Zambia - Economic Recovery and Investment Promotion Credit

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6593-ZA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN THE AMOUNT EQUIVALENT TO SDR 90.0 MILLION TO THE REPUBLIC OF ZAMBIA FOR AN ECONOMIC RECOVERY AND INVESTMENT PROMOTION CREDIT JUNE 6, 1995 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 = Zambian Kwacha (K) US$1 = K820 (April 1995) FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS BOZ Bank of Zambia CBI Cross Border Initiative CEM Country Economic Memorandum CG Consultative Group for Zambia CIR Country Implementation Review CPPR Country Portfolio Performance Review CSPF Civil Service Pension Fund DBZ Development Bank of Zambia ERC Economic Recovery Credit ERIP Economic Recovery and Investment Credit ESAC Economic and Social Adjustment Credit ESAF Enhanced Structural Adjustment Facility GDP Gross Domestic Product IBRD International Bank for Reconstruction and Development IDA International Development Association IMF International Monetary Fund LASF Local Authorities Superannuation Fund LUSA Lusaka Stock Exchange MMMD Ministry of Mineral and Mining Development MMD Movement for Multiparty Democracy NEAP National Environmental Action Plan NEDC National Economic and Development Committee NSSRI National Social Security Reform Implementation PER Public Expenditure Review PFP Policy Framework Paper PIRC Privatization and Industrial Reform Credits PTA Preferential Trade Agreement RAP Rights Accumulation Program RPED Regional Project for Enterprise Development SCC Systematic Client Consultation SEC Securities Exchange Commission VAT Value Added Tax ZCCM Zambia Consolidated Copper Mines ZESCO Zambia Electricity Supply Company ZIMCO Zambia Industrial and Mining Corporation ZNPF Zambia National Provident Fund ZPA Zambia Privatization Agency ZSIC Zambia State Insurance Company ZRA Zambia Revenue Authority  FOR OFFICIAL USE ONLY CURRENCY EQUIVALENTS Currency Unit = Zambian Kwacha (K) US$1 = K820 (April 1995) FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS BOZ Bank of Zambia CBI Cross Border Initiative CEM Country Economic Memorandum CG Consultative Group for Zambia CIR Country Implementation Review CPPR Country Portfolio Performance Review CSPF Civil Service Pension Fund DBZ Development Bank of Zambia ERC Economic Recovery Credit ERIP Economic Recovery and Investment Credit ESAC Economic and Social Adjustment Credit ESAF Enhanced Structural Adjustment Facility GDP Gross Domestic Product IBRD International Bank for Reconstruction and Development IDA International Development Association IMF International Monetary Fund LASF Local Authorities Superannuation Fund LUSA Lusaka Stock Exchange MMMD Ministry of Mineral and Mining Development MMD Movement for Multiparty Democracy NEAP National Environmental Action Plan NEDC National Economic and Development Committee NSSRI National Social Security Reform Implementation PER Public Expenditure Review PFP Policy Framework Paper PIRC Privatization and Industrial Reform Credits PTA Preferential Trade Agreement RAP Rights Accumulation Program RPED Regional Project for Enterprise Development SCC Systematic Client Consultation SEC Securities Exchange Commission VAT Value Added Tax ZCCM Zambia Consolidated Copper Mines ZESCO Zambia Electricity Supply Company ZIMCO Zambia Industrial and Mining Corporation ZNPF Zambia National Provident Fund ZPA Zambia Privatization Agency ZSIC Zambia State Insurance Company ZRA Zambia Revenue Authority 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.  I  ZAMBIA ECONOMIC RECOVERY AND INVEFSrMENT PROMOTION CREDIT Table of Contents Page SU[MARY ..........1-11....................................... i PART I: THE ECONOMY ............................. 1 A. Background ............................................. 1 B. Recent Economic Performance ................................. 2 Part H: ZAMBIA'S ADJUSTMENT PROGRAM ...................... . 6 A. Macroeconomic Policy ....................................... 6 B. Structural Policy .......................................... 7 C. External Flnancial Requirements ................................ 9 PART mII: THE PROPOSED CREDIT .................. 10 A. The ERIP Reform Program and Links to the Country Assistance Strategy .... 10 B. The ERIP Reform Program ................................... 11 1. Macroeconomic Stability and Flscal Policy .......................... 11 2. Continuing Financial Sector Reforms ............................. 13 3. Social Security Reform ....................................... 15 4. Mining Sector Reform ....................................... 16 C. Disbursement, Procurement and Auditing .......................... 18 D. Program Management and Monitoring ........ ..................... 19 E. Environmental and Poverty Impact .......... .................... 20 F. Impact Evaluation and Beneficiary Assessment ...... ................. 20 G. Benefits and Risks ......................................... 21 PART IV: BANK GROUP OPERATIONS .......... .. ............... 22 A. IDA Operations ........................................... 22 B. Implementation Issues ....................................... 23 C. EFC and MIGA Activities ..................................... 24 PART V: COLLABORATION WIT IF. . 25 PART VI: RECOMM1ENDATION ............... .................. 25 This operation was prepared by a team consisting of Emile B. Sawaya (Principal Private Sector Development Specialist and Task Manager, AF1MI); John Todd (Principal Economist, AF1M[); Lloyd McKay (Senior Economist, AFIMI); Elena Folkerts-Landau (Principal Financial Specialist, AFIMI); John E. Strongman (Principal Mineral Economist, IENIM); Paul Dyson (Senior Mining Engineer, IENIM); Said N. Al Habsy (Senior Counsel, LEGAF); Elizabeth Adu (Principal Counsel, LEGAF); Dan Mozes (Senior Financial Specialist, FSD); Monika Queisser (Financial Specialist, FSD); Ellah Chembe (Economist, AF1ZM); Maria Teresa Benito (Research Analyst, AFIMI); Biin Neyapti (Research Analyst, AF1MI). Secretarial support was provided by Ms. Adriana Arriagada (AFIMI). Ms. Phyllis Pomerantz (AFlC2) is the Country Operations Manager, and Ms. Katherine Marshall (AF1DR) is the managing Department Director.  ZAMBIA ECONOMIC RECOVERY AND INVESTM PROMOTION CRED1T Table of Contents (cont'd.) ANNEXES ANNEX A - Social Indicators ANNEX B - Key Macroeconomic Indicators ANNEX C - Balance of Payments and Financing Requirements ANNEX D - Summary Statement of Loans and IDA Credits ANNEX E - ERIP Matrix of Policy Conditionality ANNEX F - Evolution of Policy Reform Conditionality ANNEX G - Performance Indicators ANNEX H - Supplementary Data ANNEX I - Letter of Development Policy  ZAMBIA ECONOMIC RECOVERY AND INVESMENT PROMOTION CREDIT SUIMMARY Borrower/Beneficiary: Republic of Zambia Executing Agencies: Ministry of Finance Ministry of Mines and Mineral Development Ministry of Labor and Social Security Amount: SDR 90.0 million (US$140 million equivalent), on standard IDA terms, with 40 years maturity. Description: This proposed adjustment Credit would support a reform program that includes the following components: (a) macro- economic stabilization, with emphasis on continued restraint on and increased effectiveness of public expenditures (including protection of social sector allocations) and remaining trade and tax reforms; (b) selected financial sector reforms aimed at improving the mobilization and allocation of term funds, especially by insurance companies and pension funds; (c) social security reforms to establish a new basic pension system and to ensure the sustainability of contractual saving institutions; and (d) mining sector policy reforms to update and improve the legal, fiscal and environmental frameworks to attract new investors, particularly to copper mining, and the prerequisite preparatory work to privatize Zambia Consolidated Copper Mines, Ltd. (ZCCM). Benefits: The policy reforms being supported under this operation aim to enhance macroeconomic stability, improve the competitiveness of Zambian products and promote investment in the economy in general and in the copper mining industry in particular. Increasing the rate (and the sustainability) of economic growth will be essential for generating benefits from the economic reform program and alleviating poverty, the central objective of IDA's country assistance strategy. In particular, the macroeconomic stabilization objectives and the improved tariff/tax regime, particularly the VAT, should improve the prospects for increased economic growth in the short term while the improved opportunity for term financing and the privatization of ZCCM should contribute to increased investment and hence to longer term growth. In addition, the reform of the social security system and continued strong budget support for the social sectors should help directly to alleviate poverty.  - 11 - Risks: The proposed ERIP faces external, implementation and political risks. The external risk relates to Zambia's high dependence on copper exports and its large debt burden and hence its high dependence on external assistance. Recent increases in copper prices help mitigate the former in the short term, and the measures related to mining sector policy reform and ZCCM privatization will mitigate the long term risk, but Zambia remains vulnerable to a large and sudden fall in the world copper price. To mitigate the risks associated with the dependence on donor aid, Zambia is taking measures to increase exports and contain imports in order to reduce that dependence. In the meantime, the Govermment has shown determined efforts to implement the reform program and keeps donors well informed. The Government's economic reform efforts have earned broad support from the international community which continues to assist Zambia through the CG process. The implementation risk relates to Government's administrative capacity to carry out the reform program. This capacity has improved consistently over the past few years, but it still remains limited relative to the scope and complexity of the reform program. To mitigate this risk, Government continues to be vigilant and to improve its implementation systems and their staffing. Continued dialogue and concerted actions among the Government, IDA and the donor community are also planned. The political risk arises from the continuing pressure on the Government to show quick results or to slow down some of the reforms. The Government, however, appears determined to stay the course and has taken measures to accelerate the supply response and to shelter the most vulnerable groups to help mitigate this risk. Disbursement: The proposed Credit of US$140 million will assist Zambia in meeting its external financing requirements during late 1995 and early 1996. The Credit will be disbursed through the Bank of Zambia. Disbursement will be in two tranches. The first tranche in an amount of US$70 million will be released at effectiveness; the remaining US$70 million will be released when the conditions of Second Tranche release are satisfied. Project Identification Number: ZM-PA-3240  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED ECONOMIC RECOVERY AND INVESTM PROMOTION CREDIT TO THE REPUBLIC OF ZAMBIA 1. I submit the following report and recommendation on a proposed International Development Association (IDA) Credit of SDR 90 million (US$140 million equivalent), on standard IDA terms with 40 years maturity, to the Republic of Zambia, in support of its economic reform and structural adjustment program. 2. The proposed Economic Recovery and Investment Promotion (ERIP) Credit would be the fifth structural adjustment credit to Zambia since the clearance of Zambia's arrears to the Bank in March 1991. The principal objective of the proposed Credit is to generate a more vigorous private sector supply response by assisting the Government's effort to continue stable macroeconomic policies, improve the tax and tariff regimes, consolidate reforms of financial sector policies and institutions, reform the social security system, and establish a strategy for attracting new private capital and management into the mining sector, including the preparation for privatization of Zambia Consolidated Copper Mining (ZCCM), the Government majority- owned copper producer. PART I: THE ECONOMY A. Background 3. For most of the 1970s and 1980s, Zambia's economy was heavily controlled, and the Government's economic strategy relied primarily on the public sector, especially parastatal enterprises, to undertake investment and generate growth. In the early years, rising copper revenues masked the inadequacies of the public-sector dominated economy, but when copper revenues fell sharply in 1975, the necessary adjustments were not made. Instead, Government borrowed heavily in an attempt to maintain private consumption and the high levels of public- sector investment and consumption. 4. As a result, as the 1990s began, the Zambian economy faced many problems. Basic goods and services were in short supply. The money supply was rising rapidly, and inflation had been over 100 percent for three years. Military expenditures were rising and social sector expenditures declining. Tax compliance was low, and the budget deficit was large and increasing. Many parastatal companies were heavily indebted and sustaining large losses. Private investment had collapsed, business and consumer confidence had disappeared, and investment in the copper sector was inadequate to offset declining production levels. External debt was not being serviced, creating large arrears to multilateral and bilateral institutions. A parallel market in foreign exchange was flourishing, and asset-holders were shifting their capital abroad and switching to foreign currency for local transactions. The physical infrastructure was deteriorating. Finally, Zambia had neither food reserves nor financial resources to deal with natural disasters or other emergencies. 5. The present Government was elected in November 1991 with a commitment to reduce poverty on a sustainable basis through an economic reform program aimed at restoring Zambia's  economic growth prospects by stabilizing the economy, moving toward external viability, revitalizing the copper sector, promoting the private sector based on free market principles, extracting the Government from business activity, and reversing the decline in the Zambian social sector's delivery system and infrastructure. The Policy Framework Paper (PFP) for 1992-94, adopted in February 1992, outlined the extensive reforms necessary to achieve these aims, including a sharp reduction in the size of the public sector through a comprehensive program of privatization and parastatal reform. 6. Much has been accomplished in the past three years as the Government has implemented many far-reaching market-oriented reforms. To begin with, the Government liberalized formerly controlled markets, and, except for utilities, all prices, including agricultural prices, are now market determined. The Government has steadily reduced its direct role in the economy, thus opening up increased opportunities for private sector firms and individuals. Subsidies have been eliminated, and parastatals making losses have either been restored to profitability with increased efficiency and cost covering prices, or they have been closed. Public spending priorities have been focussed on social services and infrastructure. All commercial interest rates have been decontrolled and are now determined by market forces. The foreign exchange market has been completely liberalized; quantitative restrictions on imports and exports have been eliminated; and the tariff structure has been compressed and simplified. 7. Many challenges remain to be met, however, if sustainable economic growth is to be achieved. Macroeconomic stability will require consistent fiscal and monetary discipline. Further improvements in the structure of taxes and tariffs will be needed if domestic revenue is to increase while price incentives improve, and continued improvements in spending allocations will be needed if vital infrastructure and social service needs are to be met within prudent fiscal limits. Sustainability will require substantial increases in domestic savings and investment levels which will in turn require deeper and more efficient financial markets. Of particular importance to achieving external viability, the long-term decline in copper productivity and output will need to be reversed with privatization of existing facilities and major private investment in new mines. Economic reforms to support these actions will be outlined in the next PFP, scheduled for submission to the Executive Directors in July 1995. B. Recent Economic Performance 8. Over the last three years, there has been substantial macroeconomic reform, although progress was slow at first. Following fiscal setbacks in 1992 and early 1993, money growth accelerated, and nominal and real interest rates reached historic highs in 1993 and 1994, increasing the cost of domestic debt service and squeezing the private sector. In addition, the kwacha appreciated sharply in the second half of 1993, lowering the return on the production of traded goods. The Government persisted with its stabilization efforts, however, and in 1994, inflation declined to 35 percent after five years of annual inflation in excess of 100 percent. Nominal interest rates, which had reached almost 400 percent early in 1994, fell to about 25 percent by the end of the year. With positive real interest rates prevailing from the middle of 1993, individuals and firms increased their holdings of kwacha-denominated financial assets. The demand for foreign exchange declined, and the exchange rate stabilized. A major management reform to strengthen fiscal policy was the implementation of a cash budget, which restricted spending to current revenues. This facilitated the Government's efforts to restrain spending in 1994 and played a major role in stabilizing the economy. On the revenue side, the  - 3 - most important step was the establishment of the independent Zambia Revenue Authority (ZRA) in April 1994. Since then, tax administration and tax compliance have improved substantially. 9. Foflowing on 1994's strong performance, however, a serious fiscal gap developed in the first quarter of 1995 due to disappointing revenue collections and higher than projected expenditures in several areas. On the revenue side, the major shortfall was in non-tax revenue where user fees, parastatal dividends, and privatization receipts fell well short of expectations. Significant shortfalls in tax payments from key parastatals, such as the Zambia Electricity Supply Company (ZESCO) and ZCCM, also contributed to the problem. This was accompanied by spending levels that were higher than expected in defense, wages, and interest. Defense spending overruns were primarily a result of payments made on arrears for commitments made in previous years. On wages, the overall increase was somewhat above the 30 percent provided for in the original budget. Interest payments were higher than expected because interest rates increased due to higher inflation in December and January, driven primarily by higher maize prices (because of the partial drought affecting the region), and to the increased uncertainty in monetary markets caused by the problems of Meridien Bank, one of Zambia's largest commercial banks, which in March 1995 began having difficulties meeting inter-bank settlements. 10. Initially, the Government tried to contain the situation by cutting spending across the board, but it recognized that this would not be feasible for any length of time because new arrears were likely to accumulate and because further reductions in public spending in vital areas, such as infrastructure and social services, would undermine its economic program. As a result, the Government has developed, after consultation with the IMF, a revised fiscal plan for the remainder of 1995 that includes significant revenue enhancement measures and selective reductions in expenditure. Increased revenues will come from higher excise taxes on fuel, electricity, sugar, and beer, a one percent fee on all imports to offset the costs of pre-shipment inspection, and direct withholding on interest and dividend income. Targeted reductions in spending will be accompanied by increased control over budgetary commitments, including those of the Ministry of Defense. As for Meridien Bank, after trying unsuccessfully to revive public confidence, the Govermment officially closed the Bank and put it into receivership in May. 11. As a result of Zambia's economic program, some progress has been made in moving towards external viability. Zambia built up its gross foreign exchange reserves from only one month worth of imports of non-maize goods and services in 1991 to nearly 2.5 months at the end of 1994 (although this fell back to below two months by end-March 1995 as donor assistance fell short of expectations in the first quarter of 1995). Improved debt management, including a commercial debt buy-back operation (supported in part by IDA), reduced the stock of Zambia's external debt by approximately US$650 million in 1994, although Zambia's external debt, at US$6.2 billion - nearly twice annual GDP - remains one of the highest in the world. To monitor Zambia's efforts to mobilize aid and to service external debt on a timely basis, the Government established a Balance of Payments Support and External Debt Management Group, and by the end of 1994 was servicing Paris Club and multilateral debt in line with the debt service program. 12. Over the last three years, Zambia's trade policy has aimed at moving from an inward-focused strategy of import substitution dependent on high levels of tariff protection to an outward-oriented, export-led strategy based on open markets and international competition. To this end, Zambia has eliminated all direct controls on trade, except for a short list of items controlled for environmental, health, or security reasons, and has sharply reduced the levels and dispersion of import duties. A duty drawback system for exporters has also been introduced.  - 4 - In addition, Zambia has worked closely with regional organizations to promote freer external trade. It has been a strong supporter of the Cross Border Initiative (CBI) - a regional program aimed at increasing the flow of trade and investment across borders and thus promoting competition and increasing efficiency in the domestic product and factor markets of the participating countries while also decreasing tariff protection vis a vis third parties. The Government recognized that an increase in the flows of trade and investment across regional borders would increase the efficiency in all countries and broaden the markets for everyone's products. As a result, preferences under the Common Market for Eastern and Southern Africa (COMESA) agreement -the successor to the Preferential Trade Agreement (PTA) - are already being applied, with rates for products from COMESA partners at no more than 40 percent of non-COMESA rates. 13. In the financial sector, several reforms were adopted. Barriers to entry into the insurance industry have been lifted. The new Banking and Financial Services Act updated the provisions for establishment, capitalization, operation, regulation and supervision of financial institutions; and amendments to the Bank of Zambia Act have strengthened its power to regulate and supervise most lending institutions. Both Acts are now in the early stages of implementation. A Securities Act in 1993 and related regulations set up a Securities and Exchange Commission (SEC) and the Lusaka Stock Exchange (LuSE). Trading on the LuSE has been very limited because only a very small number of companies have fulfilled listing and trading requirements, but activity is expected to increase significantly over the next twelve months. Plans are also underway to apply prudential regulation and supervision to contractual savings institutions. 14. The Government adopted an ambitious privatization and parastatal reform program to reduce its direct role in business activity. Here, the initial pace of implementation was slower than originally planned. Among other factors, progress on privatization was impeded by lack of cooperation from the Zambia Industry and Mining Company (ZIMCO), the government holding company for the management of parastatals. To facilitate a uniform policy direction in privatization and to improve the transparency of parastatal management, ZIMCO was closed on March 31, 1995. With the help of external consultants, the remaining necessary ZIMCO responsibilities (e.g., monitoring of operating results) have been transferred to the Zambia Privatization Agency (ZPA) and the Ministry of Finance. 15. Despite the delays, a sound foundation for privatization has been established. As of April 30, 1995, thirteen companies, accounting for about 6 percent of the total turnover of all parastatals, had been sold to private owners for K16 billion (about US$21 million). Sales agreements had been signed for an additional two companies, and preparations to complete the legal transfers are underway. More than 100 companies, out of a total of 160, have been approved for sale by the Cabinet. Two major nonviable parastatals - Zambia Airways and the United Bus Company of Zambia - and some trading companies have been closed and are being liquidated. 16. Zambia's macroeconomic stabilization and structural reform efforts over the last four years have been supported by four IDA adjustment operations (Annex F). The first operation, the Economic Recovery Credit (ERC, Credit No. 2214), approved in 1991, was the first adjustment operation after nearly a four-year interruption in Bank support. It was quite comprehensive, reflecting the need to change course across a broad range of economic policies. The emphasis was on stabilization to control inflation, liberalization to align economic policies and signals with Zambia's underlying realities, and on initiating institutional reforms (e.g., civil service reform  and privatization). The two operations that followed the ERC - the Privatization and Industrialization Reform Credits (PIRCs, Credit Nos. 2405 and 2523) approved in 1992 and 1993 - contained follow-on actions (e.g., ending consumer maize subsidies), but shifted emphasis towards privatization and parastatal reform and restructuring. The PIRCs also supported reforms to business legislation, the setting up of the Lusaka Stock Exchange, and initiatives to promote private sector investment, including reforming the Investment Code and strengthening the Investment Center. The fourth adjustment operation, the Economic and Social Adjustment Credit (ESAC, Credit No. 2577) approved in 1994, followed through on some of the earlier policy reform plans (e.g., ending public support for Zambia Airways and eliminating maize export restrictions) and included initiatives in new policy areas, such as supporting the preparation of a value added tax, developing a more efficient land market, and improving budget allocations and delivery mechanisms for vital social services. 17. Despite the accomplishments on macroeconomic and structural reform, the response of output has been uneven. After a decrease in real GDP of 2.5 percent in 1992 (due to a severe drought) and an increase of 6.5 percent in 1993 as agriculture recovered, preliminary estimates are that real GDP declined again, by 5.1 percent, in 1994. This reflected a decline in agricultural output (due to poor rains early in the year), problems in copper mining (mainly technical and managerial), and the recession in manufacturing activities due in part to the very tight monetary policy. However, there are signs of a pickup in economic activity since late in 1994. Cement sales have been rising as construction activity expands; the index of industrial production was higher in the second half of 1994 than the first; electricity and water production grew by 9.6 percent in 1994; new businesses are being formed at an impressive rate; and there have been modest gains in non-government services. 18. Nonetheless, overall output and growth continue to be constrained in large measure by the poor performance of the mining sector. Zambia has depended upon mining, particularly copper mining, for decades. Even after several years of decline, copper mining still contributes nearly 30 percent of GDP, 75 percent of export earnings, and over 10 percent of formal employment. The sector's performance so far and its problems are synonymous with those of ZCCM which produces over 99 percent of the copper output in Zambia. ZCCM has experienced progressive declines in productivity and output, and there has been rapid depletion of proven copper reserves at existing mining operations over the last decade because of insufficient new exploration and capital investment. ZCCM's copper output declined from 551,021 tonnes in 1983/84 to 392,182 tonnes in 1993/94, and labor productivity fell from 9.48 tonnes of copper per employee in 1983/84 to 7.67 tonnes per employee in 1993/94. With an average cost of about US$0.80 per lb in 1994 (excluding all taxes), ZCCM is a high cost producer relative to most world producers and is no longer in a position to survive an extended period of low copper prices. If no new mines are developed, Zambian copper production is expected to drop by about half around the turn of the century due to depletion of existing mines, in particular the Nchanga open-pit mine. 19. The economy's poor performance has had an adverse impact on the social sectors. The recently completed Poverty Assessment (November 1994), prepared with significant donor and Government involvement, revealed increasing indices of poverty over the past decade. About 55 percent of all Zambians, including about 75 percent of those residing in rural areas, are core poor, i.e., they cannot afford even to cover basic nutritional needs. About 40 percent of all children younger than five years of age suffer from chronic malnutrition. During the 1980s and early 1990s, the provision of social services suffered from declining public sector resources, a worsening distribution of spending within those sectors, and deteriorating administrative capacity.  -6 - At the same time, the demands on these services grew due to the increasing poverty, several years of poor rains, and some dislocations of the structural adjustment program. In addition, critical institutions such as the social security and pension funds faced problems due to high inflation, poor investment results and management problems. The Government has been working to reverse these negative trends. It has strengthened overall budget allocations and improved the distribution of spending within the social sectors in favor of lower cost primary services. A key element has been the move to decentralize service provision and to make greater use of NGOs, as was done successfully during the 1992 drought. Budget allocations for the social sectors increased from 28 percent in 1993 to over 33 percent in 1994, thereby underscoring the Government's commitment to social sector development. In 1994, policy reform focused on institutional reorganization and decentralization of service delivery in health and education, the devolution of safety net measures to local groups (mostly NGOs), and the restructuring of the water and sanitation sector. The Government is also beginning to reform the social security institutions and to align pension obligations with available resources. Part II: ZAMBIA'S ADJUSTMENT PROGRAM 20. The Government's primary objective is to achieve positive per capita income growth in a stable macroeconomic environment in order to reduce poverty and to improve the general standard of living. This in turn will require tight control of fiscal and monetary policy, improved incentives for domestic savings and investment, progress on privatization, and improved delivery of social services. In addition, for such growth to be sustainable over the longer term, the Govermnent will need to reduce Zambia's heavy dependence on external assistance (and vulnerability to external shocks) by increasing and diversifying exports, containing the growth in imports, reducing external debt, and building external reserves. A. Macroeconomic Policy 21. The macroeconomic framework for Zambia's economic adjustment program is designed to be consistent with the objective of positive per capita income growth, while consolidating macroeconomic stability and moving toward external viability. GDP growth is likely to be below 2 percent in 1995, due primarily to poor rains and continuing copper production problems, but a rebound in agricultural production in 1996 could push GDP growth above 6 percent. Investment is projected to increase from an average of 11 percent of GDP in 1992-1994 to 19 percent of GDP by 1997 as a result of improved business confidence, the Konkola Deep mining project, and increased availability of credit, which should enable the private sector to respond to new market opportunities. 22. The Government intends to continue improving the fiscal position from an overall deficit of 4.8 percent of GDP in 1994, to an overall deficit of 1.5 percent of GDP in 1995, and an overall surplus of 1.6 percent of GDP in 1997. Efforts to increase tax collection efficiency will be intensified. Within the structure of taxation, the reliance on trade taxes will decrease. This will be offset by increased indirect tax collections from the value added tax (VAT), which is to be implemented in July 1995. With continued monetary restraint, the annual rate of inflation is projected to continue to fall from 138 percent in 1993 and 35 percent in 1994, to 25 percent in 1995 and 10 percent in 1996.  - 7 - 23. The share of domestic govermnent expenditure in GDP is projected to decrease from 33 percent in 1994 to 26 percent in 1997, primarily as a result of reductions in interest payments and expenditure on agricultural marketing. At the same time, the real level of spending on social services and infrastructure, critical elements for sustainable growth, will continue to increase. 24. To continue the progress already made in trade reform (paras. 6 and 12), action needs to be taken in three trade-related areas: (i) lowering tariff levels and reducing rates of effective protection over the long-term, including efforts to promote freer trade both internationally and within the region; (ii) implementing special programs to address the problems of exporters, including the anti-export bias arising from the import tariffs that will remain over this period; and (iii) addressing instances of negative protection, especially those arising from differential tariff levels across trading partners and the lack of a common external tariff within the region. 25. The Government is committed to moving to a tariff structure with the maximum tariff reduced from its current level of 40 percent to 20-25 percent by 1998. The elimination of the up-lift factor when the VAT is introduced in July 1995 will reduce overall nominal protection by about 5 percentage points. Zambia is also prepared to lower COMESA rates further on a reciprocal basis as part of its broad commitment under the regional CBI program. The next significant steps in tariff reform will be taken in the context of the 1996 budget. Reductions in tariff revenues will be compensated by increased revenues from other sources. 26. Despite substantial progress in improving the business environment, exporters continue to face serious disadvantages in Zambia, including the high rates of tariffs on imports and the cascading system of domestic taxation. Besides the introduction of the VAT and reduced reliance on trade taxes, the Government's policy to facilitate exports includes the market-based determination of exchange rates, the expansion of credit facilities, and improvements in basic infrastructure. The introduction of the VAT will provide exporters with quick and complete refunds of all domestic indirect taxes, including those on services. The duty drawback system was improved in 1994, but it remains an administratively imperfect instrument despite the improvements made. Efforts to streamline this system will continue. A one year suspension of tariffs on selected raw materials that began in January 1995 has lessened the problem of negative protection arising from the dual tariff structure. Further actions to deal with this problem include the planned general reduction in tariff levels, further selective decreases in tariffs on material imports, and regional efforts to achieve more consistent external tariffs. B. Structural Policy 27. Economic growth and improved efficiency will require a revitalized private sector. In addition to maintaining macroeconomic stability, the Government will continue to promote free and open markets, encourage greater private sector participation in the development of the financial sector, and increase the pace of privatization, including that of ZCCM. 28. In order to increase the supply of resources to the private sector, the Government will continue to reduce the fiscal deficit in order to reduce the public sector's absorption of available domestic savings. In addition, the virtual elimination earlier this year of the (non-interest bearing) statutory reserve requirement on commercial bank deposits reduced the difference between lending rates and deposit rates. Also, in order to encourage the growth of private sector financial institutions, government monopolies in insurance and building societies have been eliminated, and the recently passed Unfair Trading Practices Act will ensure that former state  - 8 - monopolies do not retain an undue advantage. The Zambia State Insurance Corporation is slated to be sold to the public through public flotation. 29. The Government also intends to restructure and eventually to privatize the Government- owned institutions that are currently involved in the mobilization or allocation of term finance, with a view to ensuring that the role of these institutions conforms to the new policy of leaving the decisions on the mobilization and allocation of term resources from commercial sources in the hands of the private sector. Action Plans have been prepared to restructure the Development Bank of Zambia as an apex institution for industrial finance and to privatize or liquidate the Zambia Export and Import Bank and the agricultural Lima Bank. The Government will also introduce regulatory and institutional reforms for insurance companies and pension funds to ensure their financial integrity, and to enhance their ability to be a source of long-term capital for investment. The Government has prepared an action plan to reform the social security system that will align its outlays with the resources available to it. 30. Parastatal reform will continue to be a vital element in the Government's effort to raise efficiency and to restore economic growth. The privatization program is all embracing. All parastatals are for sale, with no restrictions on ownership other than those needed to curtail monopolies and to encourage broad-based participation. Measures have been taken to accelerate the privatization process (paras. 14 and 15). To improve its efficiency, the Government has restructured the ZPA, and it has now approved for sale in 1995 more than 100 of the 160 companies. In addition, the Government is showing flexibility in agreeing to different sale modalities. Management buy-outs are now possible, and the Government will sell by public lotation the shares of 14 companies, including such large companies as Zambia Sugar, Zambia State Insurance, and Zambia Telecommunications. 31. While diversification away from the copper industry is an important economic goal for Zambia, the survival of the coper mining industry will be essential for improving Zambia's foreign exchange and balance of payments position for many years to come. Given the problems facing the sector and ZCCM, the Govermnent has determined that it will privatize ZCCM (para. 18). The privatization of ZCCM, the largest enterprise in Zambia, has started with the offer for sale of the Chambishi and Kansanshi Mines. ZCCM itself will be privatized after the completion of the necessary legal, financial, and technical preparatory work (paras. 64-66). This process is expected to be completed within the next 24 months. The development of the largest known unexploited ZCCM copper resource, the Konkola Deep mine, as a separately managed, private sector driven joint venture, in which ZCCM will have a minority shareholding, is being pursued on an urgent basis by both ZCCM and the Government. 32. The most powerful long-term tool for the alleviation of poverty is sustainable and widely- shared economic growth. The recently completed Poverty Assessment points out, however, that economic growth alone, even if equitably distributed, will not be sufficient to address the very special problems from which the very poorest segments of Zambia's population suffer, or to reverse the substantial decline in social conditions that has occurred in Zambia over the past 10 to 20 years. Consequently, the Government's poverty alleviation strategy encompasses several other critical components in order to achieve the largest possible reduction in poverty. The main features of this strategy are:  - 9 - (a) ensuring a pro-poor macroeconomic framework by reducing inflation, resisting excessive protection and special privileges to favored producers, accelerating privatization, and generally encouraging new private sector businesses; (b) facilitating the poor's participation in the economy by ensuring better market access for small farmers, directing research and extension efforts at labor-saving innovations, especially for women, improving access to clean water, and removing regulatory and infrastructure constraints to small scale economic activity; (c) enhancing human resource development by improving budget allocations to and within these sectors, decentralizimg budget authority to local levels, and improving the implementation capacity of the relevant ministries; and (d) improving safety net activities by increasing support for labor-intensive provision of infrastructure (for the non-incapacitated poor), reforming the public welfare scheme (for the incapacitated poor), and continuing the process of devolution of administrative responsibilities to community-based groups and NGOs. 33. To strengthen the delivery of social services in the areas of health, education, water and sanitation, and the social safety net, the increased budget shares for social sector spending that were established in 1994 have been maintained in the 1995 budget and will be continued in 1996 and beyond. Within each sector, significant intrasectoral and geographic reallocations will also be made to better target the poor. Particular emphasis is being placed on primary education and cost-effective primary health care services. C. External Flnancial Requirements 34. Zambia is a highly indebted country, with a total outstanding debt of about US$6.2 billion, or about 180 percent of GDP. Annual debt service obligations are on the order of US$375 million. The opportunities for substantial increases in exports over the near term are limited by the declining production from existing copper mines and the long lead time of new investments. Therefore, Zambia's success in generating economic growth in the near term will depend on significant amounts of external debt relief and international assistance, particularly the quick- disbursing type, to support the policy reforms described above. The Government has been broadly successful in attracting sufficient donor support to meet its external debt obligations and to maintain its import requirements so as not to impede the resumption of economic growth. The Government will need to continue its strong policy performance in order to continue to merit this support, even as it phases down its reliance on it. 35. Zambia's estimated external financing requirements for 1994 were fully covered at a Consultative Group (CG) meeting of donors in March 1994. (Details on external finance requirements are shown in Annex C.) During the first half of 1994, balance of payments assistance fell somewhat short of debt service requirements, but this was more than offset by higher-than-expected copper earnings, as the price of copper averaged US$0.91 per pound compared with the January 1994 projection of US$0.80 per pound. In addition, the Bank of Zambia (BOZ) limited foreign exchange sales (in response to lower demand) to avoid causing appreciation in the Kwacha, and this strengthened BOZ's external reserve position.  - 10- 36. For 1995, the external financing requirements were estimated at the December 1994 meeting of the CG to be US$959 million, excluding arrears payments to the IMF (which are assumed to be offset by an equivalent amount of new money from the Fund). The proposed ERIP would provide US$140 million, half of which would be disbursed in 1995. On those assumptions and looking just at balance of payments support, the Bank would be funding US$140 million of the US$285 million in carry over assistance into 1995 (from existing adjustment operations) and US$70 million (the first tranche of the proposed ERIP) of the US$156 million needed in new assistance in 1995. Other major donors also continue to provide levels of support well above what can be expected by a country of Zambia's size, in recognition of Zambia's exceptional debt burden and the limited short-term prospects for expanding copper production. Based on the estimates described above (including anticipated new debt relief), the December 1994 meeting of the Zambia CG in Paris concluded that the 1995 external financing gap would be closed. Since that time, the copper price has been higher than previously estimated, but copper output has been below expectations, and poor rains are likely to require some additional food imports. On balance, the projected assistance requirements for 1995 remain about the same as those estimated at the December meeting of the Consultative Group. 37. The proposed level of Bank support would be consistent with the leadership role the Bank has been playing in meeting Zambia's external financing needs. lDA's share in total direct financial assistance (including balance of payments support and investment projects, but excluding debt relief) was 30 percent in 1991 (when the Bank's arrears were cleared), 21 percent in 1992 (the year of the drought), 31 percent in 1993, and 37 percent in 1994. Assuming that the first tranche of the proposed ERIP (US$70 million) is fully disbursed in 1995 (together with the remainder of PIRC II and ESAC funds), the Bank's share of total external assistance will be about 36 percent in 1995 and is expected to fall back to 30 percent after that. PART m: THE PROPOSED CREDIT A. The ERIP Reform Program and Links to the Country Assistance Strategy 38. Until mid-1994, macroeconomic stabilization and structural policy reform were the central concern of the Bank's assistance strategy and the focus of its adjustment lending, economic and sector work, and aid coordination efforts. By concentrating on reforming the regulatory framework, accelerating the privatization program, improving the delivery of vital social services, and emphasizing fiscal discipline in the public sector and financial discipline in the parastatals, the structural reforms supported by the Bank have played a significant role in creating a policy environment more conducive to private sector development and efficiency improvements in the public sector. After nearly four years and four adjustment operations, increasing emphasis is being placed on the more active promotion of private sector investment and the generation of economic growth. As has been the case so far, IDA will have a critical role to play in helping the Government in the design and implementation of its policy reform program (and the supporting investment program) and in assisting it in mobilizing donor support. 39. The overall objective of the Bank's assistance strategy in Zambia, as stated in the Country Assistance Strategy (CAS) discussed by the Board in March 1994, has been to promote sustainable economic growth and to reduce poverty by: (i) supporting macroeconomic stabilization and structural reform policies; (ii) promoting private sector development and greater public sector  - 11 - efficiency; and (iii) increasing targeted direct assistance to poor and vulnerable groups. Given the significant accomplishments over the last three years in macroeconomic and structural reforms, increasing emphasis will now be needed on stimulating investment, improving efficiency in the use of scarce public resources, and increasing direct poverty reduction efforts in order to ensure the sustainability of the reform process and the resumption of growth. 40. The CAS is based on the assumption that Zambia will continue to implement its economic reform program and that IDA will provide significant assistance through lending (US$500 - US$800 million over the next three years), economic and sector work, and aid coordination. If the economic reform program continues on track and is coupled with vigorous efforts to reform sector policies and institutions, thus permitting greater reliance on integrated sector investment programs, lending at or even slightly above the highest figure in the range would be justified (the high case). If the overall program is on track, but the preparation and implementation of sector investment programs are proceeding more slowly (because additional time is needed to carry out sectoral reforms), the lower lending figure in the range would be more probable (the base case). Adjustment lending would continue to be the mainstay of the program, along with some targeted poverty interventions. If the Zambian program were to suffer significant policy reversals and delays, this would occasion a sharp and immediate decline in donor assistance, including that of the Bank. In that event, Zambia would experience significant shortfalls in the external financing available to service its large debt, particularly to its multilateral creditors, and the Bank would most likely be forced to suspend operations in the country (the low case) within a few months. 41. The proposed ERIP adjustment credit, the fifth in the recent series, would provide support for continuing macroeconomic and structural policy reforms which are an integral part of the CAS. It comes at a critical junction in terms of moving Zambia away from short-term crisis management and preoccupation with the stabilization agenda towards achieving sustainable growth. Its main objectives are to: (i) consolidate improvements in macroeconomic management, including the tax and tariff regimes; (ii) enhance the availability of term resources to stimulate investment; (iii) reform the social security system; and (iv) support the restructuring of and increase private sector participation in the mining industry in Zambia. The proposed ERIP conditionality is described below and summarized by components in Annex E. B. The ERIP Reform Program 1. Macroeconomic Stability and Fiscal Policy 42. While inflation and interest rates declined sharply in 1994 (para. 8) as a result of a tight fiscal and monetary stance agreed with the IMF, fiscal and monetary control remain a priority concern. Both inflation and interest rates increased again in early 1995, due primarily to the sharp increase in the price of maize because of poor rains and increased reliance on imported maize, but due also to the fiscal gap that emerged over the first quarter. As a result of spending cuts and revenue enhancements being adopted in the second quarter, however, fiscal balance is being reestablished, and the pace of inflation should again diminish. In fact, the rate of inflation dropped to below one percent in both April and May. As with previous adjustment credits, there will be agreement on macroeconomic aggregates, including the size of the fiscal deficit and the growth in reserve money, reached between the Government and the IMF and reflected in the Letter of Intent under an Enhanced Structural Adjustment Facility (ESAF) program to be considered by the Fund Board later this year (currently planned for late August 1995). The  - 12 - overall deficit, i.e., including grants and interest is expected to decrease from 4.8 percent of GDP in 1994 to about 1.5 percent of GDP in 1995. Assessment of satisfactory macroeconomic policy will be based on the overall fiscal and monetary objectives of the program, including these specific benchmarks. Compliance with the fiscal and monetarv program will be a condition of Second Tranche release. 43. A successful program to stimulate growth will require continued improvement in revenue collection, a more economically efficient tax system, continued restraint and selectivity on public expenditure, and sound budget management. The proposed ERIP will support Government's reform efforts in these areas. To strengthen revenues, eliminate distortions and reduce reliance on trade taxes, a broad based VAT will be introduced. Work on a VAT was initiated under the previous adjustment operation in 1994, and the Government plans to introduce it in July 1995. This will also automatically eliminate the so-called up-lift factor, which raises the base for calculating the sales tax on imports, and hence adds to the degree of effective tariff protection. Implementing the VAT (and eliminating the up-lift factor) will be a condition of Second Tranche release. 44. The objective of restraint on aggregate public expenditure must be accompanied by stricter priorities in the composition of spending. Lower priority areas, such as military expenses, official travel, and foreign representation will be further restrained. Improving public service delivery will also depend on Govermment's ability to contain the share of public spending allocated to wages and salaries, thus permitting sufficient spending on other recurrent expenditures and capital equipment. Under the previous adjustment operation, it was agreed that 33 percent of total non-interest spending would be allocated to education, health, social safety nets, and water and sanitation. This was done in 1994. The 1995 budget maintains the same shares for these sectors, as agreed during the preparation of ERIP. In order to ensure that increased funding for wages and salaries within those budgets does not depress funding for vitally needed supplies (e.g., drugs and school materials), it was also agreed that the share of non- personnel recurrent expenses for those same sectors would be at least 24 percent of total non- interest spending. The approved 1995 Budget conforms to these agreements. As a condition of Second Tranche release. the Govermment will maintain: (a) the share of total social sector spending in actual budget releases to be at least 33 Dercent of total non-interest spending and (b) the share of non-personnel recurrent expenses in those sectors to be at least 24 percent of total non-interest spendine. 45. Substantial progress has also been made in budget management. The move to a cash budget helped Government turn a primary budget deficit into a small surplus in 1994, and the introduction of the Zambia Revenue Authority (ZRA) has begun to improve collection performance. The steps initiated in 1994 to move towards program-based budgeting in pilot ministries is being consolidated and extended in 1995. The operation of the cash budget will be strengthened to improve its observance at ministry and provincial levels and to permit better control of commitments and avoid accumulation of domestic arrears. The system to monitor commitments and expenditures, introduced in late 1994, is being used by the Budget Office in 1995 to monitor and control arrears. Budget management will be further strengthened by more accurate and complete integration of donor assistance into the budget and more accurate forecasting of debt service obligations. The Government's commitment to implement these changes in budget management policies is reflected in the Letter of Development Policy - LDP - (Annex I), and the IMF will be setting structural benchmarks on controlling domestic arrears in the second half of 1995.  - 13 - 2. Continuing Financial Sector Reforms 46. Zambia's financial sector is dominated by commercial banks, the three largest of which - one state-owned bank and two branches of U.K. banks - supply the bulk of services. In addition, ten medium and small banks - some locally-owned and some foreign - fill market niches. Other financial institutions include a postal savings bank, a building society, leasing companies and emerging merchant banks. No longer effective in promoting their intended objectives are the state-owned term finance institutions, including the Development Bank of Zambia (DBZ), the Export Import Bank of Zambia (Eximbank), and the agricultural Lima Bank which, along with the Credit Union and the Cooperatives Federation, intermediated agricultural finance from the government budget. Insurance services, mainly non-life insurance, are provided by the Zambia State Insurance Company (ZSIC) and four small private companies established in recent years. 47. The term finance sub-sector in Zambia includes, in addition to the three state-owned term lenders, public and private insurance companies and pension funds. It has been facing severe problems in recent years. The reform of policies and institutional arrangements concerning term finance - both term loans and equity investments - has lagged behind other financial reforms. This lag has been largely unavoidable, due to the unstable and inflationary environrment. However, the rapid decline in inflation since mid-1994 suggests that measures to strengthen and accelerate the investment response would be timely and feasible. Policies to reform the financial, economic, institutional and legal conditions under which term resources will be mobilized and allocated must seek a sustainable balance between the introduction of new financial instruments and institutions on the one hand and Zambia's capacity to ensure adequate prudential regulation and supervision on the other hand. 48. Objectives and Strategy of Term Finance Reform. Consistent with the economic policy of shifting reliance for capital formation and investment decisions to the private sector and of using budget resources more prudently, financial sector reform aims at increasing the participation of the private sector in financial activity. This shift in policy objective translates into the following action programs to be supported by ERIP: (1) the restructuring of government- owned financial institutions, currently involved in the mobilization and/or allocation of term finance, with a view to ensuring that the role of such institutions conforms to the new policy; (2) the establishment of a system to regulate contractual savings institutions; and (3) the reform of the social security system to ensure viable and sustainable pension funds, which could contribute to the economy's supply of long-term funds. This implies a new and reduced role for the Government in term finance; it will now confine itself to the mobilization of concessionary funds, and will relinquish its role in allocating term finance resources. The Government's commitment to confine its role in mobilizing financial resources to concessionary sources requiring a state guarantee is stated in the LDP. 49. Redefining the role of Government-Owned Financial Institutions. The three state-owned institutions involved in term finance - DBZ, Eximbank and Lima Bank - have failed to achieve their assigned objectives and have run into severe financial problems. A commitment to prepare an action plan to either reorient or liquidate each institution was a condition of Second Tranche release under PIRC U, a previous adjustment credit. An action plan has been agreed between the Government and IDA for each of the three institutions.  - 14 - 50. The Government has approved the restructuring of the DBZ as an apex institution mandated to mobilize term resources exclusively from international and foreign concessionary sources and on-lend them to eligible retail financial institutions. The DBZ loan portfolio will be transferred to a separate collection agency. Implementing the DBZ restructuring plan requires the amendment of the DBZ Act. Submission of satisfactory draft legislation to Parliament and timely implementation of the restructuring plan will be a condition of Second Tranche release. 51. The action plan for Eximbank calls for closing it, either by selling it or merging it with another institution, or liquidating it. While recent financial statements indicate that Eximbank deposits could be fully repaid from liquid assets, a long delay in privatizing or liquidating it could allow its financial position to deteriorate to a point where budget funds may be required to repay depositors. The Govermment has agreed to include Exinbank in ZPA's tranche of parastatals being prepared for privatization in 1995, and to offer it for sale publicly to parties acceptable to the Bank of Zambia (BOZ). If, by December 31, 1995, the settlement of the privatization transaction has not been scheduled, the Government will ensure that the Eximbank Board of Directors passes a liquidation resolution within thirty days. The completed sale of Eximbank to a private investor or the adoption of a liquidation resolution by the Eximbank Board of Directors will be a condition of Second Tranche release. 52. The action plan for Lima Bank aims to stop the drain on the budget and to allow sufficient time for alternative means of meeting the credit needs of small farmers. It is estimated that approximately K 10 billion from Lima Bank's portfolio of K 15 billion will have to be written off. The Government has decided to refrain from providing Lima Bank with additional budget funds, as agreed between the Government and IDA under the recently approved IDA-supported Agricultural Sector Investment Program (ASIP). The Government has also decided to offer Lima Bank, or selected parts of it, for sale by September 30, 1995, through the ZPA, to investors or to its management, with an appropriate (but not necessarily total) write-off of GRZ debts. As a condition of Second Tranche release. the Government will take all the necessary measures to place Lima Bank in ZPA's program for privatization or liquidation. 53. The development of the contractual-savings system in Zambia, which includes insurance and pension-fund management companies will require policy, regulatory and institutional reforms so that these institutions can overcome the problems which inhibit their ability to perform their roles and to provide long-term capital for investment. With improved macro-stability, the insurance industry is expected to expand and the total of premiums and accumulated reserves to increase. Similarly, with the reform of the social security system (paras. 57-60), pension funds and their resources will grow in importance. 54. The existing legislation, which gives the Ministry of Finance the responsibility for the prudential regulation of insurance companies, does not cover pension-fund management companies, and no other ministry has been given this responsibility. Since the existing legislation needs to be updated, and plans are underway to do so, this is an opportunity to subject pension- fund management companies to prudential regulations. The Government has prepared draft insurance legislation and regulations upon which the Bank has commented. It has also designated the Ministry of Finance as the ministry responsible for setting policy and regulating private pension-fund management companies. There is a need to: (a) adopt the new insurance legislation and supporting regulations; (b) prepare and adopt new laws and regulations for pension-fund management companies; and (c) develop an institutional capacity to regulate the activities of all contractual savings institutions. While providing the required safeguards to the public, the new  - 15 - regulatory regime would apply to all contractual savings institutions and would be unified to allow for competition. The submission of insurance legislation to Parliament and the establishment of a new regulatory and supervisory agency and the recruitment of staff for it will be a condition of Second Tranche release. With respect to pension-fund management companies. the submission of legislation to Parliament and the setting up of the regulatory and supervisory agency will be a condition for Second Tranche release. 3. Social Security Reform 55. Pension funds in Zambia - whether public or private - are not a significant source of term finance because of the limited volume of resources available to them and the problems that adversely affect their financial performance. Developing the pension fund industry is an important policy priority, however, not only for institutional investment, but also as an integral component of a program to restructure and rationalize the existing social security system. 56. Reform Plans and Strategy. The Government established the National Social Security Reform Implementation (NSSRI) Steering Committee, comprising representatives from the relevant ministries, social security institutions, parastatals, and employers' and employees' organizations, to prepare proposals to reform the social security system. The NSSRI Steering Committee proposed a gradual, two-phase strategy for reforming the system, which is based on a joint World Bank/ILO report that analyzed the options to reform the social security system in Zambia. The reforms aim to: establish a more equitable distribution of social security benefits; restructure the social security system to improve the reliability of benefits; and broaden the scope of the social protection system. The specific proposals approved by the NSSRI Steering Committee include the conversion of the Zambia National Provident Fund (ZNPF) into a national social security pension scheme, the restructuring of the pension schemes for civil servants and local authorities' employees, and the development of private pension schemes. The Cabinet has approved the reform proposals of the NSSRI Steering Committee, and an implementation timetable has been agreed between the Government and IDA. 57. Short Term Reforms. The short-term phase of the reform strategy includes proposals for arresting the deterioration in existing social security and pension fund institutions and measures to lay the basis for future reforms. The Government has decided to amend the benefit formulae and early retirement provisions and to repeal the 22-years-of-service compulsory retirement act of 1991. Submission of draft legislation to Parliament to implement these decisions is a condition of Second Tranche release. 58. The financing of the additional burden on the pension funds arising from previous special programs and retirement arrangements should have been budgeted for and financed separately from regular pension benefits. Under both the special and regular schemes, insufficient resources have been made available by Government, with the result that many pension claims are outstanding. As part of its general strategy to clear arrears, the Government has agreed with the civil service pension funds on a plan to clear its arrears. This plan would be updated once the results of ongoing actuarial studies are completed. 59. Weaknesses in the management of existing social security institutions will also be addressed, particularly at ZNPF. Since the NSSRI Steering Committee has proposed that ZNPF form the foundation for the new social security institution that will administer the new social security pension scheme, ZNPF's requires strengthening. A time-bound institutional action plan  - 16 - to implement administrative and operational reforms in ZNPF will be adopted once technical studies are completed. 60. Longer Term Reforms. The longer-term phase of the reform strategy includes proposals to restructure the system, with the objective of establishing an affordable basic social security pension scheme. The new legislation will aim to ensure sustainable pension financing, independent boards, and improved accountability and transparency in pension fund administration. Draft legislation to establish the new basic social security pension scheme and independent social security institutions based on the approved social security reform strategy is being prepared. Submission of draft legislation, satisfactory to IDA, to Parliament will be a condition of Second Tranche release. 4. Mining Sector Reforn 61. The revival of the copper industry will require large amounts of new investment, modem technology, new management and new stakeholders who are committed to increasing productivity and lowering costs at existing copper operations and to opening up new mining areas. The required financial and managerial resources are only available in the private sector. Attracting them will require: (a) the adoption of new mining sector policies; (b) the reform of mining sector institutions; and most importantly (c) the privatization of ZCCM and the development of new deposits with private-sector equity and management. In particular, the development of the Konkola Deep project, which will require about seven to nine years for development and build-up to full production, is an urgent priority in order to avert a sharp decline in copper production around the year 2002. 62. Mining Sector Policy. The Cabinet has adopted a new Mining Sector Policy which calls for the development of the mining sector by private investors in an environmentally sustainable manner. The Government is also preparing, with assistance from an IDA Mining Sector Technical Assistance Project (Credit 2269-ZA), new legal, fiscal, and environmental frameworks that are transparent, stable, internationally competitive, and non-discretionary. The major objective of the new legal framework is to remove barriers to private sector investment. A draft of a new Mines and Minerals Act, which contains provisions for the Minister of Mines and Minerals Development to issue environmental regulations for the mining sector and which will replace the Mines and Minerals Act of 1976, has been submitted to the Cabinet Legislative Committee. A draft new fiscal regime has also been prepared. It is internationally competitive, concentrates the incidence of taxation on profits, is generally applicable, and is not discretionary. The submission to Parliament of (a) a draft new Mines and Minerals Act satisfactory to IDA. and (b) draft amendments to the Income Tax Act. the Customs and Excise Act. and the Investment Act to establish a new fiscal regime for mining satisfactory to IDA. will be a condition of Second Tranche release. In line with the new draft Mines and Minerals Act, the Government intends to adopt new environmental regulations for the mining sector by the end of 1995. Environmental impact assessments will be required for all new projects, and existing mining areas will need to be rehabilitated. The adoption of environmental regulations satisfactory to IDA will be a condition of Second Tranche release. 63. Mining Sector Institutions. As the new legal, fiscal, and environmental frameworks are put in place, the ability of the Ministry of Mines and Minerals Development (MMMD) to administer and monitor the performance of the mining sector will be essential to the sound growth of the sector. In particular, assistance is needed: (a) to develop and disseminate basic geological  - 17 - data to potential investors along the lines provided by Geological Surveys in countries such as Australia, Canada and the US; and (b) to improve mining title administration, mines inspection, environmental monitoring capabilities, etc. in line with international standards. The Government's undertaking to reach agreement with IDA on a program and timetable to support the implementation of the new mining policy, including strengthening MMMD and privatizing ZCCM, is included in the ERIP Letter of Development Policy. The specifics of the program will be agreed under a proposed technical assistance operation (para. 67). 64. Zambia Consolidated Copper Mining Company (ZCCM). Mobilizing funds for new exploration and investment in Zambia's copper industry will be a challenging task requiring decisions that are closely linked to decisions on how and when to privatize ZCCM. In order to help Government address such complex questions, consultants funded under the IDA PIRC-TA Project (No. 2406-ZA) completed a study of the strategic options to privatize ZCCM. The study recommended unbundling ZCCM into a number of separate units which would then be privatized. While breaking ZCCM up into smaller units has the benefit of potentially attracting a larger group of investors than if ZCCM is privatized in its present form, the approach is strongly opposed by Anglo-American, the minority shareholder that owns 27 percent of ZCCM. Existing shareholder agreements give Anglo-American certain pre-emptive rights, and the Government will not be able to proceed with the privatization of ZCCM without the agreement of Anglo American. As a first step, a decision to develop Konkola Deep as a majority private sector owned and managed project has been taken by the shareholders. The Board of Directors and management of ZCCM have been informed of this decision, and the Goverment has been holding discussions with potential private investors with a view to initiating this development. Also, the Government in its role as 'A" shareholder has introduced a ZCCM Board resolution instructing management to prepare for joint-venturing Konkola Deep with majority private-sector ownership and private-sector management. 65. The Government recognizes that it is important that the privatization of ZCCM should take place in a manner that helps mobilize new investment capital for the sector. This will require further analysis of different methods of privatization in order to design an Action Plan that ensures an orderly process, maximizes the value for Govermnent, and facilitates the mobilization of capital for the sector. Since ZCCM is not wholly-owned by the Government, the analysis will also need to include a detailed review of the rights and obligations of all of the parties involved according to the 1982 Amalgamation of Mining Companies (Special Provisions) Act, shareholder agreements and creditor agreements. To oversee the process on behalf of the Government and to ensure that the task is undertaken in a fully transparent and orderly manner, the Government has established a Privatization Unit, with a qualified and experienced leader, which will be responsible for the privatization of ZCCM. This will include the hiring and supervision, on behalf of the Government, of investment bankers, legal advisors, and other specialists as may be needed in order to design and implement the privatization process. The Government has agreed with IDA on the specific measures needed, including hiring of specialist advisors, and a timetable to prepare an Action Plan to privatize ZCCM. Terms of reference for the investment bankers and legal advisors have been prepared by the Privatization Unit and agreed with IlDA, and proposals have been requested from an agreed short list of candidates. As a condition of Credit Effectiveness, the Government will have completed the selection of internationally qualified legal and investment banking advisors to assist in preparing and implementing the Action Plan. Submission to IDA of a satisfactory Action Plan for privatizing ZCCM will be a condition of Second Tranche release. It has been agreed that the Government Privatization Unit will be responsible for the preparation of the Action Plan, and that, to the extent possible and subject to  - 18 - satisfactory performance, the Govermnent will use the same investment and legal advisors for the Konkola Deep project. 66. ZCCM will need to establish a team of its own to oversee, on behalf of all of its shareholders, the privatization-related tasks and the transfer of the Konkola Deep mining rights and assets to the proposed joint-venture. The Government has introduced a ZCCM Board resolution to establish a ZCCM internal Privatization Team that will report directly to the ZCCM Board of Directors and will be responsible for all privatization-related matters, including obtaining the services of investment bankers, legal advisors, environmental specialists and, depending on exact content of the package, possibly accountants and auditors. 67. In light of the identified needs for specialist assistance for institutional strengthening (para. 63) and specialist advisory services to the Government (para. 65) and to ZCCM (para. 66) regarding the development of Konkola Deep and the privatization of ZCCM, the Government has requested and IDA has agreed to prepare a Technical Assistance Credit (proposed for the first half of FY96) to help finance the necessary services. To cover the cost of these services in the meantime, funds available from a Project Preparation Facility (PPF) advance for the TA Credit will be used. C. Disbursement, Procurement and Auditing 68. The proposed Credit of US$140 million will assist Zambia in meeting its external financing requirements during the second half of 1995 and in 1996. The Credit will be disbursed through the Bank of Zambia. Disbursement will be in two tranches. The first tranche in an amount of US$70 million will be released at effectiveness; the remaining US$70 million will be released when the conditions of Second Tranche release are satisfied, which is expected to be about January 1996. 69. The proposed Credit will reimburse the Government of Zambia for 100 percent of the foreign exchange cost of general imports, exclusive of those on the negative list. The public procurement processes are standardized with emphasis on transparency and competition in tendering and utilization of pre-shipment inspection (PSI) where applicable. These factors should achieve competitive price results. All procurement for values of US$2.0 million or more will follow simplified ICB procedures, with mandatory use of IDA standard bidding documents and specified procedures when applicable. The public procurement expected to be covered under ERIP would be oil, some large ZCCM requirements, and possibly maize. Procurement by the public sector for contracts valued at less than US$2.0 million will follow Zambia's public procurement procedures, and private sector procurement within the same range of values will be undertaken in accordance with established commercial practice in Zambia, provided that such practices are acceptable to IDA. The public sector procedures call for bid procedures linked to the market price as of the shipment date. The private sector may import commodities directly from a broker using spot or market prices based on delivery date requirements and verification of price competitiveness. All procurements valued at US$2.0 million or above will be subject to prior review by IDA in accordance with IDA Guidelines. All other procurement will be subject to random post-review by IDA. Any exceptions to the above procurement procedures will require a waiver agreed to by the Government and IDA before implementing that procurement. PSI will be required for all imports valued at over US$5,000 each. Reimbursement for contracts valued at under US$500,000 will be through use of a statement of expenditure. The Bank of Zambia will be responsible for coordinating and monitoring procurement and will submit  - 19 - quarterly status reports to IDA for review. The Bank of Zambia will maintain relevant documents for all procurements. The project account and statements of expenditure will be independently audited and the audit report submitted to IDA within six months of the end of the Government's fiscal year. D. Program Management and Monitoring 70. The reform program will continue to be managed by the Economic Affairs Monitoring Unit, which is chaired by the Minister of Finance and includes members from the National Commission for Development Planning, Cabinet Office, Bank of Zambia, ZCCM, Central Statistics Office, and other ministries and Government agencies. The day-to-day follow up of the program would be undertaken by a coordinator. The Monitoring Unit will give high priority to ensuring that the implementation of the program is proceeding satisfactorily and that progress is being made towards fulfilling: (1) the objectives of the macroeconomic program based on the targets set in agreement with IDA and the IMF; and (2) the specific conditions of Second Tranche release, which are described in Annex E. Briefly summarized, the specific conditions call on Government to have: (a) implemented a VAT system, including the elimination of the "up-lift factor' (para. 25); (b) maintained budget releases for social sector spending at at least 33 percent of total non-interest spending, of which at least 24 percentage points would be for non- personnel spending (para. 19); (c) submitted to Parliament legislation, satisfactory to IDA, to restructure DBZ as an apex institution and to set up a separate collection agency for the DBZ portfolio; taken necessary measures to place Lima Bank on ZPA's Program for privatization or liquidation; either scheduled the settlement of the sale of Eximbank or the Eximbank Board of Directors would have adopted a liquidation resolution; and made satisfactory progress on implementing other aspects of the DBZ action plan (paras. 49 and 50); (d) submitted to Parliament legislation, satisfactory to IDA, for the supervision and regulation of insurance and pension-fund management companies and established a new supervisory and regulatory agency(ies) (para. 54); (e) submitted to Parliament legislation, satisfactory to IDA, to establish a new basic social security pension scheme, to amend the benefit formulae and early retirement provisions of the existing public-sector social security and pension fund schemes, and to repeal the 22-years of service compulsory retirement requirement for local government employees (paras. 56 and 60); (f) submitted to Parliament (i) a draft new Mines and Minerals Act and (ii) draft amendments to three other acts to establish a new fiscal regime, both satisfactory to IDA (para. 62); (g) adopted mining-related environmental regulations, satisfactory to IDA (para. 62); and (h) submitted to IDA a satisfactory Action Plan for the Privatization of ZCCM (para. 64).  - 20 - E. Environmental and Poverty Impact 71. Addressing the issues related to the enviromnent as a part of Zambia's economic reform program has been a priority for both Zambia and IDA. With IDA assistance, the Government completed last year a National Environmental Action Plan and is now preparing an environmental support program for possible IDA financing. The proposed Credit does not have a specific environmental focus, although its impact on the environment would be positive, particularly due to the mining sector reform component, where environmental regulations and standards would be developed. Also, as part of the preparation for privatization, more data will become available on the environmental legacy of the copper mining industry and of ZCCM, and this should enable GRZ and the industry to better design and implement mitigatory and preventative actions. 72. Since the proposed Credit concentrates on measures to evoke a greater supply response and promote economic growth, it will directly address the objective of poverty alleviation. In addition, the Credit will have a positive impact on the poor in several specific ways. First, macroeconomic stabilization will continue to shift the terms of trade in favor of rural areas where the majority of the poor live, thus benefiting smallholder farmers. Second, a lower rate of inflation is obviously beneficial for poor consumers and low wage earners. Third, the targets set for social sector spending in terms of budget allocations and actual releases will protect social services vital to the most vulnerable. Fourth, the reform of the social security system will reduce its cost to the Government, thus releasing budget resources that can be used to provide services to the poor and improve the ability of concerned institutions to deliver services and other assistance to the poor and other vulnerable groups. F. Impact Evaluation and Beneficiary Assessment 73. The impact of the operation in the four principal areas - macroeconomic, financial sector, social security, and mining - will be assessed over the medium term with the help of a few quantifiable indicators. The comparison will be with a base period (1991-1994) and/or projected objectives (e.g. additional revenue expected from VAT). These indicators are described in Annex G. 74. Because of the links between the various components of the economic reform program being supported by the proposed ERIP Credit and the issues of poverty, income growth, and welfare improvement, it will be important for both the Bank and the Government to focus closely on the effectiveness of these programs and the impact that they are having on the intended beneficiaries, particularly the poor in Zambia. Assessing the impact of ERIP-supported reforms on intended target groups would build on and complement assessments agreed to and being undertaken under PIRC Il and ESAC, the former to assess the impact of the privatization program on five specified target groups and the latter to assess the impact on recipients of increased social sector spending. It would also build on the surveys of Zambian enterprises being undertaken under the Regional Project for Enterprise Development (RPED), which revealed that the manufacturing sector's main concerns were interest rates, credit availability, and the structure of taxes and tariffs. These surveys have been complemented by mission visits to enterprises and discussions with associations representing the private sector. In order to define the baseline from which the impact of the reforms can be measured, a survey would be undertaken to define on a sample basis the baseline status of the major target groups affected by the ERIP program. A Government commitment to that effect is included in the LDP.  - 21 - G. Benefits and Risks 75. The policy reforms being supported by the proposed ERIP Credit aim to enhance macroeconomic stability, improve the competitiveness of Zambian products, and promote investment in the economy in general and in the copper mining industry in particular. Increasing the rate (and the sustainability) of economic growth wiUl be essential for generating benefits from the economic reform program and alleviating poverty, the central objective of IDA's country assistance strategy. In particular, the macroeconomic stabilization objectives and the improved tariff/tax regime, particularly the VAT, should improve the prospects for increased economic growth in the short term, while the improved opportunity for term financing and the privatization of ZCCM should contribute to increased investment and hence to longer term growth. In addition, the reform of the social security system and continued strong budget support for the social sectors should help directly to alleviate poverty. 76. The proposed operation faces virtually the same risks as those faced by the overall economic reform program in Zambia - external, implementation and political. The exteral risk relates to Zambia's external financing position and the still large debt burden combined with its high dependence on copper exports. The Bank is playing a key role in assisting Zambia to mobilize the donor resources required to support Zambia's reforms, but there is always a risk that a substantial shortfall in donor support will make debt service payments difficult, if not impossible to meet. The Government is focussing its effort on producing results and keeping the donors fully informed of the progress on the reforms. The process of donor coordination and the dialogue between the Government and donors continues to improve. The Government's economic reform efforts have earned broad support from the international community which is resolved to continue to assist Zambia's adjustment program, notably through the CG process. Even so, continuing the reform process will not be easy, and progress is likely to be uneven - as it has been in the past. Provided that Government maintains the reform momentum in 1995, the short-term external risk is somewhat mitigated since the anticipated reduction in debt service and the increase in copper prices should reduce the total need for balance of payment assistance, even with the projected needs from the current drought. 77. The implementation risk relates to Government's capacity to carry out the reform program. Although Government's capacity to implement economic reforms has improved consistently over the past few years, there remains a considerable implementation risk because of the scope and complexity of the reform program. To mitigate this risk, Government continues to improve implementation systems and staffing. Continued dialogue and concerted actions among the Government, IDA and the donor community are also planned. 78. The political risk arises from the continuing pressure on the Government to show quick results or to slow down and even reverse some of the reforms. The Government appears determined to stay the course and has taken measures to accelerate the supply response and to shelter the most vulnerable groups to help mitigate this risk. Nonetheless, people's expectations continue to be high, and the Government is under pressure to show results before the next election in 1996. The Government's efforts, which are being supported by the proposed ERIP Credit, aim at accelerating growth in production and employment in the short term and laying the foundation for vigorous long term growth. In addition, the Government has set absolute limits below which expenditures on social services will not be allowed to fall. This combination of measures is expected to mitigate the effects of the adjustment effort and to shelter, to the extent possible, the most vulnerable groups, thus reducing the political risks. The continued strong  - 22 - support of the international community for Zambia's reform program will also be a critical factor in this respect. PART IV: BANK GROUP OPERATIONS A. IDA Operations 79. IDA operations in Zambia include adjustment lending, investment/project lending, economic and sector work, and aid coordination. The role that adjustment operations have played in supporting Zambia's economic reform program in the last three years has been described above (para. 16). The role of the other types of Bank operations in Zambia are summarized below. 80. While several of the adjustment operations have focussed on privatization and private sector development, Bank-supported investment lending in recent years has emphasized capacity- building and infrastructure rehabilitation. In addition to sector investment programs, which require the Government's ability to formulate and manage a sectoral policy and investment program, technical assistance projects in financial and legal management, mining, and transport have led to ongoing improvements in planning and implementation capacity. Similarly, two recent agricultural projects have sought to strengthen research and extension services and to provide complementary investments aimed at supporting the transition to private sector agricultural marketing. A Social Recovery Project has helped build and rehabilitate infrastructure at the community level. Education and petroleum projects have focused on improving management in their respective sectors. An urban reform and water supply project, approved by the IDA Board in May 1995, aims at encouraging decentralization and strengthening the local government's financial and administrative capacity. 81. Investment lending is expected to account for an increasing share in Bank lending over the next few years and to shift towards integrated sector operations. These operations have four essential characteristics. They support an overall sector policy and institutional framework; they assist a medium-term investment program covering the entire sector; they are prepared by the Government, with donors assisting only if needed; and they involve all interested donors. The aim is to avoid the overlap, inconsistency, and administrative overload associated with a large number of separate donor-funded projects within each sector, thereby substantially increasing public sector efficiency. The first integrated sector investment operation in Zambia, approved by the IDA Board in November 1994, covers the health sector. The Agricultural Sector Investment Program (ASIP) operation was approved by the IDA Board in March 1995. Preparation has begun on similar operations in transport, education, power, and environment. By substantially increasing public sector efficiency and providing the necessary investments to stimulate increased private sector investment, integrated sector investment operations are expected to be an important part of the Bank Group's country assistance program over the coming years. 82. The economic and sector work carried out by the Bank over the last few years has helped to clarify the policy issues and to define action programs for Bank support through either adjustment operations or investment projects. The broader studies, such as the CEM, the PFP, and the PER, have provided some of the analytical underpinnings for the economic reforms and a basis on which the dialogue among the Government, Bank, and donors could be conducted. The PERs have helped define budget priorities and tradeoffs with respect to the public sector.  - 23 - A recently completed Poverty Assessment provided insights into the breadth and nature of poverty in Zambia, explored the impact of the reform program on the poor, and recommended further reforms and targeted investment programs. The Government's commitment to allocate and release at least 33 percent of the budget to social-sector and related spending is responsive to the Poverty Assessment recommendations. 83. Forthcoming economic and sector work will focus particularly on promoting private sector growth and improving public sector management. During 1995 and 1996, the work is expected to concentrate on the prospects for and constraints on achieving significant private sector growth in agriculture and manufacturing over the coming decade. At the Government's request, the Bank will also conduct an interim review of the Public Service Reform Program. The review will focus on analyzing options to achieve efficiency gains in the public service as quickly as possible, while better integrating the program's implementation with the fiscal constraints facing the Government. If warranted, the Bank may also assist the Government in increasing donor coordination and assistance in this area. 84. Assisting the Government of Zambia in aid coordination is a prominent Bank activity. There are over a dozen active bilateral and multilateral partners. Much of the aid coordination takes place in Lusaka, where different groups meet frequently under the leadership of the Government. The Bank's Resident Representative and visiting Bank missions also regularly brief the development community. The Bank chairs the Consultative Group which meets in Paris once or twice a year, and there are country consultations on Zambia at each SPA meeting. By sharing information and analysis and discussing strategic options, the Government and its partners have been able to assess frankly the progress and constraints on reform and to arrive at a consensus as to the overall direction of reform and the necessary next steps. The Bank's economic and sector work has also contributed significantly to the process of consensus building. 85. In all of its assistance to Zambia, the Bank will be making an effort to achieve and measure results. Systematic Client Consultation (SCC), which seeks feedback from beneficiaries of Bank operations, has previously been built into a number of Bank operations in the social sectors. It is now systematically being included and planned for under all new investment and adjustment operations. Also, the identification of a few key sector indicators to measure results, which will be tracked over the life of the program, is being incorporated into all of the integrated sector investment operations. Finally, a client feedback survey was carried out recently in Zambia. The results show a favorable Borrower response to Bank activities, but signal a need for the Bank. to increase its investment in the social sectors and environment. B. Iinpleznentation Issues 86. Bank operations resumed in Zambia at the beginning of 1992, following a hiatus of several years (September 1987 to March 1991 and again from September 1991 to January 1992) during which disbursement of Bank loans and IDA credits was suspended due to accumulated arrears. Since then, implementation of ongoing operations has steadily improved, although implementation capacity is still constrained. A Country Implementation Review (CIR) in February 1993 and a Country Portfolio Performance Review (CPPR) in February 1994 identified problems and sought solutions. Most problems were related to project management capacity, and both the CIR and the CPPR prepared action plans for addressing procurement, disbursement, and management problems across all sectors. These plans are being implemented under close monitoring. Also, a strategy review and evaluation session, attended by the Bank's Country  - 24 - Team and a majority of the economic and sector Cabinet Ministers, was held in October 1994 to review with Government its development objectives and priorities, and how the Bank's assistance can best contribute. It was agreed that emphasis would be placed on improving implementation of on-going efforts and accelerating new investments in four sectors - transport, education, power and the environment - to help stimulate a more vigorous supply response. 87. The portfolio management strategy emphasizes increased supervision of ongoing operations to achieve better results in the field. In addition, direct assistance has been provided under four IDA Credits - Second Technical Assistance (No. 1679-ZA), the Mining Technical Assistance (No. 2269-ZA), the Privatization and Industrial Reform Technical Assistance (2406- ZA), and the Transport Sector Reform and Technical Assistance (No. 2515-ZA) - to strengthen local implementation capacity in policy formulation and investment planning. Also, projects have been restructured where necessary to facilitate implementation (e.g., Agricultural Research and Extension Project, Credit No. 1746-ZA). Two credits [Fisheries (No. 1529-ZA) and the Development Bank of Zambia (No. 1753-ZA)] were canceled. To strengthen implementation capacity in the public sector, the Government has adopted a Public Service Reform Program designed to enhance efficiency and effectiveness in the public service, and the Bank has been asked to send an interim review mission, scheduled for late-June 1995. In addition, the Bank is also helping with the Financial and Legal Management Upgrading Project (Credit No.2535) approved by the Board in July 1993. A number of donors are also providing assistance to this program. 88. Zambia has made a commendable effort in bringing overdue audits of project accounts, special accounts and statements of expenditure up-to-date. Also, since clearing arrears to the Bank at the end of January 1992, Zambia has remained current in its debt-service payments to the Bank. There are no overdue payments of more than 30 days. Given the suspensions of May 1987 to March 1991 and September 1991 to January 1992, Zambia's debt-service payments are monitored closely. C. IFC and MIGA Activities 89. The existing IFC portfolio in Zambia is about US$17 million in six projects. In recent years, IFC activities in Zambia have concentrated on restructuring the existing portfolio. There are still a number of investments that require restructuring, and IFC's first priority is to ensure that existing companies are operating on a satisfactory basis. The Government's current strategy of emphasizing the role of the private sector and of privatizing the parastatals should allow a resumption of IFC's investment activity in Zambia. In the first instance, IFC will support, where appropriate, the privatization program. IFC could potentially provide privatization and restructuring advisory services, play a role in attracting appropriate sponsors and technical partners and contribute direct equity and loan finance. Upon Government's request, a FIAS mission provided recommendations to Government for changes in the 1991 Investment Act, which served as a basis for the 1993 Investment Act. As the investment climate improves, IFC will investigate new opportunities, especially new foreign exchange earning projects. IFC has an existing investment in the mining sector, and when Government proceeds with the privatization of ZCCM, there would be opportunities for additional IFC participation.  - 25 - PART V: COLLABORATION WITH IMF 90. The programs of the Bank and Fund in Zambia have been closely coordinated from the outset. Balance of payments needs are jointly agreed among the Bank, the Fund, and the Government as part of the PFP and the Consultative Group processes. Bank proposals on trade and taxation policy, investment incentives, and expenditure targets are kept consistent with the program's fiscal targets, and the Fund's structural policy benchmarks are developed in close consultation with the Bank. A joint Bank/Fund mission to prepare the next Policy Framework Paper was carried out in February 1995, and the PFP is scheduled for Board consideration in July 1995. It is expected that the Fund Board will consider Zambia's structural adjustment program in August or September. Should they decide that the program can be supported under the ESAF, the Rights Accumulation Program will be concluded, and the arrears to the Fund will be paid. PART VI: RECOMMENDATION 91. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association, and I recommend that the Executive Directors approve it. James D. Wolfensohn President Attachments Washington, D.C. June 6, 1995   ANNEXES   Annex A Zartbia: Social Indicators Page 1 of 2 Mosr Samr reigonluTcome group Nc= Larsr sigle year rcecnt .ub- higher onie Saharrn Loa'- incomc Indicator mcesure 1970-75 195045 19S7-92 Africa income group Priority Poverty Indicators POVERTY Upper poverty line local CU. . .. 1.380 Headcount index % ofpcp. .. 64 19 Lower poverty line local curr. 962 Headcount index % of pop. 54 GNP per capita USS 560 350 450 520 390 SHORT TERM INCONIE INDICATORS Unskilled urban wages local cur. .. Unskilled rural wages Rural terms of trade Consumer price index 1987-100 9 46 4,415 Lower income Fooda 6 46 1,469 Urban Rural SOCIAL INDICATORS Public expenditure on basic social services % of GDP .. .. 3.4 Gross enrollment raiios Pnmarv % school age pop. 97 99 92 66 103 Male ' 105 105 101 79 113 Female 88 93 92 62 96 Mormaliry Infant mortaliry per thou live births 100.0 89.0 107 0 99 0 73.0 45.0 Under 5 mortaliry .. .. 177.5 169 0 108.0 59.0 Immunization Measles % age group .. 55.0 76.0 54.0 72.7 DPT .. 47.0 79.0 54.6 80.6 Child malnutrition (under-5) 24.1 24.7 23.0 28.4 38.3 Life expectancy Total years 47 51 48 52 62 68 Female advantage 3.3 3.4 3.3 3.4 2.4 6 4 Total fertility rate births per woran 6.7 7.2 6.5 6.1 3.4 3.1 Maternal mortality rate per 100,000 live birdts .. 151 Supplementary Povertr Indicators Expendirures on social security %of total gov't exp. .. 1.3 1.5 Social securiry coverage % econ. active pop. .. .. Access to safe water: total % of pop. 42.0 58.0 59.0 41.1 68.. Urban ' 86.0 76.0 76.0 77.3 78.9 Rural ' 16.0 41.0 43.0 27.3 60.3 Access to health care ,. 70.0 75.0 Population growth rate ti GNP per capita growth rate Development diamondb 6-- average. percent) annual average, percent) I 10 - Life expectancy 2iI GNP Gross 1970-75 1980-85 198S,-92 i 1970-7S 1980-85 19S7-92 K Zambea -lZarnbla - Low-income Low-income a. Se- the technical notes, p.3S9 b. ne developrnent diamond. based on Four kev indicators, shows the avaage level of development in the countrn compared with zEs incomc group. See d.e incroduction.  Annex A Zar-bia: Social Indicacors Tage 2or 2 Hawt Same rq'wonuncamew group Next Luara siiieeyew recent higher Unit of areimwe Sahzaran Low- incomew Indicator measure 1970-75 1980.45 1987-92 Africa income group Resources and Expenditures H'LNSA-%N RESOU'RCES Population (rore-1992) thousands 4,841 6,680 8.272 546.390 3,194,535 942,547 Age depcndency ratio ratio 0.97 1.04 1.05 0.95 0.67 0.66 Urban % of pop. 34.8 40.9 42.4 29.5 26.7 57.0 Population growth rate annual