Zambia - Enterprise Development Project

Report No. PIC3967 Project Zambia-Enterprise Development Project Region Africa Sector Institutional Development Project ID Number ZMPA44324 Borrower Government of Zambia Implementing Agencies Ministry of Commerce, Industry,and Trade Date this PID prepared May 23, 1996 Date last PID prepared February 7, 1996 Projected Appraisal date June, 1996 Projected Board date March, 1997 1. Country and Sector Background. Since independence in 1964, copper has consistently remained at the center of Zambia's economy -- even after copper prices collapsed, leaving the country heavily indebted and poorer. Several partial attempts of economic reforms not only had little impact but also increased the debt burden of the country. Arrears accumulated, and the Bank and IMF suspended lending operation between 1987 and November 1991 (except for a brief period in 1991). Following elections in 1991, and a change in government, these operations resumed. Over the past four years, with considerable support from the donor community, Zambia has implemented one of the most ambitious and comprehensive economic reform programs on the African continent. In support of this program, the Bank has implemented five adjustment operations with the sixth one in negotiation stage; the country has also recently finished a Rights Accumulation Program with the Fund. 2. Enviable success in policy reform area has not, however, yet put the country on a growth path which would reduce dependence on external assistance and be sustainable in the medium to long run. There are number of reasons for the lack of growth. First and foremost, it took time for the macroeconomic situation to stabilize: in the first three years subsequent to reform, inflation averaged over one hundred percent, real interest rates went as much as 100 percent and the exchange rate was devalued more than 300 times. Second, the private sector was not immediately convinced that the changes were real and permanent. Third, Zambia has had unusually frequent major droughts in the last five years (two major and one minor drought). Finally, the country lacked the domestic savings to finance necessary investments, while foreign private capital has been hesitant. 3. Zambia's reform policies exposed the inherent inefficiencies in its industrial sector, dominated in recent decades by parastatals. In the newly liberalized environment, public and private domestic firms for the most part proved unable to compete as exporters. At the same time domestic demand remained stagnant, and competition from imports grew. The result was a significant job and output loss in the formal  sector. Although some contraction of these inefficient operations was inevitable, output and employment losses were exacerbated by high degree of dependence of manufacturing activities on purchases by ZCCM, which also has shrunk considerably. 4. It has become apparent that Zambian firms must change their traditional ways of doing business, if they are to take advantage of the new opportunities created by the new, liberal economic environment: they must abandon familiar (though declining) lines of business; identify new market opportunities, often in areas where they have no prior knowledge or experience; and restructure their physical and organizational infrastructure. Zambia lacks some crucial elements needed for this transformation to occur. The country's relative isolation has left it cut off from information on emerging market trends globally, making it difficult for entrepreneurs to learn about unfamiliar areas for profit. More fundamentally, Zambia's private sector is 'thin', so the number of existing firms with the skills, experience and organizational culture to pro-actively seek out opportunities is limited. Delays in supply response threaten the economic reform program and contribute to serious political and poverty issues in the urban areas where about half of the population live. 5. Zambia's financial sector also was completely liberalized as part of the program of reform. In addition to foreign banks and a parastatal bank, ZNCB, about fifteen new commercial banks opened subsequent to liberalization, even as the capabilities of supervisory authorities remained weak. The resulting collapse of one major (Meridien BIAO) and two minor banks strained the system. These strains were exacerbated by macroeconomic instability, which made it difficult to develop new financial products and instruments. In particular, high interest rates made it virtually impossible to provide kwacha-denominated long-term finance. 6. Project Objectives. The overall objective of the project is to complement Zambia's macroeconomic reform program with micro-level support to enterprises and financial intermediaries. The project would support firm-level efforts at restructuring by: (i) providing advice through the use of matching grants; (ii) providing long-term credit facility for investment; (iii) providing a short-term credit-line for exporters; (iv) providing technical assistance to help strengthen the institutional underpinnings of the financial system--wholesale, retail, and regulatory; and (v) providing technical assistance to create a common and easily accessible information and data base with modern tools for Zambian entrepreneurs, through the Export Board of Zambia. 7. Project Description. The project would include the following components: A Matching Grant Scheme (MGS)--US$6 million, of which IDA US$3.5 million, 9.71% of total project cost--to stimulate the use of support services to assist firms in their reorientation. MGS would share the costs of firm-level plans aimed at enhancing competitiveness. MGS could also be utilized by various business support organizations to finance development and implementation of their initiatives. To - 2 -  'kickstart' the process of learning by firms, the MGS will be implemented by a small unit which, upon the request of firms (who will retain the right to prepare plans independently) will work with them on designing their business plan, deciding what services will be most helpful, and selecting -- and getting the best out of -- suppliers. A Multi-Purpose Credit Facility (MCF)--US$54 million, of which IDA US$40 million, 87.41. of total project cost-- to provide two credit lines through commercial banks. The first credit line will be a medium-to-long term Investment Credit Facility (ICF)--IDA US$30 million-- to finance investments in all sectors excluding real estate and pure trading activities. The second credit line will be a short term Export Preshipment Credit Facility (EPF)--US$10 million IDA-- to finance working capital needs of production of exports. A Technical Assistance Program--US$1.47 million,of which IDA US$1.15 million, 2.4 W of total project cost--would be established for financial institutions and Export Board of Zambia (EBZ). The program will provide: (i) intensive courses on project evaluation, international trade transactions and portfolio management techniques for long-term lending and export financing ; (ii) a resident advisor for one-year for the Apex; (iii) two resident advisors to assist the ZNCB management to restructure the Bank; (iv) a matching grant scheme for commercial banks to stimulate upgrading of banking operations; and (iv) training for EBZ staff in managing an information broking service. 8. Project Cost and Financing. The proposed IDA credit of US$45 million equivalent would finance about 72t of the total project cost of US$62.12 milion. The project would require a retroactive financing in case the resident advisor for the Apex appointed prior to the effectiveness of the project. IDA funds would be disbursed through special accounts. 9. Project Implementation. Implementation of World-Bank supported projects in Zambia has often been complicated by an overcentralized structure, and a consequent layering of bureaucracy between the project and the final beneficiaries. To minimize these complications, the EDP will be implemented in a de-centralized fashion, with each set of beneficiaries responsible for the relevant project component: The private sector would take the lead (appointing six of seven board members) in a Matching Grant Supervisory Board (MGSB), which would have responsibility for oversight of the Matching Grant Scheme -- including 'demand-driven technical assistance' to commercial banks, which will operate on the same principles as other matching grants to the private sector. MGSB would appoint an independent executor for MGS and supervise the contractor within the agreed operational guidelines. A small apex unit will manage the credit component. The Apex unit would have the responsibilities for ensuring the efficient onlending of funds to solvent, well-managed financial intermediaries with capacity for onlending to private companies and exporters. The design and management of technical assistance to support the apex unit will be undertaken directly by the unit, with IDA approval. This apex unit -3 -  will be either a restructured Development Bank of Zambia (DBZ) or a new organization which could be temporarily located in Bank of Zambia (BOZ). Other technical assistance components will be channeled directly to the relevant recipient organizations (i.e. BOZ, Zambia Institute of Bankers, Zambia National Commercial Bank, and the Export Board of Zambia). MCTI will designate a person to provide day-to-day administrative coordination and to be the final recipient of the required implementation outputs of each component. Given the institutional requirements for the functioning of project components, it is expected that project start-up will be slow, and will initially require a significant amount of supervision. 10. Project Sustainability. Recognizing that strong institutions require years to develop, the project aims to initiate a process that will support the development of strong, sustainable institutions as follows: (i) businesses which can sustain themselves, by directly or indirectly serving export markets and/or successfully competing with imports; and (ii) financial institutions that effectively and efficiently intermediate funds to private sector. Continuation of the existing extensive dialogue with the Government and the private sector will assure wide ownership for the project. 11. Lessons Learned. The project aims to draw on the results of projects, in Zambia and elsewhere, that have sought to support on- lending and to strengthen business services. On-lending projects have often had limited results because: (i) the terms and conditions of onlending led to targeted misallocations of resources; (ii) subsidized credit mechanisms did not have the desired real sector impact; (iii) real sector reforms did not precede; and (iv) in countries with small formal financial systems, reliance on existing solvent and well-managed financial intermediaries did not result in the breadth or depth of financial intermediation needed, particularly to emerging enterprises -- hence there is a need to strengthen the insitutional base of the financial system. A key lesson that has been incorporated into a new generation of projects to strengthen the provision of business services is that provision of information and management should be specialized and tailored to the needs of firms -- generalized training and technical assistance should be avoided. 12. Environmental Aspects. The project is not expected to present significant environment risks and thus an environmental rating of 'C' is proposed. Establishment of a process of environmental review of subprojects as well as an assessment of any other environmental impact will be undertaken during project appraisal. Neither an indigenous peoples plan nor resettlement plan will be developed. 13. Poverty Category. This Project does not have a poverty category. 14. Program Objective Categories. The project would primarily contribute to the private sector development, financial intermediation and institutional development categories. - 4-  15. Project Benefits. The principal benefit of this project is to support ongoing reform program by: (i) aiding and facilitating reorientation of Zambian firms; (ii) increasing investments in internationally competitive activities; and (iii) enhancing scope and capabilities of financial system and financial institutions. The project will generate new investments and create new employments as well as preserve existing jobs by helping firms to become and stay internationally competitive. 16. Project Risks. The principal risk of the project are : (i) the Government may fail to continue its implementation of ongoing macroeconomic reform program; (ii) the Government may interfere with the efficiency and transparency of the onlending mechanism; (iii) the Government and BOZ may fail to effectively implement prudential regulations and monitoring of the financial intermediaries; (iv) information made available to the Apex about financial intermediaries may not be timely and reliable; and (v) alternative funding at below market rates could be provided by the Government or from other sources. In order to mitigate against these risks it is essential to have: (i) continuation of policy dialogue and adjustment operations to ensure the macroeconomic stability and appropriate policy environment for the project objectives; (ii) close cooperation among donors to support the economic reform program and the institution building efforts; and (iii) close supervision of the project implementation. Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone No.: (202)458-5454 Fax No.: (202)522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. Processed by the Public Information Center week ending June 21, 1996. - 5 -