Zambia - Second Privatization and Industrial Reform Credit Project

Docuet of Tlhe W:'-rld Bank FOR OFFICIAL USE ONLY R4ot No. P-6082-ZA REpORT AND RECOIENDATION OF THE PRESIDENT OF THE INTENTIONAL DEVELOPMT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN THE AOWUNT BQ1UIVALET TO US$100 IL:LION TO THE REPUBLIC OF ZAHBIA FOR A SECOND PRIVIZATION AND INDUSTRIAL REFORM CREDIT MAY 27, 1993 MICROFICHE COPY Report No.:P- 6082-ZA Type: (PR) Title: SECOND PRIVATIZATION AND INDUS' Author: BROADFIELD, ROBIN Ext.:37505 Room:J11099 Dept.:AF6IE This document has a restrited distribution and may be used by recipients only in th performanc of their official duties. its contents may not otherwise be disciosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Zambian Kwacha (K) US$1 = 1520 (April 1993) FISCAL YEAR Government January to December Zimco Parastatals April to March ABBREVIATIONS AND ACRONYMS BOZ Bank of Zambia CG Consultative Group for Zambia DBZ Development Bank of Zambia DDSR Debt and Debt Service Reduction EC European Community ERC Economic Recovery Credit (2214-ZA) ESW Economic Sector Work FIAS Foreign Investment Advisory Services (World Bank Group) GDP Gross Domestic Product IDA International Development Association IFC Intemational Finance Corporation IMF International Monetary Fund INDENI Oil refinery MMD Movement for Multiparty Democracy NCZ Nitrogen Chemicals of Zambia NGO Non-governmental organization ODA Overseas Development Authority (UK) OGL Open General License PFP Policy Framework Paper PIRC I Privatization and Industrial Reform Adjustment Credit (2405-ZA) PIRC TA Privatization and Industrial Reform Technical Assistance Credit (2406-ZA) PIRC II Second Privatization and Industrial Reform Credit PPM Program to Prevent Malnutrition PTA Preferential Trade Area PTC Posts and Telecommunications Corporation PTF Privatization Trust Fund SADC Southern African Development Community SDR Special Drawing Rights SEC Securities and Exchange Commission SIDO Small Industries Develop-ient Organization SSE Small Scale Enterprise TAZAMA Tanzania Zambia Pipeline Company UNDP United Nations Development Program USAID US Agency for International Development VIS Village Industries Service ZA Zambia Airways ZACCI Zambia Confederation of Industries and Chambers of Commerce ZCCM Zambia Consolidated Copper Mines ZESCO Zambia Electricity Supply Corporation ZIC Zambia Investment Centre ZIMCO Zambia Industrial and Mining Corporation ZIMOIL Oil Import parastatal ZPA Zambia Privatization Agency ZRL Zambia Railways  FOR OFFICIL USE ONLY ZAMBIA SECOND PRIVATIZATION AND NDUSTRIAL REFORM CREDIT Table of Contets Par No. CREDIT SiilY .................................... i-i I. THE ECONOMYANDTHEBANK'SSTRATEGY .......... 1 A. Background andReent Developmens .. . .................. 1 B. Reent Macro-Econmic performance and Structurd Reform ...... 3 C. SummaryAssessment ......... ..... 7 IL THE SECOND PRIVATIZATION AND NDUSTRIAL RERORM CREDT ............*...................... 8 A. MaoecononmicStoPgabl..onProg.am........8 B. PrivatzatonProgranm ............................... 9 C. Safety Net .. ..... .. . .. . 11 D. Private Secor Development . I.. .I. . 12 E. FinancWSectorand CapitalMarketReformm ................. 14 F. ParastaaiReform ... ..... .......................... 15 G. Disbursement and Procurement ...... .......... ........ 17 H. Program MItanagementad Monitorg ... .................. 18 MonitorableAcidons: By Effeciveas .................. 19 MonitorableActions: BySecondTrawcheRelease ........... 21 MonitorableActions: Byhird,TrancheRelease ............ 21 I. Justificationand Ris ... ....... . 22 (cone'd) This report b based on the fndings of an appraisal misson which vited Zambia in April 1993. The appraisd mission comprisd Vitor Agius, Principal Fiancial Speciist, (AF6IE) (rask ManMer) David A. Cook (Chief, AR6ME; Eric S. Daffen, Principa Energylndustry Spedalist (AF6I; Judith Prs, Conultan Chdrtin Pomie, Consultant; John Todd, Principa Economist (AP6CO); Dougs A. Webb, Pdrncip Counsel (LEGE); W. Pti Ofosu-Amaah, Chief Coune (LE F; and Adiana Arriagada, Su r Staff (AF6IE. Secretri support wa pvied by Noemi Dacany and Adana Ariagada (AF6E. Mr. Stephen Dening (AF6DR) i the maaging Departmem Dirctr. This document has a restricted distribution and may be used by rcpients ony in the perforance of their offiial duties. Its contents may not othewis be discloed without World Bank authoiation.  ZAMDJA SECOND PRIVATIZATION AND IDUSTRIAL RORM CRWDT Table of Contents (cont'd) ANNEXES Annex I: Second Letter of Development Policy Annex II: P1RC II Policy Matrix Annex III: Key Macroeconomic Indicators Balance of Payments External Financing Requirements Social Indicators of Development Annex -V: Supplementary Data Annex V: Statement of Bank Group Operations Annex VI: Firms Scheduled for Privatization Annex VII: Status of Companies Scheduled for Privaization in Second Round Annx VHII: Privatization Trust Fund  ZAMBIA SECOND PRIVATIZATION AND INDUSTRIAL REFORM CREDIT CREDIT SUMMARY Borrower/Beneficiary: Republic of Zambia Executing Agencies: Minstry of Finac Ministry of Commerce, Trade and Industry Miiry of Legal Affairs ZIMCO ZPA Amount: SDR 72.1 million (US$100 million equivalent), on standard IDA tems, with 40 years mauity. escription: The proposed Credit wil provide bance of payments support for the nex stages of Zambias parastal reform and privatzaton program, which is a key componet of Zambia's structual adjustment program. In particular, i aims to: develop financial arrangements facilitating increased participation by local investors in the owneship of newly privatized companies, deepen the absortive capacity of the domestic capital market, help Government develop a comprehensive, affordable and socially acceptable program for those made redundant through corporate restructuring, and develop the capacity of key insiuons to handle the rapidly expanding privatizton workload. Benefits and Risks: Zambia's ongoing adjustment efforts and the reforms supported by the proposed Credit are vit for stabilization and growth: enco private sector development, coniuing the privatization program, refrming what remains - temporarily - of the parastatal sector, strengthening and deepening the financial sector, while ensuring that a comprehensive program is implent o mitigate the impact of redundancies. Benefits are exected to be corepondingly significant, although they will not be immediate. The operation faces political, extenal and implemeaion risks. The political risk arises from the pressure on the Government, that will grow as more people are affected by restuctng, to slow down or reverse some of the reorms. Nevertheless, the  -"- Govemment has demonstrated coictoion and detemination in reforming the economy. The comprehensive program of redundancy assistoce and compensation is also designd to mitigat this risk. The extea risk relates to Zambias crlppling debt burden; the Bank is playing a key role in mobiizng the doaor support required to support Zambia's refom. Lastly, the Government has tken steps to improve its iplemeion capaoty, and is reciving ongoing support under the PIRC Teodnical Asistan Credit Disbursement: Ihe Credit would be disbursed in tre anches. The first tanche of US$40 million equivalent would be available upon effecdveness. Ihe second and third tranches of US$30 million equaent each would be available six to nine months and twelve to fifteen months (respecively) after effectiveness upon satisfctory filfiWment of specified conditions. Diur would follow sandard Bank prOcedu for Impots. Appraisal Report: This is combie Memorandum of the President and Staff Appraisal Report.  NTERNATIONAL DEVELOPMET ASSOCIATION REPORT AND RECOMMENATION OF THE REDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED SECOND PtIATUATION AMD INDUSRIAL REFORM CREDIT TO THE REPUBLIC OF ZAbIA 1. I submit the folowing report recom ton on a proposed Interional Development Association (IDA) Credit of SDR 72.1 million (US$100 million equivalent), on standard IDA tms with 40 yers matnity, to the Republic of Zambia in support of its ongoing ptogram of privatzaton, parastatal refom, priae sector developme and industi retutrn. 2. Tne proposed sector adjustment credit fousses on strengthening the capacity of Govrment to implement the next stages of its complex and challenging program of privazation and parastal refm; this constitutes a vit component of Zamba's oveal structul adjustment progm. This program, initiated in early 1991, has been pursued with vigor and dminaon by G'ovment, despite the difficules created over the pas year or so by the devastat drought tha hit Zambia in 1992. IDA has played an importan part in suporting this adjustn effot, cludig thrugh the Eoomic Recovery Credit (2214-ZA of March 1991) and the Prvation and Industrial Reform Credit (240-ZA of June 1992). The last Economic Memorandum on zambia o(eport No. 50-ZA) was distributed to the Executive Directors In November 1986; a new Economic Memorandum is being finalized. A Policy Framework Paper (PFP) 1992-94 was discussed by the Executive Directors on March 17, 1992. L THE ECONOMY AND THE BANK'S STRATEGY A. Bckground and Reot Development 3. Zambia's economy continues t ufer ftom severe distortions t will reqire an ongoing structul adjustment effrt over an extended period. The export base remais heavily dependent on copper. Also, an earlier policy of nationalization has left an economy dominted by parastatls. Falling world prices of copper, deterioration in the terms of trade, and failure to diversify the economy led to a steep economic decline. Per capita GDP is now a third of its 1978 level. Attempts to support conumption through borrowing failed to contribute to economic growth and ceated an exceptionally severe debt problem - total exr debt at end-1991 amouned to US$7.3 billion, over 300% of GDP. Zambia's ability to redre is economic problems is now coutingent on signkificant inteational assistance, particuady quick-disbursing assistae and debt relief. Because of its massive debt burden, including some US$1.2 billion in arreas to the IMF, Zambia faces stark choices. It must eifther sustain tough economic refbrms and rely on generus donor support to redress the exisfting imbalances or deft on debt sevie oblgaions, forsake most donor assistance, and conXtue the path of economic decline of the past twenty years.  -2 - Earlier reform efforts in Zambia 4. Recent ers at economic reform in Zambia fail imto teo distin phases. le first began in 1985 when President Kuda's Goverament adopted a comprehensive structu refom program with Bank and IM support. However, political commitment to reform proved to be weak, and the program was abandoned in 1987 when President Kaunda reversed many policy reforms undertken previously; foreign exchange shortages led Government to stop most extr debt service, including to the Bank. Consequendy, the Bank suspended disbursements, and baance of payments support from the donor community was withdrawn. By early 1991, arreas of more than US$300 million to the Bank Group had accumwlated. 5. A second phase of ewonomic reforms began in lae 1988 when dWogue bee Government gnd the BankM resumed. Steady progress was made on reitoducing refms, and in March 1991, Bank arrears were cleared with the help of a bridging loan from the Bank of England, peamituing the first tranche of an Economic Reco very Credit (JERC) to be disbursed immediately. Zambia also began a rigbs accmulation program which was approved by the Executive Board of the IMP in April 1991. However, Implemetation of the program was shortlived. In the ms-up to the multi-party elections, adherence to the reforms began to slacken. Infomal prce controls were introduced and public expenditure sted geting out of control. President Kaunda announced tO donors dt the Government did not intend to implement the ndrstandings reached on maize prices. Donor support evaporated, and Government defiauted on its paymets to the Bank, resulting in the suspension of disbursements in September 1991, and a new accumnuiaion of areas. Current economie reform program 6. In the October 1991 elections, the opposition private sector-oriented MMD party was elected to office with a strog mandate for economic reform. This change in Government ushered in a third and more robust phase of economic reforms. President Chiuba appointed pragmatic businessmen and famers to the Cabinet and the new Government quicldy adopted a comprehensive program of stabilization and sucural reform; this included steps to reduce the fiscal deficit, and slow monetary epansion; the elimination of distortions and controls on key prices, including the exchge rate, interest rates, public utility tariffs and prices of agricultura inputs and output; and reduction of the size of the civil service. Government also srted on an ambitious program of privatization and parastatal reform. 7. These changes led to a resumption of subsuta externa support from bilateral donors. Bank arrears were again cleared in January 1992, and the suspension on diss lifted. A fresh adjustment credit - the Privatization and Industrial Reform Adjusment Credit (PIRC 1) - - was made tOD Zambia in June 1992. In July 1992, the MP approved a retctured rigbs accumuaton program for Zambia. Bilateral donors provided subsiantial balance of payments support and debt relief through the Paris Club. Impact of the drought 8. The Government's impressive progress on its economic reform program has been achieved even though the country had to face the worst drought of theenury in 1992. Two-thirds of the vital maize crop was lost. The Govenment was successil in securing donor support to meet the country' maize requirement and averted a potea diter resultng from  -3 - los of the pdncip food crop. Grant assistance finaced the Import of 700,000 tons of maize and anote 245,000 tons wero imported on comrciaI terms, but financed by donors e.-post. Food shotes w avertd thaogh adoption of targeted free food and food for work programs. ConttiIg of miz purhases began In early 1992 and supplies have arrived in a timely manner since May 1992. The direct balance of payments impact of the drought is estimated at US$290 million in 1992, and a furthe US$70 million in 1993. lTis includes the cost of Increased maize Imports, of redced non-traditonal exports (mcluding electricity), and of electricity imports. 9. 'Me major instrumt for combafttng the worst sffeck; of drought on vllnerable groups was the Prgam to Prevent Mnutrtion (kPM). Ihis program, covering the crop year 199Z/93, included: (O) fuding food-for-work programs such as digging irrigation ditches, building feeder roads and preari lWa for the new cropping season; (ii) provision of free food for tose unable to work; and (iii) ransporting maize to remote, nomally self-sufficient rur areas. ihese pgrms distued more than 100,0a) tons of maize and other food (about an eighth of total food aid) and beefitted 1.7 million people (a fifh of the population). Overall, Zanbia's perfomnce in coping with the drought has been the best in the Region. This year the rains have been muclh bettwe and thr are good prospects that the size of the maize crop, which will be havested in the second half of the year, will be above normal. B. Rect Macrq-Fmaomic Performance and Strutural Reforms 10. kj n o*== Despite the heavy demands on Government time and attetion created by the drought, the Goverment has made excellent progress in its first year and a half in offie In Implementing structural reforms, liberalizing the economy, and launching a horouy prpared compreheve privsizaon program. Although the worst effects of the drought on Zambia's populace were averted, it did have significant negative effects on income gowth, fiscal and monetay operations, and domestic inflation. Agriculural production in 1992 drpped 39.3% (i constant 1985 prices); although this was offset by a 10% rise in mining, overal GDP a eto cost feU by 2.8%.jI The pdmary fiscal defiit (on a cash basis, aecluding grant and interest) for 1992 is esmated at about K19 billion, or 3% of GDP (compared to the original PFP target of KS billion). The higher-than-expected deficit was due in large pat to the cost of the drought, which were well above expectations.2/ However, non- droughtpd were also above target In several areas due to high public sector wage inaes and large loss by Zambia Airways. Monetary expansion was rapid becase of these al sippages and because the mecanism for ste n excess copper eaings (amounting to 1/ The lat revision of the national accounts shifted the base year to 1985, raised the weight of mining and redced dat of agiculture in GDP. Using the old weights, the decline in total GDP would be 9.6%. ai The higher costs of the drought refected slow reayment of credit by the mills because of cash flow problem occaoned by the need to purchase a somewhat larger than expected domestic cp at saply rig prces.  4 - 3% of GDP) wm not effectivej./ It is estimated that broad money grew by 99% for the year. Since the Govenment was taking aggressive action on the exchange rate, reduction of maize subsidies, and price liberalization, inflation accelerated to 190% for 1192. 11. The major development in the S