Senegal - Macroeconomic update report

Report No. 11041-SE Senegal Macroeconomic Update Report June 4, 1993 Africa Region Sahelian Department Country Operations Division FOR OFFICIAL USE ONLY I~~~~~~~~~~~~~ I'~~~~~~~~~~~~~~~~~~~~~~~~7 4.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. - . , g1 2 3-~~~~~~~~~~~~~-; I-~~~~~~~~~~~~~~: *~~~~~~ and may be- t bW b ents ftiet conternts.W mM o tewse   FOR OMCIAL USE ONLY MACROECONOMIC UPDAE UNPORT Table of Contents EXECUTIVESUMARY ........................ . v I. INTRODUCTION ..1.................... . 1 II. RECENT ECONOMIC DEVELOPMENTS .. 2 A. Trends in Aggregate and Sectoral Output. 2 Aggregate Production .................. . 2 Agriculture and Fishing ......... ... .... . 3 Industrial Sector ..................... 8 Service Sector .11 B. Trends in Key Macroeconomic Balances.12 Aggregate Demand.12 Budgetary Tronds.14 Balance of Payments.16 C. Trends and Structure of Financing .19 Domestic Resource Mobilization ..19 Banking Sector Reforms ........... . 22 Monetary Development... . . . 24 External Resource .25 D. Conclusion.28 III. ADJUSTMENT ISSUES AND POLICIES.30 A. Public Resource Management. Public Sector Structure and Issues .30 Public lnterprise Reform.31 Public Sector Resource Mobilization.32 Public Sector Expenditure Policies.34 B. Competitivness .37 Background ... . . . . . . 37 Cost of Production .................. 39 Real Exchange Rate and Terms of Trade.. . . . . . 40 Tariff Protection and Trade Regime . . . . . . . . . . . . 41 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.  - Li - C Hedium-Ters Options . . . . . . . . . . . . . 43 Scenario 1: Reliance on Gradual Internal Adjustment Wlthout SignifLcant Structural Change . 44 ScenarLo 2: More Vigorous Structural Reform .44 D. Conclusion.. . ..... . 45 IV. LONG-TERM ISSUES AND POLICIES.47 ANNZX It Senegal Data Bas .51 ANNS IIt Selected Bibliography. 55 ANNZX III: Statistical Annex .57 Text Tables 2.1: Average Growth and Structur- of GDP, 1981-1990 . . 3 2.2: Selected Agricultural Data, 1985-90. . 5 2.3: Origin and Use of Resources. . 13 2.4: Trends in Government Finance, 1981-91 .15 2.5: Balance of Payments .16 2.6: Composition and Growth of Exports and Imports 17 2.7: Government Revenue, 1981-91 ..20 2.8: Trends in Tax Bases, 1984-88 .. .21 2.9: Customs Duties and Rates . . . . . . . . . . . . 22 2.10s Summary Situation of the Banking System, 1988 . . 23 2.11s Deficit rinancing, 1981/82-1991/92 . . . . . . . 26 3.1: Selected Civil Service Data, 1981-92 . .35 3.2: Classification of Current Zxpenditures . . . . . 37 3.3: Real Exchange Rate vis-&-vis Selected Countries . . 41 3.4: Average Effective Rates of Protection . .43  - iii - CURRENCY EOUIVALENTS Currency Unit - CFA Franc (CFAF) The CFA Franc is tied to the French Franc (FF) in the ratio of FF 1 to 50 CFAF. CFAF/US S (Annual Average) (End Period) 437.0 1984 479.6 449.3 1985 378.1 346.3 1986 322.8 300.5 1987 267.0 297.9 1988 303.0 319.1 1989 289.4 272.1 1990 252.5 282.1 1991 259.0 264.7 1992 275.3 MEASURES AND ZOUIYALZNTS 1 meter (m) , 39.37 inches (in) 1 square moter (m2) - 10.9 square feet 1 kilometer (km) - 0.62 mile (mi) 1 hectare (ha) - 10,000 M2 or 2.471 acres 1 acre - 4,047 m2 or 0.405 ha 1 kilogram (kg) - 2.2 pounds (1 be) 1 pound (lb) , 0.454 kg 1 ton (metric) - 2,205 lbs or 1,000 kg. FISCAL YEAR for Government of Senecal July 1 - June 30 - Up to June 30, 1991 July 1 - December 31 (18 months) - For FY 1991/92 January 1 - December 31 - Starting January 1, 1993 DEVELOPMENT PLANS 4th Plan - 1973/74 - 1976/77 5th Plan - 1977/78 - 1980/81 6th Plan - 1981/82 - 1984/85 7th Plan - 1985/86 - 1988/89 8th Plan - 1989/90 - 1994/95  -iv- : . :t U g X b L .'-.ffi~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.. ...... .. .. Thlc r-port d-cib- m-ro-cobnomL#.ictg dv-lo-t in 8-n-g- *inc-E 198S but~ do- . no t go onyond tho19/ findn, yf-tar Sinc I h n,pwL th- mcron aondmic polie frumJ work h-c comocond- bly~c off Pttrack * th- conty wi nt~ in9o *nsin tol-etoral p riod (p-idniolddl and (-iltv lsationa took~.) Viotrl concid-abalytdii wornd Th r-or (bXacoti-p aywne d-t-il-d rtospp ctv-ofth tina*lcuti.n *xp ri amudd Prop y .m Scn g-l ae), *nd Kax.hal2 itcthe a An-MPnt *.rat-g Ah *uch,it Diis ion ..d.. tandtng th- cst tr This report describes macroeconomic developments in Senegal since 1985 but~~6t ..... does not go boyond the 1991/92 fiscal year. Since then, the macroeconomic policy framework has come considerably off track an the country went into an electoral period (presidential and legislative elections took place in February and May of 1993 reupectively), and the financial situation has considerably worsened. The report provides a detailed retrospective of the difficulties experienced by Senegal in designing and implementing its adjustment strategy. As such, it helps in understanding the constraints under which economic policy measures will have to be implemented in the future by the new government.  SENZGAL - MACROECONOMIC UPDATZ EXECUTIVE SUMMARY i. This report is an update of the economic situation of Senegal since 1985, the last year covered by the provious country economic mmorandum issued in February 1987. Since 1984, the Government of Senegal has embarked on an adjustment program aimed at restoring key macroeconomic balances and at fostering sustainable growth. This reform program has been supported by five IDA adjustment operations (three SALx and two SZCALs) with significant amount of cofinancing, a three-year ESAF from the INF and other concessional assistance. Overview of the Reform Proaram and Its Impact ii. Faced with major economic disequilibria and production costs which are much higher than in its main competitors including other non-CFA neighboring countries, s8negal has adopted domestic demand restraints accompanied by a number of measures designed to improve the management of public sector resources and to achieve low inflation in order to regain some degree of competitiveness. Through the curtailing of non-wage public expenditures, heavy reliance on extraordinary public revenue, and lower imports, S-nogal has managed to improve its fiscal position and external accounts. But the difficulties encountered by the government in consolidating progress of past stabilization have led to frequent policy reversals. Since 1988/89, revenue shortfall and continued imbalance between wage and non-wage expenditures have led to the need to increase public revenue when the tax base is shrinking and to drastically reduce non-wage current expenditures. Not only is this policy environment detrimental to private sector development, it also forced the delay of measures designed to reduce the cost of key factors such as energy. iii. The overall fiscal deficit declined from 9.3% of GDP in 1981/82 to 3.5% in 1986/87. This favorable trend, which reversed itself in 1987/88, has worsened in the period 1987/90 for a number of reasons including a further weakening of the tax effort, a lower relative contribution from non-tax revenue (essentially from petroleum products), and the increasing difficulty to control expenditure without drastically reducing the civil service wage bill. In 1991/92, civil service wages absorbed 56% of tax revenue. The improvement in the fiscal situation for the period 1981/82-1986/87 was achieved against the background of deteriorating tax revenue (from 18.5% of GDP in 1981/82 to 14.6% in 1986/87). Fiscal revenue amounted to 15.2% of PIB in 1991/92. This deterioration occurred despite numerous efforts to reverse the downward trend. This trend implies that additional efforts to raise revenue through higher tax rates could lead to a further shrinkage of the tax base itself if the formal sector continues to perform poorly and fraud increases. iv. Although the reduction in overall dometic expenditure was the cornerstone of the stabilization program, most of the improvement was brought about by a compression of private consumption and investment. The contraction, in relative terms, of private consumption generated higher domestic savings which turned positive for the first time in 1986 and currently stand at 9% of GDP. In  - vi - spite of the vastly improved fiscal position, the government sector has continued to be a not dissaver (current expendituro-exce-d current tax and non-tax revenues) until 1990/91. v. Important reforms have also been implemented in agriculture, industry, banking, and the management of the public sector. In agriculture, the Government has privatized the marketing of coarse grains and groundnuts (but not processed groundnut oil) and the distribution and collection of groundnut seeds, liberalized input distribution, eliminated fertilizer subsidies, and scaled down the activities of the rural development authorities. To promote the industrial sector, the Government has rationalized the structure of protection, opened mout economic sectors to outside competition, revised the investment code, and introduced some flexibility in the labor market. But the necessary accompanying measures aimed at reducing the cost of production and improving the environment have proceeded at a much slower pace due in part to fiscal constraints. The reforms have forced enterprises to improve productivity. Increased competition has also led to a decline in prices for mout industrial goods. The reforms may also be responsible for some loss in employment; this has been partly compensated by job creation in the informal sector. vi. In the area of public sector resource management, the Government has begun implementing a reform program aimed at downsizing the civil service and, following a hesitant start, has proceeded with the divestiture program. It has concurrently made important efforts to settle cross-debts between the State and the parapublic enterprises and to reduce budgetary subsidies provided to these enterprises. In the banking sector, which was practically bankrupt in 1987, the closing of several public-sector development banks, combined with the reinforcement of supervision and monitoring by the Central Bank, has helped re- establish confidence in the sector. The adjustment process is far from being complete and Senegal still faces severe financial and economic constraints which remain to be tackled. The supply response from the private sector has been weak and is expected to remain so without much deeper reforms, principally a moro aggressive real exchange rate depreciation, lower cost of inputs, and a more favorable business environment. Recent Trends in Outout vii. The analysis of Senegal's economic performance is complicated by significant weaknesses in the data base. There are, for instance, unexplained discrepancies between national accounts figures on industrial growth rates and the performances of individual sub-sectors as measured by industrial production indices. Also, compared to levels ranging from 35 to 50% in developing countries at similar stages of development, the tertiary sector in Senegal accounts for about 60% of GDP. A part of this sector consisting of activities such as trade, transportation, and other miscellaneous services are extrapolated from data obtained during the baseline survey of 1973/75. As a result, as much as 40% of GDP is derived from extrapolations of past data. These problems raise the fundamental question as to the real growth performance of S-negal, which may in fact be weaker than depicted by official data. viii. In spite of more favorable climatic conditions since 1985, gross domestic product grew on average at a rate of 3.3% per annum or while population  - vii - grew at a rate estimated in the range of 2.8 to 3.2%. Mozt of this modest expansion was accounted for by a strong rebound in agriculture, which, although accounting for only 12% of overall GDP (average of 1986-90), continued to have a major impact on the economy through the demand originating from rural areas. But from a longer term perspective, Senegal's agricultural sector has changed little in terms of total cultivated area (2.2 to 2.5 million hectares) and total output (1.7 to 2.0 million tons). Declining soil fertility and rising population pressure have led to the expansion of farming into marginal lands, to sharp declines in cultivated areal' and output per agricultural worker, and to a shift towards food crops at the expense of cash crops. Senegal's agriculture has yet to respond to the declining land/man ratio as evidenced by the absence of yield- increasing measures such as higher cropping intensity or improved cultural practices with possibly cotton and confectionary groundnutc as the exceptions. The shift from groundnuts to millet and maize has also caused a significant erosion of incomes of the rural population, thus reducing their capacity to purchase manufactured goods and to invest or to utilize more cash inputs. ix. While official national income accounts show growth averaging 5.4% for the secondary sector, detailed production indices by main industrial sub- sectors indicated that most industrial sectors have experienced a decline since 1986. The decline was particularly severe for light manufactures (textiles and shoes) which faced stiff competition from imported goods, largely due to smuggling and under-invoicing. Senegal's formal industrial sector, which provided employment to less than 2% of Senegal's active labor force faced major difficulties which stemmed in part from past policies which favored industrialization through high import protection, the narrowness of the local market, excessively high cost of key inputs and factors (particularly labor, energy and transport), intense competition from smuggled imported goods and external competition. Firms in this sector are generally encumbered by aging equipment (averaging 24 years) and low capacity utilization. x. Senegal's other two important sectors have also not been performing well. The fishing sector, which contributes 22% of merchandise export earnings, in facing serious problems. Overfishing -- particularly within the six-mile zone set aside exclusively for artisan fishermen -- , the lack of an effective strategy of resource management, and an aging fl-et are posing a major threat to this vital sector. Total fish catch, which registered an average growth of 3.9% in the past decade, has slowed to 2.5% in recent years. Five fish canning and freezing firms have closed down since 1988 because of inadequate supply of fresh fish and high energy cost. As a consequence, output of canned tuna has fallen by almost 50% between 1986 and 1990, from 27,000 tons to 15,000 tons. As a result, Senegal's share of France's tuna imports, its most important market for canned tuna, has fallen to less than 20% in 1990 with some of the slack made up by higher exports of shell fish. xi. Growth in the number of tourists has slowed. From an average of 4.3% during the period 1980-85, the rate of increase of the number of arrivals has slowed to 2.1% in the second half of the 1980s. In the meantime, tourim ' Since the mid-1960s, average area per active agricultural person has fallen from 0.8 ha to 0.6 ha for food crops, and from 0.e ha to 0.4 ha for cash crops.  - viii - facilities have increased significantly in recent years, causing the occupancy rate to fall from 45% in 1984 to 38% in 1989 with a particularly severe drop for hotels. For most hotels of good standing in Dakar, an occupancy rate of 40 to 45% is considered necessary to avoid losses. xii. The slow down in all major productive sectors and their major constraints does not augur well for its growth outlook in the medium term. The longer-term trend is moreover worrisome for a number of other factors. Problems related to the fragility of fiscal improvement, particularly the reliance on non- tax revenue and the sharp curtailing of non-wage expenditure, have already been discussed above. Expenditures in the health sector was the hardest hit while that in education declined by 15S on a per capita basis in real terms. Damages to the country's physical infrastructure have also been extensive. It is, for instance, estimated that 30% of the paved road network suffers from accelerated deterioration due to the lack of maintenance. On the other hand, most of the improvement in the balance of payments since 1986 was accounted for by falling prices for the country's major imports (petroleum products and rice) and lower import volumes. Exports have been stagnant or falling with the exception of phosphates. Between 1982 and 1990, Senegal's two key exports, fish and groundnuts, increased by a mre 0.5% per year in volume terms. Senegal's growth is moreover constrained by a very low rate of fixed investment which currently represents only 12% of GDP compared to an average of 15.5% for Sub-Saharan Africa. Compared to the general rule that, in Africa, a fixed investment rate of 12 to 13% is required to prevent the stock of capital from deteriorating, 8Snegal has been disinvesting ln the last decade. Adiustment Issu-s and Priorities for Economic Policies Public Sector Hanacement xiii. With regard to public resource management, the concern remains the excessive absorption of resources by the public sector, in spite of progress achieved during the 1980s. Past experience and the continued weakness in the economy highlight the limits of the scope of a rapid increase in the revenue- over-GDP ratio; the burden of fiscal retrenchment will need to fall on the rationalization as well as reduction of public expenditures and a better control of external borrowings in order to prevent the rapid rise of interest payments. The urgency of the these reforms is more critical since Snegal continues to rely heavily on petroleum and rice non-tax revenue to finance its current expenditures; consequently, energy prices are excessive, severely penalizing the country's industries and services. xiv. Although the civil service wage bill has also been falling, the cost of the civil service remains high in Senegal compared to countries with similar levels of income. Given the sharp reduction in non-wage recurrent expenditures in 1990/91, the wage bill share of total current expenditures has risen from 50% in the early 1980c to 56% in 1991/92. This compares with an average of about 38% for UWOA as a whole. While the Government has recognized the need for staff reduction, the implementation of the civil service reforms has encountered several slippages including backtracking regarding the reduction of the number of ministries, lack of progress on the privatization of certain services, as well as delays in basic institutional reforms, and the organizational audit.  - ix - xv. Public remource Mobilization. Deficiencies in fiscal administration have led to a growing informal sector that e*caped taxes, thereby placing an excessive tax burden on a shrinking formal sector. Recent offorts to generalize the value-added tax (VAT) to commerce and other services will not likely yield significant revenue in the near term. Thus, while waiting for domestic taxation, including that of the informal sector, to become more entrenched, Senegal's tax strategy in the next few years will have to continue to depend primarily on customs receipts and other external trade taxes such as the VAT on imported goods. Weak administration has been identified as a major obstacle affecting customs receipts in S-negal as well as in other African countries. Setting higher tariffs not only has resulted in increased smuggling but has also raised production costs with detrimental effects on the overall competitiveness of the economy. The widespread use of minimum customs tax assessment, introduced in late 1989, appears to be relatively successful in roducing the extent of under- invoicing. It is, however, important to provent the misuse (as a protective device) of the minimum taxes in the same manner that reference prices have served in the past. The recent government decision to hire SGS, an international surveillance agency, is a step in the right direction and is expected to enhance customs revenue collections. Customs receipts are also being adversely affected by the granting of numerous exemptions; for the period 1987/90, on average, 38% of total imports were exempted from the payment of customs duties. The Government is in the process of reviewing the exemptions with a view towards their rationalization. xvi. The multitude of tax measures introduced since 1989 reflects the Government's focus on short-term financial stabilization at the expense of long- term growth considerations. The reform program has so far inadequately addressed the issue of the narrow and shrinking tax base and the consequent high tax burden on a small group of tax-payers in the formal sector. The most immediate concern of tax policy in Senegal is to stop the decline in the share of Government tax revenue to GDP and mobilize additional resources, primarily through a widening of the tax base and a more rigorous control of smuggling. Therefore, new efforts should be taken to bring the informal sector under the tax net. It is, however, critical that these measures be rigorously applied to yield the expected results. In the medium term, it is important that revenue mobilization objectives be considered in light of the level and structure of public expenditures as well as their impact on the economy. Given the already high level of customs tariffs in Senegal--most imports into Senegal currently pay 90% of combined customs and value-added tax--it is critical that more focus be put on what ought to be an appropriate level of expenditure, given the amount of available resources. xvii. Adiustment to Lower External Suoiort. Total official development assistance (resource flows that are characterized by a concessionality or grant element of at least 25%) to Senegal grew at a rapid rate of 7.4% during the 1980s, averaging US$ 641 million a year during 1986-89. Compared to other Sub- Saharan African countries, Senegal received substantially more per capita assistance. Net of principal repayment, per capita assistance received by Senegal rose from US$ 59 in 1984 to US$91 in 1989. Beginning in 1983/84, external quick-disbursing budgetary assistance in support of structural reforms enabled Senegal to rely increasingly on external sources to finance its budgetary deficit. In 1987/88, budgetary assistance, including the IMF contribution, amounted to CFAF 90 billion (USS 290 million). Although it has since declined  - x - to less than USS 200 million a year, this level is still unsustainable and highlights the urgent need for Senegal to hav- a more lasting fiscal improvement. xviii. ParaDublic Sector Reforms. Although encouraging as a start, the impact of the divestiture program on total Government equity in the PE sector is relatively modest. It is important, therefore, that the Government continue its efforts toward the transfer of ownership to the private sector and other means, such as the privatization of management, beyond the SAL IV targets. Another important asp ct of the PZ sector reforms is the rationalization of the financial relations between the Government and the PE sector, namely, the reduction of direct and indirect subsidies and the settlement of cross-debts between the Government and the PZs. The Government has succeeded in reducing total direct subsidies to the sector from CFAF 14.4 billion in 1988/89 to CFAF 11.8 billion in 1990/91. Most indirect subsidies are also being more strictly controlled. The Government has also worked out a satisfactory settlement plan for all cross-debts. It is, however, important that concrete measures be implemented quickly to prevent the recurrence of the cross-debt problems. Issues of Efficiency and Competitiveness xix. Private sector activities in Senegal face many constraints ranging from a burdensome regulatory framework to excessively high input costs. High costs affect in particular energy, transport, and telecommunications. As for labor, the problems are three-folds high real wages together with low productivity, and rigidity of the labor market. Second, deteriorating terms of trade, low productivity gains, and the sharp appreciation of the real exchange rate have severely eroded the competitiveness of Senegal. Third, several recent changes in the protection system have increased distortions among sectors of the economy, leading to a less efficient allocation of already scarce investment funds. xx. Structural adjustment in Senegal must lead to an increase in the output of traded goods -- exports as well as efficient import substitutes. To do this, a depreciation of the real exchange rate is needed to provide private entrepreneurs with an incentive to produce more tradable goods. Due to its membership in the CFA franc zone, unilateral adjustment of the exchange rate is not considered to be a policy option. The alternative is to maintain very austere demand management policies in order to keep domestic inflation lower than rates in other Senegal's main trading partners. Senegal has so far adopted this strategy, but with limited success. The combination of high inflation, until the early 1980s, and adverse terms of trade, which have not been compensated for by greater productivity, has severely eroded the competitiveness of Senegal. The situation has become more difficult since 1985 due to the fall of the US dollar -in relation to the French franc, and the sharp real currency depreciation in countries against which Senegal has to compete on its own domestic market. Real exchange rate indices with Ghana, Nigeria and China show appreciations of 92, 73 and 58%, respectively, over the period 1981-90. A more vigorous adjustment effort is needed.  - xi - Lona-Term Issues and Policies xxi. Human Resources Develooment. Senegal's demographic dynamics are characterized by a young and rapidly growing population, particularly in urban centers. At current growth rates (estimated at between 2.8 and 3.2% p.a.) Senegal's population at the turn of the century will be about 10 million people. An approximate 125,000 young adults are expected to join the labor force every year. Financing the education and health care requirements for this growing population will continue to be one of the central preoccupations of economic policy in the medium term. Rapid population growth also has an adverse impact on natural resource management practices and, consequently, the environment. The adoption of the national policy on population and the definition of a priority investment program in this sector represent major steps forward in the right direction. xxii. In the health sector, the adequacy and quality of health delivery services in the public sector have deteriorated significantly over the last decade. Given the limited resource availability, the Government has decided that priority will need to be given to organizational and management issues, namely the promotion of community health organization, the establishment of a decentralized health delivery system, and the rationalization of the financing and procurement of drugs. In education, the situation is dramatic. The enrolment ratio in primary education has stagnated since the mid-1980s at about 57% (compared to an average of 95% for middle-income African countries which include Senegal) while higher education has been absorbing an increasing share of the government's resources. In 1989/90, 24.5% of the education budget goes to higher education which caters only to 2% of the total student population. There are many indicators pointing to a gradual decline in quality of education, raising doubt about basing Senegal's future economic growth on the strength of its human resources. xxiii. Environment. Senegal faces key environmental issues which are all made worse by rapid population growth. These include soil degradation, saline intrusion in large parts of the Casamance and the Delta area, loss of forest cover caused by excessive demand for charcoal and fuelwood. Soil degradation is compounded in most areas by the cutting of trees and shrubs for firewood which further exposes soils to erosion by wind and water and by overgrazing. To avert this potential ecological disaster, Government needs to improve the management of forest resources principally by delegating such management to local communities and by better demand management through encouraging substitution based on realistic, market-based pricing for all fuels. The task now is to promote integrating of the technology into traditional farming methods via the use of appropriate incentive and legal and technical measures. xxiv. Infrastructure maintenance. Problems of rapid deterioration of the country's basic infrastructure such as the road network have been highlighted above (para. xii). This problem affects other infrastructure such as major irrigation projects without which the potential of the entire Fleuve area will remain unexploited. xxv. Recional Intearation. After years of relative neglect, the question  - xii - of economic integration is once again at the center of the policy agenda in Went Africa. This is partly in line with a recent worldwide trend toward the formation of larger trading blocs. But it (5 also looked at as a way to achieve more sustainable economic growth based on a larger economic area. Senegal has been at the forefront of this new of fort, whether it concerns regional offort in the field of agriculture or the creation of a regional cereals market in West Africa. Given its geographical position, Senegal should continue to play this leadership role by providing an enabling environment for trade, competition and factor mobility and by strengthening its macroeconomic environment.  MACROECONOMIC UPDATZ 1. XNTRODUCzI 1. The last country economic report on Senegal, entitled S-neal: An Economy under Adiustment and issued in February 1987, was written at the time when the Government, recognizing the need to intensify the adjustment offort, launched a comprehensive economic reform program for the period 1985-92. The report concluded that even if the launching of the adjustment program was relatively successful, tho achievement of growth in real per capita income would be predicated on the convergence of a number of favorable developments on the supply side and the ability of the economy to generate resources for major rehabilitation of existing assets and new investments. This outcom assumes that the Government will press ahead with policies aimed at further liberalizing the economy, continue the incentive policy reforms, and strengthen public sector management. 2. Although a more limited undertaking than a full-fledged Country Economic Kemorandum, this Update represents the first systematic effort by the Bank since 1986 to review the performance of the Senegalese economy. The report also draws on the findings of two recent reportso The World Bank and S-n-cal. 1960-87 by the Operations Evaluation Department of the World Bank and Adiustmunt Postooned: Economic Policy Reform in s8necal in the 1980s by. Elliot Berg at. al. The proesnt report consists of four main sections. Section 2 reviews economic developments during the second half of the 1980., and discusses the impact of the economic reform program. Section 3 focuses on two key adjustment issues -- public resource management and competitiveness -- and highlights the country's options in the medium-term. Section 4 reviews the long-term issues facing the economy. Gaps and deficiencies in the country's economic and financial data base are discussed in Annex 1.  II RECMNT LCONOWIC DZVELOPNENTU 3. With a per capita income estimated at US $710 in 1990, Senegal is comparatively better off than other Sahelian countries. In 1989, Senegal also received about 2.5 times more per capita assistance from abroad compared to the average of other countries in Sub-Saharan Africa. Nonetheless, Senegal has, since independence in 1960, recorded the lowest growth of any African country not affected by war or civil strife. These facts raise some fundamental questions about Senegal's development performance and challenges, some of which have been examined in recent studies.' 4. The analysis of Senegal's economic performance is complicated by significant weaknesses in the data base. Besides the lack of reliability and incomplete coverage common to other developing countries, it is difficult to dissociate, in the case of Senegal, actual results from projections and preliminary estimates incorporated in financial stabilization programs. Given the magnitude and complexity of the problems, there was no attempt to re-estimate the data. The analysis presented in this report is thus essentially based on official statistics provided by the Government. Inconsistencies in the data base are highlighted where relevant; a more detailed discussion of the data probl-ms is presented in Annex 1. A. Trends in Aaarecate and Sectoral Output Aggreaate Production 5. From a broad macro-economic standpoint, the Senegalese economy has gone through six reasonably distinct periods since independence. Until 1966, when France's preferential treatment for Senegalese exports -- especially groundnuts -- was discontinued, real GDP recorded steady growth ranging between 2.5 and 4.5% per year. The ending of this treatment for groundnuts, which thereafter had to compete in the world market, led to a marked decline in groundnut production and, correspondingly, GDP growth. Groundnut production fell by almost half between the beginning and the end of this period (1967-74) and GDP grew by only 1.3% per annum on average. Concurrently, the Government actively pursued a 'Senegalization' policy (by purchasing foreign-owned enterprises) and an import-substitution industrial policy. More importantly, Senegalese industry which had before independence been the main provider for the French West African market of about 20 million people, found itself with a much smaller internal market beginning in 1960. 6. The third period (1974-78) was one of export-led growth which coincided with the commodity boom following the firat oil shock when prices and world demand for phosphate and groundnut. rose substantially. The fourth period (1978-81) was characterized by several unfavorable developments, including two Y' Besides the World Bank and Berg reports mentioned above, several other studies have focused on selected sectors and specific aspects of the reform process. See Judet (1989), Log-ay (1990), and the World Bank (1991) for more detailed discussions of the industrial sector; USAID (1991) for the agricultural sector; and the World Bank (1989) for the parapublic sector.  - 3 - movere drought years in 1979 and 1980, a drastic fall in world groundnut prices and the doubling of the world oil prices. As a result, agricultural output fell by 40% during the period. In 1981, domestic absorption exceeded output for the first time, leading to record high current account and fiscal deficits. The decade of the 1980s, which covered the fifth and sixth periods, can roughly be broken down into two distinct phases: the first half, when government efforts were directed mainly toward stabilizing the economy, and the period since 1986 when the Government began addressing structural issues. Senegal's performance during the first half of the 1980. was analyzed in the 1987 Country Economic Memorandum. The present report will concentrate on the performance of the Senegalese economy in the second half of the decade. 7. While average growth during the first half of the 1980. was restricted by poor agricultural performance due primarily to the severe drought of 1983/84, growth since 1986 was helped by a rebound in agriculture, albeit from a low base (Table 2.1). In spite of its relatively small size, relative to overall GDP, agriculture continued to have a major impact on overall growth through its multiplier effect on the rest of the economy. The secondary sector, boosted by strong performance in residential construction, also experienced high growth during the 1986-90 period. Therefore, the relative shares of the primary and secondary sectors increased, while that of the services sector declined slightly to about 60% of GDP in 1990. The bulk of value-added in the services sector originated in commerce and transportation where little reliable information exists. TkblL 21: Average Growth end Structure of GDP, 1981-1990 (in percentage) 1981-85 1986-90 Growth Share Growth Share GDP 3.0 100.0 3.5 100.0 Primary Sector 1.8 21.6 4.1 21.6 o/w: Agriculture 0.0 12.5 3.9 11.6 Secondary Sector 4.5 17.2 5.4 18.2 Services Soctor 3.0 61.2 2.8 60.2 Source: SA Tabe 7. Aariculture and Fishina 8. Although the aaricultural sector -- excluding sugarcane which is considered in official statistics as a manufacturing activity -- accounts for only 12% of GDP (average for 1986-90), it still employs 60% of the labor force and provides a living for over two thirds of the population. Demand for goods and services originating from the rural areas remains an important determinant  -4- of the level of activity in the rest of the economy. A poor groundnut crop, whose fortunec are dictated by climatic conditions, would lead to a decrease in purchasing power for 70% of the population and to repercussions throughout the economy. Being primarily rainfed, the agricultural sector in Senegal has been characterized by sharp output variations. Since 1970, agriculture output recorded 13 years of increase and eight years of decline. An an indication of the importance of this sector, the fall in agricultural production has always led to contraction in the overall level of CDP, except in 1987. Due to more abundant rainfally, agricultural production registered a significant recovery in the second half of the 1980c, albeit from the depressed level following the severe drought of 1983/84. Also, rapid population growth and deteriorating soil fertility in the north has forced a southward move of agricultural activities towards the Casamance and Bastern regions. 9. The last five years have witnessed som growth in food and cash crop production attributable in great part to the return of normal levels of precipitation. From a longer term perspective, Senegal'I agricultural sector has changed little in terms of total cultivated area (2.2 to 2.5 million hectares) since the early 1960. (Table 2.2). There has also been little change in the cropping mix, with 50% of the annual cropped areas devoted to millet, 35% to groundnuts, 4.5% to maize, 4.1% to cowpeas, and 3.5% to rice. Maize cultivation, which has registered the fastest growth in the last six years, is currently as important as that of rice. Rice and maize production together reached almost 300,000 tons in 1990/91, compared to 660,000 tons for millet and sorghum. 10. Most of the expansion in food crops appeared to be due to farmers opting out of traditional cash crops. Groundnut areas in the second half of the 19801 were thus 28% below the average acreage for the 1970s. During the same period, millet area increased by 9% and total cropped area declined by 7%. The shift toward millet and maize at the expense of groundnuts has been most pronounced in the second half of the 1980s and was most noticeable in the Groundnut Basin (consisting of the regions of Diourbel, Kaolack, ThiAn and Louga) where 54% of the rural population is located and where 70% of groundnuts and 65% of millet and sorghum are produced. While producer prices are generally believed to partly explain area and output levels, it is worth noting that the substitution of traditional cash crops by food crops occurred when groundnut prices were raised twice between 1985 and 1988, resulting in a sharp improvement in groundnut prices relative to prices of food crops. Y Between 1960 and 1980, isohyots of mean annual rainfall have showed a southward migration of about 120 kilometers. Average annual rainfall in the Dakar region has fallen from 600 to 400 millimeters. With the exception of 1985/86 when rainfall was sparse in the northern half of tho country and again in 1991/92, precipitation since 1986 appears to have returned to the levels registered in the 1960c over most of the country.  Tabl- 2 2 Selected Agricultural Data, 1985-90 85/86 86/87 87/88 88/89 89/90 90/91 s 60/70 70/80 85/91 Climatic Good Average Good Poor Average Poor Yearly Averages conditions Cult'd aroa (000 2,305 2,143 2,226 2,231 2,178 2,248 t 2,273 2,392 2,222 ha) Millet/sorghum 1,338 992 1,073 1,022 1,084 1,038 : 974 999 1,091 Groundnuto 604 807 844 902 784 910 : 1,066 1,121 809 Other crops 363 344 309 307 310 300 233 272 322 Production (000 t) 2,122 2,013 2,268 1,863 2,174 1,925 t 1,754 1,706 2,061 Millet/sorghum 949 633 801 594 766 660 : 487 540 734 Groundnutc 601 840 963 737 844 703 932 875 781 Other crops 572 540 504 532 564 562 s 335 291 546 Value of total output (CFAF billions) Nominal value 171.1 163.8 184.7 142.9 161.4 s 38.3 63.2 164.8 Real terms 174.6 163.8 180.9 138.0 151.4 s 179.2 158.4 161.7 Value of marketed output (CFAF billions) s Nominal value 56.8 74.7 77.6 56.3 66.0 s 18.8 30.2 66.3 Real terms 58.0 74.7 76.0 54.4 61.9 s 104.8 88.8 65.0 a) Good, average, and poor climatic conditions are relative rankings based on total amount and distribution of precipitation. Sources: SA Tables 10, 11, and 15. 11. This trend underlies more 4mportant changes. Rising population pressure together with the near exhaustion of arable lands, has led to a sharp decline in cultivated area per active agricultural worker, forcing farmers to allocate a greater proportion of their land to food crops in ordor to meet  -6- consumption needs. Thum, although total food crop area ha. expanded, area planted to food crops on a per capita basis has declined by about 1.0% per year since 1960, leading to a decline in per capita food production.Y This fall in per capita food production accounted in part for the rise in rice consumption (averaging 3.5% annually over the past two decades); rice consumption also increased as the country became more urbanized. An a result, rice imports (including food aid) reached 385,000 tons in 1990. Wheat imports have also experienced a similar trend, reaching 150,000 tons in 1990. 12. Although declining in relative importance, groundnut is still Senegal's most important cash crop and currently accounts for about 60% of farm cash income. Groundnut production has moved from the Groundnut Basin to the south and the southeast where rainfall is more abundant. These two regions currently account for 27% of total production compared to l-es than 15% in the 1960s. Overall, groundnut area has declined by about 25% since the 1960s. Production, which reached a high of 963,000 tons in 1987 when rainfall was favorable, has suffered a significant decline in the following three years. Consequently, the four groundnut oil mills were operating at slightly about 50% capacity in the second half of the 1980s.z Furthermore, domestic vegetable oil consumption, which is increasing at 4% per year, will continue to divert an increasing share of groundnut production to artisanal oil processing.F 13. output of edible groundnutsl' has increased steadily, reaching 25,000 tons in 1989. Their high level of aflatoxin, however, constituted a serious hindrance to the development of exports. In 1989, only less than 20% of purchased edible groundnut was of exportable quality. The remaining quantity was sold domestically for oil production. Improved cultural practices have led to a noticeable improvement in yield per hectare; the problems of aflatoxin is also expected to be resolved soon. 14. Cotton and sugarcane are the next two most important cash crops. cotton is primarily produced in Eastern Senegal. All collection, processing and marketing is carried out by a parastatal, SODEFITEX, which also provides credit and extension services. Cotton production reached its peak of 60,000 tons in 1984, and has since then fluctuated between 30,000 and 45,000 tons. Sugarcane is produced by a private firm, the Compagnie Sucri&re du S6n6gal (CSS). Production has steadily increased since 1979 to reach 770,000 tons in 1990. f Since 1960, the area in food crops per active agricultural person has fallen from 0.8 ha to 0.6 ha; for cash crops, the area has declined from 0.8 ha to 0.4 ha. See USAID (1991) for a more detailed analysis of the longer-term trends in agriculture. ' An average of 540,000 tons of unshelled groundnut, were processed by SONACOS, the Government owned oil processing company which has a combined capacity of over one million tons. F The trend toward lower production combined with the larger role of artisanal oil production was one of the major considerations for the Government's announcement in 1991 to increase producer's price of groundnut by CFAF 10/kg to CFAF 80/kg. I/ The production and marketing of edible groundnuts were under the direction of a public enterprise (SEPFA) which has been privatized and renamed SONASEN.  15. Stronger growth in agricultural production during 1986-90 was generally attributed to the return of more favorable climatic conditions. To encourage agricultural production and to slow the flow of migrants to Dakar and other urban centers, the Government had, over most of the 1980s, paid greater attention to pricing policy as a means for stimulating production and shifting income in favor of rural producers. Prices of groundnut. and paddy were raised twice in 1984 and 1985, cotton in 1985, local cereals (including maize) three times in 1983, 1984, and 1985, and cowpeas twice in 1983 and 1985. As a result, average real prices for marketable crops were 12% higher in 1987 than in 1980. Depressed world prices for groundnuts since 1988 have necessitated a reduction in groundnut producer prices; given the large weight of groundnut in total marketable crop, this price reduction has brought about a 15% decline in average real agricultural prices since 1988. 16. Aside from the particular circumstances which governed groundnut prices, government pricing policLes did translate into higher real prices for most crops, particularly for maize and cowpeas. Higher agricultural prices combined with declining real urban wages have turned domestic terms of tradeF in favor of the rural population. Although their incomes may have risen moderately compared to those of the urban population, the rural population had experienced falling real incomes. Compared to the level of the l60s, the value of marketed output (expressed in constant 1987 prices) has fallen by 38% during the 1986-90 period. This development can be explained in part by the dramatic shift toward food crops at the expense of groundnuts. The share of marketed agricultural output, which accounted for 60% of total output in the 1960., has fallen to 40% in 1986-90. These trends have important implications. Based on a population growth rate of 2.0% per year in the rural areas -- compared to 3.8% for the urban areas -- real per capita income in rural areas has declined by 20% since the mid-1970s. This decline not only seriously undermined the rural population's capacity to use more cash inputs, but also contributed, through lower purchases of manufactured goods and services, to depressing the overall level of economic activity. 17. In conclusion, in spite of a succession of relatively good harvests in recent years, the long-term trend in agriculture is alarming. Inadequate rainfall, stagnant technologies, reduced use of inputs (fertilizer use has dropped from 75,000 tons in 1980 to about 25,000 tons in recent years), and declining soil fertility in the Groundnut Basin together with a high rate of population growth have led to the expansion of farming into marginal lands where yields are lower and to a steady decline in cultivated area per agricultural worker. Furthermore, the shift from cash to food crop cultivation will continue to erode real income of the rural population, threatening to reduce investment in agriculture and the utilization of cash inputs. Under such conditions, the focus on pricing and financial stabilization measures, which emphasize reductions in budgetary transfers to agriculture, will not likely lead to significant changes in this key sector. A longer term development strategy is urgently needed. 18. The fishina sector, which employs directly and indirectly about 150,000 people, contributes 22% of merchandise export earnings but only 2.3% of