Madagascar - Second Railway Project

Document of F 1 V The World Bank FOR OFFICIAL USE ONLY Report No. P-2520-MAG REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR A SECOND RAILWAY PROJECT April 26, 1979 T This document has a restricted distribution and may be used by recipients only in the performnce of their official duties. Its contents may not otberwise be disclosed without World Bank authorization. I  CURRENCY EQUIVALENTS Calendar 1978 January 1979 Unit = Malagasy Franc (FMG) - Malagasy franc (FMG) US$1.00 = FMG 225.64 - FMG 212.06 FMG 1 = US$0.004 - US$0.005 FMG 1,000 - US$4.43 - US$4.72 (The Staff Appraisal Report is based on US$1 = FMG 220) ABBREVIATIONS AND ACRONYMS CCCE - Caisse Centrale de Cooperation Economique RRNCFM - Reseau National des Chemins de Fer Malagasy (Madagascar National Railway) SODEMO - Agency for the Economic Development of the Morondava Region MTRT - Ministry of Transport, Supplies and Tourism MTP - Ministry of Public Works USAID - United States Agency for International Development FISCAL YEAR Government - January I - December 31  FOR OFFICIAL USE ON i MADAGASCAR SECOND RAILWAY PROJECT Credit and Project Summary Borrower: Democratic Republic of Madagascar Beneficiary: Reseau National des Chemins de Fer Malagasy (RNCFM) Amount: US$13.0 million Terms: Standard IDA Terms On-lending Terms: The proceeds of the credit will be on-lent to RNCFM for a period of 20 years, including 5 years of grace, at an interest rate of 8 percent per annum. Project Description: (i) Objectives: The principal objectives of the proposed project are to help RNCFM to renew and modernize its facilities, improve the reliability and efficiency of its operations and improve its financial management and accounting methods. (ii) Components: The project components are: (a) track renewal (160 km) and improvement (124 km); renewal of points, crossings and procurement of track maintenance equipment and tools; (b) replacement of seven line locomotives; (c) replacement and new acquisition of railcars, coaches and wagons; (d) improvement of telecommunications; (e) replacement of workshop equipment; and (f) improvement of the railway's financial management and accounting system; imple- mentation of its new Transport Plan, and carrying out of studies concerning the lorg- term viability of Antsirabe-Antananarivo and Manakara-Fianara tsoa lines, with the help of consultants. This document has a restricted distribution and may be used by recipient -- y in the performance of their official duties. Its contents may not otherwise be disclosed without *orld &ak authorization.  - ii - (iii) Benefits: Increased efficiency of RNCFM's operations through track improvements, the provision of additional transport capacity for both passengers and freight, rationalization of equipment utilization and improvement of financial management methods. (iv) Risks: Uncertainty whether expected traffic will materialize and whether efficiency improvements will be achieved; impact of road competition. Estimated Cost: ---------US$ Million--------- Local Foreign Total (a) Track 4.36 13.46 17.82 (b) Motive Power and Rolling Stock 0.45 11.37 11.82 (c) Infrastructure 3.52 3.28 6.80 (d) Technical Assistance 0.05 0.41 0.46 Total 8.38 28.52 36.90 Contingency Allowances Physical 0.05 0.27 0.32 Price 1.78 4.66 6.44 Total Project Costs (net of taxes and duties) 10.21 33.45 43.66 Financing Plan: US$ Percent (million) of Total RNCFM 10.2 23.0 IDA 13.0 30.0 CCCE 20.5 47.0 Total 43.7 100.0 Estimated Disbursements: US$ Million IDA FY 1980 1981 1982 1983 1984 Annual 0.4 3.1 5.1 3.9 0.5 Cumulative 0.4 3.5 8.6 12.5 13.0 Rate of Return: 17 percent Staff Appraisal Report: No. 2202-MAG, dated April 19, 1979 Map: IBRD 13645  INTERNATIONAL DEVELOPMENT ASSOCIATTON REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR A SECOND RAILWAY PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Democratic Republic of Madagascar for the equiva- lent of US$13.0 million on standard IDA terms to help finance a second rail- way project. The proceeds of the IDA credit would be on-lent to RNCFM for 20 years including 5 years of grace, at an interest rate of 8 percent per annum. The project would be cofinanced on a parallel basis with a loan from the French Caisse Centrale de Cooperation Economique - CCCE (US$20.5 million, for 17 years including a 5-1/2 year grace period, at 6 percent per annum). PART I - THE ECONOMY 2. A Bank Group economic mission visited Madagascar in July 1978. Its report is expected to be distributed to the Executive Directors in June. A summary of its findings is set out below. Country data sheets are provided in Annex 1. 3. With a GNP per capita estimated at US$210 in 1977, Madage-seer 4S ene of the poorest countries in the world. It is predominantly an agricultural country and 85 percent of its 9.4 million 1/ people live in rural areas with a per capita income of about US$120 per annum. In many areas the standard of living is close to subsistence level. Although the country is sparsely populated (an average of 16 inhabitants per square kilometer), there is great pressure on cultivable land in some regions. Owing mainly to different eco- logical conditions, the highlands are more advanced than the coastal areas, and the south is particularly poor with a harsh, arid climate and infertile soils. The east coast is rich agriculturally, but crops are frequently devastated by cyclones. Internal migration is common and has accelerated as improved roads have provided access to new areas. However, poor roads remain a major constraint to development; many of the main highways are not passable during the rainy season in a country where production centers may be as far as 800 kilometers from main points of consumption. Many areas are cut off from the rest of the country for several months each year. 4. Over the past few years the growth of the economy continued to be slow and uneven. Having risen but marginally in the preceding year real GDP fell in 1976 by 2.9 percent owing co a slight decline in agricultural produc- tion and a steep drop of about 14 percent in manufacturing output. GDP is Note: Part I is identical to the Part I in the Madagascar Mangoky Agricultural Development project, P-2372-MAG, dated February 22, 1979. 1/ According to the latest available census data, mid-year population in 1977 is estimated to be only 8.0 million, which would raise the GNP per capita to US$240. New population figures will be used on revision of Social Indicators Data Sheet.  - 2 - estimated to have increased by 3.9 percent in 1977; even so, output of goods and services showed only a slight increase over the period since 1974; and, with population increasing by about 2.5 percent annually, per capita GDP fell by about 5 percent. Budgetary investment outlays were stepped tup con- siderably after 1975; but the investment rate remained practically unchanged at about 14 percent as the sharp rise in Government capital expenditures was largely offset by a substantial decline in private investment. The savings rate also continued to be fairly stable and fluctuated around 10-11 percent. The resource gap as a consequence has been maintained at a low level. 5. Agricultural production has not recorded any marked growth over the last three or four years. Even over the longer period since 1970 it has increased at an annual rate of only about 1 percent. Despite periodic good crops, paddy production did not keep pace with demand; and production in 1977, estimated at 2.0 million tons, was only about 7 percent higher than in 1970. Groundnut production, after rising significantly in 1976, fell again to 47,000 tons in 1977, while meat production did not register any significant rise. Imports of rice and edible oils have been increasing; at 105,000 tons and 16,000 tons, respectively, they were about three to four times as large in 1977 as in 1970-71. Sugarcane production continued to stagnate as there has been no addition to the refinery capacity for several years. Among other cash and export crops, coffee production, except for a 6 percent drop in 1976, has been rising steadily, reaching some 89,000 tons in 1977. However, raw cotton production, which had been increasing fairly fast, levelled off after 1975 due to shortages of fertilizers and pesticides; vanilla output declined, while pepper showed no noticeable increase. 6. Fostered by fiscal incentives, protection against competition from imports and provision of institutional term financing, manufacturinig normally accounts for about 14 percent of GDP. Industrial output, which still consists mainly of textiles and processed foods, declined in 1975 and 1976; and despite some recovery in 1977, remained below the level attained in 1974. However, while output of processed foods and textiles has followed a stagnant or a downward trend, some of the minor industries - chemicals, tobacco manufactures, rubber, paper products - maintained fairly steady growth. The setback to industrial growth in recent years was caused by a number of factors: capacity bottlenecks and aging equipment, owing partly to declining private investment, uncertain and inadequate availability of agricultural materials for processing industries, shortages of imported inputs, and, in some cases, even deficient demand. These factors reflect to some extent the effects of uncertainty accompanying the shift through greater Government control from a predominantly free market system to a mixed economy. In particular, private investment in industry was discouraged and maintenance of industrial plant suffered. 7. With sudden and sharp rise in current budget expenditure and Govern- ment spending on capital development, the fiscal situation deteriorated con- siderably after 1975. Current expenditures rose steeply with the rising wage bill of the Government and increasing outlay on maintenance; and the current budget surplus, which used to be substantial, dwindled as revenues failed to  keep pace with the growth of expenditures. Furthermore, as Government intensi- fied its efforts to raise investment levels and stimulate the economy, public investment expenditure rose from 11.2 billion FMC in 1975 to 20.5 billion FMG in 1977. The outlays on the consuimer rice subsidy, althouglh they declined in 1976, rose again to 3.6 billion FMG in the subsequent year. The overall Treasury deficit, which more than doubled to 20 billion FMG between 1975 and 1977, was financed increasingly through recourse to Central Bank advances. The budget for 1978 envisaged a 26 percent increase in total outlay as com- pared to the estimated actual expenditures in 1977, while capital spending was proposed to be raised by nearly 80 percent to 36.4 billion FMG. Revenues also were expected to go up sharply, partly as a result of tax reform measures. The overall deficit, however, migtht turn out to be somewhat larger than the projected 16.1 billion FMG owing to underestimation of expenditure on per- soninel and the settlement of payments deferred from 1977, on the onle hand, and shortfalls in revenues on the other. Even so, the overall fiscal situation Js likely to have shown some improvement in 1978 as compared to the preceding year. The Government is contemplating econtomies in current expeniditure, particularly by paring consumer subsidies, so as to minimize the burden of unproductive outlays in the future. 8. Monetary and credit developments since 1975 have been influenced mainly by the Government's deficit financing needs. Outstanding domestic credit went up by more than 50 percent to 126 billion FMG during 1975-77, due, for the most part, to the steep and continued rise in net claims on Government. As a result, money supply, which had been increasing moderately, rose by 15 percent in 1976 and as much as 25 percent in 1977. Despite this monetary expansion and little growth in the output of goods and services, the anntual inflation rate has been moderate -- about 9-10 percent during 1976-77, largely because of increasing demand for cash balances and the consequent accumulation of idle funds. 9. The balance of payments situation which had been deteriorating showed a substantial improvement in 1976, when a surplus of 2 billion FMG was recorded; but the payments surplus in 1977 is now estimated to have been much smaller. The turnaround in the balance of payments situation occurring in 1976 is attributable more to exogenous factors than to any significant im- provement in the structure of the balance of payments. Trade surpluses were recorded in 1976 and 1977 as a result of (a) a sharp rise in prices of exports, particularly coffee, which reversed the continuing deterioration in the terms of trade, and (b) the imposition of more strict quantitative restrictions on imports in 1976. There was a substantial decline in the availability of imports after 1975. On the other hand, the volume of exports dropped sharply in 1976, and continued to fall in 1977, while there was no lasting reduction in the services deficit, nor any sustained rise in capital inflows. 10. The growth and development of the Malagasy economy have over a fairly long period been affected by constraints resulting from shortage of savings, slow growth in markets for major primary exports and low productivity of traditional agriculture. The country, however, is relatively well-endowed with natural resources and has a well-established administrative set-up. With  - 4 - appropriate policies and adequate external capital assistance, medium and long-term prospects for the economy should be favorable. There is consider- able scope for the expansion of agriculture and livestock production. Only about a fifth of the arable land is at present being cultivated, while fer- tilizer consumption, estimated to be some 14,000 tons in 1976, is still rather smiall. The irrigation potential has as yet been only partially exploited. The outlo)k for further development of manufacturing based on locally avail- able matenials is promising. On the vhole, sustained growth at an average arnlnual rate of 4-5 percent appears to be feasible. 11. The Government has been taking far-reachinig steps to str.:ngthen national -ontrol of the economy. As E part of this process, economnic and financial institutions, productive sectors, foreign trade and inte-nal market- ing have andergone extensive reorgani2ation. Inspired by the basic needs approach, the Government has also fornulated long-term development objectives which envisage a more egalitarian inccme distribution and satisfac,ion of specified minimum consumption requirenents of the population by th,; end of the century. The Government also strEsses national self-sufficien,y and the eventual 2stablishment of an industrial base large and diversified enough to mneet the antire domestic demand for equipment and other manufactur as. 12. A Three-Year Plan, which is to be the first of a series )f medium- term investment programs designed to zttain these long-run developinent objec- tives, wag launched this year. The Plan envisages overall expansion of the economy at an average annual rate of '.5 percent during 1978-80. The rate of investment is projected to rise to 17.1 percent of GDP by 1980 from the Plan estimate of 11.5 percent in 1977. The savings rate is to be stepped up, partly through the mobilization of additional budgetary resources for capital development. But about a quarter of the investment outlays during the Plan period is expected to be financed through external loans and grants. Greater emphasis will be placed on the development of food crops; and household con- sumption is targeted to rise, in real terms, by 3.6 percent per year. The Plan also accords high priority to manufacturing, particularly basic industry anid processing of agricultural raw materials. 13. Madagascar's external public debt, outstanding and disbursed, amounted to US$202.8 million at the end of 1977. Slightly over half of it (US$102.3 million) was owed to the Bank Group, and as much as 37.8 percent to IDA alone. Bank group share of debt service in 1977 was 20.8 percent. Among bilateral donors France and the Federal Republic of Germany are the most prominent, each holding about 14 percent of the disbursed debt. Japan and the People's Republic of China rank next in importance (about 5 percent each) followed by the USA (3 percent) and Italy (1.1 percent). Suppliers' credits and commercial borrowing (4.6 percent of the disbursed debt) lhave been rela- tively unimportant. The Government, in fact, has been generally prudent with regard to external indebtedness; the outstanding disbursed debt at the end of 1976 thus amounted to nearly 11 percent of GNP as compared to the average of 21 percent for low income countries. Because of relatively limited reliance on external assistance and concessionary terms of most loans and credits, debt service payments have remained small. The estimated debt service ratio of 3.5 percent in 1976 was only marginally higher than in 1970.  -5- 14. The Bank Group should be prepared, in appropriate cases, to~ provide- some local cost financing. Inr terms of performance, Madagascar appears to have performed about as well as other countries at the same ievel of develop- ment encountering similar constraints. Its current domestic savings rate of 10 - 11 percent compares favorably with the average of 8 percent for countries in the low income group, indicating that Madagascar has made a reasonable effort to mobilize domestic savings; but its savings fall far short of the country's requirements. The Government's policy of emphasizing self-reliance has contributed further to scarcity of external resources. Despite consid- erable restrictions on imports, the country's balance of payments and reserve position have continued to be weak. PART II - BANK GROUP OPERATIONS IN MADAGASCAR 15. Madagascar has received fourteen IDA credits amounting to US$158.2 million and five Bank loans totaling US$32.6 million. About 48 percent of Bank Group lending has been for transport, 21 percent for electric power, 22 percent for agriculture and 9 percent fcr education. LFC's first investment was made in March 1977 with an equity investment of US$290,000 and a loan of US$11.0 million for the expansion of a textile mill; other projects in sugar, leather and ferrochronme are under active consideration. Annex 11 contains a summary statement of bank loans and IDA credits, and of IFC investments as of March 31, 1979, as well as notes on the execution of ongoing projects. The priority given to transport investment recognizes that improvement in communications is a precondition for Madagascar's development. Four projects have been for the construction of all-weather links between the island's different regions, one for improvements to Madagascar's main port of Toamasina and one for the modernization of the railway line between Toamasina and the capital, Antananarivo. Bank Group lending for agriculture consists of two livestock development projects, three irrigation projects and a forestry project. An agricultural develop- ment project in the Mangoky delta was approved by the Executive Directors on March 6, 1979. A study on the problem of agricultural marketing and meat pricing is being executed with the assistance of an international con- sultancy firm. 16. In the past, problems have arisen in the course of execution of sev- eral projects. There were delays in execution, cost overruns and deficiencies in institution building, especially in agriculture. The Morondava Project, which was reduced in scope in 1974, continues to encounter problems, but the Government has prepared a plan of action to deal with them; the plan includes a redefinition of the implementing agency's (SODEMO) responsibilities and financial structures, completion and audit of overdue accounts, and prepara- tion of an investment program and budget for development of the Morondava area. Implementation of the plan of action has started and is being clbs ly monitored by the Government and the Association. Implementation of the V.'- lage Livestock Project has improved substantially. The highway projects are also proceeding satisfactorily.  -6- 17. In our future lending to Madagascar, we intend to continue focusing on infrastructure development, but we expect agriculture to absorb an increas- ingly larger share of total Bank Group lending. A water and sanitation project in Antananarivo and a fifth highway project, concerned mainly with improving highway maintenance, have been appraised and will be negotiated shortly. We are assisting the Government in preparing an agricultural credit project, a DFC project, which will include assistance to handicraft industries, a rural development project based on local communities, and a second forestry project. We expect the Government to seek co-financing from other external lenders for some of these projects. PART III - THE TRANSPORT SECTOR Transport Planning, Policy and Coordination 18. The country's rugged topography, its tropical climate and the lack of suitable construction materials in some parts of the island have made road construction and maintenance relatively costly; this has contributed towards the isolation of some of the regions. Uneven population distribu- tion has also affected the development of the sector. 19. Government policy towards transport development, stated in the "hartar :of the RCvol'u-tic-i", alms at connect4ng reg4""-'l c-ital 9 1- p11- weather roads, improving road maintenance, and developing the transport organization and services. 20. Since February 1975, transport matters have fallen under the responsibility of two different ministries: the Ministry of Transport, Supplies and Tourism, which sets transport regulations, supervises the state-owned firms of the transport sector, and is responsible for modal coordination, and the Ministry of Public Works, which is responsible for infrastructure construction and development. In addition, the Ministry of Planning prepares a National Plan for all sectors, including transport. Due to communication problems between the ministries and to the lack of adequately qualified staff, there has been little coordination in the sector. From 1974 to August 1978, a team of transport specialists had been made available to the Ministry of Transport under IDA financing (Credit 488-HLAG). This team, however, did not fully achieve its major objectives, which were to improve the level and quality of transport planning in Madagascar, par- ticularly in the highway subsector. Its work was impeded by the lack of cooperation between MTRT and MTP, by changes in its work program, and by the shortage of competent staff as counterparts to the expatriate experts. A local group trained as counterparts and attached to the MTRT is now respon- sible for the transport planning and coordination function, and their efforts are being strengthened with the increasing coordination that is being achieved through the intervention of the Directorate of Planning of the Ministry of Finance and Planning. The need to coordinate the investments in the dif- ferent transport modes is now clearly perceived in the Directorate of Planning.  -7- In the past, the only objective was to provide a very basic transportation network. The need for a global strategy in the transport sector and for intermodal planning has become more acute as the network developed. Close coordination will be needed in the future to optimize use of the transport system in this corridor (see para 22 below). The Transiort Network 21. Madagascar's transport network consists of about 27,500 km of roads of which only 4,500 km are paved; 2 unconnected railway systems totalling 860 km; 4 alongside ports and 11 lighterage ports of some significance; and 56 airfields of which 17 are all-weatl,er standard. Roads 22. The paved highway network consists of a main north-south artery, connecting Mahajanga, Antananarivo and Fianarantsoa, an east-west road link- Jng Moramanga, Antananarivo, and Tsiroannmandidy, and several short stretches around the major coastal towns. A road being built with the assistance of the People's Republic of China will link Toarnasina to M4oramanga in the early 1980s and will compete with the railway for traffic on the Toamasina-Antanarivo corridor. The standards applicable to this road would be: (i) 2.5 X minimum rndi-tn; 1.4'- ?% =-=-='i grad4-nt; (4ii4) 6 !5 p-rerne- -ilt (-tvu) lA trn~ load; and (v) 25 tons bridge capacity. This road is not expected to attract bulk traffic. Roads are generally of low standard, often in poor condition, and frequently impassable during the rainy season in the north and part of the west. Mainitenance remains a major problem for the road network due to insuf- ficient funds and deficient organization. Road maintenance will be improved under a proposed Fifth Highway Project appraised in September/October 1978. In 1976, the vehicle fleet consisted of 104,000 vehicles, of which 53 percent are automobiles and 47 percent commercial vehicles. Rates for the trucking industry are established by provincial authorities. Passenger transport is regulated by the Ministry of Transport and by the provincial authorities. Railways 23. The Reseau National des Chemins de Fer Malagasy (RNCFM) operates 860 km of main line, and 175 km of branch lines and private sidings. It has so far provided the main meanis of transportation between the east coast and the high plateau wqhere most of the population and economic activities are concentrated. In 1977, it carried a total of 823,300 tons of freight (with an average haul of 334 km) and 3.9 million passengers (with an average journey of 69 kn).  -8- Air Transport 24. Madagascar has 56 airfields, 17 of which are built to all-weather standards. Only two airports can handle large aircraft of the Boeing-707 type. Wide bodied aircrafts such as the Boeing-747 can only land at Antananarivo's airport. The national airline, Air Madagascar, is owned 70 percent by the Government and 30 percent by Air France. It owns 18 aircraft including one B-707 and two B-737s. It has recently purchased a Boeing 747 whichi will be operated jointly with Air France. Ports 25. Among the four major ports, Toamasina handles about two thirds of the total national traffic, Majunga on the west coast, 11 percent; Antomboka (ex-Diego Suarez) in the north and Toliari in the south, about 4 percent each. The other ports handle mainly coastal shippiiig, which is important because of the inadequate inland transport infrastructure. Bank Group Role 26. The Bank Group is assisting the Government in restoring and improving transport infrastructure and institutions, in training staff, and in planning for the future development of the sector. Bank Group lending to the transport sector has amounted to some US$93 million, about 80 percent of which has been for the highway subsector. 27. Beginning in 1966, the Bank Group has financed four highway projects in Madagascar, amounting to US$75.6 million. A proposed Fifth Highway Project was appraised in September/October 1978. An IDA credit of US$9.6 million for extension and improvement of the Port of Toamasina was approved in 1970, followed in 1973 by an additional credit of US$1.8 million. 28. The First Railway Project in Madagascar (US$6.0 million; Credit 488-MAG) was approved in January 1974; it was designed as a "holding operation" to assist the railway in replacing outdated equipment and to determine its long-term prospects and requirements, as well as the needs of the transport sector as a whole. 29. The Bank Group-financed items originally included 60 km of track renewal, 50 freight wagons, 20 passenger coaches, miscellaneous equipment, consulting services and the provision of a transport planning team for the Government. The physical execution of the project has generally been satis- factory, though somewhat behind schedule. Cost increases have made it necessary to reduce the numbers of rolling stock to be purchased (freight wagons from 50 to 35 and pas6enger coaches from 20 to 15). Because of proposed changes in the constitution of public bodies, including that of the railway, implementation of technical assistance to the railway in some areas has been postponed and the proceeds of the credit thus released have been used to purchase 12 ballast wagons. The project is virtually completed. The railway's performance in respect to financial targets, on the other hand, has been disappointing, due partly to lower than expected traffic volume and delays in introducing necessary tariff increases. The 3 percent rate of return target has not yet been achieved (see paragraphs 45-47 below).  -9 - 30. The railway has played, and is still playing, a fundamental role in the transportation sector of the country and in the economy as a whole. Its long-term prospects are good, mainly because a large pottion of the railway's present and future traffic consists of bulky and.heavy commodi- ties, such as petroleum products, ore, timber and wood, not suitable for transport by road. The outlook for the future is favorable providing the railway's overall efficiency and productivity can be maintained, and appro- priate tariff increases are introduced when required. 31. The Government has repeatedly stressed that it will continue to support the railway in maintaining its important role and that the rail- way's current and future investment plans will be accorded high priority in the Government's'development plans. The railway has been managing its oper- ations in a commendable manner-under very difficult circumstances as, for example, poor track resulting in frequent derailments, outmoded equipment, and shortages of spare parts, etc. However, there is scope for improving the railway's overall efficiency and productivity by providing essential replacements of its worn out track and equipment. Although the railway's general management is capable, its financial management will have to be strenpgthened. The introduction of appropriate tariffs and timely reimburse- ments of accounts receivable from the Government and its agencies are also crucial to the railway's financial well-being. 32. Container traffic, though still modest in Madagascar, has recently hppin inr'rPiinP. At- nrp-Pnt. it is limited to the main line from Toamasina to Antananarivo. The Toamasina Port Authority is responsible for handling containers in that area while RNCFM is responsible for this activity in Antananarivo. Since existing facilities in Antananarivo are seriously congested, the Chamber of Commerce has agreed to create a new container terminal which is expected to be completed in 1982. RNCFM would be respon- sible for the laying of track. Periodic exchanges of views will take place between the Government and the Association with respect to the development of these facilities (section 4.03, draft Development Credit Agreement). PART IV - THE PROJECT Background 33. A report entitled "Madagascar - Second Railway Project - Staff Appraisal Report", dated April 19, 1979, is being distributed separately. A Credit and Project Summary appears at the beginning of this report and a Supplementary Project Data Sheet is given in Annex III. The Project was prepared by RNCFM with the assistance of consultants, and appraised by an IDA mission in April 1978. Negotiations were held in Washington, D.C. from December 14 to 19, 1978. The Malagasy delegation was headed by Mr. Leon Rajaobelina, Governor of the Central Bank.  - 10 - Project Objectives and Description 34. The proposed project, which is a continuation of the program started under the First Railway Project (Credit 488-MAG) of 1974, aims at ruriiier improving RNCFM's line capacity with increased safety and reliability in traffic operation to meet traffic demands up to 1982, and to improve overall efficiency. It includes the following components: (a) renewal of 160 km of track, improvement of another 124 km, renewal of points and crossings, and procurement of track maintenance equipment and tools; (b) replacement of seven line locomotives; (c) replacement and new acquisitions of a railcar, coaches and wagons; (d) improvement of telecommunications; (e) replacement of workshop equipment; and (f) improvement of the railway's financial management and accounting system, implementation of its new Transport Plan, and carrying out of studies of the long-term viability of the Antsirabe-Antananarivo and the Manakara-Fianarantsoa lines. 35. Details of the project are as follows: (i) The poor condition of the track is reducing the capacity of the line due to a great number of speed restrictions and frequent derailments. Increasing axle loads and traffic density call for heavier track, which the railway has started introducing. This track renewal program will continue under the proposed project which provides for renewal of 160 km of track, improvement of another 124 km, replacement of 136 points and crossings, and procurement of 47 ballast wagons, maintenance equipment and tools. (ii) The four oldest shunting locomotives must be retired but can be replaced by four downgraded line locomotives. Seven line locomotives will be required to replace the downgraded units, and to cope with the expected increase in traffic. Spare parts for the locomotives are included in the project. (iii) The short distance commuter traffic has been increasing steadily over the last few years. The new railcar will replace two old ones which are being scrapped, and the 10 new coaches will replace the 14 wooden body old coaches. The reduction in numbers of the new units is made possible by their higher capacity and the expected increase in their availability.  - 11 - (iv) The traffic on the northern system will increase from 268 million ton-km in 1976 to 328 million ton-km in 1982. It has been estimated that 76 new wagons will be needed to meet transport needs, taking into account larger pay-loads of the new wagons and expected improvements in productivity. (v) The 14 km track section between Ambila and Brickaville requires realignment and levelling to reduce the frequency of derailments and to eliminate the need for additional loco- motives for heavy trains, which cannot otherwise negotiate the steep grades. The first phase of the realignment (originally financed by USAID, and now continued by the railway on its own) is expected to be completed during the first half of 1979, and is therefore not included in the project. The project provides for the completion of the work as well as the rebuilding of the Brickaville yard at the end of the realigned track. Also included are minor improvements of other yards, upgrading of the telecommuni- cations system, replacement of workshop equipment, and repair of embankments and bridge foundations damaged by floods. (vi) Technical assistance is provided in the following areas: (i) implementation of a unified financial planning, accounting and information system; (ii) supetvibiUii of the implementation of the railway's Transport Plan; and (iii) participation in the studies on the long-term viability of Antsirabe-Antananarivo and Manakara- Fianarantsoa lines. The technical assistance is esti- mated to involve some 50 man-months at an average for- eign cost of US$8,000 per man-month. Cost Estimates 36. The project cost is estimated at US$43.7 million equivalent, of which US$33.5 million equivalent, or 77.0 percent, is in foreign exchange, and US$10.2 million equivalent in local costs. The items included in the Project will be exempt from local taxes and customs duties. Detailed cost estimates are given in the Credit and Project Summary. 37. The cost estimates are based on recent quotations and bids for similar equipment, obtained in 1978. Physical contingencies of 10% have been provided for realignment of the Brickaville-Ambila section and for rebuilding of Brickaville yard only, as the quantities for the other items can be considered as fixed. Price contingencies have been as follows: - for imported items at the rate of 7.5% for the year 1979 and 7.0% for the years 1980 to 1983; and for local costs at the rate of 10.0% for the years 1979 to 1983.  - 12 - Financing and Procurement 38. Of the total cost of the project amounting to US$43.7 million equiv- alent, the foreign cost of US$33.5 million is expected to be met from external borrowings, and the local cost of US$10.2 million equivalent is expected to be financed from the railway's internally generated funds. It is proposed that the Bank Group provide a credit of US$13 million. CCCE of France is expected to finance the equivalent of some US$20.5 million. The IDA credit will be onlent by the Government to RNCFM at an annual interest rate of 8 percent for 20 years, including 5 years grace, and these conditions will be reflected in a subsidiary loan agreement to be entered into between the Government and RNCFM, the execution of which would be a condition of effectiveness of the proposed credit (Section 6.01(a), draft Development Credit Agreement). The CCCE loan will be made directly to the RNCFM. The CCCE loan is expected to carry an interest rate of 6 percent per annum and to be for 17 years including 5-1/2 years grace. Fulfillment of all conditions precedent to initial dis- bursement of the CCCE loan would be a condition of effectiveness of the IDA credit (Section 6.01(b), draft Development Credit Agreement). 39. Equipment and material financed by the Bank Group will be obtained through international competitive bidding in accordance with Bank/IDA guide- lines except for small orders of under US$25,000 each. These small orders are not expected to exceed US$250,000 in total. These items will be procured abroad or locally through local purchase procedures which are acceptable to the Bank Group. The Bank Group is expected to finance track materials, points and crossing, aerial ropeway and technical assistance; while CCCE will finance ballast wagons, locomotives, motorized railcars, coaches, and realignment works. Disbursements 40. Disbursements from the credit will, for imported equipment and materials, be on the basis of 100 percent of foreign expenditures or 75 percent of local expenditures if purchased locally. For consultants' and experts' services, disbursements will be on the basis of 100 percent of foreign expenditures. All disbursements will be fully documented. Implementation 41. The project will be carried out by RNCFM, which has the capability to do so. Until 1965, RNCFM operated as a "Regie Autonome" under the Ministry of Transport with a substantial degree of autonomy. Since then, the railway passed through various forms of state control from functioning as a government department to its present form (under a Decree of May 10, 1974) as a state- owned industrial and commercial establishment with operational and financial autonomy. 42. RNCFM's general and operational management is capable, but in the financial area, a satisfactory integration has not been achieved between the accounting activities performed by the railway staff for the Agent Comptable acting as representative of the Ministry of Finance on the one hand, and the financial controls and accounting information needs of the railway as an  - 13 - autonomous organization on the other. Under the project RNCFM will set up a unified accounting system (Schedule 2, F, draft Development Credit Agree- ment), along the lines of the solution recently adopted for the Port of Toamasina Authority which had encountered similar problems. Consultants will be employed to assist in implementing this system. (Section 2.02, draft Project Agreement). RNCFM shall employ a financial manager whose qualifica- tions and experience are acceptable to IDA (Section 3.03, draft Project Agreement). 43. The impact of the expected application of the Charte des Enter- prises Socialistes (a law dated December 27, 1976 embodying general principles emphasizing the socialist pattern of the Malagasy economy and the participa- tory nature of the management and administration of its institutions) to the railway still remains to be determined. The Government will exchange views with IDA on any proposal for a material change in the present statutes or organization of RNCFM (Section 4.02, draft Development Credit Agreement). Uneconomic Lines and Services 44. Two lines of the railway system (the Antsirabe-Antananarivo and the Manakara-Fianarantsoa lines) have light traffic density and have limited pros- pects for growth. During negotiations it was agreed that their long term viability would be studied during the proposed project implementation period, and that the findings of the study to be carried out with the assistance of a consultant will be discussed with the Association. Agreement was also reached that the Government would compensate the RNCFM through appropriate measures, including the provision of funds, for any services found to be uneconomical, but retained on other grounds (Section 3.02, draft Development Credit Agreement). Financial Situation 45. Financially, RNCFM's operating results have been less satisfactory than anticipated. At a time when traffic has remained stagnant, other factors added to its difficulties, namely: (i) adequate and timely tariff increases have not been made; (ii) personnel costs, which constitute some 50 percent of the total operating costs, have been rising steeply in recent years; (iii) large amounts of accounts receivable have been outstanding from various government agencies; and (iv) Government did not reimburse the railway for amounts foregone on account of concessionary fares. Thus the railway has not been able to achieve the financial objectives agreed under the previous credit, including, in particular, a 3 percent annual return on net fixed assets. 46. The financial situation of the Railways, as shown in the projections, should improve substantially in the future if RNCFM is managed on a commer- cial basis. To this end, the Government has recently decided to implement a new tariff increase of 25% effective April 23, 1979. It has reimbursed RNCFM two-thirds of all the amounts outstanding for more than 90 days due by Government departments and agencies as of October 31, 1978; and it has agreed to reimburse the remaining third before the end of 1979. During negotiations, it was agreed that all such accounts will be collected in the future within a  - 14 - credit period not exceeding 90 days (Section 4.04, draft Project Agree- ment and Section 4.01, draft Development Credit Aereement) and that the Government will reimburse RNCFM the amounts foregone on account of concessionary passenger fares (Section 4.04, draft Development Credit Agreement). RNCFM has agreed that (a) its tariff structure and levels be established in accordance with appropriate economic and commercial principles for railway operations; and (b) the tariff structure and levels cover the economic cost of individual services and the individual carriage of goods but, taken as a whole: (i) cover the full costs of services, and (ii) generate internal funds sufficient to service debt, provide adequate working capital and make a reasonable contribution towards investment needs including replace- ments (Section 4.05, draft Project Agreement). During negotiations, agreement was reached that RNCFM will revalue its fixed assets on the basis of replace- ment costs every year beginning in 1980 and that the annual and accumulated depreciation will be adjusted to reflect the revised valuation (Section 4.03, draft Project Agreement). 47. The agreements for the first Project require RNCFM to earn an annual rate of return of 3 percent on its net fixed assets beginning in 1977. In present circumstances, these targets are not realistic. It is proposed in- stead that iNCFM earn an annual return of not less than 1.3 percent in 13979, 2.5 percent in 1980, 1981 and 1982, and 3.0 percent thereafter based on the historical value of existing fixed assets and current values of new additions (Section 4.07, draft Project Agreement). These are considered adequate to assure the railway's financial viability. However, it was agreed that in lignt ot tnte revaluation of fixed assets in respect of year i9OU as eluvisdgeu in para 46 above, the Government, the railway and the Association shall agree on revised rates of return for the purpose of maintaining the railway's financial viability (Section 4.07(c), draft Project Agreement). Furthermore, RNCFM shall not, without prior consultation with the Association, undertake any additional capital investment except for small items not exceeding FMG 50 million, and in the aggregate not exceeding FMG 200 million per annum, during the project period (Section 4.06, draft Project Agreement). 48. To ensure that adequate debt service coverage will be maintained, RNCFMt will require the Association's approval before incurring new long-term debt if the debt service ratio falls below 1.5 (Section 4.08, draft Project Agreement). 49. RNCFM's accounts are and shall continue to be audited by a firm of public accountants acceptable to IDA and carried out according to generally accepted auditing practices (Section 4.02, draft Project Agreement). Economic Evaluation 50. The project as a whole is designed to maintain RNCFM transport capacity to its present level and to provide some extra capacity for general freight transport to meet the 1983 projected traffic level of some 300 mil- lion ton-km. Without the project, some 137 million ton-km of general freight and some 30 million passenger km yearly would have to travel by road at higher economic costs by 1983, yielding an economic return on the overall project of  - 15 - 17% at the present exchange rate, I/ over the 1979-1990 period. The additional freight transport capacity would be met: (i) for 71 million ton-kin, fromn the track upgrading program, yielding an ecornomic return of 21% on this component ( 49% of the total project costs); (ii) for 50 million ton-km, from addi- tional locomotives and wagons, yielding a return of 24% ( 21% of the total project costs); (iii) for 4 million ton-kin, from the provision of workshop equipment, yielding a return of 17% ( 3% of the total project costs); (iv) for 12 million toni-km, from the realignment works on the Ambila-Brickaville section, yielding a return of 11% ( 8% of the total project costs). The passenger coaches to be procured under the project will be used for commuter and short distance traffic and are needed to replace existing coaches which have to be scrapped. Compared to the transport by bus, rhe economic return on this component (10% of the total project costs) is 10%. 51. The utajor uncertainty of the proposed project is whether the expected traffic will rmaterialize. It could fail co do so either because the economy may fail to recover within the projection period, or because road competition muay be stronger than forecast. These two uncertainties, however, were to some extent already taken into account in the previous analysis. Most of the investments are needed even if rail traffic does not increase at all throughout the projected rcriod. Much of the cr.-ick upgrading program corre- sponds to deferred maintenance ar,d che purchas s of locomotives and wagonls is also partly justified on replacement considerjtlons. Assum-ing nio traffic expanision at all, whitch is an extre,ce. case since the railway is no; even abLe to carry the present trattic, ttle return on the wno:,.e project wouje De 10% at both shadow and official exchange rates. 52. Assuming the road competition is stronger than forecast (a 50--50%, split for non-bulk Items by 1985), the rail, traffic would still amount to 300 miallion ton-km yearly by 1985, whlichi is tthe capacity the project provides for, because most of the traffic consists of bulk produicts. The extent of the road competition, however, will need to be closely analy-zed when evaluating tthe additional investments required by the railway to meet the projected traffic after 1983. Another risk facing the proposed project is whether the expected efficiency improvements will be achieved. In this case, however, in view of the railway's relatively hiigh technviical and operatioual capabilities, it should have little difficulty in reaching the proposed operatitng targets. In addition, its financial viability will depend on tiraely tariff increases and such steps as the Government sha:Ll undertake to compensate the railways for uneconomnic services. 53. The long-term viability of the raiLway has also been analyzed. In the event of exclusive reliance on road transport for all transport needs in the catclinent area of the northern system over the next 15 year period, the economic return on all investments needed (from this project arid from thle additional investments needed after 1983) would be 22%, at both shadow and official exchange rates, showing tlhLat such a reliance would be uneconomical. 1/ Shadow pricing of foreign exchange would not significantly affect rate of return calculations.  - 16 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 54. The draft Development Credit Agreement between the Democratic Republic of Madagascar and the Association, the draft Project Agreement between the Association and RNCFM and the Recommendation of the Committee provided for in Article V, Section 1 (d) of the Articles of Agreement of the Association are being distributed to the Executive Directors separately. 55. The draft Development Credit and Project Agreements conform to the usual pattern of agreements on railway projects. Special conditions of the project are listed in Section III of Annex III of this report. Additional conditions of effectiveness are: (i) signing of the subsidiary loan agreement between the Government and RNCFM (Section 6.01(a), draft Development Credit Agreement); and (ii) fulfillment of conditions precedent to initial disburse- ment of the CCCE loan (Section 6.01(b), draft Development Credit Agreement). 56. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 57. I recommend that the Executive Directors approve the proposed Credit. Robert S. McNamara President Attachments April 26, 1979  MOEX T - 17 - Page 1 MDACASCAR - SOCIAL INUICATORS DATA SlEET C REIIENCE ROUPS (ADJUSTED AVER AES LAND AN (TOUISAIID SQ. ES) - SN ST RECS STIM RI W WAz 592.0 " 1 AGRICULTURAL 368.6 8DST RECENT G- 00AARIC DICOKE INCOKF I960 A 1970 /b ESTIIATI A 1EGION L ciOUPr /d GRouP Le CHIP PU CAPITA (D5SS 11O.0 150.0 210.0 223.6 182.q 432.3 115230 C05Ulf!TIGAI PU (2tA (7IW1NS OF CODL 3UIVALUT) 38.0 71.0 71.0 86.7 88.9 251.7 POPULATIOU AND VITAL STATISTICS AL PMW. UTLAION, ID-TA * INILLIOMS) 5.9 7.6 9.4 miMI *COUS.ATIO (PUGR OF TOT01L) 10.0 14.1 14.5 13.6 15.0 24.2 POPULATION DENSIT 3 IQ. EIS. 10.0 13.0 16.0 18.4 46.8 42.t M SQ. El. ACUILTM. LAND 16.0 21.0 26.0 53.6 254.1 95.0 POPIISTOU Al:C STUICWIZ (PERCENT) 0-14 U3.. 39.0 46.1 47.3 44.4 43.6 44.,9 1544 TS.. 57.5 50.2 49,2 52.7 53.3 52.8 65 Yu. mD AonD 3.5 3.7 3.5 2.8 2.9 3.0 POPSLATICN ROWTH RATE kRCENT) 'tOTAL 2.4 2.6 3.1 2.6 2.4 2.7 mum5 4.0 6.2 5.2 5.8 4.0 8.8 CRUDE 3IRTH EATE (PER THOUSAND) 50.1 49.7 50.2 44.9 44.3 42.2 CRUDE DEATH RATE (PCE THOUSAND) 28.6 24.2 21.1 20.6 19.7 12.4 GROSS REPRODUCTION RASE 2.9 /j 3.2 3.3 3.1 2.9 3.2 FAMILY FLAMIlNIIG ACCSPTORS * ANUAL (THOUSANDS) .. .. 1.. USERS (PERtCENT OF MAURLED W2lM) .. . .. 2.5 14.6 14.2 WOOD AND 10J1IIT13R 1ID1X OF FOOD PPOWCTIOY"0 PER CAPITA (197000) t99.0 100.0 39.0 94.2 96.4 104.3 PER CAPITA SUPPLY OF CAWLNiES (PERCIEr OF REQUIi;TS: .Z) 104.0 108.0 105.0 90.1