Ghana - Third Economic Reform Support Operation Credit Project

Report No. PID10532 Project Name Ghana-Third Economic Reform Support... Operation Credit Region Africa Sector Macroeconomics Project ID GHPE50619 Borrower Republic of Ghana Implementing Agency Ministry of Finance Date this PID prepared July 12, 2001 Projected Appraisal Date May, 2001 Board Date July 26, 2001 COUNTRY BACKGROUND: 1. Ghana's poverty trends were favorable in the 1990s, with the percentage of the population defined as poor falling from 52 percent in 1991-92 to just under 40 percent in 1998-99. Such an improvement was made possible by sustained economic growth accompanied by a broad improvement in social indicators. Economic growth averaged 4.5 percent per year compared with a sub-Saharan African annual average of 2.9 percent during the 1983-2000 period. Growth has been broad-based with services, mining, and construction taking the lead. In agriculture, which remains Ghana's dominant economic sector (40 percent of GDP), export activities such as cocoa and forestry expanded rapidly in the 1990s. Life expectancy increased from 55 to 58 years; primary school enrollment rate rose from 72 percent to 79 percent; and the infant mortality rate fell from 85 to 57 per 1,000 live births. 2. Ghana made initial progress in implementing structural reforms, starting with the Economic Recovery Program (ERP) which was launched in 1983. By the early 1990s, the trade regime had been largely liberalized, the exchange rate was market-determined, macroeconomic imbalance had been narrowed, the majority of price and distribution controls had been lifted and domestic inflation had fallen to 10 percent. 3. In the 1990s, structural reform was uneven. During this period, several policy reversals took place and progress on macroeconomic stabilization and structural reforms were interrupted by episodes of weak budgetary management associated with the electoral cycle. By mid-1999, Ghana had made significant progress in restoring macroeconomic stability -inflation had fallen to below 10 percent and real interest rates were declining from high levels. However, during the latter half of the year the economy was hit by a major terms of trade shock that intensified in 2000. As cocoa prices plunged to 27-year lows and oil prices tripled in 1999-2000, Ghana's suffered a terms of trade loss amounting to 4.5 percent of GDP in 1999 and 6.9 percent of GDP in 2000. The terms of trade shock led to a sharp exchange rate depreciation in the latter part of 1999, and inflation rose quickly from 14 percent in 1999 to 40.5 percent in 2000. 4. The Government responded in early 2000 by tightening budgetary policy, but substantial expenditure overruns during the second half of the year and delays in privatizing state enterprises led to increased government borrowing. The overall result was a vicious circle of rising domestic debt and high interest costs leading to larger fiscal deficits. In total, budgetary interest payments are projected to reach in 2001 a level nearly equal to the  overall fiscal deficit (9.6 percent). 5. Financial imbalances were further aggravated by Government's decision to delay the adjustment of petroleum products and electricity rates in response to the exchange rate depreciation and the increase in world prices. Taken together the operating losses of the four major public enterprises (Electricity of Ghana, Volta River Authority, Ghana Water Corporation and Tema Oil Refinery TOR amounted to 7 percent of GDP in 2000. These translated in an accumulation of large debts, especially from the Tema Oil Refinery, to the banking sector. Externally, the domestic financial imbalances and the terms of trade losses were reflected in balance of payments difficulties. Capital inflows were insufficient to cover the current account deficit, and external reserves fell to 0.8 months of imports by end-2000. OBJECTIVES: 6. When the new Government took office in early 2001, it brought with it a new vision of Ghana. The economic philosophy of the new Government as set out in the President's "State of the Nation" address to Parliament, emphasizes the Party's commitment to democracy and the rule of law, "zero tolerance for corruption" along with transparent and well-managed public expenditures. The Government also pledged to "tackle the huge budget deficit with the aim of balancing the budget by the end of its first term in office" and to create a "golden age of business" noting that "the partnership of the private sector with the public sector is at the heart of our national strategy" as well as the Party's goal that "Ghana become a leading agro-industrial country in Africa by the year 2010". A strong commitment to creating equal access to education, tackling infectious diseases, especially HIV/AIDS, was also underscored. Finally, the Party's long-held commitment to decentralization and to strengthening democratic institutions at the local level was reiterated. 7. The proposed credit is designed to support the substantial and revitalized economic reform program that was launched by the new Government. The main elements of the reform program include: (i) tightening fiscal policy and expenditure management, including through better governance; (ii) reducing the government domestic and foreign debt; (iii) eliminating losses in the operations of key parastatals; (iv) restructuring government functions; (v) promoting private sector development; and (vi) increasing human development and poverty reduction, including strengthening the battle against endemic and infectious diseases. 8. The proposed credit will also support the development of the Government's emerging agenda of reforms for accelerated growth and poverty reduction. The new Government has launched a participatory process of consultations with civil society to define a medium-term reform program aimed at accelerating growth and poverty reduction. This process underlies the on- going preparation of the Ghana Poverty Reduction Strategy. FINANCING 9. In spite of the considerable fiscal and quasi-fiscal adjustment being put forward, exceptional levels of external program assistance will be required to finance the 2001 program. Financing requirements (grants and medium- and long-term loans) would amount to US$1,160 million for 2001. Of this total, some US$316 million would be provided by program assistance from donors, including the proposed ERSO III. An additional US$241 million would be needed to fill the residual fiscal financing gap. It is expected that it would be covered by a non-concessional deferral of payments due in 2001 from Paris Club creditors and comparable action from other non-multilateral creditors. -2-  IMPLEMENTATION ARRANGEMENTS 10. The credit will be disbursed in one tranche upon effectiveness. Simplified disbursement procedures under adjustment credits will apply. Disbursements will not be tied to any specific purchases. Once the Credit is approved by the Board, the proceeds of the Credit will be deposited by IDA in an account at Bank of Ghana at the request of the Borrower. The administration of this Credit will be the responsibility of the Ministry of Finance. SUSTAINABILITY AND POVERTY 11. The proposed Credit would allow the Government to: (i) restore macroeconomic stability with less adverse impact on the poor than otherwise; and (ii) reinforce the basis for growth and poverty reduction. In the short- term, the proposed credit will help to phase over time the size of the domestic adjustment that would otherwise be required to restore macroeconomic stability, thereby minimizing the risk of a social backlash that may compromise the continued implementation of the reform program under formulation. Over the medium term, the targeted reduction in the stock of domestic and foreign debt (including the potential debt relief from HIPC) would result in a virtuous cycle of exchange rate stabilization, lower inflation and lower interest rates. This would help stimulate private sector growth and create the fiscal space needed for increasing expenditures for poverty-reducing activities. Continued improvement in the share of producer prices for cocoa farmers and the liberalization of export marketing will also reduce poverty as cocoa earnings remain an important source of income for about one million rural families. 12. By supporting the Government's efforts to arrest a further deterioration in the macroeconomic environment, this credit will contribute to give the new Government the room it needs to focus on the elaboration of its medium-term reform agenda and to effectively engage in a meaningful consultative process with stakeholders, including civil society and development partners. ENVIRONMENTAL ASPECTS: 13. The proposed Credit is not expected to have any adverse environmental impact. The environmental assessment category is C, which does not require an environmental assessment. 14. Contact Point Task Manager Rene Bonnel The World Bank 1818 H Street, NW Washington D.C. 20433 (202) 473 42 57 15. For information on other project related documents, contact: The InfoShop The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone No.: (202) 458-5454 Fax No.: (202) 522-1500 Web: http://www.Worldbank.org/infoshop -3-  Note: This is information on an evolving project. Certain components may not necessarily be included in the final operation. The terms of trade loss due to cocoa is estimated by multiplying the GDP share of cocoa exports by the decrease in the export price of cocoa and similarly for the terms of trade loss due to oil. - 4 -