Burundi - Energy Sector Rehabilitation Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-5411-BU EMOSRANDUM AND RECOMMENDATTON OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 16.3 MILLION TO THE REPUBLIC OF BURUNDI FOR A ENERGY SECTOR REHABILITATION PROJECT FEBRUARY 14, 1991 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit - Burundi Franc (FBu) US$1.00 FBu 175 WEIGHTS AND MEASURES Gwh gigawatt hour - 1 million kilowatt hours Z kgoe kilos of oil equivalent = 10,500 kilocalories kv kilovolt - 1,000 volts kw kilowatt - 1,000 watts kva kilovolt ampere - 1,000 volt ampere kwh kilowatt hour 1,000 watts hour Mw megawatt 1,000 kilowatt Mwh megawatt hour - 1,000 kilowatt hour toe ton of oil equivalent = 10,500,000 kilocalories ton metric ton = 1.1 US tons ABBREVIATIONS DGE Direction G4nErale de lEnergie DGHER Direction Generale de l'Hydraulique et des Energies Rurales ESAF Extended Structural Adjustment Facility ESW Economic Sector Work IMF International Monetary Fund MDRA Ministere du Developpement Rural et de l'Artisanat MEM Ministare de l'Energie et des Mines NGOs Non-governmental organizations ONATOUR Office National de la Tourbe PE Public Enterprise PEP Public Expenditure Program PFP Policy Framework Paper PIP Public Investment Program REGIDESO Regie de distribution d'eau et d'elect-ricite SAF Structural Adjustment Facility SAL Structural Adjustment Loan SPA Special Program for Africa UNDP United Nations Development Program GOVERNMENT OF BURUNDI FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY REPUBLIC OF BURUNDI ENERGY SECTOR REHABILITATION PROJECT CREDIT AND PROJECT SUMMARY Borrower: Republic of Burundi Beneficiaries: Ministry of Energy and Mines (MEM), Ministry of Rural Development and Artisanat (MDRA), REGIDESO (the state electricity and water company) and ONATOUR (the state peat agency). Amount: SDR 16.3 million (US$22.8 million equivalent) Terms: Standard IDA, 40 years Onlending Terms: The Government of Burundi will onlend a maximum of SDR 4.4 million (US$6.2 million equivalent) of the Credit proceeds to REGIDESO at a 8.72 percent interest rate for a period of 25 years (including a 5-year grace period). Financing Plan: US$ millions IDA 22.8 Government 5.6 REGIDESO 3.8 TOTAL 32.2 Economic Rate of Return: 35Z (physical investments) Staff Appraisal Report: No. 9068-BU, dated February 14, 1991 Map: IBRD 22083 This document has a restricted distribution and may be used by recipients only in the perf rfmance of their official duties. Its contents may not otherwise be disclosed without World Bank auti orizatio-.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF BURUNDI FOR AN ENERGY SECTOR REHABILITATION PROJECT 1. The following memorandum and recommendation on a proposed development Credit to the Republic of Burundi for SDR 16.3 million (US$22.8 million equivalent) is submitted for approval. The proposed Credit would be on standard IDA terms and would help finance an energy sector rehabilitation project. Part I of this memorandum outlines the country policies and Bank assistance strategy. Part II describes the proposed Credit. PART I - COUNTRY POLICIES AND BANK GROUP ASSISTANCE STRATEGY Background 2. Burundi is a small landlocked country in Central Africa. Its per capita GDP is about US$220 (1989). With a population of about 5 million and a population growth rate of 3 percent, Burundi has the second highest population density in Africa (169 persons/square kilometer). About 94 percent of the population lives in rural areas and the economy is highly dependent on agriculture (more than half of GDP, 90 percent of employment and 90 percent of export earnings). Coffee accounts for 80 percent of total exports. The secondary sector (mining and manufacturing) represents only 14 percent of GDP and 6 percent of exports. The private sector plays a major role in the production of both export and food crops and transport, while the public sector enjoys a quasi-monopolistic position in the processing and export of primary commodities, manufacturing, energy, and infrastructure, and generates half of the country's formal employment. 3. Since the country's independence in 1961, ethnic rivalry between the minority Tutsis and the majority Hutus has been a major feature of Burundi's political history. The Tutsis have ruled Burundi continuously for the last three decades. The current government is led by President Buyoya, a Tutsi, who took power in September 1987 in a military coup. In August 1988, there was an outburst of ethnic violence in Burundi which led to a temporary outflow of primarily Hutu refugees to neighboring countries. The President responded by promoting a policy of national reconciliation and unity, appointing a new cabinet with equal representation from the two ethnic groups and giving priority to recruitment of Hutus in the administration. This policy has been largely successful; peace has been restored and most of the refugees have returned to Burundi. A significant opening-up of the political system is underway. 4. Burundi's anniual per capita growth has been consistently above average levels for Sub-Saharan Africa since the mid 19609, while following the general pattern of lower growth in the 1970s and stagnation in the 1980s. However, its economic and financial situation has been closely linked to the international price for coffee which has fluctuated widely from year to year. In the 1982-85 period, lower coffee prices and adverse climatic conditions, combined with expsnsionary fiscal and monetary policy, led to a financial  - 2 - crisis. The government responded with administrative controls aimed at containing the external deficit and protecting domestic industry. External borrowing, especially on non-concessional terms, accelerated, causing the debt service ratio to increase from an average of 5 percent of exports of goods and non-factor services in the late 19708 to 25 percent in 1986. The distortions introduced through these measures reinforced the role of the state in the economy, aggravating disincentives to private sector development. The Adiustment Program 5. In late 1985, the government embarked on an adjustment program. The initial phase of the reform program was supported by the first of the Bank's two structural adjustment credits (SAL) and the first of three annual arrangements under the IMF's struccural adjustment facility (SAP). The program emphasized stabilization measures, established the first steps to bring about structural changes and strengthened the management of public resources. The exchange rate was devalued by 24 percent in SDR terms and a number of import liberalization measures were taken. Production incentives were rationalized. Except for products competing with those produced by public enterprises (PE), quantitative restrictions on imports were removed and replaced by import duties, and the first phase of a comprehensive tariff reform was introduced. The number of tariff rates was cut and the tariff range for non-luxury goods vas narrowed from 0-280 to 15-50. The number of prices controlled officially by the government was reduced to certain strategic products and to producer prices for key agricultural exports. With respect to public resource management, the government prepared a first public investment program, increased fiscal receipts and initiated reform of the PE sector with the creation of an independent unit to monitor its performance. 6. Following the completion of the first phase of the adjustment program, there was a change in government and another collapse of the international price of coffee, resulting in a 34 percent decline in coffee export receipts. Despite the setback, the government decided to pursue a second phase of the adjustment program designed to broaden and deepen reforms. A comprehensive package of additional measures was formulated to strengthen macroeconomic management, create an incentive framework to stimulate exports, reform public enterprises, improve public expenditure management, increase the efficiency of the financial sector, and liberalize the labor market. Assessment of Performance 7. Measures taken under the adjustment program and the external support mobilized as a result of the program enabled the Burundi economy to weather external shocks without making sharp cuts in essential public sector programs or reintroducing price and import controls. While real growth declined somewhat during the adjustment program from 5 percent in 1980-85 to 3.8 percent in 1986-89, it was still slightly positive in per capita terms. Nevertheless, the economy remains highly dependent on the international coffee price, both with respect to fiscal and external receipts. This dependence on coffee helps explain the fact that the ratio of exports to imports declined over the adjustment period from 54 percent in 1986 to 38 percent in 1989. If the high coffee prices of late 1988 and early 1989 had continued throughout 1989, then the ratio would have remained at about the same level.  SELECTED ECONOMIC INDICATORS 1984 1986 1086 198t 198 1989 GROWTH RATES a/ GOP Mp 0.2 11.6 8.8 5.5 4.9 1.6 GDP/capita -2.6 8.6 0.8 2.6 1.8 -2.8 Consumption/capita -1.3 9.8 6.7 -5.6 6 6. -7.2 Export. (gns) 11.0 11.4 21.2 -12.0 12.3 -6.2 Imports (gnfe) -8.1 -8.8 8.1 6.9 -1.1 -15.1 RATIOS (M) b/ Dobt Service/Xgnfs 16.7 24.4 24.5 42.7 80.t 42.2 Gross Investment/CDP 18.4 18.9 11.6 22.7 16.0 16.6 Qross Domestic Savings/G1P 5.6 8.8 1.2 6.0 1.6 4.4 Govt revenue/GDP c/ 12.7 18.2 16.0 12.8 15.7 18.1 Govt oxpenditure/GODP d/ 29.2 25.1 24.5 29.6 28.7 28.0 Overall deficit/GDP o/ -16.5 -11.9 -8.5 -16.8 -11.1 -9.9 Current account f/ -92.6 -88.6 -80.9 -125.6 -98.6 -58.1 Current account g/ -180.6 -127.1 -142.6 -201.9 -162.4 -145.0 Current account/GOP h/ -9.4 -7.7 -6.7 -11.1 -8.9 -5.1 Current account/GDP I/ -13.2 -11.1 -11.9 -17.9 -15.0 -13.2 IMNDICES ;/ Consumer prices k/ 148.6 164.0 158.8 167.9 1765. 195.9 Real exchange rate I/ 132.8 136.3 116.6 99.9 88.0 90.5 a Based on constant 1980 prices, F8u b/ Bae#d on current prices c/ Current revenue, excluding grant. d/ Total expenditure / Excluding capital grant. 0/ Including current transfer receipts; In millions of USS g Excluding current transfer roeeipts; In millions of USS h/Including current transfer receipts I Excluding current transfer receipts; In milliono of US8 1980 a 100 Bujumbura, Burundi I Source: IMF Source: Planning Ministry 8. The adjustment program has not yet stimulated a strong supply side response, partly because of the mixed signals given by the government to the private sector. Even though the elaborate system of controls has been reduced, the PE sector has remained basically unchanged. However, new impetus for reform is building up. After the civil strife in 1988, the government realized that it was essential to accelerate the pace of economic and political reform. It undertook a major public information campaign during the last half of 1989 and the first half of 1990, which has been successful in mobilizing national support for the reform program and represents an important first step towards changing attitudes. The second tranche of SAL IT was released in April 1990 and the third tranche is expected to be released in the next four to six months. Performance under the four major components of SAL II is described below.  - 4 - 9. Public Resource Management. The overall fiscal deficit remained at about the same average level of 12 percent of GDP; however, during the period, extra-budgetary expenditure has increasingly been integrated into the budget. The number of extra-budgetary accounts has been reduced from over 500 in 1988 to 20 in 1991. On the revenue side, performance has improved due to increased tax revenue, and non-tax revenue rose, owing to more systematic servicing of external debt by the PEs. However, there are still many ad hoc tax exemptions accorded which have limited potential revenue growth. On the expenditure side, instruments for managing public expenditure are now in place but these have not yet had an impact on the share of public expenditure in GDP which has remained at abouxt 27 percent throughout the 19808. Procedures for formulating three- year public investment programs (PIP) for all sectors have been established. Detailed public expenditure programs (PEP) for 1990-92 and 1991-93 were also prepared for three sectors with the assistance of the Bank staff. A consulting firm has developed a methodology for preparing PEPs and a training program for civil servants will begin shortly. A partially unified budget (covering revenue and current expenditure) was adopted in 1991 and full unification is expected starting with the 1992 budget. 10. Public Enterprise Reform. There are 84 PEA in the sector that accounted for 45 percent of gross capital formation between 1984 and 1987 but generated only about 7 percent of GDP. This does not compare favorably with the Sub-Saharan African average, which is 30 percent of gross capital formation and 15 percent of GDP. The PE restructuring component includes: (i) rehabilitation of certain public enterprises when justified by studies; (ii) signing of performance contracts for strategic enterprises remaining under government control; (iii) reduction of the size of the sector through merger, privatization and liquidation; (iv) revision of the legal framework to increase the management autonomy of the enterprises; and (v) completion of studies on key issues such as pricing and tariff policies. There have been implementation delays, and performance--even for those PEs that are being rehabilitated-- has yet to improve. 11. Exchange and Trade Reforms. Under the program, effective protection was to be reduced through trade reform and maintenance of a flexible exchange rate policy. The government has been largely successful on both counts; however, these policies have not yet had a significant impact on the structure and volume of production. An examination of the composition of major exports reveals that most are either produced by PEs or, as in the case of agro- industries, are processed and exported by them. Slow progress on PE restructuring has undermined the potential effect of tariff and exchange rate reform on production of traditional exports, either because these enterprises were too inefficient to respond to price signals or because, as in the case of agro-industry, the windfall in local currency terms from devaluation was absorbed by the enterprises instead of being passed on to producers. In the case of a number of low volume, high value agricultural export products recently introduced by the private sector, such as tobacco, passion fruit and cut flowers, farmers have generally received higher shares of the international price. 12. The Incentive Structure. The incentive system was to be rationalized to improve resource allocation. De Jure price controls have been eliminated where there is some element of competition and prices in monopolistic or  oligopolistic sub-sectors are kept under review. Nevertheless, the government has utilized the import licensing system and its influence in PEs to maintain some indirect price controls but is now addressing the issue in preparation for the next phase of reform. The producer price for rice has been liberalized and a progressive liberalization of the coffee producer price is expected in the context of the ongoing coffee sector project. 13. With the political reforms underway and the atmosphere of open dialogue created during the public information campaign on economic reforms, the government's capacity to make significant progress on Burundi's central development issues has been greatly enhanced. There are signs that the economy is improving: the average number of annual commercial and industrial enterprise creations has doubled recently as has the number of importers. The government is increasingly taking charge of the reform program. In January 1991, the Council of Ministers adopted a revised policy for the PE sector which calls for an acceleration of the divestiture of the government's portfolio. The government also took the initiative to prepare the first draft of the Policy Framework Paper for 1991-93 and is currently formulating proposals for the third phase of the adjustment process. Central Development Issues 14. The Role of the State. Burundi's formal economy is still over- whelmingly public sector and is supported by substantial official development assistance. A major challenge for the years ahead is to shift the economy to one that is characterized by a smaller, more efficiently managed public sector co-existing with an emerging private sector. The transition is a difficult one and will take time to achieve. Following the first two phases of the adjustment process, which have increased the government's capacity to monitor public expenditures and the performance of PEs and to redirect public investment towards the maintenance of social and economic infrastructure, the instruments for effectively redefining the role of government are now in place. In fact, a recent survey of private businessmen revealed that private sector confidence in the government's commitment to a more limited role in productive sectors has increased. The government will continue improving public sector management while concentrating on the removal of bottlenecks at the microlsectoral level in order to stimulate growth. 15. Diversification of the Economy. Sustained growth in Burundi will result in a reduction in the country's dependence on coffee exports. Since 1986, the number of products exported by the private sector has increased, even though export volume has not yet picked up significantly. Continued efforts to liberalize the economy and, in particular, to provide an adequate legal and regulatory framework will create a favorable enabling environment for export- led private sector growth over the medium term. In the short to medium term, efforts to diversify the economy will also focus on improving the efficiency of existing enterprises (both public and private) with emphasis on a major restructuring of agro-industry. Nevertheless, constraints such as the mountainous terrain, the lack of direct access to the sea and the small size of the domestic market will tend to limit the rapidity with which the economy's structure can be modified.  16. Distortions in Factor Markets. The public sector resource allocation process has generally bypassed domestic factor markets (financial and labor). Wages have been set by government, due to the quasi-monopolistic position of the public sector in the labor market. Capital financing for the public sector has been obtained primarily from external donors on grant terms or at subsidized interest rates rather than through the domestic banking sector. However, with an increasing role for the private sector in productive activities, the need for market-determined pricing of capital and labor has become apparent. 17. Experience with the Bank's line of credit to enterprises through commercial banks demonstrates that, despite reforms, the competitiveness of the financial sector still needs improvement. Commercial banks are reluctant to lend for investment projects even when their potential financial viability can be demonstrated. The banking sector's lack of interest in medium-term lending has also placed a damper on efforts to increase domestic resource mobilization. Similarly, distortions in the labor market have persisted partly, due to automatic wage adjustments in the modern sector which have made it difficult to reduce real wages through devaluation. The labor code, despite revisions made during the second phase of adjustment, continues to discourage employment creation through excessive regulation and administrative difficulties involved in hiring and firing employees. The formal private sector is also required to bear 100 percent of its employees' and their dependents' medical expenses. The government is currently undertaking a comprehensive review of the labor code. 18. Population Growth. Burundi's Economic and Social Council, created in 1990 to provide a forum for discussing development issues with participants from all segments of the population, has just issued a draft study of the country's longer-term development prospects and constraints. The study considers the high level of population growth as the single most important constraint to future economic and social development. The government has launched an ambitious campaign to inform the public of the need for and the means of improving family planning. While training for health center staff in the use of contraceptives has proceeded satisfactorily, contraceptive prevalence has not yet increased. 19. Environment. Rising population density has led to fragmentation of agricultural land, overgrazing, declining soil fertility and the use of ecologically fragile and marginal lands for cultivation. The growing scarcity of woodfuels and loss of natural forest habitats have taken place in response to an over-exploitation of forests to meet rising demand for fuelwood. An estimated 90 percent of wood production is utilized for domestic energy consumption. In some areas there are already imbalances between wood consumption and supply. In recognition of the increasing importance of environmental issues for Burundi's economic and social prospects, a special Ministry for Land Management, Tourism and Environment was created in 1988. The government is currently preparing an environmental action plan which will be structured around the following themes: land use and population growth, management of natural environment, energy use and internal migration and urbanization.  Composition of Past Bank Assistance 20. Since 1970, Burundi has received 40 IDA credits and one IBRD loan for a total of US$576.5 million, and one investment operation from the IFC totaling US$5.6 million (loan and equity investment). IDA lending operations have financed: (a) infrastructure (28.8 percent), including road maintenance, a reform program in the transport sector, development of the telecommunications network, water supply and urban development; (b) agricultural and rural development (23.8 percent), with special emphasis on farming systems research, lmproving extension services, and forestry and fisheries development; (c) the structural adjustment program (21.1 percent); (d) human resources development (15 percent), especially in education and preventive health services and family planning; (e) industry and finance programs (4.9 percent); (f) energy (4.8 percent); and (g) technicai assistance programs (1.6 percent). 21. The current portfolio includes 16 IDA credits. IDA lending increased markedly in the 1985-90 period with the approval of two SALs, two major credits to agriculture, and substantial support to the health and education sectors. However, the disbursement pattern for the portfolio over the past three years has remained steady (US$48.6 million in calendar year 1990, US$45.6 million in 1989, and US$44.4 million in 1988). Annual commitments have averaged US$84 million for FY87-90. Forty percent of total commitments is undisbursed (US$231.7 million). Project implementation is, on the whole, satisfactory with a disbursement rate that is above average for the region. Physical implementation of projects has been adequate, and the impact of IDA financed projects on institutional development has been positive, despite implementation delays. DISTRIBUTION OF LENDING, FY71-90 (US$ Million) Sector Amount Z No. of Projects Infrastructure 165.1 28.8 12 Agriculture 136.6 23.8 10 Human Resources 86.3 15.0 5 Energy 27.3 4.8 2 Finances and Industry 28.1 4.9 5 Technical Assistance 9.1 1.6 3 Structural Adjustment 121.2 21.1 3 TOTAL 573.7 100.0 40 22. The Bank's dialogue with the government has been generally good and has become more frank and cooperative since the government's successful internalization of the adjustment program and its move towards national reconciliation. While economic policy decisions, which are now made on a consensus basis, seem to require more time to reach, the effectiveness of implementation has been enhanced considerably by a more widespread understanding of and support for the program.  - a - Country Assistance Strategy and Priorities 23. The Bank's main objective in Bunrundi is to promote sustained growth and reduce poverty. Through its policy advice and economic and sector work, the Bank is supporting Burundi's efforts to develop an incentive structure geared at promoting export-oriented private sector investment, and to reorient public expenditure away from productive sectors and towards social and economic infrastructure. The aim is to encourage a significant suppl- iide response by addressing the central development issues discussed in an earlier section. 24. The Bank and other donors have responded generously with budget and balance of payments financing in support of the first two phases of the adjustment program. These resources havy been utilized primarily for offsetting the impact of external shocks and most recently, accumulating external reserves. Given the present comfortable level of reserves, borrowing requirements to finance balance of payments gaps over the next two to three years will be limited. In view of the shifting resource requirements of the next phase of adjustment which will focus on the supply side, the Bank will reduce the level of quick-disbursing assistance and introduce new vehicles for directly promoting the private sector. Resources for the private sector will be channelled through the domestic banking sector and the Bank will focus on ensuring that adequate levels of equity financing are available and domestic resource mobilization is strengthened through the creation of new savings instruments. 25. As the government divests itself of directly productive activities, it will be looking increasingly to the private sector to provide it with certain essential goods and services. The donors are encouraging this process by using their projects to create market opportunities for the private sector in the form of maintenance contracts for certain public assets, other types of construction work and greater use of local consultants. 26. The Bank's assistance strategy involves a three-pronged approach: (i) providing support for an acceleration and deepening of the adjustment process through a modest level of non-project assistance; (ii) stimulating the productive sectors through investment operations; and (iii) designing social and economic infrastructure operations that will lay the groundwork for improving long-term development prospects while introducing more financially sustainable funding mechanisms for providing social services and maintaining public assets. The lending program calls for two to three operations a year. 27. The Adjustment Process. A third adjustment operation (SAL III) is currently under preparation. It would emphasize reforms necessary to achieve a supply response and would help ac lerate and deepen the adjustment process. Major reforms would focus on remL g remaining price controls and fully liberalizing imports and exports of goods and services, accelerating the restructuring and privatization of PEs to reduce further the role of the state, and providing an appropriate enabling environment to encourage more private sector investment by both local and foreign entrepreneurs.  - 9 - 28. Promotion and Restructuring of Productive Sectors. To complement the Bank's support to the government's adjustment program, the lending program includes investment operations in agro-industry and private sector development. These operations would be focused on promoting the creation of private sector enterprises in new sectors while increasing the competitiveness of traditional agro-industries by creating conditions for private sector entry and improving the efficiency of existing PEs. Longer-term issues which could compromise Burundi's agricultural production potential are to be addressed in an environment and land development project. The project would support the implementation of the government's environmental action plan and measures to prevent a possible deterioration in the generally satisfactory food security situation, through erosion control, management of water resources, including irrigation networks, and reforestation. 29. Economic Infrastructure. In the infrastructure area, the proposed Energy Sector Rehabilitation Credit, discussed in part two of this report, is fully consistent with the Bank's strategy. The project is designed to improve the efficiency of REGIDESO (the water and electricity utility) through better management, to promote more efficient use of various energy sources through appropriate pricing policies, to enhance the quality of the sector's PEP and to provide greater focus on the environmental impact of energy use. Another project will support the government's efforts to expand rural infrastructure including the population's access to safe drinking water. Systematic attention to the maintenance of investments will be given through regular reviews of the sector PEPs, wider application of cost recovery measures and shifting the responsibility for the management and maintenance of facilities to the local governments (communes). 30. Social Services. The Bank will be giving priority to increasing the prevalence of the use of contraceptives as a means of controlling population growth. Access to family planning services is being expanded and integrated with primary health care services. The objective of future operations in the health and population area will be to continue rationalizing delivery systems, with special emphasis on preventive medicine, family planning, decentralized management of health facilities and cost recovery. Considerable efforts have been made both by go -rnment and by parents to increase access to primary education and gross enrollment has reached 70 percent. The ratio of girls and boys enrolled at the primary level, at about 45 percent and 55 percent respectively, is fairly well balanced, but needs further improvement. The Bank's support for education sector reform will continue to emphasize the enhancement of the quality of education in primary and secondary schools by upgrading teacher and student skills and improving teachers' living conditions especially at the primary level. 31. Poverty Alleviation. In the context of the public expenditure review process, the Bank staff will continue to encourage the government to allocate sufficient budgetary resources to meet the needs of the poorest segments of the population, both longer-term and those that may be identified with the adjustment process. This target group is comprised largely of women who are heads of household and street chileren. The government has not requested a free-standing project on the role of women in development but is targeting women through the Bank-supported education and health projects, as well as the agricultural services project which focuses on more user-friendly extension  - 10 - services to farmers, of which women are a major group. In addition, a social action project is currently under preparation and will make resources available through the communes and NGOs to address the needs of vulnerable groups including women and children. 32. In order to improve prospects for the implementation of the Bank's strategy and the institutional sustainability of Bank operations, greater focus will given to the area of capacity building. Technical assistance and training needs will be taken into account by: (i) expediting implementation of the existing technical assistance project to help the government in designing macro and sectoral policies and (ii) including technical assistance components in future sector projects that reinforce public sector management objectives pursued at the macro level. The Bank will support government's efforts to improve project implementation through regular country implementation reviews and by devoting more resources to project supervision. Special emphasis will be given to streamlining procurement procedures and accelerating disbursements. 33. Economic and Sector Work. The intellectual underpinnings of the Bank's strategy and dialogue with the government are established largely through economic and sector work. The work is supportive of the strategy to address Burundi's central development issues. With respect to the adjustment agenda, the UNDP through an umbrella project for which the Bank is executing agent, is financing studies to evaluate the impact of SAL I and II and to prepare SAL III. The recently completed Public Expenditure Review and the Project Completion Report for SAL I and II (to be distributed to the Executive Directors shortly) have constituted critical inputs in the Bank's efforts to convince the government of the need to deepen the adjustment process. Bank staff has undertaken two major sectoral studies to provide a better assessment of the potential and constraints in Burundi's major productive sectors. The first, an industrial sector review, is approaching completion. It assesses relevant macro and micro issues including the enabling environment for the private sector and identifies bottlenecks to be addressed in SAL III and the private sector development operation. An in-depth analysis of the agricultural sector has also been undertaken. It addresses the issues of land tenure, soil erosion, rural credit and input use, export promotion, product development and more user-responsive extension services. This work is being complemented by studies on the labor market and communal development and will provide inputs for operations under preparation. For social services and economic infrastructure the Bank will give high priority to regular reviews of energy and transport issues, and to support for the formulation of a national population strategy. 34. Aid Coordination and Relations with the IMF. Burundi is eligible for the SPA program which has been highly successful in mobilizing non-project assistance in support of Burundi's adjustment program. Over the last four years the Bank has kept interested donors informed of its policy discussions with the government and is associating cofinanciers with the supervision of SAL II and the preparation of SAL III. A technical group, under the chairmanship of the Bank and comprised of representatives from all the major donors, meets regularly in Bujumbura to discuss ongoing concerns and to participate in the  - 11 - Bank's economic missions. The Bank has also actively participated in round table meetings organized by the UNDP in 1988 and 1989 as well as in sector follow-up meetings. 35. The Bank staff and the Fund staff have collaborated closely in supporting the adjustment program in Burundi. Three Policy Framework Papers (in 1986, 1988 and 1989) were prepared in collaboration with the government during a series of Bank/Fund joint economic missions. A fourth PFP is under preparation and will cover the 1991-93 period. The IMF staff is also considering a modest ESAP since Burundi has successfully completed all three arrangements under the SAP. Burundi had recourse to six standby arrangements with the Fund in the mid to late 1960s, and again in 1976 and 1986; however, these resources have been fully reimbursed. Drawings under a Compensatory Financing Facility approved in 1979, have also been repurchased. The country's credit position with the Fund is limited to the three annual SAF arrangements totalling US$ 42.6 million. Country Risks and Contingency 36. There are factors which could cause serious slippages in the implementation of reforms and hence the capacity of the Bank to pursue its strategy. These are both political and economic. First, the national and regional political situation remains fragile. Ethnic conflict in neighboring Rwanda (involving the same two groups as in Burundi) could lead to a de-stabilization of the current Burundi regime and its attempts to increase power sharing peacefully. The government remains convinced that the best means of avoiding more ethnic conflict is by pushing forward with democratization and with economic reforms. However, a potential short- to medium-term unemployment problem could arise with shifts in the composition of public expenditures (away from salaries and towards goods and services) and the liquidation of unviable PEs. The government will be monitoring the situation closely and the Bank has agreed to support employment generating activities through private sector development. On the political side, priority is already being given to changing attitudes through continued public information campaigns and to introducing a more democratic form of government. 37. Second, exogenous factors, such as irregular rainfall, sharp fluctuations in international prices for coffee, and to a lesser extent, the Gulf crisis and its impact on oil prices, have undermined efforts to restore growth. While the comfortable level of reserves could help deal with the foreign exchange consequences of these shocks, it does not compensate for the country's ensuing income loss. In view of the evolving political climate, continued mediocre growth linked to exogenous factors could tempt some elements of the government to push for postponement of potentially unpopular reforms. 38. The Bank has developed an alternative lending scenario to take into account risks of slippage. If government commitment to reform lags as a result of political difficulties, the Bank would remain flexible and allow the government time to build a consensus on politically sensitive reforms, but would, in the interim, postpone new adjustment operations and limit the lending program to investment projects only.  - 12 - Criteria for Evaluating Progress 39. Progress towards implementing economic reforms and achieving sustained growth will be monitored closely. A key criterion, barring any further adverse developments in coffee prices, will be the extent to which the economy can increase exports and its ability to cover import requirements through export earnings. Another indicator will be the rate of growth of the private sector in terms of investment and production and in terms of employment. On the public resource management front, progress will be assessed on the basis of changes in the volume and composition of public expenditure towards a containment of expenditure in real terms and a shift away from investments in productive sectors in favor of meeting the operating costs of critical social services and economic infrastructure. Improvements in the efficiency of PEs will also be considered. To determine the effectiveness of safety net features in the PEP, the Bank will monitor a number of social indicators such as the percentage of the population living below the poverty line and average daily caloric intake. The degree to which cost recovery mechanisms are applied to health, education and rural water supply and decentralization to the commune level of management responsibility for these services will also be kept under review. Summary Assessment 40. Burundi does not benefit from a significant natural resource endowment. Nevertheless, the country has a favorable climate for agricultural production and has been able to feed its growing population despite problems of soil erosion, small farm size and minimal use of modern inputs. On the whole, Burundi has been successful in implementing most of the measures recoammended by the Bank and the Fund. In order to maintain momentum in favor of economic reforms and to minimize the risks involved in the political reform agenda, real per capita growth must be restored. Focus will be on obtaining increased production in response to reforms by accelerating the liberalization process and concentrating on sector and micro issues. 41. The Bank's main objective in Burundi is to promote sustained export-led growth while reducing poverty. Through its policy advice and ESW, the Bank will concentrate on the development of an incentive structure geared to promoting private sector investment, and on reorienting public expenditure towards social and economic infrastructure, the development of human capital and the preservation of the environment. The lending program calls for two to three operations a year, including two adjustment operations over the next three years. The program will be assessed on the degree to which exports can be covered by imports and on changes in the volume and composition of public expenditure consistent with a diminishing role of government in the productive sectors. Should government commitment to the economic reform program lag then the Bank would postpone any new adjustment operations.  - 13 - PART II - THE CREDIT 42. Background. Burundi's energy consumption is low, corresponding to only 188 kilos of oil equivalent (kgoe) per capita. Wood and other biomass meet 94 percent of the country needs, while petroleum products account for 5 percent and electricity for 1 percent. Annual wood consumption is estimated at about 2.4 million metric tons, of which 17 percent is used for charcoal production. The sustainable supply of wood is estimated at about 1.7 million metric tons per year, or 70 percent of demand. Localized deforestation problems are already evident around urban centers. Under a program financed by IDA, 15,000 improved stoves have been sold in Bujumbura since 1985, saving about 35 percent of the charcoal used in traditional stoves. This program will be strengthened under the proposed Credit. More efficient charcoal production methods were introduced in some industrial plantations under two IDA financed forestry projects. The proposed Credit will revitalize and expand these efforts and introduce them to traditional charcoalers who represent the largest share of production. 43. The per capita consumption of modern fuels (petroleum products and electricity) is only 12 kgoe, well below the 95 kgoe average for Sub-Saharan Africa. Petroleum product consumption increased by five percent per year in 1980-88, while electricity consumption grew by 11 percent per year. All national petroleum requirements are met through imports, representing 30 percent of total export revenues in 1989. Petroleum products are imported and distributed by five private companies and the government confines itself to supervision and price control. Retail prices for gasoline, diesel and kerosene have generally been kept above international prices but remained unchanged since 1983 until 1990, when petroleum prices were increased by 30 percent. But these adjustments were not sufficient to compensate for the sharp increase in international prices in the wake of the Gulf crisis. The existing price structure is too complicated and does not give incentives to importers to reduce transport costs. Under the proposed Credit, the government has agreed to simplify the pricing structure and adopt a policy of automatic price adjustments. 44. Only 1.5 percent of the population uses electricity and 82 percent of total consumption is concentrated in Bujumbura. As the urban population represents only six percent of the total, rural electrification is crucial for increasing access to electric services. The proposed Credit will finance the extension of the distribution network in both urban and rural areas and will define a strategy for economically justified rural electrification. In April 1990, in the context of the dialogue for the preparation of the proposed project, the government decided on comprehensive electric tariff reform. Medium-voltage rates were inmediately adjusted to meet long-run marginal costs, while the adjustment was phased in for low-voltage users, with an initial increase of 27 percent for all consumption above 375 kwh per month. A social tariff for consumers using less than 75 kwh per month was also established, while the free electricity received by high government officials and utility company personnel was eliminated. 45. The agency responsible for the energy sector is the Directorate of Energy (DGE) in the Ministry of Energy and Mines. its main task is to oversee the sector as a whole, assessing priorities and ensuring overall coordination  - 14 - among subsectors. REGIDESO is responsible for the generation transmission and distribution of electricity in urban areas, while rural areas fall under the authority of the DGHER. The DGE, as well as REGIDESO and DGHER, will receive assistance from the proposed project to improve their respective performance in financial management, planning and training. 46. Rationale for Bank Involvement. The Bank's objectiva in Burundi is to promote sustainable and equitable economic growth through supporting the government in deepening and broadening the adjustment process. The proposed project fits well into this strategy in that it extends adjustment to a key sector of the economy by encouraging the more efficient use of energy resources through appropriate pricing policies. It also addresses important social concerns through the introduction of special electricity tariffs for low income groups and the provision of electricity in the poorer rural areas. The project is also responsive to the need to pay greater attention to the environmental impact of energy resource use. 47. The project is a logical extension of ongoing IDA-supported structural adjustment operations in Burundi. It strengthens institutions in a key sector and contributes to the quality of the public investment program and the efficiency in the use of resources. The Bank is playing an important role in the design of investments in the energy sector which represent about 10 percent of the public investment program. In rural electrification, in particular, the Bank's presence is a key element of external financing coordination in support of economically justified projects. Finally, the agreements reached after a dialogue with the Bank on pricing policies for petroleum products, electricity and woodfuels should lead to increased efficiency in the economy and to an improved allocation of resources. 48. The project also addresses important environmental concerns. About 90-95 percent of wood production in Burundi is for domestic energy consumption of fuelvood and charcoal. Forestry and woodfuels data are poor, but for certain areas of the country there are signs of significant imbalances between wood consumption and sustainable supply, and environmental problems are emerging. Through the improved charcoal stoves and carbonization programs, the project will improve efficiency in the consumption of woodfuels. These actions, together with the design of the strategy for the management of wood resources and the increased access to alternative fuels, would reduce the negative effects of energy resource use on the environment. 49. Project Objectives. The objectives of the project are to promote rational energy policies and to strengthen the efficient management of energy resources. Specifically, the project aims to: (i) improve efficiency in the use of energy resources through reforms in the pricing structure of electri- city, petroleum products and woodfuels; (ii) develop efficient institutions in the sector and improve the quality of public investment; (iii) expand access to electricity; and (iv) reduce negative environmental effects of the use of energy through charcoal efficiency and improved stove program. 50. Project Description. The main features of the project are summarized as follows: (a) Energy Sector Institution Building: (i) pricing policies reflecting the economic cost of supply in electricity, petroleum and woodfuels; (ii) a Rehabilitation Program for REGIDESO that includes management assistance,  - 15 - financial reatructuring, equipment and construction of limited facilities and training; (I i) feasibility studies for selected hydroelectric power projects and an update of the power sector Master Plan; (iv) institutional strengthening of the DGE in planning, coordinating and overseeing the energy sector; (v) institutional strengthening of the DGHER in support of efficient rural electrification; and (vi) coordination and monitoring of the public investment program in the energy sector; (b) Biomass and Household Energy: (i) a Charcoal Efficiency Program to disseminate improved techniques for the production of charcoal and sensitize charcoalers to the issue of deforestation; (ii) conti- nuation of the Improved Charcoal Stoves Program which aims at reducing charcoal and wood consumption; (iii) a household energy consumption survey to improve the planning process; and (iv) a feasibility study of peat substitution in secondary industries to determine the viability of increasing the use of these resources; (c) Rural Electrification: (i) Rural Electrification Master Plan to evaluate potential projects in rural areas; and (ii) selected economically justified extensions of the distribution network in rural areas; (d) Power Subsector: (i) doubling of the 110 kV transmission line from Bubanza to Bujumbura and extensions in associated substations; and (ii) an intensive program of new connections and extension of the distribution network in urban areas. 51. Agreed Actions. The government is committed to the following main actions: (a) electricity tariffs will be based on long-run marginal cost of supply; the implementation of this policy for low-voltage users will be completed by December 31, 1991 (it has already been completed for medium- voltage users) and tariffs will be reviewed annually with the Bank; (b) a policy of automatic adjustments of petroleum prices will be implemented before Credit effectiveness and a simplified pricing structure will be adopted before September 30, 1991; (c) annual agreement will be sought with the Bank on the three-year rolling public investment and expenditure program in the energy sector; (d) new investments by REGIDESO will have an economic rate of return of at least 10 percent and a financial rate of return of at least 8 percent; (e) DGHER will request Bank approval before initiating any new rural electri- fication project and for each of them will demonstrate that the internal economic rate of return is at least 10 percent, projected revenues cover all operating and maintenance expenses and that an adequate billing and collection system has been designed and will be in place; (f) REGIDESO will recruit before Credit effectiveness chiefs for its Accounting Department and Internal Auditing Unit; (f) DGHER will appoint before Credit effectiveness a project manager for the execution of the rural electrification and charcoal efficiency components and hire an expert in finance and accounting. 52. Benefits. The largest benefits will come from the pricing policy reforms and the institutional strengthening to be implemented under the project. The energy sector is a key sector and efficient use of its resources and improved public investments quality will enhance growth prospects. The charcoal efficiency and the improved charcoal stoves programs will reduce charcoal and wood consumption and represent an important element in the strategy to reduce deforestation and address environmental concerns. The programs for new electricity connections in urban areas and for rural electrification will increase access to electricity, improve the quality of  - 16 - life, and contribute to increases in rural production. The average economic rate of return of the investment programs supported by the project has been estimated at 35 percent. 53. Risks. The physical risks of this project are minimal because construction work in transmission and distribution lines would be executed under well-known conditions. The main risks are institutional: the government may resist further increases in energy prices; REGIDESO may waiver in its commitment to implement the Rehabilitation Program; the present institutional framework of the DGHER may not be adequate to manage successfully the rural electrification projects or the charcoal efficiency programs. The government's recent track record with implementing difficult energy pricing decisions and the current levels suggest that the risk of government not taking necessary actions in the future is low. Planning for the rehabilitation of REGIDESO has been the subject of long-standing and intensive dialogue and preparation, and REGIDESO is unlikely to go back on it at this stage. Furthermore, several components of the proposed project aim at strengthening the implementing agencies to further reduce risks. Advertising campaigns for more efficient charcoal producing techniques and the use of improved charcoal stoves will be carefully prepared and monitored for effective sensitization of targeted groups. 54. Recommendation. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association and recommend that the Executive Directors approve the proposed Credit. Barber B. Conable President Attachments Washington, D.C. February 14, 1991  - 17 - SCHEDULE A BURUNDI ENERGY SECTOR REHABILITATION PROJECT Estimated Costs: Local Foroln Total -------J