Mozambique - Industrial Enterprise Restructuring Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No: 20547 IMPLEMENTATION COMPLETION REPORT (IDA-20810) ON A CREDIT IN THE AMOUNT OF US$51.3 MILLION TO THE REPUBLIC OF MOZAMBIQUE FOR AN INDUSTRIAL ENTERPRISE RESTRUCTURING PROJECT June 19, 2000 Private Sector Unit Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their | official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (Exchange Rate Effective 12/31/99) Currency Unit = Meticais Meticais 10,000 = US$ 1 US$ I = Meticais 13,208 FISCAL YEAR January I - December 31 ABBREVIATIONS AND ACRONYMS BE Beneficiary Enterprise BSTM Standard Totta Bank of Mozambique (Banco Standard Totta de MoCambique) BM Bank of Mozambique (Banco de Mo,ambique) CPI Investment Promotion Center (Centro de Promo,do de Investimento) DCA Development Credit Agreement DEPAE Department of State Assets (Departamento do Patrimonio do Estado) DOC Department of Credit Operations (Departamento de Opera,ces de Cre'dito) ERC Enterprise Rehabilitation Component ERTU Enterprise Restructuring Technical Unit (Unidade Tecnica para a Reorganiza,cao das Empresas) EDP Enterprise Development Project GREAP Bureau for Restructuring Enterprises in the Ministry of Agriculture and Fisheries (Gabinete de Reestrutura9iio de Empresas Agrarias e Pesqueiras) GREICT Bureau for Restructuring Enterprises in the Ministry of Industry, Trade, and Tourism (Gabinete de Reestrutura,do de Empresas Industriais, Co,mercio e Turisms) INE National Statistics Institute (Instituto Nacional de Estatistica) IPEX Export Promotion Institute (Instituto para a Promo qao de Exportaq6es) MICTUR Ministry of Industry, Trade, and Tourism (Ministerio da Indzstria, Comercio e Turismo) PFI Participating Financial Institutions SAR Staff Appraisal Report TAC Technical Assistance Component UTRE Technical Unit for Restructuring Projects (Unidade T&nicapara a Reabilita,'do de Empresas) Vice President: Callisto E. Madavo Country Manager/Director (Acting): Michael N. Sarris Sector Manager/Director: Demba Ba Task Team Leader/Task Manager: Marilyn S. Manalo  FOR OFFICL USE ONLY CONTENTS Page No. 1. Project Data I 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 1 4. Achievement of Objective and Outputs 4 5. Major Factors Affecting Implementation and Outcome 7 6. Sustainability 8 7. Bank and Borrower Perfornance 9 8. Lessons Learned 11 9. Partner Comments II 10. Additional Information 12 Annex 1. Key Performance Indicators/Log Frame Matrix 13 Annex 2. Project Costs and Financing 14 Annex 3. Economic Costs and Benefits 16 Annex 4. Bank Inputs 17 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 19 Annex 6. Ratings of Bank and Borrower Performance 20 Annex 7. List of Supporting Documents 21 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.   Project 1D. P00] 784 Project Name: INDUSTRIAL ENTERPRISE Team Leader: Marilyn Swann Manalo TL Unit: AFTPS ICR Type: Core ICR Report Date: June 19, 2000 1. Project Data Name: INDUSTRIAL ENTERPRISE L/C/TFNNumber: IDA-20810 Countrv/Department: MOZAMBIQUE Region: Africa Regional Office Sector/subsector: IR - Industrial Restructuring KEY DATES Original Revised/Actual PCD: 06/30/88 Effective: 12/31/89 08/06/90 Appraisal: 03/15/89 MTR: 06/30/93 01/11/93 Approval: 12/21/89 Closing: 12/31/97 12/31/99 Borrower/lmplementing Agency: GOVT/GOVT OF MOZ. Other Partners: STAFF Current At Appraisal Vice President: Callisto E. Madavo E.V.K. Jaycox Country Manager: Michael N. Sarris Stephen Denning Sector Manager: Demba Ba David Cook Team Leader at ICR: Marilyn S. Manalo Vincent M. Rague ICR Primary Author. Sati Achath 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S Sustainability. L Institutional Development Impact: SU Bank Performance: S Borrower Performance: S QAG (if available) ICR Quality at Entry: U Project at Risk at Any Time: Yes 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: The Industrial Enterprise Restructuring Project (IERP) was designed as an integral part of the Government's strategy to resuscitate production and growth in Mozambique and complement the country's Economic Rehabilitation Program (ERP). The project was to focus on the rehabilitation of selected key enterprises considered important for a supply response and growth in the industrial sector and to establish an institutional framework and approach to enterprise rehabilitation and  restructuring. The original objectives of the Project were to (a) introduce a framework and criteria for selecting enterprises for rehabilitation (based on each enterprise's potential economic, financial, and technical viability and on its management capacity to operate efficiently); (b) finance rehabilitation, restructuring and operational support to pre-selected and potentially efficient major enterprises (including, rationalization of capacity, privatization, technical partnership arrangements, or closure of operations); (c) require each beneficiary enterprise to institute measures to protect the environment and worker safety; (d) strengthen Government's capacity to implement the rehabilitation program; and (e) support policy reforms and sub-sector reviews designed to strengthen enterprise operations in a more liberalized, market-oriented environment. The project was conceived as a pilot project which would focus on a limited number of enterprises, and concurrently establish the institutional capacity to rehabilitate many more critical industrial enterprises without reference to enterprise ownership. The 15 enterprises initially selected for support from the project were considered to have characteristics which would maximize the effectiveness of the credit line. Since these enterprises were considered to be least affected by the serious structural problems endemic in the economy, they had the prospect of a rapid and significant economic impact. The objectives of the project were realistic and clear. They were also consistent with the Bank's country assistance strategy and the Government's ERP. However, the project was demanding for the implementing agencies since the Borrower had little capacity to appraise applications for long term credit and both the enterprises and the Borrower had little experience in implementing rehabilitation plans. The expertise required was to be developed during the project through the Technical Assistance Component (TAC). 3.2 Revised Objective: After the first operational year of the project, the Government recognized that the rehabilitation process was slower than expected because of, among others (i) changes in the economy including the influx of undocumented imported goods; (ii) a complex and time consuming evaluation process of enterprises given the need to resolve legal questions on ownership of enterprises and financial and accounting inadequacies; and (iii) the tight fiscal position of the Government which did not make it feasible for it to inject much needed capital to restructure enterprises' debt profile and enhance their market value. At this time, only three enterprises (in cement, mining and agriculture) were to be supported under the project. The Government then decided to minimize its involvement in restructuring individual enterprises and focus on attracting private investment and restructure enterprises through privatization. In response to this change in Government policy, the Government's request to refocus the objectives of the TAC to privatization was supported by IDA in December 1992. In order to enable the Government to implement its privatization program effectively, the project shifted emphasis from "rehabilitating essential sectors first, and then privatizing eventually", to "privatizing first and restructuring later". The rehabilitation objectives became redundant. The Government's privatization program had three major objectives to (i) increase enterprises' efficiency and competitiveness; (ii) introduce modern management methods; and (iii) increase productivity and attract investment. - 2 -  The Enterprise Rehabilitation Component (ERC) was revised to become a general line of credit to support the Govermnent's objectives to assist privatized enterprises and to support the development of the broader private sector through the provision of longer-term funds. 3.3 Original Components: Consistent with the state of the art for restructuring and privatizing enterprises when the project was designed (1989), the project consisted of two main components (a) the ERC; and (b) the TAC. The ERC was designed as an apex facility (administered through the Bank of Mozambique (BM)) to finance the rehabilitation and restructuring of about 15 selected enterprises identified as having good rehabilitation prospects but facing financial difficulties because of past policy distortions and operating inefficiencies. The allocation for this component was to fund fixed investments, working capital requirements, and operational support services designed to upgrade the enterprises' technical, financial, marketing, and general management capacity. Restructuring of these enterprises was expected to be achieved through recapitalization, conversion of debt to equity or quasi-equity, injection of fresh equity through divestiture, joint venture, or technical partnership arrangements with foreign or local private investors. Originally, the TAC was to support capacity building through (a) assistance to the Enterprise Restructuring Technical Unit (UTRE) that would implement the rehabilitation program and provide operational and technical assistance to enterprises; (b) assistance to enterprises to develop satisfactory business or rehabilitation plans, liquidation, privatization, or joint venture arrangements; (c) training of laid-off staff to alleviate the social costs of personnel reductions in the course of enterprise restructuring or liquidation; and (d) five sub-sector studies in the areas including packaging, metal working, textiles, edible oils, and construction and building materials. Considering the industrial sector's constraints, such as antiquated plant and equipment, unclear ownership, deficient financial structure, and under-qualified management, the original components were reasonably expected to contribute to achieving the project's objectives. However, the difficulty of implementing the project were underestimated (see Section 3.5). 3.4 Revised Components: Consistent with the revision of the original objectives, following the project's mid-term review, the ERC was re-oriented to make additional long-term financing available to private and privatized enterprises for investrnent, term financing, working capital, and business planning requirements. Administration of the ERC was transferred out of UTRE and into the Department of Credit Operations (DOC) in the BM. The DOC served as the apex unit that would on-lend funds to participating commercial banks. The TAC component was reoriented to strengthen the Government's institutional capacity to sell state-controlled enterprises. Throughout project implementation, other revisions were made to the TAC to strengthen the Government's institutional capacity to privatize SOEs and to extend business support services and support private sector development. Beneficiary government agencies included the Investment Promotion Center, the Export Promotion Institute, and the National Statistics Institute. The - 3 -  project also coordinated and partially funded the Privatization Impact Study in 1996 and sponsored a series of successful annual private sector development conferences. 3.5 Quality at Entry: The quality of the project at entry was unsatisfactory. The project objectives and components were consistent with the (i) Government's broad policy initiatives to rehabilitate and restructure the economy by reducing or eliminating macroeconomic distortions; and (ii) Bank's assistance strategy to address structural constraints to economic growth. However, the original risk assessment did not adequately take into account either the commitment to restructuring of the enterprises affected, or the magnitude of the hurdles the enterprises faced in their external environments. In addition, the impact of the problems faced in resolving legal ownership of assets and preparing historical financial statements and business plans were not fully recognized. The quality at entry of the revised ERC was also unsatisfactory. Administration of the ERC was transferred at a time when a weak financial sector was in the midst of a reform program. The BM had just been transformed to become solely a central bank and its commercial banking functions were transferred to a commercial bank. State-owned commercial banks were being rehabilitated, restructured, and privatized. The large portfolio of non-performing assets in commercial banks reflected the absence of necessary credit management skills. Modifications to the design and implementation arrangements of the component were made largely on the basis of expectations that a large number of privatized enterprises would require long-term funds, then in short supply. In addition, capacity building issues were left to be managed under another on-going project, the Second Economic Recovery Credit (SERC). Although poor performance of the ERC had the potential of reversing gains made following sectoral reforms funded under the SERC, steps were not taken to include mechanisms to enforce financial discipline under the ERC. Deficiencies included the absence of (i) well-defined incentives and indicators to ensure the disbursement and supervisory function of the DOC were supported with equal emphasis and in coordination with the Supervision Department of the BM; (ii) criteria and procedures to address credit discipline and disallow weak financial institutions from accessing project resources; and (iii) adequate consideration of the inability of enterprises to service their debt due to their financial and operational weaknesses. The quality at entry for the TAC was also unsatisfactory when emphasis shifted to addressing the structural constraints to economic growth through the privatization of enterprises and enabling these enterprises to resume production, employment, and incomes in the productive sectors. For example, it did not sufficiently address asset valuation procedures, methods of sale, limited purchasing power of the sectors interested in purchasing state-owned assets, training for redundant employees, and appropriate guidelines and benchmarks necessary to determine achievement of objectives. 4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective: Focusing on the Government's developmental strategy in the industrial sector, support under the project contributed to the (i) recovery of production and growth in Mozambique; (ii) privatization -4 -  of enterprises considered important for a supply response and growth in the sector; and (iii) establishment of an institutional framework and approach to privatizing enterprises. The Project's outcome is satisfactory. Following the shift in policy from restructuring to privatizing enterprises, the Government decided that it would focus its efforts on commercially-oriented and non-strategic enterprises. Strategic enterprises providing basic public goods and services would be retained in the public sector. The objective of supporting the Borrower's capacity to privatize and liquidate these enterprises was achieved. A privatization framework was established through a series of laws and supporting decrees; the privatization process was accomplished with assistance from government bodies strengthened or established for this purpose. The objective of privatizing all non-strategic state owned enterprises was also achieved. The impact of the rapid privatization of SOEs was found to be highly positive in an impact study (based on a sample of about 80 privatized enterprises) conducted by the Government and IDA in 1996 (at this time, approximately 600 enterprises had been sold to the private sector). The study concluded that (i) the number of non-producing enterprises had decreased; (ii) sales in the sampled enterprises almost doubled by their third year following privatization (for large firms this was more dramatic with a reported tripling of sales); (iii) employment dropped significantly in the sampled enterprises in the years preceding privatization and increased modestly during the three-year period following privatization; (iv) real wages per employee increased by about 60 percent; (v) the collection rate of sales tax increased by about 38 percent overall and if the firms which had tax exemptions were excluded, by over 132 percent; and (vi) almost 92 percent by number, and 60 percent by value of the enterprises privatized, had been sold to Mozambican nationals. Following project closure, the very few enterprises which responded to the Government's request for current information on their results since privatization, indicated an average of about 390 percent increase in sales since privatization, a slight decrease in the number of workers employed (although the experience of the large enterprises and the smaller ones differed; employment by smaller enterprises increased, while the larger ones have a smaller work force than at the date of their privatization), capacity utilization has increased in all reporting enterprises, and taxes paid remained about flat. The 1996 impact study also documented a number of privatization and post-privatization problems, which, as of the project closing date, still existed. These included (i) the absence of a mechanism to resolve the situation where the purchase amounts received or promised were inadequate to retire the pre-privatization liabilities of the enterprises assumed by the Government; (ii) the distribution of the portions of equities which had been reserved for workers still remained uncompleted; and (iii) the Government's continued involvement in these enterprises was often perceived as a restraint to the enterprises' ability to raise additional equity. The objectives of strengthening the Borrower's institutional capacity to develop and implement rehabilitation plans became redundant when the focus of the project changed to privatizing SOEs. -5-  The capacity building initiatives directed at Government agencies including the Ministry of Industry, the Investment Promotion Center and National Statistics Institute was achieved and fostered stronger partnerships between the government and the private sector. This is illustrated by a joint public/private sector steering committee that will play a major role in guiding the future development of the private sector. This partnership is receiving support under a Bank-funded follow-up project, the Enterprise Development Project (see Section 6 below). The objective under the ERC to provide financial resources to enterprises so they could upgrade their technical, financial, marketing, and general management capacity, was partially achieved. In reviewing the repayment performance of the sub-borrowers, it is clear some participating financial institutions (PFIs) have experienced losses because sub-borrowers were remiss in servicing their debts. The poor repayment record suggests that the private sector borrowers continued to face difficulties. Despite this performance, monitoring repayment performance of sub-borrowers by BM was not regular although it debited the PFIs' account with BM once repayments were due from sub-borrowers. 4.2 Outputs by components: Enterprise Rehabilitation Component The revised ERC was made available to private and privatized enterprises to finance their investment, term financing, working capital, and business planning requirements. Resources were passed from BM through PFIs for on-lending to enterprises at an interest rate determined by the PFIs. Of the interest charged to the beneficiary enterprises, 50 percent of the nominal interest was retained by the BM to cover the foreign exchange risk and administrative costs (5 percent). The remaining 50 percent was retained by the PFIs to cover their commercial risk of lending, financial and operating costs, and expected returns. Sub-loans were denominated in Meticals and had a maturity of 3-12 years including a grace period of 1-4 years. Access to these funds was based on the enterprises' ability to meet the following eligibility criteria (a) enterprises engaged, inter alia, in agro-related industries, light manufacturing and heavy industry; and (b) enterprises with financial, economic, technical and environmental viability. Six PFIs utilized the project resources to finance 39 sub-projects totaling approximately US$36 million. The distribution of these sub-projects included (i) sectorally: 41 percent in transport, 36 percent in industry and 23 percent in other sectors; and (ii) geographically: 85 percent in Maputo, 5 percent in Nampula, and 3 percent each in Cabo Delgado, Tete, Niassa, and Zambezia areas. Ten sub-borrowers (26 percent), representing two of the original 15 enterprises identified at appraisal and the newly-privatized enterprises under IERP, borrowed about 78 percent of the total disbursed amount for this component. While loan commitment and disbursement proceeded reasonably well, the major issue for this component was the high default rates. Of the over $3 million due at end-October 1999, about 40 percent was yet to be recovered from about 21 defaulters (65 percent of borrowers whose grace periods have expired and who should have been servicing their loans). PFIs confirmed that they have experienced losses due to defaults by some sub-borrowers. PFIs were stepping up their collection efforts and provisioning against the arrears. - 6 -  Technical Assistance Component (a) Privatization Program. An Inter-ministerial Commission for Enterprise Restructuring guided the privatization process. This Commission was supported by UTRE for the privatization of large enterprises. In addition, the Bureau for Restructuring Enterprises in the Ministry of Agriculture and Fisheries (GREAP) and the Bureau for Restructuring Enterprises in the Ministry of Industry, Trade, and Tourism (GREICT) supported the privatization of medium and small-size enterprises identified by the National Evaluation and Sales Commissions and the Provincial Evaluation and Sales Commissions for the Ministry of Industry Commerce and Tourism, and the Ministry of Agriculture and Fisheries, respectively. By project closure, 1,272 enterprises (representing approximately 97 percent of all non-strategic enterprises to be privatized) were privatized under this program (MICTUR: 701 enterprises; Ministry of Agriculture and Fisheries: 278 enterprises; Ministry of Public Works: 181 enterprises; Ministry of Communications and Transport: 87 enterprises; and other ministries: 25 enterprises). UTRE and GREAP continue to deal with post-privatization issues including the claims of workers, pensioners, and creditors of the enterprises that the Government agreed to assume. At project closing, GREICT was completing the sale of approximately 12 enterprises and was also actively working on the technical aspects of the sale of the equity reserved for the employees of about 58 enterprises. GREAP was finalizing the sale of approximately 30 small enterprises. (b) Investment Promotion Center (CPI). Support under the project enabled CPI to implement its Three Year Strategic Plan. This focused on (i) re-engineering its organizational structure and internal operational procedures; and (ii) executing a proactive promotional program in areas where the country has a demonstrated comparative advantage. CPI: (a) rationalized its organizational and salary structure; (b) revised the investment registration process; (c) developed its management information systems including an investor tracking system and promotional presentations on the Internet on privatization opportunities in Mozambique; (d) implemented a pilot linkage program which stimulated increased foreign and domestic investments, employment generation, technology acquisition and transfer, and the diversification of economic production and export opportunities (CPI succeeded in maximizing business opportunities for Mozambican firms through the Mozal aluminum smelter plant, the country's first mega project, and facilitated the signing of 45 contracts or sub-contracts with local suppliers reportedly totaling about US$96 million); (e) facilitated the approval of new, less cumbersome free zone regulations by the Council of Ministers (resulting, at project closing, in the development of an industrial site in the Beluluane District and commencement of preparation work for one in the Boane District); and (f) revamped its Beira office and opened antenna offices in South Africa, Mauritius, and Brussels. (c) Ministry of Industry, Trade, and Tourism. The Private Sector Development Unit (PSD) in MICTUR was set up as a central coordinating unit to support private sector development policies. An action plan, prepared by MICTUR for an inter-ministerial working group, guided the removal of red tape and administrative barriers to investment. Achievements include the revision of legislation relating to price fixing, copy and property rights, tourism development, and land demarcation, among others. Dialogue and a consultative process between - 7 -  government and representatives of local business associations was established and is on-going. Annual private sector conferences were held since 1995 in the provincial and national levels (with business sector and donor support) wherein major investment and development constraints were identified and plans to remove them drawn. The Working Commission of Business Associations' Business Directory and a Practical Guide to Doing Business in Mozambique was published. MICTUR also carried out an assessment of the competitiveness and employment in the cashew processing industry in Mozambique. Recommendations of the study to both the Government and the private sector are under consideration. Support was also extended to the Cashew Working Group Secretariat (CWS) for market research and information services to the cashew industry and its stakeholders. Implementation of a pilot Cashew Processing Support Program did not proceed when its impact and sustainability were jeopardized after the cost-sharing aspect of the scheme was abandoned and the loan and lease guarantees expected from commercial banks were not realistically achievable. (d) Export Promotion Institute (IPEX). Capacity building support led IPEX to implement its reorganization plan, develop its corporate plan, upgrade management and staff skills, and participate in international trade fairs and seminars covering export procedures, product development and finance. IPEX also developed a Trade Market and Information Center, which provides exporters information on current trade, export and commodities information, and permits them to draw upon real-time data and relevant economic and trade news globally. (e) National Statistics Institute (INE). With the technical training and logistical support it received under the Project, INE continues to strengthen its institution (based on an INE-prepared five-year work plan, human resource plan and an information technology plan) and build its reputation as a reliable provider of statistical data. It produces the National Accounts; reports on the consumer price index for Maputo, Beira and Nampula; publishes the General Population and Housing Census; and is spearheading the preparation for an agricultural census. (f) Other Technical Assistance. Sub-sectoral studies (edible oils, textiles and garments, transportation, sugar, electrical energy) were conducted and they provided the necessary background infornation for legislators and sectoral ministries to define policies and modify legislation. 4.3 Net Present Value/Economic rate of return: N/A 4.4 Financial rate of return: N/A 4.5 Institutional development inmpact: The project made a positive institutional development impact on agencies involved with the project. Notable among these institutions are (i) UTRE, GREAP and GREICT, which successfully privatized enterprises; (ii) MICTUR, which fosters constructive dialogue between the -8 -  public and private sectors; (iii) CPI as a major player in contributing to maximize business opportunities for Mozambican firms; and (iv) INE, as a source of important statistical information and key economic indicators. 5. Major Factors Affecting Implementation and Outcome 5.1 Factors outside the control of government or inplementing agency. The damage and destruction caused by the country's civil war adversely affected the possibility of successfully rehabilitating enterprises originally selected during appraisal. Legal and accounting problems, as well as a lack of participation by enterprise management adversely affected the project as initially designed. Following the decision to refocus on privatizing SOEs instead of rehabilitating enterprises, it was clear that the limited availability of financial resources on the part of the nationals negatively affected their ability to both acquire and revitalize state-owned assets. In addition, the influx of imported goods for two years during 1989-90 prevented enterprises from finding lucrative markets and, as a result, forced many to re-evaluate their product lines in view of the changing market. The over-leveraged positions of clients with good projects prevented them from meeting the lending criteria of PFIs including equity contributions and collateral requirements. Weaker enterprises that defaulted on their loans were unable to implement their projects as planned and faced problems of insufficient working capital. Banks also found it difficult to assist enterprises whose management skills were limited and technical skills outdated. They continued to take a cautious approach to term financing for small and medium enterprises. 5.2 Factors generally subject to government control. The maintenance of favorable macroeconomic policies and the Government's demonstrated consistent level of commitment to the privatization of SOEs (reflected in the series of laws and decrees passed by Government, the approval and oversight structure to support the privatization framework, and the appointment of highly dedicated and competent people in key positions in the privatization units) permitted, with some exceptions, the relatively expeditious handling of the sale of enterprises. 5.3 Factors generally subject to implementing agency control: The impact of the ERC would have greatly improved if the DOC focused more on the performance of the project portfolio and took steps to exclude PFIs whose credit management capacity was weak. These steps were important despite the fact that PFIs bore the credit risk and their accounts with the BM were automatically debited after repayment due dates, Under the TAC, as discussed above, the flexibility displayed by the different implementing agencies (for example, CPI, MICTUR, MOF) increased their contribution to private sector development, fostered the development of the important dialogue between the public and private sectors, and resolved implementation problems including the need to establish a number of special accounts to improve the response time for disbursements. For the agencies implementing the privatization program, their responsiveness was best displayed in the conditions they created to increase the ability of nationals to acquire and re-vitalize former state owned assets. The impact of the privatization program, however, would have increased if privatization issues had been -9-  addressed earlier. These include: greater transparency in the evaluation process and valuation methods, responsibilities toward redundant labor and pensioners, sale of equity to the workers, the level of default by new owners who purchased on the basis of deferred payments, and the possible mismatch between the proceeds of privatization and the associated liabilities assumed by the Government. 5.4 Costs andfinancing: There were variations in the appraisal estimate and actual utilization of IDA's funds for the project components. These resulted from about a 20 percent decrease in utilization under the ERC and an increase of about 95 percent under the TAC. The increase in the TAC was made to accommodate requests submitted by the Government to provide private sector development assistance through MICTUR, CPI, INE and IPEX (see Sections 3-4 above). (Note: contributions made by beneficiaries were not provided to the Bank and therefore are not reflected in Annex 2). 6. Sustainability 6.1 Rationale for sustainability rating: The Government's privatization program has been completed and its sustainability is highly likely. How effective the remaining process will be depends on the ability of the Government to continue to provide a favorable business environment, strengthen and broaden the financial system, and foster the rapid development of indigenous managerial, financial and technical skills. Additional support in these areas will be extended by the Bank under the Enterprise Development Project (EDP, project effectiveness is expected by September 1, 2000). The EDP was designed to (i) help broaden the base of private participation in Mozambican economic growth by boosting its competitiveness; (ii) providing a more efficient market for training and capacity building services; and (iii) establishing forward and backward linkages to existing and new local and foreign buyers and investors; and enhancing access to term finance by both first-time and other borrowers. Finns assisted under this project will be monitored on production, investments, sales, increased exports, additional jobs, technical training, linkages with foreign owned firms, among others. The sustainability of the privatization program will also be affected by the manner in which the Government deals with post-privatization issues including: defaults in installment payments for the purchased assets (as of end-October 1999, approximately 27 percent of payments for large enterprises were received by the Government); the transfer of 20 percent of the equity position reserved for employees but still held in trust by the Government; and the payment of claims of creditors, workers and pensioners assumed by the Government. The project provided essential financial resources to the private sector at a critical time in Mozambique's development. It also contributed to the evolution and maintenance of financial sector reforms through an increase in the level of intermediation and a market-based credit allocation system. The sustainability of the achievements in providing financial assistance to the private sector under the credit line will depend on PFIs vigilantly implementing their credit management systems and the BM closely supervising PFIs. This would prevent a high level of default on sub-loans, which could adversely affect the financial system. - 1 0 -  Sustainability of the development of rehabilitation plans ceased to be relevant when the project focus shifted to privatization of SOEs. 6.2 Transition arrangement to regular operations: In discussing a future operational plan for ERC, it was agreed that DOC and the Banking Supervision Department at BM would proceed to work closely with PFIs to improve the repayment performance of sub-borrowers. Also, under the IDA-funded EDP, PFIs' access to credit resources would be based on PFIs meeting eligibility criteria which includes, initially, having total non-performing loans of less than 20 percent of portfolio and, thereafter, collections on sub-loans not dropping below 85 percent of amounts coming due. For the TAC, transitional plans include (i) the transfer and preservation of the institutional skills, responsibilities and documentation which exist in the UTRE, GREICT, and GREAP; (ii) the sale of equity to employees; (iii) the establishment of a working group to accunulate analyses of sectoral and regional privatization patterns which, when combined with other inputs, would assist in the development of economic policy to be implemented by sectoral ministries. This working group would comprise representatives from the sectoral ministries and sectoral privatization units, and representatives from the Department of State Assets. This working group will be charged with settling all post-privatization issues including collections on the sale of assets, the transfer of 20 percent of the equity position reserved for employees but still held in trust by the Government; and the claims of creditors, workers and pensioners, among others. 7. Bank and Borrower Performance Bank 7. 1 Lending: During project identification, the Bank was satisfied that the project objectives were consistent with the Bank's assistance strategy for Mozambique and the country's development needs at that time. The Bank was also satisfied that the Government's development strategy responded to these needs. During project preparation, the Bank assessed the adequacy of project design and other relevant aspects. The Bank assisted the Borrower by providing comments and guidance on prefeasibility studies for selecting beneficiary enterprises (BEs) for rehabilitation. While selecting 15 BEs, the Bank endeavored to ensure that these enterprises had the managerial capability, and economic and financial viability and that their operations were not seriously affected by the security situation in the country. While appraising the project, the Bank was satisfied with the Government's policy initiatives and determination to overcome the constraints in the enterprise sector and its commitment to the project objectives. The Bank also assessed the project's major risks including the economy's fragility, potential political and social opposition, the Government's and enterprises' limited experience in implementing rehabilitation plans, and the security situation. In retrospect, the risk assessment did not adequately consider the competence and commitment to restructuring of the BEs nor the difficult financial and operational hurdles the enterprises had to overcome after the - 11 -  civil war. 7.2 Supervision: The supervision of the project by the Bank was satisfactory. Over the eight years of project implementation, more than 20 supervision missions were conducted, with an average of 2.5 missions per year at an average stay of three weeks per mission. Aide-memoire were regularly prepared and transmitted. These alerted the Government to problems with project execution and suggested remedies in conformity with Bank procedures. Bank staff worked closely with various units of the Government and the working relationship was cordial and productive. The project team responded to the Borrower's requests promptly and expeditiously. Complementary support from the Resident Mission staff also increased the effectiveness of the Bank's support to the country under this project. The Bank showed flexibility and adaptability by modifying the project three times in order to meet the changing private sector development requirements of the country. The project was amended first in December 1992 to support the Government's privatization and parastatal reform program by increasing the capacity of UTRE in its growing role of coordinating and managing the privatization prograrn for the large SOEs. The project was modified for a second time in June 1994 to enable BM to onlend funds to participating private commercial banks, which would then undertake their own appraisal of the BEs. The third amendment was signed in October 1997 to support MICTUR through the creation of GREICT, which became responsible for privatizing small and medium enterprises. As indicated earlier, the impact and sustainability of the project would have improved if the Bank had displayed more flexibility and incorporated guidelines and benchmarks that would have guided the assessment of the project achievements. Also, increased attention during supervision to the overall repayment performance of sub-borrowers would have minimized the deterioration of banks' portfolio quality. 7.3 Overall Bank performance: The Bank's overall performance was satisfactory. Borrower 7.4 Preparation: The Government's high level of commitment to the objectives of the project was demonstrated early on in project preparation. Key officials and staff played an active role and collaborated with the Bank's project team. 7.5 Government implementation performance: The Government's performance during project implementation was satisfactory. The impact of the project was improved when the leadership in Govemment took major steps (albeit belatedly sometimes) to correct the slow progress in implementation. These included refocusing the objectives of the project to privatization, expanding the line of credit to provide access to a wider set of beneficiaries, piloting new ways to foster the establishment of foreign and local - 12 -  partnerships, and establishing a forum for annual private and public sector dialogue in key regions in the country. 7.6 Implementing Agency: The collaboration between the DOC and the Bank in the preparation and implementation of the Project was satisfactory. DOC's relationship with PFIs seemed to be good although it h)ad difficulty in obtaining the required progress reports from PFIs. The sometimes unfavorable market conditions, unsatisfactory credit management practices of PFIs, the choices made bv sub-borrowers to default on loans all contributed to the difficult challenges to bring the repayment performance ratios up to acceptable levels. The sustainability of the ERI will remain threatened if DOC continues to hesitate to conduct a more rigorous monitoring of sub-borrower and PFI performance because they feel it oversteps their boundaries as PFIs are taking the credit risk. The performance of UTRE, GREICT, and GREAP was satisfactory. Qualified and dedicated officers maintained a high level of commitment to the privatization objectives. Officers at CPI and MICTUR implemented their programs enthusiastically and proactively and other agencies utilized the capacity building resources effectively. However, throughout the implementation period, the implementing agencies had procurement and disbursements problems, often unnecessarily delaying important initiatives. Also, audit reports were submitted although sometimes late, without management letters, and with qualified opinions because of inadequate record keeping and weak internal controls over procurement of goods and services. 7. 7 Overall Borrower performance: The Borrower's overall performance was satisfactory. 8. Lessons Learned * The success of financial intermediary loans is dependent upon a disciplined credit environment. Measures should be included in the project design to address issues relating to governance, management, financial policies and credit risk management. Appropriate guidelines and benchmarks should be included so that PFIs are strengthened rather than undermined by their participation in similar projects. * Where a project has a major shift in emphasis, it is essential to do a risk assessment based on the new objectives, and to set up appropriate guidelines and benchmarks to help determine progress toward achieving those objectives. * Development of a more comprehensive structure for privatization, including clearer procedures on asset valuation and methods of sale, may have avoided delays and bottlenecks which were built up during project implementation. In addition, a clear strategy for involving local purchasers with limited purchasing power in the privatization of state-owned assets and the potential cost to the government of various alternatives should be addressed and -13 -  thoroughly assessed at the early stages of project design. * To maximize the effectiveness of privatization, a program supporting the development of the real sector is necessary. The pilot program sponsored by CPI (to identify potential partners and establish smart partnerships between local and foreign finns and to provide them with opportunities to develop effective management practices and to access up-to-date technical know-how and financing) successfully illustrates this lesson. 9. Partner Comments (a) Borrower/implementing agency: 9.1 Assessment of the project objective, design, implementation and operation experience The project had a tremendous impact in the economy, both as regards to its financing component for the beneficiary enterprises (BEs) and its restructuring of state-owned companies component and through creation of better conditions for development of the private sector. (a) Rehabilitation of industrial enterprises. Initially the project targeted mainly the rehabilitation of industrial enterprises. Even taking into account the limited amounts available for this purpose and considering the needs of the economy and lending ceilings imposed on the commercial banks, the project played a very significant role in the rehabilitation of a large number of industrial enterprises. (b) Privatization Program. About 1,272 enterprises were privatized under this program, dramatically changing the face of important production sectors, such as beverages, food, cement, building, tourism and others. This was noted in an impact study (based on a sample of about 80 enterprises conducted by the Government and IDA in 1996) and confirmed by other studies conducted with the cooperation of the Commonwealth Development Corporation (CDC). The impact of the privatization program was only reduced by the structural problems of the Mozambican economy, which at times discouraged private participation, particularly the lack of infrastructure (roads, communications) and qualified personnel. In terms of revenues for the State, the enterprise privatization program included in UTRE's program, raised more than US$82 million of cash and deferred installments already received by the Ministry of Planning and Finance. Even though part of these funds were used to pay liabilities of former state-owned enterprises, the general balance of this operation remains highly positive to the State. Taking into consideration the structural constraints of the economy and the financial weaknesses of Mozambican investors, the possibility given by law to buy state-owned enterprises partly by deferred payments, allowed a relatively fast divestiture by the State that could not otherwise have been possible. - 14 -  (c) Development of the private sector. The project with its support to the Investment Promotion Center (CPI), Ministry of Industry, Trade and Tourism (MICTUR), Export Promotion Institute (IPEX) and the National Statistics Institute (INE) played an important role in the development of institutional capacity aimed at creating conditions conducive to the development of the private sector. 9.2 Evaluation of the borrower's own performance during the development and implementation of the project In general it is considered that the institutional arrangements established efficiently served the different purposes of the project. Regarding the rehabilitation of industrial enterprises, the changes made in the co-ordination of the program that was assumed by BM, made the project much more efficient considering the direct connection between BM and the PFIs. In terms of the Privatization Program, even if its pace is sometimes considered slow, it must be noted that it was conducted in a difficult and incomplete market environment that made private investors slow in responding to the offers. Maybe the process could have moved faster if more staff and TA had been hired at the start of the privatization program, but the reaction of the private sector would probably not have been sufficiently strong to absorb all the enterprises to be privatized. Accordingly, and in general, it is considered that the legal framework and institutional arrangements made by the Government responded relatively well to the needs of the privatization process. Moreover, the Government's firm commitment to the privatization program and its availability for swift decisions in all relevant matters was also a major factor of success. However, even if the legal framework is considered satisfactory, the transfer of shares to workers clearly remains a question. Institutional arrangements were not efficient enough to resolve this outstanding matter. A specific program to settle this is needed to complete transfer of shares in the short term. 9.3 Evaluation of the Bank's performance during the development and implementation of the project The Bank's cooperation, its flexibility, and that of its task managers, in considering adaptations to the initial purposes of the project are considered to have been a decisive factor in its success. However, regarding the rehabilitation of industrial enterprises, the general conditions for the line of credit were seen as not very attractive in terms of interest rate considering the structural - 15-  deficiencies of the Mozambican economy. The market environment in Mozambique is not yet entirely competitive and without concessional credit, investors are not attracted to the country. Moreover, the investment needs are huge in light of the very low level of the National Product, and even with private investment as the motor, lines of credit are essential to stimulate increased investment. The general terms of sale for state-owned enterprises were determined in cooperation with the Bank, which always insisted on considering payments in the first place. As a large majority of proposed payments by investors were in installments after a first cash payment, the evaluation of financial bids became subjective and based on promises as development plans. A compromise was reached assigning a weight of 50 percent for financial and technical bids that satisfied both the Borrower and the Bank. The relationship with the Bank was at times difficult as regards to disbursements. Even though there were unquestionably procurement problems on the Borrower's side, the Bank frequently delayed payments, causing problems for the normal flow of the project and the rehabilitation of the enterprises. The main reason for that situation being, as had been noted, was the lack of coordination between the task team leader, following issuance of "no-objection", and the disbursements department. However, that situation improved toward the end of the project, and the Borrower feels that this lack of coordination was progressively overcome. 9.4 Proposed arrangements for future operations * In terms of Bank procedures, a better organization and simplification was advised, in order to avoid unnecessary delays in implementation and operation. * To be successful, credit lines to be set up for the private sector must be taken into account, besides bank conditions, the specific conditions of the local economic environment, as well as structural deficiencies. Otherwise, they will not be sufficiently attractive, which may delay implementation and be contrary to the interests of the end beneficiaries. * In a country like Mozambique, with the specific infrastructure and market conditions already mentioned, a privatization program must consider the financial capacity of potential investors as well as the ability to pay any deferred installments. Therefore, the Beneficiary agrees with the need to analyze this question with the interested parties, prioritizing payment of the total sales amounts at the time of sale even if these are less than the amounts considered for sales purposes. This frees the State from the need to implement complicated and inefficient systems - 16-  for controlling deferred payments. (b) Cofinanciers: N/A (c) Other partners (NGOs/private sector): N/A 10. Additional Information - 17 -  Annex 1. Key Performance Indicators/Log Frame Matrix Outcome / Impact Indicators: 0 indlca07070000torlMa0020tr 0Pro ed7 in last PSR' AcItuaiLatest Estimate Performance Indicators were not mentioned in the SAR Output Indicators: Indlc torlM 0.t ti; ;00$000 Projected ito PSR Actua fte Estimate Performance Indicators were not mentioned in the SAR End of project - 18-  Annex 2. Project Costs and Financing Project Cost by Component (in US$ million equivalent) AppraIl ActuaLatest Percentage of . smate Esatati - Project Cost By Component US$ million US$ million Enterprise Rehabilitation Component (ERC) 95.90 30.61 31.9 Technical Assistance Component (TAC) 9.15 17.96 166.3 Vehicles and Equipment 0.25 3.98 1592.3 Refunding PPF 1.50 0.86 57.3 Total Baseline Cost 106.80 53.41 Total Project Costs 106.80 . 53.41 Total Financing Required 106.80 . 53.41 Project Costs by Procurement Arrangements (Appraisal Estimate) (US$ million equivalent) Procurement IlAeOwd' Ependiture Categoy ICs NCS Mdhod N.B.F. Tota Cost 1. Works 29.38 3.67 1.84 1.84 36.73 (29.38) (3.67) (1.84) (1.84) (36.73) 2. Goods 5.02 2.05 0.00 0.00 7.07 (5.02) (2.05) (0.00) (0.00) (7.07) 3. Services 12.55 5.11 0.00 0.00 17.66 _______ _ __ _ (12.55) (5.11) (0.00) (0.00) (17.66) 4. Miscellaneous 44.75 0.00 0.00 0.00 44.75 (44.75) (0.00) (0.00) (0.00) (44.75) 5. Miscellaneous 0.00 0.00 0.00 0.00 0.00 ______________________ ..(0.00) (0.00) (0.00) (0.00) (0.00) 6. Miscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) Total 91.70 10.83 1.84 1.84 106.21 (91.70) (10.83) (1.84) (1.84) (106.21) - 19 -  Project Costs by Procurement Arrangements (Actual/Latest Estimate) (US$ million equivalent) nxpenditur Category 1 ICProcurement Method Expenditure cat-egory [I NCB her N.B.F. Total Cost 1. Works 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 2. Goods 33.50 0.00 0.00 33.50 (33.50) (0.00) 0 (0.00) (33.50) 3. Services 12.18 0.00 0.00 0.00 12.18 (12.18) (0.00) (0.00) (0.00) (12.18) 4. Miscellaneous 1.26 6.47 0.00 7.73 (1.26) (6.47) O (0.00) (7.73) 5. Miscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 6. Miscellaneous 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) Total 46.94 6.47 0.00 0.00 53.41 _ (46.94) (6.47) (0.00) (0.00) (53.41) Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies. ' Includes civil works and goods to be procured through national shopping, consulting services, services of contracted staff of the project management office, training, technical assistance services, and incremental operating costs related to (i) managing the project, and (ii) re-lending project funds to local government units. Project Financing by Component (in US$ million equivalent) } X ~~~~~~~~~~~~~~~Percentage of Appraisal Appraisal Estimate Actual/Latest Estimate l Bank Govt. CoF. Bank Govt. CoF. Bank Govt. CoF. Enterprise Rehabilitation 30.61 0.0 0.0 0.0 Component (ERC) Technical Assistance 16.50 1 .45 0.0 0.0 0.0 Component (TAC) Vehicles and Equipment | 2.44 0.73 0.0 0.0 0.0 Refunding PPF _ l 0.85 _ l 0.0 0.0 0.0 -20 -  Annex 3: Economic Costs and Benefits Not applicable - 21 -  Annex 4. Bank Inputs (a) Missions: Stage of Project Cycle No. of Persons and Specialty Performance Rating (e.g. 2 Economists, I FMS, etc.) Implementation Development Month/Year Count Specialty Progress Objective Identification/Preparation July-Aug./1988 I Operations November/88 3 Operations Officer, Economist, Financial Analyst Appraisal/Negotiation March/89 5 Operations Officer, Economist, Financial Analyst, Training Specialist, Legal Officer Supervision July/89 2 Operations Officer, S S Economist March/90 2 Operations Officer, Project S S Mgmt. July/91 I Operations Officer S S October/911 2 Operat. Officer, Economist S S March/92 I Operations Officer S S August-September./92 4 Operations Officer, Economist, 2 S S Private Sector Specialists May/93 3 Operations Officer, Economist, S S Private Sector Specialist July/93 I Private Sector Specialist S U October/93 4 Director, Div. Chief, Res. Rep, U U Economist November/93 3 Economist, Private Sector U U Specialist, Legal Officer February-March/94 4 Operations Officer, Economist, U U Private Sector Specialist, Financial Analyst June-July/94 2 Economist, Private Sector U U Specialist February-March/95 2 Financial Economist, Private S S Sector Specialist July/95 3 Financial Economist, Private S S Sector Specialist, Microenterprise Specialist October-November/95 4 Financial Economist, Private S S Sector Specialist, Microenterprise Specialist, Privatization Expert March/96 3 Financial Economist, Private S S Sector Specialist, Privatization Expert - 22 -  July-Aug/96 2 2 Private Sector Dev. Specialists S HS May/97 I Private Sector Dev. Specialist S HS March/98 I Private Sector Dev. Specialist S HS June/98 I Private Sector Dev. Specialist S HS November-December./98 2 Operations Officer, Private S S Sector Dev. Specialist May/99 1 Operations Officer S S Nov.-Dec./99 2 Operations Officer, Private S S Sector Dev. Specialist 1CR Nov.-Dec/99 2 Operations Officer, Private S S Sector Dev. Specialist (h) Staff: Stage of Project Cycle Actual/Latest Estimate No. Staff weeks US$ (,000) Identification/Preparation 49.1 93.6 Appraisal/Negotiation 29.7 58.5 Supervision 191.7 401.9 ICR 2.5 9.0 Total 273.0 563.0 - 23 -  Annex 5. Ratings for Achievement of Objectives/Outputs of Components (H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable) Rating AMacro policies O H OSUOM O N * NA Sector Policies O H *SUOM O N O A N Physical O H O SU O M * N O AA ,7 Financial C H C SU * M O N O AA X Institutional Development 0 H * SU O M 0 N 0 /\JA 2 Environmental 0 H O SU 0 M C N 0 NA Social Poverty Reduction O H OSUOM O N * NA Gender O H O SU O M O N * NA Other (Please specify) O H OSUOM O N * NA @ Private sector development 0 H 0 SU 0 M 0 N 0 NA Z Public sector management 0 H 0 SU 0 M 0 N 0 NA X Other (Please specify) O H OSUOM C N * NA - 24 -  Annex 6. Ratings of Bank and Borrower Performance (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory) 6.1 Bank performance Rating O Lending O HS OS *U OHU O Supervision C HS * S OU OHU O Overall OHS OS O U O HU 6.2 Borrower performance Rating Preparation O HS * S C U O HU O Government implementation performance 0 HS 0 S 0 U 0 HU O Implementation agency performance O HS * S O U O HU l Overall OHS OS OU O HU - 25 -  Annex 7. List of Supporting Documents 1. Aide-Memoire and Back-to-Office Reports 2. Consultant Reports 3. Consultant Studies included in the Project 4. Borrower's Evaluation Report 5. Staff Appraisal Report - 26 -