Madagascar - Supplemental Credit to the Second Structural Adjustment Credit Project (SAC-2) Oil Shock)

Report No. PID9790 Project Name Madagascar-Second Structural Adjustment Credit... (SAC-2) Second Supplemental Credit (Oil Shock) Region Africa Region Sector Adjustment Operation Project ID MGPE73340 Borrower Republic of Madagascar Implementing Agency Prime Minister's Office Date this PID Prepared December 18, 2000 Projected Board Date December 20, 2000 1. Background. Madagascar has seen a marked decline in living standards during the last 30 years. Once a flourishing society, the country now ranks with the world's poorest. Education, nutrition and life expectancy indicators have deteriorated; lack of physical access to social services, financial services and agricultural markets has crippled development; and slash-and-burn agriculture has led to severe deforestation. At the same time, population growth has remained high, near 3 percent. The result: poverty has become entrenched in the social fabric. Three-fourths of all Malagasy are poor, and GDP per capita in 1998 prices, at $255, is three-fifths its level of the late 1960s. Poor performance can be linked to decades of policies of economic nationalism and self-sufficiency, and State intervention in key productive sectors. Yet, the country's economic potential is formidable. It enjoys rich mineral deposits; fertile land with abundant rain; an environment attractive to different types of tourists with a unique eco-system, varied topography, and several climatic zones; and a coastal perimeter of about 3,000 miles which provides access to rich maritime resources. 2. Madagascar has adopted an increasingly more pragmatic economic policy stance beginning in the late 1980s with considerable progress achieved over the past four years. The macroeconomic situation has substantially improved. Inflation has declined, to 9.7 percent in 1999 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 at 1.2 percent of GDP in 1999 compared to 11.4 percent in 1994. The tax structure is more efficient, with an increased reliance on a VAT. Revenues (excluding grants) have increased from a historical low of 8.3 percent of GDP in 1994 to 11 percent in 1999. In the structural arena, progress has also been marked. Non-traditional exports have performed remarkably well, led by manufacturing EPZ and shrimp exports. Market distortions that affected agricultural commodities have been removed 3. However, Madagascar has been hard hit by the petroleum price increase in the year 2000. Without own petroleum production, Madagascar is entirely dependent on imports of oil. The average price of Madagascar's oil imports is about 65 percent higher than in 1999. As a result of these higher prices, Madagascar's oil import bill increased by about 78 percent in 2000, and is expected to increase by a further 5 percent in 2001. For 2000, the additional cost to the economy was about US$82 million, or nearly 2.5 percent of GDP. This loss is larger than estimated interim debt relief estimated under the  enhanced HIPC initiative (around US$60 million per year). Faced with this situation, consumer prices are nearly double what they were two years ago. Oil price increases, together with the three cyclones that hit Madagascar at the beginning of the year, are negatively impacting economic activity and diluting the effect of Government's reform program. 4. Project Scope and Objectives. The proposed credit supplements the on- going Second Structural Adjustment Credit, SAC-2 (Credit 3218-MAG). The supplemental credit aims to cushion the impact of the petroleum price shock and ensure that Madagascar's economic performance and progress in implementing reforms is not jeopardized. The counterpart funds generated by this supplemental credit will allow Government to reduce the specific taxes on petroleum products or to maintain existing rebates and thus moderate the impact of the shock on prices to final users in a non-inflationary manner. 5. Benefits. The proposed supplemental credit will allow the Government to proceed with the planned reform agenda and meet the key fiscal and growth benchmarks; without this credit, Madagascar's ability to do so would be jeopardized. The CAS advocates faster, broad-based economic growth, partly through higher foreign investment as a necessary means to achieve sustainable poverty reduction. Assisting Madagascar to meet the additional import bill arising from the oil shock (US$160 million over the period 2000 to 2001) is of paramount importance to keeping the adjustment program on track. Accordingly, IDA's response would contribute to sustaining growth which will contribute to upholding the confidence of foreign investors in the country. 6. Moreover, the impact of the doubling of petroleum product prices on the already poor population in Madagascar is severe. While most petroleum products directly affect everyday life, three of them are particularly important for the poor. Gasoline, the price of which increased 70 percent between April 1999 and October 2000, affects the transportation cost of all goods. For example, food stuff prices, the lion's share of the poor's consumption basket, have increased faster than other prices, as transport costs rose by more than 40 percent. Kerosene used by the poor for domestic energy increased by 65 percent in the same period and mostly affected the budget of the rural poor. Mass urban transportation, predominantly used by the poor, raised its fee by 100 percent since 1999 due to the gas price increase. Therefore, the reduction of the energy tax will provide relief also to the poor population. 8. Risks. The nature of risk wavering government commitment causing interruption or reversal of reforms is the same as in the CAS. Madagascar is entering an electoral period of about 12 months that could affect Government's ability to implement difficult reforms. Nonetheless, prospects for implementation of the supplemental credit are brighter. Key progress has been achieved on structural reform, especially in the areas of macro-stabilization, liberalization and privatization. The SAC-2 program is on track as well as the preparation of a new IMF's Poverty Reduction Growth Facility (PRGF), scheduled to be approved at the beginning of 2001. Contact Point: The InfoShop The World Bank 1818 H. Street NW Washington, DC 20433 Telephone: (202) 458-5454 - 2 -  Fax: (202) 522-1500 Mr. Willem van Eeghen Telephone: (202) 473-2399 Fax: (202) 473-8564 This PID was processed by the InfoShop during the week ending December 29, 2000. - 3 -