Report No. PID7603 PID7603.TXT Project Name Guyana-Financial and Private Sector... Institutional Development Project Region Latin America and the Caribbean Sector Financial / PSD Project ID GYPE57272 Borrower Government of Guyana (GOG) Implementing Agency Ministry of Finance Contact: Hon. Bharrat Jagdeo, Minister of Finance Ministry of Finance Main and Urquhart Streets Georgetown, Guyana Tel.: 592 2 56088 Fax: 592 2 61284 Date Initial PID Prepared March 5, 1999 Date This PID Prepared April 23, 1999 Appraisal Date May 31, 1999 Projected Board Date June 17, 1999 1. Background Country and Policy Context Guyana is a low-income country with 1997 per capita income estimated at about US$720. It is thinly populated with about 0.78 million people, or 4 persons per square kilometer. Due to emigration, population growth in the past two decades has been marginal. Most of the population and economic activities are concentrated on the narrow coastal strip, which lies below sea level at high tides and is protected by a series of sea walls. The interior is largely forested and uninhabited, except for scattered communities of Amerindians. It is well endowed with natural resources, with good agricultural land and abundant rainfalls, diversified mineral deposits, and large tropical forests. The economy is basically natural resource-based, with agriculture (mainly sugar and rice) bauxite, gold, and timber accounting for most of the output in the productive sectors. With the possible exception of potential for hydroelectricity, which remains unexplored, the country does not have energy resources and is dependent on oil imports to meet most of its energy requirements. Since 1988, Guyana has established a strong track record in implementing macroeconomic stabilization and restructuring programs, supported by IDA, the IMF and other external agencies. Before Guyana embarked on this reform program, it faced declining investment, high unemployment and negative growth. During that period, poverty became widespread, the economic infrastructure dilapidated and the external debt mounted. The economic reform programs that were initiated in late-1980s were designed with the broad strategy to reorient economic management away from the centralized administrative controls that impeded economic development in the past decades and move towards achieving sustainable economic growth with low inflation and external viability, including a lasting solution to Guyana's external debt burden. Guyana has successfully implemented these far-reaching economic reforms and has made significant progress towards the achievement of the macroeconomic objectives and the economic restructuring. Guyana's annual economic programs during 1995-97 were implemented with determination and remained broadly on track (except for a weakening in public finances in the last quarter of 1997, associated in large part with political disturbances surrounding the December 1997 elections, and the effects of the El Nito weather phenomenon). During this period, real GDP growth averaged 6§ percent a year, and 12-month inflation declined from 16 percent in December 1994 to around 4 percent in December 1997. In the area of structural reform, efforts in 1995-97 concentrated on institutional building, increasing the role of the private sector, and streamlining the public sector. Institutional reforms included the establishment of a strengthened central bank supervision unit, a new privatization unit, computerization of the Inland Revenue and Customs Departments, strengthening of anti-smuggling measures, and the improvement of the operational arrangements for the execution of the public sector investment program (PSIP). In the financial sector, the Financial Institutions Act (FIA) and other conforming legislation and regulations were passed; the Exchange Control Act was repealed to complete the liberalization of the exchange system; and a revised Act to strengthen the independence of the central bank was presented to Parliament. In June 1997, a plan was developed (in collaboration with IDB) to streamline the size of the public sector including the civil service. During the latter half of 1997, steps were taken to privatize the largest commercial bank (NBIC), begin the privatization of the state-owned mining companies, and to establish a regulatory framework for the state-owned sugar company (GUYSUCO). The Bank's dialogue with the Government on IDA assistance strategy has been through adjustment operations, annual PFPs, jointly prepared with the IMF, and Policy notes. The focus of the IDA assistance strategy for Guyana has evolved over the years. Initially, the main objective was managing the post-devaluation adjustment simultaneously with macroeconomic stabilization and liberalization of the economy. With half of the population estimated to have incomes below the poverty line, and with the large devaluation adversely impacting on the poorest, protection of the vulnerable groups through social programs, such as the Social Impact Amelioration Program, were assigned the highest priority. Later, the strategy aimed at sustainable economic growth and diversification as one of the main pillars to reduce poverty with particular emphasis on allowing the private sector to promote economic activity under an organized regulatory framework. The main objective of the current IDA assistance strategy is to support the Government's efforts to achieve the above mentioned objectives, which will crucially depend on the establishment and deepening of institutional capacities and strengthening in key areas. This will involve: (a) continuing to improve economic efficiency and encourage economic diversification, including strengthening the role of private sector through privatization of state entities (measured by the reduction of state owned assets in the - 2- economy) and development of the securities and insurance sectors; (b) ensuring a sound financial system which will allow the government to develop strategies for efficiently dealing with weak banks (measured by the reduction in non- performing loans in the banking sector), (c) modernization and improved service delivery in the public sector through the institutional strengthening of key financial and operation related services such as auditing, procurement, as well as support of year 2000 readiness for key computerized functions and streamlining procedures to encourage foreign investment. 2. Description The project has three major components to support regulatory and institutional development. The three main areas are: (a) Financial Sector Development; (b) Private Sector Development; and (c) Public Sector Business Services. (a) Financial Sector Development: This component will involve funding of technical assistance expertise and informatics equipment to put in place a procedural framework for handling banks with structural or short term solvency and/or liquidity problems; implementing uniform financial accounting reporting standards in the banking sector; updating the regulatory framework to cover merchant banks, trust, foreign exchange traders, and other non-bank institutions; restructuring and improving the financial condition of the remaining state-owned bank including an assessment of privatization options; and developing industry-specific regulations and directives to operationalize the new legal framework and supervisory bodies in the insurance, mortgage and securities sectors. (b) Private Sector Development: This component will fund technical assistance, training and equipment to support the second phase of the privatization program to transfer approximately 13-14 additional state enterprises to the private sector. Besides technical assistance to carry out the financial, net worth valuation, and legal/contractual aspects of the program, the component will also develop a framework for facilitating the public offering of shares of such enterprises on the market. It will also fund work to value the financial accounts of, and consolidate all the remaining state enterprises into a common holding company to facilitate future performance monitoring and readiness for privatization. The component will also support the development of policies under the privatization program to protect laborer's and small investor interests to ensure fair and socially equitable treatment of such interests during the privatization process. (c) Public Sector Business Services: This component will fund the development of revised public procurement procedures and regulations to facilitate the public bidding and contracting processes. It will also strengthen and update the public sector's external auditing capacity to improve standards and timeliness of audits undertaken for both multilateral investment project credits and public institutions, and to implement procedures for delegating and sub-contracting audit work to the private sector under the aegis of the Auditor General's office. The component will also fund the modernization of the public sector's payroll budget system to ensure full Y2K compliance and allow continuity and efficacy in this key public sector management function. In addition, the component will fund the development of a foreign investment promotion framework to increase the entry of private capital into key - 3- economic sectors, and to develop appropriate procedural and economic incentives for private investment. 3. Objectives The development objectives of the project are to support second generation institutional development reforms aimed at consolidating the measures taken under the previous structural adjustment and technical assistance programs (SAC, PSDAC, FISBEC, & IMF ESAF). These objectives include: (i) assistance in the transfer of major state-owned enterprises to the private sector to promote an enterprise led economy; (ii) improving the financial strength, risk management and capital adequacy of the banking system through the restructuring and private management of state-owned financial institutions, (iii) improving the regulatory framework for the financial sector to support private sector activity and achieve synergies among the banking, insurance, mortgage and securities sectors, and (iv) supporting the modernization of the public sector through improved service delivery in the areas of procurement, auditing, and public sector management, in providing an enabling transactional environment for private sector business. The key performance indicators will include (a) the implementation of a modernized financial sector regulatory framework resulting in the operationalization of new regulatory bodies and evidence of improvement in the financial performance of financial institutions in line with international bank accounting and Basle prudential standards; (b) the transfer to the private sector of a critical mass of state-owned enterprises within the context of an enabling business environment for both industrial and financial investors; and (c) the modernization of the public sector auditing and procurement framework and implementation of Y2K compliant systems for public sector management. 4. Financing The total project cost is estimated at US$ 5.60 million. IDA would finance $US 4.80 million of total costs, and the remainder would be financed with Government counterpart funding. Component Category Cost Incl. of IDA- % of Contingenc Total financing Bank- ies (US$M) (US$M) financing Financial Sector Development 1.50 27 1.30 87 Policy & Institution Building Private Sector Policy & 2.30 41 2.00 87 Development Institution Building Public Sector Policy & 1.80 32 1.50 83 Business Institution Services Building -4- Total 5.60 100 4.80 86 5. Implementation The project will be managed by the Ministry of Finance (MOF) where the project unit will be housed. The individual sub-programs will be managed from a technical perspective by the applicable executing units. For the privatization and private sector development program, the Privatization Unit (part of the MOF) will conduct the program and manage the specific technical consultancies as required. For the financial sector component, in particular, the improvement in banking regulation and supervision, the central bank (Bank of Guyana - BOG) will undertake execution of such component though the MOF project unit will handle procurement matters.. For the public sector component, the Ministry will manage the execution via its relevant units such as the Tender Board, as well as involvement of the Auditor General office in the audit strengthening component. The Ministry of Finance, however, will centralize project contract processing, procurement, auditing, and disbursement arrangements, which will be effected at the request of the technical implementation units. In the case of the Privatization Unit and the Bank of Guyana, these arrangements have already been tested under the FISBEC and determined to be adequate. Some improvement in the organization of the project unit in the MOF, and its processing and accounting capacity will be needed, however, to ensure that reports on project progress, processing of contracts, and financial execution are timely. Auditing arrangements are currently being discussed with the MOF. While the Auditor General traditionally, and by law, conducts the audits of public sector programs including IDA projects, it also has the flexibility to deploy private audit firms for this purpose. In order to improve the financial management and accountability of the project unit, the project will include a budget for the contracting or sub-contracting of a private auditing firm, once agreed with the MOF and Auditor General's office. The Auditor General would still approve said audit report, but this arrangement should also result in more timely submission of project audits. During project supervision, the IDA team would include the requisite specialists to monitor the project implementation arrangements covering the following areas: (a) progress in policy & institutional reforms under the project's technical components, (b) coordination among the MOF with the executing units, (c) project financial management, accounting, and auditing, and (d) assessment of informatics adequacy (including Y2K provisions) for project administration purposes. 6. Benefits, Sustainability and Risks Benefits: The key benefits of the program are directed to private sector participants and industry entrepreneurs, to continue the process of private sector expansion and the reduction of control by the state in key economic activities (which in the past have also been a significant drain on fiscal resources). The program is multi-faceted in that it continues the privatization effort while reinforcing the safeguards of private ownership - 5 - through reform in the securities and insurance areas. To supplement the private sector effort, reforms of specific public services are to be undertaken have a responsive public sector delivery capacity to support the requirements of the emerging business sector, including an enabling environment relating to procurement, auditing, foreign investment, and computerization of basic public sector management functions. Sustainability: The project aims to provide consulting capacity which will be structured into the business processes of the beneficiary entities, so as to ensure eventual training and honing of staff in the implementation of the subject reforms (i.e.: on-the-job technical assistance instead of report writing). This will be particularly so in the case of the improvements and implementation of the financial sector (banks and non-banks) regulatory frameworks, as well as in the operations of asset/enterprise valuation for the privatization unit. Nevertheless, the privatization unit by definition will be a temporary administrative structure, thus once all major public enterprises are privatized, it should cease to exist. In the areas of the new Insurance and Securities Commissions, direct technical assistance will be provided in setting up these new entities and working with their staff and management to instill the requisite controls and procedures (similar to the earlier T.A. provided to the Central Bank's Banking Supervision Unit using on-site technical/management experts). Risks: The risks identified involve (a) the continuation (or lack of) of sound Government sectoral policies (political change risk), (b) the absorptive capacity of private sector for public entities offered for sale, (c) political and labor opposition to further privatization, and/or (d) lack of incentives to improve public sector services. To mitigate these risks, the project design has taken the following elements into consideration: (i) ensuring a Government policy of public disclosure & stakeholder participation, (ii) advertisement of entities at the domestic, regional, and international level; and the preparation of draft sale agreements for prior examination by investors, (iii) explicit incorporation of protection measures and severance/ESOP/contract continuity options for workers, as part of privatization deals, and (iv) early on implementation of a human resource budget/payroll tracking system to allow costing and rationalizing of inputs for key public services. 7. Lessons Learned from Previous IDA Operations For the successful privatization of public enterprises, all stakeholders need to be taken into account, particularly workers in the entities and small investors interested in contributing to the domestic market. Thus, this project explicitly incorporates the development of policies to both protect workers' interests in the transistion of ownership of privatized entities, as well as financial market regulations which adequately take into account and protect the interests of small investors (including when these are the worker/employees of the privatized entities, as in employee stock ownership participation - the latter will also be assisted by the development of securities trading and disclosure regulations); Successful private sector development also requires a responsive public sector service, particularly in business transactions involving procurement, auditing and other areas which have a direct bearing on the smooth functioning of the business environment. This, along with establishment of a - 6 - more organized regulatory framework in the insurance and securities sectors, will provide better synergies to assure a smoother transition to a private sector led economy. 8. Poverty Category The project does not have a direct poverty reduction component. However, it would mitigate the effect of labor displacements and unemployment by building in contractual measures into the privatization process, to diminish any social impacts from the transfer of ownership of public enterprises to the private sector. 9. Environmental and Social Aspects As listed above, as part of the project design, the inclusion of policies to protect workers affected by the privatization process (which temporarily became a political issue during the offer for sale of the state mining companies), will be a deliberate intervention supported by this project, to assure that social impact considerations are taken into account. In this regard, policies will be developed providing for options of (a) severance packages, (b) contract continuity as part of privatization deal, (c) employee stock ownership plans, and/or (d) retraining programs. For environmental impact purposes, the project is rated as "C". The project is strictly for technical assistance and no environmental impact of significance is anticipated. As part of the privatization technical assistance, the UK ODA/DFID Office in the Caribbean will be providing grant funds to assure environmental auditing of public enterprises (e.g.: removal of scrap metal, site clean-up prior to sale) as part of the pre-sale valuation process Contact Point: The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone No. (202)458 5454 Fax No. (202) 522 1500 Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending April 30, 1999. The new regulations of the Financial Institutions Act have tightened the requirements for the provisioning for bad and doubtful debts, raised capital adequacy standards, established borrower limits, and improved reporting and disclosure to meet regional and international standards. -7-