Zambia - Privatization and Industrial Reform Adjustment Credit Project

Ce zvor- i/ Document of The World Bank FOR OFFMCIAL USE ONLY MICROFICHE COPY Report No. P- 5786-ZA Type: (PR) DAFFERN, E/ X34507 / J11097/ AF6IE ReportNo. P-5786-ZA. REPORT AND RECOIMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN THE AMOUNT EQUIVALENT TO US$200 MILLION TO THE REPUBLIC OF ZAMBIA FOR A PRIVATIZATION AND INDUSTRIAL REFORM ADJUSTMENT CREDIT JUNE 3, 1992 This document has a restricted distibution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Zambian Kwacha (K) US$1 = 130K (April 1992) 1 million K = $7,700 FISCAL YEAR Government January to December Zimco Parastatals April to March ABBREVIATIONS AND ACRONYMS AIDS Acquired Immune Deficiency Syndrome CDE Certified daily employee CG Consultative Group for Zambia EC European Community ERC Economic Recovery Credit (2214 ZA) ESMAP Energy Sector Management Assistance Program GRZ Government of the Republic of Zambia HIV Human Immunodeficiency Virus INDECO Industrial sub-holding company under Zimco, formerly the Industrial Development Corporation INDENI Oil refinery MMD Movement for Multiparty Democracy NCZ Nitrogen Chemicals of Zambia NGO Non-governmental organization QOL Open General License PIP Public Investment Program PTC Posts and Telegraph Corporation SIDO) Small Industries Development Organization SPA Special Program of Action SSE Small Scale Enterprise TAZAMA Tanzania Zambia Pipeline Company UNIP United National Independence Party ZA Zambia Airways ZCCM Zambia Consolidated Copper Mines ZESCO Zambia Electicity Supply Corporation ZIMCO Zambia Industrial and Mining Corporation ZIMOIL Oil Import parastatal ZR Zambia Railways  FOR OWICIAL USE ONLY PRIVATIZATION AND IMDUSTRIALREFORM ADJUSTMENT CREDrT Table of Conteb Page No. I. COUNTRY POLICIES AND BANK GROUP'S ASSITANCE SrRATEGY ........ 1 A. Backgroundand RecwtDevelopment. 1 B. Macroeconomic and Structr Policies andStraegy. 3 B.1 Short-TermStabilizadonMeasur.. 3 B.2 Long-Term Development Stregy and Isues. 6 H. BANK GROUP ASSISTANCE STRATEGY .................... 10 A. PastPerformance andPolicyDialogue .9 B. Bank Objecdtv and Asistnce StaWgy. .10 C. LdigProgram and Economic and Seor Work .12 D. Aid Coordinion and Relations with the IM5.15 B. CriteriaforMonitoringProgress .16 M. PROPOSED PRIVATIZATION AND INDUSTRIAL REFORM ADJUSTNENTCR.EDff ................................ 17 A. Macroeconomic Stabiization Program .17 B. Public Sector Management .18 C. PrivateSectorDevelopment . ................. 19 D. PrivatizationProgr am.21 B. Parastatal Reform .23 F. Social Safety Net .25 G. Technical Assistance .26 This report is based on the findings of an appraisal mission which visited Zambia in March 1992. The appraisal mission was led by Eric S. Daffern, Principal Energyl/ndustry Specialist (AP61E). Mr. Victor Agius, Principal Financial Specialist (AF6E) was responsible for the financial sector and stock exchange issues, Mr. James Karuga, Consultant, was responsible for the technical assistance needs, Mr. John Todd, Sr. Economist (AF6CO) was responsible for the macroeconomic stabilization program issues, Mr. Pedro Bei, Sr. Inuustrial Economist (AF6E) for trade issues, and Mr. Chang-Po Yang, Economist (AF6CO) for public sector management. Seetial support was provided by Mrs. Irene Chacon, Noemi Dacanay, and Ms. IvY Tompkins (AF6DE). Messrs. David Cook (AF61E), and Stephen Denning (AF6DR) are the managing Division Chief and Department Director, respecively. This tocutment has a restricted distribution and may be used by recipients only in the performaitue of their oMcia dutie. Its contents may not otherwise be disclosed without World Bank authorization.  ZAMBA PRIVATIZATION AND INDUSTRUAL REFORM ADJUSTMENT CREDiT Table of Contents (Cont.) [V. FEATURES OF THE PROPOSED CREDrr . . . . . . . . . ........... 26 A. Borrower and Crdft Amount ........................... 26 B. Disbuemeand Procuremen ...... .................... 26 C. ProgramManagmemnand Monitoring ..................... 27 D. Monitorable Actions. .6.............. . ....... ... 28 V. JUbSTIFCATION AND RISKS ...................... 30 VI. RECOM&ENATION ...................... 31 ANNEXES Annex I Leter of Development Policy Attachment: Policy Matrix Annex Dk: Key Macroeconomic Indicators Bial of Payments Extern FinancingRequirement Social Indicators of Development, 1990 Annex M: Slem ayDaa Sheet Annex IV: Lndig Program and Economc Sector Work Annex V: Parastat Structure Annex VL Zambia's Privatizadon Program Annex VIll Statement of Bank Group Opeatins ank and IFC) Annex Vm: Social Action Plan  ZAMBIA PRIVATIZATION AND INDUSTRIAL REFoRM ADJIusMENT CREDfT CREDrr SUMMAItY Borrowe/Benellary: Republic of Za-abia Executing Agencies: Ministry of Finance Ministry of Commerce, Trade and Industry Ministry of Legal Affairs Bank of Zambia ZimCO Amount: IDA: SDR 146 million (US$200 million), standard IMA terms. Description: The proposed Credit will support the next stages of Zambia's structural adjustment program which focusses on market liberalization and civil service reform, together with major new initatives in private sector development, privatization and parastatal reform. The main themes of the credit are to modernize the business framework through up to date laws and regulatory systems, consolidate establishment of a market-based exchange rate mechanism, direct encouragement of the private sector through privadzation, and autonomy and efficiency improvements in the remaining parastals. The centerpiece of the reform is the privatization of 90% of Zambia's parastatals over a five-year period, and giving autonomy to the remaining public udlities through a new arm's-length regulatory system. The parastatal holding companies will be abolished within the next year. At the end of the five-year period, the Government will have largely removed itself from business operations. Enefits and Risk: The Credit will provide balance of payments support to underpin Zambia's structural reform program. Key benefits of this program will be strengthened management and greater efficiency resultng from the asfer of activities to the private sector, shening the business environment and improvements to the regulatory system.  i H The operation faces politcal and implementation risk. The polidcal risks come from pressures that will arise as subsidies are phased out and reladtve prices adjusted resulting in fahlling real incomes and redundancies. Nevertheless, the new Government was elected to und8rtake a major ecnomic reform program and has shown courage and te n in facing up to the difficult decisions tua have to be mat Ihe Government has also take steps to strengt implementaion capacity and will be supported in this endeavor by a parallel technical assisance credit Disbursement: 'he credit would be disbursed in three tranches. The first tranche of USD 100 million would be available upon effectiveness. The second and tird tranches of USD 50 million each would be available three to six months and e to twelve months ,respectively) after effcctiveness upon satisfactory fulfillment of specified conditions. Disbursement would follow standard bank procedures for imorts, subject to a limit of 50% for commodities. Retroactive fiancing would be allowable up to a maximum of 35% of the credit for imports carried out since March 1, 1992. Appraisal Report. This is a combined Report of the President and Staff Appraisal Report.  INTERNATIONAL DEVELOPENT ASSOCIATION REPORT AND RECOMMENDATION OF TIlE ENT TO TE EXECUTIVE DIRECIORS ON A PROPOSED CREDIT TO THE REPUBLIC OF ZAMBIA FOR A PRIVATIZATION AND INDUSTRIAL REFORM PROGRAM 1. I submit the following report and recommendation on a proposed Internationl Development Association (IDA) Credit of SDR 146 million (US$200 million), on standard IDA terms with 40 years maturity, to the Republic of Zambia in support of the coutry's Privatization and Industrial Reform Program. Japan and Germany are expected to participate in the fiancig of this program. A parallel techical assisnce credit is recommended to provide funds to ensure that the adjustment program is properly implemented. 2. The proosed adjustment credit seeks to contiaue the Economic Recovery Program suoed by IDA through the March 1991 Economic Recovery Credit (2214-ZA), and to deepen the program in the three key areas of private sector development, privazation and parastatal reform. Ihe Credit amount specifically reflects the recommeded response for the Bank group to the severe drought affecting Zambia, within the context of wider donor efforts on this issue. The last Economic M4emorandum on Zambia (Report No. 5000-ZA) was distrbuted to the Executive Directors in November 1986; a new Economic Memorandum is under preparation. A Policy Framework Paper oPff) 1992-94 was discussed by Executive Diectors on March 17, 1992. X. COUNTRY POLICIES AND BANK GROUP'S ASSISTANCE STRATEGY A. Bakgound and Recent Developments 3. The Zambian economy suffr from severe and longstanding distortions that will require a major structural adjustment effort over an extended period if they are to be overcome. Its major characteric is heavy dependence on copper and the dualistic structre that has grown up around this depndence. From soon after independence in 1964 the United National Independence Party (UNIP) Government sought to gain control of the economy through widespread oization. The economy became domined by parasls and one-arty was introduced. Rising copper prices helped the economy to grow steadily at an average rate of 4% per annm during the first decade after independence. Since 1975, however, falling world prices of copper (Zambia's most Important export) and the general dterioration in tems of trade, coupled with the failure to develop a diversified economy, caused overal economic decline. Attempts to support continued conson through bortowing faRed to contribute to economic growth and created an exceptionally severe debt problem. Per capita GDP is now morethn a tird below its 1978 level. 4. Aftr several unsuccessful efforts at reforming the ecomy, in the late 1970s and early 1980s, Zambia adopted a comprehensive adjustme program in 1985, wIh Bank and DM support This too ran into difficulties in part becau of poor fiscal and monetary control. In 1987 the Govenment abandoned It and reversed many of the reforms undetake In the previous two years. Th exhange rate was set at an overvalued level, administrative controls for foreigl exdcange and impot were reintoduced, privileges were given to some parastatals and others were subjected to price controls. The Governmfet also stpped most extemal debt sevice, consequenty the Bank suspended to Zambia. Support from the donor community was progressively witawn. The debt overmg continued to grow, and the economy to decline. After a hiaus,  -2- Governmen resumed its policy dialogue with the Bank and Fund in late 1988; in a major policy shift, In June 1989, Government abolishe all price controls except those on maize, mealle meal, fertizers, petroleum and public utilities. Subsequntly, agreement was readced in mid-1989 with the Bank and Fund on a PFP outlinA the Govenme's medium-term developmen strategy and objectves for the period 1989-91. Ihe PFP was followed by an annual Fund-monitored program for 1990. A second PFP covering the period 1991-93 was reviewed by the Commitee of tae Whole in March, 1991 when the Bank arrears were cleared and a new Economic Recovery Credit (ERC) for US$210 million was approved on March 5, 1991. In addition, Zambia began a rights accution program which was approved by the If Board in Aprfl 1991. In response to public pressres, a new constiution was itroduced alowing for multiparty elections. S. Government adherence to the agreed economic reforms began to slacken during the run-up to the multiparty elections; Government reintroduced price controls (this time, informally), and public exenditure got out of control as a result, inter alia, of excessive public sector pay increases and increases in subsidies (maize, fertilizer) to a much hiher level than budgeted. Bese of poor perfmnce, donor support for Zambia was delayed, Govermt defaulted on Its payments to the Bank, and as a result disburements were again suspended in September 1991. 6. In the October 1991 multipat eections, the opposition MMD party (Movement for Multiparty Democracy) was elected to office and given a srong mandate for a reform program dth incdudes movig to a full market economy and significantly reducing the role of Government. Specfic proposals in the party manifeso included prvathaon of vir"ally the entire parastatl sector, and the restructuring of the utilities that will remain in public ownership. Since assuming office the new MMD Government has made a dermined start in the 1992 budget; comprehensive reforms have been adopted ahmd at bringing the budget into balance, encouring exports, liberlizing the economy, cutg back the civil service and pdvating most of the parastat sector. As a result of the strong actions by the Government, external support has resued; the Bank arrears were cleared in January 1992, the suspension was lifted and the seoond tanhe of the ERC was disbrsed. 7. The Government's rerm program will ineviably be made more difficult by the catarophc dought tdat has affected all of Southern Africa in the early months of 1992. More than half of this year's crops have been lost throughout the area. In Zambia the maize output is expected to be about one-tW of the post-planting esimates, and agricultura GDP wil be reduced by over 25%. Substan efs are beiag mounted by the donor community to meet the cost of the drought, estmated at about US$300 million for Zambia. Because the drought is forcing up prices of maize, to artficially high levels, the Govenment will use the donor support to shield the public from the full impact of the drought on maize prices. Agrement has been reached with neighboring countries on logistcal argements for large impors of maize. Total import requireme are about ten million bags (900,000 metic tons) of maize, plus smaller quantities of other products (eg., cooking oil). ITe drought has also directly affected a number of other food products such as wheat, soya, sugar and oil seed, and non-food agricultura crops such as tobacco and cotton; this has had an immedia impact on related agro-industs. Ihe drought wM also reduce power exports from Zambia's hydro stations and the loss of these revenues wi lead to a ahap increase in domestic power 8. There are daree major constrbu on Zambia breaking owut fom tspaen ofpast economic fires. First, Zambia bas an c aepdond large debt bwnle. Total debt at end 1991 amouned to US$6.7 billion, of which US$ 2.9 billion is multilateral, US$2.5 blion bilateral, US$ 0.6 billion medium/long-term aommecia icuding exportcredi) and US$ 0.7 biion short term. Excluding  -3 - the short term debt, Zambia's extrn debt reprents US$766 per head of population, one of the highest aniywhere. Further rescheduling of official debt is expected in mid-1992, and a commercial debt buy-back (with the support of the IDA Dtht Reduction Facility) is planed for later In 1992. Alleviat the debt burden is a prime focus of the CG and Paris Clut; processes, and will require substantial and concerted donor support. 9. Ihe second major constraint i the heavy dependence on copper. Copper accouns for nearly 85% of the coutr's exports, conutes about 15% of GDP, and is an important source of budgetary revenue. Ihe problem is worsened by the poor prospects for copper prices and a projected sharp decline in copper output around the end of this decade. IDA is giving direct support to improve the efficiency, profitability and longer-term outlook of copper production In Zambia through the Ming Technical Asistance Credit. However, as outlined in the medium-term strategy expressed in the PFP, it is important for Zambia to diversify its economy away from copper, to reduce the high capital and Import-intensity of production and cosuMption, to improve economic efficiency, and to ise savings and Investment rates so as to restore economic growth. Key to the success of this strateg is a reorientation of the policy framework to increase incentves for agricultural production, encourage the priva sector both through supporting new entry and privatzing the large public sector, and redirecing public e to areas that would facilitate growth and assist In human resource development. However, the first essendal step of this reform program has to be macroecnomic stabilization. 10. The third major constaint, is the domiumce of the parartat sector, the consequent stifling of competition and initiative, and the imposition of high prices and low quality in the domestic industrial sub-sectors Where parastatals have an effective monopoly. The manufacturing parastatals have not kept up with product developments elsewhere. The tourism sector has attracted only a fraction of the potental market. The gemstone parastatal has exploited a negligible portion of Zambia's trmendous potential, with most exports avoiding official chanels such that the earnings were placed direly into foreign bans. With few exceptions, the parastas have been inward looking, and conteat to rely on the small Zambian market; they have generally failed to diversify the economy or to develop Zambia's natuWal advanges to the extn possible. In the public utility sector the posiion is not much better: the railways are extremely slow and unreliable, the power company has been unable to maintain a sufficiently steady voltage for the operion of sensitive industrial plants, and the telemunications service i substandard in areas important to business. This failure of the pasatatl sector, and the measures to remed It, are the primaryfocus of the proposed Credk. B. M|c d 9r1 PoUies ad &Ed= 1.1 Short-Twm Stabiaton Measures 11. Ihe progress made over the last three years, In particular the bold measures in the 1992 Budget, bas now put the Government in position both to deal with the short-term problems (particularly iflaton and the balace of payments) and to address the undedying structural issues. Ihe medium-tem str calls for proviing a regulatory framework and Incentives to encourage sustainable gtowth, with emphasis on the priate sector parularly In agriclture, tourism and gemstone mining; significant strengtening of physical and socia rastructure increased attention to social and poverty issues; implnn of e r t policies, and a renewed effort in bstkadod strengteing.  -4- 12. The Gouenment's stabilion policies for 1992-94 are set out in the Policv Framework Paper (PFP) considered by the Committee of the Whole on March 17. The program objective set out in the PFP (pre-drought) was to achieve real GDP growth rates of 2% in 1992, 3% in 1993 and 4% in 1994, implying a positive real per capita growth by the end of the 1992-94 PFP period. These figures will be updated mid-year to reflect the impact of the drought. Gross investment is planned to grow to about 20% of GDP in 1994, more in line with the experience of the 1980s. However, investment statistics are particularly inaccurate and conclusions should be drawn with care. This rist in private investment will be facilitated by a fiscal policy designed to increase public savings and shift financial resources to the private sector, and a monetary policy seeling to attract savings though a positive interest rate policy. The most daunting task is to lower inflation from about 100% in 1991 to 45% in 1992, 15% in 1993 and 5% in 1994 (all on a calendar year basis). The stabilization plan is to achieve a primary budget deficit (excluding grants) of no more than 2% of GDP in 1992, ful balance in 1993 and a small surplus in 1994. The most impoitant of these measures are the rapid elination oftheprinc4pal subsidies (on maize, fertilizer and parastatal deficits), reprioritkingpublic expenditures, enhancing revenues by broadening the tux base and redusming loopholes (while lowering tax rates) and civil service reform to create a smaller but more efflcient, better paid and motivated staff. Civil service pay will be controlled by maintaining aggregate emoluments at a constant proportion of GDP, with any extra pay raises being offset by savings from redundancies. The success of Government in implementing these measures constitutes the key indicator of its determination to recover control of the economy. 13. Revenue Measures. The Government's revenae strategy is to simplify and reduce direct tation and simplify indirect taxation, while lowering protection and encouraging exports. Overall revenues will be increased, mainly by removing tax loopholes and by higher dividends from parastatals. 14. The Government has already made a major start on tax reform. Progress on indirect taxes has been good. In the 1991 budget, most imported goods were brought into three tariff bands at 15%, 30% and 50%, with a few exceptions such as food and fertilizer at zero tax, and minor luxury goods at 100%. Trade distortions were reduced, and Government revenues enhanced, in the 1992 budget by harmonizing the sales taxes at a uniform rate of 20% on both imported and domestically produced goods. Petroleum currently is imported tax-free, but there is no local oil production and the minimum excise tax on petroleum is 15%. In relation to the 1993 budget, the Government's program is to reduce further the highest tariff band so as to reduce the protection offered (see para. 60), but to do this in conjunction with smoother operation of the OGL (Open General License) system, and only ater the impact on business and employment has been well-studied. Government plans to raise new revenues from the introduction of a value added tax, and from the introduction of mandatory dividends from parastaas. 15. In addition to the above, Governmemi has cut the basic company tax rate from 45% to 40% begining April 1, 1992, offsetting this by phasing out non-cash finge benefits as deductible business expenses, and Is undertaking a detailed examination of the structure of company tax with a view, to implementing further reforms in 1993 or 1994. Personal income taxes were also reformed in the 1992 budget, the main emphasis being a widening of the tax net to tax cash fringe benefits, (such as the housing allowance) to offset a reduction in tax rates and an increase in the tax tLreshold. 16. Expendit . The expenditure reduction plan includes reform of the public and parastatal sectors, increased devolution of authority to local governments, better coordination and determined control of commitments and expenditures, reprioritization of expenditure, and phased elimination of  -5- subsidies. Ihe major reductions in spending will be in crop financing and subsidies. The change In crop financing is primarily a result of the greater private sector role in maize purchasing and marketig. The reduction in subsidies comes from elimination of maize transport subsidies and of fetlizer subsidies and the substantial reduction in maize meal subsidies. 17. The Zambian public did not generally benefit from the previous Government's maize subsidies as intermediaries bought up the stocks and many families had to buy at parallel market prices. The new Government moved fast to correct this situation by a speedy cut In nmaze subsidies balanced by a stronger safety net to cushion the impact on the most vunerable. In littds more than a month after taking office, subsidy cuts resulted in price increases for roller meal by 103% and breakfast mWl by 165%. Further increases were made three months later. Consequently, within its first four months in office, Government had eliminated the subsidy on breakfast meal (the more refined product) and reduced the subsidy on roller meal (the less refined, and hence more nutritious, product) to about 30%. Govermment removed the remaining subsidies on roller meal during May, and all into- mill subsidies on domestic production have now been removed. As a response to the drought, Government will pay a temporary bonus on locally produced maize delivered in May and June, and pay the cost of transport, handling and storage for locally produced maize to ease the transition to the new higher prices. The phase-in to the higher prices will be achieved by October such that the Into-mill cost will be at about the level that would have applied in a non-drought situation. This will then be an appropriate base point for the 1993 crop. In addition there will be a program of linited quantities of half price and free yellow maize to be channelled to thu- poor (mcluding subsistence farmers severely affected by the drought) through local groups supported by the World Food Program and the NGOs, and additionally a 15% subsidy on yellow maize supplied to hammermills, to encourage consumption of the more nutritious straight-run mealie meal. These poverty-focussed subsidies will expire b; mid-1993. Subsidy reduction is a particularly visible measure of Government resolve for economic reform, and becomes a key indicator of progress. Price controls and subsidies in the fertiizer sector were eliminted in March 1992. 18. Government has already announced a shift in expenditure priorities such that more money will be spent on non-wage recurrent ewpenditures in areas such as equipment and building maintenance. Further, a realistic Public Investment Program (PIP) for 19924 has been adopted, and expenditure outside of the PIP wil not be authorized except in exceptional circumstances. 19. Monetary and Interest Rat Policies. The Bank of Zambia has established a target for broad money growth of 25 percent for 1992. This is lower than the year on year inflation objective (45%) since it is anticipated that it will take sometime for inflation to decelerate as monetary policy is tightened. In addition to monetary restrain, Government has increased the maximum effective Interest rates charged to borrowers to about 70%, which is equal to the inflation rate targeted for the end of the first quarter 1992. As inflation falls during the year, interest rates charged to customers are expected to decline. To encourage savings, efforts wil also contue to be directed at raising bank deposit rates relative to lending rates, particularly through reducing the proportion of non- interest bearing deposits placed with the Bank of Zambia. A limited amount of debt-equity swaps wil be permitted at conversion rates prescribed by the Bank of Zambia. 20. External Sector Polides. The centerpiece of the strategy for expanding non-traditional exports by 10-15% a year over the next decade is an exchange ratepoliy that aligns the value of the kwacha closely to the parallel market rate, such that the efficient allocation of foreign exchange is promoted, and to give added incentive to exporters through a liberaized export retention scheme. To ihat end the kwacha was devalued by 30% on January 31, 1992. The Goverment's plan is to  -6- -djust the official exchange rate in installments to a level that will permit the OGL system to be shifted to a negative list system and steadily broaden the coverage of the OGL. Government has announced complementary reforms to encourage exports through an improved duty drawback scheme and further development of bonded warehouses. Continued development of the OGL system is a key test of progress in Zambia's macroeconomic reforms. B.2 Longer-Term Development Strategy and Issues 21. The Government's strategy to restore long-term groh calls for the creation of an enabling enviromnent conducive to the growth of the private sector, so that it can provide most goods and services, and to limit Government's role in the economy to the provision of essential services; Governent regards the most important of these to be the development of the basic physical infrastructure and of Zambia's human resources, the provision of social services (and of a social safety net) and the implementation of appropriate environmental policies. Government is also aware that for this strategy to succeed it needs to deal quickly with the overwhelming debt situation. 22. Private Sector Development and Public Sector Reform: Government is embarking on a mojorprivadzatlonprogran and seeking to make the public utilities more efficient, and to introduce fther reforms in incentives and in the legal and regulatory framework, with a view to development of a strong prwvate sector. Theprivatkationprogram aims to put all new copper developments under the control of private investors, to reform ZCCM, and to privatize all other commercially-oriented parastatals, except for the public utilities, (140 companies to be divested out of 155 parastals), over a period of five years. The parastatal reform program wXl involve a reassessment of the management, staffing, policies and finances of the public utilities, efficiency measures and establishment of performance targets, and insttion of an incentive-based regulatory system. Cuil Service ReJbrm is also an important element in Government's plans for a more efficient but smaller public sector. The Inentiw program includes improvements to the incentives offered in the 1991 Investment Act, and simplification of procedures. It continues the streamlined import and export licensing system, now operad quite efficiendy through the commercial banks, and an exchange rate policy that will move to a small ntegative list system by end-1992; and enhanced competitiveness through fiurther cutting of impov- tariffs. Government is also starting a comprehensive review of busess related laws that are out-of-date; a prioritized action plan has been drawn-up to make early amendments of Acts that affect the privatization process (including laws regulating the banking system and capital market), and to deal with all other business-related legslative modernization over a five year period. 23. Physical InTe. he Govermment intends to put renewed emphasis on a better road system to ensure that crops can be brought to market quicldy, on a more reliable freight-rail system, and on a better quality telecommunications system that is seen as essential for the development of an outward-oriented and efficient productive sector. 24. Htuna Resource Strategy. The centerpiece of the human resource strategy is the rehabilitation and susainable expansion of the education and health sectors. These sectors have borne the brunt of the deterioration in fiscal performance in the past, and the country is faced with a dilapidated and underfunded social inftructure. 25. In education h new strategy means a shap focus on improvements in basic education with a special emphasis on the provision of much-needed infrastructure, management capacity and learning materis. TMe Government bas sought, with success, donor support for this. Other activities in  .7 eduation are geared towards ensuring the necay upply of skldled manpower for the development needs of Zambia, focussing on key skills releva for private sector development. 26. In heal the Government i re-emphasizing primary health care and is in the process of decentralizing health services to ensure community participation and good governance in the sector. Ihe Government is working with key donor agencies towards developing a fhll health sector strategy and management set-up to meet the new challenge of a decentraized system of health delivery. A key area of emphasis is the prevention of AIDS and support for family-based care of AIDS patients. With prevalenc of HIV as high as 20 percent in urban areas, the treatment of opportunistic infections and support for home-based care is important to limit the otherwise devastating effects the AIDS epidenm; could have on the human resource base and the economy. In mntrition the Government is working towards streamining management of national programs and further encouraging the development of local initiatives. 27. The Government is aware of the key role wwen could play in poverty alleviation and growth of the economy and is focUSSing social service delivery, paricularly education and primary health care, on women. Govement is also working towards removing obstacles for women's participation in the labor force, and in their access to credit, and is looking to relieving the all-important time- constraint on poor women in Z mbia. 28. Social Safety Net. Government is taling steps to alleviate the impact of the drought and of the economic adjustment program on the poor and disadvantaged. Specifically Government will: (i) implement a tramsitional subsidy on imported yellow maize to cushion the price impact of the drought. Some families have lost all means of livelihood as a result of the drought. Government will channel spei assistance through local groups supported by the World Food Program and NGOs to ensure that these families can feed themselves and have the seed for next year. Further, Government will assist poorer families for one year only through a small (15%) subsidy on maize supplied to hammermills, in an effort to encourage use of straight-run maize because of its greater efficiency and nutritional value. In addition, Govermment is (U) using some of the savings from subsidy removal to expand social welfare prora ilemend through the Ministy of Community Development and Social Welfare; Oii) increasing funding for small-scale labor intensive public works (supported by IDA and other donors) and other components of the Social Action Program, and conveing some of those to paid-work instead of self-help; and (v) increasing the share of the nationra budget allocated to basic social services, with emphasis on primary education and health care and other services of partda importance to the low income poulation. Specific inter n targets have been set for the above. Paticula attention will be paid to ruml inrastructure. Government plans to heighten public aware of the social action program so as to ensure that more needy people benefit. A progm of severance pay and business counselling will be offered to those made trodundant thgh the retrhment program. For the medium-term the various measures to stmulate small-scale iustry will provide income opportunities in both urban and rural areas. 29. The withdrawal of subsidies on maize meal will have less impact than might be expected on the poor as most maie meal has bee sold on the parallel market at non-subsidized prices and because special arrangements are bing introduced for famMies financialy devasaed by the drought. Ihere appears to be public acceptac of the measres tak. The incoming Government had made its plans clear during the election campaign, and it Is evident tgat most Zambians were ready to take he twugh acdons to stop the long-tem economic decline. 'he drought has caused some adaptation of the maize pricing policy in at, with donor concurrence, Government will set the price of imported yellow maize at the price at had been expected If the drought had not happened.  -8 - 30. ' Ea _lrommta Shrteg. Zambia has a keen interest In presving and improving the physical enironmt, and there is common accpne in Government of the priority tis deserves. As an underpopulated coutry, much of the land has not been afeed by man; yet as the most urbanized country in Africa some problems exist and have to be dealt with. The principal issues are fist, some deforestation, particulay along the line of rail, caused by land clearanco, overcutting of fuelwood, overrazn and buring. In these same areas this leads to soil erosion, a problem made wore by the high natural erodibility of Zambia's soil. Second, there is a local polludon problem from the mines and facdies, particularly affecting parts of the Copperbelt and areas adjacent to industrisal operations. Although not widespread or affecting large numbers, such pollution has to be reduced. More pervasively, the poor control of agricultural chemicals and indequa treatment of human and Industria waste has an obvious impact on water supplies and health. Cholera is a serious issue. And thrd, in relation to wildlife, poaching is rampant, and elepha and rhino are found in numbers only in a few locations. 31. The National Strategy for Consaion dates back to the mid 1980's. It seeks to define and establish policies, plans, orgaization and action to ensure the sustainability of the natural resource, to maintain biological diversity and the essential ecological processes and life support systms. Specific plans and guideines bave been drawn up for all sectors, in conjunction with the International Union for Conervatio of Nature and Nntal Resources. There has been progress in some areas, yet in others, paricularly woodfoel cuing, it has not yet been possible to achieve mearable success. 32. Ihe new Govemet has reaffirmed its concem for envronmenl issues both through the establishment of a Ministry of Environment and Natura Resources and through the explicit interest Of senior policy makers. A new national environmental action plan is in the early stages of preparation, but becase of the need for proper quantiflcation of the copper mining and industrial pollution issues, and the preparation of the natural resources strategy, it is not due for completion until 1995. 33. Etea Capital Require - Tbe Debt Issue Z ia's external debts ae enormous In relation to GNP, and cannot be servied from Zambia's own export earnings. The limitod foreign exchge available in recent years for copper investment has led to decling ouput, and for 1992 (even exuding drou related Imports) the trade balance is expected to be negative. When taken together wih net -ft services, and other payments, the cunT account deficit, excluding iet pamens and offici transfers, is estimated at US$287 milion; it rises to US$587 million when the exra cost of the drought are included. Debt seice obligations amount to US$503 million for nont and US$260 mllion for multiles, and targeted earws reduction is US$294 milion. Thus, excluding any cage in its official reserves, Zambia fces a gross fiancing requim of US$1644 million including the drought needs. 34. While Zambia is putting high pdority on a rapid grwth in exports to move toward a better extern balance, for as long as the debt overhang persists the external finacial picture wil be difficult Ihe main areas for expected improvement are a modest reduction each year in the current accou defici and steady reductions in debt service obligations. 35. Donor support for 1992 has been strong. At the end of the CO meeting, the remaning fiacing gap was about US$330 million. Addition pledges as of May 14 totaled US$199 million, not including a possible US$100 mfllion in debt servico deferral being considered by the IMP. If is amount Is Included, the fincins gap would be US$31 millio and withn range of being dosed.  -9- As a condton of effeciveness for the Credit, Goernment wUi be requdred to confir that it has obtained comminnentsfrom donors and other sources adequate to complete the 192financing plan. I. BANK GROUP ASSISTANCE STRATEGY A. Past Perfnnance and Policy Dialogue 36. Zambia's economy experienced significant decline during the 1970s and 1980s. As low copper prices persisted, the authorities resorted to deficit-fimancing and external borrowing to finance consumption. Domestic saving dried up, investment plummeted, the budget deficit exploded, and the rate of inflation rose sharply. Effective use of existing productive capacity was hampered by extensive Government involvement in price regulation, subsidies, exchange rate and trade controls, and production of goods and services through parastatals. Excessive state intervention created serious distortions and Imbalances in the economy. Attempts at policy refotm and economic restructuring through diversification (supported by an Industrial Reorientation Credit and an eadier Economic Recovery Credit) in general failed because of a protracted decline in copper prices, shortfalls in exteral resource inflows, and poor implementation performance. Output has continued to decline; real GDP declined by 0.5% in 1990 and by 1.8% in 1991. Ihus, GDP growth targets set in the first PFP for 1989-93 of 2.2% in 1989, 1.9% in 1990, and 2.8% in 1991 were not achieved. 37. The Government's policy framework has been updated in the PFPs for 1991-93, and 1992-94 which articulate the policies, objectives, strategy and priorities of the couny for the medium-term. At the same time, the Government issued its Public Investment Program for the period 1992-95 for implementing the framework. At the macro-level, priority is given to eliminating imbalances between demand for and supply of goods and services through structua change. Sectorial priorities have been established. in agriculture, priority is given to smallholder development by improving the provision of research and etension services, credit, and marketing and storage facilities. The focus in the transport sector is on rehabilitation of e infrastructure and provision for adequate maintenance. In the socal sectors, priority is accorded to the rehabilitation of inrastructure at the pfimary-education and primary health-care level so as to improve service delivery. The framework and priorities are consistent with the country's development needs and prospects. If fully implemented, they should foster stability, structural change, and faster economic growth. The objective is to ahieve real GDP growth rates of 2% in 1992, 3% in 1993, and 4% in.1994. 1 Although achievement of these targets will not result in an increase in GDP per capita until 1994, it will be an improvement in the performance of the economy in comparison to the negative rates of growth experienced in the past. 38. Performance targets established in previous PFPs have not been fuly realized largely because of lapses in fiscal and monetary control by the then Government. For instance, efforts to reduce macroeconomic inbalances and to lower the rate of inflation have yielded marginal results. While inflation fell from 158% in 1989 to about 100% in 1990, it was much higher than the PFP target of 55%. Infiation rose slightly in 1991, and GDP fell. Compared with a target of 3% in GDP growth, the actual rate was -1.8%. During the second half of 1989 and 1990, some progress was made in bringing public finances and monetary growth under control. Around the middle of 1990, however, I/ These targets may have to be revised to take into acowunt the severe impact of the drought on agricultural ouput in 1992 and to a lesser etnt in 1993.  -10- signifcant pay awards and Increases in employee allowances and benefits led to a substantial shortfall in the reduction of the budget deficit. The deficit was still 4.2% of GDP in 1990 compared to the PFP target of a surphl of 0.4%. Subsies on mealie med rose shaply, and money supply increased by 100%, gms fuding Infltion. On the positive side, significant liberalization wu achieved through price decontrol, deuation of the Kwacha, Itruction of the OGL system for most merchandise Imorts, expansion of the export reuteon scheme, and reuction of the hWer tariff band from 100% to 50%. Since tuking office in November 1991, the ew Government has increased sharply the price of maize mea, eliminated most subsidies, adopted a budget whih reduced the deficit from 7% of GDP in 1991 to 2% In 1992, inaed the refom of the tax structe, embarked on a program of public service refrm, and adopted a policy of pdvatg parastatals. 39. Since the resmpon of nom rations in early 1991, policy dialogue between the Bank and IF on the one hand, and Zambian authorities on the other, has been effective except for the Issues of maize subsidies and l fkcal control in the summer of l99l which led to a cessation of donor support and suspension of Bank di e . The polic dialogue was maintaned however, and relatons with the new Gov were e8tablished quicldy, with the aid of several key officials retained by the new Economic team; prog ahieved over the past few months has been very positive. Ihe 1992-94 PFP was the product of truly odlaboradve effort among the Bank, IMF, and Govermment. While many of the Govenmens current policie were enunciated in the MMD Manifesto, the tripartite diogue has conibuted significantly tOD their alaion In the PFP. With te lifng of the spesion of disbrsements on January 31, 1992, Bank lending and economic and sector work have id. Supervbion work has also been stepped up. Ihe new Government is commited to the adjustm program and has demonstrated tis by taking tough actons within a few months of tkig office. B. Bank Objecives and Assac Strateg 40. Zambia has to desi, fmace, and implement its adjustment progrm uder particulaly difficult condio. First and foremost is the very high external debt (including to the Bank and Fund) wbich woud result in debt serce rtios near 70% In the absence of rescheduling. Even with extraoray levels of reschedWing and direct suWort from the donors and multilateral Ins"tions such as the Bank, Import levels are hgy constained and reserve le}vs at bare mini . Dealing with the debt issue over the medium term is therefe, a key focus of the Zambian authorities and of the Bank program of assistance. Ihe precario of the extenal financing situation also takes up much of the atntion of senior officials in the Govermen and the Bank. This problem is even more serious this year because of the drougt. Anoth major difficult i the on agas off again history of the Zambia program (and hence of the Bank program of sport) which has created difficulties both in progrm desig and impl bn Our emphasis in recent years has been on the extaoriay financial measures necesary to clear te arreas and restt the program (twice) and to reach an Idlng on some basic mcoonoc policy issues. a result we are staig with a low knowledge base In many areas, and the Govermnt bas not had sustained donor support in many sectors. This constrains both program desig and impI it also resuts in an empasis on tecnical assistaee and a partcular need to focus our support on a relively small number of high prority areas. In some sectors, we know enough tD get started on pry issues while launcing some broader sectoral studies. In odt areas, direct Bank support woud not be prudt until after the proper sector work has been done. 41. The Bank will conue to play a leadig role in assisting the Govenmen to design and implement the adjustme progrm, to place the econmy on a s ble growth path, and to  -11- mobilize the ncessay fincial resources. his will be accomplished through continued policy dialogue, economic and sector work, adjustment and investment lending operations, and effective aid coordinion. Ihe stregy alms to support structuli adjustment while creating a climate conducive to povety alleviation through sustable economic growth and the provision of a safety-net to protect vulnerable groups from the adverse impact of adjustment. The strategy implies substantial balance of payments support to help Zambia redress macroeconomic imbalances in the economy, and to reduce its overwheming debt burden to maageable proportions. To this end, the Bank plans to lend for at least one adjustmt operation for eadh of the net four calendar years. The primary emphasi of the opeation wll alternate between macroeconomic adjustment and sector adjusutm. Each year, the Bank will assess achievements under the ongoing adjustmnt operation to determine the priority meaues to be carried out under the successive operation. Thus, in the earlier years, Bank assistance will be primarily in the form of balance of payments suppot, supplemented by investment operations in the priority sectors; as identified by the Government these are agriculture, industry, transport and social services. In addition, it Is envisaged that IDA would assist Zambia more directly, including through the Debt Reduction Facility, to reduce its debt burden to a more manageable level. 42. Ihe main elements of the Bank's strategy are to support efforts to: achieve macroeconomic stability and initiate a path of sustainable and equitable growth through elimination of the budget deficit, atinment of a competitve exhange rate, and increasing the allocation of resources to economic and social secors by restructring the composition of public expenditure; ensure sufficient access to imports, and an adequate reserve cushion, through maienance of an appropriate exchange rate and other _mures to encourage exports and to use imports wisey, and tbrough coordination of donor asistance and efforts to secure needed debt elimination and rescheduling; improve the climate for private sector development through dereuon, provision of -ifrastuur and privatization of parastatals; - strengthen human resource capacity by rehabilitating the education and health nfrastructure and improving the quality of education and health services; and implement an effective environmental straty 43. la the context of this strateW the Bank is pwviding urgent support to mitigate the effects of this year's drought. Thus the allocation for the proposed credit has been increased to US$200 million and existing and new operations are beng reviewed to see if they could provide funding for drough- related activities. The Bank is also actively soctng donor support for Zambia. 44. Ihe aleviaton of poVy is central to the Bank's program in Zambia. While the most powerful weapon against poverty in the long run wil be sustinable and equtable economic growth, a number of other considerations wil play a vital role in combatting poverty. One is the reorientation of public spending to meet the vital human resource needs of the poor, particularly in the areas of primay education, primary health care, and clean water and sanitation. Another is deregulation of te econMY to reduce the proliferation of rens going to the relatively advantaged and to open up oppounties for small bulnesse and smalt farmers. The availability of credit to all levels, and  -12 - without gender dis ion, is a vital part of this straty of Increasing opportunities. Similarly, a labor market free of special privileges and barriers to entry will be importat if the new growth is to be as labor Itnsive as possible. Finally, a social safety net (as described In paragrah 28 above) will be importan to protect those least able to protect themselves from the disnrptions likely to accompany this program, particularly the sharp increases in the prices of vital commodities and the retrencbment of employees in the public and parastatal sectrs. 45. WOmen are play a vk roe In the Zmbkm economy not only as primary caretakers of the family but also as direct laborers at the farm level and, Increasingly, in formal sector employme To reach high levels of equitable and sustinable growth, however, the barriers to ful participation that stll exist for women will have to be addressed urgently. Many elements of the Bank's lending and ESW program wil be directed at this issue, most particularly our programs in education, health, credit, and deregulation. For example, the Education Rehabilitation project includes a comprehensive gender training and sensitization program, assistance for the design of educational establis to take better account of the privacy needs of adolescent girls, and a major policy study on the nature and causes of gender disparities in education. The Agricultral Marketing and Processing Infrstucture Project includes specific requirements to ensure that women have equal access to credit facilities. In fact the majority of beneficiaries of the credit component are expected to be women. 46. Ihe donor community is giVing strong sqiport to Goewnm's acons to protect die environnent (ref. paras. 30 and 32). IDA is providing assisance in particular to industrial pollution in Kafue, to improved agricultural practices, and (through ESMAP) support for measures to reduce the impact of fuelwood cutting. The major local company, NCZ (a fertilizer mmubcturer and a recipient of past IDA funds), has brought all the local factories together to draw-up an integrated action plua, for ensuring that the industrial waste water is treated before it reaches the river. This plan is awaiting donor fiance (US$1-2 m). A review of mining pollution issues is included in the IDA workprogram Donors are placing special emphasis on watr quality. Support for the wildlife conservation program is planned in the IDA workprogram, but it is also expected to get renewed empbasis as Government actively promotes the country's tourism potential. C. Lending Ptgram and Economic and Sector Work 47. Zambias withdrawal rights under Bank loans and IDA credits were suspended between May 1, 1987 and March 1991 on account of accmuld arrears. The Economic Recovery Credit, approved by the Board in March 1991, marked the resumption of normal Bank .. arations In Zambia. Relations were interupted again in September 1991 when disb s were suspended because of rears. The suspension was lifted at the end of Jamny 1992 and normal operaons resumed again. Ihese interruptions account, in part, for the retively low volume of lending during the period 1985 - 1991. The table below details the Bak's lending program during this period. In March 1991, IDA provided the second economic recovery credit of US$210 milion to Zambia, which was disbursed In two tranches. Since 1984, IDA committed a total of US$464 million to Zambia for adjusute operato and investment projects. Ihe credits supported the Government's economic recovery and adjustmen program, agricultural development, reabiitation of Infastructre, strengtening of Intittona capity, and establishing a social recovery fund.  ii iI -=i -g ; O~~~~ Ii iI i a  -14- 48. The recent dialogue between Bank staff and Government representatives has culminted in an agreed approach to priority sectors for Bank assistance. These include agriculture, industry, mining, transport, and social services. Assistance in these sectors would complement balance of payments support. The Government's goal is to generate rapid economic growth, with equity, through increased investment in the productive sectors and human resources and infrastructure development. A high rate of economic growth is essentia for poverty reduction, and for the development of human resources and infrastructure as well as for progress in income distnbution. Investments in productive sectors, and for human resources and infastmcture development, would be supported by efforts to enhance efficiency and effectiveness in the public sector so as to promote private sector development. 49. Over the next four years, the Bank's lending and economic and sector work (ESW) programs will constitute the main vehicles for implementing the strategy described above. Among the areas covered by recent ESW are agriculture, industry, financial sector, energy, the social sector and environment In the next four years, ESW will cover agriculture, mining, public expenditure, education, public sector management, environment, population, health and nutrition, gender issues, natural resources, and fertilizer distribution. A poverty assessment Is planned to be completed In FY4. It will be preceded by an analysis of data gathered under work initiated in FY92 for the preparation of the Country Economic Memorandum (CEM), to be issued in early 1993, and which will have the alleviation of poverty as a central focus. These activities will culminate in the formulation of a strategy for Bank assistance toward poverty reduction in Zambia. lhree major acivities dealing with the environment are included in the ESW program for the next three years. (Paragraphs 30-32 above give a brief description of the centra concern in this area.) Within the agriculture sector program a natural resources study is to be carried out in FY93. It wiU be supplememed by studies on the envronmental Inpact of mining operadons and an overall environmental strategy study in FY94. The Bank ESW program also includes a sady on women in deveopment, scheduled to be completed in FY94, which should broaden our understanding of these issues and help us develop a more comprehensive picture of the problems women face and the steps tt must be taken. The results of the study, together with lessons learned from the various other related studies and operations, wiUl be used in strengthening the Bank's assistance strategy for enhancing women's participation in development activities in the productive and social sectors. 50. Economic reform measures were initiated under the earlier Economic Recovery Credit and coinued under the recent Economic Recovery Credit. The reform program wil be fulrther assisted by the proposed Privatization and Industrial Reform Adjustment Credit (PMRC) and the parallel Technical Assistance Credit (PIRCTA). On the basis of an assessment of the achievements in macroeoonomic and structura reform under the three operations, additional measures wil be proposed for the Multi-Sector Adjustment operation included in the lending program for PY94 and subsequent adjustment operations. 51. Concurrent with the PIRC, the Bank wiUl provide assistance to agriculture, education and infatructure through the Agricultural Marketing and Processing, Education Rehabilitation, and InWrastructure Engineering projects in FY92 and FY93. These operations will be followed by others in FY94 in Petroleum Sector Rebabilitation and Agricultura Diversification with Telecommunications and Public Sector Management as reserve projects. The FY95 program includes an Industri and Financi Adjustment Credit, a Health and Nutrition project, and a Power Rehabitaon project, with financidal medion and fiuther railways project in reserve status. FinaRy, in FY96, Bank operations wil include a follow-on Multi-Sector Adjustment Project, and support for Agricultura Reseach and Extension and Transport Rehabilitation; communty development, small-scale mining,  - 15 - and natural resource preservation and development are the reserve projects. Details of these elements of the program are noted in Annex IV. The design of the IDA lending program ;eflects the tiree- year hiatus In Bank operations and the extraordinary foreign exchange needs of the past two years, including the clearing of over US$300 million in debt service arrears to the Bank and meeting the extra demmnds of the current drought which will cost US$300 million in 1992 alone. As a result, the commitment level was an unusually high US$240 million in FY91 and will be US$210 million in FY92 with this operation. 'he level of now commitments is expected to fall to an average of US$120 million per year for the period FY93-96. 52. IPC and MM: IPC's portfolio in Zambia consists of ten investments for a total gross commitments of US$106.6 milion; one of IFC's larger in the Southern Africa region. While quite diversified (mining, agriculture and manufacturing), this portfolio has not performed well in recent years; the bleak economic situation and heavily regulated policy environment adversely affected most investments. IFC however, expects that with the recent policy changes and the anticipated large privatization program, prospects for existing and new investments will improve (particularly in agriculture and in companies being privatized). IFC is keeping in close touch with the Zambian uthorities and the Bank on progress on the privatization program. Zambia has been a member of MIGA since 1988 and has paid up its subscription. MIGA has as yet no outstanding investment guarantee on Zambia. D. Aid Coordinfaon and Relations with the EF1 53. The coordination of donor assistance has been central to the Bank's program in Zambia becase of the extraordinary efforts needed to clear arrears and restart the program (twice) and because of the very large externa financing needs of Zambia that are due to falling copper revenues and the large debt burden. Formal Consultative Group Meedngs have been held in April and July of 1990, March 1991, and March 1992. In addition infmal donor meens have been held in Paris several times a year to provide urgent updates and opportunities for donor consultation. Regular informal briefings of Executive Directors and their staff are also held at both the Bank and the Fund. A considerable donor consultation process has also been established in Lusaka to coordinate the amounts of assistance and of donor policies at the sector level, with different donors taking the lead role in different sectors. Finally, the SPA meetings have provided a usefil forum for the overall coordination of donor amounts and the discussion of genera donor coordination issues such as the use of counterpart funds. 54. All of the major donors and mullter instituions are supporting Zambia's economic reform program. This support, as expressed at the latest CG and SPA meetings, has been strong and unanimous. The broad agreement on policy has meant that an increasing amount of donor assistance is now available as general balanc of payments support, and that the project assistance is increasingly being coordinated within an overall agreed program of donor support 55. A Fund-monitored program was endorsed by the IMF Board in June 1990. In April of 1991, the Fund Board approved the first ever "rights arangementW with Zambia which established conditions under which Zambia would gradually accumulate rights to withdawa of IMP resources such thatfter three years, the acmulated rights could be used to wihdraw enough resources to clear completely Zambia's arrears to the IMF, which were over US$1 billion in mid-1990. Due to poor fiscal performance, Zambia did not qualify to accimuae rights in 1991. A revised 'dghts arrangement" program is scheduled to be reviewed by the IMP Board in July.  16. E. Criteria for Montoring rogre 56. Despite policy reversals, Zambia has made genealy good progms in economic reoArm since 1989, and remarkable progress since the new Goverment came to power. Yet a great deal remains to be done. In addition to the major emphais now beig placed on private sector development, on and parastatal refrm, further stuctral measures are needed on macroeconomic issues, such as foreig excbang, eal tariffs, taxtion and corolling inflation. The facial setr needs modernzing, and greater focu has to be placed on ncouraging eports, partcaly in no- tradiional sectrs. All sectors (agiculte, tasport, local goverment, energy, and socia serices) need to address Issues that were neglected durig the post-Independence years. Civil Service reform is an important componeat of the reform program as it addrees the public sector's ability to formute and implement these reforms. Ite Govermen's PPP and the Bank's county assistance st seek to address these needs. However, the magnide of the challenges faced by Zambia is so great that economic adjustment and achievement of Zambia's full potential will be a lengthy process. Substanta foreign assistance, Incduding debt relief, will continue to be required to provide essentia iputs and tose consumer goods that cannot be competitvely produced domestically, to develop the nstion's human resources, and to strengten the basic inftruct. s7. Provges in impkmendng dds long tmm rategV wWU be eiwuated on the basis of the folowlng three a .t The,f is the Government's abiity to implement macroeconomic policies (moneta, fisc and exchange rate policies) that can accomplish and sustain financial stabilization, measured agan the achievement of targets for inflation, the fisa deficit and credit expansion. lhe second criterion is the Goverment's success in public sector reform, including progress in divesting ixf of pbstatds and in ref ing public utilites, (to be judged ant the volume of pridvzatlons and perormance ad financi targets for the remaiing public utilities), and also civ service reform and the Wprodlivery of vita socia services. lhe thd is future growth and divesficaton of the eoonomy, measured again an expected decline in dependence of the economy on copper for e t eings and government reenues and against more rapid private sector growth. The policy frmework sould ecourage private sector investnt and contned rehabilitation and development of the social and ecommic infrstrcture. S8. Successful Implemento of this adjustment program depends on three key factors. First, is the nee sustained commitment of the Zambian authorities to program implemenation. Lack of commitment and policy reversals have contrbmuted to implemI failure In the past. This risk is minmized by the new Govnerment's decisive actions toU-ate and the strong mandate it received on the basis of its unambiguous manifesto detaiing Its economic strategy. Second, is the need for substandal debt reief and highly concessional exr assistance to be extended to Zambia, to ensur adequate finacl resources ae avable for the adjustment program particularly given the effects of this drougt. ihe Bank is appealing to donors to make extraordinary efforts to increase their krn_ to support the Zambian program and food import requirements. Third, successXil impl m n of the adjustment progm will require restnt and sacrifices on the part ef all Zambians. Lack of mm support for the program could impede its implemention, and the saiey net provisions are crtic as wMI be the Goermet's ability to presen and explain its policSes clearly. Ihe criteria noted above for gmot performance should help ensure that the prograa emains on trac I te Goverm were to abandon the key elements of the reform program the Bank's leoding s would be to reduce the sort almost to zero, as we do not see how Zambia's economy In such a saion could support meaniu projects.  -17- ML PROPOD PRIVATIZATION AND INDUSTRIAL REFORM ADJUSTNME CREDIT 59. 1To proposed Credit will continue and deepen the Iple In of the Governmens pdivatatlon and parastal and mc refom progra Inidated under the recent ERC, (Credit 2214-ZA), and will be comle by follow-on operations which will pursue further reforms in the trade, finacial and Industrial are. In parslel with this Credit we are submiing to the Board aPrivatization and bIdustra Rerm Tecbnical Asistmce project, to provide the necesary funding to support ImplemeIon of the policies set out in thi documet. The prposed Credit wll have hree main objectives: (1) Promoton of competition and efficiency; ( encouagement of the private sor; and (3) improving the ability of Government to manage the reform program. Ihe measures to achieve these objectves are: (1) the maceconomic stabilization program, to ensure a suitable overal framework, (2) development of a policy and Insttutional famework to encourage the private sector, (3) the privtzadon and prastal reform progm, and (4) contInuAon of civi service reform. A. Macrecnomic Stabilzaton Program 60. In relation to the stabliabion progam, the Credit would support (i) imlw ntadon of whe refmns set out in the 1992 Budget, in particular reduction of the Government budget deficit (excluding grn) to not more than 2% of GDP and atoption of meaes to bring down inflation to a targeted level of 45% by end-1992. Ihe reforms include Increases In interest rates, reduction of company tax and personal income tax coupled with bwrade coverage of both throu closing of loopholes, simplification and revenue mn t hrough roniion of sales taxes at a common rate, and phased elimination of maize subsidies. In respect of the later, aU previous subsidies have been mated; only the drougt-reated subsidies remaa. These include a temporary subsidy on imported ydlow maize for this crop year, a temporary eady production bonus, a tnsport subsidy on domestc production, and limited poverty focussed subsidies for this crop-year including some free and half price maize for the poorest cizes. The ntmil price of locally produced whie maize will be decontrolled within the next two months, as soon as there are ufficient stock of maize in Zambia. The IB mission that visited Zambia mid-May focusse particaly on Govement adherence to the fiscal packge to liit the Govenmt deficit and on Implementatio of motary contros. Fertilizer subddies bave been eliminated and prices have been liberalized. Governmen plans to Inoduce further reforms in business taxion for 1993; (ii) continued improvement in the foreign exchauge mechanism. Exporters now have the right to retain, throu the Bank of Zambia, 100% of export earnings, and to use these for any of the purposes not excluded by the export retenton negative list, or to sell the right to another importer, sibject to the sme resic . The price at which th forei excag I bought and sold is not reguaed The export retion negative list is minimal (about 5% of iem, mainly coverng items such as weapom and luxuries) and the expor retention market is enom source of funds for vehicle sp amnd for service payments such as school fees and foreg holidays. Apart from the export retent mariet, iporters have acces through the OGL system to freig dchnge fiuds at the official e ne rate, for item oan he OGL positiwv lt Ibis lst coves about 90% of import items. The wang list for access to the OGL is about  -18 four weeks although It varies with the flow of donor fiunds and copper exports. Ibis dual system creates a number of distordons. The next urgent task therefore is to move the OGL list to a negative list system, and to broaden its coverage to cover vehicle spares and other priority items; and (ill) continued simplification of the external tariffs, and further reduction of the higher tariff bands. The prevalence of a ummber of tariff bands gives rise to problems of definition and Customs application. The bigher tariff bands (30% and 50%) in principle give significant protection to Zambian manufacrers over and above the naural protection due to Zambia's location. At the same time private sector businesses have been deprived of foreign exchange for years and their plant has become outdated and run down. They need time to modernize. Govment will therefore study carefully over the next few monts the options for furer reduction In the external tariffs, its revenue implications and impact on business, with a view to announcing a reduction in the 50% tariff band in the 1993 budget 61. Monitorable conditions proposed for the above are. as foUows: Efetiness. Gover wii Waold& evidence that the fical ackae to lfint the bWet defict is being adhered to. and that ap t montav ry controls to reduce iadton have been IMiAen-ed. Contnued satiactory oval 7n mae on bWgt olemalon and Moa controls as well as co=Mlance with m c flscal tarpets set after reiew and agreement with JMF will be second and th}rd tranche coniions. In addtion, as a third tranche conditon Gavernment wiI Introduce the net stape in the pace of collecton. n reSe gf make subidies. bv second tanche the earl sroductlon bonus gn domesi roduced maize win haue been removed, and the into mIl Sde of Mpord veAffm make wil have readed its target level of USS16.20bag. Sy thid tgnche. meaUe meal subsldes will have been c2ompetl elmiatd. The monitorable coditon fo the fort ecang steam WV_ tb eon wh = shodd_"_ a__- A -for ti OGL