Z-A 4 o / -7 - /- / Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-5987-MOR MEMORANDUM AND RECOMMENDATION OF TII PRESIDENT OF TID INTERNATIONAL BANK FOR RECONSTRUCTION AND tEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS IN AMOUNTS EQUIVALENT TO US$4 MILLION TO THE KINGDOM OF MOROCCO US$100 TO THE FONDS D'EQUIPEMENT COMMUNAL L2 ~- - WITH THM GUARANTE OF THE KINGDOM OF MOROCCO FOR A FIRST MUNICIPAL FINANCE PROJECT May 21, 1993 This document has a restricted distribution and may be used by recipients only in the performance of their officiat duties. its contents may not otherwise be disctosed without Wlortd Banik authorization. CURREPNCY Eg9§IY^NTS US$1 a DHf 8.50 (as of January 1, 1993) DH 1 - US$0.12 FISCAL YEA January 1 - December 31 aM Banque Al-Maghrib (Moroccan Central Bank) cDG Caisse de Ddp0t et de Gestion (Administrator of Insurance and Pension Funds) CL Collectivit6s Locales (Local governments) FEC Fonds d'Equipement Communal (Communal Infrastructure Fund) GT General Treasury of the Kingdom ICB International Competitive Bidding LCB Local Competitive Bidding MOp Ministry of Finance MOI Ministry of Interior USAID United St-.tes Agency for International Divelopment TDMI Training Directorate of the Ministry of the Interior VAT Value-Added Tax FOR OFCIL USE ONLY XINGDOM OF MOROCCO FIRST MnNICIPAL FINANCE PROJECT Loan and Protect Summary Borrowe£rsi: Kingdom of Morocco and Fonds d'Equipement Communal (FEC), the municipal finance agency, with the guarantee of the Kingdom of Morocco. Benefic&aries Local Governments of the Kingdom of Morocco. Amount: Kingdom of Morocco US$ 4 million FEC US$ 100 million Tarmit Bank's standard variable interest rate, with 20 years maturity. Onlendina termas FEC will onlend to the beneficiaries US$100 million equivalent in dirhams with a margin of about 4 percentage points to cover the foreign exchange risk plus 2.0 - 2.5 percentage points to cover the commercial and interest risks, and management costs. Maturities will be up to 15 years with a grace period on principal of up to two years. The Kingdom will assume exchange losses on FEC's loan in excess of the exchange margin. Financina Plan: Subborrowers' resources US$ 35.3 FEC US$ 42.0 Government USS 1.0 Bank U104.0 TOTAL US$ '-82.3 2conomic Rate of Return: 10 percent--minimum--for projects with quantifiable benefits. Staff ApDraisal Renort: Report No. 11562-MOR This docuent has a testficted distribution and may be used by recipients only in the performance of thdei omc duties Its contents may not otherwise be disclosed without World Bank authorization. MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO THE KINGDOM OF MOROCCO AND TO THE FONDS D'EQUIPEMENT CCiKMUNAL FOR A FIRST MUNICIPAL FINANCE PROJECT 1 * I submit for your approval the following memorandum and recommendation on proposed loans of US$4 million to th. Xingdom of Morocco and of US$100 million to the Fonds d'Equipement Communal (FEC), with the guarantee of the Kingdom of Morocco, for a First Municipal Finance Project which combines two interrelated projects with the effectiveness of the FEC loan being conditional upon the effectiveness of the Kingdom loan and any default by the Government on its locn being an event of default of the FEQ's loan. The loans would be at the Bank's standard variable interest r,te, with a maturity of 20 years, including five years of grace. 2. Background. The local sector in Morocco generates almost 5 percent of GDP, even with present low service and investment levels. Most urban services such as potable water supply, sewerage, solid waste and disposal, and markets are deficient, while local governments and their enterprises strive to cope with an urban population growing at about 4 percent p.a. To achieve acceptable levels of local services, Morocco's local governments need to invest about US$600 million p.a. over this decade. Yet limited financial resources now constrain investment levels to some US$400 million p.a., despite the fiscal reform of 1988, which allocated 30 percent of the value-added tax (VAT) to local governments. 3. Although the paucity of funds is a binding constraint, Morocco has ample margin to improve sector policies and institutions. Leaving distribution of the local share of the VAT among local governments largely to Government discretion is conducive neither to an efficient allocation of resources nor to the accountability of elected local authorities to their constituencies (para. 10). In particular, the distribution of part of the local share of the VAT on the basis of forecast budget deficits, which include debt service, encourages local governments to finance low-priority investments with debt beyond their capacity to pay with their own resources. Although the Government has just implemented a reform of local taxes aiming to increase local government revenues, it can further improve the country's local and intergovernmental finance. This ought to be considered once a reform of the system to distribute the local share of the VAT ia introduced and results of the reform of local taxes can be assessed. 4. The local sector in Morocco comprises the following institutionss (a) about 1,600 urban municipalities and rural communes governed by elected officials, but for which the Ministry of the Interior (MOI) approves budgets and the Ministry of Finance (MOF) manages cash; (b) provinces (which comprise municipalities and rural communes), a hybrid of local government and line unit within NOI; (c) the R6gies, semi-autonomous water distribution, power distribution, and urban transportation agencies serving the major citiess and (d) FEC, the municipal finance agency. Local governments lack sufficient trained staff and adequate management systems. The Government, for its part, lacks adeauate systems to monitor sector performance. The Rhgles, under the tutelage of local authorities and MOI, generally perform well below the standards of business enterprises. Ongoing and planned water and sewerage sector projects will address their problems. FEC, until recently a government fund managed by the Caisse de D6p8ts et de Gestion (CDG - an agency that manages government - 2 - pension funds), has lacked standard banking procedures, effective control by MOY, and supervision by the Central Bank (Banque Al-Kaghrib - BM). Yet, FEC will continue to dominate municipal finance until local governments can manage their own cash (for use as collateral for commercial bank loans). Following the recommendations of Bank sector and completion reports, the Government began restructuring FEC by converting it into a legally autonomous financial agency overseen by both MOI and MOP and supervised as a financial institution by BM (para. 10). Furthermore, FEC's Board has approved a comprehensive statement of sound lending and financial policies (Policy Statement) giving FEC effective managerial autonomy. Also, the Government, by the end of May 1993, plans to contribute an additional DH 75 million to FEC's equity, and local governments, at the Government's request, will take charge of their enterprises' loans in arrears with FEC, to bring down FEC's debt-to-equity ratio to 15 to 1 (previously 70 to 1) by the end of 1993. These measures, together with FEC's financial undertakifls (para. 12) provide FEC with financial independence. FEC, moreover, has been able to submit the appraisal of several subprojects complying with its recently approved Policy Statement. 5. To overcome the above constraints (para. 3), the Government plans to distribute most of the local sbare of the VAT among loeal governments for coverage of operating costs, debt service, and investments on the basis of objective criteria. Under this reform, no less than 50 percent of the local share of the VAT will be distributed on the basis of population, per capita endowment of tax base (poorer communities will receive more per capita), and collection rate of some taxes as an incentive to local effort; MOI will still enforce repayment of FEC's debt as a first priority and approve local budgets. in addition, the Government will: (a) formulate a strategy to further improve iPtergovernmental finance and local taxation; (b) carry out an action plan to upgrade local government capacity as well as the Central Government's information system for the local sector; and (c) to the extent possible, help the local sector reach an investment level of around US$500 million p.a. 6. Proiect Obiectives. The proposed project aims tot (a) improve the efficiency of local investments (partly by restructuring FEC); (b) improve the distribution of the local share of the VAT and lay the basis for further improving intergovernmental finance; (c) increase the availability and improve the delivery of local services; and (d) upgrade the management of local governments and central tutelage over the local sector. 7. Proiect Delcriftion. The project will be implemented between 1993 and 1999, albeit substantially completed in early 1998. It includes the following components: (a) funding for local investments (96.8 percent of total project cost), excluding major water systems and rural power systems, which other Bank loans will assist; (b) technical assistance, training, and equipment to increase FEC's capabilities (0.4 percent); (c) training for local, government staff (1.3 percent); and (d) purchase of computer equipment and software, training for central government officials, and studies to improve local sector management (1. S percent). These studies aim to: (i) formulate a strategy to improve further intergovernmental finance and local taxation, including an assessment of prospects for privatizing local services; (ii) introduce improved reporting, accounting and budgeting systems for local governments; and (iii) introduce a system to produce, collect, and disseminate information on local governments from a centralized data base. Tarms of reference for the studies have been agreed upon. The total cost of tte project is US$182.3 million with a foreign exchange content of US$68.2 million (FEC, with other funds, will finance a larger part of the local sector investment program). A breakdown of costs and the financing plan for the proposed project are shown in Schedule A. Amounts and methods of procurement and disbursement are in Schedule B. A timetable of key project processing events and the status of Bank Grcup operations are given in Schedules C and D, respectively. 8. proict Imylementation. The Kingdom of Morocco will borrow US$4.0 million for training and technical assistance to improve local sector management systems. FEC will borrow US$100.0 million for financing local investment projects and its own institutional improvement. Local governments will carry out most investments. MOI, in coordination with MOP, will carry out the studies on local finance, information systems of the local sector, investments and the data base, as well as training for the local sector. FEC will finance priority investments thats (a) match eligible sectors as indicated in FEC's Policy Statementt (3) meet FEC's borrower and project eligibility criteria; and (c) have been listed in the local authorities' investment programs. In general, FEC will apply the same eligibility criteria, standards, and lending conditions to all its operations, regardless of sources of financing. Eligible sectors Include water, sewerage, solid waste, markets, communal facilities, and some productive facilities such as slaughterhouses and markets. Eligibility criteria include maximum debt service ratios for borrowers and minimum economic rates of return of 10 percent for projects. FEC will lend An local currency at both variable and fixed interest rates. Its average interest is estimated at around 14.5 percent over the project period. That rate includess a 2 percentage point margin to cover costs and commercial risk; a 0.5 percentage point margin to cover interest risk (for fixed-rate loans); and an estimated 4 percentage point margin to cover the cost to FEC of the foreign exchange risk which the Government assumes. The Government, out of its own resources, covers the foreign exchange losses under the Bank loan over the "reference cost," which is equivalent to average rates paid on bank term deposits, plus 0.75 percentage points. FEC will supervise subprojects and manage a special account of US$6 millicni to expedite payments for project expenditures from Bank loan proceeds. The Government for its part will manage a special account of US$0.25 million. FEC is already capable of managing project start up and will further enhance its capabilities by, first, hiring new staff, and, second, improving management systems through technical assistance financed by USAID and French agencies early Luring project execution and later by the present project. Ministerial units that carry out training and supervise consultants for the studies are well organized and staffed with qualified professionals. 9. Proiect Sustainability. The project is designed to lay the groundwork for further upgrading of intergovernmental finance in Morocco, foster FEC's financial viability, and improve the capabilities of FEC and the local governments. This will support project objectives as well as overall sector improvement beyond project completion. 10. Lessons from Previous Bank Involvement. Bank's past involvement in the sector includes a pilot project, and sector and economic work. The completion report for the pilot project recommended that FEC supervise projects more closely and become managerially autonomous, recommendations that underlie the proposed project design. The sector report on local finance identified the issues that pervade project conditionality (paras. 3, 4 and 12). The sector report on issues and prospects of the public sector concludes that the system to distribute the VAT share among local governments has been detrimental to savings performance by local governments. The reform of that system is a major policy objective of the present project (paras. 5 and 12). -4- 11. Rationale for Bank Involvement. The project supports the main pillars of the Bank's country assistance strategy for Morocco, as discusse( in the Board in February 1993. First, the project is designed to enhance the efficiency of the public sector management. This is expected to be achieved through the reform of the system to distribute the local share of the VAT among local governments, and through the restructuring of FEC. Second, improved local sector performance will necessarily help consolidate and deepen macroeconomic adjustment by extending the reform beyond the Cenrtal Government level. Third, the project will help alleviate poverty and improve social indicators, as it will improve the coverage and quality of essential services for the poor. Fourth, the project, mitinly by increasing local transport infrastructure and the reliebility of watqr and power services in many municipalities, will help the private sector achieve its potential as an engine of growth. Finally, the project specifically aims to improve water resource and environmental management, as project eligibility criteria include conditionalities to foater cost recovery -- notably to reduce the wastage of water -- control any adverce environmental impact, and enhance FEC's environmental competence and improve its coordination of environmental management with the central and Local governmentes 12. Aareed Actions. Main sector issues the project will address are the paucity of funds, the weakness of sector institutions including FEC, the inadequacy of the system to allocate the local share of the VAT, and the difficulties in monitoring local sector performance. In addition to project components, the following conditionalities agreed with the Moroccan authorities address these issuess (a) By the end of May 1993, the Government will contribute DH 75 million to FEC equity. (b) As conditions of effectiveness of the FEC loan: (i) local governments will have assumed or guaranteed their Regies' loans in arrears with FEC; and (ii) FEC will have appointed its four main line managers and two environmental specialists. (c) During neootiations, the Government confirmed that it would: (i) introduce a new system to distribute the local share of the VAT among local governments by 1995 (unavailability of data on 600 new municipalities precludes an earlier introduction); (ii) implement the plan agreed with the Bank (paras. 3.6 and 5.4 of SAR), during project execution, to improve local sector management, including training; and (iii) take all measures to enable FEC to comply with its obligation under the FEC loan agreement (including, if needed, an equity contribution of DH 60 million to enable FEC to achieve the debt-to-equity ratio target for 1997). (d) Durino neaotiations, FEC confirmed that it woulds (i) adhere to and maintain the agreed Policy Statement and related project eligibility criteria and subloan conditionality; (ii) gradually increase return on assets to 1.2 percent by 1997; (iii) maintain operating costs at no more than 0.75 percent of assets; (iv) maintain a debt-to-equity ratio of not more than 15 to 1 in 1993, 1994, and 1995 and of not more than 12 to 1 in 1997 and thereafter; and (v) implement the plan agreed with the Bank (paras. 4.9 and 5.4 of SAR), during project execution, to improve its capabilities, including training. Durina negotiations, an understanding was also achieved on carrying out annual reviews (including a major mid-term review) to assess project performance with FEC and the Government, as well as the implementation of a system, to monitor that performance, according to a set of indicators. 13. Environmental Aspects. Many subprojects, particularly those in water, sewerage, and solid waste collection and disposal, will have a positive environmental impact. Any possible adverse environmental impact will be screened, assessed, and mitigated as needed, consistent with the present project'.3 environmental category of "B." FEC will approve a subproject for a sewerage system, solid waste collection and disposal, marketplace, or slaughterhouse only when such a subproject or any other subproject by the ame -5- beneficiary addresses all significantly adverse environmental aspects. FEC will employ two environmental specialists to assess environmental issues. When the Environmental secretariat of OI--with Bank asaistance--becomes operational, FEC will comply with the guidelines of the Secretariat and clear with it environmentally complex subprojects, as needed. 14. Benefits. The project, with improved services, would benefit about two million people living in urban and rural agglomerations, including many poor. All investments financed under the loan will have high priority and meet demanding quality criteria. Subprojects will have an economic rate of return of at least ten percent. Further, project benefits are expected to go well beyond Bank-financed investments on at least three additional counts. First, policy reforms and project conditionalities are designed to increase the officiency of all investments--regardless of sources of financing--through the local sector. Second, actions to improve management systems of local governments and cen..ral authorities dealing with the local sector are designed to improve local services and the financial performance of local entities. Third, the restructuring of FEC and the reform of the distribution of the local share of the VAT are designed to enhance the financial discipline of local governments and thus increase their savings. These amount to a substantial reform in terma of economic public sector management. 15. Risks. Improving local services and sector management countrywide is an ambitious undertaking which will require sustained effort for many years. The project addresses key sector issues and involves many agencies, some of which are institutionally and operation&lly weak. Three main risks have been identified. The first is that limited project preparation capacity at the local level compounded by a still untested restructured FEC may result in a slow pipeline of quality subprojects and thus delay project execution. FEC's rapid appraisal of some eligible subprojects complying with its new Policy Statement has already mitigated this risk (para. 4). Training of local government staff and technical assistance to FEC will further reduce that risk later. The second main project risk is that FEC's management and goterning bodies may fail to uphold their demanding Policy Statement. Government and Bank collaboration in designing the new FEC have already reduced this risk. Financial conditionalities should reduce it further. The third major risk is that political pressures may undermina the Government's resolve to maintain the reform in the distribution of the local share of the VAT. Intense discussion of sector issues throughout project preparation have already reduced this risk. Implementing the VAT reform early during p:oject executLon will further reduce such a risk. The annual reviews of project performance including a major mid-term project performance one should additionally mitigate all major project risks. 16. Recommendation. I am satisfied that the proposed loans would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loans. Lewis T. Preston President Attachments Washington, D.C. May 21, 1993 -6- schedule KINGDOM OF MOROCCO FIRST MUNICIPAL FINANCE PROJECT Estimated Copts and Financina Plan Us$ MILLION LOCAL FOREIGN TOTAL E8TtS^tE COSTSJ Local projects Infrastructure 109.6 63.4 173.0 Studies and designs 2.0 0.5 2.S Institutional development _.5 0.5 1.0 112.1 64.4 176.5 Local government training 1.1 1.2 2.3 Institutional improvement of FPC 0.0 0.8 0.8 Institutional improvement of Central Government units _ 0.9 2.7 TOTAL PROJECT COST' FIFINMOI=B -PW- Subborrowers' resources 35.3 0.0 35.3 FEC 42.0 0.0 42.0 Government 1.0 0.0 1.0 Bank ,3,5.8 68.2 104.0 TOTAL FINANCItG w A i nctnas about US$25 mtlitfn for taxes amd dutfes. -7 suXol or IIRRY- MUNICIPAL VINANON PROJNCM PioUSEM AIBMM (US$ mion equivalent) PROJECT ELENENT IOIAL COST IcS LCB OMfuIng cOthr 1.1 Infrestrutture wider FEC 4.6 143.4 148.0 .Aprojects (2.8) (79.4) (82.2) 2. gQ k 2.1 Lnder FEC .slprojects 2.4 3.0 20.0 25.4 (1.5) (.) (11.7) (14.9) 2.2 Equfpment for NDI. NOF ard FEC 1.4 1.4 (1.2) (1.2) 2.3 Equipment and mterials for CL 1.0 1.0 training (0.6) (1.2) 3. Cattancies 3.1 Dufmn/supervisian 2.5 2.5 (1.5) (1.5) 3.2 Technical Assistancre traIning 3.5 3.5 (2.9) (2.9) 3.3 External cour OS 0.5 0.5 (0.5) (0.5) TOTAL 7.0 146.4 22.4 6.5 182.3 (4.3) (81.1 (13.?) (4.9) (104.0) * f1g in parent_ are the respectve aonts financd by the Sank tam I=LO DISBUUNL 8CHI Bank Fiscal Year du d U A u RI Annual 8 31 33 23 8 1 Cuaulative 8 39 72 95 103 104 Schedule C KINGDOMXPMOOC FIRST MUNICIPAL FINANCE PROJECT Rev Processing Events and fesponiibilitics Timetable of Eventss Time taken to prepares 18 months Prepared by: Government, with Bank assistance First Bank Mission* May 1991 Appraisal Mission Departure: October 1992 Negotiations: April 1993 Board Presentation: June 1993 Planned Effectiveness: October 1993 Relevant PRs Communal Infrastructure Fund Pilot Project (Loan 2272-NOR, Cr. 10075) Responsibility for reoaration: Task manager: Julio Linares (NN11N) Division Chief: A. 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