Zambia - Public Sector Reform and Export Promotion Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-7286-ZA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN THE AMOUNT EQUIVALENT TO SDR 122.7 MILLION TO THE REPUBLIC OF ZAMBIA FOR A PUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT December 30, 1998 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit: Zambia Kwacha (K) US$ 1=2,33 7.95 FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS AAC Anglo-American Corporation BOZ Bank of Zambia BW Bonded Warehouse COMESA Common Market for Eastern and Southern Africa CPI Consumer Price Inflation DDB Duty Drawback ERC Economic Recovery Credit ERIPTA Economic Recovery and Investment Promotion Technical Assistance Credit ESAC Economic and Social Adjustment Credit ESAF Enhanced Structural Adjustment Facility HIPC Highly Indebted Poor Countries IDA International Development Association IDF Import Declaration Fee IMF International Monetary Fund MCDSS Ministry of Community Development and Social Services MMD Movement for Multiparty Democracy MOU Memorandum of Understanding MUB Manufacturing-under-EBond NFNC National Food and Nutrition Commission NGO Non-Governmental Organization PER Public Expenditure Review PFP Policy Framework Paper PIRC Privatization and Industrial Reform Credits PSRP Public Sector Reform Program PWAS Public Welfare Assistance Scheme SAF Structural Adjustment Facility SIP Sector Investment Program SPA Special Program of Assistance UNDP United Nations Development Program ZCCM Zambia Consolidated Copper Mines ZPA Zambia Privatization Agency Vice President: Callisto E. Madavo Country Director: Phyllis Pomerantz Sector Manager: Ataman Aksoy Task Team Leader: Sudhir Shetty  FOR OFFICIAL USE ONLY ZAMBL4 PUBLIC SECTOR REFORMAND EXPORTPROMOTION CREDIT Table of Contents L. THE ECONOMY ......................................1 A. BACKGROUND ..................................... I B. RECENT DEVELOPMENTS AND PROSPECTS ..................................... 2 II. ZAMBIA'SADJUSTMENT PROGRAM ..................................... 4 A. MACROECONOMIC MANAGEMENT ..................................... 5 B. PRIVATIZITIONANDPARASTATALMANAGEMENT ..................................... 6 C. IMPROVINGPUBLICSERVICES ..................................... 8 D. FOSTERING PRIVATESECTOR GROWTH ..................................... 9 E. MEDIUM TERMPROSPECTSAND FINANCING PLAN ......................................I.I IM. THE PROPOSED CREDIT .................................. 11 A. SUPPORTING ZCCM PRIVATIZATION ............................ 12 B. PUBLIC SERVICE REFORM ............................ 13 C. INVESTMENTAND EXPORT PROMOTION ..........................................1... 14 D. SOCIAL SERVICES ............................... 15 E. POVERTYIMPACT .............................. I 6 F. ENVIRONMENTAL IMPACT ............................... 17 G. SPECIFIC AGREEMENTS ............................... 17 H. IMPLEMENTA TiON ARRANGEMENTS ............................ .. 18 . IMPLEMENTA TION ASSISTANCE .............................. 1 8 J. COFINANCING ..............................1 9 K. PROGRAM BENEFITS ANDRISKS ..............................R. 19 IV. BANKOPERATIONS .............................. 19 V. COLLABORATION WITH IMF .............................. 21 VI. RECOMMENDA TION .............................. 22 A .NNEXES .............................. 23 A. SOCIAL INDICATORS OF DEVELOPMENT B. KEY ECONOMIC INDICATORS C. EXTERNAL FINANCING REQUIREMENTS D. STATUS OF BANK GROUP OPERATIONS E. EVOLUTION OF POLICY REFORM AGREEMENTS F. ZAMBIA AT A GLANCE G. MATRIX OF POLICY AGREEMENTS H. PERFORMANCE INDICATORS 1. LETrER OF DEVELOPMENT POLICY This operation was prepared by a team consisting of Sudhir Shetty (Principal Economist and Task Manager, AFTM I); Emile Sawaya (Principal Private Sector Specialist, AFTPI); Charles Husband (Senior Financial Analyst, EMTIE); Harry Gamett (Senior Public Management Specialist, AFT12); John Todd (Principal Economist, SRMSG); Hinh Dinh (Principal Economist, AFTM I), Aberra Zerabruk (Senior Counsel, LEGAF); Said Al-Habsy (Senior Counsel, LEGAF), Steve Gaginis (Disbursement Officer, LOAAF), Ligia Murphy (Senior Task Team Assistant, AFTM 1) and Kendall Schaefer (Research Analyst, AFTMI) This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ZAMBIA PUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT SUMMARY Borrower: Republic of Zambia Executing Agency: Ministry of Finance Amount and Terms: SDR 122.7 million (US$170 million equivalent) on standard IDA terms with 40 years maturity. Description: The proposed adjustment Credit would support Zambia's economic reform program, which aims at reducing the widespread poverty by promoting broadly-shared, private sector-led growth and improving the delivery of vital social services. In particular, the proposed Credit would support measures that would: (a) facilitate completion of the privatization of the copper parastatal, ZCCM, by assisting in its labor reduction program; (b) improve the performance of the public service by reforming pay and employment practices and improving management controls; (c) promote private investment, particularly in export-oriented activity, by improving access to imported inputs and streamlining investment approvals and, (d) strengthen the delivery of social services by monitoring budget allocations to key social expenditure categories and supporting key policy reforms. Benefits: The main benefits of this Credit will be faster economic growth, employment creation, and poverty reduction arising from a more efficient and effective public sector (ZCCM privatization and public service reforms), a more competitive private sector and fewer barriers to investment (ZCCM privatization and trade and investment reforms), mitigation of the adverse impacts of ZCCM privatization (support to its labor reduction program), and more effective social service delivery and safety net provisions (monitoring of budget allocations and social service policy reforms). These changes would benefit all groups in the population, including the poorest. They would also provide the basis for sustaining macroeconomic stability and the expansion and diversification of exports. Consequently, Zambia's prospects for sustainable medium-term growth would be enhanced.  - ii - Risks: There are two broad categories of risk. First, it is possible that the Government's reform program could falter due to policy reversal, the impact of major external shocks, or a continuing shortfall in external donor support due to either economic or governance related concerns. The commitment of the Government to economic reforms has been steadfast even in the face of adverse external conditions, including the recent collapse in copper prices. Completion of the privatization of ZCCM, and efforts to expand non-mining exports would also help withstand the effects of adverse external shocks. The Government has committed to continuing the dialogue with donors on governance-related issues, and developments in this area will be closely monitored. The second set of risks relate to the reforms supported by this Credit. The risk that the sale of the remaining core ZCCM assets could be delayed beyond mid-1999 is mitigated by the detailed agreemnents that have been reached. And, the risk that the agenda and timetable for public service reforms could pose political problems is mitigated by the Government's continuing consultations with all major stakeholders during program formulation and implementation as well as its reliance on continued support from the Bank and other external partners. Disbursement: The proposed Credit will be disbursed through the Bank of Zambia. Disbursement will be in three tranches. The first tranche (US$65 million) will be released at effectiveness. The floating tranche (US$40 million) will be released when the specific conditions related to public service reform are satisfied. The second tranche (US$65 million) will be disbursed when the specific conditions associated with its release are met, which is expected to be around May 1999. Project ID Number: ZM-PA-35641  INTERNATIONAL DEVELOPMENTASSOCIA TION REPORTAND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ONA PROPOSED PUBLIC SECTOR REFORMAND EXPORTPROMOTION CREDIT TO THE REPUBLIC OF ZAMBIA 1. I submit for your approval the following report and recommendation on a proposed development credit to the Republic of Zambia for SDR 122.7 million (US$170 million equivalent) in support of its economic reform program. The Credit would be on standard IDA terms, with an amortization period of 40 years, including a grace period of 10 years. 2. The proposed Public Sector Reform Export Promotion Credit (PSREP) would be the seventh structural adjustment credit to Zambia since the clearance of its arrears to the Bank in March 1991. Zambia continues to face very large external financing needs due to its high debt service requirements and the steep decline in the price of its principal export--copper. In recognition of this need and of the accomplishments of Zambia's economic reform program, the international community provided exceptional levels of balance of payments support between 1991 and 1997. The objective of this Credit is to continue IDA's support of Zambia's program of economic reform, which aims to reduce the widespread poverty in Zambia through measures aimed at promoting broadly-shared, private sector-led growth and improving the delivery of vital social services. In particular, the proposed Credit would support measures to: (a) facilitate completion of the privatization of the copper parastatal, ZCCM, by assisting in its labor reduction program; (b) improve the performance of the public service by reforming pay and employment practices and strengthening management controls; (c) promote private investment, particularly in export-oriented activity, by improving access to imported inputs and streamlining the investment approval process; and (d) strengthen the delivery of social services by monitoring budget allocations to key social expenditure categories and supporting the implementation of selected policy reforms. I. THE ECONOMY A. BACKGROUND 3. From Independence in 1964 through the 1980s, Zambia relied on a development strategy that emphasized central planning, public ownership, and foreign borrowing. The economy's performance was also adversely affected throughout this period by the heavy dependence on copper, despite its falling real price and declining production as a result of insufficient investment. Zambia undertook several partial economic reform programs during the 1980s, but these had little lasting effect (except to increase the national debt). When elections were called in late- 1991, Zambia was suffering from a large external debt overhang (over US$7 billion), an inefficient and highly protected parastatal sector that  - 2 - dominated the economy, continued dependence on copper, steadily declining per capita income (half its 1975 level), and an unwillingness on the part of its government to hold the course on difficult but necessary policy reforms. The election of the opposition party, the Movement for Multiparty Democracy (MMD), was seen as an overwhelming endorsement of its economic reform program. Its objectives were to restore internal and external balance, to reduce public sector involvement in business activity, and to focus government efforts on establishing the enabling environment for the private sector and on providing the necessary infrastructure and social services. 4. Zambia's overall economic policy performance has been good since the reform program was initiated in 1991. In particular, the pace of liberalization and decontrol has been impressive. Prices were decontrolled and subsidies eliminated; the exchange rate and interest rates are now market determined; quantitative restrictions on imports have been eliminated; and, import tariffs have been reduced and their structure simplified. Parastatal monopolies have ended, crop marketing has been liberalized, and an ambitious privatization program has made impressive progress. Not everything has gone smoothly, however. It took several years for the high rates of inflation to be brought down, and macroeconomic stability, including consistently low inflation rates, is still to be fully achieved. Structural reforms also remain incomplete, particularly where institutional changes are required, as with public service reform. And, the investment and output response to these reforms has been muted by high real interest rates, continued deterioration in the performance of the copper mines, a series of droughts, and aid shortfalls. Although growth resumed in 1996 and 1997, the delay in privatizing the copper mines, the fall in world copper prices, and the continued suspension of bilateral balance of payments support have tested the Government's commitment to the reform program and its ability to keep the program on track in 1998. Despite these challenges, understandings have been reached at the staff level with the IMF on a policy program to be supported by a three-year ESAF arrangement for 1999-2001. B. RECENTDEVELOPMENTS AND PROSPECTS 5. The Government's economic reform program has remained on course since the second half of 1996 despite much lower external assistance than anticipated. Bilateral donors initially suspended balance of payments assistance in June 1996, largely in response to concerns about the proposed conduct of presidential elections later that year. This hiatus extended into 1997 and 1998 in response to continued concerns about political governance. In 1998, multilateral balance of payments support was also held up due to the delays in privatizing ZCCM. Consequently, external program support, which was only US$141 million in 1996 (less than half the original estimate), was even lower in 1997 (US$120 million), and was negligible in 1998. 6. Despite the drop in external assistance, economic performance was encouraging in 1997, and by the end of the year, it looked like Zambia was well placed to move beyond stabilization to deepening the structural reforms needed to accelerate growth. Although GDP growth slowed to 3.5 percent (from 6.5 percent in 1996), due to a poor maize harvest and a fall in metals production, it was the first time since 1989 that GDP  - 3 - had grown in consecutive years. Non-metal exports continued their impressive growth -- about 30 percent in 1997 and over 25 percent p.a. since 1994. And, inflation continued to decline, with the twelve-month CPI inflation rate falling from 35 percent at end-1996 to less than 19 percent at end- 1997. The tight fiscal and monetary policy stance that was maintained during much of 1997 contributed to this reduction in inflation. The overall central government deficit (on a cash basis) was reduced to about 1.9 percent of GDP (from 2.5 percent of GDP in 1996), while a domestic budget surplus (on a cash basis, and excluding grants, external interest payments and foreign-financed capital expenditures) of about 1.2 percent of GDP was registered. Tight financial policies also helped curb imports, and despite the fall in copper prices in the second half of 1997, the trade deficit fell. But, the current account deficit widened to 5.5 percent of GDP (from 3.6 percent in 1996) due to a fall in net transfers and a deterioration in the services account. 7. However, a combination of adverse shocks -- internal and external -- has slowed the economy and worsened external and internal imbalances during the past year. Copper prices have fallen by almost 25 percent since mid-1997, while ZCCM's operational and financial problems and the delay in completing its privatization have reduced copper production and exports. This decline in the copper mining sector has hurt other sectors of the economy, and combined with the weather-related decline in maize production, GDP is estimated to have contracted in 1998 by about 2 percent. The fall in foreign exchange earnings from copper exports (of over 27 percent) has been exacerbated by the fall in non-traditional exports. Combined with the lack of balance of payments support, these factors have resulted in the Kwacha depreciating in nominal terms by over 50 percent in 1998, while official foreign exchange reserves fell from about 2 months of imports at end- 1 997 to less than 2 weeks of imports by end-November 1998. The current account deficit (after transfers) worsened to over 9 percent of GDP. Meanwhile, average annual inflation rose to almost 30 percent by end-November 1998. Although efforts were made to maintain a tight fiscal stance in 1998, the lack of balance of payment support meant that the domestic fiscal balance and the overall central government deficit deteriorated in 1998. The decline in confidence in the Kwacha since late- 1997 has been reflected in the rapid growth of foreign currency deposits as a share of broad money while the easing of monetary policy in late-1997 also led to an expansion of credit growth. 8. Progress on structural reform has been most substantial in recent years on privatization and trade policy. By December 1998, almost 80 percent of the 280 non- mining public enterprises slated for divestiture had been privatized or liquidated. The privatization of the publicly-owned copper company, ZCCM, suffered a setback in mid- 1998 when an international consortium withdrew from negotiations on the sale of the largest asset package, but this process has moved ahead with an agreement in December to sell these assets to other buyers. With the trade policy reforms since 1995, including the elimination of the 5 percent Import Declaration Fee in July 1998, Zambia now has a trade regime that is one of the most outward oriented in the sub-region. 9. The incidence of poverty in Zambia remains high, reflecting the collapse of the copper industry and the residual effects of the economic mismanagement of the 1970s and 1980s. In 1991, about 70 percent of all Zambians were living in poverty with 58 percent of the population lacking sufficient income even to meet basic nutritional needs.  -4 - Recent data show a slight decrease in poverty. After increasing to about 74 percent in 1993, poverty incidence fell to about 69 percent in 1996 with decreases in rural and urban poverty between 1991 and 1996. The depth and severity of poverty also declined during this period. Rural poverty still remains more widespread and more severe than urban poverty. Most social indicators mirror the high incidence of poverty. Infant mortality, adult illiteracy and malnutrition all remain extremely high and the prevalence of HIV/AIDS has exacerbated the situation. 10. Zambia's medium-term prospects have to be assessed in light of its resources as well as the policy challenges that remain. Its advantages include ample arable land and rainfall, abundant raw materials, and a liberalized policy environment. Accelerating growth will require policies aimed at ensuring macroeconomic stabilization, completing the privatization process, especially of ZCCM, improving infrastructure, and enhancing the quality and coverage of public services. However, even with a supportive policy environment and consistent donor support, the legacies of over two decades of economic mismanagement and the current unfavorable external environment mean that GDP is projected to grow at only about 4.5 percent per year in 1999-2001. Sustained economic growth and poverty reduction will come about only with steady policies and consistent action over a number of years combined with accelerated debt relief. HI. ZAMBIA 'SADJUSTMENTPROGRAM 11. Zambia's economic reform program aims to achieve a significant and sustained improvement in the living standards of the population through broadly-shared, private sector-led growth. Attaining this goal, in turn, will depend on achieving and maintaining a stable macroeconomic environment, improving the climate for private investment through liberalizing markets, privatizing commercial enterprises, investing in human capital and physical infrastructure, and making progress toward long-term external viability. 12. Zambia has successfully implemented many aspects of its reform program, particularly in the areas of liberalization and privatization. The emphasis has now shifted from instituting "stroke of the pen" policy measures to undertaking the more complicated agenda of institutional strengthening and program implementation. On macroeconomic management, the focus is shifting to improving budgetary management, enhancing monetary control, and strengthening the financial system, building on support from previous IDA adjustment operations. Many sectoral reforms are being supported by investment projects as described in Section IV below, and in several key sectors these are also being supported under sector investment programs (SIPs). SIPs are under implementation for the health, agriculture and roads sectors, a Power Sector Rehabilitation Prograrn will begin implementation shortly, and a SIP is under preparation for basic education. 13. The current reform program builds on these accomplishments. The status of the economic reform program, along with future actions, is summarized below under four  - 5 - general headings: macroeconomic management; privatization and parastatal management; improving public services; and, fostering private sector growth. A. MACROECONOMICMANAGEMENT 14. The domestic fiscal balance has improved steadily from a deficit of 4.2 percent of GDP in 1993 to a surplus of about 0.6 percent of GDP in 1998'. In the same period, the overall (cash) deficit of the central government, excluding grants, has fallen from 13.6 percent of GDP to about 9 percent of GDP. While this improvement is commendable, particularly in the light of the difficult circumstances in 1998, several aspects of fiscal adjustment still need to be addressed. Tax revenues have fallen from 19.8 percent of GDP in 1994 to 17 percent in 1998 and a number of tax exemptions, which were granted in 1998 but later revoked, further threatened the revenue base. The significant compression in non-wage expenditures, particularly domestically-financed public investment, since 1994 points to the need to reduce the size of the public sector and contain the wage bill. Finally, fiscal management performance has fluctuated widely during the adjustment period, prolonging the time taken to reduce inflation. 15. The Governnent's fiscal targets for 1999-2001 are to maintain a domestic budget surplus of, on average, about 1.3 percent of GDP and to reduce the overall deficit to below 1 percent of GDP (including grants) by 2001, from almost 4 percent in 1998. Strengthening tax administration and public expenditure management will be key to achieving these objectives and to strengthening overall fiscal management. Tax administration will need to improve to increase effective tax yields, particularly with respect to income and corporate taxes. The public expenditure management system will need to be strengthened by improving the linkages between the cash budget and committed expenditures, thereby avoiding the build-up of new domestic arrears. 16. On revenue, the challenge over the medium term is to continue the restructuring of the tax system while increasing its ratio to GDP. The government will build on the progress recently made in restructuring the tax system, which will involve a further shift of the incidence of taxation toward consumption and away from international trade. Given the limited scope to raise tax rates further, the bulk of revenue improvements will need to be found in the strengthening of tax administration and elimination of exemptions. 17. To be sustainable, reductions in expenditures will need to be accompanied by restructuring to safeguard priority spending on social sectors and infrastructure investments. A specific area where budgetary savings need to be achieved is in the public service wage bill. The reduction in the size of the public service (even with some increases in wage levels) will allow the government to reduce the wage bill to about 25 percent of total domestic non-interest expenditures in 2001 from about 38 percent in 1996-98. In addition, the reduction in the stock of domestic debt and declining interest Defined as the difference between revenues, excluding grants, and expenditures, excluding external interest and foreign-financed capital.  - 6 - rates will lead to a drop in interest payments of about 0.75 percentage points of GDP between 1998 and 2001. Both of these will create room for the needed increases in domestically-financed public investment and social expenditures. Public investment is projected to increase to 7.4 percent of GDP by 2001 (from 6.1 percent in 1998) in the context of a medium-term public investment program. 18. Following the setbacks in restoring macroeconomic stability in 1998, the key objectives for monetary policy will be to assist in regaining control over inflation and rebuilding external reserves. To this end, the monetary policy stance will be tightened in 1999 by controlling the growth of net domestic assets of the banking system. To allow sufficient growth in private-sector credit, the increase in the government's claims on the banking system will be regulated. The Bank of Zambia also intends to intensify its use of open market operations while maintaining positive real interest rates on Treasury bills. 19. Reflecting growing concerns over the financial weakness of the commercial banking sector, the priority in the financial sector will be strengthening prudential oversight of the banking system. Several banks have closed in recent years, while others have failed to meet the increased minimum capital requirements. Decisive actions to deal with the weak institutions and to strengthen banking supervision in the Bank of Zambia will be required to ensure that the banking sector can support the projected increase in private sector economic activity. 20. With import restrictions reduced and foreign exchange controls removed (with support from previous adjustment operations), the focus in the external sector is shifting to establishing a viable long-term balance of payments position. This requires developing the capacity to withstand external shocks due to adverse weather and falling copper prices, as well as reducing Zambia's dependence on copper receipts and donor assistance by strengthening non-metal exports. Building external reserves will be a key element of this strategy along with the maintenance of a market-determined exchange rate. Bank of Zambia operations in the exchange market will be aimed at achieving the desired accumulation of reserves and smoothing short-term fluctuations in the exchange rate. Reserves will not be used to defend the exchange rate if it appears out of line with market fundamentals and the longer-term goal of external viability, but policies will be adjusted if exchange rate developments jeopardize the inflation objective or reduce the profitability of the tradable goods sector. B. PRIVATIZATIONAND PARASTA TAL MANAGEMENT 21. The privatization program is well advanced in Zambia. At the outset of the program, the government enacted a sound legal framework and established a semi- autonomous privatization agency, the Zambia Privatization Agency (ZPA). Significant progress has been made in implementing the privatization program, which started in 1993 with a list of 138 companies to be privatized, and has increased in late 1998 to a portfolio of about 280 entities. Of these, 223 entities have been privatized or liquidated. The program will now focus on completing the sale of the remaining assets of Zambia Consolidated Copper Mining Ltd. (ZCCM), the copper mining parastatal, privatization of  - 7 - the utilities, and on increasing private sector involvement in the provision of infrastructure services. 22. By far the single most important privatization transaction that has been attempted so far is that of ZCCM. When the current government came to power in 1991, ZCCM was facing deep-rooted operational, managerial and financial problems, including undermaintained plant and equipment; aging technology; declining identified ore reserves (despite an abundant resource base); low productivity; declining profitability; excessive debt; conflicting commercial and social objectives; and surplus labor. The company's labor complement was about 57,000, and the annual productivity level was 6.8 tons of copper per employee, low by world standards. The management appointed by the new Government attempted to improve ZCCM's performance, but failed, and in 1995, the Government decided to privatize ZCCM in order to mobilize the capital, technology and management needed to restore the company and the copper mining sector to financial and operational health. 23. To accomplish this, the Government and the minority shareholders (mainly Anglo American Corporation - AAC), on the recommendation of the international investment bankers (financed under IDA's Economic Recovery and Investment Promotion Technical Assistance Credit (ERIPTA), approved in FY96), adopted a two-stage Privatization Plan for ZCCM. During the first stage, ZCCM would dispose of majority interests in its mining assets by unbundling the latter and offering them for sale to qualified private investors. In the second stage after the disposal of these packages, the residual ZCCM would become an investment holding company that would collect outstanding receivables, settle all outstanding liabilities, oversee the Government's minority interest in the privatized companies, and implement a program to reduce the residual labor force from about 7,400 people (eighteen percent of ZCCM's current labor force) to about 30 by mid-1999. Subsequently, the Government's shares in "ZCCM Investment Holding" would be sold through public flotations to the Zambian public and other investors. 24. The first stage of this plan is well under way. The company's operations have been split into packages. Two of the packages (Konkola North Mine Development area and Konkola Deep Mining Project) were subject to direct negotiations with major international mining companies. Bids were called for the other packages by end- February 1997, and the investor response was favorable. Konkola North was sold to a South African mining company, and due diligence work and negotiations for Konkola Deep was undertaken by AAC under the provisions of a Memorandum of Understanding (MOU) with ZCCM/Government. Several of the publicly offered packages and other major assets have been sold (LuanshyalBaluba Mine, Kansanshi Mine, the Power Division, Chibuluma Mine, Chambishi acid and cobalt plants, and the Precious Metals Plant). Negotiations for the sale of the other major packages are at an advanced stage and Memoranda of Understanding have been signed with two prospective buyers. The Government currently is aiming to transfer the remaining assets currently under negotiation by the end of the first quarter of 1999. In the transactions concluded so far, the new owners have undertaken to take over the existing labor force and to honor all existing terms and conditions of service. Any labor reduction programs will thereafter be implemented at their discretion and cost. The investors negotiating for the remaining  - 8 - assets are reluctant to take over all the workers. Thus, the remaining employees, along with commercial obligations and short term loans not assumed by the new owners and residual assets, will remain with "ZCCM Investment Holding." 25. The cost of the residual labor force redundancy program is now estimated at US$65 million. The amount per person appears to be high because the compensation being paid is a terminal benefit, which is tantamount to a lump-sum pension that is payable to all departing employees, including retirees, and because a large proportion of the workers being retrenched are long-time ZCCM employees. The costs of this redundancy program go well beyond the financial capability of"ZCCM Investment Holding" in the short- to medium-term. However, a successful labor reduction program would help ensure the completion of ZCCM's privatization and enhance productivity in the sector, while reducing the scope for potential distress and social up]heaval on the Copperbelt during the transitional period. In an effort to minimize the costs of severance and to encourage preference for continued employment in the privatized operations, ZCCM will: (a) actively promote the skills and services which are found in the Corporate Head Office, the Operations Center and the remaining core assets to the new owners prior to transfer of assets; (b) market the self-contained functions, such as Research and Development, Industrial Relations, and Central Winding and Materials Testing; (c) sell company-owned houses to employees; and, (d) enforce the reimbursement to ZCCM of severance benefits by those who are subsequently re- employed in existing operations by the new owners. C. IMPROVINGPUBLICSERVICES 26. The effectiveness of public services in Zambia has declined significantly over the past 10 years. The basic problems are similar to those faced in many other countries. First, there are too many employees relative to current requirements; second, personnel costs take too great a percentage of limited resources (almost 30 percent of domestic revenues), thereby crowding out expenditure on essential supplies and capital spending. Third, salary scales have been compressed, resulting in wages at senior levels too low to attract and retain good quality staff. Finally, management and organizational procedures are outmoded so that the existing manpower is not used efficiently, and the public service has become generally unresponsive to the country's development needs. 27. In 1993, the Government launched a Public Service Reform Program (PSRP) with a view to improving the quality of public services. Some progress has been made in restructuring ministries to relate their organization more closely to their functions, to hive off non-core functions, and to identify surplus positions. Although new plans have been approved for most ministries and departments and some staff appointed to the new positions, implementation continues to be hampered by the high cost of involuntary retrenchment of surplus civil servants. 28. A revised PSRP was adopted in September 1997, which aimed at substantially reducing non-military public service employment, decompressing public-sector salaries while simplifying pay scales and consolidating allowances, introducing new personnel policies and procedures, including actuarially sound pension arrangements, strengthening  - 9- the system for controlling the public payroll, and developing improved performance management systems. The program would institute a full census of civil servants to identify "ghost workers", use a combination of voluntary and involuntary separation packages for those tenured civil servants identified as surplus, and implement strengthened procedures for personnel management and a new program of performance- based management. Some of the savings from reducing the wage bill by cutting public employment would be allocated over the ensuing three years to decompress salary levels with larger increases at the higher and middle levels. Donor contributions are expected to meet a substantial share of costs of retrenchment. 29. Improved delivery of public services also involves reforms at the sectoral level in delivery mechanisms. In the health sector, those reforms are supported by a Sector Investment Program (SIP) involving multiple donors, and center around decentralization of decision-making and responsibility for service delivery to levels of government closer to those being served. For a number of years now, funding for health services has been allocated as block grants to the district level. Similar systems are being developed in basic education. These reforms are expected to increase efficiency and responsiveness to beneficiary needs. 30. Of particular importance in the social sectors, reforms are currently underway in the areas of nutrition and public welfare. Over the past year, an extensive study of the National Food and Nutrition Council (NFNC) was undertaken, and the Government has developed an agenda for reform including redirecting the functions of NFNC to be more of a catalyst than a service provider, and providing it with adequate resources. The Public Welfare Assistance Scheme (PWAS) is intended to help the poorest of the poor deal with short-term disasters, to pay for health and school fees, and to assist the chronically poor, such as widows, orphans, the aged and the handicapped. In the past, it has suffered from design weaknesses, limited administrative capacity and low budget allocations. The Governrnent has recently revamped the scheme, devising new eligibility criteria and developing new operational guidelines. The Ministry of Community Development and Social Services (MCDSS) has developed a pilot scheme to test the revamped PWAS and will launch the new scheme over four years. An eligibility criteria matrix has been developed, and implementation guidelines have been developed and field tested. Critical to the success of this revised program will be adequate funding. About K. 2.8 billion has been budgeted in 1999 for welfare transfer payments. A National Poverty Reduction Unit has also been established in MCDSS to coordinate the implementation of the Govermment's Poverty Reduction Plan. D. FOSTERING PRIVATE SECTOR GROWTH 31. Zambia's trade and investment policies have undergone substantial reform since the adoption of an outward-looking and market-oriented growth strategy in 1991. These reforms have helped to improve the climate for private investment and to enhance the attractiveness of export-oriented production. Decontrol of prices, elimination of subsidies, privatization of public enterprises, and removal of restrictions on private-sector activity have all contributed to improving the business environment. The availability of foreign exchange at the market-determined exchange rate, the elimination of quantitative  - 10- import restrictions, and rationalization of the tariff structure with consolidation of tariff bands and reductions in nominal tariffs have been of particular importance in reducing the anti-export bias of the trade regime. Meanwhile, until late-1997, tariff revenues were maintained by limiting the availability of tariff exemptions to clearly identified groups or products while extending tariff coverage to most government imports. 32. Tariff reforms since 1996 have enhanced the attractiveness of export production. Nominal tariffs were lowered, particularly for raw materials and capital goods, and the negative protection faced by many domestic businesses using imported raw materials was reduced or eliminated. The maximum tariff rate was reduced from over 100 percent in 1994 to 30 percent in 1997 (including the 5 percent Import Declaration Fee) while the average import-weighted tariff rate fell from 20.6 percent in 1994 to 11.4 percent in 1996, and the standard deviation fell from 12.6 percent to 9.9 percent over the same period. The process of lowering tariffs continued in 1998 with the elimination in July of the Import Declaration Fee (IDF), which had been assessed since late-1995 at 5 percent of the import value as a temporary measure to compensate for the revenue losses due to the first round of tariff reductions. While these tariff reductions have clearly increased the profitability of export production, as reflected in the rapid growth of non-metal exports (27 percent per year in value terms between 1994 and 1997), it is difficult to be more precise about the exact contribution of these changes to export production since the changes are recent and precise data on cost structures and effective protection rates are not available.2 33. In order to sustain the response of exports and private investment, continued macroeconomic stability, strengthening of the financial sector, and improvements in physical infrastructure will be essential in the medium term. Complementary policy and institutional reforms are also needed in two main areas. First, to ensure that exporters have access to their imported inputs at world prices, the existing schemes--the duty drawback (DDB) scheme, which refunds import duties to eligible exporters, and the manufacturing-under-bond (MUB) scheme, which exempts designated exporters from import duties--need to be improved. Despite past attempts to improve their functioning, both schemes have continued to suffer from implementation problems, and neither scheme has had a perceptible impact on the profitability of export production. The problems with the DDB have been that the availability of funding for the provision of duty refunds is inadequate and unreliable, while the procedures and documentation for claiming refunds are time-consuming and cumbersome. The MUB had suffered from not being focused on exporters because it was not distinguished clearly from the Bonded Warehouse (BW) scheme, which is available to all importers. 34. Second, the institutional basis for export and investment promotion needs to be strengthened by streamlining the investment approval process, including that related to land acquisition, and reducing the number of often-overlapping consultative private and public sector institutions. At the same time, wide-ranging investment incentives in the form of fiscal exemptions need to be avoided. 2 The fall in non-metal exports in 1998 is likely to be an aberration on account of the recession and the accumulation of arrears to businesses throughout the country by ZCCM.  - 11 - E. MEDIUM TERMPROSPECTSAND FINANCING PLAN 35. Among the most challenging aspects of Zambia's economic reform program is to establish a viable and self-reliant balance of payments that is compatible with Zambia meeting its external obligations and achieving steady economic growth. This is particularly difficult because of the weakening of copper prices with little expectation of significant recovery in the medium term. At the same time, Zambia's external debt of almost twice its GDP (nearly half of which is multilateral) implies that substantial debt service payments will be required even with successful negotiations with creditors. Thus, even with success in expanding non-metal exports and limiting the growth in the demand for imports, even modest levels of economic growth will mean an increase in the current account deficit during the coming decade. Zambia is a severely indebted low income country and, therefore, eligible to benefit from the HIPC initiative. Once a new ESAF arrangement is agreed with the IMF and the necessary technical work is completed during 1999, Zambia's case could be reviewed by the Bank and Fund Boards, provided overall program performance continues to be satisfactory. 36. With the suspension of bilateral balance of payments assistance in June 1996, a larger share of Zambia's financing needs in 1996 and 1997 was met from foreign direct investment and private capital flows, including privatization proceeds. Balance of payments support in 1997 was about $120 million, mostly in the form of IDA Credits. External financing requirements for 1998 were discussed at the Consultative Group Meeting in May 1998. Although about US$235 million was pledged as program support, it did not materialize due to delays in completing ZCCM privatization. In 1999, the external financing requirement (excluding foreign-financed capital expenditure) is estimated at about US$640 million. Of this amount, about US$190 million is expected to come from multilateral sources (including IDA), about US$360 million is expected to take the form of private capital inflows and new Paris Club debt relief, with the remainder coming from bilateral donors. It is expected that the next Consultative Group Meeting will be scheduled for the first half of 1999, following IMF approval of a new three-year ESAF. III. THE PROPOSED CREDIT 37. The proposed Credit would be the seventh adjustment operation for Zambia in the past eight years. Zambia's economic reform program is well advanced, and the emphasis is now on consolidating past reforms and improving their implementation. The central theme of the proposed operation is on improving the performance of the public sector in delivering key social services and in supporting private sector activity. To this end, it explicitly supports important actions in four critical areas of Zambia's adjustment program described above-ZCCM privatization, public service reform, export and investment promotion, and investment in social sectors. These areas are consistent with the priorities of the Bank program in Zambia as described in the most recent Country Assistance Strategy reviewed by the Bank Board in July 1996. Many of the actions to be supported under the proposed operation will be complemented by specific activities being implemented under ongoing or new investment operations. Technical assistance and  - 12 - other activities relating to the privatization of ZCCM have received ongoing support from the Mining TA and ERIPTA Credits. Public service reforms already being supported by the Financial and Legal Management Upgrading Project will be built upon in a proposed follow-up operation to build public sector capacity. To support the private sector, the Enterprise Development Credit provides credit and matching grants for project development, while the ongoing Agriculture Sector Investment Project provides a Rural Investment Fund. Complementary infrastructure is being funded under multi-donor roads and power programs. Improved delivery of social services is being supported under the Health SIP and the Social Recovery Project and will be supported by a Basic Education SIP under preparation. A. SUPPORTING ZCCM PRI VA TIZA TION 38. The assistance under the Credit aims to facilitate the completion of the privatization of ZCCM and improve the productivity of the copper industry by reducing the labor component of overheads and centralized technical services, and by mitigating the social cost of adjustment. The ZCCM redundancy program will be completed by about June 1999. Government funds for this purpose will be lent to ZCCM on commercial terms. The estimated cost of the program is US$65 million, net of the obligations assumed by the new owners in respect of divisional personnel. Of the total cost, US$58 million would be for payments to departing workers and US$7 million for retraining and outplacement assistance programs, comprising financial counseling, job search seminars, and skills bridging programs. The Government and ZCCM will agree to a redundancy plan acceptable to IDA based on a draft plan that was agreed at negotiations, which includes mechanisms for identifying those who would receive payments and the terms of those payments. A loan agreement will be signed between the Government and ZCCM for onlending the proceeds of the Credit to cover the costs of the redundancy program. An audit without qualification by an independent auditor that certifies that ZCCM has implemented the redundancy plan as agreed with IDA would be a condition for release of the Second Tranche. 39. As ZCCM sells more of its mining/core and non-core assets, it will be left with a portfolio of assets that consists mainly of investments in mining companies for which the organizational structure of a mining concern, such as ZCCM's current organization, is not suitable. The residual ZCCM will be a company that has different objectives and functions, and will have significantly different organizational and staffing requirements. Specifically, it will have to emphasize the monitoring of investments and follow-up on the commitments of the buyers of its assets under the development and other agreements. It will also need far fewer staff (about 30) whose qualifications are by and large different from those employed by ZCCM, the mining company. The change in the objectives, functions, and organizational structure will require ZCCM to revise its Articles of Association, shareholder agreements, administrative rules, and terms and conditions of service. During Negotiations, IDA agreed with Government and ZCCM: (a) on a "ZCCM Reorganization Plan,"; and (b) that ZCCM will seek the approval of the agreed "ZCCM Reorganization Plan" by the ZCCM Board of Directors. A certified copy of the Board's approval resolution will be provided to IDA, and satisfactory progress in  - 13 - implementing this Plan is a condition for release of the Second Tranche. The transfer to the new owners of ownership and control of the remaining core ZCCM assets for which MOUs and/or sales agreements have been reached and decisions concerning the future status of any major ZCCM assets that are unsold will also be conditions for release of the Second Tranche. B. PUBLIC SER vICE REFORM 40. To achieve sustainable improvements in the performance of the public service, the government recognizes that it must address the key issues of overstaffing, low and compressed pay scales, and inadequate management controls. In September 1997, therefore, it adopted a revised PSRP to address these problems decisively and comprehensively by aiming to: reduce nonmilitary public employment substantially by end-1999; decompress public sector salaries to bring pay levels and structures more in line with those in the private sector while simplifying pay scales and consolidating allowances; introduce new personnel policies, procedures, and practices, including actuarially sound pension arrangements, as the basis for a new employment contract between the government and the public service; strengthen the systems for controlling the public payroll; and, develop improved performance management systems. 41. Since the adoption of the revised PSRP, some progress has been made towards these goals. A detailed action and implementation plan for the program was prepared and approved by the Cabinet in April 1998. A full-time Director General was appointed in early-1998 to oversee the implementation of the program, in consultation with a Steering Committee of senior officials from various ministries. To ensure enforcement of tighter establishment controls, a hiring freeze was instituted in August 1997. Initial reductions in the public payroll have been made in 1998 with the retrenchment of over 15,500 classified employees (who are not eligible for the separation packages under the Pensions Act), of whom about 12,300 have been paid their terminal benefits, averaging about K. 4.5 million each. The terminal benefits for the remaining 3200 will be paid by early- 1999. Staffing reviews have been initiated for the ministries that account for the bulk of civil service employment. 42. However, the original phasing of the program, as spelt out in the action plan that was finalized in April 1998 has been modified. These changes in the implementation and phasing of actions on PSRP reflect the deterioration in the economic situation during 1998 as well as delays in moving ahead in some areas due, in part, to unclear delineation of responsibilities and inadequate coordination among the key agencies responsible for action. Specifically, the pace of retrenchment of pensionable civil servants will now be considerably slower than was originally envisioned, while the implementation of improved management controls with regard to the payroll, establishment controls, performance management, and the ministerial staffing reviews and restructurings will be completed later than was anticipated in the action plan. The pace of retrenching pensionable civil servants has been slowed because of a poor response to the voluntary severance package announced in February 1998, in part, due to the worsening economic situation.  - 14 - 43. To agree on the details of this rephasing of actions on PSRP, management arrangements for the program will be finalized and implemented in early-l 999. Following this, a revised action and implementation plan for PSRP will be prepared, and will include clearly-assigned responsibilities for time-bound actions and targets in areas such as retrenchments, pay and pension policies, establishment and payroll controls, ministerial restructuring, performance monitoring, and the mitigation of the social impact of retrenchments. It is expected that this action plan will be finalized and approved by Cabinet so that its implementation begins by June 1999. An important issue to be addressed in revising the action plan is the evaluation of various options for retrenching pensionable civil servants in an affordable manner. As the condition for release of the floating Tranche, the Government will agree with IDA on this action and implementation plan for PSRP and begin its implementation. 44. Since successful public service reform is a long-tern process, the action plan for PSRP will necessarily stretch beyond the implementation period of this operation. Continued support from the Bank and other donors to the implementation of the action plan will likely be provided under the framework of an Adaptable Program Credit aimed at building public sector capacity, which is currently under preparation. The IDA Credit would finance retrenchments as needed, depending on support from other donors, as well as the necessary technical assistance to implement the reforms in such areas as public service pay and employment, and performance management frameworks. C. INVESTMENTAND EXPORTPROMOTION 45. The reforms supported under this Credit relating to export promotion would build on the trade and tax measures implemented since 1991, and would aim at accelerating the supply response by: (i) ensuring that exporters have access to their imported inputs at world prices by improving the workings of the DDB and MUB schemes, thereby compensating for the residual anti-export bias of the tariff regime; (ii) reducing tariffs further; and (iii) improving the institutional basis for investment and export promotion. 46. Making the DDB and MUB schemes work better remains important because, despite the recent reduction in tariffs, the average rate on intermediate inputs is still over 9 percent, while less than a tenth of the value of intermediate goods imports now receive exemptions, compared to 43 percent of the value of capital goods imports. Hence, tariffs on intermediate inputs continue to have an appreciable impact on production costs for many promising export products. To address the problems with the working of the DDB and MUB schemes, changes aim at providing exporters with access to duty-free inputs quickly and transparently while ensuring that they can be administered and controlled easily by the Zambia Revenue Authority. Therefore, the funding mechanism for the DDB has been revamped to ensure adequate and timely financing for refunds, and the necessary documentation and procedures will be simplified. In particular, the duty refund mechanism, including procedures for verifying exports, builds on that already in place for VAT refunds. The MUB has been redefined so that it focuses directly on exporters and the provision of duty-free imports to them has been linked to the revamped DDB scheme.  - 15- 47. As a condition of Board Presentation, several changes in the design and functioning of the DDB and MUB schemes were announced and their implementation begun in April 1998. These changes included: (a) for the DDB, introducing procedures for computing the duty drawback based on coefficients that link duty paid to export values; adopting the standard export documentation currently used for VAT refunds; improving the mechanism for funding duty drawbacks; and, drawing up a code of conduct for applying procedures, which includes tracking the elapsed time for payment of duty refunds; and (b) for the MUB, streamlining procedures and documentation along the lines for the DDB. As a condition of Second Tranche release, it would be verified that both schemes are being implemented satisfactorily, in terms of agreed criteria including the timeliness of processing of duty refunds and the implementation of simplified processing and documentation for the schemes. 48. In facilitating and supporting private investment, the process of investment approvals needs to be clarified and streamlined. With the reduction of fiscal incentives as a tool of investment promotion, the role of the Investment Center is now that of a facilitator, especially for foreign investors. However, the investment approval process still involves the need to deal with multiple agencies, and can be both confusing and time-consuming. Streamlining the investment approval process by clarifying the role and authority of the Investment Center is, therefore, a priority. Some measures for streamlining the investment approval process have been implemented, including broadening the composition of the Committee that considers Investment Certificate applications and establishment of an independent consultancy company, which has private-sector representation on its Board, to provide services to potential investors. Additional actions are being considered by the Government to streamline the investment promotion process. These proposals would be included in an action plan to be implemented beyond the period of this Credit; and on which the Government will agree with IDA as a condition of Second Tranche release. D. SOCIAL SERVICES 49. Although some progress has been made in recent years, the delivery of social services in Zambia continues to be constrained by inadequate policies, shrinking financial resources and poor institutional mechanisms. Under this Credit, budget allocations to the social sectors would be agreed and monitored. In addition, two administrative reforms would be included. Improving nutritional status is a cross-sectoral issue that could bring significant benefits to a large share of the Zambia population at a relatively small cost. Under the previous ESAC II operation, a study of the Government's efforts to address nutritional problems and especially the role of the National Food and Nutrition Commission was carried out and some policy recommendations adopted. Applying the results of that study and developing in more detail the policies and institutional framework to deal effectively with nutrition issues will be a focus of the government's efforts. Specifically, the Letter of Development Policy reflects the Government's commitment to begin implementation of these policies during the period covered by this Credit. The second area is to improve the effectiveness of the safety net so as to assist the poor by mitigating the transition costs of adjustment. The Public Welfare Assistance  - 16- Scheme (PWAS) is the Government's main vehicle for meeting the needs of the poorest, but its effectiveness has been limited in the past. PWAS has been reformed and strengthened, and implementation of these reforms and the provision of adequate sufficient funding for the revamped program will be supported by this Credit. Specifically, the Letter of Development Policy includes the Government's commitment to initiate implementation of the revamped PWAS during the PSREP period. 50. Under agreements reached in previous adjustment operations, the share of the discretionary budget going to the social sectors has increased from 28 percent in 1993 to 33.7 percent in 1995 and 34.6 percent in 1996. In 1997 and 1998, over 36 percent was allocated to these budget categories although agreement on this figure was not a condition under an IDA Credit. Under this Credit, the Government will again maintain a minimum percentage (about 36 percent) of the total discretionary budget (i.e. excluding debt service, donor funded development expenditures, and other statutorily required expenditures) for allocations to and expenditures in the agreed social sector categories in the 1999 Budget. 51. In previous operations, there has also been agreement on a subset of items that would be specifically protected from budget cuts. These items, which totaled 6 percent of the budget in ESAC II, were felt to be the highest priority in achieving sector goals and the most sensitive to expenditure shortfalls. Under this Credit, there is an agreement, reflected in the Letter of Development Policy on protecting the budgeted amounts for key non-personnel spending components in health, education, and public welfare, including the level of transfers to the Public Welfare Assistance Scheme. However, for simplicity of monitoring, only a few key categories would be monitored. The budget shares and the mechanisms for monitoring actual expenditures have been agreed as a condition of Board Presentation. Satisfactory implementation of the agreement on social sector spending as reflected in actual disbursements at the time of program review in 1999 would be a condition of Second Tranche release. E. POVERTYIMPACT 52. The proposed Credit will improve the economic prospects of the poor in Zambia by supporting the Government's efforts to stay the course on policy reforms, thus increasing the prospects for sustainable economic growth and increased investment in Zambia's human resources. Economic growth should expand real income and employment opportunities. Further improvements in the trade regime should expand opportunities for non-mining exports, which analysis has shown to be more labor- intensive than the import substitution industrialization efforts of the 1970s. Of particular importance to the poor will be the efforts to maintain social spending. The long-term efforts to eradicate poverty can only be successful if the Government is able to increase the investment in Zambia's human resources for all population groups. This should also be strengthened by specific commitments supported under this Credit to improve budget allocations to the social services and to strengthen the administrative arrangements in the areas of nutrition and public welfare. Of possible concern in terms of its short-term impact on incomes will be the thousands of redundancies contemplated in both the public service and ZCCM. Severance benefits averaging several years of pay are to be paid to  - 17- these employees, but it will also be necessary to offer services and training to ease the transition to the private sector, and careful follow-up monitoring will be needed to identify and remedy any significant problems that these redundancies might create. F. ENVIRONMENTAL IMPACT 53. Addressing the issues related to the environment has been a vital part of Zambia's economic reform program. The Government was one of the first to complete a National Environmental Action Plan, and an IDA-supported Environmental Support Program is currently being implemented to strengthen the institutions that carry out Zambia's environmental program and to increase the cooperation between the public and private sectors in this critical area. In addition, the Government has recently issued revised environmental regulations for the mining sector, and a new environmental department in the Ministry of Mines has been established. These should ensure that future mining investment take place with due regard to environmental considerations. The proposed Credit does not have an environmental focus, but it should have an overall positive effect by strengthening the capacity of the public sector to enforce environmental legislation. G. SPECIFICAGREEMENTS 54. The specific conditions for release of the Second Tranche and the floating Tranche are summarized below. The maintenance of a satisfactory macroeconomic environment will be necessary to release both tranches. 55. The proposed specific conditions for Second Tranche Release are: (a) Satisfactory audit of ZCCM's implementation of agreed redundancy plan; (b) Satisfactory progress in implementing the ZCCM reorganization plan; (c) Transfer of ownership and control of remaining core ZCCM assets for which memoranda of understanding and/or sales agreements have been reached; (d) Satisfactory operation of revamped DDB and MUB schemes; (e) Agreement with IDA on an action plan to streamline investment promotion; and, (f) Actual spending in the first quarter of 1999 consistent with agreed social spending targets. 56. The proposed specific condition for release of the floating tranche is: (a) Agreement with IDA on a revised action and implementation plan for PSRP, which is approved by Cabinet, and its initial implementation in terms of arrangements for managing the program, strengthening  - 18- management controls, and restructuring ministries (including the necessary retrenchments). H. IMPLEMENTATIONARRANGEMENTS 57. The proposed Credit of US$170 million will assist Zarnbia in meeting its external financing requirements in 1999 and will facilitate the retrenchment of redundant employees of ZCCM to enable its privatization and conversion to efficient operation. The Credit will be disbursed through the Bank of Zambia with US$65 million available at effectiveness, US$40 million tied to a floating Tranche with a specific condition relating only to the public service reform program, and the remaining US$65 million tied to the second tranche with specific conditions in the three other areas, namely, ZCCM privatization, export and investment promotion, and social services. Simplified disbursement procedures under adjustment credits will apply. The Borrower will open an account in the Central Bank. Upon IDA notification of tranche release for each tranche, proceeds of the Credit will be deposited by IDA in this account at the request of the Borrower. If after deposits in this account, the proceeds of the Credit are used for ineligible purposes (to finance items imported from non-member countries, or goods or services in the standard negative list), IDA will require the borrower to either (a) return that amount to the account for use for eligible purposes; or (b) refund the amount directly to IDA, in which case IDA will cancel an equivalent undisbursed amount of the Credit. Although routine audit of the account will not be required, IDA reserves the right to require it. As has been the case with previous adjustment operations, the Ministry of Finance will be responsible for the overall implementation and monitoring of reforms supported by the PSREP Credit. This will involve continuing the monitoring and implementation unit already established, and revising its terms of reference accordingly. I. IMPLEMENTA TIONASSISTANCE 58. Administrative capacity remains a constraint on the Government's ability to achieve the objectives of its economic recovery program. The Bank has been assisting the Government's efforts to upgrade this capacity while recognizing that the direction of this program must remain firmly in Zambian hands. Several IDA-assisted projects are directed primarily at capacity building, including the Financial and Legal Management Upgrading Project (which includes administrative strengthening of public procurement), the Privatization and Industrial Reform Technical Assistance Project, the recently- completed Transport Engineering Project and the Economic Recovery and Investment Promotion Technical Assistance Project. All investment projects have major components addressing capacity issues, particularly the sector investment operations in health, agriculture and roads (and under preparation in basic education). Use has also been made of the Institutional Development Fund in building capacity in advance of project investments. Considerable technical assistance is being provided in the public sector management area by other donors and by the UNDP, and a possible follow-up capacity building operation by the Bank is under consideration.  - 19 - J. COFINANCING 59. At this stage, the African Development Bank has expressed an interest in parallel cofinancing. Indications are that bilateral donors will make their own arrangements for providing balance of payments support. K. PROGRAMBENEFITSAND RISKS 60. The primary benefit of this Credit will be the advancement of policy reforms in the critical areas of ZCCM privatization, public service reform, export and investment promotion, and social service delivery. These reforms should help sustain macroeconomic stability, accelerate economic growth and increase employment while improving the delivery of social services. The measures related to ZCCM privatization and investment promotion should enhance the prospects for medium-term growth while the protection of social sector expenditures should increase Zambia's prospects for sustainable growth in the longer term. 61. There are two broad categories of risk. The first is that the Government's reform program as a whole could falter. This could result from major policy reversals and/or the impact of major external shocks, including a continuing shortfall in external donor support because of either economic or governance-related concerns. The commitment of this Government to economic reform has remained steadfast in the past seven years. Many of the measures supported under this Credit and previous adjustment operations have strengthened the capacity of the Zambian economy to withstand external shocks, including the collapse in copper prices during the past year. Dialogue with donors on governance-related issues, pledged by the Government at the last Consultative Group Meeting, continues to be needed and is of high priority. The second source of risk for this Credit concerns the possibility that the specific reforms supported under it are not undertaken. While it is possible that the sale of the remaining core ZCCM assets could be delayed beyond 1999, this risk is mitigated by the detailed agreements that have been reached between the Government, ZCCM and the prospective buyers for the purchase of the bulk of these assets. On public service reform, there is a risk that the agenda and timetable for reforms could pose political problems. To mitigate this risk, the Government will continue consultations with all major stakeholders during the formulation of its action plan and implementation of the program, and rely on continued support from the Bank and other external partners. IV. BANK OPERA4TIONS 62. The Bank's 1994 Poverty Assessment prepared with significant donor and Government involvement, provides a focus for Zambia's development objectives and frames the priorities of the Bank's assistance strategy for Zambia. The Bank is pursuing a three-pronged strategy to assist the Government in implementing an action plan for reducing poverty in Zambia: creating a stable macroeconomic enviromnent favorable to growth; promoting private sector development and greater public sector efficiency; and, targeting assistance to poor and vulnerable groups. Under the first prong of this strategy,  - 20 - Zambia has achieved some notable successes, and on balance, seems to have emerged from the most difficult first stages of its economic transition. Yet Zambia's high debt burden and limited prospects for copper exports in the short term mean that continued reform and balance of payments support will be needed for the next decade if economic growth is to be achieved. Under the second prong, past reforms have resulted in the economy being now among the most open and private-sector oriented in Africa. IDA is supporting activities through specific investment projects and sector investment operations (SIPs) to improve the efficiency of service delivery as well as helping to increase the private sector's role in the economy through continued support for the privatization program and through new initiatives aimed at providing enterprises with the information, technology, and term finance to adapt to the new business environment. In addition, IDA is assisting the Government to arrest environmental deterioration and to put in place an effective environmental management system in Zambia. 63. To help target assistance to poor and vulnerable groups (the third prong of the strategy), stabilization and budget reform measures supported by IDA adjustment lending include protection of core social expenditures. Similarly, the Bank's investment lending emphasizes supporting community-based development initiatives, integrating growth and poverty reducing activities better within sectors, improving the delivery of services to the poor, and linking poverty reducing activities across sectors. 64. The Bank's program in Zambia includes adjustment lending, investment lending, economic and sector work, and aid coordination. Bank adjustment operations each year have been aimed at strengthening macroeconomic stabilization and market liberalization, supporting privatization and parastatal reform, reducing structural constraints on the delivery of social services, strengthening the social safety net, and promoting public sector reform. In addition, IDA is supporting thirteen investment operations in agriculture, health, roads, power, urban water and sanitation, environmental protection, private sector development and social recovery, and in technical assistance in mining, the petroleum sector, privatization and financial and legal reforn. The Bank is now shifting its investment lending towards SIPs, whose aim is to increase public efficiency by avoiding the overlap, inconsistency, and administrative overload associated with a large number of separate donor-funded projects within each sector. As umbrella operations in which the Government takes the lead, SIPs are expected to promote dynamic growth both broadly, through improving the efficiency of service delivery within the sector, and in a targeted way, by financing pilot projects with a more immediate impact on the poor. They also provide long-terrn capacity building within the sector. SIPs have been approved in health (1994), agriculture (1995), roads and power (1998). Future IDA investment operations will consist predominantly of similar operations in basic education and vocational education, a public sector capacity building project and a small number of narrowly targeted operations to achieve needed short-term gains. Preparation of a new CAS, involving a series of consultations with the Government and other stakeholders, is underway and will be presented to the Executive Directors early in FY00. 65. The Bank's economic and sector work will include broader studies to provide some of the analytical underpinning for the economic reforms. Recent examples of such work are the Policy Framework Papers (PFPs), the Public Expenditure Reviews (PERs),  - 21 - the Growth Prospects paper, and a Fiscal Management Review. In addition, the Poverty Assessment has provided additional insights into the extent and determinants of poverty in Zambia, explored the impact of the reform program on the poor, and recommended further reformns and targeted investment programs. As Zambia is one of the most heavily indebted of the low income countries, considerable attention will continue to be paid to analyzing the country's prospects for further debt relief, and Zambia is one of the countries highlighted in the joint Bank-Fund study on Debt Sustainability for Heavily Indebted Poor Countries. Further work on Zambia's eligibility for HIPC will take place in 1999. Aid coordination will continue to figure prominently in the Bank's strategy. This includes: supporting the aid coordination that takes place in Lusaka under the leadership of the Government; chairing the Consultative Group; providing country consultations on Zambia in Special Program of Assistance for Africa (SPA) meetings; and, maintaining frequent informal contacts with Zambia's principal bilateral partners. V. COLLABORATION WITH IMF 66. The programs of the Bank and Fund in Zambia have been closely coordinated since assistance to Zambia resumed in 1991. Balance of payments needs are jointly agreed among the Bank, the Fund, and the Government as part of the PFP and Consultative Group processes. Bank proposals on trade, taxation, spending allocations, privatization, public service reform and related structural policy benchmarks are coordinated with the Fund's fiscal targets, while the Fund's macroeconomic benchmarks are developed in close consultation with the Bank. The Fourth Policy Framework Paper was approved by the Bank and Fund Boards in December 1995, and a new PFP for 1999- 2001 is being finalized. Zambia successfully completed its Rights Accumulation Program in December 1995, and the Fund Board approved a three year SAF/ESAF program, the mid-term review of which was concluded in February 1997. An IMF team has reached understandings with the Government on a policy program for 1999, including the macroeconomic framework, to be supported by a three-year ESAF arrangement. These understandings are reflected in the draft PFP.  - 22 - VI. RECOMMENDATION 67. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association, and I recommend that the Executive Directors approve it. James D. Wolfensohn President by: Sven Sandstrom Washington, D.C. December 30, 1998 Attachments  -23 - ANNEXES A. SOCIAL INDICATORS OF DEVELOPMENT B. KEY ECONOMIC INDICATORS C. EXTERNAL FINANCING REQUIREMENTS D. STATUS OF BANK GROUP OPERATIONS E. EVOLUTION OF POLICY REFORM AGREEMENTS F. ZAMBIA AT A GLANCE G. MATRIX OF POLICY AGREEMENTS H. PERFORMANCE INDICATORS 1. LETTER OF DEVELOPMENT POLICY  - 24 - Annex A Page I of I Zambia Social Indicators Latest single year Same reglonflncome group Sub- Saharan Low- 1970-75 1980-85 1990-96 Aftica income POPULATION Total poptiation, mid-year (milions) 4.8 6.7 9.2 596.4 3,236.2 Growth rate (% annual average) 2.9 3.1 2.8 2.7 1.8 Urban population (% of population) 34.8 40.9 43.3 31.7 29.1 Total fertility rate (births per woman) 6.9 6.7 5.8 5.6 3.2 POVERTY (% of population) National headcount index 86.0 Urban headcount index Rural headcount index INCOME GNP per capita (US$) 600 360 360 490 490 Consumer price index (1987=100) 44 31,534 266 275 Food price index (1987=100) 46 40,020 INCOMEICONSUMPTION DISTRIBUTION (% of income or consumption) Lowest quintile 3.9 Highest quinble 50.4 SOCIAL INDICATORS Public expenditure Heafth (% of GDP) 2.4 1.5 Education (% of GNP) 4.7 2.6 5.3 3.6 Social security and welfare (% of GDP) 0.2 0.5 0.7 Net primary school enrollment rate (% of age gmup) Total 77 77 Male 81 78 Female 73 76 Access to safe water (% of populaion) Total 42 48 43 45 76 Urban 86 70 64 63 80 Rural 16 32 27 34 72 Immunizaton rate (% under 12 months) Measles 49 78 56 80 DPT 58 76 55 81 Child malnutrition (% under 5 years) 24 27 29 Life expectancy at birth (years) Total 47 46 44 52 63 Male 46 45 44 51 62 Female 49 48 45 54 64 Mortality lnfhnt(perthousandlivebiths) 100 103 112 91 68 UnderS(perthousandlivebirths) 181 149 202 147 94 Adult (15-69) Male (per 1,W00 population) 546 482 534 448 231 Femal (per 1,000 population) 460 413 494 376 206 Maternal (per 1 00,000 live births) 230 World Development Indicators 1998 CD-ROM, World Bank  - 25 - Annex B Page 1 of3 Zambia - Key Economic Indicators Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 2002 National accounts (as % GDP at current market prices) Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture8 13.5 16.2 15.4 16.3 15.7 15.8 15.9 15.9 15.9 Industry8 34.7 31.6 30.4 30.4 29.9 31.0 31.3 31.6 31.7 Services' 38.9 39.7 41.4 41.0 43.7 41.8 41.3 40.8 40.7 Total Consumption 90.7 91.9 91.3 90.7 93.3 93.4 93.1 91.9 91.2 Gross domestic fixed 13.3 13.6 14.5 13.1 15.2 15.5 16.0 16.3 16.5 investment Government investment 7.0 7.0 5.9 5.2 6.4 6.8 7.4 7.4 7.4 Private investment 6.5 6.9 9.0 9.3 9.8 9.7 9.6 9.9 10.1 (includes increase in stocks) Exports (GNFb)V 35.1 37.6 33.8 31.7 28.5 30.4 31.9 32.8 33.2 imports (GNFS) 39.3 43.4 39.9 37.0 38.1 40.3 42.0 42.0 42.0 Gross domestic savings 9.3 8.1 8.7 9.3 6.7 6.6 6.9 8.1 8.8 Gross national savings' 1.7 0.6 2.0 3.3 0.4 -0.4 0.1 1.5 2.2 Memorandum items Gross domestic product 3347 3498 3298 3875 3356 3504 3757 4051 4364 (US$ million at current prices) Grossnationalproductper 340.0 330.0 350.0 380.0 320.0 330.0 330.0 350.0 370.0 capita (US$, Atlas method) Real annual growth rates (%, calculated from 1994 prices) Gross domestic product at -3.4% -2.3% 6.5% 3.4% -2.0% 3.0% 4.5% 5.0% 5.0% market prices Gross Domestic Income -0.6% 0.4% 2.6% 5.4% -5.2% 2.3% 4.5% 5.3% 5.4% Real annual per capita growth rtes (%, calculated from 1994 prices) Gross domestic product at -6.1% -4.9% 3.8% 0.9% -4.3% 0.7% 2.3% 2.9% 2.9% market prices Total consumption -6.9% -1.5% -0.6% -0.1% -5.3% 0.0% 1.9% 1.6% 2.5% Private consumption -6.0% -1.0% 1.6% 0.1% -5.3% 1.1% 0.4% 1.5% 2.7% (Continued)  - 26 - Annex B Page 2 of 3 Zambia - Key Economic Indicators (Continued) Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 2002 Balance of Payments (USSm) Exports(GNFSb 1174.7 1316.0 1113.0 1230.2 955.8 1065.0 1199.1 1330.2 1450.8 Merchandise FOB 1067.3 1186.0 993.0 1119.1 845.8 951.6 1074.8 1192.3 1285.3 Imports(GNFS)b 1317.0 1518.0 1316.0 1432.4 1277.5 1413.1 1579.5 1700.1 1831.0 MerchandiseFOB 1003.0 1194.0 1055.0 1056.0 1004.8 1102.6 1251.2 1357.6 1471.7 Resource balance -142.3 -202.0 -203.0 -202.2 -321.6 -348.1 -380.4 -369.9 -380.1 Net current trnsfers -19.0 -20.0 -17.0 -16.0 -16.8 -17.6 -18.5 -19.4 -20A (including official current transfers) Current account balance -59.7 -146.2 -122.0 -239.5 -308.9 -368.7 -417.0 -395.6 418.4 (after official capital grants) Net private foreign direct 40.0 97.0 117.0 125.4 163.5 170.0 200.0 220.0 242.0 investment Long-term loans (net) .. .. .. .. .. .. Official 87.1 116.6 86.0 87.0 74.1 176.7 -12.3 60.2 76.2 Private Other capital (net, including .. .. .. .. .. .. errors and omissions) Change in reservesd -155.0 -2.0 -52.0 -25.0 185.3 -1112 -84.6 -121.5 -190.4 Memorandum items Resource balance (% of -4.2% -5.8% -6.2% -5.2% -9.6% -9.9% -10.1% -9.1% -8.7% GDP at current market prices) Real annual growh rates (1994 prices) Merchandise exports 1.8% 4.9% -0.1% 12.2% -10.3% 11.1% 9.4% 7.8% 4.6% (FOB) Primary -2.7% -10.4% 4.2% 7.2% .. .. Manufactures -98.9% 22.6% 18.3% 4.4% 4.0% 10.0% 15.0% 14.0% 14.0% Merchandise imports 1.9% 10.1% -7.6% 5.5% -10.0% 8.0% 10.3% 5.8% 5.8% (CIF) Public finance (as /o of GDP at current market prices) Currentrevenues 20.1 19.9 20.6 19.8 18.1 18.9 19.3 19.4 19.4 Current expenditures 27.9 24.2 18.5 18.4 18.2 16.2 18.0 17.8 18.6 (Continued)  - 27 - Annex B Page 3 of 3 Zambia - Key Economic Indicators (Continued) Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 2002 Current account surplus (+j -7.8 4.4 2.1 1.4 -0.1 2.7 1.3 1.6 0.8 or deficit (-) Capital expenditure 4.0 5.1 8.7 7.5 9.0 10.7 10.0 10.2 10.1 Foreign financing 9.4 9.3 8.4 8.9 9.7 12.1 6.4 8.4 8.0 Monetary indicators M2/GDP(atcurrentmarket 15.5 18.0 18.3 17.4 17.5 17.9 18.2 18.2 18.2 prices) Growth of M2(%) 74.8 55.3 34.4 24.0 21.5 25.8 19.2 13.4 13.4 Price indices( 1994 =100) Merchandiseexportprice 114.1 133.3 111.7 112.1 94.5 95.6 98.8 101.7 104.8 index Merchandiseimportprice 124.5 134.7 128.8 122.2 129.2 131.3 135.0 138.5 141.9 index Merchandise terms of trade 91.6 98.9 86.7 91.7 73.1 72.9 73.2 73.4 73.9 index Real exchange rate 169.2 162.0 169.5 203.0 220.7 .. (US$/LCU); Real interest rates Consumer price index 53.6% 34.2% 46.3% 24.8% 27.8% 20.8% 12.1% 7.7% 7.6% (% growth rate) GDP deflator 56.6% 36.9% 24.3% 25.9% 23.2% 20.0% 12.0% 8.0% 8.0% (% growth rate) a. GDP components are estimated at factor cost. b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Data refer to central government. f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.  -28 - Annex C Page 1 of I Extemal Financing Requirements Millions of US$ 1996 1997 1998 1999 2000 Exports of Goods and NFS 1113 1230 956 1065 1199 Imports of Goods and NFS 1316 1432 1277 1413 1579 Other Current Account excl. interest payments -25 -40 -20 -52 -51 Current Account Balance excl.Grants and Interest Payments -228 -243 -341 -400 -432 Debt Service Before New Rescheduling 453 413 338 457 485 Gross Financing Requirements 681 656 680 857 917 Changes in Net Reserves" -52 -25 185 -111 -85 Debt Relief and Other 2 107 130 -82 0 0 Financing Requirements after Debt Relief 626 551 577 968 1001 Identified Financing 627 550 599 779 681 Official Grants 304 198 222 223 217 Official Loan Disbursements ' 206 227 191 386 264 Direct investment 117 125 164 170 200 Financing Gap -1 0 0 189 320 Memo item: IMF Purchase 0 14 0 13 27 IMF Re-purchases 0 0 0 0 0 1/ Includes IMF purchases and re-purchases. 2/ Includes payments of arrears, debt relief, short term, portfolio investment and errors and omissions. 3/ Excludes use of IMF resources.  Status of Bank Group Operations in Zambia Operations Portfolio Difference Between expected Original Amount in US$ Millions and actual Last PSR Fiscal disbursements a/ Supervision Rating b/ Project ID Year Borrower Purpose IBRD rDA Cancel. Undisb. Orig Frm Rev'd Dev Obj Imp Prog Number of Closed Projects: 56 Active Projects ZM-PE-3251 1992 GOVERNMENT PIRC TECHNICAL ASSIS 0.00 10.00 0.00 .94 .59 0.00 S S ZM-PE-3221 1993 GOVT MKTG. & PROCESS. 0.00 33.00 0.00 13.05 11.00 0.00 S S ZM-PE-3258 1994 GOVT OF ZAMBIA FINANCIAL & LEGAL MA 0.00 18.00 0.00 5.92 4.35 4.72 S S ZM-PE-3252 1994 GOVT PETROLEUM REHAB 0.00 30.00 0.00 25.38 19.94 2.04 S U ZM-PE-3241 1995 GOZ URBAN RESTRCT &WATER 0.00 33.00 0.00 16.29 .16 -2.13 S S ZM-PE-3239 1995 GOVT HEALTH SECTOR 0.00 56.00 0.00 34.99 28.37 0.00 S S ZM-PE-3210 1995 GOVT SOCIAL RECOVERY II 0.00 30.00 0.00 5.90 4.49 0.00 S S ZM-PE-3218 1995 GOVT. AGRICULTURE SECTOR 1 0.00 60.00 0.00 36.32 23.61 0.00 S U ZM-PE-40642 1996 ERIPTA 0.00 23.00 0.00 8.28 4.47 0.00 5 S ZM-PE-44324 1997 REPUBLIC OF ZAMBIA ENTERPRISE DEVELPMNT 0.00 45.00 0.00 41.87 9.78 0.00 S s ZM-PE-3253 1997 GOVT OF ZAMBIA ENVIRONMENT 0.00 12.80 0.00 12.27 2.06 0.00 S S ZM-PE-35076 1998 POWER REHAB 0.00 75.00 0.00 76.38 8.90 0.00 S S ZM-PE-3236 1998 GOVT NATIONAL ROAD 0.00 70.00 0.00 68.81 2.81 0.00 S S Total 0.00 495.80 0.00 346.40 120.53 4.63 Active Projects Closed Projects Total Total Disbursed (IBRD and IDA): 140.50 2,017.22 2,157.72 of which has been repaid: 0.00 564.68 564.68 Total now held by IBRD and IDA: 495.80 1,403.08 1,898.88 Amount sold : 0.00 28.58 28.58 Of which repaid : 0.00 28.58 28.58 Total Undisbursed : 346.40 1.49 347.89 a. Intended disbursements to date minus actual disbursements to date as projected at appraisal. b. Following the FY94 Annual Review of Portfolio performance (ARPP), a letter based system was introduced (HS - highly Satisfactory, S - satisfactory, U - unsatisfactory, HU - highly unsatisfactory): see proposed Improvements in Project and Portfolio Performance Rating Methodology (SecM94-901), August 23, 1994. Note: Disbursement data is updated at the end of the first week of the month. 0 >( O x  -30 - Annex D Page 2 of 2 Zambia STATEMENT OF IFC's Committed and Disbursed Portfolio As of 30-Nov-98 (In US Dollar Millions) Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1972/73 Bata Shoe ZA 0.00 .22 0.00 0.00 0.00 .22 0.00 0.00 1980/84 Kafue Textile 2.78 0.00 0.00 0.00 2.78 0.00 0.00 0.00 1983/91 ZHP 2.73 0.00 0.00 13.59 2.73 0.00 0.00 13.59 1994 AEF Big Five Car .52 0.00 0.00 0.00 .52 0.00 0.00 0.00 1995 AEF Kaila Lodge .14 0.00 0.00 0.00 .14 0.00 0.00 0.00 1997 AEF JY Estates .89 0.00 0.00 0.00 .89 0.00 0.00 0.00 1997 AEF Pentire .67 0.00 0.00 0.00 .67 0.00 0.00 0.00 1997 Finance Bank 4.50 0.00 0.00 0.00 2.00 0.00 0.00 0.00 1997 IMDHZ 0.00 .50 0.00 0.00 0.00 .50 0.00 0.00 1998 AEF Amaka Cotton 1.30 0.00 0.00 0.00 1.30 0.00 0.00 0.00 1998 Nicozam 0.00 .30 0.00 0.00 0.00 0.00 0.00 0.00 Total Portfolio: 13.53 1.02 0.00 13.59 11.03 .72 0.00 13.59 Approvals Pending Commitment Loan Equity Quasi Partic 1998 AEF DRILLTECH .20 0.00 .15 0.00 1999 AEF MPELEMBE .70 0.00 .30 0.00 1998 AEF PREMIER LAP. 0.00 0.00 .65 0.00 1997 AEF ZAMBIA COFF. 1.30 0.00 0.00 0.00 1997 SAFARI INTL. 2.00 .75 0.00 0.00 1999 ZAMCELL 4.50 .60 0.00 0.00 Total Pending Commitment: 8.70 1.35 1.10 0.00  ZAMBIA Evolution of Policy Reform Agreements A. MACRO ERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/91) (6/92) (6/93) (3/94) (7/95) General fiscal and General fiscal and General fiscal and General fiscal and General fiscal and General fiscal and Primary fiscal balance changed from a deficit of monetary perfomance monetary performance monetary performance monetary performance monetary performance monetary performance 7 percent of GDP in 1991 to about I percent of with specific limit on net surplus in 1996 banking credit Annual inflation reduced from over 100 percent In 1991-1994 to 26 percent in November 1998 Harmonize sales tax on Time-bound action plan Introduce VAT Zambia Revenue Authority has increased tax imports and domestic for VAT; collection performance; products Ensure parastatal VAT introduced July 1995 Reform business dividends paid directly taxation and broaden tax to Govemment bases Redirect budget to Continue redirection of Redirect budget to social Social sector share of budget increased from 28 social sectors and within public spending from sectors and within those in 1993 to over 36 percent in 1996 and 1997. those to certain priority low-priority areas to to certain priority categories, e.g., drugs social services categories, e.g., drugs and and primary education primary education Increase nominal Interest rates completely decontrolled in 1993; interest rates Treasury Bill auction established in 1993 Improve budget Prepare guidelines for Cash budget eliminates excess of domestic management operation of the Cash spending over revenues; procedures to avoid Budget; arrears and unplanned System for monitoring arrears introduced spending Adopt and distribute procedures and guidelines for Zambia National Tender Board; Establish time bound plan for public procurement, covering computerization, record keeping, training, administrative strengthening and extemal monitoring Phase out maize Eliminate maize and Maize and fertilizer subsidies eliminated subsidies fertilizer subsidies 0  B. TRADE ERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/91) (6/92) (6/93) (3/94) (7/95) Achieve market Exchange rate determined by market forces clearing exchange rate in second-window forex market Expand OGL to all but All quantitative restrictions on imports removed a small negative list other than those for health, safety and environmental resources Remove export bans Eliminate remaining All export bans removed except for (except for ivory, oil, export ban on maize environmental reasons maize, and fertilizer) Compress tariffrates Reduce top tarifffrom More tariff reduction Provide relief from Adopt a tariff structure Highest tariffrate reduced from 100 to 25 1000/o to 50%; adopt and compression transitional anomalies in with a maximum rate of percent, and number oftariff bonds reduced to 4 strategy for further the tariff structure 25%. Many raw materials tariffreduction would be free of tariffs, Mechanism for relief from tariff anomalies Introduction of VAT capital goods would bc adopted in 1994 will automatically lower charged 5%, intermediate protection by goods 15% and final goods Most raw materials subject to zero tariffs eliminating 'up-lift" 25% factor Transparency and simplicity oftariffstructure Eliminate most tariff improved with the elimination of most exemptions, including for exemptions in 1996 Govemment purchases, and no introduction of new exemptions; qualifying NGOs to be given refunds or vouchers for customs duties Simplify and liberalize Implementation of changes in the design of the duty drawback system duty drawback scheme initiated in April 1998 .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~)T  C. PRIVATE SECTOR ERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/9 1) (6/92) (6/93) (3/94) (7/95) Reform Investment Evaluate effectiveness Investment Act of 1991 replaced with new Act Law; prepare of reformed Investment in 1993; investment guidelines; Act and Investment Investment Center reorganized streamline operations of Center Investment Guidelines issued in 1995 Investment Center Measures to streamline investment approvals l____________________ _____________________ implemented in 1997 Liberalize licensing Prepare action plan for Licensing requirements reviewed and for small-scale SSE deregulation simplified for new businesses enterprise Develop action plan for Create legal basis for Implement 1995 Land Act Market for leasehold land liberalized and land market market in leasehold including the Land regularized in 1995 land and facilitate Tribunal and the Land subdivision of land Development Fund; and property The Ministry of Lands to establish a baseline performance assessment of its leaseholds grants; Informal urban settlements to be regularized Increase budget Road Maintenance Fund established, funded allocation for road by excise tax on fuel maintenance _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ National Housing Policy National Housing Policy issued in 1995 Amend Employment, and Industrial and Labor Relations Acts Begin liberalization Marketing of all crops liberalized in 1992 of maize marketing _ _ _ _ _-__i_es_for_ __g_ Decontrol fertilizer All prices for agricultural products and inputs decontrolled Begin reducing Eliminate consumer Consumer subsidies ended in 1993 consumer maize maize subsidy subsidy Adopt new mining sector Mining policy statement approved by Cabinet policy to encourage private in 1995 sector investment; Adopt new legal, fiscal and environmental New legal, environmental, and fiscal frameworks; frameworks for mining adopted in 1995 Strengthen capacity of Ministry of Mines to Training and reorganization plan prepared ID oversee new legal, fiscal under mining sector technical assistance oa and environmental frameworks O C  D. FINANCIAL SECTOR ERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/91) (6/92) (6/93) (3/94) (7/95) Reform Securities Law Foreign Exchange transactions liberalized, and exchange rate market determined; Eliminated all interventions in credit allocations and interest rates; BOZ introduced Treasury Bills weekly Establish stock auctions; exchange and adopt Reduced high reserve and liquidity capital market requirements for commercial banks; regulations Changed Banking and Financial Services Law to place all financial institutions under Amend Bank of BOZ supervision; Zambia Act to Issued BOZ regulations for banks; strengthen prudential Developed a Stock Exchange and regulations of banks established a Securities Exchange commission to regulate it End public Reform business Adopt business Implement simplified Reform insurance industry Opened the insurance industry to private monopoly on legislation legislation procedures of 1993 policies and laws companies; new insurance law adopted insurance industry Investment Act (including pension-fund management companies) and set up new regulatory and supervisory agency _ Prepare action plans Adopt policy framework Adopted new policy and strategy for term for DBZ, Eximbank and strategy for provision finance in 1995 and Lima Bank of term finance to private sector; Decvelopment Bank of Zambia has ceased Restructure DBZ as apex new lending since 1997 bank and create collection agency for DBZ loan Apex established to on-lend external funds portfolio; to private sector through commercial banks Privatize or close down Eximbank and Lima Bank; Stopped budget allocations to agricultural Reform rural credit and credit institutions in 1995 reorient Govemment- owned credit institutions Eximbank and LIMA Bank in liquidation J I  E. CIVIL SERVICE REFORM ERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/91) (6/92) (6/93) (3/94) (7/95) Eliminate "ghost Eliminate surplus civil Improve retention Maintain adequate Approved use of in-kind benefits for workers" by physical service staff and "ghost incentives for high information system severance payments in 1994 survey workers" level staff with reliable data on number and Identify staffing Retrench 10,000 workers Reduce up-front cash deployment of Nearly all workers now paid by check needs in line and develop deeper costs of severance teachers ministries restructuring program; benefits Launched a public sector reform include compensation program; about 15,000 public measures employees retrenched since 1997; restructuring plans for 14 ministries _ _ ~~~~~~~~~~~approved F. PRIVATIZATION Announce Adopt overall Update Privatization Begin sale of state- Adopted Privatization Act in 1992 privatization policy privatization plan/strategy Program owned firms and develop Established Zambia Privatization modalities Enact Privatization Law Agency (ZPA) in 1992 Offer at least 6 Complete sale of at least Offer for sale 60 Offered for sale 280 entities; parastatals for sale 10 companies; and offer companies; for sale companies Reach point of sale Completed sale or liquidated 223 accounting for 10 percent for 20 companies; entities by December 1998 of total turnover of Complete sale or companies in program liquidate at least 15 companies; Offer for sale additional Offer for sale a total 10 parastatals of 60 companies Recruit all key ZPA ZPA operational since 1992 staff Establish PTF set-up in 1993 Privatization Trust PTF received shares in Chilanga : ________________ ____________________ Fund (PTF) Cement in 1995 Study options to Study completed; privatization under privatize ZCCM way Complete assessment Initial impact assessment completed of impact of privatization on specific target groups First_stage Adopt and begin implementing plans First stage of the two-stage to privatize and restructure ZCCM privatization plan, which split Adopt plans to develop Konkola Deep ZCCM's operations into packages, is project on urgent basis in joint-venture almost complete. Two packages were with private sector in manner resulting subject to direct negotiations of which in majority private-sector ownership one has been sold. The other and management packages were offered publicly, and several of these and other major assets t have been sold. Negotiations for the O four largest remaining packages are advanced and these are expected to be sold in early-1999.  G. PARASTATALS MANAGEMENT ERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/91) (6/92) (6/93) (3/94) (7/95) _ _ _-mbia_ __-_ys Complete studies of Adoption of acceptable Zambia Airways liquidated in 1994 Zambia Airways, Post financial plan for Zambia and Telecoms, and Airways Telecoms separated from Post and Zambia Railways commercialized in 1995 Grant autonomy to all UBZ closed in 1995 other parastatals ZIMCO to be ZIMCO closed in 1995. Directorate of restructured and sub- State Enterprises set up under Ministry of holding companies Finance abolished Establish autonomy of Study long-tern Utilities given authority to set their prices key parastatal utilities regulatory based on agreed mechanisms and establish transitional arrangement for regulatory system, utilities including price I adjustment mechanisms I H. SOCIAL SECTORS ERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/91) (6/92) (6/93) (3/94) (7/95) Implementation schedule Develop improved social for Social Action action program and Program begin implementation Increase budget Meet minimum budget Meet minimum budget Maintain a social Overall budget allocations improved allocation for education and spending targets for and spending targets for sector budget of at key social services in key social services in least 35 percent in Social sector share of budget increased 1994 1995 1996 from 28 in 1993 to over 36 percent in 1996 and 1997 Expand role of NGOs in Formulate a policy on Sector strategies adopted social services delivery collaboration with Decentralization of service delivery begun NGOs Decentralize delivery of health and education services Adopt comprehensive Water sector policy adopted in 1994 water sector policy Prepare an Education Sector strategy Formulate a national drug procurement policy  I. SOCIAL SECURITY ERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED (3/9 1) (6/92) (6/93) (3/94) (7/95) Reform Social New Social Security Act Passed by Security/Pension Fund Parliament. System Adopt action plan to Adopted refonn strategy by NSSRISC cover unfunded liabilities based on joint Bank/lLO study in 1995 of existing statutory pension funds Draft legislation under preparation Repeal 22-years-of- service compulsory retirement law and modify benefit formulae and early retirement conditions Adopt action plan to improve administration and operations of Zambia Approved Cabinet Memorandum on National Provident Fund Social Security Reform in 1995 riQ  - 38 - Annex F Zambia at a glance Page Iof 2 Sub- POVERTY and SOCIAL Saharan Low- Zambia Africa Income Devtopmnt dlamond' 1997 Population, mid-year (flYJkos) 9.4 614 2.048 Life expectancy GNP per capita (Atfas method, USS) 380 500 350 GNP (Atlas method, USS$ bons) 3.6 309 722 Avrage annual growth, 19914J7 Population (X) 2.7 2.7 2.1 G Laborforce(s) 2.8 2.6 2.3 GNP Gmrss per . primary Most recent estimate (latest year available, 1991.97) capita enrollment Poverty (X opopulaton below naflonal poverty ne) 86 Urban population (% of total Population) 44 32 28 Life expectancy at birth (years) 43 52 59 Infant mortality (per 1,000 lAS bArhs) 113 90 78 Child malnutrition (% of dukfen under5) 29 27 .. Access to safe water Access to safe water (X ofpopulatfon) 43 44 71 Illiteracy (% ofpopulaon age 15+) 22 43 47 Zambia Gross primary enrofment odshoo-age populafion) 89 75 91 Male 92 82 100 Lowincorme group Female 86 67 81 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1976 1986 1996 1997 Economic ratios GOP (USS olidons) 2.7 1.7 3.3 3.9 Gross domestic investment/GDP 31.5 23.8 14.9 14.5 Trade Exports of goods and serviceslGDP 43.3 42.2 33.8 31.7 Gross domestic savingsGDP 36.4 22.1 8.7 9.3 Gross national savingstGDP 27.0 1.3 2.0 3.3 Current account balance/GDP -4.5 -22.5 -12.9 -11.3 .oxlsti Interest payrments/GDP 2.5 4.2 2.2 1.5 Dongs ;Investmnent Total debt/GDP 69.2 345.2 217.8 174.4 avings Total debt service/exports 16.1 50.9 21.7 21.6 Present value of debt/GDP .. Present value of debt/exports ..I..b..n.. Indebtedness 197646 198747 1996 1997 199842 (average annual growth) GDP 0.2 0.8 6.5 3.4 4.4 Zambia GNP per capita 4.1 -0.9 4.8 1.4 2.3 Low-income group Exportsofgoodsandservices -4.2 1.8 4.8 14.6 8.4 STRUCTURE of the ECONOMY 1976 1986 1996 1997 Growth ratesofoutputandlnvesb.nt () (% of GDP) eo Agriculture 15.5 13.6 17.7 18.6 Industry 44.3 49.4 34.9 34.6 40.. Manufactufing 15.7 25.2 13.5 13.5 20 Services 40.2 37.0 47.5 46.7 Pdvate consumption 38.4 51.0 78.8 79.4 -20 9 General govemnent consumption 25.2 26.9 12.5 11.3 -GD1 *-GDP Imports of goods and servlces 38.4 43.9 39.9 37.0 197646 198747 1996 1997 Growth rates of exports and Imports (%) (average annual growt) e Agrtcufture 0.9 -4.5 -0.6 -5.1 . Industry -0.9 -2.8 0.2 8.7 40 Manufactudng 1.2 -9.9 5.5 7I 20 Servines 0.2 6.9 152 3.2 0 Pdvate consumption 0.0 0.4 4.2 2.6 -20 s 2 o46 97 General govemment consumption -1.3 -9.3 -10.5 0.7 Gross donmstic invtment -9.9 9.0 9.6 25.4 -40 Imports of goods and servces -6.9 -1.6 -3.6 19.2 - Expofs -e--imports Gross national product -1.0 2.0 7.6 3.9 Note: 1997 data are prliminary edimetes. The diamonds show four key indiators in the country Qn bokld oompared with its inome-group average. If dala are nissing. the dibmond wiN be Incomplete.  -39 - Annex F Page 2 of 2 Zambia PRICES and GOVERNMENT RNANCE 1976 1986 1996 1997 inflation %) Domestfc ptrcest (% change) 2. Consumer prces 18.8 51.8 46.3 24.8 150 Implicik GDP deflator 15.2 82.0 24.3 25.9 _ _ _ _ _ _ _ Govermrent finance o. (% of GOP, kcAiades curmnt grants) Current revenue .. 23.4 20.6 19.8 92 93 94 9f 9s 97 Current budget balance .. -22.3 2.1 1.4 - GDPderfator 0 CPI Overall surphis/deficit .. -28.2 46.7 -6.2 TRADE (UiS$ ,nitik,s) 1976 1986 1996 1997 Export and Inport levels (USS nmions) Total expols (fob) 1,029 698 993 1,119 1,400 Copper .. 572 567 623 1.200 Z'inc . 49 187 185 1.0 Manufactures *- 168 180 c _ I_ ri-1 Total impots (cit) 668 580 1.055 1,056 coo am 111111 Food .. 17 25 12 40DlIIl Fuel and energy 72 51 87 2_ 91 92 93 94 ff sc 97 Export pdoe index (19958100) .. 67 84 84 Import price index (1995.100) 38 68 96 91 cExports Dtmporls Terms of trade (1995.100) .. 99 S8 93 BALANCE of PAYMENTS (US$ Sditions- 1976 1986 1996 1997 Currnt account balance to GDP ratio (% Exportsofgoodsandservlces 1,112 748 1,113 1,230 0 --- - Imports of goods and services 979 778 1,316 1,432 1911 92 93 1 1 s Resource balance 133 -29 -203 -202 -4 Net income -147 -307 -206 -219 -10 .11 Net current transfers . .. -17 -16 Current account balance -125 -375 -426 -438 Financing iRems (nat) 72 -77 478 463 -20 Changes in net reserves 53 452 -52 -25 -25 Memo: Reserves induding gold (USSnltiions) 115 71 211 238 Conversion rate (DEC, !ocMUSS) 0.7 7.8 1,20a7 1,333.8 EXTERNAL DEBT and RESOURCE FLOWS 1976 1986 1996 1997 (USS nl'J5s) Compositon of total debt, 1997 (USS mnillons) Total debt outstanding and disbursed 1,898 5,745 7,181 6,758 IBRD 254 460 105 62 G G.62 IDA 0 190 1,406 1,493 F: 155 | Total debt service 180 386 246 282 IBRD 19 60 58 40 IDA 0 2 12 14 Composlion of net resource Nlova Official grants 124 276 378 E 2,8t4 Official credioms 129 197 86 87 C: 1,138 Ptivate credItors 35 127 -25 9 Foreign ded investment .. 0 58 70 Portfolio equity .. .. .. .. D:672 Wodrd Bank program Commitments 45 70 125 187 A - laRD E - Blateal Disbursements 74 114 181 169 B-IDA D-Otrmutwilatwal F-Private Prncipal repayments 4 27 50 38 C-IMF 0- Shoat-tern Neltlooto 70 87 131 131 1 Interet paymenbt 1S 34 20 16 Net Iransfeam 5 53 111 115 Development Ecocnomis 1218198  PSREP MATRIX OF POLICY AGREEMENTS AREA AND OBJECTIVE BOARD PRESENTATION SECOND TRANCHE FLOATING TRANCIIE ZCCM PRIVATIZATION - Facilitate * Agreement reached on draft ZCCM * Satisfactory audit of ZCCM's implementation by assisting with ZCCM redundancy plan implementation of agreed labor reduction program. * Agreement reached on ZCCM redundancy plan reorganization plan for which * Satisfactory progress in approval will be sought from ZCCM implementing ZCCM Board reorganization plan * Transfer of ownership and control for remaining ZCCM assets PUBLIC SERVICE REFORM - * Action Plan on PSRP adopted by * Agreement on revised action and Improve efficiency by streamlining Cabinet covering public sector pay, implementation plan for PSRP, staff, aligning salaries, and improving employment levels, and which is approved by Cabinet, management. management procedures and and its initial implementation proposals for conducting civil service census and private sector 0 pay survey * Progress in implementing PSRP action plan, particularly in reducing payroll and tightening establishment controls PRIVATE SECTOR GROWTH - * Changes to enhance DDB and MUB * Satisfactory operation of DDB Improve investment climate and schemes announced and and MUB schemes incentives, especially for exports. implementation begun * Agreement on an action plan to * IDF eliminated streamline investment promotion * Measures for streamlining the investment promotion process publicized and under implementation SOCIAL SERVICES - Improve * Agreement reached on funding * Actual spending in 1999, at time delivery of social services levels for social services in 1999 of program review, on social and on a plan for monitoring actual services consistent with expenditures agreement >Ix  - 41 - Annex H Page 1 of 2 ZAMBIA PUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT Performance Indicators Several indicators of economic and social performance will be used to assess the impact of this operation. These relate to economic outcomes expected as a result of policy changes, rather than the agreed policy and institutional changes themselves. They will be reviewed during supervision and after the operation has been completed and there has been time for the changes to have had an effect, typically two to five years after the closing date. These assessments will inevitably entail a large degree of judgment, as it is very difficult to trace causality between actions taken under the proposed operation and these performance outcomes. Moreover, performance indicators do not substitute for in- depth assessments and analyses of overall economic performance over time. The following variables will be monitored as part of this effort to assess performance: A. Macroeconomic Management * government revenue and expenditure as a share of GDP * external reserves * inflation * external debt and debt service relative to GDP * domestic savings and investment relative to GDP. B. Public Sector Management * perceived quality of public services as indicated by beneficiary assessments and private sector business climate surveys C. Fostering Private Sector Growth * growth of non-traditional exports * copper and cobalt production and exports * number of public sector companies offered for sale and sold and/or liquidated  - 42 - Annex H Page2of2 * direct foreign investment, in general and in copper and cobalt mining, in particular. D. Investing in Human Resources and Other Social Services * school participation rates by age, sex and geographic distribution * school achievement (as measured by pass rates) * infant and child mortality rates * nutrition indicators, especially of children  43 - Annex I Page I of 13 29th December, 1998 Mr. Callisto Madavo Vice President, Africa Region World Bank Washington, DC USA RE: PUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT: LETTER OF DEVELOPMENT POLICY I. INTRODUCTION 1. The Govemment has negotiated a new Enhanced Structural Adjustment Facility with the International Monetary Fund (IMF) covering the period 1999-2001. Concurrently, a new Policy Framework Paper 1999-2001 (PFP), which outlines the Government's main economic objectives and the accompanying strategies, has been formulated in collaboration with the staff of the World Bank and the IMF and has been adopted by the cabinet. 2. The main macroeconomic objectives for the period 1999-2001 are to lay the basis for sustained economic growth of 4Y/2 percent per year, further reduction in inflation and a strengthening of the external payments position. The ultimate objectives of these policies will be to reduce the incidence of poverty in Zambia from the current estimate of 70 percent to 50 percent by the year 2004. 3. During the programme period, the Government will continue with its stabilisation efforts through prudential fiscal and monetary policies. These policies will be complemented by structural and institutional reforms, of which the most fundamental ones relate to the privatisation programme, public service reform, export promotion and strengthening of the banking sector. Other reforms and measures that will be implemented are measures to improve the framework for energy pricing, provision of growth-enabling infrastructure, rural development and targeted poverty reduction and alleviation programmes. 4. The purpose of this Letter is to inform you about policy reforms in these areas of reform and adjustment. We are seeking IDA assistance to support these reforms through the Public Sector Reform and Export Promotion Credit (PSREP)  - 44 - Annex I Page 2 of 13 II. RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 5. Since the end of 1991, far-reaching policy reforms have been implemented. These include: * the decontrol of agricultural prices and the liberalisation of maize marketing; * substantial progress on a comprehensive parastatal reform and privatisation programme; * the decontrol of commodity prices and interest rates; * the removal of exchange controls; * the liberalisation of the financial sector, in particular the banking and insurance sub-sectors; and, * the dismantling of quantitative restrictions on imports and exports, as well as the reduction of the level and dispersion of customs tariffs. 6. These reforms, coupled with efforts to pursue stable financial policies, have started to improve the economic outlook. The domestic budget balance, which was one of the chief destabilising factors, was reduced and subsequently turned positive in 1995. In 1996 and 1997, the overall cash balance was maintained at 1.2 percent of GDP. The fiscal policy stance combined with tight moretary policies contributed to a steady decline in the level and rate of inflation, falling from over 100 percent in 1991 to about 18 percent by the end of 1997. Similarly, the exchange rate and interest rates were also stabilised during the period. Economic growth, however, has been uneven due partly to adverse weather conditions, and the weaknesses in the performance of the mining sector. Between 1991 and 1995, the economy declined by an average of 1 percent annually. Consequently, real per capita Gross Domestic product (GDP) declined by 13 percent during the period. Economic activity recovered significantly in 1996 and 1997, with real GDP expanding by 6.5 percent and 3.5 percent, respectively. 7. As a result of adverse weather conditions, the sharp decline in copper exports and copper prices, and the weakening financial position of ZCCM, real GDP contracted by an estimated 2 percent in 1998. Inflation increased from the beginning of 1998 to 26 percent, reflecting mainly increases in domestic food prices and pass through effect of the depreciation of the Kwacha since late 1997. In addition, due to the delay in donor support for balance of payments, the budget experienced cost overruns mainly on public service retrenchment and arrears. As a result, the targeted domestic budget surplus of 1.9 percent of GDP was not realised and the foreign exchange reserves were depleted. III. OBJECTIVES OF POLICY 1999-2001 8. The Government medium term programme aims at achieving macro-economic stability, accelerating economic growth through investment and exports, and reducing poverty. These objectives are consistent with the Government's long term vision of the Zambian economy as one with a rapidly growing private sector operating in a competitive and stable economic environment, with the public sector focusing on the provision of support services and enforcement of laws and regulations. To this end, we propose to take measures in three areas: (1) stabilisation measures to establish and  -45 - Annex I Page 3 of 13 maintain internal and extemal balance; (2) structural adjustment measures to strengthen the basis for a market based and outward oriented economy; and (3) social-sector policies aimed at poverty reduction and human resource development. 9. The objectives for the 1999-2001 period are to achieve economic growth of about 5 percent on average per year while reducing the rate of inflation from 26 percent in 1998 to 15 percent in 1999 and further down to 4 percent by 2001. To bolster our ability to respond to external shocks, gross official reserves will increase to 1.2 months import cover in 1999 and rise further to 2.2 months import cover by 2001. The external current account deficit is expected to widen from 7 percent of GDP in 1998 to 8.3 percent of GDP in 2001, largely on account of foreign investment in the copper sector, which will be financed from private capital inflows. Government's role will be centred on the provision of infrastructure, the maintenance of a favourable policy environment for achieving high growth rates in mining, agriculture, tourism and manufacturing, and the more effective delivery of social and other support services. 10. The annual growth projections over the 1999-2001 period are based on an annual increase in copper production of 6 percent, agricultural output growth of some 51/2 percent, and an increase of non-traditional exports of 15 percent annually. The completion of the privatisation process will enable an increase in manufacturing output by 5 percent per year. These growth prospects are underpinned by an expected increase in gross investment, from 17 percent of GDP in 1998 to 20 percent in 2001. The increase is to come from private investment in the mining sector, export agriculture, manufacturing and tourism, while public investment is expected to rise from 6.1 percent of GDP in 1998 to 7.4 percent of GDP by 2001. The increase in investment is expected to be financed by the inflow of foreign private capital and rising public savings. Private domestic savings are expected to remain constant at 3.8 percent of GDP over the 1999- 2001 period. 11. Zambia's heavy external public debt burden will require continued reliance on debt relief and concessional balance of payments assistance for the foreseeable future. We hope to qualify for assistance under the Heavily Indebted Poor Countries (HIPC) Initiative, as it is not expected that the external debt burden can be reduced to sustainable levels without such supplementary debt relief. The Government recognises that continued assistance from Paris Club creditors and the qualification for the HIPC Initiative will depend on a strong track record under IMF and World Bank-supported programmes in the coming years. IV. STABILISATION MEASURES Fiscal Policies 12. Key fiscal targets for 1999-2001 are to bring the overall fiscal deficit of (including grants) to below 1 percent of GDP by 2001 and to generate domestic budget surpluses of some 1.3 percent of GDP, which would create the necessary room for the expansion of private sector activity. The fiscal stance will also allow the Zambia to reduce over the medium-term its dependence on external assistance as a source of budget  - 46 - Annex I Page 4 of 13 financing. The principal key to achieving fiscal objectives will lie in the strengthening cf tax administration and public expenditure management system. Tax administration will be improved to increase effective tax yields, particularly with respect to income and corporate taxes. The public expenditure management system will be strengthened to avoid domestic arrears and ensure the proper execution of the budget. 13. The revenue-GDP ratio is programmed to increase by I1/2 percentage points over the medium-term. The Government will build on the progress already made in restructuring the tax system, which will involve a further shift of the incidence of taxation towards domestic sources away from international trade. Given the limited scope for raising tax rates, the bulk of domestic revenue improvements will be found in a more efficient tax administration. The performance of the Value Added Tax system will be improved by further reducing fraud, while the current one rate structure will be maintained. In addition, the company income tax rate structure will be reviewed with a view to its unification. Efforts to combat smuggling and customs frauds will be intensified by strengthening customs administration and intensifying co-operation with customs officials in neighbouring countries. 14. The Government recognises that public expenditures need to be restructured to safeguard priority spending in the social sectors and infrastructure development. A specific area to be addressed is the public service wage bill. The reduction in the size of the public service will allow the Government to reduce wage payments in percent of total domestic non-interest expenditures from 34 percent in 1998 to 25 percent in 2001, while decompressing and maintaining the wage bill relative to GDP at 5 percent in 1999. The reduction in the stock of domestic debt and declining interest rates will lead to a drop in interest payments of almost 3/4 percentage points of GDP between 1999 and 2001. Lower wage and interest payments in relation to GDP will create room for the needed increases in domestically financed capital investment and social expenditures. Between 1998 and 2001, domestically financed public investment is projected to increase by almost 2 percentage points to 3 Y2percent of GDP. This increase will be realised in the context of a medium term Public Investment Programme that identifies the priority infrastructure projects in support of the development of the agriculture and agro industrial production, tourism and exports, as well as through an improved delivery of social services. Monetary and Exchange Rate Policies 15. Monetary and credit policies will play a crucial role in reducing the rate of inflation. A strong anti-inflationary policy will require improvements in the effectiveness of monetary policy, including the broadening of instruments. In this context, the Bank of Zambia (BOZ) will intensify the use open market operations and reduce the reliance on cash and liquidity reserve requirements as instruments of credit control. An enhancement of confidence in the internal and external value of the Kwacha will also help the BoZ develop a market for medium and long term Government bonds. This will widen the available options for open market operations and reduce the sensitivity of the Government budget to short term fluctuations in interest rates. In addition, the supervisory and inspection functions of the BoZ will continue to be strengthened in order to ensure public confidence in the banking system.  - 47 - Annex I Page 5 of 13 16. The exchange rate of the Kwacha is market determined, and the BOZ intends to continue its policy of refraining from interventions in the foreign exchange market that go against the underlying market trends. The authorities will closely monitor conditions in the exchange market and price and exchange rate developments in major trading partner countries and will adjust policies if exchange rate developments jeopardise inflation objectives or the profitability of Zambia's tradable goods sector. V. STRUCTURAL ADJUSTMENT MEASURES Privatisation ZCCM 17. In the mining sector, the key challenge is to complete the privatisation of ZCCM, thereby mobilising the capital, technology and management needed to develop new ore bodies and restore the sector to financial health. To accomplish this, a two-stage Privatisation Plan has been adopted. During the first stage, ZCCM is disposing of its majority interests to private investors. In the second stage, the residual ZCCM will collect outstanding receivables, settle short-term liabilities, manage ZCCM's long term liabilities and its minority interest in the privatised companies, and oversee a programme to reduce the residual labour force from about 7,400 people (25 percent of ZCCM's current labour force) to about 30 over the first half of 1999. The structure of the holding company has been designed and approved by the ZCCM board as part of a transformation plan, which will be in place by March 1999. Government shares in the residual ZCCM will then be sold through public flotations to the Zambian public and other investors. 18. The first stage of this plan is close to completion. As of end-December, 1998, Memorandum of Understandings on the sale of all publicly-offered ZCCM asset packages has been finalised, including the Nchanga and Nkana Divisions, the largest of the units. The new owners have undertaken to take over most of the existing labour force and to honour existing terms and conditions of service. Government has aimed to facilitate the privatisation of ZCCM by improving productivity through the reduction of the labour component of overheads and centralised technical services and by minimising the social cost of adjustment. In addition, all self-contained non-mining assets of ZCCM have been offered to the public through management buyouts or public auctions. The Schedule for completion of the sales transactions is: * January 1999: Anglo-American relinquish Mufulira smelter and signing of sales agreement for Mufulira * February 1999: Transfer of Mufulira Mining Assets to new owners * February 1999: Signing of Sales agreement for remaining mining assets * March 1999: Transfer of remaining assets to new owners * March 1999: Completion of sale of non-mining assets 19. The labour reduction programme will be implemented over the period January 1999-March 2000 and will in part be financed out of the proceeds of the PSREP Credit to  - 48 - Annex I Page 6 of 13 Government which will be on-lent to ZCCM. The estimated cost of the programme is US $67 million. Government and ZCCM have developed a redundancy plan which has been approved by the ZCCM Board and includes, mechanisms for identifying those to receive payment, the terms of those payments, and the on-lending agreement between Government and ZCCM. 20. To minimise potential abuses of the redundancy programme and encourage preference for continued employment in the privatised operations, ZCCM will: * actively promote the skills and services which are found in the Corporate Head Office, the Operations Centre and the operating mines prior to hand-over to the new owners; * consult with the new owners to ensure that those workers that are needed by the latter are not inadvertently retrenched; and * agree with the new owners that the redundancy compensation will be paid back to ZCCM by the new owners, if the retrenched worker is re-employed by the new owners within a two-year period of the date of transfer of ownership. Non-ZCCM Parastatals 21. Privatisation of state owned enterprises is a key element of Government's efforts to raise efficiency and bolster economic growth. Since 1992, significant progress has been made in the implementation of the privatisation programme. As of December 1998, 223 state enterprises were privatised out of Zambia Privatisation Agency's (ZPA) total working portfolio of 280. Among the assets sold, seven are ZCCM assets. Other major companies still in negotiations are Zambia Forest and Forestry Industries Limited, Nitrogen Chemicals Limited, Kafue Textiles Limited and Ndola Lime Limited. 22. Over the medium term ZPA will focus on the large utility companies, parastatals in the petroleum and transport sectors, and financial institutions. The Government intends to offer a minority shareholding and management rights in the telecommunication company (ZAMTEL) and intends to study options for the commercialisation of the electricity company (ZESCO). The parastatals in the petroleum sector (INDENI refinery and ZNOC) have been added to ZPA's portfolio. As regards, the transport sector, the Government has entered into a management contract for Zambia Railways and Mulobezi Line, and intends to put out for tender the granting of concessions with regard to the railway system. The Zambian and Tanzanian privatisation agencies have started discussions on options for private sector participation in the commonly owned TAZARA railway and TAZAMA pipeline. Management rights on the operations of the National Airports Corporation in Livingstone, Ndola and Mfuwe will be tendered as well. The Government also intends to hand over the remaining parastatals in the communication sector, notably ZAMPOST, to ZPA. Substantial progress is planned on the privatisation of financial institutions. In this regard, ZPA has been requested to explore options for divestiture of Zambia National Commercial Bank, the National Savings and Credit Bank and Zambia State Insurance Corporation.  -49 - Annex I Page 7 of 13 23. Pending their privatisation, the energy sector companies will remain free of political interference in their pricing policies and management decisions and will not receive public subventions. Government has established regulatory arrangements for the utilities. Our objective is that utility prices provide an adequate return on capital and facilitate a sound level of performance and investment, while the utilities are making maximum efforts to improve their efficiency and do not exploit their monopoly positions. The Public Service Reform Programme (PSRP). 24. The cost effectiveness of the public service has declined significantly over the past 10 years. Personnel costs take 32 percent of domestic fiscal resources and crowd out expenditure on essential supplies and capital spending. As wage levels and pay differentials have been compressed, it has become difficult to attract and retain skilled personnel. Moreover, even the available manpower is not used efficiently because of inappropriate management and organisational structures. Consequently, the public service has become generally unresponsive to the country's needs. 25. In 1993, a Public Service Reform Programme (PSRP) was initiated, with the goal of strengthening the effectiveness, efficiency and quality of services delivered by the public service. This was to be achieved by, amongst other things, restructuring ministries and provinces, introducing Performance Management and Human Resource Management Systems and decentralising certain functions to district level. A core objective was also to reduce spending on personal emoluments (PEs) by reducing public servant numbers, so improving the ratio of Recurrent Departmental Charges to PEs. On September 1 1997, a revised PSRP was adopted that targeted a reduction in public sector workers from 136,984 as at June 1997 to 80,000 by the end of 1999. The new PSRP also included the decompression of salaries so as to improve remuneration for the higher/skilled grades. 26. Substantial progress has been made during 1998. 15,524 casual employees have been approved for separation, with 12,375 (80 percent) having been paid their benefits (amounting to K 57.45 billion) by end October 1998. This class of employee now accounts for about 12 percent of the civil service compared with around 22 percent in mid 1997. Further by 31 October 1998, 2,059 civil servants on permanent and pensionable terms have submitted applications for voluntary separation, 939 (45.6 percent) of whom are administrative staff and 172 (8.4 percent) secretarial. The hiring freeze is firmly in place. New hires are allowed only in critical skills required by GRZ, i.e. doctors, lawyers and police. In other skills, new recruitment has been allowed to replace those that have died, resigned or retired. All new hires are approved by the Steering Committee. During the first half of 1998, 3,863 civil servants were lost through natural attrition, while 2,400 new hires were recorded, resulting in a net loss of 1,463. 27. During 1998, other activities that have been carried out are: * The ongoing exercise on identifying and eliminating "ghost" employees from the payroll, which continues to receive special attention by the Government. During 1998, the payroll has been decentralised to ministries and provinces. This has led  -50 - Annex I Page 8 of 13 to a further reduction in numbers on the payroll as controlling officers are now better placed to verify those being paid than the centralised salaries section in the Ministry of Finance and Economic Development. * Cabinet has approved the re-structuring plans for 12 ministries and 4 institutions, resulting in abolition of 8,068 posts. Out of this figure, a total of 4,733 posts will be realised through the proposed hiving-off of some Government departments and functions with actual abolition of post contributing 3,335 * In addition, three other institutions - the Vice President's Office, PSMD and Cabinet Office have also had their restructuring plans approved by Cabinet. All the remaining ministries restructuring plans will be submitted by the end of December 1998. The Performance Management Package has been introduced into four of the already restructured Ministries and institutions (Agriculture, Local Government, PSMD and Environment) and will be introduced into other restructured institutions throughout 1999. * Cabinet decisions have been taken to commercialise 4 institutions, (the National Institute for Public Administration, the Registrar of Companies, Patents, Trade Marks & Business Names and the National Parks & Wildlife Department and the Technical Education & Vocational Training Authority). The commercialisation of these will remove 3,754 persons from the civil service. A further two institutions recommended for commercialisation are awaiting Cabinet approval, while three have been recommended to Cabinet for privatisation. Two institutions are recommended for abolition and another has been recommended ifor merger. * The decentralisation of payroll management has already been referred to above. As of November 1998, there are 46 payroll centres. A second level decentralisation of payrolls, applicable to large ministries with geographically dispersed staff, will be implemented in 1999. Under the reformed payroll system, each person on the payroll must be identified with a post in the establishment register and a job title before payment is processed. * An analysis of the composition of the civil service has been carried out. Following the retrenchments and natural attrition that have taken place during 1998, the size of the civil service has dropped to 117,166 persons by end October 1998. Of this number, 66,939 (55.1 percent) has been in service for 10 years or less. * The largest group of civil servants (46,395 or 39.6 percent) are those in the ES/TES scales i.e. primary and secondary school teachers (excluding untrained teachers) or technical education lecturers, with another 523 being school heads/inspectors or education officers. Police and prison service officers account for another 15,733 (13.4 percent), while medical personnel account for a further 11,803 (10.1 percent). Technical officers, employed in the fields of agriculture, forestry, infrastructure construction and water supplies number 6,103 (5.2  Annex I - 51 - Page 9 of 13 percent). These critical areas account for 80,557 Civil Servants, which is already above the PSRP target of 80,000. * Of those remaining, the bulk (l9,124 or 16.3 percent) are in the GAS/GMS scales and include untrained teachers (over a third), accounts and administrative personnel. The next biggest group is the rump of classified employees who now number 14,271 (12.2 percent) having been more than halved in number during 1998 through the retrenchment programme. The remaining civil servants are lawyers and other graduates, judges, magistrates, local courts officers and permanent secretaries. * The drafting of the Decentralisation Policy was completed and the draft policy was submitted for consideration by the Social Restructuring and Development committee of Cabinet in August 1998. The policy was approved in principle and is now being amended in light of the Committee's decisions, before presentation to the full Cabinet. The policy will entail further reduction in the establishments at provincial and line ministry levels, with the devolution of functions to districts. However, this may require creation of some posts at the district levels to strengthen the capacity of service delivery. 28. It is clear from the above that the 80,000 target by the end of 1999 is not realistic or feasible. Further widespread/across the board retrenchments would seriously undermine, if not destroy, the public sector's ability to deliver public services like health, education and law and order and to maintain publicly owned socio-economic infrastructure. The government is currently carrying out more detailed work to determine the optimal size of the civil service in the medium term. 29. Nonetheless, an additional 7,000 Civil Servants will be removed from the payroll in 1999 through retirement, natural attrition, and the hiving off of public institutions. To keep the reform momentum going, detailed management arrangement for PSRP will be implemented in early 1999 along with a timetable for completing the preparation of a revised action plan for PSRP. This plan will include clearly assigned responsibilities for time bound actions in areas such as retrenchment, pay and pension policies, establishment of payroll controls, ministerial restructuring, performance monitoring, and the mitigation of the social impacts of retrenchments. It is expected that the implementation of this action plan will begin by mid-1999. In addition, a new Civil Service remuneration structure will be introduced after the substantial completion of retrenchment, which will address, inter alia, the problem of compression in pay scales. Investment and Export Promotion 30. The Government is committed to maintaining the liberal trade and exchange regime, and to continuing trade liberalisation as part of the Cross-Border Initiative (CBI). The trade weighted average rate of import taxation has been reduced to below 15 percent, and the tariff schedule consists of three non-zero rates with a maximum of 25 percent. Over the medium term the Government aims to reduce the weighted average import tax to 10 percent. To this effect, the maximum rate will be reduced to 20 percent in 2001.  -52 - Annex I Page IO of 13 31. Decontrol of prices, elimination of subsidies, privatisation of public enterprises, and removal of restrictions on private sector activities have all helped to improve the business climate and profitability of export oriented production. In particular, tariff reduction and consolidation, and the elimination of foreign exchange controls and import restrictions have reduced the anti-export bias of the trade regime. To build on these achievements and sustain the supply response, the Government has undertaken the following reforms: * To ensure that exporters have access to imported inputs at world prices, the Duty Drawback Scheme (DDS - which refunds import duties to eligible exporters) and the Manufacturing Under Bond scheme (MUB - which exempt designated exporters from import duties) have been improved, as described in SI No. 48 of 27 March 1998, and workshops to publicise the new procedures have been held. * Measures to streamline the investment approval process, including broadening the composition of the Committee that considers Investment Certificate applications and the establishment of a consultancy company to provide services to potential investors with a Board of Directors that includes private sector representation, have been taken. * To improve the process of consultation between government and the private sector on economic policies, the joint private-public Zambia Industrial Partnership Council (ZIPC) has been established. The Council is intended to be the main consultative body and has broad representation from the private sector as well as the Government. * Eliminated the Import Declaration Fee as of July 1, 1998. 32. The Government intends to follow these measures up as follows: * Undertake, jointly with IDA by mid-1999, an evaluation of the working of the revamped DDB and MUB schemes focusing in particular on the timeliness of processing of duty refunds and responding to new exporters who wish to use the schemes, and, the implementation of the simplified procedures and documentation for the schemes * Consider additional actions to streamline the investment promotion process, including steps needed to access infrastructure services and options for revamping and merging concerned agencies. Before any proposals are submitted to Cabinet for approval, these will be discussed with IDA to ensure that they are consistent with earlier agreements and measures in these areas, with a view to agreeing on an action plan to be implemented beyond the period covered by this Credit