Mali - Public Enterprise Sector Adjustment Project

Document of The World Bank FOt OFFMICIL USE ONLY Rbot No. P-4734-MLI REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT OF SDR 29.4 MILLION TO THE REPUBLIC OF MALI FOR A PUBLIC ENTERPRISE SECTOR ADJUSTMENT PROGRAM June 7, 1988 This document has a restricted distribution and may be used by recipients nily in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency unit . CFA Franc (CFAF) 1/ US$1.00 - CFAF 280 CFAF 1.0 million - US$3,571 US$1.00 - Y129.28 (Japanese Yen) 2/ US$1.00 _R3.7505 (Saudi Riyal) 2/ WEIGHTS AND MEASURES: METRIC FISCAL YEAR January 1 to December 31 1/ The CFA Franc is tied to the French Franc (FF) in the ratio of FF 1.0 to CFAF 50.0. The French Franc is currently floating. 2/ Exchange rate of March 3, 1988.  "In OVVMAL UW ONLY 1BBREVIATIONS AND ACRONYMS BCEAO I Banque Centrale des Etats de l'Afrique de l'Ouest BCM s Banque Centralo du Mali BDM I Banque de D6veloppement du Mali CAA Caisse Autonome d'Amortisement CCCE I Caisse Centrals de Coop6ration Iconamique CMTR s Compagnie Malienne de Transport Routier CNRA s Commission Nationale de la Rdfore Administrative COMANAV Compagnie Malienne de Navigation COMATEX a Compagnie Malienne de Textiles EDM Energie du Mali EDIM Editions Imprimerie du Mali EMAB Entreprise Malienne du Bois EMAMA Entreprise Malienne de Maintenance EPA s Etablissement Public a Caract6re Administratif EPIC Etablissement Public & Caractere Industriel et Commercial HUICOMA Huilerie Cotonniere du Malt IAS ImpOt sur les Affaires et Services ITEMA Industrie Textile du Mali LPM Librairie Populaire du Mali OCINAM Office Cin4matographique National du Mali OERHN Office d'Exploitation des Ressources Hydrauliques du Haut Niger OPT Office des Postes et T4lecommunications PE Public Enterprise PPM Pharmacie Populaire du Mali RCFM Regie des Chemins de Fer du Mali SAT Societe Africaine de Transport SCAER Societe de Credit Agricole et d'Equipement Rural SEBRIMA Societe de Briqueterie du Mali SEMA Societe d'Equipement du Mali SEPAMA Societe d'Exploitation des Produits Arachidiers du Mali SEPOM Soci4td des Produits Oltagineux du Mali SHM a Societe des HOteleries du Mali SMECMA Societe Malienne d'Ztude et de Construction de Matdriel Agricole SOCAM I Societe des Conserves Alimentaires du Mali SOCOMA Societe des Conserves du Mali SOCORAMA Societe de Commercialisation des Radios du Mali SOCIMA Societe des Ciments du Mali SOtiBEPEC Societe Malienne de Betail, de Peau, et de Cuir SOMIEX Societe Malienne d'Importation et d'Exportation SONATAM Societe Nationale des Tabacs et Allumettes du Mali SONEA Societe Nationale SONETRA Societe Nationale d'Entreprise et des Travaux Publics TAMALI Societe des Tanneries Maliennes TIM Telecommunications Internationales du Mali UCEMA Usine Ceramique du Mali USAID T?nited States Agency for International Development UNDP United Nations Develophient Program WAMU West African Monetary Union This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS CREDIT AND PROGRAM SUMMARY ...................................... i I. THE ECONOMY ............................................... 1 A. Background ............................................ 1 B. Recent Economic Developments ..................... 2 C. Medium-Term Prospectb and Policies .................. 4 II. TLE PUBLIC 3N1ERPRISI SECTOR . .......... . . . . 5 A. Sector Profile ......................... S B. Financial Sector Implications .. ....................... 7 III. THE SECTORAL ADJUSTMENT PROGRAM ........ .................... 8 A. Reform Objectives . .................................... 8 B. Macroeconomic Policy Reforms ....... ................... 9 C. Financial Sector Reforms ......... ..................... 10 D. Institutional and Legal Reforms ...... ................. 13 E. Rationalization of the Sector ....... .................. 14 F. Program Implementation .......... ...................... 1i IV. THE PROPOSED CREDIT ......................................... 18 A. Credit History ......................................... 18 B. Relationship of Proposed Credit to Reform Program ...... 19 C. Effects of the Adjustment Program ..... ................ 19 D. Social Impact .......... ............................... 21 E. Benefits and Risks .................................... 21 F. Credit Amount .22 G. Disbursement, Procu.ement, Ac.ministration and Auditing. 22 H. Monitoring and Tranche Release .23 V. BANK GROUP OPERATIONS .24 VI. COLLABORATION WITH THE IMF AND OTHER DONORS .... ............ 25 VII. RECOMMENDATIONS . ............................................ 26 TEXT TABLES Table 1: Financial Performance of Key PEs . ...................... 6 ANNEXES Annex I :conomic Indicators .27 Annex II Public Enterprise Basic Data .30 Annex III Government's Letter of Sectoral Policy .32 Annex IV Policy Matrix .42 Annex V BDM Techrical Prospectus .45 Annex VI Financial Plan for PE Sector Restructuring .50 Annex VII Supplementary Credit Data Sheet .51 Annex VIII Status of Bank Group Operations .55  RIPUBLIC O MALI !WLIC ENTEPRISE SECTOR ADJUSTMENT CREDIT CEDIT AnD PROGWI SUMARY lorro0rs Republic of Mali Credl& Afount IDA$ SR 29.4 aillion (US$40 million equivalent) Imig Standard Program Descrintions The proposed credit would support the Government's public enterprise (PE) sector adjustment program, which is conceived as the first phase of a longer term adjustment effort to improve economic management. The principal objectives of the public enterprise program are to improve the performance of the sector and to reduce its burden on public finances. These objectives are to be achieved by action in four key areas: (a) reform of key economic policies concerning public resource management and the structure of economic incentives; (b) financial sector reforms, including restructuring a state-owned bank; (c) institutional and legal reforms redefining relations between government and public enterprises; and (d) rationalization of the sector through restructuring and divestiture. PE Institutional Development Project, prepared in parallel with this adjustment operation, will provide support to the Government for implementation. Benefits and Risks: The policy reforms are expected to (a) improve public sector resource management, (b) reduce policy distortions that impede efficient private sector economic activities, (c) enhance public enterprise performance, and (d) reduce the burden of public enterprises on public finances and the banking system. The main risk associated with the program is that, despite the important actions already taken, continued liberalization of the economy and divestiture of public enterprises would prove politically unacceptable. The program's success will depend, moreover, on sustained implementation and coordination by an administration that has relied heavily on direct state intervention in the past. The parallel PE Institutional Development Project will strengthen the Government's capability to carry out the program as envisaged.  Istzted Disbursements: The credit would be released in three tranches: US$16 million equivalent upon effectiveneas; US$12 million equivalent after a first performance review to be held within 12 months of effectieness; and the remaining US$12 after the second performance review to be held within 12 months of the first performance review. Staff AnDraisal RDeort: Not applicable M3 nIBRD 20576  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOM(ENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE REPUBLIC OF MALI FOR A PUBLIC ENTERPRISE SECTOR ADJUSTMENT PROGRAM 1. I submit the following report and recommendation on a proposed development credit for SDR 29.4 million (US$40 million equivalent) on standard IDA terms with a maturity of 40 years to the Republic of Mali to support the Government's Public Enterprise Sector Adjustment Program. The program would be cofinanced by contributions from Japan and the Saudi Fund to the Special Joint Financing Facility for Africa (SJF) totalling US$44.6 million equivalent. The SJF credit from Japan would comprise a blend of a loan of V4,000 million from the Overseas Economic Cooperation Fund (30 years maturity. 10 years grace, 1.25 percent per annum) together with a grant of Y1,000 million, the latter being administered by the Association. The Saudi Fund would contribute SR22.0 million under terms identical to IDA. The African Development Bank (AfDB) would also cofinance the program with an African Development Fund Credit of US$45 million equivalent. PART I - THE ECONOMY A. Background 2. Mali is a vast, landlocked, and resource-poor country located in the sahelian zone of western Africa. Only about a quarter of its 1.2 million square kilometers is arable. Nearly 90 percent of the population, estimated at 7.9 million in mid-1987, is dependent on the agricultural sector which accounts for roughly 50 percent of GDP. Per capita income is estimated at US$170 in 1986 1/ and social indicators, such as life expectancy and school enrollment rates, are among the lowest in the world. Population growth is an estimated 2.5 percent per annum- Key macroeconomic data are provideu in Annex I. Structural Problems 3. Mali's economic performa. .ce is highly constrained by a narrow resource base and the structural legacy of inappropriate past policies, including inefficient public resource manatement and distortions in the structure of economic incentives. 4. Weak Resource Base. Mali's potential for long-term growth is severely limited by harsh resource conbtraints. Mineral resources are meager, infrastructure is sparse, and growth in the agricultural sector is constrained by low rainfall, fragile soils, and low-productivity 1/ Based on the Bank Atlas methodology.  - 2 - traditional technologies. In addition, the weak buman resource base represents a formidable obstacle to future growth. Primary education enrollment rates are among the lowest in the world and basic health services are not widely available. These problems are c.ompounded by population growth which puts severe pressure on both the limited natural resource base and the financial resources available for the provision of basic publ:c services. 5. Pub.lc Resource Management. The state-dominated development strategy pursued until the early 1960s led to serious inefficiencies with regard to both resource mobilization and allocation. High levels of expenditure and subsidies left inad:quate funds for operation and maintenance expenditure. Public investment decisions gave insufficient attention to financial and economic selection criteria, including debt service and recurrent cost implications. The fiscal system became overly complex, severely distorted resource allocation signals, and gave little attention to cost recovery for public services. In addition, non-market credit allocation procedures led to rapid credit growth, particularly to the public sector. The Derformance of the public enterprise (PE) sector is a particularly acute manifestation of poor public resource management (see Part II). 6. Incentives Framework. In addition to the public rpsource management inefficiencies mentioned above, an appreciating real effective exchange rate, price controls, a restrictive trade regime, and excessive economic regulation have distorted .ncentives, skewed resource allocation, and thus impeded growth throughout the economy. PEs have both contributed to these distortions (import monopolies) and suffered from them (price controls). B. Recent Economic Developments 7. GDP Growth. Ma ; s- structural problems combined with a highly variable climate have led to erratic economic performance. Although GDP growth averaged 1.9 percent per annum from 1980-87, severe drought during 1982-84 led to a decline in output. Improved weather conditions and pol.icy reforms implemented in preceding years contributed to GDP growth of 18.6 percent in 1986 and an estimated 3.9 percent in 1987. Cereals production alone increased by some 47 percent in 1985/86 and another 7 percent in 1986/87. Per capita income has, nonetheless, fallen by an average of 0.6 percent per annum in the 1980s. 8. External Debt. Despite erratic growth, both consumption and investment have been sustained by inflows of official development assistance which, in real terms, increased more than sixfold between 1970 and 1985. Roughly half of this assistance has been in the form of loans and by end-1987 total public debt outstanding and disbursed exceeded 85 percent of GDP. Although most of Mali's external debt is contracted on concessional terms, a dramatic increase in debt service obligations is now coming due on past borrowings. The ratio of public debt service to public revenue, which was only 5.9 percent in 1982, increased sharply to 32  percent in 1985 (24 percent excluding IDf repurchases). Scheduled debt service rose further in 1986 and 1987, but actual debt service payments fell to CFAF 22 billion (24 percent of public revenue) in 1987 as external arrears accumulated. Despite some bilateral rescheduling and a lowering of the effective debt burden due to the appreciatton of the CFAP vis-a-vis the US$, 1988 scheduled debt service reached CFAF 35 billion or 34 percent of estimated public revenue (27 percent excluding IMF repurchases). 9. Initial Adiustment Efforts. Confronted with unsustainable fiscal a&ld e.ternal deficits, the Government launched a stabilization program in 1982, supported by Fund resources, under which a number of measures were introduced to reduce budgetary deficits, PE operating losses, and public sector arrears. In addition, initial reforms--including market liberalization and improved price incentives--were introduced to increase the efficiency of resource allocation. The Government's policy reforms led to a number of significant accomplishments. The current account deficit is estimated to have fallen to 16 percent of GDP in 1987 (6 percent including grants) from a peak of 31 percent in 1985, largely because of price and volume increases fo. cotton exports and a fall in the value of food and petroleum imports. The consolidated current budget moved from a deficit of 3.9 percent of GDP in 1981 to an overall balance in 1987 (commitment basis). Civil service recruitment has been tightly controlled and higher education graduates are no longer guaranteed public sector employment. Major reforms have been introduced in the cotton sector, which adjusted rapidly to the fpll in export prices in 1985/86. Cereals markets have been liberalizei and price controls, which had covered virtually all products, now cover only a small number of essential products. Numerous public tariffs, including those for water, electricity, railroad, and postal services, have been substantially increased to be more in line with costs. in addition, all export monopolies and most import monopolies have been abolished. 10. The pace of reform slowed noticeably in late 1986 and early 1987, however, when the Government failed to implement a number of policy measures agreed upon in the context of Bank sector adjustment discussions and the third IMF Standby. The public sector accumulated substantial arrears in 1987, and the banking system is seriously threatened by the illiquidity of a state-owned bank, the Banque de Developpement du Mali (BDM) and the postal checking system (CCP). Delays in implementing reforms occasioned a reduction in the amount of external non-project financing mobilized by the Government in 1986-87. In particular, Mali failed to make the final two drawings under the third Standby Arrangement and new adjus*iment ,,rograms were delayed. High debt amortization and IMF repurchase obligations further exacerbated the financial problems and led to a large accumulation of arrears in 1987. 11. The Government has demonstrated a strong renewed commitment to reform since late 1987 when it made a number of long-delayed decisions regarding its adjustment program and took steps to implement them rapidly. This has culminated in (a) agreement on the PE sector adjustment program to be supported by the proposed credit, (b) agreement on a macroeconomic  - 4 - program for 1988-89 to be supported by IMF resources, and (c) preparation of a medium-ternm policy framework paper (PFP). C. Medium-Term Prospects and Policies 12. Policy Framework PaPer (PFP). The Government has prepared, with the assistance of the staffs of the Fund and the Bank, a medium-term PFP which aims at achieving a sustainable rate of growth consonant with domestic and external financial stability. The three key objectives of the program for 1988-90 are (a) to attain, after an expected drop in economic activity in 1988 resulting from poor weather conditions it. the 1987-88 crop year, an average annual growth rate of re&l GDP of about 4 percent; (b) to stabilize the annual rate of inflation, as measured by the GDP deflator, at an average of about 3.5 percent; and (c) to reach a viable and sustainable external sector position by 1992. 13. The program focuses on five main areas of policy reform. First, agricultural policy reforms aimed at increasing food security, raising productivity, and eventually diversifying agricultural production will be adopted. Second, the economic incentives system--particularly as regards pricing, marketing, and trade policies--will be reviewed to ensure a further reduction in government intervention and to enhance the efficiency of resource allocation. Third, a major reform of the PE sector will be undertaken (see Part III). Fourth, the efficiency of public resource management will be improved through restructuring current expenditure, fiscal reform, and improved investment programming and budgetary control procedures. Finally, tight financial policies will be pursued with a view to strengthening the Government's financial position and freeing credit for private productive activities. 14. Financing Plan. As part of its policy framework, the Government has prepared a medium-term financing plan which is consistent with the macroeconomic framework and available financial resources. In addition to the budget deficit, the gross public sector financing requirements include substantial debt amortization, and settlement of arrears, including PE cross-arrears (see Part III). Since Mali's ratio of government revenue to GDP is already relatively high (17 percent) and the potential for major additional domestic resource mobilization remains low, the increase in financing requirements would largely have to be funded externally. On the basis of these needs, gross external financing requirements are estimated to be average US$495 million annually during 1988-90 (Table 3 in Annex I). 15. Disbursements from existing grant and loan commitments are projected to cover about two-thirds (US$ 990 million) of the external firancing required for 1988-90. Expected new commitments (including IMF resources and the proposed IDA PE credit) would provide an additional US$300 million. The remaining gap of US$ 195 million would be financed by Paris Club and/or bilateral debt relief; new quick-disbursing non-project aid commitments, including IDA adjustment lending and access to the IMF ESAF; and additional external assistance for investment projects. The proposed PE sector adjustment credits, plus cofinancing, would cover about  9 percent of external financing requirements in 1988-90. Given Mali's debt servicing capacity, the viability of the financing plan vill depend on success in mobilizing additional assistance in grant form or on terms comparable to those of IDA. PART II - THE PUBLIC ENTERPRISE SECTOR A. Sector Profile 16. Following independence, Mali pursued a de:iberate policy of parastatal intervention as the key instrument to promote economic development. As a result, a large number of PEs vere created, particularly in the 19609 and early 1970., in the industrial and commercial s6ctors. By the early 19808 there were 57 non-financial, commercially-oriented PEs, more than 20 rural development agencies, several financial institutions, and numerous other parastatals of an administrative nature providing public services as financially autonomous agencies. 2/ In 1980 the 57 commercially-oriented PEs accounted for some 70 percent of modern industrial output and absorbed 70 percent of total domestic credit, 17. Financial Performance. The performance of the PE sector has been extremely poor both with regard to the quality of goods and services provided and the costs to the economy. Inadequate data preclude a thorough assessment of the financial performance of the sector as a whole, but the net operating results of the 12 most important PEs indicate net losses of CFAF 4.0 billion in 1981 (see Table 1). 3/ Despite some initial reforms, the situation continued to deteriorate through 1985 when the net losses of these 12 enterprises reached CFAF 5.3 billion. The PE sector has, moreover, contracted considerable external debt, most often with Government guarantees. Because of their poor financial performance, PEs have not been able to service these debts and at end-1986 had accumulated CFAF 4.9 blllion in arrears to the debt service agency (CAA). 2/ See Annex II for a list of the 57 public enterprises. 3/ The I2 most important PEs, in terms of employment and financial results, are SOMIEX (import-export), Air Mali (air transport), EDM (eleccricity and water), COMATEX (textiles), ITEMA (textiles), PPM (pharmaceuticals), SEPAMA (groundnut oil processing), SEPOH (edible oils and soap), SMECMA (agricultural equipment), SONATAM (cigarettes and matches), RCFM (railroad), and OPT (post and telecommunications).  -6- Table 1: MALI--FINANCIAL PERFOXMANCE 0F REY PUBLIC ENTERPRISES (CFAP million) NET OPERATING RtSULTS 1981 1982 1983 1984 1985 1986 ---------------_---------------------------------------------------__--------__ SOKIEX 680 -1098 -160 -2255 -3031 -1371 Air Mali -1024 -907 -715 -686 87 nuM -245 127 135 -597 542 S81 COMATEX -969 -444 -728 -1176 -561 -464 ITEHA -145 19 217 310 390 486 PPM 257 335 193 8S -499 -500 SEPAMA -694 -134 -100 -340 -237 -140 SEPOM 86 -178 -191 228 141 ... SMECMA 13 20 40 -240 -670 -670 SONATAH 267 203 305 203 318 480 RCFM -1562 -1469 -1417 -1047 -2209 -1598 OPT -634 -247 129 333 527 191 -3990 -3773 -2292 -5182 -5289 -2918 18. Causes of poor performance. The PE sector's poor performance stems from (a) poor investment choices, (b) an inadequate economic policy framework, (c) the lack of financial discipline within the public sector, and (d) inappropriate government-enterprise relations leading to poor PE management. Initial investment decisions were often taken on the basis of political objectives or the availability of foreign financing rather than on economic efficien(y or least-cost considerations. Few feasibility studies were done and little rigorous investment evaluation was undertaken. As a result, many nonviable enterprises were created. Even potentially viable PEs have been severely hampered by the tolicy environment within which they opfrate. Policies such as the mandatory distribution to Government of 90 percent of after-tax profits removed any incentive for improving efficiency within enterprises. Price controls, which favored consumers over financial sol icy, and excessive delays in price adjustments, moreover, resulted in large operating losses. 19. The lack of public sector financial discipline both aggravated this situation and permitted nonviable enterprises to continue operation, irrespective of the losses they incurred. Most importantly, Government arrears to PEs compounded the liquidity problems of several key PEs, including EDM (electricity), OPT (post and telecommunications), RCFM (railroad) and Air Mali (air transport). By 1987 Government arrears to these four enterprises amounted to more than CFAF 9 billion. Nonetheless, the PEs as a group have consistently been net debtors to the Treasury, thus aggravating the Treasury's own serious liquidity shortage. PE tax arrears alone exceeded CFAF 14 billion at end-1986. Unsound credit policies have been a key element in the continuation of this situation, since BDM has, in fact, been willing to finance the operating losses of PEs with little  prospect of being repaid (see Section B). The Treasury, correspondingly, used the deposits of the postal checking system to finance its own deficits and thus ultimately rendered the postal checking system completely illiquid. As a result, a complex web of cross-arrears has developed between GovLrnment, PEs, BDM and external creditors which threatens to paralyze the financial system. 20. The above-mentioned problems have been compounded by government- enterprise relations characterized by both excessive Government interference in the day-to-day management of enterprises and the absence of accountability on the part of PE management. Until the overhaul of the legal and in-titutional framework in 1987, government supervision emphasized direct control rather than performance review. As a result, the objectives of particular enterprises were ill-defined; managers had little or no autonomy in running their companies; and there was no procedure for evaluating PE performance. The lack of autonomy and accountability, combined with a serious shortage of skilled managers, has led to severe management problems, manifested by overstaffing, poor accounting, and weak financial controls. B. Financial Sector Implications 21. As the Government's own budgetary situation has been extremely strained, the banking system has been the largest source of financing of the PE sector's deficits. In particular, BDM, created in 1968 as a state-owned multipurpose bank, provided easy access to credit for parastatal undertakings. By 1982, PEs accounted for approximately 70 percent of domestic crLdit and BDM had extended creAits amounting to about CFAF 60 billion, or two-Lhirds of its total portfolio, to more than 50 PEs. The financial weakness of BDM was readily apparent by the early 1980s as arrears mounted on its PE loans and its debts to the Central Bank of Mali (BCM) increased. At the end of its 1982 fiscal year, CFAF 50 billion of its CFAF 60 billion PE portfolio was in arrears. BDM's financial situation improved dramatically in 1984 when, in preparation for Mali's reentry into the West African Monetary Union (WAMU), BCM obligations to the French Treasury of CFAF 75.0 billion were consolidated into a long-term concessional loan to the Government. As a counterpart to this consolidation, BCM wrote off CFAF 64.7 billion of BDM's rediscounted loans and other assets, and BDM, in turn, cancelled CFAF 37.2 billion of PE loans. No improvement was made in BDM's management, however, and inappropriate lending decisions quickly brought the bank, once again, to a critical financial situ:,tion. 4/ 4/ The reasons for the deterioration of BDM's financial situation were numerous, including (a) exc3ssive lending, under government pressure, to PEs now on the verge of bankruptcy; (b) inadequate organization and procedures to properly screen credits to the private sector; and (c) (Footnote Continued)  22. In 1986, an IDA-financed review of BDM's role in the Malian banking system revealed that about CFAF 24 billion, of a BDH portfolio totalling CFAF 69 billion, was non-performing. bDH's indebtedness to the Central Bank of the West African States (BCEAO), which was minimal when Mali joined WAMU, had reached CFAF 34 billion and its net worth, after adequate provision for non-performing loans would have been a negative CFAF 11 billion. The quality of BDH's portfolio continued to deteriorate in 1987 when non-performing loans increased to more than CPAF 35 billion and BDH's obligations towards BCEAO rose to CFAF 40 billion. 23. The overexposure of BDM vis-a-vis the PE sector has not only cut off credit to other sectors of the economy but, given that BDH's portfolio represents some 80 percent of domestic credit and is partially financed with the resources of other oanks via the money market, also poses severe liquidity problems for the entire banking sector. This situation reached crisis proportions iyt 1987, when BDM became virtually insolvent and the Government took dec iive action to prevent the bank's collapse and to transform it into a viable inslitution (see Part III, Section C). PART III - THE SECTORAL ADJUSTMENT PROGRAM 24. In view of the PE sector's longstanding unsatisfactory performance and the emergence of sizable financial disequilibria, the Government has formulated, in consultation with IDA, and begun the implementation of a PE Sector Adjustment Program. The first phase of this program is embodied in the Government's Letter of Sectoral Policy (Annex III), the key features of which are summarized below and .n the policy matrix of Annex IV. A. Reform Obectives 25. The Government's overall aim vis-a-vis the PF sector is to ensure a sound allocation of public resources and the financiKl equilibrium of the sector. The PE sector adjustment program is conceived as the first phase of a medium-term adjustment effort, described in its policy framework paper, to improve public resource management; the program's principal objectives are to improve the performance of the sector and to reduce its burden on public finances. These objectives are to be attained by action in four areasi (a) reform of key economic polices regarding public expenditure and economic incentivep; (b) financial sector reforrit, including BDM restructuring; (c) institutional and legal reform of relations between government and PEs; and (d) rationalization of the sector through restructuring and divestiture. (Footnote Continued) lack of experienced personnel to efficiently run the bank, despite a work force that far exceeded banking norms.  B. Macroeconomic Policy Reforms Public Expenditure 26. In the area of public resource management the Government is committed to strengthening its budgetary and expenditure control procedures in order to assure a more efficient use of public resources. It has prepared a consolidated budget for 1988, incorporating Special Funds that had formerly been outside the budget and an investment budget comprising both domestically and externally financed investment expenditure. In addition, the Government is committed to ending all extrabudgetary subsidies, including implicit cross-subsidies among PEs. Adequate provision has been made in the budget for public utility consumption by the Government and its agencies. Moreover, in order to prevent the accumulation of new arrears, PEs are now authorized to interrupt delivery of goods and services to all public entities with accounts 120 days overdue. Future support to PEs providing public services for which total cost recovery is infeasible, or undesirable on welfare grounds, will be negotiated on the basis of performance contracts with each enterprise (see Section D). 27. Public Investment. In order to institute a more effective control of investment expenditure, the Government adopted in January 1987 procedures for the preparation of a three-year rolling investment progr. The first such program for 1988-90 was prepared with UNDP assistance in November 1987. The total program for 1988-90 amounts to CFAF 230 billion, of which 25 percent is allocated to the agricultural sector, 17 percent to the secondary sector, 38 percent for economic and administrative infrastructure, and 20 percent for the human resources sector. The program will be rolled over annually to maintain the three-year framework and assure appropriate flexibility in investment programming. 28. Recognizing that noneconomic investments have been a major source of past PE sector problems, the Government has taken action on two fronts to assure that no new PE investment be undertaken without adequate justification of its economic and financial viability. First, a fundamental reform of BDM is underway to ensure that the banking sector applies sound financial criteria to its credit decisions (see Section C). Second, all PE investments which receive direct financial support from the Government or government guarantees for their financing will be scrutinized on the basis of a systematic appraisal of costs, benefits, and financial viability. All such PE investments will be included in the government investment budget, which will be submitted annually to the Association for comment. Incentives Policies 29. With regard to the incentive structure for both public and private enterprises, the Government is committed to removing distortions engendered by the fiscal and trade regimes and to placing greater reliance  - 10 - on market-determined prices for the allocation of resources. The measures undertaken in this regard under the PE sector reform program are described below. 30. Price Policy. The Government enacted major new price legislation in October 1986 as part of its adjustment program. Whereas under the previous legislation virtually all products were subject to rigid price controls, the new code specifies that all prices are free or subject to ex-post margin controls with the exception of a negative list of goods and services deemed essential. Thirty-two products are currently so classified, only eight of which are subject to fixed prices determined by the authorities (regime de taxation). An additional 26 products are subject to fixed margins applied to produLtion or import costs and require prior government approval before changing prices (homologation rigide). Moreover, in order to avoid inordinate delays for prior approval, the new regulations stipulate that the authorities have 30 days in which to respond to requests, after which the price change is automatically granted. Finally, the Gover.nment is committed to further price liberalization and will review its new price regulations with a view to transferring products to the more flexible regimes of price control and reduce the number of products subject to price controls to 22 by end-1988 and to 11 by end-1989. 31. Trade and Commercial Policies. The Government has taken steps to reduce the barriers to trade and the free entry of private firms into existing markets. Most importantly, in February 1988 it effectively abolished SOMIEX's remaining import monopolies on sugar, salt, tea, and milk by issuing import licences to private sector traders. The only remaining import monopolies concern tobacco oroducts (SONATAM) and essential medicines (PPM). All remaining export monopolies, most notably for cotton, were abolished in 1986. In addition, a new Commercial Code has been promulgated which simplifies the procedures for operating private firms and, in particular, removes the requirement of prior government approval for the establishment of private businesses. 32. Fiscal Measures. The Government has taken measures to remove fiscal biases against PZs in order to provide them with the same incentives as provided to private firms. The automatic transfer to the Treasury of 90 percent of PEs' after-tax profits has been eliminated and each PE board of directors is now authorized to determine the allocation of such profits to dividends or retained earnings. In addition, PEs are now authorized to follow accounting practices consistent with sound financial management (e.g., to make provisions for plant and equipment renewal, as well as to write off bad debts and obsolete inventories). C. Financial Sector Reforms BDM Restructuring 33. Confronted with a situation in which BDM's insolvency, combined with its heavy borrowing from BCEAO and local banks, jeopardized the  - 11 - liquidity of the whole banking system, the Government adopted in December 1987 a comprehensive BDM restructuring plan as part of its PE sector adjustment program. The plan consists of immediate measures to halt the deterioration of BDH's situation and short- to medium-term measures for BDM's financial restructuring and conversion into a viable bank. 34. Immediate Measures. Since adotpion of the restructuring plan in December 1987, the Government has: (a) suspended BDM's Board and transferred its authority to an interim administrator (administrateur provisoire), appointed in consultation with BCEAO, France and the Association, and empowered to take all management decisions required to conserve BDM's situation; (b) restricted new BDM credit operations, (c) strengthened loan collection efforts, especially with regard to BDM's larger debtors, (d) reduced BDM's payroll by 30 percent by firing 319 people, including the bank's former management and (e) prepared a short term financing plan with BCEAO based on cash flow projections to be reviewed monthly until the medium-term measures have been put into effect. 35. Short and Medium Term Measures. Given its financial and managerial constraints, the Government has decided to reduce its shareholding in a restructured BDM from 100 percent to no more than 20 percent with a view to ensuring independent management along sound banking principles. Majority ownership in a restructured BDM would be transferred to private investors associated with a well-established bank and regional and bilateral institutional investors. BDM's balance sheet would be restructured in three steps. First, the Government would assume, after negotiation with future private shareholders, all BDM loans deemed uncollectible. Although these loans would be removed from its assets, the restructured bank would endeavor to collect them on behalf of the Government on a commission basis. Second, the Government would negotiate with potential future shareholders the value of BDM's fixed assets. Finally, the asset adjustments mentioned above would be offset by loss of the Government's equity in BDM and the former's assumption of a portion of BDM's liabilities towards BCEAO. 36. Although the exact amount of financing required by the Government to complete these operations can be determined only after negotiation with potential private partnerq, debt to the BCEAO of at least CFAF 23 billion will be left uncovered by assets of the restructured bank. If this entire amount were to be consolidated under terms equivalent to those obtained thus far from the BCEAO 5/ payments of CFAF 1.4 billion would be due during each of the next 3 years and of CFAF 4.1 billion during each of the following 7 years. It is clear that neither BDM nor the Government could service this debt from their own resources over the medium term and that concessional financing will need to be mobilized. The Government, in cooperation with the BCEAO, the French authorities, the AfDB, and IDA, is 5/ Ten years at 6 percent with a 3-year grace period.  - 12 - developing alternative options for dealing with this debt. Although a number of Ways to deal with BDM debt are being explored, all necessitate a significant contribution by BCEAO including partial write-off or concessional rescheduling. Reduction of additional debt service to a level consonant with the Government's financial possibilities, would require consolidation of BCEAO obligations for 30 years at 3 percent per annum. A similar level of debt service could be achieved through the cancellation of a part of the accumulated interest and the consolidation of the remainder by BCEAO on currently available terms. Any shortfall in concessional relief from BCEAO would need to be met by additional bilateral financing. 37. The Government has prepared, with IDA-financed assistance, a technical prospectus that it has submitted in 1988 to potential local and foreign private shareholders. The prospectus (Annex V) describes the measures underway to restructure BDM's balance sheet and invites the prospective shareholders to negotiate their participation in the capital and management of a restructured bank on the basis of the following principles: (a) recapitalization of BDM at a level compatible with BCEAO regulations; (b) assumption by the participating bank of all management responsibilities, including the appointment of a qualified president, general manager and other high level staff; and (c) introduction of an adequate management system and organizational structure. inAlucling possible further staff reductions. Preliminary discussions are .Jerwayv th three private banks that have expressed interest in BDM. 38. The opening balance sheet of the restructured btn.k ane: the legal documents relating to the transfer of the majority cwriersh:.p v private interests and to the future operations of the bank wil' I'e sub'-i:ted to the Association for review. Satisfactory progress in xht ic.- ].:..iori of BDM restructuring is a condition for the release of the set-.'rl i.( t hlr tranches of the proposed credit. Postal Checking Reform 39. The Government is also undertaking a reform of the postal checking and savings system, in order to facilitate financial transactions and mobilize savings in areas not served directly by the banking system. The Government has severed all links between the Treasury an-s the postal financial system, in order to halt the use of postal checking resources to cover Treasury financing requirements. In addition, it has engaged consultants to prepare proposals which would assure that the postal financial system is managed independently of the nonfinanCial nIostal and telecommunications activities. The Government intends tCo imrtlement the required reforms during 1988 and to monitor closely the observance of existing regulations prohibiting monetary creation vi a the po)s tal checking system. Once adequate control measures are in place, the lquidity of the postal checking system would be reestablished by the fulli or Government arrears to OPT, as foreseen in the adjustment. progranm supported by the propcsed credit, and the freezing of some public: se :.or pcstal checking accounts.  - 13 - Financial Sector Policies 40. As a member of WAMU, Mali uses the common currency of the Union, whose convertibility is guaranteed by the French Treasury at a fixed parity with the French franc, and shares a common interest rate structure with other countries of the Union. WAMU thus imposes a certain discipline with regard to monetary and balance of payments policies and, correspondingly, constrains the use of some macro policy instruments. The Government, nonetheless, maintains control of certain key credit policies and proposes to prepare a plan of action for further financial sector reforms, subsequent to its restructuring of BDM and the postal checking system. The plan of action would focus on (a) strengthening market mechanisms for credit allocation by eliminating rigid sectoral credit allocations and revising procedures for the allocation of global credit ceilings among banks, (b) improving bank supervision by strengthening the National Banking Control Commission, (c) streamlining legal procedures for enforcing loan guarantees, and (d) reducing distortions engendered by the application of the "sales' tax (IAS) to financial transactions. Preparation of the action plan will be a condition for release of the second tranche of the proposed credit and satisfactory progress in its implementation will be a condition for release of the third tranche. D. Institutional and Legal Reforms 41. New PE Law. A new law (Loi No. 87-51/AN-RM) governing PE-government relations was passed by t' legislature and promulgated in August 1987 as part of the PE sector adjustment program. It constitutes an important re'r-frnition of the relations between PEs and Government and represents a major improvement in the institutional framework, particularly with regard to four key areas. First, the composition and functions of the board of directors has been redefined. Board members are to be appointed for their specific qualifications rather than ex officio; the supervising ministry will no longer be chairman of the board; and the independent decision-making responsibility of the boards has been increased. Second, general managers are to be appointed by the respective board of directors, rather than 'by Lhe supervising ministry. Third, Government oversight functions have been separated from management decisions. Finally, mixed-capital companies (soci6t6s d'6conomie mixte) have been excluded from the PE law, as they are to be governed solely by the commercial code. Thus Government's control rights in mixed-capital companies will be limited to those ot a shareholder as defined under the commercial code. The need for separate legislation to codify these principles for mixed-capital enterprises is under examination and progress in implementing any necessary action in this regard will be reviewed prior to release of the second tranche cf the proposed credit. New boards of directors will be named and the individual statutes of all state enterprises will be revised in accordance with the rew law. This process has already begun for the public utilities ad ot';er strategic enterprises and will be completed in 1988. Model statutes. applicable to all PEs, will be issued prior to release of the second tran.he .}f the proposed credit. Full application of the new  - 14 - legal framework to all PEs will be a condition for release of the third tranche. 42. Performance Contracts. A key feature of the new institutional set-up will be the requirement that all PEs conclude performance contracts with Government, specifying the objectives assigned to the PE, the respective obligations of PE management and Government to achieve these objectives, and the criteria for monitoring the PE's performance. Performance contracts, to be adjusted annually, would constitute three-year rolling corporate plans and the principles governing their preparation and execution have been set out in a Government circular. The preparation, negotiation, and signing of such contracts for EDM, and the new telecommunications and postal companies would be completed prior to release of the second tranche of the proposed credit, and those for COHANAV, OERHN and SONATAM would be completed prior to release of the third tranche. Assistance to implement the system of performance contracts would be provided by the proposed PE Institutional Development Project. 43. Employment and Compensation. Government is addressing two key personnel issues under its sectoral adjustment program: overstaffing and inadequate incentive packages for PE staff. The number of employees of the 35 enterprises covered in the first phase of the adjustment program has already been reduced by more than 10 percent from their 1982 levels. Approximately 700 PE staff have been laid off in ..e last six months and further reductions are expected before completion of the divestiture program. The financing plan for the PE sector adjustment program includes resources for the payment of severance pay to these employees as well as the establishment of a redeployment fund to facilitate their entry into private sector activity (see Part IV, Section D). In order to improve productivity among remaining employees, the Government intends to provide greater autonomy to PE management on personnel and salary issues. In this respect, a Presidential Circular has been issued instructing the concerned ministers to review all legislation that prevents PEs from operating like private commercial entities, including the current legal framework extending civil service wages and personnel practices to PEs (Loi No. 81-10). Revisions to the current law will be promulgated prior to release of the second tranche of the proposed credit. E. Rationalization of the Sector Financial Restructuring 44. Based on a cross-debt study of 35 key PEs, the Government has submitted to IDA a plan for the settlement of all arrears vis-a-vis Government, BDM, and other PEs. The plan involves (a) Government paying its arrears to PEs (net of offsetting PE arrears to Government), (b) PEs paying their net arrears to other PEs and other creditors, including Government assumption of irrecoverable BDM loans to PEs, and (c) the Government honoring its guarantees for debts of enterprises being  - 15 - liquidated. In addition, Government will cover severance pay obligations of redundant labor in PEs being divested. 45. The resulting financial restructuring entails the gradual settlement of arrears accumulated over a number of years. Some progress was made in this regard during 1986 and 1987 through the cancellation of offsetting otligations between parties and through the settlement of arrears with funds provided by the French Caisse Centrale de CooD6ration conomi&ue (CCCE). Over the next three years, the Government is committed to settling the remaining PE sector arrears, and to provide severance pay of approximately CFAF 3.5 billion (see Annex VI). Satisfactory progress in settling PE arrears wvould be a condition for release of the second and third tranches of the proposed credit. Divestiture 46. In order to reduce the burden of public enterprises on pub:ic finances and the banking system, the Government has established a divestiture program. A key objective of the program is state divestiture of PEs other than those providing essential public services or considered strategic. Of the 35 most important enterprises covered in the first phase of PE sector reform, the Government intends to retain majority state ownership of only 6 enterprises, namely the enterprises responsible for power and water (EDM), telecommunication and postal services (OPT), rail transport (RCFM), river transport (COMANAV), tobacco and matches (SONATAM), and management of the Selingue dam (OERHN). 47. The remaining 29 key PEs would be either privatized or liquidated. The Government has dissolved 15 of these enterprises and initiated liquidation proceedings to sell their assets and settle their liabilities. 6/ Liquidation is to be completed for ten of these companies prior to release of the second tranche of the proposed credit ar.d for the remaining five prior to release of the third tranche. Liquidation is already well advanced for a number of companies, including Air Mali, the former state airline. Air Mali's Boeing 727 aircraft is being sold to reduce outstanding liabilites; a long-term lease has been arranged for its Boeing 737; and its remaining debts are to be consolidated in a government loan. The Government has also decided to liquidate SOMIEX. All SOMIEX activities, with the exception of sales of existing stocks, were halted in May 1988. The Council of Ministers approved its liquidation in May 1988 and its liquidation will be completed by October 31, 1988. 48. With regard to privatization, majority control of two companies (ITEMA and SEPOM) has already been transferred to the private sector. The 6/ Air Mali, SHM, SAT, SCAER, SEBRIMA, SOCOMA, SOCORAM, SOMBEPEC, SOMIEX, SONEA, SONETRA, OCINAM, LPM, CMTR, AND EMAB.  - 16 - Government promulgated in Fe-ruary 1988 a law authorizing the opening of the capital of 12 additional enterprises for which it intends to reduce its shareholding to a minority position. 7/ Detailed privatization strategies for each of these enterprises were submitted to IDA in April 1988. They will be reviewed, along with each PEs' financial results, and revised as necessary prior to release of the second tranche of the proposed credit. Progress in their implementation constitutes a condition for release of the second and third tranches of the proposed credit. The Government does not intend to grant any unwarranted privileges to the new private shareholders of these companies, such as monopoly rights, exclusive import licenses, guaranteed purchased contracts, subsidized credits or budget subsidies. During this first phase of the adjustment program, studies for the remaining 22 PEa will be carried out in order to establish an action plan for these enterprises prior to release of the third tranche of the proposed credit. 49. The Government has established a redeployment fund, to assure the rapid settlement of severance pay obligations and to provide additional financing to facilitate entry into the private sector for PE employees losing their jobs as a result of the divestiture program. Initially the redeployment fund will focus on payment of severance pay. On the basis of an evaluation of experience under ongoing bilateral programs supporting the integration of former public sector employees into the private sector, the Government will submit for IDA review by end-1988 proposals for additional use of the redeployment fund. An evaluation of the redeployment program will be completed prior to release of the third tranche of the proposed credit. Enterprise Rehabilitation 50. The investment requirements of enterprises to remain entirely in the public domain will be included in the Government's investment budget and supported by bilateral and multilateral donors, including IDA. French and Canadian bilateral assistance is already in place for the rehabilitation of RCFM. COMANAV's rehabilitation is being supported by German bilateral assistance and Chinese assistance is envisioned for SONATAM. The next phase of EDM investments are to be supported by IDA, AfDB, EIB, France, Canada, and Germany. France is also preparing operations in support of future OPT investments. Of these six enterprises, EDM and OPT require substantial organizational restructuring if they are to perform their public service functions efficiently and effectively. Such restructuring is an integral part of the Government's PE adjustment program. 7/ EDIM, COMATEX, EMAMA, Grand Hotel, PPM, SEMA, SEPAMA, SMECMA, SOCAM, SOCIMA, TAMALI, AND UCEMA.  - 17 - 51. EDM (Electricit6 du Mali). EDH has responsibility for the distribution of both electricity and water. Since completion of the S&lingud dam and hydroelectric plant in 1981, the responsibility for the power sector has, however, been split between EDM and OERHN (the managing company of S6lingu6). This has led to to severe managerial and financial problems. EDM's own internal structure has, moreover, been poorly adapted to the different requirements of its electricity and water operations. The most pressing financial problems were partially resolved in August 1985 by electricity and water rate increases averaging 35 percent and 200 percent respectively, and collection procedures are being strengthened under an ongoing IDA-financed power project. In order to resolve the outstanding institutional issues, the Government has given EDM authority for planning and executing future power sector investments, 8/ and established a detailed schedule for (a) separation of water and power activities within EDM, (b) preparation of a management contract between EDM and OERHN and the integration of EDM and OERHN power staff, and (c) revision of the legal texts regulating the sector (see Annex IV). 52. OPT (Office des Postes et Telecommunications). OPT provides domestic telecommunications, post., and postal checking services. In order to assure more efficient delivery of theae services and financial transparency between different activities, the Government has decided, as part of ar. action plan agreed upon with Lie Association, to (a) create and sign performance contracts with separate telecommunications and postal companies by January 1989, (b) merge domestic telecommunications services with international services, and (c) reform tl. postal checking system, in order to assure its future liquidity. With regard to postal checking services, the Government has already severed a'l links with the Treasury and has launched a study to elaborate the specific measures to be taken in order to ensure that it is subject to sound financial operating procedures (see Section C, above). The Government intends to implement these additional postal checking reforms by January 1989. Technical support for the establishment of the new post and telecommunications companies will be provided under the proposed PE Institutional Development Project. 53. Other Enterprises. The physical rehabilitation of PEs to be privatized and related working capital requirements will, to the extent feasible, be financed by new shareholders through cash purchases of newly issued PE shares and new borrowings. Any future Government commitments to these enterprises will be included in the annual investment budget and reviewed in that context. The future requirements of the textile industry are particularly problematic and the Government has agreed to prepare an action plan for the sub-sector by April 1989. 8/ With the exception of regional and multi-purpose projects.  - 18 - F. Program Implementation 54. In order to resolve the coordination problems which delayed preparation of the proposed credit, the Government instituted a new organizational structure for implementation of its PE adjustment program in January 1988. Henceforth, responsibility for implementation of the program lieo with an interministerial commission, chaired by the Prime Minister and composed of the Ministers of Plan, Finance, State Enterprises, Information, Employment, and Industry. The Cabinet Director of the Prime Minister's office will chair a technical committee charged with day-to-day implementation. The implementation responsibilities of the Ministry of Plan and the Ministry of Finance have been clearly defined and special units have been created in both ministries to monitor execution of elements under the control of their respective ministries. The Ministry of P:.an will also be the executing agercy for the parallel PE Institutional Development Project which furnishes the specialized technical skills and advisory services required for the program's execution. PART IV - THE PROPOSED CREDIT A. Credit History 55. The proposed credit supports the Government's sectoral adjustment approach to the PE sector. It is the first sector adjustment credit to Mali. Previous sector reforms in the cotton, rice, and roads sectors have been directly supported by IDA investment operations. 56. The origins of the credit stem from a diagnostic study of the PE sector undertaken in 1982 and the Government's decision in 1983 to prepare a comprehensive sector reform program. Specific reforms were prepared with support from the IDA Economic Management and Training Project (Cr.1307-MLI) and from a PPF for the parallel PE Institutional Development Project. The PPF financed diagnostic studies of selected PEs, a cross-debt study, audits of PEs to be liquidated, and consultant advisors needed to initiate implementation of the program. 57. The credit has had a long and difficult preparation. It was appraised, largely as a sector rehabilitation project, in November 1984 and substantially revised to strengthen its sector reform components in late 1985. Several post-appraisal missions were undertaken to reach agreement on these reUisions and to meet outstanding conditions for negotiations. In July 1986, negotiations began in Washington with a Malian delegation headed by the Minister of Plan but were not completed, pending preparation of consultant proposals on banking sector reforms. Moreover, the main elements of the program that were negotiated were not approved by the Council of Ministers after the return of the Malian delegation because of lack of agreement within the Government on the proposed reforms. Little progress was made during the ensuing year as severe leadership and coordination problems within the Government stalled action on most adjustment issues. 58. The situation changed in June 1987 when the Prime Minister requested that a high-level Bank mission visit Bamako to help resolve  - 19 - problems blocking impl neatation of the program. As the result of this mission in July l9E7 and subsequent discussions at the Annual Meetings in September 1987, it vt decided to proceed with the proposed credit as the first phase of support for implementation of the Government's hndium-term policy framework. Performance in putting in place the prcgr&m woula, in turn, be a key determinant of preparation of subsequent reforms under a structural adjustment program. A re-appraisal mission visited Bamako in November 1987 and negotiations of the proposed credit were held in Bamako in March 1988. Supplemental data on the credit are provided in Annex VII. The PE Institutional Development Project was prepared, appraised, and negotiated concurrently. B. Relationship of Credit to Proposed Reform Proaram 59. The proposed credit would Fupport the first phase of the Government's medium-term adjustment program, as described in its policy framework paper. The present operation would focus on reforms in the PE sector, based on the rationale presented in Part III. Subsequent phases, to be supported by IDA structural adjustment lending, would focus on macroeconomic and interse,toral issues including budget restructuring, tax reform, and trade reform. Government has provided the Association with a Letter of Sectoral Policy (Annex III) which describes the specific measures that have been or will be taken during the first phase of the adjustment program. These measures are summarized in the matrix of Annex IV. The credit would ease Mali's financial strain during the adjustment period, not only with respect to external capital requirements, but also by increasing budgetary resources available for the financial restructuring of the PE sector (Annex VI). C. Effects of the Adiustment Program 60. in the medium term, the structural improvements in the PE and financial sectors would make it possible to gradually increase economic growth without exacerbating cxisting strains on the budget and balance of payments. While the reform program will improve the policy environment, the extent of supply responses is uncertain due to Mali's limited resource base and low level of development. A necessary corollary to the policy reforms, therefore, is a concerted development effort to strengthen the country's physical and human resources. This will be a long-term process and substantial work is needed to formulate a development strategy which would allow the economy to grow on a sustained basis. 61. Scenario without Adiustment. A continuation of policies pursued before the adjustment program would entail very high costs for Mali's economy and population. GDP growth in this case would be seriously limited by public finance and balance of payments constraints, as well as by a further deterioration of the banking sector. The availability of additional external financing, particularly non-project aid, would be further reduced. This would constrain overall budgetary outlays while unmet debt service obligations would continue to grow. Delivery of public services would be negatively effected and public investment severely  - 20 - reduced, thus compounding the inefficiencies of the public sector and reducing long-term growth prospects. Given external financing constraints, the current account def2.cit would need to be smaller, thus constraining imports. Despite lower growth and borrowing, the debt service burden would reach unsustainable levels. 62. Adiustment Scenario. The adjustment program should allow the country to achieve economic growth averaging 4 percent per annum in the early 1990s, barring periods of drought to which Mali remains vulnerable. The agriculture sector would remain the primary source of this growth, although the trade and manufacturing sectors would gradually increase their relative contributions to GDP. The divestiture of public enterprises would help mobilize private resources for investment ir the modern sector while continued price lib-raiization and streamlining of government regulations would promote a more efficient allocation of resources. Remaining PEs would also become more productive. 63. These reforms, in conjunction with the financial program negotiated with the IMF, would enable the Government to reduce budget deficits to a sustainable level in the early 1990s and improve the country's balance of payments. Increased efficiency of the modern sector would eventually result in the expansion of import-competing activities and small-scale export industries. Interest payments on foreign debt would stabilize through a more prudent external borrowing strategy. However, high gross capital inflows in the form of grants and very concessional loans would continue to be required to assist Mali in meeting heavy debt repayment obligations. 64. Impact on PE and Financial Sectors. The direct effects of t} PE sector adjustment program would be to improve PE performance and reduce the burden they have placed on both the banking system and public finE.nces. A fundamental restructuring of the BDM has already begun and the size of the PE sector has already diminished relative to the rest of the modern sector. The BDM reforms will dramatically improve the financial soundness of the banking system and increase the availability of credit for private productive activities. Moreover, PEs would become more effic:.ent as a result of reforms to the incentive system and the institutional framework. In particular, the liberalization of prices and greater autonLomy and responsibility vested in enterprise management would yield improved f'nancial results and higher quality services. Greater flexibility of enterprises in setting wages and employment levels would improve work incentives for employees and reduce the inefficiencies due to overstaffing. The program of financial restructuring and settlement of cross-arrears would be accompanied by more rigorous financial discipline, which would reduce the risk of a reappearance of arrears whose buildup substantially hampered the functioning of enterpris.as in the recent past. Finally the reduction of the sector's size through divestiture of selected PEs would result in a better allocation of scarce managerial and financial resources among the remaining strategic enterprises.  - 21 - D. Social Impact 65. The sector adjustment program would allow a gradual improvement in living standards in Hali mainly by reducing the financial burden on the banking system and public finances. In the absence of the adjustment progL,m, living standards would be curtailed significantly as a result of the reduced availability of external resources and constrained imports. Prospects for rapid increases in per capita income remain very limited, however, given population growth and the weak resource base. On balance, the social costs of Mali's medium-term adjustment program are small relative to those incurred under a non-adjustment scenario. 66. The restructuring of the PE sector does, however, have a direct impact on some social groups in the short term. Measures introduced to reduce overstaffing in key enterprises have already resulted in a Fignificant reduction in the size of the PE sector labor force, and further iayoffs will occur in those PEs still to be privatized or liquidated. In tae long run, these workers are expected to be absorbed by the gradual expansion of the private sector. In the short term, this dislocation would be partially offset through the establishment of a redeployment fund to cover severance pay obligations and additional financing to facilitate entry into the private sector. The redeployment fund is an integral part of the Government's PE sector adjustment program to be supported by the proposed credit. The Government is currently experimenting with a variety of other programs--supported by bilateral donors--in order to define the most effective approach for the integration of former public sector employees into the private sector. A follow-up survey on a sample of the affected individuals would be carried out, under the proposed PE Institutional Development Project, to document the history of laid-off employees with a view to expanding or redesigning existing programs in subsequent phases of the adjustment program. E. Benefits and Risks 67. The main benefits of the reform program are (a) improved resource allocation and operational efficiency in both the public and private sectors as a result of the policy and institutional reforms incorporated in the program and (b) a reduction of the financial burden of the PE sector on the Malian economy through a reduction of the sector's size and improved PE performance. The benefits will manifest themselves in the short term as reduced PE losses, greater credit availability for productive activities, improved liquidity as the result of cross-arrears settlement, improved distribution of goods and services within the country as prices are liberalized and monopolies abandoned, and improvement in the quality of services provided by restructured public utilities. In the longer term, bencfits will arise from the more productive use of existing resources, improved credit allocation, and better puDlic investment decisions. The program should also be seen as the first phase of a longer-term adjustment process intended to lay the foundation for sustained economic growth in the future.  - 22 - 68. The main risk associated with the program is that, despite the important actions already taken, continued liberalization of the economy and divestiture of non-essential enterprises would prove politically unacceptable. It should also be noted that the success of the program depends on changing the behavior and attitudes of managers and officials who have become accustomed to an excessive reliance on controls. The proposed reforms specifically affect the institutional relationships among ministries that have vested interests in the status quo. Clear and deliberate implementation by the Ministries of Finance, Plan, and State Enterprises, as well as adequate coordination at the Prime Minister's lvel, will therefore be necessary to overcome potential resistance. The new institutional structure put in place to monitor the program's implementation, however, demonstrates high-level government commitment to the program a,d is designed to provide the necessary coordination for effective implementation (see part III, Section F). In addition, the parallel PE Institutional Development Project would provide both the Government and PEs with critical advisory services and technical analyses to support this effort. An additional risk associated with the overall adjustment program is the possible failure of aid donors to respond generously and quickly enough to Mali's financial requirements. The fragility of the reforms and the gap between Mali's financing needs and its own resources necessitate the mobilization of a steady flow of quick- disbursing external resources during the adjustment period. F. Credit Amount 69. The proposed IDA credit of US$40 million equivalent, together with the proposed US$38.7 million equivalent from Japanese contributions to the Special Joint Financing Facility for Africa (SJF), US$5.9 million equivalent from Saudi contributions to the SJF, and US$45 million equivalent from the African Development Fund (ADF), would finance about 7 percent of Mali's merchandise imports in the period April 1988 to December 1990 and meet about 9 percent of the country's gross external capital requirement for the same period. The amount of the proposed IDA contribution was determined on the basis of the IDA allocation for Mali, taking into account other priority needs for which IDA assistance has been requested. G. Disbursement, Procurement, Administration and Auditing 70. The proposed IDA credit would be disbursed in three tranches and is expected to be fully disbursed within 30 months of credit effectiveness. The first tranche of US$16 million equivalent, would be available upon credit effectiveness. The second tranche of US$12 equivalent, would become available about nine to twelve months later. Disbursement of the second tranche would be contingent upon satisfactory progress made by the Government in carrying out the sectoral adjustment program, as outlined in Annex 7TT. The third tranche of US$12 million, would become available about nine to twelve months later, contingent upon continued satisfactory progress in implementing the program.  - 23 - 71. The Government of Mali would be the Borrower. The BCEAO would be responsible for maintaining the credit accounts and submitting withdrawal applications and supporting documentation to the Association. Disbursesant and procurement procedures have been designed to ensure a rapid drawdown of the credit proceeds. The credit would reimburse 100 percent of the foreign exchange cost of eligible imports on the basis of evidence that they were imported and paid for not more than four months prior to credit signing. Retroactive financing would be limited to 20 percent of the proposed credit. Imports in CFAF from other WAMU countries would be eligible. Expenditures for goods procured under invoices for US$10,000 equivalent or less would not be eligible for financing in order to reduce the number of transactions. 72. Both private and public sector imports would be eligible for financing. Imports by private sector entities would be in accordance with normal commercial practices. For public sector imports, procurement would be made through international competitive bidding in accordance with IDA guidelines for contracts of US$1 million equivalent or more, while contracts for the procurement of goods estimated to cost less than US$1 million equivalent each would be awarded on the basis of the normal procurement procedures of the purchaser. Certain commonly traded commodities may be purchased through price quotations available from organized international commodity markets. For contracts less than US$1 million equivalent, reimbursements would be against statements of expenditure. Supporting documents related to these contracts would be retained in the BCEAO and made available on request to the Association for review. The CFAF counterpart funds generated by the use of credit proceeds would be devoted to financing general development expenditures in government budget years 1988, 1989, and 1990. In particular, they would help finance Government obligations in the financial restructuring of the PE and financial sectors--including settlement of cross-arrears, and severance pay. The Borrower would open a special account fcr the IDA Credit at the BCEAO on terms and conditions satisfactory to the Association. The authorized allocation would be CFAF 1.5 billion equivalent. 73. With regard to auditing, the proposed PE Institutional Development Project includes financing for the external audit of both the PE Sector Adjustment Credit and the PE Institutional Development Project. An audit report, conforming to internationally accepted standards and prepared by auditors approved by the Association, would be submitted to the Association within six months after the completion of the disbursement of the proposed credit. H. Monitoring and Tranche Release 74. The above-mentioned interministerial committee, chaired by the Prime Minister, would be responsible for monitoring progress under the present operation. Following the disbursement of the first and second  - 24 - tranches of the credit, Government would submit to the Association reports evaluating the progress made in implementation. These reports would serve as a basis for progress review of the program which, in turn, would form the basis for the release of the next tranche. Government would submit to the Association a final report on the implementation of the adjustment program upon full disbursement of the credit. PART V - BANK GROUP OPERATIONS 75. As of December 31, 1987, the Association h-.d extended 36 credits to Mali, bringing total commitments of IDA funds to US$424 million equiva'.ent. Of these operations, 13 have been for agriculture and related activities; 9 for transport; 3 for education; 2 for telecommunications; 2 for energy; 2 for urban development; and one each for small-scale industries, power and water supply, technical assistance, rural water supply, and health. In addition, the International Finance Corporation has made two investments totalling US$3.2 million. Project implementation has been generally satisfactory, despite difficulties and delays caused by inadequate Government counterpart financing. Mali's disbursement ratio rose to 24 percent in FY87 which is relatively high for a country with no quick-disbursing adjustment operations. Annex VIII contains a summary statement of Bank Group Operations in Mali as of March 31, 1988. 76. IDA's lending strategy in Mali has become increasingly policy-oriented in recent years. Operations have been designed to further policy reform in addition to laying the foundation for long-term growth and development. The Association has financed a technical assistance project (Cr. 1307-MLI) to strengthen economic management by providing advisory services to improve financial and economic policies and training to Malian civil servants. This has been followed by a series of operations which are supporting important reforms in specific sectors in addition to addressing long-term physical development constraints. For example, the Second Mali-Sud Rural Development Project (Cr. 1415-MLI) is supporting a comprehensive reform of the cotton sector, while the Third Education Project (Cr. 1442-MLI/SF10) and the Fifth Highway Project (Cr. 1629-MLI) are designed to improve planning and resource mobilization and allocation in their respective sectors. 77. The IDA lending strategy has stressed sectoral adjustment in order to deal directly with the most pressing adjustment issues and to focus limited government implementation capacity on specific problems. The PE sector adjustment operation represents the culmination this approach. It deals with key sector ajustment issues that have been an important stumbling block to broader intersectoral and macro reforms and introduces the first phase of reforms in public resource management and incentives policies. The next phase of IDA's policy-based lending will focus on macroeconomic and intersectoral issues, including the restructuring of current expenditure, improved investment screening, fiscal reform, and trade liberalization. IDA has begun discussions aimed at formulating a medium-term structural adjustment program addressing these issues. In this  - 25 - regard, a medium-term policy framework paper has been prepared by the Government, with assistance from Fund and Bank staff. 78. Mali's long-term grow-h prospects also depend on the full realization of its natural and human potential. The Association has accordingly financed, and will continue to finance, key projects designed to exploit and augment that potential. First priority will continue to be given to the development of the rural sector, the most important sector for longer term growth of the Malian economy. Major emphasis will also be placed on human resource development. Operations in the health, water supply, and education sectors will be designed to develop Mali's human resources by expandir,g the population's access to basic education and improving their health and productivity. The Association will also attempt to broaden its dialogue with Government concerning the interrelated issues of Mali's high population growth rate, deterioration of its fragile resource base and budgetary constraints which hinder the provision of basic services. Future infrastructure projects, to be chosen on a very selective basis, will attempt to ensure that the benefits of past investments are fully realized and that Mali's future growth is not constrained by inadequate capacity in its transport, telecommunications, and energy sectors. To maximize IDA's impact, these projects will, whenever possible, reflect a broad sectoral orientation in order to focus on the issues of investment strategy and institutional development. PART VI - COLLABORATION WITH THE IMF AND OTHER DONORS 79. Preparation of the proposed adjustment operation has been carefully coordinated with the IMF. IMF and Bank staff worked closely on the preparation of the medium-term policy framework paper and the first-year program to be supported by the Fund's Structural Adjustment Facility (SAF). Bank staff also worked closely with IMF missions that visited Mali in 1986 and 1987, particularly with regard to initial PE reforms. Draft documents and views were exchanged at every stage in the processing of the proposed credit, and the financing plan for restructuring the PE sector was prepared in close consultation with the IMP staff. IMF staff is in agreement with the program which is complementary to that to be supported by an IMF program for 1988/89. Moreover, conditionality in the IMF supported program corresponds to that in the present operation. 80. The nature of Mali's adjustment efforts, particularly for the PE sector, calls for a highly collaborative approach with other concerned donors. The AfDB, a cofinancer of the proposed operation, has been particularly active in the consultative process with IDA and Government. Financial sector reforms, particularly those related to BDM restructuring, have required intense cooperation with the French Treasury and Ministry of Cooperation. The French CCCE is also directly involved in the rehabilitation of key enterprises, particularly EDM, OPT and RCFM, and has been directly involved in the discussions leading up to the proposed operation. UNDP support to the Malian National Commission for Administrative Reform has also played a key role in preparation of the institutional and legal reforms supported by the operation.  - 26 - 81. To encourage more general aid coordination, the Government is considering the preparation of a donors meeting on macroeconomic and adjustment issues as a follow-up to the Round Table held in December 1985. The Government's medium-term policy framework and financing plan for the public sector would be presented to key donors at such a meeting. The meeting would specifically address the need for increased non-project assistance to support policy reform and the reorientation of assistance away from new physical investment projects toward financing recurrent local costs needed for efficient operation of existing facilities. PART VII - RECOMMENDATIONS 82. I am satisfied that the proposed IDA Credit would comply with the Articles of Agreement of the Association and.' recommend that the Executive Directors approve the proposed Credit. 83. I am satisfied that the proposed Japanese grant would comply with the provisions of the letters exchanged between Japan and the Association of November 20, 1985 and recommend that the Executive Directors approve the proposed Japanese grant. B. Conable President Washington, D.C. June 1988  - 27 - AM= I Page 1 of 3 Table 1. MALI: MZ MAUOSOWINhIC INDICATOS 1963 1964 1905 1986 8t7 1968 1969 1990 ast. . (projecttd) . GDP Growth Rate -5.2X 0.95 -0.7X 18.62 3.95 -0.81 5.05 4.11 ODPICapita Gro/th late -7.5X -1.S -3.15 15.7 1.42 -3.32 2.4X 1.62 Consuption/Capita Growth late -0.72 -2.32 -1.62 2.82 1.O -0.01 1.02 1.O0 Debt Service (US$ SIllon) (a) 39.5 40.2 46.3 79.4 88.0 89.8 93.8 95.1 Debt Servicel/7S (a) 19.12 17.32 21.0X 30.9X 27.11 26.82 27.42 25.42 Debt ServiceI XGS (b) 19.12 17.32 21.01 30.9Z 27.12 34.8X 35.02 30.62 Debt Servlc*1CDP (a) 3.72 3.82 4.42 5.12 4.52 4.22 4.12 3.62 Cross Ir sta_ntiCDP 14.62 15.22 19.52 22.22 18.42 18.42 17.42 17.52 Dc am tic Savings/CDP -4.92 -2.22 -14.21 -2.12 1.52 0.12 O.1X 1.62 Public Investmnt/ODP (e) 14.62 14.62 17.62 15.72 13.82 14.7X 14.02 13.72 Private InvestmentICDP (c) 3.6X 3.72 4.42 3.92 3.22 3.72 3.35 3.82 Ratio of Public/Prlvate Ina. 4.1 3.9 4.0 4.0 4.3 4.0 4.2 3.6 Government Revenus*/CIP 13.32 13.3Z 14.92 17.42 15.22 17.22 17.22 16.8X Governmnt Expenditures/GDP (d) 16.22 15.32 30.22 29.52 25.5Z 26.45 25.1X 24.11 Deficit (-) or Surplus (+)IGDP -2.92 -2.02 -15.22 -12.22 -10.32 -9.1l -7.8X -7.32 Export Vol. Growth Rate 21.02 14.02 -18.22 13.81 9.41 -4.12 2.82 3.4X Exports (fob)/GDP 15.32 18.1S 16.6X 13.12 13.32 13.22 12.71 12.82 Import Vol. Growth Rate (e) 1.32 6.22 18.22 -0.02 -5.52 5.22 3.62 2.52 Imports (cif)/GDP 32.52 34.72 44.35 31.62 25.32 26.6X 25.41 24.32 Current Account (US$ mXILLon) 212.4 196.5 329.5 358.6 313.1 383.4 395.8 394.7 Current Account/GDP -19.72 -18.52 -31.12 -22.82 -16.02 -17.72 -16.82 -15.62 (Ca) Excluding China end the USSR, including estimates for interest on new disburseemnts. (b) As per (Ca), plus debt service arrears to be settled in 1988-90. (c) Fixed capital formation, i.e.. excluding changes in stocks. (d) Data for 1983-4 exclude foreign-financed investmnt and are not comparable with data for subsequent years. (e) Excluding cereals imports, which consist largely of food aid and tend to vary inversely with GDP.  - 28 - ANNEX I Page 2 of 3 Table 2. XALI: 21ALACZ OF PAYDCCTS (US$ million) 1963 1964 196S 1986 1967 1988 1989 1990 ................... (aetual) . . ................. ....... (projected). A. Exports of Goods & Mg 206.3 232.7 220.1 257.1 325.0 357.2 376.0 408.4 1. Merchandise (703' 165.1 192.0 176.1 205.7 260.0 285.8 300.S 326.7 2. NMn-fector Servlees 41.2 40.7 44.0 51.4 65.0 71.4 75.2 81.7 B. Imports of Goods & NWS -415.6 -430.6 -577.7 -637.4 -655.1 -754.6 -785.3 -815.6 1. merchandise (FO) -247.3 -254.8 -328.5 -347. -345.5 -403.4 -419.4 -432.5 2. NoM-Fector Serviesc -168.2 -175.8 -249.1 -290.3 -309.6 -351.1 -366.0 -383.1 C. Resource Balance -209.3 -197.8 -357.5 -380.3 -330.1 -397.4 -409.3 -407.2 D. Net FVator Income -26.5 -19.5 -18.7 -24.8 -27.9 -33.6 -35.4 -37.5 S. Not Current Trawsfers 23.4 20.8 46.7 46.5 44.9 47.5 48.9 50.0 F. Current Account Balance -212.4 -196.5 -329.5 -358.6 -313.1 -383.4 -395.8 -394.7 G. Long-Term Capital Inflow 197.7 155.4 294.9 311.3 309.8 349.3 371.4 378.6 2. Official Capital Grants 114.2 1 0.4 197.0 185.7 202.3 214.6 217.5 230.7 3. Net LT Loans (DRS data) 149.0 113.9 81.3 145.3 98.6 99.1 61.8 -18.5 a. Disbursements 156.7 12.~ 6 106.9 167.9 117.3 155.6 117.1 75.1 b. Repayments -7.7 -11.7 -25.6 -22.6 -18.8 -56.4 -55.4 -93.6 4. Other LT Inflows (Net) -65.5 -45.9 16.6 -19.6 8.9 35.5 92.2 166.4 B. Total OtbUr Item (Net) 0.0 0.0 -14.8 -3.8 -4.0 0.0 0.0 0.0 I. Change in Net Reserves 14.7 1.0 4