Tanzania - Morogoro Industrial Complex Project

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLY Repat No. P-2014-TA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE :NTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO-THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO THE UNITED REPUBLIC OF TANZANIA FOR THE MOROGORO INDUSTRIAL COMPLEX March 15, 1977 |Th doeimt ha a bid iurIbWn sad way be moid by reeWeeft mly In dh pu,tu_ d thur okial dv1k. lb eut may ad iwberwie be dIelksi 1 hwW auk S_mhouu.  CURRENCY EQUIVALENTS Tanzania Sh - US$0.12 US$1.00 X TSh8.30 CAs the Tanzania Shilling is officially valued at a fixed'rate of 9.66 TSh to the SDR, the US Dollar/Tanzania Shilling exchange rate is subject to change. Con- versions in this report were made at US$1.00 to TSh8.30 which'is close to the recent average exchange rate.) ABBREVIATIONS NDC - National Development Corporation TANU - Tanganyika African National Union  FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO THE UNITED REPUBLIC OF TANZANIA FOR THE DEVELOPMENT OF AN INDUSTRIAL COMPLEX AT MOROGORO 1. I submit the following report and recommendation on proposed loans to the United Republic of Tanzania totalling the equivalent of US$23 million to assist in financing the development of an industrial complex at Morogoro. A loan of $11.5 million is proposed on standard Third Window terms, repayment of principal to start on January 15, 1983 and final maturity on January 15, 2001, at an interest rate of 4.5 percent per annum; a second loan of $11.5 million would be for 20 years including 4-112 years of grace at an interest rate of 8.5 percent per annum. The proceeds of both loans would be onlent by the Borrower to the National Development Corporation at 10 percent per annum for 15 years including 4-1/2 years of grace. PART I - THE ECONOMY 1/ A. Introduction 2. The last full economic report on Tanzania (AE-26) was distributed to the Executive Directors in 1972. While it has been some four years, therefore, since the last comprehensive economic report was issued, a substantial volume of economic and sector work has been carried out during this period. A three- volume industry and mining sector report and a special economic study on the fiscal aspects of Tanzania's recent decentralization of Government were dis- tributed in April 1975. In early 1974, at the Government's invitation, Bank personnel participated in a special task force which assessed the impact of the increase in petroleum prices on the Tanzanian economy. A further analysis of recent economic developments was contained in the Program Loan President's Report (No. P-15L7a-TA of November 25, 1974), and the Government's progress in implementing policies and programs designed to close the balance of payments gap was reported in a special memorandum to the Executive Directors (SecM75-687) in September 1975. In March 1976, also at the request of the Government, Bank staff assisted a Government task force in the preparation of a report which analyzed the fiscal implications of the new targets for universal primary education and universal rural water supply. These sector reports and special economic studies have formed the basis for our dialogue on economic policy issues with the Government and for the development of our program of operations. 1/ With the exception of paragraphs 39-42 which relate to Tanzania's eligibility for Third Window lending and the East African Community, Part I is identical to Part I of the President's Report on a Proposed Program Credit to the United Republic of Tanzania, Report No. P-1781a-TA dated February 22, 1977. 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 - Finally, a basic economic mission was conducted in July-August 1976. The basic economic report is currently under preparation and it will be discussed with the Government in Spring 1977. The updating report on the Tanzanian economy (Annex V to the President's Report on a Proposed Program Credit, No. P-1781a-TA dated February 22, 1977) is based on the findings of the basic mission. B. General Background 2 3. Tanzania has a total area of approximately 945,000 km . The population of 14.8 million (mid-1975 estimate), which is increasing at about 2.7 percent per year, is predominantly rural. About 93 percent of the population lives in rural areas, and 90 percent of the labor force is engaged in agriculture. Agri- culture and related activities constitute the largest single sector in the Tanzanian economy. Roughly 40 percent of GDP is derived from the sector and half of this constitutes subsistence production. Agricultural exports, which account for 80 percent of total exports, include mainly cotton, coffee, cashewnuts and sisal. With a per capita income of only $170, Tanzania is classified as one of the 25 least developed countries as defined by the United Nations. (Country data are provided in Annex 1.) C. Government Development Objectives and Strategy 4. Tanzania has experienced a degree of continuity and stability in political structure, leadership and objectives which is virtually unrivalled in Africa. The TANSI 1/ party, under the leadership of President Nyerere, has been the unifying force in Tanzania's political evolution since the early 1950s. For the past decade, following the Arusha Declaration of early 1967, Tanzania has pursued the objectives of social equality, self-reliance, the eradication of absolute poverty, and economic and social transformation. The fundamental strategy underlying Tanzania's development has emphasized rural development, social ownership of the principal means of production, and full participation of all regions and population groups in the development process. Economic growth has been an important objective but the leadership has been willing to forego short-term income gains for longer-term structural change and more equitable distribution. 5 ~ In restructuring the political, economic and social life of the country the leadership has introduced an impressive series of far-reaching institutional reforms. The most important of these measures are well known: most large-scale units in manufacturing, finance and wholesale trade have been nationalized; the Government has sharply increased its share of revenue in GDP through progressive taxation; a significant portion of public expenditure control has been delegated to the regions and districts; and incomes policy has prevented a further widening of the urban-rural gap and has narrowed wage differentials within the formal urban sector. / TkNJ (the mainland political party) was merged with the 7anzihbr nolitical party (the Afro-Shirazi Party) in February 1977. The new party is now called Chama Cha Mapinduzi (CCM).  - 3 - b. Rural development receives the highest priority in Tanzania inasmuch as over 90 percent of the population, most with per capita incomes of less than $100 per year, live in the rural areas. The approach to rural development is through villagization. Collecting the scattered population into villages is seen as essential for transforming production methods and to facilitate the provision of services such as agricultural extension, credit, input supply, marketing, roads, water, schools and health. 7. Mass mobilization of the population is facilitated by the political party organization which starts with the ten-family cell and is linked successively to village, division, ward, district, region and national levels. Party representatives at each level participate in organizing the development effort. In 1972 the central government administration was decentralized, giving substantial planning and implementation authority to regions and districts. Each district and region is expected to have its own development plan and budget subject to central government guidelines, control and finance; between 1972/73 and 1975/76 the regional share of the government development budget has risen from 8 percent to 14 percent. 8. The overriding goal is to develop a socialist economic system. In furtherance of this objective new government parastatal enterprises have been established in virtually all sectors of the economy. There is also state intervention in market pricing; prices of capital, labor, land, imports, industrial and agricultural products and consumer goods are controlled directly and by indirect methods such as import licensing. D. Economic Performance (i) Background to the 1974 Economic Crisis 9 Between 1967 and 1973 Tanzania's GDP at factor cost was growing at an annual rate of 4.5 percent. With population growing at 2.7 percent per annum per capita output was rising at only 1.8 percent per year on average. Domestic savings reached 18 percent of GDP while gross investment was sustained at between 20 and 25 percent of GDP, extremely high rates for a country at Tanzania's low level of per capita income. The growth rate of GDP was not commensurate with the magnitude of the investment effort, however, in part because of the high proportion of investment which was directed into slow- gestation infrastructure and social services projects such as the transportation links with Zambia, but also because of sluggish growth in the agricultural sector and stagnant or declining productivity in parastatal enterprises. 10. During this period Tanzania's overall balance of payments situation was generally satisfactory, despite the disappointing performance of the export sector. The rapid growth in imports was more than compensated by increasing capital inflows, largely from bilateral sources on soft terms. The overall balance of payments was in surplus in most years during 1969-73, resulting in a modest buildup in net foreign exchange reserves to slightly over $150 million at the end of 1973, the equivalent of almost four months' imports.  - 4- (ii) The Economic Crisis of 1974 11. In 1974 Tanzania was suddenly confronted with a severe economic crisis, caused in part by drought and dramatic import price escalation. Failure of rains in late 1973 and early 1974 caused major declines in production and marketings of the major foodgrains. In response the Government was compelled during 1974 to import large quantities of grain, particularly maize, on commercial terms in order to alleviate the hardships inflicted by drought. At the same time the production of Tanzania's main export crops was also affected by drought, and the resultant declines in export volumes prevented Tanzania from taking advantage of the commodity price boom during 1974. On the import side, total cost of merchandise imports rose by over 50 percent between 1973 and 1974, despite a slight decline in volume. As a result of these factors the trade deficit widened from $158 million in 1973 to $340 million in 1974 while the overall balance of payments moved from a surplus to a deficit of $140 million. 1/ Industrial production also stagnated in 1974 due to shortages of imported raw materials resulting from the growing foreign exchange constraint, and to interrup- tions in power and water supplies. While production declined, domestic demand increased rapidly because of expansionary fiscal, monetary and wage policies. The imbalance between domestic demand and supply, combined with the sharp escalation in import prices, resulted in severe pressure on the domestic price level. 12. Although the severity and suddenness of the crisis were largely the result of forces outside Tanzania's control, many of the problems were fore- shadowed by longer-term economic trends which, at least partially, were subject to Tanzanian control. One important adverse trend was in the composition of growth; the rate of growth of material production had been falling for several years and the overall GDP growth rate had been maintained only by an acceleration in the growth of services, particularly of public administration. Much of the slump in agricultural production was due to poor weather but the average growth rate of agricultural output failed to exceed the rate of growth of population for the six years prior to the harvest failure of 1974. In the modern sector many enterprises experienced declining labor productivity which has been attributed to lack of incentives, poor discipline and ineffective management. Furthermore, while the ratio of domestic savings to GDP rose during the 1960s, reaching a high of 18 percent in 1970, it had declined to 15 percent by 1973. Public savings were also falling as a share of GDP, mainly due to the slow growth of parastatal enter- prises' surpluses and the rapid increase in government recurrent expenditures. 13. The crisis of 1974 was also aggravated by a series of steps which were taken before the full extent of the country's economic difficulties was perceived. First, the minimum wage was increased by over 40 percent on May 1, 1974, thereby raising average labor costs by about 35 percent. The intention was to compensate low-paid wage earners for past and anticipated future cost of living increases; the effect was to worsen inflation and to aggravate the decline in domestic saving. The second step was the acceleration in the pace of villagization during 1974 which led to the physical relocation of several million people. 1/ The overall balance of payments gap was financed largely through drawings from the IMF (gold tranche, first credit tranche and 1974 Oil Facility) and by a rapid depletion of reserves which fell to $60 million (net) at the end of 1974, equivalent to only one months' import requirements.  - 5 - This mass villagization program inevitably caused some disruption in agricultural production, in part because of inadequate planning and preparation. Because the newly settled peasants understandably concentrated their efforts on growing subsistence food crops, and were encouraged to do so by the Government, the marketed surplus of export crops in affected areas bore a disproportionate share of the disruption (cotton is the prime example). Thirdly, in late 1974 and early 1975 the TANU Party leadership advanced the target dates for universal primary education (UPE) and universal rural water supply (URWS) from 1989 to 1977 and from 1991 to 1980, respectively. In large part the pressure for rapid expansion of social services arose from the accelerated villagization program - the newly-settled villagers expected the benefits of improved social services - although the declaration of these new targets should also be seen as exhortative attempts to mobilize self-help efforts by the villagers themselves. (iii) The Government's Response to the Economic Crisis 14. Once the extent of the problems facing the country was realized the Government formulated a comprehensive program of policy actions to bring the balance of payments under control while maintaining the pace of the development effort. The principal elements of the program included a reallocation of investment in favor of directly productive sectors, measures to raise agricultural output, and constraints on wages and on public and private consumption. This program was reviewed with the Bank at the time of appraisal and negotiation of the program loan in late 1974, and approval of that loan was based on the Bank's agreement with and support for the proposed program. These measures were described in the President's Report for the program loan (Report No. P-1517a-TA). The Government has, over the past two years, successfully carried out most of this program, as described below. 15. From mid-1974 the Government tightened import controls, particularly for consumer goods and industrial raw materials. Automobile imports were curtailed drastically and liquor and tobacco imports were banned. In addition, overseas travel allowances for business and tourism were reduced, certain dividend remittances were suspended, and remittances by residents to relatives abroad were restricted. Import licensing was further tightened in 1975, leading to sharp volume declines in imports of consumer goods, including textiles, and industrial raw materials and spare parts. The Government has also taken several steps since early 1974 to restrain domestic consumption of petroleum and petroleum products. These measures include increases in the domestic retail prices of gasoline and related products to reflect the full rise in import costs, the mandatory closing of petrol stations on weekends, reduction of speed limits, and a ban on Sunday driving during certain hours. 16. In addition to restricting the volume of non-food consumer goods imports, the Government took further politically difficult steps to slow down the rate of growth of private consumption demand. Retail prices of basic food- stuffs were raised sharply in late 1974, thereby eliminating retail subsidies which had previously benefitted primarily urban consumers. Indirect taxes on textiles, beer and cigarettes were raised to absorb excess consumer demand for these items, and further tax increases on these and other consumer items have been incorporated in the 1975/76 and 1976/77 budgets. User charges for water and electricity have also been raised. WVhile consumer prices have increased substantially an extremely restrictive wage and salary policy has been followed  - 6 - since May 1974. The minimum wage was frozen between May 1974 and May 1975, at which time it was increased by 12 percent for urban workers and by 15 percent for rural workers while the wage freeze was maintained for all employees earning more than T.Sh. 440 per month. There have been no further legislated wage and salary increases since May 1975. In the future wage increases will be geared to improvements in labor productivity. 17. On the production side, the Government has taken a number of steps to stimulate agricultural production. The share of Government development expenditure allocated to the agricultural sector has increased from 16 percent in 1973/74 to 23 percent in 1976/77. During late 1974 and 1975 the Government urged farmers to grow more food under the campaign "farming as a matter of life and death". The main features of this campaign were appeals to the population to expand the area under cultivation and free distribution of seeds and fertilizers under the national maize program. As a result of these factors, and given improved weather conditions, the 1975 maize and rice crops were much better than in the two previous years. 18. Recognizing the importance of agricultural pricing policy, and the fact that producer incentives had been dampened by low producer prices, the Government announced substantial increases in agricultural producer prices in May and November 1974. Also, in order to keep the issue of adequate producer prices under continuing review, an agricultural price review unit was established in the Marketing Development Bureau of the Ministry of Agriculture with the assistance of a team of FAO experts. Following extensive studies of cost-price relationships and farmer incentives this unit has recommended, and the Government has adopted, further producer price increases for all major crops in 1975 and 1976. As a result of these improvements producer prices are now close to export or import parity levels at the current exchange rate. The Government intends to maintain agricultural prices at levels which will provide adequate incentives to farmers and which will create a balance between export crops and food crops for domestic consumption. a0- In the past agricultural production has also been handicapped by inadequate project planning and implementation. Managerial staff has been dispersed too widely and staff turnover has been extremely heavy as a result of the Government decentralization and creation of new agencies. The Government rec- ognizes the need to assign competent Tanzanian managerial staff to agricultural projects and to ensure that they have sufficiently long tenure to enable them to become effective on the job. In an effort to improve agricultural sector planning and implementation a project coordination unit has been established in the Ministry of Agriculture with responsibility for monitoring and expediting implementation of projects under the Ministry. A Bank staff member and an Agricultural Development Service (ADS) staff member have been assigned to the unit. Currently about ten other ADS advisors are working in Tanzania. 1/ In project preparation the Bank has assisted directly in the preparation of three comprehensive regional development projects as well as the National Maize Project (Credit 606-TA) which is the first phase of a comprehensive national agricultural development program. 1/ This represents approximately 40 percent of the total number of ADS advisors presently in the field in the Eastern Africa Region.  - 7 - 20. Despite Government efforts to increase the availability of agricul- tural inputs and credit, agricultural production has been adversely affected by the inadequacy of the distribution system for production inputs, agricultural output, and consumer goods, including inadequate storage and road transport. In 1976 the Government introduced a number of changes in the distribution net- work. The former system of cooperative societies and regional cooperative unions is being replaced by newly-established village cooperatives which will represent all village members. :hese village sccieties will deal directly with the parastatal crop authorities, such as the tea, tobacco, cotton, sisal, coffee and cashew authorities, which have been assigned the responsibility, on a region-by-region basis, for all input distribution and crop purchases. While these changes were intended to economize on marketing and input supply costs by reducing the number of stages in the process, the reforms were introduced precipitously and a period of trial and error in the new supply and marketing structure can be anticipated. The Bank Group is facilitating improvements to the agricultural distribution system by supplying between 60,000 and 80,000 tons of storage capacity under the maize project and by financing a consultant's study of the entire grain storage system. We have also financed a consultant's study of the trucking industry under the Highway Maintenance Project (Credit 507-TA). The consultant's report has been completed and we are developing a project for assistance to the road transport sector based on its recommendations. 21. As a major component of its effort to expand material production, the Government has made significant progress during the last three fiscal years in reallocating public investment in favor of the directly productive sectors of agriculture (cited above), industry and mining. 1/ As early as 1971, following a mid-term review of the Second Five-Year Plan (1969-74), the Government recognized the need to reallocate development expenditures to more productive, quick-yielding investments. While it has taken some time for this policy decision to be reflected in the pattern of investment expenditures, because some major infrastruc- ture projects such as the Tazara Railway and the Phase I Kidatu Hydroelectric Project have only recently been completed, and because the identification and preparation of directly productive investments is a lengthy process, the results can clearly be seen in the 1974/75, 1975/76 and 1976/77 development budgets. 22. This fundamental restructuring of public investment necessarily means that relatively less investment resources are available for other sectors, in particular for primary education and rural water supply. In recognition of this fact, and also because the recurrent and capital cost requirements of these targets would be entirely unmanageable even under normal economic circumstances if they were to be implemented using past methods, the Government is stressing the need for local self-help, particularly in village school construction, lower cost delivery systems based on lower design standards, and cost recovery. At the Government's invitation the Bank participated, in March 1976, in a study which analyzed the fiscal implications of these social sector targets and examined alternative, lower-cost solutions for delivery of these vital services. 1/ The Bank Group has supported this effort by significantly increasing the proportion of our own lending to these sectors over the past three fiscal years. See Part II for details.  -8- (iv) Major Issues for the Future 23. In our view the general thrust of the Government's policy framework is correct and those initiatives already undertaken represent a commendable effort to confront the economic crisis. However, both the Bank and the Government recognize that further adjustments are required to deal with the severe constraints to growth which still remain. This need for further adjust- ments is predicated on the assumption that present levels of real external capital flows may be neither sustainable over the long-run nor consistent with the Tanzanian objective of self-reliance. Even at the present level of external aid the management of the balance of payments has required import restrictions which have taken some toll of potential output. Parastatal Efficiency and Capacity Utilization 24. One important factor underlying the present economic difficulties in Tanzania has been the poor performance of parastatal manufacturing and marketing enterprises. With parastatals accounting for about half of value added in manufacturing, declining labor productivity in these enterprises has contributed significantly to the slow growth of material production. The causes of inadequate performance are numerous and complex. These enterprises have been largely insulated from the discipline of market forces by the pre- vailing system of wage, price and import controls and by deliberate deemphasis of the profit motive. They also suffer from a basic scarcity of trained managerial personnel and skilled labor, weak incentives for management and workers, starting-up problems in some recently initiated industrial activities, and periodic shortages of key inputs. While numerous Government agencies are intended to oversee and control the operations of parastatal enterprises, clear guidelines for setting objectives and responsibilities and for evaluating performance have been lacking. 25. The low productivity of parastatal enterprises has been accentuated in the past two years by a decrease in capacity utilization. This underutilized capacity in the manufacturing sector has been largely due to periodic disruptions in power and water supplies which have been or are being corrected and to the shortages of foreign exchange for spare parts and materials which can only be alleviated in the short-run by increased external aid in the form of quick-disbursing, freely-usable foreign exchange. Solutions to the longer-term problems of low labor productivity and parastatal inefficiency are more difficult. These issues were addressed in the Bank's 1975 Industrial and Mining Sector Survey (647-TA) as well as in the 1974 program loan discussions. They were also the focus of a 1975 ILO report 1/ and of numerous Government internal policy papers. Many remedial measures have been suggested, including (a) streamlining the structure of parastatal organizations; (b) decentralizing greater decision-making authority to enterprise managers; (c) revising the incentive framework for managers and workers with stronger use of negative incentives, including reductions in work force when over- manning becomes an obvious problem; (d) modifying the present system of cost-plus price setting to induce greater cost-consciousness on the part of enterprises; and 1/ Report to the Government of Tanzania on the Past, Present and Future of Income Policy in Tanzania, International Labour Organization, Geneva, 1975.  (e) elimination of Treasury subsidies to loss-making parastatals and/or shutting down enterprises which make continuing losses. 26. Despite awareness of and concern over parastatal inefficiency, Government has not yet developed a comprehensive framework for dealing with the problem. Some steps have been taken, including retrenchment of staff in clearly overmanned parastatals such as the Tea Authority, Texco (the textile holding company), the cement works and the meat packing plant; an 8 percent ceiling imposed on allowable cost increases for overheads in manufacturing firms which apply to the National Price Commission for price increases; and the hiring of a foreign consultant group to advise on operational and managerial improvements for National Development Corporation (NDC) subsidiaries. However, the Government is still reviewing the problems and possible solutions for this sector before making far-reaching changes. The Bank has conducted a series of reviews of many of the parastatals with which we have been associated in our projects (tea, tobacco, cashews, sugar, livestock and meat) and we have been assisting the Government in attempts to improve the operations of these enter- prises. Over the next 18 months we are planning to carry out further studies on exporting parastatals and on the parastatal sector as a whole. The Need for an Export Policy 27. Another problem area which has been highlighted by the economic crisis is the poor performance of exports. The low growth in export volumes prior to 1974 was primarily due to the slow growth in agricultural production, but it may also be partly attributed to an ambivalence toward primary commodity exports, which in some quarters were regarded as symptomatic of the colonial pattern of trade. However, this ambivalence was not compensated by a sufficient effort to encourage processing industries which would increase the domestic value added component of agricultural exports. The cost of this lukewarm attitude toward the export sector was borne home by the crisis. 28. Since the economic crisis the Government's attitude has changed and some measures to stimulate exports have been taken. Cash crop producer prices have been increased and certain taxes on agricultural exports have been reduced. In October 1975 Tanzania devalued the shilling by 14 percent, acting in conjunction with Kenya and Uganda. The principal motivation for this action was to afford greater incentive to export producers by permitting increases in the shilling prices of their products. The Government has also proceeded with the expansion of agricultural processing industries in sugar, tea, cashew, tobacco and sisal and is seeking a stronger export orientation for existing resource-based industries such as textiles, wood products, cement, leather and leather products. Some investments in these subsectors have already occured and others are planned. An export promotion bureau has been set up in the Ministry of Trade and an export department has been established in the Bank of Tanzania to facilitate export financing. The World Bank has been asked by the Government to conduct a study of the prospects and problems of processed and manufactured exports. This study will be carried out during 1977.  - 10 - 29. While all of the above are steps in the right direction further efforts will be required over the medium term. In the long run Tanzania may have possibilities for mineral-based exports, but for at least the next decade a successful export strategy must rest on boosting agricultural and processed exports. The export effort remains subject to serious uncertainties, in particular the problems of institutional change, marketing and transport in agriculture and low factor productivity in manufacturing. These problems pervade the entire economy and until they are ameliorated they will continue to hamper export growth. To compensate for them exports will require special inducements. Producer prices are likely to need continued, periodic upward adjustments if the relative profitability of export crops is to be improved and then maintained. For processed and manufactured exports the Government's investments in new capacity should be accompanied by changes in the institutional and price framework, including export subsidies where needed to make such exports financially viable. Budget Control 30. Another major problem which has become apparent during the economic crisis is the difficulty which the Treasury is having in keeping Governmental expenditure within budgeted limits. From 1968/69 to 1972/73 current expenditures grew at approximately 16 percent per annum, a high rate but one which is consistent with the rapid expansion of the public sector under the Government's program of socialist development, and furthermore this rate was matched by a corresponding growth in current revenues. In 1973/74 and 1974/75, however, the rate of growth of current expenditures rose to almost 40 percent per year, well above the rate of growth of revenues. This acceleration of expenditure growth contributed to a high rate of Government borrowing with serious inflationary consequences. In response the Government introduced a budget for 1975/76 which called for containing current expenditures at a level significantly below the revised estimate for 1974/75. However, actual recurrent expenditures in 1975/76 exceeded budgeted amounts by a considerable margin, with the result that Govern- ment borrowing from the banking system exceeded the already inflationary level of 1974/75 and far exceeded the ceiling established in the annual Finance and Credit Plan and agreed with the IMF as one of the conditions for a second credit tranche drawing during 1975/76. 1/ Quite clearly, it was proving difficult to reverse the pattern of rapid expenditure growth in an environment characterized by continuing inflation and an underlying tendency to extend human and financial resources in pursuit of ambitious social and economic goals. 31. For a considerable time after the budget control problem first emerged it was not fully perceived because of delays in expenditure reporting following decentralization and because the Treasury had instituted a new system of budget control which was proving difficult to implement. However, there is now full recognition of the problem and a determination to correct it, and several significant steps have already been taken. In March 1976 the Government 1/ Because Government borrowing exceeded the limits of the IMF Agreement, Tanzania was unable to make any drawings under the standby during 1975/76.  - 11 - reduced total civil service employment by almost 10,000 persons,or some 6 percent, through forced retirements and dismissals. In addition no general wage and salary increases have been granted to Government employees since May 1974, beyond the small adjustment in the minimum wage for the lowest paid groups in May 1975. An "early warning" system has been set up to monitor regional expenditures (about 20 percent of the total) on a monthly basis and central ministry accounts on a quarterly basis. 32. For 1976/77 the Government intends to limit the growth in total public expenditures to 16 percent while revenues are expected to rise by 17 percent, due largely to new tax measures. After allowing for a reduced level of carry-over expenditures from the previous year, an overall budgetary deficit slightly lower than that for 1975/76 is forecast. Net Government borrowing from the banking system is to be limited to T.Sh. 700 million, a reduction of 40 percent from 1975/76. In January 1977 the Government entered into an agreement with the IMF for further drawings on IMF facilities (balance of first credit tranche plus trust fund) based on the above-mentioned ceilings on public spending and credit expansion. The Government intends to adhere to this agreement even if the credit ceiling necessitates a further reduction in planned expenditures. However, the problems of over-commitment arnd over- expenditure have grown to such magnitude over the past three fiscal years that further corrective measures may be needed and full restoration of fiscal control will be a matter of seme years rather than months. (v) Economic Performance in 1975 and 1976 33. The major macroeconomic indicators have generally improved since 1974, reflecting both improved weather and the effects of the policy measures which were introduced to deal with the crisis. Agricultural production increased by 6.6 percent in 1975 compared to a decline of 3.3 percent in 1974, while total GDP grew by 4.6 percent compared with only 2.2 percent in 1974. This was despite the fact that during 1975 production of cotton and some other cash crops still suffered from disorganization due to villagization. In 1976, some of the problems of villagization were being rectified through "operation correction" and since rains were once again favorable agricultural production was generally good. Preliminary estimates are that both agricultural production and total GDP increased by about 5 percent in 1976. However, output in the modern sectors of industry and construction has remained at a depressed level, in part due to shortages of building supplies, raw materials and spare parts occasioned by the severe import restrictions which have been imposed to conserve scarce foreign exchange. The high investment rate has been sustained during this period, in large part through increases in the level of foreign assistance, but there has also been a modest recovery in the domestic savings rate. While inflation worsened in 1975, there was a significant reduction in the inflation rate in 1976.  - 12 - 34. The goods and services account of the balance of payments continued to deteriorate in 1975 due to continuing production difficulties and declines in scme agricultural export prices. Total export receipts declined by 10 percent from the level of 1974. Despite further reductions in the volume of non-food imports, the total import bill rose by 6 percent over 1974 due to continuing import price inflation and the necessity to continue food imports during the first two-thirds of the year. As a result of these trends the trade deficit increased from $340 million in 1974 to $400 million in 1975, and even after allowing for a high level of project-related capital inflows and a huge increase in grant assistance and concessional food aid, there was a residual deficit of almost $75 million. Whereas the 1974 residual deficit was filled almost entirely through a combination of IMF assistance and reserve depletion, the 1975 deficit was met through foreign assistance from a wide variety of sources, including a $30 million program loan from the World Bank, further IMF drawings (1974 and 1975 oil facilities), bilateral program aid and other multilateral assistance. The total foreign assistance inflow during 1975 exceeded p300 million, or over $20 per capita. However, because of the very concessional terms on which aid has been given to Tanzania, and the Government's refusal to use higher cost commercial loans and suppliers credits, the overall debt service ratio has remained low - including a notional 40 percent share of the debt of the East African Community Corporations it was less than 8 percent in 1975. (Further details on external debt are provided in Annex II.) 35. In 1976 the balance of payments picture improved. The trade deficit declined due to strong export performance, especially for coffee and cotton, and to a slight fall in the value of imports occasioned by a greatly lessened need for foodgrain imports and continuing tight restrictions on all other categories of imports. Project related capital inflows remained at the high level of prior years, although exceptional balance of payments assistance was limited to $24 million (SDR 21 million) from the IMF's export compensatory financing facility. (Tanzania was eligible for this drawing because of the slump in exports in 1975.) The overall balance of payments is expected to show a surplus of about $35 million for the year and net foreign exchange reserves have increased to $115 million which is equivalent to two month's import require- ments at the 1976 level, a modest improvement over end-1975 but still an inadequate level. (vi) Balance of Payments Forecast 36. For 1977 the Government's objectives are to sustain the 5 percent rate of growth of GDP attained in 1976 and to further reduce the rate of domestic inflation. Based on this overall growth target, our projections indicate a widening of the trade deficit by some $100 million, reflecting primarily a selective liberalization of imports following several years of very tightly constrained import levels. The value of exports is projected to increase only moderately. Almost all of the improvement in exports in 1976 was due to higher prices for coffee and cotton, along with a recovery in the volume of cotton production, and further increases of this magnitude cannot be counted on in 1977. Thus even with anticipated improvements in the volume of sisal, cashew, tea and tobacco exports the total increase in export earnings is not expected to exceed 9-10 percent.  - 13 - 37. On the import side an increase of some 20 percent in value terms (13 percent in real terms) is projected. Consumer goods imports have been maintained at austerity levels for the past three years, and this restraint will continue during 1977. However, raw materials and spare parts imports have been severely constrained with the result that essential industries have been suffering from production bottlenecks. The Government intends to relax the import control system sufficiently to allow for an increase in the volume of industrial inputs and spare parts sufficient to raise the average utiliza- tion rate of industrial capacity from 60 percent to 80 percent. The projected rate of growth in industrial output is 7 percent, compared with an average annual growth rate of only 2.5 percent over the period 1974-76. The program of import liberalization is also designed to permit an increase in inventories which are inadequate at the present time, and in spare parts for the transportation sector. Finally, it is intended to increase foodgrain imports from $15 million in 1976 to $20 million in 1977 in order to begin building a strategic grain reserve. 38. Our balance of payments forecast assumes that grant assistance plus project-related capital inflows will be maintained at roughly the same level in real terms as in 1976. The same holds true for net service income. The residual deficit in the balance of payments which results from the above set cf assumptions is $50 million. Details of the balance of payments forecast, and a comparison with earlier years, are shown in the table below: BALANCE OF PAYMENTS SUMMARY TANZANIA MAINLAND (Millions of Current US$) 1/ 2/ 1973 1974 1975 1976 1977 A. Exports (f.o.b.) 327.9 380.7 328.4 438.3 480.0 B. Imports (c.i.f.) -485.7 -719.1 -731.9 -692.1 -835.0 Trade Balance -157.8 -338.4 -403.5 -253.8 -355.0 C. Services (net) 18.6 21.2 60.9 60.1 65.0 D. Transfers (net) 5.0 45.3 93.0 83.3 100.0 Balance on Current Account -134.2 -271.9 -249.6 -110.4 -190.0 E. Public Capital (net) 136.0 97.7 108.7 110.2 115.0 F. Other Capital (net) -6.5 31.9 21.0 23.9 25.0 G. Net Errors and Omissions 35.3 3.9 46.5 11.0 - Overall Balance 30.6 -138.4 -73.4 34.7 -50.0 H. Exceptional Financing 3/ - 53.6 64.2 24.2 I. Net Change in Reserves (+ = decrease) -30.6 84.8 9.2 -58.9 Total of H and I -30.6 138.4 73.4 -34.7 1/ Estimated. 2/ IBRD staff projections. l Includes IMF facilities, IBRD prograrn loan, and other bilateral and multilateral balance of payments support.  - 14 - 39. Tanzania is considered eligible for Bank lending on Third Window terms on the basis of the following criteria: (a) Per capita income In 1975 - $170 (b) Performance The Government's strong commitment to development is evident from the high rates of domestic savings and gross investments which averaged 17 percent and 21 percent, respectively, of the GDP between 1967 and 1973 (paragraph 9 above). Its program for economic restructuring (paragraphs 14 - 22) is basically sound and, in order to achieve this restructuring, Tanzania has shown itself willing to adopt necessary but un- popular measures over a wide front. (c) Ability to repay In view of the Government's encouraging response to the serious balance of payments crisis, its prudent management of the foreign debt (paragraph 34 above) and good medium term development prospects, Tanzania is creditworthy for limited amounts of Bank lending but in order to safeguard its creditworthiness, Tanzania needs to obtain as much external finance as possible on concessional terms. (d) Access to alternative sources of capital Tanzania's ability to implement its development program depends to a large extent on the continued availability of external capital. While it has received additional external assistance in recent years, this has not been commensurate with its need and it cannot prudently borrow substantial additional sums on commercial terms. East African Community (EAC) 40. The 1967 Treaty for East African Cooperation made provisions for far-reaching and comprehensive economic cooperation arrangements among Kenya, Tanzania and Uganda. In its initial years, the EAC had set up institutions, policies, and procedures for operating the common market and the large infra- structure services, and encouraging progress was achieved. It has been followed, however, by a period of tension and mutual suspicion concerning the distribution of net benefits derived from the Community. The infrastructure services were hampered by restrictive tariff policies; services declined, and Partner States subventions were required for the Railways from time to time to keep the services running. The poor performance of the common services in transport and communications also impaired trade and general movement of goods within  - 15 - the countries, affecting the general economic development program. These difficulties were aggravated by the severe budgetary and balance of payments constraints faced by all three Partner States in the past few years. As a consequence, there has been a continuous diminution in the authority of the Community institutions and in the effectiveness of accountability procedures. Failure to agree on arrangements for transfer of funds between the Regional Offices and the service Headquarters have often paralyzed the operation of the Headquarters, affected their morale and on a number of occasions led to delays in meeting their external obligations. 41. In 1975 the Partner States recognized that their fundamental political and economic differences had so affected the working of the Community that a review of the 1967 Treaty was called for. A Commission was appointed for this purpose in November 1975 but adjourned since die in November 1976 without being able to make agreed recommendations regarding the future structure of the EAC. Meanwhile, although no dejure action has been taken, further deterioration in Community relationships has led to a further dismantling of the Corporations. The Railways Headquarters has in effect been disbanded and the nationals working in the Headquarters have joined their respective Regional Offices. Recently, the East African Airways Corporation (EAA) collapsed in part due to the lack of effective mechanism for interstate transfer of funds. The Head- quarters of the East African Harbours Corporation has existed in name only for at least a year with the ports authorities in Mombasa and Dar es Salaam functioning autonomously. The East African Posts and Telecommunications Corporation has so far functioned with a semblance of Headquarters responsi- bilities but is in fact delegating its headquarters functions to its regional offices. The respective regional branches provide the service, and domestic development programs in this sector are not likely to be impaired. Despite these difficulties, the proceeds of the various current Bank loans are being effectively used for approved and priority purposes. 42. The difficulties facing the EAC and the common services have affected the Bank's lending to the Community. Because of failure to meet debt service obligations, the Bank suspended disbursements last year for about a month. Except for a second line of credit to the EADB in March 1976, the other corporations have received no new loans from the Bank since 1973. The Bank has continued to disburse on its 6 ongoing loans to the Corporations and as of February 28, 1977, $40.8 million remain to be disbursed. In addition, the Bank has provided assistance in the preparation of Railways, Harbours and Telecommunications development projects. However, in the light of the decentralization of the service corporations, the Bank is reviewing its ability to assist with urgently needed future investments. Bank staff have over the past year or so been providing whatever assistance has been requested by the Partner States and by the Review Commission. The Bank has also made it known to the Partner States that further assistance for moving in an orderly manner to new institutional arrangements would be made available should this be requested.  - 16 - PART II - BANK GROUP OPERATIONS IN TANZANIA 43. Tanzania jointed the Bank, IDA and IFC in 1962. Beginning with an IDA credit for education in 1962, 26 IDA credits and 11 Bank loans amounting to $433.8 million have so far been approved for Tanzania. In addition, Tanzania has been a beneficiary of 10 loans totalling $244.8 million which have been extended for the development of common services and the East Africa Development Bank operated regionally by Tanzania, Kenya and Uganda through their association in the East African Community. The only IFC investments in Tanzania to date totalling $4.7 million, were made to the Kilombero Sugar Company in 1960 and 1964. This Company encountered financial difficulties and in 1969 IFC and other investors sold their interest in the Company to the Government. Annex II contains summary statements of Bank loans and IDA credits to Tanzania and the East African Community organizations as of January 31, 1977 and notes on the execution of ongoing projects. 44. In keeping with Tanzania's overall development strategy our lending operations are increasingly focussing on the rural sector and on directly productive projects. Up to the end of FY72, 10 out of 15 loans and credits made directly to Tanzania had been for infrastructure. Of the 22 Tanzania operations approved since then all but six have been for directly productive projects. These directly productive projects are supporting both the agri- cultural and industrial sectors, including maize, tea, tobacco, sugar, cotton and cashew production, livestock and dairy development, fisheries and textiles. The first Bank Group assisted project in the forestry sector was recently approved and will provide the raw material for Tanzania's first pulp and paper plant, which is under preparation for consideration for Bank Group financing. We plan to continue assistance for such directly productive projects: a proposed second rural development project in Tabora Region is expected to be ready for consideration by the Executive Directors in the near future, and a third rural development project is under preparation for Mwanza and Shinyanga Regions. At the same time we are proceeding with the National Agricultural Development Program (NADP) strategy which was recom- mended in the agricultural sector report. The National Maize Program (Credit No. 606-TA) was the first NADP style project approved and another NADP project is currently under preparation. 45. While it should be borne in mind that over sixty percent of total Bank Group lending to Tanzania has been approved in the last three fiscal years and that initial start-up difficulties are perhaps inevitable, the project implementation difficulties referred to in Annex II have been greater than anticipated. Some of these problems stem from the scarcity of suitably trained and qualified manpower, some reflect the understandable  -17 - reluctance and apprehension of an essentially conservative traditional rural sector to adopt new technologies, and others are a reflection of the strains created in a society which is attempting a fundamental transformation from one type of economic, institutional and political system to another. The Government has become extremely conscious of these implementation issues and is taking steps to resolve the underlying problems. An earlier reluc- tance to recruit technical assistance for implementation has been replaced by a willingness to utilize such assistance whenever it is demonstrably necessary. The Bank's Resident Office in Dar es Salaam, which has been expanded from one to two professional staff member, is giving special atten- tion to implementation problems and the Bank has intensified the support which we are proving to project implementation through supervision missions. The close proximity of the Regional Mission in Eastern Africa (RMEA) has helped considerably in this effort. Also, at the request of the Government, about 10 technical staff have been supplied by the Agricultural Development Service (ADS) and a Bank staff member has been seconded to the Project Implementation Unit in the Ministry of Agriculture. In project preparation as well we are attempting to alleviate critical bottlenecks. RMEA has already been heavily involved in the preparation of projects in the agri- cultural sector. Our ability to supply such assistance has proved to be particularly valuable in a country such as Tanzania where project preparation capacity is extremely limited and will continue to be so for some time. In addition, we have provided a technical assistance project (Credit 601-TA) designed to strengthen Tanzania's project preparation capabilities. In a longer term attempt to alleviate the human resource constraints our lending is increasingly emphasizing formal and non-formal training. Furthermore, a conscious attempt is being made to develop less complex projects. PART III - THE INDUSTRIAL SECTOR General 47. The manufacturing sector in Tanzania presently accounts for 10 percent of GNP and is increasing in importance. The average growth rate of value added by the sector has been about 10 percent per year since indepen- dence. The share of manufacturing employment in total non-agricultural wage employment is currently in excess of 20 percent, having increased from 12.5 percent in 1964. The total number of jobs in registered manufacturing enterprises employing 10 or more is currently about 60,000. The contribu- tions of the mining sector to gross national product, exports and wage employment are presently small, measuring approximately 2 percent, 8 percent and 1 percent, respectively.  - 18 Industrial Development Strategy 4.. Since independence, Tanzania has followed a pattern of industrial development concentrating on establishing or expanding industries for import- substitution. Examples include textile, beer, cigarettes, radios, glass, cement and metal products. As a consequence of this strategy, imports of consumer goods have been reduced from 54 percent of total commodity imports in 1961 to a current figure of less than 25 percent. However, recently in the context of preparing its long-term development strategy, the Government reviewed its industrial objectives and chose a "basic industrial strategy." In essence, the basic industrial strategy aims at a gradual structural transformation of the economy by giving priority to industries that process domestic raw materials for consumption in the home market and by requiring that traditional exports are processed locally as far as can be economically justified. The "export promotion" aspect of the strategy has been given added urgency by the need to close the current balance of payments gap (para- graphs 27-29 above). The strategy aims at promoting harmony between the pattern of production and the pattern of domestic consumption, while the promotion of manufactured exports is seen as a logical extension of production for the home market. In the context of this strategy, the Government plans to emphasize the development of domestic machine tool manufacturing and maintenance capacity. Hence, the promotion of metal engineering industries and the training of industrial engineers will receive special attention. It is also expected that a key component of the strategy will be the establishment of an integ- rated steel mill of as yet undetermined size based on domestic coal and iron ore. Projects that do not fit the underlying strategy will be expected to earn a higher rate of return than projects that fit the strategy to be eligible for approval by the central planning authorities. li8. The Bank's Industry and Mining Sector mission report, which was dis- tributed to the Executive Directors in April 1975 (paragraph 2), raised issues concerning the improvements required in the productivity of existing state manufacturing enterprises and the need for increasing the efficiency of the public sector. Rewards for efficiency and penalties for inefficiency within the parastatal system are at present weak and this is probably one of the main reasons for a relatively low level of productivity in many such enter- prises. The absence of clear and unequivocal performance yardsticks, together with the introduction of many direct economic controls on the activities of public and private sector enterprises alike, appears to hiave had an adverse effect on the motivation of firm level management in many industries. At the same time, the Government's task of identifying inefficient operations has become more complicated as poor economic performance is not necessarily reflected in a company's profit and loss account or in any other obvious way. The sector mission recommended that a move away from more comprehensive controls  - 19 - towards a judicious and selective use of indirect controls, including material incentives and decentralized decision making on the firm level, might well be compatible with Tanzania's development objectives and at the same time be conducive to greater efficiency and industrial development. While numerous agencies are responsible for overseeing and controlling the operations of parastatal enterprises,clear guidelines for setting goals and evaluating performance are lacking. These problems, which were the subject of an ILO report on wages, incomes and prices, have been a central focus of recent negotiations for the Program Credit which was approved by the Executive Directors on March 15, 1977. 49. In resptnse to these problems the Government is now placing high priority on increasing productivity in the industrial sector, improving the organization and efficiency of parastatal enterprises, and adjusting the price system to ensure that market prices better reflect the social costs of producing industrial goods. In this connection, the Government has prepared policy papers dealing with the incentive system for workers and managers, parastatal organization, Government control of parastatals, and the price and import control system, and it is expected that policy changes dealing with these problems will be announced shortly. As part of this effort the Government is currently drawing up plans to reduce parastatal employment. This follows the reduction in Government employment of about 7 percent effected in early 1976 (paragraph 31). 50. Since the Arusha Declaration (1967) and the acquisition by the Government of majority interest in all important manufacturing enterprises, mining and financial institutions, most industrial and mining activity is now in the public sector. All major projects started after 1967 have been in the public sector. Nevertheless the contribution of private firms is appreciable and accounts for about 25 percent of the value added and 50 percent of the employment in the sector. At the April 1975 meeting of the Consultative Group on Tanzania, the Government declared its willingness to participate in joint ventures with foreign private parties particularly when such cooperative endeavors could give Tanzania access to needed tech- nical expertise. This could be particularly important in the mining sector and in export-oriented manufacturing industries. While no major project has yet attracted foreign private partners, there has been an increase in the lending activity of private foreign banks in Tanzania. Livestock and Leather 51. Following Ethiopia and Nigeria, Tanzania ranks as the third most important producer of hides and skins in Africa. In 1975 an estimated  - 20 - one million hides and 1.5 million skins were available commercially. The former figure represents the annual off-take of the national cattle herd of about 10 million head which is managed almost entirely on traditional lines. The sector has all the deficiencies usually associated with traditional production: low productivity reflecting inadequate nutrition, high disease incidence, poor herd management and poor quality of the native cattle. IDA has supported the Government's program for the development of both the commercial and traditional sector through two credits for livestock (132-TA and 382-TA), the first of which is fully disbursed. IDA is also supporting livestock development in the rural development project in Kigoma (508-TA) and a dairy project (580-TA). 52. In keeping with its strategy of increasing the local value added of traditional exports (paragraph 47 above) programs for expansion of leather processing industries have been encouraged by the Government. Currently three commercial tanneries are operating in Tanzania capable of processing some 200,000 hides and 310,000 skins per year. When the tanneries presently under implementation or planned for early implementation are complete, Tanzania will have a national capacity to process 80 percent of the domestic hides and skins expected to be commercially available in 1980. 53. Tanzania successfully exports dried and wet-blue hides, crust and finished leather from the Moshi tannery. Improved leather quality is expected from the existing or planned modern tanneries at Moshi, Mwanza and Morogoro, and there should be no difficulty in exporting tanned leather at acceptable margins of profit to a growing world market. Tanzania has not exported finished leather goods in any significant quantity. The present Tanzanian output of leather and canvas shoes, while of acceptable quality in the domestic market, cannot compete internationally. Recently leather work gloves have been exported and small quantities of leather jackets and handbags have achieved limited acceptance among tourists. Internationally there is a large and growing demand for quality leather goods provided they are competitive in price and style and suitable marketing channels are established. It is anticipated that the products of the shoe and leather goods factories to be located in Morogoro industrial complex will be able to meet these requirements. Cotton and Textiles 54. Tanzania is the fourth largest cotton producer in Africa with an output of 430,000 bales in 1973, up from 160,000 balleF in 1958. Only about 15 percent of the cotton crop is presently processed domestically into yarn and woven cloth, the balance being exported as baled cotton. The textile industry, virtually non-existent 10 years ago, is now the largest industry in the manufacturing sector, accounting for about 25 percent of sectoral employ- ment, 13 percent of value added and 11 percent gross industrial output. The National Textile Corporation (TEXCO), a government parastatal, holds shares in and oversees the operations of the seven existing textile mills in Tanzania. The Bank, in cooperation with the Kuwait Fund, is supporting a major expansion  - 21 - of the integrated textile mill at Mwanza (Loan No. 1128-TA). Currently, of 63,000 bales of cotton processed in Tanzania annually, 60,000 bales are AR and 3,000 bales BR grade. Another 40,000 bales of BR cotton are exported. Canvas is made from BR cotton and there is a promising inter- national market in this commodity. Tanzania's first indigenous production of canvas and canvas goods will take place in the Morogoro Industrial Com- plex and will consume 57 percent of current exportable surplus of BR grade cotton. The National Development Corporation 55. The National Development Corporation (NDC), headquartered in Dar es Salaam, is the largest parastatal holding company and Tanzania's principal instrument for industrial investment. NDC holds shares in 22 companies, of which 17 are classified as subsidiaries (over 50% NDC share- holding) and 5 are associate companies (50% or less NDC shareholding). The 22 companies which are operating in metal working, tobacco and beverages, printing and publishing, chemicals and allied products, and leather tanning and processing, presently employ about 9,000 people. Operations of the NDC companies have been profitable every year since 1968 on a consolidated basis although individual companies have experienced losses. In 1974, for the first time, each of the companies made after-tax profits. Similar results were achieved in 1975. The overall capitalization of the NDC is sound with a debt/equity ratio of 35/65 though a somewhat tight liquidity. Conso- lidated profits as a percentage of sales of NDC's Group Companies have fluctuated between about 6 and 8 percent per annum since 1972. These operational results of the Group Companies are considered only modestly satisfactory. In 1974/75, therefore, NDC instituted a comprehensive program of in-plant reorganization and efficiency studies to correct known problems in management, maintenance, inventory control, excess receivables, unbalanced process lines, worker skills and incentives. Initial results are promising; for example, in 1975, receivables were reduced in aggregate by TSh 25 million. In 1976 NDC followed up this initial effort by bringing in industrial consultants to review capacity utilization in each of its operating com- panies. The recommendations of these consultants are being reviewed and it is expected that NDC's efforts in these areas will lead to continued improvements in performance. 56. The staff of NDC have developed substantial capabilities in the textile and leather sectors. Three of the Group Companies -- Tanzania Hides and Skins, Tanzania Tanneries and Tanzania Shoe Company -- are the country's major processors of hides and skins from raw materials to finished products. Until 1973/74, NDC also managed the country's textile firms. These have since been transferred to another specialized parastatal (TEXCO) (paragraph 54), but NDC's experience in the textile sector provides a solid foundation for planning and implementing the canvas mill component of the Morogoro Complex.  - 22 - 57. When completed, the proposed Morogoro Project will add three operating companies to NDC's existing portfolio of 22. Projected aggregate revenue in current terms of this Project in 1982, when full operating capa- city is scheduled, will be about US$33 million representing about 7 percent of NDC's total 1982 estimated revenue of US$450 million to US$500 million (including the operations at Morogoro). These figures indicate that the Morogoro Project, while large, should not per se place an extraordinary burden on NDC's financial and management capabilities. Bank Experience in the Industrial Sector 58. Bank experience in industry has followed two separate lines -- lending to the Tanzania Investment Bank (TIB) as a financial intermediary and participation in the preparation and/or financing of large industrial projects. In both cases, the implementation records have been good. The beneficiary of one credit (460-TA) and one loan (1172-TA), TIB has built up a sound organizational structure with all Departments headed by qualified Tanzanians. Since TIB's founding, the Bank Group has had continuous involve- ment with the numerous interrelated aspects of organizational development (technical capacity, training, internal operating procedures, etc.) and has been impressed with TIB's rapid development. In the first large industrial project approved for direct Bank-finance Mwanza Textile (Loan 1128-TA) project implementation is ahead of schedule and costs are presently within appraisal estimates. In addition, in the preparation of a number of large industrial projects (particularly phosphates), the Bank has been asked by the Government to review projectconcepts and design at the very early stages of identification and preparation. PART IV - THE PROJECT 59. An Appraisal Report No. 1213-TA, dated March 3, 1977 entitled "Morogoro Industrial Complex" is being distributed to the Executive Directors separately. A Loan and Project Summary is provided as Annex III to this report. 60. The Project was prepared by consultants and NDC, assisted by several Bank project preparation missions which visited Tanzania in 1974 and 1975. Negotiations were held in Washington from August 7 to August 12, 1976. The Tanzanian delegation was led by Mr. E. Mulokozi (the then Chair- man, NDC). The Project, fully consistent with the Government's policy of increasing the local processing of domestic raw materials (paragraph 47 above) finances part of the establishment of an industrial Complex at Morogoro, specifically the industrial estate and the construction of a shoe factory and a leather goods factory primarily aimed at the export market.  - 23 - Together with a tannery already under construction with Bulgarian assistance and a canvas mill supported by the EEC (which are described in paragraph 66), these projects constitute a vertically integrated industrial complex to process raw hides, skins and cotton into intermediate and finished products. Following negotiations, lengthy discussions with EEC became necessary in order to define responsibilities and delay was also necessary to enable the selected shoe factory technical assistance contractor to review the design and cost estimates before finalizing the loans. 61. The Project would be located at Morogoro, a regional capital with a population of about 40,000, situated some 180 kilometers west of Dar es Salaam. The site is close to the Tan-Zam highway as well as the newly completed Tan-Zam railway and the central railway line connecting the Port of Dar es Salaam with Dodoma, Mwanza and Kigoma. Because of these excellent transport linkages, its central location both in terms of access to raw materials and marketing of finished products, the compatibility of its terrain and climate for the factories involved, and the ready access to labor, Morogoro is a suitable location for the proposed project. Industrial Estate 62. The Project would include the establishment of a 65 ha industrial estate constituting the first phase of a development ultimately expected to cover about 200 ha. It would comprise necessary infrastructure including land development, a basic road network, provision of utilities (including power, water, telephones, sewage disposal), four standard factory buildings and housing for senior personnel. The standard factory buildings would house the estate's administrative offices and the leather goods factory (paragraph 65) and would be available for subdivision and rental to small and medium-scale industrial enterprises. Initially only two of the standard factory buildings would be constructed. The remaining two would be built when the demand for additional factory space justifies the investment. The decision to proceed with them would be taken in consultation with the Bank (Section 3.05 of the draft Loan Agreement). A major part of this additional space is expected to be occupied by various ancillary industries producing products substituting for imported items needed by Project factories. Rental charges for both estate factories and housing would be established at levels which yield appropriate financial returns on the investments involved. 63. The Morogoro Industrial Complex, including the tannery and canvas mill, will have an average daily water demand of 2,800 m3 and a peak load of 4,000 m3. Initially water will be drawn from the nearby Ngerengere River but this source has limited capacity and during the dry season operations would have to be curtailed or shut down. A prolonged period of drought, as has occurred twice in recent years, would be a major disaster for the Complex.  - 24 - To avoid this, the Bank-financed Mindu dam and pipeline project (Loan 1354-TA) would provide a reliable water supply to both Morogoro town and the Industrial Complex. When implemented, the 29 million m3 of water impounded at Mindu Dam, five kilometers from Morogoro, will assure uninterrupted service to the Morogoro area. The Ministry of Water, Energy and Minerals has already engaged consultants to prepare detailed designs for the Mindu Dam and it is expected that con- struction will start in mid-1977 and be completed by about mid-1979, i.e. about the time the factories in the Complex will be starting production. Shoe Factory 64. The shoe factory would be designed for an annual production of two million pairs of leather and two million pairs of canvas shoes. The feasibility study for this project recommended that about 10 varieties of leather and canvas shoes be produced. However, it could be more economical to concentrate, at least for the initial product mix, on one or two basic types of leather and canvas shoes. It is also likely that equipment more suitable for hand-made rather than machine-made canvas shoes would be procured since international demand is strongly biased towards the former. This would be appropriate to Tanzania's comparative advantage in labor as well as hav!ng positive income distribution effects. Leather Goods Factory 65. The leather goods factory, which would consist of a number of working areas in which skilled craftsmen using small powered and hand tools produce various types of leather goods, would be housed in one of the standard factory buildings (paragraph 62). Annual production at full capacity would be about 18,000 handbags, 10,000 suitcases, 32,000 wallets, 14,000 leather belts and 40,000 leather jackets. In addition to leather, the basic raw material, lining material, thread, glue, locks and other hard- ware constituting about 15 percent of the total raw material cost would be needed. These items would initially be imported but in time could be replaced by domestic production in small-scale ancillary workshops. Canvas Mill and Tannery 66. There are two additional investments in the Morogoro Complex which are not being financed under the Bank project. One, the first canvas mill in Tanzania (paragraph 54) was appraised by the Bank's field mission in 1975 along with the three Project components. Subsequently, it was agreed that EIB/EDF would undertake the financing of the canvas mill. These institutions conducted an independent appraisal in October 1976 and have scheduled final approval of a combined financing package for mid-1977. The mill will produce 7,662,000 m2 of canvas cloth to various specifications, of which about 7 percent or 558,000 m2 will be delivered to the shoe factory and the balance sold for other domestic uses or exported. A leading Nether-  - 25 - lands manufacturer of canvas has reassessed the original feasibility study and will be contracted to provide engineering design, construction super- vision, mill management and marketing services. While the canvas to be produced at Morogoro is not essential to the success of the shoe factory (canvas can be imported), the development of the canvas mill in parallel with the Bank project would generate numerous benefits enhancing the over- all performance of the Industrial Complex. For that reason, the Bank and EIB/EDF project will continue to be closely coordinated through: (i) direct communication between Bank, EIB and EDF project staffs and (ii) central supervision by NDC's project management organization. The second investment is in a tannery at Morogoro (paragraph53 ). Financed under the Bulgarian aid program, this tannery was included in the original feasibility report and is designed to process 280,000 hides and 900,000 skins per year. This investment is already under implementation and is expected to commence production in about mid-1977. Implementation and Training 67. NDC would assume overall responsibility for the Project. For the Project construction period of three years, this responsibility would fall on NDC's Research and Development Department. A qualified Project Manager has been appointed by NDC. He will be provided with appropriate facilities and staff to implement the Project (Section 3.02(c) of the draft Loan Agreement) and would be assisted by a Supervising Engineer and a Works Accountant based at Morogoro. On completion of the construction period, NDC's Operations Department would assume responsibility. The three Project components (the industrial estate, the shoe factory and the leather goods factory) as well as the tannery and canvas mill would all be established as subsidiary corporations of NDC. Project companies in charge of the Bank- financed components would be established by December 1, 1978 (Section 3.02 a) and (b) of the draft Loan Agreement). 68. Operations of the estate will be the responsibility of an inter- nationally recruited resident estate manager who would be appointed after consultation with the Bank (Section 3.02(a) of the draft Loan Agreement). He would be employed by December 1, 1978 and would be responsible for training a suitable counterpart to take over his responsibilities. Any extension or termination of his contract would be initiated in consultation with the Bank (Section 3.04(c) of the draft Loan Agreement). 69. The ensurance of efficient management and quality control for the shoe factory is particularly important since its product will be entering highly competitive international markets. A technical assistance contract for the shoe factory with a qualified firm acceptable to the Bank, for factory design, procurement, construction and equipment installation, training of Tanzanian personnel, and factory start-up has been signed (Section 3.04(a) of the draft Loan Agreement). To assist in uatiaging  - 26 - operations and marketing the output of the shoe factory, it was agreed that a qualified firm would be employed on terms and conditions satisfactory to the Bank (Section 3.04(b) ot the dratt Loan Agreement). it is expected tnat the management/marketing contract will be with the same firm as the technical assistance contract. The Borrower, the Bank, NDC and the shoe company would exchange views, before contract termination, on the desirability of its ex- tension (Section 3.04(c) of the draft Loan Agreement). In reviewing draft technical assistance proposals for the shoe factory, special emphasis was placed on training and measures designed to ensure that expatriate staff can be phased out as soon as possible. In addition to in-plant programs, pro- vision has been made for training key Tanzanian .ersonnel in similar plants already operating in other countries during the construction period. This would ensure that a cadre of trained core personnel will be available in time for factory "start-up." Supervision missions would pay special attention to the training aspects of the Project. 70. It is expected that management and production personnel of the leather goods factory will, at full development, include three internationally recruited suitably qualified experts: a leather technologist, a modeler to prepare samples and patterns and a quality inspector. Growth of the leather factory will be carefully phased. This will allow the benefits of "learning by doing" to be maximized and enable the internationally recruited specialists to concentrate on training a corps of skilled Tanzanian craftsmen who will be able to continue their training functions once the specialists leave. Commercial linkages to be established with foreign marketing agencies would ensure that up-to-date designs will be continually available to keep the industry "fashion-competitive." Project Costs and Financing 71. The total Project cost, including interest during construction estimated at $4.1 million, price and physical contingencies and permanent working capital is estimated at $36.2 million net of taxes and duties, of which $23.6 million or 65 percent would be foreign exchange. Details of Project costs are included in Annex III. The industrial estate totals $9.5 million or 26 percent of Project costs; the shoe factory $25.7 million or 71 percent of Project costs and the leather goods factory $1 million or about 3 percent of Project costs. The proposed Bank loans totalling $23 million would finance nearly all of the foreign exchange requirements of the Project, including interest and other charges on the proposed loans. Financing of interest during construction is justified in view of the heavy cash outlays required for the complex until the facilities are completed. 72. The proposed Third Window loan of $11.5 million would be made to the Government on standard TW terms, i.e. 4.5 percent per annum with repayment of principal to start on January 15, 1983 and final maturity on January 15, 2001. The proposed Bank loan of $11.5 million would be made to the Government for 20 years including 4-1/2 years of grace at 8.5 percent per annum. The  -27- Government would onlend the proceeds of the loans to NDC at 10 percent per annum for 15 years including 4-1/2 years of grace. Interest would be capitalized during the three-year construction period. The execution of a subsidiary loan agreement, acceptable to the Bank, would be a condition of effectiveness of the loans (Section 6.01(c) of the draft Loan Agreement). NDC would pass on the loan proceeds to the industrial estate partly as debt ($5.5 million) and partly as equity ($1.0 million), the former on the same terms as NDC's obligaticn to the Government. It would also pass on $15.4 million of the loan proceeds to the shoe factory as debt and $0.5 million as equity, the debt again at the same terms as the Government's onlending to NDC. Finally, NDC would onlend $0.6 million to the leather goods factory on terms identical to the Government's. (Section 3.03(b) of the draft Loan Agreement). 73. NDC would contribute $13.2 million towards the costs of the Project in the form of equity. These funds would be derived from NDC's projected earned surplus over the Project execution period or from the national development budget. Assurances have been obtained from the Gevern- m.ent that any shortfall in NDC's equity funding capacity and such additional funds which may be needed to complete the Project will be provided on terms and conditions satisfactory to the Bank (Section 3.03(d) of the draft Loan Agreement). In order to ensure the financial soundness of the industrial estate, shoe and leather goods companies and timely debt service, NDC would limit the debt: equity ratio of these project companies to a maximum of 60:40; limit dividends and other forms of cash distribution by project companies to amounts which will not reduce the current ratio to less than 1.5:1; and maintain special reserve accounts in NDC's books equivalent to two years of the combined debt service of the project companies (Section 4.04 of the draft Loan Agreement). NDC and the project companies will main- tain records to adequatelyreflect the operations and financial conditions of the project companies and annual audits, acceptable to the Bank, of these companies will be conducted by the Tanzania Audit Corporation (Section 4.02 of the draft Loan Agreement). Procurement and Disbursements 74. Equipment and material orders larger than $100,000 financed out of the proceeds of the loans would be procured on the basis of international competitive bidding in accordance with Bank guidelines. In procuring manufactured goods, local manufacturers will be granted a preference of either 15 percent or the actual tariff on equipment imported, whichever is lower (paragraph C, Schedule 4 of the draft Loan Agreement). Contracts for equipment and materials smaller than $100,000 would be let following receipt of a reasonable number of quotations from qualified and experienced suppliers. Civil works contracts in excess of $100,000 would be let following inter- national competitive bidding in accordance with Bank guidelines. Local contractors would be granted a preference of 7-1/2 percent (paragraph D, Schedule 4 of the draft Loan Agreement). Civil works contracts of less than $100,000 would be let following competitive bidding in accordance with the Borrower's ordinary procedures which are satisfactory to the BanX.  - 28 - 7:;L A schedule of estimated disbursements is included in Annex III. The Bank would disburse 100 percent of the foreign exchange expenditures and 85 percent of local expenditures on equipment and materials, 50 percent of total expenditures on civil works, 100 percent of foreign exchange expend- itures on consultant services and training and the amount due for interest and other charges on the loans accrued on or before December 31, 1980. In order to avoid serious slippage in the planned three-year construction schedule provision for retroactive financing of up to $150,000 for expend- itures incurred on early design and engineering services since January 1, 1977 is proposed (paragraph 4, Schedule 1 of the draft Loan Agreement). 'farkets and Marketing 76. In an effort to help reduce Tanzania's critical balance of payments gap, the Morogoro Industrial Complex has been deliberately designed to be strongly export-oriented. Eighty percent of the outputs of the shoe factory, the canvas mill and the leather goods factory and 35 percent of the output of the tannery are expected to constitute direct export sales. It is apparent that the success of the project as a generator of foreign exchange depends, primarily, on the success of the international marketing strategy. The international demand for finished leather and bulk canvas or made-up canvas goods is so large that the modest increments to be offered at Morogoro should be easily marketable given competitive quality and prices. No major problems are foreseen in establishing external commercial relationships for these products. Outlets for canvas goods will be secured with the assistance of the canvas mill contractor, who has commercial capabilities in this respect. Tanzania already has established channels for exporting leather from the Moshi tannery to Europe, the Far East and the USA and every indication is that the exportable surplus of leather from Morogoro can be absorbed easily even by the same customers. The maximum planned production of 2 million pairs each of leather and canvas shoes would represent only 0.4 percent of the forecast imports of OECD countries in 1982 or about 14 percent of the annual incremental demand for imported shoes in those countries. Significant sales are also expected in other African countries and the near East. In view of the crucial importance of ensuring proper marketing of the shoes produced under the Project and in order to secure entry and efficient sales management in the international market, great emphasis has been placed on the marketing contract (paragraph 69'). After evaluation of the two proposals received for the marketing contract, an Italian Group with proven marketing capabilities, has been selected by NDC.  - 29 - Benefits and Risks 77. The overall financial return of the Morogoro Complex's Project is forecast at 15.2 percent after taxes in constant 1975 terms, with the industrial estate, shoe factory and leather goods factory having estimated returns of 9.2 percent, 17.2 percent and 23.2 percent, respectively. The aggregate economic return for these components is estimated at 26.4 percent. Economic rates of return for the individual components are estimated at 15.9 percent for the industrial estate (26.0 percent of project costs), 29.8 percent for the shoe factory (71.0 percent of project costs), and 46.5 percent of the leather goods factory (3.0 percent of project costs). 78. While having substantial potential benefits, particularly for Tanzania's critical foreign exchange gap, the Project is not without risks. The most important of these include potential difficulties associated with the efficient operation of the Project factories, over manning, the need to ensure adequate and timely water supply for the complex and problems of marketing Project output in the highly competitive world market. The Pro- ject has, however, been designed in the full knowledge of these potential risks and as discussed in this report specific steps including provision for adequate management, technical advice and training and marketing have already been taken or are recommended. Furthermore, NDC is an established organization whose staff has gained considerable experience since the mid- 1960's in planning, construction, and managing diverse industrial plants. The proposed Project is consistent with the country's industrial develop- ment strategy and appropriate to Tanzania's resource base and as such can be expected to succeed. No adverse environmental effects are expected from the Project. Because the feasibility study for the entire Morogoro Complex did not fully address the question of liquid waste disposal, agreement was reached that this question will be further examined by specialists in this field, acceptable to the Bank (Section 3.07 of the draft Loan Agreement). This study, to be carried out by December 1, 1977, will be financed by the Bank, as part of the technical assistance component of the industrial estate subproject. Appropriate measures will be taken and special equipment selected for the installations to be constructed to avoid adverse effects on ecology and occupational health. PART V - LEGAL INSTRUMENTS AND AUTHORITY 79. The draft Loan Agreement and the draft Third Window Loan Agree- ment between the United Republic of Tanzania and the Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement and the texts of the resolutions approving the proposed loans are being distributed to the Executive Directors separately.  - 30 - 80. Special features of the Loan Agreement are referred to in Section III of Annex IV. A special condition of effectiveness is the approval of a Subsidiary Loan Agreement specifying the terms on which the Government will onlend the proceeds of the loans to NDC. 81. I am satisfied that the proposed loans would comply with the Articles of Agreement of the Bank and with established criteria for Third Window Loans. PART VI - RECOMMENDATION 82. I recommend that the Executive Directors approve the proposed loans. Robert S. McNamara President Attachments Washington, D. C. March 15, 1977  page 1 of Li pages TABLE IA TANZANIA- SOCIAL INIDICATOR% DATA SHEET LATED AREA (THOU AN?)------------------------- --------------- ~~~~~~TANZANIA REFERENCE COUNTRIES (19701 TZITAL 945.1 mOST RECENT 4VIrI. . I 9949 1 9170 ESTIMATE KENYA NORCA , REP. U) MiALAYSIA-' IjR P3 CAPITA CUSS) 70.0 120.0 173.0 140 .0 27. 430 POPULALTION AND VITAL STATISTICS POPUILATION (MID-YR. MILLION) 9.4La 1 2.9 La 1 4.7 /aII . 2 11. 4 1 0.'.~ POPULATION OENSITY PER SQUAtRE on. I o.o i.o 1 0 i 1 9 .0 119 -0 32. 0 PRV SQUIRE (A. AGRIC. LAND 23.0 /a 23,0 . . 1 320.0 291 .0 VITAL STATI[STIES CRUDE BIRTH RATE PER THOUSAND 51 .5 53.; 50.2 69.0 35 .0 42. 2 CR?UDE DE14Tn RATE PER THOUSAND 27.1 23.0 2o,1 127.0 1 .6 12. 9 IAFVANT RORTALITY RATE C/THOU) 19 0 .0 160. 0 Lb .. s.o/a 60.8/a LIFE EXPECTANCY AT BIRTH YOTS) 36. 7 41 .3 l44.5 1.7.5 5 7.?1 56.7 GROSS PEPROOUCTIONE RAtTE . . 2 1. 2 1.4 24 2.6 / POPULATION GROWTHK RATE IX) TITAL 2.1 I/a 1 . 0/a 2.? /a 3. 1 2. 3 . JRHAN 5.0 5 5.2 ~~~~ ~~~~ ~ ~~~~~~~~~~~~~~~~~~~~~~~~~~6.5 6.i. 3.6 URBAN POPULATION AS Or TOTAL) 6.6 4. 0 6.8 9.9 410 2 7.5 AGE STRUCTURE (PERCENT) )TO 14 YEARS 42 - 5 ! 6 4. 4/b A.4.6 42.1 .b7/a 13 TO p4 YEARS Sa.5 /a 51. 0 *45.0 5 52.1 7; 45, YEARS AND OVER 2.-0 oab 2. : 3 .46 0.1 3. 2 7 ACE )EPE4DENCT RATIO 0.5 8~, 0 . I/ I. 1I 0 .9 0. 9 /a ECONiRIiC DEPENDENCY RALTIO 1.0 1,j t. 2 /La .: 1.1 l.b A 1.4F La rARILY PLANNINGD ACCEPTORS (EUMJLMr IVE. THOL') ..,. 66.? . 222. 2 USERS It OF MARRIED WOMENT 4.2.0 B.0o 77 3 M4PLO I nENT TOTL [RIAFRE(HUAO .900/ 54 00 i /a b1 6300.0 /b 100.Dtc . [0 0 0. 0 29 00 . 0/a LA83R FOACE IN AGRICULTURE (0) 96.0 91: a. 90.0/c 50.5 0%6.0 7 UNEMPL)YED (I Or LAROR FORCE) ..... .5 . 7TO 4.-0 /a.b 14 (DM3 0DISTRI BUT ION I 01 PARIRATE INCOME REC'0 BY- HIGHEST 51 OF Ii3JOEH)DLO . 1. 5 ..20.2/d 17.1 2 5.03 HIGHEST 2oo Or HOUSEHOLDS . 61. ..5. 3 540 L3ET 201 0F HSOJSFHCLDS . .1. 3 -R/d 7 . L )wE ST 4o orO HOUJSEHOLDS .. 1. .A 1I3.7dW 17.7 1. DTSTRI3UTION4 OF LAND OWRERS'AIO C ) rsEO9 RT TOP LOF or NERS .... . 2. 1~349E0 AT SRALLEST lot OWNERS ......2. 0 -EALTI AND RUTRITIJN P'OPJL ATION PER PHYSICIAN ?0080.DLoa421570.ClLa 2 14 50.0 783PAR.0/E 221 0.-0c 'POPJLATION PER NURSING RERSI4 890D. ,4,d