Tanzania - Privatization and Private Sector Development Project

Document of The World Bank Report No: 19119-TA PROJECT APPRAISAL DOCUMNT ONA PROPOSED CREDIT IN THE AMOUNT OF SDR 33.3 MILLION (US$45.9 MILLION EQUIVALENT) TO THE UNITED REPUBLIC OF TANZANIA FOR A PRIVATIZATION & PRIVATE SECTOR DEVELOPMENT PROJECT November 15, 1999 Private Sector Development Tanzania and, Uganda Country Department Africa Regional Office  CURRENCY EQUIVALENTS (Exchange Rate Effective November 15, 1999) Currency Unit = TSH TSH = US$.00130 US$1.00 = TSH775 FISCAL YEAR ABBREVIATIONS AND ACRONYMS ASMP Agricultural Sector Management Project CAS Country Assistance Strategy CCM Chama Cha Mapunduzi (Tanzania's Major/Ruling Political Party) CSD Civil Service Department CTI Confederation of Tanzania Industry DAWASA Dar es Salaam Water and Sewerage Authority DFID (United Kingdom) Department for Intemational Development FDI Foreign Direct Investment GOT Government of Tanzania LART Loans and Advances Realisation Trust MOA Ministry of Agriculture MOI Ministry of Industry and Trade NBC National Bank of Commerce NPA Non-Performing Asset PaPF Parastatal Provident Fund PPF Project Preparation Facility PPRP Parastatal and Public Sector Reform Project PSAC Public Sector Adjustment Credit PSRC Presidential Parastatal Sector Reform Commission RRP Railways Restructuring Project SAC Structural Adjustment Credit TA Technical Assistance TANESCO Tanzania Electricity Supply Company TCCIA Tanzania Chamnber of Commerce, Industry & Agriculture TCFB Tanzania Commercial Freight Board TRP Telecommunications Restructuring Project UNDP United Nations Development Program USRP Urban Sector Rehabilitation Project Vice President: Callisto Madavo/Jean-Louis Sarbib Country Manager/Director: James Adams Sector Manager/Director: Demba Ba! Alan Gelb Task Team Leader/Task Manager: Paul Ballard  Tanzania Privatization & Private Sector Development CONTENTS A. Project Development Objective ................................................................ 3 1. Project development objective and key performance indicators ............................. 3 B. Strategic 3 Context. 1. Sector-related CAS goal supported by the project .............................................. 3 2. Main sector issues and Government strategy ................................................... 3 3. Sector issues to be addressed by the project and strategic choices ......... ................. 9 C. Project Description Summary .............................................................. . . 1IL 1. Project ill components. ................................................................................ 2. Key policy and institutional reforms supported by the project ............................... I 1 3. Benefits and target population ................................................................ 12 4. Institutional and implementation arrangements ......... . ..................................... 13 D. Project Rationale ................................................................ 15 1. Project alternatives considered and reasons for rejection ..................................... 15 2. Major related projects financed by the Bank and/or other development agencies ......... 16 3. Lessons learned and reflected in the project design ............................................ 17 4. Indications of borrower commitment and ownership ............... ........................... 18 5. Value added of Bank support in this 1'9 project.................................................... E. Summary Project Analysis . ................................................................ 19 1. Economic ................................................................ 19 2. Financial ................................................................ 20 3. Technical ................................................................ 20 4. 21 Institutional. ......................................................................................... 5. 23 Social................................................................................................ 6. Environment assessment ............................................................. 25 7. Participatory 25 approach. F. Sustainability and Risks ................................................................ 26 1. Sustainability ................................................................ 26 2. Critical risks ................................................................ 28  3. Possible controversial aspects ............................................................... 28 G. Main Loan Conditions .................................................................. 29 1. Effectiveness conditions .................................................................. 29 2. Other .................................................................. 29 H. Readiness for Implementation .................................................................. 31 I. Compliance with Bank Policies .................................................................. 31 Annexes: Annex 1. Project Design Summary Annex 2.. Detailed Project Description Annex 3. Estimated Project Costs Annex 4. Financial Summary Annex 5. Financial Management Assessment Annex 6. Procurement and Disbursement Arrangements Annex 7. Project Processing Budget and Schedule Annex 8. Documents in Project File Annex 9. Statement of Loans and Credits Annex 10. Country at a Glance MAP  Tanzania Privatization & Private Sector Development Project Appraisal Document Africa Regional Office Tanzania Country Department Date: November 15, 1999 Task Team Leader/Task Manager: Paul Ballard Country Manager/Director: James Adams Sector Manager/Director: Demba Ba/Alan Gelb/ Project ID: 49839 Sector: Private Sector Program Objective Category: Privatization Lending Instrument: SIL/TAS Program of Targeted Intervention: [ ] Yes [xl No Project Financing Data [ Loan [X] Credit [1 Guarantee I] Other [Specify] For Loans/Credits/Others: Amount (US$m): 45.9 Proposed terms: [x] Multicurrency [] Single currency, specify Grace period (years): 10 [ Standard Variable [x] Fixed [] LIBOR-based Years to maturity: 40 Commitment fee: 0.5% Service charge: 0.75% Financing plan (US$m): Source Foreign Local Total Cofinanciers 5.27 0.88 6.116 Government 1.81 22.94 24.75 IDA 20.32 25.58 45.90 Total 27.41 49.40 76.81 Borrower: Government of Tanzania Guarantor: Responsible agency(ies): Parastatal Sector Reform Conmmission (PSRC); Loans & Advances Realization Trust (LART); Regulatory Agency (ies) (future); Gov't.-Private Sector Consultative Body (future). Estimated disbursements (Bank FY/US$M): 2Qoo 2001 2002 2003 2004 2005 Annual 6.27 12.17 9.23 9.55 6.57 2:11 Cumulative 6.27 18.44 27.66 37.22 43.79 45.90 For Guarantees: [ Partial credit [] Partial risk Proposed coverage: Project sponsor: Nature of underlying financing: Terms of financing: Principal amount (US$) Final maturity Amortization profile  Page 2 Financing available without guarantee?: [] If yes, estimated cost or maturity: Estimated financing cost or maturity with guarantee: Project implementation period: 5 Years Expected effectiveness date: January 3, 2000 Expected closing date: September 30, 2004  Page 3 A: Project Development Objective 1. Project development objective: The project will support implementation of Tanzania's private sector development strategy, notably through its public enterprise (PE) privatization program, banking restructuring, and infrastructure and utilities' regulation, which are aimed at improving economic efficiency through expanded private investment and production in the economy and reduced drain upon scarce fiscal resources. Specific objectives are to: (1) continue institutional support and capacity building through the Parastatal Sector Reform Commission (PSRC), for implementation of PE divestitures - including major PE's in public utilities and infrastructure; and strengthen the efficiency and transparency of the privatization program, through streamlining of government approval of divestitures, greater delegation of implementation to PSRC, and adoption of clear, consistent overall policies for the treatment of PE debt and for the retrenchment of PE employees; (2) continue support for liquidation of non-performing assets of the state- owned banks by the Loans and Advances Realization Trust (LART), including for implementation of new methods to contract out marketing of assets intemationally; and preparation and implementation of the eventual move of LART to the private sector and the creation of a competitive market for Non-Performing Asset (NPA) collection services for the banking system; (3) establish an institutional framework for regulation of infrastructure and utilities , including a program of institutional development, public education and regulatory capacity building; (4) support creation of a government-private sector dialog mechanism to promote removal of key regulatory and business environment bottlenecks to expansion of private and foreign direct investment (FDI), especially for utilities and infrastructure, and the improvement of Tanzania's image as a destination for FDI. {Performance indicators for these objectives set out in Annex 1 B: Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project (see Annex 1): GAS document number: 16554-TA Date of latest CAS discussion: June 20, 1997 The project will contribute to meeting the CAS objective of enhancing economic efficiency and the quality of services by divesting remaining parastatals on an accelerated schedule, by supporting effective infrastructure/utilies' regulation, and private sector competitiveness. This would include (a) divestiture of most major public utilities and transport infrastructure PE's; (b) promotion of competition wherever feasible, such as in port services and telecommunications, and (c) fostering of private investment and operation in these sectors. 2. Main sector issues and Government strategy: A. Privatization Program: Over the 1994-1998 period, Tanzania divested about 150 of the 385 PE's initially held. These included mainly small-medium PE's in tradable goods sectors, but also a number of large PE's (brewery, cigarette factory, etc.).In some cases, e.g., leather, privatization of PE's has opened up markets for private entrepreneurs and improved output and efficiency. Notwithstanding this, delays in divestiture of PE's have contributed in a number of cases to deterioration of fixed assets,  Page 4 and created uncertainties limiting private investment in certain sectors. In late 1996 the Government of Tanzania (GOT) took the decision to expand the privatization program to divest all major utility and infrastructure PEs (ports, railways, electricity, telecommunications, etc.) banking, agriculture and mining PE's . The GOT's stated aim is to divest all of these enterprises, as far as possible, by 2000. However, in practice, it is expected that divestiture of the remaining 230 PE's will take longer, and some (notably in infrastructure) will be opened to private investment in stages over the medium to long term. The GOT now wishes to accelerate implementation of its privatization program to reap the benefits of greater efficiency and more dynamic private investment and economic growth, Several issues need to be addressed to achieve this: a) Despite considerable progress by PSRC, the technical capacity to carry out the legal and regulatory preparations necessary as well as to prepare and execute these divestitures is still limited, particularly for the more complex privatizations in infrastructure and utilities. b) The Govermment approval process for individual PE divestitures has, in the past, been cumbersome, inefficient and, on occasion, less than fully transparent and needs to be clarified and streamlined to facilitate these major transactions. c) The internal procedures of PSRC need to be simplified, streamlined and reinforced so as to ensure that they are clear to all stakeholders (Government., civil society and potential bidders) and can be easily followed and regularly audited. d) Past experience has shown that there is a need to develop consistent policies for handling PE employee retrenchment, and PE debt issues. e) The legislation on insolvency and bankruptcy need to be revised and updated, as part of the GOT's ongoing business law reform program, to facilitate inter alia liquidation of unviable PEs. (a) Privatization Processes: The GOT and PSRC, with Bank staff technical support, have reviewed the processes of government approval, and of preparation and execution of divestitures in an effort to streamline them, while ensuring an effective handling of key sector strategy, policy and political issues early on: (1) Government Approval Process: The process of Government approval has tended to be long, and subject to multiple reviews and revisions. To simplify and streamline the system in future, to expedite transactions, it is proposed that the privatization process should more clearly separate the policy and political aspects, which are the prerogative of Government, from the preparation and execution of transactions, which are technical functions better delegated to professionals in the privatization agency under conditions of public accountability. In line with this, the Government will focus on: ( i) setting the key parameters of sector policy and divestiture strategy for large, economically critical enterprises (utilities, infrastructure and financial sector); (ii) approving clear guidelines for transaction procedures. (2) PSRC Divestiture Procedures: PSRC's procedures for divestiture transactions have entailed the use of multiple - and at times subjective - criteria in the evaluation of bidders and the awarding of sales. This has led to extended periods of consultations within the Government and lengthy negotiations with potential investors, before transactions could be completed. The process has been time-consuming and less than fully transparent to all participants. In an effort to improve the speed and transparency of future transactions, therefore, it is  Page 5 has been agreed that PSRC will modify its operating procedures: (a) PSRC will implement transactions through contracting them out to competitively recruited investment advisors, remunerated in part based upon success fees. This will be true both for the large transactions (utility, infrastructure and financial sector) as well as, whenever appropriate, smaller enterprises, which will be batched, wherever possible, and contracted out to advisors; (b) Where assurance of bidders' technical capacity and adherence to technical requirements and to government's policy matters are needed, particularly for large PE's this will be achieved through pre-qualification, with review of business plans through requiring investors to respond to a common set of investrnent and policy criteria. On this basis, final selection of the winning bidder would be based upon a competitive price tender alone; (c) Public accountability could be achieved through public opening of bids which would be broadcast on radio and TV, and public announcement of winning bidders, which would be politically approved rapidly by Cabinet. This would be coupled with periodic process audits. (b) Public Enterprise Labor Retrenchment Policy: The current system of public enterprise retrenchment payments is ad hoc and has led to widely varying retrenchment payments across PE's which do not reflect economic and social costs. In principle, GOT policy has been to limit retrenchment payments to statutory severance allowances. In practice, however, actual payments have varied widely. At one end of the spectrum, retrenchees in liquidated companies are paid severance of about US$6 equivalent (T.Sh. 4000) based on an outdated (1953) law. At the other end, larger PE's with liquidity and stronger unions have paid far larger severance per employee substantially beyond the statutory minimum including an ex gratia payment and commuted pension allowance. These have ranged from $8,000 to $14,000 equivalent. This disparity has led to social unrest and resistance by some labor unions (and some parliamentarians) to the retrenchment which is needed for the restructuring and privatization of many public enterprises. Meanwhile, for the larger PE's in infrastructure and utilities to be privatized over the next few years, the cost of retrenchment payments, if paid at the upper end of the above spectrum, could result in a high - and potentially unsustainable - fiscal cost (preliminary estimate : US$ 60 million equivalent for seven PEs). To address this issue the PSRC, in conjunction with the Ministries of Labor, Planning and Finance, commissioned a study to review PE retrenchment policy and recommend changes. The study indicates that current practices are ad hoc, inequitable, and expensive (for example NBC paid an average of over US$ 13,500 per retrenchee). To ameliorate this situation the study has proposed a clearer, more affordable and equitable policy framework for determining retrenchment payments based on the economic costs of retrenchment. Essentially, under the proposed scheme, the severance package paid to an individual worker, above the statutory minimum, would be based on the probable losses that the worker will face due to retrenchment. Those workers more likely to have difficulty  Page 6 finding other work (e.g. older, less well educated and possibly, female employees) would be paid a proportionately larger sum than those who would likely find employment quite rapidly. This policy would be relatively easy to implement during the preparation for divestiture of any firm. Such a framework would allow Government to implement a policy that is defensible to the public because of its clarity and equity. Discussions have been held with various stakeholders including the Ministry of Labor, Ministry of Finance, parastatal management and labor unions to discuss the study's findings. At negotiations, the GOT agreed that guidelines for an overall consistent and sustainable policy for PE employee retrenchment will be presented to Government for consideration and decision by January 31, 2000. (c) Public Enterprise Debt Policy: The lack of a clear policy on how various types of debt will be dealt with in the context of the privatization program has led to ad hoc treatment of parastatal debt. This, combined with past reluctance of the Ministry of Finance to authorize debt write-offs (except for on-lent grants), has led to extensive delays to privatization transactions and inconsistencies in treatment. In several instances these delays have cost the government significant amounts. In addition, the lack of a streamlined, predictable debt treatment policy makes it more difficult to outsource transaction work in a cost effective manner, since transaction advisors insist on contract clauses which ensure that they are paid in the event of such delays. GOT and PSRC commissioned consultants to assess the stock of parastatal debt and to help formulate clear policy guidelines. This study defined the categories of outstanding debt among PEs left to be privatized (including bilateral & multilateral debt, government loans, bank debt, unpaid taxes, trade and suppliers credits, etc) which amounts to approximately Tsh. 1,124 billion (US$ 1.68 billion at current exchange rates). While records are not clear, it appears that up to 80% of the debt (about Tsh. 900 billion) may carry government guarantees. It is likely, therefore that the Government will have to cover this portion of the debt. (In many cases it is already making the payments.) The study identified policy options for dealing with each kind of debt, focusing on strategies that can help minimize the cost to the Treasury. These include a significant role for liquidation (which requires other creditors to share the losses) but also using debt clearance procedures between mutual debtors, sale of non-core assets and debt-equity swaps. The procedures that will be used to assess the level of debt and determine the preferred method to resolve each kind of debt are clearly laid out. Once adopted, these procedures would become part of the operating guidelines given to the investment advisors who would use them in their assessments of firms. (For more information on the analytical work please see section E 3 below) The draft study has been discussed with the relevant stakeholders in GOT (Ministry of Finance and PSRC) and more widely in the Cabinet. At negotiations, GOT agreed that guidelines for an overall policy framework for treatment of P.E. debt will be presented to government for consideration and decision by January 31, 2000. (d) Use of Proceeds: In the November 1997 Policy Framework Paper (PFP) for 1997/8-1999/2000, GOT confirmed its policy of allocating proceeds from privatization transactions toward reduction of public sector debt and toward financing of retrenchment costs for PE's. In light of its commitment to the transparency of the privatization program,  Page 7 the GOT agreed that the proceeds account, managed by PSRC and overseen by the Ministry of Finance, will be audited annually by independent, internationally qualified auditors and the audit results will be presented to Parliament in order to ensure full accountability. B. Debt Collection for Banks (LART): The Loans and Advances Realization Trust (LART) was created in 1991 to expedite collection on non-performing assets (NPAs) of the state-owned banks. It has been very effective in this capacity, realizing substantial collections of NPA's. LART has had its mandate extended so that it can handle a larger number of NPAs that will need collection over 1999-2001 linked with the restructuring and privatization of the National Bank of Commerce (NBC). LART has proved successful due to (i) its strong management and professional staff and its operational autonomy; and (ii) its ability to ensure that collection cases are moved rapidly through a dedicated court, the LART Tribunal, rather than suffering delays in the general court system. This, in turn, has increased awareness among borrowers that they cannot expect lack of payment on loans to be forgiven, and has started to improve repayment discipline in the banking system. The issue now is how to help institutionalize this change of attitude while ensuring durable and equitable legal procedures through the establishment of permanent commercial courts and by increasing the provision of collection services to all financial institutions within Tanzania. The GOT is interested in exploring the possibility of achieving this by moving LART into the private sector. The question is how to ensure an orderly transition from the public to the private sector while ensuring effective handling of the important flow of work resulting from the privatization of NBC and facilitating growth in private sector capacity in the debt collection business. C . Infrastructure and Utilities' Re2ulation: In 1996/7 the GOT adopted a policy of attracting private operators and investors into major utility and transport sectors (telecoms, power, water, ports and railways). Its implementation will call for the development of pro- competitive regulatory frameworks and new institutional arrangements. GOT has twin objectives in establishing a regulatory framework in the utility and transport sectors: On the one hand, consumers are to be protected from misuse of monopoly power. On the other, investors require clear and predictable rules with a reasonable prospect of a fair return on their investments. In developing individual sectoral regulatory frameworks, there are some common issues to be addressed across the sectors. Economic regulation may be light-handed in areas where it is feasible to establish competition, such as electricity generation, most teleconmmunications services, and large parts of the transport sectors. However, in areas where monopolies are likely to persist, such as the telecommunications local loop, electricity transmission and distribution, water distribution or certain commodities captive to particular forms of transport, there may be a need for specified forms of economic regulation to balance consumers' and investors' needs. The GOT faces a significant task in developing regulatory arrangements across all the utility and transport industries within the next few years and at the same time has limited capacity for policy development and implementation in these areas. Accordingly there is a case for consolidating reform experience and applying the lessons of reform across sectors as the sequence of industries is worked through.  Page 8 The risks faced by investors are substantial in infrastructure and transport, where changes in the regulatory framework can greatly impact returns on investments after these have been made in significant, non-portable assets. Investor perceptions of risks may be particularly high in Tanzania where there is limited history of infrastructure regulation and perceptions of judicial weaknesses undermine confidence in the protections offered by contractual agreements. Given these risks, it is important that investors are given early and clear signals concerning industry structures, government goals and regulatory frameworks and that these signals are bolstered with effective institutions and increased stakeholder involvement in regulatory processes to strengthen transparency and ensure a "level playing-field" in treatment of investors and consumers. The GOT is giving consideration to various options for possibly two multi-sectoral regulatory institutions, permitting the pooling of economic, financial and legal expertise and facilitating the transfer of regulatory expertise across sectors. The arguments in favor of this approach are being balanced against the discrete technical needs of each industry, which would suggest a dedicated regulator for each industry. By giving early consideration to institutional issues, the GOT is acting in a way which minimizes the risk that regulators will be unready for their new tasks after privatization transactions have been completed. The GOT has commissioned consultants to examine in detail the institutional options for utilities and infrastructure regulation, including the desirability of cross-sectoral rules for private entry into these sectors. This component of the project will place considerable emphasis on building the regulatory capacity required for the privatization program, and will attempt to take advantage of cross-sectoral economies in so doing. D. Business Environment Improvements and FDI: Expanding private and foreign investment and operation, especially in utility and infrastructure sectors, will call for major improvements in Tanzania's business environment through removal of regulatory and other constraints. While the Government has undertaken actions to liberalize the trade and exchange regime, further progress is needed with respect to investment regulation, business licensing, property rights (land ownership), labor regulation, business law, judicial training, investment incentives and taxation. It is very important that the Government take steps to regularize its procedures and ensure equal treatment for investors over time thereby reducing investors perceptions of country risk. In addition, Tanzania needs to promote a much improved, investor friendly image abroad. While significant improvements have been made over the past decade in the broader macro-economic environment and in liberalizing major segments of Tanzania's previously socialist economy opening them to local and foreign private investment, GOT recognizes that the role of the government and the state-enterprise sector is still extensive and impedes a more dynamic private investor response. Also, while private sector representative organizations (chambers of commerce, industry and agriculture; confederation of industries; etc.) have been established in recent years, these are still fledgling institutions. Importantly, there is a perceived need in GOT and in the private sector for a more effective consultative mechanism to facilitate a dialog leading to effective business environment reforms in the above areas. Over the past 18 months, a private sector appointed committee - recognized by GOT - has been working to prepare proposals for the President on creation of such a consultative mechanism. Initially, the Tanzania Private Sector Foundation , TPSF, has been created as an umbrella organization representing all  Page 9 major groupings and organizations in the private sector in Tanzania. Building upon experiences of other African countries - including Uganda (private sector foundation), Mauritius (national economic council) - proposals under preparation by TPSF for GOT consideration are expected to be finalized shortly for establishment of a National Business Council, NaBC, as a high-level government-private sector consultative body on competitiveness issues. It will be important for ownership and credibility within the private sector that the consultative mechanism be an independent and voluntary private sector-led forum that is not controlled by government, nor dominated by specific private sector groups. With this in mind, the TPSF has already been established as a limited liability non-profit company. 3. Sector issues to be addressed by the project and strategic choices: A. Privatization: The proposed Project will support GOT's efforts to streamline and strengthen the privatization program to ensure timely, technically sound, and transparent privatization transactions. It will help operationalize and institutionalize the new policy of using competitively selected private sector investment advisors to prepare and market firms as well as to technically evaluate potential bidders. In order to ensure the smooth implementation of this policy, the Project will support design and implementation of a) streamlined Governmental approval processes; b) improved internal procedures in PSRC for handling transactions; guidelines for selection of investment advisors and their responsibilities; c) continued capacity building to enhance technical capabilities of the privatization commission (PSRC); d) consistent and sustainable policies for handling PE retrenchment and PE debt; e) increased accountability for use of privatization proceeds - through periodic independent audit of the proceeds account managed by PSRC and MOF. In adopting these changes, the option was considered of complete delegation of preparation and execution of transactions to PSRC - following policy approval by Government - for all transactions, including the very large strategic ones in infrastructure and utilities and other PE's presenting policy concerns for government. Given the magnitude of the political and policy issues involved, GOT has decided to delegate all but the latter to final decision by the Economic Committee of the Cabinet under a "fast track" procedure, while the full Cabinet retains more direct oversight on key implementation steps for the large and the policy-sensitive PE's. To ensure greater efficiency and transparency, GOT has issued in November 1999 a manual for privatization - procedures and process guidelines. This stipulates that in future final Government approval of divestiture sales agreements will be given in a period not exceeding thirty days from announcement of the winning bidder. B. Debt Collection for Banks (LART): The proposed Project would: (1) support the continuation and completion of LART's efforts to realize collections on non- performing assets (NPAs) of state-owned banks as part of their restructuring and privatization; and (2) prepare and help operationalize a strategy for: (a) subsequent transfer of LART to the private sector, as part of a broader approach to creation of a competitive debt collection market, and (b) subsequent transfer of the LART tribunal to the commercial court system.  Page 10 The alternative of privatizing LART immediately was considered, but rejected, as it would have disrupted LART's ongoing collection efforts, in a context in which alternative equally effective debt collection services in the private sector have yet to be established, and where the regular court system lacks the capacity to handle such cases as expeditiously as the LART Tribunal. Given the important capacity that has been created in LART and in the LART Tribunal, the alternative of winding them up - once the collection effort is completed - was discarded in favor of using these as the basis for creating a more effective private debt collection market. C. Infrastructure and Utilities' Regulation: The Project will provide technical support - including capacity building and public education - for the GOT's efforts in design, decision-making and implementation of institutional arrangements for infrastructure and utilities regulation, embracing telecommunications, water, electricity, ports, railways and airports. The option of leaving institutional arrangements to case-by-case decisions for each sector was considered, but rejected - as it would not permit the potential advantages of cross-sectoral approaches to be actively considered at a sufficiently early stage. It would also delay timely implementation of a basic regulatory capacity to coincide with privatization of the state-owned national enterprise and market liberalization. Implementation of more discretionary and inherently more demanding and complex regulatory systems was considered, but also rejected, as it would most likely overstretch initial institutional capacities. Instead, simple and largely contract-based regulation - with only limited regulatory discretion - is expected to be the initial strategy. Once firmly established, this capacity could be built up and expanded over time. Rather than postponing adoption of regulatory measures until governance and judiciary systems can be strengthened, or focusing on these per se, a program of extensive public education and awareness-raising will be carried out among the range of concerned stakeholder groups - notably including opinion-makers such as journalists in the Swahili press. The Project will also provide funding on the initial establishment costs for regulatory institutions and for up to three years' running costs, after which it is expected that a system of industry levies will be used to establish financial sustainability. D. Business Environment and FDI: The Project will support a dialog between the government and the private sector - through a consultative mechanism (the NaBC) to be established - aimed at helping define key policy, regulatory, and institutional reforms for improving the business environment for private investment and FDI, as a vital complement to the PE divestiture program. The alternative option of proceeding directly with support for business environment reforms, without such a consultative mechanism was considered, but was rejected, since experiences in Tanzania indicate (as in other African countries) that government/private sector dialog can provide an important means of building trust and a more open working relationship that is key to enacting sustainable policy change. In addition, there is a strong and growing demand in the Tanzanian private sector for such a dialog. The option of conducting such a dialog through existing private sector representative organizations (such as the TCCIA, or CTI) was also considered, but discarded, since no single organization provides a forum that can bring together the full range of private sector interests in Tanzania. Consequently, a neutral and independent body - with a temporary lifespan, and clear focus upon facilitating policy change - was considered to be more effective. C: Project Description Summary  Page 11 Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): Indicative Costs % of Total Bank- % of Bank- (US$M) financing financing (US$M) Privatization Support 1/ 41.99 55% 26.27 34% Debt Collection 1/ 12.09 16% 4.36 6% Utilities Regulatory Design 1/ 19.12 25% 13.92 18% Bus. Environment Improv. Design 1/ 3.60 5% 1.35 2% Total 76.81 100% 45.90 60% 1/ - Include (on pro rata basis) contingencies and repayment of US$ 2m. Project Preparation Facility(PPF). 2. Key policy and institutional reforms supported by the project: * Streamlining of the PE divestiture process and procedures to facilitate accelerated implementation of Tanzania's privatization program and improved efficiency and transparency in its execution. This will be achieved through : (a) early policy decisions by Government coupled with greater delegation of execution of transactions through the agreed "fast track" mechanism, and (b) use of clearer, simplified procurement procedures, based upon outsourcing to competitively selected investment advisors, and generally using price as final selection criterion, with investor technical capacity and credentials for larger transactions determined through pre-qualification. * Implementation of consistent overall policies for PE employee retrenchment and treatment of PE debt to ensure fiscal sustainability and equity and expanded stakeholder awareness and public communication concerning Tanzania's privatization program. * Creation of an institutional framework for private participation in infrastructure (PPI), as part of the PE divestiture process, aimed at fostering expanded private investment in infrastructure and utilities in the medium to long term. Establishment of an effective overall institutional framework for infrastructure and utilities regulation across the sectors, taking account of Tanzania's significant institutional and governance constraints, and supported by capacity building and public awareness raising efforts. * Strengthened repayment discipline in Tanzania's banking system, through (1) expedited collections from defaulters on non-performing assets of public sector commercial banks; and (2) expansion of Tanzania's fledgling private market capacity for debt collection through transfer of LART in the medium term to the private sector as part of an overall market-based strategy. * Creation of a government-private sector consultative mechanism and policy dialog on competitiveness improving reforms in Tanzania's business environment. In this context, as a prior action to Board presentation of the proposed IDA credit, in September 1999, the Government has already approved a streamlined process and procedures for strategy review and final approval of PE divestiture sales, based upon which, in November 1999, PSRC has adopted new operational guidelines for the  Page 12 preparation and execution of PE divestitures, which will strengthen the efficiency and transparency of the privatization program. 3. Benefits and target population: Government: Fiscal Benefits: Reduced investment expenditure, higher tax revenues, higher dividends from remaining shares in firms. Developmental Benefits: Increased services (phone, electricity, water, rail cargo, etc.), increased productivity in economy (better services, decreased waiting times (e.g. ports), less private provision of infrastructure (e.g. generators), reduced cost for intermediate inputs leading to greater international competitiveness), more rapid expansion of networks, higher connectivity and attendant information flows. Private Sector: Increased access to higher quality and lower cost interrnediate goods and services (particularly electricity, telecom, water), reductions in uncertainty of supply and opportunities for rent seeking (bribes) by suppliers. Lower transportation costs and higher degree of reliability (rail & port). Importantly, the privatization program also gives the domestic private sector an opportunity to participate more fully in the economy by opening up multiple sectors that were previously restricted to or dominated by the public sector. In addition it allows much greater scope for entering into partnership with international firms and thus increases the scope for significant technological and managerial skills transfers. Domestic Consumers: Overall consumers can expect to gain through increased access to utility and infrastructure products and services, as well as other goods and services (milling, agricultural products, etc.). In some cases (e.g. telecom) these better goods and services are expected to be provided at reduced prices due to increased competition. Since the benefits will not accrue evenly across consumers it is useful to detail benefits to urban and rural consumers separately. Urban: Ability to connect to utility services (electricity and telecoms) without long waiting periods or high bribes. Benefits in the form of lower prices on consumer goods due to increased productivity (and therefore lower unit costs) on imports coming through the container terminal as well as products transported by train. Rural: Increased access to services as networks expand due to a) more sustainable revenue stream for operators and b) agreements on rural network expansion within the sales agreement and established regulatory framework (telecoms). Lower transportation costs for agricultural products combined with increased competition among buyers in the wholesale market should help boost producer prices which would generally accrue to rural agriculturists. 4. Institutional and implementation arrangements: Implementation Period: Five years, 2000 to 2004 Executing Agencies: Given the project framework there will be two executing agencies initially; a third - and potentially a fourth - will be established in the first year of the project:  Page 13 (a)-PSRC - The privatization component of the project will be the responsibility of the PSRC. The PSRC has about 16 professional level staff, including accountants. Decisions within the PSRC are taken by the Commission (Board) which is headed by the PSRC Executive Chairman (Managing Director). The PSRC reports to the Planning Commission in the President's Office but, as a Presidential Commission, it also has direct access to Cabinet and the President when necessary. PSRC was established under the Public Corporations Act (1992, amended in 1993) with a five year legal mandate, extendable for one year, and by a further year on approval by the MOF. The Minister of Finance has recently extended PSRC's mandate through December 1999. Thereafter, however, an amendment to the Public Corporations Act will be required to further extend PSRC's term until 2004, when the proposed Project is planned to be completed. During appraisal, the GOT confirmed through a letter to the Bank from the Minister of Finance that such an amendment would be sought, and, since then, it has been prepared and presented to the October/November 1999 Parliamentary Session for approval. The Executive Chairman of PSRC is a senior, experienced and well qualified Tanzanian official, with in-depth prior experience of private business and government, and of PE divestiture. In January 1999 he succeeded the previous incumbent who had been PSRC Executive Chairman during 1993-98. (b)-LART - The liquidation/ NPA collection component of the project will be the responsibility of LART which is composed of 20 professional staff including three accountants. LART management answers to its board of directors and is responsible to the Ministry of Finance which, under the LART Act, is the ultimate authority over LART. (c)-Regulatory Agency(ies) -During the first year of implementation of the proposed Project, the final decision on the number and format of the regulatory agencies would be taken by GOT. (d)-GovemMent/private sector consultative mechanism: The organizational set-up for this will be finalized during the first year of the proposed Project's implementation. Once the agencies under (c) and (d) above are established and staffed with qualified professional staff, including accountants, they would assume executing agency status and manage their own funds from the Bank. Until such time, however, disbursement for the regulatory and business environment components would be managed by the PSRC, with the additional administrative support needed to do so. The effective execution of the Privatization and Bank Debt Collection components of the proposed Project are not dependent upon the establishment of the infrastructure/utilities' regulatory body(ies) or of the govermnent/private sector consultative mechanism. Consequently, their establishment during project implementation will not call into question the institutional framework for it. Rather, this will enhance its prospects for success by allowing necessary time for consensus-building among stakeholders before the final institutional set-up is agreed in each case. The design and preparation of the cross-sectoral infrastructure/utilities regulatory set-up is  Page 14 being coordinated by an inter-ministerial working group comprising the Ministries of Finance, Planning and Labor, with PSRC serving on an interim basis as its technical secretariat. Project Coordination and Oversight To ensure coordination at the govermnent policy level, a high-level steering committee - chaired by the Permanent Secretary, Ministry of Finance; and also comprising the Permanent Secretary Planning Commission in the President's Office; the Permanent Secretary, Attomey General's Chambers; the Executive Chairman of PSRC; and the Executive Administrator of LART - will be responsible for oversight of execution of the Project. Meanwhile, overall coordination of project administration will be assured by PSRC through the PPSDP Project Administrator Accounting. Financial Reporting and auditing arrangements: The project accounts will be integrated into the accounting system of the irnplementing agencies (PSRC and LART initially) and the Chief Accountants of both agencies will be responsible for project accounting, maintenance of overall records, management of disbursements, and production of project management reports, annual project accounts and facilitation of timely audits. The external audit of PSRC and LART is to be conducted by an independent external auditor in accordance with the TORs which were agreed upon at negotiations. The auditors would follow the guidelines as set out in the Bank's Financial Accounting Reporting and Auditing Handbook (FARAH). Audit reports will be furnished to the Bank within six months after the close of the implementing agencies' financial year. There are no audits of other IDA funded credits outstanding in the sector. Assessment of Project for PMR-based disbursement: A detailed review of the proposed financial management arrangements was carried out as part of the process and assessed the project as meeting the minimum standards required by the Bank under its operational procedures. However, it was not capable of producing Project Management Reports (PMRs) as required under the Loan Administrative Change Initiative (LACI). Changes are being made in the computer software and modifications will be effected to assure that the project can produce PMRs. An action plan for financial management was prepared for both PSRC and LART to incorporate the steps to be taken to transfer to PMR-based disbursements and was agreed at negotiations. The transfer to PMR-based disbursements is scheduled for June 30, 2001. The PMR financial reporting formats were discussed and reviewed and will be finalized in accordance with the LACI Action Plan timetable agreed during negotiations. Monitoring and Evaluation arrangements: Monitoring of project execution will be undertaken by the each implementing agency. The Bank will monitor implementation through periodic supervision missions and review of quarterly implementation progress reports prepared by the implementing agencies. These reports will be consolidated by the Project Administrator (PA). The PA will also consolidate PMRs in accordance with the approved Work Plan. The preparation of the first Annual Work Plan covering January to June 2001, satisfactory to IDA, is a condition of effectiveness of the IDA Credit Annual Reviews of the project would be will be conducted by the PSRC and LART no later than March 31 of each year, starting in FY200 1.  Page 15 D: Project Rationale 1. Project alternatives considered and reasons for rejection: IDA considered the options of supporting the Government's privatization program, and related regulatory reforms in infrastructure and utilities through: (a) the (already approved) SAC 1 alone, with follow up support through a subsequent possible policy-based lending operation (eg., a SAC2), as an alternative to providing technical assistance; and/or (b) ongoing and planned sector-specific investment and technical support operations (see table D.2 below). However, these options were rejected for several reasons: First, neither of these options would permit adequate and timely continuing support to the cross-sectoral institutions (PSRC and LART) that have played key roles in providing the independently managed technical capacity needed to ensure the effective implementation of the overall PE privatization program, and advice to top policy-makers in this area. Equally importantly, neither approach would enable valid and potentially effective cross-sectoral institutional strategies to be applied to addressing establishment and capacity-building of regulatory frameworks for infrastructure and utilities, which can potentially make possible important economies of scope (especially in terms of scarce economic, legal and financial expertise) under prevailing skill shortages in Tanzania. Moreover, under option (a) above, the Government would have inadequate upfront financial resources (given major budget constraints and privatization-related debt restructuring and retrenchment costs) to enable it to acquire the services of internationally experienced and qualified investment and legal advisers and merchant banks, and to retain the services of qualified and experienced local professional staff (in PSRC and LART), needed to execute the privatization and debt collection programs in a timely and efficient manner. Meanwhile, the economic cost of privatizing large PE's - particularly in infrastructure and utilities - without a proper regulatory framework in place could well be higher. Experience elsewhere suggests that this would lead to a much reduced investor response, while experience in Tanzania suggests that it could well lead to economically disadvantageous agreements in which many of the potential benefits to society are captured by private parties due to poor regulation.  Page 16 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned): Sector issue Project Latest Supervision (Form 590) Ratings (Bank-financed projects only) nImplementation Development Progress (IP) Objective (DO) Bank-financed Assist in privatization of PEs and collection PPRP S S of NPAs in the financial system. Privatization of: Telecommunications, SAC 1 S S Container Terminal at Port of Dar es Salaam and Marine Services Division of TRC. Also, liberalization of shipping industry through lifting of monopolies of TCFB and Nasaco. Assist in the restructuring and rehabilitation USRP S S of the water supply sector in eight centers outside_Dar_es_Salaam _______ Assist in the restructuring and privatization Dar es Proposed - Proposed - not (through lease-contract) of the Dar es Salaam Salaam not yet rated yet rated water and sewerage company ( DAWASA), water including industry structure, preparation of supply contracts, tariffs and sector regulations, and project priority rehabilitation investment _ Assist in the preparation for privatization RRP S U (through concessioning) of the national railway (TRC), including industry structure, preparation of contracts , tariffs and sector policies, and rehabilitation investments Assist in restructuring of TANESCO, Power VI U U including investments in power generation capacity Assist in the preparation for privatization of Ports S S Tanzanian Ports, including industry structure, Mod. preparation of contracts and necessary regulatory structures. Assist in ensuring that Agricultural markets ASMP S S are free of unnecessary regulatory entities and function smoothly. Assist in the preparation for privatization of TRP S S TTCL, including industry structure, preparation of contracts and necessary regulatory structures. Other Donors Assist in privatization of PE's through DFID N/A N/A technical support to PSRC for provision of Privatizati two resident international advisers and for on PSRC's communications program Irn IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)  Page 17 3. Lessons learned and reflected in the project design: The privatization program to date (1993-1999) has been supported by a previous IDA credit for the Parastatal and Public Sector Reform Project (PPRP). The lessons learned during the implementation of the PPRP have been: * The need to define better the privatization modalities and the roles of the various institutions and agencies involved (PSRC, line ministries, cabinet, etc.) to ensure an efficient, transparent process. This is particularly important as experience has shown that the lack of a clearly delineated process with clear areas of responsibility has led to confusion, a lack of coordination, and, in some cases, a lack of transparency. * The need to increase the delegation of authority to PSRC and its advisors, and at the same time, to increase accountability through periodic independent process audits. * The need to increase the technical capacity of the program through contracting out to experienced investment advisers and consultants (particularly for large, infrastructure related firms). * The need to better evaluate, plan and obtain agreement on consistent overall approaches to such problems as: a) retrenchment policy and implementation, and b) the handling of PE debt. * The need for better communication with stakeholders (including the general public) on the policies, the program and the use of the proceeds. In addition to these lessons from previous projects in Tanzania, lessons from privatization programs in the region and around the world, particularly on the importance of regulatory frameworks for privatized infrastructure, indicate: * the necessity for a regulatory framework for infrastructure and utility companies that is clearly spelled out and credibly committed to by the government in order to attract sufficient high quality investors and operators and to ensure effective competition. * the importance of ensuring -that the regulatory regime is feasible in the Tanzanian context (i.e. light contract-based regulation in the initial stages), credible for potential investors and sustainable over the longer term. This will require that GOT effectively put into place mechanisms which reinforce the Government's conmmitment to treat investors fairly and reduce the ability of the concerned parties (including future govermtents) to unilaterally undo commitments. * the significant benefits resulting from effective, mutually agreed, government-private sector consultative mechanisms for enabling a dialog on business environment reforms to yield practical and sustainable policy change, provided that both sides are committed to the process - as well as the utility of donor-supported technical assistance to help facilitate it. 4. Indications of borrower commitment and ownership: The GOT commitment to and ownership of the Tanzanian privatization program has  Page 18 evolved quite significantly over the last five years, from a situation characterized by limited commitment and timid support for the concepts of privatization and private sector- led growth, to one of strong, open support for both. The ownership and commitment of the Third Phase administration to the privatization process has been consistently strong. The Third Phase administration has been instrumental in pushing the program forward beyond medium and small scale enterprises toward actively seeking private sector investment and operation in all the major infrastructure and utilities PE's. One of the strongest signals of this change occurred in 1997 when, for the first time, the Executive Council of the ruling party, the CCM, reversed its long held policy on public ownership and formally endorsed the idea of private sector led economic growth. The government then followed up on these pronouncements and publicly displayed its ownership of the reforms by announcing their intention to privatize potentially politically sensitive sectors such as water, railways and electricity. These are not politically costless actions and normally signal relatively high levels of political commitment. At the same time, substantial progress has been made by GOT in reducing the size and scope of government activities by retrenching over 100,000 employees in the civil service, the military and the PE's and successfully privatizing over 150 parastatals - including several large ones (notably the brewery and cigarette factory) all of which has contributed to a greatly changed climate of public opinion. While it would seem that the Government is in a strong position to pursue the privatization agenda with reduced opportunities for opposition and obstruction within the ruling political Party, the experience over the last three years has been more mixed with respect to the implementation of PE divestitures. Despite repeated statements from the Government about the need to move ahead and the importance of transparency in the transactions, there have frequently been delays in taking urgently needed actions on such issues as retrenchment and debt treatment policies which have hampered timely implementation. The political risks underlying the sustainability of the privatization program are thus still high, despite the progress that has been made. The Bank is endeavoring to play a supportive role through sharing of "best practices" and by supporting more efficient and transparent approaches to handling transactions. This is especially true for the more complex, larger divestitures on which local knowledge and experience are still very limited. During the preparation of this project, the GOT committed itself to prepare the necessary policy changes in the key areas identified above, notably PE retrenchment and treatment of PE debt. The Government has undertaken a review of current processes, at both Government and PSRC level, and has undertaken a practical training program for PSRC and key ministry personnel in privatization techniques for infrastructure. In terms of the regulatory arrangements for infrastructure and utility sectors, the GOT has now begun to appreciate the importance of these issues and the need to address them as an integral part of its privatization strategy. This appreciation has been heightened in light of the mixed experiences with the telecoms regulator (TCC) created in 1993. However, knowledge and awareness of these issues, and the changes in government role they imply, are still quite limited among policymakers and officials. Hence, a major effort at sharing of "best practices" and awareness raising has been a key element of GOT's project preparation. This effort has contributed to widespread discussions on the regulatory issue and a much better understanding of the role and importance of clear regulatory frameworks and institutional arrangements. Meanwhile, in each major  Page 19 infrastructure/utility sector, the Bank has been providing technical assistance on the design of suitable regulatory arrangements. As regards the private business environment the Third Phase administration has recognized the importance of improving the dialog with the private sector as a means of building confidence and identifying and addressing the many regulatory constraints that still affect private business activities. High level support has been given to the creation of a National Business Council (NatBusC), which is in the process of formation. Meanwhile, the local private sector has expanded and become more dynamic and vociferous and effective in voicing its economic policy concerns to government - as witnessed by the effective consultations on tax reforms in 1997. Following on from this and building upon it, the Tanzanian private sector established the Tanzania Private Sector Foundation, TPSF, in 1998. In addition, the GOT's promotional efforts and improvements in the regulatory framework in the mining sector have resulted in significant inward foreign investment. Despite these positive steps, significant reticence remains within government to addressing the problems affecting the business environment. This is being addressed to some degree by efforts in the civil service reform program to "re-educate" civil servants on their role vis-a-vis private firms, and also to re-engineer government procedures to streamline them, and also recent reviews aimed at reorienting and streamlining the role of the Tanzania Investment Center (TIC). . 5. Value added of Bank support in this project: - Through the PPSDP, the Bank will be able to provide vitally needed assistance and technical support for key elements of the Government's adjustment program. In particular, through IDA financing and Bank technical support, the project will enable the Government to have access to quality advisors for both the privatization of large sections of its economy and the necessary regulatory framework so that the country can maximize the economic gains from this private sector participation and from reform of the private business environment. - The Bank is an important supporter of the client's efforts to increase transparency and public accountability. - As a multilateral institution, with considerable experience globally and in Africa in providing such assistance, the Bank is well placed to provide objective technical advice and support in the areas of privatization, utility regulation and business environment reforms. E: Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (supported by Annex 4): [ ] Cost-Benefit Analysis: NPV=US$ million; ERR= % [ ] Cost Effectiveness Analysis: [X] Other We do not feel that this type of TA operation lends itself to rigorous quantitative economic evaluation methodology, since many of the most important economic benefits are indirect and consequently difficult to impute with any accuracy. However, areas where one would expect to see some of the benefits are outlined below . The benefits expected from this operation, which will accrue to several distinct parts of Tanzanian society, have already  Page 20 been outlined in Section 3. 2. Financial (see Annex 5): NPV=US$ million; FRR= % Since this is not an investment operation we have not calculated an NPV, however the project costs and sources of funds are detailed in Annex 5. 3. Technical: Public Enterprise Debt Policy :A key policy issue to be addressed by the proposed Project, through elaboration of a consistent strategy and provision of qualified expertise, is the restructuring of excessive public enterprise debt needed to facilitate timely sale of the enterprises concerned. The enterprise debt study, carried out by consultants appointed by GOT and fanded out of the PPF, surveyed 71 enterprises which account for 95% of total fixed assets remaining to be privatized and identified a total of Tsh. 1,124 billion of debt (US$ 1.68 billion). Because of the state of the records this is likely to underestate the true total debt of the parastatal sector. About 66% of this debt is owed by just 4 companies, TANESCO, TTCL, THA and NBC, and an estimated 80% of the total may have government guarantees. Of the total stock of debt roughly 38% is multilateral, 22% has been lent or on-lent by the Treasury, 29% could not be categorized due to poor record keeping and the final 11% was due to a variety of sources including trade credit, commercial loans, inter-company arrears and unpaid taxes. The study reveals the extent of financial distress and the poor state of many of the businesses. Of the 71 companies examined, 44 companies (61% of the total) were in serious financial difficulty. Of these 13 were no longer operational, 19 had negative cash flow and 30 had current assets that were less than current liabilities (the categories are not mutually exclusive). On this basis, four policy recommendations have been made for the future of the privatization program: first, there is a need to adjust expectations of the probable proceeds from sales to the reality of the assets, among Government officials, Parliamentarians and the general public; second, the need to use rapid assessment techniques to determine the most distressed enterprises and move them into liquidation rapidly; third, that the government must be prepared to reduce the debt in a number of the larger enterprises (particularly the utilities) in order to make them attractive to investors; fourth, this does not imply that all the debt must be absorbed by the Treasury, but that a variety of debt reducing strategies will need to be spelled out and operationalized if the Govermnent wishes to keep to its privatization schedule. The study proposes a stepwise methodology be established which PSRC and the investment advisors have to use. The general purpose of the methodology is to rapidly assess firms to be liquidated and then exhaust the simpler debt reduction techniques (sale of non-core assets, cross debt settlement, etc.) before moving to more complicated measures (debt-equity swap, debt re-scheduling, etc.). 4. Institutional: (A) Privatization Process - In Tanzania, as in other countries, privatization is  Page 21 importantly a political as well as a financial, technical and economic process. As elsewhere, it is important, as far as possible, to separate clearly the political and policy decision-making functions that are rightfully the responsibility of top government policymakers, from the technical responsibilities for execution that need to be delegated to qualified and experienced professionals under conditions of transparency and accountability. Thusfar, experiences over the last five years have shown that lack of attention to broad strategic decisions, combined with excessive ad hoc involvement of policymakers in details of execution, have impeded timely and efficient implementation of transactions. The modifications discussed at appraisal and agreed at negotiations in the government approval process, as well as in PSRC's procedures for preparation and execution of transactions, are aimed at addressing this concern, while enhancing GOT's overall policy direction. In Tanzania, as elsewhere, with limited in-house capacity in government to carry out large, technically demanding transactions, the contracting of competitively selected, qualified and experienced international investment advisors will be key to effective and timely execution of PE divestitures. For such an arrangement to be cost effective, however, the process must function smoothly and with a minimum of delays. To facilitate this, the GOT has already launched a program of capacity building through intensive joint training for staff of PSRC and the line ministries on the specific issues related to large transactions and the use of investment advisors. In addition internationally qualified investment and legal advisers are being recruited to handle major utility and infrastructure privatization transactions - notably in telecoms, water supply, ports. A key change to be adopted to improve the efficiency of implementation of large divestiture transactions, will be the use of price generally as the final determinant of sale. In such cases, the GOT will want qualified investors so as to ensure technical service standards. So, it is expected that bidders would be pre-qualified based upon their experience and credentials. Qualified bidders would be required to agree to common service and regulatory requirements, where relevant - notably in certain infrastructure and utilities sectors. On this basis, final selection of the winning bidder could be based upon price , through a competitive tendering process. Financial bids could be opened and the winning bidder announced at a widely publicized official ceremony that would be broadcast live on radio and television. The President and his Cabinet would meet quickly thereafter to ratify the selection process. For small and medium PE divestitures, where possible and necessary, PSRC will "batch" these into lots of 5-10 PE's and preparation and execution of transactions would be carried out through competitively selected investment advisers remunerated in part through success fees with tenders advertised both locally and internationally. Selection of the winning bidder would be based upon price through a competitive tendering process, with widely publicized opening of bids. No business plan would be required, and no technical evaluation undertaken - except that prequalification might be used for selected large PE's. PE's slated for liquidation could be transferred to LART to handle. Lastly, as responsibility for transactions is delegated to PSRC and their transaction advisors, it will be necessary to implement stronger mechanisms to ensure their accountability in a transparent manner. To help ensure this the GOT has agreed to periodic general process audits of the implementation of the privatization program  Page 22 (B) Utility and Infrastructure Regulatorv Framework: The main aim of this part of the proposed Project is to assist GOT in establishing a basic initial framework of effective institutional arrangements for infrastructure regulation - within which appropriate regulatory arrangements can be created in stages over time as the different sectors are liberalized and privatized, and over a medium to longer term timeframe, as local regulatory skills and capacity are built up. This is thus the first stage in what must be viewed as a long term institution-building process. There are limited options to be confronted in this task - building regulatory capacity requires a concerted effort including training, international advisory support, study tours etc, with choices largely restricted to how much to spend and how to get best value from monies spent. The central policy decision to be made concerns industry coverage of regulatory authorities (multiple agencies or a single agency). . Using PPF funds, the GOT has commissioned a study examining broad institutional options, as well as issues such as independence and accountability, sectoral coverage, relationships between ministries, regulators and stakeholders and implementation/ transitional issues. It is expected that the study will be used as the basis for a Cabinet submission which would obtain an early decision on institutional arrangements. GOT's plan is to prepare draft enabling legislation for creation of the proposed cross-sectoral regulatory bodies, that could be submitted to Parliament for approval in January 2000. Following this decision it will be possible to proceed to more detailed institutional design and legislative implementation of the chosen set-up. The institutional setting for the regulators (in whatever format they eventually take) will be very important. The discussions and training engaged in with the GOT have reinforced the need for the regulator to have autonomy from the government to ensure they are not seen as politically controlled. While it is not possible, nor desirable, to predetermine a given set of institutional arrangements for utility regulation, the study has brought to bear the lessons of international experience to help ensure that attention to issues such as the methods of appointment and dismissal, the scope of responsibility and security of financing are addressed during the project. There is a distinction between the institutions which enforce regulatory rules in the utility and transport sectors and the content of those rules. Thus following one country's rules governing telecommunications interconnection need not mean that the country's regulatory institutions should also be copied. In the area of utility and transport regulation, this project focuses on institutional issues, leaving the design of sector-specific regulatory rules to separate industry-specific projects, also funded by IDA, being undertaken in parallel but in close coordination with the proposed Project. Separate, ongoing and planned sectoral Bank-funded projects (see Section D.2 above) are supporting developing the regulatory rules governing private investment in telecoms, electricity, water, ports and railways. To facilitate investor confidence, it is likely that these regulatory schemes will place strong reliance on contract-based rules, with minimal discretion for regulators. Nevertheless there are likely to remain important roles for regulators, such as contract monitoring, enforcement, resolution of disputes not warranting international arbitration and handling of consumer complaints. In some cases, forms of economic regulation requiring greater economics and accounting skills may be adopted, for example, setting telecommunications interconnection tariffs.  Page 23 The proposed regulatory component of the Project will support several initiatives aimed at establishing effective institutional arrangements for infrastructure regulation: a) it will facilitate the early consideration of institutional arrangements from a cross-sectoral perspective, including consideration of whether it makes sense to have individual regulators for each industry, regulators for related industries (e.g. gas and electricity), a multi-sectoral regulator or some combination of these; b) once the decision about what kind and how many regulators is taken it will assist in the design, creation and training of the regulator(s); and c) the project will help to install additional checks on arbitrary regulatory actions with a public education campaign aimed at increasing awareness of the objectives and roles of regulation and the role of stakeholders in the new regulatory frameworks. While not the only factor required to establish investor confidence, the effectiveness of the new institutional arrangements will play a vital role in ensuring the success of the infrastructure privatizations and will have implications for future rounds of private investment in these sectors. Competent regulatory institutions will also help to lessen recourse to judicial dispute resolution, thereby partially addressing investor perceptions of judicial weaknesses. Concerning the public awareness campaign, the choices relate to the design of the campaign and the effectiveness of different delivery mechanisms. Key stakeholder groups to be targeted are expected to be private investors, consumers and major users, as well as key groups and opinion-makers in civil society, notably including civic and political leaders, educators and journalists. 5. Social: (A) Public Enterprise Retrenchment Policv - As a basis for design of a more consistent, equitable and fiscally sustainable PE retrenchment policy, GOT commissioned a review based upon a consultant study - funded by the PPF for the proposed Project and also supported by technical advice and research from the Bank's Development Research Department (DECRG). The study made an assessment of current PE retrenchment policies and practices in recent years. It reviewed current statutory provisions for severance pay, related benefits (eg., resettlement) and pensions, and their administration. Against a backdrop of recent experiences resulting in widely varying levels of retrenchment payments - often unrelated to objective economic and social factors, the review developed a methodology for assessing the expected losses for different categories of PE employees from retrenchment, taking into account such factors as age, skills, and geographic location. The study was aimed at helping define options for ensuring a larger measure of economic efficiency and equity in the future policy and establishing guidelines for detennining the economic basis to justify severance payments beyond the statutory allowances. These guidelines are based on transparency and equity considerations associated with the probability of, and time lag anticipated for, an employee being re-employed and the likely resulting future remuneration, based upon observed labor market trends in Tanzania. The study was aimed at helping to inform and clarify all parties' understanding of what payments are being made. Up to this point the "retrenchment" packages have generally been a combination of different elements, including the statutory severance payment, statutory pension payment and often, but not always, a widely varying "ex gratia" payment ("golden handshake") as well as two types of pension payment (one upfront lump-sum payment equal to 25% of the full pension, in addition to either a further lump- sum approximating the NPV of expected future payments, or a commitment to pay future  Page 24 pension benefits.) In addition the study has clarified the magnitude of the equity problem involved with workers in liquidated firms whose statutory benefits are greatly out of line with packages in privatized firms. The reforms needed in this area were discussed with GOT during project appraisal, and it is GOT's intention to present a policy paper to Cabinet for consideration and decision by January 31, 2000. Against the previous practice until now, if adopted, the proposed new approach would, in essence, call for any severance payments beyond the statutory allowance to be determined based upon a market-based assessment of a retrenchee's re-employment prospects and anticipated resulting future wage losses. Application of the proposed new methodology for six major parastatals (that comprise a major share of the PE labor force, and would likely need to retrench about 10,000 employees) yields an absolute total cost of about Tsh. 35.2 billion (or US$54 m. equivalent) - assuming 6,000 retrenchees The unit cost would average about Tsh. 8.2 million per worker, or around 4 times annual salary (excluding pensions, the average cost per worker is about 5.2 million T.Sh.). If adopted in practice, it would represent a significant savings in total and unit costs combined with a more equitable distribution of severance benefits in relation to anticipated future income losses. The unit cost cited above is in line with retrenchment operations in other developing countries in Africa and elsewhere, and is consistent when using different data sources and methodological variations. Nevertheless, the fiscal cost is large and ways to reduce the upfront costs may be considered, in particular, with respect to pension issues. As regards possibilities for reductions in costs, the review proposes that six issues should be considered: (a) Changes in the legislation. The current Parastatal Provident Fund (PaPF) pension scheme allows a relatively young retrenched worker to receive pension benefits. This contradicts the principle of a pension. Pension payments should be deferred until retirement age. (b) Increase in the retirement age. Retirement age is apparently low (50-55) in relation to similar African countries (often 60 in other countries). (c) Reduction of up-front pension payments. This is currently set at 25 percent of the total pension to be received by the worker. (d) Long term bonds. These bonds may be issued instead of, or in combination with, option (a). (e) Pension refund. A more radical approach would be to refund pension contributions (plus interest) instead of assuming the future pension cost of workers. These proposals would require more fundamental changes than the proposed adjustment in severance benefit computation. They would be explored by GOT in future, as part of a fuller re-assessment of the Parastatal Pension Fund and pension schemes generally. (B) Affordability of Utility Tariffs - There is some potential for negative social impact due to the raising of prices for utility services to make them solvent and sustainable. We believe, however that the extremely low penetration rates for most of these services and high socio-economic skewing of provision will mean that the truly needy will be unaffected by the changes as they were never served. 6. Environmental assessment: Enviromnental Category [] A [] B [X] C This  Page 25 project did not include an upfront environmental assessment, because it is aimed at supporting an overall institutional framework for the divestiture of a large portfolio of widely differing PEs. However, as pat of that framework, environmental assessments will be undertaken where ever needed as part of the PE divestiture preparation process. 7. Participatory approach a. Primary beneficiaries and other affected groups: Privatization: Government - There has been wide discussion within the government and all ministries concerned over the lack of government finance for continued investmnent in public enterprises. All of the line ministries have had a strong say in the divestiture strategy for firms that fall within their ministries and each ministry has at least one member on the Divestiture Task Team for each of its enterprises. In addition the relevant ministries have all been included in discussions of regulatory arrangements. Investors - There has been an effort to get investor feedback on the divestiture strategies of individual enterprises. This has been particularly true for the large utility and infrastructure transactions where investor conferences are being planned to ensure that final divestiture offerings have taken into account market sentiment. Utility and Infrastructure companies - The companies themselves have been intimately involved with the preparation of their own divestiture strategy. This is most apparent with enterprises that are further along in the process (e.g. TTCL). Regulation: In the process of preparation of the proposed Project, widespread consultations were held by the inter-ministerial working group and by the Bank task team across all the relevant ministries and with the firms to ascertain their thinking on the regulatory framework. In addition a workshop was held in March 1999 for all actors within the government and the affected industries to discuss these issues more widely. b. Other key stakeholders: Privatization Labor - Previously labor had not been formally represented in the GOT's privatization program, however, the president of the Tanzanian Federation of Trade Unions as well as a former principal secretary of labor sit on the PSRC Commission. During preparation of this project however, labor was consulte extensively in the preparation of the new retrenchment remuneration guidelines. General Public - To date the general public has been involved only to the extent that they have been the target of communications campaigns seeking to raise awareness and acceptance of the program. However, under the funding of DFID, international consultants have been recruited to help design and implement a much wider communications campaign that is seeking to inform and involve the public about the program and how they can participate in or benefit from it. Regulation  Page 26 Business and Residential Consumers - The regulatory framnework design is not yet at a stage where it would be fruitful to have very widespread discussions. However, the business community has been approached (through representative organizations such as the TCCIA and CTI) and has shown interest in being involved in discussions on the regulatory framework. It has also been agreed with GOT that community and residential consumer groups be identified and participate in discussions on the regulatory framework and that mechanisms (e.g. consultative groups or meetings) be built into the regulatory set-up to ensure that consumers have a voice in regulatory affairs. F: Sustainability and Risks 1. Sustainability: The Project entails significant risks with respect to policy implementation and capacity: While GOT is now generally committed to privatization of major PE's (notably in infrastructure and utilities), and to a reduced role for the state in the economy, the transition toward private sector-led, market-based growth is still at an early stage. While the Third Phase Administration is providing strong leadership to accelerate the pace of change, within the ruling political party (the CCM), there seems more modest evidence of overall political consensus on the current reform efforts. In addition, the planned divestitures of major infrastructure and utility PE's over the next 3-4 years involve policy and regulatory issues that are new to Tanzania, given its socialist past, and for which technical and managerial capacity is very limited. The risks of wavering government commitment to an efficient and transparent divestiture process, undermined by undue influence of powerful vested interests, must be considered as substantial. Equally, the risk must be viewed as high that inadequate government commitment to necessary reforms (aimed at freeing up markets, increasing competition and removing bureaucratic controls), combined with inadequate governance and corrupt practices, may continue to constrain the business environment for private and foreign investment. More specifically, there are risks that lack of consistent policies with respect to PE retrenchment and treatment of PE debt could undermine the financial and fiscal sustainability of the privatization program. The Project design and preparation have sought to mitigate these factors in a number of ways: (a) The policy and political risks associated with GOT commitment to sustainable implementation of privatization are being mitigated by reaching early agreement on a streamlined, more transparent process for handling Government approval of divestiture transactions, and internal procedural improvements in PSRC, as well as adoption of consistent overall policy guidelines for PE retrenchment, and treatment of PE debt; (b) The business environment risks, associated with continuation of bureaucratic controls and constraints on private business activities together with political interference and rent-seeking, will be addressed through creation of a Government- private sector policy dialog forum to champion specific reforms, and, beyond the scope of this Project, support for implementation of these reforms through the proposed SAC2 (FY00); (c) The regulatory risk associated with potential political interference in the regulation of privatized activities in utilities and infrastructure, and with initially  Page 27 very limited regulatory capacity, are being addressed by: early GOT consideration of institutional arrangements for the regulatory framework built upon extensive awareness-raising with major stakeholders (especially in government and the public sector), support for a strong training and capacity building programn under the regulatory component of the Project; and a proposed campaign aimed at raising public awareness of regulatory issues and the role of stakeholders in ensuring that appropriate standards and prices are maintained. These approaches are complemented by parallel efforts aimed at developing sector-specific regulatory rules which are likely to provide limited regulatory discretion and to provide contractual protections to investors. (d) The governance risk associated with corrupt practices and excessive influence of vested interests will be addressed through improvements in the policies and process for privatization and regulation (see above), as well as, more generally, beyond the scope of the present Project, through follow-up to the recent World Bank Anti-Corruption Report, as well as related aspects of the follow-on IDA -funded Public Service Reform Project. (e) The implementation risk associated with limited technical capacity in PSRC and concerned GOT ministries, mitigated through provision of hands-on practical training to PSRC and govermment staff during Project preparation and initial implementation (funded by IDA), as well as long-term advisory and technical support to PSRC (funded by UK-DFID). (f) The social risk associated with potential for social dislocation, hardship, and unrest due to inequitable and inadequate PE retrenchment policies and practices, will be addressed through agreement on consistent overall guidelines for PE retrenchment and review of GOT policy early during Project implementation.  Page 28 2 Critical Risks (reflecting assumptions in the fourth column of Annex 1): Risk Risk Risk Minirnization Measure Rating Policy & Political Risk - Govt. H Upfront agreement on process and policy commitment to sound divestiture improvements process Regulatory Risks - Political S Early agreement on regulatory design interference and weak regulatory and guidelines (minimalist approach to capacity regulation) Awareness-raising and capacity building Governance Risk - Continuation of S Upfront agreement on process and policy non-transparent and corrupt practices improvements Irnplementation of action plan on Anti- Corruption (outside the scope of the proposed Project) Implementation Risk - Inadequate S Training and Capacity building efforts technical capacity in implementing during Project Preparation & agencies (PSRC, GOT ministries) Implementation Long-term Advisory support Social Risk in Privatization - M Early agreement on consistent guidelines Backlash and unrest caused by for PE retrenchment inequitable PE retrenchment policies H Govt.-private sector dialog forum. Business Environment Risk -Govt. SAC2 to support reforms commitment to removal of bureaucratic controls and freeing up markets Overall Risk Rating S Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk) 3. Possible Controversial Aspects (Project Alert System): Risk Type of Risk Rating Risk Minimization Risk Measure Policy & Political Risks (see above) G H See above Business Environment Risk (see above) G H See above Type of Risk - S (Social), E (Ecological), P (Pollution), G (Governance), M (Management capacity), 0 (Other) Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk)  Page 29 G: Main Loan Conditions 1. Effectiveness Conditions: The Government of Tanzania (GOT) shall: * furnish the Project Implementation Manual in form and substance satisfactory to IDA; * fumish an annual work plan for the Project covering the period January 1, 2000 through June 30, 2001, satisfactory to IDA; * open the Project Account and deposit in it the initial deposit in the amount of US$ 1.25 million equivalent; * cause to have been amended the Public Corporations (Amendment) Act of 1993 to extend the mandate of the PSRC through end December 2004. 2. Other a. The Government of Tanzania (GOT) shall: * consider and decide upon a policy framework and operational guidelines for PE employee retrenchment, satisfactory to IDA, ensuring application of consistent principles across divestiture transactions (See Sections B.2.A.(b) and E.5.(a) above) [Dated Covenant - by January 31,2000]; * Consider and decide upon a policy framework and operational guidelines for treatment of PE debt, satisfactory to IDA, ensuring consistent and timely debt resolution, as needed, for divestiture transactions (See Sections B.2.A.(c), and E.3 above) [Dated Covenant - by January 31, 2000]; * cause to be transferred in a timely manner to LART for collection suciNPAs from NBC as need to be liquidated to complete the financial restructuring of NBC (See Section B.3.B above) [Dated Covenant - by March 15, 2000]; * review and adopt an appropriate transition strategy for LART and the LART Tribunal, based upon the findings of the review (being) undertaken, once LART has completed its initial mandate of collection ofNPAs for the public sector banks (See Sections B.2.B and B.3.B above) [Dated Covenant - by June 30, 2001.]. * adopt an institutional framework for infrastructure and utilities regulation across sectors, satisfactory to IDA, based upon the results of the options review, including adoption of enabling legislation and regulations, as needed, creation of independent regulatory body (ies) with adequate sources of funding and technical support, and conduct of a public education program (See Section E.4.C above) [Dated Covenant - by April 15, 2000; Condition of Disbursement of Regulatory Component]; * agree and implement with private sector representatives a mutually  Page 30 acceptable institutional franework and modalities for the government-private sector consultative mechanism, satisfactory to IDA, to address regulatory and other constraints to competitiveness (See Sections B.2.D and E.4.D above) [Condition of Disbursement of Business Environment Component]; b. The Parastatal Sector Reform Commission (PSRC) shall: * maintain an organization, staffing, progress reporting, accounts and audits, satisfactory to IDA [Standard Bank lending condition]; * commission, on behalf of GOT, periodic (annual) independent audit of the GOT's privatization proceeds account, for which it serves as administrator (See Section B.2.A.(d) above); c. The Loans and Advances Realization Trust (LART) shall: * take receipt of, in a timely manner, and undertake collection onNPAs to be transferred to it by the public sector banks (notably NBC) as part of the latter's' fmancial restructuring (See Sections B.2.B and B.3.B above) [Dated Covenant - by March 15, 2000f * maintain organization, staffing, progress reporting, accounts and audits, satisfactory to IDA [Standard Bank lending condition]; * comnission, on behalf of GOT, the future options study for LART and the LART Tribunal, and undertake as needed preparation and implementation of their transition, further to GOT's decision in this regard (See Sections B.2.B and B.3.B) [Dated Covenant -June 30, 2001]. d. Once legally established, the Infrastructure and Utilities Regulatory Body(ies) shall: * adopt and maintain an organizational structure, staffing, progress reporting, accounts and audits, satisfactory to IDA [Standard Bank lending condition]; * adopt operational guidelines and a procedures manual for economic regulation of infrastructure in the participating sectors, satisfactory to IDA, sufficient to ensure effective, independent and balanced regulation (See Sections B.3.C. and E.4.B above) [Dated Covenant- by July 31, 2000]; * adopt and commence implementation of a capacity building and staff development program for economic regulafion, satisfactory to IDA, including as needed international technical advisory support) (See Sections B.3.C. and E.4.B above) [Dated Covenant - by October 31, 2000]; * adopt and undertake a widespread program of public education and awareness-raising on economic regulation of infrastructure and utilities, satisfactory to IDA (See Sections B.3.C and E.4.B above) [Dated Covenant - by June 30, 2001]. e. Once legally established, the Government-Private Sector Consultative Body,  Page 31 and/or an administrative agent acting on its behalf, shall: