attack the problem of modernizing Guinea's rural economy in a step by step fashion, rather than by trying - as is the case now - to change and improve the whole rural sector in one stroke. Even if the neces- sary financial means were available, absorbtive capacity constraints would demand a more cautious approach. 1.37 The other half of public investments, not devoted to the rural sector, was divided almost equally between the mining sector, transport and communica- tion and other sectors. Completion of Boke and OBK as well as preparation of the Nimba iron ore project accounted for the bulk of mining investments, while investments in all other sectors concerned a wide number of small projects, including paving of the Kissidougo-Kanhan, and Kissidougo-N'Zerekore highways. 1.38 There are no official data on the financing of public investments, and estimates are difficult to make. However, with budgetary savings (before debt servicing) consistently less than foreign debt service obligations, net investable public savings most likely were negative during the latest years, and public investments were financed amost entirely by foreign capital inflow - 18 - either directly or through drawings within the framework of bilateral payments agreements. This situation might have changed somewhat in 1975/76, consi- dering the marked improvement in budgetary savings. The high disbursement figures for foreign aid (over sylis 2 billion in 1974/75), which exceeded by far total investment figures, seem to indicate that the latter have been underestimated, even allowing for the possibility that part of foreign bor- rowing was used to finance current consumption. Public Enterprises 1.39 The situation of public enterprises remains a major weakness in Guinea's economy. Capacity utilization stagnated at 30% for manufacturing enterprises, and their contribution to financing public investments seems to have remained very limited indeed, as has their contribution to the supply of consumer goods for local consumption; furthermore, their demand for Central Bank advances seems inexhaustible. Part of their difficulties is clearly due to certain general economic problems mentioned in paragraph 12 above, such as lack of local raw materials at official prices, lack of imported raw materials and spare parts. In addition, the very cumbersome administrative system is a serious handicap for these enterprises, and makes it almost impossible for them to respond to developments in the economy. 1.40 Recently the Government took the courageous decision to close down some of the most hopeless cases, including the textile factory, one of the largest manufacturing enterprises in the country. More enterprises might be closed down if they clearly have no prospects of covering their costs. In addition, the Government has undertaken a study of eleven enterprises to evalute the possibilities for rehabilitation. The Government is also setting up, with UNDP assistance, an industrial repair center that ought to help overcome the lack of such services in the country. 1.41 Based on the preliminary study of the eleven enterprises, Government is actively seeking foreign financial aid and advice to implement a rehabil- itation program. Discussions have already taken place with EDF and the Bank, and both institutions are following these up. The outlook is helped by a clear improvement in the quality of the managerial staff in most public enterprises. Foreign Debt Management 1.42 Guinea has had a heavy foreign debt burden for many years, which has syphoned off an increasing portion of scarce foreign exchange. In spite of several debt rescheduling agreements, the situation became unmanageable in the early 1970's, and by mid-1976 Guinea had accumulated arrears of nearly US$113 million (sylis 2.2 billion), while debt service obligations in that year (excluding arrears) reached some $80 million or over one fourth of estimated export proceeds. However, actual payments were at most 20% of what was due. Half of the arrears were due to socialist countries, primarily the USSR and China and some 44% to industrialized countries, particularly Ger- many. At the end of September 1975, total debt outstanding and disbursed, - 19 - including payments agreements, reached some $840 million (sylis 16.52 billion) or slightly over 100% of total GDP for that year; over 80% was in the form of long term loans and only 12% were supplier credits. 1.43 Although Guinea still faced an extraordinarily difficult debt situation in 1975/76, there had been some improvements since 1972. The total amount of outstanding and disbursed debt increased much more slowly than before; while it had doubled during the four years 1968-72, it increased by 50% during the three years 1972-75. Since exports increased much faster, the relation of total debt outstanding to exports fell dramatically after having risen almost year by year before. Foreign debt also increased at a marginally slower pace than GDP. Text Table 1/9: DEVELOPMENT OF PUBLIC DEBT OUTSTANDING /a Excluding undisbursed but including bilateral payments agreements (in billion sylis at current prices) /b Total Debt In % of exports In % of GDP 1963 Dec. 2.82 229 52 1966 June 3.75 293 1968 Dec. 5.46 420 69 1970 Sept. 7.09 554 1972 Sept. 10.85 905 101 1973 Sept. 13.75 595 1974 Sept. 14.50 398 1975 Sept. 16.52 365 100 /a Disbursement figures by source of foreign aid are provided in para. 2.45, text table 11/16. /b At syli 19.65 the US$. 1.44 The improvement is not only due to the slower increase in indebted- ness over the past three years. Up to 1972 the massive inflow of foreign loan capital was not used in ways to create the debt servicing capacity necessary to assure its repayments. The factories financed with foreign funds worked badly if at all, and foreign borrowing also financed current consumption. However, the Boke and OBK mining projects, which accounted for most of the recent borrowing, are not only able to cover their own debt service but in addition will provide a substantial amount of freely usable foreign exchange to the Government in the form of taxes and profit sharing. Thus, for the first time, export proceeds have increased faster than total indebtness, and while the short term outlook remains difficult, the longer term outlook has much improved. - 20 - PART II THE MEDIUM TERM OUTLOOK FOR ECONOMIC GROWTH A. Introduction 2.1 There can be little doubt that Guinea reached a turning point around 1974 when its economy swung from a period of long stagnation into one of growth, which is almost certain to continue during the coming decade. Since 1974, production has increased by 7-8% p.a. in real terms and might expand faster over the coming years; exports will increase even more rapidly and so will budget revenues. Concurrently, the foreign exchange constraint, the major bottleneck for faster economic growth during the past 15 years, will become less binding. However, Guinea still faces severe medium term difficulties and even under the best of circumstances higher export growth and capital inflows will not create enough foreign exchange to satisfy all the country's needs at once. Limited foreign exchange resources will continue to require a careful setting of pri- orities and policies, and will become particularly urgent if the "best of cir- cumstances" do not materialize because of lower than expected export prices or of slower implementation of new mining projects. The following analysis shows that postponement of just one of the major mining projects under prep- aration would seriously worsen the medium term outlook. 2.2 Growth of resources (foreign exchange as well as budgetary revenues) in Guinea over the next 10 years and for a long time thereafter will be dominated by what will happen in the mining sector. By 1985 mining is likely to become the leading sector in local production reaching or even exceeding rural value added; it will account for virtually all exports, for the bulk of Government revenues and for most of the country's investments. The projection model therefore treats the mining sector explicitly and examines the effects of four different sector hypotheses, i.e. two alternatives for project imple- mentation and two alternative export price projections; furthermore it con- siders two different hypotheses concerning the inflow of foreign capital. For project implementation hypotheses I assumes that the Nimba iron ore project MIFERGUI will be ready to start production by the end of 1982; hypothesis II assumes that the project will not be undertaken during the period under consideration. The Nimba project has been selected as an example of a major mining project; results would be similar, if instead of Nimba, another major mining project as Aye-Koye were delayed. 'For prices hypothesis A assumes that world market prices for Guinea's export (i.e. primarily bauxite, aluminium and iron ore) will follow the projections made by the World Bank in November 1976; hypothesis B assumes that these prices will not increase as fast as foreseen now, and by 1985 will be 10% below the level predicted for that date in November 1976. 2.3 The assumptions concerning the inflow of foreign capital are closely related to the projected level of public investments (including - 21 - mining), which in turn is determined primarily by absorptive capacity con- straints; availability of foreign capital (private and public) is not con- sidered a limiting factor (para. 2.45). As about three quarters of total projected investments will be in the mining sector, financed to a large extent by the foreign private sector as in the past, total foreign capital inflow is expected to include a large element of private capital in addition to foreign aid (para. 2.45, Text Table 11/15). Obviously, public investments, and thus the projected level of capital inflow, differ substantially between hypotheses I and II, i.e. whether the Nimba project is implemented or not (Text Table 11/12). In addition, however, two other scenarios have been analysed, that are superimposed on the above considerations; the main scen- ario (hypothesis "b") assumed that over the entire period foreign capital will finance all foreign costs (estimated to average 55-60 percent of total investment costs) of all investments, but no local costs. Hypothesis "a" assumes that over the three years 1977-79, foreign capital inflow will fi- nance more than just the foreign cost of new investments so as to provide Guinea with some untied foreign exchange needed to amortize its foreign debt arrears; starting in 1980 foreign capital would cease to finance any local costs but would finance only the foreign cost of projects, as in hypothesis "b". Text Table II/1: MAIN PROJECTION HYPOTHESES Foreign Capital Nimba Project World Market Prices Inflow I/A/a included normal high I/A/b included normal normal I/B/b included low normal II/A/b out normal normal II/B/a out low high II/B/b out low normal 2.4 By combining these three sets of hypotheses, six different sets of projections were made as summarized in Text Table II/1. All six are fully documented in the annex tables; however, the discussion in the text generally does not treat all six hypotheses, but distinguishes only between two, called the "most optimistic" and the "least optimistic" assumption. In virtually all respects, the "most optimistic" corresponds to hypothesis I/A/b and the "least optimistic" to hypothesis II/B/b, i.e. the foreign capital inflow is "normal" in both of them. The two hypoth6ses with high foreign aid inflows ("a") are treated only with reference to the issue of the pace of amortization of foreign debt arrears (Text Table 11/6). B. Growth of Production 2.5 With a total GDP estimated at less then $840 million in 1975, any investment as large as the $500 million operation planned at Nimba is bound - 22 - to have a marked impact on almost every economic variable. In these circum- stances, projections of macro-economic trends or the use of such parameters as elasticities, ICOR's, etc., are not relevant for the Guinea economy as a whole. Just about every figure presented in this projection could change in relation to changes in large projects, a caveat which ought to be kept in mind throughout the remainder of the analysis. 2.6 Text Table 11/2 summarizes the main overall economic growth indica- tors in real terms. It shows that growth of 7 to 8% per year can be expected over the next decade with little difference between GDP and GDY as the pro- jected terms of trade show virtually no change. Even deducting the increasing transfer payments closely related to the mining industry, the expected real growth of 6.5 - 7.4% in GNY over an entire decade is a very satisfactory prospect indeed. This is particularly so, since 1985, the last year in our series, is unfavorable in that we assume completion of a major mining project early that year creating a sharp drop in construction activities while the new mine will not yet be producing at full capacity. - 23 - Text Table 11/2: MAIN ECONOMIC GROWTH INDICATORS 1975 1980 1985 1975-80 1980-85 1975-85 at 1975 prices average annual growth GDP (billion syli) Rural sector 6.37 7.51 9.14 3.4% 4.0% 3.7% Mining 3.11 5.26 9.65/8.23 11.1% 12.9/9.4 12.0/1.0.2 Manufacturing, power 0.85 1.38/1.27 1.94 10.2/8.4 7.0/8.8 8.6% Construction 0.38 2.32/1.21 1.45 43.2/25.7 -9.9/3.7 14.2% Services 2.11 3.47/2.86 4.21/4.13 10.5/6.3 4.0/7.6 7.2/6.9 Public admin- istration 2.35 3.39 4.98 7/6% 8.0% 7.8 GDP at factor costs 15.17 23.33/21.50 31.37/29.87 Indirect taxes 1.27 2.67/2.05 3.06/2.92 16.0/10.0 2.8/2.7 9.2/8.7 GDP at market prices 16.44 26.00/23.55 34.43/32.79 9.6/7.5 5.8/6.9 7.7/7.2 GDY 16.44 26.30/23.65 35.53/32.29 9.8/7.5 6.2/6.4 8.0/7.0 GNY 15.65 24.79/22.18 31.96/29.45 9.6/7.2 5.2/5.8 7.4/6.5 Import capacity /a 4.58 8.29/8.06 16.89/12.53 12.6/12.0 15.3/9.2 13.9/10.6 Per capita GNY Sylis 3.530 4,920/4,400 5,580/5,140) ) 6.9/4.5 2.6/3.2 4.7/3.9 US$ /b 180 250/224 284/262 ) /a Exports at current prices deflated by the import price index. /b At the official exchange rate of Syli 19.65 per US$. Remarks: The high figures refer to hypothesis I/A, the most optimistic hypothesis. The low figures refer to hypothesis II/B, the least optimistic hypothesis. The other hypotheses are between these two extremes. 2.7 Mining alone accounts for nearly one third of the expected incre- mental increase in value added. Rural production - virtually stagnant in the past - is projected to resume growth with public investments giving increasing priority to this sector; public administration ought to expand rapidly, stimulated by the urgent need for improved public services in many sectors sustained by the expected sharp increases in budget revenues. Manufacturing and services, while expected to increase quite rapidly, account together for less than one third of the expected incremental growth. Detailed underlying assumptions are given in paragraph 2.9. 24 - 2.8 Such a development pattern would broaden Guinea's economic base as it would change from a predominantly rural economy in 1975 to an economy equally based on mining and rural production by 1985. In.1975 rural produc- tion accounted for a high 42% of GDP (at factor costs), while the share of mining, the second most important sector, was less than half of that (20.5%) and all other sectors together accounted for less than rural output (38%). By 1985 rural and mining might each contribute about 30% of GDP with the share of all other sectors together virtually unchanged. 2.9 The projected substantial growth of GDP is reflected also in per capita revenues. Corrected for changes in Guinea's terms of trade (favor- able in case of the normal price assumptions, unfavorable by using the lower prices, but small in any case) and for transfers of interest and profits, real per capita revenues are projected to improve by nearly 4-5% per year or by some 50-60% over the entire decade. It ought to be major policy goal of the Guinea Government to make sure that this rise in income is channeled to pro- ductive activities which will improve the economic prospects for the bulk of the country's population. 2.10 ' The basic assumptions concerning mining sector development are summarized in Text Table 11/3. Hypothesis I assumes that all five mining projects listed in this table will be implemented on schedule; hypothesis II assumes that the Nimba project is left out altogether but that all other projects are completed on time. These are no doubt ambitious objectives, that will not be achieved easily but will demand determined efforts by Government to speed up project preparations in cooperation with its foreign partners. Government has proven in the past that it is capable to do so. GDP PAST AND FUTURE AT 1975 MARKET PRICES 30 Total GDY RIS total Total GDP in billion sylis Per capita GOP in thousand sylis 25 20.' 101 Per capita GDPI• Per capita GDY 1960/61 1963/64 1966/67 1969/70 1971/72 1974/75 1976/77 1979/80 1982/83 1984/85 World Bank-17293 - 25 - Text Table 11/3: ASSUMPTIONS ON FUTURE MINING DEVELOPMENTS 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 Mining Construction OBK (Kindia) completed Boke I completed Boke II (extension) Friguia extension I Friguia extension II Nimba Aye-Koye Mining Production and Exports (million tons) Bauxite: OBK 2.5 3.0 3.0 3.0 3.5 3.5 3.5 3.5 3.5 3.5 Boke I 8.1 8.1 8.5 8.5 9.2 9.2 9.2 9.2 9.2 9.2 Boke II 0.8 0.8 2.0 2.0 Aye-Koye 3.0 Aluminium: Friguia 0.66 0.66 0.66 0.66 1.1 1.1 1.3 1.3 1.3 1.3 Aye-Koye 1.0 Iron-ore: Nimba 3.0 5.0 10.0 2.11 Growth in the rural sector assumes that the present lack of incen- tives will be corrected. to some extent by improving the supply of consumer goods and rural inputs in rural areas at official prices, thanks to increased foreign exchange earnings. However, no fundamental change in the present system is foreseen. The bulk of increased production is expected to be in rice and fisheries, where growth of 5-6% p.a. in real terms could be achieved, given a sufficient and well focused Government effort. The Bank is actively considering projects in both fields that might come to fruition soon. In most other sub-sectors growth is unlikely to exceed 1.5-2% p.a. Given Guinea's considerable potential in the rural sector, growth could well be higher in the longer term. In the short and medium term, however, absorptive capacity will remain a major bottleneck keeping public investment in this sector relatively low (see paragraph 2.39). 2.12 The high growth rate for construction reflects at the same time projected high investments in mining up to 1984, and also a substantial recovery in production after the particularly depressed year of 1975 when construction activities had fallen to a very low level. Manufacturing is projected to grow fast, but starting from a very low level its impact on overall growth will remain limited. If Government pursues seriously the efforts recently initiated to redress the situation in this sector, including greater allocation of more foreign exchange and high quality manpower to it, a relatively high growth can be sustained during the next decade. - 26 - 2.13 The projected expansion of public administration has more the nature of a policy goal than is the case for the other sectors. It reflects our judgement that Government ought to step up current expenditures in the main development sectors, such as the rural sector, education, health and main- tenance. In many cases money spent for current outlays in these sectors will provide a stronger stimulus to development than additional public investments. (para. 2.33). 2.14 Mining exports are expected to increase by 10-12% in real terms, in line with mining production, and since the terms of trade will be virtually neutral, the country's import capacity in real terms is projected to expand by some 11-14% p.a.; a sharp improvement after many years of near stagna- tion. This factor is going to exercise the most important influence on Guinea's economy over the next decade. As was already the case in 1975, minerals are likely to account for 85-90% of total export proceeds; rural products might account for 6-10%; exports of manufactured goods are unlikely to become significant during this period. 2.15 The final factor likely to have an important impact on the future overall economic situation is the expected increase in Government revenue well in excess of GDP growth. Overall revenue elasticity is projected to average 1.07-1.11; this is due largely to the fast increase in mining re- venues, expected to be well above the growth of mining production, for two reasons: - the two recently completed mines (OBK, Boke) are still in the running-in stage and should reach full capacity and full profitability by about 1980 only; furthermore, the long established Friguia aluminum plant is being expanded at relatively low cost; consequently profits from these three enterprises are likely to go up faster than production; - the effect of world-wide inflation on Guinea's capital intensive mining enterprises has been to increase current revenues relative to unit costs since the latter consist to a large extent of fixed financial charges. Both OBK and Boke were largely completed at relatively low costs before the sharp world wide inflationary push of the mid 1970's, but have started exporting right after this push at much higher prices; thus, they are making size- able windfall profits, a large part of which Government has managed to capture through an increase in export taxes. C. Growth and the Use of Foreign Exchange Resources 2.16 Because lack of foreign exchange has for a long time been the main bottleneck hampering Guinea's economic growth, and a large amount of foreign -27- public debt is presently in arrears, the key element in the projected pattern of growth from a macro--economic point of view is the substantial increase in foreign exchange earnings. This chapter focuses on the impact this increase is likely to have on the Guinean economy during the next decade, and how it can be used most efficiently. Obviously, the way foreign exchange is allo- cated to different uses has a major impact on private and public consumption, rural and manufacturing production, investment and the servicing of foreign debt. A careful setting of priorities in the allocation of foreign exchange between those differenir uses is the more important, as there can be little doubt that not all legitimate claims can be satisfied over the next decade in spite of the expected substantial improvements in import capacity. Over the last 15 years, an enormous backlog of claims on foreign exchange has accu- mulated in the rural sector, in manufacturing and in the form of debt arrears, which cannot be satisfied at once but can only be reduced over time. The future availabilities will need to be allocated among: (a) foreign exchange needed to keep the mining industry running; (b) imports of inputs (raw materials, fuel, spare parts, etc.) for agriculture, manufacturing, transport and other economic activities; (c) imports of a minimum of consumer goods, particularly for sale in rural areas to stimulate rural production; (d) servicing of foreign debt. As mentioned before, the projections assume that all foreign costs of new investments are financed by the inflow of foreign exchange to finance the import content of new investments-in one set of hypotheses, foreign aid is assumed to finance even more than the foreign cost component of investments (see paragraph 2.2 above). Thus, these projections are intended to evaluate (a) how much foreign exchange Guinea can devote to the servicing of its foreign debt, after having met the first three priority needs; (b) whether there is any foreign exchange left after all four priority claims have been satisfied and for what purposes it ought to be used. 2.17 Why this setting priorities, and what does it imply? For mining, the situation is very clear. Mining is by far the most important source of foreign exchange and at the same time cannot operate without a sufficient and regular allocation of foreign exchange. There is a quid pro quo between Guinea's foreign exchange earnings and the provision of sufficient foreign exchange to the mining sector. The foreign exchange needs of the mining sector, as projected in our model, include imports necessary for the current operations of the mines (but not for new investments), the costs of sales and other offices abroad, interest and amortization of the mining related debt as well as transfers of profits by the private partners. In addition, as the Russian-Guinean agreement on the 0BK bauxite mine foresees that the entire Guinean debt vis-a-vis the USSR (mining debt plus all other kinds of debt) will be serviced out of the proceeds of this mine, all debt service payments to Russia are considered as mining related foreign exchange outflows; in fact, - 28 - their level depends on the level of production of the 0BK mine. The mining related foreign exchange outflows are defacto outside Government control and could only be changed by revising the different mining agreements between Government and its partners. At the margin, there might be some possibilities to do that, and to reduce for instance the profits of private partners. However, these profits are a small part of total mining outflows; in addition, as Guinea will depend for a long time to come on the cooperation and goodwill of foreign mining companies to develop its new mines, the country's room for manoeuvre in this respect is limited. Thus, the projections assume that the present mining agreements are not going to be changed. Text Table 11/4: PROJECTION OF GROSS AND NET MINING EXPORTS (in billion sylis at current prices) Estimate Hypothesis I/A/b Hypothesis II/B/b 1975 1977 1980 1983 1985 1977 1980 1983 1985 Total mining exports (Gross) 4.58 6.74 11.91 18.12 33.99 6.66 11.58 15.96 25.22 Mining related foreign exchange costs 2.63 3.63 6.51 8.78 19.67 3.59 6.42 7.30 14.49 Net export proceeds 1.95 3.11 5.40 9.34 14.32 3.07 5.16 8.66 10.73 In % of total exports 42.6 46.1 44.6 51.5 42.1 46.1 44.6 53.3 42.5 2.18 For all practical purposes, therefore, the Government only has at its disposal the net foreign exchange proceeds after deduction of mining related foreign exchange costs, which as shown in Text Table 11/4 above, amounts to 50-60% of total export revenues. The amount of foreign exchange freely usable by the Government during the next decade will thus remain much more limited than suggested by the growth of total exports and total import capacity. After 1985, when all big mining projects reach full capacity, the relation between total exports and net export proceeds is likely to improve as was the case in 1983, giving Government additional flexibility in foreign exchange management. During the next decade, however, and parti- cularly over the next 5 years, the situation is likely to remain quite tight. 2.19 Imports of raw materials and spare parts as inputs into the other productive sectors of the economy are given second priority in the allocations of foreign exchange. Such imports are expected to increase in line with the projected growth of production in these sectors, particularly manufacturing and transport, the two sectors most dependent on imported inputs. Past development in manufacturing and transport was very seriously hampered by lack of foreign exchange. The relatively fast growth projected in these sectors for the next 10 years (8-10% p.a. in real terms) can only be achieved if the allocation of foreign exchange increases at least at the same rate. -29 - 2.20 Imports of consumer goods were projected - as an absolute minimum - to increase in line with population growth (2.6% p.a.) so that per capita imports of such goods remain constant in real terms at their recent level. Considering the past lack of such goods in Guinea and the depressing impact it had on production, particularly in the rural sector, this might be considered unacceptably low. However, two factors make such a conservative hypothesis more palatable: (1) The starting point of the projection model, the year 1975, was a year with exceptionally high imports of general con- sumer goods, 25% above the previous year and about twice the average 1971-73 in real terms; this resulted from the special import program started by Government in 1974. Thus, the projections imply that consumer good imports per capita in real terms are continued on the same level as in 1975, which - while still not very generous - represented a marked increase over previous years. (2) The growth ok manufacturing industries of 8-9% p.a. in real terms projected for the 1975-85 period implies import sub- stitution. The imported inputs for manufacturing should thus indirectly increase local consumption, as they will be used largely to produce goods for local consumption. Taken together, direct and indirect imports of consumer goods - as projected in the model - will be sufficient (a) to allow a 1% p.a. increase in private consumption per capita, in real terms, and (b) to keep constant the share of imports in total public consumption. While still not generous this can be considered a minimum level for the allocation of foreign exchange to local consumption. 2.21 Based on those primary priorities, what will be the country's foreign debt servicing capacity after having deducted from gross export earnings (a) all mining related foreign exchange outflows, (b) the projected inputs of raw materials and spare parts, and (c) a minimum of consumer good imports? Results are summarized in Text Table 11/5 below. In many respects, this is the key table presenting in one picture how Guinea is likely to be affected by the projected sharp increase in exports over the 1975-1985 period. Under the most optimistic assumption, arrears in foreign debt would still increase sharply during the late 1970's and are unlikely to disappear before 1982, even on conservative estimates of Guinea's import requirements. These results underline the urgency of careful foreign exchange management particularly during the five-years 1977-1981. Thereafter, much will depend on which of the hypotheses will materialize; under the most optimistic scenario, Guinea's foreign exchange situation can be expected to develop quite favor- ably; under the least optimistic assumption, however, projected foreign exchange surplus is much too small to predict with certainty whether the country will have overcome its foreign exchange problems by 1985. This inevitably ambiguous conclusion is the main result of our analysis; it emerges repeatedly when assessing the outlook for balance of payments, savings and public finance. - 30 - Text Table 11/5: SUMMARY PROJECTION OF FOREIGN EXCHANGE AND FOREIGN DEBT (in billion sylis at current prices) 1976 1977- 1978 1979 1980 1981 1982 1983 1984 1985 Hypothesis I/A ("most optimistic) Foreign exchange available Net export earnings 1/ 2.86 3.11 3.48 3.35 5.40 6.13 -8.01 9.34 10.7 14.32 Minimum imports of inputs and consumer goods 2.22 2.54 2.93 3.23 3.68 4.10 4.66 5.28 5.93 6.40 Net foreign exchange available for debt service 0.64 0.57 0.55 0.12 1.72 2.03 3.35 4.06 4.14 7.92 Foreign debt service Total debt service payments n.a 0.57 0.55 0.12 1.72 2.03 2.91 0.69 0.71 0.76 Changes in arrears n.a.+0.51 +0.56 1.06 0.57 1.04 2.01 - - - Total debt in arrears 2/ 1.49 2.00 2.56 3.62 3.05 2.01 - - - - Foreign exchange available for other purposes - - - - - - 0.44 3.37 3.43 7.16 Hypothesis II/B ("least optimistic") Foreign exchange available Net export earnings 1/ 2.85 3.08 3.39 3.24 5.16 5.96 7.82 8.66 9.05 10.73 Minimum imports of inputs and consumer goods 2.22 2.54 2.93 3.22 3.66 4.08 4.65 5.27 5.93 6.40 Net foreign exchange available for debt service 0.63 0.54 0.46 0.02 1.50 1.88 3.17 3.39 3.12 4.33 Foreign debt service Total debt service payments n.a. 0.54 0.46 0.02 1.50 1.88 3.17 1.16 0.71 0.76 Change in arrears n.a. +0.55 40.66 +1.17 0.33 0.86 2.23 0.45 - - Total debt in arrears 2/ 1.49 2.04 2.70 3.87 3.54 2.68 0.45 - - - Foreign exchange available for other purposes - - - - - - - 2.23 2.41 3.57 1/ Net of mining related foreign exchange costs 2/ Stock at the end of September of each year. - 31 - 2.22 Foreign debt service payments, as indicated in Text Table 11/5 are determined by one of two variables: either by the amount of debt service due, or by the amount of foreign exchange available, whichever is smaller. In our projections, the latter limit applies until 1981 or 1982; this means that until then Guinea's foreign debt obligations exceed the amount of foreign exchange, so that part of its foreign debt will remain in arrears. After these dates, foreign exchange resources exceed debt service obligations and there will be an increasing amount of foreign exchange available for other purposes such as accumulating a minimum level of reserves, increasing imports or further reducing foreign debt outstanding. Under both hypotheses, the turning point occurs in 1980, the year in which the prior sharp increase in foreign debt arrears comes to an end and their amortization begins. 2.23 One could argue that the substantial increase in available foreign exchange after 1982 permits Government to launch at an earlier date a more expansionary import policy than the one proposed above. Two arguments militate against this: in the short run, the projected sharp increase in foreign debt arrears way above the already high level reached in 1976; in the longer run the inherent risk which strongly limits the significance attri- butable to the projected foreign exchange surplus in later years; this is particularly true for the "least optimistic" hypothesis where the projected surplus is much too small to provide a sufficiently safe base for allowing a less restrictive import policy at an early stage. Text Table 1/6: PROJECTED FOREIGN DEBT ARREARS (in billion sylis at current prices outstanding at the end of September of each year) 1976 1977 1978 1979 1980 1981 1982 1983 Hypothesis I/A (most optimistic) (b) normal foreign aid 1/ 1.49 2.00 2.56 3.62 3.05 2.01 - - (a) increased foreign aid 2/ 1.49 1.33 0.94 1.05 0.60 - - - Hypothesis I/B (least optimistic) (b) normal foreign aid 1/ 1.49 2.04 2.70 3.87 3.54 2.68 0.45 - (a) increased foreign aid 2/ 1.49 1.37 1.05 1.26 1.02 0.27 - - 1/ Foreign aid financing only the foreign exchange costs of new investments. 2/ Foreign aid financing more than the foreign exchange costs of new in- vestments during 1977-79 (para. 2.3). - 32 - 2.24 Concerning foreign debt arrears, the projections indicate indeed a very sharp worsening during the remainder of the 1970's, with total arrears more than doubling from the already high level of nearly ayli 1.5 billion reached in September 1976. Is this tolerable and what could be done to avoid it? The projections in Text Table 11/5 make it clear that Guinea can do little to prevent such a further massive increase in arrears, in spite of the sharp increase in its gross foreign exchange earnings. To keep arrears during 1977-1979 at the 1976 level, would demand a 20-40% reduction in imports of high priority raw materials, other inputs and consumer goods below what was considered a strict minimum in our projections; this could not be done without further aggravating the economic situation in agricultural and manu- facturing sectors. 2.25 The solution, thus, has to be found outside the country. Techni- cally, two possibilities exist: either foreign creditors agree to a resche- duling of much of Guinea's foreign debt in order to keep annual debt service payments within the the levels indicated in Text Table 11/5, or foreign aid donors accept to finance up to 1979 substantially more than the foreign cost component of public investments during the rest of the decade, in order to provide the country with untied foreign exchange it can use to service its foreign debt. The second solution could take the form either of a certain amount of local cost financing in the case of foreign financed investment projects, or of foreign program lending, or of balance of payments support or a mixture of all three. The projections in Text Table 11/6 under the hypo- thesis (a) "increased foreign aid" are based on the assumption that during the three years 1977, 1978 and 1979, foreign aid will finance 75% of total public investments (instead of only the foreign cost component as in the "normal" hypothesis or an average of sylis 900 million (US$46 million) more each year than under the "normal" hypothesis; this would correspond to about 40% of the local costs of public investments. 1/ An average annual inflow of.untied foreign exchange of this level would be sufficient to allow complete amorti- zation of the accumulated foreign debt arrears by 1981 or early 1982. Ob- viously, such additional borrowing would increase debt service in later years, but would not create an unmanageable problem since the longer term balance of payments outlook is much better. 2.26 The two hypotheses presented in Text Table 11/5 result in an accum- ulation of foreign exchange of sylis 14.4 and 8.2 billion respectively above the country's minimum needs during 1982-1985. This looks like a safe margin compared to total imports, which are projected to reach about sylis 20 billion in 1985, but the assumption on which it is based involved a number of uncer- tainties. First, we assume optimistically that foreign aid donors will continue to finance the equivalent of entire foreign exchange costs of all new investments up to 1985; however, if our projections come true, by 1983 Guinea's balance of payments situation will have improved to a point where foreign aid donors might well insist that the country could finance more than just the local costs of investments; in addition, its per capita GNP will have exceeded $500 at current prices ($250-270 at 1975 prices). Therefore, I/ Local cost component of I is estimated to average 41.3%. See Annex table. - 33 - it is not at all certain whether Guinea will find sufficient sources of foreign capital to finance the foreign exchange costs of all projects, in- cluding things like administrative buildings, etc. Second; while the pro- jections foresee the complete amortization of foreign debt arrears by about 1981, they indicate also a sharp increase in Guinea's total consolidated foreign debt, reaching some $2.1-2.5 billion by 1985, with a debt service ratio averaging 25%. Both these figures are very high. However, they can still be considered to remain within manageable limits, because nearly three quarters of this debt is tied to enclave mining projects that can easily generate the foreign exchange necessary for debt service. Nevertheless, it would be most advisable after 1982 to reduce dependence on foreign fin- ancing; our projections show that this is possible by using at least part of the projected foreign exchange surplus after 1982 to finance local investments and thus to reduce the need for foreign borrowing. Finally, to accumulate a minimum of net foreign exchange reserves of one month imports by 1985 an amount of about sylis 2.5-3 billion would be necessary. For a currency that stands entirely on its own, this is an absolute minimum given the possibility of short term fluctuations in export receipts. Text Table 11/7: APPROXIMATE FOREIGN DEBT PROJECTIONS 1975 1977 1980 1983 1986 estimate projections Foreign debt outstanding /a in billion sylis 16.5 18.5 22-25 33-41 42-49 in % of GDP 100% 79% 65% 54-67% 60-70% in % of gross exports 361% 275% 180-220% 200-230% 150-170% Foreign debt service ratio in % of total gross exports - 27.5% 37-38% 21-28% 23-26% non-mining debt in % of net export proceeds /b - 175-185% 29-32% 7-13% 5-7% /a at the end of September, assuming that from 1983 onwards half of freely available foreign exchange is used to reduce foreign indebtedness. /b total gross exports minus mining related foreign exchange costs. Remarks: Up to 1980 the foreign debt service ratio indicates how much the country can_pa to its foreign creditors; for that period its obligations usually are higher than its payments. From 1983 onwards, the foreign debt service ratio indicates how much the country has to pay since from then on Guinea will be in a position to honor all its foreign obligations without arrears. .- 34 - Text Table 11/8: USE OF FOREIGN EXCHANGE EARNINGS IN EXCESS OF MINIMUM NEEDS Hypothesis I Hypothesis II A/a A/b B/b A/b B/a B/b 1. In billion sylis at current prices Accumulation of reserves /a 2.9 2.9 2.9 2.7 2.7 2.7 Reduction in debt 5 /b 7.5 7.2 5.5 5.6 4.5 4.1 13.4% 13.3% 10.1% 11.8% 9.1% 8.7% Increase in consumer imports /c 4.6 4.3 2.6 3.0 1.9 1.4 Total surplus of Foreign exchange accumulated during 1982-85: 15.0 14.4 11.0 11.3 9.1 8.2 2. Percentage changes Reduction in debt lb 13.4% 13.3% 10.1% 11.8% 9.1% 8.7% Increase in consumer imports /c 20.8% 12.5% 11.8% 13.6% 8.6% 6.3% /a From minus syli 1.1 billion in December 1975 to one month imports by September 1985. /b Reduction in total foreign debt outstanding by September 1985, compared to a situation in which no foreign exchange surplus is used to keep down foreign indebtedness. /c Indicates the possible increase in imports of inputs and consumer goods during the four years 1982-1985 over and above mission's estimates of minimum requirements. It is a balancing item. 2.27 Only after these three factors have been taken into account, should more foreign exchange be used to increase current imports. As Text Table 11/8 shows, little will remain available for this purpose. In this table, it is assumed that half of the accumulated foreign exchange surplus (over and above the high priority needs) will be allocated to finance investments or otherwise reduce foreign debt; this would result in a 9-13% lower overall debt - 35 - level by 1985, not a very spectacular change; furthermore, foreign-exchange reserves are increased to a level of one month imports which is a modest target. On these assumptions, the increase in imports of*raw materials, other inputs and consumer goods could reach sylis 1.4-4.6 billion; depending on the hypothesis used, this would be 6.3-20.8% above the mission's estimates of minimum requirements. Under the most optimistic hypothesis (+20.8%), this would provide government with considerable flexibility; under the least optimistic hypothesis, however, (+6.3%) it remains well within the margin of error and this provides very little - if any - room for more expansionary policies now. If by 1980 construction of the Nimba iron ore project were well under way, and the Aye-Koye project at an advanced state of preparation, so that it could be safely assumed that Guinea will move in line with the most optimistic hypothesis, it would indeed be possible to start importing con- siderably more than the minimum level; if not, there would be little scope for increasing imports above our floor level. 2.28 Text Table 11/9 presents the same data as Text Table 11/5 above in a more usual balance of payments presentation. In this latter table, the sur- plus of foreign exchange earnings above the country's minimum needs has not been attributed to different uses, but is shown entirely as an increase in reserves. The very high trade surplus, as well as the relatively low gross foreign capital inflow in 1985 reflect the low level of investments projected for that year, after completion of a major mining project in 1.979. This is discussed in more detail in the following chapter. - 36 - Text Table 11/9: BALANCE OF PAYMENTS, SUMMARY PROJECTIONS (in billion sylis at current prices) Estimate Hypothesis I/A/b /a Hypothesis II/B/b /b 1975 1980 1985 1980 1985 Current Account Imports (goods and service) 4.83 11.66 21.14 9.17 19.29 Exports (goods and service) 4.58 11.91 33.99 11.58 25.22 Trade balance -0.25 0.25 12.85 2.41 5.93 Mining profits -0.11 -0.87 2.80 -0.78 -1.91 Interest on foreign debt -0.68 -1.35 -4.68 -1.36 -3.69 Current account balance -1.04 -1.97 5.37 0.27 0.33 Capital account Gross capital inflow: /d - for mining projects - 3.87 2.42 1.40 3.33 1 - for others - 1.25 2.59 1.25 2.59 - total 1.27 5.12 5.01 2.65 5.92 Amortization 0.34 -3.15 -3.23 -2.91 -2.68 Net capital account 0.93 1.97 1.78 0.26 3.24 Changes in Reserves -0.12 - +7.16 - +3.57 Ia "most optimistic" including the Nimba project and assuming normal world market prices. /b "least optimistic", excluding the Nimba project and assuming normal world market prices. Jc Including some short term advances by foreign mining partners to finance running-in costs of newly opened mines. Id Text Table 11/15 (para. 2.45) includes a breakdown of gross capital inflow by nature (public aid, private borrowing, share capital) and by purpose. 37 - D. Savings and the Financing of Public Investments Macro-Economic Aspects 2.29 Text Table I1/10 summarizes the projected use of resources. The most remarkable feature is the expected substantial improvement in Guinea's savings performance, w-Lth the share of savings in GDP (domestic as well as national) more than doubling even under the least optimistic hypothesis. Nevertheless, under the least optimistic assumption, national savings pro- jected for 1985 are not particularly high (12.9% of GDP), which again shows that in this scenario Guinea's performance would improve compared to the recent past, but the capacity to finance investment would remain quite linted. Under the most optimistic assumption, however, a very satisfactory level of national savings could be expected (18.7% of GDP). 2.30 Two other points are worth emphasizing in this context: (a) Very conservative assumptions about growth of private consumption are necessary to permit liquidation of foreign debt arrears within an acceptable time limit. While total per capita GNY is projected to grow at 4.7-3.9% p.a. in real terms during 1975-1985 (Text Table 11/2), real private consumption per capita is expected to expand by less than half (1.8-1.7% p.a.); thus, the sharp decline in the share of private consumption. Clearly, this represents a sub- stantial improvement over the past but nevertheless raises the question of how it will be possible - economically as well as politically - to keep growth of private consumption so low in an otherwise rapidly expanding economy. It is possible, considering that - as explained in the previous section - a large part of this expansion is taking place in the enclave mining sector and thus is not widely distributed within the economy. Mining output is entirely exported and most of the foreign exchange so created is either used to keep the mines running, to amortize the mining debt, to pay dividends to the private foreign partners, or is accruing to the Government which uses the money to amortize its own foreign debt. Very little is actually distributed to the population in the form of salaries. Even if all the addi- tional imports above minimum requirements made possible by the expected foreign exchange surplus after 1982 (Text Table 11/8) were entirely channeled into private consumption, it could not expand by more than 2.4-2.1% p.a. per capita. This seems indeed the maximum rate that could safely be sustained during the next ten years, but which might well increase substantially thereafter. While this is not particularly high compared with overall economic growth, it does represent a substantial improvement compared with past virtual stagnation. Furthermore, the standard of - 38 - living of most of the population ought to improve more rapidly than their per capita consumption suggests, if current budget outlays are oriented more directiy towards stimulating economic and social development. Increased outlays for education and health have a direct bearing on the standard of living of most Guineans and much of the projected fast increases in public consumption ought to be in these sectors. (b) The projected resource surplus in 1985, i.e. with national savings higher than investments, has to be interpreted cautiously. It is not due to a particularly high saving rate but rather to the low level of investments projected for that year, as discussed briefly in para. 2.39 Text Table 11/14. If investments reached some 18% of GDP as seems reason- able in the years after 1985, national savings would cover only about two thirds of total investments with a national savings gap hardly different from that projected for 1977 and 1983. On realistic assumptions, Guinea.would continue to remain dependent on large amounts of foreign capital for quite some time. - 39 - Text Table I1/10: CONSUMPTION, INVESTMENTS AND SAVINGS (in % of GDP) /1 Estimate Hypothesis I/A/b /2 Hypothesis II/B/b /3 1975 1977 1980 1983 1985 1977 1.980 1983 1985 Consumption: private 71.4 64.8 57.7 54.2 50.5 65.0 59.0 55.5 55.5 public 17.9 18.2 18.7 18.1 20.4 18.3 20.8 18.6 22.7 total 89.3 83.0 76.4 72.3 70.9 83.3 79.8 74.1 78.2 Investments 12.2 17.2 22.9 32.6 11.3 17.2 13.2 33.5 12.6 Balance of goods and services - 1.4 -0.2 0.7 -4.9 17.8 -0.5 7.0 -7.6 9.2 GDP (market prices 100% 100% 100% 100% 100% 100% 1.00% 100% 100% Domestic savings 10.7 17.0 23.6 27.7 29.1 16.7 20.2 25.9 21.8 National savings 5.9 11.2 17.8 21.5 18.7 11.0 1.3.8 21.2 12.9 National savings gap 51.7 34.8 22.5 34.0 -65.8 35.8 -4.2 36.8 -4.0 /I Except for national savings gap, which is in % of domestic investments (= excess savings). /2 "most optimistic", including the Nimba project and assuming normal world market prices. /3 "least optimistic", excluding the Nimba project and assuming lower world market prices. Public Finance Aspects 2.31 Projected public finance developments closely reflect the trends observed in the overall economy, including the balance of payments; i.e. a very substantial improvement, particularly under the "most optimistic" assump- tion while the "least optimistic" hypothesis leads to substantially less satisfactory results; in the latter case the sharply worsening trend for budgetary savings after 1983 is particularly worrysome. 2.32 Budgetary revenues are projected to increase much faster than GDP, particularly mining revenues, reflecting the high profitability of the exist- ing and planned mining ventures in Guinea and the very advantageous agree- ments with the private partners (para 2.14). Thus, direct mining revenues are likely to increase 15-20 times during the 1975-1985 period or from 13% .- 40 - of total budgetary revenues to 33-40%. While increasing much less fast, other sources of revenues also are likely to increase faster than total GDP, reflecting the fact that the modern, more easily taxable sector of the econ- omy is projected to expand faster than the economy as a whole. Thus, the total tax share, which in the past has fluctuated between 18-20% of GDP, might well move up by another 10 percentage points; a very high tax performance indeed. Text Table II/11: PROJECTED CURRENT BUDGET PERFORMANCE Estimate Hypothesis I/A/b Hypothesis II/B/b 1975 1977 1980 1983 1985 1977 1980 1983 1985 Summary (billion syli) 3.06 6.5 11.3 18.8 21.8 6.4 9.7 18.0 18.1 Revenues Expenditures /a 2.96 4.3 7.2 11.1 14.7 4.3 7.2 11.1 14.7 Current surplus 0.09 2.2 4.1 7.7 7.1 2.1 2.5 6.9 3.4 Revenues (in % of GDP) Mining revenues 2.4 8.9 9.9 8.3 12.7 8.8 10.6 7.6 9.4 Other revenues 16.1 18.7 19.6 22.2 17.6 18.7 17.6 22.5 18.6 Total revenues 18.5 27.6 29.5 30.5 30.3 27.5 28.2 30.1 28.0 Current expenditures: Wages, salaries 68 68 64 63 63 Material, maintenance 31 31 35 36 36 Sundries /a I I 1 1 1 Total: _a 100% 100% 100% 100% 100% same Total in % of GDP 18.0 18.3 18.7 18.1 20.4 18.3 10.8 18.6 22.1 Ia Excluding debt service. 2.33 Current budgetary expenditures (before debt service) have been projected to increase by 10% p.a. up to 1980 and by 8% thereafter in real terms or about one third faster than total GDP. This proposed rapid expansion is necessary to overcome the serious underspending during the past 15 years, particularly on maintenance and supplies. In consequence, Guinea ought to increase current budget outlays for these purposes by at least 12.5% and - 41 - 10.5% in real terms during the two periods, while growth in salary outlays should be limited to about 9 and 7% p.a. in real terms or about the same as growth of toal GDP. Even so, the share of maintenance and supplies would only increase to 36% of total current budget outlays by 1985 which is still less than adequate. 2.34 On this basis, current budgetary savings before debt service, would increase very rapidly up to 1983 from less than sylis 100 million in 1975 to about 7-8 billion, or from 3% of revenue to a very high 40%. However, between 1983 and 1985, it is projected to decline by some 10% under the most optimistic assumption, and by over half under the least optimistic scenario. With the projected sharp fall in investments and in imports, revenues from indirect taxes are foreseen to decline substantially during this period, resulting in a very slow increase in overall budget revenues, below the projected growth of current expenditures. This trend might improve again after 1985, when the new mining projects move into full production and the investment rate is increased. 2.35 Financing of public investments depends not only on the surplus of the current budget but also on the contribution public enterprises are able to make towards the financing of public investments. Cash flow of public enterprises as shown in Text Tables 11/12 and 11/13 have been derived as a balancing item, and thus do not indicate more than very global magnitudes. The figures are not unreasonable, however they show a continuous improvement of the financial situation of these enterprises with their cash flow increas- ing from a low and unsatisfactory 0.5% of total turnover in 1977 to between 12 and 14% by 1985. This assumes a marked improvement in their performance in line with steps already taken by Government during the past few years, and requires that sufficient foreign exchange be allocated to the purchase of raw materials, other inputs and spare parts for manufacturing and transport enterprises. Financing of public investments 2.36 Considering the projected substantial increase in budgetary savings and in the cash flow of public enterprises, financing of public investments would not seem to create particular problems over the next decade, with local investable surplus expected to average between 40-50% of total investments up to 1983 and substantially above that thereafter. However, these results call for two cautionary remarks similar to those made before (paragraph 2.23): in the short term, the relatively favorable situation presented in Text Table 11/12 implies a sharp increase in foreign debt arrears up to 1980, while the exceptionally good situation in 1985 is due primarily to the very low level of investment projected for that particular year, and which ought to increase substantially thereafter. .- 42 - Text Table 11/12: FINANCING OF PUBLIC INVESTMENTS (slow reduction of arrears) Hypothesis I/A/b /a Hypothesis II/B/b /b 1977 1980 1983 1985 1977 1980 1983 1985 Local resources Current budget surplus 2.2 4.1 7.7 7.1 2.1 2.5 6.9 3.4 Public enterprises cash flow /c 0.1 1.2 4.1 4.0 0.1 0.8 4.5 3.2 Gross local resources 2.3 5.4 11.8 11.1 2.2 3.3 11.4 6.6 Debt service /d 0.6 1.7 0.7 0.8 0.5 1.4 1.0 0.8 Net investable surplus 1.7 3.7 11.1 10.3 1.7 1.9 10.4 5.8 Gross Foreign Capital In-flow /e 2.3 5.1 12.3 5.0 2.3 2.6 12.0 5.9 Total Public Investments 4.0 8.8 20.1 8.2 4.0 4.5 20.1 8.2 Changes in treasury reserves - - 3.3 7.1 - - 2.3 3.5 Net investable local surplus in % of total investments 42% 42% 55% 126% 42% 42% 52% 71% /a "most optimistic", including the Nimba project and assuming normal world market prices. lb "least optimistic", including the Nimba project and assuming lower world market prices. Ic Projected as a balancing item (see para. 2.31). /d Excluding all foreign debt, serviced directly by the mining companies until 1983 this debt service does not cover all foreign debt obligations, and arrears exist. /e Assuming that foreign capital finances all foreign costs of projects, but no local costs in 1983 and 1985; including some short term advances by foreign mining partners, to finance running-in costs of newly opened mines. 2.37 The projections presented in Text Table 11/12 are based on the assumption that foreign aid remains limited to the financing of the foreign costs of public investment (hypothesis "b"), this implies that arrears in foreign debt will increase sharply up to 1980 to be amortized over the fol- lowing two to three years. As mentioned before, one way to avoid such an unsatisfactory development would consist in foreign aid donors providing Guinea with additional aid during 1977-1979 over and above the funds needed to finance the foreign cost of new investments. Such a scenario is presented in Text Table 11/13 below; it assumes additional foreign aid inflows averaging $46 million per year during the three year period and which would allow amortization of all arrears by about 1981 as projected in Text Table 11/6 [Hypothesis I/A/a and II/B/b], para. 2.25. In these two cases, debt service could be much higher during the 1970-79 period reducing the net local in- vestable surplus to an average of no more than 25% of total investments, as compared to 42% shown in Text Table 11/12; over and above all foreign costs, foreign aid would finance on average about 40% of local costs of all invest- ments during the years 1977-79 and about 75% of total project costs. Text Table 11/13: FINANCING OF PUBLIC INVESTMENTS (slow reduction of arrears) Hypothesis I/A/b Hypothesis II/B/b 1977 1980 1977 1980 Local resources: Budget surplus 2.2 4.1 2.1 2.5 Public enterprises 0.1 1.2 0.1 0.8 Gross local resources 2.3 5.3 2.2 3.3 Debt service /b 1.3 1.6 1.2 1.4 Net investable surplus 1.03 3.7 1.0 1.9 Gross Foreign Capital In-flow /c 3.0 5.1 3.0 2.6 Total Public Investments 4.0 8.8 4.0 4.5 Net investable local surplus in % of total investments 24.5% 42.0% 25.0% 42.0% 2.38 The projected marked improvement in the financing of public invest- ments by 1985 is again due primarily to the exceptionally low level of public investments projected for that year. To repeat, 1985 is particular because it represents a pause after heavy annual mining investments which come to an end at the beginning of that year. A more normal level of public investments of about 18% of GDP (instead of the 11.3-12.6% projected below), would com- pletely wipe out the surplus of local savings even under the "most optimistic" hypothesis and net investable local savings would not reach more than 85-48% of investments. Under the most optimistic scenario, this would still repre- sent a very satisfactory ratio, but in the "least optimistic" case, it would hardly cover the local cost of investments. - 44 - Text Table 11/14: PROJECTED PUBLIC INVESTMENTS 1975 1977 1980 1983 1985 estimates projections in billion syli at current prices: Mining investments 0.16 2.69 6.62/2.40 17.11 3.95 Other investments 0.97 1.33 2.15 2.96 4.21 Total 1.13 4.02 8.77/4.55 20.07 8.16 In % of GDP Mining investments 1.0 11.5 17.4/6.9 27.8/28.6 5.5/6.1 Other investments 5.9 5.7 5.6/6.2 4.8/4.9 5.8/6.5 Total 6.9 17.2 23.0/13.1 32.6/33.5 11.3/12.6 Average annual growth in real terms Other investments 9.1% 6.9% 8.0% 2.39 The volume of investments projected for the 1977-1985 period is largely a function of absorptive capacity, for mining as well as for other sectors. Mining investments, accounting for about three quarters of the total investment volume during this period have been projected project by project, based on what is known to date about their likely implementation schedules; these are indicated in text Table 11/3, para. 2.9. The likely implementation of a few very large mining projects has a determining impact on the total projected investment volume, including the large fluctuations from year to year. The very high investment levels projected for 1983 (about 33% of GDP) 1/ can only be achieved if these projects are implemented. At the same time, the rather low investment levels projected for 1985 reflect the fact that the last of these projects comes to an end early that year. In- deed, the decline in mining investment can be compensated only to a small extent by stepping up non-mining investments, which are limited - and will continue to be so - by problems of absorptive capacity. In fact, the growth of non-mining investments projected at 8% p.a. in real terms might well be too optimistic, considering that the massive investments in the mining sector also constitute a serious drain on Guinea's limited absorptive capacity. It is crucial therefore that absorptive capacity be expanded as fast as possible, particularly in the rural sector, where an increasing amount of non-mining investments should take place. This is an additional reason for stepping up current budget expenditures over the next decade, in the non-mining sectors. E. Sensitivity Analysis and Policy Conclusions 2.40 Most of the discussions above were based on the analysis of two extreme scenarios concerning mining developments over the 1975-1985 period. - 45 - As mentioned before, hypothesis I/A/b (called the most optimistic assumption) foresees that all mining projects listed in Text Table 11/3 are implemented on time and that world market prices for Guinea's main export products (mainly bauxite and iron ore) develop as projected in late 1976; hypothesis II/B/b, on the other hand, the least optimistic assumption, foresees that only one of the two main mining projects is implemented during the period under review, and that world market prices in 1985 are 10% below the level projected now for that year. Other hypotheses have been studied, as shown in Text Table I/1 but usually have not been mentioned in the text as their results fall in between the two extremes assessed in the foregoing sections. 2.41 Detailed data for hypotheses are provided in the annex tables. They indicate that over the 1975-1985 period the Guinean economy will not be very sensitive to changes in export prices but quite sensitive to the speed at which the mining sector is developed. A 10% lower export price by 1985 mainly affects profits accruing to the foreign partners in mining ven- tures, which tend to decline faster than the rate of price decline. Thus a substantial part of lower export revenues in the case of lower export prices would be compensated by much lower profit transfers abroad. On the other hand, construction of one more or one less major mining project during the 10 years under consideration has a major impact on all important economic variables; total GDP; export earnings, savings, and budgetary revenues would all be substantially lower, if one of the two major mining projects (Nimba or Aye-Koye) were not completed before 1985. 2.42 The projections of the Guinean economy during 1975-1985 thus bring out the following pattern of development: (a) very substantial improvement, compared to the difficult situation prevailing in the mid 1970's, in overall economic growth, the balance of payments, foreign debt, as well as public finance; (b) however in the short term, i.e. during the remainder of the 1970's, the projected improvement is not enough to resolve by itself the financial burden of the large accumulated foreign debt, much of which is already in arrears; without special foreign aid this situation is likely to get con- siderably worse, before it can be expected to improve; (c) in the longer term, i.e. after 1980, much will depend on whether both major mining projects will be completed on schedule; if yes, the country can reasonably expect to be out of troubles by 1985 as far as foreign exchange resources are concerned and on the way to rapid further growth; if no, the situation might well remain difficult as demonstrated by the problem of financing a satisfac- tory investment level of say 18% of GDP after 1985. 2.43 Under these conditions, what policies should foreign aid donors follow? Up to about 1980, some foreign aid on concessionary terms should -46 - continue, particularly in the non-mining sector, with conventional borrowing becoming increasingly important (blend lending); maturities should not fall before 1980. More important than repayment conditions, however, will be the provision of untied foreign exchange in the form of local 'cost financing, program lending, or balance of payments support, averaging some $45-50 million p.a. for the three years 1977-1979; the same effect could be achieved by major debt rescheduling. 2.44 By about 1980 it should be possible to predict more accurately whether Guinea's economy is likely to develop closer to the "most optimistic" or the "least optimistic" scenario. In the first case, there would be no further need for concessionary foreign lending, while the country would be ready to absorb increasing amounts of long term foreign capital at conven- tional terms. In the second case, however, some more blend lending would be needed, getting increasingly harder over time. Text Table 11/15: PROJECTED GROSS FOREIGN CAPITAL INFLOW (in million US$ at current prices) 1977 1980 1983 1985 Public aid Non-mining projects 39 64 89 130 Mining projects 30 73/26 191 46 Subtotal 69 137/90 280 176 Private Borrowing (mining projects) 30 73/27 191 46 Share Capital (mining projects) 21 50/18 131 31 Total Project Financing 120 260/135 602 253 Balance of Payments Support 34 - - - 2.45 The total need for foreign capital is projected to increase from about US$120 million in 1977 to a gross inflow of US$600 million in 1983; a substantial part of this total however, consists of private capital to finance mining projects, either in the form of share capital (assumed to average 15% of total costs of mining projects) or of capital borrowed by the private for- eign partners abroad. Public capital inflow per se will be less but still grow fast, increasing about four times between 1977 and 1983 from US$70 to US$280 million. There are not excessively high amounts and it should be possible to mobilize them without serious problems considering past levels of foreign borrowing, and considering the fact that the sources of foreign capital have considerably widened during recent years. While up to 1971/72 three coun- tries (USSR, China and the US) accounted for over 60% of total public capi- tal inflow, and for 92% of total bilateral aid, foreign capital inflow was much more diversified during the 1972-75 period with OECD countries other than the US, Yugoslavia and Arab oil producing countries becoming increas- ingly important sources of capital. In addition, Guinea has become recently an associate member of the EC and as such will receive aid from the European - 47 - Development Fund (About US$15 million per year) at least in part in grant form. The reestablishment of diplomatic relations with France can also be expected to trigger some official aid from that country, while in the past, public capital inflow from France was limited to some supplier credits. Last but not least, international organizations such as ABD and the World Bank Group are presently building up their project pipe line in Guinea and can be expected to increase considerably their capital flow, after their activities had substantially declined in recent years with the completion of the Boke project. Text Table 11/16: PAST PUBLIC CAPITAL INFLOW I/ (Annual averages in million US$ at current prices) 1969/70 - 1971/72 1972/73 - 1974/75 million $ % million $ % Bilateral aid OELD countries 4.0 4.7 8.5 8.1 Yugoslavia - - 10.0 9.5 other communist countries 48.5 56.2 47.1 44.9 Arab League-members 2.0 2.3 6.4 6.1 sub-total 54.5 63.2 72.0 68.6 Supplier credits 13.1 15.1 16.0 15.2 3.1 3.6 8.1 7.7 Private bank credits International organizations 15.6 18.1 8.9 8.5 Grand total 86.3 100% 105.0 100% 1/ Excluding private capital for mining projects, and overdrafts on bilateral trading accounts. Source: IBRD debt reporting. 2.46 Government performance during the 1975-85 period should be judged mainly on three criteria: how fast and smoothly it can develop the mining sector, how fast it can solve the foreign debt problem and to what extent the foreign exchange gained from mining activities can be used to improve the well being of the bulk of Guinea's population. The first point does not need further elaboration; during the course of our analysis the vital importance of mining development has been demonstrated; past performance proves its capa- bility as well as willingness to make all necessary efforts in this respect. - 48 - The second point has also been analysed in some detail above. Failure to make progress in resolving the foreign debt situation could cause foreign aid donors to limit their programs and impair the country'*s rate of develop- ment. Thus, even though it will demand sacrifices in the short term, every reasonable effort ought to be made to amortize foreign debt arrears as quickly as possible. 2.47 With respect to the third point the past is not an encouraging indicator. For the future the principal problem will be to implement poli- cies that will permit an effective transfer of real resources from the public administration and urban areas to the countryside. Inter alia this means an increase in public current and capital expenditures, in line with the public finance projections given in paragraph 2.35. There it was pointed out that current spending for materials and supplies should be raised and most of the increase ought to be allocated to agriculture, health and maintenance, which together have accounted for less than 15% of total current budget outlays in the past. Such expenditures are of high priority to improve absorbtive capacity as well as efficiency in the use of the existing capital stock - both preconditions to any large scale expansion of public investments in the rural sector and more generally for faster economic growth in the countryside, where the majority of Guinea's population is located. 2.48 However, stimulation of rural production depends not only on the level and composition of public expenditures, but even more important is the provision of adequate incentives to rural producers. This depends to a large extent on the amount of foreign exchange made available to that sector, i.e. on the amount of imported goods (inputs as well as consumer goods) farmers will be able to purchase at official prices. In the first part of this report, the present unsatisfactory supply of imported goods to the countryside was attributed to two factors: the distribution system and the monetary situation, i.e. the enormous money overhang in the cities. The distribution system has recently been changed and we have expressed some serious doubts about its effectiveness; and only time will tell whether it has improved. We conclude our discussion of policies with a return to the monetary issue. 2.49 During 1972-75 money circulation declined from 69 to 54% of GDP; however, this ratio is still two to three times higher than in most other West African countries, where it averages not more than 20-25% of GDP. With consumer goods in short supply there still is a large unsatisfied pur- chasing power, concentrated predominantly in Conakry, which constitutes a major obstacle to more satisfactory supply of the hinterland. 2.50 The Government took steps to improve the situation primarily by cutting the Government's debts vis-a-vis the central bank, although credits to public enterprises have continued to increase. On balance, there was some reduction in the money/GDP ratio, and the expected sharp growth in GDP will result in some further amelioration. However, the question remains whether continuation of this policy by itself will be sufficient to take care of the problem, particularly since the repayment of Government debt to the Central - 49 - Bank virtually came to an end in 1975. Our projections indicate that this is very unlikely and that other measures would be needed to bring about a better relation between supply and demand. Text Table 11/17 summarizes the main elements on which this judgement is based. The firste scenario presents a situation in which money supply would be reduced to a target rate of 20% of GDP by 1985; to achieve this objective the main variable is the rate of credit expansion to public enterprises. The projection shows that this increase would have to be limited to 6.6% p.a. under the most optimistic assumption which is only 38% of the projected growth of GDP in current prices and somewhat less than the rate of inflation projected for that period; thus, in real terms, credits to public enterprises would have to decline. Such a policy seems hardly feasible; in addition it would be highly undesirable, because to expand an economy needs credit which this sharply deflationary policy could not provide. The second scenario starts off with what can be considered a minimum expansion of credit to public enterprises that can realistically be expected over the next ten years; this growth was set at about 11.5% p.a. or 3-4% in real terms; such a policy would result in a money supply of 35-40% of GDP by 1985 or 1.5 to 2 times higher than the target level, i.e. in only a rather limited improvement over the 1975 situation. Text Table 11/17: MONETARY PROJECTIONS 1985 most optimistic hypothesis /a 1975 estimates 1st scenario 2nd scenario Net foreign ex- change reserves -0.07 1.8 1.8 (1 month imports) Credit: to government 0.60 to public enter- prises 10.08 19.1 6.6% p.a. 30.0 11.5% to private sector 1.07 6.5% of 3.6 5.0% of 3.6 p.a./b GDP GDP 11.05 24.5 35.4 Money Supply 8.95 54% of 14.4 20% of 25.3 35% of GDP GDP GDP other deposits 1.73 10.5% of 9.7 13.4% 9.7 GDP of GDP PL 480 counterpart funds 0.61 0.6 0.6 Sundries -0.24 -0.2 -0.2 11.05 24.5 35.4 /a The "least optimistic" hypothesis gives results that are 10-15% worse. /b 70% of growth of GDP. - 50 - 2.51 These two projections make it quite clear that realistic trends in economic growth and credit restraint will not be enough to absorb the disequilibrium between money supply and GDP (or excess demand) by 1985. Furthermore, severe deflationary policies needed to achieve an acceptable equilibrium are neither desirable nor politically feasible. Therefore, other measures should be considered to reduce the present huge money overhang, without the negative effects associated with sharp deflationary policies. A monetary reform along the lines of those implemented in several European countries during the first 3-4 years after the end of World War II seems a possibility. Without such, or similar measures, it seems hardly feasible to ensure satisfactory long term development for Guinea's rural economy, which has a long term potential as good as that of the mining sector.