Report No. PID6517 Project Name Cameroon-Third Structural Adjustment Credit Region Africa Sector Non-sectoral Project ID CMPA54443 Borrower Republic of Cameroon Implementing Agency Ministry of Economy and Finance Date this PID prepared April 29 1998 Project Appraisal date May 4, 1998 Projected Board date June 25, 1998 A. Country Background. 1. Cameroon, the largest Central African economy of the CFA zone, was spared the shocks of the early 1980s since its crude oil extraction, though small, was growing. But starting in 1985 three major shocks exposed the underlying weakness in economic structure and policy. First, sharp declines in coffee, cocoa and oil prices led to a 60 percent deterioration in the external terms of trade by 1988; second, oil output began to decline sharply; and the real exchange rate appreciated by 60 percent between 1985 and 1988, thus reducing Cameroon's external competitiveness. Initially, Cameroon attempted to adjust internally by reducing producer prices and public expenditures, including a 50% cut in civil service wages, however the internal adjustment strategy could not restore the conditions for growth. By 1993, per capita GDP had declined by 50 percent, even more so amongst lower income producers of export crops such as coffee and cocoa. Public utility services declined markedly, due to lack of investment and mismanagement in the publicly owned companies. Government cut basic health and education funding leading to major decline in delivery systems and school enrollment. 2. Following the devaluation of the CFAF in January 1994, there was a return to growth. An IDA Economic Recovery Credit and IMF Standbys supported the post devaluation measures. Cameroon, however, did not reap the full expected benefits. Failure to meet program objectives led to the breakdown of several IMF-supported programs and the Government was unwilling to tackle the structural distortions impeding growth. Justifiably, Cameroon continued to have the reputation of being a "reluctant reformer". 3. However, a major cabinet reshuffle in September 1996, brought a team of players with true determination to tackle the economy's fundamental problems. IDA's Second Structural Adjustment Credit, approved by the Board in January 1996, set the stage for a renewed reform effort. Policy and economic management began to benefit from the able interventions of a technocratic Prime Minister and a decisive, politically powerful Finance Minister. An Enhanced Structural Adjustment Facility (ESAF) was approved by the IMF Board in August 1997, and a PFP was negotiated with the Bank and the Fund. The possibilities of sustained reform have been further enhanced by recent governmental changes following peaceful legislative and presidential elections held, respectively, in May and October 1997. The ruling party gained a number of seats and so obtained an overall majority in the Assembly. President Biya was reelected after two major opposition parties decided to boycott the elections. 4. The President appointed a new government in early December 1997, which consolidates the position of the coherent reformist group which emerged in late 1996. The Prime Minister, Minister of Finance, and their economic team remain in place, while other reformers have been promoted to high level positions. Of perhaps equal significance is the fact that longtime opponents of reform, largely responsible for the failed macroeconomic and structural adjustment programs, have been replaced by younger technocrats in favor of change. The President has, initiated a policy of opening and intensifying dialogue with opposition groups. The leader of one of the major parties which boycotted the election has been brought into the Government as Minister of State for Commerce and Industry. B. Recent Economic Performance 5. Growth. Following the devaluation, economic growth turned positive for the first time in a decade, reaching 5 percent in 1995-96 and 1996-97. Inflation has been reduced from 30 percent in the first year following the devaluation to 4.3 percent in 1996-97. Non-oil exports have grown at up to 14 percent in volume terms. Gross national savings has risen from 11 percent of GDP in 1993-94 to 15.6 percent in 1996-97, while gross domestic investment has risen from 15.3 to 16.9 percent of GDP. On the monetary front, the growth rate of credit to the private sector has risen steadily to 7 percent in 1996- 97 whereas credit to the public sector grew at about 2.5 percent per year. 6. Budget. Revenues increased from 10.1 percent of GDP in 1993-94 to 15.1 percent in 1996-97. During the same time period, non-interest expenditure was contained in the range of 8.9 to 9.3 percent, so that the primary surplus (excluding foreign financed investment) has risen from 0.8 percent of GDP in 1992-93 to 5.4 percent in 1995-96 and 5.8 percent in 1996-97. These large primary surpluses, which are amongst the highest in the world, enabled the authorities to make large external debt service payments and reduce external arrears on non-reschedulable debt totaling US$450 M (about 5 percent of GDP) during 1996-97, even though they received no external financial support from multilateral and bilateral donors. 7. External debt. In October 1997, the Paris Club provided Cameroon with a three-year flow rescheduling package providing 50 percent relief in present value terms on arrears (excluding late interest) as of September 30, 1997 and of maturities falling due from October 1997 to August 2000 on debt not previously rescheduled or previously rescheduled on non-concessional terms. Paris Club Creditors also agreed in principle to holding a meeting on debt stock reduction in the year 2000 providing that: (a) Cameroon maintains satisfactory relations with all Club members; and (b) the IMF program remains on track. On the assumption that growth is sustained at 5 percent per annum, and the 67 percent debt stock is agreed to by the Paris Club in 2000, which is the decision point for the HIPC initiative, external debt is considered to be broadly manageable from that point on. By 2003 debt service would constitute 23 percent of Government revenues, the NPV of debt to exports would be about 148 percent and annual debt service would be 16 percent of exports. These ratios are well within the HIPC sustainability margins. Only a major external trade shock would be likely to alter this conclusion. - 2 - 8. Structural reforms. On the structural front, substantial reforms have been made since 1994. Virtually all NTBs have been eliminated on exports and imports (the notable exception is petroleum imports). Internally, the coffee and cocoa trade has been completely liberalized. Import duties have been rationalized and a VAT type turnover tax introduced. Export taxes have been reduced from 15 to 10 percent, except for forestry products. A new forestry code has been introduced, forestry taxes are being revised in an environmentally sound manner, with a notable attempt to reduce implicit subsidies to inefficient processing industries. The Labor Code has been fully liberalized. A reform of the civil service has been initiated, with a decline in the overall level of employment of about 20,000 in the last six years including 4,500 departures in the last eighteen months alone. A number of key loss-making public enterprises have been closed. On the privatization front, the main rubber company was sold to an Asian investor in late 1996, in a fully transparent manner. The new company has substantially increased investment and employment. The banking sector has been successfully restructured, profitability restored and prudential ratios satisfied. Insolvent banks have been closed, and publicly owned banks are now under private management. 9. Poverty reduction. Despite these achievements, poverty remains widespread. About half the population lives below the poverty line of 148,000 CFAF (US$250) a year. Progress on poverty reduction has been limited in recent years in part because of lackluster growth performance, and in part because of the financial burden caused by the restoration of macroeconomic balances and the improvement of relations with external creditors, which has put a serious strain on public resources. Unemployment and underemployment are high, and many rural and urban residents lack access to primary schooling, health care, and safe water. Poverty reduction efforts have also suffered from the weak institutional capacity and the inadequate delivery systems for core infrastructure and social services. 10. The strategy for poverty reduction in Cameroon must thus encompass two areas: increased and sustained growth, and greater effectiveness of public expenditures in areas that are key for lifting people out of poverty, mainly the social sectors and basic infrastructure. The Government is developing a national poverty reduction strategy along these lines, based on consultation with and participation by all segments of society. The strategy, including detailed sectoral action plans, is expected to be adopted towards the end of FY99. To this end, a draft poverty reduction strategy statement has been elaborated during the preparation of SAC III and is attached to the Government's Letter of Development Policy. The proposed Credit, by addressing key structural impediments to higher growth, and by fostering a better use of public resources, is an integral part of the poverty reduction strategy. C. The Country's Adjustment Program. 11. The goals of the Government's economic program for the medium term aims at establishing the basis for a substantial acceleration in the growth of the economy above 5 percent, in order to have a significant impact on employment creation and poverty reduction. A higher growth rate is well within the country's potential and is needed to impact upon per capita incomes and to create significant employment opportunities for the rapidly growing young labor force. The adjustment program will focus on consolidating and deepening reforms in four areas: (a) the transport sector; (b) the privatization program; (c) the financial sector; and (d) the forestry sector. The -3 - adjustment program will be cast in the overall CAS framework for promoting growth and poverty reduction through (a) consolidating the benefits of the devaluation; (b) promotion of a competitively efficient private sector; and (c) improving incomes and productivity of the poor. This will require actions in macroeconomic and public finance management, the incentives and regulatory framework, and institutional development. D. The Proposed Credit: 12. The proposed credit is for US$180 million. It would be disbursed in six tranches: two would be cross-sectoral; and four would be linked to the completion of agreed actions in the transport sector (one tranche), the privatization program (two tranches), and the forestry sector (one tranche). The first cross-sectoral tranche would be released on effectiveness, the second upon completion of agreed reforms, probably in early 1999. The four sectoral tranches would then be available for release, in any order, upon completion of the package of reforms to which they are attached. Conditionalities are summarized in Annex A. In addition, general conditions for the release of all tranches include a viable macroeconomic framework for growth and poverty reduction consistent with the objectives of the program, and satisfactory execution of the adjustment program. 13. Disbursements will follow the Bank's simplified procedures for adjustment operations, will not be linked to specific purchases, and will have no procurement requirements. IDA will deposit proceeds in an agreed Central Bank account, and may request an audit thereof at any time. 14. Implementation of the adjustment program will be monitored by an interministerial committee chaired by the Minister of State for Economy and Finance. The committee will be responsible for monitoring and evaluating progress on the program's various components, relying on input from participating ministries and institutions. The program's day-to-day supervision will be the responsibility of the Comite Technique de Suivi (CTS), which is chaired by the secretary general of MINEFI. IDA will monitor implementation of the program through regular supervision missions and Resident Mission participation in CTS meetings. In addition, privatization and transport reforms will be supported by IDA-financed technical assistance projects as well as by assistance from other donors (in particular, the European Union and France). Implementation of the forestry component will benefit from the IDA Forestry and Environment Project now being prepared, and from continued bilateral assistance provided to the Ministry of Environment and Forests by the Canadian International Development Agency. There will be close liaison with the IMF regarding supervision of macroeconomic performance. E. Benefits and Risks 15. Benefits: Successful implementation of the adjustment program envisaged in SAC III would provide the enabling environment and direct support to achieve growth and poverty reduction objectives. The transport sector reform program should have a significant beneficial impact on the cost of international and domestic transport. The privatization program is expected to lead to an increase in the availability and quality of key public utilities (water, electricity and telecommunications); as well as increase in the competitiveness of agricultural enterprises with attendant positive effects on employment. The deepening of the financial sector reforms is expected to further increase public sector confidence in the financial system leading to - 4 - an increase in its capacity to finance productive economic activity. The forestry sector reforms should lead to more sustainable development of forestry resources, and a higher level of rent capture by Cameroon with a greater share going to local communities. 16. The new adjustment program will help reduce the opportunities for corruption, while improving transparency. The removal of the State from the banking sector and the management of public utilities will substantially reduce rent seeking. The restructuring of the Port of Douala and changes in management will remove entrenched vested interests. In forestry the new system of verifiable granting of concessions and ensuring the implementation of land use plans will make more transparent a process which in the past contained serious abuses. Government insistence on tax audits in forestry and independent verification of receipts should greatly improve collections from this major national resource. 17. Risks: The main risks are that the reform program will falter because of (i) macroeconomic deficiencies, (ii) lack of Government commitment to reforms, or (iii) institutional weaknesses. 18. On the macroeconomic front, the main risk is that revenues might be less than projected, because of a decline in oil prices and/or mismanagement, which would undermine the authority's ability to adequately service their external debt and finance badly needed development expenditures. This risk is mitigated by the fact that macroeconomic management, which is closely monitored by the IMF, has improved considerably over the last two years. Furthermore, IMF program targets contain built-in adjusters to take account of volatility in international prices, especially of oil-prices. At the same time, the IMF is focusing on measures to improve the collection of non-oil revenues, which is essential given the structural changes the economy is going through. SAC III also supports important reforms in the forestry sector, which should increase its contribution to the budget. 19. Government commitment to economic reform and poverty reduction has clearly increased in the past two years, as evidenced by the successful implementation of SAC II. Moreover, the current administration increased its strength in Parliament after the recent elections, and a committed group is leading policy reforms. However, the reformers must deliver tangible benefits, in terms of poverty reduction, to the general public if they are to prevail. In this context, the Program will provide direct benefits to the public, such as better quality of transport, improved availability of water, electricity and telecommunications, improved security of deposits in financial intermediaries, and better management of natural resources including retention, by locally concerned communities, of a larger share of the benefits of their utilization. 20. The risk of program failure because of inadequate implementation capacity will be handled by the provision of technical assistance as needed in the context of IDA's ongoing TA operations, or by other donors associated with the program. Contact Point: Brendan Horton, TM The InfoShop The World Bank 1818 H Street, N.W. - 5 - Washington, D.C. 20433 Telephone No. (202)458 5454 Fax No. (202) 522 1500 Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending June 12, 1998. - 6 -