Madagascar - Agricultural Sector Adjustment Operation Project

D_su of The World Bank FOR OMCIAL USE ONLY C "e. /6" 7 ck9 Report No. P-4197-MAG REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 19 MILLION AND A PROPOSED AFRICAN FACILITY CREDIT OF SDR 31 MILLION TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR SUPPORTING AN AGRICULTURAL SECTOR ADJUSTMENT OPERATION April 8, 1986 IThis 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.  CURRENCY EQUIVALENT Currency Unit: Malagasy Franc (FMG) Conversion rate at September 30, 1985: US$ 1 = FMG 655 FMG 100 = US$ 0.15 ABBREVIATIONS AND GLOSSARY CCCE Caisse CeTntrale de Cooperation Economique (French Capital Aid Agency) FED Fonds Europeen de Dgveloppement FNUP Fonds National Unique de P&rEquation ITC International Trade Center KFW Kreditanstalt fUr Wiederaufbau MPAEF Ministere de la Productioa Animale et des Eaux et Forets (Ministry of Livestock and Forestry) MPARA Ministere de la Production Agricole et de la R&forme Agraire (Ministry of Agriculture) UNDP United Nations Development Program GOVERNMENT FISCAL YEAR January 1 - December 31  FOR OFFICLIL USE ONLY MADAGASCAR AGRICULTURE SECTOR ADJUSTMENT OPERATION CREDIT AND PROGRAM SUMMARY Borrower: Democratic Republic of Madagascar Amount: IDA: SDR 19 million (US$20 million) Special Facility for Africa: SDR 37.5 million (US$40 million) including a Special Facility Credit of SDR 31 million (US$33 million) and a Special Joint Financing of: Y 600 million (US$3 million), Japan; and DM 10 million (US$4 million), FRG KfW Terms: Standard for IDA and the African Facility Program Description: Objectives: (i) to support the 1986-87 phase of the Government's program to increase production and incomes by making its agricultural economy more market-oriented; (ii) to help prepare the next phase of the reform program (1988-90) and (iii) to provide foreign exchange for imports needed to realize fully benefits associated with the reform program. Benefits: Price and market reform would benefit primarily the farming population, whose terms of trade have deteriorated sharply over the past decade. Increased production, particularly rice, over the next years will benefit urban dwellers. Finally, import substitution and higher exports will improve the balance of payments. Risks: Failure of the economy to grow would reduce the political sustainability of reform. IDA support would help smooth the transition to a market-based agricultural economy. Further establisbment of a sound rice management program would go a long way towards allaying the Government's immediate concern about consequences of urban shortages. Finally, policy reforms aimed at increasing marketed surpluses are expected to elicit a strong response; this should enhance the adjustment prograW's credibility and sustainability. In light of the above, the risk associated with the operation is considered to be within acceptable limits. ITh docuent has a restrctd distnbuton and may be used by ecients only in the pefonmance of 1 ther officiad dutiu Its contents may not otherwise be disclosed without World Bank authorzation.  - ii - First Second Tranche Tranche Total CUS$ milljon) Agricultural inputs, materials, 27.5 27.5 55.0 equipment, spare parts, veterinary supplies and rice Rural incentive goods 5.0 - 5.0 Total 32.5 27.5 60.0 Financing Plan Amount US$ equivalent (million) IDA SDR 19 20.0 Special Facility for Africa SDR 31 33.0 Special Joint Financing: Grant from Japan Y 600 3.0 Credit from Germany (KfW) DM 10 4.0 60.0 Estimated Disbursements 1/: IDA FY 1987 1988 (US$ million) Annual. 33.0 27.0 Cumulative 33.0 60.0 Rate of Return: Not applicable. Staff Appraisal Report: No Staff Appraisal Report was prepared. 1/ Priority would be given to disbursing SFA proceeds.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON PROPOSED CREDITS TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR AN AGRICULTURE SECTOR ADJUSTMENT OPERATION 1. I submit the following report and recommendation on a proposed IDA credit of SDR 19 million (US$20.0 million equivalent), and a proposed African Facility credit of SDR 31 million (US$ 33 million equivalent) to the Democratic Republic of Madagascar to finance an Agriculture Sector Adjustment Operation. Special Joint Financing of Y 600 million (about US$ 3 million equivalent), DM 10 million (about US$ 4 million equivalent) would be provided by Japan and the Federal Republic of Germany, respectively. PART I - THE ECONOMY 2. A report entitled Country Economic Memorandumn dated March 18, 1986, was distributed on March 24, 1986, to the Executive Directors and to participants in the Madagascar Consultative Group. It is available as document 5996-MAC and its main conclusions are reflected below. Country data sheets are provided in Annex I. 3. Madagascar, with a population of 9.7 million and a per capita income of about US$265 in 1984, is among the poorest countries in the world. It is a sparsely settled country, with a population density of about 17 persons per square kilometer. Although Madagascar is generally well endowed with natural resources and a variety of soils, there are considerable regional variations in ecology and climate. The central plateau, the most economically advanced region, has a subtropical to temperate climate. The south is the poorest region with an arid climate and infertile soils. The eastern region has a tropical climate and, although the region is rich agriculturally, crops are frequently devastated by cyclones. The western part of the country comprises extensive pastureland with some tropical agricultural production along the coast. Agriculture accounts for about 40 percent of GDP; over 85 percent of the population lives in rural areas, and agricultural products account for about 80 percent of the country's export earnings. 4. In the decade following independence in 1960, Madagascar's economy grew at an average annual rate of about three percent. Agriculture was responsible for much of this growth, while manufacturing, benefitting from increased protection, gained in relative importance. The years following 1972 marked a watershed in Madagascar's economic and political development. After the 1972 and 1975 revolutions, an inward-looking economic policy was geared to self-sufficiency and consolidation of the new regime's socialist aims through decentralization to new local government institutions (the fokonolona system), nationalization of industrial, trading, and agricultural enterprises, and moves towards collectivization  - 2 - of agriculture. Towards the end of the 1970s this movement was overlaid by a policy of rapid industrialization with emphasis on capital intensity, accompanied by pricing and marketing policies heavily biased towards urban consumers. 5. During the decade 1973-82 real per capita GDP fell by an estimated 28 percent. The major contributing factors to this decline were: (i) The widespread nationalization of economic activity and suppression of private initiative, accomplished by taking over numerous enterprises and creating new parastatals, gave rise to a large and unmanageable public sector. (ii) Regulatory intervention in the economy increased substantially; price controls were generalized and enforced with greater vigor than before, local authorities assumed broad new powers, government marketing monopolies were established, and import restrictions and exchange controls tightened. (iii) Many policy actions led to neglect of agriculture and fostered the growth of manufacturing for domestic markets, including the establishment of numerous enterprises of doubtful economic value. 6. The Government's attempts in the late 1970s to stimulate expansion of Madagascar's stagnating economy through a large public investment program contributed to an economic crisis beginning in 1980-81. The share of investment in GDP, which had averaged around 13 percent from 1970 to 1978, increased sharply to 25 percent in 1979-81. The financing of this massive investment program contributed to a large public sector deficit (about 18 percent of GDP by 1980), inflation in excess of 30 percent both in 1981 and 1982, and a sharply increased debt service burden (the debt service ratio,before rescheduling, rose sharply from about four percent of export earnings in 1978 to 46 percent in 1981, nearly 75 percent In 1984, and 90 percent in 1985). The debt service burden has been largely responsible for the severe shortage of foreign exchange which has been a critical constraint to economic activity. Contributing to this shortage was a drop in export earnings as the terms of trade for agricultural exports weakened and as domestic consumption expanded. This drop was accentuated by declining agricultural production due to an overvalued exchange rate, low controlled producer prices, and state interference with the marketing of agricultural products. Industrial exports, which had never been encouraged, suffered a further blow through the impact of the foreign exchange shortage on the availability of raw materials and spare parts. 7. Faced with an unsustainable resource gap (equivalent to 17Z of GDP in 1980), Government began implementing stabilization measures in 1981. In the years which followed, aggregate expenditure was steadily reduced and gross savings increased, especially from 1983. Among specific measures taken to reduce aggregate demand, the most notable actions were on the exchange rate and on consumer subsidies. In nominal terms, the average rate of the FMG vis-a-vis the SDR depreciated by about 75X during 1982-85, and after adjustment for domestic and trading-partner inflation the real depreciation of the FMG approximated 25%. The Government more than doubled the nominal price of rice distributed through official channels; consumer subsidies on imported rice were eliminated. Madagascar's stabilization efforts also included tax measures,expenditure cuts, increases in prices  -3- of public enterprise goods and services, and sharply curtailed imports. In addition to fiscal restraint, tight bank credit ceilings were employed to reduce inflation. 8. Between 1980 and 1985, agricultural output fluctuated. Production of paddy, a staple item, remained at around 2 million metric tons per year. Madagascar had to continue importing rice throughout the period, although the volume imported declined steadily from a peak 356,000 metric tons in 1982 to about 105,000 metric tons in 1985. The decline in rice imports, however, was due to foreign exchange scarcity rather than any marked increase in domestic self-sufficiency. Production of other food crops (maize, potatoes, cassava, sweet potatoes) grew steadily and significantly for these crops as a result of increased rice prices. With the exception of cotton and sugar cane, the production of industrial and export crops generally stagnated (e.g., tobacco, coffee, pepper) or declined (e.g., groundnuts, butter beans). The output of two other principal export crops, vanilla and cloves, was restrained by limited world market demand for these products. 9. The output of the industrial sector declined sharply between 1980 and 1982, and again in 1984; modest growth obtained in 1983 and 1985 did not make up for the decline in the other years. Industrial manufacturing capacity has been heavily underutilized in recent years owing to shortages of domestically supplied agricultural raw materials, and of imported inputs and spare parts. The construction industry also remained slack, judging from data on gross fixed capital formation. Between 1980 and 1982, all types of construction - residential, non-residential and other - declined heavily. In the following years, residential and other construction grew a little, but the volume of activity was constrained by continuing restraint in investment expenditures and shortages of construction materials. 10. On the policy front, Government initiated positive changes in industry, easing pricing controls, improving the administration of foreign exchange allocation, and, as recently as June 1985, legislating a new Investment Code. The new Code provides clearer and more automatic incentives and aims to attract foreign private investment. Here again, the recent initiatives need to be strengthened by extending the export earnings scheme (the EPI account) to a greater number of bona fide exporters, rationalizing the tariff system, and quickly completing the practical rules and regulations of the new Investment Code. 11. Owing to the slow growth of agriculture and industry, the transport sector had less merchandise and fewer passengers to carry throughout 1980-85 although, within the period, there was some upturn in road and rail traffic in 1983 and 1984. The traffic that was required had to be carried at high cost given the dilapidated state of the transport system. Until recently, however, costs could not be covered as the administered tariffs were set too low, thus further discouraging the provision of services. To improve the transport system and policy environment Goverrment selected an economic networ,c of about 10,000 kms of primary and secondary roads for priority rehabilitation; established a road fund for maintenance; and permitted tariff increases for the roads, railways, and the national airline.  - 4 - 12. Public Finance. During the 1978-80 period, the country experienced an unprecedented growth in public capital expenditures financed by external loans, leading to substantial budget deficits and accumulation of indebtedness and arrears. Successive adjustment measures adopted between 1981 and 1985 progressively reduced the magnitude of the deficit and domestic arrears. The bulk of the fiscal adjustment has been accomplished by cutting expenditures, with a lower investment level, contained payroll expansion, and a reduction in materials and supplies used for government activity. The current budget balance turned positive in 1983 and remained so during 1984 and 1985. The size of the current surplus, however, remained small relative to the need to increase public savings. The overall deficit declined from 18.4% of GDP in 1980 to 8.7Z in 1982 and 4.8% in 1984. It was estimated at approximately 4.7% of GDP in 1985. 13. Revenue. Total revenue declined from 17.9% of GDP in 1980 to 15.7% in 1985. The tax structure was altered frequently with yearly changes in the tax rate system. The tendency was to increase tax rates on income and imports, without visible results on e'fective tax revenue, this being partly due to unsatisfactory tax administration, partly to increased tax avoidance, and partly to reduced imports. Extrabudgetary revenues represented a growing share of total government revenue, with surplus from export stabilization funds yielding the main contribution in this category. 14. Expenditure. Improvement in fiscal performance was mostly the result of tight control of expenditures. Between 1980 and 1985, central government expenditures increased by only 26%, representing a substantial decline in real terms. The ratio of expenditures to GDP over the period declined steadily from 36.3% in 1980 to 20.4% in 1985. The main factor in this decline was cutbacks in capital expenditures from the unsustainable level of 1980. In real terms, capital expenditures declined by 15% per year during 1980-85. 15. Monetary developments during 1980-85 were generally in line with fiscal developments, reflecting implementation of stabilization measures. Throughout the period, the growth of credit to Government was reduced, and, beginning in 1982, credit to the non-government (i.e., parastatal and private) sectors generally expanded faster than credit to the Government. 16. Domestic inf..ation in Madagascar was reduced considerably after 1982, from about 30% in 1981 and 1982 to approximately 10 percent in 1985. This performance was due mainly to demand management measures during the period, and to some decline in foreign prices of Madagascar's imports. The reduction of inflation during the period was all the more remarkable in that it occurred at a time when the Malagasy Franc was depreciating. Madagascar's balance of payments remained weak throughout 1980 despite substantial annual reductions in the volume of imports to the point of adversely affecting economic activities. To a large extent, the position remained weak owing to poor export performance and heavy debt service payments, the latter a legacy of large borrowings on hard terms during 1978-80.  - 5 - 17. Stabilization efforts throughout the period led to steady and marked improvements in the resource and current balances. In dollar terms, the resource gap in 1985 ($102 million) was less than 20% of what it was in 1980 (US$557 million); and the current account deficit in 1985 (US$237 million) less than 40% of what it was in 1980 (US$599 million). 18. Based on the existing debt portfolio at end 1985 and after taking into account pipeline disbursements, Madagascar will need new net capital inflows of about US$380 million per year during the 1986-90 period to cover current account deficits, meet scheduled debt repayments, and maintain a modest amount of gross reserves. The conditions at which Madagascar is able to obtain new finance and reschedule the debt are of crucial importance and will determine if the country is able to emerge from its low-level trap, even with a high quality policy program. 19. Since the emergence of the debt crisis at the beginning of the 1980s, Madagascar'has managed the balance of payments by cutting imports and rescheduling debt service payments. These are very costly options, involving disruption of economic activities and refinancing of some originally concessional loans at less concessional terms. Madagascar now has probably reached a limit to further cuts in imports as these are down to bare essentials. As to debt rescheduling, the country's creditors may continue to accord such arrangements to Madagascar. But, to generate significant amounts of annual debt relief, the rescheduling arrangements would need to provide liberal coverage. Unless Madagascar would boost export earnings and thus strengthen the balance of payments, the debt burden would not be overcome. 20. Relationship with DEM. As of December 1985, the Government had complied with all performance criteria set in the fifth standby agreement signed in April 1985. Most of the important program targets have been achieved and all scheduled purchases have been effected. In the second review of the current standby, the Government has decided to accelerate the depreciation of the exchange rate and agreed to continue this process under the sixth standby agreement. A mission visited Madagascar in March 1986 to negotiate a program supported by a sixth standby agreement, but unfortunately the negotiations could not be completed since a major cyclone affected Madagascar and the impact of the damage could not be assessed immediately. A new mission is therefore scheduled and the stand-by is expected to be presented for IMF Board of Executive Directors approval in July 1986. A meeting of the Consultative Group is scheduled for April 24/25, 1986 and the Paris Club is expected to meet in July. PART II - THE AGRICULTURAL SECTOR A. Profile and Recent Performance 21. Agriculture accounts for over 40% of GDP and employs 88 percent of the population. Over half of Madagascar's production by value is for  -6- subsistence, predominantly rice (30 percent) and beef (16 percent). Coffee, cloves and vanilla represent about 15 percent of this production and about three-quarters of merchandise exports. Industrial crops, notably sugar and cotton, account for another 7 percent. About 80 percent of overall production comes from small farmers. 22. In spite of very favorable factor endowment, including irrigation on about one-third of cultivated land, the sector's performance has been highly deficient, impinging upon growth of the economy. During the past seven years, unlike the 1960s and early 1970s, production of basic foodstuffs and major export crops has stagnated. Groundnut production, previously the major source of edible nils, fell to negligible levels while other commodities, such as butter beans, declined sharply. Only cotton contradicted this trend as production increased over the last two years. The negative effects on the balance of payments of these developments have been serious. Once a net exporter of rice, Madagascar's growing imports of rice and edible oils consumed an increasing share of foreign exchange resources, peaking at 21 percent of total export receipts in 1982. B. Policy Issues 23. A principal cause of faltering production has been the Government's far-reaching control of the agricultural economy, including direct involvement in production and administration of prices. This conflicted with the needs anai potential of a sector dominated by private, smallholder production, and neglected the potential economic contribution of larger farmers and existing private marketing and processing networks. 24. Marketing and Pricing. Following the 1972 revolution, both the national and local governments intervened increasingly in the market. Decentralized local governments (the fokonolona) were given power to control prices and markets, and taxation on sales of agricultural products became a main source of revenue. The result of these interventions was wholesale disruption of private trade. In 1974 the national Government established an official marketing monopoly for paddy and rice and by 1977 its monopoly covered virtually all agricultural and livestock products. 25. Prices and margins were set at every level, from producer to consumer. This led to serious distortions and production was depressed by low official prices. Parallel markets for controlled foodcrops emerged, but could only function with high margins. Private entrepreneurs, such as rice and oil millers let their facilities deteriorate for lack of profit or foreign exchange, and many plants were absorbed into the public sector. The State-run entities were generally inefficient and suffered severe financial problems as consumer prices were held down. In line with the Governmeant's objective of providing rice to the entire population, imported and domestic rice was provided through official channels at subsidized prices. This changed dietary patterns and, together with population growth, led to spiralling demand while per capita production fell by 20 percent over 1975-82. Subsidies imposed a mounting financial burden, and the growing gap between production and consumption led to a heavy rice  import bill. By 1981-82, direct financial outlays on rice price subsidies equalled total Government spending for agricultural investments and services. 26. Resource Allocation and Management. While public sector investments in agriculture expanded rapidly, private sector access to bank credit and foreign exchange was sharply curtailed by national policies. Returns to public investment were low because management was weak at every level, and politica.A considerations often superseded economic choices. External financing tended to be accepted uncritically and used unproductively. Salaries eroded, reducing incentives in the public service, but overall staff costs increased absorbing most of the operating expenditures. Cost recovery was neglected, contributing to the fiscal burden and asset erosion. Meanwhile, the private sector became progressively decapitalized. Few private investments were made during this period. 27. Farmer Services. During the 1960s and 1970s, the Government merged input supply and rural credit with the other services it offered, including animal health, management of large and medium scale irrigation networks, research, extension and rural afforestation, sharply reducing the effectiveness of their delivery. Organization, management and re6ources all became insufficient. Research and smallholder credit came virtually to a standstill, and the veterinary service collapsed. The irrigation network deteriorated badly. Subsidized inputs flowing through the centrally managed supply system dwindled for lack of foreign exchange. Finally, deterioration of rural infrastructure (roads, the transport fleet, and processing plants) seriously impeded marketing and production. 28. Sector Institutions. The state control policy depended heavily on the capacity of statal and parastatal institutions, which faced grave problems. They had unclear objectives, poor management, ill-defined relationships with local authorities, and limited qualified staff. They proliferated in number and frequently worked at cross purposes. Financial problems further impaired performance. C. The First Phase of Reform 1982-85 29. Objectives and Strategy. In response to these problems, at the 1983 Consultative Group Meeting for Madagascar, the Government set out the broad outlines of a restructuring program aimed at increasing food production and reducing imports. A second objective was to increase the production of export crops while at the same time improving their quality. Consistent with these goals, the following policy measures were proposed: (a) promotion of private, smallholder production, and de-emphasis of parastatals and collective production; (b) concentration of investment in rehabilitation; (c) reliance on market prices;  -8- (d) withdrawal of the agricultural ministries and parastatals from direct-production and commercial activities; and (e) improvement of essential public sector services. 30. Some progress was made in carrying out the above, including reduction of price ard marketing controls. In 1984 the Government prepared for the first time a public investment program for the sector which led to some redirection of scarce resources but still retained a dominant share of direct production-oriented investments. The Government did, however, begln to redress the bias against the private sector by easing administrative controls, adopting an investment code more favorable to private investors and allowing them some access to foreign exchange. The Government also began to reinforce extension and research services. With support from IDA, the two major agricultural ministries, the Ministry of Agricultural Production (MPARA) and the Ministry of Livestock (MPAEF), were reorganized and large personnel reductions were effected. They began to establish performance criteria for parastatals and priorities for their rehabilitation, restructuring, or selective divestiture. Several public enterprises have ceased operations, staff and functions of others have been sharply curtailed, and some production units were given to operators under individual contracts. 31. For livestock, marketing monopolies were no longer enforced at the national level, but locally-imposed wholesale and retail price controls still persist. These controls have conflicted with the improved producer prices, forcing operating losses on the public sector slaughterhouses and giving rise to widespread artisanal meat processing. Direct livestock marketing by parastatals dwindled and trade largely passed to the private sector. The animal health service was reorganized with stronger central management, and now operates a vaccination campaign that covers about 60 percent of the cattle herd. A cost recovery policy on medicines and stud services was adopted and put into practice. 32. The Government also responded to recommendations for improving export crop marketing contained in major studies commissioned from several international bodies. Incentives to diversify exports were provided, with the elimination in 1984 of all taxes on agricultural exports, excluding the traditioral ones (coffee, cloves, vanilla and pepper). Producer price increases for coffee in 1984 and 1985 amounted to a total real increase of about 15 percent, which contributed to narrowing the gap with real 1975 prices. Services for coffee growers in key southeastern zone are to be strengthened under a project appraised by the CCCE. Export promotion activities and improvements in market and price information are being supported by UNDP and ITC. Finally, the Government has started to reorganize supervisory institutions, notably within MPARA and the Ministry of Commerce, and the stabilization funds. The Government lifted marketing and price controls on groundnuts and increased the wholesale and retail prices of edible oil. These measures, intended to improve producer incentives for oil crops, have been only partially successful as the Government has continueu to control the ex-factory and consumer price at too low a level, giving rise to a high cost parallel market. Although technical assistance and financing for certain tree crops (oil palm,  -9- coconut) are being provided, the viability of some of the planned investments needs to be reassessed. For cotton, prices are still controlled but were raised in 1985 to world levels and input sultsidies removed. In addition, investment funds and support to producer sdrvices are being provided under an IDA/CCCE-financed project (Cr. 1433-MAG). Following these actions, production has responded (42,000 tons in 1985 compared to 40,000 tons expected). However, as domestic demand has remained stable and export outlets have not yet been found, stocks are accumulating. 33. The most important actions during the first phase of reform were rice liberalization. Because of the political sensitivity associated with urban rice supply, these reforms represented a highly visible test of liberalization. By 1982 it had become clear that existing policies were financially unsustainable (para 25). In a widely publicized, new approach to economic and social balance, market incentives were introduced to promote production and urban supply. The retail price of rice was increased by 82 percent in 1982, thus eliminating explicit consumer subsidies while improving producer prices. In the following year, quantity restrictions were placed on imports, and private sector marketing was legalized, with the exception of the country's 'rice baskets' (Lac Alaotra and Karovaoay) where the Government monopoly continued to help ensure sufficient urban supply. To keep prices within certain limits, the authorities legislated floor and ceiling prices for paddy and rice respectively, but these were overtaken by market forces. 34. In this initial phase several problems arose. To be successful, liberalization had to elicit a substantial farmer response. The supply response, however, was not immediate. Farmers in the monopoly areas, accounting for 25Z of marketed production, were excluded from the incentives of market competition. Moreover, the authorities disposed of imported and domestically-procured rice stocks in the post-harvest market. This not only depleted Government stocks but also depressed prices and encouraged speculation among traders. Skyrocketing pre-harvest prices brought ad hoc trade controls and gave rise to scepticism about the benefits of economic liberalization. The Government therefore, is now seeking a new approach to deal with the rice problem as part of the second phase of the agricultural adjustment program. 35. Proposed Strategy. In retrospect, the first phase of the adjustment process fell short of its goals largely because of lack of coherence in the spectrum of Goverament policies. Incentives were not provided for all products, accentuating the preference of farmers for outputs with high returns. Controls on prices and markets gave room for crop retention, speculation and black-marketing. At the same time, import policies were not tailored to overcoming shortages and acted as a disincentive to production. Rice, a staple in the Malagasy diet, was one of the causes of resistance to liberalization among the political forces. To help restore credibility to the reform program, the Association feels that the Government must tackle first the rice problem, while continuing to move gradually with other areas such as edible oils and export crops. The Operation proposed in this Report supports this strategy. As part of the Operation also, other important measures will be taken to improve resource  - 10 - allocation, farmer incentives, marketing channels for domestic products and imports, and farmer services. Finally, under this Operation, the program for the next phase of adjustment will be prepared. PART III. THE AGRICULTURE SECTOR ADJUSTMENT OPERATION A. History 36. IDA's involvement in agriculture policy has taken three forms: dialogue on the policy framework, assistance in developing a rice strategy, and support of key agricultural institutions and of technical solutions to production constraints. An Agriculture Sector Mission visited Madagascar in 1982 and 1983 and an Export Crop Review Mission in 1984, focussed upon domestic and external trade policies and practices for agricultural commodities. These themes were pursued further by a series of preparatory agricultural missions which were in the field during 1984-86. 37. The Operation emerged from discussions with the Government during 1983-86 on strategy to correct erosion of productivity and incomes, reduce food imports and promote exports. The proposed IDA Credit,the African Facility Credit and Special Joint Financing from Japan and the Federal Republic of Germany would provide the financing needed. The Operation was appraised in June and October 1985. Negotiations were held in Washington and Antananarivo during most of the period from December 23, 1985 through March 7, 1986. The Malagasy delegation was led by Mr. Jose Andrianoelison, Minister of Agriculture. Supplementary Credit data are provided in Annex III. B. Objectives and Rationale for IDA Involvement 38. The objectives are (i) to improve the returns on scarce resources by financing from public sources only selective investments of high economic priority; (ii) to put into place a coherent rice strategy to restore market confidence, improve productivity and reduce pressure on the balance of payments; (iii) to provide better incentives to farmers and improve market-networks; and (iv) to help formulate consistent strategies for the next phase of adjustment. 39. Progress toward objectives will set the stage for the next effort, which will expand into edible oils and export crops, and the use and management of export crop receipts. The Government's preparedness to restructure these areas and a favorable IDA assessment of the macroeconomic framework would form the basis of a second Credit. 40. The reform program supported by the Operation is presented in the Government's Policy Statement on Agricultural Adjustment (Annex IV), and the rice policy measures subsumed by this program are set out in Annex V.  - 11 - C. The 1986-87 Adjustment Program Under the Operation 41. Resource Allocation. The Government has committed itself to focussing on priority investments that are economically and financially viable, and unlikely to attract venture capital. Application of these criteria to the proposed 1986 public investment program for agriculture has resulted in a 20 percent reduction in planned outlays of US$125 million equivalent. An uneconomic oil seed project was dropped, as were several others that were too limited to have an impact. New feasibility studies will be done before proceeding with agroindustrial investments for oil palm and cashew and study results are expected to be presented to IDA by end-October 1986. Should the outcome of these studies be favorable the Government will seek risk capital interest. Feasibility studies will also determine the future of two proposed rural development projects in the middle-west and north-east of the country. A third project of this nature will be reshaped by end-August 1986 in consultation with IDA, with the ai of enhancing services to the farming community in the South. The Government will seek the Association's agreement prior to proceeding with new investments costing US$5 million equivalent or more. IDA's concurrence that the 1987-89 public investment program for agriculture meets the aforementioned tests would be a condition for release of the second tranche of the Credits. 42. Fiscal measures would also be taken. Five state-run agricultural trading companies have a competitive edge over private firms as they receive an important share of export crop revenues as a subsidy. The Government has agreed to eliminate these transfers and, in 1986, reduced them by one-third. They will be similarly lowered next year and by April 30, 1988, all transfers will have been phased out, representing savings on the order of US$20 million annually which will accrue to the national budget. 43. Subsidies on agricultural inputs sold through the official system will also cease. Average fertilizer subsidies amount to an estimated 30% and pesticides range even higher. By the time of Credit effectiveness, the Government will have reduced them to not more than seven percent of their equivalent c.i.f. cost. Prior to release of the second tranche, no input subsidies would be provided, except for a maximum of five percent of the cost of pesticides, and pesticides used for demonstration purposes by the extension services. 44. The Rice Strategy Package. With the aim of regaining self-sufficiency by the 1990s, the Government has decided to correct the weaknesses of past reform efforts. This is to be done by giving the maximum of incentives to producers through the freeing of domestic production, processing, trade flows and prices from all controls. The Government will also operate a stock of imported rice to: (a) dampen excessive seasonal price fluctuations until traders gain confidence that markets will not be subject to destabilizing interventions; (b) provide supply to certain categories of consumers for social welfare purposes; nd (c) cover emergency needs in the aftermath of natural disasters. The stock is to be constituted and maintained by imports.  - 12 - 45. In the context of the above strategy, and as part of the proposed Operation, the following policy measures have been agreed upon: (a) the monopsony areas, Lac Alaotra and Marovoay, will be opened. From April 15, 1986, producers in these zones may sell their paddy or rice to any traders, and traders, millers and hullers may compete freely. Trade flows in these areas and throughout the country will be unrestricted; (b) the supply of social welfare rice would be phased out over the next five years in line with anticipated production response. Meanwbile, sales would take place only during the period of shortage, from November through April, in line with volumes and prices agreed annually with the Association. For 1986, the volume would be limited to 85,000 tons (compared with 105,000 tons in 1985), and the retail sale price has been set at FMG 265 per kilo. Although this price is lower than expected market prices, it is not subsidized and includes transport, storage and selling costs; and (c) the operation of a stock to moderate abnormal price spirals would be guided by a trigger price. Open market sales from the stock would commence when retail prices reach a predetermined level that -triggers- such sales. The trigger price, to be agreed annually with the Association, would be set high enough to encourage strong private sector activity and to enable the Government to recover fully the costs of the stock program. For the 1986-87 season, the agreed price has been calculated at 40 percent above the average market price during the post-harvest period, when dealers are normally purchasing for stock. This would permit a dealer margin which may be considered over-generous by some standards, but is necessary in Madagascar because of the scarcity of credit and the history of public sector interventions in the market. 46. The smooth functioning of the above system will depend upon efficient stock management, and several measures have been agreed to achieve this. First an import program has been agreed upon with the Government and, by end-October in each of 1986 and 1987, the program for the following year will be established by the Government with IDA's concurrence. Because the volumes needed to satisfy demand in open market transactions activated by the trigger price cannot be forecast with precision, the import program will be reviewed regularly with IDA and adjusted if necessary. Secondly, a volume threshold for the stock has been set, at which the stock manager will automatically order a new shipment to avoid dealer speculation undermining the system. Third, measures will be taken to ensure efficient procedures for placing orders, making payments and obtaining delivery. Finally, the program will be monitored closely. The Government will provide the Association with quarterly reports on imports and stock management, and a first review by the Government and IDA of operations is planned for July. 47. Import financing will be provided by donors and the Government. IDA's r-'e is that of a last-resort source of foreign exchange, to guarantee and underwrite the functioning of the system in the event that need arises. The nature of an open-market operation, supplying all tha.t is demanded at a given price, entails some risk that quantities will exceed targets. Aaalysis suggests a 5% likelihood of open-market volumes reaching  - 13 - 30,000 tons under the price rule. At this level, the Association may finance marginal imports, but at lower levels financing should not be needed. IDA's readiness to stand behind the Government as it uses market-influencing, rather than controlling instruments is expected to result in normalizing farmer and market expectations. Once this happens, the new policies should be self-sustaining. 48. Farmer and Market Incentives. To underscore its intentions and thereby encourage investment, the Government has recently promulgated new legislation endorsed by IDA. It confirms that agricultural prices will not be subject to controls, except for certain industrial exports (cotton, sugar and tobacco) and high-rent taxable crops (coffee, cloves, vanilla and pepper). Methods and schedules for setting prices for these commodities are sound (Annex IV). Prior to Credit effectiveness, the Government will announce next season's coffee price following agreed procedures. Edible oil remains controlled not at the farmgate, but ex-factory. Pending the results of an oils strategy study (para. 52), the Government has recently raised the ex-factory price to FMG 1,100 compared to the past FMG 550. As an interim measure, this is considered satisfactory. Finally, before Credit effectiveness, new quarantine regulations will be enacted permitting farmers access to improved seed varieties developed abroad, thereby opening the door to greater returns and output. 49. In addition to balancing better the terms of competition between public and private trading companies (para. 42), the Government intends to take measures to encourage private trading networks. The areas where improvements are likely to have a strong impact - access to credit and streamlining of administrative procedures - are addressed in an action program prepared by the Government. This program wiln be finalized in agreement with IDA by October 31, 1986, and then carried out. 50. The Government will also accelerate the handing over of agricultural inputs to commercial interests, from the import stage through retail sales. The proposed Credit will help with this divestiture by making available to importers foreign exchange for a wide variety materials and equipment used by farmers. For its part, the Government has recently closed more than 70 sales outlets previously operated by MPARA. In 1987 supply networks on the economically-active Central plateau will be fully served by commercial firms. Continued progress will be reviewed in the course of the Operation. 51. Preparation for Medium-Term Adjustment. To carry the restructuring process over the medium term, the Government will carry out studies to formulate coherent strategies for edible oils and export crops. Problems associated with taxation of agricultural transactions will also be addressed. This choice reflects economic priorities including balance of payments considerations. 52. An edible oils study, to be financed by UNDP under terms of reference agreed with the Association, will examine options for reviving production and the processing industry. The influence of past policies on performance will be assessed and alternatives weighed. The comparative advantages of the different oil crops will be considered, as well as the  - 14 - scope for rehabilitation of existing processing facilities. Prior to second tranche release, the Government will present a plan of action for the subsector acceptable to the Association. 53. Export studies would focus upon prospects for increasing and improving the quality of traditionally traded products, and for diversifying the export base. MPARA would draw up strategies responsive to these prospects for discussion with IDA by June 1987. Technical assistance support would be provided under the Proposed Second Agriculture Institutions Development Project which will be presented shortly for consideration by the Executive Directors. Further, the Government will participate with the Association in an analysis of the country's comparative advantage in world coffee markets. Before the second tranche of the Credit, the Government will prepare an action program consistent with the results of this analysis. 54. Within the same period, the Government will present action plans for improving export crop administration and the management of resources generated by sales abroad. Present export licensing and contract approval procedures act as disincentives and thus need to be brought into line with national policy. Export-generated resources are mainly handled outside the budgetary system. Part of these resources accrue to the stabilization funds which do not perform the function implied. Among other things, they finance investments in export-producing areas, but do so outside the public investment program framework. Another channel for export receipts is an account maintained in the Central Bank (the FNUP), which is used for diverse purposes on an ad hoc basis. All of these areas will be reviewed in light of the Government's commitment to strengthening economic management. Prior to credit effectiveness, the Government will employ suitably qualified consultants, under terms of reference which have been agreed with IDA, to analyze the impact of present practices and recommend corrective measures consistent with the principles of sound economic management. As a condition of second tranche release, a plan of action that takes account of study results would be presented to the Association. D. Financing 55. Credit Channeling. Credit proceeds would be disbursed in two tranches, with the second one contingent upon satisfactory progress in carrying out the adjustment program. The IDA Credit of US$20 million equivalent, Special Africa Facility of US$31 million equivalent and Special Joint Financing of US$9 million equivalent would finance a broad range of agricultural imports. The US$60 million equivalent financing package reflects two-years' estimated foreign exchange needs to permit producers, traders, and processors to take advantage of production opportunities. Goods, materials and equipment financed under the Credits would be purchased abroad by local commercial firms, with the exception of some veterinary products that may be purchased by the Government. The Government is moving away from the administrative allocation of foreign exchange imposed in the past. Unrestricted access to foreign exchange for a small range of products was introduced during 1985 in connection with the  - 15 - IF Standby. Under the proposed Operation, importers will also be granted foreign exchange on a first-come first-served basis, up to a ceiling to avoid collusion among a few importers. Financing provided for most items is expected to cover fully residual demand. For those few where demand far exceeds financing possibilities and raises the prospect of severely directing foreign exchange away from primary inputs, a cap has been set on the amount of proceeds from the Credits that may be expended on them. Such items include veterinary supplies, incentive goods, and tractors and transport equipment. 56. Financing is provided for US$42 million equivalent for agricultural inputs and, if needed, rice, US$3 million equivalent for veterinary products and animal protection materials and US$10 million for tractors and transport equipment. US$5 million of the Credits would be used to import consumer goods that are predominantly used in rural areas. This would avoid the current shortages of such goods from blunting the impact of higher farm prices. The specific goods to be financed are lanterns, hand pumps, hand sewing machines, outboard motors and transistor radios. These items were chosen because they are traditionally highly appreciated by producers, and because total demand is limited so that relatively small resources can meet total national demand (to avoid resale at scarcity prices). 57. Procurement. Procurement of lots valued above US$1.0 million equivalent would follow the Bank's ICB guidelines. International shopping would be used for lots between US$200,000 and US$1.0 million, and for tractors and tires. Below US$200,000, standard procedures of the purchaser would be followed. Local competitive bidding procedures will be used for fertilizer. Non-proprietary spare parts would be secured by seeking offers among a list of potential suppliers approved by IDA. Rice would be obtained using standard commercial practices. Pesticide purchases will exclude chemicals that pose known environmental hazards. 58. Disbursements and Audit. The first tranche (US$ 32.5 million equivalent.) would be available upon effectiveness, and the second (US$ 27.5 million equivalent) about nine months later provided conditions of tranche release are met. Proceeds from the IDA Credit would be disbursed against 100L of the foreign cost of eligible goods. Similarly, SFA and Japan will together cover 100X of such costs of goods financed from these sources. A Special Account for IDA deposits would be established in the Central Bank, with an initial deposit of US$ 4 million equivalent. A second Account would be opened for SFA and the Japanese participation, with a total initial deposit of US$ 7 million equivalent. KFW may agree to use the latter account or open its own. The Central Bank would manage and maintain the Accounts and prepare requests for replenishment. All disbursements will be fully documented, except that those for imports costing less than US$200,000 will be based on statements of expenditure. The Credits are expected to disburse over two years, with completion by September 30, 1988. E. Expected Economic and Social Impact 59. The Government's overall economic program encompasses reforms which lie beyond the scope of this Operation. It is therefore difficult to  - 16 - isolate the direct impact of agricultural reforms. The table below summarizes the expected effects of the Government's program in comparison with the absence of adjustments. The improvements indicated reflect implementation of all the policy measures in the ongoing sector reform programs and economy-wide reforms in domestic resource mobilization and allocation, and export promotion. Projection of Selected Economic Indicators 1980-1985 1986-1990 With Adjustment Without Adjustment Growth Rates in Program Program Constant Prices GDP -0.9 3.0 2.0 GDP, per capita -3.6 0.3 -0.8 Exports GNFS -0.6 4.1 2.5 Imports GNFS -16.5 2.1 2.0 of which: food -6.6 -16.2 2.5 capital goods -23.7 1.1 -0.9 intermediate goods -5.6 2.4 1.1 Ratios 1980 1985 1990 1995 With Without With Without Current account balance 20% 10% 7% 11% 3Z 8% as X of GDP Debt service ratio a/ 17% 49% 32% 69% 25% 48% X of export a/ after debt rescheduling 60. The recovery program should permit higher levels of imports than in recent years, particularly basic wage goods and production inputs. Given Madagascar's present low import capacity, the enhanced external support is needed. As recovery takes hold, the country's own capacity to finance intermediate imports would increase as a result of higher export earnings and declining food imports. 61. Madagascar's export sector would have to grow substantially if the economy is to extricate itself from pervasive foreign exchange crisis and an excessive debt burden. Exports are projected to grow at 3.8Z per year for 1987-90 and to accelerate to 5.8% thereafter. Over the next ten years, export volumes are projected to rise to the peak levels attained prior to the mid-1970s. 62. This requires firm measures to strengthen the incentives, infrastructure, and institutions along the entire spectrum of production, transportation, and marketing of Madagascar's dozen or so traditional export items and potential import-substitutes. This would be a major task seafood), past policy has resulted in stagnation (e.g., vanilla, graphite,  - 17 - cotton fabrics) and decline (e.g., coffee, pepper, sugar, meat, butter beans, sisal) of volumes. 63. Madagascar's data are too fragmentary and uncertain to underpin an estimate about the magnitude and timing of the supply response to the 1986-87 agricultural adjustment program. However, experience across countries indicates that, during periods of sector rehabilitation, when prices are adequate and there is excess capacity, large production increases are associated with eliminating input bottlenecks. This is the expected response in Madagascar. In the improved policy environment, the inputs financed shculd yield high returns. For example, at present price relationships, NPK fertilizer for rice should bring net benefits about double its cost. Thdere is reason to believe that returns to other inputs/equipment should be as high or higher, given shortages over the last several years. If rice and fertilizer are representative, returns to Credit financing of say US$20 million in the first year could easily exceed US$40 million, or more than two percent of agricultural production. The impact of supplying the marketing and primary processing sectors with spares and materials is expected to be considerable. 64. The improved pricing and marketing framework, as well as the more favorable environment for economic activity in general, will ensure far higher returns to agricultural investments than in the past decade. Hence, development programs to be promoted in the future (extension services, plant materials, credit) will yield greater benefits than in the past. Because Madagascar's prospects depend heavily on agriculture, and the latter can prosper only to the degree that the environment is conducive to growth, it is difficult to exaggerate the importance of this effect. 65. Income effects would be strongly positive for farmer families. They produce over 40 percent of gross national product, but farm income is about one-sixth of the income realized by the non-farm population. The terms of trade between agriculture and other sectors would shift in favor of the former because of pricing reforms and increased access to inputs. Input prices will increase with the elimination of subsidies, but this will be more than offset by higher farmgate prices and input availability. In Madagascar about 300,000 families (equivalent to the entire urban population) grow coffee, usually in combination with other crops. On average each such family sells about 200 kg of coffee per year. If their incomes, which are above average for the entire farm population, are about 3/4 of the country-wide mean, an increase of 50 percent in the producer coffee-price alone would imply a one-fifth increase in income. Needless to say, the employment impact would also be strongly positive, because smallholder agriculture is very labor intensive. 66. As for the urban population, the Government has already had to take measures to reduce their real income. Since 1982 the quantity of imported rice has decreased by two-thirds. Also, the domestic price has been allowed to increase in real terms. Before these austerity measures, the urban population was spending two-thirds of its income on food, including 23 percent on rice. As incomes have fallen, this share has become larger. The adjustment process may imply still higher real prices for rice and its substitutes (maize, cassava) for the next three years or  - 18 - so. The Government and IDA are convinced that this is justified in view of the need to expand agricultural production. Continuation of official rice distribution over this period will assist the Government in mitigating the impact on the most vulnerable group, the urban poor. 67. Risks. The risks associated with this Operation lay heavily on the determination of the Government to pursue the required adjustment policies on a sustainable basis. The assurances contained in the Government's policy letter point to commitment to market-oriented growth. Key in this is the rice policy supported by IDA. The program agreed for carrying it out should go a long way towards allaying the Government's immediate concern about urban food shortages. Policy reforms aimed at increasing marketed surpluses should elicit a strong response; this should enhance the adjustment program's credibility and sustainability. Continuing assistance from IDA would enable imports needed for economic recovery over the medium term and provide the Government with encouragement to proceed with reform. PART IV - BANK GROUP OPERATIONS IN MADAGASCAR 68. Overall Lending Levels and Sectoral Composition. IDA credits to Madagascar amount to US$492.6 million (including US$29.9 million from the Special Fund) and Bank loans total US$32.6 million. Bank Group assistance to Madagascar has been concentrated in the key areas of infrastructure (including urban and social infrastructure), agriculture and energy. Since the start of Bank Group involvement in Madagascar, about 34 percent of Bank Group lending has been for transport, 29 percent for agriculture, 12 percent for electric power and petroleum, 12 percent for industry and water, 3 percent for technical assistance and 4 percent for education, 3- percent for urban development and 3 percent for cyclone rehabilitation. IFC has four investments in Madagascar in textiles, footwear, and fisheries. Annex II contains a summary statement of past loans and IDA credits as of September 30, 1985. 69. Agricultural Lending. The Bank has supported 14 agricultural projects, of which five have been completed and five are under execution. This has included three livestock development, four irrigation and two forestry projects, and one for each of agriculture credit, rice intensification and cotton development. Between 1972-79, several projects faced severe problems as a consequence of Government policy and other constraints. As a result, no new agricultural projects were approved between 1975 and 1979 and virtually no formal sector work proved feasible. 70. Rtecent credits for the Lac Alaotra (Cr. 1337-MAG) and Cotton (Cr. 1433-MAG) Projects (both cofinanced by the Caisse Centrale de Cooperation Economique) focus upon restoring rice and cotton production. A Second Village Livestock Project (Cr. 1211-MAG) supports development of livestock services for traditional producers and provides for sector-wide policy reviews. A credit for Irrigation Rehabilitation (Cr. 1249-MAG), cofinanced by the Caisse Centrale and the FED, is assisting with rehabilitation of smaller irrigation networks, subsequent maintenance, and  - 19 - strengthening of government services in this sector. The Agricultural Institutions Technical Assistance Project (Cr. 1249-MAG) addresses sector policy and institutional issues. 71. Infrastructure Lending. Four credits have provided for the construction of all-weather highway links between the island's different regions and three credits have been made for road maintenance and rehabilitation. There have been credits to improve Madagascar's main port of Toamasina and to support the railways modernization efforts. Urban infrastructure development has benefitted from a water supply and sanitation credit for the capital city of Antananarivo. In addition, studies for urban development financed by the UNDP with the Bank as Executing Agency led to approval of an urban development credit (US$12.8 million in FY84). A US$15 million credit for cyclone damage rehabilitation was made in 1984. Energy projects have received growing Bank Group attention. IDA participated with several co-lenders in the financing of the large Andekaleka hydroelectric project, which was successfully completed in June 1982. Two credits (for US$12.5 million and SDR 10.7 million) for petroleum exploration support the Government's efforts to develop a domestic supply of hydrocarbons and to improve planning in the energy sector. Both projects are proceeding well. Over US$250 million in exploration development by foreign oil companies has been generated by promotion under one of the projects. 72. Other lending. A first US$5 million DFC credit was made to the Industrial Development Bank of Madagascar (BNI) in 1980. A follow-up US$ 5 million DFC credit, forming part of an Industrial Sector Credit of US$ 40 million, became effective in August 1985. In adda.tion, a credit for an accounting and audit project was signed in June 1981 and a new credit for training auditors, accountants and managers has been approved by the Board on February 26, 1986. 73. Implementation Problems. Problems have arisen in the execution of a number of projects, mainly delays, cost overruns, deficiencies in managemeLt, and inadequate financial performance of project agencies. Current problems center on difficulties linked to the country's economic crisis, notably the acute shortage of foreign exchange and budget funds and institutional problems related principally to the parastatal system. The Bank approach has been to maintain supervision and to address the generic problems through every instrument available, from the Consultative Group through the Country Implementation Review (the most recent was June 1985), including the macroeconomic, sectoral and project-level dialogue, technical assistance and secondment staff. The Government has been responsive and there have been significant improvements in Government portfolio management and a reduction in implementation problems. 74. Project Evaluation. Since the start of the Bank/IDA program in Madagascar, eight projects have been completed and audited by the Operations Evaluation Department. Audit Report No. 1622 of December 1976 on the first Lac Alaotra project concluded that the project was generally successful. However, the Impact Evaluation Report No. 3600 of August 1981 concluded that earlier assessments of project performance had been over-optimistic, and that the actual rate of return was probably negative.  - 20 - The Audit Report No. 1143 of April 1976 of the first education project concluded that the education and manpower training objectives were satisfactorily achieved. The Audit Report No. 5434 of January 29, 1984 on the first Railway Project concluded that due to overruns and delays in implementation the project had to be downscaled and that the estimated rateof return was less than 10%. The Audit Report No. 1559 of April 1977 on the Beef Cattle Development Project concluded that the project had contributed little to Madagascar. The Audit Report No. 2143 of July 1978 concluded that the Third Highway project was well justified and had a good rate of return despite substantial cost overruns. Report No. 2299 of December 1978 concluded that the physical objectives of the Tamatave Port Project were satisfactorily achieved but pointed out that the institutional objective was not accomplished during project implementation because of inadequacies in the staffing of the port authority. Audit Report No. 5403 of December 28, 1984 covered two agricultural projects: the Morondava Irrigation and Rural Development Project was assessed to be a profoundly disappointing operation, but the Village Livestock and Rural Development Project contributed to laying the groundwork for more effective services for traditional livestock owners, with good prospects for sustainability. 75. Bank Strategy and Future Program. The Bank strategy is to support the Government's efforts to rehabilitate and restructure the economy by: (a) promoting policies and programs aimed at reforming incentive structures, to make the economy more market-responsive and provide a more favorable climate for private sector initiative and investments, and providing financial and other support for appropriate policy programs; (b) supporting adoption of viable sectoral strategies aimed at rehabilitating productive and economic infrastructure and establishing conditions for long-term growth, and providing financial and technical assistance to implement these programs; (c) strengthening the institutions responsible for macro and sectoral economic and financial policy formulation and management; and (d) helping Madagascar mobilize donor aid and to make effective use of donor financial, technical, and debt relief support. 76. On the assumption of continued Government responsiveness, the Bank is supporting Government adjustment efforts by emphasizing policy-based lending as the main vehicle of Bank financial assistance. Additional sector policy-based operations in agriculture and industry would be prepared. These would support continued market deregulation, export promotion, cost recovery, private investments, case-by-case parastatal rehabilitation, and sector institution building. A core lending program will also be supported which accords priority to the rehabilitation of productive and economic assets, and addresses longer-term issues in human resource development, health, agricultural research, and environmental degradation. Overall, future lending would concentrate on agriculture, industry, energy, transport and health.  - 21 - 77. Aside from sector and project-level efforts, the main vehicle for aid coordination has been the Consultative Group. Making the Consultative Group a more effective means of addressing Madagascar's payment problems is an important part of Bank country assistance strategy. This would contribute to resolution of the country's external financial problems. Donor and creditor support of a comprehensive financing strategy, combined with a sound Government program to stimulate real growth offers the best prospects for future development. This implies active participation by the Government and the IMF in the preparation of meetings, and Bank focus on longer-term structural adjustment issues. 78. In addition to a substantial economic and sector work program, the Bank is supporting the Government in policy analysis and selected institution-building through technical assistance. Further, two secondment positions have been recently approved, and the Bank's Resident mission has been augmented by a resident economist. SPPF resources have and will continue to be used to provide technical support for future policy-based work, as well as to help strengthen investment planning, programming and budgeting. PART V - RECOMMENDATIONS 79. I am satisfied that the proposed IDA Credit would comply with the Articles of Agreement of the Association. I am also satisfied that the proposed African Facility Credit would comply with provisions of Resolution No. IDA 85-1 of May 21, 1985. I recommend that the Executive Directors approve the proposed IDA Credit and the proposed Africa Facility Credit. 80. I am further satisfied that the proposed Grant would comply with the provisions of the Exchange of Notes between Japan and the Association dated November 20, 1985 and recommend that the Executive Directors approve the administration by the Association of the proposed Japanese Grant. A. W. Clausen President *ttachments Washington, D.C. April 8, 1986  -22- Annex 1 1 of 4 MADAGASCAR - SOCtAL INDtCATORS DATA SHCET MAAGASCAR RE CEGROUPS (WzEICGTD AVCRAreS) /a HOST (MSr RECeNT ESTIMATE) lb 9 RCENT LOW [COME ARICA MIDDLE INCOME 19601! 19701k ESTINATELk SOUTH Or SAHARA AFRICA S. OF SAHARA a, (sDusm sQ. MO TOTAL 587.0 5N7.0 587.0 AGRCULTRtAL 361.2 363.7 370.5 GM PU CP CIOS) .- *- 310.0 238.8 10b3.8 mum com_nmS F CPI (KLOGAMow OF OIL QmnVALeNT) 28.0 60.0 41.0 62.3 581.5 FOrmaoN A vITAL STATSTn FOPIJATION,HID-TEAR (THOUSANDS) 536Z.0 6785.0 9452.0 URBAN PWIoAo" CX oP TOTAL) 10.6 14.1 20.4 20.1 32.0 POPULATUIO PROJETONS POPULATION IN YEAR 2000 (MILL) 16.2 STATInOAR PaPULATION (MILL) 55.0 POPULATION ICHUFIU 1.9 POPULATION DENSm PER SQ. KM. 9.1 11.6 16.1 33.2 65.1 PEu SQ. EK. KRI. LAS 11.8 18.7 24.8 112.8 124.8 POPULATION ACE STRUCTURE (Z) 0-14 nRS 42.5 43.6 46.3 46.0 45.6 15-64 YRS 54.2 52.9 50.2 50.8 51.5 65 AIID ABO 3.2 3.3 3.4 2.9 2.7 POPULATION CRO1 RATE (X) TOTAL 1.9 Z.4 2.6 2.9 2.9 URBAN 5.0 5.2 5.3 6.' 5.1 CRUDE BIRTH RAE (PER THOUS) 43.8 43.7 46.7 47.2 47.0 CHIE DEATH RATE (Pu THUS) 25.0 19.7 17.6 17.8 15.0 CROSS REPRODucTION RATe 2.8 2.9 3.2 3.3 3.2 FAMILT PLAHIN ACCEPTOlS. AWiAL (TCOUS) USERS (X OF MARRIED W .. .. .. 3.3 6.4 OO A INDEI OF FOOD PROD. PEu CAPItA (1969-71-100) 89.0 102.0 94.0 83.3 82.9 PER CAPITA SUPPLY OF CALORIES CZ 0F REQUIREMENTS) 109.0 110.0 114.0 87.7 9B.5 P-rINS (GRAM IER DAY) 61.0 60.0 59.0 51.9 55.4 OF WHIC ANIMAL AS PULSe 18.0 17.0 15.0 /c 18.7 16.5 CHWLD (ACES 1-4) DEATH RATE 20.2 15.8 10.0 23.1 16.6 rALs LIFE ERPECI. AT BIRTH (TEARS) 38.8 44.7 49.4 47.8 52.0 INFANT HOE. RlAT (PER tUS) 109.0 89.0 66.0 119.5 108.8 ACCESS TO SAFE WATXER (IPOP) TOtAL .. 11.0 21.0 Id 27.1 42.4 URBAN .. 67.0 8o.x Td 63.5 67.5 RURAL '' 1.0 7.0o7Td 19.3 35.8 ACCZSS TO ECRA DISPOSAL (z OF POPULATION) TOTAL .. .. 9.0 /d 26.5 28.9 URSAN .. 8.0 9.0 7; 65.6 57.7 URAL .. .. 9.0 7i 20.8 20.7 POPULATION PER PRYSICIAN 8720.0 10170.0 10220.0 Ie 27901.7 11791.7 POP. PER NURSINC PERSON 3060.0 /f 3350.0 3670.0 77 3308.4 2459.8 POP. PER HOSnTAL BED TOTAL 420.0 350.0 510.0 /e 1273.6 981.1 URBAN 150.0 /f 210.0 240.0 7T 428.2 368.8 RURAL 600.0 7T 480.0 520.0 77 3292.5 4371.9 A0hlSSIONS PEA HOSPITAL BE .. .. .. .. 27 ? MrS AVERAGE SIZE OF HOUSEHOLD TOTAL '' 5.8 URBAN ., 5.3 RURAL 5' 5.9 AVERARE NO. OF PERSONS/ROOM TOTAL .. .. RMA .. .. RURAL PIRCGITAGE OF DWELLINCS WITH ENACT. TOTAL .. .. URA .. .. RURAL .. ..  -23- Annex 1 2 of 4 ILDAGASCAR - SOCIAL INDICATOS DATA ADAGASCAR REFERCC GROS (UHEGCT AVZRAGES) /a NMST COST RECINT ISTMATC) lb 190b 191jb _RoCa"I LOV INCOR AFRICA 111011 LCn 19/ j Is7eESTIM&/- SoUm OF SAHARA AFRICA S. OF SAHARA ADJUSrED ENROLUIENT RATIOS PRIMAR: TOTAL 52.0 88.O 100.0 /a 67.8 95.7 KALE 58.0 95.0 .. 77.6 100.0 FrLE 45.0 31.0 .. 54.9 83.2 SECONDARY: TOUAL 4.0 11.0 14.0 /c 13.5 17.3 HALE 5.0 O3.0 .. 17.9 25.0 FEMALE 3.0 9.0 .. 9.1 14.8 VOCATIONAL CZ OF SECONDARY) 9.1 8.7 .. 13.2 5.9 PUPIL-TZACHEt RATIO PRIMRY 70.0 65 J 55.0 44.9 41.1 SECONDARY 24.0 20.0 23.0 /c 27.4 Z5.5 COESONUYI PASSENCER CARS/THOUSAND POP 4.1 6.8 7.1 Ic 3.8 20.8 RADIO RECEIVEILSITOUSAND POP 15.3 79.7 206.5 55.8 107.8 TV RECnIvERS/TBUS pop .. 0.3 7.7 2.6 20.8 NEUSPAPER ("DAXLY ENERAL INT]RUST') CIRLATION PER TiOOSAND POPUATION 7.8 7.8 6.0 5.0 18.4 CINEMA ANNUAL ATTENDACECAPITA 0.5 If 0.7 .. 0.5 0.4 TOTAL LABOR FORCE (THOUS) 2943.0 3570.0 4602.0 Fl2ULE (PERCENT) 46.2 45.4 44.1 34.2 36.2 AGRICOLTURE (PERCNT) 93.0 90.0 87.0 /d 77.5 54.5 NDIISrSRY (PERCENT) 2.0 3.0 4A 7;i 9.7 18.3 PARTICIPATION RATE (PERCUNT) TOTAL 54.8 52.6 48.7 39.3 36.8 NALE 60.7 58.8 54.7 50.9 47.1 FEMALE 49.4 46.7 42.8 28.1 27.2 ECONOMC DEPENDENcr RATIO 0.8 0.9 1.0 1.3 1.3 INCO DISIZEU PERCENT OF PRIVATE ICOMD RECEIVED a! I-cEEsT 5S or DO 5 IOm/ 41.0 . HIGHEST 20S oF NOUsENOs 60.1 STM zoz OF sUUSENOLDS 5.2 . LacsT iC7 OF HUSmSLDS 13.0 . IY ur cR ESTIKATED A850UIIC POVERTY INCOME LEVEL (USS PER CAPITA) URuN .. .. 150.0 Ie 165.5 590.7 RURAL .. .. W.E71 95.0 275.3 ESUMED RELATIVE POVERTY INCOM LEEL (USS PER CAPITA) URBAN .. .. 135.0 /c 113.1 545.6 RURAL .. .. 86A0 7 67.6 201.1 ESTIATED POP. BEOW ABSOLUTE POVRTY INCmE LEV C(S) URBAN .. .. 50.0 /C 36.6 RURAL .. .. 50A 7; 61.8 NOT AVAIIABL NOT APPLICABLE NOTES /a The group averages for each indScator are popLatibeighted arit' tic ue&n. Covra of countr_es among the indicators depe_ on availablty of date and In not unform. /b Unlies otberwiae noted. "Data for 1964? refer to my year betumen 1959 and 1961; Deta for 1970' betw_e 1969 and 1971; and data for "Mt lcat Estimate" betwen 1981 and 1983. /c _i77; Id 1980; /a 1978; If 1962; , Populaton. JUNE. 1985  Annex 1 -24 - 3 of 4 MADAGASCAR: ECONOMIC INDICATORS GROSS DOMESTIC PRODUCT IN 1984 Annual Rate of Growth USS Mln. Z 1970-78 1978-84 GDP at Market Prices 2,382 . 9 100.0 -0.1 -. Consumption 2,172.4 91.2 -0.7 0.0 - Private (1,849.8) (77.6) (-0.9) (-6.3) - Public (322.6) (13.6) (-0.1) (1.9) Gross Domestic Investment 324.3 13.6 -4.4 -6.4 Current Account Balance -252.2 -10.6 Exports of Goods, NFS 388.7 16.3 -0.7 -8.9 Imports of Goods, NFS 502.4 21.1 -6.2 -9.9 OUTPUT LABOR FORCE AND PRODUCTIVITY IN 1984 Value added /I Labor Force VA per Worker USS Mn. 1 '000 Z USS Agriculture 1,007.6 42.3 4,356 88.1 231.3 Industry 371.1 15.6 135 2.7 2,749.2 Services 1,004.2 42.1 454 9.2 2,211.8 Total/Average 2,382.9 100.0 4,945 100.0 482.0 GOVERNMENT FINANCE Central Government F1G Bln Z of GDP 1984 1982 1983 1984 Current Receipts 273)0 15.2 15. 7 77 Current Expenditures 197.7 16.1 14.2 14.4 Current Deficit 45.3 -0.9 1.0 3.3 Capital Expenditures 107.6 7.5 7.2 7.8 Foreign financing (net) 36.6 5.1 3.8 2.7 MONEY, CREDIT, and PRICES 1978 1979 1980 1981 1982 1983 1984 - - (Billion FHG Outstanding at the End of the Period) - - Money and Quasi Money 141.0 173.G 206.0 250.0 276.0 271.5 321.0 Bank Credit to Public Sector 49.0 99.0 176.0 238.0 269.0 307.0 338.0 Bank Credit to State Enterprises 101.0 121.0 150.0 165.0 198.0 229.6 288.0 and Private Sector - - - - - - - -(Percentage or Index Numbers)- - - - - - - - Money and Quasi Money as Z of GDP 29.0 29.1 29.9 30.7 27.7 22.2 23.4 GDP Price Deflator (1970-100) 195.7 217.9 250.6 313.7 403.9 490.3 540.5 Annual percentage changes in: GDP Price Deflator 6.8 11.3 15.0 25.2 28.6 21.5 10.2 'Bank Credit to Government 75.0 102.0 77.8 33.0 13.7 14.3 10.1 Rank Credit to Other Sectors/2 5.2 19.8 24.0 10.0 20.0 16.2 25.2 Note: All conversions to dollars in this table are at the average exchange rate prevailing during the period cove-ed. At market prices. ,? Private Sector and State Enterprises.  Annex 1 - 25 - 4 of 4 BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERASE 1980-84) 1982 1983 1984 /I US5 Mn. S TUSS Million.) Coffee 135.0 38.8 Exports of Goods 6 N.F.S. 380.2 356.4 388.7 Vanilla 38.6 11.1 Imports of Goods 6 N.F.S. 651.7 550.7 502.5 Cloves 47.2 13.6 Fishing products 19.7 5.7 Resource Balance -271.5 -194.3 -113.8 Meat products 7.1 2.0 Textiles 10.7 3.1 Factor Income, Net -99.0 -112.6 -141.8 Petroleum products 8.7 2.5 Private Transfers, Net -1.4 -1.2 3.5 Mineral products 13.5 3.9 Other commodities 67.0 19.3 Current Account Balance -371.9 -308.1 -252.1 Total 347.6 100.0 Official Unrequited Trsnsfers 72.3 60.8 67.8 EXTENAL DEBT, DECEMBER 31, 1984 /3 USS Mn. Net MLT Borrowing: 121.3 196.8 168.0 Public Debt. Incl guaranteed 2,120.6 Disbursements 209.9 193.6 120.8 Non-Guaranteed Private Debt Amortization -181.3 -195.7 -175.4 Total Outstanding A Disbursed 2,120.6 Debt Relief 92.7 198.9 222.6 DEBT SERVICE RATIO FOR 1984 14 Other Capital (net) /2 186.9 36.5 41.5 _ Public Debt, Inl. guaranteed /5 33.3 Change in Reserves -8.6 14.0 -25.2 (increase - - ) lBRD/IDA LENDING, Sept.30 , 1985 USS millions RATE OF EXCHANGE 1982 1983 1984 IBRD IDA Outstanding & Disbursed 27.7 308.7 USS1.00 - FMC 349.74 430.45 576.60 Undisbursed 180.5 FNCI - UIS5 0.0029 0.0023 0.0017 Outstanding tcl. Undisbursed 27.7