Zambia - Public expenditure review (Vol. 1 of 2) : Executive summary

Document of ,IfLE CoCy The World Bank FOR OFitlCIAL USE ONLY V Report No. 6438-ZA ZAMBIA PUBLIC EXPENDITURE REVIEW VOL I: EXECUTIVE SUMMARY October 6, 1987 Country Department VI Africa Region This document bas a rfsbicted distribution and maly be used by recipients only In the perfommaee of their offEeiW duties. Its teoets may not othenrwls be diwlsel_ without World Bank author2thion.  CURRENCY EQUIVALENTS Currency ZUnbian Kwacha (K) US$1.00 K 8.00 (as of May 1, 1987) K 1.00 US$0.13 The following are averag.i annual exchange rates for recent years. 1970 K 1.00 = US$1.40 1975 K 1.00 US$1.55 1980 K 1.00 - US$1.27 1981 K 1.00 - US$1.15 1982 K 1.00 - US$1.08 1983 K 1.00 - US$0.80 1984 K 1.00 - US$0.56 1985 K 1.00 - US$0.37 1-86 K 1.00 x US$0.13 WEIGHTS AND MEASURES 1 Hetric Ton (Tonne) . 1000 Kg. or 2,205 Lbs ABBREVIATIONS CDE = Classified Daily Piployee CEM - Country Economic Memorandum GDP - Gross Domestic Product GFCP - Gross Fixed Capital Formation GNS - Gr.oss National Savings INDECO = Industrial Development Company Limited MAIID - Ministry of Agriculture and Water Development MET M Mineral Export Tax ' MOF - Ministry of Finance NAMBOARD - National Agricultural Marketing Board NCDP = National Commission for Development Planning PE = Personal Emoluments RDC - Recurrent Departmental Charges ZCCM = Zambia Consolidated Copper Mir,es Limited ZIMCO = Zambia Industrial and Mining.Corporation Limited FISCAL YEAR Government -- January l-December 31 ZIMCO, ZCcM -- April 1-March 31  FOR OFFICIAL UhI ONLY This report was discussed with the Government of Z"mbia during two missions In November 17-2X, 1986 and February 23-Match 20, 1987. Volume I of the report was cireulated as a separate document to the Consultative Group for Zambia and discussed at the meeting of the Group on December 16-17, lI86. The Government of Zambia has indicated its general acceptance of the recommendations of the report, with the following exceptionst (i) the macroeconomlc framework should be modiW!d to incorporate a more gradual declina-1ni the overall budget deficit and a longer period for the reduction of subsidies; and (ii) the Government feels that there is less scope for-the privatization of various public activities than is receomended at times b! the public expenditure review. Subsequent to the discussions oy the report, the Government decided on may 1, 1987 to abandon the reform program atgreed with the IMF and the World Bank and to pursue its own program based largely on self-reliance. As the deta.ls of this program, have-not yet been made available publicly, it was decided to complete the7processing of the report without revising and updating the macroeconomlc framework. Other comments' provided by the Government as to factual matters have been largely incorporated into the final report. This document has a rstkctI dbtibuton a may be used by reiints ona in te peformance of thr o*l dutes Its contts may not othewi be dicloed wihout Wodd Bouk authonzo  Table of Contents ZAMBIA: PUBLIC EXPENDITURE REVIEW VOLUME I Page OVERVIEW AND MAJOR RECOMMENDATIONS .................................. I EXECUTIVE SUMMARY ................. 1 I. M,croeconomic Pr-3pects for the Public Expenditure Program ..... 5 II. Reforming the Govermment Budget ...... .......................... 5 Sectoral Expenditure Programs *...o...................o.. 8 Agriculture ........ .................. .... 8 Health .. .eee............. * 10 Educatton .. . . . .. . . . .. . .l Roads ........................ . 12 Development Administration ........................ 12 Cross-Sectoral Expenditure Issues ............................ 13 Wages and Employment Policy ................................ 13 Budgeting for Recurrent and Capital Expenditures ........... 14 -Reductions In Government Services .......................... Planning and Budgeting ................0...... * 16 Social Impact of Expenditure Reform .......................... 17 III. The Parastatal Investment Program .............................. 18 Sectoral Expenditure Programs ................................ 20 Mining ................................ 20 - Industry ................................. 22 Energy *-**--*-**----** -**-**-*4? 23 Telecommunications *...........*.... cc........... ........... 25 Implicatlons for the Public Investment Program 26 Investment Review ........... ...... eec ............. 27 Setting Parastatal Objectives .............................. 27 IV. ImPLementation of the Expenditure Reform Program ............... 28 Ard Coordination ................ ........ ..................... 30 IV. Conclusion .................................................... 31  OVERVIUW AND MAJOR RECO*EDUATIONS 1. In the face of continuing sharp deterioration in economic conditions, exacerbated by an acute external payments and liquidity crisis, Zambia has introduced a number of radical reforms in economic management and policy. The major policy changes include imprrt liberalization, market determination of the exchange rate through a weekly foreign exchange auction, and decontrol of interest rates and prices (with the exception of roller maize meal). The objectives of these changes are two-folds first, to provide a framework for the restoration of domestic and external balances; and second, to restore the momentum for growth and promote essential restructuring of the economy. To achieve these objectives, the policy changes undertaken by Zambia must be completed by appropriate monetary and fiscal policies. Fiscal restraint is absolutely essential to ensure the maintenance of the ti"wuous balance between available and required resources, while the introduction of economic p:riorities in Goverment expenditure and parastatal investment is a prerequisite for general importance of fiscal reform and has already taken steps to improve budgeting procedures and ensure that budget allocations reflect the priorities of the reform program, both in the aggregate and in individual sectors.1/ 2. Fiscal reform is not an additional burden that Zambia must bear, rather it is an integral part of the overall programs through fiscal reform, Zambians will see the evidence of improved Government services in key sectors such as health, education, and agriculture; through reform of the parastatal investent program, the private sector will see evidence of the Government's commitment to rehabilitation and maintenance of Zambia's deteriorated infrastructure. Early progress in these areas along the line summarized below is essential to sustain the momentum of Zambia's reform program. 3. The major findings of the public expenditure review pertaining to Government budget ares (a) Macroeconomic Obj'ctives. The Government should seek to achieve a recurrent budgetary surplus by 1990. This will requires (1) the reduction of consumer subsidies according to a phased schedule, with the exception of subsidies targeted specifically for lower income groupst (1i) zero growth of recurrent expenditures (excluding debt- service payments) in real terms over the next three ye,ars; and (iii) greater emphasis on cost recovery and other non-tax revenues. 1/While the major elements of the economic scenario which determines the level of public expenditures are described in this report, the full macroeconomlc scenario, In particular the Interrelations of the domestic and external sectors, are described in a World Bank Country Economic Memorandum (6355-ZA) dated November 19, 1986.  - 1i- (b) Sectoral expenditure reform. Few Government services that are necessary for the development of Zambia's economic and human resources are adequate. At the same time, considerable resources are going to low priority activities and redundant employment. The Government should: (i) d'signate a core group of activities, including agricultural services, health, education, road maintenance and development administration; (ii) prepare reform programs in the core sectors to improve cost-efficiency and target resources to essential activities; (iii) increase the share of resources going to the core sectors; and (iv) reduce services in the non-core sectors to meet the macroeconomic constraints on the budget. (c) Composition of expenditures. Over the medium-term, the reform program should include: (i) increased salaries at the upper grade levels in the civil service to Improve the retention and motivation of skilled staff; (ii) redeployment of skilled staff to core services; (iii) reductions in temporary workers, particularly in ministries such as the Ministry of Agriculture and Water Development, in conjuction with abolishing the current system for employing temporary workers; (iv) increases in recurrent operating expenditures; (v) reduced subsidies to individuals (such as secondary and higher education subsidies); (vi) permission for ministries to retain a portion of internally generated revenues for their own use; (vii) sharp cutbacks in domestically financed capital projects; and (viii) reductions in donor-financed projects to concentrate local staff and funding. (d) Planning and budgeting. The Government has intiated a new system of annual planning to guide budget preparation and introduce a performance-based review of Government programs. The next step is to upgrade the capacity of the planning units in sectoral ministries and involve them more directly in the budgeting process. In order to conserve on scarce planning personnel, NCDP needs to use the annual plan as the primary instrument for guiding public expenditure policy and deemphasize five-year and provincial planning.  - iii - 4. The major findings of the report pettaining to the parastatal investment program are: (a) Macroeconomic objectives: Investment levels have been severely depressed over the past several years, and much of Zambia's capital stock urgently requires rehabilitation. Major increases in investment are required by the parastatals, which hold much of Zambia's essential infrastructure. Most of the parastatal investment program will not contribute directly to economic growth, but rather is necessary to avoid further declines in production (mining) or to prevent the emergence of bottlenecks (e.g., railways and petroleum supply) which could stifle recovery and expansion of the private sector. (b) Size of the investment program: The current parastatal investment program substantially exceeds available resources. A core investment program that fits approximately within the available resource envelope can be achieved by eliminating virtually all new investment and capacity expansion and focusing on major rehabilitation programs in sectors closely linked to the economic recovery program. Other projects, even these with potentially high rates of return, will have to be postponed or cancelled. (c) Composition of the core program: Five projects account for three-fourths of the core investment program: ZCCM rehabilitation, NCZ fertilizer plant, Tazama pipeline, Maamba Colleries and Zambia Railways. Shortfalls in resources for the program should be met by greater restraint in sectors such as industry, transportation (other than railways), power and telecommunications. Agreement on investment priorities with foreign donors and lending agercies is essential, and projects which are not an explicit part of an agreed public investment program should be excluded from external financing. (d) Institutional changes: Investment review procedures in ZIMCO and the Ministry of Finance need to be upgraded through an increase in qualified staff and training and technical assistance. A review of prices in major non-industrial enterprises is essential. Investment review should be institutionalized through an annual process of setting negotiated targets for parastatals and providing managers with adequate autonomy and flexibility to achieve the objectives. A system of regular performance reviews and financial incentives based on the target setting exercise should be introduced.  - iv - 4. teps: This review represents a key step in the process of public expenditure reform in Zambia. In implementing these recommendations, the Government Aill need to move decisively to fix appropriate aggregate budget ceilings and parastatal investment targets consistent with the restoration of macroeconomic balance. This process should include detailed consideration of the sectoral recommendations in this report, which should lead to the preparation of time-bound action programs for the major line ministries. These programs must be agreed with the Ministry of Finanene and NCDP to ensure consistency with plan objectives and the macroeconomic situation. Parastatals will have to undertake a similar process in consultation with ZIMCO and the Government. It will be very important for donors to demonstrate their own commitment to the Government's efforts by ensuring that their programs and projects are consistent with ministerial action programs and parastatal investment plans. Generous donor support has played a key role in encouraging macroeconomic and policy reform in Zambia. As the Government begins the difficult but absolutely essential steps involved iL public expenditure reform, the cooperation of donors will become even more Important in supporting this process and providing the resources to carry it through.  EXECUTIVE SUMMARY ZAMBIA: PUBLIC EXPENDITURE REVIEW I. Macroeconomic Prospects for the Public Expenditure Program 1. The Government of Zambia has introduced major policy reforms to reverse the long economic recession that has been associated with the decline in Zambia's terms of trade. These difficult and far-reaching policy decisions, such as the introduction of the foreign exchange auction, liberalisation of the foreign trade regime, and virtual elimination of price controls, have fund&aentally altered the prospects and incentives for economic growth. However, a large number of additional actions remain to be taken by the Government before satisfactory growth returns to the Zambian economy. Some of the most important measures involve the restructuring of the public expenditure program. To an unusual extent, the public sector exercises direct control over the allocation of resources in Zambia. The central Government and the parastatals provide over 60 percent of gross domestic product and account for 80 percent of capital formation. in this situation, the quality of public sector decision making concerning resource allocation and the efficiency and flexibility of public sector management will play a significant role in determining bow quickly the Zambian economy can respond to the Improved policy environment. 2. The prospects for the public expenditure program form an integral part of the growth scenario for the economy, particularly the savings-investment balance. One of the major constraints on the economy is the severe depression of capital investment that has taken place over the past several years. Between 1980 and 1985, the level of gross fixed capital formation declined at an average annual rate of 12 percent, and by 1985, capital formation accounted for less than 10 percent of gross domestic product, which is below the requirements for replacement and rehabilitation of the existing capital stock. The major share of capital investment over the next several years will have to go into reducing the large backlog of rehabilitation and replacement needs in sectors such as mining, transportation, energy ad industry. As much of Zambia economic infrastructure is held by parastatals, the parastatal investment program will account for a large proportion of total investment and will place severe constraints on the resources available for Government and private sector investment. Much of the parastatal investment program will not contribute directly to economic growth, but rather is necessary in order to avoid further delines in production (e.g., mining rehabilitation) or prevent deterioration of infrastructure that could create bottlenecks to economic expansion (e.g., railwafs and power rehabilitation), This maans that the sources of growth for the Zambian economy must be based on activities that do not have large capital requirements, Particular emphasis must be given to stimulating growth through improvements in factor productivity, Including better utilization of existing capacity and reductions in unit costs.  - 2 - 3. In order to support an increase in Investment, greater emphasis must be given to Improving the savings performance of the Zambian economy, particularly of the public sector. Gross national savings accounted for only six percent of GDP between 1980 and 1985, which is significantly below the level needed to provide sufficient resources for productive investment. The Government has been a consistent dissaver, with revenues less than recurrent expenditures in every year since 1975. While the financial performance of the parastatal sector has recently improved due to the relaxatioa of price controls, aggregate savings of the parastatals have been considerably below their investment requirements. In order to cover the large Government deficit and meet the financing requirements of the parastatals, the public sector has resorted to Internal and external borrowing on a large scale, which has crowded-out investment by private enterprises and contributed to the large debt overhang that burdens the Zambian economy. In order to rectify this situation, the Government will need to make reduction of the budget deficit one of its major objectives in establishing targets for the public expenditure program, while the parastatals will need to place greater emphasis on improved profitability through economic priciug and greater cost efficiency. 4* The economic prospects for the Zambian economy have been discussed in a recent World Bank country economic memorandum.1/ Assuming that the pace of policy reform is maintained, a slow improveui'nt in economic growth is envisioned over the next five years, on the order of 3.1 percent annual growth in real gross domestic product (GDP). This will be sufficient to support a needed increase in investment and provide for a modest improvement in private consumption per capita. However, achieving this outcome will require strict controls on the growth of public consumption in order to release resources required by other sectors. Improvement in domestic savings would be somewhat slower than growth in GDP, on the order of 2.8 percent per year (to be supplemented with an increased inflow of foreign savings) and will depend primarily on improvemeuts in public savings. Thus, control of the public expenditure program is an Integral part of the macroeconomic strategy for recovery of the Zambian economy, as well as being important on the sectoral level to support an improvement in vital services. 5. For the parastatal sector, the critical decision target will be the size of the investment program. On the basis of the growth scenario described above, it is estimated that approximately K 3,800 million2/ I/Zambia: Sconomic Reforms and Development Prospects, Report No.6355-ZA, November 19, 1987. 2/All prices in this report are estimated in constant terms on the basis if prices prevailing as of January 1, 1986 at an assumed exchange rate of K 6 - US$1.00.  -3- (US$635 million3 will be available for parastatal investment during the period 1986-88.3/ The investment program ahich has been proposed by the parastatals is iubstantially in excess of this amount and cannot be tuplemented with the resources that are expected to be available. In this report, a core parpatatal investment program is suggested that focuses on high priority rehabilitation projects and which fits approximately within the available resource envelope (within 15 percent). Achieving this core program will require very tight control of the public investment program, and a number of investments with potentially high rates of return will have to be postponed or cancelled. 6. For the Government budget, the critical decision targets will be the sise of the budget deficit and the absolute level of recurrent expenditures. In setting these targets, the Government will need to take account of several important structural changes that have occurred in the budget as a result of the economic reform program. on the revenue side, the tax base has shifted largely from domestic taxation to taxes on external trade flows as a result of devaluation and changes in the tariff structure. This has provided a "devaluation dividend" that has allowed the Government to absorb many of the short term fiscal impacts of the reform policies without making more fundamental changes in t)" budget structure. However, future growth in tax yields is likely to be constrained by: (i) the limited prospects for significant growth in exports and imports in rial terms; (ii) the need to reduce the Mineral Export Tax in order to improve the profitability of ZCCH and sustain its rehabilitation program; and (iii) the need for overall tax reform in order to encourage investment and savings and limit special treatment in the current tax code. As a result, the very high ratio of taxes to GDP in the 1986 budget (estimated at 30 percent of GDP) is expected to fall over time, and the Government will need to make increasing use oi non-tax revenue instruments, particularly cost recovery measures, to support the budget. 7. On the expenditure side, the most significant change in the budget is the substantial increase in interest charges as a result of devaluation and decontrol of domestic interest rates. Interest payments (on an accrual basis) have increased from an average of 15 percent of Government expenditures during 1980-85 to 42 percent in the 1986 budget, representing a four-fold increase in real terms between 1980 and 1986. In order to cover the large deficit in the 1986 budget that resulted from this 3/This projection assumes that parastatal investment will increase to 70 percent of gross fixed capital formation (GFCF) during the period 1986-88 (as compared to 59 percent of GFCF during 1980-84), while Government and private investment will each be 15 percent of GFCF (as compared to 23 percent and 18 percent respectively during 1980-84).  -4 - increase, the Government resorted to extensive use of foreign exchange debt-rescheduling and use of local counterpart funds generated from the sale of foreign exchange through the auction. These are expedient measures to absorb the short-term impact of the reform policies, but It has left the budget heavily dependent on foreign financing sources in order to cover the deficit. The Government needs to set phase4 targets for reducing the deficit as a first step toward establishing a more sustainable basis for the budget and improving the level of national savings. 8. In order to be consistent with the medium term savings requirements of the economic growth scenario described earlier, the Government should set a target of achieving a positive level of Government savings (revenues exceeding recurrent expenditures) by at least 1990. This can be accomplished bys (1) reducing consumer subsidies according to a phased schedule, with the exception of subsidies targeted specifically for the lover Income groups; (11) constraining all other recurrent expenditures (excluding debt-service payments) to zero growth In real terms over the next three to five years; and (ill) placing greater emphasis on non-tax revenues, particularly cost recovery charges, to supplement the Government's revenue base. In economic terms, this strategy is equivalent to using economic growth to fund increases in consumption and investment in the non-Government sectors, while freezing the size of the Government sector in real terms and allowing growth to reduce the relative size of the Government sector to a level that is more consistent with Zambia's long term development prospects. While providing a plausible basis for reviving growth in the economy, this strategy will place significant constraints on the Government's options for expenditure reform. Many Government programs are currently performing poorly, and a substantial realignment of expenditures is needed in order to Improve key Government services. The Government will therefore have to adopt an extensive program of expenditure reform if it is going to simultaneously achieve its targets for macroeconomic restraint and provide for improvements in sectoral programs. In undertaking this program, the Government will need technical assistance to improve expenditure planning procedures, develop sectoral reform programs which are consistent with overall budget prospects, and Implement these programs in a phased and realistic fashion. Financial support will also be an essential factor in achieving these objectives, but it is important that this support be provided within a clear and consistent framework for expenditure reform. 9. Desplte the apparent severity of the expenditure targets described above (zero real growth in the Governnmnt budget and a highly constrained parastatal livestment program), these projections are in fact based on a fairly optimistic scenario for economic recovery which is contained in the country economic memorandum. Given the disruptions that have occurred in the economy over the past year and the vulnerability of the economy to internal and external shocks, there is a significant possibility that economic conditions will not be as favorable is assumed In this report and that the constraints on the public expenditure program will be even tighter than proposed here. The Government will therefore have to monitor the core expenditure program carefully to ensure that the most  -5- critical elements are maintained. For the parastatal investment program, major rehabilitatlon programs In mining, energy (petroleum supply) and transportation (railroads) deserve priorlty, while investments in industry, transportation (other than railroads), power and telecommunicatlons may have to be cut-back more severely than recommended here. Within the Government budget, programs for key agricultural servlces, health care, education and road maintenance deserve to be protected, while expenditures for sub'ldies, admtnistration costs and non-core services should take the brunt of any expenditure shortfalls. 10. In the longer term, the Government should update its public expenditure program and review the expenditure targets regularly, at least on an annual basis. The demands of the public expenditure program will have to be continually reevaluated against other objectives of the economic recovery program. ?or example, this report has recommended that a large share of the total investment program should go to parastatals over the next few years, both because of the high priority of many of the parastatal rehabilitation programs and because the private sector is expected to take some time before It is prepared to undertake significant new investments. As economic recovery proceeds, more resources will have to be made available for private investment in order to develop new sources of growth for the economy. Similarly, the prospects for the budget are highly constrained by the need to reduce tle budget deficit and increase public savings over the next few years. As expenditure reform improves the cost effectiveness of key services, there may well be a need to reduce the high rate of growth of public investment and devote more resources to the recurrent expenditure programs of the Government. In order to make these decislons, the Government will need to have informatlon not only about the macroeconomic performance of the economy, hut 'also about the priorities and performance of public expenditure programs. Publlc expendlture reviews ahould become an integral component of the Government's economic management program, and institutlonal reforms to carry-out these reviews should have high priority for technlcal assistance. II. Reforming the Government Budget II. The quality and avallability of Government services have deteriorated drastically In recent years. This is a bitter pill for citlzens who have become accustomed to looking to the Government to provide the requisites of a modern society, such as better education, health care and infrastructure. Moreover, it belies the promise of success established after independence In meeting basic human needs, when services were expanded rapidly and effectively to meet the aspirations of a socially conscious society. These expectations and the widely held hope for a rapid retur; to economic growth (a hope shared by many external lenders) meant that the continulng sequence of budgetary cutbacks was done in a spirit of temporary retrenchment rather than fundamental adjustment. Expectations for improved Government services were maintained, even while budgets were shrinking In real terms and quality problems were becoming more acute.  - 6 - Operating ministries were provided with little guidance or flexlbllity to adjust their programs to fit within diminishing budgets, other than exhortations to cut costs, postpone capital expendltures and be more efficient. As a result, the reductions in essential services and compromlses with quality have been much deeper and more painful than if a program of expenditure reform had been inltiated earlier. 12. Even more binding than the financial constraint, however, is the shortage of skilled human resources available to manage Government expenditure programs. The Government is serlously overextended in terms of the capaclty of its manpower cadre, and it has become virtually unmanageable in terms of operating efficiency and accountabillty. The Immediate cause of thls situatlon Is the severe compression of the civil service pay scale, whlch encourages better qualifled staff to leave and lesser q'ialified people to stay. Other important factors are the lack of adequate trainlng programs and poor personnel management practices. These are serious problems which deserve prompt attention in order to preserve the integrity of Government servicci. However, given the shortage of trained manpower throughout the economy, the Government is unlikely to attract enough qualified staff to operate its vast array of programs at any time within the foreseeable future. In order to make effective use of its limited complement of skilled and motivated manpower, the Government needs to reduce the demands on public sector management by closing down low priority programs and transferring other acttvities, where feaslble, to non-governmental agencies. 13. Examination of Government expendlture patterns indicates that as operating budgets have shrunk in real terms, expenditures have become Increaslngly concentrated on lower priority activities. The Government has reduced expenditures on personal emoluments through wage restraint and compression of the salary structure, but controls on hiring of new workers have been lax, particularly for temporary workers (classlfied dally employees) which Increased by approximately 10,000 employees between 1978 and 1983. As a result, the employment structure of the Government has become increasingly 'bottom-heavy,' with high vacancy rates at the middle and upper levels and substantial overstaffing at the lower levels. Wlth regard to operatlng -funds (recurrent departmental charges), preference has been given to maintaining transfers to lndlviduals (e.g., student bursaries, boardlng costs in medical facilitles), while funds to support the delivery of essential services (e.g., medical supplies, educational materials, vehlele operating costs) have been cut disporportionately. Funds for central admlnistrative funetions have been protected at the expense of productive activities (e.g., agrlculture), social services and Infrastructure maintenance. Thus, even within the constrained prospect of zero budgetary growth, there is conslderable scope for Improving the delivery of Government services through the reallocation of funds to priority uses and by taking actlons to Improve the cost efficiency of Government servlces. This process will not be easy, as It will involve substantial cuts in areas such as Government employment and administrative expenditures that have strong constituencies within the Government. Moreover, ln order to justify the reallocation of expenditures, there will have to be a substantial rethinking of sector objectives and priorities at the level of the individual ministries. In some sectors (e.g. agriculture  this process has already begun, but the effort to improve the planalng and budgeting of Government expendttures needs substantial improvement in order to support a coherent program of expenditure reform. 14. The program of expendlture reform for the Government budget that is proposed in thls report is based on the following prlnciples: (i) Budgettng for Core Activities. The Government should agree on a core set of hlgh priority services whieh are required for the productive growth of the economy and the direct well-being of the population and which can be taplemented at low cost relative to the expected benefits. This set should Include support services for smnallholder agrlculture, prlmary education, primary health care, and malntenance and rehabllitation of essentlal infrastructure. Expenditures for the core services should be allocated preferentially during the annual budget discussions, and cuts in expenditures to meet macroeconomic constraints should fa'l largely on the non-core activities of the Government. (ii) Accountabllity of Sectoral Ministries. Shifting of resources between ministries will be essential in order to meet the Government's development objectives. However, emphasis should also be given to Improvements In the allocation and efficiency of expenditures within individual ministries and increases In direct revenue generation. This places the burden for expenditure reform largely on the sectoral ministries, rather than the Ministry of Finance. (iii) Reduction of Government Services. Reductions in Government services are an essential part of the program of expenditure reform in order to release financial and managerial resources for Improvements in core activities. This process will often involve shifts In the compositlon of expenditures, for many core services require increases in recurrent operating funds and skilled personnel in order to perform effectively, while reductions In expenditures will often involve elimlnation of redundant and lower skilled employees and cancellation of locally funded capltal projects. Programs involving direct participation in agricultutral production, construction of low priority infrastructure, and services for the middle and upper income groups should be eliminated, transferred to non-governmental agencies or placed on a full cost recovery basis.  15. A proposed program of expenditure reform for the Government budget is outlined in Table 1._'/The overall budgetary target is consistent with the macroeconomic projections discussed above, i.e., consumer subsidies have been eliminated and other operational expenditures (other than debt- service) are constrained to zero real growth in aggregate terms. Within this envelope, there would be a significant shift of funding to the core sectors--agriculture, health, education, roads and development administration--which would Increase from 41 percent of the budget in 1986 to 58 percent in 1988. Programs outside the core sectors would have to decrease by 21 percent in real terms to accocmodate this reallocation of expenditures. 16. Within the core sectors, there would also have to be significant reallocations in order to justify the increases in funding proposed in Table 2. For example, the proposed increase of 30 percent for agricultural programs would not be adequate to Improve the delivery of key services unless funds are shifted within the agriculture budget from programs such as area development to higher priority programs such as agricultural research and extension. Similarly, the budget for the roads program should be conditional on postponement or cancellation of virtually all new road projects and reallocation of the funds to road maintenance and rehabilitation. In some cases, particularly health and education, most of the increase in funding would not involve any change in the amount of general Government revenues allocated to the sector, but rather would be based on increases in cost recovery charges and improvements in cost- efficiency that would free up existing funds for core services which are undirfunded. Thus, a prerequisite for any shift in funding between sectors in the budget should be the preparatior. of detailed sectoral development plans that would guide the allocation of staff and funding within each sector in a annmer consistent with macroeconomic priorities. Sectoral Uxvenditure Programs 17. Agriculture (see paras. 2.09-2.28 in main report). The benefits of current agricultural expenditure programs are limited by: (a) an orientation towards the needs of coammercial farmers rather than small-scale and traditional producers; (b) inappropriate balance between personnel and other operating costs; (c) diffusion over too many projects and programs; and (d) involvement in activities better left to the private sector. 4/For illustrative purposes, all expenditure reform recommendations in this report have been worked out on the basis of the 1986-88 period. However, it is recognized that given the magnitude of the proposed shifts in funding allocations, most reform programs, including the phased reduction of consumer subsidies, will have to be implemented over a longer period, and this will have to be worked out on a case-by-case basis with the individual sectoral ministries.  9 Te'1: PstMd Qwe t!dltwe PnM 198 (K urllin In amnstt 1986 prices) btioe a/ As X 'As luenitre Pzg9am i 1986 of ITO 1988 of na amp a"r SWYoOrs 1. Agiicalture 152 299 11 390 16 +33% 2. -sdth b/ 145 203 8 253 11 + 3. ation 29 466 17 510 22 +1(1 4. Ros 72 82 3 150 6 5. Jlvelopit AMLnistration d/ 32 42 2 59 3 44( 9b-totl 4697 1092 41 1362 58 +24X Otber Sectors 6. abidies 190 334 12 0 0 -1O0( 7. All othdx e/ 872 1270 47 1000 42 -21% Seb-total 1062 1604 59 1000 42 -371 - - TOW 1759 2696 10 2362 100 -120 lult*s both capital and nrremnt enditubre. QuIts debt 81vic ad mm rdinary e diuwem. 8/ 1985 estimted wuditues are in owrint prtas. b/ ased n K 1) v illc morns in user fees and gensl bwlget allocatim a aswm K )D mllalm in cost - ai redtictions In ndstio svitee. c/ Tneblues allocain for capital prolet. d/ on Misty of nane and IF oly. e iul categry. f/ 1986 b*t allocatin to 1988 reh lmued allocatn.  - 10 - In many instances, donor participation has contributed to the fragmentation of agricultural programs by concentrating on narrow project concerns instead of broader sectoral problems and by placing excessive demands on the limited supply of skilled local manpower and counterpart funds available to the public sector. Expenditure reform in the agricultural sector should therefore concentrate on strengthening a limited number of key programs which are critical for long term agricultural development, improving their cost efficiency, and eliminating competing demands on the public sector that are of lower priority. 18. Highest priority should go to services needed to increase the productivity of smallholder and emergent farmers, particularly agricultural research and extension. The provision of agricultural credit also needs improvement, which will require Government actions to consolidate and strengthen the current institutional framework. Savings in agricultural programs are possible by deemphasizing area development projects (which require large inputs of local funds and staff and suffer from poor coordination at the national level), trimming of MA'D's 6xcessive complement of low-skilled labor (two-thirds of MAWD's employees are classified as temporary workers), and by reducing public involvement in activities such as marketing, input distribution and crop production which are better suited to private participation. A major effort is needed to review MAWD's project portfolio (currently numbering over 10 projects of various sizes) and consolidating, closing or divesting many of these activities according to a definite time schedule. In order to accomplish this program of expenditure reform, strengthening of MAWD*9 Planning Division will be essential to improve the technical coordination and review of agricultural expenditure programs. 19. Health (see paras. 2.29-2.38 in main report). Health services have been seriously curtailed by budget constraints and '.he lack of clear guidance for expenditure reform. The most immediate problem is the shortage of key drugs and medical supplies, which have been out of stock for up to 30 weeks in some rural health clinics. In urban areas. prescriptions are routinely issued on the understanding that the patient will purchase the drugs from a private supplier, thereby introducing cost recovery on a de facto basis. Maintenance of transport operations and facilities has been neglected, with over half of the vehicle fleet operated by the Ministry of Health (NOR) out of running condition and much of the remaining fleet in poor shape. Perhaps most serious, however, is the growing shortage of trained medical staff, including physicians, due to the unattractive conditions of service offered by the Government. 20. It is estimated that NOR programs in the 1986 budget were underfunded by approximately one-third (or K 100 million) of the amount that would be needed to operate them on a minimally satisfactory basis. At least 75 percent of this funding shortfall should be made-up through expenditure reforms within MOR programs. First priority should go to cost savings through reductions in the number of unskilled and redundant  - 11 - employees, rationalization of health facilities with low utilization rates, and improvements in the drug procurement and distribution system. User fees should be introduced on a systematic basis, with a realistic target of covering 10-15 percent of MOR recurrent costs within five years. Experience from other countrios has shown that such fees can help improve the efficiency of health services as well as provide revenues, and they need not discriminate against lower income groups if they are applied selectively and at moderate rates. Reductions in ongoing programs should be a part of expenditure reform by allowing greater scope for private provision of health services and eliminating lower priority activities 4n the budget. Concurrent with the development of a realistic plan for achieving savings in MOR expenditure programs, there would be justification for increasing the budget allocation by a moderate amount to complete the overall financing requirements for health. 21. Education (see paras. 2.39-2.46 in main report). Government policy statements call for the achievement of universal primary education. However, a recent study of educational reform conducted at the University of Zambia concluded that this objective cannot be achieved without a substantial reordering of expenditure priorities within the budget.5/ Discrepancies in the unit costs of education are enormous in Zambia, it costs 160 times as much to educate a student for one year in the university as it costs to educate a primary school student. The differences in unit costs are attributable to large student subsidies, low teacher productivity and cost inefficiencies at higher levels of education, combined with gross underfunding of education costs at the primary level. Educational quality has suffered at all levels as the budget has become increasingly skewed toward maintaining employment levels and subsidies in the sector. The capital budget shows limited relation to sectoral priorities, emphasizing construction of rural secondary schools and university facilities, while ignoring the critical need for capacity expansion of primary education in urban areas. 22. Education already consumes a relatively large share of the Government budget, and increases in the amount of general revenues devoted to the sector would not be feasible. Instead, improvements should be financed through cost savings and increases in user fees, particularly at the technical and higher levels of education, which would release funds to support an increase in funding for primary education and, to a lesser extent, junior and secondary education. These measures should be adequate over time to support a 40 percent increase in funding in real terms for primary education, without causing any significant decline in the quality of educational programs at other levels. The educational reform study cited above provides a sound framework for developing an action program to realign expenditure priorities in the sector to fit current needs. 5/*Provision of Education for All," Educational Reform Implementation Project, School of Education, University of Zambia, July 1986.  - 12 - Improvements In the planning capability of the education ministries will be an important element in implementing this program. The current division of responsibilities between two ministries (the Ministry of General Education and Culture and the Ministry of Higher Education) has hindered the development of a realistic approach to education problems. Preparation of a program for rationalizing educational expenditures will require a common planning and budgeting framework for the two ministries. 23. Roads (see paras. 2.47-2.49 in main report). The major part of Zambia's extensive road network wae constructed almost twenty years ago, and much of it is reaching the end of its design lifetime. This situation is aggrevated by a serious neglect of maintenance over the past ten years and by lax enforcement of vehicle weight controls, so that the road network has deteriorated over much of its length with major s4trface and foundation failure. A recent study has estimated that rehabilitation of the four major trunk roads in Zambia will cost K 348 million (approximately US$58 million), which, with Improvements to other roads and replacement of maintenance equipment, will require a total budget for road maintenance of K 1,200 million (US$200 million). This program would require almost 30 percent of gross fixed capital formation for the economy as a whole over the next few years and is clearly well beyond the level of resources that can be made available to this sector. A more realistic program stretching over 8-12 years should be prepared, with the Implication that some of the road network may have to be left to fail and possibly to be abandoned. 24. Despite the urgent situation regarding road maintenance, little appreciatiou has been shown for priorities in this sector. The 1986 budget allocated 72 percent of highway funding for new road construction and only 28 percent for maintenance. Many of the new roads are very low priority, such ass the road between Mansa and Nchelenge which previous studies had showns would not be economically Justified before at least the 19909. Besides the road maintenance program described above, the Ministry of Works and Supplies has prepared a request for additional funding of K 1,200 million for new road projects over the next three years. With very few exceptions, this program should be postponed indefinitely, and the Government should review existing contracts for low priority roads to identify areas where construction can be reduced or cancelled. 25. Development Administration (see paras. 2.50-2.61 in main report). The economic crisis has put a severe strain on the capacity of the central economic ministries, particularly the Ministry of Finance and the National Commission for Development Planning (NCDP). These ministries have not developed the analytical capability or the administrative machinery needed to cope with the demands of the economic recovery program and initiate a difficult process of expenditure reform. Even for their traditional functions such as budget formulation, data collection, tax administration and debt management, MDF and NCDP have been plagued by the same problem that constrain other ministries, including lack of qualified staff at upper levels, overstaffing at lower levels, and inadequate operating funds to maintain their programs. Recognition of development administration as a core activity of the expenditure reform program would be a valuable first step In resolving this problem. This priority needs to  - 13 - be supplemented with technical assistance in staff training, data processing systems, macroeconomic planning, and planning and budgeting in order to allow these ministries to fulfill their critical role in guiding the economy. Cross-Sectoral Expenditure Issues 26. While the sectoral ministries must take a major responsibility for realigning their expenditure programs, there are a number of issues that cut across ministries and need to be addressed at a general level by the Government. The topics discussed here are: (a) wages and employment policy In the civil service; (b) budgeting for recurrent and capital expenditures; and (c) reductions in Government services. 27. Wages and Employment Policy. The Government faces two Important issues in employment policy: (i) the critical shortage of skilled personnel to manage and operate Government programs; and (ii) the excessive burden on the budget from the large number of redundant employees at lower skilled levels. These problems arise both from deliberate policy decisions of the Government and from inadequacies in the planning and budgeting system, Successive salary review commissions in Zambia have maintained a policy known as 'narrowing the gap," which imposes a larger share of adjustment costs on upper income workers while maintaining a relatively high wage floor for lower skilled workers.6/ Growth in the number of civil servants was restrained by the need to obt7ain authorization for new positions, but individual departments were largely free to hire temporary workers as they wished, with the budget allocation for these workers gaining protection during the next year's deliberations because it represented personnel costs. As a result, the budget system had a built-in tendency to increase the number of employees at the lower end of the skill distribution, even while higher skilled employees were leavlng the Government because of the increasingly unattractive remuneration. 28. The Government has recognized that reductions in expenditures on personnel costs are necessary and has announced strict measures to achieve this objective. These include a freeze on hiring for most civil service positions, mandatory retirement of civil servants at a reduced age, limitations on wage increases to be less than the rate of inflation, and targets for all ministries to reduce the number of temporary workers by 40 percent over a three year period. These measures represent a serioli% 6/For example, between 1979 and 1983, the real wages of upper grade civit servants fell by 55 percent, while real wages at the lower end of the grade scale fell by 17 percent. In comparison, real income per capita fell by 18 percent during the same period.  - 14 - attempt to reduce personnel ceits, but they need to be evaluated on the basis of their impact on the ability of the Government to maintain services. Earlier retirement of higher skilled employees may reduce the efficiency of Government services by depriving the Government of some of its most experienced personnel. Wage restraint, if it is combined with a policy of 'narrowing the gap," could result in increased vacancy rates at middle and upper managerial and technical levels. Finally, while a minimum target for reductions ir temporary workers is desirable, particular attention should be placed on ministries such as HAND and the Ministry of Works and Supply which maintain excessively large complements of under-utilized temporary workers. 29* It would be in the national interest to increase salaries at the higher grade levels in the civil service, both to improve the retention and motivation of existing employees and to promote the Government's longstanding policy of Zambianization. This will have to be balanced by greater reductions in the number of lower skilled and temporary employees. improvements in manpower management practices in the civil service should have high priority. These should include information, training and redeployment programs to assist the Government in allocating its cadre of skilled employees to key services, while lower skilled workers will need assistance in making the transition to alternative forms of employment. The Government should abolish or strictly limit the current system of hiring temporary workers, which no longer serves its original purpose because of the employment benefits and guarantees that have been introduced over time. Some positions will warrant permanent employment and should be incorporated into the civil service, but a large number of the remaining positions should be eliminated or converted to contractual arrangements with individuals or private firms on a performance basis. 30. Budgeting for Recurrent and Capital Expenditures. Past budgeting practices have focused primarily on reductions in recurrent operating funds, with the result that many key Government services have been virtually immobilized over time. In the longer term, the Government will have to move to a system of performance based budgeting, in which all categories of funding, including personal emoluments and capital expenditures, are considered to be flexible inputs for achieving the Government's ab*ectives, rather thas scrutinized and budgeted separately as is current practice. Even in the near term, however, the Government can obtain improvements by simple measures such as allowing ministries greater discretion to reallocate funds between expenditure categories, such as between personal emoluments and recurrent operating costs or between capital and recurrent expenditures. A particular problem is the erratic release of funds for both operating costs and capital expenditures, which encourages the buld-up of arrears and disrupts orderly planning of activities. Many ministries indicated that they could improve services on a smaller budget if the funds were released in a predictable manner. 31. The Government should place high priority on reducing subsidies to individuals (such as education subsidies) and increasing cost recovery charges for Government services. Many ministerial officials agree that there is substantial scope for improving cost recovery, but they refrain from increasing fees because of political pressures and because all revenues are budgeted directly to the Ministry of Finance and do not  - 15 - bezafLt the collecting agency. The Government should experiment with methods for encouraging greater revenue collections, for example by allowing operating ministries to retain a certain proportion of revenues (up to 100 percent in many cases) for their own use. This approach would especially help ministries such as health and higher education, but it should also be applied to aetivities such as Zambia Broadcasting Service and the Ministry of Tourism. Some services such as land registration and the issue of mining licenses should be reoriented to emphasis revenue generation as a primary objective. 32. The Government should introduce uniform criteria for screening capital projects, whether or not they are donor financed. Currently 88 percent of all local capital funds are used for domestically financed projects, while only 12 percent are used for donor financed projects. Many of the local projects involve very low priority activities, such as prestige construction projects, rural infrastructure with low rates of return, and staff housing in urban areas. At the same time, the limited supply of funds for donor projects is spread thinly across all projects, with the result that implementation uniformly suffers. A related problem is the tendency for donor financed projects to be accepted virtually automatically, whether or not there are local funds and staff available to support them. A much smaller and more focused capital program would improve the productivity of Government programs significantly. 33. Reductions in Government Services. Zambians have generally assumed that the public sector should play a major role in most areas of the economy. However, the deterioration of Government services that has occurred over the past ten vears demonstrates the practical limits of public sector intervention, and a reduction in the scope of public services is necessary in order for the Governmant to concentrate its resources on those activities essential for economic recovery. First priority should go to eliminating programs whose justification has ceased to exist or which have not been effective in meeting their objectives. The Government does not review the priority or performance of ongoing activities on a systematic basis, and it is common for overlapping agencies to be established or for services to 5e continued beyond the time they are required. For example, there are currently four separate Government agencies with price review responsibilities even though price controls have been largely abolished, while the Zambia National Service continues to receive a large budgetary subsidy despite the fact that it accepts no recruits and the productivity of its farms is poor. Likewise, the elaborate administrative structure established to promote decentralization has instead led to a deterioration of the effectiveness of local services because of bureaucratic problems and inertia. In each case, these programs were established to promote valid national objectives, but the resources they continue to consume should now be used for much more important activities elsewhere. 34. Second priority in reducing Government services should be activities where the Government does not have a clear comparative advantage or overriding social objectives for justifying its involvement. The most obvious example Is public participation In agricultural crop production, which has had a disml performance record in Zambia. In addition, various  - 16 - types of agricultural research, veterinary services aimed at commercial farmers, and some forms of health services on a voluntary basis could all be taken over by the private sector. In the near term, these activities may justify increased expenditure of Government funds in order to establish their viability prior to divesting them, but this should be done on an exceptional basis and according to a definite timetable for ending public involvement. The Government should also move slowly in establishing parastatals that will have to depend on the Government budget for their income. The University Teaching Hospital in Lusaka has recently been established as a parastatal, and similar actions have been discussed for the Zambia Broadcasting Service and the Mechanical Services Department. Bstablishment of a Government department as a parastatal can have significant advantages in -erms of greater freedom to set salaries and control costs. However, it can also lead to a diffusion of budgetary control during a very difficult period, and the increased salary differentials within the sector can contribute to a deterioration of those services staying with the Government, such as rural health care. 35. Beyond these examples, the Government will have to face difficult decisions about where services should be trimmed back in order to release funds for the core expenditure program. In virtually every sector, the Government is sign'ficantly overextended in term of the objectives of its current programs, and substantial cuts will be necessary to obtain improvements in core services. In order to make the necessary trade-offs between programs and assess the likely implications of expenditure reform, significant improvements in the system of planning and budgeting will be required. Planning and Budgeting 36. Until recently, planning in Zambia was carried out largely in the context of multi-year development programs for capital expenditures. AA economic constraints became more binding, this type of planning became increasingly irrelevant for day-to-day decision making. Given the inherent biases in the budgeting process toward maintaining employment levels and reducing operating expenditures, It was inevitable In the context of scarce resources that Government services would be allowed to deteriorate. During the past few years, efforts have been underway to introduce a revised system of planning and budgeting that will address these problems. Beginning with 1986, the Governmnt budget was accompanied by an annual plan which was intended to explain and justify the choices that had been made in developing the budgetary allocations. While this system is still evolving, the changes that have been introduced so far provide the framework for a flexible and efficient mechanism for guiding expenditure choices. 37. The major change Introduced in the new planning and budgeting cycle that operating ministries prepare a strategic plan for allocating expenditures in the sector on the basis of preliminary budget guidelines issued well in advance of the annual budgeting process. This step is intended to provide a mechanism through which the operating ministries can make an assessment of the impact of proposed expenditure levels on the  - 17 - delivery of services, as well as raise major issues regarding expenditure choices in the sector for resolution at a more senior level. The draft submissions of the operating ministries are used to prepare a draft budget paper for discussion by the Central Committee and the Cabinet. This document presents the principal issues of economic policy - most importantly, the resource constraints and major sector problems -- and propose policies and expenditure allocations to deal with them. Onae accepted by the Central Committee and the Cabinet, the Ministry of Finance prepares a Budget Circular with instructions and final ceilings for preparing the budget estimates. Unlike previous years in which senior decision makers were asked to approve the budget document in final form shortly prior to its presentation to Parliament, the new system provides the basis for making more informed choices about the budget early enough in the process to affect the final outcome. 38. The revised sys',im of planning and budgeting requires that Government agencies operate somewhat differently than they have in the past. The division of labor between the Ministry of Finance and NCDP is no longer based on the division of the budget into recurrent and capital accounts. Instead, the Ministry of Finance has full responsibility for preparing the budget and NCDP for preparing the annual plan and establishing expenditure priorities. The experience during 1985 demonstrates that additional improvements will be necessary to make the system operate effectively. The annual plan that was produced by NCDP in conjuction with the 1986 budget was well-received in Zambia and constituted a significant acouplishment in a relatively short time. However, the analysis was generally regarded as inadequate, and the propnsed allocations had far less effect on the budget than was intended. This result was not unexpected, as 1986 was a transitional year in the planning process and took place in an atmosphere of considerable economic uncertainty. Nevertheless, the active participation of the operating ministries in taking greater responsibility for their submissions will be essential to make the process work. During the current year, the attention of NCDP and the operating ministries was distracted by the preparation of a five-year development plan in addition to the annual plan. NCDP has also stated that it intends to give priority to strengthening provincial planning units. This proli2leration of planning activities in the context of scarce skilled manpower is unrealistic, and NCDP should focus its attention on the most critical planning activity, which is the annual plan and budget. Social Impact of Expenditure Reform 39. One of the major reservations of many Government officials to revising the budget is the possible social impact of the proposed reforms. While this is an important concern, progress on expenditure reform has been significantly hampered by a narrow perspective on social considerations without giving adequate weight to longer term benefits, For example, the Government has strongly resisted introducing user fees for health and education, even though the resulting deterioration of services due to lack of funds has hurt the recipients much more than the imposition of modest charges. Similarly, the policy of wage compression in the public sector coupled with large increases in employment levels could be justified as a measure to address short term problems of rising unemployvient, but it has  - 18 - been continued far beyond the time when it could benefit the economy and now threatens to undermine the continuity of Government services. Thus, the decline in social services has resulted largely from a failure to adopt adequate programs of expenditure realignment, rather than from the impact of economic rezorms. 40. The Government can no longer afford to provide a wide ranging program of heavily subsidized social services and still maintain adequate coverage for the lover income group. In order to restore equity concerns in the distribution of social services, the following measures should be taken: (M) Concentrate Government expenditures on programs which provide basic services at relatively low cost, such as primary health care, primary education, and low cost site and service housing projects; (it) Introduce targeted trausfer programs, such as a subsidy on roller meal and feeding programs for vulnerable groups such as lactating mothers and children, in place of broad-based subsidy programs; aud (iii) Intensify cost reduction efforts in all social programs in order to achieve greater efficiency and lower unlt costs. These measures can ensure that all Zambians have access to a minimally acceptable level of social tervices. that the system neither penalizes nor excludes those who cannot pay, and that those who can afford to pay for privileged services do so. III. The Parastatal Investment Program 41. Parastatals play a major role in the Zambian economy, accounting for over 30 percent of GDP and 60 percent of investment. The majority of parastatals (approximately 120) are grouped together under the ZIMCO state holding company. ZIMCO is dominated in terms of gross turnover, value of assets, and taxes paid by ZCOC, the copper mining company. Other important sectors in which ZINCO plays a major role include industry (under the INDECO sub-holding company), energy, transport, and telecommunications, with smaller holdings in agriculture, finance, trading, hotels and real estate. The non-ZIMCO parastatals (approximately 30, sources vary on the actual number) are controlled directly by sectoral ministries and are must important in agriculture (particularly NAMBOARD, the agricultural marketing board), finance, housing and railways (TAZARA). 42. The ZIMCO parastatals are independent of the sectoral ministries and expected to operate on a financially viable basis.. Prices were largely decontrolled in 1982, and the profitability of individual parastatals has improved since then. Despite this, the consolidated accounts of the ZIMCO group show a mediocre financial performance, and after tax profits were last earned in 1980. As a general policy, the Government does not pay operating subsidies to ZIDCO parastatals and transfers of funds between  - 19 - ZIMCO parastatals are not common. However, soft loans, Government assaumption of parastatal debt and distortions in transfer prices and taxes are frequently used to assist financially weak parastatals. Thus, the original expectation that the parastatals would be net contributors to the Government has not in general proved true. Since these companies control some of the country's major resources and dominate key sectors of the economy, their low returns give serSous cause for concern. 43. Parastatal pricing policy can be a major instrument for Improving the aggregate savings performance of the Zambian economy. Because of low profitability, companies have been unable to generate adequate funds to cover maintenance and replacement costs. Low profitability hba also contributed to liquidity problems for the parastaXals and excessive dependence on debt financing for investment. Between 1980 and 1984, self-generated funds accounted for only 23 percent of ZINCO's investment financing, with the remaining funds provided almost entirely through loans from internal and external sources.7/ 'Improvements in parastatal pricing would also contribute to better investment decisions by providing a clearer indication of the economic return on investments and making enterprises aware of the financial implications of their decisions. With the iitroduction of the foreign exchange auction and liberalization of the trade regime, many ZIMCO companies, particularly in the industrial se,ctor, are operating in a more competitive environment and have adopted pricing and cost control policies to meet this challenge. Many of the parastatals outside INDECO, however, continue to operate in non-competitive markets, and more direct interventions in pricing policies may be required. A staged process of raising prices to achieve target rates of return should be introduced, as well as measures to control costs and improve operating efficiencies, so that price increases do not simply provide a cost cushion to protect inefficient firms. In cases where a firm cannot be made viable vithout extraordinary assistance, the enterprise should be closed down to reduce the burden it places on the rest of the economy. INDECO has already initiated a process of reviewing the peformance of industrial firms, and this effort should be extended on a selective basis to cover major enterprises outside INDECO. 44. Despite the concerns about the financial performance of the parastatals, ZIMCO has also made a number of important contributions to establishing a sound business environment. The separation of direct ministerial control from the parastatals has removed a major factor that inhibits the flexibility and reduces the autonomy of parastatal managers in many countries. ZINCO has introduced a number of procedures, such as uniform corporate planning and investment review, that have improved the process of management review and direction in the group. Most commendably, ZIMCO maintains audited accounts on a regular basis for all 120 subsidiaries, which sets a standard of transparency and regularity in parastatal financial transactions that is a very valuable asset for economic development. As a result, it is possible to form judgements on 7/As of January 1, 1986, ZIMCO's total indebtedness was estimated at about K 6,000 million (US$1 billion).  - 20 - the overall size, composition and financing plan for the parastatal investment program, a task that would be difficult to duplicate in many other countries. 45. A sumary of the proposed core parastatal investment program for 1986-88 is provided in Table 2. In developing this table, a substantial number of cuts have been made in the investm at programs prepared by the parastatals, and projects which have not been shown to have high rates of return or which do not conform to the objectives of the economic recqvery program have been deleted.8/ Most of the remaining projects appear to be well-justified on the basis of an initial screening and would contribute positively to Zambia's economic recovery. However, the total sise of the core program still exceeds the amount of resources expected to be available by about K 450 million (US$75 million). This indicates that only projects which are explicitly included in the core investment program should be allowed to proceed, and even some of these may need to be scaled-back or postponed if resources remain tight. In order to understand the difficult decisions facing Zambia, it is necessary to review the detailed investment plans in the major sectors. Sectoral Investment Programs 46. mining (see paras. 4.16-4.22 in main report). In January 1986, ZCCM announced a comprehensive five-year production and investment plan designed to increase copper production and improve mining productivity. The main elements of this plan include management reorganization, cost reductions (including closure of high cost mining operations) and major investments to increase production and improve efficiency. The proposed plan represents a coherent approach to resolving the operational problems that have contributed to a continuing decline In ZCCM's production over the past several years, Nevertheless, the cost of this plan,,particularly the ambitious investment program, is unsustainable in terms of its impact on the rest of the economy, and significant cuts will be necessary to release resources for essential rehabil'l-ation investmcnts in other sectors. 47. The principle componen ' the ZCC( investment progr&a are: (i) equipment replacement and reh.-Litation; (ii) mine development; (iii) metallurgical facilities; and (iv) other investments. These elements address the major constraints on ZCCM's operations in recent years; i.e., the low availability of mining equipment due to lack of spare parts, and the increasing difficulty of mining operations due to lagging mine development in order to concentrate on current production. Rates of return on the projects, where available, are estimated to exceed 20 percent. Given the critical importance of the mining industry for Zambia's economic 8/The main report provides more detail as to the various cuts made Tn the core parastatal investment program. Some of the projects that are proposed to be delayed or cancelled include a parts manufacturing facility proposed by ZCQ(, a steel re-rolling mill and sawmill rehabilitation project by INDECO, most rural electrification projects by ZESCO, and all components of the PTC investment program that are not already under implementation.  - 21 - TAU2 PIoposed core pantaa lieetmut Po , 1986-88 Fbre* Flnmncig PtoIedEWAdltue As Z Comitted (C)/R4uired (R) ~seaw/ptolec 198648 (K uIW ) of Total l9K 1, 19688 (-U* ,Lfljw a, - ZMO aW.1t K2105 SD $ 212, f Aid 112 () INDhE( Inotimnt PI: r's la 344 8 44, of ihid 37 (tR) ;z flhabiUtation 230 5 31 (C) Otbe 240D/ 6 29 (i) total 814 19 Mom 1esbldII tati*n 180 4 22 (R) - b bClliazy 135 3 20, ofdd 5 (R) Other 129 3 18, of &ld 18 (R) aSib-otl 444 10 %MP= Zardia BRlbw8 430 10 66, o idid 11 (R) Other 202 5 . 28 (R) 9ub-total. 632 15 PDC lstmut fPrm 253 6 36, of *ddh 2 (R) .~~~~S - - -_Ew Dbtal K 4248 100 $ 506, ofu dh264 (R) a/ Flnnc bsed on lnfonuibn available as of Fabeuy, 196. Finirg amounts rew to the period 198688 aoly and do rt dmerily reflect the tota findg ura%nt for the project. b/ A rldiul toWqy to arwer 1mtxIa lne w rDt c