Madagascar - Second Private Sector Development Project

Report No. PID9606 Project Name Madagascar-Second Private Sector... Development Project Region Africa Regional Office Sector Privatization Project ID MGPE72160 Borrower(s) REPUBLIC OF MADAGASCAR Implementing Agency Address MINISTRY OF PRIVATE SECTOR DEVELOPMENT AND PRIVATIZATION Ministry of Private Sector Development and Privatization, Antananarivo, Madagascar Contact Person: Monsieur Constant Horace Tel: (261-20)22-666-67 Fax: (261-20)22-601-38 Email: magpriv@dts.mg Environment Category A Date PID Prepared October 16, 2000 Projected Appraisal Date October 23, 2000 Projected Board Date December 5, 2000 1. Country and Sector Background In 1996, the Government of Madagascar (GOM) embarked on a program to reform the financial sector and encourage private sector development through changes in the business environment, liberalization, and privatization of the main Banks and 49 major companies (Annex 11). This strategy has put Madagascar on a path of economic growth with GDP growth of 3.6 percent outstripping population growth in 1998 for the first time in a decade. The 2 State Banks that control over 50% of the market were successfully privatized with technical assistance provided under the APEX project. With the support of the PATESP, the first phase of regulatory reforms opening up targeted sectors (air transport, petroleum, and telecommunications) was enacted and autonomous regulators were established. As a result of new private operators in the telecommunications and air transport sectors, the number of telecom subscribers and the number of international tourists have doubled in less than two years, and tariff has been reduced by 50 percent in some services. These initial phases of liberalization contributed to a GDP growth rate of 5 percent in 1999. A mid-term review of the PATESP in mid-october 2000 covered the institutional set up of privatization, the results achieved to date, and the impact. Concrete results achieved under the program are as follows: (a) with privatization law 96-011 and 98-014 and related decrees enacted by Parliament and the GOM, the institutional framework to carry out the current liberalization reform and privatization program was made fully operational. In addition, a privatization agency and a technical secretariat (a secretary managing six transaction experts hired from the local private and financial sector) were set up two years ago and have become fully operational.(b) technical assistance was  provided to build capacity at the Technical Secretariat level: (i) two international experts helped design and launch a road map for the preparation of companies for privatization, and for the sequencing of transactions in the program; (ii) an international legal consulting firm advised the agency about legal matters pertaining to the liberalization and divestiture program; and (iii) an international public relations firm designed and implemented a broad communications campaign for the public at large;(c) procedures to call for competitive bids and clear objective criteria to evaluate tenders were adopted and applied;(d) adoption and implementation of the legal and regulatory framework for liberalizing the air transport, petroleum, mining, and telecommunications sectors;(e) establishment of regulators in the air transport, petroleum, and telecommunications sectors; (f) introduction of competition in telecom sector by issuing 4 mobile licenses and 3 data transmission licenses to private operators;(g) introduction of competition in air transport by totally liberalizing: (i) charter flights and domestic air transport and (ii) air fares;(h) adoption of a social mitigation plan for all enterprises slated for privatization and implementation of an employee retraining and redeployment scheme; (i) adoption of a strategy to operationalize local participation schemes, including a privatization trust fund intended to facilitate the sale of shares to local Malagasy investors; (j) divestiture of 56 companies including 19 petroleum related companies, the railway, and major agro-industrial companies (FAMAMA, SODIP, SOPRAEX, and AFM) which account for US$110 million of receipts and US$70 million of investment; (k) adoption of privatization strategies for eight additional companies (airline, airports, telecoms, sugar, and other agro-industrial companies); (1) establishment of a local private funding facility (FASP) which has provided assistance to 323 enterprises; and(m) establishment of the Competitiveness Review Committee (CRC) which has helped significantly improve dialogue between the private sector and public sector officials on key economic reforms.Part A of the PATESP was successful in (i) jump-starting the liberalization reform and the privatization process and (ii) developing a critical mass of knowledge within the Secretariat, which is now capable of successfully managing the tendering process. Shortly after project effectiveness, it became clear that (i) the composition of the privatization agency and (ii) the issue of separate leadership between the line ministries in charge of liberalization and the privatization committee in charge of privatization implementation had to be dealt differently than originally planned at project appraisal.Under original plans, the privatization agency was composed of independent private and public officials with little ties to the GOM, thus resulting in a lack of ownership of the process by the Government. Acknowledging the political nature of the privatization process, it was agreed that the composition would incorporate key Government players such as the Minister of Finance, Privatization and the line Minister overseeing the company being privatized. This change has resulted in full commitment of the GOM in the execution of the program and proved successful particularly in getting their quick attention in tackling sensitive issues. The second issue was the difficulty in ensuring the proper sequencing between liberalization and privatization because of the differing paces of execution of the agencies in charge of the programs. To avoid sequencing problems, the preparation of minimum regulatory safeguards was transferred to the privatization agency to ensure that these minimum rules would be in place by the time of the entry of private operators. Funding shortages occurred because: (i) two - 2-  infrastructure companies namely the petroleum and the telecom companies were added to the original list of enterprises slated for privatization; (ii) related sector projects have been closed or canceled; and (iii) some of the activities of these projects, including advisory services for legal and regulatory reforms in the telecom, petroleum, and air transport sectors were transferred to this project (PATESP).These results thus remain fragile and modest as the reforms could only be partially completed. In particular, the following specific issues need to be addressed. First, the combination of low penetration rates in key sectors such as power, telecommunications, and transport and the inability of the remaining public enterprises to meet demand exclude the majority of the population from accessing basic services.Second, introduction of various private operators has brought to the forefront the practical difficulties facing the recently established regulators in: (i) applying consistently across the board transparent regulatory procedures; (ii) monitoring adequately on the ground the planned commitments; and (iii) maintaining autonomy vis a vis Government intervention during the transition period until the regulators reach financial independence. Finally, recent completion of a major infrastructure transaction in the petroleum sector, the biggest divestiture to date in the country and the related resurgence of foreign investors have left unaddressed the fear of the Malagasy population that the liberalization and privatization program will favor international investors and privileged local elites at the expense of small local investors. More importantly, the issues of the participation of Malagasy nationals in the privatization and financing of their participation need to be tackled. To pursue this unfinished agenda, the GOM embarked in 1999 in a second economic reform program (SAC-2). In addition, in the context of a multi-donor-supported effort led by UNDP, the Government recently approved in May 2000, a Programme National d'Appui au Secteur Prive (PNSP), which sets out the strategic vision for private sector development. The PNSP is based on three main tenets: (a) strengthening of the legal and business environment to support enterprise development; (b) boosting of private sector investments; and (c) launching of business initiatives ensuring the participation of the whole spectrum of private sector operators from micro-enterprises to SMEs and larger firms. 2. Objectives The proposed Second Private Sector Development Project (PSD-2) is IDA's response to the request of the Government of Madagascar (GOM) for immediate support to consolidate gains achieved during the first phases of market deregulation and divestiture reforms supported by Part A of the Private Sector Development and Capacity Building Project (PATESP). Timely support will also help capitalize on the momentum produced by the recent effectiveness of the Second Structural Adjustment Credit (SAC-2). The development objective of the project is to improve the quality and coverage of essential economic and infrastructure services through increased private investment and better performing regulatory authorities. The specific objectives of the project are to: (i) improve access to reliable services in key sectors (energy, transport, and telecommunications) deemed critical to promoting high growth opportunities; and (ii) secure access of these services to the poor through market-friendly delivery channels. These objectives will be achieved by: (i) completing the divestiture program thereby improving efficiency in the companies providing critical services; (ii) accelerating -3 -  sectoral reform to encourage opportunities for new private entry and investment; and (iii) providing direct assistance to private Information Communication Technology (ICT) companies through the Fonds d'Appui au Secteur Prive (FASP), an entirely locally run private sector Institution, to develop new ICT services as new source of growth. 3. Rationale for Bank's Involvement Through its association with Madagascar, in particular through the execution of the Financial Sector Project and the PATESP, IDA has developed an extensive knowledge of the cross-sectoral issues affecting private sector in Madagascar.IDA has taken the lead in most regions and in particular in the Africa region in assisting the execution of such programs: it has developed first hand practical knowledge of the issues faced by the local private sector in particular given the low level of savings and financial intermediation. The Bank Group has also acted as a pioneer in designing programs with a unique blend of FDI and local investments. Its leadership role in privatization efforts in Latin America in the 1980s has allowed to draw significant lessons to be integrated into the design of new programs.In the infrastructure sectors, in particular in the air transport, power, and telecommunications sectors, IDA holds a recognized knowledge advantage on reform issues. It has a unique experience in helping country clients design and implement reforms in these sectors. Its involvement in the sub-region, notably with SADC will allow Madagascar to harmonize its sector policies in lines with its neighbors and potential strategic business partners. Moreover, the importance of IDA portfolio currently being deployed by the Country team is bringing invaluable benefits in addressing cross-sectoral issues affecting private sector development.Finally, the team composition drawing from the cross country experience and expertise of staff coming from regional departments and global practices, including IFC, uniquely places IDA in a position to respond to Government request for assistance with a pool of staff which can be flexibly deployed. 4. Description Component 1: Liberalization ReformThis component will provide hands on experience to the regulatory agencies, in particular but not exclusively to the petroleum and telecom regulators, to efficiently apply award procedures for licensing new entrants and transparent monitoring methods in line with internationally accepted sector standards. Specifically, the component allows for: (i) financing of equipment and monitoring devices such as frequency management system for telecom regulator and a Laboratory for the petroleum regulator; (ii) hiring of legal and regulatory advisory services under retainer arrangement with reputable international law firms; and (iii) hiring of specialized advisory services, such as environmental audits and environmental regulation, for the petroleum sector. The component also includes funds for hiring short-term specialists and/or organizing a study tour for comparing regulatory arrangements in utility reform. This component also aims at strengthening the operational capacity of the newly established Center for Facilitating Enterprise Creation to streamline procedures and reduce transaction costs of entry for the private sector. Component 2: Transaction and Implementation Support to Privatization AgencyThis component aims at providing direct support in the implementation of the divestiture program and the Privatization Trust Fund (PTF). Specifically, the component allows for hiring of: (i) investment banks to complete the divestiture - 4 -  program; (ii) legal advisory services; (iii) advisory services to design specific outreach and information activities; (iv) advisory services in the area of financial market and investment fund developments; and (v) private fund managers. The component will finance operating costs, equipment, and internet services.Component 3 : Developing new ICT activitiesThis component will provide direct technical and financial support to private ICT companies through FASP. One of the identified activities is to assist GOTICOM, an association of private ICT operators in Madagascar to establish a cyber park in the country. FASP will provide assistance to ICT companies through an incubation mechanism on (i) product development, (ii) marketing, (iii) human resource development, and (iv) funding. Liberalization Reform Privatization Implementation Support Development of ICT activities 5. Financing Total ( US$m) GOVERNMENT 6.9 IBRD IDA 31.8 Total Project Cost 38.7 6. Implementation The project will be coordinated by the PCU (Program Coordination Unit) established under the chairmanship of the MDSPP. This Unit will be in charge of the orientation, coordination, and supervision of activities carried out by implementing agencies. The PCU will review the project work programs, consolidate budgets and financial reports, and submit them to IDA, contract out project audits, ensure that IDA funds are used in accordance with the objectives and modalities spelled out in the Development Credit Agreement, review the progress toward achievement of project's objectives and decide on necessary corrective actions. It will play the needed interface with IDA and the borrower. The PCU staff will include the Program Coordinator, an internal auditor in charge of project monitoring and evaluation, and a financial assistant. The implementation of the proposed PCU will take advantage of the structures and arrangements of the present Coordination Unit implemented within the Private Sector Development and Capacity Building Project. Appointment of PCU staff (with qualification and experience) will be conditions of effectiveness. Project ComponentsComponent 1: Liberalization ReformComponent 2: Transaction and Implementation Support to Privatization AgencyThe executing agency for these two components will be the Technical Secretariat (STP), which will carry out general administration of these components; it will assure therefore: (i) the execution of all activities under these components except the management of the contract related to the environmental audit which will be entrusted to a selected firm; (ii) the preparation of its annual work program and the related procurement plan; (iii) the management of disbursement procedures; and (iv) the record-keeping and preparation of any documents (Project Management Reports) required for the project management and monitoring. As a condition of effectiveness, the STP shall have an adequate number and mix of skilled and experienced staff in financial management and procurement. For the environmental audit of the petroleum sector, a management contract acceptable to IDA will be signed between the borrower and a firm selected through competitive bid. This - 5 -  will be a condition for Credit effectiveness. This contract will specify the responsibilities of the selected firm and the management fees to be paid for the service rendered. Component 3: Development of new ICT Technology The executing agency of this component will be the FASP implemented within the Private Sector Development and Capacity Building Project. The borrower shall conclude an agreement (convention) with the FASP, under which it shall transfer to FASP the proceeds of the credit to finance this component on a non reimbursable basis and on such other terms and conditions as shall be acceptable to the Association, including provisions specified in the Development Credit Agreement.Financial ManagementThe STP and FASP will maintain separate accounts for all transactions related to the components for which they have overall implementation responsibility and will produce their individual annual financial statements in accordance with internationally accepted accounting principles. The implementation of the project accounting system will take advantage of the structure and procedures in place within the context of the Private Sector Development and Capacity Building Project. To strengthen both STP and FASP financial management systems an agreed action plan by the borrower has been proposed following the assessment carried out by the Bank/IDA Financial Management Specialist. The main measures to be taken include: (i) clear definition of the STP's organizational structure and responsibility assignments; (ii) update of the STP and FASP's Chart of Accounts to reflect useful categories (project components, activities) detailed in the PAD; (iii) update of the accounting manual of procedures to ensure adequate safeguard of assets and facilitate record-keeping and preparation of reliable information for the controls and reporting requirements of the project; and (iv) appointment of the key staff for the PCU and the STP. To allow consolidation and project monitoring the FASP will maintain separate accounts for expenditures paid under the Credit No 2956 - MAG (PATESP) and the new Credit (PSD-2). The project financial statements will be consolidated by the Program Coordination Unit at the end of each fiscal year. To ensure the management, monitoring and evaluation of the project, the same accounting software will be used by the STP, PCU, and FASP. A consulting firm selected on a competitive basis will be appointed to design and implement the computerized system that should in particular facilitate: annual programming of activities and project resources, accounting, financial and budgetary management of the project, procurement management, follow-up of project implementation progress, monitoring of key indicators to assess the results and impact of the project, preparation of progress reports and Project Management Reports as required by the Financial Management Initiative. Before credit effectiveness the Bank/IDA Financial Management Specialist will evaluate the progress made by the project (STP, PCU, and FASP) in the implementation of aforesaid actions to strengthen project financial management system. A management system satisfactory to the Association will be an effectiveness condition.Project Management ReportIn accordance with Bank policy and procedures, the project needs to adopt a financial management and reporting system in compliance with the Financial Management Initiative (ex-LACI). But given the lack of capacity of the accounting software presently used within the context of the Private Sector Development and Capacity Building Project and since the accounting staff in both STP and FASP is not very familiar yet with the Financial Management Initiative procedures, it is more efficient for the project to run, during the first eighteen months of the implementation, with the traditional disbursement methods. The transitional reporting - 6 -  requirements during this interim period are: (i) the basic financial statements; and(ii) on quarterly basis: Sources and Uses of Funds;Procurement Management Report (a Contract Expenditure Report- Goods & Works, a Contract Expenditure Report- Consultants, a Procurement Management Report- Goods & Works and a Procurement Management Report- Consultants).In addition the executing agencies should comment on progress of important aspects of the project. Before the end of this interim period and once the new accounting software is in place, an assessment will be carried out to determine whether the project has in place an adequate financial management system that can provide, with reasonable assurance, accurate and timely information on the status of the project (PMR/FMI) required by the Bank/IDA. AuditingThe consolidated project financial statements will be audited in accordance with international audit standards by independent and experienced auditors acceptable to IDA. The auditors will review and provide opinion on the financial statements, the special accounts (one for each executing agency) and statements of expenditures. The auditors will be also required to carry out a comprehensive review of the internal control procedures and provide a management report outlining any recommendations for their improvement. The auditors report will be submitted to IDA not later than 6 months after the end of each fiscal year. The terms of reference of the audit will be reviewed with the financial analyst of the Bank/IDA. The appointment of an independent auditor acceptable to IDA will be a condition of effectiveness. 7. Sustainability Over the past two years, the GOM has expressed its continued commitment to the promotion of private sector participation as evidenced by the privatization of the whole banking sector, the petroleum sector, and other agro-industrial companies, resulting in the sale of 58 companies in 2 years. 8. Lessons learned from past operations in the country/sector IDA has been involved in private sector development activities in Madagascar through four technical assistance projects (Financial Sector, APEX, Mining, and PATESP) and two adjustment operations projects (SAC-1 and SAC-2) between 1996 and 2000 totaling SDR 167.3 million. These operations shared common characteristics, including a slow start-up followed by an acceleration of activities, resulting in satisfactory completion of reforms. Several lessons can be drawn from these past projects and applied to private sector development in Madagascar. Strong and firm commitment from the highest levels of Government is crucial to successful project implementation. In the past, a change of President and Government at the time of project start-up resulted in delays in project effectiveness as institutional arrangements for privatization agreed upon with previous governments were not deemed satisfactory by the new Government. Once agreement and consensus were reached on institutional arrangements, in particular on the sharing of responsibilities between the Technical Unit and the inter-ministerial Privatization Agency, project activities began and ultimately picked up. Previous projects had been designed on the premise that the private sector project would focus on the transaction side while sector projects would accompany the program with sector reforms. This design turned out to significantly slow the project implementation down because of timing and sequencing between reform execution and privatization. Privatization was hindered by the slow pace - 7 -  of reform preparation by line ministries and later, by the implementation difficulties of sector related projects which were canceled or delayed. In the end, critical reform measures to ensure proper minimum safeguards were transferred to PATESP, and medium-term sector policy development was left under the responsibility of the line ministry. The inclusion of social mitigating measures and participatory schemes to allow the participation of nationals in the privatization program have been critical ingredients of success of the previous projects in ensuring Government willingness to tackle these difficult reforms and in gaining the support of the population.Finally, past experience has shown that an intensive public information campaign should be sustained throughout the project life to ensure continued support of the stakeholders for reform execution. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) Issues : The Bank is actively assisting the Government of Madagascar in its effort to privatize public enterprises (PEs) and some of these enterprises include various environmentally sensitive activities such as sugar making factories and others. Privatization of SOLIMA was completed under a separate project in June 2000. The oil and gas pipelines running from the port in Tamatave to the refinery will involve involuntary resettlement of approximately 1,000 individuals. The new owners reached an agreement with the Government to carry out the planning and the implementation of a resettlement plan. The World Bank involvement in this endeavor is to provide advice to ensure compliance with national requirements as well as World Bank safeguard policies.The environmental issues are divided into 2 categories. The first category is preexisting environmental problems or "pollution stocks" resulting from activities while on the public sector ownership. The second category is "pollution flows" and other environmental problems related to ongoing and future practices. The past pollution from SOLIMA's activities may have caused damages or maybe a potential future hazard if soil and groundwater are or could become contaminated due to improper past practices, example storage and disposal of waste. Hence the need for the project to carry out a comprehensive environmental audit with an appropriately costed remediation action plan. Contractually the Government is responsible for remediation of all preexisting liabilities while ongoing and future environmental conditions will fall on the new investors. The audit action plan will also be clear on the timeframe for each implementation. In essence, the audit report will attempt to answer the following questions: (a) to what extent do the privatization candidates have preexisting environmental problems?; and (b) what can be done to ensure proper handling of these problems? For the other privatization candidates, which the Government with World Bank assistance plans on privatizing in the immediate future, environmental audits and other safeguard policy requirements will have to be met to ensure compliance. Thus the need to make financial provisions for the safeguard policy measures could be met. 11. Contact Point: Task Manager Marie-Ange Saraka-Yao The World Bank 1818 H Street, NW -8-  Washington D.C. 20433 Telephone: (202) 473-2712 Fax: (202) 477-0218 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. This PID was processed by the InfoShop during the week ending October 20, 2000. 9