Guinea - Second Structural Adjustment Program Project

Document of The World Bank FOR OmcAL USE ONLY Repot No. P-4805-GUI REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 47 MILLION TO THE REPUBLIC OF GUINEA FOR A SECOND STRUCTURAL ADJUSTMENT PROGRAM May 24, 1988 This document has a resticted 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 (Annual Average, Guinean Francs per US Dollar) 1986 GF 345 1987 GF 428 FISCAL YEAR January 1 - December 31 GLOSSARY OF ACRONYMS AfDF African Development Fund CBG Compagnie de Bauxite de Guin4e CCCE Caisse Centrale de Cooperation Economique (Francet CCEF Comite de Coordination Econdmique et Financier EMSP Economic Management Support Project IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund MEF Ministry of Economy and Finance MID Ministry of Interior and Decentralization MPCI Ministry of Plan and International Cooperation MRAFP Ministry of Administrative Reform and Civil Service PFP Policy Framework Paper PIP Public Investment Program OECF The Overseas Economic Cooperation Fund of Japan SDR Special Drawing Rights SJF Special Joint Financing  FOR OMCIAL USE ONLI - i)- REPUBLIC OF GUINEA STRUCTURAL ADJUSTMENT CREDIT Table of Contents Page PART I - THE EC.ONOMY Background ......... ............ ..........**. 1 The Economic and Financial Reform Prograr3............... 3 Economic Performance and Current Issues ................. 9 PART II - THE GOVE2NMENT'S STRUCTURAL ADJUSTMENT PROGRAM Consolidation of the Market-oriented Economic System .... 12 Strengthening the Management of the National Economy .... 15 Sector Strategies ....... ............. .. .... ........ 22 social Policy .......... ................. ..................... 23 PART III - ECONOMIC AND FINANCAL IDMPACT OF THE ADJUSTMENT PROGRAM Projected Medium-Term Prospects for Growth .............. 25 External Financing Requirements ..................... 27 PART IV - THE PROPOSED CREDIT Objectives and Description .............. .... ............ 31 Monitorable Actions and Conditions for Tranche Release.. 31 Financing ...... ................. .. ....... .......... 33 Coordination with the IMF .............................. . 34 Credit Administration and Management ..... ........ ...... 34 Procurement and Disbursement .................. ........... 35 Benefits and Risks ............. ....... ............... . .. . .. 35 PART V - BANK GROUP OPERATIONS AND STRATEGY .................. 36 PART VI - RECOMMENDATION .. ....... .................. ........ . 39 ANNEXES ANNEX I - Social Indicators ANNEX II - Economic Indicators ANNEX III - Supplementary Loan Data ANNEX IV - Status of Bank Group Operations in Guinea ANNEX V - Development Policy Statement and Policy Matrix This document has a restricted distribution and may be used by recipients only in thc Performance of their official duties Its contents may not otherwise be discled without Wodd Blank authorization.  - ( ill) - REPUBLIC OF GUINEA SECOND STRUCTURAL ADJUSTMENT CREDIT Credit Summary Borrowert Republic of Guinea Amounts: IDA Credit; SDR 47 million Termss Standard IDA with 40 years' maturity Cofinancins: African Development Funds UA 10 million (US$12 million equivalent); Government of Japan: Yen 1,000 million (US$7.9 million equivalent) OECF credit and Yen 425 million (US$3.3 mill.on equivalent) grant, to be administered by IDA. Protram Descriptions The Credit would support the second phase of the Government's Economic and Financial Reform Program and address key constraints on Guinea's meditum-term growth potential. The objective of the Program is to achieve an annual average GDP growth rate of about 4 percent through 1993 while improving the internal and external payments equilibria. The major elements of the program are improvements in rublic finance management (enhancement of revenues and control of expenditures); further restructuring of the public enterprise sector; measures to enhance the participation of the poor in future growth and alleviation of the transitory costs of adjustment; and creation of a better managed and more effective civil service. The Government will further reinforce the incentive system to favor the private sector through appropriately flexible and realistic exchange and interest rate policies within a market-oriented price and trade regime. External debt management will be strengthened. The Credit will provide foreign exchange to finance non-military imports. Riskss The principal risks associated with the proposed Credit  - (iV) - are the uncertainty of international aluminum market prices, the possibility that the Guinean adwinistration would be unable to implement the program fully or in a timely fashion, and resistance of interest groups benefitting from the status quo. The risk arising from administrative weakness will be offset by the provision of technical assistance and training under an IDA Economic Management Support Project prepared in parallel with the Credit. Estimated Disbursemewts: The Credit would be disbursed in two tranches over the next 18 months. The first tranche of SDR 21 million (US$29 million equivalent) would be available upon effectiveness and the second tranche of SDR 26 million (US$36 million equivalent) upon satisfactory progress in implementing the program. Performance reviews would be carried out before tranche release and at the end of the program.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT OF SDR 47 MILLION TO THE REPUBLIC OF GUINEA FOR A SECOND STRUCTURAL ADJUSTMENT PROGRAM 1. I submit the following report and recomendation on a proposed Development Credit of SDR 47 million (US$65 million equivalent) on standard IDA terms with 40 years' maturity to the Republic of Guinea to support the second phase of the Government's structural adjustment program. The African Development Fund (AfDF) would cofinance the program with UA 10 milfion (US$12 million equivalent). Financing is also expected to be provided from the Special Program of Assistance to Low Income Debt Distressed-Countries. Japan would provide Yen 425 million (US$3.3 million equivalent) in Special Joint Financing to be administered by IDA and Yen 1,000 million (US$7.9 million equivalent) in concessional OECF credits. The European Community would also provide a grant of ECU 12 million (US$14 million equivalent) in parallel financing in support of the adjustment program. Additional bilateral financing linked to the structural adjustment program would be provided by Prance and the United States in the amounts of FF125 million (US$23 million equivalent) and US$8 million respectively. PART I - THE ECONOMY 2. The most recent economic memorandum (Report No. 4690-GUI) was distributed to the Executive Directors in February 1984. Developments since that period have been described in the President's Report (Report No. 4162-GUI) to the Executive Directors on the First Structural Adjustment Credit (January 1986) and the Policy Framework Paper presented in July 1987. The following section summarizes developments described in these reports and updates the information on the performance of the Guinean economy. Updated country data appear in Annex I1. Backsround 3. Guinea's agricultural, mineral and energy resources make it one of Africa's richly endowed countries. Yet, per capita income in this country of 5.6 million (1986) inhabitants is less than US$300 (1986), placing it among the least developed countries as defined by the United Nations. Living standards are uniformly poor, as reflected in key social  -2- indicatorss life expectancy is 37 years, infant mortality is about 160 per thousand, more than 80 percent of the population lacks access to safe water and, 80 percent of the population is illiterate. 4. In September 1958, Guinea became the first independent nation of former French West Africa. From being a major exporter of agricultural products at independence, Guinea's economy was transfurmed by the Aid-1970s into that of a major bauxite exporter and a net food importer. The private sector was largely displaced by a pervasive network of state enterprises in all sectors of the economy. Urbanization accelerated as productive activities and incomes were increasingly shifted from the rural to the urban sector. 5. Emphasis on state-led development did not achieve the desired modernization and industrialization; the currency became increasingly overvalued under pressure from the inefficient public sector and resulted in serious misallocation of resources creating disincentives to exports; the inability to mobilize domestic savings led to an increasingly heavy debt burden; and, the dynamic ag;icultural sector retreated into subsistence production. Throughout the 1958-84 period, the economy prod"ced at levels well below potential due to inadequate producer incentives and deteriorating physical infrastructure. Economic growth remained below the rate of population increase of close to 3 percent per annum, except in 1973-76 when activity was stimulated by expanding bauxite operations. The economy became increasingly dualistic. The official sector depended on bauxite exports for its income and functioned through an elaborate system of administered prices linked to a highly overvalued currency 1/ while the non-official sector, which derived its income from clandestine exports and private transfers from abroad, was supplied largely by smuggled or pilfered imports. Its scope expanded steadily as the supply of goods imported through official channels became insufficient to meet demand for foodstuffs and other essential goods. By the early 1980s, the non-official sector satisfied about 80 percent of urban consumer demand and virtually all demand for marketed consumer goods outside Conakry. 6. The extended deterioration of Guinea's economy was reflected in increasingly severe financial difficulties by the early 19808. The financial position of the Government itself was eroded chiefly by poor performance in the parastatal sector. Tax receipts and transfers from the enterprises declined as the private sector grew to dominate consumer trade, while budgetary subsidies to the enterprises expanded. The economy's esternal position became unsustainable, chiefly the result of public investment outside the mining enclave which failed to generate returns adequate to service the associated external debt. Mounting debt service obligations and private capital flight, unmatched by increments in capital /1 The Guinean syli (GS) traded officially at 23 GSJ$US at the end of 1985 as against a parallel market rate of about 400 GSI$US.  -3- inflows, resulted in a continual rise in foreign liabilities of the Central Bank and a massive accumulation of payments arrears amounting to o%er US$300 million at end-1985. The Economic and Financial Reform Program 7. The military coup that brought a new regime to power on April 3, 1984 signalled a dramatic change in Guinea's political and economic policies. In an effort to reverse the longstanding deterioration of the economy and redress financial imbalances, the new leaders embarked in late 1985 on a series of ambitious economic and financial reforms supported by a fi:st Structural Adjustment Credit including Special Joint Financing from Germany and Japan, and cofinancing from Switzerland, France and the United States. The reforms were further supported by two consecutive IM Stand-By Arrangements and a first annual arrangement under the SAP. S. The overriding objective of the Government's program was to free the economy from pervasive state controls and government intervention and to put in place a policy framework supporting a market oriented economic system. Specific measures to meet this broad objective were designed tos Ci) correct the serious overvaluation of the currency; (ii) establish a new, reliable banking system to replace the defunct state banks; (iii) decontrol prices; (iv) liberalize internal and external trade; (v) introduce institutional reforms to promote private sector savings and investment; (vi) reduce the scale and improve the efficiency of the public sector by cutting employment levels and by withdrawing from cownercial and industrial activity; and, (vii) reorient public investment towards supporting the directly productive sectors. 9. Honetarv and Banking Reform. In a major reform in early 1986, the Government replaced the overvalued currency with a unified rate, reflecting the scariLt7 value of foreign exchange, thereby permitting the efficient allocation of resources. First, on January 4, 1986, the exchange rate for public sector transactions was raised from GS 23 to GS 3001$US while a second window for private sector activities was established, initially at the rate of GS 345/$US and subsequently subject to a weekly auction. During January 1986, the Guinean franc (GF) replaced the syli as Guinea's currency. Finally on May 30, 1986, the Central Bank unified the two exchange windows, requiring the Government to purchase foreign exchange at the rate determined at the weekly auctions, which henceforth became open to all current account transactions of the private and parastatal sectors. At end-1987 the rate of exchange stood at GP 440ISUS as against a parallel market rate of about GF 495/$US. In 1987 the private sector financed about US$120 million of imports of goods and services through the auction. Seventy percent of these imports were financed from the Central Bank's foreign exchange resources, which consist of tax revenues received from the mining companies and balance of payments assistance obtained from the I[F, IDA and cofinanciers. 10. As part of the Government's overall reform, all six state banks were closed at end-1985 and replaced with three new majority private  -4- joint-venture banks. A fourth new comnercial bank was set up as a joint venture with the French Crddit Lyonnais and has begun operations in early 1988. Branch banking was recently begun by BICI-GUI in ten provincial centers. 11. Prices and Marketing Policy. The Government's objective in the area of prices and marketing has been to reestablish a flexible and coherent structure of domestic prices conducive to efficient resource allocation and growth of national production. Prices for all goods other than for imported rice and petroleum pro-ducts were decontrolled in 1986 and the private sector was permitted to engage freely in all levels of internal and external marketing. Furthermore, the state monopolies on long-distance freight transport and freight storage and handling were abolished. These measures had the result of unifying the official and parallel markets and played an important role in the favorable supply response of the agricultural sector. 12. In view of the private sector's effectiveness in handling rice imports and their marketing, the Govern