Madagascar - Railway Project

DOCUMfENT OF INTERN TIONAL DEV I6LOP M A SO IA IO NVot For Public s CTION Repo, tN PNo 362 =IlA REPORT AND RECo 16-ND OP THE PRESIDEN_T To me EXECUTIVE D c DIRECToR's ON A PRoPOSED DEVELPJC VETCR5!)12 To 7q GSY REpUBLIC FOR A 3luA PROJEcT January 3, 1974  CURRENCY EQUIVALENTS / Unit = Malagasy Franc (FMG) US $1 = FMG 215 FMG 1 = Us $o.oo465 FMG 1 million = US $4,651 Fiscal Year = January 1 to December 31 As at the time of negotiations in November 1973.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE MALAGASY REPUBLIC FOR A RAILWAY PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Malagasy Republic for the equivalent of US$6.0 million on standard IDA terms to help finance a railway project. US$5.2 million of the proceeds of the credit would be relent to the Reseau National des Chemins de Fer Malagasy (RNCFM) for 20 years, including 3-1/2 years of grace, with interest at 7-1/4 percent per annum. PART I - THE ECONOMY 2. An economic report entitled "Recent Economic Position and Prospects of the Malagasy Republic" (Report No. AE-11a) was distributed to the Executive Directors on January 27, 1971 (R71-17). A basic economic mission visited Madagascar in November 1972. A basic economic report has been prepared and has been submitted to the Government of Madagascar for review; it will be distributed to the Executive Directors early in 1974. Country data are attached as Annex I. 3. The economy of Madagascar has developed at a rather slow pace since the independence of the country in 1960. There was virtual stagnation up to 1965-1966 and income per capita actually declined during this period. .,.n the second part of the 1960s, the growth in real GDP barely kept up with :-ae population increase of about 2.5 percent annually. In 1970 a substan- tial rise in agricultural output and increases in world market prices for some of Madagascar's main exports resulted in a 10 percent growth in GDP. This was followed, however, by less favorable developments in 1971. Since then, the uncertainties about future economic strategy and policies result- ing from the change in Government have adversely affected production and incomes. 4. The sluggishness of. agriculture accounts for Madagascar's limited growth performance. Agricultural output has risen at about the same rate as population whereas production of foodstuffs lagged behind growth in domestic demand. Agriculture supports directly about 80 percent of the population and contributes about one-third to GDP. The development potential was there: the diversity of climatic conditions and the relative abundance of fertile land should have allowed faster agricultural growth. The relative stagnation can be explained largely by two major constraints, namely the difficulties of both internal and external transport and the lack of appropriate Government policies.  5. Most of the country is well suited for diversified agriculture. The hot and humid coast produces coffee and bananas. in the northeast, there are timber and vanilla, while the west is suited for cotton production and cattle raising. Rice is the staple food; it is grown on more than half of the area under cultivation and accounts for about half of the country's crop production. About 15 percent of the island is considered as potentially arable land, of which less than one-third is presently under cultivation. 6. While the country is sparsely populated - 13 inhabitants per square kilometer - there is great pressure on cultivable land in specific regions. In these areas, people have standards of living close to subsistenc:e level; nutrition is deficient and child mortality can reach 44 per thousand. Another difficulty has been the lack of an adequate inland transportation network. Despite the heavy investments which took place in the last decade, only one- third of the highway network is all weather roads and only 3,000 kilometers are paved in a country where production centers may be as far as 1,200 kilometers from the capital. Finally, it seems that the Government has not taken the appropriate steps to ensure the farmers - through price incentives and marketing facilities - that additional efforts in increasing output would be rewarded. This may not have been particularly significant for some of the main commodities that are exported, such as coffee, cloves and vanilla which face inelastic international demand. With respect to rice and meat, however, this policy which was aimed at maintaining low retail prices for the urban consumer, affected adversely domestic production. Madagascar, which was a net exporter of these two commodities in the 1960's is now facing shortages. In recent years there have been net imports of rice and a substantial de- crease in exports of meat. As a first step to rectify this situation, pro- ducer price for paddy was recently increased by 40 percent which Government cornsiders adequate at this stage, but little has been done as yet with respect to meat prices. 7. Manufacturing has made a small contribution to overall econoiTic growth although it has expanded faster than national income. It still is a small sector occupying about 3,000 people or less than one percent of total labor force; it contributed about 12 percent to GDP in 1972. Industrial production is almost entirely devoted to consumer goods for domestic use. As it expanded, th? -imports ct aood consumer goods declined as a percen- tage of total merchandise imports frclm 42 percent in 1960 to 30 percent in 1971 However, the scope for furth;er import substitution is limited by the .a:. ;'.-s of the monetized domestic DiarrEA. In addition, this industrial g,7owth has required high protection agairst .rapilt.:itive imports and resulted ia a sharp increase in imports of raw materials and intermediate products utiized for local processinig. 8. During 1966-71, total capital formation averaged 15 percent of GDP, a ratio probably too low for a country which needs to build its inf.astruc- ture, promote its industry and develop its agriculture. During this period, domestic savings financed 95 percent of investment and increased from 12.4 percent of GDP in 1966 to 15.6 percent in 1971. The Government contributed about one-third to this increase. In fact, the private sector only saved about 14 percent of its disoosable income between 1966 and 1971 and invested less than it saved. According to the national accounts, private transfers  ab:'osRd aTmuncef cuiuThatirJy t about Fl'x? 32 billion (US$125 million) during t hisq : riJt 'G,otterinent p'il.i,.Les were not sufficiently geared to economic and social development. To a certain extent. they favored manufacturing and trade through protective policy; they favored urban consumers through price controls onl donestically produced "'mucdities; they favored high income groups through liberal fmnorts of g-oods that did not compete with local production. Invest- ments in agriculture and transportation were too low and the education system ,LS not adapted to the development needs for skilled and technical manpower. Pi: the same time, reliance on foreign techlnical assistance was heavy and xccottrre to external capital aid was limited. This relative conservatism c.an be ex-plained in part by the inertia of a tradition-bound society, the %O:r.ai fragme-ntation anJ the ethntc diversitv. It can also probably be capiaThaI bY oen institutior.al framewcrk inherited from the colonial period ;htcn wa:s unsuftable to a vigorous developmental effort. 10. Other impediluents to faster economic growth probably were insuffi- ci.ent investment in development projects, and inappropriate development pvllcies and programs. Madagascar's f!rst five-year development plan (1964- 68's vas based on specific production objectives, but the investment program was en;pressed In general terms only. In 1967, it became clear that progress of both investment and production was insufficient. By that time, public capital expenditure in the transportation sector had amounted to almost half of the target program, hut agriculture was lagging behind with only 34 per- cent. The Government decided to take remedial action and in 1968 introduced an iaterim program "Le Programme des Grandes Operations" which consisted in a number of investment projects, mainly in agriculture to be implemented over the subsequent two years. Since then, Madagascar has not had a formal deue:;nrpment program. A draft interim plan for 1972-1974 was prepared but r.,gz; never adopted. H; . New economic policies have recently been announced as a result of more tchan a year of intern-al deliberations and international negotiations. The Government has decided to tighten its control on a number of basic sectors - including manufacturing - to increase the role of nationals in the management and ownership of private enterprises and to apply austerity ne.asures with respect to fiscal and import policies. In the framework of new cooperation agreements with France, Madagascar left the Franc Zone in -lily 1973. This withdrawal has been accompanied by the introduction of exchange :ontrol regulations and the establishment of an autonomous central bank, In August 1973, the Government announced its decision to prepare specif ic actioni programs and a set of economic policies which are expected to be discussed with a Bank mission in early 1974. E2. The proposed economic organization thus entails a greater role for the pxublic sector as the most appropriate means to bring about changes in economic and social development, reduction in unemployment and income dis- parities. As a first step to establish closer relationship with the peasaut  - 4 - communities, the Government has abolished the head tax and the cattle tax, in addition to increasing the producer price for paddy mentioned in paragraph 6 above. In the longer run, it intends to associate villages with the manage- ment of development projects, the marketing and processing of agriLculture commodities and the distribution of agricultural inputs, including credit. To meet the goals set by the Government, substantial efforts have to be made by the country in terms of organization, investment, savings and mobilization of talents. 13. The Government intends to reduce its reliance on foreign technical assistance. In fact, Madagascar has a relatively large number of people with a high level of education and only a few positions in the Administration are occupied by non-Malagasy. In 1971, however, there were about 100,000 foreign- ers in Madagascar of whom 34,000 were French, mainly in industry and trade. Technical assistance provided by individuals or consulting firms was substan- tial. In order to avoid any disruption in the economy, detailed plans have to be prepared to train local management staff and technicians. 14. The balance of payments prospects of Madagascar are uncertain. The country's export trade is already diversified and, if appropriate policies are implemented, export earnings could increase by about 6 percent annually. Cof- fee, cloves, vanilla and sugar face inelastic demands on international markets; their future depends to a great extent on developments in these markets. They account, however, for only half of total Madagascar's merchandise exports. Investments and policies favoring production of meat, high quality rice, fish and medicinal herbs should permit Madagascar to regain its traditional export position. In addition, the association with the EEC should provide in the long run markets for an iTidustry more oriented cowards exports. There is al.so some potential for tourism. 15. Changes in the composition of imports are likely to take place. Import controls that were recently established will probably result in some reduction in imports of non-primary necessity. ALt the same time, if invest- ment is stepped up as is the fkovernment's intention, additional imports will be required. Imports of goods and non-factor services may go up by about 7.0 percen-- anrnually. This would be in line with the savings effort planned by tPc- 'ovcrnmcnt co achieve a S percent: growth rate in Gr&P. The savings rate woil-d increase from a current level of 15 p2rcent to about 22 percent by 1980, ,hus allowing for a 4 percent annual increese in domestic consump- tion. 16. Future gross capital requirements should be much higher than they were in the past. In the 1966-71 period, official capital inflows averaged $32 million annually, of which $20 million were foreign grants. While these grants roughly matched the outflow of private transfers, loan disbursements were equivalent to net imports of goods and services of $7 million annually (about 5 percent of total investment) and debt repayment of about $5 million per year.  1k; At: the eni of 1972, foUl'VwiaS cancellation by the French Governnient of about 45 percent cK Mhdagascar<s debt vis-a-vis France, Madagascar's dis- burs,