Tanzania - Second Integrated Roads Project

Docuant of The World Bank FOR OmCIAL USE ONLY Repot No. P-6230-TA MEMORANDUM AND RECOENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS (-N A ONA~~~~~~~~~~~~~~~~~~~~~~~~~ - PROPOSED CREDIT OF SDR 123.3 MILLION TO THE REPUBLIC OF TANZANIA FOR A SECOND INTEGRATED ROADS PROJECT MARCH 17, 1994 MICROGRAPHICS Report No: P- 6230 TA Type: MOP This document has a restitted disbtibution and may be used by recpients odby in the perfornace of their official dues. Its contents may not othewise be disclosed witbout World Bank autbonization.  Currency Equivalent (As of September 30, 1993) Currency Unit =Tanzanian Shilling Tsh 1.0 = US$0.002 US$ 1.0 - Tsh4S0 FISCAL YEAR July 1 to June 30 WEIGHTS AND MEASURES (metric system) GLOSSARY OF ABBREVIATIONS AfDB African Development Bank CAS Country Assistance Strategy CEM = Country Economic Memorandum CESP = Country Environmental Strategy Paper cG = Consultative Group CODAP = Coordination Office for Donor Assisted Projects CPPR Country Portfolio Performance Review EEC European Economic Community ERR Economic Rate of Return ESAF = Enhanced Structural Adjustment Facility FINNIDA - Finnish International Development Agency FSAC = Fmancial Sector Adjustment Credit FY - Fiscal Year GDP = Gross Domestic Product ICB - Intemational Competitive Bidding LCB Local Competitive Bidding IMF - Intemadonal Monetary Fund IRP-I Integrated Roads Project I IRTAC - Industrial Rehabilitation and Trade Adjustment Credit MIGA Multilateral Investmnent Guarantee Agency MRC = Multisector Rehabilitation Credit MWCT Minstry of Works, Communications & Transport NBC = National Bank of Commerce NEAP = National Environmental Action Plan NGOs = Non-Governmental Organizations NORAD = Norwegian Agency for Development Cooperation OPEC = Organization for Petroleum Exporting Countries PEHCOL - Plant and Equipment Hire Company Limited PPF = Project Preparation Facility PPRJP = Parastatal and Private Sector Reform Project PSAC = Public Sector Adjustmnent Credit SDC = Swiss Development Corporation SIDA - Swedish International Development Agency TAC - Tanzania Audit Corporation TANAA Tanzania Agricultural Adjustmnent TANESCO - Tanzania Electric Supply Company TAZARA = Tanzania Zambia Railway TRC - Tanzia Raiways Corporation  FOR OFFICIAL USE ONLY UNITED REPUBLIC OF TANZANIA SECOND INTEGRATED ROADS PROJECT CREDIT AND PROJECT SUMMARY United Republic of Tanzania Beneficiaries: Ministry of Works, Communications and Tansport, NatioDal Constuction CounciL National TranWort Corporation, and National Institut of Transport. SDR 123.3 million (US$170.2 million equivalent) Terms Stndard IDA terms with 40 years maurity IDA US$ 170.2 million EEC 178.1 million AfDB 108.9 million NORAD 41.7 million OPEC 38.3 million JAPAN 19.8 million KUWArT 14.9 million SDC 5.1 million FINNIDA 5.4 million Govenment 67.9 million Total USS 650.3 mdllion Povety Alleviation: Program of Targeted Intervention Economic Rate of Retrn: 21%. Mp No.: 25511 Staff Appraisal Report: 12536-TA This docLment has a restricted distibution and may be used by recipients only in the perfomance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE UNITED REPUBLIC OF TANZANIA FOR THE SECOND INTEGRATED ROADS PROJECT I submit for your approval the following memorandum and recommedation on a proposed development credit to the United Republic of Tanzania for SDR 123.3 million (US$ 170.2 million equivalent) to help finance a Second Integrated Roads Project. The proposed credit would be on standard IDA tms with maturity of 40 yes. The project would be cofinanced by eight other donors who are contributing about US$412.2 million equivalent. PART I: COUNTRY POLICIES AND BANK GROUP'S ASSISTANCE STRATEGY A. BACKGROUND AND RECENT DEVELOPMENTS (i) Background 1. Adjustment Policies. Beginning m the mid-1960s, the Goverment of Tanzania greatly increased the role of the public sector in production and undermined the development of the private sector. Marketing and processing of agricultural products were controlled by monopolistic marketing boards and cooperative unions, reducing furmers' incentives to produce. Large invesatents were made in industrial parastatals that operated at very low levels of capacity utilization and with substantial losses, inhibiting private sector competition and serving as a considerable burden on public sector finances. Nationalization of financial instiutions, iterest rate controls, and political influence in lending decisions greatly ipired the efficiency of financial ineon. An overvalued exchange rate coupled with extensive controls on trade and capital movements created a scarcity of foreign exhange. Overall the Govwnment was successful in forging a unified nation and making initial progress in improving social conditions. However, flawed economic policies severely distorted relative prices, which combined with successive droughts, a costy war with Uganda, and a fail in the terms of trade, led to a protacted decline in output. The resulting decrease in Government resources led to a severe deterioration in economic and social infiwstructure. 2. In early 1986, the Government of Tanzania embarked on an adjustment progran to dismantle the system of pervasive economic controls and encourage more active participation of the prvate sector in the economy. The program included a comprehensive package of policies which reduced the budget deficit and improved monety control, substantially depreciated the overvalued exchange rate, liberalized the trade regime, removed most price controls, eased restrictions on the marketmg of food crops, freed interest rates, and initiated a restructuring of the financial sector. The Goverment also launched progams to rehabilitate key infriaucture (roads, railways and ports) and to strengthen research and extension services. The economy responded positively to the reform program and the increased availability of extnal resources, with increased production of food, traditional export crops and nontraditional exports. During 1986-91, both Gross Domestic Product (GDP) and exports increased at an average of about 4% per year in constant prices, after near-station in GDP and a dramatic decline in exports in the early 1980s.  2 3. It is likely that the impact of the adjustment program on the poor was positive. The devaluation of the exchange rate and removal of restrictions on the marketing of food crops boosted incomes in rural areas, where the majority of poor Tanzanians live. A recent study of poor communities in Tanzania, commissioned by the Swedish1 International Development Agency (SIDA), concluded that the increased availability of consumer goods as a result of liberalization directly benefited the rural poor. The urban poor experienced an initial increase in consumer prices. However, the trade liberalization program increased the availability of consumer goods, which, on balance, probably led to improved conditions in urban areas. More importaty, the liberaliation program increased the access of small-scale enterprises to production inputs. Thb raised the demand for labor and led to a rapid expansion of low-wage employment in the informal seutor of the economy, thus improving the condition of many of the urban poor. 4. Political Liberalization. After three decades of rule by one party, Tanzania has embarked on a process of political reform. Multi-party elections at the local level are scheduled for mid-1994, with elections for President and Parliament scheduled a year later. The introduction of different political parties into the political arena has been a new experience for Tanzania. Despite some friction, a lively debate is being carried on in the local newspapers and the new parties have been provided access to the stae-controled adio. It is difficult to predict what impact the advent of new parties and the anticipation of elections will have on the implementation of economic reforms. (ii Recent Economic Developments 5. Maqreooc Performane Tanzania recendy has experienced a severe deterioration in macreconomic management. Macrocoonomic stability had been tenuous during the adjustnen process, owing to the Cental Govenments budget deficit and substantial leakage through the financial stem. From the start of the reform program, a key issue was the provision of cit by the National Bank of Commerce (NBC) to parstals and agricultural cooperatives at subsidized rates and regardess of repayment prospects. In turn, NBC was financed by automatic access to the refinancing from the Bank of Tanzia. Still, through FY92 progress was being made in reducing inflation through a steady decline in the budget deficit (wiich, in FY92, actually showed a surplus after grants ), limits on credits provided to parastals and cooperatives, and the cutting off of NBC from Central Bank refinancing. 6. This progress was significantly compromised in FY93 and FY94. The fiscal deficit (including grants) equaled 8% of GDP in FY93, largely owing to a dramatic decline in indrect tax rwenues. As the magnitude of the fiscal problem became clear during the year, the Goverment took steps to restrain money growth by increasing some tax rates, cutting tax exemptions, and reducing sources of monetary expansion from the Bank of Tanzania. Still, money supply increased by over 40%/O, and inflaion remained over 20% in FY93. 7. The second quarter of FY94 saw a further deterioration. The Govenment borrowed approximately 5% of GDP from domestic sources from October to December 1993, indicating a serious loss of monetary contro. This sharp increase in bonmoing by the Central Government was largely due to very high levels of expenditure, particulary wage increases granted the defense and security establishment and a surprisingly large check float from the previous year. On the mvemue side, customs administration is in a state of crisis, with collections of taxes on imports equaling less  3 than half of assessed values, in part due to the decision in August 1993, to grant tax exemptions on imported inputs of a number of industries. 8. The prospects for a return to macroeconomic stability have been reduced by the lack of progress in efforts to create an efficient banking systen. The restructunng program for the National Ban;k of Commerce (NBC), which dominates the banldng system, has virtually been at a standsI for the past six months. NBC is facing a difficult liquidity position, and recently has incurred anrs to the check clearnghouse, with these arrears financed by overdrafts fron the Bank of Tanzama. Meanwhile, NBC continues to make subsidized loans to agicultural coopertives. The recent decision to recapitalize the Cooperative and Rural Development Bank, in the absence of a viable restructuring plan, also may have unforunate implications for macroeconomic stability. 9. An International Monetary Fund (IMF) mission in October 1993 did not complete the mid-term ESAF review due to the Government's failure to meet quantitative targets. Similarly, an IMF mission in late January 1994 concluded that the macroeconomic program remained substantially off track. A shadow program for the second half of FY94 was agreed with the Government, with the results to be evaluated in mid-1994, at which time a decision will be made concerning commenceraet of negotiations for a third year ESAF. 10. lhe AdMustmnt= Program. Implementation of key structural reforms over the past year has been mixed . Financial sector reform program suffered a severe reverse, as descnbed above. Progress was reported on the paastal sector reform program: in calendar 1993, the Goverment concluded 16 privatization transactions (divestment, joint venture, lease, or management contract), placed 12 companies under receivership, and closed an additional 13 companies pending liquidation. Bidding documents are being prepared or negotiations are underway for an additional 26 companies. Legislation was enacted to introduce private sector competition into the mareting of traditional crops. However, the legislation provides for the licensing of private sector traders by the marketing boards, which may have the effect of limiting competition. Little progress has been made in easing other administrative constraints on private sector business, for example through simplifying business licensing procedures. The Government did complete the initial retrenchments called for under the civil service reform progam. However, preparations for reform of the compensation system have yet to start and litle work has been done on the planned studies of the organization and responsibilities of each ministry. A strategy for privatizing the holdings of the National Housing Corporation also needs to be prepared. 11. The Govemment has rapidly implemented the reform of the exchange and trade system. The exchange rate was unified in August 1993, and weekly foreign exchange auctions introduced. Trade restrictions were greatly eased through the elimination of import licensing (except for goods controlled for health and safety reasons), the elimination of export licensing and registration requirements, and the narrowing of the list of goods subject to export pernits to a small, negative list. This program has greatly reduced administraive impediments to the operation of the trade and payments system and should, over time, improve the allocation of foreign exchange resources. However, the sustainability of exchange and trade reforms would remain vulnerable in the absence of fiscal and monetary discipline. 12. Macroeconomic instability and slow implementation of the refbrm program will make it all the more difficult to deal with the very serious development problems facing Tanzania  4 (a) Tanzania is excessively dependent on the donor community, and the economy does not generate sufficient savings to sustain development over the medium term. The level of domestic savings, while difficult to estimate, probably is little more than 5% of GDP '. Tbe 28% of GDP devoted to investment has largely come from external donors. The Government is unable to finance its recurrent expenditures without substantial donor assistance and past loans have left a huge debt burden which the country is unable to service. (b) Approximately 45% of the population is under the age of 15, and present rates of output growth may not be sufficient to create enough high-productivity jobs to absorb the expected, large increases to the labor force. (c) Perhaps most importandy, the public sector lacks the skills and resources to cope with the challenges posed by extensive poverty, a rapid increase in population, a growing menace from AIDS, the poor state of essental infrastructure and the reversals of the gains in the social sectors. B. THE EXTERNAL ENVIRONMENT 13. The 30% faUl in the terms of trade during 1986-92 greatly complicated the adjustment process. While somc diversification has occurred through strong growth in nontaditional export products, export revenues remain heavily dependent on a limited number of primay commodities, which accounted for 50% of the dollar value of merchandise exports in 1992. Despite declines in prices for major commodities, growth in export volumes from 1990-92 resulted in a modest rise of about 6% in revenues from merchandise exports. 14. The terms of trade decline contributed to the widening of the current account deficit (after grants) from about 3% of GDP in 1986 to almost 12% of GDP in 1993, further increasing the need to depend on donor funds to support the economy. Last year, export receipts (including flows classified as pnvate transfers but believed to be unofficial export receipts) financed only about two-thirds of total imports. The rmainder was financed by grants and loans from donor agencies. Tanzania's debt service burden does not change greatly with variations in international interest rates, as almost all loans are provided on soft terms. However, the availability of foreign resources remains very important concem, both to finance imports and to service payments on existing debt. There is a need for a greater effort at mobilization of domestic resources and removal of constraints on the efficiency of private sector production to ensure sustainable growth, reduce dependence on donors, and encourage increased inflows of private capital (initially in the form of trade credits and direct foreign investment). 15. Tanzania has a real opportunity to benefit from private capital inflows, from both residents and foreigners. There is some evidence that capital held abroad is returning to Tanzania. Imports under the own funds scheme, which made up 32% of import purchases in FY93, are at least partly financed by assets held abroad. The country's relative stability (compared to some other parts of Africa) and the progress made since 1986 in dismantling controls appear to have elicited increased Data on Tanzania's economy are particularly unreliable, owing to the large informal sector, weakness in Govenument institutions responsible for data collection, and inadequa.e accounting for Govemment expenditures financed by donors. lbus, estimates of savings (the residual in the national accounts) can only provide rough order of magnitude.  5 interest by foreign investors. However, the poor business environment and uncertainty over government policies greatly limits Tanzania's access to private capital. C. TANZANIA'S DEVELOPMENT OBJECTIVES AND POLICIES 16. In the context of the problems discussed above, and the underlying need to accelerate the pace of reform, the Tannia reform program aims to stimulate the private sector's capacity to produce and deliver goods and services, while at the same time limiting the role of the public sector in this area and strengthening instead its capacity to manage the economy and to provide social and physical infiastructure more effectively. The Government's program was set out in the joint GovermnentlBank/IMF Policy Framework Paper of October 1992 and was outlined in the Country Assistance Strategy (CAS) discussion in the Memorandum of the President for the Parastatal and Public Sector Reform Project (Report No. P.605 1-TA, May 7, 1993) and reviewed by the Board in June 1993. The major aspects of the reform program are outlined below. 17. Macroeconomic Policy. The Government recognizes tbat the present crisis requires a radi