Djibouti - The challenge of a city state

Report No. 8111-DJI Djibouti The Challenge of a City-State May 31, 1991 Africa Region Country Operations L_>.partmnt FOR OFFICIAL USE ONLY U C K~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Document of the World Bank This.-docurnent has a restricted distribution and may be used by recipients only in the performlance of tlei. official duties. Its contents may not otherwise bt disclosed withtout World Bank authorization.  CURRENCY EQUIVALENTS The Djibouti franc (Dv) is pegged to the U.S. dollar at the rate of US$ 1.00 DF 177.72 Year FF/DF (Annual average) 1980 42.l 1981 32.88 1982 27.04 1983 23.32 1984 20.33 1985 19.78 1986 25.66 1987 29.57 1988 29.83 1989 27.85 1990 32.64 1991 (lst quarter) 34.11 FISCAL YEAR: January 1 to December 31 WEIGHTS AND MEASURES: Metric system ACRONYMS AND ABBRFVIATIONS ACP African, Caribbean and Pacific States AfDB African Development Bank AFESD Arab Fund for Economic and Social Development CCCE Caisse centrale de cooperation economique CDE Chemin de fer Djibouti - Ethiopie DINAS Direction nationale des statistiques EdD Electricite de Djibouti EC European Community FAC Fonds d'aide et de cooperation GDP Gross Domestic Product GNP Gross National Product IDA International Development Associaticn IFAD International Fund for Agricultural Development IMF International Monetary Fund IPC Interministerial Planning Commission ISERST Institut superieur d'etudes et de recherche ONAC Office national d'approvisionnement et de commercialisation OPEC Organization of Petroleum Exporting Countries PIP Public Investment Program SMI Service medical inter-entreprises UNICEF United Nations Children's Fund UNECA United Nations Economic Commission for Africa UNIDO United Nations Industrial Development Organization UNDP United Nations Development Programme UNHCR United Nations High Commission for Refugees USAID United States Agency for International Development  FOR OFFICIAL USE ONLY PREFACE This report is based on the findings of a World Bank economic mission that visited Djibouti from November 14 to December 1, 1988. The mission was led by Pisei Phlong Eap and included Pierre Demangel (public finance expert) and Rene Rakotobe (national accounts expert from the United Nations Economic Commission for Africa). The mission was joined by I4anu Bheenick (public investment consultant, African Development Bank). Valuable contributions were provided by Gary Hyde as external advisor. Ginette Francois processed the various drafts of the report. Given the severe limitations of the quantitative information, the report draws heavily on data estimated by the team members and on information provided by World Bank project and sector work. The population and national accounts estimates are provisional and their discussion with the authorities has been postponed, pending the results of the 1991 population census and additional studies on national accounts commissioned by the government. In the absence of statistical information for 1988-90, the report provides a largely qualitative assessment of economic developments during these years. The policy recommendations of the report were discussed with the Djibouti authorities on September 15-16, 1990. The government has endorsed and is implementing several of these recommendations, in particular those in public finance and economic management. Although the authorities acknowledge the need to correct the high cost-price structure in Djibouti, they do not agree with all the recommendations of the report in this area. In particular, they consider the current exchange rate policy (currency pegged to the U.S. dollar) an advantage, and are concerned that an exchange rate adjustment would endanger Djibouti's role as a regional financial and commercial center. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS Page No. COUNTRY DATA EXECUTIV& SUMMARY . . . . . . . . . . . . . . . o . . . . . . . . . i INTRODUCTION . . . . . * . . . e e . . . . . . . . * . . . . . . 1 CHAPTER I: SALIENT FEATURES . . a . a . . . . . . . . . . . . . 3 As The Country Setting and Historical Background . a 3 B: Human and Natural Resources . . . . . . . . . . 4 C: Economic Structure . . . . . . . . .o . a .e o o e 5 CHAPTER II: RECENT ECONOMIC DEVELOPMENTS . . . . . . . . . . . . a 7 A: v'rowth and Utilization of GDP, 1984-87 . . a . . a 7 Bs Employment, Income and Prices . . . a . . . . . a . 9 C: Public Sector Financial Performance. . . . . . . . . 11 1. Public Finance. . . . . a. . . . . . . . a a a a 11 2. Public Enterprises. . . . . . . . . . . 14 D: Money, Credit and Interest Rates . . . . . . . . . . 15 E: Balance of Paymente. and External Debt Management . a 16 F: Assessment of 1988-90 . . . . . . . a a . a a a a 18 CHAPTER III: SECTORAL DEVELOPMENTS AND ISSUES . . . . . . . . . 20 AS Services and Infrastructure. .. . . . . . . . . . 20 B: Agriuultuj.._, Industry and Tourism . a a a . . a a 22 C: Energy . . . . a a . . . . . . a a a a a a . . . . . 24 D: Social Sectors . . . . . . . . . . . . . . . . . . . 25 1. Education and Training a . . a a a a a a a a a a 25 27 Population and Health . . . a . . . a . . . . . a 26 E: Urban Development. . . . . . a . . . . . . . . . . . 27 F: Environment . a a a . . a a a . a . . a . a a a 28 G: Women in Development . a . . . . . . . . . . . . . . 29 CHAPTER IV: DEVELOPMENT POSSIBILITIES AND FUTURE OUTLOOK . a . . . 31 As Economic Management . a a a a a a a . . a . . a a 31 1. Public Administration . . . . a a a a a a a .. 31 2. Fiscal Administration . a a a a a a a a a a a a 32 3a Data Collection and Quality . a . . a a . . a a a 33 4. Public Investment Programming and Aid Coordination 33 B: Development Possibilities . . . . . . . . . a . 34 C: Problems and Issues . . a . a . . . a . . . . a a a 37 D: Medium-Term Outlook. . a a a . . a . . . . . . . . . 39) 1. Public Investment . . . . . . . . . . . . . . 39 2. Medium-Term Scenario . . . . . . . . . . . . . . 41 E: The Development Challenges A Long-Term View . . . . 44 ANNEX Is National Accounts Estimates - Methodological Note . . . . . 45 ANNEX TIs List of Investment Projects a a a . a a a a a . . . . a 86 STATISTICAL APPENDIX . . . . . . . . . . . . . . . . . . . . . . . . 110  LIST OF TEXT TABLES page-No. Table 2.1: Resource Availability and Use, 1984-87 . . . . 8 Tablt 2.2: Macroeconomic Balances, 1984-87 . . . . . . . . . . . 9 Table 2.3: Central Government Operations, 1984-89 . . . a . e 12 Table 2.4: Monetary Survey, 1985-88 . . . . . . . . . . . . . . . 16 Table 2.5: Balance of Payments, 1984-87 . . . . . . . . . . . . . 17 Table 4.1: PIP, Proposed Core List, 1989-91 . . . . . . . . . . 40 Table 4.2: Balance of Payments Projections, 1988-95 . . . . . . 43  RJIBOUTI~~~~~~~~~~~~~~~~~~~~~~~~~~~~~OIOT DJIBOUTI - ECNGiC INDICATORS Mld-1989 Population (mIls.)PAEIO 1989 Per Capita GNP in USS.. A. Shares of Gross Domestic Prodict 8. Growth Rates(% per arnnuz) (from current price data) (from constant price data) 1985 1973 1980 19R8p 1SbSe 1990 1r65-73 1973-80 1980-90 1989e 1990 GrossDomesic Prduct n,p, 00.0 00.0 100.0 100.0 100.0 10.0 .. . . -0.8 Net lindirect Taxes .. . . 15.6 15.2 . , . Agriculture .. . . 2.4 2.4 ... . .. -2. industry .. . . 15.1 15.4 ... . . . (of which) ManufacturinC) .. . . 4.1 4.2 ... . . . Servines .. . . 68.9 67.0 . . . .. -0.6 Resource Balance .. . . -20.1 -23.0 . . . Exports of GHNFS .. . . 48.0 46.7 ..4 . . 36 Imports of GNFS .. . . 68.1 69.7 . . . .. 2.5 Total Expenditures .. . . 120.1 123.0 . . . .. 2.2 Total Constnntlon .. . . 104.5 104.6 . . . .. -0.2 Private Consumption .. . . 70.4 71.0 . . . General Government .. . . 34.1 33.6 . . . Gross Domestic Investment .. . . 15.5 18.5 . . . .. 18.0 Fixed Invtjtment .. . . 14.4 17.4 . . . Changes In Stocks .. . . 1.2 1.1 . . . Gross Domestic Saving . . . -4.5 -4.6 . . Net Factor Income . . . . .. ... . Nat Current Trantsfers .. . . -0.3 -0. . . . Gross National Saving.. . . . .. ... . In thousands of LCUs 1965 1973 1980 1988 1989 1990 (at constant 1987 prices) Gross DOmestic Product .. . . . . . . . . -0.8 Capacity to import .. . . . . . . . . -2.7 Terms of Trade Adjustment .. . . . .. ... . Gross Domestic income.. . . . .. ... . .. -3 Gross National Product . . .. . .. ... , Gross Nationai Income . . .. . .. ... . (1987 a 100)- Inflation Rates(% p.a.)- C. Price Indices 1980 1985 1988 1988 1989 1990 1985-73 1973-80 1980-90 1989 1990 Consumer Prices (IFS 64) 75.1 81.3 98.1 .. . .. . 3.8 Viholesale Prices (IFS 63) . . .. . ,. .. . Implicit GDP Deflator .. 3.8 98.6 105.0 108.0 . . . . 2.9 Implicit Expenditures Defl. . 83.5 98.5 107.6 110.2 ... . .. 2.'4 0. Other Indicators: 1985-73 1973-80 1h8D-90 Growth Rates(% p.a.): Population 1/ 8.1 5.2 6.0 Notes: Labor Force Gross Natl. Income p.c. .. . .National accounts estimates are tentative Private Consumption p.c. .. . .and are based on the findings of the November 1988 Bank economic mission. Import Elasticity: Only growth rates and percentage shares ImportS (G+NFS) / G0P(mp) .. . .are presented here f or analytical purposes. Marginal SavilngS Rates: 1/ Ref lecting high Imligration from Gross Nati onal Saving .. . .neighborling coutries. Natural population Gross Domestic Saving .. . .growth rate Is 3% a year. ICOR tperlod averages): a... ..e estimated data p. prelIminary data Share of Tot,[ 1985 1973 1980 1989 1990 Labor Force in; -- - - - -- Agriculture . . lndustry . . Services Total 100.0 100.0 100.0 100:0 166  WIOUTI~~~~~~~~~~~~~~~~~~~~~MOT DJISOUTI DJIBVJTI - ECOIOEIC INDICATORS PAGE 2 OF 3 Volue index Vale at Crrent Prices (uilliws USS) E. Merctd ise Exports 1980 1985 1987 1988 1989 1990 1980 1985 1987 1988e 19 1990 Fond .. .. .. .. .. .. .. 4 5 5 5 Manufactures .. .. .. .. .. Resldual . . . . . . . 6 3 7 3 Total ExportsFCB .. .. .. .. .. .. .. 30 40 42 41 F. Merhandise lImorts Food .. .. .. .. .. 51 56 67 Fuel and energy .. .. .. .. .. .. .. 20 14 11 Oth. cwis goods .. .. .. .. 92 104 115 Other Intermed goods .. .. .. .. .. .. 14 16 17 Capltal goods .. .. .. .. .. .. .. 42 33 29 Total Imports CIF .. .. .. .. .. .. ., 219 222 239 249 G. Merchandise Terms of Trade 1980 1985 1987 1988 1989 1990 Merch. Exports Price Ide .. .. ..r. Merch. imports Price Index .. .. .. Merch. Terms of Trade .. .. .. 6S$ millions (at current prices): H. BaWance of Payments 1980 1985 1987 1988e 1989p 1990 Exports of Goods & NFS 151 178 190 188 Merchaidise (FOB) .. 30 40 42 41 Non-Factor Services .. 121 139 148 147 Imports of Goods & NFS .. 245 251 269 281 Merchandise (FOB) .. 219 222 239 249 Non-Factor Services .. 26 29 30 32 Resource Balance .. -94 -73 -80 -93 Net Factor Income .. 12 16 9 10 (Interest per ORS) 2 5 5 6 6 Net Current Transfers 0 -12 -12 -1 -1 (workers remlttances) .. .. COAr A/C Bal Before Off. Grants .. -95 -69 -71 -84 Net Official Transfers .. 52 54 47 49 Curr A/C gal After Off. Grants -42 -15 -24 -35 e. estlmated data Lng-Term CaPital Inflow .. 32 33 12 4 .. p. prellminary data Direct Investment 0 Net LT Loans (ORS dtta) 8 30 21 12 4 Other LT Inflow (Not) .. 2 12 0 0 Total Other Items (net) .. 16 -9 20 33 Net Short Term Capltal 0 0 0 Capital flows N.E.1 0 0 0 0 0 Errors and Omisslons .. 16 -9 20 33 ChanOes In Net Reserves .. -6 -10 -8 -2 Met Credit from the IMF .. 0 0 0 0 Other Reserves Changes .. -6 -9 -8 -2 As Share of GDP: Resource Balance . -27.8 -19.4 -20.1 -23.1 Interest Payments .. 1.5 %1.3 1.5 1.4 Current Acoont Balance .. -28.0 -18.3 -18.0 -20.9 Memorandue Items' Reserves excl. Gold (mil. LIS$) * 51 64 64 59 94 Reserves Incl. Gold (ml1. US$) .. 51 64 64 59 94 Official X-Rate (LCUs/US$) 177.72 177.72 177.72 177.72 177.72 177.72 Index Real Eff. X-R Base 1980 .. GOP (mlillons of current USSl) .. .. .. .. .  OJ5BOUrI - ECNOIL INDICATORS PAGE 3 OF 3 SWar. of GMP (s) Groth Rates Govurtuent FInance 1980 1988 1387 1988e 1989p 1990 1920-88 1987 1988B 198 P 1990 Current Receipts .. 32.7 31.7 31.1 32.9 .. ,. 0.0 3.7 8.0 Current Expendltures .. 35.1 32.7 32.3 32.0 .. .. -4.0 4.7 1.2 Durrent Budet Balance .. -2.4 -0.9 -1.2 0.9 .. .. .. Capital Recelpts .. .. .. .. . .. .. .. Capital Expenditures .. 19.1 19.9 17.3 17.9 .. .. 7.1 -.2 6.0 Overall Deficit 1/ .. 21.5 20.9 18.5 17.0 .. .. .. Official Capital Grants 2/ .. 15.0 15.8 14.5 14.8 .. .. 6.8 2.4 -4.0 External Borrowlng (net) .. 3.8 4.5 3.5 2.5 .. .. .. Ooestic Non-Bank BorruAvlng .. -0.1 3.7 0.3 0.7 .. .. .. -92.3 158.4 Domestic Bank Financing .. 2.7 -3.2 0.2 -1.0 .. .. .. Net Olsbzrsements (USS ml iI lors) Debt QutstadIlng & Osbursed (USS oIII los) O. External Capital Fio,s, Debt-- and Debt Burden Ratlos 1980 1985 1987 1988 1989 1990 1980 1985 1987 1988 1989 1990 PMillc & RPbilcly Gar. LT 8 30 21 12 4 11 26 96 154 158 133 150 Official Creditors 3 30 23 14 5 11 21 90 151 157 132 150 kultilateral 2 14 14 8 1 7 2 39 75 80 79 90 of which lIBR 0 0 0 0 0 0 0 0 a 0 0 0 of vhich IOA 0 5 7 5 2 3 0 7 21 25 26 32 Bilateral 1 16 9 6 3 5 19 50 76 77 53 60 Private Creditors 5 0 -2 -2 -1 -1 5 7 3 1 1 0 SipIIers 0 0 0 0 0 0 0 1 0 0 0 0 Financial Markets 5 0 -2 -1 -1 .. 5 6 3 1 1 Private Non-zuranteed 0 0 0 0 0 0 0 0 C 0 0 0 Total LT 8 30 21 12 4 11 26 96 154 158 133 150 IMF Credit 0 0 0 0 0 0 0 0 0 0 0 0 Net Sort-Term Capltal .. 0 0 0 .. .. 6 48 29 26 47 47 Total Incl. I F & Net ST .. 30 21 12 .. .. 32 144 183 185 180 197 Bank and IDA Ratios 1980 1985 1987 1988 1q99 1990 Share of Total Long-Term 000 1. IMRD as X of Total 0.00 0.00 0.Go 0.00 0.00 0.00 2. IOA as % of Total 0.00 7.08 13.41 15.79 19.79 21.46 3. IBRD+iDA as of Total 0.00 7.08 13.41 15.79 19.79 21.46 Share of LT Debt Service 1. IRD as % of Total 0.00 0.00 0.00 0.00 0.00 0.00 2. IDA as % of Total 0.00 2.44 1.57 1.49 1.74 1.56 3. IBRD+IOA as % of Total 0.00 2.44 1.57 1.49 1.74 1.58 DOD-to-Exports RatIos 1. L.ong-Term Debt/Exports .. 58.22 78.28 77.98 61.47 .. 1/ excluding grants 2. IMf Credit/ExParts .. 0.00 0.00 0.00 0.00 .. 2/ both budgtary and capital grants 3. Short-Term Debt/Exports .. 29.11 14.70 12.96 21.83 4. LT+liMF+ST D00/Exports .. 87.3? 92.95 90.94 83.30 .. e - estimated data p * prelImInary data OOD-to-QP Ratios 1. Long-Term Debt/GDP .. 28.40 41.35 40.04 32.93 2. IF Credit/GDP .. 0.00 0.00 0.00 0.00 3. Short-Term Debt/GOP 14.20 7.77 6.65 11.70 4. LT+iF+ST D0D/GDP 42.60 49.12 46.69 44.63 Debt farvice /Exports 1. PUbilc & Guranteed LT .. 2.49 6.44 8.60 5.32 2. Private Non-miranteed LT .. 0.00 0.00 0.00 0.00 3. Total Long-Term Debt Servlce .. 2.49 6.44 6.60 5.32 4. 1F Repurchases+Serv. Chgs. .. 0.00 0.00 0.00 0.00 5. Interest only on ST Debt .. 1.82 0.66 1.08 1.57 6. Total (LT+IMF+ST Int.) .. 4.31 7.10 7.68 6.89  DJIBOUTI THE CHALLENGE OF A CITY-STATE ENCUTIVE SUM*ARY Salient Features 1. The Republic of Djibouti, independent from France since 1977, is a small country of 23,200 sq km, occupying a strategic location in the Horn of Africa. Two-thirds of its 456,000 inhabitants (official estimates, subject to revision when the 1991 population census will be available) live in the capital, Djibouti City. Djibouti has received some 60,000 refugeer and immigrants since the 1980s from Ethiopia and Somalia, at great economic and social cost. According to the UN classification, Djibouti belongs to the Least Developed Countries grcup. (However, based on national accounts estimates of this report and the official population data, the GNP per capita is estimated at US$740 in 1987.) 2. The constraints on economic development are substantial; they are those of a dualistic economy with skewed income distribution between a small modern sector based on a relatively well-developed infrastructure and on expatriate skills, and a larger traditional society close to a subsistence level. The tertiary sector dominates the economy by contributing nearly 70 percent of GDP and providing the bulk of foreign exchange earnings. Its mainstay arc services provided to the French military personnel stationed in the country (about 30 percent of GDP), and other services .elated to the role of Djibouti as a regional center due to its port facilities, private banking and telecommunication services. 3. Djibouti has managed to survive mostly on external assistance, both financial and technical. External aid finances about 40 percent of government expenditure and is equivalent to about 24 percent of GDP. Merchandise exports of local origin are insignificant, and the country depends heavily on impv.rted food and consumer goods. Djibouti has one of the most liberal economic regimes in Africa, banking and commerce being practically unrestricted. Its currency is freely convertible and has been pegged to the U.S. dollar since 1449. However, the economy is distorted by high wage-cost structure and ar overvaluation of the Djibouti franc. Recent Economic Developments 4. Analysis of DNibouti9s economic performance in recent years shows real GDP declining by an average of 2.7 percent per annum between 1984 and 1987, compared to an average growth of 3 percent during 1978-1982. The economy was severely hurt by the decline in demand for local goods and services from the expatriate community due to the appreciation of the currency vis-a-vis the French franc in the mid-1980s, in addition to the recession in private housing construction. The end of the real estate boom and the tapering off of public investment projects brought down fixed investmcnt from 26 percent of GDP in 1984 to 17 percent in 1987. The domestic savings rate, although improved, was still negative, and the country continued to rely heavily on external resources. The economic situation  - ii - improved moderately in 1988 owing in part to more frequent stops of French navy ships. However, the economy suffered a setback in 1989 due partly to the flood that affected about half of the population in the capital. In 1990, the Djibouti economy was adverrely affected by the Gulf crisis, which raised the country'a import bill and caused a significant loss of sales of servicea due to a sharp decline in commercial ship traffic in the port of Djibouti. This loss was, nevertheless, partly compensated by additional revenues from increased visits by warships to the Djibouti port. The economic situation in 1991 is expected to improve with the recovery of commercial activities in the region following the end of the Gulf war. Overall, the war is not likely to have a lasting negative effect on the Djibouti economy. Nonetheless, the sustained drop in economic activity since 1984, combined with the hi,h population increase estimated to be 6 percent a year -- 3 percent for natural growth and 3 percent due to a steady high influx of immigrants and refugees -- has led to acute unemployment and a decline in per capita consumption of over 30 percent by 1988. 5. On the fiscal front, budgetary deficits were financed largely by drawing on cash reserves. With cash reserves almost depleted in 1987, the government adopted additional austerity measures to curtail expe.nditures and obtained increased support from France. As a result, the overall deficit (including grants) declined from 6.3 percent of GDP in 1984 to an estimated 4 percent in 1938, but public finances remain extremely dependent on external aid. The fiscal situation improved in 1989 owing to the government's efforts to strengthen tax collection, which led to an estimated increase of 8 percent '.n government revenue. The external current account deficit (including public transfers) improved sharply from 17 percent of GDP in 1984 to an estimated 4 percent in 1987 owing to a reduction in imports and an increase in investment income and budgetary grants. However, the deficit deteriorated again in 1989 and 1990 due to the sluggish sales of services, &a increase in the import bill for petroleum products and consumer goods, and a decline in investment income. Because of sizable borrowing in the early 1980s to finance public investment projects, Djibouti's deot service payments more than tripled to US$15 million in 1989, representing about 7 percent of total exports and 11 percent of budgetary expenditure. Economic Policy Initiatives 6. The dualism between a privileged civil service and the rest of the economy is extreme in Djibouti. Recognizing the difficult financial situation, the government has been implementing austerity measures. These measures include mainly: a freeze on hiring with the exception of key social sectors (education and health) and eli% Ination of vacant positions arising from retirement. These measares are str>ragthened by the recont adoption of a new pay scale and the reduction of friuige benefits of civil servants. In addition, the government has become more cautious in undertaking new projects and is relying more on grants in financing public investments. At the same time, taxes on some imports have been raised and efforts have been made to improve w-ax collection by strengthening tax administration. Although these measures are in the right direction, they need to be followed by further internal adjustment to reduce wages and salaries substantially over time and to allow lower pay for new recruits in the public sector.  7. While some public enterprises have generated surpluses, others have continued to suffer from poor mana'ement. This has led the government to privatize the management of its hotel company and to promote the sale of the dairy products plant and the water bottlitg company. An audit report hbr been prepared for the airport authority, and a rehabilitation program being implemented. Sectoral Developments e"td Issues 8. Services and Infra&L.oucture. With agriculture, industry and tourism at extremely low levels because of the characteristics and location of Djibouti, most of the investments have rightly gone to modernize infrastructure in the service sector. As a result, Djibouti has one of the most developed ports in the region, a fairly modern airport, and an excellent telecommunications system. The railway link to Addis Ababa is being rehabilitated. Unfortunately, most of these facilities are underutilized. Further investments in these sectors will need to be carefully selected and future efforts geared to promote maximum use of the existing facilities. As a first step, the port's operating practices should be examined with a view to increasing its operational efficiency and making the costs more competitive. The port of Djibouti is facing fierce competition from other ports in the region. 9. Social Sectors. The government has given high priority to developir* human resources through strengthening the education and training system and improving health and living conditions. Since independence, both the school network and the school enrollment rate have improved, but the change of the French-style education system to adapt it to local needs has progressed slowly. The school enrollment rate of 40 percent is still one of the lowest in Africa, to some extent because of the lack of school buildings, but also because of bureaucratic requirements. The government will need to increase access to primary education by extending it to all resident school- age children, regardless of the availability of their official birth certificates. 10. Efforts are being made to improve the living conditions of the urban poor through provision of sites and services. In the hinterland, wells will continue to be built wherever feasible to provide water to nomads and their herds. To stop desertification, the government has undertaken a project to save the remaining Day Forest and established pilot projects for desert agriculture. To help women participate in the developm6nt effort, school enrollment for girls will need to be encouraged, and the severe health and economic effects of female circumcision should be addressed through broad dissemination of factual health information by the government. Economic Management 11. Economic management in Djibouti has suffered from a severe shortage of qualified personnel and a lack of interagency coordination. Technical assistance is being used as a substitute for local manpower, which reduces its benefits to nationals, for example, through on-the-job training. Technical assistance should be reoriented to help government strengthen its  - IV economic management anid formulate a coherent overall development strategy fot long-term economic growth and employment generation. Another area of concer- is the deficiency of the economlc data base, especially the lack -& systematic national account estimates, balance of payments data, ano populationl statistics. Thus, Driority should be given to improving data collection and reinforcing the role of the statistical office (DINAS.) The preparation of a complete and transparent budget also deserves high priority since thls' is crucially needed for proper financial management and forecasts. WJth regard to investment programning, a positive development has been the recent creation of an Interministerial Planning Commission (IPC) to coordinate external aid and examine investment projects. The IPk, could pro-re more effective if its approach and working methods were modified and its role expanded to include the formulation of a multi-year investment program with an appropriate long-term perspective and within a proper macroeconomic framework. Development Prospects ard Policies 12. Despite sizable investments to modernize infrastructure, the current economic system has failed to provide enough impetus to sustain economic growth and to create significant employment. This reflects the lack of dynamism and the fragility of the Djibouti economy. The extremely high cost-price structure and the shortage of skiM"ed labor discourage development of exports. If no action is taken to promote broader-based development and increase the country9s competitiveness in terms of labor productivity and production cost, the likely result will be the continued existence of a tiny prosperous enclave amid unemployed and impoverished masses. In this respect, the authorities have become more aware of the need to implement in the immediate future economic policies that can help meet the long-term challenge posed by tbe limited endowments and the constraint of Djibouti. The country does have assets: (i) strategic location; (ii) modern transport and banking infrastructure; and (iii) liberal economic and tr&Ae policy and freely convertible currency. Against these assets, the country faces formidable constraints that will take time and courageous efforts to overcome. 13. Development Possibilities. It is important to realize that, given the size of Djibouti, even a comparatively modest expansion can make ass important contribution to the country's development. A few sources of potential growth can be identifieds - Revitalize Service Activities. Given its modern infrastructure, the Djibouti port has an advantage over some ports in the region, but a more aggressive approach will be needed to sell services to land-locked countries in Africa. To revitalize these services, a survey of potential users would be useful. Meanwhile, rates and charges as well as efficiency need to be reviewed in order to make port services competitive. - Promote Offshore Business. Djibouti seems to have some aasets to foster this activity, and legislation for free-zone corporations has been enacted. The government will need to undertake a high publicity promotional campaign to attract investors.  - v - Diversify Productive Activities. Given the abundance of unskil-led labor, labor-intensive export processing activities, such as textile and knitwear industries, which need only short on-the-job training, could be considered if strong measures were taken to increase Djibouti9s competitiveness. 14. Although government policy toward private investment is very positive, very few private enterprises have been created. The main reasons have been the lack of local entrepreneurs and skilled labor, the small size of the domestic market, high production costs, and rigid labor regulations. To promote productive and labor-intiensive activities, priority should be given to attracting foreign partners who, in addition to their capital, will provide the necessary technical know-how and marketing channels. As a first step, an export processing zone could be promoted, building on the existing free trade zone arrangements at the port, along with a special legislation allowing at the least freely negotiated wages and minimal labor regulations. Consideration could also be given to providing "free zone" status to service- oriented industry (e.g., hotels), regardless of their geographical location within the country. Electricity and water tariffs will also need to be changed to favor industrial and commercial users. The investment code will need to be revised, and administrative processes for establishing foreign investment operations in the country will have to be vastly simplified. 15. Public Investment. Based on the proposals for projects provided by bot- the spending ministries and donors, a public investment program (PIP) consisting of a core list is presented in this report to keep investment spending more in line with the macro-framewcrk and expected resource availability. This core list could provide a point of departure for a rolling three-year investment program that can be reviewed and adjusted annually. The PIP core list requires a capital outlay of about US$180 million over three years, or about the same as in previous periods. However, only priority projects are retained, with some projects phased down or excluded until results of studies and details of financing are available. The largest share of public investment spending is allocated to infrastructure and energy (48 percent), followed by social sectors and services (28 percent.) 16. Medium-Term Outlook. Under the scenario set out in this report, Djibouti is likely to "muddle through" with modest improvement in economic growth, given the weak base of the economy and limited institutional capacity to implement policy changes. In the medium-term (1991-95), the most likely prospects are for a real GDP growth averaging at best 2 percent a year, accelerating from 1 to 2.7 percent over the projected period. Most of this growth is expected to be generated by the secondary sector and the recovery of some service activities, in particular transport and commerce, assuming limited policy reforms including current measures to contain the budget deficit and an internal adjustment to reduce distortion in wages and prices. With a projected natural population growth rate of 3 percent a year (assuming migration would net out to zero), total per capita consumption continues to decline under this scenario, but private per capita consumption would begin to increase by 1995. To achieve higher growth rates, the government will need to accentuate budgetary discipline through wage compressiori and  - vi - reductions in other expenditures, and to adopt a more aggressive approach to malke Djibouti more competitive in terms of production cost and labor productivity. Djibouti will continue to be highly dependent on external financial assistance. External financing to meet needed import payments and debt service obligations is projected to average about US$60 million a year during 1991-95. 17, Problems and Issues. As noted, apart from the severe shortage of skilled manpower and low labor productivity, Djibouti faces severe structural problems caused by the very skewed income distribution and high price and wage levels. Rough estimates indicate that about 10 percent of income recipients may be receiving half of the total national income and that the expatriate residents in Djibouti, representing less than 2 percent of the total population, obtain about 25 percent of the total income. As for wages, the general impression is that Djibouti is trying to maintain salaries and benefits, especially in the administration and the modern sector, at levels similar to those of France. The salaries for civil servanto average about US$7,800 a year -- 3 times higher than those in Mauritius and 11 times those in Madagascar. A salaried employee in the private sector earns, on average, an annual income of about US$4,200 plus fringe benefits. The lowest paid domestic servants earn on average US$1,600 a year. If Djibouti were to adopt a more outward-looking development strategy to generate job opportunities, the dollar-equivalent wages and benefits of Djibouti's workers would have to become competitive with those of other developing countries at comparable national income levels. 18. The high cost-price structure is largely the result of over- valuation of the Djibouti franc. Adjustment of the parity, whether a substantial one-time devaluation or in stages, would be one way to improve 1)jibouti's development prospects. The magnitude of the adjustment required will have to be carefully studied. Such a devaluation would undoubtedly have a negative effect on import costs in the short-term; but over time it could promote Djibouti's sales of services, reduce the high cost-price structure, bring demand more in line with available resources, and improve income distribution. Djiboutian authorities are concerned that adjustment in the parity would provoke capital flight and endanger Djibouti's role as a regional financial and commercial center. This might be true in the short- term, but this adjustment should help place Djibouti oa a more sustainable basis for dealing with the development needs of the colntry. The adjustment of the exchange rate alone will not provide the desired effect, but would need to be preceded or at least accompanied by strong measures to cut government current expenditures, in particular through severe wage compression. 19. More efficient allocation of public resources is called Eor so that adequate resources are available to vital sectors such as education, health, transportation and utilities. To reduce the burden on the budget, the government should withdraw from its involvement in productive activities such as bottling and dairy plants, slaughterhouse, hotel, pharmacy, etc. In general, the government should refrain from investing in industrial and commercial enterprises and leave them to the private sector.  - vii - Policy Recomendations 20. In addition to the need for continued emphasis or .inancing health and basic education, a variety of actions are recommended n Chapter IV of this report. The priority actions are outlined below. (a) Strensthening Economic Management - Strengthen austerity measures to reduce current expenditure: freeze wages and salaries; adopt new wage policy allowing much lower salaries for new recruits; reduce fringe benefits; limit recruitment to priority functie.ts; review the size of civil service and military personnel. - Reinforce tax administrations improve tax collection; adopt a unified income tax system; transform specific import surtaxes into ad-valorem taxes. - Privatize the dairy products plant and water bottling company. - In the utilities group, review prices to discourage waste by lndividuals X.'ile maintaining competitive pricing for services provided to commercial and industrial users. - In transport (port, airport, railroad), review rates and charges to assure Djibouti's competitiveness. - Prepare a complete and transparent budget that includes all capital expenditures (financed by loans and grants) to help decision makers forecast and control revenue and expenditure. - Formulate a three-year rolling public investment program. - Improve the data base by reinforcing the role of DIMAS. (b) Development Possibilities - Revitalize service activities by promoting Djiboutli's port as distribution point for the region. - Promote private initiatives wherever possible and limit government involvement to providing a favorable climate for private investment. - Enhance DJibouti's development prospects through improvement of Djiboutil': competitiveness, special legislation for the export processing zone, and upgrading of the labor force.  viii - The Development Challen:es A Long-Term View 21. Many of the recommendations listed above are general and must be viewed in the context of the goal of fostering Djibouti's development while progressively building its economic independence. The government's challenge is to translate these recommendations into a specific action program, with a definite timetable for implementation. Recent political upheavals in neighboring Somalia and Ethiopia must be taken explicitly into account. Partly because of the impact on refugee flows, but also for a variety of other reasons, these political developments are a source of constructive opportunities as well as problems. The government's initiative at defining policy options at this juncture would signal to the donor community its willingness to improve the country9s economic and financial situation. 22. Although it is difficult to predict what Djibouti might become in the long run, it is clear that continuing on the present policy course will not reverse the declining trend in economic activities and will not generate job opportunities for most of the population. If higher rates of growth leading to an increase in per capita consumption are to be achieved in the longer term, Djibouti's economy will have to be strengthened through upgrading service activities which have a higher demand potential and diversifying the economy toward manufacturing activities. The feasibility of this scenario depends largely on the government's determined effort to implement rapidly more comprehensive reform measures that would substantially improve prospects of full exploitation of the country's limited endowments. This would require (i) a substantial reduction of the real wage level in order to make Djibouti9s economy more competitive; (ii) an aggressive approach to attract foreign investors in labor-intensive export processing industries; (iii) a revision oi labor legislation, the investment code, and administrative procedures; (iv) upgrading the labor force through appropriate training and significant reduction in khat consumption; and (v) strengthening marketing and management to increase sales of services. 23. To enable a successful implementation of reform measures necessary to improve Djibouti's long-term development prospects, further examination of wage structure and labor market as well as the impact of a currency devaluation is critically needed. The social and economic problems of Djibouti are difficult but not insurmountable in the long run. This would require concerted and determined efforts by the Djiboutian authorities to address the structural constraints to development. The principal donors would also have to adapt their assistance strategies with a view to supporting Djibouti's long-term development as a regional commercial and financial center less dependent on external aid. Finally, the population (the city dwellers as well as the herders) would need to accept short-term sacrifices, especially lower wages, in order to build a better future for this city-state.  DJIBOUTO THE CHALLENGE OF A CY-STATE INTRODUCTION 1. This country economic memorandum (CEM) is the third World Bank report on Djibouti. The first, prepared in 1980, presented a rough sketch of economic developments during the years immediately following the country's independence. The second, prepared in 1984, covered developments through 1982 and examined key sectoral issues, including public investment projects prepared for the Donors' Conference in November 1983. 2. After a decade of independence, the Djiboutian authorities began to turn their attention t.. long-term development and to promote a national rcflection on the country's development issues. To assist the government in this task a World Bank economic mission visited Djibouti in November 1988, This CEM attempts to provide the government, the Bank, and other donors with a basic framework that can help in defining a medium-term development strategy. 3. It should be noted that statistical development in Djibouti is still at an early stage. The lack of systematic national accounts .estimates, balance.of payments data, and population statistics has created difficulties in assessing the country's performance. This deficiency can be ascribed to inadequate financial resources and skilled manpower, as well as to the lack of consistent demand for regular and reliable statistics. Nevertheless, the Bank team has been able to develop most of the critical data needed for the CEM. Tne estimates, which are relatively consistent, provide reasonably reliable indications of trends, but their level could be subject to a significant margin of error. Therefore, the statistical data presented in the report need to be interpreted with caution. 4. The national accounts and public finance tables have been processed from primary data collected during the mission, according to the UN System of National Accounts and the Government Finance Statistics methodology of the IMF. Gross domestic product is used in the report primarily to illustrate trends in economic development rather than to measure the level of activities. Data on the balance of payments have also been estimated by the mission, since the Djibouti Central Bank has not developed sufficient institutional capacity to prepare them. However, with technical assistance from the IMF, the Central Bank has started to collect monetary statistics and has considered establishing data collection on transactions by residents and non-residents. This should make the future estimates of gross national product more reliable. The Bank mission has adjusted the official trade statistics to include unrecorded imports resulting from some unofficial trade activities. Apart from the budget figures, most statistics were available only through 1987 at the time of the mission. In late 1988, the IMF began to  ! -2- publish a country page for Djibouti In its International Finance Statistics; it covers mostly r tary statistics and the latest data are for 1990. 5. The CEh does not attempt to provide an encyclopedic view of the economy but rather focuses on issues and sectors of primary importance. Chapter I provides background on the country setting and its resources. Chapter II anasyzes trends of the main macroeconomic aggregates for the period 1984-87 and provides a largely qualitative economic assessment of 1988-90; it also reviews initiatives taken by the government to reduce financial imbalances. Sectoral issues and priorities are examined in Chapter III. Chapter IV examines the determinants of the long-range outlook, assesses the economic prospects over the medium-term and discusses the policies necessary to improve Djibouti's competitiveness. 6. Annex I is a methodological note on the national accounts estimates and recommendations on strengthening data collection. Annex II gives a list of public investment projects and a table summarizing projects excluded from the core program, with a brief explanation. A Statistical Appendix, from which all the text tables are derived, concludes the report.  v3- CHAPTER 1 SAUENT FEATURES A. The Country Setting and Historical Background 7. Independent from France since 1977, the Republic of Djibouti is a tiny country of 23,200 sq km, strategically located at the Horn of Africa. It is a city-state, with two-thirds of its inhabitants living in the capital, Djibouti City. The hinterland, an extension of the desert of Ethiopia and Somalia, is sparsely inhabited by a poor pastoral populatlion. The climate is harsh, and the temperature can reach well above 40f C during the summer months. (However, from October to March the temperature is rather pleasant, averaging about 250 C.) Life expectancy is low and infant mortality high, despite a significant improvement over the past decade, from 42 to 47 years, and from 147 to 115 per thousand, respectively. The literacy rate of about 40 percent is among the lowest in the world. According to the UN classification, Djibouti belongs to the Least Developed Countries group. 8. The location of Djibouti on the Suez Canal route and the discovery of a dependable subterranean water supply led the French authorities to develop a port in the late 19th century, at the present site of Djibouti City. The role of the Djibouti port was increased by the completion in 1917 of a railway line connecting tne port to Addis Ababa in Ethiopia. As a result, Djibouti became one of the most important bunkering ports in the world, providing fuel, water, etc. to ships. Noreover, it served as an entrepot port for many countries on the Arabian peninsula and handled most of Ethiopia's international trade. To diversify the economy, the French authorities sought to establish Djibouti as an international business center and in the late 1940s established a monetary, banking and excha.Lge system in it for this purpose. 9. The closing of the Suez Canal in 1967 abruptly reduced the number of ships calling at the port. Despite the reopening of the Suez Canal in 1975 the bunkering business did not resume significantly, mostly because of the development of other ports in the area and less need for modern ships to refuel. In addition, the completion of a road link between the Ethiopian port of Assab and Addis Ababa increased competition with the Djibouti-Addis railway for Ethiopia's international trade. Against this background, services provided to the French military posted in Djibouti have become a mainstay of the economy of independent Djibouti. 10. Djibouti has a democratic government headed by a president elected for six years. The prime minister is selected from a legislative assembly consisting of 65 memberso A careful balance exists between the two main ethnic groups (see para. 12) in the composition of the government and the legislative assembly. The country is divided into five dis;ricts: Djibouti, Tadjou ah, Ali Sabieh, Dikhil, and Obock. Economic and social activities center in Djibouti City.  B. Human and 1atural Resources 11. Pppyqtjion. According to official data, the population of DJiboutl is estimated at 456,000 inhabitants in 1986, including refugees and expatriate residents. However, this figure is subject to question since the unpublished 1983 population census indicates a population estimate of 270,000 inhabitants in 1983. The Government claims that the census significantly underestimates the population figure and arbitrarily adopts an official figure of 383,000 inhabitants for 1983. It also adopts a population growth rate of 6 percent a year, of which 3 percent for natural growth and 3 percent for immigration. There is reason to accept that the census underestimates the population figure, given a large nomadic population, but a 40 percent correction adopted by the Government is unrealistic. For this reason, the report proposes a correction factor of 20 percent, which should bring the population figure to 330,000 inhabitants in 1983. Given high immigration from neighboring countries, the report aC pts the estimated population growth rate of 6 percent a year until detailed information on age and sex groups are available. This leads to 393,000 inhabitants in 1986. A new populatior. census has been undertaken and its results are expected by end-1991. This should help determine a more reliable and recent population estimate for Djibouti. 12. Djibouti's population consists of two major ethnic groups: the Issas, related to inhabitants of Northern Somalia, and the Afars, related to some tribes of Eastern Ethiopia. The Issas and Afars are both Muslim and have a long pastoral tradition, with little experience in agriculture and industry. The most important minority group is of Yemenite origin, representing nearly 5 percent of the population and being mainly active in commercial and maritime trades. An estimated 100,000 nomads live with their herds in the desert area of the hinterland, with an extremely low level of subsistence. Djibouti has a large expatriate community (f about 11,000 people, which is made up of French military personnel, technical assistance staff and their families, and private business personnel. Djibouti has a relatively young population, with 40 p_rcent under 15 years of age and only 15 percent over 40. This young population and fast-growing unskilled labor force have created severe burdens on Djibouti in terms of p-ovision of education and health facilities, employment opportunities and foodstuffs. 13. Refugees. In the late 1970s, Djibouti received thousands of refugees fleeing the Eritrean and Ogaden conflicts in Ethiopia. By 1981 there were an estimated 50,000 displaced persons living in Djibouti, of whom about half were Eritreans living in or near the capital. The remainder were mainly women and children from the Ogaden, living under the auspices of the UN High Commissioner for Refugees in desert camps in the Djibouti hinterland. In 1985, many individuals and families returned to Ethiopia under the voluntary repatriation program organized by Djibouti, Ethiopia and the UNHCR. As a result, the camp at Ali Sabieh was closed, and the UNHCR is nowy operating only the camp at Dikhil.  - 5 - 14. However, with recent drought and political upheavals in the region, several thousands of new refugees have come to Djibouti again. Although there are only a few thousands of Ethiopian refugees living in the UNHCR camp at Dikhil, some 30,000 to 60,000 displaced persons, coming mostly from Somalia, are reported to live wiith friends and relatives in an underground existence. These people receive very little assistance from the humanitarian organizations because they are considered illegal refugees. This hiah influx of migrants and refugees has created serious social pressur- on the Government of Djibouti which does not have the resources it would need to provide them with basic need, health care, and employment opportunity. 15. Natural resources, Recent exploration has confirmed the existence of important geothermal resources in Djibouti. Apart from geothermal energy, Djibouti has very limited natural resources, consisting mostly of salt, limestone, gypsum, perlite, and other construction materials. Arable land is scarce and perennial rivers non-existent. Underground water can be found in some selected areas at more than 100 meters depth, with a high degree of salinity and high temperature. C. Economic Structure 16. Djibouti has come a long way from a nomadic tradition to a more modern but small and dualistic economy. It has managed to survive as an independent state, mostly with external assistance. The country is characterized by a dualistic economy with a small modern sector based on a relatively well developed infrastructure and on expatriate skills, contrasting with a large traditional society close to the subsistence level. Income distribution is very skewed with a ,small portion of the city dwellers living at quasi-French standards and the majority of the population living at a subsistence level given the very limited job opportunities. Moreover, the economy is distorted by high wage and price levels. 17. Directly productive activities remain little developed, owing to the harsh climate, high production cost, and limited natural resources and domestic skills. The tertiary sector dominates the economy, contributing nearly 70 percent to GDP, and concentrates on services provided to the French military personnel and on trade with neighboring countries. Other services are related to the role of Djibouti as a regional trade and service center due to its port facilities, private banking and telecommunication services and, to a lesser extent, international airport and railroad to Addis Ababa. Because of the above, the economy is very fragile and highly dependent on external demand and its vagaries. 18. Djibouti depends heavily on external aid, which corresponds to 24 percent of GDP. Marchandise exports of local origin are insignificant, and the country relies almost entirely on imported food and consumer goods. Foreign exchange earnings are largely generated by selling services and re-  exporting goods to the Fren?h military personnel and neighboring countries. Djibouti has one of the most liberal economic regimes in Africa, banking and commerce being practically unrestricted. Its currency is freely convertible and has been pegged to the US dollar sizce 1949. The fixed rate was changed from DF 214.39 per dollar in 1949 to DF 197.47 in 1971 and again to the current rate of DF 177.72 in 1973.  -7- CHAPTER 2 RECENT ECONOMIC DEVELOPMENT 19 Djibouti's economy was severely hurt when the Ogaden war broke out in 1977-78 and railway traffic and associtted port activities were substantially curtailed. In 1979, the economy started to recover, and private investment in ^ommerce and construction, together with public capital expenditure, increased by about 40 percent. Between 1979 and 1981, both the budget (including grants) and the balance of payments recorded surpluses because of substantial growth in government revenues through taxation and high inflows of official external assistance. As a result, the treasury accumulated sizable foreign exchange reserves. Beginning in 1982, however, a significant turnaround in the economy occurred. While the Government was engaging in major investment projects, official grants started to decline because of the world economic recession. The fiscal position worsened, the current account of the balance of payments became negative, and foreign exchange reserves declined by nearly 40 percent by 1983. This chapter provides an analysis of the economic and financial performance for the period 1984-87 and a qualitative assessment for 1988-90, in the absence of aew economic data during this period. A. Growth and Utilization of Gross Domestic Product, 1984-87 20. Declining economic activity. Djibouti's econtomic performance of recent yeers is disappointing. GDP declined in real terms by an average of 2.7 percen: per annum between 1984 and 1987, as compared to an average growth of 3 percent in 1978-82. The economy was negatively affected by the decline in demand for services from neighboring countries and from the expatriate community, due mostly to the appreciation of the Djibouti franc in 1984-85. Year-to-year examination shows a slight decline in economic activity of 0.4 percent in 1985, a sharp drop of nearly 7 percent in 1986 and another reduction of 0.6 percent in 1987. This implies a decline of at least 23 percent in the per capita consumption, since the population increase is estimated at about 6 percent per annum, of which 3 percent is due to a high influx of immigrants an. refugees. 21. Table 2.1 summarizes trends in main sectors in real terms for 1984-87. A2riculture, which contributes only 2 percent to GDP, consists mostly of traditional livestock, small garden plots and artisanal fishing. Output in the sector dropped by nearly 3 percent per annum, due to severe drought in the region. In the secondary sector, accounting for 15 percent of GDP, growth was mixed. The value-added in manufacturing improved with the opening of a dairy products plant in 1985 and a flour mill in 1987. Performance in the utilities subsector was outstanding following major Investments to improve water and electricity production capacity. Daily electricity cuts experienced in the early 1980s, attributable to insuff icent  plant capacity, no longer exist. However, the sector was hurt by a severe drop in construction when the real estate boom, especially construction of rental housing for higF-income expatriates, came to an end in 1984. In the tertiary sector withn 6 percent of the value-added, almost all service activities suffered a major setback in 1986, in particular hotels and restauranes, transport, telecommunications, and banking, mainly as a result of the appreciation of the U.S. dollar. In 1987, however, certain service activities were recovering, thanks to more frequent stops of warships, particularly those of the French navy, at the port of Djibouti. This took place while the Persian Gulf was closed during the war between Iran and Iraq. Aa a result of a Government policy to curtail expenditures, value-added in public administration declined in real terms by an annual average of 7 percent in 1986 and 1987. Table 2.1: RESOURCE AVAILABILITY AND USE, 1984-87 (in millions of Djibouti francs) GDP in Shares of GDP Annual growth rate in X current US8 in % (At constant 1986 prices) 1987 1984 1987 1985 1988 1987 1984-1987 GDP at markot prices 873.4 100.0 10D.0 -0.4 -8.9 -0.6 -2.7 Net indiroct taxos 69.8 18.3 16.0 -3.1 -18.7 1.6 -7.2 Agriculturo 9.0 2.8 2.4 0.1 -8.8 -2.0 -2.9 Industry 68.4 14.7 16.1 -2.1 2.8 -0.7 -0.2 (o/v Manufocturing) 16.4 8.4 4.1 -1.0 6.1 2.3 2.4 Services 248.2 64.7 68.6 0.8 -6.7 -1.0 -2.0 (o/w Administration) 101.6 28.8 28.8 2,4 -8.1 -8.6 -4.2 Resourco Bolanco 72.6 -81.8 -10.4 -86.P -1.4 -1.4 -17.6 Exporto of GNFS 178.4 49.1 47.8 -8.7 -8.5 4.4 -8.9 Importo of ONFS 260.9 80.9 e7.2 -10.1 -17.6 2.6 -8.7 Roaourco Availability 446.9 131.8 110.4 -3.8 -13.1 -0.7 -6.9 total Consumption 876.3 103 100.8 1.1 -8.4 .4.6 -8.6 Privato 243.6 66.3 65.2 -2.0 -9.2 0.9 -8.6 Governmont 182.8 36.9 36.6 6.7 -7.1 -10.8 -4.0 Gross Domostic Invostment 69.6 28.5 18.6 -10. -34.8 17.8 -14.8 (o/v Fixod Investmant) 64.8 26.1 17.4 -21.8 -17.2 -8.4 -14.3 Groas Domestic Saving -2.9 -8.3 -0.8 .. 22. Significant reduction in domestic investment. On th.; demand side, fixed investment declined from 26 percent of GDP in 1984 to 17 percent in 1987. This level is still relatively high by sub-Saharan Africa standards. As shown in Table 2.2, private investment dropped from 5 percent of GDP in 1984 to 2 percent in 1987, due to the recession in housing construction. Similarly, public sector investment declined from 21 percent of GDP to 15 percent during the -me period, reflecting the tapering off of major investment projects, especially in port, telecommunications, and ener7y.  - 9 - 23. Corfronted with adverse extarnal developments, the Government has succeeded in containing the erosion of private consumption. As a result, Government consumption declined by 7 percent in 1986 and another 11 percent in 1987 because of austerity measures adopted to reduce the budget deficit. Meanwhile, total private c.o.sumption rccorded an increase of nearly 1 percent in 1987 as a result of the cutback in investments. With an estimated population increase of 6 percent a year, total per capita consumption declined by 25 percent between 1984 and 1987. Since the overall consumption was reduced, an improvement in the domestic savings (although still negative) occurred. Frivate savings improved dramatically from 1.7 percent in 1984 to 5.2 percent in 1987. Table 2.2: MACROECONOMIC BALANCES, 1984-87 (porcentago of GDP) 1984 1986 1988 1987 Balance an Current Account -17.4 -12.4 -S.8 -3.9 (including unrequited transfers) Private Sector Cross Domestic Investment 7.2 7.7 1.2 8.4 - Fixed Investoent 4.9 6.2 8.9 2,2 - Change In stocks 2.8 2.5 -2.1 1.2 Privato Savings 1.7 a.4 8.8 s.2 Investment minus Savinso 5.6 4.8 -2.1 -1.8 Public Soctor 1/ Croce Domostic Invostmont 21.8 16.1 14.0 16.2 - Fixed Investment 21.8 16.1 14.9 15.2 - Chonge in etocko .. Public Savings -6.0 -7.4 -6.7 -6.0 - Current Revenues 43.1 43.6 42.5 40.5 - Curront Expenditures 48.1 50.9 49.2 46.6 Invostment milnus Savings 26.3 23.6 21.6 21.2 Public and Private Xnvent m iue Savings 81. 8 27.8 19.6 lb.' Memo Item Share of CDI financed by: - Foreign Savings (including unrequited transfers) % -81.1 -52.2 -36.8 -21.6 1/ Consolidated account of the genoral govornment and public soctor enterprieoo. B. Employment, Income aInd Prices 24. Worsening of Employment. Djibouti's formal labor market is very limited, and the employment situation has become critical as a result of the drop in economic activity. Out of a potential active population of 160,000 in 1987, only 48,000 held permanent positions -- 24,000 were in the formal sector (69700 in the public civil service, 4,000 in public enterprises, and 13,300 in the private sector). This quantitative disequilibrium results from the relatively high population grotfh and influx of refugees, a lack of nnv,7  - 10 - job opportunities and, more important, from the high salary level that hinders creation of significant employment in the formal sector. Between 1984 and 1987, employment in the formal sector appears to have declined by nearly 3 percent, in particular in the private sector, due largely to the reduction in construction and service activities. The inability of the private sector to absorb labor has led the public sector to expand and to assume responsibility as the main employer in the country. 25. Relatively High Wages. According to the wage bills declared at the social security agencies, a salaried employee in the private sector earned, on average, an annual income of about US$4,200 in 1987. The lowest paid group was domestic servants, who received an average income of US$, 600, and the highest paid groups were in commerce and transport, with an average of US$6,000. The salaries for civil servants averaged about US$7,800 -- alm-st 3 times higher than those in Mauritius and 11 times those in Madagascar. School teachers received starting salaries of approximately US$7,090 excluding benefits such as housing allowances, which were as much as their salaries. The general impression is that Djibouti is trying to maintain wage and benefit practices, especially in government services and the modern sector, similar to those of France. The guaranteed minimum wage has remained at US$89 per month (or US$1,068 per year) since July 1980, but only a few workers are at this wage level. While this minimum wage seems high in comparison with that of neighboring countries, it should be kept in mind that consumption includes a large share of high-cost imported items, such as basic foodstuffs and other consumer goods. 26. Although statistics on income distribution are not available, rough estimates indicate that income distribution is very skewed and that about 10 percent of income recipients may be receiving half of total Income. The expatriate residents representing less than 2 percent of the total population hold about 25 percent of the national income. The presence of a sizable expatriate community and the relatively high income of wealthy city dwellers raise the average income of Djibouti. However, more than half of the urban population and most of the rural population live in very poor conditions. According to some indicators, the structure of household expenditures is as follows: 29 percent on food, 25 percent on housing, 22 percent on _onsumption of khat (a narcotic product flown daily from Ethiopia, see para. 126) and tobacco, 2 percent on health, 1 percent on education, and the remaining 21 percent on transportation, clothing, and other items. 27. GNP per Capita. Tentative estimates have been made for the GNP per capita based on the national accounts estimates of this report. As explained in more detail in Annex I of the report, the mission followed the methodology of the United Nations System of National Accounts in estimating the GDP series for 1984-87. The mission estimates of GDP in 1984 are very close to those of the government (latest government-published estimates were for 1984, Aunuaire Statistique de Djibouti 1984, page 120.) However, there are major differences between the GNP estimates. Whereas the mission follows the UN definition to derive GNP, the government uses highly questionable adjustments to bring down the GNP to nearly one-third of the mission estimates. The main adjustments consist of deflating the GNP by an arbitrary cost-of-living factor and by a "monetization" coefficient, in addition to subtracting all of the expatriate incomes. As a result, the government  - 11 - obtained a GNP per capita of US$276 for 1984, compared with mission estimates between US$800 and US$927 depending on population used. In 1987, mission estimates of Djibouti GNP per capita would be US$740 with official population data and US$855 if Bank population data are used. Although these represent the mission's best estimates, they are subject to uncertainties due to weak primary production and population data. The GNP per capita will be revised based on the results of the 1991 population census and the additional studies on national accounts. 28. There are reasons to believe that the GNP per capita for Djibruti is inflated by an overvaluation of the exchange rate and the presence oi a large expatriate community. Similar cases are found in the small Caribbean islands. Therefore, despite the relatively high per capita income, it could be argued that Djibouti belongs to the lower-middle income group and should continue to receive very concessional assistance due to the fact that it is: (i) a very small economy with an extreme dependence on external assistance; (ii) a desert country with extremely limited natural resources ar.d development potential; (iiI) a country that has a large illiterate population and serious health problems; and (iv) a country that faces tremendous problems with high influx of refugees from Somalia and Ethiopia. 29. High Consumer Prices. Most prices are free of any control, except for a few basic food items, such as wheat flour, bread and sugar. Since most goods are imported by air from France and Saudi Arabia and by air/train from Ethiopia, consumer prices in Djibouti City are high. Mutton, the most consumed meat in Djibouti, costs about US$5/kg, rice ranges from US$0.50 to US$1.351kg, fruits imported from Ethiopia US$1.12/kg, and khat US$28/kg. However, the subsidized price of bread (225g French 'baguette") has been fixed at US$0.11 for the past several years, to make it affordable to the poor. The Office national d'approvisionnement et de commercialisation (ONAC) plays a key role in stabilizing the prices of basic food items. 30. The consumer price index for expatriates living in Djibouti is used to measure inflation rate since no other Indicators are available. In general, the inflation rate in Djibouti seems to be lower than the international inflation rate, measured by the unit value of manufactured exports index. When the U.S. dollar started to appreciate in 1984, the consumer price index in Djibouti was relatively stable since most imports come from France. However, when the reverse occurred in 1986, a 16 percent Increase in consumer prices was recorded before slowing down to about 4 percent in 1987. The inflation rate has been estimated to be 5 percent in 1988 and 3 percent in 1989. C. Public Sector Financial Performance 1. Public F.inance 31. This section presents the financial situation of the central government and the five districts, consolidated with two government employee pension funds and two autonomous government agencies (Office National du Tourisme et d'Artisanat et Chambre de Commerce Internationale de Djibouti)  - 12 as defined by the government Finance Statistics of the IMF. The Government budget is clear and includes a debt section, t-e current budget, and the capital budget. However, the capital budget covers only expenditures paid on treasury funds; most of it being now the domestic counterpart of externally- financed development projects. Expenditures inanced by foreign grants and loans are not included in the budget and are referred to as "extra- budgetary." 32. 'lhe Overall Budget Deficit, As shown in Table 2.3, the overall deficit, including grants, fell from 6.3 percent of GDP in 1984 to 4 percent in 1985 due to new tax measures initiated in 1984 and the reduction of domestically-financed capital expenditure; however, the deficit rose to 6.5 percent with the slowdown in economic activity in 1986. In 1987, the government introduced additional austerity measures to curtail expenditures, with increased finazicial support from France, thus reducing the deficit to 5 percent of GDP. In. 1988, the deficit is estimated to have declined further, to 4 percent of GDP. The deficits have been largely financed by the use of cash reserves ir the Treasury and external grants. Grants declined steadily from 17 percent of GDP in 1984 to 14.5 percent in 1988 with the exception of 1987 when they reached 16 percent owing to the inDrease in budgetary support. Direct budgetary support from France has beer. declining. Nevertheless, France increased its exceptional financial assistance to Djibouti when the latter adopted austerity measures in 1987. In addition, Djibouti has continued to receive grants from Saudi Arabia, Kuwait, Italy and the United States. When loans ate included, total external aid averages about 24 percent of GDP during 1984-88. Table 2.8: CENTRa. GOVERNMENT OfERATIONS, -1984-89 (it. millions of DJibouti francs) 1984 1985 1986 iQ87 1988 1989 Prov. est 8udget Revonuo and rants 29.988 31,917 30.749 S1 582 S2,S3 B4.229 Revenue 19,862 22,833 21,071 21,086 21,811 23,595 Tax revenue 16,931 16,046 17,442 17,671 18,861 19,152 Non-tax revenue 2,930 4,286 3,829 8,494 8,490 4,443 Grants 10,127 9,684 9,678 10,517 10,208 10,684 Budgetary 1,640 1,830 2,401 3,269 2,258 2,684 Extra-budgetary 8,686 7,764 7,277 7,269 7,960 8,060 Expendituro 88 684 84 816 84 941 34 9114 84 838 8s8,33 currentoexpendituro !8&/LT -wiFeL MY Wt-0 S7 28,67i7 28U,647 of which: budg.tary 19,434 21,410 22,601 21,692 22,708 22,971 Capital expendituro 1/ 7,688 6,219 8,062 7,187 6,160 7,A87 Deficit (8,878) (2.899) (4.192) (8.322) t2,.786) (1606) Frnancing 8,676 2,399 4,192 8,322 2,706 1,606 External loans (not) 2,047 1,842 2,476 2,984 2,476 1,810 Domestic financing (net) 1,628 667 1,717 3a9 810 (206) Memo Items: (as % of GDP) Tax revonue 29.1 30.0 27.1 26.6 26.1 26.7 Non-tax revenuo 6.0 7.1 6.6 5.8 5.0 6.2 Grants 17.4 16.0 16.0 16.8 14.6 14.8 Current expendituro 44.3 48.8 44.8 dl.G 40.8 89.9 of which: budgotery 83.4 35.6 36.1 82.7 82.8 82.0 Capital oxpondituro 18.6 10.4 9.4 10.8 8.8 10.0 Deficit -6.8 -4.0 -6.6 -6.0 -4.0 -2.2 I/ Xncludoo on-londing.  13 - 33. Although there has been some improvement, the financial situation remains worrisome. The previously accumulated cash reserves (budget surpluses before 1982 held in bank accounts by the Treasury), which were used to finance part of the deficit, were nearly depleted by 1987. This led the government to request public enterprises to transfer the equivalent of 25 percent of their outstanding bank deposits into an account at the Treasury. These deposits, which amounted to about DF 3 billion (US$17 million) at the end of 1988, could be used to cover short-term cash shortages. In addition, the government increased recourse to external resources to finance the deficit. Another area of concern is the government9s accumulation of expenditure arrears, which reached about DF 3 billion at the end of 1987. More arrears were accumulated during 1988. Djibouti is current on the service of its external public debt. 34. Fiscal Measures. In order to cope with the fiscal situation, the government has taken tax measures mainly aimed at specific imports. In 1984, the surtax on khat was raised from DF 250/kg to DF 350/kg. The surtax on tobacco was raised by 5 percentage points and on alcoholic products by 20 percentage points. In 1985, the income tax rate on personal businesses was raised from 15 to 20 percent. As a measure against tax evasion, a 10 percent levy on goods imported by the "charcharis" (unlicensed merchants) was instituted as a downpayment on business income tax. A new surtax on dairy product imports was created with the opening of the dairy products plant. Registration and stamp duties were substantially raised. An additional surtax of DF 100 was imposed on khat, raising it to DF 450/kg. In 1986, a 25 percent surtax on imported automobiles and video equipment was instituted, but it was repealed in 1987. In 1988, public enterprises became subject to the corporated income tax. The -surtax on tobacco was raised by another 11 percent (bringing the surtax rate to 56 percent) and on alcohol about 10 percent. On khat, the surtax was raised again to DF 550/kg, and the imputed border price used as a base for the consumption tax, was raised from DF 1000/kg to DF 1100/kg. 35. Although these new measures brought additional revenues to the &,avernment, they could not compensate for the revenue decline from the economic slump. After reaching a peak of 37 percent of GDP in 1985, government revenues (excluding grants) declined steadily to 31 percent of GDP in 1988. For 1988, revenues from all categories of taxes were estimated to have fallen by 7 percent below the budget forecast, due to stagnant economic activity and a disruption in the import of khat. While government revenues were stable in current terms in 1986-88, they declined rapidly in real terms. 36. Tax revenues fluctuate between 26 and 30 percent of GDP. Although the overall tax pressure is high, the rate of direct taxation if fairly reasonable, with a marginal rate of 15 percent on wages and salaries and a flat rate of 20 percent on personal or corporate profits. Taxes on imports, which represent about 60 percent of tax revenues, are derived mainly from an "internal tax on consumption" levied at a rate of 23 percent of c.i.f. value (26 percent for luxury goods). A 5 percent surtax on all imports is also levied. Specific surtaxes also apply to certain imported goods, partly to discourage their consumption and partly to protect domestic plants (e.g., dairy products, water bottling, etc.).  - 14 - 37. Effort in Containi.a Current Expenditure. With the initial rise in budgetary current expenditures from 33 percent of GDP in 1984 to 35 percent in 1985 and 1986, a special effort has been made to curtail the current expenditures. The nor_nal rise in expenditure on wages and salaries was due mostly to the increase in the number of civil servants and fixed-term government employees, which went up from 6,000 in 1983 to nearly 7,000 in 1988, since the pay scale itself has not changed for a nubmer of years. The most serious efforts to bring down the level of current expenditure in real terms were made in 1987, when appropriations for operations and maintenance were cut by about 15 percent across the board and recruitment to fill vacant positions was frozen. As a result, current budgetary expenditures fell back to 33 percent of GDP in 1987 and improved further to 32 percent of GDP in 1988. 38. Nearly half of total expenditures is devoted to General Public Services and Defense, reflecting a heavy fiscal burden and inability to make more public resources available for social and economic expenditures. Education accounted for 17 percent and health for 7 percent of total expenditures. Since these two sectors are vital to future development efforts, their budget share needs to be increased. Expenditure on transport declined to about 10 percent of total expenditure after the completion of the Djibouti-Tadjourah road in 1988. The share of housing and community expenditure (about 3 percent) seems low, given the need to upgrade housing for poor city dwellers and to provide adequate water and sanitation. Thus, the allocation of expenditures will need to be reviewed within the context of national priority and resource availability. 2. Public Enterprises 39. Djibouti has fourteen non-financial public enterprises that enjoy either the status of Industrial Public Establishment or State Corporation. All of them have autonomous management and separate budgets, although each enterprise is under the supervision of a related technical ministry. The most important enterprises are in public utilities, transport, and communications, while others operate in the tourism and industrial sectors. The consolidated parastatal sector has a positive operating account, leading to a sizable cash flow before allowance for depreciation. Consolidated net cash flow increased from DF 1.7 billion (US$9.6 million) in 1984 to DF 2.5 billion (US$14 million) in 1987. Given the healthy financial situation of the public enterprises as a whole, government decided to appropriate 25 percent of their bank deposits as a financing resource for the Treasury and to subject public enterprises to the corporate income tax starting in 1988 (see para. 34). 40. Enterprises operating with surpluses include the post office, the telecommunication corporation, and the port. The electricity and the water supply companies have operating deficits but large cash flows. The main threat to these profitable enterprises is the rise in account receivable. This problem is connected with the increasing arrears of the government (see para. 33) and the financial situation of non-profitable public enterprises. The financial situation of the water bottling company improved as the plant started to increase its production in 1988, but serious losses have been incurred by the airport, the Sheraton Hotel, and the dairy products plant.  _ 15 - 41. Although government policy toward private investment is very positive, very few private enterprises have been created. The main reasons have been the lack of entrepreneurs, smallness of domestic market, and high production costs. As a result the government has been taking initiates in creating several enterprises with the hope that they will be taken up by the private sector through divestiture. Two new public enterprises were opened in 1988: an animal feed plant and a slaughterhouse. 42. Situation of Non-Profitable Public Enterprises. The DIibouti airport has a structural deficit, personnel costs being much higher the.n at comparable airports in the region. Its deficit is covered by a yearly budget subsidy and by arrears. Its future financial situation is threatened by the potential decrease in traffic (see para. 63). Several measures have been undertaken to redress the financial situation of the airport, including the integration in the government workforce of the technicians who perform government duties such as meteorology or air traffic regulation. This has helped reduce the personnel costs of the airport and has allowed better personnel management to increase the productivity of the remaining workforce. The operations of the Sheraton Hotel are a source of concern, the company being obliged to borrow locally, in order to meet its obligations. Given the hotel9s consistent losses, the government has privatized the management of the hotel as well as reorganized its structure. The dairy products plant as well as the water bottling company are small industrial units with a tendency to) show deficits. The public ownership of such operations -- whose size is wall adapted to a private take-over -- is not justified. The government has g.lready decided to privatize these two plants and promotion for their sale has been taken. D. Money, Credit and Interest Rates 43. The government9s primary concern regarding monetary policy is to maintain the stability of the Djibouti franc and a liberal foreign exchange system, which is essential to Djibouti's role as regional service center. The Djibouti francs in circulation, equivalent to about US$47 million, are fully covered by U.S. dollar deposits held with the French American Banking Corporation in New York. Foreign exchange holdings by monetary authorities had been restored from a critical level in early 1985 to over US$64 million by the end of 1988, and net deposits in banks had almost doubled over the 1985-88 period. As a result, the banking system's net foreign assets improved from US$112 million in 1985 to US$170 mi'Llion by 1988. The monetary situation is summarized in Table 2.4. 44. Domestic credit increased modestly over 1985-88, reflecting lower demand in the private sector, in line with sluggish economic activity. At the same time the broad money supply expanded fairly rapidly when commercial bank bank deposits increased by nearly nearly 30 percent between 1985 and 1988. The lending operations of the six commercial banks are relatively short term. The Development Bank (Caisse de Developpement de Djibouti) provides medium- and long-term credits to selected projects as part of the government's policy to promote activities in productive sectors.  - 16 - 45. Commercial bank interest rates in Djibouti follow the trend in the international financial market, in particular the Eurodollar market, with a marginal adjustment. Lending rates are generally from 2.5 to 8 percent about the prevailing Eurocurrency rate, depending on creditors and the nature of the credits. Interest rates on term deposits vary from 6.5 to 8 percent and on passbook savings from 3 to 6 percent. Recently, interest rates on deposits in local currency were raised from 3 to 4 percent on a minlmum balance of DF 20,000. Demand deposits are not remunerated. The financial situation of the banking sector seems to be sound, with increased deposits reported in recent years. Table 2.4: MONETARY SURVEY, 1985-89 (in miTTions of US dollars, end of poriLd) 1986 1986 1987 1988 Foreign assete, net 112.2 134.8 168.6 170.9 Monetary authorities 60.9 63.6 68.6 64.4 Commorcial banks 61.2 81.1 96.0 108.6 Domestic credit 168.7 191.7 177.8 182.8 Claims on Tresury, not -26.3 -16.2 -29.5 -26.2 Clalms on private sector 194.8 207.9 207.8 212.0 Money and quasi-Money 222.6 256.6 266.6 284.6 Currency outsido banko 87.6 40.4 46.1 47.6 Deposits with TroDsury 2.4 2.9 2.3 2.7 .-Ooposits uith coamarcial 182.6 218.3 219.2 234.3 banks Other items (not) 58.8 89.8 69.7 68.9 E. Balance of Payments and External Debt Management 46. After serious deterioration in the early 1980s, the current account deficit of the balance of payments improved from 17 percent of GDP in 1984 to 4 percent in 1987, owing to a reduction in imports and a significant increase in investment income and unrequited transfers; this helped bring the overall balance of payments into surplus starting in 1985. This resulted in the restoration of gross foreign exchange reserves from 2 months equivalent of total imports in 1984 to 3 months in 1987. Table 2.5 summarizes the balance of payments for 1984-87. 47. Export earnings come mostly from sales of services and re-export of goods to French military personnel and to neighboring countries. Domestic exports, accounting for less than 10 percent of total exports, consist primarily of live animals, which are reported to be largely the animals crossing the border from Somalia and Ethiopia. In 1585, exports dropped significantly, reflecting the adverse effect of the appreciation of the U.S. dollar to which  - 17 the Djibouti franc is pegged. As food and consumer goods sold ir Djibouti became more expensive to French military pexsonnel, the French authorities opened their own shops within the military complex. M1en the U.S. dollar started to decline, beginning in late 1986, total export earnings picked up and peaked in 1987 when Djibouti port serviced more foreign warships (see pare. 21). In real terms, exports of goods and non-factor services declined by an annual average of nearly 4 percent in 1984-87. Table 2.5: BALANCE OF PAYMENTS, 1984-87 (ln millions of US dollars) 1984 1986 1988 1987 Exports of goods (f.o.b.) 1/ 133.4 123.0 134.9 145.7 Imports of goods (f.o.b.) 238.6 219.8 207.4 222.8 Trado balanco -105.1 -98.3 -72.6 -76.7 Exports of NFS 27.4 28.0 29.8 32.7 Imports of NFS 26.4 25.5 27.6 28.6 Resource balance -104.1 -93.9 -70.7 -72.6 Not factor income 8.8 6.8 7.6 9.3 Not curront transfore 38.9 46.1 42.0 48.6 Current account balanco -67.0 -42.0 -21.1 -14.8 Official transfers 14.9 8.4 12.8 18.0 Long-torm loano (not) 87.8 23.4 28.2 20.1 .Othor 2/ -6.6 16.0 -14.8 -8.6 Ovoroll balanco -10.4 6.8 2.6 9.7 memo items Current account balance as % of CDP -11.45 -12.4% -S.8% -4.0% 17 Xnclud-s re-exports to French military porsonnol. 2/ Privato capital Including commercial banks, and errors and omissions. 48. Djibouti imports virtually everything since the primary sector is little developed and natural resources are scarce. Imports declined over the period 1984-87 in line with the general economic slowdown and the drop in investment outlays. The main trade partners are France, Ethiopia, Japan and some Arab states. Food items are imported largely from France and Ethiopia and represent about 25 percent of imported goods. Imports of khat represent nearly 10 percent of imported goods and cost about US$18 million a year. The share of imports of transport equipment and capital goods declined from 29 percent in 1984 to an estimated 17 percent in 1987. Energy requirements have been mostly met by imported petroleum products, which represent 9 percent imported goods. In real terms, imports of goods and non-factor services declined by an annual average of 9 percent in 1984-87.  - 18 - 49. As foreign exchange holdings increased, investment income went up by more than 30 percent over the 1984-87 period to reach an estimated US$12.7 million in 1987. This increase more than offset interest payments on public debt, which tripled from US$1.3 million in 1984 to US$3.4 million by 1987. Unrequited transfers also went up by nearly 25 percent over the sam.a period due to the increase in official grants. In 1987, France increased its exceptional budgetary assistance in support of Djibouti9s austerity measures. Also beginning in FY87, the United States changed its assistance from project grants to balance-of-payments aid. Meanwhile, capital flows declined significantly, reflecting the tapering off of malor investment projects. Capital grants were reduced from US$15 million in 1984 to US$13 million in 1987 and net disbursement- from medium- and long-te.m borrowingL from US$37 million to US$20 million during the same period. 50. Due to heavy borrowing in the early 1980s to finance public investment projects, DJibouti's disbursed and outstanding external debt (DOD) rose from US$62 million in 1984 to US$153 million at the end of 1987, or 40 percent of GDP. In 1988, D^B increased moderately to US$157 million. Total commitments form the 1986-88 period declined to US$65.6 million from the US$110 million for 1983-85. Although most external borrowings were on highly concessional terms, debt service payments more than tripled: from US$4 million in 1984 to US$13.4 million in 1988, representing about 8 percent of total exports. Among multilateral creditors, the Arab Fund for Economic and Social Development has been the largest donor, with 17 percent of total DOD, followed by IDA (16 percent) and the African Development Fund (11 percent). France, Saudi Arabia and Kuwait are among the major bilateral creditors, holding about 15 percent each of total DOD. F. Assessment of 1988-90 51. General Economic Situation. According to the few indicators available, the Djibouti economy showed mixed results in the last three years. In 1988, real GDP growth was estimated at less than one percent. While the service sector, in particular hotels and restaurants, continued to pick up with the frequent stops of warships, the demand for transit and related services slowed down when relief shipments to Ethiopia ended in 1988. In April 1989, the economy suffered a setback when a flood affected about half of the population in the capital city. In addition, warships had returned to Gulf ports after the cessation of the Iran-Iraq war; this had an adverse effect on some service activities in Djibouti. As a result, real GDP declined by about 0.8 percent. 52. In 1990, the Djibouti economy was adversely affected by the Gulf crisis. Commercial ship traffic in the port of Djibouti sharply declined, causing a significant loss of sales of services. However, this loss was estimated to be partly compensated by additional revenues from increased visits by warships to the Djibouti port. In addition, the commercial activities performed by the unlicensed merchants (see para. 34) practically stopped during the Gulf crisis, leading to a reduction both in government fiscAl revenue and in the incomes of the merchants. Investment was also estimated to have declined, especially in the public sector since several  -19 - projects have been financed by Arab funds. In 1991, the economic activities in Djibouti are expected to recover with the resumption of commercial ship traffic in the region, following the end of the Gulf war. 53. Fiscal Situation. The fiscal situation in 1989 is estimated to have improved owing largely to government efforts to reinforce tax collection, including the call for a national effort to pay all taxes. the tax administration has been strengthened by the appointment of tax verification officers and the provision of specialized training for personnel in the income tax and customs department. As a result, government revenue is estimated to have increased by about 8 percent over the 1988 level. Fringe besiefits of civil servants were reduced. The housing rental costs for teachers that were paid by the government have been replaced by fixed and lower allowances (see para. 81). By contrast, budgetary developments in 1990 were disappointing in view of the bleak general economic situation combined with the effect of the Gulf crisis. No new revenue measures were introduced, except for the doubling of the contribution of the Petroleum Products Importing Company to the budget. 54. The government is determined to curtail the budgetary deficit. This is reflected in the 1991 budget in which the following measures have been adopted: (i) vacant positions have not been filled; (ii) new recruits have been limited to education and public health; (iii) the wage bill has been budgeted to increase by only 1.1 percent over the 1990 level; and (iv) fiscal revenues have been budgeted to increase by about 6 percent over the previous year, with continued effort to improve tax collection. 55. In the external sector, the current account balance is estimated to have deteriorated in both 1989 and 1990 due to the sluggish sales of services, an increase in the import bill for food, consumer goods and petroleum products (especial.ly in 1990), and a decline in investment income. Owing to the debt cancellation by France as a result of the Dakar Agreement in 1990, total debt has been reduced from US$157 million at end-1988 to US$133 million at end-1989. Incliding new uisbursements during 1990, total debt is estimated at about US$150 million by end-1990, or about 33 percent of GDP.  - 20 CHAPIYMR 3_ SECTORAL DEVELOPMENT AND ISSUES 56. Since independence, the government has been trying to promote activities in other sectors and to strengthen social infrastructure while continuing to reinforce the dervice sector. However, the sectoral structure has changed very little. The service sector has remained dominant in Djibouti9s economy, reflecting the country's character of a city-state with well-developed international facilities. The existence of modern infrastructure has enhanced Djibouti's role as a service center for the region. Agriculture and industry continue to play a minor role in the economy owing largely to the scarcity of natural resources, including arable land and water, the lack of skilled labor, and high production costs. Social sectors have improved because of the goverrnment's efforts in providing better health facilities and in upgrading the educational and trainirg level of Djibouti's population. This chapter reviews recent developments and government policy initiatives in the various sectors of the economy. A. Services and Infrastructure 57. The Port. The port complex, operated by the Djibouti International Port Authority, continues to serve, though to a lesser degree than before, as the regional center for international transit and for trans-shipment. The port of Djibouti, which used to be Ethiopia's main gateway to the rest of the world, is generally well managed, and its financial performance has been good. However, it is handling at present only about 7 percent of Ethiopia's total external trade. Occasionally, Djibouti9s port has been used as an alternative to the congested port of Assab (in Ethiopia) to transport relief food to drought victims in Ethiopia. 58. Significant investments have been made to develops modernize, and maintain the port's infrastructure and equipment. With the completion of the container terminal in 1985, Djibouti's port became one of the most developed in the region. Unfortunately, with the exception of tne container terminal, the port has been used at less than 50 percent of the total optlimum handling capecity of the general cargo berths. Since the Djibouti port is as much subject to the vagaries of politics -- particularly concerning its regional role -- as to commercial activities, it faces two problems. First, if regional traffic remains at the current level, no new investment is needed because the port is underutilized. Second, if regional traffic were to substantially increase, the port might suffer from lack of facilities to meet such regional demand. For these two problems, careful consideration should be given before deciding on new investment. Moreover, since the port now faces fierce competition with other ports in the region, which also see themselves as having a regional function, the Djibouti Port authority must ensure its own competitiveness in the region, given its strategic location and modern facilities.  - 21 - 59. As a first step, the operating practices of the port should be examined with a view to increasing operational efficiencies, making the cost more competitive and strengthening management, which would lead to maximizing the use of port facilities. Meanwhile, special rates for transit cargo could be negotiated with Ethiopia, as the latter might increase its external trade traffic through Djibouti's port if it became more cost effective. However, this would need to be done in conjunction with railway rehabilitation, a joint-ownership project between the governments of Djibouti and Ethiopia (see below). 60. Railway, Under a treaty ratified in 1981, the railroad linking the port of Djibouti to the highlands of Addis Ababa is jointly owned by Djibouti and Ethiopia, each having equal management responsibility and taking an equal share of profits. In case of losses, the Government of Djibouti is responsible for only 10 percent, however. The Ethiopia-Djibouti Railway (CDE) has a 781 km single-line railway, of which 106 km is in Djibouti territory, and a relatively outdated rolling stock. Because of the poor technical state of both the railway and the locomotives, rail operations have been insufficient, especially for the heavy trans-shipments of drought relief food to Ethiopia. The recent purchase of new locomotives has helped relieve the congestion, but inefficient operations and excessive delays for customs service continue to harper turnaround and delivery time. A project to rehabilitate the railway line and to improve the rolling stock has been undertaken with assistance from the EC. 61. Management of the railway is complicated by the physical location of the railroad administration in three different places. The commercial department is located in Djibouti, the civil and mechanical engineering -department in Dire Dawa (Ethiopia) and the transportation, finance, and personnel departments at headquarters in Addis Ababa. The financial performance of CDE has been weak. Efforts have been made to diagnose some of the problems related to management and operating inefficiencies. 62. Roads. Djibouti's roads have improved considerably sirce independence. The government's policy for road development has been to upgrade selected roads ard to unify the country. The latter goal led the government to build the 125 km Djibouti-Tadjourah Road from the capital to the northern part of the country. The project has been completed, with a total cost of about US$35 million, financed by a concessional loan from the Saud$ Fund. With the physical infrastructure in place, increased attention must be given to road maintenance. Other road construction projects seem less pressing and should not be considered until more detailed information is available on their economic rates of return. 63. International Airport. The modern airport, equipped uith facilities capable of accommodating jumbo jets, is another essential element that has enabled Djibouti to maintain itself as a service economy. Although the Djibouti airport supplies connections to a few countries in the region and is used as a transit point between Europe and the Indian Ocean, it is extremely dependent on a single airline (Air France) for revenues. If this carrier were to introduce long-range aircraft capable of covering major routes without stopovors in Djibouti, the effect on the airport's financial situation would be highly adverse. Therefore, a thorough study should be  - 22 - undertaken to explore ways of maximizing the use of the airport as well as revenues from air traffic so as to reduce the degree of dependence on a single airline. As for investment projects of the airport, they are few since the present infrastructure remains satisfactory. For this reason the governmsnt has decided to scale down and delay the ai-port extension project, co-financed by a number of Arab donors. 64. Telecommunications. Djibouti possesses excellent worldwide telecommunication services. This constitutes a major asset that enables the country to play a central role in the region and to attract foreign investors for industry, tourism, and financial services. Following the goverrment's decision to make Djibouti a major relay center ou the Singapore-Europe undersea cable communication link, a submarine cable project has been completed. Two other wajor projects were also completed: MEDARABTEL and ARABSAT. Since the international telecommunication system is already well- equipped, the government now is considering the modernization of the inter- city telecommunication system, a project that could be rescheduled, if necessary, to ensure that investment in the sector does not outstrip demand. B. Agriculture, Industry and Tourism 65. Agriculture. As can be expected in this small city-state, agriculture is almost non-existent. In addition, scarce water resource3 and the harsh climate limit traditional agriculture. At pr.,sent, the cultivated areas are insignificant (about 600 ha with vegetable proluction of 1,800 tons a year.) However, Djibouti appears to have some potential for desert agriculture. A pilot project to experiment with the cultivation of jojoba has shown signs of promise. (The oil from jojoba, a desert plant that produces nuts after 4-5 yeargs, is used in the production of some cosmetics, medicine, liquid wax, and high quality lubricants. Jojoba plants have a long life span, normally over 100 years, and their extremely long roots help prevent soil erosion; the plants need light irrigation during the first two years.) The next stage would be to make a careful examination of the financial and economic characteristics of the pilot project in order to determine whether the model could be replicated in other areas of Djibouti. Another desert agriculture project to plant date palm is being implemented with financing from the African Development Bank. 66. Livestock. Livestock is ra_ied by the nomads in the interior of the country, and the construction of water wells in the rural areas has helped development in this subsector. It consists mostly of raising goats, sheep, camels and, to a lesser degree, cattle and donkeys. Stockraising faces two major constraintss frequent drought and the tradiU.oual attitude to flocks and herds as a source of prestige and wealth. Government policy has been to upgrade stockraising and improve the infrastructure of the sector. Construction of a new slaughterhouse and an animal feed factory was completed recently. Future efforts should focus on building more water wells wherever economically feasible. A project to build drying facilities for hides should be encouraged, preferably as a private initiative, since it would enhance the value of a by-product that has not been fully exploited. Poultry farming is being considered for development as well.  - 23 - 67. Fisheries, Djibouti has good fishing potential that could reach production of about 3,000 to 4,000 tons a year. Thanks to government effort to develop the sector through vhe creation of fishing cooperatives and the construction of cold storage facilities, fish production has reached between 600 and 700 tons a year, a significent improvement since independence when the catch was less than 100 tons. Government policy in this subsector is geared toward development of artisanal fishing to satisfy the domestic market. In this respect, it is encouraging that fish has been accepted more and more by the Djiboutians as part of their daily diet. However, given the fact that fisheries could constitute a key resource for the economy if proporly developed, the govermuenL would need to review its policy in the sector by considering progressive modernization of facilities so that the transition could be made from artisanal to Industrial fishing. The construction of a fishing port, a project under implementation with financing from the African Development Bank, is a step in the right direction. 68. Industry. Industry 'n Djibouti has developed little despite the government's promotional efforts. It consists mostly of a few bottling plants, a dairy products factory, a flour mill, a few units supplying building materials, and some repair shops. Handicraft activities are limited due to the nomadic nature of the miajority cf the population. Local construction industiies, though well developed, operate only on a small scale. Industrial development has been hampered by a small local market, the high cost of unskilled labor and utilities, and lack of entrepreneurial capacity and skilled labor. 69. Several initiatives have been taken to promote activities in the sector, Recently, the govetnment obtained assistance from UNIDO to andertake a study to promote small- and medium-scale industries. Credits on favorable terms have been made available through the Development Bank of Djibouti. The development of export-oriented industry along the Mauritian model is under consideration. A committee, with participation from the private sector, is examining the possibility of creating an export processing zone and is reviewing measures that could improve export competitiveness. This effort should ba accompanied by a thorough study by a consulting firm specializing in this type of activity. In the interim, some thought should be given to the possibility of setting up a small industrial estate or constructing factory premises that would encourage Djiboutian nationals in industrial undertakings. 70. Tourism. Mass tourism would be hard to develop, but small-scale tourism to attract families of military personnel and expatriate residents holds further potential. The scenery of Djibovti is unspoiled and can be attract've to certain types of tourists. The coastal areas are rich with varied marine fauna and coral reef. Although the land is bare and dry, it is marked by sharp cliffs, deep ravines, and mini-volcanoes, a few of which are still active. The mo3t dramatic sites are the Abbe and Assal lakes. Lake Assal is famous for its salt deposits; it is the lowest point in Africa and the second lowest point on earth. Lake Abbe is attractive for its tall rock columns and its floor covered by several fumaroles and thermal sprIngs. Although the climate is generally hot, it is quite pleasant from October to April, comparable to a Mediterranean summer.  - 24 - LI 71. Despite adequate facilities, tourism in Djibouti suffers from lack of promotion. The occupancy rate is low at about 50 percent. With the exception of the Sheraton Hotel, all hotels are privately owned. With the completion of the Djibouti.Tadjourah Road, tourism seems to be developing in the interior of the country, and small bungalows are being built by private investors along the road, in particular near Lake Assal. The government should limit its involvement to promotional campaigns encouraging tour operators to adopt Djibouti as a vacation destination and fosteiing private investment in hotel construction. C. Energy 72. Djibouti relies heavily on imported petroleum products to meet its energy requirements (petroleum imports average around US$17 million a year or 9 percent of merchandise imports). Because of the government's efforts to develop its own energy resources, research has been ongoing during the past decade to explore energy potential in the country. A recent geothermal exploration project has proven the existence of sizable geothermal energy in the Assal area. Apart from the geothermal potential, some renewable energy resource potential exists in the form of wind and solar power. In addition, the possibility exiits to utilize the steep drop in elevation from the Gulf of Ghoubet and Lake Assal to generate hydroelectric energy. This is the only hydropower potential in the country due to the absence of permanent rivers. 73. In light of the favorable conditions for the development of commercial geothermal resources in Djibouti, the government is giving high priority to the program through the Geothermal Development Project financed by IDA, Italy, OPEC and UNDP. The project includes, inter alia, the drilling of four development wells in the Assal Geothermal steam field, the installation of two 5 mw generators and a 1 mw well-head generator unit, and the construction of a single-circuit 132 kv transmission line of 100 km from the well-field substation to the main power station in the capital. The project, expected to be completed by 1993/94, would supply geothermal electricity of approximately 35 percent of the country's base lo&d. As a result, the importation of petroleum products could be reduced by about 10 percent. 74. As part of its rational energy plan, the government has also started to adopt conservation measures, including the improvement of building insulation and the installation of low-power street lighting. These programs should have a significant impact on fnture demand fer electricity, in particular during the sumer season when the demand is dominated by the air conditioning load. The electricity company (EdD) is considering changing the electricity tariff to reflect the economic costs and to favor industrial and commercial users over householders.  - 25 - D. Social Sectors 1. Education and Training 75. Although both the school network and the school enrollment rate have expanded notably since Djibouti's independence, adaptation of the education system and its curriculum to local needs has progressed slowly, as formal education and training remain closely modeled on the French system. Even with some improvement, the school enrollment rate of about 40 percent is still one of the lowest in Africa. This is due mainly to (i) the high unit costs of education; and (ii) to some extent, the lack of school buildings (despite the practice of double-shifting of classroom) and the access problem. The unit cost was estimated to be US$372 for primary, US$576 foz secondary, and US$983 for technical education. If technical assistance replacement costs were included, unit costs would increase by 10 percent for primary and over 50 percent for secondary and technical level. In primary school, girls' enrollment is about 42 percent. 76. Final examination pass rates are low at primary (25 percent) and 'lower secondary' (48 percent) while acceptable at "upper secondary' (56 percent). These shortfalls are due mainly to the languages used for teaching (French and Arabic), which are foreign (the native tongue of the majority being Somali and Afar), and t-a inadequacy of the cultural and environmental content of the curriculum. To remedy these shortfalls, the government has started to revise the curriculum for primary education and plans to revise the curriculum for lower secondary education in 1992. Education is provided free of charge, except for small rental fees for textbooks. There are about 100 high school graduates a year. 77. Higher education is offered through fellowships abroad since Djibouti's small size does not justify university development within the country. Currently, about 300 students are studying abroad (90 percent of them hold government scholarships), specializing mainly in law (20 percent), literature (18 percent), economics and management (12 percent), and history (11 percent). This training clearly does not produce entrepreneurs, but instead puts pressure on public employment. 78. Manpower Manasement. Djibouti faces a serious shortage of trained manpower, particularly at the middle and higher professional and management levels. However, the vocational school seems to focus mostly on training for skills such as masonry, carpentry and plumbing, which are now in excess of supply because of the drop in construction activities. The development of relevant training capacities should be prudently pursued given the labor market uncertainties. In addition, management of the institutions in charge of manpower development and training needs to be strengthened. Technical capacity for data collection and processing of employment information, for analysis of the labor market, and for policy development is almost non- existent. 79. Since responsibility for technical and vocational training is divided among several ministries and parastatal institutions, there is a tendency to create and expand training centers in various institutions with  - 26 - a view to redressing the shortage of needed skills. The activities, if not reviewed and coordinated carefully, will undoubtedly result in overlap of teaching and under-use of capacity. This calls for close coordination among i various institutions as well as more active participation by potentiel private sector employers to determine priority areas for training. As a result, the government created, in March 1991, the National Council for training and employment to better coordinate the training activities. 80. Government Policy in the Education Sector. The government has given high priority to education and manpower development, as it recognizes that human resources are one of the country's few and key assets. Government policy in the sector is to (i) expand primary education and increase access to post-primary general education; (ii); raise the effectiveness and relevance of both primary and lower secondary levels, as well as the technician level in vocational training; and (iii) strengthen the overall planning and management of the sector to improve its cost-efficiency. 81. Recently, the government has adopted a scaled-down five-year plan (1990-94) for the sector, and has increased budget allocation to primary, secondary and technical education. Cost-containment measures and the civil service salary scale (including that for school teachers) have been adopted with the aim of controlling the recurrent budget growth. Other positive measures to reduce the recurrent costs in the sector include the creation of an instituteur-adjoint category with a fellowship significantly lower than the previously provided pre-salary. In addition, the government has started to replace the housing rental costs for teachers that it previously paid (rental housing averages about DF 120,O0o/month or US$675) with fixed monthly allowances for housing of DF 30,000 (US$170) for single teachers and DF 40,000 (US$225) for married teachers. 82. The current practice of a single shift for primary school teachers results in a relatively inefficient use of one of the most costly primary education inputs. The government is against the introduction of a double shift system (for school teachers) because it is afraid that the system might adversely affect the studentb9 achievement. When school building capacity improves in the future, the government will need to review the current conditions for access to primary education by extending it to all resident school-age children, regardless of their official birth certificates or nationality. Changes in these two practices are highly desirable. IDA will pursue discussion of these issues with the government under the supervision of the Manpower Training project. 2. Population and Health 83. Although the average population density is low (20 per sq km), the desertic nature of much of the country and the relatively fast population growth, combined with the high flow of refugees from neighboring countries has put tremendous social pressure on the government. The persistence of a very high rate of natural population increase (3 percent per annum) is partly the result of an implicit pro-natalist policy (providing family allowances up to the sixth child for registered wage earners). There is a need for family planning starting with mass education on the spacing of births and reducing the eligibility for family allowances.  - 27 - 84. The vast majority of the population haa poor nutritional and health status due mostly to the h1arsh clim,tte and scarcity of safe water. Pulmonary tuberculosis and malnutrition are widespread. Young girls and women have persistent and often grave problems with Infections and complications caused by the widespread practice of female circumcisions, mostly done in the traditional -- and unhygienic -- way. Infant mortality, although reduced in the last decade, is still very high at 115 per thousand. Most of the deaths of newborns are attributed to the poor health of the mothers (anemia and malnutrition). 85. Although Djibouti appears to have better medical facilities than many other African countries, due to the presence of a large expatriate community, public health services are not adequate, especially for the poorer segment of the population. Although public health care facilities are free, efforts to improve their efficiency are constrained by high operating costs and lack of trained medical staff. To help with the country's difficult financial situation, a cost-recovery system in the health sector is being examined with assistance from France and a cost-recovery practice will be adopted in light of that study. Greater attention and effort should be given to preventive health care (including immunizations), a tuberculosis control program, information on the health damage from female circumcision, and increased training for health personnel. Although no cases of AIDS have been reported, there is a need to take measures to prevent the possibility of the spread of this disease due to the fact that Djibouti City is a port and a military base. E. Urban Development 86. Djibouti City faces the dual challenge of high sinemployment and rapid population growth, with the slum areas around the canital expanding. In the past, only the narrow peninsula of the city was settled, with the Wadi Ambouli serving as a natural barrier to expansion. Recently, however, population pressures have changed this pattern. Beyond the Wadi Ambouli, about 709000 people (about 30 percent of the city's population) live in the squatter settlement of Balbala, and area with virtually no services. The poorer "Old Wards" of the inner city have become more densely settled and contain 50 percent of the city's population. Housing conditions in the Old Wards and Balbala are generally poor, with few houses of permanent construction. Expatriates and a small number of high-income Diiboutians still live in the low-density areas north of the commercial center and in the military compounds around the city. 87. Government Policy in the Urban Sector, The Djibouti vernment has emphasized the need to (i) improve the living conditions of the urban poor with basic infrastructure; (ii) strengthen institutions responsible for the management of urban growth, and (iii) bring financial sector funds within reach of residents wishing to acquire housing. Proper urban development should help make the urban setting in Djibouti City more efficient and more attractive as a center for services, industry, and finance. Several projects have been implemented with assistance from many donors. They include the construction of affordable housing units, rehabilitation of the Old Wards and  - 28 - Balbala, provision of sites and services in the Saline Ouest, and the extension of water and electricity services to newly developed land. A cost- recovery mechanism in low-cost housing has been put into practice, thus mobilizing local resources while stimulating the participation of the private sector in urban development. The use of local construction materials has also been initiated. 88. Water Management, Water quality provided by the public utility company is satisfactory. Water is supplied exclusively by underground squifer, and therefore is very slow to replenish. However, the pricing system for water, and extremely scarce resource in Djibouti, is inappropriate because it encourages the use of large quantities and offers no incentive to conserve. The pricing structure is also regressive. Wealthier individuals, who tend to have greater access to and use more water, pay relatively less for it. In order to conserve water, pricing should be revised to discourage waste by individuals by charging a steeply progressive water tariff to households. However, in order to maintain competitive pricing for water supplied to ships and industrial establishments, special tariffs should be applied for such use. A study on water tariffs financed under the first urban project recommended the use of a new tariff structure that takes into consideration progressive pricing of water. These recommendations have been rejected, so far, by the government. The matter will be pursued under the second urban development project (financed by IDA), which has made the increase of water tariffs and the change in tariff structure a condition of credit effectiveness. 89. Future development of Djibouti City will be implemented within the framework of recommencations made in a recent (1989) study, financed by UNDP, on the long-term development of the city. The study recommended appropriate water supply in the needed areas, standards of housing and other urban facilities to be set according to affordability criteria, in addition to the development of new residential areas to the west of the city and improvement of conditions in Balbala. F. Environment 90. The environmental issues facing the city-state of Djibouti are predominantly urban. Although no institution is directly responsible for environmental protection, the Prime Minister's Office, the Ministry of Public Works, and the Ministry of Agriculture are three institutions involved with the environmental issue in terms of territory, town planning and rural development. To protect marine fauna, an official permit for sea fishing is required. To stop desertification, the government has undertaken a project to protect what remains of the "Day Forest" with assistance from UNDP, IFAD and other donors. Moreover, experiments are under way to develop desert agriculture, which should help Djibouti diversify its economy as well as protect the environment. 910 One area of concern is the possible environmental impact of the geothermal development project. So far, the ecological effect of the project appears to be minimal since the geothermal field is in a barren and  29 - uninhabited desert. Nevectheless, the project provides for a close monitoring of effects from reinjection of geothermal fluids back into the underground reservoir in order to minimize possible seismic activity. The main indirect effect of the project is likely to be socioeconomic: the availability of services such as dirt roads, electricity, and fresh water supply, built for permanent staff at the geothermal site, may attract additional population. The iSacrease in population would in the medium-term create a demand for schools, medical service, commercial stores, and commercial transportation. To assess this potential population and settlement issue, a study will be undertaken as part of the geothermal project. G. Women in Development 92. Women have an active role in the djibo"ti economy and form an important part of the labor force. While very few women are at the managerial level in the public sector, many of them work at technical and clerical levels and as school teachers and nurses. In the private sector, women are very active in commerce and trade. Most of the charchariss or unlicensed merchants, are women; for examples, they travel to Saudi Arabia and import merchandise such as electronic equipment and textiles for sale in Djibouti and for re-export to Somalia and Ethiopia. Many women also work as distributors, retailers, and in service establishments such as restaurants. As in other pastoral cultures, Djibouti women play and important role in herding. 93. -The National-Union of Djiboutian Women has started to play a key role in promoting women in the development process and has also received strong support from the government. This organization, along with the Mother and Child Center, established a training center providing primary education and crafts instruction for women. 94. One area of concern is women's health. As in many other regions of Africa, most girls in Djibouti are subject to the radical form of circumcision, which in most instances has serious adverse health effects throughout their life. In turn, these health problems have a substantial negative impact on women's economic productivity and therefore also pose a significant constraint on the country9s development as a modern economy. It would be extremely difficult for the government to ban this practice outright, as it is ancient and embedded in complex attitudes and traditional values. However, it is very important for the government to support the efforts made by some Djiboutians to inform individuals and society about the health and economic effects of female circumcision. (Also, as in many other countries, a replacement of radical with symbolic circumcision could obviate many of the problems while preserving traditional values.) The National Union of Djiboutian Woman could play an important role in this effort, since circumcisions are practiced by women. Direct dissemination of factual health information by the government and indirect support through the educational system could succeed over time in rending this economically harmful practice obsolete.  - 30 - 95. In addition, appropriate incentives should be designed to encourage the enrollment of young girls in the educational system in order to help their absorption into the labor market and, therefore, provide them with financial Independence. Efforts should focus in particular on the rural areas where the enrollment ratio for girls is low (33 percent as compared to 42 percent of total primary enrollment).  - 31 - CHAPTER 4 DEVELOPMENT POSSIBILITIES AND FUTURE OUTLOOK 96. Analysis of Djlbouti's economic performance and sectoral developments in recent years shows a decline in economic activity, and increase in unemployment, and a difficult financial situation. Sizable investments to modernize the port, telecommunications and other infrastructure have failed to provide enough impetus to sustain economic growth and to create significant employment. Income distribution is skewed, with very high earnings for employed persons and businessmen. If no action is taken to promote broader-based de%elopment and increase the country's competitiveness in terms of labor productivity and production cost, the result might be the continued existence of a tiny enclave of prosperous people amid the unemployed and impoverished masses. 97. The Government has become more aware of the need to lay down in the immediate future the economic bases that can help meet the long-term challenge posed by the small size and the basic poverty of Djibouti. Nevertheless, the prospects of the Djibouti economy depend to a large extent on the country9s ability to: (i) effectively manage its public resources; (ii) strengthen and diversify sources of potential growth; and (iii) attract private foreign investment. These constitute the focus of this chapter, which examines the economic management of the country, discusses the policies necessary to improve Djibouti's competitiveness, and assesses economic prospects over the medium-term. A. Economic Management 1 Public Administration 98. After one decade of independence, Djibouti is still building and reorganizing its administrative units. The severe shortage of qualified personnel to carry out tasks formerly performed by the French administration is making this process slow and difficult. The widespread use of technical assistance in Djibouti partly reflects the weakness of domestic institutions. In fact, technical assistance is being used as a substitute for local manpower. The absence of domestic counterparts reduces the benefits that should be derived from technical assistance; for instance, instead of providing advice and on-the-job training to nationals, foreign advisers often perform line duties that normally should be discharged by local counterparts. Although the government wishes to step up the training of nationals, there are severe problems in identifying suitable candidates for many positions. Until more Djiboutians acquire professional experience, technical assistance will remain necessary. But so long as technical assistance is provided in inappropriate ways, Djiboutians will not acquire professional experience.  - 32 - 99. The problem with the Djibouti administration is not, as in many developing countries, its capability to attract nationals -- because the salary level is high -- but primarily the severe shortage of qualified personnel, a weak organizational structure, and a lack of interagency coordination. Future technical assistance should help the government improve its economic management and design a coherent overall development strategy for long-term economic growth and employment generation. In addition, a special effort should be made to define a long-term training program adapted to local needs and constraints, and future scholarships in higher education should be geared toward needed areas, such as, economics, finance, accounting, statistics and engineering. 2. Fiscal Administration 100. Progress in fiscal management depends largely on the (i) quality of tax administration; (ii) budget preparation and implementation; and (iii) government accounting. Improvements of the system have been made in recent years, including the introduction of a new government accounting system, the creation of a debt management unit, the planned introduction of computers, and the implementation of a more realistic budget preparation mechanism. In fact, the budget presentation is clear, and government accounts are kept on a regular and consistent basis. A cash management system is maintained to anticipate and avoid short-term cash problems. 101. The budget and accounting system shoulds however, evolve further and be more adapted to the global fiscal management that is needed. The preparation of a complete and transparent budget should be given high priority. The budget should include all expenditures, current and capital, regardless of their financing or present-institutional classification. In particular, all capital expenditures financed by grants and loans should be included in the budget with a proper distinction between commitment appropriations and disbursement appropriations. The operations of the special accounts should either be integrated into the budget or kept separately in the budget document, with the same quality and detail as the main budget. 102. The present 15-month fiscal year poses two main difficultiess (i) inability to assess correctly the fiscal situation at a given time since two budgets are running simultaneously and the last final accounts do not reflect what actually happens dur'ng the last 12-month year; and (ii) inability to make short-term forecasts ai budget figures are not meant to represent a strict 12 months' implementation. As a result, Djibouti should adopt the 12 month fiscal year system. This involves taking concrete and practical steps to have commitments terminated and goods and services delivered before the end of December. A supplementary accounting period not exceeding one month can be kept in order to deal with the lag between service delivery and actual payment. Also, the budget should include an evaluation of the amount of capital appropriations budget in the preceding year likely to be carried over. 103. The above measures are intended to help the integration of the budget and the special accounts more closely in the consolidated presentation of public finance operations. In addition, efforts should be made to  - 33 - transfer the unallocated common expenditures to the budgets of the slending ministries in order to get a better appreciation of the functional allocation of expenditure. Finally, it would be advisable to develop and maintain a public finance statistics system based on international methodologies. A tax statistical system is needed to facilitate the assessment of tax collection by groups of taxpayers, by sectors of activity, or by products. Improvement in this field, with the help of microcomputers, will be extremely useful for fotecasting and revenue control. Recently, the government has strengthened the tax administration to improve tax collection by creating a task force to control taxes and providing a full training program for the staff in the tax department and Treasury. 3. Data Collection and Quality 104. Statistical development in Djibouti is still at an early stage. The lack of interest in the use of statistics is one of the main reasons for this deficiency. Priority should be given to improving data collection and to making good use of available studies and surveys. External trade data need to be collected on a regular basis. This should be completed by data re-exports and purchases by tbh French military personnel. Data collection on transactions by residents awA non-residents should be instituted without delay. The preparation of national accounts and balance of payments should be given utmost importance since they provide leading economic indicators, which are crucial foz management decisions. The issue of population figures should be discussed openly (see para. 11) so that appropriate estimates can be made based on the results of the 1991 population census. Detailed recommendations on data collection are given in Annex I. In brief, a Committee for the Coordination of Statistical and Economic Information should be established. It should be responsible for (i) instituting legislation requiring 3tatistical information from ministries and governmental units, and (ii) determining requirements related to economic and social statistics. A standardized accounting system should also be devised, The statistical office (DINAS) should become the organization in charge of data compilation and coordination of the ministries in gathering statistics. To that end, DINAS must be strengthened and given adequate resources to perform its functions effectively. 4. Public Investment Proiramming and Aid Coordination 105. The Planning Department -- now in the Prime Minister's Office, which is also the Ministry of Planning and Regional Development -- lacks the country data base and information on investment projects needed to make a meaningful assessment of the economy. Institute nial memory, and indispensable element in any effort at economic coordii. -ion$ is seriously lacking. These shortcomings need to be redressed if national planning and the programming of public investments are to be improved. The UNDP has been providing technical assistance to strengthen the planning capacity of this department; but, at present, the department is far from being in a position to fill the gap. 106. One encouraging sign has been the recent creation of an Interministerial Planning Commission (IPC) to coordinate external aid and examine investment projects. Included among its members are the Prime  - 34 - Minister (as chairman), the Minister of Foreign Affairs and the Minister of Finance and Economy. Since the Foreign Minister also holds the cooperation portfolio, the IPC may succeed in coordinating external aid better and ensuring thai. its distribution among the various economic sectors is consistent with national development priorities. 107. The IPC could prove more effective if its approach and working methods were modified. To stimulate the spirit of programming, the IPC should: (i) have a regular timetable for meetings; (ii) request from technical ministries and public enterprises progress reports on major on- going projects and clear descriptions of new projects; and ;iii) formulate a three-year rolling public investment progruim that can be reviewed and adjusted annually. lo enable the IPC to play this role fully, an executive secretariat composed of senior officials could be created.. This secretariat, supported preferably by short-term rather than long-term consultants, should assist the IPC in selecting projects based on sound economic and financial criteria. 108. The government's approach -- not to increase the country9s present level of indebtedness but to rely where possible on grants rather than loans -- is correct. The concern about recurrent cost implications associated with public investments and the insistence that capital spending be financed from grants reflects some emerging realism among the country's economic and political authorities. The IPC should ensure that these parameters are observed strictly. B. Devel2opmant Possibilities 109. Given the lack of dynamism and the fragility of the Djibouti economy, the supply side of the economy will continue to be weak for some time. The Djibouti authorities have started to promote national thinking on long-term development possibilities in order to broaden the country's development base and to sustain long-term economic growth. The country's assets are its strategic location, modern infrastructure, good banking system, open economy, and freely convertible currency. Djibouti faces formidable constraints, both physical and structural, which are not susceptible to rapid solution. The constraints to economic development include the scarcity of na-tural resources, harsh climate and small domestic market, as well as the shortage of skilled manpower resources, limited institutional capacity and very high cost-price structure. A careful reflection on Djibouti's long-term economic development will be needed to examine all facets of development possibilities to ensure that Djibouti's assets are exploited in such a way that broader segments of the popdlation will benefit. In the meantime, this report attempts to outline some development possibilities, taking into account the country's assets and constraints. 110. Revitalize Service Activities. Given its modern infrastructure, the Djibouti port has a comparative advantage over some ports in the region. A more aggressive approach would be needed to sell services regionwide. In the 1970s, Djibouti acted 8s a transit place for Rwanda, Burundi and Uganda  - 35 - to export their coffee whesi the ports of Dar-es-Salaam and Mombasa were not operative. To revitalize these kinds of activities, a survey of potent .al users would be useful. Rates and charges of both the port and airport would need to be reviewed in order to make them competitive, and the ctficieu2ry of the loading and unloading services closely examined. Another type of activity at the port, such as ship repair, could be envisaged if the investment is not too costly and training of technicians not too difficult. With the railroad link between Djibouti and Addis Ababa being rehabilitated, special rates could be negotiated to encourage its more intensive use by Ethiopia. The recent internal political changes in that country are likely to increase possibilities for mutually-beneficial cooperation with Djibouti. lll. Promote Offshore Business, D4ibouti seems to have most of the assets to foster the development of an offshore corporate zone. Competition in the region is low, with the exception of some Gulf states. A diagnosis for this type of activity has beei made in the past, and legislation for free-zone corporations has been enacted. Although some free- zone corporations have been in operation, it is difficult to evaluate how successful this legislation has been because (i) the yearly fees are not fully budgeted and recorded in the budget; and (ii) no apparent multiplier effect on the economy has taken place yet. In order to take full advantage of the offshore business mechanism and to develop it further, the government will need to undertake a high publicity promotional campaign to attract investors. A careful examination is needed to ensure its viability in Djibouti. 112. In countries where similar legislation has produced successful effects (some small Caribbean islands and Gulf countries), offshore activities are conducted free of local taxes. In return, enterprises pay a yearly fee to the government and to law firms or banks. Services provided by local law firms or banks include the establishment of the offshore corporations, their representation, and the preparation of the administrative requirements and the yearly financial statements. The benefits that offshore business would provide to the country consist of (,) a steady, although modest, revenue for the budget; (ii) tho creation and operation of a local offshore service sector, for instance law firms and private banks, which are subject to normal local taxation; (iii) the creation of some local employment; (iv) an opportunity for foreign investors to get to know the country; and (v) the stimulation of accompanying activities for the banking system, which could offer the offshore corPorations good financial management. 113. Diversify Productive Activities. As an extension of Djibouti9s traditional role as a service center, consideration could be given to creating employment-generating activities in industry and agriculture. In agriculture, there is some potential to develop desert cash crops such as jojoba and date palm. A study to examine the feasibility of larger planting of these cash crops should be encouraged. In industry, efforts are being made to promote small- and medium-scale industries with assistance from UNIDu, Potential is, however, limited by the small size of the domestic market.  36 - 114. For this reason, the government is actively considering establishing an export processing zone, based on the Mauritian model, in the existing free trade zone near the port. Careful consideration should be devoted to whether it is feasible to create this type of export processing facility in Djibouti, given the high production costs and the lack of skilled labor. Moreover, most new industrial ventures will be more successful if they are set up in association with foreign partners because the latter can provide, in addition to their capital and know-how, marketing channels and foreign market outlets. The question is whether Djibouti will be able to attract them. 115. Promote Private Investment. The government has attached a high priority to encouraging private investment, both foreign and domestic, in Djibouti. It recognizes that such investment is critical in providing employment and for generating additional government revenue to sustain economic growth. A few measures are under consideration to relieve some constraints and provide a more attractive environment for foreign investors. 116. As a first step, the investment code was revised in 1984 to provide tax incentives and freedom for foreign investors to purchase real estate in Djibouti. However, this has not yet given any positive result. Lately, the government has begun to study a policy package to make Djibouti more competitive in terms of operating costs for business. This includes special legislation for an export processing zone that allows complete freedom for employers to recruit and/or lay off their employees and to negotiate salaries. In the meantime, electricity and water tariffs are being reviewed to favor industrial and commercial users, and a committee is examining ways to streamline administrative processes for entrepretiurs who wish to establish operations in the country. In addition, the government is considering another revis...on of the Investment Code with a view to making it more attractive to foreign investors. 117. If the government succ eds in making Djibouti more competitive, it will have a good chance to promote foreign investment in export-processing industries. Whereas the domestic market is small and would not be attractive to foreign investors, Djibouti possesses good potential in its access to various international markets. Being a member of the Associated States of Africa, the Caribbean and the Pacific (ACP), goods exported from Djibouti to the EC benefit from trade preferences accorded to ACP States, As a member of the Arab League, Djibouti has preferential access to the Arab markets. Djibouti's potential as a beneficiary of the United States Overseas Private Investment Corporation is also promising. Concerning import regulations, Djibouti has adopted a very liberal policy: there are no import licensing requirements or import price controls affecting foreign-owned firms.  - 37 - C. Problems and Issues 118. Shortage of Skilled Manpower. Insufficient administrative and technical staff contributes to low productivity in almost every fleld. To help redress the situation, the goverrment has stepped up efforts in education and manpower training. It will take some time for Djibouti to overcome this problem. 119e While skilled manpower is lacking, substantial unskilled labor can be found around Djibouti City (mostly young, uneducated people and unskilled immigrants). The people in this category are willing to work and are more settled, more urbanized, and more familiar with economic institutions than their nomadic brethren. They would need only short on-the-job training to perform simple repetitive tasks in textile and knitwear industries. Unfortunately, opportunities in such industries are lacking due to the extremely high cost-price structure in Djibouti. 120. High Cost-Price Structure. Ti.e. high cost-price structure makes Djibouti uncompetitive. Wages are excessively high for employed persons in spite of the low qualifications of the labor force. In addition to wages, employers are required to provide significant social and fringe benefits for registered wage earners, and labor regulations are strict. If the country were to adopt a more outward-looking development strategy to generate Job opportunities, the dollar-equivalent wages and benefits of Djibouti"s workers would have to be made competitive with those of other developing countries, and labor regulations would need to be revised. 121. Exchange Rate. One of the most sensitive topics in Djibouti's development dialogue is the long-standing link between the Djibouti franc and the U.S. dollar. The Djibouti franc is overvalued, and the effect is apparent in the high cost of labor and services and high consumer prices, which frustrate development of exports. Adjustment of the parity, whether a substantial one-time devaluation or in stages, would be one way to improve Djibouti's development prospects. With an associated substantial compression In nominal wages, the exchange rate adjustments could reduce wages in dollar- equivalent terms. The magnitude of adjustment required cannot be estimated without considerable study. 122. The Djiboutian authorities find it difficult to think about such an adjustment after many years of fixed parity. They are concerned that a devaluation would provoke capital flight and endanger Djibouti's role as a regional financial and commercial center. The authorities claim that current exchange rate levels are necessary to provide security to foreign capital and to keep inflation low. This might be true in the short term, but the long- term effect of adjustment should help place Djibouti on a more sustainable basis for dealing with the development needs of the country. Therefore, an exchange rate adjustment should be strongly considered as an adjunct to government measures to significantly reduce wage levels and other non- priority current expenditure.  - 38 - 123. On the revenue side, thv scope for increasing resources is limited. Since the overall tax pressure in Djibouti is already high (27 percent of GDP as compared to an average of 20 percent for developing countries), raising tax rates to increase revenue could have an adverse effect on economic activities (in addition to increased incentives for fraud). Efforts should, therefore, be continued to improve tax collection through strengthening tax administration, an area in which the government has already started to take concrete actions (see para. 53). A number of measures could be considered to simplify tax collection and thus improve revenue: (i) create a unified income tax system where salaries and individual business profits would be treated on the same basis, subject to the same income tax rates (the marginal uniform rate should be maintained at 15%); (ii) transform certain specific import surtaxes into ad-valorem surtaxes, which would give them some buoyancy with respect to the value of nominal imports; (iii) adjust the domestic price of petroleum products in accordance with import prices; and (iv) continue to budgetize yearly fees resulting from offshore corporation activities. 124. On the expenditure side, the initial austerity measures undertaken to reduce current expenditure need strengthening. The envisaged policy of replacing housing rental costs for school teachers by fixed, and lower, allowances is a step in the right direction and the recent adoption of a new pay scale should help to freeze wages and salaries. However, stronger measures are needed to reduce further the artificially high wages in the ad-.inistration, including the adoption of a much lower pay for new recruits. Wihile civil servants" fringe benefits are being examined with a view to reducing their burden on the budget, the size of the civil service and military personnel will need to be reviewed. Another area of concern is the allocation of resources because, at present, a large share of expenditure is devoted to general services, interior, and defense. As a first step, the government will need to define its expenditure priorities so that adequate public resources are made available to vital sectors such as education, health, transportation and utilities. 125. Although some public enterprises are financially sound, some constitute a burden on the budget. The government has recently privatized the management of the Sheraton Hotel and has taken active steps to privatize the bottling and dairy products plants. The involvement of government in the remaining productive activities such as printing, runnin6 slaughterhouses, a pharmacy, and producing animal feed, will need review. Budgetary involvement in those activities, although small, does not necessarily correspond to the best use of public resources. Privatization of those facilities should be implemented promptly in order to reduce the bud-et and provide better service to the public. To this end, the government should refrain from investing in industrial and commercial enterprises and leave them to private initiatives, 126. Economic and Social Impact of Khat. A striking feature of Djibouti society is the widespread chewing of khat. Imported daily from Ethiopia, this narcotic costs about US$18 million a year (10 percent of imports). More than 80 percent of the adult male population accounts for the consumption of an average of 10 tons daily. The khat business is buoyant and provides jobs to at least 150 wholesalers and 2500 retailers. To the budget, khat imports contribute about US$13 million a year, or 14 percent of total fiscal revenue.  - 39 - 127. Khat is known to give a euphoric sensation but to cut appetite and sleep. Khat chewing is normally done in a group for several hours in the afternoon and evening and is accompanied by soft drinks. A substantial share (22 percent) of limited family incomes is devoted to the purchase of khat, and khat chewing is clearly detrimental to labor productivity. Little has been done to inform and educate the public about the side effects of sustained khat consumption. 128. The practice has existed for a long time in the region, and vested interests exist with respect to the importation and marketing of the product. The government has indicated that the only viable approach to this problem is to eradicate the plants in the source countries, which would require regional cooperation. It appears, however, that some countries have been quite successful in combatting khat by banning its consumption. It is hoped that Djibouti would do the same in order to upgrade its labor force and prevent future generations from becoming addicted. In addition, the financial resources that go to khat consumption could be diverted to more productive use. The concern of the report is neither moral nor legal, but economic. The elimination or a significant reduction in khat consumption would be necessary for the country's human resources to begin to be fully mobilized and used efficiently. D. Medium-Term Outlook 1. Public Investment 129. In light -of the intentions and ideas for projects obtained from both the spending ministries and the donors, a list of investment projects was compiled by the mission as an indicative public investment program (PIP) for 1989-91. When these projects are put together, the capital outlay required for the three-year period amounts to US$248 million, as compared to US$173 million for 1986-88. However, the implementation capacity of Djibouti's public sector would be severely constrained by an investment spending of this size. Also, the resources needed to carry out this investment fully are unlikely to be available. Because of this, a 'core list" has been proposed for implementation at a more moderate cost and in line with capital flows projected in the balance of payments. This core list could provide a point of departure for the rolling three-year investment program that will need to be formulated within the framework of the new economic and social development plan for 1990-2000 (Loi sur 190rientation Economigue et sociale de la Republique de Djibouti, 1990-2000). 130. The core list was prepared by reducing or phasing down various projects so as to reduce total capital spending over the three-year period to US$180 million, a reduction of US$68 million from the original estimate. On a yearly basis, capital spending will increase from US$56 million in 1989 to US$66 million in 1990, then fall to US$58 million in 1991. The decline in capital spending projected for 1991 reflects the lack of a viable project pipeline rather than any anticipated drop in the volume of resources available for investment. Although most of the projects have obtained some financing, some are still in need of financing. A breakdow-n of the PIP core  - 40 - list by sector is given in Table 4.6. The largest share, approximately 48 percent, is allocated to infrastructure and energy. Social sectors and urban development would absorb 28 percent, thus leavlng nearly 20 percent for directly productive activities. Although at the time of issue of this report the planning period under consideration was almost over, the sectoral composition, project selection, financing sources, and institutional issues remain current and relevant to public investment in the coming years as well. Table 4.1: PIP - PROPOSED CORE LIST, 1989-91 (USI i IllI on) Tota1 1989-91 Sector 1989 1990 1991 Mouni I of Utol Directly productive 10.9 12.7 12.9 86.6 20.8 Infrastructure, energy 27.0 83.2 27.4 87.6 48.7 Social infrastructure 16.9 18.9 16.1 60.6 26.2 of which Education Al Heaith (4.4) (7.4) (9.8) (21.6) (12.0) General services 2.8 1.6 1.2 6.0 2.8 Total 56.1 68.0 67.6 179.7 100.0 131. Annex II of this report provides a detailed list of investment projects. Major projects retained in the core list are highlighted belows Productive Sectors. Noteworthy new projects include the integrated rural development of-the Day Forestlands; if the pilot venture gives good results, a full-scale project would be undertaken, with possible financing from IFAD. Given good potential in fisheries, the construction of a fishing port should be given priority since the catch is being unloaded under difficult conditions. In industry, a project to set up a small industrial estate is included. Infrastructure and Ener2y. The road subsector includes only small projects for road maintenance. For the port, an ongoing project to rehabilitate the port and a new project to expand the container terminal, with financing from the Saudi and Kuwait Funds, are retained with some phasing. For the airport, the ongoing project to improve the runway and air navigation equipment seems to be justified. A regional project to rehabilitate the railway has been adopted. A project to modernize the in-country telecommunications system is retained but could be postponed if necessary. In energy, the main project is geothermal development. A project to set up a vocational training center in the electricity company (EdD) is included in the core program, although scaled down since it appears somewhat over-ambitious in view of the actual need of EdD. A scheme to ensure adequate water supply in the urban areas is also included.  - 41 - Social infrastructure. In education, two new projects are included: a second education project financed by IDA and a vocational high school financed by AfDB. Most of the health projects are modest (campaign against tuberculosis, training for health personnel, rural dispensaries), with the exception of two projects concerning maintenance and renovation of existing hospitals. In the urban sector, most of the projects are sites- and-services. In other sectors, there are two major projects: the new Islamic Center and the national Ptadium. The latter is financed by a soft loan from China. 2. Medium-Term Scenario 132. The medium-term scenario, covering the period 1991-95, was developed with the help of the Bank's Revised Minimum Standard Model (RMSM). RMSM is a trade gap model which provides an accounting framework for the national accounts, balance of payments, and external debt. A module or public finance has been added to illustrate the financial situation of the consolidated accounts of the public sector. The model uses current commodity prices and international inflation rates projected by the Bank, pipeline and projected aid flows, and other current and capital account items to calculate the amount of financing requirements needed to sustain the projected level of imports, and, implicitly, the public investment projects outlined above and the projected rate of economic growth. Detailed projections of the main aggregates, consolidated accounts of the public sector, and balance of payments are given in Section IX of the Statistical Appendix. The main assumptions and results are summarized below. (Clearly, the political upheavals in neighboring Somalia and Ethiopia, particularly in December 1990- May 1991, will have a major impact on Djibouti's economy. However, it is impossible to predict even the direction, let alone the magnitude, of such an impact.) 133. In the medium term, the most likely scenario is a umuddling- through' situation with modest improvement in economic grcwth owing to limited reform measures. With a projected natural population growth rate of 3 percent a year, total per capita consumption continues to decline under this scenario, but private per capita consumption begins to increase at the end of the projected period. The scenario assumes basically that the current characteristics of the economy will conAlnue to prevail and that the French military presence will continue at its present level. Also, because in- and out-migration are determined largely by political developments in neighboring countries which are difficult to predict, net migration is assumed to be zero in the years to come. Should immigration continue, the scenario would be affected, as regards both the growth rates and balance of payments, and the composition of public expenditure. During the next few years, Djibouti would need to go through a period of austerity requiring cuts in government spending, both current and capital, and policy reform to stop the declining trend in economic activities, to generate job opportunities for the population, and to increase Djibouti competitiveness in the international market. The feasibility of a higher growth which would lead to an increase in per capita consumption by 1995 would depend on a more rapid implementation of substantive reform measureso However, the downside risk and  - 42 - implementation at a slower pace of reform would lead to continued significant decline in per capita consumption with serious social consequences. 134. AggureRate Output. The "muddling-through" scenario projects a modest recovery in the 1990s with GDP real growth at an annual average of 2 percent during 1991-95, accelerating from nearly 1 percent in 1991 to 2.7 percent by 1995. Measures to promote local production will take some time to materialize, given the weak base of Djibouti and limited institutional capacity to implement changes. The investment rate is projected to be around 16 percent. Output in the primary sector is projected to grow moderately since the sector is small and Djibouti is vulnerable to drought and other natural calamities. Output in the secondary sector is projected to grow by an annual average of 3.5 percent stemming from the geothermal energy development and the recovery in construction and public works. The tertiary sector, which accounts for 70 percent of GDP, is projected to grow on average by less than 2 percent per annum. In this sector, t'ne scenario projects zero growth in the value-added of the public administration, under the assumption that the government will pursue further budgetary discipline through wage restraints, 2.5 percent annual increase in commerce, transport and telecommunications, and a modest increase in other service activities. Once again, these trends are highly sensitive to developments elsewhere in the region since the Djibouti economy is extremely dependent on external demand. 135. The Public Sector. In public finance, the scenario assumes further budgetary discipline and austerity on the part of the government and willingness on the part of donors to maintain financial assistance at the current level. The main assumptions underlying the fiscal scenario are: (i) taxes will continue to be collected at the same effective rates; (ii) current expenditure will remain constant in real terms, Pxcept for the addition of a yearly increment in goods and services to take inL_ account recurrent costs of new capital expenditure; and (iii) public capital ftpenditures will decline from the high 1990 level to 12 percent of GDP. As for public enterprises, the scenario assumes that they will continue to generate cash surpluses, before capital expenditure, equivalent to 4 percent of GDP. With the same effective tax rate, total revenues of the consolidated public sector are likely to decline, from 40 percent of GDP in 1990 to 38 percent by 1995. This would require a reduction in total expenditures from 58 percent of GDP in 1990 to 53 percent by 1995 if the overall public sector deficit, including grants, is to be maintained at about 4 percent of GDP. 136. The Balance of Payments. The balance of payments prospects are not encouraging. While exports of goods (mostly re-exports) are projected to remain almost stagnant in real terms due to constant demand from the French military entity, exports of services are assumed to increase by 2 to 3 percent per annum. Imports of food are projected to increase by 3 percent a year, in line with the projected natural growth rate of the population. Imports of khat are projected to remain constant in volume with the assumption that the government will make an effort to contain the consumption of this narcotic product in order to upgrade its labor force. Other consumer goods are projected to grow in line with their re-export capacity. With the geothermal development project expected to be completed in 1993/94, imports of petroleum products are projected to be reduced by 10 percent in real terms  - 43 - in 1993. Imports of capital goods are assumed to grow in line with the investment level. 137. With limited exports and rising imports and interest payments, the current account deficit (including public transfers) is projected to remain high at over 4 percent of GDP during 1991-95. To enable Djibouti to meet its debt service obligations and to maintain foreign exchange reserves at 3.5 months equivalent of imports, foreign capital requirements for 1991-1995 would average US$60 million a year, as shown in Table 4.2. Tablo 4.2: BALANCE OF PAYMENTS, 1988-96 (in millione, current USS) 1988 1989 1990 1991 1992 1993 1994 1996 A. Exports of Goods A NFS 1/ 189.8 188.4 211.2 220.3 230.7 241.7 263.8 266.6 B. Imports of Goods A NFS 269.2 281.3 30?.6 317.6 334.7 362.7 372.0 391.6 C. Resource Balance -79.4 -93.0 -98.4 -97.3 -103.9 -111.0 -118.6 -126.0 D. Net Fector Income 9.4 9.9 10.7 11.4 12.1 12.7 18.8 14.0 E. Not Current Trantfore 46.8 47.7 47.8 49.' 63.0 66.4 60.9 66.7 F. Current Account Balance -24.1 -36.3 -38.0 -36.3 -38.9 -41.8 -44.4 -46.3 Amortization -9.6 -11.2 -12.6 -12.8 -14.1 -14.8 -14.8 -16.2 Reserve Requirwemnt -8.1 -2.1 -8.6 -7.2 -4.4 -4.7 -5.0 -6.0 Financing requirements -41.7 -48.6 -59.0 -66.9 -57.8 -60.9 -64.2 -67.6 G. Financing 41.7 48.6 69.0 66.9 67.8 60.9 64.2 67.6 Capitol grants 11.8 12.8 13.2 16.6 16.9 18.8 19.2 20.1 Othor 6.8 0.4 0.0 0.0 0.0 0.0 0.0 0.0 Disbursement feom pipeline 24.1 82.5 83.9 28.1 14.6 8.6 4.0 2.8 Disb. from new commitment 0.0 2.9 11.9 17.8 26.8 34.1 41.0 44.7 1/ Mostly re-exports. 138. To meet the above foreign capital requirements, annual average commitments of US$64 million are called for. Given Djibouti9s limited resources and capacity to service debt, commitments of at least US$24 million a year would be needed in the form of capital grants. This would leave an average of US$40 million to be contracted on very concessionary terms because Djibouti cannot afford loans on commercial terms. Even under concessionary terms, debt service obligations are projected to increase from US$16 million in 1990 to US$22 million by 1995. This represents a heavy burden for Djibouti since nearly 80 percent of export earnings are simply re-exports of imported goods. Thus, a large share of the export earnings has to be earmarked for imports and cannot be viewed as available for other purposes. In relation to government revenue, debt service obligations are projected to remain between 11 and 12 percent during 1991-95.  - 44 - E. The Development Challenge: A Long-Ternt View 139. To meet the development challenge posed by the country's own heritage and external competition, efforts over the next few years would need to be focused on three main areass (i) strengthen economic management; (ii) define development possibilities of Djibouti; and (iii) improve the social sustainability of development. One of Djibouti's limited resources is its human resources. In the long run, the most effective way to increase the welfare and productivity of the populatioA is through education. The Government of Djibouti has recognized this and has given priority to strengthening the education system, improving the living conditions of the urban poor and providing water wells to the nomadic population. This special attention will need to continue in the future. 140. The recommendations in this report must be viewed in the context of the goal of fostering Djibouti's development while progressively building its economic independence. Although it is difficult to predict what Djibouti will become in the long run, it is clear that a change in economic policy is urgently needed to improve the economic situation and to generate job opportunities for the population. This would require concerted efforts by the DJiboutian authorities and the donor community. Top priority would be to reduce distortions in wages and prices. An internal adjustment in the level and composition of public expenditures and wage level compression might have to be followed by a devaluation of the currency in order to make Djibouti's economy more competitive. However, the Djiboutian authorities have expressed reservations about currency devaluation as they are concerned that this would endanger Djibouti's role as a regional financial and commercial center (see para. 122.) 141. Djibouti is likely to "muddle-through" the situation with modest improvement in economic growth given the weak base of the economy and limited institutional capacity to implement changes. However, higher growth in the longer term leading to positive per capita consumption could be feasible if the government made a determined effort to implement rapidly more comprehensive reform measures. This would requires (i) a substantial reduction of the real wage level to improve Djibouti's competitiveness; (ii) an aggressive approach to attract foreign investors in labor-intensive export processing manufacturing; (iii) a complete revision of labor legislation, the investment code, and administrative procedures; (iv) upgrading the labor force through appropriate training and significant reduction in khat consiunption; and (v) strengthening marKeting and management to increase exports of services. 142. To enaole a successful formulation of the reform measures needed to restore Djibouti's competitiveness, further examination of the wage structure and the labor market as well as of the impact of a currency devaluation is critically needed. Support from interested donors would be necessary. Thus, there is a need for coordinated analytical reflection on a long-term development strategy for this small city-state.  - 45 - ANNEX I NATIONAL ACCOUN ESTIMATES METHODOLOGICAL NOE  46 - ANNEX I NATIONAL ACCOUNTS ESTIMATES - METHODOLOGICAL NOTE A. Introduction 1. This annex presents the results of the World Bank/UNECA economic mission (November 1988) on the national accounts of the Republic of Djibouti and outlines recommendations on strengthening data collection. The government's last detailed national accounts estimates were for 1983, and an extrapolation was made for 1984; no subsequent estimates have been prepared. The Bank/UNECA mission followed the methodology of the United Nations System of National Accounts (UNSNA) in estimating the GDP series for 1984-87. Part I of this Annex provides the accounts of the main economic agents in 1986 and Part II describes methods used to compute the estimates of GDP by industrial origin and by use. Tables on GDP estimates both in current and constant prices for the period 1984-87 are given in the Statistical Appendix of the main report. 2. In the absence of systematic national accounts estimates and balance of payments data, the mission relies heavily on primary data collected during the mission. Given the generally poor quality of data in Djibouti, the level of GDP estimates could be subject to a margin of error. The national accounts estimates in this annex are prepared on the basis of: (i) information officially provided by the government during the mission: public finances, accounts of public enterprises and autonomous agencies, consolidated financial statements of the commercial banks, monetary statistics, statistical bulletin of DINAS; (ii) general and sectoral studies available within the World Bank and the UNECA: the unpublished 1986 Household Survey, the unpublished 1983 population census, ILO surveys of the informal sector, the National Energy Plan published by ISERST, and IMF reports; and (iii) information gathered during field discussions with major bilateral and multilateral donors. B. Comparative Analysis 3. GDP and GNP estimates. As shown in the table below, GDP estimates by the mission for 1984 are very close to those of the Government. However, there are two major differences between the GNP estimates: ti) Net factor income from abroad. Following the U.N. definition, the mission obtains a net factor income of DF 2.2 billion. This is explained by large interest receipts on deposits abroad and labor income of the Djiboutians working with the French military personnel (who constitute an extra-territorial entity). However, government estimates of net factor income amount to DF -6.6 billion; the government claims to include also in this item the portion of the income transferred by technical assistants and expatriate businessmen.  - 47 - (ii) Other adjustments. There is a large expatriate community in Djibouti whose status (residents or non-residents) is very difficult to determine due to lack of information. Therefore, the mis3ion proposes to deduct from GDP the estimated portion of transferred income by technical assistants (about 55 percent of the TA cost in the budget), thus giving a GNP of DF 57.7 billion. This estimate could be refined further on the basis of data on transfers by residents and non-residents, which the government intends to estimate with technical assistance from the IMF. The government, on the other hand, makes a highly questionable adjustment to bring down the GNP by over 60 percent from DF 53.6 billion to DF 19.9 billion -- nearly one-third of our estimates. This adjustment includes: (i) substracting all of the expatriate incomes by assuming that all expatriates are non-residents; the mission doubts the validity of this assumption; (ii) deflating GNP by an arbitrary cost-of-living (price) factor by arguing that the price levels in Djibouti are very high compared with the neighboring countries; the mission cannot accept such a correction factor although the argument on high price level is correct; this implies that the Government recognizes that the exchange rate is out of line but is not ready to do anything about it; and (iii) deflating GNP by a 'monetization' coefficient by claiming that the Djibouti economy is almost fully monetized compared with a much smaller monetization rate of other developing countries; while this is true, neither the Bank nor the U.N. can make assumptions about adjustment for monetizatioi, level due to its impracticality and questionable validity. 4. GNP per capita. Based on the estimates discussed above, the GNP per capita for 1984 and 1987 are as follows: 1984 1987 Population ('000): - Government 405 483 - Bank (6% g.r.) 350 417 GNP p.c. (US$): - Government 276 n.a. - Bank: (i) with Bank population 927 855 (ii) with Gov9t population 800 740  - 48 - DJIBOUTI SUMMARY COMPARISON OF NATIONAL ACCOUNTS AGGREGATES, 1984 I/ (In billions of Djibouti francs) ------------------------------------------------------------__------------- Government Bank Mission Difference estimate estimate Gross Domestic Product at factor cost 48.1 46.0 2.1 Plus: Indirect taxes 12.1 12.2 -.1 Gross Domestic Product at market prices 60.2 58.2 2.0 Less/plus: Net factor income -6.6 2.2 -8.8 Gross National Product 53.6 60.4 -6.8 Lesss Income earned by expatriate residents, cost-of-living adjustment, monetization adjustment, cumulated 2/ -33.7 -2.7 3/ -31.0 GNP, adjusted, in billions of DF 19.9 57.7 -37.8 GNP, adjusted, in millions of USS 111.8 324.5 -212.7 Population (thousands) 405 350 55 GNP adjusted, per capita, in DF 49,057 164,766 -115,020 GNP adjusted, per capitap in USS 276 927 -651 1/ Bank mission estimates are derived independently, based on standard U.N. methodology; Government estimates are from Annuaire Statistique de Dlibouti 1984, p,120. Bank estimates have also been calculated for 1985-87, but there are no official government data for the years after 1984, 2/ The detailed breakdown of the adjustments among these three items has not been provided by the Djibouti authorities. 3/ Partial adjustment, 55% of technical assistance cost (equal to 652 of estimated technical assistants' salaries.)  - 49 - C. Recommendationn 5. The following recommendations are made to facilitate analyses of economic development and planning activities. These recommendations relate (i) to the regular analytical tasks to be carried out for the public sector and relations with the rest of the world; and (ii) to the administrativo machinery that needs to be strengthened or established for execution of these tasks. (a) The ublic sector 6. To enable a comprehensive analysis and to have a complete picture of the Djibouti economy, efforts should focus on the following: - Preparation of a comprehensive listing of all the organizations and extra-budgetary accounts making up the government sector and the parastatal sector, the latter to be broken down by kind of activity. - Establishment of detailed accounts, including financial operations, for government entities: central government budget, local authorities, treasury accounts, public and semi-public entities, social security agencies, etc. These accounts should make it possible te identify the nature, origin and destination of operations involving these various units. - Preparation of consolidated accounts, including the financial account, for government agencies and public enterprises. (b) Relations with the outside world 7. For the external sector, work should concentrate on the following: - Analysis of imports and exports should focus both on the current situation and on trends (value and volume), with information on origin, user groups and taxes allocated to products. - With regard to re-exports (purchases by extra-territorial entities), indirect methods and cross-checking of information from a variety of sources should be used, in particular: information obtained from foreign diplomatic and military authorities, use of the results of consumption budget surveys among expatriate families for calculation of the housing allowance, etc. - Other balance of payments items (income, transfers, capital flows will be estimated from other sources of information, while taking account of special studies carried out by the Djibouti National Bank in relation to monetary statistics. (c) Institutional strenathening 8. As regards administrative provisions, the following issues will be examineds establishment of a Committee for the Coordination of Statistical and Economic Information, the role of the National Directorate of  - 50 - Statistics (DINAS) in Djibouti, and the strengthening of its management capacity. 9, 1,ommittea for the Coordination of Statistical and Economic Information. This committee, made up of representatives of all the ministries, will form an ideal meeting point for producers and users of statistics. Its chief functions will be (i) to prepare legislative texts on statistical information, more particularly the confidentiality of information and the obligation to provide statistics; ano (ii) to determine requirements with regard to economic and social statistics and establish their priorities. In the near term, a standardized accounting system should be devised for both the public enterprises and private corporations. 10. The role of DINAS. DINAS should be the organization responsible for data compilation. To this end, it should work to coordinate and standardize the work done in the individual ministries and other governmental agencies. Although the latter publish often lengthy and interesting information, the information is heterogeneous in nature and frequently ignores standard collection and aggregation criteria. Centralized coordination is, therefore, required for the organization of data collection, and currently only DINAS has the necessary structure for this function. 11. Strengthening DINAS9s capacity. In ordeL to enhance its role, adequate resources must be given to DINAS. First, its staffing structure will need to be strengthened through provision of qualified, experienced senior professionals and also mid-level staff to increase its technical capacity. This could be done through: recruitment of graduate statisticians and economists; - intensive training of graduate statisticians currently in post in their respective fields; - establishment of a training plan for Djibouti nationals. 12. Second, DINAS should also be provided with more and better working tools to enable it to produce information quickly: data processing equipment (PCs, software), means of transportation to collect date, financing to organize surveys, printing equipment for its publications, etc. 13. In view of the financial cost involved in strengthening DINAS's capacity, various sources of outside assistance should be approached.  - 51 - PART I ECONOMIC ACCOUNTS FOR 1986 DETAILED ACCOUNTS AND TABLES 1. Consolidated Accounts for the Nation 2. Gross Domestic Product by Economic Activity 3. Institutional Sector Accounts: (1) Business enterprises including individual entrepreneurs (2) General government (3) Households  - 52 - TABLE I: CONSOLIDATED ACCOUNTS FOR THE NATION, 1986 (millions of Djibouti francs) Gross Domestic Product and Expenditure Compensation of employees 35,383 Govt final consumption expend. 25.419 Gross operating surplus 16,761 Private final cons. expend. 41,192 Indirect taxes 12,726 Gross fixed capital formation 11,788 Less Operating subsidies -413 Increase in stocks -1,380 Exports of goods and services 29,184 Less Imports of goods and serv. 41,746 Gross Domestic Product 64,457 Expenditure on GDP 64,457 National Disposable Income and its Approiriation Govt final consumption expend. 25,419 Compensation of employees 35,383 Private final cons. expend. 41,192 Compensation of employees Gross saving 6,661 from rest of world, net 986 Gross operating surplus 16,761 Property and entrepren. income from rest of world, net 1,354 Indirect taxes 12,726 Less Subsidies -413 Other current transfers from rest of world, net 6,475 Disposable income 73,272 Disposable income 73,272  - 53 - Capital Finance Gross fixed capital formation 11,788 Gross saving 6,661 Increase in stocks -1,380 Capital transfers from Net lending to rest of world -1,568 rest of world, net 2,179 Gross accumulation 8,840 Financing of gross accumulation 8,840 Net acquisition of Net lending to rest of world -1,568 financial assets 3,916 Net liabilities 4,649 Adjustment 835 Net acquisition of Net lending to rest of world financial assets 3,916 and net liabilities 3,916 All Accounts: External Transactions Current Transactions Exports of goods and services 29,184 Imports of goods and services 41,746 . Goods (fob) 5,735 . Goods (cif) 36,865 . Services 5,205 . Services 4,881 . Extraterritorial organizations 18,244 Property and entrepren. income to rest of world 538 Compensation of employees from . Interest 538 rest of world 986 Property and entrepren. income Other current transfers from rest of world 1,892 to rest of world 3,224 Interest 1,892 * Households (technical asst.+fellowships) 3,224 Other current transfers from rest of world 9,699 National surplus on . to households 1,110 current transactions -3,747 . to Government 8,589 Current receipts 41,761 Disposal of current receipts 41,761 Capital Transactions National surplus on current transactions -3,747 Net acquisition of foreign Capital transfers from financial assets 3,916 rest of world, net 2,179 Net foreign liabilities 4,649 Adjustment 835 Receipts 3,916 Disbursements 3,916  - 54 TABLE II. GROSS DOMESTIC PRODUCT BY ECONOMIC ACTIVITYg 1986 (millions of DF) Economic Activity Produe- IC GDP Empl. Indir. Oper. Group Op. tiofl resun. taxes subs. surplus 1. Agriculture, livestock, fiehing 1,787 240 1,497 146 1,S61 2. Manufacturing 6,958 4,620 2,433 1,232 l16 -177 1,243 21. Food and beveraesg 6,263 4,101 2,162 1,043 103 -164 1,160 24. Paper and printing 149 74 76 78 12 -23 8 26. Chemicalc 230 163 77 30 6 42 29. Other 321 192 129 81 15 a8 3. Water and electricity 6,869 2,601 4,368 1,300 168 2,892 4. Construction 7,728 4,414 8,809 2,384 109 816 S. Commerce, hotels and restaurants 14,683 4,876 9,807 S,954 1,886 3,988 61. Wholoeale and retail trade 11,921 8,219 8,702 8,346 1,760 3,587 52. Hotels and restaurants 2,762 1,657 1,105 608 116 S81 6. Banking, insurance, real estate and businoss services 11,229 2,830 8,899 2,288 286 5,846 7. Transportation and telecommunications 14,358 6,748 7,610 4,428 89 -104 3,217 8. Other services 2,804 1,212 1,592 1,101 41 -182 582 9. Government services 26,216 7,688 18,660 18,650 10. Imputed banking output 8,154 -8,164 -8,164 11. Import duties 10,658 10,066 10,058 TOTAL 102,618 38,161 64,467 86,388 12,728 -418 16,761 IC: Intermodiate consumption  - 55 - TABLE III INSTITUTIONAL SECTOR ACCOUNTS. 1986 (millions of DF) 1. Business Enterprises (includina Individual Entrepreneurs) Production Account Use Supply Intermediate consumption 30,495 Production of goods and services 66,346 Value added 45,907 Import duties 10,056 Total 76,402 Tota.l. 76,402 Operating Account Use Supply Wages and social contributions 16,833 Value added 45,907 Indirect taxes 12,726 Operating subsidy 413 Gross operating income 16,761 Total 46,320 Total 46,320 Income and Outlay Account Use SUPPlY Withdrawals from Gross operating income 16,761 entrepreneurial income 13,192 Property income 1,977 Interest paid 1,421 Interest received . Other countries 386 . Other countries 1,892