Rwanda - First Structural Adjustment Program Project

Document of The World Bank FOR OFFICIAL USE ONLY t}. !' -? 5/ C - J Z Repowt No. P-5544-RW REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 67.5 MILLION TO THE RWANDESE REPUBLIC FOR A FIRST STRUCTURAL ADJUSTMENT PROGRAM MAY 29, 1991 This document has a restrkted distribution and may be used by recipients only in the performsmce of their official duties. Its contents may not otherwise be disclosed without World Bonk authorization.  CURRENCY EQUIVALENTS Since September 1983, the Rwandese Franc has been pegged to the SDR. The rate remained unchanged at SDR 1.00 = RF 102.71 until November 10, 1990, when the Rwandese Franc was devalued to SDR 1.00 = RE 171.18. MEAS ES AND EOUI_ALENTS Metric System FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS AG@D ACRONYMS BRD Rwandese Development Bank CND National Council for Development (Parliament) COPIMAR Mining Cooperative ELECTROGAZ National Water and Electricity Company LIR Liberalized Import Regime LRMC Long Run Marginal Cost NGO Non-Government Organization OAU Organization of African Unity OCIR Promotion Agency for Export Crops OGL Open General License ONAPO Population Agency ONATRACOM Public Transport Company PE Public Enterprise PEP Public Expenditure Program PIP Public Investment Program REDEMI State Mining Company RWANTEXCO Rwanda State Textile Company SAF Structural Adjustment Facility SAL Structural Adjustment Credit SAP Structural Adjustment Program SGS Soci6t4 Gen6rale de Surveillance (Swiss Preshipment Surveillance Company) SOE Statement of Expenditure SONATUBE State Pipe Factory SPA Special Program of Assistance for Africa STIR National Transport Company  FOR OmCIc USE ONLY FIRST a.WM= CR8UDIT Tale of 2ontent am redlt andProjectSummary ........ ... -Li to COUWTRY POLICIE$ AND AN GROP ASSISTANC STRATEGY A. Background . . . . . . . . . . . . . . . . . I1 S. RecantMaoroaecoeic Perfoarance .......... 2 (l) Devloentsdurngl987-89 ...... . 2 (2) De.lopmnts during1990 . . . . . . .9 3 C. Gov'ernment Economic ?olice.e . . .. . . . .4 0. rinancing equiremete .......... ..... 6 3. BankGroupAseLtance Strategy . . . . . . . .. 6 i?. SAkL I PPOGRAM . . . . . . . . * * . . . * . . - . . . 8 A. Exchange and Trade Policy Refcrm . . . . . . . . . 9 Exchange Rate Reglme 4944.9449494. 9 9 Forelgn Exchange Allocation and iMport Liberalization 9 Tariff Regime . . . . . . . . . . . . . . . . . . 11 S. Incentives for Private Sector Development . . . . . 11 Price Decontrol ................. 11 Regulatory Framework ........ .. ... . 12 C. Supply-Side Measures ...... ... * 13 Coffee Sector # . . . * . . . . . . . . . . . . . 13 Energy sector . . . . . . . . . . . . . . . 14 a. Public Resource Management 9499449994999 15 Programming and Monitoring of Public Xxpenditures 1S Civil service Reform .... .......... 16 TaX Reform . . . . * . . . . * . . . * . . . 16 Publlc nterprise Reform ............ 17 3. Social and lnvironmental Aspects . 18 III. TUBPROPOSEDCREDIT ..................... . 19 A. Credit History ... .. . . . .. . .. . . . . .. . . 19 S. Crodit Amount and Borrower . .. ....... 19 C. Management and MonltorLng of the Program . . . . . . 19 D. DLebursement and Procurement . . . . . . . . . . . 19 S. MonLtorable ActLons .. .... ...... 20 F. Benefits and Rlks ........ .. .. . 21 . RECOKEMDATIOM . . . . . . * *. . . . . . 23 Annex A Key Procesalng Events. . .24 Annex B Letter of Development Pollcy ........ 25 Annex C SAL Policy Matrrx............. 42 Annex D Key indicators ............. . 45 External Financlng: Reuirements and Sources 46 Balance of Payments, 1987-9s . . . . . . 47 Social Indicators of Development, 1990 . . . 48 Annex 3 Status of Bank Group OperatLons ln P.,anii . 50 Annex F Bank's Assistance to Date ln Rwanda 52 Annex C Map of Rwanda........ . . 53 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 disclsed without World Bank authoriation.  RWAUDRsE REPUBLIC FIRST STRUCTURAL ADJUSTMENT CRE2DI CREDIX AND PROJECT SUMMARY orrowers IRwandese Republic Amounts IDA Credit of 8DR 67.5 million (US$90 million equLvalent) Cofinangina: Switzerland (SwF 10 million); Belgium (BF 400 million); cordinated financing is being negotiated with the African Development Bank (AfDB), the European Community (EDP) France, Austria, Germany, USA, and Canada. The total external cofinancing associated with this credit amounts to about US$140 million equivalent. Tsnms: Standard IDA Terms aroara 20scriptiont The proposed Structural Adjustment Credit (SAL) will support the first phase of the Government's economic reform program as described in its Policy Framework Paper (PFP) for 1991-93. The main objectives of the Program are to stabilize the economy, improve its competitiveness, create an incentive framework for the efficient allocation of resources, lay the foundation for export-led growth and for improved living conditions for the Rwandese people. Specifically, the credit will support measures to: (i) establish and maintain a competitive exchange rate and a more liberal foreign exchange allocation and trade regimet (ii) liberalize domestic trade, simplify and reduce the regulatory environment; (iii) alleviate institutional and production constraints in key sectors (coffee, and energy); (iv) establish a process of public expenditure programming; (v) provide a satisfactory social "safety net" within the framework of an agreed public expenditure program and consistent with a sound macroeconomic framework; and (vi) initiate policy reforms dealing with taxation, labor legislation and civil service. Benefits and Rinka: The proposed SAL is expected to contribute to the restoration of internal and external financial and economic equilibria. The proposed measures to improve economic incentives are also expected to have a positive impact on economic growth and employment creation in the private sector. The major risk is the Government's ability to stay the course of adjustment in a period of ethnic unrest. The Government has so far demonstrated its commitment to the reform process by implementing politically dlfficult policy measures. The second risk is that inadequate foreign exchange availability may slow down the pace of trade liberalization. This risk is minimized by the strong support of the international  - Li - community in mobillizng quLck disbursing support for the adjustment program. Estimated Dicbtn"w3ents: The proposed Credit will be disbursed in two tranches. The first tranche of US$55 million equivalent would be released upon effectiveness, and the second tranche approximately eLght to ten months later. Glven the urgent need for balance of payment assiLtance, retroactive financing will be allowed for up to 20 percent of the Credlt for expendlturee Incurred not earlier than four months before credlt approval date. NAW: IBRD 22995  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE RWANDESE REPUBLIC FOR A FIRST STRUCURA ADJUSTMENT CREDIT 1. I submit the following report and recommendation on a proposed First Structural Adjustment Credit (SAL) to the Rwandese Republic for SDR 67.5 million (US$90 million equivalent), on standard IDA terms, with a mat'irity of 40 years, to support the Government's structural adjustment program (SAP). The Governments of Switzerland and Belgium are cofinancing the proposed adjustment credit in the amount of SwF 10 million (about US$7.5 million equivalent) and SF 400 (about US$18.3 million equivalent) respectively. In addition, a number of bilateral donors are providing coordinated financing: Austria (about $6.2 million equivalent), Canada (about US$10.3 million equivalent), the European Development Fund (about US$18.8 million equivalent), France (t-out $13.2 million equivalent), Germany (about $16.0 million equivalent), the United States (US$20 million) and the African Development Bank (about US$15.6 millior. equivalent). 2. A Policy Framework Paper (PFP) for the period 1991-93 was discussed by the Committee of the Whole on April 23, 1991. The first annual arrangement under the Structural Adjustment Facility (SAF) was approved by the IMF Executive Directors on April 24, 1991. Part I of this report provides an overview of Rwanda's development problems, prospects, the key priorities for reform, and the Bank's assistance strategy. A description of the Government's SAP to be supported by the SAL is presented in Part II, while Part III describes the features of the proposed Credit, identifies specific performance conditions attached to it, and evaluates the potential risks of the program. The Government's Letter of Development Policy is presented in Annex B. Data on key indicators and external financing requirements are provided in Annex D. PART I - COUNTRY POLICIES AND BANK GROUP ASSISTANCE STRATEZY A. Backaround 3. Rwanda is a small, largely mountainous landlocked country, with scarce natural resources whose exploitation is hampered by the long distances to the nearest sea ports. It is the most densely populated nation in Africa (290 inhabitants per square kilometer) and has one of the world' fastest demographic growth rates (3.7 percent per annum). The country is populated by two main ethnic groups (Butus, the majority tribe, and Tutsis who constitute about 15 percent of the population). Ethnic conflicts led to a massive exile of Tutsis in 1959. since independence in 1962, the two groups had cohabited relatively peacefully until the eruption of violence in late 1990. The country is heavily dependent on foreign assistance to finance its import requirements. To alleviate this dependence, over the past three decades authorities followed a development strategy centered on achieving self-sufficiency, in food in particular. This approach was feasible as long as arable land could be expanded. In implementing this strategy, the Government generally favored the rural areas in pricing policy, public expenditure priorities, and in developing effective rural institutions and  - 2 - infrastructure. However, that strategy has recently come into question as the population grcwth rate has begun to outstrip that of food supply, clouding the country's long-term devalopment prospects. 4. In the 1960. and the 1970s, Rwanda pursued prudent financial policies and Government intervention in the economy was selective and generally limited. These policies resulted in sustained growth in per capita income and one of the lowest levels of external indebtedness in Africa. However, in the 1980s, in response to external shocks and the collapse of coffee prices (the main export), the authorit.es reaorted to increased controls over the economy instead of adjusting to the new environment and maintaining the competitiveness of the economy through a flexible exchange rate policy. This led to a decade of steadily declining per capita income. 5. After nearly three years of intensive dialogue, the Government requested the help of the Bank and the IMF in preparing an adjustment program. A PFP had been negotiated with the authorities and a Bank mission was ready to depart to appraise the First SAL in October 1990, when the country was invaded by Tutsi refugees from abroad. Fighting spread briefly to Kigali, the capital city, but within few weeks the Government was able to reassert its control over the country. Diplomatic efforts with neighboring countries to find a political solution to the conflict and President Habyarimana's decision to initiate a process of national reconciliation and political reform led to a formal cease-fire, which was signed on March 29, 1991. In parallel with the economic reform program, the Government is pursuing a process of democratization which is expected to lead shortly to increased political pluralism. On April 28, 1991 a new draft constitution was approved by the Mouvement National Revolutionaire pour le Developpement, the ruling political party. The draft constitution is currently under consideration by the National Development Council (the Parliament) and multi-party elections are expected to take place before the end of the year. B. Recmnt Macroeconomic Performance 6. In the 19709, Rwanda experienced relatively high economic growth -- 4 percent on average a year -- under conditions of relative financial stability and low inflation. However, following the coffee boom of the late 1970'B, Government embarked on an ambitious public expenditure program (PEP). When coffee prices returned to trend levels in the early 19806, and the external terms of trade declined by more than one third, the Government adopted restrictive fiscal policies and restrained public expenditures as measures to restore the country's competitiveness. At the same time, though, the authorities increased the scope of Government intervention in the economy. Beginning in 1983, for instance, price controls were applied more strictly to prevent prices of imported goods from rising excessively as a result of tightened import licensing. Similarly, transfers for payments of invisibles were restricted. Moreover, inefficient industrial enterprises were protected through the imposition of *temporary" import prohibitions on competing imports. By the mid-1980s, the fiscal and financial situation had somewhat improved but annual GDP growth had averaged only 2.5 percent during the first half of the decade, a rate below the population growth rate.  - 3 - 1. Dee_met dn.1970 7. Since early 1987X Rwanda has been faced wlth preclpltous declines in world coffee prlces and unfavorable climatic conditions, which have had an adverse impact on agrlcultural productLon. As a result, primary sector output decline by about 14 percent over the perLod 1988-89. etrictiLt?e import licensing lntroduced to respond to forelgn exchange scarcities caused a slowdown 'n several activitLes. Real GDP stagnated ln 1988 Fnd declLned sharply ln 1989 (5.7 percent). Inflatlon as measured by the official consumer price index remained low (2.7 percent per year on average since 1986) malnly due to the overvaluation of the national currency. 8. Rwanda's balance of payments situation has been under pressure since 1987, largely because of poor export performance. Despite sharply curtaLled imports from 1987 to 1989, representing a decline of about 13 percent in real terms, the current account deficit (excluding official transfers) remained at 10.7 percent of GDP in 1989. The deterLoration in export performance cannot be explained solely by the fall in world coffee prLcesg the quallty of Rwandese coffee has also declined due in part to a producer price policy that does not recognize a prsmium for quality. Non- coffee export performance has also been mediocre largely because of the highly overvalued exchange rate, low productivity, and qxcessive regulations and controls. In the past, Rwanda has generally been able to finance its modest external deflcits through highly concessional external assietance, which explains the country's relatively low debt service ratio (18 percent of exports and goods and non-factor services in 1989). Since 1987, however, the authorities have increasingly relied on foreign exchange reserves to finance the balance of payments deficits. As a result, net reserves declined steadily from the equlvalent of 5 months of imports in 1987 and had virtually disappeared by end-1990 desplte the introduction of tighter import restrictions. 9. Notwithstanding the Government's efforts to contain the growth of public expendLture, the fiscal deficit remains at an uneustainable level. Since 1980, the Government has controlled the wage bill by limiting civil service wage increases to the annual 3 percent merit increase. In addition, there hare been cuts in the allocation for goods and services as well as for investment expenditures. However, in view of the overvaluation of the exchange rate and the declining world prices for coffee, the burden on government finances of maintaining an artificially high producer price for coffee had become increasingly difficult to sustain: during 1987-89, average annual transfers to coffee producers accounted for 1.3 percent of GDP or 9.6 percent of total current public outlays. On the revenue sLde, the tax base is narrow, with strong reliance on trade and a few sales taxes. For most taxes, there are problems of administration and collection. Although the fiscal deficit as a percentage of GDP declined from the high level of 10.4 percent recorded in 1987, it was stlll 7.3 percent in 1989. Financlng of this deficit required recourse to local borrowing. The domestic debt burden, which grew from 12 percent of GDP in 1987 to 17 percent ln 1989, is becomlng an lncreasingly important drain on public resources. 2. Develonmente durina 1990 10. The economic and financlal situatLon deteriorated further in 1990, especially during the last quarter when the country faced the invasion from abroad. Despite the recovery of agrLcultural production,  - 4 - mainly coffee, the hostilLtLes serLously affected the economy, and ODP La estimated to have d.elined by 2 percent. The moat severely affected sectors were transportation, trade and tourLsm. On the fLocal front, tho outbreak in hostilltles neceseLtated a substantial Lncrease in securLty- related outlays. Also, the transfers to coffee producero almost doubled, despite the reduction of the producer prlee for coffee from RP 125/kg to RF 100/kg at the beginnLng of the 1990/91 season. These factors led to an Lncrease in current expendLture by 30 percent. Capital outlays fell by 11 percent as implementation of projects alowed down slgnifiLantly because of the hostilLtLes. On the revenue oide, tax revenue fell by 11 percent due to the decline in economic activlty and lower imports. For these reasons, the fiscal deflict rose to 11.7 percent of GDP and was largely financed by accumulatLng domestLi arrears and heavy recourse to the domestic bankLng system. Domestic debt thus ln