UIIUULAIING GUPY TO BE RETURNED TO REPORTS DES DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1220a-ZA REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE ZAMBIA ELECTRICITY SUPPLY CORPORATION LIMITED WITH THE GUARANTEE OF THE REPUBLIC OF ZAMBIA FOR THE KAFUE HYDRO-ELECTRIC PROJECT JUNE 21, 1973 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. CURRENCY EQUIVALENTS Zambian Kwacha (K)1 = US$1.)b US$1 = KO.64 GOVERNMENT OF REFUBLIC OF ZAMBIA FISCAL YEAR January 1 - December 31 ZAMBIA ELECTRICITY SUPPLY CORPORATION FISCAL YEAR July 1 - June 30 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPRNT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ZESCO FOR THE KAFr.TE HYDRO-ELECTRIC POWER PROJECT 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$115.0 million to the Zambia Electricity Supply Corporation Limited (ZESCO) for the construction of a storage dam at Itezhi Tezhi, a 300 MW extension of the Kafue power station and a 60 km, 330 kv transmission line. The loan would have a term of 25 years, including 5'2 years of grace, with interest at 7¼ percent per annum, and be guaranteed by the Republic of Zambia. PART I - THE ECONOMY 2. A report entitled "Economic Position and Prospects of Zambiar was distributed to the Executive Directors on January 1d, 1973 (R73-11). A summary of this report together with an account of development silce January, 1973 was presented in the President's Report dated May 15, 1973 (PA-1229a-ZA) on the loan to Zambia for the third edacation project, and is attached in Annex I. PART II - BANK GROUP OPERATIONS 3. As of April 30, 1973 the Bank had made thirteen loans to Zambia totalling $178.6 million after cancellations, of which $123.9 million is now held by the Bank. IFC made its first investment in Zambia in February, 1972, providing $1.1 million for expansion of a shoe manufacturing company. Present and future Bank operations have been discussed in the President's Report on the third education project dated May 15, 1973 and are summarized in Annex II which also contains a statement of Bank and IFC operations as of April 30, 1973 and notes on the execution of ongoing projects. A President's Report on a proposed program loan to Zambia was distribu--ed on May 25, 1973. PART III - THE ELECTRIC POWER SECTOR 4. Mining, which dominates the Zambian economy by contributing about 98 percent of foreign exchange earnings and employing 16 percent of the wage labor force, is by far the largest consumer of electricity. Copper is the most important mineral and in 1972 the copper industry consumed 92 percent of electricity consumption. Manufacturing industry has increased its elec- tricity consumption by about 20 percent annually in recent years, but its share of total consumption is still small. Per capita consumption is about 1,000 1Wh which is high for an African country, but comparable to per capita consumption in other copper producing countries such as Chile. All principal -2- cities, industrial centers, and the majority of towns along the line-of-rail from Livingstone to the Copperbelt are supplied with electric power, but the more remote areas are not serviced. Almos-t half of the people in urban areas have access to electricity compared to 2.5 percent in rural areas. In the past, electricity consumption grew by 6½ percent a year, but for the future a faster growth of 7 tc 8 percent is expected mainly because of a large copper expansion program and changing technology in the copper industry. 5. Total generating capacity in Zambia is presently 843 M4W comprising 108 mW at Victoria Falls, 600 MW at Kafue I and 135 mW from small thermal stations. Generating capacity presently available to the interconnected system serving Zambia and Southern Rhodesia is 1884 MW and is adequate to meet the estimated maximum demand until shortly before the Kariba North project on the Zambian side of the Zambezi River is commissioned in late 1975. The construction of the Kariba North station which is being assisted by a Bank loan, will add 600 MW capacity to the interconnected system. By 1977 another 300 MW generating capacity would be required and this would be met by the proposed project. 6. The major wholesale supplier of electric power to Zambia as well as to Southern Rhodesia is the Central African Power Corporation (CAPC) which owns the Kariba dam and the South Bank power station, and transmits power from this and other sources over its extensive 330 kv grid. The CAPC, established following the dissolution of the Federation of Rhodesia and Nyasaland in 1963, is jointly owned and operated by Zambia and Southern Rhodesia. The Corporation is controlled by a Higher Authority for Power (HAP) comprising members from both Zambia and Southern Rhodesia. Following Southern Rhodesia's Unilateral Declaration of Independence (UDI) in 1965, Zambia refused to recognize the members appointed from Southern Rhodesia to the HAP and CAPC. In spite of UDI, CAPC has continued to carry out its day-to-day operations under a management committee, and the interconnected system has operated efficiently for over a decade. 7. Other distributors of power in Zambia are the Copperbelt Power Company (CPC), owned 51 percent by government and 49 percent by the government-controlled mining companies, and ZESCO, which is wholly owned by the government. CPC purchases power from CAPC to supply the copper companies; and ZESCO is engaged in bulk production, transmission, and retail supply to all users in Zambia except for the mines and mine townships. In addition to a few small, isolated hydro-electric and thermal stations, ZESCO operates three hydro-electric generating stations at Victoria Falls and the Kafue Stage I hydro-electric development. Bulk power from these sources is sold to the CAPC but ZESCO also purchases power from the CAPC grid for its retail supply. Until 1972, energy was imported from Zaire for use in the CAPC system. However, Zaire no longer has excess energy and has indicated it -ould like to import from CAPC's system from 1973 onwards. 8. Future planned development in the electric power sector to 1978 besides this project,consists of the expansion of (a) CAPC's 330 kv -3- transmission system in Zambia and Southern Rhodesia, and (b) ZESCOs dis- tribution system. Additional generating capacity, expected to be required by 1979, is likely to be met most economically and conveniently by a third stage of Kafae (450 MW) and a further expansion of ZESCO's transmission system. Construction plans for this scheme, however, have not yet been completed. 9. Bank lending has been a major factor in developing the inter- connected system in Zambia and Southern Rhodesia. The first Bank loan (145-RN) was made in 1956 for the Kariba dam, the adjacent South Bank station in Southern Rhodesia, and the interconnected 330 kv power system; the second Bank loan (392-RNS) was made in 1964 for power system extension; the third Bank loan (701-ZA) was made in 1970 for the Kariba North Bank station; and the proposed loan would be the fourth loan in support of the power sector in Zambia. A supplementary loan to help finance a cost overrun on the Kariba North Bank project is also contemplated (see Annex II). PART IV - THE PROJECT 10. An Appraisal Report entitled "Zambia - Appraisal of Kafue II Hydro- electric Project (Stage II)" No. 86a-ZA dated May 7, 1973 is being circulated separately. A Loan and Project Summary is provided in Annex III. 11. The Project was prepared by government and ZESCO with assistance from their consultants, the Swedish Consulting Group (SWECO). The Project was appraised in the field in August and October 1972, and negotiations were held in mid-April, 1973. Mr. E. C. Chibwe, Permanent Secretary, Ministry of Finance, led the Zambian delegation, which included MIr. P. Siwo, Permanent Secretary, Ministry of Power, Transport and Works, and Mr. B. 1Munyama, Chairman of ZESCO. Description and Purpose 12. The Project would form Stage II of a program for the hydro-electric development of the Kafue River - a tributary of the Zambezi and a major source of low cost power in Zambia. The first stage was completed in April, 1972 at a cost of $118 million and consisted of a dam at Kafue Gorge and 600 ml of installed generating capacity. 13. The Project would consist of a storage dam across the river at Itezhi Tezhi (250 Ion upstream from the Stage I powerhouse), a 300 }W extension of the Stage I power station, and a 60 km, 330 kv transmission line connecting the power station with the CAPC grid at Kafue town. The 600 M4W Stage I station presently operates with little water storage and generates 3600 Gwh annually, on average, of which 1800 Gwh is firm. This firm output would increase to 5200 Gwh on completion of the Project and, together with the output from the two additional generators, would enable total annual generation to increase to about 6200 Gwh0 Stage III would involve the installation of 450 MS; immediately downstream from the Stage I powerhouse. Execution 14. The Project would be undertaken by ZESCQ.; SWECO would supervise its construction. Construction of the dam is expected to commence during the latter half of 1973. Partial filling of the reservoir is planned for 1976 and the generating units are scheduled to be installed by the end of that year. 15. The geological formation of the dam site comprises granite overlain by mudstone rock and alluvium overburden. Granite would not be available as part of the immediate foundation for the dam in the valley portion but the mudstone rock would offer adequate support for the proposed dam. The alluvium would be removed to the fTull depth under the central portion of the dam structure. As there are some faults in the area, the geological conditions, sources of construction material, and project design were reviewed by an international Board of Consultants comprising wellknown experts. They concluded that the system does not constitute an attive fault pattern and that there should be no major construction problems. 16. Nearly all of ZESCO's senior staff are expatriates, and there is a shortage of experienced Zambian staff at all levels. However, ZESCO is making extensive efforts to train and recruit staff to keep pace with its expanding operations and is receiving substantial technical assistance from Sweden. To help ensure that competent management would be maintained assurances have been obtained that the Bank would be consulted on appoint- ments to the posts of Chief Engineer and Financial Controller, and that ZESCO would recruit experienced staff to fill vacant key positions. Pro ect Costs and Financing Plan 17. * The cost of the Project, excluding interest during construction, is estimated at US$137.7 million equivalent. Not including physical and price contingencies, civil works account for $58.9 million equivalent and generating plant and trar-smissilon equipment for $17.2 milllion equivalent. A3sessments of the Project cost were wade by the Project consultants and also an independent firm of consul-tan-ts. In addition, after prior review by the Banks bid invitations were issued for construction of the main dam on the basis of international competitive bidding. The tenders were opened in JannaUr,v 1973 and the contract has been awarded to Imprdgilo-Recchi,9 Italian fivM, a4t a price aboMut 25 peraent less than the canauItanrts' cost -etmate. The consu'tdnts' earlier cost estimate has been reduced accordingly. 18. The contingencies included in the cost estimates still amount to $h7.0 Pdllion. These are high but justified considering recent cost esca- lations on civil works projects in Zambia and uncertain transport conditions in the area. 19 The proposed loan would finance the foreign exchange cost of the Project, estimated at $96.3 million equivalent, and interest during construction oxI the Bank loan, estimated at $18.7 million equivalent. The total Bank loan would thus be $115 million. The loan would be for a period of 25 years including a 52 year grace period. The local costs of the Project, estimated at $41.4 million equivalent, would be financed by borrowing from the govern- ment on terms samil±ar to the proposed Bank loan. The Government of Zambia has agreed to provide any additional funds required to complete the Project. ZESCO1s Financial Condition 20. ZESCO, incorporated in December, 1969, was established to take over the existing power supply undertakings in Zambia, other than CAPC and the Kariba North Bank Company. The takeover of these entities brought a number of problems which have to be taken into account when assessing ZESCO's financial position. Firstly, the organizations acquired were financed entirely by long-term debt and a small government grant. As a result, ZESCO's capital structure as of June 30, 1972 contained little equity. Secondly, because of inadequate rates and difficult operating conditions, ZESCO's predecessors obtained insufficient revenues, and the combined operations of ZESCO therefore produced a net loss during 1970/71. 21. Measures are being undertaken to improve ZESCO's financial position. The preliminary operating results for 1971/72 indicate a net income of about Kl.l million. A significant upward revision of ZESCO's bulk supply tariffs to CAPC from the Victoria Falls and Kafue stations is currently being nego- tiated and is expected to be implemented by the end of the year. A 25 percent increase in ZESCO's retail tariffs - from which it derives the bulk of its operating revenues - has been approved by government and will become effective July 1, 1973. These revised retail tariffs, which would be put into effect before the proposed loan becomes effective, would signi- ficantly improve ZESCO's financial position. The appraisal forecasts, based on ZESCO's present bulk supply tariffs to CAPC and the revised retail tariffs, indicate that ZESCO would achieve an annual rate of return on its net fixed assets of at least 8 percent and contribute a minimum of 25 percent to the cost of expansion (including Kafue III) to 1977. Assurances have been obtained during negotiations that ZESCO would take all necessary steps to earn an 8 percent return from 1974/75 and that the government would take necessary measures to enable it to do so. In addition, it was agreed that ZESCO would not incur any debt without prior Bank approval unless maximun future debt service is covered at least 1.4 times. 22. To improve its capital structure, ZESCO has asked the government to convert to equity one half of K40h2 million of debt which was assumed when ZESCO took over existing undertakings. No action has yet been taken since the government is presently reviewing its general policy towards its investments in all parastatal organizations. During negotiations, the government agreed that it would not ask for repayment of any portion of this debt during the construction period of the Project if such repayment would have a material and adverse effect on ZESCO's ability to meet its financial requirements. However, even if this debt were not converted into equity, the gradual accumulation of retained earnings is expected to improve the debt/equity ratio to 82/18 by 1979/80. 23. In 1972, the government transferred the Kafue Project - Stage I to ZESCO in exchange for a K84 million loan. Although the asset and liability have been recorded on. 7S.JCO1s books, and thus do not affect the financial structu-re of ZESCO, the transaction has yet to be completed. During the negotiations it was agreed that as a condition of effectiveness the govern- ment vest in ZE3CO the legal title to these assets and thle loan agreement be sigcned. 24. As each of the organizations acquired boy ZESCO used different accounting systems and procedures, and. in some cases had improperly maintained records, ZESCO faced difficult problems in establishing proper accounting records. ZESCO has engaged an accounting firm to serve as auditors and to assist in the establishment of a proper accounting system. An assurance has been obtained -that ZESCO3 w.ill continue to employ auditors satisfactory to the Bank. ',arket for Energy Produced 25. The facilities, scheduled to be installed by 1977, are designed to meet the needs of the interconnected system serving both Zambia and Southern Rhodesia and all of the energy produced will be sold to CAPC. Sales by CAPC have been increasing at an average rate of 9 percent per annum during the last seven years. CAPC's sales during 1973/80 are forecast to increase at 8 percent oer arnnum to a total of 16,100 Gwh, excluding possible sales to Zaire. Sales in. Zambia are expected to increase by '7 percent per .nnuum to a total of 7900 Gwh in 1980, and in Southern -Rhodesia by 10 per annum to a. total of 83500 Gwh-h in 1980. 26. Pespite MD3I, t'ie CAPC has continued to function as a joinu entityr and has operated the system writh great savings to both Zambia -and Southern Rhodesia. If th.e interconnected system, in spite of the two countries' continuous support, should break down, the hydroelectric resources within Zambia would barely meet the estimated requirements in 1977 and the program of construction of the Itezni Tezhi dam would therefore be appropriate. Under these circumstances the extension of the Kafue power station could be postponed for about 2 years; however, if Zambia were to meet the indicated Zaire power requirements, the phasing of the project would be justified as proposed. 27. ila)dmum demand on the CAPC system is expected to reach 2460 MW in 1980 with energy requirements at that time reaching 1'7000 Gwh. '1ithout the KaTue Stage II project, shortages of capacity would be experienced in 1978 and shortages in firm energy resources would occur in 1977. By 1980, these shortages would amount to 507 14.d and 5000 Gwh respectively. 28. The energy supply position would also be difficult until the cormmissioning of TKariba IJorth if there is a period of less than average rainfall. To protect against a possible shortage, the government has agreed to consider, among other mneasures, a temporary increase in the lake level of the Ktafue Stage I reservoir by 1.2 m. This would only affect some marginal pasture land0 Economic Justification and B,enefits 29. The proposed Project is the most economic source of the additional power required. Investigations by CkPC and ZESCO of other possible sources -7- (i.e. hydro-electric development on the Zambezi downstream from Kariba, or thermal stations in Zambia or Southern Rhodesia) have shown that costs of these alternatives would be considerably higher than Kafue II. It would meet CAPC's needs for increased energy, and as such be complementary to investments in additional mining capacity necessary to increase Zambia's foreign exchange earnings, government revenue and employment. 30. The economic return on investment in the Proiect is at least 18 percent. It ivas calculated using revenues assessed on the basis of average energy generation and CAPC's prevailing average retail tariff and therefore represents a conservative estimate of the return on the project. Procurement and Disbursement 31. All goods and services costing over $20,000 would be procured through international competitive bidding in accordance with Bank/IDA guidelines. The Bank loan would be disbursed to finance 70 percent of the total cost of civil works, the c.i.f. cost of the equipment and the foreign cost of the engineering services. A preference margin of 15 per- cent would be given to Zambian suppliers of equipment. The loan also provides retroactive financing not exceeding $3.0 million for certain preliminary civil works expenditures incurred after July 1, 1972 and for engineering costs incurred after January 1, 1973. Environmental Aspects 32. The ecological aspects of the Project have been examined, and no serious problems are expected. The most significant impact of the Project on the environment is the elimination of flooding on the flats below the dam in dry years. Such flooding is responsible for much of the grass upon which a large number of cattle and wildlife survive. The reservoir, therefore, will include a sufficient volume of water in addition to that required for the power discharges to induce a degree of flooding necessary to reproduce the natural condition. The reservoir, which would partly be located within Kafue National Park, would not affect any settle- ments. rlith time, the reservoir is likely to become important for fishing. 33. Tse-tse flies and snail hosts of schistosmiasis are common in the area. As these would present health hazards to the temporary labor force, the contractor for the Project would be responsible for ensuring that satisfactory sanitary and health measures are established and enforced. The nature of these measures was indicated in the bidding documents for the Itezhi Tezhi dam, and would also be outlined in those for the powerhouse extensions. -8- P.ART V - LEGAL I'NSTRUTMENTS AND AUTHORITY 34. The draft Loan Agreement between ZESCO and the Bank, the draft Guarantee Agreement between the Republic of Zambia and the Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement, and the text of a resolution approving the proposed loan are being distributed to the Executive Directors separately. The loan documents conform to the normal pattern for loans for power projects. 35. I am satisfied that the proposed loan would comply with the Articles of Agreement of t,he Bank. PART VI - RECO?I4ENDATIOiT 36. I recommend that the Executive Directors approve the proposed loan. Robert S. 1lcNamara President Attacl-hments Jume 21, 1973 ANNEX I Page 1 CQUNTRY DATA - ZAMBIA AREk 2 POPULATION DENSITY 2 752-,-600 km 4.25 million (mid-1971) 5.6 per km2 Rate of Growth: 2.5% (from 1963 to 1969) 42.5 per km f arable land POPULATION CHARACTERISTICS (1969) HEALTH (1969) Crude Birth Rate (per 1,000) 42 Population per physician 11,200 Crude Death Rate (per 1,000) 17 Population per hospital bed 280 Infant Mortality (per 1,000 live births) 160 INCOME DISTRIBUTION DISTRIBUTION OF LAND OWKNERSHIP (1969) % of national ixacome, lowest quintile .. 91i Of the land is communally owned. highest quintile ACCESS TO PIPED WATER (1969) ACCESS TO ELECTRICITY (1969) X of populaticn - urban 87.0 % of populatio - urban 26.5 - rural 10.5 - rural NUTRITION EDUCATIOIN (1970) Calorie intake as % of requirements 95 Adult literacy rate %/ 43 Per capita protein intake (grams per day) 69 Primary school enrollment % GNP PER CAPITA in 1971: US $350 GROSS NATIONAL PRODUCT IN 1971 (cstimate) ANNUAL RATE OF GROWTH (%, constant prices) US $ Mlxn. % 1960-65 1965-70 1971 GONP at Market Prices 1,509 100.0 +5.6 +5.5 +0.5 Gross Dcmestic Investment 477 31.6 +19.5 +29.8 +14.5 Gross National Saving 253 16.7 +10.2 -53.5 Current Account Balance -224 2 -14.9 Exports of Goods, NFS 697 46.2 .. +1.1 -7.0 Imports of Goods, NFS 713 47.2 +10.4 +5.2 TEMS OF TRADE (1964 - 100) I964 1965 1966 1967 1969 1969 1970 1971 Price index Exports of Goods (1) 100 112 156 156 170 234 201 160 *Price index Imports of Goods (2) 100 101 104 103 113 117 121 126 Tenns of Trade (1) : (2) 100 120 150 151 150 201 166 127 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1971 (estimates) Value Added Labor Force V.A. Per Worker US Mln. _ 1000 Xa US$ e Agriculture 219 15.2 656 54.3 334 28 Industry 718 49.8 176 14.5 4,087 342 Services 506 35.0 298 24.6 1,698 142 Unallocated . . 79 6.6 . Total/Average 1,3 00.0 209 100.0 1,193 100 GOVERNMENT FINANCE General Government Central Government (K. Mln.) % of GDP 1971 1971 196>71 Current Receipts ) 309.0 28.0 32.1 Current Expenditure ) 273 29.7 22.5 Current Surplus ) not availaole -18.3 -1.7 97 Capital Expenditures ) 142.5 12.9 12.6 External Assistance (net) ) 35.3 3.2 1.7 a of population 10 years and older .. not available contains substantial amount of private capital flight . not applicable figures do not differ significantly from "Central Government" ANNEX I Page 2 COUNTRY DATA - ZAMBIA MONEY, CREDIT and PRICES 1965 1969 1970 1971 1972 (Million K. outstanding end period)F Money and Quasi Money 113.7 281.5 371.9 318.5 341.1 Bank Credit to Government -84.9 -120.5 -155.1 19.3 1146.o Bank Credit to Private Sector A L42.5 124.2 1J42.9 183.1 1t5.4 (Percentages or Index Nunbers) Money and Quasi Money as % of GDP .. 19.4 29.0 31.0 General Price Index (1963 = 100) 107.9 134.2 139.5 147.1 154.7 Annual percentage changes in: General Price Index +4.9 +3.2 +4.0 +5.5 +5.2 Banki credit to GoverTnlent . . Bank credit to Private Sector L .. +24.9 +25.1 +28.1 -9.7 BALtPN;CE OF PAIM2ENTS MERCHANDISE EXPORTS (AVERA5E 1970-72) 1970 1971 1972/3 US $ MlIn (Milions US$7 Copper 757.2 94n.2 Exports cf Goods, NFS 959.6 700.4 B0h.2 Imports of Goods, NFS 658.7 749.4 73B.6 Lead, Zinc, Cobalt 32.8 1 Rescurce Gap (deficit - -) 300-9 -49-0 65.6 All other conmodities 13.4 1.7 Factor Payments (net) -46.8 -61.0 .9b.8 Total W3 1o0O.0 Net Transfers, private -1L7.1 -152.0 -136.5 Balance on Current Account 107.0 - W . t165.7 EXTEB1NAL DEBT, DECEB2P.1 31, 1971 Direct Foreign Investment Net .aT Borrowing US $.Mln Disbursements 27.7 41.5 42.0 Amortization -14.6 -10.2 -Z5.0 Public Debt, incl. guaranteed 795 Subtotal 13.1 31.3 17.0 Non-Guaranteed Private Debt Capital Grants 0.8 1.1 0.7 Total outstanding & Disbursed Other Capital (net)) 39.2 -37.8 5.2 tInc-ease in Reserves (+) 160.1 -267. -1143 DEBT SERVICE RATIO for 1971 2 Gross Reserves (end year) 538.9 290.3 168.0 Public Debt, incl. guaranteed 9.3 Net Reserve:s (end year) 536.8 269.4 l26.6 Non-Guaranteed Private Debt Total outstanding & Disbursed RATSp OF EXCH`kNGE IBRD/IDA LEh'DIWG, (Mar. 1973) (Million US $): . F.b 1. Kuachy 1977' ISORD IDA U-S api('=rQc;0.71ji Kwacrin i.OO = US $ l.LC Outstanding & Disbursed 64.0 Undisbursed h9.3 - Since February 1973 Outstanding incl. Undiabursed 113.3 US .'3 l.OC - Kwacha O.k43 Kwacha l.oo us s 1.56 / Inciudes parastatal bodies .. not available - Rtatic of Debt Service to Zbcports of Goods and Non-Factor Services . not applicable reliminary estimates ANNEX I Page 3 ?LECEWT ECO(iqO?HIC DD-ETEL0PFEN'TSi/ 1. The econormy of Zambia is dominated byr the copper industry, which contributes nearly 40 percent of GOP, 95 percent of exports and, up to 1970, 60 percent of government revenue. It, follows that the world copper price has a large and pervasive effect on the economy. Since independence in 19614, copper pRices have been notoriously unstable, fluctuating between .1700 and K1,300 per ton. Because the government has no adequate instruments to insulate itself from the vagaries of the copper market, the economyr; is inherentlly unstable. 2_ (GNP per capita is relatively high (estimated at +;3f5 in 1.971) ut there is a distinct contrast between the modern sector and the traditional rural sector. The modern sector is concentrated in the Copperbel t !iovin-e uhere the mining activity is locatecl and along the rlline-of-rail' whiLch is the central area of the country where Earopearn farmers settled in the colonial era and a numib)er of industries have been established. Almost half the nopulation lives in the Copperbelt and near the line-of-rail, :-n i7i :nvci1_ved in tile ,nodern sectcr. The rest of the popul:.-tion is sca.rcI over the country and is riainl,r engaged in small-scale agriCahure. Since independence the governrm=et Ja'1 eConoc '._a,d .:. Fo: Is have been, firstly, to narrow the gap bet.ween urban ard ru-ral t n.s of living by increasing the productivity of small-scale agriculture air. secondly, to raise the general level of education, as wel aLs deacs e Tid.e rance of technical, administrative and mana,-erial slldI]s to les3efi t> dependence on expatriate expertise. The exp'!z..nsion of educati-on i a. i has been impressive since independence, blt i;i.n sanite of thi..-> !Jrnn :ho>- t.n, of educated and skilled manpower has remained vamnan s most S inpur i r structural constraint in econoramic develoT)renIt. ]Little proFrress rn- M-'(t .irovii:- the standards of livirnc o' the --ilral. pc oi.tion. "T.o 'T liave ai.fected economic progress during the first Fears of in6ependeicc :.h. Unilateral Declaration of Indenendence ir. .;outherii T1fhodesia in ''r - :7a_mbia 1;o sever her close ties with Southern L;hodesia at a con c - and disruption to the developmenit program, .->d the decision in -to .nssume state con-trol over most of the import,nt sectors of the ecclnrom caused a great strain on the administrative capacity of the countrv. In the Second .ational Developmexit Plal 1972-1976 (SiDE), the g-eneral. economic and soci;.l goals mentioned above are restated. H1owever, the Plan recognizes -that in spite of all effort w.hich mLight be made to ,tcp the flowr of people leaving rural areas, this wil.l not preverit all such rmovements. It therefore stresses the need to further develop the modern sector, incl-iding lnining. In. the past, expendituire for agriculture was thirl- sprea.d over the country, with little impact anywhere. Under l.h.- '1'), the government intends to concentrate its efforts in a numlDer of -1reas wJith suificient potential where an integrated approach to rural development will be attenipted. 5. Economic developments in 1970 and 1971 are in sharp contrast with those up to 1969. Between 1964 and 1969, gross national income at constan.t prices grew on the average by a]Tost 17 percent a year. `Iore than half of l/ Tis account of the economy .s included in the Iresident's .eport on the Third Education Project, dated Hay 15, 1973. AI\INNX I Page 4 this increase, however, resulted from the improvement in terms of trade, (rising copper prices), 1.) percent from a relative decline of factor payments abroad, and 5.5-6 percent1 from the physical increase in production (GD1). The sharp increase in world copper prices had placed Zambia in a strong financial Position, The government's Dudget and the balance of payments procuced growing surp-luses. in the course ot 1970, however, the econulTc tide turned as a result of a combination of unfavorable factors. b. The two most important factors were no doubt the sharp decline in copper prices in the second half of 1970 from K1200 to K780 a ton and, in September 1970, the partial flooding of the Mufulira mine which accounted for 25 percent of Zarnbia's copper output. As a result of lower copper prices and production losses, the value of copper output in 1971 was 40 per- cent lower than in 1969. GNP per capita is estimated to have fallen from $425 in 196? to about $3~5 in 1971. 7. The decline L- and output of copper had, of course, also strong adverse effects on governinent revenue and the balance of payments. The deterioration in the budgetary situation, however, was comipounded by two additional factors: f-irst, recurrent expenditures had been allowed to increase sharTply, and, second, government reverrue from tne miring sector declined also sharply because ot new capital allowances granted under the 1969 Master Agreement governing state participation in the mining industry. Pre-viously, capital depreciation allowances were based on estmated asset life, out, in order to bDoost production from some 70u,Ouo tons at present to some 90U,000 tons by 1976, all capital expenditure was made tax deductible in the year it occurs. This will result in lower revenue in the medium-term, but increase the taax base substan'tially after completion of the expansion program in 1976. As a result of the factors mentioned above, the recurrent budget, which in 1970 still had a surplus of K176 million - more than enough to finance all development expenditures - showed a deficit of K18 mnillion in 1071. Foreign reserves declined from a peak of K432 million in August 1970 to K100 million by June 1972 (3 months' imaports), but this sharp decline cannot be explained by the unfavorable development of prices and output of copper alone. There can be little doubt that legal and illegal capital flight has increased since 1969. In 1971 alone, it may have amounted to more than Kloo million, most likely in reaction to the government's decision to have the country's retail and wholesale business transferred to Zambian ownership. b. During 1972, the government took a number of steps to restore financial balance. To imiprove the balance of payments, imports of certain llLxury goods and consumer goods that are also produced locally were prohibited, and a surtax on dutiable imports was introduced. Exchange control regulations were tigh-tened, including measures to curb capital flight. Preliminary indications are that these measures have had some success; since June, 1972 the level of external reserves has remained stable at an equivalent of somewnat over two months' imports. To improve the budgetary situatior., new tax measures were introduced in the 1972 and 1973 budgets. Austere spending policies reduced recurrent expenditure in 1972 by nearly a percent. These policies are to be continued in 1973. Nevertheless, it appears unlikely that the government will be able to generate any budgetary ANNEX I Page 5 savings in 1973. Although by the mid-1970s a substantial increase in mining revenue can be expected as a result of the expansion program currently underway, a continuation of the government's policy of increasing non-mining tax revenue and, at the same time, containing recurrent expendi- tures is necessary if the government is to make a substantial financial contribution to its own development budget once again. 9. To limit deficit financing, government development expenditure was severely cut in 1972 and 1973 to a level of some K115 million in both years as compared to levels originally intended under the Second National Development Plan 1972-1976 of same K175 million in 1972 and K185 million in 1973. In 1972, the government was ill-prepared for the need to cut development expenditure. Cuts were made in an indiscriminate way witnout proper consultation with spending ministries with the result that some severe disruption in ongoing priority programs occurred. In 1973, the determination of priorities has been made in a far more rational and selective manner. Preference has been given to the completion of ongoing high-priority projects, such as those supporting the copper expansion program and education. Projects of relatively low priority such as new roads, improvements and extensions of airports and government office build- ings have been postponed. The government has recently begun to redefine priorities and levels of development expenditure for the remainder ot the plan period (1974-76) in the light of the expected resource availability. 10. The government is now actively seeking foreign assistance for projects for the execution of high priority development programs that it originally intended to finance domestically. But tne government will have great difficulty during the next two or three years in providing local counterpart funds to foreign loans, and especially in projects where the foreign exchange component is low, some local cost financing by external agencies is required. It will also take some time before disbursements from new foreign loans will become available. In the interim, to keep deficit financing within tolerable bounds and to prevent further cuts in the develop- ment program, it would appear necessary for Zambia to seek quick-disbursing non-project aid. 11. Zambia's immediate economic future is clouded by the closure of the border between Zambia and Rhodesia last January. With the help of a United Nations .4pecial Mission, the government is drawing up an emergency program to maintain the country's transport capacity until the Tan-Zam Railway between Dar es Salaam and Zambia opens in 1975 or 1976. The direct and indirect economic costs of the border closure are difficult to evaluate. Volume of exports might not be adversely affected, but since the tonnage ol imports is roughly twice that of exports, it will be much more difficult to maintain the normal level of imports. Therefore, in the short-term, scarcity of raw materials, intermediate goods and equipment is likely to affect the level of production. However, no decline is expected in copper production from the 1972 level. The recent increase in copper price may actually lead to an increase in the value of exports. With lower imports, production in the rest of the economy would fall and cause a loss in government revenue, thereby exacerbating the already precarious budgetary position. ANNEX I Page6 12. The estimated direct cost of the emergency is still highly uncertain. The Zambian government estimates that in order to maintain the flow of strictly essential imports, an additional budgetary outlay of about K44 million would be necessary in 1973. To cover the foreign exchange cost it has actively tried to mobilize loans and grants from various governments as well as suppliers' credits. Indications are that the necessary amounts will be fortncoming. To cover the local cost connected with the emergency the government intends to increase its borrowing from the non-banking sector and in the Euro-Dollar market, thereby avoiding a diversion of funds intended for the development budget. 1j. Because of its considerable mineral and agricultural development potential, Zambia's longer-term economic prospects are good despite her dependence on copper and her landlocked position so far from markets, provided she continues successfully to weather the recent economic and political storms. In the future, Zambia's need to borrow will be much greater than in the past. Because of limited borrowing in the past, Zambia's debt service obligations are low. Thus, there is considerable scope for further borrowing abroad at conventional terms. If, for example, Lambia contracts foreign loans in the amount of $175 million on the average each year from 1973 through 1985, which would be well above the level of borrowing in the recent past, the debt service ratio would still not exceed 10 percent by 1985. ANNEX II Page I STATUS OF BANK GROUP OPERATIONS IN ZAMBIA A. STATEMENT OF BANK LOANS AND IDA CREDITS (as at April 30, 1973) US$ Million Loan Amount (less cancellations' Number Year Borrower Purpose Bank IDA Undisbursed 74 1953 Zambia Railways 14.o 1) - - 145 1956 Central African Power Corp. Electric Power 40.0 1)2) - - 197 1958 Zambia Railways 9.5 1)2) - - 392 1964 Central African Power Corp. Electric Power 3.9 1)2) - - 469 1966 Zambia Highways 13.3 - - 562t 1968 Zambia Forest Planting 5.3 - 2.2 5563 1968 Zambia Highways 10.4 - - 592 1969 Zambia Education 17.4 - 15.0 627 1969 Zambia Livestock 2.5 - 1.7 645 1969 Zambia Education 5.3 - 2.0 685 1970 Zambia Crops Farming 5.5 - 3.8 701 1970 Kariba North Bank Co. Power Station 40.0 - 23.6 882 1973 Zambia I.F. Farming Project 11.5 - 11.5 Total 178.6 of which has been repaid 42.3 Total now outstanding 136.3 Amount sold 38.6 of which has been repaid 26.2 12.4 Total now held by Bank 123.9 Undisbursed of Bank held 59.8 - 59.8 total Undisbursed of participations .8 - .8 1) Guaranteed by Zambia and the UK 2) Amounts shown represent Zambia's half of loans also benefiting Southern Rhodesia ANNEX II Page 2 B. STATEMENT OF IFC INVESTMENT (as at April 9~ 7T3) Amount in US$ Year Obligor Type of Business Loan Equity Total 1972 Zambia Bata Shoe Co. Ltd. Shoe manufacturing . .85 0.23 l.o8 Total. gross commitments o.85 0.23 1.08 less cancellations, termi- nations, repayments & sales 0.39 - 0.39 Total. now held by IFC 0.46 0.23 o.69 Undisbursed of IFC held tota-l 0.22 - 0.22 Undisbursed of participations 0.18 - 0.18 ANNEX II Page 3 C. PROJECTS IN EXfECUTIoN/l1 Loan No. 562 Industrial Forestry Project: $5.3 million loan of October 5, 1968; Closing Date: June 30, 1977 Execution of the project is making more rapid progress than expected at the time of appraisal. There is a lack of accountants and the project management still relies on the services of a member of our Agriculture Development Service. We have suggested that government seek technical assistance from bilateral sources until qualified Zambian acccuantants beccme available. Project costs have proved to be higher than expected so that the disbursement percentage applicable to expenditures other than direct imports will have to be reduced fron 44 to 25. Loan No. 592 First Education Project: $17.4 million loan of April ll, 1969; Closing Date: September 30, 1974 The project became effective in July, 1969, but was initially delayed some 12-1I4 months due to management problems and prolonged negotiations regarding studies and the consultant's contract which eventually led to the efficient and economical modular construction system ultimately adopted for the project schools. Construction is now proceeding well. The efficient construction method would have regained six months of delay but for the government's financial problems which resulted in a cutback of funds early in 1972 and the extension of the closing date by 2½ years. The Northern Technical College (Nortec) item ($1 million) is behind schedule because of a review of the government's technical education policy which has now been completed. This review has resulted in greater emphasis on pre-employment training and less on apprenticeship than originally envisaged; the school is now being redesigned. The entire project was to cost US$36.2 million; the government now expects a US$3.41 million cost overrun which it will finance itself. Loan No. 627 Livestock Development Project: $2.5 million loan of June 30, 1969; Closing Date: November 30, 1974 The project was expected to be conpleted by mid-1974 and development has begun on all but one of the beef ranches. However, progress is now at a standstill and serious financial problems have emergea. Financial viability of the Zambia Cattle Development Limited (ZCDL), /1 These notes are designed to inform the Executive Directors regarding the progress of projects in execution, and in particular to report any problems which are being encountered, and the action being taken to remedy them. They should be read in this sense, and with the understanding that they do not purport to present a balanced evaluation of strengths and weaknesses in project execution. ANNEX II which is responsible for execution, and also of some of the ranches to be developed under the project, is uncertain. Management problems and government policy which held down prices on beef and milk while costs rose rapidly are the principal causes. At the government's request the Bank and Barclay's Bank, a co-lender, assisted govern- ment officials in reappraising the project. We concluded that the project be reduced to include only those components which offer promise of becoming viable, that management be given authority to operate fully on a commercial basis, that organizational changes be introduced to that end, and that prices on beef and milk be raised. The government has subsequently raised these prices and is consider- ing the other recommendations. Loan No. 645 Second Education Project: $5.3 million loan of November 30, 1969; Closing Date: August 31, 1973 This project is almost complete, but a delay in the initial stages caused by periodic building material shortages, contractors limited managerial capacity and insufficient local representation by one firm requires a nine months' extension of the Closing Date (to June, 1974) to allow for the construction guarantee period and for the closing of the accounts. Loan No. 685 Commercial Crops Far¶ming Project: $5.5 million loan of June 5, 1970; Closing Date: December 31, 1975 The project is scheduled for completion in mid-1975. After a slow start, the project is now making satisfactory progress. So far, 66 assisted tenants have been settled, 23 of them since the end of the last growing season. During that season, assisted tenants produced h4o,6g'a kg tobacco, representing 7 percent of the national crop; yields were slightly above the national average of 901 kg/ha. Loan No. 701 Kariba North Bank Hydro-electric Power Project: $40.0 million loan O. juxy 2-9, 1970; Closing Date: July 1, 1976: 'nhe cost of the Kariba North Hydro-electric Project, for which the Bank made a loan of $40 million in July, 1970 to cover the foreign exchange expenditure, has turned out substantially higher than estimated at the time of appraisal. When bids were opened in October, 1970 it became clear that the foreign exchange expenditure alone would be more than $10 million higher. That increase was attributable to world wide price increases on heavy electrical equip.ent over and above appraisal estimates arnd high contingency allowances included by contractors in tneir bids for unexpected expenditures arising from Zambia's position as a land-locked country. Subsecuently, changes in exchange rates in December, 1971, delayed provision of access roads to the site and staff housing on the site, and adverse rock conditions have caused further significant increases in cost. In addition, the main civil works contractor experienced ANNEX II Page 5 severe financial difficulties and was forced into receiversnip in February, 1973. A new contractor has been selected to complete the main civil works. Construction work has restarted. Negotiations are now under way to finalize the contract; a work schedule and revised cost estimates, including the effect of the recent currency realignments, are being prepared. A supplementary loan is contemplated as soon as the cost estimates have been revised. Loan No. 882 Integrated Family Farmiing Project: $11.5 million loan of February 2d, 1973; Closing Date: June 30, 1979 Conditions of effectiveness are likely to be met shortly, but one month's extension of the termination date of May 28, 1973 might be required. AINNEX II Page 6 2. e ANK GRaROP 0GC)T,TP L0TTCIk . IC. 1. As of Arri' 30, 1973, the -ank had made thirteen loans to Zambia and IFC one investment,i/ Four loans were made for railways and electric Do-wer bepfoe Zmbia became independent and are guaranteed by the UK as well as Zanbia. After independence, four loans were made for agricultural devel- op.ment, t,w,,o for education, two for highways, and one for the Kariba INorth h,ydcroelectric station. Total lending to date has been $178.6 million after cancellations, of whi.ch $83.9 milliorn is for electric power, $47.2 million for transportation, t.;22.7 million for education and $24.8 million for agri- culture. .i l-oans are -.Illy disbLused and the first loan made in 1953 (1H1o. 74-?iI) was repaid in full in February, 197'2. The IFS made its first investment- in Zambia iL Fe'bruary, 1972, providing $1.1 million for expansion of a shoe r,anuf-ectarin-- corsorany. Progress on Banl operationls in Zambia has been adversely affected by the diff.culties Zambia has f"aced over the past few years. The Unilateral '.'Beclaration of Independence in Southern Hhodesia in 1965 forced Zambia to sever her close ties wit' 3outhern Rhodesia at a considerable cost and dis- ruption to the develocrmenit program. Shortage of educated and sidlled man- power has interfered with Iarogress on some proJects while recent cost esca- lations have caused. d.ifficulties on others, especially the Kariba North Bank p.ro'.ect. inally, the sharp fall in copper prices forced the governmnent to repnase camital expenditures on the first education project for Which the governmient is providinz '- of pruoject cost. The recent border closure, however, is not e->.pected to cause significant delays on Bank financed projects aE the govrernment is pvi-rirl tra-Msport priority to goods reouired for develo,- ment pnro.jec ts supporting the mining industry, education and agricultuirea 3. le propose to continiue assisting Zambia in achieving her develop- ment objecti-res of (i) correctin7 the rural-urban imbalance, (ii) distributing wealth; and (iii) providing- emnlcvent and educational opportunities. Zambia hopes to achieve these olbjectives by investments in (a) the power sector supporting the mining expan sion programu which yields income for strengthening lesser developed sectors, (k) manufacturing. industries to become less de- pendent on imports and to expand em-ployment opportunities, (c) agricultural production and procres- g industries to rnalke Zambia self sufficient in most .foodstuffs; (d) rural developrent nrojectsto increase production and benefit larg,e numbers of rural poor, and (e) education and other social sectors for human resources develo-orient. A mixed far'.-ing nroject, aiming at increasing m. aize, sunflower and beef production to nationci self-sufficiency, has been appraised, and an inte.,.rated rural development pro jectc in areas of high agricultural potential has been identilfied, Assis,ance in telecoRmmunications and urban developmnent is also envisaged. Andl in .ddi-tion to the education proj iect recently presented to the Board, further assistGance to the education sector is expected primarily for technical education. 1/ A loacn o-f U33 riLi.lli.on for a third education project and an IFC invest- ment of .21.2 million 7;ere ap.proved by the Executive Directors on May 31, 1973 and J.unie 12, 1973 resnectively. A proogram loan of `-30 mTtillion was appioved by the Board on June 1L, 1973. ANNEX III Page 1 Zambia - Kafue Hydro-electric Project (Stage II) LOAN AND PROJECT SUMMARY Borrower: Zambia Electricity 3apply Corporation (ZESCO) Guarantor: Republic of Zambia (GRZ) Amount: Various currencies equivalent to US$115 million Terms: Interest Rate: 7% Amortization: 25 years including .5t years of grace Project Description: The main features of the Project to be constructed over the period 1973-79 are: (1) a storage dam across the Kafue River at Itezhi Tezhi consisting of: (a) rock and earthfill dam, 1500 m in length, and 53 m maximum height above riverbed, involving about 8 Mm3 of fill; (b) two diversion tunnels in rock, each with a cross- sectional area of 190 m2 and a length of 300 m, incorporating regulating structures and gates; and (c) concrete chute spillway with three radial gates; (2) an extension of the Stage I Kafue power station located 250 km downstream from the dam, and consisting of the installation of two 150 MW generating units with ancillary civil works and switchyard extensions; and (3) a 330 kv single circuit transmission line, bo km in length, connecting the Kafue power station to the Central African Power Corporation (CAPC) grid at Kafue town. In addition to increasing the firm energy of the Kafue power station, the dam would provide sufficient water storage to permit additional water discharges in dry years to reproduce the annual flood cycle downstream of the dam on whicn present agricultural development depends. The storage could be increased to allow for possible future irrigated agriculture on the Kafue Flats. Regulation of the river flow provided by the Project would also be useful for subsequent development under a third stage of the Kafue Project. Estimated Cost: Project costs are estimated at $137.7 million, with $96.3 mil- lion (about 70%) in foreign costs and $41.4 million in local costs. A more detailed breakdown is set forth in the following table: ANNEX III Page 2 Million US$ Foreign Local Total Preliminary works 1.0 3.O 4.2 Civil Works 16.8 22.1 58.9 Equipment 15.6 1.6 17.2 &gineering . 0.4 6. Site supervision 2.8 1.' 4.1 Sub total 62.1 28.6 90.7 Contingencies - physical 7.7 3.9 11.6 Contingencies - price 26.5 8.° '5. Total construction cost 96_A 41. b 197.7 Interest during construction on Bank loan 18.7 Total including interest 115.0 Financing Plan: Million US$ Bank $115 Covernment $41.4 Estimated Disbursements (US$ thousands): For the civil works, disbursements would be made against a percentage of the amount of the contractor's periodic invoices. For engineering services and equipment, pannents would >:e made in full on the basis of the foreign costs of contractors awarded. The schedule of estimated disburse- ments in US$ thousands is as follows: 73/74 74/75 75/76 76/77 77/78 78/79 19,'00 22,700 26770 19,1450 17,000 17,000 Procurement Arrangements: Procurement will be on the basis of internation2l competitive bidding, except for items involving expenditures of less than $2C0,000. These exeempted items would be procured on the basis of government tendering procedures. The proposed loan also include retroactive financing for engineering services since January 1, 1973 and for certain preliminary civil works started during 1972 and currently under construction. These :tems are estimated to involve a maximum cost of $3.0 million equivalent. Bid invitations for construction of the dam were issued to prospective tenderers after review by the Bank and an award has been made. Bids for the Kafue power station extension will be invited by the end of 1973. ANNEX III Page ? Rate of Return: Estimates made on the basis of the prevailing tariffs indicate that a return on investment for the Project is at least 18 percent. Estimated Project Completion Date: December 31, 1978 Appraisal Report: ReDort No. 86a-ZA dated way 7, 197' ii'RD 2965R2 \ F R I C A t7.' .CENTRAL AFRICA~N' _POWER' CORPORATION - .-- 8 _ \ -. w- - INTERCON,NECTIED- SYSTEM '-ffr-- ( ,la° -# R o--t;-w -EPUBLIf C ,-. $r _,, @? ~~~~~~~~~~~~~~ROAN ANIEc. 5lt 1:3 t _ 1a; '~~' , ' jz'~~~~~~<~~ ~~ - F~:Atl ROKEIN HILL r g__;,, , - t~ | ? 4542 ~~~~~~~~~~ ~~ _~LUSAKA t Ly[EOPARDS HILL j ' :! \ e, ~~~~~KAFUE STG AiKARIBA NORTH 2j_ e ja J YDROLEC;R IC STTAG DOS. E~ 7~~~UNI TISEWO 1=1 UN~~~~~~~~~~~~~HDRELECONTRIUC TION O=R\S SX ) >tJrt-. i\IeA8POET4 % >CE\ _ C/ PC558KV TANSHYDROEL CYT£HR AAO X -; '|XITIG LU8TAIONGS SBURY/ I t .i F c v IrRANSMISSION~~ ~~~~~~S Ul£ TNE t x 1 , _ ~~~DOELECTRI SU8TATIOI1N g/1 '...0 w;oi 7 ' R O R A I L n A Y , , , , ' 8 R E P U 8 l l C st - ' .~~~c , - , : - - 5UNEIHSTFING\ ,-*-.