Guinea - Structural Adjustment Program Project

Dcunmnt of The World Bank FOR OFFMCIAL USE ONLY Reot No. 8826 PROGRAM PERFORMANCE AUDIT REPORT GUINEA FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDITS 1659-GUI AND SFA AOl1) JUNE 25, 1990 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTTS (Annual Average. Guinean Francs per US Dollar) 1986: GP 345; 1987: GF 428; 1988: GF 475 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS CBG Compagnie des Bauxites de Guinee (bauxite company) CCEF Economic and Financial Coordinating Committee ENCOBE Entreprise de commercialisation du betail EPCOA Prefectoral Agency for Agricultural Produce Marketing FAPA Ferme Agro-Pastorale d'Arrondissement (District Collective Farm) MEF Ministry of Economy and Finance MPCI Ministry of Planning and International Cooperation MRAEP Ministry of Administrztive Reform and Civil Service ONAH Hationwl Hydrocarbons Company (petroleum products import and distribution) PROSECO State enterprise responsible for Product Exports (coffee and palm ke.rnels) SGC Soc.iete Guineenne de Commerce (Joint ventura trading company)  FOR OFFMCLAL US ONLY THE WORLD BANK Washington. D.C 20433 U.S.A. Office tel OvfftEv.GWaI Op0srat tvattutm June 25, 1990 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Program Performance Audit Report on Guinea - First Structural Adjustment Credit (Credits 1659-GUI and SPA AOIl) Attached, for information, is a copy of a report entitled "Program Performance Audit Report on Guinea - First Structural Adjustment Credit (Credits 1659-GUI and SFA A0ll)" prepared by the Operations Evaluation Department. Attachment This documient has a mttited distrbutiont and may be used by moipients only in the pM. .aef of their officil dutLe Its conenttat my wat otherwise be diwoe without Wol Bsnk auwzin  FOR OMCIAL USE ONLY PROGRAM PERFORMANCE iUDIT REPORT GUINEA FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDITS 1659-GUI AND SFA AO11) TABLE OF CONTENTS Page NQ. Preface . ........................................................... i Basic Data Sheet ................................................... ii Evaluation Summary ................................................. iii PROGRAM PERFORMANCE AUDIT MEMORANDUM I. BACKGROUND ................................................... 1 II. CONCEPT AND DESIGN OF SAL I .................................. 2 III. IMPLEMENTATION ............................................... 4 A. Monetary and Banking Reform .............................. 4 B. The Incentive System ..................................... 5 C. The Public Sector ........................................ 6 IV. IMPACT AND INITIAL RESULTS ..................... 8 V. FINDINGS AND ISSUES .................................. 9 PROGM COMPLETION REPORT I. INTRODUCTION ........................ ......................... 13 II. SETTING ........................... ........................... 13 III. THE ECONOMIC AND FINANCIAL REFORM PROGRAM .................... 15 IV. PROGRAM IMPLEMENTATION ........ ........... .................... 16 V. GOVERNMENT MONITORING OF THE PROGRAM .......... .. ............. 29 VI. BANK SUPERVISION ......... ............. ....................... 30 VII. DISBURSEMENT AND PROCUREMENT .............. .. ................. 31 VIII. THE IMPACT OF SAL I .......................................... 31 IX. LESSONS LEARNED ....................... ....................... 33 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.  PROGRAM PERFORMANCE AUDIT REPORT GUINEA FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDITS 1659-GUI AND SPA A011) PREFACE 1. This is a Program Performance Audit Report (PPAR) on the First Structural Adjustment Program, involving an IDA credit in the amount of SDR 22.9 million and an SFA credit in the amount of SDR 15.6 million to the Government of Guinea, with the objective of supporting Guinea's Economic and Financial Reform Program designed to free the economy from pervasive state controls, lessen public sector intervention and to put in place a policy framework favoring a market-oriented economic system. The credits were approved on February 11, 1986, and became effective on May 19, 1986. Closing date of the credits was December 31, 1988; and final disbursements were made on February 23, 1989. A Second Structural Adjustment Credit, No.1926-GUI in ttv amount of SDR 47 million, was approved on June 16, 1988 and became effective on March 2, 1989. 2. The PPAR consists of the Program Performance Audit Memorandum (PPAM) prepared by the Operaticns Evaluation Department (OED) and the Project Completion Report (PCR) prepared by the Africa Region. The PPAM is based on the attached PCR, the President's Report, the loan documents, the transcripts of the meeting of the Executive Directors at which the program was considered, on a study of program files, and on discussions with Bank staff. An OED mission visited Guinea in Octoberl/ovember 1989, and discussed the effectiveness of the Bank's assistance with the Ministry of Finance, the Planning Office and the Central Bank. Their kind cooperation and valuable assistance in the preparation of this report is gratefully acknowledged. d3. The PCR p' vides a complete account and assessment of the project experience, and discusses the performances of the Bank and the program executing agencies. The PPAM elaborates on particular aspects such as the concept and design of SAL I, the incentive system, and the impact and initial results; and sets out the major findings of the audit. 4. Following standard OED procedures, copies of the draft PPAR were sent to the Government. However, no comments were received.  ii PROGRAM PERFORM4ANC3 AUDIT REPORT GUINEA FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDITS 1659-GUI AND SFA AOl1-GUI) BASIC D SHEET KEY PROECT DATA Original Amount Disbursed OutstanaOng (as at 31 March 1989) IDA Credit No 1659-GUI* 25 (SOR 22.9) 29.09 0 SFA A011* 17 (SOR 15.6) 19.62 0 *Denominated In SORe Source: Statement of Development Credits CUKULATIVE CREDIT DISBURSEMENT FY 86 FY 87 FY 88 FY 89 (I) Planned CUSS million) 34.20 42.00 0.00 0.00 (I1) Actual Total 12.72 22.75 39.12 48.71 o/w A 011 4.97 10.84 17.10 19.62 1659-GUI 7.75 11.91 22.02 29.09 Ciii) as percent of (I)* 37 54 93 116 * Disbursed USS amounts exceed original USS amount due to SOR/USS parity changes. Appraisal Mar. 10, 1985 Documents to Nov. tt, 1985 Loan Committee Negotiatio'us Dec. 12, 1985 Board Approval Feb. 11, 1986 Signature of DCA Feb. 27, 1986 Effectiveness may 19, 1986 Credit closing Dec. 31, 1988 FOLLOW-UP ADJUSTMENT OPERATIONS Guinea: Second Structural Adjustment Program, Credit No 1926-GUI approved on June 16, 1988 in the amount of SDR 47 million (US$65 million equi- valent). The Credit was signed on June 29, 1988 arnd became effective on March 2, 1989.  iii PROGRAM PERFORMANCE AUDIT REPORT GUINEA FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDITS 1659-GUI AND SFA AOlI) EVALUATION SUMMARY The Background 1. After more than two decades of economic mismanagement the economy of Guinea was in a state of complete disarray by the early 1980s. The centrally planned state-led development model had failed to produce growth and moderniza- tior. Instead, despite its favorable resource endowment, Guinea remained one of tht poorest countries in Africa with comparatively unfavorable social in- dicators. 2. A 1982 stand-by agreement with the IMF soor became inoperative as there was no clear government commitment with regard to systemic reforms and the required radical adjustment of the exchange rate. Under a new government, assuming power after the death of Sekou Toure in 1984, the prospects for basic changes in Guinea''s economic policies improved. The government demonstrated its commitment to policy reform by abolishing all internal barriers to the movement of goods and by stopping compulsory sales by farmers to the government, thereby giving the private sector access to all activities previously under the monopoly of the state. The SAL I - Concegt and Desi 3. There were long negotiations on an adjustment program with the Fund and the Bank during all of 1985. It was clear to both sides that systemic reforms had to take place in the Guinean economy toward a market-oriented system which would, in combination with the large needs for rehabilitation in all sectors, require several years to be implemented. IDA's First Structural Adjustment Credit approved by the Board in February 1986 was to be the first of a series of operations in support of Guinea's Economic and Financial Reform Program started by the regime which came to power in April 1984. 4. Due to the deep financial disarray of the country the adjustment process had to be initiated with a monetary and banking reform, devaluing the Guinean currency by a factor of twelve and replacing the inefficient state bantks with a new banking system based on private joint-venture banks. The large external deficit of the country required a joint effort of the international donor community adding up to almost US$150 million including special joint financing and cofinancing from bilateral donors. While the Fund's and the Bank's contributions covered only a fraction of the financial gap, their support of Guinea's adjustment program was instrumental in mobilizing additional external assistance. 5. The adjustment program was designed to be carried out in three phases. Phase I, from end-1985 to mid-1986, consisted of a range of major  iv monetary, pricing and fiscal adjustments, complemented by multilateral debt rescheduling in the framework of the Paris Club. Phase 1I (during 1986) was to consolidate the reorientation of the economy to the new exchange rate and pricing system by a progressive liberalization of the productive sectors, the establish- ment of the new banking system and by improving public sector performance. In Phase III, from 1987 onwards, the private sector was to play the major role in employment generation following public sector rationalization. The essential actions in these phases were directly linked to specific conditions for the release of the second tranche of the SAL, which was delayed by a year-and-a- half pending the satisfaction of these conditions but ensured a constructive dialogue and positive action in most areas. Implementation 6. The monetary and banking reforms were carried out swiftly by the Guinean authorities. A foreign exchange auction system wa' introduced after the initial large devaluation and four new private banks were established. The pursuit of an active exchange rate policy was hampered however by the continuing internal financial disarray, particularly with regard to the public budget. 7. The reforms of the incentive system for the private sector proceeded relatively well with regard to price adjustments (rice, petroleum, coffee, palm kernels) and the simplification of the tariff regime. However, an increase in the petroleum tax as well as the tariff reforms did not result in a substantial increase of budgetary revenucs due to 'leakages' from parastatals and an inefficient customs service. The establishment of a coherent institutional and legal framework for a market-oriented economy proceeded on a piecemeal basis only and was not completed under SAL I. 8. The public sector reforms, namelv the reduction of the civil service by 10,000 employees and the privatization and liquidation of public enterprises, were initiated quickly but soon encountered difficulties due to insufficient planning and monitoring as well as a certain loss of credibility in the view of the public because of exonerations and irregularities. The civil service reduction was fully implemented but the creation of alternative employment opportunities in the private sector was very limited. The economic benefits of the privatization of public enterprises have been qualified by the granting of monopoly rights, high protection and generous fiscal holidays to some privatized enterprises. However, quantitative targets for privatization have been met, though with some delay. Impact and Results 9. The Guinean economy has reacted favorably to the adjustment measures with GDP growth rates of 3.1X in 1987 and 5.9X in 1988. The inflation rate declined but fiscal and balance of payments deficits remained high, due to slippages in financial discipline and a persisting weakness in the management capacities of the economic ministries. Despite the comprehensive deregulation and liberalization policies there has been no significant increase in private investment, rneither local nor foreign, except in the agriculture, trade sectors and housing where a positive supply response could be felt. It was clearly too  v optimistic to expect significant employment creation in the private sector already under SAL 1. Evaluation - Findings and Issues 10. As the first phase in a sequence of policy-based lending operations the contents and conditionality of SAL I appear appropriate in view of the severe distortions of the Guinean economy. Quick results in all aspects could not be expected, given the weak human resources and the physical deterioration of the country. The gradual improvements since the start of the adjustment program can be regarded as a success; but the remaining requirements for reform are enormous, and in view of the weak financial position of the country and the expected deterioration in its terms of trade medium-term growth prospects are only modest. 11. There were some weaknesses in the design and implementation of the program. Among the more important the following issues have been identified: - - The adjustment program wab designed by Bank and Fund staff and was not fully internalized by the Guinean authorities. This deficiency was only partly compensated by continuous dialogue between the resident missions and the government on the details of the implementation of the program. - - The companion TA operation for economic management was not sufficient to substitute for the fundamental management deficiencies in the Guinean admiristration. - - SAL I focussed mainly on the establishment of a rational public investment program but neglected revenue generation and budgetary management in general. -- The Bank's approach was flexible with regard to the conditionality and the timetable for program implementation, but somewhat superficial in the design and monitoring of comprehensive reform programs such as the restructuring of the public service and the public enterprise reform. Lessgns 12. This PPAM essentially agrees with the statement of lessons learned contained in the program completion report. While some reforms hinge on executive and or legislative decision and can be implementcd quickly, the economic response and effects depend on changes in the behavior of people and are much slower in becoming manifest. Still other reforms involve institutional changes which can be put in place only slowly and which are dependent on the availability of skilled people to design, implement and manage these changes. In both cases realistic expectations require that an adequate time span is allowed for the desired effects to appear.  PROGRAM PERFORMANCE AUDIT MEMORANDUM GUINEA FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDITS 1659-GUI AND SFA-AO11) I. BACKGROUND 1.01 Despite its great agricultural, mining and hydroelectric potential Guinea still belongs to the least developed countries with a GNP per capita of about US$300. In the quarter century after its independence the Guinean economy had changed drastically: from a net food exporter, based on a vital agricultural sector, the country became the world's largest bauxite exporter, a major alumina producer and exporter, and a net food importer. Except for a short period in the mid-1970s, when bauxite operations expanded, economic growth r6-ained below the population growth rate of approximately 3 percent per annum. The low level of development is reflected in comparatively unfavorable social indicators: life expectancy at birth, literacy rate and health standards are considerably lower than in the average low income Africa South of tne Salhara. 1.02 Starting from very difficult conditions at indeper-'ence Guinea chose a model of centrally planned state-led development whici. -ight have been appropriate at the outset but produced increasingly unfavorable t'sults as time passed. A network of state enterprises in all economic sectors replaced foreign ventures and private enterprises, but did not achieve the expected modernization and industrialization objectives. Due to the lack of producer incentives and poor performance of public support services, agricultural exports declined and most of the agricultural sector retreated into subsistence farming. Urbanization increased rapidly and the economy grew severely dualistic as between the official and non-official sectors. The former depended mainly on the bauxite enclave economy and functioned through an unsustainable system of administered prices and a highly overvalued currency, while the expanding parallel markets increasingly overtook the function of satisfying urban and rural consumer demand. 1.03 By the early 1980s the Guinean economy was in a state of complete disarray. The external deficit gree, and public investments outside the mining enclave failed to generate returns adequate to service external debt. The government's internal fiaancial position eroded due to increasing transfers to the parastatals and to declining tax receipts as the non-official sector grew to dominate consumer trade. The Guinean currency, the syli, traded on the parallel market at more than twenty times the official rate by 1985. The situation was aggravated by the declining performance of the inefficient and overstaffed public sector, in which remuneration consisted largely of official rations, notably rice. It was also aggravated by the severely deteriorated infrastructure, such. as the road network, energy supply, telecommunication links and the physical deterioration of the capital city of Conakry. 1.04 The pressure of the economic situation led to some tentative economic reforms in the early 1980s. In 1982 Guinea entered a one-year stabilization program with the IMF, which included policy elements aiming at longer-term recovery. There was, however, no clear government commitment to the necessary  2 refor-ms of the regulatory framework of the economy and to the required radical adjustment of the exchange rate. Thus the stand-by soon became inoperative. 1.05 Only after the death of President Sekou Toure in March, 1984, and the subsequent assumption of power by a group of military officers did the prospects for basic changes in Guinea's political, and economic policies improve. The new government expressed its determination to set the economy on a new path towards realizing its full development potential and appealed to the international community for support. 1.06 During 1984 and 1985 the Bank and the Fund held discussions with the government of Guinea on the economic reform program. Najnr stumbling stones in the nvgotiations on an IMF stand-by and a Structural Adjustment Credit from the Bank were the weak capacity for policy formulation on the Guinean side leading to a slow pace in decision making, and the hesitation of the government with regard to a radical devaluwtion of the Guinean syli. However, the government demonstrated its commitment to policy reform by initial reform measures in 1984 and 1985 directed toward eliminating all internal barriers to the movement of goods. It also abolished compulsory sales by farmers to the state. By enacting a ne- investment Code, a Banking Law and a Commercial Law, and by abolishing the state monopoly for foreign trade, the government gave to the private sector access to all activities previously under the monopoly of state-owned enter- prises, leading virtually to the legalization of the non-official sector of the economy. 1.07 When in the last quarter of 1985 the details of a structural adjustment program were discussed by the Bank and the Government of Guinea it was clear to both sides that the rehabilitation of the Guinean economy would be a long-term endeavour, that the centrally planned state-led development strategy had to be further changed in favor of a market-oriented economic system with a greater role for the private sector. It was also clear that the first phase of the reform program had to consist of a set of short-term fiscal and monetary measures to stabilize the economy and set the stage for subsequent structural reforms with a medium-term perspective. 1.08 The urgent financial needs of Guinea, reflected in an accumuletion of payments arrears amounting to over US$300 million at end-1985, required the joint effort of the international donor community as the financial contributions of the Bank (US$25 million IDA Credit sa'd US$17 million African Facility Credit) and the Fund (US$36.3 million) were riot sufficient to cover the financial gap. The total financing package committed in 1986, including Special Joint Financing from Germany and Japan, and cofinancing from Switzerland, France and the United States, added up to almost US$150 million. The Bank's and Fund's support for Guinea's economic recovery program was instrumental in mobilizing this assistaitce. Furthermore, a Paris Club meeting for the rescheduling of official debts was scheduled for March 1986 and a Consultative Group conference for one year later. II. CONCEPT AND DESIGN OF SAL I 2.01 In its Statement of Development Policy the Government of Guinea formulated four main development priorities. First, the exchange rate issue had  3 to be resolv&.1 as a prerequisite for the removal of price distortions and the unification of the official and parallel economies. Second, the capacity and performance of the public secto., particularly in supplying basic infrastructure and social services, had to be greatly improved. Third, the environment for private sector development had to be established. Fourth, export earnings had to be boosted by diversification out of bauxite, and rice imports had to be cut by augmenting domestic production. 2.02 The program was to be carried out in three phases. Phase I, from end-1985 to mid-1986, consisted of a range of major monetary, pricing and fiscal adjustments, such as the devaluation followed by a floating exchange rate; an increase '.n the prices of rice and petroleum products to reflect prices on the international market at the new exchange rate; a corprehensive debt rescheduling and strict control of credit and the money supply; measures to increase tax collection and to control public expenditure through reduced transfers to public enter- prises and reduced 1ublic sector employment; a core public investment program to rehabilitate and complete ongoing projects with assured viability and economic returns; a new investment code and other fiscal and administrative measures to encourage private investment; reform of tariffs and import/export procedures; and the opening of new, privately-managed commercial banks to replace the former Government banks, which were to be liquidated. Phase II (during 1986) was to consolidate the reorienta- tion of the economy to the new exchange rate and pricing system by maintaining price flexibility and progressive liberalization of the productive sectors, largely through rapid withdrawal of government involvement and intervention; establishment of institutions to support this process - particularly a viable and efficient banking system; and improving public sector economic performance. In Phase III, from 1987 onwards, the private sector would play the major role in employment creation following public sector rationalization, the firm reestablishment of financial sector institutions, and the expansion of smallholders agriculture and consumer demand. New or rehabilitated physical and social infrastructure should support this growth. 2.03 Due to the major distortions in the regulatory framework of the Guinean economy the program was focussed mainly on monetary and fiscal stabili- zation, based on the advice of the Fund, and on deregulation and liberalization of the economy. Other program elements dealt with the legal and institutional set-up of the emerging market-oriented economy. Most of these program elements  4 were to be carried out during 1986, while the major supply responses, based on private sector initiative, were expected to materialize during Phase III, which waa left conceptually relatively open, apparently to be filled with more policy actions under a subsequent structural adjustment credit. Taking into account the weak administrative capacities of the Guinean Government, it was a very ambitious and tight schedule for reform. It seems that the Bank didn't want to t iss the opportunity of a highly committed government, ready to accept the advice of the Fund and the Bank, and pushed ahead for major deregulatory reforms, leaving some of the complex problems of the transformation of the productive system and the establishment of new viable structures in the productive sectors to the future. 2.04 The short time frame of SAL I was reflected in the intention to disburse the second tranche of the credit (US$17 million) already in the second half of 1986, following a performance review. Specific conditions for the release of the second tranche referred to the establishment of a new legal framework (investment code, commercial law, petroleum code); the start of the liquidation program for the state-controlled primary banks; the reduction in the number of public employees by 10,000 persons; a review of rice stocking and distribution arrangements; and adjustment of the prices of rice, coffee, palm kernels and petroleum. Additionally, the government agreed to pay regularly its charges for water and electricity; establish an action plan for the restructur- ing of the non-industrial parapublic sector and to consult with the Bank before formation of or taking participation in new state enterprises and before making any changes in the contractual or fiscal arrangements pertaining to the exploitation of bauxite. 2.05 The implementation of the reforms was to be supported by a Technical Assistance Project (Cr. 1559-GUI) and by advisors and consultants financed by France, the IDF and UNDP. The support of the advisors was geared mainly to the banking and public enterprise reform programs, the implementation of the public service reform and reduction effort, and to the ministerial coordination body CCEF (Economic and Financial Coordination Committee). III. IMPLEMENTATION A. Monetary and Banking Reform 3.01 In a major reform in 1986 the Guinean franc replaced the syli as Guinea's currency. The currency was devalued by a factor of twelve for public transactions and by a higher rate for private sector activities, to be unified by mid-year and continuously adjusted afterwards. A weekly foreign exchange auction system was introduced, principally open to all current transactions of the private and parastatal sectors. However, the auction system - which was in fact more a fixirng by the Central Bank after receiving bids from the large foreign exchange buyers - did not capture all foreign exchange earnings from the parallel market and therefore a considerable spread remained for some time in favor of the parallel market. During 1986 and 1987 the exchange rate policy did not fully comply with the lIF's policy prescription and only from late 1988 onwards did the authorities pursue a more active exchange rate policy, which  5 was, however, hampered by the continuing internal financial disarray, part- icularly with regard to the public budget. 3.02 At end-1985 all six state banks were closed and replaced with three new majority private joint-venture banks. A fourth joint-venture bank followed in 1988. The liquidation of the state banks - being a conditi .or the second tranche release - proceeded with some irregularities and a cons.derable increase in liquidity due to the reimbursement of depositors, but was completed, though with considerable delay, by es -1,18. 3.03 Although the moneta' - .4 banking reforms, having been carried out with courage and determination by ta.- authorities, .