Senegal - Economic Recovery Credit Project

Docmenat of The World Bank FOR OFFICIAL USE ONLY MI CROGRAPHICS Rort No.P-6273-SE Report No: P- 6273 SE Type: PR REPORT AND RECOMMIENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED ECONOMIC RECOVERY CREDIT OF SDR 18.2 MILLION TO THE REPUBLIC OF SENEGAL FEBRUARY 28, 1994 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = CFA franc (CFAF) US$1.00 = CFAF 592 (January 31, 1994) CFAF I millior, US$ 1,687 (January 31, 1994) SYSTEM OF WEIGHTS AND MEASURE: METRIC Metric U.S. Equivalent 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 miles (mi) 1 square kilometer (km2) = 0.39 square mile (sq mi) 1 hectare (ha) = 2.47 acres (a) 1 metric ton (t) = 2,205 pounds (lb) 1 kilogram (kg) = 2.2046 pounds (lb) FISCAL YEAR January 1- December 31 ABBREVIATIONS AND ACRONYMS AGETIP : Agence d'execution des travaux d'int6ret public contre le sous-emploi (Public Works and Employment Project II) BCEAO : Banque Centrale des Etats de l'Afrique de l'Ouest (Central Bank) CFA : Communaute Financiere Africaine (African Financial Community) CNCAS : Caisse Nationale de Credit Agricole Senegalaise (Agricultural Bank) COUD : Centre des Oeuvres Universitaires de Dakar (University Services) CPSP Caisse de Perequation et de Stabilisation des Prix (Fund for Price Equalization and Stabilization) PAD : Port Autonome de Dakar (Dakar Port Authority) SAED Societ6 d'Amenagement et d'Exploitation des terres du Delta (Senegal River Rural Development Agency) SENELEC : Societe Senegalaise d'Electricite (Power Company) SMD : Small and medium-sized enterprises SMI : Small and medium-sized industries SNCS : Societe Nationale de Chemins de Fer du Senegal (Railway) SODEFITEX: Soci6te pour le Developpement des Fibres Textiles (Textile Company) SONACOS : Societe Nationale de Commercialisation des Olegineux (Groundnut Oil Company) SONEES : Societe Nationale d'Exploitation des Eaux (Water Company) UEMOA : Union Economique et Monetaire de l'Ouest d'Afrique (West African Economic and Monetary Union) UMOA : Union Monetaire de l'Ouest d'Afrique (West African Monetary Union)  FOR OFFMCIAL USE ONLY REPUBLIC OF SENEGAL ECONOMIC RECOVERY CREDIT (ERC) Table of Contents Credit and Program Summary ............................................ i I. THE GOVERNMENT'S ECONOMIC AND SOCIAL PROGRAM ..1 A. Recent Economic Developments .. B. The Decision to Change the Parity of the CFAF. 2 C. Macroeconomic Objectives and Policies for 1994 ...... .............. 3 D. Structural Policies ............................................ 5 E. Social Aspects ............................................. 7 F. Financing Requirements . ....................................... 8 II. IDA'S STRATEGY AND OPERATIONS IN 1994 .............. 8 A. Country Strategy and Priorities ............ ....................... 8 B. Follow-up Operations to the ERC in 1994 . ........................ 10 HI. THE ECONOMIC RECOVERY CREDIT ............11................. 1 A. Financing and Management of the Program ........................ 11 B. Procurement and Disbursement ........... ....................... 12 C. Environmental Aspects . ....................................... 13 D. Project Implementation . ....................................... 13 E. Benefits and Risks ............................................ 14 IV. RECOMN ENDATION ............................................ 14 Annexes Annex I Main Economic and Social Indicators . ................ I ....... 1-5 Annex II Status of Bank Group Operations in Senegal .................... 1-2 Annex IH Supplementary Project Data Sheet ............................. 1 Annex IV Government's Statement of Economic and Social Policies .... ..... 1-14 Annex V ERC Action Matrix for 1994 ............. ....................... 1-2 | This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  REPUBLIC OF SENEGAL ECONOMIC RECOVERY CREDIT (ERC) Credit and Program Summary Borrower: Republic of Senegal Amounts: IDA Credit: SDR 18.2 million (US$25 million equivalent) Terrns: IDA Credit: Standard with 40-year maturity Program Description: The African member countries of the Franc Zone decided to devalue their currency, the CFA franc, effective January 12, 1994. By shoring up support for the measures taken in the aftermath of the devaluation, the proposed operation is a crucial element in helping to deepen the adjustment program that the Senegalese Government has been pursuing since August 1993. The previous internal adjustment programs of the 1980s were supported by four Structural Adjustment Credits (SAL I-IV) as well as by the IMF Enhanced Structural Adjustment Facility (ESAF). The proposed credit would support the post-devaluation reform program as outlined in the Government's Statement of Economic and Social Policies (Annex IV), and, more particularly, the measures aiming at minimizing the negative social impact of the devaluation in the short term. The Government's program has also obtained the support of an IMF Stand-by arrangement. The Senegalese Government has already taken a series of key macroeconomic and structural measures to regain and consolidate competitiveness. The ERC is desinged to support the implementation of these measures in 1994. The main measures are: (i) devaluation of the CFA Franc from 50 CFAF to 100 CFAF/1 IT; (ii) increase in key producer prices (groundnuts, cotton); (iii) a substantial program of social measures to attenuate the effects of the devaluation on the vulnerable groups; (iv) prudent demand management policies to reduce absorption by the public sector and limit wage increases; (v) reduction and simplification of tariffs and domestic taxation; and (vi) protection of social sector expenditures. Estimated Disbursements: Due to the urgent nature of the operation, the entire US$25 million would be disbursed in a single tranche shortly after effectiveness. There is no separate staff appraisal report.  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE, INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED ECONOMIC RECOVERY CREDIT TO SENEGAL 1. I submit for your approval the following report and recommendation on a proposed Economic Recovery Credit to Senegal for the equivalent of SDR 18.2 million (US$25 million equivalent) in support of a recovery operation designed to provide the financial and teclnical support needed as a follow-up to the parity change of the CFA franc. The Credit would be at .he standard IDA terms, with a maturity of 40 years. 2. A 12-month stand-by arrangement with the IMF, to be replaced by a three-year arrangement under the enlarged enhanced structural adjustment facility, for the equivalent of US$63.3 million will be considered by the IMF Board on March 2, 1994. A Country Assistance Strategy (CAS) is under preparation and will be presented to the Board with the next adjustment operation. The last CAS was discussed at the Board on May 1, 1992. The Sixth Policy Framework Paper (PFP) is expected to be ready at the beginning of FY95. PART I. THE GOVERNMENT'S ECONOMIC AND SOCIAL PROGRAM A. Recent Economic Developments 3. Since the early 1980s, adjustment in Senegal has been supported by various World Bank structural and sectoral loans, IMF stand-by, SAF, and ESAF arrangements, and by other multilateral and bilateral creditors. Despite temporary setbacks and delays in the implementation of some measures, the structural reforms undertaken have contributed to reducing financial imbalances and ensuring progress toward liberalization of the economy. However, as the lack of competitiveness of the economy became more acute and the terms of trade deteriorated, the reform process suffered major setbacks, in particular with respect to trade liberalization. As a result, the Senegalese economy is still facing substantial financial and structural difficulties. Over the period 1986-92, real GDP growth has remained low (3.1% p.a.) barely above the population growth rate (about 3.0% p.a.). 4. In 1992 and 1993, the fiscal and balance of payments position deteriorated and substantial domestic and external payments arrears accumulated. The stock of debt increased considerably, and the net foreign assets position remained strongly negative. The economy experienced a serious contraction in key sectors, notably fishing, phosphates, groundnuts, and food processing. To halt this deterioration, the authorities adopted several measures in August 1993 based on an internal adjustment strategy, including a cut in public sector wages and an increase in both import duties and in the plice of petroleum products. Although these measures contributed to reduce the imbalances (the budget deficit, on a commitment basis and excluding grants, was contained at 3.8% of GDP in 1993 and the current account deficit, excluding official  - 2 - transfers, amounted to 9.7% of GDP), they could not restore the competitiveness of the economy and growth prospects remained extremely poor. 5. The economic conditions in the rest of the CFA zone were as difficult as those of Senegal. Adverse external shocks affected all countries. The strengthening of the French franc against the zone's trading partners and competitors made it increasingly difficult to restore competitiveness by a deflationary policy alone. Investment and exports declined precipitously; the distribution of income worsened as the burden of adjustment fell on rural populations, often among the poorest Senegalese; macroeconomic balances deteriorated; the financial sector was severely hit: capital flight, arrears to the public sector, weak portfolio of enterprises which are still surviving; and smuggling from neighboring countries became rampant. A major policy change was therefore called for. B. The Decision to Change the Parity of the CFAF 6. The Government of Senegal, after close consultation with other member countries of the CFA zone, decided to strengthen its adjustment strategy: Effective January 12, 1994, the fixed parity of the CPA franc was changed from 50 to 100 CFAF per FF. With the realiginment of its currency, the Government of Senegal has adopted an adjustment program for 1994-96. During that time, the program aims to: (i) achieve a rate of real GDP growth of at least 5.5% starting in 1995; (ii) increase the investment-to-GDP ratio; (iii) achieve primary surpluses in the Government's budget; (iv) sustain the improvement in external competitiveness through structural and regulatory reforms and a return to a low inflation after a transitional period; and (v) expand poverty alleviation measures and intensify human resource development. 7. This historic decision represented a major step to launch a broad development agenda, aimed at accelerating growth in a region which had experienced a serious economnic decline. The nominal devaluation of the CFA franc is part of a comprehensive program designed to pursue and deepen poverty alleviation efforts. 8. In a small low income country such as Senegal, export-led growth is the only viable option for accelerated, sustained improvements in living standards and reduction in poverty. While efficient import substitution can contribute to the growth process by eventually leading to the creation of new export industries, it cannot be the engine of growth. In fact, typically the rate of growth of exports sets a ceiling on the attainable rate of GDP growth. Thus, it is expected that the parity change will contribute sig, ificantly to the resumption of growth. In particular, a quick and strong response is expected from fishing (aggregate sales were already higher in the first week following .le devaluation), tourism (as foreign tour operators lowered their prices immediately), agriculture and food processing, cement, chemnical industries, and small manufactures (e.g., clothing, shoes, etc.). 9. International experience suggests that devaluations in low-inflation countries can  - 3 - effectively bring about real depreciations with only a temporary increase in the inflation rate. The CFA zone's history of low in1'ation, which is largely due to the supra-nationality of monetary policy -- a unique situation in the world -- ,confers an important advantage, and the probability is high that the devaluation, backed by complementary policies, will succeed in restoring competitiveness, while allowing the currency to resume its role as the nominal anchor of macroeconomnic policy. 10. In order to guarantee the success of the devaluation and to reach their development objectives, the Government of Senegal is aware of the need to accompany the change of parity with measures designed to: (i) pass through the benefits of the devaluation to rural producers; (ii) reduce the absorption of the Government and limit wage increases; (iii) address the political and social dimension and receive policy advice and technical assistance to manage the process; and (iv) accelerate the structural reforms necessary to support the supply response. The measures announced by the authorities in the week following the change of parity and the reform agenda of the Government are filly consistent with the above. Government's policies are summarized in the Statement of Economic and Social Policies shown in Annex IV. C. Macroeconomic Objectives and Policies for 1994 11. The main macroeconomic objectives for 1994 are to: achieve a real GDP growth rate of 2.5%, increasing to 5.5% the following year; limit inflation to less than 40%, and to 8% the following year; contain the external current account deficit, excluding official transfers, to 11% of GDP, reducing it to 8.5% the following year. 12. Public finances. Strengthening the budgetary position through lasting measures is one of the key components of the adjustment strategy adopted by Senegal. The deficit on the Government's financial position, on a commitment basis and excluding grants, is limited to CFAF 84.7 billion (3.6% of GDP) to be reduced to 2..1% of GDP the following year. External payment arrears, estimated at CFAF 174.2 billion under the new parity, will be eliminated by the end of 1994. Verified outstanding payment arrears, which at end-December 1993 amounted to CFAF 45 billion, will be reduced by at least 32 billion by end-1994 and should be totally eliminated the following year. 13. Wage Policies. The wage bill will be limited to CFAF 149 billion in 1994. To achieve this objective, the number of civil servants will be kept at its end-1993 level of 67,100 with no new recruitment on a net basis. Salaries have been raised to their August 1993 level and will be raised by a maximum of 10% after March 31, 1994. Salary arrears will be identified and a timetable will be established for settlement. However, the cost of doing so will be contained in the above-mentioned overall ceiling on the wage bill. Export subsidies will be eliminated. 14. Taxation. The realignment of the CFA franc is expected to give added impetus to structural reforms the Government had been implementing in the past. With regard to  - 4 - trade reform, the Government immediately adjusted tariffs and other taxes. The maximum tariff rate has been reduced to 45% and the minimum rate set at 10%, in addition to a stamp duty of 5%. All exemptions have been abolished with the exception of those related to projects and diplomatic privileges. All restrictions on imports of certain goods will be lifted during 1994 and replaced by a temporary import surcharge of 20%. This surcharge will also apply to luxury items. As for the value-added tax (VAT), the existing five rates (0, 7, 15, 20, and 30%) for non-petroleum products have been replaced by a system comprising three rates (0, 10, and 20%); the list of exonerated goods will be kept to a limited number of products (including basic goods and pharmaceutical products); and the VAT tax base was enlarged to include the transportation of certain commodities (rice, petroleum products, and cement). For petroleum products, the custom duty rates (0, 25, ard 45%) have been replaced by two rates (25 and 35%), while the VAT rates (0, 7, 20, and 34%) have been replaced by a single rate of 20%. 15. Price policies. The Government will continue its price liberalization efforts and will not introduce new price controls. (a) Ir the agricultural sector, producer prices were increased immediately: 43% for groundnuts and 30% for cotton. (b) The pi ces for petroleum products were modified so as to reflect international prices under the new exchange rate. The aforementioned reduction in taxes and the decrease of the stabilization levy allowed price increases to be limited to 20-30%, thereby containing inflation and helping competitiveness by limiting the increase in production costs. Prices of petroleum products will be adjusted in the future in line with the mechanism put in place in 1991 to reflect fluctuations in world prices. The prices of water, electricity, and telecommunications were initially increased by 22-30%. As needed, firther price revisions will be made following the completion of more detailed studies of the cost structure of the enterprises in these sectors. Particular attention will be given to containing increases in costs. (c) As regards essential goods, the price of rice was raised by 33%, that of flour 30%, that of sugar 30%, and those of vegetable oil and groundnut oil by 25%, taking into account social and political constraints and budgetary resources. (d) For products under the system of "homologation" (including flour, bread, tomato paste, cement, and pharmaceutical products), prices will be adjusted in consultation with the enterprises concerned, taking into account the parity change, reductions in certain taxes, as well as elimination of all subsidies. Prices of all other products will be freely determined in the market. 16. Monetary policy. The authorities will implement a prudent credit policy, consistent with their balance of payment objectives. Between end-December 1993 and end-December 1994, credit to the economy will increase by 24.4% only. In view of the  - 5 - foregoing and of the objectives of improving net foreign assets, the money supply should rise by 34.2% in 1994. Credit and financial intermediation policies will continue to benefit from the reform of monetary policy instruments which has been undertaken by the Central Bank of West African States (BCEAO). In particular, beginning October 1993 the administrative controls were replaced by indirect policy instruments, consisting of the pursuit of a more flexible interest rate pclicy, the introduction of mandatory reserve requirements, and the expansion of the role of the money market. Pending the stabilization of prices after the initial increase of the inflation rate, the discount rate of the Central Bank has been raised from 10.5 to 14.5%. 17. To ensure the return to a high and sustainable rate of economic growth, the program foresees an increase in the investment-to-GDP ratio from 13.6% in 1993 to 18.4% in 1996 while focusing on improving its efficiency. In consultation with IDA, the Government will adopt by end-June 1994 a revised three-year public investment program covering the period 1994-96. For 1994, investment spending will reach CFAF 12 billion and the priority will be given to productive sectors, human resources, and infrastructure investments. Efforts will be pursued to improve on the follow-up of projects at the implementation stage. Finally, the Government will take all the necessary measures to ensure that their counterpa.t funds commitments are met. D. Structural Policies 18. The structural measures of the Government's program aim at improving the competitiveness of the private sector and diversifying production. The liberalization of trade and prices, as well as the improvement of the regulatory framework, are essential. 19. In the agriculture sector, the Government intends to implement a number of measures designed to remove price controls and other restrictions on private sector economic activity, and to further disengage the public sector from productive and commercial activity. As a rule, the change in relative prices imp'ied by the parity change should facilitate the accomplishment of these objectives, since for several commodities maintaining the existing distortions is either no longer warranted (the devaluation produces the necessary natural protection) or prohibitively expensive in the long term. In the groundnut sector, producer prices will now vary each year in accordance with the prices in the world market. The Government intends to privatize SONACOS; the privatization arrangements for this company will be finalized by end-December 1994. For the cotton sector, the Government will implement a flexible price policy linking prices to world market prices and intends to proceed to the restructuring of SODEFITEX. The Government is also committed to proceed with the restructuring of the CPSP with the objective of achieving its withdrawal from the purchase and commercialization of broken rice. The fishing sector has benefited iinrnediately from the parity change. The Government intends to encourage private investment, intensify marketing efforts, and improve the management of natural resources to prevent overfishing and ensure adequate stocks in succeeding years. Other reforms envisaged by the Government include  - 6 - improvements in land management practice and expanding the system of rural credit, particularly through the promotion of participatory savings and credit associations as the main retailers of rural credit. 20. Industrial policy will continue to be centered on the promotion of exports and the development of small and medium-size enterprises for import substitution through improvements in the competitlveness and productivity of the industrial sector. Accordingly the most important measures concern regulatory reforms and the elimination of bottlenecks throttling the supply response. With respect to the reform of the labor market, the Government will open discussions with the concerned partners to reach a consensus that will permit before the end of 1994 the introduction into the labor regulations of the flexibility which is necessary to encourage production and the creation of employment. With respect to public enterprises other than SONACOS or SODEFITEX, the Governmeiit intends to pursue the restructuring of SENELEC (electricity) and SONEES (water). To reach this objective, the on-going study regarding SONEES and a financial audit of SENELEC will both be completed by June 30, 1994. Furthermnore, the cross-debts of the public sector will continue to be settled in accordance with the previously-established timetable. The Government intends to consolidate the progress already accomplished under the 1989 financial sector reform by accelerating the recovery of non-performing assets and corresponding liabilities of all liquidated banks, and taking further steps towards the rehabilitation of the banking system, notably that of the Caisse Nationale de Credit Agricole Senegalaise (CNCAS) through its recapitalization. A program aimed at restructuring the insurance sector will also be introduced. 21. Since the last quarter of 1993, the Government has taken steps to relaunch the transport and infrastructure sector which had been experiencing serious difficulties due to the inadequacy of local funds. The Governnent is committed to increasing the share of road works carried out by private contractors from 35% to 75% by 1996. In order to do so, it will be necessary to minimize payment delays by the administration for the works executed. A further objective is the restructuring of SNCS (railways), PAD (port), and AIR SENEGAL to reestablish their commercial viability and eliminate the need for subsidies. 22. In the education sector, primary education will continue to remain the priority. The focus will be on expanding access to the rural areas and increasing the girls enrollment ratio in the 20 departments where it is currently below the national average of 45%. These goals will be reached by speeding up the program of construction of additional classrooms. The Government will contain costs through a continued use of double-shift and multi-grade teaching. The Government intends to implement the outcome of the National Symposium on Higher Education which calls for the reduction in university costs through the privatization of COUD (housing and food services) and the establishment of a limit on the length of time students can be registered at the university. 23. In the health sector, the Government has drawn up a medium-term plan that  - 7 - outlines manpower planning goals including guidelines for the assignment of personnel to health centers and health posts. In the area of fhiancing, the Government is committed to increasing the percentage of health expenditures of the national budget to 7.5% by 1996. Client and community contributions should constitute a growing share of financing. The use of generic drugs should be accelerated as the result of the impact of the parity change on the local currency cost of drugs. 24. The Government adopted a population policy which is being financed by the Bank. The Govermnent has decided to intensify the availability of family planning services to be able to realize its objective of a contraceptive prevalence rate of 11% by 1996. Greater use of public information will be required with particular linking of family planning activities to target groups, including mother and child health and functional literacy programs for women. In conformity with IDA policies, the Government is preparing a National Environmental Action Plan (NEAP) for CY94. 25. Regional Integration. Together with the devaluation, a major step towards regional economic integration was taken by the seven Heads of State of the UMOA in Dakar with the signing of the Treaty transforming the UMOA into an economic and monetary union (UEMOA). This improves the prospects for services and manufacturing development in Senegal, as in the six other UEMOA countriest, by increasing the potential for intra-regional trade in a market of nearly 60 million people and permitting economies of scale. Moreover, the strengthening of the Union institutions and the proposed mechanisms to ensure the convergence of fiscal policies and the harmonization of economic and sectoral policies among the seven countries increase the likelihood for them to maintain viable macroeconomic frameworks. E. Social Aspects 26. The adjustment strategy adopted by the Government aims at increasing the standard of living of the population and reducing poverty. The rise in producer prices of agricultural commodities will lead to an increase in the income of the rural population. In particular, the 43% increase in groundnut price will contribute significantly to increase incomes of some of the poorest farmers. The general economic recovery, resulting from the res.oration of competitiveness, is expected to create new employment opportunities and benefit all social groups in the medium term. In the short term, however, the increase in food prices will be visible before the supply response begins to increase incomes. To limit the detrimental effects of the devaluation on the most vulnerable groups, the Government has introduced accompanying measures with the objective of limiting the price increases of certain products, improving the availability of social services in health and education, and directly helping the most vulnerable segments of the population during the transition period. lBenin, Burkina Faso, Cote d'Ivoire, Mali, Niger, and Togo.  -8 - (a) Fiscal measures have been taken to limit to the maximum extent feasible the price increases of products that mrake up a significant part of the consumption basket of low-income households (oread, rice, vegetable oil, medicine). (b) Budgetary appropriations for social expenditures, in particular in the areas of prinrary education and basic health services, have been increased to take fully into account the price increases of imports. (c) A special program targeting the poorest social groups will be put in place with the aid of non-governmental associations (NGOs) and certain donors. (d) An amount of CFAF 15 billion is explicitly budgeted to cover the cost of the social safety net measures. These include temporary subsidies for the consumer price of rice in the amount of CFAF 8 billion; temporary subsidies in the consumer price of wheat in the amount of CFAF 2 billion; health expenditures, including purchases of essential drugs, of CFAF 2 billion: education expenditures to increase primary school enrollment ratios of CFAF 2 billion; and other social outlays benefiting the most vulnerable groups. F. Financing P equirements 27. After taking into account commitments already made for project loans, the gross external financing requirements for 1994 will amount to CFAF 297.7 billion (492.3 millions dollars). These requirements will be covered by exceptional financial assistance from multilateral institutions and bilateral creditors, and debt relief operations. The exceptional financing already identified for 1994 totals CFAF 139.7 billion distributed as follows: CFAF 64 billion in loans from multilateral institutions; CFAF 13 billion in transfers from the European Communities; CFAF 47 billion in official bilateral assistance; and CFAF 15.7 billion in the form of debt reduction recently announced by France. The residual gap will be covered by expected debt rescheduling. Total imports (f