Burundi - Structural Adjustment Program Project

The World Bank FOR OFFICIAL USE ONLY cR/. 4CC-'3L Rhis Ne. P-4250-BU REPORT AD RECOMMENDATION OF TUE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT 0F SDR 13.2 MILLION AD PROPOSED AFRICAN FACILITY CREDIT 0F SDR 14.3 MILLION TO TUE REPUBLIC OF BURUNDI FOR A STRUCTURAL ADJUSTMENT PROGRAM April 30, 1986 This document has a restricted distribution and may be used by recipients only in the performance of their officiai duties. lis contents may not otherwise bc disclosed without World Bank authorization.  Currency Equivalents Currency Unit - Burundi Franc (FBu) US$ 1.00 - FBu 120.7 (Annual Average, 1985) SDR 1.00 = FBu 122.17 (Since November 1983) Weights and Measures 1 meter (m) - 3.28 feet 1 kilometer (kam) 0.62 mile 1 sq kilometer (km2) - 0.386 square mile 1 sq meter (m2) = 10.76 square feet 1 cubic meter (m3) - 1.13 cubic yards 1 metric ton (ton) = 2,204 pounds Glossary of Abbreviations and Acronyms AF Special African Facility BCC Burundi Coffee Company BEI Extraordinary Budget BNDE National Economic Development Bank (Development Bank) BO Ordinary Budget BRB Bank of the Republic of Burundi (Central Bank) CADEBU Burundi Savings Bank CGEP Public Enterprise Commission COTEBU Textile Company of Bujumbura FWA Fully Washed Arabica (coffee) IBRD International Bank for Reconstruction and Development (World Bank Group) IDA International Development Association (World Bank Group) IFC International Finance Corporation (World Bank Group) 11F International Monetary Fund INSE National Statistices Institute OCIBU Industrial Culture Office of Burundi ONAPIA National Pharmaceutical Office OTB Burundi Tea Office PE Public Enterprise PEP Public Expenditures Program PIP Public Investment Program PTA Preferential Trade Zone RDC Regional Development Company SAL Structural Adjustment Lending (financed under the IDA and SFA Credits, the Swiss and Japanese Grants, and the Japanese Loan) SBF Burundian Finance Company SCEP Service in Charge of the Public Enterprises SGS Inspection Company SOSUMO Nosso Sugar Company SPPF Special Project Preparation Facility Fiscal Year Government of Burundi: January 1 - December 31  FOR OFF0CM USE ONLY BURUNDI FIRST STRUCTURAL ADJUSTMENT OPERATION Credit and Program Summary Borrower: Republic of Burundi Amount: IDA Credit: SDR 13.2 million (US$15 million equivalent) AF Credit: SDR 14.3 million (US$16.2 million equivalent) Swiss SJF Grant: Sv.F. 15.0 million (US$7.7 million equivalent) Japanese SJF Grant: Yen 400 million (US$2.2 million equivalent) Japanese SJF Loan: Yen 1.6 billion (US$8.9 million equivalent) Terms: IDA and AF Credits: Standard IDA Terms Swiss SJF Grant: Non-reimbursable contribution Japanese SJF Grant: Non-reimbursable contribution Japanese SJF Loan: Maturity: 30 years Grace Period: 10 years Interest Rate: 1.25X Description: The proposed financing would be the first in a series to support the Government's structural adjustment program. The principal aim of the program is to redirect the Burundian economy towards a development path which vill reduce the present dependence on coffee and lay the basis for sustained growth in the medium-term, with more reliance on market forces and a more outward orientation. The measures to be taken in this phase of the program, as outlined in the Government's Letter of Development Policy and supporting Sector Policy Statements, fall into two main categories: (a) At the macroeconomic level, the adjustment program focusses on the development of a mediumrterm framework, and includes rationalization of public investment, improvement of public expenditure management, import liberalization, credit reform, and adoption of a flexible exchange rate policy. This document bas a restricoed distribution and may be used by roecipients onWl in the performance ofh deir oficial duties. Its contenis may not otherwise be discosed without World Bank authorization.  - ii - (b) At the sectoral level, the program includes: (i) an agriculture sector action program designed to raise output and improve the quality of export crops through adequate incentives to farmers and improvement in the existing processing and marketing capacity; and a rationalization of sector organization; (ii) a public enterprise sector reform through restructuring, privatization where possible, and closure if necessary, of key enterprises; and (iii) trade and industrial reform aimed at improving resource allocation, removing the bias against exports, and promoting activities in which the country has a comparative advantage. The credits and loans would finance all imports with the exception of items financed by other sources, military and para-military items, alcoholic beverages, tobacco, and precious metals or stones. Estimated Disbursements: The proceeds of the proposed financing vould be disbursed in two tranches. The first tranche of US$25 million equivalent would be available for disbursement upon credit effectiveness. Disbursement of the second tranche of US$25 million would be contingent upon the Government's taking the actions exumerated in paragraph 102 of this report. A performance review would be held at end-1986. Disbursements of the entire credit are expected to be completed vithin 18 months after credit effectiveness. Appraisal Report: Not applicable. Nap: IBRD 12260  - iii - BURUNDI FIRST STRUCTURAL ADJUSTMENT OPERATION Table of Contents Page No. CREDIT AND PROGRAM SUMKARY .................. i I. The Economy . . . . . . . . . . . . . . . . . . . . 1 Background . . . . . . . . . . . . . . . . 1 Macroeconomic Developuents . . . . . . . . 2 Adjustment Policy Issues . . . . . . . . . 5 Prospects and Needs for Financing . . . . . 6 II. The Government's Structural Adjustment Prograo . . 7 A. Need for Structural Change . . . . . . . . . . 7 B. The Government's Short-Term Financial Program, 1986-87 . . . . . . . . . ... . 10 III. The SAL Program 1986-88 . . . . ........ . . 14 A. Public Expenditures Policies . .. . . . . . 15 B. Public Enterprises . . .. ... . . . . . . 19 C. Agriculture . . . . . . . . . . . . . . . . . . 22 D. Trade and Industrial Policies . . . . . . . . . 24 E. Credit Allocation System . . . . . ...... 30 IV. The Proposed Operation ....... . . .. . . 31 A. Uistory . . . . . . . . . . . . . . . . . . . 32 B. Relationship between the Proposed Operation and Policy Reforus . . . . . . . . . .. . . 32 C. Effects of the Adjustment Program . . . a . . 40 D. Benefits and Risks . . . . . .. . . . . . 43 E. Social Costs of Restructuring . . . . . . . . . 44 F. Proposed Financing . . . . .......... 45 G. Disbursement, Procurement, Administration and Auditing . . . . . . . . . . . . . . . . . . 45 B. Counterpart Funds . . . . . . . . . . . . . . . 46 I. Monitoring . . . . . . . . . . . . . . . . . . 46 V. Bank Group Operations and Strategy . . . . . . . . 48 VI. Relations with the IMF . . . . . . . . . . . . . . 50 VII. Recommendation . . . . . . . . . . . . . . . . . . 50  - iv - Table of Contents (Continued) Page No. TEXT TABLES Table 1: Main Economic Indicators . . . . . . . . . 3 Table 2: Balance of Payments, Actual and Projected . 12 Table 3: Fiscal Impact of Stabilization Program . . 14 Table 4: Public Investment Program, 1986-88 . . . . 17 Table 5: Structural Reform Program (SAL) . . . . . . 33-39 Table 6: Projections of Selected Economic Indicators under Structural Adjustment Assumptions . 41 ANNEXES Annex I: Social Indicators Data Sheet . . . . . . 53 Annex II: Economic Indicators; Balance of Payments, External Capital and Debt; Status of Bank Group Operations in Burundi . . . 57 Annex III: Supplementary Project Data Sheet . . . . 61 Annex IV: Covernuent of Burundi - Statement of Development Policies . . . . . . . . . 63 Aunex V: Government of Burundi - Policy Statement on the Public Enterprise Sector . . . . 77 Annex VI: Government of Burundi - Policy Statement on Agriculture . . . . . . .. . . .. 83 Annex VII: Government of Burundi - Policy Statement on Trade and Industry . . . . . . . . . 87 Annex VIII: Government of Burundi - Policy Statement on Public Expenditure Management . . . 95 MAP Burundi - Administrative Divisions (IBRD Map 12260)  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT AND AFRICAN FACILITY CREDIT TO TUE REPUBLIC OF BURUNDI FOR A FIRST STRUCTURAL ADJUSTMENT PROGRAH 1. I submit the folloving report and recommendation on a proposed development credit to the Republic of Burundi for SDR 13.2 million (US$15 million equivalent) on standard IDA terms and a proposed African Facility Credit of SDR 14.3 million (US$16.2 million equivalent) from the Special Facility for Subsaharan Africa (the African Facility), established by Resolution No. IDA 85-1 of May 21, 1985. In addition, I recommend that IDA would administer a proposed Special Joint Financing non-reimbursable contribution of SwF 15 million (about US$7.7 million equivalent) by Switzerland, and a proposed Special Joint Financing nonrreimbursable contribution of Yen 400 million (about US$2.2 million equivalent) from Japan. The proposed financing aims at supporting the Government's program of structural reforus designed to restore financial equilibrium and achieve sustained growth. 2. Part I of this report reviews the characteristics, performance and constraints of the economy. Part II outlines the Government's structural adjustment program, including the short-term financial program. Part III describes in detail the actions to be supported under the proposed Credit. Parts IV and V assess the expected effects of the Government's structural adjustment program, and describe IDA's role in the adjustment process, the proposed operation, and other IDA operations in Burundi. Part VI provides a summary account of the relations of Burundi with the IMF. PART I - THE ECONONY 3. The assessment of the Burundian economy in this report is based largely on the work of two preparation missions (May and September 1985) and the appraisal mission (November 1985) of the proposed credit. The findings o' the 1983 economic mission are reflected in the economic report (No. 4784-Eu) which vas distributed to the Executive Directors on December 26, 1984. Country data are provided in Annex I. Background 4. With a per capita income of US$240 (1984 Atlas), Burundi is one of the poorest countries in the world. The country is landlocked, small in size, and densely populated, vith no significant natural  resources other than relatively fertile agricultural land. Social indicators compare vith those of the poorest African countries. Population growth (2.9 percent per annum projected for the 1980-2000 period) is high. The society is mainly rural, as only about 5 percent of the population live in the few urban centers. Despite the high demographic pressure on already constrained land, migration to the urban centers has been limited, urban growth having averaged about 5 percent a year. Although there are considerable regional differences in income and large urban-rural disparities, there is little absolute poverty in the sense that most people have access to basic shelter and nutrition. School enrollment has expanded, but the auult literacy rate remains low - about 30 percent. 5. Agriculture is the dominant economic sector, contributing 60 percent of GDP and 85 percent of both employment and exports. Burundi is one of the few African countries self-sufficient in food (at least for the most popular staples). The industrial sector (including energy and construction) accounts for about 15 percent of GDP and ouly 7 percent of exports. The private sector, while small in terme of total fixed investment (15 percent), plays the major role in agricultural production and trade. The public sector is important in manufacturing, energy and infrastructure, and the parastatal sector accounts for half of formal employment. One obstacle to Burundi's development is its landlocked situation, which makes the country vulnerable to the transportation conditions of neighboring countries. Although progress has been made in recent years to improve physical facilities and to simplify transit formalities, transportation costs to and from the Indian Ocean are very high. Passage through neighboring countries is not reliably secure (as occurred recently because of civil var in Uganda), and disruptions in transport can cause serious domestic shortages and shortfalls in export revenues. Macroeconomic Developments 6. Following the accession of President Bagaza to power in 1976, Burundi undervent a substantial economic change. Frost in Brazil in that year caused world coffee prices to triple, and this development, together with a substantial increase in foreign aid, contributed to a considerable increase in public savings and accumulation of foreign exchange reserves. During the second half of the '709, Burundi's development strategy, as reflected in the Third Development Plan (1978-82), vas based on achieving a high rate of growth and diversifying the economy. The public sector took the leading role in promoting productive activities and financing infrastructural investments. The overall outcome vas largely positive. Despite the decline in coffee prices, the rise in oil prices and the disrupting effects of the Tanzania/Uganda var in the supply of essential importa, real GDP growth averaged 6.7 percent per year between 1978-81, investment rose to 13-14 percent of GDP (compared vith 8 percent in earlier years), and manufacturing grev by 14.5 percent per year. Transport infrastructure, particularly roads, expanded considerably, leading to a road network vhich is basically adequate to the couutry's  - 3 - present needs. Pover generating capacity increased from 6 MW to 11.6 MW. Social services, particularly coverage of education, vere improved. 7. Developments were not as positive in some other areas. Following the decline of coffee prices and the doubling of oil prices in the late '70s, the terms of trade deteriorated substantially (45 percent between 1978-81), but the Government did not adjust to these developments. A rapid increase in domestic demand and expansionist fiscal and monetary policies led to a deterioration in the balance of payments. The current account deficit increased from 5 percent of GDP in 1978 to 12 percent in 1982. Domestic savings fell from 6.7 percent of GDP in 1978 to 2.6 percent in 1982. Until 1980, part of the current account deficit vas financed Ly foreign aid. Hovever, after 1980, the widening current account deficit was financed largel; by a drawdown of foreign exchange reserves, which declined to about 1.1 months of imports equivalent by end-1982. On the fiscal front, the growth of expenditures (both recurrent and capitaL) outpaced the growth of public revenues. The resulting deficits were financed by credit from the Central Bank, foreign borrowing, and an accumulation of domestic arrears. The overall budget deficit rose froa 4.3 percent of GDP in 1977 to 7.6 percent of GDP in 1981 and to 6.4 percent in 1982. Inflation ran at a high 25 percent a year between 1977 and 1981, leading to a rapid appreciation of the Burundi franc, which remained pegged tO the U.S. dollar at the same rate as in 1978. In the real sector, manufacturing grev overprotected, oriented to thr. douestic market, and heavily dependent on imports. Moreover, the overvalued currency and the relatively high labor costs hindered expansion of exports. Coffee remained therefore Burundi's major export commodity. Table 1: MAIN ECONOMIC INDICATORS 1978 1981 1982 1983 1984 1985 (est.) As Z of GDP: Exports 11.7 8.9 10.1 9.0 12.7 11.5 Imports 20.2 20.2 25.5 23.8 27.0 23.6 Current Account Def. 5.3 8.9 12.4 12.4 12.2 10.0 External Debt (DOD) 6.8 14.3 15.4 24.3 38.3 42.3 Gov't. Revenues a/ 19.0 15.4 19.0 16.7 18.8 18.8 Current Expenditures 11.7 11.4 11.9 12.0 13.2 13.0 Public Investment 11.6 11.8 13.5 16.7 15.3 14.2 Total Gov't. Deficit 4.3 7.6 6.4 12.5 9.7 8.4 Investment (FGI) 14.0 13.3 15.0 19.4 19.2 19.8 As Z of Exports: External Debt (DOD) 47.8 179.3 196.7 302.1 298.9 380.2 Debt Service 2.9 6.1 5.6 7.8 14.2 22.1 Terms of Trade (1978=100) 100.0 55.8 57.6 71.2 86.9 84.5 a/ Includes capital grants.  - 4 - 8. The Fourth Development Plan (1983-87) vas prepared in 1982 when the budget and balance of payments were already under strain. Nevertheless, the Plan incorporated an ambitious investment program of US$230 million per year (US$100 million more than what had been achieved during the Third Plan), of which 70 percent vas to be financed by foreign aid and 30 percent by domestic resources, mainly from the budget. Emphasis vas put on the development of agriculture through large rural development projects and physical and administrative infrastructure. To finance this program, the Government tried to mobilize resources by several means. In 1983, the rates of main taxes (e.g., transaction and beer taxes) vere increased between 50 and 100 percent, tax collection vas reinforced, transfers to public enterprises vere cut drasticallv, and public vages vere frozen. (Public employment continued to expand, however, and merit and promotion increases vere granted.) Moreover, to control the increasing deficit in the balance of payments, the Government resorted to administrative controls, including restrictions on imports and on remittances of foreign exchange abroad. The profession of importer vas regulated and price controls vere imposed upon imported and domestic goods. 9. Burundi's economic and financial performance in 1983 vas not satisfactory. While 80 percent of planned investment was implemented, this vas obtained at a high cost: public domestic debt increased by 32 percent; public external debt (outstanding and disbursed) reached US$292 million, or ten times the 1977 level (reaching 24 percent of GDP in 1983, compared with less than two percent in 1977); domestic arrears accumulated, reaching 30 percent of Government spending at the end of the year; and the overall budget deficit rose to 12.5 percent of GDP. Moreover, the restrictions on imports had adverse effects on the economy. Imports of consumer goods fell by about 33 percent and imports of non-oil intermediate products declined by 9 percent, hindering the activity of the modern sector. Administrative controls, notably on imports and prices, led to a distorted price structure. High rents accrued to monopolist importers, incentives to invest in productive sectors vere diminished, and there vas a slowdown in the economic activity. Non-coffee manufacturing stagnated and value added in the tertiary sector declined in absolute terms. GDP grew by 2 percent mainly due to a good performance in the coffee sector. The balance of payments' current account deficit remained above 12 percent of GDP, and foraign exchange reserves remained at less than two months of imports equivalent. 10. At the end of 1983 the Government took some adjustment measures: the Burundian franc vas pegged to the SDR, with an implicit devaluation of 30 percent against the U.S. dollar; producer prices of the main export crops vere increased between 6 and 50 percent; and public wages remained frozen. The impact of these measures vas felt mainly in the budget, whose revenues increased significantly due to increased receipts from coffee and other exports. Hovever, continued imports restrictions constrained capacity utilization in the modern sector due to the lack of intermediate goods and favored the development of parallel markets. In addition, climatic conditions vere  extremely adverse. A prolonged drought led to a reduction in agricultural value added, contributing to a decline in real GDP of 4 percent in 1984. Inflation reached 14.4 percent. 11. The economic situation improved in 1985. According to official estimates, GDP growth reached 6 percent, largely as a result of the recovery of agricultural output and increased coffee production. Coffee exports reached 32,000 tons (a 15 percent increase vith respect to 1984) as Burundi's ICY quota vas raised. On the whole, exports of goods and non-factor services reached US$130 million in 1985 as compared vith US$112 million in 1984. This, together vith the increase in public transfers associated with the 1984 drought, allowed an increase in imports of intermediate goods and an expansion of manufacturing output. The current account deficit is estimated to have declined from 12.2 percent of GDP in 1984 to 10 percent in 1985. The debt service ratio, however, reached 22 percent of exports of goods and non-factor services, compared vith 14 percent lu 1984. On the public finance front, revenues increased by 16 percent in nominal terma due to higher revenues accruing from coffee and excise taxes. The growth of public expenditures vas about 10 percent (for a domestic inflation of less than 4 percent), leading to an improvement in the overall budgetary deficit, which fell from 10 percent of GDP in 1984 to 8 percent in 1985. Recourse to domestic borrowing continued to be important. Credit to the central Government continued to absorb the largest part of the credit to the economy. 12. The outlook for 1986 is marked by the unexpected increase (about 50 percent) of world coffee prices in consequence of the Brazilian drought. Burundi's coffee windfall in 1986 is estimated at about US$44 million, equivalent to nearly one-third of previously projected exports. This, together with the decline ln oil prices, vill provide important relief to the country's balance of payments and budget. The Government is avare, however, that this improvement i8 tumporary and it is committed to implementing a structural adjustment program aimed at ensuring sustainable financial equilibria and economic growth in the future. Adjustment Policy Issues 13. While the expected coffee windfall vill provide substantial financial relief in the short-term, there remain two critical tasks facing Burundi's economic managers. The first i to address the underlying financial disequilibria by increasing mobilization of public savings to finance public investment (hence reducing dependency on domestic and external borroving) and by following prudent fiscal and monetary policies to avoid inflationary pressures and difficulties in the balance of payments. The second is to achieve longer-term structural adjustuent of the economy by stimulating the productive sectors and private investment, lessening dependence on coffee, and developing a wider resource base. With regard to the short term, the measures included in the Governuent's financals program (to be supported by the IMF) will help the country to reach more sustainable financial equilibria on both the external and domestic fronts.  - 6 - 14. To resolve the structural issues, a comprehensive and consistent package of measures is needed to: (i) strengthen macroeconomic management, including through appropriate exchange rate and credit policies, fiscal reform, and prudent foreign borroving; (ii) control aggregate demand thror:gh prudent monetary, fiscal and vage policies; (iii) improve efficiency in the use of public sector rzsources, including through proper planning and effective implementation of public investment/expenditure programs and rehabilitation of the public enterprise sector; (iv) rationalize and increase incentives for export growth and efficient import substitution, including the adoption of adequate industrial incentives, a tariff-based trade policy and pricing policies conducive to growth of the agricultural export crops; and (v) increase private and public savings through steps such as raising interest rates and improving tax collection. These policy areas form the basis of the Governnent's program to be supported by the IMF and by the proposed Structural Adjustment Credit (SAC). Prospects and Needs for Financing 15. While progress has taken place in non-traditional exports, notably of manufactured goods, the bulk of foreign exchange earnings vill continue to come from coffee in the next ten years, making the economy vulnerable to volatility in the vorld coffee market and rendering macroeconomic management quite difficult. To accelerate economic growth and maintain financial equilibrium, major structural changes are needed in order to lessen the economic dependency on coffee. The volume of coffee exports is presently affected by the fall in coffee production in Brazil. As coffee quotas established by the International Coffee Agreement have been lifted until 1987, Burundi is likely to export all its coffee production, projected at 34,000 tons in 1986 and 35,200 tons in 1987. It is expected that Burundi vill subsequently be able to negotiate a ouota level compatible with its production capacity, presently projected to grow at about 4 percent per year. However, given the expected future decline in coffee prices (prices are projected to fall by 14 percent in 1987 from their expected 1986 level and to remain at the same level until 1990), the export revenues accruing from coffee vill decline despite increases in the volume exported. To offset in part the effects of coffee price oscillations, Burundi needs to improve the quality, value added, and marketing of its coffee. 16. Burundi's external borroving requirements for 1986 and 1987 have been reduced by the expected coffee windfall, estimated at US$44 million and US$14 million respectively (33 and 6 percent of exports respectively) and by the fall in oil prices (equivalent to US$6 million in 1986). Hovever, the need to pay increased debt service, the requirements of major development projects, the demand of the modern sector for essential imports of raw materials and spare parts, the volatility of coffee prices, and the need to build foreign exchange reserves (which have fallen to 1.2 months of import equivalent in 1985), will require the implemertation of prudent policies in terms of domestic demand and monetary and fiscal policies. The Government's  - 7 - objective is to use the coffee windfall to accumulate reserves, securing a comfortable coverage of about 3-1/2 to 4 months of imports, in 1986 and 1987, and maintaining it at above 3 months in the medium and long term. This is a sensible objective, in view of the country's landlocked situation and its dependency on coffee exporta. Under conservative assumptions with respect to imports, external capital requirements to allow the country to build that level of reserves amount to about US$335 million during the 1986-87 period, of which US$160 million are expected to be financed by concessionary aid already committed, US$90 million from capital grants, and the remaining US$85 million would come from the proposed financing package and other donors' programs. This is consistent with the public investment program as agreed with the Government. The debt service ratio, which more than doubled from 10 percent in 1983 to 22 percent in 1985 is expected to be 17 percent in 1986 and 20 percent in 1987, declining steadily aftervards. While Burundi has an important debt problem, especially taking into account the dependency of its exports on a single coumodity, the country remains creditworthy for long-term borrowing, provided sound economic policies are pursued by the Governuent. Given the concessionary terma of Burundi's debt (2.7 percent average interest rate, 31 years of maturity and a grant element of 56 percent), there is no reason to consider advance repayment of outstanding debt. In the context of the proposed program, the Goverament is committed, however, to borrow only at concessionary teras. PART Il - THE GOVERN~HENT S STRUCTURAL ADJUSTMENT PROGRAM A. Need for Structural Change 17. As noted above, Burumdi's rapid economic growth in the second half of the 1970s (6.5 percent per year) was in large part the result cf the boom in coffee prices in the mid-1970s and the consequent accumulation of public savings, which in turn, allowed a considerable expansion of public investment and growth in related sectors. At the turn of the decade, the Goverament failed to adjust to the changing environment, characterized by a deterioration of the terms of trade and increasing pressure over the balance of payments. An expansionary policy, together with administrative controls, led to serious financial disequilibria, a slow-down in economic growth (1.4 percent per year between 1982 and 1985) and important economic distortions. The main objectives of the Government's structural adjustment program are to diversify the economy and lay the basis for a sustained growth in the medium term based on the country's comparative advantages and relying on the private sector. Diversifying the economy will be a difficult task since coffee accounts for 10 percent of the GDP, 85 percent of export earnings, and about 25 percent of government revenues; moreover, much of the service sector, and some manufacturing activities, depend, directly and indirectly, on incomes generated by coffee. However, the need for diversification is pressing. While the windfall expected from the recent increase in coffee prices will allow some real increase in  - 8 - imports and in growth, the coffee prospects for the long run indicate depressed demand and prices. Moreover, the fluctuations of coffee prices affect both public revenues and export revenues making the economy difficult to manage. 18. The achievement of the structural adjustment will require a long-term effort, as it represents fundamental changes in attitudes, institutions, and policies. Even if appropriate policies begin to be applied immediately, it would be unrealistic to expect the initial adjustment process to take less than a decade. During this period Burundi will lay the foundation for an economy where both agriculture and industry are provided incentives sufficient to permit sustained export growth. A significant shift should progressively occur towards greater private investment and production activities relative to public sector investment and production, and a more efficient public sector should begin to emerge vith more reliance on decentralized decision-making than upon direct controls. Investments in infrastructure and the social sectors will be designed to support efficient growth in the productive sectors and other development objectives. Finally, the capacity for bringing about future needed structural changes will be strengthened by establishing appropriate policies and institutional mechanisms. The Government recognizes that while the adjustment process will involve some short-term hardship, it vill contribute significantly to improvements in the standards of living of the population over the medium term. 19. To accomplish this, even over an extended period, will not be easy. The achievement of other objectives fundamental for sustained economic growth, such as a decline in population growth (a program to vhich the Government is now fully committed), vill take even longer. In the initial period, priority should be given to reinvigorating the productive sectors, promoting private investuent, and P:rengthening Burundi's institutional capacity to effect the process of structural change. The effects of the initial adjustuent vary across sectors. The industrial sector probably will be the first to react. Inefficient enterprises which have grown up protected by an inappropriate tariff structure and an overvalued exchange rate will have to adapt to the new system of increased competition; industries based on domestic raw materials and intermediate goods will assume greater importance compared to those based on imported materials and components; and new technologies will be more labor intensive than in the past. The Government's financial adjustment program includes control of public wages, which will help to reduce the relative costs of labor (compared to the cost of capital), promote employment, and increase the competitiveness of Burundi's goods abroad. Agriculture vill respond initially through better performance of export crops (due to improved incentives). The foodcrops sector will benefit from the increase in revenues accruing fron higher prices for export crops as vell as from the reinforcement of support activities and application of improved technologies. Building an institutional capacity to deal with structural change vill require better mechanisus to deal with fluctuations of export earnings, and to implement flexible exchange rates and other pricing policies.  20. Bank support for structural adjustment. A meaningful adjustment program vill need close support from both the Bank and the Fund. Fund support is proposed initially for the implementation of a stabilization program to cover the period mid-1986/end-1987. Bank support is proposed to be extended through several Bank interventions including: (i) a series of structural adjustment credits; (ii) technical assisttnce credits aimed at strengthening general economic management in the ministries of Planning, Finance and some line ministries and to support the rehabilitation program of the public enterprise sector; (iii) strengthening of technical assistance components of future Bank projects in agriculture and other sectors to focus on the structural adjustment needs of these sectors; and (iv) financing of consultants' studies under the Third and Fourth Technical Assistance projects and other IDA-financed projects. 21. The period 1986-87 covered by the first SAC vould be used to p:t in place the new incentive structure and strengthen the institutional capacity needed for improved public expenditure planning and control as vell as other reforms. An exchange rate policy, agreed vith the INF, 6nd a new tariff structure would be put in place to provide appropriate incentives to both agriculture and industry. The public enterprise sector vould be rehabilitated, vith closure of some enterprises, and partial or total privatization of others. The size and composition of the 1986-88 public investment program has already been determined as a function of resource availabilities and development priorities within a three-year financial framework. The private sector would be given the signal that the public sector investment is to be supportive in nature and will not preempt resources avay from the private sector. The institutional framevork in support of agricultural development will be strengthened. 22. As the structural adjustment process does not encompass all of Burundi's development problems, it is important that the Bank support other projects to complement the SAL program, and to address important problems not dealt with under the SAL. For example, in agriculture we propose to help strengthen and develop agricultural research, as well as the central services through an agricultural services project. Bank vork in other related areas is also proceeding: urban sites and services, expanding vater supplies in rural areas, vocational teacher training and manpower development in agriculture as vell as technical assistance components in a number of sectors. 1/ Moreover, Bank support vill be needed for the Government's structural adjustment program even after the period covered by the first SAL. Some of this support vill consist of folloving up on actions initiated under SAL I. Other areas will also be addressed, notably regarding management of the public sector (aiming at revieving organization and vage structure), employment generation, and preparation of the Fifth Development Plan (1988-92). l/ An account of the Bank's operations in Burundi is provided in Part V.  - 10 - B. The Government's Short-Term Financial Program, 1986-87 23. The Governnent's short-term financial program has been discussed vith the IMF in close coordination vith the Bank. The program encompasses important areas of policy which are addressed under the proposed SAL. The financial program includes policy actions in the folloving areas: (a) External payments. The program aims at reducing the deficit in the balance of payments' current account, and at building up foreign exchange reserves while limiting debt service to a reasonable proportion of exports; (b) Budgetary and monetary policies. The objectives are to reduce the past level of Government's domestic borroving to finance the budget deficit and allow expansion of credit to the private sector, increase the level of public savings to finance the public investment program, avoid inflationary pressures, and contain domestic demand; and (c) Credit policies. The program's objectives are to improve incentives for private savings, and orient credit to productive sectors. 24. External payments. The objectives of the government program are to limit the deficit of the current account of the balance of payments to a level wbich vill allow: (a) a decline, in the long term, in the ratio of external debt vith respect to GDP and that of debt service vith respect to export revenues as needed to maintain the country's creditworthiness; (b) rapid improvement in the balance of payments and consequently in net official foreign exchange reserves; and (c) relaxation of controls over imports and transfers of foreign exchange vith the objective of encouraging foreign investment and avoiding expansion of the parallel market for goods and foreign exchange. The Government vill rely on an appropriate exchange rate policy and prudent monetary and fiscal policies to control demand for imports, and direct controls over imports vill be progressively eliminated (para. 60). 25. The financial program for 1986-87 assumes that the average international coffee price vill reach US$4.70/kg in 1986, decline to US$4.05 in 1987, and remain there in nominal terms until 1990 (as projected by the Bank) and that the average export prices for Burundi's coffee vill follow the same pattern. This vould imply coffee exports of US$140 million in 1986 and US$126 million in 1987, compared to the projections before the price increase of US$97 million and US$112 million, respectively. The stabilization program is geared to achieving the objective of accumulating foreign exchange reserves to a level of at least 3 months of imports (compared vith 1.2 months in 1985). The Government's adjustment program therefore aims at adjusting imports and economic activity tO levels compatible vith prospective developments in the vorld coffee market and vith resources available from Burundi's own foreign exchange earnings plus foreign aid  - il - contributions. Assuming a conservative evolution of imports, the current account gap is expected to average US$105 million in 1986 and 1987 (Table 2). Net inflows from the existing pipeline are estimated to average US$55 million a year during 1986-87 and Bank non-project lending (including African Facility Fund) is expected to provide about US$25 million per year, the remaining coming from project lending commitments from the World Bank and other major donors. Assuming that the major donors endorse the program and maintain their aid levels in constant terms (about US$70 million a year), Burundi could accumulate foreign exchange reserves to about 3-1/2 to 4 months of import equivalent during this period. The debt service ratio vould fall from 22 percent in 1985 to 20 percent in 1987. The ratio vould progressively decline aftervards as the result of Government's commitment to borrow only at concessionary terms and as debt contracted at near-commercial terms is paid off. 26. The management and follow-up of external debt vill be strengthened, and the Government vill create an interministerial coumittee vith representatives of the External Debt Service in the Ninistry of Finance, the Bank of the Republic of Burundi, and the Ministry of Planning. This committee vill be established before June 1986, and will be responsible for the management of the public external debt, including that of the Central Government and Public Enterprises, and vill ensure that future commitments will be only on concessionary terms. The Bank vould provide technical assistance to the Governmeut in this area under a proposed Fourth Technical Assistance project. 27. The incentive policies to be adopted by the Government include an initial exchange rate adjustment agreed vith the IMF, and followed by an additional adjustment over a ten-month period, and the simultaneous adoption of a flexible exchange rate policy vith a commitment to maintain the real effective exchange rate. A major change in trade policies (see paras. 54-60) vill take place as vell. A revised tariff schedule (developed by the Government with Bank assistance) to effect a more efficient and equitable structure of protection ,il be adopted simultaneously vith the exchange rate reform. The trade reform includes reductions in the number of tariff rates and their range, a reduction in custom duties exemptions (granted at present under the Investment Code), and a replacement of quantitative restrictions by tariff duties. These measures will have the effect of increasing competition among importers, and it is estimated that the proposed trade reform vill lower the level of protection (measured by the decline in domestic prices of lmported goods after liberalization) by about 25 percent. The proposed devaluation together with the Government's budgetary and monetary policies (para. 28) would restrain import growth and pressure on the balance of payments.  - 12 - Table 2: BALANCE OF PAYMENTS, ACTUAL AND PROJECTED (in millions of dollars at current prices) Estim. - Projected 1982 1983 1984 1985 1986 1987 1988 1989 Exports 88 81 99 118 170 157 169 181 (Coffee) (78) <70) <83) (93) (141) (126) (131) (136) Imports 214 184 187 193 214 235 257 278 Services & Income, Net -55 -91 -74 -87 -89 -93 -101 -110 (Interest Payments) (2) (4) (9) (13) (10) (11) (12) (13) Transfers, Net 56 52 44 52 47 48 50 53 Current Account -126 -142 -118 -111 -86 -123 -139 -155 Direct Investment 2 0 1 2 2 3 4 5 Capital Grants 37 40 40 44 45 46 49 53 M&LT Capital, Net 1/ 53 111 82 56 100 95 91 91 (Amortization) (3) (6) (8) (16) (22) (25) (25) (25) Other Capital 2/ 10 3 -8 19 -8 -1 4 4 Overall Balance -24 12 -3 10 54 22 9 -2 Memo Items: Debt Service Ratio (Z) 6 8 14 22 17 21 20 19 Net Reserves as Month's Imports 0.7 1.4 0.9 1.2 3.3 3.8 3.8 3.4 Coffee Expts.('OOOt) 30.4 24.8 29.0 32.9 34.0 35.2 36.5 37.8 Coffee Price (US cent/kg) (international) 309 290 318 321 470 405 405 406 (Burundi) 257 282 286 283 415 358 359 360 Exchange Rate 90 93.3 119.7 120.7 1/ Does not include IMF resources. 2/ Includes short-term capital and errors and omissions. 28. Fiscal and monetary policies. The Governuent intends to pursue a prudent budgetary and monetary policy during 1986-87 aimed at increasing public savings, controlling inflationary pressures, and providing incentives to efficient allocation of resources available for investment. The program includes the following elements: (a) Measures to rationalize the fiscal system and increase its revenue potential including: (i) reform of the transaction tax; (ii) trade reform as described below; (iii) reform of all consumption taxes from specific to ad valorem basis; (iv) reduction in the customs duty exemptions granted to selected imports; (v) strengthening of the collection and auditing system; and (vi) review of exemptions granted under  - 13 - the Investment Code. These measures, together vith the expected effects of the increase in coffee prices and the devaluation, are projected to raise public revenues in 1986 by 49 percent in nominal terms and keep them at the same level in 1987. (b) A prudent monetary polfcy vill be adopted aimed at keeping annual inflation at 10 percent in 1986 and 9 percent in 1987, while providing incentives to private savings and to investment in projects of assured economic justification. To achieve this objective, in the context of a policy of trade and foreign exchange liberalization, the Governuent vill: (i) increase the interest rates on one-year deposits by five percentage points (from 7 to 12 percent). The other interest rates will be adjusted accordingly; and (ii) taking into account the program's objectives of increasing the level of net foreign exchange reserves in 1986, and the important acceleration of monetary expansion in 1985, the Government will endeavour to reduce credit expansion in 1986. This objective vill be achieved by reducing net credit to the Government by 36 percent, while expanding credit to the private sector by about 12 percent. These objectives are compatible with a reduction in the budgetary deficit from FBu 11.2 billion in 1985 to FBu 2.4 billion in 1986 and FBu 4.1 billion in 1987. Taking into account the expected level cf foreign resources available to the budget, the Government vill be in a position to repay FBu 5 billion of its domestic debt in 1986 and 1987. (c) Restrictive public expenditures policy including (i) an average annual increase of 7.9 percent in personnel expenditures and of 6.5 percent in transfers and recurrent subsidies (including scholarships); (ii) a 12 percent increase in non-wage operating expenses; (iii) payment of domestic arrears; and (iv) limit of the public investment to FBu 20.1 billion in 1986 (of which, FBu 1 billion vould be financed by extra-budgetary sources) and FBu 22.0 billion in 1987, which is compatible with the expected foreign aid available in these years (FBu 16.1 billion and FBu 19.6 billion, respectively), and vith the expected availability of budget resources to pay the local counterpart.  - 14 - Table 3 presents the fiscal and monetary targets of the Government's financial program for 1986 and 1987 and projected values for 1988-89. Table 3: FISCAL IMPACT OF STABILIZATION PROGRAM (FBu billions in current prices) Stabiliza- -Actual-- Est. tion Prog. Projected 1983 1984 1985 1986 1987 1988 1989 Revenues and Grants 16.6 21.8 24.7 35.2 36.8 37.9 39.2 Revenues 12.9 17.0 19.5 29.4 30.0 30.6 31.3 Coffee 0.2 2.7 3.7 9.9 7.7 6.9 6.0 Current Expenditures 12.1 15.3 17.2 18.1 18.2 19.2 20.6 Wages and salaries 6.0 6.5 7.1 7.9 8.2 8.9 9.6 Goods and services 2.3 2.8 3.8 4.3 4.7 5.2 5.7 Interest 0.9 1.6 1.9 2.7 2.6 2.3 2.2 Payment of arrears 1.6 2.5 2.1 0.8 - - - Other 1.2 1.9 2.3 2.4 2.7 2.8 3.1 Current Balance (without grants) 0.8 1.7 2.3 11.3 11.8 11.4 10.6 (with grants) 4.6 6.4 7.5 17.1 18.6 18.7 18.5 Capital Expenditure a/ 17.3 17.7 19.0 19.1 22.0 24.4 26.0 Overall Balance -12.8 -11.2 -11.2 -2.4 -4.1 -5.7 -7.5 Financing: Foreign 9.7 8.1 8.2 8.1 10.0 9.7 10.1 Domestic 3.1 3.1 3.0 -5.7 -5.9 -4.0 -2.6 Memo item: Balance as Z of GDP 11.5 -9.7 -8.2 -1.5 -2.4 -2.0 -3.8 Inflation (CPI) 8.4 14.4 3.6 10.0 9.0 8.0 8.0 a/ Includes investment of public enterprises and RDCs as included in the Public Investment Frogram. Source: Ministry of Finance, IMF and IBRD projections. PART III - THE SAL PROGRAM 1986-88 29. The Structural Adjustment Program which the SAL would support, covers the period mid-1986 to end-1987. The program is outlined in the Government's Letter of Development Policy and attached timetable for action (Annex IV) and covers five main areas: (a) public expenditures policy; (b) public enterprises policy; (c) agriculture sector policies; (d) trade and industrial sector policies; and (e) credit allocation. The structural adjustment program would be implemented by the various government departments and agencies involved in the reform process and coordinated by the Ministry of Planning. A proposed Fourth Technical Assistance Project, to be appraised in September 1986, would be specifically designed. to assist in the implementation of programs initiated under the SAL. Support necessary  - 15 - before the effectiveness of the Fourth Technical Assistance Credit would be financed from the ongoing Third Technical Assistance Credit, or under a Project Preparation Facility Advance for the Fourth Technical Assistance Credit. A. Public Expenditures Policies 30. The public expenditures policies covered by the program include those affecting: (i) the public investment program; (ii) budgetary reform; and (iii) strengthening of the institutional capacity. 31. Public Investment Program. The Fourth Development Plan (1983-87) provided for investments of about FBu 129 billion (in 1984 constant prices) or about FBu 26 billion per annum, over an estimated 460 projects; of the total expenditures, about half would be for 27 large projects. During the 1983-85 period, actual spending was lover than what had been planned: FBu 19.2 billion in 1983, FBu 17.4 billion in 1984 and FBu 18.4 billion in 1985 (in constant 1984 prices). Initially, a sum of FBu 24 million had been planned for the years 1986 and 1987 to keep the momentum of the investment plan and reach at least 70 percent of the plan target. It is nov clear that Burundi cannot undertake these levels of investment, as the needs for domestie financing would be excessive compared to the requirements for stabilization of the economy. In fact, the targets of capital expenditures which are compatible vith the overall program are about 70 percent of these levels, i.e., an average of EBu 17 billion (in constant 1984 prices) for the two years. The Coverament has therefore decided to eut back the investment program in an economic manner, maintaining the aliocations to the major sectors, notably agriculture (30 percent of the total investment). The completion of ongoing viable projects and the beginning of high priority projects took precedence in the exercise. 32. In the context of preparation for the SAL, the Governument has reviewed the overall PIP and put apecial emphasis on the 1986 program to ensure that this vas compatible with the resources available and the stabilization requirements. Some lesser priority projects vere dropped completely, notably a ferryboat project, a second severage project in Bujumbura, three industrial projects to produce cement, malt and bricks, a large project to invest in port storage, and six projects to improve administrative infrastructure (including two government residences and some regional administrative offices). 33. The revised program for 1986-88 comprises 123 projects, 50 of which are in the agricultural sector. The average size of the projects are small. Only 33 projects are larger than US$3 million (FBu 350 million), accounting for 75 percent of the investment program. These projects have been reviewed by the Bank, and their economic justification has been found adequate, except for the SOSUMO sugar project (para. 34). The program is to be financed by concessionary aid (85 percent of total investment) and by the government budget.  - 16 - 34. The SOSUMO sugar project (US$60 million) consists of a plantation of 1,400 ha of sugar cane and a sugar plant vith a production capacity of 14,000 tons of sugar a year. The project represents about 15 percent of the total public investment program over the period 1986-88. It was appraised in 1981 by the African Development Bank, and is cofinanced by the AfDB, OPEC, BADEA, the Abu Dhabi Fund, Belgium and Germany. The terms of financing are very favorable (3 percent average interest rate and 15 years of average maturity). At the time of project appraisal in 1981, the economic rate of return was estimated at 14 percent. In the context of Its economic and sector work, the Bank expressed reservations about the assumptions on which this rate vas based, in particular the level of domestic demand for sugar, and questioned the priority of the investment. Since then, the price of sugar declined subtantially (from US$0.37/kg in 1981 to US$0.09/kg in 1985). A review of the project in 1985 by a Bank consultant showed a marginal positive ERR on the basis of still optimistic assumptions with respect to sugar demand. The Governument of Burundi, however, gives high priority to the project, which is to contribute to the development of the Mosso province, a remote and underpopulated region. At the time of appraisal of the proposed structural adjustment program, contracts had already been signed and penalty costs in the event of cancellation would have been high. An understanding vas reached, therefore, by which the Government agreed: (a) not to enter into any new commitment vith respect to the project until it has carried out a detailed analysis of the proposed investment and until the Government has consulted the Association; (b) to contract vith a reputable management firm, vith terms of reference and qualifications acceptable to IDA, taking into account existing requirements of other donors, for the management of the plantation and of the factory; (c) that the full cost of production should be borne by the consumer and that there should be no operating subsidies to the sugar project from the budget; and (d) to ensure that SOSUMO will be audited annually by an independent and reputable firm with terms of reference and qualifications acceptable to the Association, and that the audit will be submitted to IDA for review and comments vithin six months of the end of each fiscal year. These understandings have been included in the Statement of Development Polic4es (Annex IV) and in the Development Credit Agreement. A Bank mission will assess whether the distillery component is justified despite the recent decline in petroleum prices, and whether this component would improve the economic justification of the project. 35. As of now, the project pipeline for 1987 and 1988 could be increased taking into account the expected resource availability. However, the Goverument intends to decide on the allocation of available resources between capital and recurrent expenditures in the context of an overall public expenditures program. Moreover, the Government will identify developient projects vhich fit the Government's sectoral priorities and have an adequate economic justification. The preparation of the PIPs in 1987 and 1988 will be carried out in the context of a three-year public expenditures progranm.  - 17 - Table 4: PUBLIC INVESTMENT PROGRAM, 1986-88 All Projects Financing Sector Allocation No. of Av. Size (FBu bn) (Z) Projects (FBu mn) Foreign Domestic Agriculture 14.27 34.3 50 284.2 11.51 2.76 Energy and Water 7.23 17.4 19 381.0 6.21 1.U2 Industry 5.76 13.8 4 1,450.0 3.31 2.45 a/ Telecommunications 1.89 4.5 13 145.0 1.77 0.12 Roads 6.87 16.5 9 767.0 6.32 0.55 Education 3.30 7.9 8 413.0 2.67 0.67 Public Health .83 2.0 5 166.0 0.59 0.24 Social and Administ. Infrastructure 1.50 3.6 15 99.0 1.02 0.48 Total 41.65 100.0 123 339.0 33.40 8.25 a/ ai Includes non-budgetary resources such as local contributions. 36. Budgetary reform. The present one-year budget system has two components: the ordinary budget (BO) and the extraordinary budget (BEI). The bulk of tax and non-tax revenues goes to the BO to finance recurrent expenditures and repayment of public debt. The BEI is allocated special taxes from coffee and beer, dividends accruing to the Government and an annual amount of Central Bank financing (FBu 2 billion) included in the BEI as regular annual revenue. The BEI finances mostly capital expenditures (including counterpart funds for projects financed by foreign aid) and non-capital iteus, such as contributions to regional organizations. Investment expenditures financed by foreign aid are not shown in either budget. Each budget is separately discussed and approved by the Council of Ministers; deficit financing is also individualized, leading to a complex structure of public domestic debt. 37. The present system has serious drawbacks for an efficient public expenditures management: the arbitrary allocation of revenues between budgets, the inclusion of bank financing as revenue, and the failure to include foreign-financed expenditures distort the public finance picture, making it difficult for the Government to obtain a global view of its expenditure program, to progran investment expenditures as a function of public savings, and to adjust the expenditure program to fluctuations of revenues. 38. To make the budget an efficient tool of macro-economic management, the Covernment intends to implement the folloving reforns in the context of the SAL: (a) Adoption of a unified system of budget preparation vith a clear identification and separation of current revenues,  - 18 - current expenditures (excluding repayments of debt), and capital expenditures financed both by the budget and foreign aid; (b) Preparation of a comprehensive three-year public expenditures program (PEP) which vill include for each executing agency recurrent and capital expenditures. This would permit a better planning of resources to finance central administration expenditures, social services, maintenance of fixed assets, and recurrent expenditures associated with on-going and new investment projects. The annual budget to be presented to the National Assembly would correspond to the first year of the three-year budget; (c) Identification vithin the public investuent program of a core" program of projects of highest priority for which full funding would be assured. A non-core (stand-by) program would be prepared simultaneously; this would be financed if additional resources became available. The core projects would be those with the highest rates of return (whenever these can be computed) and according to the criteria defined by the Government and its development priorities in terms of inter-sectorial allocation. All projects above US$3 million would be subject to feasibility studies (prepared by the Government or donors) according to guidelines provided by the Government. The feasibility analysis would be discussed with the technical ministries to ensure that the Government's priorities and criteria are taken into account; and (d) Consideration of the following aspects while establishing the investment program: (i) it must be compatible with the objectives set for the debt service; (ii) it should require minimal domestic bank credit; and (iii) its foreign currency part should be financed through grants or concessionary oans. 39. Institutional capacity. To support the implementation of these reforms, there is a need to reinforce existing institutional capacity at several levels. In the Ministry of Finance, the services responsible for preparing the annual budget vould be strengthened to improve the public accounting system (namely by adopting a double-entry accounting system) and trained to prepare a three-year public expenditure program and a unified budgetary framework before the ordinary and extraordinary budgets are presented to the National Assembly. The Government will receive technical assistance from IDA to prepare the three-year PEP, with financing under the Third Technical Assistance Project, and from the INF on public finance accounting. 40. At the level of the planning structure, the Government has recruited a consultant for two years to help establish a system to monitor project implementation. With respect to project preparation and appraisal, there is also a need for ir.stitutional strengthening.  - 19 - At present, the largest investment projects have been appraised by foreign donors and consultants often using differing criteria and country parameters. The Government vishes to follov more closely the preparatory vork of large projects as vell as to enhance the capacity of its technical ministries to carry out appraisal work for smaller projects. In this process, common criteria and guidelines vill be used, including those of standard coot/benefit analysis (whenever possible) and relevant parameters which have been developed to reflect the specific conditions of the country. These guidelines (described in detail in the Policy Statement on Management of Public Expenditures, Annex VIII) will be used by all ministries in preparing and appralsing projects to be submitted for financing. To implement this reform, the Government will create a project preparation unit in the Ministry of Planning with satellite units in the major technical ministries. The planning unit of the Ministry of Agriculture vill be reinforced and new units will be created in the ministries of Commerce and Industry, Transportation, Education and Health. Under the Fourth Technical Assistance Project, the Government would hire an expert on project preparation and appraisal for two years to assist the project unit of the Ministry of Planning and its satellites in technical ministries. B. Public Enterprises 41. The Government of Burundi owns and operates about sixty public enterprises (PEs) which are engaged in a vide variety of commercial and social activities. This sector grev rapidly during the Third Development Plan period (1978-81) to play different roles, notably as provider of public services, to compensate for the lack of private investment (especially in industry) and to co-ordinate economic sectors notably export crops. The role of the PE sector in the economy is considerable, accounting for about half of the formal employment and the same proportion of industrial value added. 42. In the early 1980s, the Government channelled considerable financial resources to these enterprises, but the parastatal sector as a whole did not perform satisfactorily, with many enterprises operating at a low capacity, incurring substantial operating losses, unable to contribute to their own investment program or to service their debt. The Government has felt since 1982 that the tight public finance situation did not permit the continuation of financial support to these enterprises, and transfers vere severely cut. Today, the burden of these enterprises in the government budget is therefore much smaller than in the past. Their impact on the economy remains hindered, however, by their poor economic performance and management. A recent study has shown that in 1984, four of these enterprises were on the verge of bankruptcy, fifteen had suffered substantial losses, twelve had negative cash flows and four had negative equity. 43. The poor financial performance of these enterprises steias from several sources, including their unclear relations with the relevant ministries in decision making, lack of adequate management capacity, and excessive government coutrol over investment and pricing  - 20 - decisions. Some enterprises also suffer from inadequate capital structures. The Government has recognized the need to include the parastatal sector in the current structural adjustment program. The Bank has provided assistance for the diagnosis and preparation of a rehabilitation program for the sector, initially during the preparation for the Third Technical Assistance Credit and lately under the SPPF for the proposed SAL. 44. The Policy Statement on the Public Enterprise Sector (Annex V) states the Government's main objectives for the sector: (a) to ensure that government participation vill be limited to those cases which require public investment either because they are vital public services, or because strategic sectors are involved; and (b) to maximize the contribution of viable public enterprises to GDP by ensuring that they operate efficiently. This will be accomplished by providing a sound financial structure and more managerial autonomy to the enterprises and by ensuring that all commercial PEs can generate profits which justify public investment. The elements of the government strategy to achieve these objectives include: (a) Development of clear objectives for the PEs; (b) Rehabilitation of PEs whose medium-term economic profitability has been demonstrated; (c) Improvement of PE management; (d) Restructuring the parapublic sector through privatization or cessation of activity when operations are not profitable over the medium run; (e) Limitation of the establishment of new PEs to those where private investors are not forthcoming and whose economic profitability is demonstrated; and (f) Establishment of systems to enable the Government to follow up the cevelopments and performance of the sector. 45. The Government has decided to create a service with responsibility for coordinating the rehabilitation program of the sector as vell as for monitoring its development. This Service in Charge of the Public Enterprise Sector (SCEP) vill review the current legislation on the sector and propose changes, as necessary, vith the objective of avoiding overlapping responsibilities between the PEs and the relevant ministries and decentralizing and delegating responsibilities to the maximum extent possible. This service vill receive technical assistance under the Fourth Technical Assistance Project. Prices vill be deregulated and public enterprises will be subject to the same market environment as the private sector. Exceptional cases vould be made for those enterprises carrying out non-commercial social activities (which the Government may have to subsidize), and public utility monopolies for which price regulation will be appropriate, and vould take into account the requirements associated with sound financial management.  - 21 - 46. In the context of the SAL, and based on studies financed by the Bank, the Government action plan for selected enterprises includes: - Closure of four enterprises facing serious financial probleus: viz., SOBECOV (foodcrops commercialization), SUPOBU (fishing), AGRIBAL (Agriculture), SOMEBU (studies). The initiation of the liquidation of these enterprises vould be a condition of effectivenes of the Credit. In the case of SOBECOV commercial activities would be liquidated and the management of storage facilities would be transferred to the Ministry of Commerce. - Reintegration in the public administration of the laboratory of LAPHAVET (production and research on veterinary products), and subsidization of two other public enterprises performing non-commercial activities: CPI (industrial promotion center), and ONT (tourism promotion); - Rehabilitation of a priority group of five enterprises: CADEBU (savings institutions), ONAPHA (pharmaceuticals), OTRABU (road transportation), OTRACO (urban transportation), VERRUNDI (glass factory); - Assistance to six major enterprises to design and implement strategic plans to improve their economic performance in the medium to long term; and - Review of two economic sectors (trade and tourism) and identification of public enterprises which will be the object of rehabilitation programs in a second phase. 47. The rehabilitation programs will be based on diagnostic studies of each enterprise upon which performance contracts vill be designed and negotiated. These contracts will include _he objectives of the enterprise, the strategy adopted, an evaluation of costs and multi-year targets for operations, type of Government control and monitoring, and amount of resources contributed by the State. To assist the rehabilitation program, the Government vill establish an Intervention Fund in BNDE, which would be jointly managed by SCEP and BNDE, to finance activities such as rehabilitation investments, purchase of parts and raw materials, training of personnel, tecbnical assistance, and enterprises' working capital. The Fund will disburse in the form of equity capital or loans, and will be financed from the counterpart funds of the proposed credit. Institutional arrangements for the Fund would be designed and implemented in the context of the proposed Fourth Technical Assistance Project, which also would finance technical assistance services to SCEP and selected enterprises. C. Agriculture 48. The acceleration of the GDP and export growth in the medium term depends crucially on the performance of the agricultural sector to maintain self-sufficiency in food crops in the rural areas, and  - 22 - increase production for export. In the past, fooderop production has been sufficient for the country's staple food needs. Increasing demographic pressure is leading to abandoning the practice of fallow, cultivation of marginal lands, reduction in average farm size and declining soil fertility. A higher level of productivity to offset these phenomena can be achieved only through intensification, which will require increased research for and extension of improved cultivation packages. With respect to export crops, the Government's objective is to provide adequate incentives to producers, increase efficiency in resource utilization, and improve crop quality and marketing. The policy measures included in the SAL program consist of: (i) tlhe design and establishment of price mechanisus which would allow for regular adjustment of export crop prices; (il) a modification of processing techniques for coffee and increased efficiency in its marketing; and (iii) rationalization of sector organization and strengthening of research and extension services. 49. Producer prices. Prices for locally produced fooderops, both at producer and consumer level, are market determined, and the Government intends to continue to pursue this satisfactory policy. As for producer prices for export crops (coffee, tea, and cotton), which are determined by the Government, the official policy has been irregular and has led to a deterioration of prices in real terms. For example, coffee prices remained constant between 1980 and early 1984 when they vere increased by only 6 percent. As a result, real prices declined by 15 percent. For cotton and tea, the decline in real prices has been even more pronounced. Producer prices remained constant between 1977 and early 1984 when they were increased by Il percent for cotton and 30 percent for tea. Considering that the consumer price index more than doubled between 1977 and 1984, producer prices in real terms declined by more than 40 percent during that period. 50. In the context of the proposed adjustment program, the Government will continue to let fooderop prices be market determined, and will establish producer prices for export crops at levels sufficient to provide incentives for increased production and quality, taking into account the evolution of international prices. For the 1986/87 campaign, the Government has increased coffee prices by 28 percent (from FBu 125/kg to FBu 160/kg) and tea prices by 20 percent (from FBu 15/kg to FBu 18/kg), thus raising their prices in real terms. The price of cottonseed has been maintained, given the poor outlook for international prices for cotton and the relatively high producer price for cottonseed in Burundi compared with other African countries. This increase in prices was based in part on a limited rural consumption survey undertaken in selected producing areas. For the following years price will be determined on the basis of: (a) a rural consumer index updated on a quarterly basis; and (b) regular surveys of consumption and revenue patterns to assess the potential competition between crops and between agricultural and non-agricultural activities of farmers.  - 23 - 51. Coffee processing, marketing, and pricing. In recent years, Burundi has invested in the construction of coffee vashing stations to improve the quality of exported coffee. In 1983, Burundi received a premium of 18 percent for fully washed coffee (FWA) over the price of washed coffee. In 1985, this premium had eroded to less than 4 percent. Based on the conclusions Gf a study financed under the SPPF for SAC I, this decline vas due to (a) a decrease in coffee quality because of too-high levels of humidity of both parched and green coffee, which resulted from inadequate storage and handling conditions; and (b) the weak management capacity and performance of the coffee marketing board, the Burundi Coffee Company (BCC), which raises doubts as to whether Burundi obtains the best price for its coffee. These problems could be overcome at a relatively low cost (approximately USS3 to $4 million) through additional investments in storage facilities, grading and handling equipment at the processing plants and at the harbor, and through improved management of both the coffee processing and marketing chains. The Governuent has taken steps to decrease the humidity content of parched coffee by lovering the humidity requirement of parched coffee delivered to the factories and installing additional drying equipment at the two existing factories. The Government's action program, in the context of the proposed credit, includes: (a) Preparation of additional actions to improve coffee quality, including necessary investments, studies and recruitment of technical assistance. These measures will be prepared and financed under the proposed IDA Muyinga and the Fourth Technical Assistance Projects; and (b) Preparation of a medium-term strategy for the coffee sector to maximize export revenues, taking into account the potential for increased output and quality, competition among crops, and prospects and fluctuations in the coffee international market. This strategy would be based on: - a study of the sliding scale of coffee prices, taking into account the requirements of a marketing and processing system that places greater emphasis on quality and on efficiency of the processing and commercialization.- circuits. This study is to be carried out with financing from the French Caisse Centrale de Coop