Zambia - Economic and Social Adjustment Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15837 IMPLEMENTATION COMPLETION REPORT ZAMBIA ECONOMIC AND SOCIAL ADJUSTMENT CREDIT (CREDIT 2577-ZA) June 28, 1996 Macro, Industry, and Finance Division Southern Africa Department 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 660' UIS$1 K 1,2402 ABBREVIATIONS AND ACRONYMS CPI - Consumer Price Index ESAC - Economic and Social Adjustment Credit ESAF - Enhanced Structural Adjustment Facility IDA - International Development Association IMF - International Monetary Fund GDP - Gross Domestic Product MLGH - Ministry of Local Government and Housing NGO - Non-Governmental Organization OED - Operations Evaluation Department PIRC - Privatization and Industrial Reform Credit RDC - Recurrent Departmental Charges SAL - Structural Adjustment Loan VAT - Value Added Tax ZCCM - Zambia Consolidated Copper Mines FISCAL YEAR January I - December 31 At Appraisal, January 1994 2Current conversion date, as of May 31, 1996  FOR OFFICIAL USE ONLY Table of Contents Page No. Preface Evaluation Summary ...................................... i-iii Part I: Program Implementation Assessment A. Design and Objectives Restoring Macroeconomic Stability ................................I Promotion of Non Traditional Exports .................................2 Improved Access to Land .................................2 Restructuring Social Services ..................................2 B. MaJor Factors Affecting the Project ..................................3 C. Borrower Performance Macroeconomic Stability .................................4 Access to Land .................................5 Export Promotion .................................5 Restructuring Social Services .................................5 Civil Service Reform ................................7 Audit Reporting .................................7 D. Bank Performance .................................8 E. Assessment of Outcome .................................8 F. Project Sustainability ................................ 10 G. Lessons for the Future .................................11 Part II: Statistical Tables 13 Table 1: Summary of Assessments .14 Table 2: Related Bank Operations .15 Table 3: Project Timetable .16 Table 4: Disbursements .16 Table 5: Key Indicators, Actuals and Projected, 1991-96 .17 Table 6: Status of Legal Covenants .18 Table 7: Bank Resources - Actual Staff Inputs .19 Table 8: Bank Resources - Missions .19 Annex I: Borrower Assessment Annex II: Aide Memoire 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 wiLhout World Bank authorization.   IMPLEMENTATION COMPLETION REPORT ZAMBIA ECONOMIC AND SOCIAL ADJUSTMENT CREDIT (CREDIT 2577-ZA) Preface This is the Implementation Completion Report (ICR) for the Economic and Social Adjustment program in Zambia, for which Credit 2577-ZA in the amount of SDR 108.9 million (US$150.0 million equivalent) was approved on March 10, 1994, and made effective on May 9, 1994. In addition, a first Reflow in the arnount of SDR 9.7 million (US$13.7 million equivalent) was approved on December 8, 1994, and made effective on August 11, 1995. The Credit closed on December 31, 1995 as specified in the original agreement. The credit was fully disbursed, and the last disbursement was on January 4, 1996. This operation was prepared and supervised by a team consisting of Jack Kisa (Senior Country Officer and Task Manager), John Todd (Principal Country Economist), Lemma Merid (Economist), Steen Jorgensen (Senior Economist), H.H. Andresen and J. Kalbermatten (KfW), lain Shuker (Consultant), Said Al-Habsy (Senior Counsel), Rogerio Pinto (Senior Public Sector Management Specialist), and Ellah Chembe (Resident Mission). Mr. Praful Patel was the Managing Division Chief, and Mr. Stephen Denning was the Managing Department Director. The ICR was prepared by David G. Greene (Consultant), John Todd (Task Manager, AFIMI), and Carolina Machado (AFIMI). It was reviewed by Phyllis Pomerantz, Country Operations Manager, AF I C2, Jacomina de Regt, Acting Operations Adviser, AF 1 DR, and Gene Tidrick, Lead Economist, AF I DR. The Borrower contributed to the preparation of the ICR by preparing its own evaluation of the program which is included as Annex I of the ICR. Preparation of this ICR was begun during the Bank's final supervision/completion mission during 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 Loan Agreement, and other materials in the project files. The Borrower contributed to preparation of the ICR by commenting on the draft ICR.   Evaluation Summary i. The primary objective of the Economic and Social Adjustment Credit (ESAC) was the reduction and alleviation of poverty in Zambia through support of measures aimed at increasing economic growth and improving social services. The specific purposes of this credit were to contribute to filling the identified external financing requirements for Zambia in 1994 and 1995 and to support reforms in the areas of public sector management, developing a market for land, ending the budgetary drain of Zambia Airways, planning for a value added tax, improving the duty drawback system, strengthening and decentralizing social service delivery systems, and improving budget allocations to and within the social sectors. ii. The areas to be covered and the specific undertakings reflected in the credit were developed jointly by the Bank and the Government on the basis of close consultation with the private sector in Zambia, NGOs, bilateral donors, and expected beneficiaries. The basic idea was to continue the emphasis on macroeconomic stability (e.g., the VAT and Zambia Airways agreements) while increasing the emphasis on the promotion of efficient private markets (land and trade policy) and on increasing the quantity and quality of vital public services (public sector management, social delivery mechanisms, and budget allocations to the social sectors). The emphasis on social services was motivated both by the recognition that the quality of Zambia's human resources is a vital determinant of long-term economic growth and by the judgment that improving these services (e.g., in health and water supply) is the single most powerful step the government can take to improve the well being of the poor. iii. Nearly all of the project's objectives were achieved by end- 1994 (and the remaining objective, the passing of a revised Land Act, was achieved in July 1995 ). In particular, arrangements were made to include government assets in severance benefits, and alterations were made in the civil service salary structure to promote higher pay levels for professionals. Some of the amendments necessary to create an effective market for leasehold land were passed in 1994 (with the more comprehensive reform act passed in 1995). The duty drawback scheme for exporters was expanded and simplified. Spending in the social sectors increased sharply over 1993 levels, and specific allocations for certain key categories of recurrent costs (e.g.. drugs and school supplies) were increased and protected. Numerous reforms were begun on the delivery of social services including decentralizing of health services. Finally, the public support of Zambia Airways was ended, and the airline was liquidated. iv. The results from these and related reforms were that macroeconomic stability improved (e.g., money supply growth dropped from 122 percent in 1993 to 46 percent in 1994), the climate for export production improved (e.g., non-traditional exports grew by 45 percent in 1994), and the delivery of social services began to turn around (particularly  - ii - in health, where beneficiary surveys show an improvement in the quality of care through improved staff attitudes and physical facilities beginning in 1994). v. Achievement of the credit's objectives was made more difficult by the return of drought conditions in 1994 and 1995, the deteriorating performance of the parastatal mining company (ZCCM), and the continuing constraints on the management and implementation capacity of the civil service. Fiscal control in particular remained difficult. In the early months of 1994, 1995, and 1996, fiscal imbalances emerged. There were different specific reasons each year, and to its credit the Government made the necessary adjustments to return to a relatively sound fiscal position, but the recurring crises suggest that Zambia's macro program remains precarious. vi. The Government's performance in carrying out the program was very good, and the second tranche was released as scheduled. Governnent commitment to the program remained strong. An implementation group headed by the Budget Advisor in the Ministry of Finance kept close tabs on the specific agreements under the credit and made regular written reports to the Bank on the progress being made. There were two problem areas. First, the Government tried for an ambitious land reform bill (including many controversial elements not required under ESAC), and this effort failed. Only some of the agreed specific steps could be done piecemeal, and the condition was not met. The Bank agreed to waive the condition since the Government had achieved several specific improvements and had only failed on the larger package because of poor political tactics. The second difficult area was developing a viable plan for Zambia Airways. There was considerable support in government for keeping the airline in business, but with appropriate financial advice (supplied by a local consulting firm), the government gradually realized that saving the airline would be expensive and was not necessary. Liquidation was finally adopted, and the second tranche was released. vii. Bank performance in the design and supervision of the project was also very good. In the design phase, Bank staff consulted widely with sector ministry staff, donors, NGOs, academics, and potential beneficiaries and benefited considerably from this input. The emphasis on social service delivery mechanisms and budget allocations (and disbursements) was largely a result of these consultations and is considered one of the concrete successes of the credit. Looking at the experience under the two previous operations (PIRC and PIRC II), it was decided to include only two tranches and to reduce considerably the number of specific conditions. This allowed more focused supervision. viii. The sustainability of the program and hence of the reforms under this operation will depend on the Government's success in generating improved living standards for the majority of Zambians. To date, government and public support for the basic elements of the economic reform program remain strong, but implementation capacity remains limited, and the national elections (to be held by October 1996) could severely test this commitment as pressures for various short-term interventions increase. Another serious test will come from the emphasis by bilateral donors on various governance issues as a pre-requisite for continuing aid. An impasse in this area could bring down the  - iii - international financing of the program because significant shortfalls in external financing could result in Zambia's inability to pay external debt service resulting in a complete suspension of international assistance. Beyond these immediate issues, long-term economic success will depend on expanding the revenue base, carrying on with privatization (especially ZCCM), holding firm on market liberalizations, and improving the implementation capacity of the public service. ix. Several important lessons were learned from this operation: * First, budget targets can be an effective tool for improving several services, provided there is follow through on monitoring actual disbursements and provided that policy reforms within the sectors are proceeding at the same time. (This is illustrated by the greater progress made in health where a sector investment program followed quickly.) * Second, sub-sectoral budgetary targets (e.g., for supplies) are particularly important in achieving final results since overall sectoral spending targets can be met by inflating personnel costs with little discernible impact on the quality of services. * Third, providing access by the Government to independent expertise can be an effective way of allowing them to discover the analytical merits of a particular position (e.g., the difficulty in making Zambia Airways into a viable enterprise). * Fourth, it is better to keep such operations simple with a minimum of tranches and specific conditions. x. Other lessons emerge from looking at the overall Bank program in Zambia over this period: * First, it is advisable to be cautious in projecting the immediate impact of these reforms on economic growth. * Second, it is important to keep focused on the most critical issues -- in Zambia's case, these are macro stability and mining. * Third, more consistent efforts should be made to obtain independent assessments of the Bank program.  ...  PART I: PROGRAM IMPLEMENTATION ASSESSMENT 1. The Economic and Social Adjustment Credit (ESAC) was the fourth in a series of adjustment operations designed to support the reinvigorated stabilization and economic reform effort launched in early 1991 and accelerated and strengthened by the new Government elected in 1991. The Privatization and Industrial Reform Credits (PIRC and PIRC II) of 1992 and 1993 supported the stabilization efforts of the new Government and its privatization and parastatal reform programs begun under the Economic Recovery Credit of 1991. Although the implementation of the structural reform programs has generally been on track, the overall performance of the Zambian economy has been disappointing. Economic growth has not revived, and thus poverty is still increasing. To some extent, this has been the result of continued adverse weather, but it has also reflected problems in the execution of the program, particularly difficulties in attaining and sustaining macroeconomic stability, and the continued weakness of the state mining company, ZCCM. Weak performance of ZCCM has made fiscal recovery difficult and has had adverse balance of payments consequences and strongly negative effects on the growth of domestic product and employment. A. Design and Objectives 2. The ESAC represented a response to this weak growth and increasing poverty. It was designed to support reforms that would further improve the climate for private investment and accelerate growth while also supporting improved delivery of social services. Although it continued to depend on maintenance of macroeconomic stability, the adequacy of the external financing package, and continued progress on structural adjustment, it included efforts to generate supply response through removal of bottlenecks to exports and agricultural expansion, including development of a market for state land, and basic policy changes removing structural obstacles to delivery of vital social services. Restoring Macroeconomic Stability 3. The project continued efforts under earlier operations to restore and sustain macroeconomic stability. Agreement was reached on key targets, the size of the fiscal deficit and the rate of growth of the money supply, in the context of an IMF program. Under the ESAC program, the Government was to improve expenditure control by limiting budgetary support to Zambia Airways, exercising appropriate restraint on public sector wages, and ensuring that maize marketing is financed from the commercial banking system.  -2 - Promotion of Non Traditional Exports 4. The Government had already taken a number of measures to improve the incentives for international trade. Among these were liberalization of the foreign exchange market, elimination of almost all administrative restrictions on imports and exports, simplification and reduction of the level and dispersion of import duties, and introduction of a system of rebate of customs and sales taxes paid by exporters. The Government had also adopted a plan to reduce the maximurn tariff from 40 percent to 20 percent by 1997. (The top rate was reduced to 25 percent in 1996.) 5. This project specifically supported simplification and broadening of the system of tax rebates for exporters. Coverage was extended to all imported raw materials and intermediate goods used in the production of exports. Procedures for claiming drawbacks were simplified and the computation changed to a credit system based on physical input/output coefficients. The Government also decided to eliminate many discretionary tariff exemptions that contribute to the inefficiency of the tariff system. Finally, an action plan for the introduction of a value added tax was adopted. Improved Access to Land 6. Agricultural development has been hampered by land legislation that does not provide secure tenure. The land law did not recognize the value of land or permit the freehold possession of land. Over 93 percent of available land is held under customary tenure through tribal and local government structures; the remainder is effectively owned and administered by the Government. The process for conversion of customary land into leasehold was not well defined. Transferring land under leasehold has been hampered by outmoded legislation and slow processing. Furthermore, a large proportion of urban settlements are not recognized by local governments and are thus denied access to urban services. Without formal titles, residents cannot obtain credit to improve their properties or to undertake other investments. Legalization would provide a strong impetus for growth and improve the living standards of thousands of low and middle income Zambians. A key objective of the ESAC was therefore to support preparation and enactment of a package of land market reforms. This included: (i) implementation of a pilot scheme for subdivision of state owned farms for commercial use and provision for subdivision and sale of state farms; (ii) approval of amendments to land laws to remove the notion that land has no value, to facilitate the subdivision and trading in land, and to reduce the land transfer tax. These measures would help to establish a more efficient market in leasehold land. Restructuring Social Services 7. In order to mitigate the adverse effects of stabilization and structural adjustment, especially on the urban poor, and to set the stage for longer-term growth and thus to improve the political sustainability of the program, the Government determined that the delivery of social services had to be improved and the social safety net strengthened. Therefore, it decided to decentralize decision making authority and resources from central  - 3 - administrators to local service providers who would be more responsive to community needs. A key objective of the ESAC was to support decentralization of health, education and water and sanitation services. Specifically, this would involve: (a) devolution of safety net-type activities to community groups and NGOs, (b) restructuring budgets for health, education, water supply and the safety net to ensure that the overall level of funding is appropriate and that allocations for critical inputs are adequate; and, (3) arrangements that ensure that funds actually flow to the local offices responsible for supplying these services. 8. The project was also designed to support the ongoing Public Sector Reform Program by ensuring that the Government devise and adopt a revised package of redundancy benefits (including in kind benefits) and begin efforts to restructure pay levels and to link pay and performance in a way that would attract and retain skilled professionals in the civil service. B. Major Factors Affecting the Project 9. Despite significant progress toward stabilization, the fiscal situation remains precarious. Output growth has not recovered, and the revenue base continues to stagnate. The situation of the state mining company (ZCCM) has deteriorated, and its contribution to government revenues has evaporated. Little progress has been made in rationalizing or reducing the public service. Moreover, large fiscal deficits and high interest rates have resulted in a heavy burden of domestic interest payments. Three droughts in four years have seriously affected agricultural growth. The weak growth and fiscal picture affect the Government's program and the project in several ways: first, it makes it difficult to fund adequate levels of outlays for social services and the safety net; second, it adds to the difficulty of developing an "affordable severance package" for retrenched government employees (unless non budgetary resources are used, such as state assets); and third, it leads to high and variable nominal and real interest rates, which are a disincentive to investment and interest-sensitive business activity. 10. It appears that the administrative mechanisms currently available for budgetary planning and implementation are still not adequate. As a result, the Government has faced recurring budgetary "surprises," with the macroeconomic program going off track with unfortunate regularity. It is also not clear that the Government can be sure that actual expenditures are in line with budgetary allocations. 11. Considerable uncertainty surrounds the future of Zambian copper earnings. Copper has accounted for nearly 85 percent of exports, contributed 15 percent of GDP, and has been an important source of budgetary revenues. Long term prospects for copper prices are problematic, and a sharp decline in Zambia's copper production is expected 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  -4 - reversed, or there is a dramatic upturn in international copper prices, near term prospects for economic growth and expanding government revenues will remain bleak. 12. Zambia has achieved some success in stabilizing its economy and seems to be emerging from the difficult first stage of the transition. However, because of its high debt service burden and the poor prospects for copper exports in the near term, the country will continue to need extraordinary levels of external assistance. The international community has provided Zambia generous debt relief and rescheduling, as well as balance of payments support. Sustaining high levels of external financing in the face of generally diminishing aid budgets will require good relations between Zambia and the international financial community and exceptional performance in policy formulation and implementation. C. Borrower Performance 13. The Government's performar.ce in carrying out the program was very good, and the tranches of the operation were disbursed as scheduled. Government commitment to the program remains strong despite an increasingly contentious political environment in the run up to elections of 1996. All the specific actions to which the Government was committed were accomplished, and progress was satisfactory in meeting monetary and fiscal targets. However, the Government underestimated the political controversy surrounding the procedures for converting customary tenure to leasehold (even though such action was not specifically a condition under the ESAC agreement), and the Parliament deferred consideration of the complete package. A smaller set of amendments was approved. A waiver was granted on the remaining land low amendments so that the second tranche of the ESAC could be disbursed. It was agreed that completion of action on land legislation would be added to the program to be supported by a forthcoming (since passed) agricultural sector investment project to insure follow through. Macroeconomic Stability 14. With tighter fiscal management, inflation was brought down in 1994. The Government's overall domestic balance (cash) was reduced from 3.7 percent of GDP in 1993 to 1.2 percent in 1994, and the increase in the CPI declined from 187 percent (average) in 1993 to 53 percent in 1994. In fact, inflation was reduced from an annual rate of 50 percent in the first half of the year to only 22 percent in the second half of the year. Treasury bill interest rates declined in parallel. However, macroeconomic stability was still fragile. The deficit widened in the first half of 1995, reflecting the budgetary implications of the failure of one the country's largest commercial banks (Meridien BIAO). As a result, inflation increased to annualized rates of over 50 percent in the second half of 1995. 15. In a major step, after consideration of the options, the Government decided to liquidate Zambian Airways. The airline ceased operations, but the feared gap in air transport did not materialize. "Open skies" policies allowed international carriers to  -5- serve Zambia air traffic to neighboring countries, and two private carriers, serving the domestic and regional market, started operations. Access to land 16. Amendments to land laws facilitating subdivision of land and real estate trading and related transactions were approved by Cabinet and submitted to Parliament (see Table 6). The reduction in the property transfer tax from 7.5 percent to 2.5 percent did not require legislation. The proposed land law amendments also contained provisions concerning conversion of land from customary tenure to leasehold. However, this proposed codifications of procedures for converting customary tenure to leasehold was not supported by the chiefs in advance. There was limited understanding of and consensus on the program, and the Government underestimated the political controversy these additional changes would cause. Consequently, Parliament deferred consideration pending further consultations. The Parliament did, however, pass the Common Leasehold Schemes Bill, providing for the subdivision of leasehold land into subunits with separate titles. It also passed a bill simplifying registration of land and allowing registers to be kept electronically. The remaining amendments were passed in 1995. 17. Two state farms were sold as part of the privatization program in 1994. The government policy is to privatize those state farms smaller than 2000 hectares as going concerns and subdivide the larger ones so that the developed parts can be sold. Export promotion 18. Exports are being encouraged though broader provision for manufacture under bond, export processing zones, and streamlined provision of duty drawbacks. Manufacturers are now permitted to use the amount of any drawback due as credit against future import duty payments. Eligibility has been broadened to include "third party" exporters who do not import directly but purchase imported goods from others or use components produced with imported inputs. Officers have been stationed at major customs stations to deal with duty drawback matters. As a result, duty drawback benefits more than doubled in 1995. Restructuring social services 19. The human resource strategy supported by the operation emphasized rehabilitation and sustainable expansion of the education and health sectors, which had borne the brunt of the deterioration in fiscal performance in the past. The education strategy gives greater emphasis to infrastructure, leaming materials for basic education, and improving management capacity in the short-term while full scale reforms are being developed. The Government is emphasizing decentralization of primary health care and education to ensure community participation and good governance. In 1993, the Government launched a wide ranging and ambitious health sector reform program emphasizing decentralized delivery of an integrated package of services. Beginning in 1994, the share of the national budget allocated to basic social services was increased,  - 6 - with emphasis on primary education and health care and other services of importance to the low income population. This Credit helped move key policy reforms forward, including those outside the direct control of the social ministries, and supported the increases in budget allocations. 20. As a demonstration of its commitment to improving social services, the Government targeted increases in the 1994 budgetary allocations for health, education, water and sanitation and social safety net programs from less than 29 percent in 1993 to over 33 percent in 1994. (a) Health increased to 13 percent of the budget; with 9 percent of the Ministry of Health budget allocated as grants to district health management teams and 9 percent for drugs. Progress was also made in decentralization of funding and management. The District Capacity Building program was executed for all 61 districts, and eight more Hospital Management Boards were created. (b) Education was allocated 15 percent of the budget, including a special allocation for book distribution. The Ministry of Education allocated 5 percent of its budget to primary education recurrent departmental charges (RDCs) under a sub warrant to Provincial Education Officers. The Ministry of Education is devolving responsibilities to District Education Management Boards and School Management Boards, which are responsible for teachers, infrastructure and learning materials. A total of 54 lower primary schools were upgraded to full primary schools and 77 primary schools were expanded. Water and sanitation have been improved and desks upgraded. (c) At least 5 percent of the budget of the Ministry of Community Development and Social Welfare was allocated to such schemes as Public Welfare Assistance, Program Against Malnutrition, and Urban Self Help. These resources were channeled mostly through NGOs. (d) The share of the budget allocated for water supply and sanitation in Ministry of Local Government and Housing was increased to 1.8 percent and 1.4 percent was allocated to the Ministry of Energy and Water Development, of which at least 4 percent was to be allocated for operations and management. A Water Sector Policy was adopted which clarifies policy and administrative responsibilities. Under that policy, implementation was transferred from the Department of Water Affairs of the Ministry of Local Government and Housing to the new Council- Owned Regional Companies that will assist councils in service delivery, supervised by the Ministry of Local Government and Housing (MLGH). Regulatory and policy oversight was to be transferred to the Water and Sanitation Council.  -7- 21. Apart from water and sanitation, actual releases exceeded those agreed as shown in the table below. The modest shortfall in the water sector was due to major cuts in the capital budget which is a much higher percentage of spending in the water sector. Within the capital budget, however, water and sanitation received 61 percent of its allocated compared to 41 percent for the overall capital budget. Subsectoral releases also exceeded those programmed for all categories. Budgetary Allocations, 1994 Health 13.0 15.3 Educaion 15.0 16.5 Safety Net 2.0 2.1 Water & Sanitation 3.0 2.8 Total 33.0 36.7 Civil service reform 22. In order to reduce the up front cost of severance pay and to make retrenchment more affordable, the Government approved in-kind payment (in the form of government- owned houses, vehicles and land) as part or all of severance benefits. The package has been agreed with the Union of Public Service Workers. 23. Several measures have been taken to improve the incentives for skilled professionals in the civil service. The adoption of "equal pay for equal work" has resulted in more competitive salaries in areas of the public service where shortages of manpower had forced hiring of expatriates. The adoption of "parallel progression" has permitted salaries of technical and professional employees in the civil service to approximate those of senior managers. Audit Reporting 24. As required in the Development Credit Agreement (DCA), audit reports were generally submitted on a timely basis. Originally the 1994 audit reports were found to be qualified as a result of expenditures ineligible under DCA's Schedule 1. Further examinations by the auditors of supporting documentation for the amount in question concluded that the expenditures were in fact eligible, and an unqualified report was submitted in June 1996.  - 8 - D. Bank Performance 25. Bank performance in the formulation and supervision of the project was very good. The operation was designed in close consultation with the Government, the IMF, potential beneficiaries and participating bilateral donors. Other donors were kept informed on the formulation of the project and its execution. 26. The operation built on the foundation established under the PIRCs, but was simpler, with fewer policy actions. The reduction from the three tranches (effectiveness plus two tranches) under the PIRC to two tranches in the ESAC eased the supervision burden and allowed more time for critical actions to be discussed and acted on. 27. Bank interventions were particularly helpful in bringing about a decision to liquidate Zambia Airways. A review by the Bank found that the business plan that had been prepared for Zambia Airways was not satisfactory in that it did not provide a balanced and comprehensive analysis of closing the airline versus continued operation, did not discuss up front capital requirements of closing down, ignored the possibility of combining negotiation on arrears and termination payments on closed airline, relied on optimistic assumptions on passenger increases, and ignored revenues from sale of traffic rights. Reconsideration of the alternatives based on the Bank's comments led to the (correct) conclusion that the best alternative was closure of the airline, which the Government did. 28. The Bank also closely monitored release of funds to the social sector ministries. An interim review of performance found that releases for social safety net and water supply and sanitation were short of agreed levels. Sub sectoral releases were far below the 50 percent agreed as a benchmark for second tranche release. In several cases, budget releases did not reflect government policy: (1) the share of releases for capital expenditures was lower than share in budget and a substantial part was used for unproductive purposes; (2) the share of releases for personnel emoluments was higher than budgeted; (3) releases for recurrent departmental charges (RDCs) were below the share in budget. The Bank missions suggested measures that would permit increases in outlays to the agreed levels, and the targets were eventually reached. 29. The Bank also pressed hard for provisions that would allow the use of government-owned assets such as housing, land and vehicles as a part of a compensation package for retrenched civil service employees. This recommendation was eventually accepted. E. Assessment of Outcome 30. It is difficult to assess the outcome of this program because it cannot fairly be considered outside the context of previous and subsequent concurrent adjustment-type operations in Zambia and because the measures supported by the program, while largely accomplished, are more properly viewed as inputs, or determinants of growth and development, and not as outcomes. Successful outcome of this program, and indeed of  -9- the program of various adjustment-type operations in Zambia, should be seen in terms of whether Zambia achieves sustained macroeconomic stability, improved efficiency of resource allocation and use, accelerated growth of per capita income, and declining poverty although there will certainly be many other contributing factors. 31. The ESAC President's Report projected GDP growth of 5 percent per year over the next five years, based on accelerated agricultural growth through increased smaliholder productivity and diversification. Some new and existing manufacturing was also expected to contribute to growth if sufficient credit were available and constraints on exports overcome. Output from existing mines was expected to grow modestly as efficiency improved. Overall investment was expected to rise from 13 percent of GDP in 1991 to 22 percent and domestic saving from 1 1 percent of GDP to 17 percent by the end of the decade. These projections were clearly optimistic in view of recent developments. GDP growth was negative in both 1994 and 1995, and gross investment fell from 10.4 percent of GDP in 1993 to 6.9 percent in 1994. While these decreases were largely a result of poor rains, unless macroeconomic stability can be achieved and sustained and ZCCM's output stabilized and then increased, positive growth of per capita income will not be possible for sustained periods. The impressive record on liberalization and privatization, however, have definitely improved the overall business climate for the private sector. 32. The improvements in access to land will clearly be helpful for the longer term development of agriculture, but availability of land is only one constraint on production over the near term. In all probability, marketing of output and inputs will be a more important near term constraint. In fact, the May 1995 report on Participatory Poverty Monitoring in Zambia cites continuing problems with agricultural marketing and the supply of farm inputs and animal diseases as reasons for declining rural livelihoods (access to land was not mentioned). Agricultural marketing is an interest rate sensitive activity, depending heavily on credit. The instability of the Zambian economy, with recurrent bouts of inflation and highly variable nominal and real interest rates, is probably the critical immediate constraint on development of the sector. More sector work appears to be warranted to identify the constraints to development of smallholder and emergent agriculture and to develop a comprehensive policy package to address them. 33. The poverty monitoring exercise of 1995, cited above, showed continuing problems in social services. In particular, it pointed to inaccessibility of public health services, poor access to and quality of education, crime, drought related water shortages, and poor condition of roads as important aspects of the deterioration of the social welfare situation. On health, the assessment noted that beneficiaries found improvements in staff attitudes and the quality of care, but concerns remained on the application of fees, the lack of a consistent exemption program, and contiaued poor drug supplies in urban hospitals. Low enrollment rates in primary education are perceived to be the result of lack of school places, high financial costs and declining quality of education, as evidenced by high failure and dropout rates, and long distances to schools.  - 10- 34. It is difficult to measure "real" spending in these sectors because much of the increased spending has gone into higher salary costs and because efficiency improvements can often bring better services with less money. Looking just at total spending deflated by the CPI, however, it appears that real spending in 1994/95 was no higher than it had been in 1990/91. In view of this, the achievement of budgetary targets for the social sectors under the ESAC must be viewed as a defensive, short term measure, designed to limit the decline of real outlays, rather than to increase them, and unlikely to result in and of themselves in a significant sustainable improvement. These budgetary measures supported by the ESAC should be viewed as a stopgap measure until sector- wide programs can be launched. 35. In a similar vein, the improvement in the duty drawback scheme will clearly be helpful, but only as part of a continuing overhaul of the trade regime. The next steps, further reduction of duties, elimination of exemptions and implementation of a value added tax are being supported by ESAC II, scheduled for Board presentation in calendar 1996. 36. Lastly, the ESAC successfully pioneered the use of a qualitative poverty monitoring survey, which has been sustained through the Second Social Recovery Credit. This was done using trust funds and the Departmental Client Consultation Fund. F. Project Sustainability 37. 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. This situation will be exceptionally critical during 1996 in the run up to elections. It is not possible to produce sustained improvements in living standards, however, without accelerated and broad-based growth in output and employment. Although short-term safety-net measures can be helpful, they are not a long term solution to the problem. More important will be increasing expenditures for public services, such as primary health care and education, which improve living standards directly and build human capital, and vital urban and rural infrastructure to support growth. These in turn will depend on expansion of the revenue base through growth and broadening of the tax base through consumption-based taxation (such as the VAT). In addition, the allocations of public expenditures must be further improved, de-emphasizing defense, and tertiary government services for which beneficiaries should be expected to pay, and streamlining the public service. Making better use of existing capacity, as has happened in health, will help as will the involvement of extra-governmental groups and individuals, as has been the case for health and safety net services. 38. Several of the sectoral reforms are likely to be difficult to reverse such as the recent reforms in health where politicians, beneficiaries, and care givers have all bought into these improvements. Similarly, the streamlining of policy-making and service delivery in the water sector are likely to be sustained as well as the general trend toward  decentralization and devolution in service delivery. Macro stabilization seems less secure, however, as is evident from the continuing pattern of lapses and repairs in the area of fiscal and monetary control. 39. The sine qua non for accelerating growth is still improved 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 tradable sector. The key to this will be further improving fiscal performance through enhanced revenues and rationalized expenditures. 40. ZCCM's poor performance also remains a major impediment to growth. An immediate, determined effort is required to rehabilitate existing operations, to put privatization on the fast track, and to settle the future of Konkola Deep (the most promising new venture) so that development work can begin quickly. 41. Finally, adequate external financing must be insured. This will require demonstrated continued government commitment to the reform process. The benchmarks of the IMF ESAF program will need to be met. Concerns of bilateral donors about "governance" issues, unless dispelled, could result in a decreased availability of aid flows. Bilateral donors are concerned that corruption and asset stripping have reached levels where they jeopardize macroeconomic stability. They also feel that the exceptional priority given to Zambia in their aid budgets can only be justified if democratic traditions continue to be observed. G. Lessons for the Future 42. Some of the lessons learned derive directly from the experiences under this operation. They are: 43. Social Sector spending targets can help. Budget targets for the social sectors can be an effective tool for improving social services, provided there is follow through on monitoring actual disbursements and provided that policy reforms within the sectors are proceeding at the same time. (The importance of the latter is evident in the greater successes achieved in the health sector where a sector investment program followed soon after ESAC). Sub-sectoral budgetary targets are particularly important in achieving final results since overall spending targets can be met by increases in personnel costs with little discernible impact on the quality of services. 44. Develop specific monitorable outcome indicators. Although it is clear that the budget for social services was being squeezed severely, spending more by itself does not necessarily improve access to services. Administrative and policy reforms are also needed. In Zambia's case, this is illustrated by the greater success in health services where the decentralization policies were quickly implemented compared to education where administrative reforms were less pronounced. To keep a clearer focus on final results, performance indicators on internal and external efficiency of primary education  - 12- and basic health care allow formation of more precise policy initiatives and better evaluation of results. 45. Keep it simple. The Bank underestimated the administrative complexity of the program (particularly in the early SALs) and overestimated the capacity of the Government. Budget preparation and fiscal administration were weak. A Government Budget cannot be prepared and managed by the Minister of Finance himself, and monetary policy cannot be conducted by the head of the Central Bank. Effective monetary and fiscal management require strong bureaucracies. In the absence of these, less sophisticated tools are needed (such as cash budgets), which minimize the demands on management. This requires continuous priority attention to macroeconomic management and ensuring that budgeted funds are spent as intended. 46. Other lessons learned derive from looking at the broader picture of the Bank program in Zambia over this period. 47. Be cautious about predictions of recovery. The Bank was persistently optimistic about the prospects of recovery for Zambian economy (or at least expressed optimistic views). The actual poor performance of the economy jeopardized Bank staffs credibility with the Bank management, the borrower and other donors. It is better to err on the conservative side and increase the chances of pleasant surprises. 48. Tackle the critical problems first. The Bank was quite cautious initially about two things that really mattered, macroeconomic stabilization and rehabilitation of the mining sector. Both the Bank and IMF could have pushed harder for tougher administrative measures (such as imposition of cash budget) earlier on in the game. In general, a new government's willingness and ability to take tough measures tends to diminish with its time in office. 49. Provide for independent assessment and advice. The Bank's involvement with adjustment in Zambia could benefit from more independent assessment. Bank staff are sometimes too close to and involved in the process to assess it dispassionately. It is now five years since the first adjustment operation with the "new" government. It is time to assess the Bank's total involvement in adjustment in Zambia over that period. The forthcoming Country Assessment Review by OED will illustrate some of those issues. In general, the consultative group process with the donors and the participating monitoring exercises with beneficiaries are important ongoing sources of alternative perspectives.  - 13 - 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, 1992-96 Table 6 Status of Legal Covenants Table 7: Bank Resources - Actual Staff Inputs Table 8: Bank Resources - Missions  - 14 - Table 1: SUMMARY OF ASSESSMENTS A. Achievement of Objectives Substantial Partial Negligible N/A Macroeconomic Policies Sector Policies v ......................................................................................... ....................... ..................... ....................... ........... .......... .................................. ........... ...... ................................... Financial Objectives 4 ....... ........................................................................ .................... ................. ...... ............................... ............. .......... ................................. .. ..... ,....................................... Institutional Development 4 ......................................................................................... .................. ..... .................... ........................ .......... .......... .................................. ........... .......................................... Physical Objectives 4 ...................................................................... ................... ....................... ..................... ....................... .......... ........... ................................. ........... .......................................... Poverty Reduction 1 Gender Concerns Other Social Objectives Environmental Objectives Public Sector Management Private Sector Development . I B. Program Sustainability Likely Unlikely Uncertain C. Bank Performance Highly Satisfactory Satisfactory Deficient Identification l ......................................................................................... ....................... ........................................................... ............... ........................................................... .................... Preparation Assistance . ............ ............................................................................ ....................................... ........................................................... ........... ................................ Appraisal . ................................................................................... ........... .. ...... .................................................. .... ..... ............ ............................... ..... ....................... ............ ......... Supervision D. Borrower Performance Highly Satisfactory Satisfactory Deficient Preparation 4 .... ..................................................................................... ....................... .................................... ....................... .............. ...................... .................... ................. ....................... Implementation 1 ...... ................................................................................... ............ ........... ................................... ........................ .............. ..................... ...................................... ............... ....... Covenant Compliance E. Assessment of Outcome Highly Satisfactory Unsatisfactory Highly Satisfactory Unsatisfactory  - 15 - Table 2: RELATED BANK OPERATIONS Credit Title Purpose Fiscal Status Year Preceding Operations Second Economic Recovery Credit Macroeconomic stabilization, agricultural 1991 Completed sector liberalization, private sector expansion, and restructuring and reforming the civil service and the parastatal sector. Social Recovery Credit To foster community development efforts in 1991 Under alleviating negative effects on the poor of the implementation economic crisis, through rehabilitation and improvement of existing infrastructure and service delivery. Privatization/Industrial Reform To modernize business framework, establish 1992 Completed market-based exchange rate mechanism, and promote private sector through privatization and improvement in parastatal efficiency. Privatization/Industrial Reform II To provide balance of payments support to the 1993 Under parastatal reform and privatization program. implementation Privatization/Industrial Reform TA To strengthen capabilities in ministries and 1992 Under other responsible institutions for parastatal implementation reforms and privatization. Parallel Operations Financial/Legal Management To improve flow of government business in 1994 Under Upgrading developing programs and reforms in areas of implementation accounting, auditing, public sector procurement, legal drafting, justice administration, and provision of business information. Following Operations Second Social Recovery Credit To assist the Government' poverty reduction 1995 Under program through financing of community implementation initiatives and building of capacity of poverty analysis and monitoring. Agriculture Sector Investment Economic growth and poverty reduction by 1995 Under Program 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 access to and utilization of quality 1995 Under health care, nutritional interventions and implementation family planning. Economic Recovery/Investment To consolidate improvements in 1996 Under Promotion macroeconomic management, stimulate implementation investment, reform the social security system, and support mining industry restructuring, with increased private sector participation. I  - 16 - Table 3: PROJECT TIMETABLE Steps in Project Cycle Date Planned Date Actual Identification April 1993 April 1993 Preparation September 1993 September 1993 Appraisal October 1993 November 1993 Negotiations January 1994 January/February 1994 Letter of Development Policy February 1994 February 1994 Board Presentation March 1994 March 1994 Signing March 1994 April 1994 Effectiveness March 1994 May 1994 First Tranche Release March 1994 May 1994 Second Tranche Release November 1994 January 1995 Closing Date December 1995 December 1995 Table 4: DISBURSEMENTS FY94 FY95 FY96 Appraisal Estimate (US$ million) 75.0 75.0 First Reflow - August 1995 13.7 Actual (US$ million) 36.9 117.7 8.8 First Reflow - August 1995 14.5 Cumulative (US$ million) 36.9 154.7 163.5 First Reflow - August 1995 14.5 Date of Tranche Disbursements May 1994 January 1995  - 17 - Table 5: KEY INDICATORS, ACTUALS AND PROJECTED, 1992-96 (% unless otherwise indicated) Actual Est. Bank Projections' 1992 1993 1994 1995 1996 1992 1993 1994 1996 GDP Growth -2.5 6.5 -3.1 -3.9 8.3 -10.0 12.3 5.3 4.5 Real Per Cap. Consumption Growth -8.6 -5.4 0.3 -3.2 1.7 13.2 -2.9 0.6 -1.8 Total Investment/GDP 10.5 12.0 6.9 11.7 12.0 15.0 14.1 17.2 18.3 Gross Domestic Savings/GDP 6.4 8.6 3.0 2.9 3.9 6.4 9.1 7.9 10.9 Current Account Balance - US$ Mn2 -753.0 -471.8 -408.3 -624.6 -571.6 -714 -568 -766 -658 Total Debt excl. Gapfill - US$ Mn 6943 6788 6496 6139 5757 7041 n/a n/a n/a Total Revenues/GDP3 18.4 14.6 18.1 16.9 15.8 31.7 22.0 27.7 27.3 Total Expenditures/GDP4 33.1 26.5 28.7 25.1 21.6 28.4 21.2 22.1 20.3 Deficit (- = deficit)/GDP -14.7 11.9 -10.6 -8.2 -5.8 3.3 0.8 5.6 7.0 Consumer Price Index Growth Rate | 197.4 | 189.01 53.4 34.6 30.0 226.1 147.5 46.8 10.0 IProjections are from the ESAC President's Report (P-6248-ZA) dated February 15, 1994. 2Excluding foreign grants. 3Excluding capital grants. 4Including net lending.  - 18 - Table 6: STATUS OF LEGAL COVENANTS Loan Agreement Description of Covenant Comments Section Schedule 3 The Borrower has: adopted a revised package of severance benefits for public Complied with. No. I servants that permits the efficient restructuring of employment within the public sector. adopted a revised duty drawback scheme with the following Complied with. features: (a) simplicity, automaticity and transparency of No. 2 procedures; (b) a shift from a refund to a credit system based on input/output coefficients; (c) expansion of product coverage to include all imported raw materials and intermediate inputs; (d) a plan to ensure dissemination of information and publicity about the revised system; and (e) a time bound action plan satisfactory to the Association for implementing the scheme. satisfied the Association that its spending in the social sectors in Complied with. 1994 has been in accordance with the Program and in particular No. 3 that: (a) expenditures in the health, education and water supply No. 3 and sanitation sectors and for social safety nets have not dropped below the shares set out in the budget; and (b) that at least half of the budgeted amounts for the following budget subheads have been released to the implementing agencies: public welfare assistance, Social Recovery Program, recurrent charges of primary education in the provinces, district health management teams; recurrent changes for drugs, and operation and maintenance expenditures in water and sanitation sectors. adopted and started to implement a program of incentives to Complied with. No. 4 attract and retain highly skilled professionals and to linking performance to pay and, where appropriate, has revised its job classification system to reconcile with such program. (a) enacted amendments to land laws to: (i) remove the notion Complied with. No. 5 that land has no value; (ii) facilitate the subdivision of land; (iii) facilitate real estate trading and other related transactions; (iv) reduce land and property transfer tax; and (b) implemented policy measures to provide for the subdivision and sale of state farms. No. 6 adopted a financial plan for Zambia Airways consistent with the Complied with. need to avoid direct and indirect support for the airline from public funds.  - 19 - Table 7: BANK RESOURCES - Actual Staff Inputs' Stage of Project Cycle Staff Weeks US$'0002 Preparation to Appraisal 28.4 91.4 Appraisal 20.8 70.8 Negotiations through Board Approval 6.5 22.0 Supervision 29.3 105.9 Completion 8.0 20.0 TOTAL 93.0 310.1 Table 8: BANK RESOURCES - MISSIONS Stage of the Project Cycle Month/Year Number of Days in Field persons Identification April 1993 4 10 Preappraisal September 1993 4 10 Appraisal November 1993 6 10 Supervision May 1994 3 7 July 1994 4 7 October 1994 3 8 November 1994 2 8 Completion March 1996 1 10 Source: MIS Report - Staff Time and Schedule (COSR2). 2 Includes travel and labor costs.  - 20 - Annex I Page 1 of 2 BORROWER ASSESSMENT COIOMENTS AND EVALUATION OF ESAC I Introduction 1. During the 1992-1993 period, extensive policy reforms were introduced to bring about improved macroeconomic stability and more effective delivery of social services. These objectives were pursued through implementation of the Economic Recovery Programme (ERP) which included macroeconomic policy measures and reforms in the social sectors, notably in education, health, water and sanitation. The ERP involved a wide range of structural adjustment measures. Overall, progress on structural adjustment was substantial in the period under review, but progress with poverty reduction was hampered by low economic growth rates. 2. Public debate of the Government's Economic Recovery Programme (ERP) brought out criticism occasioned by the inequitable sharing of the benefits of adjustment among various population groups. A review by Government of the implementation of the ERP did reveal uneven progress between economic and social adjustment. This was largely due to capacity constraints and management weaknesses in the social sectors. The Government then decided that more tangible progress with social improvement needed to be made in the 1994-1995 period. 3. Thus, new approaches to the resolution of problems in the social sectors were introduced, including expanding Government support for NGO programmes to achieve improved social service delivery. The Government initiated an Action Plan for Social Sector Rehabilitation and Maintenance which provided the basis for ESAC I. The ensuing reforms were facilitated by the support provided by IDA under the first Economic and Social Adjustment Credit (ESAC I). The latter was co-financed by bilateral donors. Accomplishments 4. Progress under ERP supported by ESAC I has been substantial on many fronts, but slippages did emerge, largely on account of underestimation of the time required to forge a political consensus for several difficult adjustment measures to be put in place and for institution building to succeed. 5. Despite these delays, however, economic activity began to respond favourably in a number of areas. There have been tangible improvements in transport and communications, the provision of financial services, real estate activity, wholesale and retail trade and non-traditional exports. Activity in the informal sector has also been vigorous. The positive developments in these areas, however, were more than offset by the poor performance of mining, manufacturing, construction, tourism and agriculture. Thus, economic growth remained elusive in the 1994-1995 period as output in the economy fell. Since population grew by over 3 percent per annum over the period, per capita income continued its long-time decline. Formal sector employment also declined. The drought of 1994 contributed to this disanpointing result.  -21- Annex I Page 2 of 2 6. Government did begin to have success with improving social conditions in Zambia which had declined substantially over the past twenty years. Among the constraints impeding effective delivery of social services were excessive centralisation, organisational problems, limited implementation capacity in Government ministries, shortage of qualified personnel reflecting high attrition rates, poor regional distribution of staff (80 percent of physicians work in 4 provinces along the line of rail), and shortage of financial resources. 7. The steps which Government took with IDA's help under ESAC I to reverse the declining trend in social sector service delivery included decentralisation of service delivery, particularly de-concentration of service delivery in health and education (under the Heaith Reform Programme and the Education Sector Investment Programme), of safety net measures to local groups, mostly NGOs, and re-structuring the water and sanitation sector. In addition, the 1994 Budget called for an increase in expenditures on social services from 27 percent of expenditures in 1993 to 33 percent in 1994. This higher share has been maintained until today (and is being exceeded in 1996). Mobilisation of Donor Support. 8. Government was greatly helped by IDA's provision of its BOP support which stimulated the granting of significant financial support from the international community in 1994/1995. This refers to both the volume of debt relief obtained and the volume of donor assistance which was provided. While over time there were shifts between the various categories of external assistance that was provided, in particular from balance-of-payments' support to project assistance, overall Zambia obtained the external resources which had been requested from its donors and creditors. This was facilitated by IDA' leading role in the economic dialogue with Government, supplemented by the positive role of IDA in the coordination of external assistance through its leadership of the Consultative Group for Zambia. Conclusion. 9. With the help of IDA under ESAC I, the Government was able to implement an ambitious agenda to transform the economy into one where private initiative and market forces is playing the guiding role in the development of the economy. At the same time, the Government was able to reduce inflation and restore macro- economic balance, permitting the laying of foundations for a resumption of investment and of economic and employment growth. Finally, good progress was achieved with improving social sector service delivery.  - 22 - Annex II Page 1 of 10 Aide Memoire Implementation Completion Reports: Privatization and Industrial Reform Adjustment Credit (PIRC I) and Second Privatization and Industrial Reform Credit (PIRC II); and Economic and Social Adjustment Credit (ESAC) Purpose of the Implementation Completion Report (ICR) and Role of the Borrower 1. The World Bank requires that an ICR be prepared for each project shortly after its closing date. The purpose of this mission has been to prepare ICRs for PIRC I, PIRC [I and ESAC. Because the two PIRCs are closely related, a single report will be prepared covering both. The ESAC will be covered in a separate ICR. The purpose of this aide memoire is to review briefly thie puLpose of ICRs and the borrower's responsibility for assisting in their preparation and to convey a preliminary assessment of the implementation experience of these operations, their development impact and the sustainability of the reforms they supported. At the outset, I would like to thank the Government for its cooperation in this effort and for the frank and useful comments on the major issues. 2. The ICR is designed to provide feedback from implementation experience, to promote greater development impact and sustainability of future projects, reinforce self-evaluation, meet requirements for accountability and facilitate assessment of development impact. 3. The borrower is responsible for preparing its own final evaluation report on the project, as required in the General Conditions. This report should be no longer than ten pages and should include: (i) an assessment of the project objectives, design, implementation, and operation experience; (ii) an evaluation of the borrower's own performance during the evolution and implementation of the project, with special emphasis on lessons learned that may be relevant for the fLittire: (iii) an evaluation of the performance of the Bank and any cofinanciers during the evolution and implementation of the project, including the effectiveness of the relationships among the borrower, the bank, and cofinanciers. 4. The borrower will receive the Bank staffs draft ICR and should provide comments on it within two months of receiving it.  - 23 - Annex II Page 2 of 10 Background of the Adjustment Operations 5. Structural adjustment in Zambia is a particularly complex and demanding task, requiring the uLtl comilmitment of Governnent and the populace and the cooperation of multilateral and bilateral aid agencies. Zambia's economy has experienced prolonged, deep decline and many of the key institutions needed to carry out a reform programn 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 government revenues 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 steadilv. Attempts to maintain domestic incomes and employment in the face of declining copper earnings by borrowing abroad only succeeded in accumulating a massive external debt, mortgaging the country's future. 6. NLumerous efforts at stabilization and adjustment during the 1 980s were not successfully implemented, as the Government did not have the cormmitment to reform needed to withstand the political pressures caused by the inevitable short term dislocations. In the face of these pressures, fiscal and monetary discipline faltered, policy reform was halted and on more than one occasion, the countrv defaulted on its international debt, bringing external capital flows to a halt 7. The Goverrunent elected in 1991 indicated by word and deed its full cornmitment to restoring macroeconomic adjustment, liberalizing the domestic market and the monetary and trade systems, privatizing the parastatals and giving autonomy to the remaining public utilities, reforming and reducing the civil service, and improving the legal and institutional framework for private enterprises. The international community responded quickly with (i)balance of payments support, (ii)debt rescheduling; (iii) projects and programs supporting reform, and (iv) technical assistance. The two IDA financed PIRCs and the ESAC were an important part of that response. S. Ui'del the two PIRCs and the ESAC, the Government's intentions were formalized into a concrete, time-bound plan of specific actions designed to restore economic growth, while protecting vulnerable groups in the society and improving vital social services. The achievement and sustaining of macroeconomic stability and the evidence of the adequacy of external financing have been important general conditions of all three operations. The latter ensures that all external partners: the Bank, IMF (through its Rights Accumulation Program) and bilateral donors (including those involved in rescheduling debt) support the Government's program and are sharing the financial burden fairly. The keystone of the PIRC programs was the privatization of parastatal companies. But important actions such as civil service reform, measures to promote private sector development (improvement of business- related legislation and the investment approval process and the functioning of the capital market), arrangements to deal with public utilities retained in public ownership, and ensuring a social safety net, were important elements of the program.  -24 - Annex II Page 3 of 10 9. The emphasis of ESAC was somewhat different. Although it continued to depend on maintenance of macroeconomic stability, the adequacy of the external financing package, and continued progress on structural adjustment, it included efforts to generate supply response through removal of bottlenecks to exports and agricultural expansion, including development of a market for state land, and basic policy changes removing structural obstacles to delivery of vital sociaL services. Implementation and Impact of the Government's Program 10. The Governument's program, as incorporated into the adjustment operations, was complex, especially compared to of its limited institutional capacity. The implementation of the program supported by the three Bank operations, which was to cover the period 1992- 1995, was complicated by droughts, which sharply reduced crop production and required emergency expenditures of fiscal revenue and foreign exchange to import maize, and by a conitinued decline in copper production., followed by a precipitous drop in the second half of 1995. 11. In retrospect, the program appears to have been overly ambitious and beyond the implementation capacity of the Government. Progress has been slow where institution building or the development of new inechanisms for institutional reform were required. This is particularly true of the privatization process and actions such as passage of land laws and business-related legislation, the latter requiring actions by third parties (i.e. the legislature rather than the executive). It also appears that some of the actions required were either not central to the achievement of objectives of the program and/ or could have been accomplished later. 12. Drafting and passage of amendments some business-related legislation proved to be more time consuming than anticipated and the final actions were shifted from PIRC I to PIRC II. NMeasures which would permit release of the third tranche of PIRC II have not yet been completed: this includes a performance contract for ZESCO (which will be signed soon) and ZAMTEL (still in draft); and passage of the Small Scale Enterprise Act. Amendment of the land laws under ESAC proved impossible within the time frame of that operation and the condition was waived, although some partial reforms were passed. 1 3. tb en with these adjustments, release of the third tranche of PIRC I was delayed half a year and release of thie third tranche of PIRC II will be at least two years later than originally scheduled. Disbursement Experience Operation PIRC I PIRC II ESAC Board Date 6/92 5/93 2/94 Schedule* original actual original actual original actual Second Tranche 12/92 3/93 11/93 . 10/95 8/94 11/94 Third Tranclhe 6/93 12/93 5/94 6/96** *Schedule as per Board document; *"current schedule  -25 - Annex II Page 4 of 10 14. As a result of the adverse developments in agriculture and mining, inadequacies in the forrnulation of the adjustment program, (discussed in para. 18 below) delays and slippages in its execution, and problems in the implementation of the macroeconomic program, growth targets established in the Policy Framework Papers and in the President's Reports to the World Bank's Executive Directors have not been achieved. GDP growth has been positive in only one year since 1991 (1993, a year when agriculture was recovering from drought). Per capita income has continued to decline. Initial findings of the ongoing Poverty Assessment indicate that there has been a severe adverse impact on the urban poor. Poverty may well have increased over the last four years, due to removal of producer and consumer subsidies. Infant mortality has risen from 108 in 1990 to 113 in 1994; adult illiteracy from 25% to 33%. 15. Nevertheless, there are some bright spots. Some new cash crops have developed -- soya, cotton, tobacco, horticulturals, floriculture -- although marketing and credit remain obstacles to continued expansion. Market liberalization has encouraged a shift from maize to more droughlit resistant crops. Nontraditional (non metal) exports have been increasing by 15- 20%, per year and exceeded US $ 175 million in 1995. 16. Despite numerous challenges over the past four years-- drought, fiscal pressures, unpopularity and hardships caused by many adjustment measures, and failure of the economy to revive-- the Government has so far remained firm in its commitment to reform. Execution of the. Government's program has been uneven, although, taken as a whole, moderately successful. There has been an almost complete transformation to a market economy. All price controls and subsidies have been eliminated. The exchange rate has been unified and is market determined. Importers have virtually unrestricted access to foreign exchange The credit market andl initerest rates are not controlled but are managed through issue of T-bills. After a slow start, privatization has been a significant success as the number of enterprises privatized accelerated in 1995. Safety net provisions, especially drought relief, have been fairly successful. Progress has been made toward macroeconomic stability, although it was late in coming. The inflation rate was 200% as late as the first half of 1993, and has only come down because of the fiscal discipline imposed through the adoption of a cash budget. Sustaining macroeconomic stability has proved difficult, and the country continued to experience inflationary episodes. Civil service reform and government restructuring have not been successful. Measures designed to promote private sector development present a mixed picture. Finally, the poor performance of ZCCNI continues to be a major obstacle to stabilization and econoiic g,rowth. Strategic Issues 17. When the Bank's response to the Government's new commitment to stabilization and reform was formulated, there was a long agenda of actions that had to be taken. The program, as conceived, tried to accomplish as many of these actions in the shortest possible time. As a result the program for PIRC I and, to a lesser extent, PIRC II, was complex and. too demanding of government teclnical and managerial resources. Some of the key measures were delaved, while others of lower priority were included in PIRC I By the time ESAC was prepared. tlis lIC,soLI %%as learned and fewer actions were included in the program.  - 26 - Annex II Page 5 of 10 18. In retrospect, more immediate priority should have been given to (1) the need for macroeconomic stabilization to permit private sector investment and growth; (2) the need to abolish of ZIMCO sooner.to end resistance to privatization; (3) the need to develop a workable strategy and compensation package for civil service reform; and, (4) the urgency of rehabilitation and privatization of ZIMCO. On the other hand, streamlining the Investment Center; amending or enacting various business-related legislation, issuing guidelines for operation of the capital market; and developing a regulatory agency for public utilities, included in PIRC r, could have been done later in the adjustment process Similarly, dealing with the problems of the DBZ, Lima Bank and Eximbank, establishment of a stock exchange, regulationis conceming contractual savings institutions, assessment of the impact of privatization, development of a plan to strengthen the regulatory framework for public utilities; and development of a plan for streamlining the regulatory and licensing requirements for small scale enterprises and easing their access to credit included in PIRC II could have been postponed for a year or so. In fact, given the delays in implementation, it might have been more realistic to stretch out the program into three PIRCs, supporting implementation over 1992-96. Process Issues Program Formulation 19. The Government elected in 1991 had an 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 Government, fully reflected the Government's objectives and was helpful in translating them into a plan of action. There was close consultation with the IMF. Bilateral donors, who were to play a key role in providing external assistance, were consulted and kept informed. 20. 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 hiav ing a Project Launch Workshop involving a larger number of people. Project Implementation 21. During the early stages of implementation it became clear that some key government officials had not read the documents and were not aware of the content of the program. Tlis required continuing "educational" activity on the part of Bank staff during supervision. All three operations were closely supervised by the Bank. 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 aide memoires wvere left with Government, including matrixes outlining status of actions taken and further measures required. The donor community was briefed by supervision missions and task managers visiting Zambia, as well as at Consultative Groups Meetings. 22. Government monitoring of the program was generally good, especially after initiation in mid-1993, of a weekly Friday Group, chaired by the Minister of Finance. However, the group seems to have given most of its attention to macroeconomic issues.  27 - Annex II Page 6 of 10 23. Where progress of the program was not satisfactory, tranche releases were delayed and when timing, no longyer seemed realistic, actions were shifted until later in the program. Progress in Key Areas of Adjustment Privatization of Parastatal Enterprises 24.. The most encouraging development has been the progress of privatization. Once ZPA established an adequate operating framework, with international technical assistance, staffing and executive leadership problems were resolved, and the political decision was made to dissolve ZTMCO and thus end a major source of resistance, privatization accelerated. 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 transfer its shareholdings to the Directorate of State Enterprise in the Ministry of Finance. 25. The number of firms to be privatized has been increased as decisions were made to privatize autonomous operating units separately. As of February 1996, 113 of 208 firms and productive units had been privatized.. This does not include 106 shops. The number of individual firms privatized was about 83. The liquidation of Zambia Airvays and the end of its drain on1 the budget has been a major achievement. New methods of privatization are being used, especially management buyouts. It now appears that the privatization process can be completed in two to three more years. 26. Measures have been taken to give remaining public utilities more autonomy on key business decisions, including prices and rates, within the context of understandings on performance with the Government, although the performance contracts for have not yet been signed (delaying the release of the third tranche of PIRC 1I). 27. 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 liquidation of Zambia Airways, private minibus transport has successfully replaced the municipal bus company, privatization of beer and cement companies has resulted in increased supplv and better customer service. .ZPA feels that the amount of retrenchment directly associated with privatization has been minimal, perhaps 100 to 150 workers. Most of the retrenchment was pre-privatization, and resulted from liberalization and the curtailment of subsidies. No privatized company has yet shut down, although it would be unrealistic to assume this record could continue. 28. Privatization of ZCCM was not a central feature of the program: this turns out, in retrospect, to have been a strategic error. The unanticipated sharp decline of the company's copper production, its deteriorating financial performance and its declining contribution to government revenues have been major constraints on growth of the economy and impediments to macroeconomic stability.  -28- Annex II Page 7 of 10 Civil Service Reform and Government Restructuring 29. Civil service reform has not been successful. 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 the lack of 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 are not yet reliable, but are being improved. Although it is not possible to be definitive, it is likely that the government payroll is larger than it was in 1991. So far, an equitable, affordable severance package has not been formulated. The Government has recentlv adopted a "three for one" program, allowing the hiring of one new employee for every one that leaves throughl attrition. This should result in a gradual decline in the civil service rolls. 30. Reorganization of government ministries is underway, but there does not be a strategic framework for the redefinition of government functions in a way appropriate to supporting development of a market economy, while protecting the public interest. Encourag,ing Private Sector Development 31. Progress on some measures facilitating private sector development has been encouraging. Mlost business-related legislation has been revised in an appropriate manner. Anti monopoly legislation has been enacted and laws relating to 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 was issued. 32. Attempts have been made to encourage exports. Improvements have been made in the duty drawback system for exporters. However, tariff reform is incomplete and because of continued numerous exemptions, loopholes (including COMESA preferences) and administrative weaknesses, some business suffer negative protection. It appears that either the study of the tariff system was inadequate or that framers of the tariff revisions were not alert to its implications. Further reform of tariffs, including further reduction of rates, elimination of exemptions, improvement of administration and expediting of drawbacks is essential and a good start has been made in the 1996 budget. 33. The major problem for business has been continued macroeconomic instability. The most damaging aspect of this has been the emergence of high and variable nominal interest rates, often translating into very high real rates of interest, and unpredictable movements of the effective exchange rate. 34. AgricuLtural development continues to be hampered by land legislation that does not provide secure tenure. The process for conversion of customary land into leasehold was only defined in 1995 and is just now being implemented Transferring land under leasehold has been hampered by outmoded legislation and slow processing. Furthermore, a large proportion of urban settlements are not recognized by local governments and thus denied access to urban services. Without formal titles, residents cannot obtain credit to improve their  -29- Annex II Page 8 of 10 properties. Legalization would provide a strong impetus for growth and improve the living standards of thousand of low and middle income Zambians. 35. The Government's program called for legislative remedy of these problems. However, the shift from customary tenure to leasehold was not discussed with, or approved by, the chiefs in advance. There was limited understanding of and consensus on program. As a result, the legislation was not enacted by parliament until 1995. A waiver was granted so that the second tranche of ESAC could be released. Macroeconomic Stabilization 36. Some progress has been made toward reducing macroeconomic imbalances, especiallv since the adoption of the cash budget in 1993. 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 has declined from triple digits for a few years before 1992 to just under 40% since mid 1993. But this is still far too high. The Government successfully competed its IMF Rights Accumulation Program, and is now implementing an ESAF arrangement. However the program was off track in the first two months of 1996. 37. Sustaining macroeconomic stability has, however, proven difficult. There has been a disturbing tendency for fiscal performance to go off track, especially in the early part of the year. AlthougL1 the specific reason seems to be different each year, it is clear that there are problems with the budget making process, especially since, with low growth of revenues and continued high civil service employment, there is no margin for error in the budget. These problems are generally resolved later in the year by squeezing expenditures and/or introducing ad hoc revenue measures. Because of this, completion of the Fund's Rights Accumulation Program required a number of waivers and resetting of benchmarks. 38. With liberalized credit and foreign exchange markets and the Government being the major player in these markets, variations in Government's issue of T-bills have a strong effect on intcrest rates and Government's management of foreign exchange reserves has a major inmpact on exclKmn.ze 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. Provision of a Social Safety Net 39. TThe Government was successful in alleviating the impact of the drought on the poor and disndvantaged. It implemented a transitional subsidy on imported yellow maize to custionl the pricc iImpact of thie drought. It channeled special assistance through local groups supported by the World Food Program and NGOs to ensure that affected families were fed and had seed for next year's planting. Furtlher, it assisted poorer families through a 15% subsidy on the type of maize with higher nutritional value. Although the subsidy has since been removed, thie Government used some of the resulting savings to expand social welfare  - 30 - Annex II Page 9 of 10 programs implemented through the Ministry of Community Development and Social Welfare, increased funding for small-scale labor intensive public works (supported by IDA and other donors) and other components of the Social Action Program, and converted some of those to paid work instead of self help. 40. In 1993 Government decided to increase access to social services removing structural constraints. Progress has been made on decentralization of budgetary and implementation authority to lower levels of government, devolution of activities to comrnunity groups and NGOs, and restructuring budgets for health, education, water supply and the safety net. .The share of the national budget allocated to basic social services was increased, with emphasis on primary education and health care and other services of importance to the low income population, including water supply and sanitation. Nevertheless, budgetary allocations for social sectors continue to be inadequate. Despite some increases in their allocations relative to the total budget, delivery of some important services continued to deteriorate as total expenditures have shrunk in real terms. Rehabilitation and Privatization of ZCCM 41. Failure to deal with problem of ZCCM early in the adjustment process has proven to be a serious problem. ZCCM's production, which averaged 700,000 tons per year during the early 1970s, is now down to about 250,000-260,000 tons.. Production dropped by 30% in September 1995 and whether and how soon it can recover is problematic. The firm's procurement practices are unsatisfactory and are a major source of financial losses. The company is now experiencing cash losses, is in arrears to its suppliers and is not making payments to the Treasury. 42. The privatization of ZCCM is the only permanent solution to the problems of the copper sector. However, the Government has not settled on a strategy for doing so. Moreover, the future role principal minority shareholder and most likely buvers, Anglo and a consortium of other mining companies, has yet to be worked out. Privatization of ZCCM% is inevitable and lawyvers and investment bankers have been hired to plan it. In the interim, the company clearly needs to develop an emergency rehabilitation program, but the current management has not been able to formulate one. There is an obvious need to strengthen top management In any event, production from the open pit mine can only last about four more years. Thie Koikola Deep project, which would fill the gap. needs to be put on the fast track. Sustainability of the Program 43. 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 situation will be exceptionally critical over the next few months in the run up to elections. 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, especiCl11 iII rurral areas. 44. Accelerating growth will require improved performance in macroeconomic managTement. *with the aim of bringing the rate of inflation down to single digit levels.  -31 - Annex II Page 10 of 10 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. 45. ZCCM's poor performance is a major impediment to growth. An immediate, determiiicd effort is required to rehabilitate existing operations, to put privatization on the fast track and to settle the future of Konkola North so that development work can begin quickly. 46. Adequate external financing must be insured. This will require demonstrated continued government comrmitment to the reform process and sustained stabilization. The benchmarks of the IiMF ESAF program must be met. Concerns of bilateral donors about "governance" issues, unless dispelled, could result in a decreased availability of aid flows. Bilateral donors are concerned that corruption and asset stripping have reached levels where they jeopardize macroeconomic stability. They also feel that the exceptional priority given Zambia in their aid budgets can only be justified if democratic traditions continue to be observed. Recent and ongoing developments have cast some doubt on this. In the long run, attaininent of sustained positive growth and increasing well-being of the populace depends on the character and quality of governance. 47. Finally, the privatization process is irreversible. By the end of 1990, 75% of the privatization (other than ZIMCO) will have been accomplished. Even if a decision were made in principle to reverse privatization, external financial support would end and resource constraints would prevent the decision from being implemented. Failure to go ahead with the privatization of ZIMCO would almost certainly result in the demise of the company. David G. Greene, Consultant. The World Bank Nlarch 16, 1996 Soutlhern Africa Department A:\ZAMBIAAI.DOC March 16, 1996 10:19 AM  I   .MAG l;lNG Rkeport No: 158b37 Type: ICF.