Document o f The World Bank Group FOR OFFICIAL USE ONLY Report No. 50223 -TUN INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT COUNTRY PARTNERSHIP STRATEGY FOR THE REPUBLIC OF TUNISIA FOR THE PERIOD FY10-13 November 23,2009 Maghreb Country Management Unit Middle East and North Africa Region 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 W o r l d Bank authorization. The Date o f the Last Country Assistance Strategy Progress Report was September 21,2007 CURRENCY AND EQUIVALENTS Unit o f Currency = Tunisian Dinar (TD) IUS$= 1.28 TD (November 2009) FISCAL YEAR January 1 - December 3 1 ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activity AFD French Development Agency AfDB African Development Bank AIDS Acquired Immune-Deficiency Syndrome ALMP Active Labor Market Program APL Adaptable Program Loan AWI Arab World Initiative CAS Country Assistance Strategy CASCR Country Assistance Strategy Completion Report CASPR Country Assistance Strategy Progress Report CFAA Country Financial Accountability Assessment CER Certificate o f Emission Reduction CDM Clean Development Mechanism CPF Carbon Partnership Facility CPIA Country Policy and Institutional Assessment CPS Country Partnership Strategy CPSCL Caisse de Pr&t et de Soutien a m CollectivitPs Locales CSM Commission SupPrieure des MarchPsslHigher Tender Board cso Civil Society Organization CSP Concentrated Solar Power CTF Clean Technology Fund DPL Development Policy Loan DPR Development Policy Review ECAL Economic Competitiveness Adjustment Loan ESMAP Energy Sector Management Assistance Program ESW Economic and Sector Work ETF European Training Foundation EU European Union FDI Foreign Direct Investment FSAP Financial Sector Assessment Program FY Fiscal Year GAC Governance and Anti-Corruption GDP Gross Domestic Product GEF Global Environment Facility FOR OFFICIAL USE ONLY HIV Human Immune-DeficiencyVirus IBRD International Bank for Reconstruction and Development ICL Integration and Competitiveness Loan ICT Information and Communication Technology IDF Institutional Development Fund IEG Independent Evaluation Group IEQ Institut d'Economie Quantitative IFC International Finance Corporation ILA Investment Climate Assessment IMF International Monetary Fund IOM InternationalOrganization of Migration JSDF Japanese Social Development Fund MDCI Ministry of Development and International Cooperation MDG Millennium Development Goals MENA Middle East and North Africa MOU Memorandum o f Understanding MTEF Medium-Term Expenditure Framework NDP National Development Plan PEFA Public Expenditure and Financial Accountability PESW Programmatic Economic and Sector Work PHRD Policy and Human Resource Department PIC Public Information Center PPI Private Participation in Infrastructure QA Quality Assurance QAG Quality Assurance Group R&D Research and Development ROSC Reports on the Observance o f Standards and Codes SME Small and Medium Enterprise SWAP Sector Wide Approach TA Technical Assistance UMA Union for Arab Maghreb VAT Value Added Tax WB World Bank WBI World Bank Institute WTO World Trade Organization This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not be otherwise disclosed without W o r l d Bank authorization. MANAGERS AND STAFF RESPONSIBLEFOR THIS CPS Vice President I Shamshad Akhtar Country Director I Mats Karlsson I Task Manager I Eavan O'Halloran I ACKNOWLEDGEMENTS This Country Partnership Strategy was prepared under the guidance o f Mats Karlsson, Country Director, by a team led by Eavan O'Halloran. Core team members o f the report include Ndiame Diop, Sophie Muller, Kathleen So Ting Fong, Donia Jemail, Narjes Jerbi, Micheline Faucompre and Luis Alvaro Sanchez. In addition, the following colleagues contributed: Najy Benhassine, Silvia Pariente- David, Alexandra Ortiz, Rebekka Grun, Adriana Jaramillo, Anwar Soulami, Raffaello Cervigni, Nabil Chaherli, Julian Lampietti, Daniela Marotta, Kanta Kumari Rigaud, Heba Elgazzaar, Lhassan Abnaou, Jean Michel Marchat, Chantal Reliquet, Michel Bellier, Julia Bucknall, Lucie Tran, Mohammed Benouahi, Dahlia Lotayef, Simon Bell, Jonathan Walters, Yolanda Tayler, Salim Benouniche, Gloria L a Cava, Natalia Agapitova, Alexander Kremer, Catherine Laurent, Roberto Rocha, Xavier Chauvot de Laila Moudden, and Leila Chelaifa. Beauchene, Jaafar Sadok Friaa, Tony Bigio, Philippe ROOS, For the IFC, Abdelkader Allaoua, Yasser Charafi, and Rapti Goonesekere were the core contributors to the parts of the CPS dealing with the IFC program. The World Bank Group greatly appreciates the collaboration with the Tunisian government in the preparation of this CPS. In particular, the Bank would like to thank the excellent collaboration with Minister Mohammed Nouri Jouini, Minister o f Development and International Cooperation (MDCI), Mr. Abdelhamid Triki, Secretary o f State, MDCI, and Mr. Kame1 Ben Rejeb, Director General, MDCI. The document benefited from extensive and thoughtful discussions with government representatives and was also enriched by contributions from other partners in Tunisia - development partners, members o f civil society organizations, parliamentarians, academics and representatives of the private sector. TABLE CONTENTS OF Page EXECUTIVE SUMMARY 1 I. COUNTRY CONTEXT 1 A. Introduction B. Tunisia's Development Achievements 11. RECENT ECONOMIC DEVELOPMENTS 5 A. Global Economic Climate 5 B. Medium Term Prospects and Debt Sustainability 7 111. TUNISIA'S DEVELOPMENT CHALLENGES 9 A. Boost Growth and Transform Tunisia into a Knowledge Economy 9 B. Increase Employment and Address the Problem of Employability 12 C. Improve the Quality o f Service Delivery 13 D. Manage the Impacts o f Climate Change 15 E. Exploit the Benefits o f Regional Integration 16 IV. NATIONAL DEVELOPMENT PLAN 17 V. WORLD BANK GROUP PARTNERSHIP 18 A. Nature o f the Partnership 18 B. Implementationof the CAS and Lessons Learnt 19 C. CPS Guiding Principles 21 D. Results 24 E. CPS Program 25 F. Financing 36 G. AAA 38 VI. R I S K S AND IMPLEMENTATION CHALLENGES 38 APPENDICES: Appendix 1: CPS Results Matrix 40 Appendix 2: CAS Completion Report 49 Appendix 3: Regional Integration Activities 83 Appendix 4: Tunisia CPS and Link to Bank-wide and MENA Region Priorities 89 Appendix 5: MENA Region Concentrated Solar Power Scale-up 91 Appendix 6: Donor Programs in Tunisia 93 Appendix 7: CPS Consultations Report and Communication Outreach 97 Appendix 8: World Bank Export Promotion in Tunisia 104 Appendix 9: SME Finance in Tunisia 108 Appendix 10: World Bank Managed Trust Funds in Tunisia 114 CAS TABLES Annex A 1 : Tunisia at a Glance 115 Annex B2: Selected Indicators of Bank Portfolio Performance and Management 118 Annex B3 : Proposed IBRD Base-Case Lending Program FY 10- 13 119 Annex B3: IFC Investment Operations Program 120 Annex B4: Summary o f Non-Lending Services 121 Annex B6: Key Economic Indicators 123 Annex B7: Key Exposure Indicators 125 Annex B8: Operations Portfolio (IBRD/IDA/Grants) 126 Annex B8: Statement of IFC's Held and Disbursed Portfolio 127 BOXES: Box 1: Key Social Indicators Box 2: Tunisia's Strong Track Record in Water and Energy Management Box 3: Government's Policy Response to the Global Economic Crisis Box 4: Areas o f Future Reform Box 5: Five Axes o f the National Development Plan Box 6: Good Donor Coordination Box 7: CPS Consultations and Communication Plan FIGURES: Figure 1 : Tunisia and Emerging Countries' Growth Performance Figure 2: The Dramatic Shift in the Composition o f Exports Figure 3: Trend in Fiscal Deficits Figure 4: Public Debts and Interest Payments Figure 5: Current Account Deficit and Gross Official Reserves Figure 6: GDP per Capita, Tunisia and Comparator Countries Figure 7: Unemployment by Age Group Figure 8: Unemployment by Schooling Level TABLES: Table 1: Investment Rates Table 2: CPS Lending Program and Other Operations Table 3: AAA Program EXECUTIVE SUMMARY 1. Since independence, Tunisia has performed better than most countries in the region, successfully implementing a far-reaching and ambitious development strategy with strong results. This strategy i s characterized by an early commitment to structural reforms, steady investments in human capital and infrastructure, pro-active macroeconomic management and a focus on global trade integration with the accompanying needed market reforms. This development model has served Tunisia well as it has sustained an average 5 percent growth rate over the past 20 years, with a corresponding increase in the welfare of its population underscored by poverty levels that are the lowest in the region and strong education and health indicators. 2. Despite the excellent growth track record, Tunisia continues to suffer high rates of unemployment particularly among the better educated. Tunisia recognizes that it must do more in order to grow faster and become even more competitive and, most importantly, create jobs for its young, well-educated population. This calls for an acceleration o f the economy's structural transformation towards a higher value-added, knowledge-intensive one. The Government i s finalizing the update o f the 1 lthNational Development Plan (NDP) which has the main goal to transform the economy to bring about sustained job creation. At the same time, the current global economic crisis, especially the EU recession, i s impacting negatively on Tunisia with a rapid decline in exports in late 2008 and the first half o f 2009. The Government has shown skill in addressing the challenge and responded with mitigating measures, drawing on experience o f managing exogenous shocks. There are promising signs that the worst o f the impact may be over and the overall macro-economy remains solid with a comfortable level o f reserves. 3, I n this overall context, the strengthening o f the partnership between Tunisia and the World Bank Group through this CPS comes at an opportune time. Tunisia considers that the Bank Group i s a key strategic partner which plays an important role in its development. The Government has often expressed its appreciation for the Bank's knowledge services and considers the Bank's dialogue and analysis as important inputs to the NDP and sectoral strategies. The Bank has notably supported the Government on reforms and investments targeted at maintaining the country's development achievements, as well as providing support to better target further reforms. Thanks to i t s strong development performance and continuous reforms, Tunisia achieved Investment Grade status and was able to access financing on the global market for i t s development strategy, such as it did in 2007 with a successful bond offering. In FY09, in the context of the global economic crisis, Tunisia turned to the Bank for increased financing and the Bank responded by delivering record lending o f $335.6 million. 4. The Government considers its partnership with the Bank as a strategic and long-term one where the Bank's role of knowledge partner in accompanying the country on i t s reform path i s highly valued. Tunisia plans to carry out i t s NDP in the overall context o f continued pragmatic economic management and pro-active public debt management. I t intends to engage external financing when necessary but expects this to remain modest as the economy rebounds and the Government's mobilization o f i t s own internal financing further strengthens. I t will continue to engage the World Bank Group in a broad range o f sectors given its appreciation for the knowledge role o f the Bank but will maintain its IBRD debt at moderate levels. In a context of reduced international commercial financing, IFC expects to play an active role in supporting the Government's ongoing PPP program in infrastructure (in particular in the power, water and transport sectors), by providing debt and equity financing to selected projects. Tunisia views IBRD and IFC financing as contributing to long-term development purposes to accompany the transition to a higher value-added and more knowledge-intensive economy. 5. Tunisia has shown itself to be a consistent and successful development partner and this CPS builds on its track record as a well-performing IBRD client. The sustained improvement o f human development indicators and recognized leadership in critical areas such as water resource management i and energy efficiency underscore the good development performance. Tunisia i s considered a leader in the region as regards to gender issues and strengthening women's role in society. Furthermore, it scores highly on comparative governance rankings and development indexes: it has consistently scored above its income category and the MENA average on most dimensions, although there remains room for progress in areas such as voice and accountability. The CAS Completion Report highlights that the achievements recorded in the previous CAS were positive, underscored by the Government's commitment to prudent macro-economic management, phased structural reforms and steady investments in priority sectors. 6. Alignment with the NDP, flexibility in approach and selectivity in the areas of engagement are the core principles o f the CPS. Tunisia's NDP provides strategic priorities which guide the CPS and allow for greater alignment. I t confirms that employment generation remains the highest priority o f the Government. The rolling nature o f the NDP obliges the Bank Group's program to be flexible, responding to challenges and demands as they present themselves. The NDP priorities have guided the selectivity on where the Bank i s engaged and reflect the understanding o f where the client sees the value- added of the Bank. The Government and the Bank have agreed on three CPS strategic pillars; (i) employment, growth and competitiveness; (ii) sustainable development and climate change; and (iii) improving the quality o f service delivery. Within these pillars, the CPS outlines a partnership program which i s grouped into results areas that facilitate focusing activities and tracking impact. As the program i s implemented, the Bank and Government will jointly assess progress and update results and indicators to reflect the increased specificity of the program and to ensure continued alignment. 7. The CPS outlines a lending program up to $280 million for FYlO and an indicative lending program for FY11-13. The lending requests from Government all build on the Bank's engagement to date either through on-going operations or particularly through the programmatic AAA support to employment, environment, SMEs, energy and social sectors. Increased IFC financing i s also expected although investments would remain contingent on progress in key ongoing infrastructure projects, the extent o f investment appetite in the country, and the financing terms in the local Tunisian debt markets. The Bank and IFC also plan to work together on public-private partnership opportunities as requested. The CPS outlines how the Bank's regional integration initiatives and its management o f global funds can benefit Tunisia, and discusses Tunisia's interface with the Arab World Initiative. 8. The CPS discusses the risks faced by Tunisia and the Bank Group's program and describes the measures for mitigating these risks. The most immediate risk of the global economic crisis i s mitigated by Tunisia's pro-active macro-economic track record, its proven capacity to respond and prudent debt management that gives the authorities room to conduct fiscal policy and engage financing. There are risks related to the pace o f reform on ensuring greater competition in the private sector environment to move to a knowledge-based economy. To respond, the flexible CPS design ensures that the program will move with the speed o f the Government in its implementation o f reforms under the NDP. In addition, the approach to AAA will allow the Bank to assist the Government in addressing challenges and thus reducing risks. Finally, implementation risks to the Bank's program are posed by slow procurement which causes significant delays in the execution o f Bank projects. The Government and the Bank have been working in a concerted way to address the procurement issues in the portfolio and the need for greater progress in procurement has been given more urgency recently by the Government as it continues to manage the impacts o f the crisis and accelerates NDP implementation. 9. In' conclusion, the CPS sets out the enhanced strategic engagement of the World Bank Group in Tunisia as the country continues to integrate globally and carries out an ambitious transition to a knowledge-based economy. This partnership builds on the excellent opportunity offered to the Bank to provide support not only through IBRD financing but, perhaps more importantly, through strong knowledge products at country and regional level. .. 11 I. COUNTRY CONTEXT A. Introduction 1. Tunisia's 1lthNational Development Plan (NDP, 2007-2011) charts an ambitious course to generate sufficient employment through transforming its economy to a higher value-added, knowledge-intensive one that will allow it to consolidate and improve its strong progress to date. The NDP builds on a prolonged period since the 1960s o f very solid economic and social development often in the face of unprecedented challenges and exogenous shocks. However, high unemployment threatens the social achievements to date and the impact o f the global crisis puts extra pressure on Tunisia to do better in terms o f growth. Tunisia recognizes that it needs to carry out a transformation to a higher value-added, knowledge-based economy through increasing further the integration of its economy, bringing about even faster improvements in productivity growth and innovation, and carrying out deeper structural reforms in order to generate employment, particularly for its well-educated population. 2. Tunisia is calling on the World Bank to play a key role in i t s development plan and strengthen its partnership through its knowledge engagement and financing. The Bank has remained a valued partner during important periods in Tunisia's development, most often for its knowledge role, although IBRD financing has proven important and timely. The Bank has a broad program already in Tunisia and a productive dialogue with the Government and the country's development partners. This invitation for the World Bank to step up its engagement reflects a strengthening o f the partnership with Tunisia and provides an excellent opportunity for the Bank to provide enhanced support to a well performing, middle-income country. B. Tunisia's Development Achievements 3. Tunisia has made remarkable progress on equitable growth, fighting poverty and achieving good social indicators. It has sustained an average 5 percent growth rate over the past 20 years with a steady increase in per capita income that compares favorably to other emerging countries' growth performance (see figure l), and a corresponding increase in the welfare of i t s population that i s underscored by a poverty level o f 3.8% (2005) that i s amongst the lowest in the region. The steady increase in per capita income has been the main engine for poverty reduction. In addition to rising incomes, public investment in infrastructure (roads, transport and communications) and human capital, including housing programs, also played an important role in reducing poverty (about 60 percent of Tunisia's budget i s allocated to the social sectors). Rural roads have been particularly important in helping the rural poor connect to urban markets and services. Food subsidies, which have been targeted to the poor, albeit not optimally, have also helped the urban poor. 4. Tunisia is on track to reach the MDGs (Box 1). As regards education, in 2007/08, 97.4% o f both male and female 6 to 11 year olds were enrolled in school. Primary completion rates are high for girls at 91% and have been increasing for boys reaching 87% in 2007/08. If the pattern o f lower repetition rates in primary continues, all students regardless o f gender should complete primary school by 2015. Health status i s generally better than that found in most other MENA countries, as life expectancy i s approximately 74 years and the infant mortality rate i s nearly the lowest in the region. Rapid progress has been made on reducing infant and maternal mortality rates and malnutrition over the past two decades, and HIV/AIDS prevalence remains relatively low. Coverage o f health care benefits i s provided through two national social assistance schemes, which together cover approximately 85 percent of the population. Access to basic socio-economic services (water, electricity, sanitation) i s near universal and there i s a broad social protection system in place. Tunisia i s considered a leader as regards gender issues and strengthening women's role in society. With 66% o f the population living in cities or towns, Tunisia i s one o f the most urbanized countries in MENA. Figure 1 - Tunisia and emerging countries' growth performance (Growth average for 2000-2007) 10 9 8 7 S 6 .- C 2 5 8 4 3 2 1 0 Source: World Bank, World Development Indicators Life expectancy at birth (all/women) I 70172 I 73/75 I 74/76 I Poverty: Official poverty numbers show a decline in poverty between 2000 and 2005 from 4.2% to 3.8%. Data from the latest household survey conducted in 2005 show a 37.6% increase in average per capita income between 2000 and 2005. The gap between Grand Tunis, the richest region, and the northwest and center west, the least affluent regions, has narrowed. However, Tunisia's official poverty line only captures the essential needs of physical survival. Using a higher poverty line, the World Bank global poverty project finds an incidence o f poverty o f 7% for 2005, still the lowest in the MENA region. Policy makers are trying to face the challenge to look beyond absolute deprivation as captured by poverty incidence to issues o f vulnerability and exposure to risk. 5. Increasing integration into the global economy has driven economic growth. The first wave o f integration reforms in the early 1970s created an off-shore regime that has attracted FDI and led to the creation o f new industries for export (including textiles and clothing). The composition of exports in 2006 shows a strong evolution compared to 1980 when fuels accounted for 50 percent o f all exports (see Figure 2 2). The second wave o f trade liberalization in the 1990s helped penetrate new markets in manufacturing (for example, mechanical and electrical engineering sector) and led to remarkable improvements in total factor productivity'. These evolutions occurred, however, mostly in an offshore sector, operating with a liberal investment climate. The domestic on-shore economy i s less dynamic, with lower levels o f growth and a domestic private investment rate which continues to remain sluggish (around 14-15% in recent years, see table 1). Figure 2. The dramatic shift in the composition o f exports +Fuel s 20 Table 1: Investment Rates ~~ 2002 2003 2004 2005 2006 2007 2008* Gross investment ratio 25.2 23.4 22.8 22.3 23.5 24.0 24.9 Gross private investment 14.2 13.6 13.0 12.7 13.3 14.4 15.4 Foreign direct investment 3.3 2.5 2.4 2.5 3.8 4.4 6.3 National private 10.2 11.1 10.6 10.2 2.3 10.0 9.1 investment Note Figures for F D 1 in 2006 do not include the $2 35 billion for the partial privatization o Tunisia Telecom f 6. Good and effective macroeconomic management, especially since 1996, has underpinned the strong growth performance and helped moderate the impact of exogenous shocks on economic growth. A continued pro-active fiscal policy has kept fiscal deficits below 3% (Figure 3) and prudent debt management has brought down the public debt ratio to 47.5% o f GDP in 2008 (Figure 4), which has '"Tunisia's Global Integration: A Second Generation o f Reforms to Boost Growth and Employment", A World Bank Country Study, 2008 3 contributed to Tunisia's stable investment credit rating (BBBBaa2). Tunisia also has a good track record o f keeping inflation under control at or below 3 percent (except in 2008 due to imported inflation). The drop in the public debt ratio meant a decline in interest payments and, together with a favorable evolution o f revenues, provided the fiscal space to increase transfers and subsidies from 3.7 to 4.2 percent of GDP between 2006 and 2007, and thus protect the population from the increases in food and energy prices. Figure 3 - Trend in fiscal deficits (YO) - Figure 4 Public debt and interest payments (YOGDP) 'O Ia -- --- 7 4 00% BO 35 -05% 50 3 -10 % 25 40 -15 % 2 -20% 30 15 -25% 20 1 -30% -35% 1) 05 0 0 0FKCal deficn excl grants and p w a t (46GDP) -Linear (Overall fiscaldeficlt (46GDP)) 7. This development model that Tunisia pursued over the past two decades has thus served the country well. However, despite the excellent growth track record, the Tunisian economy has not generated sufficient jobs to employ the growing and better educated labor force. Unemployment has been persistently high in Tunisia - 14.1% in 2008 - with the burden mostly falling on young and educated individuals. The high level of unemployment reflects an imbalance between the demand for labor, tilted towards the unskilled, and a growing supply of skilled labor where 57% are graduates of tertiary education. In addition, the insufficient creation of businesses in knowledge-intensive sectors has also contributed to keep employment of the educated workforce low. The profile o f labor supply positions Tunisia well to changing the structure of i t s economy toward more skill-intensive sectors and higher productivity in the long-run. 8. Tunisia scores highly on governance rankings but business environment and accountability issues continue to be cited as constraints to growth. Tunisia has consistently scored above i t s income category and the MENA average on most dimensions of comparative governance rankings and development indexes, although there are nuances behind these rankings. It achieves high scores on the CPIA ratings, ranks 691h on the 2010 Doing Business indicators (up from 73rd in 2009 and from 81" in 2008) and 36th on the Global Competitiveness Index. In WBI's World Governance Indicators, Tunisia i s ahead in terms of government effectiveness, rule o f law, control of corruption and regulatory quality, but has made less progress in areas of voice and accountability. Moreover, there i s still room for further progress on strengthening the business environment - characterized by a heavy and pervasive intervention by the state in the economy2-which has defined the private sector in Tunisia to date. The MENA region has recently finalized a regional report on private sector development that concluded that there exists a business environment in most MENA countries, including Tunisia, that i s perceived to be based on privilege and unequal application of the rules of the game and has resulted in less competition. In Tunisia, this environment has constrained the creation of jobs and i s the likely reason why private domestic investment has remained intractably low. * Based on a 2008 survey by lnstitut d `Economie Quantitative (IEQ) that surveyed 85 1 enterprises. "From Privilege to Competition: Unlocking Private Led Growth in the Middle East and North Africa", World Bank 2009 4 9. Since the 1980s, Tunisia has been a pioneer among developing countries in emphasizing environmental conservation, rationalizing energy use and managing its water resources prudently. I t has also successfully implemented Bank projects using country systems for safeguard compliance, with particularly strong results with respect to environmental safeguards. As shown in Box 2, Tunisia has carried out impressive reform programs in water and energy in particular. Box 2: Tunisia's Track Record in Water and Energy Management ~ % %a has achieved remarkable results in the areas of water supply and sanitation and improvements in these services have continued to be priority areas in the national development plans. Currently the entire urban population and over 90% o f the rural population have access to potable water. Moreover, 85% o f the population has access to improved sanitation services. Though per capita renewable water resources are less than half the MENA average, urban water i s supplied 24 hours a day, while water saving technology in the agriculture sector has increased water use efficiency to the second highest in the region. These achievements are even more remarkable given that water resources are limited, the climate i s arid, the ecosystems are fragile and the required financial investments are high. The water sector's performance i s due to the vision and experience of the operators, to the institutional framework which has been implemented and to the sustained growth of the economy. The relatively low-cost of water for low-income households has also helped increase overall service delivery and the implementation of an efficient cost recovery system has played an important role. Tunisia i s addressing the important water challenges of the next few decades through regularly updating i t s water resource management and sanitation strategy with support from the World Bank amongst others. Enerev Tunisia should be particularly recognized for its early investments in energy efficiency and promotion of renewable sources of energy. I t formulated a policy for rational use o f energy and promotion o f renewables as early as 1985. The energy intensity of the economy stopped increasing in 1992 and has declined to the lowest level in the MENA region. The Government has formulated a 4 year energy conservation program for 2008- 201 1 which proposes to strengthen further the institutional and legal framework that i s already well established. I 11. RECENT ECONOMIC DEVELOPMENTS A. Global Economic Climate and its Impact on Tunisia 10. The current global economic climate, especially the EU recession, i s having a negative impact on Tunisia mainly through weakening external demand. Total export growth dropped from 12 percent in 2007 to 1 percent in 2008 at constant prices, and further to negative 22 percent (at current prices) in the first half o f 2009 (the European Union i s the destination o f 76% o f Tunisian exports). This was driven largely by declines in exports o f textiles, clothing and automobile components which together represent more than 60% o f total merchandise exports, However, the worst o f the crisis in exports may be over as much o f the decline occurred in the first quarter o f 2009. Textiles and clothing exports rebounded in June and July 2009, while automobile components have regained a p p i t i v e growth trajectory since July. Domestic trade remained unaffected and the telecommunications sector has continued to grow strongly. Tourism, another sector sensitive to external demand, seems so far little affected by the global crisis and could register positive growth in arrivals this year, thanks to Tunisia's price-competitiveness and the importance o f tourists coming from Algeria and Libya. Nevertheless, a decline in the number o f tourists from the E U i s likely, accompanied by a decrease in the number o f hotel nights. 5 11. Fortunately Tunisia was well prepared to respond to this shock and the authorities have responded effectively. Growth in 2008 reached 4.5%, revised downwards from the expected 6.3%, a respectable performance given the global environment. The macro-economy in 2008 was sound with a modest fiscal deficit (-1.2% in 2008), low inflation (3%), and a healthy level of reserves (5 months of imports). The manageable level of public debt (47.5% of GDP in 2008 compared to 58% in 2005), together with the modest fiscal deficit, have provided the Government with room to respond. Furthermore, the financial sector was insulated - local banks have little foreign exposure and foreign participation in the stock market i s only 28%, real estate loans represent only 10 percent of GDP, the money market i s s t i l l highly liquid, Tunisia has managed i t s foreign reserves prudently and the Tunisian dinar i s non-convertible for most capital-account transactions. Figure 5. Current account deficit and gross official reserves (Months of imports GNFS) p^ l___l____ ------ ---- _I 6.0 I I 2004 2005 2006 2007 2008 2009 (proj) 12. Despite the export shock, the economy shows resilience. This i s confirmed by the recent assessment by the IMF in the framework of i t s Article I V consultations. Real GDP growth dropped significantly from 4.5% for 2008 to 1.3% in the first quarter of 2009 but rebounded in the second quarter to 2.5% as the fall in external demand was partially compensated by the dynamism in the mining, energy and services sectors. The increase in salaries o f public servants (4.7%), public enterprise employees (4%) and private sector employees (between 4.2 and 5.5%), decided in late 2008, i s also bringing about a positive dynamic in private consumption. 13. The external position remains comfortable. The current deficit contracted in the first trimester of 2009 after having increased in 2008 (4.2% in 2008, due to oil and food subsidies) and i s projected to decline to 3.5% in 2009. Thanks to the resilience of its tourism receipts and remittances of Tunisian workers abroad, the external position remains solid despite a slight decrease in FDI. Reserves reached a total of US$10.6 billion at end July 2009. The continuous inflow o f foreign exchange combined with reduced issuance of government bonds over the last few years led to a situation o f over-liquidity which the Central Bank managed to absorb by raising the reserve requirement o f banks. From January to May 2009, the nominal exchange rate depreciated by 1.7%, due to the depreciation o f the dinar vis-a-vis the euro (4%) while the effective exchange rate appreciated by 1.5%. 14. Inflation remains controlled, decreasing from its peak of 5% in 2008 to 3.5% in June 2009 thanks to a decrease in the price of basic products (food and oil) and an appropriate monetary policy. Inflation i s estimated around 3.5% in 2009 (y-0-y) and i s expected to be contained and remain in the range o f 3-3.5% thereafter. After two increases in 2008, the ratio of obligatory reserves was reduced from 10 to 7.5% by the end o f 2008. In addition, the Central Bank reduced the key inter-bank rate from 5.25% to 4.5% in February 2009 for the first time in 30 months. Finally, even through customs receipts have 6 fallen by 3.6%, overall revenues increased by 9.5% thanks to an increase in VAT revenue and petrol receipts. - Box 3 Government's policy response to the global economic crisis The Government's response to the global crisis confirms both its approach to pro-active macroeconomic management and to economic reform. In fact, the Government used the onset o f the crisis to move the reform agenda forward. The Government took a set o f quick actions to support the real economy in response to the economic slowdown. Measures were announced in December 2008 to increase public investment by 20 percent and to assist exporting f m s . The main support measures were: (i) a subsidy o f 50 percent o f the employer's cost o f social security for f m s experiencing a dramatic fall in exports to Europe; (ii) a subsidy o f 100 percent o f the employer's cost o f social security for f m s that had to stop production and run down stocks; (iii) a subsidy o f 50 percent o f the cost o f export insurance; (iv) an acceleration o f procurement procedures for public contracts granted to the local private sector; and (v) selected reforms to enhance integration, improve the business climate and strengthen the financial sector within the framework o f the Integration and Competitiveness program. This program supports reforms including reducing the number o f tariff bands from 9 to 6, converging product quality and safety norms to international standards, preparing a strategy for regulatory reforms in the services sector, improving the business registry to make it accessible and up-to-date, reducing the delays in access to industrial land (amendment o f the urban code) and reforming venture capital and mutual funds to make them more effective. The Integration and Competitiveness Program i s being supported by Tunisia's main donors - World Bank, E U and African Development Bank ( A D B ) - who increased their financing in 2009 to the reform program in line with the Government's strategy for undertaking greater external finance. The Bank increased the amount for its DPL on Integration and Competitiveness to $250 million, in line with the increased financing from the EU and AfDB o f $350 million combined. In addition, in July 2009, the Parliament approved an additional stimulus package featuring an increase in public spending o f more than TN700 million (equivalent to 1.4% o f GDP). Infrastructure projects (mainly road and highways) ready for incorporation in next year's Finance Law were advanced and are now being implemented. The December 2008 measures aimed at supporting exporting f m s have also been renewed for another six months, with eligibility now extended also to partially exporting f m s . The Bank worked closely with the government in assessing the impact o f the crisis and preparing the response. This program o f analytical support is ongoing as additional analyses requested by the Government are being finalized. B. Medium-Term Prospects and Debt Sustainability 15. The Government forecasts growth to increase to 3.3% in 2009. This i s expected to be reached if the risks linked to the EU economic recession do not materialize and if the fiscal stimulus produces the necessary effects in the short term. Further impacts from the global economic downturn are expected to dampen external demand in most sectors not just for exports o f goods but also for services, including tourism. Internal demand, especially private consumption and public investment, will act as the main driver o f growth, supported by the Government's stimulus plan4. Agriculture and energy are expected to 4 The impact o f the stimulus plan in 2009 (year 1) should not be overestimated. A recent paper shows that the impact o f an increase in public investment i s small in the short run but robust in the medium term. Lengthy procurement procedures prevent a rapid impact o f public investment on output. For more details, see Diop and Abdallah (2000): "The Dynamic Effects o f Countercyclical Fiscal Stimulus on Output in Tunisia", Policy Research Working Paper 5087 (October 2009). contribute positively to growth, as well as most services sectors (notably trade and telecommunications). Manufacturing industries (which account for 19% of GDP) should likely suffer negative growth given their export-orientation, The pace of growth i s expected to increase in 2010 to 3.8% and to return to a more sustained pace of around 5% from 201 1 onwards. Key Macro-Economic Indicators and Projections Actual Estimate Projection Growth o f Real GDP 40% 57% 63% 45% 33% 38% 5 0% 5 6% CPI inflation (%change) 20% 45% 31% 50% 30% 31% 3 1% 3 2% REER (US$/LCU) 75 5 74 9 12 7 12 0 65 h 64 4 62 9 61 2 Gross Domestic Fixed Investment 22.3% 23.5% 24.0% 24.9% 25.8% 26.5% 26.2% 25.1% Gross National Savings* 20.9% 22.7% 23.6% 22.8% 23.2% 24.8% 24.0% 22.8% Current Account Balance -1.0% -2.0% -2.6% -4.2% -3.6% -2.6% -3.1% -3.2% Trade Balance -6.8% -8.1% -8.1% -9.8% -2.4% -2.4% -2.0% -1.3% Exports (merchandise fob) 36.2% 37.8% 42.7% 47.1% 38.3% 36.9% 35.9% 35.1% Imports (merchandise fob) 42.9% 45.9% 50.8% 56.9% 40.7% 39.2% 37.9% 36.3% Foreign Direct Investment (net private) 2.5% 10.7% 4.4% 6.3% 6.0% 5.6% 5.2% 4.9% National Government Balance (excluding grants) -3.2% -3.1% -2.9% -1.2% -3.8% -3.6% -3.3% -2.5% Primary balance -3.2% -0.3% -0.3% 1.1% -3.8% -3.6% -3.3% -2.5% Total (current) revenues 23.8% 23.7% 24.0% 26.6% 24.5% 24.8% 24.3% 24.4% o/w tax revenues 21.0% 20.6% 20.9% 22.6% 20.9% 21.3% 21.3% 21.4% Total (current) Expenditures 1 20.4% I 20.2% I 20.2% I 20.9% I 21.0% I 20.5% I 20.4% I 19.8% Net Interest I 2.8% I 2.7% I 2.6% I 2.3% I 1.9% I 2.0% I 2.0% I 2.0% I Debt I Total Government Debt I 58.3% I 53.9% I 50.2% I 47.5% 1 47.6% I 47.0% I 47.1% I 45.8% External debt I 37.3% I 32.2% I 29.3% I 29.0% I 27.8% I 26.2% I 21.7% I 20.1% Nominal GDP (million US$) 29,009 30,962 35,474 40,743 43,394 46,674 50,524 55,006 16. The financing o f the current account deficit comes mainly from foreign sources. FDI i s expected to slow down in 2009 (from a record increase in 2008) and then stabilize or increase in the mid- term. Remittances showed a strong resilience to adverse economic conditions. Reserves are expected to stay at comfortable levels in 2009 (around 4.5 months of imports) and for the rest of the mid-term period. 17. Major public investment activities in 2009 and 2010 should help the economy recover so long as the project preparation procedures and procurement are accelerated. Public investment i s an important driver of growth and a key political counter-cyclical tool, but as noted in footnote 4 its impact in the short term remains weak due to the long delays in the preparation of projects. The uncertainty as regards the global environment and the possible delay in the execution of projects proposed in the stimulus plan constitute risks to growth in 2009. Added to this would be the delay in the EU's recovery and i t s impact on Tunisia. A l l factors being considered, it i s likely that unemployment will worsen in 2009 and the beginning of 2010 even if growth rates are positive. 18. I t i s important for the Government to continue its policy of fiscal consolidation and active debt management in the medium term. Once the downturn i s over, a decrease in energy subsidies could facilitate both macro-economicmanagement and especially the debt management policy to decrease further the ratio of debt to GDP. The Government intends to continue pro-active public debt management through: (i) early repayment of high-interest debts; (ii) active management of the risk related to the 8 interest rate (8% of external debt in 2008 had a variable rate); and (iii) active management of exchange and refinancing risks (in part through issuance of long maturity bonds in local currency). Keeping debt increases below the rate of growth of the economy will help reduce debt-to-GDP ratios, freeing foreign exchange reserves and allowing for the maintenance of reserves at a comfortable level through 201 1, 1. 11 TUNISIA'S DEVELOPMENT CHALLENGES A. Boost Growth and Transform Tunisia into a Knowledge Economy 19. The broad challenge for Tunisia over the long-term i s to accelerate the structural transformation of the economy to increase productivity and generate sufficient numbers of skilled jobs. The growth model followed to date has served the country well and Tunisia has attracted FDI and established a light manufacturing industry that i s competitive on an international scale. This industry has been supported by an off-shore regime that offers a good incentive framework to investors as well as attractive fiscal and financial advantages. This regime facilitated a strong increase in exports and FDI as well as a large creation of low-skilled jobs, especially for women which in turn helped reduce poverty. This growth model was successful in the early stages in reducing total unemployment as, up until the late 1990s, the public sector was there to employ most university graduates. Now the public sector i s seldom recruiting and the light manufacturing sector has not reinvented itself. The latter remains specialized in low value-added sub-contracting and has not incorporated more knowledge-intensive segments in the production process (in part because the European client does it). As analyzed in the World Bank's 2009 Development Policy Review (DPR)', the majority of new entrants to the labor market today have a university degree while the productive sectors have weak capacity to absorb highly qualified workers. This naturally raises concerns on the quality of growth achieved by Tunisia whereby growth has created an employment profile focused on low skilled workers, leaving highly qualified workers behind. 20* The task for Tunisia is thus to bring Figure 6: GDP per Capita, 1960-2007, constant 2000 US$ about an economic transformation which Tunisia and Comparator Countries intensifies the sophistication of the economy, creating demand for highly qualified labor, )6,0w which in turn will contribute to a rising --Jordan productivity o f the economy. The DPR P- . ... ... provides a detailed analysis of the strategic @,ow options to accelerate the structural transformation of the economy and identifies reforms in the areas of innovation, support to SMEs, integration, and the other accompanying policies la,ooo / needed to strengthen the financial sector, adapt education, improve the functioning of the labor t*,ooo market and continue to improve economic governance. Tunisia's own past experience and the experience of other countries (such as ti,ow Malaysia) that have managed to jump the ladder of technological sophistication (Figure 6 ) can $0 inform economic policy in the coming years. continue to be crucial for growth to transcend the smallness o f the domestic market, tap into global knowledge, transfer new technologies, foster competition and boost productivity. But this will "Tunisia Development Policy Review: Towards an Innovation-Driven Growth", Report # 50847-TN, World Bank 9 require reforms to integrate better the on-shore sector with the off-shore sector. Indeed, the on-shore sectors benefited from high tariffs but faced a highly regulated business environment where enterprises regularly cite anti-competitive practices. As the tariff protection o f on-shore activities decreases, the regulatory and incentives gaps between on-shore and off-shore business increases. Not surprisingly, domestic private investment has been low in this context despite the successful reforms in many areas o f the business climate (underscored by international evaluations such as the Doing Business Indicators). 22. Tunisia i s relatively well positioned to move towards a knowledge-based economy given its progress, albeit at different speeds, on exploiting external markets, education, logistics, energy and other areas. Tunisia can learn from i t s own positive experience, particularly in the off-shore sector, and the experience o f other successful countries to launch this `transformation. Besides continuing to assure macroeconomic stability in an environment o f high global uncertainty, Tunisia faces a broad agenda that Box 4 identifies. The strategic thrust i s to seek a greater integration into the global economy (including services and agriculture), such as has been undertaken in the framework o f the integration .program. This should be supported by further efforts to strengthen the business environment, make finance available to start-ups and innovators, reduce the costs o f logistics and create an innovation platform that can launch the country into new areas o f economic activity such as I T and advanced services. Box 4: Areas of Future Reform Further Integration into the World Economv: Trade policy: Tunisia i s advancing well in its trade policy reforms. Since January 2008, trade o f industrial goods with the EU i s duty-free. The agenda i s however unfinished as import tariffs for non-EU trade are high and product standards are not fully aligned with those of potential markets. The government has been reducing tariff dispersion created by the gap between tariffs on EU imports and imports from other sources and these efforts should continue. A key challenge will be to reduce non-tariff barriers in the services sectors unilaterally for some sectors (e.g. telecom) and in partnership with regional and global partners for others (e.g., open skies agreements). Finally, export promotion and particular support to SMEs will be critical since Tunisia's f i r m s often manage to penetrate new markets but do not mature in those markets (opportunistic export behavior). Logistics: Logistics i s an integral part of integration reforms and improvement in logistics will benefit the overall economy. The challenge i s to better integrate Tunisian services with international logistics networks, by blending openness and consolidation o f local providers. A wide spectrum of areas need attention including trade facilitation at customs, improving port performance, encouraging investment in logistics platforms and reducing entry barriers and informality in the logistics sector. The government has launched investments in ports (Enfidha) and other critical infrastructurebut there i s s t i l l a way to go to bring about the needed logistics overhaul. ComDetition and the Business Environment: For Tunisian firms to benefit fully from global integration and for greater innovation and productivity to flourish, enhanced and fairer competition in markets i s required. Repeated surveys show that competition i s weak in the on- shore economy, underscored by the 2008 IEQ study where 60 percent o f f i r m s denounced anti-competitive practices such as implicit agreements, discrimination among clients and linked sales and 67 percent of firms cited at least one type o f unfair competition in the domestic market. The private sector has often denounced the regulatory environment which they face. The slow execution o f reforms often reduces their credibility and thus their equal and reinforced application would greatly improve their credibility and the private sector's response. The MENA region's flagship report on Private Sector Development6 emphasizes that this i s a regional problem. As Tunisia looks to the future, and ifit intends to pursue a credible transformation of i t s economy, the role o f the state needs to become more selective and much lighter with a smoother and more equal implementation of policies. "From Privilege to Competition: Unlocking Private-Led Growth in the Middle East and North Africa" 10 Financial Sector: Onshore firms need better access to credit as do potential new entrants. Most financing tools are available (bank finance, factoring and leasing, stock market, venture capital, etc.) and the government has put in place several dedicated support mechanisms ( e g BFPME a bank specifically dedicated to SME finance and SOTUGAR for guarantees). However, despite this fairly favorable environment that generates viable financing opportunities, private sector funding (as a percentage o f GDP) has leveled off in the last decade. Tunisia's IMF- World Bank Financial Sector Assessment Program (FSAP - 2006) presented a diagnosis with recommendations that remain valid. In line with the recommendations, the government has been improving the design o f the public credit registry and promoting the creation o f well-regulated credit rating agencies. A plan i s underway - with the support of the Bank's DPL to the Integration and Competitiveness Program - to reduce the size o f the non-performing loans, and provisioning them (only 53.8% are currently provisioned). In addition to strengthening banking, and in line with the FSAP recommendations, the development of the non-banking financial sector i s a priority, as innovative channels of financing are needed to support SMEs and encourage entry and innovation (see Appendix 9 for details on SME financing in Tunisia). Innovation, Research and DeveloDment: Tunisia has followed an active policy to develop a national innovation system including scientific research, technological diffusion, education and industrial upgrade. It has achieved notable progress in terms of the public investment rate in R&D - including ICT and e-government, the proportion o f researchers in the population and the education level o f its work force. In addition to the investments made, a dense institutional infrastructure has also been put in place to support innovation, science, technology and research with multiple research and promotion agencies active, often with overlapping mandates. Despite this progress and investment, recent analysis shows that there i s still a limited contribution o f research in the economy, a developed technological base i s still fledging and the partnership between the productive sector and research institutions i s weak. 23. Agriculture requires special attention as it remains an important sector of the economy (about 10 percent of GDP) and employs a sizeable percentage of the labor force (about 16 percent of the total labor force and 27 percent o f the rural labor force). The natural potential o f agricultural land has been mobilized fully and rainfed agriculture remains dominant in terms o f land use, with strong inter-annual variations in rainfall. Despite decades o f Government efforts to protect natural resources, over-exploitation and inadequate land management have led to significant resource degradation. The performance o f the sector and the agricultural policy o f the Government have a respectable record o f growth but the agriculture sector i s working below its potential for pro-poor growth. Agriculture growth has not been as strong as the overall economy (average annual growth o f 2.8 percent), and to a great extent, poverty i s a rural phenomenon (the Government figures estimate rural poverty as being twice the national average o f 3.8 percent). In this regard, there i s a need - as mentioned in Box 1 - to look at poverty beyond absolute deprivation and poverty incidence and instead try to address issues o f vulnerability and risk for poor farmers. 24. A recent study on Tunisian agriculture' found that productivity in certain sub-sectors i s low and not competitive internationally. Some o f these sectors survive through subsidies, most notably a low price o f water for irrigation. Fulfilling agriculture's potential will require (i)trade and price liberalization and a reconfiguration o f the state intervention in commodity markets; (ii)modernized public services in areas such as input and output marketing, research and phyto-sanitary controls; (iii)leveraging support to the private sector based on needs expressed rather than by imposing regulations; and (iv) supporting more effective rural finance and irrigation water management. Tunisia has taken an active part in the Doha process and has started bilateral negotiations for liberalizing agriculture and services as part o f its Association Agreement with the EU. But, as Tunisia contemplates further liberalization o f trade, there i s greater urgency - expressed by the Government through the NDP - to address the current limitations o f the enabling environment, while at the same time developing an upgrading program ("Mise ci niveau '7 aimed at improving productivity. '"The Competitiveness o f Tunisian Agriculture: Retrospective and Perspectives", May 2009, World Bank ESW 11 25. The transport sector in Tunisia contributes about 5.9 percent o f GDP and i s relatively well developed even though quality and capacity could be strengthened. In several instances, Tunisia's current transport infrastructure and logistics services are still short o f fully supporting a growing and modem economy, especially one that i s dependent on exports and integration. There are capacity gaps in urban and inter-urban infrastructure, value-added logistics are under-developed, and congestion i s a growing and serious problem in most large urban areas. Energy saving i s a key challenge for the transport sector as it consumes 3 1 percent of the country's energy and 56 percent of oil products, thus being one of the main contributors to Green House Gas (GHG) emissions. Relevant reforms are being pursued in several transport-sub-sectors (institutional reform o f ports, public-private partnerships in Enfidha airport) but the pace of these reforms should be accelerated to strengthen Tunisia's ability to grow at a stronger rate. The Government has a large transport investment program in the NDP with a focus on facilitating trade and improving urban transport services. As part o f the stimulus plan described in Box 3, the Government has targeted increased public investments in the transport sector. B. Increase Employment and Address the Problem o f Employability 26. The pattern o f economic growth until now has not generated sufficient employment for an increasingly better educated labor force. Unemployment has been persistently high in Tunisia reaching 14.1% in 2008 with the burden falling on young and educated individuals (Figures 7 and 8). The unemployment rate reflects three factors; (i)demographically, Tunisia i s boasting a large number of higher education graduates entering the labor market (57% o f entrants have a university degree), thus swelling the labor supply o f educated people; (ii) the existing economic sectors (textiles and clothing, agriculture, agro-industry, automobile components, tourism, etc.) are predominantly intensive in low- skilled workers and do not generate sufficient demand for workers with a post-baccalaureate level o f educatioddegree; and (iii) while greater trade integration and significant FDI inflows have allowed new sectors to emerge, the trend o f business creation in newer, knowledge-intensive sectors i s insufficient. Despite high levels o f education o f women in Tunisia (who make up the majority o f university graduates), their participation in the labor market remains low. Figure 7 - Unemployment by age group Figure 8 - Unemployment by schooling level & 1641 20% - I & 20.24 T A p 26.21 16%. 1OX . ,_" -. . 6% - OK , oal 184 1118 2W4 2006 O 2M 2001 1894 1nr m 2Wb 2WS 2007 27. A critical action to address some aspects of the unemployment problem lies in the move towards a knowledge intensive economy which can shift the demand for labor towards the more educated. This brings rise to a particular set of issues that need attention; (a) the workings o f the labor 12 market; and (b) the availability of required skills. The labor market in Tunisia i s relatively rigid, affecting the distribution of jobs between formal and non-formal, and affecting negatively the labor productivity of the overall economy. Firms create informal jobs because the labor code i s overly rigid. This rigidity i s also linked to a public policy of protecting workers that i s provided through the firm rather than more effectively through neutral general schemes. Removing this rigidity would require putting in place social safety nets that go beyond what i s now in place towards well-targeted labor market programs. In addition, the government could increase the flexibility in the rules and procedures governing hiring and firing, retrenchment and firm restructuring which are currently too rigid. 28. There i s an urgent need to provide the appropriate skills to assist transformation of the economy. The Investment Climate Assessment surveys point to quality of labor as a constraint and there i s widespread evidence through various business surveys of a skills mismatch and a high-skilled brain drain (the 2008 IEQ enterprise survey found that over 60 percent of f i r m s were constrained because of lack of engineering, technician or skilled worker profiles). Therefore, there i s a need for re-orienting higher education to technical and scientific sectors, as well as a need for a new and comprehensive focus on skills development encompassing professional reinsertion and retraining of workers in traditional sectors and reforming the higher education system to respond to the needs o f a knowledge-based economy. New ways of working will need to be explored with the private sector to ensure both a better match with the needs of firms and the delivery of training. 29. Notwithstanding the importance of skills and a well functioning labor market, the driver to create more jobs remains the private sector demand for hiring people. Thus the issue i s how to unleash the demand for employment in the private sector. If Tunisia's economy remains in the traditional sectors, this will imply that firms will continue to need more uneducated labor as they grow, thus leaving the unemployment situation relatively unchanged. The solution i s naturally increased trade and investment but calls for a more fundamental shift to a skills-intensive, knowledge economy that operates in a more competitive and enabling environment. C. Improve the Quality o f Service Delivery 30. Tunisia's public sector has helped steer the economy along a sustained growth path and deliver increasingly better outcomes. However, now the public sector once again faces the challenge to reinvent i t s e l f to meet emerging challenges. Selected and phased reforms have been undertaken to date but would need to be further continued in five areas that are already identified in the NDP as priorities: (i) introduction of new methods of public adminstration; (ii) weeding out of obsolete regulations; (iii) equitable rule enforcement; (iv) active encouragement of greater openness and participation; and (v) strengthening of Monitoring and Evaulation capacity. The Government has introduced performance based budgeting and Medium-Term Expenditure Frameworks (MTEF) which are showing some progress. The effectiveness of public procurement urgently needs to be addressed and a serious reform program undertaken. Slow and burdensome procurement procedures have greatly constrained the delivery of services and infrastructure. 3 1, Tunisia has made great progress in extending the educational system to greater segments of the population. As already noted in Section Iabove, Tunisia most likely will meet i t s MDG targets. In addition, enrollment rates and completion rates continue to improve in upper basic education (12-16 year olds) and secondary levels. Enrollment in tertiary education has tripled in the past ten years reaching 3 1% of 19-23 year olds, 58% o f whom are female. Forecasts are that higher level education enrollment rates will continue to increase at a rate of approximately 10% per year. Total expenditures on education (not including vocational training) represented 6.1% of GDP in 2006, higher than the average of OECD and middle-income countries. Allocations within the sector follow the needs emerging from a shrinking 6-1 1 year old population and an expansion o f post-primary education. 13 32. The coming challenge i s to improve the quality and relevance of education. International students tests for children in Grade 4 and 8 show that Tunisian students' scores in math and science are average for countries o f similar income levels. Since 2000 the government has undertaken extensive curriculum reforms, but evaluations show that greater attention should be paid to linking pedagogical reform and learning outcomes. The rapid expansion o f the popuation in secondary education has seen worsening of performance and higher drop-out rates, with resulting weak links between secondary education, vocational training and higher education institutions. In addition, the increased demand for secondary education has led to hiring o f young teachers who are not prepared to respond to the demands o f a diversifying population. In the future, Tunisia will continue to face a demographic transition that will shift a greater share of the student body to secondary and tertiary education, making it urgent to work on relevance and quality. Universities and other institues o f higher learning need to have the incentives aqd the flexibility to respond to labor market demands which will imply controlling the flow o f students, particularly where there i s recognized over-supply in certain professions. The Government i s aware o f these challenges and i s undertaking strategies to address them, taking into account that the challenges of reform across all forms o f higher level education (university, vocational) are significant and additional measures will be needed to ensure the sufficient re-orientationo f the education system to the needs o f the market. 33. Health status in Tunisia is generally better than that found in most other MENA countries, and the health-related MDGs are largely on track to be achieved. The population enjoys a relatively high life expectancy rate o f 74 years (76 for women), rapid progress has been made as regards infant and maternal mortality rates and HIV/AIDS prevalence remains relatively low. Coverage o f health care benefits i s provided through two national social assistance schemes, which together cover approximately 85 percent of the population. Tunisia i s also experiencing an epidemiologic and demographic transition, such that a greater prevalence o f non-communicablechronic diseases and a gradually ageing population will likely increase the demand for more technologically complex health services. This transition will require ensuring effective and sustainable health services and promoting healthy lifestyles to address demand. 34. While the health sector performance compares favorably with other countries at a similar income level, there are a number of health system challenges that need to be addressed. These include improving the quality o f public services and the efficiency o f health resources, particularly in public hospitals, and improving equity in terms o f expanding health insurance coverage and reducing the financial burden on the poor. Tunisia has witnessed a relatively rapid increase in total health expenditures, largely attributed to the particularly high rate of growth o f out-of-pocket household spending at private health facilities. This trend reflects a growing dissatisfaction with the quality o f service offered by the public sector. 35. Tunisia has developed a comprehensive social protection system combining active labor market programs (ALMPs), social insurance and social assistance programs. The latter include consumer food and fuel subsidies, targeted transfers, emergency and education loans and family allowances. Tunisia i s rightly proud of i t s social protection system and spends approximately 19 percent o f GDP through the general budget or through contributions levied on the affiliates to the social security system. However, the current system o f unemployment assistance leaves most workers uncovered and provides weak and even adverse incentives. As noted previously, i t would be advisable to move gradually to a more universal and neutral protection scheme that would support a greater mobility in the labor market. The pension system i s running annual deficits which have to be covered from reserves. Various pillars o f the social safety net system are not well targeted to the poor despite some reform efforts in the past - such as food and fuel subsidies. The system has unconditional transfers in cash and in kind that are high and it lacks evaluation on their impact. The Government has made efforts to simplify and 14 streamline the system but much remains to be done to ensure greater efficiency and better targeting. Medium-term fiscal stability will requre continuing reform o f the subsidies system. 36. Sustaining the decentralization and de-concentration process, through strengthening of municipal and local authorities, i s needed to improve the quality o f services to citizens. With a 66% urbanization level that continues to increase, there i s pressure on municipalities to improve their services as service delivery has not kept pace with population growth in urban areas. Some o f the pressing challenges in this area are: (i) capacity building at municipal levels; (ii)fostering local economic development; (iii) preserving the urban environment; and (iv) safe-guarding the country's cultural heritage. In the 1990s, a process o f decentralization was supported by an increased transfer o f responsibilities to municipalities and the creation of a specialized financial institution (Caisse de PrBt et de Soutien uwc Collectivite`s Locales - CPSCL) to provide lending and manage central transfers to municipalities. These measures were followed by reforms of local finance and tax systems which have had positive but limited effects. There has been little progress made in the de-concentration o f municipal income and municipalities have few services for which they are fully responsible, a narrow set o f income sources and a constraining infrastructure investment program. There i s a need for future budgetary reforms in order to target a more de-concentrated delivery o f public services, as well as engage the private sector more in the delivery o f services. Tunisia benefits from a huge cultural heritage that currently remains under-exploited. Preserving and promoting better this heritage i s a critical element in continuing to transform the current tourism model (based on the lower-end, beach-type holiday) to a higher-end model with greater value-added to the local economies. D. Manage the Impacts o f Climate Change 37. Tunisia's already vulnerable environment is being further tested by climate change. Tunisia i s a land and water scarce country and has managed these scarcities well, building an institutional set-up that has kept the country well supplied with water (see Box 2). However, the rapid demand for water associated with economic growth and greater coverage of the population has meant that the country i s reaching i t s maximum potential and must bring demand in balance with supply. This means measures to induce greater productivity in water use, particularly in agriculture that i s the major consumer (agriculture uses the.majority o f the water resource base, although the potable water share i s projected to increase from 13.4% in 2010 to 17.7% in 2030). There i s also room to expand the recycling o f water through treated waste water reuse. Tunisia's agricultural economy, despite the investments that have been made, remains vulnerable to the variability of rainfalls that causes recurrent droughts: in years where drought occurred, there was a decline in agriculture output with an average corresponding 1% decline in overall economic growth. The urgency to meet the water use challenge i s further highlighted by the current consensus amongst experts that Tunisia's climate will become warmer and drier over the coming decades, with precipitation possibly declining 10% by 2030. Moreover, efforts to increase water productivity in agriculture should be accompanied by efforts to preserve fertile arable land (it i s currently estimated that about 47 percent o f arable land i s eroded). A combination o f conservation, desalination, recycling and agricultural rationalization i s essential to ensure water use i s sustainable in the medium to long-term. 38. Tunisia has achieved considerable progress to date on energy efficiency and increasing the use o f renewable energy sources. As previously outlined in Box 2, Tunisia boasts one of the highest energy efficiencies in the MENA region. However, it must bring about greater progress if it i s to reach the levels o f neighboring Mediterranean countries such as Greece and Portugal. Tunisia has made some laudable efforts in promoting alternative and renewable forms o f energy although the vast majority of its energy needs are s t i l l met through the use o f fossil fuels. Tunisia evolved from being a net exporter o f oil and gas in the 1970s and 1980s into a net energy importer by the late 1990s. Today imports supply a quarter of energy needs but this i s expected to increase with greater advances in industrialization and greater consumer demand in cities. The challenge thus remains to continue the path o f reducing the 15 energy intensity o f the economy, find alternative non-fossil sources o f energy and reduce energy dependency on imports and fossil fuels. Leveraging the resources of the private sector in the development o f large scale renewable energy projects can accelerate the pace of diversification o f Tunisia's energy mix, in particular in electricity generation, taking advantage o f Tunisia's good wind and solar resources. The recent new law allowing large industrial customers to generate their own electricity from renewable resources, and efforts to develop large scale wind and solar parks are steps in the right direction. Encouraging private sector participation, through a more favorable regulatory framework, as well as providing visibility to international investors could accelerate the pace o f development o f Tunisia's renewable energy sector. 39. High value assets in urban areas and tourism resorts, and strategic infrastructures in transport and other sectors are already exposed to natural disaster risks, which could be exacerbated by climate change. Flooding in cities i s happening with greater frequency, causing severe damage to sanitation and road infrastructure. Urban development i s concentrated in coastal areas that are increasingly vulnerable to the impacts of climate change. Coastal cities in particular, often the location o f globally-important cultural heritage sites, are increasingly under threat from rising sea levels and coastal erosion. Changes in sea temperatures are also impacting the delicate marine ecosystems o f key tourism sites (for example, Gulf of Gabes). 40. Tunisia i s well placed to benefit from external financing in support of climate change mitigation and adaptation. Financial instruments, such as the Clean Technology Fund (CTF) and the Carbon Partnership Facility (CPF) can help re-align low carbon development options with Tunisia's national interests, by closing the financial gap at investment stage (CTF), or generating additional stream o f revenue upon delivery o f carbon emissions reductions, even beyond 2012 (CPF). IFC's strategic focus on the financing o f private-sector led renewable projects in Tunisia can also play a substantial role in encouraging private sector investment in the country's renewable energy sector, in particular early investors. Furthermore, Tunisia could eventually become a net exporter o f renewable energy through participation in the MENA Concentrated Solar Power (CSP) scale-up initiative and the possible energy interconnection project between Tunisia and Italy (see section on CPS program for details). E. Exploit the Benefits of Regional Integration 4 1. Tunisia would be in a better position to address most of the above development challenges if it anchors its development strategy into an open regional framework. Regarding the employment challenge, Tunisia's strong integration with the EU could yield much more benefits in terms of growth and job creation with stronger regional integration. Indeed, by widening the scope for economies o f scale, the latter would allow Tunisia to attract more foreign (and regional) investments to fuel growth and job creation. A larger market would also make Tunisia more attractive for investors outside the EU. This would create more effective capacity to reduce unemployment in Tunisia and in the region as a whole. 42. Regional integration would also allow Tunisia to better address climate change issues. Concerted efforts at the regional level would allow Tunisia and its neighbors to address drought, water and land scarcity issues while enhancing the capacity to invest in clean technologies, undertake research on environment sustainability, biotechnology, water management technologies and renewable energy. Situated between Libya and Algeria, two large and energy-rich countries, Tunisia cannot afford to manage its key environment concerns alone. 43, Mainstreaming regional integration in Tunisia's development agenda will require greater cooperation in many areas. In the area o f trade, regional integration should be considered as one element in a strategy o f trade and broader economic liberalization, which also encompasses unilateral and multilateral removal o f trade barriers. A decisive move towards adopting common approaches to 16 standards and eliminating behind-the-border barriers to trade and investment would improve the overall regional investment climate and boost growth. Beyond synchronizing trade and. investment regimes, greater project-based cooperation could be sought in many areas: energy, transport, banking and environment. Tunisia stands to benefit from the different activities underway through the Arab World Initiative and has been active in pushing for such initiatives both in the Maghreb and the MENA region. IV. NATIONAL DEVELOPMENT P L A N 44. I n 2007, the Government launched its llth National Development Plan (NDP) which covers 2007-2011. The Government i s currently updating the N D P to adapt it to a rolling development plan with regular updates during i t s implementation, to respond to new challenges and demands as they present themselves and assess risks and constraints regularly. The update o f the N D P will be finalized before the end o f 2009 and extended to cover the 2010-2014 period. The NDP emphasizes that employment generation remains the highest priority o f the Government and it lays out the goal for Tunisia to establish an information society and a knowledge-based economy with a focus on human capital development. The plan outlines that the next decade in Tunisia w i l l be marked by deepening reforms and the acceleration o f the pace o f their implementation. The Government recognizes that Tunisia must do more in order to grow faster and become more competitive, in order to deliver on the employment challenge. . Box 5: The Five Axes o f the NDP The consolidation o f the economy and acceleration o f growth through further efficient integration into the global onomy and private sector development. This involves deepening o f structural reforms, consolidation o f good ivemance and transparency, strengthening competitiveness, diversification o f the sources o f growth and velopment o f innovation capacities and continued solid macroeconomic management A comprehensive development approach that guarantees sustainable growth and a harmonious balance among economic, social and environmental priorities. The Government will continue to pursue poverty-fighting programs that ensure effective income distribution and further strengthen the social safety net. This axe focuses on integrating the environment dimension into programs, generalization of environment upgrading, increased energy efficiency, improved waste management and rationalization of natural resources exploitation The modernization o f the national economy towards a knowledge-based one, so as to offer new sources o f growth and to improve the capacity o f job creation and adapt it to the new structure of employment demand. This encompasses accelerating the improvement o f productivity, upgrading of knowledge in the private sector, and upgrading the ICT infrastructure and promoting generalization in its use. The axe also focuses on the development o f the necessary human resources, adaptation o f the educational system to the knowledge economy and the creation o f centers of excellence in training and research. Finally, as regards the critical issue o f innovation, the plan targets greater focus on science and technology, introduction o f a partnership between research centers and the productive system. The consolidation o f investment in human capital in order to increase i t s contribution to growth and consequently to establish its driving role in the development process. This involves improving the quality of education, better adaptation of professional and vocational training programs, reforms in the university system, creation o f centers o f excellence in the universities and development o f pre-school education. In the health sector, the goal i s to bring about a higher quality in medical services and a control o f health expenditures. Finally, efforts will be concentrated on the generalization o f social security coverage and better targeting of support programs to women and children. The adoption of sectoral policies which respond to the need for transforming the economic structure through a greater diversification in the productive base and an increase in the contribution o f high value-added and skill- intensive activities. Efforts will be focused on transforming the agricultural system, exploiting investment and development opportunities in traditional sectors such as textiles, tourism, mechanical engineering and electronics. and strenethenine the Derformance o f services in the economv. 45. As part o f its NDP, the Government i s evaluating the availability o f financing for the investments and reforms planned, given the overall macro-economic and public finance situation. This i s being undertaken in the overall context o f continued pragmatic economic management and pro- 17 active public debt management that has served Tunisia well up to now8. With a public debt ratio o f 47.5% o f GDP in 2008, Tunisia has some space to increase its debt prudently. IBRD financing will be requested for those key investments where the value-added of the partnership with the Bank i s strong. For some large projects, IFC's financing and support to public-private partnerships can support the NDP (on the model o f the Enfidha Airport when IFC arranged the total debt package o f EUR380 million). Tunisia does not view the World Bank Group's financing partnership purely as a response to the global crisis but sees the role o f IBRD and IFC financing as contributing to long-term development purposes to accompany the transition to a higher value-added and more knowledge-intensive economy. 46. The strong collaboration between the Bank and the Government on analytical work has facilitated a common understanding of the challenges and reform options. The Bank's knowledge work contributes to the national dialogue on challenges and constraints to development. For example, the recently-completedDevelopment Policy Review has informed the NDP update. Other parts of the Bank's knowledge work - particularly programmatic ESW - inform the design of sectoral strategies and their related investment programs. There i s agreement on the analysis and reforms needed and also a large degree of convergence between development partners' and the Government's perspectives o f areas where progress to date has been good. V. WORLD BANK GROUP PARTNERSHIP A. Nature of the Partnership 47. The Bank's relationship with Tunisia i s mutually acknowledged as being good and has emphasized the importance o f flexibility to evolving needs. In particular, the Bank's engagement in Tunisia has focused on quality analysis and global knowledge which has underpinned all lending operations. The Government has often expressed i t s appreciation for the knowledge services of the World Bank' and it considers the Bank's dialogue and analysis as useful inputs to their National Development Plans and sectoral strategies. The knowledge role o f the Bank i s especially valued because the Bank has undertaken economic and sector reports in a fully collaborative way, with strong ownership from Government. Equally important, the Bank has been able to mobilize rapidly its team and resources to respond flexibly when requested and to focus on providing just-in-time policy advice. The Bank's non- lending program i s one that builds on a good track record and i s sufficiently multi-sectoral in nature to respond flexibly to the client's demand. 48. The financing role o f the Bank has also remained flexible and has undergone some important evolutions over the past few years. The management o f the economy by Government meant that Tunisia achieved Investment Grade status and was able to access favorable financing on the global market". As a consequence, the Government did not seek large financing from IBRD during the FY06- 08 period as foreseen in the previous CAS. In parallel, the Government decreased its public debt and repaid considerable amounts o f its debt to IBRD. The fiscal year 2009 marked a significant new departure in the Bank's relationship with Tunisia. Due to the more favorable IBRD terms, and in the context of the global economic crisis, Tunisia sought the Bank as a preferred financial partner with record lending delivered o f $335.6 million in FY09. In particular, Tunisia engaged i t s first Development Policy * One element o f the country's prudent management o f its debt involves the support o f the Bank's Treasury department. Tunisia was the first country to sign an MDA with the Bank in 2003, and i s among the top users o f hedging products and one o f only three countries to have used the MDA to execute hedging transactions. This occurs in the context o f the World Bank Group's annual and spring meetings as well as visits to Tunisia by senior management. lo I n 2007, the Government launched a highly successful $260 million equivalent yen Samurai bond, underscoring its stable investment credit ratings (BBBIBaa2). 18 Loan ($250 million) in support o f its ambitious global integration and competitiveness agenda. The experience of the last several years has thus shown that the Government masters itstmobilization o f external financing and the Bank has shown flexibility in adapting its financing to needs. The Bank's role i s valued independently of the volume o f financing which has allowed it to maintain an important strategic and fruitful partnership with the country. Finally, Tunisia has appreciated the Bank's reliance to a large extent on its country systems for financial management and for safeguards due diligence and has performed successfully in this regard. 49. I F C has been active in Tunisia since the early 1990s and currently has a committed portfolio o f US$278 million in 8 companies. While IFC has historically had a limited role in Tunisia due to alternative sources o f financing at lower spreads, it has more recently stepped up its activities and been positioning itself as a partner which can add value on a wide range o f issues instead o f just financing. IFC's engagement i s predominantly in infrastructure and financial markets, including microfinance targeting women borrowers. Recently, IFC has been active in Tunisia's infrastructure sector in step with the Government's efforts to develop i t s public private partnership (PPP) initiatives, as well as in the general manufacturing sector. For instance, in FY08, IFC invested EURlO5 million for its own account and mobilized EUR255 million to finance the upgrade o f Monastir Airport, the construction of the new Enfidha Airport, and the operation o f both under a 40-year Build-Operate-Transfer concession. In.FY09, IFC invested an additional EUR28 million in this project. B. Implementationo f the CAS and Lessons Learnt 50. The previous CAS for Tunisia was approved in June 2004 and covered the FY05-08 period. The CAS had three strategic pillars: (i) strengthen the business environment; (ii)enhance skills and employability; and (iii) improve the quality o f social services. The CAS continued to emphasize the knowledge role o f the Bank and proposed an ambitious lending program for FY05-08 of up to $200-$300 million each year. The CAS Progress Report (CAS-PR) was completed in September 2007 and confirmed that the CAS pillars and strategy remained valid. The CAS-PR updated the lending program of the CAS and laid out an indicative program for FY08-09 o f $200-$250million per year. 51. The CAS Completion Report (CAS CR) notes that the implementation o f the CAS was globally positive although lending volumes did not reach the proposed amounts. The decision o f the Government to engage alternative external financing on the global market reduced new IBRD commitments to Tunisia, which declined from $163 million in FY05 to $1 14 million in FY06, $88.8 million in FY07 and just $6 million in FY08. This trend was reversed in FY09 when lending increased to $335.6 million. In parallel, the size of the project portfolio, comprising IBRD and GEF operations, declined slightly from 17 projects to 15. However, given that a substantive program was in place at the beginning of the CAS, yearly disbursements averaged $123 million and the overall size o f the portfolio remained relatively robust at around $500 million. The average disbursement ratio for FY05-09 was satisfactory at 21.4 percent, close to the Bank's average. There were no problem projects during the CAS period, and pro-activity and realism indicators remained good. While all new lending did not develop as expected during the CAS, the Bank was able to deliver i t s program through the on-going portfolio of projects, selective new investments and a concerted focus on AAA. 52. The Trust Fund portfolio made an important contribution and allowed the Bank to innovate. The trust fund portfolio - encompassing GEF, IDF, and several country-specific and regional trust funds (see Appendix 10 for details) - has been integral to the Bank's overall partnership with Tunisia. It has allowed for innovation in the program through financing a more comprehensive AAA program than the one financed purely through the Bank's budget, testing o f pilot approaches in new areas and increasing the Bank's ability to deliver a critical mass o f support within the overall framework of 19 sectoral engagements. Tunisia's strong leadership in' environmental management has allowed it to benefit from a broad and dynamic GEF portfolio, often as a complement to IBRD financing. The mobilization o f other types o f trust funds in support o f AAA has also facilitated important areas o f reform dialogue on procurement, labor markets, energy sector, youth and environment. 53. The CAS CR highlights that there were important positive achievements of the Bank's program but there were also areas of improvement needed. Overall, the picture i s a positive one with clear results in the following priority sectors: (i)export promotion, trade integration and tariff reform; (ii) improvements in access and quality o f service in the transport, water and energy sectors; and (iii) progress noted in the education sector and developing the knowledge economy. Tunisia also performed strongly in the Use o f Country Systems approach for safeguards,where two projects piloted the approach successfully and for financial management where country systems are mainly used. The CAS CR also concludes that there was good performance on cooperation with donors (see Box 6). However, the CAS CR points out that more modest results were achieved in some key sectors - employment, social protection policies and increasing the competitivity o f agriculture. Improving the quality of social services, especially making higher education more relevant, remains challenging. 54. The Bank's program i s judged to have been responsive and timely in delivering good quality AAA which was conducted in close cooperation with the Tunisian authorities. In particular, there was gradual but significant results of the Programmatic ESW (PESW) approach, which helped build capacity and consensus on a set o f major issues in employment, macro-economy, trade integration, and energy. In its April 2009 report, IEG evaluated the Bank's performance in Tunisia on earnings growth and employment creation and gave the Bank's Program a satisfactory outcome rating. The report concluded the following (i) the Bank's strategy and interventions were relevant to the issues; (ii) performance was strongest in the Bank's support to macroeconomic policy; (iii)there was a positive contribution from the Bank on trade liberalization and fiscal policy; and (iv) high quality work was delivered on the financial sector, including work undertaken jointly with the IMF. The Government has also emphasized i t s appreciation for the good quality o f country dialogue and analysis" which has been greatly strengthened by the increasingly decentralized Bank team in Tunis. 55. The CAS CR identifies the operational factors that dogged the Bank's program and which are, for the most part, linked with procurement weaknesses. This led to slow disbursements and repeated extension o f projects. Excessive centralization of decision making power on procurement processes i s the main cause for the considerable delays. The lessons learnt on procurement are particularly pertinent going forward: Tunisia must grasp more opportunities to align procurement systems with international best practices, as well as to harmonize and develop knowledgeable and skilled human resources and institutional capacity. The need for greater progress in this regard has been given more urgency recently by the Government as it launches the rolling development plan and steps up public investments. The CPS will aim to capitalize on this momentum to ensure real progress in procurement. 56. The CAS-CR recommends a greater alignment between the Bank's program and the country's priorities. A main conclusion o f the CAS-CR i s that the CAS could have been more aligned with Tunisia's NDP priorities and time-frame for undertaking intended policy reforms. This i s a key lesson learnt that i s embedded in the CPS which aims for greater alignment with the NDP. The CAS-CR also emphasizes the importance o f having a more practical results framework with a corresponding focus needed on strengthening M&E systems. I ' Main analytical reports produced during this time included the Global Integration Study, MILES, FSAP, Employment PESW, Water and Sanitation Strategy, SME Finance Study, Agriculture Sector Review, Energy Management Policy, and Development Policy Review. 20 57. An important conclusion o f the CASCR i s that Tunisia performed well in areas where it was ready to deepen reforms and it has performed less well in areas where it determined that the political or economic context was not yet ripe for such bold measures. The experience in Tunisia i s that reforms are undertaken steadily but relatively slowly to allow for the necessary time to study issues, consult with all national parties, and ensure consensus before embarking on any new policies. Once the climate i s considered ripe to move forward with reforms, Tunisia has brought about good results. Consequently, key considerations for this CPS include the need to be more sensitive to the time-frame o f reforms and not just the substance o f reforms. The Bank's experience in Tunisia has shown that when Tunisia has committed to a reform path and has engaged the necessary financial and institutional resources, then its achievements are impressive. 58. Lessons learnt from the I F C program. Tunisia benefits from i t s stable business environment and i t s investment grade rating. However, there continues to be high levels o f regulation and government intervention in the economy. IFC's experience in the country has demonstrated that successful project implementation i s often contingent on Government support to investors (particularly foreign investors) to navigate the Tunisian administration and meet the country's regulatory requirements. Box 6: Good Donor Coordination In the context o f a strongly-owned and country-led program, the Government plays a lead role on donor harmonization and coordination. The Government has a deep understanding of the comparative advantage of each donor based on its assessment of the technical quality of their work and the terms o f their financial support. The main donors in Tunisia are the European Union (EU), the African Development Bank (AfDB), Agence Francaise de Developpement, Japan and the World Bank. The EU, AfDB and World Bank have deepened their collaboration in the past couple o f years, most notably around their budget support which i s being provided to Tunisia's integration and competitiveness program. This positive experience has solidified the increased financial role that Tunisia i s requesting from donors and serves as a model o f donor cooperation in support o f the Paris Declaration. The EU i s an important development partner for Tunisia because o f the overall context of the EU Neighborhood Policy and Tunisia's strong political, economic, social and cultural ties with Europe. The EU has an active program o f support focused on economic reform, education and environment. In addition to their support to the integration and competitiveness program, the World Bank and the EU have a particularly close collaboration on performance-based budgeting, PEFA, employment and education and are seeking greater collaboration around water and agriculture. The Bank, AfDB and Agence Francaise de Developpement are also collaborating well in sectors such as water, energy, agriculture, municipal development and cultural heritage management. Appendix 6 has further detailed information on donor programs in Tunisia. IFC has also been actively collaborating with other IFIs and will pursue more opportunities moving forward, especially for large projects. For instance, IFC helped bring in the AfDB, Proparco and the European Investment Bank as co-financiers for the Enfidha Airport project. C. CPS Guiding Principles 59. The Bank's engagement emphasizes the importance o f understanding the Tunisian context and building on the strong relationship that already exists. The World Bank Group i s working with a Government that has a strongly-owned strategy and a solid understanding o f where the Bank can add value. IBRD financing i s very small compared to the country's budget so the Bank's financing role must be selective on the critical priorities. Similarly, IFC financing w i l l selectively target projects where its additionality, role, and development impact are clear. The Bank's role w i l l be very much in the vein o f partnering with the country when requested and agreeing on how and where we should and should not engage. Within this context, and with the benefit o f the lessons learnt from the implementation o f the 21 Bank's program to date, the main principles that guide the Bank's partnership for the future are alignment, flexibility and selectivity. Alignment 60. The update o f the NDP into a rolling development plan provides strategic priorities which guide the Bank's program as outlined in this CPS. The CPS aims to align the Bank's program to the maximum extent with the NDP as regards priorities, approach and pace o f reform. As previously mentioned, the Bank's knowledge work informs the NDP, particularly the recently-completed Development Policy Review. There i s agreement on the analysis and reforms needed and also a large degree o f convergence between the Bank's and the Government's perceptions o f areas where progress to date has been satisfactory. The CPS focus i s on supporting the directions that the Government has decided on but aiming to clarify thematic context when necessary, highlight trade-offs, add value by fine- tuning implementationmodalities, assess risks and bring international experience to bear. 61. Greater alignment with country systems will also be pursued. Tunisia has successfully piloted the use o f country systems approach for safeguards compliance in the Bank's water and solid waste projects and will continue this going forward through broadening it to other projects in the portfolio. The Bank has also concluded that Tunisia has performed well with respect to financial management in the Bank's operations. Such a track record strengthens the case for greater use o f DPLs in the Bank's program. Flexibility 62. The CPS aligns with the flexibility demanded by the rolling development plan. Within the context of clear national priorities, the CPS adopts a flexible approach on how best to support the government as circumstances change. By being demand driven, it avoids programs that are not realized, as noted above about the last CAS. The CPS builds on the experience in Tunisia that the Government only requests IBRD financing when it judges it necessary, when it has carefully weighed the pros and cons o f all alternatives and where it assesses that the Bank can add most value. In the same manner, the IFC program i s designed to be focused on a select number o f sectors, yet will remain flexible and responsive to new opportunities. 63. The use o f DPLs will become gradually more important as a way o f introducing flexibility through aiming for a realistic assessment o f reform progress and possibilities and focusing attention on where success i s most likely and reforms are most urgent. The challenge for the Bank i s to deepen its understanding o f the pace o f reform implementation and develop more the "how" rather than the "what" given the degree o f convergence on the substance of the strategies and reforms needed. This approach will be critical in ensuring effective implementation and results. In areas where a phased approach i s required, the Bank will use opportunities to promote future reform efforts through advocacy and sharing o f international best practice. 64. Flexibility means that the AAA program i s aimed to provide timely analysis and to set the ground for operational work. On the knowledge front, the Bank will continue to provide just-in-time policy advice and to mobilize Bank and non-Bank international best-practice, even if in some cases the Bank's knowledge work does not lead to IBRD lending but rather to financing from other partners. The Bank's knowledge work i s valued and requested by the Government both for its substance and for its timely delivery, so having flexibility in the AAA program i s critical to be able to respond to requests when they are forthcoming. 22 Box 7: CPS Consultations and Communication Plan In the preparation of this CPS, and as a regular part o f a l l its activities, the Bank has consulted different development partners and independent actors in Tunisia which has greatly enriched its knowledge base and understanding o f the country. The elaboration o f the CPS has been a collaborative process with Government through multiple discussions at different levels starting in November 2008. The Government has a clear vision o f where it wants the Bank to engage but it has also been open to dialogue on other issues on which the Bank was in more o f an advocacy mode. This has nurtured the context o f the CPS and the sectoral content o f the Bank's engagement in areas such as employment, education and service delivery. For the CPS itself, consultations were carried out with other development partners at urban and rural levels with representatives from private sector, NGOs, Parliament, civil society, unions, farmers' associations and women's groups. The following issues were highlighted (further details are in Appendix 7): 0 Rural development: Participants were particularly keen to stress that special attention should be given to improving access to micro-finance and strengthening rural infrastructure for water accessibility/coverage and improved hygiene. Private Sector: The main recommendation from entrepreneurs i s for an improved administrative and bureaucratic inter-face with the Government, strengthening the financial sector and access to finance for firms, and developing trade and transpop further. The importance of professional training was also highlighted. Parliamentarians: The challenges as they seem them revolve around areas identified as priorities: education, employment, developing the private sector, agriculture and health. 0 Civil Society: The CSOs cited issues o f transparency and accessing information on the state's activities due to what they perceive as a lack of communication and insufficient consultations. CSOs would like to see the Government encourage a more effective participatory dialogue and implicate it in aspects of the decentralization process and its relationship with the various development priorities. The Bank also consulted Tunisia's main donors and collaborated particularly closely with the African Development Bank (AfDB), given the degree of harmonization o f the two development banks' programs and due to the fact that the AfDB was conducting i t s mid-term review of it s strategy at the same time. The development o f the CPS benefited from several other Bank-related activities that occurred during the process which are detailed in Appendix 7 "CPS Consultations Report and Communications Outreach". The CPS consultations reaffirmed the importance o f reaching out and listening to different audiences. Stake-holders expressed great interest in interacting more with the Bank to debate development issues and have greater access to Bank reports (global, regional and national). Moving forward, the main vehicle for outreach efforts and access to development content will be: (i) the Tunisia websites; (ii)conferences, workshops, dissemination events on topics o f relevance for Tunisia's or the region's social and economic development (Le. World Development Report 2009, MNA report on Job mobility); (iii) ongoing consultations on the Bank's activities, and (iv) further strengthening the Public Information Center (PIC) housed within the library o f the University of Tunis. Consultations around the CPS will continue in order to interact further with those met during the CPS process and share the Bank's strategy with a broader audience to promote a better understanding of issues, challenges and reform trade-offs. In addition, Bank teams working on lending and analytical work will be encouraged to identify mechanisms early on for engaging with civil society and strengthening participatory processes. The Bank will ensure that the PIC'S impact be further increased by generating greater awareness o f its services among stake-holders. The Bank's outreach efforts will be conducted jointly with local and development partners such as the European Commission Delegation, the United Nations and the African Development Bank in Tunis. These are proactive institutions in their outreach efforts and have expressed willingness to co-organize events with the Bank as was already successfully done previously. 23 SeIectivity 65. The priorities o f the NDP will continue to guide selectivity on where the Bank i s engaged. While the Bank's program in Tunisia remains broad, selectivity i s imbedded in the program by the client. The Bank has had an active and fruitful dialogue with the Government during the CPS preparation process and the design of the program reflects the decision of the Government to engage the Bank on specific areas where it sees a clear role and value-added. These areas o f intervention are those where the Bank already has a long-term engagement or where the Government i s now inviting the Bank to step up i t s partnership. The choice o f selected areas has gone through the filter of whether they meet the criteria o f ownership, strategic impact, harmonization with other actors and a focus on implementation. 66. The CPS emphasizes synergy across interventions around priority results. The Bank's support will aim to bring greater synergy in the range o f Bank instruments around the client's priorities through ensuring streamlining o f IBRD, Trust Funds, and AAA, and eliminating where possible dispersion in the portfolio. In particular, the Bank will continue to strive to create the building blocks for engagement through phasing of instruments: on-going dialogue and AAA program (supported by trust funds) form the foundation of the engagement and lending will only be carried out where there i s already a solid knowledge base and a clear assessment of the reform program and implementation schedule. Trust Fund financing - including GEF, Carbon Funds, and Clean Technology Fund - will continue to be delivered in those areas such as energy and environment where the Bank already has an engagement and a coherent approach, preferably in parallel with IBRD financing. 67. The Bank's program seeks greater synergies and collaboration with the other main development partners in Tunisia (see Appendix 6 for further details on donor harmonization). The Government pro-actively coordinates the programs of donors, requesting co-financing where appropriate and encouraging greater harmonization around priority issues such as global trade integration, employment and education. For its part, the Bank has continued to deepen i t s collaboration with the African Development Bank, EU and AFD, as well as participate in other donor coordination fora involving bilateral and the UN agencies. There i s a good understanding among Government and donors o f the comparative strengths o f each donor which enhances the complementarity o f programs. The Bank recognizes that harmonization with other donors may mean disengaging where we do not bring the most value-added, letting other donors lead in areas where they have greater comparative advantage, and accepting that the Bank may be asked to play a convening role rather than a financing one. 68. For the IFC, the focus will be on projects where its additionality, role and development impact are strong. Through its debt instruments, IFC will focus i t s interventions on: (a) projects with large financing needs, exceeding the capacity of the domestic banking sector; (b) projects which necessitate foreign currency financing; or (c) projects requiring longer term maturities than those available locally. In select cases, IFC will also target smaller size investments in the manufacturing, agribusiness and social sectors, using debt substitutes, such as guarantees as may be needed. Through its equity and quasi-equity instruments, IFC will consider projects with strong demonstration effect and high development impact (for example, renewable energy projects, high value-added manufacturing, ICT and health & education). D. Results 69. One important lesson learnt on results from the CAS-CR i s to ensure a more reasonable and practical results framework that accounts for the flexibility o f the Bank's approach. The previous CAS contained a highly ambitious and, in some cases, inappropriate results matrix which had overly detailed goals and indicators that were not aligned with the evolution o f the program. It proved 24 out-dated, overly rigid and often didn't capture progress. The CPS results framework i s simplified but dynamic, with the intention that it should evolve as the Bank's program evolves. Where the Bank's program i s already engaged (those projects active at the time of this CPS and confirmed areas of future engagement), the matrix provides a detailed description o f expected results and indicators. For those activities where the nature o f the Bank's engagement has yet to be defined but where we expect future opportunities will lie, the matrix aims to set out the broad goals. The matrix also has designed outcomes realistically given the pace o f reform in Tunisia. As the program i s implemented, the Bank and Government will jointly assess progress and update the matrix to reflect the increased specificity o f results and indicators and to ensure continued alignment with the country's program. 70. Naturally any attempt to show attribution for outcomes i s difficult because the Bank has limited influence on the achievements o f broad social and economic objectives. Rather, the goal i s to assess contribution instead o f attribution. Achieving and demonstrating results will remain a critical element o f the Bank's program and monitoring results o f Bank-financed interventions will coincide with overall monitoring o f Government results in the National Development Program. In this regard, the Bank will ensure that results indicators in projects/programs are those which are shared by the Government and will provide continuous support to strengthening capacity at the national level for monitoring and evaluation. E. CPS Program 71. The Government and the Bank have agreed on the CPS Program that supports Tunisia's strategy to generate employment through establishing a knowledge based economy with emphasis on human development. The pillars o f the CPS are: 1. Growth, competitiveness and employment; 2. Sustainable development and climate change; and 3. Improving the quality o f service delivery. The Bank's program i s hereafter laid out along the lines of these three pillars and its delivery i s focused through six results areas that facilitate targeting o f activities, tracking o f impact and monitoring of results. Both the country-specific activities and the regional activities which cover Tunisia are described (Appendix 3), as well as Tunisia's interface with the Arab World Initiative (Appendix 4). 72. IFC's partnership with Tunisia will continue in the next few years, with efforts focused on the infrastructure and financial sectors. On a case by case basis, IFC will also support private led investments in the social sectors (health and education) and in the manufacturing sector. In the infrastructure sector, IFC will continue its support to the Government's PPP program, with an emphasis on the power (gas-fired and renewable energy generation), water (sanitation and desalination) and transport (ports) sectors. In the financial sector, IFC will support the country's banking sector, through direct investment in important banks, and a continued focus on enhancing domestic financing to local SMEs, including micro-finance institutions. Pillar 1. Growth, Competitiveness and Employment 73. Given its political and economic importance and the high priority assigned by the NDP, the employment challenge i s central to the CPS. To address this, the Bank's program focuses on two results areas which combined should help Tunisia transform over the long-haul into a knowledge economy and generate employment for an increasingly educated population. The first results area addresses the growth and composition o f the demand for labor by deepening global integration, enhancing 25 the environment for private sector (especially SMEs) and financial sector development, as well as opening space for the development in Tunisia o f a knowledge economy through greater global integration o f services and improved conditions for existing business to innovate. The second results area turns attention to the employability o f labor, with the aim to improve the adequacy o f the skills mix supplied by the educational system and to develop the labor market policies and social assistance mechanisms that w i l l facilitate an increased mobility o f labor in the economy. In both o f these areas, the Bank's work will increasingly take a regional outlook as regional integration i s critical to further growth. Success achieved in Tunisia in addressing unemployment would yield valuable lessons for other countries in the region. Results Area 1: Deepening Trade & Facilitating the Transformation of the Economy and services The export penetration o f new markets i s increased Logistics costs are reduced Greater convergence o f product standards and quality norms to the EU and international norms The services sector i s better integrated to the regional and global economy The enabling business environment for private Strengthen implementation o f competition law sector (SMEs) improves Continue to improve the quality o f the business environment Capacity o f the financial sector to fund Improved stability o f the banking sector. productive activities increases Improved access to finance Improved institutional and regulatory environment for micro- finance Access to finance o f MSMEs and private sector participation in infrastructure increases through IFC investments The foundations for a knowledge economy are Increased share o f ICT sector in GDP strengthened Streamline science, technology and innovation (STI) policy at the highest levels. Agriculture Sector performance improves Increase in average agricultural income o f rural households in the North-West region o f Tunisia Agricultural production systems improved and crops diversified 74. Together, the various components o f the first result area work to facilitate the transformation o f the economy with the contribution o f the CPS organized around three themes. The first theme focuses on global integration through support to rationalizing tariff protection, trade facilitation and logistics with the objective to open to competition those activities (including services) that have not been well integrated into the global economy through improving conditions under which businesses operate. The second theme i s to improve the environment for businesses (especially SMEs) through reducing the regulatory burden, curtailing anti-competition behavior and strengthening the capacity o f the financial sector to intermediate savings and finance investment especially among small enterprises and new entrants. Lastly, the CPS assistance focuses on two sectors that the government has assigned a special priority, strengthening the foundations o f the knowledge economy and agriculture. Deepen Global Integration for Trade in Goods and Services 75. The CPS will support a greater integration o f Tunisia into the global economy. The World Bank Group's support focuses on a gradual reduction in the external tariffs and thus the level o f protection o f the on-shore economy, which includes the serviced sector and where the Tunisian economy has a great potential to generate skilled jobs. Thus far, the growth o f the services sector has lagged the growth o f the rest o f the economy and i t s participation in total exports i s below that at countries with 26 similar levels o f development. The tariff reduction and simplification i s already underway and will serve to eliminate distortions across various preferential trade regimes with the support o f the Integration and Competitiveness DPL program (ICL). The first ICL was already delivered in FY09 in close collaboration with the EU and African Development Bank (AfDB) and the second phase will be delivered in FY 1 1 and will deepen the agenda. 76. The CPS will continue to provide strong support to the improvement o f logistics to help further the integration of the economy into the global markets. The expectation under the CPS i s to help reduce the direct and indirect costs o f trading with the rest of the world. Although Tunisia already has made progress in developing a working logistics sector that facilitates trade, recent analytical work on trade points to gaps that need attention for the country to be fully integrated into international logistics networks. To help close these gaps, the Bank will continue supporting improvements in the access to export markets through availability o f finance and support for the improvement o f trade logistics. The third phase of the Export Development project (FY 11) will build upon and anchor more deeply the institutional reforms and support to SMEs started in the first two phases o f the project, whose positive achievements are informing the design o f similar projects in the region (see Appendix 8 for full details on the Bank's Export Development projects in Tunisia). Further work on logistics i s carried out under a PPIAF, AAA and other trust funds. While the Government has not requested Bank financing for transport in FY 10 or FY 1 1, the large program o f transport infrastructure investments outlined in the NDP and the stimulus plan mean that future requests for financing may be forthcoming. The WBG would consider such requests positively given its long-term engagement in the transport sector, both through lending and providing technical advice. 77. Work on integration and trade facilitation will have a regional focus as well. A broad AAA program - strengthened by additional activities o f the Arab World Initiative - will address specific regional issues such as barriers to integration, cross-border trade issues, regional transport and logistics, and regional financial systems (see Appendix 3: Regional Integration Activities for more details). The Bank i s discussing with its regional partners potential activities in the trade and transport sectors that could strengthen the overall momentum and widen benefits expected from facilitated trade. The Bank's role i s that of convener and facilitator, as well as knowledge partner and potential future financier. The support of the Bank aims to complement the priorities of the EU's Regional Transport Action Plan for the Mediterranean Region 2007-2013. In the area of logistics, the Bank's program i s looking at the following initiatives; (i) audit o f logistics efficiency on intraregional trade aiming to support improved trade facilitation between countries; (ii)regional trade facilitation and logistics conferences for Maghreb countries; and (iii)a study on logistics training programs to agree on quality standards and develop curricula for the training of logistics specialists in each country. 78. As part of the focus on global integration, the I F C will continue supporting inward and outward South-South investment flows. IFC will assist companies interested in investing in the region and other developing countries given that Tunisia i s proving to be a source o f South-South investments in the Maghreb and Africa. IFC has financed some projects with Tunisian sponsors looking to invest within the Maghreb and other developing countries in the areas of manufacturing, banking, and health, insurance and leasing. Conversely, as it did in the past in the infrastructure sector (Enfidha Aiport), IFC will also support investments in Tunisia by other regional or other emerging markets investors. The Enabling Business Environment for Private Sector (SMEs) Improves 79. The CPS prioritizes improving further the business environment, especially in the on-shore sector o f the economy and for SMEs. As the economy opens, the CPS supports a strategy that increases the attractiveness o f doing business in Tunisia, building on the continued progress shown to date in this area (Doing Business 2010 places Tunisia in 69thplace, an improvement o f four rankings compared to 27 2009). The strategy i s based on a large body o f analytical work that has identified the main restrictions to doing business and the needed reforms to allow the country to move to a more knowledge-based one. Particular focus will be on strengthening competition law and support to SMEs, and tracking progress through periodic surveys. This i s being supported by the ICL series, the Export Development Projects, as well as through AAA (a possible future AAA could cover specific aspects o f the business environment for services sector development - construction, tourism, financial, real estate). Capacity o the Financial Sector to Fund Productive Activities Increases f 80. The Government i s working on improving the stability o f the banking sector and deepening its ability to finance new economic activity. The Government's work to improve the performance of the financial sector i s on the analysis and recommendations o f the 2006 FSAP by the Bank and the IMF, a recent policy note on S M E financing (Appendix 9: SME financing in Tunisia) and on the on-going regional flagship report on the financial sector. The assistance of the Bank, tracked in part through the ICL series but delivered mainly through AAA, will center on improving the stability o f the banking system by reducing the share o f non-performing loans and increasing the share o f provisioning. In addition, the support foresees increasing financial resources from the banking and financial sector towards SMEs and the creation o f new companies. IFC will maintain its engagement in the financial sector focused on (i) improving access to finance and competitiveness especially o f SMEs; (ii) exploring financing opportunities o f large and complex private sector infrastructure investments which will help unleash the growth potential o f the country; and (iii) engaging in sectors that are not serviced by Tunisian commercial banks, . e.g. IT, health, and education. IFC will retain flexibility and continue exploring opportunities in Tunisia where it can add value and where it has a clear developmental role to play. IFC and the Bank will also work together, as requested, on supporting public private partnerships. 81. Support for the financial sector includes a regional focus. The Bank's Arab World Initiative (AWI) knowledge program i s looking at the benefits o f greater financial integration in the MENA region and the 2010 Flagship Report for MENA will focus on the financial sector. For the Maghreb, the Bank's AAA work encompasses assessing possibilities for enhanced competition and greater scope for economies o f scale. The Bank i s aiming to contribute to the Maghreb financial integration effort by maintaining an active policy dialogue and offering technical assistance in areas critical for harmonization: (i) governance o f the banking system, (ii) managing financial crises, (iii)accounting, auditing and credit reporting; and (iv) insolvency and creditor rights. The Foundationsfor a Knowledge Economy are Strengthened 82. The support for the knowledge economy centers on the further development of the I C T sector as part o f a strategy that seeks to make the services sector overall more competitive. The ICR project (FY05) will continue to be implemented and a new TA will be conducted on innovation and high technology that will seek to identify promising high-tech/knowledge-intensive sectors and provide guidance on how they should best be supported. Further, to create conditions that foster the development o f high value industries, the Bank i s completing a AAA on Competitiveness Poles and would consider financing investments as part o f a follow-up project in FY 1 1 or later years. Such a project would support the development of competitiveness poles to be designed and managed by the private sector targeting high value-added industries through the financing o f needed infrastructure, technological platform (incubators, technological resources centers), and technical assistance. Agriculture Sector Performance Improves 83. The CPS proposes to continue support for agriculture and the rural population. The Bank will continue supporting interventions that improve the incomes and socio-economic conditions o f some 28 of Tunisia's poorest people who live in the rural areas o f the north west of the country, with a focus on farmers associations, SMEs and micro-finance.To this effect, the Bank will prepare a fourth phase o f the North West Development Project (FY 1 1.) The Government has also requested a follow up on the Bank's Agriculture Sector note and Agricultural Support Services Project (which closed in December 2008) with an operation in agriculture in FY 1 1. This operation may take the form o f a DPL and would be delivered in close cooperation with the EU which has ear-marked budget support in this area. Results Area 2: Improving Employability ResuWOutcomes at end-FY13 Specific Areas of Focus Institutional framework for higher education Improved access to higher education favors quality improvements Quality Assurance Agency for higher education fully operating The Grants under the Competitive Fund (PAQ) are completed and evaluated Skills o f professionals and graduates improve Regional plans for technical and vocational education are under through continuous education implementation Greater integration o f ICT in education and training Improvement in the utilization rate o f continuous education Facilitate employment through effective and Improved incentive environment for hiring workers well targeted Labor Market Policies Improved safety net for the unemployed 84. CPS activities under this results area support the objective o f increasing the employability o f labor from two perspectives. On the one hand, the CPS includes work to improve the alignment between the needs o f the labor market and the supply o f skilled personnel coming into the market. On the other hand, the CPS will support the reform of the labor market in an effort to combine greater flexibility in hiring and firing with a more adequate system o f social assistance that protects workers rather than specific jobs. Institutional Framework for Higher Education Favors Quality Improvements 85. The CPS supports improvements in the quality of education and greater adequacy of the supply o f skills to the market. First, the focus on inclusion will continue at all levels of education, while at the same time promoting excellence in teaching and learning. In this regard, higher enrollments are expected in secondary and tertiary education, which are supported by the on-going Education and Higher Education projects. Here the agenda includes reforms o f the institutions o f higher learning that would provide the universities with greater autonomy and would engage the private sector more forcefully in the delivery o f educational services. f Skills o Professionals and Graduates Improve Through Continuous Education 86. The work on skills and their adequacy will be supported by the Education and Higher Education Projects and a Skills Development Project (FY11). The latter will support the government to put in place a program that includes (i) consolidation o f the partnership between the training system and private sector; (ii)reform of the financing mechanisms used for pre-service and in-service training; and (iii)developing a life-long learning policy framework. The project will define the specific results under the program. The AAA program will focus on skills analysis and youth inclusion which will encompass analyzing the current skills o f the unemployed youth and how these align to what the market needs. 29 Facilitate Employment Through Effective and Well-Targeted Labor Market Policies 87. The CPS will respond to the request of the Government to support labor market reform through a new DPL program on Employment (FYlO), with a focus on easing o f hiring and firing restrictions. This DPL i s under preparation and specific reforms are not yet identified. Extensive AAA (through the Programmatic ESW on Employment) i s informing the design o f the Employment DPL. This DPL, like the ICL, will be closely coordinated with the European Union that also has earmarked budget support in this area. The Employment DPL will be delivered in alternate years to the ICL, thus ensuring one DPL operation per year in Tunisia. In addition, the Bank will continue i t s AAA program within a programmatic framework which encompasses Active Labor Market Policies (ALMP), study on youth exclusion (looking at unemployment issues beyond educated youth), social protection, and education. The gender dimensions of the unemployment challenge will feature strongly in these activities. IFC will consider investing in sectors that are both technology-intensive and labor-intensive. Employment generation, as well as the skill-intensity o f employment, will remain key selectivity criteria for IFC during this CPS period. IFC's focus on the financial, infrastructure and select high value-added manufacturing and social sectors will also support this objective. 88. The Government and the Bank are discussing options for support to different aspects of the current social protection system. The Bank's AAA program can provide support for targeted reforms to the social protection systems which can increase labor mobility and job creation, while at the same time improving efficiency in budget management. The Government has expressed an interest in support for piloting labor-intensive services such as early childhood development, old-age and community nursing and after-school tutoring which can be win-win in terms o f human development outcomes and in terms o f employment (especially for female and university graduates). Other areas of work could encompass statistical capacity building for better monitoring o f vulnerabilities and impact evaluation o f social programs. The specific activities in this area will be discussed in the CPS Progress Report as confirmation on the lines o f engagement i s not yet in place. 89. At the regional level, the Bank's program in the Maghreb countries encompasses different elements of employability issues (more details are in Appendix 3): (i) skills development - improving the quality and relevance of post basic education to give better job opportunities for young people, through the development o f a regional qualifications system; (ii) building the capacity of management and provision of Quality Assurance (QA) in Higher Education in the MENA countries, to enable them to participate in the mutual recognition of International Qualifications and Standards. The Mediterranean Integration Program will help the Tertiary Education Institutions and the Quality Assurance Agencies in the MENA region to reach the European QA standards; (iii) activating labor markets,- building the capacity (including design, implementation, and monitoring and evaluation o f results) for effective labor market intermediation institutions to improve matching o f demand and supply for existing skills; better employer-focused skills enhancement; facilitating the transition between education and employment; creating opportunities for young people to develop entrepreneurial skills and income generating activities, supported by twinning arrangements between relevant and interested public sector institutions in the EuroMed area; and (iv) improving social protection and labor management for migrants - in partnership with the European Training Foundation (ETF) and IOM, facilitating legal and safe intermediationo f labor demand and supply across the Mediterranean. Pillar 2. Sustainable Development and Climate Change 90. The CPS supports the government's commitment to manage the impacts of climate change and to maintain the leadership position it has built in the region. While Tunisia has been in the forefront in MENA on environmental issues, it still faces serious challenges on environmental sustainability and natural resource management. The main challenges include, first, the limited 30 availability of water, which i s likely to decrease in the future and, second, the growing dependence on fossil energy. The Government i s looking to the Bank to step up its assistance to respond to these challenges given the Bank's broad experience in the country through its previous and on-going interventions on the environment, energy, agriculture and water sectors and its global knowledge o f climate change issues. To respond, the CPS aims to focus efforts to bring about synergies across activities around an integrated approach which delivers value-added over the long-term while addressing urgent issues. The World Bank Group will therefore target its interventions towards producing results in two cluster areas which are: (i) strengthening environmental and natural resources management; and (ii) promoting energy efficiency and renewable energy. As regards the latter area, the CPS recognizes the linkages between this pillar and pillar 1 whereby investment in clean energy can create more jobs per dollar invested than investment in fossil fuel energy. As part o f the CPS program, the Bank will endeavor to mobilize greater financial support for Tunisia through the Clean Technology Fund, Carbon Funds, GEF and other Trust Funds. Greater use of country systems for environmental and other safeguards will also be carried out. Results Area 3: Strengthening Environment and Natural Resource Management ResuMOutcomes at end-FY13 Specific Areas of Focus Measures to strengthen the management o f water Irrigation intensity i s improved demand in place and measures to increase water supply Strengthen infrastructure for wastewater re-use in Tunis introduced Progress in managingthe impacts o f climate change Improved soil conservation Improved conservation, utilization and management o f natural resources Increased capacity for dealing with climate change Reduction o f national ozone depleting potential The negative environmental and health impact in cities Increase volume o f sewage collected in Greater Tunis i s reduced Improved modalities o f public private partnerships for waste management Improved management o f health waste f Measures to strengthen the management o water demand in place and measures to increase water supply introduced 9 1. The CPS supports Tunisia's strategy to manage judiciously and in a sustainable manner its limited water resources. I t supports both the demand side to curb the use o f water and the supply side by increasing its availability. On the demand side, the Bank will promote more efficiency in the management and operation o f selected irrigation schemes, improved access to and consumption o f drinking water in poorly-served rural communities, and strengthening the water institutions in demand management practices. The Bank will provide its support through the recently-approved Second Water Sector Investment project (FY09) and a follow-up operation in the outer years o f the CPS. On the supply side, the Bank will assist in developing the re-use o f treated waste water for irrigation purposes, through the planned Northern Tunis Wastewater project and its GEF partner project (both FY lo), which may also have a follow-up operation during the CPS period depending on progress. In turn, building on the Government's efforts in promoting PPPs in the water sector, the IFC and the Bank will consider investing in private-sector sponsored projects in desalination and water sanitation. Tunisia i s one o f the priority countries for the IFC comprehensive MENA water sector strategy initiative. 92. The AAA program will provide further support to the government in water management through continued evaluation o f the implications o f climate change for water resource management and analyzing options for water supply-augmenting projects (desalination and waste-water re-use), which 31 could be submitted to careful cost-benefit analysis, explicitly incorporating future climate change scenarios and developing analytical tools required to deal with trade-offs. The Bank will also continue to support key reforms and institutional strengthening, building on the recently-completed Water and Sanitation Strategy (April 2009), through further promoting demand-driven water management, incentivizing water savings and better controlling ground water extraction. The Bank will provide technical advice to the Government in the re-balancing of water resource allocation in favor o f higher value added production in irrigated agriculture through the proposed Agriculture/Climate Change Project (FY 11). Other areas of support through regional and country AAA would be in helping the Government with disaster risk management based on Tunisia's vulnerability to weather induced hazards whereby the Bank can work with the Government on mainstreaming disaster risk reduction into priority sectors to mitigate disaster risks. Progress in Managing the Impacts o Climate Change f 93. The Bank will support Tunisia's efforts to improve land management practices, with emphasis on creating sustainable production systems in rural areas. The focus o f the Bank's work will be on helping farmers improve agricultural productivity and natural resource management through soil and water conservation, small-scale irrigation, agro-forestry and pasture improvements. The goal i s to ease the vulnerability o f some o f the poorest communities in Tunisia and develop better capacity to manage the impacts of climate change. Bank support for these efforts will be provided through the Community Based Integrated Rural Development Project (FY 10) and its GEF complement the Water and Land Optimization Project. An Agriculture/Climate Change project will also be delivered in FY 1 1 (as mentioned in paragraph 83). Other projects already mentioned, the Northern Tunis Wastewater project (FY10) and the North West Development Project (FY11) will also contribute to improving land management practices and incorporate as necessary disaster risk reduction measures. Tunisia is also the recipient of a PHRD Grant on Climate Change o f the Forest Ecosystem that will provide further synergies with other Bank work. The Bank will continue i t s support to help Tunisia reduce ozone depleting substances in the country through the on-going Ozone Depleting Substances project. The Gulf o f Gabes project will continue to focus on coastal environmental issues that are being exacerbated by climate change. The Negative Environmental and Health Impact in Cities is Reduced 94. The CPS supports the country's environment agenda to meet the mounting urban challenges. Objectives of the government's environment agenda in urban areas include improving municipal solid waste management practices, containing coastal erosion, developing infrastructure that i s adapted to climate change impacts, and reducing landfill gas emissions and the production of ozone depleting substances (these issues are being supported by the on-going portfolio o f projects - Gulf of Gabes, Ozone Depleting Substances, Landfill Gases Project, Municipal Development and Sustainable Municipal Solid Waste Management). In particular, the CPS provides concerted support to consolidate improvements in solid waste collection, disposal/treatment and management services, with a focus on cost effectiveness and environmental sustainability while benefiting from carbon finance funds. The on-going Municipal Solid Waste Management Project and Municipal Development projects will provide this support. 95. Lastly, the Bank will use several regional initiatives to provide further support to Tunisia in addressing climate change especially in the context o f the Arab World Initiative. Relevant initiatives include a multi-donor regional climate change trust fund, study on social impacts o f climate change, an assessment o f the climate change ecosystem of the region, technical support to planning and capacity for waste water treatment and a regional analysis looking at the economic and social impacts o f climate change on agriculture. The city of Tunis i s also covered under a regional study on the vulnerability o f 32 coastal cities to climate change and natural disaster. In the water sector, MENA supports capacity building o f institutions such as the Arab Water Council, and activities such as the Arab Water Management Initiative, Regional Water Initiative and a regional IDF in Public Engagement in Water Management. Finally, the Marseille Center for Mediterranean Integration has two relevant programs on Strategic Urban Development and Cities and Climate Change which will also facilitate knowledge sharing in the region. Results Area 4: Promoting Energy Efficiency and Renewable Energy Improve Energy Intensity Reduced energy intensity o f GDP Reduce dependency on fossil fuels Decline in Green House Gas emissions Increased energy efficiency investment Increase the share o f renewable energy in primary energy Improve Energy Intensity 96. The Bank's program supports the ambitious strategy o f the Government in the energy sector to reduce the intensity o f energy by 3% per year which recognizes the importance o f effective energy efficiency policy and related investments. The goals o f this program include (i) providing a larger and more secure energy supply through scale-up of the potential in renewable sources; (ii) s promoting enhanced energy efficiency in key sectors such a industry, transport and residential buildings; and (iii) contributing to global efforts to control carbon emissions. The design o f the strategy under this pillar has benefited from Bank's AAA delivered mainly through the Programmatic ESW which i s supported by the Energy Sector Management Assistance Program (ESMAP) Global Partnership (a type o f trust fund). The ESMAP covers various studies to review the country's energy management policy, assess the options for pricing methodologies and procedures, identify barriers to energy efficiency improvements, increase penetration of renewables and make recommendations to scale up investment in energy efficiency and renewable energy. 97. To increase the supply of efficient energy, the Bank i s helping develop a local market to finance energy-efficiency investments by the private sector. To this effect, the recently-approved Energy Efficiency Project (FY09) provides lines o f credit to financial institutions in Tunisia to finance investments and assistance to develop the capacity to evaluate these investments. Pending on the pace o f project progress and the demand from the private sector, the Bank would consider a follow-up operation later in the CPS period. The Bank i s also supporting enhanced energy efficiency in the industrial sector through the implementation of a Global Environment Facility (GEF) Energy Efficiency project (FY05). Another GEF grant has been requested by the Government o f Tunisia in FY 10 to complement the Energy Efficiency IBRD project through technical assistance and biomass pilot projects. In turn, IFC i s committed to support viable renewable energy investments, contingent on the evolution of the Tunisian regulatory environment and the availability o f well designed private sector sponsored renewable energy generation projects. In a first phase, this will consist o f providing financing, as needed, to industrial companies seeking to generate wind power for their own consumption. In a second phase, IFC will also consider solar generation projects. Reduce Dependency on Fossil Fuels 98. I n a further effort to increase domestic supply of non-fossil fuel energy, the Bank i s working with the Tunisian authorities on accessing resources o f the Clean Technology Fund (CTF) in order to help the country use i t s large, and largely untapped, renewable energy potential for wind and solar 33 energy. Tunisia's solar energy potential could be promoted in the context of the Bank's regional initiative on Concentrated Solar Power (CSP), launched together with the African Development Bank, which i s likely to get up to $750 million concessional financing for the region from the Clean Technology Fund (see Appendix 5 for details). This initiative has synergies with the Mediterranean Solar Plan which promotes CSP and other renewable technologies, as well as regional market integration. Tunisia has already proposed several projects for consideration in the CSP regional investment plan. Further support to develop wind energy will come through preparing a carbon finance operation that will purchase Certificates of Emissions Reductions (CER) from the Sidi Daoud wind farm of 34 MW. Several other Clean Development Mechanism (CDM) projects are in preparation with Bank assistance, including a solid waste project and a gas flaring reduction project. 99. To curb energy demand, the Bank i s preparing a Low Carbon Transport Strategy in support of the Government's stated objectives of improving the energy efficiency of the transport sector and reduce i t s vulnerability to oil price increases while decreasing GHG emissions, air pollution, and noise pollution through some specific strategic decisions and actions. This i s part of the NDP's focus for the transport sector on energy savings activities as part of an overall coherent strategy to reduce energy consumption and pollution. 100. The CPS supports sharing o f knowledge on energy at the regional level, where Tunisia's experience can serve as a model in various areas and should contribute to activities under the AWI. For instance Tunisia has been conducting industrial audits and offering capital subsidies for energy efficiency investments since the late 1980s, and the approach could be adopted by other countries. The U M A (Union for Arab Maghreb) organization has set-up several committees to improve cross-country cooperation and one of them i s focusing on energy efficiency programs in industry and buildings. The Bank i s coordinating on these initiatives. In addition, the Bank i s bringing international knowledge to inform the thinking behind a possible creation of a regional energy market by being an honest broker in helping cross-border coordination, bringing experience from other regions and catalytic financing, including for interconnection projects within the Maghreb. The Bank has very recently been asked by the Government to provide technical assistance to the early stages of a possible interconnection project between Tunisia and Italy that would involve a sub-marine cable between the two countries. This could eventually lead to a future request for financing of the project. Pillar 3. Improving the Quality o f Service Delivery 101. Following good progress in ensuring access to services, the Government sees as the next challenge to improve the quality o f service delivery, particularly as regards delivery of services to citizens (education, health, and municipal services.) The support under the CPS i s grouped around two results areas: (i) improving the quality of social services; and (ii)strengtheningthe capacity of the state at central and municipal levels to deliver quality services. Results Area 5: Improving the Quality o f Social Services ResultdOutcomes at end-FY13 Specific Areas of Focus Remain on track to meet the MDG education goals Primary Completion Rates move closer to 100 percent Quality o f basic and secondary education improved The quality o f service delivery and long-term efficiency Improve availability o f outpatient and inpatient services at hospitals improves and medical goods at hospitals Build operational and financial management capacity at the central government and hospital level 34 Remain on Track to Meet the M D G Education Goals 102. The CPS will support the Government's commitment to the continued transformation o f the education system and address the efficiency in the delivery of health services. In education the strategy of the government is: (a) to continue improving access in secondary and tertiary education; (b) to work on quality at all levels; and (c) to achieve a greater level of matching between the supply of the educational system and the needs of the market. In line with this strategy, the government has asked the Bank to provide support through the Employment DPL, Education, Higher Education, and Skills Development projects, which have already been discussed under the first pillar. f The Quality o Service Delivery and Long-Tem Efficiency at Hospitals Improves ,103. I n the health sector, after two years o f World Bank technical assistance, the Government has invited the Bank to work on improving the quality of hospital service delivery and the efficiency and sustainability of financing for health services. The Bank will respond to this request for advice and resources to improve service delivery at hospitals through a Health project, which will be delivered in FY 11. Support to the health sector will also be provided through an Avian Flu Trust Fund that was activated in August 2009. Results Area 6: Strengthen the Capacity of the State at Central and Municipal Levels to Deliver Quality Services Results/Outcomes at end-FYU Specific Areas of Focus Capacity o f the public management system improves Procurement reform Multi-annual budget and performance based budgeting Further integration and alignment o f public financial management with international standards and good practices. Improved relevance and targeting o f public services to the private sector Living conditions in urban areas improved by upgrading Surveys under the Municipal Development Project show the quality o f service delivery by municipalities improvement in the perception o f quality o f l i f e Enhanced performance indicators o f SONADE Financial indicators for CPSCL improve each year Greater private participation in solid waste management More efficient and sustainable development o f Cultural Number o f visitors to museums supported under the Heritage potential project increases. f Capacity o the Public Management System Improves 104. At the level of the central Government, the CPS will continue to support the Ministry of Finance with the modernization of budgetary practices. The Bank, in close cooperation with the EU, i s providing analytical and methodological support to strengthen budget management through multi-year programming and improved expenditure efficiency through performance-based budgeting (PBS). The work undertaken thus far has already led to the development o f MTEFs in education, higher education, and vocational training. In mid-2009, a PEFA exercise was launched in Tunisia which will analyze and make recommendations on strengthening the public expenditure management system, and provide a benchmark to track future progress. The Bank will also continue to work with Tunisia on the successful experience of using country systems for financial management by further integration and alignment of the country's PFM arrangements with international standards and good practice. In this regard, two main 35 areas will be the focus o f attention; (i)move towards computerization o f the accounting system which remains manual despite a well computerized budget; and (ii) supporting a more comprehensive view o f the public sector control systems and framework. 105. Additional support includes assistance with the reform of public administration. The Government has recently requested the Bank to mobilize Trust Fund financing for the National Program for the Development o f the Public Administration (known by its French acronym PROQAP). This program i s an ambitious one that targets the modernization o f the public administration through (i) focusing on the quality o f services to the public and enterprises, especially as regards services targeted at SMEs and the R&D sector; (ii) reducing costs through optimization o f procedures and (iii) strengthening human resources. Bank support will come through AAA and the mobilization o f trust fund resources. Living Conditions in Urban Areas Improved 106. The CPS supports strengthening o f municipalities to deliver better services and bring about improved living conditions in urban areas. The main thrust in this regard foresees strengthening the operational capacity o f the Caisse de Pr&tet de Soutien aux Collectivites Locales (CPSCL) that provides lending to and manages central transfers to municipalities. The Bank's contribution centers on the design o f incentives to improve municipal finance performance and on the upgrading o f the capacity o f CPSCL to select projects and co-finance investments. The Government has asked the Bank to continue its support and focus in addition on large agglomerations and on the preparation o f urban development strategies focused on environment sustainability issues. The main instrument to support these objectives will continue to be the Bank's Municipal Development Project, which i s now in its third phase and for which a fourth phase i s planned under the CPS. The expectation i s that these efforts will contribute to improving the living conditions in urban areas, the perception of which will be tracked by the follow-up Municipal Development project through periodic surveys. 107. Complementary efforts to improve the quality o f life in urban areas center on waste management, sanitation, urban services and preserving cultural heritage. Rapid urbanization i s putting pressure on sanitation services and waste management. The Government has requested the Bank for a follow-on operation to the Solid Waste Management project with delivery likely in FYI2 to consolidate improvements in solid waste collection, disposalhreatment facilities and management services, with a focus on cost-effectiveness and environmental sustainability, benefiting from carbon finance funds. f More Efficient and Sustainable Development o Cultural Heritage Potential 108. The Government has indicated its desire to have a follow-up Cultural Heritage project to the one currently underway that would cover issues o f heritage preservation (including rehabilitation o f old urban centers, medinas), cultural industries, urban management, and local economic development. The Bank will seek to continue to innovate in responding to this request and to ensure synergy with other urban and municipal development projects underway or planned. F. Financing 109. The proposed IBRD lending program i s confirmed for FYlO through official requests received from Government and project preparation i s already underway (Table 2). Tunisia can access a financial envelope o f up to $280 million in FY10, of which 25% i s likely to be development policy lending. This financing will be sufficient to cover the Government's IBRD requests in FY10. 36 Thereafter, the Government would likely only request higher levels o f IBRD financing should it face a protracted difficult global environment and not mobilize sufficient financing elsewhere either on the local or global markets'*. Such a request would be considered in the context o f IBRD's overall resource availability. 110. The lending program for FY11-13 i s indicative at this stage and will be managed in the context o f country demand and the Bank's ability to service such demand in the context of its capital position. For now, the Government has indicated i t s project requests for FY 1 1, o f which several are already under preparation. The FY 12 and FY 13 lending program i s indicative only and currently outlines the natural evolution o f the Bank's long-term engagement in certain sectors and thus foresees follow-up DPLs for Integration and Competitiveness and for Employment, as well as follow-up investment operations in Education, Higher Education, Energy Efficiency, Water Sector Investment, Tunis Wastewater and Solid Waste Management. These and other possible new operations would be agreed with Government during the course o f CPS implementation and as the country situation evolves. I Community Based Integrated Rural Development ,I F Y I1 Integration and Municipal Development 4 Competitiveness DPL 2 Other: GEF Operations for FYIO: Land and Water Optimization $10.7m, Tunis Wastewater $8m and Energy Efficiency $3.5m. GEF Operations for FY 11: Eco-Tourism $2.8m and Health Waste $6m. The Sidi Daoud Wind Farm will benefit from the Carbon Finance facility ($2.6 million), A Japanese Social Development Fund (JSDF) grant o f $2 million i s being finalized for an Active Labor Market Policy in support o f Community Based Child Care Centers A Trust Fund Grant of $3 million i s being mobilized in support o f the National Program for Development o f the I Quality o f the Public Administration (PROQAP). ''The prudent management by Tunisia o f i t s debt, its good access to international capital markets, its mastery o f risk mechanisms and its strong relations with donors suggest that the country will be able to comfortably secure the needed financing. 37 G. AAA Program Improving Employability Employment Programmatic ESW ALMP (incl. thesis competition) Social Protection AAA Global Crisis Competitiveness Poles ESW Youth Exclusion Study T A on Unique Identifier Innovation & Technology T A Skills Development Analysis PPIAF on Transport Logistics Assessment o f Government Debt Market JSDF on ALMP for Community Child Care Centers in MENA T A Financial Sector Maghreb Regional Migration Study Regional Flagship Report on Financial Sector in MENA Doing Business Assessments ANGE Strengthen Environment & Natural Resources Management Promoting Energy Efficiency and Renewable Energy PHRD Grant on Climate Change Impacts on the Oak Forest Ecosystem Programmatic ESW Energy PROFISH - TA on Fisheries Regional Energy Management Incentive Global Facility for Disaster and Risk Reduction (GFDRR) (REMIT) Regional Costs o f Water Degradation AAA Concentrated Solar Power (studies and Regional GEF in support o f planning and capacity for waste water treatment and TA) recycling Low Carbon Transport Strategy AAA Strengthening Capacity for Clean Development Mechanism Pilot on Use o f Country Systems for Environmental Safeguards Multi-Donor Regional Trust Fund on Climate Change c Administration Trust Fund (PROQAP) TA Public Financial Management (follow up to ROSC Accounting and Auditing) VI. R I S K S AND IMPLEMENTATION CHALLENGES 11 1. The global crisis i s the most immediate risk facing Tunisia due to the recession in the EU and Tunisia's dependence on the EU market for its exports. Should the crisis continue across the medium-term, this will likely result in a further drop in demand for Tunisia's exports and a reduction in foreign direct investment. The economic risks can be partly mitigated through continued strong macroeconomic management: Tunisia's track record shows that it has good capacity to respond to negative shocks and, so far, it has weathered the impacts well. The Bank hopes to help mitigate this risk through ensuring close monitoring of the overall macroeconomic context through regular liaison and dialogue with the Government and an enhanced AAA program that focuses on management o f macro- risks and impact of the global crisis, as well as just-in-time analysis of options for remedial measures. If the crisis proves longer-lived, the Bank's program can be adapted through the application of the principle o f flexibility. 38 112. IFC's program may also be affected in the event of a continued deterioration o f Tunisia's macroeconomic situation, declines in FDI, and reduced risk appetite o f local and foreign investors. During the financial crisis, IFC has been actively engaged in portfolio management and i s ready to provide assistance to existing clients in need o f restructuring their companies to adjust to the external environment. IFC also actively stepped up to mitigate the impact o f the sharp contraction o f available external private financing by initiating early discussions with interested bidders in relation to ongoing infrastructure PPPs (power and water) on alternative financing options and IFC's potential contributions. 113. There i s a risk that the desired outcome o f the increase in public investment will not materialize because of lack o f fiscal space to follow through on the stimulus package. Given Tunisia's room to engage more public debt, the financing from local and external sources (including IBRD and other development partners) should help to mitigate any possible squeezing in fiscal space. Moreover, the Government has consistently shown that it adheres to its fiscal deficit targets (below 3%) and manages its reserves prudently. This macroeconomic management provides a solid foundation for responding to the negative impacts and suggests that policy will respond in the face o f negative shocks. The launch of the PEFA in mid-2009 could also allow the Bank and other partners to provide an updated assessment on the management o f public finances. 114. The nature and ambition o f the reform agenda may be such that only slow progress will be made. The goal o f the Bank Group's program i s to ascertain carefully when opportunities for addressing difficult issues arise, build on the analytical foundation and then respond in a supportive and beneficial way. Tunisia has shown that it engages steadily but, in some cases, slowly on reforms as many important reform measures are based on a consultative and consensus-building approach that takes time. Given the complexity o f such reform measures, a key consideration for this CPS includes the need to be more sensitive to the time-frame o f reforms and not just the substance of reforms. This underscores the importance o f ensuring knowledge sharing on the "how" o f reforms and not just the "what". The Bank Group will also endeavor to have wider dissemination o f analytic work and continued consultations with development partners, civil society, private sector and other actors to help generate a broad consensus for reform. The impact o f the crisis may have a positive effect here as it underscores the urgency o f timely reforms to ensure that the economy - and the private sector in particular - can respond. 1 15. There is a risk that the NDP may not achieve the desired success and that growth rates will remain respectable (at 4-5 percent) but not reach a higher level. I t i s possible that the risks already identified above will combine with a slow implementation o f the NDP and Tunisia would, in the medium- term, get stuck exporting low-productivity goods and would not be able to master the high-productivity knowledge-intensive course that it wants to take. The Bank Group hopes to mitigate this risk through a broad program of support to the goal o f transforming the economy that encompasses global integration, private sector development (especially SMEs), skills development, education, labor market reforms and innovation. In particular, the Bank Group will make available international best-practice knowledge to Tunisia and can draw on i t s global experience in other countries that have pursued such a path. 116. There are implementation risks to the Bank's program given the problems of slow procurement. Tunisia's track record in implementing IBRD investment projects i s satisfactory but .not stellar and there i s a room for more progress to be made here. Mitigation measures being taken include a gradual increase in the use o f the DPL instrument within the allowed lending envelope, continued AAA in support o f the Government's reform program which focuses on implementation, continued intensive procurement training and stepped-up portfolio support on the investment portfolio through reinforcement o f the Bank's decentralized team in the Tunis office. The risk o f implementation delays in the DPLs i s being mitigated through careful design that takes into account the necessary time-frame for reforms and lays out a building-block approach to reform measures to ensure continued engagement. 39 0 d- M Y iz x '0 9 % 0 8 8 8 1 C 9 Y m B 8 3 m - c) 0 G o Y 3 d- x * * * * * * * * N d * * * m d .- m u C cd 4 a, * m E .* d u ri 0 VY Y 8 8 .3 W s eI .- C z cd C .e VY B e a * * 4 * * * * I 0 CI - m a, 3 .- c m e e 0 r 0 c a, e a, 8 a, Y 2 * * - c4 - E! P Y 9 B - E! P Y m Y 8 9 3 m a 5 a 0 Y VY s C I- U C 8 E 0 .I 3 8 : + a E .- a K cd -c .- 0 e a, 5 8 & s : 8 C .- m .- 2 C a Q 6 b c 3 Y a n G E S 3 3 41 0 W 0 ri g a a, 5 z z s M a m a, 0 u a 3 c L .- e a, L 0 . e L i * * * * * * * * Appendix 2 CAS COMPLETION REPORT Date af CAS: June 3,2004 Date of CAS Progress Report: September 2 1,2007 Period Covered by the CAS Completion Report: June 2004 - March 2009 CAS Completion Report completed by: Sophie Muller, Junior Professional Associate, and Eavan O'Halloran, Senior Country Officer, with contributions from Country Team members. Date: April 2009 Summary The CAS Completion Report (CASCR) assesses the contribution o f the Bank's program in Tunisia for the period June 2004 -March 2009. I t concludes that the CAS strategic objectives were consistent with the government program and the country's long term goals. Under CAS pillar I "Strengthening the business environment and improving the competitiveness of the Tunisian economy", clear results have been obtained in areas such as trade integration, access and quality of service in the transport, water, and energy sectors, protection of the environment and the strengthening o f the banking sector. Good progress has been recorded in improving the investment climate and business environment, although there i s s t i l l room for hrther gains in this area. Under pillar I 1 "Enhance skills and employability o f graduates and labor force in a knowledge economy", significant progress has been made in terms o f efficiency at all educational levels, while results have been modest regarding the relevance o f the education system, employability o f the labor force and development o f a knowledge economy, and insufficient in terms o f financial sustainability o f the education system. Achievements of pillar I11 "Improve the quality o f social services through enhanced efficiency o f public expenditures", are notable as regards fiscal mobilization and debt management, where very strong results were achieved. Progress in the areas of social protection policies has been slower than expected and only more recently has some progress been made. Little progress has been achieved in the areas o f health and pension where the Bank's program during the CAS period was limited. The Bank's program in Tunisia i s characterized by a good country dialogue as the Tunisian Authorities value the Bank's support, especially for the knowledge aspect o f the Bank's work. However, the CASCR highlights implementation delays - based mainly on slow procurement - as a recurring issue that has affected the portfolio quality. An important conclusion of the CAS CR i s that Tunisia made steady progress in areas where it committed to reforms and provided the necessary leadership and resources, although sometimes the pace o f this progress was slower than expected. This was due to the political sensitivities o f the reforms and the need to build consensus across stakeholders in the country which naturally demand more time. Key considerations for the next CPS period include the need to be more aligned with the country's own national development plan, be more sensitive to the time-frame of reforms and not just the substance o f reforms, and to provide enhanced support to Government in addressing unemployment. 49 Introduction 1. The CAS completion report (CASCR) assesses the effectiveness o f the 2004 Country Assistance Strategy for Tunisia in bringing about expected results and highlights the lessons learned over the period. The report's conclusions will inform the new Country Partnership Strategy (CPS). It i s an evaluation tool for the Bank's country team to help guide strategic thinking for the future and learn important lessons from past engagement. 2. I n addition to discussions with the country team, this assessment i s based on reference documents such as the CAS, the CAS Progress Report, Project Implementation Status and Results Reports, supervision reports (Aide-Memoires and Back-to-office Reports), Implementation Completion Reports, IEG reports and QAG Assessments. The draft of the CASCR has been shared with the Tunisian Government and their reactions and comments will be incorporated. 3. The 2004 CAS had a strong focus on results with a detailed results matrix. As such, it provides a set of core measurable outcomes that has helped guide the implementation o f the program and facilitated'the assessment process. Since it was the first attempt by the Bank in Tunisia to systematically identify results and indicators, it was conceived as a joint learning exercise where lessons learned would help design subsequent monitoring and evaluation efforts. However, the results matrix had important weaknesses - it was very ambitious, over-reaching and applied a standard of attribution rather than contribution to the Bank's activities in influencing development outcomes. Moreover, the Bank's program in Tunisia evolved significantly from what was laid out at the time of the CAS so many important activities were not encapsulated in the results matrix. I. Tunisia's Long Term Strategic Goals 4. The 2004 CAS was designed to support Tunisia's loth National Development Plan (2002- 2006) whose main goals were to (a) accelerate the pace of growth in order to reduce unemployment, boost incomes, and consolidate Tunisia's progress in the reduction of poverty; (b) foster the emergence of a knowledge economy in order to take advantage o f Tunisia's valuable human resources and facilitate integration in the global economy; and (c) uphold social achievements by ensuring that all social groups participate in the benefits of economic and social development. 5. I n 2006, the Government set an ambitious agenda to double per capita incomes by 2016 and to reduce unemployment from 14 percent to 10 percent over the same period. Tunisia's 1 IthNational Development Plan for the period 2007-11 supports this agenda and i s based on four pillars: (a) accelerating private sector driven growth; (b) maintaining macro stability; (c) upholding social achievements and human development and (d) preserving natural resources. 6. - The key challenges identified in the CAS (a) employment growth and (b) maintenance o f - macro stability and social achievements were fully in line with the Government's development agenda. The three strategic objectives (pillars) set out in the CAS: (a) strengthened investment climate and competitiveness, (b) improved education quality and graduate employability for an increasingly knowledge-based economy, and (c) improved social services through more efficient public expenditure-- also respond directly to the goals of the 1 lth Plan. 7. During the CAS period, Tunisia made progress towards these long-term strategic goals, although challenges remain. The GDP growth surpassed the average rate of 5 percent a year that had been anticipated in the base case scenario, since it reached 5.5 percent in 2006, 6.3 percent in 2007 and 4.5 percent in 2008 (thus averaging a 5.4% growth rate over the period). This i s particularly good given the impact of the global economic slowdown in 2008. Overall, recent growth performance reflects the 50 dynamic behavior o f exports, robust private consumption and growing foreign investments. Tunisia has been particularly successful in integrating into the global economy thanks to trade reforms, the establishment o f a free trade area between Tunisia and the EU for industrial goods in January 2008, and the signing o f a large number o f trade agreements with other partners. Sound macroeconomic management has allowed Tunisia to resist adverse shocks, including the Multi-Fiber Agreement dismantling in 2005. 8. Tunisia committed to reforms in priority areas - such as supporting private sector development (as witnessed by continued improvements in its ranking on Doing Business indicators) - and reforming higher education and indeed some notable progress was made. However, reforms took longer than anticipated which had an impact on the expected results. The modest level o f gross private sector investment (between 13 and 14 percent between 2005-2008), remains a concern that i s shared by the Government and the Bank. Moving forward, the Government recognizes the need for building on past progress and strengthening reforms to support private sector investment and to ensure that growth and investment further accelerate and translate into job creation. 9. Despite the admirable progress on economic management, the unemployment challenge remains and i s threatening Tunisia's good economic and social achievements. The 1 lth Plan considered that an annual growth rate o f at least 6.1 percent was needed to reduce unemployment. While growth has been respectable, it fell short o f this target (except in 2007) and no progress was made in terms o f reducing the unemployment rate over the CAS period, which hovers around 14 percent o f the labor force. 11. Progress and Achievements of CAS Outcomes 10. Outcomes for each CAS pillar are analyzed in terms o f the pillar's main objective, related Bank instruments and the CAS monitoring indicators. I t i s understood that activities in any particular pillar are likely to contribute to the outcomes o f other pillars, that CAS activities build on each other, and that each outcome i s likely to be influenced by more than one instrument and by activities in other pillars. Consequently, pillars are not separated or seen in isolation, but as the main arteries through which efforts and resources flow in the direction towards achieving the CAS goals. 1 1. Although the results matrix has proved relevant in the assessment process, some weaknesses have been noted. I t was far too detailed and ambitious given the nature of the Bank's program and often the choice of indicators was not the most appropriate. The CAS had clearly indicated the need to better define some indicators as the implementation was progressing, and set the CAS Progress Report as an opportunity to do so. Yet, it seems that this has not been done as the result-matrix does not report relevant updates. Where data on indicators i s weak, the assessment has also used information related to CAS milestone^'^ and incorporated qualitative judgments. The CAS results are collectively summarized in Annex 1. A. Pillar I Outcomes: Strengthening the business environment and improving the competitiveness o f the Tunisian economy 12. This CAS pillar responded directly to both the loth Development Plan (2002-2006) and the llth (2007-2011) that set the objectives to accelerate growth, integrate Tunisia to the global plan economy and promote the role of the private sector. The ECAL I V project and the Bank's AAA work have been the backbone o f the Bank's engagement in the competitiveness agenda. Building on the l 4 CAS milestones are intermediate outcomes that were incorporated to the results matrix to track implementation towards expected CAS outcomes. 51 analytical work, the ECAL IV focused on improving the regulatory framework for private investment and strengthening competition. Overall, CAS outcomes under this pillar have been satisfactory. Clear results have been obtained in areas such as trad,e integration, access and quality of service in the transport, water, and energy sectors, protection o f the environment `and the strengthening of the banking sector. The promotion of economic competition has, however, yielded more moderate results. 13. I n i t s March 2009 report, I E G evaluated the Bank's performance in Tunisia on earnings growth and employment creation and gave the Bank's Program a satisfactory outcome rating. The report concluded the following (i) the Bank's strategy and interventions were relevant to the issues; (ii) performance was strongest in the Bank's support to macroeconomic policy; (iii)there was a positive contribution from the Bank on trade liberalization and fiscal policy; and (iv) high quality work was delivered on the financial sector, including work undertakenjointly with the IMF. Outcome 1.1 Improved incentives system and increased transparency and predictability o the regulatory f fiamework: satisfactory Table 1 Performance Indicators Baseline Goals for 2008 Result (year) Increase in annual FDI inflows $650 million average Increase by 50% $1.6 billion (2007) for 2002-2003 S 2.038 billion (est. 2008) Proposed Activities Activities Undertaken during CAS 0 Economic Competitiveness DPL (ECAL) I V 0 ECAL I V project (2005-2007) 0 ECAL V project 0 SME Study (2007) 0 ICA 0 Global Integration Study (2007) 14. The CAS monitoring indicator shows considerable progress, other relevant data provide important contextual elements. The CAS monitoring indicator, which was the increase in annual Foreign Direct Investment (FDI) inflows, surpassed the target, as shown in table 1. However, the IEG report o f the ECAL IV points out that FDI was relatively limited in a few sectors - the large increase in FDI in 2006 reflects US$2.35 billion received from the partial privatization of Tunisie TBlecom, and around two thirds of overall 2007 FDI went to the energy sector. 15. The CAS monitoring indicator may not be the most suitable to assess achievements under this outcome. As stated in the CAS, this outcome also has to be measured against indicators of the ECAL IV", which were defined after the CAS and the result matrix were finalized. One of the ECAL IV indicators shows that investments by on-shore and off-shore companies have increased but the target set in 2005 was not met: On-shore investment grew by 6.1% instead of 9.7% and off-shore investment grew by 17.7% instead of 37.9% (perhaps reflecting overly ambitious expected indicators at that time). The ICR o f the ECAL IV indicates that the number o f private investment opportunities increased and the number of administrative authorizations for private investment and the delays in granting authorizations have been reduced. However, the CAS Progress Report expressed concern about the low level o f domestic private investments, and highlighted the need for better understanding the reasons for it and identifying measures to help the authorities redress the situation. Further improvements o f the business climate are being supported by the FY09 Integration and Competitiveness Loan - ICL (proposed in the CAS as ECAL V), which was approved by the Board in March 2009. In addition, the Loi sur l'lnitiative Economique that was enacted in December 2007 contains several "investment climate" reforms, including '' PDO Indicators o f the ECAL I V are: (i)level o f bank provisioning as a share of NPLs; (ii)job creation by private sector; (iii) evolution of investment by on-shore and off-shore companies; (iv) evolution o f FDI and (v) number and amount of new l i f e insurance contracts. 52 provision on the protection o f investors; and the level o f private investment showed some recovery signs in 2008. 16. The Bank contributed to noticeable results with regard to the tax system, the increased transparency of accounting standards and the improvement of the competition regulatory framework. Following an assessment o f the fiscal system, undertaken as part o f the ECAL I V project, the fiscal Law no. 2006-80 was enacted in December 2006, normalizing VAT rates and reimbursement mechanisms and simplifying the relationship between tax payers and tax administration. The standard rate o f corporation tax was reduced from 35 percent to 30 percent in order to increase competitiveness and encourage investment. The ECAL IV also contributed to improved transparency and respect o f international accounting standards with the requirement for public companies to publish certified financial statements. The Competition Authority and the competition regulatory framework have been improved thanks to the Law 2005-6 that aims at strengthening the power o f the Competition council, notably in terms o f auto-seizure, the council's independence and actions taken against unfair competition. However, the Global Integration Study underlined that while Tunisia's competition laws meet international standards, implementation issues remain and the capacities o f the competition authorities could be enhanced. Recognizing this situation, the Government undertook to pursue these reforms with the support of the Bank's Integration and Competitiveness Loan (FY09). 17. Some progress has been made towards other CAS milestones such as leveling o f the playing field between off-shore and on-shore firms and upgrading the capacity of the judiciary. Despite considerable Government's efforts to reduce the incentive gap between onshore and offshore sectors in recent years, as witnessed by the continued improvement in the Doing Business indicators and other indexes such as the Global Competitiveness Repod6, the on-shore sector s t i l l faces constraints. In contrast with offshore firms, formal enterprises selling in the domestic market cite what they perceive as anti-competitive practices and unfair competition stemming from privilege, informality, tax and social security avoidance. Following a round-table of magistrates that took place in January 2007 to assess Bankruptcy procedures, bankruptcy regulations have been implemented. 18. Sustainability o f the outcomes o f the ECAL I V i s high due to the particular attention given to supporting the reform program, the clear commitment o f the authorities and the synergy between donors supporting the reforms (the WB, AfDB and the EU). The design was the result o f an extensive dialogue with the Tunisian authorities, which were very active in the loan preparation and, in some cases, went beyond the committed benchmarks o f the loan agreement. This activity i s also a good example o f donor coordination since it was designed, implemented and supervised jointly with the EU and the AfDB. The cooperation between partners was excellent and the presence o f the EU, World Bank and the AfDB in Tunis helped the dialogue between all three institutions and with the Government. 19. Other activities proposed in the CAS have not been carried out, at the client's specific request. The Investment Climate Assessment was not conducted as planned because the authorities wished to carry out the analysis on their own, with some limited level o f Bank support. This involvement helped foster country ownership and capacity building but, at the same time, did not allow for international benchmarking. Instead o f producing an ICA, and as requested by the client, the Bank delivered a SME Study. Focusing on SME development, the study provided concrete recommendations for the reforms o f the technical centers o f the Ministry o f Industry and of industrial land management in Tunisia, and contributed valuable input to the Ministry o f Industry's strategy in these two areas. Another result o f the study was the capacity building o f IEQ (Institut d'Economie Quantitative) to independently conduct ICA surveys and analyze the data. l 6 Tunisia's ranking on the Doing Business Indicators improved from 8 I in DB2008 to 73 in DB2009 and 69Ih in DB2010. In the 2009 Global Competitiveness Index, Tunisia i s ranked a commendable 361h place. 53 Outcome 1.2 Lower transaction costs: moderately satisfactory Table 3 Performance Indicators Baseline Goals for 2008 Result (year) Number of procedures to start 10 in 2003 4 10 (Source: Doing business reduced Business 2009) Minimum capital requirement 352% o f GDP in 2002 <50% Eliminated (2008) reduced 8% of estate in 2003 Cost of closing business reduced 4% 7% of estate (Source: Doing Business 2009) Customs clearance and technical Average o f 8 days in controls delays reduced 2003 2 days 2 days (2008) Table 4 Proposed Activities Activities Undertaken during CAS Economic Competitiveness DPL (ECAL) I V Projects under way at start o f CAS: e ECAL V project e Export Development Iproject (2000-2004) Export Development I1 project e Information Society project Activities undertaken during CAS: e Additional demand-driven policy notes e ECAL I V project (2005-2007) e Export Development I1 project (started in 2005) e ICT Sector Development project" (started in 2005) SME Finance policy note (started in 2007) e Global Integration Study (2007) TA Development o f logistics services and infrastructure (2008) e TA for implementing Trade Integration Reforms (started in 2008). 20. Two out of four indicators were met, as shown in table 3, and two CAS milestones" were achieved, which are the revision o f the Customs Code and the continued reduction o f the number o f tariffs on imports outside the E U (which was reduced from 14 to 9). Some reductions also took place in the applied most-favored nation (MFN) tariffs on imports o f inputs and intermediate products from the rest o f the world. Little progress was made, however, with regard to the dismantlement o f import monopolies and the modernization o f commercial registries. A study on the modernization of commercial registries was carried out by the Bank in 2004, but no action was taken by the Government until March 2009 when the Inter-Ministerial Council o f Tunisia adopted a draft law amendment designed to ensure an effective updating of the information contained in commercial registries. This measure was a prior action o f the I C L that was approved by the Board in March 2009. 21. Strong results were achieved in the areas o f customs and trade facilitation thanks to the 1 Bank's Export Development projects I and 1 . Activities supported by the Export Development I project, which was rated satisfactory by IEG, helped improve trade transactions. Customs clearance and technical controls now take 2 days on average, compared with an average o f 8 days in 2003. This was achieved through the simplification and adoption o f international standards for trade documentation, and " ICT SectorDevelopment project was called Information Society project during CAS preparation. CAS milestones are intermediate outcomes that were incorporated to the results matrix to track implementation towards expected CAS outcomes. 54 the establishment of electronic processing, through the creation of a semi-public agency (Tunisie Tradenet - TTN). These results are likely to be sustainable as the modernized customs are now more focused on trade facilitation than control. However, there i s a need for stronger coordination among different agencies involved in the TTN network to accelerate progress in this regard. This issue i s currently being addressed by the second Export Development project (EDP2), which pursues the same development objectives and also includes a component on WTO technical barriers to trade enquiry point. Additional financing of the EDP2 was granted in FY08 to respond to the high demand for Export Market Access Fund (EMAF) services by the private sector. As of March 2008, this operation i s making satisfactory progress. In addition, the ECAL I V contributed to the implementation of measures designed to reimburse VAT taxes more quickly to those doing international business, which should create an incentive for exporters. 22. Although the two CAS indicators on business creation and closing costs did not register strong improvements Tunisia made laudable progress on the Doing Business Indicators. Tunisia's ranking in the Doing Business survey improved from 8 l S t in DB2008I9 to 73rd in DB2009 and 69`h in DB2010 with major regulatory improvements in the area of business creation and in the financial sector. Improvements have taken place regarding business transaction costs. The minimal capital requirement was eliminated in 2008 but it i s not evident that this was due to the Bank's contribution. Activities initially planned in the area of ICT were modified and did not include a component on reducing transaction costs and improving market access. The ECAL IV, as mentioned in Outcome 1.1 a, contributed to reduce the number of administrative authorizations for private investment and the delays in granting the authorizations. 23. Bank ESW, especially the Global Integration Study, played an important role in shaping the Government's trade and competitiveness program. This study made various recommendations to reduce the gap between preferential and MFN tariffs make the on shore sector more competitive and harness the potential in services sectors, which formed the basis of the recently approved ICL operation. The review of logistics services and infrastructure has prepared a strategy to develop efficient logistics infrastructure and services that also helped inform the content of the ICL program. The SME finance policy note, currently being finalized, focuses on the demand for enterprise credit and i s aiming at identifying potential credit market failures and credit rationing for SMEs, and assessing the quality of demand of credit. Preliminary findings of this study have provided inputs to the design of the ICL. In addition, technical assistance i s being provided on tariff reforms to anticipate trade integration reforms to be supported under the ICL. l9 The Doing Business website does not provide information on rankings prior to 2008 55 Outcome I.3 Improved delivery/efjciency o infiastructure services by public and private j r m s : f satisfactory Table Performance Indicators BaseIine Result (year) Share o f I C T sector in GDP 5% in 2003 9.2% (2008) No. of fixed and mobile telephone lines as YO f o 32% i n 2003 60% 94.7% (2008) population Share o f population using the internet 6.3% in 2003 30% 27.25% (2008) Internet hosts based in Tunisia 1,625 in 2003 4000 11,534 domain names (Jan 2009) Container terminal o f Rad& privatized by Concession process o f the Rades 2006, deep-water port in Enfidha put in container terminal has been put on hold. concession and Center-East Airport put in Enfidha deep sea port: Bidding concession by 2006. documents have been issued to 8 short- listed investors with a view to award the concession in 2009. Enfidha airport: Works are in progress and the airport should open for traffic by end 2009. Subcontracting o f urban transport services 1.70% 3% in 2006 4.6% (2007) (passenger-km) by SociCtC des Transports de Tunis. Labor costs o f SNCFT of total operating 58% in 2003 50% in 2006 52% (2007) expenses Increased gross investment in energy efficiency 0 $20 million for $16 million (2005-2007) in Tunisian industry 2005-2008 No. o f energy services enterprises in operation 3 8 (2009) (indicator added) Energy saving I O ktoe/year 200 ktoe/year on average (2000-2008) Average water tariffiaverage cost 98%in 2002 110% 88.6% (2006) Average sewerage tariff/ average cost 67.6% in 2002 80% 61%(2006) Unaccounted for water 20.1YO 2002 in 18% 19% (2006) Sewerage coverage rate (Indicator added) Rural 4.8%, urban Rural 5% in 2008, 80.1% and national Urban 87% in 2006 (in cities covered by total 40.2% in 2004 ONAS), National total 55% in 2006 Connection to potable water rate (Indicator Urban 98.7%, rural Urban 100% in 2006, Rural 91YO 2008, in added) 40.2% and national National 97% in 2006 total 40.2% in 2004 Share o f municipalities with financial situation 100% 54%. problems that have restructuring plan contracts Out o f 132 municipalities which were in difficult financial situation, 34 have gained a sound financial situation per the XIth Plan. Out o f the 98 municipalities - left, 53 municipalities Le. 54% - have signed a restructuring plan and 45 - - municipalities i.e.46% are currently preparing their restructuring plans which are expected to be completed by June 2009. 1 private concession project financed by 2005, 3 In 2008, the Municipality o f the city o f 3 by 2008 in municipalities. Sfax has launched a private concession for the regional slaughter house. 4 private Parking contracts for municipalities confirmed by end 2008 Pilot municipal waste collection by private sector launched in 2 cities 2007 figure i s 455 TD 2008 figure i s 470 T D Increase o f tourism receipts by tourist 400 T D per tourist 5% in 2002 Increase o f no. o f visitors on cultural sites 3 million in 2003 4 million 2.7 million (2007) 56 Table 6 Proposed Activities Activities Undertaken during CAS e Urban Water Supply project Proiects under way at start o f CAS: Energy Efficiency project Transport Sector Investment Iproject (1998-2005) Tourism project Transport Sector Investment I1 project (started in 2002) Tunis urban transport project (potential) e Grand Tunis Sewerage project (1 998-2005) WBI capacity-building program on PPI Cultural Heritage project (started in 2002) Infrastructure/water notes Municipal Development 111project (started in 2003) Strategic environment assessment Solar Heating GEF2' project (1995-2004) Information Society project Ozone Depleting Substance M T 2 ' project (started in 1994) Activities undertaken during CAS: ICT Sector Development project" (started in 2005) Urban Water Supply project (started in 2006) Energy efficiency GEF project (started in 2004) Nine Landfills ICFZ3 project (started in 2006) Jebel Chekir Solid Waste Management ICF project (started in 2006) Tunis West Sewerage project (started in 2006) Sustainable Municipal Solid Waste Management project (started in 2007) e Avian Influenza Preparedness project (approved in 2008) Water and waste water strategy (2007) e Review o f energy management policy (started in 2007) e TA Development o f logistics services and infrastructure (2008) e Financing strategy o f Urban Transport (2008) Low Carbon Transport Strategy (started in 2008) 24. Overall, results under this outcome were good. Eight CAS indicators have been achieved, six partially achieved and three not achieved. However, those indicators that were partially achieved have registered very good progress and one could conclude that the indicator was overly ambitious to begin with. Four activities have not been conducted but five projects were added to the Bank's program. 25. I n the transport sector, the overall quality o f service has improved, the private sector involvement increased and pollution reduced. During the implementation period o f the Transport Sector Investment Iproject, the private sector's share o f transport investments increased to 55% against the baseline o f 25% and the target o f >50%. A reform o f the port sector has set the stage for a more efficient model, more conducive t o competition and more commercially managed operations in ports. A new transport law has also reformed the institutional framework and paved the way for new financing mechanisms o f urban transport. This, combined with trade facilitation measures and custom modernization achieved under the Export Development Iproject (outcome 1.2), resulted in increases in efficiency and quality o f service. Regarding pollution, the use o f unleaded gas has increased gradually from 4% in 1998 to 71% in 2005 and a regulation limiting the sulfur content o f fuel to 0.035% has been approved and effective. The on-going TA on development o f a l o w carbon transport strategy will provide valuable input regarding adaptation t o climate change and mitigation measures in the transport sector. 26. Implementation delays characterized both phases o f the Transport Sector Investment project, which had to be extended. This i s not only due to procurement delays resulting from the *' Environmental Facility Trust Fund Global 2' Montreal Protocol Trust Fund 22 ICT Sector Development project was called Information Society project during CAS preparation 23 Italian Carbon Fund 57 procedures of the Commission Superieure des Marches (cf. part 111), but also to the magnitude of reforms prescribed under these projects and the time needed for the Government to establish and enact new legislation. 27. All indicators have been reached in the energy sector and some were even surpassed. Achievements in terms of energy savings and the number of energy services enterprises created have surpassed the targets. The value of gross investment in energy efficiency in the Tunisian industry may be higher than the $16 million stated in Table 5 as this figure only reflects one part of the Tunisian industry that i s dealt with under the Energy Efficiency project. The gross investment in energy efficiency in the Tunisian economy as a whole i s $110 million. The Solar Heating project also reached i t s goal of encouraging the use o f renewable energy, establishing a competitive market of suppliers in Tunisia and strengthening renewable energy institutions. Nevertheless, energy programs lack continuity and are heavily dependent on government financial support and international grants. For instance, the solar water heater program slowed down when GEF support came to an end. This i s why the Government decided to revisit i t s energy management policy, for which the Bank i s currently providing support. 28. Significant achievements have been made in terms of access to water and sanitation, and reduction of urban and coastal pollution. As stated in the IEG evaluation report of the Grand Tunis Sewerage project, this operation has substantially improved the service levels of urban sewerage. Appropriate new sewerage technologies have also been introduced and urban and coastal pollution has been significantly reduced. The connection to potable water rate has greatly increased, in particular in rural areas, as shown in Table 5 . An additional project on Tunis sewerage started in 2006 in order to pursue the objectives of the first project. Urban water supply issues are also being addressed through a Bank project that i s progressing slowly due to procurement delays. Finally, the Bank has provided the Government with guidance on a water and waste water strategy that was finalized in 2009. 29. Municipal infrastructure activities are producing mixed results, as the CAS indicators show. The Municipal Development I11 project, still ongoing, has produced good results in terms of financing priority municipal investments but the institutional strengthening component i s making slower progress, although QAG has rated the achievement of development objectives as moderately likely. In addition to the Municipal Development I11 project, the Bank i s providing technical assistance, via PPIAF, to the city of Sfax to include private sector participation in the operation of a new slaughterhouse. The Sustainable Municipal Solid Waste Management project, started in 2007, i s making progress, although delays occurred in starting up the institutional component of the project. 30. Efforts were made towards privatization of services, improved financial capacity o f public enterprises and opening o f tariff regulations in the transport and water sectors. The privatization processes have produced mix results. In transport, the container terminal of the port of Rades has not yet been privatized but the concession o f the passenger terminal at the port o f L a Goulette has been awarded and that of Enfidha deep sea port should come to fruition later in 2009, while the construction of the concessionned Enfidha airport i s ongoing. Furthermore, private bus operators are providing 4.6% of urban transport services in the Tunis area under concessions with the Ministry o f Transport. Private sector objectives in the water sector have not been achieved because of the Government's change of view on the Build, Operate and Transfer (BOT) scheme that would have allowed the Office National de 1 Yssainissement (ONAS) to outsource some of its activities. Delays in concession processes are partly due to the lack of capacity in Tunisia for private provision of infrastructure. The Bank played a role in the preparation of the recent concession law and should pursue this effort and help Tunisian counterparts develop regulations and tools to manage such complex procurement processes. 31. The Government has faced challenges with regard to reforms aimed at improving the financial capacity or reaching the financial autonomy of public enterprises such as the water utility ONAS and Socie'te' Nationale des Chemins de Fer Tunisiens (SNCFT), and still subsidizes some 58 subsectors. Although the severance program for the SNCFT was fully implemented, i t s labor costs remain above the 2008 target and its financial situation i s still fragile, as well as that of ONAS. Tariff restructuring objectives in the water sector and on the financing o f public service obligations in urban transport have not been reached either, partly due, in the water sector, to the changes in the Minister and ONAS' CEO, which made tariff increase decisions more difficult to obtain. The financing strategy o f urban transport, recently completed, has identified sustainable financing mechanisms relying on non budgetary resources for this sector. 32. The I C T sector has substantially developed. Three out o f four CAS indicators, as shown in table 5, have been met and even surpassed the target, showing evidence o f improved access to ICTs. The ICT sector development project contributes to better delivery o f services also through the creation o f e- portals such as e-culture that has been recently completed. An achievement o f this project i s the design o f special software to enhance the learning performance o f disabled students (3,000 disabled students have been reached to date) and the equipment o f 24 Internet centers to allow disabled persons to access the Internet. Such an achievement i s considered as international best practice. However, delays in the implementation of the process to award new fixed line and mobile licenses have prevented fwrther liberalization o f the sector during the CAS period. The Government has recently announced its intention to award new competitive licenses and the process i s expected to be completed by end 2009. 33. Progress in the area o f cultural tourism has been steady but slow. The ongoing Bank's activity, the Cultural Heritage project, i s experiencing implementation delays and the other planned activity, the Tourism project, was dropped because o f change in government priorities. Tunisia was the first country where the Bank designed a free standing Cultural Heritage project. Although this project has significantly contributed to the renovation o f some cultural sites and the improvement o f communication on the national heritage, the implementation of major components i s slow, mainly because o f procurement delays and the institutional difficulties within the two institutions in charge o f cultural heritage preservation and management to adapt to techniques necessary to improve cultural heritage management and promote cultural tourism. One should mention that no progress on CAS indicators should be expected until the project closes since cultural visitors to the museums rehabilitated under the project will be attracted only after the site works are completed. At the time o f the mid-term review, the project was reduced to four sites rather than six. This decision was made to increase focus on a reduced number of emblematic sites for added impact and also to accommodate for higher costs than originally expected. However, as QAG underlined, the potential economic benefits may be underestimated from a "world site" o f the caliber o f the Bardo museum (which i s being renovated and expanded with the support of the project). 34. Other Trust Fund activities are addressing the following issues: The Bank's activity designed to provide Tunisia with support in decreasing the use o f Ozone Depleting Substance (ODS) i s progressing well despite the slow implementation. Waste management issues are tackled through two activities that are aimed at installing a Gas Recovery and Flaring Project at the Djebel Chekir landfill and nine new landfi11s. 4. Outcome I . Increased competitiveness o agriculture while enhancing environmental and social f sustainability: moderately satisfactory Table 7 Performance Indicators Baseline Goals for Result (year) 2008 Improved irrigation efficiency 85% in 2003 105% 85% in 2005. No new data but related studies do not indicate that there has been much improvement since 2005. Other indicators to be proposed The rural sector-wide review was only finalized 59 following the completion o f the in mid 2009 due to delays caused by Ministerial Rural Sector-Wide Review and reorganization and by the need to refocus the reflected in CAS Progress Report. strategy to take into account Tunisia's accession to the preferential EU markets for agricultural products. Therefore the sector wide review was not completed in the CAS period and no indicator was ever proposed Table 8 Proposed Activities Activities Undertaken during CAS Natural resources management I1 project Proiects alreadv under way at start o f CAS: Water sector investment I1 project Natural Resources Management Iproject Gulf o f Gab& project (1 997-2004) Africa Stockpile project Water Sector Investment Iproject (2001-2007) Strategic environment assessment Agricultural Support Services project (2002- Rural sector-wide review 2008) TA and AAA on environment for harmonizing e Northwest Mountainous and Forestry Areas environmental impact assessment systems, Development project (started in 2003) mainstreaming environment in sectoral policies, Protected Areas Management GEF project and developing environmental indicators (2002-2009) related to MDG#7 Activities undertaken during CAS: Gulf o f Gab& GEF project (started in 2005) e Africa Stockpile GEF project (started in 2005) e Agriculture policy review (2006) e Cost assessment o f water degradation (2007) 35. The objective o f increased competitiveness of agriculture has been partially met. The C A S monitoring indicator does not indicate any progress and other indicators that were t o be added and included in the C A S Progress Report in order to reflect the conclusions o f the rural sector-wide review, were not actually added. It i s therefore difficult to determine the extent to which this outcome has been reached. However, all projects that include components on agriculture competitiveness are rated moderately satisfactory, and all C A S milestones24 have been met: the Water Sector Investment project contributed to the implementation o f a water tariff structure based o n fixed and variable terms. 186 new irrigation schemes have also been created or rehabilitated and 80% o f irrigated areas equipped with water saving techniques, thereby increasing water productivity. The Agricultural Support Services project helped develop regional research centers and programs and produce agricultural statistics. With the project support to agricultural commodity trade associations, agricultural product quality and exporting capacity have also been improved. The Northwest Mountainous and Forestry Areas Development project contributed t o increase in crop yields and diversification and greatly supported poverty reduction efforts in the northwest region o f Tunisia, one o f the poorest regions in the country. Some important issues affected the effectiveness o f the Water Sector Investment and Agricultural Support Services projects, as highlighted in their ICRs, Poor access to finance in rural areas has led to lower production ratios than anticipated; and the lack o f synergy between the Water Sector Investment project and the Agricultural Support Services project limited their potential outcomes. IEG rated the performance o f the Agricultural Support Services project as substantial based on progress made towards specific project objectives. 36. Good achievements were reached in terms o f environment protection. Achievements under the Water Sector Investment project in this area, rated as modest by IEG, include the development o f several maps showing areas at risk o f salinization and zones o f possible land degradation covering the entire country, and the identification o f 206 potential sources o f water pollution and 11 sites which could use 24CAS milestones are intermediate outcomes that were incorporated to the results matrix to track implementation towards expected CAS outcomes 60 treated wastewater in non-agricultural sectors, so that water resources could be used sustainably. Furthermore, the study covering the cost assessment of water degradation was able to build capacity on environmental valuation, which will enable the Tunisians to replicate this type of cost analysis in other sectors of the economy. The Protected Areas Management project, which closed at the end of 2008, developed capacity o f national parks' staff, public awareness of natural resources management, and improved biodiversity conservation in three distinct ecosystems of Tunisia as demonstrated by the increase in the number of selected species. 37. The participatory approach developed by the Bank's projects yielded good results in terms of community development and social impact. The Natural Resources Management I project was successful in promoting local integrated development and paved the way for participatory projects in Tunisia. The first Water Sector Investment project achieved considerable progress in terms of community development. An estimated 80% of irrigation schemes are currently managed by local water users associations, although female participation remains low. As noticed by IEG, however, these local associations have yet to achieve full financial autonomy and are not able to fully cover their operational and maintenance costs. The Northwest Mountainous and Forestry Areas Development project has achieved its objective of assisting 180 rural communities to formulate community development plans, which contributed to better policy and planning framework for local governments and increased participation by the beneficiaries. Continued support to these young institutions i s s t i l l required, however, in order to ensure their sustainability. Improvement of irrigation schemes has also enabled beneficiaries to diversify and increase their revenues, contributing to labor generation and a reduction in rural migration. The Bank's activities allowed the rural population to have better access to safe drinking water (cf. Table 5). 38. Other planned activities have either been delivered, albeit later than planned, o r are under preparation. The Natural Resources Management I1 project has been renamed the Community Based Integrated Rural Development Project and i s currently under preparation for delivery in FYI0 and the second phase of the Water sector investment I1 project was delivered in FY09. In the case of the Water Sector Investment 11, i t s delivery was delayed as the first project had to be extended in order to complete various project activities which took longer than planned given their innovative and cross-sectoral nature. 39. The ECAL I V has been instrumental in the reduction o f the level o f non-performing loans (NPL) and the increase in the provisioning ratio. The CAS target was almost fulfilled reaching 17.3% in 2008 and the provisioning and restructuring efforts of the NPL portfolio have brought their level to 53.8 % in 2007 while the target was 55% for 2006. NPL levels are still high by international standards but similar to other Middle Income Countries. New targets have been set up in the context of the 1lth and are Plan supported by the Integration and Competitiveness DPL (ICL): 15% o f NPLs and 70% of provisioning by the end of the ICL. 61 Outcomel.5. Banking sector more responsive to the needs o the private sector: satisfactory f Performance Indicators Baseline I Goalsfor2008 I Result (year) Proposed Activities Activities Undertaken during CAS 0 Economic Competitiveness DPL (ECAL) I V Projects undertaken during CAS: 0 ECAL V project 0 ECAL I V project (2005-2007) Follow-up technical support to the ROSC FSAP Update (2006) Accounting and Auditing 0 AML/CFT25 Assessment (2007) 0 TA Support for Financial market integrity 0 ROSC data module (2006) 40. Overall, the banking sector has been institutionally strengthened. The 2006 Financial Sector Assessment Program (FSAP) Update provided the framework to allow the government to conduct a series of reforms intended to improve the credit culture, promote good governance, and strengthen the legal framework for banks. A 2006 legislation gives the Banque Centrale de Tunisie (BCT) new powers to monitor the financial system, ensure alignment with prudential norms and regulations, enforce transparency, and supervise publication of financial and economic data. Thanks to the ECAL I V project, transparency and respect of international accounting standards have greatly improved with the requirement for SMEs to publish certified financial statements. A working group has been set up to apply IFRS standards to consolidated accounts. The credit registry sponsored by the central bank has been modernized and i s now fully operational. 41. Two out of three CAS monitoring indicators have met their targets and the third one shows progress. The number of listed companies and mutual funds has increased and this trend i s continuing, in particular as a result of fiscal incentives that have encouraged the opening of capital and stock exchange listings. 42. Significant progress was made with the support o f the ECAL I V in the development o f contractual savings, especially in the insurance sector. As underlined in the IEG report of the ECAL IV, the role of the insurance supervisor was strengthened, restrictions on the participation of foreign investors in insurance companies were reduced, and the flexibility of companies to raise regulated insurance rates was granted. In addition, a new law was passed that increased the mandate of the securities market regulator, and enhanced the transparency o f the market. Sales turnover of life insurance rose 44% from 2005 to mid- 2007, while the capital of insurance companies rose 28% during the same interval. The total number of life insurance contracts, however, has slowed down between 2005 and 2006 but this i s due to consolidation of numerous small contracts and the value amounts o f the contracts have increased considerably from 56.5MDTto 78.4MDT. '' Anti-Money Launderingand Combating Financingo f Terrorists 62 Outcome 1.6. More dynamic local public and private financial markets: satisfactory Table 11 Performance Indicators Baseline Goals Result (year) for 2008 Increase no. o f f i r m s listed in stock exchange 42 in 2003 60 5 1 listed companies and 57 Flexible money market interest rate created by mutual funds (end 2007) 2007 Created in 2007 Share o f bonds issues and increases in equity 6% of gross 10% 11% (2008) capital through the stock exchange investment in 2002 (calculation: share o stocks and bonds issues f (excluding Government bonds) in the total gross investment - Source: Central Bank) Table 12 Proposed Activities Activities Undertaken during CAS Economic Competitiveness DPL (ECAL) I V 0 ECAL I V project (2005-2007) 0 ECAL V project 0 IDF Public Debt Management 0 TA on public debt management and development o f local debt market 0 Study on non-banking finance sector B. Pillar I1 Outcomes: Enhance skills and employability of graduates and labor force in a knowledge economy 43. This CAS pillar was relevant to the Government's development agenda to reduce unemployment to 10 percent by 2016. Both the loth Development Plan (2002-2006) and the 1lthplan (2007-2011) aim at expanding the knowledge economy and investing in Tunisia's human capital. Overall achievements under this pillar are moderately satisfactory. Significant progress has been made in terms o f efficiency at all educational levels, while results have been modest regarding the relevance o f the education system, employability o f the labor force and development o f a knowledge economy, and insufficient in terms o f financial sustainability o f the education system. The 2009 IEG review o f three countries' performance o n growth and employment (Tunisia, Turkey and Columbia) assessed that the Bank's program on earnings growth and employment creation had been satisfactory and well adapted to the needs. Outcome 2.1. Improved quality and relevance o all levels o the education system: moderately f f satisfactory Table 13 Performance Indicators Baseline Goals for 2008 Result (year) Primary (first cycle) completion rate 79.4% in 2003 90% in 2007 89% (90.6% for girls, 86.7 % for boys) (200712008 school year) Secondary education completion rate 45.5% for girls & 50% 50.6% (57.2% for girls, 42.8% for 42% for boys in boys) (2007/2008 school year) 2003 Percentage o f university students who 30.5% in 2003 40% by 2006 39.4% (2007) graduate from 2-year degree programs Student to computer ratio in secondary 1000: 1 15:l 26 : 1(2007/2008 school year) schools 63 Table 14 Proposed Activities Activities Undertaken during CAS EQIP I11 project Projects already under wav at start o f CAS: Higher Education reform support 111 project EQIP Iproject (2000-2006) Vocational training project EQIP I1 project (started in 2004) PESW Employment Higher Education Reform Support I 1 project (1998-2004) ICA Study on lifelong learning and vocational Proiects undertaken during CAS: training Higher Education Reform Support I11 project (started in 2006) Higher Education strategy (2004) Programmatic ESW (PESW) on Employment that included (i) TA Employment strategy capacity building (2005); (ii) TA Employment strategy (2006); (iii) TA Skills development / social insurance (2007); (iv) TA Skills development / social insurance (2008) 44. The internal efficiency o f primary, secondary and higher education significantly improved. The EQIP Iproject was rated moderately satisfactory by IEG as there was progress made on achieving the development objectives. This operation did achieve results in terms of quality of primary education, mainly due to the generalization of the competence-based approach. The completion rate came very close to meeting i t s target (89% instead of 90%). The only area of concern remains the dropout rate in the upper primary education, which kept increasing until 2006, partly because the number o f students increased and the curriculum changes were not introduced until 2006. In higher education, the Higher Education Reform Support I1 project contributed to introducing pedagogic reforms, teacher training, greater university autonomy, quality assurance plans and to expanding shorter-term professional programs, which in turn played an important role in improving overall quality. The follow-up Higher Education Reform Support I11 project made good progress on the implementation o f the new law approved in February 2008 that includes the adoption of Quality Assurance Standards for external evaluation o f institutions. 45. Sustainability of these achievements will depend upon better results in terms o f program evaluation and stakeholders' involvement. The above-mentioned activities have introduced changes in the areas of student assessment, teacher evaluation, and pedagogic reforms but have not allowed for program evaluation, which would have ensured the sustainability o f the use of the new approaches. Their outcomes would also have been greater had they developed a communication strategy towards parents, teachers and communities in order to reach a larger consensus in favor of the reforms. Such issues are currently being dealt with by the ongoing operation EQIP 11. 46. Some achievements have been made in terms of relevance of the education system and employability o f the labor force. The Higher Education Reform Project I11 was designed to deal with the issue of relevance of the education system and included piloting two-year programs with the business sector. The issues of integration of higher graduates to the labor market, skills mismatch and development o f vocational training programs were analyzed through the PESW Employment, which was delivered under a series of four TAs. This work fed into the design of the Higher Education Reform 111 project. The capacity of monitoring and evaluating the relevance of education and employability has improved markedly. 47. The PESW has contributed to a sustained dialogue with the Government on Employment issues covering a wide range o f topics. (See Box I on PESW Employment). The Government demonstrated strong commitment and co-delivered several of the PESW outputs, and synergies were created with activities under CAS Pillar I(such as the SME study). The Bank's PESW outputs fed into the 'national consultation on employment' that was carried out by the Tunisian Authorities in 2008. 64 Box 1: Main Achievements of the PESW Employment The PESW Employment i s an innovative Bank instrument designed to provide the Tunisian Government with a multi-year capacity building program in the area o f employment policy formulation and monitoring. This activity was delivered during the CAS period under a series of four TAs, which have contributed to strengthening the skills and methodology of the staff of the Observatoire de I'Emploi et des Qualifications (ONEQ). With the support o f the PESW, the ONEQ and the Ministry o f Employment have co-delivered high quality individual level tracer surveys on VET, Higher Education graduates and micro-credit ALMP graduates. In particular, the ONEQ has developed capacity to deliver to very high standards, which i t could effectively share throughout the MENA region. Furthermore, the MILES report (the integration report of the PESW, product o f the TA FY08) has received a warm reception by various Ministries and the Ministry o f Employment has called it the 'new strategy for employment'. The Bank's PESW outputs fed into the 'national consultation on employment' that was carried out by the Tunisian Authorities in 2008. This consultation was aimed at developing concrete new employment policies, in various cross- institutional thematic stakeholder groups, involving all relevant Ministries as well as the Higher Education sector, Tunisian scientists from abroad, industry experts, the unions and research institutes. As a result o f this consultation, a decree reforming the ALMP portfolio was issued in February 2009. The initial steps for the planned project on vocational training have been conducted and have allowed for a sustained dialogue with the Government over employment issues. This dialogue has recently led the Government to express an interest in the Bank taking a leading role for a national reform for employment, under a DPL operation planned for FY 10. As part of the PESW, a tracer survey of Vocational Training graduates was conducted, and the results will be used as a baseline for the future professional development project (FY 10). As part o f the reforms to be supported, the Government i s initiating financing o f TVET reform, through piloting the use o f vouchers for 1000 trainees. Outcome 2.2 Improvedfinancial sustainability o the education system: not achieved f Performance Indicators Baseline Goals for 2008 Result (year) Share of budget for non-salary 2.5% for primary remains at least 3.3% for primary current expenses education and 6.5% 2.5% for primary education and 4.7% for for secondary education and 6.5% secondary education education in 2003 for secondary (2008) education Share o f student services 15% in 2003 outsourced 50% 20% o f housing Table 16 Proposed Activities Activities Undertaken during CAS EQIP 1 1project 1 Projects already under way at start of CAS: Higher Education reform support 111 project EQIP 1 project (2000-2006) Vocational training project EQIP I1 project (started in 2004) Economics of education note Higher Education Reform Support I1 project (1 998- 2004) Projects undertaken during CAS: Higher Education Reform Support I lproject l (started in 2006) Higher Education strategy (2004) 65 48. The CAS indicators under this component were highly ambitious and consequently were not achieved. The Higher Education Reform Support I1 project, which closed in 2004, was intended to support the implementation of cost-recovery reforms, the increase of tuition fees, non-academic services and private sector participation in service delivery. None of these materialized, and the non-salary expenditures even f e l l from 12% to 5% of total expenditures for higher education. As part of the CAS goal on improved financial sustainability, the restructuring of scholarships and loans schemes made some progress but did not allow for major changes. Although the internal efficiency improvements impacted the financial sustainability of higher education, it i s not sufficient to ensure the long-term sustainability of the system given the growing demand for higher education in Tunisia. 49. The weak achievements under this outcome were mainly due to an over-reaching CAS objective that wasn't grounded in the realities o f the reform environment. The overall implementation of financial reforms of higher education rested on measures that did not change the existing structure o f relying on state expenditures. The action of the Government towards such reforms was influenced by their political sensitivity and the practice to guarantee free access to higher education. The Higher Education strategy, which was mainly designed to inform the design of the third phase of the Higher Education Reform Support project, did not manage to build a consensus with the Government on cost-recovery reforms. More attention to developing a communication strategy and building support for financing reforms amongst students and parents, who showed resistance to cost-recovery reforms and skepticism concerning public-private participation, could have strengthened the outcomes. But the setting of this CAS goal was overly ambitious and not relevant to what was feasible at that time. 50. Possibilities for future improvements exist. The private sector participation has gained in strength as a priority objective in the Government's strategy. One has to acknowledge that reaching consensus over policy reforms takes time and that the results of the Higher Education I1 operation that closed in 2004 may bear f r u i t s in the future. The follow-up operation, which started in 2006, supports the same objectives and i s making good progress on the implementation o f the new Higher Education Law that was approved on February, 25, 2008. This law promotes increased autonomy for Universities and provides opportunities to outsource student services. The Ministry o f Higher Education plans to introduce performance-based budgeting and sign contracts with universities to deliver their work programs. Outcome 2.3 Improved linkages between research, higher education and the market place leading to greater innovation and competitiveness ofjrms: moderately satisfactory Table 17 Performance Indicators Baseline Goals for 2008 Result (year) Share o f students graduating with 3 1.95% in 2003 and 42% 34.8% (2007) scientific and technological 32.87% in 2005 qualifications Employment rates among these 87% in 2004 (based on 90% (2006) There i s no reliable information on graduates 2005 longitudinal this specific group o f graduates but survey) it i s unlikely that the indicator o f 90% has been achieved because overall unemployment rates o f graduates increased to 25 percent in 2008 Doubling o f number o f start-ups by year 2008 Private sector investment in R&D (Note: 0.75% o f GDP in 2003 Increase o f 50% Total investment in R&D reached the baseline uses incorrect terminology. 1.19% o f GDP in 2008 and 1.25% in The 0.75% figure for 2003 i s not for 2009. private sector investment in R&D but rather for total investment (private and public) in R&D. For the sake o f consistency, therefore, the indicator should be "Investment in R&D" 66 Table 18 ~~ ~ Proposed Activities Activities Undertaken during CAS TA for production o f annual report on knowledge Pro-iectsalready under way at start o f CAS: economy and support on scientific research policies Agricultural Support Services project (2002-2008) and innovation Higher Education Reform Support I1 project (1998- Information society project 2004) Follow-up support on knowledge economy and innovation Projects undertaken during CAS: Knowledge economy (2005) Follow-up support on knowledge economy and innovation (2007) 5 1. The CAS indicator on private investment in R&D shows clear progress and some progress is noted on students graduating with scientific and technical qualifications. Steps have been taken towards better awareness of the knowledge economy. The Bank organized with the Tunisian authorities, in November 2004, a national knowledge economy conference that included a wide audience from the private sector, and helped raise awareness. This activity allowed building capacity of the IEQ, which was in turn able to contribute a summary document at a Maghreb Knowledge Economy Conference held in Tunis in early May 2005. Technical assistance has been provided to Tunisia in the preparation of an annual report surveying knowledge economy developments and policies, the second edition of which was published in May 2006 by IEQ. Yet, IEQ has produced no other annual report since 2006. The follow-up activity consisted mainly in facilitating the idea of techno parks through a series of conferences. Two techno parks are now operational and five others are under preparation. The government i s rehabilitating and expanding industrial zones in different regions and i s trying to integrate them with research institutes and laboratories. 52. Some improvements have been made in the development of the scientific and technological educational system and linkages between research and the market place. The Higher Education Reform Support I1 has been instrumental in the purchase of 42 lots of laboratory equipment, which benefited students and teachers of several engineering schools, science faculties and Higher Institutes of Technology (ISETs) throughout the country. The expansion of short-term professional programs at ISETs, whose students are the most successful in finding employment, as well as the provision of teacher training for ISETs have played a role. The Agricultural Support Services project also helped develop regional research centers and programs and produce agricultural statistics. 1: C. Pillar 1 1 Improve the quality of social services through enhanced efficiency o f public expenditures 53. This pillar was aligned with the Government's goal to uphold social achievements and ensure equitable growth where all social groups participate in the benefits o f economic and social development. Tunisia has made good progress in terms of fiscal mobilization and excellent progress in terms of debt management by reducing the debt to GDP ratio to 47.5% in 2008 from 61% in 2003. Progress in the areas of budget management and employment and social protection policies has been slower than expected which reflects the complex nature of reforms in these areas and the need for a longer-term reform horizon (as witnessed in many other countries). Little progress has been achieved in the areas of health and pension where the Bank's program was limited in these areas. 67 Outcome 3. I Increased budget flexibility and better fiscal mobilization to reduce public debt: satisfactory Table 19 ~ Performance Indicators Baseline Goals for 2008 Result (year) Reduction o f wage bill (% o f total 46% in 2003 <40% 43% (estimated 2008) central government expenditures) Reduction o f total public debt (% o f GDP) 6 1YOin 2003 <55% 47.5% (2008) Interest payments reduced to 10% o f total central government 1 1.5% in 2003 10% 10% (2007) expenditures starting from year 2006 and kept below thereafter Table 20 Proposed Activities Activities Undertaken during CAS Public expenditure review Proiects already underway at start o f CAS: IDF grant for public debt management IDF grant for Public Debt Management (2004- TA support for public debt management and 2007) local debt market development TA support for public debt management and local debt market development (2004-2005) 54. The CAS indicators show good progress. The reduction o f total public debt i s a result o f the government's pro-active public debt management, which included using Tunisie Telecom privatization, proceeds to cover a substantial share of the public debt. Notable progress was also made in reducing the wage bill even if the CAS indicator wasn't met (again, possibly due to an overly ambitious CAS indicator). Furthermore, progress towards normalizing the tax system was achieved with the support o f the ECAL I V as VAT rates reimbursement mechanisms were clarified (cf. Outcome 1.1). 55. One may question, however, the extent to which the Bank contributed to this progress as the PER was not conducted and the two Bank activities conducted under this outcome yielded poor results. The ICR o f the IDF grant for Public Debt Management rated it unsatisfactory as activities were achieved under only two out o f the five components. The objectives, however, were partly achieved through other Bank instruments, including the Treasury's Technical Assistance on Public Debt Management in 2004-2005. But this TA has been executed only partially due to implementation delays and limited coordination within the Bank, between this activity and the IDF grant, caused some confusion. The improvement of budget management functions has also been supported through the PESW on Public Financial Management (cf. Outcome 3.2). Performance Indicators Baseline Goals for 2008 Result (year) piloted performance budgeting now structured their budget in piloted in two large programs with performance ministries by 2006 and indicators for FY08; budget rolled out to key line law i s expected to be passed ministries by 2008 in the new program structure for these Ministries in FY201 I 68 Table 22 Proposed Activities Activities Undertaken during CAS 0 Public expenditure review Pro-iectsundertaken during; CAS: ECAL I V project ECAL I V project (2005-2007) 0 ECAL V project 0 TA Performancebased budgeting reform 0 Follow-up on CFAA recommendations (2005) 0 Potentially other ESW and TA 0 TA Public financial management (2006) 0 TA Public financial management (2007) 0 TA Budget management reform (2008) 56. Important achievements were made under this component despite the complexity of the reform and the time needed to reach consensus. Achievements under this outcome were reached with the support of the PESW on Public Finance Management that was delivered under a series of four TAs. The first TA, conducted in 2005, had modest impact on policy reforms and was rated moderately satisfactory by QAG for this reason. The Bank pursued a step-by-step approach and dialogue with the government was maintained through a dissemination workshop on budget reforms in the Maghreb countries in 2006, and the delivery of a methodological guide for program budgeting classification in 2007. The reform i s now on track and the government i s making good progress. Most of the necessary institutional arrangements for the reform have been made and four pilot Ministries have restructured their budget by programs. The reform master plan which was delivered in 2008 has raised awareness amongst the Tunisian authorities with regard to the sequencing and the financial and technical implications of the reform. This result has been reached thanks to a prudent and participatory approach where the master plan was developed in close coordination with the Tunisian authorities. The global MTEF work has now begun, with financial support from the European Union, a partner with whom the Bank has been working since 2006. Furthermore, although no follow-up activity to the 2004 CFAA was conducted (as requested by the Tunisian Government), some of the CFAA recommendations are included in this performance budgeting reform program. Outcome 3.3 Improved coverage, quality and financial sustainability o health, social protection and f pension systems: not achieved Table 23 Performance Indicators Baseline Goals for Result (year) 2008 Increase in health care expenditures 15% increase