Tanzania - Program Credit Project

Document of FILE COpy The World Bank FOR OFFICIAL USE ONLY D Sh Report No. P-1781a-TA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IIITERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED PROGRAM CREDIT TO THE UNITED REPUBLIC OF TANZANIA February 22, 1977 This document has a restricted distribution and may be used by reciplents only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS 1/ SDR 1.00 = Tanzania Shilling (T.Sh.) 9.66 US$ 1.00 = Tanzania Shilling (T.Sh.) 8.30 T.Sh. 1.00 = US$0.12 TANZANIA FISCAL YEAR July 1st - June 30th 1/ In October 1975 the Tanzanian Shilling was pegged to the value of the Special Drawing Rights (SDR) of the International Monetary Fund. The US Dollar/Tanzania Shilling exchange rate is therefore subject to change. Conversions in this report were made at US$1.00 to T.Sh. 8.30 which is close to the recent average exchange rate.  FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED PROGRAM CREDIT 'TO THE UNITED REPUBLIC OF TANZANIA I submit the following report and recommendation on a proposed program credit for the equivalent of US$15.0 million to the United Republic of Tanzania on standard IDA terms. PART I - THE ECONOMY A. Introduction 1. The last full economic report on Tanzania (AE-26) was distributed to the Executive Directcors in 1972. While it has been some four years, therefore, since the last comprehensive economic report was issued, a substan- tial volume of economic and sector work has been carried out during this period. A three-volume agricultural sector report was issued in December 1974, and 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 distributed 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-1517a-TA cf 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. 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 which is incorporated in this President's Report (Annex V) is based on the findings of the basic mission. A summary of Bank Group operations in Tanzania is included in Annex II. B. General Background 2. Tanzania has a total area of approximately 945,000 km2. 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 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  rural areas, and 90 percent of the labor force is engaged in agriculture. Agriculture 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 I.) C. Government Development Objectives and Strategy 3. Tanzania has experienced a degree of continuity and stability in political structure, leadership and objectives which is virtually unrivalled in Africa. The TANU 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. 4. 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. 5. 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.  - 3 - 6. Mass mobilization of the population is facilitated by the political party organization wh:ich 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 reg.ion 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. 7. The overrid-Lng goal is to develop a socialist economic system. In furtherance of this objective new government parastatal enterprises havJe been established in virtually all sectors of the economy. There is also state intervention in markel: pricing; prices of capital, labor, land, imports, industrial and agricu:Ltural 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 8. Between 196,' 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 outpuLt 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. 9. 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. (ii) The Economic: Crisis of 1974 10. In 1974 Tan2:ania was suddenly confronted with a severe economic crisis, caused in part by drouLght 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  - 4 - 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. 11. 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. 12. 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. 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 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 - primary education (UPE) and universal rural water supply (URWS) from 1989 to 1977 and from 1991 tc 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 13. 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. 14. 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. 15. 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. While consumer prices have increased substantially an extreme:Ly 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. 16. 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. 17. 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. 18. 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 - 19. 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. These village societies 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 consultantts report has been completed and we are developing a project for assistance to the road transport sector based on its recommendations. 20. As a major cDmponent 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. 21. 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 Annex [I for details.  - 8- (iv) Major Issues for the Future 22. 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 23. 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. 24. 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.  - 9 - (e) elimination of Treasury subsidies to loss-making parastatals and/or shutting down enterprises which make continuing losses. 25. 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 co'nsultant 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 parastata:Ls and on the parastatal sector as a whole. The Need :or an Export Policy 26. 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. 27. 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 anc! 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 - 28. 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 29. 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 Y'inancial resources in pursuit of ambitious social and economic goals. 30. 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 ,mall adjustment in the minimum wage for the lowest paid groups in May 19'75. 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 accolnts on a quarterly basis. 31. 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 l:o 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 and over- expenditure have growl 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 some years rather than months. (v) Economic Performance in 1975 and 1976 32. 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 f'act that during 1975 production of cotton and some other cash crops still suffered from disorganization due to villagization. In 1976, some of the problems cf villagization were being rectified through "operation correction" and since rains were once again favorable agricultural production was generally good. Ereliminary 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 - 33. The goods and services account of the balance of payments continued to deteriorate in 1975 due to continuing production difficulties and declines in some 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.) 34. 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 35. 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 - 36. On the import side an increase of some 20 percent in value terms (13 percent in real terns) 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. 37. 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 of assumptions is $50 miLlion. Details of the balance of payments forecast, and a comparison with earlier years, are shown in the table below: ]3ALANCE OF PAYMENTS SUMMARY TANZANIA MAINLAND (Millions of Current US$) 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. 3/ Includes IMF facilities, IBRD prograr loan, and other bilateral and multilateral balance of payments support.  - 14 - PART II - THE PROGRAM CREDIT 38. The analysis in Part I indicates that Tanzania is currently facing extremely difficult problems in the pursuit of its development program. Two objectives have dominated the Government's policy response to the economic crisis: first, to protect the population from possible famine by importing sufficient food to meet minimum requirements, and second, to maintain the pace of the development program - to follow a strategy of "growing out of the crisis" despite the reduced availability of real resources. It has been possible for Tanzania to continue the investment effort and at the same time to alleviate the burden of drought for the poorest groups in the society only because of the exceptionally high levels of foreign assistance which have been committed over the past three years. This assistance has afforded the Govern- ment time to begin a restructuring of the economy in order to cope with the shift in the terms of trade as well as with the factors underlying the sluggish growth trend of the major economic sectors. The Government has responded with a series of measures to curtail petroleum and non-essential imports, to hold down recurrent budget expenditures, to reallocate public development expenditures to directly productive sectors, to impose a public sector wage and salary freeze, to raise consumption taxes, and to stimulate higher agricultural pro- duction through substantial increases in producer prices. To a considerable extent the modest recovery in the Tanzanian economy over the past two years may be attributed to the fact that this comprehensive restructuring program was undertaken rapidly and forcefully. While we are greatly concerned about the magnitude of Tanzania's economic difficulties, we are persuaded that the Govern- ment is fully committed to carrying out a program of policy actions to confront the economic crisis. We have analyzed that program carefully and we feel that it is one which the Bank Group should continue to support. The Government's committment to maintain and to strengthen the elements of this restructuring program is set out in a memorandum of policy understandings from the Minister of Finance which is attached as Annex VI to this report. 39. The Tanzanian Government first approached the World Bank in mid-1974 to request program lending for assistance in meeting the immediate balance of payments crisis. In the discussions relating to the program loan it was clearly recognized (a) that the economic crisis stemmed from longer-term trends in the Tanzanian economy as well as from immediate drought and import price effects; (b) that a wide range of policy measures would have to be introduced if the Tanzanian economy was to regain its development momentum without sacrificing the poiitical, social and economic goals of the country; and (c) that balance of pay- ments support would be required from many sources, both bilateral and multilateral in addition to the World Bank, if the projected 1975 balance of payments gap was to be covered. 40. The Bank's first program loan of $30 million approved in December 1975 was an important element in the Tanzanian Government's ability to meet the balance of payments crisis without sacrificing the development program. Foreign exchange provided under the loan was utilized for essential imports of capital equipment, intermediate goods and raw materials for which other sources of foreign financing were not available. The program loan was fully disbursed by the end of May 1975, only four months after effectiveness. Furthermore, the Bank assisted the Government in mobilizing additional balance of pavments support from bilateral sources, in particular through the meeting of the Consultative Group for Tanzania held under the Chairmanship of the World Bank in April 1975. Finally, during the program loan discussions the Fank made an important contribution to the design of the Government's program of policy actions to cope with the economic crisis.  - 15 - 41. From the outset of the first program loan discussions in 1974 it was fully recognized that the process of adjustment to the economic crisis would be both difficult and protracted. It was understood that the balance of payments problem was likely to persist through the 1970s before the measures which the Government was taking to restructure the economy could have full effect. Therefore it was also recognized that further balance of payments support beyond 1975, from the Bank Group as well as other sources, could well be required. The Tanzanian Government did request a further program credit of $30 million from the Bank Group in late 1975. In response to this request a special economic mission visited the country in November 1975 to examine the economic situation and to appraise the adequacy of the Government's development policies and investment program. The credit was negotiated in April 1976; however, the decision was made not to proceed further with the credit at that time for two related reasons. First, we were extremely concerned about the problem of growing imbalance between recurrent revenues and expenditures which had only become evident following release of the provisional accounts for 1974/75. Second, we were concerned that our assistance should not substitute for IMF facilities. While Tanzania had taken full advantage of IMF facilities in 1974 and 1975, and had negotiated a standby agreement for a second credit tranche in 1975/76, the agreement had been breached because of excessive Government borrowing from the banking system - a direct out- growth of the budgetary problem. Since April of last year we have been following closely the Government's efforts to restore expenditure controls, as well as negotiations between Tanzania and the IMF over reestablishment of a standby agreement. The Tanzanian Government has now produced a program for short-run fiscal management which has been accepted by the IMF, and her eligibility for credit tranche drawings has been reestablished. Based on this agreement between the Government of Tanzania and the IMF, we are satisfied that corrective measures are being taken to curb the growth of public consumption. 42. Tanzania was able to improve her balance of payments position slightly in 1976 without additional program lending from the Bank Group or further IMF drawings beyond the export compensatory facility, in part because of the bonanza of high world coffee prices, but also because of continued stringent controls on imports. However, as a result of this continuation of drastic import controls the need for balance of payments support has merely been postponed into 1977. The immediate problem nDw confronting Tanzania is to obtain financing for a projected 1977 balance Df payments gap of some $50 million. Most if not all of the financing should be quick-disbursing program aid. Commitments rust be secured as early as possible in order that necessary import liberalization not be further delayed. The alternative would be either a drawing down of foreign exchange reserves, whichi would be undesirable, given' that reserves are still at the comparatively low level of only two maonth's import requirements, or ccntinuing restrictions on essential imports which wotuld delay econoric recovery. 43. We believe thai: Tanzania's anticipated 1977 balance of payments deficit can be financed through a combination of program assistance and food aid. The remaining portion of Tanzania's expanded first credit tranche plus trust fund  - 16 - allocations from the IMF should provide approximately $13 million, while the OPEC Special Fund will furnish $5.5 million. The Government anticipates bilateral program assistance of $15-20 million; if this amount materializes the remaining gap would be approximately $15 million. Therefore we are recommending that the Bank Group should provide a program credit of $15 million at this time to cover the remaining deficit in Tanzania's balance of payments for 1977. We believe that this reduced amount should be sufficient to insure the desired amount of import liberalization, and that the commitment should be made at this time in order that the Government can plan its import program for the entire year without waiting several months for additional aid commitments. It must be admitted however that the size of the gap cannot be estimated with complete accuracy because of the uncertainty associated with certain key variables such as the coffee Trice, or fluctuations in agricultural output due to weather. It is possible that the deficit could exceed our estimate if a less favorable outcome should occur in export performance or import require- ments. In this event Tanzania would have recourse to the IMF for a second credit tranche (SDR 15 million). Nevertheless, it is still possible that the Government could approach the Bank Group for further program assistance during the year if either bilateral assistance should fall short of expectations or if the gap should be significantly larger than we have forecast. W4e will remain in close touch with the IMF and will monitor the balance of payments situation closely over the course of the year in order to assess the degree to which Tanzania's essential balance of payments requirements are being met. 44. Given the magnitude of the projected balance of payments deficit in 1977, the heavy volume of project-related capital assistance already anticipated, and the time that would be required to commit and disburse new project loans, it would not be possible for external lenders to assist in any immediately effective way through additional project lending, even with a substantially increased element of local cost financing. If capital goods and construction materials imports were to be reduced by the extent of the antici- pai:ed deficit, public sector .nvestment would have to be curtailed by a like amount and this would sericusly undermine the development effort. Furtherrore, because a very high proportion of total capital goods imports are financed entirely by foreign donors under development assistance programs, curtailment of these imports would have little if any beneficial balance of payments effect in the short-run. Over the past few years we have significantly increased our lending to directly productive projects, as well as the share of local currency costs covered by our loans and credits, and these projects are beginning to have a favorable impact on the balance of payments. While there have been problems associated with implementation and disbursement under these projects we have been working on many fronts to improve implementation performance, as described in Annex II, and these efforts are beginning to show results. While we can therefore anticipate further improvements in disburse- ments of Bank and IDA project loans, this has already been taken intc account in our balance of payments forecast.  - 17 - 45. The justification for the program credit emerges, firstly, from the foregoing analysis of the short- and longer-term development problems facing Tanzania; secondly, from the review of the Government's policies and programs to deal with these problems; thirdly, from the estimate of external assistance available to help finance the balance of payments gap; and finally, from the expectation that a residual gap will remain unfilled, thus leading to a further cutback in production in key sectors, unless the Bank makes available quick-disbursing assistance. This justification conforms to Bank policy in respect of program lending. Moreover, it is complementary to Bank project assistance. The risks associated with this program credit are the basic risks associated with the bold and imaginative development strategy upon which Tanzania has embarked. Essentially these risks reduce to the question: can the strategy result in effective programs and policies which increase material production in the country? This risk is very clearly recog- nized by the Governmenz. This recognition has led to the adoption by the Government of policies and programs which address the problems of production, which in turn has prov[ded the basis for the rapid development of the Bank's involvement in project identification, preparation and implementation in recent years. The risks are reduced to the extent that many of the policies and programs have already been introduced. However, these actions cannot avoid the fundamental risks associated with development in a least-developed country such as Tanzania in which the respcr.se to changes in policies is highly uncertain. Furthermore these risks are made even greater by such extraneous factors as the weather and the international t:erms of trade. Nevertheless we are sufficiently impressed not only by i:he genuine commitment of the Government to its develop- ment objectives but also by its commitment to taking strong actions to achieve these objectives that we believe that these risks should be accepted. 46. I, therefore, recommend that a credit of $15 million be made to Tanzania at this time in support of the Government's development program. In assessing the special circumstances underlying the need for this program credit to Tanzania, the following general criteria were given special emphasis: (a) the country should have an ongoing development program and should have taken and intend to take supporting economic and financial policy measures which provide a satisfacl:ory basis for external assistance; and (b) the needed timely transfer of resources from external lenders -Ln support of the ongoing development program cannot be achieved effectively and expeditiously solely by the fijnancing of specific investment projects, including justifiable local currency expenditures. I am satisfied that the proposed credit meets these criteria.  - 18 - 47. Procurement procedures under this credit will be the same as those followed under the first program loan. Foreign exchange provided under the credit would be utilized for agreed categories of essential imports of capital and intermediate goods fcr the public and private sectors. No disbursements would be made for food, fuel, fertilizers and consumer goods. Tanzania would be reimbursed for foreign exchange expenditure on eligible imports on the basis of import documents and evidence of payments submitted to the Association. Appropriate arrangements to this effect have been agreed between the Association and the Borrower. In order to simplify disbursement procedures, individual import expenditures of less than $1,000 would not be eligible for reimbursement. No disbursements would be made for imports for which other sources of foreign financing have been secured (Section 2(d), Schedule 1, draft Development Credit Agreement). It is expected that the proceeds of the proposed credit would be disbursed by the end of July 1977. 48. It is anticipated that the major part of the credit proceeds would be used for direct Government and parastatal enterprises' imports, following procedures of the Government Central Tender Board which are satisfactory to the Association, or procurement policies in accordance with the Bank Group's guidelines. A part of the credit proceeds would be used for private sector imports, which have accounted for about 40 percent of total imports in Tanzania in recent years; procurement of these imports would be subject to normal coumer- cial practices. Practically all countries from which prospective suppliers are likely to be interested are represented by missions in Tanzania. Adequate time, usually at least six weeks, must be given for prospective suppliers to prepare and submit tenders. These procedures ensure full opportunity for participation by foreign suppliers. The bids are evaluated on the basis of prescribed procedures and are awarded to the lowest evaluated bidder. As a check, particularly on the private and parastatal sectors, the Bank of Tanzania requires that, with a few exceptions, all imports be subject to compulsory quality and quantity inspection and price comparison by the General Superintendence Company of Switzerland before shipment is effected. General Superintendence is required to ascertain whether f.o.b. prices invoiced correspond, within reasonable limits, with the generally prevailing export prices. The above procedures are generally sound and ensure economic procurement of goods. 49. The Bank of Tanzania will open a special project account in the name of the Government, to which the Tanzania shilling equivalent of the imports financed under the project will be credited. The Government will withdraw funds from the project account to cover expenditures under the 1976/77 and 1977/78 Government Development Budgets for each of the following votes: Prime Minister and Second Vice President's Office; Agriculture; Education; Commerce; Industries; Communications and Transport; Lands, Housing and Urban Development; Works; Finance and Planning; Health; Water, Energy and Minerals; and Natural Resources and Tourism (Schedule 3, draft Development Credit Agreement). The use of the counterpart funds in financing investments would be limited to those expenditures which are not otherwise financed by external sources.  - 19 - PAIRT III - LEGAL INSTRUMENTS AND AUTHORITY 50. The draft Development Credit Agreement between the United Republic of Tanzania and the Association, the recommendation of the Committee referred to in Article V, Section l(d) of the Articles of Agreement of the Association and the draft resolution approving the proposed Credit are being distributed to the Executive Directors separately. The draft Development Credit Agreement follows the form previously used for this type of Credit. 51. I am satisf'ied that the proposed Credit would comply with the Articles of Agreement. of the Association. PART IV - RECOMMENDATION 52. I recommend that the Executive Directors approve the proposed Credit. Robert S. McNamara President Attachments Washington, DXC. February 22, 1977   ANNEX I Page I of I, pages TABLE 3A TANZANIA- SOCIAL INDICATORS DATA SHEET LAND AREA (THOU MN2)