Senegal - Financial Sector Adjustment Program Project

Document of The World Bank FOR OFFICIAL USE ONLY C6zZ 2- --7 Report No. P-5183-SE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT IN AN AMOUNT EQUIVALENT TO SDR 35.3 MILLION TO THE REPUBLIC OF SENEGAL FOR A FINANCIAL SECTOR ADJUSTMENT PROGRAM NOVEMBER 28, 1989 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.  CURRENCY EQUIVA%LENTS Currency Unit = CFA Franc (CFAF) 1/ US$ 1.00 CFAF 315.75 (November 1989) 2/ CFAF 1 million = US$ 3,167.06 (November 1989) 2/ SYSTEM OF WEIGHTS AND MEASURES: METRIC Metric U.S. Equivalent 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 miles (mi) 1 square kilometer (km2) = 0.39 square mile (sq mi) 1 hectare (ha) = 2.47 acres (a) 1 metric ton (t) = 2,205 pounds (lb) 1 kilogram (kg) = 2.2046 pounds (lb) FISCAL YEAR July 1 - June 30 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 November 14, 1989.  FOR OFFCIAL USE ONLY ABBREVIATIONS AND ACRONYMS APB Association professionelle des banques (Bankers' professional association) BCEAO Banque centrale des Etats de l'Afrique de l'Ouest (Central Bank of West African States) BIAOS Banque ..nternationale pour l'Afrique occidentale - Senegal (Commercial bank) BNDS Banque nationale de developpement du Senegal (National development bank of Senegal) BICIS Banque internationale pour le commerce et l'industrie du Senegal (Commercial bank) BSK Banque senegalo-koweitienne (Commercial bank) CIDA Canadian International Development Association CCCE Caisse centrale de cooperation economique CFA Communaute financiere africaine (African Financial Community) CNCAS Caisse nationale de credit agricole du Senegal (National Agricultural Credit Bank of Senegal) ONCAD Office national de cooperation et d'assistance au developpement (defunct groundnut marketing agency) SME Small and medium-scale enterprise TEN Taux d'escompte normal (normal rediscount rate) TEP Taux d'escompte pr4f4rentiel (preferential rediscount rate) TES Taux d'escompte (rediscount rate of last resort) TMM Taux du marche mon6taire (money market rate) UMOA Union monetaire ouest-africaine (West African Monetary Union) USAID Unites States Agency for International Development USB Union senegalaise des banques (Commercial bank) This document has a restricted distribution and may be used by re :ipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  REPUBLIC OF SENEGAL FINANCIAL SECTOR ADJUSTMENT PROGRAM (FSECAL) Table of Contents Pages Credit Summary ............................................ (iii)-(iv) PART I. THE ECONOMY ......................... 1 A. Recent Developments ............................. 1 B. Prospects and Financing Needs . . 2 PART II. THE FINANCIAL SECTOR . . . 3 A. Background . . 4 The Banking System . . 4 The Policy Environment . . 5 B. Policy and Regulatory Reforms ................. 8 Background . . 8 Interest rate policies . . 9 Credit allocation policies . . 10 Taxe sur la Prestation de Services (TPS) ... 13 Bank supervision . . 13 Impact of the Reforms . . 14 C. Bank Restri,cturing ............................ 14 D. Social Impact . . 19 PART III. THE PROPOSED PROGRAM . . . 20 A. Program objectives . ......................... 20 B. Amount of Cofinancing and Credit . . 20 C. Tranching, procurement and disbursement ... 20 D. Management, monitoring and reporting of the program . .. 21 E. Coordination with the IMF . . 22 F. Benefits and Risks . . 22 PART IV. BANK GROUP STRATEGY AND OPERATIONS ................. 23 A. Country Assistance Strategy ... 23 B. Bank Group Operations, Past and Future ........ 24 PART V. RECOMMENDATION ....................... . 26  - ii - Text Tables Table 1: Summary Situation of the Banking System ............ 4 Table 2: Credit Growth and BCEAO Rediscounts ................ 7 Table 3: Consolidated Balance Sheet for the Eight Distressed Banks, 9130/88 ........................ 8 Annexes Annex I - Economic Indicators; Balance of Payments, Status of Bank Group Operations. Annex II - Supplementary Project Data Sheet Annex III - FSECAL Policy Matrix Annex IV - Government's Letter of Devalopment Strategy for the Financial Sector.  - iii - REPUBLIC OF SENEGAL FINANCIAL SECTOR ADJUSTMENT CREDIT CREDIT SUMMARY Borrower: Government of Senegal Credit Amount: IDA: SDR 35.3 million (USS 45.0 million equivalent) Cofinancing: France (US$34.0 million); United States (US$33.0 million). Terms: Standard IDA terms with a 40 years maturity. Description: The proposed Credit will support the efforts of the Government of Senegal to restructure its banking system and lay the groundwork for the development of well functioning financial and capital markets. It would take place within the framework of reforms by the West Africa Monetary Union (UMOA) of which Senegal is a member. These reforms follow intensive consultations between staff of the BCEAO (the common central bank ot UMOA) and the Bank, the IMF, France and the US. They are noteworthy because they represent the consensus on a course of action toward financial sector reform by the seven members of the Union: Benin, Burkina, Cote d'Ivoire, Mali, Niger, Senegal and Togo. Benefits and Risks: The potential benefits of this Credit are substantial in that it not only would rehabilitate the Senegalese banking system but it would also establish an improved financial intermediation system that would aid in the mobilization and term-transformation of financial resources and in their channeling to borrowers hitherto largely excluded from access to credit, The risks associated with this adjustment credit are acceptable. The macroeconomic weaknesses that have undermined financial restructuring in other countries are alikely to compromise the restructuring of Senegal's financial sector. SAL IV, whose preparation is now lia its final stages, provides, in conjunction with the I"F's ESAF, for measures improving Senegal's fiscal and internal sector positions. Senegal's overall macro-economic stability is also reinforced by a central feature of the franc zone, which imposes strict and well-enforced limits on member-governments borrowing from the Central Bank.  - iv - Estimated Disbursements: The proposed credit would be disbursed in two tranches, the first becoming available on effectiveness (December 1989), the second nis.e months after disbursement of the first. In view of extensive reforms already undertaken, 60 percent of the credit (USS 27.0 million) would be disbursed in the first tranche. Disbursement of the second tranche (USS 18.0 million) would depend upon satisfactory overall implementation of the Program. Disbursements are expected to be made over a period of 12 months ending in December 1990. Map: IBRD 18499R Appraisal Report: There is no separate Staff Appraisal Report.  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED IDA CREDIT TO THE REPUBLIC OF SENEGAL FOR A FINANCIAL SECTOR ADJUSTMENT PROGRAM 1. I submit the following report and recommendation for a proposed credit to the Republic of Senegal to help finance a Financial Sector Adjustment Program (FSECAL). The proposed credit for SDR 35.3 m4illion (US$45.0 million equivalent) would be on standard IDA terms with a maturity of 40 years. PART I - THE ECONOMY 2. The latest Country Economic Memorandum entitled "Senegal: An Economy Under Adjustment" (No. 6454-SE) was distributed to the Executive Directors on February 13. 1987. Basic country data are given in Annex I. A. Recent Developments 3. Adjustment of the Senegalese economy became unavoidable at the end of the 1970s, when a combination of poor financial and economic policies plunged an already weak economy into a severe crisis. A first attempt to stabilize the financial situation and create the basis for growth did not yield satisfactory results. Renewed efforts were launched in 1984 and resulted in the reduction of the fiscal deficit (from 5.8 percent of GDP in 1Q83/84 to 2.6 percent in 1987/88), the strengthening of the current account position (from 17.3 percent of GDP to 9.6 percent) and the dampening of the inflationary pressures (from 12 percent to 2.0 percent). 4. Adjustment efforts have also been accompanied by a revival of the economy. Between 1984 and 1988, real GDP grew by 4.3 percent annually as compared to long-term average growth rate of less than 2.5 percent in the preceding two decades. Growth has been driven principally by a good performance of the agricultural sector due to both favorable price incentives, particularly for groundnuts, which is the key cash crop, and to several years of good rainfall. As a result, the production of groundnuts and cereals has expanded at an annual rate of about 10 percent during the past four years. The fishirg sector has also experienced significant growth and fish exports have become Senegal's largest export earner since 1985. There are, however, signs of resource depletion, particularly for the high-value pelagic fish species. While the recovery in groundnut production has stimulated the oil-processing industry, other manufacturing industries have remained depressed because of a combination of factors, including the poor investment climate, high cost of production factors (particularly labor and energy), a rigid labor market, and stiff competition from imports following the trade liberalization measures introduced since 1986. The service sector, which accounts for over half of GDP, has performed well in spite of the declining share of Government services. With domestic credit growing at an annual rate of 8.4 percent  . 2 - since 1984 (about half of which was for crop credits), the domestic inflation rate has been modest, with the GDP deflator increasing at a rate sligntly over two percent per annum. 5. With the population currently growing at 2.9 percent a year, higher GDP growth in the past few years has helped reverse the gradual decline in real per capita income which was experienced in the period 1960-84. Demand management measures implemented since 1984 have succeeded in reducing gross domestic expenditures especially total ccnsumption, which exceeded GDP during the first half of the eighties. As a result, domestic savings, which were negative in earlier years, recovered to reach 7 percent of GDP in 1988. Prudent demand management, which 1s crucial for avoiding real exchange rate appreciation under a fixed exchange rate regime, as well as a succession of good harvests, have contributed to the fall in the inflation rate which has enabled Senegal to regain some competitiveness iv foreign markets. The country's exports continue to be impaired by the high cost of production in particular labor cost. Although growth in the level of nominal wages has been moderate, it still remains quite high by comparison to countries in the same GDP bracket as Senegal. 6. In spite of these improvements in the economic situation, the Government's fiscal situation remains fragile as evidenced by the significant shortfall in fiscal revenue in 1988/89. The combination of a weak economy and social disturbances related to the border conflict with Mauritania caused tax revenue to fall in nominal terms by 5 percent compared to the level in the preceding year and 13 percent compared to the projected l$el. The Government budget also relies heavily on the tax on petroleum product3 (about 25 percent of total revenue' whose domestic prices are 2.5 times world prices. Moreover, Senegal is still highly dependent on direct budgetary assistance from abroad to cover current expenses, including the servicing of foreign debt and the repayment of arrears. The excessive reliance on petroleum and external financing increases the vulnerability of the Government's financial operations vis- a-vis external developments. The debt service ratio of 25 percent in 1988 could be held to this level largely because of successive debt rescbedulings by Paris Club members. Without reschedulings, the ratio would have exceeded 30 percent in that year. B. Prospects and Financing Needs 7. The successful implementation of the PSECAL depends to a large extent on the macroeconomic stabilization program proposed under the SAL IV, currently in its last stages of preparation, and the ESAF of the IMF, which is in its second year of implementation. Both SAL IV and the ESAF contain specific policy measures aiming at the improvement of the fiscal situation and the current account position and providing for a prudent monetary policy. Assuming quick and full implementation of the policy reforms under the proposed SAL IV consistent with those spelled out by the Government in its fourth Policy Framework Paper to be discussed soon by the Committee of the Whole, the performance of the economy achieved in the recent past would be sustained. Real GDP growth, after registering a decline in 1989 to 1.3 percent would increase to an average of 3.8 percent over the period 1990-97, representing an increase of nearly 1 percent per  capita. Gross domestic investment, in particular private investment, would increase gradually and would be financed increasingly from domestic savings. 8. The overall fiscal situation, now in deficit, is projected to turn into a surplus by 1992, and then remain positive thereafter. This would be achieved through both containment of expenditure (reduction in nominal terms of the civil service wage bill and of transfers to parastatals) and improvement in resource mobilization (widening of the tax base, better tax administration, and higher across-the-board import duty rate). The current account position, which is projected to decrease by nearly half during the period 1990-97, would be strengthened through a further improvement in the export incentive system (i.e., reduction in the costs of production, in particular labor and energy, and elimination of administrative bottlenecks) and in the rationalization of public investment programming. The stabilization program contains also measures to limit the expansion in the domestic credit to 5 percent and to contain the inflation rate to less than 3 percent per annum. 9. The cumulative external capital requirements implied by this scenario during the period 1989-97 is projected at US$7.6 billion or about an average of US$ 840 nillion a year. This consists of US$4.5 billion of current account deficit (excluding transfers), USS 2.4 billion of debt amortization (including IMF repurchases) and US$ 0.7 billion of changes in reserve-. The proposed FSecal and SAL IV will meet part of these financing requireuients. Nearly 30 percent of the identified financing would be in the form of official grants, consistent with the need to reduce the ;Y't service burden. The unfilled gap is projected to average 15 perc'- ox total financing requirements which is quite manageable given declining deb. service levels. PART II - THE FINANCIAL SECTOR 10. Senegal's banking system has become increasingly illiquid because of the accumulation of nonperforming loans now amounting to about US$750 million. These loans represent about half the portfolio of the banking system, or 13 percent of GNP. The absence of liquidity in much of the system hobbles the day-to-day functioning of commerce and industry and limits the access of potential borrowers to financing. It also affects the operations of the Treasury as taxpayers have increasingly been paying their taxes with checks drawn on frozen accounts in the illiquid banks. Finan- cial intermediation, never well developed in Senegal, has been weakened by the growing inability of distressed banks to supply critical services and by the undermining of the country's financial transactions system. The weakness of financial interruediation impedes the progress of structural adjustment, with its focus on the re-dynamization of the private sector. 11. Except in Burkina Paso and Togo, similar crises of varying seriousness have erupted in other countries of the West African Monetary Union (UMOA: Union Mondtaire Ouest Africaine) stemming largely from urnderlying weaknesses of the system. The Bank has been discussing systemic issues with the Central Bank of the zone, and the discussions have led to the reforms outlined below. These aggressive reforms constitute an  - 4 - adequate framework for the restrur!turing of the fo;,ncial sector, not only in Senegal but in the other UMOA cQuntries as well. They also provide a sound basis for the medium-term deveiopment of the flexible financial systems and capital markets needed for economic growth. 12. Some first steps toward reform of the banking and financial sector began within the SAL process. Under SAL III, a review of the operations of the banking system was completed which documented the extent of the crisis and provided the elements for putting together an agenda for reform under this operation. Following this review, the minimum capital requirementa of the banks were raised, the Banking Association was revived, and the tax on interest earnings was lowered and subsequently eliminated. A. BACKGROUND The Banking System 13. Senegal's banking system has 15 banks. The Government of Senegal holds equity in nine banks and has exercised direct control in five of them. In 1986 a liquidity crisis affected eight of the 15 banks, including two larger ones that had accumulated overdrafts of CPAF 50 billion (about US$180 million) with the Central Bank (BCEAO: Banque Centrale des Etats de i'Afrique de l'Ouest). To deal with their liquidity problems the distressed banks had increasingly resorted to borrowing from the BCEAO. However, when this latter stopped, in 1988, providing them with additional refinancing facilities, their operations came virtually to a halt. The following table summarizes the financial situation of the Senegalese banking system as of September 30, 1988. Table 1: SUMMARY SITUATION OP THE BANKING SYSTEM (CFA? billion, US$ million) Eight distressed Sound barAcs Total banks