Zambia - Second Industrial Forestry Project

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLY Report No. P-2Ol2a-ZA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ZAMBIA FOR AN INDUSTRIAL FORESTRY PROJECT - PHASE II April 29, 1977 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. I  CURRENCY EQUIVALENTS Currency Unit - Zambian Kwacha (K) K 1 - US$1.2444 US$1 - K 0.8036 ABBREVIATIONS LNRT - Ministry of Land, Natural Resources and Tourism FD - Forest Department IPD - Industrial Plantations Division CDC - Commonwealth Development Corporation KITE - Kafubu Industrial Timber Enterprises INDECO - Industrial Development Corporation Limited ZSBS - Zambia Steel and Building Supplies Limited GOVERNMENT FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ZAMBIA FOR AN INDUSTRIAL FORESTRY PROJECT - PHASE II 1. I submit the following report and recommendation on a proposed loan to the Republic of Zambia for the equivalent of US$16.8 million to help finance an industrial forestry project. The loan would have a term of 20 years including 4-1/2 years of grace, with interest at 8.2 percent per annum.l/ The Commonwealth Development Corporation of the United Kingdom is expected to help finance the local costs with a loan of US$6.2 million equivalent, on terms not yet finally determined. PART I - THE ECONOMY 2. A basic economic mission visited Zambia in June/July 1975; its report is under preparation and is expected to be issued in July 1977. The information in this report was gathered by the basic mission and also by subsequent missions which visited Zambia between October 1975 and October 1976. The most recent economic data are summarized in Annex I. 3. With its large mineral reserves and wide area of land suitable for crops and livestock, Zambia has the potential for rapid and sustained development, but over the decade real gross domestic product has grown at a modest rate of less than 3 percent per annum. -The economy is characterized by a pronounced dualism between a large modern sector dominated by copper mining and a rural subsistence sector. The large differential in incomes between the urban and rural sectors has led to continuing rapid migration to towns. Today more than one third of the country's population lives in towns and there is substantial urban iinemplcyment. 4. The broad economic and social goals of Zambia's last two national development plans (1966-70 and 1972-76) may be summarized as follows: (a) raising the general level of welfare; (b) diversifying the economy to make it less dependent on copper; (c) narrowing the gap between urban and rural incomes; and (d) raising the level of education and developing a wide range of technical and managerial skills. 5. The slow growth of the economy (about 3 percent per annum since 1965) has been the result of stagnation in mining and slow rates of expan- sion in agriculture and transport and communications. All other sectors of 1/ In the attachment to my memorandum on Grace Periods and Final Maturities on FY77 Bank Loans (R 76-206 of August 9, 1976) Zambia was included in the group of countries with a 1975 GNP per capita between US$521 and US$1,075. The classification was then based on the official parity rate of US$1.5541 K 1, but the subsequent devaluation of the currency has established a more appropriate rate and Zambia is now included in the group of countries with per capita incomes below US$520, with the corresponding loan terms. This document has a restricted distribution and may be used by recipients only in the performance of their omcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - 2 - the economy have been growing at moderate to rapid rates - construction at 4 percent per annum, services at 6.8 percent per annum and manufacturing at 7.9 percent per annum. 6. In 1976 the mining sector still accounted for more than 90 percent of exports and for about 25 percent of GDP. Such a heavy reliance has had unfortunate repercussions for the country. Widely fluctuating and unpre- dictable world copper prices have caused serious instability in Government revenues and the balance of payments. Periods of high prices, and hence large revenues and foreign exchange earnings, resulted in expanding levels of expenditure, which could not be sustained without serious stress in periods of low prices. As a result of the slump in world demand for copper, Zambia is presently passing through its most serious economic crisis since inde- pendence (paras. 13-17). Efforts of the two Government-controlled mining companies to raise production from 700,000 to 900,000 tons per annum between 1972 and 1976-(as projected in the Second National Development Plan) were not successful. Their investment program was delayed by transport rerouting resulting from the Rhodesian border closure in 1973 and Angolan war in 1975, and low copper prices (except in 1973 and 1974) restricted the funds available for investment. A recent Bank mission to study the mining sector concluded that, with investments already made or currently underway, copper production would expand at the rate of about 1 percent per annum to a level of 760,000 tons by the mid-1980s. 7. Despite plentiful land resources for crops and livestock, the contribution of the agricultural sector to increasing welfare, diversify- ing the economy and bridging the rural-urban gap has been below potential. During the past ten years, output expanded at a rate of 3.2 percent, mar- ginally above the population growth rate, resulting in a continuing reli- ance on imports of food and agricultural raw materials. 8. For a long time, the Government's economic development strategy did not give the agriculture sector the priority it deserved. While farmers failed to receive proper incentives to increase output, public investment failed to set the stage for the longer-term development of the rural areas. The prices of agricultural products, most of which are fixed by Government marketing boards, were not allowed to rise as rapidly as those of manufac- tured goods, discouraging production and depressing farm incomes. With the rapid rise in modern sector wages, the gap between urban and rural areas widened. At the same time, the Government did not devote sufficient re- sources to the rural sector and investments suffered from inadequate plan- ning and implementation, largely because of the shortage of qualified per- sonnel and weak organization. 9. It is against this background that the Government has begun in the last two years to devote greater attention to the rural areas. In mid- 1975 producer prices for maize and wheat were raised by 26 and 33 percent, respectively, and in January 1976 producer prices on a number of important farm products (e.g., cotton, groundnuts and milk) were raised by amounts ranging from 20 to 56 percent. These increases, which substantially reduced  - 3 - the gap between domestic and border prices and increased the prices of farm products relative to those for non-farm products, provided greater incentives for farmers while raising their real incomes. Improved pricing, as well as favorable weather, contributed to a 4.6 percent increase in agricultural out- put in 1976, with maize production reaching a record level and large increases being registered in cotton, groundnuts, wheat, rice and sunflower seeds. The Government has also designed a number of programs aimed at reorienting atti- tudes (particularly among youths) toward rural work and living. All those who leave primary and secondary school are supposed to serve two years in agricultural training in rural work camps (National Service). Also, there are plans for establishing a School Production Unit Program where each sec- ondary school, both urban and rural, would have a small farming unit to produce food and students would participate in community related projects. Finally, the Rural Reconstruction Program, mainly to provide rural employ- ment and slow the rural-urban exodus, was launched in 1975. It is planned to establish 250 Rural Reconstruction Centers (five in each of the country's districts) where about 800 youths per center will settle and clear the land for crop, poultry and livestock production on a communal basis. 10. Despite these recent improvements, however, a well-coordinated approach to agricultural development remains to be implemented. The Gov- ernment last fall announced to the Bank its intention to strengthen both the Ministry of Rural Development and provincial administrations. A work- ing group has studied the problem and submitted its draft report to the Government. The Government also assured the Bank that it would review the price structure of agricultural commodities and productive inputs on a periodic basis and take whatever measures necessary to maintain incen- tives for production (see para.17). These steps should help increase the Government's implementation capacity in the rural sector and encourage agri- cultural output. 11. Manufacturing, though expanding more slowly than in the 1960s, still has contributed significantly to growth and diversification while providing employment for a growing number of migrants from the rural areas. However, much of investment in manufacturing has been for final stage assembly or pro- cessing industries, necessitating large inputs of imported raw materials and capital goods. Therefore, the contribution of the sector to the Government s import substitution and employment goals has been less than would have been the case with a greater agro-processing orientation in industrial investment. 12. Zambia has made important strides in creating the economic and social infrastructure necessary for future development. It has made major investments in power and transportation, which have set the stage for growth in copper production and the rest of the modern sector. It has also made significant progress toward relieving the skilled manpower constraint. At independence, Zambia was in a worse position regarding the availability of trained manpower than virtually any other ex-British colony. The expansion of the educational system has, therefore, received high priority and the re- sults achieved have been impressive. From 1964 to 1974 primary school en- rollments doubled and secondary and technical school enrollments more than quadrupled; since its inception in 1966, the University of Zambia has pro- duced 860 graduates and enrollment has increased more than sevenfold.  - 4 - 13. Because of Zambia's dependence upon copper (see para. 6), the fall in copper prices has had serious balance of payments and budgetary consequences. After reaching an all-time high of $1.52/lb in April 1974, copper prices declined rapidly. Prices averaged $0.56 and $0.64/lb in 1975 and 1976 as compared to $0.93/lb in 1974. The effects of low copper prices on the balance of payments were compounded by further transport problems caused by the civil war in Angola. As a consequence, comparing the 1975 and 1976 balance of payments with 1974, (a) the value of copper exports dropped by 44 and 23 percent respectively; (b) the current account turned from sur- plus to deficits; (c) large arrears in payments for imports and private transfers have been accumulated (totalling about $195 million by October 1976); and (d) the average level of gross international reserves has been the equivalent of about one month's imports and net foreign assets have been negative. 14. As part of a continuing austerity program initiated during 1975 and 1976, the Government has severely restricted imports and in mid-1976 announced a 20 percent devaluation and that, henceforth, the Kwacha would be tied to the SDR instead of the dollar. The devaluation was an important step in restoring Zambia's international competitiveness, promoting export diversification and import substitution and thereby a better utilization of labor and other domestic resources. As a result of these measures coupled with increased copper exports, the 1976 current account deficit of $190 million represented a substantial improvement over the 1975 figure of $611 million. Despite the improvement, however, payments arrears continued to climb and gross international reserves declined further to a level slightly less than the equivalent of one month's imports at the end of 1976. 15. Low copper prices have also led to budgetary difficulties. Mining revenues were only $92 million and $16 million in 1975 and 1976 as compared with $517 million in 1974. Following a large deficit in its 1975 budget, about 80 percent of which was financed through the monetary system, the Gov- ernment adopted a number of austerity measures in its 1976 and 1977 budgets. Although relatively successful in restricting capital expenditures, in cut- ting subsidies (through increases in food prices), and raising non-mineral revenues (by increasing taxes on income and luxury consumption), the Govern- ment in 1976 was less successful in curbing other recurrent expenditures (mainly for salaries and defense) and, hence, the total budgetary deficit amounted to about $370 million. However, because the cutback in the Govern- ment's development program led to lower disbursements on foreign loans, domestic borrowing was greater than expected and the size of the deficit in 1976 that had to be financed through the monetary system was not signi- ficantly lower than in 1975. Preliminary estimates indicate that the money supply and prices grew by 20-25 percent during the year. 16. The 1977 budget attempts still greater austerity by tight restric- tions on expenditures and tax measures designed to raise an additional $67 million in revenue (the largest package of tax increases implemented since independence). The budget's recurrent and capital expenditures are substan- tially unchanged from the 1976 preliminary actual figures. The revenue  - 5 - measures include higher personal and corporate income taxes, increases in customs duties, sales and excise taxes (mainly on luxury consumption items), and a higher tax rate on the wages of expatriate employees. Despite these measures, the 1977 outlook is not encouraging: tax revenues from mining, projected at $19 million, will not increase much even if copper prices rise more rapidly than expected since the profits generated would be largely off- set by the losses the mining companies sustained during 1975 and 1976 which can be carried forward. Moreover, the projected budget deficit is highly inflationary; the central bank and commercial banks are expected to expand their loans to Government by approximately $190 million, an amount equiva- lent to over one fourth of the money supply in the final quarter of 1976. 17. The Government's austerity program has taken considerable political courage and is a measure of its concern about the current financial crisis and of its awareness of the need to provide a firmer foundation for future agri- cultural development. The reduction in consumer subsidies (see para 15) and the new income,excise and sales tax measures will have their greatest impact on urban real incomes. The improvement in agricultural prices will raise farmers' real incomes and provide greater incentives for increasing agri- cultural output. Taken together, these measures give a positive indication that the Government intends to carry out programs and policies to achieve its objectives of economic growth and social equity. 18. Zambia has relied on external capital flows to an extent similar to other African nations with comparable per capita income (e.g., Ivory Coast and Congo). The terms of these flows have varied, ranging from the very concessionary terms given by the People's Republic of China to sup- pliers' credits and Euro-dollar loans. The Bank is the country's third largest creditor after the People's Republic of China and private banks. Zambia's outstanding and disbursed external public debt amounted to $952 million at the end of 1975. However, owing to the magnitude of its export earnings, which have averaged 47 percent of GDP at current prices over the past five years, Zambia's debt service ratio has generally been low (e.g., only 7.9 percent in 1975). 19. With respect to the future, Zambia's capital requirements and debt service burden will depend heavily upon developments in mining. Copper pro- duction is projected to grow at 1 percent per annum and Zambia's terms of trade also are expected to improve markedly. According to the Bank's com- modity price forecasts, they should improve 50 percent, compared with 1975, by 1980 and 67 percent by 1985. Much of the improvement is projected to occur by 1978. Thus, while recovery from the present recession may take about a year longer, as mining output expands and import controls are loosened, the GDP growth rate should average about 4.5 percent per annum up to 1985. On this basis, Zambia's gross capital requirements would cumu- latively amount to about $1.5 billion over the next five years. Its debt service ratio would rise from 8 percent in 1975 to about 14 percent in 1980, declining thereafter to about 11 percent in 1985.  - 6 - 20. These projections are very sensitive to copper prices. A price each year 10 percent lower than the Bank currently forecasts, for example, would mean that, while Zambia's terms of trade would still improve, its current account deficits would increase fourfold in current terms; its capital requirements would total $2.4 billion over the 1977-81 period and its debt service ratio would reach 21 percent in 1985. In view of the rapid rise of debt servicing, relative to exports and GDP, implied by such a fore- cast, it is highly unlikely that Zambia would be able to mobilize such a large capital inflow. PART II - BANK GROUP OPERATIONS 21. Since 1956, the Bank has made 22 loans in Zambia totalling about $490 million. Ten loans, totalling $323 million (66 percent), financed physical infrastructure projects of which power, transportation and communi- cations accounted for three-quarters of the total amount. Four loans for education helped to expand and develop Zambia's secondary school system, teacher training and higher education. In 1974 the Bank made a loan for urban development and a $30 million program loan. The program loan was slow to disburse due to dramatically improved copper prices which reduced the Gov- ernment's need for the funds, and partly because the disbursement mechanism proved more complicated than expected. At the Government's request, $12.5 million of the loan was cancelled in June 1975. The Bank also made a loan to the Development Bank of Zambia in 1976 to help finance manufacturing and commercial farming. A second program loan extended in late 1976 provided foreign exchange for importing essential capital and intermediate goods, raw materials and spare parts for agriculture, mining and manufacturing. Twelve loans are now fully disbursed; one for livestock (627-ZA) was can- celled and the disbursed portion prepaid. In 1975, the Bank's shares of Zambia's total debt (disbursed and outstanding) and total debt service pay- ments were 19 percent and 22 percent respectively. On the basis of present projections, these percentages are expected to be about 32 percent and 18 percent respectively in the mid-1980s. 22. IFC made its first investment in Zambia in 1972 by providing $1.1 million (including $227,500 in equity) for the expansion of the Zambia Bata Shoe Company, Ltd. and, in 1973, invested an additional $1.2 million in Bata for a tannery. IFC in May 1975 invested $1.04 million in Century Packages, Ltd. for a packaging materials factory. The most recent IFC investment of $550,000 equivalent was in the share capital of the Development Bank of Zambia (February 1976), in conjunction with a $15.0 million Bank loan to that institution. A summary statement of Bank loans and IFC investments along with notes on the execution of ongoing projects is contained in Annex II. 23. Agricultural and rural sector development is essential to diversify the economy and improve rural living conditions. Progress in this sector, however, has been difficult, primarily because of the Government's weaknesses  -7- in making and carrying out suitable policies and in formulating and imple- menting effective programs. Nevertheless, the Bank made four loans during 1968-73 for industrial forest plantations, livestock, commercial crops and integrated family farming. The livestock loan was cancelled in 1973 at the Government's request. The project was having serious problems due mainly to adverse pricing policies and poor management. Two projects which had been prepared with Bank assistance were withdrawn in March 1975 because of inadequate implementation capacity. To help identify the problems and their possible solutions, the Bank, at the Government's request, undertook a rural sector survey in 1975. The report has stimulated wide discussions about agri- culture and rural development at all levels of Government, and is playing a key role in the increasing Zambia-Bank cooperation in the development of this sector. 24. Very recently, the Government has again sought further Bank assist- ance in the preparation of programs and projects for rural development. With the help of the Bank's Regional Mission in East Africa, it has begun to identify and prepare the first of two agricultural projects for which it expects to request Bank financing during the next three years. Bank assist- ance in this sector, however, is not limited to agricultural projects as such. The Fourth Education project, approved in late 1976, includes a major component for training farmers and Government agricultural technicians. A Second Urban project, scheduled for FY78, and a Rural Water Supply project, now under preparation, will both provide assistance to smaller towns in predominantly rural environs. 25. In addition to the agricultural and rural sector, the Bank has studied urbanization and water supply and sewerage. A basic economic mission which visited Zambia in June/July 1975, and subsequent follow-up missions, focused largely on the industrial and mining sectors as well as manpower planning in its broadest aspects. The reports of these missions will provide the basis for a more intensive Bank-Zambia dialogue. 26. While the Bank's program will continue to emphasize agricultural and rural development, it will also continue to support the development of industry, physical and social infrastructure. Assistance is being consid- ered for a Third Road project, which would concentrate on improving road maintenance and institutional capabilities in the transport sector, and for the next stage of the country's hydropower development. In all aspects of the Bank's program, institution building will continue to occupy a central position.  - 8 - PART III - AGRICULTURAL AND FORESTRY ENVIRONMENT The Agricultural Sector 27. The agricultural sector is characterized by its dualism. On one extreme are about 600,000 smallholder subsistence farmers, using hand tools and traditional technology, producing primarily for their own re- quirements with little marketable surplus, from which they derive small cash incomes (major crops are cotton, maize, groundnuts and free-grazed beef). On the other extreme are large state farms and an economically important group of about 600 expatriate and Zambian commercial farmers, whose farms are large and on good land. They use modern methods to produce cereals, dairy produce, beef, poultry and eggs for the urban market and tobacco for export. 28. The sector's performance, particularly in relation to its poten- tial, has fallen short of expectations over the last decade. Agriculture contributes about 12 percent to GDP, about 9.5 percent to wage employment and only about 1 percent by value of Zambia's total exports. In 1974, about 40 percent by value of Zambia's marketed food was imported. In spite of this, the sector has grown only about 3.2 percent per annum over the last decade. In addition, the gap in real incomes between the rural and urban sectors has been widening rather than narrowing. 29. The reasons for this inadequate performance are mainly (a) lack of an effective sector strategy; (b) inappropriate producer and consumer price structures; (c) overcentralization of policy planning and control of financial allocations and management of public services relating to the sector; and (d) inadequate resource allocation. 30. Zambia's objective for its agricultural and rural development are stated as (a) achieving a more even distribution of real income by redressing the imbalance of social and economic opportunities which favor urban workers over rural dwellers; (b) attaining self-sufficiency in foodstuffs and cotton; and (c) diversifying the economy and widening the export base by producing and exporting agricultural surpluses. In the last two years, the Government has been devoting greater attention to the rural areas as a means towards improving its overall economic strategy. It has designed a number of programs aimed at reorienting attitudes (particularly among youth) toward rural work and living, including the Rural Reconstruction Program (para. 9). This Pro- gram, however, does not fully address the overall problem of rural develop- ment in Zambia, since it focuses on reducing unemployment instead of the urgent task of increasing the productivity of traditional subsistence farmers. Nevertheless, it is an indication of the Government's serious concern about rural development. 31. Other favorable developments include the steady increase in sugar output which enabled Zambia to reach self-sufficiency in 1975 (a further ex- pansion oriented towards exports is presently underway) and the 4.6 percent  - 9 - overall increase (in real terms) in agricultural output registered in 1976. Marketed production of maize reached a record level of more than 8 million bags, an increase of 30 percent over the 1975 level. Substantial increases also were achieved in other crops: 50 percent in sunflower, 60 percent in rice, 25 percent in groundnuts and 19 percent in cotton, while wheat produc- tion increased fourfold (starting from a very small base). 32. A well-coordinated approach to agricultural and rural development, however, still remains to be defined by the Government. The report of the Bank's Agricultural and Rural Sector Survey carried out in 1975 suggested a two pronged strategy based upon (1) transforming the rural sector by focus- ing public investments and services in areas of high growth potential, and (2) obtaining more immediate increases in output through improved pricing policies and better marketing. The Government has responded positively to a number of the report's recommendations. For instance, it has raised prices of many agricultural commodities upwards towards more economic levels and has taken steps toward strengthening the Ministry of Rural Development. The Forestry Environment 33. The Government of Zambia has accorded high priority to the develop- ment of forest resources in the First and Second Five-Year Development Plans, so that in due course it can become self-sufficient in meeting its require- ments for timber, sawnwood and the products of woodbased industries. It also recognizes the importance of afforestation programs in providing pro- tection against soil erosion and in maintaining river flows. To this end the Government has been carrying out an afforestation program since 1949. This project is part of the Government's forestry program, which the Bank has already assisted in the past (para. 38). 34. Since agricultural statistics in Zambia are not disaggregated, it is not possible to illustrate statistically the importance of forestry in Zambia's economy. Some idea, however, can be gained from She fact that, in 1975, consumption was istimated at about five million m of roundwood, of which about 4.5 million m was used for fuelwood and charcoal. The country's natural hardwood forests have met its requirements for fuelwood, for most types of poles, and for some sawnwood but imports of wood products have been substantial. In 1975, Zambia's demand for wood products, in terms of cubic meters of roundwood, was 250,000 for sawnwood, 70,000 for poles, and 200,000 for other wood products. Most of Zambia's sawnwood, wood-based panels and all paper products were imported. 35. Zambia's demand for sawnwood and poles is projected to grow at an average rate of about 5.5 percent per annum. Demand for industrial wood of all types is rising faster than domestic supply. By the Snd of this century, for examp e, demand is projected to increase to 860,000 m for sawnwood, and to 235,000 m and 675,000 m for poles and w9od-based panels, respectiveVy. Do- mestic sugply is expected to be 465,000 m for sawnwood, and 45,000 m and 700,000 m for poles and wood-based panels, respectively.  - 10 - 36. Natural hardwood forests cover about 50 percent of Zambia's area. Accessible productive forests are shrinking rapidly because of shifting cul- tivation, clear-burnings, and large-scale charcoal production. As part of the Government's afforestation effort, a forest estate of 8 million hectares (about 9 percent of the total land area) has been established within which exploitation of forest resources is controlled by the Forest Department in the Ministry of Land, Natural Resources and Tourism. Following a decade of research and trials, the Government developed a program to plant approximately 2,000 hectares of pine and eucalyptus annually, starting from the early l_60's. 37. The M-inistry of Land, Natural Resources and Tourism, is responsible for the overall coordination of all forestry and wood-based activities. However, the primary responsibility for the formulation of forest policy, forest administration and management rests with the Forest Department. Its Industrial Plantations Division is responsible for afforestation, construction of roadwork, forest exploitation, wood processing and marketing. Research, surveys, and training are all specialized functions of the Forest Department. Provincial forest offices are responsible for the management of indigenous forests. Until recently, the Industrial Development Corporation Limited, a large parastatal holding company, was responsible for processing and importa- tion of a number of wood-based products. The Government has now placed the responsibility for all wood-based activities under IPD, except for the proposed pulp and paper mill ,hich reamna inxzder the Corporation. However, to ensure proper coordination, the Corporation will be answerable to the Ministry of Land, Natural Resources and Tourism, regarding its pulp and paper mill activities. 38. The Bank's first loan for Industrial Forestry (Loan No. 562-ZA of October 5, 1968) of $5.3 million helped to finance planting 16,000 hectares of pine and eucalyptus over an eight year period (1969-76). As confirmed by the recent audit report (No. 1538, dated April 11, 1977), once the initia management, technical and staffing problems were solved, the project vas implemented satisfactorily. The total plantation target of 16,000 hectares was reached in seven years, instead of_eightF and the full amount of the loan was fully disbursed by August 1975, about one year ahead of schedule. The project economic and financial rates of return have been estimated at over 13 percent and over 10 percent respectively, both above appraisal estimates. Nevertheless, it became clear during this period that unified control of planta- tion development and exploitation was essential for the orderly development of the forestry and forest industries sectors. This situation has been partly rectified by the Government's recent decision to make the Industrial Development Corporation responsible to the Natural Resources Ministry for its forestry activities. Total project cost was K 15.0 million, compared with appraisal estimates of about K 8 million. The main cause of the cost overrun was unexpected inflation. However, as sawn timber prices have increased at about the saMe rate, the projected financial and economic returns were achieved. The project strengthened the country's capabilities in industrial forestry, logging and sawmilling and established the Industrial Plantations Division as a sound institution.  - 11 - 39. Primary forest industries in Zambia consist mainly of savailling and the conversion of eucalyptus roundwood to poles and posts. There are presently about twelve major sawmills in Zambia which produce over 90 per cent of the country's total production, mostly from indigenous wood. Ten of these are privately owned and two are operated by IPD. The sawmills are bunched closely in two areas (1) the teak forests in the Western Province, and (2) the eucalyptus and pine forests in the Copperbelt Province, near Ndola and Kitwe. Many of the sawmills in the past operated below capacity because of poor location, inappropriate equipment, poor management and in- adcequate maintenance, 'but the situation has improved in recent years and most of them now operate near full capacity. 40. Presently about 50 private firms comprise Zambia's secondary forest industries, of which approximately half are engaged in furniture manufactur- ing while a further 20 percent are engaged in joinery manufacturing of items such as doors and prefabricated houses. The country has one blockboard fac- tory located near Kitwe. These firms use, in addition to locally manufactured timber and blockboard, large quantities of imported wood products. 41. Forest education and training in Zambia are at the technical and work levels only. Professionals are trained overseas and the number of qualified Zambian professional foresters is still small (only seven in 1976). The Forest College at Mukera, on the copperbelt, trains foresters and forester rangers and runs refresher courses for all the technical grades. A Forest Workers Training Center at Chati, also on the copperbelt, provides short training courses in a wide range of forestry skills to about 300 work- ers annually. Future Forest Industries Development 42. During the implementation of the first forestry project, a number of technical studies were carried out concerning the development of forest industries in Zambia. These studies indicated that substantial economic benefits would re- sult from a program that included, in addition to increasing the country's saw- milling capacity and creating a wood-based panel industry, the construction of a pulp and paper mill in the early 1980's. The studies have shown that, by 1985, domestic demand for kraft and industrial papers would be adequate to justify such a mill. The mill would also provide additional economic bene- fits by utilizing the high level of waste products from sawmilling activities, since the proposed wood panel industries would be relatively small users of such waste. The Government has declared its intention to construct a pulp mill, but the high financial cost and difficulty in locating a suitable com- mercial partner may cause delays. Zambia's afforestation plans and the pro- posed project, however, would not be affected by a postponement, since they are justified on the basis of sawmilling and wood-based panel manufacturing alone. 43. The relative merits of the various kinds of panel industries and their optimum sequence and timing are still undetermined. The Government recognizes, however, that the existing blockboard factory, which is dependent  - 12 - on imported materials and makes little use of local forest resources, should be replaced with a facility using local resources, and is actively investi- gating the possibilities of establishing an appropriate boardmill. The Government will consult the Bank before establishing such a boardmill (Sec- tion 5.07 of the draft Loan Agreement). PART IV - THE PROJECT 44. A report entitled "Zambia - Appraisal of a Second Industrial Forestry Project" No. 1429-ZA, dated April 20, 1977 is being distributted separately. Annex III slummarizes the project and proposed loan. 45. The proposed project components were discussed extensively between the Government, representatives of the FAO/IBRD Cooperative Program and the Bank in connection with the technical studies carried out during the first forestry project. Bank missions visited Zambia in August 1975 and April 1976 to review the Government's forestry development plans and priorities. A specific Government request for Bank Group assistance for a second forestry project was received in April 1976. The project was appraised in June/July 1976 and negotiations were held in Washington from April 4-8, 1977. The Zambian delegation was led by Mr. Ndalama, Permanent Secretary, Ministry of Land, Natural Resources and Tourism. Objectives and Description of the Project 46. The objectives of the proposed project are to assist the Government in continuing its long-term afforestation, reafforestation and maintenance program over the period 1978 to 1982; expanding its logging and sawmilling capacity and conducting studies designed to lead to more economical and effi- cient land clearing procedures and charcoal production. 47. The project will consist of: (a) planting about 3,500 ha of new plantations annually, of which about 3,000 ha would be pine and about 500 ha eucalyptus (totals for the project period: pine 15,000 ha; eucalyptus 2,500 ha); (b) replanting annually approximately 400 ha clearfelled plantations with eucalyptus (total for the project period: 2,000 ha); (c) maintaining all IPD's plantations; (d) doubling IPD's logging and transportation capacity from about 60,000 m3 to about 120,000 m3 roundwood per year;  - 13 - (e) constructing and equipping 3a sawmill with an annual capacity of about 40,000 m of sawnwood; (f) staff training and fellowships to facilitate (a) to (e) above; and (g) research, experimentation and studies designed to improve land clearing and charcoal production methods. Project Design and Execution 48. The new plantations will consist of extensions to those planted on the copperbelt near the towns of Ndola and Kitwe under the first Forestry Project. The area is well served by roads and rail and is in the region with the largest concentration of population, and industrial and mining development. The plantations are on good soils and conditions are generally excellent for growing pines and eucalyptus. Plantation development is ex- pected to extend over a period of five years starting in January 1978. The plantations would be maintained through pruning, thinning and eLearfelling at appropriate intervals. 49. The sawmill would be located at Chati, close to Ndsla and the plantations. The capacity of the proposed sawmill (40,000 m ) has been matched to the Division's planned tree-felling program over the next five years. The sawmill construction contract is expected to be awarded in early 1978 and the work completed by March 1979. 50. The Division's present logging and transportation procedures will be maintained under the proposed expansion. They consist of felling with chainsaws and bowsaws; skidding with tractors of various sizes; loading with front-end loaders; hauling by truck or log trailer; and unloading with large hydraulic cranes. The project would provide for the doubling of IP 's logging and transportation capacity from about 60,000 m3 to about 120,000 m roundwood per year. 51. Land clearing costs are relatively high, and charcoal production methods appear uneconomic in Zambia. The project would provide for research, experimentation and studies designed to improve land clearing and charcoal production methods. 52. The Project would provide for the training of Zambians required to fill the vacant posts and replace expatriate staff on short-term contracts now heading many of the units and sections in IPD. The training would be mainly in engineering, accounting, and marketing fields. The costs include travel expenses, tuition, allowances and other living costs in-Zambia and abroad.  - 14 - Organization and Management 53. IPD will be responsible for implementing all aspects of the project. It operates on a self-accounting commercial basis. Although most of IPD's plantations have not yet matured for commercial exploi- Although most of IPD's plantations have not yet matured for commercial exploi- tation, from 1970 to 1975 IPD made a net profit every year except in 1973. It has a professional and administrative staff of over 130 people, and em- ploys a labor force of over 1,000. IPD successfully implemented the first Bank-financed Forestry Project (see para. 37). All the proposed components of the project fall within the range of its experience. It pres- ently owns and operates two sawmills near Kitwe and Ndola, produces transmis- sion poles, purlins, and prefabricated houses, and operates a forest products research center in Kitwe. IPD is organized in seven sections: plantations, accounts, administration, production, marketing, logging and engineering, each headed by a well-qualified and experienced professional. However, two key posts of a mechanical and an equipment engineer are vacant. The Borrower will make appointments to these positions not later than December 31, 1977. In addition, successor appointments to other key positions will be made promptly and after consultations with the Bank (Section 4.01 of the draft Loan Agreement). 54. The Bank has suggested that IPD be incorporated in order to enhance its ability to operate as an autonomous, commercially-oriented entity. This would facilitate a clear separation of IPD's financial accounts and activities from those of the Forest Department. The suggestion is under consideration within the Government. Unless the Government and the Bank agree otherwise, IPD's incorporation will be effected by December 31, 1978 in a manner satisfactory to the Bank (Section 4.02 (b) of draft Loan Agreement). Project Costs, Financing and Cost Recovery 55. The total project cost is estimated at $34.5 million equivalent, net of taxes and duties, of which $16.8 million (about 49 percent) would be the foreign exchange cost. Of the total, $18.6 million is for plantation development, $1.5 million for logging and transport, $2.9 million for saw- milling, $0.13 million for training and fellowships, $0.37 million for land clearing and charcoal production trials, and $11.0 million for con- tingencies (further details are given in Annex III). 56. The proposed Bank loan of $16.8 million would finance about 49 percent of the total costs and 100 percent of the foreign exchange costs. The Common- wealth Development Corporation is expected to lend to Zambia an amount of $6.2 million equivalent (18 percent of total net cost) to help finance the local cost. The terms of its loan have not yet been finally determined, but will not be less favorable than the Bank loan. The Government would finance the remaining local costs of $11.5 million (33 percent of total net cost). Since IPD would be required to operate commercially, it would return to the central budget the equivalent of the debt service on the proposed loan. However, after IPD's incorporation some of the loan proceeds relent to IPD may be converted to equity in a manner satisfactory to the Bank.  - 15 - 57. Until now IPD has charged prices designed to recover the historical cost of plantation development and processing. Starting from January 1, 1978, IPD will shift to a system for the determination of ex-factory prices for its products which shall permit IPD to recover at all times logging, transport, handling, and processing costs and the replacement costs of its plantations. The adequacy of IPD price levels shall be reviewed annually by the Borrower in consultation with the Bank (Section 5.05 of the draft Loan Agreement). Procurement and Disbursement 58. Sawmilling and other heavy equipment, tractors, and motor vehicles (about $11 million including contingencies) would be subject to international competitive bidding in accordance with Bank Group guidelines, and would be bulked whenever possible. In accordance with current IPD practice, fuel, tools, spares and stores (about $5.5 million, including contingencies), equipment, vehicles (including tractors) and other items in contracts of $100,000 or less, as well as contracts for land clearing ($2 million, in- cluding contingencies), would be purchased or awarded in accordance with Government procedures, which are satisfactory. Land clearing for affor- estation would continue to be done by local contractors but would be grad- ually taken over by IPD during the Project. This transfer has been necessi- tated by the decline in competition and high prices charged by the remaining private contracting capacity. Road and other construction and maintenance, as well as the sawmill building, would be carried out by competitive bidding advertised locally or by IPD itself if this proves less expensive. These contracts are too small and scattered to attract foreign bids. 59. The proposed Bank loan would be disbursed as follows: 100 percent of foreign expenditures on all project components; or 60 percent of the total cost of goods previously imported but purchased locally and 40 percent of the total cost for civil works. Disbursements against equipment, vehicles, civil works contracts and consultancies would be fully documented. All other disbursements would be made against certificates of expenditure the documentation of which would not be submitted to the Bank but retained for review during Bank supervision. Accounts and Audit 60. IPD already operates an efficient accounting system. However, during the project implementation period it will be further refined to get a better picture of the profitability of each project component, particularly, the sawmilling and logging activities. This would involve maintaining sepa- rate cost accounts as well as full profit and loss accounts for these two project components. IPD will have its annual accounts audited by an inde- pendent auditor acceptable to the Bank, and forward such audited accounts to the Bank not later than 6 months following the year to which they relate.  - 16 - Environmental Aspects 61. The project is not expected to have any adverse impact on the en- vironment. The new plantations will help to preserve the water catchment and prevent soil erosion as did the indigenous forests which will be replaced by the plantations. Benefits, Justification and Risks 62. The project would assist Zambia in executing the country's long- term afforestation program by planting about 15,000 ha of pine, 2,500 ha of eucalyptus and replanting about 2,000 ha Sf clearfelled plantations. The proposed sawmill would add about 40,000 m a year of sawnwood to the existing sawmilling capacity. The project would enable Zambia through import substi- tution to save an average of about $1.2 million per annum in foreign exchange during the first ten years rising to about $15.3 million in year fifteen. 63. The project has been evaluated in terms of Zambia's planned in- dustrial forestry program, including a pulp and paper mill. On this basis, the financial rate of return is estimated at 11 percent and the internal economic rate of return at 20 percent. Should the pulp mill not be con- structed as planned the economic rate of return would still be about 20 percent while the financial rate of return would be reduced to about 10.5 percent. The large differential between the economic and financial rates of return is due to shadow pricing of foreign exchange and labor. 64. The major risk the project faces is from fire, a risk common to all forestry projects. To minimize this risk, IPD will implement all the conventional fire preventive measures. PART V - LEGAL INSTRUMENTS AND AUTHORITY 65. The draft Loan Agreement between the Republic of Zambia and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement and the text of a draft Resolution approving the proposed loan are being distributed to the Executive Direc- tors separately. 66. Special conditions of the loan are listed in Section III Annex IV of this Report. It is an additional condition of effectiveness that the Borrower and IPD have entered into arrangements satisfactory to the Bank for passing on the proceeds of the Bank loan to IPD (Section 7.01 of the draft Loan Agreement). 67. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 17 - PART VI - RECOMMENDATION 68. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments April 29, 1977  0 -a oZ so OC 0 00 0..0-O e S C-| 000 C 1 e. _ _OC .. o.. 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