Guinea - Country economic memorandum (Vol. 1 of 2) : Main report : the Guinean economy

Report No. 8774GUI Republic of Guinea Country Economic Memorandum (In Two Volumes) Volume l: Main Report The Guinean Economy November 16, 1990 Country Operations Division Occidental and Central Africa Department FOR OFFICIAL USE ONLY Document of the World Bank 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.  CURRENA ENC IV S (Annual Average, Guinean Francs per US Dollars) 1988 OF 346 1987 OF 428 1988 OF 476 1989 OF 592 1990 OF "61 (eat.) FISCAL R January 1 - December 31 GLOSSARY OF ACRIYUS APE Parents' Association AuG Guinean Gold Company BARAF Bureau d'aide & la reconversion des agents de Ia fonction publique BCRO Central Bank of the Republic of Guinea CBG Guinean Bauxite Company CDP Prefectural Development Contribution 5NPIP National Private Investment Promotion Office CPI Consumer Price Index DAAF Administrative and Financial Affairs Directorate DAFO Lands Directorate DND National Customs Directorate DNI National Tax Directorate DNP National Postal Directorate DNT National Telecommunications Directorate DOD Debt outstanding and disbursed EAP Environmental Action Plan EIA Environmental Impact Assessment IPN National Pedagogical Institute kgoe kilograms of oil equivalent MARA Ministry of Agriculture and Animal Resources MEN Ministry of National Education MPCI Ministry of Planning and International Cooperation MRAFP Ministry of Administrative Reform and the Civil Service MRNE Ministry of Natural Resources and the Environment MSPP Ministry of Public Health and Population MTTP Ministry of Transport and Public Works MUH Ministry of Urban Development and Housing MUV Manufacturing Unit Value OBK Kindia Bauxite Office ONAH National Hydrocarbons Office ONCFG Guinean National Railroad Office ONPPME National Office for the Promotion of Small- and Medium-scale Enterprises OPPI Industrial Fisheries Protection Office OPR Road Project Office PAC Autonomous Port of Conakry PIP Public Investment Program PPP purchasing power parity PREF Economic and Financial Reform Program SEEO Water Management Company SEEPU Secretariat of State for Pro-university Education SNE National Electricity Company SONEG National Water Authority TCA Turnover tax TP Production tax TREN Normal Refinancing Rate TREP Preferential Refinancing Rate TSPP Specific tax on petroleum products TUV Unique vehicle tax UPSU Urban Services Management Unit ZEE Exclusive Economic Zone  FOR OFFICUAL U ONLy This report was prepared by Hasan Tuluy and Jon Walters. Contributions for the sectoral chapters were made by Jim Stevens (education and health), Dirck Strycker (consultant, rural development), Paul Dyson (mining), Bernard Delaval (urban), RAma Skelton (energy), James Bond (energy), Yves Duvivier (transport), Leila Zlaoui (consultant, posts and telecommunications), Jean-Jacques Deschamps (manufacturing and financial sectors), Robert Crown (environment), Bernard Drun (public enterprises), and Richard Verspyck (water supply). Genevieve Cantet provided secretarial assistance throughout. Ibis docuent has a rsteddbtibutn and may be ud by rxeints oly in the pafonrane of their offcW dutis Its contents may not oherwws be dicosed wihout Word Bank athornzation.  REPUBUC OF GUINEA COUNTRY ECONOMIC MEMORANDUM TABLE OF CONTENT^ VOLtME Is MAIN REPORT THE GUINEAN ECONOMY Pane Executive Summary .......... . .... .................4 * *. i I. THE FIRST REPUBLIC -- 1958 TC ROUGH 1984 .........THR0U4............. 1 A. The results for economic growth ........................1 B. 'The results for public finances .............. ...........5 C. Monetary policy under the First Republic ............... 6 D. Trends in the external accounts . ......8................. E. The final balance sheet . .. ...... 9 TI. THE SECOND REPUBLIC TO DATE -- 1984 THROUGH 1990 ........... 10 A. The launching of the economic reform program .......... 10 B. Measures taken in the first phase of the PREF (1985-88) .... . .............................. 11 C. The second phase of the PREF (1989-1990) ....... 28 III. MUJOR POLICY ISSUES OR TBE FURE URE ......42 A. The management of the budget ..42 B. Management of the exchange rate .49 C. The r8le of government . .......... 51 D. Sectoral policy issues ..53 IV. PROSPECTS FOR THE MACROECONOMY ............ .. ......... 66 List of Boxes BoX 1. The restructuring of urban water supp ly .. 35 Box 2. The inflationary problem...... 38 Box 3. Technical assistance and on-the-job training ... ............ 54  List of F'ares and Tables Figure 1T Guinea Foreign Exchange Market ............................. 12 Figure 2: Projected Decline in CBG Tax Revenues ...................... 43 Table l Comparative Social Indicators ........... ........ . . .......... .2 Table 2: Gross Domestic Product ....................... . 3 Table 3: Money and Credit ...... . ... .................................. 7 Table 4: Balance of payments. ...... ................................ 9 Table 5: Foreign Exchange Auction (1986-89) . . . 13 Table 6s Foreign Exchange Budget .. .................................. 15 Table 7s Civil Service Reform - Net Staff Reductions . . 24 Table 8s Salary Structure of the Public Sector .. 25 Table 9: Estimate of the Purchasing Power Parity Exchange Rate of the Guinean Franc .. 37 Table 10: Sectoral Composition of GDP . . .............. 40 Table 11: Balance of Payments (1986-1989) ...... . . 41 Table 12: Tax Yield in African Mining Economies in 1987 .............. 44 Table 13s Percentage Tax Yield in Guinea ............................. 45 Table 14: Composition of Tax Revenues (1986-89) .... 46 Table 15: Revenue losses from Duty and Tax Exemptions on Imports of Key Products (1988) . .......... . 47 Table 16s Sectoral Composition of GDP (1990-2000) . .... 67 Table 17s Balance of Payments (1990-2000) . . 68 Table 18: Financial Operations of the Central Government ............. 69 Annexe Table l Key macroeconomic ....... .......................... 71 Annexe Table 2: Sources and uses of goods and services . . 72 Annexe Table 3: Financial operations of the Central Goverrment ...... 73 Annexe Table 4: Balance of payments (1986-2000) . . 74 Annexe Table 5: Exports ............................................ . 75 Map  EXECUTIVE SUMIARY OP TEE KEY ISSUES AND RECONHENDATIONS The Second Republic, established in April 1984, was faced with an appalling legacy from the First Republic. A poverty-stricken population labored under the burdens of a grossly inefficient administration incapable of running a command economy, which ultimately existed on paper only. The country's infrastructure was virtually destroyed and its people were very poorly educated. Its economy revolved around the increasingly wasteful consumption of revenues generated by the enclave mining sector. Savings were minimal and remunerative investment was barely possible. In short, Guinea had no future without a radical shift in economic policy. Since the end of 1985, the Government has been implementing an ambitious program of economic and financial reforms (the "PREF'). The first phase of the PREF, lasting through the end of 1988, was very much a 'shock treatment* for the economy, concentrating on removing the most important distortions in the incentives environment. It involved a massive devaluation, extensive privatization, trade liberalization, the abolition of state marketing, the creation of a commercial banking system, and the removal of most price controls. At the same time the difficult process of reducing civil service overstaffing was begun. The measures taken in the first phase of the PREP were such that they could be centrally-decreed, and implemented in a clearly-defined and monitorable manner. The second phase, however, for which these measures set the stage, involves a much more complex and difficult process of reforming institutions and changing attitudes both within the administration and in the private sector. In addition, it involves completing and "fine-tuning' some of the measures taken during the first phase after some of the initial momentum of adjustment has waned. This has in turn allowed special interest groups to regain some lost ground. To date the supply response to the PREF has been encouraging but not dramatic. Moreover, the nature of this growth has been, in some ways, disappointing. Growth in agriculture has not been accompanied by major productivity improvements; in mining and manufacturing expansion has come largely fron increased utilization of existing capacity. The most vigorous growth has taken place in ancillary sectors -- transport, trade, construction, utilities, and services -- driven to a great extent by external financing. However, although considerable external financing will remain necessary for the foreseeable future, this growth can ultimately only be sustained by increased demand from other sectors of the economy. In addition, because of the severe supply rigidities in the directly productive sectors, this growth has only come at the cost of persistent inflation, which further jeopardizes its sustainability. Indeed, the issue of the sustainability of growth is of serious concern, since domestic savings levels remain low, financial intermediation is ineffective, and private investment in productive assets is still very limited. Clearly, the incentives environment which will enable the profitable exploitation of Guinea's considerable resources and sustained growth in employment and per capita incomes has not yet been created. Much remains to be done to promote agricultural growth, to facilitate downstream investment in agroprocessing, and to stimulate mining production, since it is in these sectors that the greatest growth potential exists. Realizing  - ii. - this potential will require a judicious combination of policies to promote private investment and a public investment program supportive of this goal. Moreover, if the benefits of growth are to be equitably distributed, a balance must be attained between formal mining and more labor-inte.nsive sectors with greater linkages to the rest of the economy. The adoption of an appropriate long-term exchange rate policy will be crucial in this regard. The first phase of the PREF concentrated largely on removing the most important distortions in the incentives environment; in other words it was a process of "getting the prices right". In the second phase two clear lessons emerged: (i) for the 'right prices" to have the desired effects on supply, the Government would have to improve significantly its policy formulation and implementation capabilities; and (ii) maintaining "right prices' requires careful management of one key price - the exchange rate - particularly because of its importance for competitiveness and its relationship with all other prices through the inflation mechanism. In this regard, control of the budget deficit plays a crucial r8le due to its major impact on the level of aggregate demand. This control will require a major and sustained increase in domestic revenue mobilization, and the avoidance of excessive monetary financing. This will be all the more important should the availability of external financing decline as expected. From these lessons there emerges a number of crucial and closely interrelated issues, which the Government will have to face over the coming years, if sustained development of the Guinean economy is to be possibles (i) There is an overriding need to deepen and widen the skills base both in the orivate sector and in the public administration. Guinea's gross primary school enrollment rate of just under 30 percent places it among the bottom ten countries in the world; the Government spends just 20 US cents per child per year on primary school recurrent non-salary costs. At higher levels of education the picture is not much better. In consequence, levels of basic skills, such as literacy and numeracy, are very low and there are extreme shortages of more specific skills. As a result public administration is highly inefficient and the private sector lacks the educated workforce which is essential to its development. Addressing these issues will involve a substantial and sustained increase in the funds made available to the education sector and a major reorientation in the manner in which the sector's resources are allocated. In particular, the current imbalances need to be addressed by an increase in the resources allocated to primary education, non-salary recurrent expenditures, the education of girls, and schools in rural areas. Such reallocations are not only justified on equity grounds; the areas targeted are also those where the greatest productive potential currently remains unexploited due to a lack of education. At the same time, improved curricula and teaching methods need to be introduced as a matter of urgency if the quality of the service provided by the education system is to reach an acceptable level. In addition, local commmity resources should be  - iii - mobilized, to the extent allowed b' limited incomes, to supplement those provided by the State. The needs of post-primary levels of education and of vocational training are also pressing. In order to satisfy the requirements of an increasingly professional civil service and a growing private sector, both the quality and quantity of education and training provided at these levels will have to be increased. In particular, university level education will require a radical overhaul if the essential technical, administrative and professional skills are to become available in Guinea. In short, the education and training system as a whole will, in the coming years, make great demands both on public resources and on the Government's ability to manage those resources efficiently. The expected returns are however enormous. (ii) There is a need to substantially improve domestic revenue mobilization if the Government is to be able to fulfil its responsibilities. Numerous growlng and competing demands will be made on the government budget over the coming years. Although it is essential that expenditure control improve substantially, many of these demands will be justifiable and overall expenditures can be expected to rise. Civil service salaries must increase if civil servants are ever to be sufficiently motivated and able to resist the temptations they currently face. The level of expenditure on such services as education and health must increase simply to maintain access levels in the face of population growth, let alone to achieve the improvements so urgently required. The substantial public investments that have been made since 1986, and that will continue to be required for several years to come, will entail very significant recurrent implications if they are to make a contribution to development. Similarly, servicing the debt incurred in the course of making these investments will place an increasing burden on the budget. The challenge will be to resist expenditure pressures in excess of available revenues, in order to avoid incurring unsustainable levels of debt and inflationary budget deficits. Unless very significant increases in mining sector output occur over the coming years or bauxite-pricing arrangements are substantially revised, mining tax revenues will almost certainly decline in real terms. This revenue decline will take place against a background of considerable uncertainty as regards the availability of external financing. The central budgetary issue, therefore, is how to offset the need for rising expenditures and the risk of declining development assistance and mining revenue, with rising domestic non-mdning revenue. In addition, given that expenditures can be expected to rise fairly steadily, it is essential that overall revenues should increase at at least an equivalent rate. This implies ensuring both that public expenditures create economic growth, and that growth yields public revenue; at present both links in the chain are weak, particularly the latter.  - iv - Although, in the long term overcoming Guinea's revenue problem would be facilitated by sustained economic growth accompanied by diversification of revenue sources, it is clear that there is enormous potential for lmproved collection In the shorter term. For this improvement to take place a number of measures will be necessary. Management information systems ueed to be improved, certain categories of taxpayer could be cost- effectively targeted In a collection campaign. and certain taxes that are relatively easy to collect could be developed as revenue sources. The process of updating the basic legislation providing for the major taxes and duties should be completed as soon as possible and the main provisions publicized widely. Valuation and assessment skills need to be improved both in the Customs and in the Tax Administrations. This will require considerable staff training, accompanied by efforts to improve staff morale, which appears to be abysmally low in many cases. In the medium term, the taxation of imports will be capable of yielding more significant revenue gains than the taxation of domestic production. Much work remains to be done on restricting the granting of import duty exemptions to eligible imports, Including reviewing existing agreements to identify clauses where clearer definitions are possible. Future agreements should be much more restrictive in their granting of exemptions. In addition, the Government should introduce tax-inclusive budgeting whereby governrmnt imports would no longer be duty-free, and therefore the incentive to import for private sale under the cover of a government contract would be removed. The specific tax on imports of petroleum products has the greatest potential for increased revenue in the medium term. The immediate problem is that the losses of the petroleum distribution parastatal, ONAH, are financed by its retention of the tax revenues it collects on behalf of the Customs Administration. This problem is only likely to be resolved when ORAN is subject to comuercial pressures to be profitable. However, a major cause of ONAH's losses is the non-payment of amounts owed by Air Guinee and Enelgui, which is in turn due to their own continual losses. Given this situation it is unlikely that the ONAH problem can be resolved without a parallel restructuring of the other two enterprises. These parastatals, along with the Kindia Bauxite Office and the post and telecommunications service, represent a very severe drain on the budget; this is felt in terms of both the explicit and implicit subsidies required for their operation, and the loss of tax revenue on activities which are typically important revenue earners in comparable countries. The restructuring of parastatals will be a crucial determinant of the success of budgetary management over the coming years. (iii) There is an urgent need to eliminate the corruption Guinea can so ill-afford. Under the First Republic, the poverty of civil servants was such that they tended to use their administrative powers for their own immediate profit rather than for serving the public. The Second Republic has not yet managed to eradicate this mentality. The President of the Republic has frequently and publicly expressed the view that civil servants still tend to neglect those duties which do not benefit them personally and to turn  those that do Into profit-making activities. As a result, administrative decisions are distorted and public resources wasted, and private initiative is discouraged by the expense and insecurity of operating in such a system. Those private operators who are not discouraged tend to respond to this Insecurity by investing only where the payback is very short-ter. There is wide public awareness that Guinea cannot afford a system In which the privileged few consume today resources which they have not earned, and which could be invested In the future of the many. Moreover, those who are asked by the Government to make sacrifices aow as part of the process of structural adjustment, will be significantly less willing to do so the more they see such consumption taking place. The Government should immediately undertake a well-publicized and comprehensive assault on impropriety and corruption in the public service, with firm disciplinary action being taken against all officials guilty of such offenses, no matter how senior they may be. This should be spearheaded by the enforcement of rigorous public accounting and p' ocurement procedures, supported by independent external auditing of public expenditures and of tax collection, the results of which should promptly be made public. (iv) There is a need to greatly increase the efficiency of the Government's provision of those services it should retain. of equal importance to rigorous procedures and sanctions against corrupt practices are more direct measures to increase the zificiency of the civil service, which should be urgently undertaken. Improved education, extensive training, more transparent and widely-publicized procedures, better working conditions, a meritocratic career and salary structure in which civil servants have an incentive to invest their efforts in the acquisition of skills, and the payment of generally higher salaries (within the constraints of a limited budget), would all contribute to increasing the professionalism of the civil service. These reforms should form part of an integrated long-term strategy to address the fundamngtal Institutional and human resource constraints vhich permeate the civil service. It is only with such efficiency gains, that the Government will be in a position to fully implement its policy of reorienting the r8le of the state away from interventionism and towards providing services supportive of private sector development. To date progress in this regard has been seriously undermined by a marked tendency among civil servants to view private business as requiring strict control. Until civil servants are reeducated to understand their new role, and managers assert their authority to implement the new policies, the Governaent will remain a source of may of the obstacles to development in Guinea.  - vi - (v) There is a need to foster an environment of confidence which encourages private savin4s and productive investment. particularly in sectors which create income and employment for the broad mass of the Guinean people. Until economic agents can be assured of earning an adequate return on their activities, the current vicious circle of low savings and low investment will not be broken. Savers will be deterred from saving in financial institutions if inflation continues to erode the real value of their savings in the face of low administered interest rates. Due to the consequent shortage of savings, and to the lack of enforceability of contracts, lenders will restrict their loans to short-term trade credits to established firms. In addition to this restricted access to credit, a multiplicity of factors tending to raise operating costs and lower revenues will discourage investors: harassment by officials, low effective tariff protection. interference in hiring and firing, inconsistent implementation of legislation relating to private enterprise, poor infrastructure, and unreliable utilities. Unless these obstacles are overcome, the non-mining private sector will not become thu engine of growth with equity in Guinea. Expansion of the relatively protected formal mining sector may occur, but it will do less to increase incomes and employment for the majority of the Guinean people, than would private investment in agriculture, mannfacturing, services and artisanal minlng. Indeed, if the formal mining sector should expand significantly, there is a danger that the resulting fiscal and foreign exchange revenues will retard the growth of the non-mining economy. Not only might they be channeled into inefficient public expenditures, but also these revenues are likely to fluctuate considerably; it would be dangerous to create public expenditure commitments and 3"ort requirements in 'good' years that cannot then be fulfilled in 'bad' years. In addition, if there is a series of good years, and the real exchange rate is allowed to appreciate in response, the fledgling non-mining private sector may be severely undermined; recovery in ensuing bad years would by no means be assured. One solution to these problems would be to establish a 'stabilization fund' into which above-average revenues from the mining sector are deposited in good years, to be spent in bad years; the corresponding exchange rate policy objective would be long-term stability in the real rate of exchange. This recommendation, and indeed most of tbe recommendations in this report, would require greater consensus on economic policies and the role of the State than has hitherto been the case. Forging this consensus will be an essential task for the Government if sustained growth and the alleviation of poverty are to be achieved. The proposed democratic reforms of political institutions will play an important part in this process, as will the free press which can be expected to flourish as a result.  THE GUINEAN ECONOMY I. THE FIRST REPUBILIC -- 1958 THROUGH 1984 1. On September 28, 1958 Guinea rejected by an overwhelming majority membership on Fren.h terms of the proposed French Community. As a direct result, independence from France was immediate and complete. The colonial administration abruptly severed its ties with Guinea and departed, leaving behind -n administrative, managerial and entrepreneurial void. In large part to fill this sudden void, authorities of the First Republic, with support from European communists, adopted a dirigiste development strategy which sought to modernize and industrialize the predominantly agricultural e,' )nomy under the guidance of the State. 2. Guinea, like many other LDCs of the period, relied on multi- annual Plans and on public enterprises to bring about this transition, but to a greater extent than was generally the case elsewhere. Whilst the private sector was initially permitted to coexist with the rapidly expanding public settor, over time it was increasingly restricted. With the Lol Cadre of 1964, the Government moved to a fully centrally-planned development model and nationalized all formal private activity. Credit and access to foreign exchange were directed exclusively to the public sector. In parallel, the Guinean Democratic Party became the sole authorized political party and its structures were closely integrated with these of the State. 3. Legal private activity was limited largely to rural production and minor services, and even these were highly circumscribed by price and wage controls, marketing quotas, lack of credit and persistent official harassment. The disincentive environment these policies created pushed private producers increasingly towards the parallel market or to unrecorded exports at the expense of supplying the official markets with raw materials or consumption goods. Despite increases in export earnings from the mining sector in the mid-1970s, the decline in recorded non-mining exports, coupled with growing public consumption, exerted such pressure on foreign exchange availability that imports of consumer goods and raw materials frequently had to be cut back. The incentive environment was highly unattractive for both Guinean and foreign investors. Private Guinean investment was minimal and restricted to activities with relatively low risk and very short-term payback periods. Foreign investment remained confined to enclave mining and related transportation infrastructure with almost no linkages to the rest of the econc'iiy other than the employment of labor. A. The Results for Economic Growth 4. While the First Republic's economic policies altered traditional production patterns, they failed glaringly to bring about the anticipated industrialization, sustained economic growth or social development. GDP is estimated to have grown on average at less than the population growth. of rate of 2.8 percent. From 1960 to 1974, GDP grew by only 2.4 percent per annum, representing a total decline of 4 percent in per capita terms over the period. While the 1975-80 period was marked by growth of about 3.5  . 2 - percent per annum with the start-up of major new bauxite operations (Compagnie des Bauwites de Guinie, CBG and Offi1e de Bauxite de Kindla, OBX). growth declined again from 1980 as the new mines reached full capacity and most of the rest of the economy le 1 continued in its inexorable decline. By 1985, per capita COMPARAT X SOCIAL INDICATORS income estimated at US$ 250, had declined to below the level Low-incoem attained in the previous decade eub-Seharan and placed Guinea amongst the _ Af rica uie poorest countries in the world. Lift expectancy at birth g/ 49 s9 The effects of this generalized ri* crigery enrol Imant 78 81 CPUd et rate per 'MS0 48 48 poverty are reflected in Crude death rate per '*S 10 2a Table 1. Infant mortality per '"w 3/ 129 178 Daily calory Intake 2162 two 5. Guinea's wide range of natural conditions allowed Data are for 198O unles Indicated othems e. diversified rural production 1984 which sustained nearly three- *' fourths of the country's Sources: World Bank population and accounted for over half of GDP in 1960 (See Table 2). Plantation agriculture, principally bananas, pineapples, palm kernels and coffee, provided much of export earnings and public revenue. Although data for the period are highly unreliable, it is evident that Guinea's per capita agricultural output declined substantially over the 1960-1985 period; the performance of cash crops during this period was particularly poor (see Volume II, Rural Development Chapter, especially Table 3). While exports to the Eastern Bloc partners, with whom Guinea developed increasingly close trading arrangements, partially compensated for the loss of convertible currency markets, this shift in agricultural trading patterns diminished Guinea's long-term ability to regain access to markets with more stringent quality requirements. Growth in focd crop production also fell below the rate of population growth. 6. While natural calamities undoubtedly contributed to the decline in production and exports after Independence, the steady decline was the result, above all, of the disabling incentive environment created by a massively overvalued exchange rate, administratively fixed producer prices which declined in real terms, exploitative marketing quotas, barriers to domestic private trade including State marketing monopolies, and misguided investments in inefficient public enterprises at the expense of investments in institutions supportive of productive activity. Smallholders, who constituted the vast majority of rural producers, were forced into self- sufficiency, and where possible, into clandestine exports to neighboring countries. The decline in domestic production led to rapid growth in food imports to supply the urban population; between 1974 and 1984, the volume of cereal imports, for example, tripled (see Volume II, Rural Development Chapter). 7. Guinea's mineral potential makes it one of Africa's resource- rich countries. The country has one-third of the world's bauxite resources, and while gold reserves are not well quantified, estimates of  -3 Able 2 GROSS eOsErTIC PRODUCT a/ 19S0 1965 1e9 1976 198 1005 ....... billion currmnt Guinean Sylit ) tP mt alrket prices 11.9 12.8 16.8 24.2 82.9 51.5 Primary Sector 0.4 7.8 0.8 11.7 18.4 20.6 Secondary Secor 8.0 8.2 4.0 4.8 7.8 11.2 Tertlary Sector 2.5 2.9 4.6 0.2 12.1 19.6 Indirect Taxes len subeidies 9.0 0.8 1.8 1.7 4.8 n/a OP t factor cost 11.0 12.0 16.6 22.5 28.6 61.5 ................................ ....... ........ GMP per capita (GS) 8040 8600 5900 5280 6209 048 Primary sector X GDP 65.8x 57.9X 49.4X 48.8X 40.7X 40.0 Secondary sector X QOP 26.21 25.9X 28.8X 17.0X 22.2X 21.71 Mlning sector X GOP ?.61 9.4X1 0.01 7.4 14.0X 18.41 Tertiary sector X1 DP 21.01 22.71 20.861 8a.9x 8.61 80.41 Administration X GOP 0.41X 18.81 16.X 9.51 18.11 O.O1 .... ( consnt 190 Quineen Sylis ) .... GOP (market prices) (billions) 19.7 19.7 22.9 20.0 82.9 85.5 GDP per capita 6859 "989 5589 so9w 6210 8890 a/ Thes dato are calculatd using official prices and probably e-riously underestimate informl secor output; thy should theroeore be interpreted with caution. ure: World Bank production potential range from 10 to 15 myetric tons per annum. Considerable diamond reserves with a high percentage of gem quality, iron ore deposits and potential deposits of other minerals such as lead, zinc, silver, uranium, cobalt, nickel and platinum have also been identified. However, in 1960 the extractive industries' contribution to GDP was less than 10 percent. The sector consisted of joint-ventures with Western mining concerns which operated the FRIA bauxite-alumina plant and mined small deposits of bauxite, two foreign-owned diamond mines and thousands of artisanal gold and diamond miners. All foreign-owned private diamond activity was nationalized in 1961 and then artisanal diamond mining was banned, although this decision was reversed several times and artisanal diamond extraction continued on a large scale throughout the First Republic. 8. Mining of the high-grade bauxite deposits in the Boke region was begun in 1973 by the joint-venture CBG. Output was exported from the mining port at Kamsar to processing plants in Northern Europe and America. In 1979, the State-owned OBK commenced mining the DebEli deposit near Kindia, its output destined for smelters in the USSR. 1/ Bauxite exports rose rapidly during the latter part of the 19709 with output increasing from 10.6 million mt in 1975 to nearly 13.0 million mt in 1980, thereby raising Guinea's share of world production from 15 percent to nearly 17 percent. With the development of the CBG and OBK mines, the mining sector had replaced the rural sector as the supporting pillar of the economy by 1/ See Volume II, Mining Chapter for details of the ownership and management structure of CBG and OBK.  the 19709. In the 1983-85 period, the mining sector provided, on average, 30 percent of fiscal revenue and over 95 percent of export earnings, although it represented only 15 percent of GDP and employed only about 7,000 people. These figures are indicative of the unbalanced nature of the economy and the role of the mining sector in sustaining that situation; mining was more important for its financing of State employment and of the consumption of imports than for its contribution to production and to private sector employment. The mines operated in enclaves, failing to establish either forward or backward linkages with the rest of the economy, other than through their employment of labor. 9. Guinea's industrial base in the early 1960s consisted of a few foreign-owned firms established prior to Independence and industrial production represented less than 5 percent of GDP. Beginning with the first development plan, an ambitious industrialization program was launched with the creation of some 20 state-owned factories. With the exception of the pineapple canning, essential oils, and quinine plants, all of the enterprises produced for a protected and shallow domestic market where they often enjoyed monopolies. The industrial public enterprises soon suffered from low capacity use due to shortages of raw materials, imported spare parts and managerial skills. Over time, all remaining private industrial enterprises were nationalized and public sector activity also spilled over into the commercial and service sectors with activities ranging from the marketing of consumer goods to taxi services. By 1984 Guinea had about 130 industrial and commercial public enterprises employing an estimated 100,000 people. However, owing to the inability of these enterprises to satisfy demand, the informal sector progressively became the dominant source of supply of consumer goods and services. 10. The rudimentary infrastructural base Guinea inherited at Independence consisted of a limited road network, a rail line from Conakry to Kankan built at the turn of the century, and commercial ports in Conakry and Benty. Owing to lack of maintenance, this infrastructure deteriorated considerably over time, increasing operating and investment costs, and weakening linkages between Conakry and the interior. Power and water utilities functioned in the main urban centers with increasingly antiquated equipment. Utility rates were changed infrequently, collection rates remained dismally low, and the utilities suffered from operating problems resulting from weak and corrupt management. Large mining concerns insulated themselves from these problems by building and maintaining their own enclave transportation facilities and utilities. 11. One of the avowed aims of the First Republic was to dramatically improve social services, and in this vein free education was guaranteed to all citizens. Enrollment increased dramatically from 45,000 students in 1958 to nearly 400,000 in the early 1980s, with the increase being most notable at the secondary and technical school levels. 2/ These numbers hide, however, the meager success of the education system which suffered from inadequate resources and from a high degree of politicization. The system placed excessive emphasis on theoretical 21 Enrollments at the secondary and technical levels increased from 3,000 to about 115,000 over the period.  - 5 - education, which was of poor quality, at the expense of practical training. As a result, graduates were not trained in useful skills and could not easily be absorbed into the labor force and, despite the high numbers of graduates, Guinea faced critical shortages of trained technical staff and adminiscrators. 12. Furthermore, university graduates were guaranteed employment. Given the regime's bias against private activity this policy entailed continued recruitment by the State. In the late 19709, for example, employment in the civil service increased at a rate of 7 to 10 percent per year. Given weak public finances, employment could only be provided at very low wages, which were frozen in nominal terms from 1965 until July 1980 -- when average increases of 16 percent were granted. The Government sought to compensate for the erosion of real wages through comprehensive controls on prices and generally ineffective administrative rationing for nearly all goods and services. Low wages led to massive absenteeism and widespread corruption; those privileged civil servants with access to goods at official prices supplemented their salaries by arbitrage between official and parallel markets. Habits of rent-seeking and immediate consumption became deeply ingrained; productive labor and investment were effectively discouraged. B. The Results for Public Finances 3/ 13. As private non-mining production and recorded trade were displaced by public enterprise, government revenue became increasingly dependent on mining taxes and public enterprise transfers. Tax revenue from the three mining companies as a share of total revenue increased from negligible levels in 1966 to 33 percent in 1984. 4/ Transfers of public enterprise surpluses, which contributed about 25 percent of total revenue in 1966, declined to about 15 percent in 1980 with the decline in capacity use and profitability of most public enterprises. Transfer of surpluses was essentially limited to the trade monopoly IMPORTEX which by virtue of its preferential access to overvalued foreign exchange was able to maintain large mark-ups on imports and, with low expenditures on maintenance and replacement, realize significant nominal profits. 5/ Perhaps most damaging 3/- A systematic, consolidated account of the financial operations of the public sector under the First Republic is rendered impossible by the insufficient, and often conflicting, data on the public enterprise sector. Nevertheless, broad trends in public finances reflecting the transformation in the economy's productive base can be identified. 4/ This was, of course, not entirely due to the decline of the non- mining private sector; in the 1970s, it was also due to the increasing absolute revenue from the mining sector. S/ Throughout the First Republic, import requirements were formulated in the framework of a restrictive annual General Import Program managed by IMPORTEX although imports for the investment plans and for the public enterprises were made directly by the Government or the enterprise concerned.  - 6 - in the long run, the fact that revenues derived largely from four companies resulted in the deterioration of tax and customs administrative capacity. 14. Between 1966 and 1980, current expenditures are estimated to have risen 10 percent faster than current revenue. Despite the very low level of remuneration, wages and salaries represented 50 to 60 percent of current expenditures, reflecting the rapid increases in employment in the civil service. From the mid-1970s the current budget also financed large periodic grants to public enterprises as working capital to cover operating losses and to service banking sector and external debt obligations. 15. During the First Republic, investment levels were generally low, averaging 15 percent of GDP in the 1970s, compared to about 20 percent in other West African countries during the same period -- two-thirds of this investment being public and most of the remainder being in mining. Public investment expenditures were programmed in the context of a series of multi-annual development plans to be implemented by the Central Government. 6/ Plans were prepared without reference to a macroeconomic framework nor were they based on clearly articulated sectoral strategies. In addition, plans were conceived without a financing schedule on the implicit assumption that financing gaps would be fully met from external sources. This excessive optimism over the availability of external financing, compounded by weak project preparation capacity, caused substantial underrealization of investment plans. Moreover, the limited public investment resources were directed to inefficient collectivized agriculture and unprofitable public enterprises. 16. The consolidated budget is estimated to have accumulated a deficit of GS 11.5 billion during the 1976-81 period, representing an annual average of 8 percent of GDP. This deficit resulted mainly from the level of net transfers to the public enterprises in the face of continued increases in operating expenditures. The deficit was financed through external borrowing, and above all, through rapid monetary expansion. C. Monetary Dolicy under the First Republic 17. In March 1960 when Guinea ceased to be member of the West African Monetary Union, the CPA Franc was replaced at par by the Guinean Franc and monetary policy ceased to be constrained by external regulation. Guinea relied heavily on monetary tools to finance the public sector with little regard to the impact on the rest of the economy. Net domestic credit grew by an average of 16.5 percent a year between 1960 and 1980, rising from less than 10 percent of GDP in 1960, to over 40 percent of GDP in 1970, and to 66 percent of GDP in 1980 (See Table 3). The public sector accounted for nearly 93 percent of total net credit during the 19708. 18. Money supply increased by an annual average of 17 percent between 1960 and 1975, that is from less than 12 percent of GDP to 46 percent of GDP, as compared to the 20 to 25 percent observed in other West 6/ These Plans consisted of the three-year plan of July 1960-July 1963, the seven-year plan of May 1964-September 1971, the five-year plan of October 1973-December 1978; and the four-year plan of 1981-1985.  -7- able 3 MONEY *nd CREDIT 1960 1966 1970 1976 198 1966 .... ( billion Gulnean Sylis ) .... b/ Net Foreign Assets 0.6 -0.8 -1.9 -1.1 -0.7 -8.8 Asset. 1.2 0.8 0.4 0.9 1.9 Liabilities 0.7 1.1 2.8 2.0 6.6 Not Domestic Credit 1.0 5.8 9.9 12.8 21.6 27.4 Government 0.4 1.8 4.0 0.9 0.1 32.7 Public Enterprises 0.6 8.8 5.8 10.6 14.6 -4.0 Private Sector 0.0 0.2 0.6 1.1 1.2 0.7 Money Supply 1.4 8.9 7.4 11.1 18.0 28.7 Money in circulation 0.9 1.3 8.2 8.7 8.8 21.8 Demand Deposits: Public Ent. 0.2 1.0 1.6 2.9 4.7 Demand Deposits: Private Sec. 0.3 1.2 2.1 2.7 c/ 1.2 Term Deposits -- 0.2 0.2 0.6 9.6 Import deposits - 0.1 0.4 1.8 4.4 - Other items 1.2 Memo items: GDP 11.9 12.6 10.8 24.2 82.9 61.6 Net Foreign Assets X COP 4.2X -60.X -11.8% -4.6% -20.4X -7.$X Net Domestic Credit X GDP 8.7% 41.4% 58.9X S62.9 66.8X 68.2X Money Supply X GDP 11.8X 29.7X 44.0X 45.9X 39.6X 48.0X a/ Monetary data are for Dec.81, except for 1986 which Is for Jan. 6. (GDP for this year is therefore that of 1985). b/ Data are in billions of Guinean Francs. c/ Demand deposits of the private sector In 1980 are Included In public enterprise demand deposits. Source: World Bank African countries. Any potential inflation in the official sector was repressed through controls on prices and wages; with a stagnant economy and controlled import levels, a severe inflationary burden of this expans4.onary monetary policy was, however, felt on the parallel market. The currency became increasingly overvalued under the mounting inflationary pressure; the Guinean syli (GS) traded officially at GS 23/$US at the end of 1985 as against a parallel market rate of about GS 400/$US. 19. In October 1972, in an effort to soak up excess liquidity, the Guinean Franc was replaced by the Guinean Syli at a rate of 10 to 1. 7/ The growth of mining resources between 1976 and 1979 facilitated the adoption of more prudent, deflationary monetary policies aimed at reducing the levels of currency in circulation and demand deposits. As a result of these measures, the money supply declined somewhat to about 40 percent of GDP by 1980. However, the measures to control liquidity in the economy, which included inter alia monthly limits on withdrawals from private bank accounts, further eroded the confidence of the private sector in the currency ai,d in the banking system. 7/ All pre-October 1972 Guinean Franc data in this report have been converted to Sylis for ease of comparison.  20. Recourse to monetary financing of the failing public sector increased again during the 1980s to compensate for the slowdown in mining sector revenues. Money creation accelerated in particular after 1980 when the Central Bank's authority to issue currency was turned over to a Currency Board controlled directly by the President and interbank clearing was discontinued. 8/ by the early 1980s, money supply was estimated at nearly 50 percent of GDP. Inflationary pressures rekindled by the uncontrolled expansion of money in turn exerted pressure on the exchange rate. As a result of the ill-conceived monetary policies only the public sector operated with the Syli; joint-venture enclaves maintained off-shore foreign exchange accounts with minimal linkages to the Guinean currency, while the bulk of the economy operated outside the monetary system holding its savings in foreign exchange or in real assets. D. Trends in the External Accounts 21. The economic policies pursued after Independence dramatically altered the structure of Guinea's external accounts (See Table 4). Agricultural exports vhich had accounted for over 70 percent of export value at Independence, declined markedly in both absolute and relative terms to 30 percent of exports by 1965. A general stagnation in total exports was reversed in 1973-74 with the rapid growth of mineral exports. From 1975 until 1984, minerals represented between 95 and 98 percent of total exports. Despite the fall in agricultural exports and growing food imports, Guinea's trade deficit turned to a surplus from 1977 as the new bauxite mines sharply increased official export earnings. From Independence the demand for imports rose steadily owing to the progressively overvalued exchange rate. In an effort to reduce pressure on foreign exchange avai'ability, Guinea established numerous clearing agreements with Eastern bloc nations, which were intended to promote bilaterally-balanced trade. However, as each bilateral balance was usually in favor of the partner, substantial clearing account deficits were consolidated into medium and long term debt -- on payments of which Guinea was generally substantially in arrears. 22. The services account was consistently in deficit throughout the 1965-85 period. The deficit deteriorated over time as the burden of public debt service obligations and private factor payments (interest, dividends and remittances) on account of mining investments increased. The growing services account deficit outweighed the positive trade balance after 1980. Guinea ran a deficit on the current account throughout the First Republic which reached a high point of over 10 percent of GDP in 1971/72. 23. In the absence of sufficient domestic savings, Guinea financed much of its investment through external borrowing. However, productivity of these public inveszments was generally dismally low and did not result in growth or exports, creating instead a serious debt burden on the already strained external accounts. Because of capital flight and the heavy 8/ In other words, checks could be deposited and credited without the corresponding debit ever being made, so that those with the privilege of access to blank checks could create money at will.  - 9 - amortization on public external borrowing, capital movements were unable to compensate for the current account deficit. The overall balance was negative from 1970, financed increasingly by the accumulation of external payment arrears. able 4 BALANCE OF PAYMENTS 1984/66 1969/70 1974/75 1950 1985 (ml II on current US dollars) Trade Balance -12.6 -28.9 -29.5 100.2 195.0 Exports (FOB) 61.9 54.8 191.8 495.6 506.6 Imports (CIF) 64.4 78.2 221.8 896.4 890.6 Covernment Services A Transfors -10.1 -28.4 -19.7 -10.5 -160.8 Private Services & Transfers n/a n/a -34.4 -10S.4 n/a Current Account Balance -22.7 -52.8 -83.6 -15.8 -54.9 Capital Account 28.9 65.5 54.1 18.2 -48.0 Public sector Medium & Long-Term 21.9 52.7 89.4 18.2 -31.0 Private sector MLT 2.0 2.8 14.8 0.0 -17.0 Short-Term movemnts (not) Errors and omissions 2.9 -24.8 -14.8 -84.3 -8.0 Overall Be ance -1.6 -21.1 -44.8 -87.0 -110.9 Finaneng 1.6 82.4 81.8 80.1 96.9 Changes In reserves 1.6 20.8 -4.9 42.2 18.0 External payment arrears n/a 12.2 86.7 88.0 78.9 External Debt Outstanding and Disbursed, DOD (end-year,) 15.0 814.1 761.8 1028.2 1811.0 .................................................................................. Memo items Exports X GDP 10.0X 8.ex 18.1% 28.6X 23.9% Imports X GDP 12.4% 11.5X 18.6X 22.8x 18.9X Trade Balance X GDP -2.4% -8.sx -2.5% s.8x 5.0x Current Account Balance GODP -4.4X -7.7X -7.0x -0.9% -2.6% Overa II Balance X GOP -O.% -4.9X -2.sx -4.9x -4.6x DOD X GOP 22.2x 46.2X 64.0% 59.0% 61.9x Source: World Bank 24. Guinea's reliance on external sources to meet its financing requirements raised the country's disbursed and outstanding debt stock sharply from about 25 percent of GDP in 1965 to an average of 62 percent of GDP in 1975-85. Private debt was essentially limited to the financing needs of the mining companies. By the early 1980s, Guinea's external position had become completely untenable; payments arrears had accumulated to over US$ 300 million by the end of 1985. E. The Final Balance Sheet 25. By the end of the First Republic in 1984, Guinea's pclitical and economic system was bankrupt. The abrupt break with France had denied the country the phased transition of public administration, by means of training and technical assistance, which most of the other former colonies had enjoyed. As a result, the development of skilled technicians and administrators was severely impeded and normal bureaucratic behavior  - 10 - seriously undermined. For this reason alone, the centrally-planned development model was doomed to failure as the country in no way possessed either the management resources or the administrative capacity necessary to implement the command economy, which its leadership hoped would lead Guinea towards modernization. Economic failure was paralleled by extensive abuses of human rights by the regime, and a pervasive atmosphere of terror in which debate and individual initiative were stifled. Many talented Guineans fled the country or perished in prison. The severe curtailment of private sector activity had contributed to the grossly inefficient allocation of resources and diverted those entrepreneurial and organizational talents that remained to socially-unproductive rent-seeking. At Independence, the country was poor but potentially productive with a relatively high degree of integration of rural producers into the national economy; the Guinean economy of the early 1980s was extremely fragmented with its potential largely unrealized. A virtually self-subsistent rural sector existed alongside an urban population almost entirely dependent on recycled mining revenues, and engaged almost exclusively in the informal trading of imports or in unproductive public sector labor. Bauxite financed consumption but did little to finance worthwhile investment; the non-bauxite economy stagnated. However, as the inefficiency of the public sector increased and the growth in both fiscal revenues and foreign exchange earnings from the mining sector declined, previous consumption levels could not be sustained. The Guinean welfare state was in urgent need of fundamental reform. II. THE SECOND REPUBLIC TO DATE -- 1984 TROUGH 1990 A. The Launching of the Economic Reform Program 26. Within eight days of Sekou Toure's death on March 26, 1984 a group of army officers stepped into the ensuing political vacuum, taking power in an almost bloodless coup, and declared the establishment of the Second Republic. The Military Committee for National Recovery (Comlte Militalre de Redressement Natlonal, CMRN), as it later became known, encountered little immediate opposition to its takeover but nevertheless required eighteen months to consolidate its power base before it could turn its attention to pressing economic issues. 27. During late 1985, intensive preparation of a package of economic reforms took place, and on December 22 the President, General Lansana Conte, launched the Economic and Financial Reform Program (Programme de Reformes Economlques et Flnanclbe.s, PREF). The guiding principle of the reform program was to radically restructure the Guinean economy by a drastic reduction of the interventionist r6le of the State, in order to allow the private sector to becc4ae the engine of growth. This new orientation was motivated by the widely-held view that extreme dirigisme had been an almost unmitigated failure; only an equally radical liberalism could release the forces necessary for Guinea to make up for the "wasted" years since Independence and to begin to realize her full productive potential.  - 11 - 28. The PREF can be divided into two fairly distinct phases with the first phase running from the end of 1985 through the end of 1988. This phase constituted a radical "shock" treatment for the economy with a massive devaluation, liberalization of pricing and marketing, extensive privatization including that of the entire banking system, a fundamental trade reform and large-scale layoffs in the public service. Such measures were necessary because of both the extreme nature of the distortions inherited from the past and the need for the Government to convey its firm commitment to restructuring as clearly as possible. B. Measures taken in the First Phase of the PREF (1985-88) (a) Devaluation 29. One of the measures most urgently required to lay the foundations for sustained growth and balance of payments viability was a substantial devaluation of the Syli from its long-established rate of GS 24.6853 to the SDR (approximately equivalent to GS 23 to the US dollar at the end of 1985). This rate represented a severe disincentive to import- substituting or export-oriented production and ensured the immediate outflow of any capital accumulated. On October 7, 1985 the first, albeit limited, step towards a general devaluation was taken with the opening of a window (gulchet) for capital inflows, non-mining exports, grants and tourist transactions at a rate of GS 36 to the French Franc (equivalent on that date to GS 290/US dollar). On January 4, 1986 the exchange rate at the public sector window was raised to GS 300/US dollar and a new private sector window was created with an initial rate of GS 340lU3 dollar. On January 28, the private sector window was transformed into a weekly foreign exchange auctinn, initially with the same rate. This rate represented a fifteen-fold devaluation with a corresponding reduction in the parallel market premium from over 1600 percent to under 16 percent. On May 30 the public sector window was incorporated into the auction with an initial rate of 355 Guinean Francs to the US dollar 9/; the auction became open to most current account transactions without restrictions. 10/ 30. The policy adopted concerning the determination of the exchange rate can be best described as a managed float. Demands for foreign exchange by the private sector were submitted to the Central Bank (BCRG) in the form of an import declaration (descriptif d'/mportatlon, DI) specifying 9/ The Guineat Franc replaced the Syli during January 1986 (see para. 39). 10/ Initially weapons, narcotics, perfumes, alcohol, cars, the transfer of dividends and interest, and all services except airline tickets and freight charges were excluded. These exclusions were gradually relaxed during 1987 and 1988 until only weapons, narcotics and the transfer of dividends and interest remained. However, maximum limits were retained on travel allowances (allocatlons voyages) and the purchase of airline tickets. Capital account transactions require case-by-case BCRG approval.  - 12 - the type, quantity and value of the goods. ill These demands, taken together with offers for sale of foreign exchange by the private sector and the level of foreign exchange assets of BCRG, were then reviewed by the BCRG aach Friday at the so-called auction. The auction rate was then set not so much by the direct interplay of supply and demand but rather through a BCRG fixing taking into account supply and demand factors, although all demand was satisfied at this fixed rate. 12, The rate was first established vis-a-vis the US dollar and then against other currencies using, broadly speaking, international market cross-rates. 31. After the initial FORE IGN EXCHANGE MARKET devaluation the Guinean Franc was allowed to depreciate against the US u. dollar by about 18 percent, from an annual average AJ of GF 364 in 1986 to GF 428.5 in 1987, and by a further 11 455 percent to GF 475 in 1988, ax LZ reflecting both persistent inflation and the appreciation of o 4 ftralt.bt the US dollar (see Box 2 on inflation). 13/ Figure 1 Available data suggest that after allowing the official to parallel market spread to widen to on average 17 percent between May 1986 and April 1987, the Central Bank was 111 Those in the private sector with independent access to foreigu exchange (deriving from exports or capital inflows) were not obliged to surrender it to the BCRG. They were nevertheless required to submit import declarations when they used their foreign exchange for imports. 121 In other words, no actual bidding took place in the so-called auction. 13/ The nominal depreciation against the French Franc in 1987 and 1988 was 30.2 and 15.6 percent respectively.  - 13 - able to maintain the Guinean Franc to US dollar rate generally within 10 percent of the parallel market rate (See Figure 1). 141 32. Gross foreign exchange sold by the Central Bank at the auction expanded by nearly 60 percent per annum between 1986 and 1988, from about US$ 90 million to USS 222 million. Central Bank purchases of foreign exchange at the auction, which represented 14 percent of gross sales in 1986, doubled to 29 percent in 1988. The difference between gross sales and purchases, i.e. the net sales of foreign exchange by BCRG, derived mainly from mining sector tax revenues, mining sector exports net of outflows, and balance of payments assistance. (Table 5 illustrates key trends relating to the foreign exchange market. In this table, "demand' refers to the gross sales of foreign exchange by BCRG to the non-mining private sector, "supply" refers to the purchases by BCRG from that sector, and the "balance" is the excess demand which is satisfied by thew "net sales" of BCRG as described above.) ahle 5 FOREIGN EXCHANGE AUCTION (1988-89) (in millons of US1) ~~~ ..... .. . I 9 0 7 .... ..... .1 9 a a .... ..... .1 9 a 8 ...... .1S.. Dend Supply Balance Demand Supply Balance Demand Supply Balance Deand Supply Balance Q I 7.7 0.8 -8.9 21.9 10.2 -11.7 37.8 12.4 -26.4 59.4 21.6 -88.0 Q II 25.2 8.2 -22.0 32.3 7.8 -24.7 68.4 19.0 -39.4 65.0 18.9 -87.7 Q III 33.2 4.6 -28.6 38.7 8.9 -31.8 65.2 13.8 -51.9 68.9 21.0 -87.9 Q IV 22.7 4.3 -18.4 89.9 11.1 -28.7 80.5 18.7 -41.8 54.2 27.8 -28.4 L--------------------- --------------------- --------------- --- TOTAL 88.7 12.8 -75.9 132.8 35.8 -97.0 221.9 63.8 -168.8 229.1 89.1 -140.0 Sot-rce: BCRG 33. Auction sales to finance imports of goods grew from US$ 88 million in 1986 (99 percent of total Central Bank sales) to USS 195 million 14/ However, the thinness of trading on the parallel market, and its diminishing importance, reduces its usefulness as an indicator of the appropriateness of the official rate. In addition, since the Central Bank base rate is quoted net of commissions and charges (which represent up to 1 to 2 percent of the base rate) the real spread between the two rates is less than the quoted spread. Nevertheless, a number of sti:uctural factors mitigate against the elimination of the parallel market in the short term: (i) official access to foreign exchange remains restricted for some types of transactions (see footnote 10/); (ii) smuggling is facilitated by avoiding the official foreign exchange market; (iii) imports financed through purchases of foreign exchange at the auction are subject to pre-shipment verification for which the importer pays a fee; and (iv) purchasers of small quantities of foreign exchange may resort to the parallel market to avoid the administrative delays of the official system.  - 14 - (89 percent of sales) in 1988. 15/ During the same period "off-auction' (hors ench*res) sales of foreign exchange for airline tickets. travel allowance, and transfers grew from USS 1 million to US$ 27 million. During 1987-88, foodstuffs represented 40 percent of the goods financed by the auction followed by non-food consumer goods (31 percent) and capital and intermediate goods (19 percent). 16/ 34. The auction was able to make available large sums of foreign exchange to the private sector. As the foreign exchange budget clearly indicates, however, the private and public sectors have both been consistently in deficit (see Table 6). The sustainability of the system therefore has depended heavily on the availability of significant amounts of balance of payments assistance, debt reschedulings, the accumulation of arrears on external debt, and sometimes the depletion of foreign exchange reserves. 17/ Indeed, when balance of payments support fell short of projections in 1988, the Central Bank satisfied demand at the weekly auction through a depletion of its reserves and through payments arrears on Guinea's external debt, rather than through depreciation. This demand was itself driven by that year's high budget deficit being financed by net money creation, in the absence of the balance of payments assistance. 35. In consequence, estimates of the rate of exchange which would maintain purchasing power parity (PPP) indicate that the Guinean Franc was allowed to appreciate in real terms during 1988. The devaluation was a mere 4 percent against the US dollar between June 1987 and May 1988 as compared to an inflation rate of 15.3 percer.t over the same period. Over the year as a whole the Guinean Franc appreciated by some 6.5 percent over the June 1987 rate (GF 435/US$) considered to have been an equilibrium rate vis-&-vis the US dollar. 18/ Indeed, this understates the extent of the overvaluation, given that the current account deficit, driven by demand pressure from the rising budget deficit, was at an unsustainable 10 percent of GDP in 1988. Since domestic interest rates on deposits did not compensate for the risk of an eventual compensating devaluation of the Guinean Franc, there continued to be an incentive to hold foreign exchange. 15/ The distinction between auction and off-auction sales is not of any obvious economic significance. Indeed, it is not clear that it facilitates management of the foreign exchange system either. 16/ The classification of the remaining 10 percent is undetermined. 17/ The Foreign Exchange Budget (Budget en devises) is the consolidated account of all of Guinea's recorded foreign exchange transactions and is used by the Central Bank for cash-flow programming purposes. It includes foreign exchange transactions of the central government (debt service payments, direct imports), of the public enterprises (principally ONAH and Air Guinee), and the private sector. The foreign exchange budget as presented here in Table 6 is a broader framework, including transactions with the USSR and certain non-cash items. 18/ In this month the gap between the official and parallel exchange rates narrowed to only 2-3 percent.  1able 6 FOREIGN EXCHANGE WDCET (in millions of US2) .... 1987 ... . 1966.... 1 9 ..... ..... 9 ... Demand Supply Bolance Demand Supply Balance Oemnd Supply Balance U8U C SECTOR 808.9 270.6 -88.8 876.? 267.2 -116.6 408.7 270.0 -12 .7 rv-rnment Import 56.8 -66.6 68.2 -68.2 66.9 -65.9 ubllc Enterprises 7.9 s0.8 22.4 47.5 68.4 86.9 45.0 76.0 90.4 ublic Debt 199.4 -189.4 272.0 -272.0 802.2 -302.2 ining tax*. 17n.s 177.6 161.8 151.8 196.8 186.8 thor 12.8 12.6 22.0 22.0 14.7 14.7 PRIVATE SECTOR n/a n/a -47.2 n/a n/a -76.5 n/a n/a -90.8 uction 1a2.8 S6.. -97.0 221.9 68.8 -156.6 229.1 69.1 -140.0 Son-auctIon n/a n/a 49.6 n/a n/a 60.1 n/o n/* 49.7 (o mining (34.9) (34.9) (33-89) (88.9) (41.2) (41.2) ompanie.) .................................... ......................- ...................... ...................... ALANCE OF PAYMENTS ISTANCE 67.9 87.9 54.9 54.9 94.1 94.1 ... .... ................. - ...... .. .. ... . ...................... K IN EXTERNAL ESERVES -48.2 22.4 -89.7 a accumulation) ..................... ............................... ...................... ...................... ...................... ARREARS CC WULATION 24.0 76.0 16.2 . ...................... ................ .............. EBT RESCHEDULXNGS 81.6 48.7 147.4 ................................ .................... ............................................. ource: 8CRO, Ministry of Economy and Finance, World Bank (b) Currency and Banking Reform 36. In the eighteen months following the change of regime the already disastrous state of the banking system worsened further. As the restrictions on the hitherto specialized banks were lifted, the volume of transactions increased and the fear of harsh sanctions diminished, unsound banking practices in general and fraud in particular flourished. The practice of issuing certified checks without provision drawn on one bank for immediate deposit in another bank spread rapidly. Prohibition of this practice in July 1985 was to no avail, and the fictitious assets of the banking system continued to mushroom. On the day the PREF was launched the banks were closed down and their liquidation commenced. Private sector ydeposits were frozen to be reimbursed only in a phased fashion to minimize the danger of inflation and external account instability; public sector  - 16 - deposits were cancelled, with Government committing itself to provide directly for those enterprises' financial needs. 19, 37. However, in parallel to the collapse of the state banking system Government was taking preparatory measures for the creation of private banking. 20/ In March, 1985 a new banking law was enacted and new Central Bank. legislation was passed in September. The former legislation made possible the establishment of a private banking system; the latter legislation returned to BCRG the right of currency issue it had lost five years before, a function that is particularly important for monetary control in an economy where currency continues to represent an extremely high proportion of the stock of money. However, neither law provided for bank supervision, nor even for prudential ratios that the banks would have to observe. 38. Early in 1985, the Government had opened negotiations with a number of French banks to establish new banking operations in Guinea. The first such bank, the Banque Internatlonale pour rAfrique en Gulnde, commenced operations in August 1985, to be followed by the Soc3ete G6nerale de Banques en GuIn4e in December, and the Banque Internatlonale pour le Commerce et Industrle en GuInee the following January. 21/ The attraction of foreign banking capital into such an uncertain operating environment was a creditable achievement for the Government and an essential step in the process of economic recovery. It was not, however, without cost in that generous tax exemptions were granted to the banks; moreover, this was done on a case-by-case basis, undermining the free play of competitive forces. In addition, Government became a shareholder in two of the banks, which 19/ However, the whole process of liquidation of the banks is estimated to have cost Government approximately GF 43 billion (about US$ 65 million at current exchange rates), net of realizable assets of the banking system. Much of this amount was financed by money creation, adding to inflationary pressures. A significant portion of this cost could have been saved by means of tighter management of the liquidation process. 20/ More accurately, the growth of a private banking system since the tiny Banque Isiamlque de Gulnee, operating according to Islamic banking law, had existed since August, 1983. 21/ The principal foreign partners in the capital, and the providers of the management, of these banks were the Banque Internatlonale pour r'Afrique Occldentale, Socilte Generale and the Banque Nationale de Paris respectively. In 1988, they were joined by the Union Internatlonale de Banques en Guinee of which the principal foreign partner is the Credit Lyonnais France.  - 17 - increased the risk of intervention in banking affairs for commercially unsound reasons, until such time as those shares could be transferred to the indigenous private sector. 221 39. In January 1986, a currency reform was implemented with a one- for-one exchange of the Syli for the new Guinean Franc (GF), which was intended both as a symbolic act designed to generate confidence in the financial system, and as a means of ascertaining the volume of currency in circulation. The exchange of currency symbolically reversed the four exchanges of the First Republic, which had often involved a loss to currency holders, and had more generally come to represent the impoverishment of the Guinean people. However, as with the previous currency exchanges, there were also some who gained from the process, as new notes issued exceeded old notes presented by GF 2.2 billion (US$ 6.3 million at the January 1986 official private sector exchange rate). (c) Trade Liberalization 40. The trade regime inherited by the Second Republic appeared, on paper, highly protectionist with tariffs generally in excess of 100 percent. 23/ In addition, tariff rates were highly dispersed ranging from zero to about 1000 percent. No detailed information is available on effective protection rates, but the high level of tarisfs on imported inputs (on which Guinean industry was highly dependent) implies that effective protection rates were often much lower than nominal protection rates alone would suggest. In addition, effective protection rates were clearly quite highly dispersed given the dispersion of nominal rates. The effect of this system on the structure of production was, however, limited by a number of factors: (i) any potential effective protection must have been to a great extent offset by the overvaluation of the Syli; (ii) most import-competing production took place in the public sector where the influence of levels of protection on investment decisions was probably minimal; and (iii) non-mining private sector imports were highly restricted and tariff evasion was widespread. 24/ 25/ 221 Indeed, since the indigenous private sector now holds shares in three of the private banks, thereby demonstrating the existence of a local financial capacity in this regard, it is inclear that the Government needs to continue to hold any. 231 The paucity of reliable import data by commodity makes - computation of any meaningful weighted average duty rate impossible. 24/ From 1975 to mid-1979, all importing by the non-mining private sector was prohibited. From mid-1979, this prohibition was lifted but only for imports financed by the importer's own foreign exchange resources, i.e. no recourse to the foreign exchange assets of the Central Bank was possible. Since the source of an importer's foreign exchange would usually be an activity that was illegal or, on the basis of past experience, likely to become so, importers generally preferred to avoid the scrutiny of the State by smuggling.  - 18 - 41. However, such a tariff structure was clearly inappropriate for an economy in which prices were to be given a much greater rOle in ensuring the efficient allocation of resources. This was particularly relevant in that one of the most important prices in the economy, the exchange rate, was about to be adjusted to a market-determined level. In some cases the effective protection rate afforded by the tariff system would be too high to allow the efficient development of infant industries; in others it would be too low g.ven the level of import dependence for inputs of those industries. The extreme degree of dispersion of rates would distort investment decisions away from a basis of relative production costs and the sheer complexity of the system would deter investment. 26/ In addition. the urgently-needed improvements in revenue collection would be impeded by high tariff rates. Moreover, with the devaluation such high rates would be prohibitive and the consequent cost-of-living and protective effects extreme. 42. As a result of these considerations the tariff regime was extensively reformed eleven days after the initial major devaluation of January 4, 1986. A basic tariff rate of 10 percent was introduced with a 5 percent rate for some essential commodities and agricultural inputs and a 20-30 percent surtax for some luxury commodities. 27/ 28/ This was intended as a transitional measure pending further analysis of the situation. This was advisable both on the grounds that the response of the economy to the shock of devaluation was unpredictable and that the customs 25/ Mining sector imports were subjected to a separate, much lower, tariff regime. This further undermined *he effect of the general tariff regime since consumables imported on the account of the mining companies supplied a significant portion of the parallel market. 26/ Even senior customs officials reportedly did not fully understand the system. 27/ The Guinean tariff rate is in fact divided into the customs duty * (drolt de douane d'entree) and the fiscal duty (drolt fiscal d'entrde); this distinction is of no economic significance. 28/ Various further modifications were subsequently made to the tariff structure during the first phase of the PREF. In July 1986, some luxury surcharges were raised to 40 percent and then in May 1988 that for tobacco products was again raised to 125 percent (with a lower rate of 48 percent for certain brands). Also in July 1986, the turnover tax on imports (taxe sur le chiffre d'affaire a /'Importation, TCA) was raised from 2 percent to 8 percent; it was raised again in January 1988 to 10 percent at the same time as the turnover tax on domestic production (taxe a la production, TP) was reduced from 12 percent to 10 percent. It should be noted however that the collection effort was even poorer for the TP than for the TCA, thus the TCA provided some degree of protection in addition to that provided by the basic tariff. Throughout most of this period imports of rice and medical supplies were exempted from either tariffs or TCA.  - 19 - service was so "porous* that rates in excess of 10 percent might well lead to lower levels of collection due to increased evasion. 43. In parallel to the tariff reform and the devaluation, the system of import licensing was reformed. Although the State's exclusive accass to the foreign exchange resources of the Central Bank was rapidly eliminated after the change of regime, the quantitative rationing of foreign exchange by license remained necessary while the currency was still seriously overvalued. However, with the devaluation and the institution of an exchange rate management system broadly aimed at clearing the foreign exchange market, licensing became superfluous. It was therefore replaced by a simple system of import declarations available to all registered traders. However, the approval of BCRG was still required before a declaration could be presented to the foreign exchange auction for financing and this approval was occasionally delayed or withheld as a form of quantity rationing. 29/ (d) Removal of Price Controls and the Liberalization of Marketing 44. The pervasive system of price controls and official marketing agencies was dismantled in 1986, as was the State monopoly on long-distance freight transpc. ., storage and handling. These measures had little immediate economic impact since most trading already took place through parallel channels at market prices. 30/ However, the potential effect on private investment decisions was enormous, signalling as it did the new legitimacy of the private sector; in the agricultural sector in particular the new liberalism could be expected to revive production for surplus, which had been deterred by low official producer prices and inefficient marketing. 45. However, certain important exceptions to this policy remained in place. The price of rice remained controlled (although direct intervention in rice trading was restricted) and prices administered by some public enterprises exercising near-monopolies continued to be set below cost. 31/ This had serious budgetary implications and significant disincentive effects for potential competition from private enterprise. 29/ This requirement was abolished in early 1989. 30/ It did, however, imply that a very significant source of rents for those with privileged access to goods at official prices disappeared. In a similar fashion, those in a position to arbitrage between the official and parallel exchange rates lost out in the devaluation. It should be noted, however, that civil servants continued to extract rents from the private sector even after official controls were abolished - see the extensive discussion in Section III of how this constitutes a major obstacle to private sector development. 31/ This was of particular significance for petroleum distribution, electricity and water supply, and urban transport.  - 20 - (e) Privatization and Public Enteririse Restructuring 46. The new economic program implied a radical change in policies towards the public enterprises. The Government decided in 1985 to divest itself of all but the essential service industries and 'strategic' industries such as mining, and to restructure those enterprises to be left in the State portfolio to improve their performance. This involved an ambitious program of privatization and liquidation of public enterprises and major rehabilitation programs for the public utilities. Improvements were to be made to the legal and institutional framework for government supervision of the remaining public enterprises to enhance their autonomy and accountability, by strengthening the r8le of their boards of directors and improving systems for the monitoring of performance. Performance contracts were to be used as a means of clearly defining the mutual responsibilities of the State and the enterprises, while granting the latter greater autonomy in managing their affairs. 47. Although little progress was made on the restructuring of the enterprises to be retained by the State, more than 80 percent of the programmed privatizations and liquidations were completed during the 1986- 88 period. Of the 131 enterprises in existence when the program began the Government had, by the end of 1988, privatized 25 enterprises, mostly industrial, and liquidated 68 enterprises, mostly commercial. 32/ 33/ Of the remaining 33 enterprises Government's aim was to privatize or liquidate 20; of the 18 enterprises to be left under government control only 8 were to be fully government-owned. 48. The size and speed of the first phase of the privatization program were impressive. However, the generous terms granted to some investors, the lack of transparency of some of the privatization deals and the slow pace at which privatized companies resumed activity left the program open to widespread criticism. Many of the privatized enterprtses benefited from generous tax exemptions and monopoly rights granted on a case-by-case basis outside the provisions of the Investment Code. In addition to the special concessions granted to privatized companies, which undermined the intended economic efficiency gains, the financial aims of the program were also often neglected. Some of the enterprises were sold at very low prices, often payable over periods of several years after a generous grace period and without interest. Assets from liquidated enterprises were often sold for only token prices. Moreover, by the end of 1988, much remained to be done to restructure those enterprises retained by the State, and several important enterprises remained to be privatized or liquidated. 32/ 'Privatization' is used here in the sense of the State reducing its participation in an enterprise to less than 49Z of the share capital, with these shares to be transferred to the private sector as soon as that should prove possible. 33/ In the figure of 131, the National Hydrocarbons Company (Office Nationale des Hydrocarbures) has been counted as one enterprise. In some documents its 50 outlets are counted separately.  - 21 - (f) Civil Service Reform 49. From the beginning of the PREF, it was clear that the new rOle envisaged for the State would require a fundamental reform of the public sector. This in turn would require a redistribution of administrative functions within and between ministries, a significant strengthening of personnel management capabilities, and a program of staff restructuring "to arrive at an effective Government structure with a greatly reduced number of staff (which) would make possible a significant real increase in salaries' (Declaration of Development Policy, December 22, 1985) of those staff retained. Guaranteed employment for university graduates was abolished in 1985, and a decision was taken to freeze further recruitment into the civil service. 34/ 50. The civil service reform was entrusted to a commissariat (Commissariat gd-4ral a la Reforme administrative, CGRA) attached to the Presidency, created for the express purpose of implementing the reform. 351 The program began with the completion of a census of public sector employees. 36/ The census, undertaken between December 1985 and May 1986, indicated 90,000 public servants (excluding military personnel), about 72,000 of whom were in the administration, and the remaining nearly 18,000 in public enterprises. 51. While the 1986 census presented a snapshot of public sector employment, it was inadequate as a management tool in the absence of continuous verification and updating. The task of updating was not begun until April 1987 when a special commission (Commission de ratlonallsatlon de la gestlon des personnels de l'Etat, CORAGEPE) began verifying staffing rosters in Conakry. As the task of redefining administrative functions within and between ministries had not yet been completed, verification of staff numbers was complicated by the large number of often overlapping administrative structures dealing with personnel matters. It was thus not until after November 1988, with the establishment of the Administrative and Financial Affairs Divisions (Divislon des Affaires administratlves et financI&res, DAAF) within each Government agency that the verification could commence in earnest. In the event, the CORAGEPE found that 5 percent of the nearly 22,000 staff in Conakry should not have been on the payroll. 52. Reduction in staffing levels was viewed as a means of establishing a more effective administrative structure rather than as a 34/ There was however recruitment of at least 1,330 people into the civil service during the first phase of the PREP, mostly in the Ministries of Education and Health. 35/ In April 1988 the CGRA was merged with the Ministry of Civil Service to become the Ministry of Administrative Reform and Civil Service (iInIst6re de la Reforme Administrative et de la Fonctlon Pubilque). 36/ Preparations for the census were made between July and November 1985 and included a vast public information campaign and extensive training of census enumerators.  - 22 - means of reducing the wage bill. 37/ To this end, the CGRA began preparing new organization charts (cadres organiques) for all ministries and public agencies to define staffing requirements. The new organization charts were designed to reflect the revised tasks of the much-reduced civil service, against which skills of existing staff would be matched. 53. The first stage of staff reduction began immediately after the completion of the census with the retirement of staff above the statutory retirement age of 55, and the early retirement of public employees with 30 years of service. Staff of the liquidated State banks and parastatals were also struck from the active civil service rolls, while employees of the joint-venture mining companies were transferred to the accounts of the those companies. 54. Whereas employees of the parastatals and State banks were removed without the possibility of testing and selection, staffing levels of the civil service were to be reduced through a testing program. Tests were scheduled to be conducted both across ministries for common skills as well as within eech ministry for function-specific know-how; staff found lacking in requisite skills were to be laid off. Although testing began in 1987, political resistance, the constant reorganization of ministries, and the difficulty of designing function-specific tests, frequently delayed the completion of the testing-selection process. By December 31, 1988, testing of nearly 25,000 staff of the Administration was completed. Of these, 53 percent passed the tests and were retained, and 21 percent failed and were placed in a temporary reserve where they continued to receive their salary until being definitively severed from the civil service (see paras. 56 and 68). The remaining 26 percent were provisionally placed in reserve with a view to possible re-hiring upon successful completion of training programs. Although initially all staff were to be subject to testing and selection, two specific groups, totalling nearly 26,000 people, were in fact partially exempted. These "special staffI (effectlfs sp4claux) included the paramilitary corps (customs, police and presidential guard) and the technical staff of the Ministries of Education and Health. 38! The former were to be exempted from the whole process, while the latter were to be 371 Civil service wages and salaries in Guinea represented an estimated 171 of current revenue in 1987. By comparison in the same year, the government wage bill represented 33 percent of current revenue in C6te d'Ivoire and 37 percent in Togo. Whereas the average annual public sector wage was only twice the estimated per capita GDP in Guinea in 1987, the comparable figures for COte d'Ivoire and Togo indicate that average annual wages were nearly eight and nine times their respective per capita GDPs. 38/ In addition, staff with 15 years of service, over 45 years of age, returning from overseas training programs of at least 1 year's duration, or able to obtain agreement of his or her superiors, were exempted from the testing process.  - 23 - tested but their staffing levels were not to be reduced in recognition of the need to protect access to these services. 39t 55. At the end of 1988, the active civil service had been reduced to approximLtely 71,000 from its estimated end-1985 level of 104,000; at least, the testing and selection procedure indicated this eventual level, which was not fully attained until the end of 1989. Of these 71,000, about 15,000 were military personnel and approximately 5,000 were employed by the administration on a contractual basis, rather than as established civil servants (see Table 7) 40/ 56. In order to minimize the social costs to those public enterprise staff who lost their jobs as a result of the liquidation and privatization process, the Government, on December 22 1985, instituted an administrative reserve (DIsponlbilte sp4clale) status. Staff placed in administrative reserve status were to receive payment for 6 months at their base salary of their last month of active service, including the cost of living allowance. Under severe political pressure, payment of salary under this program was extended to three years, with a cut-off date of December 31, 1988. In addition to the administrative reserve, the Government created a program to encourage active public sector employees not eligible for retirement and early retirement, to voluntarily leave public service (Programme speclal de depart volontalre). 411 Staff participating in this program were eligible for a bonus payment equivalent to approximately 5 years salary, of which 30 39/ There has been extensive discussion of the nature of the exemption from testing of the Ministries of Education (18,200 staff) and Health (6,700 staff). It is understood that all staff were to be tested, although only administrative staff were to be subject to staff reduction. For technical personnel, the testing process was to be used as a means of improving staff deployment; the possibility of recruiting better-qualified staff to replace staff found to be unqualified was not excluded (see Volume II, Education and Health Chapters for more on this process). 40/ Information on public sector employment should be interpreted with caution as data from various sources differ. These differences result from the overlapping nature of severance measures where for instance, staff forced into early-retirement or placed in reserve were able to, and often did, take advantage of the voluntary departure package. 41/ Staff participating in the voluntary departure program were prohibited from public sector employment for a period of 10 years after their departure.  - 24 - percent was to be paid as a lump-sum and the remainder in equal monthly payments over a 20-month period. 42/ able 7 CIVIL SERVICE REFORM - NET STAFF REDUCTIONS Mining Stat. Public MinTstry Co. Danks Ent. Staff Military Indeterminat. TOTAL Staff at end-1986 6517 4894 8200 70989 12F,79 209W 103800 ---- -