Madagascar - Second Structural Adjustment Credit Project

Document of The World Bank FOR OFIFICIAL USE ONLY Report No. P-7294-MG REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED SECOND STRUCTURAL ADJUSTMENT CREDIT OF SDR 73.5 MILLION TO THE REPUBLIC OF MADAGASCAR April 19, 1999 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY AND EQUIVALENT UNITS Currency Unit Malagasy Franc (FMG) 1991 1992 1993 1994 1995 1996 1997 1998 FMGIUS$ 1835 1864 1914 3067 4266 4061 5091 5273 (average) WEIGHTS AND MEASURES Metric System ACRONYMS AND ABBREVIATIONS BFV Commercial Bank (Banky FIAS Foreign Investment Advisory Fampandrosoana ny Varotra) Services BTM Rural Development Bank FMG Malagasy Franc (Bankin'ny tantsana Mpamokatra) GDP Gross Domestic Product CAS Country Assistance Strategy ICR Implementation Completion CEM Country Economic Report Memorandum IDA International Development CNaPS Caisse Nationale d'Assurance et de Association Prevoyance Sociale IMF International Monetary Fund CPR Caisse de Prevoyance et de IVAMA Institut de la Vanille de Madagascar Retraite OMNIS Office Militaire National des CRCM Caisse des Retraites Civiles et Industries Strategiques Militaires PAIGEP Public Sector Management and EPZ Export Processing Zone Capacity Building Project ESAF Enhanced Structural Adjustment PATESP Private Sector Development and Facility Capacity Building Project EU European Union PER Public Expenditure Review FDHA Fonds de Developpement SAC Structural Adjustment Credit Halieutique et Aquicole SDR Special Drawing Rights FDI Foreign Direct Investment US$ United States Dollar FF French Franc VAT Value Added Tax FISCAL YEAR January 1 - December 31 Vice President: Callisto Madavo Country Director: Michael Sarris Sector Manager: Luca Barbone Task Team Leader: Juan Zalduendo  FOR OFFICLIL USE ONLY REPUBLIC OF MADAGASCAR SECOND STRUCTURAL ADJUSTMENT CREDIT Contents CREDIT AND PROGRAM SUMMARY ...........................................................i 1. BACKGROUND TO THE ADJUSTMENT OPERATION ........................................................ 1 A. Country Context ...........................................................1 B. Recent Economic and Political Developments ...........................................................2 C. Medium-Term Prospects and Financing Requirements ....................................................... 3 2. MADAGASCAR'S ECONOMIC REFORM PROGRAM ..........................................................4 A. Economic and Social Development Strategy ................................... ........................4 B. The Reform Program Supported by SAC-2 ................................ ........................... 7 C. Links to the Country Assistance Strategy ............................. ............................. 16 3. THE PROPOSED SECOND STRUCTURAL ADJUSTMENT CREDIT ................................. 18 A. Credit Rationale, Lessons from Previous Operations, and Credit Amount ............ ............ 18 B . Operation Design, and Timing and Triggers for Tranche Release .................. ................... 19 C. Disbursement Procedures, Implementation and Supervision ............................ ................. 21 D. Benefits and Risks .......................................................... 21 E. Policy, Intermediate, and Impact Indicators ....................................... ................... 23 F. Strategic Considerations .......................................................... 24 4. OTHER BANK GROUP ACTIVITIES .......................................................... 24 5. COLLABORATION WITH THE IMF AND OTHER DONORS ............................. ................ 24 6. RECOMMENDATION .......................................................... 25 ANNEX 1: MEASURES SUPPORTED BY SAC-2 ........................................ .................. 27 ANNEX 2: GOVERNMENT'S LETT7ER OF DEVELOPMENT POLICY ................ .................. 29 ANNEX 3: MONITORING SOCIAL SECTORS IN SAC-2 ........................................................ 39 ANNEX 4: POLICY, INTERMEDIATE, AND IMPACT INDICATORS .................. .................. 41 ANNEX 5: SUPPLEMENTAL CREDIT DATA SHEET .......................................................... 43 ATTACHMENTS ........................................................... 45 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.  REPUBLIC OF MADAGASCAR SECOND STRUCTURAL ADJUSTMENT CREDIT CREDIT AND PROGRAM SUMMARY Borrower: Republic of Madagascar Amount: IDA Credit SDR73.5 million, US$100 million equivalent Terms: Standard IDA terms (40 years maturity with 10 years' grace period) Program Description: Madagascar can achieve, over the next few years, much higher economic growth. A doubling of growth rates is needed to reduce widespread poverty (75 percent of Malagasy are poor). An improved climate for private sector development, underscored by better governance, is key: development has been stifled by a strong government presence, widespread rent-seeking behavior in the public sector, and the absence of clear rules for private business. The Government's reform program, supported by the proposed structural adjustment credit (SAC), aims at improving governance and brighten prospects for private sector growth through: (i) streamlining and reform of institutions and rules governing private sector activity; (ii) reduction of State involvement in key economic sectors; and (iii) provision of more and better- quality social services and public goods. The proposed SAC-2 supports the next phase of Madagascar's adjustment program, following SAC-1 approved and disbursed in March 1997. The program rests on four pillars for high growth. First, macroeconomic stabilization is being consolidated, as fiscal imbalances, though lower, are still too large. Second, privatization of public enterprises is at the core of the Government's reforms, thus signaling the State's willingness to disengage from key sectors and make room for private sector activity. Chief among them are the privatization of state institutions and companies in the banking, petroleum refining and distribution, air transport and telecommunications sectors, together with the introduction of competitive regulatory frameworks to ensure efficient operation of these sectors. The privatization process is supported by a fair and equitable program of severance payments. Third, an improved business environment is being put in place to boost private sector investment and job creation, emphasizing less discretion in administrative procedures and elimination of bottlenecks to private sector growth. Reforms are targeting promising sectors such as mining, tourism and fishing. Transparency in licensing for the exploitation of natural resources is in particular a priority. Finally, the program emphasizes strengthening of public finances. To increase revenues and eliminate opportunities for abuse, the tax base is being expanded and ad-hoc tax and tariff exemptions are being eliminated, - 1 -  while ensuring that revenues allocated to social sectors are in fact effectively used for the benefit of the poor, especially in primary education and basic health. Attention is also given to increasing non-tax revenues through reforms in the allocation of fishing licenses. Benefits: The proposed two-year credit aims at creating the necessary conditions for increased growth, which will drive poverty reduction. Under its reform program, the State will: visibly disengage from key sectors; unblock private sector activity; and do fewer things better. The key expected outcomes are higher private investment, foreign direct investment in particular, and job creation. The direct impact of policy reforms on stabilization, structural change and improved public service delivery will be felt in many areas, including lower airfares, more efficient and accessible telecommunication services, higher customs collections, and increased budget allocations (and actual spending) for primary education and basic health. The emphasis of the operation on introducing mechanisms for increased accountability and on developing regulatory frameworks that promote competition in key economic sectors is expected to help these benefits materialize. The reforms envisaged are at the heart of the Country Assistance Strategy (discussed by the Board on February 18, 1997), and their full and effective implementation would help the country move to a high-case lending scenario. SAC-2's focus on privatization of key, high-profile sectors and actions to improve governance and transparency is expected not only to help transform the economy but also to maximize the impact of change signals on investor confidence. Further, the Government is now embarked on possibly the most challenging phase of the adjustment agenda, in terms of political courage; selective targeting of high-payoff reforms is expected to bring rewards in setting important precedents and easing the path of future adjustment. Payoff is seen to be high both in terms of the choice of sectors to be privatized (with service sector enterprises reducing the cost of doing business), and the reforms' strong links to governance (measures to remove discretion and promote automaticity and transparency in decisions affecting private sector activity, thus reducing opportunities for corruption). Finally, the proposed reforms - far-reaching for Madagascar but already accomplished by Africa's high performers - will prevent the country from falling behind in the competition for investor capital, particularly FDI, as it enters the new millennium. Risks: The nature of risk - wavering government commitment causing interruption or reversal of reforms - is the same as in the CAS, but prospects for significant steps forward seem brighter. Political will for reforms has in the past been weakened by the presence of a small but economically and politically powerful elite which exploits the general Malagasy fear of foreigners, ostensibly as a threat to local culture but in reality for fear of losing its privileged position. The country's elected leaders have therefore been reluctant to publicly embrace a foreign investment-led growth strategy and stake their political future on reforms to deregulate and open up the economy. This reluctance is reinforced by the rent-seeking opportunities for political leaders themselves and for civil servants in a State-dominated and over- - 11 -  regulated economy. As a result, at times the momentum and energy for reform seems to be largely driven by a desire to comply with Bretton Woods 'conditionality' rather than true 'ownership'. The risks of continued support have proven worth taking in the past, however. This report documents a story of significant policy advances over the years; experience in Madagascar has been that reform moves ahead incrementally, with periods of foot- dragging under sustained external pressure leading eventually to irreversible action, making each subsequent step that much easier. Furthermore, at present, there is a growing convergence of factors which could shift the balance in favor of sustained reform. Political stability is now more likely than at any time since the transition to democracy in the early nineties, as national-level elections - which slowed follow- through of earlier reforms - are not foreseen for the next three years; with the leadership more secure, reform prospects should improve. At the same time, there is a growing realization within civil society that better governance and an open economy are key to Madagascar's development, with especially the press and young entrepreneurs being at the forefront of pressure for change. Such awareness, moreover, is also making the potential losers less adverse to change: the ultimately well-received privatization of banks - longstanding bastions of corruption, privilege and financial favors - and early evidence that even modest growth can provide opportunities for many more Malagasy (e.g., export processing zone and tourism jobs) without lowering the incomes of the current elite, have shown that opening up can be a 'win-win' situation. Apart from improved prospects for sustained reform, several design features of the proposed operation should help reduce risks: (i) a flexible design, with "menu- based" policy reform measures in the second and third tranches (to accommodate political timing considerations), and government leeway in defining certain reforms (to promote ownership, while also ensuring participation from other stakeholders); (ii) substantial up-front actions demonstrating commitment to reform and safeguards against backtracking, including a tranche structure aimed at providing increased financial support only as the policy environment improves; (iii) a program of severance payments and retraining and mechanisms to facilitate local ownership opportunities, to make privatization socially sustainable; (iv) a focus on few, high- payoff reform areas to maximize the impact of change and increased openness; and (v) existence of adequate technical assistance support. SAR: None required Schedule of Disburse- ments: The credit would be disbursed in three tranches: US$25 million at effectiveness and in two "menu-based" tranches of US$30 million and US$43.8 million, and includes the re-financing of two PPFs totaling US$ 1.2 million. - iii -  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED SECOND STRUCTURAL ADJUSTMENT CREDIT TO THE REPUBLIC OF MADAGASCAR 1. I submit for your approval the following report and recommendation on a proposed Second Structural Adjustment Credit (SAC-2) to the Republic of Madagascar for an amount of SDR 73.5 million, the equivalent of US$100 million. The credit would be on standard IDA terms with 40 years maturity and a 1 0-year grace period. 2. The proposed credit supports reforms in the business environment, privatization of key state enterprises, and greater efficiency in public finance, and is central to the Bank's Country Assistance Strategy (CAS) discussed by the Board on February 18, 1997. It is an integral part of the Government's reform program, articulated in the Letter of Development Policy attached to this report (Annex 2) and in the Policy Framework Paper being finalized, which is also supported by the LMF through an Enhanced Structural Adjustment Facility (ESAF) approved in November 1996. The ESAF's second-year arrangement is expected to be reviewed by the IMF Board in July 1999. Support for the reform program is also provided by Paris Club creditors, the European Union (EU), the African Development Bank, and several bilateral donors. 1. BACKGROUND TO THE ADJUSTMENT OPERATION A. Country Context 3. With a population of about 14.6 million, Madagascar has over three decades seen a marked decline in living standards. Once a flourishing society, the country now ranks with the world's poorest. Education, nutrition and life expectancy indicators have deteriorated, with public spending on health and education falling in real terms and favoring the non-poor; lack of physical access to social services, financial services and agricultural markets has crippled development; and slash-and-bum agriculture has led to severe deforestation and loss of topsoil. At the same time, population growth has remained high, near 3 percent. The result: poverty has become entrenched in Madagascar's social fabric; three-fourths of all Malagasy are poor, and GDP per capita in 1998 prices, at $266, is three-fifths its level of about 30 years ago. 4. Yet, Madagascar's natural resource endowment is formidable, and economic potential is clearly present. The country enjoys rich mineral deposits; fertile land with abundant rain; an environment with a unique eco-system, varied topography, and several climatic zones that is attractive to different types of tourists; and a coastal perimeter of about 3,000 miles which provides access to rich maritime resources. The recent Country Economic Memorandum (Madagascar: An Agenda for Growth and Poverty Reduction, October 1998), traces poor -1I-  performance back to policies of economic nationalism and self-sufficiency, and to State intervention in key productive sectors. Such policies included: price controls to complement public enterprise monopolies; an overvalued exchange rate defended by restrictions on external trade and excessive foreign borrowing; large budget deficits; and a tax system dependent on external trade taxes. They resulted in an overall environment marked by discretionary decision- making and the resulting rent-seeking behavior in the public sector, poor public investment choices, and cronyism. B. Recent Economic and Political Developments 5. Growth in 1990-98 averaged 1.4 percent. The decade has been marked by halting but sustained progress towards a more pragmatic economic policy stance. Madagascar's macroeconomic framework is now substantially improved. Inflation is in single-digits; there has been progress in fiscal management; private investment is slowly expanding; and, for the second year in a row, GDP growth surpassed the population growth rate. These developments are discussed below. 6. Beginning in the late 1980s, export processing zones (EPZ) were set up to attract investment and generate employment opportunities. The exchange rate was adjusted to more realistic levels and the privatization of state companies was initiated. Foreign direct investment (FDI) responded, rising from virtually zero to US$22 million in 1990 (0.7 percent of GDP). Non- traditional exports expanded their share in total exports between 1986 and 1990 from 31 to 63 percent, as three years of reform began to take hold. 7. Recovery was interrupted by serious political instability between 1991 and 1993, a period characterized by increased demands for political liberalization. The ensuing transition to, and the first steps of, a young democracy were lengthy and conflictive; many reforms initiated in the late 1980s were either halted or reversed. Although the exchange rate was allowed to float freely beginning in 1994, unsustainable fiscal policies undermined this reform. Weak and accommodating monetary management led to mounting inflation, and price subsidies were re- introduced in some key agricultural products. FDI dried up and tourist arrivals, which had been rising since favorable policies were put in place in the late 1980s, receded to earlier low levels. 8. With a return to pragmatic economic policies over the last three years, economic developments have turned positive. On the macroeconomic stabilization front, inflation has declined, to 6.2 percent in late 1998 from a peak of 49 percent in 1995, reflecting decisive policy measures which halted erratic monetary expansion. Fiscal management has improved, with the fiscal deficit (excluding grants) at 7.5 percent of GDP in 1998 compared to 11.4 percent in 1994. Total revenues, again excluding grants, have increased from a historical low of 8.3 percent of GDP in 1994 to 10.6 percent in 1998. The external current account deficit (excluding current grants) has also improved: 7.7 percent of GDP in 1998 compared to 10.9 percent in 1994. Meanwhile, changes in tax structure and a flexible exchange rate policy have enabled further increases in the non-traditional exports' share in total exports, from 63 percent in 1990 to over 86 percent in 1998. Simplified visa procedures and opening up of air transport to charter flights have led to an increase in tourist arrivals and foreign exchange revenues in tourism by about 100 - 2 -  percent and 137 percent, respectively, since 1995. With investment also on the rise, economic growth was 3.6 percent in 1997 and 3.9 percent in 1998. 9. Madagascar politics remain complex, marked by latent ethnic divisions and strong regional interests that complicate the pursuit of reform-oriented policies. President Ratsiraka, who held office from the mid-1970s until the early 1990s, was re-elected in early 1997. A revised Constitution (March 1998) assigns greater powers to the Presidency, and recent National Assembly elections (May 1998) provided a comfortable majority to the President's party. A new government was constituted in August 1998, and a less crowded political calendar - in contrast to the past year - is helping the implementation of reforms. Decentralization - constitutionally mandated in 1996 and slowly evolving since - could bring needed additional change. As power and resources are devolved to newly established local governments, greater participation of communities in their own development could help reduce wide regional disparities and foster greater national harmony. The process, however, has many administrative, fiscal, and institutional implications that need to be carefully dealt with to avoid pitfalls and negative experiences of other countries, as ill-conceived decentralization processes could also be a major source of macroeconomic instability. 10. Since the late 1980s the ups and downs of economic reform have been mirrored by ups and downs on the political front. Political instabilities have negatively affected economic performance. The converse, perhaps more importantly, is also true: when political will and support for reform have been present, the economy has responded rapidly, if only modestly. Indisputably, per capita growth in Madagascar's post-independence history has been highest during periods of reform and political stability. The challenge for the country is to avoid political infighting and consolidate reforms, to enhance prospects for adopting a high-growth, poverty- reducing development path. C. Medium-Term Prospects and Financing Requirements 11. Under the reform scenario outlined in this report, Madagascar's economic growth rates could by the middle of next decade reach as much as 7 percent per year and lead to an increase in GDP per capita of about 23 percent relative to 1998 (Table 1). This would help reduce poverty from 75 to 69 percent by 2005, and more rapidly thereafter. Growth would in part come from capitalizing on unexploited potential. Tourism could more than double during the next ten years, and the mining sector could, under favorable circumstances, develop vigorously. In the short-run, implementation of an ambitious reform agenda would help foster investor confidence and contribute to growth through gains in efficiency. It would also enable the EPZ to continue playing a major role in the country's export performance. In the medium-term, mobilizing savings to finance an expansion in essential public services and private investment will be required. These outcomes would depend crucially on opening up to FDI, broadening the tax base and improving tax administration. 12. The residual financing gap (before adjustment support) for 1999-2001 totals US$345 million, of which the proposed SAC-2 (US$100 million) and the accompanying ESAFs (US$75 million) will cover 50 percent of the financing needs. The bulk of the remainder is largely - 3 -  covered by identified funding from the EU, which has committed about US$55 million in balance of payments support for 1999-2000, the African Development Bank and the main bilateral donors active in Madagascar. This gap includes the need to increase foreign reserves, from 8 weeks of imports of goods and non-factor services at end-1998 to 14 weeks by end- 1999, and the need to invest in human and physical capital. The current account (without current grants) will improve from a deficit of about 7.7 percent of GDP in 1998 to 6.6 percent in 2001. Debt indicators will improve, with the debt service to exports ratio (excluding arrears in 1998) declining from 28 in 1998 to 20 percent by 2001. With progress in the agenda supported by the proposed SAC, Madagascar's debt burden would have to be evaluated in terms of eligibility for the HIPC initiative. A decision is scheduled for 2001. Table 1: Madagascar, Medium-Term Macroeconomic Framework in a Reform Scenario J,2 199 - 1,99 -l-000-- 2001 l-- 200i5' GDP Growth (in percent) 3.9 4.5 5.3 5.6 T 7.2 GDP per Capita in 1998 US$ 266 270 276 283 327 Head Count Index (% of pop. below poverty line) 75 74 74 72 69 ......................... ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ..... .................. ................. Fiscal Deficit (before grants) 7.5 5.8 4.6 4.5 5.4 Fiscal Deficit (after grants) 4.1 2.4 1.4 1.3 2.3 Total Govemment Revenues (before grants) 10.6 11.8 13.0 13.7 16.0 Total Government Expenditures 18.1 17.7 17.7 18.3 21.4 Gross Domestic Investment 13.3 14.4 16.2 16.5 17.9 Total Debt Outstanding 105 111 105 100 77 Current Account Deficit (before current grants) 7.7 7.3 6.8 6.6 6.4 Current Account Deficit (after all grants) 4.3 3.6 3.4 3.3 3.3 FDI (includes privatization receipts) 0.4 4.0 1.6 1.7 2.2 ~~~~~~~. .. .. -..... .. . . , . . .S i: _1 II I .. 1 1 - - :..................... ................ .......l.....fU S$ ___ _ ;__mll_o_ -_}l} Exports of Goods and Non-Factor Services 821 906 979 1073 1373 Imports of Goods and Non-Factor Services 1129 1210 1272 1367 1725 FDI (includes privaization receipts) 17 165 71 82 141 2. MADAGASCAR'S ECONOMIC REFORM PROGRAM A. Economic and Social Development Strategy 13. While recent economic growth is encouraging, there is broad agreement that Madagascar must adopt policies leading to an even higher growth path. Given widespread poverty, strategies that only target the poor would, on their own, have little impact in reducing poverty. Closing the gap between economic performance and potential is, therefore, critical. 14. To bridge this gap, an improved climate for private investment, underscored by better governance, is essential: economic development has been stifled by a strong government presence, widespread rent-seeking behavior in the public sector, and the absence of clear rules - 4-  for investors. The Government's economic reform program, supported by the proposed SAC, implements a series of measures that should significantly improve governance through: (i) streamlining and reform of institutions and rules governing private sector activity; (ii) substantial reduction of State involvement in key economic sectors; and (iii) provision of more and better- quality social services and public goods. Opening up the economy to foreign investment is also a key aspect of the program. Moreover, the impact of opening, once it occurs, will likely be magnified in the case of Madagascar, given the longstanding policy of economic isolationism which deprived the country of FDI and its associated benefits (managerial skills, technologies and trade link synergies). 15. Madagascar has made progress on all reform fronts, notwithstanding some implementation delays and policy reversals. Cross-country experience shows that macroeconomic stabilization is the first step towards economic growth and private sector development. As noted earlier, the country's macroeconomic framework has shown substantial improvement. Key to stabilization was the role of a series of JMF programs with strong adjustment support from IDA and other donors. On the negative side, stabilization initially resulted in some expenditure compression, often at the expense of basic, critical needs in the social sectors. Revenue generation has more recently registered a marked improvement, however, with stabilization thereby becoming increasingly based on tax revenues (still, at 10.1 percent of GDP, tax revenues are well below the average for Sub-Saharan Africa of about 15 percent of GDP, and further improving revenue performance is one of Madagascar's most pressing challenges). 16. In the structural arena progress has also been marked. In the area of price and market liberalization, Madagascar now compares favorably with other reforming countries in Africa. Distortions affecting key agricultural commodities have been eliminated; for example, export taxes on all agricultural commodities have been eliminated, and the vanilla trading parastatal IVAMA no longer intervenes in the sector and is under liquidation. In 1995, reforms introduced in the banking sector served to control inflation; particularly the naming of special administrators in the two remaining state banks which led to more rigorous credit policies. The tax structure is more efficient, with the total elimination of export taxes and increased reliance on a VAT tax. Tourist visa procedures have been simplified; visas can now be obtained at the airport or port of entrance and user surveys (6/98) indicate that the new procedures are working satisfactorily. This measure and the licensing of a charter airline had a remarkable impact on tourism, with tourist arrivals increasing by 36 percent in 1997 and over 20 percent in 1998. Madagascar's unique bio- diversity suggests further growth potential. 17. Many of the reforms noted above were supported by SAC-1, a one-tranche operation approved and disbursed in March 1997. The operation was based inter alia on progress accomplished on the stabilization front, particularly decisive actions aimed at controlling inflation; interest rate liberalization and the introduction of a market-based means of monetary management; adherence to a floating exchange rate in the context of significantly reduced import barriers; elimination of subsidies; and more realistic energy prices. Additional up-front actions included measures aimed at: (i) setting the stage for complete State withdrawal from the banking sector; (ii) putting in place a framework for transparent privatization; and (iii) efforts to encourage private investment through the removal of legal monopolies in key sectors. These - 5-  measures (summarized in column 2 of Box 1) were expected to help open up the economy, thus beginning the process of unlocking FDI in the magnitude needed for achieving high growth and poverty reduction. The international community assessed that progress achieved was worthy of financial support, with the appraisal of an ESAF arrangement and the provision of financial support by the EU and bilateral donors accompanying or preceding the approval of the Bank's SAC operation, including a program to clear up arrears to the Paris Club. 18. SAC-1 advanced adjustment in each of the targeted areas, but implementation was slow. These delays were largely due to political developments, specifically an intense electoral activity during 1997 and the first half of 1998. The effect of the political calendar on the speed and impact of reforms was not adequately assessed. Privatization of the two state banks, originally planned for late 1997, suffered delays and the privatization program was held hostage by political infighting. Furthermore, despite the removal of legal monopolies, many key sectors remained in practice uninviting to competition. For example, though imports, transformation, and distribution of petroleum products were liberalized by decree, investor interest was lacking, mainly because of concerns that the existing petroleum parastatal would be given unfair advantage in a sector where taxes are a major component of the market price. 19. Following sustained dialogue, much progress has taken place on the reform agenda in recent months. Economic transformation has been gradual, but definitive. While the pace of reform has not matched that intended in the CAS (discussed by the Board on February 18, 1997), the actions taken or about to be taken are far-reaching and irreversible. As seen in Box 1, the adjustment agenda has moved substantially forward since the CAS with several key up-front actions tied to the present operation. In a country in which reforms are typically of an incremental, rather than sweeping, nature, the present spurt of progress represents a window of opportunity that cannot be ignored. The political environment is now more supportive of reform than it has been at any time since the transition to democracy. At this time, all actions originating under SAC-1 have been essentially completed. In particular, the BFV - in its origins a commerce/trade bank - was sold to Societe GWnerale in a transaction completed in December 1998. The sale of BTM - in its origins an agricultural sector bank - has proven somewhat more complex, as the sole interested buyer pulled out of the sale in June 1998. However, the Government has mounted a determined second effort over a short period of time, and a sales protocole with a buyer was signed in early April and should be finalized by mid-1999. To allow for the completion of this sale, the Government has agreed that the second tranche of SAC-2 will not be disbursed until a controlling interest in BTM is in the hands of its new owners or, if the deal unravels, already agreed steps for full State disengagement from BTM are put in place. 20. The proposed operation comes at the end of the period covered by the 1997 CAS. The CAS had planned for total financial support during that period - FY1997 to FY1999 - of US$330 million in the base lending case, increasing to US$450 million if another adjustment operation was justified. The proposed adjustment operation embodies substantial progress in reform and would bring total support to about US$420 million. As mentioned above, the pace of reform has not matched that intended in the CAS, but the actions taken or about to be taken are far-reaching and irreversible. Disbursements are tied to completion of privatizations in key sectors, for which the stage was prepared by the first SAC, and visible additional reforms that would support the high-growth, poverty reducing strategy described in the CAS. Special -6-  emphasis is given to measures that would improve governance, in turn serving to solidify the reform process. B. The Reform Program Supported by SAC-2 21. The proposed SAC addresses several outstanding areas of reform identified in the CAS. The program rests on four pillars for high growth and poverty reduction. First, macroeconomic stabilization is being consolidated, as fiscal imbalances, though lower, are still too large. Second, privatization of public enterprises is at the core of the Government's reforms, thus signaling the State's willingness to disengage from key sectors and make room for private sector activity. Chief among them are the privatization of state institutions and companies in the banking, petroleum refining and distribution, air transport and telecommunications sectors, together with the introduction of competitive regulatory frameworks to ensure efficient operation of these sectors. The privatization process is supported by a fair and equitable program of severance payments. Third, an improved business environment is being put in place to boost private sector investment and job creation, emphasizing less discretion in administrative procedures and elimination of bottlenecks to private sector growth. Reforms are targeting promising sectors such as mining, tourism and fishing. Transparency in licensing for the exploitation of natural resources is in particular a priority. Finally, the program emphasizes strengthening of public finances. To increase revenues and eliminate opportunities for abuse, the tax base is being expanded and ad-hoc tax and tariff exemptions are being eliminated, while ensuring that revenues allocated to the social sectors are in fact effectively used for the benefit of the poor, especially in primary education and basic health. Emphasis is also given to increasing non-tax revenues through reforms in the allocation of fishing licenses. 22. Macroeconomic Framework. Major objectives are to maintain inflation under control and strengthen the State's fiscal position, pre-conditions for high growth. The annual inflation rate is estimated at about 6.2 percent for 1998, with further declines in later years. Projected at 5.8 percent of GDP in 1999 and 4.5 percent by 2001, the fiscal deficit (without grants) is expected to improve mainly through expansion of the tax base as well as improved revenue administration and collection of non-tax revenues. Under the reform scenario, growth is expected to increase, reaching 5.6 percent by 2001 and about 7 percent by 2005 - well above the 3.6 and 3.9 percent reached in 1997 and 1998. The external current account deficit (without current grants) will continue to improve, declining from 7.7 percent of GDP in 1998 to 6.6 percent by 2001, and to 6.4 percent by the middle of next decade. SAC-2 tranche releases will require maintenance of a macroeconomic framework satisfactory to IDA; this includes securing the international financial support necessary for the sustainability of this framework. 23. Privatization in Key Economic Sectors. This first phase of privatization, which includes 46 state enterprises, is supported by a technical assistance IDA credit (Private Sector Development and Capacity Building Project, PATESP). The main objectives of this privatization program are to: (i) improve the availability and quality of key services at competitive prices; (ii) facilitate competition by lowering barriers to entry; (iii) encourage alliances between local and foreign operators; and (iv) eliminate potential burdens on fiscal accounts. The framework of the privatization process is provided by the Law on State Disengagement (Law 96-011), a Board - 7 -  presentation requirement of the previous SAC. The privatization program is likely to help eliminate the distortions introduced by the dual - and often contradictory - regulatory and operational roles of the State. It is designed to increase private sector investment while fostering competition. The underlying features of the regulatory frameworks for major sectors have been agreed with IDA, and necessary regulatory bodies will be created and provided with the necessary financial and human resources prior to the completion of privatization transactions. 24. Improved governance is at the core of the privatization reforms. The privatization program is based on a legal framework which includes mechanisms to ensure that the process is transparent and competitive. This encompasses: (i) a thorough public information campaign for the enterprises in which private sector participation (total or partial) is being sought; (ii) pre- qualification criteria and selection methods that are clearly presented in the bidding documents; and (iii) publication of bidding results, including conditions of sale, offers received, and prices at which transactions take place. Quarterly reports will be issued to the press and the general public summarizing progress in execution of the privatization program, including information regarding revenues and expenses, and use of resources originating from the privatization process. 25. Specific actions to increase the social sustainability of the privatization program have been introduced. Their inclusion reflects lessons from the Bank's worldwide experience with privatization, combined with in-country consultation to ensure their suitability for Madagascar. A program of severance payments has been prepared on the basis of principles of equity and fairness, and retraining programs have been designed. For the 46 state firms in this first phase of privatization, which is to be completed before mid-2000, the cost to meet severance payment obligations has been taken into account in designing the macroeconomic framework and in structuring the Bank's quick-disbursing support. To facilitate local participation in the ownership of privatized companies, a financial instrument (Fond de Portage) has been created, and will be endowed with equity participation in privatized companies (between 10 and 20 percent of total equity in large state firms). The State has also decided to maintain a participation of 10 to 20 percent in large state firms. State and Fond de Portage participation - with a view to selling those shares to a wider public as the country's capital markets develop - will remain below the controlling minority stake (i.e., 33 percent or less). The Government has chosen to finance social and regional investment projects with a share of net privatization proceeds (i.e., after deducting for firm liabilities) while maintaining consistency with the macroeconomic framework. 26. Following progress in the banking sector under the previous adjustment credit, SAC-2 focuses mainly on the petroleum, air transport and telecommunication sectors. The State will sell a controlling interest in these enterprises to domestic and foreign strategic investors, and, because they call for politically difficult decisions, should serve as powerful signals of change and increased openness (Table 2). The Government's privatization program includes smaller enterprises in other sectors (e.g., sugar and cotton), linked to SAC-2 by the financing provided for the social programs. However, by focussing on privatization in three high-profile sectors, as well as on measures to address the social aspects of privatization, SAC-2 is expected to help build momentum for the completion of privatization transactions (or liquidation of state enterprises) in the less visible economic sectors of this first phase of privatization. -8-  Box 1: CAS Update, Score Card on Economic and Financial Reforms This box, copied from the CAS discussed 2/97 (Box 3, page 5), updates the score card on Madagascar's structural reforms. In the last column items in bold indicate reforms already completed or under way; those addressed in the proposed operation are marked with an asterisk. Underlined items denote additions to the reform agenda. Actions Taken Key Elements of Remaining (Short to Medium-Term) Agenda Exchange * Floating of Malagasy Franc * Maintain flexible exchange rate Rate and * Liberalized access to foreign exchange * Improve competition through exchange Trade * Lowered top tariff from 80 percent to 30 percent bureaus * Removed export, import licensing requirements * Further reduce tariffs (under CBI) * Agreed to abolish export taxes (vanilla, 1997) * Eliminate controls on current account * Cut taxes on inputs for export production * Relax and gradually open capital account Interest Rates * Liberalized lending and deposit rates * Maintain positive real interest rates and Monetary * Linked Central Bank reference rate to an indicator * Develop inter-bank market in support of Policy of anticipated inflation market-determination of cost of credit * Introduced indirect instruments for monetary * Complete transition to indirect monetary control control instruments * Lifted bank-by-bank credit ceilings, introduced * Develop and improve T-bill market reserve requments Financial * Appointed administrators at both state commercial * Complete divestiture of state banks* Institutions banks; selected (experienced) sales agents for their * Strengthen regulatory framework privatization * Establish effective intermediation for small * Passed new banking law entrepreneurs (addressed in proposed Micro * Strengthened supervision Finance project) * Enhance financial depth teasing, insurance)* Public * Improved public expenditure management: * Strengthen tax and customs administration* Finance reoriented funds from defense to social sectors; * Broaden tax base* strengthened PIP monitoring * Increase expenditures for basic health, i * Raised energy prices significantly primary education, basic infrastructure and public * Ended petroleum, flour, retail rice subsidies security* * Passed law on public enteiprise divestiture * Divest State from most public enterprises beginning with strategically important ones* * Define distribution of authority/resources between central government and local govemnments Private Sector * Passed privatization law, revised laws/regulations * Actively promote competition in air transport, Development on land ownership, property rights, commercial telecommunications, tourism, petroleum activities distribution* * Removed ex-ante investment approvals and fiscal * Maintain simple tourist, investor regulations* incentives from Investment Code, and integrated * Complete agreed divestiture from vanilla incentives into Tax Code parastatal; eliminate other monopolies (ind * Eliminated state monopoly and liberalized sugar, cotton, ports, water supply,insurance) legal/regulatory framework in petroleum, electricity * Reform judicial system; establish legal/ s Amendedclawttooallowrnewsentrants institutional framework favoring competition* * Amended law to allow new entrants imto telecommunications * Privatize public enterprises per agreed * Abolished exit visas, relaxing visalwork/residence schedule* regulations for foreign investors and tourists * Reform high-potential mining and fisheries * Liberalized air access policy and abolished sectors to make them more investor-friendly monopoly of Air Madagascar on air traffic rights (increase transparency, automaticity)* * Pilot measures to resolve land-tenure blockages in high-potential zones* -9_  27. As indicated earlier, the privatization agenda has evolved slowly but picked up speed in the second half of 1998. Two transactions (petroleum and air transport) are well underway and are expected to be completed by next July and September, respectively. The telecommunication sector is expected to follow suit in late 1999 or early 2000. The liberalization framework for these sectors has been finalized and was approved by an extraordinary session of the Assembly last March. Table 2: Measures Supported by SAC-2 on Privatization ..,,- ,s,,w,Z,,,,A,~~~~~~~~~~~~~..., ......, - I.. ig E- - iDiii LdDiRiEdR ^ - ::-:: E --Oe i42qgiyi4; Reform Areas S~~pecfcMaue Obectves, Petroleum Sector * Constitute joint ventures for each of the ten petroleum The privatization program has (1st tranche) los of SOLIMA, limiting the State's voting stock to no been designed to encourage more than 30 percent (sale of assets in the distribution investment, reduce the risk of and gas networks; and sale of equity in the refinery- destabilizing burdens on fiscal storage complex, four distribution lots, storage complex accounts, and improve quality without Tamatave, lubricants, and aviation fuel lots) and efficiency of provided * New regulatory framework and regulatory body in services. place with finctions, membership, budgetary resources and staffing agreeable to 1DA * Signing of sales contract/long-term land leases for non- petroleum sector lots (hotels, villas, and half of SOLIMA land holdings in which legal disputes do not exist) * Adoption by the Council of Governnent of a methodology, acceptable to IDA, for the calculation of indemnities and severance payments Air Transport * Signing of a sales contract through which the State sells 65 percent of the voting stock of Air Madagascar * Issue call forbids forthe concession of Madagascar's main airports in at least two lots * New regulatory framework and regulatory body in place with functions, membership, budgetary resources and staffing agreeable to IDA * Satisfactory implementation of social program Telecommuni- * Signing of a sales contract through which the State sells cations 34 percent of the voting stock of TELMA * New regulatory framework and regulatory body in place with fimctions, membership, budgetary resources and staffing agreeable to IDA * Satisfactory implementation of social programn Petroleum Refining and Distribution: Regarding the legal framework for oil downstream operations, a draft law was approved by the Council of Ministers in mid-November 1998 and adopted during an extraordinary session of the National Assembly during the second half of March 1999. Inports of refined products are fully liberalized and all new distribution companies will have unrestricted access to existing and new storage facilities. Application decrees, in particular the ones pertaining to pricing structure, creation of the regulator and mechanisms for licensing, have been prepared and published after the passing of the mentioned law. The call for bids for the privatization of SOLIMA was launched in December 1998. Ten petroleum sector lots have been offered to strategic investors, including four distribution lots for which about 25 - 10 -  offers have been received. The refinery will be sold with the port and storage facilities at Tamatave, an acceptable arrangement to petroleum distribution operators as shown by the strong interest in distribution lots. Negotiations are underway with the successful bidders, which include several multi-national firms. Finalization of the privatization process through the establishment of joint venture companies in the 10 petroleum lots will be fully completed prior to declaring effective the proposed credit. Air Transport: A two-phased open skies policy has been designed. In a first phase, the charter air transport segment has been fully liberalized and charter companies allowed to operate on the basis of an open-ended license to be delivered by a newly set up regulator. During this phase, which will last for five years, Air Madagascar will be allowed to operate the 8 traffic routes it is currently operating regionally and internationally on an exclusive basis (i.e., no other Malagasy carrier will be allowed to operate these routes, but this does not preclude foreign companies from coming into Madagascar on the basis of existing bilateral agreements). At the end of this phase, open skies will prevail for the regular air transport market: any carrier technically certified according to international standards will be allowed to service Madagascar without need for bilateral agreements. The decrees pertaining to the regulatory framework were enacted prior to the launch of bids last March. The bidding documents specify that a total of 65 percent of the company's equity will be offered for sale which, together with the voting stock already in the hands of private sector operators, will be sufficient to preclude the State from having a controlling minority stake. At least two concessions for Madagascar's main airports will be offered for operation and capital investment; launching the bids for these concessions is expected prior to the release of the tranche that supports the privatization of Air Madagascar and these concessions will be adjudicated during SAC-2's lifetime. Telecommunications: The 1996 telecommunication law created a fully liberalized environment allowing full competition in all services. As of December 1998, 4 cellular licenses have been granted and all of them are operational. A new interconnection decree, adopted in November 1998, ensures equal treatment of all the companies in the sector in their connection to the fixed network of the national operator, TELMA. Under the proposed SAC-2, the reform process will be completed with the sale of a controlling interest in TELMA (i.e. the State will sell shares representing at least 34 percent of the company's voting power which, together with the 33 percent stake currently held by France Cable & Radio, will be sufficient to preclude the State from having a controlling minority stake). Further competitiveness gains are expected as a call for bids for a second-national operator will be launched during SAC-2's lifetime, which will be allowed to offer the full range of telecommunication services; only a few months of de facto monopoly are given to the strategic investor buying into the existing national operator. 28. Private Sector Development. In addition to withdrawal from productive activities, the Government's program includes measures to improve the business environment (Table 3). Box 2 offers a closer look at one of the measures supported by SAC-2, under which the government and the private sector will jointly define reforms to facilitate private investment and firm entry guided by a survey-based report prepared by FIAS (Foreign Investment Advisory Services). The programn was discussed during a recent seminar sponsored by FIAS and US AID. Implementation of the first phase of this program must be completed prior to disbursement of the corresponding - 11 -  tranche; this phase includes reforms for simplifying the process of firm creation and registration and the elimination of restrictive rules for the creation of firms in the tourism sector. Box 2: FIAS Report, Problems faced by Investors in Madagascar (11 /98 draft report based on 4/98 field surveys of private entrepreneurs, civil servants) The fmdings of the Bank's Foreign Investment Advisory Services (FIAS) report highlight the stifling bureaucracy pervading the climate for private investment in Madagascar. Administative obstacles raise the cost of doing business and appear to create a sense of powerlessness among investors. Company registation can takl up to six months, and involve no less than 10 bureaus; residence and work permits are rarely obtained within the three-month promised delivery period; and construction permits take three to six months to obtain, in comparison with the stated 45 days. Key problems are: * Lack of information on procedures Procedures are complex, and change frequently * Lack of transparency and predictability Unstable legal environment: new laws coexist with old ones * Excessive requirements for documents (distrust of foreign investors prevails) Lack of coordinafion within government: same documentation/form requested mulfiple times * Pervasive formalities (especially for company registration, work permits) Ubiquitous needfor approvals creates restrictive, controlled environment * Excessive concentration of decision-making High-level signatures neededfor even minor formalities 29. Other areas for action will include facilitating access to land, and strengthening the judicial system. On land tenure, reform is crucial but constrained, given issues of culture and tradition on ownership, especially by foreigners, for which there are no easy solutions. Policies to ease land access will thus only include reforms to improve the functioning of existing long- term land lease instruments (bail emphyteotique), namely preparing a manual of procedures and modifying the method of calculating certain registration fees which make the process too onerous, and pilot programs in selected zones that are hoped to help build the consensus necessary for more lasting nationwide solutions. Under the latter, publicly owned lands will be allocated through competitive and transparent mechanisms (i.e., sale for Malagasy nationals and long-term land leases for foreigners): five of these "zones" close to agreed upon tourism regions and five in industrial areas close to ports and/or large cities. The zones will be selected following consultations with private sector representatives and, when appropriate, environmental assessments will be prepared or requested from potential investors. Additional reforms will also aim at strengthening the rule of law, including the promotion of arbitration as a mechanism to resolve commercial disputes for which a new Arbitration Law has been approved by the National Assembly, and further strengthening of the judiciary. To this end, a study has been commissioned to identify major impediments and bottlenecks affecting the normal functioning of the judicial apparatus, and an action program will be defined to address these constraints. Substantial progress in the implementation of such action plan is included in the measures to be adopted for the release of the tranche that supports private sector development and the strengthening of the judicial system. As one example, proportional registration fees for executing judicial rulings (droit de condamnation) have become a major stumbling block to the expeditious administration of justice and will be eliminated. - 12 -  Table 3: Measures Supported by SAC-2 on Private Sector Development Reform Areas Spe a Objectives 1. Mining . Enact law redefning role of OMNIS and return mining Create the conditions for Sector licenses of OMNIS to the State (B) transparent allocation of mining * Approval of a new Mining Code by Council of licenses; provide private sector Ministers and submission to the National Assembly (B) with a more predictable * Adoption of the Mining Code by the National business enviromnent in mining Assembly and publication of implementation decrees activities. * Reduce existing backlog in mining applications by 80 percent following mechanisms agreed with IDA 2. Land Tenure * Introduce modifications to improve the functioning of Simp]ify long-term land lease the bail emphyt6ofique (long-term land lease): fraction instrument; enable access to payment of registration fees to make the process less land in high-potential zones. expensive, and publish a guide/procedures manual * Auctions for five tourism and five industrial zones following methodology agreeable to IDA 3. Enabling * Adoption of an Arbitration Law by the National Build ownership of reforms and Business Assembly (B) mechanisms of dialogue Environment * Government and private sector jointly design medium- between the State and private term action program to support private sector sector representatives; development; implement first phase of such action strengthen rule of law, thus program, namely streamlining procedures and formalities providing an enabling business for creating enterprises, and reducing the requirements environment. for the creation of tourism related firms * Substantial progress in the implementation of action program to reduce bottlenecks affecting the functioning of the judicial system; program to include the elimination of cost disincentives to the execution of judicial rulings (droit de condamnation) and other priority actions identified by a study under preparation; provision of additional budgetary resources to the judicial system 4. Sector * Publish in official bulletin interconnection decree for Improve quality and efficiency Liberalization fixed and cellular telecommunication operators (B) of services and facilitate and other Sector * Sign at least two concession contracts for main airports investment in key sectors. Reforms * Enactment of a law for large mining projects (more than US$200 million in investnents) * Issue call for bids for a second-national telecommunications operator (B) - Required for Board presentation of SAC-2 30. Sector-specific refonns are also being pursued. Mining is a priority sector, with the potential to quadruple total exports by the end of next decade if nickel-cobalt and titanium projects under consideration are implemented. A new Mining Code will be enacted during SAC- 2's lifetime, and seeks to ensure: (i) a better incentive framework for the sector's development, through provision of legal and fiscal stability frameworks in mining projects; and (ii) increased transparency in the allocation of mining concessions, mainly through a "first come-first served" system for issuing mining authorizations. Additional sector reforms, supported by an on-going IDA-financed Learning and Innovation mining operation (LIL), aim to clear up - using non- discretionary rules - the existing backlog in mining applications and to limit the role of the State to the carrying out of surveys and promotional activities, away from production and - 13 -  commercialization of mining products. As a result, the public entity OMNIS has recently returned all its mining licenses to the State. Further liberalization strategies will be supported in air transport, through the concession of operation and capital investment in main airports; the further opening of the telecommunication sector, through the launch of bids for a second-national operator; and the approval by the National Assembly of a fiscal regime for mining projects of more than US$200 million in direct project-related investments. 31. Public Finance Reform. The development of Madagascar will require many changes in the role of the State that go beyond the described privatization program. Actions programmed under SAC-2 focus on a limited number of reforms that would help the government increase revenue collection and better administer natural resources. The Government is also committed to the fair application of tax rules, and to ensuring that budget allocations, once made, are in fact used effectively, especially in primary education and basic health and focusing on rural areas. 32. To this end, higher revenues will be sought through extension of the tax base. The practice of allocating ad-hoc tariff and tax exemptions, which has been responsible for significant shortfalls in tax revenues, was stopped in August 1998. At the same time, procedures have been agreed with the IMF to ensure that exemptions become only extraordinary events (e.g., driven by natural disasters) so that revenues foregone are kept to a minimum. Procedures for legal exemptions have been more carefully specified to reduce abuse, mainly through the publication of the list of firms that may benefit from exemptions so that custom and tax authorities can verify which companies are in fact entitled to tax and tariff exemptions. Revenue performance will be reviewed and publicized to ensure that the Government remains accountable and maintains mechanisms of dialogue with private sector and civil society representatives. The goal is also to engage in a more systematic analysis of revenue performance, thus facilitating the identification of reforms that would allow the Government to increase tax revenues towards the Sub-Saharan Africa average of 15 percent of GDP. To this end, a unit at the Ministry of Budget and Autonomous Provinces will expand its activities from monitoring fiscal revenues to examining medium and long-term structural weaknesses in tax policy and tax administration. 33. The Government has initiated substantial reforms in shrimp fishing, to pioneer management of its natural resources in a transparent and sustainable way while increasing public revenues. Shrimp fishing is now the single most important source of foreign exchange, about 8 percent of total exports. The Government has committed to changing the way in which licenses are allocated, introducing a system that will be transparent, non-discretionary, and competitive (e.g., bidding mechanism); the next step - under SAC-2 - is to define an allocation mechanism which is tailored to Madagascar's specific conditions (e.g., rights of traditional fishermen, local participation to help maintain support for the reform program, and fair competition with those firms which may receive foreign subsidies) while respecting the above principles. The Government has agreed to freeze the number of shrimp fishing licenses (to 69 industrial ships and 36 artisanal boats in the west coast, and 6 industrial ships in the east coast) until a new allocation system has been put in place and the sustainability study that has been commissioned is completed and assessed. The new system, which will include rules for revoking licenses, will be prepared in close cooperation with the private sector. With respect to revenues, the Government has doubled shrimp license fee revenues for 1999 relative to 1998, and introduced a mechanism to monitor and disseminate information on actual payments. Measures have also - 14 -  Table 4: Measures Supported by SAC-2 on Public Finance Reform Rem reasSures ob-:ctives 5. Revenue * Procedures for legal exemptions have been more Ensure equitable tax and tariff Policies and carefully specified to reduce abuse and include: treatment; identify early on Monitoring publication of list of beneficiaries from tax and tariff deficiencies and weaknesses in exemptions and elimination of ad-hoc exemptions (B) revenue collection; improve * Mandate unit within Ministry of Budget to analyze government accountability. revenue perfonnance and prepare special technical works, following terms of reference agreeable to IDA, with the aim of identifying medium and long-term reforms in tax policy and tax administration 6. Monitoring * Reconciliation of Budget and Treasury classifications in Improve the delivery of public Progress in order to match Budget Law execution with Treasury services, particularly social Social Sector accounting system (B) services in primary education Expenditures * Implement budgetary modifications to ensure that and basic health. agreed indicators of primary education and basic health expenditures canbe monitored on a quarterly basis and within 45 days of end-quarter, prepare one of these reports (satisfactory to IDA), including assessment of compliance with PER recommendations of October 1998 * Define semi-annual survey methodology, agreeable to IDA, to evaluate delivery of social services (primary education and basic health) and carry-out such survey 7. Fishing . Increase fishing license fees 100 percent in 1999 Three main goals are pursued in Licenses relative to 1998; and prepare report on actual and the reforms introduced in this potential payments of license fees in 1998 and 1999 (B) sector: (i) to increase revenues * Freeze number of licenses in the west coast to 69 accriing to budget; (ii) to industrial and 36 artisanal, and to 6 industrial in the east increase transparency in the coast, respecting in all cases the 1998 allocation by zone allocation of licenses; and (iii) and boat-type per fimn and maintaining the freeze until to ensure the sustainable results of sustainability study are known (B) exploitation of the resource. * Agree on terns of reference for a study aimed at proposing a transparent, non-discretionary, and competitive allocation system for shrimp licenses (B) * Begin implementation of a new allocation system consistent with the principles of transparency, competitiveness, and non-discretionality * Increase license fees of old allocation system in line with new allocation system * Issue FDHA decree: (i) limiting FDHA resources (a maximum of 20 percent of all sector revenues, with FMG 4 billion in 1999 and a real increase cap thereafter); and (ii) redefmning FDHA role and use of funds (financing of projects in the sector and with 80 percent of its funds used as counterpart funds of donor finded projects) . Carry out audit to assess performance of FDHA in 1999 and introduce changes, including re-assessing its need 8. Financial * Cany out organizational, financial and, if applicable, Preparatory work for reforms, Sector Reforms actuarial audits (period 1995-97) for the three social including the privatization of (audits and other security funds (CNaPS, CRCM, and CPR) and the two insurance companies and the preparatory state insurance companies (Aro and Ny Havana) introduction of reforms for work) * Agree with IDA on action plan for reforms, including a social security funds. I privatization timetable for the two insurance companies (B) - Required for Board presentation of SAC-2 - 15 -  been agreed on the use of resources from the fisheries sector: 80 percent to general budget needs and a maximum of 20 percent to guarantee the availability of resources for projects proposed by the Fonds de Developpement Halieutique et Aquicole (FDHA), compared to 25 and 75 percent, respectively, in 1998. The 1999 allocation to the FDHA has been limited to FMG 4 billion and annual increases thereafter will be constrained. Eighty percent of FDHA budget allocations are to be used as counterpart funds for donor projects. Madagascar is also being considered as a pilot country on which the Forum for Sustainable Fisheries - a coalition of multilateral agencies, bilateral donors, and NGO's - may focus to develop a dynamic and sustainable fisheries sector. 34. While increasing revenue collection is crucial, for this revenue not to be wasted the public sector must also increase its efficiency. This too requires institutional and organizational changes. With this goal, the program supported by the SAC introduces mechanisms that would allow monitoring of, and accountability for, social sector expenditures: while budget allocations to these sectors have improved, actual expenditures have been falling short in part because warning signals on poor budget execution do not exist. The proposed monitoring system (see Annex 3 for a more detailed discussion) will also track the implementation of sector reforms agreed during the last PER mission (October 1998), particularly measures to facilitate the delivery of resources to the district level, and user surveys will help assess performance in the delivery of social services. To strengthen accountability, a Financial and Budget Discipline Council has been created; its specific goals are to strengthen budget programming and execution and reduce corruption in public finances. The Council, with support from the Prime Minister and under the oversight of the National Assembly, will identify transgression of rules in budget execution and in the preparation of annual budget final accounts. 35. In the medium-term, Madagascar needs to reduce the threats imposed by a still weak financial system. Beyond the completion of the reform agenda in the banking sector, SAC-2 supports the identification of remaining structural weaknesses. To this end, organizational, financial, and, when appropriate, actuarial audits, will be carried out in state insurance companies (i.e., Ny Havana and Aro) and social security funds (i.e., CNaPS, CRCM, and CPR), thus preparing the ground for future reforms that will allow to complete the objective of putting the country's entire financial system on a sounder base. These reforms include the Government's commitment to privatize the two state insurance companies together with the liberalization of the insurance market, the latter being already an integral part of a draft law under preparation. C. Links to the Country Assistance Strategy 36. Poverty reduction is at the center of the Madagascar CAS (discussed by the Board on February 18, 1997). Given widespread poverty (75 percent of the population is poor), the CAS argues for faster and broad-based economic growth, led by significantly higher levels of foreign investment, as the only means to achieve meaningful poverty reduction. Visible economic opening to turn around investor confidence is, therefore, critical. SAC-2 aims for such opening by focusing on a few, high-payoff reform areas. Efforts to privatize key state enterprises and create a business-friendly climate in high-potential sectors will not only directly benefit the economy by unleashing market forces, they will also establish Madagascar as having made a clean break from past closed and over-regulating policies and entering a new era of openness and - 16 -  competition. SAC-2 also stresses the need to improve public finances, another key area of emphasis in the CAS. On the revenue side, it calls for an equitable application of tax rules, including a more restrictive and transparent policy for tax and tariff exemptions (a key aspect of the ESAF program, as noted). On the expenditure side, it emphasizes delivery of public goods and services to the poor - key to the CAS - and user surveys to monitor results on the ground. 37. The 1997 CAS remains highly relevant in today's context: objectives and instruments are entirely valid; risks are the same, but appear to be gradually lessening; sector dialogue has advanced (particularly in transport, health and micro-finance where new operations are being prepared); and the impact of IDA's portfolio remains effective. Economic opening and privatization have proceeded slower than implied in the adjustment scenario foreseen in the CAS, but this was a risk recognized and one that does not warrant a change in the fundamentals of the strategy. The eventual completion of actions under SAC-1 called for considerable political courage, and macroeconomic performance has remained close to target. Given increased presidential powers and a political environrment more supportive of reform than at any time during this decade, it behoves the donor community to reinforce the present political will to carry out reforms and maintain the momentum of adjustment. Not doing so could result in a missed opportunity, increasing the risk that Madagascar will not benefit from the difficult actions already completed. Supporting adjustment now would help capitalize on current investor interest in the targeted sectors; indications of investor interest are strong in all sectors being privatized, while reforms in the mining sector are also drawing concrete investment proposals. The proposed SAC assumes that the Government will push forward the outstanding reform agenda, aiming for high growth and poverty reduction driven by economic opening and private sector initiative. As such, it pushes the FY97-99 lending envelope towards the CAS high-case (paragraph 20). 38. Governance. At the heart of the growth and investment-led strategy for Madagascar and of this SAC-2 operation is governance, a major driver of investor preferences and developmental progress. Poor governance is the most frequently cited constraint to private investment in Madagascar (71 percent of firms cited public sector corruption as their main concern in a 1997 survey), costing the country external financing and assistance as investors and donors - including IDA - become increasingly selective in their country choices. The challenge can be fully met neither quickly nor easily, but the Government's program takes a giant first step: reforms go to the heart of public sector institutional arrangements that have long bred discretionary decision- making and, as a result, corruption. Measures to eliminate ad-hoc tax and tariff exemptions and allocate rights and licenses in the high-potential mining andfisheries sectors in a transparent, non-discretionary way will 'clean' up the fiscal landscape while providing a boost to revenues. A similar effect on the business environment is expected as a result of simplifying procedures to reduce pervasive formalities and authorizations - a key expected outcome of the reforms to be designed jointly by the government and private sector. Eliminating monopolies in key sectors will further reduce scope for corruption. Close monitoring of public expenditures to ensure adherence to programmed targets in primary education and basic health is expected to channel public finances towards important, agreed needs, leaving less room for extravagant, non- developmental ones. To strengthen governance in public finance the Government has taken concrete steps to tighten budget programming, execution and control, contributing to the elimination of corruption in public finances. A Code of Conduct for civil servants is under preparation and the Government is committed to increasing accountability. Beyond these, the - 17 -  overall thrust of the adjustment program - to reduce the overwhelming presence of the State and strengthen market forces - should serve to reduce opportunities for corruption. 39. These measures under SAC-2 are complemented by dialogue and efforts in other areas to improve governance. In the context of a longer-term civil service reform effort, studies on new remuneration and employment policies have recently been completed. However, these are reform areas that require the building of consensus and need to evolve in line with implementation capacity; policies in these areas are best developed away from the conditionality pressures of quick-disbursing operations. In addition, EDI provides periodic support to journalists to help sharpen press vigilance and increase the corresponding sensitivity in public behavior (newspapers were quick to report on the discussion of corruption in the CEM and evidence of suspected corruption are now much more frequently reported and attacked in the press). Finally, efforts to ensure a clean IDA project portfolio include greater reliance on outside procurement audits, while ongoing project technical and financial audits (using the procurement/financial specialists recently hired in the resident mission) are becoming standard practice for all projects. 40. Environmental Aspects. SAC-2 also supports the CAS environmental objectives, as environmental concerns are incorporated in reforms pertaining to the fisheries, mining, and petroleum sectors, and also those that address land tenure issues. In thefisheries sector, reforms go to the heart of sustainable management. The current incentive framework results in large quantities of by-catch fish being rejected back to the sea, contributing to the degradation of the marine environment. The proposed allocation system for licenses will provide a better incentive framework by clarifying property rights, thus serving to ensure a sustainable exploitation of the resource. As to mining, the new Mining Code was reviewed by the National Office for the Environment and is consistent with existing environmental regulations. In the petroleum sector, an environmental clean-up program is required, particularly at the Tamatave port and storage facilities. The Government has assumed full responsibility for past environmental damage and is considering several options; for example, agreeing with the purchaser at the time of negotiations on an environmental clean-up program. The land tenure measures regarding tourism and industrial zones will have special provisions to address environmental concerns. 3. THE PROPOSED SECOND STRUCTURAL ADJUSTMENT CREDIT A. Credit Rationale, Lessons from Previous Operations, and Credit Amount 41. Credit Rationale. The proposed SAC focuses on policies that will lead to high growth and poverty reduction. The core of the challenge is to modify the environment in which economic agents operate, encompassing issues related to governance, State functioning, and competition. The reform program thus aims at institutional changes and a substantial redefinition of the role of the State, including opening up key sectors of the economy to local and foreign investors. Selectivity, moreover, is a salient feature of SAC-2: it focuses on few, key reform areas. A sustained momentum in implementing adjustment reforms in the coming months will afford Madagascar the greatest possible signaling impact from structural change. Decisive - 18 -  action, to which both the President and Prime Minister are committed, would entrench the country firmly on a path to poverty reduction through private sector-led high economic growth. 42. Lessons from Previous Operations. Madagascar's previous adjustment experience shows that reform does help growth, but reform momentum is often driven by domestic politics, and ownership and consensus register wide swings. In fact, during the last 25 years, per capita income has been positive only in those years that followed the decisive introduction of a reform program. Regarding the pace of reform, evidence is clear that election delays thwarted timely progress in carrying out the previous SAC reforms to completion. These delays also partly reflect inadequate buy-in of the proposed reforms and, as the previous SAC operation was a one-tranche credit, the Bank found itself without the financial leverage to push forward the reform agenda. Reflecting these lessons, SAC-2 is designed as a multi-tranche, "menu-based" operation which recognizes that implementation of reforms must evolve across time, a process which will be facilitated by maintaining Madagascar engaged in a medium-term reform dialogue. The "menu- based" approach - where any one reform area within a list of eight reform areas can be selected to trigger the release of the second or third tranches, as described below - offers flexibility in the timing of reforms. To allow for ownership and consensus-building for reform, key components of the reform program have been left for involved parties to define. For example, key private sector development measures are to be defined jointly by the State and private sector representatives. Finally, to promote the link between reform and performance, SAC-2 emphasizes results more than process (e.g., completion of privatization transactions, and pilot mechanisms on land tenure issues). 43. Credit Amount. The total amount of the operation is US$100 million to be disbursed in three tranches, with amounts increasing from US$25 million in the first tranche to US$30 million in the second, and about US$43.8 million in the third tranche. The operation will also refinance two PPFs related to the telecommunications sector and totaling, including accrued charges, US$1,2 million. These PPFs were used to support the drafting of the Telecommunication Law and accompanying regulatory framewvork decrees, including the preparation of the interconnection decree between fixed and cellular operators (a Board presentation requirement) and the creation of the OMERT, the telecommunications regulatory body which must be fully operational in order to disburse the second (or third) "menu-based" tranche. The macroeconomic framework has been agreed with the Bank and the Fund. Lack of adjustment support during 1998 has led to a marked decline in reserves to about 8 weeks of imports and increasing reserves is a key aspect of the program. In addition, for the 46 enterprises in the first phase of privatization, social programs have been developed, added to the macroeconomic framework; and taken into consideration in defining the Bank's adjustment support. Consistent with the timing of these programs and, more importantly, with the strategy of providing increased fmancial support only as the policy environment improves, tranche amounts are increased in a stepwise fashion. B. Operation Design, and Timing and Triggers for Tranche Release 44. The proposed SAC-2 would be disbursed in three tranches: at effectiveness and in two "menu-based" tranches. Each tranche, in addition to the general conditions of the program, would comprise a core measure and additional measures in private sector development and - 19 -  public finance reform. Each core measure, in turn, involves the sale of any one of three state companies (telecommunications: TELMA, air transport: Air Madagascar, and petroleum refining and distribution: SOLIMA), to be accompanied by the introduction of pro-competitive regulatory frameworks, which must also be fully operational (Table 2). The additional measures for the second and third tranches are to be selected from a total of four private sector development (Table 3) and four public finance (Table 4) reform areas. The second tranche will be released when at least four out of eight reform areas, in addition to a core measure, have been fully completed, the choice being left to the Government. Completing the remaining measures will then become the trigger for the release of the third tranche. The use of "menu-based" core and additional measures will allow access to resources based on the internalization of the reform measures supported by the operation, as well as the pace of preparatory work of each of the companies being privatized. No pre-set time lag between tranches is scheduled, except that all tranches must be disbursed by the SAC-2's proposed closing date of December 2001. 45. Several actions supported by the proposed credit have been adopted prior to the submission of this report to the Board and include (see also Annex 1): -- publication of an interconnection decree for fixed and cellular telecommunication operators (November 1998); -- adoption of an Arbitration Law by the National Assembly (December 1998); -- introduction of reforms in the mining sector, including: approval of the Mining Code by the Council of Ministers and submission of this draft code to the National Assembly (December 1998); and redefinition of the role of OMNIS, and thus the State, to a promotional and informational activities and out from commercialization and production activities (April 1999), including the return of all OMNIS held mining licenses to the State (December 1998); -- introduction of modifications in the fisheries sector, including: (i) increase in shrimp fishing license fees by 100 percent - on average - to be paid before the 1999 fishing campaign (January 1999); (ii) prepare report on actual and potential payments by firm (February 1999); (iii) limit the number of west coast industrial and artisanal shrimp fishing licenses to 69 and 36, respecting the 1998 distribution of authorizations per boat-type and per zone (February 1999); (iv) limit the number of east coast industrial shrimp fishing licenses to 6, respecting the 1998 distribution of authorizations per boat-type and per zone for each company (February 1999); and (v) commit to the introduction of a transparent, competitive, and non- discretionary system for the allocation of shrimp fishing licenses in the campaign 2000 and based on a study commissioned following terms of reference agreed with IDA (April 1999); -- procedures for legal exemptions have been carefully specified to reduce abuse, including publication of list of beneficiaries and elimination of ad-hoc exemptions (March 1999); -- complete reconciliation of Budget and Treasury classifications in order to match Budget Law execution with Treasury accounting system (April 1999); and -- signing a sales protocole for BTM (April 1999). 46. By effectiveness the Government will -- adopt a social program, agreeable to IDA, to support the privatization process (April 1999); -- maintain a macroeconomic framework consistent with the objectives of the Program; this includes securing the international financial support necessary for its sustainability; - 20 -  -- constitute joint ventures for each of the petroleum lots of SOLIMA, with the State limiting its voting stock to no more than 30 percent (sale of assets in the distribution and gas networks; and sale of equity in the refinery-storage complex, four distribution lots, storage complex without Tamatave, lubricants, and aviation fuel lots); and provide evidence of progress in the signing of sales contracts/long-term land leases for the non-petroleum SOLLvIA lots (hotels, villas, and half of the SOLIMA land holdings in which legal disputes do not exist); and -- introduce a new regulatory framework and regulatory body for the petroleum sector with functions, membership, budgetary resources and staffing agreeable to IDA. 47. Release of the second and third tranche will, in addition to: (i) the completion of the sale of BTM or the adoption of already agreed measures referred to in paragraph 19; (ii) the maintenance of a macroeconomic framework consistent with the objectives of the Program; and (iii) the implementation as agreed of the privatization social programs, require -- signing a sales contract for either of the remaining companies to be privatized (for second tranche) and for the last remaining one (for third tranche), including the establishment of new regulatory frameworks and regulatory bodies with functions, membership, budgetary resources and staffing agreeable to IDA (see Table 2); and -- compliance of all components of four out of eight reform areas per tranche, to be chosen by the Government from the eight reform areas presented in Tables 3 and 4 (see also Annex 1). C. Disbursement Procedures, Implementation and Supervision 48. Disbursements will follow the Bank's simplified procedures applicable to all adjustment operations, will not be linked to specific purchases, and will have no procurement requirements. IDA will deposit proceeds in an agreed Central Bank account, and may request an audit at any time. Funds used for ineligible purchases will have to be returned to IDA, but may be re-used. 49. The reform effort is being implemented under the overall supervision of the Prime Minister, who is also the Minister of Finance and Economy. A special Technical Secretariat, tied directly to the Prime Minister's office (Secretariat Technique de l'Ajustement, STA), is in charge of coordinating implementation. This Secretariat, supported by the IDA-financed Public Sector Management and Capacity Building Project (PAIGEP), is responsible for: (i) monitoring implementation of the reform program; and (ii) coordinating all government agencies. Progress will be reviewed by missions in coordination with the Bank's resident mission and the IMF. D. Benefits and Risks 50. Benefits. The ultimate objectives of the proposed credit are to increase growth and reduce widespread poverty. Under its reform program, the State will: visibly disengage from key sectors; unblock private sector activity; and do fewer things better. The key expected outcomes are higher private investment, foreign direct investment in particular, and job creation. The direct impact of policy reforms will be felt in many areas. SAC-2's focus on privatization of key, visible sectors and actions to improve governance and transparency is expected not only to help - 21 -  transform the economy, but also to maximize the impact of change signals on investor confidence. The Government is now embarked on possibly the most challenging phase of the adjustment agenda, in tenns of political courage; selective targeting of high-payoff reforms is expected to bring rewards in setting important precedents and easing the path of future adjustment. Payoff is seen to be high both in terms of the choice of sectors to be privatized (service enterprises to reduce the costs of business), and the reforms' strong links to governance (measures to remove discretion and promote automaticity and transparency in decisions affecting the private sector, and reducing opportunities for corruption, see paragraph 38). Finally, the proposed reforms - far-reaching for Madagascar but already accomplished by Africa's high performers - will prevent the country from falling behind in the competition for investor capital. 51. Risks.The nature of risk - wavering government commitment causing interruption or reversal of reforms - is the same as in the CAS, but prospects for significant steps forward seem brighter. Political will for reforms has in the past been weakened by the presence of a small but economically and politically powerful elite which exploits the general Malagasy fear of foreigners, ostensibly as a threat to local culture but in reality for fear of losing its privileged position. The country's elected leaders have therefore been reluctant to publicly embrace a foreign investment-led growth strategy and stake their political future on reforms to deregulate and open up the economy. This reluctance is reinforced by the rent-seeking opportunities for political leaders themselves and for civil servants in a State-dominated and over-regulated economy. As a result, at times the momentum and energy for reform seems to be largely driven by a desire to comply with Bretton Woods 'conditionality' rather than true 'ownership'. 52. The risks of continued support have proven worth taking in the past, however. This report documents a story of significant policy advances over the years; experience in Madagascar has been that reform moves ahead incrementally, with periods of foot-dragging under sustained external pressure leading eventually to irreversible action, making each subsequent step that much easier. Furthermore, at present, there is a growing convergence of factors which could shift the balance in favor of sustained reform. Political stability is now more likely than at any time since the transition to democracy in the early nineties, as national-level elections - which slowed follow-through of earlier reforms - are not foreseen for the next three years; with the leadership more secure, reform prospects should improve. At the same time, there is a growing realization within civil society that better governance and an open economy are key to Madagascar's development, with especially the press and young entrepreneurs being at the forefront of pressure for change. Such awareness, moreover, is also making the potential losers less adverse to change: the ultimately well-received privatization of banks - longstanding bastions of corruption, privilege and financial favors - and early evidence that even modest growth can provide opportunities for many more Malagasy (e.g., EPZ and tourism jobs) without lowering the incomes of the current elite, have shown that opening up can be a 'win-win' situation. 53. Apart from improved prospects for sustained reform, several design features of the proposed operation should help reduce risks: Number of Tranches and Flexible Design. A multi-tranche, "menu-based" operation will tie disbursements to important achievements in the reform program while giving the Government added flexibility to advance on a number of fronts at a pace consistent with shifts in the political - 22 -  economy of reform. Definition of measures - to improve the business environment - jointly by the government and private sector also provides flexibility into the design of SAC-2, while promoting ownership and helping develop consensus among stakeholders. Up-Front Actions and Safeguards Against Policy and Implementation Reversals. All elements of the previous SAC have been decisively acted upon. Board presentation measures have been met; and sale contracts will have to be signed (or the constitution of joint ventures in the case of SOLIMA petroleum lots completed) prior to tranche release. Disbursements are designed to increase substantially with each tranche, not only to finance the privatization social programs but also, and more importantly, to provide stronger financial support only as the policy environment improves and signal the importance of full implementation of the reform agenda. Actions to Strengthen the Social Sustainability of the Privatization Program. Severance payments and programs to retrain affected employees, as well as opportunities for local ownership, should help reduce the risk of opposition to the privatization program. Operation 's Limited Scope. The Policy Framework Paper under preparation contains a larger set of reform areas, but SAC-2 targets those reform with the highest payoff in terms of visibility, thus helping to improve the investment climate and to speed up growth and poverty reduction. The areas selected are also those better suited to implementation under adjustment lending. Technical Assistance Support. Three ongoing projects will support SAC-2's technical assistance needs. PATESP (Private Sector Development and Capacity Building Project) finances the technical team in charge of privatizing state enterprises, preparing retraining programs for licensed personnel and private sector development measures, while PAIGEP (Public Sector Management and Capacity Building Project) supports the STA, unit which coordinates ministries and institutions involved in the operation, and many of the public finance reform components of SAC-2. Coordination between these projects and SAC-2 preparation has been extensive. The mining LIL credit provides technical assistance for the reforms introduced into the mining sector. E. Policy, Intermediate, and Impact Indicators 54. Excluding exogenous factors, Madagascar's economy can be expected to react positively to the proposed reforms. The SAC's full developmental impact will be spread over several years, but progress by closing date may be measured in terms of: increased levels of FDI (from 0.4 percent of GDP in 1998 to 1.7 in 2001); a larger share of private investment (public/private investment ratio from 1.2 to 0.9 in 2001); and higher GDP growth (from 3.9 percent to 5.3 percent by 2001). 55. An effort has also been made to define in detail intermediate/output indicators, following the suggestions of the 1998 Bank report Higher Impact Adjustment Lending in Africa. These indicators attempt to monitor the direct impact of policy reforms on stabilization, structural change and the improvement of provided services. A few examples include: increase in telephone line penetration rates, and reduction in the gap between budget allocations and actual expenditures in education and health. The full list - which is not linked to tranche release - will - 23 -  be monitored during implementation and serve as support for preparation of the ICR of the operation (see Annex 4). In turn, it is expected that this list will provide lessons for the preparation of future operations. F. Strategic Considerations 56. Selection and Exclusion of Reform Areas/Subjects. This is a focused, high-payoff reform agenda that will help Madagascar signal a new commitment to private sector development and a redefined public sector with strengthened public finances. The second and third tranches have each only five reform areas, one core condition (privatization component) plus completion of four out of the eight reform areas described in Tables 3 and 4. Civil service reform and decentralization are two inportant areas of reform that have been excluded from SAC-2. These are linked areas that require the building of consensus and need to evolve in step with technical capacity, for which policies are best developed away from the conditionality pressures of quick- disbursing operations. They will nevertheless remain an integral part of our dialogue and policy advice, as future success in supporting Madagascar's economic and social development challenges will rest heavily on the fiscal, institutional, and administrative arrangements put in place as decentralization begins to be implemented. To this end, the IMF and the Bank are assessing mechanisms of assistance to the government that will help define an effective and sustainable decentralization process. The main objective is to take advantage of opportunities offered by effective decentralization while avoiding the negative experiences of other countries. 4. OTHER BANK GROUP ACTIVITIES 57. IFC has outstanding operations in Madagascar totaling US$10.5 million. Its involvement in the banking and tourism sector could potentially develop further as a result of this operation. As noted earlier, FIAS has prepared a pivotal report that identifies bottlenecks to private sector development in Madagascar. The conclusions of a related seminar, sponsored by FIAS and US AID with the participation of government and private sector, have been reviewed and a medium- term action program is being prepared. Implementation of the program is a disbursement trigger for this operation. MIGA has operations amounting to over US$5 million. Key sectors for MIGA's involvement are likely to be mining and tourism. 5. COLLABORATION WITH THE 1MF AND OTHER DONORS 58. Donors have worked well together and with government in Madagascar. In particular, close BankfIMF coordination has been an important aspect of the economic reform dialogue. Joint missions have taken place in recent months to assess progress on both the macro front and the structural reform agenda. Coordination with other donors has also been strong, with joint work in rural development and roads (reform programs under preparation), and in an education sector project already under implementation. Some of the reforms are also the result of joint - 24 -  discussions with some of Madagascar's major donors. For example, policies in the fisheries sector have developed as an outcome of extensive discussions that have taken place within Malagasy society and with support - including financial - from the European Union. The EU is also providing substantial support to the reform program in areas complementary to those supported by the Bank. 6. RECOMMENDATION 59. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association and I recommend that the Executive Directors approve it. James D. Wolfensohn President by Sven Sandstrom Washington, DC April 19, 1999 Attachments - 25 -   ANNEX 1: MEASURES SUPPORTED BY SAC-2 ~~~~~~~~. . . . . . . .. ..... . . MEASURES TAKEN POR TOBOARD PRESENTATION1-::: * BTM: Signing a sales protocole for BTM. * Public Finance: Complete changes in budget nomenclature to match Budget Law and Treasury accounting. * Arbitration: Adoption of an Arbitration Law by the National Assembly. * Telecommunications: Publication of inter-connection decree between fixed and cellular operators. * Mming: Mining Code, agreeable to IDA, approved by the Council of Ministers and submitted to the National Assembly. Re-definition by law of the role of OMNIS, in practice precluding the State from participating in commercialization and/or production of mining products and limiting its role to promotional activities. * Fisheries: Increase license fees by 100 percent (on average) in 1999 relative to 1998, and prepare report on actual and potential payments per firm. Conunit to the introduction of a transparent, non-discretionary, and competitive mechanism for the allocation of fishing licenses before the fishing campaign of the year 2000 (e.g., bidding mechanism that takes into consideration Madagascar's own features, and following terms of reference already agreed with IDA). Limit the number of licenses in the west coast to a total of 69 industrial and 36 artisanal, and to 6 industrial licenses in the east cost (freeze to remain until completion of sustainability study), and respecting the 1998 distribution of authorizations per zone and boat for each firm. .. . :: -:::- -:-~~~~~~~~~~~~~~~~. .........E .:.::: ... :: . . ... . .. . .. . . ........... ...... .. . . . ......... . . . . . ................. . . ...... .... . . . . . . . . . . . .. .. . . . .. . . . . . . . . . . . . M E A SUR ES IFO.R` C R EnD IT P EFE9Cl.TI!V..E -NE tS S (1 T RA N CHE): - - -. - ~~~~~~~~~~~~~~~~~... .. . ....- . . -.--- * The Borrower has: (a) a macroeconomic framework consistent with the objectives of the Program, this includes securing the international fnancial support necessary for the sustainability of this framework; (b) adopted an action plan (including an implementation schedule) describing the methodology to be followed to compute severance payments; (c) firnished evidence that: (i) with respect to the privatization ofSOLIHMA's oil operations, each of the joint-venture companies referred to under paragraph 17 of the LDP has been established (in particular with respect to the relevant share of the capital stock to be held by the Borrower), and duly registered; and (ii) with respect to SOLIMA's non-oil operations, the Borrower has concluded contractual arrangements aimed at transferring the ownership/use of the said operations to private sector entities; and (d) the Borrower has established a legal and regulatory framework and a regulatory authority for the petroleum sector with functions, membership, budgetary resources and adequate staffing, all satisfactory to the Association and in accordance with paragraph 19 of the LDP. GENERAL CONDITIONS AND DESIGN OF 2hd AN rd NU BASED" TRANCHES ~~~~~~~~~~~~~~~~.................................. ............... ~~~~~~~~~~~~. ....................... . . ... . ..... . . .... . ........ . . ... . . . - .. . .- - - .. - - - -- - - - - - - -- - - - - . ............... , . -, - ...... . ... . . .. .... .. .. . . . . . . . . . .. . .. ........ * The Borrower has achieved satisfactory progress in the carrying out of the Program, including: (i) BTM privatization process has been settled prior to the release of the second tranche through the completion of the existing sales protocol or, if the deal unravels, already agreed steps for full State disengagement from BTM are put in place; (ii) social programs have been implemented as agreed with IDA; and (iii) a macroeconomic framework consistent with the Program has been maintained. In addition, each of the "menu-based"tranches requires a CoRE MEASURE (one sales contract, and fully operational regulatory framework and body), and ADDmTIONAL MEASURES (fully complied a total of 4 out of the 8 reform areas listed in the next page). - 27 -  MEASURES FO RU2nd AND 3rd" -BASED". ETRANC S CORE MEASURES * Air Transport: The Borrower shall have: (a) sold at least 65 percent of Air Madagascar's voting stock; (b) established an adequate legal and regulatory framework and a regulatory authority with functions, membership, budgetary resources, and adequate staffing (all in accordance to paragraph 19 of the LDP); and (c) invited airport operators to bid for the concessioning of at least two main lots of airport infrastructure. OR * Telecommunications: The Borrower shall have: (a) sold at least 34% of TELMA's voting stock; and (b) established an adequate legal and regulatory framework and a regulatory authority with functions, membership, budgetary resources, and adequate staffing (all in accordance to paragraph 19 of the LDP). ADDITIONAL MEASURES Private Sector Development 1. Mining Sector. The Borrower shall have enacted a revised Mining Code, including implementation decrees; and adopted an action plan aimed at expediting the processing of mining permit applications. 2. Land Tenure. The Borrower shall havetaken all the measures referred to in paragraph 12 of the LDPto facilitate access to land; and invited investors to submit bids for five tourism and five industrial zones. 3. Business Environment and Judicial Processes. The Borrower shall have: (a) on the basis of the results and recommendations of its ongoing study (Etude sur les lenteurs de la procedure judiciaire), adopted an action plan to improve caseload management within the judicial system; and achieved substantive progress in the execution of the said action plan; and (b) on the basis of a consultative process involving all interested parties, adopted an action plan for the purposes of streamlining formalities and procedures required to carry out economic activities, and achieved substantive progress in the execution of the said action plan. 4. Sector Liberalization and Additional Sector Reforms. The Borrower shall have: (a) granted at least two anport concessions to qualified and experienced private operators; (b) invited telecommunications operators to bid for a national license to provide telecom services; and(c) enacted a law governing the fiscal regime of mining projects whose investment costs exceed about US$200 million, including implementation decrees. Public Finance Reform 5. Revenue Policies and Monitoring. Established a unit within the Ministry of Budget with terms of reference satisfactory to IDA to monitor public revenues, and to review medium and long-term tax policy and tax administration reforms. 6. Expenditure Monitoring in Social Sectors. The Borrower shall have: (a) established an appropriate monitoring system to capture the implementation of the Borrower's social policies and expenditures actually incurred for primary education and basic health with respect to the specific budget items andsectoral policies specified in paragraph 24 of the LDP; and (b) carried out a survey based on a methodology aimed at assessing the Borrower's performance in the delivery of primary education and basic health services. 7. Fishing Licenses. The Borrower shall have: (a) established an appropriate system, satisfactory to the Association, to allocate shrimp fishing licenses in a non-discretionary, competitive and transparent manner, (b) adjusted annual shrimp fishing fees for licenses granted for the 1999 fishing campaign in accordance with the methodology adopted as a result of the revamped licensing system referred to above; and (c ) carried out the recommendations resulting from the technical and financial audits of the FDHA. 8. Financial Sector Reforms. The Borrower shall have: (a) carried out the financial, organizational and actuarial audits through independent consultants for the insurance companies Ny Havana and Aro, and the social security funds CNAPS, CRCM and CPR; and (b) adopted action plans to improve their performance. - 28 -  ANNEX 2: GOVERNMENT' S LETTER OF DEVELOPMENT POLICY REPUBLIC OF MADAGASCAR 1. Reducing poverty, which currently affects 75 percent of the population, through faster economic growth is the main objective of the Government. Economic growth averaging only 0.5 percent annually since the early 1970s and annual population growth rates of close to 3 percent have resulted in a significant decrease in per capita income. The Government's reform program has begun to show positive results, materializing in low and stable inflation rates and higher growth rates, reflecting an improved overall performance, with, in particular, increases in levels of per capita income. The challenge facing Madagascar is to further reduce the gap between potential and actual perfonnance, thus permitting a sustained increase in per capita income. 2. This Letter of Development Policy (LDP) describes the Government's development strategy; which consists in strengthening the growth determinants of Madagascar's economy. The strategy in underpinned by a sound macroeconomic framework that signals continued commitment to fiscal and monetary responsibility, and by the adherence to free market policies. The three pillars of this strategy are: * creation of an enabling business environment that facilitates private sector development; * disengagement of the State from productive economic activities; and * public finance reform, with emphasis on the provision of more and better-quality social services, particularly those targeted to the poor, and the rehabilitation and development of basic infrastructure. 3. In addition, it is the Government's belief that the process of opening up to the trade forces and foreign direct investment flows that have supported development efforts in other countries should be expedited. The Government is committed to continuing the trade liberalization policies that have helped diversify Madagascar's sources of export earnings, 86 percent of which are derived from non-traditional economic sectors. However, the progress made in attracting foreign direct investment (FDI) has been less successful; only US$27 million in 1998. The Government's goal is to strengthen those reforms that would enable Madagascar to attract more FDI, with a view to realizing the country's potential. Policies will be continued aimed at: (i) liberalizing the foreign exchange market; (ii) eliminating price and market distortions in key economic sectors; (iii) strengthening monetary and fiscal management; and (iv) pursuing other reforms supported by the international community. PROGRAM OBJECTIVES 4. The program focuses on highly-visible reforms that are expected to maximize the pay- offs from policy changes. Growth rates are hoped to increase further from their already encouraging levels (to more than 5 percent by 2001), driven by: (i) growth in the manufacturing - 29 -  and service sectors; (ii) increased private sector investment; and (iii) reforms aimed at attracting foreign direct investment, the latter providing access to management know how and trade links. 5. Indicators have been identified for assessing the results achieved, and monitoring mechanisms will enable to evaluate performance in the implementation of the adjustment program. Semi-annual surveys are scheduled to begin in early 1999, and will be used in particular to assess the impact of reforms in streamlining the formalities affecting private sector development, and to monitor social sector reforms,. The aim is to learn lessons that will serve to re-direct program implementation, if this becomes necessary. MACROECONOMIC FRAMEWORK 6. The Government has agreed with the International Monetary Fund and the World Bank on a macroeconomic framework for the 1999-2001 period. This framework is consistent with a high-growth scenario, and takes into consideration the poverty-reducing objectives referred to above. The trend over the last few years, with economic growth exceeding population growth for the first time in the 1990s, is encouraging, but the goal is to ensure that the necessary conditions are established for an even higher growth driven by private sector initiative. 7. More specifically, monetary and fiscal policies are expected to remain consistent with a declining inflation rate, which will be down from 6.3 percent in 1998 (61.2 percent in 1994) to about 4 percent by 2001. Public finance management will aim at reducing budget deficits, from 4 percent of GDP in 1998 (including grants) to 1.2 percent in 2001, while increasing revenues, from 7.7 percent of GDP in 1994 to 10.1 percent of GDP in 1998 and about 13 percent by 2001. Financial stability has led to stable exchange rates and good export earning performances, including those of some non-traditional sectors such as fisheries and tourism. The current account deficit in the balance of payments (including grants) fell from 7 percent of GDP in 1994 to 4 percent in 1998, and is expected to reach 3 percent by 2001. The program also aims to build foreign exchange reserves to over 13 weeks of imports of goods and services by end- 1999. 8. The Central Bank will continue to make use of indirect monetary policy instruments, and has committed itself to strengthening its supervision capabilities and to enforcing prudential regulations. Consistent with the Government's objective of strengthening financial stability and promoting private sector activities, the State has sold its controlling interest in BFV (a commercial bank) and has signed a memorandum of understanding for selling a controlling interest in BTM (a rural development bank), a process that will be completed by mid-1999. To reduce restructuring costs, the Government has adopted a Law to facilitate the recovery of non- performing loans, and has announced its commitment to publish the list of debtors. The total costs entailed have been entered in the 1998 and 1999 Budget Laws in a transparent manner. STRUCTURAL REFORMS 9. While supporting the macroeconomic stability objectives described above, the Government has opted for a development strategy that will be driven by the private sector. The first pillar of this strategy will be based on the creation of an enabling business environment that can facilitate private sector development, including the streamlining of the rules and the reform - 30 -  of the institutions governing private sector activities. The second pillar relates to the State's commitment to disengage from most productive activities by June 2000, a decision that will be reflected in: (i) the sale to private sector investors of the Government's controlling interests in 46 state enterprises; (ii) liquidation of those enterprises that have not generated private sector interest; and (iii) application of modern regulatory frameworks that support sector liberalization. Finally, the third pillar aims at refocusing Government activity, with emphasis on the provision of more and better-quality social services, particularly those targeted to the poor, and the rehabilitation and development of basic infrastructure. Action on the above areas is bound to strengthen the substantial progress already achieved since 1996. Progress has been noticeable in the strengthening of the financial sector, the sweeping changes made in the exchange rate system, and the elimination of non-tariff barriers, with the exception of those relating to certain health and security concerns. Private Sector Development 10. Enabling Business Environment. A program to provide support for private sector development has been developed by a task force consisting of representatives of the Government and the private sector. This program is intended to streamline and reform the institutions and rules governing private sector activities, thus facilitating private investment and the entry of new firms. This will be achieved by clarifying and simplifying information on procedures, increasing coordination between various branches of the public administration, and increasing the timeliness of decisions by public officials. Procedures for issuing work permits and residence visas will also be simplified. The first phase of the program, to be completed by end-1999, will focus on two areas: facilitating the establishment of enterprises, and simplifying the administrative procedures applied to tourism enterprises, while enforcing regulations on quality, safety, and hygiene. 11. Rule of Law. The Government will continue its program for reforming the legal sector, with special emphasis on the following activities: (i) completion of the compilation of laws and various codes; (ii) introduction of additional reforms identified by the Commercial Law Reform Commission; (iii) development of policies on remuneration linked to performance; (iv) introduction of an arbitration system for settling commercial disputes; and (v) continuation of training programs for judges and other personnel at the ENMG (Ecole Nationale de la Magistrature et des Greffes or National School of Magistrates and Officers of the Court). In addition, all appointments of judges and officers of the court will be based on an ENMG competitive examination. A special study has been commissioned to determine the causes of delays in processing cases, whether these arise from the procedures themselves or from the behavior of those officials involved in the judicial process, the purpose being to adopt measures for speeding up legal processes. A medium-term action plan will be prepared on the basis of the recommendations of this study, the first phase of which is to be implemented by June 2000. A number of measures have already been identified, and should be fully introduced by end-1999. These include: (i) elimination of certain court costs; (ii) review and reconciliation of budget items relating to legal personnel with the actual numbers of positions; and (iii) determination of the costs of postal fees for judicial correspondence and of mission allowances incurred as a result of the need for judicial oversight. The justice system will be provided with budget appropriations under the 2000 Budget Law to enable it to improve its performance in the above areas. - 31 -  12. Access to Land. A key aspect of the program now being implemented is the facilitation of access to land. The Government will implement a pilot program for allocating land, through transparent competitive mechanisms, in areas with high economic potential. Five tourist zones and five industrial zones (about 10 hectares, with expansion potential) will be identified and designated as reserved areas. The invitation to bid will describe the methods of allocation and the rights and obligations of investors. The procedures for granting of a bail emphyteotique (long- term land lease) will be simplified through special reforms for clarifying the allocation process (manual of procedure or guide) and for amending the taxation system to permit payment in installments. Although these measures will provide a short-term solution to this pressing problem, mechanisms will be developed for finding more durable solutions to land access. 13. Mining. Since mining has the potential to quadruple the level of exports by the end of the next decade, it is a key sector for Madagascar's development strategy. A new Mining Code has already been submitted to the National Assembly for its approval. This code is intended to provide stable legal and fiscal frameworks for mining projects, and increased transparency in the allocation of mining concessions through the use of "first come, first served" allocation systems in risk areas and the use of a bidding system in areas of recognized potential. For large scale mining projects, the Government will prepare a law establishing the special tax system to be applied to these projects. This law, which will apply to investments of over US$200 million, will preclude case-by-case negotiations and will establish a tax system that is in line with international best practices. The existing backlog in the processing of mining applications will be cleared, using transparent and non-discretionary mechanisms, by at least 80 percent by the end- 1999. The State is committed to restricting its activities to surveys and promotional activities, and, to this end, it has redefined the role of OMNIS, a parastatal enterprise, thus ending State participation in production and commercialization. In addition, KRAOMA will be privatized. 14. Fisheries. The Government, in consultation with private sector representatives, the World Bank, and other donors, has committed itself to the adoption of new policies in the fisheries sector. The objectives are to: (i) increase revenue accruing to the budget; (ii) increase transparency in the allocation of fisheries licenses; and (iii) ensure the sustainable exploitation of fisheries resources. To this end, the Govemment has commissioned a study that will propose methods of allocating shrimp fishing licenses in a competitive, transparent, and non- discretionary manner, and has undertaken to gradually introduce the new system, starting with the fishing season in the year 2000. It is also planned to carry out a special study that will evaluate the sustainable level of exploitation for this resource. Until this study has been completed, fishing operations have been limited by freezing the number of industrial fishing licenses to 6 on the east coast and 69 on the west coast. Artisanal fishing licenses are limited to 36 for both coasts. This freeze also precludes, in the case of those firms that were also in operation during 1998, any changes in allocations by type of boat or authorizations by area. Licenses and authorizations that may become available will be allocated through a transparent, competitive, and non-discretionary process. 15. Rural Development. The development and implementation of a special rural development program (PADR) is being carried out through close collaboration between the Government and Madagascar's key donors. The program will develop a priority based strategy that will improve the sector's support infrastructure, particularly rural roads and irrigation works. - 32 -  A key aspect of the program consists in carrying out research to establish best practices, and facilitate their dissemination. A program of action was introduced after the resurgence of plagues of locusts and this program has achieved positive results. It includes policies for minimizing negative impacts on health and the environment. Mechanisms that will allow for more effective control are being developed, including a preventive surveillance system. 16. Other Economic Sectors. The high-growth, poverty-reducing path described in this Letter of Development Policy is also contingent on the development of the secondary and tertiary sectors, including tourism and export oriented manufacturing. Tourism has developed largely as a result of the reforms the country has introduced since 1996 in air transportation, telecommunications, and tourist visa procedures. The Government is committed not only to maintaining these policies, but also to searching for mechanisms to enhance Madagascar's attractiveness as a tourist destination. The performance of the export processing zones has been remarkable in the 1990s, and the Government is committed to its future development. State Disengagement from Productive Activities 17. Privatization Program. The State has total or partial ownership of about 136 enterprises and by June 30, 2000 it will sell its controlling interests in - or proceed with liquidations of - 46 of these enterprises. The program objectives are to: (i) improve the availability and quality of key services at competitive costs; (ii) encourage alliances between local and foreign operators; and (iii) eliminate potential burdens on the government budget. This program includes the State's divestiture from key sectors, including: the transfer of assets for gas and road transportation lots and the sale of equity for the petroleum companies formed as a result of the breakup of SOLILMA into eight petroleum lots, with State participation not exceeding 30 percent of the voting stock in any of these enterprises; the sale of at least 34 percent of the voting stock in TELMA, the State telecommunications enterprise, thus reducing public sector control to no more than 30 of the voting stock; and the sale of 65 percent of the voting stock in Air Madagascar. The ultimate objective is not only to disengage the State from these economic activities, but also to liberalize these sectors. Other companies on the privatization list include the sugar company SIRAMA, the cotton firm HASYMA, the railway company RNCFM, and the State's controlling interests in rice enterprises. 18. Transparency of the Privatization Process. The privatization program is based on the 1996 Law on the Disengagement of the State from Public Enterprises (Law 96-011), and includes mechanisms for ensuring that the process is transparent and competitive. This entails: (i) wide publicity for enterprises for which private sector participation (total or partial) is being sought; (ii) pre-qualification criteria and methods of selection that are precise and streamlined and are presented in the bidding documents; and (iii) the publication of bidding results, including conditions of sale, bids received, and transaction prices. Reports will be issued periodically (one per quarter) to the press and general public indicating the progress made in the implementation of the program, as well as information regarding the revenues and costs generated. 19. Regulatory Frameworks. To develop competitive forces, the disengagement strategy will be accompanied by fully operational regulatory frameworks. In the oil sector, legislation was passed by the National Assembly in March 1999. The decrees governing application of this - 33 -  Law (including those pertaining to the establishment of the OMH) were adopted in April 1999. Imports of refined products will be fully liberalized, and distribution companies will have unrestricted access to existing and new storage facilities. Air transportation in Madagascar was liberalized through the implementation in February 1999 of the decrees governing the application of Law 96-033 (No. 99-123, establishing the methods of exploitation of international air transportation services; No. 99-124, organizing the civil aviation administration of Madagascar; No. 99-125, establishing the methods by which civil aviation in Madagascar is to be financed; and No. 99-126, regarding the operation of services for the public). A draft law on civil aviation will be submitted to the upcoming session of Parliament in May 1999. Currently, the charter airline segment is fully liberalized, with operators allowed free entry on the basis of open-ended licenses issued in accordance with selection criteria that comply with international standards of safety. Concessions will be granted for main and secondary airport lots, based on economic and financial viability criteria, so as to permit private sector investment. Air Madagascar has been authorized to operate exclusively for 5 years the 8 regional and international routes that it currently services, but this does not prevent foreign companies from operating in Madagascar on the basis of the existing bilateral agreements. The decrees governing application of the Law on the Liberalization of the Telecommunications Sector (No. 96-034) have been adopted (the Decree amending Article 8 of Decree No. 97-1155; the Decree establishing tariff controls; the Decree governing the implementation and financing of access to telecommunications services; the Decree defining the procedures and measures to be applied by OMERT for regulating the sector; and the Decree regulating and managing frequencies and radio-frequency bands). A bid for a second national operator will be launched before the release of the last tranche of CAS-2. 20. Social Component of the Privatization Program. Specific actions for addressing the social dimension of the program have been introduced in the form of a social component. To make this component operational, the Government has officially charged the management of PASERP (Social and Economic Program for Occupational Retraining) with the task of providing the necessary administration and guidance. The methodology to be used has been adopted by the Council of Government and forwarded to Bank. These operations will be evaluated during Bank supervision missions and judged on the basis of how closely they adhere to the methodology that has been adopted, and what progress has been made in the privatization program. Moreover, the Government will submit an application for increased technical support for the current occupational retraining program. To facilitate local participation in the purchase of the enterprises to be privatized, a fund has been created (Fond de Portage et de Privatisation), which will be given equity in the privatized enterprises which it will sell to Malagasy nationals, with preference being given to the staff of those enterprises. A share of net privatization receipts (excluding debt) will be used to finance regional and social investment projects. Public Finance Reform 21. The development strategy described in this Letter of Development Policy requires stronger public finances, implying changes in the role of the State that go beyond the privatization program. The Government intends to act on reform on all fronts, but attention will be given to providing more and better-quality social services targeted to the poor, particularly as regards primary education and basic health, with special emphasis on rural areas where 79 percent of the population lives. This general objective is based not only on the Government's - 34 -  commitment to assist the poor, but also on its conviction that the private sector driven growth strategy described in this LDP could fail if it is not socially inclusive. In addition, certain reforms to increase revenue collection and better manage natural resources are being considered, particularly the fisheries resource. 22. Tax Revenues. The Government is committed to the application of tax measures that will enable revenue to be increased by broadening the tax base. Specific measures have been adopted to stop tax exemption practices, which have been responsible for substantial shortfalls in revenue. The strict application of regulations has limited exemptions to those cases provided for by law and international conventions. The Govermnent's commitment to the administration of public resources will be reflected in a better performance in terms of revenue collection and the quarterly dissemination of information to the general public. The goal is also to engage in a more systematic analysis of revenue performance in order to identify areas that require reform, as revenues have increased but are still below the Sub-Saharan average of 15 percent of GDP. Improvements in revenue collection are also expected from the institutional strengthening of the revenue administration. A tax unit responsible for collecting payments from large enterprises has been created (the Service des Grandes Entreprises). A series of new measures have been introduced into the Budget Law, including the elimination of ad-hoc exemptions (the 1998 amended Budget Law), the repeal of the Investment Code (1996), and subsequent authorizing decisions (1997), as well as new rules for enterprises operating in export processing zones (1998). A system of VAT refunds has been introduced for export and investment activities. 23. Non-Tax Revenues and the Use of Resources from the Fisheries Sector. In 1999, Shrimp fishing license fees have been increased by an average of 100 percent over their 1998 level, all arrears of fees for 1998 have been paid, and further increases are expected once the new allocation system for licenses has been introduced (see paragraph 14). Implementation of this new system will be gradual, but fees for those licenses issued under the old system will be reviewed in light of the fees payable under the new system. The resources allocated to the FDHA (Fonds de Developpement Halieutique et Aquicole) in 1999 have been set at FMG 4 billion, thus enabling an increased contribution to the priority needs of other sectors. Allocations for future budget years will depend on the Fund's performnance, and will neither exceed 20 percent of the revenue generated from the exploitation of fisheries resources and other revenues generated by the sector, nor FMG 4 billion, the latter increased by 10 percent in real terms per year. These resources will be transferred from the Treasury to the FDHA as license fees and other revenues are received. Eighty percent of FDHA resources will be used as counterpart funds for projects co-financed by donors. The Fund will be administered by an ad-hoc inter-ministerial committee (Fisheries, Budget, and Finance), with the participation of donors and the private sector. Projects financed by FDHA are included in the Public Investment Program. In addition, technical and financial audits of FDHA will be carried out by end-1999, and measures for improving its performance will be developed on the basis of the recommendations of these audits. 24. Budget Policy. As revenue collection is increased it is critical, in order to avoid wasting these resources, to achieve efficiency gains as soon as possible through the reform program. The Government has instituted a monitoring system for the social sectors which includes three different sets of measures: (i) selection and monitoring of expenditures in the budget chapters relating to the delivery of certain administrative and technical services, as well as maintenance; - 35 -  (ii) implementation of sector reforms agreed upon during the last Public Expenditure Review (October 1998), particularly as regards the procedure for delegating the use of allocations in outlying areas receiving primary education and basic health services; support by the government for primary schools run by local communities; and cost recovery activities in the health sector; and (iii) user surveys for assessing performance in the delivery of social services in primary education and basic health-care. Special attention will be given to vocational training programs, nutrition programs, the cost of legal services, the financing of basic infrastructure in rural areas (roads and irrigation works), and the protection of the environment. To the extent possible, some of these policies will involve user fees and cost recovery mechanisms. 25. Budget Monitoring. Expenditures will be very closely monitored by the Ministries of the Budget and Finance, and budget allocation will be tied to revenue performance and used for priority programs. With regard to capital expenditures, the Government will continue to apply the strict selection criteria for projects in the Public Investment Program, ensuring a balance between investment expenditure and the possibility of covering the recurring costs created by the projects, and the elimination of arrears. The functions and powers of the State General Inspection Office (Inspection Generale de l'Etat, IGE) will be strengthened with regard to the monitoring of off-budget expenditures, and consideration will be given to selecting the most appropriate of the proposed sanctions. In addition, the creation of the Financial and Budget Discipline Council (Conseil de Discipline Financiere and Budgetaire, CODIF) will permit sound budget execution and reduced levels of impropriety and corruption. Once the 2000 Budget Law has been voted on, the application of the new chart of acco-unts for public transactions (PCOP) will enable the same classifications to be used for all govemment accounting and budgetary transactions, whether these concem: (i) the Central Govemment; (ii) decentralized regional authorities (CTDs); or (iii) public enterprises (i.e. EPICs and EPAs). 26. Other Areas of Public Sector Reform. In the medium-term, Madagascar also needs to reduce the risks inherent in a still weak financial system, and to implement decentralization, as constitutionally mandated. In the financial sector, and beyond the completion of the reforms discussed for the banking sector, the Government is committed to identifying the remaining structural weaknesses. To this end, organizational, financial, and actuarial audits will carried out in the state insurance enterprises (Ny Havana and Aro) and social security funds (CNaPS, CRCM, and CPR), thus preparing the ground for future reforms. The Government has already decided to privatize the insurance companies, and a competitive and liberal draft Insurance Code has been approved by the Council of Ministers. As regards decentralization, work is in progress to assess its many fiscal, administrative, and institutional ramifications. The objective is to take advantage of the opportunities provided by effective decentralization, while avoiding the pitfalls encountered in this process by other developing countries. CONCLUDING REMARKS 27. The Government is implementing a strategy of high growth combined with poverty reduction. The foundation of this strategy is an improvement in governance resulting from the three pillars described in this Letter of Development Policy: (i) creation of an enabling business environment that facilitates private sector development; (ii) disengagement of the State from productive activities; and (iii) public finance reform, with emphasis on the provision of more and - 36 -  better-quality social services, particularly those targeted toward the poor, and the rehabilitation and development of basic infrastructure. Commitment to reform will also be reflected in the use of mechanisms that serve to monitor and disseminate information on expenditure in the social sectors, thus enhancing the credibility of the program. Similarly, surveys will be carried out in the business and social sectors in order to assess progress in the implementation of the program, and reports on the privatization program will be issued. The program is expected to garner the support of the international community, including that of the World Bank in the form of a Second Structural Adjustment Credit. Antananarivo, April 12, 1999 - 37 -   ANNEX 3: MONITORING SOCIAL SECTORS IN SAC-2 Madagascar's education and health sectors are subject to structural problems which have limited the effectiveness of government actions. Some of these problems are tackled in sector operations. The monitoring of the social sectors under the SAC aims to support corrective government action in the areas of resource availability for budgetary commitments, implementation of flagship policies (those already agreed for 1999 and those that may be introduced for 2000 based on 1999 assessments), and benchmarking of overall performance in primary education and basic health. Sector Management Issues Madagascar's primary education has a highly centralized management structure and poor ministerial control over substantial portions of financial and human resources. Together with cumbersome expenditure control mechanisms which have a disproportionate impact on remote locations, these factors have led to a misallocation of teachers between urban and rural areas, and to a shortage in books and supplies particularly in rural areas. This has also led to the healthy development of private schools and community schools, albeit with the negative implication that the poor pay for much of the education services received. The health status of the Malagasy population is similar to that of Sub-Saharan Africa and is in large part curtailed by the country's limited economic development. Systemic factors restraining the national health system's potential from improving the quality of life for the Malagasy are the inefficient use of existing financial and human resources, the high degree of centralization in decision making and resource management, and only thirdly, the low level of public expenditures. As in primary education, the number of health care facilities is inadequate and under-staffed in remote areas. Unlike education however, the private sector plays only a marginal role in the health sector service delivery. Indicator Set 1: Government Commitment to Budget A key benefit of a stable macroeconomic environment is the provision of timely and predictable levels of financing to programs of line ministries and other agencies. Madagascar's budgetary procedures are such that line ministries have most discretion over recurrent non-salary expenditures. Past experience shows that budget resources were not spent as originally programmed or that expenditures take place excessively during the last quarter of the fiscal year. The SAC aims to monitor resource availability of particular subcategories of the budget with greatest operational importance to sector programs. Namely, for primary education, chapters 13 (general supplies), 14 (books), and 17 (maintenance), and for health, chapters 14 (medications) and 17 (maintenance). Allocation to the chapters will be monitored on a quarterly basis so as to introduce corrective measures early on during Budget execution should that be necessary. Indicator Set 2: Government Commitment to Sector Policies In primary education, government policies are aimed at reducing the disparities in services provision between urban and rural areas by overcoming some of the systemic obstacles caused - 39 -  by a centralized management system combined with a poor communications and transportation infrastructure in a mainly rural country. The poor performance of the public school system has led to greater community involvement in the management and financing of public schools (resulting in increased accountability of school teachers and consequently better services), and the development of community schools. In this context, the Government's two-pronged strategy calls for: (i) simplifying budgetary procedures so remote districts can draw directly on allocated amounts from the line ministry; and (ii) direct line ministry support (school books and partial financing of teachers) to community schools. In the health sector, the Government has made formidable efforts through 1998. Nevertheless, important areas remain to be tackled to address urban and rural disparities in service provision, and to ensure availability of medical supplies. Although the Govemment is implementing an array of policies, SAC-2 will focus on two important ones, which are also more simple to monitor: cost recovery (to enable a larger share of non-salary recurrent expenditures to be used for maintenance), and simplification of budgetary procedures so districts can draw directly on allocated amounts from the line ministry, thus avoiding past delays. Indicator Set 3: Surveys for Evaluation of Budgetary and Policy Effectiveness In order to assist authorities evaluate the effectiveness of current policies, the Government will use survey methods to assess their impact across Madagascar. The surveys, to be more completely defined at a later date, would include urban and rural, as well as poor and non-poor distinctions. The surveys would be conducted on an approximately semi-annual basis, and will build on the ones carried-out for the Public Expenditure Review of October 1998. It is expected that these surveys would be potentially useful for upcoming rounds of budgetary decision making. The survey results would be disseminated nationally through adequate publication in national newspapers. - 40 -  ANNEX 4: POLICY, INTERMEDIATE, AND IMPACT INDICATORS Following the report on "Higher Impact Adjustment Lending in Africa," 1998, performance indicators are classified into policy/measure, intermediate/output, and outcome/impact indicators. The first refer to the actual policy or institutional change that constitutes conditionality. The intermediate or output indicators attempt to monitor the direct impact of the policy reforms on stabilization, structural change, and the improvement of provided services. Outcome indicators monitor progress towards the ulterior objective of reform: growth and poverty reduction through private sector driven investment. The relationship of the latter to specific conditionality is difficult to isolate among the different supported reforms. It is expected, however, that the proposed SAC would lead to: (i) increases in FDI as a share of GDP (from 0.4 percent of GDP in 1998 to 1.7 percent in the year 2001); (ii) increases in private investment (with public investment/private investment ratio declining from 1.2 in 1998 to 0.9 in 2001); and (iii) growth increasing to levels above 5 percent by the 2001, the latter driven by manufacturing and service sector growth. ... ,,,, ,,, . A . ,. .. , . .........~~~~~~~~~....... .. .. ............ ....... . ..... ...... ................ ............... ...... ..........,-.-EFORM AREAS EPQICY / MEASUE :NTERMEDA TE, OUTPUT INDICATORS INDICATORS. (by SAC-2. d:osing d ate Privatization and Sector Liberalization Telecommunications * TELMA sold * Penetration rate (number of telephone * Issue call for bids for second-fixed lines by 100 inhabitants) increases from telecommunication operator 0.37 in early 1999 to 0.90 in 2001 * Publish interconnection decree for * Number of lines per employee fixed and cellular operators increase from 15 in 1999 to 35 in 2001 * Call completion rates increase from 55 percent in early 1999 to 70 percent in 2001 * Waiting period for line declines from 7.5 months in early 1999 to 4 in 2001 * Cost of calls Antananarivo-Paris decline by 10 percent between early 1999 and 2001 Air Transport * Air Madagascar sold * Round-trip passenger ticket * Concession of main airports in at least Antananarivo-Paris (tourist class, APEX 2 lots fare) declines by 20 percent between early 1999 and 2001 * Cost of freight per pound Antananarivo-Paris declines by 10 percent bAv early 1999 and 2001 * Cost of freight prices per pound between Antananarivo-Johannesburg declines by 1O percentb/w early 1999 and 2001 Petroleum Distribution * All petroleum lots privatized @ 30 percent increase in investment level in the distribution network between early 1999 and 2001 * 50 percent of service stations in the country meet international safety standards by 2001 - 41 -  .SSEi ..... i..i.REEiR ..Ei . ..... ....E....E.... ... AN ERM E T E -IE E JT Ei ::riiEE.-jj,E ............................... .......... .. . .._.... .... . . . . - - - 1 REFORMARAS - I WPLI:-E i EAUE ::---DI-- -OU TUT ...... i ... i iRERiC.EFEEEPS ..........E.........................................---E---E .......... ....... ............ ............ ----. -.......--"............I - ~~~~~~~~~~. il. i. -i- ., . tidSE...............i. i.R.i.E:. - ......... il. .i} ilER. - . E ER E . ...g r?N y ER .. . . - ............... . . .... -N)) ATOX-S- - - -i--g. :: --E ..............E C iiDiid Ei- . .............. .. ......... .i..............i....... .....i. ....D.F i F y i ) i g i E i E i R i . . i E E Mining Sector i Enact new Maning Code Mining authorizations under * New decree redefining role of OMNIS exploitation as a share of total * Clear existing backlog in mining authorizations increases from 25 to 50 concession applications by 80 percent percent Land Tenure * Changes to bail emphyteotique * Total number of bails issued increase procedure 100 percent in Antananarivo, * Bidding for "tourism" and "industrial" Antsiranana, and Tolagnaro regions blw zones carried out 1999 and 2001 * Foreigners share in total bails issued increases from 0 percent to 20 percent * At least one of each of the tourism and industrial zones is being developed Enabling Business Environment * Inplementation of first phase of the * Replication of WDR surveys show action plan agreed between government greater overall investor satisfaction and private sector (progress will build on recommendations of FIAS report) Revenue Monitoring and Policies * Preparation and quarterly publication * Actual customs collection, cormnon of revenue collections, including custom regime, increases from 75 percent to 90 revenues, detailing difference between percent of the theoretical share; the actual and theoretical collection (when suspensive regime's share in total applicable), or between projected and imports declines from 50 percent to 40 actual revenues percent * Legal exemptions monitored more closely, publishing list of existing beneficiaries and canceling the rights of those that have not met legal requirements; elimination of all ad- hoc exemptions Monitoring Progress in Social * Mechanisms to improve match * Actual recurrent non-salary Sectors between budget allocations and actual expenditures for primary education and expenditures for primary education and health (chapter C.3) increase from 80 health, including quarterly publication percent and 84 percent in 1997 of actual expenditure data per district respectively, to a mini- mum of: 90 percent in 1999, and 98 percent in 2000, for both sectors. * Community schools begin to receive government support (non-wage recurrent expend., and mostly for rural schools): 75 schools 1999, and 150 additional in 2000. * Actual cost recovery, introduced in 1998, increases from FMG 20 billion in 1998 to: FMG 50 billion in 1999, and FMG 100 billion in 2000. Fishing Licenses * Revenue to State increases by 100 * Shrimp share in sector declines from percent (to about 5 percent equivalent of 90 percent to 80 percent resource value) * Carry out and implement study to choose mechanism for the transparent, non-discretionary and competitive allocation of licenses Audits (insurance companies and * Audits carried out * Action program discussed and agreed Social security funds) with IDA based on audit recommendations - 42 -  ANNEX 5: SUPPLEM:ENTAL CREDIT DATA SHEET Timetable of Key Processing Events Time taken to prepare: 15 months Project prepared by: Government and IDA Appraisal: March 16-24, 1999 Negotiations: March 30-31, 1999 Board Presentation: May 18, 1999 Closing date: December 31, 2001 The Task. Team Leader. is Ja Za edo ( M). T . Mebers are a . f u ............... .o s: Maroeconomincs.:: uan Zaldu'endo, EmmAanuel Cuvillier, Raiju Kalidifidid Christos9j Kostop'Onos (AFTM3), Dieudonne Randfiamananpisoa (aFMMG); rivatizaion and Private Sector ' 'Develop,,.,,,,,,ffi,.t: iMarie~~~~J .... ... ....... ... . ., .. a.'.. . --:'i''',,' h....,,l, Development: :Marie-Ag aaaYo,Jve ugs Ibefl Cailat Chistope Petit (PSDtPS): Nei Si.mon. ray (AFTPT); Pierre Vieilescazes (PFG); Finacial Se.ctor: Hermina ,Martnez, Jeam-Bernar&d Mauor (FTP), oland Tenconi,(cons.ut t); -g Angel Baide (AFTGI), Eleodoro Mayorga Alba (EMTO. ..r.nnt .Micel . Si.eo Nina - . .~~~~~~~~.. .... . ... .. . ... . ... - ... .-..-.......... .. . . .. ...... (AFTE.1); Fisheries: Vicenhte FererAndeuTAF 2) Miin: Paulo 'De:' Sa.,MT. Th Babon,e (TM). The Resident RepresentativeisPhilippe.Le...(M Difect'o's,s'eio.r.operati,,,'on's ay.... til th reviw .byte R egioal Ope .Comie............. was Maora Gotr (M KCt8). The count te assistantisi Ccile Wodo 'F 3'' -. 43. .. . .. ... - . . . .. .. S . . -~~~~~~~~~~~~~~~~~ ... .....   ATTACHMENTS List of Contents Attachment I: Madagascar at a Glance Attachment II: Madagascar - Key Economic Indicators Attachment III: Madagascar: External Financing Requirements and Sources Attachment IV: Madagascar Social Indicators Attachment V: Status of Bank Group Operations in Madagascar Operations Portfolio Attachment VI: Madagascar - Bank Group Program Summary, FY 1999-2001 Attachment VII Madagascar - Selected Indicators of Bank Portfolio Performance and Management Attachment VIII Madagascar - Statement of IFC's Committed and Disbursed Portfolio Attachment IX Madagascar - lFC and MIGA Program, FY96-99 - 45 -  Attachment I Page I of 2 Madagascar at a glance Sub- POVERTY and SOCIAL Saharan Low- Madagascar Africa Income Development diamond 1997 Population. mid-year (millions) 14.1 614 2,048 Life expectancy GNP per capita (Atlas method, USS) 250 500 350 GNP (Atlas method, US$ billions) 3.5 309 722 Average annual growth, 1991-97 Populaton (%) 2.8 2.7 2.1 Labor force (%) 2.8 2.6 2.3 GNP Gross per / primary Most recent estimate (latest year available, 1991-97) caprta \ ' enrollment Poverty (% of population below natinal povedy line) 75 Urban population (% of total population) 28 32 28 Life expectancy at birth (years) 58 52 59 Infant mortality (per 1,000 live births) 86 90 78 Child malnutrition (% of children under 5) 32 27 .. Access to safe water Access to safe water (% of population) 29 44 71 Illiteracy (% of population age 15+) 54 43 47 Gross primary enrollment (% of school-age population) 72 75 91 -Madagascar Male 73 82 100 Low-income group Female 70 67 81 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1976 1986 1996 1997 Economic ramtos GDP (US$ billions) 2.2 3.3 4.0 3.5 Gross domestic investmentVGDP 8.1 9.0 11.6 11.9 Trade Exports of goods and servicestGDP 15.2 12.1 20.5 21.8 Gross domestic savings/GDP 5.8 6.1 6.3 3.7 Gross national savings/GDP 5.8 6.1 5.4 6.3 Current account balancetGDP -3.1 -3.0 -6.2 -5.3 Domestic Ivte Interest payments/GDP 0.2 1.5 1.5 1.3 Savings Investment Total debW/GOP 9.2 92.1 112.4 118.2 Sa/ Total debt servicetexports 3.8 47.6 27.8 24.3 Present value of debt/GDP .. .. 96.0 92.5 Present value of debt/exports . . Indebtedness 1976-86 1987-97 1996 1997 19982 (average annual growth) GDP -0.1 0.9 2.1 3.6 5.4 Madagascar GNP per capita -3.4 -1,4 0.3 1.6 2.3 Low-income group Exports of goods and services -4.4 5.2 2.5 -3.9 5.9 STRUCTURE of the ECONOMY 1976 1986 1996 1997 Growth rates of output and Investment#% Agriculture 33.3 36.8 31.8 31.5 100 - Industry 16.1 12.9 13.5 13.4 135 Manufacturing .. 10.6 11.5 11.1 o _ Services 50.6 50.3 54.6 55.0 -50 0 92 93 94 95 go 97 Private consumption 83.0 85.0 87.6 88.7 -ipo I General govemnment consumption 11.2 8.8 6.1 7.6 GDI *-GDP Imports of goods and services 17.5 15.0 25.8 30.0 0 1976-86 1987-97 1996 1997 Growth rates of exports and Imports (Y.) (average annual growth) Agriculture 1.5 1.9 2.5 1.9 20- Industry -2.3 0.8 2.0 4.1 1f Manufacturing .. 0.1 1.1 1.7 o Services -0.6 1.1 2.1 4.6 93 94 95 16 Private consumption -0.5 1.2 1.8 5.7 *204 General govemment consumpton 2.1 -1.4 -3.8 14.8 Gross domestic investment -1.7 -0.9 12.5 -1.5 40 Imports of goods and services -4.2 3.1 4.2 7.5 Exports O*Imports Gross national product -0.7 1.4 3.4 4.6 Note: 1997 data are preliminary estimates. The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.  Attachment I . Page 2 of 2 Madagascar PRICES and GOVERNMENT FINANCE 1976 1986 1996 1997 Inflation (%) DomesVc priFces 6 (% change) s Consumer p)ies 8.3 12.4 19.8 4.5 401 Implicit GDP deflator 9.9 14.2 17.8 7.4 304 20 - Government finance 10 (% of GDP. indudes current grants) o Current revenue 12.7 9.4 11.8 92 93 94 9s 96 97 Current budget balance 1.9 -1.1 0.9 - GDP deflator CPI Overall surplus/deficit -3.5 -8.4 -5. 6 TRADE (US$ millions) 1976 1986 1996 1997 Export and import levels (US$ millions) Total exports (fob) 326 561 510 no Coffee 130 62 33 700 Otherfood 46 20 10 6e| Manufactures 57 356 353 sWn. Total imports (cif) 356 758 802 2* Food .. 52 60 49 __ Fuel and energy 58 106 117 1 91 9_ 9l 94 93 96 97 Capital goods 94 164 146 o _ _ _ _ Export price index (1995=100) , 105 88 82 Importpriceindex(1995=100) 86 100 92 aUExports Imports Terms of trade (1995=100) 155 88 88 BALANCE o PAYMENTS (US$ millions) 1976 1986 1996 1997 Cuffent account balance to GDP rato %) Exports of goods and services 330 396 821 773 0 Imports of goods and services 393 490 1,033 1 071 2 Resource balance -63 -95 -212 -276 Net income -17 -155 -158 -108 4 I." " Netcurrenttransfers 13 152 121 196 Current acount balance -68 -97 -249 -188 -10 Financing items (net) 79 163 384 243 -121 Changes in net reserves -12 -66 -135 45 91 92 93 94 95 9s 97 Merno: Reserves including gold (US$ millions) 0 41 241 280 Conversion rate (DEC, locaUlS) 239.0 676.3 4,054.6 5,093.4 EXTERNAL DEBT and RESOURCE FLOWS 1976 1986 1996 1997 (US$ millions) Compositon of total debt, 1997 (US$ millions) Total debt outstanding and disbursed 201 3,003 4,498 4,189 IBRD 26 31 7 2 A: 2 F:7 IDA 88 422 1,099 1,211 Totaldebtservice 13 211 255 218 B' 1,211 IBRD 2 4 5 4 IDA 1 5 18 22 Composition of net resource flows Offidal grants 22 110 117 179 E 45s Official creditors 18 149 118 139 2, Ceo Private creditors 1 -47 -5 -1 Foreign direct investment 1 10 14 D: 442 Portfolio equity 0 Worid Bank program Commitments 36 103 60 173 A - IBRD E - Bilateral Disbursements 16 95 78 130 B-IDA D - Other multilateral F - Private Principal repayments 0 3 13 13 C-IMF G-Short-term Net lows 16 92 85 117 Interest payments 2 6 10 13 Net transfers 14 87 55 104 Development Economics 2/22/99  Attachment I1 Page 1 of 3 Madagascar - Key Economic Indicators Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 2002 National accounts (as % GDP at current market prices) Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture' 36.6 30.5 29.6 29.2 28.0 27.2 27.0 27.1 27.2 Industry' 12.7 12.7 12.6 12.4 12.5 12.3 12.2 12.2 12.3 Services' 44.6 49.7 50.9 50.9 51.2 51.0 50.8 50.5 50.3 Total Consumption 96.6 96.4 93.7 96.3 94.7 92.9 90.4 89.7 89.2 Gross domestic fixed 10.9 10.9 11.6 11.9 13.3 14.4 16.2 16.5 16.8 investment Government investment 6.2 5.8 6.7 6.3 7.2 7.0 7.3 7.5 7.8 Private investment 4.7 5.2 5.0 5.6 6.1 7.4 8.9 9.0 9.0 (includes increase in stocks) Exports (GNFS)b 22.0 24.1 20.5 21.8 21.2 22.0 22.1 22.5 22.7 Imports (GNFS) 29.5 31.5 25.8 30.0 29.2 29.3 28.7 28.7 28.7 Gross domestic savings 3.4 3.6 6.3 3.7 5.3 7.1 9.6 10.3 10.8 Gross national savingsc 1.4 1.2 5.4 6.3 6.1 7.7 9.9 10.3 10.6 Memorandum items Gross domestic product 2962 3158 4002 3546 3869 4127 4432 4759 5159 (US$ million at current prices) Gross national product per 238.2 237.0 246.1 253.3 260.0 .. capita (USS, Atlas method) Real annual growth rates (