Mauritania - Public Enterprise Sector Adjustment Program

Document of The World Bank FOR OFFICIAL USE ONLY Rkpti No. P-5293-MAU REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT OF SDR 30.7 MILLION TO THE ISLAMIC REPUBLIC OF MAURITANIA FOR A PUBLIC ENTERPRISE SECTOR ADJUSTMENT PROGRAM May 30, 1990 TIs document has a restricted distribuon and may be used by recipilent only In tie perfonmace of thdir offichl dutie Its contnts may not otherwise be disclosed without World ank authortion.  CURRENCY EQUIVALENTS Currency Unit ougulya (UM) US$1.00 - UM 84.8 1/ UK 1 million - US$ 11,790 SYSTEM OF WEIGHTS AND MEASURES: METRIC FISCAL YEAR January 1 - December 31 1/ Exchange rate as of March, 1990  FOR OMCIAL USE ONLY ABBREVIATIONS AND ACRON YMS ADB 2 African Development Bank CRSP s Cellule de Rehabilitation du Secteur Public EPIC s Etablissements Publics a Caractere Industriel et Commercial FADES s Fonds Araoe pour le Developpement Economique et Social OPT s Office des Postes et des T6lecowunnications PANPA s Port Autonome de Nouakchott dit Port de l'Amitie SEK : Societe d'Economie Mixte SMAR s Soci6th Mauritanienne d'Assurances et de Reassurances SMCP s Socidte Mauritanienne de Commercialisation du Poisson SMCPP s Soci4t6 Mauritanienne de Conmmercialisation des Produits Petroliers SNIM I Societe Nationale Industrielle et Minibre SOMIS s Societe Mauritanienne des Industries du Sucre SONADER s Soci6te Nationale de Development Rural SONELEC s Societe Nationale d'Eau et d'Electricite SONIMEX I Societe Nationale d'Import-Export 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.  ISLAMIC REPUBLIC OF MNURITANIA PUBLIC ENTERPRISE SECTOR ADJUSTMENT PROGRAM TABLE OP CONTENTS CREDIT AND PROGRAM SUMMURY ..........s.ees.... o............. i I. THE ECONOMY ........................................ 1 A. Background ....... ... .................***..... 1 B. Government's Adjustment Program ................. 2 C. Economic and Social Impact of the Adjustment Process .................................................... 3 D. Medium term Objectives and Policies and Future Fnancing Needs ................................. 4 II TBE PUBLIC ENTERPRISE SECTOR ........................... 6 A. Sector Size and Performance ..................... 6 B. Mauritania's Experience with Public Enterprise Reforms *.... ............. .... ....... 7 III. THE PUBLIC ENTERPRISE REFORM PROGRAM ................. 13 A. Reform Objectives ............................... 13 B. Legal and Institutional Development ............. 14 C. Enterprise Rehabilitation and Restructuring ..... 15 D. Sector Rationalization .......................... 21 IV. THE PROPOSED CREDIT ....... *so* ............. .. ....... 22 A. Credit History ........................................... 22 B. Relationship of the Proposed Credit to the Reform Program ............................................... 23 C. Effects of the Adjustment Program .... .......... 23 D. Social Impact ............ .......... *. ....... 25 E. Enviromnental Impact . ........................... 26 F. Benefits and Risks .............................. 27 G. Credit Amount ................................... 28 H. Monitorable Actions, Disbursement and Procurement 29 I. Administration and Auditing ..................... 32 V. BANK GROUP OPERATIONS AND STRATEGY ................... 32 A. Bank Group Operations ....... ......... .......... . 32 B. Country Assistance Strategy ............ ... ..... 33 VI. COORDINATION WITH TH IMP AND OTHER DONORS ........... 35 VII. RECOIIENDATION .. so .......................... 35  ANNEXES Annex I Mauritania - Economic Indicators .................. 36 Annex 2 Status of Bank Group Operations ................... 40 Annex 3 Supplementary Project Data Sheet .................. 41 Annex 4 Letter of Sector Development Policy ............... 42 Annex 5 Policy Matrix .................................... 67 Annex 6 Financial Plan .................................. 71 Annex 7 Public Enterprise Data ..................... ..... 73 Annex 8 SNIM ............ .................* 75  ISLAMIC REPUBLIC OF MAURITANIA PUBLIC ENTERPRISE SECTOR ADJUSTMENT PROGRAM CREDIT AND PROGRAM SUMMARY Borrowers Goverment of Mauritania Beneficiariess SNIM and other public enterprises Credit Amount: SDR 30.7 million (U*$40.0 million equivalent) Cofinancins: Arab Donors (US$5O.O million); Spain (US$5.0 million), Germany (US$4.0 million). In addition, Mauritania has requested an amount equivalent to US$500. million from Japan. Termst Standard IDA terms, with a 40 years maturity. Description: The proposed credit would support the extension of the Government's structural adjustment program aimed at deepening the reforms in the public enterprise sector. Actions under the proposed program would include: (i) modification of the legal and institutional framework with the objective of eliminating state monopolies and facilitating increased private sector participation; (ii) a program of divestiture aimed at reducing the number of enterprises in the sector; and, (iii) financial restructuring programs for key enterprises remaining in the sector, particularly SINH, the iron ore mining company, which is by far the largest enterprise in the country. The PE Institutional Development and Technical Assistance Project, prepared in parallel with this adjustment operation, will provide support to the Government for implementation of the program. Benefits and Risks: The potential benefits of this program are substantial in that it would restore the financial viability of iron ore mining and improve public sector resource management which are essential for achieving sustainable, long term growth. The more immediate benefits will be the reduced financial burden of the sector on the Government budget and the domestic banking system and the freeing of resources for more economically productive uses. The risks associated with the program are that continued liberalization of the economy and divestiture of public enterprises would prove politically unacceptable. The difficult actions already taken, however, show the high level of government commitment to the program. Another risk is  the possibility that the adjustment program may prove too demanding for the limited capabilities of the Mauritania administration. particularly ln view of the difficulties arising from the large number of people repatriated from Senegal. The companion technical assistance project, however, is expecteu to help the Ministry of Plan implement the reform program. Another risk is the impact of the fluctuating value of the dollar and the international price of the iron ore on SNM5 s finances. To mitigate against this risk, SNEM plans to build up reserves to help tide it over any such crisis. Estimated Disbursements: The proposed credit would be disbursed in three tranches, the first at credit effectiveness - expected in July 1990 - and the rest within 24 months thereafter. Three tranches have been provided to allow for adequate monitoring of various reforms and activities that require more time to be completed. Rate of Return: n.a. Appraisal report: There is no separate Staff Appraisal Report. Map: IBRD 22261  REPORT AND RECOMOENDATION OF THE PRESVIENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED IDA CREDIT TO THE ISLAMIC REPUBLIC OF MAURITANIA FOR A PUBLIC ENWTERPRISE SECTOR ADJUSTMENT PROGRAM 1. I submit tue following report and recommendation on a proposed development credit to the Islamic Republic of Mauritania to support the Government's Public Enterprise Sector Adjustment Program (PESAP). The proposed credit for SDR 30.7 million (USS 40.0 million equivalent) would be on standard IDA terms with a maturity of 40 years. The program would be cofinanced by contributions from the Spanish (US$5.0 million) and German Governments (US$4.0 million), under the Special Program of Assistance to Debt Distressed Countries of Sub-Saharan Africa (SPA). The Government of Mauritania has also requested Japan for financing in an amount equivalent to US$50.0 million also under the SPA. Further cofinancing in the amount of US$50.0 million would be provided by Arab donors. PART I - THE ECONOMY A. Backkround 2. Mauritania is a vast country, with a population of 1.8 million and a very narrow resource base. Of the 1.1 million square km total surface area, only 0.2 percent is suitable for cropping. Moreover, agricultural production has been severely impaired by twenty years of recurrent and worsening drought. The non-agricultural resources of the economy are also limited. Iron ore mining has long represented a large part of national income, but its contribution has diminished since the late 1970's due to the downturn in iron ore prices in world markets. In recent years, fish exports have surpassed iron ore as Mauritania's largest source of export earnings. 3. As a result of declining economic prospects in many of Mauritania's rural areas, there has been substantial migration to urban centers from all parts of the country, except the Senegal valley region, where some potential for growth exists. About half of the inhabitants live in urban areas with a majority of them suffering from extremely low standards of living, as reflected in key social indicators: life expectancy at birth is estimated at 45 years; infant mortality is 132 per 1,000; only 55 percent of school-age children attend primary school, and less than 20 percent of the population is literate in either of the two official languages, Arabic and French.  - 2 - 4. Por many of the last seventeen years Mauritania's economic development has been uneven and marked by major financial imbalances. As a result of a series of droughts in the 1970, and early 19808, which led to rapid desertification, the country has become structurally dependent on food aid. At the same time, the iron ore mining sector, which was the main source of growth in the early 1970s, was heavily hit by the world steel market crisis in the second half of the decade, and the mining industry's share in GDP declined sharply. 5. While exogenous factors contributed significantly to the deterioration of Mauritania's economic and financial situation, their impact was aggravated by weak economic management. Poorly managed, overstaffed public enterprises became increasingly inefficient and accumulated heavy financial losses. The Governa nt's development strategies neglected long-term external and domestic demand constraints and intersectoral linkages, and the lack of appropriate criteria for selecting public investments resulted in projects with low or even negative rates of return. In the late 1970s and early 1980s, the Government embarked on a large public investment program financed almost entirely with external borrowing; the program channeled resources toward low-yielding projects and led to a large external debt and a heavy debt service burden. Domestic demand was sustained by an excessive growth of public expenditures, which in turn contributed to large balance of payments deficits. Price distortions and regulated markets for agricultural and industrial products discouraged the development of viabla small-scale private activity in the secondary sector and hampered agricultural development as well. B. Government's Adiustment Program 6. Against this background, the Government launt-he- an adjustment program in 1985 aimed at laying the foundation for sustained growth while at the same time restoring the balance of payments to a viable position. The adjustment effort was supported by successive stand-by arrangements with the IMF in 1985, 1986 and 1987 and, after June 1987, by an IDA structural adjustment credit of US$42.4 million, of which the final tranche was released in October 1988. Subsequently, in May 1989 the IMF board approved a three year ESAP for about US$68 million, and in early February 1990 the Bank's Board approved a credit of US$25 million for an Agriculture Sector Adjustment Operation. While civil disturbances resulted in considerable economic dislocation in early 1989, the Government reaffirmed, in late February during the appraisal of the Public Enterprises Sectoral Adjustment Operation and again during the preparatory discussions of the PPP 1990-93, its ccomitment to the adjustment program. 7. The adjustment process supported the Government's medium-term objectives of (i) reaching an annual growth rate of about 3.5 percent; (ii) containing the fiscal and external account imbalances; and (iii) preparing the basis for sustainable growth and development. At the same time, efforts were made to better identify and monitor the social impact of the country's adjustment program and to design measures to provide safeguards for the most vulnerable groups in society. Considerable progress has been achieved since 1987 in implementing structural reforms. The processing  and marketing of local cereals was liberalized and all rice mills were privatized. In the financial sector, substantial progress was achieved in reforming the legal and administrative framework. The interest rate grid was simplified and lending rates better reflect specific risks. Concerning public resource management, the selection criteria for projects were significantly improved, with the resulting projects integrated into an annual consolidated budget. In order to further promote private investment, the Ministry of Planning established a National Investment Secretary to streamline the review of applications for investments licenses and ensure their conformity with the newly introduced investment code. In the area of fisheries, a new development policy aimed at protecting fishing resources, avoiding overfishing, and increasing domestic value added is in early stages of implementation. The effect of these measures was to double the relative share of private investment in total investment beween 1985 and 1989. As a result, preliminary data indicate that real economic growth in 1989 was higher than anticipated (3.5 percent against 3.2 percent forecast). This growth has been the result of higher output in the mining, crops and livestock subsectors. C. Economic and Social Impact of the Adjustment Process 8. During the period of implenentation of the adjustment process, the macroeconomic performance of the economy was considerably better than in the immediately preceding years. Real GDP growth rose from an average of 0.2 percent per year during 1982-84 to an estimated 3.4 percent per year during 1985-89. As a result of the adjustment policies pursued, the overall fiscal deficit on a commitment basis declined from 4.5 percent of GDP in 1985 to 0.1 percent in 1989. Helped by consecutive good harvests, stable prices for the country's key imports, and strict credit control. the annual rate of inflation, measured by the GDP deflator, fell from 13.6 in 1985 to 9.0 percent in 1989. Mauritania's external position has also shown steady improvement, with food imports reduced in response to improved incentives in the agricultural sector and favorable weather conditions. As a share of GDP, the current account deficit (excluding official transfers) declined from 26.2 percent in 1984-85 to an estimated 13.6 percent in 1989. 9. During this period, the Mauritanian economy witnessed a shift towards a more decentralized and market-oriented structure, with improved efficiency in public resource management. Quantitative import restrictions and price controls have been mostly removed so that prices move more freely with supply and demand. There is today much more private activity in all economic sectors especially in processing and marketing of agriculture commodities and in fisheries. Strict budgetary discipline reversed the consolidated government deficit (including foreign- nanced investments) from -1.8 percent of GDP in 1987 to a surplus of 2.3, percent of GDP in 1989; the number of civil servants was frozent and public investments were cut from 22.6 percent of GDP in 1985 to 10.3 pertent in 1989. Interest rates were kept positive in real terms, monetary policy was restrictive and credit to the Government was maintained at its 1984 level through that period.  10. The need to take specific actions to mitigate the social costs of adjustment in the short term was recognized by tne Government from the beginning. Food aid and food-for-work programs have been an important element in helping the most vulnerable groups in Mauritania to cope with the social cost of adjustment. Furthermore, despite budgetary constraints, the Government has protected basic social services, namely education and health. Measures were also taken to increase employment and mitigate the hardships of unemployment, espauially thosv brought about by the implementation of specific adjubtment measures such as administrative reform and the restructuring of public enterprises and cosuercial banks. Furthermore, a Reinsertion Fund (FIRVA) was created with the aim of helping young technicians and former civil servants to start small business operations. Under the program, retrenchcd workers were provided with employment counsellingt access to training and financial assistance for the establishment of small businesses in priority sectors. 11. A 'Priority Action Program' (PAP) identifying a number of short term projects targeted to the most vulnerable social-economic groups was prepared under the SDA initiative. These projects included cowunity development initiatives, labor intensive actions at the municipal level, health and nutritional actions, urban housing alleviation and micro- enterprise initiatives. Following the civil disturbances with Senegal in mid-1989, the Government prepared a two-year Reinsertion Program to assist the estimated 160,000 returnees from Senegal to reintegrate themselves into the Mauritanian economy. The PAP has been integrated in the Government's reinsertion program, which is being financed with donor support, and would provide returnees with training, and credit programs to assist them in finding economic employment. D. Medium Term ObJectives and Policies and Future Financing Needs 12. Mauritania's third PFP which covers the period 1989-91 was presented to the Committee of the Whole in May 1989, and Bank and Fund staff are currently assisting Government in the preparation of a fourth PFP for the period 1990-93. The PFP policy reform program, if implemented in a full and timely manner, should permit the continuation of the levels of economic growth and adjustment progress which have marked recent years. Real GDP would grow at an average rate of about 3.0 percent over the period 1990-93. In response to the more favorable investment climate generated by recent reforms, private investment would increase gradually from the 1989 level of 5.3 percent of GDP to almost 8.0 percent in 1993, and public investment would rise from 11.4 percent in 1989 to 14.7 percent of GDP in 1993, primarily as a result of new inveetment in the mining sector. Imports of goods and non-factor services would increase from 55 percent of GDP in 1989 to 57 percent of GDP in 1993. This is due to stabilizing the level of food imports and expected increases in imports of intermediate and capital goods as a result of restructuring the public enterprise sector and improvement in the incentive system. Exports of goods and non-factor services are expected to decrease from 49.3 percent of GDP to 45 percent of GDP over the same period. This is a result of a projected 10 percent fall in iron ore exports in 1992 due to lower iron ore production and slow expected growth in fish exports until 1992193 due to current operational  5- difficulties. Mauritania's financial requirements during the period 1990- 93 are shown in the table belowt Ikuritenie - Extrnal Financing (UNe milI Ion.) 190 191 1992 1998 1990-1998 Current Acount Dit Ist 1/ 12-.? 178.6 180.4 18.6 "0.2 (excluding inter, public transfd") Increase In Reserve 2/ 10.5 10.0 22.6 21.0 09.7 Scheled Debt Service 175.9 19860 204.5 178.1 762.1 multi laterlsl 60.4 70.4 86.? 51.7 250.2 World Dank 10.6 19.7 27.? 10.9 74.8 I81R 14.8 17.3 24.9 7.9 64.4 IDA 2.2 2.4 2.8 8.0 10.4 Iw 19.5 1.8. 9.6 7.4 51.8 Repurchese 14.5 12.0 7.t 5.9 40.8 Charge 4.0 t.0 2.0 1.5 10.5 "on-Multi lateral. 97.7 112.0 109.0 114.0 488.8 Arrears Payment 9.8 0.0 0.0 0.0 9.8 Gross Financing Requirnt 318.1 888.2 412.5 376.2 1492.0 Debt Rell Agreed Through 1969 12.6 0.0 0.0 0.0 12.6 Expeted Debt Relief t/ 35.6 76.0 U88. 78.0 267.1 Requir ement After bDt Reletd 205.1 818.2 828.9 805.2 1212.4 Projected External Financing 202.4 250.0 288.8 220.0 914.5 Invetunt ProJet. 110.0 177.0 178.6 177.3 650.0 Grants 29.6 88.7 41.5 48.5 158.8 Loans 66.4 130.8 187.0 138.8 497.5 Of which SUWI 81.5 06.4 57.0 50.0 204.9 Adjustrent Financing 11.0 11.0 0.0 0.0 22.0 Grent. (otinancing) 2.0 2.0 0.0 0.0 4.0 Loans 9.0 9.0 0.0 0.0 18.0 of whIch IDA 4/ 9.0 9.0 0.0 0.0 16.0 IMF ESAF 22.0 22.0 11.0 0.0 65.0 Direct Foreign Investment 3.7 4.0 4.5 4.5 16.7 Food Aid, Grants In Kind 47.7 44.0 89.8 89.0 170.0 Financing Gap (- Indicates surplus) 02.7 55.2 95.6 64.4 297.9 1/ naeuming fish experts stabilize at the 1968t leel 2/ increao roeervo to 8 months of Imports by 1998 8/ reschedling of all Arob bilateral debt 1991-1998 4/ excluding the propoeed credit 13. As shown in the table above, the cumulative capital requirements during the period 1990-93 are projected at US$1492.0 million. This comprises US$670.2 million of current account deficit (excluding public transfers and interest payments), USS752.1 million of public debt service (including IMF repurchases), and a US$69.7 million increase in reserves to reach a level of three months of imports. Given the high debt service ratio in Mauritania, around 35 percent in 1990 and 1991 before rescheduling, it is likely that the country will receive additional debt relief, particularly from Arab creditors, having benefited from the Dakar  initiative and other debt forgiveness in 1989. Debt relief is expected to amount to US$267.1 million between 1990 and 1993. 14. Mauritania expects to continue to receive substantial amounts of foreign assistance on concessional terms from traditional multilateral and bilateral creditors to finance external requirements of US$914.5 million for 1990-93. Such assistance would be mainly in the form of project, and nonproject, food, and commodity aid. Disbursements against existing and expected comuitments of official grants and medium and long-term loans from bilateral and multilateral creditors excluding the proposed operator, are projected to total about US$727.8 million during 1990-93. These disbursements include (i) US$55 million from the IMF under the ESAF; (ii) adjustment financing of US$22.0 million, including US$18 million from the IDA AGSECAL and US$4.0 million in cofinancing from other donors and (iii) US$650.8 million for investment projects. Taking direct foreign investment and food aid into account, there remains a financing gap of US$297.9 million which would be financed through further debt relief, additional official grants, and additional concessional loans from bilateral and multilateral donors, Including IDA. The proposed credit would fill approximately 162 of ttk 1990-93 financing gap. PART II - THE PUBLIC ENTERPRISE SECTOR A. Sector Size and Performance 15. After independence, Mauritania pursued a deliberate policy of parastatal intervention to promote economic development. Such a policy was viewed as essential, given the underdeveloped nature of resources and markets and the absence of investible funds and entrepreneurial skills. As a result, the parapublic sector grew rapidly in the 1960 and early 1970s. Mauritania now has 80 public enterprises (Annex 7), of which 22 are of a non-ccmmercial nature. 1/ The remaining 58 public enterprises, 40 of vhich are majority owned by the Government, are involved in virtually all economic sectors. They account for more than half of public investment, and receive almost one-fifth of the credit disbursed through the domestic banking sector. The PE sect-r also employs more than one-fourth of the modern sector workforce, or provides for about 12,000 jobs. 1/ These 22 institutions classified as public enterprises are mostly professional and administrative organizations. They include schools, the university, a hospital and the offices of statistics, agriculture, fisheries and geological research. They received about US$19 million in subsidies in 1988 and will continue to be funded at that level by the public budget for the foreseeable future.  - 7 - 16. Twelve enterprises account for over 95 percent of 8818e and about 75 percent of employment in the sector. 21 Overall PE sector performance reflects the performance of these large enterprises. It has been characterized by high losses, mounting arrears, a rising debt burden, increasing illiquidity, and reliance on monopoly privileges. (See para 31) The causes of poor performance have been rapid changes in the external environment, poor investment choices, weak management, lack of financial discipline, and inappropriate and ill-defined relations between the Government and the PEs. B. Mauritania's Experience with Public Enterprise Reforms 17. The Government's medium-term adjustment program, initiated in 1985, included important reform initiatives specifically aimed at improving the performance cs public enterprises and encouraging private sector activity. These initiatives were supported by a Structural Adjustment Credit (Cr. 1812 MAU), a Rehabilitation Project for SNIM, the iron ore mining company (Ln.2643-MAU), a Rural Sector Technical Assistance Project (Cr. 1414 MAU), and a Public Enterprise Technical Assistance and Rehabilitation Project (Cr. 1567-MAU). Reforms were undertaken in five main areas: (i) improvements in the legal and institutional framework for the public enterprise sector; (ii) revisions in the incentives policies; (iii) restructuring of the banking sector; (iv) rehabilitation of individual enterprises; and (v) introduction of other measures to rationalize and improve the efficiency of the sector. These are further discussed below. 18. Institutional and legal framework. Important improvements in this area were introduced in 1984 and 1985. First, a law was approved that clarified the legal status of the public enterprises and the responsibility in the Government for supervision and control. Public enterprises were reclassified in three distinct categories: professional and administrative enterprises (EPA); industrial and commercial enterprises (EPIC); and enterprises of mixed public--private ownership (SEM). Second, all EPIC's and SEM's were required to keep their accounts in conformity with a new budgetary and accounting system ('Plan Comptable National,) and report their financial results on a quarterly basis to a special division in the Ministry of Finance, in charge of monitoring the financial performance of the PE sector. Currently about 30 enterprises, including all major ones are reporting regularly, but the speed of reporting and quality of data needs to be ixproved. Third, a special unit, *Cellule de Rehabilitation du Secteur Public" (CRSP), was created to oversee specific parastatal reform programs. This unit also undertook several studies, financed by IDA, on PE salary policy and structure, budget procedures, information systems, and training. Finally, under the SAL, two enterprises were required to conclude performance contracts ('contrats plan') with the Government, 21 Tne twelve most important PEs, in terms of sales and employment, are SNIM (iron ore), SMCP (fish exports), SONIMEX, (imports of tea, sugar and rice), MAUSOV (fisheries). SMCPP (petroleum distribution), SONELEC (water and electricity utility), OPT (post and telecommunications), PANPA (Port of Nouakchott), AIR MAURITANIE, ALMAP (fisheries), SOMIS (sugar processing) and SMAR (insurance).  specifying the objectives assigned to them, respective obligations of the management of the enterprises and the Government to achieve these objectives, and the criteria for monitoring the performance of the enterprises. The first of these performance contracts was signed in February 1989 with the power and water utility, SONELEC, which has yielded some good results. 19. Incentive policies. Mauritania's reform program included specific measures to improve the structure of incentives facing both public and private enterprises. The number of industrial and comercial imports subject to price controls has been reduced by two thirds, with remaining price controls planned to be abolished during 1990. Moreover, the number of locally manufactured products subject to price certification has been cut from nine to three. Government has also abolished import licenses and import quotas and has begun implementing a second phase of its tariff reform. A new Investment code adopted and implemented together with the new tariff code in 1989, streamlined investment licencing procedures and encouraged labor intensive and export oriented industries and created a one-stop window to process applications for new investments. A particularly encouraging development was the private sector response to the recent liberalization in the cereals subsector. The private sector is rapidly replacing the public sector in land development for agriculture as well as in the production, processing and marketing of cereals. The role of the cereal marketing board (CSA) has been redirected to include only the distribution of food aid and direct purchasing in isolated areas where no private sector alternative exists. 20. Banking reforms. Beginning in 1985, and under the SAL, the Government and IDA agreed on a banking reform program which focussed on three main areas: (i) reforming credit policies and bank regulations; (ii) strengthening of the Central Bank; and (iii) restructuring four (government owned) of the seven commercial banks. Overall progress on the banking reforms has been satisfactory. A new banking law has been enacted, prudential banking ratios are being applied, a new and uniform accounting plan has been established, the Central Bank's supervisory function over the commercial banks has been reinforced, performance contracts for each of the commercial banks have been prepared, and the collection of loans in arrears has improved. With respect to the restructuring of the four ailing banks, one has been fully privatizised, another has been merged with a government fund and the new bank has now signed a twinning contract with a foreign bank. The two other banks have been merged and the Mauritania private sector has already subscribed to 22 percent of the equity of the merged bank. These reforms give the banks the autonomy they need and are expected to remove one of the main props supporting inefficient public enterprises. It would also make greater credit available for productive investments. 21. Enterprise rehabilitation and restructuring. Since 1985, five public enterprises have been the target for programs of physical and financial rehab'litationt the iron ore mining company (SNIM), the power and water utility (SONELEC), the postal and telecommunications agency (OPT), the port of Nouakchott (formerly EMN, now PANPA) and a rural development agency (SONADER).  22. Rehabilitation of SNIK. Iron ore mining In Mauritania began in the mid-1960. with the successful development of a high-grade iron ore deposit (Kedia) in the northern part of the country, financed in part with a US$66 million Bank loan. Faced with the gradual depletion of this deposit. SNIM in the early 80. undertook the development of a large new low-grade iron ore deposit (Guelbs), that was expected to ensure its long- term future. (More detailed information on SNIM is provided in Annex 8). Unlike the Kedia ore, the Guelbs ore needs to be upgraded to be marketable. The upgrading i. done in a beneficiation plant, which uses a uniqua, dry magnetic separation process. The Guelbs project, consisting of a mine, beneficiation plant and associated infrastructure was completed at a cost of US$500 million and supported by financing from several donors, including the Bank with a loan of US$60 million. 31 The processing of Guelbs ore, which began in 1985, has been plagued by technical problems. The plant's present output is only about 2.0 million tons a year, or 33 percent of its design capacity. In 1985, supported by a Bank loan of US$20 million, SNIM undertook a major rehabilitation program to reduce costs and improve the company's organization and management. SNIM's workforce was reduced 11 percent when 1,000 workers were laid off in March 1987, cutting overhead costs by about 30 percent. As a result of these cost reduction measures and productivity improvements, SNIM's average unit cash operating costs are about US$9.5 per ton of iron ore, a level comparable with its major competitors and about 20 percent lover than 5 years ago. 23. Despite these rehabilitation efforts, SKIM's financial position has not improved as expected, because of low iron ore prices, the decline in the dollar's value, and SNIM's inability as yet to put its Guelbs plant an full production. In current ECUs, the price of iron ore was 40 percent lower in 1983 than in 1985. SNIM's sales contracts are denominated in dollars, but about two thirds of its supplies (from Europe) and half of its total outstanding external long-term debt of US$340 million equivalent (mainly for the Guelbs project) are denominated in currencies other than the dollar. 41 In 1988, SNIK operations generated a cash flow of about US$31 million but its debt service was about US$53 million resulting in a cash deficit of about US$22 million, as can be seen in the table below: 31 To reduce their financial risk, the Bank and its co-lenders, established a security system by which proceeds from the sale of iron ore are channeled into a trust fund and allocated as a matter of priority to debt service payment. 41 Although SNIM has made payments totaling about US$40 million on the US$60 and US$20 million Bank loans, the current value (April 30, 1990) of debt outstanding is still about US$54 million.  - 10 - SNIMi Selected Indicators and Ratios 1987-1989 1987 1988 1989 Sales Volume (million tons) 9.0 10.0 11.1 Average Ore Revenue, US$It 15.1 13.7 5.5 Average Cost of goods, US$It *1 11.2 10.7 9.5 ............ .. . USS million. Total Revenues 145.7 145.3 183.5 Total Production Costs Sl 122.3 122.6 159.6 Net income (11.8) (4.9) 3.5 Gross Internal Cash Generation 38.4 31.0 77.8 Debt service 62.0 53.2 56.6 Net Internal Cash Generation (23.6) (22.2) 21.2 Investments 20.1 16.1 33.4 Accumulated Cash (12.3) (18.5) (10.3) Ratiost Current Ratio 0.7 0.6 0.7 LTD Debt Equity Ratio 1.7 1.6 1.4 Debt Service Ratio 0.6 0.6 1.4 *f before depreciation and interest In 1989, because of increased sales, productivity improvements and substantial debt relief, SNIM's recorded a modest net profit but its financial situation remains nonetheless critical. The various security and trust arrangements put in place for the Guelbs project in 1979, have assured that debt service payments to lenders were promptly met. But to accomplish this SNIM had to resort to overdraft financing and has been rapidly building up its accounts payable to be able to continue operations. By the end of 1989, SNIM's current ratio was still only 0.7 and its current liabilities had risen to US$134 million (excluding the current portion of long-term debt), of which about two-thirds represented bank overdrafts and money payable to suppliers, insurance companies, and the Government in social security dues and worker-retained income taxes. 24. Rehabilitation of other key public enterprises. Early in the 1980's, essential public services in Mauritania neared collapse because of years of neglect, poor maintenance, deficient financial management, and inadequate tariffs. Emergency rehabilitation programs were prepared for thrt key enterprises -- SONELEC, OPT, and EMN --and included as part of the Public Enterprise Technical Assistance and Rehabilitation Project (Cr. 1567-MAU) financed by IDA in 1985. S/ The increase in production cost in 1989 is because of an increase in the depreciation charge for the Guelbs plant, following a management decision, that 1989 was to be considered as the first year of commercial production.  - 11 - 25. Water and power. In the cities of Nouakchott and Nouadhibou, SONELEC's water and electricity generating and distribution networks have been upgraded and services restored. Significant progress was made in upgrading SONELEC's accounting and computerized billing systems. Accounts were adjusted on the basis of external audits and SONELEC's accounts receivables that were uncollectible were written off. Staffing was reduced 10 percent and tariffs for water and power were raised 35-40 percent. With the assistance from the ADB and FADES, SONELEC recently commissioned a new 28 MW plant in Nouakchott, which will help reduce further operating costs and in the long run, reduce tariffs. The performance contract that was signed between the Government and SONELEC in February 1989, clarifies and rationalizes their financial relationship, in particular with regard to SONELEC's long term debt, the need for a capital increase and Government's obligation to pay for water and electricity services. It also virtually eliminated government interference in SONELEC's daily operations. In 1989, SONELEC met the objectives set for billing and collection and savings in the order of UM 300 million were realized. As a result, operating losses were reduced from UM 536 million in 1988 to UK 182 million in 1989. It is expected that SONELEC will receive an operating subsidy for the last time in 1990, and that thereafter, would operate without direct or indirect Government subsidies. 26. Port facilities. The PE Technical Assistance and Rehabilitation Project concentrated on providing equipment and technical assistance and improving the financial position of the port au':hority responsible for the existing wharf in Nouakchott (EMN), while a new deep-water port was under construction with assistance of the People's Republic of China. EMNNs staff was cut 25 percent, tariffs increased 25 percent, working methods improved (by revising shifts and work hours), and productivity more than doubled. As a result, EMN showed a profit in 1987 and paid off its accumulated arrears. In the same year, the Government decided to create a new public enterprise (PANPA) to operate both the old wharf and the new deep-water port, which had started operations. The transition did not go smoothly. Rather than transferring part of personnel from the old wharf to the new port, an entire new staff was recruited. As a result of over staffing and inefficient stevedoring, PANPA suffered a net loss (after depreciation and financial charges) of UM 199 million in 1988 and an estimated UM 2/0 million in 1989. 6/ 27. Post and telecommunications. So far, efforts under the PE technical assistance project to improve post and telecommunications services have been modest, and were aimed mainly at the introduction of a new accounting and budgeting system, including the separation of telecommunications and postal accounts. While in this area reasonable progress has been made, the implementation of other elements of the rehabilitation plan approved in 1987 has suffered. The review of the 6/ A preliminary analysis has shown that it is more economical to rehabilitate the old wharf rather than modifying the new port facilities to enable it to handle small vessels that carry a large part of the general cargo to the capital. The rehabilitation costs are estimated at about US$4 million and is expected to be financed by the European community.  - 12 - organizational and personnel needs of the company has not yet started and introduction of a new computerized accounting and budgeting system is facing problems because of acquisition of inadequate and incompatible software. Much remains to be done in separating the accounts between the postal and checking systems and the postal savings bank, on improving bill collection and coordinating OPT's investment projects. Moreover, OPT has been asked by the Government to implement a number of investment projects which are not viable, although OPT is expected to service the debt associated with these investments. 28. Rural development. Under the Rural Sector TA Project, a first phase restructuring of SONADER was undertaken in 1985 with a view to streamlining operations and divesting functions that could more appropriately be handled by the private sector. A second phase will be undertaken under the agriculture adjustment operation recently approved by the Board (February 1990), which will include reducing current expenditures and reinforcing its investment selection practices. SONADER has already reduced staff by 10 percent and increased water charges for irrigation by 15 percent with a view to completely recover 0 & H costs in the future. 29. Sector rationalization. Besides making efforts to rehabilitate the utilities, the port and the rural development agency, the Government in addition, prepared a rationalization plan for the sector which was only partially implemented. Operating subsidies to PEs were reduced and arrears of some PEs were paid. The Government monopoly on the import and distribution of pharmaceutical products was eliminated and the private sector has effectively taken over this function. Similarly, the State's monopoly on the import and distribution of petroleum products and urban and inter-urban passenger transport was abolished. 30. While the full impact of the above reforms will be not known for some time, it is already clear; (i) that the benefits resulting from the reforms undertaken have been overshadowed by the problems facing a few enterprises in the sector, such as SNIM; (ii) that there are still major weaknesses in the legal and institutional framework that need to be addressed; and (iii) that more drastic measures are needed to rationalize the sector if it is to function efficiently and profitably. 31. Inadequate data preclude a complete assessment of the sector's financial performance since 1984, but operating results of a number of the more important PEs show that more than 60 percent of the public enterprises incurred losses in 1988. Aggregate losses in 1988 exceeded US$25 million, of which three enteprises, including SNIM accounted for US$16 million of the losses. Moreover, half of those enterprises showing any profits, were less profitable in 1988 than in 1987. Even more alarming is that a large number of companies have their equity capital totally eroded, including enterprises that are of crucial importance to the economy. To cover expenses, number of enterprises resorted to short-term loans from local banks further aggravating their financial situation as well as that of the banks. The PE sector has, moreover, contracted a considerable amount of external debt (US$520 million), or about one third of the public and publicly guaranteed obligations, of which SNIM alone accounted for US$338 million. In fact, PE debt increased from 10 percent of public debt in 1983 to over 30 percent in 1988. Because of their poor financial performance,  - 13 - some PEs have besn unable to service these debts. This is an increasing problem for the Government because of the constant devaluation of the OuguSya. Results of a cross-debt study show PEo owing considerable sums (over US$40 million) to the Government, banks, and suppliers. Public monopolies -- such as SONIMEX (rice, tea, and sugar imports) and SMCP (fish exports) -- have been collecting important amounts of import and export taxes (tM5.9 billion In 1989 or about US$71 million) but it is increasingly evident that these Government revenues might have been higher and raised at less cost to the economy without going through a monopoly. PART III - THE PUBLIC ENTERPRISE REFORM PROGRAM 32. Given the continued financial disequilibria in the sector, the Government has formulated, in consultation with IDA, a Public Enterprise Sector Adjustment Program (PESAP). This program is embodied in the Goverwoent's letter on Sector Development Policy (Annex 4), key features of which are summarized below and in matrix form in Annex 5. A. Reform ObJectives 33. The primary objective of the Government's Public Enterprise Sector Adjustment, Program is to extend and deepen the ongoing reform efforts, by completing the basic policy reforms that were supported by the SAL and the PR technical assistance and rehabilitation project, and to undertake other needed actions. These actions specifically aim: (i) at fundamentally modifying the legal and institutional framework governing the sector so that privatization of public enterprises would be facilitated, more autonomy would be provided to enterprises and financial control would be improved; (ii) financially restructuring key enterprises, including SWDM, and Air Mauritanie; and, (iii) substantially reducing the state role by privatizing and liquidating public enterprises and eliminating the state monopolies. 34. At the end of the reform period, the public enterprise sector ic expected to comprise of the utilities, the ports and those industrial and commercial enterprises which have been financially rehabilitated, such as SNIM and Air Mauritania, as well as those enterprises that would be operating on a profitable basis without subsidies or privileged access to credit. As a result, losses that characterized the sector are expected to disappear, internal and external debt reduced. arrears eliminated, the number of people employed by the sector diminished, liquidity of the banking sector restored, and in the longer run, tax receipts from the sector increased. Similarly, state monopolies will have been suppressed, thereby incressing competition and efficiency in the trade, insurance and petroleum products distribution sectors.  - 14 - B. Legal and Institutional Development 35. Adoption in 1984 of a PE law was an important step in the right direction. Experience with the law over the years, however, revealed weakness in several areas, in particular with respect the classification of enterprises and the relationship between the Government and the PEs. Prior to credit negotiations, this law was substantially modified to allow for increasing degrees of autonomy and to further streamline the relationship between the State and the enterprises. Six EPICs have been reclassified as EPAs because of the non-commercial nature of their activities. A new category of public enterprises has been created known as societe nationale (SN), consisting of those companies whose share capital is wholly owned directly or indirectly by the State. This category, which comprises of commercially oriented companies, such as the post and telecommunications agency, and the water and power utility, is designed not only to give more autonomy, but also to serve as a launching pad for the privatization of state-owned enterprises, since shares can be sold to the private sector without further approval from the Council of Ministers or the Government. (See Annex 7) The statutes of the enterprises affected will be modified not later than December 31, 1990. 36. The revisions to the law also put an end to the practices whereby management decisions within state-owned enterprises were, as a matter of routine, subject to prior approval by Ministers. The modifications to the law substitutes a more flexible procedure whereby only a specified number of acts and decisions of state enterprises are subject to state control. For the SNs and the majority Government owned SEHs, a priori approval of the ministry concerned is required only with respect to the composition of the procurement committee, the investment program, the medium term plan and If a performance contract is to be signed. Similarly, the law drastically limits the number of instances in which the State can interfere in the management of the enterprises. Thus, the Government will exercise its influence on policy and operations, like any other shareholders, through its representation on the board of directors. Also members of the board of directors will be appointed on the basis of their personal competence and knowledge of the activities of the enterprises rather than their function. Responsibility for daily operations will be delegated to the General Manager. Finally, performance contracts, (tcontrats plan') will be signed between the Government and public enterprises to further define their relationship. In view of the progress achieved in case of SONELEC, the Government has agreed as a condition of disbursement of the second tranche, to sign performance contracts, satisfactory to IDA, with Air Mauritanie and PANPA and to continue implementation of OPT's Rehabilitation Plan. As was the case for SONELEC, it will specify objectives, list obligations of both the Government and the enterprise as well as specify performance criteria. As a condition of third tranche release, a performance contract will be signed with OPT to allow it to carry out its financial restructuring and to ensure implementation of the updated rehabilitation plan. Within that framework it is also envisaged to create a subsidiary that would combine the national savings bank and postal checking services of OPT in order to facilitate financial transactions and mobilize savings in outlying areas not served directly by the banking system.  - 15 - 37. While financial control of the EPA's will be exercised following normal Government budgetary control procedures, all other PE's are obliged to submit their budgets and accounts (which are to be kept in accordance with the *commercial Mauritanian accounting system) to a special division in the Ministry of Finance, which is responsible for monitoring financial performance of the public enterprise sector. To enable it to perform better, the information system within the Ministry of Finance will be improved, and the Ministry will assist the remaining PEs with the introduction of the new accounting system and budgetary procedures. The latter will be extended to all PEs before December 31, 1990. Towards the end of 1991, the system will be evaluated to ensure its effectiveness in responding to the Government's need for PE data. The new procedures, together with strict enforcement of the requirements for timely submission of audited financial statements and closer scrutiny of the investment budgets, is expected to increase financial discipline in the sector. C. Enterprise Rehabilitation and Restructuring. 38. While substantial progress has been made on the physical rehabilitation of the iron ore mining company (SNIM) and the water and power utility (SONELEC), and some improvements achieved in the post and telecommunications organization (OPT) and the port of Nouakchott (PANPA), the financial problems of these and other strategic enterprises are only now being fully addressed. 39. SNIM. Despite the important efforts at rehabilitation, SNIM's financial position remains critical. Its cost savings measures have enabled it to generate a substantial positive cash flow from its operations over the last three years, but because of debt service obligations (mainly on Guelbs related debt) its net internal cash flow was negative in 1987 and in 1988. Only in 1989, because of continuing productivity improvements and debt relief from France amounting to about US$ 13 million, SNIM's net internal cash generation amounted to USS 21 million. Thus, for the first time in years, SNIM recorded a modest profit of US$3 million in 1989. 40. Although SNIM's financial performance has recently improved, its financial situation remains critical, with current liabilities amounting to US$ 134 million and its current ratio at 0.7. The past rehabilitation efforts supported by the Bank and other donors have focussed on SNIM's productivity improvements and the implementation of the action program for the Guelbs plant. Lenders have very much supported SNIM's rehabilitation efforts by providing financing for improvements and rationalization of production capacity at relatively concessional terms. However, despite the good progress with the implementation of the productivity improvements and other measures, SHIM's survival in the long-run is still not assured. 41. Prospects for SNIM's continued operations in an economic fashion have brightened with the discovery of a high grade iron ore body at nearby M'haoudat which in 1994 would replace the depleting reserves of Kedia. Development of this deposit, together with increased production at Guelbs would allow SNIM to produce about 10 or 11 million tons of iron ore a year for the next 15 years. It is at the same time vital that SNIM be financially restructured, so that it can sell iron ore at prices that are  - 16 - competitive internationally. The objective of the financial restructuring is to generate a level of cash resources to ensures (i) adequate level of mining operations with reasonable levels of working capital; (ii) the retention and recruitment of qualified and experienced xanagers and staff, including expatriates; (iii) that debt service obligations are met and that expensive long-term debt is reduced; and, (iv) that SNIM can make a reasonable contribution to its future investments. including K'haoudat. These actions which are described In detail in Annex 8 are further discussed below: 42. Guelbs production and other productivity improvement. While the Guelbs mine is a modern low cost and efficient operation, which from the beginning produced as planned, the availability of the beneficiation plant has only reached 33 percent. Extensive pilot plant testing and careful engineering have not been able to avoid errors in designing the plant's process, in particular in relation to the big dry grinding mills, the heart of the Guelbs plant. Key equipment has shown mechanical and electrical failures in excess of normal expectations. These are risks inherent to similar projects in the industry, in particular if a prototype process and plant is involved 7/. In addition, dust generation at the mills and major transfer points became a major hazard for plant operation. With assistance from experts, who played a key role in starting Carrol Lake, the only other plant comparable to SNIH's, an appropriate action program was formulated, which is currently being implemented. The program includes steps to reduce dust leakages, modification of the mill air circuit, better mill load control, as well as changes in material flows. SNIM has also made wide ranging managerial changes. As a result of these actions, which will be completed by mid 1991, it is expected that at least SOX of the plant availability and the hourly throughput rate, as originally envisaged in 1979 during the project appraisal, will be achieved. Apart from the implementation of the Guelbs action program, SNIM is looking for further possibilities to improve maintenance, spare parts management and purchasing. SNIM also intends to engage the services of investment bankers to help them deal effectively with changes in exchange rates, iron ore prices and interest rates. 43. M'haoudat. The development of the M'haoudat mine is needed to replace the depleting resources at Kedia and allow SNIM to maintain its production level at a rate of 10 to 11 million tons per year. Reserves at M'houadat are estimated to be a minimum of 80 million tons and the cost of developing the mine is estimated at about US$ 160 million, including physical and price contingencies. The feasibility study on the project has been audited by a well known mining consulting firm which found the exploration and preparation work compatible with accepted international standards. Geology, mining methods, ore crushing and handling are very similar to the Kedia operations for which SNIM has accumulated vast 7/ Dry grinding mills similar to SNIM's are only existing at Carrol Lake, in Canada, where it also took a relatively long time to reach full production. At the time when the Guelbs plant was designed, Carrol Lake was in the start-up phase. A full transfer of experience was therefore not possible.  - 17 - experience and demonstrated good managerial capabilities. Based on present iron ore price projections and conservative assumptions on production, implementation delays and operating costs, the economic rate of return on the project is calculated at 12 percent. A drop In iron ore prices by 5 percent would reduce the rate of return to 9 percent. An increase in production of the mine to 7 million tons per year, which is feasible, increases the return to 16 percent. During a meeting of cofinanciers in February 1990, Arab, French and European dono.s and the African Development Bank have indicated their willingness to support the development of the project by providing the necessary financing. Implementation of the project is expected to begin in 1991. 44. Financial restructuring. The objective of the financial restructuring, of which the principles were approved in a donors meeting held in Paris on February 28 end March 1, 1990, is not only to ensure that the financial burden resulting from the difficulties of the Guelbs iron ore project are substantially reduced by providing further debt relief, but also to restore SNIM's working capital position and enable it to maintain its current production levels in the long-run. The financial restructuring takes therefore into account the need for SNIH to make a substantial contribution (about US$34 million in 1990 dollars) towards the cost of the new M'haoudat mine. This is essential for maintaining SNIM's debt service and debt equity ratios at acceptable levels in the long-run. The need to maintain these ratios has been one of the principal factors for determining the amount of additional financing required. Apart from the continued emphasis on productivity improvements, the proposed financial restructuring would be achieved through a combination of: (a) debt relief from France and Japan; (b) capitalization by the Government of past taxes and other liabilities; (c) an increase in SNIM's share capital; and (d) the provision of a restructuring loan at relatively concessional terms. While France and Japan have agreed to provide substantial direct debt relief and debt rescheduling, SNIM's remaining creditors which are mostly multilateral and include IBRD, EIB, ADB and various Arab funds cannot do so. Hence, the Government has agreed to provide SNIM a part of the local currency counterpart funds of the proposed PESAP as equity contributions. Also, the Arab donors have agreed to provide assistance equivalent to TJS$50 million to the financial restructuring. A condition of credit effectiveness is the signing of a financing agreement between the Government and SNIM satisfactory to IDA. The proposed capital increase and restructuring loans will enable SNIM to eliminate its short term debt and retire some of its most expensive long term debt prior to maturity. The proposed financing plan for SNIM's financial restructuring, part of which has already been provided in 1989, is as followst USS million Provided in 1989 ProRosed 1. Japanese debt relief and rescheduling - 21.7 2. French debt relief and rescheduling 12.6 29.2 3. Government tax capitalization 7.8 4. Other Government capitalization 8.2 5. Restructuring loan from Arab funds 50.0 6. Capital increase 69.0 28.6 169.9 Grand Total 198.5  - 18 - In addition, avoided interest costs as a result of debt cancellation amount to US$ 7.8 million for the Japanese loans and UJS$ 12.3 million for the French loans over the period 1989 to 2005. SKIM would first use the available funds to normalize its working capital situation. This would include paying off its bank overdraft and settling of the the remaining obligations to the Government, and allow SKIM to bring its credit from its supplier to normal industry standards (initially 90 days, there after 60 days). The additional equity would also ensure that SKIM would continue to be in a position to service its remaining long term debt and provide it with a hedging cushion against foreign exchange and other risks. It is currently anticipated that about US$15 million of SNIM's *cash reservet, be used to retire in 1991, prior to maturity some of its long term debt, which was provided at relatively high interest rates. Other loans with relatively high interest rates (loans from the IBRD, EIB and ADB) will be fully repaid by 1994. The donors concerned have agreed to the principle of prepayment of part of the relatively expensive long term debt, but formal approval needs to be obtained by SNUM. A larger prepayment of debt might be desirable if SNIM's financial situation has improved more than currently anticipated. 45. As a result of the implementation of the above interdependent actions, SN3M's financial health will be restored and the economic life of iron ore mining in Mauritania will be substantially extended. SNIM's current ratio would increase from 0.7 in 1989 to 3.8 in 1995, while its debt equity ratio would go from 1.4 to 0.9 in the same period, as can be seen in the table below: SNIM Selected Indicators 1989-2000 1989 1990 1991 1992 1995 2000 Sales Volume (million tons) 11.1 11.0 11.0 10.0 10.0 10.0 Average Ore Revenue, USS/t 15.5 16.1 15.7 15.3 14.0 14.3 Average Costs of Goods Sold a/9.5 9.8 9.9 10.5 11.0 11.5 ...# ....... Constant US$ million.... Total Revenues 183.5 185.6 181.8 162.0 147.8 150.5 Total Production Costs 159.6 149.4 147.7 142.0 151.1 148.5 Yet Income (loss) 3.5 19.9 18.7 4.8 (15.3) (5.4) Gross Tnternal Cash Generation 77.8 78.0 72.6 56.5 37.4 35.3 Debt Service bI 56.6 77.2 62.6 48.6 29.6 32.3 Net Internal Cash Generation 21.2 0.8 10.1 7.9 7.7 3.0 Investments 33.4 31.3 66.4 57.5 7.0 5.0 Accumulated Cash (10.3) 1.0 11.0 23.5 34.8 28.9 Ratios: Current Ratio 0.7 1.4 2.6 2.7 3.8 3.1 LTD Debt Equity Ratio 1.4 0.9 0.9 0.9 0.9 0.6 Debt Service Ratio 1.4 1.0 1.1 1.2 1.3 1.1 a/ Before depreciation and interest hi Includes in 1990 French debt cancellation of US$29.2 aillion and in 1991 prepayment of US$15 million of debt.  - 19 - The above financial projections have been prepared in constant dollar terms, which presents a more conservative picture. This is justified because of the commercial risks inherent to SNIMWs activity. On the other hand, it tends to somewhat overstate the burden of SNIr's debt service obligations. Also, in line with the most recent revisions of commodity price forecasts made by the Bank (January, 1990), the financial projections are based on iron prices remaining fairly stable in real terms until 1991, but declining thereafter by about 12 percent. It is only in the year 2000 that iron ore prices are assumed to recover to a level of 10 percent below the 1989 price level. 46. These projections have been further tested as follows: (i) a 5 percent raduction in real terms of the price of iron ore, on top of the 12 percent decrease, assumed for the Base Case; (ii) a 5 percent reduction in real terms of the price of iron ore, and an increase in production to 11 million tons per year; and (iii) maintaining the price of iron ore at the 1989 level throughout the projected period. The key results are presented in the table below. Sensitivity Analyses: Key Indicators (million US$) Cumulative 1990 - 1995 M,i (ii) (iis ) Iron Ore with 1989 Price Product'-on Price Base Case Down 52 increase Level Total Revenues 986 948 1004 1034 Net Income 10 (28) 6 58 Net Internal Cash Generation 26 (11) 23 74 47. As expected SNDM's financial performance is highly sensitive to variations in prices. A further 5 percent decrease in real terms on the price of iron ore results in a cash deficit of about US$12 million or US$2 million a year. which is not disastrous and can be compensated by an increase in production to 11 million tons, which is technically possible as SNIM has demonstrated in 1989. A price decrease has a more dramatic effect than a production decrease, a production decrease case has therefore not been presented. A one year delay in the opening of the M'haoudat would not significantly change the situation. Debt service ratios would be considerably more favorable if iron ore prices remained at the 1989 level, which then would even allow resumption of dividend payments and/or payment of taxes or royalty fees. 48. Timely implementation of SNDM's plans is important. Therefore, assurances would be sought that the second and third tranches would be released only after a review takes place, focusing on whether satisfactory progress has been made in implementing the operational program and the financial restructuring plan, and whether the financial and efficiency objectives have been attained. (See Annex 8, Para. 51) If necessary, and  - 20 - if IDA agrees, actions would be postponed or now actions decided upon to achieve the financial and efficiency objectives. As a condition of the second tranche release, SNIM would also agree with IDA on a satisfactory financing plan and project managements arrangements to develop the new iron ore deposit at M'haoudat. The Government would also attempt to sell part of its shareholdings in SNM to interested private sector partners. 49. Air Mauritanie. Air Mauritanie is the other enterprise that will be the target of financial rehabilitation under the proposed operation. Air Mauritanie, a company in which the Government is the majority shareholder, plays a useful role in transporting goods and passengers. Its fleet consists of two Dutch-built 70-seater F-28 jets and some smaller planes, with which it services a number of domestic destinations as well as a few cities in the region such as Bamako, Banjul and Casablanca. Air Mauritanie has built a reputation as a reliable airline. A recent management audit confirmed that, taking into account the difficult operating conditions and market characteristics in Mauritania, Air Mauritanie's operational efficiency compares reasonably well with similar small airlines in the world. In 1989, its operating expenses were less than US$ 0.1 per seatikm, a reasonable performance. Still, it is losing money -- partly because of low domestic tariffs and servicing of unprofitable domestic destinations, but mostly because of burdensome debts it contracted in foreign currency. The depreciation of the Ouguiya against the Dutch Guilder has inflated the company's long term debt and the original debt of about DPI. 32 million in 1984, is still valued in Ouguiya terms at about DPI. 30 million, in spite of principal and interest payments of about DFL 16 million. In 1989, Air Mauritanie was able to cover its operating expenses, but after financial charges and provisions for foreign exchange fluctuations, it lost an estimated UM 650 million, and was unable to meet its debt service obligations in spite of three Paris Club rescheduling. 50. Based on the recommendations of a management audit, the Government has proposed a plan to restructure Air Mauritanie that will be implemented in the context of the proposed PE program. This plan involves an increase in domestic and international tariffs, a reduction in operating costs (including partially freezing salaries) and the sale of one of its smaller aircraft, improvement of the organizational structure, management information and accounting systems. The Government also plans to sell the President's plane and use the proceeds to help in the restructuring. Other measures include the settlement of Government arrears, development of new sources of revenue and further debt rescheduling. When implemented, these actions are expected to put the airline on a sound financial basis. During negotiations, agreement was obtained on the details of the plan, vhich are to be reflected in a performance contract to be signed between Air Mauritania and the Government as a condition of the second tranche release. In the medium term, the composition of the fleet needs to be reviewed, including the sale of existing planes and leasing of planes better adapted to the physical and market conditions.  - 21 - 51. Other Public Enterprises. The rehabilitation of SONELEC will continue with support provided by the proposed PE Institutional Development and Technical Assistance Project prepared in parallel with this operation. Similar support would be provided to other key enterprises in the energy, transport and telecommunications sectors. D. Sector Rationalization 52. In the context of the PE operation, the Government has agreed to undertake an ambitious rationalization plan which involves the following: (i) Divestiture. The Government has agreed to divest enterprises (SEMs) over the next two or three years, unless they demonstrate that they are financially profitable (the financial criteria has been agreed to during appraisal) and operate without subsidies or other privileges. Already, prior to credit negotiations, the largest manufacturing company in the country (SOMIS), which is involved in sugar processing and employs over 450 persons has been liquidated, as have three enterprises in the fisheries sector (SOFRIMA, MSP and SAMIP). Also, prior to credit negotiations, the large stevedoring activity at the port of Nouakchott (PANPA) has been privatized, and two small companies in the textile sector (MIE and CNCH) will be privatized or liquidated. Also as condition of negotiations, PANPA's personnel was reduced by over 255 persons. Plans are also well advanced to privatize the state owned petroleum product distribution company (SMCPP) which caters to more than half of the market in the country. The Government has established a redeployment fund, to assure the rapid settlement of severance pay obligations and to provide additional financing to facilitate entry into the private sector for PE employees losing their jobs as a result of the divestiture program. (See paras 61 to 66) (ii) DemonoPolization. In order to improve the efficiency and reduce the costs to the economy, the Government has agreed to eliminate the state monopoly on the insurance sector. At present, the sector is dominated by one state-owned company (SMAR) which operates inefficiently and does not provide all the services needed. Similarly, the Government has agreed to eliminate its monopoly on the imports and distribution of sugar, tea and rice, with the monopoly on rice to be removed before September 1990. This decision has proven particularly painful to the Government, because the enterprise (SOMINEX) raises substantial tax revenues (about US$40 million in 1988) and paid some hefty dividends to the Government (about US$5 million in 1988) and to foreign and Mauritanian shareholders. The Government has also agreed to liberalize the petroleum products distribution sector by modifying an existing law which restricts the entry of private firms. Finally, the operating costs of the state monopoly for fish exports (SMCP) would be capped. To eliminate losses, the  - 22 - Government has sold all the fishing boats operated by SMCP as a condition of credit negotiations. (iii) Financial measures. Based on a cross-debt study and an evaluation of the financing needs of key public enterprises, the Government has prepared a plan for settlement of all major debts and arresrs. The plan involves: (a) Government paying its arrears to PES (net of offsetting PE arrears to Government); (b) the Government honoring its guarantees for debts of enterprises being liquidated; and (c) Government honoring its commitment to fully pay in share capital due to key enterprises or meet its commitment as part of a financial restructuring plan (SONELEC, SMCP, OPT. Air Nauritanie and PANPA). About one half of the arrears are to be settled from the counterpart proceeds of the first tranche and the remainder from the second (See Annex 6). Satisfactory progress in settling PE arrears in accordance with agreed targets by the Government would be a condition for release of the second and third tranches of the proposed credit. Assurances have been obtained that there would be no new arrears and that adequate provisions will be made in the public budget for payment of services provided by the water and power utility (SONELEC), the telecommunications agency (OPT), and for the surveillance of fishing in Mauritania waters. In order to facilitate financial transactions and mobilize savings in areas not served directly by the banking system, the Government will establish a separate subsidiary that would combine the functions of the national savings bank and postal checking services in OPT. In order to reduce the burden on the budget and costs of public enterprises, the Government has agreed that staff from 14 enterprises would be reduced by 1,550 persons by the end of 1991, including those from enterprises being divested. This is expected to increase profitability or limit losses of these enterprises. It has also been agreed, in the context of the AGSECAL to reduce staff and increase water charges so that O&M costs are fully recovered. PART IV - THE PROPOSED CREDIT A. Credit History 53. The origins of the credit stem from the Government's efforts, dating back to 1983, to redress the situation of the PE sector. These efforts were supported by a Rehabilitation Project for SNIM (Ln. 2643- MAU), a Rural Sector Technical Assistance Project (Cr. 1414-MAU), and a Public Enterprise Technical Assistance and Rehabilitation Project (Cr. 1567-MAU), which is almost fully committed. Although the PE Technical Assistance and Rehabilitation Project aimed to introduce wide reforms in the sector and to rationalize and redefine relations between Government enterprises, implementation of these broader measures progressed slowly or not at all, because of inexperience, incompleteness of measures, weakness in the institutional and legal framework, and delays in completing sector studies. Also, the deepening degree of financial problems of enterprises  - 23 - such as SNIM and Air Mauritanie over which they had little control, led to little significant improvement in the performance of the sector. Moreover, experience has shown that a technical assistance project is not the proper vehicle for carrying out policy and institutional reforms. 54. The present PE Reform program was prepared by the Government with the assistance of consultants. Several diagnostic studies and audits of selected PES set the basis for the restructuring of some enterprises and the liquidation or privatization of others. A cross-debt study initiated a year ago was completed in time for appraisal. Similarly, the Government prepared a plan to reduce the social impact of the reforms and also a program for the reinsertion of refugees following the border problems with Senegal. 55. The PE program was appraised in January 1990. Negotiations were held in May 1990; the Mauritania delegation was headed by His Excellency Moustapha Ould Abeiderrahmane, Minister of Planning and Employment. Supplementary data on the credit are provided in (Annex 3). The PE Institutional Development and Technical Assistance Project was prepared, appraised and negotiated concurrently. B. Relationship of Proposed Credit to the Macro-Economic Reform Progra 56. Mauritania's program for public enterprise reform constitutes an essential element in its overall program for structural adjustment, as outlined in the third year PFP covering the period 1989-91 which contained specific macroeconomic targets. The program supported by the proposed operation is fully consistent with the macroeconomic framework outlined in that document. Implementation of the measures under the proposed operation will both depend on adherence to the overall macroframework and be essential to meeting overall macroeconomic targets. Thus, maintenance of appropriate macroeconomic policies, consistent with the directives outlines in the PFP, is a condition for releasing the second and third tranches of the proposed credit. Since macroeconomic objectives for growth, inflation, credit expansion and balance of payments (see paras 12-14) are currently under review in the context of preparing a fourth year PFP for the period 1990-93, specific quantitative targets agreed in the updated PFP would replace those in the previous PFP as the basis for macroeconomic reviews prior to tranche release. C. Effects of the Adiustment Program 57. In the medium term, the structural improvements in public resource management, the parastatal, banking, fisheries and agricultural sectors should make it possible to gradually increase economic growth without exacerbating existing strains on the budget and balance of payments.  - 24 - S8. Scenario without structural adjustment. A continuation of policies that had been pursued before the adjustment program would entail high costs for Mauritania's economy and population. GDP growth in this case would be seriously limited by public finance and balance of payment constraints . The availability of additional external financing, particularly non-project aid, would be reduced due to bad performance. Thi-s would constrain overall budgetary outlays, while the already large unmet debt services would continue to grow dramatically. Delivery of public services would be negatively affected and public investment severely reduced, compounding the Inefficiencies of the public sector and reducing long-term growth prospects. Reflecting external financing constraints, the current account deficit would need to be smaller, thus constraining imports. Despite lower growth and borrowing, the debt service burden would reach unsustainable levels. 59. Macroeconomic impact. It is too early to link the Government's adjustment efforts with specific macro-economic results such as higher GDP growth rate or expanded exports. It is however possible to say that during the period of implementation of the economic and financial recovery program, the macroeconomic performance of the economy was considerably better than in the immediately preceding years. Also, as a result of the reforms implemented by the Government, the economy is no longer as regulated as it was until late 1987. Quantitative import restrictions and price controls have been mostly removed so that prices move more freely with supply and demand. There is today much more private activity in all economic sectors especially in processing and marketing of agriculture commodities, transport, and in fisheries. Most important is the direction of future change which the Government has spelled out in various policy statements. The Mauritanian economy is set to become a more market- oriented one with the Government's role limited to facilitating private initiatives rather than one of controlling and directing the economic activity as in the past. 60. Impact on parastatal sector. The direct effects of the PESAP would be to encourage a favorable environment for improved PE performance created by the adjustment program and to drastically reduce the number of enterprises in the public sector to no more than a dozen companies which would be financially healthy and operating in a normal competitive environment without monopoly privileges, subsidies or privileged access to credit. Under this program, the PE sector has already diminished in size in relation to the rest of the modern sector, and state enterprises are becoming more efficient, resulting from the reform of the incentive system and improvements in the institutional framework. In particular, the liberalization of prices and greater autonomy and responsibility vested in enterprise management have resulted in improved quality of services and financial results. The demonopolization measures are expected to increase the efficiency of these enterprises and reduce the cost to the economy of goods and services provided. The reforms in the banking sector will dramatically improve the financial soundness of the banking system and increase the availability of credit for private productive activities. Since the program of financial restructuring and settlement of cross-debts will be accompanied by more rigorous financial discipline, there would be a reduction of the risk of a reappearance of arrears whose build-up substantially hampered the functioning of the enterprises and of the rest  - 25 - of the modern sector in recent past. Finally, the reduction of the sector's size through privatizatlon or liquidation of selected public enterprises would result in a better allocation of the scarce managerial and financial resources among the remaining strateglc parastatals. D. Social ImPact 61. The country's structural adjustment program, of which this operation is a key element, would allow a gradual improvement in living standards in Maurltania mainly by reducing the drain on the banking system and public finances. In the absence of the adjustment program, living standards would be curtailed significantly as a result of the reduced availability of external resources and constrained imports. Prospects for rapid increases in per capita income remain very limited however, given population growth and the weak resource base. 62. The restructuring of the PE sector does, however, have a direct Impact on some social groups in the short term. Measures introduced to reduce over staffing in enterprises will result in approxvimately 1550 workers becoming redundant, which represents just over 11 percent of the total work force of the publlc enterprise sector, but 48 percent of the workforce of the concerned industries and 46, percent of their combined wage bill. The expected distribution of the affected workers is as follows: some 150 are lower level managers or supervisors, some 700 are skilled workers and 700 are unskilled workers. 63. The time frsme in which the staff reduction programs are meant to be implemented is quite short, with more than half of the redundancies to be effected before Board Presentation in June of 1990, and the balance by December 1990. While, on the one hand, this can be taken as an indication of the Government's commitment to implement the reform program in a timely and efficient manner, on the other hand, this process will inevitably create social and political tensions, which will further aggravate increased unemployment caused by the repatriation during the past twelve months of returnees from Senegal, especially in the vicinity of Nouakchott, where the effects of the public enterprise reform program will be felt most acutely. 64. Given the recent upsurge in private sector activity, and our assessment of the prospects for continued private sector-based economlc expansion, one can envisage that the workers affected under this program will, within an acceptable time frame and with appropriate retraining, be able to find employment ln the private sector. To facilitate this transition and to compensate these workers for the loss of employment, the program proposes to provide each worker with a package consisting of a cash severance payment together with counseling and training to assist them either in finding alternative employment, most in the emerging private sector. The total cost of thls component is estimated at US$ 7 million and would include severance pay, technical assistance, training, surveying and collection of data started under the SDA initLiaIve. 65. With regard to training and given the exLstence of a multitude of programs In Mauritania offering a wide variety of courses sultable for  - 26 - this group of workers, it will not be necessary to establish new facilities. The PE program proposes instead to make use of existing programs and facilities and to provide specialized counseling services to laid off workers to assist them in a choice of training, corresponding most closely to their qualifications, experience, and aptitudes. An IDA- financed Education Restructuring Project (Credit No. 1943-MAU) is supporting (inter alia) a restructuring and strengthening of technical education and training programs aimed at ensuring that they are tailored to the requirements of the potential growth sectors of the economy, including fisheries, service industries, and small scale enterprises where studies have shown there are shortage of middle-level technicians and skilled workers. Coursis are offered at three facilities (in Nouakchott, Nouadibou and Boghe) in a wide variety of subjects, at the professional and technical levels, including industrial and artisanal fishing, automotive mechanics, gasidiesel engines, agricultural equipment maintenance and repair, construction, industrial electricity, electro-mechanics, data processing and management of small and medium enterprises. Capacity in virtually all of these programs is thought to be adequate to absorb within the next 12 months the workers displaced under the PE adjustment program. 66. In addition and following the civil disturbances with Senegal in 1989, the Government has formulated a Reinsertion Program to assist returnees in finding employment and reintegrating themselves into the Mauritanian economy. The Reinsertion Program, which is well funded, will offer over a two-year period expanded technical and vocational training which will complement those being developed under the IDA-supported project, most prominently in the fields of artisanal fishing, construction and mechanical skills, and small and medium enterprise management. However, while the courses under the IDA supported project are open to all Mauritanian applicants, the Reinsertion program, as presently conceived, is intended to be available only to returnees from Senegal. With a view toward avoiding costly duplication of efforts and diseconomies of scale in equipment and facilities, assurances have been sought during negotiations that training programs funded through the Reinsertion Program will be available to all applicants including those displaced under the PESECAL. This will also apply to the facilities for credit including the Reinsertion Fund (FIRVA) is being expanded for the returnees with the assistance of several Arab, French and other European donors. A small unit will be established rithin the Ministry of Plan to inform and counsel workers in their choice of training and in their choice of small enterprises to invest. The Hinletry of Plan will also continue under this operation the collection and analysis of baseline data on welfare, both at the houselhold and community level. E. Environmental Impact 67. SNIM's mining operations have a low impact on the environment, due to favorable geological and geographical conditions and the use of modern mining equipment. There is relatively little waste material from the mines, due to the low overburdenlore ratio. The material consists of solid, inert rock and is deposited in a safe manner in rugged mountain valleys next to the mine, in an uninhabited desert area without rainfalls. The rejects of totally dry Guelbs beneficiation process are equally inert  - 27 - and are stacked in low, safe benches with modern stacking equipment next to the plant. Dust generation within the Guelbs plant is relatively high, but a study carried out by the International Labor Organization, Geneva, concluded that the health risk is acceptable. Moreover, the measures under way to improve the plant availability will also considerably reduce the dust load in the plant. SNIM is monitoring semi-annually the health of staff employed in the plant and generally, the health record of the Guelbs staff is good. F. Benefits and Risks 68. The main benefits of the reform program are (a) improved operational efficiency in the sector as a result of the policy and institutional reforms incorporated in the program and (b) a reduction of the financial burden of the PE sector on the economy through a reduction of the sector's size and improved PE performance. The benefits will manifest themselves in the short term as reduced PE losses, greater credit availability for productive activities, improved liquidity as the result of cross-arrears settlement, improved distribution of goods and services within the country as prices are liberalized and monopolies abandoned, and improvement in the quality of services provided by restructured public utilities. In the longer term, benefits will arise from the more productive use of existing resources, and better public investment decisions. 69. Failure to proceed with the proposed restructuring could lead SNIK to default on its loans (US$338 million) with serious consequences on the country's ability to obtain financing in the future and on its efforts to adjust. As a result of the restructuring, Mauritania would maintain an important source of foreign exchange earnings and employment. The net foreign exchange earnings that SNIM has generated has been about US$40 million a year on average, a substantial contribution to the balance of payments. SNIM is also an important source of employment. It employs 4500 persons (about 10 percent of modern sector employment) and provides work to another 1,100 local laborers on a temporary basis. All in all, iron ore mining activity provides the living base for the entire population of Zouerate (50.000) and a major portion of the population of Nouadhibou (70.000), Mauritania's two major population centers outside of the capital city of Nouakchott. SNIN also spends over US$3 million a year to support local schools, child care centers, dispensaries, a small hospital and regional municipalities. It also provides about US$15 million of business to some 30 local suppliers. SNIM also has the potential to contribute between US$ 6 to US$ 10 million a year in taxes, largely in the form of taxes on wages and salaries. 70. The program is also expected to improve the organizational and human resource base for sound PE management. Government's supervision will be based on ex-post performance, whereas accountability and autonomy of PE managers will be strengthened commensurately through performance contracts. Controls will be streamlined and the direct supervision of PEs will be gradually devolved or transferred to relevant technical ministries. The program will also specially address the question of two problematic enterprises, SNIM and Air Mauritanie; help intensify the reform efforts of  - 28 - SONELEC, OPT and PANPA, in addition to the ongoing programs for other enterprises. Given the size of the country and the undeveloped nature of its road networks, it is essential that Air Mauritania contin.es to provide the valuable service it has to date. 71. The risk associated with the program is that, continued liberalization of the economy and divestiture of public enterprises would prove politically unacceptable. The difficult actions already taken, however, show that the high level of government commitment to the program. Another risk is the possibility that the adjustment program may prove too demanding for the limited capabilities of the Mauritanian administration, particularly in view of the number of people repatriated from Senegal. The companion technical assistance project, however, is expected to help CRSP and a unit in the Ministry of Finance implement the reform program. Also, stroug support Is expected from SNIM, which has already shown its counitment to the reform program. There is also the possibility of a weaker than expected response from the domestic and foreign private sector. The Government has already begun discussions with private investors who have shown interest in investing in selected enterprises. Eliminating the monopoly enjoyed by SONIMEX could threaten the almost US$40 million in taxes and dividends that it produces for the Government. Hence, assurances have been sought from the Government that it will reinforce the customs service so that taxes will continue to be collected. 72. With regard to SNIM, there is some uncertainty about the real production capacity of the Guelbs plant. The assumption made here, however, is conservatives that it will only reach 65 percent of its design capacity. Furthermore, any shortfall in Guelbs production can be compensated by increased production from M'haoudat by switching to three shifts a day instead of two shifts as currently envisaged. Another risk is the impact of the fluctuating value of the dollar and the international price of iron ore on SNIM's finances. To mitigate against this risk, SNIM plans to build up reserves to help tide it over any such crisis. Also, under the proposed Technical Assistance project, SNIM will engage the services of investment bankers to help them deal effectively against changes in interest rates, exchange rates and the price of iron ore. The risks associated with the development of M'haoudat are limited, because the geology and mining methods are similar to the Kedia operations for which SNIM has accumulated vast experience. G. Credlt Amount 73. The required financing of this adjustment operation would total US$159 million, of which US$109 million would be quick disbursing balance of payments support. It is proposed that the IDA contribution be US$40 million. Cofinancing in the amount of US$50 million is being sought from the Japanese Government, US$5 million from the Spanish Go%ernment and US$4 million from the German Government, all under the Special Program of Assistaose to Debt Distressed Countries (SPA). In addition, it is proposed that Mauritania be eligible for IDA reflows to be approved on an annual basis, which would provide an additional US$10 million. Further cofinancing in the amount of US$50 million would be provided by Arab donors  - 29 - and would directly finance SNIM's foreign exchange working capital requirements. The proposed operation, including cofinancing, would meet some 16 percent of the country's external financing gap during the credit's three year disbursement period. Local currency counterpart funds generated by the credit and the cofinancing (excluding the Arab cofinancing) would be used for the financial restructuring of SNIMl (estimated at US$69 million equivalent) and other public enterprises(US$25 million), as vwll as for settlement of Government arrears (US$8 million) and payment of indemnities to workers who lose their jobs (US$7 million). (See Annex 6) SignIng of a financing agreement between the Government and SNII satisfactory to IDA is a condition of credit effectiveness. B. Monitorable Actions, Disbursement and Procurement 74. The credit would be disbursed in three tranches, the first (US$18 million) at credit effectiveness -- expected in July 1990, the second in July 1991, (US$12 million) and the third in July 1992 (US$10 million). Three tranches have been provided to allow for adequate monitoring of various reforms and activities that require more time to be completed. 75. The following actions have already been taken by the Government under the proposed program: (a) The existing PR law has been substantially revised to improve the legal and institutional framework for the sector (pars 35). (b) A large but unprofitable sugar factory, employing some 450 persons, has been liquidated (para 52). (c) Five other defunct companies in the textile and fishing sectors have been liquidated (para 52). (d) Action plans for Air Mauritania, PANPA, SMOP, and SMCPP hWve been discussed with IDA during negotiations (para 50). (e) The excess personnel on the payroll of the Port of Nouakchot have been dismissed (255 persons) and the stevedoring activities of the port has been privatized (para 52). (f) The monopoly of the Government on the insurance sector has been removed (para 52). (g) The petroleum products distribution sector has been fully liberalized (para 52). (h) The technical management of the Guelbs plant has been changed (para 42). (i) The operating costs of the state monopoly for fish exports has been capped (pars 52).  - 30 - t3) All of SMCP's fishing boats have been sold (para 52). (k) A cross-debt plan for settling of arrears has been approved by the Council of Ministers (para 52). 76. Disbursement of the second tranche would be contingent upon a satisfactory review of macroeconomic performance to verify its consistency with the performance objectives specified in the PFP, and satisfactory progress in carrying out the program, in particular with regard to: (a) divestiture (liquidation or privatization) of one half of the enterprises (SEMs) that are not financially profitable (para 52); (b) achievement of efficiency and production targets by SNDM (para 48. 51 of Annex 8); (c) finalization of financing plan and project management arrangements to develop the iron ore deposit at Mvhaoudat satisfactory to IDA (para 48); (d) implementation of the financial restructuring plans for SKIM and Air Mauritanie, including signing of a performance contract with Air Mauritanie and PANPA (para 36, 49 and 51) and the action plans for SONELEC, and SMCP; (e) reduction of 50 percent of the Government arrears with public enterprises (US$4 million), (para 52); (f) adequate provision in the budget for payment of services of SONELEC, SMCPP and OPT and for the surveillance of fishing waters off the coast of Mauritania (para 52); (g) removal of SONDMEX's monopoly on rice imports (para 52); 77. Disbursement of the third tranche would be contingent upon satisfactory implementation of macroeconomic policies consistent with the PFP's performance objectives anu satisfactory progress made with regard to the following: (a) divestiture (liquidation or privatization) of the remainder of the enterprises that are not profitable (para 52); (b) achievement of efficiency production and restructuring objectives by SNIM, including further reduction of long-term debt if SKIM's financial situation permits (para 49 and Annex 8); (c) elimination of the remaining Government arrears (US$4 million) (para 52);  - 31 - (d) making adequate provisions in the budget for services provided by SONELEC, SMCPP and OPT and for surveillance of fishing grounds para 52); (e) removal of SONIMEX's monopoly on the remaining products (para 52)s and, (f) signing of a performance contract with OPT (para 36), based on the action plan a8reed with IDA. 78. The Government of Mauritania would be the Borrower. The Central Bank of Mauritania (BCM) would be responsible for maintaining the credit accounts and for submitting withdrawal applications and supporting documentation to the Association. The Government would establish a Special Account at the Central Bank in an amount equivalent to US$6 million to facilitate disbursements. The account would be replenished regularly on the basis of fully documented disbursement applications in excess of US$1 million which will include the report of findings of the import verification agency (see para 79) together with the attendant documents or on the basis of statements of expenditures (SOE) for expenditures below that amount except for transactions less than US$5,000. The proceeds of the credit would be used to reimburse 100 percent of the CIF cost of eligible imports on the basis of evidence that they were imported and paid for not more than four months prior to credit signing. Retroactive financing would be limited to 20 percent of the proposed credit. It is proposed that not more than US$10 million equivalent each would be allowed for imports of petroleum and food. Public and private sector imports would be eligible, except for: (a) negative list; (b) imports of goods procured under contracts costing less than US$ 5,000 equivalent; (c) imported goods already financed under bilatcral or multilateral credits ard (d) imported goods purchased in the local market. 79. Procurement procedures have been designed to permit rapid use of the funds while ensuring efficiency and accountability in the process. Contracts exceeding US$2 million equivalent would be subject to international competitive bidding for both the public and private sectors. For contracts below US$2 million, public agencies would follow standard practices *ich have been found to be acceptable in the past. The private sector would follow established commercial practices , and, wherever possible, a minimum of three quotations from eligible suppliers from at least two countries would be sought. Direct contracting would be used only for proprietary items or where compatibility with existing equipment would call for standardisation. Procurement documentation would be maintained for ex-post review by IDA. Agreement was reached during negotiations that the Government will engage an expert agency to certify the quality, quantity and price of each shipment of goods. The agency will be selected  - 32 - in accordance with Bank Group guidelines dated August 1981 and would be employed on terms and conditions satisfactory to IDA. 80. The Ministry of Plan would be responsible for monitoring progress under the present operation. Following the disbursement of the first tranche and before disbursement of the second and third tranche of the credit, Government would submit to the Association reports evaluating the progress made in the implementation. These reports would serve as a basis for a progress review of the program which, in turn, would form the basis for the release of the next tranche. Government would submit to the Association a final report on the implementation of the adjustment program upon full disbursement of the credit. I. Administration and Auditing 81. The PR adjustment program will be implemented by the Ministry of Plan and the individual enterprises. It will be monitored by an existing unit in the Ministry, "Cellule de Rehabilitation du Secteur Publique (CRSP). Because of the complexity of the tasks, CRSP will need continued assistance from external consultants to carry out its functions. Such assistance will be provided through the Institutional Development and Technical Assistance Project to be processed at the same time as this operation. With regard to auditing, the PE Institutional Development Project includes provision for the external audit of both the PE Sector Adjustment Operation and the PE Institutional Development and Technical Assistance Project. Audit reports, conforming to internationally accepted standards and prepared by auditors approved by the Association, would be submitted to the Association annually. PART V - BANK GROUP OPERATIONS AND STRATEGY A. Bank Group Operations 82. To date, the Bank Group has had thirty operations (three IBRD loans, twenty-six IDA credits, and one IFC operation) in Mauritania, for a total of $368 million. The three IBRD operations were for iron ore mining operations ($66 million to MIFERMA in 1960, and $60 million to SNIM in 1979, for the Guelbs Iron Ore Project and $20 million for SNIM's rehabilitation in 1985). The twenty-six IDA credits totalled $221 million, and included two adjustment operations (SAL I and the AGSECAL), eight investment projects in the agricultural sector, five in transportation sector, three in education, two in the industrial sector, and six technical assistance operations to support development and institutional improvements in the agricultural, urban, public administration and public enterprises sectors. In 1985, IFC financed an edible-oil refinery. The average Bank Group's share in the external capital assistance received by Mauritania, on a disbursement basis, amounted to some 7.6"r Iotween 1987-88.  - 33 - B. Country Assistance Strategy 83. The overriding aim of the Bank assistance program in Mauritania remains the promotion of long-term growth with equity. Since 1985, when the Government instituted its economic recovery plan, a main focus of IDA's country assistance strategy has been to sutpport the Government's adjustment efforts. Following the completion of SAL _, economic and financial disequilibria have been reduced and the economy has undergone a shift toward market oriented resource allocption, with much less Government intervention and a significant increase in private sector activity. For the coming years the Bank's country assistance strategy for Mauritania will continue to support this evolution towards increased private sector-based economic growth and greater efficiency in the management of public resources, including continued strengthening of policy formulation and implementation capabilities. 84. For the future, IDA assistance to Mauritania will be split approximately equally between policy based and project lending during FY 91-93. This emphasis reflects both the fact that the Government's budgetary resources are more constrained than investment financing, and IDA's comparative advantage in supporting policy formulation. In tne period of SPA-2, IDA will continue to mobilize the necessary donor financing to support the adjustment program. However, since Mauritania needs a mixture of project and policy based lending, IDA together with other donors, will support selective investment operations, within the context of coherent macro and sectoral policy frameworks. IDA will influence the latter through public investment reviews in the context of PFPs and SALs. 85. With regard to structural adjustment at the macro level, the first SAL operation to Mauritania, implemented in 1987-88, complemented stabilization measures being supported by the DMF, with initial structural reforms in seven principal areast (i) public sector management; (ii) banking sector reforms; (iii) public enterprise reforms; (iv) energy; (v) agriculture and rural development; (vi) fisheries development; and (vii) private sector promotion. A second SAL would focus on supply side measures to stimulate the growth of private sector production and employment. In addition, SAL II would assist the Government in defining social development objectives, including both short term measures to compensate the adverse effects of adjustment and medium term measures to ensure an adequate human resource base for growth ane an equitable distribution of the benefits of such growth. 86. In the agriculture sector, IDA's strategy involves (i) policy and institutional reforms aimed at diversifying production and increasing productivity in the sector; (ii) project support for expansion of irrigation schemes and extension, research and training; (iii) encouragement of private sector participation; and (iv) attention to environmental protection issues and improved resource management. A recently approved Agricultural Sector Adjustment operation is supporting continued efforts in the key areas of liberalization of cereals marketing and pricing policy, land tenure a..& institutional strengthening. These activities complement on-going efforts under the Second Rural Sector Technical Assistance Project (Cr.1414-MAU) approved by the Board in  - 34 - December 1983, the Small Scale Irrigation, Project (Cr.1571-MAU) approved by the Board in March 1985, the Second Livestock Project (Cr.1658-MAU) approved by the Board in June 1987, and the Agricultural Sector Adjustment/Investment Project (Cr. 2093-MAU) approved by the Board in February 1990. 87. In t'e education sector, the Education Sector Restructuring Project (Cr. 1943-MAU), a sectoral adjustment operation signed on August 29, 1988, is helping to expand access to and improve the quality of primary and secondary education. It is promoting cost-effective use of sector resources and encouraging public policies to balance outputs from the secondary and higher educational cycles with labor market demand. 88. In the population and health sectors, sector work is ongoing which will prepare for an FY92 project aimed at assisting the Governrent to improve delivery of basic health and family planning services, and to articulate an action oriented population policy. This will reinforce both the priority which is ascribed to the development of human resources as a critical element in long-term development and ongoing Bank efforts to deal with the social dimensions of adjustment. Population and Health Sector Memoranda have already been prepared and discussed with the Government. 89. In the industrial sector, and in order to assist Mauritania's efforts to diversify employment and sources of income, the Bank provided financing (under the Urban and Rural Development Credit, 888-MAU and through the Mauritanian Development Bank) to encourage private enterprise development. A second Industrial Development Project (Credit 1572-MAU), approved by the Board in PY85, is supporting these objectives by financing studies to develop appropriate policies for improving sub-sector performance and for further expanding tUe manufacturing sector. The proposed Public Enterprise SECAL operation will provide support to continue the restructuring of the public enterprise sector and to promote an expanded role by the private sector in the economy. 90. In the infrastructure sector, the Bank's recent interventions have consisted mainly of highlighting the priority of maintenance expenditures over new investments, in the course of the SAL I dialogue on public investment programming and successive Policy Framework Papers. The adequacy of planned support from other donors for financing key investments and maintenance requirements in the sector was ascertained at the July 1989 donors's meeting. 91. The Bank has also been actively involved in Mauritania's iron- ore mining sector since 1963 by assisting SNIM, the Mauritanian mining company. PART VI - COORDINATION WITH THE IMF AND OTHER DONORS 92. Since 1985, the Fund has supported Mauritania's adjustment strategy with three successive stand-by agreements. A three-year structural adjustment arrangement and the first two annual arrangements thereunder in the amount of SDR 16.9 million were approved by the IMF in  - 35 - September 1986 and November 1987, respectively. On the basis of the 1989- 91 Policy Framework Paper (PFP) considered by the Committee of the Whole on May 12, 1989, the IMF Board approved access to the Enhanced Structural Adjustment Facility for SDR 50.85 million in 1989-91. A mid-term review mission in October 1989 found that the macroeconomic program was being satisfactorily implemented. A fourth Policy Framework Paper for the period 1990-93 is expected to be finalized by mid 1990. Cooperation between the Bank and the IMF has been close, with continuous consultation and participation of IMF staff in Bank economic and sector missions. This cooperation will continue throughout the preparation of future structural and sectoral adjustment operations. 93. The nature of Mauritania's adjustment efforts, particularly for the parastatal sector, calls for a highly coilaborative approach with those donors supporting individual enterprises. Almost all the major donors have been involved in financing SNIM's iron ore operations since 1979. A donor's meeting on the financial restructuring of SNIM was held in November 1988 and a second one on the M'haoudat project in March 1990. In addition the French, ADB, EIB, FADES and the Islamic Development Bank have been involved in the rehabilitation of SONELEC, OPT, and the ports. 94. To encourage more general aid coordination, a donor's meeting for Mauritania was held in Paris in July 1989 to discuss the Government's "Economic Consolidation and Growth Program, 1989-91' and the 1989-91 Public Investment Program. At that meeting and at follow up meetings held in Washington in September 1989, and in Nouakchott in January 1990, the Government's plans to assist the returnees from Senegal were discussed. All meetings were well attended and donors are regularly informed of each other's activities. PART VII - REC0MMENDATION 95. I am satisfied that the proposed IDA Credit would comply with the Articles of Agreement of the Association. I recommend that the Executive Directors approve the proposed IDA Credit. Attachments Washington, D.C. Barber B. Conable May 30, 1990 President  t t. 8 *W 9' 0- 9 Ct9- tm 9C AS- O*i-lt lw t's- co ae C's? 6*A- 0B* -'04 " . C,.- SC'- A' - ??- 'S^- oa0'- 39, - t t-9 It " - hi 94