Madagascar - Third Railway Project

D_cnm of The World Bak FOR OFFICIAL USE ONLY Report No. P-4178-MAG REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 10.4 MILLION TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR A THIRD RAILWAYS PROJECT April 15, 1986 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Unit Malagasy Franc (FMG) US$1.00 FMG 650 FMG 1 million US$1,538 WEIGHTS AND MEASURES: METRIC 1 meter (m) 3.28 feet (ft) 1 cubic meter (m3) 35.29 cubic feet (cu.ft) 1 kilometer (km) 0.62 mile (mi) I square kilometer (km2) = 0.386 square mile (sq.mi) 1 hectare (ha) 2.47 acre (ac) 1 kilogram (kg) 2.2 pounds (lb) 1 metric ton (m ton) 2,204 pounds (lbs) ABBREVIATIONS CCCE - Caisse Centrale de Cooperation Economique DGP - Direction Generale du Plan (Directorate General of Planning) MTP - Ministere des Travaux Publics (Ministry of Public Works) MTRT - Ministere des Transports, du Ravitaillement et du Tourisme (Ministry of Transport, Supply and Tourism) RNCFM - Reseau National des Chemins de Fer Malagasy (Madagascar National Railway) TSM - Transport Sector Mlemorandum SEPT - Societe d'Exploitation du Port de Toamasina (Toamasina Port Authority) Railway Lines: TCE - Antananarivo - East Coast Line MLA - Moramanga - Lac Alaotra Line TA - Antananarivo - Antsirabe Line FCE - Fianarantsoa - East Coast Line Fiscal Year January 1 - December 31  FOR OFFICIAL USE ONLY MADGASCAR THIRn RAILWAYS PROJECT CREDIT AND PROJECT SUMMARY Borrower: Democratic Republic of Madagascar Beneficiaries: Reseau National des Chemins de Fer Malagasy (RNCFM) and Societe d'Exploitation du Port de Toamasina (SEPT). Auount: SRD 10.4 million (US$12.0 million equivalent). Terms: Standard IDA terms. Project The purposes of this credit are to enable RNCFM to maintain Objectives: an efficient northern railway system, over the next ten years, at its present level of capacity for hauling critical bulk commodities such as rice, petroleum produc:Zs, chemicals, construction materials, coal and chromite; and to assist RNCFM and SEPT in repairing and rehabilitating facilities damaged by a recent cyclone. Project The project would finance priority items of the RNCFM, Descriptic.Z investment plan for 1987-89, as well as RNCFM's and SEPT's cyclone damaged facilities. The project would consist of the following main components: telecommunications and track rehabilitation, reconstruction of a bridge; provision of cargo handling equipment and construction of a rail/road link and terminal for a cement plant; provision of spare parts for locomotives and wagons and purchase of trolleys for track maintenance; workshop machinery, tools and other equipment; staff training and technical assistance studies; and cyclone damage repairs and rehabilitation. Benefits: The main benefits of the project are to allow the railway to continue providing essential services to the economy at current traffic levels, and to permit RNCFM and SEPT to resume normal operations following the March 1986 cyclone. 318isk The main risks facing the project are: traffic level could be lower than expected and project implementation could suffer from delays or interruptions in service. Sensitivity analysis has sbown that even with a 20% decline in traffic volume, RNCFM will still break even f_nancially; traffic is unlikely to decline given the already depressed state of the economy and the declines in traffic in recent years. Rail traffic projections have taken into account road I s docwen hs a restictd disaftrib and may be used by recipients only in the performanee of te official dutis Its contts may not otherwise be dcowd without World Bank authorization.  - ii - competition. Other major risks are unlikely since track renewal targets are minimal to maintain current operations. Equipment to be purchased is common, easily available and unlikely to incur drastic price increases. The planned cyclone repairs and rehabilitation work are simple in nature, and the required labor and materials to be imported are easily available. Special delays and/or other risks are therefore unlikely. Local Foreign Total US$ Million Estimated Costs Permanent way 2.3 3.4 5.7 Rolling stock 0.1 1.4 1.5 Machinery, tools and equipment 0.1 0.7 0.8 Telecommunications 0.2 0.5 0.7 Training 0.6 0.8 1.4 Technical assistance - 0.3 0.3 Studies 0.1 0.4 0.5 Cyclone damage repairs/rehabilitation 0.3 2.0 2.3 Base Cost: 3.7 9.5 13.2 Contingencies: Physical 0.4 0.7 1.1 Price 0.8 1.8 2.6 Total project cost: 4.9 12.0 16.9 1/ Financing Plan IDA - 12.0 12.0 RNCFM 4.8 - 4.8 SEPT 0.1 - 0.1 Total project cost: 4.9 12.0 16.9 Estimated IDA Disbursements: Bank Fiscal Years 1987 1988 1989 1990 1991 US$ Million Annual 2.1 2.4 3.0 3.4 1.1 Cumulative 2.1 4.5 7.5 10.9 12.0 Economic Rate of Return: 16Z Appraisal Report: No. 5702-MAG Map: IBRD 13645R 1/ Taxes and duties are excluded.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE DEMOCRATIC REPUBLIC OF MADAGASCAR FOR A THIRD RAILWAYS PROJECT 1. I submit the following report and recommendation on a proposed Development Credit to the Democratic Republic of Madagascar for SDR 10.4 million (US$12.0 million equivalent) on standard IDA terms to help finance a third railways project and emergency cyclone damage repairs znd rehabilitation works. The proceeds of the credit would benefit the National Railway Company, REseau National des Chemins de Fer Malagasy (RNCFM) and the Toamasina Port Authority, SocietE d'Exploitation du Port de Toamasina (SEPT). Out of the US$12.0 million credit, the Government wo.Id pass on (a) US$500,000 to RNCFM as grant and US$10.5 million as a loan; and (b) US$1.0 million as loan to SEPT. Onlending terms would be 9.5 percent interest per annum for 20 years, including a grace period of 6 years. PART I - THE ECONOMY 2. A report entitled -Country Economic Memorandum- dated March 18, 1986, was distributed on March 24, 1986, to the Executive Directors and to participants in the Madagascar Consultative Group. It is available as document 5996-MAG and its main conclusions are reflected below. Country data sheets are provided in Annex I. 3. Madagascar, with a population of 9.7 million and a GNP per capita of about US$270 in 1984, is among the poorest countries in the world. It is a sparsely settled country, with a population density of about 16 persons per square kilometer. Although the country is generally well endowed with natural resources and a variety of soils, there are considerable regional variations in ecology and climate. The central plateau, the economically most advanced region, has a subtropical to temperate climate. The South is the poorest region, with an arid climate and infertile soils. The eastern region has a tropical climate and, although the region is rich agriculturally, crops are frequently devastated by cyclones. Agriculture accounts for about 40 percent of GDP; about 80 percent of the population lives in rural areas, and agricultural products account for about 80 percent of the country's export earnings. 4. In the decade following independence in 1960, Madagascar's economy grew at an average annual rate of three percent. Agriculture was responsible for much of this growth, while manufacturing, benefitting from increased protection, gained in relative importance. The years following 1972 marked a watershed in Madagascar's economic and political development. After the 1972 and 1975 revolutions, an inward-looking economic policy was geared to self-sufficiency and consolidation of the new regime's socialist aims through decentralization to new local government institutions (the fokonolona system), nationalization of industrial, trading, and agricultural enterprises, and moves towards collectivization  -2- of agriculture. Towards the end of the 1970s this movement was overlaid by a policy of rapid industrialization with emphasis on capital intensity, accompanied by pricing and marketing policies heavily biased towards urban consumers. 5. During the decade 1973-82 real per capita GDP fell by an estimated 28 percent. The major contributing factors to this decline were: (i) The widespread nationalization of economic activity and suppression of private initiative, accomplished by taking over numerous enterprises and creating new parastatals, gave rise to a large and unmanageable public sector. (ii) Regulatory intervention in the economy increased substantially; price controls were generalized and enforced with greater vigor than before, local authorities assumed broad new powers, government marketing monopolies were established, and import restrictions and exchange controls tightened. (iii) Many policy actions led to neglect of agriculture and fostered the growth of manufacturing for domestic markets, including the establishment of numerous enterprises of doubtful economic value. 6. The Government's attempts in the late 1970s to stimulate expansion of Madagascar's stagnating economy through a large public investment program contributed to an economic crisis beginning in 1980-81. The share of investment in GDP, which had averaged around 13 percent from 1970 to 1978, increased sharply to 25 percent in 1979-81. The financing of this massive investment program contributed to a large public sector deficit (about 18 percent of GDP by 1980), inflation in excess of 30 percent both in 1981 and 1982, and a sharply increased debt service burden (the debt service ratio,before rescheduling, rose sharply from about four percent of export earnings in 1978 to 46 percent in 1981, nearly 75 percent in 1984, and 90 percent in 1985). The debt service burden has been largely responsible for the severe shortage of foreign exchange which has been a critical constraint to economic activity. Contributing to this shortage was a drop in export earnings as the terms of trade for agricultural exports weakened and as domestic consumption expanded. This drop was accentuated by declining agricultural production due to an overvalued exchange rate, low controlled producer prices, and state interference with the marketing of agricultural products. Industrial exports, which had never been encouraged, suffered a further blow through the impact of the foreign exchange shortage on the availability of raw materials and spare parts. 7. Faced with an unsustainable resource gap (equivalent to 17X of GDP in 1980)., Government began implementing stabilization measures in 1981. In the years which followed, aggregate expenditure was steadily reduced and gross savings increased, especially from 1983. Among specific measures taken to reduce aggregate demand, the most notable actions were on the exchange rate and on consumer subsidies. In nominal terms, the average rate of the FMG vis-a-vis the SDR depreciated by about 75% during 1982-85, and after adjustment for domestic and trading-partner inflation the real depreciation of the FMG approximated 25%. The Government more than doubled the nominal price of rice distributed through official channels; consumer subsidies on imported rice were eliminated. Madagascar's stabilization efforts also included tax measures,expenditure cuts, increases in prices  of public enterprise goods and services, and sharply curtailed imports. In addition to fiscal restraint, tight bank credit ceilings were employed to reduce inflation. 8. Between 1980 and 1985, agricultural output fluctuated. Production of paddy, a staple item, remained at around 2 million metric tons per year. Madagascar had to continue importing rice throughout the period, although the volume imported declined steadily from a peak 356,000 metric tons in 1982 to about 105,000 metric tons in 1985. The decline in rice imports, however, was due to foreign exchange scarcity rather than any marked increase in domestic self-sufficiency. Production of other food crops maize, potatoes, cassava, sweet potatoes) grew steadily and significantly for these crops as a. result of increased rice prices. With the exception of cotton and sugar cane, the production of industrial and export crops generally stagnated (e.g., tobacco, coffee, pepper) or declined (e.g., groundnuts, butter beans). The output of two other principal export crops, vanilla and cloves, was restrained by limited world market demand for these products. 9. The output of the industrial sector declined sharply between 1980 and 1982, and again in 1984; modest growth obtained in 1983 and 1985 did not make up for the decline in the other years. Industrial manufacturing capacity has been heavily underutilized in recent years owing to shortages of domestically supplied agricultural raw materials, and of imported inputs and spare parts. The construction industry also remained slack, judging from data on gross fixed capital formation. Between 1980 and 1982, all types of construction - residential, non-residential and other - declined heavily. In the following years, residential and other construction grew a little, but the volume of activity was constrained by continuing restraint in investment expenditures and shortages of construction materials. 10. On the policy front, Government initiated positive changes in industry, easing pricing controls, improving the administration of foreign exchange allocation, and, as recently as June 1985, legislating a new Investment Code. The new Code provides clearer and more automatic incentives and aims to attract foreign private investment. Here again, the recent initiatives need to be strengthened by extending the export earnings scheme (the EPI account) to a greater number of bona fide exporters, rationalizing the tariff system, and quickly completing the practical rules and regulations of the new Investment Code. 11. Owing to the slow growth of agriculture and industry, the transport sector had less merchandise and fewer passengers to carry throughout 1980-85 although, within the period, there was some upturn in road and rail traffic in 1983 and 1984. The traffic that was required had to be carried at high cost given the dilapidated state of the transport system. Costs could not be covered as the administered tariffs were set too low, thus further discouraging the provision of services. To improve the transport system and policy environment Government selected an economic network of about 10,000 kmsof primary and secondary roads for priority rehabilitation; established a road fund for maintenance; and permitted some tariff increases for the roads, railways, and the national airline.  - 4 - 12. Public Finance. During the 1978-80 period, the count-ry experienced an unprecedented growth in public capital expenditures financed by external loans, leading to substantial budget deficits and accumulation of indebtedness and arrears. Successive adjustment measures adopted between 1981 and 1985 progressively reduced the magnitude of the deficit and domestic arrears. The bulk of the fiscal adjustment has been accomplished by cutting expenditures, with a lower investment level, contained payroll expansion, and a reduction in materials and supplies used for government activity. The current budget balance turned positive in 1983 and remained so during 1984 and 1985. The size of the current surplus, however, remained small relative to the need to increase public savings. The overall deficit declined from 18.4% of GDP in 1980 to 8.7% in 1982 and 4.8% in 1984. It was estimated at approximately 4.7% of GDP in 1985. 13. Revenue. Total revenue declined from 17.9% of GDP in 1980 to 15.7% in 1985. The tax structure was altered frequently with yearly changes in the tax rate system. The tendency was to increase tax rates on income and imports, without visible results on effective tax revenue, this being partly due to unsatisfactory tax administration, partly to increased tax avoidance, and partly to reduced imports. Extrabudgetary revenues represented a growing share of total government revenue, with surplus from export stabilization funds yielding the main contribution in this category. 14. Expenditure. Improvement in fiscal performance was mostly the result of tight control of expenditures. Between 1980 and 1985, central government expenditures increased by only 26%, representing a substantial decline in real terms. The ratio of expenditures to GDP over the period declined steadily from 36.3% in 1980 to 20.4% in 1985. The main factor in this decline was cutbacks in capital expenditu-es from the unsustainable level of 1980. In real terms, capital expenditures declined by 15% per year during 1980-85. 15. Monetary developments during 1980-85 were generally in line with fiscal developments, reflecting implementation of stabilization measures. Throughout the period, the growth of credit to Government was reduced, and, beginning in 1982, credit to the non-government (i.e., parastatal and private) sectors generally expanded faster than credit to the Government. 16. Domestic inflation in Madagascar was reduced considerably after 1982, from about 30% in 1981 and 1982 to approximately 10 percenr in 1985. This performance was due mainly to demand management measures during the period, and to some decline in foreign prices of Madagascar's imports. The reduction of inflation during the period was all the more remarkable in that it occurred at a time when the Malagasy Franc was depreciating. Madagascar's balance of payments remained weak throughout 1980 despite substantial annual reductions in the volume of imports to the point of  -5- adversely affecting economic activities. To a large extent, the position remained weak owing to poor export performance and heavy debt service payments, the latter a legacy of large borrowings on hard terms during 1978-80. 17. Stabilization efforts throughout the period led to steady and marked improvements in the resource and current balances. In dollar terms, the resource gap in 1985 ($102 million) was less than 20Z of what it was in 1980 (US$557 million); and the current account deficit in 1985 (US*237 million) less than 40Z of what it was in 1980 (US$599 million). 18. Based on the existing debt portfolio at end 1985 and after taking into account pipeline disbursements, Madagascar will need new net capital inflows of about US$380 million per year during the 1986-90 period to cover current account deficits, meet scheduled debt repayments, and maintain a modest amount of gross reserves. The conditions at which Madagascar is able to obtain new finance and reschedule the debt are of crucial importance and will determine if the country is able to emerge from its low-level trap, even with a high quality policy program. 19. Since the emergence of the debt crisis at the beginning of the 1980s, Madagascar has managed the balance of payments by cutting imports and rescheduling debt service payments. These are very costly options, involving disruption of economic activities and refinancing of some originally concessional loans at less concessional terms. Madagascar now has probably reacned a limit to further cuts in imports as these are down to bare essentials. As to debt rescheduling, the country's creditors may continue to accord such arrangements to Madagascar. But, to generate significant amounts of annual debt relief, the rescheduling arrrngements would need to provide liberal coverage. Unless Madagascar would boost export earnings and thus strengthen the balance of payments, the debt burden would not be overcome. 20. Relationship with IMF. As of December 1985, the Government had complied with all performance criteria set in the fifth standby agreement signed in April 1985. Most of the important program targets have been achieved and all scheduled purchases have been effected. In the second review of the current standby, the Government has decided to acceler.te the depreciation of the exchange rate and agreed to continue this process under the sixth standby agreement. A mission visited Madagascar in March 1986 to negotiate a program supported by a sixth standby agreement, but unfortunately the negotiations could not be completed since a major cyclone affected Madagascar and the impact of the damage could not be assessed immediately. A new mission is therefore scheduled and the stand-by is expected to be presented for IMf Board of Executive Directors approval in July 1986. A meeting of the Consultative Group is scheduled for April 24-25, 1986 and the Paris Club is expected to meet in July.  PART II - BANK GROUP OPERATIONS IN MADAGA.SCAR 21. IDA credits to Madagascar amount to US$492.6 million (including US$29.9 million from the Special Fund) and Bank loans total US$32.6 million. Bank Group assistance to Madagascar has been concentrated in the key areas of infrastructure (including urban and social infrastructure), agriculture and energy. Since the start of Bank Group involvement in Madagascar, about 34% of Bank Group lending has been for transport, 29Z for agriculture, 12% for electric power and petroleum, 12% for industry and water, 3% for technical assistance, 4X for education, 3% for urban development and 3% for cyclone rehabilitation. IFC has four investments in Madagascar in textiles, footwear, and fisheries. Annex II contains a summary statement of past loans and IDA credits as of September 30, 1985. 22. In infrastructure, the Bank has supported nine transport projects with IDA credits totalling US$177.78 million. Six credits (US$147.2 million) were provided for the construction, maintenance and rehabilitation of highways. There have been one Credit (US$11.65 million) in 1970 to improve Madagascar's main port of Toamasina and two Credits in 1974 and 1979 (US$19 million) to support the railway's modernization efforts. Except for the fifth and sixth highway projects, all transport projects have been completed. Urban infrastructure development has benefited in 1980 from a Water Supply and Sanitation Credit for the capital city of Antananarivo (US$20.5 million). In addition, studies for urban development financed by the UNDP with the Bank as Executing Agency led to an urban development project (US$12.8 million) in FY84. In 1984 a US$15 million Development Credit for cyclone damage rehabilitation was signed with the Government. 23. The Bank Group has supported 14 agricultural projects in Madagascar. Five projects have been completed and nine are under execution. Lending for agriculture has included three livestock development projects, four irrigation projects, two forestry projects, an agricultural credit project, a rice intensification project and a cotton project. Technical assistance support is also being provided under two free-standing projects, one to study investment alternatives in the Plain of Antananarivo area, and the other designed to strengthen institutional development of key sector institutions and to support agricultural policy reform. In April 1985, the Executive Directors approved an irrigation rehabilitation project of US$12 million. In addition, the Bank has appraised and is supervising the IFAD-financed Highland Rice Project (US$30.0 million) to increase rice production by providing agricultural inputs and by reorganizing and strengthening agricultural extension services. 24. Energy projects have also received growing Bank Group attention. In 1978, IDA participated with several co-lenders in the financing of the large Andekaleka Hydroelectric Project, which was successfully completed in June 1982. A US$12.5 million Credit approved in 1980 for petroleum exploration promotion is supporting the Government's efforts to develop a domestic supply of hydrocarbons and to improve planning in the energy sector. A heavy oil exploration Credit (Tsimiroro) in the amount of SDR10.7 million was approved by the Executive Directors in November 1982.  -7- 25. Other lending. In 1980, a first US$5 million credit was made to the Industrial Development Bank of Madagascar. A follow up credit of US$5 million to the Industrial Sector Credit became effective on August 1985. A supplemental SFA to the existing Industrial Sector credit of US$20.0 million was approved in December 1985. In the social sectors, education has been the major recipient of Bank assistance with two Credits in 1967 and 1976 totalling US$11.8 million. A credit of SDR 9.4 million (US$11.5 million) for an accoctting and audit project which included an important training component was approved in 1981; and a follow up credit of US$10.3 million for training auditors, accountants and managers was approved in February 1986. 26. Implementation problems. Problems have arisen in the execution of a number of projects. The main problems encountered include delays, cost overruns, deficiencies in management and inadequate financial performance of project agencies. Current problems center on difficulties linked to the country's economic crisis, notably the acute shortage of foreign exchange and budget funds and institutional problems related above all to the parastatal system. The Bank approach has been to maintain intensive supervision efforts at the project level and to address the generic problems through every instrument available, from the Consultative Group through the Country Implementation Review (June 1985) including the macroeconomic, sectoral and project-level dialogue, technical assistance and secondment staff. The Government has been responsive and there have been significant improvements in Government portfolio management and a reduction in implementation problems. 27. Project Evaluation. Since the start of our program in Madagascar, eight projects have been completed and audited by the Operations Evaluation Department. The Audit Report No. 1622 of December 1976 on the first Lac Alaotra project concluded that the project was generally successful. However, the Impact Evaluation Report No. 3600 of August 1981 concluded that earlier assessments of project performance had been over-optimistic, and that the actual rate of return was probably negative. The Audit Report No. 1143 of April 1976 of the first education proj4ect concluded that the education and manpower training objectives were satisfactorily achieved. The Audit Report No. 5434 of January 29, 1984 of the first Railway Project concluded that due to overruns and delays in implementation, the project had to be downscaled and that the estimated rate of return was less than 10%. The Audit Report No. 1559 of April 1977 on the Beef Cattle Development Project concluded that the project had contributed little to Madagascar. The Audit Report No. 2143 of July 1978 concluded that the Third Highway project was well just_fied and had a satisfactory rate of return despite substantial cost overruns. Report No. 2299 of December 1978 concluded that the physical objectives of the Tamatave Port project were satisfactorily achieved but pointed out that the institutional objective was not accomplished during project implementation because of inadequacies in the staffing of the port authority. Audit Report No. 5403 of December 28, 1984 covered two agricultural projects: the Morondava Irrigation and Rural Development Project was a profoundly disappointing operation, but the Village Livestock and Rural Development Project contributed to laying the groundwork for more effective services for traditional livestock owners, with good prospects for sustainability.  - 8 - 27. Policy-based sectoral lending. The program for Madagascar has been broadened to include sectorlending in support of priority recurrent imports. This process started with the Sixth Eighway project, which includes US$10 million for spare parts for the rehabilitation of the private road transport fleet, and is linked to significant changes in policy with regard to road tariffs and regulations. The Industrial Assistance Credit aims at supporting Government efforts in the rehabilitation of the industrial sector by providing spare parts and raw materials to key industries. It also includes a package of policy measures to liberalize prices in the industrial sector, promote exports, reduce import restrictions, rationalize public investment, and formulate a new investment code promoting private initiative. Progress has been made on liberalizing prices, reducing import restrictions and in encouraging exports. A satisfactory Public Investment Program in industry for 1985 (US$10.6 million) was agreed with the Government and a new investment code was approved in June 1985. A Credit similar in design for the agricultural sector was negotiated with the Government in January 1986. This program includes reform measures to improve the effiiciency of agricultural marketing, strengthen producer incentives, define a food security strategy and an agricultural export program, and improve management of public resources for agriculture, as well as agricultural institutions and key services to farmers. 28. Bank Strategy and Future Program. The Bank strategy is to support the Government's efforts to rehabilitate and restructure the economy by: (a) promoting policies and programs aimed at reforming incentive structures, to make the economy more market-responsive and provide a more favorable climate for private sector initiative and investments, and providing financial and other support for appropriate policy programs; (b) supporting adoption of viable sectoral strategies aimed at rehabilitating productive and economic infrastructure and establishing conditions for long-term growth, and providing financial and technical assistance to implement these programs; (c) strengthening the institutions responsible for macro and sectoral economic and financial policy formulation and management; and (d) helping Madagascar mobilize donor aid and to make effective use of donor financial, technical, and debt relief support. 29. On the assumption of continued Government responsiveness, the Bank is supporting Government adjustment efforts by emphasizing policy-based lending as the main vehicle of Bank financial assistance. Additional sector policy-based operations in agriculture and industry would be prepared. These would support continued market deregulation, export promotion, cost recovery, private investments, case-by-case parastatal rehabilitation, and sector institution building. A core lending program  - 9 - will also be supported which accords priority to the rehabilitation of productive and economic assets, and addresses longer-term issues in human resource development, health, agricultural research, and environmental degradation. Overall, future lending would concentrate on agriculture, industry, energy, transport and health. 30. Aside from sector and project-level efforts, the main vehicle for aid coordination has been the Consultative Group. Making the Consultative Group a more effective means of addressing Madagascar's payment problems is an important part of Bank country assistance strategy. This would contribute to resolution of the country's external financial problems. Donor and creditor support of a comprehensive financing strategy, combined with a sound Government program to stimulate real growth offers the best prospects for future development. This implies active participation by the Government and the IMF in the preparation of meetings, and Bank focus on longer-term structural adjustment issues. 31. In addition to a substantial economic and sector work program, the Bank is supporting the Government in policy analysis and selected institution-building through technical assistance. Further, two secondment positions have been recently approved to assist the Planning Directorate and the Ministry of Livestock, Water and Forests; and the Bank's Resident mission has been strengthened by a resident economist. SPFF resources have and will continue to be used to provide technical support for future policy-based work, as well as to help strengthen investment planning, programming and budgeting. PART III - THE TRANSPORT SECTOR The Transport Network 32. Madagascar's transport infrastructure includes an extensive but poor road network, two rail sections of considerable length, a well-developed air network, four main ports, eighteen lighterage ports and a navigable canal along the east coast. Transport needs are relatively well served on the central plateau, where half of the population is concentrated. But, generally speaking, Madagascar's transport infrastructure is inadequate as it fails to provide access to all productive areas of the country. 33. Road Transport. The road network comprises about 50,000 km of which 5,200 km(i10.4Z) are paved. The paved highway network consists of: (a) a main north-south link connecting the port of Mahajunga on the west coast with Antananarivo (the capital) and Fianarantsoa in the highlands (parts of which can sustain heavy vehicles), and (b) an east-west road linking the cities of Moramanga and Antananarivo to the port of Toamasina. A new paved section on the Toamasina-Moramanga road, built with the  - 10 - assistance of China, provides all-weather transit between Moramanga and Brickaville on the coast (Map IBRD 13645 R). While this development greatly improves road communications between Antananarivo and Toamasina, heavy truck traffic will continue to be constrained on the highland Moramanga-Antananarivo (115 km) road, which is, as most of the island's roads, of low standard, narrow, badly aligned and in poor condition. Except for the southern region, which has a dry climate, heavy rains make many roads impassable, and for half the year the northern and parts of the western regions have little or no road connection to the rest of the island. With the country's limited implementation capability and resources, maintenance remains a major problem for the road sub-sector. With IDA assistance, the Government prepared a maintenance and rehabilitation program for a 10,000 kilometers economic road network which includes the most heavily used roads in the country. This program constituted the basis of the IDA-financed Sixth Highway Project. 34. Air Transport. By regional standards, Madagascar has developed a dense domestic air transport network in response to the distance between population centers and the poor condition of surface transport. Air Madagascar, 80% owned by the Government, 18% by Air France, and 2% by private shareholders, provides international service to Paris, Marseilles, several countries in East Africa, and all domestic services. There are 56 airports, 17 of which are built to all-weather standards and five of which are suitable for international flights; the remainder are gravel or grass strips. The international airport at Antananarivo handles 50% of all traffic. Since 1979, Air Madagascar's financial situation has been seriously affected by declining loads, a heavy debt service burden as a result of the uneconomic expansion of its fleet in 1978-80 and unprofitable services to small airports. In 1985, the Government undertook a number of actions to strengthen Air Madagascar including changes in management and a financial recovery program; Air Madagascar successfully re-negotiated its long-term debt with foreign banks, and has concluded lease agreements with foreign carriers to increase the utilization of its jet fleet. 35. Ports and Coastal Shipping. Madagascar relies almost exclusively on maritime shipping for its foreign trade but coastal shipping is also important, as the only means of transport between many areas of the country with no access to all-weather roads. There are four main ports: Toamasina, the main international port serving the populated central highlands via the railways, handles 55% of total traffic; Mahajanga in the west handles 11%; Antseranana in the north 5%, and Toliara in the south, about 4%. The remaining 25% of the traffic is handled by smaller coastal shipping ports. The port of Toamasina has adequate capacity to handle present traffic, but operations are hampered by low labor productivity and lack of spare parts for equipment. The Societe Malgache des Transports Maritimes (SMTM), the state-controlled international shipping line,  - 11 - operates four cargo-vessels for the country's external trade. Currently, most secondary ports are ill-equipped and suffer from poor fleet maintenance and difficult operating conditions. Coastal shipping is handled primarily by the Compagnie Malgache de Navigation (CMN), 92Z state-owned. Its nine ships are relatively modern but CMN is also plagued by a shortage of spare parts and low productivity. In November/December 1985, IDA appraised a Ports Rehabilitation and Institutional Development project, which will seek to address the priority needs of Madagascar's key ports. 36. Railways. The railways are operated by the Reseau National des Chemins de Fer Malagasy (RNCFM), a parastatal agency under the authority of the Ministry of Transport, Supply and Tourism (MTRT). The railways consist of two separate and unconnected systems: the northern system, with about 700 km of track, connects the capital (Antananarivo) and industrial areas in the plateau region to the main deep water port of Toamasina; and the southern system, about 160 km of track, connects the semi-industrial town of Fianarantsoa and the agricultural areas in the southern plateau to the port of Manakara. The Antananarivo-Toamasina line (TCE) is the most important link, since it is still the most reliable means of surface transport between the country's main seaport and the capital. Because of the difficult terrain, RNCFM has 362 bridges and 94 tunnels, and speed restrictions are common. Frequent heavy rains and cyclones exacerbate railway wear and tear, making maintenance and rehabilitation expensive. Transport Policy and Planning 37. While several ministries and Government agencies have some responsibility for managing the sector, the two most important are the Ministries of Public Works (MTP) and of Transport, Supply and Tourism (MTRT). MTP is responsible for planning, building and maintaining highways, ports and airports; MTRT is responsible for transport operations in all modes, management of the ports (except Toanasina) and airports, and oversight functions for RNCFM, the Port of Toamasina, Air Madagascar and the state shipping companies. Others with significant responsibility in the sector are the Ministries of Industry and Commerce and of Agriculture, the Army and the Directorate General of Planning (DGP). 38. Government policy towards transport development is to improve the road network and maintenance as well as transport organizations and services. The overriding objective is to satisfy the country's quantitative and qualitative transport requirements at reasonable cost. These objectives are consistent with the recommendations of IDA's 1983 Transport Sector Memorandum (TSM) which helped focus the orientation of Government's development strategy for the transport sector. The main recommendations of the 1983 TSM Report included the following: (a) priority for rehabilitation and maintenance rather than new investment; (b) improved management and financial recovery for transport enterprises; (c) increased efficiency in road transport industry through policy reforms and improved allocation of foreign exchange to private operators; and (d) increased training and technical assistance to improve operational efficiency, and  - 12 - strengthen planning as well as project implementation capability. Action has been undertaken towards the implementation of the overall strategy as set out below. 39. The content of the public investment program (PIP) in transport for 1984-87, responded well to Government's objectives with rehabilitation in transport taking the highest priority; but the investment program was found to be too ambitious in view of the country's financial constraints. In fact, though the Government was successful in attracting sufficient external financing for transport, actual transport investment levels have been lower than anticipated due to a shortage of local resources and the country's weak implementation capabilities. Domestic resources for investment in the transport sector are limited almost entirely to the Government capital budget, as net domestic resource mobilization from the public sector enterprises is negative. This is a result of Government's policy of fixed tariffs for all transport modes, which does not allow transport operators to cover their operating costs and maintain or replace their assets. A common denominator in most sub-sectors is the need for more autonomy of management (except for the railway and Air Madagascar); and for liberalization of actions (pricing, traffic itineraries, and commodities to be transported) for transport operators, whether parastatal or private. 40. The IDA-financed Sixth Highway project (Credit 1391/SF-4-MAG) constitutes a major step towards addressing these key issues. Besides its strong rehabilitation content and institution building support of MTP and MTRT, the project represents a major effort directed at introducing policy reforms for efficiency in the road transport industry. Government agreement under this project to allocate US$10 million for the procurement of spare parts exclusively for the rehabilitation of the private transport industry is a sign of its willingness to promote the private sector. 41. Under the Sixth Highway Project, the Government agreed to remove all restrictions on routes and commodities to be served by private transporters and to deregulate all tariffs for road transport, unless otherwise agreed by IDA, on the basis of recommendations satisfactory to IDA resulting from a transport policy study and pricing policies study which were to be carried out by the Ministry of Transport, Supply and Tourism (MTRT) as part of the preparation of a National Transport Plan. It was convenanted that these actions would take place by December 1984. Government postponed action on these matters, pending the conclusions of the studies, which were delayed. On the basis of the preliminary findings of these studies, the Government has now agreed to create conditions for sound competition between transporters, provide freedom of access to all routes, except on those where restrictions can be justified on technical grounds, ensure free movement of goods within the entire country and liberalize road transport tariffs. The Government also agreed by  - 13 - September 1986, to amend a 1971 decree restricting private road shipment on the main highway (RN2) linking the capital city of Antananarivo to the Port of Toamasina; and to start from June 30, 1986, the publication of average operating costs for different vehicles in order to assist transporters in setting rates. IDA supervision missions will pay particular attention to Government follow-up on these matters, and be available to assist in resolving implementation problems. 42. MTRT's Directorate of Planning is in charge of overall transport sector planning and coordination. Its task is still complicated by sub-sector agencies, which prepare projects and investment proposals without proper coordination with MTRT. With technical assistance financed partly by IDA under the Sixth Highway Project and French aid, MTRM's Directorate of Planning is being strengthened. Its National Transport Plan is expected to focus attention on long-term policies and actions to improve overall transport efficiency. So far, the main positive achievements under the Sixth Highway Project have been the re-establishment and strengthening of the country's road maintenance capacity, and the raising of substantial additional financing from other donors for road rehabilitation and maintenance. RNCFM 43. RNCFM is managed by a Director General, under general supervision of a Board of Directors which is presided over by the Minister of Transport, Supply and Tourism (MTRM). The senior management team is competent and motivated. In December 1984, RNCFM had about 4,000 permanent and 850 temporary employees, out of whom 350 people will become eligible for retirement over the next five years. A large number of these staff are highly experienced and their replaceme-nts will require considerable training. Currently, despite special attention paid to training, RNCFM's training center is seriously lacking in physical and technical resources. RNCFM offers attactive incentives to induce experienced staff to teacb others. Recently, overall management of training has been given high status within RNCFM. 44. Infrastructure. The railway is old and for years was not well maintained. Since the early 1970's, RNCFM has been gradually trying to rehabilitate and upgrade the track. Under the Second Railways Project the oldest and most worn out rail on the Antananarivo East-coast (TCE) line was replaced. Today approximately 120 km of rail on the TCE segment is less than 5 years old while 255 km is between 25 and 45 years old. Most of the rail on the entire Moramanga-Lac Aloatra (MHL)section, however, is over 60 years old; ballast is sparse; and the sleepers, fasteners and fishplates are in poor condition. The rate at which rehabilitation work is accomplished is slow and therefore even more expensive than warranted.  - 14 - 45. Rolling Stock. RNCFH's locomotive fleet consists of 33 line locomotives, 10 railcars and 24 shunters; all are dieselized. Eleven 750 horsepower locomotives are over 30 years old and must be progressively retired as spare parts are no longer available. All are due for major overhaul. CCCE has agreed to finance the purchase of four locomotives, whiTh should satisfy the railway's motive power needs during the project period. The railway remains in need of spare parts for locomotives and wagons. The passenger cars (58) and freight wagons (967) are in fair condition and adequate for the traffic handled. 46. Signalling and Telecommunications. RINCFM uses a train order system to direct trains. All trains are controlled by phone; signalling exists only at the approach to Antananarivo. The methods of control are adequate for the traffic involved. The telecommunications system on the TCE line was recently modernized with the laying of a new underground cable. On the other lines, however, the system is old, in poor condition and much of the equipment is obsolete. Yet spare parts are no longer manufactured. A low cost two-way radio system is proposed for the MLA line; repairs on other lines can be accomplished using spare parts released as a consequence of MLA line renewal. 47. Other Facilities. RNCFM's equipment maintenance is undertaken at workshops located in Antananarivo, Moramanga, Manangareza and Fianarantsoa. The depots are adequate, although work flow could be improved by rearranging the layout of some of the facilities. A more pressing need, however, is tools and spare parts. Container handling facilities also need upgrading to better serve the steadily developing container traffic. Loading and unloading facilities at the main Port of Tosmasina are up to date but inland facilities are overtaxed and incapable of handling any increase. 48. Financial Results. The railway reported a profit in 1983 and 1984 and is in compliance with the revenue covenant under the Second Railways project (Credit 903-MAG). The turnaround resulted largely from actions taken as a consequence of donor pressures to increase the freedom of RNCFM's management in two key areas: pricing and receivables collection. As a result, despite stagnating traffic, revenues increased nearly threefold between 1980 and 1984 and RNCFN generated a healthy cash flow of FMG 5.3 billion (US$8 million) in 1984. Besides significant improvements in its financial performance, RNCFM has made tangible progress in the areas of capital budgeting, costing and human resources planning. An analytical cost accounting system, introduced under the Second Railways Project, is enabling RNCFM to improve its tariff structure and will help, together with the establishment of a new marketing unit, to orient its marketing strategy during the proposed Third Railways Projerc.  - 15 - 49. Impact of Cyclone "Honorinina- on RNCFM. In mid-March 1986, the eastern coast of Madagascar was struck by cyclone 'Honorinina", which damaged several key transport facilities. The main damage to RNCFM occurred on the northern railway system; the Antananarivo-east coast line (TCE) suffered landslides, wash-outs and track subsidence, which cut the line; telecommunications were disrupted. Similar but less extensive damage occurred on the MLA line. To restore normal operations, RNCFM currently needs emergency assistance to undertake essential repairs/rehabilitation works. 50. Investment Plan. RNCFM continues to rely heavily upon consultants and the Bank's guidance and analysis in preparing its medium and long-term capital budgets and in developing operating strategies. To assess its future investment requirements, in light of the reductions made in the size of the Second Railways Project (Credit 903-MAG) during implementation (Para. 56) and the current stagnation in rail traffic, RNCFM prepared a new five-year investment plan for 1985-90. This plan was revised during appraisal of the proposed project to reflect more realistic traffic forecasts taking into account expected future road competition, and to retain only those investments required to ensure that the railway could remain operational and capable of maintaining current service levels. Towards that end, the plan focuses on improvements in operational efficiency and staff development needs, and on rehabilitation of physical assets. RNCFM's five-year investment plan and the proposed project were jointly reviewed and appraised with CCCE. CCCE agreed to provide a loan of FF 98 million (US$13.0 million) to finance expenditures planned for 1986. The proposed project would finance selected high priority elements for the three mid-years (1987-89) of the plan. RNCFM's Five-Year Investment Plan (1985-90) has been reviewed and agreed. RNCFM will not undertake any investment which is not included in its 1985-90 investment plan unless th,e economic justification of such investment is established in consultation with IDA. The Plan will be revised annually, as appropriate, in agreement with the Association. 51. Future Role of RNCFM. RNCFM has been and is expected to remain the main transport mode for key sectors of the island's economy, as it is the primary means of transport for bulk commodities such as petroleum products, grain, chemicals and construction materials from the Toamasina port to the central highlands, and thus between the most populated and economically developed parts of the country. Long-term projections indicate that rail traffic is unlikely to increase significantly even if the economy resumes growth, due to increased modal competition (particularly road) for non-bulk commodities. LIstead it is likely to stabilize at the current level. RNCFM's main role in the long-term will be to handle bulk commodities that are not sensitive to time or exceed road weight restrictions and for which rail transport costs are much lower than trucking costs. In the medium term, despite significant declines (30%) in  - 16 - rail passenger traffic since 1979, in addition to bulk commodities, RNCFM will continue to carry a substantial number of passengers as most existing road traffic vehicles need to be replaced and this is expected to take some time given the current scarcity of foreign exchange. 52. RNCFM's southern line (FCE), faces competition from a partially improved road on the coastal plain (Map IBRD 13645R). Traffic density on the FCE line is light and likely to remain so. While the FCE line accounts for nearly 20% of RNCFM's total track, in 1984 it carried only 5% of total traffic and incurred an operating cash deficit of about FMG 263 million (US$405,000). A study financed under the Second Railways Project (Credit 903-MAG) concluded that the most economic long-term solution would be to close the line. However, the same study also indicated that until the road along the rail line is improved to permit full substitution, operation of the FCE line should continue under the most efficient conditions. A recently completed study, financed by a project preparation facii'ty (PPF) advance under the proposed project, has investigated in detail all practical alternatives to serve the area now being served by the southern line at the least economic cost. On the basis of the findings of this study, the Government and RNCFM have prepared an action program including provisions for cost recovery, appropriate pricing for road and rail services in the region served by the FCE line, and cost reduction targets. The action program will aim at first reducing and then eliminating deficits during project implementation or alternatively phasing out rail service and developing roads if traffic on the FCE line continues to dwindle and subsidies to cover operating deficits grow. During IDA supervision missions, progress on the implementation of the program will be monitored closely. Impact of Cyclone 'Honorinina on the Port of Toamasina 53. The Port of Toamasina suffered extensive damage on the brea.k-water, beacons, a lighthouse, warehouses, sheds and cranes. Repair of the main break-water appears to be of the highest priority but cannot be undertaken until detailed engineering studies are carried out. Without urgent repair works, further severe damage would occur to the unprotected por: infrastructure, the handling capacity of the port would be seriously redused and unprotected cargoes would be damaged. 54. The Port of Toamasina, the primary port of the country, is the only autonomous port authority. The Societe d'Exploitation du Port de Toamasina" (SEPT) operates the port, cargo handling and a few unrelated services. SEPT was established in 1976 with IDA assistance under Credit 200-MAG. It enjoys a degree of management and finanrcial autonomy and  - 17 - employs just over half the wage earners in Toamasina. A study carried out in 1982 by a French consulting firm indicated that the port's inefficient operations and low productivity result mainly from management and institutional problems. The main objective of a proposed Port Rehabilitation and Institutional Reform project, currently under appraisal, would be to address the institutional problems of the ports-subsector, particularly those affecting the efficiency of the Port of Toamasina. Bank Group Involvement in Transport 55. The Bank Group has placed special emphasis on lending for transport, as the development of other sectors, particularly agriculture, depends on transport. From 1966 to 1985, the sector benefitted from about US$177.8 million of Bank Group financing, of which US$19.0 million (10.72) were for the two projects financed in 1972 and 1979 for the railways sub-sector and US$11.6 million (6.5%) for a port project financed in 1970. The main objectives of Bank Group assistance to RNCFM were to rehabilitate its infrastructure and equipment, replace old rolling stock, improve its managerial, operational and financial situation, and introduce a more market-based pricing strategy. Though some shortfalls occurred in physical implementation, institution building achievements in RNCFM have been substantial. 56. As described by a Project Performance Audit Report of June 1984, the First Railway Project was found to have been a -holding operation- that successfully benefitted the Malagasy people by keeping the railway operational. However, underestimated costs and delays in implementation resulted in a scaling down of the project's initial scope. Project completion took three years longer than estimated; its overall estimated rate of return was less than 10%; and the railway's financial and institutional performance remained poor. The Second Railways project, not yet audited, was completed in December 1984. This project also suffered from delays in implementation; lower than anticipated ballast and sleeper production resulted in fewer kilometers being rehabilitated than planned; and low cost estimates reduced the number of wagons and coaches actually purchased. Between March and October 1982, disbursement under the Second Railways project was suspended as the Government was reluctant to institute tariff reform. In June, 1982, the Government complied with the agreed covenant and agreed to improve RNCFM's management (para. 48). Since then, RNCFM has adjusted its tariffs and has made a significant financial turnaround. The Second Railways Project can be credited for the above achievement, as well as for progress made in the evolution of RNCFM towards a commercially oriented institution.  - 18 - PART IV - THE PROJECT 57. The proposed project was appraised in February 1985. A staff appraisal report entitled "Democratic Republic of Madagascar - Third Railway Project' (5702-HAG) dated March 28, 1986, is being distributed separately. A supplementary Project Data Sheet is attached as Annex III. Negotiations were held in Washington, D.C., during March 17-21, 1986. The Malagasy delegation was led by His Excellency Mr. Joseph Bedo, Minister of Transport, Supply and Tourism. Project Objectives 58. The proposed project will continue the rehabilitation and maintenance efforts started under the first and second Railways projects. Its main objectives are to enable Madagascar's northerm railways system to continue service at its current level of capacity and to operate at a reasonable level of efficiency over the next ten years. To achieve these objectives, the project would: (i) improve track conditions between the chromite ore mines and rice growing region, the main port and the populous central highlands, (ii) replace a bridge critical to continued rail services on the Antananarivo-Antsirabe line, (iii) provide a road/rail link to a new cement plant, likely to become a substantial source of rail traffic, and (iv) ensure more consistent availability of motive power and improve RNCFM's basic operations and staff productivity in the areas of maintenance, track rehabilitation and container handling. The project wiln also provide emergency assistance to RNCFM and SEPT to allow resumption of normal operations disrupted by Cyclone -lonorinina-. Project Description 59. The proposed project, based on RNCFM's five-year investment plan (1986-90) as revised and agreed with the Bank, would include the following components: permanent way improvement; rolling stock improvement; purchase of shop machinery, tools and other equipment; provision of low cost radio telecommunications equipment; staff training and procurement of training facilities, technical assistance, studies and cyclone damage repairs and rehabiliration. 60. Permanent Way Improvement. About 60 kilometers of track on the Moramanga - Lac Alaotra line would be rehabilitated because the main track components are beyond repair. This rail line is an important adjunct to the main line between the coast and the capital. The Lac Aloatra Region supplies rice to the highland population and chromite ore for export. Yet  - 19 - the present condition of the line is poor and has led to deterioration in train service. Some of the rails left over under the Second Railways project (Credit 903-MAG) would be used for renewing this line. The proposed project will finance steel sleepers and rail attachments for difficult track sections with many sharp curves as local production of wood sleepers is limited and suited mostly for maintenance replacements and rail attachments are not available locally. A long term objective of RNCFM and the Government is to eliminate dependence on imported sleepers through improved local production. 61. The line from Antananarivo to Antsirabe is generally in good condition with the exception of a 60-year old bridge close to Antananarivo. Re-.paired and shored up several times, this old bridge is on the verge of total collapse. The Antananarivo-Antsirabe line makes a positive net financial contribution to RNCFM, which warrants the reconstruction of an old bridge under the proposed project. 62. A new cement plant near completion at Ibity, located near Antsirabe, will require rail access to obtain coal and other raw materials necessary for its operation. A rail spur to the plant, as far as Vinanikarena, is in the process of being built. For the final link to the plant, the proposed project would include construction of a 6 kilometer road link, a small bridge and a rail terminal and the purchase of coal handling equipment. The combined road and rail access to the plant is expected to be cheaper than building a 20 kilometer rail spur, as originally envisaged by RNCFM, and should be sufficient to handle transport of coal and other inputs to the plant and the cement plant output. 63. lmurovement in Rolling Stock Availability. Two years worth of spare parts for locomotives and wagons would be provided to RNCFM under the proposed project to maintain and repair the fleet. Past shortages have resulted in deferred maintenance which has seriously affected car and engine availability. The major locomotive maintenance repair program initiated under the Second Railways Project will continue. Also, five trolleys will be purchased under the proposed project to alleviate the acute shortage of reliable transport of tools, materials and workers for track maintenance and repairs. 64. Shop Machinery, Tools and Other Equipment. A limited amount of lathes, turret drills and planers that are old and beyond repair in the workshops will be replaced under the proposed project. These machine tools are required to make parts that are not available locally. A bulldozer, track tools and equipment would also be provided to handle washouts and other emergencies. The proposed project will also include provision for the purchase of a forklift for handling containers at the Antananarivo inland container terminal to improve the handling of this increasing business.  - 20 - 65. Telecommunications Equipment. The poor condition of the Moramanga-Lac Alaotra (MLA) line (para. 44), is aggravated by an unreliable telecommunications system which cannot be repaired because it is outdated and spare parts are no longer available. A two-way radio scheme will be developed in detail by a consultant study to be financed under the proposed project (para. 68), and then acquired and installed. 66. Training. With assistance from France, RNCFM prepared a training program for 1986-90, which was found to be too ambitious. During appraisal, the program was revised to reflect more realistic objectives and target dates. Under the proposed project, the training component would consist of (i) construction of new training facilities; (ii) procurement of teaching equipment; (iii) provision of 32 overseas fellowships for senior and middle managers and (iv) provision of 48 staff-months of technical assistance for manpower planning, job analysis, and specific training techniques. The training component is aimed at improving staff productivity in the near term. 67. Technical Assistance. About 30 staff-months of technical assistance will be provided as follows: (i) six staff-months to improve ballast production; (ii) eight staff-months to improve train operations planning and coordination; (iii) eight staff-months to strengthen planning and scheduling of workshop repairs; and (iv) eight staff months to demonstrate techniques to increase the productivity of track rehabilitation. Terms of reference for the proposed technical assistance have been discussed and agreed. 68. Studies. Several studies are included in the proposed project to help RNCFM and the MTRT planners in specific areas. They are: (i) 12 staff-months to improve efficiency in production of wood sleepers including quality control, forest resources management, sustainable yield, and recommendations regarding the long term financial viability of sleeper and timber production operations; (ii) 10 staff-months for the detailed engineering study of the cement plant's rail terminal, road and small bridge link at Ibity; (iii) 8 staff-months to develop a least cost solution to improve the NLA. telecommunications system; and (iv) 10 staff-months to develop practical alternatives to serve the transport needs to the Fianarantsoa-Manakara axis more economically than currently done by rail. Two of the proposed studies (ii) and (iv) have already been carried out under a project preparation facility (PPF) advance under the proposed project. Terms of reference for the remaining two studies have been agreed. Cyclone damage repairs and rehabilitation 69. During negotiations, it was agreed to modify the scope of the project to accommodate inclusion of emergency civil works and repairs for RNCFM and SEPT. These emergency works would consist mainly of (a) RNCFM removing landslides and fallen trees that cut the TCE and MLA lines and of repairing and rehabilitating damaged track sections and telecommunications equipment on these lines and railway buildings damaged in the area of  - 21 - Toamasina; and (b) SEPT carrying out a detailed engineering study of repairs for the break-water, and repairing and rehabilitating navigation aids, warehouses, sheds and cranes. Items proposed by the Malagasy Delegation for emergency repairs and rehabilitation will be re-assessed by an IDA mission, and their priority more firmly established. It is only following this field evaluation, that the specific emergency repair and rehabilitation items to be financed under the proposed credit will be agreed, along with the associated procurement arrangements. Project Cost 70. The total project cost for the three year implementation period (1986-88) is estimated at FMG 11,027 million (US$ 16.9 million) including foreign exchange costs of FMG 7,782 million (US$12.0 million) or 71% of the total cost. The estimated cost of cyclone damage repairs and rehabilitation amounts to US$2.3 million, with a foreign exchange cost of US$1.9 million. Baseline costs for the project were estimated at mid-1985 prices and were increased by 10% to include physical contingencies. Price escalation for foreign costs is based on projected increases in international US dollar prices and estimated to be 7.5% in 1986, and 8% in 1987 and onwards. The international rates have been also used for local cost escalation assuming that the difference between domestic and international price inflation will be offset by adjustments in the foreign exchange rate in accordance with Government policy. A total of US$3.6 million has been provided for both price and physical contingencies, representing 25% of total project cost. Local taxes and duties were excluded from cost estimates as project expenditures would be exempted from them. Project costs include US$1.7 million for about 155 staff-months of consultancy services. Detailed engineering for the reconstruction of the bridge was completed in June 1985, and detailed engineering for the road bridge and rail terminal at the Ibity cement plant in February 1986. Financing Plan 71. The foreign exchange cost of the project would be financed by the Association (US$12.0 million or 71%), and the local cost (US$4.9 million or 29%) by internally generated cash of RNCFM (US$4.8 million) and of SEPT (US$0.1 million). 72. IDA Credit. During negotiations, the planned IDA credit amount was increased to US$12.0 million equivalent, to assist RNCFM and SEPT in rehabilitating and repairing facilities destroyed or damaged during the cyclone. Under the credit, RNCFM and SEPT will each receive US$1.0 million to finance emergency repairs and rehabilitation works. Since the six (6) kilometers road link and the small bridge to be constructed for the, Ibity cement plant would be considered public investment for public uses and would not generate any additional revenues for RNCFM, the cost of these investments amounting to US$300,000 will be passed on to RNCFM as grant, in addition to the US$200,000 provided under a project preparation facility advance to finance the detailed engineering study of the cement plant  - 22 - terminal and the study of the Fianarantsoa-Manakara axis. The US$200,000 advance would be re-financed from the proceeds of the proposed IDA credit. In summary, out of the proposed US$12.0 million, the Government would pass on (a) to RNCFM US$500,000 (4.2%) as a grant and US$10.5 million (87.5%) as a loan; and (b) to SEPT, US$1.0 million (8.3Z) as a loan. Government on lending terms to RNCFM and SEPT would be 9.5Z interest for a period of 20 years including 6 years of grace. RNCFM and SEPT would bear the foreign exchange risk. Conclusion of subsidiary loan agreements, between the Government and RNCFM and between the Government and SEPT, acceptable to IDA, and incorporating the above terms, would be a condition of credit effectiveness. Project Implementation and Procurement 73. Aside from SEPT's involvement in cyclone damage repairs and rehabilitation, RNCFM will be responsible for implementing the project. RNCFM's track improvement will be carried out by RNCFM's track and building department, which has done similar work under past projects. Rehabilitation and maintenance of locomotives and wagons will be carried out in RNCFM's central workshops in Antananarivo. Experts to be financed under the technical assistance component will ensure that the proposed track rehabilitation is fully carried out with available funds, and will assist in improving the quality of work produced and productivity of RNCFM's central workshop at Antananarivo. Training and technical assistance for track rehabilitation and improvement in train operations and maintenance are expected to start during the last quarter of 1986 and to be completed by September/October 1987. Except for the civil works components (track rehabilitation, re-construction of the bridge, road/rail link for the Ibity cement plant) which are expected to be carried out over the three year period of project implementation (1986-88), procurement of most spare parts, equipment and tools is expected to be fully completed by September 1987. 74. Procurement arrangements are summarized in the table below. Procurement of all goods and services would follow Bank Group Guidelines. RNCFM will carry out track relaying and cyclone repairs and rehabilitation works by force account. The construction of RNCFM's training center is expected to be carried out by local contractors on the basis of local bidding procedures, which have been reviewed and are acceptable to IDA. Orders for RNCFM would be grouped whenever possible into contracts valued at US$ 100,000 or more and would be procured through international competitive bidding except for: (i) proprietary spares and supplies (US$1.4 million) which would be procured by direct order; and (ii) rail fastenings and miscellaneous equipment costing less than US$100,000 and totalling no more than US$1,000,000 to be procured either through limited international tendering or local shopping based on comparing price quotations from at least three manufacturers, dealers or suppliers. The execution arrangements for SEPT would be worked out during an IDA mission.  - 23 - Procurement Arrangements Project Element ICE LCB OTHER N.A. TOTAL COST (million US$'s) a) Civil Works Track Relaying 1.1 1.1 Bridge PK2 2.7 2.7 Ibity terminal 0.8 0.8 Training Center 0.7 0.7 2.7 0.7 1.9 5.3 (2.3) (0.5) (2.8) b) Track Materials Sleepers 2.3 2.3 Fastenings 0.4 0.4 2.3 0.4 2.7 (2.1) (0.3) (2.4) c) Rolling Stock Spares 1.4 1.4 Gang Trolleys 0.6 0.6 0.6 1.4 2.0 (0.5) (1.2) (1.7) d) Equipment Shop Machinery 0.3 0.3 Crane 0.2 0.2 Telecommunications 0.8 0.8 Training 0.4 0.4 Ibity Terminal 0.3 0.3 Other 0.6 0.6 2.0 0.6 2.6 (1.4) (0.2) (1.6) e) Cyclone repairs and 2.3 2.3 rehabilitation (2.0) (2.0) f) Consulting Services 1.7 1.7 (1.2) (1.2) g) Fellowships 0.3 0.3 (0.3) (0.3) TOTAL 7.6 0.7 4.3 4.3 16.9 (6.3) (0.0) (2.2) (3.5) (12.0) Note: Figures in parenthesis are the respective amounts proposed for IDA financing.  - 24 - Disbursement 75. The proposed credit would be disbursed against 100 percent of foreign expenditures for imported materials, equipment, consulting services and fellowships and 75 percent of local expenditures eligible for IDA financing in the above categories. Disbursements would be fully documented. The estimated disbursement profile for the project is faster than the standard profile for transportation projects because the extent of civil works and erection work involved is limited, and the implenentation period of the project is shorter than a full scale conventional railway project. There is provision for retroactive financing up to a total of US$500,000 for cyclone repairs and rehabilitation expenses incurred after April 1, 1986. Withdrawals from the credit proceeds would be made on accounts of payments for cyclone repair and rehabilitation expenditures only for items for which specific execution arrangements were made in agreement with IDA. The full credit amount is expected to be fully disbursed by December 31, 1990. Operational Objectives 76. The project is oriented towards track and locomotive improvements which are the principal limiting factors to higher efficiency. With these improvements, the railway would be able to concentrate on better operations by improving wagon turn around and train scheduling. Operational objectives such as utilization of motive power, availability of rolling stock, turnaround times and wagon loads, and a detailed implementation schedule, prepared by IDA staff, have been agreed. These operational objectives would be monitored during IDA supervision missions, and RNCFM would submit to IDA an annual synthesis report at the end of each fiscal year. Financial Covenants, Auditing and Reporting. 77. RNCFM's financial objectives during its current Investment Plan period (1985-90) are to: (i) continue the program of financial recovery; (ii) improve its tariff structure; and (iii) re-orient its marketing strategy. While the financial recovery program has already been largely successful, the positive achievements of the last three years must be consolidated and protected. Forecasts prepared for RNCFM indicate that the RNCFM can achieve its financial objectives during the period 1985-1990 provided it continues to be managed on a sound commercial basis. Assurances have been provided by RNC!M that it would (l) price each railway service at or above its avoidable costs 1/; (2) provide service only to 1/ Avoidable cost means any and all costs RNCFM would not incur if such services were not provided.  - 25 - customers whose receivables are aged 60 days or less; (3) keep the working ratio at 65 percent or less; (4) earn a net return on fixed assets revalued annually of at least 3 percent and (5) maintain a current ratio of at least 2.5:1 and a debt/equity ratio of no more than 55/45. 78. RNCFM's accounts are and should continue to be audited by an independent accounting firm acceptable to IDA. Assurances were obtained from RNCFM that they would submit annual audit reports to IDA within six months following the end of each fiscal year. The annual audit report would include a statement of compliance with the above financial covenants. Project Benefits and Risks 79. Benefits. The main benefit of the project is to allow the railways to remain operational and capable of providing services essential to the economy at current traffic levels, as traffic for the period 1984-90 is estimated to increase only by three percent due to increased road competition for non-bulk traffic. Without the proposed investments, RNCFM's effective carrying capacity and operating efficiency would be gradually eroded by a reduction in available motive power and an increase in derailments and other operational difficulties. Emergency assistance provided for cyclone damage repairs and rehabilitation works would avoid further deterioration of RNCFM and SEPT facilities. 80. Economic Bate of Return. Aside from the cyclone damage components, the project has been divided into four main components, each of which has been subjected to a separa':e cost-benefit analysis: (1) track improvements on the Mora-snga-Lac Alaotra (MLA) line; (2) investments to provide a rail/road spur to bring raw materials close to a new cement plant near Antsirabe; (3) reconstruction of an old bridge on the Antsirabe line; and (4) investments in equipment and maintenance (mainly spares, shop machinery and tools). On a combined basis, the economic rate of return for the project is estimated at about 16Z. The estimate assumes a project life of 10-years and that traffic will not increase after 1990. This calculation also includes the training and technical assistance components, as well as other capital items (4 locomotives and other priority equipment) that CCCE has already agreed to finance (paras. 45 and 50). 81. The cyclone damage repair and rehabilitation component was not included in the calculation of the economic rate of return as the specific items to be financed under the credit have still to be agreed. However, time lost in restoring normal rail and port activities could be very costly to the country since the TCE and MLA lines are the main railway lines in the country and the Port of Toamasina is the primary port for foreign trade. 82. Risks. The main quantifiable risks of the proposed project are that: (i) demand for rail services could be lower or significantly greater  - 26 - than expected because estimates of rail/road modal splits underlying traffic forecasts could not materialize; and (ii) project execution would not take place as planned due to cost overruns and implementation delays. 83. If traffic is less than anticipated the economic return on the project will be less than expected but not seriously jeopardized. Sensitivity analyses indicate that traffic volumes can be 20Z below forecasts before RNCFM reaches a break even point on the investments. In the unlikely event of a further reduction in traffic, the flexiblity of the proposed project would allow investment levels to be modified. If traffic is greater than anticipated, the railway has some flexibility to expand capacity by operating more intensively, and improving turnaround times. Besides, given the short term nature of the project and the fact that significant shifts in traffic levels are easily detectable, RNCFM could plan additional rolling stock purchases in 1988 and 1989 to carry traffic that cannot otherwise be shipped by road. 84. The risk of cost overrtms is fairly small because of the nature of the project. Only a few project elements are sensitive to change in procurement or execution. For track rehabilitation, the main source of potential cost increase is an increase in the price of imported steel sleepers. New rail for the project has already been purchased under the second railway project and is in Madagascar awaiting installation. Shop equipment, tools, spare parts for machinery, and rolling stock to be purchased are common, easily available, and unlikely to incur drastic price increases in the near future. There is no special risk associated with the cyclone damage repairs and rehabilitation. In sum, the implementation of the proposed project does not have major risks of delay or cost overruns. Part V - RECONMENDATION 85. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association and recommend that the Executive Directors approve the proposed credit. A.W. Clausen President Attachments Washington, D.C. April 14, 1986  Page 1 of L - CflA0aSCh1 - SOCIAL ImtCAlUES 047* ?ar s RA0I*SC - ifLUC3 CIOPS {It A~1I?f