Guinea - Industrial Rehabilitation and Promotion Project

Document of The World Bank n i - FOR OFFICIAL USE ONLY Report No. 3690-GUI STAFF APPRAISAL REPORT GUINEA INDUSTRIAL REHABILITATION ANID PROMOTION PROJECT March 22, 1982 Western Africa Projects Department Industrial Development and Finance Division 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 EQUIVALENTS The Syli is linked to the SDR at a rate of SDR 1 = Sylis 24.6853. The official rate of conversion to US$ was US$1 = Sylis 21.35 as of October 1981. ABBREVIATIONS OCOFI Organisation pour la Coordination Financiere de l'Industrie IMPORTEX State Importing Monopoly ONP Office National des Petites et Moyennes Entreprises Min. SME Ministry of Small and Medium Enterprises and Artisans CNC Conseil National du Credit SME Small- and Medium-Scale Enterprises PPF Project Preparation Facility SONACAG Societe Nationale de Carreaux et de Granite CNCIH Credit National pour le Commerce, lIndustrie et l'Habitat FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY GUINEA INDUSTRIAL REHABILITATION AND PRLOMOTION PROJECT TABLE OF CONTENTS Page I. THE SECTOR SETTING ......................................... 1 A. General ..................... 1 B. The Industrial Sector .. .......................* . .1 C. Publicly-Owned Industrial Enterprisesi - Structure and Procedures ............. * 0. 0 . .....I......... . . ....... . 2 D. Privately-Owned Industrial and Service Enterprises. 3 E. Financial Sector ................... . 5 F. Policy and Scope for Future Development .......... 7 G. Assessment of Industrial Policy and ';trategy 8 H. Industrial Problems .......... ...................... . 10 I. Relevance of the Project to Industrial Policy and Problems ............................1................... l II. THE PROJECT ................. .................... 13 A. Project Formulation .................................... . .......... . 13 B. Co-financing ......... ............ 14 C. Objectives of the Project ................................ 14 D. Project Description - General ........................... 14 E. Rehabilitation of State-Owned Enterprises . .............. 15 F. Feasibility Studies .......................... . .... 22 G. Promotion of Small- and Medium-Scale Enterprises. 23 H. Assistance to Credit National . 24 I. Industrial Policy and Planning Assist:ance .25 J. Summary Project Costs and Financing .25 III. PROJECT IMPLEMENTATION, RISKS AND JUSTI:FICATION ........... 27 A. Implementation Responsibilities ................. ........ 27 B. Credit National (CNCIH), Financial IiLtermediation .28 C. Use of IDA Funds ................... , 29 D. Procurement ................. . ... I.......... 31 E. Disbursements ........... . . . . 31 F. Accounts and Project Reports . .. ........................ 32 G. Project Risks ................................. . . . . 32 H. General Economic and Financial Justilication ... 32 IV. PRE-CONDITIONS, ASSURANCES AND RECOMMENrDATIONS ............ 33 This report is based on the findings of a mission to Guinea in May/June 1981 by Messrs. Uche Mbanefo, Cherif Azi, and Bahadur Jetha, and Miss Kathleen di Tullio. 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.  ANNEXES 1. The Financial Sector 2. List of Publicly-Owned Enterprises 3. Rehabilitation Financial and Economic Calculations 4. List of Privately-Owned Factories 5. Estimated SME Technical Assistance Costs 6. Proposed Organigram of the Ministry of Small- and Medium-Scale Enterprises (Min. SME) 7. Terms of Reference of Technical Assistance Staff Proposed for Min. SME 8. List of Privately-Owned Enterprises Visited by the Appraisal Mission 9. List of Loan Requests Received by Min. SME during 1980/81 10. Guinea Investment Code 11. Conditions for Granting of Privileges Under the Investment Code 12. Estimated IDA Disbursement Profile 13. Estimated IDA Disbursement Categories 14. Documents Available in Project Files  I. THE SECTOR SETTING A. General 1.01 An IBRD-prepared Economic Memorandum 1/ was discussed with the Guinea Government in June 1981. Also, an IMF consultative mission visited Guinea in June, and reported in July 1981. rhese reports provide ample information on the general economic conditions in Guinea which will not be repeated here. B. The Industrial Sector 1.02 Guinea's economy is agricultural, but foreign exchange earnings are dominated by the mining industry. Bauxite reaserves are currently estimated at about 6.5 billion tons (about 30% of the estt:Lmated world reserves), and contributes 90% of export earnings and 20% of GDP. In addition to bauxite, Guinea is also believed to have substantial deposits of iron ore, uranium and diamonds, while prospects for petroleum finds are considered hopeful. This project (and therefore this report), however, deals only with the manufac- turing, service and financial sectors. The Manufacturing and Service Sectors 1.03 With its 5 million population, rich agricultural potential, mineral exports and potential, free education througt university, and relatively skilled workers, Guinea has the necessary elements to justify a modest domestic processing sector. The desirable size, structure, or content of such a sector are questions which do not appear to have been addressed in any systematic fashion in the past. This project, therefore, includes technical assistance for industrial policy formulation and planning in the Ministry of Industry to begin to address such issues. 1.04 The formal manufacturing sector, mostly engaged in import substitu- tion, consists essentially of some 38 state-owned enterprises (Annex 2) and some 26 privately-owned factories (Annex 4). It employs about 7,500 persons, and contributes some 3% of GDP. Major sub-sectors include: food and drink; plastics (shoes, raincoats, sheets, etc.); construction materials and timber products; and the chemicals sub-sector. 1.05 The service and artisanal sector consists of numerous (mostly privately-owned) enterprises ranging in capital size from a few syli to several million syli, and in employment from one or two persons to more than 50. This sector, which is not well-documented, is, nevertheless, be- lieved to employ many more people than the formal manufacturing sector. A recent Government census of private enterprises and artisans in the Conakry Region reveals that there were about 700 privately-owned enterprises of this class in that Region alone, employing about 4,000 persons, with total invest- ment of about 300 million syli. 1/ Report No. 3150-GUI.  -2 C. Publicly-Owned Industrial Enterprises - Structure and Procedures 1.06 When the French left Guinea after independence, they took with them practically all the technological and administrative infrastructure embodied in their colonial civil servants. One of Government's responses to this situation was to husband carefully what little technological and administrative expertise it could attract to Guinea, and centralize it in the public sector. This factor, coupled with the socialist orientation of Govern- ment policy, led to the creation of a large number of public enterprises, centralization of control and management, and relative neglect of the private sector. 1.07 The Party formulates industrial policy, the Government (President and Ministers) articulates it; the Ministry of Industry, through its specialist technical divisions (e.g. agro-industries, mining, etc.) as well as through OCOFI, implements the policy. Each State-owned factory has its own General Manager and Financial Manager, both appointed by the Head of State, an account- ing system run by a Guinean qualified accountant, and a full complement of technical and production personnel. Until the summer of 1981, all State-owned industrial enterprises were centrally administered by a holding company -- the "Organisation pour la Coordination Financiere de l'Industrie" (OCOFI) -- whose abolition in 1981 leaves all these enterprises free for the first time to manage their own finances. 1.08 Until 1981, Guinea's State-owned enterprises have been subject to a very comprehensive system of controls designed mainly with the intention of preventing unauthorized deviations from a pre-determined plan. In addition to OCOFI, which had to approve all borrowings and procurements of each indus- trial enterprise, all procurements involving imports must also pass through IMPORTEX--the state import monopoly organization, as well as the Bank for external commerce; all labor is sent by the Ministry of Labor; all marketing is done through a State marketing organization. In addition, all enterprise accounts are audited annually by the Ministry of Internal Control, which reports to the National Economic Council. The latter reviews annually: - the objectives established 12 months earlier for each enterprise; - the extent to which the enterprise has achieved those objectives; - the specific obstacles encountered by the enterprise during the year; - the objectives for the next 12 months and what the enterprise must do to achieve them. 1.09 A basic public sector problem in Guinea has been that the above controls have proved so restrictive that, by strangling management initiative and occasioning long delays, they have considerably reduced the sector's efficiency and performance. A major objective of this project, therefore, (greatly advanced by the recent abolition of OCOFI) is to demonstrate (using  - 3 - the four enterprises to be rehabilitated) that a conversion of some of these controls to monitoring functions can i.prove the sector's efficiency without adversely affecting macro-economic management (See Chapter II, para- graphs 2.26 and 2.27). 1.10 About 38 state-owned factories were set up between 1958 and 1972, most of them as gifts from Eastern Block countries, with an industrial policy generally no more sharply-focussed than the pursuit of import-sub- stitution. These factories fulfill some important policy objectives apart from production of goods, notably provision cf off-farm employment for many persons graduating annually from the University, and geographical dispersion of industry to promote more even regional development. 1.11 The public sector enterprises' performance has deteriorated through- out the 70s. Operating with old and worn out equipment due to lack of spare parts, irregularly supplied with raw material and power, their production level has steadily decreased over the years. With few exceptions, they operate at 10 to 30% of capacity, when operations are not completely stopped. 1.12 Since 1975 the Government has been engaged in the rehabilitation of existing facilities. Progress has been slow because of lack of external financing for fixed asset renewals, and import of essential inputs. Yet the rehabilitation of economically and financially viable enterprises appears desirable for three reasons. Firstly, some of the enterprises can earn or save significant amounts of foreign exchange, thus breaking the vicious circle in which they are trapped: foreign exchange is a necessary input to generate foreign exchange earnings. Secondly, for all of them the rehabilitation will maintain - and in some cases create - a significant number of jobs. Thirdly, since the Government seems willing to reassess its industrial poli- cies, the rehabilitation project could, through localized and successful reforms, constitute an example for more ambitious ones in the Guinean manage- ment system of the public sector enterprises. 1.13 Another major Government public sector policy objective being assisted through this project (apart from improving public sector efficiency) is to introduce private ownership into as many public enterprises as possible, as a means of gaining access to additional foreign capital, technology, and management. Thus, Government would invite the foreign suppliers to partici- pate in the equity of the enterprises to be rehabilitated. Also, the Ministry of Urbanism and the Ministry of Small and Medium Scale Enterprises (SME) (as official representative of the private sector) have agreed to form the first joint-venture company between Government and private Guineans. The company will operate sand and gravel quarries, an operation which could be financed through the SME line of credit, subject to a satisfactory feasibility study. D. Privately-Owned Industrial and Service Enterprises 1.14 Despite official neglect, or even discouragement (including the ban on private retailing, from 1975 to 1977), there have always been enough private factories (Annex 4), bakeries, restaurants, carpenters, tailors, etc., for the private sector to constitute an important economic sector in Guinea.  -4- Nevertheless, official emphasis on public ownership and development during most of the last 20 years has meant, at best, an etiolation of private sector growth. 1.15 A period of liberal credit to the private sector immediately after independence was followed by a total ban on all bank lending to the private industrial and service sectors between 1974 and 1981. Throughout that period, Government controlled all imports of industrial inputs including fuel, fixed the prices of all inputs and outputs, and marketed all industrial output of the private sector. Since 1978, however, the Government has been signalling its readiness to support a rehabilitation of the private sector, including extension of credit (which has yet to be implemented), and provision of state-financed technical assistance to privately-owned enterprises. In pursuit of this new policy, Government in 1980 created the Office National de Promotion des Petites et Moyennes Entreprises (ONP), which, in 1981, was elevated to the status of a full Ministry of Small- and Medium-Scale Enter- prises (Min SME). 1.16 As of April 1981, the Min. SME had 40 staff members. In general, staff members have good educational backgrounds (typically University degrees), and many have experience in their technical fields in public enterprises. A small group who demonstrates capability of taking on management positions is emerging and with the technical advisors provided in the project should form the backbone of the department implementing policies and offering technical services to encourage growth of private sector enterprise. Private Sector Demand for Credit 1.17 Government official support of private enterprises dates only from 1980 and local banks have not yet started lending to them. There is therefore substantial pent-up demand for funds to modernize, expand or invest in new projects. It is still too early to put parameters on the demand for credit, but the early applicants are representative of the kinds of projects that entrepreneurs are proposing. In 1980 and -81 the Min SME received credit applications from private sector enterprises for a total of US$30 million in foreign exchange. The 45 projects are listed in Annex 9. They cover a broad range of activities and vary greatly in size of investment, as shown below. Fully half of the number of applications is for bakeries. They are relatively small investments, each averaging about $112,000 in foreign exchange. At the other extreme are new projects in agro-industrial food processing sectors, soft drinks, and chemical (plastic) products where the average loan applica- tion is for US$5.5 million. Overall, for all activities, 50% of the applica- tions are for loans not exceeding US$100,000 with another 30% for loans not exceeding US$0.5 million as can be seen in the table below.  Demand for Credit in Foreign Exchange Only Type of Projects Average Loan Size (US$'OOO) No. of Rehab./ Above Projects New Expan. 0-100 101-500 501-1000 3000 Bakeries 24 2 22 16 8 Food Processing & Beverages 3 3 3 Clothing & Textiles 3 1 2 2 1 Leather, Wood & Paper Prod. 4 1 3 2 2 Chemical Products 3 2 1 2 1 Construction Materials 2 2 2 Metal Fabrication 2 2 1 1 Services (Inc. Ice Making) 4 2 2 2 1 1 Total Number of Projects 45 13 32 22 14 5 4 Total Amount US$'000 1,735 3,286 3,801 21,760 Average Loan Amount 80 235 760 5,500 E. Financial Sector Background 1.18 A member of the French West African monetary community at the time of its independence in 1958, Guinea withdrew from the Franc Zone two years later to establish its own currency, the Guinean Franc, and its own banking system. In the initial phase, all banking functions in the country (central and commercial) were directly carried out by Guinea's first central bank. Subsequently, however, sector specialized banks were established to discharge the Central Bank's retail banking activities. Guinea's financial system, 100% state-owned, currently consists of the Central Bank, five specialized banks, and a national insurance company (see Annex 1). All these institutions are still treated as part of the Government machinery rather than as indepen- dent financial institutions. The Currency 1.19 Created at par vis-a-vis the CFA Franc in 1960, the Guinean Franc was changed to Syli in 1972 at an official value of 10 Guinean Francs to a Syli. In August 1975, the Syli became linked to SDRs at a parity of Syli 24.6853 to one SDR. The currency is non-convertible and its free market value is well below the official value of approximately 20 Sylis to one US dollar.  -6- Credit Policies 1.20 In line with policies pursued for other sectors of the economy, all decisions concerning credit in Guinea are centrally planned. Determina- tion of interest rates, global credit ceilings, and sectoral credit alloca- tion, is primarily made by the Conseil National du Credit (CNC). The Central Bank, acting as executing agency of CNC, manages the credit ceilings, deter- mines bank specific allocations and authorizes individual credits. Moreover, since all credit resources available in individual banks, including their profits and depreciation, are pooled into one national credit fund managed by the Central Bank, the control of the Central Bank over credit in Guinea is total. Resource needs of deficit banks are primarily satisfied by advances from surplus banks, but advances from the Central Bank are also available to the banks. In early years, the banking system apparently had an unlimited and automatic access to Central Bank advances but in recent years, the Central Bank appears to have substantially restricted this facility, even though Government continued to finance public enterprises. Credit Distribution 1.21 Most investment projects in Guinea have been, and are still, financed directly by the state from external sources. As a result, the major share of domestic credit provided by the banking system is short term finan- cing, primarily seasonal credit needs of large state sectoral companies. In recent years, due to mounting financial difficulties of many of these companies, an increasing portion of past unpaid short term credit has been consolidated into medium term credit. Virtually no long term credits are currently being made by the banking system in Guinea. 1.22 The private sector has not had access to credits from the banks in recent years. Apparently, the rate of default on private credits in earlier years was so great that the government decided to stop any lending to the sector in the late sixties. As a result, almost 98% of the banks outstanding credit today finances the public sector enterprises. Organization and Operating Policies 1.23 A special feature of the banking system in Guinea, apart from its high degree of sectoral specialization, is the high degree of control exercised by the Central Bank over the activities of individual banks. Although member banks are all financially autonomous institutions, they have in fact little operational autonomy. All policy and most operational deci- sions, including all credit approvals, are made by a Board and Management Committee common to all banks including the Central Bank. The governor of the Central Bank, President of both of these bodies, the Vice-Governor, and the directors of individual banks, constitute the Committee, while the Board comprises some key government officials in addition to the above committee members. Through this structure, and also because the Central Bank in Guinea enjoys an absolute monopoly over all credit resources in the country, indivi- dual banks operate more like specialized branches of the Central Bank than as autonomous banks.  -7- Interest Rates 1.24 Until August, 1981, interest rates inI Guinea had remained unchanged since 1967 when, by a presidential decree, thEy were set at 5.5% for all long term loans, 4% for medium-term loans, 5.5% for short-term loans to industry and at 7.5% for short-term loans to commercial enterprises. Interest paid on deposits varied from 2.5% on sight deposits of Syli 200,000 and more to 3.5% on term deposits of 5 years but no interest was paid on small deposits. Lending rates were increased in August 1981 to between 10% and 1-4%, and deposit rates to between 4% and 7%, which the Association considers reason- able at this time, given an annual inflation rate of about 3.7%; also a considerable (almost 100%) improvement on the rates applied until now. Prospects 1.25 There is some evidence that in line with its recent policy of encouraging the private sector, the government has begun to relax its restric- tions on credit to Private firms and individuals. At the same time, there appears to be a recognition of the need to review the structure and policies of the financial sector institutions. A commission, comprising the Governor of the Central Bank and directors of primary tanks, recently looked into these matters, and recommended a series of measures designed to improve operations, mobilise domestic savings, and maximise foreign exchange earnings. The com- mission, while recommending greater autonomy for State-owned enterprises, was completely silent as regards autonomy for the banks themselves. Also, while acknowledging the need to resume lending to both private and public enter- prises, the commission left it up to the Council of Ministers to determine the rules and policies that should govern such lerding, limiting its own specific recommendations on this point to the need to strengthen the Banks' debt recovery capabilities. F. Policy and Scope for Future Development 1.26 A recent Guinea Government submissicn to the United Nations Con- ference on less developed countries (summarized below) sets out the Govern- ment's industrial policy objectives and strategy. Also, since its decision to rehabilitate both the public and the private sectors, government, in stating overall industrial policy objectives, no longer distinguishes clearly between public sector and private sector objectives. The overall objective is to achieve an annual growth rate of 10% in industrial output by 1990. 1.27 Government strategy for achieving that growth includes: - a focus on agro-industries (cotton development; sugar plantation and mill; tomato, fruit, fruit juice and fish canning; agricultural and marketing improvements); - import-substitution industries (textiles, plastics, leather, building materials, tools, utensils, bicycles, mopeds, phar- maceuticals and a foundry);  - 8- - agricultural support industries (natural and chemical fertilizers, agricultural equipment); - industries based on minerals (aluminum foundry, kitchen utensils and fittings); - development of production, management and marketing methods for public, private, and mixed enterprises; - reorganization, supply and increased productivity of existing enterprises; - development of regional specialization on the basis of aluminum industry and hydro-electric power. 1.28 In support of its new policy towards the private sector, Govern- ment has promulgated an Investment Code (Annex 10) prescribing specific privileges for new investors in a wide field of industrial activity. It has also promulgated a special code to encourage Guineans living abroad to repa- triate and invest their foreign exchange in Guinea. IDA staff have reviewed both documents and found them generally satisfactory. The main weakness of the Investment Code is that its high qualifying threshold for Code privileges would exclude most Guinean SMEs. Government agreed during negotiations to take steps not later than June 30, 1982, to ensure that no enterprise is excluded from Investment Code privileges purely on grounds of total invest- ments. Work on industrial sector policy to be financed under the proposed project, and support from ongoing sector work by the Bank would enable the Government to establish a more operational strategy for industrial development over the next few years. It is in this context that a more detailed scrutiny of the Investment Code would be appropriate. Meanwhile, many private sector enterprises (foreign and local) have sought approval to establish under the Investment Code privileges. The indicative types of industry being promoted through grant of such privileges, and which will continue under the project, are listed in the "Conditions d'Agreement" (Annex II). The three major sectors are food and drink, mechanical and chemical manufacture, and building materials. G. Assessment of Industrial Policy and Strategy 1.29 The main weakness of the policy and strategy described in paragraphs 1.26 to 1.28 above is that they sound more like a catalogue of desirable goals than realistic objectives based on adequate information, resources, or plan- ning. There appears to be, for example, an absence of information on the size, resource requirements, and contributions of the private industrial sector. Also, the chronic lack of foreign exchange suggests an unrealistically large industrial sector, given current exports and exchange rates, yet the Government's apparent efforts to rehabilitate virtually all old state-owned industries, create new ones, and at the same time promote private enterprises suggest a failure to recognize the parameters of the industrial sector which can be sustained in the short, medium and long term.  - 9 - 1.30 The logical approach described in paragraph 1.29 above presupposes the existence of adequate information on the resource demand and supply factors at work in the sector, as well as the policy formulation and planning capacity necessary to design and implement a realistic industrial development plan. 1.31 Neither such information nor the planning capability seems to exist in Guinea now. Consequently, the primary focus of Government and IDA indus- trial sector work during the next three years will be first, to create the capability for industrial sector information gathering and analysis; second, to define industrial objectives that are attainable; and third, to prepare detailed plans (including industrial sector resource demand and supply projec- tions) to achieve the objectives. 1.32 The analysis of economic aggregates is only a part of the important industrial sector work to be done in Guinea. Equally important, and much more visible, is the great need to create executive capability to implement the far-reaching changes in policy and economic management style recently embraced by Government. The more independent state enterprises; the Banks undertaking new forms of lending; the newly-created SME Ministry--all collectively repre- sent an unusually large need for industrial sector institution building, now and for several years to come. Indeed, it will be institutional and human resource capacity that will limit the extent to which the benefits of these policy changes are realized. 1.33 The first step in this sector work started during preparation of this project, when IDA staff assisted the Government in developing criteria for sub-project selection, especially for the public sector rehabilitation component (see para. 1.41). The next step wouLd involve the industrial planning technical assistance to be provided through this project. This would be followed by industrial sector information gaithering and analysis, and the planning of future industrial development. Parallel with such sector work, the Government, with IDA and other external assistance, would undertake necessary institution building--creating the statutory anid legal framework for new institutions, and training technical and managerial staff locally and abroad. 1.34 The short-term (3 to 4 years) sector objectives, reflected in this project, are, therefore, to initiate -industriaL sector information gathering and analysis; improve the efficiency of public sector enterprises; and begin the shift of the industrial economy from the public to the private sector. In the longer run, through technical assistance, LI training, and further develop- ment of the private sector, possibly through repeater projects, the country should, perhaps ten years from now, have: - a much more realistic and sharply focussed industrial plan and strategy than at present; 1/ IDA is currently preparing a technical assistance project which, along with other measures, would contribute towards this end.  - 10 - - a much better awareness of the total consequences of the size and structure of industrial sector it is aiming to establish; - stronger banking and similar institutions which service the industrial sector; - a major structural alteration of the industrial sector from public sector to private sector dominance; - a much more efficient industrial sector than at present. H. Industrial Problems 1.35 Guinea's major industrial problems can be classified into three main categories: technical; managerial and administrative; and macro-economic. The technical problems include: - The severe lack of technological know-how, ubiquitous all over Africa; and - the severe lack of infrastructure, particularly power, causing many factories to be closed many days in the year. 1.36 Management and Administrative problems include: - The monopoly of all rights to import by the state-owned company IMPORTEX: this means that enterprises are dependent on IMPORTEX for acquiring all imported raw materials, and occasions considerable delays, sometimes up to 6 to 12 months. - The need for all state owned enterprises to sell all their products at fixed prices to state marketing monopolies reduces the managers' ability to increase profitability of their units through more efficient marketing, especially since each marketing outlet typi- cally handles the output of many factories. Yet this situation cannot be changed until after the newly independent enterprises have built up their capabilities in this and other areas of management. - A decade of operating in a severe shortage economy has tended to breed in many state-enterprise managers a management style based not on forward planning, but on crisis management and improvisation. For example, raw material inventories are rare and spares inventories virtually non-existent. A manager who anticipates the need for a spare part next month has to line up behind many managers whose machines have already broken down, so he typically does not attempt to acquire the spare part before the break-down occurs. 1.37 Macro-economic problems include the severe shortage of foreign exchange needed to import fuel, raw materials and spares; the Government's policy until very recently of officially fixing prices of all items (including  - 11 - raw materials, fuel, spares, intermediate and finished goods) passing through official (i.e. non-smuggled) channels in Guinea. Also, the official over- valuation of the Guinean currency implies a subsidy to the manufacturers which is now passed on to the consumers, but which ,as in many other developing countries) severely distorts the official prices of inputs and outputs as compared with developed countries, and as compared with inputs and outputs which have no access to official sources of foreign exchange. 1.38 How the project design will attempt to address the above problems is described in Section I below. I. Relevance of the Project to Industrial Policy and Problems 1.39 Given the difficulties described above, and the limited financing and managerial experience available, the stral:egy described in paragraph 1.27 appears too ambitious. On the other hand, industrial output is currently so low that achieving a 10% rate of increase thereof (i.e. the overall objective) may not be too difficult. 1.40 The project described in this report, consisting of rehabilitation of four state-owned industrial units (two agro-industrial and two concerned with building materials), and promotion of privately-owned industrial enter- prises, fits neatly into the strategy described in paragraphs 1.26 and 1.27. 1.41 The Project is also, in many respects, a pilot scheme, to demon- strate that industrial enterprises, freed fromn most of the obstacles described in paragraph 1.36, are likely to function more efficiently. In addition, the project assumes that there is no point in establishing industries (public or private) unless Guinea can keep them regularly supplied with raw materials and energy; that the theoretical industrial capacity existing in the recent past was not substainable in the long run; that, for these reasons Government needs to establish criteria for selecting which industries to rehabilitate or develop; and that, until further notice, an important criterion should be the ability of the industry to earn or save foreign exchange. 1.42 Government is in general agreement with these principles which guided the Bank to select for rehabilitation only four of the twelve indust- ries originally suggested by the Government. At least two of the industries (essences and quinine) export most of their output; all but one depend wholly on local raw materials, and the sole exceptiorL is nevertheless partially dependent on domestic raw materials; two support the construction industry so essential to further economic development. 1.43 In addition, the project introduces, for the first time, some machinery to coordinate the industrial demands and contributions of both the public and the private sectors. The project (Chapter II) will address the industrial problems discussed in para 1.35 to 1.37 in the manner described below.  - 12 - 1.44 The management and administrative problems (para 1.36) cause in- efficiency mostly by causing delays in implementing decisions already taken by factory management (especially in purchasing). Detailed measures to be introduced through this project (Chapter II) and IDA's standard procurement procedures, including direct payment of foreign suppliers, will avoid most of the delays. In addition, Government has recently passed a decree freeing all State enterprises from control by OCOFI--one of the main sources of delay. 1.45 The technical problems (para. 1.35) of inadequate technology will be addressed through reliance on internationally recruited technical assistance, or foreign partnership where possible, coupled with training of Guinean managers and officials both in Guinea and abroad. The project design also provides as much energy independence as possible for project activities, through the financing of initial working capital, and independent electricity generation capacity. 1.46 Macro-economic problems (para. 1.37), and especially exchange rate and domestic pricing issues, affect all sectors of the economy, and are, therefore, central to the current discussions between the Guinean Government, IMF and IDA. The sensitivity and breadth of these issues are such that they should be pursued in the context of that dialogue, but the proposed project would introduce more orderly industrial planning and analysis of industrial constraints, including measures to ensure satisfactory economic evaluation of proposed investments. 1.47 Apart from its decision to emphasize the private sector and de- emphasize public involvement in production and distribution, including what may be the only Government Ministry in Africa devoted exclusively to the promotion of private sector small, medium and artisanal enterprises, Govern- ment has, in the few months since the field appraisal of this project, taken the following additional measures to remove or reduce price and other economic distortions: - Prices of all but state-owned enterprise output and a few essential commodities (e.g., pharmaceuticals, rice, gasoline,, cement) have been freed from all official control, and are now to be determined by free market forces; - Private enterpreneurs are free to acquire foreign exchange from any source and at any price and to use it in their business. Indeed this is still practically the only way private entrepreneurs can obtain foreign exchange in Guinea; - Interest rates have been doubled; - State-owned enterprises have been freed from control by state holding companies, and are now largely free to manage themselves under terms the details of which are yet to be worked out; - Banks have been authorized to finance private sector enterprises, although lending has not yet started (para. 1.25); and - The Government no longer guarantees employment to all school-leavers.  - 13 - 1.48 The Government-s willingness to take such far-reaching and effi- ciency-promoting policy measures within such a short time reflects a clear determination to improve economic management along the lines so far suggested by the IMF and IDA. With the application of appropriate shadow pricing in sub-project selection, the passing on of the foreign exchange risk to sub- borrowers and the market freedom recently announced by Government, the project would not exacerbate present distortions resu:Lting from the official over- valuation of the currency. Individuals and ot:her project participants would derive real and measurable benefits from the project. 1.49 At the same time, the Government's efforts at one of the most difficult and most desirable structural adjusl:ments being attempted in Africa in recent years deserve strong support. The provision of essential foreign exchange to the selected public enterprises deserves support because these enterprises either earn foreign exchange or provide essential building mater- ials, while the terms of the proposed rehabilitation would make the enterprises a vanguard for desirable change in the managemient style of public enterprises in Guinea. 1.50 As for the promotion of private sector enterprises, the technical assistance being provided through the project would help the Government in planning and ensuring the recurrent foreign exchange needs of that sector, while the foreign exchange this project would provide for private sector needs would prove an indispensable lubricant in shifting the Guinean economy from public sector domination to private sectcor orientation. II. THE PROJECT A. Project Formulation 2.01 The project originates from a request by the President of Guinea to the President of IDA in late 1979 for assistance in rehabilitating state-owned industrial enterprises, and in promoting privately-owned small and medium scale enterprises (SMEs). Following that request, several IDA missions have studied Guinea-s industrial and financial sectors and identified this project. Preparation included PPF financing for feasibility studies conducted by internationally-recruited consultants (available in project files). 2.02 Of the twelve state-owned enterprises originally suggested by the Government for rehabilitation, the consultants studied six, selected mainly on the criteria of export earnings potential, or import savings through the local production of essential building materials. Based on the financial and economic viability projected in these feasibility studies, and their review by IDA, only four of the six state-owned enterprises studied have been included for rehabilitation through this project.  - 14 - 2.03 In the private sector, the preparatory work has consisted mainly of assisting the government, through its newly-created Ministry of Small and Medium Scale Enterprises (Min. SME), to create both the policy and the insti- tutional framework necessary for the first serious effort in many years to increase the productivity of the non-farm private sector in Guinea. The private sector component of the project will continue the creation of this framework, but will move on to provide actual technical and financial assis- tance to the private sector. B. Co-financing 2.04 During preparation of the project Government requested IDA to play a co-ordinating role in identifying a program of external aid to the industrial sector. The project described in the following paragraphs is the result of that effort. While each of the donors in the project is financing specific needs, the individual parts contribute to a coherent effort to promote growth in the sector. However, in Annex 5, and where appropriate in the text, donor contributions are shown separately. C. Objectives of The Project 2.05 The various objectives of this project have been alluded to in various parts of Chapter I, (especially paragraph 1.34) and may be summarized below as: - Creation of industrial sector policy formulation and planning capability in the Ministry of Indusry. - Support for Government's new policy of shifting some of the respon- sibility for national production, import substitution, and employ- ment creation, from the public to the private sector. - Improvement of the performance of public sector industrial enter- prises through selective rehabilitation coupled with relaxation of Government controls, and thereby furthering their objectives of foreign exchange earnings (or savings), employment creation, and regional development. D. Project Description - General 2.06 The project consists of: (a) complete rehabilitation of four state-owned enterprises through the provision of equipment, civil works, imported materials, engineering, technical assistance and training; (b) studies of the feasibility of two other state enterprises (slates and ornamental stones);  - 15 - (c) promotion of private sector enterprises through the provision of term credit to them, and the support with equipment, technical assistance, training and minor expansion of the office building of the Ministry of Small and Medium Scale Enterprises (Min. SME); (d) provision of foreign exchange finanicing, technical assistance, and training, to Credit National pour le Commerce, l'Industrie, et I'Habitat, a Guinean bank, to enable it to act as the local financial intermediary for (a) and (c) above; (e) three man-years of consultancy for the Government of Guinea, to assist with the formulation of industrial policy and strategy, co-ordination of public and private sector industrial development, and industrial planning; and (f) financing for the foreign costs of the external audit of all IDA funding for the project. E. Rehabilitation of State-Owned Enterprises (Annex 3) 2.07 A full history and description of the four state-owned enterprises to be rehabilitated, the detailed rehabilitation program, and detailed finan- cial and economic analysis of each of the enterprises (including sensitivity analyses) are in the feasibility studies (para. 2.01). A brief summary of those descriptions and analyses is presented in this chapter. Annex 3 presents the definitive financial and economic calculations and their basic assumptions. (i) Station Autonome de Seredou (Quinine plantation and factory) Established in 1943 2.08 The 250 ha plantation was developed mostly between 1943 and 1954. The 12.5 ton factory was built in 1954. Since then, due to lack of foreign exchange to import fertilizers, spares and energy, only 120 ha of the planta- tion remain, and factory capacity is down to 2.5 tons a year. The proposed rehabilitation includes only the Cinchona tree plantation and the factory. Quinine is a net foreign exchange earner and its use in soft drinks and as an anti-arrhythmic for heart diseases is increasing. 2.09 The objective of the agricultural rehabilitation is to restore the plantation to its original size as far as possible. This would require a ten-year program involving: i) seeding new Cinchona trees in nurseries; ii) clearing 300 ha of land (the 250 ha of the existing plantation plus 50 ha of additional land around the plantation), and soil preparation and fertilizer application at a rate of 30 ha./year; iii) planting new Cinchona trees at the same rate and maintaining the plantation with appropriate pesticides and agricultural work. This project will finance the equipment and all necessary inputs, road and other infra-structure for the first 3 years of the program. However, Cinchona trees take 8 to 10 years to mature, with the consequence that many of the plantation "operating" costs are really investment costs to develop the plantation. Additional net costs from years 4 to 10 are estimated al US$2.6 million, most of it needed to expand the factory from 12.5 tons output to 22.5 tons annually around year 10 (see below).  - 16 - 2.10 Factory rehabilitation is designed to restore the factory to its original 12.5 ton/year capacity through i) restoration of the factory building and some equipment which need only new parts ii) replacement of all obsolete or unrepairable equipment, iii) furnishing of laboratory equipment and basic mechanical tools to allow manufacture of basic spares. 2.11 Base costs for rehabilitating Seredou are estimated as follows: Foreign Local Total