Ghana - Second Economic Reform Support Operation Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P- 7311 Gil REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE; INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE E:XECUTIVE DIRECTORS O'N A PROPOSED SECOND ECONOMIC REFORM SUPPORT OPERATION CREDIT oF SDR 132.7 MILL:ION (US$180 MILLION EQUIVALENT) TO5 T'HE REPUBLIC OF GHANA May 4, 1999 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Cedi (0) US$ 1.00 =2418 (March 31, 1999) WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1-December 31 ABBREVIATIONS AND ACRONYMS ADB Agricultural Development Bank APL Adaptable Program Lending BHC Bank for Housing and Construction BOG Bank of Ghana BPEMS Budget and Public Expenditure Management System CAS Country Assistance Strategy CEPS Customs, Excise and Preventive Service CG Consultative Group COCOBOD Cocoa Board COOP Cooperative Bank CWIQ Core Welfare Indicators Questionnaire DIC Divestiture Implementation Committee EC Energy Commission ECG Electricity Company of Ghana ERP Economic Recovery Program ERSO Economic Reform Support Operation ERSO 11 Second Economic Reform Support Operation ESAF Enhanced Structural Adjustment Facility GCB Ghana Commercial Bank GDP Gross Domestic Product GNPC Ghana National Petroleum Cooperation GOIL Ghana Oil Company GLSS Ghana Living Standard Survey IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IRS Internal Revenue Service LBC Licensed Buying Company LDP Letter of Development Policy LIL Learning and Innovation Loan MIGA Multilateral Investment Guarantee Agency MTEF Medium Tenn Expenditure Framework NGO Non-governmental Organization NIB National Investment Bank NRS National Revenue Service PBC Produce Buying Company Vice President Jean-Louis Sarbib Country Director Peter Harrold Technical Manager Charles P. Humphreys Task Team Leader Rocio Castro  FOR OFFICIAL USE ONLY PEPTA Public Enterprise and Privatization Technical Assistance PFP Policy Framework Paper PUFMARP Public Financial Management Reform Program PURC Public Utilities Regulatory Commission RAGB Revenue Agencies Governing Board SDR Special Drawing Rights SSB Social Security Bank TIN Tax Identification Number TOR Tema Oil Refinery WAEMU West African Economic and Monetary Union VAT Value Added Tax This operation was prepared by a team consisting of Rocio Castro (Senior Economist and Task Team Leader, AFTM4), Ulrich Hess (Economist, AFTM4), Camille Lampart (Economist, World Bank Ghana Office), Gerard Byam (Principal Economist, AFTPS), Paul Murgatroyd (Lead Specialist, AFTPS), Joel Maweni (Senior Financial Analyst, AFEN), Solomon Bekure (Senior Operations Officer, World Bank Ghana Office), Said Al Habsy (Legal Counsel, LEGAF). Contributions were received from Theresa Jones (Country Progam Coordinator, AFCIO), Oliver Campbell-White (Senior Public Enterprise Specialist, AFTPS), Mangesh Hoskote (Power Sector Specialist, EMTEG), Snorri Hallgrimssom (Principal Engineer, AFTT2), Gunter Heidenhof (Senior Public Sector Management Specialist, World Bank Ghana Office), Jose Sokol (Lead Economist, AFT4) and Luis de Azcarate (Consultant, AFTM4). Peer Reviewers were Sudhir Shetty (Principal Economist, AFTM1) and Heman Garcia (Principal Power Engineer, EMTEG). Al Crego (Reasearch Analyst,AFTM4) and Ann Martinov (Team Assistant) provided operational support. This document has a restricted distibution and may be used by recipients only in the perfonnance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  REPUBLIC OF GHANA SECOND ECONOMIC REFORM SUPPORT OPERATION CREDIT TABLE OF CONTENTS Credit and Program Summary ..........................., i L THE ECONOMY .1 A. Background . B. Recent Economic Developments .2 R. GHANA'S ADJUSTMENT PROGRAM ............. .......................................................... 3 A. Restoring Macroeconomic Stability .4 B. Structural Reform Efforts .6 C. Human Development and Poverty Reduction ..................................................................... 12 D. Medium-Term Outlook and Financing Requirements .................................................................. 12 IIL THE PROPOSED CREDIT ..................................................................... 14 A. Credit Rationale and Components ..................................................................... 14 B. Specific Actions Supported by the Credit ..................................................................... 15 C. Poverty Impact ..................................................................... 16 D. Link to the CAS ..................................................................... 17 E. Credit Amount, Disbursement Procedures and Implementation Arrangements ........................... 17 F. Program Benefits and Risks ......................................................................18 IV. BANK GROUP OPERATIONS AND COLLABORATION WITH OTHER DONORS .... 19 V. RECOMMENDATION ..................................................................... 20 Annexes A. Matrix of Policy Actions B. Ghana at a Glance C. Key Economic Indicators D. External Financial Requirements E. Social Indicators of Development F. Status of Bank Operations G. Impact Indicators H. Timetable of Key Processing Events 1. Letter of Development Policy J. Policy Framework Paper  REPUBLIC OF GHANA SECOND ECONOMIC REFORM SUPPORT OPERATION CREDIT CREDIT AND PROGRAM SUMMARY Borrower: Republic of Ghana Amount: SDR 132.7 million (US$180 million equivalent, which includes US$1.8 million IDA Reflows) Terms: Standard IDA terms with a maturity of 40 years Description: The proposed Credit will seek to consolidate recent gains in restoring macroeconomic stability and will support the implementation of a deeper and more challenging phase of the reform program in the cocoa, energy, and banking sectors. The proceeds of the Credit will help cover the external financing requirements of Ghana in the context of a vulnerable external position and low level of external reserves. Moreover, by generating counterpart funds for the budget, the Credit will also assist in reducing the government's domestic financing requirements and help support a downward trend in inflation and interest rates, thereby reducing the country's heavy domestic debt burden. Benefits: Successful completion of the program will enable the Government to create firmer grounds for sustained private sector-led and poverty-reducing growth. In addition to establishing a favorable environment for the private sector, the reduction in inflation will have a beneficial impact on the poor. The anticipated decline in interest rates and reduced debt service payments will allow an expansion of private sector credit as well as increased budgetary allocations to the social sectors. Moreover, proposed reforms in the cocoa sector will boost exports and have a positive impact on the incomes of farmers with significant multiplier effects on the rural economy where most of the poor live. Reforms in the energy sector intended to facilitate private sector participation in power generation and distribution are likely to enhance private investment prospects. Finally, banking restructuring will improve the soundness of the financial system and eliminate sources of quasi-fiscal deficits and inefficient allocation of financial resources. Risks: As shown by past experience, there is a potential risk of policy slippage in the run-up to elections in the year 2000. The Government is quite aware of this risk and, more importantly, of the damaging effects on the population of repeated policy failure. In this regard, the Government has, over the past two years, demonstrated greater commitment to fiscal discipline and has reinstated politically sensitive measures such as the VAT and the rise in electricity tariffs.  ii The Govemment will likely face opposition to some reforms, i.e., the opening of cocoa exports to private operators, from special groups who may perceive proposed changes as a threat to Ghana's quality standing in the world market as well as to their economic interests. To mitigate this risk the Government has opted to implement reforms in a gradual manner and engaged in wide consultations with stakeholders. Finally, while the export price for cocoa is expected to recover over time after its recent downfall, prolonged depressed prices could offset gains from proposed reforms. The Government's ability to manage external shocks from commodity prices (including gold and timber) is limited in the short terma. Disbursement: The Credit will be disbursed in three tranches, one of them being a floating tranche. The first tranche in an amount equivalent to US$80 million will be released upon effectiveness. The second and the floating tranches in amounts equivalent to US$80 million and US$20 million, respectively, will be disbursed upon completion of agreed actions. Map: IBRD 23606  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED SECOND ECONOMIC REFORM SUPPORT OPERATION CREDIT TO THE REPUBLIC OF GHANA 1. I submit for your approval the following report and recommendation on the proposed Second Economic Reform Support Operation (ERSO II) to the Republic of Ghana for SDR 132.7 million, an amount equivalent to about US$180 million, on standard IDA terms. The Credit is proposed as a three tranche operation, including a floating tranche, that would underpin the Government's adjustment program. The proposed Credit seeks to consolidate recent gains in restoring macroeconomic stability and to support the implementation of difficult reforms in the cocoa, energy, and financial sectors. The proposed Credit will also assist in covering Ghana's external financing requirements for the period 1999-2000. I. THE ECONOMY A. Background 2. Since 1983, the Government of Ghana has implemented a gradualist adjustment strategy under the Economic Recovery Program (ERP), designed to stabilize and liberalize the economy. The program succeeded in reversing the profound economic decline suffered in the decade preceding the ERP. Since then, real Gross Domestic Product (GDP) and per capita income have consistently increased at an average annual rate of about 5 and 2 percent, respectively. However, the political liberalization that began in the early 1990s brought about a resurgence of macroeconomic instability and slowdown of reforms which threatened to undermine the economic and social gains achieved thus far. Against this background, since 1997 the Government has taken decisive steps to bring the macroeconomic program back on track and to accelerate structural reforms. 3. Early Stabilization and Reforms. Initial stabilization efforts centered on reducing budget deficits through enhanced revenue mobilization. Fiscal revenues rose from 6 percent of GDP in 1983 to 15 percent of GDP in 1991, allowing for increased public investment, which had collapsed prior to the ERP, and for reduced fiscal deficits. Fiscal and monetary restraint brought down inflation from a peak of 142 percent in 1983 to 10 percent by the end of 1991. Structural reforms focused on removing price controls, liberalizing the trade and foreign exchange regime, and simplifying the regulatory framework for private investment. The Govemment also began a program to divest from parastatals and to restructure the financial sector.  2 4. Adjustment Setbacks. Ghana's adjustment process suffered significant setbacks between 1992 and early 1997. Higher than planned public spending in the run up to the first democratic elections in 1992 and later in 1996 worsened fiscal imbalances and increased inflationary pressures. The domestic rate of inflation averaged 40 percent during the 1993-96 period, peaking at 71 percent in 1995, while the exchange rate depreciated sharply against the dollar. Increased reliance on treasury bills to finance large fiscal deficits and absorb excess liquidity led to a rapid increase in domestic debt, high real interest rates, and a sharp increase in debt servicing obligations. Unbudgeted expenditures and increased non-concessional borrowing in the second half of 1996 and early 1997 caused a one and a half year delay in support under the Enhanced Structural Adjustment Facility (ESAF) arrangement with the Fund. Moreover, key policies were reversed in the midst of considerable social unrest: a 17.5 percent value added tax (VAT) was repealed shortly after its introduction in June 1995 and a 200 percent increase in electricity tariffs was withdrawn in May 1997. 5. Poverty and Social Indicators. Social indicators improved since the inception of the ERP, after a marked deterioration during the preceding decade. According to the third Ghana Living Standard Survey (GLSS3), the incidence of poverty fell between 1987 and 1992 from 36 percent to 31 percent. The reduction in poverty was predominantly a rural phenomenon brought about by the growth in non-farm income, mainly from wholesale and retail trading, while urban poverty increased, mainly in the Accra area. While most of Ghana's social indicators compare favorably with average levels for Sub-Saharan Africa, some indicators appear to have worsened more recently. The 1997 Core Welfare Indicators Questionnaire (CWIQ) indicates that public health has improved with declining levels of sickness while literacy rates have decreased. Poverty predictors from CWIQ, such as household assets, also suggest that more Ghanaians may be below the poverty line than in 1992. More definite results will be available once the GLSS4 is completed in June this year. B. Recent Economic Developments 6. Ghana's macroeconomic situation began to turn around in 1997. The domestic primary surplus (defined as domestic revenues minus domestically-financed non-interest expenditures) increased sharply from 0.3 in 1996 to 3.2 percent of GDP as a result of substantial expenditure cuts, while inflation was brought down from 33 percent to 21 percent. On the structural front, the Government signaled its intention to move ahead with unfinished reforms. In February 1998, Parliament passed the VAT law for its re- introduction later in the year and electricity tariffs were increased by 90 percent. These actions paved the way for the resumption of the second annual ESAF arrangement in March 1998 as well as the approval of IDA's most recent adjustment credit in June 1998. 7. Economic Performance and Outcomes. Performance in 1998 under the ESAF program has been broadly satisfactory. Notwithstanding the energy crisis that hit the country early in the year, the domestic primary surplus rose to 3.6 percent of GDP, but was slightly short of the program tiarget (3.8 percent of GDP) because of higher capital spending. Net domestic financing of the budget increased to 5.2 percent of GDP and - exceeded its target level (3.8 percent of GDP) as high real interest rates led to  3 substantially higher than programmed domestic interest payments. The 90-day treasury bill rate, which had averaged around 40 percent since 1995, declined only gradually throughout 1998 reaching 27 percent by October. Monetary growth was significantly tighter and broad money increased by only 18 percent (40 percent in 1997). As a result, the end-year annual rate of inflation fell to less than 16 percent while the stability in the nominal exchange rate led to a 4 percent real effective appreciation of the Cedi. Despite the severe energy crisis of early 1998, real GDP grew at 4.6 percent, close to the average level recorded since 1983. A good agricultural crop and buoyant export growth both of traditional, (e.g., of cocoa and gold) and non-traditional exports were main contributing factors. Strong exports and improved terms of trade for Ghana allowed a substantial narrowing of the current account deficit and a higher than targeted increase in gross international reserves. II. GHANA'S ADJUSTMENT PROGRAM 8. Ghana-Vision 2020 (The First Step: 1996-2000), spells out the Government's medium term strategy aimed at turning Ghana into a middle income country by the turn of the next decade.' The program aims at achieving higher rates of economic growth and eliminating hard-core poverty through increased private sector activity, particularly in non-traditional exports; balanced social and regional development within Ghana; and proper consideration of environmental aspects. The thrust of the strategy is to make the private sector the engine of growth and main provider of goods and services whilst reorienting the public sector toward the creation of enabling conditions for private sector development and the provision of social and basic infrastructure. In light of the adjustment setbacks suffered in the 1990s, the Government recognizes the need to substantially step up reform efforts, if Ghana is to meet its development goals. 2 9. The medium term reform agenda will focus on consolidating recent gains in restoring macroeconomic stability, through sound fiscal and monetary policies, including improved public expenditure management and revenue collection; pursuing liberal economic policies to ensure competitive investment opportunities; establishing an efficient and reliable economic infrastructure (telecommunications, energy, roads, water); enhancing the soundness of the financial system; and restructuring the public sector to improve the quality and delivery of public services. The Policy Framework Paper (PFP) for 1999-200 1, prepared jointly by the Government, the Bank, and the Fund in February 1999, provides a detailed account of Ghana's economic and social policies for this period. In support of these policies, a new three-year ESAF program was approved by the Fund's Board on May 3, 1999. Government of Ghana: Ghana Vision 2020- Ghana's Long Term "Path to Prosperity", Januaryl995. 2 Ghana would need to achieve GDP growth rates of 8 percent annually to become a low middle income country by 2010.  4 A. Restoring Macroeconomic Stability 10. The Government's macroeconomic program for 1999-2001 aims at: (i) accelerating real GDP growth, to about 6 percent annually; (ii) bringing down inflation to single digits, to 9 percent in 1999 and 5 percent subsequently; and (iii) maintaining the country's external position at manageable levels by increasing the stock of gross international reserves to about 3 months of imports. Fiscal and monetary policies will aim at substantially reducing the government's net domestic borrowing requirement, thereby reducing pressures on interest rates and freeing resources in the banking system for private sector credit; and containing money growth by limiting reserve money growth. Fiscal Policies 11. Fiscal Objectives. A central fiscal objective is to reduce the government's net domestic borrowing to about 2.8 percent of GDP in 1999-2000 and to 1.3 percent of GDP in 2001. As a result, the stock of domestic debt should start declining by 2001. To achieve these objectives, and assuming that interest rates fall as anticipated, the Government plans to maintain domestic primary surpluses at around 3.5 percent of GDP and to draw on extemal program aid at a level of about 2 percent of GDP. Domestic revenue is projected to gradually increase to 19 percent of GDP by 2001, allowing for a concomitant expansion in domestically financed expenditures. Revenue efforts will focus on improving tax administration, expanding the tax base, and correcting renmaining distortions in the tax system. Expected increases in tax collections will more than compensate for reduced tax rates (from the replacement of the sales tax by the VAT and from planned reductions in the cocoa export tax). 12. VAT. A cornerstone of the Government's tax reform is the replacement of the 15 percent sales and service tax by a VAT. Following intense preparations and a wide public education campaign, the VAT was smoothly re-introduced in late December 1998. The VAT was set at a lower standard rate of 10 percent3 with a view to ensuring public acceptance and successful implementation. As of March 1999, over 13,000 taxpayers had registered for VAT, against a target of 6,000. Once the VAT is fully implemented, and depending on revenue considerations, the Government will consider the need to raise the rate. 13. Central Revenue Board. Improved tax administration is also expected from the recent establishment of a common revenue board to coordinate the activities of the Internal Revenue Service (IRS), Customs, Excise and Preventive Service (CEPS), National Revenue Service (NRS) an.d the VAT Service. The initially proposed central revenue authority was reformulated as the Revenue Agencies Governing Board (RAGB) because a constitutional amendment would have been required to replace CEPS and IRS. The Act, which was passed by Parliament in December 1998, replaces the boards of respective revenue agencies with a single new board. The RAGB will be responsible for 3 The VAT was proposed at 15 percent when tabled to Parliament in 1997. 4 By comparison, VAT rates in neighboring countries are mostly in the 15 to 20 percent range.  5 administering the Tax Identification Number (TIN) system, monitoring the collection and audit activities of the revenue agencies, and designing and implementing uniform personnel, legal, and administrative practices. The TIN system will be extended to all taxpayer categories in 1999. 14. Import Tariffs. Once the VAT is fully operational, the Government plans to further rationalize the import tariff regime. The import tariff schedule currently consists of four duty rates (0,5,10,25 percent)5. An important objective of future reform would be to reduce dispersion and revenue loss resulting from the large proportion of zero-rated imports (about 50 percent) and the scope of exemption regimes. To carefully assess the revenue and efficiency impact of future changes, the Government will undertake a comprehensive review of its tariff regime in 1999, taking into account developments in the West African Economic and Monetary Union (WAEMU), and will introduce measures based on this review with the 2000 budget (such as a lowering of the top duty rate to 20 percent). In the meantime, the Government has abolished a 17.5 percent 'special tax' levied on a selected group of products, which since last year applied to imports but not to domestically produced goods, thus restoring the top duty rate to an effective level of 25 percent. 15. Road Sector Arrears. The Government reported payment arrears to private road contractors representing some 0.3 percent of GDP as of end 1997. While provisions were made under the 1998 budget to eliminate these arrears, it was later found that arrears had tripled throughout the year. Compounding levels reflected, in part, high interest rates (over 20 percent in real terns) on overdue payments. In order to address this serious problem, the Government commissioned in October 1998, under the IDA-supported Highway Sector Investment Project, an audit of the eight largest contracts, which accounted for 70 percent of the arrears. The audit found that arrears to these contractors amounted to US$63 million (equivalent to 0.8 percent of GDP) with remaining work valued at around US$220 million. The audit noted that the costs of road works in seven of the contracts were well above normal levels and recommended their termination following a review of the legal covenants of each contract. The cost of terminating the contracts was estimated at around US$10 million. In light of these findings, the Government has adopted an action plan to terminate these referred seven contracts, re- tender them under competitive bidding, and pay-off outstanding amounts within the next two years. In addition, the Government has scaled down its investment program in line with available resources and is to apply competitive bidding procedures to award all future road contracts. 16. Planning and Budgetary Systems. The Government is making good progress in implementing its Public Financial Management Reform Program (PUFMARP) initiated in 1996. A major accomplishment in this area has been the adoption, for the first time, of a Medium Term Expenditure Framework (MTEF) as the basis for the formulation of the 1999 budget. The MTEF aims at integrating the planning process for development and recurrent expenditures, increasing transparency in the allocation of government resources 5 The 5 percent rate was introduced in March 1998 to replace some zero-rated items.  6 (including external funds), and allowing for better prioritization of expenditures according to sector strategies. The MTEF exercise for the 1999 budget covered all sectors rather than the three priority sectors originally targeted. Three-year indicative ceilings were given to ministries, departments and agencies to prepare their detailed annual expenditure plans. All government resources, including external financing, were accounted for in the new budget guidelines and all personnel expenses, including allowances, were consolidated. Future budgets will continue to be prepared on an MTEF basis. In particular, the 2000 budget will extend the allocation of all types of expenditures, including administration and personnel emoluments, to specific sector activities. 17. To accompany the MTEF process, a new set of expenditure control rules will be put in place in 1999. The accounting framework has also been revised to include new codes so that expenditures can be identified not only by type and sectors, but also by activity, source of funds, and geographic location. In addition, the Government has begun the implementation of a Budget and Public Expenditure Management System (BPEMS) to be fully operational by the end 2000. The system will support better budgetary preparation and execution, improved cash management, and strengthened accounting functions, all on an integrated, computerized basis. B. Structural Reform Efforts (a) Promoting the Private Sector 18. The creation of an enabling environment for private investment (domestic and foreign) is at the heart of the Government's strategy for accelerated economic growth and poverty reduction. In addition to restoring macroeconomic stability, Government's reform efforts in the coming years will focus on enhancing Ghana's competitiveness in cocoa world markets; establishing the necessary institutional, regulatory and legal framework to attract private investment in economic activities including in the provision of basic infrastructure (telecommunications, transportation, energy, water); moving ahead with the privatization of economically significant public enterprises in the water, transportation and energy sectors; and further strengthening the financial system. The Government's ultimate goals are to make Ghana attractive as a trade and investment gateway to West Africa as well as a major regional financial center. 19. Cocoa Reform. Ghana's cocoa marketing arrangements are currently restrictive. The Cocobod, the state-owned marketing agency, has retained a monopoly on cocoa exports, largely out of concems that liberalization of the external marketing could undermine Ghana's high quality standards and that foreign interests could eventually take control of this strategic national resource. At the same time, while the domestic marketing has been liberalized since the early 1990s, the state-run Produce Buying Company (PBC) still handles arouncl sixty percent of total purchases owing to its large buying network and preferential laccess to Cocobod's financing and warehousing facilities. Moreover, the farmer's share in the fob export price is low compared to other cocoa producing countries, with the exception of Cote d'Ivoire, on account of a high  7 export tax (currently at 26 percent of the fob price) and relatively high marketing costs (around 18 percent of the fob price). In line with the on-going reform agenda, the producer price was raised to 56 percent of the export fob price in June 1998 (matching that offered in COte d'Ivoire). Also, preparations are underway to offer for sale PBC in 1999 while the unification of the extension services of the Ministry of Agriculture and Cocobod has been initiated. 20. With a long-term view of improving the performance and competitiveness of the cocoa industry, restoring Ghana's leading role in world markets, and raising farmers' incomes, the Government has now revised its medium term strategy for the sector, in broad consultation with stakeholders. In September 1998, the Government established a task force comprising representatives across the sector to prepare a comprehensive report on the sector with recommendations on production, marketing, pricing, infrastructure, and financial arrangements. The report was discussed in a national workshop in January 1999 and served as the basis for the formulation of a revised strategy. The vision of the strategy is to create market incentives that lead to broad based rural growth and income enhancement that will reduce poverty. Notably, the strategy features accelerated increases in the farmer's share of the fob export price and the introduction of private competition in external marketing. The main elements of the strategy include: (i) raising the producer price to 65 percent of the fob price in 1999/2000 and to 70 percent by the year 2004/5; (ii) reducing the cocoa export tax to 15 percent of the fob export price by the year 2004/5; (iii) allowing qualified licensed buying companies (LBCs) to export 30 percent of their domestic purchases starting with the 2000/2001 crop season; (iv) deepening internal marketing competition by giving all LBCs equal access to Cocobod's warehousing and crop financing facilities; and (v) abolishing price discounts on exportable cocoa to domestic processors. The Cocobod will undertake a regulatory role and will reduce its share in the fob price. Quality control will remain the responsibility of a public institution. As a result of these measures, cocoa production, currently estimated at about 400,000 tons, is expected to reach 500,000 tons by 2004/5. 6 21. To ensure the successful implementation of the strategy, a reform secretariat will be established by June 1999 for a period of two years. It will report to a stakeholder steering committee in order to assure its independence from vested interests such as the Cocobod. The secretariat will design regulatory and organizational changes with the help of consultancies and will be the interface between donors, stakeholders and the Government regarding the reform program. The Government will assess progress during the first phase of reforms with a view to moving toward a fully competitive system with open entry. 6 The 25 percent projected output increase over a period of five years will amount to approximately a 7 percent increase of world exports. Considering disease problems of competing producers in South America, the unique quality of Ghana cocoa that puts it into a special input segment for processors and a steadily increasing world demand, no significant adding up problem is anticipated.  8 22. Energy Reform. The Government's strategic objectives are to create an efficient and reliable energy sector through the establishment of competitive pricing and marketing arrangements, and to foster an enabling environment for the participation of private investment in the provision of petroleum products and power services (generation and distribution). The Govemment has prepared and published a Statement of Power Sector Development Policy. The statement outlines progress made to date and the remaining reform agenda. 23. Reform efforts in the power sector are focused on: (i) establishing transparent regulations for tariff setting, licensing, and operation of the national interconnected system; (ii) coordinating and rationalizing strategic investment planning for the sector taking into account projected demand in Ghana and neighboring countries; and (iii) improving the efficiency of the sector through the restructuring of the utilities, the Electricity Company of Ghana (ECG) and the Volta River Authority (VRA), and the privatization of thermal generation and distribution systems through joint venture arrangements. In addition, the Government is discussing with Cote d'Ivoire the formation of a regional power pool aimed at creating an organized market for electricity trade. 24. In late 1997, the Government established the Public Utilities Regulatory Commission (PURC) with autonomous power to set tariffs. The PURC implemented two increases in 1998 which raised the average tariff by over 200 percent to a level that would cover cash flow operating costs of the public utilities and own-guaranteed debt service obligations throughout 1999. By September 1999, the PURC will have published tariff setting guidelines. Moreover, the Government plans to complete electricity regulations covering the operation of the national interconnected system by end 1999. These regulations will establish transparent rules for the market, including conditions for non- discriminatory access and the criteria for economic dispatch of power into the network, and will provide the basis for issuing licenses. The Energy Commission (EC), established in 1998, will be responsible for licensing both petroleum and power operators and for coordinating power sector investment planning. Pending the creation of adequate planning capacity within the EC, the Government is preparing a Transitional Plan for Wholesale Power Supply for 1999-2001, to avoid over- or under-capacity. New generation and related transmission capacity to be committed during this period will be subject to competitive bidding. The Transitional Plan replaces the Emergency Supply Expansion Plan developed in 1998 to fill critical power shortages through temporary contracts with private operators. 25. To improve the economic and financial viability of the public utilities, a financial recovery plan was adopted in 1998. The tariff adjustments authorized by the PURC in 1998 were an integral part of the financial recovery plan which also included efficiency improvements as well as the settlement of arrears and the postponement of government- guaranteed debt service obligations until the year 2000. The restructuring of the public utilities will also involve the separation of generation, transmission and distribution into distinct business units with no cross subsidization. The separation and corporatization of the transmission activities from generation is expected to be completed by December 1999. The distribution company, the Electricity Company of Ghana (ECG), is being  9 restructured into a holding company and five distribution business units. These business units will be offered for sale by June 2000 to strategic investors with the technical capacity to run the distribution zones. This will be the first such divestiture in Africa. 26. On petroleum, important steps have been taken to deregulate the sector. These include the liberalization of crude oil importation, the adoption of an automatic price adjustment mechanism based on an import parity price, and the introduction of uniform ex-depot wholesale prices. Negotiations are now underway for the divestiture of the Ghana Oil Company (GOIL) and retail prices will be liberalized by end 1999. The Government plans to complete the financial restructuring of the Tema Oil Refinery (TOR) in preparation for its divestiture by end 1999. 27. Financial Sector Reform. When financial sector reforms began in the late 1980s, the government-dominated banking sector (seven out of ten banks) was in deep financial distress. Between 1989 and 1992, all government banks were recapitalized and new banking legislation (the 1989 banking law and the 1992 Bank of Ghana law) was introduced to strengthen the regulatory and supervisory powers of the central bank and allow the entry of new private banks. Since 1992, the Government has also sought to enhance the efficiency of the banking system through a program of divestiture of government banks. The majority share holdings of the Social Security Bank (SSB) passed to a strategic foreign investor in 1995. Forty one percent of the Government's shares in Ghana Commercial Bank (GCB), now the second largest commercial bank, have been sold to the public through the Ghana Stock Exchange. 28. The banking system now comprises seventeen banks, of which twelve are private and account for about 70 percent of deposits. While much of the banking system is functioning reasonably well, some small banks are experiencing financial problems and there is a need to further strengthen the laws and regulations to supervise banks. Three banks (two of which are government-owned) do not meet capital adequacy requirements and have a high proportion of non-performing loans (over 80 percent). In addition, the divestiture program has slowed considerably. The strategic investor selected in 1996 to acquire 40 percent of shares in GCB has recently withdrawn its offer owing to financial difficulties linked to the Asian crisis. Meanwhile, the Government is in the third process of soliciting proposals from potential strategic investors for the National Investment Bank (NIB); after two failed prior attempts, while the bank is deteriorating (with a non- performing loan portfolio of 36 percent). 29. The Government has adopted a program for dealing with these problems and strengthening the financial system. First, Bank of Ghana (BOG) has established limits on deposit mobilization and lending to banks not meeting the capital adequacy ratio. By September 1999, it will withdraw the licenses of these banks and start procedures for their liquidation. Second, immediate steps will be taken to place new management at GCB and to offer for sale at least 30 percent of the Government's shares in the bank to a strategic investor and sell remaining shares through the Ghana Stock Exchange. Third, BOG has entered into a Memorandum of Understanding with NIB and its owner, the Government, which obligates NIB to comply with an agreed quantified and monitored  10 program for strengthening itself. With regard to the government-owned Agricultural Development Bank (ADB), the Government will undertake a study of its role in rural finance and options for ownership to be completed by June 2000. By this time, BOG will have disposed of its shares in all banks (including a 30 percent share in ADB). 30. In parallel, the supervisory and liquidity management functions of BOG will be further strengthened. By June 1999, it will enforce new regulations to limit banks' foreign exchange exposure. In addition, the banking law and the central bank law are being amended to, inter-alia, sharpen BOG's powers to intervene in troubled banks. Revised draft legislation will be presented to Parliament by end 1999. BOG is also taking steps to improve the efficiency of the domestic money market (treasury bills), through the recent introduction of repurchase agreements and planned improvements in its liquidity forecasting capabilities. 31. Divestiture. Initial divestiture efforts mostly focused on small and medium size firms and were conducted on an ad-hoc basis. Major divestitures include the Ashanti Goldfields Corporation (1994) and Ghana Telecom (1996). In 1995, the Government launched a program to accelerate the divestiture of 139 enterprises under the Divestiture Implementation Committee (DIC). However, only sixty enterprises have been divested as of January 1999; ten in 1998. Main difficulties relate to low investor interest, delays in outsourcing companies for divestiture, and problems with land titling and outstanding liabilities. Meanwhile, in May 1998, the Government revised its divestiture list to include all economically significant state owned corporations either for privatization and/or private sector participation and adopted a policy to recruit qualified investment banks/consulting firms to formulate and implement the appropriate divestiture strategy for each enterprise.7 Of the referred list, the non-core assets of Ghana National Petroleum Corporation (GNPC), and GOIL have been offered for sale while TOR, Ghana Ports and Harbours and Ghana Water and Sewerage Company have been outsourced for divestiture. As noted above, the divestiture strategy for remaining government banks has been redefined. 32. To improve the pace and quality of the divestiture process, the Government undertook during April 15-19, 1999 a comprehensive review of the program in the context of the mid-term review of the on-going IDA-financed Public Enterprise and Privatization Technical Assistance (PEPTA) project. On this basis, the Government has decided to assign greater resources and attention to the larger, more significant divestitures, to streamline the bidding process, and increase the speed of decision making. Specifically, all qualification issues will be assessed up-front and selection of winning bids will be based on price only. Smaller enterprises would be disposed of more rapidly through clear procedures that do not require high level decision making. The completion of the entire divestiture program is targeted for end 2001. At the same time, the Government will intensify its public information program on divestitures including, inter- 7 These included non-core GNPC assets, theTema Oil Refinery, Ghana Airways, Electricity Company of Ghana, Ghana Oil Company, Ghana Water and Sewerage Corporation, Ghana Ports and Haibours Authority, Ghana Railways Corporation, and the remaining (five) state-owned banks.  11 alia, the dissemination of the findings of the forthcoming impact assessment and continued publication of DIC's audited financial statements. 33. Institutional and Regulatory Reforms. There has been considerable legislation enacted to promote private investment, including the Free Zones Act (1995) and the Ghana Investment Promotion Act (1994). Furthermore, the IDA-financed Gateway Trade and Investment Program, approved in July 1998, is now under implementation. The program aims to attract a critical mass of investors in non-traditional exports by providing the off-site infrastructure for a privately owned free trade zone. The program also entails reorganizing the customs and immigration services and enhancing the investment promotion program. The establishment of independent regulatory bodies, such as the PURC and EC, will provide the necessary basis for increased private sector participation in the provision of energy and water services. Furthermore, in February 1998, the Government created a fully independent road fund, financed from a petroleum tax, to ensure adequate maintenance of the road infrastructure. (b) Public Sector Management Reform 34. The Government has begun to implement a public sector reform program to be carried out over the next decade. The Bank will assist the implementation of this long- term program through an Adaptable Program Lending (APL) operation just approved by the Board. Initial efforts will focus on (i) reforming central management agencies (e.g., the Ministry of Finance, the Public Service Commission, the National Development Planning Commission, the Office of Head of Civil Service) and (ii) rationalizing 175 subvented agencies employing approximately 400,000 staff. All central management agencies will be restructured by end 2001. The objective of the exercise is to address on- going weaknesses such as duplication of functions, lack of uniform standards and guidelines, and poor performance and accountability. In 1998, the Government initiated a pilot program to close down/restructure at least seventeen subvented agencies by end- 2001. The pilot will involve the closure of at least five; the partial commercialization of at least seven (a minimum of 30 percent of whose expenditures will be removed from the budget), and the full commercialization of five. Cabinet is expected to approve the specific agencies to be targeted in the pilot by mid 1999. The legal framework and procedures for closing down or commercializing subvented agencies created by statute will be enacted by end 1999. As part of this program, the Government will develop out- placement and re-deployment initiatives to assist redundant employees. In addition, the Govemment is setting up a new wage structure for public servants. The first phase, which involved a re-grading and re-classification of the entire public service, has been completed and will facilitate the assessment of the financial implications of proposed wage reforms. Inplementation of the new wage structure is to be conducted within budget constraints. 35. Decentralization. The Local Government Act enacted in 1993, recognized the existence of 110 district assemblies. A District Assembly Common Fund, created in 1995, receives by law not less than 5 percent of domestic tax revenue and channels resources from the Village Infrastructure Project and the recently established Social  12 Investment Fund. Several other sources of funds and administrative responsibilities are being deconcentrated, notably those of the new Ghana Health Service and the Ministry of Agriculture. The 1999 budget has allocated 163 billion cedis (about US$65 million) to the District Assemblies Common Fund to finance investments at the local level. As this trend continues, district administrations, which are very weak, will need to strengthen their management and financial capabilities. By mid-1999, draft legislation will be submitted to Parliament to establish a local government service with the aim of improving the districts' capacity to manage expenditure and raise their own revenues. A fiscal decentralization study is to be completed by end 2000. C. Human Development and Poverty Reduction 36. To accomplish its social development objectives, the Government has emphasized the reorientation of resources to the social sectors and to poverty reduction programs. The share of health and education in total domestically-financed expenditures dropped sharply between 1990 and 1995, from 36 percent to 17 percent. Since then the share of expenditures in health and education has gradually recovered reaching 22 percent in 1998 (5.6 percent and 16.5 percent respectively). Under the MTEF, allocations to health and education are programmed to reach, 29 percent of domestically-financed expenditures by 2001. Key targets for 2001 under the Government's health sector program include: (i) reducing infant mortality to 50 deaths per thousand live births; (ii) reducing the fertility rate to 5 births; and (iii) reducing maternal mortality to 100 per hundred thousand live births. The main objectives in education are to increase the gross enrollment rate in primary schools to 81.2 percent by 2001 and improve pupils achievements in learning tests. 37. The Government has also launched a series of targeted interventions at the local and community level to protect those who have not directly benefited from overall economic growth. Main programs include, the National Program for Poverty Reduction, the Village Infrastructure Project, the Social Investment Fund, and micro-finance and rural-finance schemes. Under these schemes, resources are channeled to poor groups and communities through District Assemblies, non-governmental organizations (NGOs), and community-based organizations. The new IDA-financed Community Development Learning and Innovation Loan (L1L), to be approved in FY99, will target street children, nutrition programs, and poverty monitoring. In addition, the Government's Accelerated Agricultural Growth Strategy supports small-scale and commercial private agriculture, including out-grower schemes. The: Government is also preparing a sector-wide program to coordinate support from all donors involved in agriculture-related activities for implementation in 2000. D. Medium-Term Outlook and Financing Requirements 38. Ghana's medium-term macroeconomic prospects assume continued political stability, successful stabilization, implementation of the policy agenda for private sector development, and adequate public spending on social services and rural infrastructure. Real GDP growth, averaging about 6 percent annually over the 1999-2001 period, is to be  13 derived from increases in agricultural productivity (e.g., in the cocoa sector) and increased private investment in the agro-processing industry (food, wood products) and light metal manufacturing mainly for exports. Private investmnent is projected to increase to 15 percent of GDP by 2001. Concessional extemal assistance will continue to play a significant role in Ghana's economic development. 39. After a projected slowdown in 1999, reflecting lower cocoa volumes due to unfavorable rainfall patterns, export growth will pick up in subsequent years led by non- traditional exports. New investments in export processing zone activities under the Gateway project should begin to bear fruit by 2001. Import volumes will grow in tandem with real GDP and will stay moderate in nominal terms assuming low oil prices and international inflation. The current external account deficit, including official transfers, is projected to average 2.6 percent of GDP over the next three years. Gross international reserves are projected to reach 3 months of imports in 2001. Adherence to the Government's fiscal and monetary targets should permit it to maintain a stable real exchange rate and thus help preserve Ghana's external competitiveness. Ghana's stock of public external debt stood at about US$5.9 billion at the end of 1998, or about 80 percent of GDP. In net present value terms, the external public debt was estimated at below 200 percent of exports of goods and services. The external debt service ratio (as a percentage of goods and non-factor services) is projected to decline to below 19 percent by the year 2001. This decline in the debt service ratio will be buttressed by the Government's on-going moratorium on non-concessional borrowing. Table 1. Ghana: Selected Economic Indicators, 1995-2001 (annual % change) Real GDP 4.0 4.6 4.2 4.6 5.5 6.0 6.0 Consumer Prices (end-period) 70.8 32.7 20.8 15.8 9.0 5.0 5.0 (as % of GDP) Domestic Revenue 21.4 19.2 17.3 18.3 18.8 18.9 19.1 Total Grants 3.8 2.6 1.4 2.2 2.4 2.0 1.7 Total Expenditure 31.8 32.6 28.6 28.6 26.8 25.6 24.4 Overall Balance (commitment basis) -6.4 -9.5 -9.9 -8.1 -5.5 -4.7 -3.6 Domestic Primary Balance 1.6 0.3 3.2 3.6 3.5 3.6 3.7 NetDomestic Borrowing -0.4 5.1 5.1 5.0 2.8 2.7 1.3 External Current Account Balance a/ -2.3 -4.7 -8.8 -3.5 -2.9 -2.5 -2.4 Gross Intemational Reserves b/ 4.4 4.4 2.6 2.5 2.7 2.8 3.0 Extenal Public Debt (US$ bn) 5.6 5.8 5.6 5.9 6.2 6.4 6.6 Extemal Debt Service ratio (%) c/ 35.8 35.6 31.6 28.1 24.5 24.7 18.7 Source: Government of Ghana and staff projections. a/ Including external grants. bJ In months of imports of goods and non-factor services. c/ In percent of exports of goods and nonfactor services. 40. External financing requirements over the 1999-2000 period would total about US$1.7 billion. While adequate financing has been identified for 1999 (including this proposed Credit), a residual gap of about US$70 million has been estimated for 2000. It is hoped that the gap would be covered by additional donor pledges at the forthcoming Consultative Group Meeting (CG) scheduled for November 1999.  14 III. THE PROPOSED CREDIT A. Credit Rationale and Components 41. The proposed Credit follows up on the one-tranche Economic Reform Support Operation (ERSO) which was approved by the Board in June 1998. The ERSO supported the completion of an important phase of reforms in Ghana and laid the foundations for the next generation of reforms in the areas of public sector management, privatization, and the cocoa and energy sectors. The Government has made good progress in implementing the ERSO reform agenda including measures identified as triggers for proceeding with further adjustment support. Notably, fiscal performance has remained broadly on track, inflation and real interest rates have declined, the VAT has been re-introduced smoothly, the 1999 budget was prepared for the first time on an MTEF basis, and electricity tariffs have been substantially increased to ensure the financial viability of the utilities. Moreover, a new medium term strategy for the cocoa sector has been developed with a view to enhancing both the growth prospects of the sector and the incomes of cocoa farmers. Box 1. Ghana: Implementation of Triggers under ERSO a/ Triggers under ERSO Date of Completion * Achievement of main fiscal targets for 1998 1998 targets broadly on track, 1999 agreed in and agreement on program for 1999 February 1999 . Re-introduction of the VAT December 1998 * Establishment of Central Revenue Authority December 1998 * Fornulation of 1999 budget on an MEF basis January 1999 * Adequate progress hi the divestiture program Partially done. Good progress on large enterprises. . Actions to restore financial viability of public September 1998 energy utilities, including regularization of arrears and further tariff increase * Complete a medium term cocoa strategy Februaryl999 . At least match cocoa producer prices with those On-going. Done for 1998/99 crop season of neighboring countries a/ Excludes two measures relating to public sectDr reform which are being monitored under the proposed Public Sector Reform Management APL. 42. Building on the on-going reform momentum, the proposed Credit seeks to consolidate recent gains in restoring macroeconomic stability and support the implementation of difficult reforms in the cocoa, power, and financial sectors. Fiscal policies supported under the Credit are aimed at improving fiscal sustainability while raising the efficiency of resource mobilization and use. In particular, the termination of specific road contracts will address the root cause of large payment arrears thus removing an important source of fiscal imbalance and resource misallocation. Also, the elimination of the 'special tax' on imports will begin a process to further rationalize the import tariff regime so as to provide adequate incentives to local industry within a regional context. Very importantly, the proposed Credit will support the implementation of a revised strategy for the cocoa sector developed with strong stakeholder ownership. As part of this strategy, and in light of a recent downfall in the export price, the increase in the farmers' share of the fob price will Ibe further accelerated while external marketing will  15 be gradually opened to private competition. In the power sector, the proposed Credit supports the implementation of key elements of the remaining reform agenda as outlined in the recently published power sector strategy, particularly the establishment of regulations for the market and the divestiture of ECG's electricity distribution units. In the financial sector, the proposed Credit will seek to enhance the soundness of the financial system and remove a source of quasi-fiscal pressures by targeting the closure of distressed banks and continuing the divestiture of remaining government banks. 43. The proceeds of the proposed Credit will help cover Ghana's external financing requirements in the context of a vulnerable external position and low level of reserves. Moreover, by providing counterpart funds for the budget, the Credit will help reduce the government's net domestic financing and domestic debt burden by limiting increases in the stock of debt and supporting a decline in real interest rates. B. Specific Actions Supported by the Credit 44. Prior to negotiations of the Credit, the Government: i. removed the 'special tax' of 17.5 percent levied on selected import products; ii. obtained Cabinet approval of an action plan to terminate seven contracts underlying 70 percent of the road arrears; iii. obtained Cabinet approval of a revised medium term strategy for the cocoa sector, including accelerated increases of farmers' share in the fob price and allowing qualified licensed buying companies to export 30 percent of cocoa purchases; iv. issued instructions to ensure that all licensed cocoa buying companies will have equal access to Cocobod financing and warehousing facilities; v. published a Statement of Power Sector Development Policy; vi. established quarterly targets for banks not meeting the capital adequacy requirements, including limits on deposit mobilization and lending; vii. agreed on a strategy to resolve the insolvent position of the Bank for Housing and Construction (BHC) and the Cooperative Bank (Coop). 45. Prior to Board presentation of the Credit, the Government: i. publicly announced its revised medium term strategy for the cocoa sector, including a timetable of agreed actions; ii. signed a Memorandum of Understanding (MOU) with Bank of Ghana and NIB to stop further deterioration of the bank.  16 46. Prior to Second Tranche release of the Credit, the Government will have: i. increased the cocoa farmers' share in the fob price to 65 percent in the 1999/2000 crop season, ii. issued instructions to allow qualified licensed cocoa buying companies to export 30 percent of their domestic purchases starting with the 2000/2001 crop season; iii. withdrawn the licenses of all commercial banks which do not meet the capital adequacy ratio requirement; iv. offered for sale8 at least 30 percent of the shares of the GCB to a strategic investor and placed remaining shares in the Stock Exchange; v. presented to Parliament a legislative instrument establishing the electricity regulations for the operation of the national interconnected electricity system. 47. Prior to Floating Tranche release of the Credit, the Government will have: i. offered for sale9 shares in ECG's electricity distribution business unit(s) to strategic investor(s). C. Poverty Impact 48. The Credit would contribute to improving the economic prospects of the poor in Ghana by supporting the Government's efforts to reduce inflation and to stay the course with economic reforms that will enhance the prospects for sustainable broad-based ecofiomic growth and employment generation. The anticipated decline in interest rates will lower interest payments and thus help release public funds to finance expenditures in health and education. Of direct importance to the poor in this Credit will be measures to raise the incomes of cocoa farmers. There are about 800,000 cocoa farmers in Ghana who support about 5 million people. As a result of direct and indirect multiplier effects of proposed measures, it is estimated that roughly one million cocoa household members who are currently below the poverty line would be lifted out of poverty by the year 2005. The divestiture and banking restructuring program would indirectly benefit the poor, by moving the state away from activities that can be better performed by the private sector and thereby releasing funds for development expenditures and basic services. "Offer for sale" means that the Government would have: (i) prepared a prospectus or information memorandum with the assistance of an investment adviser, (ii) solicited bids from potential investors; and (iii) evaluated technical and financial proposals. See above definition of "offer for sale".  17 D. Link to the CAS 49. The Bank's Country Assistance Strategy (CAS) for Ghana, discussed by the Executive Directors in September 1997, supports the Government's overall strategy for poverty reduction. Key elements of the CAS include restoring macroeconomic stability; ensuring a breakthrough in private investment (especially in non-traditional exports); promoting broad-based social and rural development; and implementing direct poverty- reduction interventions. By underpinning stabilization efforts and including measures to remove constraints for private sector development, the proposed Credit is fully consistent with the CAS. The CAS proposes a base case lending amount in the US$430-660 million rangel'. Within this range, lending would be graduated in response to changes in key indicators during the CAS period, including benchmarks for the primary fiscal surplus and social and health spending, as well as progress in implementing the unfinished reform agenda for promoting private investment, i.e., regulatory reform for infrastructure (power, rails, ports), revenue reform (VAT, central revenue authority), domestic cocoa deregulation (privatization of PBC), and public service reform. The present operation goes a long way towards meeting these goals and takes Ghana closer to the high end of the lending range, particularly, by breaking new ground on cocoa reforms. E. Credit Amount, Disbursement Procedures and Implementation Arrangements 50. Credit Amount. The amount of the Credit is proposed at US$180 million. This will bring the level of adjustment lending during the FY98-00 to US$230 million compared with US$150 million envisaged under the CAS's base case scenario. The higher amount is justified given progress in implementing the reform agenda in the cocoa, energy, and fiscal areas. Notably, proposed reforms in the cocoa sector represent a major breakthrough in policy dialogue and underscore the Government's commitment to poverty reduction. Moreover, the proposed accelerated increases in the farmers' share of the fob price will result in substantial revenue shortfall which would warrant further financial assistance, particularly in the context of currently weak international prices for cocoa. In addition, the CAS provides for increased adjustment lending, or a "safety net" of adjustment loans, should the domestic debt burden (level of external reserves) be higher (lower) than originally projected under the macroeconomic program. This is certainly the case in Ghana. Despite the recent tight fiscal and monetary stance, interest rates did not come down as rapidly as originally envisaged and domestic interest payments during 1998-2000 will be above earlier projections by about 1.5 percent of GDP (equivalent to US$100 million). 51. Tranche Release. The Credit will be disbursed in three tranches. The first tranche in an amount equivalent to US$80 million will be disbursed upon effectiveness. The second and floating tranches, in amounts equivalent to US$80 million and US$20 million, respectively, will be released upon completion of agreed actions. The program 10 The bottom end of the range (i.e.US$430 million) assumes no adjustment lending and is applicable if fiscal performance is on track but not much progress is made on the reform agenda.  18 was designed to emphasize actions taken prior to Credit approval to demonstrate progress in turning the fiscal situation around and Govermment's commitment to the program. 52. Procurement and Disbursement Procedures. The Credit will follow the Bank's new simplified disbursement procedures for structural adjustment operations. Under the revised procedures, the Credit will be disbursed in three tranches against satisfactory implementation of the adjustrnent program. Disbursement will not be tied to any specific purchases and no procurement requirements will be needed. Once the Credit is approved by the Board, the proceeds of the first tranche of the Credit will be deposited by IDA in an account at Bank of Ghana at the request of the Borrower. Subsequent tranches will be deposited in the same account once the agreed conditions are met. If, after deposit in this account, the proceeds of the Credit are used for ineligible purposes as defined in the Credit Agreement, IDA will require the Borrower to either: (a) return the amount to the account for use for eligible purposes; or (b) refund the amount directly to IDA. The administration of this Credit will be the responsibility of the Ministry of Finance. Although an audit of the deposit account will not be required, the Bank reserves the right to require audits at any time. 53. Implementation of the policy and actions under the program will be monitored by a technical committee from the Minister of Finance and the Bank of Ghana. The committee will prepare progress reports on the various components of the program with inputs from participating ministries and agencies. IDA will monitor implementation of the program through regular supervision missions. 54. Impact Indicators. To monitor the proposed Credit's impact, the following indicators will be monitored on an annual basis: (i) domestic interest payments as a share of recurrent expenditures; (ii) expenditures in health and education as a share of domestically-financed expenditures; (iii) road arrears as a share of GDP; (iv) volume of cocoa exports; (v) non-performing loans in the banking system; and (vi) private investment as a share of GDP. (For details on impact indicators see Annex G). F. Program Benefits and Risks 55. Benefits. Successful completion of the program should enable the Government to maintain a stable macroeconomic framework and to create firmer grounds for sustained, broad-based, private sector-led economic growth. The reduction in inflation will have a beneficial impact on the poor. The anticipated decline in domestic interest rates and reduced debt service payments will allow for an expansion private sector credit as well as increased spending in health, education and poverty reduction programs. Moreover, the proposed reforns in the cocoa sector will provide incentives for increased cocoa production and will lead to increases in farmers' incomes with large multiplier effects on the rural economy. Reforms in the energy sector intended to facilitate private sector participation in power generation and distribution are likely to enhance private activity. Finally, financial sector reforms will improve the soundness of the financial system and eliminate sources of quasi-fiscal deficits and inefficient allocation of financial resources.  19 56. Risks. As the 2000 elections approach, the risk of policy slippage increases. However, the Government is aware that the population at large has been hard-hit by inflation and low per-capita GDP growth and is politically committed to having in place the necessary policies that will underpin a process of sustained growth and poverty reduction. Over the past two years, the Government has demonstrated greater fiscal discipline and has reinstated politically sensitive measures such as the VAT and the increase in electricity tariffs. In this spirit, it has wholeheartedly embraced the MTEF process as an instrument for more effective and transparent expenditure management. The approval of a new three-year ESAF program offers an additional source of comfort. It should be underscored, however, that the Government will likely face opposition to proposed reforms in the cocoa sectors from special groups, i.e., Cocobod and international cocoa importers, who may perceive these reforms as a threat to Ghana's quality standing in world markets as well as their economic interests. The Government is mitigating this risk by conducting extensive consultations with all stakeholders and by adopting a gradual approach to policy reforms in the sector. In particular, concerns about safeguarding the quality of cocoa beans will be addressed by maintaining the quality control function within the public sector during the transition period. There is also the risk of opposition to proposed reforms in the financial sector. The Government intends to manage these risks by protecting depositors, reimbursing terminated staff, and implementing a public relations campaign. On GCB, there is a risk of not finding a suitable strategic investor both because of some public opposition to the sale and adverse market conditions following the Asian crisis. Given the complex nature of the proposed privatization of ECG, unforeseen delays are likely. The floating tranche provides an appropriate vehicle to address such risk. Finally, after its recent downfall, the export price for cocoa is expected to recover over time, but if it remains depressed for a prolonged period, gains from proposed reforms may not materialize. The Government's ability to manage external shocks from commodity prices (including gold and timber) is limited in the short term. IV. BANK GROUP OPERATIONS AND COLLABORATION WITH OTHER DONORS 57. Bank Group. As of March 31, 1999, the Bank's active portfolio for Ghana included 24 projects, totaling US$1,014 million, of which US$474 million were undisbursed. The Intemational Finance Corporation's (IFC) total investments amounted to US$60 million, comprised of US$26 million in loans, US$7 million in equity, US$14 million in quasi-equity, and US$13 million in participation. Currently, Ghana does not have guarantees from the Multilateral Investment Guarantee Agency (MIGA). 58. International Monetary Fund (EMF). Bank staff are working closely with the IMF and other donors in helping Ghana design and implement its reform program. The Bank and the IMF collaborated with the Ghanaian authorities on the preparation of the eighth Policy Framework Paper covering the 1999-2001 period. The PFP was distributed to the Bank Board in mid-April 1999. A new three-year ESAF Arrangement for Ghana was approved by the Fund's Board on May 3, 1999. The Government of Ghana plans to  20 conduct, with the Fund, a midterm review of its program supported by the first annual arrangement by September 1999. 59. Other Donors. The Bankl Group is increasing its collaboration with donor agencies, the United Nations system, and NGOs. The Bank, as Chair of the CG, provides the forum for meetings every alternate year. Following the November 1997 CG meeting, the Government and the Bank sponsored the creation of the Government/Donor Economic and Finance Coordinating Group, which meets quarterly under the co- chairmanship of the Minister of Finance and the Bank. The next CG meeting is scheduled for November 1999 in Accra. Consultations with bilateral and multilateral donors also take place in the context of specific projects or programs and also under the Special Program of Assistance for Africa. The development of sector programs in roads and health has enhanced donor coordination considerably. A sector program is also being prepared for agriculture. V. RECOMMENDATION 60. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association and I recommend that the Executive Directors approve it. James D. Wolfensohn President by Shengman Zhang Attachments Washington, D.C. May 4, 1999  Annex A Page 1 of 2 Matrix of Policy Actions The Reform Agenda Supported by ERSO II Objectives Specific Measures Status Fiscal Reform Enhance revenue Re-introduction of the VAT Trigger under ERSO mobilization December 1998 Establishment of Central Revenue Authority (now Revenue Trigger under ERSO Authorities Governing Board) December 1998 Increase Formulation of 1999 budget on an MTEF basis Trigger under ERSO efficiency of January 1999 public spending Cabinet approval of an action plan to terminate seven contracts Condition of underlying 70 percent of the road arrears and to eliminate them Negotiations by the end of 2000 Implement BPEMS system in targeted ministries and spending Budgets for 2000 and units 2001 Remove Remove the 'special tax' of 17.5 percent levied on selected Condition of distortions import products Negotiations Complete comprehensive review of tariff regime. September 1999 Reduce the tariff top rate to 20 percent in harmony with the Budget for 2000 subregion. Cocoa Sector Reform Define long term Complete a medium term cocoa strategy ERSO trigger visionFeray19 Cabinet approval of a revised medium term strategy for the cocoa Condition of sector, including accelerated increases of farmers' share in the Negotiations fob price and allowing qualified licensed buying companies to export 30 percent of cocoa purchases Publicly announce revised medium term strategy for the cocoa Conditionfor Board sector, including a detailed timetable of actions presentation Increase farners' Increase the cocoa farmers' share in fob price to 65 percent in the Second Tranche incentives 1999/2000 crop season condition Encourage Issue instructions to ensure that all cocoa licensed buying Condition of competition in companies will have equal access to Cocobod financing and Negotiations cocoa marketing warehousing facilities Offer for sale the Produce Buying Company June 1999 Issue instructions to allow qualified cocoa licensed buying Second Tranche companies to export 30 percent of their domestic purchases condition starting with the 2000/1 crop season  Annex A Page 2 of 2 Energy Sector Reform Define long term Publish a Statement of Power Sector Development Policy Condition of vision agreeable to IDA Negotiations Rationalize Complete and issue Transitional Power System Development September 1999 sector investment Plan (1999-2001) Establish a Publish and implement complete guidelines for fixing electricity September 1999 transparent tariffs regulations Submit to Parliament the legislative instrument establishing the Second Tran che electricity regulations for the operation of the National condition Interconnected System Restructure Adopt financial restructuring plan for the electricity utilities ERSO trigger electricity including regularizatio:n of arrears and further tariff increase September 1998 utilities Complete separation of electricity transmission utility (National December 1999 Grid Company Ltd.) from Volta River Authority (VRA) Increase private Offer for sale ECG's distribution units Floating Tranche sector condition participation Financial Sector Reform Stop further Establish quarterly targets for banks not meeting the capital Condition of deterioration of adequacy requirements, including limits on deposit mobilization Negotiations troubled banks and lending Agree on a strategy to resolve the insolvent positions of the Bank Condition of for Housing and Construction (BHC) and the Cooperative Bank Negotiations (Coop) in 1999. Withdraw the licenses of banks not meeting the capital adequacy Second Tranche ratio requirement condition Sign a Memorandum of Understanding between Ministry of Condition of Board Finance, Bank of Ghana and NIB presentation Reduce Offer for sale 30 perce:nt ofGCB's shares to a strategic investor Second Tranche govemment and place remaining shares in the Ghana Stock Exchange condition ownership in banking system Select a strategic investor for NIB or re-launch search with June 1999 assistance of financial adviser Complete study on role of ADB in rural finance June 2000 Strengthen Implement revised guidelines for foreign currency exposure June 1999 banking limits supervision Submit revised draft central bank law and banking law to December 1999 parliament  Annex B Ghana at a glance 4P29age of 2 Sub- POVERTY and SOCIAL Saharan Low- Ghana Africa income Developmentdiamond^ 1998 Population, mid-year (millions) 18.4 614 2,048 Life expectancy GNP per capita (Atlas method, US$) 407 500 350 GNP (Atlas method, US$ billions) 7.5 309 722 Average annual growth, 1992-98 Population (%) 2.6 2.7 2.1 Labor force (%) 2.7 2.6 2.3 GNP Gross per primary Most recent estimate (latest year available, 1992-98) capita enrollment Poverty (% of population below national poverty line) 31 Urban population (% of total population) 37 32 28 Life expectancy at birth (years) 59 52 59 Infant mortality (per 1,000 live births) 69 90 78 Child malnutrition (% of children under5) 27 27 .. Access to safe water Access to safe water (% of population) 56 44 71 Illiteracy (% of population age 15+) 36 43 47 Gross primary enrollment (% ofschool-age population) 76 75 91 Ghana Male 83 82 100 Low-income group Female 70 67 81 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1977 1987 1997 1998 Economic ratios GDP (US$ billions) 3.2 5.1 6.9 7.5 Gross domestic investmenVGDP 11.1 10.4 24.1 22.9 Trade Exports of goods and services/GDP 10.5 19.7 24.0 26.7 Gross domestic savings/GDP 10.0 3.9 9.8 13.2 Gross national savings/GDP 9.6 5.6 15.4 19.4 Current account balance/GDP -4.5 -4.4 -11.1 -6.6 Domestic Interest payments/GDP 0.5 1.1 1.9 2.0 Domengst Investment Total debVGDP 33.4 64.6 81.3 79.2 | Savngs Total debt service/exports 3.7 45.8 34.1 31.1 Present value of debt/GDP .. .. 54.2 50.8 Present value of debVexports .. .. 220.3 186.6 Indebtedness 1977-87 1988-98 1997 1998 1999-03 (average annual growth) GDP 0.4 4.3 4.2 4.6 6.1 GNP per capita -2.7 1.4 1.7 1.9 3.5 Ghana Low-icome group Exports of goods and services -4.7 9.7 -0.4 14.4 5.6 STRUCTURE of the ECONOMY 1977 1987 1997 1998 Growth rates of output and investment (%) (% of GDP) 30 Agriculture 56.2 50.6 36.6 36.8 20 Industry 15.8 16.3 25.4 25.0 1 0 Manufacturing 10.8 9.9 8.3 8.3 0 Services 28.0 33.1 38.0 38.2 -10 95 94 X 9 97 9s -20 Private consumption 77.4 85.5 77.8 76.5 -30 General govemment consumption 12.6 10.6 12.4 10.3 GDI C GDP Imports of goods and services 11.6 26.2 38.4 36.4 1977-87 1988-98 1997 1998 Growth rates of exports and imports (%) (average annual growth) Agriculture 0.8 2.5 2.2 3.7 25 Industry -4.0 4.5 4.8 5.7 20.A Manufacturing -4.0 2.9 4.0 5.0 15 - Services 1.9 6.0 5.9 4.9 10 Private consumption 0.3 3.7 12.1 1.6 s/ General government consumption 1.4 4.6 -11.7 11.3 0 Gross domestic investment -4.6 3.8 3.4 2.8 -s 93 94 9S 97 93 Imports of goods and services -7.0 7.3 14.7 8.3 Exports -0Imports Gross national product 0.2 4.3 4.3 4.6 Note: 1998 data are preliminary estimates. 'The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.  Annex B Page 2 of 2 Ghana PRICES and GOVERNMENT FINANCE Domestic prices 1977 1987 1997 1998 Inflation (%) (% change) 80 Consumer prices 116.5 39.8 27.9 19.3 60 Implicit GDP deflator 67.3 39.2 19.5 17.6 40 Government Finance 20 (% of GDP, includes current grants) 0a Current revenue .. 14.1 17.8 18.9 93 94 95 90 97 98 Current budget balance 2.9 1.6 1.6 -GDP deflator -6---CPI Overall surplus/deficit -5.1 -10.8 -9.7 ___ deflator _ )CPI TRADE (US$ millions) 1977 1987 1997 1998 Exportand import levels (USS millions) Total exports (fob) .. 824 1,491 1,830 3,ooO Cocoa .. 495 470 629 2500I Timber .. 91 172 170 Manufactures .. .. 2,000 Total imports (cif. 1,009 2,321 2,417 1r-T0 Food .. 73*,100 2 3 4 5 7 5 Fuel and energy .. 145 240 212 500 Capital goods .. 166 ... _ _ _ _ _ __ _ _ _ _ _ _ _ _ Export price index (1995=100) .. 97 93 98 Import price index (1995=100) .. 69 97 81 0 Exports Elmports Terms oftrade (1995=100) .. 141 96 121 BALANCE of PAYMENTS (US$ millions) 1977 1987 1997 1998 Current account balance to GDP ratio (%) Exports of goods and services 1,018 903 1,656 2,004 0 -1 - Importsof goods and services 1,121 1,203 2,645 2,732 -2 92 93 97 T Resource balance -103 -300 -989 -728 -4 Net income -35 -127 -134 -142 -6 Net current transfers -6 202 360 378 -8 -10 Current account balance -144 -225 -763 -492 12 Financing items (net) 254 363 787 591 -14 Changes in net reserves -109 -138 -25 -99 -16 Memo: Reserves including gold (US$ millions) 182 332 508 502 Conversion rate (DEC, local/US$) 3.5 147.0 2,050.2 2,314.0 EXTERNAL DEBT and RESOURCE FLOWS 1977 1987 1997 1998 (US$ millions) Composition of total debt, 1997 (USS millions) Total debt outstanding and disbursed 1,067 3,280 5,599 5,943 IBRD 43 151 30 27 G:| 28 IDA 79 700 2,617 2,963 F: 704 Total debt service 38 415 578 636 IBRD 5 22 15 9 IDA 1 7 31 46 B: 2,617 Composition of net resource flows Official grants 65 122 160 230 E: 1,075 Official creditors 70 254 350 325 Private creditors 22 3 -76 -74 Foreign direct investment .. 5 110 152 0D:53 Portfolio equity .. 0 46 80 C 1 | ~~~~~C: 354 World Bank program Commitments 57 233 54 165 A - IBRD E- Bilateral Disbursements 30 194 237 280 B - IDA D - Other multilateral F - Private Principal repayments 3 13 23 30 C-IMF G - Short-term Net flows 27 181 214 250 1 I Interest payments 3 16 22 25 Net transfers 24 165 192 225 Development Economics 4/29/99  Annex C Page 1 of 3 Ghana - Key Economic Indicators Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 National accounts (as % GDP at current market prices) Gross domestic product 100 100 100 100 100 100 100 100 Agriculturea 36.4 36.3 36.5 36.6 36.8 36.9 31.7 31.0 Industrya 24.9 24.9 24.9 25.4 25.0 25.1 25.3 25.8 Servicesa 28.0 28.2 28.1 28.7 29.1 28.9 33.9 34.0 Total Consumption 87.4 88.3 88.1 90.2 86.8 85.3 83.7 82.1 Gross domestic fixed 22.6 21.1 20.6 23.2 22.1 23.0 24.0 24.8 investment Government investment 13.3 14.0 13.3 12.4 11.3 11.1 11.3 10.6 Private investment 10.7 6.0 8.2 11.7 11.6 12.6 13.4 14.8 (includes increase in stocks) Exports (GNFS)b 22.5 24.5 24.9 24.0 26.7 25.4 26.9 27.9 hmports (GNFS) 33.9 32.8 34.5 38.4 36.4 34.5 35.2 35.5 Gross domestic savings 12.6 11.7 11.9 9.8 13.2 14.7 16.3 17.9 Gross national savings' 15.5 13.7 13.8 15.4 19.4 20.8 22.2 23.0 Memorandum items Gross domestic product 5440 6457 6926 6884 7501 8070 8568 9334 (IJS$ million at current prices) Gross national productper 327 378 395 383 407 426 441 469 capita (US$, Atlas method) Real annual growth rates (%, calculated from 1975 prices) Gross domestic product at 3.3% 4.0% 4.6% 4.2% 4.6% 5.5% 6.0% 6.0% market prices Gross Domestic Income 4.6% 3.5% 2.2% 4.6% 4.8% 5.8% 6.1% 6.2% Real annual per capita growth rates (%, calculated from 1975 prices) Gross domestic product at 0.6% 1.4% 1.9% 1.5% 1.9% 2.8% 3.3% 3.4% market prices Total consumption -1.3% 0.7% -0.8% 3.8% 0.9% 2.4% 2.5% 3.2% Private consumption -1.5% 0.6% 1.7% 9.2% -0.9% 1.9% 2.3% 3.1% (Continued)  Annex C Page 2 of 3 Ghana - Key Economic Indicators (Continued) Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 Balance of Payments (US$m) Exports (GNFS)b 1374 1582 1730 1656 2004 2052 2301 2606 Merchandise FOB 1227 1431 1573 1491 1830 1880 2119 2412 Irnports (GNFS)b 2000 2126 2396 2645 2732 2782 3016 3310 Merchandise FOB 1580 1684 1937 2128 2213 2253 2463 2719 Resource balance -626 -544 -666 -989 -728 -730 -715 -705 Net current transfers, 271 263 276 360 378 380 418 439 (including official current transfers) Current account balance -265 -154 -328 -603 -261 -233 -225 -258 (after official capital grants) Net private foreign direct 206 259 70 55 -11 45 100 100 investment Long-term loans (net) 228 395 556 660 484 502 284 325 Official 385 268 419 350 325 192 198 198 Private -157 127 137 310 159 311 86 127 Other capital (net, including -6 -289 -312 -87 -112 -236 -125 -79 errors and omissions) Change inreservesd -164 -211 14 -25 -99 -77 -34 -88 Memorandum items Resource balance (% of -11.5% -8.4% -9.6% -14.4% -9.7% -9.0% -8.3% -7.6% GDP at current market prices) Real annual growth rates (1975 prices) Merchandise exports 0.6% 3.8% 12.5% -0.7% 16.3% 3.5% 9.2% 7.8% (FOB) Primary 2.2% 5.4% 11.4% -2.3% 15.2% 1.7% 7.6% 5.9% Manufactures .. .. .. .. .. Merchandise irnports -8.4% 1.8% 13.8% 14.4% 24.5% 7.1% 6.2% 6.2% (CIF) Public finance (as % of GDP at current market prices)e Current revenues 20 22 18 18 19 19 19 19 Current expenditures 18 16 16 16 17 16 14 14 (Continued)  Annex C Page 3 of 3 Ghana - Key Economic Indicators (Continued) Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 Current account surplus ( 2 5 2 2 2 4 5 6 or deficit (-) Capital expenditure 13 14 13 12 11 11 11 11 Foreign fmancing 7 7 6 6 5 4 3 3 Monetary indicators M2/GDP (at current market 19.4 18.4 17.6 19.9 19.0 19.0 19.0 19.0 prices) Growth of M2 (%) 53 41 40 41 18 15 14 12 Price indices( 1975 =100) Merchandiseexportprice 89 100 91 91 103 98 104 112 index Merchandise import price 121 127 129 144 134 126 132 137 index Merchandise terms of trade 74 79 71 63 77 77 79 81 index Real exchange rate 63 72 81 86 93 101 108 117 (IJS$/LCUJ)l Real interest rates Consumer price index 24.9 74.3 46.6 27.9 19.3 10.0 6.4 5.0 (% growth rate) GDP deflator 30.1 43.2 39.8 19.5 17.6 8.6 7.4 5.9 (% growth rate) a. GDP components are estimated at factor cost. b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Central government. f