Zambia - Recovery Program Project

Document of The World Bank FOR OMCIAL USE ONLY Repot No. 11555 PROJECT COMPLETION REPORT ZAMBIA ECONOMIC RECOVERY PROGRAM (CREDIT 1720-ZAM) JANUARY 12, 1993 Country Operations Division Southern Africa Department Africa Regional Office This document has a restricted distribution and may be used bv recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Kwacha (K) Initial Year (1986) Completion Year (1991) US$1 = K 7.30 US$1 = K 65.9 ABBREVIATIONS AND ACRONYMS BOZ - Bank of Zambia CDE - Contract Daily Employee CG - Consultative Group FEMAC - Foreign Exchange Management and Allocation Committee INDECO - Industrial Development Assistance LC - Letter of Credit MMD - Movement for Multi-Party Democracy NAMBOARD - National Marketing Board NCDP - National Commission for Development Planning NCZ - Nitrogen Chemicals of Zambia ODA - Overseas Development Assistance OGL - Open General Licensing PER - Public Expenditure Review PFP - Policy Framework Paper UNIP - United National Independence Party ZCCM - Zambia Consolidated Copper Mines ZIMCO - Zambia Industrial and Mining Corporation FISCAL YEAR OF THE BORROWER January 1 - December 31  FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.SA. Offlice of DIrector-Goneral Operations Evaluation January 12, 1993 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Zambia - Economic Recovery Proffam (Credit 1720-ZAM) Attached is a copy of the report entitled "Project Completion Report on Zambia - Economic Recovery Program (Credit 1720-ZAM)" prepared by the Africa Regional Office. The Government did not complete Part II, but provided a short comment accepting the findings of the PCR. The PCR indicates that the reforms included in the ERP will take a much longer time to accomplish than was originally envisaged. The Economic Recovery Program, accompanied by an IMF Stand-by, was a wide ranging and ambitious reform program. The PCR concludes that the ERP got off to a good start but "unravelled" following food riots. Continued Bank ESW during suspension of operations led to an eventual release of the second tranche and. partial salvaging of certain policy elements of ERP. Foreign exchange allocation and foreign debt management improved and parastatal reform and privatization began. Overall, the operation is rated as unsuccessful and unsustainable. The PCR provides a good narrative of developments during the period of the ERP but contains little analysis and fails to address the need for economic diversification away from copper dependency. This issue will be among those covered in the proposed audit of this adjustment operation. Attachment This document haa a rstuicted distribution and maq be used by recipients only in the performance of their oMical duties. Its contents may not otherwise be discsosed without World Bank authorization.  I  FOR OMCIAL USE ONLY ZAMBIA ECONOMIC RECOVERY PROGRAM (Credit 1720-ZAM) PROJECT COMPLETION REPORT TABLE OF CONTENTS Paxe No. Preface.... ...... Evaluation Summary.. . . . . . . . . . . . . . ii. PART I: PROJECT REVIEW FRoM BANK'S PERSPECTIVE Project Identity . .. . . . . . . . A. Background, Scope, Objectives of the Credit . . . . . B. Accomplishments of the Government Economic Reform Program . . . . . . . . . . . . . . . . . . . . . . 2 C. Implementation of the Reform Program . . . . . . . . 8 D. Credit Administration . . . . . . . . . . . . 11 E. Evaluation and Lessons of Experience . . . . . . . . . 14 F. Sustainability of Reforms and the Remaining Policy Agendat*eo..* a o . 16 PART III: STATISTICAL DATA SUMMARY . . . . . . . . . . . . . . . . . 19 Annexes 1. Summary of Masures to be Taken . . . . . . . . . . 20 2. Conditionalities and Modalities for Implementation and Execution of the Project . . . . . . . . . . . . . 27 3. Conditions for Release of the Second Tranche . . . . . 29 Tables 1. Zambia's Foreign Exchange Auction . . . . . . . . . 30 2. Foreign Exchange Auction Allocation . . . . . . . a 33 ATTACHMENT: Comments by Zambian Government (Ministry of Finance) to the PCR . . . . . . . . . * . * * . . . . . . . . 35 This document has a restricted distribution and may be used by recipients only in the performance or their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  I  ECONOMIC RECOVERY PROGRhE (Credit 1720-LZA) PROJECT COMPLETION REPORT PREFACE This is the Project Completion Report (PCR) for the Economic Recovery Program in Zambia, for which Credit 1720-ZAK in the original amount of SDR 42.6 million was approved on June 26, 1986. The Credit was suspended on May 1, 1987, and so were IDA disbursements to Zambia, following the country's failure to meet overdue debt service payments. The Credit was reactivated after payment of arrears and suspension lifted. Second tranche release was on February 27, 1991. The Credit was fully disbursed and closing date was June 30, 1991, one year after the original estimate. Parts I and III of this PCR were prepared by the Country Operations Division of the Southern Africa Department. Part II (Review from Borrower's Perspective) has not been received. Parts I and III were sent to the Government with a request for their coments, which were received and is reproduced as Attachment at the end of this report. Preparation of this PCR began during a mission in February 1992 and is based inter alia on the President's Report, the Development Credit Agreement, internal IDA and Government documentation, and discussions with some of the key participants during the implementation of the program. This Project Completion Report was prepared by James Karuga (Consultant). The Task Manager at the time of project appraisal and throughout Implementation was George Gebhart. The managing Division Chief and Country Director are Praful Pate (AF6CO) and Stephen Denning (AF6DR).   -iii- ECONOMIC RECOVERY PROGRAM (Credit 1720-2AM) PROJECT COMPLETION REPORT EVALUATION SUMMARY OBJECTIVES The objective of the Credit was to support Zambia's policy and institutional reforms during a critical period of its adjustment process by providing foreign exchange necessary for the country's recovery and diverstflication effort. Without sufficient foreign exchange many of the Goverrm.nt's liberalization measures would have been ineffective and the entire government's reform initiative jeopardized. Besid-e reforms aimed at restoring macroeconomic stability (undertaken vith the support of the IMF) structural measures in each of the productive sectors - mining, industry, and agriculture were to be supported in order to ensure a positive supply response. In addition, efforts to restructure the extensive parastatal sector initiated under an earlier Industrial Reorientation credit were to be deepened and extended. Key elemnts of the reform program were the introduction of the foreign exchange auction system as a transitional mechanism for achieving a market determined exchange rate, and the initiation of the process of reducing (and ultimately remOving) the high consumer subsidies in order to bring down the budget deficit to manageable levels. IMPLEMENTATION EXPERIENCE The project got off to a good start, with the authorities implementing some of the less controversial elements of the credit pertaining largely to institutional reforms for more effective agricultural marketing, restructuring of public expenditures, and public enterprise reform. The project, however, foundered on the key issues of the foreign exchange auction when the authorities sought to manipulate the rate of the kwacha, thus effectively aborting the process of liberalizing the exchange system. The auction was blamed for what was seen as an excessive depreciation of the kwacha (K), falling from K 2 to the dollar at the beginning of the auction in October 1985 to K 21 to the dollar at the end of the auction in April 1987. On May 1, 1987, the Government formally abandoned the reform program, and coincidentally, the Bank suspended disbursements to Zambia as a result of failure to meet overdue debt service payments which had gone beyond the 75 days limit. After suspension of disbursements, the World Bank maintained a policy dialogue with the authorities, albeit at a low key level, leading to the revival of the adjustment effort in mid-1989 with the adoption of the first PFP. Since then, many of the Government's interventionist policies have been reversedt price controls have largely boen dismantled, the exchange  -iv- system has been liberalized, with an open general licensing (OGL) system in place covering nearly 90 percent of imports, and the Government has embarked on a major privatization program. But because of the constant reversals in policy and the continued weaknesses in program implementation particularly in controlling the fiscal deficit and hence inflation, the adjustment measures have not as yet elicited a sufficient supply response to turn around the economy. The task of achieving macroeconomic stability therefore still remains to be achieved, with the Government deficit at over 7 percent of GDP in 1991 and inflation still quite high at 118 percent at the end of 1991. RESULTS The adjustment measures supported by the credit were not given time to work through the economy before the Government abandoned the reform effort in May 1987. The performance of the Zambian economy has been weak, with GDP growth negative in 1989 and 1990. But since resumption of the policy dialogue in mid-1989, many incremental changes have taken place in public expenditure restructuring. There have been improvements in foreign exchange management; trade liberalization and deregulation of the economy; public enterprise reform; privatization and general economic management and program implementation. The first multi-party elections in 17 years were successfully completed last October and the Movement for Multi-Party Democracy (MMD) party came into power. The new Government is committed to the objectives and the process of reform supported by this credit. SUSTAINABILITY The sustainability of reforms in Zambia has to be seen in the context of experience of reform under this credit, from partial acceptance and weak political support for reform to recently demonstrated support for the goals of the adjustment program. But the process remains essentially slow and the results of the effort can only be evaluated over a longer time frame. Continuity of the adjustment effort is threatened by the high expectations of immediate benefits of reform, against the background of increasing signs of adjustment fatigue. The high indebtedness of Zambia further exacerbates its medium term economic prospects. FINDINGS AND LESSONS LEARNED The experience of the reform program supported by the Credit demonstrates the need to: (i) ensure as widespread and committed political support for reform measures as is possible in all strata of decision-makers and the general public; (ii) evaluate and strengthen the technical capability of implementing agencies before and during reform; (iii) ensure satisfactory safeguards and safety nets before implementing such measures as dismantling consumer subsidies  and price decontrols on the socially vulnerable groups; (iv) ~.asure adequate and timely financing of reforms in order to assure continuous access to foreign exchange by the business community, so as to maintain an even pace of reform; (v) maintain the pace and direction of reform, avoiding policy reversals which send confusing signals to the economy; (vi) maintain consistent policy measures over a longer period in order to assure an appropriate supply response from the real economy.   ZAMBIA ECONOMIC RECOVERY PROGRAM (Credit 1720-ZAM) PROJECT COMPLETION REPORT PART I - PROJECT REVIEW fOtf BANK'S PERSPECTIVE Proiect Identity: Name: Economic Recovery Program Credit Number: 1720-ZAM RVP Unit: Africa Sector: None Specific A. Background. Scope. Obiectives of the Credit 1. After a period of relatively buoyant growth in the early years of independence, (1964-1974), Zambia in 1975 experienced a sharp decline in copper prices, the main export commodity and its terms of trade thereafter deteriorated steadily, such that by 1984 they were 70 per cent below the average for the early 19709. Real GDP had been declining on an yearly average of 1.5 percent between 1975 and 1984. With a population growth of 3.1 percent per annum, real GDP per capita in 1984 was 25 percent lower than in 1974. Furthermore, the balance of payments was in continuous disequilibrium, reaching a deficit of 19 percent of GDP in 1980-82. These trends were exacerbated by a rising level of external debt: at the end of 1985. Zambia's total debt stood at $5.0 billion, with a debt service ratio of over 70 percent. 2. Concerned about these developments, the Government of Zambia sought to introduce economic reforms to stabilize and restructure the economy. The main objectives of the reforms were to: (i) create a sound macroeconomic policy environment conducive to mobilization of domestic savings and the efficient allocation of resources; (ii) restructure economic incentives and encourage productive investments to achieve economic growth and diversification of the productive base; and (iii) move the economy toward a sustainable external and internal balance. To support these reforms, Zambia entered into an agreement with IDA on an Economic Recovery Program (Credit 1720-ZA) on November 21, 1986, for an amount of SDR 42.6 million (US$50 million equivalent). 3. These reforms were also supported by an IMF Stand-by program in 1985 as vwll as by the Bank's ongoing economic and sector work. In particular, the credit would complement other IDA operations operations, namely the Industrial Reorientation Credit (Credit 1630-ZA) and the Agricultural Rehabilitation Credit (Credit 1545-ZA). The initial emphasis in this adjustment process was on stabilization of the macroeconomic framework,  -2- with the budget deficit targeted to docline from 24 percent of GDP in 1986 to seven percent in 1987, and to about five or six percent in the period 1988/89. The external imbalance was expected to be brought under control through a market determined exchange rate supported by tight fiscal and monetary policies and the increased support from the international donor community. It was expected that the implementation of these reform measures would result in an early and positive supply response, thus halting the continued downward spiral of the economy. During the early years, emphasis was to be on rehabilitation and reorientation of mineral and industrial production and the rapid development of agriculture and non traditional exports. Growth in GDP was expected to pick up from 1.5 percent in 1986 to 2.6 percent in 1987 and to 4 percent in 1990. The tight demand management policies under the IMF Stand-by Program yore expected to help bring down the rate of inflation from 50 percent in 1986 to 30 percent in 1987. While rapid recovery of the economy was not anticipated, an overall medium term growth rate of 2.8 percent per annum was projected (for 1986-90) while a further rate of growth of 4.5 percent between 1991-95 was forecast. 4. The credit sought to support and extend the Government's reform measures by making available the foreign exchange needed to bring forth a supply response from the real economy. It was recognized that without sufficient foreign exchange to allow increased capacity utilization in industry and agriculture, the reform program would not be fully effective, and neither could the trade and exchange liberalization targets be achieved. The measures to be supported by the credit were to be concentrated in four main areas: (i) planning and budgeting, to bring about sound fiscal adjustment; (ii) public expenditure rationalization, to provide maxilmu support to the reform effort through more effective targeting of expenditures; (iii) foreign exchange and debt management, to make more effective use of the limited foreign exchange resources; and (iv) the productive sectors, to extend the reform programs in critical areas. Implementation of reform measures in these areas was to be comprehensive and balanced in accordance with a schedule of actions agreed upon with the Bank (See Annex 1). B. Accomplishments of the Government Economic Reform Program 5. Strenathenina of Budaet and Planning Processes: During preparation of the Credit, the Government had recognized that weak fiscal performance continued to hamper the successful implementation of the Government's previous reform efforts. The Government, in the Letter of Development Policy, committed itself to take measures to strengthen fiscal management at the Ministry of Finance. Actions to improve this process had been initiated in 1985 with the introduction of a forward looking Annual Plan as the basis for the preparation of the annual budget, but many of the changes made were ad hoc and were as yet to be institutionalized. During credit negotiations agreement Was reached on the guidelines to be issued in the preparation of the 1987 budget. In addition, a Public Expenditure Review (PER) was undertaken with the assistance of IDA between November 1986 and February 1987. The main findings of the expenditure review with regard to  -3- strengthening fiscal performance and improving the budgetary process included: (a) Macroeconomic Obiectives: The Government was to seek to attain a recurrent budgetary surplus by 1990. This was to be achieved through actions to (i) reduce consumer subsidies according to an agreed schedule (except for subsidies targeted to socially vulnerable groups); (ii) curb real growth of recurrent expenditures over the following three years, i.e. a zero rate of growth of real expenditures; (iii) increased reliance on cost recovery and other non tax revenues. (b) Sectoral ExDenditure Proaram: In order to redirect the scarce government resources to priority development activities, the PER recommended that the Government should: (i) designate a core group of activities, including agricultural services, health, education, road maintenance and development administration; (ii) prepare reform programs in these core sectors to improve cost-effectiveness and target resources to high priority activities; (iii) increase the share of resources going to core activities; (iv) reduce services in non-core activities to accammodate the macroeconomic objectives. (c) ComDosition of Expenditures: Over the medium term, expenditure reform was to include: (i) increased salaries at the upper and technical grades to redress the erosion of salaries at these levels, in order to retain skilled personnel in public service; (ii)redeployment of skilled personnel to key sectors; (iii) reduction of temporary workers (Contract Daily Employees, CDEs); (iv) increases in recurrent operating expenses of ministries;reduction of subsidies to individuals (e.g. secondary and higher education fees); and (v)sharp cut-backs in domestically financed capital projects. 6. Finally, the Annual Plan was to become the primary instrument for guiding public expenditures instead of the five-year plan framework. 7. Since 1987, the Government has continued to implement many of these recommendations, and a series of PERs have been undertaken with the assistance of IDA, as part of sector and economic work activities, even during the suspension of disbursements. As a result of these reforms, the budgetary and planning processes in Zambia continue to be strengthened. The identified core sectors - agriculture, roads, health and education have in most cases received enhanced allocations of resources, while there has been a general improvement in the composition of expenditure to reflect a better balance between recurrent and capital expenditure programs. A series of public expenditure reviews has been undertaken with the assistance of IDA and the process of capital expenditure programming initiated. Government  4- budgetary control has been strengthened. Comitment registers have been introduced while cash control and reporting systems have been improved. Macroeconomic management at the Ministry of Finance has improved and external resource mobilization has also been strengthened through donor supported technical assistance. A program of public sector management reform is also under way, with the aim of improving the match between skills and tasks while reducing the size of the civil service. Actions in this latter area are supported by the successor operation to the Recovery Credit, Credit 2214-ZA of 1981, and the resources of the old TA II project. Already, the exercise to identify 'ghost workers* has been completed; and Government is committed to a comprehensive program of restructuring and reducing the size of the public service. 8. The study of the tax structure called for in the Credit was completed with the assistance of the IMF in 1986; many of its recommendations have been incorporated in subsequent budgets since 1987. As a result of this study, revenue prospects have improved considerably, while the structure of taxes in Zambia has been rationalized to reflect the need to maintain incentives for investments and enhance general resource mobilization. 9. Tariff Study: This study was undertaken with the assistance of IDA in 1987. In line with the study's recommendations,the tariff structure has been rationalized, the variance and degree of effective industrial protection reduced and the maximum tariffs have been reduced, and the number of tariffs categories effectively reduced to three. Many exemptions (except those required by international law) have been eliminated, and the administration of the system as a whole has improved. These reforms, together with the subsequent relaxation of price control measures in 1989, have led to significant improvement In the predictability and efficiency of business transactions. 10. Reormanisation of the Ministry of Agriculture: Reforms to improve the performance of the agricultural sector were also initiated in 1985 under the Agricultural Rehabilitation Project (Credit 1545-ZA). One of the primary recommendations of the study carried out under this program, was the reorganization of the Ministry of Agriculture to strengthen its planning and project implementation capacity. The implementation of this recommendation was a principal condition of the Recovery Credit. Hardly any progress had been made to implement the recommendation when the reform program Was interrupted in May 1987. 11. Zambia Consolidated Copper Mines (ZCCM) Audits: The continued good performance of the main copper company, ZCCM, has remained central to the prospects of the Zambian economy; the company contributes 90 percent of export earnings. Yet the company's maintenance program and general management have been less than satisfactory leading to concerns about the medium- and long-term viability of the sector. A review of the mining operations of the company, under terms of reference agreed with IDA, was done with the assistance of consultants. The performance audit of the company demonstrated the need to curtail capital expenditures and to  -5- tighten financial controls as vell as improving the efficiency of operations in ganeral. Implementation of these recommendations started in January 1986 and including the closure of some of the uneconomic mines (Chambishi mine, Konkola No.3, Kansenshi mine); the shutting down of uneconomic operations (Nkana Oxide Concentrator, Luanshya Smelter); reduction and restructuring of personnel at headquarters and at the mines. A now compensation policy recommended by the consultants vas also implemented beginning in 1986. A firm of auditors has continued to do mid- year reviews and audits of performance as condition of the Credit. The viability of ZCC remains a major concern to the Government and the IA, and a follow-on operation, the Mining Technical Assistance Project (Credit 2269-ZA) was signed in July 1991. 12. External Debt Manatement: Weaknaseas in foreign exchange management at the Bank of Zambia had been identified as an area of major concern during implementation of the adjustment program. Of equal concern to the authorities was the capacity of Zambia to manage its external debt in view of the country's high degree of indebtedness. In 1985 Zambia's external debt vas one of the highest in Africal today it is the highest on a per capita basis. While the Government had taken steps to improve the recording of debt data, there had been little progress in designing a long- term strategy to deal vith the debt issue and to structure the Government's borrowing to minimize costs. Policies for improved debt management, including the debt of parastatals, were therefore crucial to the success of the whole adjustmant strategy. 13. Under the Credit, Zambia availed itself of technical assistance for debt management and as a result an improved system is now in place at the Bank of Zambia (BOZ). BOZ has also benefitted from technical assistance provided by the IM and bilateral donors (the Swedish supported computerisation of bank operations, and the ODA- supported system for improved procurement and commodity aid use program). 14. Maize and Consumer Subsidies: The removal of maize and meal consumer subsidies was one of the key elements of the reform program supported by the Credit. Over a long period in Zambia, these subsidies had been the Government's responsibility. But while the Government could afford such subsidies during the early years of independence, when copper prices were good and the urban population still small, funding of consumer subsidies came to represent a major drain on the budget by the early 1980's; maize meal subsidies amounted to 4.4 per cent of GDP by 1986. Clearly, this level of subsidies was inconsistent with the goal of fiscal stabilization. 15. During negotiation of the Credit, the Government agraed to keep the aggregate level of maize subsidies to amounts consistent with the fiscal targets previously agreed vith the IMF and the IDA. As a start, maize subsidies used for the production of animal feed and opaque beer (chibuku) were to bo eliminated, while the remaining consumer subsidies in 1987 were not to axceed in nominal terms the levels appropriated in 1986. A study on the targeting of maize subsidies to benefit the poor was to be  completed no later than March 1987. These actions yore successfully implemented before the suspension of the Credit in May 1987. But because of the suspension of operations at that time, no plan for removal of subsidies was presented to IDA as required in the Credit. Since the resumption of the reform effort in September 1989, reductions in maize subsidies continued, and although they increased sharply in the run-up to the elections last year they have been reduced sharply in 1992. Under the follow-on adjustment operation, the second Economic Recovery Program (Credit 2214-ZA) the Government is expected to eliminate all maize consumer subsidies by 1993. 16. Other measures to improve the efficiency of maize marketing were taken during the implementation of the Credit. These included the elimination of the National Marketing Board (IAWBOARD) monopoly in maize marketing, and a study on improvements in the efficiency of maize marketing and fertilizer distribution. Finally, the Government strengthened the system of delivery of agricultural credit by merging the two agricultural credit institutions, the Agricultural Finance Corporation, and the Zambia Agricultural Development Bank to form the LIMA Bank, which is now the main agricultural credit institution. 17. Public Enterprise Restructurina and Parastatal Reform: A major thrust of the Government's adjustment program was the reform of the public sector. A comprehensive set of measures to reform individual enterprises had been initiated in 1985 under the Industrial Reorientation Credit. By setting out broad policy directives those measures aimed primarily at reducing the budgetary and external debt burden of the large parastatal sector. Many parastatals had in 1985 large foreign debts, at the same time relying excessively on subsidies from the Government and the main holding company, Zambia Industrial and Mining Corporation (ZIMCO). Between 1985 and 1989, direct and indirect subsidies to parastatals amounted to US$405 million, compared to US$22 million of paid dividends. Under the Credit subsidies were to be eliminated, and debt to the Government repaid. One of the conditions for second tranche release was the resolution of the large parastatal debt to the Government. The Government was expected to submit to IDA a plan outlining the circumstances under which it would absorb parastatal debt. The program of individually restructuring various parastatals initiated under the Industrial Reorientation Credit would continue; thirteen companies, in addition to the eighteen selected under the Industrial Credit, would be restructured with IDA assistance. 18. As a result of these and other reforms, especially the increased managerial autonomy and price decontrol, the financial performance of the Industrial Development Corporation (INDECO) improved. The number of companies making losses was reduced from ten to five, and the group profit before tax increased from K 33 million in 1984/85 to K 130 million in 1986/87. The group return on capital employed similarly increased from 15 to 22 percent. At the same time, the Government converted the parastatal debt into equity and imposed a mandatory dividend policy on all parastatals in 1987. In addition, all direct subsidies to the parastatals were withdrawn, and parastatals required to operate on comercial principles.  -7- Several enterprises which were found to be economically unviable were also closed down. These included the Zambia-Tanzania Road Service Corporation (road haulage) and Zambia Clay Industries Ltd. This exercise of restructuring the parastatal sector was to be continued under the first and second recovery credits. Another fifteen enterprises will be reviewed and restructured in readiness for privatization, while the relationship between the main industrial holding company, ZIMCO, and its subsidiaries is being reviewed by consultants financed by the second Recovery Credit. In May 1990 the Government announced a major program of privatization of the state enterprises during which all but a few strategic enterprises (mainly public utilities) would be sold off to domestic and foreign investors. It is expected that this program will be further supported by an IDA credit, the proposed Privatization and Industrial Reform Credit. 19. Foreign Exchange Management: Underpinning the entire Government's adjustment effort was the continuation of the foreign exchange auction system which had been introduced by the Government in October 1985 through the Industrial Reorientation Credit, as a transitional mechanism for arriving at a market-determined exchange rate. The special conditions for operating the foreign exchange auction are described in Schedule 5 of the Economic Recovery Credit Agreement (see Annex 3). Ultimately, the operation of the foreign exchange auction came to symbolize the entire reform process both to the business and the international donor communities. Its successful implementation (or otherwise as was to prove the case) would ultimately determine the success or failure of the program. In the event, the perceived failure of the foreign exchange auction system led to the unravelling of the entire reform program supported by the Credit. The operation and causes for failure of the auction system are described separately in paragraphs 23-30 below. 20. But notwithstanding the Government's decision to abandon the auction system, commendable progress has been made in the system of foreign exchange allocation at the Bank of Zambia, subsequent to the resumption of policy dialogue in September 1989, and after the endorsement of the first Policy Framework Paper (PFP). A dual exchange rate system was introduced in February 1990, consisting of an "official" (window 1) rate set at K 22 to the dollar, and a market related rate (window 2) at K 40. Government transactions were initially handled through the official window, but by the end of 1990, nearly 80 percent of all non-government imports (except oil and fertilizer) had been brought under the OGL system (window 2). At present, the OGL system comprises more than 90 percent of base period imports, excluding petroleum. The Government also abolished the Foreign Exchange Management and Allocation Committee (FEMAC), *and the exchange rates were finally merged in April 1991. The exchange rate has been progressively devalued on a weekly basis to keep up with inflation and was further devalued by 30 percent in early February 1992. The authorities are committed to attaining a market clearing rate by end 1992. 21. Technical Assistance and Training: As shown in Annex I (the policy matrix) the Credit would finance technical assistance and training activities at the Bank of Zambia, the Ministry of Finance, the Ministry of  Agriculture and the ZCCM. to improve foreign exchange management; external debt management; the targeting of maize subsidies, and review and audit of ZCCM's 5-year production plan, respectively. Although there was some slippage in the timing of some of the studies, all the technical assistance and training activities vere undertaken successfully. Work on the improvement of management of foreign exchange at the Bank of Zambia vas particularly critical the liberalization of the exchang- system; the eventual abolition of the Foreign Exchange Allocation and Management Comittee is testimony to the success of this component of the Credit. Improvements in data systems and the managerial organization are still going on at the Bank of Zambia with the assistance of the IF and other donors. Finally, the program implementation process continues to benefit from the resources provided under the Second Technical Assistance (IDA Credit 1679-ZA). C. Implementation of the Reform Proaram 22. IDA had played an important role in the design and implementation of the reform program in Zambia, since identification, preparation and appraisal of the Credit in March 1986. Credit negotiations were completed in May 1986, and the Credit, signed on November 21, 1986, became effective on December 22, 1986. The detailed design of the components of the reform program emerged from discussion with Goverment officials as well as the collaboration with the IMF. The policy dialogue with the Government was generally satisfactory, although there were a number of senior Government officials in key positions who were opposed to the reform program. Soon after the Credit became effective, there was a reshuffle of senior government officials. Most of the officials supporting the reform program were reassigned, leaving the task of implementing the program passed to officials who were originally opposed to the main thrust of the reform program. This, more than anything else, led to the eventual unravelling of the reform program, symbolised by the abandonment of the foreign exchange auction and the reversal of many of the liberalization measures on May 1, 1987. At the same time, IDA suspended disbursements to Zambia after its failure to meet overdue service payments. IDA staff continued to supervise the credit and carried on normal economic and sector work. 23. The Foreign Exchange Auction System: The auction of foreign exchange introduced in October 1985 under the Industrial Reorientation Credit was in many ways the centerpiece of the Government's reform program. The auction, which was held weekly had gained the confidence of the international and business communities, came to symbolize the Government's determination to move from administrative controls in the allocation of foreign exchange, to a market determined rate. The Government, however, still retained administrative allocation of foreign exchange to the mining industry, its own foreign exchange expenditures, and debt-service payments. Under the Credit, the Government would expand the scope of the foreign exchange system to include these transactions. Together with the auction, the system of import licensing was to be liberalized, licenses for successful bidders would be issued automatically, and import restrictions would be correspondingly reduced and ultimately eliminated through the  -9- gradual introduction of an OGL system. A study on how to broaden the auction system would be undertaken by end-September 1986, and implemented by March 1987. 24. The immediate effect of the auction was a substantial devaluation of the kwacha versus foreign currencies. As of end-March 1986, the auction rate was approximately K 6.9 per US$, as compared to a rate of K 2.2 per dollar imediately prior to the auction in October 1985. The devaluation led to large price increases on a wide range of domestic goods, including petroleum products (100-150 percent), bus fares (70 percent), trucking services (80-95 percent), rail services (passenger, 33 percent; freight, 75 percent), bread (100 percent), sugar (49 percent) and beer (70 percent). Prices of international air tickets, telephone calls, telex charges, and first class hotel rooms were also denominated in US dollars, and the Government made it clear that parastatal companies were expected to adjust their prices to avoid operating losses. While price changes were clearly unpopular with consumers, businessmen generally expressed satisfaction with the auction in terms of its impartiality and more flexible access to foreign exchange. Production costs were reduced through more careful use of foreign exchange, i.e., more precise estimation of import requirements and lower stocks of imported goods. In addition, some importers reported substantial discounts in foreign price quotations for purchases financed with cash through the auction rather than by suppliers' credits. 25. In order to maintain a reasonably stable exchange rate and develop confidence that foreign exchange would be available when required, it was absolutely critical that the auction was adequately funded. It was estimated that a minimum weekly average of US$9 million was required for the import requirements of items covered by the auction. Given the depressed level of receipts from copper exports and the high debt-service payments that had to be made, the Government was unable to meet its other obligations and sustain this allocation of foreign exchange without substantial foreign assistance. Several donors were to make funds available through the auction for industrial and agricultural imports. As Table 1 indicates, the auction worked reasonably well during the first six months of its operation, between October 1985 and April 1986: against a bid of US$201 million, US$135 million was sold through the auction. The authorities during this period managed the auction prudently to ensure a "stable" exchange rate. During this period, the exchange rate fell from K 2.23 to K 7 to the dollar, and close to the parallel market rate. The availability of foreign exchange to many firms, both private and public. and the general relaxation in price controls, led to an initial spurt of increases in manufacturing output with a real growth in output of 8 percent in 1986. There were also significant increases in capacity utilization in many sectors, but the underlying uncertainties about the auction and the continued shortages of foreign exchange during the second phase of the auction system meant that the impact of these liberalization measures was short-lived. 26. The second, and more turbulent, phase of the auction covers the period April 1986 to May 1, 1987. In April 1986, the leaders of the  -10- economic reform team were replaced by persons who were generally opposed to the reform program. At the same time the Government carried out an internal review of allegations of abuse and problems with the auction which showed widespread dissatisfaction with how the mechanism was working. IDA staff reviewed the auction's workings and concluded that the allegations were not supported by evidence. Contrary to public opinion, analysis of data from BOZ indicates that the auction did not finance luxury consumer imports. Only 6 percent of the auction proceeds (see Table 2) were used to finance consumer imports, mainly pharmaceuticals and paper products, which could hardly be called luxuries. Expenditures on passenger cars accounted for only 1.5 percent of the total auction imports. 27. During the second phase of the auction the authorities seemed to have been concerned more with achieving a 'realistic" exchange rate as opposed to maintaining stability of the [wacha and the auction system in general. The authorities were concerned about the continued deterioration of the Kwacha and in an effort to stem the downward drift introduced several procedural changes and administrative requirements. Inter alia, bidders were asked to produce income tax clearances and evidence of payment of other taxes and use of previous allocations. At one point, bids higher than K 8.07 were rejected. Bidders' names and bids were published in newspapers, implying that the higher bids were unpatriotic. On August 2, 1986, the auction went "Dutch" i.e. the bidders were asked to pay at the r. te they bid rather than at the marginal rate that would exhaust the supply of foreign exchange at the auction. At the same time, the supply of foreign exchange was drastically curtailed by a sharp decline in receipts from copper, caused by falling international prices, and by some modest shortfalls in promised donor aid. Faced with the prospect of continued depreciation of the Kwacha, the Government started "overbooking", i.e. offering more foreign exchange than was available. These interventions destroyed confidence in the exchange rate and the auction. Business leaders surmised that the country was running out of foreign exchange and that the auction would eventually be suspended. They increased both the amount and price of their bids to assure themselves of access to foreign exchange, while the auction lasted. Despite quick injections of foreign exchange by some donors in an effort to preserve the auction, the Kwacha continued to depreciate. From the end of October 1986 to January 24, 1987, the rate climbed from K 10.32 to K 14.92 to the dollar. On the latter date, the auction was suspended and the exchange rate was fixed at K 8 to the dollar. It reopened on March 20, 1987, at K 15 to the dollar and finally closed on May 1, 1987, the final rate being K 21. 28. Abandonment of the Reform Program: On May 1, 1987, the Government formally abandoned the reform program. In particular, the foreign exchange auction was discontinued and an administrative allocation mechanism was reinstituted; the exchange rate was set at an overvalued level of K8 to a dollar; tight import controls were put into place with free access to export retention denied; duty rates for many items were raised and widespread duty exemptions were allowed; prices of many products were controlled while underlying inflation was high; and interest rates which were already negative were reduced substantially. In addition, with  -11- the loss of monetary and fiscal control, the Government embarked on an expansionary fiscal program, with budget deficits of nearly 35 percent of GDP in 1986 and the doubling of money supply between 1985 and 1986. As a result inflationary pressures were intensified, thus putting further pressures on the exchange rate. 29. The one incident which appears to have contributed most to the erosion of political commitment was the eruption of riots in the copperbelt in early December 1986. The riots were precipitated by the end of the subsidy on breakfast meal in November 1986 and the mismanagement of subsidy payments on roller meal which led to the disappearance of the lower priced roller meal from the market. The reduction in subsidy was required to control an expanding budget deficit. Earlier in the year, IDA and the IMF had recommended moderate subsidy reduction, among other measures, as a means of controlling the budget deficit. But political concerns about increasing maize meal prices delayed the action by several months. This had the unfortunate effect of requiring a much higher meal price increase later in the year to meet budgetary needs and still leaving too high a budget deficit during most of the year. The meal price increase and related problems led to riots and the large budget deficit to increased money supply. The latter, combined with an unchecked credit expansion to the non-government sector, created serious inflation and downward pressure on the exchange rate. When people saw the cost of living rise at the same time as the cost of foreign exchange they concluded that the deterioration of the exchange rate was responsible for the increase in the cost of living. In fact, the deterioration of the exchange rate and the increase in the cost of living were both caused by an increase in the budget deficit and the money supply. 30. The other reasons for failure in the implementation of reforms were (i) the absence of a broad-based political support for the program; (ii) the significant changes required in long-established decision making patterns and power relations within the bureaucracy, and (iii) the reaction of the groups whose economic rents were substantially reduced. D. Credit Administration 31. The Credit (about $50 million equivalent) comprised three components, namely (i) import support of approximately US$48.8 million; (ii) technical assistance of about $1.0 million; and (iii) training services for about US$200,000. The funds to be made available under the import support component were to be sold to importers through the foreign exchange auction managed by the Bank of Zambia. The technical assistance funds would finance mining audits for the main copper company, ZCCM; improvements in external debt management in the Ministry of Finance; studies on the targeting of maize subsidies on the socially needy groups; while the funds for training would be made available on a grant basis to the Bank of Zambia and the Ministry of Agriculture for general training purposed. The Kwacha counterpart funds generated from the sale of the credit proceeds would be made available to the Government of Zambia for general budgetary support.  -12- 32. Procurement and Disbursement: Procurement procedures for the credit were designed to ensure rapid disburement of the credit proceed. while preserving efficiency, accountability and transparency. Under conditions for procurement purchases and contracts above or in the amount of US$2 million would use international competitive bidding procedures. The credit financed the foreign exchange costs of general imports, other than those negative list, as specified in the Credit Agreement. In accordance with the requirements of Schedule 6 of the Credit Agreement, a Special Import Account was established at the Bank of Zambia, and withdrawals and replenishments made to finance the import of goods and services as provided for in the Credit Agreement. A special training and technical assistance account was similarly opened and successfully administered at the Bank of Zambia. 33. After the first tranche had been disbursed in March 1987, disbursement of the second tranche was delayed as a result of the suspension of operations in May 1987. However, after the resumption of the policy dialogue in September 1989, disbursement of the second tranche became conditional upon the clearance of Bank arrears and the policy performance, stipulated in the conditionality of the Credit. In order to clear the arrears, an extraordinary effort was made by the Government of Zambia, the Bank, the IMF and the donors. A series of Consultative Group Meetings were held in 1990 and early 1991, culminating in the successful execution of the bridge loan operation on March 13, 1991, when the arrears to the Bank, amounting to US$323 million were cleared with the assistance of a bridge loan from the Bank of England for an amount of US$200 million. 34. As soon as the arrears were cleared, it became possible to release the remaining balance of the credit proceeds, amounting to approximately US$30 million, as part of the second tranche of the Credit. Again, to facilitate this operation, extraordinary arrangements had been approved by the Board such that the proceeds of this second tranche could finance goods and services on a highly retroactive basis, with the cut-off date of September 1989, when Zambia's PFP was formally approved by the Co mittee of the Whole. Consequently, claims for an amount of US$30 million were accepted by IDA to permit disbursement of the second tranche. A high-level IDA procurement mission went to the U.K. to examine claims submitted in support of ZCCM purchases, and the mission was satisfied with its findings. Similarly, IDA staff were satisfied with the SOEs submitted by ZIMOIL (the state oil company) for oil purchases. 35. Because of the suspension of operations, the credit did not close on June 30, 1990 as envisaged, but a year later. The local currency generated by the credit was made available to the Government of Zambia for use to supplement the budget without restrictions. 36. Audits and Accounts: The financial covenants provided that the audit reports and accounts would be produced within six months of the end of each fiscal year of Zambia. Although disbursements had been suspended, IDA continued to supervise the implementation of the Credit, and the first audit reports, relating to the first tranche release, were due by end  -13- June 1988. The Bank of Zambia did not provide acceptable audit reports for the first tranche until late 1989. This delay reflected the continuing weaknesses in data processing at the BOZ and problems of coordination between the BOZ, the Ministry of Finance and the Loans and Investment Department of the NCDP vhich was responsible for countersigning the claims for reimbursement from IDA. In preparation for the release of the second tranche, several IDA disbursement missions were sent to Zambia to assist in the preparation of the bridge-loan and clearance of arrears operation. Because some of the background documentation for the proceeds of the first trenche were missing at the Bank of Zambia, work on auditing the credit had to be partially completed at World Bank Headquarters, by the firm of auditors hired by BOZ, and staff from IDA Africa Loan Department. 37. Conditionalitvy and Tranchina: As noted above, the credit was disbursed in two tranches, the first was made available in March 1987, five months after signing and four months after effectiveness. In the light of the review of the adjustment performance of Zambia on March 5, 1991 by the Board, it was decided to waive two of the five second tranche conditions, namely, condition 2, requiring the Government to broaden the scope of the foreign exchange to include government transactions and condition 4, the essence of which was the elimination of maize subsidies, which remains yet to be achieved. Implementation of these conditions was not attained because (i) the auction system was abandoned in May 1987 when the Government reversed the adjustment program as explained in paras 23 - 29 above; (ii) removing subsidies required a functioning safety net which was not yet in place in 1987; and (iii) it was found that the process of dismantling consumer subsidies would require longer than anticipated in the original program. 38. Coordination with the IMF and Bilateral Donors: The measures supported under the Credit were part of an overall stabilization and adjustment program supported by the IMF as well. Indeed, the IMF has been deeply involved in the process of resuming the policy dialogue with Zambia. The PFP process has been the main vehicle through which collaboration and coordination with the IMF has been maintained. To date, two PFPs on the Zambia adjustment program have been issued with IMF support. Furthermore, a Fund Rights Accumulation Program was approved by the IMF Executive Directors in March 1991. 39. Coordination and collaboration with donors have been a distinguishing feature of the Zambia program. Indeed, the whole program of clearance of arrears and external support to the adjustment process would not have been possible without the extraordinary efforts made by the donor community, individually and collectively, during Consultative Group (CG) meetings to mobilize financial support for Zambia. Such a concerted effort on the part of the international community demonstrated goodwill towards Zambia; perhaps even more significantly, it underscored the importance attached to adequate financing in support of adjustment by IDA and the donor community. From an operational perspective, it also demonstrated the improvements in donor cordination machinery and processes in Lusaka. In order to help in the process of adjustment the World Bank Resident Mission  -14- now has one Senior Operations Officer from Headquarters and two local higher level staff. e. Evaluation and Lessons of Experience 40. The circumstances of the rupture of relations between the Bank and Zambia in May 1987 were particularly unfortunate, the food riots, and the subsequent political posturing and the attack on the Bank supported adjustment program tended to cloud the issues surrounding the failure of this reform episode. Indeed, it was to the credit of the Government and IDA staff involved in the program that relations were maintained for normal economic sector work to continue, and ultimately the policy dialogue to be picked up again in late 1988. In retrospect, it can be said that Zambia, like many African countries undergoing adjustment at that particular time (early to mid 1980's) did not fully embrace or accept the free market principles which were the driving force of the entire adjustment process. Zambia's own philosophy of Humanism, with its emphasis on socialist principles and an explicit anti-capitalist stance, based on populist principles, was the very antithesis of the thrust of the adjustment effort. It was therefore inevitable that political economy considerations would figure prominently in the implementation of the program. 41. First, although the program was discussed with a group of Zambian technical officials who shared the goals of the adjustment program, the implementation of the program was, after an initial period, entrusted to the group of technocrats who had been most opposed to the thrust of the reforms. This, perhaps more than anything else, undermined the implementation of the reforms. Wider canvassing of political support for the program before effectiveness might also have helped in mobilizing public and political opinion in favour of the reforms. Because the reforms lacked visible support amongst the ruling party, other than the President, the program was seen as an imposition from outside. Yet without full ownership of the program by the Zambian decision makers and ruling elite, it was impossible to push through and sustain such fundamental changes as price decontrol and market determination of the exchange rate, which removed the economic rents associated with a command economy, not to mention the extremely politically sensitive issue of the removal of consumer subsidies. 42. Second, the reforms required a fair degree of technical expertise in implementing some of the elements of the program. Certainly, the design of the auction system at the Bank of Zambia would have benefitted from more technical analysis prior to implementation. With hind sight, other options to achieve a market determined exchange rate other than the auction could have been considered. A large initial devaluation (of the order of at least 50:) followed by discrete periodic adjustments of the exchange rate might have given the authorities more sense of "control" of the determination of the rate, in contrast to the auction which seemed to take away all their powers to influence the economy at the stroke of a pen. In the context of Zambia, where Bank staff admitted that many of the policy makers were opposed to the reform program, the introduction of the auction  -15- was a radical if not a revolutionary step. The implementation of other elements of the program, particularly the macro stabilization program also suffered from lack of basic instruments for more effective control of public spending, particularly at the district level. Government accounting systems suffered from lack of qualified personnel and basic systems to ensure a reliable and timely flow of data on fiscal performance. Tax administration wva equally weak, and as already admitted, the capacity for debt management vas lacking. All these shortcomings the credit recognised; but the administrative burden eventually proved too much for the credit to attain its goals within the indicated time frame. Recognition of the weak implementation capacity of the Government of Zambia would have argued for either a less complex adjustment program, or an adjustment process extended over a longer period. In the event, the stabilization program went out of gear, and the structural reforms were hardly given the time to work through the economy. 43. Third, the process of dismantling consumer subsidies should have been preceded by the design and setting in place of a safety net to cushion the more vulnerable groups from the adverse short term effects of the adjustment process. A maize coupon system was put in place in 1987, but by then the damage of the food riots of December 1986 had already been done, and any actions the authorities took thereafter were seen as too little too late. Eventually, though, a social action program to alleviate the unemployment efforts of the program was put in place in 1990 with the assistance of IDA and the donors; but even this program has suffered from poor implementation capacity. 44. Fourth, adequate and timely financing of the program were extremely critical to the success of the reform program. For a country such as Zambia which was experiencing acute debt distress and deteriorating terms of trade for much of the 1980's, availability of foreign exchange resources to finance the required imports, particularly under the more liberalized import and trade regime, was absolutely crucial for the sustainability of the program. As it were, the inadequate flow of donor resources to the auction frustrated the timing of the reform measures: the Government could not move in key areas, especially exchange liberalization, without assurance of timely and long term external resource flows. Every time performance slipped, donor funds would be delayed which would in turn delay government actions and thus give wrong signals to the business community about the continuity of reforms. This in turn would worsen expectations of continued macro instability. Indeed, inflation in Zambia is still well above the levels it was in 1987 at the comencement of the adjustment process - 118 per cent in 1991 compared to 34 per cent in 1987. 45. Fifth, a strong supply response to changed incentives as introduced in the Zambia adjustment program requires that the direction of reform is maintained, without too many reversals in policy as occurred during the implementation of the Zambia's own economic recovery program in 1987/88 which replaced the IDA supported program after suspension of operations in May 1987. These policies, entailing the reintroduction of price controls and a fixed overvalued exchange rate, were expected to  -16- revive production. Instead, they drove economic activities und-rground. Smuggling and shortages of essential commodities became rmp*ant, in Novembeer 19888 the Government wva forced to change direction by introducing more liberal measures in the form of price decontrols and devaluation of the Kwacha in June 1989. The impressive economic growth registered in 1988 - 6.3 percent compared to 2.7 percent the previous year, was largely fortuitous, arising primarily from the favorable weather which raised agricultural output by over 20 percent. Because of the uneven implementation of the reform program in Zambia, economic performance has been faltering - registering -1 percent growth in 1989, -0.5 percent in 1990, and an estimate of -1.8 percent in 1991. The growth rate of total per capita consumption ha therefore been negative for such of the adjustment period, at -8.5 percent in 1988. -10.1 percent in 1989, -3 percent in 1990 and an estimated -2.8 per cent in 1991. After such poor performance, it was perhaps inevitable that adjustment fatigue would set in. 46. Sixth, it is now recognized that the adjustment process is a long-haul operation, requiring a sustained implementation effort, adequate external support and strong institutional and political support. For Zambia, the political climate is now supportive of economic reform, and it is to be hoped that the next adjustment operations will meet with more resolute support. F. Sustainability of Reforms and the Remainina Policy Atenda 47. Zambia's adjustment effort has been characterised by an unusual degree of risk, largely as a result of the highly politicized atmosphere at the beginning of the program and the continuing financial uncertainties underlying the program and the extreme indebtedness of the country. But there is hope that with the nev government, the reform effort will be maintained. The new political leadership has reiterated its total commitment not only to the goals of the adjustment program, but perhaps even more fundamentally, the leadership publicly espouses the principles of a free market economy, in contrast to the previous regime. 48. But if this new regime is comitted to the continuation of the adjustment process, the austainability of the program of reform in Zambia faces the opposite risks of too high expectations from the process of reform under the new Government. Continued slow economic performance in the short-term risks eroding the political support for reform. This, the Government recognizes, and continues to respond to through the Social Action Program. But even this program cannot deal with all of the problems. Several other elements of r-form pose threats to the political support for the adjustment program. These include (i) the Government's privatization and parastatal reform program; and (ii) the program of civil service reform. Implementation of these two elements of. reform are increasingly aeen in critical terms, vith the former being accused of selling the family silver, while the latter calls for reductions in the size of the public service in a context of economic recession. Arrangements must be put in place to ease the transition for the affected  -17- staff, while masures to ensure Zambian participation in the privatization process must be an integral part of the proposed Privatization and Industrial Reform Credit. 49. Continued high inflation (still at over 100 per cent in January 1992) further threatens the implementation of the program. Without reasonable macro-economic stability, the economy is unlikely to benefit from the positiva incentives arising from the Government's more liberalized echange and pricing policies. In attaining this goal, tight fiscal and monetary discipline will be essential. Hopefully, the new government will attain this goal faster than its predecessor, given its more professional approach to economic manag em nt and the support of donors through financial resources and technical assistance. 50. In the medium term, the high indebtedness of Zambia will also continue to pose serious risks to the sustainability of the adjustment process. At $7.2 billion. Zambia's debt is already the highest in the world on a per capita basis. Although Zambia continues to enjoy bilateral debt relief through the Paris Club, much of Zambia's debt is owed to multilaterals, :ith little scope for unilateral write-off arrangements. Access to IDA resources will continue to be conditional on satisfactory adjustmant performance, as will 1KF support within the Rights Accumulation progrm. 51. Adequate performance will also depend on continued efforts to strengthen the institutional capacity for program implementation in Zambia. This will call for increased technical assistance to key economic decision making units, as well as a more extensive manpower training program at the middle management level. Although the follow-on adjustment operation, the Second Recovery Credit approved in March 1991 has made provisions for a large element of technical assistance, general training needs in Government need to be addressed more comprehensively. 52. On the policy front, further progress still remains to be achieved in (a) the achievement of a market-clearing exchange rate as soon as possible; (b) the attainment of positive real interest rates, if possible by end 1992; (c) the reduction of the budget deficit to about 1 per cent GDP as soon as possible which should reduce inflation to levels consistent with the above macro economic objectives. 53. In addition to these macroeconomic stabilization goals, actions need to be pursued in (a) the further liberalization and total price decontrol of maize and fertilizer marketing; (b) the further streamlining of the trade regime to reduce the anti-export bias, and to provide more incentives to non-traditional exports; (c) the expansion and support to the private sector through reform of the regulatory framework (particularly urgent is the program of measures to support small scale enterprises); (d) the further restructuring of the public service through parastatal reform and the continuation of the public sector management program to strengthen the civil service for more effective program implementation.  -18- 54. These actions are the focus of amongst others, the follow-up adjustment operations in the fonr of the new Economic Recovery Credit of March 19911 the proposed Privatization and Parastatal Reform Program to be presented to the Board during FY93; and the continuing Public Sector Manage ent program supported by resources from the Second Technical Assistance Credit.  -19- PART III - Statistical Data Summary ZAMBIA: ADJUSTMENT CREDIT Economic Recovery Program (Credit 1720-ZAM) As of: 30-Jun-91 Amounts in SDR Million ---> Original Actual Disbursed Cancelled Repaid Outstanding IDA Credit 1720-ZA 42.6 42.6 42.6 0.0 42.6 Original Credit Date Actual or Re-estimated Initiating Memorandum 31-Mar-86 31-Mar-86 Letter of Development PoLicy 23-Apr-86 23-Apr-86 ............... - - - - - Negotiations 19-May-86 19-May-86 Board Approval 26-Jun-86 26-Jun-86 Credit Agreement 30-Jun-86 21-Nov-86 Effectiveness 30-Jun-86 22-Dec-86 .. ........... ----- Second Tranche Release 01-May-87 27-Feb-91 Credit Closing 30-Jun-90 30-Jun-91 ACTUAL CUMJLATIVE DISBURSEMENTS (SDR MiLLion) FY87 FY88 FY89 FY90 FY91 20.8 20.8 20.8 20.8 42.6 X of total 48.8X 48.8X 48.8X 48.8X 100.0X MISSION DATES No. of No. of Staff Date of Month/Year Weeks Persons Weeks Report Preparation NO RECORDS AVAILABLE Appraisal NO RECORDS AVAILABLE Supervision Nov-86 1 I 1 09-Jan-87 ~~~~~~~~........... ----------. ... . --- -- -- --- -- -- ---------- Supervision Jan-89 1 1 1 19-Apr-89 .......... .......... ----------..... -- -- ---....- -- Completion Feb-92 2 1 2 21-Apr-92 (Draft) -- - - - -- - -- - ---------- .......... --------.. FOLLOW-ON ADJUSTMENT OPERATIONS 1. Second Economic Recovery (Credit 2214-ZA), for an mount of SDR 149.9 million, and an IDA Reflows Supplementary Credit of SDR 19.4 million, signed on March 13, 1991. 2. Privatization and Industrial Reform Project. Expected Board approval on June, 23, 1992.  A,nnx I Page I1of7 ZAMBIA RECOVERY CREDIT SUMMARY OF MEASURES TO BE TAKEN MEASURES TAKEN BEFORE MEASURES TO BE SUPPORTED OBJECTIVE EFFECTIVENESS BY THE CREDIT AND TIMING 1. To restructure public i) Public expenditure review i) Agreement with the sector spending to underway with assistance from Association by Sept. 30, 1 66 support more the Bank. on an action program for effectively the restructuring public country's goals Ii) Government agreenent to expenditures, indudng within overall Increase In real terms spedfic timetable for availabIlIties. alocations for recurrent for impleentg expenditures, In reatuct . Agreement agriculture. also on the 1c u to be _ hpofe e In thee budget This wE Include a core program of high prW- ty er_xp tre, pls a m imen program sould addional resours beconm available. Any suppleen- tary expnftres would alo conform to the spending prbrlw  Amex I Page 2 of 7 ii) Completion of study of tax structure with assistance from the Bank and Funid and agreement on action plan with timetable for e ation, by Deceber 31, 1986. 2. To improve planning and i) New procedures introduced 1) Agreement on guideines to Budgeting to define more to unity and improve be issued to ministries for cleariy obectives recurrent and capta preparing 1987 annual plan strategies and resource budgeting. and an associated budgetary availabilities, and to submissions by June 30, focus expenditure on 1986. development goals. ii) Annual Planning ii) Approval by Central introduced with first Committee and Cabinet of plan produced in 1986. planning and budgeting guidelines and of general procedures to be followed in 1986617 planning and budgeting cycle by September30, 1986. Ili) Unkages forged between ilIl Issue guAidines planning and budgeting. specifying the circumstances and conditins under which Government will absorb debt of parastatals by September30, 1986.  Annex 1 Page 3 of 7 3. To broaden the scope of i) About 50 percent of total i) Furnish to the the foreign exchange foreign exchange receipts Association by December auction so as to improve are auctioned, with major 31, 1986. an action plan rate determination. exceptions being ZCCM and to Include government govemment requirements. goods and services In the auction and begin implementating the plan by March 31, 1987. 4. To Improve overall Q) Monthly budgets with i) Review operations of iOZ management of the three months forward to assess foreign country's foreign look, being prepared by exchange manageent by exchange resources, the BOZ. Also, quartely December 31, 1986. Including mechanisms budgets are prepared for for channelling remainder of year. receipts and payments through international banks. i1) Agree with the Association on an action program for improving foreign exchange management by BOZ. including timetable for impmentation, by September30, 1986. 5. To improve management of i) Assistance obtained from 1) Impiement technical external indebtedness, a consulting firm proved assistance recommendations incduding contracting of to be inadequate. on assiace In debt debts by parastatals. management by December 31,1986.  Annex I Page 4 of 7 6. To eliminate subsidy in i) Maize price has been i) Complete a study on maize and improve increased to cover nearly impact of subsidies on marketing by allowing one-half of the maize the poor and on mechanism trading by private sector wbsidy, pre-auction. for targeting subsidy to to establish proper Increased to approxlmate lowest income level by producer prcing border price equivalents. December 31, 196, and methodology. remove subsidy to higher income groups by September 30, 1987. i) Remove subsid on maize used to produce iVisock feed and opaque beer by December 31, 1986. III) Private traders have been Iii) Take measures to allowed to trade in maize. implement recomeindations of ongoing agricultural marketing study, by September 30, 1986. iv) Agree on floor pricing methodology for maize, by September 30, 1986 and Implement for 1987 crop season. 7. To Improve the i) ReView of planng divins i) Agree on and prepare functioning of the has been completed and some action plan, plus Ministry of Agriculture Improvements have been made. ident TA needs, for and Water Development. improving operations of MAWD by June 30,1986.  Annex 1 Page 5 7 actlon plan by December 30, 1906. 8. To Improve delvery of 1) Govrnment has agreed to 1 ) Prepr acton plan to credit to farmes, merge AFC it ZADB. effect mer; prepae partcularty and asue bndng smnaliholders. poNces and procedures; and adequately capitalze ZADB by September 30,1966. 9. To encourage export of r) Ince have been provided ) Review Imp_le an of agricultural goods. for agrkiultural exports, export Nenoug system incuding foreign excha as appied to agricultural retention, tax incentves and goods to esure its simplfed Nensing proper functioning and procedures. confirm dangeover to registration syst. . 10. To Improve operating of i) Indeco's Investment programs i) Review with the Acaon public enterprise in for 1985/86 and 1986/87 have Assocation action prorams order to avoid drain been agreed with the for phasing out or public resources. Asociation. resrcuing dvidua pubk entepris under control of ndob and agee on schedules for impbent- ing reomnmndalone, by Septebw 30. 91n.  Page 6of 7 11. To Lnprove custom tarf 1) A minimum tadff of 15 ) Come review of tarif structure to achIev pecent has ben wucture by greater unformity in Weid on aN goods 31,1966 and effectiW protection. himoporateommwea dtod hI 1967 budgeL N) lmaimm wtais hav been reduced fro 150 pecn to 100 peoenL II) Twf commissin ha been Iv) Agreement OMa Tarif Comm (with _xler assancem) WIN carr out comprehensive review of tari sucture. 12. To improve operatons of 1) A compreherne review of i) Sin contract with mining the mining Industy. ZCCM s operatbons by consutants of external consultants has internatonal repute to been comphted. carry out audts of ZCCM 5-yea plan by September 30, 1966. i) ZCCM ha prared a 5-year production and and Investnot Plan based on the review which has been agreed with te Assclation.  Annex 1 Page 7dof7 iii) Terms of reference for independent audits of impementation of ZCCM's 5-year plan agreed at negotiations. iv) Timetable for Implementig ZCCM's 5-year plan during 1986 and 1987 confirmed during negotiations. 13. To improve financial i) Impact of kwacha devaluation i) Carry out review of tax viability of ZCCM while on ZCCM's finances has been regime applicable to ZCCM at the same time reviewed. by July 31, 1986. maximizing contribution of mining Industry to public resources. ii) Minerals export receipt tax H) Incorporate recommendafons was increased from 10 percent of review in 1987 budget or to 13 percent. sooner If possible. il) Agreement reached to study tax regime applicable to ZCCM and implement results in time for 1987 budget.  -27- Annex 2 Page 1 of 2 Conditionalities and Modalities for Implementation and Execution of the Project (Artide HI of the Credit Agreement) Section 3.01. (a) The Borrower declares its commitment to the objectives of the Project as set forth in Schedule 2 to this Agrment and, to this end, shall carry out the Project with due diligence and efficiency and in conformity with appropriate administrative and finncial practices, and shall provide, promptly as needed, the funds, facilities, services and other resources required for the Project. (b) Without limitation upon the provisions of paragraph (a) of this Section, the Borrower shall carry out the Project in accordance with the Implementation Program set forth in schedule 5 to this Agreement, as such Schedule may be amended from time tot time by agreement between the Borrower and the association. Section 3.02. Except as the Association shall otherwise agree procurement of the goods and consultants services required for the Project and to be financed out of the proceeds of the Credit shall be governed by the provisions of Schedule 3 of this Agroement. Section 3.03. The Borrower shal, not later than March 31, 1987, submit to the Association a plan of action, acceptable to the Association, for implementing a tariff structure geared to achieve greater uniformity in effective protection. Section 3.04. The Borrower shall, not later than March 31, 1987, take appropriate measures to implement the recommendations of the study on the organization of MAWD carried out under the Agricultural Rehabilitation Project No. 1545-ZA). Section 3.05. Th Borrower shall, not later than March 31, 1987, take appropriate measures to institute a system for carrying out a periodic independent audit of ZCCM's mining operations under terms of reference acceptable to the Association. ion 3.06. The Borrower shall, not later than March 31, 1987, take appropriate measures to being implementing a program of action, acceptable, to the Association, for improving extrnwl debt management, including debt of the public sector enterprises. Section 3.07. The Borrower shall take appropriate measures to implement, with effect from its 1987 Budget, the recommendations for the study currently being undertaken by the Borrower for modifying its tax structure, including ZCCM's tax structure. Section 3.08. The Borrower shall, not later than January 31, 1987, commence implementation of an Action program, acceptable to the Association for: (i) phasing out or otherwise disposing of on-going industrial activities and enterprises within the public sector considered by the Borrower and the Association to be economically unsound; and (ii) restructuring and/or taking other appropriate measures to improve the performance of on-going industrial enterprise considered by the Borrower and the Association to be potentially economically viable. Section 3.09. The Borrower shall: (a) not later than March 31, 1987 complete a study on targeting maize subsidies to lower income groups; (b) not later than June 30, 1987, furnish to the Association a plan  -28- hMM2 Paap 2 of 2 of action acceptable to the Aonw for iplWemting te condatio. of heb study; and (c) not lato thn Deember 31, 1987, impemet dte pln of acti whoe ocve sall be, intwe ai, the comploet removal of mabaidies on mae to higher incm o s. Section 3.10. The Borrwer shl: (a) not later tl Mark 31, 1987, tk al appropriae mesr to completdy remove subidie on mnum used lo prode hvesock fed ad opaque beer, ag (b) take al appropiate measures to nmare tdat the evel of reuA_g oosaumrs esbam omaze for Fial Year 1987 do not exceed in nominal trm tho levels appdfor PFicl Year 1986. Section 3.11. Ibh Borwer shall: (a) ot later ta Janury 31, 1987, compleb a review on th impLicato of broadening the ope of the foreip exchanp mauco sym to inhWlo 1rncto of the ministries and other agecies of the Borrowe, (b) wet lae April 30, 1987, frnish to the Asciation a plan of action acceptable to eo Asociation for implem ting theo rmmndation of the review; and (c) not lat than July 31, 1987, commenco implemeting the plan of aco. Secion 3.12. Th Borrwer and the Aocitdion sl, fmm time to time, at te rqt of deitr party, exchnge views on the progs achievod in ca g cut te d Prjct ad the progrm To that end, th Bonower hall furnish to tho A -ociatio for its mview d comment a report an th progres acieved in marying out the Proect ad the Progmin, in mch detil and at sock ti_m a th Asociation sa reaso-ably request.  -29- Page 1 of 1 ZAMBIA RECVERY 1RGA e Borower shll have: (a) mubmitted to the Association an action program, acceptable to the Association, for resucturing public expenditures; (b) completed a review for broadening the scope of the foreign exchange auction system to include govement trnactions; (c) submitted to the Asociation a policy sbatemnt, acceptable to the Asociation, setbng forth the cicumstance and conditions under which the Borrower would consider absorbing the debts of the P m; (d) wubmitted to the Association a plan of action aceptable to the Aociation for impblmen the r d of the agricultural maketig study carried out under the Agricultural Project (Credit No. 154S-ZA); and (e) ave takn or caused INDECO to take mesure acceptable to the Aseociation for restuctuing individual INDECO entoeprises in acoordnce with a plan of action submitted under the b _dstra Rorienation Project (Credit No. 1630-ZA).  -30- TABLE1 ZAMBIA'S FOREIGN EXCHANGE AUCTION i 2 a D O L LA R S AUCTION TOTAL SUCCESS SUCCESS- NOT EXCH. WEEK DATE NO. FUL FUL DISO REQUESTEDALLOCATED ALLOCATED RATE 1 11.10.I5 299 94 205 7 S16.9M 4.SM 12. IM K 5.01 2 18.10.I5 397 137 260 7 12.5 5.0 7.5 6.10 3 2.510.35 345 186 159 ? 10.3 5.2 5.1 7.00 4 31.10.S5 270 241 29 ? 10.2 7.5 2.7 6.44 5 08.11.S5 232 181 51 ? 8.1 6.2 1.9 6.25 6 15.11.85 229 195 34 7 4.3 4.1 0.7 6.03 7 23.11.S5 234 213 21 ? 5.0 3.9 1.1 5.S0 a 30.11.35 205 166 39 7 4.9 4.2 0.7 5.75 9 07.12.95 117 169 IS ? 4.6 4.2 0.4 5.74 10 14.12.15 201 IS0 21 ? 5.2 4.5 0.7 5.75 11 21.12.95 172 160 12 ? 4.6 4.3 0.3 5.77 12 28.12.85 101 100 1 ? 3.5 3.5 - 5.70 13 04.01.36 117 106 11 ? 5.0 4.6 0.4 5.76 14 11.01.86 164 105 59 ? 5.4 4.1 1.3 5.16 15 11.01.16 234 102 132 ? 6.7 3.3 3.4 6.01 16 25.01.86 309 151 151 ? 10.2 4.7 5.5 6.40 17 01.02.96 287 260 27 ? 6.5 6.1 0.4 6.36 1s 08.02.86 254 143 111 ? 7.2 3.9 3.3 6.51 19 15.02.36 2S1 20S 76 ? 6.7 5.2 1.5 6.68 *20 22.02.96 304 191 113 ? 11.9 7.7 4.2 6.78 21 01.03.96 301 136 165 ? 10.2 5.4 4.3 7.01 22 08.03.16 287 141 146 ? 7.7 5.9 1.3 6.90 23 15.03.S6 246 143 103 ? 7.4 5.6 1.8 6.75 24 22.03.86 357 253 104 ? 10.3 3.8 2.0 6.91 25 29.03.S6 193 173 20 ? 8.3 7.4 0.9 6.85 26 05.04.S6 251 216 42 7 3.3 7.2 1.1 6.87 27 12.04.16 246 171 75 ? 9.3 3.7 * 5.6 6.98 23 19.04.36 273 176 97 ? 11.4 3.6 2.8 7.06 29 26.04.36 281 196 3S ? 3.3 6.8 2.0 6.98 30 03.05.S6 236 200 36 ? 7.2 6.3 0.9 7.00 31 10.05.16 274 234 40 ? 3.9 7.6 1.3 7.03 32 17.05.86 297 143 149 ? 10.6 3.7 6.9 7.11 33 24.05.16 279 153 126 ? 7.3 4.0 3.3 7.23 34 31.05.86 332 244 33 ? 10.1 7.3 2.3 7.31 35 07.06.16 313 170 148 ? 7.3 4.0 3.3 7.26 36 14.06.96 397 244 153 ? 11.1 7.0 4.1 7.32 037 21.06.S6 333 267 116 3 12.2 3.0 4.2 7.39 33 28.06.16 404 134 270 2 12.3 7.0 5.3 7.S1 39 05.07.86 518 151 367 16 15.2 7.6 7.6 K 7.71 40 11.07.86 451 163 283 5 13.9 7.3 6.6 8.07 *41 19.07.36 396 82 314 313 15.2 4.4 10.3 5.03 42 26.07.36 600 155 445 335 23.5 7.5 16.0 6.03 43 02.08.16 760 634 126 126 24.0 20.3 3.2 5.01 44 09.03.36 501 329 172 1 17.5 10.3 7.2 5.35 45 16.08.86 542 220 322 80 15.4 6.0 3.4 5.76 46 23.08.36 621 173 448 49 IL2 3.3 14.4 6.26  -31- AUCTION TOTAL SUCCESS SUCCESS- NOT EXCH. WEEK DATE NO. FUL FUL DISQ REQUESTEDALLOCATED ALLOCATED RATE 47 30.0S.S6 690 264 426 24 20.4 9.9 10.S 6.17 48 06.09.86 674 SO 173 70 22.1 13.6 9.2 7.00 49 13.09.86 418 326 92 43 12.9 11.7 1.2 S.64 SO 20.09.16 484 99 315 22 14.1 3.1 11.7 6.37 51 27.09.86 606 167 439 20 20.1 6.0 14.1 7.09 52 04.10.86 712 172 S40 43 22.3 S.6 16.7 7.64 53 11.10.16 769 121 641 9 22.1 5.0 17.1 1.30 54 18.10.16 734 125 609 16 22.6 2.6 20.0 9.35 55 25.10.16 493 84 409 35 17.3 4.1 13.2 10.32 56 01.11.16 517 119 398 33 13.1 4.0 9.3 11.51 *57 01.11.86 439 111 328 12 12.2 4.2 1.0 12.30 51 15.11.16 407 116 291 4 11.3 4.2 7.1 13.48 59 22.11.16 324 122 202 1 1.4 4.1 4.3 14.68 60 29.11.16 273 140 133 S 7.2 4.1 3.1 15.25 61 06.12.16 221 130 91 29 5.6 4.1 1.5 12.10 62 13.12.16 333 107 226 33 12.4 4.0 8.4 11.90 63 20.12.S6 310 116 194 9 8.4 4.0 4.4 12.50 64 27.12.16 251 141 117 IS 6.6 4.1 2.S 12.71 65 03.01.87 192 11 74 6 5.7 4.1 1.6 12.97 66 10.01.87 232 55 177 1 9.9 4.1 5.1 13.51 67 17.01.87 257 111 146 12 1.9 4.0 4.9 14.12 68 24.01.87 250 109 141 3 1.9 4.1 4.1 14.92 *1A 28.03.87 62S 151 474 ? ? 1.0 ? ? 15.00 2A 04.04.17 457 62 395 ? ? 6.0 ? ? 16.99 3A 11.04.87 370 71 299 ? ? 6.0 ? ? 11.75 4A 16.04.17 270 S1 139 ? ? 6.0 ? ? 19.95 SA 24.04.87 250 91 IS2 ? ? 6.0 ? ? 21.01 6A 02.05.17 192 IS1 34 ? ? 6.0 ? ? 15.00 SOURCES 1. B.O.Z. unpublished study 'The Foreign Exchange Auction System. A Review of the First Year of Operations' for Auctions 1 - 35; and other Bank documents. 2. 'TimesodZambalforAuctions36-58&1A-6A. NOTE: The figures for Dollars allocated do not Include te Banking System.  -32- I.SZ (Page 1 of 1) Week 20: Zimoil, Tazaza, Tazara and Zambia Airvays are brought into the auction. Week 26: Dr. L. Chivuno appointed Governor of the Bank of Zambia on 4.4.86 Week 27: The figures for dollars allocated and dollars not allocated are doubtful. Week 37: Auction results are published in full in the press from now until Week 68. Week 41: a) Stringent documentary requirements introduced. Bids to be accompanied by tax clearance certificates and proof of receipt of goods for which L/Cs had been opened 90 days or more previously. b) In addition only 20% of funds used for bidding could come from bank overdrafts. (This condition was found to be unworkable and was later rescinded) c) As a result of these new requiriehts 313 applications (for $10.8-) which would otherwise have succoeded were disqualified. Week 42: All bids above X8.07 (total 385 for $10.1-) disqualified. Week 43: a) Dutch auction system introduced b) 126 disqualifications ($3.2m). All other bids succeded, as enough dollars are sold to clear all bids down to the lowest at K5.01. Bank of Zambia nets a K40 million profit. Week 44: 81 bids disqualified ($2.8-) Week 45: 80 bids disqualified ($2.8-) Week 48: 70 bids disqualified (S5.0-) Week 57: a) Bank rate raised to 30% b) 30% deposit on all bids introduced Week 61: 29 bids disqualified ($0.3m). Without these disqualifications the rate would have been K14.50. Disqualifications in the preceding 3 weeks had not exceeded 152,000. Week 62: a) 33 bids disqualified ($l.7u). Without these disqualifications the rate would have been K12.G0. b) Riots reduce number of bids week IA: Auction reintroduced. Deposit raised to 40%.  -33- (Pr" 1 or 1) and Use, .aaeAmtla leete (Peset shar) Consumer Goods 6* 02 Internediate Goods 46.55 Machinery, quipment, spare-parts 15.66 Miscellaneous Goods 15.63 Services 11.77 Total 1OAs 0 (US$ 342.1 million) Aqriculture 5.99 Manufacturing 41.61 Parastatals 45.65 Others 6.74 Total 2ag D (US$ 342.1 million) Sank of Zambia   -35- Attachment COMMENTS BY ZAMBIAN GOVERNMENT (MINISTRY OF FINANCE) TO THE PCR (Received June 4, 1992) The Government of the Republic of Zambia accepts the Project Completion Report am prepared by Mr. James Karuga. The Zconomic Recovery Credit I (Credit 1720-ZA) laid a foundation for the implementation of most of the current economic liberalization measures. It is undoubtedly clear that most of the requirm-nts which needed action at the inception of ERC I have in the course of time boen taken care of. The resultant structural reforms that took place under the Agricultural Rehabilitation Credit (Credit 1545-ZA of 1985) and the Industrial Reorientation Credit (Credit 1630-ZA of 1986) enhanced the adjustment effort. Trade liberalization measures introduced as part of the Government's adjustment and stabilization programme established the need to trim the public enterprise sector. It further established a liberal approach to foreign exchange management which evolved from the auction to the Open General Licence System. Zambia fully appreciates efforts being made by the World Bank in helping the country continue to restructure. In spite of amounting pressure from the effects of the drought, Zambia is committod to continue restructuring its economy.