Senegal - Private Sector Adjustment and Competitiveness Credit Project

Document of The World Bank FOR OmCLAL USE ONLY Repo"t N P-6522-SE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 27.6 MILLION (US$ 40 MILLION EQUIVALENT) TO THE REPUBLIC OF SENEGAL FOR A PRIVATE SECTOR ADJUSTMENT AND COMPETITIVENESS CREDIT JANUARY 24, 1995 FILE COPY This document has a restricted distribution and Report No: P- 6522 SE their official duties. Its contents may not othe Type: PR  CURRENCY EOUIVALENT Currency Unit CFA franc (CFAF) US$ 1.00 CFAF 531 CFAF 1 million US$ 1,883 SYSTEM OF WEIGHTS AND MEASURE: METRIC Metric U.S. Eauiv_alen 1 meter (m) 3.28 feet (ft) 1 kilometer (kn)) 0.62 miles (mi.) 1 square kilometer (km2) e 0.39 square mile (sq. mi.) 1 hectare (ha) 2.47 acres (a) 1 metric ton (t) = 2,205 pounds (lb.) 1 kilogram (kg) 2.2046 pounds (lb.) FISCAL YEAR January 1- December 31 ABBREVIATIONS AND ACRONYMS ASAC : Agricultural Sector Adjustment Credit BCEAO Banque Centrale des Etats de l'Afrique de l'Ouest (Central Bank) BMOP : Bureau de la Main d'Oeuvre du Port CNPS Conseil National du Patronat du S&66gal COSEC Conseil S6n6galais des Chargeurs COSENAM : Compagnie S6negalaise de Navigation Maritime CPI Consumer Price Index CRG Competitiveness Review Group CSS : Compagnie Sucriere S6n6galaise FTZ Free Trade Zone GMD Grands Moulins de Dakar ICOTAF Industries Cotonnieres Africaines ICS Industries Chimiques du S6n6gal; PAD : Port Autonome de Dakar (Dakar Port Authority) PFP: Policy Framework Paper SAR Soci6t6 Africaine de Raffinage SFZ : Single Factory Zone SIPS Soci6t6 Industrielle de Papeterie du S6n6gal SNTI Soci6t6 Nationale de la Tomate Industrielle SOCAS Soci6t6 des Conserveries AlimentairoB du SEn6gal SOCOCIM Soci6t6 Commerciale des Ciments SOCOSAC Societe Commerciale du Sac SODEF1TEX Soci6t6 pour le D6veloppement des Fibres Textiles (Textile Company) SONACOS : Soci6te Nationale de Commercialisation des 016agineux (Groundnut Oil Company) SOTEXKA : Soci6t6 des Textiles de Kaolack UEMOA : Union Economique et Mon6taire Ouest Africaine (West African Economic and Monetary Union) UMOA Union Mon6taire Ouest Afncaine (West African Monetary Union) WAEMU West African Economic and Monetary Union  FOR OFFICIAL USE ONLY REPUBLIC OF SENEGAL PRIVATE SECTOR ADJUSTMENT AND COMPETITIVENESS CREDIT Table of Contents Credit and Program Summary .......................................................1i PART L THIE MACRO-ECONOMIC FRAMEWORK AND RECENT DEVELOPMENTS 2 PART IL THE PRIVATE SECTOR 5 A. Private Sectors Role in the Economy ................................................... 5 B. Strategy for Private Sector Development .................................................7 PART IIL THE PROPOSED CREDIT 10 A. The Policy Reform Program ......... ................................ 10 1. The Promotion of Competition in Domestic and Import Trade ....... 10 2. The Promotion of Exports ............................................. 14 3. Investment incentive system ............................................. 15 4. Enterprise Competitiveness ............................................ 16 B. Credit Features .................................................. 17 C. Agreements reached and Conditionality .................................................. 19 D. Credit Benefits and Risks ................................................... 20 PART IV. RECOMMENDATION 22 This document has a restricted distnbution and may be used by recipients only in the perfornance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ANNEXES Annex I: Policy matrix Annex II: Letter of Sector Development Policy Annex III: Key Economic Indicators Annex IV: Balance of Payments Annex V: Key Exposure Indicators Annex VI: Status of Bank Group Operations Annex VII: Senegal's Relations with the AMF Annex Vm: Timetable of Key Processing Events This operation was prepared by a team comprising Cherif M. Azi (Senior Operations Officer and Task Manager, AF5SE), Ana Novaes (Econonist, AF5LE), Hasan Tuluy (Principal Economist, AF5CO), Bruno Boccara (Economist, AF5CO), Mark Lewis (Economist, AF5CO), Melkonian (LOAAF) and Kishor Uprety and Theodoor Elsen (LEGAF). Brendan Horton (AF3C1) is the Peer Reviewer. Melakou Guirbo provided secretarial support Mr. Jean-Louis Sarbib and Ms. Silvia Sagari are respectively the Department Director and the Managing Division Chief for the operation. Mr. Franpois Laporte is the Lead Economist.  REPUBLIC OF SENEGAL PRIVATE SECTOR ADJUSTMENT AND COMPETITIVENESS CREDIT CREDfT AND PROGRAM SUMMARY Borrower: Republic of Senegal Beneficiaries: The Government of Senegal and the private sector Amount: IDA Credit: SDR 27.6 million (US$ 40 million equivalent) Terms: IDA Credit: Standard with 40-year maturity Program Description: The overall objective of the proposed credit is to support the structural measures needed to derive the full benefits of the January 1994 devaluation. The credit will support a program of policy reforms which are necessary for establishing an environment conducive to supply-response and self-sustained growth of the private sector. The measures included in the reform program are an essential part of the reforms agreed upon with the Bank and the IMF in August 1994, in the context of the PFP for the period 1994-1997. The reform program aims at: (i) completing the liberalization of domestic and external trade by eliminating the monopolies granted through special agreements and prior authorizations to import or export; (ii) improving the existing export and investment incentive regimes; (iii) reducing maritime transportation costs; and, (iv) eliminating rigidities in the labor market. Benefits: The expected benefits of the credit would be to: (i) create an environment favorable to private sector development that would result, in the short- to medium-term in economic growth through increased exports and investments; (ii) help the Government, through balance of payment support, maintain appropriate macro-economic equilibria and keep inflation under control; and, (iii) contribute to the improvement of living conditions by eliminating policies that have been detrimental to the poor, mainly through the abolition of monopolies, the completion of trade liberalization and the reduction of the price of essential consumer goods. Kiska: Supply response from the private sector to the CFAF adjustment is already in evidence in a number of activities and there is a high probability that Senegal's expected economic performance would be achieved if the reforms proposed under this operation are implemented. Such probability would be  ii would be significantly lower in the absence of Bank support. Although Senegal has been a reluctant adjuster in implementing previous Bank supported adjustment programs, the likelihood of unsatisfactory implementation and/or backtracking is reduced because: (i) as compared to the past, the devaluation has made unnecessary many of the protection and special benefits granted to selected enterprises; (ii) the Government's commitment to reforms is much stronger as evidenced by the many difficult measures taken during 1993 and 1994; and, (iii) the reform program to be supported by the credit is heavily front-loaded and the program's most important measures were implemented before Board presentation. The risk of back-tracking is mitigated by the fact that the reform program supported by the credit is the result of an intense debate which took place in Senegal since the Fall of 1993 around the austerity measures proposed by the Government. Public opinion has been educated on the costs of monopolies, and there is political pressure from a myriad of small economic operators and consumers to put an end to such practices. The Government is also committed to continue to widely explain the rational for reforms and publicize their impact. Finally, the support envisaged to be delivered through the Private Sector Capacity Building Project being prepared in parallel to this operation should mitigate this risk that the private sector mnight prove ill-equipped to respond as expected to an improved policy and regulatory environment. Rate of Return: Not Applicable Porty Catego: Not Applicable Aopraisal Report: Not Applicable Estimated Disbursements: - US$ 30 million equivalent would be disbursed upon credit effectiveness; - USS 10 million equivalent would be disbursed upon satisfaction of the conditions for release of the second tranche.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF SENEGAL FOR A PRIVATE SECTOR ADJUSTMENT AND COMPETITIVENESS PROGRAM 1. I submit for your approval the following memorandum and recommendation on a proposed development credit to the Republic of Senegal for SDR 27.6 million, the equivalent of US$ 40 million. The credit is to support the Government's structural adjustment efforts with particular focus on the development of the private sector. The credit would be on standard IDA terms, with a maturity of 40 years, in support of a Private Sector Adjustment and Competitiveness program. A Country Assistance Strategy (CAS) accompanies this report. 2. Senegal, along with the African members of the Franc Zone, devalued its currency in January 1994, opening a window of opportunity to rekindle a long stagnant economy. The devaluation has also eliminated a number of rent-creating distortions, thus altering significantly the political economy of reform in Senegal. The Government is taking advantage of these changes to resume structural adjustment after a long period of stop-and-go implementation. The management of the immediate post-devaluation period and the behavior of the ministers in charge of economic affairs over the past year have been characterized by a keen appreciation of the need for reforms, strong efforts at consensus building, and a determination to re-establish the country's credibility with its international partners. 3. Immediately after the devaluation, Senegal was one of the first two CFA countries to agree on a program for 1994 with the IRA and the Bank: it adopted specific actions to safeguard the macro-economic equilibrium and control inflation in order to achieve a lasting real depreciation. These measures were supported by an IMF Stand-by Arrangement and an IDA Economic Recovery Credit, both approved in March 1994. The Stand-by arrangement was converted into an ESAF in August 1994 after the IMF and the Bank approved a PFP covering the period 1994-97. The proposed Private Sector Adjustment and Competitiveness Credit would support, along with an upcoming Agricultural Sector Adjustment Credit (ASAC), specific policy and regulatory reforms agreed under the PFP, and aimed at alleviating constraints that still impede the development of the private sector and a full supply response to the devaluation. It would address, in particular, the issues of trade liberalization, special agreements, and labor market liberalization which were not satisfactorily resolved in the past. The most important measures supported by the proposed operation have already been implemented and measures which are conditions of second tranche release are at an advanced stage of preparation.  2 PART L. THE MACRO-ECONOMIC FRAMEWORK AND RECENT DEVELOPMENTS 4. Background'. Since 1980, Senegal's adjustment efforts have been supported by four IDA structural adjustment credits and two sector adjustment credits. Overall, the country's performance in implementing and sustaining reforms has been mnixed. Much progress has been achieved in: (i) liberalizing the economic system; (ii) improving public resource management (e.g., public investment programming, public enterprise reform, external debt management); (iii) restructuring the banking sector; and (iv) reforming monetary and credit policy. In other areas, namely civil service reform, production incentives, and industrial and trade policies, important reforms were implemented but later reversed (e.g., liberalization of external trade and civil service reform) and other reforms were never implemented (e.g., deregulation of the labor market and removal of special agreements with selected enterprises2). 5. Senegal's economic performance in the 1980s has been uneven. Between 1984 and 1988, real GDP grew at an average rate of 4.3% per annum, the fiscal balance continued to improve, falling from a deficit of 5.8% to 2.5% of GDP. These achievements, however, were not sustained. The large real depreciation achieved by many competitor countries and trade partners since 1985-86, combined with negative terms of trade shocks, led to an increasing overvaluation of Senegal's real exchange rate, making it more difficult to sustain the reform process. In addition, the government became increasingly preoccupied by domestic political concerns, while high levels of aid (more than twice the Sub-Saharan average in 1989) allowed the authorities to postpone necessary adjustments. A serious decline in key sectors after 1988 resulted in low overall real GDP growth during the 1988-1993 period (1.7% per annum). Faced with a deteriorating macroeconomic environment, Senegal renewed its adjustments efforts under SAL IV, approved in 1990. The results, as reported in the Project Completion Report of SAL IV, were disappointing. Some progress was made in the privatization of public enterprises and in the simplification of the tax structure. However, efforts to introduce more flexibility in labor legislation, to reduce non-labor input costs, and to reduce the civil service wage bill met limited success or failed. Senegal's external debt ratios remained high although falling slightly over this period. Total external debt declined from 73% of GDP in 1986 to 57.5% in 1992. As a percentage of exports of goods and services, total debt service fell from 22% to 20.6% over the same period. 6. Recent developments. In 1992 and 1993, Senegal's economy deteriorated even further and was mired in a low-level equilibrium characterized by a sustained recession and underutilized capacity. The difficulties of pursuing an adjustment strategy based on internal deflationary policies became more acute, and the economic reformn program went off-track in 1992. Senegal was unable to obtain a fourth year ESAF, and SAL IV was closed without the third tranche being disbursed. The fiscal and balance of payment positions worsened, with the fiscal balance A comprehensive analysis of Senegal's performance and of the current situation can befound in the County Assistance Strategy which accompanies this report. 2 These special agreements provide companies with tax breaks and, in some cases, a monopoly to import and produce a particular commodity. This is the case, inter alia for sugar CSS) and cement (SOCOCew4).  3 (excluding grants) changing from a 0.2% surplus in 1991 to a 3.9% deficit in 1993 and the current account deficit rising (excluding transfers) from 8.7% of GDP to 9.9% over the same period. Substantial domestic and external arrears accumulated and foreign reserves declined sharply. Output shrank in key sectors such as fishing, phosphates, groundnuts, and food processing, and GDP registered an increase of only 0.8% in 1991, 2.9% in 1992, and declined by an estimated 2% in 1993. The inability of firms to compete implied a shrinking tax base which led the Government to increase its reliance on exceptional revenue measures (e.g., heavy taxation of petroleum products) and on last-minute juggling and ad hoc measures (e.g., payment of tax arrears by certain enterprises in return for offsetting payments of non-budgeted export subsidies). Investment levels at current prices remained low at 14.1% of GDP in 1993, and gross domestic savings declined from 7.9% of GDP in 1991 to 7.4% in 1993. To halt this deterioration, the GOS adopted in August 1993 a more rigorous series of internal adjustment measures, including cuts in public sector wages and an increase in import duties and taxes applied to petroleum products. These measures contributed to containing the budget deficit at 3.9% of GDP and the current account deficit at 9.8% of GDP. They were not sufficient, however, to restore the competitiveness of the economy and its growth prospects. 7. The extent of the appreciation of the real exchange rate, coupled with the Government's problems in removing structural rigidities in the economy, made it increasingly difficult for Senegal to restore competitiveness through internal adjustment alone. The decline of investments and exports, widespread smuggling and customs fraud, and increasing macro-economic imbalances made the January 1994 devaluation of the CFAF inevitable. To restore sustainable long-term economic growth, the Government realizes, however, that the devaluation must be accompanied by additional policy and structural reforms in support of the development of the private sector. Consequently, the GOS has outlined a medium-term strategy to promote private sector activities, the key elements of which are the provision of a stable macro-economic environment and policy and institutional reforms favorable to sustained economic growth. 8. The GOS set out the macro-economic objectives of its strategy for the 1994-1997 period in the Statement of Economic and Social Policies submitted to IDA in March 1994 and detailed them further in the Policy Framework Paper (PFP) of August 1994. These objectives, for which financial performance criteria and benchmarks were agreed on with the GOS, are: (i) a GDP growth rate of 4.7% in 1995; (ii) a return to low inflation after an initial adjustment in prices in response to the devaluation, with the inflation rate projected to decrease from an estimated 39% in 1994 to 8% in 1995 and 2.5% thereafter; (iii) a reduction of the current account deficit from 9.8% of GDP in 1994 to 7.3% in 1996; and (iv) a reduction of the budget deficit from 4.5% of GDP in 1994 to 1.7% by 1996. The main thrust of the government strategy consists of rekindling the adjustment process, particularly by implementing long-delayed reforms in external trade, labor market and in the agricultural sector. This strategy also includes a program of measures to improve public sector management: (i) the adoption of a public investment program, taking into account the devaluation of the CFAF that would be periodically updated over a three year period; (ii) the reduction of the wage bill through an audit of the civil service, whose recommendations would be implemented during 1995-1996; and (iii) the pursuit of the Government divestiture program by privatizing 12 of the 40 remaining public enterprises over the period covered by the PFP, three of which before the end of June 1995.  4 9. Immediately after the devaluation, as a first step, the GOS: (i) established a maximum 45% limit to import tariffs, including the 5% stamp duty; (ii) reduced the number of VAT rates from five to three, with a maximum rate of 20%; (iii) increased energy and utility prices to reflect more closely current economic cost of production; and (iv) decided to pass-through the benefits of the devaluation to agricultural producers. The GOS also announced its determination to accelerate the structural reforms necessary to bolster the supply-response through policy reform programs to be supported by two separate but complementary Bank-financed operations: the proposed Private Sector Adjustment and Competitiveness Credit (PSAC) and the Agricultural Sector Adjustment Credit. The reform program to be implemented under the PSAC aims at: (i) completing the liberalization of domestic and external trade; (ii) improving the export and investment incentive regimes; (iii) reducing maritime transportation costs; and (iv) eliminating rigidities in the labor market. 10. In 1994, inflation remained below the 40% target resulting in a real depreciation of over 30% in foreign currency terms sufficient to permit renewed economic growth provided that the accompanying structural reforms are implemented. Some signs now point out to an economic recovery. Available data on a comparison between January-June 1993 and the same period in 1994 indicate that industrial power consumption has grown by about 8% and increases in production of industrial products range from 14 to 32%. In the meantime, tourists arrivals have increased by 30% and exports in volume of fish and phosphates have increased by 17% and 30% respectively while imports declined by 11% in real terms. 11. Financing requirements. As shown in the folowing table, external financing requirements, before adjustment support and debt relief are estimated at US$ 247 million for the 1995-96 period. These requirements wiLl be met by projected adjustment support of US$ 217 million and debt relief of US$ 8 million. The need for exceptional balance of payments support is projected in the PFP to be eLiminated after 1997 when the remaining balance of payments and fiscal gap will be met by debt relief alone. Senegal Financing Plan (USS Millions) 1995 1996 IQTol External Fin. Requirements 145 102 247 Debt ReLief -1 9 8 Exceptional Financing 136 81 217 Residual Financing Gap 10 12 22 Source: IMF and SPA documents  S PART IL THE PRIVATE SECTOR A. PRIVATE SECTOR'S ROLE IN THE ECONOMY 12. Overview. Senegal's private sector dominates the economy in terms of contribution to GDP, employment, and investment. According to the Bank 1993 Private Sector Assessment, the share of the private sector in the country's GDP was estimated at about 82% and amounted to almost 1000/% of value added in the primary sector, 80% in the secondawy sector, and 77% in the tertiary sector. Private sector activities are very important in both the rural and informal sectors, employing about 90% of the country's labor force; the modem private sector, however, employs only 2% of the labor force. 13. In agriculture, productive activities are carried out primarily by small private family farms. In contrast to most African countries, their output accounts for a modest 20% share of GDP. Agriculture, however, employs 60% of the country's labor force and provides a living to about two-thirds of the population. In the secondary sector, informal entrepreneurs are very active and operate micro-enterprises, producing metal products, wooden furniture, textiles, leather, and garments. In the tertiary sector, their contribution in the areas of trade and transportation is also substantial. As a response to a complex and restrictive web of policies and regulations, and to the stagnation of the modem sector, the informal sector has expanded over the recent years. Employment in the informal sector is estimated to have increased on average 3% per year in the 1980s while it decreased in the modem sector. 14. The Modem Private Sector. The modem private sector, which contributed about 26% of the country's GDP in 1987, is dominated by large enterprises with substantial foreign ownership. In 1988, this sector was estimated to include about 1000 enterprises, of which 264 were in industry, 69 in construction and public works, and 667 in services, including hotels and tourism. In the secondary sector, private enterprise activities are concentrated in food processing and tobacco (about 74% of industrial output); chemicals (about 11%); construction material (about 3%); and textile, garment, and leather (about 12%). In the service sector, private enterprises operate mostly in commerce, transport and tourism. The tourism sector has succeeded in attracting private investors and contributed roughly 11% of total exports earnings in 1990. 15. The modem private sector has never become very efficient. In addition to the overvaluation of the CFAF and to excessive protection, the private sector assessment identified four main constraints to the development of the private sector: (i) market rigidities resulting from an inward-looking and monopolistic economic structure; (ii) high cost of inputs and transportation; (iii) labor market rigidities; and (iv) ineffective incentive and legal frameworks, coupled with weak institutional support. Most private enterprises operate at sub-optimal levels of capacity utilization, have high levels of operating costs, and do not contribute to job creation. In  6 the late 1980s, enterprises operating in the textiles, garments, leather, wood, paper, and construction sub-sectors were reported to experience a decline in the level of permanent employment. As a result, total employmnent in the modem manufacturing sector is estimated to have fallen from about 41,500 in the mid 1980s to about 38,000 in 1990. 16. Public/private sector interface. At the beginning of 1987, there were 87 public enterprises (PE's) in Senegal. Because of their overall poor performance and adverse impact on public finance and on the economy in general3, the GOS initiated in 1987 a public enterprise reform program, including reform of the institutional framework of PEs, restructuring and privatization. Since the inception of this program, government divestiture has been practically completed in the financial sector where only the agricultural bank which receives assistance from several external donors remains owned in majority by the government. With regard to non financial public enterprises, 26 have been privatized, 21 liquidated and 404 remain under government control. Although only 13 of the remaining public enterprises have commercial or industrial activities, PEs still play a substantial role in strategic sectors and have a monopoly in water, power supply, and in processing and marketing of agricultural products such as rice, groundnuts and cotton. Their role is also preponderant in the mining, transportation and communication sectors, and significant in commerce, manufacturing, and tourism. In 1993, the PE sector accounted for 1/3 of total domestic credit and held 1/3 of the external total public debt. 17. The privatization and restructuring program aimed at lessening the importance of the public sector and eliminating money-losing enterprises is still being pursued. Under the PFP for the 1994-1997, 12 enterprises are earmarked for privatization, of which three before June 1995. Other Bank-supported sectoral operations address the privatization/restructuring of the related public enterprises. Ongoing and upcoming projects include the restructuring and privatization of the management (and possibly assets) of water company (SONEES). The Transport SECAL aims, in particular, at strengthening the railroad (SNCS) and at privatizing or liquidating the airline company (SONATRA). The GOS has also requested Bank's assistance to address the problems of the power company (SENELEC) in the context of an upcoming energy sector project. 18. PEs Performance and Budgetary Impact. In terms of performance, in 1993, six of the 13 largest PEs reported profits and seven reported losses. The information available for four of the money-losing enterprises (SENELEC -- power company, SOTRAC - urban transportation, CSPT - phosphates and Dakar Marine -- shipyard), shows 1993 losses totaling about CFAF 8.5 billion (about US$ 29 million, or 0.5% of GDP), 4.3 billion of which due to SENELEC, 3.0 to SOTRAC and 1.0 to Dakar Marine. In 1994, the combined losses of SENELEC, SOTRAC and CSPT are projected to decline slightly to CFAF 4 billion. No reliable information is available on the magnitude of the losses of the four others. 3 In 1998189, the budgetary burden of PEs was estimated at 6% offiscal revenues and 75% of the budget deficit, while 41% of bank credit benefited the public enterprise sector. 4 Of these, the 13 largest include utilities and transport companies, agro-industries and an enterprise producing fertilizers. The remaining are research institutions, hotels, real estate and other service ventures.  7 19. Although there is no direct subsidy from the budget to PEs, the full impact of their performance on the overall public budget cannot be accurately assessed . Since SAL IV, Senegal has eliminated all direct operational subsidies to commercial and industrial PEs while drastically reducing those given others (research and training institutes, etc.). The only exception made right after the devaluation was to earmark in the 1994 budget - with Bank and IMF agreement -CFAF 10 billion under the social safety net to compensate the groundnut oil company (SONACOS) and the rice stabilization fund (CPSP) for the limits on price increases of edible oil and imported rice placed for social reasons as part of the post-devaluation package. This, in fact, is a subsidy to Senegalese consumers. A detailed analysis of the impact of the parastatal sector's financial performance on the overall public budget cannot be carried out because a consolidated budget of the public sector including the PE sector is presently not available. In particular, data on possible implicit subsidies - in the form, for instance, of funds on-lent with preferential interest rates, loan guarantees, assumption by the Government of foreign exchange risks of PE-related transactions and foreign liabilities - are not available at this time. However, this issue will be addressed in the context of the Private Sector Capacity Building operation presently under preparation. B. STRATEGY FOR PRIVATE SECTOR DEVELOPMENT 20. Government strategy. With the recent devaluation, Senegal has a unique opportunity to restore competitiveness and exploit the country's potential to expand production in fishing, light manufacturing, horticulture and agriculture, and services, essentially in tourism. The GOS realizes, however, that the devaluation alone will not generate a sufficient supply-response of the private sector, particularly in terms of new investment and exports. It has prepared, therefore, an overall medium-term adjustment strategy to be carried out over the period 1994-1997 whose main components were described above (para. 8). As part of this medium-term strategy the Government adopted a program for the development of the private sector whose content results from a consensus achieved with representatives of the private sector during a Competitiveness Seminar organized days after the devaluation in January 1994 and during discussions carried out within the Competitiveness Review Group (CRG) - which includes representatives of the private sector, of the labor unions and of the Government - established in February 1994. This program outlined in the Government's Statement of Economic and Social Policies supporting the Economic Recovery Credit is based on the following components: (i) strengthening of domestic competition and improvement of competitiveness; (ii) rationalization of direct and indirect taxation, including that of imported goods; (iii) promotion of export activities; (iv) improvement of the regulatory and legal frameworks; (v) amelioration of the functioning of the labor market; (vi) alignment of factor prices to their economic costs; and (vii) strengthening of the institutional support for the private sector. 21. Throughout project preparation, Bank missions worked in close collaboration with the CRG, which formed five commissions comprised of concerned government officials, representatives of private professional associations and labor unions to analyze and propose adequate measures in the following areas: (i) domestic competition and monopolies; (ii) export promotion; (iii) investment promotion; (iv) reduction of transport costs; and (v) labor regulations  8 and cost. Each commission produced a memorandum including specific measures that could be implemented in 19945 and others whose preparation would require additional studies to be carried out in due course by the CRG. The commissions' recommendations constitute the basis of the policy reform program to be supported by the proposed credit. This program has been extensively discussed by the GOS with the private sector during the Journees de concertation nationale held in Dakar from July 22 to July 24, 1994 and the GOS is determined to continue its program of wide information/discussion on the adjustment process. 22. Bank's strategy and Rationale for IDA's involvement. As described in the Country Assistance Strategy which accompanies this operation, the main objective of the Bank is to help Senegal achieve sustainable growth with equity and targeted poverty reduction. While in the short-term agriculture is the sector where the supply-response is most likely to occur first, exports from the private sector should be the main source of growth in the long term. With the devaluation of the CFAF, the most important impediment to competitiveness has been removed. The proposed credit constitutes, along with the upcoming ASAC, an imnportant element of IDA's strategy to help the GOS improve the policy environment for private sector development. It is an essential element of the government's adjustment program that is being adopted in the context of the PFP to create, and maintain, a business environment conducive to private investment. A Private Sector Capacity Building project is being prepared in parallel to this credit to help the private sector rapidly take advantage of a new policy environment favorable to a sustained development. This project, expected to be presented to IDA's Board in FY96, will specifically aim at: (i) strengthening, through the CRG, the dialogue between the government and the private sector on specific measures needed to further private sector activities; (ii) providing on a demand- driven and matching grant basis, missing skills to private entrepreneurs; (iii) identifying and implementing measures to strengthen the legal framework of the private sector; and, (iv) assisting the government in implementing its divestiture program. 23. Lessons learned. As mentioned earlier, Senegal's performance under the last adjustment operation (SAL IV) supported by the Bank was not satisfactory the third tranche was canceled. A Bank analysis of the implementation of past adjustment programs indicates that two major factors are responsible for their relative lack of success. Firstly, in the past, the availability of quick-disbursing budgetary assistance has had the undesirable effect of focusing government attention primarily on the accessibility of such funds, often to the detriment of long-term development issues. Consequently, the government's ownership of the reform programs might have been overestimated. Secondly, although the design of the previous adjustment programs improved over time, the implementation of the reforms had some serious sequencing shortcomings because of the difficulty in implementing key measures. For example, liberalizing extemal trade before eliminating the constraints to enterprise competitiveness (e.g., exchange rate, labor rigidities, high cost of production) was not sustainable. 5 The measures were selected because they were significant and could be implemented quickly, bolstering the immediate impact of the devaluation. Reforms with a longer lead timefor preparing. or whose success depends on growth resumption (fnalizing PE refonrs, reducing the size and improving the performance of the civil service, etc.) were not included under the proposed PSAC and will be picked up under future operations provided that the PSAC and ASAC are successful.  9 24. The design of the proposed credit takes into account the lessons learned from past adjustment operations in Senegal. Firstly, particular attention has been given to the ownership issue. During preparation and appraisal, efforts were made to associate representatives of the private sector and of the GOS, through extensive discussions within the Competitiveness Review Group. Broad consultations resulted in a consensus on the content and sequencing of the policy reform program to be implemented under the proposed credit. In other words, with the exception of representatives of the CNPS -- which regroups entrepreneurs of the modem sector who benefit the most from special agreements - there is a domestic constituency supporting the reforms and pushing for their implementation. In addition, since the devaluation of the CFA, opposition of interest groups to these reforms has become economically less justifiable. Secondly, the reform program is front-loaded and most of its measures were implemented before Board Presentation. Thirdly, the reforms proposed to be carried out under the credit will be taking place after an important adjustment of the real exchange rate. This has been a major obstacle whose removal should improve the private sector competitiveness and bring the objectives of the program within easier reach. Fourthly, the policy package supported by the proposed credit gives priority to establishing a sound business environment that would enable the private sector to take advantage of the new exchange rate, thus facilitating a rapid supply-response, especiaDly in the export sector. FinaDly, attention has been given to the identification of well-focused conditions with precise implementation criteria that should avoid differences of interpretation. 25. Status of Bank Group Operations. As of June 30, 1994, the Bank Group had approved 102 operations for total commitments of about US$ 1.3 billion consisting of 70 IDA credits, 20 Bank loans, and 12 IFC operations (Annex VI). To date, 57 IDA credits and the 20 IBRD loans have been fully disbursed. Of the remaining, one (Transport SECAL) is a hybrid adjustment/mvestment operation. The rest are divided between agriculture (four), infrastructure (two), human resources development (three), industry (one), and a technical assistance project. Since the devaluation, an Economic Recovery Credit has been approved in March 1994. Among the operations supported by IFC, three were in the financial sector, four in industry, one in services, two in agriculture, and two in fish processing. IFC's current loan and equity investment portfolio is composed of five operations: ICS (phosphoric acid and fertilizers), which was restructured in 1987 and whose financial position is now improved; African Seafood (fish processing), which is in receivership; Africamer (fish processing), which is facing cash flow problems; a leasing company; and an agribusiness project. These projects did not perform well because of a combination of external and policy problems, particularly high factor costs and low international prices, aggravated by the overvalued exchange rate. The performance of these projects is expected to improve after the devaluation and the improvement of the environment for private sector activities. 26. Status of IMF-Senegal Relations. As of June 30, 1994, Senegal's outstanding use of Fund resources amounted to the equivalent of SDR 199.6 million (167.9% of quota). If the full amount under the ESAF arrangements were drawn, Senegal's use of Funds resources, taking into account scheduled repurchases and repayments, would increase to SDR 241.2 million (202.9% of quota) by end-June 1997 (Annex VII).  10 PART Ill THE PROPOSED CREDIT 27. Objectives. The overall objective of the proposed credit is to support policy measures that stimulate the supply-response of the private sector to the January 1994 parity change. To achieve this objective, the credit supports the implementation of the Government's program of policy reforms towards the development of the private sector described in the Letter of Sector Development Policy agreed upon during negotiations (Annex ). Detailed measures included in the reform program, which constitute a complement to the adjustment measures that are being implemented in the context of the PFP, are in the policy matrix attached in Annex . The reforns to be supported by the credit that were envisaged but not implemented in previous adjustment programs have been made before Board presentation. The reform program to be implemented under the proposed credit aims at: (i) completing the liberalization of domestic and external trade; (ii) improving the export and investment incentive regimes; (iii) reducing maritime transportation costs; and (iv) eliminating rigidities in the labor market. Its content is described in the following paragraphs. A. TBE POLICY REFORM PROGRAM 1. The Promotion of Competition in Domestic and External Trade 28. Present situation and recent developments. Despite progress towards liberalization in recent years, competition is still handicapped by administered prices in the domestic market, and quantitative restrictions imposed on external trade. These constraints result from past policies aimed at making the supply of essential goods affordable to the general public and providing protection to de facto monopolies granted to public and private enterprises6 through "special agreements" (Conventions Speciales or Protocoles d'Accord). As a result, despite the elimination in 1987-1988 of a complex price control system that affected more than 200 products, in 1994 the price of 24 products7 --estimated to represent about 12% of GDP and 40% of the CPI- was still being administratively determined. In the area of trade liberalization, the reforms implemented to open the economy in the context of SAL m were reversed in mid-89. The reversal was basically caused by two facts: (i) the decline of industrial activity due to competition from imports in face of an overvalued exchange rate, and (ii) a drop of fiscal revenues that could threaten the country's macro-economic equilibrium. As a result, import tariffs were increased and the use of reference prices reintroduced. In 1994, imports of 18 products were still subject to quantitative restrictions 6 The enterprises benefitingfrom Conventions Speciales are CSS (sugar), SONACOS (edible oil), SAR (petroleum products), ICS (fertilizers), GMD and MOULINS SENTENAC (wheatflour), SOCOCIM (cement), ICOTAF and SOTEXKA (textiles), SODFITEX= (cotton), and SOCOSAC (packing bags). 7 These products are sugar, rice, cotton, groundnuts, vegetable oil, tomatoes and tomato paste, wheatflour and bread, pharmaceutical drugs, health care services, imported milk, imported instant coffee, soap, bottled gas, charcoal, soft drinks, cement, reinforced steel bars, petroleum products, urban transportation, and utilities (water, electricity and telephone).  11 through Autorisations prealables (APs or prior authorizations). With regard to Special Agreements, a review carried out under SAL II showed that, in addition to introducing distortions in the incentive system, they resulted in substantial foregone revenue for the government - estimated for the four most important beneficiary firms at about CFAF 17 billion/year on average, over the period 1979-1986, or about 7.7% of the 1993 tax receipts. 29. Special agreements have also had an adverse effect on poor consumers. Monopoly arrangements which have increased prices govern basic consumption goods such as tomato paste, wheat flour, vegetable oil and sugar while fuel gas, consumed essentially by the non-poor, was subsidized. A recent report revealed that if one includes only major consumption items, inefficiencies from monopolies, trade restrictions, and tariffs cost Senegalese consumers between 12,000 and 14,000 CFAF per capita or 2.5 to 3 times as much as spent on health per capita or 47% of the average expenditure of a poor person. 30. Immediately after the devaluation, the GOS took a first step towards correcting price and tariff distortions by raising all administered prices by 20 to 35% to align them with their real economic level. At the same time, the GOS decreased tariffs on all imported goods and limited them to a maximum of 45%8 (not including a stamp duty of 5%). Rough estimates of the average effective rate of protection (ERP) indicate that it was reduced by about 50% when a value added of 30% is assumed. Although the level of nominal protection is still relatively high by international standards, it was not possible for Senegal to further reduce it because Government's revenues are highly dependent on trade-related taxes (about 50% of total revenues in 1993). The current tariff structure is, however, temporary, pending the harmonization of Senegal's tariff system with those of the other member countries of the West African Economic and Monetary Union (WAEMU). The common tariff structure expected to be implemented in 1996 will include three tariff categories of about 5% for essential goods, 20% for intermediate and capital goods, and 30% for consumer goods. 31. In order to ensure that fair competition among a limited number of existing suppliers will be preserved, the GOS has created a Competition Commission whose mandate would be to assess situations of anti-competitive behavior and to propose appropriate measures to correct them. In August 1994, a law establishing this Commission and provisions relating to free competition in Senegal was adopted by the National Assembly. An application decree satisfactory to IDA specifying the conditions under which price controls are allowed was adopted in January 1995. The decree establishes the criteria that will be applied to define categories of products whose price could be controlled (e.g., non-contestable monopolies). The decree also limits price controls to the list of 11 products whose prices remain administered (agreed in the PFP, para. 32 (a) below) and indicates that this list will be reviewed periodically to eliminate the products whose prices can be freed. 32. Reforms supported by the credit. As stated in the Policy Framework Paper, the GOS is committed to eliminating the remaining barriers to free domestic and import trade and to creating 8 The tariff on intermediate goods and equipment did not change; however, the drop in the tariff on consumer goods was substantial:from 61% and 44% to 45% and 35%for consumer goods that are locally produced and for the other goods, respectively.  12 an environment conducive to increased competition. The current impediments take three principal forms: (i) price controls; (ii) non-tariff barriers on imports; and, (iii) special agreements which grant selected enterprises specific tax, price or import advantages. Reforms will address those three areas: (a) Price controls. In the context of the PFP, the GOS decided to let the price of aDl products be determined by market forces, except for eleven goods and services9 deemed essential and representing only about 3% of GDP. For several products, price liberalization had to be concomitant with the elimination of the prior authorization to import them. The price of six products -soap, miDc, coffee, soft drinks, reinforced iron bars and yeast- was decontroDed in August 1994 and those of cement, localy produced cooking oil (excluding localy produced peanut oil), tomato paste and fresh tomatoes, in January 1995. The price of wheat flour is scheduled to be liberalized in November 1995. In the context of the Agricultural Sector Adjustment Credit, presently under preparation, the GOS is committed to freeing the price of peanut oil in early 1995 and that of rice in June 1995. In addition, targets will be set for reducing the real domestic consumer prices of sugar over a period of three years. Finally, the producer prices of cotton and groundnuts will be determined as a floor price by a committee including farmers and marketing agencies. This measure, already in effect for cotton, will be extended to groundnuts at the beginning of the 1994/95 harvest period. Most of the eleven prices that would remain administered relate to goods and services that are either supplied by monopolies (e.g., electricity, water, telephone) or controled on social grounds (e.g., pharmaceuticals products). Nevertheless, pricing of water and transportation wil be reviewed in the context of the ongoing Water Supply Project and Transport SECAL, both supported by the Bank and aiming at restructuring/privatizing the public enterprises supplying these services. The prices of petroleum products and electricity are expected to be addressed by an upcoming Energy Sector Project to be supported by the Bank and other donors. (b) Non-Tariff barriers. The GOS has also agreed to a complete liberalization of imports, except for gold and silver bars'