Haiti - Technical Assistance Project

Document of The World Bank FOR OFFICIAL USE ONLY P / /a-6 -Ao Report No. P-4433-HA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT OF SDR 2.4 MILLION (USt 3.0 MILLION EQUIVALENT) TO THE REPUBLIC OF HAITI FOR A TECHNICAL ASSISTANCE PROJECT April 7, 1987 This document has a resuricted 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 EQUIVALENTS Currency Unit - Gourde (G) G 1.00 - US$0.20 US$1.00 - G 5.00 The Courde has been pegged to the U.S. Dollar since 1919 at this rate. WEIGETS AND NEASURES Metric System FISCAL YEAR October 1 - September 30 This report uses FY for fiscal year. Thus FY87 refers to the period from October 1, 1986 to September 30, 1987. AdBBEVIATIONS BC& Bureau de Credit Agricole (Agricultural ^redit Bureau) BND&I Banque Nationale de Developpement Agricole et Industriel (National Agricultural and Industrial Development Bank) CUG Conseil National de Gouvernement (National Government Council) CPN&P Commissariat a la Promotion Nationale et a l'Administration Publique (planning agency) ENAOL Enterprise Nationale des Oleagineux (vegetable oil factory) FDI Fonds de Developpement Industriel (Industrial Development Fund) IDB trnter-American Development Bank fIF International Monetary Fund MCI Ministry of Commerce and Industry MR1 Ministry of Economy and Finance SOe Statement of Expenditure TAF Technical Assistance Fund UNDP United Nacions Development Programme USN Usine Sucriere du Nord (sugar mill) USND Usine Sucriere Nationale de Darbonne (sugar mill)  Foi omcUiL USE oNLY DAITI TECUNICAL ASSISTANCE PROTECT Table of Contents Page No. CREDIT AND PROJECT SMAY .......................................... i I. Tbe Economy I 1 A. Main Features............................. .. I B. Developments, FY3O-85...6........... 3 II. The Goveroment' S Economic Recovery Program, Y86-88 ... 4 A. Political Background .e...e..................m ...... 4 B. Overall Strategy ...................... 5 C. Macroeconomic Stabilization ..... *oee.............s 6 D. Tax 8..................... ..SCe ...... 8 E. Public Expenditure.......... ................. 9 F. Public Enterprises............................me 13 G. Competition and Industrial Incentives............... 16 H. Agriculture ........ .....e.........*. 19 I. Economic, Environmental and Social Impact ........... 21 III. The Proposed Project ...... ............................ 25 A.Hsoy............................. 25 B. Objectives ......................... ......... 25 C. ecito ......** 26 D. Implementation and Administration............e...... 29 E. Cost and Financing .............m....e.. 29 F. Procurement, Disbursement, Accounts and Auditing.... 30 G. Benefits and Risks.............................. in... 31 IV. Bank Group Operations and Strategy .................... 32 V. Relations with the DW and with Other Donors .....e.... 34 VI. Reco=endation .......... ....... 34 Thi document has a tricted distribution and may be used by recpients only in the pefomance of theiroffFicildutic s1 contents maynototherwiwbe dbwlau withut World Bank autxiborinw  Table of Contents (continued) Page . TEXT TABLES Table 1: Treasury Budgets, FY86 and FY81................... 11 Table 2: Public Investment Program, FY86 and FY87........... 12 Table 3: Summary Economic Projections With and Without Recovery Progra . .............. 22 AUSIES Annex I: Economic Indicators and ProjectionsJ............o s. 35 Annex II: The Status of Bank Group Operations in Haiti....... 38 Annex III: Supplementary Project Data Sheet................... 40 Annex IV: Government's Letter of Recovery Policy.,*..,*,.... 42 Annex V: The Government's Program, the Economic Recovery Credit and the Proposed Project.................... 49 Annex VI: Public Investment Program, FY87.Y.................. 54 Annex VII: Project Cost Estimates and Financing Plan.......... 61 Annex VIII: Draft Terms of Reference: Public Sector Management 64 Annex IX: Draft Terms of Reference: Environmental Studies... 82 Annex X: Draft Terms of Reference: Industrial Restructuring and Deve lopment.......... me......eme.eosm......e. 87 UP Haiti (IBRD Map 17094R)  HAM TECHEIEAl ASSISTACR PROJECT Credlt and Project Summary Borrower: Republic of Haiti. hecuri AR4-enes` Ministry of Economy and Finance (MEY) and Industrial Development Fund (PDI). Amount: IDA credit of SDR 2.4 million (US$3.0 million equivalent). Terms: Standard IDA. Description: The main objectives of the proposed project are to strengthen the Government's capacity to liplement its Economic Recovery Program, develop a strategy to deal with Haiti's deteriorating environment and to assist manufacturing enterprises affected by the ongoing trade reforms. Its principal components would be: (i) public sector management support including assistance in the progrsmming, control and monitoring of public expenditure; (ii) studies to assess the degradation of Haitils natural environment; (iii) assessment and support of the restructuring and development needs of private industry to facilitate adaptation to recent trade reforms; and (iv) other related studies and technical assistance. Benefits: The project would strengthen the capability of the Government to impleaent the Economic Recovery Program and thus foster the restructuring of the Haitian economy toward the production of exports. Risks: Project implementation would be adversely affected by delays in appointment of consultants. However this would be mitigated by intensive IDA supervision and the appointment of a Ministry of Economy and Finance (HEF) Project Manager and a firm to handle administration for the Public Sector Management and Environmental Studies components, as well as by the hiring of an international consultant to assist with the startup and management of the Public Sector Management component. Agreement was also reached during negotiations to hire, by October 31, 1987, the consulting firm to undertake the in-depth studies for the Industrial Restructuring and Development component. Another project risk pertains to possible overestimation of the Initial  - iI - demand for technical assistance for restructuring and development by private industry, especially lf the Increased levels of contraband trade noticeable since September 1986 persist. Finally, there is a riak that the Government that will take office in February 1988 could fall to Implement the recommendations of studies financed under this project. However, the availability of well-prepared studies, useful for decision making, should help the new Government in developing its policies and would contribute to continuity of approach. Estimated Cost: Foreign Local Total ------(US$ 000)- Public Sector Management 930 240 1,170 Environmental Studies 180 26 206 Industrial Restructuring and Dbv. 1,211 766 1,977 Other Studies and Te hnical Assistance 82 15 97 Total 2,403 1,047 3,450 Financing Plan: IDA 2,403 597 3,000 Government and FDI - 315 315 Private industry - 135 135 Total 2,403 1,047 3,450 Estimated Disbursements: (US$ million) IDA Fiscal Year FY87 FY88 FY89 Annual 1.2 1.5 0.3 Cumulative 1.2 2.7 3.0 Appraisal eport: None. IBRD 17094R  INTNlUATIONAL DEVELOPMENT ASSOCIATION REPOLT AN1 RECIhEhIMTIOn OF TEE PRESIDENT TO THE KIECUTIVE DIRECTODRS ON A PROPOSED DEVELOPMENT CREDIT TO THE RNPULIC OF HAITI FOR A TECHNICAL ASSISTANCE PROJECT 1. I submit the following report and recomnendation on a proposed development credit to the Republic of Haiti for SDR 2.4 million (US$3.0 million equivalent) on standard IDA terms to help finance a Technical Assistance Project. PART I - TE ECONOMY 2. The assessment of the Haitian economy in this report is based largely on three documents already distributed to the Executive Directors and on the work of the appraisal mission (September/October 1986) for the proposed credit. Haiti: Policy Proposals for Growth (5601-HA) ias distributed on June 18, 1985 and Haiti: Public Expenditure Review (611341A) on October 5, 1986. The joint Covernment/IDA/IHF Policy Framework Paper for an IMF Structural Adjustment Facility arrangement was discussed by the Committee of the Whole on November 18, 1986. All three were also made available to the members of the Caribbean Group for Cooperation in Economic Development, whose Haiti Subgroup met in November 1986. Annex I presents economic data. A. Maiu Features 3. Haiti is a small, densely populated, predominantly rural, and open economy. Its 5.4 million people occupy 28,000 square kilometers, the western end of the island of Hispaniola, and are among the poorest in the world. Absolute poverty in Haiti is unmatched in the Western Hemisphere. Life expectancy at birth is only 53 years, the infant mortality rate is about 120 per 1,000 live births, over 25 percent of children suffer from second or third degree malnutrition and 27 percent die before the age of five; about 65 percent of adult Haitians are illiterate. Economic and social conditions improved in the 1970s, but the economy stagnated during the 1980s, unemployment increased, and real per capita income fell; in 1985, it averaged US$350 (Atlas basis), and half the laber force is unemployed or underemployed. 4. Three quarters of the population live in the rural areas, and ultimately depend on agriculture, historically the principal productive sector. Since the early 1970s, however, the volume and value of agricultural output, including exports, have increased little. Physical production per capita has fallen steadily as relentless population pressure  -2- has forced peasants to cultivate ever more margina; hillside land. Strernlous family planning efforts, largely by non-governmental organizations, have yet to show results. Only about 20 percent of the rugged, mountainous terrain is considered cultivable; nonetheless, aDOUt 30 percent is actually cultivated. The average farm size is below 1.1 hectdres. This shortage of land, coupled with insecurity of tenure and the demand for wood and charcoal for energy, has generated a vicious circle of deforesetation and soil erosion that hae further intensified the shortage. Declining rural Incomes have led to substantial rural-urban and international migration. The total population is growing at 1.8 percent per annum, net of emigration of 0.5 percent, while the urban population is expanding by four percent. 5. Past public policies in agriculture exacerbated the scarcity of land and the pressure of population. A million people on the hillsides depend on coffee, the major cash crop, expansion of which has been discouraged by an export tax. Reduced from 26 percent in the early 1980s, this tax was still about 22 percent in FY86, representing half the price received by the producers. Producer prices for foodgrains were increased to well above world prices by import restrictions. This fostered the cultivation of maize on the hillsides instead of coffee and worsened soil erosion. Cotton production was also discouraged by a producer price below the import parity price. Public agricultural investment and credit programs were occasionally targeted more to social relief than to stimulating either growth in productivity, output and employmcnt or effective soil conservation. On the plains, where agricultural potential is much greater than on the hillsides, irrigation systems lack operating and maintenance finance, and are silting up from the erosion on the hills; much State and private land is unexploited; and peasants practice highly risk-averse production patterns. 6. These agricultural problems have resulted in Haiti's increasing dependence on imported staples to satisfy basic food requirements. In FY85, food imports accounted for about 24 percent of all official merchandise imports, compared to 20 percent ten years earlier. Substantial and increasing quantities of contraband food, particularly rice, maize and sugar, are also entering the country. 7. In recent decades, output and employment have shifted toward urban activity, largely as a result of a scarcity of cultivable land and the establishment in the 1970s of a labor-intensive, export assembly industry. Agriculture now accounts for only one third of GDP compared with one half in the early 1950s. Gross national savings are very low, averaging only about five percent of GDP since FY80. This deficiency of savings, which is particularly marked in agriculture, leaves the economy reliant on external savings in the form of concessional aid to attain levels of investment consistent with sustained growth. The economy has become much more open; by 1980, the total value of exports and imports of goods and services had risen to about 50 percent of GDP.  - 3 - 8. Despite the expansion of manufacturing for export, the external payments position is weak; the export base remains narrow, leaving Haiti vulnerable to exogenous shocks. The aesembly Industry produces a very limited range of products--electronics, clothing, and sporting goods-yet accounts for over 50 percent of all exports; external factors, such as the 1980-83 world recession and the shakeout in the North American computer industry have contributed to the recent slowdown in this subsector. Coffee, which accounts for about 25 percent of exports, is particularly vulnerable to world price fluctuatlons and to hurricanes. Tourism has virtually ceased as a result of publicity concerning AIDS and the only bauxite mine closed in 1982, when deposlts were exhausted. 9. In the second half of the 1970s, economic growth, averaging 4.5 percent per annum, allowed for some Improvement in real per capita income. A basic physical infrastructure was established and education and health received attention, virtually for the first time since the 1930s. Prudent financial policies were pursued and foreign development assistance was substantial. The economy was virtually on a dollar standard, with the Gourde remaining at a fixed parity of five to the U.S. dollar, and prices were relatively stable. These conditions helped engender private sector confidence and promoted the continued rapid expansion of the export asseubly induitry, largely based on Haitian entrepreneurial talent. Although it has enjoyed tax holidays and other investment incentives, this subsector's primary advantage has been the freely determined structure of wages in Haiti. Until recently it was the fastest growing assembly industry In the Caribbean Basin; over 50,000 jobs were crested by 1980. In contrast, the private industrial subsector producing for the domestic market, which grew quickly in the early 1970s behind high walls of protection, quickly saturated this market and has stagnated for almost 10 years. There is little scope for this domestic subsector to expand into export markets without major restructuring. D. Developments, 7Y0" 5 10. From FY80-85 the public sector expanded its influence in the economy through higher rates of taxation, even higher levels of public expenditure--the control and allocation of which was seriously deficient--and an increase in the number of public enterprises. Waste and inefficiency became endemic. Extrabudgetary expenditures rose disturbingly, as did the level of corruption. New and inefficient public industrial enterprises were formed, resulting in real resource losses equivalent to almost four percent of GDP each year. Too much spending went to salaries and non-development purposes, not enough to non-salary operating costs; too little went for development, and the returns on public investment were very low or even negative. Transfers from the Treasury to the investment budget were partly diverted to meet salary payments in ministries without development functions, reducing the availability of counterpart funds for aid-financed projects. Per capita public spending on health declined by 45  - 4 - percent from FY80-86. The overall public sector deficit before grant. averaged over 10 percent a year (6.5 percent after grants). Public savings dropped to lees than one percent of GDP on average and recourse to nonconcessional financing, mostly Central Bank credit, increased to more than three percent of GDP on average. Thio in turn exerted heavy pressure on the balance of payments; official net reserves declined at an annual rate of US$22 million and had fallen to minus US$93 million by the end of FY85. Cross reserves had declined to less than three weeks' Import coverage. Payments arrears accumulated and a parallol foreign exchange market developed, with the Gourde selling at a discount which at times exceeded 20 percent. 11. The confidence of the Haitian people, the prtvate sector and the international aid donor community was eroded and the economy declined by an average of 0.6 percent per yrar from FY81-86, compared to the growth of the late 1970s. Per capita incomes In FY86 were 15 percent below those in FY80. There was increasing immiseratlon in the rural areas and emigration--the "boat people-increased. Starting In April 1984, there was intermittent civil unrest. The assembly industry stagnated since 1983. Employment in this subsector peaked at about 60,000 jobs but is estimated to have declined by around 10 percent since, mainly in response to political uncertainty and civil unrest. Donors expressed concern over inappropriate public investments, the lack of overall public investment priorities, and poor policies in agriculture and Industry. In the absence of a major overhaul of public investment, foreign aid declined from seven to five percent of GDP from FY83-85 and several donors allocated their aid away fror the public sector toward non-governmental organizations. 12. The Government's increased revenue demands on the domestic economy in the 1980s were met through rent-seeking pricing policies by public industrial enterprises that enjoyed trade monopolies. Together with the Intensification of import restrictions and of private production and importing monopolies, this inflated prices for basic consumer goods to well above world levels. The annual increase in constiner prices averaged eight percent in FY80-86, double that of Haiti's main trading partners. An outright ban on the importation of specific consumptlon Items was first introduced in 1981 and then replaced by an administered system of import licensing after 1982. Both trade restrictions and pricing policies created price distortions with neighboring countries, and encouraged contraband in imported consumption goods. PART II - THE 'S ECODNONC RECOVERY PROGARM, 7786-88 A. Political Background 13. Coming to power in 1957, President Francois Duvalier closed the economy, conducted an effective reign of terror, and ended all hope of progress until his death in 1971. His son and successor, Jean-Claude, began a limited modernization process. The economy became more open, foreign aid  - 5 - began co flow, and emigrants returned from the diaspora. The initial response of the economy was positive; by the late 1970s, as noted, it was growing at about 4.5 percent per annum. 14. The economic stagnation of the early 1980s, however, led to increasing political discontent. By late 1985, civil unrest was widespread and the economy was deteriorating rapidly; by early 1986, the situation was unsustainahle. The political system changed dramatically on February 7 with the sudden departure from Haiti of President Duvalier. A provisional National Covernment Council (CNG) came to power, pledged to hold elections and promote economic recovery. Civil calm was largely restored within a few months, although occasional disturbances continue. An electoral calendar has been established and so far followed; presidential elections are scheduled for November 1987, wlth a new Government taking office on February 7, 1988. B. Overall Strategy 15. The Government's intentions for the Haitian economy are set out In its Letter of Recovery Policy (Annex IV): to reform public finances and economic policies in order to hand over a viable, growing economy to its elected successor and to establish conditions from which retrogression to the inappropriate pnlicies of the past would be difficult. The essence of the program is to reduce the exploitation of the average Haitian, long impoverished by high consumer prices set to expropriate economic rents to beneflt former regimes. An attempt is thus being made to end the past system of privilege and monopoly. These actions are also intended to lead to more sustained economic expansion; the overall target of the Economic Recovery Program is GDP growth of at least 4.5 percent a year through improved exports and agricultural performance. This target is to be promoted both directly by the removal of impediments to efficient resource allocation, and indirectly by the impetus to higher capital inflows that these policies should generate. Central to this strategy is the need to rebuild the confidence of Haitian workers, farmers and investors, on the one hand, and foreign investors and aid donors, on the other. 16. The policy measures to achieve the Government's objectives are, first, macroeconomic stabilization and, second, the improvement of resource allocation through reform of taxes, public expenditure, public enterprises, competition and industrial incentives, and agricultural pricing and credit. These are discussed in subsequent sections of Part II; reform of the trade regime is a principal vehicle for many of them. The public sector's scope is to be reduced, and it is to be made more efficient. In addition, the Government is working to reduce external obstacles to Haitian exports. In September 1986 it successfully negotiated a major increase in the United States' import quota for Haitian textiles. If the new U.S. import ceilings are achieved, Haiti's export assembly industry could expand its output by some 45 percent and create 10-12,000 new jobs.  - 6 - 17. The present Government's Economic Recovery Program will not, of course, resolve lInitt's many severe development problems. Thin will take much more time than the short life of thrn Government, an it wall recognIzes. ThusNi ts program ln demlgne'd to pave the way for futtire development. 18. A longer term development striAtegy will hdve to be based on taiti's people; the couintry han ft'w nattiral reNourcets. laitie's comparative aidvantage lies In the development of urban industrial, export-oriented produetion; Its internatltonally competitive wage structure has already led to the establishment of the expor, assembly subsector, the most dynamic element of the economy. A development strategy based on human resources implies major investments in human capital, through Improved education and healthl. It also implies raising agricultural productlvity, productlon and employment, as the bulk of the lHaitian people will continue to depend on agriculture for nt least another generation. This in turn will necessitate alleviating the pressure of population on the land through the introduction of effective family planning and through migration from the hillsides to the plains and cities. The development of urban industry and of agriculture on the plains will require major improvements in Haiti's physical infrastructure--espectally its urban capital stock, its export facilities and services, and its irrigation systems--and in its deteriorating natural environment. C. Macroeconomic Stabilization 19. Performance in FY86. The public sector's financial position improved significantly in FY86. The year began in October 1985 with approval of a budget that called for a reduction in the overall public sector deficit (after grants) from 4.0 percent of GDP in FY85 to 1.7 percent; Central Bank financing was to be limited to 0.4 percent of GDP, compared with 2.2 percent in FY85 and 3.5 percent in FY84. When the present Government came to power in February 1986, the deficit and financing plan were broadly on track. The composltion of expenditure, however, was noticeably different from that budgeted as sound budgetary procedures were being ignored. 20. The Government took drastic steps to redress the budgetary situation. From February on, both expenditures and taxes were cut and a balanced budget was maintained, except for concessional financing. Many wasteful current expenditures and unjustified "development" projects, equivalent to some three percent of GDP on an annual basis, were eliminated. About half of the savings were reallocated to priority sectors (health, education, agriculture and internal security). The rest enabled excise taxes to be reduced on basic consumption items such as flour, sugar, vegetable oil, and petroleum products, and certain taxes, previously earmarked for special projects of the previous regime, to be eliminated. In total, current and development expenditure came to only 17 percent of GDP compared to the 23 percent foreseen in the previous Government's budget. 21. As a result, Haiti's financial situation improved substantially. In FY86 the public sector was able to make net repayments on its external commercial debt and to reduce the stock of debt to the domestic banking  - 7 - system. The overall public sector deficit before grants was 5.2 percent of GDP, compared to 7.5 percent in FY85; the deficit after grants was 1.0 percent of GDP. The reduction of the public sector deficit was accompanied by a marked improvement In the balance of payments. The current account deficit narrowed by two percent of GDP to 4.8 percent in FY86 and, after six years of deficits, the overall balance of payments registered a surplus of over US$20 million. The discount on the Gourde on the parallel foreign exchange market fell back sharply after July 1986 to about 5-7 percent. Inflationary pressures have also ended; the consumer price index fell by four percent from February to September 1986. 22. Objectives. The Government recognizes that without continued stabilization, the other elements of the recovery program will be ineffectual. It aims to reduce further its outstanding stock of nonconcessional debt, both external and to the domestic banking system; to generate overall balance of payments surpluses equivalent to almost 1.5 percent of GDP in FY87 and close to one percent in each of the following two years; and to keep inflation below about four percent, as in Haiti's main trading partners. The centerpiece of this effort is fiscal policy. The overall deficit (after grants) is expected to increase in FY87 to 1.8 percent of GDP from the low of 1.0 percent in FY86 and to remain close to this level in the following two years as higher levels of concessional financing are sustained. Assuming a favorable response of donors to its Economic Recovery Program, the Government will limit the overall public sector deficit, before grants, to about seven percent of GDP. The anticipated level of grants and concessional aid will more than finance this deficit, permitting the reduction of nonconcessional debt. Haiti's nonconcessional debt and liabilities to the IMF should decline sharply, falling by US$27 -llion or 16 percent in FY87 and by similar percentages in the following two years. The Government and the monetary authorities do not intend to contract or guarantee any nonconcessional external credit within the 1-12 year maturity range, other than the refinancing of arrears. 23. This fiscal stance will set a sound basis for monetary and credit policy by facilitating a reduction in the stock of Central Bank credit to the public sector. This in turn should allow an expansion in credit to the private sector without either jeopardizing the inflation objective or placing pressure on the balance of payments. 24. Program for FY87. In line with these broad objectives, the Government has established a continued stabilization program for FY87, supported by an IMF Structural Adjustment Facility arrangement which includes quarterly benchmarks for Treasury receipts and outlays, net financing of the public sector, and credit. 25. This program projects Treasury revenue at 10.2 percent of GDP, compared with actual collections of 11.5 percent in FY86. A similarly cautious approach has been followed in making budgetary provision for outlays financed with external cash grants. Although expectations are that these may be as high as G 180 million, for programming purposes grant disbursements have been set at G 140 million. The budget places a limit on Treasury expenditures of 11 percent of GDP, permitting it to run a surplus of G 40 million, which will be used to reduce Government debt to the Central Bank. The public enterprises are expected to make net repayments to the domestic banking system and reduce somewhat their indebtedness to external  commercial creditors. The overall public sector surplus (after grants) is to rise to G 60 million, from C 48 million in FY86. Including public Investment, overall public expenditure should recover to about 20 percent of GDP. 26. The Central Bank and the state-owned National Credit Bank will be subject to ceilings on their net domestic assets and on credit extended to the private sector. As a result, the Central Bank's net credit to the public sector will be reduced by two percent, while commercial bank credit to the private sector is projected to increase by 14 percent. The program also calls for an overall balance of payments surplus of US$32 million which will allow some reconstitution of net international reserves. External arrears, which stood at US$14 million at the beginning of the fiscal year, will be rescheduled or settled with cash payments by its end. By December 31, 1986, all first quarter benchmarks had been achieved. D. Tax Reform 27. Despite measures to overcome their sluggishness, including a value added tax introduced in FY83, tax revenues remained low, at around 10 percent of GDP, through FY85. Besides Haiti's poverty, several factors accounted for this. First, exemptions increased as part of industrial investment and export promotion. This increased the difficulty of assessing and collecting income taxes and customs duties. Second, the structure of these taxes was too complex with unrealistically high marginal rates. Third, taxes on agricultural exports, notably coffee, reduced farmers' incentives to expand output. Fourth, too much reliance was placed on a vast array of excises, fees and charges which depressed the buoyancy of the system. Fifth, and above all, evasion and fraud were increasingly widespread, largely reflecting the common perception that taxes were used to finance inappropriate public expenditures. 28. Starting in February 1986, the new Government embarked on a program of far-reaching reforms aimed at improving the equity of the tax system and increasing its respuasiveness to economic growth. The Government believes that evasion can be reduced by broadening the tax base, lowering rates and managing public finances in a transparent manner. The FY86 reform measures were relatively modest while more important ones were being prepared. As noted, excise taxes an consumption goods were reduced and certain taxes, mainly ancillary taxes on wages, previously earmarked for special projects of the previous regime, were eliminated. The revenue loss from these latter sources, estimated tentatively at G 70 million, represented a benefit for wage earners in Port-au-Prince and the other main towns. In addition, a variable excise tax was imposed on petroleum products to capture the difference between import costs and the domestic fixed prices. Finally, as discussed in Part I1.G, quotas on 76 imported goods were replaced with ad valorem tariffs. 29. More fundamental measures were adopted in early FY87. The export tax on coffee was reduced from 22 to 10 percent and other export taxes on cocoa and sisal were eliminated. The Government intends to eliminate the coffee export tax when overall revenue and expenditure performance has improved sufficiently. Also effective in early FY87, the income tax system  - 9 - was simplified, with fewer tax brackets, fewer exemptions, lower marginal rates, a greater degree of consistency between the treatment of individuals and corporations, and improved collection procedures, the latter including the dismissal of non-performing staff from the internal revenue service. Administrative procedures are also being improved, in particular by systematic cross-checks between income, value-added and trade taxes. In the longer run, the Government intends to replace most excise taxes by the value added tax. Finally, the Government implemented in early FY87 a further round of import quota and tariff changes, replacing quotas and specific tariffs with ad valorem tariffs, and intends to improve customs valuation and enforcement procedures. E. Public Expenditure 30. From a development perspective, there were two major resource allocation and expenditure control problems of the central Government before FY86. First, the four development-oriented ministries--agriculture, public works, education and health-suffered from inadequate non-salary operating funds. Agricultural extension workers could not get to the fields, irrigation systems were not properly maintained, schools were without furniture and books, and public health clinics without drugs. Since the internal efficiency of these ministries was low, the returns to existing private and public investments in their areas of responsibility were much lower than expected. The four ministries at the same time spent too much on salaries. They had recruited too many unskilled employees, largely for social or political reasons, and found it difficult to attract the skilled staff they needed because of relatively low salary scales compared to other parts of the Government. Fraudulent wage payments were also a serious problem, especially in education and health. 31. Second, the size and composition of the public investment program has been determined more by the availability of externally packaged and aided projects than by careful consideration by the Government of national priorities and domestic resources likely to be available as counterpart funds for these projects. The availability of foreign funds was consistently overestimated. In addition, local resonrces earmarked for investment included too many socially-oriented projects with low economic returns in terms of their contribution to output and exports; many represented disguised salary support. Shortages of local counterpart funds were therefore common during project implementation. Overall implementation of past programs never exceeded 70 percent of that forecast. During the first half of the 1980s, the public investment program also included inappropriate, resource-los'ng public industrial enterprises, as discussed in the next section. Among justified projects, too may suffered from insufficient technical design and poor implementation. In agriculture, public investments were not accompanied by necessary pricing and structural changes. 32. Reflecting these two problems was a complex system of planning, budgeting, monitoring and disbursing public investment, which provided numerous opportunities to divert funds. The situation regarding current expenditure was little better.  - 10 - 33. The present Government has embarked on a widespread program of reforms designed to begin to tackle these problems. Its aim is to manage public finances transparently, to reallocate current expenditure toward development-oriented ministries and the non-wage needs of development projects, while concentrating public investment on the consolidation and rehabilitation of existing and ongoing investments. These objectives are modest but well chosen, given the limited life of this Government. By February 1988, it should have achieved substantial results by comparison with the past, but much will remain to be done, especially in the complex and difficult areas of rationalizing public employment and establishing efficient procedures for planning, budgeting, disbursing and monitoring public expenditure. 34. FY86 Reform. After February 1986, Treasury expenditure, which is mostly current, was cut from an average monthly level of G 111 million to C 84 million. Expenditure for the political support of the former regime was eliminated; audits of several ministries and agencies identified wasteful expenditures. The public investment program was severely pruned; preliminary estimates indicate that only about 60 percent of the G 1,113 million forecast in October 1985 was actually implemented. In August 1986, the former Ministry of Planning was replaced with a more streamlined National Promotion and Public Service Commission (CPNAP), charged with improving the public investment program and, together with the Ministry of Economy and Finance, with examining development projects' recurrent financial needs. Finally, toward the end of the fiscal year, the salary question was addressed. First, wage payments were controlled in the education sector to eliminate fraud; the Government intends to extend this review to health and other sectors once the necessary staff and procedures can be put in place. Second, untaxed fringe benefits were eliminated. 35. During the last four months of FY86, the Government allowed Treasury expenditure to rise again to an average monthly rate of about G 100 million. The G 16 million increase on the average of the previous four months was intended to be used both for sorely needed salary increases and for operating supplies in the education and health sectors. This intention was, however, defeated. After teachers' and health workers' salaries were raised, Government employees elsewhere went on strike for commensurate increases. The end result was that the G 16 million was almost fully allocated to raising salaries, not only in education and health, where the functional need was greatest, but also in the armed forces and the departments of customs, internal revenue, agriculture, interior and justice. Very little was left for the purchase of operating supplies in education and health. The effect on the Government's wage bill was permanent. Resolving this problem is not feasible in the short term, however. The Government is considering establishing a mechanism at the highest political level to develop a policy to rationalize the public wage bill and public employment. 36. FY87 Treasury Budget. The Treasury budget for FY87 includes a cemplete allocation of expenditures, abandoning the practice of reserving large sums for unspecified programs; unallocated expenditures comprised almost one fifth of the FY86 budget. There will be no extrabudgetary Treasury spending and no transfers to public enterprises. The auditing program is continuing, including audits of both the Ministry of the Economy and Finance and of the Central Bank. Public sector accounting will be  - II - improved by monthly reconciliations of the accounts of the Ministry of Finance and the Central Bank. The current Treasury budget (i.e. excluding debt service and transfers to Investment) more adequately reflects the non-wage recurrent needs of development projects, particularly in education and health. These two sectors' share of total current expenditure has increased from 19 percent in FY86 to 32 percent. A lesser increase is provided for agriculture because of administrative constraints. Table 1 compares the FY86 and FY87 current budgets. Table 1: TREASURY BUDGETS, FY86 AND FY87 (C million at current prices) Ministry or Agency FY86 Budget FY87 Budget Percentage Change Education 98.3 161.6 64 Health 89.5 144.4 61 Agriculture 37.5 42.2 13 Public Works 77.3 78.0 1 Armed Forces 96.3 142.0 48 Other 589.6 385.1 -35 Current expenditure 988.5 953.3 -4 Debt service 324.4 236.7 -27 Transfer to investment 136.0 100.0 -27 Treasury expenditure 1,448.9 1,290.0 -11 Source: Ministry of the Economy and Finance. 37. The FY87 budget establishes a limit of C 676 million on wage payments to civil servants, compared to last year's G 561 million. This Increase not only reflects salary increases but also the reclassification of remuneration previously included in other budget categories or paid outside budgetary channels. The official figure for central Government employment in early FY86 was 32,400; the actual figure may well have been over 50,000, however. The Government intends to revies rhe staffing levels of all ministries and agencies; streamlining has already occurred at the Ministry of Economy and Finance, the internal revenue service and at CPNAP. 38. FY87 Public Investment Progra The size and composition of the FY87 public investment program were determined by the needs to meet the local counterpart requirements of projects and to consolidate and rehabilitate existing and ongoing investments. Unfortunately, the process began late and was rather disorderly. The attempt to do better than in the past was, however, genuine and by and large effective. The overall public investment program is estimated at G 1,140 million, to be financed by public savings (G 280 million) and concessional external aid (G 860 million). Likely disbursement; of project aid are still overestimated. However, considering both the increased level of overall public savings because of untied aid for budgetary support and improvements in project preparation and administration, actual disbursements may well result in an overall implementation rate of about 80 percent, or between G 900-950 million, consistent with the Government's macroeconomic stabilization target of a  - 12 - public sector deficit before grants of about seven percent. Table 2 summarizeb the sectoral composition and financing of the program and compares it with that for FY86. Table 2: PUBLIC INVESTRENT PROGRhN, FY86 AND FY87 (percentage shares) FY86 Program FY87 Program Total Program Cost (G million) 1,113 1,140 Financing Public savings 25.5 24.5 Concessional external aid 74.5 75.5 Sectoral Composition Agriculture 18.5 21.2 Industry, including mining 11.9 4.8 Electric power 15.0 12.7 Transportation a/ 10.5 12.2 Telecommunications 5.6 11.2 Urban development 5.4 6.5 Water supply 6.0 4.8 Education 5.8 7.1 Health 10.5 9.6 Other sectors 10-8 9.9 Implementation Rate (percent) 60.3 80.0 (est.) (proj.) Sources: CPNAP; Annex VI. a! Excludes proposed Cap Haitien airport project (para. 39) 39. Details on the sectoral composition of the program and the largest projects are given in Annex VI. In brief, agricultural projects concentrate on irrigation rehabilitation (including where necessary protection of associated watersheds), feeder roads and input delivery. Soil conservation and reforestation are maintained at financially sustainable levels and increasingl- linked to treecrop rehabilitation or expansion. There are no new irrigaAion projects in the program. Similarly, there are no investments to expand the capacity of public industrial enterprises, although there are some productivity enhancing investments at the public flour mill and cement factory. Projects to benefit industry are those which improve the physical infrastructure and public utilities serving the private sector. The transport data exclude a proposal to construct an international airport at Cap Haitien. This would represent at most two percent of public investment in FY87. No cost estimation or feasibility analysis has been carried out for this project, which has not yet started. The Government does not, however, intend to use any funds for this project other than those available to the National Airport Authority from one third of a G 75 user charge levied on air passengers, about G 5 million per year; no external concessional or commercial financing will be used. Development expenditure  - 13 - in the social sectors is concentrated heavily on the completion of ongoing projects in education, training and health, and on urban development and water supply. 40. On the financing side, Treasury development expenditures are almost exclusively devoted to meeting the counterpart fund requirements of foreign aided projects. All projects are financed exclusively with concessional external aid. The program is by and large appropriate for Haiti's development needs. In addition to this program, the Government has presented to external donors a list of 26 new projects proposed for external financing of G 217 million (US$43 million). These modest projects are within Haiti's absorptive capacity and will be added to the program as financing is secured. 41. The Government intends also to continue to strengthen the planning, budgeting and disbursing of public expenditure through improved procedures, These will include the elimination of fraudulent wage payments at the Ministry of Public Health and Population, the improvement of recurrent budgeting at the Ministry of National Education, and the preparation of the public investment program for FY88. This last will be based on a joint review with IDA staff of actual progress made in the first nine months of FY87 and of preliminary proposals for FY88, and will start much earlier than has previously been the custom. F. Public Enterprises 42. Policy toward public enterprises has undergone a radical change. There were in early 1986 five major public industrial enterprises: Entreprise Nationale des Oleagineux (ENAOL), a vegetable oil mill; two sugar mills, Usine Sucriere Nationale de Darbonne (USND) and Usine Sucriere du Nord (USN); Ciment d'Haiti, a cement plant; and La Minoterie, a flour mill. All five used to enjoy trade privileges which, in each case, protected grossly inefficient operations and enabled financial procedures inconsistent with sound business practices. Annual real resource losses were equivalent to almost four percent of GDP during FY82-85, a period in which the Haitian economy never grew by more than one per cent per year. In addition, the two sugar mills and the vegetable oil mill incurred heavy financial losses. To stem and eventually reverse this economic and financial waste, the Government has combined the closure and restructuring of enterprises with market liberalization and the introduction of financial monitoring. 43. ENADL. This enterprise, which produced semi-refined vegetable oil from oilseeds by crushing and solvent extraction, was never economic. Since beginning operations in 1981, it had a negative balance of payments impact of about US$16 million each year. The scale of the crushing and solvent extraction was too small to be economic; the plant also carried out second stage refining to fully refined oil, a process already amply catered for in Haiti through the existence of six other private refiners. 44. The mill was accordingly closed on July 31, 1986. The approximately 300 employees were offered either generous severance pay or the option to form a private cooperative to run the factory; about 60  - 14 - percent opted for the former, each receiving about nine months' salary. The remainder, Including most of ENAOL's previous managers, will lease the plant from the Government for 25 years at a nominal rent. If the cooperative is to survive, it will have to adapt to a highly competitive market environment: the Government has pledged not to grant It any subsidies, privileges or loan guarantees. Moreover, the market for vegetable oils has been liberalized: ENAOL's import monopoly was dissolved with the company itself; licencing requirements for importation have been eliminated, and a tariff of 20 percent has been imposed on vegetable oil Imports. 45. USND and USE. Until mid-1986. Haiti had four operating sugar mills, two private and two public. The two latter, USND and USN, operated at a loss despite the high price of US$0.24 per lb paid for raw sugar at the factory gate and the low price of US$13 per ton paid for cane. If prices and costs are adjusted to reflect long term international values, then neither mill is economically viable even under highly favorable assumptions concerning raw material supply and efficiency. USND was built directly by the state in 1982; the equipment was supplied on a turnkey basis at prices well above those prevailing on world markets. Capacity utilization has been low because of insufficient cane supply, while operating costs were inflated by a labor force of about 700, some four times as many as required to run the plant. 46. The USED mill was therefore closed in July 1986. The 700 factory employees were, Like those at ENAOL, offered the choice between indemnization and the formation of a cooperative to run the mill; all opted for the former, again receiving about nine months' salary. The plant would in any case have required between G 10-20 million of expenditure on rehabilitation and maintenance to reopen and could not have been operated for the FY87 harvest. Farmers in the surrounding Leogane plain, who ,reviously supplied the mill, can either sell their cane to the small nkrtisanal -guildives-, which use it to manufacture cane spirit, or to one of the private mills which used to purchase cane from the area before USND's establishment. This mill has both the necessary capacity and logistic support to absorb the Leogane crop. The Government is actively encouraging the planting of alternative crops, principally rice and vegetables, in the Leogane plain to supply the nearby Port-au-Prince market. 47. The case of USN is sore complex, since the plant is located in the north of the country, far from the main market and where technically and economically viable alternatives to cane are difficult to identify. Several thousand families depend for their livelihood on supplying or working for the sill. The Government will undertake a study of alternatives to cane, including improvements in watershed and erosion control which they might imply. In the meantime, to identify ways in which mill operating expenses might be reduced, the Government has ordered an independent audit of the company. 48. Cieant d'Eaiti. This company, 90 percent Government-owned, supplies most of Haiti's current consumption of cement, about 250,000 metric tons per year. Until recently, a licence was required to import cement and a  - 15 - speciflc tariff of G 300 per metric ton was levied, equivalent to over 100 percent ad valorem at current CIF prices. This gave the company a de facto monopoly on the production and legal importation of clinker, cement and by-products. The company was exceedingly inefficient: annual operating expenditures, net of taxes, were about US$83 per metric ton, some 66 percent higher than the estimated landed cost of Imported bagged cement. There were two main reasons for these high costs. First, personnel costs, at some US$17 per metric ton, were over twice industry standards. This was due both to excessive employment and high wages and salaries. The plant employed In September 1986 about 380 persons on a regular basis, plus a similar number of "temporary" workers, as against efficient industry standards of about 200. It paid unskilled workers more than twice what they would have earned in the private sector, while some managerial staff earned extremely high salaries. Second, energy consumption was high due mainly to the plant's antiquated power generating equipment. New equipment, which may take up to a year to order and install, will still only reduce costs by about US$8 per metric ton. 49. Options under consideration for Ciment d'Haiti include partial divestiture, and switching from the local production of clinker to its importation. The Government has approached IFC about the former. The latter would imply additional investments in storage and handling facilities, and perhaps also in port works, which would have to be subjected to detailed engineering studies. For any option for the plant's continued existence to be economic, it is essential to reduce personnel and administration costs, which amount to about 25 percent of total operating expenditures, and to subject the factory to competition from imports. As a first step, personnel were reduced by 12C by the end of January 1987, and a detailed plan to reduce the company': u;dge bill has been prepared in connection with an independent financial and management audit. Second, the cement market has been liberalized. Import licencing requirements have been lifted and a tariff of 33 percent placed on imports of bagged and bulk cement. 50. La Hinoterie, the Government-owned flour mill, has a monopoly over both the importation of wheat and the legal sale of wheat flour, except for specialized products directly imported by bakeries. Wheat cannot be grown in Haiti's climate. The mill has an effective capacity of about 2.8 million 100-lb bags of flour a year. Production has remained near this figure in recent years. La Minoterie has been financially profitable, but only because of a controlled price for wheat flour more than twice border parity. La Minoterie's declared operating costs appear to be about 52 percent above the border price for imported flour. However, while there are undoubtedly major operating inefficiencies and considerable overstaffing employment of some 1,200 in September 1986 was over ten times industry standards--the cost data on which this analysis was based is unreliable. A recent audit was unable to verify the company's financial statements, partly due to the non-observance of standard accounting practices, but mainly due to significant abuses. Large sums, in some cases totalling several million U.S. dollars, had been siphoned off from the company; moreover, cash management and purchasing and sales procedures were maintained in a deliberately disorganized fashion to facilitate the misappropriation of funds. Despite this, there is no doubt the mill could be run more efficiently aud economically in either the public or the private sector.  - 16 - 51. Privatization is under consideration, among other options. The Government changed the management team in October 1986 and separated the Board and the management. The new team, pledged to restructure the company, has engaged consultants to implement the key recommendations of the audit, including the preparation of a plan for wage bill reduction, the consolidation and reorganization of cash and bank accounts, the establishment of a cost accounting system, and the reform of purchase, production and sales procedures. By the end of January 1987, the wage bill at the mill had been reduced by some seven percent. 52. In addition the Government has liberalized the wheat flour market by revoking La Minoterie's monopoly on wheat imports. Import competition will encourage efficiency and facilitate continued supply of the market when demand increases above La Minoterie's current capacity. 53. Financial Monitoring. To improve its financial monitoring of all public enterprises, the Government has established a unit in the Ministry of Economy and Finance to review the enterprises' budgets, financial results and the execution of their programmed investments. All public enterprises will also be subject to regular, independent, external auditing. The objective of this more systematic financial monitoring is not to increase state interference in the day-to-day management of the enterprises, but rather to enable the state, as the shareholder, to ensure that the enterprises' operations are consistent with the wider aims of economic policy. C. Competition and Industrial Incentives 54. The dynamic export assembly subsector grew up without protection, though with tax holidays and other incentives. There has, however, been little linkage between it and the rest of the ecoromy, except through wages, partly because Haitian local industry has been so inefficient that its products are not competitive as intermediate inputs to the assembly subsector. 55. Starting more than 15 years ago, however, import-substitution policies followed by balance of payments constraints led to progressively higher tariffs and barriers to trade as well as to discretionary fiscal incentives for investment. The resulting trade regime created an incentive structure for industry producing for the local market that deterred competition, efficient production and exports. It also led to high domestic prices for many basic consumption items. There were export taxes on agricultural products, import quotas and licenses, high import tariffs, an overly complex and inefficient Customs system and staff, and a complicated adminkistrative structure facing any investor, exporter or provider of services to exporters. The arbitrary operation of the system provided further major disincentives to the establishment of efficient exporting industries. Industrial firms tended to rely on rents from the narrow, protected domestic market rather than investing to correct inefficiencies a  - 17 - and compete in the international marketplace. As a result, local industrial production is stagnant with excess capacity, obsolete equipment and low quality products sold at high prices. Tariffs as high as 180 percent combined with quantitative restrictions on imports resulted in effective protection levels averaging about 100 percent, with more than 10 percent of industTial production enjoying effective protection of over 300 percent. 56. Until mid-1986, more than 100 goods, most produced locally, were subject to import quotas and licencing. In addition, 25 were subject to price controls fixed by the Ministry of Commerce, mostly for monopolistic markets such as milk, soap, matches and fish. Import prohibitions affected several products, such as tomato paste, used cars and used newspapers. De facto import monopolies were enjoyed by the public industrial enterprises for vegetable oil, cement, sugar and flour. More than a dozen petty taxes were also levied on imports by the Customs service, each yielding less than G 500,000 per annum. 57. The Investment Code, revised and simplified in 1985, guarantees various domestic tax holidays and tariff exemptions on imported inputs or equipment to encourage new investments. As with the trade regime, these incentives did not stimulate the development of efficient industries but rather increased the protection of existing firms at the expense of fiscal revenues, consumer prices and the unemployed. While the assembly industry created over 40,000 jobs since 1975, local industrial employment stagnated at around 25,000. 58. The wide range of customs regimes could not be controlled by a weak Customs administration, already burdened with complex import documentation and procedures and afflicted by widespread corruption. Actual collected import duties bore only a coincidental resemblance to official rates. Total collections in FY86 corresponded to 12.5 percent of dutiable imports. As tariff rates rose, contraband increased; it is now virtually endemic. 59. To lower prices, reverse past distortions and stimulate the economy, the Government embarked in July 1986 on a thorough program to liberalize trade, stimulate competition and revise the incentive structure. Its objective is a stable, neutral incentive system to channel resources toward competitive rather than rent-seeking activities. The narrow domestic market means that industrial expansion has to be driven by exports. The Government is thus progressively reducing the average level of effective protection and harmonizing its distribution across sectors through various reforms. Lower tariffs will also be easier to collect than the previous complex system. 60. Quantitative Restrictions. In July 1986, the Government reduced the number of products subject to licensing, quotas or prohibitions from lll to 35. In December 1986, it abrogated the import licensing and quota law. No import monopoly remains in effect. Two products are restricted for sanitary reasons: used newspapers and used clothes. A new import licensing law, without formal ceilings, was introduced for seven agricultural products: rice, maize, millet, beans, sugar, chicken parts and porkmeat parts.  - 18 - 61. Tariffs. The quantitative restrictions removed in July 1986 were replaced by ad valorem tariffs averaging about 20 percent with a maximum of 40 percent. At the same time, specific tariffs were replaced with ad valorem ones or ad valorem tariffs were lowered for approximately 300 of the 2,000 tariff positions. In February 1987, following the abrogation of the remaining quantltative restrictions, the Government implemented a complete revision of the entire tarlff structure. All specific tariffs were replaced with ad valorem ones. With five exceptions (rice, maize, millet, flour and petroleum), rates range between 0 and 40 percent. Their application takes Into account the ending of quantitative restrictions. Exemptions allowed by the Investment Code will be ended by December 1987. Medical supplies and agricultural imports are exempted. 62. The cascading of the rates followed a physical input/output rule rather than the necessities of the existing industrial base to avoid as far as possible ex ante negative protection or sectoral biases. CDosumer and final goods are subject to a maximum rate of 30 percent whereas equipment, raw materials and some inputs are subject to 10 percent. A 5 percent rate was used to provide a little protection to locally produced essential intermediate goods (such as packaging, cans, and metal working) without overburdening downstream industries. The targeted average tariff rate is 20 percent. 63. The level of effective protection for existing firms has been drastically reduced by these measures from an average of over 100 percent to below 40 percent; 95 percent of industrial firms now have less than 60 percent effective protection. The state of Haitian trade statistics and customs data and the prevalence of contraband make it impossible t) predict accurately the likely impact of the trade regime changes on either the balance of payments or fiscal revenues. Insofar as lower protection should discourage contraband, however, both recorded imports and fiscal revenues may well increase. 64. In addition to these major changes, the Government is streamlining the various Customs procedures and rationalizing petty taxes on trade. Import notifications are now processed quickly and automatically at the Ministry of Couerce and Industry. Customs clearance procedures are being simplified. Further institutional strengthening of the Customs will, however, be necessary. An administrative charge of one percent of CIF value has been extended to all imports except pharmaceuticals and petroleum to cover the costs of an independent, foreign firm that Is responsible for import verification. Petty taxes on imports and exports will be eliminated by the end of FY87. The maximum tariff for imports from non-GATT countries is being reviewed. 65. Investment Code. The Government intends to revise the Investment Code to harmonize with the above measures. In particular, general exemptions of import duties will no longer be available and existing ones will be progressively eliminated. Eligibility criteria will be neutral in terms of sector, years in business, value added content and market shexe.  - 19 - 66. Price Controls. The Ministry of Commerce aind Industry has elimlnated its price control office. Price controls remain in effect for very few products, notably sugarcane. sugar and petrolcum products. 67. Export Promotion. The Government Is also reducing the bias against exports. Taxes on agricultural exports are being progressively reduced (Pert I1.H). In addition to the revised Investment Code, the Government intends to implement an endorsable drawback system by the end of 1987 to reduce anti-export bias. Export promotion is being Btepped Lip and, as noted, a new textile agreement has been reached with the United States. 68. Restructuring Asslstance. The Government is making available both technical and financial assistance to industrial firms that wish to restructure to operate in the new incentive envi:onment. The Industrial Development Fund (FDI) has been charged with this responsibility; a program of technical assistance has already begun, offering diagnostic surveys to enterprises to advise on priority areas for restructuring and following this up with detailed consulting services and credit to finance new investments. B. AFiculture 69. The stagnation of agriculture, its declining ability to satisfy minimum nutrition requirements, and the loss of non-renewable natural resources (Part I), are major preoccupations of the Government. Half the mountain land, which accounts for 60 percent of Haiti's total area, has a slope greater than 400 and is suitable ecologically only for forest cover. Nevertheless, much of the forest has been removed for energy and to permit cultivation. Farm technologies are rudimentary. The topography, small size and scattered location of most farm plots offer little scope for mechanization. Investments such as reforestation and terracing are logistically difficult, because of the priority given by farmers to food crops, the insecurity of tenure in many places, and the sheer inmensity of the erosion problem. The lowland plains represent about 15 percent of the total land area; 90,000 ha are irrlgated. Most systems are in disrepair, however, as a result of inadequate operation and maintenance. Watershed protection is virtually nonexistent, leading to the siltation of irrigation channels after heavy rains. 70. Overcoming Haiti's agricultural crisis will take much time and investment. Referas should aim at increasing productivity, production and exports; improving nutrition; preserving non-renewable resources; increasing fiscal revenues; and lEproving equity. The present Government has made a determined start In addressing problems of pricing, policy-induced rents and deficient public services to agriculture. Much remains to be done, however, for many years to come. 71. Pricing. Prices have been affected by four major Government interventions: (a) prices and tax levels established at food processing plants for wheat, sugar aud vegetable oils (Part II.F); (b) export taxes; (c) quantitative import restrictions and tariffs; and (d) administered  - 20 - farmgate prices for sugarcane and cotton. Their combined effects have been to tax agrlcultural producers--mostly in coffee, sugarcnne and cotton--and consumers--mostly in sugar, wheat flour, rice and vegetable oils. 72. Despite coffee's comparative advantage over maize and sorghum, it has been subject to an export tax of around 25 percent of FOB prices. lPrices of maize, sorghum, rice nnd wheat flour have hovered in receont years At some 20-30 percent above Import prices btcause controls resulted In negligible imports of the first three while La Minoterie required high flour prices for financinl viability and the extraction of rents. By August 1986, farsgnte prices for maize were around 100 percent higher than CIF Import prices, 30 percent for rice and 40 percent for wheat flour. Those policies--of supporting" grain and flour prices above world levels and suppressing coffee prices below world levels--have had negative results. In the competition for scarce hillside land, many farmers have replaced their coffee trees with maize and sorghum, exacerbating soil erosion. 73. The previous Government made a hesitant effort to deal with the coffee export tax, reducing it to about 22 percent by 1985. It also eliminated the 5 percent export tax on essential oils in 1985. The present Government has moved more forcefully, reducing the coffee export tax to 10 percent, and eliminating the export taxes on cocoa (6%) and sisal fibre (G 1.25 per 100 kg). Provided overall revenue and expenditure performance remain satisfactory, the Government intends to eliminate entirely the coffee export tax by the end of FY87. 74. The Government reduced the excise tax on wheat flour in February 1986, has permitted wheat flour imports, and has replaced import quotas with import licensing restricted to seven products: rice, maize, millet, beans, sugar, chicken parts and porkmeat parts. Even before this, domestic grain prices fell substantially in the second half of 1986, following the unprecedented decline in international prices (and pervasive contraband) and possibly the strengthening of the Gourde on the parallel foreign exchange market. The Government also intends to free the producer price of cotton. 75. Policy-induced rents. Past Government policies for State lands created rents for a privileged few, rather than capturing them for the fisc. Substantial areas of public lands were leased at nominal rates to influential individuals, who in turn subleased them to small farmers or sold the leaue rights, both at market rates. The law provides that annual rents on State lands are to be assessed at six percent of the fair market land value. Yet most primary leases have been assessed at G 15-60 per ha, compared to fair market rental assessments of G 250-2,000. The Government is thus foregoing some G 100-200 million per annum in revenues. The Government intends during FY87 introduce a scheme to raise rents on all new and renewed leases according to the fair market value of the land. 76. Credit. Only 10-15 percent of the rural populatipn has access to institutional credit. Past primary sources have beea the Agricultural Credit Bureau (BCA), which lends mainly to smallholders, and the National Bank for Agricultural and Industrial Development (BNDAI), which has been  - 21 - geared to medium and large farmers engaged in capital-intensive production, notably of irrigated rice. 77. The loan portfolios of both credit agencies have deteriorated. According to a recent audit, BCA had 6,470 borrowers in August 1986, many associations each averaging 10 farmers, and a portfolio of G 52 million, 50 percent in arrears. An audit of BNDAI is also underway; arrears on its portfolio rose from around 45 percent in mid-1985 to 70 percent a year later. Most of BCA's and BNDAI's arrears are considered uncollectable. During FY87, the Goveinment intends to close BNDAI and will, with assistance from the Inter-American Development Bank, establish a new agricultural credit bank, to Jlclude BNDAI's performing agricultural portfolio. I. Economdc, Environmental and Social Impact 78. Economic Impact. The Government's Economic Recovery Program, especially the elimination of financial imbalances and price distortions, is having its intended effects. As discussed above, the public sector's affairs are new more transparently managed, it has reduced its stock of nonconcessioral debt, the balance of payments is running an overall surplus, the discount on the Courde on the parallel foreign exchange market has declined significantly, and consumer prices have dropped. Assembly industry exports, which fell in the second quarter of FY86, have picked up again. Confidence is returning and should continue to increase, so long as there is reasonable political stability. The endorsement of the program by external donors and the IMF has also provided a powerful boost to confidence, stimulating private investment and aid flows. 79. Resources have been freed by the reduced burden of public enterprises and the more effective management of a leaner public sector. In the medium term, the public investment program should yield higher returns, though time and major reforms are still needed. The elimination of the coffee and other export taxes, the raising of rentals on State lands, and the reorganization of credit should help to sustain agricultural growth. Furthermore, as commerce becomes less attractive relative to production--as trade liberalization reduces opportunities for rent-seeking activities--Haitian industrial entrepreneurs car be expected to produce more efficiently for export or to supply the export assembly industries. Above all, the consumer will benefit from the reduction of economic rents and the fall in prices of basic consumption goods. 80. Haiti's economic prospects, like those of most small countries, also depend heavily on ti.a external factors: market access and international prices for its exports, and the flow of concessional aid. While the first is largely beyond the Government's control, the second is directly linked to the policies it pursues, as the experience of the early 1980s demonstrated. Table 3 summar4zes projections of economic indicators through FY90 for two cases, with and without the Economic Recovery Program; uncertainty about political developments after February 1988 necessarily makes them very tentative after FY88.  Table 3; ECONOMIC PROJECTIONS WITH AND WIThOUT RECOVERY PROGRAM (percent) Average Annual Growth Rate Share of GDP at Market Prices (Z at constant price.) CZ at current prices) FY76-51 FY81-86 FYS5-90 FY55-90 FY76 FYSI nYSB 7Y90 FY9 WLth Without (eSt.) With Without Progran Program Program Program Gross Domestic Produict 3.4 -0.6 4.6 -0.8 100.0 100.0 100.0 100.0 100.0 Agriculture 0.8 -16 5.5 -0.7 38.4 33.8 32.1 33.2 32.2 Indtstry 6.2 0.2 5.1 -1.0 19.4 22.2 23-0 23.4 22:S Other 4.3 -0.2 3.7 -0.8 42.2 44.0 44.9 43.4 45.0 Consumption 3.9 -1.2 4.4 0.6 93.1 98-3 93.9 93.7 100.1 Cross Domestic Inveatment 6.3 -3.7 13.9 -3.1 15.8 16.9 12.1 17.0 11.0 PLibI Lc 9.7 -9.8 15.4 -1.' 9.5 11.9 6.2 9.1 6.0 Privae 0.1 -4.6 12.4 -5.0 6.3 5.0 5.9 7.9 5.0 Exports of CNFS 3.2 0.1 4.4 0.9 16.8 16.8 13.8 13.7 14.6 Coffee 4.9 -0.3 7.1 4.7 5.0 2.2 2.6 2.1 2.3 Other Agricultural Coods ,. .. 2.7 0.5 2.5 2.0 1.5 1.4 1.6 Assembly Industry 6.2 - 2.8 5.4 5. 5.6 5.3 Imports of CNFS 6.8 -4.4 9.5 5.3 -25.7 -32.0 -20.3 -24.4 -25.7 I Gross National Savings -32.2 -7.8 14.5 -69.2 6.1 0.7 4.9 7.2 4.6 Balance of Payments Current Account -6.5 -11.3 -4.8 -5.8 -6.6 Public Sector Deficit a/ -7.6 -12.9 -5.2 -6.0 -10.0 Debt ServiceIODP Including IMF 1.2 1.7 3.4 1.3 1.6 Excluding IMF 1.2 1.4 2.3 1.0 1.2 Debt BervicelEaports of Goods I NFS Including IMF 6 9 9.9 24.4 11.0 12.5 ExcludLng IMF 6.9 8.4 16.4 8.2 9.3 aI Sefore grants. 12-Dec-86  - 23 - 81. The With Progra, case assumes improved allocative efficiency and the restoration of confidence among both the private sector and Haiti's external aid donors; details of the projection are included in Annex I. Macroeconomic stabilization would remain effective and GDP could grow at an average annual rate of 4.6 percent in FY86-90. Lower input and consumer prices resulting from the reform of the trade regime would stimulate the economy while domestic industry would restructure in line with the new Incentives and would, by the end of the period, start to increase its exports. Subsequent growth would be fueled by new investment, restoring investment's share of GDP to the level of the early 1980s but with a much greater proportion coming from the private sector. Public investment could rise from about six to about nine percent of GDP, financed by increased aid flows, and would become more efficient, being focused on the rehabilitation and expansion of the existing capital stock; the neglect of maintenance would slowly be overcome with the provision of more adequate recurrent funding. By FY90, the public sector deficit before aid could be about six percent of CDP, financed entirely with concessional aid. 82. Export growth and foreign aid would finance the increased imports resulting from increased investment and trade liberalization. The current account deficit would widen slightly from the artificially low FY86 level but could be easily financed by foreign aid. Reserves would begin to increase and should turn positive during FY87 for the first time since FY80. Assembly industry exports could expand by over six percent per annum in FY86-90 due to restored confidence and the new textile agreement with the United States. Coffee production would ride the peak of its agronomic cycle in FY87 and FY88, benefiting also from relatively high world prices, and the reduction and elimination of the coffee export tax would promote replanting and sustained export growth averaging seven percent per annum. 83. The Witbout Program case, by contrast, would be characterized after FY87 by a return to the ineffective policies and zero growth of the early 1980s. This is not likely in FY87 because of the anticipated coffee crop and the relatively high levels of aid promised at a November 1986 meeting of the Haiti Subgroup of the Caribbean Group for Cooperation in Economic Development. Despite good coffee yields and prices in FY87, agricultural production would weil fall because price disincentives would remain and rehabilitation of neglected irrigation systems would not occur. Local industry would continue to stagnate in the small protected domestic market, and assembly industry confidence would likely flag. Public investment and non-wage recurrent spending could very well be crowded out by popular pressure for public sector wage and employment increases. Increased public sector employment would become an obstacle to more effective public administration and would offset restructuring efforts at public enterprises, which would again become a major drain on the economy. The public sector deficit would widen, perhaps to 10 percent of CDP, and external concessional aid would be inadequate to finance it because policy-based external aid, which accounts for some 30 percent of projected aid inflows in the With Program case, would be lost and project aid disbursements would lag. The deficit would be financed by Central Bank credit which would lead anew to financial disequilibrium, inflation and a loss of confidence. Private investment could drop back to the very low level of FY81. While exports would stagnate, imports would continue to increase, likely provoking  - 24 - a balance of payments crisis and the continued loss of reserves. Such a collapse of the Economic Recovery Program would not only leave the economy in recession, it would undermine the basis for future growth. 84. Neither case considers the exchange rate. The Government considers it of paramount importance to maintain the fixed parity of five Gourdes to the U.S. dollar. In the transition to new democratic institutions the Government judges that the preservation of this rate provides a firm anchor for fiscal and monetary policy in the imediate future. Moreover, in the late 1970s this fixed exchange rate regime, together with the pursuit of prudent fiscal and credit policies, created a climate of confidence which led to the establishment of the assembly industry. For several years beginning in 1979, the link with U.S. dollar led the Gourde to appreciate in real effective terms against the currencies of Haiti's main trading partners. This had little effect on Haiti's export performance because the domestic wage structure remained largely market-determined and highly competitive. Recently, as noted, real wages have increased as prices have fallen, without affecting Haiti's international competitiveness. Indeed, aside from protection, the principal obstacle to expanded exports has been market access, a situation now improved with the new U.S. textile agreement. Horeover, the recent depreciation of the dollar against other major currencies has brought about a decline in the real effective value of the Gourde of over 10 percent during the last 12 months, offsetting to an important extent the earlier rise. However, the Government recognizes that its commitment to trade liberalization while maintaining a stable exchange rate implies the maintenance of demand management policies to avoid excessive growth in imports. 85. Envilronmentnl Impact. The reduction and ultimate elimination of the coffee export tax should increase the incentives for hill farmers to maintain and replant soil-binding coffee trees and decrease those to grow crops like maize that contribute to erosion. This shift in relative prices will be complemented with several programs, financed with external aid, to improve coffee yields and promote reforestation. 86. Social Tupact. The immediate adverse social consequences from the program affect the employees of public enterprises that are shut or restructured, and for some employees of private industrial firms that may not prove viable once protection is reduced. These direct consequences will be more than offset by resulting benefits to Haitians as a whole, especially the very poorest members of the society. 87. Severance pay of about nine months salary has been provided to employees of the ENAOL and USND factories. According to a recent study, less than a dozen of the approximately 200 industrial firms producing for the local market (averaging 90 employees each) may find it difficult to survive the reforms of the trade regime. These are largely firms whose products are not economic in the Haitian context, such as milk processing, metal working and packaging. Technical and financial assistance would be available to facilitate the restructuring of the vast majority of firms that are not at present competitive internationally but have the potential to be so.  - 25 - 88. Against these negative social consequences, there are five major social benefits from the Economic Recovery Program. First, real resources equivalent to some two percent of GDP are being released by the reform of public enterprises for investment in productive activities and the creation of productive employment. Second, the reform of these enterprises, the reduction of excise taxes, and the reform of the trade regime have already lowered the cost of living for the Haitian consumer, particularly the poorest, without hurting farmers, especially as prices of basic consumption goods fell; the retail price of vegetable oil has dropped by 40 percent since February 1986 and that of flour by 11 percent. Decreases may also be anticipated in the price of cement and hence in the cost of construction. Lower consumer prices not only improve welfare, especially of the very poorest, they raise real wages and so reduce the pressure to increase wages and help maintain Haiti's international competitiveness. Third, small scale industrial enterprises now stand to benefit from the advantages, such as low tariffs on inputs, that larger firms have enjoyed in the past; the trade reform thus eliminates many monopolies and barriers to entry. Fourth, the program should increase the income of over a million people who depend on coffee as their principal cash crop and should result in the encouragement of new directions for farmers locked into the vicious poverty circle of sugarcane production. Fifth, equity will be improved by the reform of the income tax, especially by stepped-up collection efforts and by the capturing of former private rents through the trade regime reforms and the raising of State land rents toward market levels. PART III - THE PROPOSED PROM=C A. History 89. The proposed project would support the Government's Economic Recovery Program and complement IDA's Economic Recovery Credit (Report No. P-4411-HA), approved by the Executive Directors on March 24, 1987. It was prepared during an intensive dialogue with the Government since May 1986, based on IDA's economic, public expenditure and agricultural reports. Appraisal was completed in October 1986 and negotiations were held in Washington, D. C. between March 23-27, 1987. The Haitian delegation was led by Mr. Leslie Delatour, Minister of Economy and Finance. Annex III is a supplementary project data sheet. B. Objectives 90. The proposed project has three objectives. First, it aims to strengthen the Government's capacity to carry out its Economic Recovery Program, including several of the actions agreed as conditions of release of the second tranche of the IDA Economic Recovery Credit. Annex V shows the relationship among the Government's Program, the IDA Economic Recovery Credit and the proposed project. Second, it would develop information about and help develop a strategy to deal with Haiti's deteriorating natural environment. Third, it would assist on a priority  - 26 - basis those private manufacturing enterprises affected by the reform of the trade regime to take appropriate measures to raise their productivity and be able to produce at internationally competitive prices; it would also assist private firms willing to develop export activities and otherwise interested in improving performance. C. Descriptlon 91. Three principal components would correspond to the objectives above. A Public Sector Management component would strengthen the Government's implementation of its Economic Recovery Program and the progrmming, control and monitoring of public expenditure. An Environmental Studies component would assess the degradation of Haiti's natural environment and propose policies and investments to improve It. An Industrial Restructuring and Development component would help manufacturing industry adapt to the new set of incentives that are now in place following the trade regime reform. In addition, a very small fourth component would finance studies and technical assistance still to be determined. 92. Public Sector Management (US$1,170,000).. The project would finance technical assistance in several areas of the Government's Economic Recovery Program. A full-time macroeconomic adviser would assist the Minister of Economy and Finance with macroeconomic management and in developing a training program for relevant staff; draft terms of reference are in Annex VIII.A. Under the guidance of a visiting senior adviser, a program of assistance, training and purchase of computer equipment would be implemented in the Ministry of Economy and Finance (NEF) and the National Promotion and Public Service Commission (CPNAP) to improve the programming, monitoring and control of public expenditure. The senior adviser would provide assistance with development expenditure budgeting, current Treasury expenditure budgeting, end the public sector wage bill. A full-time senior project economic adviser would help improve development project selectlon and monitoring. Draft terms of reference for these public expenditure consultants are in Annex VIII.B. In addition the project would finance the expansion of MEF's mini-computer capacity and also microcomputer hardware and software for CPNAP. An advance from the IDA Project Preparation Facility has been extended to the Government to permit the purchase of a new mini-computer and the early installation of the macroeconomic adviser and the senior project economic adviser. 93. Closely linked to the public expenditure subcomponent would be a study of public service employment and pay designed to assist the Government reorganize and make more effective the civil service; draft terms of reference are in Annex VIII.C. Assistance would also be provided to the new MEF unit charged with the financial monitoring of public enterprises; Annex VIII.D contains draft terms of reference. A limited amount of consulting services would aid the Government decision-making on the electric power plant and on other aspects of the restructuring of Cinent d'Haiti; terms of reference would be agreed with IDA. Consultants would advise on the introduction of a trade drawback scheme to complement the refonm of the trade regime; draft terms of reference are in Annex VIII.E. In agriculture, consultants would advise and  - 27 - assist with the introduction of a scheme to raise rentals on State land. and would study'alternatives to sugarcane production in the Flamne du Nord, the area around the uneconomic USN sugar mill (Annex VIII-F and G). The entire Public Sector Management component would be managed by MEF, working closely with CPNAP and, where applicable, the Ministries of Commerce and Industry and of Agriculture and Rural Development. To assist initial implementation and subsequent operation of this component, the Government will hire an international consultant to aid MEF In project startup and management and in the selection of consultants. The hiring of the international consultant is a condition of effectiveness of the proposed Credit. Approximately 74 staffmonths of consultant services would be required, with all work to start as soon as possible and be completed by June 1988. 94. EHvironmental Studies (US$206,000). The project would finance a study designed to assess the extent of land degradation in Haiti and recommend lnterventions to arrest and reverse it, using an approach which integrates environmental and natural resource management directly Into economic and social policy. The results should provide pollcy options and specific investment proposals to the Government, the latter of potential interest also to external aid donors. This study would be managed by NEF with extensive collaboration from other relevant ministries, particularly the Ministry of Agriculture and Rural Development. Approximately 18 staff- months of consultant services would be required; the study should take 6-9 months to complete. Annex IX contains draft terms of reference. 95* Industrial Restructuring ad DeRelopment (US$1,977,000). This project component would finance: (a) additional operating costs of the Industrial Development Fund (FDI) to provide technical assistance to identify restructuring and development needs of private industrial enterprises-this will include hiring additional contract staff (market specialist and a production engineer), increased administrative expenses and a two-year extension of the existing contract of a consultant to the FDI management; and (b) outside consultants who, with FDI coordination and support, would diagnose and prepare restructuring and development plans for the enterprises that wish to obtain such assistance. Following the Government's reform of the trade regime, FDI has initiated a media campaign to inform Industrial enterprises of the services it can provide. In addition, it has contacted selected enterprises most likely to be affected by the trade reforms to obtain direct knowledge of the problems they face and ascertain if they would be interested in technical assistance. 96. The first phase of such assistance would consist of a diagnosis, provided free of charge, designed to assess an enterprise's strengths and weaknesses and to indicate functional areas where an in-depth study is warranted. This phase would be conducted by FDI staff and outside consultants and last a total of up to four months. About 80 of the 200 enterprises manufacturing for the domestic market have requested a diagnosis. This diagnostic phase has already started, with financing from the IDA Project Preparation Facility. On the basis of the diagnosis, consultants would proceed for each firm that so wishes with an in-depth analysis of identified problems and develop a restructuring plan for the enterprise's consideration. Such a plan might include financial restructuring and divestiture; changes in products and/or activities; changes in the scale of production; product quality improvement; technical rehabilitation or upgrading; reorganization of the production process;  - 28 - changes in management structure; formulation of new marketing strategies; and employee training. FDI would manage this component which would require approximately 45 staffmonths of consultant services and last 12-15 months through 1988. Annex X contains draft terms of reference for these two phases. 97. In order to help enterprises finance the in-depth studies, a Technical Assistance Fund (TAF) would be established within FDI. The TAF would be simply a separate account of FDI used to finance up to 80 percent of the costs of individual in-depth studies contracted to outside consultants, the enterprises providing the balance of the financing to FDI. FDI would select the consulting firm that would carry out the In-depth studies and would sign with them, before October 31, 1987, a contract Indicating the type of assistance to be provided to the firms. In addition, FDI has agreed that it would sign, with each individual enterprise, a contract which will specify, among other requirements, that the firm will pay 20% of the study cost to FDI before such study is started. The 80% part of the cost of the study advanced by the TAF would be refinanced from future FDI subloans for investment projects in the event the restructuring or development plans result in investment loans. These requirements will be specified in the agreements to be signed between FDI and the enterprises. The TAF would be established as a revolving account for a duration of five years. If there were no subloan, the cost of an individual in-depth study would be absorbed by the TAF and by the enterprise. Agreement has been reached that, as a condition of disbursement for the In-depth Study subcomponent of the Industrial Restructuring and Development component, the standard contract to be signed with each enterprise would have been approved by the Association. In addition, FDI has agreed that it will not authorize in-depth studies in any enterprise unless the respective contract (providing for the 20Z advance payment and the eventual replenishment of the TAF) has been signed. 98. In addition to these elements, this component of the proposed project would also refinance advances under the Project Preparation Facility for its preparation and initiation and for a study of industrial incentives. The incentive study, now completed, was an input to the Government's reform of the trade regime. 99. Other Studies and Tecbnical Assistance (US$97,000). During preparation of this project, the Government expressed interest in receiving assistance in other related areas of economic managemeat, including special studies of the financial sector, the scope for cotton and textile development and the improvement of economic and social statistics and the national accounts. Broad outlines of these other studies and their relationship with the proposed project were discussed during negotiations. The Government has indicated that it will send specific proposals to the Association by July 1, 1987. Additional technical assistance to support the other components of the project could also be undertaken. This would be done upon mutual agreement between the Government and IDA on the priority of the proposed technical assistance, its specific objectives, the scope of work involved and the expected output.  - 29 - D. Implewntation and hduinistratlon 100. HEF would be responsible for administering the Public Sector Management, Environmental Studies and Other Studies and Technical Assistance components. It would coordinate as appropriate with other involved ministries, notably those of Commerce and Industry, Agriculture and Rural Development, and with CPNAP. In view of the complexity of these three components of the proposed project and the large number of consulting contracts they would generate, the Government has agreed, as conditions of effectiveness, to appoint a NEF Project Manager with qualifications and experience acceptable to IDA and to hire an international consultant to assslt HEF in project startup and management and in the selection of consultants. The Government has also agreed that as a condition of disbursement for these components, it will hire a firm acceptable to IDA to act as agent for the ministry in the hiring of consultants and the servicing of their contracts. 101. The Central Bank_/ acting through FDI would be responsible for providing and administering the technical assistance for Industrial Restructuring and Development. The Government would transfer the Industrial Restructuring and Development component of the proposed Credit to the Central Bank for FDI use as a grant and assume its repayment to IDA. It has been agreed that the contract providing for such transfer would be signed as a condition of disbursement of this component. FDI was established in 1981 as a special fund in the Central Bank, to provide medium and long-term financing for private industrial enterprises. IDA extended to Haiti for the benefit of FDI a first Industrial Credit and FDI has proved competent and dynamic. Consultants contracted by FDI would assist it in carrying out the diagnostic phase and would undertake the in-depth studies and prepare project proposals for enterprise restructuring and development. 102. The Public Sector Management and Environmental Studies components are expected to be completed by mid-1988; the Industrial Restructuring and Development component by end-1988. The Project Manager and the Director-General of FDI would send to IDA quarterly progress reports. In addition, progress would be monitored by IDA through regular supervision missions. These would be relatively intense initially to ensure that the project gets off to an effective quick start and, in particular, that the Public Sector Management sub-components are underway which are essential for successful implementation of the second tranche release conditions of the Economic Recovery Credit. The project is expected to be completed by December 31, 1988. E. Cost and Fin^aning 103. The total project cost, net of taxes and duties, is estimated at about US$3.5 million with an estimated foreign exchange component of US$2.4 million (Annex VII). The proposed credit of US$3.0 million would finance all of the estimated foreign exchange cost of the project and 57 percent of local costs. It would include the refinancing of two advances from the 1/ Banque de la Republique d'Haiti.  - 30 - Project Preparation Facility of US$0.5 and US$0.7 million. Contributions from the Government and FDI in the form of counterpart staff, offices and logistical support (US$0.3 million) and from private industry (US$0.16 million) would finance the rest of the project. Nb price contingencies have been included in view of the short expected life of the project. Other contingencies could, If necessary, be met through reallocation from the Other Studies and Technical Assistance component. 104. The Government would be the Borrower of the proposed IDA Credit of US$3.0 million. Of this, about US$1.0 million would finance the Public Sector Management component; about US$0.2 million the Environmental Studies component; and US$1.7 million would finance the Industrial Restructuring and Development component. About US$0.1 million would remain available for Other Studies and Technical Assistance to be agreed upon with the Government. Of the US$3.0 million IDA Credit, US$1.2 million would be used to refinance two advances from the Project Preparation Facility for (i) preparation of reforms in public expenditure and public enterprises; (li) technical assistance and diagnostic studies; and (iii) an Industrial incentives study. F. Procurement, Disbur seent, Accounts and Anditing 105. Consultants would be recruited In accordance with IDA guidelines; contracts and final terms of reference for each subcomponent of the project would be approved by IDA prior to the appointment of consultants, Draft terms of reference have been agreed between the Government and IDA (Annexes VIII, IX and X). Consultants' contracts would include specific timetables for the completion of different phases of their work. Procurement would be by international shopping on the basis of quotations from at least three qualified suppliers for microcomputers and associated hard and software. All packages for computer equipment over US$50,000 would be subject to IDA's prior review of procurement documentation. The balance of the contracts would be subject to random post-review by IDA after contract award. . 106. Disbursements for the Public Sector MNanagement, Environmental Studies and Other Studies and Technical Assistance components would be for 100% against expenditures on consulting services, both foreign and local, and 100% against expenditures on computer equipment. Appointment of a Servicing Agent would be a condition of disbursement for these components (para. 100). In addition, the credit would refinance an advance from the Project Preparation Facility for expenditures pertaining to computer equipment and consultant services eligible for financing under the Credit. Disbursements for the Industrial Restructuring and Development component would cover: (i) 100I of the consulting contracts for a two-year period for a management consultant to FDI's Director General, and for a marketing specialist and production engineer for FDI; (ii) 80% of financing of consulting contracts for the In-depth Study phase for prediagnosed industrial firms; and (iii) 37% (not to exceed SDR. 63,000) of FDI's operating budget for FY87 that has been reviewed and approved by IDA. The signing of an agreement between the Republic of Haiti and the Central Bank, specifying the terms for implementing and transferring the Credit proceeds earmarked for the Industrial Restructuring and Development component, would be a condition of disbursement of this component (para. 101). It was  - 31 - agreed that the Association would approve the standard contract to be signed with each enterprise for the in-depth studies as a condition of disbursement of this component. Furthermore, the opening of the account for the Technical Assistance Fund by the FDI would be also a condition of disbursement of the Industrial Restructuring and Development component (para. 97). In addition, this component of the Credit would refinance an advance from the Project Preparation Facility covering expenditures pertaining to the following items which are eligible for financing under this Credit: (1) 100X of the consultants' contracts and administrative expenditures related to the Industrial Incentives Study; (ii) 100% of the FDI consultants' contracts for diagnostic studies of selected Individual enterprises; and (iii) advances made to FDI for other eligible disbursement items. 107. In order to accelerate disbursements, a special account (revolving fund) with an initial deposit of SDR 396,000 corresponding to the average four month disbursement needs of the project would be established in a private commercial bank acceptable to IDA. Two sub-accounts would be established, for MEF and for FDI. Replenishments would be made either once a month if expenditures exceed US$100,000, or once a third of the special account is used, whichever is sooner. Disbursements against equipment contracts valued up to US$50,000 equivalent, against FDI's 802 share of consultant contracts for the in-depth studies and against FDI's operating expenses would be on the basis of Statements of Expenditure; supporting documentation would be retained by the executing agencies and made available for review by IDA supervision missions and external auditors. Payments against all other consultant contracts and against equipment contracts amounting to US$50,000 equivalent and above would require full documentation. The Closing Date is expected to be Marcb 31, 1989. 108. MEF and FDI would maintain records of all transactions under the credit in accordance with sound accounting practices. At the end of each Haitian fiscal year, all accounts, including the special account, would be audited by independent auditors acceptable to IDA and the Audit reports would be submitted to IDA no later than four months after the end of the fiscal year. Audit reports would include a separate opinion with regard to the claims submitted to IDA on the basis of Statements of Expenditure and state whether such claims have been effected in accordance with the IDA Development Credit Agreement. G. Benefits and Risks 109. The proposed project would strengthen the Government's ability to carry out its Economic Recovery Program and thus encourage the restructuring of the Haitian economy toward the production of exports. It would therefore complement the IDA Economic Recovery Credit. Several studies would assist the Government and its successor in tackling the pressing problems of the efficiency of the public service ano the deterioration of the natural environment. Technical assistance to private industry should enable a significant number of firms to adapt to the new incentive structure and prevent them from closing, reducing the risk of unnecessary unemployment. 110. There are three principal risks. First, delays in appointment of consultants could jeopardize timely implementation. For the Public Sector  - 32 - Management component, this would be mitigated by the hiring of an international consultant to assist MEF in project startup and management and with the selection of consultants, the appointment of a full-time Project Manager, the use of a private firm to handle the administration of consultante' contracts, and by intensive IDA supervision, especially at project startup. For the Industrial Restructuring and Development component, FDI's experience in handling consultants and the diagnostic studies already undertaken under the PPF would lessen this risk. In addition agreement was reached during negotiations to hire by October 31, 1987 a consulting firm to undertake the in-depth studies. Second, there is a risk that the initial demand for technical assistance under the Industrial Restructuring and Development component might be overestimated especially if the increased levels of contraband trade noticeable since September 1986 persist. The Government recognizes that the contraband trade is adversely affecting the capacity utilization of domestic firms and could undermine the recent trade reforms. Third, the Government that will take office in February 1988 could reverse the economic policy reforms and thus reduce the value of the complementary technical assistance, not implemeniting its recommendations. However, the studies would be useful for decision making and their existence may well help reduce this risk and ensure continuity in economic policy. Besides, implementation of the studies would demonstrate to the international community the new Government's commitment to economic reform, which would be a factor in determining support forthcoming from the donor community. PART IV - BANK GROUP OPERAONS AND STRhXG I11. Operations. Since beginning operations in Haiti in 1956, the Bank Group has extended one loan and 24 credits totalling US$319.0 million equivalent and IFC has made one investment (US$1.5 million). As of September 30, 1986, the total of credits outstanding was US$271.4 million equivalent, of which US$62.0 million equivalent was undisbursed. Annex II summarizes Bank Group operations in Haiti as of September 30, 1986. Since then, a US$20.0 million equivalent credit for a transport project and a US$40.0 million equivalent Economic Recovery Credit have also been extended. The Bank Group has financed projects in transport (7), power (4), educativn (4), rural development (2), agricultural rehabilitation (1), industrial credit (1), ports (1), water supply (1) urban development (1) and economic recovery (1). A pilot project in forestry is also underway. Some of these projects have enjoyed cofinancing or parallel financing from the aid agencies of Canada, France, Germany, and Switzerland. IFC's investment is for an integrated poultry project. 112. Overall, project implementation and disbursement performance are satisfactory. However, a lack of counterpart funds has in the past delayed IDA disbursements. The establishment of revolving funds in recent projects has improved this. IDA is in addition carefully monitoring Haiti's absorptive capacity for external assistance, with particular attention to projects' local cost counterpart financing requirements. 113. The Bank also chairs the Caribbean C-roup for Cooperation in Economic Development, whose Haiti Subgroup provides a framework for cooperation among donors.  - 33 - 114. Strategy. Within the last two years, IDA has prepared an economic memorandum, an agrlcultural sector study and a public expeaditure review. These documents identify the major obstacles to economic recovery and the specific actions needed to achieve and sustain financial stabilization, reduce resource losses, increase agricultural and industrial production and exports, save foreign exchange, meet the infrastructure and training needs of agriculture and industry, increase the efficiency of public institutions and, for the longer term, improve basic education. A population, health and nutrition sector report is currently under preparation and Was discussed with the Government in mid-March, 1987. 115. The present Government's Economic Recovery Program, described in Part II, follows closely the principal recommendations of the three recent reports, all of which were submitted to the new authorities. Consequently, IDA's program, in close collaboration with the IMF and with other donors through the Caribbean Group for Cooparation In Economic Development, aims at supporting the Government's Economic Recovery Program with both policy-based operations and investment project credits. 116. Indeed, since May 1986, IDA has been involved in an intensive policy -!ialogue with the Haitian authorities which has led to four operations now underway or proposed to provide specific support for the Economic Recovery Program: (i) The Government prepared jointly with IMF and IDA staff a Policy Framework Paper to underpin an IMF Structural Adjustment Facility Arrangement that was approved by the Executive Board of the Fund ln December 1986. The paper was discussed by IDA's Executive Directors meeting as the Comittee of the Whole on November 18, 1986. (ii) The Economic Recovery Credit, approved on March 24, 1987. (iii) The proposed Technical Assistance Project. (iv) A Industrial Restructuring and Development Project, scheduled for Board presentation in IDA FY88, which would provide financial and technical assistance to industrial firms which need to restructure or invest to operate under the new set of incentives that the reforms to the trade regime described in Part IT will establish. 117. IDA would maintain an active policy dialogue with the Government through monitoring the Economic Recovery Project and supervising the proposed Technical Assistance Project. Further policy-based operations are envisaged as long as an appropriate policy framework remains in place. Future investment credits now under preparation include electric power and water supply projects. 118. IDA's share in Haiti's external debt disbursed and outstanding is estimated at 38 percent as of September 30, 1986. This is high only because grants constitute a very large share of the external assistance Haiti has received. IDA's share of external public debt service was about five percent in FY86.  - 34 - PART V - 3EL1AfSU WI TEE IMF AMD WITE DTXI DO30G8 119. [IF. Haiti has been a member of the IMF mince September 1953 under Article VT!? status. Its current quota I1 SDR 44.1 million. In December 1986 the Executive Board of the Fund approved a throe-year structural adjustment arrangement, and the first annual arrangement theroundar, under the Structural Adjustment Facility. The macroeconomic stabilization and structural reform program that this supports was described in Part II; the DMP will monitor particularly closely the implemntation of the stabiliza- tion program. IDA and IMF staff will continue their close cooperation while monitorlng the Government'a Economic Recovery Program. There are no ongolng Stend-by arrangements; the last was approved in November 1982. Haiti made a purchase under the Compensatory Financing Facility in 1981. As of December 31. 1986, total Fund credit outstanding was SDR 54.7 million, or 124 percent of quota, and Trust Fund loan disbursements totalled SDR 18.6 million, of which SDR 9.3 million is outstanding. A resident representative has been stationed in Port-au-Prince oince 19?2. The last Article IV consultatlons were held during September 1986 and were concluded ln December 1986. An IMF expert on bank supervision and credit control is presently on assignment at the Central Bank; a tax administration adviser has been assigned since early 1987 to assist the Government to Implement the lncome tax and customs tariff reforms. 120. Othbr Donors. Many public and private aid agencies are active In Haiti. With the proposed credit, IDA disbursements would amount to about 25 percent of total ald flows to Haiti in FY87. Among the most important agencies are the Inter-American Development Bank, the United States (about 50 percent of disbursements), France, the Federal Republic of Germany, Japan, Canada, and the United Nations Development Programme (UNDP). All are members of the Haiti donors Subgroup of the Caribbean Group for Cooperation in Economic Development. At Its meeting in November 1986, donors announced their support for the Government's Economic Recovery Program and also sub- stantial increases in their intended levels of financial support for Haiti. In addition, the Goverment presented a list of 26 projects proposed for external financing, drawn up with the assistance of UNDP and IDA staff. This list also formed the basis of the UN Secretary-General's appeal for Haiti in October 1986. Direct donor assistance for the Government's Economic Recovery Program includes the United States' Economic Support Fund grants, which are policy-based operations supporting many of the same re- forms as the DIF Structural Adjustment Facility Arrangement and the 'DA Economic Recovery Operation. Other support is detailed in Annex V. PART VI - aCnUEDIION 121. I am satisfied that the proposed Development Credit would comply with the Articles of Agreement of the Association and recommend that the Executive Directors approve It. Barber B. Conable President Attachments Washington, D. C. April 7, 1987  - 35 - ANNEX I Page 1 of 3 UA7TIs ICONWEIC INDICATORS AND PROJECTIOhS Aount Averge Annual growth Rate Share of CDP at Market Prices CUS$ milion) (t a constant prices) (Z at current prlae) m8 Ff74-al VY31-36 FYlu-90 J176 FY31 rY36 nY90 (eat.) (projected) (naot. (proj.) National Accounts Cross Domtle Produat 2147.0 3.4 -0.6 4.6 100.0 99.7 100.0 100.0 IndLreet Taxes 35.P 6.0 -3.0 4.6 4.0 4.2 4.0 4.0 AarLculture 689.2 100.3 -1.6 5.5 26.4 33.8 32.1 22.1 Industry 493.8 6.2 0.2 5.1 19.4 22.2 23.0 13.0 Other 578.1 4.1 0.1 3.6 38.2 39.5 40.9 40.9 Cenoaiption 2028O 7 3.9 -1.5 4.4 93.1 98.3 94.5 94.5 Cross Domestic Investmnt 259.7 6.3 -3.7 13.9 15.3 16.9 12.1 12.1 Exports of CUPS 294.0 3.2 -0.1 4.3 16.3 16.3 13.7 13.7 lmports of CUPS 435.4 6.3 -5.4 9.5 -25.7 -32.0 -20.3 -20.3 Cross National SavLngs 104.3 -32.2 -7.8 13.1 6.1 0.7 4.9 7.1 External Trade Merchandlse Exports 209.2 3.9 12.7 10.7 9.7 3.9 Coffee 55.0 4.9 -0.3 7.1 5.0 2.2 2.6 2.1 Other Agricultural Exports 33.2 2.7 2.5 2.0 1.5 1.4 Assmebly Industry 121.0 6.2 2.3 5.4 5.6 5.5 Minerals - -100 - 2.4 1.1 - - MerchandLis Imports 245.1 9.5 -13.7 -21.4 -11.4 -12.9 Prices FY31 FY52 FY83 FY84 FP85 FY86 FY87 PY88 FY89 FY90 (ot.)