Mauritius - Public Expenditure Reform Loan Project

Document of THE WORLD BANK FOR OFFICIAL USE ONLY Report No.: P-75 1 8-MAS REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ONA PROPOSED PUBLIC EXPENDITURE REFORM LOAN IN THE AMOUNT OF US$40 MILLION TO THE REPUBLIC OF MAURITIUS April 3, 2002 Poverty Reduction and Economic Management 1 Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without Bank authorization.  REPUBLIC OF MAURITIUS FISCAL YEAR July 1 - June 30 CURRENCY EQUIVALENTS (as of April 2002) Currency Unit = Rupee (Rs.) US$1.00 = Rs. 30.3 ABBREVIATIONS ACP African Caribbean and Pacific IMF International Monetary Fund AGOA The African Growth and IMR Infant mortality rate Opportunity Act LRT Light railway transit CAS Country Assistance Strategy MFA Multifiber Arrangement CEB Central Electricity Board MDG Millennium Development Goals CFC Chlorofluorocarbon MIGA Multilateral Investment Guarantee Agency CPAR Country procurement assessment MMM Mouvemeni Militant Mauricien review DRS Debt reporting system MSM Mouvement Socialiste Militant ESW Economic and sectoral work MTEF Medium-term expenditure framework EPZ Export processing zones NEA Economic Agenda for the New Millennium FY Fiscal year NEAP National Environment Action Plan EU European Union NGO Non govenmmental organization GDP Gross Domestic Product ODA Official developmental assistance GEF Global Environment Facility OECD Organization of Economic Cooperation and Development GOM Govermment of Mauritius PER Public Expenditure Review HBS Household budget survey PERL Public Expenditure Reform Loan HCI Head Count Index PPP Purchasing power parity HSC Higher School Certificate STC State Trading Corporation IBRD International Bank of TFP Total factor productivity Reconstruction and Development ICT Information and Communication U.S. United States Technology IDA International Development WTO World Trade Organization Association IFC International Finance Corporation VAT Value Added Tax Vice President: Callisto E. Madavo, AFRVP Country Director: Hafez M. H. Ghanem, AFC08 Sector Managers: Philippe H. Le Houerou, AFTP1, Brian Levy, AFTPR Task Managers: Christos Kostopoulos, AFTPI, Guenter Heidenhof, AFTPR  FOR OFFICIAL USE ONLY REPUBLIC OF MAURITIUS PUBLIC EXPENDITURE REFORM LOAN Table of Contents I. INTRODUCTION .................1 II. RECENT ECONOMIC AND SOCIAL DEVELOPMENTS .2 III. AN ECONOMIC AGENDA FOR THE NEW MILLENNIUM (NEA) . 5 A. IMPROVING THE COMPETITIVENESS OF MAURITIUS' PRIVATE SECTOR ..6 B. INVESTING IN PEOPLE AND SOCIETY .8 C. PRESERVING MAURITIUS' FRAGILE ENVIRONMENT .11 D. IMPROVING ECONOMIC MANAGEMENT. 1 3 E. THE FIRST BUDGET UNDER THE NEA: 2001/2002 .14 F. SUBSEQUENT BUDGETS AND SUSTAINABILITY .15 IV. THE PROPOSED OPERATION .18 A. THE NEW COUNTRY ASSISTANCE STRATEGY . .18 B. THE PROPOSED OPERATION .19 C. MONITORING AND EVALUATION .24 D. BUDGETING AND FINANCIAL MANAGEMENT .26 E. RISKS.26 F. COORDINATION WITH THE IMF .27 V. RECOMENDATION .28 SCHEDULES SCHEDULE 1. LElTER OF DEVELOPMENT POLICY SCHEDULE 2. REFORM PROGRAM UNDER THE ECONOMIC AGENDA ANNEXES ANNEX 1. MAURITIUS - SELECTED INDICATORS TABLE ANNEX 2. MAURITIUS AT A GLANCE ANNEX 3. MAURITIUS SOCIAL INDICATORS MAP THE REPUBLIC OF MAURITIUS iii 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.  BOX Box 1 Preferential Trade Treatment of Mauritius TABLES Table I Mauritius: Key Economic Indicators Table 2 Unemployment Rates (Unadjusted) by Age Group and Gender, 1990 and 2000 Table 3 Predicted Magnitude of Sector Pressures on Environmental Resources for Mauritius Table 4 Historical Expenditures (1995/96 and 2000/01) and Allocation for 2001/02 Table 5 Mauritius: Bank Medium Term Projections Under the NEA Table 6 Anticipated Milestones in Priority Areas CHARTS Chart I Base Case - Growth 5.5% per annum; deficit reaches 3.5% of GDP by 2005/06. Chart 2 Low Case - Growth 3.5% per annum; deficit reaches 3.5% of GDP by 2005/06. - iv -  REPUBLIC OF MAURITIUS PUBLIC EXPENDITURE REFORM LOAN Loan and Program Summary Borrower: Republic of Mauritius Amount: US$40 million Description: The proposed Public Expenditure Reform Loan (PERL) would support the program of the Government of Mauritius as articulated in the Economic Agenda for the New Millennium (NEA) and the accompanying public finance reform. It will finance specific actions taken by the Government during budget year 2001/2002. The PERL would particularly focus on key reforms in education, training, poverty alleviation, environment and economic management. Complementary knowledge assistance would concentrate on human capital development and economic management. Benefits: The loan will assist the Government in implementing and sustaining its reform program that focuses on transforming Mauritius into a "high-tech high income service and knowledge economy" over the medium term. Risks: The three main risks of the proposed assistance are (i) a shortfall of political support in implementing far-reaching reforms specified in the NEA, (ii) Government may not meet its deficit targets, and (iii) potential capacity constraints of the public sector in meeting the vision of a high-tech knowledge economy outlined in the NEA. Poverty Category: C Estimated Disbursements: The loan will be disbursed in a single tranche to be released after the effectiveness of the loan agreement. Project ID Number: P075070   REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED PUBLIC EXPENDITURE REFORM LOAN TO THE REPUBLIC OF MAURITIUS 1. I submit for your approval the following report and recommendation on a proposed Public Expenditure Reform Loan to the Republic of Mauritius for US$40 million. The operation is intended to support the program of the Governnent of Mauritius as articulated in the Economic Agenda for the New Millennium (NEA) and the accompanying public finance reform.' The NEA aims to alter the development path of the country and assure Mauritius a place among high-income economies. I. INTRODUCTION 2. Mauritius is a strong economic performer. Since 1980, Mauritius has grown at an average annual rate of 5.5 percent, almost quadrupling its per capita income to US$3,800 and diversifying its economy from sugar to apparel manufacturing, tourism, and more recently financial services. The success of the Mauritian economy reflects the good governance and transparency that have been established over the past twenty years in the country. Mauritius' development has been based on a stable macroeconomic environment, a favorable investment climate, strong capitalization of preferential trade arrangements, and a comprehensive welfare system. 3. Mauritius is keen to stay on a high growth trajectory which would allow the country to increase the welfare of its people, especially those that are at risk of falling behind. The NEA aims to achieve this objective by developing Mauritius into a "high- tech high income service and knowledge economy" in about five year's time. 4. The proposed single-tranche Public Expenditure Reform Loan (PERL) aims to assist the Government in the first year of implementation of the NEA. Policy reforms under the NEA and complementary public investment concentrate on education, the environment, the operational framework for the private sector, economic management, and selected programs for poverty reduction. These activities jointly aim to lay the foundation for continued growth and increased welfare. 5. The Government has already taken key actions to implement the NEA. Such actions concern critical reforms to enhance competitiveness, improve the quality of education, prevent deterioration of the country's fragile environment, and improve economic management. These actions underline the commitment to implement the NEA in a sustainable macroeconomic framework. To assist in the implementation of the NEA, X The Economic Agenda for the New Millennium was presented to the National Assembly as part of the Budget Speech for the 2001/02 budget in June 2001. - 1 -  Government and the Bank have agreed on a work program, consisting of analytical and advisory services to support policy making in education, public expenditures, social policy and labor markets. These services, which would include a joint Public Expenditure Review, would pave the way for the discussion of a subsequent lending operation, in the second year of the implementation of the NEA, should financing be required. II. RECENT ECONOMIC AND SOCIAL DEVELOPMENTS 6. Mauritius' economy is buoyant. GDP grew strongly in the past two years (1999/00 and 2000/01) with modem sectors carrying the expansion. Non-sugar GDP growth averaged about 5.8 percent per annum for the two years 1999/00 and 2000/01.2 Manufacturing growth averaged about 6 percent per annum for both years, while tourism (hotels and restaurant services) grew at 4 percent and 14 percent in the two years respectively. Similarly, financial services recorded double digit expansion figures. The sugar sector, in contrast, has had uneven performance: it contracted by almost 50 percent in 1999/00 due to a drought and recovered in 2000/01. 7. The external current account balance improved significantly from 1999/00 (-1.6 percent of GDP) to 2000/01 (1.8 percent of GDP) mirroring sugar export proceeds. Since October 2000, the Mauritian Rupee has depreciated against the US Dollar, and since January 2001, it also depreciated against the Euro. Today, foreign exchange reserves of the Bank of Mauritius are above 3 months of imports. Between 1999/00 to 2000/01, the fiscal deficit has worsened (from -3.8 percent to -6.6 percent of GDP), largely due to lower tax revenues stemming from the implementation of WTO and regional trade agreements, and the relatively high level of expenditures maintained to meet economic and social needs. 8. Economic performance in 2001/02 is expected to be good. Mauritius' economy is likely to grow at 5.3 percent, relying on exceptional performance in the sugar (8 percent growth) and financial sectors (11 percent growth) and good performance of the Export Processing Zone (5 percent growth). The tourism sector stabilized in the aftermath of the September 11 events and is likely to close the fiscal year without a contraction. Cyclone Dina destroyed parts of the cane crop in the northern part of the island in January 2002. Crop damage is estimated at about 10-15 percent of total sugar output, causing a negative impact on GDP of at most 0.5 percent, which would materialize in fiscal year 2002/03. The external current account is expected to remain positive. 9. The strength of Mauritius' economy in the last two years, as presented in table 1, reflects the country's development over the past 20 years. During this period, structural change from the traditional sugar sector towards industry (especially apparel manufacturing) and services is noted. High investment and growth have gone hand in 2 Total GDP grew at 2.6 percent that in 1999/00 due to a drought, but recovered to 7.2 percent growth in 2000/01. In 2000/01 value added from the sugar sector amounted to 3.5 percent of GDP at factor cost and accounted for 20 percent of merchandise export earnings. -2 -  hand with a stable external debt situation (as can be witnessed by the stable external debt to GDP ratio) and moderately increasing domestic debt. Table 1. Mauritius: Key Economic Indicators Period averages (fiscal years) Estimates Projection 1981-85 1986-90 1991-95 1996-00 1999/00 2000/0la 2001/02 GDP growth (% per year) 5.1 6.9 5.0 5.4 2.6 7.2 5.3 Non-Sugar gr. (CY) 4.2 8.1 6.1 6.0 5.8 5.9 Changes in CPI (avg - % per year) 7.8 8.3 6.6 6.2 5.3 4.4 6.0 Per Capita Income (US$) 1,130 2,153 3,251 3,770 3,814 3,800 3,830 Share of value added Agriculture 15.7 13.9 10.4 7.9 5.9 6.3 6.5 Industry 27.0 33.1 32.6 31.5 31.6 31.2 31.1 Services 57.3 52.9 57.0 60.7 62.5 62.5 62.4 As percent of GDP Gross domestic investment 20.7 28.6 28.8 26.2 25.7 24.4 25.1 Gross domestic savings 18.8 25.3 24.3 24.4 23.7 25.3 25.3 Total revenue 22.4 23.3 20.1 19.6 20.4 18.3 18.3 Total expenditure 29.7 25.1 23.9 24.8 24.6 24.8 24.8 Overall fiscal balance -7.4 -1.8 -3.6 -5.0 -3.8 -6.6 -6.5 External current account balance -3.2 -0.6 -2.2 -0.9 -1.6 1.8 1.7 Total external debte 52.5 39.8 37.2 42.4 41.1 38.7 39.4 Domestic debt (central govt.) .. 27.0 31.8 39.6 41.6 43.7 44.9 Memo: Exchange rate (Rupees/US$) 12.7 14.1 17.1 23.9 25.5 27.6 30.4 REER (avg annual change)' .. .. -1.3 1.9 5.8 2.8 -3.3 Gross foreign reserves' 0.6 3.2 4.3 3.1 2.9 3.3 3.8 GDP in US$ millions 1117.9 2227.2 3527.4 4326.1 4423.8 4500.3 4537.3 Notes: (a) preliminary estimate; (b) for 1990 only; (c) includes ST debt, about 15 percent of GDP in 2000/01; (d) in months of imports; (e) Real Effective Exchange Rate, "minus" is depreciation. Also, CY denotes calendar years. Source: Government of Mauritius, IMF and Bank estimates and projections. 10. Mauritius achieved the structural transformation of its economy by capitalizing on the preferential trade agreements with the EU in the sugar and textile areas (box 1). Mauritius was able to take advantage of these opportunities because of its political stability, sound governance framework, and attractive investment environment. In the process, Mauritius developed a dual economy, highly open for the export sectors, but with protected domestic markets. Mauritius maintains a tri-partite approach to economic and social decision-making (Government-private sector-labor). The approach has helped to develop a comprehensive welfare system, which is a key instrument in helping make Mauritians stakeholders in the country's development. 3 Discussion of the role of institutions in the development process of Mauritius is presented in Subramanien and Roy (2001) Who Can Explain the Mauritian Miracle: Meade, Romer, Sachs or Rodrik? IMF Working Paper August 2001. -3 -  Box 1. Preferential Trade Treatment of Mauritius Sugar. The EU Sugar Protocol (SP) provides Mauritius with a guaranteed quota for sugar of 507,000 tons annually. The EU-ACP Special Preferential Agreement for Sugar (SPS) (1995) foresees additional 85,000 tons at 85 percent of the SP quota. In addition, the US Sugar Program provides Mauritius with a quota of 15,000 tons to the US market. Sugar revenues account for approximately 2-4 percent of GDP per year and about a fifth of merchandise export earnings. Since January 1999 the abolition of the Green rates for EU currencies and exchange rate fluctuations has led to an 18 percent decline in the Rupee price for the 2000 sugar harvest. With production costs at 25-50 percent above competitors, Mauritius will have to adjust. Concurrently, under the Everything But Arms initiative, which granted duty free and quota free access to 48 least developing countries to EU markets, Mauritius has its SP quota cut in half for 2001/02; transitional arrangements for sugar under the SP, which are being worked out, will expire in 2009. Textiles. Mauritius has also benefited from preferential trade treatment by the EU for its textile exports under the Lome Convention by which ACP countries are granted duty free and quota free access to the European markets. Non ACP countries, including Mauritius' competitions in the Far East have been subjected to tariffs and quotas under the Multi-Fiber Agreement (MFA). The preferential status will end by December 2004. With unit labor costs in Mauritius 3-4 times higher than those of Asian competitors Mauritius is facing a significant challenge for its market share and revenues. The US Africa Growth and Opportunity Act (AGOA 2000), which provides for quota-free access to apparel import from sub-Saharan Africa is likely to mitigate or eliminate the impact of the termination of the MFA by 2004. The preferential treatment is expected to lead to a 17 percent increase in exports by 2005 and to a 30 percent increase in exports through 2008 when AGOA expires. 11. Social development has accompanied the economic boom of the past 20 years. Life expectancy of women increased from 66 years (1971) to 75.3 years (2000); life expectancy of men from 61 years (1971) to 67 years (2000). Over the last decade, functional literacy was raised from 80.8 to 85 percent. Impressive reductions in maternal and infant mortality have been realized, and communicable diseases have been eliminated. Primary education attendance is universal today. 12. Although poverty is overall modest, several groups in society are at a higher risk of being poorer than others, with Rodrigues having a higher concentration of poor than the rest of the country. Based on the latest available household expenditure survey (1996/97), it is estimated that about 9.4 percent of the population is poor.4 One parent families with children are four times more likely to be poor than two parent families. Similarly, the poverty rate for the elderly living alone is three times as high as those being able to benefit from living arrangements with extended families. 13. The recent rise of unemployment is causing increasing concern among policy makers. From 1990 to 2000, the rate of unemployment (unadjusted) almost doubled, from 5.6 percent to 9.6 percent. Job creation fell short of the demand for labor especially as the female participation rate in the labor market increased strongly. In 2000, youth unemployment rates were extremely high, reaching 40 percent for the age group below 20. In the same year, two-thirds of the unemployed were younger than 25, first-time job 4 World Bank estimate based on a relative poverty approach where the poverty line is defined as one-half of median monthly equivalized per capita income. -4 -  seekers, and without technical or vocational training. These young Mauritians have been at considerable risk of being left behind in a more and more prosperous society. Table 2. Unemployment rates (unadjusted) by age group and gender, 1990 and 2000 1990 2000 Female Male Total Female Male Total Age group (percent of age cohort) 15-19 14.0 23.7 20.4 39.4 42.0 41.1 20-24 9.6 11.9 11.2 20.2 21.5 20.9 25-29 5.1 5.2 5.1 8.7 7.9 8.2 30-34 3.1 2.4 2.6 7.3 4.5 5.4 All age groups 5.1 5.9 56b 10.1 8.8 9.6 olwfirst timejob seekers' 86.7 82.9 86.7 70.5 61.0 67.0 o/w without any training' 88.9 96.5 94.4 91.8 94.0 93.2 Notes: (a) percent of unemployed; (b) for comparison, the adjusted unemployment rate for 1990 was 2.8 percent. Source: Mauritius Population Census, 1990 and 2000 ; staff calculations. 14. Poverty and unemployment are intrinsically linked to education. While Mauritius has achieved universal primary school attendance, drop out and failure rates are high. There are also significant failure rates linked to the selective and competitive completion examinations at the pimary school level and after the first cycle of secondary school. Of the total adult population roughly about a third have failed or have not even taken the primary school exam, indicating the need for upgrading the basic professional skills of the labor force. About 60 percent of Mauritius' 12-19 year age group are enrolled in secondary schools and colleges; however, more than one third of those starting secondary education fail to pass the exams. The majority of these failures are among students from lower income households. An analysis of poverty shows that the largest part of poverty risks are explained by the educational background of the household head rather than household structure or geographical location. Similarly, evidence shows that students failing in secondary school examinations are more than thirty percent more likely to become unemployed than students successfully completing the cycle. III. AN ECONOMIC AGENDA FOR THE NEW MILLENNIUM (NEA) 15. The Government designed the NEA (June 2001) to achieve high and inclusive economic growth while addressing the economic and social challenges the country faces. Mauritius is aiming to become a "high-tech high income service and knowledge economy" in about five years time. To achieve the country's development objectives, the NEA encompasses reforms to: (i) improve the competitiveness of Mauritius' private sector, (ii) invest in people and society, including in poverty alleviation, (iii) preserve and protect Mauritius' fragile environment; (iv) modernize the country's economic management. -5-  The NEA accompanied the budget for 2001/2002 which prioritizes capital expenditures in line with the above objectives. The budget is anchored in a stable macro-economic framework, ensuring sustainable deficits and debt paths in the next years. A. Improving the Competitiveness of Mauritius' Private Sector Objectives and Strategies 16. The NEA aims to increase economic efficiency by (i) streamlining incentives and improving the operational framework for the private sector, (ii) improving the functioning of factor markets, (iii) rendering the markets for utilities more competitive and improving transportation infrastructure; and (iv) engaging in structural reforms in specific sectors. In doing so, Mauritius is seeking to gradually reduce the segmentation of its economy and increase its competitiveness in world markets. 17. Streamlining of incentives and improving the operational framework for the private sector. Mauritius has long maintained differential corporate tax rates, and differential customs duties on raw materials and intermediate inputs, for the export and domestic sectors. In addition, Mauritius has attracted offshore companies by offering an attractive tax regime. The NEA foresees a comprehensive reform of the regulatory framework to rationalize and consolidate the regulations for onshore and offshore companies. 18. Improving the functioning offactor markets. Mauritius is seeking to introduce greater flexibility in the labor market and to assist the private sector to better respond to market needs within the framework of the existing tripartite wage negotiation mechanism. To increase mobility, a review and reform of the rigid wage structure (which determines wages by function and sector) is planned. Financial sector reform encompasses designing a regulatory structure for the non-banking financial sector, and strengthening supervision in banking and the stock exchange. The NEA also aims to gradually improve the functioning of the land market by lowering restrictions on the alternative use of cane land. 19. Rendering the markets for utilities more competitive and improving transportation infrastructure. The Government aims to reduce communications costs (and connectivity fees) and to improve effectiveness of the public transportation infrastructure. This would be accomplished by seeking strategic partnerships for Mauritius parastatal enterprises. 20. Engaging in sectoral reforms. The NEA includes important reforms for the country's traditional economic sectors as well as for information technology, a new sector under development. These reforms aim to (i) reduce production costs of sugar; (ii) provide incentives for agricultural diversification; (iii) increase value added of the textile sector by vertically integrating and specializing in higher value added activities, while moving overseas the lower value added activities; (iv) further increase expenditures per tourist. In the near future, a fiber optic cable will link Mauritius to Asia, Southem Africa, - 6-  and Europe. This would provide the bilingual country - with its time-zone location between Europe and Asia - an entry into the expanding information technology market. Program Actions in 2001/02 21. In the first year of implementation of the NEA, Government has taken actions to improve the competitiveness of the economy. Regarding the incentives framework, Government has (i) established a uniform tariff rate for intermediate inputs for almost all sectors; (ii) reduced the import-weighted average tariff from 32 percent to about 12 percent (at substantial fiscal cost)5; (iii) implemented the Companies Act (May 2001; effective December 2001) which addresses registration, incorporation, issuance of shares and debentures, responsibilities of directors, and similar issues for all economic sectors; (iv) set up a Committee on Corporate Governance to ensure that financial and equity markets function efficiently. 6 In parallel, the private sector's representative body, the Joint Economic Council, drafted a Code of Conduct for private sector operators. 22. Government has undertaken a number of financial sector reforms. The Financial Services Development Act (May 2001) has been enacted, allowing for the creation of a non-banking financial sector regulator (eventually under the Bank of Mauritius) covering insurance, stock market, securities insurance, and pensions. A Financial Services Commission has been established and is operational since December 2001 to oversee the implementation of the Act. A Trusts Act (to ease asset management), a Financial Intelligence and Anti-Money Laundering Act, and a Prevention of Corruption Act have also been passed. The strength of the banking sector is underlined by a relatively low share of non-performing loans in bank portfolios (9 percent). 23. In the area of utilities and infrastructure, Mauritius has (i) adjusted the domestic prices for petroleum products to reflect world market levels in order to reduce the financial losses of the State Trading Corporation; (ii) significantly increased the electricity tariffs to reduce the financial deficit of the Central Electricity Board, (iii) passed the Freeport Act (July 2001) which clarifies the role of Mauritius Freeport Authority as the regulator of freeport activities, whereas all commercial activities are left with independent operators and developers. The telecommunications market is expected to be fully liberalized by December 2003 (40 percent of Mauritius Telecom was sold to France Telecom in November 2000). 24. Two fundamental sectoral reforms are ongoing in the current program year. First, Mauritius has undertaken a fundamental restructuring of the sugar sector. The Sugar 5 The simple average of Mauritius' customs tariff rates on imports from scheduled territories was 19.4 percent for 2000 compared to 29 percent for 1994. The WTO estimates that the simple average of Mauritius' MFN tariff for 2000/01 was 19.9 percent. For 2000/01, 55 percent of the 5,499 tariff lines were zero-rates compared to 28 percent in July 1999. Source: Mauritius Trade Policy Review Report by the WTO Secretariat, November 2001. 6 In cooperation with UNCTAD, Mauritius is currently undertaking a review of its fiscal incentives regimes (report expected in the second half of 2002) The review is expected to cover the multiple incentive regimes applying to the real sector (including EPZ and information technology) and to the financial sector (including off-shore activities). -7-  Sector Strategic Plan (SSSP, September 2001) entails early voluntary retirement of employees (8,000 or about one quarter of the sugar sector labor force) and the conversion of sugar land for alternative uses (land will be given to the government and beneficiaries of the voluntary retirement scheme). A five-year Rs. 2 billion loan from Bank of Mauritius via commercial banks to the private sector will help smooth transition costs. Some smaller (less efficient) sugar plants are to be closed and processing will be centralized in larger establishments. 25. Second, Government has created Business Parks of Mauritius Limited (BPML) as a parastatal entity to develop the information technology sector. BPML is promoting Mauritius as a bi-lingual location (providing Asian firms with access to francophone markets) and benefiting from a time zone in between the US and Asia. A seed loan has been obtained from the government of India in the amount of US$100 million. Construction of the business park is expected to begin in May 2002, on cane land recently converted via the Sugar Sector Strategic Plan. The CyberCity will contain its own independent satellite link. BPML is expected to be financially independent in two years' time. B. Investing in People and Society Objectives and Strategies 26. Mauritius has succeeded in increasing the longevity of its population by 10 years since the late 1970s and eliminated communicable diseases. It has also achieved universal primary education. Mauritius has accomplished these gains by raising employment and wages, as well as by establishing a comprehensive welfare system. 27. The welfare system provides free education, free health care, a universal pension to everybody over 60, assistance to families with special needs, low cost housing, subsidies for rice and flour, social aid transfers, and entails several large micro-finance projects. The system is however costly -it absorbed about 12 percent of GDP last year, or almost half of recurrent expenditures- and requires substantial reforms as it has: (i) Not been able to significantly raise education levels, leading to a poorly equipped work force. A key problem is the elitist nature of the education system, which results in 20 to 25 percent of each cohort - especially those from weaker income groups - dropping out without adequate remedial schooling or vocational training, resulting in inadequate education for labor market entrants. The existing system is highly centralized, with students from all over the country competing for positions in selected secondary schools. It is inefficient as it encourages private after-hours tutoring to increase chances to pass classes and exams, and also to enter the best secondary schools. Partially due to the overly selective secondary school system, tertiary enrolment is low. (ii) Not met the changing demands of the population in health. These demands focus on the delivery of sophisticated tertiary health care such as cardiac and vascular - 8 -  surgery, renal dialysis, diabetes complications treatment, etc. At the same time, the health system has to cope with an increasing demand for general health services partly due to increasing living standards and an aging population, but also triggered by the "free-of-charge" policy. (iii) Not been able to contain costs of the basic pension. Mauritius has a three-tier pension system, with the basic pension designed as a non-contributory and universal pension, available to all Mauritians over 60. Costs of the scheme are mounting and projections show that the system would absorb twice its current share of GDP in 20 years and triple in 40 years.7 While the basic pension has succeeded in reducing old-age poverty, it still leaves a sizable portion of elderly households (about 30 percent) in poverty. In order to sustain costs, the Government will be required to rethink the universality of the basic pension. (iv) Been unable to effectively protect the most vulnerable in society. A wide variety of social assistance programs exist; including rice and flour subsidies, micro-credit schemes, and income support for individuals with special needs (ranging from spectacle subsidies to targeted income support for single, non-working mothers). Mauritius also maintains two large anti-poverty housing programs for low and very low income households. Little is known about the effectiveness of these welfare programs and about their contribution to poverty alleviation. Most of the programs are very small and have a low coverage of the target population. 28. Education sector reform and investment are the backbone of the NEA. Government has committed Mauritius to compulsory 1 -year education. Over the next few years, Mauritius aims to (i) raise educational attainment, (ii) narrow the existing educational gap to Mauritius' international competitors, (iii) provide greater opportunities for the poor with easier access to education, and (iv) improve its vocational and training system to equip and maintain an agile labor force. In vocational training, Mauritius aims to increase responsiveness of training to the private sector and also clarify regulator and provider issues. 29. In the health sector the NEA aims to raise private sector participation in health provision as a means to ensuring quality services while assuring sustainability. Although the HIV prevalence rate is very low, Mauritius is designing a national AIDS awareness campaign as part of a national multi-sector strategy. 30. The Government intends to modernize the pension system. Based on analytical work conducted with the Bank, it aims to (i) contain the fiscal cost of the basic pension, (ii) increase the returns to assets of the contributory scheme and thereby increase pension benefits to contributors at retirement, and (iii) establish a regulatory and supervisory framework for occupational schemes and voluntary individual provision. This would include the development of a financially viable pension system with adequate care for the poor and room for voluntary provision. 7Mauritius spent 3.5 percent of its GDP on the basic pension in 2000/01. -9-  31. To help those in need, Government intends to consolidate the existing social assistance programs. Government is planning to adopt a more targeted approach to social support which would move away from the categorical classifications and make access to social programs based on need. As a first step Government will conduct a comprehensive assessment of the effectiveness of existing programs. The Program for 2001/02 32. Government has decided to reform the education system as outlined under the NEA. The most important policy decision has been the extension of the compulsory education from 6 to 11 years of schooling (to be fully implemented by 2005), which paves the way for a comprehensive adjustment of the education system. Government has also provided the necessary budgetary resources to meet program needs. Actions that have been launched include (i) the revision of the curriculum at the primary level (ii) the construction of 6 new secondary schools (out of 16 planned), the design of tenders for equipment of 354 computer laboratories in primary schools, and the extension of infrastructures and facilities for the tertiary education, and (iii) the recruitment of additional 730 teachers (of which 330 for ICT) for implementing the education reform program. 33. Additional activities are currently underway and include: (i) introduction of an early detection system to identify poor performers at an early stage with remedial assistance, (ii) change of the end-of-primary exam (CPE) to allow higher opportunities to enroll to secondary school level, (iii) provision of reading rooms, (iv) replacement of the existing centralized star-school system for secondary education by a regionalized one (5 regions for the country) for the first 5 years of secondary education, (v) pre-vocational training for the secondary level early drop-outs to prepare them better for the labor market, and (vi) extension of the University of Technology of Mauritius (UTM) to help transform Mauritius into a regional information and communication technology hub. 34. In the health sector, a High Level Task Force has produced a draft strategy and action plan based on initial work supported by a PHRD grant. The strategy proposes to maintain free health care for basic services while using health insurance for tertiary care and emergency services. Increase in medical staff and in provision of medicine, construction of a new hospital and modernization of existing infrastructure and equipment as well as institutional reforms complement the plan. 35. Regarding social assistance and poverty reduction programs, Mauritius launched a broad consultative process and developed an Action Plan for Poverty Alleviation (completed July 2001). A very important action to be taken is the in-depth review of the poverty impact and efficiency of the 10 largest welfare programs. The plan also entails several components, including: (i) micro-credit schemes, (ii) very low income housing, (iii) improved access to education for the poor (free transport and food in some deprived areas to encourage children to go to school), and (iv) an extensive public investment program in Rodrigues. - 10-  C. Preserving Mauritius' Fragile Environment Objectives and Strategies 36. Mauritius' economic development has significant consequences for the country's limited natural resources. Under the assumptions of continued economic growth stemming from the sugar sector (including development of high grade sugar), textiles (including moving to higher value added production), tourism and continued double digit growth of the remaining service sectors (financial and trade) environmental pressures are expected to grow significantly on land and soils, water and the coastal zone. Table 3, an excerpt from the National Environmental Strategies (NES, 1999) which proposes an action plan for the environment until 2010, presents an overview of the environrnental resources under pressure for the island of Mauritius. For Rodrigues, agriculture and fishing will put a heavy burden on land, soils, and the coastal zones. 37. To address these issues, the Government is building on the NES-proposed three- pronged approach: * On the erconomic side, Government is considering to (i) phase out fertilizer subsidies in agriculture, (ii) introduce cost recovery for environmental services, electricity, and water, (iii) review pricing of leases of land in the Pas Geometrique, and to (iv) use taxes and allowances to support environmental goals. * On the institutional side, Government will improve compliance with environmental legislation through voluntary agreements and incentives as well as through fines and penalties. * On the information management side, to raise awareness Government considers it critical to improve public disclosure of information on the state of the environment. Table 3. Predicted Magnitude of Sector Pressures on Environmental Resources for Mauritius Resources Landl Water Air Biodiv- Marine Coast. Sector soils ersity Envir. Zone Agriculture 0 0 0 0 Fishing 0 0 Industry/Energy 0 0 0 0 Tourism/Recreation 0 0 0 Transport 0 0 0 0 Housing 0 0 Sewerage * 0 Solid waste 0 0 0 0 Other* Notes: *Non human; * large pressures; 0 medium pressures; 0 small pressures. Source: National Environmental Strategies for the Republic of Mauritius, Environmental Resources Management and Government of Mauritius, 1999. - 11 -  38. The NEA prioritizes Government's actions in three key sectors: management of solid waste, management of liquid waste and transportation: * Solid waste management: Government strategy focuses on maximizing the value from waste and minimizing waste production. Private sector involvement by partially contracting out collection, transfer, and disposal operations will be extended to other areas of solid waste management. Government will also modernize the institutional framework for the entire logistical chain (storage, collection, transfer, and disposal) and the structure of the cost recovery mechanisms. To achieve this objective an Integrated Solid Waste Management Program has been prepared. * Liquid waste management: Because of the threat posed by the use of soakage pits (80 percent of households are not connected to sewerage networks) to the underground water supply, the lagoon, and the marine environment, Government is proceeding with the rapid implementation of the National Sewerage Master Plan (NSMP). As part of a Sector Policy Letter (1998) Government will invest in wastewater laboratory facilities to enforce environmental standards, implement a phased revision of waste water tariffs based on metered water consumption, and ensure economic and financial sustainability of the sector through a country-wide connection program. The Wastewater Authority has been converted into a parastatal under the Wastewater Management Authority Act 2000. It is anticipated that - in accordance with the "Polluter Pays" principle - a Waste Water Surcharge Tax will be levied on industries over and above the monthly waste water tariff, in case of non-compliance with the waste water standards under the Environment Protection Act. . Transportation: Mauritius has an ambitious programme of developing the transport infrastructures of the country. A Transport Master Plan has been established that addresses issues of reduction of congestion, improvement of public transport, development of safety and minimization of costs. On the air transport, the objective is to extend airport capacity (in terms of passengers and freight) and turn Plaisance into a world-class airport. The Government is preparing an Air Transport Master Plan that will include the upgrade of the infrastructures and facilities, air traffic safety and consolidation of air routes. Finally, on the port side, Port-Louis is expecting to become a major center for trade. In this objective, the Port Master Plan will be updated and new infrastructures and activities will be identified. Productivity and efficiency are primarily sought with the identification of an international Strategic Alliance for Cargo Handling Corporation. Program Actions for 2001/02 39. In the areas of environment and transport the program for the year 2001/02 focuses on: (i) extending water distribution networks, (ii) initiating action for an incinerator plant for the treatment of solid waste -expected to be operational in 2005/06, - 12-  (iii) speeding up the construction of sewerage treatment plants, (iv) connecting households to the sewage network, (v) improving the road network, and (vi) on seeking a strategic alliance for Cargo Handling Corporation Ltd (CHCL). The Government also created an Environmental Police to monitor emission of pollutants. 40. To address the environmental problems on Rodrigues the Government aims to foster economic development for the island. The most significant feature in this context is the extensive public works program included in the present budget, which is expected to raise incomes as well as to reduce over-fishing of the lagoon and deforestation. D. Improving Economic Management8 Objectives and Strategies 41. The improvement of economic management has been a key element of the Government's strategy. Activities have so far focused on (i) designing and implementing fiscal and monetary policies, (ii) retaining sound budgetary control, and (iii) improving public procurement regulations, practices and fiduciary controls. The NEA aims to further enhance the quality and effectiveness of public expenditures to meet the needs of an increasingly sophisticated economy and to balance mounting fiscal pressures due to high expenditure needs. To achieve this, the NEA seeks to adopt a comprehensive approach to the role of Government in view of redefining the relationship between the public and the private sector as well as adjusting the institutional and procedural dimensions of government operations. In this context, Mauritius will need to refocus its civil service on improved service delivery to facilitate the development of an internationally competitive economy. Mauritius will also take a critical look at fiscal vulnerabilities, to minimize risk to its macroeconomic stability and assure a stable environment for the development of the financial sector. 9 42. The NEA has set course to modernize economic management and introduce second generation reforms. These will include a gradual change in the role of the public sector with greater emphasis on interaction among economic and social partners in important public policy decisions and on cost-efficiency centered decision-making. The Government intends to link expenditures to strategic objectives and monitor the impact of public expenditures. It will also develop and adopt a strategy to minimize fiscal vulnerability that includes the following elements: * Consolidated government accounts will be published and will include the various extra-budgetary operations; * Off-budgets funds associated with the Privatization Fund will be ceased; 8 Policy aspects of economic management, particularly related to the incentive structures in the economy, were discussed in Section III.A. This section addresses institutional aspects of economic management. 9 This will include central government debt (which stood at about 51 percent of GDP at end June 2001), parastatal debt guaranteed by the central government about 9 percent of GDP at end June 2001), extra- budgetary funds, pressures on social protection system (pensions in particular), directed credits (to the EPZ and the sugar sector), and tax expenditures. - 13 -  * Oversight and accountability of parastatals and other public bodies will be strengthened; * The system for procuring goods, works and services will be strengthened to enhance economy, efficiency and transparency; * A Medium Term Expenditure Framework (MTEF) will be developed; and * Estimate of tax expenditures will be published to inform the population about the cost of tax concessions and exemptions. Program Actions for 2001/02 43. Upon taking office, the Government focused on the following key areas: first, it adjusted the retail prices of petroleum products and electricity to avert losses of the State Trading Corporation and the Central Electricity Board. The 25-50 percent rise in petroleum prices sent an important signal about the future course of pricing policies. Second, under the Finance Act 2001, the VAT was increased from 10 tol2 percent. Third, off-budgets funds associated with the Privatization Fund were integrated into the annual budget. The Government also strengthened the management of the customs and excise department and has established a unit for large taxpayers. All these measures are expected to increase revenues by 1 percent of GDP in the 2001/02 budget and offset the revenue loses from WTO and other regional commitments in the same year. 44. Government has also focused on ensuring a stable macroeconomic enviromnent. A key element in this context is the decision to adopt a Medium Term Expenditure Framework. A High Level Committee (HLC), headed by the Financial Secretary of the Ministry of Finance, has been established which consists of all relevant stakeholders including the potential pilot ministries. The objective of the HLC is to design the scope of a MTEF for Mauritius. An action plan and timetable for piloting the MTEF is under preparation. To better coordinate and strengthen macroeconomic activities the Government has established a Macroeconomic Coordinating Committee and a Debt Management Unit in the Ministry of Finance. 45. Government has also initiated a review of the parastatal sector and is working in conjunction with the World Bank on a comprehensive assessment of fiscal risks. This analysis will constitute a first step to develop an adequate risk management strategy which includes improved monitoring, evaluation and future mitigation of fiscal risks. E. The First Budget Under the NEA: 2001/2002 46. The first budget to implement the NEA has allocated 25.2 percent of GDP to central government expenditures for 2001/02, compared to 24.3 percent of GDP spent in 2000/01. This represents an expected increase of 0.9 percent of GDP over the previous year's expenditures. In order to meet the wide range of reform objectives under the NEA, the higher budget envelope was also reprioritized relative to the previous year's expenditures. This resulted in increased allocations for four strategic priorities: education, the environment, infrastructure and poverty reduction programs. - 14-  47. Table 4 illustrates the priorities of the incremental allocation and confirms a gradual shift in overall expenditure priorities of the 2001/02 budget. The shift in functional priorities towards the social sectors entails a move towards more capital expenditures. The table indicates that of the 0.9 percent of GDP increase in expenditures, 1.9 percent of GDP (i.e. almost 200 percent of the increase) is allocated to community and social affairs while 1.0 percent of GDP was allocated away from other sectors. From a functional perspective there has been a 1.3 percent of GDP increase in the capital budget, as shown in the last column of table 4 below. This implies a reduction of the recurrent expenditures of 0.4 percent of GDP. Table 4. Historical Expenditures (1995/96 and 2000/01) and Allocation for 2001/02 Change in 2001/02 As Percent of GDP 1995/96 2000/01 2001/02 Total o/w Capital TOTAL EXPEND. (RECURR &CAPITAL) 23.8 24.3 25.2 0.9 1.3 Community and social affairs 11.6 11.9 13.7 1.9 1.5 Education 3.8 3.5 4.4 0.9 0.9 Health 2.0 1.9 2.0 0.1 0.1 Social Service & Welfare 4.1 4.5 4.6 0.1 0.1 Housing & Communities Amenities 1.3 1.7 2.2 0.5 0.4 Recreation & Cultural & Religious Affairs 0.4 0.4 0.5 0.1 0.1 Other expenditure 12.2 12.4 I .S -1.0 -0.2 General Public Service 2.5 2.3 2.2 -0.1 0.1 Defense & Public Order 2.5 2.0 2.1 0.1 0.1 Fuel & Energy 0.0 0.0 0.0 0.0 0.0 Agriculture, Forest., Fishing & Hunting 1.3 1.1 1.0 -0.1 0.0 Mining, Manufacture & Construction 0.2 0.2 0.1 -0.1 0.0 Transport & Communication 0.9 1.0 0.7 -0.3 -0.4 Other Economic Affairs & Services 4.8 5.8 5.3 -0.5 -0.2 Note: The figures presented in the column for actual expenditures for 2000/01 relative to GDP match the budgeted allocations for that year. Source: Government of Mauritius and Bank calculations. F. Subsequent Budgets adClnd :i_ Li r-'.-:! , >Fj9E 48. The significant investments identified in the NEA raise questions about the fiscal sustainability of the expenditure program and Mauritius' ability to maintain its creditworthiness. The total costs of the NEA were estimated at Rs. 50 billion, to be undertaken from 2001/02 through 2005/06; the total costs amount to about 40 percent of GDP of 2000/01. To maintain macroeconomic stability, Government has decided to prioritize and sequence the implementation of the NEA. It is currently anticipating to spend about Rs. 40 billion between 2001/02 and 2005/06 in capital investments (an average annual capital expenditure 80 percent higher than in 2000/01), while allowing Rs. 10 billion to be implemented after 2005/06. Governent's continued commitment to fiscal discipline and its capacity to further prioritize public expenditures and to raise additional revenues are key factors in maintaining macroeconomic stability under the current positive economic environment and in the event of a economic downturn. - 15 -  Specifically, Government is expected to maintain a higher rate of implementation of the NEA during high-growth and high revenue years relative to lower growth and lower revenue years that could occur under a potential downturn. 49. Short and medium term growth projections. In the short to medium term, Mauritius expects to maintain its strong economic performance with continued efforts to modernize, innovate and increase value added per worker. The sources of growth are expected to remain as today, i.e. sugar, textiles, tourism, and financial services, with the possible addition of information technology services. Drastic steps have already been taken to improve productivity in the sugar sector, so the sector is likely to stay healthy. The textile sector is expected to continue to grow as the preferential trade agreement (MFA) will not be phased out till 2008. It is also anticipated that Mauritius' exports to the US will gain importance enough to sustain the growth rate of the sector to about 5 percent. Tourism is expected to continue to perform well in the coming years. On the basis of the confidence generated by the new regulatory framework the financial sector is expected to continue its double-digit growth rates. With the establishment of a fiber optic infrastructure over the next year and the liberalization of the telecommunications market by the end of 2003 the ICT sector is projected to significantly gain economic importance. This scenario is presented in table 5. 50. Fiscal policy. Government is committed to implement the NEA in a sustainable macroeconomic framework. Table 5 presents a gradual and conservative assessment of the pace of deficit reduction given the Government's public commitment to reduce the central government deficit to about 3 percent of GDP by 2005/06. In the short term, government aims to .ol1solidate parts of recurrent expenditure, to keep total expenditures at about 25 percent of GDP. In the outer years, Mauritius aims to reduce pension expenditures and limit debt accumulation (and debt service) for highly prioritized investment needs. Capital expenditures under the NEA come to about 4-5 percent of GDP over the next 5 years, for the aforementioned Rs. 40 billion priority package. 51. To help meet its deficit targets, Government aims to undertake a significant revenue enhancement effort. There are several possibilities for raising revenues. The tax effort is now 15.6 percent of GDP (2001/2002), still among the lowest in upper middle income countries and there appears to be substantial room for raising taxes without affecting the competitiveness of the economy. Under the prospect of revenue losses due to regional trade commitments, Government is planning to broaden the tax base for import duties by reducing exemptions and improving tax administration (strengthening collection, audit and reporting to revenue departments). As stated above, VAT rates have already been raised from 10 to 12 percent and a further increase of indirect taxes could be contemplated. On direct taxation, the Government can limit exemptions as most corporate taxpayers are effectively paying 15 percent, compared to the statutory rate of 25 percent. Similarly, Government can incorporate most individuals into the tax scheme, as they are currently left outside it. Table 5 indicates that by 2005/06 Mauritius expects net increases in revenues of about 2.2 percent of GDP compared to the 2001/02 rates. - 16-  52. Given the current macroeconomic outlook, the central government debt path is sustainable. The base line scenario presented table 5 includes a significantly improved revenue effort which would finance an increase, in real terms, of central government capital expenditures while reducing the overall fiscal deficit gradually to about 3.5 percent of GDP by 2005/06. Under this scenario, central Government debt would be expected to peak at about 53.7 percent of GDP in 2003/04. As illustrated in chart 1, the debt/GDP ratio would decline thereafter, implying the sustainability of the borrowing strategy of the Government.10 Consequently, the implementation of NEA is expected to result in only a temporary increase in indebtedness. Similarly, central government debt service as share of government revenues would show a small increase till 2004/05 to about 23 percent, and decline thereafter. 53. A sensitivity analysis of the NEA program shows that the debt level is also sustainable in the event of lower domestic growth rates. Chart 2 presents a low-growth deficit-reduction scenario, in which the economy's growth rate drops to about 3.5 percent by the middle of the projection horizon and stays at such low level thereafter. If Government follows its deficit reduction strategy as well as planned revenue effort (as share of GDP), the debt/GDP ratio would peak on in 2005/2006 but decline thereafter. Chart 2 also visualizes the impact of such lower growth rates on public investment: with tax revenues lower and deficit targets to be met, real capital expenditures would have to decline quite strongly after 2003/2004 - which would necessitate a stringent prioritization of expenditures."I Table 5. Mauritius: Bank Medium Term Projections under the NEA 2001/02 2002/03 2003/04 2004/05 2005/06 GDP growth 5.3 4.6 5.5 5.3 5.5 As percent of GDP Gross Domestic Investment 25.1 25.8 26.0 26.3 26.3 Total gov. revenue 18.3 19.2 19.6 20.1 20.5 o/w new net revenue efforta .. (0.9) (1.4) (1.9) (2.6) Total gov. expenditure 24.8 25.2 25.1 24.6 24.0 o/w capital expenditure (4.9) (4.8) (4.8) (4.7) (4.5) Fiscal balance after grants -6.5 -6.0 -5.5 -4.5 -3.5 External CAB 1.7 1.0 0.6 0.8 1.0 Total external debt 39.4 37.0 34.6 32.7 30.2 of which: Central Gov. 6.0 7.4 8.5 8.1 7.7 Domestic debt 44.9 45.4 45.2 45.5 44.8 Memo: GDP in USD (million) 4,537 4,724 4,975 5,216 5,520 Note: (a) New net fiscal effort is defined from the 2001/02 budget henceforth. 10 This scenario assumes real interest rates at about 4 to 5 percent. Given that 90 percent of government debt has maturity less than two years and interest rates are globally expected to rise, a sensitivity analysis on the interest rate was undertaken. The interest rate in the aforementioned scenario was increased by 1-2 percent in the outer years. The analysis suggests that the peak government debt to GDP ratio is expected to be displaced by 2 years and reach 55.1 percent in the event the capital expenditures under the NEA are implemented as planned. " The simulations also confirm the importance of Government maintaining the planned reduction in the fiscal deficit. Should the growth rate drop and/or revenues and expenditures not be adjusted, the overall central government debt to GDP ratio would continue to rise throughout the forecast period. - 17-  Chart 1. Base Case - Growth 5.5% per annum; Chart 2. Low Case - Growth 3.5% per annum; deficit reaches 3.5% of GDP by 2005/6 deficit reaches 3.5% of GDP by 2005/6 60 8 60 8 x IA!~~~~~~4 40 2 40 2 2000 2005 2010 2000 2005 2010 -DebtVGDP -Ama caita Expand. Debt/GDP -Ann Capita Expwd. 54. Fiscal vulnerability. The task of reducing the central government fiscal deficit can become more difficult as Government seeks to reduce fiscal vulnerability by explicitly recognizing and incorporating into the budget fiscal obligations and risks to assets and revenues. A first step was the inclusion of various off-budget funds in the budget for 2001/02, which contributed to increasing the adjusted 2000/01 deficit by 2-3 percent of GDP, and brought it to 6.5 percent of GDP. To assure the sustainability of the current reform program the Govermnent has begun to (i) compile a consolidated fiscal deficit, which includes central government and the three largest parastatals, and to (ii) address the exposure of parastatals. In addition, with World Bank assistance, technical work on pensions has been initiated. External parastatal debt at the end of June 2001 stood at about 14.5 percent of GDP. The risks associated with this debt, and other contingent liabilities of GOM, will be addressed in forthcoming analytical work. IV. THE PROPOSED OPERATION A. The new Country Assistance Strategy 55. The proposed operation is the cornerstone of the new Country Assistance Strategy (CAS). In view of Mauritius' steadfast commitment to modernizing its economy and its demonstrated capacity to implement a development agenda, the new CAS proposes a paradigm shift: moving away from project assistance (with embedded technical assistance) and piecemeal analytical work towards (i) supporting Mauritius' overall government reform program under sequential umbrella lending operations and (ii) development of a complementary program of knowledge assistance. 56. The lending operations would assist the Government to implement its NEA. Under the new CAS, Bank financing would take the place of other non-project financing sources and would be linked to achievements that are considered critical for the success of Mauritius' reform program, in particular in the areas of education, environment, and economic management. - 18 -  57. The parallel knowledge assistance would be provided on the basis of (i) a pre- determined three-year program of formal analytical work and (ii) punctual strategic advice and feedback as the need arises. The knowledge assistance program will support the implementation of priority reforms and will focus on two themes: (i) human capital development and (ii) economic management. 58. The new CAS proposes a maximum of one umbrella operation per year of approximately US$40 million for the three-year CAS period, with an envelope of approximately US$120 million. The CAS envisages the preparation of a series of subsequent operations as the Government proceeds with the implementation of its reforms and as the financing need arises. The (up to three) operations intend to finance specific actions taken by the Government in the implementation of its NEA. B. The Proposed Operation 59. The present operation supports the program of the Government as articulated in the NEA, and in particular reforms in education, training, environment, infrastructure, and economic management. The program period covers the second half of 2000 through the budget year 2001/02. Objective 60. The overall aim of this operation is to support Government's reform program which aims to maintain the country's growth performance and improve welfare in an inclusive way. The program intends to facilitate the transition of Mauritius into a high- income high-tech service economy in the next 5 years by strengthening the private sector, investing in people, protecting the environment, and modernizing economic management. Areas of focus 61. Bank support is linked to specific achievements in selected areas which are specified in table 6 below. These areas are a subset of the detailed NEA reform agenda presented in schedule 2 which is attached to this document. Table 6 summarizes planned and intended achievements in these key areas prior to and beyond Board presentation. It also identifies the strategic goal and objectives for the interventions in these areas. - 19-  Table 6. Anticipated Milestones in Priority Areas Policy Actions Prior to Indicative Actions Objective/ Area Board FY 02/03 FY 03/04 Intended outcome Investing (i) Government (i) New examination (i) Improved Education and in People decision to extend the system for primary assessment and training system and compulsory education school exam (CPE) examination system has been Society - from 6 to 11 years of introduced based on in place successfully Educa- schooling to be fully grading instead of (ii) Modernized adjusted to meet tion and implemented by 2005 ranking to improve curricula for the requirements Training (ii) Budget law for access to secondary secondary education of the public and 2001/2002 allocates education implemented the private sectors adequate resources to (ii) Modernized (iii) Implementation the education sector curricula for primary of program to address education the problems of low implemented performance schools (iii) Cost and has started financing plan for the education and training sectors with medium-term budgets adopted (iv) Program formulated to address the problems of low performance schools Investing (i) Action Plan for (i) Review of the (i) Review of the Welfare programs in People Poverty Alleviation impact of the 10 impact of the 10 and and completed and largest welfare largest welfare implementation of Society - approved by Cabinet programs initiated programs completed, poverty alleviation Poverty (ii) Budget law for (ii) Action plan to action plans for plan improve Allev. 2001/2002 allocates for reform the national consolidation social cohesion the island of Rodrigues pension scheme prepared and more than Rs. I billion confirmed (White monitoring indicators Paper) developed (ii) Program in place to address the social needs of the deprived regions (iii) Implementation of the recommendations of the 'White Paper' on pension has started - 20 -  Table 6. Anticipated Milestones in Priority Areas (cont.) Policy Actions Prior to Indicative Actions Objective Area Board FY 02/03 FY 03/04 Intended outcome Environ- (i) Wastewater (i) Wastewater (i) Wastewater Liquid waste, ment Management Authority Tariffs progressively Tariffs further solid waste and Act of November 2000 increased according increased according transport sectors enacted by Parliament to the Letter of Sector to the Letter of Sector are financially, and regulations Policy Policy institutionally and published to revise the (ii) Study to assess (ii)Implementation of legally sustainable wastewater tariffs for the feasibility of the the recommendation and operate in full 2002 extension of the Mare of the solid waste compliance with (ii) Tendering process Chicose Landfill and feasibility study has environmental initiated for a Multi to examine the started standards Criteria analysis for the possibility to develop selection of the most new sites completed appropriate alternative mode of transport (AMT) for the Port Louis-Curepipe corridor Econ. (i) Finance Act 2001 (i) Medium term (i) Strategic Comprehensive Mgmt. increases VAT from macroeconomic objectives and 3-year reform of the 10% to 12% framework presented budgets developed public expenditure (ii) Regulations with budget for 5 pilot ministries management published to adjust (ii) Action plan for (ii) Implementation system allows to domestic petroleum the introduction of a of the strategy to better prioritize prices to reflect market Medium Term contain contingent and assess impact rates Expenditure liabilities has started of public (iii) Government Framework (iii) Strategy to expenditures decision to establish developed and rationalize the high level committee approved fragmented incentive Rationalization of for the development of (iii) Comprehensive regime developed fiscal incentive a Medium Term analysis of all (iv) Liberalization of regime improves Expenditure contingent liabilities the telecom sector competitiveness Framework completed and completed and reduces strategy for their economic containment distortions formulated (iv) Initial review of Liberalization of the fiscal incentive the telecom sector regime completed improves (v) ICT authority for competitiveness regulating the telecom sector established (vi) New procurement legislation enacted - 21 -  62. Education and training: To implement the NEA Mauritius will need to comprehensively reform its current education and training sector to produce a better educated workforce. The current system is inflexible, characterized by inequity and mainly focused on the CPE examination.'2 Curricula at primary and secondary levels are outdated and overloaded. Similarly, institutional, regulatory and procedural arrangements need to be adjusted to create an enabling environment for the delivery of services and to meet the expectations of the private and the public sectors. Education and training reform will require a broad political, economic and social consensus among the relevant stakeholders. The relevant sector ministries will need to (i) improve budgeting and financing practices to allow the development of sustainable budget projections, (ii) improve accountability at central and regional levels, (iii) adopt better monitoring and evaluation practices (including improvement of the examination and assessment system), and (iv) improve the learning and teaching process by modernizing and streamlining the curricula, introducing ICT at primary and secondary levels, and by providing better teacher training and assessment. Initial actions have focused on (i) extending the compulsory education from 6 to 11 years of schooling scheduled for full implementation by 2005, to allow for the completion of school construction and capacity building activities, and (ii) allocating adequate resources for the intended reform of the education sector in the budget law 2001/2002. Subseguent reforms would focus on revising the assessment and the examination system to improve equity, on developing a medium-term cost and financing plan (based on the ongoing education finance study), on modernizing curricula and on developing programs to address the problems of low performance schools as well as the education and training needs of the poor. 63. Poverty alleviation: Key objective in this area is to improve social cohesion in line with the Action Plan for Poverty Alleviation which provides strategic direction for Mauritius' poverty reduction efforts. This will include a comprehensive review and consolidation of all social assistance programs. In the short run three programs for poverty reduction will be implemented which focus on (i) very low income housing, (ii) micro-credit schemes, and (iii) Rodrigues. The activities for Rodrigues include: two water desalination plants for the island as well as the improvement of storage and distribution facilities. To promote development, the airport of Rodrigues will be extended to accommodate international flights. Complementary activity will focus on moving towards a budget system which would allow to adequately assess impact of social assistance programs. Initial actions have concentrated on the completion of the Action Plan for Poverty Alleviation and on ensuring sufficient budgetary allocations for Rodrigues. Subseguent reforms would focus in particular on the review and consolidation of existing welfare and social assistance programs and would implement a program to address the social needs of the deprived regions. 64. Environment and transport: In this area the ultimate objective is to put in place a sustainable financial, institutional and legal framework for the liquid waste, solid waste and transport sector that meets relevant environmental standards. Activities focus on the preservation of the environment, in particular on (i) the implementation of the overall 12 The CPE examn is taken at the end of primary school, and has in the past served as a ranking instrument, allocating students to few slots in a limited number of secondary schools. - 22 -  solid waste management program (including construction of a 150,000 t/year incinerator as a private sector initiative), the extension of the existing landfill at Mare Chicose and the development of new landfill sites, the improvement of the collection and transfer of waste, the necessary institutional and regulatory adjustments, and the implementation of a cost recovery system and tariffs for the overall financial sustainability of the sector; (ii) successful completion of implementation of the ongoing National Sewerage Program (NSP) which would include further refining of the financing plan and launching of the connection program (estimated at about $150 million over the coming six years), implementation of the Government's Sector Policy Letter especially with, regard to cost recovery system, progressive tariffs and industrial wastewater treatment standards; (iii) implementation of the National Integrated Transport Strategy with regard to different modes of transport, completing additional studies required for the selection of the alternative mode of transport for mass transit on the Curepipe-Port Louis corridor (to relief traffic congestion in Port Louis and other major cities, solve pollution and environmental problems in these cities, and contribute to increase productivity through travel time saving and reducing stress). Initial actions have focused on (i) the Parliamentary enactment of the Wastewater Management Authority Act, (ii) the revision of wastewater tariffs, and (iii) the tendering process for the concept for the alternative mode of transport for the Port Louis-Curepipe corridor. Subseguent reforms would concentrate on (i) progressively increasing wastewater tariffs in line with consumption levels, (ii) implementing the recommendations of the solid waste feasibility study, and on (iii) implementing a national connection program in line with the National Sewerage Program. 65. Economic management: In the areas of economic management the ultimate objectives are to (i) comprehensively overhaul the existing budget planning and expenditure management of the Government, (ii) rationalize the fiscal incentive regime and (iii) liberalize the telecom sector. The reforms are likely to assist Government in linking and prioritizing public expenditures according to strategic priorities. To improve transparency of Government activities and the delivery of public services the reforms would also establish adequate institutional and procedural mechanisms to assess the impact of public expenditures. A new procurement legislation would complement these reforms. Other reform activities would focus on the sustainability of the NEA, in particular on revenue generation and the assessment of fiscal risks. The existing fiscal incentive regime would be reviewed and consolidated to improve competitiveness and reduce economic distortions. Initial actions have focused on (i) establishing a committee to oversee the development and introduction of a Medium Term Expenditure Framework for Mauritius, (ii) raising VAT from 10% to 12%, and on (iii) adjusting domestic petroleum prices. Subseguent reforms would concentrate on (i) presenting together with the annual budget a medium-term macroeconomic framework, (ii) developing an action plan for the introduction of the MTEF with subsequent development of strategic objectives and 3-year budgets for 5 pilot ministries, (iii) rationalizing the fiscal incentive regime, (iv) developing a strategy to contain the contingent liabilities of the Government, (v) liberalizing the telecom sector to further improve competitiveness, and on (vi) enacting a new procurement legislation. - 23 -  Complementars Knowledge Assistance 66. To assist Government in achieving its key objectives the lending operation is being complemented by knowledge assistance in critical areas. The Bank has been providing advice to (i) reform budget and expenditure management, in particular to develop a medium term expenditure framework and to review the public procurement system, (ii) implement education sector reforms, (iii) design reforms in liquid waste management (iv) reform the pension system (ESW), and to (v) reorient the welfare state. It is anticipated to continue to provide knowledge assistance in critical areas, in particular economic management and human capital development. Specifically, the Government and the Bank plan to conduct joint reviews of public expenditures and the labor market. Disbursement of the operation 67. The loan would be disbursed in a single tranche, to be released after the effectiveness of the loan agreement and prior to the end of June 2002. On request of Government, the loan currency will be US Dollars to allow Government to maintain the desired balance of its loan portfolio. In line with World Bank guidelines simplified procedures will be used for the disbursement of the loan. Disbursements to be administered by the Ministry of Finance will not be linked to World Bank procurement requirements. Government will be required to establish a separate deposit account at the Bank of Mauritius into which all disbursements of loan proceeds will be made. Government will convert the US Dollar proceeds of the loan into Mauritian Rupees to be integrated into the bujdget. The deposit account may be subject to independent audit at the request of the BanK. 68. The operation is likely to diversify the central Government's loan portfolio, almost 90 percent of which is domestic liabilities, more than 80 percent of which have maturity of less than two years. In the process, the operation is expected to reduce the potential crowding out of the private sector that would occur from domestic financing. Subsequent Bank Support 69. Subsequent support of the implementation of the NEA will depend on the (i) continued implementation of policies and programs in the prioritized areas specified in table 6 above, and (ii) maintenance of a sustainable macroeconomic framework. The milestones in columns 2 and 3 of table 6 above will be used to assess progress in the priority areas and will also determine the need for additional Bank financing under subsequent lending operations, in line with the overall framework outlined in the CAS. C. Monitoring and Evaluation 70. Government and the Bank have agreed on monitoring and evaluation activities to be carried out at various levels: As a first step, monitoring will concentrate on the specific macroeconomic targets set out in the first and second year of the NEA as specified in the Letter of Development Policy attached to this document. This includes - 24 -  (i) real GDP growth of 5.3 percent in 2001/2002 and 4.6 percent in 2002/2003; (ii) the budget deficit approximately 6.5 percent of GDP in 2001/2002 and 6.0 of GDP in 2002/2003; (iii) maintain revenue effort in 2001/02 at around 18 percent of GDP and increase it by around 1 percent of GDP in 2002/03; and (iv) substantial realization of the budgeted capital expenditures 2001/2002. In addition, the Bank will assist the Government in reviewing progress in the implementation of the milestones presented in table 6 based on regular supervision missions. 71. To adequately assess progress of the implementation of the NEA the Government intends to monitor the short-and medium achievements against the input and output targets specified in the matrix accompanying the CAS (see schedule 2 of this document) which will be discussed by the Board together with the PERL. Of particular importance are indicators such as (i) public secondary school enrollments; (ii) pass rates in the primary and secondary school general examinations; (iii) implementation of anti-poverty programs (beneficiaries in micro-credit and housing schemes); and (iv) the percentage population connected to the central sewerage collection system. 72. Within the next year the Government will, with support from the Bank, further define and develop a comprehensive monitoring and evaluation system which would build on analytical work linking inputs, outputs and outcomes. While the Government has specified outcome targets in areas including poverty reduction or education achievements (outlined in the CAS matrix in schedule 2), further analytical work is necessary which would link specific program actions to outcomes and establish a limited number of core indicators to be followed for each sector. Results of such analytical work would then assist Government in reassessing targets and defining timelines for their achievement. 73. An important instrument for such a monitoring and evaluation system will be the introduction of a Medium Term Expenditure Framework which will allow Government to link expenditures to strategic priorities and intended outcomes. This would also allow the Government to budget its resources according to progress made in achieving its strategic priorities. As outlined above, an action plan for the introduction of the MTEF will be developed in FY02/03. The Bank would seek to support these activities through a capacity building grant. In addition, the Bank and the Government intend to finalize an Education Finance Study and a Public Expenditure Review within the next year.'3 74. Regarding fiduciary accountability, Government expenditures are subject to regular internal and external audits by the Internal Control Cadre and the Government's Audit Office. A review of the audit system confirmed the efficiency and adequacy of these control mechanisms. The Audit Office also intends to conduct value-for-money 13 The Education Finance Study aimns to assess the costs of various reform measures and the impact of agreed measures to improve intemal efficiency in the educational system. Govermment also intends to carry out a number of other studies in the education sector over the next two years, including (i) study of teacher supply and demand, teacher quality, and decentralized teacher management; (ii) an intemational comparative analysis of the relevance and pedagogic quality and the curricula at primary and secondary school level' and (iii) and analysis of equity and private (household) contributions to education and training, with recommendations to institutionalize equity measures in the sector. - 25 -  audits in targeted areas to fiurther assess the impact of public expenditures. Such internal and extemal audits are of particular importance given the nature of this loan. D. BlEudgeding and IFinancial Management 75. A prerequisite for the proposed Bank assistance is the existence of a sound expenditure management system. The existing system of public expenditure management in Mauritius and the control mechanisms are generally adequate, efficient and transparent: key functions within the system of public finance are clearly defined and separated with proper checks and balances. Compliance with formal rules and procedures is high. Budget planning is currently based on a one year timeframe which undermines efficiency and poses some macroeconomic risks. Government therefore intends to move to a medium