Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15840 PERFORMANCE AUDIT REPORT TUNISIA ECONOMIC AND FINANCIAL REFORMS SUPPORT LOAN (Loan 3424-TUN) June 28, 1996 Operations Evaluation 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 (annual averAes) Currency Unit = Tunisian Dinar (TD) 1987 Uf$1.00 $0.8297 1988 USS1.00 $0.8578 1989 US$1.00 $0.9493 1990 US$1.00, $0.1783 1991 US$1.00 $0. 46 1992 US$1.00 $01844 1993 LS$1.00 $1 37 1994 US$1.0 $1.4)116 Acronyms and Abbreviations ASAL Agricultural Sector Adjustment Loan BCT Bauque Centrale de Tuniste BDET Banque de Dtv4oement Econorique de Tunisie BTC Bons du Tr6sor Gessibles BTN Bons du Tr6sor N gociables en'Bourse: (Negotiable Tre6suils) BVMT Cy Boursedes Valcurs mobill6res de Tunis S.A CAVIS Cgisse d'assurance viedlesse, invalidit6 et survivarf& CNSS Caisse nationale de securite sociale CNRPS Caisse nationale de retraet de pkvOyance sociale EFRSL Econmic ari Financial Reforms Support Loan EU European Union GATT General Agreement on Tariffs and Trade GDP gross domestic product IMF lateriional Mortary Fund ITPAL inustrial and -Naoe Policy Adjustment Loan MTL Medium to Long eri Treasury Bills PERL Public Enterprise Reform Loan SAL Structural Adjustment Loan SICAFs clcsed-end mutual funds SICAVs open-end mutual ftds SMEs small and mediunt enterprises WTO Werrd Trade Orgapization Fiscal Year Fiscal year CB e rddar yea a Baqe eD6* pmn.Eoomqe eTuii FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.SA. Office of the Director-General Operations Evaluation June 28, 1996 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on Tunisia Economic and Financial Reform Support Loan Project (EFRSL) (Loan 3424-TUN) Attached is the Performance Audit Report (PAR) on the Tunisia Economic and Financial Reforms Support Loan (Loan 3424-TUN, approved in FY92), prepared by the Operations Evaluation Department. The EFRSL was the sixth adjustment loan to Tunisia, following two Agricultural Sector Adjustment Loans (FY87 and FY90), one Industry and Trade Adjustment Loan (FY88), one Structural Adjustment Loan in FY89 and a Public Enterprise Reform Loan in FY90. The EFRSL was designed to support a number of complex reforms including: (i) virtual elimination of trade restrictions; (ii) changes in the financial system, including adoption of new regulations to bring the banking system up to international standards; (iii) improvement of the special incentives for investments; (iv) enlargement and improvement of the social security system and improved targeting of existing subsidies for the poor; and (v) establishment of a coordinated system for managing the external debt. Achievement of the objectives was substantial, with some weak spots. The Government maintained a suitable macroeconomic framework for growth and reform during the period of the operation. The trade liberalization program did not go as far as predicted, although it made some progress towards the achievement of its goals. Through a waiver of the conditionality on trade reforms, the Bank accepted the Government's argument that the removal of trade restrictions would be met in the context of its obligations under the GATT Round and the recently concluded free trade agreement with the European Union. The financial sector reforms were well implemented. Audits of some banks exposed the weakness of their loan portfolios, and they were required to provision for these inadequacies in accordance with new prudential regulations. The poor performance of public enterprise loans was not, however, fully addressed since the guarantees extended by the Treasury on their borrowings made their loans current with the banks. The simplified investment incentives law was an improvement over the previous incentives regime, but the incentives continue to be too generous and with high fiscal costs. The reforms in social security have only been agreed in principle. The management of the external debt is now coordinated under an interministerial team. The PAR ratings agree with those of the ICR: outcome of this project is rated as satisfactory; institutional development impact as moderate; sustainability as likely, and Bank performance as satisfactory. Attachment 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. FOR OFFICIAL USE ONLY Contents Preface ............. 3 Basic Data Sheet.................... .................................................. . 5 Evaluation Summary .................. .................................................. 13 1. Project Objectives, Design And Relevance................................................................. 17 Background: the Tunisian Economy in Retrospect (1980-1991)..................... 17 Loan Objectives and Design ...... ...................................................... . 18 Loan Amount, Tranching and Conditionality ................................................... 22 R elevance ... ..... ...................................................................................... 23 2. Project Implementation....................................................... 24 Overview ................................................. 24 Trade Reform ................. .................................................. 25 Financial Sector Reforms .... ..... ........................................................... 29 Banking Reforms .............................. .............. 31 Interest Rate Policy ........ ..... ........................................................ 35 Special Incentives: Investment Code .. ................................................. 36 3. Bank and Borrower Performance .................................................................... 37 4. Conclusions: Outcome, Sustainability and Performance ............................. 39 5. Lessons of Experience................................................................................................... 40 Annex I - Statistical Information ......................................... 43 Annex II - Definitions of Various Regulatory and Supervision Ratios Per Central Bank directives, since 1991.................................... 47 This report was prepared by Gerardo Sicat (Task Manager) and Ivan Christin (Consultant), who audited the project in November 1995. Alejandra Sarmiento provided administrative support. The report was issued by the Country Policy, Industry and Finance Division (Manuel Penlalver, Chief) of the Operations Evaluation Department (Francisco Aguirre-Sacasa, Director). This document has a restricted distribution and may be used by recipients only in the pedormance of their official duties. Its contents may not otherwise be disclosed winhout World Bank authoriation. Preface This is the Performance Audit Report (PAR) on the Tunisia Economic and Financial Reforms Support Loan (L3424-TUN). The loan, approved on December 12, 1991 in the amount of US$250 million, was disbursed fully in three tranches, and closed on December 31, 1994. The first tranche of US$100 million was released upon effectiveness in December 1991; the second tranche of US$70 million in August, 1993; and, finally, the third tranche of US$80 million in November, 1994. The PAR was prepared by the Operations Evaluation Department (OED). It is based on the President's Report, the loan documents, sector and economic reports, the project files, the summary of the Board discussion, discussions with Bank staff, and the Project Completion Report (PCR) prepared by the Middle East and North Africa Region. An OED mission visited Tunisia in November, 1995 and discussed the effectiveness of the Bank's assistance with the Government authorities and representatives of the private sector. Their kind cooperation and invaluable assistance in the preparation of this report is gratefully acknowledged. The PAR discusses the objectives, design, and implementation of reforms supported by this loan. It deals more fully with the issues on trade liberalization, financial sector reforms, and investment incentives reform than the ICR. The ratings in this PAR agree with those of the PCR. The PAR rates the outcome of the project as satisfactory; institutional development impact as moderate; sustainability as likely; and Bank performance as satisfactory. A draft of the PAR was sent to the Government for comment, and no comments were received. = Basic Data Sheet ECONOMIC AND FINANCIAL REFORMS SUPPORT LoAN (LOAN 3424-TUN) Table 1. Loan Data FY 95 (Amount: USS250 million) Original Disbursed Cancelled Repaid 250.00 250.00 0 0 Loan Disbursement FY 92 FY93 FY94 FY95 (i) Planned 100.0 70 80 0 (ii) Actual 100.0 0 70 80 Table 2. Project Timetable Steps in Project Cycle Date Planned Date actual/Latest estimate Identification - Preparation 04/91 04/91 Appraisal 07/91 07/91 Negotiations 11/91 11/91 Board presentation 12/91 12/91 Signing 12/91 12/91 Effectiveness 12/91 12/91 II Tranche 12/92 08/93 III Tranche 12/93 09/94 Loan Closing 12/94 12/94 Source: World Bank Management Information System, Back to Office Reports, President's Report. Table 3. Bank Resources: Staff Inputs Planned* Revised Actual Stage of project cycle Weeks US$** Weeks USS Weeks US$** Through appraisal 70.6 Appraisal - Board 70.6 Board - effectiveness Supervision 92.8 Completion 6.0 TOTAL 240 Source: World Bank Management Information System * No planned figures available. ** MIS did not provide dollar amounts 6 Table 4. Studies Included in Project Study Purpose Status A. Investment Code To review the existing incentive system; to Completed prepare an action program for the The fiscal incentive system establishment code. B. Social Security Reform * Improving coverage of the social * To examine methods of extending the Completed security system coverage of the existing social security system to the entire population. * Investment strategy * Formulating guidelines regarding risk Completed and liquidity of investments by social security funds and insurance companies. * Social security numbers * To examine the problems involved in Completed establishing a unique system of social security numbers for individuals. * Family assistance mechanisms * To examine the current system of Completed family assistance benefits and their possible replacement. * Unemployment insurance * To examine the (a) desirability and (b) Not Completed the feasibility of providing income support to the unemployed. 7 Table 5. Related Bank Loans/Credits Loan/Credit Year of Title Purpose Approval Status Loan 2754 ASAL To support Government's agricultural September 1986 Closed June 30, Agricultural Sector sector reform program, focusing on 1989. Adjustment Loan increasing producer prices, reducing (USS150 M) subsidies on inputs, strengthening extension and research and increasing interest rates. Loan 2781 ITPAL To support the initial phase of February 1987 Closed in Industrial and Trade Policy Government's adjustment program December 1989, Loan (US$150 M) for the industrial sector, including one year behind price and trade liberalization and schedule. The fiscal reform. fulfillment of certain conditions (concerning labor issues, the introduction of a VAT tax and the design of a foreign exchange risk system) took longer than expected. Loan 29962 SAL I Structural To support the medium-term June 1988. Closed in June Adjustment Loan macroeconomic adjustment program 1991, 26 months (US$150 M) of the Government and continue the behind schedule. trade liberalization and foreign The delay was due exchange risk coverage reforms to slow initiated under the ITPAL; reform of implementation of taxation through introduction of VAT liberalization and simplification of income tax. measures, because of a severe drought, rising unemployment and declining investment. Loan 3109 PERL Public To support the Government's public July 1989. Closed in June Enterprises Reform Loan enterprise reform, including legal and 1993, 2 years later (USS130 M) institutional reforms, to reinforce the than planned Government's program of divestiture because of slow and restructuring, progress in privatization (for fears of social unrest), and delays in the preparation of performance contracts. Loan 3078 ASAL 11 To support the reforms of the June 1989. Expected to be Agricultural Sector marketing, institutional and price closed in December Adjustment Loan framework in agriculture, reorienting 1994, extension to (USS84 M) public investment in agriculture and June 1994. improving the management of natural resource . Loan 3671-SO Private To finance the needs of new and November 1993. Project under Investment Credit Project existing private enterprises by supervision, (US$ 120 M) channeling funds through eligible expected to close in financia intermediaries. 1999. 8 Table 6. Bank Resources: Missions Performance rating* Stage of Month Number Days in Specialized Implemen Develop- project / year of field* staff skills -tation ment cycle persons represented status objectives Types of problems Through 04/91 8 100 3 E Identification appraisal 2 R Preparation 2F ID Appraisal 07/91 10 140 4 E Appraisal through 2 R Board 2F approval 2 D Supervision 05/92 3 30 2 E 2 1 IF 11/92 4 60 2 E 2 1 Slow I F implementation of I R the planned audits of 1/3 of the banking system and of measures concerning banking supervision and prudential regulation. 04/93 3 20 2 E 2 1 Slow I F implementation due to: (i) delays in the preparation of the bank's action plans; (ii) disagreement on parts of banking legislation and on investment code proposal. 09/93 3 12 2 E, I F 2 1 No Form 590 in files. 12/93 2 20 1 E 2 1 Delays in taking I F measure (i) to liberalize interest rates; (ii) to reform the social security system. Sources: Back to Office Reports, Form 590s E = Economist F = Financial Specialist R = Research Assistant D = Debt Specialist 9 Table 7. Legal Covenants: Conditions for Effectiveness, II and m Tranche Release Description of Covenant Conditions for Effectiveness: Section 5.01 a) The Borrower has submitted for adoption by its Chamber of Deputies a draft Fiscal Year 1992 Finance Law (Loi de Finances) allowing the Borrower to take all necessary action to reduce the share of its imports subject to quantitative restrictions by at least fifteen percentage points (15 percent), in terms of Domestic Production Value of NAP Classification item 6632 to item 6414 applicable as of Fiscal Year 1989, from the level in effect as of May 30, 1991. b) The Borrower has reduced the aggregate share of goods subject to price control at the distribution stage by at least ten percentage points (10 percent) in terms of their value of Domestic Production, as determined on the basis of the Domestic Production Value of NAP Classification item Ill to item 6414 applicable as of Fiscal Year 1989, from the level in effect as of May 30, 1991. c) The Borrower has taken any and all necessary action, satisfactory to the Bank, to amend the requirement on deposit banking institutions to hold twenty percent (20 percent) of their deposit assets in Bons d'Equipement, and to permit such institutions to hold any available freely market traded treasury securities of the Borrower, other than Bons d'Equipement. d) The Borrower has furnished to the Bank an action plan, acceptable to the Bank, for the redemption over four (4) years, covering the period 1993-1996, of any and all outstanding Bons d'Equipement issued after Fiscal Year 1988. e) The Borrower has furnished to the Bank the relevant extracts, satisfactory to the Bank, of the Borrower's draft Fiscal Year 1992 Finance Law (Loi de Finances), submitted for adoption by its Chamber of Deputies, which extracts shall: (i) amend the tax treatment of financial instruments so as to remove all restrictions limiting the sale, purchase and freedom of transfer of said financial instruments within the Borrower's territory; and (ii) harmonize the taxation of income derived from special savings accounts with the taxation of income derived from other financial instruments within the Borrower's territory. f) The Borrower has taken any and all necessary action, satisfactory to the Bank, to allow each deposit bank operating within its territory to provide its loans at an interest rate above the prevailing Money Market Rate plus three percentage interest points (3 percent), provided, however, that the difference between said Money Market Rate and each such bank's respective average lending rate in respect of all of its loans, excluding Rediscounted Preferential Credits and Special Resource Credits, does not exceed three percentage points (3 percent). g) The Central Bank has adopted a program of actions to strengthen its prudential banking supervision capabilities, which program shall be satisfactory to both the Bank and the Borrower. h) The Central Bank has adopted regulations, satisfactory to the Bank, for interalig: (i) the provisioning and classification of loans, as of January 1, 1992, by banking institutions operating within the Borrower's territory; (ii) the fixing of maximum loan concentration for each of said banking institution at forty percent (40 percent) of such institution's respective aggregate own funds; (iii) the definition of group ownership and control in respect of said institutions' borrowers; (iv) the definition of auditing principles upon which auditors must base their opinions, and the removal of ceilings on the cost of long-version audits; and (v) the obligation of banking institutiuns operating within the Borrower's territory to provide to the Central Bank quarterly profit and loss accounts; and The Borrower has increased, by at least one percentage point (1 percent), the interest rate on Rediscounted ) Preferential Credit, based on a methodology satisfactory to the Bank. 10 II Tranche Release Schedule 4 Part A: Actions referred to in Paragraph 4 (a) of Schedule I 1) Continued maintenance by the Borrower of a macro-economic framework consistent with the objectives of the Program, as determined on the basis of indicators acceptable to the Bank. 2) The Borrower has reduced the share of its imports subject to quantitative restrictions by at least thirty percentage points (30 percent), in terms of Domestic Production weights, as determined on the basis of the Domestic Production Value of NAP Classification item 0111 to item 6632 applicable as of Fiscal Year 1989, from the level in effect as of May 30, 1991. 3) The Borrower has increased the aggregate share of goods not subject to price control at the distribution stage to at least forty percentage points (40 percent) in terms of their value of the Domestic Absorption in Fiscal Year 1989, as measured on the basis of a methodology satisfactory to the Bank. 4) The Borrower has: (i) removed any and all taxation requirements, and related rights and obligations, that restrict or otherwise impair the development and operation of an efficient secondary market for the purchase, sale and free trade of financial instruments within the Borrower's territory; and (ii) has adopted rules and regulations, satisfactory to the Bank, exempting from taxation at least one quarter (1/4) of all specific provisions and interest suspension. 5) The Central Bank has adopted regulations, satisfactory to the Bank, for inter alia: (i) reducing the maximum loan concentration permitted for each banking institution operating within the Borrower's territory to thirty-five percent (35 percent) of such institution's respective aggregate own funds; (ii) setting forth standard auditing principles in respect of banking institutions operating within the Borrower's territory, which principles shall be consistent with internationally accepted auditing practices and shall include, inter alia, the obligation to provide long-version audit reports; and (iii) regulating the provision by said institutions to the Central Bank of required accounting and statistical documentation, which regulation shall become effective not later than January 1, 1993. 6) The Borrower has submitted for adoption by its Chamber of Deputies a banking law satisfactory to the Bank. 7) (a) The Borrower and the Bank shall have carried out a joint review, based on data acceptable to the Bank, of the individual financial position of each audited or inspected banking institution operating within the Borrower's territory; and (b) Taking into consideration the Bank's recommendations pursuant to such review, the Borrower has put into operation action plans for, inter ai , strengthening or restructuring each of said banking institutions. 8) The Central Bank has adopted a program, acceptable to the Bank, for auditing and examining the overall viability of banking institutions accounting for at least two-thirds (2/3) of the banking operations carried out within the Borrower's territory. 9) The Borrower has taken all action necessary, satisfactory to the Bank: (a) limiting the duration and selectivity of tax advantages accorded to investors under the Borrower's investment codes; and (b) adopting satisfactory measures to reform related financial advantages. 10) Without limitation or restriction to the provision of Section 5.01 (i) of this Agreement, the Borrower has increased, by at least two percentage point (2 percent), the interest rate on Rediscounted Preferential Credits, based on a methodology satisfactory to the Bank. 11) The Borrower has adopted guidelines, acceptable to the Bank, in respect of the investments and related operations of its social security funds. 11 III Tranche Release Schedule 4 Part B: Actions referred to in paragraph 4(b) of Schedule I 1) Continued maintenance by the Borrower of a macro-economic framework consistent with the objectives of the Program, as determined on the basis of indicators acceptable to the Bank. 2) The Borrower has taken necessary measures, to eliminate all quantitative restrictions on imports of all goods, except for the following goods which have been previously specified in agreement with the Bank: (a) security related goods; (b) basic consumption articles whose consumer prices are subsidized by the Borrower; (c) certain luxury goods which are not produced within the Borrower's territory; and (d) certain other articles previously approved by the Bank. However, the resulting steps were inadequate and a waiver of this conditionality was secured. 3) The Borrower has reduced the aggregate share of goods not subject to price control at the distribution stage to at least sixty percentage point (60 percent) in terms of their value of the Domestic Absorption as of December 31, 1989, as measured on the basis of a methodology satisfactory to the Bank. 4) The Borrower has achieved progress, satisfactory to the Bank, in carrying out the action plan referred to in Section 5.01 (d) of this Agreement. 5) The Borrower has removed any and all percentage interest point ceilings applicable to the lending rate or rates charged by each deposit bank operating within its territory. 6) The Central Bank has adopted regulations, satisfactory to the Bank, for, intuia, reducing the maximum loan concentration permitted for each banking institution operating within the Borrower's territory to twenty-five percentage points(25 percent) of such institution's total own funds and providing for the establishment of a surcharge, in the form of an addition to own funds, for exceeding the said maximum of twenty-five percentage points (25 percent). 7) The Borrower and the Bank have carried out a joint review, based on data acceptable to the Bank, of the individual financial positions of each audited or inspected banking institution operating within the Borrower's territory. 8) The Bank and the Borrower have carried out a joint review, based on terms of reference acceptable to the Bank, of the progress achieved in carrying out the action plans referred to in sub-paragraph 7 (b) of Part A of this Schedule. 9) The Central Bank has adopted a program, acceptable to the Bank, for auditing and examining the overall viability of banking institutions accounting for all banking operations carried out within the Borrower's territory. 10) The Borrower has: (a) carried out the action plans referred to in sub-paragraph 9 (b) of Part A of this Schedule; and (b) adopted an Investment Code and related implementing regulations, all satisfactory to the Bank. I1) The Borrower has adopted the principles of a program, for reforming its social security system, and has carried out the measures of said program in respect of the most disadvantaged groups of its population. However, a program of reform is only to be undertaken in the future. Evaluation Summary 1. Tunisia's structural adjustment program, initiated in 1986, was designed to make the economy more outward oriented, less dependent on administrative controls and more responsive to incentives based on market signals, a modem tax system and reliable information produced by a modem financial system. This program has been supported by a succession of adjustment operations: two Agricultural Adjustment Loans (ASAL in FY87 and FY90); an Industrial and Trade Policy Adjustment Loan (ITPAL, FY88); a Structural Adjustment Loan (SAL, FY89); and a Public Enterprise Reform Loan (PERL, FY90). The Economic and Financial Reform Support Loan (EFRSL), the subject of the present performance audit report, was approved on December 12, 1991 and was closed on December 31, 1994. The Loan Project 2. The EFRS loan of US$250 million, was disbursed in three tranches: the first tranche was US$ 100 million; US$70 million for second tranche; and US$80 million for the third and final tranche. The EFRSL project supported the continuation of Tunisia's adjustment program, covering trade and price liberalization, investment incentives policy, financial sector modernization and restructuring, social security reform; and external debt management. 3. The trade reforms envisioned the lifting, by the end of 1993, of most import restrictions, with only limited exceptions. To facilitate the transition from quantitative restrictions to tariffs, and the reduction of high nominal tariffs on domestic industry, temporary surcharges could be instituted for a period of three years maximum. Price liberalization was to be undertaken by removing a substantial portion of the existing controls on distribution margins at the producer and retail level. 4. The financial sector reforms covered: (a) changes in treasury practices to facilitate greater tradability of government debt instruments by improving their yield and marketability, and by removing tax distortions on debt instruments; (b) introduction of stronger supervision and regulation of the banking sector; and (c) interest rate policy. Financial institutions would be strengthened, first, by revising the banking law and putting in place a system of regulation and supervision up to international standards; second, by instituting a system of bank audits to strengthen the loan portfolios of the banks; and, third, by removing the caps on lending rates to make interest rates more market-based. 5. The reform of investment incentives was intended to simplify a complex pattern of special incentives. The number of promoted industries was to be narrowed down and the incentives offered would be neutral among promoted investments. The reform would enhance the effectiveness of incentives in promoting desired investments and reduce their contribution to the erosion of fiscal revenues. 6. The social security reforms were meant to achieve a greater integration of social security funds; to widen coverage of the system; and to improve the targeting of existing subsidies for the poor. Various studies on the options for reform of the social security system were to be completed and a corresponding reform of social security undertaken. Finally, the project 14 supported the improvement of the management of the external debt by proposing an interagency coordination. Implementation 7. The loan became effective on schedule (December 31, 1991, with the release of US$ 100 million equivalent). Elements of the trade and financial sector reforms were undertaken upfront. This justified the higher amount of the first tranche. Delays in the preparation of action plans for audited banks and protracted debates concerning the new banking law and the new investment code caused the second tranche (US$ 70 million equivalent) to be released behind schedule (by nine months, in September 1993). The release of the third tranche (US$ 80 million equivalent) occurred one year later (September 1994) and the loan was closed on December 1994. 8. The macroeconomic framework remained on track throughout the loan period. Progress in the liberalization of trade and prices was accomplished, but not all of its objectives were met. Quantitative restrictions were kept for a number of products, going beyond the limited list allowed under the agreement. The codification and simplification of the investment code was undertaken, but the resulting investment code continued to be too generous and covered more industries than was intended. Progress was achieved in finishing policy studies for the reform of the social security system, but only an agreement on the principles of social security reform was made. The financial sector reforms were undertaken and the results were highly satisfactory. 9. The condition for the removal of trade restrictions was not met. However, the Bank accepted a waiver of the condition, recognizing that the Government made some progress and that a continued liberalization schedule would be pursued under the GATT agreement and the free trade agreement with the European Union. The slow implementation of trade reforms was the result of accommodations made by the Government to protectionist pressures. Several measures adopted by the Government in dealing with trade issues slowed down the schedule for liberalization, as demonstrated by: (a) issuing an order prior to the third tranche release which included a larger list of products covered by quantitative restrictions than originally anticipated under the loan agreement; (b) negotiating trade agreements (GATT Round and free trade agreement with the European Union) in which provisions on tariff levels and timetable for the removal of trade restrictions were at variance with the agreements made in the adjustment program; and (c) employing complementary provisional duties extensively to raise the protection level. 10. Nevertheless, definite progress towards trade liberalization has been achieved. There is now more transparency in the protection of industry than at the start of the adjustment program, although the actions on this front have demonstrated that the Government's political will for trade reform has vacillated in the face of sector opposition. The trade reforms have moved forward but at a much slower pace and, from the evidence so far, the emerging trade regime has shifted to a higher level of protection rates than that conceived under the adjustment program. However, under the free trade agreement with the European Union and within the framework of the Uruguay Round and the World Trade Organization, greater openness of the trade regime could be achieved and is likely to be sustained. 11. The most satisfactory performance under this operation is the reform of the financial system. The financial reforms enjoyed a high level of Government ownership. Treasury practices were revised; older debt instruments were retired in favor of treasury securities with 15 improved yield and greater marketability. The cap on lending rates was removed, and interest rates were allowed to reflect market rates in the loan market. 12. Financial authorities succeeded in addressing the weaknesses of the financial system. A new banking law enhanced the supervisory role of the central bank and led to the adoption of improved regulations of the financial system. Audits of financial institutions facilitated the provisioning for problem loans up to prudential standards. The financial reforms influenced the behavior of the financial institutions, as a result of the new regulations and strict supervision. 13. Financial sector reforms cannot, however, make up for the deficiency of the real sector that are often behind financial distress. For example, the treasury guarantee on public enterprise loans from public banks enabled these loans to be classified as current and hid the true financial condition of weak public enterprises within the books of the financial sector. The Government still faces the task of undertaking a serious program of privatization, of taking these enterprises out of the contingent liability of the treasury and to make them efficient. 14. The new investment code succeeded in applying the same special incentives for new investment under a single law. But the fiscal benefits accorded to promoted industries continue to be very generous and have a high fiscal cost . Potential beneficiaries for investment incentives include a wider list of activities than was originally planned. An opportunity to improve significantly the fiscal incentives regime was missed, although the incentives law was an improvement over the old set of incentives laws. 15. The intended reform of social security resulted only in the announcement of a future agenda for reform. The policy studies agreed upon under the project were undertaken, but they were delayed before completion. The Bank was too optimistic that a major reform of social security could be undertaken within the schedule of the EFRSL. Social security reform will require more internal consultations and debate in order to improve the ownership of the reforms. Outcome, Sustainability and Performance 16. In spite of its many shortcomings, the EFRSL made substantial progress towards achieving its objectives. Thus, outcome is rated as satisfactory. Institutional development impact is rated as moderate, and sustainability as likely. Bank performance is rated as satisfactory. 17. Overall economic management was very effective. The macroeconomic framework remained conducive to growth. Trade and fiscal imbalances were kept within reasonable bounds and inflation was minimal. 18. The EFRSL operation had no direct institutional development objectives. The financial sector reforms, however, installed a set of new regulations which will help to improve institutional capacity within the banking institutions. The institutional impact of the project is modest, but it is nonetheless important. 19. The Bank performance is rated as satisfactory. Even though not all reforms contemplated under EFRSL were carried out with uniform success, all aspects of these reforms moved forward towards their goals. The Bank's assistance, at the design stage and during supervision, helped to focus on the remaining structural reforms that had to be supported. The Bank also assisted in 16 facilitating co-financing of projects related to the reform program from other donors. The Borrower's reform pace was governed by the extent of its commitment to the reforms. In the case of the financial reforms, a high level of commitment enabled the banking system to undergo a major restructuring through effective supervision and change in regulatory environment. In areas where some Borrower ownership was inadequate, the reform goals were not fully- achieved. Lessons of Experience 20. Borrower ownership of reforms is not necessarily the same for all components of a structural reform package. 21. "Satisfactory" implementation of specific conditionality should be spelled out upfront rather than left for judgment and interpretation during supervision. 22. Policy studies which are used as basis of recommendations for changes in policy should be linked more directly to conditionality or to side agreements that are relevant to satisfactory performance. 23. It is not realistic to expect that some reforms can be implemented quickly especially if the reform touches on very complex social issues, such as social security. 1. Project Objectives, Design and Relevance Background: the Tunisian Economy in Retrospect (1980-1991) 1.1 Tunisia is a lower-middle income economy with a GNP per capita of US$1,720 (in 1994). Compensating for its modest natural resources, its development strategy initially emphasized investment in human resources' and infrastructure development. The country was however misled by the unexpected revenues of the 1974-1980 oil boom. Relying heavily on income from exports of oil, Tunisian authorities overexpanded development expenditures.2 The economic situation seriously deteriorated especially during 1980 to 1984. Although the Sixth Plan (1982-1986) envisaged both the depletion of oil reserves and the fall in oil prices, major macroeconomic imbalances developed in 1984. The current account deficit amounted to 10.9 percent of GDP, the budget deficit to 7.8 percent of GDP and total external debt reached 50 percent of GDP. 1.2 The Government's reaction to this crisis was, at first, mainly dirigiste in style. It restricted imports, which helped to stabilize the current account deficit at about 7 percent of GDP. However, this also resulted in various shortages and discouraged exports. Public investment was cut from about 15 percent of GDP to less than 11 percent of GDP. Progressively, the Government had also to recognize that with less global resources (and specifically with oil resources nearing depletion), the Government's role in the economy had reached a definite limit. The Bank and the IMF were instrumental, through their dialogue with the Government, in helping set up a reform program aimed at making the economy more outward oriented, less based upon administrative controls (the basics of a dirigiste economy), and more sensitive to a renewed set of incentives based, among others, upon market signals, a modern tax system and reliable information produced by a modern financial system. A series of adjustment loans started in 1986, addressing structural issues in different sectors of the economy: * ASAL I (Agricultural Sector Adjustment Loan, in FY87) and ASAL II (in FY90) addressed reforms of the agricultural sector reform issues, including liberalization of price of basic commodities; * ITPAL (Industrial and Trade Policy Adjustment Loan, in FY87), initiated the liberalization of investment and the introduction of a new investment code, streamlining of the foreign exchange risk coverage scheme, liberalization of banking, reform of industry and trade related institutions, and reform of indirect taxation; * the SAL (Structural Adjustment Loan, in FY88), supported the liberalization of prices and trade, further reforms of indirect taxation (introduction of a VAT) and those related to direct taxes, initial reforms in the financial system; and Allowing the life expectancy at birth to increase from 60 years in 1980 to 68 years in 1993, and an adult literacy rate to increase from 62 percent in 1980 to 65 percent in 1990. 2 In 1990, petroleum accounted for 53.3 percent of total merchandise exports and about 17 percent of budget revenues. 18 the PERL (Public Enterprise Reform Loan in FY89), addressed the reduction of State ownership in major sectors as well as the reduction of Government intervention in enterprises that would remain under State ownership. 1.3 Adjustment of the macroeconomic framework proceeded satisfactorily. The economy grew at around 3 percent per year during 1987-1989, and the current account and budget deficits were reduced to manageable levels. The Gulf crisis in 1990 had, however, a dramatic adverse impact: tourism fell, capital inflows and direct foreign investments from Arab countries were substantially reduced, and unsold inventory accumulated. The Government adjusted by tightening monetary and fiscal policy, but quick disbursing assistance was needed to fill the gap caused by the changes. At the same time, certain components of the structural adjustment program-completion of trade and industrial reforms, investment code reforms, financial liberalization and introduction of improved banking supervision and regulation, and social security reform-needed to be further advanced. Loan Objectives and Design 1.4 From the macroeconomic perspective, the EFRS Loan was designed to provide relief from, and to help overcome the effects of, the Gulf crisis, and to enable Tunisia to move towards a sustainable growth pattern (a GDP growth rate of about 5 percent per year), while reducing both the non-interest current account and budget deficits to 2 percent of GDP by 1996 (against- planned-3.4 percent and 3.6 percent, respectively, for 1991). Previous reforms had emphasized the reduction of government controls and the removal of major obstacles to the private sector. The EFRS loan was to foster improved efficiency in the private sector by supporting a financial system that was more market oriented. Improved efficiency of the private sector would result from increased competition permitted, among others, by the removal of excessive protection measures. Greater labor mobility would result from a reform of the social security system. More capital mobility, on the other hand, was to be promoted by reforms designed to: (i) increase both the transparency and safety of the banking system; (ii) removal of limits on lending rates; and (iii) promotion of long term instruments for financing the budget without creating major distortions to private investment. 1.5 The program of reforms covered the following areas: * Trade, prices and competition; * Financial sector; * Special incentives provided by sectoral investment codes; * Social protection; and * External debt management. 1.6 Trade, prices and competition. The EFRSL focused on three major items: 19 a) Import liberalization. In 1991, about 70 percent of production in manufacturing and agriculture was still protected by import restrictions, although these restrictions were managed with some flexibility by Tunisian authorities (in case of shortages or monopolistic behavior). Under the program, by the end of 1993 all import restrictions were to be lifted, except for goods accounting for 2/3 of textile production', subsidized articles of basic consumption, a few luxury goods not produced domestically and security related items. To facilitate the transition, temporary surcharges would be instituted for three years maximum, a detailed timetable would be made public, and a special lending program would help enterprises acquiring modem technologies suited to meet new competition conditions. b) Distribution margins. It was also estimated that, in 1991, only about 30 percent of distribution margins were free. Under the agreed program, by end- 1993 about 75 percent of such margins were to be freed, and 100 percent by end-1994. c) Producer prices. With over 70 percent of production prices already liberalized by 1991, the remainder was to be freed during 1992, with the exception of natural monopolies and subsidized articles of basic consumption. 1.7 Financial sector reforms. The program emphasized the need to continue the reform of the financial system in three major areas: (a) the financial markets; (b) the banking sector; and (c) interest rates policy. a) Financial markets. For a long time, financial markets had been dominated by the Treasury's borrowing practices, which created major tax distortions. * The Treasury's borrowing practices consisted of issuing ten year bonds (Bons d'6quipement) with yields of 8.1/8 percent. As these yields were too low to attract voluntary purchases, banks were obliged to hold up to 20 percent of their deposits in these bonds4, insurance companies had to place, on a compulsory basis, 50 percent of their technical reserves in bons d'dquipement, and social security funds had also to invest in these bonds as a result of agreements with the Treasury. Of the 1,565 million TD of outstanding bonds (Treasury and corporate) as of end- 1990, the bons d'dquipement represented about 70 percent. This practice resulted in crowding out the private sector, and also resulted in severely constraining the trading of bonds. The program supported by EFRSL provided that: (i) the issuance of new bons d'dquipement would be stopped as of 1991; (ii) the redemption of all bons d'quipement issued after 1988 would be effective by 1996; (iii) special provisions would be made for banks and insurance companies to adjust to this redemption program; and (iv) new Treasury bonds would be issued at market rates. However, yarn imports would be free in 1993 and all textiles imports would be liberalized in 1994. As of end-1990, total outstanding bons ddquipement amounted to 1 275 million TD, of which 75.6 percent was held by banks and the rest by insurance companies and social security funds. 20 * Tax distortions were related to: (i) special incentives attached to "A" bonds issued by the Government in the framework of Emprunt national;s (ii) special incentives attached to shares held for at least two years, and/or to earnings reinvested in equity; (iii) special tax arrangements attached to closed-end mutual funds (SICAFs) and ambiguities characterizing the taxation of open-end mutual funds (SICAVs); and (iv) the treatment of special saving accounts. Fiscal reforms aimed at removing most of these distortions would be introduced in the Loi de Finances for 1992. b) Banking reform. The banking sector had major shortcomings, which were to be addressed through four components of the loan program: * Prudential regulations of Tunisian banks were to be improved in several areas, by: (i) defining arrears in accordance with international norms; (ii) bringing minimum provisioning and interest suspension rules in line with international norms; (iii) reviewing tax exemptions for specific provisions; (iv) reviewing the rules applying to the re-classification of loans as a result of: (c) loan renewals, extensions, rescheduling; (D) lack of information; (y) deterioration of the borrower's capacity to generate cash flows; and (6) granting overdrafts. Also, the rules governing lending limits and capital adequacy were to be made stricter. * On-site examination and surveillance of banks were to focus more on asset quality and less on administrative criteria. In addition to specific prudential returns that were to be produced by it, the Central Bank was to receive information from banks' internal auditors and from banks' external auditors. It was then to develop a new data base with a financial analysis model permitting to detect, in advance, anomalies and shifts in performance trends. * Banking legislation was to be amended to strengthen the Central Bank, giving it more powers to enforce sound prudential practices, impose financial discipline on banks and on banks' boards and managers. * The Tunisian authorities agreed on a program to be implemented for auditing and inspecting banks. The accounting and reporting requirements of domestic banks were to be upgraded to international standards. c) Interest rate policy. The policy on interest rates were characterized by a 3 percentage points cap on the spread between the interest rates on loans made by commercial banks and the money market rate. This cap was to be removed cautiously,' after a transition phase in which the cap was to be applied to the average spreads of individual banks over the money market rate. Primary purchases of such bonds were tax deductible (up to 35 percent) provided they were held five years. 6 In order to avoid risky lending by banks. 21 1.8 Investment code reform. Until 1991, incentives were offered on a sectoral basis, through several uncoordinated (and sometimes competing) investment codes.' In addition, the advantages were too generous (tax exemptions for very long periods, preferential credits at below market rates, etc.). After the reform of direct taxation, it was recognized that streamlining investment incentives became necessary. Sectoral investment codes were to be replaced by a unified code with a limited set of special incentives. The new code was to be enforced in 1993, its basis for tax exemption eligibility was to be narrowed and the financial advantages were to be revised. A centralized procedure was to be set up, and the role of sectoral agencies was to be reduced to technical proposals to be submitted to the decision making authority. 1.9 Social protection. Tunisian workers have benefited from an extensive system of social protection. However, the system revealed major inefficiencies: fragmentation between several funds [Caisses, such as: CAVIS (Caisse d'assurance vieillesse, invalidit et survivants), providing pension and invalidity benefits, CNSS (Caisse nationale de sicurite sociale) providing health care, CNRPS (Caisse nationale de retraite et de privoyance sociale), providing benefits to most of public sector employees except those of gas, electricity and water companies, covered by the CREGT], absence of a unified identification numbering, lack of incentives for participation and contribution, financial management of reserves of the funds [which were used for various purposes from economic development to social housing, in such a way that they were illiquid, unremunerative and progressively depleted]. 1.10 Projected reforms were designed to provide a basic minimum cover for the poor and optional insurance for other social categories. Revised contributions and benefits were to make the new funds financially viable, while offering a wider range of choice in the types of available coverage (including, for instance, the possibility of unemployment insurance). The long term objective was to create a universal system, to which all would contribute, unless needy or unemployed and which would provide benefits on proof of contribution or exemption from the obligation to contribute. Several studies were to be prepared to help attain the basic objectives of the reform. 1.11 Consumer subsidies had been, in Tunisia, one major device used in an attempt to help the poor. However, they also benefited the better-off, resulted in high budgetary costs and remained politically sensitive. With the contemplated reform of the Social Security, protecting the poor would progressively switch from food subsidies to different kinds of protection. A program for reducing subsidies was adopted in 1990, which took into account: (a) continuing price increases, (b) cost reduction and (c) improving the selection of products (those consumed by the poor) that would still be subsidized. 1.12 External debt management needed improvements in order to establish a global long-term debt strategy and a short-term debt management which would facilitate Tunisia's access to financial markets. Three different entities had been responsible for managing debt policy'. This fragmentation was detrimental to: (a) a clear knowledge of the overall debt situation; (b) formulating a debt strategy; and (c) managing the debt through the use of modem hedging instruments. The reform program included the setting up of a high level policy committee which would unify the basic responsibilities, the creation of a unified debt data base and the Codes for Industry, Agriculture and Fishing, Services, International Trading Companies, Tourism, Housing. The Ministry of Planning and Regional Development, the Ministry of Finance, the Central Bank. 22 modernization of the legislation in order to facilitate hedging and sophisticated borrowing operations. Loan Amount, Tranching and Conditionality 1.13 The loan was made in the amount of US$250 million, to be disbursed in three tranches: US$ 100 million upon loan effectiveness (planned for end-1991); US$70 million after the completion of a first set of key actions (planned for end-1992); and US$80 million after the completion of a second set of key actions (planned for end-1993). Originally, the proposed loan amount was smaller (about US$150 million). But during appraisal, the Bank's assessment was that the reforms being pursued, especially those promised in relation to trade and industry reform, were sufficiently deep, and that it was agreed to raise the loan amount.9 1.14 The conditions for first tranche release were: a) Trade and prices. Liberalization was to be undertaken covering 15 percent of imports subject to quantitative restrictions and of products involving 10 percent of distribution margins. b) Financial markets. (i) The adoption of a four-year program for the redemption of the bons d'9quipement; (ii) issuance of new rules to permit banks to hold up to 20 percent of their deposits in any Treasury securities and not only bons d"quipement; (iii) the revision, in the Loi de Finances for 1992, of the taxation of financial instruments; and (iii) setting up of a new cap for bank's lending rates, based upon their average spread. c) Banking supervision and prudential regulation. The adoption by the Central Bank of: (i) a program to reinforce its supervision services; (ii) adequate provisioning and classification rules; (iii) definitions of audit practices to be imposed to financial institutions; (iv) measures requiring the banks to communicate quarterly their financial statements to the Central Bank; and (v) definition of the concept of group of related borrowers and fixing at 40 percent of bank's own funds of the loan concentration ceiling. d) Special incentives. The rates of preferential credits rediscounted at the Central Bank to be increased by 1 percentage point. 1.15 The conditions for the release of the second tranche were: a) Satisfactory macroeconomic framework; b) Liberalization of another 30 percent reduction in imports subject to quantitative restrictions (QRs) and liberalization of up to 40 percent of domestic distribution margins (weighted by the 1989 production level) The Operations Committee Meeting, after the meeting on the Initiating Memorandum, decided that the depth of reforms being planned justified an increase in the loan amount. See Staff Memorandum, dated September 27, 1991, on the Yellow Cover Meeting for the Presidents Report. 23 c) The promulgation and the implementation of the law concerning the taxation of financial instruments; d) New provisions in banking supervision and prudential regulation aimed at: (i) raising from 20 percent to 25 percent the tax exemption of specific provisions and interest suspension; (ii) decreasing to 35 percent the loan concentration limit; (iii) adopting auditing principles to be used by bank's auditors in line with international practices: (iv) presenting a satisfactory draft banking law to the Chamber of Deputies; (v) issuing a Central Bank circular on accounting and statistical documents to be furnished by the banks; (vi) achieving a joint review of individual banks situation, and action plans designed to improve those of banks already audited; (vii) adopting a program of special audits for at least 2/3 of the assets of the banking system; and e) Revising the special incentives policy for investment along the following objectives: (i) limiting the duration and selectivity of tax advantages; (ii) reducing other financial advantages such as preferential credits; and f) Issuing guidelines for the investment of social security funds' reserves. 1.16 The conditions for the release of the third tranche were a) Satisfactory macroeconomic framework; b) Liberalization of all imports with the exception of certain agreed items and a new step in liberalizing the domestic distribution margins which covered at least 60 percent of distribution margins. c) The implementation of the program of redemption of the bons d'iquipement and the elimination of the cap on the spread of lending rates; d) The reduction to 25 percent of the loan concentration limit, with the obligation for banks to increase accordingly their capital if such limit is exceeded; the implementation of action plans designed to strengthen banks already audited; performing special audits of banks to complete the coverage of the banking system e) The adoption of a satisfactory unified Investment Code and the implementation of measures to reform the preferential credit system; and f) The adoption of a satisfactory program to reform the social security system. Relevance 1.17 The project was well integrated with the overall strategy of Tunisia's structural adjustment program. The trade and price liberalization was the centerpiece of the overall adjustment efforts. This was supported through earlier adjustment operations (ITPAL and SAL I). Fiscal and tax reforms were also an integral component of the adjustment program, together with efforts to reform the public enterprise sector and privatization (PERL). In all of these aspects of the adjustment program, progress was achieved. But the EFRSL was designed to 24 continue further reforms in trade and industry, at the same time that the needed reforms in the financial sector were to be adopted. The modernization of the financial system correctly addressed the issues of monitoring, with the required prudence and with appropriate rules, applying to a set of already diversified financial institutions which successfully went through its preliminary stage of liberalization. The objective of a more outward oriented economy required the revision and unification of the tax and financial advantages granted to foreign investors, and to put domestic and foreign investors on a more level ground. Reforming social security was a more ambitious and more far-reaching task. A few manageable short-term targets" were established, beginning with undertaking policy studies involving social security reform. Lastly, introducing a centralized external debt management system was important for macroeconomic stability and for gearing the economy to international financial markets. 2. Project Implementation Overview 2.1 The loan became effective on schedule (December 31, 1991, with the release of US$100 million equivalent). Delays in the preparation of action plans of audited banks, and protracted debates concerning the new Banking law and the new Investment code, caused the second tranche (US$ 70 million equivalent) to be released behind schedule (by nine months, in September 1993). The release of the third tranche (US$ 80 million equivalent) occurred one year later (September 1994) and the loan was closed on December 1994. The macroeconomic framework remained on track throughout the loan period. Progress was made in the liberalization of trade and prices, but not all of its objectives were met. Quantitative restrictions were kept for a number of products, going beyond the limited list allowed under the agreement. The Bank agreed to a waiver of the related conditionality. The codification and simplification of the investment code was undertaken, but the resulting investment code continued to have large fiscal concessions. Progress in studies towards the reform of the social security system was made, and the basic principles of its reform were formalized. But the expected reform of the system was not accomplished. In the context of the financial system reforms, the progress achieved was highly satisfactory. 2.2 The economy grew satisfactorily during the period, within the framework of relative macroeconomic stability. The average growth rate was 4.4 percent per year, as against the planned 4 percent. The fiscal deficit was kept within the level of 2.5 percent of GDP but the current account trade deficit was much higher than expected (average of 5.6 percent as against a target of 2.9 percent, for 1992-1993). This was due to a sluggish growth of exports, partly due to exogenous factors (e.g. a sluggish demand in Europe, the major export market of Tunisia). But the Government's reaction was appropriate (it devalued the dinar in 1993 and maintained a tight monetary policy). Fiscal and debt service ratios remained within targets and indicated appropriate fiscal management. 1o Definition of the objectives of the reform, drafting preparatory studies. setting guidelines for the investment of funds reserves, creation of a single identification number system. adoption of a long term program. etc. 25 Trade Reform 2.3 The trade reform component was designed to accomplish the removal of the remaining restrictions on trade and prices except for a few agreed items. In fact, most of these reforms should have been completed under the SAL, but slippage in implementation carried over to the program under the EFRSL. On the basis of Bank staff optimism that substantial trade liberalization and other reform goals would be achieved, the amount of the loan was increased." But the implementation of the trade reforms proved increasingly more difficult as highly protected domestic industries began to feel threatened directly by import competition. The Government met this opposition by delaying the program schedule. Trade reform, as a result, suffered a substantial slippage in implementation. The original timetable for trade liberalization was to complete the reforms substantially by 1991. The pace of this reform has been considerably slower, and, it was not achieved at the time of closing of the loan. 2.4 Thus, the objective of the removal of trade restrictions was not met. The Bank, however, accepted a request for waiver of the condition, recognizing that some progress was accomplished in trade liberalization and that a continued liberalization schedule would be pursued in relation to the GATT agreement and the negotiation of a free trade agreement with the Economic Union. 2.5 The Government adopted measures which effectively slowed down the timetable of the liberalization program, by: (a) issuing an order prior to the third tranche release which included a larger list of products covered by quantitative restrictions than originally anticipated under the loan agreement; (b) negotiating trade agreements that did not agree with the tariff rate level and timetable for the removal of trade restrictions envisioned in the adjustment program; and (c) extensively employing complementary provisional duties to raise the protection level. 2.6 Trade restrictions. Prior to the release of the third tranche, the Government issued (on August 29, 1994) an order which listed products subject to quantitative restrictions. The list went significantly beyond products related to "public health safety, national security, and environmental regulations," as permitted in the agreement. This list included many agricultural products (olive oil, nuts, potatoes, honey, vegetables, animal products, processed foods, wines); some artisan products (carpets. precious stones, jewelry); and automobiles." Also included under these restrictions were textile industry products. In pushing for a wider list of products, the authorities argued that trade restrictions on luxury imports were justified for balance of payments reasons. The Tunisian authorities contended that a "luxury" was a subjective definition to be taken in the light of country conditions; that, for instance, automobiles (which they included in trade restrictions) were luxuries in Tunisia, whatever their cylinder size, unlike in high income countries. For other products, quantitative restrictions were designed to extend protection to some weak industries until they were ready for competition. The Bank accepted the Government's estimates that these items covered by non-tariff restrictions protected about 25 H The loan amount was originally proposed for US$150 million, but as approved, it was for US$250 million, or US$100 million more. See footnote 9, previous section. Decree No. 94-1742 of August 29, 1994, issued by the Ministry of National Economy. As published in the Journal Officiel de la Ripublique Tunisienne. September 2, 1994 issue. pp. 1395-1456. Of the sixty pages of the Journal devoted to this order . 48 pages contained the listing of products, with their tariff nomenclatures and the description of the items. 26 percent of domestic production, and that it represented a major improvement over the 72 percent of domestic production covered in 1991.13 2.7 However, revised Staff estimates" of the degree of domestic production protected by the import restrictions indicate that the extent of liberalization is exaggerated. Using the negative list of imports exempted from liberalization in August 1994, and taking into account the special controls on energy products exerted by a state import monopoly on these products, the estimates showed little significant change in the extent of liberalization of imports in terms of domestic production between 1989 and 1992. These developments are shown in Table 2.1, especially part C. The liberalized imports affected 58 percent of agriculture and fishing in 1989, and this was even slightly lower, at 54 percent of domestic production in 1992, in view of the increase in restrictions. Liberalization affects only 53 percent of manufacturing production. Only 39 percent of textiles and leather production is free of import licensing. If existing restrictions on textile imports are eliminated (as promised), the liberalization of the textile and garments sector would reach 87 percent of production. As much as 60 percent of domestic production of processed foods manufacture is under heavy licensing regulations, even including olive oil, which is a major export and therefore hardly needs regulation. More than one half of the chemical sector is restricted through prior import authorization because of the contention that it is related to population health risks. 2.8 Trade liberalization schedule and agreement with third parties. The Government made trade commitments under the GATT Uruguay Round and concluded a free trade agreement with the European Union. In both cases, the tariff rates submitted (under GATT) and the timetable for liberalization (under the agreement with the EU) deviated widely from the original plans under the adjustment program supported by the Bank. 2.9 Tunisia acceded to GATT in 1990 and was a signatory to the Uruguay Round agreement in 1993. Therefore, it is a charter member of the World Trade Organization (WTO). In 1990, Tunisia adopted, upon accession to GATT, the Harmonized System of tariff classifications covering 6,052 headings at the seven digit level. In addition to tariff concessions for 909 tariff headings upon full accession, Tunisia made further concessions under the Uruguay Round, by binding another 2,900 lines of items at the seven digit level of the tariff classification. The tariff for agricultural products ranged from 25 percent and 200 percent nominal rates. The total items under the industrial tariff headings covered 2,330 items, or 51 percent of all non-agricultural headings. The bound duties for industrial items ranged from 27 percent to 43 percent, but excluding textiles on which a uniform rate of 90 percent was bound starting in 1996 and was to decline to 60 percent in year 2005. The total rate bindings made by Tunisia represented about 63 percent of all tariff items under the trade classification system, a phenomenon which is comparable to that made by other developing countries during the Uruguay Round. But these bound rates are very high for agriculture and textiles, in the judgment of the GATT review of 13 The use of percentage of domestic production covered by trade restrictions and distribution margins was utilized as a basis for calculating the liberalization of the economy. This was a roundabout method and depended on fixed production weights to estimate progress in liberalization . It would have been easier to eliminate products subject to trade restrictions and to distribution margins, a method relying on positive listing. In the audit of SAL, the method applied to calculate trade and price liberalization was described as difficult to monitor for purposes of supervision. See Tunisia SAL (Loan 2962), PAR, No. 12135, June 30, 1993. 14 See World Bank. Republic of Tunisia Towards the 21st Century. Country Economic Memorandum, October, 1995. Report No. 14375-TUN, vol. II, Annex II, "Competition Policies." 27 Tunisia's trade policies" and under the criteria on trade liberalization in the structural adjustment program. Table 2.1. Trade Liberalization, 1983-94. A. Number of Tariff Lines Liberalized 1983 1986 1987 1988 1989 1990 1994 Restricted Imports - Number of tariff lines 6598 7966 6781 5963 4747 4045 1646 - % of total number of lines 78.3 94.2 80.0 69.8 56.7 48.3 27.4 Unrestricted Imports - Number of tariff lines 1827 489 1694 2577 3629 4331 4367 -% of total number of lines 21.7 5.8 20.0 30.2 43.3 51.7 72.6 Total number of tariff lines 8425 8455 8475 8540 8376 8376 6013 B. Liberalized Imports as Percent of Total Imports 1987 1988 1989 1990 1991 1992 1993 Food 0.9 0.4 2.5 9.4 19.6 28.9 41.5 Energy 0.0 0.0 15.4 17.5 23.9 94.1 99.7 Raw Mat. & Semi-Processed 37.0 54.2 65.1 82.7 82.9 85.9 86.1 Capital Goods 40.5 69.6 77.9 73.5 76.2 94.6 80.3 Consumer Goods 41.2 31.7 54.9 66.1 78.9 91.0 70.4 Total 31.8 39.4 53.0 64.0 72.2 84.2 76.8 C. Liberalized Imports in Terms of Percent of Production Covered by Liberalization In terms of production weights In terms of production weights 1989 1992 (4) (2) % lib. if Activity (1) % if garments (3) garments Share (in %) included Share (in %) included Agriculture & Fishing 58.0 58.0 54.5 54.5 Manufacturing 54.1 64.9 52.8 65.0 - Agro-industry 41.5 41.5 38.7 38.7 - Construction materials 79.8 79.8 81.7 81.7 - Mechanical & electrical products 82.9 82.9 81.6 81.6 - Chemical products 47.1 47.1 49.9 49.9 - Textiles, clothing and leather products 41.2 86.2 39.1 86.8 - Other manufacturing products 69.7 69.7 69.1 69.1 Agriculture, Fishing and Manufacturing 54.9 63.6 53.2 62.6 Minerals and Energy 24.6 24.6 25.2 25.2 All Goods 51.1 58.8 50.4 58.9 Source: World Bank, Republic of Tunisia: Toward the 21st Century, CEM, Volume II, Annex II, Report No. 14373- TUN. 2.10 In granting the waiver requested by the Government for the removal of trade restrictions, the Bank accepted the argument that the remaining trade restrictions would be removed under the provision of the free trade agreement with the European Union and under GATT " lhii The findings of the GATT report is summarized in this CEM. 28 commitments. The free trade agreement with the European Union was signed on July, 17, 1995, and Tunisia became the first country in the North Africa region to sign such an agreement. Under this agreement, all remaining quantitative trade restrictions, except for some agriculture, processed foods, and some textile items, will be removed when the agreement takes effect. A phased removal of tariff protection will be undertaken covering several years. Nevertheless, the gradual removal of some tariff barriers even under the free trade agreement reflects the slow process of trade liberalization in Tunisia. It is estimated that the gains from entry into the free trade agreement are large (around 4.5 percent of GDP per year), provided that existing trade barriers for protected sectors are removed. 2.11 Temporary complementary duties. Under the loan agreement, "complementary provisional duties" could be used to help cushion the removal of trade restrictions by raising the level of tariffs during a transition period towards the lower tariff rates. The provisional duties are being used more widely now than originally planned. First utilized in 1991, the provisional duties were supposed to be used only for a transitional period of three years. But in 1995, after the closure of the loan, additional provisional tariffs covering more products were introduced. The mission could not obtain a list of products subject to temporary duties by the Directorate General in charge of collecting the customs duties, and was told that the Ministry of Industry prepared the list." The impact of provisional duties on the rate of industrial protection has been analyzed in the recent Country Economic Memorandum for Tunisia." The average nominal protection rate has risen to about 33 percent (in 1994), and additional complementary duties introduced in 1995 caused the overall average tariff to rise by another 2 percentage points to 35 percent for the whole economy. The program of tariff liberalization suggested an average nominal tariff rate of about 20 percent ad valorem to keep domestic industry relatively competitive. 2.12 Annex Table A2 shows the impact of these measures on the nominal rate of protection. When the complementary provisional duties are taken into account, the "adjusted" nominal rate of tariffs increased dramatically for protected industry lines. The average rate of protection has risen, as stated above, far above the expected average rate of protection anticipated under the adjustment program, and the dispersion of the tariff rates has widened again. Whereas, before, such dispersion was only from 0 percent to 43 percent, with the complementary duties, the dispersion of the duties have again widened, ranging from 0 percent to 73 percent. This is of course much narrower than the initial dispersion which ranged from 5 percent to 236 percent before the adoption of the adjustment program. 2.13 In conclusion, definite progress towards trade liberalization has been achieved. There is now more transparency in the protection of industry than at the start of the adjustment program. However, the objectives for trade reform under the structural adjustment program, which commenced in 1986 and continued through the EFRSL, have not yet been fully attained. It is clear that the original objective of full liberalization is far from being accomplished. From all indications, the Government commitment for trade reform has vacillated in the face of sector opposition. But the Government continues to declare support for a program of trade liberalization. 1 Previous experience (in earlier audits) of obtaining such lists from the Ministry often took more time than the mission had in the field. The files on supervision did not contain any information on this important detail. " World Bank, Republic of Tunisia: Towards the 21st Century. vol. II, Annex 11, pp.1-29. 29 2.14 Under the framework of the free trade agreement with the European Union and within the framework of the Uruguay Round and the World Trade Organization, the openness of the trade regime for Tunisia is likely to be firmly established and sustained. However, the trade liberalization program has been implemented at a much slower pace and, from the evidence so far, the emerging protection regime has shifted to a higher level than that conceived under the adjustment program. Financial Sector Reforms 2.15 The most remarkable progress achieved under EFRSL is the reform of the financial system. The implementation performance in this aspect of the reform program was highly satisfactory. 2.16 The outstanding amount of Bons d'dquipement has substantially and steadily declined since 1990. Table 2.2 shows the trend in the composition of government debt through the substitution of the Bons d'dquipement by two categories of Medium to Long term (MLT) Treasury bills, issued at market rates. The first category consists of Transferable MLT Treasury Bills (Bons du Trisor Cessibles: BTC), which are issued for maturities of 2, 3, 5 and 7 years with flexible interest rates'" . The second category is a new financial product introduced in November 16, 1993: the Bons du Trisor Nigociables en Bourse: BTN [Negotiable Treasury Bills]. These are registered securities, issued for maturities of 5 or 10 years at 9.5 percent or 10.5 percent respectively. As of October 1995, the outstanding value of MLT-BTCs amounted to 33.15 percent of Total Public Domestic Debt (TD 3,206.4 million). The outstanding value of BTNs amounted to 9.26 percent of Total Public Domestic Debt, while the remaining outstanding value of the Bons d'quipement declined to 11.93 percent of Total Public Domestic Debt (from 55.51 percent in 1990). The mandatory purchase by banks of Bons d'dquipement has been replaced by an auction process, resulting in higher yields for both the banks and the public. is As of July 1995 (compared to July 1994), the interest rate of BTC's subscriptions were: * 10 percent for 2-years BTCs (compared to 10.9375 as of July 1994) * 9.75 percent for 3-years BTCs (compared to 10.0 percent as of July 1994) * 10.125 percent for 5-years BTCs (compared to 10.0 percent as of July 1994) * 9.5 percent for 7-years BTCs (unchanged since 1974) 30 Table 2.2 Tunisian Public Domestic Debt (in million TD) 1990 1991 1992 1993 1994 1995d 19960 Short-Term Treasury Bills (TB) 448 592 650 824 591 300 300 Medium & Long-Term (TB) 0 212 340 650 1,210 1,576 1,666 LT Negotiable TB 0 0 0 95 241 461 675 Bons d'equipement 1,086 1,119 934 652 440 294 144 o.w. banks 755 753 625 418 n.a. n.a. n.a. o.w. other 331 366 309 234 n.a. n.a. n.a. Other Public Borrowings 59 66 190 148 119 87 58 Other Components of Domestic Public Indebtedness 363 440 536 617 543 616 6616 Total Domestic Public Debt 1,956 2,429 2,648 2,986 3,144 3,334 3,458 a As projected in the Loi de Finances for 1995. b Projections. Sources: Data provided the Ministry of Finance. 2.17 The taxation of financial instruments was revised with the objective of equalizing the tax treatment. A detailed picture of the new tax regime is provided in the Annex Table A2.3. The reform was first aimed at reducing the fiscal advantages granted to saving accounts. Since the Loi de Finance for 1992, the following changes have taken place: * interest payments received from special saving accounts" are deductible from the tax base up to an amount of TD 1,000 (subject to the payment of the minimum tax); otherwise they are subjected to a 15 percent withholding tax; * interest payments received from bonds issued after January 1, 1992 are deductible from the tax base up to an amount of TD 1,500 (subject to the payment of the minimum tax); otherwise they are submitted to a 15 percent withholding tax; anonymous bearer bonds pay a 25 percent withholding tax (which is a payment in full discharge from the tax obligation); * interest payments received from other fixed income financial investments (time deposits, savings bonds, Treasury bills) are submitted to a 15 percent regular withholding tax if registered, or to a 35 percent withholding tax (with full discharge from the tax obligation) if the instrument is anonymous (a bearer bond or bill); * Dividends from shares (or from assimilated securities) have been made tax free since January 1, 1990. In addition, subject to the payment of the minimum tax, purchases of shares of companies submitted to the Investment code are deductible from the tax basis within a range from 35 percent to 100 percent [70 percent if they are new shares issued on the primary market]. Realized capital gains on shares are tax free for individual entities, temporarily [from 1992 to 1996] tax free for banks [which have to freeze the capital gains during 5 years], and fully incorporated in the taxable basis for other legal entities. Realized capital gains on investments in mutual funds are tax free. 19 Those held with the Caisse National d'Epargne de Tunisie (CENT) or with banks. 31 Banking Reforms 2.18 As of August 31,1995, the Tunisian banking sector consisted of the following institutions: * A Central bank: Banque Centrale de Tunisie (BCT); * Deposit banks20 * Investment (Development) banks;" * Off-shore banks;22 * Foreign banks representative offices; * Leasing institutions;" and * One merchant bank25. 2.19 Until 1994, the Central Bank's powers were defined in very general terms. Amendments to the existing banking law" were introduced through a specific law" strengthening the regulation and supervision of banks. The extent of these changes are as follows: * define the conditions under which the banks (deposit banks, investment banks, and merchant banks-a new category created by the amendment law-) may grant 2o Namely: the (1) Arab-Tunisian Bank (ATB); (2) Banque Franco-Tunisienne (BFT); (3) Banque Nationale Agricole (BNA); (4) Banque du Sud, (5) Banque de Tunisie (BT); (6) Crddit Foncier & Commercial de Tunisie (Amen Bank); (7) Banque Internationale Arabe de Tunisie (BIAT); (8) Union Bancaire pour le Commerce et L'Industrie (UBCI); (9) Socidt6 Tunisienne de Banque; (10) Union Internationale de Banques (UIB); (11) Banque de 'Habitat (BH); and (12) Citibank (On-shore branch). 21 Namely: the (1) Banque de D6veloppement Economique de Tunisie (BDET); (2) Banque Nationale de Ddveloppement Touristique (BNDT); (3) Banque Tuniso-Koweitienne de D6veloppement (BTKD); (4) Banque Tuniso-S6oudienne d'Investissement et de D6veloppement (STUSID); (5) Banque de Coopdration du Maghreb Arabe (BCMA); (6) Banque Tuniso-Qatarie d'Investissement (BTQI); (7) Banque de Tunisie & des Emirats d'Investissement (BTEI) and (8) Banque Arabe Tuniso-Libyenne de Ddveloppement et de Commerce Ext6rieur (BTLD). 22 Namely: the (1) Beit Ettamouil Saoudi Tounsi (BEST); (2) North Africa International Bank (NAIB, subsidiary of BTLD); (3) Alubaf International Bank (ALUBAF, subsidiary of Alubaf IB -Bahrein-), (4) Union Tunisienne de Banques (UTB); (5) Tunis International Bank (TIB); (6) Loan and Investment Co (LINC); (7) Citibank (Off-shore branch), and (8) Arab Banking Corporation (ABC). 23 Namely: the (1) Bankers Trust Cy; (2) Arab Investment Cy; (3) Crddit Lyonnais and (4) Arab Banking Corporation. Namely: the (1) Union Tunisienne de Leasing; (2) Tunisie Leasing; (3) Compagnie Internationale de Leasing, (4) Arab Tunisian Leasing, and (5) Amen Lease. I.e.: International Maghreb Merchant Bank. 2 It is the Law No 67-51 of December 7, 1967 (Loi riglementant la profession bancaire). 27 Law No 94-25, of February 7, 1994 (Loi portant amendement b la Loi riglementant la profession bancaire). 32 credits to their clients (articles 5 to 6 bis-a new article-); * examine the applications for bank's licensing and registering; request, for this purpose, any kind of information deemed necessary (article 7); request the termination of a bank's license (article 10); * approve the valuation of a bank's capital in case of a merger of banks and grant permission to open or close bank branches (new drafting of article 15); * define (article 19 was fully rewritten and introduced entirely new provisions which did not exist before) the regulations to be followed by the banks in the area of prudential management, and more precisely, the regulations concerning: * the use of a bank's own funds; * the ratios between own funds and liabilities, * the ratios between own funds and financing granted to individual clients; * the mandatory reserves; * the liquidity ratios; and * more generally the risks incurred in the banking business; * The same (new) article 19 allows the Central Bank to sanction (with fines) the banks that would not comply with these rules; * make off-site and on-site inspection of banks (article 23 fully rewritten and completed in 1994). For this purpose, all banks must: * operate along the lines of accounting standards defined by the Central Bank; * submit, no later than 6 month after the closing of the fiscal year (Dec. 31), a balance sheet, an operating account and a profit and loss account, to their board of directors; * set up, in the course of each year, financial statements in accordance with standards defined by the Central Bank; * set up internal auditing procedures (an entirely new provision); * upon request of the Central Bank, have their accounts audited by external auditors (an entirely new provision); * provide the Central Bank with all documents and all kind of information allowing the Central Bank to verify their compliance with the existing regulations (an entirely new provision); and 33 * The same article also allows the Central Bank to impose fines on banks that would not comply (new provision). + to be immediately informed by the external auditors of any circumstance that could endanger the position of the bank or of its depositors. In addition, external auditors must report in writing to the Central Bank (in accordance with standards defined by it) their verifications and submit to the Central Bank a copy of their report to the bank's board (Article 23 bis, a new provision); * request the shareholders of a bank to provide the financial support required to restore its financial soundness, and/or organize the support of all the banks (article 26 bis, a new provision); * when required by the situation of a bank, to impose (a) a capital increase, (b) adequate provisioning, or to forbid any payment of dividend; and * to impose additional sanctions to banks non complying with the existing regulations (articles 27 to 29, fully redrafted , with the introduction of a new provision article 28 bis). 2.20 Significant among the Central Bank directives defining prudential standards23 were those pertaining to ratios on: general risk exposure; specific risk exposure; capital adequacy; currency exposure; and foreign exchange position. The capital adequacy ratios were defined according to the risk classification based on the bank's current loan portfolio, consistent with international standards. The model used for these ratios follows closely the standards set by the French central bank (Banque de France) and the guidelines recommended by the Bank of International Settlements (BIS). For instance, the specific risk exposure ratio, or loan concentration ceiling, is equivalent to the 40 percent, as in the French formula. The capital adequacy ratio is also closely allied to the French formula, and variations in the ratio applied depends on the definition of "risk-weighted assets", referring to the quality of the loan assets. Also, the 5 percent Tunisian ratio for capital adequacy is close to the 4 percent ratio recommended by the BIS for the first tier of capital assets. The foreign exchange position coverage ratios are derived from French equivalent formulas, but the Tunisian ratios are more conservative.29 Annex II gives a brief definitions of the exact formulas used for these ratios. 2.21 The list of ratios began to be introduced in 198930 with the objective of monitoring the activity of Tunisian banks. The new regulatory and supervisory framework was tested through 23 ,Circulaire aux banques". 29 Specifically, the Frfnch ratios for "currency-by-currency foreign exchange position coverage ratio" and the "overall foreign exchange position coverage ratio" are set at 15 percent and 40 percent, respectively, while the corresponding ratios used in Tunisia are more cautious, at 5 percent and 20 percent. See Appendix II, below, for the definitions of the formulas. 30 In 1989, the Central Bank issued a circular (Circulaire aux banques no 89-15) imposing to the banks a mandatory reserve ratio [40 percent of suspense accounts and capital accounts, 2 percent of other accounts (demand and time deposits, saving bonds, certificate of deposit, etc.)]; this ratio was further modified in 1990 (Circulaire aux banques no 90-02) and set up at 2 percent of all deposits received by the banks (with the exception of saving accounts related to housing, to projects, to investments) plus 100 percent of the increase in the related deposits. In May 1989, the Central Bank issued another circular (Circulaire aux banques n' 89-16) imposing to the banks a "priority activities ratio" 34 audits that have been systematically conducted on all Tunisian banks. The mission has been provided with a sample of auditors report". The analysis of such reports suggest that the auditing has been implemented very satisfactorily, in accordance with the most demanding international standards. For instance, in the case of BIAT, the auditors did verify (inter alia): * whether BIAT's accounts were (or were not) in line with international standards. They observed that the bank's financial statements did not include the required statement of cash flow and that the notes to financial statements were inadequate; * whether the bank's organization and internal auditing procedures were or not adequate for both the monitoring and follow up of credit risks, administrative risks and computer-related risks (they were considered as satisfactory); * whether the foreign exchange risk was borne by the bank in accordance with the Central Bank's regulation. Auditors did check that BIAT remained within the limits prescribed by the formulas (5) and (6), and * Whether BIAT complied or not with the provisions of the "circulaire 91-24"3 They noticed that the bank: (a) did comply, in 1994", with the provisions related to the general risk exposure ratio; (13) did.not comply with the provisions related to the loan concentration ceiling because four borrowers benefited from credits exceeding 25 percent of the bank's net own funds; (y) did comply with the provisions related to the risks related to the bank's managers, board members, shareholders having more than 10 percent of the bank's capital; (8) did comply with the capital adequacy ratio requirements since the bank's ratio amounted to 5.48 percent; and (e) did not comply with two additional provisions of the circulaire. 2.22 More generally, the systematic auditing exercise produced a good picture of the current situation of the banking system. It also created the opportunity to set up actions plan and implementation policies aimed at correcting the observed deficiencies. Most public banks (which were undercapitalized) have been subjected to these actions plans and their audits have exposed the underlying problems. The public banks continue to have problems as a result of their lending to public enterprises and their financing of commercial operations in the past. They will require further attention, through restructuring. BNA (through a doubling of its capital) should be fully rehabilitated by June 1996; the situation of STB is to be regularized by December 1995; some banks (e.g. UIB) have benefited from Central Bank's financial support for their restructuring. Most private banks which did not adequately provision against their risks have made appropriate corrections. Overall, the situation of the Tunisian banking system has improved significantly as a result of this systematic exercise. (ratio des activitis prioritaires) set up at 10 percent of [demand deposits, plus time deposits & saving bonds, plus saving deposits plus certificates of deposit]. 31 Those for BTKD (1993 and 1994, audit conducted by Ahmed Mansour & Associds, member of DELoiE-TOUCHE- TOMAHA7sU), BDET (1994, audit conducted by Finor and KPMG Audit (France), ) and BlAT (1994, audit conducted by A. Ben Amor, and R. Fourati member of KPMG TUNISIE). 32 See Annex II. Definitions of Ratios. 3 In 1994 the related risks amounted to 6.8 times the bank's own funds (i.e. well below 10 times). However, in 1993 the related risks amounted to 16.3 times the bank's own funds. 35 2.23 Notwithstanding these remarkable accomplishments, a few problems will need further attention. The issue of the Treasury's guarantee of the debt of public enterprises is such a problem. Until now, the Central bank has implemented a straightforward policy; its general principle is that (i) a bank's loans to the Central Bank or to the Government are systematically considered as current assets, and (ii) loans to public enterprises enter are classified as any other loan as soon as such loans become overdue. In most cases, the amount which is past due is 100 percent covered by the government guarantee and therefore the required provision (for instance 100 percent for a class-4 loan) is zero. In some cases however, the government guarantee is less than 100 percent and the remaining portion must be covered by other collateral (e.g. mortgages). 2.24 Two basic issues are raised by this procedure. First, the problem of the burden of default is transferred to the Treasury which becomes committed for considerable amounts of contingent liabilities. As long as there is no call upon these guarantees, the problem is only latent. However, because many public enterprises are in bad shape, a long term solution for the viability of such enterprises is needed. The Treasury's guarantee will eventually be called upon, thus creating a considerable pressure on the public finance. At this juncture, it is important to notice that the process of restructuring the economy is far from being over at the end of the EFRSL: developing the private sector and privatizing the public enterprises are next steps that must be undertaken. The privatization process will therefore require that the Treasury mobilize the guarantees provided to the public enterprises. The ultimate solution to the hidden burden of public enterprises on the banking system is to privatize them. In this way, the provisions for would become fully transparent. 2.25 Second, it seems that a controversy already started to develop between the Central Bank and the Ministry of Finance concerning the interpretation of the Article 10 (fourth paragraph) of the Central Bank's circulaire 91-2414. The Ministry of Finance considers that the Central Bank (and the external auditors who are obliged to comply with the Central Bank's rules) has thus underestimated both the extent of government guarantee and the value of physical assets provided as guarantees. As a result for instance, the Central Bank (and the external auditors) pointed out that BDET's provisions where short by 11 million TD with the result that BDET's net own funds were also inadequate, thus requiring the Government (which is the major shareholder of the bank, with 40.93 percent) and the other shareholders to decide upon a recapitalization of the bank. Globally, the issue of Government guarantees may trigger a chain reaction, capable of jeopardizing, through several bail outs of public enterprises and/or banks, the fragile equilibrium of Tunisian public finance. Interest Rate Policy 2.26 Interest rates were substantially liberalized over time. Through a series of measures covering more than seven years, the Central Bank removed restrictions on interest rates and on margins for lending. As a first step, in 1987, the setting of interest rates on credit were Cf. supra, para 2.12 (a) and footnote 33. The concerned paragraph stipulates that <<chattels and real estate provided as guarantees by the borrowers are considered as valid guarantees if and only if the related mortgage has been duly registered by the bank, and if independent and frequent valuations of such guarantees are available. In addition, the possibility of a quick liquidation at market prices must be ensured. ["Les biens meubles et immeubles donnis en garantie par les emprunteurs ne sont considdrgs comme des garanties valables que dans le cas o* la banque dispose d'une hypothique dAment enregistrde et que des dvaluations indipendantes et frdquentes de ces garanties sont disponibles. En outre, la possibilitid d'une liquidation rapide sur le marchi au prix ddvaluation doit 9tre assurde.'] 36 abandoned, with the exception of priority sectors. A cap was placed, however, on the margin which banks could charge, set at 3 percentage points above the money market rate. This cap was replaced in December 1991 with an "average" margin of 3 percentage points over the money market rate. In 1994, this last restriction was removed, and interest rates were fully liberalized for about 90 percent of all banks credits. Administered interest rates remain only for agriculture, few export operations and small and medium enterprises (SMEs). 2.27 In practice, however, the money market rate, which is used as a reference rate for some lending rates, is not freely determined. In most countries, this rate is variable and reflects the movements in the interest rate market. This is, however, not entirely the case in Tunisia. First, the money market rate has remained unchanged since December 1993. The minimum as well as the maximum rates have been "static" at 8.8125 percent". In fact, the Central Bank controls both the price and the relative "quantities" traded in a market which is not very liquid. Second, in the absence of a satisfactory secondary market for bonds (specially for BTNs), long term rates still lack an adequate and competitive fixing process. Special Incentives: Investment Code 2.28 Background. During almost thirty years of industrial promotion, investment promotion became increasingly complicated through the adoption of different laws to develop specific industries, sectors, activities, and regions. Moreover, the investment incentives often differed for different activities, so that investment promotion sometimes nullified the attractiveness for investment of important sectors. In addition, the incentives were quite generous and offered to a wide range of activities. This contributed to the erosion of the tax base. Almost 1 percent of GDP per year, representing about 4 percent of total fiscal revenues, was lost due to taxes foregone. It was estimated that, given the corporate income tax rate of 35 percent, the marginal effective tax rate for a given investment was practically zero percent. In addition, the policy of preferential interest rates on investment created a strong bias for companies to borrow from the banks rather than infuse their own equity to finance the investment. 2.29 Under the EFRSL, investment incentives were to be made simpler and more effective as instruments for encouraging investments and reducing the erosion of the tax base. In the past, special incentives were adopted partly to offset distortions in resource allocation created by the existing policy regime. Since these distortions were themselves being dismantled under the adjustment program, it was essential to complement the new investment policy with the appropriate provisions and to remove those that were no longer compelling. The new investment code also was needed to improve the climate for new foreign investment. All these reasons necessitated a reform of the investment code, through simplification, codification and rationalization. 2.30 Investment Code Reform. The objective of the investment code reform under the EFRSL was to replace the various incentives laws into a single, codified investment law, and to apply investment incentives uniformly among promoted sectors, which would also be narrowed down to a short list. By assuring neutrality of the incentives among promoted investments, they were expected to become more efficient in investment promotion. The reform of the investment incentives system started very well. A comprehensive and excellent study was carried out by 3 And the auction rate remained static as well as 7.875 percent. 37 Tunisian experts, which prepared the ground for the reform. This study proposed to replace the fragmented-"vertical" (sector-based) approach of the old investment promotion laws by a more functional-"horizontal" approach. This approach would target the objectives and reward investors pursuing them. 2.31 The resulting investment code, Law 93-120, approved in December, 1993, made possible a single law dealing with investment incentives. It is an improvement over the preceding regime, but it is not markedly superior. It continued to give generous fiscal incentives in comparison with international standards (for instance, 10 years tax holiday to exporters). It also continues to encourage a broad list of investments instead of a much shorter list. Originally, only the following objectives were proposed to be qualified for incentives: exports, regional development, acquisition of new technology, and protection of environment. The following sectors were however added as beneficiaries of incentives: agriculture, support activities (such as education, culture, scientific research, etc.), small enterprises, and new entrepreneurs. Moreover, the investment code continued to rely on sector committees (instead of a centralized body) for the approval and monitoring of the fiscal incentives. In general, it is anticipated that the new investment code will still result in a high level of tax revenues foregone. 2.32 The codification of the investment promotion provisions, however, allowed the elimination of various laws on the same subject and enabled a more uniform treatment of sectors promoted as far as fiscal incentives and other promotion instruments were concerned. The new investment code also improved the provisions for foreign direct investments. All export activities were made unrestricted for foreign investors, with the exception of agriculture. For agriculture, it opened the possibilities for the leasing of agricultural land, but not ownership. Under the new investment code, domestic producers are placed on a more equal footing with export companies, although they are still recognized as separate entities. This distinction still contributes to a lack of integration of the export industrial sector with the domestic industrial sector. 3. Bank And Borrower Performance 3.1 The Bank's performance was satisfactory in all stages of EFRSL, although there were some shortcomings. The Bank was prompt to respond to the Government's assistance request, with an identification mission starting in April 1991, an appraisal in July 1991 and a Board presentation in December 1991. The loan was well integrated within the adjustment program being implemented under the country assistance strategy and in the context of the Government's Eighth Five-Year Plan (1992-1996). In responding relatively quickly, however, the Bank integrated various reform components together, causing some complex programs of reform to be packaged in a single project. In retrospect, it would have been better to unbundle the components into two or even more separate pieces of reform, since the loan amount was large enough and almost twice as much as the average value of earlier adjustment operations. During loan preparation, there was optimism among Bank staff that the schedule of reforms would be on track. The Bank, however, had enough experience on previous adjustment operations in the country to know that trade reform was posing difficulties of implementation. 38 3.2 The Bank correctly diagnosed the importance of restructuring the financial system. The objective of modernizing and upgrading the working standards of the Tunisian banking sector was timely. In addition, the loan was supported by appropriate economic work. The Bank coordinated well with the IMF during loan preparation. Last but not least, the Bank was active and successful in looking for cofinancing, an activity which resulted in the supply of US$ 120 million by Japan Eximbank, and 40,000 ECUS (about US$50,000) from the EU. 3.3 The Bank's supervision performance was also satisfactory. Delays experienced in the release of the second and third tranche were probably warranted as part of the process of internalizing the reforms. To secure the success of the reforms, it was important to convince the involved Tunisian participants of the need to support the complex financial reforms calling for a change in banking law, a system of banking supervision, and action plans to raise prudential standards for banks. The Bank was overoptimistic in expecting a short time horizon for the reform of the social security system. Such reforms deal with critical problems deeply rooted in the social (and political) fabric, and need to be undertaken with great precaution, with the preliminary support of substantial analytical work, and within a time horizon much longer than the one which was initially considered. This largely explains why the social security reform fell short of initial expectations. It is unlikely that more staff inputs during supervision could have improved the pace of the social security reform process. 3.4 In retrospect, some of the supervision issues could have been smoothed out if the definition of "satisfactory performance" had been clarified upfront. This wording was used in several instances in tranche release conditionality, especially in relation to investment incentives and social security. The files did not show any specific guidelines on what constituted satisfactory performance in relation to the actions that were expected to be taken. This was particularly the case with the investment code. Also, although the standards for a satisfactory macroeconomic framework are well-known (external and fiscal balances and debt service ratio), those pertaining to structural measures are more problematic. In such a case, it was essential to define adequately the expectations on what would have constituted satisfactory performance. The Government's letter of development policy contained a general statement of goals and aspirations but did not spell out the commitments or expectations on the content of the measures to be taken by the Government. An example of this issue is related to the use of the recommendations of policy studies in terms of defining the expected actions related to satisfactory performance. The policy dialogue did not provide a link of these recommendations to the measures to be adopted. 3.5 On average, the Borrower's performance was satisfactory, especially because of the highly satisfactory performance on financial sector reforms. Because these were, in fact, initiated by the Tunisian Government, there was a high degree of program ownership. From the beginning to the end of the process, the Government remained highly committed to the objectives and substantially complied with the others. The Government even went further in several areas in the financial sector reforms. For instance: (a) since January 1995, it has introduced regulation for the merchant banking business, and since July 1994, leasing companies have been submitted to an equally adequate regulation; (b) a law, enacted on November 14, 1994, has initiated the necessary modernization of the stock market (the Bourse de Tunis) with the creation of : (i) a Conseil du marchi financier (a body in charge of regulating the market and protecting investors); (ii) the BVMT Cy (Bourse des Valeurs mobilires de Tunis S.A.), which is in charge of managing the market; and (iii) the Socit6 de dip6ts, de compensation et de riglement des titres which provides depository, custody, clearance and settlement services; (c) 39 new liberalization measures were introduced concerning the foreign exchange market (on March 1, 1994, of an inter-bank foreign exchange market, liberalization of foreign investments by Tunisian enterprises with net foreign exchange revenues, etc.). 3.6 With respect to the implementation of trade reforms, however, the Government's commitment to the agreed agenda was inadequate. The trade liberalization program had been defined in a succession of adjustment loans-ITPAL, SAL, and EFRSL. Each loan operation promised a bold schedule of trade liberalization, but delays in tranche releases had been experienced in part because actions were incomplete. The program kept moving forward partly as a result of the appraisal of the next slice of adjustment operations. Under the EFRSL, it can be said that some minor reversal of the trade reform program occurred, as a result of the long list of commodities made subject to trade restrictions and the higher (than expected) rate of tariff protection presently in effect, even if the trade reform agenda has moved forward significantly when compared with the highly protected regime and highly dirigiste distribution systems in effect in Tunisia before 1987. 4. Conclusions: Outcome, Sustainability and Performance 4.1 The outcome of this project is rated as satisfactory, its institutional development impact as modest, and sustainability as likely. Bank and Borrower performance are rated as satisfactory. 4.2 The outcome rating reflects overall performance, but the performance of different components was uneven. Some components of the reform program performed below expectations while others performed very well. 4.3 Overall economic management was very effective. The macroeconomic framework remained conducive to growth. Trade and fiscal imbalances were kept within reasonable bounds and inflation was minimal. The financial reforms enjoyed a high level of government ownership and their implementation was highly satisfactory. With the Bank's help, and also relying on technical assistance from other donors, the financial authorities were able to address the weakness of the financial system with appropriate remedial actions. New regulations based on international standards made it possible to undertake thorough audits of financial institutions. Professional capacity for audits within the accounting profession in the private sector helped to assure a high standard for these audits and made their findings credible and facilitated the task of provisioning for problem loans up to prudential standards. The financial reforms have had an influence on the behavior of the financial institutions, as a result of the new regulations and the accompanying supervision of the Central Bank. 4.4 The financial reforms cannot, however, make up for the remaining problems in other areas. For instance, the poor financial position of the public enterprise sector still has to be remedied. The treasury guarantee of the loans of public enterprises from public banks enabled these loans to be classified as current and hid the true financial condition of weak public enterprises within the books of the financial sector. It is clear that the Government now faces the task of undertaking a serious program of privatization in order to force these enterprises to be efficient and to take them out of the contingent liability of the treasury. 40 4.5 The trade and price liberalization program did not proceed as fast as predicted. The pace of implementation was slowed down by a weakening of the Government's commitment to implement the original pace of liberalization. Although some progress in trade liberalization was accomplished, and the recent agreements with GATT and the European Union are likely to strengthen a regime of openness in trade, the conditions for the removal of trade restrictions were not met and required a waiver of the corresponding condition. 4.6 The new investment code succeeded in applying the same special incentives for new investment under a single law. But the fiscal benefits accorded to promoted industries continues to be very generous and therefore has a high fiscal cost . Potential beneficiaries for investment incentives include a wider list of activities than was originally planned. An opportunity to improve the fiscal incentives regime was significantly missed. 4.7 The reform of social security was at best only announced as a future agenda for reform. The policy studies agreed upon under the project were undertaken but were delayed. The Bank was too optimistic in assuming that a major reform of social security could be undertaken within the schedule of the EFRSL. Social security reform will require more internal consultations and debate. 4.8 The EFRSL had no direct institutional development objectives. The financial sector reforms, however, installed a set of new regulations which will help to improve institutional capacity within the banking institutions. The institutional impact of the project is modest, but it is nonetheless important. 4.9 The Bank and Borrower performance are rated as satisfactory. Even though not all reforms contemplated under EFRSL were carried out with uniform success, all aspects of these reforms moved forward to those goals. The Bank's assistance, at the design stage and during supervision, helped to focus on the remaining structural reforms that had to be supported. The Bank also assisted in facilitating co-financing related to the reform program from other donors. The Borrower's pace was governed by the extent of its commitment to the reforms, as in the case of the financial reforms. Even in areas where some shortcomings were found in the level of Borrower ownership, the Government moved positively in advancing the agenda for reforms. 5. Lessons of Experience 5.1 The extent of Borrower ownership often varies among components of a structural reform package. Overall, the Government of Tunisia was committed to the program of reforms, and the pursuit of these reforms is demonstrated by satisfactory implementation of macroeconomic stabilization and of the financial reforms. But a number of reforms have lagged behind. In this operation, the trade reforms have been slower than planned. 5.2 Policy studies which are used as basis of recommendations for changes in policy should be linked more directly to conditionality or with side agreements that are relevant to satisfactory performance. When this is not undertaken, the actual outcome of the reform may deviate from what is envisioned. 41 5.3 It is not realistic to expect that reforms that touch on very complex social issues can be quickly implemented. The reform of the social security system is a case in point. Experience from other countries would suggest that reforming the social security system in the context of the objectives set out under EFRSL was too optimistic. And yet, the reform of the social security system was made an objective of the project, by the time of the third tranche. The policy studies undertaken to reform the social security system should be more widely exposed to discussion, and the dialogue with the Bank on this issue will require more time. r 43 Annex I Statistical Information Table A.1. Major Macroeconomic Indicators 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994* [1] Exchange rate (TD/US$, per. Av.) 0.8345 0.7940 0.8287 0.8578 0.9493 0.8783 0.9246 0.8844 1.0037 1.0116 [2] GDP at current prices (million TD) 6910 7021 7997 8685 9531 10798 11997 13754 14659 15928 [3] GDP Deflator (1990 = 100) 73.8 76.1 81.3 88.1 95.0 100.0 107.0 113.6 118.3 124.4 [4] GDP at 1990 prices 9359 9231 9840 9863 10035 10798 11209 12 103 12393 12808 [5] GDP growth rate 5.6% -1.4% 6.6% 0.2% 1.7% 7.6% 3.8% 8.0% 2.4% 3.3% [6] Curr. acc. bal. af. transf. (million $) -587.2 -618.4 -60.3 219.0 -117.0 -469.0 -464.0 -961.0 -905.0 [7] idem (million TD) -490.0 -491.0 -50.0 187.9 -111.1 -411.9 -429.0 -849.9 -908.3 -420.0 [8] Budget deficit (million TD) -354.2 -510.9 -372.1 -326.9 -411.6 -585.5 -497 -349 [9] Total Debt Service (million US$) n.a. 877 1 105 1 058 1 101 1 432 1 372 1 342 1 350 [10] Total Debt Service (million TD) n.a. 696 916 908 1 045 1 258 1 269 1 187 1 355 1360 Ratios 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994* [11] GDP growth rate 5.6% -1.4% 6.6% 0.2% 1.7% 7.6% 3.8% 8.0% 2.0% 3.8% [12] Curr. account balance/ GDP -7.1% -7.0% -0.6% 2.2% -1.2% -3.8% -3.6% -6.2% -6.2% -2.6% [13] Budget Deficit/ GDP 5.1% 7.3% 4.7% 3.8% 4.3% 5.4% 4.1% 2.5% 3.3% 2.6% [14] Debt service/ GDP 9.9% 11.5% 10.4% 11.0% 11.6% 10.6% 8.6% 9.2% 8.5% Sources: [1], IMF, International Financial Statistics (IFS), Oct. 1995., various issues. [2], 1985-1992: The World Bank, World Tables 1995,(WT-95); 1993-1994: IMF, IFS, October 1995. [3], 1985-1992, based upon WT 1995; 1993-1994, based upon IFS, Oct. 1995. [6], 1985-1987: WT-95; 1988-93: IFS, Oct. 1995. [7] = [6]*[1]. [8], 1985-1993: IFS, various issues. [9], The World Bank, World Debt Tables 1995. [10] = [9]*[1]. [13], 1993-1994: Banque Centrale de Tunisie, Rapport annuel 1994. 1994* = provisional figures. Annex 1 44 Table A.2. Nominal Protection Rates, 1994: With and without the effect of Provisional Complementary Duties (DCP) (In Percent) Nominal Protection Rates, 1994 Tariffs without DCP Tariffs with DCP Average Low High Average Low High Agriculture and Fishing 34.1 10 43.00 43.30 20.00 73.00 Agriculture and Livestock Production 34.4 10 43.00 42.40 10.00 73.00 Forestry and Logging 23.4 20 43.00 25.10 20.00 73.00 Fishing 39.8 0 43.00 41.50 20.00 73.00 Mining and Energy 22.9 0 43.00 23.10 0.00 73.00 Coal Mining 20 20 20.00 20.00 20.00 20.00 Crude Petroleum & Natural Gas 0 0 0.00 0.00 0.00 0.00 Metal Ore Mining 20 20 20.00 20.00 20.00 20.00 Other Mining 25.4 17 42.00 25.70 17.00 73.00 Manufacturing Total 30.7 0 43.00 33.10 0.00 73.00 Food, Beverages & Tobacco 37.5 15 43.00 42.10 15.00 73.00 Food Products 37.8 15 43.00 42.70 15.00 73.00 Beverages 39.7 20 43.00 40.80 20.00 73.00 Tobacco 38.5 34 43.00 38.50 34.00 43.00 Textiles, Wearing Apparel & Leather 39.1 17 43.00 43.00 17.00 43.00 Textiles 38.4 17 43.00 42.10 17.00 73.00 Wearing Apparel 42.4 20 43.00 72.00 50.00 73.00 Leather Products (exc. Footwear) 36.8 20 43.00 44.20 20.00 73.00 Footwear 41.8 31 43.00 62.30 31.00 73.00 Chemicals 24.5 0 43.00 25.80 0.00 73.00 Industrial Chemicals 23.2 15 43.00 23.30 15.00 73.00 Other Chemicals (Pharmaceuticals) 26.3 0 43.00 28.60 0.00 73.00 Refined Petroleum 9.1 0 43.00 9.90 0.00 73.00 Rubber Products 32.7 17 43.00 43.00 17.00 73.00 Plastic Products 38.3 20 43.00 38.60 20.00 53.00 Construction Materials, Ceramics,Glass 34.7 10 43.00 39.10 10.00 73.00 Basic Metal 25.4 0 43.00 25.80 0.00 63.00 Fabr.Metal Products, Mach.& Equip. 26.5 0 43.00 28.00 0.00 73.00 Fabricated metal products 35.3 0 43.00 28.00 0.00 73.00 Non-Elect. Mach. incl. Computers 19.3 0 43.00 20.40 0.00 73.00 Electrical Machinery 31.3 10 43.00 33.40 10.00 73.00 Transport Equipment 26.5 0 43.00 28.80 0.00 73.00 Prof. & Scientific Equipment 26.3 0 43.00 26.70 73.00 73.00 Other Manufacturing 37.2 10 43.00 38.80 10.00 73.00 Source: GATT, 1994 and Budget Law 1995; World Bank, Country Economic Memorandum, Report No. 14375-TUN, vol.II, Annex II 45 Annex I Table A.3. Taxation Of Financial Instruments Type of Financial Instrument Individual entities Legal entities I - Shares and assimilated instruments Ordinary shares and Preferred Stocks - Dividends Tax exemption Tax exemption - Capital gains realized Tax exemption Common law [banks are tax exempted with a 5-years gains freeze] Investment certificates Cf. Shares Cf Shares Fees Cf. Dividends Cf Dividends Tokens Cf. Dividends Cf Dividends II - Bonds and other similar instruments Ordinary bonds - Registered bonds 15% withholding tax 15% withholding tax (TD 1500 tax allowance) - Bearer bonds 25% withholding tax 25% withholding tax (with full discharge: w f d.) Earnings of legal entities tax exempted 20% withholding tax or exempted from corporate income tax (with full discharge: w fEd) Bonds issued under special saving accounts - with 5-years freeze 15% withholding tax (w.f.d.) - if withdrawal during the 5-years period additional 10% withholding tax (w.f d.) Participation certificates - Dividends * fixed part Cf. Bonds Cf Bonds * variable part Cf. Shares Cf Shares * Capital gains realized Cf. Shares Cf. Shares III - Investments in Mutual Funds * if option of withholding tax 20% withholding tax (w.f d.) * if not 15% withholding tax IV - Saving Accounts * Interests of Special Saving Accounts 15% withholding tax with CENT and Banks (with a TD 1000 tax allowance) * Savings/Investment Accounts 35% (of Tax base) Tax allowance 35% (of Tax base) Tax allowance for the subscribed amount for the subscribed amount * Savings/Projects Accounts 15% withholding tax, and 35% (of Tax base) Tax allowance for the subscribed amount, with a TD 5000 ceiling * Savings/Housing Accounts Tax exemption Annex 1 46 Table A.3. Taxation Of Financial Instruments (Cont.) Type offinancial Instrument Individual entities Legal entities IV - Money Market Instruments Certificates of Deposit Option: * 15% regular withholding tax * or 35% withholding tax (w.f.d.) Commercial paper Option: * 15% regular withholding tax * or 35% withholding tax (w.f d.) Transferable Treasury Bills * Registered 15% regular withholding tax 15% regular withholding tax * Bearer bills 35% withholding tax (w.fd.) 35% withholding tax (w f.d.) Registered Negotiable Treasury Bills 15% regular withholding tax 15% regular withholding tax Savings Bonds * Registered 15% regular withholding tax 15% regular withholding tax * Bearer bonds 35% withholding tax (w.f.d.) 35% withholding tax (w.f.d.) 47 Annex II Definitions of Various Regulatory and Supervision Ratios Per Central Bank directives, since 1991 Several Central Bank circulars defined the various ratios which are relevant to the regulation and supervision of the banking system. The technical definitions of these ratios are provided below: (a) The "circulaire aux banques no 91-24" has set up requirements related to risk exposure, assets classification, provisioning and the treatment of accrued interests: * A general risk exposure ratio [GRERb] has been defined, for a bank b, as: (1) GRERb \ (Rk\Rk o0.05*OFb)510*OFb, k where: GRERb= General risk exposure of bank b Rk = Risk related to the kth beneficiary (borrower), OFb = Net Own Funds of the bank b. * A specific risk exposure ceiling or loan concentration ceiling [SREC(j(k))] has been defined, for a bank b, as: (2) SREC(j(k))b \ R(k) < 0.4 * OFb32 where Rj(k) = j risk incurred by a single beneficiary k3. * A specific risk exposure ceiling related to vested interests34 [SREC(vi)] has been defined, for a bank b, as: (3) SREC(vi)b \ R, < 3 * OFb, Vi I where Ri = Risk related to vested interests. * A capital adequacy ratio (CARb), has been defined, for a bank b, as: (4) CARb \ OFb 0.05 RWAb , Annex H 32 The ceiling was further reduced to 0.25 * OFb as of January 1994. 33 The concept of single beneficiary (borrower) has been defined to include all members of a group. A group is, in turn, defined as comprising two, or more than two, legal persons with either (i) a common management, or (ii) direct commercial or financial links inducing an automatic and reciprocal transmission of difficulties, or (iii) mutual (direct or indirect) equity ownership involving some kind of control. those which are related to banks' managers or board members and/or to shareholders having with more than 10% of the bank's share capital. Annex ll 48 where RWAb = (Net) Risk weighted assets (on-balance sheet + off- balance sheet) of the bank b. Two articles give precise (and adequate) definitions of, (a) a bank's "Net Own Funds" (Article 5)35, (b) "risk related to a single beneficiary (borrower)"36 (Article 6), (g) "risk weighted assets"37 (Article 6). In addition, banks have to classify (and continuously monitor the classification of) their assets in accordance with new standards which have been put in line with 38 international ones . It is quite important to notice that this loan classification does not merely Net Own Funds are defined by (i) [Share capital, plus reserves, plus retained earnings, plus specific provisions non allocated to risks or to likely expenditures], minus (ii) [unpaid capital, plus treasury stocks, plus revaluation reserve, plus the estimated amount of insufficient risk provisioning]. 36 Risks related to a single beneficiary (borrower) include : (i) any kind of financial support (a credit, a leasing, an equity financing etc.) granted to a single beneficiary, less (ii) [the amount of guarantees provided (by the State, insurance companies, banks), plus the amount of collateral (deposits, marketable financial assets, etc.), plus the amount of provisioning]. Risk weighted assets of a bank b are calculated in accordance with the following table: - Assets with a 100 % weight: * on-balance sheet components : credits to ordinary clients (discounted paper, syndicated loans oranted to non-banks and non-Government clients, debit accounts, credits based on earmarKed funds, outstanding payments, doubtful loans), credit to the personnel, leasing, paid stocks, bonds (other than those issued by banks or specific financial intermediaries), partnership shares or accounts, net property and equipment, miscellaneous assets). * off-balance sheet components: standby commitments (foreign trade related acceptances, documentary credits opened, undrawn credits, customs duty bills, unpaid stocks). - Assets with a 25 % weight: * off-balance sheet components: other stand-by commitments. - Assets with a 20 % weight: * on-balance sheet components: financing granted to banks abroad (ordinary accounts, demand and time deposits, other), bonds issued by banks abroad. * off-balance sheet components: contingent commitments with banks or financial intermediaries abroad, counter-guarantees received from banks abroad. - Assets with a 10 % weight: Syndicated loans granted to foreign governments. - Assets with a 5 % weight: * on-balance sheet components: financing granted to Tunisian banks and Tunisian specialized financial intermediaries (Money market lending, ordinary accounts, demand and time deposits, other financing); bonds issued by Tunisian banks and specialized financial intermediaries; * off-balance sheet components: other contingent commitments with Tunisian banks or financial intermediaries, counter-guarantees received from Tunisian banks. 38 The new assets classification is defined as follows: * CURRENT ASSETS (Class 0): those for which the repayment on due date is almost certain and which are related to enterprises with (i) a sound financial situation based on recent information, (ii) a good management and satisfactory development prospects based on on-site inspection (iii) a current financing consistent with the needs of their major activity and with their repayment capacity. 49 Annex II derive from a mechanical exercise (e.g. counting the number of days past due) but requires that an analytical exercise is developed in order to identify the problems encountered by the concerned enterprise, a requirement which is consistent with international standards. In addition to the loan classification, the banks must adjust their provisioning policy in accordance with the following rules: Current assets and Class-1 assets: 0 %, Class-2 assets: 20 %, Class-3 assets: 50 %, Class-4 assets: 100 %. The amount of provision is calculated on the net value of the related asset (Gross asset value, minus the amount of guarantees39). (b) The "circulaire aux banques no 91-25" has made mandatory for banks to set up, on a quarterly basis, a profit and loss account in accordance with a detailed prescribed format, and to communicate this account to the Central Bank. (c) The << circulaire aux banques no 93-08 has further standardized and made more precise the accounting and statistical documents40 that must be transmitted to the Central Bank by the banks, on a monthly and quarterly basis. Analytical blank forms have been annexed to the < circulaire >>. (d) The << circulaire aux banques no 93-23 >> has defined terms of reference for the external auditors of Tunisian banks. It is expressly mentioned that the external auditors have to draw justified conclusions concerning: (i) the internal auditing procedures set up by a bank, (ii) the general accounting principles implemented, (iii) the bank's credit policy, debt collection policy and commitments follow-up policy, (iv) the valuation of on-balance sheet and off-balance sheet assets (further extended by a classification exercise), (iv) the accounting principles implemented for accrued interests and risk related provisions (in case of inadequacy of * CLASSIFIED ASSETS (Class I to 4): - Class-1 assets (assets requiring a specific follow up): those which are likely to be repaid on due date and which are related to enterprises with, at least, one of the following feature: (i) they belong to a problem economic sector, (ii) they have a deteriorating financial situation. - Class-2 assets (uncertain assets): those for which the repayment on due date is uncertain and which are related to enterprises with, at least, one of the following features: (i) they experience problems similar to enterprises mentioned in Class-1, (ii) their financing is no more consistent with their major activity, (iii) their financial situation cannot be assessed due to a lack of information, (iv) they experience management problems or conflicts of partnership, (v) they experience technical, commercial or suppliers' difficulties, (vi) their cash-flow is deteriorating, (vii) the repayment of principal and/or interests is overdue for more than 90 days but less than 180 days; - Class-3 assets (worrisome assets): those for which the repayment on due date is unlikely and which are related to enterprises with, at least, one of the following features: (i) they experience problems similar (but with a more acute degree) to enterprises mentioned in Class-2, (ii) their situation suggests likely losses requiring a serious action from the bank, (iii) the repayment of principal and/or interests is overdue for more than 180 days but less than 360 days. - Class-4 assets (jeopardized assets): those for which the repayment of principal and/or interests is overdue for more than 360 days, or those which must be accounted as losses. The value of such guarantees is further specified: guarantees provided by the State, the insurance companies, the banks or guarantees based on financial assets which may be traded or liquidated without loss of value are accounted for their full nominal value; guarantees based on physical assets are considered as valid only if a registered mortgage has been taken out and must be valued at a realistic market price. 40 Including the accounting principles which must be followed by the banks. Annex II 50 provisions, the auditors must calculate the additional provisions required), (v) the capital adequacy of the bank (in case of capital inadequacy, the auditors must make recommendations concerning the required additional capital) . In addition, external auditors must express their independent opinion and draft detailed reports concerning the bank's financial statements (end- year balance sheet, operating account, profit and loss account, statement of cash flow for the same fiscal year). These reports and opinions must comply with the standards set up by the 41 <<Ordre des experts comptables de Tunisie>> , the IASC (International Accounting Standards Committee) and the IFAC (International Federation of Accountants). (d) The < circulaire aux intermidiaires agreds no 94-02 >> is an implementation regulation42 designed to monitor the foreign exchange position of involved Tunisian financial intermediaries. The following additional prudential ratios have been defined for compliance by Tunisian financial intermediaries: * A currency-by-currency foreign exchange position coverage ratio (FEPC), which is defined, for a financial intermediary j, and for a currency c, as: FEPC (5) FEPC \ F 5% OF where: FEPjc = j's open foreign exchange position related to c, OFj = j's Net Own Funds. * An overall foreign exchange position coverage ratio (OFEPC43) which is defined as: FEPc (6) OFEPC \ <20% OF Association of Tunisian certified accountants. 42 designed to implement (i) the Law 93-48 (May 3, 1993) which has modified the legislation concerning the foreign exchanges, (ii) the decree 93-1696 (August 16, 1993) which introduced changes in the Foreign Trade and Foreign Exchange Code, and the <circulaire aux intermidiaires agrg6s 94-01> (February Ist, 1994) issued by the Central Bank as a general regulation of the foreign exchange market. 43 In the formula, the sum is calculated for the Tunisian dinar equivalent.
Groupe de la Banque mondiale · Project Performance Assessment Report
Tunisia - Economic and Financial Reforms Support Loan Project
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Banque mondiale