Madagascar - Review of the public investment program

Report No. 5286-MAG Madagascar Review of the Public Investment Program November 5, 1984 Country Programs Department Eastern African Region FOR OFFICIAL USE ONLY Document of the World Bank 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.  FOR OFFICIAL USE ONLY PREFACE This report is based on the findings of a mission that visited Madagascar in May-June 1984. The mission members were Mr. S. Rahim (Mission Chief and author), Mr. A. Neurisse (Consultant, Agriculture), Mr. B. Bostrom (Transport), Mr. G. Boulch (Industry), and Mrs. Bolenge-Bongeli (Data base). This document has a restricted distribution and may be used by recipients only in the performance of their official dutics. Its contents may not othcrwise be disclosed without World Bank authorization.  TABLE OF CONTENTS Page No. Introduction and Summary I I. INTRODUCTION AND BACKGROUND 1 II. THE OVERALL PROGRAM: 1984-85 3 Size and Financing of the PIP 4 General objectives 7 III. AGRICULTURE 9 Assessment of the Agriculture Sector Program 9 Economic Assessment 13 IV. TRANSPORT 17 Composition of the Program 18 Policy Issues 21 V. INDUSTRY 22 Manufacturing 23 Mines, Energy, and Water 28 VI. SOCIAL SECTORS 31 VII. ISSUES IN PLANNING 31 Consensus and Coordination: the Planning Council 33 Economic Analysis and Project Preparation 34 Implementation and Monitoring 39 Training 41 VIII. ISSUES OF SIZE AND RESOURCES 42 IX. ISSUES FOR THE PREPARATION OF THE NEXT PIP 44  - i - INTRODUCTION AND SUMMARY i. The present Public Investment Program (PIP) is the Malagasy government's first systematic attempt to program all public sector investments. It responds to the need to (i) set priorities among future investment projects (ii) coordinate various sources of financing, both domestic and external, and (iii) contribute to the assessment of overall capital requirements. As such, the PIP can be considered as a very positive step towards meeting the above objectives. ii. The preparation of the Program has faced formidable problems. By 1982, when the economy was in severe difficulties and Government was beginning to reorient some of its economic policies, public sector investments were in extreme confusion. Large numbers of projects had been started in all sectors without adequate preparation or regard to resource availabilities. Information on on-going projects, the state of their implementation and their financing was sketchy at best. It was, however, clear that their resource requirements would go nuch beyond availabilities and that the economic value of many projects was questionable. In addition, the rapid expansion of the public sector over the previous ten years had not been accompanied by appropriate institutional changes. Although the various ministries and economic agencies determined the greater part of their own investment, no coordination mechanism had beer. established to consider their investment proposals against the background of overall financial resources. In fact, no medium term economic projections of national investments and finances were made until 1982. Within ministries the arrangements for project preparation, evaluation and monitoring were weak, the emphasis being mainly on administrative procedures. Under these circumstances the Directorate General for Planning, then part of the Ministry of Finance and Planning, could have little influence over investment decisions and was rather isolated. iii. Once the political commitment was made to prepare a Public Investment Program, the Government took a number of measures. The first step was to ensure that institutional arrangements would be appropriate. The Directorate General for Planning (DGP) was transferred to the Presidency in January 1982 and played a central role in improving interministerial exchanges of information and views. Joint commissions were established to deal with specific problems or sector wide issues related to the preparation of the Program. The institutionalization of a PIP culminated with its presentation to the National Popular Assembly in July 1984. Further organizational changes are being contemplated with regard to the follow up on the program, its implementation and the preparation of ics updating.  - ii - iv. Inventories and reviews of the existing project portfolio were the next step to be taken by the Government to prepare a PIP. These were carried out systematically in the three major sectors. In agriculture, as part of an IDA technical assistance project, consultants have been reviewing the sector's projects since late 1982. In transport, after a review of the whole sector, the investment program was directed very largely to rehabilitation. In industry the on-going manufacturing projects were reviewed by consultants 1n early 1984 and the more problematic ones will be further studied. Although substantial progress has been made in obtaining basic information on public sector investments, the project schedules are still tentative and the economic viability of many projects has not been ascertained. v. The third move in the preparation was to draw up an overall program which would set priorities against the background of overall financial resources. An Interim Economic Program for the next few years has recently been prepared, in part to this effect. Aggregated disbursements of projects proposed in the PIP are roughly in line with projected levels of domestic investments in the macro-economic framework. They would amount to about 10 percent of GDP while the domestic investment rate would be around 12 percent in the next four years. At the same time, it is quite possible that future achievements will fall short of expectations. Several factors may play a hindering role in implementation of somewhat optimistic projections of both macro-economic developments and public investment program. vi. The availability of financial resources may oblige the Malagasy authorities to reduce their investment targets, revise their forthcoming commitments and streamline existing projects. Financial constraints may be both external and internal. The current PIP will impose an increasing burden on a government budget which is already strained. The squeeze on recurrent expenditure adversely affects numerous government services such as agricultural extension and research, project monitoring, schools and health services which are probably as important to long-term growth as any addition to the national capital stock. In addition. it is not certain that Malagasy banks and public enterprises will be able to contribute much to local financing of the PIP. Many of them are in financial difficulties and their rehabilitation would require some policy reforms in the field of pricing, management and perhaps debt restructuring. Economic policies which would set a better stage to domestic resource mobilization would also be more conducive to the expansion of the private sector. In this connection, it should also be noted that implementation of the PIP as proposed is likely to keep private enterprises seriously short of resources for investment. vii. If Madagascar can achieve the government objectives set in the Interim Economic Program it would go a long way towards meeting the PIP requirements of domestic resources. As explained in the Bank's Economic Memorandum of October 1984, both domestic savings and the government current budget would substantially improve by 1988. It would thus be necessary that external donors provide assistance to the public investment program in amounts and terms consistent with current and future government efforts.  - iii - viii. The main tenets of the program are to complete on-going projects and to rehabilite existing productive capacity. The social sectors take a small share of the investment while there are relatively few projects in other sectors for creating new capacity, though some of these are large. The agricultural program accounts for 32 percent, transport and communications for 23 percent and industry, comprising manufacturing, mining, energy and water, for 41 percent. ix. About 90 percent of the agricultural program is on-going, and a substantial part of it has only been started since 1982. Most of these recent projects are in line with the reorientation of agricultural policies that the Government initiated in 1982. Most of them are large, supported by external assistance and have been economically appraised. More generally, the program is dominated by larger projects, since 15 of the total of 102 constitute 70 percent of the total cost for the sector. The smaller projects were only submitted to internal review and have most often not been appraised. x. The transport sector program is almost entirely for rehabilitation. Road rehabilitation accounts for about 70 percent of the program, with high rates of return. Three road projects are not mentioned; one, the reconstruction of the road linking the capital city to the main port, is of high priority while another is almost complete. The port investment program is likely to be revised in the light of recent studies and most of the railway program will depend on the availability of external financing. Only the modest airport improvement program depends on Madagascar's own resources. xi. The major questions of economic viability arise in manufacturing. A number of projects that are being or are likely to be implemented have been omitted from the investment program and in some cases information on their costs was unavailable. About half the known costs of the projects consist of two projects for creating new capacity that will depend on the availability of new external financing and technical partners. Otherwise 21 percent consist of on-going projects, of which most are doubtful and under study with a view to determining possible further action. There are several rehabilitation projects, most of them small, accounting for 26 percent of the outlay. Of these a couple have been reviewed and found acceptable. It is understood that the Goverment final response to a number of proposed investments in manufacturing will depend on the outcome of studies and its success in finding suitable partners. xii. The mining program, excluding petroleum exploration, is small and consists almost entirely of studies and prospecting. However, some of the proposed studies are large enough to warrant smaller initial studies. In  - iv - the energy sector, petroleum exploration, consisting of a drilling program being conducted by major oil companies, involves negligible costs to the Ma.4agasy government. Madagascar is also seeking to exploit its heavy oil and tar sands deposits, but initial exploration and the experience of other countries indicate that the prospects of viability are uncertain. The justification of the remaining projects appears dubious. The urban and water projects, consisting of two large projects financed by IDA and several smaller ones, are addressed to genuine needs. However several organisations are active without clear demarcation of responsibilities between them, leading to problems of execution and cost recovery. xiii. The above review of the sectoral context of the proposed investment program shows that the Malagasy authorities have made a considerable effort at restoring order in the confused state of public sector expenditure. At the same time, the Government envisages the establishment of (i) a Planning Council to advise on investment priorities and sectoral allocations, (ii) planning and policy units in the major economic ministries, and (iii) stricter project evaluation procedures and criteria. In the medium run, these improvements should lead to the preparation of public expenditure prograns more tailored to available financial resources. xiv. Government intends to prepare, during 1985, a PIP for 1986-90. For that and subsequent PIPs certain actions would be needed to continue the process of improving management of public sector resources. The first would be to ensure closer correspondence between PIP priorities and resource availabilities. This would be achieved partly by better financial projections, especially 2-3 year projections of government finances, and closer coordination by Government of external assistance, particularly the initial contacts with potential donors. Even after during this it would be useful to define a core program or some other means of deciding where cuts would be made in case of unexpected shortfalls in resources. xv. Secondly the process of project review would need to continue in order to improve the project content of the next PIP. A number of studies being done would contribute substantially to this. Thirdly, there is a need to strengthen project identification, and preparation since the drop in scheduled outlays and project starts in 1987 indicates that viable new projects may be in short supply. Finally, Government would need to review the issue of the size of the next PIP and its implications for recurrent government expenditures and private sector investment. It would be appropriate to consider beginning reviews of recurrent expenditures and to establish better data on public and private capital formation.  I. INTRODUCTION AND BACKGROUND Introduction 1. Madagascar's 1984-87 public investment program is the result of efforts by the Malagasy Government over the past two years to take stock of public sector investments and to adjust them to the priorities determined by the prevailing economic difficulties. It was formally adopted by the National Popular Assembly in July 1984. 2. As the first operational medium term program for public sector investments to be formally adopted by the Government, the program marks an important stage in the rehabilitation of the Malagasy economy and in the establishment of effective arrangements to manage public sector resources. It follows an earlier, preliminary program presented to the Consultative Group at its meeting in April 1983, which constituted the first stock-takiig of public sector investment activities since the upsurge of investment in 1978. Beginning in 1982, extensive reviews of public sector projects, together with the initiation of major rehabilitation programs, have permitted the greater concentration of financial resources and the better administrative focus on priorities that were needed to give the present program sufficient operational significance for formal adoption. Government intends to prepare a five year program, 1986-90, in 1985 and to revise the program regularly on a rolling basis. 3. The present review constitutes part of the Bank's continuous association with the preparation of the public sector program. At Government's request, a Bank economic mission visited Madagascar in April 1982 to collaborate with the Directorate General for Planning in preparing national accounts and making the first medium term economic projections. The Bank has also been assisting in reviewing projects in the major sectors. In agriculture this has been done through a continuing program of technical assistance financed under a technical assistance credit. Similarly the Bank has provided technical assistance to the transport sector through the IDA 6th Highways project. In industry the major on-going manufacturing projects were reviewed in early 1984 and future action with regard to some of them is being studied with financing from a Project Preparation Facility. With continued improvement of the dialogue, we expect to be closely associated with the preparation of the 1986-90 PIP during 1985 and are considering providing technical assistance for that purpose to the Directorate General for Planning. Background 4. The present PIP follows considerable efforts since 1981 to restore order into the confused state of public sector investments. Heavy expenditures beginning in 1978 had not been adequately controlled and had resulted in an accumulation of external and domestic obligations whose number and total amounts were not known. Similarly there was no overview  of the projects that had proliferated in this period. It was, however, apparent that resources were too scarce to implement more than a part of the on-going investments and that the scarcity would last several years. 5. The first steps taken were to make inventories of government obligations, to start preparing economic projections, and to take stock in a preliminary way of the investment activitie- in the public sector. In late 1981 a fairly clear picture of the external debt situation had emerged and by mid-1982 the first medium term projections were ready. The stock-taking of projects, which resulted in a provisional investment program in late 1982, has turned into a process of data collection and project reviews that is still continuing. From the results Government has been able to make the estimates of resource requirements and to take the decisions on project priorities that constitute the basis of the present PIP. 6. There were substantial differences between the sectors, both in the nature of the reviews and the actions taken. A major review was made in the agricultural sector, beginning in 1982, where all projects were summarily reviewed and a number discarded. In the transport sector the highway program, which constitutes most of the sector program, was redirected, from 1982 on, to rehabilitation of the badly deteriorated road network. Only three road construction projects, all with assured external financing being retained, one being reconstruction of the vital link between the capital city and the main port. In the industry sector, where the response was slower and more limited, all the on-going manufacturing projects were reviewed in early 1984 and work on some postponed pending further study. 7. Despite the efforts in some sectors, there were difficulties in preparing a PIP due to the absence of an adequate institutional framework for managing public sector resources. Precisely this deficiency was one of the main reasons for the ill-advised policies and investments of the previous years. In preparing the investment program a number of temporary and ad hoc arrangements and procedures had to be resorted to. Moreover a considerable learning process was involved, since much of the work was unfamiliar. 8. More permanent arrangements for managing public sector resources are being gradually put in place. Three broad types of issues need to be addressed. The first is the need for some coordination mechanism for establishing consensus on the main features of the investment program. The second is the absence in certain sector ministries of adequate arrangements and procedures for sectoral planning and project preparation. Third come improvements in project implementation and monitoring, which would be indispensable to the proposed preparation of rolling plans.  II. THE OVERALL PROGRAM: 1984-85 9. The public investment program comprises policy statements and individual project summaries (fiches de projet). The policy statements cover the overall objectives of the PIP and sector goals and policies. The project data are supplied by the fiches de projet. With a few adjustments, the fiches constitute the data base for the present review. For this exercise, the Government has made an attempt to collect information on all the projects financed out of its budget or being undertaken by state-controlled enterprises and special economic agencies. It should be emphasized that this was a formidable task; as a first attempt, the present PIP is a substantial achievement. 10. There are, however, a number of shortcomings in the information provided, project-by-project, in the fiches. The data provided are incomplete in several respects. A number of projects known to be under implementation in the period 1984-87 have been omitted. Whereas in the agricultural sector the coverage appears complete, in transport three road projects in the capital budget have no fiches. The greatest deficiencies Oc%...uein the industry sector, where at least thirteen manufacturing projects, including some major ones, have no fiches and are not mentioned elsewhere in the PIP documents. 11. The data on the fiches are also of variable quality. In a high proportion the schedules of costs are tentative; improvement should be expected in the quality of this information from further project review and better project preparation. In particular, the fiches were not required to include estimates of value added or economic benefits, though Government intends to include such information once suitably trained staffs are available in the ministries. There were minor inconsistencies and omissions in the data of the fiches for all sectors. In manttvacturing, however, cost and implementation schedules were sometimes unzertain and financing data were usually not given. 12. The economic viability of the individual sector programs depends to a considerable extent on Government's continuing some of its present actions. In the agricultural sector the program conforms to the stated objectives, which are appropriate to the economic situation, but is encumbered with projects whose economic justification has not been established. It would be necessary to continue the on-going process of project review. The transport sector program Is largely for rehabilita- tion. While the economic justification of most of the program is high, there remain uncertainties about some aspects. About half the manufacturing program's cost are due tn 1wo projects that would need to be examined closely. Most other projects are on-going projects, including several of doubtful viability. Finally several small manufacturing projects involve rehabilitation of old enterprises. In the relatively small energy and mining programs, leaving aside petroleum exploration, the larger projects, including studies, seem premature. The level of investment in other sectors is much smaller and spread over many diverse activities.  -4- Size and Financing of the PIP 13. The total cost of the PIP would amount to about FMG 713.5 billion for the period of implementation of the program (see Table 1). This is -bout US$1,219 million in 1984 prices for fcur years, or an annual average of about US$305 million. As mentioned above, these totals are not firm statistics with a well defined financial and economic connotation. The PIP would also need to be adjusted to remove certain recurrent costs and operating capital included in the costs of projects; The totals are thus not strictly capital formation figures. Special allowance should also be made for petroleum exploration which is included in the totals and would amount to US$98 million and US$65 million in 1985 and 1986 respectively. This exploration would be conducted by four oil companies with insignificant cost to Madagascar (see Table 2). Table 1. Composition of PIP: 1984-87 1/ (FMQ billions) Percent of 1984 1985 1986 1987 Total Total PIP Agriculture 66.7 71.9 62.7 61.7 263.0 36.9 Transport and 35.8 44.3 34.5 51.1 185.7 26.0 telecommunication Manufacturing 10.8 24.9 26.4 24.5 86.6 12.1 Mining 1.1 3.3 6.0 4.9 15.3 2.2 Energy and Water 3.8 62.7 47.7 14.3 128.5 18.0 Other sectors 7.9 6.8 9.3 10.4 34.4 4.8 Total 126.1 213.9 206.6 166.9 713.5 100.0 1/ 1984 prices. 14. Another element of uncertainty is introduced by the manufacturing sector progLam, which includes several projects for which there were no project fiches. Leaving aside the rehabilitation of the oil refinery, which would depend on extornal financing and whose cost has not yet been determined, the projects without fiches are unlikely to exceed FMG 12 billion. Government is currently re-examining the viability of its manufacturing projects and will allocate sector resources in the light of the studies. 15. Furthermore, it appears from the fiches that commitments of external financing for the agricultural program of 1984 and 1985 have been lagging. By Hay 1984 the equivalent of US$7.2 million was still being sought for 1984 and about US$37.4 million for 1985. In contrast, the  - 5 - program of the transport sector, including the projects for which there were no fiches, has been 99 percent assured for both years. Since a large part of the program of the industry sector for 1984 and 1985 consists of projects near completion, the foreign exchange requirements and, consequently the amounts being sought, are quite small. Table 2. PIP Expenditures: 1984-87 1/ (FMG billions) 1984 1985 1986 1987 Local Foreign Local Foreign Local Foreign Local Foreign exchange exchange exchange exchange Agriculture 28.0 38.7 29.6 42.3 27.5 35.2 29.6 32.1 Transport and 13.3 22.5 16.3 28.0 17.9 36.6 18.9 32.2 telecom. Manufacturing 4.1 6.7 9.8 15.1 12.6 13.8 4.7 19.8 Mining 0.1 1.0 0.1 3.2 1.7 4.3 2.1 2.8 Energy & Water 1.5 2.3 2.3 60.5 2.8 44.9 4.9 9.4 of which Petroleum - - - (57.6) - (40.0) - - exploration Other sectors 1.8 6.1 3.2 3.6 4.8 4.5 6.2 4.2 Total 48.8 77.3 61.3 152.7 67.3 139.3 66.4 100.5 w X. . - _ _ Total in US$ 84.9 134.5 104.3 259.7 114.5 236.9 112.9 170.9 million (Petroleun (98.0) (68.0) exploration) I/ 1984 prices 16. An Interim Economic Program for the period 1984-87 has recently been prepared by the Government. It sets out a number of objectives of economic policy and proposes a broad strategy for their attainment. The quantitative targets seen in a consistent macroeconomic framework are spelled out in the Bank economic memorandum recently issued1/. This Economic Program provides a general economic background to the public investment program. Madagascar, current Economic Situation and Prospects, Reports 5154 MAD. dated October 25. 1984.  - 6 - Table 3. Comparisons of PIP Expenditures: 1984-87 1, (in percent) 1984 1985 1986 1987 PIP Total As Z of GDP 8.4 10.1 10.3 10.0 As X of capital budget 2/ 122.7. 146.3 155.7 159.2 PIP Foreign exchange As X of imports GNFS 21.8 26.3 27.6 28.2 Excluding petroleum exp'loration. 2/ Including on-lending. 17. Comparisons with the macroeconomic projections (Tabl; indicate that the scheduled outlays of the Program are in line wil'L over- 11 investment levels and imports. Total outlay each year would r- qu -Jalent to about 10 percent of GDP, as compared to projected investmer. evels of 12 percent. The foreign exchange cost would increase to 28 pei. Lt of - imports, remaining slightly below imports of capital goods. The _atter is only an indicative comparison, since the PIP will include some raw materials and spare parts, while certain capital goods will be destined for private investment or maintenance. But it indicates that the Investment Program conforms broadly to the size and composition of the import program. 18. However, the availability of financial resources may oblige the Malagasy authorities to reduce their investment targets, revise their forthcoming commitments and streamline existing projects. In particular comparisons with the capital budget indicate that the PIP will impose a substantial burden on the government budget, which is already strained. The capital budget, including on-lending of external capital to public sector enterprises, constitutes much the greater share of financing for the PIP. The remaining sources, the commercial banks and retained earnings of public sector enterprises, are not likely to contribute much in the next couple of years. Consequently recurrent expenditures are likely to be squeezed, with adverse effects on numerous government services, such as agricultural extension and research, schools, health services, project monitoring, and training programs, which are as important to long term income growth as fixed capital. 19. Uncertainties on the resource availabilities are somewhat matched by uncertainties on the pace of program implementation. On the basis of experience, the limitation of absorptive capacity can be expected to reduce resource requ4.rements and lead to a more even level of capital expenditure in 1985-87. If only on this basis, the Government should reconsider the timing of new projects with the aim of reducing congestion and improving the speed of execution.  20. The resource requirements of the PIP raise two broad issues. One is the importance of increasing the financing capacity of public sector enterprises and hence the public sector's savings rate. The inability of the commercial banks and state enterprises to finance a substantial part of the PIP is due to the financial difficulties of many of these enterprises and the heavy commitment of bank resources to them and to private firms, with little prospect of early repayment. This is an issue that needs to be addressed through a wide range of reforms, including pricing policies, management and, perhaps, debt restructuring. It is discussed further in Chapter VIII. 21. The second issue raised by the size of the PIP is that public and private sectors may be competing for insufficient resources. Although there is little information on private capital formation in the past, it is likely that, if the public sector is short of resources, private investment will also be squeezed. It is difficult to estimate what level of investment could be expected of the private sector since most of the larger enterprises that were private are now under state control. In recent years it has been low. But there is considerable unsatisfied demand in the private sector for foreign exchange for replacement, rehabilitation and extension of plant and machinery. As Government's policies to relax administrative controls progress, this demand is likely to increase. General objectives 22. The statement on general objectives is in line with both the quantitative growth targets presented in the above mentioned Bank economic memorandum and the Government's policy objectives. It stresses that the fundamental long-term goal described in the Charter of the Malagasy Socialist Revolution, of an independent, self-sustaining economy capable of meeting the population's needs on the basis of new social relations, remains unchanged. The PIP's objectives are directed to overcoming the current difficulties of the economy that prevent it from reaching this goal. 23. The economy is to recover through rehabilitating the existing capital stock, raising economic and financial efficiency, and increasing the financing capacity of the economy. These objectives would be supported by more active export policies. The criteria for resource allocation would therefore be: (i) continuation of viable on-going projects; (ii) rehabilitation of productive capacity, especially in agriculture and transport; (iii) increased utilization of installed capacity; (iv) promotion and diversification of exports and substitution of imports; (v) _fficient transport arrangements for productive activities, especially agriculture; (vi) measures to achieve self-sufficiency in energy.  -8- 24. They are a good indication of the contents of the PIP. It is unavoidable that a large part of the program should consist of projects on-going at the start of 1984 since they embody a large sunk cost. The extent to which the viability of projects has been examined is, however, limited; it is doubtful, that many projects could have been reappraised and, perhaps, restructured, with the resources available and in the midst of economic difficulties. 25. Among the many issues relating to improving economic efficiency,the most important concern rehabilitation and increased utilization of installed capacity, which, along with increased yields in agriculture, are likely to be the sources of growth over the medium term. The new manufacturing capacity coming on-stream faces problems of obtaining inputs and of financial viability that will probably make its contribution to growth of income very small. The donor community is supporting major programs of rehabilitation of infrastructure in transport and agriculture, as well .s giving balance of payments support for supplies of raw materials and spare parts. Although much remains to be done to ensure that higher maintenance standards reduce the need for costly rehabilitation in the future, government policy is to increase the availability of spare parts, while measures have been taken to ensure a minimum of resources for highway maintenance for the next few years. 26. The promotion and diversification of exports is a major long term requirement dictated by the modest prospects of traditional exports and not likely to produce significant results for some time. Government has taken czrtain initial measures to encourage exports, notably convertible currency accounts in which exporters Eay retain some export proceeds for purchases of inputs, but is still at an early stage in formulating long term policies. With assistance from donors, it is studying the problems and possibilities of traditional exports and the measures needed to encourage new ones. As yet its investment proposals in this direction are largely tentative. On the face of it, the wide variety of crops cultivated in Madagascar gives scope for diversification, but state enterprises have shown little initiative in finding new markets and new export products, while problems of logistics and administrative procedures still discourage the private exporter. Some new exports from new state manufacturing enterprises that are included in the projections underline the importance the Government attaches to exports, but the volumes, not being based on market research, are optimistic, while their high import contents cast doubts on the net foreign exchange benefit. 27. Improving the financing capabilities of the economy is largely a question of restoring the profitability of enterprises, especially of those in the public sector. Few state enterprises make profits and many private sector firms are in financial difficulties. Measures to restore profitability would necessarily include more liberal pricing policies, regular supplies of inputs, and better management. On the other hand, if resources for investment in the public sector were to be increased by further restriction on the recurrent budget, the effectiveness of several government services could be further reduced and would have a negative net effect on long-term growth. These points are discussed in more detail later. Projects will remain highly dependent on external assistance for  their foreign exchange costs, even if resources are freed by rescheduling debt on considerably more generous terms than obtained up to now. Discovery of commercially viable oil deposits during the drilling scheduled to begin in 1984, is not likely to improve Madagascar's creditworthiness enough to attract much private lending on reasonable terms in the fcreseeable future. III. AGRICULTU?.E The Present situation 28. The agricultural sector, which accounts for roughly 40 percent of GDP and 80 percent of exports, is exceptionally diverse. The main crop, rice, is the staple of the Malagasy diet. In addition there is a large cattle population, estimated at 11-12 million head. The mainly tropical east cost produces most of the export crops, of which the main ones are coffee, cloves and vanilla, and a wide variety of fruits, spices, and vegetables. A considerable range of fruits and vegetables are also produced in the temperate highland area. Assessment of the Agriculture Sector Program 29. In 1982 Government began a process of reviewing its agricultural projects and redefining certain priorities. Nearly all the projects were in difficulties. There had been an accumulation of projects, many ill-prepared, far beyond what could be financed. Consequently local resource shortages were causing widespread implementation problems. They also caused maintenance of equipment and infrastructure to be neglected, in particular of major irrigation schemes. Several major state agricultural enterprises, including those managing irrigation sc-hemes, had additional financial problems due to inappropriate pricing and cost recovery policies, as well as difficulties arising from management and labour. 30. At the same cime certain priorities needed to be reconsidered. The first was the need to favour rehabilitation rather than new projects. The second was to give higher priority to export crops, which had been relatively neglected. The third was to scale down some oversized projects to match implementation capabilities. Finally the project preparation and implementation capabilities of the ministries needed to be strengthened. The Ministry for Agricultural Production and Agrarian Reform (MPARA) was handicapped by major organisational problems. Apart from the Ministry's own internal organisation, these problems were mainly due to the large number of activities the Ministry had responsibility for and the decentralisation in the mid-1970's of some of its services. 31. The review of the agricultural sector projects, beginning in 1982, resulted in the elimination of a number of mostly moribund projects. It helped Government concentrate resources on the retained projects, while bringing out their problems. The review had to use basic and practical criteria for the selection of projects. Much of the information was missing, and, although the review involved considerable data collection,  - 10 - calculations of economic rates of return were not feasible. Projects with assured financing were retained, though not all appear to be fully justified. Otherwise the main criteria employed were: (i) adequacy of the technical package; (ii) adequacy of management; (iii) physical accessibility (in view of the state of the transport system); (iv) contribution to the balance of payments; (v) emphasis on rehabilitaton; (vi) reduction of subsidies. Despite the review, which is continuing, cost data are extremely rough and the source of considerable uncertainty in judging the size of the program. Many of the smaller projects are still unlikely to receive financing for implementation and are likely to be postponed or even discarded at a later stage. 32. Rehabilitation became a major component of the program. Seventeen projects, accounting for 32 percent of the outlay, are projects with major rehabilitation components. Export crops are also receiving more emphasis; seven projects, accounting for 7 percent of the program are being devoted to them. In addition a study of the export crops subsector has been prepared by the Bank and discussed with Government as a basis for future policy. A number of projects have been scaled down, notably projects to supply new agro-industrial projects. 33. The MPARA began to centralise again some of its decentralised services in 1982 and was split into two ministries in July 1983: the MPARA, with responsibility for annual crops, and the Ministry for Livestock, Fisheries and Forests (MPAEF). Both ministries are undergoing reorganisation, under a technical assistance project, and instituting training programs. Composition of the Agricultural Program Table 4. Composition of Agricultural Program: 1984-87 (FMG billions) 1984 1985 1986 1987 No.of Local Foreign Local Foreign Local Foreign Local Foreign Proj ects exchange exchange exchange exchange Crops & gen. 53 22.1 25.0 20.6 29.4 19.3 23.2 21.6 21.9 agriculture (of which rice) (26) (12.6) (14.3) (9.7) (12.7) (11.8) (12.4) (12.4) (13.5) Livestock 15 1.5 4.5 4.3 4.1 4.0 3.3 4.0 2.9 Forestry 19 1.3 3.7 2.0 4.3 2.0 5.5 2.0 4.9 Fisheries 7 0.3 0.4 0.1 1.1 0.1 0.9 0.1 0.6 Other 9 2.7 5.1 2.6 3.3 2.1 2.3 1.9 1.8 Total 102 27.9 25.7 29.6 42.2 27.5 35.2 29.6 32.1  - 11 - 34. Although the program consists of a large number of projects, it is dominated by a few big ones. It is these bigger projects that embody the efforts of recent years to reorient agricultural investments, while the smaller ones are mainly projects retained from the past. Table 5. Size Distribution of Agricultural Projects 1, (Numbers or projec-s) Less than FMG 1 bn. FMG 3 bn. More than FMG 1 bn. to FMG 3 bn. to FMG 5 bn. FMG 5 bn. Crops and gen. 14 17 12 9 agriculture: (of which rice) (4) (10) (7) (5) Livestock 11 1 - 3 Forestry 15 2 2 Fisheries 6 1 - Other 4 4 I 1 Total 50 25 12 15 Total outlay 17.9 44.9 47.4 152.8 (FMG billions) ,/ Only outlays during 1984-87 35. This is significant in interpreting the table below. Although projects started before 1984 account for the bulk of the program, much of their total cost is due to projects starting after 1982. For instance projects of FMG 5.0 billion or more each started in 1982-83 constitute 38 percent of this cost. It is probable that projects in the FMG 3-5 billion range started in this period are also a significant percentage. A further three larger projects, with total cost of FMG 12.9 billion that have been appraised and are being externally financed, begin in 1984. Such projects depend heavily on external assistance and constitute the better prepared part of the program; through them a good deal of the reorientation of agricultural investment appears already to be incorporated in the on-going program.  - 12 - Table 6. PIP Project Starts in Agriculture 1/ Before 1984 1985 1986 1987 1984 No. of Projects 71 13 13 4 1 Total Cost (FMG billion) 189.1 44.7 22.9 6.0 0.3 1/ By date of initial outlay. 36. Taking the MPARA's program first, the main economic objectives of the projects are to substitute for imports, supply inputs for domestic processing capacity, and to increase exports. These are not mutually exclusive objectives; in fact most of the projects of the second are included under the first. Moreover, a high proportion of the investment to achieve these objectives would be in the form of rehabilitation. Relatively little of the program consists of new projects. 37. The prominence of import substitution is due to the major objective of attaining self-sufficiency in rice. Of thirty six import substitution projects with fiches, twenty six are to a significant degree directly related to rice. The next most important category of product is vegetable oils (excluding cotton), which account for seven projects. These categories include the major rehabilitation projects. The other import substituting projects mainly supply inputs to processing capacity. 38. The ten projects supplying inputs to agro-industries are largely directed to newly created processing capacity. In the cases of textile and vegetable oils, the supply of raw materials did not meet requirements even before processing capacity was expanded. With the exceptions of sugar and textiles, all the output of the new processing capacity substitutes for imports, as does the output of the old vegetable oil industry. The remaining project, rehabilitating paka and hybiscus productior., will supply the old jute mill that has been virtually out of production for some years. 39. A considerably larger export oriented program than the proposed seven projects might have been expected given Madagascar's potential, but the importance currently attached to exports is too recent in origin for many projects to have been identified. The emphasis is on rehabilitation again, since the three such projects - for coffee, cashew nuts, and lima beans - account for 60 percent of the total cost. Only three projects concern traditional exports: coffee, lima beans, and cocoa. The remainder, including the cashew nuts project, are intended to diversify exports. 40. Although the program of the MPAEF has almost the same number of projects, it is much smaller. Only three of its projects involve expenditures above FMG 1 billion in 1984 and only five projects have total expenditures exceeding FMG 5.0 billion.  - 13 - 41. The MPAEF's program does not reflect a clear strategy since the Ministry has not been in existence long enough to have formulated one of its own, while its subsectors pose some especially difficult problems. Nearly all its projects were inherited when it was created in July 1983. Livestock accounts for fifteen projects for a total of FMG 28.6 billion. This subsector has had a low success rate despite major efforts. The fisheries subsector is now beginning to receive more attention than it did until recently, but the change has been too recent for a well prepared program to be ready. There are only seven fisheries projects for a total of FMG 3.6 billion. Seventeen forestry projects for FMG 25.7 billion constitute the rest of the MPAEF program. Economic Assessment 42. A high proportion of the program on-going in 1984 is being financed from OECD and multi-lateral sources of assistance. As a rule, projects with assured external financing, hav'ng been appraised, are economically justified, though there are exceptions. Of 84 projects marked as incurring outlays in 1984, 35 are marked as having some assured external financing. These 35 account for 70 percent of the sector program outlay in 1984 and for 57 percent over 1984-87. Thirteen of the fifteen projects with total costs of over FMG 5.0 billion each are on-going in 1984 and ten of these are assured of external financing. Only one other project, the rehabilitation of the Morondava basin irrigation scheme discussed below, has an outlay of over FMG 1.0 billion in 1984 without assured external financing. 43. Of these thirteen large on-going projects, apart from the three without assured external financing, there are two that raise questions. The remaining eight projects are receiving external assistance after having been carefully studied and include five with IDA financing. The biggest of the three without assured external financing is a program of veterinary protection for cattle, at a cost of FMG 10.2 billion, for which financing is being sought. The second is an irrigation rehabilitation project, for FMG 9.0 billion, which begins to incur foreign exchange costs in 1985. Clarification is needed on which irrigation schemes it is intended to rehabilitate and its relation to the other major efforts to rehabilitate Madagascar's irrigation schemes. The third is a project of FMG 6.2 billion to develop coffee production. It is under study by the FAC and could continue France's program of assistance for export crops. 44. The two other large projects to raise questions are a project labelled "Research" and a project to rehabilitate the long-ailing Famama state farm. The research project appears to be a collection of research proposals in several sectors to be implemented by the Ministry of Research. The project summary gives little information on it. Its inclusion under agriculture is apparently due to the sector's accounting for the largest share of the research, and 80 percent of its external financing needs for 1984 and smaller proportions for later years are marked as assured. Clarification is needed on its content and relation to the rehabilitation of the agriculture research agency, FOFIFA (CENRADERU). The Famama state farm has a long history of problems and its impending  - 14 - transformation into a socialist enterprise is likely to complicate the essential task of improving its management. Until the causes of its problems have been overcome, the rehabilitation of its cashew nut plantation and the addition of a processing unit for the nuts, both of which are being financed by the African Development Bank, are likely to face difficulties. 45. The preparation of projects beginning in 1985 or later has been lagging. Of those scheduled to begin in 1985, leaving aside the two major projects, only two out of eleven are marked as having assured external financing. Although it may have been too early at the time of the preparation of the PIP to have assured financing for projects scheduled to begin incurring outlays in 1986-87, the slow preparation of those scheduled to begin in 1985 is largely due to the weaknesses of the ministries' project capabilities. The project and fiches provide little information on economic analysis performed or envisaged. 46. The two major projects beginning in 1985 happen to be the only two projects of over FMG 5 billion beginning after 1984. They are to be distinguished from the other projects beginning in 1985 because one, a dairy protect, is marked as incurring no external costs while the other, a forestry project could not, in fact, begin implementation before 1988. The dairy project is a World Food Program project of FMG 7.3 billion for training and organising smallholders to supply milk to dairy units. It would be financed entirely out of WFP counterpart funds. The forestry project is being proposed as the third forestry project to be financed by the Bank Group. It would increase the supply of fuelwood, the main primary source of energy, and raise the efficiency of its utilisation. Since it would simultaneously address the main cause of deforestation and meet the needs of the poor, the project concept is well justified. However preparatory work on it has not started and it is highly unlikely that major expenditures could begin during the present PIP period. 47. Rehabilitation accounts for seventeen projects amounting to FMG 80 billion. Some of them include extension. Four major ones concerning irrigation schemes are fully assured of their external financing. They involve some of the largest out'ays in the sector, two of over FMG 5.0 billion each, and are of high priority. A fifth raises doubts. The two largest projects concern the Lac Alaotra and Marovoay schemes managed by state enterprises and supplying the bulk of marketed rice. The cost of the Lac Alaotra project is put at FMG 17.9 billion, and that of the Marovoay project at FMG 9.6 billion. The third, the Irrigation Rehabilitation project (petits perimetres), includes a major effort to establish an efficient maintenance system for smaller irrigation schemes. The fourth is the rehabilitation of the Bas Mangoky scheme. The project fiche included an extension of the scheme, but Government has since decided to restrict the project to rehabilitation and overcoming its management and labour problems. The fifth, the rehabilitation of the Morondava basin scheme for FMG 2.8 billion, was mentioned earlier as incurring an outlay of over FMG 1.0 billion in 1984 without assured external assistance. The scheme has been in difficulties ior several years, despite major expenditures through external assistance, and, until its labour and management problems are solved, the advisability of more large expenditures on it appears questionable.  - 15 - 48. Some of the projects for supplying inputs for agro-industries have been scaled down, while some others need reconsideration. The soya cultivation project for the Mamisoa flour and vegetable oil factory was originally proposed by the Ministry of Industries to cover 70,000 ha, but has been reduced to a pilot project in cooperation with the MPARA. A similar project for wheat cultivation for the new mill at Antsirabe has also been scaled down, but is being implemented by the milling enterprise, Kobama. 49. Government is reconsidering its proposal for an oil palm plantation near Maroantsetra, beginning implementation in 1986, after a recent study showed it was highly unlikely to be viable. Madagascar's climate is not ideally suited to the competitive production of palm oil and even the rehabilitation of the existing Somapalm plantation might need reconsideration, despite its assured external financing. The resources for these projects could probably be more effectively used in reviving groundnut production. The decline of this crop to about 10 percent of its former levels has been due to Government policies and has caused substantial problems for existing vegetable oil enterprises. At present there is only one small project for groundnuts. 50. Implementation. The elimination of numerous projects from the investment program and the concentration of resources on the remaining ones has already improved project implementation in agriculture. However, limitations of implementation capabilities and shortages of resources will substantially delay project implementation. Further review of projects is needed to bring them more in line with resource availabilities. Moreover, the extensive reorganization in the agricultural public sector may reduce implementation capacity in the short term. From mid-1982 until it was split in mid-1983 the MPARA was engaged in reversing the decentralization of its services that had been implemented a few years before with unsatisfactory results. The split into two ministries has entailed further reorganization. Both ministries are now studying the question of their future organlzation with the aid of consultants. They are also preparing extensive long term training programs for their staffs. Over the medium term these measures should result in considerably better project implementation. 51. Examination of the fiches shows in particular that several new projects are likely to start late or have problems during implementation. Some of the new forestry projects do not identify the implementing agency and, except where the Mangoro forestry agency is concerned, may overstretch the existing forestry services. In the case of the biggest of these, the third forestry project, scheduled to be in full swing by 1986, it is unlikely that implementation can start before 1988. A project for developing fruit exports, whose implementing agent has not yet been identified and whose objectives and design are vague, is unlikely to reach implementation during 1985 as scheduled. It would seem to be a case where private partnership would be advisable. Another export oriented project, to promote cultivation of Lima beans among smallholders, is to be implemented by the agricultural research agency, FOFIFA, which itself faces serious difficulties and is expected to undergo major reorganization. It  - 16 - is questionable that this project is the sort of work FOFIFA is intended for. These projects are all scheduled for implementation to start in 1985. Delays would appear very probable and advisable. 52. Policy Issues. Although the Government has been reconsidering its role as entrepreneur in the agricultural sector, some elements of the program indicate a lack of clarity over this issue. One consequence of its investment in production oriented projects is that resources may be diverted from recurrent expenditures, which in the agricultural sector more than any other, also determine the longer term growth of output. A longer term view is also needed in formulating sub-sectoral policies, particularly in deciding which sub-sectors have the best growth potential. 53. The Government's role as entrepreneur has been reduced in the last two years as measures have been taken to manage state enterprises with private partners or through management contracts. Nevertheless, some projects in the agricultural program are straightforward production projects that might more suitably be left to the private sector. Examples are the vaguely defined fruit export project, and the cashew nut project to be implemented by an ailing state farm. In each case there is a problem of executing agent. It is not clear why, if the projects are economically viable, the private sector is not expected to invest in them. 54. ProjecEs that do not receive external financing absorb resources that could yield more growth of output as recurrent expenditures. The agricultural sector has been especially hard hit by squeezes on recurrent exPenditures over the last decade and, though the Government is now taking active measures to rehabilitate its services from the damage caused by prolonged resource shortages and organizational problems, recurrent resources remain a severe constraint. The inability to purchase materials and services has paralysed a number of agricultural agencies, including extension services and research, while reducing travel, inspection, training and other routine activitie:s of ministries' and agencies' staffs well below normal levels. Catching up on the backlogs alone will place a continuous strain on resources for several years. 55. Until recently, partly because of a tendency to emphasize projects and global objectives, sub-sectoral policies were often poorly defined. Some measures being taken now constitute a beginning in improving policies, though a longer term perspective for agricultural development is needed. Rice has always been the focus of the Government's attention but no specialized unit for analyzing issues in formulating policy alternatives existed, until the creation of such a unit in 1983. For export crops there has been extensive study by several agencies that would result in a coordinated approach to this sub-sector. Other sub-sectors are less advanced. The most striking is the vegetable oil sub-sector in which production of groundnuts was allowed almost to disappear because of low producer prices, inefficient crop collection, and degenerate seed, while large investments were made in processing facilitles for soya and palm oil, whose local supplies are limited. A groundnut project to promote production by smallholders again is scheduled to start in 1985, while pricing and input policies for the crops are being formulated.  - 17 - 56. The livestock and fisheries sub-sectors pose fundamental issues in view of the consistently low productivity of the cattle herd and the declining per capita consumption of proteins. Since the beginning of the century efforts to raise cattle productivity have yielded disappointingly few results; traditional practices continue to prevail and the Zebu cow has proved more enduring that any of the mixed breeds. After many costly failures, livestock policies have retreated to promoting animal health especially vaccination programs. Alternatives to cattle as a source ot increased protein supplies are pigs, poultry and fish. Support by the ministries to private sector pig and poultry raising has been limited. Success in increasing the output of pigs and puiltry would relieve the growing protein shortage and release more beef foi export. 57. The fisheries sub-sector has equally great potential, which the MPAEF has only begun to investigate. Despite some recent investments in modern fishing capacity in both public and private sectors, Madagascar's coastal and ocean fishing capabilities seem to be explnited more by other countries. The possibilities of fish farming also appear to be considerable and virtually untouched. Some stimulus to fish projects has come from exports, which are now a more important foreign exchange source than meat, though the volumes are still well below the peak levels of the early 1970s. Nevertheless, the fisheries subsector accounts for only 1.5 percent of the agricultural investment program. An early increase in the size of the fisheries program would however be difficult to implement since the policies need to be elaborated on the basis of sector studies that have yet to be carried out and the Government's own services need to be strengthened. 58. The shortcomings of sub-sector policy formulation reflect a lack of a long term, overall view of agricultural development. The PIP itself is largely addressed to the medium term, rehabilitation, reducing rice imports and providing inputs to agro-industries, while nearly all the projects are either on-going or were identified some time ago. Choices about the longer term did not have to be made at this stage. However, decisions will have to be made in choosing which of the wide variety of vegetables and animal products the country can produce should be given priority. The cost of neglecting the country's comparative advantages are seen in the agro-industrial projects whose raw materials are either unavailable locally or relatively costly. Even on a tentative basis, longer term assessment of agricultural development policies will permit Government to focus on the most promising possibilities, instead of risking a wide dispersion of its efforts. IV. TRANSPORT The present situation 59. Because of the size of the country and the sparse population, transport poses major problems. Road transport is the main mode; there are 50,000 kms of road, 4,900 of which are paved, requiring a considerable maintenance capacity that has been lacking. Yet the only link between the highland area, where the capital city and most industrial enterprises are  - 18 - located, and the main port is an old railway line of limited capacity with a branch to the chrome mines. Two other stretches of railway exist, one being of doubtful economic viability. Air transport is a major means of passenger movement across the country, though several of the nineteen airports have low traffic densities. Coastal shipping is relatively undeveloped, in spite of the existence of eighteen ports. 60. Largely because of insufficient maintenance, the transport system has deteriorated seriously over the last twelve years. The condition of highways and ports has become alarming, while as much as half the vehicle fleet has been out of commission due to the shortages of spare parts. Government policies emphasized the creation of new state transport companies and made major investments in trucks, ships and aircraft for them, while spare parts for the existing vehicle and shipping fleets were limited because of foreign exchange shortages. Similarly navigational, handling and other equipment for the ports and airlines have also deteriorated. Composition of the Program Table 7. Composition of Transport and Telecommunications Program: 1984-87 (FMG billions) 1984 1985 1986 1987 Local Foreign Local Foreign Local Foreign Local Foreign exchange exchange exchange exchange Highways 8.0 15.7 9.9 21.2 9.1 26.0 10.1 28.0 Rehabilitation 6.9 14.0 8.9 20.2 9.0 26.0 10.0 28.0 Workshop & eq. 1.1 1.7 1.0 1.0 0.1 - 0.1 - Railways 1.3 1.6 0.9 0.3 0.5 2.3 0.8 1.8 Rehabilitation 1.1 - - 0.1 0.4 0.7 0.7 - Equipment - 1.6 0.1 0.2 0.1 1.6 0.1 1.8 Branch Line 0.2 - 0.8 - - - - - Air Transport 2.4 - 1.0 - 2.0 - 2.3 - Port & shipping 0.5 3.2 3.1 5.6 3.8 5.9 3.7 0.6 Infr. & equip. 0.3 1.2 2.5 - 3.2 0.3 3.7 0.6 of which rehab. - 1.1 1.2 - 3.0 - 3.4 - Pang. Canal 0.2 2.0 0.6 5.6 0.6 5.6 - - Telecomm. 1.1 2.0 1.4 0.9 2.3 2.4 2.0 1.8 Total 13.3 22.5 16.3 28.0 17.8 36.6 18.9 32.2 = = NM~ =MM= -~ - -  - 19 - 61. The contents of the program respond well to the Government's three main objectives for the sector: rehabilitation of infrastructure and equipment, training of personnel, and reorganization of public sector enterprises. Apart from three roads for which there were no fiches, rehabilitation accounts for 68 percent of the total cost. There is a substantial training component included among the various projects, especially road rehabilitation, though training projects per se are an insignificant proportion. The reorganization of public sector enterprises is not clearly explained, while raising a number of issues including the role of the private sector. 62. As given in the fiches, the road program of FMG 128.0 billion accounts for 69 percent of the total transport program. Of this FMG 123.0 billion is rehabilitation and the remainder is acquisition of equipment for road maintenance purposes. To this must be added the three roads for which there were no fiches, which constitute almost all the non-rehabilitation part of the program. In the case of one of these roads, that between Antananarivo and Toamasina, being constructed by China, the authorities, themselves have little information on implementation or costs. The other two are being constructed with assistance from the African Development Bank and the BADEA, but cost data were not available. The railway program of FMG 9.5 billion constitutes 5 percent of the sector total. FMG 3.0 billion is marked as rehabilitation and FMG 5.5 billion is purchases of equipment. The distinction is rough, however; the rehabilitation refers to track and installations while the equipment refers to rolling stock, tools, and spare parts, much of which replaces worn out equipment or is used for maintenance. The remaining FMG 1.0 billion is the cost of the branch line to the new cement plant at Ibity, the only extension of the railway system in a long time. 63. The ports and shipping program of FMG 26.7 billion amounts to 14 percent of the sector total. FMG 14.8 billion is the cost of restoring the Pangalanes canal, which has been in disuse for many years, and FMG 8.9 billion are for the rehabilitation of ports. The remainder consists of additions to port infrastructure. All the air transport program of FMG 7.7 billion, including a training project, is labelled rehabilitation, even though a part of the work on landing strips and installations, amounting to FMG 6.3 billion, and of the purchase of equipment, for FIG 1.0 billion, are to some extent airport improvements rather than rehabilitation. 64. Justification. The investments in the transport sector are largely based on assessments of economic requirements. The road program, which several donors are financing, is concentrated on a priority network of 10,000 km,out of a total of roughly 50,000 km, and includes almost all the paved road. It was selected in 1983 by a joint commission of the ministries of Transport, Public Works, Agriculture, and Industries, in discussion with major users and represents the best judgement as to where rehabilitation was most urgent. The economic returns on it are estimated to be high. It is a major step in addressing the problems of the deteriorating transport infrastructure involving a concerted effort by Government and several donors. Nevertheless, complete rehabilitation of the old road system will take several more years.  - 20 - 65. The economic returns on the road being constructed by China between Antananarivo and Toamasina are certain to be high; the road is a high economic priority since otherwise the only direct surface connection between the highland areas and the main port is the railway line. The inadequacy of this connection (and difficulties in the port of Toamasina) have led to the occasional use of Mahajanga as a port for the highlands area. However, Mahajanga's future is uncertain because of siltation and its road to Antananarivo is not able to take a heavy traffic load. The economic returns on the other two roads are not known. One has been delayed, though construction began some years ago, because of difficulties in deciding its exact course. It connects Bealanana to Antsahabe in the North and requires a decision between a shorter route that would involve dykes and loss of rice fields and a longez route that would preserve the fields. The other, a gravel road from Tsiroanamandidy to Maintirano, is almost complete and would link the far West of the country to the capital city. 66. The railway program is mainly justified as rehabilitation and strengthening of maintenance capacity. The new branch line is probably the least cost transport solution for the cement plant. The investments in the rehabilitation of ports are, in principle, urgent and desirable, though the recent studies by consultants may alter some of the proposals. The restoration of the Pangalanes canal has been more controversial. Work was started without prior analysis of the economic feasibility and, though the idea of a waterway in that region safe from the weather problems affecting coastal shipping is attracti-'e, the original reason for abandoning the canal, high siltation rates, was not addressed. Moreover the economic viability of investing in production capacity for fiberglass barges, which are difficult to maintain, is open to doubt. The agency executing the canal project, however, estimates its rate of return at 14 percent. It has also been able to obtain multilateral financing. 67. The airport investment program consists entirelv of rehabilitation or improvements that are routine and would be justified in themselves. The only query would arise from doubts about continuing the use of some of the smaller airports where the investments are being made. An answer to this will depend on the longer term development of air transport in Madagascar, hence on a full transport plan. 68. Implementation. Most of the program would be implemented through contractors and is not expected to present major implementation prob'ems. The highway program has been progressing smoothly on this basis. At present the Ministry of Public Works' capacity is limited, by its equipment and staff, to routine maintenance, but should extend to a wider set of activities over the next two to three years. The railway system has enough implementation capacity to depend relatively little on contractors. Port rehabilitation and maintenance are the responsibility of the MTST, which contracts the work to the MTP or to contractors. Given the limitations on the MTP, it is likely that most of the work would be performed by contractors. The airport program is implemented by the Ministry of Transport with technical assistance from ASECNA. The rehabilitation of the Pangalanes canal is being supervised by the IMI, but little information is available on project implementation.  - a1 - Policy Issues 69. The sector program is characterized by its concentration on measures to restore the transport system from a seriously run down condition. Certain objectives mentioned in the PIP but not essential to the rehabilitation effort consequently received less attention except incidentally. These include reducing the isolation of certain regions, lowering transport costs, and developing tourism, which would be expected to be more prominent once the urgency of rehabilitation has been reduced and longer term transport planning has started. 70. The statement of policies for the rehabilitation of the sector otherwise confirms the recent trends noted in the CEM, though without going further on some of the major outstanding issues. The three major issues here are tariffs, reorganization of public sector enterprises, and the role of the private sector. Tariffs for the railway are to be based on cost accounting using long term marginal costr. This is, however, the only case where the principles of tariff determination are stated. For the ports and domestic air transport the recent tariff increases are not accoupanied by statements on future tariff actions, while the coastal shipping tariff proposals for 1983 had not been approved by mid-1984. Furthermore, though the Government's role in determining tariffs in the sectors where it has a monopoly - railways, domestic flights, and, to a lesser degree, shipping - is accepted, the objectives of tariff controls for a competitive business like trucking are not clear. The policy statement on road transport does not go beyond the enumeration of recent increases in trucking tariffs. 71. In view of the parlous financial condition of a number of state transport enterprises and the ports, measures to improve their efficiency and increase their revenues would be essential. The PIP's references to reorganization do not indicate major changes, but appear to indicate a belief that the problems can be solved through the provision of equipment and training. It overlooks some of the real problems. The extraordinarily low productivity in the port economically crucial of Toamasina is due to the complex labor relations. The managenent of the other ports is also in need of drastic improvement. The provincial and military trucking companies, which were created from scratch in 1981, have proved unworkable. 72. None of the policies outlined in the PIP indicate a reduction of state control and a more liberal attitude towards the private sector. To a certain extent this may be attributed to political necessities. Certain actions of the Government favor the private sector. These include the use of contractors in the road rehabilitation program, provision of spare parts for the vehicle fleet, and the abandoning of controls on truck movements. However the tariff controls and the attempts to keep some unworkable state enterprises operating in road transport need to be reconsidered.  - 22 - V. INDUSTRY Present Situation 73. The industry sector, comprising manufacturing, mining, energy, and water accounts for 15 percent of GDP. Manufacturing, accounting for roughly two thirds of the sector's value added, caters mainly to domestic demand with high levels of protection. Foodstuffs and textiles alone account for half of its value added. There are a number of known mineral deposits, though few of them seem viable. Mining was, until receutly, mainly an export activity, the chief products being chrome ore, graphite, mica, and semi-precious stones, which together accounted for 3 - 6 percent of exports. However, exploration for petroleum has considerably enlarged the sector's activity. Wood remains the main source of energy, while hydro-electric stations feed the grid around thecapital city, with a large thermal unit used as a back-up. Owing to the dispersion of the population and the size of the country, power for many small towns, manufacturing Plants and even a few individual homes is generated by diesel units. 74. The dominant issues in the program of the industry sector are posed by the on-going manufacturing projects and the run down condition of much manufacturing plant. The on-going projects constitute the greater part of the investment started since 1978 with financing through suppliers' credits or bank loans, and have considerable political prestige attached to them. In most cases their ability to make positive economic or financial returns is in doubt confronting Government with difficult decisions regarding their completion. The run down condition of many manufacturing enterprises, largely due to shortages of spare parts, poor management and prolonged closures, has reduced output in some branches substantially over the years. 75. In the mining, energy and water sectors projects have been less controversial and the financing more favorable. Most of the investment since 1978 has been in energy, including two hydro-electric schemes, oil exploration, and an extension of the oil refinery. Both the hydro-electric schemes are complete, but extension and transmission lines are included in the PIP. Four major oil companies have taken concessions in Madagascar on the basis of preliminary survey work financed multi-laterally and three are beginning drilling programs. The oil refinery was badly damaged by fire in 1983, and its rehabilitation, though not yet included in the PIP, may be started soon. Otherwise investments have been mainly studies and exploration of mineral deposits, while water supply and sanitation have been relatively neglected. Objectives 76. The economic difficulties of recent years have resulted in a partial retreat from the industry sector objectives of previous years. The prime objective of the past, an inward looking (auto-centre) industrial structure, symbolised the economic ambitions of the 1970s, though it was not rigidly observed in the choice of projects. It has been tempered since  - 23 - with the addition of explicit reference to economic efficiency in using local resources and has to a great extent been off-set by the addition of promoting and diversifying exports as a higher priority. Between these two objectives most industrial activities would be included. Nevertheless, an inward looking element remains in the objectives of satisfying the population's needs of essential goods and energy self-sufficiency. 77. The more immediate need is recognised to be to rehabilitate enterprises and restore them to profitability. The first priority goes to essential goods, following which come export industries and certain intermediate goods. The program, however, gives at least equal priority to completing on-going projects, though it is not clear that they are all economically justified. Although it is recognised that resources will not suffice to cover all the rehabilitation needs and there is mention of the need for judicious selection, no specific criteria are mentioned. The profitabilitv of enterprises depends on supplies of raw materials and on adequate prices, where there has been a very substantial improvement. However, Government is undertaking a substantial liberalisation of prices of manufacturing goods. It would be desirable to add to these a clearer definition of the objectives of the remaining price controls, especially in power and water. Manufacturing Composition of Program Table 8. Manufacturing Sector Projects: 1984-87 (FMG millions) No. of No. of projects Known total Known costs Projects with known costs costs in 1984-87 Food and beverages 9 9 33,823 14,552 Textiles 2 2 21,416 21,416 Wood, leather and stone 7 5 14,718 2,536 Chemicals 9 9 68,976 19,936 Petroleum products 2 1 1,540 1,540 Non-metallic minerals 3 3 16,902 4,091 Basic metals 1 1 30,000 30,000 Metal products 5 3 8,333 2,476 Other 1 1 413 413 Studies 2 1 650 650 Total 41 35 198,771 97,610 78. There are 39 projects and two studies in the manufacturing sector that are known to be under implementation or about to be implemented. Thirteen projects and one study do not have fiches; data on their costs were in most cases obtainable from other sources, but it was not possible  - 24 - to construct a project schedule for them. Moreover, since some of the projects with fiches are being implemented ahead of schedule, it is impossible to construct a meaningful table of the sector's year by year investments. The tables indicate the composition of the manufacturing program as far as the data allow. Table 9. Numbers of Manufacturing Projects: 1984-87 1/ By Size and Type Less than FMG 1 bn. FMG 3 bn. More than Costs FMG I bn. to FMG 3 bn. to FMG 5 bn. FMG 5 bn. not known Completion 7 5 1 - 3 Rehabilitation 6 4 4 - 2 New capacity 2 1 1 2 - Other 3 - - 1 1/ Costs during 1984-87. Cotona rehabilitation counted separately from extension. 79. Twenty of these projects were reviewed in early 1984 by consultants and were classified as acceptable or of moderately or seriously doubtful viability. Five were found to be acceptable, while the remaining doubtful projects are being studied further to determine what economically justifiable actions could be taken. Of sixteen projects that were on-going at the beginning of 1984, fifteen were reviewed. The table below gives the distribution of these projects. Table 10. Classification of Manufacturing Projects 1/ In PIP Not in PIP Total Total Started Total not Started No. in PIP before '84 in PIP before '84 Total No. 39 27 8 12 7 Projects reviewed 20 14 8 6 6 Acceptable 5 5 2 - - Moderate doubts 5 4 2 1 1 Serious doubts 10 5 5 5 5 Not reviewed 19 13 - 6 1 1/ Excluding 2 st..dies 80. Most of the nine projects in food and beverages present problems. Two were reviewed and found acceptable. One is the soya milk project, Lalasoa, which has started functioning, but depends on imported soya beans. The other is the SNHU, a vegetable oil refinery, with some good equipment, but plagued with problems of maintenance and reduced almost to a stand-still by the decline in the supply of groundnuts.  - 25 - 81. Three projects were reviewed and found to be seriously doubtful: a soya vegetable oil project, Mamisoa, a palm oil refinery, Somapalm, and a wheat mill at Toamasina. The industrial plant of Mamisoa and Somapalm are complete and trial runs are beginning with imported raw materials. Studies are being carried out to determine the most economically justified actions to be taken. Investment at the Toamasina wheat mill has just begun, though it would be advisable to postpone further outlays until justification has been established. 82. Two sugar projects, both with fiches are the rehabilitation and extension of long established enterprises. The SNBCE project of FMG 3.1 billion is described as replacement and rehabilitation of worn out plant and equipment. It has started ahead of its schedule, which was indicated to begin in 1985. The Sirama project of FMG 6.2 billion includes the distillery of Ambilobe, which is one of the projects reviewed and found moderately doubtful. The distillery would produce industrial and fuel alcohol and its viability would depend on close and efficient coordination with the sugar refinery. It has assured bilateral financing and technical assistance. Sirama has serious liquidity problems, largely due to its overdrafts of about FMG 9 billion, on which it pays interest at above 23.5 Percent. Government is converting the debt into equity to enable the enterprise to generate the cash it needs to renew its stock of handling and transport equipment, most of which is worn out. 83. The remaining two food and beverages projects are small rehabilitation projects. One, for which there is a project summary, is the rehabilitation of an old meat processing plant, Lachaize Freres, for FMG 215 million. The equipment is old and Madagascar has had problems in maintaining sanitary standards needed for export. The other project has no fiche. It is the rehabilitation of an old bakery for roughly FMG 300 million. 84. There are two textile projects, both with fiches. The large one is the rehabilitation and extension of the Cotona textile mill at Antsirabe for FMG 18.6 billion. This enterprise, which is privately and efficiently managed, is engaged in discussions with, inter alia, the IFC for financing the replacement of old equipment. But the extension, intended for exports, may not be justified since it is not certain that Cotona could export at a profit. The other project is to rehabilitate the old jute mill, FITIM, for FMG 2.9 billion. The project was reviewed and found acceptable and Government has interested private parties in a partnership. Tile project is accompanied by an agriculture component for rehabilitating the cultivation of paka and hybiscus. 85. Of the seven projects in che wood, stone and leather subsector, four have been reviewed and little is known of the other three. Of the re"iewed projects two are tanneries for which there are no fiches. Both are seriously doubtful projects. Both were set up by the same group of suppliers, who are taking over the management, though their suitability for managing these enterprises is in question. A precast concrete project with a fiche, SABBAT, from the same suppliers was also found to be seriously doubtful. These three projects are scheduled for completion in 1984. A further project, rehabilitating the Panomad a board factory for FMG 400 million, has a fiche and was found acceptable.  - 26 - 86. Information on the other three projects mentioned above, of which one has a fiche, is fragmentary. The one with the fiche, costing FMG 900 million, is a proposal of the Institut Malgache d'Tnnovation (IMI) to produce sanitary equipment using resin with marble and sand. No information on its viability is available, but the capability of the IMt to execute and manage an industrial project is open to doubt. The other two are the rehabilitation of a furniture factory, Malgadecor, for FMG 100 million and an extension of a marble work, Sevmacam, where Government has not decided on suppliers and technical partner. 87. Leaving aside the alcohol distillery already discussed in connection with food and beverages, the eight quite disparate projects in chemicals include some of the major problem projects. Four of those reviewed and found to be seriously doubtful are among them. By far the largest is the ZEREN urea plant, estimated to cost US$80-100 million, (a sunk cost of FMG 40 billion in early 1984). It is close to complete and Government is eager to complete it in 1985, despite the extra cost of around FMG 4.7 billion, because of commitments it has entered into. However, Government wishes to ascertain the viability of the enterprise before starting operation. Government is also completing the SOPRAEX medicinal plant unit and the CNPP pharmaceutical project, both of which were found to be seriously doubtful. 88. Of the other five chemica'. projects, two are large and have fiches. One is the rehabilitation of the SNA match factory for FMG 4.8 billion, which would depend on finding suitable partners. The other would be a new project, a caustic soda plant, on which construction would begin in 1986 for an estimated FMG 4.8 billion. The remaining three projects are all under FMG 500 million. One is an extension of a recently completed organic fertilizer plant ZEMA, to enable it to export. Another is the rehab4litation of a glue and gelatine factory, Somagel, which has been closed almost since its construction in 1970. Both of these have fiches. The third, would be to modernize and expand the Wonder battery factory at a cost of FMG 468 million. 89. There are two projects in petroleum processing. One, still tentative, would be the rehabilitation of the oil refinery of the state oil company, SOLI4A, which was damaged by fire in 1983. The economic viability of such a small refinery, when extremely large ones are being constructed in petroleum exporting countries, is uncertain. Since corrosion is rapid when the refinery is not in use, it would need to be rehabilitated soon, if at all, and hence might not be adapted to refining an eventual output of Malagasy crude. The other project, also to be executed by SOLIMA, for FMG 1.5 billion, would recycle used oil. No data on its feasibility are available. 90. The three projects under non-metallic minerals are associated with cement. One is the CIMA cement plant, which has no fiche but was reviewed and found to be moderately doubtful. It is scheduled for completion in 1984, but it is served at present only by a temporary road. A link to the railway system is to be constructed shortly. The lime plant, SOABE, which was also reviewed and found to be doubtful, has a fiche and is  - 27 - estimated to require a further FMG 600 million for completion by 1986 for a total cost estimated at USS6.8 million. It is near the CIMA plant, which would supply its raw materials. The other cement project would be to rehabilitate the old cement plant at Amboanio for FMG 2.0 billion. This plant has been keptworking at half its capacity of 70,000 tons in face of extreme deterioration of equipment. A study is being financed for determining whether its quarry would support a second cement plant. 91. The one project in basic metals, a ferro-chrome plant, is the biggest in the manufacturing program and raises several questions. Madagascar has been pursuing this project for several years. According to its fiche implementation would begin in 1985 and the cost would be FMG 30 billion. It would use domestic chromite and, presumably, imported steel, for an output that would be entirely exported. The plant's high energy consumption would be met by the addition of a turbine to the Andekaleka dam and the construction of the Ankorahotra dam upstream. Later, the mini-steel mill, for which extensive studies are included in the PIP, might supply the ferrous inputs. 92. The economic viability of the project has not been studied recently, but it may depend on a reversal of the persistent decline in the demand for chrome. The decline has been due to a broad range of causes, including changes in consumer demand, different metallurgical practices and substitution of plastic for metals. But the executing agent, OMNIS, justifies the project as a means of stabilizing the demand for the chrome ore produced by its mining enterprise, Kraoma. At present Government is searching for financial and technical partners, and would like to ensure that the technical partner has a substantial investment in the project. 93. Of five projects included under the heading of metal products, four have been reviewed. The fifth project is the lone one that was on-going at the beginning of 1984 but not reviewed and consists of the addition of a glass unit to a light bulb factory, Anjara, set up by the Water and Power authority, JIRAMA. The factory began operation in November 1982, but, since it was located in Antananarivo, instead of Toamasina as originally envisaged, the possibility of arranging the supply of glass from the glass factory, which is in Toamasina and wholly foreign owned, was abandoned. It is closely linked to another of these five projects, the Akora factory for producing water meters and taps, being sponsored by JIRAMA and the FNI. This plant is scheduled for completion in 1984 at a further cost of FMG 200 million, and, though it was found acceptable, its viability will depend on establishing export markets. The third project that is on-going is the Socomi project to produce mechanical parts, which was found to be seriously doubtful. It is scheduled for completion in 1984 for a further cost of FMG 400 million. The remaining two metal working projects, which were found moderately doubtful, had not begun at the time of the review. Since then one of them, the rehabilitation and extension of the Tamalu kitchen utensils factory, has been partially completed. The search for financing for rehabilitation of the ship repair facility, SECREN, is continuing. The problems of the enterprise are complex and, despite an audit in 1980, which made a number of recommendations, little progress has been made in solving them.  - 28 - 94. Finally there is a project for promoting artisanal production, to which should be added a second artisanal project in the mining sector for precious stones. The first project, for PMG 0.4 billion is labelled creation of a National Centre for Malagasy Artisanary (CENAM). The CENAM has, in fact, been in existence for some time and has benefited from UNDP and other assistance. The project is scheduled to end in 1987, though the fiche gives expenditures for 1984 only. The project for precious stones, intended to promote artisanal training and create a precious stones industry, would begin in 1986 and would cost FMG 0.2 billion. It is to be implemented by the Directorate of Mines in the MIEM and its relationship to the CENAM is unclear. Mines, Energy, and Water Composition of program 95. In the program for mines, energy, and water, petroleum exploration accounts for 70 percent of the total outlay. A further 16 perceiit consists of energy projects, of which more than half are the two major hydro-eclectric schemes of Ambodiroka and Ankorahotra. Mining (excluding petroleum) is another 11 percent, but almost all of it consists of studies and prospection. The projects in water supply are discussed under the social sectors, Chapter VI. Energy (including petroleum) 96. Petroleum exploration has progressed well in Madagascar and there are good prospects of finding commercial oil deposits. Beginning in 1978, without experience in the sector, Madagascar has been able to carry out a program of data collection, survey work, and creation of the legal framework for entering into contracts with multi-national oil companies. At present four major oil companies have concessions for exploration and three are beginning drilling programs. Apart from this, Madagascar is seeking ways to exploit its deposits of heavy oil and tar sands, though there is no fiche for either of these. 97. The oil exploration agreement involves little cost to the state. If commercial deposits of oil are found the state and the companies would enter into production sharing agreements. At this point a substantial Malagasy investment would also be required. At present the oil companies are engaged in programs up to 1986 and further activity on their part would depend on the results. If production is started, it would not be much before 1990 and entirely for export. 98. The heavy oil and tar sands deposits are less promising. Present exploration of heavy oil deposits is being financed by the Bank to determine whether or not further exploration would be worthwhile. Experience in Canada indicates that the possibility of the tar sands becoming viable is remote, although the sands are close to the high grade of the Canadian sands.  - 29 - 99. Over 60 percent of the remaining energy program consists of two hydro-electric schemes, for which Madagascar is seeking external financing. Neither is likely to be feasible as early as indicatecd in the PIP. The justification of the proposed schedule of the Ankorahotra project, which would augment the Andekaleka dam, would depend entirely on projects, such as the ferrochrome, with large energy demands. The Ambodiroka project would supply the Mahajanga area, which is not connected to the Antananarivo grid and depends on thermal or diesel units. The justification of the project needs to be studied, but even if it justified, the implementation schedule in the PIP appears optimistic. Table 11. Energy Sector Program: 1984-87 1/ (FMG billions) 1984 1985 1986 1987 Local Foreign Local Foreign Local Foreign Local Foreign exchange exchange exchange exchange Aimbodiroka - - - 0.1 0.3 0.9 1.4 3.0 Ankorahotra - - - - 0.1 0.5 2.5 5.0 Strengthening 0.1 1.9 - 0.8 - - - - thermal units Electrification 0.1 0.1 0.1 0.4 0.3 0.6 0.6 0.1 Other 0.1 0.1 0.3 0.7 1.3 1.8 0.1 0.2 Total 0.3 2.1 0.4 2.0 2.0 3.8 4.6 8.3 ==_= - If Excluding petroleum exploration 100. Three other projects concern the Andekaleka and the Namorona hydro-electric schemes, which are the main power sources to the highland areas. Of these, the largest, would improve the utilization of the Andekaleka scheme mainly by adding cooling units, improving some other equipment, and obtaining technical assistance for the management. The project is justified and its financir.g assured. The other two are intended to increase the utilisation of the Andekaleka and Namorona hydroelectric schemes. One would extend the Antananarivo area electricity network, while the other would set up transmission lines to Antsirabe, Fianarantsoa, and Ambositra from Namorona, and to Toamasina from Andekaleka. Were these projects to be financed by the executing agency, JIRAMA, out of its own resources with good prospects of a high financial return, they would be justified. But they are to be finRnced by the State, since JIRAMA's pricing policies prevent it from generating its own resources, which would be tantamount to making an investment that would result in more consumption subsidies at a time of economic difficulty. It is, however, unlikely that the transmission lines, as proposed, could be profitable since they are intended to supply some very hypothetical industries, such as a pulp mill, while Toamasina has excess generating capacity.  - 330 - 101. The largest of the remaining projects is the strengthening of the thermal generating units. It is a continuation of the old policy of relying on diesel generators for local power production to avoid the high transmission cost due to the sparse population and long distances. Because of the rise in oil costs, alternative policies might be more economical. One proposal is small hydroelectric schemes, such as the largely complete Bezaha project, serving a restricted area. Table 12. Mining Sector Program: 1984-87 1/ -FMG billions) 1984 1985 1986 1987 Local Foreign Local Foreign Local Foreign Local Foreign exchange exchange _ exchange exchange Maximum - 0.3 0.3 0.7 0.7 1.0 1.2 0.7 prospecting Sakoa coal 0.1 0.1 0.7 2.3 0.2 0.8 - - Soalala - - - - 0.4 2.0 0.3 1.3 feasibility (iron ore) Other - 0.6 - 0.2 0.4 0.5 0.6 0.8 Total 0.1 1.0 1.0 3.2 1.7 4.3 2.1 2.8 - == == =- I/ Excluding petroleum exploration. 102. Over 95 percent of the mining program (excluding petroleum) consists of studies and prospection, 80 percent being accounted for by three projects. Each of these three projects is a program that would need to be justified by considerably smaller initial studies. In the case of uranium, Madagascar has been seeking external financing for such an initial prospecting study. The coal project's cost includes some infrastructure, that would properly be reserved for the actual exploitation of the coal deposits. The deposits themselves would not be costly to mine, but, being located in a remote and arid region, transportation or local generation of power would raise the cost considerably. The feasibility study of the iron ore deposits at Soalala also need justification. The intention is to feed the proposed mini steel mill, for which no economic prefeasibility study is available.  - 31 - VI. SOCIAL SECTORS 103. The remainder of the PIP consists mostly of social sector projects, with the urban sector accounting for over 60 percent of the outlay. Of the FMG 20.8 billion for urban projects, two IDA financed projects account for 61 percent. One is the water and sanitation project for Antananarivo for FMG 8.0 billion and the other a new urban project for FMG 4.9 billion. There are three water projects, amounting to FMG 3.6 billion, that are included under energy and water because they are being implemented by the Ministry of Industry, Energy and Mines (MIEM) and JIRAMA. The other projects of note are a dyke to protect Antananarivo from flooding, a percursor to a larger project for flood protection, and a housing project for the poor, whose details are not given, except that it is to be implemented by the Ministry of Public Works. 104. Urban and water projects raise complex issues of jurisdiction and executing agency. Apart from the MIEM and JIRAMA, the municipal, or local, government and the Ministry of Public Works are all involved, each with its own projects. For an urban project to be implementable the municipal government has to be actively involved, especially as there would be no other means of ensuring any cost recovery or maintenance. The problems with rural water projects are more complex still, since local government is weaker outside the cities. 105. The investment proposals for the education and health sectors are modest. The Health Ministry's program of FMG 9.7 billion emphasizes preventive measures, creation of primary health facilities and acquisition of some much needed equipment for hospitals. The statement of the Ministry's objectives is in accord with the investments proposed. The education sector's stated objectives are more grandiose, including substantial extensions of the primary and secondary education systems at the same time that the university's decentralisation program is accelerated and its enrolment increased by 80 percent. The decentralisation of the university was the motive behind the vast expenditure on the regional university centres in 1979-80. It is true that the investment proposals of only FMG 0.7 billion do not reflect the ambitiousness of these objectives, but there is no reference in the education policy statements to the serious difficulties of the sector, especially to the basic problem of matching the sector's growth to the availability of recurrent resources. The other sectors of the investment program, amounting to FMG 3.2 billion, comprise a large number of diverse matters, none of which entail any single major investment. VII. ISSUES IN PLANNING 106. Analysis of the policies and investment decisions that have been the main causes of Madagascar's prolonged economic stagnation and external debt difficulties brings out forcefully that jne of the underlying weaknesses of the economy was its lack of an effective institutional  - 32 - framework for managing public sector resources. Until the economic crisis, the arrangements for economic management remained much the same as they had always been, despite the fact that the economy had been transformed during the 1970's from easy-going laissez-faire to one with a high degree of state control. Once the crisis broke, some institutional and procedural steps were taken to cope with the immediate problems of foreign exchange and debt management. Soon after, further steps were taken to address the problems of public sector investments, in particular to begin preparation of the PIP. These steps were responses to urgent needs and had an element of Improvisation. Far from being considered by the Malagasy authorities as adequate, they are regarded as a prelude to more permanent arrangements. 107. Three broad sets of issues can be distinguished. The first and fundamental issues concern the absence of a framework for coordinating the objectives and actions of the various ministries and special economic agencies, or for establishing a consensus on economic priorities. Ministries usually acted with a high degree of independence from one another and, even when pursuing objectives decided at a political level, came into increasingly intense competition for financial resources. Much of the inefficiency in allocating resources was due to the inability of the established mechanisms, designed for very different economic conditions, to resolve efficiently the competing claims. The Directorate General for Planning (DGP) was in theory meant to ensure coordination, but, by itself, could not replace the missing framework and was practically isolated. Its influence was further reduced by its position in the Ministry of Finance and Planning, which meant that its views could be overruled within its own ministry. The DGP's ability to coordinate the preparation of the present PIP was due to two measures: one was its transfer to the Presidency in January 1982 and the other was the political decision that a PIP should be the basis for the dialogue between Madagascar and the donor community. As short term measures they were successful and initiated the broader process of establishing effective arrangements for preparing investment programs regularly. 108. The second set o issues concerns the capacity and arrangements for economic analysis and project preparation. One of the major deficiencies at the macroeccnomic level used to be the absence of medium term projections of resource requirements and availabilities. However, since 1982 the DGP has regularly prepared such projections and the issue at present is mainly to continue improving them. At the sector level policy formulation and project preparation have been weak, largely because ministries were organised along technical and administrative lines, without economically oriented policy or planning units at a high enough level. In particular the procedures for the preparation of projects conceni-ated on administrative steps and financial controls, such as budgetary rules, without measures to ensure economic efficiency. 109. The third set of issues concerns project implementation. To some extent poor implementation was due to the excessive number of projects, resulting in resources being spread too thinly. Poor project preparation also inevitably led to implementation problems. But the implementation capabilities of many of the executing agencies were limited. In some cases  - 33 - an agency, often a state enterprise, would be created from scratch without suitable trained and experienced staff. In general there has been a lack of skills that can only be remedied through training programs, which have been restricted by the shortage of recurrent budget resources. Monitoring was similarly a victim of resource shorteges. The main improvements that can be expected will be due to the greater concentration of resources on fewer projects, especially through better budget preparation, and greater use of technical assistance or contractors. 110. Some features of the planning system for the public sector that the Government intends to put in place are now fairly clear, though some others still need to be defined. Projects would be prepared by the ministries, state enterprises, and special economic agencies. The Directorate General for Planning (DGP) would, in discussion with the ministries, establish priorities following the policy guidelines set by the Government. Projects would only be implemented if included in the Government's PIP and found to satisfy criteria of acceptability, though inclusion would not guarantee implementation. The PIP would be revised annually and presented to the Assembly for approval. The revision would permit projects to be redefined or replaced by others. However, since a project could only be replaced by another project in the same sector, sector allocations would be changed little. The annual budget exercise would automatically determine which of the projects with financing from the budget would be implemented. Consensus and Coordination: the Planning Council 111. The broad issue of coordination among ministries and other institutions would cover defining policies and objectives, agreeing on broad sectoral allocations of resources, and deciding on acceptability of project and financing arrangements. The DGP is under instructions to make detailed proposals on a Planning Council (Conseil Superieur du Plan)that would be the main forum for these issues. Though the work is at an early stage, the DGP's proposals would be a broadly based Council organized into a number of committies with the DGP acting as secretariat. The technical weaknesses in preparing the PIP are due to a large extent to the organizational weaknesses in ministries and the DGP. The main proposala of the DGP are the creation of a planning unit in each ministry, a change in its own organization, and more operationally oriented training programs. These proposals along with some procedural changes would permit considerable strengthening of project monitoring capability and improved implementation. Apart from these broad issues of creating an effective planning system lie other questions of Government policy, notably of how the private sector is to be accommodated and longer term resource policies. 112. The main purpose of the Planning Council would be to establish the consensus that would be needed for conmitment from the main decision makers and agents implementing the PIP. Since neither the DGP nor any other organization could take over the project and policy work nf the ministries, state enterprises and special economic agencies, such consensus would be essential. The Council would be the forum for ensuring the  - 34 - coordination necessary for determining overall policies and objectives, sectoral allocations of resources and the acceptability of projects. 113. It is still too early to have more than certain broad indications as to the composition and organization of the CSP and only a rough picture can be given. The composition woul1 include representatives of ministries, state enterprises, the private sector, provincial governments, and workers. Although the representation may appear to be so broad as to make the Council unwieldy, since it has to fulfill a partly political function, it cannot be Judged on purely technical grounds. It would, however, require strong leadership committed to obtaining the necessary consensus. 114. Its organization would divide the Planning Council into a number of -horizontal" and "vertical" committees. The two main -horizontal" ones would be the Investment and Finance Comnittees. The Investment Committee would ascertain that technical preparation and economic analysis of projects are adequate and in conformity with policies and objectives. The Finance Committee would examine the financing arrangements, including the current costs, and, at its discretion, propose alternatives. A project, to be implemented, would need the ap;roval of both committees sitting in joint session. The "vertical", or sectoral committees would formulate sector objectives and policies as well as assuring the inter-sectoral coordination needed for the implementation of projects. H15. By functioning as the Planning Council's secretariat the DGP would automatically establish its planning role. First, since it is the DGP that would present project dossiers to the Council, it would obtain project data regularly and not, as up to now, only on special occasions such as the preparation of the PIP. Second, the DGP would be responsible for the technical work of estimating resource availabilities for the Council to determine the size and sectoral composition of the PIP. Thi=d, the scheduling of projects in conformity with resources would necessarily have to be done by the DGP in discussion with the ministries. This would occur on an annual basis through an already functioning informal joint commission with the Ministry of Finance for the budget, and over the medium term, in the drafting of the PIP. Finally, though this is at an early stage, the DGP would follow project implementation and resource use, both to inform the Planning Council and as a basis for preparing rolling plans. Economic Analysis and Project Preparation Ministry planning units 116. Each ministry would need a central policy and planning unit to perform or supervise the ministry's economic policy work, prepare the sector programs, and liaise with the DGP and th^ Planning Council. The DGP, itself, would like to see such units created soon in all ministries. One has been created recently in the Ministry of Transport, Supplies and Tourism for the whole transport sector. A planning urit was created in the  - 35 - MPARA a year before the ministry's split, but it was not central in the administrative organization and encountered difficulties. Nevertheless each sector has its specific features which would determine the precise functions and organization of such units. 117. Defining sector objectives and formulating policy would constitute the main types of economic work. Most ministries have had difficulty in this. While ministries and high level officials can outline objectives and policies, they must rely on their staffs to put in the detail, analyse the implications, and suggest alternatives. In response to the need, some ministries have created special advisors' positions around the ministers, an arrangement that has resulted in considerable improvement, but, nonetheless a short term response to a long term need. 118. The preparation of the sector program would consist mainly of ensuring that project preparation is adequate and in putting together the investment program. The extent to which the planning units would do project appraisal themselves might depend on the sector, but they would have to advise on whether preparation of projects was sufficient for submission to the Finance and Investment Commissions of the Planning Council. Most ministries have units for studies, but in the past these mostly processed technical feasibility studies by consultants, all too often prospective suppliers. Putting the program together would be the essential planning function, involving, on the one hand, close coordination with the DGP and the Ministry of Finance in estimating resource needs and availabilities, and, on the other, scheduling project implementation with the technical departments and state enterprises. The greatly improved coordination between ministries and the DGP for preparing the PIP was achieved partly through ad hoc arrangements. Most ministries, not having planning units, assembled task forces to collaborate with the DGP in putting together the sectors' programs, and later disbanded them. At the time there was no alternative, but the continuous and close, collaboration at a technical level between the ministries and the DGP would need to be assured by the planning units. 119. The effectiveness of these units would depend to a great extent on their being centralized in the organization of the ministries. The experience of the planning department set up in the MPARA between mid 1982 and mid-1983 is instructive. Even though it proved invaluable in the early stages of the preparation of the PIP, the department was handicapped by being under the same administrative control as the technical and administrative departments. Consequently its precise functions and authority remained uncertain, complicating its relations with other departments. It had difficulty in obtaining data, incidentally disapointing the hope that it might accelerate the notoriously slow flow of information, and co-lad not represent its ministry with conviction in dealings with other ministries and the DGP. Macro-economic projections 120. The macro-economic projections, though still limited in scope, constitute an important step in establishing a statistical basis for planning. Until the onset of the economic crisis in 1980 and the beginning  - 36 - of the stand-by arrangements by the IMF, little importance had been attached to reliable forecasts of resource availabilities. There would have been difficulties in any case in making them, since the mast recent national accounts were usually more than two years old, and, after 1978, until 1981, information on investment and debt was at bast fragmentary. In view of the urgent need to obtain national accounts data and lay the basis for projections, the DGP took over the task in 1982 and created a department for the purpose. It has also elaborated a methodology for estimating recent GDP trends on a six month basis. 121. At present the macro-economic projections are still limited to the crucial functions of indicating overall balance of payments and savings constraints. They do not, however, distinguish between foreign exchange committed (except for debt servicing) and free foreign exchange, while savings are calculated from past trends and, therefore, in combination with the resource gap, only provide a standard of comparison for the level of capital formation implied by the PIP. The comparison is complicated by uncertainties over the amount of Government consumption included in the PIP, inconsistencies in the treatment of working capital and finance charges, and lack of data on private capital formation, which, together, reduce the accuracy of calculations of total capital formation. Budgetary projections 122. Projections of Government finances would be especially useful if they could be used to guide ministries on their possible future resource availabilities. A marked weakness in Malagasy budget preparation until recently was the absence of such guidance, even when the annual budget submissions were being prepared. Since the budget was in theory zero based, though in practice there was considerable continuity from year to year, each ministry had a strong motive to inflate its demands for resources, and the motive grew stronger the more others were seen to be doing the same. The budget submissions of several ministries became in the end large multiples of the final allocations, while the Ministry of Finance attempted to ellocate the available resources as fairly as they could, with allowance for any specific instructions received from higher levels. This w2s one of the main reasons for the proliferation of projects in the capital budget with very few receiving adequate funding. Ministries would then, during the fiscal year, attempt to transfer allocations from projects to which they attached lower priority to the ones to which they gave higher priority. 123. In the preparation of the 1984 budget, however, ministries were informed of amounts that they would receive and were instructed to allocate them strictly according to priorities. This information was communicated to them after they had made their initial submissions. Then an informal joint commission of the Ministry of Finance and the DGP collaborated with the ministries in selecting the project priorities and in framing the final budget. The procedure appears to have been successful; resources were concentrated on fewer items, there was broad agreement on priorities, and the 1984 budget was the first in several years to become effective at the beginning of the fiscal year. Now, with the availability of the PIP and  - 37 - with the experience from the last exercise, preparation of the 1985 budget following the same procedure should be equally smooth. The extension of this procedure through a tentative indication of resources each ministry might expect over the next three years would further strengthen its ability to program its capital expenditures. 124. It would be desirable to start making projections of Government finances and to translate PIP expenditures into capital formation figures but considerable improvements in the data would be needed before projections of free foreign exchange or for the financial sector could be usefully made. The Ministry of Finance has, in fact, set up a unit to estimate Government finances over the medium term. Identifying recurrent expenditures in the PIP and obtaining consistency in the treatment of working capital and financial charges should also be possible when the fiches are correctly filled out. But the extremely confused situation of the financial sector and the poor quality of information on project preparation and financing, especially in the industry sector, would make projections of free foreign exchange and domestic credit availabilities meaningless. The DGP itself is reluctant to engage in such exercises until the data base has been better studied. 125. Associated with the projections of the budget is the programming of counterpart funds, which have grown to substantial size with the inflow of balance of payments assistance and are an important source of PIP financing. They are accounts held by the government at the Treasury, or in a few cases at the agricultural bank, and were generated from sales of certain goods received through external assistance. Their use is subject to agreement with the donors and does not represent an addition to resources, but is included in the limits on government spending and credit. They have two particular features; one is that they give donors some influence in channelling local resources to their projects and the other is that they permit the ministries to by-pass the procurement procedures of the Commission des Marches, which sometimes cause delays. 126. The use of these funds has often caused problems because they do not fit easily into the normal budget procedures and because agreements with donors vary. The Ministry of Finance and the DGP are adopting a system of medium term programs to be agreed with the donors that may allow them to run these funds down. However, since balance of payments support could continue generating more counterpart funds for some time, it is worth weighing their advantages against their disadvantages, particularly the burden they impose on the Malagasy administrative system, and considering whether these funds should not simply be passed on to the Treasury as revenue. Project preparation 127. A clear set of procedures for project preparation needs to be established to ensure feasibility and the arrangement of coordinating actions between sectors. Even at the risk of their being cumbersome, they are needed to supplement the existing procedures, which have changed little over the last decade and have proved to be severely deficient. In any  - 38 - case, such procedures would be needed for the Planning Council. The DGP intends to introduce a criterion for project appraisal, which it would like to see routinely applied in two to three years. 128. The procedures would define the steps to be taken in verifying the technical, financial, and economic feasibility of projects. Although technical feasibility was strongly emphasised, often leading to costly and elaborate studies, it was sometimes so narrowly focused as to ignore alternative project designs and to accept long obsolete technologies. Independent checks on suppliers' designs and specifications were not called for. An example of investment in obsolete technology is the urea plant using naphtha as a raw material. The new palm oil refinery is a technology not suited to the local raw material, which it was meant to process. Until recently the financial analysis of projects received low priority in the public sector, and was rarely performed except when the banks, who alone had the capabilities for such work, expected to provide financing. 129. The procedures for economic appraisal would depend on the type of appraisal criteria used and on whether the appraisal is performed by the DGP, within ministries, or by other agencies. Since the economic appraisal was only performed when external donors required it, and then rarely by Malagasy experts, no system has been established for the country. A set of criteria based on the effects method", has been devised using the sum of discounted value added, weighted according to the priority attached to the product, and to the value of effects on the balance of payments, employment, linkages, and Government revenues, less costs. There is provision for shadow exchange rates. But the reliability of these criteria is questionable and the details of how its variables are to be calculated are unclear. However they are relatively simple to apply and, if applied consistently, would still be a great improvement in project preparation. The DGP intends that the system should be applied to all projects in two or three years. It remains uncertain, however, whether the DGP would itself perform the appraisal or whether it would verify appraisals performed within ministries or by other agencies. 130. To improve the scheduling of projects and the monitoring of public sector financing, the procedures for arranging financing also need to be tightened. The existing procedures do not differ substantially from the old ones, where the emphasis was on ensuring that external debt was kept limited and highly concessional. But in the present situation, which can be expected to last for several years, there is a strong temptation to accord priority to projects to the degree that their financing is assured. There is little to prevent one project from pre-empting financing that might have been available to another that would otherwise have had higher priority. It may not be desirable to remove the freedom minLstries have in searching for financing, but the DGP or the Planning Council should give clearance for the initial contacts with potential sources or financing. Even if it were the financing committee of the Council that gave the clearance, the DGP, as the Council's secretariat, would still need to be in a position to give its advice to the Commission. This would moreover be necessary to ensure consistency in the presentation of the PIP financing requirements to the CG and, where the financing source does not provide assistance in project preparation, in ensuring that the project has been suitably identified.  - 39 - 131. Monitoring of public sector financing should be assured through informing the Ministry of Finance and the DGP of all financing agreements and providing them with regular information on disbursements. The debt monitoring system at the Central Bank, since it only records commitments and disbursements of external debt, is limited in the extent to which it can provide an overall picture of project financing. The scarcity of data with MIEM on the financing of projects under its charge underlines the need for a stronger system. Projections of disbursements, which depend on project implementation schedules, would have to be made either by the ministries in charge or by the DGP. Implementation and Monitoring 132. Although resource constraints would not have permitted implementation of all the projects that had been started, at least nominally, some of the main reasons for that are likely to diminish in importance with the the measures being taken or envisaged by the Government. These include the reduction in the number of projects, more effective allocation of resources, and reorganization of certain ministries. Certain measures have already been taken to improve project preparation, project monitoring, and the implementation capabilities of state enterprises, but additional measures will be needed. 133. The reduction in the number of on-going projects has already made it easier to avoid spreading resources too thinly over many of them. The 1984 capital budgets for the agricultural and transport sectors reflect the change; they have smaller numbers of allocations, but none are the nominal amounts that were common in previous budgets. A closer accord in the future between resource requirements and availability would be achieved by better programming of projects through the coordination mechanisms of the Planning Council. 134. Numerous delays in project implementation have been caused by lack of complementary actions in other sectors, usually because of insufficient coordination between ministries or omissions in project preparation. Striking examples such as the omission of transport connections for the new cement plant or of arrangements for collecting the wheat crop for the mill at Antsirabe, had analogues in many smaller cases. The recent use of commissions within or between ministries to arrange such complimentary actions reflects the greater spirit of coordination and has produced immediate results. The most notable case was the interministerial commission that determined the priority network for the highways program, but similar arrangements are being put into effect between the agricultural and industry ministries for the operation of agro-industrial projects. 135. Further measures to ensure timely measures of such complementary actions would depend on more thorough project preparation and the establishment of planning units within ministries. The success of the measures so far has been primarily in addressing major problems that had already arisen. However, such programs need to be anticipated at the time of project preparation and, when a project is included in the investment  - 40 - program, complementary action in other sectors should also be included and should form part of the project appraisal. This would be automatic and universal with appropriate project preparation- procedures, while the planning units and the DGP would be able to arrange the intersectoral coordination. The creation of a planning and coordination unit for the transport sector would facilitate the provision of transport facilities for other sectors. But its efficacy will also depend on how well and how early transport needs are identified in other sectors. 136. Some of the organizational problems of ministries that have contributed to difficulties in project implementation are likely to be overcome in the near future. The MPARA, before its split in mid-1983, was recentralizing some of its services, after decentralization had proved unsatisfactory. Because of the split a transition period of further reorganization was necessary. The two new ministries are now putting in place permanent, more effective organizations with technical assistance. The Ministry of Public Works is also taking over road maintenance and rehabilitation activities that had been decentralized with equally unsatisfactory results and has considerably increased the pace of implementation. 137. Project implementation by state enterprises depends on the extent to which measures are taken to overcome the numerous problems of these enterprises. Although several of the major state enterprises are reasonably well run, few of these are implementing projects. In the agricultural sector most state enterprises are in difficulties and are, themselves, objects of rehabilitation efforts. Significant improvements are already occurring, but it is doubtful that they could lead to much stronger project implementation capabilities by these enterprises during the period of the PIP. Apart from the agricultural sector, most of the projects being implemented by enterprises are in manufacturing, where, in almost all cases other than rehabilitation, new enterprises had been created as turn-key projects. But even though physical implementation may not present problems, the efficiency of the management and the workers are uncertain. Experience with newly created state enterprises has been disappointing; quite apart from the technical problems of some of these projects, the managerial skill and experience for creating new, and often large, enterprises ex nihilo have been difficult to find. In several cases Covernment has been seeking partners or contracting management out to private parties. It has had some success in this, but whether it will have enough to make a major contribution depends on the conditions under which it seeks private sector cooperation, in particular measures such as the proposed new Investment Code. 138. Several steps have been taken or are proposed to strengthen the monitoring of projects, which was not given sufficient priority and was consequently handicapped by shortages of resources and, occasionally, technical expertise. The weaknesses of project monitoring in the past prevented ministries, who are ultimately responsible for it, from obtaining the feedback necessary to overcome implementation problems. The former tendency to neglect it has been replaced by fuller recognition of its importance. The Ministry of Public Works has instituted a system of  - 41 - monthly on-site reports that are studied in the Minister's office, and the agricultural ministries are making arrangements for further project monitoring in their reorganization. The DGP is proposing a considerable strengthening of its own monitoring services, which has mainly prepared progress reports for the Government, with the intention of increasing its own role in monitoring both in collaboration with ministries and separately. However the resource constraints need to be overcome. Since monitoring activities are normally recurrent expenditures, the constraint on the recurrent budget have severely handicapped them by limiting the resources available for travel and inspection, or the engaging of technical expertise. It would be desirable either to include the cost of monitoring in the total project costs, or to ensure that the recurrent budget includes sufficient allowance for them. Training 139. These and other measures in establishing the framework and mechanisms for managing public sector resources will require substantial improvements in the planning and technical qualifications of public sector personnel. The Malagasy authorities have long been conscious of the shortage of planners, managers and accountants, but have tended to rely on lengthy formal courses in specialised institutions to train them. Otherwise they rely on standard formal education. 140. It is doubtful whether substantial progress can be made in the medium term in meeting the need for more skilled personnel without much greater emphasis on in-service training. Over the years in-service training has diminished considerably because of budget constraints. At present university level training provides graduates who might sometimes have more up-to-date specialised skills than their more experienced seniors in ministries and enterprises, but are often unable to make effective use of it. With time, unless they receive in-service training, their skills atrophy, as did those of their seniors. This is both wasteful and bad for morale. 141. In-service training for planners could be provided by short-term or evening courses and by seminars organised by the Malagasy Institute for Planning Techniques (IMATEP), which at present teaches planning methodology through two year courses that largely duplicate university courses. Short courses aud seminars for managers might be arranged by an institution like the National Investment Fund (FNI). Accountant training is being provided by the Centre for Accountant Training (CFC) recently started with IDA financing, whose night courses are in great demand. Similarly, various forms of in-service training would be needed for project management, from technical preparation and appraisal to monitoring and implementation, and for the regular upgrading of skills of technical personnel such as agronomists, engineers and chemists. 142. A comprehensive program for all types of in-service training would be unnecessarily complicated. More effective would be a firm Government commitment to such training, including provision of budget resources, while leaving the training in each branch to be arranged by an  - 42 - appropriate organisation. Technical assistance would play a major part in assessing training needs, drawing up training programs, establishing appropriatr- uin1irs and pravi.iing instrtirtnr'-. Thl' wntilr rnntiniie the growth of technical assistance of the last few years, which has included training programs and projects for several organisations, including the two agricultural ministries, the Ministry of Public Works, and the accounting firm, RINDRA. VII1. ISSUES OF SIZE AND RESOURCES 143. Although the emphasis on investment as the engine of growth has given way to a fuller recognition of the importance of the economy's recurrent needs, the present PIP iB a large one in the sense of diverting resources from certain recurrent expenditures that may be essential for long-run growth. In particular, it diverts resources from the recurrent budget, which has declined in real terms continuously since 1978, to the capital budget. The government's economic activities have been deprived of resources for some time; first because of the expansion of the social sectors and then because of the increase in investment. And, since 1981, the social sectors have also been extremely short of resources. As a result the effectiveness of numerous government activities, such as agricultural extension, project supervision, and training programs, has been low for some years, while the education system is seriously short of school materials and the health system of basic medical supplies. It is questionable that the resources allocated to projects not receiving external financing would yield higher long-term growth than if allocated to such recurrent activities, or that they would help achieve the cbjective of greater social justice more effectively. 144. It is not possible to judge from the data whether there may not be scope for releasing foreign exchange for other uses to increase imports of inputs. The DGP's assumption is that there is not since Government, in pursuing the primary objective of increasing capacity utilization, allocates as much foreign exchange to imports of raw materials and spare parts as it judges compatible with a mininum of imports of essential consumer goods. Moreover, there is little likelihood of new projects with substantial costs being implemented without assured external financing. However, in some cases the assured financing does not cover all the foreign exchange costs, while a number of on-going projects that might be rescheduled do require imports that are not financed. Supplies of raw materials and spare parts are crucial determinants of the output of industry and services sectors and increasing them could result in higher sustained growth over the medium term than has so far been achieved through investmeent. The financial sector 145. Increasing capacity utilisation in the context of more liberal pricing policies would also be the means of improving the extremely difficult situation in the financial sector. It is characterized by heavy indebtedness of many enterprises with small prospects of repayment in the  - 43 - next few years. A further complication is the arrears of payment of the Government to enterprises and between enterprises themselves. The problem will only be solved by making enterprises profitable again or, where this is not possible, by closing them down. But it would also be advisable to study the possibilities of restructuring the debt of selected enterprises, possibly with concessionary interest rates. Moreover, some possibilities for long term financing of investments could be found among the resources of non-bank financial institutions that are being used mainly to finance the Treasury. 146. The situation arose mainly because of the prolonged difficulties enterprises had in covering their operating costs. Bad management had a big part in this, but equally important were the rigid price controls and the perpetual shortages of inputs, whether imported or from the agricultural sector. Up to J980 the Treasury had to cover the costs of numerous state enterprises, its advances and loans reaching a peak of FM. 9 billion in 1979. But the major role has been played by the three banks. Both because of Government instructions and to shore up their old clients, the bariks extended and continued to roll over credit without prospects of repayment in the short term. At present the three banks are heavily lent and unable to disengage themselves without throwing their borrowers into bankrupcy. Moreover, from 1978 to 1982 the Government fell heavily into arrears in its payments to enterprises, who also accumulated massive arrears between themselves. 147. The prospects of restoring a number of loss-making enterprises to profitability have improved recently, though additional measures might be necessary to accelerate the restoration of order in their balance sheets. Government has considerably relaxed price controls and has been giving higher priority to raw materials and spare parts in foreign exchange allocations. An improved performance in the agricultural sector has also helped. More direct action being taken by Government include the search for private partners for several industrial enterprises and a..ranging management contracts for certain agricultural ones. Government has also decided not to operate the new industrial enterprises until assured of other potential profitability. 148. Nevertheless the mass of debt is large, in many cases leaving enterprises with a negative net worth, and real interest rates are positive, some well over 7 percent. Given the urgent need for many enterprises to make up for large backlogs on maintenance and sometimes for major rehabilitation, addition measures may be required. It would, therefore, be advisable to study the possibilities of restructuring the debt of certain enterprises and reducing real interest rates on this debt. The selection of candidates would be determined in first place by their prospects of financial and economic viability, allowing, when necessary, for rehabilitation programs. 149. Both because of the commitment of bank credit to enterprises in difficulties and because the three banks have traditionally been commercially oriented, alternative sources of financing need to be tapped to obtain long term financing for investment. As with many low income  - 44 - countries, only a small part (17 percent) of bank credit is medium or long term, i.e. more than one year. Moreover, only one of the banks has even limited capacity for investment banking. In recognition of this the FNI was created in 1979 with the purpose of acting as an investment bank and industrial promoter. 150. The FNI has had major problems in obtaining financing itself. Its original financing was meant to come from earmarked government revenues, which would have been inappropriate in a bank. It has also had difficulty attracting external financing, since it is involved in some of the economically more questionable public sector investments. Nevertheless, its management is now unequivocal on its mandate to act strictly on a profitability basis. The need for some institution fulfilling the functions the FNI is designated to fulfill is there. Moreover, the FNI's proposal that it should be allowed to make use of institutional savings which at present is worth considering. The use of such funds, with suitable insurance arrangements, would help in establishing its creditworthiness. IX. ISSUES FOR THE PREPARATION OF THE NEXT PIP 151. Government intends to prepare during 1985 a PIP for 1986-90. It is expected that the new PIP would continue the process of improving the management of public sector resources whose early stages are reflected in the present PIP. Some of the actions that would contribute to this process are discussed here. 152. Firstly, since it is likely that resources will not suffice to implement the present PIP as scheduled, there will be a need to decide on where eventual cuts would be made to avoid a situation in which project implementation is severely affected by resource shortages. At present priorities are set on an annual basis for the part of the PIP financed from the budget at the time of budget preparation. This has been effective in reducing starts of new projects that might deprive on-going ones of resources, but does not ensure that the resource requirements of projects started or on-going in one year will be within the resource Lvailabilities of the next. It also does not prevent substantial preparatory work being done on projects that are then repeatedly postponed because of resource shortages. 153. The likelihood of a resource shortfall for the present PIP is partly due to the fact that the PIP was prepared to conform with projections of overall investment levels, rather than according to financial resources. It would be considerably reduced by improving the financial projections, especially by making 2-3 year projections of government finances to give the sector ministries guidance on their capital budgets. This would need to be supported by greater coordination of external assistance by Government, especiallv of initial contacts with donors, to ensure that commitments follow priorities. However, even with  - 45 - potential successful implementation of these measures, provision would need to be made for shortfalls of resources below projected levels. A core program or some other means of deciding on where cuts should be made or how projects should be rescheduled would permit closer adherence to implementation schedules of the projects that are started. 154. The second major line of action would be to continue the project review process as a means of improving design and implementation, as Jell as removing projects that are not economically justifiable. In view of the time needed to train staff, collect the data still missing, and perform the necessary analysis, it might not be feasible to appraise or substantially redesign many of the projects of the present PIP. However, the conclusion of the studies that are currently being performed would be available and should be taken fully into account in preparing the next PIP. 155. Thirdly, there is a need for strengthening the identification and preparation of new projects. The present PIP shows a marked drop in outlays and project starts in 1987. This may not give rise to a practical problem, since there may be delays in project implementation and resource shortages in the earlier years. But it indicates that there may be a shortage of viable new projects which would particularly affect the later years of the next PIP. Appropriate steps would incude enhancing the project preparation capabilities of sector ministries, increasing the ability of state enterprises to generate financing to implement their own projects, and further reinforcing the public sector's cooperation with the private sector through partnerships and joint ventures. ' 156. Finally, Government would need to review the size of the PIP to ensure that economically important recurrent government expenditures are not restricted unnecessarily and that the private sector also receives an appropriate share of investment resources. For determining appropriate levels of private investment it would be indispensable to improve on the available data on capital formation and to construct reliable estimates for the public and private sectors. In due course criteria for determining suitable levels of recurrent expenditures would need to be formulated by systematic reviews of all government expenditures. This would be best achieved by a nore comprehensive approach to government expenditures, covering recurrent as well as capital expenditures, which should be given priority in the near future.  ,-12 1 MADAGASCAR Antseranano Paved roads All weather roads Railways NOSY.BE o106e . Airports Hell-villP ;V himorino Forests Contours in mete s ,i -14' Rivers 1'' Prefecture boundaries , Sambova Provincial boundaries ,'. / Antsohovo0 Antsohihy <; oAntalaha O 50 100 150 P e MI 11EI Mohoajnga, Part Be} _'t -' ) tt VA 0 50 100 150 200 250 M a / .V So16l' o Moro oy runcr Bescl.mby erwra . .i s rof,rorno I' ' 14 0 * riArr-oneno /;;t- FenoorivoAisinanona .Morafencbe Ar, k . Maoinrrono a ;' ~~' '' ' 'A b r Ari o te Anio ) .o Toamosina Cl a