Guinea - Financial Sector Operation

* ~~~~~C~ A2$3r- e#&)/' Do_met of Tle World Bank FOR OFFCIAL USE ONLY Rept No. P-6339-GUI REPORT AND RECOXMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOIPMET ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 16.3 MIlION (US$23 MILLION EQUIVALENT) TO THE REPUBLIC OF GUIM FOR A FINANCIAL SECTOR OPERATION AUGUST 31, 1994 This docment has a restricted d_stbution and may be used by recpen only in dte perfouce of their official daties Its conents may not otherwise be disclosed whout World Bank authorization.  CURRENCY EQU1VALTS Current Una = Guiman Franc (GF) US$1 = GF953 GFI = USS0.001 GF100Q = US$1.05 MEASURFS Im = 1.09 yd le = 10.76 sq A lkm2 = 0.38 sq mi GLOSSARY OF ABBREVIATIONS BCRG anue Centrale de Ia R6publique de Guinde BIAG Banque lntewnationale pour I'Afrique en Guin6e BIAO Banque nternationale pour I'Afrique de l'Oest BICIGUI Banque Internationale pour le Commerc et lindustrie en Guinde BID Banque Isamiqe de D6ve1oppenent BIG Banque slamque de Guin6e BNP Bque Nadonale de Paris BPMG Banque Populaire MarocoGuineenne CAS County Assistance Stategy CCIAG Chambre de Ccmmerce, Industie et Agriculture CECC Caisses dpgne et de Cr6dit de Conakry CFI Caise F:naaiso de DMveloppement CiD' Canadian Intational Deveopmeat Agency CICM Centre International de Cr6dit Muniel CNSS Caisse Nationale de S6curit6 Sociale DEG Deutsche Entwkic gs Geseshaflt DMC Division Mornaie et Cr6dt DMMI Dar Al-Maal Al-slhmic DNT Direction Nationale du Tr6sor BEC Europea Economic Communit IB European lnvestent Bank GDP Gross Domestic Product ICB bIernational Competitive Bidding ]DA Intern&0onal Devebpment Associaon IFC Intrnainal Fimance Corpontion MARA Mestre de l'Agriculre et des Ressources Animales MUTRAGUI Mutuelle d'Assurance des Travalileurs de Guinme NGO Non-Government Organizations OPIP Office de Promotion des Investssements Privds PAGEN Proame d'Aide A ta Gestion Economique PFA Pr6servatrice Foncibre d'Assurance P1P Policy Framework Paper PIP Public Invesanent Progam PPF Project Preparaion Facility PSPP Prvate Sector Promotion Program SAL Stucal Adjusunn Lon SPOM Soci*e Fnancire d'Oztre-Mer SGBG Societ6 Genetab de Banque en Guine SIFDA Socie lternationale pour le Fioancement et le Devebppement en Afiique SOGAM Soci5te GuE e d'Assurances Mutelies SONAG Socwi6t Nouvelle d'Assurances de Gum6e SONAM SociME Natinale des Asurances Mutuells du Sng UIBG Union Inernatonale- de Banque en Guin6e UGAR Union Guinenne des Assuances et REassurances UNDP United Naios Devdopment Progpam USAID United States Agency for Intrnon Development FISCAL YEAR Januay 1 - December 31  FOR OFFICLL USE ONLY Qs& FmdI Sector O-we REPUBLIC OF GUINEA FINANCLAL SECTOR OPERATION Table of Conkents . ~~~~~~~~~~~~~~~~page Credit and Project Summay ............................ ....... iii PART L BACKGRO 'ND ....................1:........ I PART U. OVERAULL ECONOMC SITUATION AND PROSPECTS.. 2 A. Current conomic Perfonnance .2 B. Fiscal Policies. 4 C. MonetaryPolicies ............................... 4 D. Econoii Prospects. S E. Red Sector - Current Siuation and Prospects.6 PART m. THE FINANCIAL SECTOR: CURRENT SrrUATION AND MAJOR ISSUES.. 7 A. GCenrd Structue of the Finanial Sector. 7 B. Finanial nstitutions. 7 C. The Environent .13 PART IV. THE FINNCIAL SECTOR REFORM PROGRAM ..17 A. Reforming the Enroment ....... .......... 18 B. Refoming the Strture of the Financial Sector .22 C. Instuional Restuctuing and Buflding .................. 25 D. Techal Assistance .......... 26 PART V. THE OPERATION ...............................27 A. Amount and Thming ...................., . 27 B. Mangemet, Monitoring and Reporing . 27 Letter of Sector Developmnt Poicy and Policy Matrix 27 Disbursement of the Second Tranche .27 Implemeting Istituions.. . 28 Coionwith the IMF and JFC.28 Coordination with Other Donors .29 PART VI. BENEFITS AND RISKS ........................... 29 Benefits .29 Projec susaia....y 30 Risks .30 Tab of Contents (contd.) This dociet has a rsricte diributin and may be ud by recian only in me Pe e_ a i1o ica duts Is ontes nmyrt ehawis bedilosed ift World Bank ahoriz do  pag PART VI. PROCUREMENT, DISURSEMENT AD ADMNS TION ...............- 30 Procuement . .30 Disbuseme . ... 30 Accouns and Audits . 31 PART VIL BANK GROUP OPERATIONS IN GUINEA . 31 PART X RECOMMENDATION ...........................,.. 33 ANNEMPS: ANNEX I Statistical Annex Table 1: Commercial Banks: Growth m Domestic Currency Deposits and Loans Table 2: Key Macroeconomic Indicators Table 3: Extenal Financing Requiemeb, 1993-97 Table 4: Financial Insdions: Assets Table 5: Commercial Ban: Distrbton of Ownership Table 6: Commercial Banks: Summary Balance Sheet Table 7: Commerci Banks: Distrion of Cradt by Economic Sector Table 8: Commercial Banks: Distribuion of Public and Private Sector Deposits Table 9: Insurane Companies: Distibution of Ownership Table 10: Cr6dit Rual: Selected Data Am Supplemenal Note on Technical Assisance Componen Anex m Letter of Sector De-Jlopment Policy Amex IV Polcy Matrix Annex V Bank Group Operatons in Guie Anne VI Timetable of Key Progm Processing Events Map IBRD 25798  nab ro"scwOma REPUBLIC OF GUINEA FINANCIAL SECTOR OPERATION CREDrr AND PROJECT SUMMARY Rorrower Republic of Guinea Mnistry of Emae (MOF), Minsty Of Justice (MO), central Bank of Republc of Guiea (BCRG), Financial Insttutions Por Categorr: Poverty-Focwed Opetion: eliminat distordons in savions and credt that discriminate against the poor Credit Amount: SDR 16.3 million (US$23 million equivalen) Tms: Standard IDA tms, with 40-year maturity In :rn IDA US$23.00 million CIDA U,S$ 0.60 milLon CFD US$ 0.46 millon USAID US$ 1.60 million Not yet deernined US$ 0.38 million TOTAL US$26.04 mUllion Rate of Retu Not applicable map IBRD No. 25798  thb eRudl Saor Ope*wio iv REPUBLIC OF GUINEA FINANCIAL SECTOR OPERATION CRED1T AND PROJECT SUMMARY (contd.) Neojee Ducripiom T'he proposed credit will support a multi-fceted finacl secto operation to be underkn in the context of the country's medium- term economic program. ITe operation's objectives will be to: (a) stengthe the monetay regulatory, superory and judicial environment; (b) develop a bridge between the infonnal and formal sectors to increase the reach of he financial sector; and (c) build upon the human resource base and mprove institutional capacity. On the policy front, the Government will contnbute to the development of indirect instruments of monetary sanagement such as open mark operations, diseage from the s.pital and management of financial institutions, adopt regulation for all categories of financial institutions, reinforce supervision mechanins, and take measures to improve the judicial system in its enforcement of financial contracts and the recovery of bW debt. To build a bridge betwee the formal nd informl sectors, the system of mutualistic savings and loan institutions will be extended in rural areas, and a new system will be introduced in Conakry. Isidtout buildng will focus on: (i) improving the capacity of the Central Bank to conduct monetary policy and supervise and retuctur financial institutions; (ii) building the capaci within the Ministry of Finance to monitor and analyze financial sector developments; (iii) strngtning the Ministy of Justice and the court system; and (iv) training commercial bank and insrance company staff, as well as members of the legal profession. PItject 1_: The program will lead to a competitive, solvent and self- sustainable financial sector, composed of healthy institutions, catering to the needs of savers, investors and borrowers in the formal and informal sectors, which will support economic growth and social progress. An efficient financial sector will contribute to an effective monetMy and credit policy and to the stability of dte Guiean economy. In particular, the movement toward market- determined interest rates will contbue to domestic resource mobilization and spur economic activity. The financial sector reform program wil also facilitate the development of the private sector and the privatization of public enterprises. Through the mral finae schemes, the program wil reach owners of small businesses, particularly women, and contribute to poverty alleviation. The progam emphasizes governmne, institution bilding and human resource developmen. Lasty, the program supports the rehabilitation of the judicial system, paularly with  Guinea RbmwmcI Sector Openadcs v respect to the enforceme of financial contas and will contribte to increasing confidence in the busines envonent. Projed Ris: Deteroration of the c stuaion and public financ may have a negative impact on filancial Insttutions. To preveot this fom hapening, the credit is contingent upon thde mntenane of a stable anc mc famewrk. Contuing dialogue between Guina authorities, the Bank and the IMF, in the contet of an active Fund program, will minimize the rik of deterioratnof the mauroeconomic siuation. Further riks are related to the capacity of Govemment to implement such a lrge progm. To minimize this risk, the adjustment credit has been supplemented by a tedhical assistance component, designed and targeted to maxmize the ransfer of technology and skldls, and facilitate the imple ion of the policy measures. Eatited IDA The total Credit (US$23 million equivalent) would consist of an D _1 Ments: adjusUent credit of US$18.0 million equivalent and a techmical assistce componen of US$5 million equivalent which includes refinaning of the Projet Preparation Facility (PPF) of US$1.5 million equivalent. The adjustment credit will be disbursed in two trches. A first tranche of US$9.0 million will be made availble upon effectiveness. The second tranche of US$9.0 million will be made avalable upon sasfacory progress in impleming the maoeconomic and financial sector programs. The technical assistance component will be disbursed over a 24-month period, and will follow standard Intenonal Development Associaion (IDA) procedures.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOAMATION OF THE URSIDENT TO TH EXIUTIVE DIRECTORS ON A PROPOSID CREDf1 TO THE REPUBLIC OF GUIMEA FOR A FINANCIAL SECTOR OPERATION 1. I submit for your approval the following report and r eon on a proposed Financial Sector Adjustment Credit to the Republic of Guinea for SDR 16.3 miion, the equivalent of US$23 million, on standard IDA terms with a maturity of 40 years. The proposed credt is a quick disbursing operation with a technical assistance component, to support the Governm's financial sector reform program as descibed in a Letter of Financial Sector Development Policy submitted by the Govemsent to IDA on June 6. 1994. PART I. BACKGROUND 2. In 1985, after more than 25 years of cental economic planning, a new Govemment decided to reintroduce a market economy m Guinea. The country thus embarked on a series of economic and financial reforms supported by IDA, the INIF and bilateral donors. The main objective was to radically resrue the Guinem economy, reduce the role of the State in productive activities and develop the private sector as the engine of growth. 3. As part of the first phase of financial reforms, six statewned bunks were Liquidated and the country was left with one privately-owned commcial bank. The only iurance company, a Govermen-owned institution, was also liquidated. A more umodernu Central Bank (Banque Centrale de la R6publique de Guinee, BCRG) was established. To att new commercial banks and insurance companes to Guinea, generomus inctive packages were offered which resulted in the establshment of severa new insuions in Guinea. These reforms gave the bankig sector a new impetus which translated into phenomenl growth of deposits and loans in the early years. Credit to the private sector, almost non-exstent at the begining of 1986, represented almost half of domestic credit by1988 and over 90% at the end of 19' Tbl of Annex I provides informion on the growth in domestic currecy deposits and loans of commercial banks. 4. However, the euphoria of the early post-reform years quicldy subsided and many busines ventures tuned sour, negatively affectig commerci banks. Furtemore, some of the fundameal problems that plagued the financial sector had not been adequaely addressed. For insance, bankng regulation did not include directives for loan classification and provisioning; the judiciary apparatus did not provide adequate support to financial institutions in the enforcement of contracts and recovery of bad loans because of shorigs in legal texts, weak enforcement of legal rulings and a cuture which gave Little weight to writen contracts. As a result, financial institutions found themselves once agai in a difficult environment. Some banks had to limit the scope of their opefations in the face of nonpefoming portfolios wlch had not been adequately provioned. Until  GidiaU FM. &awor C 'Jarw 2 recely, bans also had difficulty finding an oudet for their excess funds, which were left in non-interest earning deposits at the Ceniral Bank, and u curtailed depsit moiization. Most banik ino originated ftom fcreign exchange opetions rather than frm more taditional loan and deposit activites. Insurance compaies also experienced difficuties, several having used up most of their capital in the early years of operation. Two rur finance projects bave been successfil n mobilizing resources and extending small credits (the recovery rate excieeds 98%), but they depend beavily on donor subsidies to cover their opertig costs. There is a small morney market and no bond market. On the other hand, there is a very active inforaal financial market in the cities, as well as in rural aras. The lack of penetraion of the formal financial sector is reflected in a low ratio of M2 to Gtoss Domestic Product (GM?) of 7%, less than half the average ratio for Sub4ahar Africa, and a high currency/M2 ratio, which at 47% is among the highest in Afra. 5 For the adjustment of the Guinean economy to be successful, it is necessa to create a business environment which will encourage investment and growth. To achieve this, the econmy mum be supported by a healthy financial sector that effectively mobizes domestic resourcs and enables entrepreneurs to obtain funds at the lowest cost commenurate with risk. Increasing the level of buess mitennediated by the formal sector would permit institons to reach a more optimal size and thus help reduce the average cost of providing financial services. The objectives of the reorm supported by te proposed Fincia Sector Adjustment Credit are articulated around three main axes: (a) strenghn the environment within which financial insutions operate; (b) developing a bndge between the informal and formal sectors to increase the reach of the financial sector; and (c) building upon the human resource base an strengthening institutioa capacity. PART HI. OVERALL ECONOMIC SRIUATION AND PROSPECTS A. Cumet FEnomic Perfonace 6. Guinea is one of the poorest and least urbanized countres in Africa. Its per capita GDP is approximatly US$511 (1993). About 75% of its 6 million population live in ural areas, while 90% of the remaining 1.5 million persons live in the captal city of Conakry. In 1993, the mining sector accounted for 20% of real GDP, 85% of export eaings and 39% of Government domestic revenue. Agriculture and other primay sector activities have traditionally provided the bulk (about two-thirds) of employment and account for about 25% of real GDP. Trading activities, incluing the infrmnal sector, contute to an estimated 26% of total GDP. he ma i sector is small, accountg for less than five percent of real GDP. 7. In less than a decade after the dure of the old regime, the Government has achieved delrating inflation and positive economic growth. Table 2 of Annex I provides key m mic data. Inflation dropped to an estmated 7.1% in 1993 from highs of 37% and 28% in 1987 and 1989, respectively. GDP growth rates averaged 4.0% a year during the 1987-93 period, concenated in small-holder farming and small- scae enterprses, while the response from the modem sector was modest. Gross domestic inetent averaged 16.4% of GDP bdewe 1988 and 1993. The economic prgm has  Gahm Fi!awc Seder Operao 3 also involved a an3jor change in the policies towards public sector e prises. As a rest, the number of public enterprises were reduced frm 200 to 110 from 1985 to 1988. The program still has to deal with some of the larger entetprises. 8. The agricultural sector, including agro-industries. has grown in recent yean and higher nural incomes have, in turn, boosted overall commercial activity, particularly in the tuade sector. National account estimates show that value added in the agicultural sector grew by about 3% per annun in 1989.91 and more than 4% in 1992. While agricturai sector performace in Gumea has surpassed that of neighboring counties, it remains below the cuntry's potential Past investment in agrictuWre (fmanced almost exclusively by the international donor community), whle considerable, concentrated both on the improvement of the Ministry's capacity to provide services, and the creaion of public enterises engaged in production and marketing. Moreover, while there have been imprvement in ptices and export incentives, they have been insufficient to elicit the appor response. To achieve higher GDP gtowth based on expansion and diversification of exports in agriculture, Guinea will need to make strategic chmges in agricultural policy. Further improvements in the pricig, gatory and instittional framework are needed to develop food crops; achieve food security (the production of rice and vegetable oils); stimulate the expansion of traditional expoit crops (coffee, cotton and horticultural products); and foster diversification into other export crops. Achieving these objectives will necessitate measures to: (a) clarify the responsibility of cen institutions; (b) reduce the involvement of the public sector in the production and marketig of gricultural output; (c) strengthen incentives for local food production (by eliminatig import duty exemptions and r ining the tariff rate on rice imports); (d) implement the land temnre code of 1992 (which provides for pnvate land ownebip); and (e) improve economic infrstrucxtre. 9. Besides agricultural resources, Guinea is endowed with sizable mineral deposits (bauxite, gold, diamond, iron-ore and other minerals) dth make it one of Africa's resource-rich countries. In particuar, Guinea has bauxite reserves of about 20 billion tons, or approximately one-third of the world's proven reserves and an esfimated long- term gold exaction potential of between 10 to 15 tons per year. It also has considerable diamond deposits which presendy support an anal production of about 200,000 carats (inclung artisa mining). Finally, Guinea has miner resources which have not been exploited yet, partly due to economic factors (hiadequaes of uporting fastructure, weak ncentive StrC and insufficient private ivetmet), technical shoromings (insuicient geological reseach) and environenl problems. To achieve higher GDP growth, Guinea will have to overcome these problems and diversify minin production and exports. 10. Guinea has made substantia progress in _ policy. Since 1985, it has undetken a broad range of financial and strucral reforms, aimed at eviizing the economY and reducing domestic and external i anc, based on market-oriened policies. These reforms have included the inmtroduction of a liberad and flexible exchange system, the lifting of price controls, the divestiture of a large number of public ntrprises, e curilment of public sector and civil service employment, the lifting of interest rate controls and the introduction of indit monetary policy instrents, the reiinforcemen of Governmen expenditure controls and the st engt of economic moniting and management capacity.  D. Fisnal Poies 11. Before 1988, Guin had no formal budget; the Government spent the bauxite Ming revenues as the funds came in. In 1989, the Governmen issued its first modern budget. It established: (a) centralized control over debt contracting; (b) new procedures for commhimnt of expenditures, -including the creation of a specialied unit to screen the quality of expenditures; (c) ceilings on the wage bill and size of the civil service; and (d) a sytem of monthly budget execution overviews and spendng plans, with ceilings on acal tpending enforced by the Treasury and Central Bank. Since April 1993, a public finance monitoring committee (Comit6 de Suivi des Finances Publiques) has met weeky to monitor the Governmen's fiscal perfomance. 12. Govemment has made significant prct,;ess in controlling its budget. Tough budget measr and a reduction of inflation helped improve the prmary budget deicit (excluding mining revenues) from 5.3% of GDP in 1991 to an estimated 3.5% In 1992 and an estimatd 2.8 % in 1993. This result was achieved with severe budget cuts and ta meeas. 13. Governmen revenue collection improved significantly during the first nine montbs of 1993. In contast to earlier experiences, improvement in program monitoring alloved ealy detection of diverging reveme trends and the timely adoption of corrective actions by offt cuts in Govanment expenditure. This enabled Govanment to contain the oveal fiscal imbalances, while also strengthening Govemmernt expenditure control. Duing the last three yeaus, total expeiture has been reduced as a raio to GDP by ablost sx percentge poins, reflecing cuts in both cur and capia outlays. 14. Government is not a net user of resources from the financial sector and it has lmited recourse to commercial bank fina g to a strict minimum; the public investment pogram is financed entirly with budgetary and concessional foreign funds. Durig the 19889 Peiod, Governmnt accmulated substantal arrears on its foreign debt (US$313.6 million at the end of 1991) which were subseqenly clered through Pwais Club arrangements in November/December 1992. C. M ary Poicies 1S. Monetar vargets are set in collaboration with the IMP. Central Bank credit to Govenmet is capped at 20% of the previous year's Govemen revenues. Money supply (currency and sight deposits) increased at an annual average rate of 20.8% beween 1988 and 1992. Quasi-noney, comprising term deposits and foreign currency deposits, incresed at an annual average rate of only 7.7% during the same period. Foreign arrcy r _ep ed the fastest growing component, averaging 12.4% amnaly. 16. INerest rates are crrently positive in real terns and the steamlning of administratvely set rates1 in June 1993 has been a major improvement in the conduct of monetay and credit policies. With falling inflation, real interest rates have been high. Until Jume 1993, niAeeen rates of intest bad been administraely set by the Cetal Bak (fbuee maulmn rates and five minimu deposit ras).  Qiava AW &aw Opupa 5 VWe T y Bis auction maket, stard in Decemner 1993, wlI allow IAnrt rates ti better reflect market force. Most rat, with the eception of th minimum savings rte will be d to the auction rate. Iterest ra o e auCtion maket have bon flling from one aucton to another. Ti will, In time, brting nomina ate more In line with the Iation e. 17. Forei8n excdge oraomw can best be described as a 'managed float'. Demands for forei excange by t private sctor are bmed to the Cetral Bank an tne basis of import dcluion frm. These demands and the offers for sale of foreign excbange by the private sector are reviewed by BCRG each Friday at the auction. The main purpose of te meeting at th ction betwee commrcial ban and BCRG officialX is to assess the validit of the demands for forign exchage. AU valid demands are sasfied (i.e. demand to fiac imports d by requir documentation, iwluding certficatio of value of the imported goods). The exche rate is admnistravly set by the BCRG in view of the net demand for foreig excage, the level of foreign assets held by the Cental Bankc, the rate on the paralll maurkt and the afe agreed upon between the Government and the DI. D. conomic Prospoec 18. Implementation of the Govement's macrconomic stabilization and adjustment prom ted in red economic growth averging 4.0% per amrn for the period 1987-93, as noted in pan. 7. The prospet for achieving subsnlly bigher GDP gth are consained by the country's dependency on the mining sector, ptcularly bauxite and alumina. The volit of foreig exchange ammngs, which b unavoidably inked to a nearly sW e- economy, has rendered the conrs strucu adjustme process more difficult ad has bee largely esponsable for an uneven fiscal performae. Guinea's long-term developnt s y will need to stress the diversfction of its export base away firom mining and concentrate on the asricultural sector as the focal point of future GDP growth In the medterm, however, Guinea will contu to depend on the min sector as a scurce of reveue. New invesmns in mining, particlarly in gold and diamonds, will compnsate for the low prices of bauxdte and alumina. 19. ITe Gu ilean Adinistrati has con_ti to underscore the importance of remaining fuly on course with ma omic ngent refdorms, s ing the priples of stiza, liberaliien and privatization, of the economy. This will imply, inter , in the rguatory fmework - partiuarly affectig the financial sector, minig and agriculture - to elicit the necessary private sector response. The Government tends, at the same time, to give priority to ivsmet in infrastute, poverty reduction and human resources, and the environment in order to enosure the sutinability of economic growth. Based on tis strategy, the Government expects to gradualy improve real GDP gowth in the next thre years: from 4.5% in 1993 to 4.8% by 1997. Thi is8 expected to resut from incrased grvwth both in the minig sector (from its curret level of 2% to 4% in 1996) and in non-mining acdvity (from 4% in 1993 to 5% in 1996). lnflation is expected to be contaned at about 4% per annu. lhe Goverment has conlded an agrement wih the IMP and an ESAP is being put Into place.  GWa ca Sor Operato 6 20. The ant account deficit of the balce-of-paymts, before official trfs, is anticipated to decline from an estimated 10.9% of GDP in 1994 to about 8.1% in 1997. This is the result of two factrs: the projected low prices of ming exports, in pariular, bauite and alumina; and the high level of imports of iftrmediate nd capital goods that are needed to sustain GDP growth. Beginning in 1997, the impact of weak bauxite and alumin prices will be offset in part by now mining venues (particularly in gold and diamonds) and the expansion in agricutural exports resulting from implenation of macroeconomic and sectoral policies and strategies. 21. Extrl resource requiems are likely to remain high for the period ending in 1997, reprenting 11% of GDP in 1994 and 8% in 1997. [gIf a of Anex I provids the exal fiancin requiements for 1994-97. In 1994, a current account deficit (excuding public transfers) of about US$374 million is expected. Official transfers are exected to be of the order of US$131 million. Part of the fhicing requirements are anticipated to be met by private commercial sources. Te remining financing requremen are excted to be covered by project-related financing (US$143 million), exceptional fiancing (US$43 million) and debt relief. With the IMF-fiac ESAF in place} Guinea wil benefit from substatl debt relie under Enhanced Toronto te. A Paris Club meeting is expected to be held in late Sqeptber 1994. Guinea is also seeling IDA financing under the IDA-only Debt Reduction Facility for a debt-buy-back operation wbich witl enable it to purchase eligible commercal debt in the seconday market. This operation is now under preparation. Table 2 of Annex I presents bac of-payments projecions for the 1994-2000 period. E. Real Sector - Crrnt Storn and Prospects 22. Preliminry meures, taken by Govemmen to improve the enviromnent, have encouraged the developmet of the private sector and provided suppor for the privatiztion of public enterprises. An inial supply response by the real sector is already apprent. New registrations of companies have inreased approximately 14% (416 new enterises, January-October 1993, compared to 365 regtered during the previous year). The largest increse occurred in commerce and services, rqprsnting 50% of new eness registered, while m represented 38%. The remaining 12% were in the fishing sector. More than 80% of these investment projects were made by Gulneans with the support of a foreign technical or financial partner. 23. Furemore, a recent study identified 55 potetial investment projects in need of financing, toang US$30 million (34 prvposed new enterprises, 11 projects to exand and modernize existig enerprises and 10 projects to renovae and modernize privatized businesses). The same study concluded td strengthening of the financial sector wiUl bring about an increase in produve investmet of about US$3 - 3.5 milliom per year over a five-year period in small- and medisized businesses, beyond the genral increase in economic activity geneated by improvWed financial i edian. In addition to new annual investment, it is expected, as the economy impr , that demand for finacing to expand and modern ze operations wil also incrase. 24. Government has made progress in reducing the role of the State in the economy, stregthenig the pubhc finances and incre_sng the demand for domestic and foreign resores. Of a total of 200 public enterpis operating in the commercial, industri and service sectors, 90 have been privatized or liquidated (pata. 7). After a temporry  Gidne Anw Setr Oprada 7 slowdown of the privatiaton effort, the Government has undtaken to reform enterpis of strategic importance. As part of this effort, it has privatized petrolum ditibution, has sucessfully transferred the responsibility for the management of Gine's uba watr supply system to private hands, and is compleing similar private na _gement arragements for producing and distributing electricity, teleommunications and postal services. In November 1993, the Govemn signed a contac allowing for tota prvae owneship of a gold mine parially ficed by Interntional Finance Coration (IC and is negotiatig fill pivate ownershp with two other mining companies. An additional 43 public enterprises with commercial functions are being examied for possible privatization. All of these privatizations will require financing frm a renewed fiancial sector. PART mII. TE FNANCIAL SECTOR: CURRENT SITUATION AND MAJOR ISS)ES A. Genea Setucur of the Fin i Sector 25. The financial sector of Guia comrises: (a) the Banque Centrale de la Rpiblique de Guin6e (BCRG); (b) six commercial bans: Banque In le pour l Commerce et l'Industrie en Guin6e (BICIGUI), Banque Internationale pour l'Afe en Gut& (BIAG), Socidt6 G6nrale de Banqu en Guin6e (SGBG), Banque Islamique de Guin6e (BIG), Banque Populaire Maroco- enne (BPMG) and Union In onale de Baque en Guin6e (UIG); (c) four insurnce companies: Soci6t6 Guin_= d'Assun Mtelles (SOGAM), Soci&t Nouvelle d'Assurances de Guin6e (SONAG), l'Union Guin6enne des Assurc et R6assurances (UGAR) and Mutuelle d'Assurance des Travailleurs de Guin6e (MUTRAGUI); (d) two rural credit projects: Cr6dit Rural and Cr6dit Mutuel; (e) a social security institution, Caisse Nationale de SEcurM Sociale (CNSS); (f) several fiuds and credit lnes set up by dono agencies; and (g) an inrmal sector. There are no fiancial markets, although the recent issues of Treasury Bills mak the beginning of a money market. 26. The commercial banks dominate the formal financial sector, accounting for over 90% of total finaial sector assets. The modem insuran industry which began operatig in 1988 accunts for four percent of total financial istitutiIons' assets, while rural savings instiuions account for only one percent. On the other hand, the inforal market is esmated (on the basis of activity in the gold, diamond and informal trade sectors) to be larger than the formal financial sector and appears to operate effiienty. Table 4 of Annex I lists the financial institutions. This section analyzes the finncial instituidons and the monetary, regulatory and judiciary evionme in which they oprate. Paut IV discusses the reform program aimed at resolving the problems ientfied in this section. B. Finmcia Ixslttons 27. Comnmrl baks. As noted in para. 25, six bans curreny operate in Guiea. Mme two largest banks, BICIGUI and SGBG, account for more than 60% of the matket (measured either in terms of assets, deposits or loans outstai . Most of the banks limit their activities to Conakry. BICIGUI is the only bank with a branch network (throe  G~w Raal&tr Opiaku 8 points of sale in Conakry and eight braches outie the capital). BPMG, which iMn to Aimcton as a mutual bank, plans to open two branches in Conakry and two in nta areas. 28. Ow *p. Three bans (BICIGUI SGBG and UIBG) are linked to lage French commercial bak. BIG is an Islamic bank with a large partidipation of Sadi inerests and BPMG is contoled by a group of Morccan saving bank. The Goverme participates in the capital of three of the banks (BICIGUI, BIAG and BPMG). The other three banks, SGBG, UIBG and BIG are filly privately owned. Finally, the donr ommuity, cluding IFC and CFD, holds shares in the BICIGUI. Table 5 of Annex I provides a distribution of shareholder equity of the com rcial banks. Several BCRG and Govment officials also hold man_ament positions in comercil banks which places them in a possible conflict of interest siuaton. 29. Activtes. Commercil banks are rdatively small and rly on foreig exchange taactions and investments in foreign currenc assets to generate income. Forei currency denomined asset represent about half of the total asses of commer,ia bak. The table on the followmg page and Table in Annex I provide nformatin on the acdvities of commercl banks. 30. In their more traditonal banking actvies, baks focus on short-term credit whih represents close to 90% of total creit outing. Longerterm loans are extended on the basis of the availability of donors' lines of credit or refinancig from BCRG. Most bank credit is oriented toward m.port/export/trade, agribusiness, textiles and consrction. Tbese categories accou for about 80% of total bank lending with trade finncing representing close to 50% of the total. Table 7 of Annex I provides the disbution of credit by economic sector. Credit is mainly exended to the private sector, although it is concentrated on a Ihmited number of bonowers. In most banks four clients or less acount for one-thid of credis outstndi. Tlis high conenaon reflects the narowns of the market for forma banking services and raises the risiness of the prtfolio of these situtons. Less than one percent of the loan portfolio is outsading to the public sector. On the other hand, 22% of bank deposits originate from the public sector. Table8 of Annex I provides the disrbution of public and private sector deposits. 31. IquWdty. Most bans have been in a very liquid posiion becase of a sccity of lending opportuities that translate into viable loan demands. The ratio of deposits to loans, a proxy for liqidit, was greater thn 100% for five out of six commercial banks and averaged 144% for the total banking sector. Because of a lack of appropriate markets and istruments, banks were unable to obtain an adequate return on tbeir excess liquidity. Until recetly, surplus fmda Led idle, often deposited in zero inerest accounts at the BCRG. As a result, deposit mobilization has stagnated. 32. Qualiy of prifolfo. Commercial bans suffer from a high level of non- perfring loans. On average, 33% of the portfolio of commercial banks has been non- performing. Many credits were extended during the 1986-88 period without adequate analysis in the wave of euphria that followed the change in regime. They were ofenm based on unduly optimstic projections of grwth and devdopment. Many credits were granted to European bs often adventurews, and at tmes under presse from  Qkdne FRUN&"a SeoMr OPCIe,Wuo 9 CooerWa8: Sdeetd Asse ad Liabilit (as of Sember 30. 1992) (CMW bilio) CICIGU SOG6 UBG MG AG RPMG AN Daub L1W 29.9 23.2 10.3 1L7 16.0 3.1 96.2 GNP 22.8 19.2 9.0 14.0 13.9 3.1 62.0 Fonelsgn uy 7.1 4.0 13 1.7 2.1 - 162 11 b 5l423 30.0 15.7 11X 18.0 Ss 143.9 - 01W 4S.6 22.2 12.8 1(56 13.0 S5. 109.7 Forecuracy 16.9 7.8 2.9 1.3 5.0 3 34.2 (h"D 209 129 L52 76 113 1S7 147 o arm: DCRG forein authorities. Credit analysis was complicated by the absence of financi and other inormation on most borrowers and the lack of apropriate accountig and historical records. Moreover, bank were not equipped to conduct such analysis. Bank did not moni ns and there was little atempt at recovery. Becuse of a lack of intaer contols, the degradation of the loan portfolio was not caught at an early emugh stage, nor wae remedial acos taken. 33. Problems have boen compunded by the deficiencies of the judicial ystem (discuse in pam. 65-70). While the main responsibility for the poor perfomance of their portfolio rests with the bank which eeded the loans in the first place wthout proper analysis and control, the deficiencies of the judicial apparatus have faciitaed, and up to a point, have been an incentive for delinquency on the part of bomroers. 34. Profitabity. Banks opae with high interest margi, a result of the abse of remueradon on demand deposits, which constite the bulk of the resources, and the high interest cost applied to short-term loas. However, several ban also suffer from high operang costs. As a result, profitabit has been low or non-existent. Until their rcent rsucuing, two bans, BIG and BIAG, regitered losses before provisioning. BPMG i in a break-even siation. However, BPMG is in its early years of operations and under the r t , its low return is not umnual or noteworthy. Only BICIGUI and UIBG exhibit a positive real rate of return on equity. 35. Commeral baksb provide employment to over 600 persons, of which 47 are eatries. Untl recently, banks were iadequately staffed to successfully montor and recover loans. Staff was also poorly trained to perform financial risk analysis, and credit  Guinea Fhnw*d Sccor Opwatdn 10 decisions were based on the perceptions of bank manage_mn or the reputation of the borrower. Computer is at an early stage. Internal auditing and control mechanisms are rudimentary. 36. In the last two years, senior management has been caged in all banks and some corrective measures have been taken. The credit granting process has been strengted in many institutions; monitoring systems have been put in place; and several bans have recently esabished reowvery units. Since Septmber 1993, commercial ban have also made provisions against their non-perfonning loans and two bans are being resuured and recapitized. 37. In sumary, the banking ser of Guinea is firage. While bank margins are relatively high, the sector suffers from generally high opert costs in relation to the volume of busines, a large non-perfrming portfolio and the lack of profitable lending and investment opportunities. Until recent restrucming (parn. 108), two banh were tecnically insolvent and a tr faced serious difficulties. The performance of the other banks remamns lackusr. Banks are involved in traditional banlkng activities only in a limited fashion and derive their mcome from foreign exchange transactions and imvestment m foreign currency assets. Bankng activities are severely constrained by the small size of the formal market. The size of modern financial markets is limited by the low libeacy rate (44% for males and 19% for females) and by the low level of economic activity that can generate a demand for modern financial services. In this context, financial sector development and deepening would seem to require the introduction of non-traditional financial services which are not yet being offered by the modern banking sector. 38. he hsrance sector. The four companies that offer insrance products in Guinea have been in operion for less than three years. L'Union Guin6enne des Assuances et Rarsuans (UGAR) statted operations in January 1989 and inherited the business of a public sector insurance company, SNAR. it is still majority owned by Government, but has a large participation of French UAP in its capital. UAP is also responsible for the manaeme of the company. The Soci*t6 Nouvelle d'Asrances de Guin6e (SONAG), a private company, with a majority ownership by the French Pr6servatrice Fonciere d'Assurance (PFA) stated operatng in July 19892. The Socift6 Guinenne d'Assurances Muteles (SOGAM), a private company with a large participation of Socift Nationale des ances Mutuelles du S6n6gaI (SONAM) began operations in January 1991. Finally, the Mutuelle d'A 'umns des Travailleurs de Guin6e (MUTRAGUI) began operating in Spring 1992. Government is absent from the ownershi of the last tree companies. Tabl 9 of Anmex I provides a distnbution of ownership of the insurance companies. UGAR is by far the largest companW accounting for 85% of the market, measued either in terms of total assets or premm issued. 39. The industy employs 140 people and offers a diversified range of products including automobile, transport, theft, fire and life inurance. The table on the following page provides selected data on the three largest insurance companies. Automobile insurance is the predominant source of business. 2 PFA is aury egodaia the sale of is interests to uinean investos as part of an oveall stutkig of SONAG.  GQin F twW aor Operaton 11 a CiPnIMIN: Siedd DaBa (Fisl Yea 1991) SONAG SOGAM Al Companie Tota Assets 8,891 1,379 205 10,725 (GNF millkm) Number of Etployees 108 22 1O 140 Pmm s 7,370 1,111 S7 6,538 (CNM milkm) Source Uvaudked flal stemen of hrace companies. 40. The insurace industry has been facing problems. An erodg capital base and a spectrum of financial and operational problems have weakened its financial position. All of the isurAnce companies registered operating losses in 1991, although negative profitability is not an unusual occurence m the first years of operation of a insurance- company. They all suffered from high operaing costs. For instance, one company had a ratio of operatig expenses to premiums greater than 100%. Initial start-up cost related to legal, pricing and underwrin, plus daily opet expenses may be significant. Other large expenses may also occur during a period of rapid new business growth, with first year commissions and reinsurae costs resulting in significant one ime chages. However, the industry suffers from more fuxnmental problems. Most of the losses were attrbutable to the automobile insurance branch, plagued by controlled premiums and large awards. lsurance companies' profitability was also handicapped by the lack of financial I,struments to invest reserves and provisions. Most instrm s were in the form of low yielding term deposits in commercial banks, although the introduction of the Tasury Bils market will provide an outlet for their excess liquidity and an opporty to imvest in higher yielding instruments. 41. Sodal secuity Instution. The Caisse Nationale 4 Scrit6 Sociale (CNSS) was established in 1955 as the Caisse de Compensations Familiales with the current name adopted in February 1960. CNSS offers: (a) family benefits (primarily matemity leave); (b) occupational accident and sickness benefits; (c) bealth benefits (after the eighth day of sickness); and (d) death, disability and retirement benefits. Employees coanrbute 3.2% and employers contribute 16-20% of base salary, up to a maximum cap of GNF 300,000. 42. CNSS is a poorly managed, technically bankrupt instition. It has high operating costs; it does not have a proper accounting system; internal control procedures to ensure the integrity of the institutionts mssets are inadeqe; there is a sole signatory authority in all financial transactions; claims are processed manually and benefits are paid on a cash basis from arent revenue. Moreover, no financial provisions are made for future or pending claims nor is thee a longterm investment strategy to provide adequate income to complement premhums received.  Gduva Financial SeCIor Operadon 12 43. Rura savings and loan Istions. To foster monetization of rural areas and develop rural credit, two projects were launched in 1988. Each of the existing structures has a different philosopy and caters to a different clientele. The Rural Credit Prtvject led by the CFD and co-financed by FED focuses mainly on a Grameen-type system. Tk?e Mutual Credit Bank (Caisses de Credit Mutuel) led and financed by the Centre International du Cr6dit Mutuel (CICM), linked to the Crdit Mutuel de France, concentrates on resource mobilization. Credit Rural is more of a development institution dealing with lower income customers. C6dit Mutuel's customers are generally civil servants and the more elite merchants in rural areas. Both project have a large proportion of women among their clientele. These projects respond to the needs of rural commnities by mobilizing savings and extending credit on financial conditions commensurate with their customers' needs. To overcome the low literacy rate, they incorporate an important training component. Both projects benefit from extensive technical assistance. They depend on subsidies to cover operatig expenses and fiud their investment program. It is still uncertain whether further growth will permit them to achieve self-sustainability. A U.S. fimded project, PRIDE, operates on the same principles but is more limited in scope. 44. The >bit Rural project began opertn in 1989, under the tuteae of Xt Ministry of Agricultue and Animal Resources (MARA), as a pilot operation in two rural prectres, Koundara and Telimele. At the end of December 1993, there were 19 local units ("caisses") and 18 offices ("bureaur. d6centralisds") throughout the county. Credit is provided to over 13,000 local farmers, fishermen, crafsme and tradesmen under two programs, Cr6dit Solidaire and Credit Agricole. Under its statutes, Cr6dit Rural cannot lend to civil servants. Table 10 of Annex I presents the allocation of credit in the four regions. Total credit outstanding amounted to GNF 812 million at the end of June 1992. Credits are to a large extent, financed by external lines of credits as total deposits mobilized by local caisses, amounted to GNF 255 millon. Under CrEdit Solidaire, credits are extended to groups of five clients which share responsibility for timeljr debt service. Loam are extended for a maximum term of one year, bear a 36% annual rate of inerest, and are for a maximum amount of GNF 120,000 in the first year of existence of the group, GNF 150,000 for the second year and GNF 200,000 for the third year. Financial penalties are imposed for undmely payment of principal and interest due. Delinquent groups are barred from further extension of credit. So far, delinquency has been kept at the low level of less than two percent, by the Grameen-type aroach of sbared rensibily and by the involvement of village elders ("sages"). A solidarity fund has been established receiving one percent of the loan proceeds to protect the borrowers against default caused by sickness or death. 45. Education is an important aspect of the intervention of CrEdit Rural, given the illteracy of a large proportion of its clientele. Formal grating of credit is preceded by the attendance at three mandatory training sessions and successful comletion of an exam. Training of clients involves learing how to sign one's name, u ta the conditions attached to the loan and the various docments distributed. 46. Cdt Mutuet, unlike CrEdit Rumal, focusses on savings mobilization through demand, savings and tenn deposits and has experienced success in the somewhat wealthier and more urban areas. Cr6dit Mutuel operates with 30 local "caisses" in the regions of Labe, Kindia and Gueckedou. Its head office is located in LabE.  gulia nnd,c