Madagascar - Agricultural Sector Adjustment Operation Project

Documuat of The World Bank FOR OMCIAL USE ONLY Report N0o 12544 PROJECT COMPLETION REPORT MI-ACASCAR AGRICULTURAL SECTOR ADJUSThENT CREDIT (IDA CREIDIT 1691-MAG AND SFA CREDIT A-16-NAG) NOVEMBER 24, 1993 MIICRORAPHICS Report No: 12544 Type: PCR Agriculture Operations Division South-Central and Indian Ocean Department Africa Regional Office This document has a restricted distribution and may be asd by recipients only in the performance of their o:icdal dties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit: Malagasy franc (FMG) 1985 US$1 = FMG 662 1986 US$1 = FMG 676 1987 US$1 = FMG 1069 1988 US$1 = FMG 1407 1989 US$1 = FMG 1603 1990 US$1 = FMG 1494 1991 US$1 = FMG 1835 ABBREVIATIONS AflB African Development Bank ASAC Agricultural Sector Adjustment Credit BFV Commercial Bank (Banky Fampandrosoana ny Varotra) BNI Industrial Development Bank (Bankin' ny Indostria) BTM Nationat Rural Development Bank (Bankin' ny Tantsaha Mpamokatra) COROI State t.ading company (Comptoir de Commerce et de Representation de l'Ocean Indien) EIB European Investment Bank EMSAP Economic Management and Social Action Project FMG Malagasy franc (franc malgache) FNUP National Consolidated Equalization Fund (Fonds, National Unique de PNrdquation) GDP Gross Domestic Product IDA International Development Association IMF International Monetary Fund ISAC Industrial Sector Adjustment Credit ITPAC Industry and Trade Policy Adjustment Credit MPAEF Ministry of Livestock and Forestry (Ministere de la Production Animale et des Eaux et Forets) MPARA Ministry of Agricultural Production (Ministere de la Production Agricole et de la Reforme Agraire) O:L Open General License PCR Project Completion Report PIP Public Investment Program PSAC Public Sector Adjustment Credit SDR Special Drawing Right SFA Africa Facility Credit UNDP United Nations Development Program UNIDO United Nations Industrial Development Organization USAID United States Agency for International Development WFP World Food Program  FOR OFCIAL USE ONLY THE WORLD BANK WashiMntO D.C 20433 U.SA OPeIffm Evdudon November 24, 1993 MEMORANDUM TO THE ECT DRECrORS AMT PRESNT SUBJECD Project Completion Report on Madagascar Agricultural Sector Adjustment Credit aDA Cr. 1691-MAG and SA Cr. A-16EMAG) Attached is the Project Completion Report on Madagascar Agricultural Sector Adjustment Credit (IDA Cr. 1691-MAG and SFA Cr. A-16.MAG) prepared by the Africa Regional Office. Part H was requested from the Borrwer but was not received. The adjustment operation was consistent with both Government policies and Bank support strategy. The rice liberalization component, the core of the reform program, was successfully implemented, even though the proces proved bumpier than anticipated. The intended reforms wore, in the event, fully implemented, and the anticipated benefits are being reached. In contrast, compliance with other policy changes was poor, and the rationale and justifcation for teleasing the Credit's second tranche are questionable. Eventualy, however, these other policy changes were either effected under, or rendered irelevant by, the two subsequent adjustment creds (Industry and Trade Policy, and Pubhc Sector). The outcome of the operation is thus rated as satisfactory, and its achievements as likely to be sustainable. The Credit included no institutional development objectives. The PCR is complete and informative. An audit is in process. Attachment -Tisdoumnthas a reSWWte distbuaon OM may be used by ecw o* nb th a& we ome of thel ofL duds ft contrds may not ostw be dscosed wfthot wadd Bank auIbd  FOR OMCIL USE ONLY PROJECT COMPLETION REPORT MADAGASCAR AGRICULTURAL SECTOR ADJUSTMENT CREDIT (IDA Credit 1691-MAG and SFA Credit A-16-MAG) TABLE OF CONTENTS PREFACE ............................................. EVALUATION SUMMARY ......................................... iii PART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE .................... 1 Project Identity ............................................. I Background ............................................... I Credit Origin and Genesis ......4............... 4 Credit Objectives and Description ............................ 6 Credit Implementation ........................... 8 Implementation of Individual Components ........................... 9 Credit Inpact and Sustainability ............................ 8 Istitutional Perfomance ........................... 20 PART II: PROJECT REVIEW FROM BORROWER'S PERSPECTIVE .... ......... 24 PART III: STATISTICAL INFORMATION ............ .. ................ 25 Table 1: Related Bank Loans/Credits ............................. 25 Table 2: Credit Data ......... 26 Table 3: Credit rTmetable: Original and Actual Dates ................... 26 Table 4: Cumulative Credit Disbursement .......................... 27 Table 5: Use of Bank Resources ................................ 28 MAP IBRD 20035R This document has a restrcted distribudon 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.  PROJECT COMPLETION REPORT MADAGASCAR AGRICULTURAL SECTOR ADJUSTMENT CREDIT (IDA Credit 1691-MAG and SFA Credit A-16-MAG) PREFACE This is the Project Completion Report (PCR) for the Agricultural Sector Adjustment Credit (ASAC) to Madagascar. Tle Credit was approved by the Board on May 8, 1986 and comprised of: IDA Credit 1691-MAG in the amount of SDR 19 million, Africa Facility Credit A-16-MAG in the amount of SDR 31 million and grants from the Govc-nment of Japan in the amount of Y600 million and from the Government of Germany in the amount of DM10 million. The original closing date of June 30, 1988 was extended three times to June 30, 1990. The final disbursement was made in October 1990; Credit 1691-MAG and SFA Credit A-16-MAG were fully disbursed. This PCR was prepared by the Agriculture Operations Division, Country Department III of the Africa Region (Preface, Evaluation Summary, Parts I and IlH). It is based on the Project briefs, the President's Report and Credit Agreements, preparation and supervision reports, correspondence between the Bank and the Borrower, consultant and internal Bank studies, memoranda and interviews of Bank staff, Government officials and private operators. The Government was sent Parts I and Im of the PCR on March 26, 1992. No comments were received, despite the follow-up from the Resident Mission.  iii PROJECT COMPlEIJON REPORT MAIDAGASCAR AGRICULTURAL SECTOR ADJUSTMENT CREDIT (IDA Credit 1691-MAG and SFA Credit A-16-MAG) EVALUATION SUMMARY Background 1. The Agricultural Sector Adjustment Credit (ASAC), approved in May 1986, was the second in a series of four adjustment operations extended by IDA to Madagascar since 19&i. Initially. the Government and the Bank adopted a cautious strategy and agreed to begin addressing the many structural distortions affecting the economy sector by sector, first in industy and then in agriculture. After ASAC, the adjustment process gained momentum and Government moved to a broader agenda of policy reforms supported by the Industry and Trade Policy Adjustment Credit ITPAC) in 1987 and the Public Sector Adjustment Credit (PSAC) in 1988. 2. When ASAC was prepared in 1984-85, the agricultural sector was heavily taxed both directly and indirectly through price controls and currency overvaluation, and Government intervention dominated the internal and external marketing of major agricultural products and inputs. A large share of public investment in the agricultural sector went into large-scale and capital intensive operations managed by the state. As a result of Madagascar's balance of payments difficulties, agricultural inputs as well as consumer goods were extremely scarce In rural areas. Government had started to partially lit mralize the domestic marketing of rice in 1983, but poor management of the rice imports had resulted in periodic rice shortages on urban markets and extremely high seasonal price fluctuations. Credit Objectives and Design 3. ASAC's objectives were: (i) to improve the returns on scarce resources in agriculture by financing from public sources only selected high priority investmer.ts; (ii) to put into place a coherent rice strategy to restore market confidence, improve productivity and reduce pressure on the balance of payments; (Iii) to provide better incentives to farmers and improve marketing networks; and (iv) to help formulate consistent strategies for the next phase of adjustment. The package of policy reforms supported by ASAC concerned mainly the management of rice imports after full liberalization of domestic rice trade, the removal of input subsidies and transfer of input distribution to commercial operators, improvements in the public investment program for agriculture, improved pricing of edible oils and export crops, and various studies and action plans to prepare a follow-up sector adjustment credit. 4. At the identification stage, a more ambitious program was envisaged, covering four key subsectors (rice, export crops, edible oils, beef). It was later decided that ASAC should concentrate on the completion of reforms in the rice subsector as a main priority, while gradually moving into other subsectors, such as edible oils and export crops, and improving overall resource allocation in  iv agriculture. S. During project preparation, the politically sensitive qLestion of rice marketing had given rise to intense debate between Government and the Bank. Government wanted to maintain its monopoly and price controls on the purchase of rice in the two surplus areas (Lac Alaotra and Marovoay), while the Bank considered the opening of these areas to private trade, as had already been done in the rest of the country, an essential condition. Shortly before negotiations, following a meeting between the President of Madagascar and the Regional Vice-President of the Bank, it was agreed that the Bank, with the assistance of other donors, would help Government set up a buffer stock of imported rice, provided Government would open up all areas to private trade and adopt appropriate practices for the counter-seasonal release of imported rice on the domestic market. Detailed operational arrangements for the management of the buffer stock of imported rice, which became the major component of ASAC, were worked out during negotiations. 6. The total funding for ASAC of about US$60 million equivalent (including grant financing) was to be disbursed in two tranches, the first upon effectiveness and the second upon satisfactory progress in implementing the agreed package of sectoral reforms. Financing was provided for US$42 million equivalent for agricultural inputs and, if needed, rice imports to complement the contributions of other donors, US$3 million for veterinary products, US$5 million for incentive goods (i.e. consumer durables to improve production incentives in ural areas) and US$10 million for tractor and transport equipment. Credit Implementation 7. ASAC was approved on May 8, 1986, after a last minute confirmation by the President of Madagascar of the opening up of all rice producing areas to private trade. Mainly due to administrative delays, the Credit did not become effective until November 18, 1986 (a delay of four months). First tranche disbursements toek thirty-two months instead of the twelve to sixteen months originally anticipated, in part due to sluggish demand for commercial imports of fertilizers and other agricultural inputs, particularly after the mid-1987 devaluation. Moreover, the two subsequent Bank supported adjustment operations, nTAC and PSAC, made foreign exchange available to banks and importers under adminL rative procedures which were less restrictive and time-consuming than those of ASAC. 8. The release of the second tranche, originally expected in 1987, took place on May 1, 1989. Besides slow disbursement of the first tranche, several factors contributed to this delay, including the large devaluation of mid-1987. This devaluation deepened and strengthened the agricultural market reform process, but also affected the pace and direction of the liberalization program and required some adjustments in the specific reforms agreed under ASAC. Despite an agreement to disburse ASAC's second tranche funds on the same terms as those applying to ffPAC and PSAC, full disbursement of the second tranche was not completed until October 1990. ASAC was closed on June 30, 1990, after three extensions of the original closing date of June 30, 1988. 9. Rice management program. The essential element of the rice management program agreed under ASAC was, in addition to the full internal trade liberalization, an automatic mechanism for putting imported rice on the domestic market whenever the market price exceeded a trigger price, set during ASAC negotiations at a level providing adequate incentives for private sector purchase and storage of domestic production. It had been further agreed that the official distribution of rice (i.e.  v the Government operated ration scheme that provided rice at sub-market prices to urban residents), also based on imported rice, would be gradually phased out from 80,000 tons in 1986 to 20,000 tons In 1989, and that sales under official distribution would cover the full cost of imported rice at the prevailing exchange rate, including transportation, storage and distribution costs. An annual rice import program was to be submitted by Government to the Bank for approval. 10. In general terms, the rice management program was implemented as agreed under ASAC during the first 1986-87 season. The buffer stock went into operation in November 1986 at the beginning of the pre-harvest season, by selling imported rice at a fixed price- in wholesale lots. This intervention was very successful; with a relatively modest volume of sales, it held rice prices throughout the pre-harvest season at a level only slightly higher than the sales price of the buffer stock. After the painful price fluctuations of the previous year, the stable prices brought about by the buffer stock were highly appreciated in Madagascar. The full liberalization of domestic rice trade in April 1986 had also resulted in intense competition for paddy purchases, which had pushed farmgate prices up and induced farmers to increase their paddy production for the following year. As a result of this, combined with favorable weather conditions, prospects for the 1987 harvest were quite good. 11. Starting in late 1987 and until 1989, however, rice imports were used to support Government's political interests. The rules agreed under ASAC were largely circumvented, and Government went ahead with imports that were in excess of actual needs for buffer stock replenishment. A semi-private agency (PROCOPS) imported rice commercially that was sold throughout the year to urban consumers at sub-market prices. This policy, which continued throughout 1988 and 1989, disrupted domestic rice trading activities and caused operating losses to traders who passed them on to farmers in the form of lower farmngate prices, thus contributing to a slow down of the growth of rice production in subsequent years. As the Credit Agreement only imposed limits on public sector imports, the Bank protested but could not take any legal action. 12. Government intervention in the domestic rice market was significantly reduced in 1990, when the private sector accounted for the first time for a large share of rice imports and the bufferstock was abolished in 1991. Government's stated policy is now to rely mainly on the private sector for rice imports needed to complement the official grants that it may receive from external donors and, except for special emergencies or disaster areas, to allocate external rice donations to commercial operators at a price reflecting their full commercial value. Rice remains nonetheless a highly political commodity, which entails significant uncertainty for commercial operators. 13. Export crops. Under ASAC, the producer price of coffee was raised significantly in 1986 and 1987, and the special rebate which discriminated in favor of parastatal enterprises in the collection, processing and storage of coffee was eliminated. These measures did not translate into any increase in coffee production and/or exports, because producer prices in real terms and relative to rice remained unattractive, and because of the dilapidated state of the road network and the absence of significant measures to improve traders' incentives. The latter were subsequently introduced under rTPAC and PSAC, with the abolition in 1988 of the state monopoly on exports of majors crops other than vanilla (i.e. coffee, clove and pepper). However, these measures came too late, as international coffee prices collapsed following the suspension of the International Coffee Agreement in 1989. 14. Edible oils. Government had agreed in late 1985 to an increase in the ex-factory price of groundnut and other edible oils, but not to the full liberalization of edible oils prices which the Bank  vi thought iecessary. Instead, it had been agreed under ASAC that Government would prepare and agree with the Bank on an action ptogram for the edible oils subsector and, prior to second tranche release, take appropriate steps for its implementation. The Bank iwtially insisted on this action progrm, the prepartion of which was made difficult by the unclear allocation of responsibility and insufficient collaboration between the various ministries involved (agriculture, industry, commerce). After mid-1988, the Bank decided that it was best to rely instead on the general trade liberalization, export promotion and parastatal restructuring measures supported under MTPAC and PSAC. The edible oils subsector presently remains heavily dependent on donations of unrefined oil and/or imports, and the groundnut production, which had undergone a substantial decline throughout the late 1970s and early 1980s, Is still stagnant. 15. Inputs pricing and distribution. Under ASAC, the Ministry of Agriculture (MPARA) continued to disengage itself from the direct distribution of fertilizer and other chemical inputs, and leased most of its input stores to commercial operators, including parastatals. It had been agreed that input subsidies would be reduced to a maximum of 7% of c.i.f. by the time of ASAC effectiveness, and fully eliminated by second tranche release. However, the devaluation of mid-1987 translated into a sharp increase in the border price of imported inputs, at a time when abundant supplies of fertilizer were availabe on the domestic market, as a result of increased aid donations (representing about 50% of total supplies). At the insistence of the MPARA, the Bank shifted its position in 1988 from a policy of full import parity pricing of donated fertilizer to a policy which would instead allow the disposal of fertilizer through an auction system that would still promote the development of commercial channels. In 1988, MPARA finally opted for an administrative allocation system of donated fertilizer to established operators, at a price 20% to 30% below import parity. This policy is still in effect. 16. Public investment program for agriculture. Seven projects of doubtful economic value included in the agricultural Public Investment Program (PIP) had been questioned by the Bank during ASAC post-appraisal, and it had been agreed that they would be reexamined. Three were rural development and/or irigation projects which were either dropped from the PIP or reshaped in consultation with the Bank. The most contentious projects were agro-industrial investments in oil crops (oil palm, soya and copra) and cashew which were both of doubtful economic viability and inconsistent with Government's stated policy of disengagement from direct production and marketing activities. Two of them (oil palm and cashew) were new projects with an ensured source of external finance., which were executed as originally planned in the PIP, despite Bank suggestions to the contrary 17. In 1987, several new externally-financed irrigation projects were introduced in the PIP which, as pointed out by ASAC supervision missions, were inconsistent with the strategy agreed between Government and the Bank. An agreement was reached to drop some of these projects, and reassess the others. From 1988 onwards, dialogue between Government and the Bank on the PIP has been pursued in the broader context of ITPAC and PSAC. Credit Impact 18. Most of the impact came from the policy reforms introduced under ASAC, in particular from the rice management program which was the core of this operation. During the 1986-90 period, domestic paddy production increased at an average rate of close to 3.5% per year. Although this growth was aided by favorable weather and has slowed down since then, with a resulting average  vii growth rate of only around 2.5% per year for the whole period 1986-92, it nonetheless represents a significant improvement over the stagnation which had prevailed throughout the 1970s and early 1980s. Rice imports, which exceeded 200,000 tons per year on average during 1980-83, have stabilized at an average level of around 70,000 tons per year over the 1987-90 period. 19. Although rice consumerprices became significantlyhigher in real terms with the liberalization of domestic markets, most urban consumers have benefited from the liberalization of internal rice trade and, at least during the 1986&87 pre-harvest season, from the sr'ccessful operation of the buffer stock. Official rice prices were hardly enforced before their elimination, and Government's attempts to control the domestic market together with poor timing of the release of imports had translated until mid-1986 into wild fluctuations of consumer prices and periodic rice shortages which badly hurt consumers. Thereafter, rice became available in adequate quantity throughout the year, and inter- seasonal ptice fluctuations have remained in a reasonable range throughout the second half of the 1980s and early 1990s; these gains have, however, been pardy set back from mid-1991 onwards, with the onset of political turmoil and recurring foreign exchange shortages. A significant proportion of the population, both in urban and in rural areas, nonetheless continues to live below poverty level, thus facing serious difficulties in securing adequate food supplies. Specific measures are needed to help these vulnerable groups, and the Bank has started in late 1988 to support Government's efforts to address this problem under the Economic Management and Social Action Project (EMSAP). Also, a Food Security and Nutrition Project was approved in 1993. 20. The direct and immediate impact of ASAC on agricultural production other than rice was marginal. Increases in the producer price of coffee supported by ASAC in 1986 and 1987, although substantial, did not translate into increased production and/or exports, mainly due to the dilapidated state of the transport network in coffee producing areas, the absence of significant measures to improve traders incentives and the collapse in international coffee prices. The edible oils subsector remains heavily dependent on oil donations or imports. 21. On the whole, the performance of the agricultural sector in Madagascar has shown some progress but remains nonetheless disappointing. During the 1984-PO period, the agricultural sector grew at an average rate of 2.6% annually, which compares favorably with the performance of the late 1970s and early 1980s but still remains modest and masks a wide disparity in performance among subsectors. Most of that growth originates from the fisheries and to a lesser extent the livestock sectors, which together grew on average 4.9% annually between 1984 and 1989. By contrast, the performance of the crop sub-sector has been much more modest, with an average growth of only 1.5% per year during the 1984-89 period, which is well below the 3% population growth rate. Within the crop subsector, most of the growth has come from rice and to a lesser extent from other foodcrops. Traditional exports crops (coffee, vanilla, cloves), faced with increased international competition, have stagnated or regressed, and this has not been compensated for by the emergence of alternative export crops. 22. In order to sustain and expand agricultural growth, iuprovements will be needed simultaneously on several of these fronts. Appropriate and consistently followed macro-economic policies (exchange rate management, tariff and trade policies, fiscal regime, etc.) will also be essential for preserving and building upon the gains which have been made under ASAC and other adjustment operations. Political stability and consensus is an obvious pre-requisite for achieving this, together with well conceived and coherent support from external aid agencies.  viii Conclusions and Main Loessons 23. Ihe main lessons learnt from the experience gained under ASAC can be summarized as follows: (a) the adoption of a phased and gradual approach to sectoral adjustment, as has been the case under ASAC., has its merits but nonetheless results in substantial foregone benefits; in Madagascar, the external liberalization of major export crops other than vanilla (i.e. coffee, clove, pepper) occurred only at a late stage in the adjustment process, at a time when world coffee prices had already collapsed to a level that considerably reduced private sector incentives to engage in this sector; (b) the Bank should be fimer in reacting to serious lapses in program implementation. Government's renewed intervention in the rice market in the 198749 perod and its going ahead with investments outside the agreed upon PIP are cases in point; (c) the trends in paddy production since 1986, point out the benefits which can be drawn from a sustained policy of minimal market intervention; (d) special programs of targeted food subsidies should have been put in place simultaneously with the establishment of the buffer stock; this would have helped ease the transition for the poorest segments of the urban population, particularly after the mid-1987 devaluation; (e) greater coherence between the strategies followed by Government and the various external donors or lending agencies is needed in order to improve the PIP process; and (t) in the case of commodities for which grants in kind represent a major share of domestic supplies, as was the case under ASAC for fertilizers and edible oils, pricing policies need to be worked out carefully, taking into account the potentially distortional effects of this type of aid on prices and the absorptive capacity of the market.  PROJECT COMPLETON REPORT MADAGASCAR AGRICULTURAL SECTOR ADJUSTMENT CREDIT (IDA Credit 1691-MAG and SFA Credit A-16-MAG) PART I: PROJECT REVIEW FlROM BANK'S PERSPECTIVE 1. Project Identity Project Name: Agricultural Sector Adjustment Credit (ASAC) Credit Number MDA Credit: 1691-MAG SFA Credit: A-16-MAG Region: Africa Country: Madagascar Sector: Sectoral Adjustment Credit 2. Background 2.1 In the decade following independence in 1960, Madagascar's economy grew at an average annual rate of about three percent. Agriculture was responsible for much of this growth, with a positive per capita increase in rice production and a substantial growth of agricultural exports. This growth process was, however, highly dependent on external funding and continued reliance for expertise on the former colonial power. 2.2 Starting in 1972, the Malagasy authorities introduced sweeping changes in the political and economic management of the country. Inward-looking policies aimed at self-sufficiency in industry and agriculture, most of the largest private companies were nationalized, interventionist practices characterized by price controls and administrative regulations were adopted, and direct or indirect state control over major agricultural marketing activities was established. Real GDP rose at an annual rate of less than one percent between 1970 and 1978 as agricultural output stagnated and Madagascar, which had been self-sufficient in food production and a net exporter of rice, became increasingly dependent on food imports (especially for rice). Between 1978 and 1980, in an attempt to stimulate the expansion of Madagascar's stagnating economy, the Government embarked on a public investment policy which included several large aned economically non-viable projects. This policy was financed by a substantial increase in external borrowing. Combined with declining terms of trade, this led to a large public sector deficit and rising inflation, together with a heavy external Jebt burden. By 1982, real per capita GDP had fallen by an estimated 28 percent from its 1973 level. 2.3 Faced with an unsustainable resource gap, the Government began implementing financial stabiization measures in 1981, with International Monetary Fund (IMF) assistance. Policy adjustment from 1981 to 1985 focused mainly on containing aggregate demand. During this period, the Government deficit was substantially reduced through cutbacks in public expenditure; the remaining deficit was financed increasingly by foreign loans on concessionary terms. On the external  2 side, the current account deficit was significantly reduced. With stagnating export receipts and increasing external interest payrnents, the brunt of adjustment fell on imports, which dropped by more than half in real terms between 1980 and 1985. The stabilization program succeeded in arresting the decline in real GDP, but economic per capita growth remained negative. 2.4 In the second half of the 1980s, the focus of economic management moved from the urgent need of financial stabilization with IMF assistance towards supply-oriented adjustment measures supported by the Bank and the IMF. The main policy instruments used during the 1983-88 period included increases in producer prices of major commodities followed by a gradual decontrol of most -prices and other internal and external trade liberalization measures, together with significant devaluations in real terms. In 1982, the Malagasy franc (FMG) w:.s pegged to a trade-weighted basket of currencies 1/ and a series of devaluations followed. By mid-1989, the real effective exchange rate had fallen to 45% of its level at the beginning of the decade. Non-tariff barriers to imports were gradually eliminated, and a step-by-step freeing up of foreign exchange allocation culminated in July 1988 with the introduction of a non-discretionary Open General License (OGL) system of foreign excnange allocation for merchandise imports. In the next phase of adjustment, from 1988, an increased emphasis was put on budgetary reform aiud public enterprise privatization. Agricultural Sector Policies and Performance Prior to 1986 2.5 Starting in 1974, the marketing of paddy and rice throughout the country had been a state monopoly impleminted through state companies and/or parastatals with Government majority participation. Decentralized local govermnent authorities were also heavily involved in the primary marketing of paddy and the official distribution of rice. A single price for paddy purchase and for retail rice sales was set by the central Governmenw, at a level that was insufficient to provide producer incentives and significantly below import parity, but that provided substantial consumer subsidies. The problems of managing the official marketing circuits and enforcing the marketing monopoly became increasingly acute, and the share of domestic production officially marketed declined from about 241,000 toris of rice in 1975/76 (representing an estimated 12% of total production) to 93,000 tons or 5% of domestic production in 1982/83. V Faced with stagnating paddy production, declining official purchases and increasing consumer demand due to population growth and low consumer prices, the Govermment had to rely increasingly on rice imports in order to supply the urban markets through the subsidized official channels. Rice imports, which had been negligible throughout the 1960s and early 1970s when Madagascar was a net exporter of rice, increased steadily to reach a high of 287,000 tons in 1982. Consumer subsidy for rice also increased regularly between 1972 and 1981 to reach an aggregate amount of 19 million FMG or 2.5 percent of GDP, exceeding the total budget (operating and investment) of the Ministry of Agricultural Production. In theory, subsidies were financed through a special equalization fund, the "Fonds National Unique de P&requation" (FNUP), whose resources were derived from surpluses of export crop stabilization funds. However, clear arrangements for computing and paying for the subsidy were never worked out, and the parastatal agencies involved in the marketing of rice suffered substantial losses and experienced serious fmancial problems. 1/ Although Madagascar left the franc zone in 1973, the Malagasy franc remained fixed at 50 FMG per French fri.nc until 1982. 2/ Eighty percent of rice production is for auto-consumption.  3 2.6 In 1982, as part of the financial -stabilization efforts undertaken with IMF support, the official retail price of rice was increased by 82%, eliminating explicit consumer subsidies at the prevailing exchange rate. Further measures were taken in subsequent years to promote domestic paddy production and improve urban supply. Private sector marketing of paddy and rice was legalized in 1983, with the exception of the two "reserved areas" of Alaotra and Marovoay, representing about 25% of marketed production, where the Government monopoly and price controls were maintained in order to help supply the official distribution channels. The producer price of paddy was gradually increased from a fixed price of FMG 47 per kg in 1982 to a floor price of FMG 85 in 1985, and the ceiling price of rice to the consumer was eliminated in 1985. In the 1983-85 period, quantity restrictions were imposed on rice imports as part of the IMF Standby agreements. Several problems did arise during this initial phase of reform of the domestic rice market. First, farmers in the monopoly reserved areas were excluded from the incentives of market competition. Second, the authorities disposed of imported and domestically-procured rice stocks in the post-harvest market for political celebrations, in 1985, which not only depleted Government stocks but also depressed prices and encouraged speculation among traders. For these reasons, the supply response was delayed. By end 1985, rice prices on the domestic market had risen sharply, which brought ad hoc trade controls and gave rise to widespread skepticism about the benefits of economic liberalization. 2.7 Stabilization funds for export crops were established shortly before independence, and the corresponding pricing mechanism remained basically unchanged until the second half of the 1980s. A detailed price structure was issued at the beginning of each marketing season, setting the prices and margins at every level in the marketing chain from producer to exporter. The initial purpose of this system was to protect domesth; operators from excessive fluctuations in international prices, and provide a mechanism for financing crop development from export profits. Government's direct intervention in the marketing of export crops was considerably reinforced after 1973, when all trade in agricultural commodities was officially brought under public control. The largest private companies involved in the processing and export of coffee and cloves were nationalized in 1975. In the following two years, state trading companies were given a monopoly for handling exports of coffee, cloves and pepper on behalf of Government, and the role of the private sector became confined to the purchase, processing and storage of these commodities. Although free competition prevailed in primary marketing and processing of these crops, the state trading companies had a competitive edge over private firms as they received a special commission amounting to 10% of export crop revenues. The Government also exerted a broad range of administrative and financial controls over trade in vanilla and other agricultural export commodities. 2.8 Export crops became a major source of Government revenues and the corresponding increases in taxes and levies resulted in a steady decline in real producer prices. This contributed to a stagnating export crop production. Incentives to diversify exports started in 1984, with the elimination of all taxes on non-traditional agricultural exports (i.e. commodities other than coffee, cloves, vanilla and pepper). Producer price increases for coffee in 1984 and 1985 amounted to a total real increase of about 15 percent, but they still remained significantly below the levels received in the early 1970s, and remained unattractive relative to the price of rice. 2.9 Most industrial crops (in particular cotton, sugarcane and oilseeds) were purchased from the producers by parastatals involved in the processing of these crops, at a price that was fixed by Government. With a view to protect consumers, producer and/or ex-factory prices were only infrequently revised with little regard for actual trends in production costs, which discouraged new investments in the production and processing of these crops. Cotton production stagnated at a low  4 level in the 1970s, and the edible oils industry faced increasing difficulties in securing adequate supplies mainly as a result of steadily declining groundnut production from the mid-1970s onwards. The ex-factory price of groundnut oil, which had been previously maintained at a low level giving rise to a high cost parallel market, was also increased in late 1985 from FMG 750 per kg to FMG 1150. Ambitious plans to develop soybean, coconut oil and oil palm production were developed in the late 1970s and early 1980s with the help of external donors; the economic viabilitv of some of these investments was questioned by the Bank and gave rise to controversy during ASAC's preparation and implementation. 2.10 The provision of inputs and services to rural producers also fell largely to the public sector, and underwent a steady deterioration throughout the late 1970s and early 1980s. During this period, commercial fertilizer imports were severely curtailed as a result of foreign exchange restrictions and became mainly confined to a few parastatals dealing with sugar and cotton production. Limited quantities were granted by external donors under aid programs, and sold to farmers at subsidized prices through a network of retail outlets managed directly by the Ministry of Agricultural Production (MPARA); in 1982, MPARA started to transfer its fertilizer distribution activities to a state trading company (Comptoir de Commerce et de Representation de l'Ocean indien, COROI). The availability of all other types of agricultural inputs (pesticides, veterinary products, etc.) and equipment was also limited because of insufficient foreign exchange allocations, and farmers' access to improved seeds and planting materials was further constrained by extremely restrictive quarantine regulations on imports. 2.11 More generally, all services in rural areas (including the management of large and medium size irrigation schemes, rural credit, research, extension and veterinary services, etc.), which were typically under the responsibility of public agencies or enterprises, quickly deteriorated in the late 1970s and early 1980s. This, together with increasing transportation problems due to the dilapidated state of the road network, declining real producer prices for most agricultural products, a-I increasing shortages of consumer goods in rural areas, led to a withdrawal of farmers into a subsistence economy and a sharp decline in marketed output. 3. Credit Origin and Genesis 3.1 An Initial Project Brief for ASAC was issued in May 1984. Policy reforms to be supported by the credit, as envisaged at that stage, were both of a general nature (i.e. integration of counterpart funds of external assistance and of FNUP resources into regular budget mechanisms; improvements in public sector procurement; and streamdining of inter-sectoral management responsibility between agriculture, industry, commerce and transport) and commodity specific, with an emphasis on marketing and pricing policies for rice and other agricultural products, transfer of agricultural inputs distribution to commercial channels, improved resource allocation and management in agriculture, and parastatals reform. Action programs for key subsectors (rice, beef, export crops, edible oils) were to be agreed with Government, and a Bank credit of US$35 million was proposed in order to finance the foreign exchange costs of implementing these programs over a three-year period. Bank financing was to cover the importation of agricultural inputs, credit for the rehabilitation and development of processing plants and other farming or agro-industrial ventures, inputs and equipment for relaunching seed production, purchases of vehicles for transport in rural areas, and a rural roads pilot program. A second Agricultural Institutions Technical Assistance Project (Cr. 1709-MAG), also under preparation at that time, was expected to provide the required support for additional policy  5 analysis and strategy formuiation during implementation. 3.2 During further preparation, the scope of the proposed credit was gradually scaled down and its time span reduced to a two-year period, and financing focused on quick-disbursing balance of payments support. The rural roads pilot program was dropped as it was to be handled through on- going and future infrastructure projects, and the seed production component was reduced to a reform of the quarantine regime to facilitate the introduction of new crop varieties in Madagascar. The proposed policy package became explicitly focused on the completion of reforms already initiated by Government in the marketing and pricing of rice, with measures of more limited scope for other agricultural commodities and for parastatals reform which were mainly designed to prepare the next phase of sectoral adjustment. It was decided that part of the credit would be allocated to the importation of consumer durables for rural areas. The total credit amount was then estimated at US$25 million, and procurement and disbursement were to be done through the allocation of foreign exchange to conunercial importers. 3.3 At a later stage, it was decided that the credit line for sectoral investments should be detached from ASAC and handled separately. This led to the Second Agricultural Credit Project (Cr. 1804- MAG). 3.4 The politically sensitive question of rice marketing gave rise to intense debate during and after the appraisal mission of May 1985. A commitment to open up the reserved areas to free market competition was viewed by the Bank as an essential pre-requisite for restoring producers and traders incentives and promoting increased domestic production. The Government of Madagascar was, however, reluctant to commit itself on this matter until a rice security strategy could be put in place. Access to the large rice surplus of the reserved areas was considered by Government as its best insurance against urban rice shortages and possible political unrest, and the importance of retaining this monopoly had in fact increased following the sharp curtailment of rice imports in 1984 and 1985 under the IMF Standby agreements. During appraisal and post-appraisal missions, Government policy towards edible oils also emerged as another contentious issue. Government was hesitant to allow full liberalization of edible oil prices, arguing that other constraints (ack of seed) were the main limiting factors to domestic groundnut production. For export crops, it was agreed that the 10% special commission benefiting parastatals would be gradually eliminated and that Government would increase the producer price of coffee. Management of the export crops stabilization funds and of FNUP resources were to be improved, and studies would be carried out in order to examine options for simplifying the pricing and taxation system for export crops and promoting the diversification of agricultural exports. Detailed terms of reference for studies on the management of counterpart funding and on the finances of decentralized local authorities including their involvement in the taxation of agricultural products were prepared. 3.5 In December 1985, conditions for negotiations (i.e. announcement by Government of acceptable prices for paddy in the reserved areas, and for ex-factory edible oil) were met. During a visit to Madagascar in early November, the Regional Vice President had agreed with the President of Madagascar that the Bank would encourage other donors to finance the establishment of a rice buffer stock and participate itself on a last resort basis, as a Quid pro quo for the opening of reserved a:eas to private traders and the adoption of appropriate practices for counter-seasonal release of imported rice on the domestic market. Definition and mechanics of the buffer stock were worked out during negotiations.  6 3.6 At the Loan Committee meeting of December 1985, several committee members questioned the proposal for a rice buffer stock to be fmanced by the Bank. It was clarified that the proposal was for the Bank to define with Government a program to manage rice-imports and their sale. The Bank would encourage the donor community to finance Government rice inports on concessional terms, .and would provide financing for these imports only as a last resort. As post-appraisal missions had identified several projects of doubtful economic value in the draft 1986488 agricultural public investment program, the Chairman of the Loan Committee meeting also stated that the Credit should be presented to the Board only when the Bank would be satisfied with the agricultural PIP. The Loan Committee agreed on negotiations for a US$60 million package (including grant financing), of which US$45 million would be allocated for agricultural inputs including the possibility of rice buffer stock financing, US$5 million for incentive goods and US$10 million for transportatio-1 equipment and spare parts. 4. Credit Objectives and Desceiption 4.1 The objectives of ASAC, as described in the President's Report, were: (i) to improve the returns on scarce resources in agriculture by financing from public sources only selective investments of high priority; (ii) to put into place a coherent rice strategy to restore market confidence, improve productivity and reduce pressure on the balance of payments; (iii) to provide better incentives to farmers and improve marketing networks; and (iv) to help formulate consistent strategies for the next phase of adjustment. 4.2 ASAC was designed to support a deepening of the sector policy reforms initiated by Government in the first half of the 1980s and put them into a coherent framework, thus allowing expected benefits to materialize. To help restore credibility to the reform program, which had so far largely fallen short of its goals, the Bank felt that the Government should tackle the rice problem first, which was one of the main causes for resistance to liberalization among political forces, while continuing to move gradually with other areas such as edible oils and export crops and improving overall resource allocation in agriculture. Progress under ASAC was expected to set the stage for a follow-up sector adjustment credit that would expand into edible oils and export crops, and the use and management of export crops receipts. 3I Credit Conditlonafity 4.3 The full liberalization of domestic rice trade was a condition of Board presentation. It was agreed that Government would manage its rice imports in accordance with principles agreed with the Bank during negotiations. The rice management program was summarized in an annex to the letter of development policy, and the corresponding technical parameters (i.e. trigger price for sales of imported rice on the domestic market, quantities of rice to be distributed each year to low-income consumers through official channels, rules for the replenishment of Government's buffer stock of imported rice) had also been agreed upon during negotiations. Before October 31 of each year, Government was to submit to the Bank for approval its rice import program for the following year and the corresponding financing plan. Government was also to fiunish to the Bank quarterly reports on rice inports and stock management. The implementation of a rice management program 3I President's Report, paras 35 and 39.  7 acceptable to the Bank was a condition for second tranche release. 4.4 Under ASAC, Government was to submit to the Bank by end October 1986 a program for the promotion of private sector participation in the marketing of agricultural products, and to take appropriate action for its implementation in particular through improvement in credit access and streandining of administrativeprocedures. A study and action plan on local government finances was also required prior to second tranche release, with a view to finding alternative sources of local revenues to the taxation of agricultural products and promoting their free circulation within the country. 4.5 The ex-factory price of groundnut oil had been increased by Government in late 1985 to a level that was judged acceptable by the Bank, pending the completion of an edible oils strategy study that was being launched by Government with the help of UNDPIUNIDO, under terms of reference agreed with the Bank during negotiations. Based on the results of this study, Government was to agree with the Bank on an action program for the edible oils subsector and take appropriate action for its implementation as a condition for ASAC second tranche release. For export cs. Government had already reduced the special commission for parastatals to 7% prior to Board presentation, and it was to be further reduced to a maximum of 4% by April 1987 and eliminated by April 1988. The setting of producer prices for coffee in accordance witha methodology acceptable to the Bank was a condition of Credit effectiveness. Studies were to be carried out, and corresponding action plans presented to the Bank prior to second tranche release, on: (i) the disposition of the surplus generated by export crops, including the future of the export crop stabilization funds; A/ and (ii) Madagascar's potential and comparative advantage in coffee production, and the administration of export crops. 51 The implementation of improved pricing systems for major export crops was a condition for second tranche release. 4.6 ASAC also supported the elimination of subsidies on agr.cultural inpMt, and the transfer of corresponding distribution activities to commercial (rather than Ministry-operated) channels. Average subsidies on agricultural inputs, which amounted to an estimated 30% for fertilizer and even more fur pesticides, were to be reduced to a maximum of 7% of c.i.f. cost by the time of Credit effectiveness, and to be fully eliminated thereafter as a condition for second tranche release (except for a naximum of 5% on pesticides and for pesticides used for demonstration purposes by the extension service). As a condition for second tranche release, Government was to implement a program acceptable to the Bank for the promotion of the role of commercial enterprises in the importation and marketing of agricultural inputs and veterinary products. ASAC credit proceeds were to be used for the importation of inputs and other goods by local commercial firms, thus also contributing to the development of commercial channels for input distribution. In order to facilitate farmers' access to improved seed varieties developed abroad, new quarantine regulations were to be enacted as a condition of Credit effectiveness. A/ It had been agreed during negotiations that this study would be financed with remaining funds under Credit 881-MAG (Mangoky Agricultural Development Project). These studies were to be carried out jointly with the Bank as part of its sector work. In addition, funds were to be provided under the forthcoming second Agricultural Institutions Technical Assistance Project (Cr. 1709-MAG) for the elaboration of an export crop development and diversification program.  8 4.7 Following the questions raised during post-appraisal on the public investent program (PIP) for agriculture, Government had agreed to undertake new feasibility studies and/or furnish additional information to the Bank before proceeding with the contentious projects (which included two agro- industrial projects respectively for oil palm and cashew nut, a copra project, three rural development or irrigation projects, and a soybean production project to be dropped). Under ASAC, Government was to consult with the Bank on any change on the agricultural PIP for the years 1986-1988 and 1987-1989, and to seek the Bank's agreement prior to proceeding with any new investment costing the equivalent of US$5 million or more. The adoption of a 1987-89 PIP for agriculture acceptable to the Bank was a condition for second tranche release. Disbursement and Procurement Mechanisms 4.8 The total credit proceeds of about US$60 million equivalent (including an IDA credit of SDR 19 million and a SFA credit of SDR 31 million, together with a grant from Japan of Yen 600 million and a credit from Germany of DM 10 million) were to be disbursed in two tranches, the first one (US$32.5 million equivalent) released upon loan effectiveness and the second one (US$27.5 million equivalent) contingent upon satisfactory progress in carrying out the sectoral adjustment program. Financing was provided for US$42 million equivalent for agricultural inputs and, if needed, rice, US$3 million for veterinary products, US$5 million for incentive goods and US$10 million for tractor and transport equipment. 4.9 Agricultural inputs, incentive goods and equipment financed under the Credits were to be purchased abroad by local commercial firms, with the exception of some veterinary products that maight be purchased by Government and rice imports that would be allowed only as a last resort after consultation between Government and the Bank. For fertilizers, pesticides, veterinary products, tractors and tires for transport equipment, it had been agreed during negotiations that Government would invite bids from importers and allocate the required foreign exchange to the lowest bidders. A limit of US$3 million equivalent per importer had been set in order to avoid collusion among a few importers. As a general rule, importers using foreign exchange from ASAC proceeds were required to provide evidence that they had followed the procurement procedures agreed with the Bank. In order to manage the financing of imports under ASAC, Government was to enter into subsidiary agreements with the three national banks (BTM, BFV and BNI) who would act as intermediaries with importers, and provide the required support for implementing the agreed procurement and foreign exchange allocation mechanisms. 5. Credit Implementation 5.1 Effectiveness. ASAC became effective on November 18, 1986, about four months behind original schedule. Late effectiveness was mainly due to administrative delays in drawing up the manual on import procurement procedures and finalizing the corresponding subsidiary agreements with intermediary banks. After effectiveness was declared by the Bank, public announcement of the availability of ASAC funds was made by Government only in early January, thus contributing to further delays in initial disbursements. 5.2 Second tranche release. The release of the second tranche, originally expected in May 1987, took place in May 1989 only. Besides slow disbursement of the first tranche, several factors contributed to this delay, including initial disagreements on several projects included in tl:e public  9 investment program for agriculture, and difficulties in defining the contents of the edible oils action program and the corresponding steps to be taken by Government prior to tranche release. The Bank's position on the elimination of fertflizer subsidies was significantly softened before second tranche release, on the grounds that available supplies from donations largely exceeded potential domestic demand at fl import-parity prices. After Initial successes that translated into a significant improvement of producer and trader incentives, performance under the rice management progrun had quicldy deteriorated with the onset of the 1988-89 election campaign and the resumption of rice distribution to urban consumers at sub-market prices. By the time of second tranche release, however, it was felt that significant results had been obtained under this difficult and politically- sensitive component of ASAC, and that Government had carried out the rice management program in conformity with the Development Credit Agreement. 5.3 Disbursements. First tranche disbursement took thirty-two months, instead of the twelve to sixteen months originally anticipated. Tbis was pardy due to sluggish demand for commercial imports of fertilizers and other agricultural inputs after the mid-1987 devaluation. A contributing factor was also the progressive introduction of the market-based OGL system of foreign exchange allocation, which the Bank supported under its subsequent adjustment operations. The Industry and Trade Policy Adjustment (ITPAC) and the Public Sector Adjustment (PSAC) Credits made foreign exchange available to banks and importers under administrative procedures that were less restrictive and time-consuming than those required under ASAC. This difficulty was solved upon ASAC second tranche release, as it had been agreed in advance during negotiations of n`PAC that coherence would be ensured by disbursing ASAC funds, after second tranche release, under the OGL import regime. 5.4 ASAC's second tranche was nonetheless fully disbursed only in October 1990, mainly due to administrative delays on Government side. In December 1989, the Bank agreed on an exceptional basis to finance petroleum products from ASAC proceeds. 6. Implementation of Individual Components Rice management program 6.1 The rice agreement worked out during ASAC negotiations was primarily a program to manage rice imports and their sale, in a way that would restore producers and traders incentives and allow Madagascar to regain self-sufficiency. Underlying the agreement was acceptance of Govermment's monopoly on importing rice until 1990, when self-sufficiency would be attained and rice imports would no longer be needed. The essential element of the rice management program was the sale of imported rice on the domestic market when the market price exceeded a trigger price, set during negotiations at an initial level of FMG 480 per kilogram. .6I While providing adequate incentives to producers and traders, this mechanism also aimed at containing excessive seasonal price fluctuations which had been disrupting the market and badly hurting consumers in previous years. It was also agreed that the official distribution of rice (i.e. the Government operated ration scheme that provided rice at sub-market prices to urban residents), based on imported rice, would be