Madagascar - Structural Adjustment Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 19159 IMPLEMENTATION COMPLETION REPORT REPUBLIC OF MADAGASCAR STRUCTURAL ADJUSTMENT CREDIT (CREDIT 2937-MG) May 5, 1999 Macroeconomics 3 Economic Management and Social Policy Africa Region This document has a restricted distribution and may be used by irecipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY AND EQUIVALENT UNITS Currency Unit Malagasy Franc (FMG) 1991 1992 1993 1994 1995 1996 1997 1998 FMG/US$ 1835 1864 1914 3067 4266 4061 5091 5273 (average)I WEIGHTS AND MEASURES Metric System ACRONYMS AND ABBREVIATIONS BFV Commercial Bank (Banky IBRD International Bank for Fampandrosoana ny Varotra) Reconstruction and Development BTM Rural Development Bank ICR Implementation Completion (Bankin'ny tantsana Mpamnokatra) Report CAS Country Assistance Strategy IDA Intemational Development CEM Country Economic Memorandum Association EU European Union IMF International Monetary Fund ESAF Enhanced Structural Adjustment PER Public Expenditure Review Facility SAC Structural Adjustment Credit FDI Foreign Direct Investment SDR Special Drawing Rights FF French Franc USD/US$ United States Dollar FMG Malagasy Franc VAT Value Added Tax GDP Gross Domestic Product FISCAL YEAR January 1 - December 31 Vice President: Callisto Madavo Country Director: Michael Sarris Sector Manager: Luca Barbone Task Team Leader: Juan Zalduendo  FOR OFFICIAL USE ONLY TABLE OF CONTENTS Preface .................................................................. i Evaluation Summary .................................................................. ii PART I: PROJECT IMPLEMENTATION ASSESSMENT ........................1................................ A. BACKGROUND AND PROJECT OBJECTIVES ...................................................................1 Background And Political Context ................................................................... 1 Project Objectives .................................................................. 3 B. AcHiEvEMENT OF OBJECTIVES .................................................................. 3 Macroeconomic Management .................................................................. 4 Incentives For Private Investment In Exports And Labor-Intensive Activities ...... 6 Refocusing Public Expenditures ........................ .......................................... 8 C. MAJOR FACTORS AFFECTING THE PROJECT .................................................................. 9 D. SUSTAINABILITY OF AcHIEVEMEN Ts .................................................................. 9 E. BANK PERFORMANCE .................................................................. 1 0 Identification And Preparation .......................................... ........................ 10 Supervision And Technical Assistance ................................................................. 10 F. BORROWER PERFORMANCE .................................................................. 10 G. ASSESSM ENT OF OUTCOAES ............................................................... . ........... ........ 11 H. FuTuRE OPERATIONS ...................... 12 I. KEY LESSONS LEARNED ...................... 12 PART II: PROJECT IMPLEMENTATION FROM THE BORROWER P:ERSPECTIVE ........ 15 PART III: STATISTICAL TABLES ................................................................. 19 Table 1: Summary Of Assessments ............................................................ .... 19 Table 2: Related Bank Loans/Credits ................................................................ 20 Table 3: Project Timetable ..................... ........................................... 22 Table 4: Cumulative Estimate And Actual Disbursements ............. ....................... 23 Table 5: Fulfillment Of Conditionality ................................................................ 24 Table 6: Project Costs ................................................................ 26 Table 7: Compliance With Operational Manual Statements .............. ...................... 27 Table 8: Bank Resources: Staff Inputs ................................................................ 28 Table 9: Bank Resources:-Missions ................................................................. 29 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  IMPLEMENTATION COMPLETION REPORT REPUBLIC OF MADAGASCAR STRUCTURAL ADJ1USTMENT CREDIT (CREDIT 2937-MG) Preface This is the Implementation Completion Report (ICR) for the Structural Adjustment Credit (SAC) to the Republic of Madagascar (Credit 2937-MG) in the amount of US$70 million equivalent, which was approved on March 14, 1997. The Credit became effective on April 1, 1997. The single tranche was disbursed on April 2, 1997. The credit was closed on December 31, 1997, in accordance with the original schedule. While delays in the implementation of the reform agenda supported by the operation emerged after disbursement, dialogue remained active and the reform program was later resumed as the Government requested additional financial support. Progress in the implementation of the reform program supported by the SAC was a key determinant of the timing of additional support. For these reasons it was decided to postpone the preparation of this ICR until early April 1999 to enable a more complete assessment of the impact of the operation. Preparation of this ICR was begun during the appraisal mission for the forthcoming adjustment operation in November 1998 and was completed during the negotiation mission for that operation in March 1999. It is based on material in the project file and at the Resident Mission in Antananarivo. This ICR was prepared by Christos Kostopoulos (AFTM3). The Task Team Leader for the ICR was Juan Zalduendo (AFTM3). The report was reviewed by Luca Barbone, Sector Manager (AFTM3), and Michael Sarris, Country Director for Madagascar (AFC08). The borrower provided comments that are included in Part II of the ICR.  IMPLEMENTATION COMPLETION REPORT REPUBLIC OF MADAGASCAR STRUCTURAL ADJUSTMENT CREDIT (CREDIT 29370-MG) Evaluation Summary Introduction 1. Economic reform in Madagascar had taken place throughout the 1980s with keen support from the World Bank and other donors. The year 1991 saw a disruption in the reform agenda: exchange rate rationing was introduced, fiscal management deteriorated, and reversals took place in the privatization process initiated in the late 1980s. Although dialogue between the Bank and Madagascar was maintained in the early 1990s and an active project portfolio was implemented, the Bank refrained from designing adjustment support until an economic liberalization agenda was advanced in 1994 and prior actions were completed. Political developments resulted, however, in a stop-and-go preparation cycle over 1995 and 1996. The SAC was finally approved by the Board in March 1997, in the amount of US$70 million equivalent; the project became effective the same month and was fully disbursed in April 1997. The credit was closed in December 1997, as scheduled. However, implementation delays in the privatization agenda prevented a thorough evaluation of the operation and were reason for the ][CR to be postponed until the SAC agenda was complete, as the adjustment dialogue was still ongoing and government had requested additional financial support. Project Objectives 2. The operation addressed three overarching themes important to Madagascar at the time of project design and still crucial to the country's development strategy today: the paramount need to address poverty (impressed by the need to reverse the real decline in per capita income of the past 20 years), the importance of engaging foreign investors and generating the right signals to attract them, and the redefinition of the role of the State. The SAC consequently had three objectives: first, to stabilize the economy, second, to promote the role of the private sector by introducing incentives for private investment in exports and labor-intensive activities, and third, to refocus public expenditures towards the social sectors. All three objectives support the Country Assistance Strategy approved by the Board in February 1997. Implementation Experience and Results 3. The project achieved fully or partially the majority of its objectives. The first objective of economic stabilization was achieved with unqualified success, the Malagasy Franc was floated, the rate of inflation was reduced to 4.5 percent in 1997, compared to 19.8 percent in 1996, the external current account balance was reduced in US Dollar terms, and the overall fiscal deficit fell to 5.6 percent of GDP in 1997, compared to 8.4 percent of GDP in 1996. iii  Stabilization was maintained in 1998 and prospects for 1999 are good. The project achieved more moderate success in its second objective, that of promoting the private sector, mostly owing to the political challenges posed by state divestiture from productive activities. Nevertheless, the key measures contained in the Memorandum of the President, the Letter of Development Policy, and other official documentation have been met as of the writing of this ICR; these are freer movement of tourists and business people, introduction of competition in the telecommunications sector (there are four cellular operators currently operating), authorization for air charters to service the Madagascar market, and, though with over a one year delay, divestiture from the two remaining commercial state banks. Success on the third component of the operation, refocusing the public expenditures on the social sectors is harder to claim. Although conditionality on re-direction in the public expenditure program has been met, as a slight increase in resources allocated to the social sectors took place, no meaningful improvement in the delivery of social services can be observed; this is possibly attributable to the fact that improvement in service delivery requires deeper reforms than increases in expenditure levels. In evaluating the overall performance of the operation, Madagascar's first two years of positive per capita income growth (1997 and 1998) in the 1990s, the continued efforts at greater stabilization of the economy, and maintenance of adjustment dialogue to date support a satisfactory rating. Aided by recent progress in state divestiture, partly resulting from the dialogue for a new SAC, the reforms are sustainable, and are expected to be sustained. 4. The dominant factor that affected achievement of the objectives was the complex political environment in which the project was prepared and executed. The lack of political continuity and the heavy electoral calendars weakened the momentum for reform. Other factors that affected project performance were the complexity of some of the underlying work of the operation (regulatory environments underlying privatizations), and institutional weaknesses of the Malagasy state, despite the parallel assistance provided by a capacity-building project. 5. The Bank's performance during identification and preparation of the operation was satisfactory. The Bank used the potential credit as an opportunity to advance the reform agenda in Madagascar and to engage reformist politicians and technocrats during a period that was politically charged. The Bank's quick responses to government's policy corrections were reasonable and judicious. In the design of the operation, the Bank took into consideration the borrower's past poor commitments to reforms (policy reversals in the early 1990s and more recent ones in 1995-96) and required that substantial actions be completed up front, prior to disbursement. The operation's complexity, particularly privatization, required close supervision and technical assistance. For these reasons, the operation was designed as a one-tranche operation assisted by a capacity building credit. Unfortunately, political pressures were such that when the single tranche was released, reform momentum weakened substantially so that even discussion of a second operation was delayed for more than a year. Success of the stabilization component of the operation was a big feat, but was overshadowed by trepidation on the private sector promotion component, and especially state divestiture. Finally, the lack of improvement in the provision of social services during the operation was also unconvincing. Madagascar proved once again proved to be a hesitant reformer. Consequently, the borrower's performance is rated as marginally satisfactory. The agenda, as articulated in the Letter of Development policy and other official documents, did picked up in 1998 once the political calendar cleared up. iv  Summary of Findings, Future Operations, and Key Lessons Learned 6. There is ample cross-country evidence now available showing that lack of client ownership of reforms will undoubtedly lead to their reversal. Adjustment money cannot buy commitment, if political will is lacking. This being said, in real life it may be very hard to gauge the extent of commitment to reform, and, equally important, the political leadership in any country may be divided on the path to pursue. This is the rationale for continuing to engage in policy dialogue even at times when commitment may be questionable. In this optic, one can say that in retrospect the SAC did indeed prove to be an invaluable vehicle for advancing the development dialogue in Madagascar during times of political tunnoil and economic reform backtracking. Through the preparation stage of the operation, the Bank used the potential credit as a means to engage the pro-reform elements in Madagascar and tailored its pitch to the political leadership when receptive or to analytical work when dialogue was slow. 7. Despite the advances accomplished in different reform areas, Madagascar is expected to require additional external assistance to consolidate progress already achieved. Additional work is required in four areas: (i) consolidating gains from macroeconomic stabilization by further reducing fiscal imbalances; (ii) improving the business environment; (iii) completing the state's disengagement from productive activities, and (iv) tackling anew public finance issues, without unduly raising expectations. A multi-tranche adjustment credit addressing these problem areas is scheduled to be reviewed by the Board in mid-May. 8. There is however a question of project design that merits reflection. As discussed above, the SAC should be viewed as a combination of the specific measures that were taken prior to Board presentation, and the commitments under the Letter of Development Policy to continue to execute the reforms. In some areas, as this document discusses, the lack of financial leverage after disbursement of the single tranche resulted in less commitment and capacity to focus on objectives on the part of the government. And the fact that several items of the agreed conditionality were of procedural nature, led to the result that the letter, but not the spirit of the program were met in a number of cases. These considerations reinforce the shift in Bank adjustment operations towards the use of floating tranches, particularly in cases where the reform program is multi-faceted, and therefore subject to a differentiated pace of implementation. In addition, conditionality should be specified in ways in which results, rather than process, are clearly identified and rewarded. 9. Finally, the operation reinforces the by-now-accepted view that weak institutional capacity needs to be fully factored into program design. Additionally, instilutional strengthening cannot be viewed simply as the provision of technocratic technical assistance: a thorough understanding of the factors underlying the incentives and commitments of civil servants and politicians alike is a precondition for putting together realistic programs. v  IMPLEMENTATION COMPLETION REPORT REPUBLIC OF MADAGASCAR STRUCTURAL ADJUSTMENT CREDIT (CREDIT 29370-MG) PART I: PROJECT IMPLEMENTATION ASSESSMIENT A. Background and Project Objectives Background and Political Context 1. The SAC was prepared over a three-year period, 1994-1997, rmarked by important struggles for political leadership in Madagascar. Reconciling campaign promises of different political actors with prudent fiscal management and resource availability became a central part of the adjustment dialogue between the Bank and Madagascar. The credit is to be viewed as a key vehicle for development dialogue during those times. 2. Preparation for the SAC took place against a backdrop, since independence in 1970, of failed attempts at socialism and half-hearted efforts at market reforms. Population growth has also been high in Madagascar, at just under 3 percent per year in recent times. The end result of alternating economic paradigms and high rates of population growth was arl increase in poverty: from 40 percent of the population in 1960, to 68 percent in 1990. Although the late 1980's and very early 1990s saw a resurgence in economic performance through the implementation of market reforms, they also saw a balance of payments crisis in 1991 and civil unrest due to dissatisfaction with political reforms and economic management's inability to address poverty. As a consequence, the ongoing adjustment efforts were disrupted. (See Box 1 for a summary description of reforms and reversals during the preparation and implementation of the SAC.) 3. The unstable policy environment also adversely affected assessments made by potential foreign investors, who chose to stay out of the country despite its attractive natural resource base. Foreign direct investment (net) was negligible through 1988, and had reached only 0.3 percent of GDP by 1995. Such low rates represented a lost opportunity for MadagascaLr, which was heavily in debt, had low skilled workers and poor technological capacity, and was not reaping financial or other capacity-enhancing benefits of greater foreign involvement. 4. Hence, several overarching themes needed to be addressed at the beginning of 1994, at the time discussions on a potential adjustment operation began to become imore concrete. First, the paramount need to address poverty, and second, to acknowledge the importance of engaging foreign investors and to generate the right signals to attract them. Integral to the success of both objectives was redefinition of the role of the state which was overextended and inefficient.  5. The year 1994 saw a Box 1: The SAC Timetable Amidst Political Battles for Reform break from populist and Adjustment Dialogue Political Developments nationalistic policies initiated 1991 Civil unrest leads to new gov. in 1991, through flotation of 1993 and to undoing of econ. reforms 1994' the Malagasy Franc and Policy of exchange rate rationing (In March 1993 Mr. Zafy came definition of the national reversed: FMG floated to power from the opposition by reconstruction and Reconstruction, liberalization beating Mr. Ratsiraka in .liation agenda. . agenda advanced Presidential elections; reformist reconclllatlon agenda. A WB/IMF mission May Ravony was elected joint Bank/Fund mission SAC Concept Paper May Prime Minister) discussed a draft Policy Optimistic CAS to Board Jun, Framework Paper early that Stabilization plan with IMF Jan _ year with the government, Commission for Privatization Jan and in May, a SAC Concept Techn. Secr. for Adjustment Mar Mar President Zafy's Ist attempt to Paper was reviewed. In ~~SAC Initiating Memo. Aug oust Prime Mfinister Ravony Paper was reviewed. In SACInitiating Memo. Aug Sep Zafy wins referendum to January 1995, after further SAC Loan Committee Oct appoint Prime Minister monetization of the deficit President Zafy rolls back reforms had contributed to an annual SAC processing slowed 1996 inflation rate of 61 percent CAS Progress Report sees fragile Mar May 2/3 of Parliament votes No (in December 1994), the consensus for reform Confidence in government non- govemment sought a ~~~~SAC Appraisal Jul political Primne Minister to powei government sought a SAC Appraisal Jul Sep President Zafy impeached stabilization plan with the SAC Negotiations Oct Nov Presidential elections, I' round IM4F. Technical progress was 1997 also taking place on the CAS to Board with triggers for Jan Ratsiraka wins Presidential adjustnent lending elections (second ballot) reform agenda. The SAC Board Mar Post Reform pace on privatization Independent Commission for Effective Apr Apr agenda slows significantly Privatization (CP\ wa Disbursed APr alongside preparation for Privatization (CIIP) was SAC closes but some Dec the 1998 elections established in January 1995 privatizations incomplete _ to prepare the divestiture law 1998 and the Technical Secretariat Mar Constitution revised May National Assembly elections for Adjustment (STA) was Aug New government constituted set up in March 1995 as a 1999 focal entity for the State banks sold, SOLIMA sold Apr adjustment program. The SAC ICR IApr Bank proceeded with an Initiating Memorandum for the SAC in August 1995. An important objective of the proposed operation was, in support of the draft 1996-99 PFP, to transfer resources and help unblock the Paris Club process, reducing the country's debt overhang. However, 1995 also turned out to be a year of intense political infighting, as President Zafy sought, and succeeded in September, to oust the reformist Prime Minister Ravony. The Loan Committee met in October 1995, shortly after the Prime Minister lost power. It noted that in the event of back-tracking, processing of the loan should be stopped. Unfortunately, President Zafy's government did roll back some key reforms. Country dialogue reverted to sectoral issues rather than SAC processing. 6. The CAS progress report, issued in March 1996, characterized the consensus for undertaking comprehensive reform in Madagascar as fragile, due both to factionalism in the Executive and to policy differences. In May 1996 over two thirds of the parliament adopted a 2  motion of no confidence in the government; a non-political Prime Minister (former head of the constitutional court) took power. This coincided with an improvement in the policy dialogue as an appraisal mission for the SAC took place in July 1996. In September 1996, President Zafy was impeached. The Bank team undertook negotiations for the SAC in C)ctober 1996 with an interim Government. President Ratsiraka won the elections in January 1997, and appointed a reformist team. The CAS was presented to the Board in January 1997, stipulating the triggers for an assistance scenario with adjustment lending. The SAC was presented to the Board in March 1997. 7. Politics of 1997 and 1998 President Ratsiraka won the second ballot of the Presidential elections in January of 1997 with a very narrow margin. However, the new President chose to exercise his right to postpone parliamentary elections from July 1997 to M:ay 1998, and use the opportunity to pass a national referendum shifting some government functions away from the National Assembly and towards the Presidency. Consequently, the latter half of 1997 was spent gathering political support, prompting the adjustment agenda to second place in the politically charged environment. The Constitution was revised in March 1998 ancd National Assembly elections were held in May, yielding a comfortable majority to the President's party. A new government was constituted in August 1998. Against this backdrop, implemnentation of the SAC, and preparation of the next adjustment operation, had been taking place. Project Objectives 8. There were three objectives for this operation. First, to stabilize the economy by supporting low inflation and regularizing the external debt situation within a viable balance of payments. Second, to increase incentives for private sector investment in exports and labor- intensive activities by: (a) divesting government from public enterprises, (b) establishing a framework for private sector incentives, (c) introducing tax reform, (d) divesting from two state- owned banks, (e) introducing competition into the petroleum sector, (f) improving telephone service delivery, (g) liberalizing the vanilla sector, and (h) reducing the cost of air travel. Third, to refocus public expenditures towards the social sectors. The operation was a pillar of the base case scenario of the Country Assistance Strategy approved by the Board in January 1997. The Strategy supports (a) broad-based growth led by private investment, (b) human capital development, focused on primary education, health care, and rural infrastructure, (c) strengthening public sector's capacity, and (d) natural resource management. The strategy remains relevant today. The program was also based on a Policy Framework Paper negotiated with authorities in August 1996; the IMF Board approved a three-year ESAF in November 1996. B. Achievement of Objectives 9. Key objectives of the adjustment program were to stabilize the economy and to restore economic performance in Madagascar. These objectives were by and large attained. Table I shows that economic growth targets were surpassed in 1997, and performance remained strong during 1998. Additionally, as reforms are expected to be sustained through 1999, the program may have had a medium-term impact and successfully reversed the pattern of low growth rates of 1993-96. Although favorable external conditions contributed to Madagascar's improved performance, the marked reduction in inflation as well as improved fiscal balance have 3  contributed to building investor confidence. Private investment has increased from an unwavering 5 percent of GDP in 1994, 1995, and 1996, to 6.1 percent in 1998 and is expected to reach 7.4 percent of GDP in 1999. Table 1 also indicates an improvement in the external balance (including total grants) which was lower than projected at the time of the MOP in US Dollar terms for 1997. The external current account deficit (including current grants) amounted to 5.6 percent of GDP in 1997, compared to 9.5 percent in 1994. External reserves also improved, rising from 0.7 months of imports in 1994 to about 3 months in 1997. These figures yield a picture of internal and extemal balance attained by the adjustment program. Table 1: Comparison Macroeconomic Performance; Projections and Actuals, Before (MOP) and After the SAC (ICR) (in percent) 1993 1994 1995 1996 1997 :1998 1999 2000 2005 GDP growth MOP 2.1 0.0 1.8 2.0 3.0 3-5 4.5 .. 9.5 ICR 2.1 0.0 1.7 2.1 3.6 3.9 4.5 5.3 7.2 GDP per capita growth MOP -0.6 -2.7 -0.9 -0.7 0.2 0.8 1.7 .. 6.6 ICR -0.6 -2.8 -1.2 -0.9 0,5 0.8 1.5 2.2 1.2 Fiscal Balance MOP -10.0 -11.1 -8.7 -7.9 -6.5 -6.1 -5.1 .. -2.4 (percent of GDP) ICR -10.0 -10.6 -8.9 -8.4 -5.6 -7.2 -5.5 -4.2 Extemal CAB, (incl. MOP -176 -208 -231 -164 -153 -155 -124 .. -298 capital grants, US$M) ICR -176 -208 -222 -150 -85 -167 -151 -153 -212 CPI gr. (annual avg.) MOP .. .. 49.0 24.0 11.5 5.8 4.8 .. 3.1 ICR .. 39.1 49.0 19.8 4.5 6.2 5.6 4.9 3.0 Note: For the Memorandum of the President (MOP), 1996 was and estimate and 1997-2005 were projection years. At the time of production of the ICR, 1998 was an estimate and subsequent years were projections. Macroeconomic Management 10. The objectives of the adjustment credit in macroeconomic management were to introduce fiscal discipline, curtail credit expansion, restore a floating exchange rate mechanism, and remove barriers to external trade. 11. (a) Fiscal Management The objective of the operation was to minimize the need for domestic financing by curtailing the public sector deficit. Although no expenditure target was set in IMF conditionality, domestic financing and monetary stock benchmarks were set in such a way that determined expenditure levels given a projected revenue base. Recent figures suggest that revenue targets surpassed expectations in 1997, making a shortfall in expenditure reduction bearable, and largely meeting the deficit target. Table 2 presents projected and actual current revenues, expenditures, and the current balance for 1997. The table also suggests that expenditures exceeded forecasts in 1998 as well, but revenues were stronger than expected, making the deficit target attainable. 4  Table 2: Fiscal Performance; Projections and Actuals, Before (MOP) and After the SAC (ICR) (percent of GDP) 1995 1996 1997 1998 1999 2000 2005 Cur. Revenue MOP 8.6 8.7 9.8 10.6 11.8 14.0 ICR 8.8 9.4 .11.8 10,.9 12.0 13.4 16.3 Cur.Expenditure MOP 11.2 10.4 9.1 9.3 9.4 .. 9.1 ICR 11.3 10.5 ... 0.1.9.. ....i0.2 9.8 9.7 11.7 Cur. Balance MOP -2.5 -1.7 0.7 1.3 2.4 .. 4.9 ICR -2.6 -1.1 0. .19: 0.6 2.2 3;.7 4.6 Note: For the MOP, 1996 was and estimate and 1997-2005 were projection years. At the time of production of the ICR, 1998 was an estimate and subsequent years were projections. 12. (b) Monetary Policies In tandem with fiscal consolidation, the program's key monetary policy objective was to lower inflation which had in large part resulted from extensive domestic lending. Measures taken between 1994 and 1995 (including increases in interest rates, increased reserve requirements and caps in Central Bank credit to the Treasury) contributed to a reduction in the inflation rate from 8.3 percent at end-December 1996 to 4.8 percent at end-December 1997. 13. (c) Exchange Rate Policy The principal action taken by Government was the adoption of a floating rate arrangement. Since May 1994, the exchange rate was determined by a daily interbank foreign exchange market. Floatation of the Malagasy Franc was a, condition for project preparation (MOP para. 34a). At the time of Board presentation, it was envisioned that the Government would continue to float the Malagasy franc, and improve competition by the introduction of exchange bureaus. Table 3 suggests that floatation of the FMG has resulted in greater competitiveness for Madagascar's exports. Table 3: Comparison of Exchange Rate and Terms of Trade Since the Floating of the Exchange Rate in 1994 1994 1995 1996 1997: i:t!:19981, 0 1999 FMG/JUSD eop1 3067 4266 4061 5091 5273 5452 ExportPrices2 (1994=100) 100 101 89 82 90 89 TOT3 (1994=100) 100 93 82 82 ;96 91 1999 is a projection year. 'Franc Malagash per U.S. Dollar, end of period; 2Merchandise export prices in U.S. Dollars; 3Terns of trade. 14. (d) External Trade The Government terminated practically all imrrport prohibitions and reduced the maximum import tariff from 50 percent to 30 percent (import -tariff reduction was a condition for project preparation, MOP para. 34d). The expectation, at time of project preparation, was that by 1998 a harmonized tariff with three rates would be in place, having a top rate of 20-25 percent, and an average tariff rate of 15 percent (from a rate of 18 percent at negotiation). To date only equipment, primary imports, and necessity consumption items have 5  adopted the rate structure of 5/15/25, while the weighted average tariff is expected to be above 15 percent. Incentives for Private Investment in Exports and Labor-Intensive Activities 15. Madagascar's interventionist policies and wavering reforms during the early part of the 1 990s had solidified a negative perception of government, which had to be countered with strong policy signals towards the private sector. Bureaucratic hassles, multiple permits, and competition against state-run enterprises constituted the typical environment in which the private sector. The reforms supported the Credit aimed at removing the public sector from productive activities, increasing transparency about private/public sector involvement, and establishing a framework for private sector activities. 16. (a) Divestiture of Public Enterprises Based on the work of the Independent Privatization Commission (CIP), a divestiture law was adopted in August 1996. Appointing an independent commission to draft the law was a condition for Preparation (MOP para. 34g). Following the law, a decree containing 45 public enterprises (excluding banks) was drafted; recently, in 1999, TELMA, the public telephone company (discussed below) was added to the list. It was expected that implementation of the adjustment agenda would continue after Board presentation and the privatization committee would fulfill its objectives. However, to date, only a hand-full of enterprises have been sold or liquidated, revealing the political difficulties that adjustment faces in Madagascar. 17. (b) Framework for Private Sector Incentives The Committee for Reflection on Competitiveness (joint public/private sector group) issued a study in August 1996. Constitution of the committee was a condition for project preparation (MOP para. 34f). The committee's recommendations were summarized into eight areas, which were translated into components of the operation: (i) abolishing exit visas for nationals and foreign residents (Board condition, MOP para. 35a; currently sustained), (ii) liberalize tourist visas (Board condition, MOP para. 35a; currently sustained), (iii) business visas made multiple-entry, valid for up to three years (no conditionality); (iv) work permits and residency rights for immediate family members of foreign technical and managerial staff issued only with valid employment contract (Board condition, MOP para. 35b; currently sustained), (v) liberalization of land tenure rules granting foreign investors access to land in 99-year leases and approvals given maximum two months after application (Board condition, MOP para. 35c; sustained), (vi) tax reforms to promote exports (no conditionality); (vii) effective lifting of legal monopolies in the power, petroleum, telecommunications, and air transport sectors (no conditionality on power; other sectors discussed below), (viii) opening-up of investment regime by removing the requirement for prior authorization to invest and by integrating fiscal investment incentives into the tax code (Board condition for removing prior authorization, MOP para. 35d; for tax incentives see below; sustained). 18. (c) Tax Incentives The government's 1996 budget reflected Bank and IMF recommendations to move fiscal incentives that were previously in the investment code into the general tax code. This was a Board condition (MOP para. 35d), and these reforms have been sustained. In addition, provisions were made to reduce taxation of imports designated for the 6  production of exports. Additional provisions were aimed at strengthening tax and customs administration (particularly setting up a service to monitor large tax payers) and reforming the VAT by extending it to cover all activities above a threshold while limiting a zero rating to exports and eliminating most exemptions. Measures were taken in 1997 and 1998; there are no policy reversals. 19. (d) Banking At the time of project preparation, Madagascar's financial system was rudimentary in terms of coverage and range of services provided. The operation supported the priority given by Government to the divestiture (defined as sale or liquidation in the MOP, para. 20) of two state banks (BTM and BFV) which dominated the banking sector (60 percent of total assets); the two banks had engaged in politically motivated lending and corntinuously disregarded credit ceilings and reserve requirements. That behavior had led to unprogrammed monetary expansion in 1994 and 1995. The adjustment program adopted a two step approach to the state- owned banks. First, independent administrators were appointed as a condition for project preparation (MOP para. 35c). Second, experienced negotiators were appointed to design and carry out the divestiture (sale or liquidation). The appointment of negotiators was a Board condition, and had the objective of selling or liquidating the banks. The Memorandum of the President indicated that sale or liquidation of the banks would be completed by the end of 1997 (by project closing), which was all re-stated in the Government's Letter of Development Policy (para. 6). Political infighting contributed to long delays in meeting this commitment. However, since mid-1998 the reform progress has advanced significantly. As a result, BFV was sold in December 1998 and a sales protocole for BTM was signed in April 1999. 20. (e) Petroleum Under the assistance of an IDA-financed petroleum project (CR 2538- MAG) the Government had (i) issued a decree in 1995 liberalizing the import, transformation, storage, transport, and distribution of petroleum, (ii) established a legal and regulatory framework to foster competition in the sector, and (iii) set up an entity for joint management by all oil companies for pipelines and all facilities for unloading and storage of oil. Conditionality for Board presentation (MOP para. 35i) consisted of (i) issuing legal instruments required to render effective the aforementioned decree [completed], and (ii) issuing the legal instruments required to render the aforementioned joint entity operational [completecd]. The program also included taking the necessary steps to allow at least one oil company to compete with SOLIMA. This proved to be an insufficient condition as the existence of SOLIMA has in effect deterred investors from entering the sector. The forthcoming adjustment operation requires that a controlling interest in SOLIMA be sold to private sector operators, with the State reducing its participation to no more than 30 percent. 21. (f) Telecommunications The poor quality of Madagascar's telecommunications sector had been a hindrance to the country's economic and social development. The government's policy objective was to improve access to services at lower prices, and the strategy was to introduce competition into a sector operated solely by TELMA, the state telephone company. The government took several steps in that direction, although none comprised SAC conditionality. They were: (i) amendment of the 1993 Telecoms Law lto abrogate monopoly conditions, (ii) strengthening of interconnection rules (a new decree, adopted in November 1998, ensures equal treatment of all companies in the sector in their connection to the fixed network operated by TELMA), (iii) creation of an independent regulatory body, (iv) placing a time lirnit 7  on utilized concessions utilized. On the operator front, the government awarded two cellular licenses (including for international calls) based on competitive bidding. This latter action fulfilled a condition for Board presentation (MOP para. 35g) which required that at least one company for cellular phone operation be selected based on international competitive bidding. The Board condition (MOP para. 35g) regarding telecoms also stipulated that ending the monopoly in telecoms was required; that condition is implicitly fulfilled with the selection of a cellular service provider. Currently 4 cellular licenses have been granted, all of them operational. Additional reforms are supported by the upcoming second structural adjustment operation. 22. (g) Vanilla At the time of SAC preparation, pursuant to government's intention to withdraw from productive activities, Government rejected a request from IVAMA, the vanilla trading parastatal, for additional capital (approximately US$ 4 million). The government also abolished the export tax on vanilla in 1997. Currently, IVAMA does not intervene in the sector, and is under liquidation. The vanilla sector has been performing well: export volume increased in 1998 by almost 5 percent over the previous year, despite 63 percent increase in price. There was no SAC conditionality for the vanilla sector or for IVAMA. 23. (h) Air Transport The government of Madagascar recognized the constraints imposed on the Malagasy people and on the country's tourism sector by Air Madagascar's exclusive air rights over the country. The SAC sought to alleviate those constraints by countering Air Madagascar's monopoly position in the air transport industry. Board conditionality (MOP para. 35h) required canceling Air Madagascar as the sole beneficiary of Malagasy air traffic rights (rights were then distributed by the Ministry of Transport on the basis of bids) and: (i) allowing regional airlines access to all Malagasy airports, (ii) allowing new airlines to operate on other international routes, and (iii) opening ground handling facilities to competition. Refocusing Public Expenditures 24. As part of the efforts to improve fiscal management, Madagascar sought to restructure expenditures towards foreign financed capital and towards the social sectors. At the time of SAC preparation, Madagascar was spending about 1 percent of GDP on health expenditures and about 1.6 and 1.8 percent of GDP on primary and secondary education. The public investment program consisted of 600 projects. Board conditionality (MOP para. 35k) required the government to revise the 1996 budget and to reallocate approximately 0.1 percent of GDP away from the munitions factory towards health and education; in addition, the number of projects in the PIP had to be reduced to 250. As a separate Board condition (MOP para. 351), an audit on the satisfactory implementation of the social safety net (0.1 percent increase in health and education sectors) was required. The condition was met. 25. Today, although some of the monitoring and procedural solutions discussed in the Memorandum of the President have been implemented, the efficiency and effectiveness of Madagascar's public expenditure and management system remain poor. This is because in an environment where accountability and transparency are absent, service delivery cannot be improved with the introduction of new regulations. It is therefore difficult to rate this component of the SAC as satisfactory. Evidence found in a recent public expenditure mission (October 8  1998) identified some institutional issues on social expenditures and on public management which have been incorporated into the forthcoming structural adjustment credit. C. Major Factors Affecting the Project 26. The complex political environment under which the project was prepared and executed has been discussed in section A. Lack of political continuity was no doubt a main factor affecting the project and its objectives. The heavy electoral calendars and the frequent changes in government contributed to a long preparation cycle for the project, and no doubt made the project objective of signaling an end to government intervention and policy flip-flops much more difficult to attain. Nevertheless, the political struggles of the 1990s 'in Madagascar were legitimate and within the realm of possibilities for a young democracy. 27. There were in addition other factors that led to difficult execution of reforms. These included the complexity of some of the underlying work (for instance, the elaboration of appropriate regulatory environments in many important sectors undergoing privatization). Finally, the institutional weakness of the Malagasy state remained a major stumbling block. Although an accompanying capacity-building project was processed in parallel, only modest improvements were registered during the relatively short life of the project, a common occurrence in this complex area of reform. D. Sustainability of Achievements 28. Between mid-1997 and early 1998, the first six months after the closing of the operation, commitment to reform wavered. There was little progress on privatization, the banking sector, public expenditures and SOLIMA. Serious questions were raised on the albility and willingness of the Government team to carry out the reforms discussed in the LDP, the PFP and other official documentation. On the other hand, as the political situation became more clear and the President's party gained a stronger hold on power, the latter half of 1998 and early 1999 have seen the program come back on track. BFV has now been privatized and a sales protocole for BTM has been signed, while sale of controlling interests in SOLIMA's petroleum and non- petroleum lots are in the process of being finalized. Public financial management is advancing more slowly than originally planned, but perhaps expectations were too high to start with. 29. Madagascar is also likely to sustain its stabilization gains, should investment continue to increase and employment continue to be generated, thus reducing poverty and building support for reforn. The projected trends in tourism seem to be strong, and the completed sales of the state banks are irreversible steps, which will hopefully deliver well-received signals to foreign investors. The economy grew at a rate of 3.9 percent in 1998 while the inflation rate was 6.2 percent, suggesting that the economy attained its original targets. Projected trends for GDP growth are that it could reach 4.5 percent in 1999 and 5.3 percent in 2000. 30. Despite the reasonable success to date, Madagascar's adjustment gains need to be consolidated. First, fiscal imbalances are still too high and progress needs to be made on expanding the tax base and on revenue containment. Second, privatization should advance and competitive regulatory frameworks need to be put in place. Third, the business environment 9  needs improvement. Finally, public finances need to be addressed as Madagascar needs to improve its performance in the social sectors to help alleviate social tensions. E. Bank Performance Identification and Preparation 31. The Bank's performance during identification and preparation of the operation was satisfactory. The Bank used the potential credit as an opportunity to advance the reform agenda in Madagascar and to engage reformist politicians and technocrats during a period that was politically charged. In the design of the operation, the Bank took into consideration the borrower's past poor commitments to reforms (policy reversals in the early 1990s and more recent ones in 1995-96) and required that substantial actions be completed up front, prior to disbursement. However, Madagascar's broad reform agenda, especially in the banking sector, also contained components that required a longer timeframe to complete. Consequently, to support Madagascar for the substantial actions taken, and to assist the ongoing reform agenda, the operation was designed as a one-tranche operation, to be disbursed early-on in the life of the credit, with additional support for the remaining reform areas assisted by components of other Bank projects. Consequently, further to the up front actions, the Bank also based its decision to lend to Madagascar on the Letter of Development Policy (LDP) attesting to Government's commitment to pursue a broad sweeping reform agenda. The LDP was taken at face value, as an irrevocable declaration of commitment to reforn that would be further strengthened by the need for a subsequent operation that would serve as a disciplining factor. Supervision and Technical Assistance 32. The Bank's approach of supporting government for completed actions was reasonable, given the array of reforms already undertaken. However, in hindsight, the one-tranche design lacked the incentive afforded by forthcoming tranche releases and weakened the Bank's financial leverage in support of the broader reform agenda. Perhaps the Bank's reliance on the country's need for additional financial support was less binding than anticipated. Madagascar waited an extra year before completing the SAC reform agenda and seeking a second adjustment operation. In this regard, the government gave political requirements priority over adjustment reforms in late 1997 and early 1998, choosing in the process to deplete foreign reserves (from about 3 months of imports in 1997 to about 1.5 months in 1998). But the reform agenda has picked up in mid 1998 after a new constitution was adopted and parliamentary election completed. The aforementioned delays necessitated a substantial dialogue effort to ensure the course of adjustment was put back on track. Technical assistance was continuously provided by the Public Management Capacity Building project and the Private Sector Development Technical Assistance Credit. F. Borrower Performance 33. The borrower's heavy electoral calendar led to implementation delays immediately following the single-tranche disbursement. Government's pursuit of political objectives, and the poor commitment shown to economic reforms during that time period, undermined the potential 10  benefits of the adjustment operation. In terms of the three components of the operation, the borrower's performance could be rated (i) satisfactory on macroeconomic performance; (ii) barely satisfactory on incentives for the private sector (because implementation of reforms stalled after the tranche release); and (iii) unsatisfactory in refocusing public expenditures (despite the fulfillment of conditionality, the reforms were pursued without commitment to the end result). 34. No procurement or disbursement procedures were violated. No audit was required. G. Assessment of Outcomes 35. Although the MOP does not set forth a detailed set of expected outcomes, the operation's overall outcome was satisfactory in the short term, given that 1997 and 1998 were the first two years of positive per capita income growth for Madagascar in the 1990s. This result is attributable to several successful outputs: (i) the stabilization of the economy, (ii) the initial positive signals from designing a program of state divestiture, although the impact was mitigated by the fact that implementation delays emerged, and (iii) increased competition in telecommunications and air transport resulting from regulatory actions. Anticipated outcomes in the medium and longer term include better education and better health for the Malagasy, stemming partially from greater predictability and continuity in the financing of social programs, and from increased demand for better human capital stemming from a growing economy. Those benefits, however, are dependent on government staying the adjustment course. The satisfactory overall rating benefits from the fact that the reform program is now moving forward. 36. Macroeconomic Performance. The adjustment program met the macroeconomic performance objectives set by the credit, which were primarily aimed at stabilizing the economy. This is evidenced by the sustained reduction in inflation and improvements in the public sector and external balances. 37. Incentives for Private Investment in Exports and Labor-Intensive Activities The critical steps taken by Government to signal curtailment of the state's direct invoivement in productive economic activities seem to begin to pay off as foreign direct investment (FDI) almost doubled from about USD 10 million in 1996 to USD 17 million in 1998. Although the level of FDI is still low given the Malagasy economy's size and high potential, the consistent increase in FDI over 1996-98 is considered a significant breakthrough. The increase in FDI is also attributed to one of the SAC's conditions abolishing prior approval for equity capital contributions by foreign investors. The service sectors were the main short-term benefactors of the adjustment program: tourism showed sizable gains (arrivals increased by 23 percent in 1997 and 18 percent in 1998), in part owing to the liberalization of air access to Madagascar (in addition to the regional airlines now servicing the country, the new international airline is a charter, putting further pressure on ticket prices) and to the easing of visa requirements; the telecommunications sector saw four cellular operators by 1998, compared to the single one stipulated by conditionality. Unfortunately, employment statistics are not available. On the more timid side, private investment has edged up only one percentage point since 1996, to 5.9 percent of GDP in 1998. These statistics suggests that Madagascar is fertile ground for adjustment reform, yet more needs to be done to consolidate those gains and to further motivate entrepreneurial activity. Although Madagascar did fulfill conditionality by the time this ICR was 11  written, the project's outcomes could have been better if government's commitment were stronger; wavering in the implementation of reforms, an all too frequent event in Madagascar, diminishes the impact of change signals. 38. Refocusing Public Expenditures. Madagascar continues to face the challenge of ameliorating its public management as the government remains the main conduit for the provision of social services. The 1997 and 1998 public expenditures reviews, and performance indicators themselves, suggest that improvement will only arrive with deep-seeded institutional reforms. H. Future Operations 39. Despite the advances accomplished in non-reformn areas, Madagascar is expected to require additional external assistance to consolidate progress already achieved. Additional work is required in four areas: (i) consolidating gains from macroeconomic stabilization by further reducing fiscal imbalances; (ii) improving the business environment; (iii) completing the state's disengagement from productive activities, and (iv) tackling anew public finance issues, without unduly raising expectations. A multi-tranche adjustment credit addressing these problem areas is scheduled to be reviewed by the Board in mid-May. I. Key Lessons Learned 40. There is ample cross-country evidence now available showing that lack of client ownership of reforms will undoubtedly lead to their reversal. Adjustment money cannot buy commitment, if political will is lacking. This being said, in real life it may be very hard to gauge the extent of commitment to reform, and, equally important, the political leadership in any country may be divided on the path to pursue. This is the rationale for continuing to engage in policy dialogue even at times when commitment may be questionable. In this optic, one can say that in retrospect the SAC did indeed prove to be an invaluable vehicle for advancing the development dialogue in Madagascar during times of political turmoil and economic reform backtracking. Through the preparation stage of the operation, the Bank used the potential credit as a means to engage the pro-reform elements in Madagascar and tailored its pitch to the political leadership when receptive or to analytical work when dialogue was slow. 41. There is however a question of project design that merits reflection. As discussed above, the SAC should be viewed as a combination of the specific measures that were taken prior to Board presentation, and the commitments under the Letter of Development Policy to continue to execute the reforms. In some areas, as this document discusses, the lack of financial leverage after disbursement of the single tranche resulted in less commitment and capacity to focus on objectives on the part of the government. And the fact that several items of the agreed conditionality were of procedural nature, led to the result that the letter, but not the spirit of the program were met in a number of cases. These considerations reinforce the shift in Bank adjustment operations towards the use of floating tranches, particularly in cases where the reforrn program is multi-faceted, and therefore subject to a differentiated pace of implementation. In addition, conditionality should be specified in ways in which results, rather than process, are clearly identified and rewarded. 12  42. Finally, the operation reinforces the by-now-accepted view that weak institutional capacity needs to be fully factored into program design. Additionally, institutional strengthening cannot b.e viewed simply as the provision of technocratic technical assistance: a thorough understanding of the factors underlying the incentives and commitments of civil servants and politicians alike is a precondition for putting together realistic programs. 13  . .. . ................ ... ...... . . . -  PART II: PROJECT IPLEMENTATION FROM THE BORROWER PERSPECTIVE THE REPUBLIC OF MADAGASCAR PROJECT IMPLEMIENTATION: FIRST STRUCTURAL ADJUSTMENT CREDIT Borrower Perspective 1. Although Madagascar was able to recover its political stability after the 1991 disturbances, which were followed by a two-year transition period, its economic situation, in retrospect, was in such a state that support from the international community was deemed essential for meeting the country's need to finance its development projects, honor its external debt obligations (which had accumulated since payments were suspended during the transition period), and ensure that at least the minimum daily needs of the Malagasy people were met. From 1993 to 1996, successive governments strove for a speedy re-establishment of the country's relationship with the Bretton Woods institutions, so that Madagascar could regain its credibility with donors; however, despite a number of courageous measures, the most important being flotation of the Malagasy Franc, suitable conditions for concluding a credit agreement did not arise until 1996, with negotiations on SAC-I taking place in September 1996, followed by discussions with other partners, including the IMF and the members of the Paris Club. 2. Despite a change of government between the negotiation of SAC-I in September 1996 and approval by the World Bank's Board in March 1997, the new government team already give its backing to the program even before it came into power, although it did have its own views on how the measures adopted by the previous leaders should be implemented. Given that the political calendar for 1997 and 1998 made it very difficult to comply with a schedule of activities that was in itself quite crowded, it proved impossible to complete the agreed program and enter into new commitments under a second structural adjustment credit until early 1999. 3. Regarding the impact of SAC-I on the Malagasy economy, particularly at macroeconomic level, the Government's objectives with respect to inflation, the rate of economic growth, and the major external balances, were achieved and even exceeded. Despite some problems with the collection of fiscal revenue, the Government succeeded throughout the period in maintaining the public sector deficit at the target level. Certain measures, particularly monetary ones, were at times excessively restrictive, adversely affecting support for the private sector; nonetheless, they did make it possible to speed up the stabilization process, which is a prerequisite for any form of economic development. Thus, at the beginning of the process the Central Bank established very high prime rates, reaching 33% as of end-1995, before gradually lowering them, in parallel with the decline in inflation. 4. As regards the divestiture and rehabilitation of the banking sector, it was expensive for the Government to hire expatriate managers for the two banks in 1995, the year when it had to 15  obtain the APEX credit to replace funding from the Japanese grant; nevertheless, this made it possible to gradually improve the banks' position, increasing their value in preparation for privatization. The privatization process, carried out by international and domestic negotiators, took a long time particularly for BTM, but was finalized ahead of the presentation of the second structural adjustment operation to the Bank's Board. 5. Regarding the privatization of the public enterprises (PE), in May 1997, the Government produced a list of 45 public enterprises slated for privatization. Subsequently, TELMA was added to the list. The 46 enterprises were originally scheduled to be privatized in 1998, but the program was delayed because of the heavy political calendar in 1997 and 1998, and because of the complexity of the process itself. In fact, the time allowed was too short to organize a vast public information campaign, prepare terns of reference for 46 specialized entities, issue the necessary bidding invitations, and complete the sales of the enterprises. Moreover, in the case of the large enterprises, it was not anticipated that, neither in Law 96-011 nor at the date of issuance of the Decree 97-584 (which listed the enterprises to be privatized), to separate the privatization strategy (technical instrument) and the sale of the PE (by an investment bank). The process was delayed even more because it was not always possible to obtain World Bank approvals in a timely manner, since these had to be applied for through a technical assistant who was outside Madagascar most of the time. All these factors explain why this component suffered more delays than any other with respect to the schedule set at appraisal SAC-I; nevertheless, this overrun was also caused by a concern to make the process as transparent and beneficial as possible. 6. Of the other structural reforms, the one that produced the most impact was simplification of procedures for obtaining tourist visas. However, although in three years this measure has resulted in doubling the number of tourists, it has also had the perverse effect of allowing an influx of illegal immigrants and making it difficult to track international criminals. Indeed, computerization of frontier posts was one of the support measures that should have been introduced when the system was established, but this was not done, despite the promises made by the donors (the World Bank and the European Union) and the reminders sent by the Office of the Secretary of State for Public Safety. Nevertheless, the Government does not intend to revoke this measure, which has clearly had a positive impact, but stricter procedures for checking on aliens have now been introduced, and these will remain in place until the donors' promises are fulfilled. 7. Other measures, such as those relating to long-term leases (for 99 years) and long-stay visas and work permits, are still difficult to evaluate, since so far few have been applied for or issued. Consequently, the Government has called upon an agency to conduct a survey among potential applicants, so that the real impact of these measures can be assessed and any necessary additional steps can be taken to attract more foreign direct investors. However, the findings of these surveys may be skewed because of reluctance to participate on the part of certain communities. 8. The above is our rapid and by no means exhaustive evaluation of the implementation of the measures supported by the first structural adjustment credit from the World Bank. These comments were more or less implicitly taken into account during the preparation of the second 16  credit which will shortly be submitted to the Board of the World Bank, and are particularly relevant to the feasibility of the various components, in light of existing circumstances and the capacities of the various agencies responsible for implementation. The Government wishes to reassert its intention of moving forward with plans to create a socioeconomic environment in Madagascar that will be favorable to the development of the private sector, with the purpose of accelerating economic growth and to reduce, or even eliminating, poverty in the country. 17  i  PART III: STATISTICAL TABLES Table 1: Summary of Assessments A. Achievement of Objectives Substantial Partial Negligible Not applicable Macro Policies lX3 E 0