Cameroon - Country assistance strategy

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15275-CM MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF CAMEROON JANUARY 17, 1996 Country Department III Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  The last Country Assistance Strategy for the Republic of Cameroon was reviewed by the Executive Directors on June 16, 1994 CURRENCY EQUIVALENTS (as of December 1995) The CFA franc (CFAF) is pegged to the French Franc at the rate of FFI = 100 CFAF Average Exchange Rate Fiscal Year US$1 = CFAF 1993 265.4 1994 435.0 1995 521.5 FISCAL YEAR July 1 - June 30 ABBREVIATIONS AND ACRONYMS BEAC Regional Central Bank CAEMC Central Africa Economic and Monetary Community CET Common External Tariff ERC Economic Recovery Credit ESAF Enhanced Structural Ad justment Facility EU European Union FIAS Foreign Investment Advisory Service of the World Bank GEF Global Environment Facility GDP Growth Domestic Product IBRD International Bank for Reconstruction and Development IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund MIGA Multilateral Investment Guarantee Agency NGO Non-Governmental Organization PER Public Expenditure Review PFP Policy Framework Paper SAL Structural Adjustment Loan SDF Social Democratic Fund SNH National Oil Company SRC National Loan Recovery Agency SSA Sub-Saharan Africa TCA Turnover Tax UNDP United Nations Development Program USAID United States Agency for International Development  FOR OFFICIAL USE ONLY REPUBLIC OF CAMEROON COUNTRY ASSISTANCE STRATEGY TABLE OF CONTENTS Page No. I. Introduction ................................................... II. Economic Performance and the Reform Challenge .................................................4 A. Internal adjustment: 1988 - 1993 ..............................................4...................... 4 B. The CFA franc devaluation and CAEMC reforms in 1994 ...............................................4 C. Reforms Achieved and the Unfinished Agenda ..............................................S5 D. External environment ...............................................6 E. Debt ...............................................7 F. The financial sector ..............................................8 111. The Government's Strategy ..............................................8..........8 A. Objectives and strategy ...............................................8 B. Growth, constraints and medium-term prospects .............................................. 12 IV. Bank Group Assistance Strategy .............................................. 13 A. Key Objectives ...............................................13 B. Overall strategy ......................................... ......13 C. Instruments for achieving key objectives .............................................. 14 E. Portfolio perfor manc e a nd management ............................................... 16 F. IFC and MIGA ........................................... ....17 G. Coordination with IMF and other donors .............................................. 17 H. Risks .............................................. 18 V. Agenda for Board Consideration ............................................. 19 Boxes 1. Cameroon: A Political Profile ............................................... 2. Import Duties and Taxes before and after the CAEMC Reform .........4....................................4 3. Adjustment: Achievements and Unfinished Agenda ..............................................6 4. Total External Debt ..............................................8 5. Government Finance (% of GDP) ............................................. 10 6. Poverty Reduction Strategy .............................................I 1 7. Key Economic Indicators ............................................. 13 8. External Financing Requirements ............................................. 13 9. Cameroon - IDA Assistance Strategy ............................................. 16 10. Proposed IDA Lending Program, FY96 - FY98 ............................................. 17 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ii Annexes Annex A Al. Selected Indicators of Bank Portfolio Performance and Management A2. Bank Group Fact Sheet FY1993-1998 A3. Summary of Economic and Sector Work A4. Poverty and Social Development Indicators A5. Key Economic Indicators A6. Key Exposure Indicators A7. Status of Bank Group Operations in Cameroon Annex B Objectives and Instruments of Country Assistance Strategy, FY96-98 (see Box 9: IDA Assistance Strategy, p. 15) Annex C Technical Annexes Cl. National Accounts C2. Exports and Imports C3. Balance of Payments C4. External Debt Stocks and Flows C5. Public Finance C6. Monetary Survey  MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF CAMEROON I. INTRODUCTION 1. Summary. Cameroon's economy remains the largest in the CFA franc zone, notwithstanding its steady decline since the mid-1980s. Following the devaluation of the CFA franc in January 1994. the country has shown hopeful signs that it is again ready to take a leadership role among the six members of the CAEMC, the customs and monetary union of Central African States. At slightly over 3 percent in 1994-95, GDP growth was positive for the first time in ten years. Sustaining this relatively modest growth rate will be a major challenge, however. First, rapidly declining oil production has a negative effect on GDP and export growth. Second, Cameroon's external debt is larger than its GDP and has an average interest rate over 6 percent. Tthe strong fiscal contraction under way (which has already resulted in turning a primary deficit of 2.3 percent of GDP in FY94 into a surplus of 2.9 percent of GDP in FY95) is compounded by the effect of transferring abroad over 6 percent of GDP per year in debt service. Third, confidence in political and financial institutions needs to be built up for the private sector to become the engine of a strong economic expansion. 2. The government's two-pronged strategy for the next few years, which this Country Assistance Strategy (CAS) aims at supporting, would first, through fiscal adjustment, release sufficient resources to keep the government current on its interest payment obligations. Together with significant assistance from the donor community, including IDA and the IMF, which approved a Stand-by in September 1995 to be soon followed by an ESAF, this strategy would provide the basis for yearly rollovers of Cameroon's external debt at favorable terms, and overtime a reduction of its burden. Second, a comprehensive privatization and financial sector reform program, accompanied by several measures aimed at improving the business climate, would seek to stimulate a recovery of private investment. Implemented expeditiously and successfully, this strategy could lead to annual GDP growth rates gradually increasing to 5 percent or more after 1998. 3. There are obvious risks to the government's strategy, however. First, as anti-reform lobbies are well aware, its benefits are unlikely to be palpable in terms of per capita consumption in the short term. Second, notwithstanding far-reaching and politically costly reforms implemented in the recent past, Cameroon has not yet been able to build the reputation of a committed reformer. Thus, refinancing the large negative net transfers projected for the next few years will be a daunting task, and the rollover risk is high. Finally, Cameroon's exports are concentrated in few commodities, and even relatively minor declines in commodity prices could have devastating effects on an already vulnerable external position. Mitigating some of these risks, and central to the proposed CAS, is an active economic dialogue, emphasizing to the government, the costs of postponing needed reforns, and to creditors, the need for significantly higher levels of debt relief than those currently available. This dialogue will be complemented by an exceptionally high level of IDA adjustment lending in the next three years, focused on critical reforms needed for a recovery of private investment. Adjustment lending will be disbursed in a gradual manner and only on the basis of full implementation of successive triggers. 4. The political situation. Cameroon's transition to democracy is regarded by some observers as incomplete, though it has been peaceful by continental standards. Ethnic, regional, linguistic and political  2 divisions (Box 1) -- partly the legacy of three colonial powers -- have been contained during two decades of centralized, unitary-state presidential rule. Strong tensions remain, however, and the legitimacy of the present administration is broadly challenged among civil society, not just among fringe secessionist elements. Falling living standards and collapsing social services, since the oil boom started to wane, have sapped taxpayer discipline, just as flagrant corruption and rent-seeking activities feeding on the declining State have undermined social solidarity. This "governance gap" and its economic fallout have recently spurred President Biya into assuming active leadership of sweeping economic reforms, which challenge powerful vested interests. He is supported in this endeavor by a core group of advisers and ministers within a coalition government. The parallel challenge of managing three rounds of elections in the next 18 months, including municipal elections in January 1996 and Presidential elections in 1997, against both internal and extra-Parliamentary dissent, makes the iimplemnentation of Cameroon's economic reforms unusually risky. Box 1: Cameroon: A Political Profile The heritage. Cameroon is an ethnically diverse country with a triple colonial heritage. Following the first World War, the German colony was divided into a French and a British protectorate. The struggle for independence escalated into a guerrilla war which continued after independence in 1960. In 1961, the westem and southern Cameroons, previously under British rule, opted by referendum to form a federation with francophone Eastern Cameroon. The centralized state. The first President, Mr. Ahmadou Ahidjo, established a one party-state. His power was based on a delicate balancing of privileges among ethnic groups. Following a referendum in 1972, Cameroon became a unitary state. President Ahidjo was re- elected in 1975 and 1980, but resigned in 1982 for health reasons. in favor of Paul Biya. The new President, a technocrat, embodied the expectations for political liberalization of a growing middle class. His tenure was marred, however, by a coup staged by his predecessor in 1983. The coup failed, but the old power-sharing arrangement among ethnic groups crumbled Road to political liberalization. In 1990. the concept of political pluralism was introduced, but the President rejected the proposal to hold a National Conference to draft a new constitution and oversee transition to elections. This led to a civil disobedience campaign, which persisted in the western part of Cameroon. Parliamentary and Presidential elections were held in 1992. The major opposition party (the SDF - mostly active in western Cameroon) boycotted the elections, claiming that they had been rigged to exclude the SDF candidate, Mr. J. Fru Ndi. Based on official results, President Biya mobilized a relative majority of only about 40 percent of the voters. Municipal elections are being held in January 1996. Major opposition parties seek a decentralization of power to local govemments, though the SlF and the leadership of the anglophone community seek a return to a federalist state. An increasingly vocal minority amongst the anglophones is calling for secession from Cameroon. Cameroon's recent admission to the Commonwealth has reduced the immediate appeal of secession. Conflict with Nigeria. Skirmishes flare up occasionally between Nigerian and Cameroonian forces in the disputed Bakassi peninsula located in the oil-rich waters of the Gulf of Guinea, which the Nigerian forces occupied in January 1994. The Cameroonian authorities emphasize the need to maintain combat preparedness through an adequate level of military expenditures (3.3 percent of GDP in FY95). 5. Economic Developments. Cameroon is richlv endowed with natural resources and has a diversified production base and a well-developed -- albeit poorly maintained -- infrastructure. Real growth averaged 7 percent a vear from independence in 1960 through 1985. Agriculture was the main source of growth and foreign exchange earnings until 1978, when oil production started, and quickly took over. As in many oil-producing countries, however, the oil bonanza was not wisely invested. It translated into higher civil service expenditures, public enterprise subsidies and low return and capital-intensive investments. In 1985, three major shocks exposed the weaknesses in economic structure and policies. First, sharp declines in coffee, cocoa and oil prices led to a 60 percent deterioration in the external terms of trade by end-1988; second, the long-term slide in oil output left oil exports in 1994 at about a third of their 1985 level; and finally, the real exchange rate appreciated by about 54 percent during 1986-88, greatly reducing Cameroon's competitiveness. By 1993, the economy and its external accounts had deteriorated significantly. GDP declined by 6 percent per annum on average during 1986-1993 producing a 50 percent fall in per capita incomes. Economic decline was accompanied by increased poverty, as poor farmers suffered the brunt of the fall in producer prices and the Government cut basic health and education delivery systems. The middle class, once among the most developed in sub-Saharan Africa (SSA), shrank in numbers.  3 6. Poverty. The steep 50 percent decline in per capita income between 1986 and 1993 has led to a significant impoverishment of the population, particularly in the rural areas, where the reduction in cash crop producer prices and the elimination of government subsidies to the main export crops have caused incomes to drop by an estimated 60 percent before the 1994 devaluation of the CFA franc. The economic crisis has also led to a serious decline in urban incomes, in part because of the 50 percent reduction in the salaries of the civil service in 1993. While fewer than I percent of households in Yaounde and Douala fell below the poverty line in 1983, more than 20 percent of households in Yaounde, and 30 percent in Douala, did so in 1993. Urban unemployment has risen sharply, from about 7 percent in 1983 to nearly 25 percent in 1993. The 1994 Poverty Assessment estimates that about 50 percent of the population lives in poverty, compared to 40 percent in the mid- 1980s. 7. The Poverty Assessment also highlighted that over recent years spending in the social sectors has been sharply curtailed and that, as a result, Cameroon's social achievements are being rapidly eroded. Enrollment rates have declined substantially, though remaining higher than the SSA average; immunization coverage fell from 84 percent in 1987 to 37 percent today; at least one out of five children is not vaccinated. AIDS has become an important health risk, malnutrition is widespread, and maternal mortality is high (430 per 100,000 live births). The Poverty Assessment also revealed significant gender differences in earnings, time allocation, land ownership and use rights, literacy, as well as participation in public life. Women carry disproportionately heavy workloads and are central to food production and the development of the nation's youth. As indicated in the development diamond below, access to safe water supply in Cameroon compares poorly with the African average (31 percent of the total population - 27 percent of rural and 43 percent of urban). This has serious consequences for women's ability to increase their incomes, as well as for health indicators. Development Diamond r Poverty Indicators Life Infant expectancy Mortality Gross primary Child /nurtoIlliteracy per capita - erollment Malnutrition Ilea a arieroon Maternal &amineroon '- Access to safe|Sub. Sah. Africa Mortality Sub.Sah.Africa ) L water l _ _ 8. Environment. Cameroon, partly situated in the tropical forest belt of the Congo Basin, is richly endowed with natural resources. The long-term development of the country is closely associated with the sustainable use of those resources, including forests, soils and biodiversity. High population pressure on fragile ecosystems in the North is a cause for concern, with major potential issues of food security and fuelwood availability; problems of urban sanitation are also growing. To identify comprehensive policy measures and appropriate investment actions to promote the sustainable use of resources and address the already evident environmental problems, the Government is preparing a National Environmental Action Plan (NEAP), expected to be completed in early 1996. Because of the importance of the forestry sector (4 percent of GDP and 12 percent of exports in 1995), and concerns with the sustainability of forestry production, the Government has recently revised its Forestry Law and  4 taxation policy so as to introduce more transparency in the attribution of concession rights, correctly price timber resources and promote economically efficient local transformnation activities. II. ECONOMIC PERFORMANCE AND THE REFORM CHALLENGE A. Internal adjustment: 1988 - 1993 9. In 1988, the Government launched an economic reform program supported by an IMF Stand-by and a Structural Adjustment Loan (SAL) from the Bank. The program was designed to enhance competitiveness through internal adjustment and trade liberalization; restructure the public enterprise and financial sectors; reform the civil service; and increase expenditures on key social sectors. In the absence of exchange rate adjustment and sustained Government commitment to reform, however, the strategy failed to improve competitiveness and correct fundamental imbalances. Instead, budget deficits grew and arrears on both internal and external debt mounted, as revenues declined faster than expenditures. Deteriorating terms of trade and a strongly appreciating real exchange rate proved impossible to absorb through expenditure reduction policies alone. Investment and savings declined, while economic policy and management deteriorated after 1989, reflecting the corrosive effects of political instability fueled by a sharp decline in incomes. In 1993, however, in the face of growing deficits, the Government took the unprecedented action of cutting the wage bill by about one half, resulting in a ratio of the wage bill to GDP of 4.4 percent in FY95, one of the lowest in the CFA franc zone. B. The CFA franc devaluation and CAEMC reforms in 1994 10. In January 1994, Cameroon, along with other CFA Box 2: Import Duties and Taxes before and after the CAEMC Reform countries, realigned its parity with the French franc from 50 to 100 Before After CFAF. This was part of al comprehensive reform program Import Duties Three different levies. All levies consolidated into one single comprehensive reform program ~~23 rates in total ranging duty i.e. the common external tariff (CET), supported by the IMF and the from 2.5 to 150 percent. streamlined to four rates (5, 10, 20, 30 Bank, which was intended to percent). lntra-CAEMC trade: 20 percent produce a budgetary surplus, shift of the corresponding CET. spending to priority activities, holdl inflation to no more than 5 percent Sales tax Imports 10 percent VAT-type sales tax (TCA) introduced with Domestic goods 9 percent a general rate of 12.5 percent for imports per annum, and generate annual substantial cascading and domestic transactions. Cascading GDP growth of 5 percent. At the effect. reduced time of the devaluation, Cameroon also began the implementation of a Excise tax None. 25 percent on alcohol, tobacco, mineral far-reaching reform of trade, tariff water, perfume, jewelry and guns. and transit policies, jointly with the other members of CAEMC (Box 2). The few remaining non-tariff barriers were abolished. 11. Following the devaluation, Cameroon became an IDA-only country (per capita income US$670, Atlas methodology). An Economic Recovery Credit (ERC) was approved by the Board in June 1994. It was designed to secure gains in competitiveness from the devaluation, while setting the stage for more fundamental structural reforms aimed at generating an employment-creating supply response. Prior actions included the elimination of all remaining import licenses and completion of the CAEMC tax and tariff reforms. Subsequent measures included civil service reform, revision of public procurement regulations, privatization and public enterprise restructuring, tax reform, liberalization of coffee and cocoa marketing, revision to the forestry code, and reform of the regulatory  5 framework in the petroleum sector. These reforms have been implemented in full. Cameroon has effectively completed the essential trade and price liberalization agenda, and in doing so, is ahead of any other franc zone country. 12. A Staggered Start. Triggered by the 50 percent nominal devaluation (a 30 percent real depreciation), economic recovery is under way in the tradable sectors. The volume of non-oil exports increased by 12 percent in 1994. Following a sizable decline, imports started to pick up in late 1994. As in all other CAEMC countries, however (Gabon excepted), budgetary performance was poor, with serious shortfalls in revenue in the first half of 1994. Disruptions caused by the tariff reform and outright fraud led to an abnormally low level of customs revenues. As a result, the IMF could not complete its first review under the Stand-by and put in place, in August 1994, a shadow program for FY95. Following the appointment of a new Minister of Finance in July 1994, the situation has remarkably improved. Total revenues increased by 55 percent in FY95. Non-interest expenditure declined from 20 percent of GDP in the early 1 990s to 9 percent of GDP in FY95. As a result, the primary balance improved from a deficit of 2.3 percent of GDP in FY94 to a surplus of 2.9 percent of GDP in FY95. The diamonds below show results against original objectives for Cameroon and the CFA zone in 1994. Cameroon outperformed the rest of the zone in private savings and investment and in external trade surplus, but revenue mobilization was weaker, resulting in abnormally low public investment. Cameroon And CFA Franc Zone Post Devaluation Program Objectives and Results in 1994 Cameroon: Objectives vs Results Cameroon vs CFA Zone GDI GDI Wage Bill GDS Wage Bill .GDS Budget Deficit '\Trade Surplus/ Budget Deficit / Trade Surplus - b ec tives CFA Zone = Cameroon Cameroon C. Reforms Achieved and the Unfinished Agenda 13. As a result of the reforms supported by the SAL and the ERC, Cameroon's economy is now one of the most open in sub-Saharan Africa (Box 3). This was achieved despite strong opposition from vested interests and unfavorable economic conditions. These results have been marred, however, by delays in implementation of constitutional and political reforms essential for private sector confidence. The new economic reform team also faces basic governance challenges, including long-entrenched corruption in key departments. Cameroon's efforts to improve its image abroad have been undermined as a result, and critical donor support is less available than in the past. Unless the quality of governance improves, neither domestic nor donor support for reform will materialize, and the country will be unable to attract the private investment it needs to sustain accelerated economic growth.  6 14. Recognizing the critical need for improved governance, the President in early 1995 strengthened the authority of the Ministry of Finance and his own core team of advisors committed to reform. With greatly improved fiscal performance, which eventually led to the approval in September 1995 of a new IMF Stand-by, the Government is now turning its attention to dealing with the institutional and policy weaknesses which have permitted mismanagement and corruption to prevail. Recent actions have been taken to produce greater transparency and accountability in customs, public procurement, and the management of the forestry and petroleum sectors. Restoring public, donor and investor confidence will require further efforts, however, particularly to settle arrears with the private sector, reinforce banking supervision, revitalize the judicial system, and restore discipline to, and incentives for, the civil service. Moreover, such reforms will not be easy, implying a fundamental social transformation. While resistance to reform from entrenched interests will no doubt be strong and carry significant risks of delay, the President has begun to publicly broaden his appeal for support through a series of keynote speeches spelling out his agenda for economic reform. The Government intends to widely disseminate its medium-term economic strategy, to further broaden support for the agenda. Box 3: Adjustment: Achievements and Unfinished Agenda l. Major achievements iE Exchange rate: 50 percent devaluation of the CFA franc (1994). Trade reform: elimination of quantitative restrictions, and.adoption offour-tiertariffranging from 5 to 30 percent in conjunction with other members of CAEMC (1994); full:liberalization of coffee, cocoatrade (1990-94). Prices: elimination of price controls, except for petroleum products, medicines, textbooks, public utilities, maritime transport and port services; elimination of price stabilization mechanisms, with exception of petroleum products; elimination of coffee, cocoa reference prices; elimination of agriculture input subsidies (1989-94) Financial intermediation: liberalization of interest rates and establishment of regional money market (1994). Investment: reformn of investment, labor codes (1990, 1992). Public sector; reform of procurement code (1995); reformn of legal framework for public enterprises (195) and initiation of privatization program to include all enterprises, including utilities; simplificationof indirect taxes (1994); sharp reduction of wage bill in 19933. Petroleum sector: opening up of national petroleum company'sbooks (1994); elimination of its monopoly: for the supply of crude oil; elimination of subsidy to the state refinery (1995). Forestry: enactment of newcode including transparent concession allocation, and improved forest management mechanisms (1995). Other sector reforms: privatization of dredging Douala port (1995). 2. The unfinished agenda Making the budget a development tool: increase revenues by eliminating unjustified exemptions, broadening the tax base and strengthening customs and tax administration; increase reliance on expenditure-based taxes versus export taxation; increase budget allocations to education, health, infrastructure maintenance, agriculture services, within severely constrained ovtrall ependiture envelope. Civil service reform: rightsize and improve incentives for good performance, imnprove skills-match, and quality, of public services Disengage the State from productive activities: accelerate privatization. Reform the financial sector: liquidate insolvent financial institutions; privatize state-run banks; strengthen banking supervision. Eliminate arrears and establish good payment track record: ncuritize internal debt and maintain good payment record. Reinforce judiciary system: restore adequate compensation, eliminate political interference, strengthen supervision ofjudges. Improve business environment: harmonize business laws with CFA zone; strcamline regulatory framework and reduce transport and transaction costs (especially inland, maritime and air transport). D. External environment 15. The 1994 devaluation increased Cameroon's external competitiveness. This, and a recovery of international commodity prices resulted in a strong surge in non-oil exports. Yet in the medium-term, Cameroon's economy will remain highly vulnerable to changes in world prices of its main export commodities. It will also be constrained by its external creditors' willingness to extend significant debt relief in support of its reform program. Cameroon's proximity to Nigeria has important consequences for its economy.  7 16. Cameroon 'sproximity to Nigeria has significant economic effects. Cross-border trade in both directions is extremely sensitive to inter-country price differentials resulting from fluctuations in the CFA franc - Naira exchange rate, as well as tax and tariff differentials. In the first months following the CFA franc devaluation, Cameroon witnessed a pronounced decline in smuggling and a significant increase in exports of Cameroonian products to Nigeria (especially textiles and cattle). In the wake of the subsequent depreciation of the Naira, however, these results are being reversed and the Naira is now being traded on parallel markets at its pre-CFA franc devaluation rate. Of particular concern is that Cameroon's capacity to increase indirect taxes, especially on petroleum, is severely circumscribed by the likely impact of such increases on smuggling. Following the increase in petroleum taxes introduced in July 1995, the retail price of premium gasoline in Cameroon was increased to CFAF 325 per liter, compared to about CFAF 70 per liter in Nigeria. As a result, many retail outlets in the northern part of the country adjacent to the Nigerian border closed down. Similar considerations apply to textiles, detergents and other light consumer goods. 17. The fact that Cameroon 's economic prospects are Ihighly depenident on four exports -- oil, coffee, cocoa, and timber -- exposes it to additional uncertainty. T hese commodities alone ac^ounted for 65 percent of total merchandise exports in 1994. Although over the past four years the share of oil exports declined from 44 to 32 percent of total exports, cocoa remained stable (from 8 to 9 percent), the share of coffee increased from 8 to 13 percent; and the share of logs and wood products increased from 6 to 12 percent. As a result of the devaluation, other exports such as bananas and cotton also registered sharp increases in 1994 (88 and 60 percent respectively). The recent boom in coffee and cocoa prices has also helped to reduce the current account deficit. A reversal of these trends however would weaken Cameroonian performance. In particular, negative price developments would significantly hurt the country's external debt servicing capacity. A 10 percent decline in the prices of Cameroon's four main export commodities could lead to a 2-3 percent of GDP deterioration in the current account balance. Given the increasing scarcity of development assistance resources and Cameroon's fixed exchange rate regime, fiscal adjustment would need to be further intensified, with unpredictable effects on investment. E. Debt 18. External debt. Cameroon's debt problem is more severe than that faced by Latin American Box 4: Total External Debt (FY95) Countries in the 1980s. At end-June 1995, total Other external debt of US$9.2 billion amounted to 108 Short-term Multilateral percent of GDP, with an average interest rate of Banks 4% 7% IDA slightly over 6 percent. Bilateral debt represented 69 IBRD percent of the total, multilateral debt, 17 percent (10 Bilateral:Post 6% IMF cutoff percent to the World Bank) and debt to commercial c2% 04% banks, 9 percent. Arrears amounted to 16 percent of total debt (Box 4). 19. Cameroon has benefited from four Paris Club Agreements, most recently in November 1995. In the latest agreement, Cameroon obtained the equivalent of Naples terms for the first time. Total relief of US$873 million equivalent was provided, of which cutoff US$386 million concerned arrears as of September 57% 30, 1995 and US$486 million in maturities falling due during the period covered by the Agreement (October 1, 1995-September 30, 1996). As a result, debt service for FY96 was reduced from 46 to 39 percent of exports and from 90 to 77 percent of Government revenue. But, even after the rescheduling, the debt overhang ratio (present  8 value of debt to exports) exceeds 300 percent and would remain over 200 percent until 2002-03 in the absence of further rescheduling. During the same period, the debt service to export ratio remains above 20 percent. Under these circumstances, Cameroon's external debt situation remains severe at best and will pose difficult management problems for at least the next decade. Additional debt-relief is therefore essential for long run growth. At the same time, Cameroon's macroeconomic policy should aim at easing the debt problem through vigorous export promotion and fiscal revenue mobilization. 20. Internal debt. Internal debt represents about 35 percent of GDP, about half of which is owed to financial institutions. Arrears have severely squeezed liquidity, especially for suppliers and banks. The supply of loanable funds from the banking system has been reduced. A solution to this problem is urgently needed to restore private sector confidence and is a priority action under the Government's economic program. F. The financial sector 21. Cameroon is the pillar of the Central African Monetary Union (BEAC), as it accounts for more than half of the money supply and central bank refinancing. The crisis of the last decade has led to substantial difficulties for the financial sector. The first attempt to restructure it in 1989-92 was unsuccessful. From 1990-1993, total bank credit declined by 58 percent and deposits by 35 percent. Today the sector is in danger of collapse. Most banks and insurance companies are again plagued by large and inadequately provisioned non-performing portfolios. Despite high lending interest rates, which discourage good borrowers, most institutions lose money, have negative net worth, and are technically bankrupt. Some are illiquid as well, and therefore unable to participate effectively in financial transactions and support the supply response, which the devaluation was designed to elicit. The social security institution is also bankrupt. After four years of operation, recoveries by the specially created recovery agency (SRC) are only about 13 percent of the assets entrusted to it. A comprehensive reform of the financial sector is essential for economic recovery, and is a key element of the Government's strategy. III. THE GOVERNMENT'S STRATEGY A. Obj)ectives and strategy 22. A decade of economic depression, growing impoverishment, increasing political fragility and waning donor support have brought the Government to the realization that Cameroon's crisis is structural rather than cyclical in nature, and that fundamental reforms are needed. The Government's long-term objectives are to create a democratic society, within an ethnically diverse context, in which per capita income would at least double within twenty years. Food security is also considered an important objective, particularly in the North because of its fragile economic environment and high risk of drought. Attaining these objectives in per capita income terms would require GDP to grow on average at least 6.3 percent per annum over the next two decades. Taking account of the continued decline in oil production and the heavy debt burden, however, GDP growth of 5 percent on average (up from 3.3 percent achieved in FY95) is the best Cameroon can expect over most of the coming decade. The challenge of economic management is to ensure that even this modest growth is achieved. 23. Macroeconomic management. Essential to a sustained recovery of the Cameroonian economy is the re- establishment of a viable macroeconomic framework. In the absence of debt relief instruments which could effectively reduce debt service burden relative to GDP in a sustained manner, government resources available for development expenditures will be severely constrained (Box 5 summarizes fiscal trends and projections). Cameroon has to generate primary fiscal surpluses large enough to ensure full payment of interest on external debt  9 -- currently 6 percent of GDP -- in the hope that creditors will in turn provide enough debt relief and some additional money to fund public investment. To break out of this predicament, Cameroon needs to raise revenues, without killing off competitiveness, and increase exports, while soliciting relief from external creditors to reduce in a lasting manner debt service and the stock of debt itself. If this policy is not successful, Cameroon will find it increasingly difficult to service its external debt, even to preferred creditors. Box 5: Cameroon - Govcrnment Finance (percent ofGDPI C'ameroon: (iovernment Finance Cameroon: Revenues and Expenditures (% of GDP) 30 -- -- - - ---Year Receipt Expenditures Total DS Wages Non Inv. Total 2s / m incl. DS wages exclDS FY85 20.6 24.5 4.8 5.6 7.0 7.1 19.7 20 & Q X FY88 16.6 24.7 5.5 7.4 9.1 2.7 19.2 I X <