Guinea - Private Sector Promotion Program Project

V Docunent of The World Bank FOR OFFICAL USE ONLY Repot No. P-5207-GUI REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 38.7 MILLION EQUIVALENT TO THE REPUBLIC OF GUINEA FOR A PRIVATE SECTOR PROMOTION PROGRAM APRIL 19, 1990 Ths document bas a restricted distibutbo and may be used by recipients only In the performnace of ther offcal duties. Its contents may not otherwise be dicosed without World BDak authorization.  CURRENCY EQUIVALENT Currency Unit: Guinean Franc (OF) US$ - GF 650 (as of April 1990) ABBREVIATIONS AND ACRONYMS BCRG - Banque Centrale de la R4publique de Guin4e (Central Bank) CCCE - Caisse Centrale de Coop6ration Economique CCEF - Comite de Coordination Economique et Pinancibre CNI - Commission Nationale d'Investissements CNPIP - Centre National de Promotion des Investissements Prives EKSP - Economic Management Support Project FAC - Fonds dAide et de Cooperation FIAS - Foreign Investment Advisory Services ILO - International Labor Organization ONEMO - Office National de l'Emploi et de la Main d'Oeuvre ONPPME - Office National de Promotion des Petites et Moyennes Entreprises PFP - Policy Framework Paper SAF - Structural Adjustment Facility SAC - Structural Adjustment Credit UNDP - United Nations Development Program USAID - United States Agency for International Development  FOR OFFICIAL USE ONLY REPUBLIC OF GUINEA PRIVATE SECTOR PROMOTION CRIT Table of Contents I. THE ECONOMY A. Background: 1958-84 ................................. 1 B. The Reform Program: 1985-89 . . 2 C. Medium-Term Prospects: 1990-93 ...................... 4 II. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT A. Background . .......... 5 B. The Depressed Investment Climate . . 6 1. Overview . . ............................. ....... 6 2. The Legal/Regulatory Framework . . . 9 3. The Incentive Structure ....................... . 11 4. The Institutional Framework for Investment Promotion ....................... 13 C. The Fragility oi the Financial Sector .. . 14 1. Overview ....................................... 14 2. Resource Mobilization .......................... 17 3. The Functioning of Credit Markets .............. 17 4. The Role of the Central Bank ................... 19 III. PROGRAM DESCRIPTION A. Program Rationale and Objectives . . 20 B. The Establishment of an Enabling Investment Environment .............................. 22 1. Imr.roving the LegallRegulatory Framework ....... 22 2. Rationalizing the Incentive Structure .......... 23 3. Restructuring the Institutional Framework for Investment Promotion ............. 25 C. The Deepening of Reforms in the Financial Sector.... 26 1. Implementation of the Reform Program . . 26 2. Interest Rate Reform ........................ ... 26 3. Rationalization of Credit Markets . . 28 Table of Contents (Cont'd) This document has a restricted distribution and may be used by recipients only in the pe.formanc., of their official duties. Its contents may not otherwise be disclosed without World 8ank at th r.v ion.  4. Enhancing the Effectiveness of the Central Bank ................................... 30 IV. PROGRAM IMPLEMENTATION A. Amount and Timing .................................... 30 B. Coordination with the IMF and IPC ................... . 31 C. Co-Financing . ........................................ 31 D. Procurement and Disbursement Arrangements .. 31 E. Program Administration and Auditing . . 32 F. Benefits and Risks ..... ........ ... . ........ .. 33 G. Conditionality ....................................... 35 V. RECO)MBNDATION.. ................ 36 APPENDIXES APPENDIX I (Table 1) - Key Macroeconomic Indicators (Table 2) - Balance of Payments. 1988-93 (Table 3) - Gross Domestic Product - Sectoral Composition APPENDIX II (Table 1) - Financial Sector, 1986-1989 (Table 2) - Structure of Interest Rates APPENDIX III - Summary Performance under Previous Adjustment Operationr APPENDIX IV - Supplementary Credit Data APPENDIX V - Policy Matrix APPENDIX VI - Statement of Sectoral Policy APPENDIX VII - Status of Bank Group Operations in Guinea APPENDIX VIII - List of Documents in Project Files APPENDIX IX - List of Privatized Firms APPENDIX X - Status of Manufacturing State Enterprises  - (i) - REPUBLIC OF GUINEA PRIVATE SECTOR PROMOTION CREDIT Program Summary Borrower: Government of Guinea. Credit Amount: IDA Credit of SDR 38.7 million (US$50 million equivalent), to be disbursed in two separate tranches. Terms: Standard IDA terms, with 40-year maturity. Program Description: The Credit would support a series of reforms aimed at improving the investment climate in Guinea. The objective of the Program will be to establish a regulatory, incentive and institutional framework designed to improve the local business enviroDment and to encourage both local and foreign promoters to undertake investments in productive activities. Specific reforms targeted by the Program include: (i) Simplification of the legallregulatorj framework: streamlining of enterprise establishment and registration procedures; liberalization of labor regulations; and enactment of texts establishing legal basis for private ownership rights on commercial buildings. (ii) Enhancement of the overall incentive structure: improving the effectiveness of the new tariff and investment regimes; eliminating distortions related to the ad hoc award of exemptions and other special incentives outside of the Investment Code's framework; and overhauling of Customs Administration. (iii)Increased effectiveness of the institutional framework for investment promotion: rationalization of the existing framework, to lead to enhanced operational efficiency. (iv) Improving the policy and operational framework in the financial sector: deepening of interest rate reform in order to broaden resource mobilization at the level of local banks; rationalization of credit markets, including the consolidation of discount/refinancing windows; establishment of an improved legal framework for banking activity;  - (ii) - and strengthening of the Central Bank's capacity to monitor activity in the banking sector. Benefits and Risks: The Guinean Government undertook in the mid-1980s an ambitious economic adjusument program aimed in particular at liberalizing the economy and at reforming the public sector. Although successful in other respects, the program has so far failed to bring about a favorable supply response by private operators. The reforms made part of this cperation would further deepen the reforms undertaken under the two SACs, by seeking to improve the confidence of hoth local and foreign promoters in the local environment, and thus promote new productive investment. As a result, these reforms would enhance financial flows to sectors heretofore starved of new capital, thereby boosting growth in the manufacturing sector. New jobs created in the process would in turn provide a much-needed alternative source of employment for the urban population, at a time of lay-offs tied to public sector reform. The Program would thus alleviate the social cost of adjustment and improve the overall sustainability of the adjustment program. The risks involved are two-fold: (1) that, given the long-standing negative attitudes towards the private sector by public officials, the new set of reforms will not be forcefully implemented by government officials that deal on a daily basis with business operators; and (2) that despite the new measures, private promoters will maintain a cautious, non-committal attitude towards Guinea. The first type of risk should be offset by the commitment felt at the highest level of Government to push forward the reform program. Moreover, the program does not only focus on the regulatory framework per se, but also attempts to improve the administration's oversight capacity, effectiveness, and accountability. As for the second type of risk, it is clear that the constraining regulatory and incentive framework added to the government's interference in the daily operation of local businesses have been key factors in local as well as foreign investors' reluctant attitude towards Guinea. Given the country's strong -- and still mostly untapped -- economic potential, private investors should, in time, respond favorably to the improved investment climate to result from this operation.  INTERNATIONAL DEVELOPMENT ASSOCIATION PRESIDENT'S REPORT AND RECOMMENDATION TO THE EXECUTIVE DIRECTvRS ON A PROPOSED CREDIT TO THE REPUBLIC OF GUINEA FOR A PRIVATE SECTOR PROMOTION PROGRAM 1. I submit for your consideration the following report on a proposed Credit of SDR 38.7 million (US$50 million equivalent) to the Republic of Guinea in support of the GoverDment's Private Sector Promotion Program. The Credit would be on standard IDA terms, with 40- year maturity and a 10-year grace period. The report is based on the findings of several preparation missions undertaken between September 1988 and February 1990, as well as on a review of the industrial sector conducted by the Bank in November/December 1988. A summary of Guinea's performance under previous adjustment operations is provided in Appendix 3, while updated economic data on Guinea will be found in Appendix 1. PART I. THE ECONOMY A. Background: 1956-84 2. Guinea is blessed with natural resources which make it one of Africa's most richly endowed countries. It is in particular a major producer and exporter of bauxite and other minerals. It also offers strong agricultural potential resulting from abundant land resources and rainfall; indeed, the country was at independence a leading exporter of bananas and other agricultural commodities to 'European markets. Yet, per capita income of less than US$350 (1988) and uniformly poor living standards of its six-million-plus population place it among the least developed countries in Africa: life expectancy is only 43 years, and the literacy rate is a low 28 percent. 3. Under the regime of President S4kou Toure (1958-84), the private sector was largely displaced by a pervasive network of state enterprises in all sectors of the economy. Urbanization accelerated, as productive activities and incomes were increasingly shifted from the rural to the urban sector. However, emphasis on state-led development failed to produce the desired modernization and industrialization of the economy: the official sector was functioning under an elaborate but ineffective system of administered prices; the financial sector's inability to mobilize domestic savings under the skewed policy environment led to an overreliance on external financing and hence to a progressively heavier debt burden; and, the currency became increasingly overvalued, as inefficiency in the public sector produced a serious misallocation of resources in the economy, as well as a disincentive to  export 11. A poor incentive structure concurrently pushed the dynamlc agricultural sector into subsistence production. As a result of the sharp ensuing drop in agricultural product.on, Guinea had become by the mid-1970s a net food importer, with the economy increasingly reliant on bauxite exports. On the aggregate, economic growth 'tver the period remained below an annual population growth rate of close to 3 percent. 4. Meanwhile, the informal sector continued to thrive, feeding on clandestine exports and private transfers from abroad, and dealing mostly in smuggled or pilfered imports. Its scope expanded steadily, as the supply of goods imported through official channels could not meet the demand for foodstuffs and other essential goods. By the early 1980s, this parallel sector satisfied an estimated 80 percent of Conakry's consumer demand, and virtually all such demand in the country's interior. However, growth in the informal sector hardly compensated for foregone investment in the formal private sector, depriving the Government of otherwise badly-needed revenues. 5. By the early 1980s, tha extended deterioration of Guinea's economy had resulted in. an increasingly severe liquidity crisis. The Government's fiscal position had worsened, chiefly because of the growing weight of subsidies and other transfers to public enterprises. The economy's external position became unsustainable, due in particular to the failure of public investments outside of the mining enclave to generate returns sufficient to service the associated external debt. Mounting debt service obligations and private capital flight, unmatched by capital inflows, resulted in a continuous rise of foreign liabilities at the Central Bank, as well as in a massive accumulation of external arrears which amounted to over US$300 million by end-1985. B. The Reform Program: 1985-89 6. The new regime that came to power in 1984 embarked upon a radical -- and in many ways unprecedented -- program of reforms designed tot (a) redress financial imbalances; and (b) replace the old system of state controls and government intervention with a policy framework aimed at the creation of a market-oriented economy. The program was supported by the IMF in the form of two Standby Arrangements and a Structural Adjustment Facility, and by the Bank through a first Structural Adjustment Credit cofinanced by other donors. 7. Starting in 1985, the program involved a series of significant reforms (summarized in Appendix 3) in the areas of: ti) Money and banking. In 1986, the Guinean franc (GF) replaced the syli as the national currency. A weekly foreign exchange auction was instituted which, following an initial 94 percent 1/ The Guinean syli traded officially at 23 to the dollar at the end of 1985, as against a parallel market rate of around 400.  - 3 - devaluation (in foreign currency terms), yielded a rate of exchange of OF 4001US$ by end-1986, increcsing to GF 6501US$ by April 1990. Concurrently, the bankrupted state banks were all liquidated and replaced by three (now four) commercial banks with full or partial private shareholding. (ii) Pricing, trade and tariff 2olicy. The system of pervasive price controls was disbanded, except in the case of rice and petroleum products; import licensing procedures were replaced by a more liberal system of import declarations; the tariff regime was rationalized through the introduction of a uniform tariff of 10 percent for most goods; and, as of January 1988, turnover taxes on imports and on domestic production were fully harmonized. (iii)The civil service and state enterprises. About 30,000 public sector employees were removed from both active duty and payroll between 1986 and end 1988, with further reductions of 10,000- odd taking place in 1989. Over twenty public enterprises have been privatized since 1986, and an additional seventy -- mainly commercial -- parastatals are now in various stages of liquidation. (iv) The legislative environment. Several significant pieces of legislation were enacted, covering respectively new investment, mining, petroleum exploration, public procurement, banking, accounting, and commercial activity. 8. The reform package has produced encouraging results. Overall, macroeconomic aggregates show evidence of improved econoaic performance since the reforms were undertaken: GDP grew by around 3.2 percent in real terms in 1987, by over 6 percent in 1988, and by an estimated 4.4 percent in 1989, while inflation fell from 72 percent in 1986 to 26 percent in 1989. The country's long economic decline was thus reversed, leading to increased confidence by economic operators; private sector investment picked up over the periud, spurred by the privatization of major economic activities; and renewed trading boosted opportunities for local businesses while improving local availability of consumer and other goods. 9. Notwithstanding these gains, serious economic imbalances remain. Due to poor revenue collection, public receipts failed to grow in tandem with the overall level of economic activity. Lack of fiscal discipline led to an overshooting of the public sector's expenditure targets, and to a significant rise of the Government budget as a percentage of GDP over the 1986-88 period. The ensuing budget deficit of 7 percent of GDP in 1988 vs. the 5 percent target set in the Government's Policy Framework Paper (PFP) increased pressure on import demand which, in combination with the continued -- albeit significantly reduced -- overvaluation of the exchange rate, resulted in large deficits of the external curzent account.  - 4 - 10. Problems also arose in the execution of the reform process itself: 1988 saw an accumulation of arrears on the external debt and a further depletion of foreign exchange reserves (the Government yet continued to make foreign exchange available to the private sector through the weekly auction, and many of the arrears on the external debt were subsequently rescheduled at the April 1989 Paris Club meeting); meanwhile, the administrative reform program fell behind schedule. By the end of 1988, however, the Government had launched new initiatives to deal with some of the key problems, including a sharp devaluation of the exchange rate and new steps to test, select, and as needed dismiss civil servants. Given the significant progress already achieved, the second SAC was declared effective on March 2, 1989. C. Medium-Term Prospects: 1990-93 11. As presented in the PFP, basic objectives for the 1990-92 period are to: (i) achieve an average real annual economic growth rate of 5 percent; (ii) gradually reduce the rate of inflation to 10 percent at the end of the period; (iii) avoid any further appreciation of the real exchange rate; and (iv) reduce the current account deficit (including official transfers) to an average of 5.1 percent of GDP over the period, while helping restore the level of available foreign exchange reserves to the equivalent of 4.3 months worth of imports. 2/ The PFP's underlying macroeconomic scenario projects a decline in the overall budget deficit 3/, including grants, from 8 percent of GDP in 1988 and 5.1 percent in 1989, to less than 4.5 percent o'er 1990-95 (see Appendix 1, Table 1). The Government's recurrent budget situation is also expected to improve, from a deficit of 1.2 percent of GDP in 1988 to a surplus of nearly 3.5 percent over 1990-95, thereby contributing to the national savings effort. Such outcome is, however, contingent upon strict expenditure control, as well as on the Government's success in increasing non-mining revenues (given its dependence on bauxite-related income, Guinea's economy remains highly vulnerable to adverse trends in the international bauxite and alumina markets). Under that scenario, manufacturing is projected to grow over 1990-95 at an annual rate of 5.1 percent. 12. Despite the increase in national savings to result from the adjustment program, Guinea will be left with a balance-of-payments gap of US$104 million in 1990-92, over and above the amounts already committed (see Appendix 1, Table 2). These requirements are due both to the anticipated deterioration in Guinea's terms of trade, and to the debt service burden inherited from the period prior to 1986. The proposed Private Sector Promotion Credit would contribute to the financing of gap over 1990-91, both directly through the provision of 2/ Excluding imports of the mining sector and those related to the public investment program. 3/ All budgetary data exclude transactions with the USSR.  - a US$50 ntllion of quick-disbursing funds available against general import-, and indirectly through stimulus to foreign capital inflows which the improved investment climate would provide. A third SAC, currently planned as an FY92 operation, could, in association with cofinancing, be mobilized to meet Guinea's financing needs in 1992-93. 13. The proposed operation would complement the macroeconomic adjustment efforts supported by the first two SACs, as well as by the two companion Economic Management Support Projects (EMSP-I and II) which aim at improved ecornomic management through targeted technical assistance activities. The second SAC combined with the second-year arrangement under the SAF which came onstream in 1989 focused on: (1) resource moLilization and expenditure control; (2) the rationalization of the civil service; (3) the continuation of public enterprise reform; and (4) further strengthening of macroeconomic management, particularly with respect to budgetary management, exchange and interest rate policy, and price liberalitation. The proposed Program would expand on these efforts, by introducing the detailed reforms necessary to allow private sector operators to take full advantage of the favorable macroeconomic environment created under the existing adjustment programs. 14. The Program would also contribute to Government efforts to maintain an adequate social safety net for poor and disadvantaged groups. It would in particular lead to the creation of new jobs in the private sector, and improve overall living standards through increased revenue flows and generally higher levels of activity throughout the economy (see para. 112 for a specific discussion of the Credit's social benefits). PART II. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT A. Background 15. As indicated above, the Government has since 1985 taken significant steps to foster a favorable environment for private sector development in Guinea: a new Investment Code was introduced in January 1987; the trade regime was rationalized, and duty rates were substantially reduced; price controls were removed; and, a private banking sector vas set up and became operational. The initial response to the reform program was encouraging. Overall, the economy grew by 3.1 percent in real terms in 1987, and 5.9 percent in 1988. Agricultural production responded particularly well to changes in relative prices; as a case in point, official coffee exports grew to 8,000 MT in 1988, up from negligible amounts in 1985. Significant increases in activity were achieved in 1987 in mining, in energy, as well as in the service sector -- particularly construction, trade and transport. By comparison, the manufacturing sector grew at a compounded rate of barely 3 percent in 1987-88 (Appendix 1, Table 3). Overall growth weakened somewhat in 1989, but was still an estimated 4.4 percent. However, economic growth threatens to slow further in coming years, as the reduced fiscal deficit  will no longer provide the level of economic stimulus it did in the past. 16. Despite the introduction of the macroeconomic reforms, the local business climate remained plainly unsatisfactory, providing conflicting signals to promoters and thus contributing to the continued sluggishness in investtment levels. As a result, the enthusiasm that Guinea had initially evoked from potential local as t'ell as foreign investors now appears to be dwindling, a trend which must be reversed if Guinea is to meet the targets it has set for itself in the PFP. The proposed Program aims simultaneously at improving the local business environment and at addressing continued constraints in the financial system, with a view to bringing about a sustained supply response to the reforms from Guinea's private sector. In so doing, it will focus on promoting investment in the industrial sector, to redress the private sector's present strong bias towards trading activity. Constraints relating respectively to the business climate and to the financial sector are analyzed separately below. B. The Depressed Investment Climate 1. Overview 17. Prior to the introduction of the reform program, formal private sector activity in Guinea was very modest. Until 1984, state control ov-r all formal commercial and manufacturing activity was pervasive, stifling private initiative. State enterprises held monopolies over all exports, over marketing channels for most consumer and intermediate goods, and over practicslly all industrial activity. In 1985, there were 42 state-owned industrial enterprises, representing a sunk investment cost in excess of US$325 million and accounting for an estimated 42 percent of ma;facturing value added. These enterprises employed approximately 7,2u0 workers, and were primarily involved in agro-processing, with others in chemicals, pharmaceuticals, and metal products. Despite the existence of a substantial unsatisfied demand for their output, these enterprises operated at a paltry average rate of capacity utilization of 22 percent. In effect, only 23 of these 42 state-owned firms were still operational in 1985; of these, only six generated operational surpluses, and none were profitable after depreciation and amortization. 18. The formal private sector was, at the time, comprised of around 360 small- and medium-scale enterprises, 130 of which were engaged in simple manufacturing activity (mainly in food, wood and simple metal manufacturing). These firms, which had somehow msnaged to adapt to the hostile policy environment of the former regime, accounted for an estimated 3,100 employees, and 40 percent of manufacturing value added. The balance of the private sector was comprised of an unknown number of micro-enterprises engaged in informal activity. One estimate put the number of such enterprises involved in manufacturing at about 3,500, representing some 12,700 jobs and 18 percent of manufacturing  - 7 - value added. Overall, industrial activity was heavily concentrated in the Conakry area. Estimated Composition of Guinea's Manufacturing Sector in 1985 Type of Enterprise Number Number of t of Total of Ent. Jobs Value Added State-wned 42 7,200 42 Private companies 360 3,100 40 Micro-enterprises 3,500 12,700 18 Total 3,902 23,000 100 19. Since the introduction of the reform program, privatS sector activity has remained concentrated in commerce and trading, with estimated GDP generated in that sector in 1988 being four times larger than that of the non-mining manufacturing sector (Appendix 1, Table 3). The liberalization and privatization process begun in 1985 has therefore failed to alter the strong bias of the local economy towards the trading sector: most of the newly-established firms have focused either on import trade with Europe and other countries, or on internal trading and transport activities. Manafacturing activity in general -- and that of the formal sector in particular -- remains thin, with the non-mining industrial sector accounting for only 5.5 percent of GDP in 1987. In fact, indications are that the formal sector's share of total manufacturing value added actually declined since 1984. 20. The above applies all the more to the informal sector, where employment in trading has grown an estimated 42 percent between early 1985 and early 1989, with the informal sector still playing a dominant role in such activities. Although the informal sector has clearly contributed to employment growth in manufacturing -- the informal sector accounted for an estimated 18,000 jobs in manufacturing in 1987, vs. the aforementioned 12,700 prior to the reform program -- over eighty percent of all informal sector enterprises are still engaged in non-manufacturing activity: a 1988, ILO-financed survey of Guinea's informal sector identified only 3,450 enterprises in the manufacturing sector (19 percent of the total), vs. 8,760 in the trading sector, 3,298 in services, and 2,695 in transport. 21. The bulk of Guinea's formal private sector is now comprised of the nucleus of recently privatized state-owned enterprises; 26 of a total of 42 state-owned industrial enterprises have so far been privatized, and another four privatizations are currently under negotiation. 41 All privatizations have involved the active 41 Of the remaining parastatals, six have been closed down, and the others, including the entire textile manufacturing complex, are mostly inoperative.  - 8 - participation of foreign interests (see list in Appendix 10). The privatized firms cover a wide range of activities, including the production of alcoholic and non-alcoholic beverages, fruit-pulp processing, saw milling and plywood manufacturing, paint production, brick making, cigarette manufacturing, and cement. All of them have benefitted from special investment incentives outside of the new Investment Code, some of which have proven to be overly generous, such as, for ten of 21 companies surveyed in the course of an industrial survey, the granting of monopoly status on production. However, only ten of the privatized firms have commenced production; of chese, two have already shut down and another four are in serious financial trouble, due in the main to competition from illegal imports, a deteriorating investment climate, and continuing internal operational problems . 22. Many of the privatized firms have experienced difficulties with public authorities, which in some instances reportedly failed to respect their commitment under existing privatization agreements. In particular, restructuring of these companies, labor force remained constrained by continuous intervention of the Ministry of Labor, as well as by the intrusive role of trade unions: despite very substantial staff reductions, 5/ their work force remails plagued by considerable redundancy and inefficiency. As a result of these problems as well as of the continued flooding of the local market by illegal imports, capacity utilization, although improved, remains low. Under present circumstances, these firms consequently have very little incentive to expand their activities and hire or train workers, and planned investments have been cut back or cance.led. 23. Other investment in the formal manufacturing sector has been equally disappointing. Although 70 private firms have so far qualified for benefits under the 1987 Investment Code, most of them are not yet operational. In fact, the number of operating licenses awarded by the Ministry of Industry started dropping off as early as 1987: only 14 licenses were awarded that year compared to 89 in 1986. A more detailed review of the manufacturing sector also reveals large variations in outlook between subsectors: some of them already suffer from excess production capacity (bakeries, woodwork, simple metal manufacturing), while others -- such as textiles -- are constrained by insufficient capacity due to weak past investment levels. The manufacturing sector is therefore still hampered by inadequate diversification, with present industrial activity concentrated essentially in the wood processing, metal products, and food and agro- processing subsectors, which account respectively for an estimated 32, 40, and 15 percent of industrial value added. 24. In the short-term, only the food/agro-processing subsector offers realistic prospects for export growth, but despite recent efforts to export packaged fruit, cut flowers, and other agro-based commodities, 5/ The labor force of 25 privatized companies was down to 1,800 at the end of 1988, compared to a pre-privatization level of about 4,000.  - 9 - the industrial sector's aggregate contribution to Guinea's export earnings remains negligible. A review of Guinea's business environment has generally indicated that formal private sector activity, particularly in manufacturing, is still limited by three types of constraints, related respectively to: (1) the legal and regulatory framework; (2) the incentives structure; and (3) a weak investment promotion framework. These constraints are analyzed successively below. 2. The Legal/Regulatory Framework 25. Although important legislation was adopted in the past three years as part of the Governme.it's efforts to promote private sector development in Guinea, the legislative framework regulating business activity remains marred by inconsistencies and weaknesses that compromise its effectiveness. In some cases, no coherent guidelines or procedures were provided to implement the new laws. In other instances, lack of coordination between ministries has led to the development of overlapping -- or in some cases contradictory -- regulations. The absence until early 1989 of an official gazette providing the local business community with the "final word" on their rights and obligations has only compounded the problem. As a result, the settlement of disputes is typically "negotiated" with public officials on a case-by- case basis, leaving private entrepreneurs permanently exposed to harassment by public officials. 26. Establishment procedures provide a clear illustration of the wide discrepancy between legal principle and accepted practice. In theory, any business not subject to explicit nationality restrictions or that does not first have to comply with technical standards should be free to establish itself in Guinea by simply incorporating at the Trade Registry. In practice, incorporation procedures are both onerous and time consuming, and involve dealings with a number of other governmental departments such as the Ministry of Industry and of Finance, and often the technical ministry concerned. The right of free establishment is in effect not respected, as individual ministries require investments falling within their technical competence to be cleared through issuance of special operating licenses (agrements techniques). 27. Despite their formal appearance, these licenses run directly counter to the spirit of the Investment Code and have no proper legal basis (except for those professions specifically regulated to ensure enforcement of minimum technical standards). They represent sources of irritation for promoters, subjecting projects to arbitrary evaluation criteria, delaying actual start-up, and often exposing the entrepreneur to demands for improper payments. The fact that commercial banks refuse to consider credit applications in the absence of a technical license from the relevant ministry further compounds the problem, forcing businessmen to comply. Aside from that license, the Ministry of Industry also requires all firms to obtain a commercial license (agrement commercial), and firms and individuals involved in trading activity to obtain a business license (carte de commercant). The commercial license is yet another hurdle to overcome for  - 10 - entrepreneurs. As for the business license, neither its rationale nor its legality are clearly established; although its only acknowledged purpose is statistical, its award is sometimes withheld as a means of controlling access to specific trading activities. 28. Land and Property Titles. By law, all land in Guinea belongs to the State, and private entrepreneurs, whether local or foreign, need permission to lease it. However, most investors are not granted clearly defined leases, which all too often exposes them to lengthy disputes later on. In other cases, companies seeking to expand existing operations have been unable to obtain leases on neighboring plots, as requests for land occupation rights are either denied or remain unanswered. Worse yet, poor record keeping has at times led to the granting of leases on land and buildings to two different parties at once. Such problems, which arise from both lack of appropriate property ownership legislation and from poor administration of land registration, constitute a major irritant for private firms, particularly for foreign investors unfamiliar with the local context. They also prevent firms from offering adequate collateral demanded by local banks. 29. Labor Retulations. Despite the introduction of a new Labor Code, procedures for hiring labor, both local and expatriate, still constitute a hindrance to business activity. Firms in the formal sector have had to hire workers through the Ministry of Labor on the basis of a list of prospective candidates provided by the Ministry's National Labor Office for each job opening (direct hiring has been subject to severe penalties). This process has proven both time consuming and restrictive. Not surprisingly, it has made it difficult for potential employers to hire qualified staff, particularly when skilled workers were needed. Procedures for laying off workers have been likewise restrictive, since prior approval of the Ministry of Labor was in many cases required 61. 30. Specific limitations also apply to the hiring of expatriate staff. All contracts for expatriate employees must be approved by the Ministry of Labor, and cannot in any case exceed two years. However, there are no set criteria for the approval of such contracts, nor are there any rules governing their renewal. Consequently, overseas investors frequently face arbitrary denials both for new contracts and for renewals. Such problems have only contributed to the further alienation of foreign investors. 31. More generally, guidelines for the implementation of the new Labor Code have not yet been finalized. As a result, the Ministry of Labor's Inspection Department is able to excercise highly discretionary power in labor relations, intervening arbitrarily as 61 As per the Labor Code, firms wishing to lay off 10 or more workers on economic grounds must have prior approval -'rom the Ministry of Labor. The Ministry itself appears to have arbitrarily set a maximum limit of 30 workers that it will allow any firm, irrespective of its size, to lay off for economic reasons.  - 11 - intermediary between employers and employees. The Ministry has in that respect often been involved in wage negotiations on behalf of employees, or has fixed minimum remuneration levels payable to workers by individual firms. 3. The Incentive Structure 32. An initial reform of Guinea's incentive structure was undertaken under IDA's first Structural Adjustment Credit. The trade regime was radically simplified; all import licensing regulations were abolished, and replaced with a simple import declaration to be endorsed by the Central Bank; following the major devaluation of January 1986, the tariff regime was rationalized, and duty rates were reduced; as of January 1988, turnover taxes levied on imports and on domestic production were harmonized, resulting in a more neutral trade regime; and, a new Investment Code was promulgated in January 1987, linking the award of incentives and privileges to performance-based criteria. As will be seen below, this package of measures has been only partially successful in creating an efficient and transparent structure of incentives for private promoters. 33. Investment Code. Although a significant improvement over the old code, the new code provides an array of incentives under conditions which hamper implementation of its various provisions. In order to achieve the Code's various objectives -- such as the development of the country's natural resources, the local processing of its raw materials, export development, SHE promotion, or harmonious regional development -- over twenty different types of benefits may be awarded, relating respectively to corporate tax, apprenticeship tax, flat-rate tax, wage tax, import tax, and customs duty (these benefits can be awarded either individually or simultaneously to eligible firms). Furthermore, some of the Code's eligibility criteria are imprecise, complicating the evaluation of individual applications. 34. Although most of these eligibility criteria are performance-based and thus require subsequent monitoring of the beneficiary firm's compliance with the Code's provisions, the National Investment Commission (CNI) lacks both the internal capacity and the established procedures to collect from beneficiary firms the necessary data on total turnover, share of revenues constituted by exports, or labor costs. CNI's job is further complicated by the poorly defined and/or unenfotceable obligations which the Code imposes on the investor, such as compliance with "national and international quality standards", "priority' usage of domestic raw materials and supplies, and so forth. She problem will only be compounded in the future, as the projects previously approved start coming onstream in greater numbers and thus impose a higher monitoring burden on CNI. 35. Applying for eligibility under the Investment Code first involves the completion of enterprise establishment procedures (see paragraph 26). Once established, a firm normally has to wait another 80 days to have its application processed by CNI. In practice, longer  - 12 - delays are covmon, and it typically takes investors over six months just to find out whether they will qualify for any ber-efits under the Code. 36. Exemptions. As a result of the long processing time and of the uncertainty surrounding the implementation of the Code's provisions, individual entrepreneurs and firms alike have often elected to circumvent the Code altogether and negotiate special incentive packages entirely outside of the Code's framework. As a result, duty and tax exemptions have been awarded on an ad hoc and often arbitrary basis, which has served only to distort the general ;ncentive structure and encourage rent-seeking on the part of individual promoters. Such exemptions have not been restricted as originally intended either to privatized firms or to imports related to government contracts. They have on the contrary been granted to all types of enterprises by technical ministries (Industry and Commerce, Agriculture, and so forth), often without the consent -- or even the knowledge -- of the two ministries -- Planning and Finance -- in principle responsible for such awards. 37. Not surprisingly, privileges granted in the process are generally poorly devised or outright abusives duty exemptions have been awarded on products often unrelated to the purpose of the investment, product description is often vague, or no time limitation applicable to the particular privilege will be specified. Although the exact magnitude of the problem is not known, indications are that such ad hoc benefits entail a major shorfall in tax and duty revenues for the Government. Also, such practices end up being particularly discriminatory against small domestic producers, who do not have the bargaining power vis-a-vis the administration to negotiate their own separate concessions. 38. The problem resulting from the award of such exemptions is further aggravated by lack of monitoring: neither Customs nor the Ministry of Finance's Tax Department keeps an inventory of the numerous special conventions and exemptions granted to individual promoters, and thus no breakdown of these exemptions is available by type of product or period of validity. This has resulted in total absence of control and widespread abuse of the system, with individual enterprises left free to negotiate whatever privileges they may obtain. 39. Deductibility of Turnover Taxes on Imported Inputs. In order to maintain a uniform 10 percent effective rate of protection across the board, the tariff reform adopted under Guinea's structural adjustment program called for the deductibility of turnover taxes paid on imported inputs. Due to the absence of implementation procedures, the deductibility scheme has neither been applied systematically nor uniformly. This has had a discriminatory effect on local manufacturers who, given the normally high import content of local production, may  - 13 - find themselves at a substantial disadvantage vis-a-vis importersltraders. 71 40. Customs Administration. Since documentary requirements for customs clearance are complex and time consuming (twenty-odd separate signatures are required for clearance), they are routinely used by customs officials to extract illegal payments from importers or their agents. Customs fraud and illegal imports resulting from inefficiency and corruption in Customs may represent the single most important impediment to a fair trade regime in Guinea, contributing in a major way to the bias against domestic manufacturing activity and in favor of imports. As a case in point, a recent Government report recognized that, in past years. customs credits (granted in lieu of actual payment of duties) were granted without limits, and without any serious assurances, causing duties arrears of more than GF 10 billion (over $20 million at the time) for the period 1986-88'. In the same vein, outright illegal operations amounting to almost GF 2 billion were reportedly uncovered over a 19-month period, representing, according to the same report, part of a vast network of embezzlement and fraud. 41. While use of the services of a private customs agency helps control the overvaluation of imports -- and thus reduce the incidence of disguised capital flight -- the task of monitoring possible undervaluation of imports aimed at avoiding import duties is the responsibility of Customs. The latter is however ill-equipped for this task, and as a result, criteria for valuation are used in haphazard fashion. This often leads to disputes over duty assessments and to delayed customs clearance or, alternatively, to suitably 'negotiated' settlements with the importer. Also, due to lack of coordination between Customs Administration on the one hand and the National Investment Commission and the various technical ministries on the other, exemptions claimed by individual firms either in the context of the Investment Code or of special investment conventions are often rejected by Customs, or in other cases approved without verification. This leads again to disputes, delays, as well as illegal settlements. 4. The Institutional Framework for Investment Promotion 42. A host of investment promotion agencies are presently operating in Guinea, including: o The National Center for the Promotion of Small- and Medium- Scale Enterprises (ONPPME), which operates under the supervision of the Ministry of Industry and aims mainly at providing pre-investment-type services to SMEs. 7/ In particular, the turnover tax is applied to the CIF price of imported inputs instead of the duty-inclusive price, which in effect reduces the effective rate of protection of locally-manufactured goods against imported products.  - 14 - o The National Center for the Promotion of Private Investment (CNPIP), which is overseen by the Ministry of Plan and has, as one of its principal objectives, the promotion of foreign investment in Guinea. O The Assistance Bureau for the Employment of Former Public Servants (BARAF), which is sponsored by the Ministry of Finance and provides pre-investment services to former civil servants who chose to leave government service or who lost their job as a result of the adjustment program. O The Chamber of Commerce and Industry, which was established as an autonomous institution to protect the interests of private sector operators. 43. Unfortunately, none of the above institutions has had a material effect on enterprise creation and on the level of local or foreign investment in Guinea. Despite its 150-odd staff based both in Conakry and the interior, ONPPME has not had the anticipated effect on the creation of SMEs; in effect, its massive undertaking of feasibility studies has led to the creation of, at best, a trickle of new firms. CNPIP's efforts to attract large, mostly foreign, investments to Guinea have been to no avail, given the country's unfavorable image abroad. As for BARAF, it was indeed able to promote the creation of several hundred new projects sponsored in the main by former civil servants, but at the cost of a mounting number of delinquent loans for local banks. Indeed, it appears that the latter provided the necessary financing for these projects only because their lending risk was covered by a BARAF-managed guarantee fund. C. The Fragility of the Financial Sector 1. Overview 44. Until 1985, Guinea's financial sector was almost entirely devoted to serving the command economy which the Government had set up after independence. Six specialized state-owned banks had been established, to deal respectively with agriculture, industry, foreign trade, foreign capital remittances, domestic savings, and private domestic trade. These banks were essentially used as instruments to implement the country's development plan. The bulk of bank credit was absorbed by state enterprises, generally in the form of direct credit allocations determined on the basis of the latter's annual plans of operations. On the other hand, credit to the private sector was prohibited until 1979, and remained insignificant thereafter. In that context, interest rates played no allocative role in the functioning of local credit markets. 45. Meanwhile, low confidence in the banking system rendered regulations designed to encourage the mobilization of private resources in the banking sector -- such as the compulsory payment of salaries into  - 15 - bank accounts or quantative limits on withdrawals -- ineffective. The Central Bank turned increasingly to monetary creation to finance the growing deficits in the public sector, which only resulted in accelerating inflation. In time, the banking system grew increasingly illiquid, as banks had to finance a mounting level of overdrafts to cash-strapped state enterprises, and as delinquent loans piled up. Such delinquent loans were estimated in 1985 to represent as much as 76 percent of total banking assets and about 140 times the aggregate value of bank equity. 46. The new administration recognized at that time that the six existing state banks could not realistically be rehabilitated. It therefore decided to: (1) liquidate them; and (2) compensate depositors for their ensuing losses. Smaller depositors were compensated first, and private sector deposits were given first priority over deposits held by parastatals. By July 1989, aggregate compensation had amounted to an estimated GF 13.5 billion (close to 15 percent of the money supply at that time); repayment of a remaining GP 6 billion of claims has been planned for by the Government, at a rate of GF 2 billion a year for the coming three years. 47. To fill the void left by the liquidation of state banks, three new banks were given licenses to operate in 1985-86. All three were created with partial or full private shareholding and were affiliated to large French banks. 81 Among them, BICIGUI was set up with material and technical assistance from IDA and participation in share capital from IFC with a specific mandate to: (1) make available externally-funded project financing to the industrial sector; and (2) open a network of up to ten branches in the country's interior. The new banks were granted special tax incentives and other privileges on a case-by-case basis under separate agreements with the Central Bank (BCRG). The establishment of the new banks was accompanied by a reorganization of BCRG, the enactment of a new banking law, and a substantial liberalization of credit and other banking activities. 48. Progress achieved in the three years since the establishment of a new banking system is impressive. Total local currency deposits in the banking sector grew from GF 8.0 billion at the end of 1986 to GF 16.3 billion in 1987, GF 24.5 billion in 1988, and GF 81 These were: the Banque Internationale pour le Commerce et l'Industrie en Guinee (BICIGUI). an affiliate of Banque Nationale de Paris with 50 percent Government participation; the Banque Internationale pour l'Afrique de l'Ouest en Guin6e (BIAG), an affiliate of Banque Internationale pour l'Afrique de l'Ouest with 51 percent Government participation; and the Societe Generale de Banques en Guinee (SGBG), an affiliate of Societe Generale with no Government participation but 55 percent ownership by local private investors. As the only privately-owned bank in Guinea prior to 1985, the Islamic Bank was allowed to remain in operation; however, it plays an insignificant role in the system. A fifth bank -- the Union Internationale de Banques en Guinee (UIBG) -- opened its doors in 1988 as an affiliate of Credit Lyonnais.  - 16 - 34.4 billion by the end of 1989. This represented a 52 percent increase in real terms in 1987 (admittedly from a small starting base), and real increases of respectively 24 and 11 percent in 1988 and 1989 (see Appettiix 2, Table 1). Meanwhile, total outstanding credit to the private sector grew to GF 42.3 billion at end 1989, with real increases of 64 percent in 1987 and 6 percent in 1988, with no increase in real terms registered in 1989. 49. Beyond these figures, the mere fact that the Government has succeeded in reorganizing the financial sector and in making customary banking services available to private sector operators and to the public at large where such services were totally unavailable three years back is a major achievement of the reform program. Among such new services, private firms have had mostly unconstrained access to foreign exchange required to finance their imports through the newly-established weekly auction at the Central Bank. 50. Past progress should however not mask the continuing deficiencies of the sector. Overall. financial markets are still notably shallow, and no financial deepening has occurred in the past two years (see para. 52). Generally, the banking system's participation in day-to-day economic activity is weak. Despite the growth in overall credit activity noted above, credit to the private sector is still essentially limited to the short-term financing of international trade, with critically-needed term credit being mostly unavailable to private operators. The local banks' very conservative approach to lending has not prevented them from experiencing relatively high delinquency ratios, stemming in particular from the difficult environment in which they are operating (see para. 55 for details on the banking environment). 51. The banking system as a whole is also highly inefficient by standard measures. Overhead expenses amounted to 8.6 percent of average assets in 1988 and a huge 14.4 percent of the outstanding portfolio, due in large part to the high number of expatriate staff sent from home office to manage local operations (the fact that such expenses apply to a reduced asset base only aggravates the nroblem). In addition, at least two of the four major local banks are saddled with a high percentage of non-performing loans. These high operating costs and mounting losses have so far been offset by the unusually high spreads of over 20 points available to banks on lending operations: most outstanding loans were made at or above the 25 percent interest rate ceiling prevailing until January 1989, vs. an average cost of funds estimated in June 1988 at 1.7 percent. These spreads have allowed the banks to constitute a substantial cushion of reserves for bad debts. However, the extent to which these reserves adequately cover future default risks is uncertain. Moreover, both the generous spreads and high operating expenses under which banks are presently operating will eventually have to be reduced if the system is to perform its intermediation role effectively. The various constraints to the development of an efficient financial sector are discussed in more detail below.  - 17 - 2. Resource Mobilization 52. Low confidence in the financial system has seriously hampered the mobilization of private savings needed to finance investment. Trust in the banking system was seriously eroded by over 25 years of mismanagement and neglect. The national currency was demonetized on five occasions since independence, including in January 1986 when the syli was replaced by the Guinean franc. These currency upheavals coupled with rapid monetary erosion led to the spoliation of currency holders, whose mistrust in the local economy was -- and still is -- reflected in their preference for offshore or non-monetary holdings. Thus, monetization of the economy (Ml) is still weak at an estimated 6.7 percent of GDP in 1989, a ratio whi'-h has remained unchanged since 1986. Although deposits in the system have increased substantially as a percentage of the monetary base since 1986, they still accounted for only 33.1 percent of that base at 1989 year end. The private local currency deposit base of the Guinean banking system remains very small at an estimated 2.4 percent of GDP at 1989 year end, compared to a 1987 mean of 19.8 percent for a sample of 33 African countries. 53. Inappropriate interest rates have been a second factor behind the weak mobilization of private savings in Guinea. Prevailing rates have provided insufficient incentive to save in local currency, to the detriment of the achievement of the Government's broad long-term objectives. Recently-introduced savings accounts have yielded until recently only 12 percent per annum, as against an inflation rate still hovering between 25 and 30 percent. Term deposits yielded only a slightly higher 17 percent until January 1989. Moreover, less than 30 percent of all deposits were actually interest-bearing, of which only 16 percent were in the form of term deposits at end-1988, the remainder being held by banks in non-interest-bearing accounts. 9/ Additionally, prevailing deposit interest rates provide no incentive to overseas depositors to transfer their foreign currency holdings back into Guinean francs. As a result, these critically-needed resources are not available for domestic investment, further compounding resource constraints in the economy. All told, a major shift in savings patterns will be needed to increase the capturing of resources in the formal financial system to more satisfactory levels. 3. The Functioning of Credit Markets 54. Recent net increases in lending pointed out in paragraph 48 should not mask the fact that absolute levels are still quite modest. At 1988 year end, outstanding loans to the private sector represented barely 40 percent of total bank assets, and an extremely low 3.1 percent of GDP. The relatively insignificant role played by institutional 91 Local banks have in effect been discouraging potential depositors from opening interest-bearing accounts, in particular through the setting of high minimum account balances.  - 18 _ credit in industrial activity stems, at least in part, from the weak demand for investment financing resulting from the morose business climate. It also reflects the cautious lending policies of the new banks. 55. The key factor in the banks' extremely cautious lending practices is without doubt the unfavorable environment in which these banks are themselves operating. Banks are particularly constrained bys (1) the absence of past credit records on local operators coupled with a lack of financial discipline on the part of local promoters; and (2) the generally deficient functioning of the judicial system and legal void surrounding the issue of bank sureties. The latter problem probably constitutes the major limitation to banking activity in Guinea. It renders banks unable to enforce their rights as creditors through foreclosures or other court-approved actions, due in particular to debtor-judge collusion and rampant corruption in the legal and paralegal professions. The absence of proper land registration and property ownership legislation further compounds the problem, by making it in effect impossible for banks to secure their loans with matching collateral. Clearly, local banks cannot be expected to become more responsive to the needs of local investors in the absence of a more supportive legal framework. 56. As a result, banks have heretofore focused mostly on short-term lending (about 85 percent of total outstanding loans at 1988 year end), particularly import financing for large traders. On the other hand, term lending to local enterprises is severely restricted (in the case of projects involving foreign exchange costs, local banks are reluctant to rely on the guarantee schemes set up by the Government to cover losses they may incur through utilization of the externally-funded lines). Limited access to investment credit applies even to foreign investors: unable to claim ownership rights on buildings put up on leased property, they have often had to rely on financing from their parent company overseas. 57. The policy framework has only tended to reinforce shortcomings in the functioning of local credit markets. This has been particularly the case of interest rate regulation: until January 1989, all domestic lending was subject to a 25 percent interest rate ceiling, while under the externally-funded lines of credit, banks soill operate with narrow spreads of only 3 percentage points in the case of small enterprises, and 5 points for larger borrowers. This has provided banks little incentive for competition, and scant encouragement to assume the higher risk (notwithstanding the existence of the guarantee schemes) and poorer collateral associated with term lending, thus further constraining investment. 58. Additionally, interest rates applicable under the major externally-funded lines are highly subsidized as compared to both market rates and inflation levels. Similarly, as late as January 1989, banks were able to refinance eligible local-currency loans at the Central Bank at deeply subsidized rates: (1) a normal discount rate of 17 percent; (2) a preferential rate of 10 percent; and (3) a super-preferential rate  - 19 - as low as 7 percent (two other windows were available for interbank transactions, at respectively 15 percent and 18-20 percent). The existence of such subsidized rates has contributed to the fragmentation of financial markets between borrowers eligible under these facilities lines end those forced to pay market rates, and has tended to distort the efficient channeling of resources to the productive sector. Also, easy access to such cheap resources has in turn provided local banks with little incentive to aggressively seek interest-paying deposits. 4. The Role of the Central Bank 59. BCRG has since 1985 played a key role in setting up the new financial system. Aside from overseeing the liquidation of the former banks and the gradual compensatinn of depositors, it negotiated the conditions of establishment of the new banks, and has operated the newly-established official weekly foreign exchange auction. It was further burdened by the need to deal with the consequences of the continued fiscal deficits the public sector has accounted for a substantial portion of total credit outstanding, much of which has been funded through overdrafts and direct advances from BCRG to the Treasury. 60. The active role played by BCRG in these various areas has tended to distract it from its normal -- but critically important -- responsibilities relating to monetary policy on one hand, and to the monitoring and supervision of the banking sector cn the other. Much prog-'ess has been achieved since 1988 in establishing new procedures and internal control systems within the Central Bank. A total of six long- term advisors are presently providing BCRG much needed technical assistance in the areas of credit, foreign exchange management, accounting, and cash management, with other assistance forthcoming with respect to internal control. However, the advisory team has had to concentrate mostly on day-to-day management of Central Bank operations, at the expense of the needed training of local staff. 61. Moreover, the technical assistance program has not to date dealt with BCRG needs relating to supervision of the banking sector. In this respect, the Central Bank has yet to undertake a comprehensive supervision of commercial banks (aside from a quick oversight of the banks undertaken under the guidance of an IMP consultant in late 1988), and its present capacity to undertake an in-depth review of a comercial bank's operations is largely inadequate. As a result, little is known of the financial condition of local banks, and particularly of the quality of their assets. Indications are that around 30 percent of the portfolios of the two largest banks (BICIGUT and SGBG) may be uncollectible, with other banks facing a lesser problem. The fact that BCRG has not yet defined a set of pradontial ratios to be maintained by the banks only increases the potential pitfalls of the present situation.  - 20 - PART III. PROGRAM DESCRIPTION A. Proaram Rationale and Obiectives 62. The proposed Private Sector Promotion Program evolved from the Government's recognition of the central role that private investment will have to play if Guinea is to achieve the ambitious growth objectives it has set for itself in the coming years. As a result of investors' low confidence level in Guinea's near-term prospects and of the absence of a supporting environment for business activity, direct investment in productive activities has -- after an initial revival in 1985-87 -- slowed to a virtual halt. In this respect, local investors have themselves opted for short-term, quick-turnover importing/trading activities, while spurning the uncertainties 3f long-term investment in industrial projects. Yet, faced with the continued austerity linked to the reform program, Guinea ba-'ly needs new investment, in order to add value to local resources, create new employment opportunities, compete effectively against imports, and, in key sectors, actively trade in export markets. 63. An upsurge in private investment can only occur, however, if existing regulatory, administrative, and institutional constraints to private sector activity are effectively removed. Indeed, these constraints -- as described in Chapter II -- have strongly contributed to a deterioration of Guinea's image as a place to do business, undermining in the process the initial goodwill and enthusiasm shown by private investors in the wake of the change of government and of the reform program launched in the mid-1980s. It is in this respect unfortunate that the drying up of private _4ivestment occurred despite the adoption by the Government of the impressive array of reforms affecting the mocroeconomic environment. 64. One of the main factors behind the above has been the contrast between the government's clear intentions to open up the economy to private initiative on one hand, and the limited capacity or willingness of executing agencies to implement this new policy in its daily dealings with private entrepreneurs on the other. It is now clear that the set of macroeconomic reforms already undertaken will not suffice to reverse the unfavorable investment trends, but that these initial reforms need to be complemented by interventions specifically designed to draw back private promoters. For the reforms to take effect, the Government will also have to improve the responsiveness of Guinea's administration to the specific needs of these promoters. 65. The objective of the Program will thus be to establish a more favorable local business environment that will encourage both local and foreign promoters to invest in new productive activities. This will be achieved through a combination of actions and policies to include, inter alia, a simplification of existing regulations, a rationalization of the incentive framework, and a strengthehing of the government's capacity to provide support to individual entrepreneurs -- while  - 21 - changing the attitude of civil servants at all levels from that of private sector "watchdog, to that of facilitator and purveyor of essential services. 66. Attitudinal changes involved on the part of these public officials will only occur over a fairly extended period. What can be changed in the short run is the operational framework under which the administration is currently functioning, through the setting of new rules, improved incentives, and more effective institutional set-ups. To implement these reforms, the Program will also rely on technical assistance made available to the Government through the EHSP Project as well as on bilateral assistance from France. In particular, Caisse Centrale and FAC have indicated their readiness to associate themselves to this operation through the financing of specific technical assistance activities (see para. 103 on co-financing). 67. The proposed Program will usefully complement the Bank's overall country strategy for Guinea. It would deepen the reforms already undertaken under the two Structural Adjustment Credits, by focussing on the detailed legal and regulatory reforms now required to bring about the needed supply response from the private sector (see below). It would also make direct use of the administrations' improved technical and managerial capacity to result from the Economic Management Support Project, particularly in Customs, in the Ministry of Finance, and at the Central Bank; it would also complement the legal assistance program provided under that project, by concentrating more specifically on continued weaknesses in the application of banking and commercial law. 68. The Program also would represent a new approach to private sector development in Guinea. In the past, efforts to promote private investment revolved around the privatization of parastatals, the provision of technical assistance to key ministries, and the establishment of credit lines, such as that financed under IDA's Industrial Rehabilitation Project. However, that strategy fell short of creating a more buoyant and competitive environment for private activity. In particular, the IDA-financed line of credit for SMEs, although actively used in 1985-87, then fell into disuse, due in part to continued lack of demand related to sluggish investment levels. The strategy adopted under the proposed operation would be to establish an environment more conducive to business activity, setting the stage for other supportive activities to the private sector in the future. 69. As described below, the Program would introduce a wide- ranging set of reforms relating to the legal and regulatory framework, the incentive structure, the institutional set-up, and the functioning of the financial sector. The reform package has been endorsed at the highest level of Government, in line with the President's recent appeal to encourage investment in the private sector. Many of the reforms considered have already been implemented in the course of Program preparation, particularly with respect to the incentive structure and to financial sector policy. The objectives and content of the Program are summarized in a Statement of Sectoral Policy (Appendix 6).  - 22 - B. The Establishment of an Enabling Investment Environment 1. Improving the Legal/Regulatory Framework 70. One of the Government's top priorities in the coming years will be to make the legal framework governing private sector activity coherent, as well as to overcome the procedural/administrative obstacles to its effective implementation. This will be a complex task which will take years to complete and will be no doubt resisted by entrenched interests. However, any major improvement in the investment climate is contingent upon progress in this area. On the legislative side, the Bank-financed EMSP technical assistance project is presently assisting the Government in: (1) conducting a global review of existing legislation; (2) making regulations and procedures more consistent with the general intent of the law; and (3) formulating new legislation as required. EMSP-financed consultants are also helping the Government publish the Official Gazette, which was reinstituted in January 1989. 71. As part of the proposed Program, the Government will clarify and simplify procedures governing the establishment and registration of private firms. A detailed review of existing legislation -- including the Commercial Code -- has been completed with assistance from the EMSP legal advisors, and proposals aimed at eliminating ambiguities in registration procedures and making the process more automatic have been drafted. The Government will abolish the need for individual promoters to obtain a commercial license to operate, with specific decrees to be issued as a condition for Board presentation. Instead, new streamlined enterprise establishment procedures will be introduced, to involve the creation of a one-stop window where all registration formalities will be completed in a single place (see para. 83) lO/. 72. As pointed out in Chapter II, labor hiring procedures need to be simplified and made more flexible for employers. The new Labor Code lays down the legal foundations for employer-employee relations. However, Code procedures for the hiring of labor are both too restrictive and complex. The Government has drafted, with assistance from the International Labor Organization and the Bank, implementation guidelines for the new Code, aimed at eliminating ambiguity of interpretation of the Code's provisions and at no longer making its implementation subject to the discretion of the Ministry of Labor's Inspection Service. These guidelines will be enacted by the Government prior to Credit effectiveness. The new guidelines will then be appropriately publicized through a workshop to include representatives from the private sector and from the trade unions. Meanwhile, labor inspectors will be provided with ongoing training related to their responsibilities under the new Code, to be financed under IDA's Industrial Rehabilitation Credit. 10/ A description of specific conditionality related to this and other issues will be found in Section IV.  - 23 - 73. As per the recommendations of a recent UNDP-financed study of the role of the Ministry of Labor's National Labor Office (ONEMO), the Government will transform the Office into a unit responsible for labor statistics and the monitoring of the labor market, thus leaving individual finms free to select and contract local workers directly without intervention from the Ministry of Labor. The legal texts needed to restructure ONEKO have been drafted, and their execution will also be undertaken prior to Credit effectiveness. Concurrently, ONEMO's capacity to undertake effectively its new functions will be strengthened, in particular through technical assistance financed under UNDP's ongoing project and through computerization of its operations to be financed under IDA's Industrial Rehabilitation Credit. 74. A review of the land tenure issue is currently being undertaken by the Government, to lead to the adoption in 1990 of a new Land Tenure Code. Once the new Code adopted, the Government will, as a condition for second tranche release, establish a conceptual and operational framework outlining private property rights, to include an appropriate system for their publication. Such rights will at a minimum allow promoters to pledge commercial buildings and other property as collateral for bank loans (see also para. 97 for other measures relating to the legal environment for banking activity). 2. Rationalizing the Incentive Structure 75. The new Investment Code introduced in January 1987 sets a generally satisfactory policy and incentive framework for potential investors. However, the continuing award outside of the scope of the Code of ad hoc exemptions and other special incentive packages constitutes a significant source of distortion of the incentive framework, and particularly of the new trade regime introduced in 1986. Such exemptions are typically part and parcel of establishment conventions signed between technical ministries and individual promoters, and therefore cannot be eliminated outright. As a first ster. to rationalize the system, the Government prohibited in February 1989 the grantinR of exemptions by individual ministries without the prior approval of the Ministry of Finance and, when required, of the Ministry of Plan. Next, the Government will institute prior to Board presentation the obligation for all special conventions negotiated by individual ministries to be specifically reviewed and commented upon by the National Invesment Commission (CNI) before final approval by the Ministry of Finance, thus making the CNI an obligatory passage for all privileges granted within or outside of the Code's framework. In the process, CNI would ensure that exemptions granted under these conventions are generally consistent with the scope and intent of the Investment Code. 76. In addition, as a Board condition for the proposed Credit, the Code's effectiveness and attractiveness will be improved through clarification of eligibility criteria and other conditions, in line with the recommendations of a Bank-financed study on the incentive structure.  - 24 - Concurrently, the technical capacity of CNI's Secretariat will be strengthened, in order to: (1) improve the review of all special conventions presented for its approval; (2) ensure heretofore strict application of the Code's provisions; and (3) coordinate monitoring activities to be undertaken by the Secretariat and various other government departments to ensure beneficiaries' compliance with the Code's provisions. FIAS will provide short-term technical assistance as needed to restructure CNI and establish new operating procedures, while Caisse Centrale is committed to provide the CNI Secretariat with long- term assistance to help build up its internal technical and managerial capacity. Also, computerization of CNI operations will be financed under IDA's Industrial Rehabilitation Project. 77. In addition, a separate unit was set up within Customs in November 1989 to monitor the award of all duty and tax exemptions granted within or outside the Investment Code. The unit's operating procedures and precise functions will be formulated in conjunction with a recently appointed FAC-financed technical assistance team in the Ministry of Finance. Based on preliminary work done as part of the Bank-financed study on the incentive framework, the unit will first compile a complete inventory of all exemptions granted to date, assessing their distortionary effects on the incentives framework as well as the resulting loss of revenue for the Government. That inventory will serve as a basis for the establishment of a definitive list of exemptions, their beneficiaries, product coverage, and period of validity, to then serve as a basis for monitoring their application. It will also help the Ministry of Finance clarify contradictory or incomplete provisions contained in previously-signed special conventions. 78. The uneven implementation of the scheme allowing for the deductibility of turnover taxes on imported inputs penalizes domestic producers vis-a-vis importers/traders. Improved application of the scheme in a uniform and systematic manner will depend in large measure on the overhaul of tax administration itself, a detailed diagnostic of which has recently been completed by the IMF. The Government will take up the issue of improving implementation of the deductibility scheme in the wider context of efforts to reform the Tax Department under the Economic Management Support Project. 79. Fair treatment of domestic manufacturing activity is not possible without a complete overhaul of Customs Administration. In this context, a number of initiatives are underway. In February 1989, the head of the Customs Department was relieved of his duties as part of the strongest attempt yet by the Government to clean up the service. Following several months of uncertainty, during which the Department was left to be managed by an interim team, a new Director General of Customs was appointed in October 1989. As part of this Program, the Government then undertook to: (1) revise outdated valuation tables for imported goods; (2) institute as of April 1990 an obligatory written customs declaration applicable to all Customs offices, and train offices managers in applying the new procedures; (3) deploy Customs officers along Guinea's borders in order to reduce the incidence of illegal  - 25 - imports; (4) create an eight-person strong Inspection Service; and (5) train 25 inspectors of the Ministry of Finance in existing customs procedures. 80. As described in an appendix to the goverrment's Statement of Sectoral Policy, the second phase of Customs reform will includes (1) adoption of a new Customs Code, the draft of which will be submitted shortly to the CCEF; (2) revision of the import tariff structure, in order to fine-tune it to the specific situation and needs of each sector; (3) simplification and rationalization of customs clearance procedures at the port and aeroport, in line with the recommendations of an ongoing study by the EMSP technical assistance team; (4) the completion of a procedures manual describing step by step the new responsibilities of customs officers; and (5) a EMSP-financed training program for customs agents, including overseas training for Customs inspectors. These reforms will be undertaken by the Government prior to second tranche release. Yet other actions will be taken in the future, based upon the recommendations of an Interministerial Committee set up by the Government to restructure Customs. Such actions will include, inter alia, a new organizational chart and operational mode for Customs Administration, and the installation of a computerized system for customs control. 81. In order to carry out the above, Customs will benefit from technical assistance provided under the aegis of the EMSP Project. A senior FAC-financed advisor has now been placed in a position of line responsibility in Customs , and another two advisors have been appointed to deal respectively with customs valuation and with the setting-up of 15 roving anti-smuggling brigades (brigades mobiles) throughout the country. The new team will, as a priority: (1) seek to improve Customs efficiency, particularly through the establishment of a reliable system to assess declared import values and combat under-invoicing; (2) help strengthen and restructure customs' services; (3) draw up a plan for training and upgrading of personnel; and (4) the setting-up of the new mobile anti-smuggling brigades. 3. Restructuring the Institutional Framework for Investment Promotion 82. Given the ineffectiveness of the host of investment promotion institutions currently operating in Guinea, the Government will commit itself under the Program to establish a rationalized and effective investment promotion institution, in line with the recommendations of a recently-completed, Bank-financed study. The National Center for the Promotion of Small- and Medium-Scale Enterprises (ONPPME) will be replaced by a small, private sector-oriented institution to be managed and staffed by professionals with first-hand experience in dealing with the needs of private operators. It will remain under the general oversight of the Ministry of Industry, but its Board of Directors will have mixed public-private composition. The new institution will aim at providing promoters, particularly local SME operators, with pre-investment services such as the review of the  - 26 - technical and financial feasibility of their projects or the completion of project documentation to be presented to iocal banks for financing. However, given the typical inability of publicly-sponsored institutions to provide effective services of this type to private sector operators, the delivery of such services will be contracted out to private agencies or individuals (accounting and auditing firms, lawyers, management consultants, etc.). Promoters will be asked to shoulder at least part of the cost of such services, with the remainder being financed out of a special fund to be set up by the Government and the donor community. 83. As already mentioned, the Program will also involve the creation of a one-stop window allowing for the completion in a single place of all formalities required to legally establish a new enterprise. In line with the above obiectives, the Government will submit prior to Credit effectiveness a plan outlining the proposed modus operandi of the institutions dealing respectively with enterprise registration. promotion of SMEs, and the promotion of overseas investment. C. The Deepening of Reforms in the Financial Sector 1. Implementation of the Reform Program 84. Despite the Government's success in re-establishing since 1985 a fully functional financial system, the latter has still fallen short of its anticipated role both in terms of the effectiveness of the financial intermediation process, and of the system's ability to finance private sector investment. The Credit will support interventions in the financial sector at the policy level, complementing past IDA initiatives such as the establishment of a line of credit for SMEs and other services provided under IDA's Credit 1234-GUI. In dealing with financial sector policy, the Program is consistent with the Bank's new financial sector guidelines which call first and foremost for the setting of an appropriate policy environment for financial sector development -- over and above the channeling of resources for targeted sector lending. 85. Much has already been accomplished during the preparation of the proposed Program. The Central Bank has in particular introduced a number of reforms seen as key to a more effective financial sector, including two rounds of across-the-board adjustments and/or liberalization in both deposit and loan interest rates (see paras. 88 and 90 below), initial rationalization of refinancing windows made available at the Central Bank (para. 93), and the establishment of a BCRG-managed risk-management unit available to commercial banks (para. 99). Moreover, the Central Bank has, under the guidance of the IMF, signed an agreement with Treasury designed to regulate the latter's access to BCRG advances (para. 95). Further reforms in these areas will be undertaken as needed under this operation.  - 27 - 2. Interest Rate Reform 86. Given the public sector's weak projected savings capacity and limited access to external financing, private savings will be key to future growth and investment: aggregate private savings should, according to Bank projections, account for 61 percent of total national savings and provide close to 75 percent of the resources needed to finance private investment over 1988-93. The achievement of broad economic objectives is thus contingent upon a strong deposit mobilization performance in the private sector. 87. In the absence of major distortions in the market, appropriate real rates of interest would result from normal competition between banks. In the case of Guinea however, lack of competition for deposits will in the foreseeable future require continued intervention of the Central Bank to provide adequate interest rate incentives for private depositors. In view of the financial sector's weak mobilization of local savings, an upward readjustment of deposit rates was thus long overdue. Although the elasticity of local savings levels with respect to interest rates is unknown, it is still clear that establishing positive real interest rates is a precondition to capturing a higher share of local savings in the system, by encouraging the public to deposit its savings in local banks rather than investing in other, non- monetary investment hedges. Similarly, higher deposit rates are needed to convince holders of offshore, foreign exchange accounts to shift their savings to local currency deposits. 88. During project preparation, the Central Bank has, as already mentioned, taken a number of steps in the right direction. It introduced in February 1988 savings accounts bearing an interest rate of 12 percent, since increased to 16 percent. It then increased minimum rates on time deposits from 17 to 19 percent in January 1989, and to 21 percent in September (Appendix 2, Table 2). These rates represent substantial progress towards the achievement of positive real interest rates, as inflation has slowed down to an estimated 26 percent in 1989. 89. Clearly, future adjustments to the interest rate structure should follow changes in inflation levels. Tighter fiscal discipline linked to the adjustment program is expected to reduce inflation to 16 percent in 1990, which would establish positive term deposit rates of 5 percent at present levels. As part of this operation, interest rates on both sight savings accounts and time deposits will be reviewed twice- yearly with the Central Bank and adjusted as needed to ensure further progress towards the establishment of positive real deposit interest rates. The first review is to take place in August 1990, when inflation figures for the first six months of the year will be known. 90. The existence of a 25 percent interest rate ceiling on all loans has constituted another source of distortion in the financial sector, involving the subsidization of those t w enterprises with access to institutional credit. Together with the Jaiuary 1989 adjustment in deposit rates, the Central Bank removed the interest cap on short-term loans. In September, it then liberalized interest rates on term loans,  - 28 - removing one of the disincentives for banks to extend such loans from their own resources. 91. Interest rate reform on both the deposit and the lending sides should eventually lead to increased competition in the banking sector and thus to a narrowing of the exceptionally high spreads available to local banks. Such narrowing will in turn force banks to reduce their unusually high operating costs, which could be achieved through a combination of cost-cutting (particularly through reduction of expatriate staff) and of higher activity levels that would reduce the banks average cost of lending. In the short run, interest rate liberalization is however not expected to materially affect gross margins in the banking sector, with both the average cost of funds and the lending rates applied to the banks' traditional customers moving gradually up. 3. The Rationalization of Credit Markets 92. Interest rate reform can only be fully effective if implemented within the framework of a rational monetary policy. The Central Bank has initiated two types of actions in that respect: (i) in January 1989, it consolidated and simplified the various discount/refinancing windows open to commercial banks; and (ii) it signed in March 1989 an agreement with Treasury which restricted Treasury's access to cash advances at the Central Bank. 93. The rationalization of BCRG's discount/refinancing schemes involved both the consolidation of the five former windows into three new windows as well as increases in the cost of such resources to the banks (a second round of increases took place in September 1989; see Appendix 2, Table 2). Commercial banks now have access to three types of refinancing to manage short-term, local currency liquidity: (1) a normal discount window at 24 percent (up from 17 percent previously); (2) a preferential window at 14 percent; and (3) interbank financing, at a rate freely negotiated between banks. This constitutes an important improvement over the five separate refinancing schemes available until January 1989, which included, inter alia, a super-preferential window at only 7 percent. Further progress in reducing the implicit subsidies available through refinancing will be reviewed with the Central Bank at the time of the semi-annual review of interest rates, with in particular a view towards narrowing the abnormally high ten-point gap between the preferential and normal discount rates. 94. IDA will also maintain a continuing dialogue with other donors aimed at seeking a reduction of the level of subsidization on foreign currency financing available through externally-funded lines of credit. In this respect, Caisse Centrale has indicated its willingness to increase rates on its SME line by about two percentage points at the time of its renewal later this year.  - 29 - 95. The newly-signed agreement between BCRG and Treasury governing BCRG advances to the Government resulted from continued dialogue with the rMF on vays to control the budget deficit. As per that agreement: (1) Treasury will from now on be charged interest on BCRG advances (albeit initially at a token rate); and (2) the level of such advances will be limited to a given percentage of Government tax receipts, as per the system already applied by BCEAO to its member countries in West Africa. This agreement will result in tighter control on the financing of public deficits, and thus force stricter fiscal discipline on the Government. 96. Finally, the proposed operation will aim at improving the legal/judiciary framework surrounding credit activity. Guaranteeing local banks' access to legally enforceable collateral is a long-term objective which first requires resolving the wider issue of land and property rights. As a first step, the Government will adopt a Land Tenure Code that will provide the foundation for the establishment of private rights on buildings and other commercial property in urban areas (see para. 74). This will allow such buildings to be pledged as collateral for bank loans. 97. Also, a series of actions will be agreed upon with Government aimed at improving the effectiveness and objectivity of the legal and para-legal professions in cases involving banking and commercial transactions. A specific action program will be agreed upon with the Government by September 1990, based upon the recommendations of a recently-completed study financed under the FAC Trust Fund. The program will include the training of iudges in commercial and banking law, and is expected to lead to greater transparency of court decisions through improved publicity and the establishment of jurisprudence records. FAC has indicated its readiness to finance selected activities in this area. The launching of such reforms would be particularly timely, occurring as they would in the aftermath of the President's November 1989 declaration on the need to clearly separate the judiciary and the executive branches of Government. They would contribute strongly to the capacity of individuals, entrepreneurs, and banks to enforce their contractual rights, a key step towards building up investor confidence in the local environment. 98. Also, initial steps have been taken in the course of Program preparation towards the possible setting-up of a bonded warehouse in Conakry, in line with the recommendations of a recently- completed, Bank-financed pre-feasibility study. Such a warehouse would greatly facilitate the financing by banks of imported commodities, which could be kept warehoused as collateral for loans until their release against gradual or total payment by the trader. Such a warehouse would also facilitate export financing -- particularly in the case of agricultural commodities -- by allowing banks to keep physical control of these commodities as they are shipped in from the interior for export. As per the study's recommendations, the construction and ownership of the warehouse would be entrusted to a property company (socidte de capital) with mixed public-private shareholding, while the  - 30 - operation of the facility would be the exclusive responsibility of a management company (societe d'exploitation) which would include various private sector interests (shippers, forwarding agents, banks, local trading companies, etc.). Since various private projects have cropped up since the completior. of the study (including one with possible IFC involvement), a further review of the feasibility of a Government- sponsored project will be undertaken in the course of the proposed operation. 4. Enhancing the Effectiveness of the Central Bank 99. As already mentioned, the Central Bank has, while carrying out its many tasks unrelated to the monitoring of financial markets, failed to establish a capacity to monitor, control, and supervise the banking sector. However, liberalization of the financial sector cannot be undertaken in the absence of adequate regulation and supervision by the Central Bank. BCRG has already initiated a number of actions in that respect, aimed in particular at improving access to information on the banking sector. It has established a reporting format to be used by commercial banks for their quaterly submissions to the BCRG. It has also set up a risk management unit (centrale des risques) allowing banks to keep abreast of their clients' obligations with other local banks. 100. Under the proposed Credit, the Central Bank will also substantially strengthen its regulatory and supervision capacity, to include: (1) issuance and verification of application of prudential ratios applicable to individual banks, such as capital adequacy, liquidity and asset-risk ratios; and (2) closer scrutiny of banks' financial soundness, both through direct inspection and through systematic review of their financial statements. Progress in these areas will be assessed at time of second tranche release. In order to carry out this program, BCRG will be provided two long-term advisors financed by USAID under EMSP, one for bank supervision, and the other to help BCRG collect and analyze balance-of-payments statistics. Additional short-term interventions could be financed as warranted by IDA (under the Industrial Rehabilitation Credit) and the French. PART IV. CREDIT IMPLEMENTATION A. Amount and Timing 101. Preparation of the proposed operation first began in February 1989 with IDA's first identification mission. The detailed content of the Program was agreed upon during the appraisal and post-appraisal missions which took place respectively in June 1989 and February 1990. Program design was based in part on the findings of several studies financed by IDA (see list in Appendix 8). An IDA Credit of SDR 38.7 million (US$50 million-equivalent) would be made to the Gover.,nent at standard IDA terms in support of the proposed reform program. The Credit would be disbursed  - 31 - in two equal tranches, the first tranche being made available at effectiveness and the second tranche upon satisfactory progress in implementing selected actions agreed upon with Government. Specific conditions that would have to be met by the Government are summarized in the Policy Matrix (Aypendix 5). The proposed Credit would be disbursed over an 18-month period extending to December 1991. B. Coordination with the IMF and IFC 102. The proposed operation has been prepared in close coordination with the IMF, and its thrust is in line with the content of the PFP. In particular, the IMF has been associated with decisions affecting on-going and proposed policy changes related to interest rate reform, monitoring and supervision of the banking sector, and the tariff regime. The presence of IMI advisors to the Central Bank will ensure coordination of future interventions at that level. The reforms to be carried out under the Credit were also designed in close liaison with IFC and with PIAS. In particular, FIAS completed a comprehensive review of Guinea's investment climate in September 1988, the content of the proposed operation being fully consistent with the review's recommendations. C. Co-financing 103. The important links this operation and Guinea's overall adjustment strategy has attracted strong interest from the donor community. In particular, Caisse Centrale, of which a representative participated as an observer in Credit negotiations, has indicated its interest in financing technical and other assistance required to strengthen tne National Investment Commission (see para. 76), and possibly the new institution responsible for the promotion of SMEs. PAC will for its part finance specific measures to be adopted to strengthen the judiciary system, such as the training of judges in banking and commercial law, based on the recommendations of a consultant financed under the FAC trust fund. USAID will be providing two long-term advisors to BCRG respectively for bank supervision and for the collection of balance-of-payments statistics. UNDP will be providing continued assistance to the Ministry of Labor's National Employment Office. D. Procurement and Disbursement Arrangements 104. Proceeds from the Credit would be used exclusively for the financing of 100 percent of the CIF costs of eligible imports. All public sector as well as private sector imports would qualify for financing, except for: (1) a negative list to include military equipment and luxury consumer goods; (2) imported goods financed under tied bilateral credits or by other multilateral donors; (3) imports of less than $10,000 per contract; and (4) imports under existing contracts if they are single  - 32 - source purchases (direct contracting), unless they qualify for proprietary or standardization reasons, or if they are arranged under bilateral trade agreements. The Credit would also include an aggregate ceiling of $25 million-equivalent for petroleum products and for foodstuffs. Quantity, quality, and price of all eligible imports will be verified as part of the standard verification undertaken at port of embarkation by the private agency contracted by the Government. 105. Direct imports by Government and the private sector would require international competitive bidding (ICB) for contracts above US$2.0 million. For amounts below that amounts (1) the Government would follow public procurement procedures, which were found to be acceptable to the Bank; and (2) private sector purchases would follow established commercial practices, and wherever possible, quotations from eligible suppliers in at least two countries would be obtained. 106. At Credit effectiveness, an initial amount of US$5 million would be credited to a special project account to be established at the Central Bank prior to effectiveness. The account would be replenished regularly up to the limit of the first tranche on the basis of fully documented reimbursement applications presented by the Central Bank's Foreign Exchange Department, according to procedures presently used under the SAC. The reimbursement applications will include all relevant supporting documentation, including invoices, pre-shipment validation of quality and quantity of goods, and customs declarations, and, in the case of goods procured under ICB, solicitation of bids, evaluation reports and contract. All relevant documentation including evidence of payment will be maintained by the Central Bank for review by supervision missions. 107. The funds generated by the sale of foreign exchange provided by the Credit will be deposited into a counterpart fund account at the Central Bank in the name of the Treasury. Counterpart funds will thereby be channelled through the national budget according to standard public finance expenditure procedures. E. Program Administration and Auditing 108. Overall responsibility for the implementation of this operation will rest with the monitoring unit (Cellule Technique) of the Government's Economic and Financial Coordinating Committee (CCEF). The unit was involved throughout in program preparation, and is thus well aware of the scope and content of the Program. Ha.-ing use of the permanent secretariat established under the auspices of the EMSP Project, the unit will keep track of the various facets of the Program and deal with pending issues. It will also prepare semi-annual progress reports to be submitted to IDA, with the first report due six months after effectiveness. An Interministerial Committee has also been set up by the Government under the Chairmanship of the Advisor to the Governor of the Central Bank (also a member of the monitoring unit of CCEF), to deal with policy-related issues and to ensure a smooth flow of information on the reform program between the various ministries involved. The Committee will include  - 33 - representatives from the ministries of Plan, of Industry, and of Finance, as well as from the Central Bank. Representatives from other ministries (Social Affairs and Labor, Justice, etc) as well as from the private sector will be called upon to participate in committee deliberations as needed. An audit report conforming to internationally accepted standards and prepared by auditors approved by the Association will be submitted by the Government within six months of the close of each fiqcal year. 109. Both short- and long-term technical assistance will be required to carry out the proposed reform program. Part of such assistance (covering in particular the functioning of the new unit to monitor exemptions, tariff hanmonizaticn, customs reform, labor law practices, and the reinforcement of the Central Bank's supervision capacity) will be provided for under the ongoing Economic Management Support Project, using either existing technical advisors -- including, for the preparation of new legislation, the legal assistance team -- or drawing on funds as yet unallocated to specific activities. Other technical assistance required under this operation would, as described in para. 103, be financed by Caisse Centrale, FAC, and UNDP. F. Benefits and Risks 110. The Private Sector Promotion Program broadly aims at giving new impetus to private investment in Guinea by: (1) removing legal and regulatory constraints which continue to stifle private initiative (enterprise establishment procedures, legal void surrounding the issue of land and property rigths); (2) reducing Government interference in daily business activity (hiring and firing of workers, harassment of private operators by customs officals, etc.); (3) improving the competitive environment (discontinuation of the ad hoc award of exemptions, effective application of import duties); (4) making existing Government institutions more supportive of private sector development (National Investment Commission, National Labor Office, investment promotion institutions, Customs Administration); and (5) increasing the banking sector's capacity to provide key financial services to individual entrepreneurs (adoption of interest rates conducive to the mobilization of resources, rationalization of refinancing schemes at the Central Bank, improved treatment of legal disputes involving loc-1 banks, stronger monitoring and supervision of banking activity). 111. These reforms, which would usefully complement the macroeconomic reforms already undertaken under the SAC, are expected to have a positive impact on the confidence of both local and foreign promoters, and thus on their willingness to undertake new investment in Guinea. As a result, the Program should enhance financial flows to sectors heretofore starved of new capital. It will thus eventually boost growth in the industrial sector -- a sector which has lagged behind in the context of the government's overall reform program -- eventually bringing growth in that sector up to par with overall economic performance.  - 34 - 112. Social lmPact. Government policy has been to ensure that adjustment with growth is not pursued at the expense of equity. Policy changes during the first phase of the adjustment program have shifted the terms of trade in favor of rural producers. The Government therefore adopted a number of transitional measures to cushion the adverse effects of adjustment on vulnerable groups in urban areas, in particular through higher salaries or voluntary departure bonuses for civil servants, and labor-intensive work programs in Conakry funded in part through IDA's Urban Project. Growth in industrial activity generated by the proposed operation would contribute to such efforts, by providing a much-needed alternative source of employment for the urban population, at a time of lay-offs tied to the administrative reform program. It should generally lead to improvements in overall living standards through the incleased revenue flows tied to higher levels of activity throughout the economy. 113. The risks involved in the Program are two-fold: (1) that, given the long-standing negative attitudes towards the private sector by public officials, the new set of reforms will not be taken seriously and not be forcefully implemented by those government officials that deal on a daily basis with business operators; and (2) that despite the new measures, private promoters will maintain a wait-and-see attitude towards Guinea. The first type of risk should be offset by the commitment felt at the highest level of Government to push forward the reform program. In this respect, the President himself has emphasized in two recent declarations the importance of encouraging private sector initiative on one hand, and of improving Guinea's judiciary and security environment on the other. Implementation of the Program through the technical unit of CCRF should also encourage individual ministries to pursue reforms in their field of prerogative with all due diligence. Moreover, this operation does not only focus on the regulatory framework per se, but also attempts to improve the administration's oversight capacity, effectiveness, and accountability. In that respect, technical assistance financed from EMSP and other sources will play a key role in improving government responsiveness to private sector needs, particularly within the Ministry of Finance (tax collection, monitoring of special investment and duty conventions), Customs Administration (actual collection of taxes, improved effectiveness of customs services), and the Central Bank (closer supervision of the banking sector). 114. As for the risk that private operators might not respond favorably to the reform program, it is clear that the combination of a constraining regulatory and incentive framework and of the administraion's interference in the daily operation of local businesses have been key factors in local as well as foreign investors' reluctant attitude towards Guinea. Given the country's strong -- and still mostly untapped -- economic potential, one can reasonably expect that private investors will, in time, respond positively to the improved investment climate to result from this Program.  - 35 - G. Conditionality 115. The Government has, in connection with the Program, submitted a Statement of Sectoral Policy outlining its overall sectoral objectives, and including specific action plans and timetables for their implementation. Progress in implementing these various action programs will be closely monitored in the course of this operation, with the following measures being specific conditions of Credit approval and disbursement (see Policy Matrix in Appendix 5): Conditions for Board Presentation (i) Signature by the Government of its proposed Statement of Sectoral Policy. (ii) Adoption of texts abolishing the requirement for private operators to obtain commercial licenses to operate, and limiti-tg the requirement to obtain technical licenses to specifically regulated activities. (iii)Clarification of the Investment Code's eligibility criteria. (iv) Adoption of text specifying that all special conventions implying the granting of fiscal or duty privileges should, prior to their approval by the Ministry of Finance, be submitted for review to the National Investment Commission. Conditions for Effectiveness Si) Issuance of guidelines for implementation of the new Labor Code confirming an enterprise's freedom to hire and fire labor without prior approval from the Ministry of Labor, and publication of decree defining the new role of the Ministry of Labor's National Labor Office (ONEMO) as a labor statistics unit. (ii) Submission of an acceptable Action Plan to streamline institutional framework for investment promotion. Conditions for Second Tranche Release (i) Enactment of legislation establishing basis for private rights on buildings and other commercial property. (ii) Implementation of first phase of customs reform program. (iii)Establishment of new institutional framework for investment promotion, including publication of decree establishing new investment promotion institution for SMEs.  - 36 - PART V. RECOMMENDATION 116. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association, and I recommend its approval by the Executive Directors. Barber Conable President  - 37 - APPENDIX I Table 1 REPULIC of OUI PRIVATE SECTOR PRMOTION CREDIT KEY MACROECOOIIOC INDICATORS (excludlag transactions vith USSR) 1966 1967 1980 1904 199 1 1992 1998 19 1998 ea-. -projge to d - ---------- Real arowth Rats (in S) Groes dometic producte (%PW 8.2 6.0 4.4 4.0 4.6 6.8 4.7 4.7 4.3 COP per capita 0.8 8.1 1.8 2.0 1.7 2.9 1.8 1.8 1.4 CenAtion per capita -1.1 1.2 1.7 .0 8.1 1.7 1 16 1.2 In Current Prices Debt Services USS millions) 107.9 124.6 164.1 140.8 140.6 162.7 188.8 137.8 120.3 102.0 Debt Services as a share of exports of goods and NFS (9) 20.8 22.7 88.4 21.7 20.4 22.0 21.8 19.0 17.1 18.0 Dbt Serviee as a share of gross dometic produec (S) 8.7 6.1 7.8 .2 8.0 4.0 4.7 8.9 8.4 2.6 == ~~~~- - -- - -- - -- -- -- -- -- -- -- -- -- -- -- -- -- - -- - -- -- -- - -- - - - - - - - - -- -- -- -- __-_- -- - - - - - - - - - - - - - - - - - In Current Prices Cros Investment as I of MP 14.9 16.8 17.6 16.9 18.9 17.5 17.7 18.0 17.9 17.2 Dometic Savings a S of CDP 10.6 15.7 12.8 1S.1 17.4 18.7 18.7 18.7 18.S 15.0 National Savings as S of CMP 12.7 11.5 8.0 10.7 12.1 11.6 12.7 12.9 18.2 13.2 Public Investent as S of aCP 8.0 6.1 7.0 6.4 6.9 7.8 7.9 7.9 7.7 6.9 Private Invot_ent s IS of CDP 9.9 10.2 10.9 10.6 9.0 9.7 9.8 10.0 10.8 Ratio Public to Private Investmnt SO.8 89.7 64.1 60.1 77.1 81.8 80.0 78.7 75.0 68.3 Of Public Savings a S dof GP 1.8 4.1 2.2 4.2 6.7 6.9 7.7 7.7 7.9 8.4 0N Private Savings as S of COP 11.8 7.4 s .6 6.6 85 8.0 8.0 8.1 8.4 4.9 =o _- -- - -_ -- - -- -- -- - - - - -- -__- - - - - - -- -- -- - -- - - -- - -- - -- - - __-_- - - -- -- -- -- -- -- -- - In Currnt Prices Gornment revenues a S of ODP 11.8 1l.9 14.4 18.0 16.8 16.0 16.8 16.1 18.9 16.0 Oovernment Expenditure as S of COP 17.9 20.7 22.4 20.1 20.4 21.8 20.4 20.0 19.8 17.7 Deficit n I of CdP: *xcl grant -4.0 -4.8 -11.4 -s.. -7.8 -8.0 -7.8 -7.8 -7. 1 -5.4 Deficit a S of GDP d gnal nt, -6.0 -4.8 -8.0 -8.2 -8.8 -4.7 -4.9 -8.9 -8.4 -1.7 ==_ - ----------------------------___ - _- - ---- ---- ------ ------------- In Current Prices Export of Oode and NFS. Growh Rate 4.0 -5.1 24.1 11.4 -4.2 2.8 1.0 4.0 4.8 Exports as of 1G 27.8 26.7 24.1 27.7 27.7 28.1 24.1 22.6 21.9 21.3 Imports of Ooodo nd uS. arowth Rate 22.4 1S.4 8.0 1.8 11.4 4.1 2.4 8.8 8.7 Imports as S of CDP 1j 24.1 27.8 9 28.6 26.0 27.2 26.8 28.1 24.6 25.6 Current Account (US11 millions) -42.1 -97.7 -281.4 -168.0 -111.0 -178.8 -166.8 -160.8 -178.7 -162.0 Current Account a S of CDP -2.2 -4.8 -10.7 -7.1 -4.8 -4.4 -8.6 -8.7 -8.2 -4.4 J/ Date relating to external transactions ma shown in the balance of pymnts table diffor from those included in the NteSIo Income Account. Whitle the differencs have been minained foe the bas year (1901). projections for the COP reflect trend- mamsad for the purpose of balance of paymnta projection.  - 38 - APPXIX I Table 2 RIEPULIC OF OUIN PRIVATE SICOR PROMOTION CREDIT BMALACE OF PAMETS. 1988-93 (In millions of U.S. dollars, excluding transactions with USSR) iwo 1969 1000 im0 1I too i94 199 Trad elu.. -25.4 4.0 1.:$ .9 8. 46.0 3492 3. beO ()89 d64.: no.7 o. 714.6 9 f.7 16.7 fame" 644.4 -514. -m.2 -9. .06.0 7. -714.8 -745.7 lac. P t tt r -26.7 -357.5 -.2 -.6 -5.1 -35.7 -149.9 -&1.6 am-feote ow e, u* -101.1 -115.1 -106.7 -2.1 -.. -15.5 --1.5 *1;0.