Benin - Structural Adjustment Program

Documnt of The World Bank FOR OFFCIL USE ONLY C#Z~~ e' ' 3 - 15a~ Repot No. P-4931-BEN REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 33.5 MILLION TO THE PEOPLE'S REPUBLIC OF BENIN FOR A STRUCTURAL ADJUSTMENT PROGRAM APRIL 26, 1989 Thi docment has a restricted dsbutIon and may be used by reipints only in the perfonnaue of their offical ddes Its contents may not otherwise be dicosed without World Bank athoriation.  CIJRCY EQUIVAL TS Currency unit - CPA Franc (CFPA) 11 US$ 1 - CPAF 303 CPA? 1 million - US$ 3,300 WEIGHTS MMD mEASURES Metric System 1 meter (m) - 328 feet (ft) 1 kilometer (km) - 0.62 mile (mil 1 sq. kilometer (km2) 0.39 square mile (sq. mO) 1 metric ton (t) - 2,205 pounds (lb) 1 hectare (ha) - 2.47 acres FISCAL YEAR January 1 - December 31 GLOSSARY OF ACRONYMS ACP African, Caribean and Pacific Countries AGB Alimentation Gdn6rale du B#nin BBD Banque Beninoise pour le Developpement BCB Banque Commerciale du Benin BCEAO Banque Centrale des Etats de l'Afrique de l'Ouest CCCE Caisse Centrale de Cooperation Economique CIB Ceramique Industrielle du Benln COBERAM Compagnie Beninoise de Navigation Maritime IBETEX Industrie Beninoise de Textile OAAR Office Beninois d'Aenagement Rural OBEAR Office Beninois des Arts OBECI Office BeninQis de Cln4mas OBEMAP Office Beninois de Manutention Portuaire ONATHO Office National de Tourisme et de Hotellerie ONPB Office National de Pharmacie du Benin OPT Office de Postes et de Tdlecommunications SCB- Societe du Ciment du BEnin SCO Soci6te du Ciment d'Onigbolo SONACI Societe Nationale du Ciment SOGECOB SocietE GEnerale du Commerce du Benin SONAFEL Societ6 Nationale des Fruits et des LEgumes SONAE Societe Nationale d'Equipements SODIHAS SociEte Nationale pour la Distribution de Materiels Solaires SEE SociEtE Beninoise de l'Eau et de l'tlectricite SEB SocietE d'Engrais du Benin SSS Societe Sucriere de Save PAC Port Autonome de Cotonou 11 The CFA franc (CFAF) is tied to the French Franc (FF) in the ratio of FF1 to CFAF 50. The French Franc is currently floating.  FOR OMCIL USE ONLY PEOP E S REPUBLIC OF BENIN STNUCTURAL ADJUSTMENT CREDIT CREDIT AND PROGRAM SUMMARY Borrower X People's Republic of B4nin Credit Amount X SDR 33.5 million (US$ 45 million equivalent) Tomes s Standard, with 40 years maturity Program Description * The proposed credit would-provide financial support for Benin's program of economic and financial recovery. The program aims at a fundamental reorientation of lEnin's development strategy from over-emphasis on the state intervention in the economy to greater reliance on private Initiative and market forces. Specifically, the program aims at : (a) reducing the role of the public sector in the economy in order to focus it more on a core set of services, and improve the management of those services; (b) reinforcing public sector resource management by further improving investment planning and programming as well as the management of the residual portfolio of State enterprises; (c) restructuring the banking system to enable it to resume effective financial intermediation; and (d) reorganizing incentive policies to promote private sector activity, especially of small and medium scale enterprises, through liberalizing trade (both domestic and external), removing goods and factor market rigidities. Program Benefits s The proposed program is essential if the public sector is to overcome its financial and institutional weaknesses, with a better balance established between public and private sectors to improve growth prospects. Particular benefits are expected to accrue from the restoration of viable public finances, a rationalized and more efficient civil service, the elimination of loss-making State enterprises, and the restoration of a sound banking system. T,i document has . sted distribution and may be used by ecipents onb In the peformane of their official duties. Its contents may not otherwise be disclosed without World Bank authorizdton.  - As. - Proar~m Risks t The Government faces three risks in the implementation of this program. First, further terms of trade losses as a result of new drops in the prices of the main exports could extend the time needed for financial recovery. Second, domestic political opposition to reforms could re-omerge in segments of the society that benefitted from previous public sector employment and pricing policies but who must now forego those privileges. The arguments of opponents of free market policies, who associate income disparities with the private enterprise system, will acquire some force if widespread income losses occur among workers while private business entrepreneurs appear to be doing well. Third, difficulties in finding a foreign private bank willing to establish in Benin could delay implementation of the banking system reform component. These risks are reduced by the program's focus on the core issues, its full internalization, and the expected donor support. Actions being taken to strengthen resource mobilization and eliminate waste will protect the financial viability of the program. The broad-based doaestic participation in the formulation of the program has gained it wide acceptance internally. Further, the measures designed to address cases of poverty (unrelated to adjustment) as well as alleviate the negative impact of lay-offs and the civil service retrenchment will minimize the extent of social dislocation that would arise during its implementation. Finally, the Government's clear statement of non- interference in the running of the new bank and the attitude towards private enterprise evidenced in the recent and planned privatization of key public enterprises increase the prospects of finding a partner within a reasonable time frame. Estimated Disbursements The credit would be disbursed in two tranches, of US$ 22.5 million equivalent each, the first tranche being available upon effectiveness and the second after a performance review to be held about five months after effectiveness.  - iii a TAB OF CONTENTS PART I. THE ECONOMY A. The Macroeconomic Context .............. ............ .... .. 1 - Political Environmnt .......................*.....*...........2 - Economic Situation ................ ............ 2 B. Medium-Term Adjustment Issues ........................... 6 PART II. THE STRUCTURAL ADJUSTMENT PROGRAM Public Sector Reform .................................... 8 - Public Finances ....................................... 8 - Public Employment and Pay ........... . 9 - Public Administration ..................... . 11 - Investment Planning ................................... ll - Public Enterprise Reform ............. 12 Banking System Reform ................................... 13 Trade Policy Reform and Deregulation .................... 14 PART IIT. THE PROPOSED CREDIT A. Credit History ................................................ 16 B. Support of Policy Reform ........................... 16 C. Effects of Adjustment ...... .............. . 16 D. Benefits and Risks .............. . .......... . 20 S. Social Impact ...................................... 21 F. Disbursement, Administration and Procurement ....... 22 PART IV. BANK GROUP OPERATIONS AND STRATEGY ...................... 25 PART Y. COLLAWORATIONVITH DF AND OTHER DONORS .... .......... 27 PART VI. RECOMHENDATION..... .....................................28  I - ANUU AM3 I - Socio-econosic Indicators A1M1= II - Status of Bank Group Operations in Benin AM=31 III - Supplementary Data Sheet AN33 IV - Statemnt of Developent Strategy AM13 V - Public Enterprise Refom Action Plan, 1988-89 AN311 VI - Macroeconomic Projections  INTERNATIONAL DVELOPME ASSOCIATION REPORT AND BECO DION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A ROPOSED CRDIT TO THE PEOPLEl'S EUMLIC OF BRN FOR A STRUCTURAL ADJUSTMET PROGRM 1. -I submit t'he following report and recomendation on a proposed c.-edlt in an amount of SDt 33.5 million (US$ 4S amllion equivalent) to the People's Republic of eonun to support the Government's Structural Adjustment P:ogram. The proposed credit would be on standard IDA terms with 40 years maturity including 10 years of grace. 2. A Country Economic Memorandum (Report No. 4686-BEN) was dlstributed to the Executive Directors in March 1984. The report chich follows is based on the conclusions and recommendations of that memorandum and the findings of recent economlc missions, including one that appraised the proposed structural adjustment program in July 1988. Updated country economic data are shown in Annex I. PART I - THE ECONOMY A. The Macroeconomic Context Background 3. Benin is a small country of 4 million people with an annual income per capita of about USS 340 (1987). The economy's most Important natural resource is its arable land, which enables the country to enjoy overall food self-sufficiency as well as produce cash crops of which oil palm and cotton are the most important. Oil palm is now In relative decline owing to increasingly insufficient rainfall and its marketed output has stagnated at about 300,000 tons of fresh fruit bunches over the last few years. In contrast, cotton has experienced very rapid growth over the past few years, its output rising from 20,000 tons in 1982/83 to about 130,000-tons in 1986187, due to improved incentive pricing and Input distribution and extension system. Food crops could also easily become an important export item now that controls have been lifted and private entrepreneurs allowed are to export. 4. The overland cor.idor is another asset which, aided by the excellent deep-sea port of Cotonou, the capital cLty, and the reasonably good network of roads, provides transit services to neighboring land- locked countrles. The brisk transit and re-export trade that occurred In the Vest Africa region during the commodity boom years between 1976 and 1982 led to strong growth in the volume of traffic handled by the port (an annual average of 5 percent). Similarly, the downturn in regional trade after 1982, and the modest recovery since 1984, have been reflected in the volume of throughput at the port. A nascent industrial sector producing mainly light consumer manufactures and accounting for about 10 percent of GDP, a vigorous informal trade sector, and a small offshore oilfield, with modest known reserves producing about 6000  -2- barrels per day (18 percent of exports in 1987) and whose economic life is expected to run through 1992, are the other main economic activities. Political Environment S. Politically, Benin is organized as a one-party State, headed by a military President who is both chairman of the Party's Politbureau and Central Committee, and Head of Government. The President runs the Government through a National Executive Council whose members, Ministers and the Prefects of the six provinces, are selected In consultation with the Politbureau. A National Revolutionary Assembly of elected representatives is the law-making body, but it meets with long intervals. Despite this institutional structure, political authority in Benin is diffused, and important decisions are made only after prior consultations have generated a consensus among key groups (tribes or socio-economic groups like labor unions, Army etc.). The President oversees the process, often arbitrating the conflicting interests of the various groups until a common position is worked out on the particular issue. This implied sharing of political power has given the country a long period of stability (16 years since the frequent changes of government ended). But it has also exacted a toll by rendering the leadership virtually incapable of taking firm and prompt decisions on policy matters except in extreme crisis. The cumbersome decision-making process and opposition to reforms within the Politbureau on ideological grounds have been responsible for the slow progress in the Bank's economic policy dialogue with Benin and the delay in working out a broad-based adjustment program. The Politbureau dropped its opposition to comprehensive reforms when increasingly severe economic and financial problems during 1986187 made it abundantly clear that the dirigiste policies had failed. Three of its members currently serve full-time on the National Commission set up in 1986 to prepare the reform program. In addition, in July 1988 the Politbureau's presence in the Cabinet was increased from four to seven members, partly to strengthen their upstream involvement in the formulation of reforms and thus reduce delays in decision-making on the adjustment program. The Economic Situation 6. During the period 1977-82, the Beninese economy performed well on most accounts, achieving an average real growth of 5 percent, with internal and external financial stability due, in part, to buoyant investment activity under the First State Plan (1977-80), and in part, to strong re-export trade with neighboring Niger and Nigeria, which were then experiencing uranium and oil export-led booms. A reversal of these trends began in 1983, when the booms in the neighboring economies ended and Benin's own vigorous construction activity under the First State Plan ended with the completion of the projects initiated at that time. 7. The downturn in public investments occurred at the same time that the re-export trade sharply declined. The recently completed projects also turned out to be a major drain on the economy as they had, in most cases, been of low quality and low return. With the  - 3 - commencement of the debt service for the investments in this situation, the economy entered a period of low growth with overall financial decline. Between 1983 and 1987, real GDP growth averaged under 1 percent while the population grew at about 3 percent, and the public finances and balance of payments registered deficits averaging 9 percent and 7 percent of GDP respectively, which were covered mainly by internal and external arrears. 8. While the recent terms of trade deterioration and the post- 1982 slump in regional trade opportunities explain part of the present difficulties, these are also the result of domestic policy errors of the 1975-82 period. During that period, the Government sought to accelerate growth and development by having the State become the owner of the major modern sector activities. The State would thereby, it was reasoned, have control over the surpluses generated by these activities and would re-invest them to induce rapid growth. To implement these ideas, most private sector businesses were nationalized, and several new public sector enterprises were set up. In agriculture, collective farming systems were actively promoted, State farms were set up, and controls established on the trading of food crops. These initiatives failed to yield the expected results, for a variety of reasons. 9. Owing to the weight of social and political considerations introduced into their management, even those businesses which did well prior to nationalization faltered under public ownership. In addition, many of the newly-created enterprises ran into an assortment of problems, including poor initial design, inadequate managerial capability, undercapitalization, and limited market opportunities. The negative growth was particularly pronounced in the manufacturing sector, its share in GDP declining from 6 percent during 1977-80 to 3 percent by 1985-87. In contrast agriculture, which remained predominantly in the hands of the peasants and has benefitted from improved producer policies and extension system since the early 1980s, raised its share in GDP from 30 percent over 1977-80 to 35 percent during 1985-87. 10. The initiatives of the 1975-82 period had equally unfortunate financial outcomes. Internally, the public enterprises relied on the banking system for financing which t!uld have been largely provided by the budget. The banks, having themselves become public-sector institutions through nationalization in 1975, failed to apply rigorous standards in appraising public enterprise credit demands, and are now virtually bankrupt, with an estimated 75 percent of the consolidated portfolio of CPAP 149 billion (at end-1987) non-performing, owing mainly to public enterprise failures. As of end 1987, the Banque Commerciale du Benin (BCB) had CFAP 89 billion in outstanding loans of which 61 percent was non-performing. For the Banque BEninoise your le D6veloppement (BBD), an amount of CPAP 42 billion was outstanding, with 60 percent classified as bad debt. In the case of the Caisse Nationale de Credit Agricole (CNCA), an amount of CFAP 21 billion was outstanding, of which 86 percent was non-performing. These events later resulted in a major liquidity crunch in the banking system. Externally, commercial borrowing to finance the industrial projects undertaken under the First State Plan raised the external debt five-fold (from CPAF 57 billion at end-1978 to CFA? 259 billion at end-1983), and increased the debt  -4- service, which rose Zrom about 3 percent of exports during 1977-78 to an average of 38 percent during 1985-87. Meanwhile, in line with the growing role of the public sector, the civil servlce grew in strength by 60 percent within six years (from 29,000 in 1980 to 47,000 in 1987), and the central government wage bill tripled (from CPA? 15 billion to CPA? 45 billion). 11. These trends were reflected in the public finances, the monetary situation and the balance of payments (Table 1). The growing personnel outlays raired current expenditures from about 13 percent of CDP during 1981-84 to 14 percent during 1985-87. Although capital expenditures were cut back after 1982 and have stabilized at about 7 percent during 1985-87, the overall deficit (including grants) still averaged about 6 percent of GDP during 1985-87, about the same level as in the preceding eight-year period. This is because the drop in transit trade reduced revenues during 1983-84 and they have not recovered since then, while the growing civil service and two general increases in the minimum wage in 1980-82 raised the wage bill substantially. The Government drew down all its deposits in the banking system to finance the deficit, and became a net debtor to the banks by 1984. An estimated CPAP 69 billion in domestic arrears was accumulated by the end of 1987. Delays in meeting the payroll began in 1986 and worsened in 1988, with civil serv'Luts' salaries delayed often for as long as three months. This situation turned into a full crisis late in 1988 when the proportion of taxes paid in liquid form fell as low as 10 percent of all receipts. 12. The monetary developments closely mirror the trends in aggregate demand. Net domestic assets more than doubled during 1980-84 under the expansionary policies of that period but fell by about 12 percent three years later when domestic credit contracted as the econmy slowed down. The BCEAO's refinancing facility was used extensively by the CNCA and BBD, resulting in its exhaustion by 1987-88 (para. 35). The net foreign assets position turned negative in 1982, and deteriorated steadily through 1987, reflecting Benin's growing use of the French Treasury Operations Account resources. A 15 percent decline in domestic credit in 1986-87, together with the deterioration in the net foreign asset position, accounted for a 10 percent reduction in the broadly defined money supply. 13. In external transactions, the current account deficit reached 15 percent of GDP when the investment/GDP ratio attained 30 percent of GDP ,n 1981-82. With the completion of the large projects, capital imports declined in 1983 and 1984, stabilizing the following year. Higher export earnings arising from the start of petroleum production and increased output of cotton led to an improvement in the current account balance, bringing the current account deficit/GDP ratio (before grants) to under 10 percent during 1983-84. In spite of declines in cotton and crude oil prices in 1985186, the current account/GDP ratio (before grants) further declined to about 7 percent over 1985-87 owing to a decline in imports. The overall deficit could not be fully  - 5 ~- Table 1. Bmin: Rwrcoelum c indicators, 1977-1997 1977-60 1981-84 1985s 7 Real M Gratm 4.9 1.7 -0.3 lnwuse tiWLD 20.1 18.8 12.7 CuiqJtImvl3 100.7 105.8 100.2 Savbkq&GGP -0.7 -5.8 -0.2 Sector Shrea In GDP f.c. (M) (strut Price.) Primary 41.7 41.2 46.0 Seomdairy 11.0 13.7 13.8 Tertiary 37.5 35.4 34.6 Ptbi lc Fimnos (M) (,rent prIcs) PAsrMW/ 15.3 14.3 11.9 ourrent Expenditwmss 12.6 13.8 14.4 Panmel ExendJU11P 6.8 9.2 8.2 capital Oed./GOP 13.5 11.4 7.3 Overall 9sf icit/iP -5.6 -5.4 -5.9 ialar of Pmet M (wrrent prIces) Ejports of GNFSUGOP 24.0 23.0 12.8 li orts c NSEAP 39.6 37.2 24.8 urrent Mest/P -10.4 48.6 -7.0 Overall Damla -0.9 -3.5 -6.1 Oebt ServiceDoxS 2.4 8.9 38.0 Oebt Servioe i usn 4.1 28.9 67.2 Real Exr*lg PAtU lnvi /a (OaMs 1 a80m100) 100.0 124.1 108.9 khWsy ad Credit (in CAF bililen, endof-period) Net Forelgi Asets -7.6 -24.4 -52.6 Net Oentlc Asfts 62.7 155.2 138.5 Not Clail an Gowlt -15.2 14.1 11.8 Not Claim en Priv. Seotor 77.9 141.1 124.9 Of dich BCA0Fmned (22.8) (41.1) (48.9) NWe ad CuOasibNeny 61.4 110.8 98.8 a/ Osf ned as relative price-msiptsd CFAFrA3 rate. Souro: Off lcial data and BEtk Staff estinates.  - 6- financed in any of these years and arrears were accumulated, principally on debt service obligations. External debt arrears reached US$ 243 million at end-1987 (counting only lenin's share in the bi-national debt for Onigbolo Cement and Save Sugar). 14. Thus, mainly as a result of the policies iplemented during the mid-to-late 19709, the Government now faces a situation where it has suppressed formal private sector activity and established a non- performing public sector apparatus with extremely weak public finances, a bankrupt banking system, and an unmanageable external debt burden. Efforts since 19&3 to initiate reforms have been limited to improved agricultural producer pricing (cotton), reducing capital expenditures and reforming public investment programming and project selection, and initiating the restructuring of the public enterprise sector. The development of a full reform program was hampered by lagging political Will. D. Medium-Term Adiustment Issues 15. The medium-term adjustment issues facing Benin are twofold. A first set of issues relates to the effects of exogenous factors such as the weak export market price prospects for Benin's main cash crops (palm oil and cotton), the depreciation of the dollar vis-a-vis the CFA franc, and the slump in regional trade opportunities. All of these require Benin to take steps to improve the international competitiveness of its products. Second, there are the issues arising from the largely unsuccessful dominant role played by the public sector in the economy for more than a decade, and the distortions created by past policies which must be addressed to create a more suitable environment for private initiative. 16. Unfavorable External Market Situation and Declining International Competitiveness. World market prices for the main foreign exchange earners, palm oil and cotton, weakened dramatically after 1984. According to recent projections, neither is expected to regain the 1984 level before the year 2000, although palm oil prices are expected to recover more rapidly. With even moderate inflation rates for imports the terms of trade losses are considerable compared with 1984 (Table 2). The negative impact of the declining export prices on agricultural incomes and incentives is compounded by the recent appreciation of the CPA franc in terms of the US dollar. These external price developmei?.s also mean, given domestic price tren.i, reductions in the International competitiveness of Benin's tradeable goods sector. Given the present fixed ClAPIFF parity, Benin must rely on Internal productivity gains and real exchange rate shifts, made possible in part by changes in expenditure policy (compression and shifts In composition), to increase -the international competitiveness of its products.  Table 2. tIENM - Terms g Trade. 1H04-1 1064 108S 19 67"? ME 11 1990 lw01M9 106 Ewort Price Inex 100.0 9J.9 5.? 3.1 70.5 00.9 OC.0 0.0 95.7 101.2 ISport Prece led.x 100.0 101.1 113.5 113.4 168.0 107.8 170.4 170.4 101.9 106.7 Term* of Tred* Iex, 100.0 02.9 4.6 20.9 4.0 40.8 50.4 50.0 51.2 61.7 17. Weak Resource Position. With the public sector being a large net dis-saver over the recent past, gross domestic savings have shrunk. averaging -0.2 percent of GDP (current prices) during 1985 - 8V. With regard to foreign savings, large scheduled external debt service (30 percent of consolidated government revenues and export earnings, respectively) reduce net foreign inflows when the payments are made; when they are not made, such obligations cause the interruption of new gross inflows. Both outcomes have the same ultimate negative effect on investment. In order to relax the resulting resource constraint, productive efficiency must be increased, costs reduced, and consumption contained, while generous external debt restructuring is sought. 18. Distorted Incentive Framework and Market Rigidities. The regulatory framework developed to shield the parastatal enterprises and the impact of the tax system have resulted in a highly distorted incentive system. These policies have also created an environment limiting market responsiveness of factors and products, with the effect of reducing resource allocation efficiency and growth. Examples include price controls, excessive regulation of the labor market, and the restriction of some areas of economic activity to public sector entities. Efforts will have to be made to correct the distortions and to open up markets in order to endow the economy with the flexibility needed to adjust to changing circumstances and ensure stronger growth in the long term. PART II - THE STRUCStURAL ADJUSTMENT PROGRAM 19. With the assistance of the Bank and the IMP, Benin has formulated a program of economic and financial reforms to be implemented over the period 1989-91 which reflect a radical re-orientation of its economic policies in favor of the private sector. The main objective of this Structural Adjustment Program (SAP) is to raise the real GDP growth rate over the medium term to about 3 percent annually within a viable macroeconomic framework. The Government has set forth its reform program in a Statement of Development Strategy (Annex IV). The program encompasses essentially reform of the current budget and general public sector management (paras. 20-29); reinforcement of the quality of investment planning and prograuming (paras. 30-31); deepening and amplifying of the public enterprise sector reform under way (paras. 32-34); the restructuring of the banks (paras. 35-38); and reform of trade policy and deregulation of markets (paras. 39-43). These reforms are to be accompanied by measures to aid the poor and also minimize the negative social impact of the changes on those likely to experience income losses during the adjustment process, while preparing the transition to enable the lower income groups to participate in the benefits of growth.  -8- Public Sector Reform 20. Public Finance. The objective here is to restore the viability of public sector finances as the essential ingredient in restoring macroeconomic balance and improve allocation of resources by (i) strengthening resource mobilization; (ii) reducing and restructuring current expenditure and taking steps to contain its subsequent growth; (iii) improving the funding of supplies and materials especially for maintenance, agricultural extension services, education and health. These efforts should also generate savings to support development projects. 21. Resource Mobilization. The Beninese tax system currently yields revenues equal to 10-11 percent of GDP, although in times of brisk re-export trade, this ratio has gone as high as 16-17 percent. The tax structure is complex, and some of its provisions discriminate against local industry and investment. The tax system will therefore be reformed to make it easier to administer, to improve its yield from 10 to 13 percent of GDP by 1991 (even under the conditions of depressed re-export trade), while at the same time to eliminate its disincentive effects to local industry and investment. 22. A start was made in this area in 1987, drawing on the recommendations of a 1985 IMP report on the fiscal system. The main import tariff, taxe fiscale d'entree (TFE), was raised on a number of products and the low officially-fixed (mercurial) bases used to tax some products were adjusted upwards or replaced altogether with c.i.f. values, and an advance partial payment requirement was introduced for business profit taxes, impot sur les benefices industriels et commerciaux (BIC), and impOt sur les ben6fices non- commerciaux (BNC). The tax changes resulted in a revenue increase of CPAP 1.4 billion in the one quarter in which they were applied before the year ended, and the advance payment requirement for business taxes achieved a-once-for-all revenue increase of ClAP 3.5 billion. In July 1988, quantitative restrictions and prohibitions on imports (textiles, non-alcoholic beverages, vegetable oils and others) were removed and import taxes were put in place instead. 23. In addition, as a start towards improving tax administration, the following actions were taken in December 1988: the first set of microcomputers to aid record keeping were installed; work on updating the valuation and assessment methods for domestic and external taxes was launched; and a program of continuous in-service training was introduced. The statistical tax on imports was raised to 5 percent and a 3 percent downpayment on imports against profit taxes was introduced (March 1989). Further major efforts at tax system reform to be undertaken as part of the adjustment program include the transformation of the internal turnover tax, impOt sur le chiffre d'affaires interieur (ICAI), into a general expenditure tax. taxe sur le chiffre d'affaires (TCA) applicable to domestic goods and services as well as imports. This tax will incorporate a tax credit to avoid cascade effects, and will be used to absorb a number of specific earmarked taxes. Its introduction will be coordinated with the more thorough reform of the main revenue source, import taxes. The specific decisions will be based on the results of an evaluation of import and related indirect taxation to be conducted during the first quarter of 1989 (concurrently with a study of industrial tariff protection, para. 41). An action plan to implement its recommendations will be agreed  with the Bank and the Fund by September 1989 to permit its introduction with the 1990 budget. 24. Public Emploament and Pay. The near-doubling of the civil service in six years, combined with the upward creep in the average wage, has caused a personnel expenditure explosion. When the situation rose to a head in '986 with the appearance of delays in meeting the payroll, the Government devised a two-phase approach to tackling the problem: first, improving the personnel data base and eliminating suspected inefficiencies in the administration of the payroll; second, reducing the size of the civil service to achieve a once- for-all substantial reduction in personnel expenditures, and modifying public employment policy in order to keep the future size and cost of the civil service under control while improving its general efficiency. The application of the first phase began in 1986 with a census of the civil service, followed by its use to eliminate payment irregularities (cases of ghost employees and Instances of double payments resulting from delayed processing of documents of new employees) as vell as to catch up on the application of retirement regulations. These actions achieved a saving of about CFAF 2 billion in 1987, or 5 percent of the gross payroll, and resulted in the belated retirement of some 200 staff. Next, a directive was issued ending automatic recruitment of all new graduates into the civil service. All these were followed in 1988 by a 10 percent reduction in the wage bill through the abolition of housing allowances for civil servants and the military. However, the personnel records had to be updated, entailing the regularization of the status of about 1200 employees whose wages had to be adjusted upwards. As a result, total personnel expenditures in 1988 fell to CFAF 42 billion, compared with CFAF 45 billion in 1987. 25. Under the SAP, the Government will seek to achieve further reductions In the wage bill and contain its subsequent growth through a program of voluntary separation from the civil service and the rigorous application of the regulations on retirement. The program of voluntary separation from the civil service started in April 1989. It is based on an estimate of the interested population identified in an opinion survey, who are being encouraged (selectively in order to retain those with needed skills) to leave with financial compensation. The program takes into account the fact that, unlike in other countries, the private sector in Benin is very small and leavers wishing to enter gainful self-employment in the private sector must be aided technically in the early stages. The leavers will therefore be able to obtain that advice from the Private Sector Promotion Unit that is being set up concurrently (para. 26). At present, the Government's aim is to have by 1991 a civil service numbering about 41,000 personnel, with expenditures of around CPAF 37 billion, compared with the current 47,000 and personnel expenditures of CFAP 45 billion in 1987. This will be achieved in part through the retirement of some 2000 civil servants who would have attained 55 years of age or have rendered 30 years of service, as prescribed by the Civil Service Code. The remaining 4000 reduction is expected to result from the voluntary departures. It is estimated that the voluntary departure program would coit about CPAF 8.0 billion to implement. Some donors (e.g., the European Development Fund and France) have already expressed their willingness to contribute to the financing of this component of the reform program through non-reimbursable grants to facilitate redeployment in private sector  - 10 - activities. 26. A related issue to be tackled is the absorption of the new graduates from Benin's institutions of higher learning. As in many other francophone African countries, prior to January 1987, these graduates were all guaranteed jobs in the civil service. In the light of the abolition of the wholesale and automatic recruitment, the institutional arrangements being set up to support reduction of the size of the civil service have been broadened to incorporate measures to help such new graduates find gainful employmenttself-employment outside the public sector. At the request of the Government, an ILO team financed by the UNDP studied employment opportunities for new graduates outside the public sector. The study released in February 1988 identified project ideas which offer a starting point for a self-employment program. %nother study conducted by UNIDO in 1987 examined the issue of the creation of a unit to aid the development of private sector business. Using the findings of the two studies, the Government will set up a Private Sector Promotion Center that would aid the existing private sector as well as the young aspirants leaving the school system or the civil service. 27. Recurrent Cost Fundins. The rapid growth in personnel expenditures has crowded out not only allocations for public infrastructure maintenance and services, supplies and materials in government offices, but also supplies needed to deliver health and education services. Efforts to remedy the situation began in 1986-87 in the context of the IDA-assisted Transport Infrastructure Rehabilitation and Second Water Supply project, with the design of measures to improve allocations as well as improve the efficiency with which the allocations are used. In the case of road maintenance, the Road Fund is being reinforced, as from January 1988, by giving it more resources and a reinforced institutional structure. During 1989-91, these resources will cover 100 percent of all routine maintenance, 30 percent periodic maintenance of earth roads, and 10 percent of periodic maintenance of paved roads. The remainder of the road maintenance costs will be provided through progressively declining foreign assistance. The above reforms being undertaken under other IDA-assisted projects will be complemented under the SAP by measures dealing with utilities and the social sectors. 28. In the area of utilities, the consumption of public servants, formerly paid from the budget, will now E financed from fixed monetary allowances included in the salaries of tLe beneficiaries. A decree to this effect was issued in 1987, and telephone connections in the homes of officials have been transferred into the names of the beneficiaries (July 1988); those for water and electricity were made in December 1988. In the case of health and education supplies, new budgeting procedures leading to improvements will be initiated under the adjustment program. As a first step towards improving allocations, the 1989 budgetary requirements were prepared on the basis of detailed work programs. Nevertheless, general expenditure cuts necessitated by the public finance difficulties would make it impossible to fund, from national sources, the higher level of non-wage expenditures judged adequate for the social sectors during 1989-91. The Government has, therefore, set up a Social Fund into which the contribution of external donors will be channeled for the support of these sectors. The approach to budgeting according to work programs will be refined in 1990-91 and extended to other areas.  - 11 - 29. Public Administration. The Government is also determined to reform the public administration apparatus in order to modernAie and adapt it to its role under the new development strategy - the efficient provision of the core public sector services that support future private sector-led growth and development. Towards achieving this goal, the government has outlined an action program consisting of (i) using the recently compiled computer records to prepare the profile of the civil service in terms of the size and distribution by Ministries and other agencies, as well as skills, grades and wage levels; and (ii) reviewing the basic personnel management texts to identify provisions that need to be changed to make the civil service structure lighter and easier to manage; (iii) an analysis of the structure of the Administration and Ministries' assignments and preparation of revised organigrams where necessary and (iv) proposal of a new staffing plan by size, functions and skills, accompanied by proposals for in-depth reform. The first two tasks were accomplished in November 1988 and the remainder are on-going. The operation is carried out under the coordination of the Ministry of Labor and Social Affairs, but with the technical work being done by the Adjustment Commission's sub-commission on civil service reform, assisted by technical expertise provided by the Ecole Nationale d'Administration of the University of Quebec. The services of the technical assistants are being paid for under the IDA-supported Technical Assistance Project (Cr. 1530-BEN). Given the complexity of such an operation and its relation to the personnel reduction program, the bulk of it will be prepared and reviewed with the Bank during 1989-90 and its implementation begun in 1990. 30. Investment Planning. Investment planning procedures adopted in mid- 1986 have improved the annual investment program. The annual programs are now compiled by subjecting each proposed project to scrutiny for technical, financial and economic justification. Where the project concerned is industrial or commercial in character, a minimum 10 percent economic rate of return and a 12 percent financial rate are required. Social sector projects are screened for cost-effectiveness and conformity with sector strategies, taking account of recurrent costs. The investment programs now average about 9 percent of GDP, which is more in keeping with the resource constraints and the absorptive capacity, compared with 18 -20 percent of GDP during 1984-85 which was far beyond the Government's capacity to finance and execute. Sectoral distribution of investments has also improved with agriculture and infrastructure being given priority over industry which was over emphasized during the preceding plan period, 1978-82. To improve project monitoring capacity, investment programming sheets (fiches de programmation et suivi) better adapted to the new procedures were developed in 1985-86 and seminars held in July 1986 to familiarize users with them. These actions were accomplished in the context of the dialogoue based on Bank economic reports (Report Nos. 5910-BEN, FY86 and 6951-BEN, FY88) and a Technical Assistance Project (IDA Credit 1530-BEN). 31. The Government intends to build on this foundation to further Increase the efficiency of resource allocation by keeping the general framework as well as the projects consistent with the macroeconomic outlook and objectives of the adjustment period. A satisfactory general framework for 1988-92 has been developed in the draft Third State Plan. The detailed programming of investments will be done in three-year rolling programs, in  - 12 - order to retain a degree of flexibility In the face of uncertainties in the external and internal environments. Accordingly, for the period of the SAP, a three-year program (1989-91) drawn from the medium-term Plan was discussed and agreed with the Bank in November 1988 and adopted In December 1988. As to the project portfolio, the Government has decided to strive for higher quality by applying Internal rate of return criteria to all projects amenable to such an analysis. In the case of social sector projects, the least cost criterion will continue to apply. In order to complement these efforts with better management of the portfolio, project execution monitoring is being further strengthened. 32. Public Enterprise Reform. The public enterprise reform program being Implemented with the support of Public Enterprises Rehabilitation Project (IDA Credit 1748-BEN) aims at reforming the institutional framework in which the public enterprises operate, liberalizing their pricing decisions, and rationalizing the sector (liquidation of those to be disposed of, privatization and restructuring of those that remain) to one that can be managed efficiently. To date, progress has been made on several fronts in keeping with targets. In February 1988, a new law defining Government- enterprise relationships (Loi 88-005) was adopted to give greater autonomy to enterprise managers and the Boards of Directors in return for greater accountability. Twelve enterprises have been dissolved and are under liquidation (CIB-ceramics, TRANSBENIN-trucking, IBETEX-textiles, SONATRAC and SOTRACOB-freight handling and forwarding, SOGECOB-household appliances, SODIHAS-school books, TAB-air transportation, SONAFEL-fruits and legumes, ONPB-pharmac), OBAR-farmland preparation, and OBEAR-entertainment. Six have been privatized (SONAE-vehicles and equipment, AGB-imported consumer goods, OBECI-cinemas, ONATHO-hotels, RAVINAR-ship outfitting, and LA BENINOISE-soft drinks and beer, for which negotiations with the potential partne- is underway). The progress made so far is in keeping with the targets of the project. 33. Restructuring efforts are also on-going in the Port Autonome de Cotonou (PAC), the Societe B6ninoise d'Eau et d'Electricite (SBEE), and the Office Beninois de Manutention Portuaire (OBEMAP) and are envisaged for the Office des Postes et des Telecommunications (OPT) as part of projects supported by IDA, the CCCE and other donors. The individual programs are being implemented through actions focussing on the enterprises' tariff policy, investment priorities and financial management -- for all of which performance indicators have been agreed between IDA and the Government for the 1989-92 period. 34. Under the SAP, the objectives of reducing the sector's financial losses and increasing its contribution to growth through an appropriate mixture of divestiture and restructuring efforts will be further pursued on the basis of a new overall portfolio review completed in July 1988. The review identified 2 enterprises as candidates for liquidation, 7 as candidates for privatization, and 10 as enterprises to study in-depth for possible rehabilitation. An action plan (Annex V) has been developed for the liquidation and privatization as well as the diagnostic studies decided on the basis of the portfolio review. Diagnostic studies have already been launched on six of the enterprises (SCB, SONACI, and SCO-cement, BSS-.ugar, SEB-  - 13 - fertilizer, SONICOG-fats and oils, and COBENAM-shipping). These diagnostic studies will permit further winnowing including selection of the enterprises worth retaining and rehabilitating. In cases where rehabilitation programs would be prepared, new statutes and enterprise contracts based on the revised framework law (pars. 32) will be used to clarify objectives as well as reciprocal rights and responsibilities. At the same time, systematic procedures have been developed for pursuing privatization which, past experience has shown, can be difficult to achieve efficiently. Meanwhile, through the annual public investment program and parastatal budget reviews to be carried out by Bank staff as part of the ongoing dialogue, the expenditure plans of all the enterprises will continue to be closely monitored. A monitoring system (tableau de bord), with indicators enabling performance review, has been prepared for the use of the supervising ministries (Finance and Justice). The first full report based on the monitoring system will be produced in September 1989. Finally, the Government has decided that no new enterprises will be created during the period of the first SAP except in cases of involving a minority share in an enterprise in a strategic sector (such as petroleum). Specific guidelines for decision making in those circumstances were developed in the second half of 1988 and, after review by the Bank, have been put in place in January 1989. Banking System Reform 35. Following a detailed supervision report on the Beninese banks by the BCEAO in August 1984, the Government undertook a number of corrective measures in the banking system. These included an overhaul of the accounting system, the re-instatement of Credit Committees on which the BCEAO is represented, and a change to taxing banks on their real rather than presumed profits, as was the practice in the past. Though badly needed, these selected measures were not enough to solve the banks' problems. Those problems became exacerbated in the last quarter of 1987 as a result of an exodus of funds from the system following a government decision to sequester the bank deposits of tax delinquents. Prior to this event, the banks were already vulnerable owing to the large share of non-performing loans in their balance sheets and their illiquidity (para. 10). Furthermore, prior rediscounting by the CNCA and the BBD of some of their poor quality assets at the BCEAO had exhausted the economy's rediscount facility at the Central Bank. The exodus of funds under those circumstances accentuated the liquidity crisis, leaving the BCB, in particular, unable to honor clients' requests for withdrawals or external transfers. This intensification of the difficulties of the banking system's problems led the Authorities to request twice from the BCEAO an exceptional increase in Benin's rediscount facility to permit the banks access to some additional liquidity while a lasting solution to the problem is sought. That request has been met by the granting of temporary facilities outside the normal ceiling, of, first, CFAF 6.8 billion in January 1988 and a further CFAF 7.8 billion in August 1988 outside the normal ceiling. 36. With Bank and IMF assistance, a program of actions to achieve longer- term viability of the banking system has been worked out. These actions comprise: (i) liquidation of the CNCA (currently under way) and the reorganization of the rural credit network involving its regional and local affiliates (CRCAM and CLCAM) on the basis of the results of a study completed  - 14 - affiliates (CRCAM and CCAM) on the basis of the results of a study completed In September 1988 and being deepened in the first half of 1989 ; (U) creation of a new bank with majority share held by a foreign private banking entity; (Wii) the liquidation of the BCB and 8BD; (iv) rescheduling of the banks' debts to the BCEAO with the Government on terms compatible with the public fiance situation; and (vi) general reinforcement of the supervisory and regulatory framework of the banking system. The search for a private sector Is taking longer than initially foreseen. Meanwhile, in order to prevent further deterioration of the existing banks, the Authorities have decided to place the BCB and BBD under interim administration by a team of foreign experts proposed by the BCEAO and France. The Bank and the IMF concur with the assignment and have found the technical qualification of the team acceptable. The team has the responsibility of (i) ensuring a minimum level of banking services during the transition period; (ii) assisting with the implementation of the program for the recovery of the banks" claims on the private sector; (iii) supervising the auditing of individual accounts and the reimbursement of depositors along the lines of the priorities established and (iv) generally overseeing the liquidation process. 37. The scheme adopted for the restructuring will require that the Government assume net liabilities of about CFAF 150 billion, of which CFAF 64 billion constitutes debts to the BCEAO, CFAP 18 billion represents short- and medium-term external debts, and CPAF 69 billion is debt to the Beninese private sector and public enterprises in form of time and demand deposits. Agreement has been reached with the BCEAO on the consolidation of CPAF 37 billion of its claims and a timetable for the payment of the remainder. The Government seeks to consolidate the claims of other external creditors on terms at least as favorable as those accorded by the BCEAO. The Authorities will, however, reimburse small private deposits (after verification in an audit underway) and portions of those belonging to enterprises, with the priority given to private enterprises in good standing with the Treasury and the banks and public enterprises undergoing restructuring. 38. The net budgetary costs of the above program have been estimated provisionally at CFA? 10-12 billion annually for the 1989-91 period, based on the scenario described in para. 37. These estimates will be revised when appropriate consolidation terms are decided for the treatment of private sector deposits not reimbursed immediately, and on the basis of other detailed plans for operating BCB in the interim period to be worked out by the Government by end May 1989, with the assistance of the interim administrators. The identification of an interested foreign bank, a suitable work-out with BCEAO, and the availability of external assistance to finance the Government's cash injection are all crucial to the success of the program. Contacts with potential private sector partners continue with a view to arriving at an agreement by mid-1989 and having a new bank in operation in the third quarter of 1989. Trade Policy Reform and Deregulation 39. In the early years of the development of the public enterprise sector through nationalization, indigenous private sector SMEs were spared. Owing to that experience and the general public enterprise bias of national policy, it has made good business sense for local entrepreneurs to keep their activities small and unnoticed, and to expand laterally, if need be, rather than vertically. Cumbersome business licensing, labor management and general  - is - reporting requirements--all of which small enterprises, but not large ones could avoid--reinforced these trends. On the other hand, public and certain privileged private sector enterprises are able to obtain benefits under the Investment Code that compensate, if not over compensate, them for the fiscal system's and other disincentive effects while the bulk of private enterprises remain penalized. 40. The Second State Plan declared the Government's desire to see the private sector play a greater role in the economy, but concrete actions to give content to that declaration have so far been limited to: (i) abolition of the State monopoly on the import of most consumer goods; (ii) initiation of pricing policy reform by shortening the list of goods for which prices are set administratively and making the procedures for ex-post control of others lighter; (iii) permitting private operators to trade in food crops; and, more recently, (iv) abolition of quantitative restrictions and prohibitions on imports of selected goods produced locally. Under the adjustment program, the Government intends to go beyond those first steps and give the SME sector real impetus in order to have it make a stronger contribution to growth and employment generation in the years ahead. This objective will be sought through a series of trade policy reform and deregulation measures. 41. The impact of the regulatory framework and the tariff structure developed over the past decade have, among other things, discouraged private sector activity in the industrial sector. In order to reduce industrial sector losses and strengthen its contribution to growth in a rationalized policy framework, the Government plans to reform relevant trade policies in a two-step approach. The first step taken in July 1988 involved removing QRs and prohibitions on all imports and replacing them with tariffs. In the second step, the Government is evaluating the framewerk of industrial tariff protection and import taxation concurrently in a study launched in November 1988 (para. 23), with a view to devising measures to rationalize the structure of industrial incentives in a manner consistent with the program's revenue objectives. An action plan to implement these actions will be agreed with the Bank in the second half of 1989. The Government also plans in 1989 to liberalize trade further by abolishing import licensing for the bulk of Benin's imports (Franc Zone, EEC, and ACP countries). 42. In the area of exports, the Government has taken measures to promote the development of food crops into a structural export item (para. 3) and stimulate the growth of secondary cash crops. This was done through the liberalization of the marketing of food crops, both at home as well as for exports, and the opening up of trade in secondary cash crops to the private sector (December 1988). 43. In order to introduce greater flexibility into the business environment and facilitate the functioning of markets, the Government has abolished price controls for all goods except a small number of essentials (7 as against 25 previously). Next, it will (i) revise business registration, licensing and reporting requirements to make them lighter and easier for all businesses to comply with; (ii) amend the labor laws to allow greater flexibility in the hiring and firing of labor; and (iii) revise the Investment Code to make it neutral as between public and private enterprises,  - 16 - and as regards size and factors, to make its application more transparent, and reduce its privileges over time. The actions required to introduce these changes were discussed by Bank staff and Government in July 1988, and the appropriate revisions to existing texts are under way. The decrees and laws to implement (i) and (ii) will be adopted by September 1989. In the case of (iii) a first draft commented upon by the Bank in April 1989 will be further discussed internally in Benin, including with the private sector, and an action plan outlining the steps towards its adoption will be prepared by September 1989. PART III - THE PROPOSED CREDIT A. Credit History 44. The proposed credit will support Benin's structural adjustment program, the elaboration of which has been made possible by Bank economic missions during 1986-88 and inputs from the IDA-financed tecbnical assistance project. A March/April 1988 mission helped identify the main elements of adjustment and assisted the Government in preparing its Statement of Development Strategy. The structural adjustment program was appraised in June/July 1988. Negotiations were held in Washington in November 1988; the Beninese delegation was headed by H.E. Didier Dassi, Minister of Finance. Supplementary credit data are provided in Annex ITI. B. Support of Policy Reform 45. The proposed operation would support Benin's economic stabilization efforts and help consolidate recent adjustment measures into a comprehensive program of medium-term adjustment of the economy, focusing mainly on public sector management reforms, banking system rehabilitation and improving the incentive environment for private sector development to encourage the expansion of productive activities. The Government has provided the Bank with a Statement of Development Strategy which articulates the principles of restructuring the economy and describes the specific measures that have been taken and will be taken to implement the program (Annex IV). These measures are summarized in the Policy Matrix annexed to the Statement of Development Strategy. The proposed credit would ease Benin's financial constraint during the adjustment period, not only with respect to external capital requirements, but also by increas'ng budgetary resources especially to permit the payment of the costs associated with the restructuring of the banks. C. Effects of Adjustment 46. Benin is undertaking a major re-orientation of its development strategy in the direction of greater reliance on market forces to drive the growth and development process. The objective is to lay the foundation for sustainable growth over the longer term within a stable macroeconomic framework. Recognizing the errors in the past policies of State control of all major modern sector activities, the program will seek to reduce the size and role of the public sector and concentrate it on providing a core set of public services while removing impediments to the growth of the private sector. This should facilitate stronger performance in agriculture--both cash  - 17 - and food crops--and lead to the re-emergence of formal SHE activities especLally in the secondary and tertiary sectors as new sources of growth and employment. Macroeconomic Impact of Program 47. It is expected that the measures being taken in the context of the adjustment program will enable the cotton subsector to weather the world market price decline and still attain the projected maximum output level of 150,000 tons by 1990. Together with improved performance of food crops, which can be expected, particularly as a result of the recent measure to free exports of food, this should ensure that primary sector value added grows by an average annual rate of 3 percent over the period 1989-92 (Table 3). In the secondary sector, further public enterprise rehabilitation, including the recently-completed physical rehabilitation of the major industrial plant (La Beninoise, producer of beer and soft drinks) which was damaged by an explosion in 1986, and the intended privatization of the enterprise (whose level of operation greatly influences the demand for, and output of, water and electricity), the restructuring of the cement subsector, and the commencement of the delayed investments in the S4mb Oil project (assisted by IDA and RIB) should reverse the recent decline and permit an average annual industrial growth rate of 2 percent over the next five years. In addition, expected recovery in the commerce and transport services in respense to liberalization should more than offset the expected stagnation in government services to permit a tertiary sector average growth rate of 3 percent over the 1989-92 period. These developments should lead to real GDP growth rates averaging 3 percent during the period of the first SAL (1989 - 91) and about 4 percent thereafter when the policy changes begin to have their full impact. 48. The present macroeconomic disequilibrium is evident in the high aggregate consumption and the consequent poor savings effort. This reflects mainly the imbalances in the public sector and has its counterpart in a weak external current account balance. The program envisages achieving some reduction in government consumption. It is expected that, as a result of the reduction in real government consumption during 1988-89 and its stagnation thereafter, public savings equal to 1 percent of GDP would emerge in 1990 and increase steadily aftezwards. By curbing the role of the public sector, and shifting resources into the tradeable sector the program should enable exports to grow at 5 percent per annum in real terms. As a result, in spite of slightly higher imports, especially of capital linked with the higher investment/GDP ratio (from 12 percent in 1988 to 13 percent in 1991), the external current account/GDP ratio should improve from a deficit (before grants) of 9.6 percent in 1988 to 8 percent In 1991. The measures aimed at reducing the public finance imbalances and eliminating public enterprise financial losses together with restored confidence in a rehabilitated banking system, should result in an improvement of the savings effort and the gradual narrowing of the savings-investment gap while permitting a modest increase in the investment ratio (Table 3). The relatively cautious expectation about the response of exports to the adjustment measures takes into account (i) the low competitiveness of Beninese manufactures owing to the higher cost structure relative to neighbouring Nigeris, for example; and (ii) the gradual leveling- off of crude oil production by 1991 unless new discoveries are made.  - 18 - 24tr-49 Table 3. rnIn: woo ruotr with AdM ~t 19 137 1ow 190 lo" ecti Prol a. Eftim. - perod awrs - GO at M.p. -1.1 -8.6 1.8 2.9 3.7 - prary 6.0 4.7 2.3 3.0 4.7 -Sandry -9.8 a.5 2.0 2.4 3.0 - TertIary 0.2 0.5 1.0 2.2 2.5 Ebort -23.4 13.4 -12.1 4.7 2.8 lrts -4.3 2.2 -3.4 3.2 2.8 Cnmwt lm 4.1 -4.5 -0.8 2.1 3.1 oh Privat Per Capita -4.2 2.1 0.2 0.5 l _wetmt 5.9 -3.0 7. 5.0 IbtIaul Ilu -0.1 0.8 3.3 8.4 Tumof Trade ibx 4.6 52.9 48.8 49.9 50.9 ( 1! * 100 ) Curret Act.,WM -8.7 -8.0 -9. -8.4 -7.8 tabie 4. min: Grow firra Rawirts 198 1980 1801 1991 ra fInamirg Rpuirts 1/ 500 m 138 16 To be at by: Project Ln se 8Os W 248 Dobt bitf 274 S 8 XS0 IDA Sl. 45 0 0 45 IwS w 9 12 9 30 Gap 112 im 74 287 1/ Isrent dmsat def Icit plu ectmI arrusi, mortlutian an roitla In burkirpa's net foreig I ibi I itiS Il capital graft ad act-te caital. See kms VI tble 3. 98w: OffIolal dat nd 98'k Staff estlute ad project lam.  * 19 - 49. The average Investment rate of 13 percent is projected for 1989-91 which, in view of the 3 percent average growth rate, implies the maintenance of an incremental capital-output ratio of about 4:1, compared with an average of 5:1 for the period 1978-87. This embodies the expected improvoment in the quality of capital expenditures during the period 1989-91 on the basis of the enhanced investment planning and project selection procedures (paras. 30-31). External Canital Requirements and Financing Sources 50. The above scenario assumes that the appropriate supply response will be forthcoming and that the external financial resources will be available to cover the economy's import requirements and permit a reduction of the net foreign liabilities (i.e. raise reserves to about one week of imports), the elimination of external arrears and the funding of emergency social programs. After stagnating during 1985-87, imports are projected to increase at an annual average of 3 percent in real terms during 1989-91, in line with the investment and intermediate input requirements of the growth assumptions. In spite of the expected improved performance of exports, the external sector will be characterized by large deficits during the period, partially because of the weight of debt service payments, which average about 40 percent of exports of domestic goods and non-factor services. The current account deficit/GDP ratio is projected at an average of 7.8 percent, leading to overall payments deficits averaging 3.0 percent of GDP. Detailed national accounts, public finance and balance of payments projections are set out in Annex VI. 51. The gross external capital requirements are expected to be US$ 916 million for the period 1989-91 of which disbursements from the existing pipeline and new commitments should provide US$ 248 million (Table 4). An additional US$ 306 million is projected to come from debt relief, assuming that external debt arrears and new scheduled payments will be rescheduled in line with the terms of the Toronto initiative. Taking into account IDA's SAL of US$ 45 million and the 1MP's SAW resources of U8$ 29.7 million, the remaining gap (US$ 287 million) is assumed to be covered by exceptional financing under the SPA auspices. 52. The proposed credit of US$ 45 million equivalent could finance about 10 percent of Benin's merchandise imports during 1989 and meet about 9 percent of the country's gross external capital requirements during the period. The credit amount could cover 20 percent of the Government's gross external financing requirements in the 1989 budget. The credit would be on Standard IDA terms with 40 years maturity, including 10 years of grace. The proposed credit will be disbursed in two tranches, the first of which is US$ 22.5 million which will be available upon credit effectiveness. The credit is expected to be fully disbursed within 7 months of effectiveness. 53. Benin's debt presents a major difficulty for the future viability of its external sector. Even with the above generous rescheduling terms, the savings from debt relief disappear in 1992 and become negative from 1993 onwards (Annes VI, Table 3). This is due to the weight of the commercial debts of the sugar and cement companies of Savr and Onigbolo (80 percent of arrears and 20 percent of future payments) on which the moratorium interest  - 20 - rises rapidly. The Government has listed these companies among those to be studied and possibly privatized in the years ahead (para. 34). and vill also explore vith Nigeria (part-owner of the enterprises) the possibility of a debt-to-debt conversion work-out for the two enterprises. D. Banefits and Risks 54. While the policy changes required under the adjustment program run counter to the ideological stance that the Government has had over more than a decade, they are necessary if the public sector is to become manageable again, the banking system operational and growth prospects improved. Particular benefits are expected to accrue from the restoration of a viable public finance situation and a rationalized and more efficient civil service, the elimination of loss-making enterprises from the State's portfolio and the restoration of a sound banking system. In addition, as controls on economic activity are lifted, local farmers, craftsmen, traders, small industrialists should prosper. Also, as the business environment is made more conducive to private initiative, the economy is likely to benefit from increased local and foreign investment as confidence grows in the system. 55. The Government faces three risks in the implementation of this program. First, further terms of trade losses from declining cotton, palm oil and crude oil prices could play havoc with the financial plans, making it difficult to pay remunerative producer prices and also carry tbrough those parts of the program dependent on growing financial strength. For Instance, if export prices were to fall by an average of 10 percent over the adjustment period, the external financial requirements would increase by about US$ 60 million. Second, domestic political opposition to reforms could re-emerge, as a result of social strains arising from the changes being introduced (described in Part E below), especially as some ambivalence towards free market policies still remains within the radical wing of the Politbureau. Since most of these public sector proponents associate income disparities with inequalities fostered by the private enterprise system, their arguments will acquire some force if widespread suffering appears among workers while new private businesses seem to be doing well. Third, the complexity of the process of privatizing the banking system poses additional risks, including that of a long search for a partner. 56. These risks are reduced by the structure of the program and the political establishment's (both the President's and the Politbureau's) firm and clear endorsement of the reforms. First, actions are being taken to strengthen resource mobilization, on one hand, and eliminate waste and inefficiency, on the other; this would among, other things, permit the resumption of orderly payments of salaries and relieve some political pressure. Second, the measures designed to alleviate the social impact of the program (Part B) will minimize the extent of social dislocation likely to arise while the poverty alleviation package Included in the program should improve its sustainability. Third, the up-front declaration of non- involvement in the management of the new bank, the new attitude towards private business reflected in the strong parastatal privatization efforts and the promising contacts made so far with private banks reduce the risk of a drawn-out search for a partner.  - 21 - E. Social Impact 57. Although income per capita is low ia Benin, the economy's capacity to foed itself ensures a reasonable nutritional standard for the population. That standard is all but guaranteed in the case of rural households. In the urban centers, however, the money income status of households determtne nutritional well-being. It is therefore mainly in the urban areas that reductions in real wage incomes (as a result of lay-offs andlor price increases) could lead to hardships. S8. Of the adjustment measures implemented so far, increased cotton producer prices and SONAPRA's reinforced capacity to import and distribute modern inputs have raised incomes among the rural population. In the urban areas, the significant measures are those related to the reduction of the labor force of restructured public enterprises. Already about 3000 employees from four fully liquidated public enterprises have been laid off. Of that number, 293 covered by the Civil Service Code (Statut des Agents Permanents de l'tat) have returned to the central Government. The others are to benefit from self employment aid under the redeployment scheme of the parapublic sector project. The Project Unit of the Public Enterprises Rehabilitation Project (Cr. 1748-BEN) is working through a special commlttee to implement the redeployment scheme. 59. During the implementation of the SAL program the contrasting rural- urban impact is likely to be accentuated. laitially, urban unemployment will grow as people leave the civil service, further hiring is frozen and more enterprises are liquidated. There are, however, countervailing measures which are an integral part of the program aimed at agriculture, the private sector, small farmers and artisans, and human resource development. In addition, the program will attempt to limit the social impact of the shifts in the urban areas in various ways. First, the civil service employment reduction program will be supported by a well-funded compensation package. Each leaver will receive as a minimum hislher accumulated pension rights. Second, for those wishing to do so, there will be technical advice on relocation from the Centre for Private Enterprise Promotion. Third, a labor-intensive urban works program focused on maintaining the road network and upgrading the sanitation system, Including the drainage system, will be used to upgrade living conditions while employing about 1,500 workers during 1989-91. This program would respond to a pressing need while helping mop up some unemployed labor during the critical period when laid-off workers shift to new occupations under the resettlement program. 60. Beyond these, social services (education and health) will be protected and their delivery improved, including increasing financing for non- wage recurrent expenditure in these sectors (para. 28). Given the exceptionally difficult financial situation, these vital expenditures will be financed from a Social Fund being set up with foreign contributions to finance social programs during 1989-91. Finally, a unit to monitor the evolution of social conditions will be set up as part of the Africa-wide Social Dimension of Adjustment (SDA) research effort to provide indicators for guiding policy decisions on mitigating the social impact of adjustment. The Bank SDA mission to start the creation of the unit is scheduled for May-June 1989.  - 22 - Environment 61. Owing to the importance of agriculture and fisheries to the Beninese economy. as well as for health reasons, the Government pays particular attention to the environmental problems of soil degradation and the evacuation of effluence into the rivers that empty themselves In Cotonou and Porto-Novo. These coancerns have become more preoccupying In the face of rapid expansion of the use of chemical fertilizers in agriculture, the increased salination of the Nokoue lagoon, and the rapid erosion of the coastal areas of the Mono Province. In order to respond effectively to these environmental problems and concerns, the Government inten-s, as part of the general review of the policy orientation of the economy, to prepare and adopt a rational policy on the environment by end 1989. This work is being supported by the Bank In the broader context of the dialogue on protection of the environment and natural resource maagement. F. Disbursement. Administration and Procurement 62. Prior action by Government has been taken recently In the following areass I. Public Sector Reform (i) increase in the main import tariff, taxe fiscale d'entr6e; and reversal from officially-fixed (mercurial) prices to c.i.f values for taxing some imports; increase of the officially-fixed (mercurial) bases for others; (ii) census of civil service and use of data as new base for budgeting personnel expendituress (iii) end to automatic recruitment of all graduates into the civil service; (iv) suspension of automatic wage increases following promotions and/or reclassification; (v) reduction by 50 percent of basic salary of public service officials on study leave; (vi) abolition of housing allowances to civil servants and military, equivalent to 10 percent of basic salary; (vii) adoption of internal rate of return criteria from screening of Industrial, agricultural and infrastructure projects and least cost criteria of social sector projects; (viii) promulgation of a new framework law defining government-public enterprise relations; (is) dissolutionlliquidation of 12 public enterprisess  - 23 - (x) privatization of 6 public enterprises; II. Bankina System Reform (xi) dissolution of CACk; (Xii) overhaul of accounting system of the BCB; (xiii) audit of the portfolios of the BBD and the BCBs (xiv) preparation of a sector restructuring program including a program to recover private sector debts to the banks; (xv) placement of BCB and BBD under Interim adminLstration; III. Trade Policy Reform and Deregulation (xvi) liberalization of the marketing of food crops internally as well as for exports and the opening up of trade in secondary cash crops to the private sector; (xvii) removal of quantitive restrictions and prohibitions on all imports and their replacement with tariffs; (xviii) reduction of number of goods subject to price control from 22 to 7 and those subject to profit margin guidelines from 65 to 15; 63 The second tranche will be released following a review indicating satisfactory progress has been made in implementing the program as a whole, and the following measures in particulars I. Public Sector Reform (i) agreement on an action plan for the introduction of the general expenditure tax, taxe sur le chiffre d'affaires; / (it) satisfactory progress in implementation of the civil service personnel reduction program (para. 9 (ii) of the Statement of Development Policy); (iii) satisfactory progress in Implementation of the parastatal sector restructuring program adopted in December 1988 (Annex V)1 III. Trade Policl Reform and Deregulation (iv) removal of import licensing on goods from the Franc Zone, the European Commnity and the ACP countries, and a8reement on an action plan for application of the recommendations of the import taxation and industrial protection studies;  - 24 - (v) adoption of new, simplified business registration and licensing procedures and labor regulations; (vi) agreement on an action plan for the adoption of a revised Investment Code; Program Management and Monitoring 64. The National Adjustment Commission set up in May 1986 is the official organ of the Government charged with the responsibility of preparing the program of structural adjustment in collaboration with the World Bank and the IMP. It is composed of senior civil servants at the level of section chief and above, and is directed by a Praesidium made up of the Minister of Finance, as Chairman, and the Ministers of Planning, Justice, Industry and Energy, Rural Development and Labor and Social Affairs. At the technical level, the Commission works in sub-commissions according to the key areas targeted for reforms. The sub-commlttees are headed by Department Directors who together constitute the technical secretariat of the Commission. The full Comdission meets once a week to review various aspects of the work on the program. The Commission is not a decision making body; it reports to the Central Committee of the Party which makes decisions under the Chairmanship of the President. So far, this arrangement has worked smoothly, including enabling the Government to implement up-front a large number of measures discussed with the SAL appraisal mission in July 1988. 65. At the program preparation stage, each subcommission worked with the Bank team on designing the reform measures, and saw to the implementation of the up-front ones. The sub-commissions continue to work on the measures to be taken during the period 1989-91 and will be involved in their implementation at the technical level. Each leader of a sub-commission, being himself a member of the Commission's Technical Secretariat, will be responsible for reporting progress on the measures of his concern to the Praesidium. The Praesidium in turn will put before the Central Committee issues requesting a political decision. After these decisions are made, the appropriate instructions will be issued to the executing Ministries by the Central Committee. The National Commission will monitor the implementation of the measures through the various sub-commissions and its Praesidium will remain the interlocutor of visiting Bank follow-up missions. 66. Following the disbursement of the first tranche of the proposed credit, the Commission will submit to IDA a report evaluating progress made in implementation. This report will serve as a basis for the release of the second tranche. The Commission will submit to IDA a final report on the program's implementation upon full disbursement of the credit. Disbursement and Auditing 67. The credit will reimburse the foreign exchange cost of eligible imports (excluding luxury goods and defense items). Disbursement would be facilitated by the establishment of a USS 8 million equivalent Special Account in the central bank (BCEAC). IDA flnanclng of Imports of foodstuffs will be  - 25 - limited to an aggregate amount equivalent to no more than US$ 6 million. The Ministry of Finance will be responsible for collecting the supporting documentation (copies of the invoices and evidence of shipment and of payment) and for preparing withdrawal applications. Disbursements would be against Statements of Expenditures (SOEs) for eligible contracts valued at US$ 500,000 or less. The supporting documentation for these would be retained by the Ministry of Finance and would be made available to Bank staff during supervision and audited annually by independent auditors. The nature and origin of the goods as well as the payment date would be indicated on the SOBs. Expenditures for goods procured under invoices for USS 10,000 equivalent or less would not be eligible for financing out of the credit proceeds. All other disbursements would be made against full documentation submitted to IDA. The minim withdrawal application size would be US$1 million equivalent. In order to enable the Government meet urgent foreign exchange needs, IDA would disburse up to 20 percent of the credit for eligible imports which were paid for and entered the country after November 1, 1988. An audit report, conforming to internationally accepted standards and prepared by auditors approved by IDA, will be submitted within six months after the close of each fiscal year. Procurement 68. Both private and public sector imports would be eligible for financing. Imports by private entities would be in accordance with normal commercial practices, which are acceptable. For public sector imports, procurement would be made through international competitive bidding in accordance with Bank Guidelines for contracts of US$ 2 million equivalent or more. Contracts for the procurement of goods estimated to cost less than US$ 2 million equivalent each would be awarded on the basis of normal procurement procedures of the purchaser which were evaluated by the appraisal mission and found to be satisfactory to the Bank. PART IV - BANK GROUP OPERATIONS AND STRATEGY Past Assistance Strategy 69. Since becoming a member of the Bank Group in 1963, Benin has benefitted from 26 IDA credits amounting to USS 247 million of which about $ 170 million is disbursed and outstanding. Initially, much of the assistance was delivered in the context of traditional projects mainly in the agriculture, transport, and energy sectors. When the economic dialogue was broadened after 1982, the country assistance program was adjusted accordingly to focus it on supporting macroeconomic management and the rehabilitation of key sectors which had become weakened or overextended as a result of projects and policies executed under the First State Plan (paras. 6-10). Accordingly, the CESU emphasized public sector management issues (a CEM In FY84, a Public Investment Review in FY85, Fiscal System and External Debt Studies in FY86, and a Public Expenditure Review in FY87), and sector efficiency issues (Food Crop Marketing, FY86 and Education Sector and Banking System Reviews, FY86- 87), while the lending program included credits to assist rehabilitation of infrastructure (Transport infrastructure Rehabilitation Project in FY87), and  - 26 - support adjustment in the public enterprises (Public Enterprise Sector Reform Project, FY87) and the cotton sub-sector (Second Borgou Rural Development Project, mF8). 70. Further severe deterioration of the country's economic and financial situation in 1987, including the virtual cessation of banking sector operations in the last quarter of the year, convinced the Government that only a broad reform program can deal effectively with the economy's problems. The Government therefore used the opportunity of a meeting with donors (Bank, XW, France and ICE*O) on the banking system in Paris in February 1988 to disclose its decision to abandon piecemeal adjustment in favor of the comprehensive reform program described in Part D above. Proposed New Strategy 71. The decision of the Government to embark on a comprehensive market- oriented reform program represents a fundamental change in Benin's development strategy and the Bank's assistance strategy has been adjusted to support its implementation. At the macroeconomic level, the Bank strategy will support the objectives of rationalizing the public and parapublic sectors promoting private sector growth, and reforming the banking system. At the sectoral level. the strategy is to assist Benin to re-establish the international competitiveness of its cash crops and revitalize the transport and transit sectors, to help the Government find a least-cost solution of the problem of idle and/or seriously underutilized industrial plants and substitute a planned and rational incentive system for the present one that is largely the inadvertent result of other policies. The strategy also aims at assisting lenin to improve the internal efficiency in the social sectors through selective re-orientation of their programs and increasing their non-wage recurrent budgets (para. 28). 72. Lending Program. The centerpiece of IDA assistance in Benin over the next few years will be Structural Adjustment Lending in support of the Government's policy reforms, providing fast-dlsbursing resources to meet the economy's balance of payments financing needs (Annex VI, Table 3). The adjustment being pursued by Benin will necessarily take a number of years to accomplish. Accordingly, the first SAL, described in this report, is likely to be followed by others that will assist the Government to consolidate and build on the achievements of the first phase of the reform process. 73. IDA is also assisting the Government in the preparation of operations in agriculture to support the objectives of strengthening agricultural research and extension services as well as build food crops into a structural export earner while ensuring internal food security. A private sector development project is under preparatlon to support follow-up actions to give further content to the private sector objectives of the general reform program. Projects in education and population and health are being examined to help improve the quality of services in these critical areas and the cost effectiveness of their delivery. In the case of the latter, a Health Services Services Project has been prepared.  - 27 - PART V - COLLABORATION WITH IM AND OTHER DONORS Aid Coordination 74. Benin enjoys a highly diversified flow of foreign aid. From fairly low levels In 1970-72, foreign aid has now risen to the point where it finances about 90 percent of the annual investment program. Among the main donors are OECD countries, especially France and Germany, the European Community and the UN system, although regional aid institutions -- the African Development Bank and Fund, the West African Development Bank and the Arab aid agencies -- have a growing presence. 75. The diversification of the country's aid sources provides IDA with aid coordination opportunities as well as challenges. In all the sectors where IDA has been active, IDA has coordinated its inputs with those of other partners to ensure technical quality and coherence. In continuati.n of those aid coordination efforts, IDA is in touch with bilateral and multilateral donors desirous of cofinancing Benin's adjustment effort. In this vein IDA will assist the UNDP in organizing a donors' conference in late 1989 to mobilize financing for the tedium-term public Investment program that Benin will adopt in the context of the adjustment program. 76. Given its debt burden over the next few years (average debt service ratio of 30 percent during 1989-91) and its determination to carry out a program of structural adjustment, Benin qualifies for aid under the Special Program of Assistance (SPA) for debt-distressed countries. Further resources for SPA sources will be available to cofinance Benin's first structural program. Relations with the DIM 77. Over the last few years, aside from the annual Article IV Consultations, Benin requested and received several staff visits to pursue the dialogue towards a stabilization program. The country also benefitted fram three technical assistance missions that reviewed the fiscal system and estimated public finance arrears. In the policy discussions, however, although a close working relationship was forged during the period, concrete progress was slow until this year, for the same reasons as in the Bank-Benin dialogue (pars. 4). The preparation of a sound current budget for 1988 and the macroeconomic policy declaration made in Paris (para. 3) marked a turning point In the policy dialogue. On the basis of that, an IMP mission visited Cotonou In July 1988 to begin preparatory work for a SAP program to be adopted in parallel vith the Bank's SAL. The mission worked in close collaboration with the Bank on the preparation of the adjustment programs including assisting the Government on the preparation of a Policy Framework Paper (PFP). A joint Bank-IMF mission vLsited Cotonou in February 1989 to negotiate and agree on the PFP with the Government, following which the DNF finalized its first year's SAF program in Paris in March. The presentation of the PFP to the Committee of the Whole is scheduled for May 1989.  - 28 - PART VI - RECOMMINDATION 78. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association and I recommend that the Executive Directors approve the proposed credit. Barber B. Conable President April 26, 1989 Washington, D.C.  -29- ANNEX I 1988 SOCIAL INDICATOR OATA SHEET BENIN Roeore4c Groups (661) Most ROcent Lower sid 19WI 197S Estimste Low- Income inaeO MARE Totel land area (thou sq km) 112.6 112.6 112.6 Agricultural (Sot total) 6. 7 19.6 20. 0W PER CAPITA (current US$) 100 170 300 280 739 POPULATtO 4AM VITAL STATISTICS Total population (thou) 2.332 3.029 4.315 Urban pop. ( of total) 13 22 37 29 38 Population growth rate(%): total 2.7 3.0 1.0 2.5 Urban 8.2 0.0 5.7 4.2 Life xp Ct at birth (yrs) 42 41 S0 61 59 Population projections: PoP. in 2000 (thou) 6.636 Stationary pop. (thou) 20.251 Population Fensity per sq km of agricultural land 124 137 173 349 404 Pop, age structure (X): 0-14 yes 45 46 47 37 42 15-f4 yres S2 o 49 S9 S5 5 and above 3 3 3 4 3 Crude birth rate (per thou) 49 49 49 30 ff Crude dath rate (per tnou) 24 20 17 10 10 Total fertility rate 6. 6.6 6.5 3.9 4.7 Intant mort. rate (per thou) le6 136 1O9 72 76 Child death rate (per thou) 52 39 19 9 tt Family planring: Accp tors, annuat (tnou) Users (X of married women) 6 FOOD. HEALTH AND MTRIt ION Index ot foodc production per capita (1979-81 a 100) 9g 93 116 115 106 Par Capita supply of: Calories (per day) 2,004 1.999 2.248 2.327 2.507 Proteins (grams per dasy) 45 45 49 55 56 Pop, per physician (thou) 32.4 t7.0 5. 7.5 Pop. per nurse (thou) 2.5 2.6 1.7 4.0 Pop. per nospital bed (thou) . 0.9 1.1 1 Access to safe water (% of population): total 20 14 Urban . 42 45 Rural Is 9 Population Growth Infant Mortality PriTcory School Enrollment 53 190 -_______ ______ 2"~~~~~~~~~2