Zambia - First and Second Privatization and Industrial Reform Adjustment Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 16192-ZA IMPLEMENTATION COMPLETION REPORT REPUBLIC OF ZAMBIA PRIVATIZATION AND INDUSTRIAL REFORM ADJUSTMENT (CREDIT 2405-ZA) SECOND PRIVATIZATION AND INDUSTRIAL REFORM (CREDIT 2523-ZA) December 30, 1996 Country Department 2 Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Zambian Kwacha (K) US$1 - K 130' US$1 = K 5202 US$1 = K 1,2503 FISCAL YEAR Government January 1 - December 31 ZIMCO Parastatals April 1 - March 31 ABBREVIATIONS AND ACRONYMS COMESA - Common Market for Eastern/Southern Africa ERC - Economic Recovery Credit ESAF - Enhanced Structural Adjustment Facility IDA - International Development Association IMF - International Monetary Fund GDP - Gross Domestic Product NGO - Non-Governmental Organization PIRC - Privatization and Industrial Reform Credit PFP - Policy Framework Paper SDR - Special Drawing Rights TA - Technical Assistance lNIP - United National Independence Party ZAMTEL - Zambia Telecommunications ZCCM - Zambia Consolidated Copper Mines, Ltd. ZESCO - Zambia Electricity Supply Corporation ZIMCO - Zambia Industrial and Mining Corporation ZPA - Zambia Privatization Agency Vice President Mr. Callisto E. Madavo Country Director Ms. Phyllis Pomerantz Staff Member Mr. Emile B. Sawaya IAt Appraisal of PIRC 1, April 1992 2 At Appraisal of PIRC 11, April 1993 3Current conversion rate  FOR OFFICIAL USE ONLY Table of Contents Page No. PREFACE EVALUATION SUMMARY ...................... i - iii PART I: PROGRAM IMPLEMENTATION ASSESSMENT 1 A. Statement/Evaluation of Objectives 1 B. Achievement of Objectives 2 C. Major Factors Affecting the Project 3 Structural Characteristics of the Zambian Economy 3 Exogenous Factors 5 D. Borrower Performance 5 Privatization of Parastatal Enterprises 6 Civil Service Reform and Government Restructuring 7 Encouraging Private Sector Development 8 Macroeconomic Stabilization 8 Rehabilitation and Privatization of ZCCM 9 E. Bank Performance 9 F. Assessment of Outcome 11 G. Project Sustainability 12 H. Key Lessons Learned 13 PART II - STATISTICAL TABLES 14 Table 1: SUMMARY OF ASSESSMENTS 15 Table 2: RELATED BANK OPERATIONS 16 Table 3: PROJECT TIMETABLE 17 Table 4: DISBURSEMENTS 18 Table 5: KEY INDICATORS, ACTUALS AND PROJECTED, 1992-96 19 Table 6: STUDIES 20 Table 7: STATUS OF LEGAL COVENANTS 21 Table 7A: STATUS OF LEGAL COVENANTS 22 Table 8: BANK RESOURCES - MISSIONS 23 Appendixes: A. ICR Mission's Aide Memoire 24 B. Borrower's Evaluation Report 36 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   IMPLEMENTATION COMPLETION REPORT REPUBLIC OF ZAMBIA PRIVATIZATION AND INDUSTRIAL REFORM ADJUSTMENT (CREDIT 2405-Z) SECOND PRIVATIZATION AND INDUSTRIAL REFORM (CREDIT 2523-ZA) PREFACE This is the Implementation Completion Report (ICR) for the Privatization and Industrial Reform Credit (PIRC I) and the Second Privatization And Industrial Reform Credit (PIRC II) in Zambia. PIRC I (Credit No. 2405-ZA), which was approved on June 30, 1992 and became effective on July 23, 1992, provided SDR 146.0 million (US$200.0 million equivalent) and an additional SDR 15.0 million (US$20.9 million equivalent), and SDR 12.1 million (US$17.8 million equivalent) under two IDA Reflows. PIRC II (Credit No. 2523-ZA), which was approved on June 24, 1993 and became effective on December 3, 1993 provided SDR 72.1 million (US$ 100.0 million equivalent) and an additional SDR 7.0 million (US$10.0 million equivalent) under an IDA Reflow. PIRC I closed on April 26, 1995 (original Closing Date was June 30, 1994) and PIRC II, whose original Closing Date was June 30, 1995, is expected to close on June 30, 1997. The ICR was prepared by Emile B. Sawaya (Task Manager, AFTP 1), with the assistance of David G. Greene (Consultant), and Carolina Machado (AFTMI). It was reviewed by Phyllis Pomerantz, Country Director (AFC02) and Gene Tidrick, Technical Specialist (AFTM 1). The Borrower provided an evaluation report that is included as Appendix B to the ICR. Preparation of this ICR was begun during the Bank's supervision/completion mission in March 1996. It is based on discussions with Bank staff, on findings of the completion mission, which held discussions with Government officials, and on the President's Report, the Credit Agreement, the supervision reports, and other materials in the project files. In addition to providing its own assessment (Appendix B), the Borrower's comments which were included as appropriate in the ICR.   PRIVATIZATION AND INDUSTRIAL REFORM ADJUSTMENT (CREDIT 2405-ZA) SECOND PRIVATIZATION AND INDUSTRIAL REFORM (CREDIT 2523-ZA) REPUBLIC OF ZAMBIA EVALUATION SUMMARY i. The Zambian economy suffers from severe and long standing distortions needing major structural adjustment. It has suffered, since Zambia's independence, from state intervention and ownership, resulting in inefficient resource allocation and use. The country has been, and still is, heavily dependent on copper for export earnings and the copper industry has directly and indirectly supported a substantial share of the country's industry and commerce and employment. Since the mid-1970s, both world copper prices and Zambia's copper production have declined substantially. Attempts to maintain domestic income and employment by borrowing abroad, especially in the late 1970s and early 1980s, resulted in the accumulation of a massive external debt. ii. Despite several attempts at reform to impose fiscal and monetary discipline in the 1980s, the Government did not have the commitment to reform needed to resist political pressure. A comprehensive reform program supported by the Bank and the IMF and adopted by the Government in 1985 came to a halt in 1987. This led to suspension of debt service payments, including those to the Bank, and an abandonment of reform in 1987, resulting in a two-year hiatus in relations with the Bank. Policy dialogue between Zambia and the Bank resumed in 1989. An Economic Recovery Credit (ERC) was approved in March 1991, following clearance of arrears, but a policy impasse over maize subsidies arose and service on debt to the Bank stopped again, resulting in a suspension of disbursements, although, unlike in 1987, most policy reforms were retained. iii. In November 1991, a newly elected Government affirmed its commitment to economic reform, cleared arrears, and agreed to a new Policy Framework Paper (PFP) for 1992-94. Disbursements on IDA operations resumed in February 1992. The new Government dismantled nearly all controls and moved to market-based prices, eliminated import and export licensing, simplified tariffs, decontrolled interest rates, launched an ambitious privatization program, and began to decentralize and improve the efficiency in delivering public services. The international community responded quickly with balance of payments support, debt rescheduling, and projects and programs supporting reform. The two IDA financed Privatization and Industrialization Reform credits (PIRCs) were an important part of that response. Program Design and Objectives The two PIRC programs were designed to continue the implementation of the privatization and parastatal reforms and the macroeconomic stabilization started under the ERC. The two Credits supported Zambia's structural adjustment program, focusing on market liberalization and civil service reform, and private sector development.  - ii - V. The specific objectives of PIRC I were to: (a) support Government efforts to modernize the business framework by revising existing laws and regulations or enacting new ones appropriate to the development of a private sector-oriented, market-driven economy; (b) consolidate the establishment of a market-based exchange rate, foreign trade system and domestic financial market; and (c) privatize the vast majority of state-owned enterprises, increase the autonomy and efficiency in the few remaining publicly owned enterprises and streamline and improve the efficiency and effectiveness of the civil service. In addition, PIRC I was used as a vehicle for supporting Government efforts to meet the cost of the severe 1992 drought; the Credit amount was raised from US$100 million to US$200 million. vi. The second program (PIRC II) advanced the objectives of the first one and expanded them to include: (a) developing financing arrangements to facilitate increased participation by local investors in ownership of newly privatized companies; (b) deepening the absorptive capacity of the local capital market; (c) helping Government to develop a comprehensive, affordable and socially acceptable program for those made redundant through corporate restructuring; and (d) developing the capacity of key institutions to deal with the privatization program. Implementation Experience and Results vii. The general outcome of the PIRCs has been rated as satisfactory. The two credits supported a program of (a) privatization and private sector development; (b) civil service reform and government restructuring; and (c) macroeconomic stability. The success of the program and its sustainability will depend on continued commitment on the part of the Government. viii. Progress in privatization has been particularly encouraging. The privatization agency (ZPA) has established a good operating framework with technical assistance and staffing which helped accelerate implementation and the decision-making process. Also, the number of entities to be privatized has gone up. Several measures were adopted which have helped promote private sector development. They were: enactment of anti-monopoly legislation and updating of laws related to banking and non-banking financial institutions, business licensing, insurance, and the stock exchange. ix. The program of civil service reform and government restructuring has begun but has not shown significant results. Initial progress was made in 1992 with the elimination of "ghost workers", but further progress has been stymied by the lack of an affordable severance package and shortage of budgetary funds. As a result, the re-organization of government ministries has been proceeding slowly. x. Although some progress has been made in achieving macroeconomic stability, macroeconomic imbalances have caused problems for business in general. Fiscal performance tends to go off track at the beginning of each year, and as a result the budget making process becomes inefficient. xi. Government performance has been rated satisfactory in terms of covenant compliance, preparation, and implementation of the program under the two Credits, although there were  - iii - increasing delays in releasing the tranches. In retrospect, the program seemed too ambitious as to Government institutional capacity to implement it in the expected time frame. This was particularly true of the privatization process and actions such as passage of land laws and business-related legislation. xii. Bank performance has been rated highly satisfactory in preparation assistance and supervision, and satisfactory in identification and appraisal. The Bank's program of adjustment operations was prepared in consultation with the Government, and its design helped in translating the Government's intentions into a concrete plan of action. The program as conceived tried to accomplish too much too soon. As a result, the agenda of actions for PIRC I and, to a lesser extent, PIRC II was quite demanding of government technical and administrative resources. Supervision reports were detailed, and concrete recommendations were given for the resolution of implementation problems. xiii. The main conclusions and lessons learned were: - Macroeconomic stabilization is fundamental to private sector investment and growth. - More priority should have been given to abolishing Zambia Industrial and Mining Corporation (ZIMCO) to end its resistance to privatization, as well as to the rehabilitation of the Zambia Consolidated Copper Mines (ZCCM). Civil service reform requires the development of a workable strategy and an affordable compensation package. * Some actions should have been postponed and/or not incorporated as specific conditions. They include issues related to the Development Bank of Zambia, Lima Bank and Eximbank; establishment of a stock exchange; regulations concerning contractual savings institutions; development of a plan for streamlining the regulatory framework and licensing requirements for small scale enterprises and assessing their access to credit. * It is essential to ensure support of key government officials for the reform program during the early stages of preparation and implementation. This includes ensuring full understanding within the Cabinet of the program's content.   PART 1: PROJECT IMPLEMENTATION ASSESSMENT A. Statement/Evaluation of Objectives 1. Structural adj ustment in Zambia is a particularly complex and demanding task, requiring the full commitment of the Government and the populace and the cooperation of multilateral and bilateral aid agencies. Zambia's economy has experienced a prolonged, deep decline, and many of the key institutions needed to carry out a reform program have atrophied. Furthermore, the economy has been subjected to pervasive state intervention and ownership, resulting in deep seated inefficiencies in resource allocation and use. The country has been, and still is, heavily dependent on copper for export earnings. and the copper industry has directly and indirectly supported a substantial share of the country's industry and commerce and employment. However, world copper prices have experienced a secular decline (interrupted by cyclical movements) and Zambia's production has been declining steadily. Attempts to maintain domestic incomes and employsnent in the face of declining copper earnings by borrowing abroad only succeeded in accumulating a massive external debt, mortgaging the country's future. The result of economic mismanagement was a prolonged decline in per capita output. From its peak in 1974 to 1990, domestic product fell at an average of 2.8% per year, and per capita income by 4.8% per year. 2. The Government made several attempts at reform in the past. Internationally supported programs were undertaken sporadically during the 1978-1987 period. However, Government did not have the commitment to reform needed to withstand the political pressures caused by the inevitable short term dislocations. In the face of these dislocations, fiscal and monetary discipline faltered, policy reform was halted and, on more than one occasion, the country defaulted on its international debt, bringing external capital flows to a halt. The Kaunda government adopted a comprehensive reform program in 1985 with support for-m the Bank and IMF, but this program came to a halt in 1987 with policy reversals which led to the suspension of debt service payments, including those to the Bank, abandonment of reform, and a two-year hiatus in relations with the Bank. The policy dialogue resumed in 1989 and, with the clearance of arrears, normnal relations with the Bank were reestablished when the Economic Recovery Credit (ERC), the immediate predecessor of the PIRCs, was approved in March 1991. However a policy impasse over maize subsidies arose and service on debt to the Bank was again halted. Disbursements were suspended in September 1991, although most of the policy reforms were retained. 3. Iin November 1991, a new Government committed to the restoration of macro:conomic balance and structural reform was elected. The new Government affirnmed its commitment to economic reform, cleared arrears and agreed to a new PFP for 1992-94. Disbursements on IDA operations resumed in February 1992. The new Government began to take action immediately It dismantled nearly all controls and moved to market-based prices, eliminated import and export licensing, simplified tariffs, decontrolled interest rates, launched an ambitious privatization program, and began to  - 2 - decentralize and improve the efficiency of delivery of public services. The international community responded quickly with balance of payments support, debt rescheduling, and projects and programs to support reforms. The two IDA financed PIRCs were an important part of that response. 4. The PIRC operations continued and broadened implementation of the privatization and parastatal reforms and the macroeconomic stabilization program that were initiated under the 1991 ERC (2214-ZA) and were to be complemented by follow up operations to support reforms in trade, finance and industry. The PIRCs supported Zambia's renewed and reinvigorated structural adjustment program, which focused on market liberalization and civil service reform, together with major new initiatives in private sector development, privatization and parastatal reform. The main objectives of PIRC I were to support government efforts to modernize the business framework by revising existing laws and regulations or enacting new ones appropriate to the development of a private sector-oriented, market-driven economy; consolidate establishment of a market-based exchange rate, foreign trade system and domestic financial market; privatize the vast majority of state owned-enterprises, increase the autonomy and improve the efficiency of the remaining publicly owned enterprises and streamline and improve the efficiency and effectiveness of the civil service. The centerpiece of the reform was to be the privatization of 90% of Zambia's parastatals over a five-year period, and giving autonomy to the remaining public utilities through a new arm's length regulatory system. The objectives of PIRC II were primarily those set forth in PIRC I, but went somewhat beyond these to include: (1) developing financial arrangements to facilitate increased participation by local investors in ownership of newly privatized companies; (2) deepening the absorptive capacity of the local capital market; (3) helping Government to develop a comprehensive, affordable and socially acceptable program for those made redundant through corporate restructuring; and (4) developing the capacity of key institutions to handle the rapidly increasing privatization workload. 5. Under the two PIRCs, the Government's intentions were formalized into a concrete, time-bound plan of action designed to restore economic growth. Achieving and sustaining macroeconomic stability and securing adequate external financing have been overriding conditions of the operations. The latter ensures that all external partners -- the Bank, IMF (through its Rights Accumulation Program and later through its ESAF) and bilateral donors (including those involved in rescheduling debt) -- are satisfied with the progress of the Government's program and bear the costs of assistance equitably. B. Achievement of Objectives 6. The two PIRC operations have to a large extent accomplished their objectives, and in terms of general outcome, they have been rated satisfactory. In the long term, however, the success of the PIRC Program and its sustainability will depend on continued Government commitment to the program.  - 3 - 7. Progress on the privatization program has been particularly impressive. The Zambia Privatization Agency (ZPA) has established suitable policies and procedures and, with help from IDA and other donors, has been able to recruit appropriate staff and accelerate the implementation of the privatization program. Good progress has also been made on private sector development. The measures that were adopted aimed to reform investment laws and the institutional arrangements to promote investment, as well as the laws that govern the operations of existing business, such as the company law, anti- monopoly legislation, the banking and non-banking financial institution, business licensing, and the capital market and stock exchange. Significant progress has also been made on the macroeconomic front. Inflation has come down significantly, although it remains relatively high. Macroeconomic imbalances which appear on a periodical basis have had an adverse impact upon business activity because of the uncertainty they generate and the high real rates of interest that are associated with them under a liberalized setup. 8. The area where the PIRCs only partially accomplished their objectives is civil service reform and government restructuring, an area that was emphasized more under PIRC I. Despite initial progress in 1992 with the elimination of 10,000 "ghost workers", the 1995 payrolls appeared larger than those of 1991. This was due to Government's inability to attain an affordable severance package due to the shortage of resources and the fact that the decision to add non-cash compensation to the severance package as agreed under PIRC II proved to be less attractive to civil servants than expected. The reorganization of government ministries is underway, but it seems to be suffering from the same problem as civil service reform efforts under the PIRCs, i.e., shortage of resources. C. Major Factors Affecting the Project Structural Characteristics of the Zambian Economy 9. The Zambian economy suffers from severe and long standing distortions that will require a major structural adjustment effort over an extended period to overcome. Its major characteristic is heavy dependence on copper and the dualistic structure that has grown up around this dependence. From soon after independence in 1964, the United National Independence Party (UNIP) Government sought to gain control of the economy through widespread nationalization. The economy became dominated by parastatals, and a one party system was introduced in 1974. Rising copper prices helped the economy to grow steadily, at an average rate of 4% per annum during the first decade after independence. Since 1975, however, falling world prices of copper and the general deterioration of the terms of trade, coupled with the failure to develop a diversified economy and continued misguided policies, resulted in general and prolonged economic decline. Attempts to support unsustainable levels of consumption through borrowing did not contribute to economic growth and created an exceptionally severe debt problem. Per capita GDP is now more than a third below its 1978 level.  10. Copper has accounted for nearly 85% of exports, contributed 15% of GDP, and has been until lately an important source of budgetary revenues. The problem is heightened by the poor prospects for copper prices and a projected sharp decline in copper production toward the end of the decade. IDA is giving direct support to improve the efficiency and profitability of copper production through the Mining Technical Assistance Credit. Given the importance of copper, unless the decline in production can be arrested and reversed, near term prospects for economic growth and expanding government revenues will remain bleak. 11. The dominance of the parastatal sector has stifled private sector competition and initiative. Productivity of monopoly parastatal enterprises is low and prices are high. Publicly provided services are poor: the railways are slow and unreliable; the power company has been unable to maintain steady voltage, and telecommunication services are substandard. Privatization and improving the efficiency of the parastatal sector required breaking the political power of parastatal executives, especially those in the holding company ZIMCO, who opposed privatization and with it the end of their privileged positions. 12. As a result of heavy external borrowing, Zambia had an extremely high debt burden. Total debt at the end of 1991 amounted to US$6.7 billion, of which US$2.9 billion was multilateral, US$2.5 billion bilateral, US$0.6 billion medium / long term commercial (including export credits) and US $ 0.7 billion short term. Excluding the short term debt, Zambia's external debt was US$ 776 per capita, one of the highest levels anywhere. Alleviating the debt burden has been a prime focus of the Consultative Group and Paris Club processes, and is the main reason for the yearly and rather large balance- of-payments IDA operations. Without debt relief and external financing, resource constraints would result in even sharper declines in living standards, jeopardizing the political will to proceed with stabilization and structural reform. 13. The technical and administrative capacity of the Zambian Government to carry out a complex and demanding program of stabilization and structural adjustment was and remains extremely limited. Moreover, low levels of civil service compensation make it difficult to recruit qualified Zambians for high level positions. In recognition of this, the PIRCs were accompanied by a Technical Assistance Credit (2406-ZA approved on July 13, 1992) of SDR 7.3 million (US$ 10 million equivalent) to finance consultants' services, training, equipment and services for (i) the development and implementation of the privatization program; (ii) development of the private sector; (iii) reform of the utilities remaining in the public sector; (iv) carrying out a Social Action Plan to provide a safety net for those affected by the reform; and (v) training of Zambian officials. Several other donors provided generous amounts of technical assistance funds as well. As a result, many of the key parts of the program were carried out by expatriates and/or by Zambians paid with technical assistance funds. Unfortunately, in some of these areas, less attention seems to have been paid to training Zambians so that the capacity of the Government to carry out the program using Zambian civil servants has not improved appreciably.  -5 - Exogenous Factors 14. Weather is always a complicating factor for economic management in Southern Africa. Recurrent droughts are a fact of life and the Government's reform program was made more difficult by the catastrophic drought that affected all of Southern Africa in the early months of 1992. Zambian maize output was about one third of the post-planting estimate and agricultural GDP was reduced by over 25%. Substantial efforts were mounted by the donor community to meet the cost of the drought, estimated at US$ 300 million. It was primarily as a result of this drought that the size of PIRC I was increased from US$ 100 million to US$ 200 million in April 1992. This increase was also useful in leveraging donor drought assistance to Zambia. The Government used the donor support to shield the public from the full impact of the drought on maize prices. Agreement was reached with neighboring countries on logistical arrangements for large imports of maize. The drought also directly affected a number of other food products, such as wheat, soya, sugar, oil seed, and non food agricultural crops such as cotton and tobacco, with an immediate impact on related agro industries. D. Borrower Performance 15. The Government's program, as incorporated into the adjustment operations, was complex, especially in view of its limited institutional capacity. In retrospect, it appears that the program was overly ambitious in terms of the areas it covered and the number of conditions it included and beyond the capacity of the Government to implement in the time frame foreseen. Progress was slow where institution building or the development of new mechanisms for institutional reform were required. This is particularly true of the privatization process (as opposed to the transactions themselves) and the preparation of business-related legislation. The problem of limited capacity in privatization could be resolved because it required skills that are normally found in the private sector. Funds from PIRTA were provided for a limited period of time to ZPA to enable it to recruit the managers and specialists it needed. The preparation of legislation, however, needed a permanent capacity at the Ministry of Legal Affairs, and while TA funds were used to recruit international advisors and to train Zambian draftsmen, the delay of civil service reform meant that the terms and conditions of employment could not be improved enough to retain the trained staff. 16. Government's willingness to enter into agreement with IDA that were dependent on the action of third parties, especially Parliament, proved to be a problem. Drafting and passage of amendments to some business-related legislation proved to be more time consuming than anticipated and the final actions were shifted from PIRC I to PIRC II. Some of the measures which would permit release of the third tranche of PIRC II such as the performance contracts for ZESCO and ZAMTEL were considerably delayed. The third tranche was only released in late June 1996, and the Credit closing date had to be postponed by one year to June 30, 1997.  - 6 - 17. The Government monitored implementation of the program closely, especially macroeconomic stabilization, which was also critical to continued IMF and donor support. In mid- 1993, a weekly Friday Group, chaired by the Minister of Finance, was established to monitor the program. 18. Even with the more intensive monitoring, the release of the third tranche of PIRC I was delayed half a year and the release of the third tranche of PIRC II by two years by comparison with the original schedule. Disbursement Experience Operation PIRC I PIRC II Board Date June 1992 May 1993 Schedule* original atuali original actu Second Tranche Dec. 1992 March 1993 Nov. 1993 Oct. 1995 Third Tranche June 1993 Dec. 1993 May 1994 June 1996 *Schedule as per Board document 19. Despite numerous challenges over the past four years-- drought, fiscal pressures, unpopularity and hardships caused by many adjustment measures, and the failure of the economy to revive, the Government has so far remained firm in its commitment to reform. However, execution of the Government's program has been uneven. Privatization has been a significant success; safety net provisions, including drought relief, have been moderately successful; progress has been made toward macroeconomic stability, although sustaining it has proved difficult; civil service reform and government restructuring have not been successful as yet; measures designed to promote private sector development present a mixed picture; finally, the poor performance of ZCCM continues to be a major obstacle to stabilization and economic growth. Privatization of Parastatal Enterprises 20. The most encouraging development has been the progress of privatization. Once ZPA established an adequate operating framework, with technical assistance, staffing and executive leadership problems were resolved, and the political decision was made to dissolve ZIMCO and thus end a major source of resistance, privatization accelerated. A new CEO took over the helm at ZPA in April, 1995 and the decision to close down ZIMCO was implemented in March 1995. These two measures resulted in a notable acceleration of privatization. Since ZIMCO continued to interfere in the management of otherwise well-functioning companies and was lax in preventing asset stripping of companies scheduled for privatization, it would probably have been better to eliminate ZIMCO at the outset and set up an alternative arrangement to carry out some of its monitoring activities.  - 7 - 21. The number of entities to be privatized has been increased as decisions were made to privatize some operating units and assets separately. As of November 30, 1996, 165 of 271 firms and productive units/assets had been privatized. The number of individual firms privatized is over 60. The liquidation of Zambia Airways and the end of its drain on the budget has been a major achievement. New methods of privatization are being used, including management buyouts. It now appears that the privatization process can be substantially completed in two to three more years. 22. Transitional measures had been taken to give the public utilities more autonomy on key business decisions, including prices and rates, within the context of understandings on performance with the Government. Permanent arrangements to govern the utilities' operations were agreed upon in performance contracts which were signed in mid-1996. 23. Although the review of privatization experience was carried out before a sufficient number of firms had been privatized and therefore could not draw meaningful conclusions, anecdotal evidence indicates that the objectives of privatization -- increased efficiency and better products -- are being achieved. For example, the private companies Aero Zambia and Zambia Express have filled the gap left by the liquidation of Zambia Airways; private minibus transport has successfully replaced the municipal bus company; and the privatization of beer and cement companies has resulted in increased supply and better customer service. 24. Privatization of ZCCM was not a central feature of the program at the outset because (1) it was thought that ZCCM was too sensitive and too big to be handled (2) it was thought that ensuring a successful privatization experience early on would be helpful to generate support in Government and the Zambian public for privatizing ZCCM; and (3) studying the strategic options to privatizing ZCCM was thought to be a necessary pre- requisite to a decision to privatize -- hence the agreement to a study on this topic. In retrospect, this turs out to have been a mistake in timing, if not a strategic error. The need to give the new ZCCM management time to show what it could do, out-weighed the need to deal with the effects on the company of years of poor management and under- investment. This resulted in an unanticipated sharp decline of the company's copper production, deteriorating financial performance and declining contribution to government revenues, which have been major impediments to the growth of the economy and to macroeconomic stability. Civil Service Reform and Government Restructuring 25. Civil service reform has begun but has not shown significant results. Initial progress was made by eliminating 10,000 "ghost workers" and non civil service "classified daily workers" in 1992. Further progress has been stymied because of the lack of an affordable severance package and the shortage of budgetary funds. In the meantime, the Government continued to hire recent graduates of teaching, medical and other programs, as required by law. Statistics on civil service employment although not  - 8 - yet reliable, are being improved. The Government has recently adopted a "three for one" program, allowing the hiring of one new employee for every three that leave through attrition, and this has already resulted in a modest decline in the civil service rolls. Encouraging Private Sector Development 26. Progress on some measures facilitating private sector development has been encouraging. Most business-related legislation has been revised in an appropriate manner. Anti-monopoly legislation has been enacted, and laws relating to banking and non-banking companies, business licensing, insurance and the stock exchange have been updated. Measures strengthening regulation and supervision of banks and nonbank lending institutions were implemented and guidelines for capital market transactions and operations of stock exchange issued. 27. Attempts have been made to encourage exports. Improvements have been made in the duty drawback system for exporters. However, tariff reform remained incomplete because of continued numerous exemptions, loopholes (including COMESA preferences) and administrative weaknesses, and some businesses suffer negative protection. In retrospect, the study of the tariff system undertaken as part of the PIRC I program was not complete and took too narrow an approach. Further reform of tariffs, including further reduction of rates, elimination of exemptions, improvement of administration and expediting of drawbacks was essential, and some of these reforms were adopted as part of the Second Economic and Social Adjustment Credit approved in 1996. 28. The major problem for business has been continued macroeconomic instability. The most damaging aspect of this has been the emergence of high and highly variable nominal interest rates, translating into very high real rates of interest and unpredictable movements of the effective exchange rate. Macroeconomic Stabilization 29. Some progress has been made toward reducing macroeconomic imbalances, especially since the adoption of the cash budget in 1993. The Government successfully competed its IMF Rights Accumulation Program, and is now implementing an ESAF arrangement, although the completion of the Fund Rights Accumulation Program required a number of waivers. Domestic expenditures have fallen from 25% of GDP in 1991 to about 18% in 1995, while revenues have regained their 1991 level of 19% of GDP, despite falling receipts from mining. The fiscal accounts, which showed a deficit equivalent to 7% of GDP in 1991, were nearly in balance by 1995. The inflation rate declined from triple digits for a few years before 1992 to under 40% in mid 1993, but has hovered between 40 and 50 percent in recent years, which is still too high. 30. There has been a disturbing tendency for fiscal performance to go off track, especially in the early part of each year. Although the specific reason seems to be different each year, it is clear that there are problems with the budget making process.  - 9 - With low growth of revenues and continued high civil service employment, there is little margin for error in the budget. Budgetary problems that arise early in the year are generally resolved later in the year by squeezing expenditures and/or ad hoc revenue measures, but the damage, in terms of volatility of interest rates and lack of confidence is already done. 31. With liberalized credit and foreign exchange markets, and the Government being the major player in both markets, variations in Government issue of T-bills have a strong effect on interest rates, and government decisions on foreign exchange sales have a strong influence on exchange rate movements. Sustained macroeconomic stability requires better management of the budget, monetary policy and foreign exchange reserves. It also requires augmentation of revenues and rationalization of expenditures to provide a better balance between wage and nonwage outlays and increased expenditures for infrastructure and its maintenance. Rehabilitation and Privatization of ZCCM 32. In the PIRC II LDP, the Government committed itself to privatize ZCCM. However, other than a commitment to review the appropriate privatization options, there was no agreement on follow-up actions or on timing. Failure to deal more explicitly with the problems of ZCCM at this stage in the adjustment process has proven to be a serious problem and may have been a major contributing factor to the slow growth. ZCCM's production, which averaged 700,000 tons per year during the early 1970s, was down to about 310,000 tons in 1995/96. The decline in ZCCM's production prevented it from benefiting from the high prices in 1994 and 1995. The company is now experiencing cash losses and is in arrears to its suppliers. 33. The privatization of ZCCM is the only permanent solution to the problems of the copper sector and is now inevitable. Lawyers and investment bankers have been hired using IDA TA funds to plan it. In the interim, the company developed an emergency rehabilitation program and is implementing it with help from newly recruited managers and specialists. Even with rehabilitation, production from the open pit mine can only last about four more years. The Konkola Deep project, which would fill the gap, is under intensive negotiation between the Government and a consortium of investors headed by Anglo-American Corporation, the largest private minority shareholder in ZCCM. E. Bank Performance 34. When the Bank's response to the Government's new commitment to stabilization and adjustment was formulated (1989-1991), there was already a long policy agenda. Many of the actions in this agenda had been included in past adjustment operations (in the 1980's), but not successfully implemented. The program, as conceived, tried to take advantage of the new Government's commitment to reform to accomplish as many of these actions as possible in the shortest possible time. ERC included measures to decontrol prices, liberalize trade, start privatization and reduce the budget deficit. As a  - 10- result, the agenda of actions for PIRC I and to a lesser extent PIRC II, proved to be quite demanding of government technical and administrative resources. Many of the key measures took longer than expected by both the Bank and the Government, while others of lower priority were carried out. However, viewed out of the context of the PIRC operations, the actual time required for implementation was not excessive, given the complexity of the agenda, opposition and foot dragging by affected parties, the Government's limited technical and administrative capacity, and the time required for technical assistance to crank up. 35. The Government that was elected in 1991 had a good understanding of the issues facing the country and the measures it needed to take. The Bank's program of adjustment operations was prepared in close consultation with the Government and was helpful in translating the Government's intentions into a concrete plan of action. There was close cooperation with the IMF. Bilateral donors who were expected to play a key role in providing external capital, debt relief and technical assistance, were consulted and kept informed of progress. 36. During the preparation of PIRC I, efforts were also made to keep the private sector and NGOs informed about the content of the program. For PIRC II, the process was formalized by having a Project Launch Workshop to which key public, private and NGO representatives were invited. The donor community was also briefed by supervision missions and task managers visiting Zambia, as well as at Consultative Group meetings. 37. In retrospect, more immediate priority should have been given to: (1) the importance of macroeconomic stabilization for private sector investment and growth; (2) the urgency of abolishing ZIMCO to end its resistance to privatization; (3) the development of a workable strategy and compensation package for civil service reform; and (4) the rehabilitation and privatization of ZCCM. On the other hand, streamlining the Investment Center, amending or enacting various pieces of business-related legislation, issuing guidelines for operation of the capital market, and developing a regulatory agency for public utilities, all included in PIRC I, could have been done later in the adjustment process. Similarly, dealing with the problems of the Development Bank of Zambia, Lima Bank and Eximbank, establishment of a stock exchange, regulations concerning contractual savings institutions, development of a plan for streamlining the regulatory framework and licensing requirements for small scale enterprises and improving their access to credit, included in PIRC II, could well have been postponed for a year or so, or action could have been focused on a smaller number of the most urgent of those actions. 38. During the early stages of implementation, it became clear that some key government officials were not fully aware of the content of the program. This required continuous educational activity on the part of Bank staff during preparation and implementation of the program. Execution of the program was closely and virtually continuously overseen by the Bank. The two operations were presented to the Bank's Executive Directors less than a year apart. This meant that PIRC II was being appraised  - 11 - and negotiated during the implementation of PIRC I, reinforcing the pressure for close monitoring and coordination. Moreover each operation was supposed to disburse in three tranches within a year, (one on effectiveness and, the second after six months and the third after a year). As a result, Bank involvement in Zambia was almost continuous and, given the limited capacity on the Zambian side, somewhat overwhelming. 39. Supervision reports were detailed, covering the program point by point. Where implementation was lagging or problems seemed to be arising, concrete recommendations were made for their resolution. Extensive, detailed Aide Memoires were left with the Government, including matrices outlining the status of actions taken and further measures required. When progress of the program was not satisfactory, tranche releases were delayed and when timing of actions no longer seemed realistic, appropriate adjustment were made to allow them to be undertaken later in the process. F. Assessment of Outcome 40. The success of the stabilization and structural reform strategy was to be evaluated on the basis of three criteria: (1) implementation of macroeconomic policies for stabilization as measured against targets for fiscal deficit, monetary expansion and inflation; (2) progress of public sector reform, including divestiture of parastatals and reform of public utilities, as judged by the volume of privatization, achievement of financial targets for the remaining public utilities, reform of the civil service, and improved delivery of social services; and (3) diversification and growth of the economy, as measured by reduced dependence on copper and increased growth of the private sector. 41. The projects can be viewed as satisfactory, in the sense that almost all of the policy agenda was implemented However, macroeconomic stabilization lagged seriously behind expectations. PIRC I forecast the rate of inflation as declining from over 93% in 1991 to 5% in 1994. In fact, inflation accelerated to almost 200% in 1992 and, although it declined significantly thereafter, the increase in consumer prices in 1994 was still over 50%. This persistence of inflation reflected a slower than expected reduction in the fiscal deficit. In addition, inflation was accompanied by high and volatile interest rates, which discouraged domestic investment. The (macroeconomic) outcome indicators in the appendices to the PIRC operations proved to be optimistic. PIRC I foresaw GDP growth of 2% in 1992, 3% in 1994 and 4% in 1995. PIRC II recognized the negative growth of GDP in 1992 (-9.6), primarily as a result of drought. However, it forecast a recovery of 11.9% in 1993 and a steadying of growth thereafter at somewhat over 5% per annum. In the event, growth has not recovered, in part because of continued adverse climatic conditions. However, the failure of domestic investment to recover was critically responsible for the poor growth performance. Whereas PIRC I and PIRC II forecast investment recovering to 20.5% of GDP in 1993, the actual level appears to have been less than 10%.  - 12 - GDP Growth Estimates 1991 1992 1993 1994 1995 PIRC I -1.0 2.0 3.0 4.0 PIRC II -1.8 -9.9 11.9 5.4 5.6 (1996) Latest Estimate 0.0 -2.5 6.5 -3.1 -3.9 42. As a result of adverse developments in agriculture and mining, inadequacies in the formulation of the adjustment program and delays and slippages in its execution, and problems in the implementation of the macroeconomic program, targets for growth and diversification of the economy were not attained. GDP growth was positive in only one year since 1991 (1993, a year when agriculture was recovering from drought) and per capita income has continued to decline. Poverty probably increased over the last four years due to the decline in per capita income. Infant mortality has risen from 108 in 1990 to 113 in 1994; and adult illiteracy from 25% to 33%. Initial findings of the ongoing Poverty Assessment indicate that there was a severe adverse impact on the urban poor. 43. Nevertheless, there are some bright spots. Some new cash crops have developed - - soya, cotton, tobacco, horticulturals, floriculture. Market liberalization has encouraged a shift from maize to more drought resistant crops. Nontraditional (non metal) exports have been increasing by 15-20%, per year and exceed US $ 175 million in 1995. G. Project Sustainability 44. The sustainability of the Government's program ultimately depends on its success in generating improving living standards. Without this, the Government will come under increasing political pressure to abandon or slow down implementation. The Government must also increase its efforts to protect the livelihood of vulnerable groups and to spread the benefits of growth through intensified provision of human services and critical infrastructure, especially in rural areas. 45. Accelerating growth will require improved performance in macroeconomic management, with the aim of bringing the rate of inflation down to single digit levels, reducing the nominal and real rates of interest, and maintaining the real exchange rate at levels that promote growth of the tradables sector. The key to this will be further improving fiscal performance through enhanced revenues and rationalized expenditures. ZCCM's poor performance is a major impediment to growth. Given the enormous amount of investment required to rehabilitate existing ZCCM operations, only after privatization is completed will copper mining begin to recover. Finally, adequate external financing must be insured. This will require continued government commitment to the reform process and stabilization. Performance on macro policy, ZCCM, and "governance" issues will be vital for the resumption of aid flows.  - 13 - H. Key Lessons Learned Some of the lessoizs learned from the implementation of the PIRC's are: (a) macroeconomic stabilization is fundamental to private sector investment and growth; (b) less faith should have been put into ZIMCO's ability to reform itself, and more priority should have been given to abolishing ZIMCO to end its resistance to privatization and to the privatization of ZCCM because of its importance to growth strategy; (c) civil service reform requires the development of a workable strategy and an affordable compensation package; (d) there were too many specific conditions of tranche release and too much emphasis on legislation; and (e) it is essential to ensure the support of key government officials for the reform program during the early stages of preparation and implementation. This includes ensuring full understanding within the Cabinet of the program's content.  - 14- PART II - STATISTICAL TABLES Table 1: Summary of Assessments A. Achievement of Objectives B. Program Sustainability C. Bank Performance D. Borrower Performance E. Assessment of Outcome Table 2: Related Bank Operations Table 3: Project Timetable Table 4: Disbursements Table 5: Key Indicators, Actuals and Projected, 1992 - 1996 Table 6: Studies Table 7: Status of Legal Covenants (PIRC I) Table 7A: Status of Legal Covenants (PIRC II) Table 8: Bank Resources - Missions  - 15 - Table 1: SUMMARY OF ASSESSMENTS A. Achievement of Objectives Substantial Partial Negligible N/A Macroeconomic Policies 4 Sector Policies i in i e........................................... ............ ................................ .................................. ........................................... ........................... ................................... Financial Objectives . Institutional Development 4 ....................................................................................... ........................................... ........................................... ................................................................ Physical Objectives 4 Poverty Reduction 4 ....................................................................................... ................................ ........... ................................ ........... .... ...................................... ..... ............... ................................. Gender Concerns 4 ....................................................................................... ........................................... ........................................... .......................................... ...................... Other Social Objectives 4 Environmental Objectives 4 ....................................................................................... ................................ ........... ................................ ........... .... ...................................... ..... ............... ................................. Public Sector Management 4 ............................................................................. ........................... ........................................... ........................................... Private Sector Development i B. Program Sustainability Likely Unlikely Uncertain _ _ _ _ _ _ _ ___ I ____ ____ C. Bank Performance Highly Satisfactory Satisfactory Deficient Identification 4 ....................................................................................... ................................ ......................................................... ..................... ................................................................................ Preparation Assistance 4 Apr i................ ............................................................... ..................................... .....................................................................I... Appraisal 4 Supervision 4 D. Borrower Performance Highly Satisfactory Satisfactory Deficient Preparation 4 ....................................................................................... ......................................................... ......................................................... ..................................... Implementation 4 Covenant Compliance 4 E. Assessment of Outcome Highly Satisfactory Unsatisfactory Highly Satisfactory Unsatisfactory  - 16 - Table 2: RELATED BANK OPERATIONS Credit Title Purpose Fiscal Status Year Preceding Operations Economic Recovery Macroeconomic stabilization, agricultural 1986 Completed Second Economic Recovery ector liberalization, private sector 1991 Completed xpansion, and restructuring and eforming the civil service and the parastatal sector. Parallel Operations Privatization/Industrial Reform TA To strengthen capabilities in ministries 1992 Under nd other responsible institutions for implementation parastatal reforms and privatization. Economic and Social Adjustment Macroeconomic expansion and structural 1994 Under completion djustment; expansion of non-traditional xports; agricultural expansion; improved _________________________________d elivery of social services. Financial/Legal Management Upgrading To improve flow of government business 1994 Under in developing programs and reforms in implementation areas of accounting, auditing, public sector procurement, legal drafting, justice administration, and provision of business information. Following Operations Economic Recovery/Investment To consolidate improvements in 1996 Promotion macroeconomic management, stimulate investment, reform the social security system, and support mining industry restructuring, with increase of private sector participation. Agriculture Sector Investment Program Economic growth and poverty reduction 1995 Under by improving efficiency in agricultural implementation production, increasing food security, generating income and employment, and increasing export earnings. Also support to privatization of agricultural enterprises Health Sector Support Program To improve the access to and utilization 1995 Under of quality health care, nutritional implementation interventions and family planning  - 17 - Table 3: PROJECT TIMETABLE Steps in Project Cycle Date Planned Date Actual Identification PIRC I June 1990 PIRC II November 1992 Preparation PIRC I March 1992 PIRC II April 1993 Appraisal PIRC I March 1992 PIRC II April 1993 Negotiations PIRC I May 1992 PIRC II April 1993 Letter of Development Policy PIRC I May 1992 PIRC II May 1993 Board Presentation PIRC I June 1992 PIRC II June 1993 Signing PIRC I July 1992 PIRC II September 1993 Effectiveness PIRC I July 1992 July 1992 PIRC II July 1993 December 1993 First Tranche Release PIRC I July 1992 July 1992 PIRC II December 1993 December 1993 Second Tranche Release PIRC I December 1992 March 1993 PIRC II November 1993 October 1995 Third Tranche Release PIRC I June 1993 December 1993 PIRC II May 1994 June 1996 Closing Date PIRC I June 30, 1994 April 26, 1995 PIRC II June 30, 1995 June 30, 1997  96/90 S06/O