Bolivia - Economic memorandum

Report No. 5680-80 Economic Memorandumn on Bolivv August 2, 1985 Latin America ind the (artbhean Reoi~ulon,d FOR OFFICIAL USE ONLY i,~~~~~~~~~~~~~~~~~~~~~~~J . ! 'I I Ir;1 TT Document of the World Bank This dlocument hias a res,tricted distribUtion d1ld 1mayI 1)( Used by teCip)ientS only in the pertorialic e o) their otfilcal dutles. Its ortents may mA otherwise be disclosed vviUhout Wor!(3 Bank dUthorizwt ion. -i, . 0 FOR OFFlCIAL USE ONI Y t1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~P  CURRENCY EQUIVALENTS Currency Unit = Bolivian Peso ($b) Exchange Rate Effective Nay, 1985 US$1.00 = $b 67,000 Sb 1,000,000 = US$14.925  FOR OMCIAL USE ONLY FOREWORD This report is based on the findings of a main mission which visited Bolivia in March/April 1984 and an updating mission which visited La Paz in November 1984. The main mission corsisted of Roberto Zagha (Mission Leader); Claudia Franco, Andrew Freyman, Helen Garrison, Homi Kharas, Arnaldo Leon, and Oscar Ugarteche. The following background papers, which expand on this report, are available upon request: (i) The 1980-84 Economic Crisis; (Ui) External Debt; (iii) The Mining and Metallurgical Sector; and (iv) Nontraditional and Hydrocarbon Exports. This document has a restic dibuuon and may be used by recpts onlyint the por ol I hteir offca dues Its cutents may not othise be disdosed without World Bank utoritin.  FISCAL YEAR January 1 to December 31 ABBREVIATIONS CAF - Corporacion Andina de Fomento (Andean Corporation of Development) COMIBOL - Corporacion Minera de Bolivia (Bolivian Mining Corporation) COMSUR - Compania Hinera del Sur (Southern Mining Company) EMUSA - Empresas Mineras Unificadas, Sociedad Anonima (United Mining Enterprises) ENAF - Empresa Nacional de Fundiciones (National Smelting Corporation) FONPLATA - Fondo Financiero para el Desarrollo de la Cuenca del Plata (Financial Fund for the Development of the River Plate Basin) GEOBOL - Servicio Geologico de Bolivia (Bolivian Geological Services) IDA - International Development Association IDB - Inter-American Development Bank IBRD - International Bank for Reconstruction and Development IMF - International Monetary Fund ITC - International Tin Council USAID - United States Agency for International Development  TABLE OF CONTENTS SUMMARY AND CONCLUSION S ............................................. i-ix CHAPTER 1: RECENT ECONOMIC DEVELOPMENTS 1............................ I. The Economy of Bolivia ....... 2 A. Historical Background .................................. 2 B. The Legacy of the 1970's ............................... 5 C. The 1980-1984 Economic Crisis . . . 7 D. Addressing Bolivia's Economic Problems . . . 14 II. Bolivia's External Debt .................................... 16 A. The Scope of the Problem .. 16 B. Some Consequences of Bolivia's Debt Problem . . 17 C. Some Causes of Bolivia's Debt Problem . . 18 D. The Resolution of the Debt Problem . . 18 III. The Mining and Metallurgical Sector ........................ 20 A. The Mining Sector . . 20 B. Bolivia's Metallurgical Sector .. 22 C. Institutional Constraints .. 22 D. The Future of Mining in Bolivia .. 23 E. Recommendations .. 23 IV. Nontraditional and Hydrocarbon Exports ..................... 24 A. Nontraditional Exports ................................. 24 B. Hydrocarbon Exports .................................... 25 CHAPTER 2: THE YEARS AHEAD ......................................... 27 I. The Status Quo ............................................. 27 II. A Feasible Scenario ........................................ 35 III. The Public Investment Program, 1984-1987 ................... 41 ANNEX I Market Prospect for Bolivia's Minerals STATISTICAL APPENDIX MAPS  TEXT TABLES Table 1.1 Average Real Growth Rates of GDP in Selected Sectors, 1956-1984 1.2 Financing the Current Account 1.3 Balance of Payments, 1978-1983 1.4 Evolution of Real Minimum Wage Since it was Introduced in November 1982 1.5 Evolution of Nominal Exchange Rate, 1958-1985 1.6 Exchange Rates in the Official and Parallel Market, 1982-1983 1.7 Central Government Operations, 1976-83 1.8 Debt Outstanding and Disbursed, 1983 2.1 Exports in the Status Quo Case, 1985-1992 2.2 Projected Average Metal Prices 2.3 Total Annual Commitments, 1980-1984 2.4 Capital Inflows in the Status Quo Case, 1984-1995 2.5 Bolivia's Foreign Exchange Cash-Flow in the Status Quo Case, 1984-1995 2.6 Debt Service Obligations on Existing Debt (As of December 1984) 2.7 Balance of Payments in the Status Quo Case, 1984-1995 2.8 Exports if Policies Change, 1984-1992 2.9 Capital Inflows if Policies Change, 1984-1992 2.10 Bolivia's Foreign Exchange Cash-Flow if Policies Change, 1984-1995 2.11 Bolivia's Balance of Payments if Policies Change, 1985-1992 2.12 Public Investment Program, 1984-1987  Page I of 2 COUNTRY DMTA - (3IVIWW AREA PoPUxow DENSSrY S.098.6 km2 5.6 .illio. (mid-198D) 5.1 per km2 Rate of Crowth 2.7 (from ;970 to 1978) 18;- per km2 of srable land POPULATO CRA;hC5USTlC (1976 to 1979) HEALTH (1976 to 1979) Crude R--th Rate Cper 1.000) 43_2 Population per pwsrician 1845 Crude Deahr Rote (per 1.000) 16_4 Popalation per hospital bed 456 Infaat mortality (per 1.000 live b4rtbh) 15860 mOPD!E DISEEInuTION (19'0) DISERIBITIDo OF LA4D ONSIP (1976 to 1979) S of national ncome, higbhet quintile 36.0 Z owned by top 107 of alners 4 lowest qulntile 13.0 : owned by smallest 102 of ohmers . - ACCESS TO rDPED iATE& (1976 to 1979) ArSS 1O ElECTRiCITY '1976 to 1979) Z of population - urban 81.0 1 of p2pulatIon - urban 33-0 - rural 6.0 - rural NUraITDON (1976 to 1979) EDuCArION (1976 to 1979 Calorie intake as : of requirescuts 83_0 Adult literacy rate r 63.0 Per capr-a proteln intake 52.0 Primary scbool enrollment : 86.0 ,1 GIP PER CAPI TA N 1983 -S U 510 CRS DOMESTIC PRODUCT 1N 1984 ANNUAL RATE OF CRCUTH (:, constant price) US$ mb. 1 1975-80 1980-84 CMp at Market Prices 3.896 100.0 3.7 -4-0 Cross Domestic Investmaet 136 3.5 -9-5 -26.5 Gross National Sawing 314 8.1 -7.0 -4.0 Current Account Balance -269 -6.9 Exports of Goods, NFS 815 20.9 0.9 -3.2 inrorts of Coods. NFS 727 18.7 -2_4 -12_5 owrurp. LABOR FORCE AND pRo'DUCrlTIVrIY IN 1982 Value Added Labor Force V. A. Per Worker uSS Min : Thousands USS : Agriculture 768 19.7 793 42 960 47.4 tMning and Netallurgy 234 6.0 67 * 3.391 166.1 Hanufacturing 573 14.7 156 8 3.673 180.0 others 2.321 59.6 891 46 2b605 Total/Average 3.896 100.0 1.909 100.0 2.041 100.0 GOVERNMENT FINANCE Consolidated Public Sector Central Government ' Sb Mln.) : of CDP ( Sb KIn) : of CDP 1983 1983 1980-83 1983 1983 1979-82 Current Receipts __ __ 74 4.9 9.3 Current Expenditures 2 _ Z50 16.5 13.2 Current Surplus -231 -9.3 -2.7 -17 -11.6 -4.1 Capital Expenditures 63 4.2 6.1 12 0._ 2.8 External Assistance (net) 832 0.1 2.7 - - 2.3 1/ Total Labor force; unemployed are allocated to others- V/ Includes Social Securlty. not available not applitcable  Page 2 of 2 CUBTY DATA - (BOLIVA) MONEY, CREDIT AND PRICES 1978 1979 1980 1981 1982 1983 1984 (Million of Sb outstanding end ,erLed) Honey and Quai Honey 13.716 15.926 22,485 29,016 97.530 263.592 n.m. - - Public Sector 4,325 8.394 14.033 18.929 94.435 315.224 n.&. r -o Private Sector 13,658 16,958 19.416 24.046 97.474 206,431 u. Honey 7 Qua Money as O of CDP 18 17 17 17 24 17 n. Cener& erice tndex (1970-1_0) Annel percentag cbanges in: 348 413 610 825 1,847 7.459 10.559 Ceneral Price Index 10 19 48 35 124 304 1.316 Bank Credit to PublLc Sector 99 94 67 35 499 334 U.S. Bank Credit to Private Sector 28 24 14 24 405 214 n.s BALANCE OF PAIHENrS MERCRANDISE EXPORTS (AVERIUE 1980-83 in 1970 prices) 1975 1980 1983 1984 US$ Bin. I - (Mfillions UsS) - Exports of Goods. BFS 505 1.045 846 815 Tln 82.9 35.5 Imports of Goods. MPS 641 958 661 594 Other Minerals 93.5 40.1 Resource Cap (deficit - -) -136 87 185 221 Rydrocbro 18.1 7.8 Agricultural products 18.6 8.0 Interest Paymets (met) -24 -157 -Z99 -287 All other ceoiditles 5.2 8.6 Wotkers enitces Total 233_2 100.0 Other Factor Payments (net) -13 -104 -174 -278 Net Trasfers 3 8 18 1t Balance on Current Account 1710 6-6 -270 -269 EM=L DBET, DKCDIIER 31, 1983 Direct Foreign Investment 35 45 43 7 Bet ILT Borrowing 1i1 3ZZ 13 -467 Public Debt. mDCI. guaranteed 3.405 Capital Crunts 8 48 80 70 Ion-Cuaranteed Private Debt 376 Other Capital (net)/2 -66 Z83 467 491 Total outstanding 6 Disbursed 3.781 Increase in Reserves- (+) -50 -34 -330 -168 DEBT SERVICE RATIO0 for 1984 1 Public Debt. mcl. s-ranteed 40.9/3 Bon-Guaranteed Private Debt Total Outstadilng 6 Disbursed IBRD/IDA LENDit, (December 31. 1984; Million 115): IBRD MDA Outstanding 4 Disbursed 211 95 Undibursed 119 11 Outstanding luct. Undisbursed 230 106 /I Average for the year. /2 Includes building up of arrears. 13 Excludes arrears. not available not applicable  SUMMARY AND CONCLUSIONS (i) The Government which is to take power in August, will face one of the most serious economic crises that Bolivia has known since it became an independent sta.e in 1825. By 1984, per capita income was below the level it had reached in the early 1950's. Inflation surpassed 2,000% and in early 1985 prices were doubling within a month. By the end of 1984, arrears reached 25Z of Bolivia's total foreign debt, which amounted to US$4 billion. In June 1981, foreign exchange could stiLl be purchased freely at $b25/US$; by March 1985, however, foreign exchange could normally only be purchased in the illegal parallel market at a rate of $bl60,000/US$ (representing a roughly tenfold depreciation of the Bolivian peso in real terms). The process of economic deterioration has been accompanied by hostile relationships between socio-economic groups. Since 1979 there have been no less than three elections, six presidents, three coups that succeeded and twice as many that failed. The democratic Government that took power in October 1982 found itself unable to cope with the situation and put forward new elections by one year (to July 1985). (ii) Until the middle of the 20th century, Bolivia's monetary economy was confined to mining and mining-related activities, with little spill-over into the rest of the economy because both Bolivian and foreign mining entrepreneurs chose to reinvest abroad most of the profits generated by their operations. The vast majority of the population was excluded from both political and economic life; until 1952, less than 3Z of Bolivians were entitled to vote and over 70% lived in a quasi-feudal rural economy. Bolivia's highly unequal distribution of wealth in those years led to a similarly unequal distribution of incomes. The perception that landowners blocked improvements in the rural population's welfare, and that mine-owners played the same role with respect to mine workers (and to the diversification of the economy as a whole), led the leaders of a revolution in 1952 to give priority to agrarian reform and to aationalization of the major mines. The new Government saw nationalization as a way to finance investment in other sectors of the economy, while the miners saw it as a way of raising their living standards. As a result of this conflict, an adversary relationship has developed between Government and the miners since 1952 with b,th groups trying to seize the surpluses generated in the mining sector. The main consequence for the economy as a whole has been chronic undercapitalization in the mining sector: neither Goveranment nor the miners have had any incentive to invest in the development of the mining sector, partly because it has been unclear which of the two parties would be able to appropriate the future benefits generated by new investments. No large mine has been put into production since 1952. COMIBOL, the public sector holding company created to manage the nationalized mines, has become a prime example of state inefficiency; in 1984, the company's mineral production was at its lowest level since the 1950's.  - ii - (iii) Since the 1952 revolution the state has become Bolivia's most important economic agent in the economy. This process has been steady and relatively independent of the political orientation of successive Governments. Conservative Governments have not attempted to reverse the trend: if anything, they have strengthened the management and efficiency of the public sector bureaucracy as, for example, during the 1970's, without questioning or redirecting the role of the state in the economy. More radical Governments have increased Government involvement by expanding the scope of state activities. For example, Gulf Oil in Bolivia was nationalized in 1969, as was a large mine belonging to United States Steel (Mina Matilde) in 1971. In 1983, a public enterprise was established in a sector-passenger and freight surface transportation-that had previously been free from Government intervention. (iv) The process of capital accumulation has thus been heavily influenced by the Government, which has been responsible for over two-thirds of all such accumulation since 1952. The framework within which investment decisions have been taken, however, has given more weight to group interests than to economic considerations. Basically, any project backed by a strong lobby and with assured foreign financing has become part of the Public Investment Program. Easily granted Government guarantees, tempting terms from bilateral aid and suppliers credits have helped funds to flow into sectors or regions run by influential agencies (or local governments) rather than to sectors where returns would be higher. (v) The issue for Bolivia is not whether the Government participates in the development process. but rather what kind of state intervention is most appropriate. The mutual mistrust built up over time between the private sector and important segments of the population has had two consequences. First, the private sector has come to feel that participation in Bolivia's development process entails an unacceptable degree of risk and has therefore continued, whenever possible, to accumulate assets abroad. Second, the Government has chosen to compete with the private sector in activities that are more suited to the latter (such as consumer goods, agroindustry and metallurgy), while giving inadequate attention to the production of public goods in which it has a natural role to play. (vi) The pitfalls of this style of economic management did not become fully evident until the 1980's. In the 1970's, an oil, gas, and commodities boom associated with the discovery of hydrocarbon fields which indicated the possibility of sizeable petroleum and gas deposits, made the country attractive to foreign financial entities and exacerbated the weaknesses of Bolivia's development pattern-it further increased the role of the state in the economy, and accelerated the private capital flight. In spite of an unprecedented degree of political stability in most of the 1970's, private entrepreneurs did not find investing in Bolivia an attractive proposition and new private flows failed to materialized. Therefore, the accumulation of capital needed for Bolivia's long term development has inevitably become a government responsibility. Ti.e already strong tendency for successive Administrations to participate extensively  - iii - in economic activities has been legitimized by the dearth of private sector investments, and by relatively easy access to international capital markets. The capital inflows were partly offset by capital outflows, however. Capital flight (and unrecorded imports) amounted to over 60Z of the value of the debt accumulated during the years 1971/81. Government foreign borrowing for public investment thus, in effect, financed the accumulation of privately owned assets abroad. (vii) The accumulation of debt to finance publicly-sponsored investment was interrupted in 1978/79 by a change in the commercial banks' perception of Bolivia's export potential and debt servicing capacity. This led the banks to reduce their exposure, leaving Bolivia without the substantial foreign inflows needed to help service its large external debts-debts which had in turn financed a capital stock which could not contribute to repaying them. At that point, two lines of action were open to the Government: (i) a large devaluation in real terms (which would reflect the reduction in the supply of foreign exchange caused by the withdrawal of foreign financing sources); and (ii) a reduction in aggregate demand (which would reduce the demand for imports, and thus the demand for foreign exchange, to a level compatible wich the newly restricted supply of foreign exchange). Initially, the Government opted, in late 1979, for a combination of devaluation and reduction in public expenditures. The program was disrupted by a coup in 1980, however, and no consistent policy for economic recovery has subseq1uently been implemented. The 1980 coup was followed by three military governments, which could not muster the political support needed for an adjustment policy, and turned power over to a democratically elected Government in October 1982. During its nearly three years, however, the democratic Government has also been unable to create a mandate to manage the economy effectively. The net outcome is that Bolivia has existed without any economic management to speak of for nearly five years, and that the problem of how to handle the losses of the debt accumulation of the 1970's has remained unaddressed. The absence of a coherent medium term economic program, together with a confusing wage policy and a rigid foreign exchange regime are the main causes for successive Governments' failure to halt the process of economic deterioration. (viii) Since the 1979 protram, Bolivia has had six stabilization packages, adopted in February 1982, November 1982, November 1983, April 1984, November 1984, and February 1985. While the 1979 program contained relatively well defined and comprehensive policies for stabilization, the subsequent six economic packages were ad hoc in nature. They concentrated on the short term, gave no sense of continuity, and often neglected measures needed for effective progress towards stabilization. (ix) A confusing wage policy has been one of the prime causes of trade unions' hostility to the various stabilization efforts. With the exception of the November 1982 package, successive programs have been unclear about the extent to which the Government intended to reduce real wages, the timeframe within which real wage reductions were to take place, and the form ar.d timing of the transition from economic recovery to gains in real wages. Labor was asked to accept reductions in real wages without knowing if this reduction was a once-and-for-all loss, or the beginning of a  - iv - reduction in real wages of unknown proportions. The vagueness of government wage policies meant that each reduction came to be seen as a portent of further cuts. Labor action has been intensified by the vagueness and uncertainty surrounding Government's intentions. The fact that most strikes have been rewarded by nominal wage increases has put a premium on labor action and may help to explain the steady increase in strikes and work stoppages over the last five years. (x) Many Bolivians continue to view cheap foreign exchange as a sign of economic prosperity. The Governmentts desire to keep the nominal exchange rate fixed after the Central Bank stopped freely selling foreign exchange at the official rate in June 1981, while capital inflows were falling and the public sector deficit was still at its high 1970's level, triggered the fiscal, monetary, and balance of payments disequilibria of recent years. In spite of accelerating inflation rates during 1980/85-the consumer price index rose by about 100,OOOZ between January 1980 and January 1985-the nominal exchange rate was readjusted only seven times (in each of the six economic packages plus one isolated adjustment in August 1984), and always insufficiently. The overvaluation of the exchange rate has paradoxically been one of the main causes of increases in the money supply, and thus in inflation, since 1980. The dynamics of Bolivia's inflationary process, which has led to the hyperinflation of 1984/85, reflect the overvaluation of the official exchange rate at a time when capital inflows are falling, public sector revenues depend significantly on the level of the official exchange -ate, and domestic prices are influenced by the exchange rate in the parallel market. Reluctance to adjust the official exchage rate has thus entailed a passive monetary policy whereby the Central Bank was instructed by the Ministry of Finance to finance the deficit stemming from the gap between fiscal expenditures and fiscal revenues. This deficit partly reflects the subsidy implicit in providing foreign exchange at the official exchange rate when the prices charged by importers reflect the value of the parallel market rate. (xi) Bolivia's economy has already experienced most of the necessary costs of an adjustment process. There have been reductions in imports (generating a trade surplus), in per capita consumption, in real wages, and in gross investment. The reduction in real wages, however, has not meant more competitive exports, and thus higher export earnings. The type of adjustment Bolivia's economy has gone through is of a recessive nature and the increase in unemployment is not the transitory consequence of a reallocation of resources in the economy towards export sectors. Therefore, despite the fact that Bolivia has already experienced the costs of an adjustment process, adjustment has not taken place, and a stabilization policy is still an essential precondition for the reestablishment of the country's long term development. (xii) The indispensable elements of any stabilization effort include: improving the foreign exchange allocation system; maintaining public sector tariffs and foodstuff prices at levels that dissuade smuggling to neighboring countries; defining a coherent and consistent wage policy; and  - v - defining a strategy to renegotiate foreign debt payment terms. Whether such measures will be sufficient or not is difficult to assess at this stage. There is no historical example of hyperinflation being reduced without major changes in economic policies and in the role of the public sector in the economy. The measures suggested here are necessary conditions for a stabilization effort, but they may not be sufficient. (xiii) By the end of 1984, Bolivia's excernal debt outstanding totaled about US$4.0 billion, an amount larger than the country's GNP and equivalent to nearly five times the value of its exports of goods. Despite the onset of a debt and general economic crisis as far back as 1980, new public foreign liabilities continued to mount at an average annual rate of 12%. There is little evidence that current trends will be reversed in the near future. Although the accumulation of debt will be limited by the slowdown in new commitments, it is likely to continue to grow through the build-up of arrears on principal and interest payments and their de facto capitalization, and through continued use of short-term credit facilities. (xiv) The consequences of Bolivia's high and rising debt include: (i) a low import capacity; (ii) reduced access to new credit for project and trade financing; (iii) reduced maneuverability in domestic macroeconomic management; (iv) uncertainty about the availability of foreign exchange and a correspondingly volatile market exchange rate. Perhaps the most fundamental problem, however, is the strain on the balance of payments caused by current debt service obligations. These are expected to range between $650 and 700 million equivalent a year in 1985-87 (16% of GDP), excluding the substantial arrears at the end of 1984. (xv) The source of Bolivia's debt problems is not so much the absolute size of the debt or the terms on which it was contracted, but rather the uses to which borrowed funds have been put. The debt was contracted based on expectations of a surge in hydrocarbon exports which did not materialize. Additionally, a large proportion of the debt incurred was used to finance consumpticn, uneconomic projects, or effectively financed capital flight. (xvi) Bolivia's ability to service its debt depends on its export performance, but export prospects are currently poor. The country's exports consist of three types of goods: minerals, hydrocarbons, and so-called non-traditional exports (which include handicrafts, agricultural commodities, and manufactured goods like beer end sawn wood). Mineral exploration has stagnated during the last three decades. Not one new mine of importance has been put into production since the expropriation of the major mines in 1952. While Bolivia's mineral potential is large, the lack of exploration in the past precludes shirt term expansion of the sector beyond the levels which were reached in the late 1970's; time and new investment are required to develop additional output. The prospects for  - vi - hydrocarbon exports are uncertain. Gas sales to Argentina have become Boliviats most important export item, but Argentina has now developed its own gas reserves and consequently may no longer need Bolivia's gas; it is therefore in doubt whether the current gas sales contract will be extended beyond 1992. The gas pipeline to Brazil may materialize at some point in the future, but it is too early to say when it will become operational. Meanwhile, Brazil has considerably reduced its investment in the energy sector and is also developing its own gas resources. Finally, non-traditional exports, while potentially large, will take time to grow, even within an appropriate policy framework. (xvii) Given near-term export prospects, it seems clear that Bolivia will not be able to meet its existing debt service obligations on schedule. A comprehensive strategy is required to deal with the situation. Two essential decisions need to be taken within such a strategy. First, the Government needs to decide how to allocate foreign exchange among competing import requirements and debt servicing needs. Second, the Government needs to approach financial institutions to reschedule existing arrears, as well as amounts falling due in forthcoming years that Bolivia will be unable to pay. (xviii) The mining sector has historically been central to Bolivia's economic and political development, and remains a major source of foreign exchange, tax revenues and employment. Since the nationalization of the major mines in 1952, however, the sector has not been managed with the efficiency needed for sustained development; it has attracted too little public investment, and private investment has been discouraged by the fear of nationalization and other constraints. Mineral production in 1983 and 1984 was at its lowest level since 1952, and the sector's future has never been more uncertain. On the other hand, the metallurgical sector, which did not exist in 1952, has been given priority by the Government. It has developed into a relatively complex industry, consisting of the National Smelting Company (ENAF) plants for tin and antimony; COMIBOL's bismuth smelter/refinery; COMIBOL's volatization plant at La Palca; and a lead and silver smelter (Karachipampa, a COMIBOL/ENAF joint venture which started operations in an experimental basis in late 1984). In spite of the enormous investments undertaken to create this infrastructure, the metallurgical sector has not contributed to economic growth-a failure that the sector shares with mining industry, while it has been a prime source of Bolivia's external debt problem. (xix) The stagnation of production in the early 1980's, the consistently inadequate exploration and development efforts since the early 1950's, and the limited public resources available for investment in the remainder of the present decade, raise questions about whether the Bolivian mining sector can continue to play the role in the economy that it played in the past. On the demand side, prospects are not bright. Following the boom of 1980/81 and the subsequent decline, mineral prices are not expected to increase in real terms in the foreseeable future. While non-tin production faces no market limitations, the international market can only  - vii - accommodate limited increases in the production of tin (which accounts for some 60% of Bolivia's mineral export and some IO of world tin production) without a decline in prices. The supply side is characterized by a promising but iusufficiently explored geological base, and by a wide gap between what now exists and what is needed in terms of supporting investment, institutions and policies. In sum, while there are indications of a large mineral resource base, the mining sector can at best expect modest recovery in the rpmainder of this decade and early 1990's. (xx) The extent of recovery will depend largely on the quality of Government policies. Underutilized capacity in both the mining and metallurgical sector stands at about 50%. A realistic exchange rate, a strengthening of COMIBOL's management, adequate allocations of foreign exchange to producers and modest rehabilitation investments could offset the decline in mineral production of the early 1980's in a relatively short period of time. An increase in mineral production of some 30% could take place within two to three years. Geological data suggest, however, that Bolivia has sufficient mineral resources to sustain much larger output. To realize this potential, substantial investments will be needed in exploration and mine development. Since the general macroeconomic situation will limit the official funds available for investment in coming years, the Government should consider inviting private capital, both foreign and domestic, to participate in the development of the mining sector: unless the Government can successfully attract private capital into the sector, it is very likely that mining will continue to stagnate. It will also be necessary to begin to strengthen the government institutions operating in the mining sector, and to devise and put in place a flexible system for remitting profits abroad. Joint ventures between government enterprises and private capital could also be explored, particularly in the case of already identified projects such as the development of the Bolivar Mine or some gold projects; postponement of these operations would have a high opportunity cost. (xxi) Unti'l the mid 1960's, minerals made up 95% of Bolivian exports. Since then, two other items, nontraditional (mainly agriculture) and hydrocarbon exports, have become important. Nontraditional exports have been expanding since the end of the 1960's, reflecting the development of commercial agriculture in the valleys and lowlands. In 1980, nontraditional goods amounted to 15Z of all exports, but have subsequently declined, reflecting the overvaluation of the exchange rate. The renewed expansion of these exports is hampered by government policies and longer-term structural constraints. In addition to its foreign exchange policy, the Government has imposed a wide range of restrictions on nontraditional exports, especially agricultural goods. 'xxii) Bolivia's nontraditional exports are substantially below potential. Both agricultural production and handicrafts enjoy a relatively large resource base. In the short term (say two years), most nontraditional exports could be restored to the levels they had reached in the 1970's and could contribute significant foreign exchange earnings. In the longer term, agricultural and handicraft exports could become a new source of foreign exchange earnings. In addition to adopting a more  - viii - realistic exchange rate, the Government could promote nontraditional exports by (a) simplifying the regulations governing exports of agricultural origin; (b) reforming the current tariff system (with a view to making rates more uniform and reducing illegal imports); and (c) simplifying the current export promotion system. (xxiii) Reflecting the hydrocarbon price increases of the 1970's, natural gas has become Bolivia's largest export item, replacing not only tin but also the whole metals sector. Hydrocarbons cannot be expected to contribute as much to Bolivia's future as they have in the past, however. Gas exports depend on the development of markets in Brazil and Argentina, and the prospects are uncertain in both cases. Bolivia's most pressing challenge in the hydrocarbons sector may now be how to avoid becoming an oil importer by the beginning of the next decade. The outcome in this respect will depend on two projects: the development of the Vuelta Grande fields, which would increase the production of oil, and the construction of a gas pipeline to the Altiplano; this latter operation could substitute gas consumption for oil usage in industry, thus reducing Bolivia's oil consumption by some 20%. Because of insufficient exploration in the past, Bolivia still runs the risk of becoming a net oil importer over the longer term. This can only change if substantial oil discoveries (which are unlikely to occur without the participation of foreign oil companies) are made, and if appropriate pricing policies for hydrocarbons encourage more efficient domestic use. The Government could adopt a more effective policy to manage energy resources, including a realistic price structure for hydrocarbon products. This means changing relative prices to encourage the substitution of relatively abundant products (i.e., gas) for relatively scarce ones (i.e., diesel and fuel oil) and introducing absolute price levels that promote energy conservation. It also implies completing the gas pipeline to the Altiplano as soon as possible. It is also recommended that the Government adopt policies to attract additional foreign investment to help develop Bolivia's hydrocarbon sector. There are a number of possible ways to do this. Private operators could be assigned to explore high risk areas, being compensated with a share in an area reserved by YPFB. Alternatively, new acreage could be offered to foreign companies for exploration. Or contracts could allow an increase in the foreign company's share in the case of small scale discoveries. (Xxiv) Bolivia is not likely resume its development process until the Government introduces a short term economic program of the type outlined above. Only such a program can reverse current adverse trends of declining GDP and exports, high and accelerating rates of inflation, and mounting arrears on foreign debt service. The existing distorted price system hinders the creation of new sources of growth and lowers the returns on capital investment. The situation will deteriorate even further after 1992, when sales of gas to Argentina may fall off (or their terms become less favorable to Bolivia), if no alternative source of export growth will have been developed.  - ix - (xxv) Changes in policies can improve the performance of Bolivia's exports in a relatively short period of time. Such an increase in exports could allow GDP growth rates of 5Z and a viable balance of payments for some years, i.e. a situation where Bolivia would be able to pay its preferred creditors and service interest to commercial banks although it might not be able to service principal to commercial banks or private non-guaranteed debt. Any reduction in the pace of export growth would again make the balance of payments position untenable, however; arrears would accumulate and debt service payments to all creditors would be jeopardized. Finally, new sources of export growth will have to be found after the expiration of the gas sales contract in 1992. Whether Bolivia will be able to develop these new sources will depend on the actions and policies the Government will pursue from now on.  CHAPTER I RECENT ECONOMIC DEVELOPMENTS 1. The Government which is to take power in August, will face one of the most serious economic crises that Bolivia has known since it became an independent state in 1825. By 1984, per capita income was below the level it had reached in the early 1950's and so were mineral exports, which are still one of Bolivia's main sources of foreign exchange. Unemployment exceeded 10%, an unprecedentedly high rate for Bolivia. The country also experienced difficulties in servicing its external debt; by the end of 1984, arrears reached 25% of Bolivia's total foreign debt, which amounted to US$4 billion. In June 1981, foreign exchange could still be purchased freely at $b25/US$; by March 1985, however, foreign exchange could normally only be purchased in the illegal parallel market at a rate of $b160,O00/US$ (representing a roughly tenfold depreciation of the Bolivian peso in real terms). In 1984, inflation reached an annual rate of over 2,000Z; by early 1985, prices were doubling within a month. Welfare losses caused by falling incomes were exacerbated in 1983 by floods and droughts from which the agricultural sector has not yet recovered; in 1984, agricultural output was 13% below its 1982 level. In a country which is the second poorest in Latin America (after Haiti); where life expectancy is the lowest, infant mortality the highest, and where much of the population exists at the borderline of survival, declines of the kind just outlined imply dramatic losses in welfare. Lack of data makes it difficult to assess with precision the impact of recent developments on the quality of life of the population. Indirect indicators suggest, however, that the 1980-1984 crisis has increased poverty, malnutrition, and ill-health, eroding the human resource base in ways . will take a long time to reverse. 2. The process of economic deterioration has been accompanied by hostile relationships between socio-economic groups. Since 1979 there have been no less than three elections, six presidents, three coups that succeeded and twice as many that failed. The democratic Government that took power in October 1982 found itself unable to cope with the situation and advanced new elections by one year (to July 1985). Between 1980 and 1982/84, the number of strikes rose from 120 to an average of over 300; in 1984 alone, over 30 working days were lost in nationwide general strikes. The Government's authority has been eroded to the point where blatant lack of compliance with official regulations and policies has become commonplace. In 1984, for example, the Central Bank went on a two month strike because it opposed the economic program adopted by the Government. Likewise, state enterprises have more than once granted wage increases above the authorized levels. Finally, no budget was presented to Congress in 1983 and 1984; in effect, all public agencies' operations were undertaken with unauthorized expenditures.  -2- I. THE ECONOMY OF BOLIVIA A. Historical Background 3. Until the middle of the 20th century, Bolivia's monetary economy was confined to mining and mining-related activities, with little spill-over into the rest of the economy. The vast majority of the population was excluded from both political and economic life. Until 1952, less than 3Z of Bolivians were entitled to vote and over 70% lived in a quasi-feudal rural economy. No significant linkages developed between mining and the rest of the economy, because both Bolivian and foreign mining entrepreneurs chose to reinvest abroad most of the profits generated by their operations. This strategy may have been appropriate from a private point of view, but meant that investments in infrastructure and education needed for Bolivia's long-term development, were not undertaken. Moreover, successive Governments found themselves unable to tax mining activities in any meaningful way; Bolivia's political instability in the first half of the twentieth century was due in part to conflicts between Governments' attempts to tax mining activities and mining entrepreneurs' resistance to these efforts; until 1952, the latter were generally able to ensure that Onvenments enacted policies favorable to their interests. 4. Bolivia's highly unequal distribution of wealth in those years led to a similarly unequal distribution of incomes. The perception that landowners blocked improvements in the rural population's welfare, and that mine-owners played the same role with respect to mine workers (and to the diversification of the economy as a whole), led the leaders of the 1952 Revolution to give priority to agrarian reform and to nationalization of the major mines. Both these policies were carried out, but with mixed results. Inadequate investments and lack of support services, in both quantitative and qualitative terms, prevented the 1952 agricultural reform from producing sustained and vigorous agricultural growth. In the case of mining, both Government and miners saw nationalization as a means for achieving their own, conflicting, objectives. The Government saw nationalization as a way to finance investment in other sectors of the economy, while the miners saw it as a way of raising their living standards. As a result of this conflict, an adversary relationship has developed between Government and the miners since 1952, with both gro'?ps trying to seize the surpluses generated in the mining sector. Governments have extracted resources from mining through exchange rate overvaluation, export taxes, and allocating minimal funds for investment in mining. The miners have extracted resources through higher-than-average real wages and fringe benefits, making the workers a relatively privileged class in Bolivia. Depending on the political orientation of the Government and the strength of the trade unions, Governments and miners have taken turns at being the beneficiaries of these efforts. Meanwhile, the main consequence for the economy as a whole has been chronic undercapitalization iu the mining sector: neither Government nor the miners have had any incentive to invest in the development of the mining sector, partly because it has been unclear which of the two parties would be able to appropriate the future  3- Table 1.1: AVERAGE REAL GROWTH RATES OF GDP IN SELECTED SECTORS, 1956-1984 (Percentage annual changes) 1956-61 1962-67 1968-73 1974-79 1980-84 GDP at Market Prices 2.0 5.5 4.6 4.5 -4.0 Agriculture 2.8 2.3 3.6 3.5 -0.7 Mining 5.2 8.4 1.9 -3.8 -5.9 Hydrocarbons -0.2 - 6.2 12.9 -10.6 -0.7 Manufacturing 7.1 7.0 4.3 6.7 -8.7 Source: Statistical Appendix, and Central Bank. benefits generated by new investments. Not surprisingly, no large mine has been put into production since 1952, and the development of Bolivia's mining sector has lagged well behind its potential. COMIBOL, the public sector holding company created to manage the nationalized mines, has become a prime example of state inefficiency; in 1984, the company's mineral production was at its lowest level since the 1950's. 5. Since the 1952 revolution, Bolivia's public sector has developed into a complex entity composed, by the mid-1970's, of some 520 agencies-120 in the Central Government, 350 in regional and local Government, and 50 public enterprises and financial institutions. Fears that private entrepreneurs would develop domestic resources for their own to benefit and accumulate assets abroad rather than domestically have led heavy state participation in most economic activities; the public sector is uow responsible for sez-e 65% of mineral production, 80% of hydrocarbon output, 70% of enetgy prcduction, over half the assets of the banking system, and over 70% of air passenger transportation. Lack of information makes it hard to quantify the Government's share in manufacturing, but indirect data suggest that private participation in Bolivia's industry is one of the smallest in che non-socialist world. The state owns glass, textile, and cement factories. The bulk of Bolivia's agroindustrial sector is also run by the state: milk, dairy products, sugar, rice, maize by-products, edible oils, and tea are produced or marketed almost exclusively by state-owned agencies. 6. This process of growing state involvement in the economy has been steady and relatively independent of the political orientation of successive Governments. Civil servants have attempted to maximize their income and employment opportunities by expanding the scope of their agencies' activities. Conservative Governments have not attempted to reverse the trend: if anything, they have strengthened the management and efficiency of the public sector bureaucracy (as, for example, during the 1970's) without questioning or redirecting the role of the state in the economy. More radical Governments have increased Government involvement by expanding the scope of state activities. For example, Gulf Oil in Bolivia  - 4 - was nationalized in 1969, as was a large mine belonging to United States Steel (Mina Matilde) in 1971. In 1983, a public enterprise was established in a sector-passenger and freight surface transportation-that had previously been free from Government intervention. In 1984, the Ministry of Hines drafted a law giving the scate a gold mining monopoly. (This law has not been sent to Congress as yet.) This tendency to enlarge the public sector is not restricted to the Central Government. The nine Departamentos (the political and administrative entities into which Bolivia is divided) have also expanded their authority. Earmarked taxes on minerals and hydrocarbons have given some of them a high degree of financial autonomy, which they have used to expand their activities into running, among others, hotels and manufacturing and agroindustrial plants. 7. The process of capital accumulation has thus been heavily influenced by the Government, which has been responsible for over two-thirds of all such accumulation since 1952. Investment decisions, however, seem to have given little weight to economic considerations. Basically, any project backed by a strong lobby and with assured foreign financing has become part of the Public Investment Program. Easily granted Government guarantees, tempting terms from bilateral aid, and suppliers credits have helped funds to flow into sectors or regions run by influential agencies (or local governments) rather than to sectors where returns would be higher. During the 1970's, for example, investments in metallurgy have been disproportionately high compared to investments in mining-with the result that the numerous metallurgical plants built during this period are operating at an overall capacity level of less than 30%. Likewise, investments in airports have exceeded Bolivia's needs while support for feeder roads has been insufficient. Finally, because of local pressures, agroindustrial plants have been built in inaccessible areas. 8. The issue for Bolivia is not whether the Government participates in the development process, but rather what kind of state intervention is most appropriate. The mutual mistrust built up over time between the private sector and important segments of the population has had two consequences. First, the private sector has come to feel that participation in Bolivia's development process entails an unacceptable degree of risk and has therefore continued, whenever possible, to accumulate assets abroad. Second, the Government has chosen to compete with the private sector in activities that are more suited to the latter (such as consumer goods production, agroindustry and metallurgy), while giving inadequate attention to the production of public goods in which it has a natural role to play. 9. The pitfalls of this style of economic management did not become fully evident until the 1980's. In the 1950's and 1960's, the economy was still adapting itself to the new institutional and political environment introduced by the 1952 revolution. The agrarian reform and the nationalization of mines implied a major redistribution of we?1th Vwhich initially destabilized the economy. Between 1952 and 1958, inflation soared, while GDP fell at an average rate of some 2X per year. During these years, most major public investment projects were sponsored by official multilateral and bilateral agencies, a fact that imposed some discipline over the investment process. For example, the Government plan to develop the lowlands was financed, alaost entirely, by bilaterals. Brazil financed the Santa Cruz-Sao Paulo Railroad, which linked a  previously isolated region of Bolivia to the Atlantic seaboard; similarly, USAID financed the road link between Santa Cruz and Cochabamba, already linked to La Paz; and Argentina financed a rail link between Santa Cruz and Jujuy thus linking Santa Cruz to Buenos Aires. These projects made possible the 1970's boom in commercial agriculture in the Santa Cruz area. B. The Legacy of the 1970's 10. In the 1970's, an oil, gas, and commodities boom associated with the discovery of hydrocarbons fields which indicated the possibility of sizeable petroleum and gas deposits, made the country attractive to foreign financial entities. Capital inflows grew-encouraged by a World Bank-sponsored Consultative Group meeting and a parallel meeting of private bankers-reaching US$300 million a year at their peak in 1975J78-an amount that was equivalent to some 5OZ of total exports during those years. The relatively easy access to foreign exchange during the 1970's exacerbated the weaknesses of Bolivia's development pattern-it further increased the role of the state in the economy, and accelerated the private capital flight. Increasing the Role of the State in the Economy 11. In spite of an unprecedented degree of political stability in the 1970's private entrepreneurs did not find investing in Bolivia an attractive proposition. Although the Government issued policy statements encouraging foreign and domestic private sector entrepreneurs to invest in Bolivia, new private investment flows failed to materialize. During the period 1971/81, foreign private investment was at some US$20 million a year, while Bolivian's capital investment abroad (and unrecorded imports) amounted to some US$150 million a year. The political stability was recent from a historical point of view, and memories of nationalization were still fresh; investors consequently perceived the risks of investing in Bolivia to be out of proportion to the expected returns--which were and still are subject to the vagaries of government policies and the restrictions of a highly regulated economy. In mining, for example-a sector which could potentially attract large amounts of private investment--the allocation of mineral concessions is tia consuming and cumbersome, taxation on minerals is perhaps the highest in the world, and support services such as geological surveys are inadequate; meanwhile, returns on investment and profit remittances are subjected to an inflexible foreign exchange policy, which has resulted in frequent foreign exchange shortages and balance of payments crises. Likewise, commercial agriculture is restricted by controlled prices, trade restrictions and cumbersome government regulations. Foreign Debt and Capital Flight 12. Therefore, the accumulation of capital needed for Bolivia's long term development has inevitably become a government responsibility. The already strong tendency for successive Administrations to participate extensively in economic activities has been legitimized by the dearth of private sector investment, and by relatively easy access to international  -6 - Table 1.2: FINANCING THE CURRENT ACCOUNT (Annual average, million dollars) 1971-75 1976-81 1982-83 Current Account -6.5 -208.6 -196.2 Capital Account 6.5 208.6 196.2 Transfers 8.5 27.7 54.6 Foreign Investment 11.4 33.8 40.0 Change in reserves/I -12.8 42.9 -123.4 Public Debt/2 76.7 321.1 331.2 Private Capital flows -77.3 -216.9 -106.2 and other Capital /1 (-) indicates growth of reserves. /2 Includes exceptional financing and capitalization of interest. Source: Bank staff estimates. capital markets. The 1970's saw the creation of relatively large, complex and inefficient state-owned metallurgical and agroindustrial factories, and of several public sector industrial plants. Rising publicly-financed investment produced rising public sector deficits (which amounted to over 10% of GDP during the years 1975/78) and an expansion of aggregate demand. The economy grew at over 5% a year in the 1970's, an historically high rate for Bolivia. 13. In retrospect, together with the anticipated imminent large petroleum exports which did not materialize, the main error of economic policy during the 1970's was the ease with which the Government granted its guarantee to external financing of both public and private investment projects. The capital inflows were partially offset by capital outflows: capital flight (and unrecorded imports) amounted to over 60% of the value of the debt accumulated during the years 1971/81. The Government's foreign borrowing for public investment thus effectively financed the accumulation of privately owned assets abroad. Bolivia's heavy indebtedness in the early 1980's thus involves a regressive redistribution of income; the decline in consumption required to repay the debt is, in effect, a tax imposed by those who have accumulated assets abroad on those who were unable to do so. This outcome was not inevitable, however. Had the assets financed by foreign borrowings been more producWive, yielding higher rates of return that could have helped to service the external debt, the shadow price of foreign exchange would have not risen as it did in the 1980's, and those who had accumulated assets abroad would not have realized the capital gains created by the large depreciation of the $b in real terms. Bolivia's nationals' assets held abroad are estimated to be over US$1 billion (excluding narcotics proceeds). Thus, one of the main challenges or Bolivian policy makers today is not only how to service the country's external debt, but also how to create investment opportunities that will attract private sector participation.  - 7 - 14. The accumulation of debt to finance publicly-sponsored investment was interrupted in 1978/79 by a change in the commercial banks' perception of Bolivia's export potential and debt servicing capacity. This led the banks to reduce their exposure, leaving Bolivia without the substantial foreign inflows needed to help service its large external debts-debts which had in turn financed a capital stock which could not contribute to repaying them. At that point, two lines of action were open to the Govern- ment: (i) a large devaluation in real terms (which would reflect the reduction in the supply of foreign exchange caused by the withdrawal of foreign financing sources); and (ii) a reduction in aggregate demand (which would reduce the demand for imports, and thus the demand for foreign exchange, to a level compatible with the newly restricted supply of foreign exchange). C. The 1980-1984 Economic Crisis 15. Initially, the Government opted for a combination of devaluation and reduction in public expenditures. The program was initiated in December 1979, supported by an IMF stand-by and a World Bank structural adjustment loan. Negotiations with creditor banks on rescheduling Bolivia's co mmrcial debt began at the same time (concluded in April 1981 with a rescheduling agreement). The program was disrupted by a coup in 1980, however, and no consistent policy for economic recovery has subsequently been implemented. The 1980 coup was followed by three military governments, which could not muster the political support needed for an adjustment policy, and turned power over to a democratically elected Government in October 1982. During its nearly three years, however, the democratic Government has also been unable to implement a coherent economic program. The net outcome is that the problem of how to handle the losses of the debt accumulation of the 1970's has remained unaddressed. The absence of a coherent medium term economic program, together with a confusing wage policy and a rigid foreign exchange regime are the main causes for successive Governments' failures to halt the process of economic deterioration. Lack of a Medium Term Economic Program 16. Since the 1979 program, Bolivia has had six stabilization packages, adopted in February 1982, November 1982, November 1983, April 1984, November 1984, and February 1985. While the 1979 program contained relatively well defined and comprehensive policies for stabilization, the subsequent six economic packages were ad hoc in nature. They concentrated on the short term, gave no sense of continuity, and often neglected measures needed for effective progress towards stabilization. The February 1982 package, for example, consisted of a deraluation together with adjustments in public sector tariffs and petroleum and foodstuff prices. It had no provisions dealing with wage compensation or future Government wage policy. This failure was one of the reasons for the popular discontent that forced the return to democratic rule. The November 1982 package, while providing a coherent wage policy, included the elimination  Table 1.31 BALANCE OF PAYMENTS, 1970-84 (Millions of us$) 1970 1971 1972 1973 1974 1975 1976