Madagascar - Public Sector Adjustment Program Project

Document of The World Bank FOR OFFCIIAL LUSE ON(I Peport No. P-4780-MLAG REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMFENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPnSFD CRED1 r OF SDR Q0.5 MILLION TO THE DEMncRATIC REPUBLIC OF M!ADAGASCAR FOR A PUBLIC qFCTOR ADJUST-ENT PROGRAM June 10, 1988 This document has a restricted distribution and man he used by recipients onls in the performance of their official duties. Its contents ma! not otherviwe he disclosed without N%orld Bank authorization.  DEMOCRATIC REPUBLIC OF MADAGASCAR CURRENCY EQUIVALENTS Unit = Malagasy Franc (FMG) USS = 1280 FMG (on May 31, 1988) FISCAL YEAR January 1 - December 31 WEIGHT AND MEASURES Metric System GLOSSARY OF ABBREVIATIONS ADF = African Development Fund ASAC Agricultural Sector Adjustment Credit BNI = Industrial Bank BTM = Agricultural Bank BFV = Commerce Bank CG - Consultative Group DGP = Directorate General of Planning EMSAP = Economic Management and Social Action Program ISAC = Industrial Sector Adjustment Credit ITPAC = Industry and Trade Policy Adjustment Credit LIR = Liberalized Irrort Regime OGL = Open General L:-ence PE = Public Enterpt .,es PEP = Public Ex?enditure Program PIP = Public Investment Program PSAC = Public Sector Adjustment Credit SAF = Structural Adjustment Facility SFA = Special Facility for Africa  FOR OFFICAL USE ONLY MADAGASCAR PUBLIC SECTOR ADJUSTMENT OPERATION Credit and Program Sunmnary Borrower: Democratic Republic of Madagascar Amount: IDA Credit SDR 90.5mn. (US $125mn. equiva2ent) Cofinancing: ADF UA 30mn. Switzerland SF lOmn. Terms: IDA Credit: Standard IDA terms (with 40 year's maturity) ADF Credit: Maturity 50 years (incl. 10 years grace); interest rate 0.75% Switzerland: Non-reimbursable contribution Oblectives and The proposed operation is intended to support Description: the next phase of the adjustment process. Its objective is to promote an early transition to per capita growth with increased social equity, through measures to accelerate the supply response to the new market-oriented incentive structure. It consolidates the policies recently adopted, and capitalizes on them by additional measures in the public enterprises, financial sector, public expenditure, external sector, and social policy areas. Atter a 5-year period of stAbilization through demand management, and of partial scctoral reforms in industry and agriculture, Madagascar launched in 1987 a broader program of economic reform (including major exchange rate adjustments) incorporated in the Policy Framework Paper for 1987-91 and in IDA's Industry and Trade Policy Adjustment Credi. (ITPAC). The major liberal4zation effort is uell under way, but requires concentrated attention to practical impleuen.zation problems, correcting certain major distortions, and continued financial support. Growth, so far, has been slow to respond, because of deteriorated infrastructure, severely depressed imports after six years of consecutive iecline, slow growth in domestic demand, and serious credit difficulties partly arising from an inefficient parastatal seLtor and banking system. Progress to-date has exposed a next generation of problems, which are addressed by the program supported by 'he proposed credit. 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.  -ii- First, public expenditure has been cut with insufficient attention to the country's development strategy or the new incentive fran'ework. The program, therefore, includes measures to strengthen the public expe ire budgeting and allocation process, or(,.. improve the efficiency of experndi. -: r* quality of public services. Secor.-, the larce and inefficient parastatal sector has (wiusec a severe resource drain. Partly from t'is, c:;d partly from the inefficiencies of' the 0,ate- owned banking system, credit for productive activities has been crowded ou t. T'h,e prc f:o: includes malor reforms, Incor:p':i nt I substantial upfront actions, to r-r.t' n .e the parastatal sector and 1 ibe: a' - . ' improve the efficiency of the bankr' An the external sector, Ic c implementation problems are - &d--essec e rermoval of remaining acc ' resLrictions, ar.d by tri :nrr m.chkanisms to assure fu ' ! i m7l e o: f the liberalizatior. meas_res. external marketing of coffee, : major expcrt crop, is iibc: n 2c Ma,or attention is paid : progra-; supportec by the o e c trie socia aspectas of t;he ard_-: in, order to address th.e coc-t.: prolonged econo:;'ic dec rIo, . : re?erc.;ssions of certain ad:- on spec.fic groups, ard he e effectively the general social rib e' -, development. 7st `maed Disbursements: The proceeds of the credt w available in three tranches, resmecti'.d ^-' effectiveness, and upon satisfac 'fa o c- conditions listed in paragraphs 8S this report. To even ov.t t e foreign exchange cash flow durnnr. *he i I period, the first two tranches wii ze o : 25.34 mn each, while the thi4rd tra..cP-e of SDR 39.82 inn. A perforr.ance rev'ewe:: be held around March 1989, before the rc>.-ce of the second t ranc'ne, and - .o r er>r z around November 1989, before the rtie-.e the third tranche. Disbursement s are exr; ed to be completed withiin 24 rmonth-s from. th7 c : e of effectivenes M3RD No. 20035  MADAGASCAR PUBLIC SECTOR ADJUSTMENI OPERATION Table of Contents Page No. CREDIT AND PROGRAM SUMMARY ....................................... PART I - THE ECONOMY A. Background ................................................ 1 3. Macroeconomic Developments and Stabilization Policies ..... 2 C. Earlier Adjustment Policies and Results ...e ............... 3 D. Economic Prospects ...................... . 6 E. The External Debt Problem ................................. 7 F. Rationale of Bank Support ................................. 8 PART II - THE GOVERNMENT'S ADJUSTMENI PROGRAM A. The Adjustment Strategy ................................... 8 B. The Government's Financial Program ..... .................. 9 PART III - THE PROPOSED OPERATION A. Background ........................0........................ 1 B. The Policy Reform Program 1. Public expenditure policies ........................... 11 2. Public enterprises .................................... 12 3. Financial sector ...................................... 14 4. Export promotion and trade liberalization .... ......... 15 5. Social policies ....................................... 17 C. Effects of the Adjustment Program .......... .. ............. 20 D. Risks .......................... ........................... 23 E. Social Impact ........ .............. ....................... 24 F. Credit Amount, Tranching, Coordination and Cofinancing .... 24 G. Disbursement, Procurement, Administration and Auditing .... 25 H. Monitoring and Tranche Release ............ .. .............. 26 PART IV - BANK GROUP OPERATIONS AND STRATEGY A. The Existing Portfolio .................................... 28 B. Bank Strategy ........... 28 PART V - RELATIONS WITH THE IMF .................................. 30 PART VI - RECOMMENDATIONS ........................................ 30  Table of Contents (Cont'd) Page No. TEXT TABLES: Table 1: Main Economic Indicators, 1983-87 ............. 2 Table 2: Projections of Economic Indicators under Adjustment Assumptions, 1987-91 .... ........ 20 Table 3: Financing Requircments, 1987-91 .... ........... 21 ANNEXES: I: Country Data ........ .......................... 31 II: Status of Bank Operations ..... ................ 37 III: Supplementary Credit Data Sheet .... ........... 39 IV: Government's Letter Development Policies ...... 41 V: Matrix of Policy Issues, Measures and Timing . -6 MAP: Madagascar - Map No. 20035 IBRD  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR A PUBLIC SECTOR ADJUSTMENT PROGRAM 1. I submit the following report and recommendation on a proposed IDA Credit of SDR90.5 million (US$125 million equivalent) to the Democratic Republic of Madagascar on standard IDA terms, to help finance a public sector adjustment program. In addition, I recommend that IDA administer a proposed non-reimbursable contribution of Sw FIO million (about US$8 million equivalent) by Switzerland. 2. In mid-1987, shortly after the approval of IDA's Industry and Trade Policy Adjustment Credit, the Government requested IDA assistance in support of the next phase of its adjustment program. The principal elements of the proposed program we - discussed at the 1987 Annual Meetings. On that basis, a Bank pi paration mission took place in October/November, and the program was appraised during February 1988. The conclusions of the appraisal mission are reflected in this report. 3. Also reflected below are the findirgs of an economic review, entitled "Economic Progress Report" and dated December 1987, which was distributed to participants in the Madagascar Consultative Group meeting in January 1988. The Consultative Group strongly endorsed both the general thrust and the substance of reforms in the principal policy areas covered by the Government's adjustment program, which is described in Parts II and III. PART I - THE ECONO.MY A. Background 4. With a population of ten million growing at three percent per year and a per capita income of US$230 in 1986, Madagascar is one of the poorest countries in the world. Its economic record is one of modest growth from independence in 1960 to 1972, stagnation from 1972 to 1980, sharp deterioration between 1980 and 1982, and financial stabilization with limited economic growth from 1983 to date. (Table 1 shows the ptincipal macroeconomic indicators, and detailed country data are found in Annex I). 5. The poor economic performance of the 1970s stemmed largely from inappropriate economic policies, which emphasized a much increased public sector role, with industrialization as the central objective, agriculture in a supporting role, nationalization of foreign-owned enterprises, extensive consumer subsidies, and pervasive controls on private economic activity. Nevertheless, cautious financial policies led to low fiscal deficits; the balance of payments remained in approximate equilibrium; and the debt-service ratio was only 4 percent.  - 2 - 6. Between 1978 and 1980, however, the Governmen- embarked on a policy of all-out publ4c investment, very poorly coordinated, concentrated on economically unvilable projects, and financed mainly by external borrowing. This policy combined with declining terms of trade and stagnant domestic revenues to produce a fiscal deficit of ovet 18 percent of GDP, an inflation rate of 30 peLcent, a 10 percent decline in real GDP from 1980 to l982, and a large increase in the external debt burden, which still severely constrains economic recovery. Table 1. MAIN ECONOWIC INDICATORS, 1983-87. 1983 1984 1985 1986 1987 As % of GDP: Wdse. Exports fob 10.9 :4.0 11.9 12.4 16.0 Jdse. Imports fob 13.3 14.8 14.3 12.5 16.2 Current Account 10.9 10.4 10.9 8.7 11.7 External Debt 71.6 90.1 96e3 101.0 167.3 Gov't Revenues 16.2 17.8 18.2 165. 19.1 Current Expenditures 13.1 13.7 13.3 12.3 13.6 Public investment 7.2 7.9 7.1 6.s 8.7 CGv't Deficit 6.7 4.8 4,7 4.0 4.4 Cross Domestic Investment 13.2 13.8 14.0 13.8 14.1 AS of X of Total Exports CebQ Service (after resch.) 31.4 33.4 49.2 45.e 62.0 Terms of Trade % change 19,7 1.2 -6.7 8.2 -24.7 -P rm growth (%) 0.9 1.7 2.3 0.8 1.4 *Changes ;n tie ratios of external variables to GDP are heavily influenced by deva;.at>