Cambodia - Emergency Rehabilitation Project

- s r~~~~~~~~~~~~~~~~(r f. ReotN:PU0sK | X, Type: MOP  CURRENCY BOUIVALENT (September 1993, official rate) Riel 2600 = 1 US dollar WEIGHTS ND MEAS=S Metriz System ABBREVIATIONS ADB Asian Development Bank CMEA Council for Mutual Economic Assistance ERC Emergency Rehabilitation Credit DC Direct Contracting ICB International Competitive Bidding ICORC International Committee for the Reconstruction of Cambodia IDA International Development Association IDF Institutional Development Fund IMF International Monetary Fund IS International Shopping NBC National Bank of Cambodia NCRD National Committee for Rehabilitation and Development NGO Non Governmental Organization PED Policy and Human Resources Development Fund of the Japanese Government PIA Project Implementation Agency PIU Project Implementation Unit SIDA Swedish International Development Authority SDR Special Drawing Right STF Systematic Transformation Facility UN United Nations UNDP United Nations Development Programme UNHCR United Nations High Commissioner for Refugees UNTAC United Nations Transitional Authority in Cambodia FISCAL YEAR January 1 - December 31  FOR OMCAL US ONLY RINGDOM OF CAMBODIA EMERGENCY RRHABILITATION PROJECT CREDIT A_ND PROJECT SUMMARY Borrower: Kingdom of Cambodia Amount: SDR45.2 million (US$62.7 million equivalent) Terms: Standard, with 40 years maturity Financing Plan: Local Foreign Total -------- US$ million --------- IDA - 62.7 62.7 SIDA - 2.3 2.3 Government 8.1 8.1 Total 73. Economic Rate of Return: Not applicable Poverty Category: Not applicable Staff Appraisal Report: Not applicable; Implementation Volume is available upon request. mm: IBRD No. 24293 This docuiment has a restricted distribution and may be used by recipients only in the ptrftrmance of their olficial duties. Its contents may not otherwise be disclosed without World Bank atthor2ztion.  KINGDOM OF CAMBODIA EMERGENCY REHABILITATION PROJECT Table of Contents PART 1 - RECENT ECONOMIC DEVELOPMENTS AND PRIORITIES . . . . . . . . . . 1 Recent Economic Developments . . . . . . . . . . . . . . . . 1 . . I Sector Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Policy Objectives and Medium Term Outlook . . . . . . . . . . . . . 6 Objectives . . . . . . . . . . . . . . . . . . . . . . . . . 6 Macroeconomic Framework . . . . . . . . . . . . . . . . . . . 6 The External Environment . . . . . . . . . . . . . . . . . . 8 Governing Framework . . . . . . . . . . . . . . . . . . . . . . . . 9 The IDA Country Assistance Strategy . . . . . . . . . . . . . . . . 9 Relations with IDA . . . . . . . . . . . . . . . . . . . . . 9 objectives of IDA Assistance . . . . . . . . . . . . . . . . 9 Lending . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Economic and Sector Work . . . . . . . . . . . . . . . . . . 11 institutional Development and Technical Assistance . . . . . 11 Performance Indicators . . . . . . . . . . . . . . . . . . . 12 Relations with the IMF . . . . . . . . . . . . . . . . . . . . . . 12 Aid Coordination . . . . . . . . . . . . . . . . . . . . . . . . . 13 Issues for Board Consideration . . . . . . . . . . . . . . . . . . 13 PART 2 - THE CREDIT . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Project Objectives and Scope . . . . . . . . . . . . . . . . . . . 14 Project Description . . . . . . . . . . . . . . . . . . . . . . . . 15 Cost Estimates and Financing Arrangements . . . . . . . . . . . . . 16 Project Implementation . . . . . . . . . . . . . . . . . . . . . . 16 Agreements Reached . . . . . . . . . . . . . . . . . . . . . . . . 17 Environmental Aspects . . . . . . . . . . . . . . . . . . . . . . . 18 Benefits and Risks . . . . . . . . . . . . . . . . . . . . . . . . 18 Recommendation . . . . . . . . . . . . . . . . . . . . . . . . . . 19 ANNEXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 AlINXU 1: Key Economic Indicators . . . . . . . . . . . . . . . . 21 ANNEX 2: Core Expenditure Program . . . . . . . . . . . . . . . 22 Table 1: Core Expenditure Program and Other Rehabilitation Activities . . . . . . . . . . 24 Table 2: Financing of the Rehabilitation Program . . . 25 Table 3: External Financing Requirement - 1993-94 . . 26 ANNEX 3: Summary Cost Estimates . . . . . . . . . . . . . . . . 27 ANNEX 4: Implementation Arrangements . . . . . . . . . . . . . . 28 Table 1: List of Goods and Materials to be Imported by Specific Type . . . . . . . . . . . . . . . . 33 ANNEX 5: Timetable of Key Events . . . . . . . . . . . . . . . . 35 ANNEX 6: Status of Bank Group Operations . . . . . . . . . . . . 36  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF CAMBODIA FOR AN EMERGBNCY REHABILITATION PROJECT 1. I submit for your approval the following memorandum and recommendation on a proposed development credit to the Kingdom of Cambodia for 8DR45.2 million (US$62.7 million equivalent), on standard IDA terms with 40 years maturity to help finance an emergency rehabilitation project. Economic indicators and a map (IBRD No. 24293) are attached. An Implementation Volume is available upon request. PART 1 - RECENT ECONOMIC DEVELOPMENTS AND PRIORITIES 2. The signing of the Paris Accords in October 1991 set in motion a peace process under the aegis of the United Nations, which culminated in the conduct of free and fair elections in May 1993, the promulgation of a new constitution and the establishment of an elected government in September 1993. The United Nations operation, initiated in November 1991 and carried out by the United Nations Transitional Authority in Cambodia (UNTAC) is now completed. 3. Rehabilitation activities were an essential part of the transition process, so much so that this was the subject of one of the instruments of the Paris Accords, i.e. the Declaration on the Rehabilitation and Reconstruction of Cambodia. on April 20, 1992, the Secretary-General of the United Nations (UN) launched in Pbnom Penh an Appeal for Cambodia's Immediate Needs and National Rehabilitation, requesting the international community to provide assistance for humanitarian activities and for the rehabilitation and operation of basic public services, through project and program aid. 4. A Ministerial Conference on Cambodia, held in Tokyo in June 1992 pledged some US$880 million to the country's rehabilitation and endorsed the priorities identified in the UN Secretary General's Appeal for Cambodia's Immediate Needs and National Rehabilitation and detailed in a joint document by Asian Development Bank (ADB), International Monetary Fund (IMP), United Nations Development Programme (UNDP) and World Bank. 5. The successful implementation of the Paris Accords required restoring a sustainable degree of economic stability to minimize social and regional tensions that could frustrate national reconciliation. A crucial element of this objective was anti remains the rehabilitation of essential public services and infrastructure to ensure the maintenance of a functional administration. The proposed Emergency Rehabilitation Credit is an element of a continuous broad based international effort to support the rehabilitation program. Recent Economic Develorments C. With the long awaited return to peace, Cambodia can devote its resources once agair to the goal of development. However, with insufficient resources to generate productive income, and isolated from the mainstream of world trade, Cambodia has run down its physical capital and has severely depleted its human resources. While considerable headway was made in putting the country back to  work after the turmoil of the late 1970s, these efforts are now running out of steam. With the loss of aid from the former Council for Mutual Economic Assistance (CMEA) and only modest amounts of western aid so far, nothing is being set aside to maintain social capital, and no surplus resources are available with which to begin the process of rehabilitation and recconstruction. 7. Thus, in recent years, the authorities have relied primarily on improving policies to keep the economy afloat. These reforms, however, were undertaken more as a partial and ad hoc response to emerging difficulties than as a comprehensive and consistent plan. They have consequently yielded uneven results. on the positive side, starting in 1989, agricultural land was returned to the tiller, which has greatly facilitated the recovery in food production. On the other hand, the process of enterprise reform has been more uneven. In late 1989, the authorities launched a new system of financial autonomy for state enterprises, under which enterprises were supposed to operate without administrative interference. In practice, however, operational autonomy is still curtailed by the necessity for the budget to extract as much revenue as it can from them. More recently, privatization has become another important strategy of the Cambodian authorities to reform the state enterprise sector. In many cases the process has, unfortunately, been akin to "spontaneous privatization"; hence it has generated little divestiture revenue for the budget. 8. Nevertheless, the foundation for a new pattern of development resting firmly in private hands is being established. Informal sector industrial activity and the support sectors of distribution and transport have been growing rapidly over the past four years. Small private firms have been multiplying and expanding at a rapid rate. Market reforms have thus brought about a positive, but uneven, supply response, as the economy remains subject to the vagaries of the weather, lack of security and to unreliable access to imported raw materials and spare parts. GDP in real terms (constant 1989 prices) has experienced uneven growth in recent years, advancing by 3.5 percent in 1989 and 1.2 percent in 1990, before recovering to 7.6 percent in 1991 and 7.0 percent in 1992 in response to reforms since 1991. While output of state enterprises was in relative decline, private activities took the lead in fostering economic growth. 9. This expansion of private activities, however, is increasingly threatened by a breakdown in the supply of basic infrastructure services and by growing macroeconomic imbalances. These have inflicted high inflation on the country, running at 91 percent in 1989, 152 percent in 1990, 88 percent in 1991 and 177 percent in 1992. Although prices stabilized somewhat during the second quarter, the price level rose by 93 percent during January - June 1993. 10. The country's present macroeconomic imbalances are due to the rapid deterioration in the financial position of the budget. Even after public investment and maintenance expenditures were curtailed to negligible levels, the budget showed a huge financing gap, representing about 36 percent of total expenditure in 1992. In 1992, about 46 percent of total expenditures were financed out of monetary creation. The origins of these developments emerge most clearly from an examination of the trends of revenues, expenditures and external financing in relation to GDP. Revenue collection declined from 6.4 percent of GDP in 1989 to 3.9 percent in 1990, 4.4 percent in 1991 and 6.2 percent in 1992. Budgetary expenditures remained roughly constant relative to GDP, at around 8-9 percent during the 1989-92 period. The public deficit thus widened by 1-2  -3- percentage points of GDP during the 1989-1992 period; in the meantime, the country lost the assistance of the former CMEA, throwing the burden of finanuing this deficit almost exclusively on the domestic sector, i.e., largely on monetary creation. 11. Two series of factors have contributed to this situation. First, the liberalization of the economy starting in 1989 has acted to hinder revenue mobilization and inflate expenditures. On the revenue side, Cambodia is experiencing conditions similar to those in many other formerly planned economies. Enterprise reform combined with price and trade liberalization has slashed the economic rents formerly captured by public sector enterprises through price distortions and budget subsidies, inevitably impairing their capacity to contribute to fiscal revenues. Owing to lack of appropriate instrwments and administration, this loss of revenues has not been made up by revenues from the emerging private sector. The contribution made by public enterprises to budget revenues (including enterprises leased to the private sector) fell from 36 percent of total expenditure in 1989 to 20 percent in 1992, and the budget anticipates a further decline in 1993. In an attempt to deal with this problem, several new taxes have been introduced by the authorities in major tax reforms since 1991, but these have made only a small contribution to the budget so far. User charges and other non-tax revenue sources were even less buoyant than taxes in the period under review, falling from 5.5 percent of budgetary expenditures in 1989 to 1.6 percent in 1992. Fortunately, the elimination of customs duties exemptions that benefitted state enterprises and imports from the nonconvertible zone has allowed these revenues to increase their contribution from 8.5 percent of expenditures in 1989 to 32 percent in 1992. During the first half of 1993, despite additional tax measures, total revenues remained disappointingly low as external trade dampened customs duty receipts and the outgoing Government was unable to enforce fully tax collection. 12. On the expenditure side, the gradual elimination of forced procurement from the productive sector at below market prices has considerably increased the unit cost of the goods and services that the state procures for operations and investment. The attempt to protect the real value of large categories of expenditure, particularly civil servantsI wages and defense, has put immense pressures on the total expenditure bill (despite a concomitant reduction in public employment from 213,000 persons to 151,000), practically crowding out categories of expenditure, such as public investment and operations and maintenance; the latter saw their share in the budget reduced from 41 percent in 1989 to 16 percent in 1992. During the first half of 1993, the Government scaled down current expendituras further by, among others, postponing wage payments in response to the sharp loss of revenues. 13. The second factor contributing to the current fiscal situation has been the elimination of CambodiaIs credit facility under the 1986-90 trade and payment agreement with the former Soviet Union. Commodity aid received under this agreement still financed 15 percent of budgetary expenditures in 1989, but the agreement was not renewed after 1990. The implementation of a non-humanitarian aid program from international agencies and Western bilateral donors has only partially made up for this loss. Thus, with the important exception of humanitarian aid, which was about US$20-30 million a year in 1990-92, foreign assistance under the form of project and commodity assistance declined to an estimated US$ 26.8 million in 1992. During the first half of 1993, only US$8  - 4 - million under the form of project and commodity assistance was disbursed due to political uncertainties. 14. A monetized deficit of only a few percentage points of GDP can give rise to high levels of inflation in Cambodia because the demand for taonetary assets is as low as 6 percent of GDP. A lingering mistrust of banks and local cu-rency, resulting from the demonetization of the economy under the Democratic Kampuchea regime, is obviously at play here, but the fact that official policy maintained nominal interest rates at unrealistically low levels did not help the situation: until December 1992, Riel-denominated savings deposits paid 12 percent per annum, and one-year time deposits 28.8 percent, rates which were well below past, present, and expected future inflation. Since December 1992, banks are allowed to offer three month riel - denominated deposits at an interest rate of 6 percent per month. 15. In brief, owing to the growing fiscal crisis, key infrastructure, already crumbling after years of destruction and neglect, is no longer being maintained and civil servants fail to provide essential services. The authorities cannot plan for, much less undertake, new activities to accommodate additional demands placed on infrastructure and services. Sector Issues 16. The deterioration is nowhere more visible than at the sectoral level, where services and infrastructure are already experiencing considerable strain. Across sectors, fiscal pressures have exacerbated prevailing structural deficiencies in all the public services. It is now imperative to arrest this deterioration if any meaningful rehabilitation is to take place. The following discussion reviews this situation sector by sector. 17. Transport infrastructure is in a state of great disrepair. After 10 years of neglect and destruction during the 1970s, transport services resumed in 1980 and managed to operate with a minimal degree of efficiency despite severe shortages of material, human and financial resources. This has indeed been a remarkable achievement. Many roads and bridges have been patched temporarily to allow movement of goods and people. Major ferry crossings of the Mekong and the Tonle Sap Rivers have been kept open. Ports have continued to function and river ships and barges have managed to move the freight. Despite a severely deteriorated roadbed, rotted sleepers, mangled tracks, and an old rolling stock, the railways have managed to operate. At present, it is estimated that transportation infrastructure is functioning at about 40 to 50 percent of prewar capacity. Since 1990, the rapid deterioration of the fiscal situation following the drying up of Soviet aid put additional pressures on transport services already subject to considerable strain. Budget appropriations have shrunk and arrears have accumulated to such an extent that even routine road and bridge maintenance, let alone new construction, have come to a virtual standstill. The equipment of transport companies have been cannibalized or rapidly rundown, and the finances of the railway company have deteriorated to a point where interruptions of services are a distinct prospect. 18. Utilities and urban services, which were generally able to meet the country's requirements in the 1960s, are now woefully inadequate to accommodate present and fixture demands. Only about 20 percent of the population in Phnom  Penh is served by piped water. Drains are silted and clogged since refuse collection is almost nonexistent. As a result, sanitation problems and major health risks are serious. Power shortages are so acute that economic activities and the provision of essential power-dependent services (water treatmerst and pumping, telecommunications, hospitals, etc.) are severely curtailed. However, obsolete equipment accounts for only part of this situation. Rather, the problem is that the largest consumers of these services (the administration and other public entities) are increasingly unable to meet their bills, leaving the utilities with no resources with which to purchase fuel, spare parts, and other inputs. Moreover, the prevailing scarcity of supply gives rise to widespread pilferage of water and electricity, further depres,ing the finances of the utilities. 19. Social sectors, after their near-destruction in the turmoil of the late 1970s, have shown considerable progress in cuantitative terms, in resurrecting social services. Official efforts, supported by the local communities, have created an extensive education system in which an estimated 82 percent of the population of school age is enrolled. Similar efforts, although more unevenly successful, have oeen deployed in the rehabilitation and staffing of basic health structures, providing one physician per 12,800 population, one nurse per 6,300 population, and one hospital bed per 1,440 population. This is certainly much lower than overall Asian standards although Cambodia fares better than some Asian countries which have not experienced any of the devastation that the country suffered. Achievements in aualitative terms, while impressive under the circumstances, are uneve~n by comparison. The dropout rate in education is high, especially among girls, with only about 40 percent of children enrolled in the first grade completing education within five years. The literacy rate is officially reported at 93 percent, but a more conservative estimate places it at about 70 percent. Also, while on paper rural health facilities are in place in most districts, it is estimated that fewer than 53 percent of the population has access to health services and only 12 percent of the rural and 20 percent of the urban population have access to a safe and reliable source of water. All health indicators show the mark of the still insufficient level of services. 20. At present, due to fiscal pressures, however, the delivery of services is deteriorating rapidly. Social infrastructure maintenance and rehabilitation have almost ceased; production and distribution of textbooks have virtually come to a standstill; and suppliers of pharmaceuticals to the public sectors are stopping their deliveries. While they are still officially illegal, all types of fees are now charged in education and health that have enabled some degree of *services to continue - although inequitably. 21. Aariculture, which employs 84 percent of the population, has been comparatively less affected than other sectors by current pressures. Crop production, now largely in private hands, has been able to progress in spite of the country's problems. However, major constraints persist, including the mining of large tracts of arable land and the security situation (which still hinders both planting and marketing), the dilapidated state of transport infrastructure and the inability (since the cessatiorn of aid from the former CMEAI to import the level of fertilizers needed. Fiscal pressures have affected those areas in which the role of public services is irreplaceable -- or as yet unreplaced -- such as fisheries and forestry management, where the day-to-day operations rely on the  capacity of the administration to charge and retain fees and other payntents, outside the public finance framework. Policy Obtectives and Medium Term Outlook ObiJectives 22. The immediate objectives of the Cambodian rehabilitation program are to restore macroeconomic stability, to ensure adequate functioning of the administration of the newly formed government and to maintain essential services that were partially restored during the last decade. To this end, the economic priorities for the remainder of 1993 and 1994 are (a) to frame rehabilitation activities within a macroeconomic strategy that would bring dowu inflation to more acceptable levels and (b) to establish the basis for a broader, longer-term reconstruction effort. This will be done through the delivery of a core expenditure program based on a feasible fiscal strategy aimed at (a) ensuring the rehabilitation of the most critical public infrastructure and (b) maintaining the delivery of essential services to the j.opulation. This strategy necessitates renewed efforts at public resource mobilization and monetary restraint, on the one hand, and the restoration of minimum appropriations for operation and maintenance of essential services, and public investment, consistent with the macroeconomic objectives and the availability of foreign assistance, on the other hand. Macroeconomic Framework 23. The macroeconomic framework that underpins the rehabilitation program has been defined in close collaboration with the International Monetary Fund and the Bank and is common to the two institutions. It will be supported by a first tranche release of SDR6.25 million under the Systemic Transformation Facility. (The key features of the macroeconomic framework are outlined in Table 1, Annex 1) . 24. It is expected that arowth could accelerate to 7-8 percent during the initial years of recovery, compared with projected 5.5 percent growth in 1993, as private sector activity would respond to a more stable environment and the rehabilitation of key infrastructure would be undert.-ken. Inflation would decline to about 10 percent by the end of 1994, compared with 98 percent inflation in 1993. The implementation of the rehabilitation program would thus bring about a steady improvement in the living standards and per capita income of the Cambodian people. It would ensure that the initial boost to the economy provided by the United Nations' presence will be sustained over the mediun term. Production in agriculture and in the modern sector is still constrained by (a) lack of inputs such as fertilizers and fuel, (b) fragile security situation and (c) decayed infrastructure. However, the alleviation of import constraints through program aid, the consolidation of the peace process and the removal of some of the most critical infrastructure bottlenecks under the rehabilitation program will help establish conditions under which refugees, displaced persons and demobilized soldiers can put their resources and skills to productive uses. An expanding marketable surplus, the resumption of private and public investment, a recovery in public services, the integration of the economy into world markets, and the continued development of an active private sector will be the main fuel for the engine of growth.  - 7 - 25. Further steps have been taken to stem the macroeconomic deterioration described in paras. 8-14 and make it feasible to start rehabilitating the country. The authorities have started to implement a package of economic actions including (a) new revenue measures in customs, such as a switch to a uniform ad valorem for the consumption tax on imports, as well as in the area of domestic taxation, such as the extension of the hotel room tax to cover restaurants, (b) introduction of a new budget nomenclature and accounting procedures (c) introduction of reserve requirements for commercial bank deposits and (d) maintaining the interest rate provided under the three-month Riel deposit scheme positive in real terms. Adontion of such a package was a condition of Board Dresentation of the nronosed credit as well as of the IMF program, and has been fulfilled. 26. Under present circumstances, fiscal nolicv remains the strongest instrument available to achieve the twin objectives of rehabilitation and stabilization. These objectives will be imbedded in the 1994 budget which is being prepared in consultation with IDA. During project implementation, IDA will need to be satisfied that the execution of this budget, or any revision thereof, meets the rehabilitation priorities. Failure to do so would be a cause of default. In order to achieve the target of reducing inflation to 10 percent in 1994, this budget will drastically reduce domestic bank financing of the budget to no more than 0.1 percent of GDP. With the introduction of the economic measures mentioned in para. 25, further supplemented by new actions to strengthen the buoyancy of customs duties and increases in the taxes on petroleum products, the erosion of budgetary revenues should be arrested and such revenues should pick up again from 5.0 percent of GDP in 1993 to 6.6 percent in 1994. 27. With the expected aid disbursements, total expenditures will expand in 1994 to about 15 percent of GDP (including those expenditures in the core rehabilitation program which may be financed directly by donors), compared to about 10 percent in 1993. A continued reorientation of expenditure priorities will, however, be necessary. In particular, a wage restraint mechanism will remain in place as long as the constraint on the net recourse to monetary financing of the budget remains binding. As security conditions are expected to improve, defence and public security expenditures would decrease to 3.3 percent of GDP in 1994 compared to 3.8 percent in 1993. 28. As regards operation and rehabilitation, priority is being given to restoring minimum appropriations for operating expenditures. Within the overall financial constraint, public investment would recover substantially from about 2.5 percent of GDP in 1993 to about 6 percent in 1993, concentrating on repairing existing infrastructure and re-establishing critical services. 29. Monetary Policy will further support the attainment of the inflacion objective. To contain the expansion of liquidity to 20 percent during 1994 compared to a projected 32 percent during 1993, net credit to government will be limited to less than 0.1 percent of GDP. To support economic activities, credit to the rest of the economy will be allowed to grow by 48 percent. Within this category, though, it is expected that credit to the private sector will continue to expand fastest, supporting efficient economic activities, with no expansion in credit to state enterprise.  30. Monetary restraint will be facilitated by the maintenance of interest rate guidelines from the National Bank of Cambodia, directing commercial banks to set term deposit rates above some minima, the level of which exceeds the inflation target. Commercial banks will be free to set their lending rates as they see fit, provided they charge a positive spread on all maturities. Prude..tial rules are also being established to regulate the rapidly expar.ding banking business. 31. To encourage the flow of foreign exchange through official channels, the official exchanae rate will be adjusted flexibly to maintain it within a r percent range of the market rate through December 1993 and within 3 percent through June 1994. This policy combined with the expected inflow of foreign capital should permit a US$ 17.5 million build up in foreign reserves, bringing them from 2.2 to 2.6 weeks of imports between 1993 and 1994 (excluding transit trade). The External Environment 32. Cambodia should initially benefit greatly from its current opening up to the world economy, after almost two decades of isolation from the rapidly growing South-East Asian market. Trade liberalization has resulted in expanded transactions with the convertible zone. Until 1987, all foreign trade was under state monopoly and most transactions governed by annual protocols with Council for Mutual Economic Assistance (CMEA) countries. Starting in 1988, private companies were gradually allowed t'. operate in foreign trade. The expansion of trade with the Western world was further supported when the port of Sihanoukville was opened up to international shipping and the coastal provinces of Koh Kong and Kampot were authorized to trade independently with Thailand and Singapore. The initial progress in reorienting trade smoothed to some extent the impact of the abrupt cessation of trade and payments relations with the ex-CMEA countries (except Viet Nam). 33. The opening of the economy and the signing of the Paris Accords caused an immediate surge in foreign investment, for instance in hotels and privatized state enterprises, coming primarily from Cambodia's trade partners of Thailand and Singapore. This immediate reaction was facilitated by the earlier adoption of a liberal foreign investment code and by the links between the Sino-Khmer community, in Cambodia and overseas, with the business communities of East Asia. 34. In addition, owing to its low customs duties and weak snforcement, Phnom Penh has become a hub of sorts for transit trade in the regiL , especially with Viet Nam. It is estimated that about half the imports of _ambodia is being reexported, primarily to Viet Nam. A further boost to the regional integration of Cambodia's economy in world business was the lifting in early 1992 of the US embargo that had been in place since 1975. A future lifting of the US embargo on Viet Nam, however, may reduce the attractiveness of Cambodia as a transit point to Viet Nam although this negative impact would probably be counterbalanced by (a) the consequent boom in the overall volume of regional trade and (b) initially, the fact that Cambodia has two seaports, whereas Viet Nam does not yet have any in neighboring provinces. Finally, the return to peace should permit the full reactivation of the Mekong Community and the development of a water management policy common to riparian states.  9- Governing Framework 35. Cambodia's present governing framework is derived from the implementation of the provisions of the "Agreements on a Comprehensive Political Settlement of the Cambodia Conflict" (the "Paris Accords"). The Paris Accords were signed on October 23, 1991 by representatives of Cambodia's four political factions and seventeen UN member states. 36. Following the election of the Constituent Assembly in June 1993 pursuant to the terms of the Paris Accords, an interim government was formed and a new Constitution was adopted by the Assembly and officially promulgated by the King on September 24, 1993. Upon the promulgation of the Constitution, the Constituent Assembly was transformed into a National Assembly. The King appointed a Prime Minister and a Deputy Prime Minister charged with forming the Cabinet to be confirmed by the National Assembly, as required under the Constitution. The holding of free elections, promulgation of a new Constitution and subsequent establishment of a new governing framework in Cambodia were carried out on the basis of the Paris Accords. 37. The Constitution establishes a system of government based on an elected Constitutional Monarchy and the separation of powers between the executive, legislative and judicial branches. Under the Constitution, the King is the sovereign Head of State, to reign over but not govern Cambodia and is the ultimate guarantor of the fundamental rights and liberties of the Cambodian people. The King is elected by a Royal Council of the Throne. The Constitution also provides for the adoption of a multi-party democratic political regime and a fr.ee market economic system. The National Assembly is established as a 120- member legislative organ empowered to, among other things, adopt laws, approve the national budget and ratify and annul treaties and international conventions. According to the Constitution, the government comprises of a Prime Minister, Dept,ty Prime Minister and a Council of Ministers. Moreover, the judiciary is inaependent and a Constitutional Council is charged with interpreting the Constitution and opining upon the constitutionality of the laws. The IDA Country Assistance Strategy Relations with IDA. 38. Cambodia became a member of the IMF on December 31, 1969 and joined the IDA on July 22, 1970. Between the two dates, Prince Sihanouk had been overthrown and the country was in turmoil. As a result, Cambodia never borrowed from IDA, although it borrowed from the IF in 1971 and 1972. Relations with the IDA and the Fund were interrupted between 1975-1992. In September 1992, Cambodia decided to resume active participation in the IDA, appointing a representative on the IDA Board of Governors and designating the National Bank of Cambodia as the depository institution for IDA assets in Cambodia. Obiectives of IDA Assistance 39. At the moment, IDA assistance to Cambodia focuses on a "holding strategy" aimed at helping the country through the rehabilitation period. Success in this strategy should permit the adequate functioning of the new Government's administration. As the Government gradually determines its own development  - 10 - strategy, an appropriate IDA strategy will be firmed up accordingly. Therefore, the following considerations need to be seen in light of this two stage approach. 40. IDA lending strategy will develop in two phases - rehabilitation and reconstruction. During the "rehabilitation" phase which will likely extend over the next 12-18 months, the main objective is to (a) help maintain a stable economy and functioning infrastructures, (b) help develop effective administrative structures, and (c) provide a firmer basis for the reconstruction of the country. The proposed Emergency Rehabilitation Credit supports these key objectives. 41. A successful rehabilitation will open the way to a second phase of international assistance, that of reconstruction and development. Bearing in mind that the new Government has yet to dettz.mine and adopt its own policies and priorities, it is premature at this stage to single out clearly established priorities. Nevertheless, the IDA reconstruction assistance is likely to be deployed on two broad fronts: one is the continued pursuit of economic stabilization and the other is the building up of physical and human potentials. 42. Owing to the depth of the country's present financial troubles, it is envisaged that quick-disbursing balance-of-payments support will be needed for some years. It is recognized that the success of the reconstruction effort will hinge primarily on the capacity of the country to set in place appropriate policies and provide the institutional environment for mobilizing domestic financial and human resources. Three factors will be critical: (i) the effort that the administration will undertake to address the public finance problems on the domestic front, primarily by way of revenue mobilization, and to strengthen the cost-effectiveness of the administration and the civil service; (ii) the selectivity of expenditure programs and their complementarity with private sector endeavors; and (iii) the strengthening of the institutional capacity through technical assistance. Were the government determined to carry out such policies, IDA would stand ready to play its part in providing of balance-of-payments support, through the initiation of adjustment lending. These policy-based loans would support a strengthening of the market reforms undertaken so far, particularly in the areas of public finance, enterprise reform and private sector development, civil service and administration, and financial sector development. 43. Project work, on the other hand, will seek to boost investment in key sectors on the basis of well articulated strategies. IDA assistance would concentrate on: (i) restoring key transport infrastructure and the rehabilitation and expansion of water and power utilities destroyed by the war or run down for lack of repair and maintenance; (ii) recovering agricultural productive potentials with particular emphasis on (a) ensuring food security and reintegrating displaced populations through reclamation of rice land, repairing irrigation networks and providing the required level of imported inputs; (b) developing cash production primarily in the rubber and fishery sectors; and (c) defining a policy and institutional framework conducive to the sustainable exploitation of the country's two largest natural resources, forestry and water (particularly the Tonle Sap); and (iii) developing severely crippled human resources, focusing on (a) establishing a conducive policy and institutional framework for health and education; (b) ensuring the provision of sufficient  - 11 - inputs (textbooks, drugs, etc.) for these sectors to operate; (c) rehabilitating, consolidating and selectively expanding sectoral facilities; (d) developing the productive capacity of and employment opportunities for women, which currently constitute over 60 percent of the adult population; and (e) expanding the access of the population, particularly its poorest, rural segment to clean water and minim=m sanitation. Taking into account the particular circumstances of Cambodia, IDA project work will give priority to building up sectoral institutions and providing inputs, equipment and advisory services needed to carry on agreed sectoral programs. Economic and Sector Work '9 44. Building up this lending pipeline and developing sound policy advice will require that IDA expands its knowledge and understanding of the country issues. Early initiation of our economic and sector work already helped us formulate the proposed Emergency Rehabilitation Project (ERP). Before the normalization of IDA relations with Cambodia, staff carried out reconnaissance activities under the aegis of the United Nations. Following an economic mission in March-April 1992 under the authority of the UN Secretary-General Special Representative for Cambodia, IDA prepared an economic assessment which was released in June 1992 at the Ministerial Meeting in Tokyo under the title "Cambodia - Agenda for Rehabilitation and Reconstruction". IDA also contributed to the joint ADB-IMF- UNDP-World Bank report entitled "Cambodia - Socio-Economic Situation and Immediate Needs", tabled at that conference. 45. A Country Economic Report together with a Medium-Term Investment Strategy will be prepared in December 1993. This report will provide the analytical underpinning for the meeting of the International Committee for the Reconstruction of Cambodia (ICORC) to be held in March 1994. It will also serve as a basis for a possible first adjustment operation and a Reconstruction Credit in FY95. The preparation of a Policy Framework Paper, in parallel to the adjustment operation, would further deepen our already close relations with the International Monetary Fund in Cambodia. 46. The focus of our sector work would be similar to that of the proposed lending strategy, i.e. infrastructure, human resource development and agriculture, particularly emphasizing the areas of forestry and water resource management. Numerous and extremely useful sectoral overviews have been recently prepared by various international organizations, particularly from the United Nations system. All have found the quality and availability of data a severe limitation to the scope of these studies. Aiming now at moving towards operational recommendations, IDA program will give priority to more time- consuming efforts of building of data bases and developing master plans, with donor financial support. Institutional Development and Technical Assistance 47. Despite brave efforts to restore institutions to functioning levels and train a new generation of cadres after the turmoil of the 1970s, the development of minimal human and institutional capacities is still highest on the country's agenda. Compounding the problems linked to the legacy of 1970s, the country has to (a) make up for the loss of the substantial technical assistance from the now defunct cMEA, which in some sectors (such as vocational training and health) have  - 12 - left existing institutions in disarray, and (b) transform its economic institutions as required by the rapid transition to a market economy and the implementation of a reconstruction program. 48. The IDA made an early start in providing technical assistance for institution building. Starting in July-August 1992, it fielded two public finance experts with bilateral financing. This technical assistance to the administration for strengthening expenditure programming and public finance control is now being expanded with support from two grant sources (the Japan PHRD Fund and the Bank's IDF) for a total of US$1.25 million. It emphasizes those immediate improvements in expenditure management needed to properly program and execute rehabilitation activities within a consistent fiscal framework. Similarly at the sectoral level, two UNDP projects executed by IDA, one for water and one for power rehabilitation, amounting to US$4.11 million and US$3.8 million, respectively, were approved in November 1992. Implementation of both projects is proceeding satisfactorily. The technical assistance included under the proposed project should further help strengthen such functions as procurement, textbook production and distribution, drugs management, and road maintenance. 49. Such assistance, initiated during the rehabilitation period, will fully develop during the reconstruction and development period. In particular, IDA will continue to assist beyond that initial effort in helping create a full- fledged budget management and expenditure programming system. The IDA will also stand ready to assist in areas such as privatization, civil service reform and financial sector development. Performance Indicators 50. Satisfactory functioning of the Government's administration, and the subsequent start of the reconstruction period, will be major milestones on the way towards full-fledged IDA assistance. Recognizing how critical domestic policies and capacities are to the reconstruction effort, IDA will pay particular attention, when determining the scope of its assistance, to (i) the progress being achieved toward fiscal adjustment; (ii) the strict prioritization of the overall reconstruction package and the country's track record in implementing it; and (iii) the effectiveness in aid utilization. Relations with the IMF 51. As with the IDA, Cambodia also officially resumed active participation in the IMF in September 1992. In August 1993, the Cambodian authorities agreed to a new macroeconomic program (which is reflected in paras.23-31) and requested an initial purchase from the IMF under the Systemic Transformation Facility (STF). On September 29, 1993 Cambodia's arrears towards the IMF for an amount of SDR43 million, on the drawings made by the country in the early 1970s, were cleared with the assistance of bilateral donors led by Japan and France. In early October 1993, the Board of the IMF is expected to approve an arrangement under the STF for Cambodia. Under this arrangement, the first STF tranche in an amount equivalent to SDR6.25 million (25 percent of quota) is expected to be disbursed by the end of November 1993.  - 13 - Aid Coordination 52. Effective coordination will continue to be critical to the success of international efforts. Initially, the Paris Accords specifically assigned to UNTAC the responsibility of coordinating assistance during the transitional period, a mechanism which has been in place since April 1992 under the responsibility of the UNTAC Director of Rehabilitation. After UNTAC's departure, an integrated UN office will be established in Phnom Penh. 53. The June 1992 Ministerial Conference of Tokyo formally established the International Committee on Reconstruction of Cambodia (ICORC) contemplated by the Paris Accords, a consultative body under the chairmanship of Japan. It was charged with coordinating aid during the reconstruction period and open to all countries and international organizations contributing to the long-term reconstruction of Cambodia. The first ICORC meeting was held in Paris in September 1993. The next ICORC meeting will convene in March 1994 in Tokyo. The IDA has been requested to prepare a report on the analytical underpinnings of the economic situation in Cambodia for this meeting. Issues for Board Consideration 54. At the moment, IDA assistance to Cambodia focusses entirely on contributing to the international effort to consolidate peace through adequate functioning of the Government's administration and rehabilitating essential services and productive capacities. Success in this endeavor will allow the authorities to devise their development strategy. IDA will define its own assistance priorities within this framework. Issue that may arise during this process would be brought to the attention of the Executive Directors in conjunction with subsequent operations.  - 14 - PART 2 - THE CREDIT Backaround 55. Responding to the Appeal of the UN Secretary General and to an invitation from Prince Sihanouk, the IDA sent a mission to Cambodia in September 1992 to prepare the proposed Credit. On the basis of priorities identified in the UN Secretary General's Appeal for Cambodia's Immediate Needs and National Rehabilitation, a core expenditure program (Annex 2) was prepared, reflecting the macroeconomic strategy outlined in paras. 22-31. This program includes rehabilitation activities selected according to three main criteria: (a) number of beneficiaries, (b) absorptive capacity and (c) resettlement needs of the displaced population. Inter-sectoral linkages and the evolving role of the State in the transition towards a market economy were also taken into account. 56. The domestic policy measures outlined in paras. 22-31 by themselves are unlikely to bring about a decisive improvement in the macroeconomic situation or allow the delivery of the core rehabilitation program without a rapid infusion of foreign assistance, estimated at US$182 million for 1994 (Annex 2, Table 3; all foreign assistance numbers exclude humanitarian aid, technical assistance, and studies). As mentioned in para. 4, bilateral and multilateral donors at the Ministerial Conference of Tokyo, expressed strong support for Cambodia's rehabilitation program, pledging US$880 to be disbursed over the next 2-3 years. In 1994, about US$67 million would be in the form of program assistance mainly from IDA, Japan and France. Another US$115 million would be in the form of project aid (excluding N50s), including US$25 million from IDA. Proiect Obiectives and Scone 57. The proposed Emergency Rehabilitation Project would support the implementation of critical rehabilitation activities included in the core expenditure program. The main objective of the project is to help restore and maintain capacity utilization and production in key sectors during the next 12 to 18 months. This would be achieved by importing and distributing critical inputs required for ensuring the rehabilitation of economic activities and critical public infrastructure, and improving the delivery of essential services. 58. The project scope is derived from the overall financing requirements of the core rehabilitation program based on a feasible fiscal strategy. It takes into account existing activities, pledges and commitments of other donors as well as the likely disbursement of this financial aid during the next two years. The project would include the provision of (a) critical imports for specific rehabilitation activities (presently not covered by other donors) in the transport, agriculture, health, education, power and water supply sectors, as well as (b) essential commodities required for the Cambodian economy to undertake its recovery. The project is consistent with IDA's policy on emergency operations and is designed to focus on essential repairs and rehabilitation activities that can be implemented rapidly, as opposed to longer-term development projects.  - 15 - Protiect De&crintion 59. The project would provide critical goods and materials to enable key sectors of the economy to continue to operate. It would mainly finance priority imports to the agriculture, transport, power and water supply, health and education sectors as well as other urgently required goods and services. The target areas and the list of commodities have been chosen to cover gaps left by other immediately available external financing sources (see Annex 3, Summary Cost Table). 60. The aQriculture component (US$10.12 million) would include (a) the provision of vehicles and demonstration materials (including fertilizers and pesticides) for extension/demonstration support to farmers in intensive rice growing areas; (b) equipment to improve the collection of agricultural statistics; (c) the import of 100 tractors for reclamation of rain-fed paddy land; (d) essential materials for the repair of two diversion weirs; (e) the import of chemicals, fertilizers and herbicides to stimulate rubber production and rehabilitate immature areas; (f) essential materials for capture fisheries development; (g) equipment and materials for livestock development; (h) equipment to support land titling and registration; and (i) materials and equipment for the development of the agricultural training institutions. 61. The transnort component (US$11.8 million) would include (a) required material, fuel and equipment to carry out about 60 km of priority road rehabilitation work, rehabilitation or reconstruction of about 200 meters of damaged or unsafe bridges, and routine maintenance work by two road maintenance brigades, (b) spare parts for existing cargo handling equipment at Phnom Penh and Sihanoukville, (c) spare parts and consumables for the rehabilitation and operation of two dredges, (d) equipment, supplies and materials for the resumption of hydrographic surveys and the installation and replacement of navigational aids and channel markers, and (e) spare parts, supplies, materials, tools and machinery for the railway workshops. 62. The nower com_onent (US$7,76 million) would include the provision of four 2.1 MW medium-speed diesel generating sets in Phnom Penh. 63. The water sunnlv component (US$5.98 million) would include the provision of (a) distribution pumps and motors to rehabilitate pumping groups of the booster station in Phnom Penh; (b) pipelines in Phnom Penh and Sihanoukville; (c) small pumps, mechanical and electrical equipment needed to repair production facilities in four or five provincial capitals; and (d) small semi-mechanized drilling riggs, tools for digging wells and hand pumps to construct potable water points. 64. The education comnonent (US$5.65 million) would include the provision of (a) spare parts, raw materials and printing equipment for the production of textbooks, (b) new textbooks, (c) spare parts, consumables, storage and handling equipment for the distribution of textbooks; and (d) imported construction materials required for the rehabilitation and construction of primary school classrooms. 65. The health component (US$4.15 million) would include the provision of: (a) essential drugs; and (b) medical/surgical equipment such as laboratory  - 16 - equipment, mobile x-ray equipment and operating tables, instruments, sterilizers, etc. 66. The ceneral administration component (US$2.63 million) would finance imports of office equipment for the public entities involved in project implementation (US$0.33 million) and consultant services for technical assistance in procurement, project implementation and financial management (US$2.3 million). 67. The essential commodities com=onant (US$25.0 million) would include the financing of commodities according to a positive list, including raw materials, manufacturing and transport equipment and spare parts, essential foodstuffs and building materials. Details on goods and services to be imported, costs, and implementation arrangements for the main project components are available in the implementation volume. Cost Estimates and Financinc Arrangements 68. The total cost of the project is estimated at US$73.1 million. Cost estimates for the project are expressed net of taxes and duties. IDA would provide a credit in the amount of US$62.7 million which would cover 100 percent of foreign expenditures for directly imported goods under the project components. The technical assistance component (US$2.3 million) will be financed under a grant provided by the Swedish International Development Authority (SIDA). The government will finance local expenditures. 69. The project will generate about US$25.0 million equivalent of counterpart funds from the sale of foreign exchange and/or commodities to private importers. The National Bank of Cambodia will apply its official exchange rate for this purpose. Counterpart funds generated will be allocated for budgetary expenditures satisfactory to IDA. Project Imnlementation 70. Key to the successful implementation of the rehabilitation program is a strengthening of the planning, programming/budgeting and control of central and provincial expenditures, both recurrent and investment. The expertise required to carry out these improvements is being provided under two technical assistance grants: a Japan Grant (PERD) of about US$750,000, to be administered by the IDA, and an Institutional Development Fund (IDF) Grant of US$500,000 from the IDA. This assistance (one budget specialist and one treasury specialist) is already in place at the Ministry of Finance. It will be complemented by former UNTAC financial controllers previously assigned to the various levels of Cambodian administration. 71. The Niational Committee for Rehabilitation and Development (NCRD) will provide general oversight of the project on behalf of the Government. The NCRD was established in July 1993 to prioritize rehabilitation needs and ensure overall coordination of the Rehabilitation Program. The Ministry of Finance will be the project executing agency, directly responsible to NCDR and IDA for coordinating and managing project implementation. The various agencies involved in the project (Ministries of Transport, Agriculture, Health, and Education, Electricity of Phnom Penh, Municipality of Phnom Penh, and the National Bank of  17 - Cambodia) will be the project implementing agencies (PIAs) for their respective components. 72. Given the multi-sector nature of the project and the need to ensure rapid implementation, adequate distribution of goods and proper financial control, the ma .agement, administration and coordination of the project will be the responsibility of a Proiect Imolementation Unit (PIU) in the Ministry of Finance. The PIU has been established under the direction of the Vice-Minister of Finance and staffed with personnel of the Financial Affairs Department. The main functions of the PIU will be to (a) manage and administer the project, (b) handle all aspects of procurement, based on specifications prepared by the PIAs (c) ensure proper allocation and distribution of goods, (d) coordinate with user- ministries and agencies, (e) prepare withdrawal requests for disbursements and maintain project accounts, and (f) prepare quarterly progress reports on the execution of the project. The work of the PIU will be supported by technical assistance, financed under a grant from SIDA, in the fields of procurement (30 man-months) and financial management (18 man-months). Recruitment of technical experts is already underway. The PIU will be maintained, with staffing satisfactory to IDA, throughout the project. 73. All procurement of goods and services under the project will be in conformity with IDA Guidelines for Procurement Under IBRD Loans and IDA Credits. Detailed procurement arrangements are described in Annex 4. IDA would retroactively finance eligible items procured in accordance with its guidelines after July 15, 1993 but before credit signing up to a maximum of US$12 million, or 20 percent of the credit amount. Disbursements will be made on the basis of 100 percent of foreign expenditures for directly imported goods. To facilitate disbursement, a Special Account would be established in the National Bank of Cambodia (NBC) under terms and conditions satisfactory to IDA. The closing date of the project is June 30, 1996. Aareements Reached 74. The Government has agreed to the following: a. Satisfactory implementation of the 1994 budget and its program of economic measures (para. 26). b. Maintenance of the PIU in a form and with functions satisfactory to IDA (para. 72). c. Review by the NCRD and IDA of progress achieved in implementing the project not later than June 30, 1994 and annually thereafter. d. Setablishment of satisfactory arrangements for the distribution of goods under the health and water supply project components. e. Application by the National Bank of Cambodia of its official exchange rate to the sale of foreign exchange to private purchasers of essential commodities financed by the credit.  - 18 - f. Allocation of counterpart funds generated by the sale of goods financed under the Credit to budgetary purposes satisfactory to IDA. 75. The following will constitute credit default events. a. Failure to carry out the 1994 budget in a manner satisfactory to IDA. b. Failure to use proceeds generated by the sale of goods financed under the Credit in a manner which is consistent with the objectives of the project. Environmental Aspects 76. The project has been placed in the C-category with respect to environmental ranking. One potential environmental impact may be from imports of agrochemicals. Agrochemicals to be financed would be selected and used in accordance with IDA guidelines in order to minimize their environmental impact. To be eligible for financing under the credit, their procurement will have to strictly follow the guidelines established in O.D. l.00, paragraphs 119 to 121. Benefits and Risks 77. This project constitutes an essential element of the Cambodia rehabilitation program which is being supported by an internationally broad-based financing plan. The main benefit to be derived from a successful implementation of the rehabilitation program will be to restore a more stable macroeconomic environment to Cambodia at a critical juncture and to arrest a further deterioration of public services beyond which any meaningful rehabilitation is unlikely to occur. It would also foster an improved economic climate under which the consolidation of the peace process can take place. In addition, it would help the c