Morocco - Public Enterprise Rationalization Project

Document .o The World Bank FOR OMCAL USE ONLY Report No. P-4545-MOR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$ 240 MILLION TO THE KINGDOM OF MOROCCO FOR PUBLIC ENTERPRISE RATIONALIZATION April 30, 1987 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.  CUTRRENCY EQUWVALENTS Average Calendar 1985 January, 1987 Currency Unit = Dirhams (DH) 1 Dirham (DH) = US$ 0.09938 0.116 1 US Dollar (US$) = DH 10.0625 8.57 FLSCAL YEAR January 1- December 31 ABBREVIATIONS AND ACRONYMS BOD : Board of Directors BRPM : Bureau de Recherches et de Participations Minieres CDG : Caisse de Dep6ts et de Gestion CDM : Charbonnages du Maroc CEO : Chief Executive Officer CIPEP : Comite Interministeriel pour les Enterprises Publiques et des Participations COMANAV : Compagnie Marocaine de Navigation COTEF : Compagnie de Textile de Fez CT : Centres de Travaux CTM/LN : Compagnie de Transport au Maroc/Lignes Nationales DEPP : Departement des Enterprises Publiques et des Participations EPIC : Etablissement Publics Industriel et Commerciaux ITPA : Industrial Trade Policy Adjustment Loan LRMC : Long Run Marginal Cost MIS : Management Information System OCP : Office Cherifien des Phosphates ODI : Office pour le D6veloppement Industriel ONAREP : Office National de Recherches et d'Exploitations Petrolieres ONCF : Office National des Chemins de Fer ONE : Office National de l'Electricite ONEP : Office National de l'Eau Potable ORMVA : Office Regional de Mise en Valeur Agricole PERL : Public Enterprise Rationalization Loan PE(s) : Public Enterprise(s) PPF : Project Preparation Facility RAM : Royal Air Maroc SAMIR : Societe Anonyme Marocaine de l'Industrie du Raffinage SCP : Societe Cherifien du Petrole SA : Societe Anonyme SNI : Societe Nationale d'Investissements SNPP : Societ6 Nationale des Produits Petroliers  FOR OMCIAL USE ONLY KINGDOM OF MOROCCO PUBLIC ENTERPRISE RATIONALIZATION LOAN PRESIDENT'S REPORT Table of Contents Page No. Loan Sunmmary ..........................*....... i - ii PART I. THE ECONOMY ........................ PART II. THE PUBLIC ENTERPRISE SECTOR ............................. 10 (a) Organization of the PE Sector .............10 (b) Government Management of the PE Sector ........... 11 (c) Rationale for PE Adjustment ......................... 11 (d) Financial Situation of the PE Sector ..... .. 12 (e) Public Enterprise Problems and Development Issues ... 13 PART III. THE PROPOSED PUBLIC ENTERPRISE RATIONALIZATION PROGRAM ... 14 A. ORIGINS .*..........#.. o ...14 B. THE BANK'S ROLE ..15 C. PRINCIPLES# OBJECTIVES AND SCOPE ................... 15 D. POLICIES AND MEASURES TO FOSTER FINANCIAL AUTONOMY, ACCOUNTABILITY, AND COMPETITION .............16 (a) Reform of PE Financing ............17 (b) Reform of Pricing Policies ..........19 (c) Investment Planning and Selection .........21 (d) Government Arrears to PE Sector ........21 E. INSTITUTIONAL REFORMS TO FOSTER ADMINISTRATIVE AND MANAGERIAL AUTONOMY AND EFFICIENCY ................ 23 (a) Rationalizing Government/PE Relations ............... 24 (b) Improvement of PE Management Information Systems .... 26 (c) Improvement of General Accounting and Auditing Principles and Practices ....27 F. POLICIES AND MEASURES TO RATIONALIZE THE ROLE OF THE STATE IN THE ECONOMY .......................28 (a) Inventory of the State Portfolio of PEs ............. 28 (b) Restructuring Studies ..............29 (c) Disengagement of the State from Productive Economic Activities ..... 29 (d) Restructuring Programs for Selected PEs ............. 30 G. PERL JUSTIFICATION AND RISKS ..........32 This document has a restricted distribution and may be used by recipients only In the performance of their offlcial duties. Its contents may not otherwise be disclosed without World Bank authorztin.  Table of Contents (continued) Page No. PART V. THE BANK LOAN ........................ 34 (a) Disbursement ........*. **............ 34 (b) Procurement ............................... ***.. 35 (c) Monitoring and Tranche Release ...........*........... 35 PART VI. OTHER BANK GROUP OPERATIONS IN MOROCCO ................... 36 PART VII. RECOMMENDATION ..........******* ................. ..... 38 ANNEXES Annex I Country Data ............39 Annex II Status of Bank Operations ........................... 42 Annex III Supplemental Loan Data Sheet 43 Annex IV Government Statement of Sector Development Policy 45 Attachment I - Rehabilitation of the Financial Structure of the PEs 49 Attachment II - Promoting Efficiency and Autonomy in PEs.... 55 Attachment III - Rationalization of the Role of the State in the PE Sett o r 59 Anrex V Action Timetable for Medium-Term Sector Adjustments 63 Annex VI Technical Assistance and Training .................... 69 MAP OF MOROCCO  MOROCCO PUBLIC ENTERPRISE RATIONALIZATION LOAN Loan S_ry Borrower: Kingdom of Morocco Beneficiary: Treasury and selected Public Enterprises Amount: US$240 million equivalent Terms: 20 years, including five years of grace, at the standard variable interest rate. Description: The loan will support the first phase of a program to rationalize Moroccan public enterprises (PEs). Its principal objective ia to improve the efficiency of public enterprises in Morocco through: (i) promoting their financial autonomy and accountability by (a) restructuring PE finances through the elimination of government transfers, except for equity contributions, and a greater reliance on internal and commercial sources of financing, (b) adjusting output prices to match market values, and send correct signals to consumers, (c) eliminating existing arrears and preventing their recurrence, and (d) improving the planning, evaluation and monitoring of investments; (ii) enhancing managerial autonomy and accountability of PEs through: (a) delineating the relationship between the Government and the enterprises, (b) developing a competitive environment, with effective government monitoring of PE performance, and (c) introducing modern management information systems and improved accounting and auditing principles and practices; and (iii) rationalizing the role of the State in the economy through the development of the strategies, programs and instruments to divest the State of uneconomic enterprises and of activities which could be handled more effectively by the private sector.  - ii - In addition to policy reforms in the above areas aimed at changing the nature and extent of Government interventions in the economy, the loan will support the implementation of restructuring programs in six selected major PEs operating in the power, water, railways and petroleum refining and distribution sectors, and the preparation of restructuring studies for PEs operating in the mining, sugar refining and transportation sectors. The risks of the program relate to the possibility of further deterioration in Morocco's public finances which could lead to the re-emergence of arrears to PEs, and difficulties in balancing the length and rigor of the reforms. Financing and Disbursements: In accordance with its twin objectives of supporting general policy reforms and enterprise restructuring, the loan will finance general imports and imports by six public enterprises, each in amounts of US$117 million. In addition, US$6 million would (a) refinance a PPF for up to US$1.25 million for the initiation of key studies included in the project; and (b) be available to finance Technical Assistance related to the PE reform process. Disbursements against general and enterprise imports will be made in two tranches of US$70 and US$47 million (general imports) and uS$50 and US$67 million (enterprise imports). Disbursement Estimates: FY88 m9 - US$ million - Annual 123 117 Cumulative 123 240 Map: IBRD 19858 R  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$240 MILLION TO THE KINGDOM OF MOROCCO FOR PUBLIC ENTERPRISE RATIONALIZATION 1 I submit the following report and recommendation on a proposed loan to the Treasury of the Kingdom of Morocco for the equivalent of US$240.0 million, to support the first phase of a program to rationalize Moroccan public enterprises (PEs). The loan would have a term of 20 years, including 5 years of grace, at the standard variable interest rate. PART I - THE ECONOMfY 2. The following section reflects the findings of economic updating missions that visited Morocco at various times to prepare a paper, entitled "Morocco: Issues for a Medium-term Structural Adjustment Program", for presentation to a meeting of the Consultative Group for Morocco in Paris on March 12-13, 1987. Data and analysis have been updated to reflect the recent mission which reviewed the progress on policy adjustment loans and analysed Public Resource Mobilization (report in preparation). Country data are given in Annex I. Intrducto 3. During nearly two decades after Independence in 1956, Morocco followed relatively conservative economic policies. Cautious external borrowings supplemented a weak savings effort to permit a slow rise in investment, so that the economy grew only at about 4 percent per annum. Primary products - principally phosphates - accounted for 90 percent of merchandise exports. During the mid-1970s, after a sudden increase in phosphate prices, Morocco launched an ambitious public investment program which boosted GDP growth to 7.5 percent annually during the period 1973-77. The phosphate boom, however, began subsiding in mid-1975. Meanwhile, the petroleum import bill, which had quadrupled in 1974, continued to place considerable pressure on the balance of payments, and the current account deficit reached 16.5 percent of GDP in 1977. Domestically, the large public investment program and increased defense expenditures in the Western Sahara caused -he treasury deficit to rise to 15.8 percent of GDP in 1977. Morocco resorted to considerable foreign borrowings to finance these deficits.  4. To redress the rapidly deteriorating financial situation, the Moroccan Government introduced a three-year stabilization program in 1978 centered on reductions in public sector outlays and stricter import controls. These reforms were only partially successful. They did little to stimulate exports. The exchange rate was kept overvalued and trade barriers were raised. The measures did not adequately tackle the excessive budgetary exposure and made inadequate attempts to increase the efficiency of resource use. The agricultural sector failed to grow, while value-added in manufacturing declined. Meanwhile, public investment was not restrained; the number of costly, poorly-targeted social programs was expanded and investment in infrastructure was undertaken, often well ahead of need. Efforts to stabilize the economy were compromised by severe external shocks - most notably the 1979 oil price increase, the rise in international interest rates, the international recession which reduced phosphate earnings and workers' remittances, and a prolonged drought. Continued internal pressure to provide social services and affordable basic foodstuffs to a rapidly growing population put considerable strains on a budget already stretched by the need to finance expenditures in the Western Sahara. The 1981-85 Development Plan aimed at an ambitious 6.5 percent per annum growth rate in GDP. Notwithstanding the difficulties confronting the economy, Morocco did not appear willing to introduce a comprehensive program of policy measures which could have confronted the economic crisis. The shortcomings in the adjustment performance caused the IMF to convert a three-year Extended Fund Facility into a one-year Stand-By Arrangement in 1982 ana prevented the Bank from proceeding with a Structural Adjustment Loan at that time. Reeent Economic 5. By 1983 it had become clear that the Government's room to maneuver was becoming very restricted by debt service payment requirements. In 1982 external public long-term debt (excluding military debt) had risen to about two-thirds of GDP and 235 percent of exports of goods and services, while the debt service ratio reached 35 percent. Morocco was confronted with the prospect of a very large external payments gap for 1983. With exchange reserves virtually depleted and debt service rising, the Government imposed emergency import controls and budgetary cutbacks in early 1983. In November 1983 the Government entered into an 18-month standby arrangement with the IMF (SDR 300 million, or 98 percent of quota) supporting a stabilization program which included fiscal and credit restraints and a flexible exchange rate policy. Shortly thereafter, official creditors agreed to reschedule external debt interest and principal payments coming due between September 1, 1983 and December 1984, as well as arrears as of August 31, 1983. Commercial bank creditors agreed in principle to provide comparable relief on amortization. The total amount of debt relief obtained in 1983-84 under these agreements was estimated at more than US$2 billion (including US$575 million of relief on military debt). In November 1983, a Donors' meeting spensored by the IMF, generated pledges of atout US$500 million of exceptional balance-of-payments assistance for 1983-84. To meet its fiscal targets the Government restricted public service recruitment and salary increases, raised the prices of  electricity, water, petroleum products and subsidized foodstuffs (by between 17 percent and 60 percent), and cut canital outlays by one third. At the same time, it began a significant adjustment effort supported by the Bank program, including the January 1984 ITPA I loan (No. P-3707-MOR), to improve its balance of payments situation with comprebensive measures to restructure its trade regime. This included a 102 reduction in the special import tax as part of a general program to reduce overall import taxation, an easing of quantitative restrictions, flexible management of the exchange rate, and a reduction in export licensing. Following a Financial Sector Study conducted by the Bank in 1984 (No. 4957-MOR), the Government extended these reforms to the Financial Sector with the objective of raising domestic resources and improving resource allocation. Greater flexibility was introduced in setting interest rates, measures were designed to increase competition among banks, and taxation reforms to benefit the financial sector were implemented. 6. As a result of the policies adopted since 1983, macroeconomic balances improved. The economy's resource gap shrank from 13 percent of GDP in 1982 to 7 percent in 1985 and fell further to 4.1 percent in 1986 (at constant 1980 prices). This was achieved through a significant decline in the GDP share of consumption and investment relative to their high levels earlier in the 1980s. Import growth was restrained by appropriate demand management and by the depreciation of the Dirham, while the share of exports and gross domestic savings increased substantially. The Government budget deficit was reduced from 12.3 percent of GDP in 1982 to about 10.4 percent it 1985 on a commitment basis, before taking into account the impact of external debt rescheduling on interest payments. In 1986 it fell to 6.2 percent of GDP, although the improvement stemmed chiefly from a sharp reduction in investment outlays, there was also a significant slowing down in the rate of growth of current expenditures. As was to be expected, the rate of GDP growth has been low (a little over 2 percent per annum), reflecting the impact of stabilization policies on consumption and investment de-and, along with the effect of a prolonged drought on agricultural sector incomes in both 1983 and 1984. A good harvest has helped boost the growth rate to about 4.3 percent in 1985 and an estimated 5.7% in 1986. 7. The current account of the balance of payments improved considerably, reflecting both the better resource balance of the economy and the impact of the debt relief obtained by Morocco from its official creditors on interest and military debt service payments. In 1983, the external current account deficit was reduced by half, from US$1.9 billion and 12.7 percent of GDP in 1982 to US$873 million and 6.6 percent of GDP. The balance subsequently worsened in 1984, particularly in relation to GDP, but still remained under US$1 billion. In both 1983 and 1984, about half of the roughly US$1 billion improvement in the current account compared to 1982 was attributable to debt relief.L' The net inflow of public medium and long-term capital (including grants) has declined sharply from about US$1.5 billion in 1982 to an average U/ Ovcr US$200 million in interest payments were rescheduled in each of the two years. In addition, the current account balance benefitted from military debt relief in the amount of US$325 million in 1983 and US$25 million in 1984.  of only US$600 million during 1983-1984. In 1985, the net inflow fell to about US$400 million, despite an exceptional US$300 million grant from Saudi Arabia. In 1986, the net inflow declined further to about US$275 million. These inflows had to be supplemented by continued debt relief along the lines of the 1983-84 debt rescheduling and demand management policies, to keep import growth under control. 8. A stand-by arrangement with the IMF was approved on September 13, 1985. A formal debt rescheduling through the Paris Club covering maturities from September 1985 to February 1987 was agreed on September 17, 1985. Ninety-five percent of the total debt due were rescheduled along lines similar to those obtained under the 1983-84 debt relief arrangement. The 1983-84 rescheduling agreement between Morocco and the commercial banks was signed, after long delays, on October 21, 1985. As a result of slippages in meeting performance criteria, howeve-, the IMF stand-by arrangement became inoperative. The Government ihas since recognized that stronger corrective measures are needed to keep the stabilization program on course including, in particular, restraining current expenditures and reducing subsidies on foodstuffs and public services. A new standby for the period December 1986 to February 1988 has been negotiated and is now in effect. Additional external resources have been mobilized for 1987/88 as a result of recent agreements reached with commercial banks and Paris Club creditors. The implementation of a new stabilization program attendant on gains from the Bank-supported program of sectoral adjustment and favorable external developments should enable Morocco to achieve a balance on its current account during 1987. The Medium Term Outlook 9. The Policy Framework. Since 1983, the Government's objective of achieving viable external and fiscal positions along with satisfactory growth has been translated into a coherent medium-term strategy to restrain domestic absorption and increase the efficiency of resource allocation throughout the economy. The principal elements of Morocco's medium-term adjustment program involve a shift to outward-looking trade and exchange rate policies; far-reaching reforms of price, credit, tax and regulatory policies to remove institutional and other obstacles to efficient mobilization and use of resources in key productive sectors of the economy; considerable improvements in the efficiency of gcrernment investment; more cost-effective methods and better targetting of social programs; and a thorough overhaul of the education and public enterprise sectors. 10. The shift to an outward-oriented development strategy is the cornerstone of Morocco's medium-term adjustment program. Continued adjustments in trade and exchange rate policies will be made to complete the reform of the overall incentive framework designed to accelerate export growth and reduce and rationalize import protection. Key instruments are to be a flexible exchange rate; a general reform of the tariff level and atructure, with the objective of reducing the overall level of protection to 25 percent through decreasing maximum duty rates and evening out the spread in tariff rates within and between sectors by the end of 1988; and finally, a phasing out of quantitative restrictions on imports. Domestic price controls, which began to be removed in 1983-84 on many manufactured products, are planned to be fally eliminated, in parallel with progress in import liberalization. Remaining export licensing requirements will be abolished, with exporters to be entitled to import all inputs on a duty-free basis.  11. At the same time, appropriate sector strategies for the key productive sectors, particularly agriculture and industry, will be promoted. In industry, although the development of Morocco's potential for export of phosphate fertilizers will continue to be an important objective, the contribution of this highly capital-intensive sector to employment and to the establishment of a broader industrial base through forward and backward linkages, will remain limited. Moreover, a high degree of dependence on phosphete and phosphate fertilizer exports has made Morocco extremely vulnerabie to cyclical fluctuations in the volatile world phosphate market. For this reason, the industrial strategy must be based on the diversification of manufactured exports, including processed foods and nontraditional manufactures where Morocco may have a comparative advantage on world markets. In agriculture, Morocco needs to continue developing an appropriate package of policies designed to overcome existing constraints to rational land use patterns, to ensure that farmers have adequate incentives to improve farming techniques and use modern inputs, and to provide the support services needed to bring about these changes. A first Agricultural Sector Adjustment Loan (No. 2590-MOR) supporting such policy direction was extended by the Bank in June 1985. A second is to be negotiated in the near future. 12. The low productivity of investment has been one of the majot factors in the poor performance of the Moroccan economy in the past ten years. The allocation of capital and the efficiency of investment need to be improved considerably both in the public and private sectors. In the private sector, the reform of the protection framework described above should go a long way towards removing distortions in investment patterns. However, it will also be necessary to review the bias in favor of capital-intensive activities inherent in the current investment incentive system, including tax exemptions and interest rate subsidies which artificially depress the cost of capital. In the public sector, increasing the efficiency of investment will require a considerable improvement of existing planning and budgeting mechanisms, including better procedures for setting investment priorities, strengthening of project preparation and monitoring capability, and placing more emphasis -an the economic evaluation of projects before they receive Government sanction. Policy actions to improve the public investment and enterprise framework as well as continuing reform of trade policy and a comprehensive approach to financial sector reform are supported by the Bank's second Industrial and Trade Policy Adjustment loan approved in July 1985. After some delays, the Government completed the agreed reforms, and the second tranche of this loan was released on October 29, 1986. 13. An exceptionally strong savings effort will be essential for the success of Morocco's adjustment process. In the private sector financial savings have been repressed in the past due to inadequate financial policies and negative real interest rates. Savings are now being encouraged through increases in deposit rates and a program of financial sector reforms to improve financial intermediation and develop the domestic money and capital markets. But the most intense savings efforts in the next few years will have to take place in the public sector, which continues to be a major source of dissaving, particularly through the Government budget. In the medium term,  sustained improvement in the mobilization and utilization of resources by the public sector will require fundamental reforms in a number of key areas, including social expenditure policies, taxation, and cost recovery and efficiency in the public enterprise sector. In the social sectors, where coverage of the population is still inadequate, Government activities need to be restructured so that basic services, particularly education and health, can be delivered more effectively but at substantially lower cost. More cost-effective methods and better targeting will be prerequisites to a further broadening of access to these services in the future. Food and other subsidies also need to be targeted to the groups most in need rather than directed to the general population. 14. Macroeconomic Projections. An assessment of the Government's reform programs indicates that Morocco may not complete its adjustment process before the early 1990s. The growth of the economy is likely to be severely constrained in the early years of the adjustment process. However, as the restructuring measures designed to promote exports, improve resource use and increase domestic savings begin to work their effects through the economy, the external imbalance should lessen, and restraints on domestic demand could gradually be relaxed. Moreover, the growth of external demand expected to result from the trade liberalization and export promotion policies, and the switch in the composition of domestic demand from imported to domestic goods, fostered by the adjustment of relative prices, should help mitigate the temporary negative impact of slower public expenditure growth on incomes and employment. 15. The projections suggest that GDP is likely to grow on average at 4.32 p.a. until 1990, gradually rising to an average annual rate of 4.81 thereafter. Domestic demand is expected to increase in the future in line with the strong recovery of investment. Assuming that central government investment expenditures remain constant in real terms in the medium term, the adjustments would occur primarily in the public enterprises and in the private sector. Government consumption, which had grown very rapidly until recently, is projected to decline marginally in real terms and to drop by 3 percentage points in relation to GDP between 1985 and 1993. The growth of private consumption, which already slowed significantly in the early 1980s, would remain just above that of GDP in 1985-90, and decline only slightly in the 1990s. Restructuring policies should bring about an acceleration in the growth of exports of goods and nonfactor services. The acceleration of export growth would help sustain a modest recovery of imports, the overall trend of which has been downward since 1978. Imports, however, should rise much more slowly than exports between 1985 ar.d 1990, as a result of the demand restraint and expenditure switching policies. 16. As a result of the drop in the GDP share of both investment and consumption, there should be a steady decline in the economy's resource gap through 1990. Gross domestic savings are expected to rise much faster than GDP over the medium-term, initially as a result of improved savings mobilization by the public sector, and later reflecting continued substantial improvements in private savings as well. The marginal savings rate with  Medium-Term Projections of Macro-economic Astresates Annual Growth Rate (%) Share of GDP (S) 1980-86 1986-90 1990-95 1985 1990 1995 - (At constant 1980 prices) - GDP 3.3 4.1 4.8 100 100 100 Consumption 3.0 3.8 4.1 88.3 86.2 83.2 Public 3.0 1.4 4.8 20.9 18.0 18.0 Private 3.0 4.5 3.9 67.5 68.2 65.2 Investment -1.6 3.9 8.4 16.9 16.8 19.9 Total Domestic Demand 2.2 3.8 4.8 105.2 103.0 103.1 Exports of GNFS 4.7 6.0 5.4 19.6 21.5 22.1 Imports of GNFS -0.2 4.6 5.4 24.9 24.5 25.1 Resource Gap 5.3 3.0 3.0 Gross Domestic Savings 5.1 6.7 9.2 9.8 14.2 17.4 Memo Items Marginal Savings rate 0.16 0.25 0.35 11.3 16.4 20.7 (GNS/GNP) ICOR 6.5 5.2 3.8 respect to GNP will need to be relatively high in 1985-95, as a necessary concomitant to reducing the external deficit. High domestic savings should enable the economy to finance the recovery of investment without recourse to external savings in the early 1990s. This will be essential, since, throughout the remainder of the 1980s, the balance of payments will remain under considerable prassure because of continuing high debt service payments. By the end of the decade, reforms of the overall economic incentive framework and increased efficiency of public investment should have raised the productivity of new investment considerably, and the ICOR should drop substantially from the high levels prevailing in the early 1980s. 17. External Accounts. A steady improvement in Morocco's external payments position should result from the acceleration of export growth relative to import growth anticipated in 1987-90. The economy's negative resource balance, which averaged more than US$2 billion in 1980-82, and dropped to US$1.2-1.3 billion in 1983-84, is projected to decline until 1990 and increase slowly thereafter. Assuming that the growth of workers' remittances can be sustained at a moderate pace, the current account should improve roughly in parallel with the overall resource balance and should reach equilibrium around 1987. However, the overall balance of payments can be expected to continue to show large deficits because of the heavy principal repayments coming due on the extornal debt, including substantial repayments to the IMF. Because of mounting debt service obligations, gross public long-term capital requirements are projected to average close to US$2.3 billion annually during the period 1987-90.  - 8 - Medium-Term Balance of Payments Prolections (US$ millions) 1986 1987 1988 1989 1990 1995 Exports of GNFS 3747 4130 4563 4982 5456 8689 Imports of GNFS 4244 4628 5096 5435 5845 9285 Net Resource Balance -497 -498 -533 -453 -388 -596 Factor Service Income 286 409 420 218 323 800 Net Current Transfers 170 186 216 233 252 322 Current Acct Balance -41 97 103 -2 186 526 Capital Long term (net) 274 71 181 -186 -332 -321 Other Capital (net) 122 -412 82 91 100 161 Use of net IMF Credits -279 -97 -152 -2( -251 0 Change in net foreign assets -76 -144 -217 -78 -162 -100 ( inc = - ) Financing Gap - 485 2 436 555 272 Memo Items Debt relief 1850 1266 1074 Debt service as 2 of Exports (GWS) 37 34 28.1 44 46.5 24.4 18. External Debt. It is clear, under these circumstances, that Morocco will continue to require debt relief for several more years. As a result of agreements recently concluded with official Paris Club creditors and commercial banks, debt relief has been obtained on medium-term debt falling due through 1988, as well as previously rescheduled debt. The effects of these rescheduling agreements on the servicing of the civilian debt have been incorpor*.ed into the medium-term balance-of-payments projections. In addition, the model assumes additional rescheduling in 1988 but only on civilian debt.- Normal public long-term capital inflows could be barely sufficient to cover the remaining financing requirements in 1986-88 (about US$1.1 billion annually), assuming that new loan commitments from Morocco's official lenders can be maintained at their current rate (about US$800 million a year). Recourse to commercial bank financing is likely to remain constrained, with gross disbursements from private sources expected to average about US$100-150 million per annum, probably strongly conditioned on, if not directly tied to, specific adjustment programs. In 1987, a financing gap of approximately US$500 million corresponding to short-term arrears (which is expected to be reduced to about US$400 million at the end of the year) will be met through rescheduling. 19. In view of the continuing large capital inflows required in the next few years and the need to build reserves, the long-term external debt 1/ About US$206 million and US$174 million of military debt service payments coming due in 1986 and 1987, respectively, are assumed to be rescheduled along the same lines as other obligations.  - 9 - outstanding and disbursed would continue to rise slowly until 1992, but would begin to stabilize thereafter. The ratio of debt outstanding and disbursed to exports of goods and services, which had risen to 268 percent in 1984, would start to decline, progressively dropping to 173 percent by 1990 and 79 percent by 1995. In the absence of debt rescheduling, the long-term debt service ratio would have risen to 57 and 74 percent of exports of goods and services in 1985 and 1986, respectively. The debt relief obtained for the period 1985-87 reduces the debt service ratio to about 35 percent. Without any furt -. debt relief, it would rise sharply in 1989, with repayments on the 1983-b4 rescheduled maturities (including military debt) falling due, but would then start declining gradually in the 1990s. 20. Given this difficult debt situation, Morocco's commitment to an aggressive program of structural adjustment is essential for the country to be considered creditworthy for continued Bank lending. Bank exposure amounted to 112 of total debt outstanding in 1985, and approximately 12% in 1986, and is projected to be about 20Z by the early 1990s. Future Bank lending is conditional on the deepening of policy reforms already underway and on the mobilization of additional external resources from sources other than the Bank. The March 1987 Consultative Group meeting, the rescheduling of commercial bank debt falling due through March 1988, and the recent consolidation of trade arrears, constituted initial efforts in this direction. 21. Social Impact. It is important to recognize that the implet tation of the stabilization policies and measures for structural adjustment e;.visaged in this scenario will entail some transitional social costs. With population growth at about 2.5 percent p.a., GNP and consumption per capita, which have been essentially stagnant since 1980, are not likely to show much improvement in real terms until the end of the present decade. Stabilization policies and measures to increase efficiency will initially be reflected to some extent in depressed domestic demand, increased unemployment, and some decline in real incomes, particularly the real income of urban populations, Government employees, and workers in less competitive industries. On the other hand, the real income of farmers, who constitute by far the poorest segment of the population, should rise as a result of increases in agricultural producer ?rices and improvements in support services and marketing institutions and infrastructure. This will be particularly true of farmers in rainfed areas. The political and social implications of these welfare shifts are likely to be significant, and to keep them manageable will be a major concern of the Government in the next few years. Several compensatory programs in the area of nutritional support are under study in orcier to identify more effective methods of alleviating the plight of the poor. While the cost of not undertaking the required economic adjustments would be greater in the long run, it will be important to minimize the negative short-term impact of these adjustments on the poorest groups. After 1990, as a result of the reforms undertaken in the 1980s, the economy could return gradually to a higher growth path without endangering external equilibrium. Per capita levels of income and consumption could begin to rise again, and the restoration of economic dynamism would greatly improve Morocco's ability to deal with its serious unemployment problem.  - 10 - PART I - THE PUBLIC ENTERPRISE (PE) SECTOR (a) Organization and soope of the PE secter 22. PEs co-exist with private enterprises in a mixed economic system whose origins can be traced to the post-World War I period. Initially PEs developed in number, scope, and nature based on a perceived need to secure public control of natural resources. PE objectives were progressively broadened to Moroccanize and spearhead economic development, to create employment, and to promote the growth of underdeveloped areas. The miaing, energy, transportation and telecommunications sectors feature prominently in the span of PE activities. 23. PEs generally take one of two principal legal forms: those created by legislation or regulation, known as Etablissements Publics Industriels et Commerciaux (EPIC), and PEs created pursuant to corporate law, known as Societ6s Anonymes (SA). The legal form reflects convenience or historical accident, with most public service PEs and regulatory or quasi-governmental agencies being EPICs, and most industrial and commercial PEs being SAs. The PE sector includes some 450 major enterprises of which 25S are regulatory, quasi-governmental institutions, 8% public service monopolies and the remaining 671 industrial and commercial concerns. Government has full ownership of 521 of these enterprises, majority participation in another 252 and minority participation in the remaining 231. In essence, however, Moroccan nomenclature and the organization of the sector masks the fact that many EPICs function in fact as extensions of Government departments engaged in providing agricultural, educational and health services to the general population. 24. The organs of direction, management and internal control of PEs generally include a General Assembly of Shareholders (for PEs organized under company law), a Board of Directors (BOD), a Technical Committee (optional), a Chief Executive Officer (CEO), and staff. Members of BODs are usually selected and appointed by the Government and represent the ministries whose activities are related to those of the enterprise. By legislation (Dahir of September 19, 1977), the Prime Minister is the Chairman of the BODs of the EPICs. Usually he delegates this function to the Minister of the concerned parent ministry or another senior representative of the Public Administration. The presence of Ministers -on BODs has often resulted in under-involvement or over-involvement of the Boards in the management of PEs, decision-making based on political rather than economic considerations, and confusion of the roles of the parent ministries and the Boards. The CEO implements the decisions of the Board and ensures the day-to-day management of the enterprise. The CEOs of all EPICs are appointed by the King upon recommendation of the parent Minister or their BODs. Enterprise staff are under the authority of the CEO, though statutes governing the conditions of their employment and remuneration need to be submitted to the Government for approval.  - 11 - (b) Govermment Management of the PE Sector 25. The State directs and oversees PEs through a system of double tutelage. The sponsoring Ministry is responsible for technical and administrative control, and the Ministry of Finance for financial control. The Ministry of Finance exercises its financial control through its Department of Public Enterprises and Participations (DEPP), which supervises all PEs, with the exception of those of a quasi-governmental nature; these, as non-income generating entities, report directly to the Department of the Budget in the Ministry of Finance. DEPP staff numbers 100 professionals including: (i) financial comptrollers, who are appointed directly by the Minister of Finance to approve all important financial and procurement decisions by enterprise management, and (ii) accounting agents who are permanently assigned to the most important PEs to countersign payment orders, and to ensure that their accounts are properly kept. The General Inspectorate within the Ministry of Finance is responsible for the auditing of PEs. 26. An Interministerial Committee for Public Enterprises and State Participations (CIPEP), chaired by the Prime Minister and comprising the key ministries concerned with PE operations, was established in 1980 to coordinate government policies and decisions with respect to the sector. However, the CIPEP remained dormant mainly because of unclear lines of responsibility between the ministries involved and PEs. The Government has also established a Vigilance Committee for PEs to identify solutions to the problem of financial arrears in the sector. The Committee is chaired by the Minister of Public Works. The Government institutional framework to oversee PEs will be altered and strengthened under the proposed loan. (*) Rationale for PE Reform 27. The PE sector is an important element of the Moroccan economy, accounting for approximately 20% of GDP, 30% of investment, and 502 of exports. Its performance has declined markedly since the mid-1970s. The relative ease of obtaining financing through either borrowing or Government transfers induced a degree of laxity in PE financial discipline. For example, a significant portion of PE resources was channeled into investments of limited productivity, as evideuced by the growing operating deficits of numerous PEs. In the early 1980s, access to external sources of financing was curtailed and budgetary resources became increasingly scarce, subjecting many PEs to liquidity difficulties. Moreover, the Government failed to reduce its own consumption of PEs' goods and services in line with available Government resources, leading to a consequent build-up of domestic payment arrears to PEs which disguised the actual magnitude of the budget deficit and further exacerbated PE liquidity problems. In 1985, budgetary transfers to PEs totaled approximately DR 3 billion (US$300 million) or nearly 25% of the overall Treasury deficit, whereas the outstanding stock of Government payment arrears to PEs totalled DH 6.1 billion at end-1985, or 51 of GDP. Because of its share in overall economic activity and links to the Government budget, reform of the PE sector is a key component of the Government's program of structural adjustment and stabilization.  - 12 - 28. Lessening the dependence of public enterprises on budget:ary transfers, however, implies a thorough restructuring of the sectur to enhance its overall efficiency, including measures to improve its competitive environment, promote financial and managerial autonomy and accountability, and rationalize institutional arrangements. Reform of the PE sector is expected to mitigate the financial and administrative demands on the Government in the short-term and contribute to economic growth by raising the level of enterprise production and productivity in the medium-term. (d) Financa Situation of the PubUc Enterpnse Sector 29. The financial situation of the PE sector as a whole has become increasingly strained as a result of weak profitability, high indebtedness, undercapitalization, and over reliance on the Treasury as a source of financing. A study of the financial performance of a selected cross-section of the largest PEs reveals net operating losses for some, excessive levels of debt, and li-ited working capital. The inability to raise prices to meet rising costs has strained earnings, and the considerable level of Government payment arrears to PEs has constrained their liquidity. Consequently, many of the enterprises have had to resort increasingly to borrowings and budgetary transfers to finance the gap. 30. Recourse to borrowing has tended to accelerate in periods of stabilization-induced fiscal austerity with scarce budgetary resources. During the periods 1976-78 and 1983-84, characterized by significant real reductions in budgetary transfers, PEs experienced substantial increases in indebtedness. Much of this borrowing took place on international capital markets in order to bolster the Government's dwindling foreign exchange reserves. However, in view of the reduced access to external capital markets and the tight credit ceilings established under the IMF Standby arrangements in the recent past, borrowings have slowed and served to finance a smaller proportion of PE investments. In fact, domestic and external borrowings financed respectively 122 and 27.62 of PE investment in 1982 compared to 10% and 36S in 1973-77. The substitution of Dollar for Dirham liabilities which characterized the 1970s is thus being reversed. On the other hand, there has been a dramatic shift in the term structure of PE debt, with short-term debt now predominating, as PEs borrowed to finance the build-up of arrears. 31. The financial profitability of certain PEs has been generally insufficient to meet debt service obligations and remunerate shareholders, with the result that much of the PE debt to external creditors had to be rescheduled along with that of the Government. This situation reflected both rigidities in pricing policy and investments which did not generate requisite rates of return at the prevailing financial prices. At present, only a limited nuumber of PEs transfer funds to the Treasury in the form of dividends and taxes. At the same time, stabilization demands have reduced the potential for financing PE activity with budgetary resources. This situation militates in favor of a restructuring of PE operations in order to generate the operating surplus necessary to finance a higher portion of their investment programs, reduce their reliance on the budget, and eventually transfer funds to the Treasury. This generalized increase in public savings is a key component of Morocco's adjustment program.  - 13 - (e) Public Enterprise Problems and Development lsues () Weak competitive environment 32. Many PEs have been immunized from competitive pressures and market prices, since they are either monopolies or are protected by high tariffs or other import restrictions. Procurement decisions are often insulated from market forces. Incentive systems are not geared to promote efficiency. Consequently, the sector is prone to inefficiencies, the costs of which are transferred to taxpayers through Government subsidies, and to consumers through low quality products and services Performance monitoring of PEs is ineffective or non-existent, so that PE management faces neither sanctions nor rewards in the execution of PE business. Finally, the Government's inability to meet its financial obligations toward the sector shields managers from financial accountability. (O) Inappropriate pric!ngpoliies 33. Social and political, as well as budgetary and financial, considerations have created a web of price controls and formulae which do not reflect economic costs. In the service and monopolistic PEs, the problem has been compounded by the lack of detailed cost-accounting systems which inhibits the matching of price movements with changes in input prices. As a result, the Government has frequently been unable to set prices at economic levels. Some enterprises also suffer operating deficits since the Government requires them to engage in unprofitable activities for social or political reasons, or provide public services for which they receive little or inadequate compensation. Excessive borrowing or subsidies are required to replace foregone revenues. In the case of international borrowings, foreign exchange losses to PEs have resulted. in many instances. (fii) Government Arrears 34. The financial health of many PEs is seriously threatened by the failure of the Government to pay for goods and services provided by PEs to various branches of the public administration, as well as to make available in a timely manner funds committed under existing finance laws, principally for investment purposes. This results in an increase in liabilities of these enterprises to the banking sector or to their failure to pay for goods and services they purchase from other enterprises. (iv) Interface between Government and Enterprise 35. The absence of ways and means to set coherent and consistent corporate objectives for PEs has led both to insufficient Governmental policy direction and monitoring of them, as well as excessive Government interference in the more routine decision-making responsibilities of enterprise management. This interference has been manifest in financial, investment, procurement, and staff recruitment and career development decisions, and has had adverse consequences for enterprise operations.  - 14 - (v) Ihternal Enterprise Maeent 36. Wbile the largest commercial PEs generally have adequate management information systems (MIS), many others still lack any organized form of information gathering for managerial and operational purposes. This is a major constraint to the establishment of effective Government monitoring of PE performance. (vi) Inadequate Accotmting Standards and Auditing Principles 37. Morocco lacks a uniform and well-defined accounting system. There is no appropriate legal framework regulating the profession of chartered accountants and establishing auditing requirements by recognized, independent auditors. These shortcomings have prevented meaningful consolidations and comparisons of the financial statements of different enterprises. (vui) Involvement of the State in Productive Ativities 38. There is no coherent strategy determining the role of the State in the 1ational economy. In many instances, the original reasons for the creation of a PE, such as scantiness of risk capital or qualified entrepreneurs, have vanished. The State is presently engaged in a multitude of economic activities whose strategic importance is questionable, and which could be carried out by the private sector. 39. The above-mentioned problems and development issues for PEs have been recognized by the Government and corrective measures will be implemented under the proposed loan. The following section presents the proposed PE rationalization program to address these issues. PART m - THE PROPOSED PUBLIC ENTERPRISE RATIONAUZATION PROGRAM A. Introduction 40. Following a study of the PE sector carried out in the early 19808 by consultants working under a special Government task force, the Government decided to undertake a number of measures to improve the performance, monitoring and control of PEs. Several enterprise-specific rehabilitation programs were launched in 1983-84, including: (i) signing of a contract prograin&' with the national airline; (ii) establishment of a similar arrangement with the national bus company; (iii) launching of a development program for the coal company; (iv) review of commercial and business policies of a small-scale mining organization; (v) reorganization of the financial 1/ A contract program is a corporate developmet plan agreed between the Government and a PE in which the PE's objectives, the actions to achieve these objectives, and the measures required to carry out such actions are defined.  - 15 - structure of a sugar company; (vi) restructuring of cargo handling and operations in major ports; and (vii) the establishment of a Vigilance Committee in 1984 to address the arrears problem. Energy conservation measures were taken to reduce costs; substantial price increases were effected for a broad range of goods and services; and, beginning in 1985 under an IMF Standby agreement, a ceiling was established for Government transfers to PEs. 41. At the same time, to improve enterprise efficiency and to promote growth, the Government pursued its public commitment to continue a program of divestiture to the private sector of PE activities not considered to be of strategic importance. Hotels belonging to the Moroccan National Tourist Office were leased to private concerns in 1982 and 1985. Three subsidiaries of the National Fishing Office were sold to private groups in 1984, and fishing boats were leased to Moroccan or Spanish private ship-owners. In 1984, the State sold the bulk of its holdings in certain sugar factories. Responsibility for the marketing of processed food products and the monopoly on exports of fresh fruits and vegetables was removed from the Office de Commercialization des Exportations, OCE. In 1985, the State relinquished its monopoly of cargo handling to an enterprise which functions in accordance with commercial principles. B. The Banks Role 42. The Government program, while helpful financially, did not include basic structural measures to rationalize the sector, since it was too limited in scope and ad hoc in nature. In 1985 the Government invited the Bank to analyze the sector and to help it devise a broader policy framework and reform program for PE operations. Bank sector work was initiated, as a result of which a medium-term program was developed which was designed simultaneously to address the problems related to the external environment in which PEs operate, as well as to the internal constraints confronting PE management and operations. C. Prinei les. Objectives and Seoe of the Rationaization pam 43. The rationalization program rests on the principle that only the existence of competitive or similar pressures promotes the continuing pursuit of efficiency. With this principle in mind, a broad set of measures was identified with the objective of (i) promoting financial independence and accountability of PEs, (ii) developing their administrative and managerial autonomy and accountability, and (iii) disengaging the State from productive activities which could more effectively be carried out by the private sector. The program is expected to enhance the productivity of PEs, reduce their dependence on scarce budgetary resources, and rationalize the role of the State in the economy by concentrating it on policy making and the provision of essential services. 44. The Public Enterprise Rationalization Loan (PERL) has been ^onceived as the first of a series of operations through which the policy framework and the measures stated above would be implemented. Reforms are to be introduced  - 16 - at Governmental level affecting all PEs, as well as through the institutional, managerial, organizational, financial and physical restructuring of selected PEs, according to the needs identified by successive Bank missions. Multiple criteria have been used to manage the introduction of PE reforms at enterprise level. In light of the severe budget constraints facing Morocco, the largest beneficiaries of Government transfers appear to be the most appropriate initial candidates for restructuring. Also those PEs most affected by Government arrears (para. 34 above) and those whose operations and finances had widespread multiplying effects throughout the economy were considered principal potential beneficiaries of this loan. Six PEs which represented the bulk of Government transfers and were most affected by arrears have been selected for restructuring during the first two years of the reform. In addition, sector surveys of the mining, sugar refining and Transport sectors will be conducted to facilitate the identification of future candidates for restructuring. The six selected enterprises are the national power company, Office National de l'Electricite (ONE); the national water supply company, Office National de l'Eau Potable (ONEP); the railways company, Office National des Chemins de Fer (ONCF); the refineries Soci6te Anonyme Marocaine de l'Industrie du Raffinage (SAMIR) and Societe Cherifien du P6trole (SCP); and the oil distribution company, Soci6te Nationale des Produits Petroliers (SNPP). Aside from the national phosphate company (OCP) and the agricultural organizations (ORMVAs and CTs) which are being assisted through separate Bank Group operations, these firms account for about 56% of all transfers to PEs. Previous Bank association with some of these enterprises and knowledge of their operations have also provided the basis for their use as vehicles for introducing the reform measures. 45. The medium-term objectives and scope of the planned reform, as well as the steps to be taken during its first two years, are specified by the Government in a Letter of Development Policy, the English translation of which is presented in Annex IV. The letter also contains the Government's commitment to continue pursuing macro-economic stabilization and adjustment programs, so as to ensure that arrears to the sector do not recur. The Bank and IMF have worked in close association to ensure the consistency of the terms of the current Standby and this loan. A timetable for implementing these policies in the next two years (the implementation period for the proposed operation) is included in Annex V. D. Policies and Measures to Foster Financial Autonomy Accountabiity and Competition 46. The disappointing financial performance of PEs has three interrelated causes, namely, inappropriate financing plans for PEs, inadequate pricing of output, and poor investment planning and project selection. In addition, the financial viability of PEs as a whole has been undermined by the considerable accumulation of receivables from central and local government as well as other PEs. Under the Government's reform program, financial restructuring of PEs would be based on the two following fundamental objectives: first, cost efficiency within the PEs, to be achieved through enhanced management accountability and performance monitoring; second, increased PE revenues would  - 17 - be achieved through appropriate pricing policies. This second objective would be reached by setting market prices for enterprises operating in a competitive environment. For non-competitive enterprises, price mechanisms to reflect economic values will be established, so as to produce a set of signals which would induce these enterprises to behave as if they were exposed to competitive forces. In particular, the Bank loan would assist the Government in promoting financial autonomy of enterprises through (a) a restructuring of the way in which PEs are financed by putting greater reliance on commercial sources of financing and eliminating unjustified government transfers; (b) the adjustment of output prices to match their market value, promote financial viability of PEs and send correct signals to consumers, (c) improvements in the planning, evaluation and monitoring of PE investments in accordance with economic and financial criteria, and (d) the restoration of financial discipline and viability deriving from the Government's implementation of a comprehensive program to settle its arrears to the sector and prevent their recurrence. (a) Reform of PE Financing (i) Publc Service PEs 47. Service-oriented PEs, such as ONE, ONEP and ONCF, generally do not receive operating subsidies, although they depend on capital grants and concessional treasury financing for a large part of their investment needs. The present structure of their financing +.-icates that, on average, self-financing ratios are less than 25X with Government contributions averaging 50% of their financial needs. Government medium-term objectives are to eliminate the operating subsidies entirely and provide investment funds exclusively in the form of equity contributions, whenever required, to meet the costs of creating new production facilities, and to maintain debt/equity ratios consonant with prudent financial management. Prices of utility services will be set in accordance with efficiency criteria to achieve and maintain enterprise financial autonomy, and internally generate financial resources at appropriate levels. Assets would be revalued according to predetermined depreciation and revaluation schedules and will include past government-financed investment. The medium-term objective of the government reform program of which this loan supports the first two years of implementation aims at achieving, by the early 1990s, self-financing ratios of 25-451, reducing Government contributions to 0-302 of PE investment requirements, and having the capital market and other sources provide the remaining 40-652. 48. For the PEs to be restructured under PERL this objective will be reached through the combination of tariff adjustments, strict control of new investment and increasing productivity of existing assets described in the coming sections of this report. As a result of these measures, self-financing ratios will rise considerably after 1987 and result in an estimated decline of investment transfers by about 151 p.a. in nominal terms i.e. from approximately DR 1.3 billion annually during the period 1984 to 1986, to DH 300-400 million million by 1990.  - 18 - (ii) Industra and Commerel PEA 49. In accordance with Government policy of redefining its role in the Moroccan economy, no public financial assistance will be provided to PEs which are able to raise funds on the capital market. This approach is already being applied to commercial enterprises in the petroleum sector, namely, SAMIR, SCP and SNPP, which have already achieved full financial independence. 50. The main commercial PEs still receiving budgetary support are ONAREP and BRPM. For ONAREP, the national oil company, the Government has decided that the enterprise will limit its oil exploration activity to what is strictly needed to concentrate on the development of existing wells, as well as the promotion of exploration of Moroccan fields by foreign oil companies. Investment transfers to BRPM, the national mine holding company, amount to about DH 100 million annually, comprised of operating losses of its subsidiaries, some of which have already been closed down and await formal liquidation. The global downturn in prices for minerals and metals, combined with management problems at BRPM and in the mines, compound the problems. The loan will support the preparation of an overall restructuring program for BRPM. In the meantime the Government will significantly reduce its budgetary transfers to the company. (iui) Investment Transfers to PE Sector 51. For the PE sector as a whole, Government transfers will be limited as follows: (millions of Dirhams) 1986 1987 1988 1989 1990 a) Total Public Invest. Budget (authorizations) 20,500 19,900 23,190 25,560 28,170 b) Total Invest. Transfers to PEs (authorizations) 3,573 2,350 1,700 1,500 1,500 c) Share of PE Transfers in Total Invest. Budget (auth.) 17.4S 11.8S 7.3% 5.82 5.3% d) Total Investment Transfers to PEs (cash payments) 1,770 1,300 1,400 1,250 1,250 The transfer ceilings for 1987 anmd 1988 are reflected in the loan conditionality. 52. The share of the PE sector in overall investment transfers will decline consistently, begining in 1987, notwithstanding a marginal increase in levels of cash payments in 1988 due to an unavoidable increase in the investment cash requirements of the water supply sector. A significant feature of the new Government policy is the reduction of the present gap between authorization and cash payments which is expected to move from over 100% in 1986 to below 20S starting from 1988. This reduction is part of a set of measures to establish a cash management system which will ensure consistency between available budget resources, commitments and expenditures.  - 19 - (b) Reform of Ptinc Po,lies i) Prioln of Public Utilities 53. Under the Letter of Development Policy, the Government is committed to achieve price levels which enable the enterprises beginning January 1, 1989, to recover all their operating costs, under efficient operations, aervice their debt and make appropriate contributions to the financing of future investments so as to limit Government financing to essential equity contributions1'. Studies financed by the Bank to define appropriate tariff structures based on LRMC will be carried out for ONE and ONEP, to be completed by mid-1988. ONCF tariffs will be further reviewed during 1988 in connection with the revaluation of its assets and the deregulation measures which will emerge from a Transport Development and Policy Study included in PERL. 54. Prior to the implementation of the pricing policies that will result from these studies, the Government will ensure that the two utility companies and ONCF make interim adjustments to prices in 1987 and 1988 as specified below: Increases in Utility Rates (nominal terms) 1987 1988 ONE 51 51 ONEP 101 12% ONCF - Passengers and Freight 10 101 55. The tariff increases were determined on the following basis. First, the investment programs for the enterprises were set at the minimum necessary to maintain service levels in the face of increasing demand (for ONE and ONEP) and increased competition (for ONCF). Second, the financing plan for these investments was agreed, including debt that the PEs could contract and the equity that the Government could provide. The gap in the financing plan determined the internally generated funds that the enterprises needed to generate from tariff increases. In addition to these contributions to investments, the level of tariff was set to enable the enterprises to cover all operating and maintenmace costs and service all debt. The 1987 tariff increases for ONE and ONEP and ONCF's request to the Government to increase its tariffs were effected on May 1, 1987. Tariff increases for ONCF will be a condition of loan effectiveness (first tranche release). Proposals for the 1988 tariff increases for all three enterprises are indicative, and will be 1/ ONE would meet the above requirements starting from 1987.  - 20 - reviewed before their introduction in the light of general economic conditions, including inflation, and the status of execution of the investment programs of each concerned PE. Implementation by these three PEs of appropriate tariff increases will be condition of second tranche release. After 1989, tariffs will be set in accordance with the principle described in para. 53 above. The Government is also committed to ensuring that all prices to ONE and ONEP are immediatly passed on to the ultimate consumers in order to protect the financial health of the water and electricity distribution agencies (Regies). 56. As a result of these increases, the financial performance of the concerned PEs will improve, and their demands on the budget will decrease. Over the period 1987-1990, ONE is expected to become a major net contributor to the Treasury. Its income and other tax transfers in this period will amount to DR 3.5 billion, compared to demands for budget funds for investments of only DH 32 million which are for electrification of the Sahara provinces made at the Government's request. ONE's rate of return on net fixed assets in service will increase from 11.8% to 16.42 during the period 1987 to 1990. ONEP will be able to decrease its need for Government contributions to its investment program from 512 in 1987 to 36% in 1990 while increasing its own contribution from zero in 1985 to 16% in 1990. Its debt service coverage ratio will improve from 1.2 to 1.9, while the rate of return on net fixed assets in service will increase from 1% to 5%. ONCF will achieve a self-financing ratio of 4% in 1987 and 30% on average in the following years as compared to -212 in 1986; government transfers to ONCF will decrease from DH 515 million in 1986 to less than DH 200 million by 1990. (i) Pricig of Petroleum Products 57. Prices of petroleum products are distorted due to the arbitrary system of price-setting, which has resulted in prices bearing little relationship to overall supply-demand balances, so that they do not adequately serve to balance imports and refinery output to optimize the supply in Morocco. Margins do not compensate distribution costs, leading to decapitalization, and insufficient maintenance and replacement. The system of price administration, and consequent payments to and from the Compensation Fund, are unwieldy, slow, and disruptive, with payments being held up for as much as five months. The Government intends to liberalize prices by gradually aligning ex-refinery prices with c.i.f prices, thus promoting more efficient procurement of crude oil or finished oil products by the two refineries, SAMIR and SCP. The margins of the distribution sector will be increased. The Compensation Fund will be replaced by a Stabilization Fund whose mandate will be to ensure some degree of stability in domestic prices, by adjusting local prices in accordance to moving averages of international prices, rather than reflecting fluctuating spot prices. The implementation of the new price scheme to link domestic prices to international pri. es, and the establishment of the Stabilization Fund will take place during 19W, following the results of studies to be financed under the loan. These studies will define detailed procedures and schedules for the implementation of the pricing measures and will assess their impact on industrial production costs and household expenditures.  - 21 - (iii) Pricing of Tradeable Outputs 58. Government controls on pricing of tradeable outputs of PEs had traditionally been limited to products subject to limited domestic competition, such as tea, steel, cement and tractors. However, price controls on all products have now been eliminated in the context of the Bank-supported Industrial and Trade Policy Adjustment (ITPA) program. Under the above program, the Government stated its commitment to abolish price controls simultaneously with the lifting of quantitative restrictions and the establishment of appropriate tariffs. Insofar as Moroccan steel producers are not likely to be competitive for all steel products, even with tariff protection, it is incumbent on the Government to undertake a strategic review of the sector with a view to rationalizing its structure. Bank assistance for this review could be considered under a future operation. (e) Investment Plannning and Selection 59. The high ICOR in Morocco is indicative of weak investment planning, and inadequate mechanisms to appraise, select, monitor and evaluate specific projects. There is a need to improve investment reviews and decisions at all stages of the project cycle. As part of the PE sector reform, the Government intends that all PE investment proposals estimated to cost DH 10 million or more will be evaluated in accordance with financial and economic criteria as a condition for receiving Government financial support. The Government will also introduce new budget policies aimed at the effective integration of PE investment planning into the budgetary process. 60. In the power, water supply and transportation sectors, the Government will delineate responsibilities of PEs and the parent ministries with respect to investment planning, programming, selection, monitoring and evaluation; design a system for supervising and monitoring project execution; develop appropriate programs to define and apply sound investment appraisal methodologies; and direct staff of PEs, tutelage ministries and financing ministries to existing training programs being financed under the first Vocational Training Project (Loan 2479-MOR). (d) Gomernment Arrears to PE Sector 61. At the end of 1985, total accounts receivable in arrears in the PE sector amounted to approximately DH 26 billion (approximately US$2.7 billion). Upon cross-cancellation of all mutually owed obligations among Government and PEs, DH 7.1 billion remained outstanding, consisting of DH 6.1 billion of net Government arrears to PEs, and DR 1.0 billion of arrears owed by insolvent PEs to other entities for which the State, as guarantor, is liable. Provisional data on 1986 indicate that net arrears increased in that year by an additional DH 400 million - ie. to about Dl 7.5 billion (approximately US$800 million). 62. Arrears stem mainly from under-budgeting of Government consumption and from the Treasury's inability to transfer resources committed to PEs under existing finance laws or agreed programs. Indirectly, arrears are also caused  - 22 - by rigidities in pricing policy and Government insistence that PEs provide costly and, at times, unrealistic levels of service for which inadequate financial provisions are made. Arrears have grown very rapidly in the 19808, and their effects have spread to financial and other commercial enterprises in both the public and private sectors. Settlement of arrears and implementation of measures to avoid their recurrence is a sine qua non of the Government's macroeconomic stabilization program and of the PE rationalization program. A Government Vigilance Committee (see paras 26 and 40 above), with Bank assistance and IMF concurrence, has defined a comprehensive scheme to clear past arrears and identify a program of measures to prevent their recurrence. (V Settlement of Arrears 63. The objectives of the proposed arrears settlement scheme are to clear all bilateral and multilateral obligations in a manner consistent with Morocco's fiscal stabilization program. The scheme has been established to ensure that the increased liquidity of PEs resulting from the settlement of arrears will have minimal impact on money creation. To this end, and to ensure an even-handed treatment of PE claims on the Government, appropriate monitoring systems have been established. 64. The implementation of the scheme, which will start in 1987, will be as follows: (i) mutual obligations between the Government and PEs will be cross-cancelled through entries in a special arrears clearance account to be maintained and supervised by the General Receiver of the Kingdom (Tr6sorerie Gen6rale) within the Ministry of Finance. This action, as well as Government action to negotiate write-offs or to convert part of its debt to some PEs into equity, is expected to reduce the arrears to a net balance of DO 5 billion; (ii) the Government will provide PEs with Treasury bonds for the amount of the net balance. These bonds will be redeemed over 5 years beginning in 1987 by DR 1 billion per anum. Repayments falling due during the PERL implementation period will be DR 2.5 billion; (iii) for the first two years the bonds will not bear interest and have only limited negotiability. Starting in the third year from their issuance, i.e. on about July 1, 1989, the bonds will bear an interest rate of 62 and become fully negotiable; (iv) the operations related to the issuance and exchange of bonds will be monitored by the Bank of Morocco in a special ledger. The liquidity positions of PEs and of the Treasury will be determinant in the Bank of Morocco's decision to authorize the banking sector to discount the bonds during the period of limited negotiability. 65. Completion of the bilateral cancellation process and the issuance of bonds are conditions of first tranche release. All bonds issued to PEs will be used to retire the short term debt which has been resorted to to finance  - 23 - arrears. The arrears settlement process would essentially replace short-term informal credit extended by PEs and the private sector to the Government with long-term credit to the Government. The inflationary or "crowding out" effects of the arrears reduction process would be negligible, since the transformation of existing credit to Government in the form of arrears into obligations vis-a-vis the banking sector, attendant on the reduction of PE liabilities to the latter, is the formalization of a phenomenon that has already occurred. The above procedures, including the establishment of the special account and the ledger, have been authorized. The Bank will monitor Government operation of the arrears clearance account and of the ledger to ensure that the arrears settlement process is carried out as planned and according to schedule. (i) Prevention of Future Arrears 66. Since 1984, the Government has undertaken steps to prevent the accumulation of new arrears. They include reducing consumption of utility services and supplies by the public administration, making civil servants pay the cost of utilities in Government housing, and increasing the budgetary allocations earmarked for Government consumption expenditures. The introduction of these measures has already resulted in a 41 decline in the volume of government consumption of water, electricity and telephone services from 1984 to 1985, and has narrowed the gap between allocations and actual expenditures. Under the reform program, the Government would continue its efforts to eliminate waste in the public consumption of services and goods provided by PEs. It will also make full budgetary allocations for its consumption of services by ensuring that budgetary provisions are based on actual billings of the preceding year, adjusted for expected tariff increases. 67. Reducing Government consumption of utility services is, however, only a small part of the Government's overall strategy to avoid the re-emergence of arrears. The most critical component of that strategy will be a rigorous pursuit of fiscal stabilization. Rationalizing Government finances combined with measures to streamline budgetary procedures and introduce cash management into Government budgeting, is to be supplemented by the programs described in this report to correct the structural operating deficits of PEs through inter alia, the correction of price rigidities. Finally, policies to control overall levels of investments in the PE sector, to close PEs where the reduction of operating deficits is not feasible and to remove many PEs from State ownership and control are all directed at ensuring that arrears do not begin to accumulate. E. Intitutional Reforms to Foster Admnistrative and MbaagerIai Autonomy and Efficiency 68. In order to increase enterprise efficiency, the program to reform PEs calls for the introduction of competitive and equivalent forces. For sectors with competitive structures, the enterprises will be subject to market forces through price liberalization measures mentioned in para. 58 above. In monopolistic and non-competitive sectors, such as public utilities, in the absence of market competitive forces, enterpries will be induced to  - 24 - continuously pursue efficiency through the obligation on them to set clear objectives, develop performance indicators to quantify the achievement of the objet ,es, implement management information systems to measure the progress in achieving the objectives and make them more transparent, and reward or penalize enterprise management on the basis of the degree to which the objectives were achieved. This performance-setting and evaluation system is expected to encourage continuing efforts by monopolistic enterprises to increase efficiency. 69. At present, Morocco does not have a generalized system or procedures to establish PE objectives and monitor enterprise economic, financial and operational performance. The most urgent reform is to allow more administrative and managerial autonomy to competitive and monopolistic commercial PEs while strengthening the Government's ability to oversee their activities and to monitor their performance. The Government will pursue this objective by focusing the functions of Government institutions on strategic development, policy matters, major investment decisions, and performance evaluation, while shifting the responsibility for current organizational and operational decisions and investment implementation, to enterprise management. To this end, the reforms described in the sections below are envisaged. (a) Rationalizing Government/PE Relations (i) Contract-Programs 70. Government/PE dialogue on the performance objectives and programs of PEs presently occurs during the discussion of their provisional annual budgets. Under the reform program, Boards of Directors of major PEs will require them to define both long range and annual programs to indicate their physical, socio-economic and financial objectives, and any environmental impact these might have. The above programs will establish target values for key internal indicators such as economic and financial ratios, rates of return on fixed assets, employment, and capacity utilization levels. When implementation of the program requires financial or other assistance from the Government, the program will be formalized in a document (contract program) agreed between the State and the enterprise, stipulating the mutual obligations of the parties regarding these programs. Under the reform program, the Government will renegotiate its present contract program with the national airline RAM, and establish new contract programs with ONE, ONEP, ONCF, SAMIR, SCP, and SNPP. The Bank has reviewed drafts of the above contract programs. The signing of contract programs with SNPP and ONEP will be a condition of loan effectiveness; signing of the remaining four contract programs will be a condition of second tranche release. During the first year of project implementation the Government will also carry out an analysis of the experience with contract programs with a view to their extension to other appropriate enterprises. It is the intention of the Government to develop a system of tangible rewards and penalties for successful and delinquent management of all enterprises as it gains experience in administering this new instrument.  - 25 - (0i) Revitalization of CIPEP 71. Under the reform program, the Interministerial Committee for Public Enterprises and Participations (CIPEP), which is chaired by the Prime Minister, will be strengthened by clearly identifying its functions, better defining its operating criteria, and endowing it with a Permanent Secretariat. CIPEP's main functions will be as follows: (a) formulate general strategy on overall PE investment, financing, tariff setting and wage and salary policy; (b) advise on the acquisition and divestiture of holdings by the State or public entities; (c) provide guidelines for the privatization or reorganization of specific PEs; (d) recommend and approve reforms and improvements in State/PE relations; (e) monitor the results of the PEs performance as a whole; (f) oversee the execution of PE restructuring programs including the program to clear arrears and prevent their recurrence; (g) arbitrate disputes that may arise between PEs; and (h) advise on the composition of BODs, their members to represent the Governments and the appointment of their chairmen. 72. CIPEP will operate through specialized sub-committees to study specific problems, such as terms of PE employment and PE restructuring. Its permanent secretariat will be the existing Department of Public Enterprises and Participations (DEPP), which will be adequately staffed with qualified professionals to fulfill this additional function. DEPP's role as Secretariat will include supporting the activities of CIPEP and its sub-committees as well as preparing and presenting to CIPEP queries and proposals by PEs and their parent ministries. A Prime Ministerial directive establishing CIPEP's functions has been issued. Oi) Reform of BODs 73. Reforms affecting the role, operating methods and composition of the BODs will require time and careful study since their design is conditioned by the existing legal framework and by the divergent operational nature of the sector. The reform process has commenced with the issuance by the Prime Minister of a directive to all the parent Ministers on the composition and functioning of the BODs of the enterprises in their portfolio, designed to ensure that Ministers' involvement in the BODs follows clear and appropriate guidelines for intervention on policy matters, and does not extend to day to day enterprise management. The directives specifies that BODs should contain members experienced in management or the field of business of the concerned PE. After the first year of project implementation, when experience has been gained from the operation of the directives, a study will be carried out,  - 26 - according to TOR agreed upon with the Bank, to review the present role and organization of BODs and streamline their relations with the parent ministries and the enterprise management. This study will lead to the development of a program of action to implement possible reform measures, including possible new legislation. The Government would discuss the above program of action with the Bank. (rv) Reorganization of the DEPP 74. The establishment of new objective-setting and performance monitoring procedures, the replacement of a priori audits with ex post monitoring activities in commercial PEs and its selection as the Permanent Secretariat of the CIPEP, call for a redefinition of the functions of the DEPP and strengthening its staff. 75. The loan will assist the reorganization of DEPP through the following actions: (i) improvement of staffing - a study, completed in January 1986, has defined the organizational and staffing needs of the DEPP emphasizing portfolio management expertise as the main staff qualification rather than formal accounting. (ii) establishment of a public enterprise data system - to draw on information provided by the PEs and other sources on the economic, financial, labor, and legal matters affecting the PE sector to assist concerned ministries in PE monitoring. (iii) staff training - focussing on strengthening the skills of the existing financial comptrollers and accountants to enable them to effectively monitor the performance of the PE portfolio. (b) Inprovement of PE ManagementInformationSystems 76. Accounting and auditing procedures for public and private enterprises at large will be reformed along the lines outlined below. For commercially- oriented PEs, the DEPP will progressively replace the current system of a priori control of commitments and expenditures by its financial comptrollers and accounting agents with a posteriori checks, exercised through a reporting system based on reliable accounting and management information and appropriate auditing procedures. 77. Adequate Government performance monitoring will depend on the establishment or improvement of management information systems (MIS) in PEs . As an initial step the Government will ensure that the 12 selected enterprises hire appropriate consultants and procure the equipment required to establish their MIS according to the results of a study financed under a PPF and already completed. The MIS will be designed and installed also to generate the information which is required by Government agencies, such as the DEPP itself, the parent ministries, the Ministry of Plan and the Bank of Morocco, to monitor development trends and performance of the individual enterprises and  -27 - the overall PE sector. The MIS will be based on the following elements: general accounting, cost accounting, budgeting, financial planning, and performance indicators. 78. The cost of establishing/improving their MIS, including staff training, will be borne entirely by the enterprises with no specific financial assistance from the Government. The Bank will, however, finance a new study, to be carried out by the DEPP with the help of consultants, to assess the status and need for establishing or improving the MIS of an additional group of 12 enterprises to be identified during the first year of project implementation. (c) Improvement of General Account!gg and Auditing Principles and Praetices 79. The success of new objective-setting procedures and effective government monitoring of PE activities depends on the availability of reliable and uniform accounting systems and the introduction of appropriate auditing practices. At present this is hampered by the absence of a modern and generally recognized accounting system and of an appropriate framework for the auditing profession. Moreover, there are shortages of well qualified accountants and auditors, in the country. 80. To address the above shortcomings, the Government will carry out the following actions: (i) Prepare a new National Accounting Plan. The Plan will define uniform, minimum standards for accounting and auditing. A Commission, assisted by experts financed under the French bilateral assistance program, has already prepared a new draft legislative and regulatory framework, which is being reviewed by all interested parties in the public and private sectors and will be submitted to the Government for approval at the beginning of 1988; (ii) Establish a National Institute of Certified Accountants. Representatives of the accounting/auditing profession have prepared draft legislation specifying the required qualification and training standards of certified accountants and auditors and defining their legal responsibilities. The proposed legislation will be submitted to Parliament for approval at the beginning of 1988; (iii) Introduce independent external audits to commercial PEs. As part of the proposed reform of the existing control system of commercial PEs, the Government will require these enterprises to have their accounts audited annually by qualified auditors. External audits of the enterprises selected for the introduction of MIS will be made, starting in 1987. The introduction of audits in other PEs will be carried out subsequently as further MIS and a posteriori monitoring practices are introduced. (iv) Establish a degree program for accountants and auditors. A draft decree has been prepared outlining the relevant curricula and basic  - 28 - educational requirements for certified accountants. The program would combine three years of course work straddling three years of internship training in private firms or in PEs. A fourth year will be devoted to thesis preparation. The proposed decree will be submitted to the Government for approval at the beginning of 1988; (v) Prepare a training program in accounting and auditing for the staff of PEs and the DEPP. A preliminary assessment of the training needs of the 12 PEs selected for the introduction of MIS and the DEPP shows that to upgrade the skills of their professional and mid-level financial staff will require about 120 man-months of instruction for basic training and 50 man-months of instruction for refresher programs. Additional 70 man-months of instruction will be required for training the operators of computerized MIS and will be provided by the suppliers of hardware. The training needs of these PEs and the DEPP would be addressed through the preparation of a comprehensive training program which will include the identification of the most appropriate institution(s) and framework to deliver it in the most cost effective fashion. F. Policies a Measures to Rationalize te Role of the State in the 81. Under this component of the reform, the Government would develop and implement comprehensive programs to restructure non-performing enterprises, liquidate those which cannot be made economically viable, and disengage the State from activities which can be effectively carried out by the private sector. The principles for PE restructuring will aim at an initial ranking of interventions among non-performing enterprises prior to the definition of programs that would restructure, merge or liquidate such PEs. The privatization strategy and program will aim at identifying optimal procedures, targets, and schedules for the progressive disengagement of the State from economic activities which can be more appropriately carried out by the private sector. The Bank will assist the Government to achieve the above objectives through actions designed to improve the knowledge of the present portfolio of enterprises, prepare studies for the restructuring of key economic sectors dominated by the presence of PEs, and implement privatization programs and actions. These three basic measures are discussed below. (a) Inventory of the State Portfolio of PEe 82. An inventory is under preparation which will provide a reliable picture of the identity of each PE including its legal structure, capital structure, links to the State, type and sector of activity, localization of main activities; the characteristics of its markets such as captive, competitive, domestic, foreign; the worth of its assets at book and market value; its financial position and performance; its impact on public finances through subsidies and dividends; and its socio-economic role through employment generation and regional development. The inventory will also provide a general assessment of the restructuring needs of the enterprises such as in organization, marketing and production; their potential for  - 29 - privatization through complete divestiture, sale of shares or leasing; and the constraints to be overcome for the implementation of both restructuring and divestiture programs. The inventory is being prepared with the assistance of international consultants. Discussions with the Bank of the result of the inventory and the definition of a detailed privatization strategy and programs will be a condition for the release of the second tranche of the loan. (b) 2sFtructuring Studies 83. Restructuring feasibility and diagnostic studies to be conducted under this loan will cover the mining, sugar refining and transport sectors which currently absorb sizeable amounts of Government funds. The studies will include detailed programs for the rehabilitation, liquidation or privatization of poorly performing PEs. 84. In the mining sector, a thorough diagnostic analysis is planned for BRPM and its affiliates, leading to the preparation of a restructuring plan. Terms of reference for the work to be performed by an international consultant have been discussed in detail with BRPM, the Ministry of Finance, and the Ministry of Mines. The analysis would be in three parts and will recommend steps to: (i) adapt BRPM's geological survey work to the economic relevance of the mininRg sector while enhancing its ability to attract private investment; (ii) improve the prospects for its affiliates for merger or privatization; and (iii) define which affiliates should be closed and the legal, social and financial measures which should accompany the actions taken. 85. In the sugar sector, a restructuring program will be designed within the framework of gradual deregulation of the industry. The program would provide incentives for greater efficiency and productivity, simplify the process of setting prices and allocating resources, and allow uneconomic farms to switch to other crops. The program would lay the basis for the closure of uneconomic processing units, and spur ongoing actions to privatize the sugar mills. 86. In the transport sector, a development and policy study will be financed under the Fourth Highway Loan (No. 2254-MOR) to propose a strategy for deregulation of transport. This would include: (i) defining the Government's deregulation options for the transport sector over the next 5 years, (ii) evaluating each option based on its impact on unit transport costs and tariffs, and (iii) elaborating an optimal strategy to implement deregulation policies. 87. During implementation of the project, the Government and the Bank will hold discussions on the results of the above three studies, and on plans for implementing their recommendations. The release of the second tranche of the loan is to be contingent on completion of the mining sector study and the first phase of the transport study. The sugar sector study has been already completed.  - 30 - (c) Disenaement of the State from Productive Economic Activities 88. The Government is publicly committed to the continuation of its privatization program. It will proceed on a case by case basis, to include those in which the State has direct or indirect minority participation. Particular attention will be paid to enterprises operating in the manufacturing sector. State owned holding companies, such as ODI, SNI and CDG, will also develop restructuring and divestiture plans of their manufacturing holdings in harmony with the general Government program. 89. The Government also recognizes that the institutional, financial and business environment would have to improve to create conditions conducive to successful privatization actions. This requires: (i) the introduction of regular audits of PEs and the definition of a clear policy regarding the payment of dividends, taking into account the specific nature of each sector; (ii) the progressive deregulation of sectors planned to be privatized (prices, monitoring, regulations); (iii) measures designed to develop the capital market (taxation, legislation authorizing the issuing of new financial instruments); and (iv) measures to create a brokerage profession. 90. Assistance for the creation of conditions for effective privatizaticni and the implementation of critical privatization actions will include advice on administrative and legal aspects, the organization of packages of enterprises, and the identification of an optimal form of privatization. It also will include advice on measures to create conditions conducive to privatization such as removal of price controls, deregulation, stimulation of the stock market, introduction of new financial instruments and promotion of brokerage institutions. The proposed technical assistance is to be provided by appropriate individual experts and/or by a merchant bank. (d) Restructuring Progoams for Selected PES 91. To spearhead the introduction of PE reforms in Morocco, six enterprises, namely, ONE, ONEP, ONCF and three enterprises operating in the petroleum sector, will be restructured under this loan, with reforms to be introduced that will change policies governing their management, financing, arrears, pricing, investment planning and selection, and accounting and auditing procedures. In addition, a number of measures at enterprise level will be taken that are supported by ongoing and proposed Bank operations. 92. In the case of ONE (the national power company), the actions envisaged under the loan will focus on enabling ONE efficiently to meet the rising demand for electricity. Per capita consumption of electricity in Morocco is among the lowest in the EMENA region, and will have to grow to support economic expansion. Undependable rainfall, and the erratic nature of international fuel oil and coal markets on which Morocco has to rely for its thermally generated power, make electricity investment planning difficult. The problems are exacerbated by the lack of internal coordination in Morocco between ONE and the Regies which distribute most of the power, divergencies between the tariff and the marginal costs structures, and an unclear framework for the evaluation of multi-purpose hydro-projects. Specific restructuring actions for ONE will therefore concentrate on improving coordination within the sector, initiating studies of a least-cost investment program to meet future needs, and increasing tariffs to enable ONE to cover a substantial share of its investments.  - 31 - 93. The position of ONEP (the national water supply company) is similar to that of ONE. It too must cope with rising demand, and will be hard-stretched merely to maintain existing service levels through which about 832 of the urban population has access to safe water, 63% through house connections. Urban population growth of at least 3.52 per year will require ONEP to implement a large investment program to produce, transport and supply water in bulk to the urban communities, including a new major water conveyor to the Casablanca area to be built between 1988 and 1991. Under the loan appropriate tariff measures will ensure a rising self-financing capability for ONEP. Like ONE, ONEP suffers from the lack of coordination within the subsector, especially in the division of responsibilities with the Regies - which distribute both electricity and water in the urban areas. These issues of coordination will be addressed under a National Water Supply Rehabilitation project, the negotiations of which have been recently completed. The establishment of high level coordinating bodies and the study of optimal institutional arrangements will be undertaken in the latter operation, as will improvements to the management and operation of the Regies. 94. A different set of circumstances confronts ONCF (the national railway Company) although it, too, faces a major investment program for track and rolling stock replacement needed to maintain service capability and improve technical performance. Future demand for railway services will depend on ONCF's ability to compete in a deregulated transportation market. It has shown considerable commercial astuteness, even under present circumstances of limited autonomy, with its development of highly profitable short-haul, closed circuit haulage of special freights, and rapid transit inter-urban passenger service. It has also moved towards operating more at arm's length with its major customer, OCP, the phosphate mining and exporting company. Restructuring actions are designed to continue these initiatives. Under the loan, ONCF is eventually to be given full responsibility to set its own tariffs so as to cover its costs and generate surpluses for investments. The contract program to be established between the Government and ONCF will contain explicit provisions to enable ONCF to move towards financial autonomy. In addition, the Bank will assist the Government to proceed towards a progressive deregulation of the transport sector thus fostering competition between the railway and other transport modes such as buses and trucks. Steps will be taken to ensure that a transport development and policy study proceeds as already agreed with the Government, and that the Government will announce the steps by which deregulation will take place. 95. The three PEs in the petroleum sector which are to be restructured - SAMIR, SCP and SNPP - face very different problems. Overall, demand for petroleum products is barely growing (2% per year), but the situation varies for individual products. LPG has been growing strongly because of deliberate policies designed to encourage its use instead of the wood and charcoal now being used in many households. Gasoline demand is essentially stable, because of high prices, and fuel oil consumption could drop by as much as 20S if coal is substituted for it in power generation. The refineries which now operate at only 601 of capacity may have to reduce throughput even further under these circumstances. Moreover, there is a significant and growing imbalance between the structure of internal petroleum product demand and the product mix being  - 32 - produced by the local refineries. This is exacerbated by the variance between the structure of international petroleum product prices and the prices set domestically for ex-refinery output. Finally, the ability of these companies to respond in a commercial manner to changing market conditions has been hampered by the growing burden of arrears. The restructuring actions will concentrate on handling these arrears which now bind the three PEs financially, and on studying the pricing and supply of petroleum products with a view to'giving the companies greater flexibility while optimizing the supply of petroleum products to Morocco. 96. Detailed financial projections have been made for ONE, ONEP and ONCF based on the proposed investment programs, tariff levels, and accounting standards proposed. They show that ONE achieved the ability to cover operating and maintenance costs without recourse to Government financing in 1986, while ONCF is expected to reach that point after 1990. ONEP will need government support for its investment programs if it is to keep tariffs low enough to make water affordable to most urban dwellers. Detailed projections have not been undertaken for the petroleum enterprises because of the uncertainties surrounding the future levels of prices, and the requirements for investments. For the immediate future, the refineries will face no financial difficulties as the pricing system provides them with sufficient resources, but the distribution companies are strained as distribution margins are too low. The studies in the petroleum sector are intended to address these issues. G. PERL Justification and Risks 97. The adjustment of the PE sector is a critical component of Morocco's medium-term recovery and development strategy. This loan will provide technical and financial support to rationalize the role of the State in the economy and improve the operating efficiency of selected PEs. 98. The promotion of financial autonomy and accountability, and the introduction of programming procedures and contract programs will serve to streamline the respective functions of the State as owner or shareholder and the PE management as operator. The progressive disengagement of the State from commercially- oriented activities should result in a more responsive operational environment with greater reliance on decentralized decision-making. Properly appraised and economically viable operations should raise returns on investment. Reforms in the Government's budgeting procedures will ensure greater consistency among the allocation of resources, the future demands of the economy, and medium-term development objectives. 99. At the enterprise level, the improvement of management information systems, accounting and auditing will strengthen managerial decision-making and increase the transparency of operations. The specific restructuring programs and studies supported by this loan will help PEs adapt to an environment which is increasingly subject to market forces. 100. Reform of pricing policy, the elimination of arrears, and greater financial autonomy for the PE sector will have positive effects on both the macro-economic performance as well as the performance of individual  - 33 - enterprises. Setting output prices at levels which reflect the true scarcity value of the goods or services provided by PEs should serve to monitor efficiency gains and to check unrestrained growth of overall domestic demand, while achieving a more efficient deployment of productive resources. Arrears clearance and the prevention of future arrears will help improve budgetary discipline, reduce Government consumption of public services and thereby contribute to the goal of macro-economic stabilization. Finally, the increased financial autonomy of PEs will help to enhance their internal cash generation and reduce their budgetary dependence, thus improving Government savings and reducing claims on credit to the economy. 101. The incremental impact of the reform program on the broad macro-economic aggregates during the 1987-88 period is expected to be as follows: (i) the Government budget deficit should decline by DR 2.5 billion as a result of reduced transfers to public enterprises and higher tax and dividend revenues accruing to the Treasury; and (ii) the current account deficit should decline by US$ 7.5 million. Moreover, inflation is expected to fall owing to productivity gains in the major PEs and the deflationary impact of eliminating arrears, and employment is projected to grow as a result of a reallocation of real resources in line with the country's comparative advantage in relatively labor-intensive activities. 102. Project risks are essentially financial and institutional in nature. A re-emergence of the arrears problem through an inability of the Government to meet its commitments for investment budgetary transfers or to pay for its consumption of PE output is the main financial risk. It will be mitigated through: (i) the pursuit of a satisfactory fiscal stabilization program throughout the 2 year duration of the loan disbursement period; (ii) the implementation of an arrears settlement scheme; (iii) the establishment of realistic budgetary appropriations for the payment of obligations due and expenses incurred by the Government; (iv) the institution of mechanisms that promote price adjustments to reflect economic costs; (v) the implementation of restructuring programs of economically viable PEs; and (vi) the formulation and implementation of policies and programs to decrease the weight of the PE sector in the economy through State disengagement and privatization actions. 103. The main institutional risks are that existing vested interests within governmental institutions will resist the measures aimed at reforming the current situation whereby the Tutelage Ministries interfere with PE management and the Ministry of Finance exercises ex ante controls over critical PE activity. This risk is mitigated through the reactivation of the CIPEP which will promote the appropriate expression of ministerial interest in PE matters. The replacement of ex ante controls by ex post monitoring will be supported by appropriate accounting practices, independent auditing requirements and contract programs. 104. The capacity of existing Governmental institutions to implement a broad-ranging and complex reform, while monitoring the implementation of many enterprise restructuring programs, will be strained. This risk has been addressed through the organization of specialized task forces, assisted by consultants, to help government agencies in implementing each of the tasks envisaged under the reform program. It should, however, be recognized that full achievement of the PE reform can only be accomplished in the medium-term.  - 34 - PART V - THE BANK LOAN (a) Disbursement 105. The loan, in an amount of US$240 million equivalent will finance sectoral policy reform, enterprise restructuring and technical assistance. The Loan is expected to be fully disbursed by June 30, 1989. 106. A component of US$ 117 million will support policy actions and overall reform measures that the Government will undertake for the entire PE sector. Disbursement will be made against foreign exchange expenditures related to eligible general imports. Ineligible imports will include goods financed from other sources, goods intended for military or paramilitary use, and goods for luxury consumption. A further US$ 117 million will support actions that the Government will undertake to implement the envisaged reform measures in the six selected enterprises, as well as to address some of their organizational, financial and operational problems. Disbursements will be made against foreign exchange expenditures (spare parts for ONCF, chemicals for ONEP, coal for ONE, crude oil for SMIR and SCP, and LPG for SCP and SNPP) of the six PEs to be restructured under this loan. Disbursement against petroleum products will be limited to US$60 million of the total allocated to the six PEs. Six million dollars, including the refinancing of a US$1.25 million PPF advance approved by the Bank on September 10, 1986, will finance consulting services required to support the implementation of the reform measures, restructuring actions and studies. Annex VI contains details of Technical Assistance and Training activities to be financed under this loan. The Ministry of Finance (DErP) will bear financial and technical responsibility for the component. Disbursement will cover 1002 of all foreign exchange expenditures for imported goods, 1001 of total expenditures for both foreign and local consultants' services, as well as 100% of the foreign and 80% of the local expenditures for the purchase of the hardware required for the development of DEPP's public enterprise information system. 107. Disbursement of the loan proceeds for general and enterprise imports will be made in two tranches totalling US$120 and US$114 million. Disbursement against general imports will be US$70 and US$47 million in the first and second tranches, respectively; those for enterprise imports US$50 and US$67 million. Disbursements of the TA component will be carried out throughout the disbursement period according to the pace of TA expenditures. 108. Applications for withdrawals from the loan account will be consolidated and submitted in amounts of not less than US$1 million, with the exclusion of the TA component fox which smaller withdrawal applications will be accepted. In view of the progress made by the Borrower in implementing significant aspects of the envisaged reform program, the Bank will provide retroactive financing to March 1, 1986 of eligible expenditures up to a maximum of US$24 million. A Special Account (revolving fund) for general and PE imports and TA will be established in the Bank of Morocco, to which the Bank will make initial deposits of up to US$50 million. The revolving fund will be replenished against withdrawal applications at monthly intervals, or as appropriate, when their individual undisbursed balance falls below US$20 million. The closing date of the loan will be June 30, 1989.  - 35 - (b) Procurement 109. Contracts for the procurement of imported goods by the private sector estimated to cost less than US$5 million will be awarded on the basis of the normal procurement practices of the purchasers, which are generally based on price quotations obtained through international commodity markets. Imports under US$5 million by public sector entities, including the six selected enterprises, will be procured in accordance with government LCB procedures which are generally consistent with the need for economy and efficiency in the execution of the project and will be applied in such a manner as to be acceptable to the Bank.. Contracts for all other goods, public and private, estimated to cost US$5 million or more each, will be procured through international competitive bidding, with simplified advertising and currency provisions, in accordance with Bank Guidelines. Procurement of coal, crude oil and LPG will be carried out on the basis of the normal procurement practices of the purchaser. In particular, coal procured by ONE is based on long-term existing contracts which have been reviewed by the appraisal mission and found satisfactory. Crude oil procured by SAMIR and SCP is carried out either under bilateral agreements with oil exporting countries, based on prevailing market prices, or on the spot market through direct negotiations in accordance with accepted industry practices. Goods of a proprietary nature, such as computer equipment, may be procured under contracts directly negotiated with the supplier. Contract for general and specific imports will be grouped in bid packages of US$1 million or more each, to the extent possible. (c) Monitoring and Tranche Release 110. Bank supervision of project implementation will focus on: Xi) Government progress in pursuing appropriate programs of fiscal stabilization; (ii) the implementation of the PE sector rationalization program as a whole and of the particular six PEs included in the project; and (iii) procurement supervision. Loan expenditures (including Statements of Expenditures) and the Special Account will be audited by independent auditors acceptable to the Bank. 111. Release of the two tranches of the proposed loan will be contingent on the achievement of the following conditions: FIRST TRANCEE (loan effectiveness) Release of the General Reform (US$70 million) and Enterprise (US$50 million) Components - adjustment of ONCF tariffs; - completion of cross-cancellation of arrears and issuance of bonds required to settle Government net arrears to PE sector; - signing of contract-programs for ONEP and SNPP; and  - 36 - - signing of consultant contracts for key studies, notably the inventory and evaluation of the portfolio of PEs, the restructuring program for BRPM, the definition of electricity tariffs and establishment of a least-cost coordinated investment program for the power subsector, the definition of potable water tariffs, and the transport development study. SECOND TRANCHE (about one year after loan effectiveness) Release of the General Reform (US$47 million) and Enterprise (US$67 million) components. - the Bank being satisfied with the overall progress achieved by the Borrower in carrying out the PE rationalization program; - allocation in the government budget for 1988 of amounts sufficient to cover its water and power consumption during 1988 and limitation of budgetary transfers for investments (payments for 1987 and allocations for 1988) to agreed levels for ONE, ONEP and ONCF; - further adjustment of tariff of ONE, ONEP and ONCF, as appropriate; - completion of the studies for the restructuring of the mining sector, discussion of their results with the Bank and agreement on timetables for implementation of agreed results; - review with the Bank of the inventory and evaluation of the portfolio of PEs and agreement on an associated recommendations for a privatization strategy and program; - completion of the first phase of the study on tariff structures and levels for electricity and potable water and on the restructuring of the transport sector, and discussion and agreement with the Bank to implement results, as appropriate; - completion of the study on price structure of petroleum products, and discussion and agreement with the Bank to implement results as appropriate; - introduction of external audits in ONE, ONEP, ONCF, SAMIR, SCP and SNPP; and - signature of contract-programs for ONE, ONCF, SAMIR, and SCP. PART VI - OTIHER BANK GROUP OPERATIONS IN MOROCCO 112. Bank Group lending to Morocco, in support of 70 projects, has totalled US$3013.4 million (net of cancellations) of which US$25 million were from a third window loan. US$2,534.3 million are currently outstanding, of  - 37 - which US$1,433.5 mi.llion are disbursed. These figures include IDA credits, totalling US$45.2 million, which were made available for five projects until 1975. Total IFC investments amount to US$94.5 million in 12 operations (US$90.4 million after cancellations, terminations, repayments and sales). Annex II contains a sulmmary statement of Bank Group operations as of September 30, 1986. 113. In recent years, project implementation experience has been mixed. While technical and management constraints within many project entities have been overcome, shortages of budget funds since 1983 have hampered the performance of those entities which rely on the Government budget for part of their project financial requirements. Insufficient budgetary provisions pertain both to investment and current Government expenditures. Combined with rigidities in pricing policy, these shortfalls have contributed to disappointing financial performance of project entities through a build-up of arrears to private contractors and to public enterprises. Disbursement results have largely reflected the above conditions, as well as the fact that for much of the period 1984-86, appreciation of the Dollar vis-a-vis the Dirham reduced project costs and therefore reimbursable expenditures in Dollar terms. To alleviate budgetary constraints and improve project implementation, Special Action Program (SAP) provisions were applied to 15 Morocco loans during this period. This contributed to improving the ratio of actual disbursements to appraisal estimates from an average of about 43b in 1984, to 54.3% in March, 1986 - close to EMENA Region averages. In FY86, total Bank disbursements to Morocco were US$375.0 million, while repayments were the equivalent of US$103.0 million. 114. The overall objectives of the Government's medium-term strategy are to restore sustainable growth rates and reduce the debt burden to manageable levels. The Bank's assistance strategy is to support Government programs which contain concrete measures to: (i) mobilize resources, particularly increase public savings; (ii) improve mechanisms for the efficient allocation, monitoring and use of public resources; (iii) promote exports and efficient import substitution; (iv) enhance equity in the distribution of economic gains. Such support implies promoting flexible institutional structures, enhancing the decentralization of decision-making, and creating an environment which stimulates private sector investment and production. The principal vehicles for supporting Government programs to promote stabilization and structural adjustment in the major economic sectors will be sectordl policy operations. They will form a large part of the Bank's assistance program. Given the resource constraints imposed by fiscal stabilization, investment proposals relying on the Government budget need to be carefully scrutinized. There is, however, scope for (i) formulating investments which redress imbalances in income distribution and in the access of the population to public services, and (ii) financing the resource needs of private sector enterprises and export industries which are being restructured so to operate efficiently within the new trade regime. Viable operations financing essential maintenance required to sustain essential service levels are also included in the strategy. Project lending will thus continue, albeit at constrained levels similar to those characterizing the past three years of the program. The Bank's economic and sector work program has been designed to  - 38 - provide the analytical basis for the structural reform programs in each of the major sectors, and for subsequent Bank lending in each. In addition to addressing key sectoral policy issues, economic and sector work contains periodic reviews of the public investment programs to help the Government allocate its scarce resources to high priority projects. The results of the Bank's general macro-economic work, shared with members of the Consultative Group for Morocco in March 1987, is being supplemented by special studies on resource mobilization, on the employment situation and the impact of the overall structural adjustment program on economic activity and on the poor. Together with the IMF, the Bank intends to evolve a medium-term framework for fiscal policies aimed at a broadening of the tax base and a rationalization of public expenditures. A recurrent element of the macro-economic dialogue is the evolution of a program to streamline and integrate investment planning and budgeting, with emphasis on appropriate resource allocation and project selection. Sectoral studies in the Energy, Urban, Population, Health and Nutrition sectors are expected to provide the basis for future operations in these areas. 115. The Government's constrained resource position has led to the postponement of preparation of a new Development Plan. Budget constraints have limited investment expenditures essentially to the completion of ongoing investments. In these circumstances, the Government's development strategy has been modified to concentrate on policy reforms in major economic sectors aimed at the transformation of the economy into a more efficient producer of goods and services and with greater participation in international trade and more reliance on the private sector. Reforms have been introduced in the Financial, Industrial and Trade regimes so as to improve resource use, change incentives to realize the potential for export development and to promote private and public savings. The Agricultural sector is being modernized through a restructuring of the investment program and a re-orientation of prices and incentives: support and delivery systems are being strengthened and the capacity for sector planning, policy analysis and execution reinforced. The Education system is being re-oriented to improve its balance, quality and equity of access through the promotion of primary education and vocational training; sectoral efficiency will be enhanced through measures to reduce unit costs and curb the growth of budgetary outlays. In the recognition that the dependence of Public Enterprises on the Government budget needs to decrease, the Government has decided to change the nature and scope of its interventions in the public enterprise sector through the promotion of financial, managerial and administrative autonomy of public enterprises as well as a rationalization of the State's role in the economy. PART VII - RECOMMENDATION 116. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve this loan. Barber B. Conable President April 30, 1987 Washington, D.C.  - 39 - Poulation 21.4 million (196") of I GNP Per Capita: USS 610 (I8)Page 1 J un1t (mitlon USS at 6-ws Ok 3nal d current prices)__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __P i e d Indicator Cu1L. 13n1 132 1 11 -2 1 1n I3 11 NATIONAL ACtlJWS Gross dstic product s 11191 -1.2 6.8 2.2 2.1 4.3 5.7 3.8 4.4 3.9 4.3 Agricultu 218" -22.9 19.9 -3.7 -.3 12.1 15.0 10.0 8.0 3.5 3.5 Industry 3776 -0.1 2.2 2.9 -1.1 2.3 8.3 4.3 6.2 5 5 5.9 Services 5929 5.8 6.1 3.7 4.6 3.3 1.5 1.5 2.0 3.0 3.5 Cnnsrution 10497 2.0 6.0 0.) 2.7 3.1 4.3 3.3 4.3 3.5 4.0 Gross investent 2583 -11.2 6.8 -13.0 1.4 2.8 5.7 *.0 4.6 3.6 4.4 Exports of GNFS 3184 0.2 4.9 6.2 2.8 4.8 7.4 6.9 5.7 5.7 5.8 Igrorts of Glf 437" 1.9 3.1 -11.) 4.2 -0.3 2.1 4.1 5.3 4.0 5.0 Gross national savings 1330 -3S.1 4.0 24.7 -4.3 10.4 37.7 7.4 7.5 2.1 10.4 U= ~ im im mau nu ma mt JIM GOP deflator (1980 a 100) 100.0 110.8 121.8 125.1 135.7 148.6 163.1 ExCb