Document of The World Bank FOR OFFICIAL USE ONLY Report No.: 18058 IMPLEMENTATION COMPLETION REPORT REPUBLIC OF ZAMBIA ECONOMIC RECOVERY AND INVESTMENT PROMOTION CREDIT (Cr 2764-ZA) June 24, 1998 Private Sector Finance Group 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 World Bank authorization. CURRENCY EQUIVALENTS Currency unit: Zambian Kwacha (K) US$ I = 820 Kwacha (Exchange rate of April 1995) US$ 1 = 1400 Kwacha (Exchange rate of December 1997) WEIGHT AND MEASURES Metric system FISCAL YEAR OF BORROWER January 1 - December 31 ABBREVIATIONS AND ACRONYMS BOZ - Bank of Zambia CBI - Cross Border Initiative CEM - Country Economic Memorandum CG - Consultative Group of Zambia CIR - Country Implementation Review CPPR - Country Portfolio Performance Review CSPF - Civil Service Pension Fund DBZ - Development Bank of Zambia ERC - Economic Recovery Credit ERIP - Economic Recovery and Investment Promotion ESAC - Economic and Social Adjustment Credit ESAF - Enhanced Structural Adjustment Facility GDP - Gross Domestic Product GOZ - Government of Zambia IBRD - International Bank for Reconstruction and Development IDA - International Development Association IMF - Intemational Monetary Fund LASF - Local Authorities Superannuation Fund LUSA - Lusaka Stock Exchange MMMD - Ministry of Mineral and Mining Development MMD - Movement for Multiparty Democracy NEAP - National Environmental Action Plan NEDC - National Economic and Development Conmmittee NSSRI - National Social Security reform Implementation PER - Public Expenditure Review PFP - Policy Framework Paper PIRC - Privatization and Industrial Reform Credits PTA - Preferential Trade Agreement RAP - Rights accumulation Program RPED - Regional Project for Enterprise Development SCC - Systematic Client Consultation SEC - Securities Exchange Commission VAT - Value Added Tax ZCCM - Zambia Consolidated Copper Mines ZESCO - Zambia Electricity Supply Company ZIMCO - Zambia Industrial and Mining Corporation ZNPF - Zambia National Provident Fund ZPA - Zambia Privatization Agency ZSIC - Zambia State Insurance Company ZRA - Zambia Revenue Authority Vice President :Callisto E. Madavo, AFRVP Director -:Phyllis R. Pomerantz, AFC02 Technical Manager :Thomas W. Allen, AFT?PI Staff Member :Emile Sawaya, AFTP1 FOR OFFICIAL USE ONLY REPUBLIC OF ZAMBIA ECONOMIC RECOVERY AND INVESTMENT PROMOTION CREDIT (Cr 2764-ZA) IMPLEMENTATION COMPLETION REPORT TABLE OF CONTENTS Preface .................................v Evaluation Summary ................................. vi PART I -- PROGRAM IMPLEMENTATION ASSESSMENT A. Statement/Evaluation of Objectives ............................1 B. Achievement of Objectives ............................1 C. Major Factors Affecting the Program ...........................,. 4 D. Project Sustainability .........................5 E. Borrower Performance ...........................5 F. Bank Performance ...........................6 G. Assessment of Outcome ..8 H. Key Lessons Learned ................8 PART II -- STATISTICAL TABLES ........................ 10 Table 1 Summary of Assessments ............................................... 10 Table 2 Related Bank Loans/Credits ................................................1.1 Table 3 Project Timetable ............................................... 13 Table 4 Credits Disbursements: Cumulative Estimated and Actual ................. 13 Table 5 Key Indicators for Project Implementation and Operation .................. 14 Table 6 : Status of Legal Covenants ............................................... 20 Table 7 : Bank Resources: Staff Inputs ............................................... 22 Table 8 : Bank Resources: Staff Missions ............................................... 23 APPENDICES A. ICR Mission's Aide-Mdmoire ..................................................... 25 B. Borrower Assessment ..................................................... 30 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 World Bank authorization. IMPLEMENTATION COMPLETION REPORT REPUBLIC OF ZAMBIA ECONOMIC RECOVERY AND INVESTMENT PROMOTION CREDIT (Cr 2764-ZA) IMPLEMENTATION COMPLETION REPORT PREFACE This is the Implementation Completion Report (ICR) for the Economic Recovery and Investment Promotion (ERIP) adjustment operation for which a credit of SDR 90 million (US$140 million equivalent) was approved on July 11, 1995 and made effective on September 6, 1995. The credit was closed on December 31, 1997, compared with the original closing date of December 31, 1996. The first tranche, released upon effectiveness, was fully disbursed by August 1995; the second tranche was released on August 22, 1997 and the credit was fully disbursed. The project was not co-financed. This report was prepared by Emile B. Sawaya and Lucy Fye, Private Sector Finance (AFTP1) of the Africa Region and David Greene (consultant). It was reviewed by Phyllis Pomerantz, Country Director (AFC02), and Ataman Aksoy, Manager (AFTM1), Macroeconomics 1. Preparation of this ICR started during the Bank's final supervision and completion mission of February/March 1998. It was based on materials in the program file, including the Memorandum of the President (MOP), Development Credit Agreement (DCA), supervision reports, progress reviews and monitoring reports by the Borrower. The Borrower contributed to the preparation of the ICR by supplying the views reflected in the final mission's aide-memoire, preparing its own evaluation of the Program, and commenting on the draft ICR. REPUBLIC OF ZAMBIA ECONOMIC RECOVERY AND INVESTMENT PROMOTION CREDIT (Cr 2764-ZA) IMPLEMENTATION COMPLETION REPORT EVALUATION SUMMARY 1. The objective of the Economic Recovery and Investment Promotion (ERIP) Credit was to support the Government's stabilization and economic reform effort. Specifically, ERIP supported continued implementation of sound macroeconomic policies designed to stabilize the economy; increasing the supply of long-term capital and improving its allocation; establishing a new national basic pension scheme; and strengthening the mining sector, by privatizing the parastatal mining company, and improving the sector's legal, fiscal and institutional frameworks. The objectives of the project were, to a large extent, achieved and its impact on economic performance has been positive. Substantial progress has been made toward macroeconomic stabilization, albeit not smoothly and not without fiscal relapses. Inflation has been reduced by improving fiscal performance, while protecting budgetary allocations for vital social services. A Value Added Tax (VAT) system has been successfully launched. Government's support for private investment has been reoriented: the government's financial institutions are no longer providing directly long term finance to private enterprises. A new apex institution is mobilizing concessionary funds for on-lending to private investors through commercial channels. The Development Bank of Zambia (DBZ) has suspended its lending activities and is concentrating on loan collections, but vigilance will be required to ensure that it does not resume lending, that its staffing and expenses are consistent with its reduced functions, and that all loan collections (net of expenses) are transferred to the Treasury. Legislation establishing a new national basic pension system has been enacted, but several critical issues remain to be resolved, including contribution rates, benefit levels and transitional arrangements for present members of Zambia National Provident Fund (ZNPF). Also measures have been taken to regulate private pension funds and insurance companies. Finally, the stage has been set for rapid, environmentally sound development of the mining sector by efforts to privatize Zambia Consolidated Copper Mines (ZCCM), and the establishment of a supportive legal and institutional framework for private investment in mining. 2. This has been accomplished despite a generally less than favorable external environment, including poor weather, a volatile world copper market and sharp declines in copper prices, and the hiatus in bilateral balance-of-payments support. Sustainability of the Government's economic reform program, and, indeed, future economic progress will depend critically, however on ensuring that sufficient and timely balance-of-payments support is available for the implementation of the macroeconomic program. This will require continued Government commitment to the economic reform process and the stabilization program. It requires, above all, the expeditious conclusion of the privatization of ZCCM, which is essential for ensuring the rapid rehabilitation of the mining sector and for providing a clear signal to investors of Zambia's commitment to private enterprise. It also requires addressing the concerns of donors about governance issues, including economic governance issues. 3. The economy responded positively to the Government's program supported by the ERIP credit, as evidenced by lower inflation, increasing Gross Domestic Product (GDP) in 1996 and 1997, rising private investment, expanding nontraditional exports, and increased interest of international mining enterprises in exploring Zambia's mineral resources. The Government and other stakeholders have indicated that they consider the performance of the Bank in the design and supervision of the ERIP operation to have been satisfactory. On the whole, the performance of the Government in implementing the ERIP Program was satisfactory. Although the release of the Second Tranche was delayed about a year because it took longer than expected to prepare the legislation and institutional arrangements needed to regulate and supervise insurance companies and pension fund management companies, and to complete the restructuring of DBZ, these tasks were eventually completed satisfactorily. The first phase of privatizing ZCCM, whose objective was to prepare the ZCCM Privatization Plan and seek the requisite approvals proceeded smoothly, and in accordance with an ambitious timetable. The process also proceeded well until the bid opening and evaluation stage of the second phase, whose objective was to actually privatize the company. In March 1997, changes were made in negotiating leadership, strategy and tactics, as well as in the objectives of the sales process to place more emphasis upon the cash up-front component of the deal. This led to delays and many of the negotiations encountered problems. The delays and the problems facing the negotiators were most serious for the package that includes the Nchanga and Nkana mining divisions, ZCCM's largest and most profitable. 4. The lessons of the ERIP project are: (1) Timing of reform is critical. For example, an effort to push the privatization of ZCCM in 1991-92, would probably have been unsuccessful, as the Government was not yet committed to such a course. Moreover, once Government commitment is in place, the pace of reform must allow for building consensus among stakeholders. (2) Recovery of the economy after stabilization can take longer than expected, but should not be a reason for despair. The Zambian case illustrates that stabilization, coupled with vigorous structural adjustment will ultimately produce positive results. (3) Availability of technical assistance funds can facilitate acquisition of critical technical expertise, if task managers and government have flexibility in'allocating these funds to problem areas as they arise. (4) Adjustment programs are easier to implement and supervise as well as more effective, if they have fewer, but more critical conditions, fewer tranches and shorter disbursement profiles. (5) Continuity of task management is beneficial, as is having the manager of the adjustment operation also responsible for related technical assistance projects. REPUBLIC OF ZAMBIA ECONOMIC RECOVERY AND INVESTMENT PROMOTION CREDIT (Cr 2764-ZM) IMPLEMENTATION COMPLETION REPORT PART I - PROJECT IMPLEMENTATION ASSESSMENT A. Statement/Evaluation of Objectives 1. The ERIP operation built on the achievements of the preceding operations, while also targeting areas where progress had not, so far, been adequate. The key elements of the ERIP Reform Program were: (1) execution of the macroeconomic program consistent with the objectives of stabilization, while strengthening the system of taxation by introducing the VAT, and protecting fiscal expenditures on critical social programs; (2) reorienting the role of Government in the financial sector in support of private investment by ending direct state lending for private investment, mobilizing term foreign exchange resources through a new apex institution, and ensuring the financial health of contractual saving institutions -- insurance companies and pension funds; (3) establishing a new national pension system; and (4) improving the legal, fiscal, environmental and institutional framework for the mining sector, strengthening the Ministry of Mines and Minerals Development (MMMD), and adopting a plan for the privatization of ZCCM. B. Achievement of Objectives 2. The Macroeconomic Program. Zambia made significant progress towards economic stabilization during the period of implementation of the ERIP Program (July 1995 to December 1997). Along the way, there were problems of budgetary management, but these were adequately addressed, and fiscal performance improved from year to year. The Government's cash deficits have been relatively small (there was a surplus equivalent to 0.7% of GDP in 1995, and deficits of 2.5% in 1996 and 1.8% in 1997), domestic arrears were reduced, and there was virtually no net domestic financing of the budget during 1995-1997 taken as a whole. 3. The combination of relative fiscal balance and tight monetary policy led to a deceleration of inflation, although this task was at times complicated and slowed down by the fiscal relapses. As measured by the CPI (end of period), inflation declined from 48% in 1995 to 18% in 1997. Moderating inflation had a favorable impact on interest rates: commercial bank rates fell from 52% at end-1995 to 24% at end-1997, and the treasury bill rate fell from 42% at the end of 1995 to 13% at the end of 1997. Exchange rates remained fairly stable, with the market rate depreciating only 9% relative to the dollar in 1997, compared to a depreciation of almost 30% the previous year. There was, however, an acceleration in the rate of depreciation of the kwacha 2 in early 1998 because of the shortfall in ZCCM's foreign exchange earnings--due to declining production and low copper prices--and the continued hiatus in balance of payments support. 4. The IMF Board approved the midterm review of the first annual ESAF program under the three-year SAF/ESAF arrangement in February 1997, allowing the 1996 Paris Club Agreement to go into effect formally. Discussions with the IMF staff on the second-year ESAF were concluded in December 1997. Presentation of the second-year ESAF to the IMF Board was put on hold until after the May 1998 Consultative Group Meeting because of uncertainties in external financing. It has now been further delayed pending clarification of the potential fiscal impact of delays in privatizing the bulk of ZCCM. 5. As agreed under the ERIP Program, the Value Added Tax was implemented, on schedule, in July 1995. The Revenue Authority did an outstanding job introducing and gaining acceptance for the VAT. Collections on internal transactions (the VAT is also applied to imports) increased from K 108 billion in 1995 to K 184 billion in 1997. Total VAT collections in 1997, including the tax on imports, were about K 300 billion, providing almost a quarter of total tax revenues. 6. The Bank and the Government first agreed on minimum targets for social sector spending under the first ESAC, approved in 1994. Under ERIP the objective was to maintain the share of social sector spending. Actual budget outlays for the social sectors in 1995 were at or above the levels specified in the ERIP Letter of Development Policy. The share of total social sector spending in non-debt service budget releases was 35% (compared to the minimum target of 33%), and the share of non-personnel spending in these sectors was 25% (compared to the minimum target of 24%). Similar targets for social sector spending in 1996 under the ESAC II Program were fulfilled. 7. Strengthening the Financial Sector The Government is no longer playing the role of direct provider of term finance to private enterprises. The financially distressed Eximbank and Lima Bank have been closed and are being wound up. The ERIP Program also called for the Development Bank of Zambia (DBZ) to cease direct lending and to be restructured into an apex institution responsible for mobilizing and on-lending concessionary finance through commercial banks, and for its loan portfolio to be transferred to a separate collection agency. Transferring DBZ's portfolio to a collection agency proved to be legally problematic, and creating a new apex institution was not accepted by parliament. Instead, the objectives were accomplished by having DBZ's Board of Directors suspend lending operations and order the DBZ management to concentrate on the collection of non-performing loans. A new apex institution, Zambia Enterprise Finance Ltd., has been established under the Companies Act to mobilize concessionary external financing to be on-lent by commercial banks to the private sector. DBZ, however, has not been wound up and vigilance will be required to ensure that it does not resume lending operations, that its staffing and expenses are consistent with its reduced functions, and that all loan collections (net of expenses) are transferred to the Treasury. 8. Parliament has enacted legislation to establish clear, enforceable regulatory frameworks for insurance companies and pension funds. Under this legislation, which was drafted in consultation with the industry, all insurance companies and brokers and pension fund managers 3 will be licensed. A regulatory agency, the Registrar of Pensions and Insurance, has been established in the Ministry of Finance. A well-qualified Registrar and Deputy Registrar for Pension Funds have been appointed and other staff are being recruited, the process of consultation with the industry is underway and drafti ng of regulations will begin soon. 9. Establishing a National Pension Scheme. Legislation has been passed to establish a National Pension Scheme and to transform the existing Zambia National Provident Fund (ZNPF) into the agency responsible for operating it. The ILO is in the process of drafting proposals for transforming ZNPF into the administrative agency. In the meantime, several critical issues remain to be resolved, including contribution rates, benefit levels and transitional arrangements for present members of ZNPF. 10. Privatizing ZCCM and Promoting Private Investment in Mining. The privatization of ZCCM, per se, was not a part of the policy agenda of the MMD Government when it took office in late 1991. Rather, the new Government hoped that the efficiency and profitability of ZCCM could be improved and that investments in new mining projects could be carried out as joint ventures with private international companies. It was not until 1993-94, when ZCCM ran into severe difficulties maintaining its production levels and efforts to improve its efficiency had failed, that it was recognized that there was no alternative to privatization. In the January 1995 Budget Speech, the Minister of Finance announced that ZCCM would be privatized within two years. 11. A plan for the privatization of ZCCM was prepared by ZPA with the assistance of investment banking and legal advisors financed under the IDA ERIP Technical Assistance (ERIPTA) Credit. The plan, which called for dividing ZCCM's assets into packages for sale, was approved by the Boards of Directors of ZCCM and the Zambia Privatization Agency and by the Cabinet and issued in May 1996. This fulfilled the specific condition for the release of the Second Tranche of the ERIP Credit, and set the stage for beginning the implementation phase of the ZCCM Privatization Plan. 12. Although the ultimate objective of the ERIP program was the actual privatization of ZCCM, this was not made a condition of the ERIP Credit in order to keep the playing field level for ZCCM and the Government vis-a-vis potential buyers. The first phase of privatizing ZCCM, with the objective of preparing the ZCCM Privatization Plan and seeking the requisite approvals proceeded smoothly, and in accordance with what was at the time considered by most stakeholders to be an ambitious timetable. The process also proceeded well in the early stages of the second phase, when the objective was to actually privatize the company. Interested investors were pre-qualified and asked to submit bids. By the target date of February 28, 1997, bids were received for all the packages that were put out for competitive bidding. This was a very good response, and a good testimony to the attractiveness of the new mining policies in Zambia, and to the efforts of ZPA and the Advisors in marketing the ZCCM assets. At that time, ZPA and the advisors continued to aim to complete the process by the end of Junle 1997. Many of the stakeholders thought that was possible, and those that did not felt that slippages would be minor. 4 13. There was a change in the leadership of the ZCCM negotiating team in March 1997. As a consequence, there was a change in the negotiating strategy and tactics, as well as in the objectives of the sales process, which placed more emphasis upon the cash up-front component of the deal. Delays began to occur and many of the negotiations encountered problems. Agreements to sell the Power Division and the Luanshya-Baluba, Kansanshi, and Chibuluma mines were reached late in the third quarter of CY1997, several months later than planned. The delays and the problems facing the negotiators were most serious for the package that includes the Nchanga and Nkana mining divisions, ZCCM's largest and most profitable. As of the date of this Implementation Completion Report (ICR), there still is no agreement between Govemment/ZCCM and private sector buyers of these assets. 14. Government is continuing its efforts to privatize ZCCM and aims to complete the process in the third quarter of CY1998. This implies, in addition to a successful conclusion to the negotiations for the sale of the Nchanga and Nkana mining divisions, the successful conclusion to the sale of the Konkola mining division, including the Konkola Deep Mining Project, and the sale of the remaining assets of the Mufulira division. It also implies the sale of Ndola Lirne Company, the last major subsidiary of ZCCM for which bids have been received and are now being evaluated. 15. With respect to the mining sector, several measures have been taken to improve the legal framework and the institutional support for mining investors. The Government adopted a new Mining Sector Policy Statement in December 1995, the objective of which was to "ensure a self- sustaining mineral-based industry, and encourage private investment in exploration and development...." Also, a new Mining and Minerals Act was passed. It guarantees security of title, unrestricted access to foreign exchange, companies' right to market products, and freedom of commercial operation. It also provides for international arbitration of disputes. A new mining fiscal regime was also put in place by amending relevant sections of the Income Tax Act, the Customs and Excise Act and the Investment Act. The new fiscal regime concentrates taxation on profits, rather than output and is non discretionary, and internationally competitive. 16. Under the new mining environmental regulations, impact assessments will be required for all new projects, and mining areas will have to be rehabilitated after decommissioning. All licensees will be required to provide baseline studies, environmental engineering studies, an environmental management plan, and a plan for rehabilitation after decommissioning. 17. Progress has been made in strengthening the Ministry of Mines and Minerals Development (MMMD). The mining title system is working well and new geological data bases and maps are being prepared. MMMD has begun to implement recommendations of the studies on institutional improvements, including the establishment of regional mine offices to assist medium and small mining companies and gemstone miners. 5 C. Major Factors Affecting the Project 18. Zambia's ability to carry out the macroeconomic stabilization program that is central to the reform program has been made difficult by the limited room for maneuver that the country has because of its continued heavy reliance on copper exports, its high debt service burden and the key role played by international assistance and debt relief. Continued poor performance of ZCCM and the volatility of the international copper market has made budgetary and balance of payments management difficult. Copper still accounted for 56% of Zambia's exports in 1997 (copper and cobalt together accounted for 83%). The production of copper by ZCCM fell from 403,000 tons in 1993 to 307,000 tons in 1995, before stabilizing at an average of about 315,000 tons in 1996-97. The effects of production problems have been compounded by the volatility of the international copper market. The price of copper fell from 133 cents per pound in December 1995 to about 80 cents in December 1997 and Zambia's gross copper receipts declined from US$851 million in 1995 to US$613 million in 1997. 19. The suspension of balance of payments support by bilateral donors in 1996 largely because of their concern about governance issues has further complicated the tasks of budgetary and balance of payments management. Balance of payments support from sources other than the World Bank, which totaled US$ 133 million in 1995, amounted to only US$ 9 million in 1997. 20. Past ICRs for adjustment operations in Zambia have noted that the technical and administrative capacity of the Zambian Government is quite limited. This seems to have been less of a problem in the case of the ERIP operation because: (1) the Government has gained experience and confidence through implementation of past programs; (2) ERIP implementation was supported by Bank-financed technical assistance in key areas; and (3) while the tasks to be accomplished were complex, there were fewer of them and they were more clearly focused. D. Project Sustainability 21. The Government appears to be committed to continue making progress on the overall economic reform program and that enhances the prospects for sustainability. Privatization is a good example of how progress on implementation affects economic performance and impacts sustainability. The progress on the privatization of non-mining companies by ZPA, which was not included in the ERIP program, reflects the Government's commitment and has elicited a good response from investors and is starting to show good results in terms of investment and economic growth. During 1995-97, 152 companies were privatized, bringing the total number of units privatized to 224 out of ZPA's working portfolio of 330. Moreover, the Minister of Finance in the 1998 Budget Speech announced that ZPA would begin work on the privatization of the large parastatals, not yet part of its portfolio, including ZAMTEL, and other parastatals in the hydrocarbon, transport and commercial banking sectors. However, the slowdown in the privatization of ZCCM, which was a major focus of ERIP, poses serious risks to the economy's recovery and the program's sustainability. 6 22. Sustainability of the reform program will be enhanced if the government continues to take the necessary measures to ensure the continuation of the economic recovery. Improved economic conditions will, in turn, increase the political and social acceptability of the reform effort and reinforce the positive impact of the Government's commitment to stabilization and structural reform. Nonetheless, sustainability depends critically on the expeditious completion of the ZCCM privatization. ZCCM's financial situation is precarious. Further delay could affect its operations and its relations with its creditors. Completion of the sale would allow the payment of the company's domestic arrears and provide a boost to the economy. Inflows of foreign exchange resulting from the sales proceeds would provide some relief for Zambia's presently critical foreign exchange reserve position. New owners taking control rapidly would accelerate the process of improving efficiency and increasing output, which is in the company's and the country's interests as well. Finally, the completion of the ZCCM privatization would provide a strong positive signal to other potential investors in mining as well as other sectors. 23. There are other factors influencing the programs sustaintability. Unless sufficient balance-of-payments support is available for the implementation of the macroeconomic program over the next two years, the stabilization program could unravel. Ensuring that this does not happen will require addressing the concerns of bilateral donors on governance matters, including the Bank's concerns about economic governance issues. The Consultative Group meeting held in Paris in May 1998 clarified that donor support will be forthcoming if further progress is made on governance issues. Govemment has stated that it is fully committed to the strengthening of governance in Zambia and is preparing a medium term program to strengthen the capacity of institutions that promote and enhance good governance. Government is planning to request donor support for its governance program. E. Bank Performance 24. Bank performance in preparing and supervising the project was satisfactory. The project was better focused and structured than its predecessor PIRCs (Credits 2405-ZA and 2523-ZA), had fewer tranches (two rather than three) and fewer, more specific and high priority conditions for tranche release. Nevertheless, the tasks of macroeconomic stabilization, privatizing ZCCM, liquidating government banks, establishing a regulatory framework for pension funds and insurance companies, and establishing a new social security system, were undoubtedly the maximum the Government could handle in the two years the ERIP was planned to cover. Some elements of prior adjustment operations were, therefore, not included in the ERIP. For example, because progress on the privatization of companies other than ZCCM, seemed assured, it was not necessary to make this part of the ERIP program. On the other hand, the complex issue of civil service reform, was not included in ERIP in order not to overload the agenda. In retrospect, the reform agenda under ERIP could have been even more focused, with fence areas and related conditionality. 25. IDA's Technical Assistance credits played a vital role in ZCCM's privatization and improving the legal and institutional framework for private sector mining. Funds from the earlier Mining Sector Technical Assistance Credit (Cr. 2269-ZA) supported the development of the new mining code and fiscal regimne, and the parallel ERIPTA Credit (Cr. 2875-ZA), including its 7 US$2 million project preparation facility advance funded the hiring of the legal and financial advisors, whose role in the ZCCM privatization was indispensable. Use of the samne staff to supervise the two TA credits and ERIP ensured close complementary of the operations. 26. Supervision of the project was good. Supervision missions were frequent, especially during the earlier stages of implementation. Bank staff provided timely and useful advice to the Government and their role was appreciated. Discussions with the Government and other stakeholders indicated that they also considered that the Bank had done a good job in preparing and supervising the project. F. Borrower Performance 27. There were two problematic areas in project implementation. Release of the Second Tranche of the Credit was delayed by about a year because it took longer than originally expected to prepare the required legislation and to put in place the required institutional arrangements for the regulatory regime for insurance and pension fund management companies. Nevertheless, legislation was enacted and the agency responsible for supervision has gotten off to a fast start, to some extent making up for lost time. 28. Restructuring the DBZ was delayed because the requisite legislation was not approved by the Zambian Parliament. The Government, however, showed ingenuity and determination in achieving DBZ restructuring, and the intent of the agreement between the Government and IDA, namely, to discontinue DBZ's retail lending activities, to focus greater effort on the collection of DBZ's loan portfolio, and to establish an apex institution which would allow Zambia to mobilize concessional funds for on-lending through commercial banks, was achieved. 29. Once a decision was made to privatize ZCCM, the process proceeded as smoothly and as quickly as possible until the bid opening stage, but began to encounter difficulties and delays after that. Because of its popular image as Zambia's "crown jewel," the Government newly elected in late 1991 had to consider every reasonable alternative to privatization, in order to avoid accusations of giving the company away to foreign interests. However, once it was obvious that the company was not capable of self-reform, the decision to privatize it was inevitable and politically acceptable. Many tasks had to be undertaken. Experienced, high quality international investment and legal advisors had to be recruited (in part to give the sale political and business credibility) to prepare a privatization plan. Following the plan's approval, documentation to solicit bids had to be prepared, data centers to enable due diligence had to be established, the capacities of interested investors had to be reviewed to select those who qualified, requests for bids had to be issued, bids needed to be reviewed and evaluated and finally deals had to be negotiated and sales concluded. 30. Both the Bank and the Government may have underestimated the complexity and the time required to implement the ZCCM Privatization plan, particularly after the change in the leadership of the negotiating team and the adjustmnent of the objectives and strategy of the sales process (paras. 10-14). However, if the current plans to complete the privatization in the third quarter of CY1998 materialize, then this transaction would not be unduly slow by international 8 standards. This transaction was comparable in size and complexity to the privatization of British Coal, which took four years to complete. Moreover, complex issues relating to retrenchment of labor, handling of ZCCM's accumulated arrears, liability for past environmental damage, ownership of staff housing, and provision of social infrastructure and municipal services had to be resolved. The fact that the Government was not the sole shareholder meant that the rights of the other shareholders had to be considered and protected and that proved to be time consuming. Table 1: Macroeconomic Indicators 1991 1992 1993 1994 1995 1996 1997 Real GDP growth % Shares of GDP -1.7 6.8 -8.6 -2.0 6.4 3.5 Consumption Government 14.8 16.2 17.9 14.8 14.6 12.6 12.3 Private 75.4 82.1 78.1 76.3 77.6 78.5 77.9 Investment 13.9 14.9 15.0 Gross fixed capital 11.4 11.4 14.6 13.0 13.6 14.5 14.7 Public 5.8 4.0 3.4 4.4 5.7 5.8 5.2 Private 5.5 7.4 11.3 8.6 7.9 9.7 9.6 External Debt (US$ million) 6898 6827 6260 6532 6347 7012 7033 Fiscal performance (% GDP) Revenues and grants 27.4 28.5 23.9 26.9 30.8 28.0 24.0 Expenditures and net lending 34.7 31.0 29.4 33.7 34.8 26.4 24.4 Overall balance (accrual) -7.2 -2.5 -5.6 -6.8 -4.0 1.6 -0.4 Increase in consumer prices 160.1 183.4 54.5 39.4 43.1 24.5 (annual average) T-Bill rate (annualized, end of period) 23.3 42.0 75.8 13.0 Commercial Bank rate (end of period) 36.2 47.7 52.0 37.9 24.0 Real exchange rate period average K/US$ 691 715 905 687 670 668 Exports(US$Million) 1085 1120 994 1066 1186 993 1101 o/w metals 998 1020 870 910 984 754 806 Imports -952 -1302 -1019 -1003 -1194 -1055 -1125 Debt service due 683 522 542 590 453 371 Debt rescheduling/relief 551 359 227 37 310 159 Copper export volume (000 MI) 375 409 403 360 307 341 310 Copper export price US$/lb. 1.09 1.08 0.96 0.8 1 1.19 0.85 0.98 9 G. Assessment of Outcome 31. Though not fully accomplished as yet, by end of 1997, it was apparent that progress on stabilization and the liberalization of the Zambian economy was beginning to have positive effects on economic performance. After declining by 2.3% in 1995, real GDP increased by 6.4% in 1996 and, despite a decline in agricultural output due to relatively poor weather, by 3.5% in 1997. Growth in 1997 was broad based, with all sectors other than agriculture and financial services expanding. Manufacturing value added grew by 6.9% compared to 2.6% the previous year. Mining value-added grew by 2.4%. However, GDP per capita in 1997 was still about 13% below its level in 1991. Gross domestic savings increased from 7.7% of GDP in 1995 to 9.1% in 1997 and gross fixed capital formation rose from 13.8% of GDP to 15% over the same period. The private sector accounted for almost all of the increase in investment. 32. The new mining policies had already had a positive impact. For example, the operations of the Bwana Mukubwa mine, which had ceased in 1984, were reactivated in 1997 under private ownership. There has been an upsurge in new private exploration since the passage of the new Mining Act. The number of prospecting licenses in force has risen from two to about twenty, and an estimated US$100 million has been spent on exploration over the past three years. 33. The shift towards a pro-export orientation in policy is helping to make the export sector a more dynamic and significant feature of Zambia's economy. The value of non-traditional products increased in 1997 by 26%, reaching a record level of over US$300 million. These exports now account for 28 % of the total and include an expanding range of agricultural, non- metal mining, agro-industrial and engineering products. Table 2: Social Indicators Nutritional status of the under five population 1991 1996 Stunted Growth 40% 42% Underweight 22% 22% Access to safe water 50% 50% 1989-91 1994-96 Total fertility rate 6.5 6.1 Infant mortality rate 107 109 Child mortality rate 94 98 1990-93 1995-96 Literacy rate 73% .78% Gross Primary enrollment rate 97% 93% 34. The economic reform program, with the support of ERIP and its predecessor and successor adjustment operations seems to be having a positive effect on poverty. According to a Government study based on the Priority Survey in 1991 and the Living Conditions Monitoring 10 Surveys in 1993 and 1996, the incidence of poverty, which had increased from 69.7% of the total population in 1991 to 73.8% in 1993, declined to 69.2% in 1996. Extreme poverty (consumption insufficient to meet basic daily food intake) which rose from 58.2% in 1991 to 60.6% in 1993, declined to 53.2% in 1996. As evident in Table 2, the country's social indicators show some deterioration since 1991, but probably less than might have been expected given the decline in per capita income. This suggests that preserving government outlays for social services may have had a positive effect, but the situation is still precarious and any emerging positive trends may reverse if the reform program is not sustained. I. Key Lessons Learned 35. Successful implementation of the ERIP program provides some useful lessons. (1) Timing of reforn is critical. For example, an effort to push the privatization of ZCCM in 1991-92, would probably have been unsuccessful, as the Government was not yet committed to such a course. Moreover, once Government commitment is in place, the pace of reform must allow for building consensus among stakeholders. (2) Recovery of the economy after stabilization can take longer than expected, but should not be a reason for despair. The Zambian case illustrates that stabilization, coupled with vigorous structural adjustment will ultimately produce positive results, provided the efforts can be sustained. (3) Availability of technical assistance funds can facilitate acquisition of critical technical expertise, if task managers and government have flexibility in allocating these funds to problem areas as they arise. (4) Adjustment programs are easier to implement and supervise as well as more effective, if they have fewer, but more critical conditions, fewer tranches and shorter disbursement profiles. (5) Continuity of task management is beneficial, as is having the manager of the adjustment operation also responsible for related technical assistance projects. 11 REPUBLIC OF ZAMBIA ECONOMIC RECOVERY AND INVESTMENT PROMOTION CREDIT (Cr 2764-ZA) IMPLEMENTATION COMPLETION REPORT PART II - STATISTICAL TABLES Table 1: Summary of Assessments A. Achievement of Objectives Substantial Partial Negligible Not Applicable Macroeconomics policies Sector policies 4 Financial objectives 4 Institutional development N Physical objectives N Poverty reduction N Gender concerns 4 Other social objectives 4 Environmental objectives 4 Public sector management 4 Private sector development 4 B. Project Sustainability Likely Unlikely Uncertain C. Bank Performance Highly Satisfactory Satisfactory Deficient Identification Preparation assistance 4 Appraisal 4 Supervision 4 D. Borrower Performance Highly Satisfactory Satisfactory Deficient Preparation -4 Implementation 4 Covenant compliance 4 Operation 4 E. Assessment of Outcome Highly Satisfactory Unsatisfactory Hi Satisfactorv Unsatisfactory 4 12 Table 2: Related Bank Loans/Credits Loan/Credit Title Purpose Year of Status Approval Preceding Operations 1. Second Economic Macroeconomic stabilization, agricultural 1991 Closed Recovery Credit sector liberalization, private sector expansion, and restructuring and reforming the civil service and the parastatal sector. 2. Mining Sector To assist the Government of Zambia to 1991 Closed Technical Assistance implement an effective development strategy for the mining sector that would make the mining sector efficient and productive, in order to generate resources needed to support recovery and diversification of the Zambian economy. It would also promote new copper mines by private investors in the framework of joint ventures with ZCCM; and strengthen environmental protection in the mining sector. 3. Privatization and To modernize business framework, 1992 Closed Industrial Reform I establish market-based exchange rate mechanism, and promote private sector through privatization and improvement in parastatal efficiency. 4. Privatization and To provide balance of payments support to 1993 Closed Industrial Reform II the parastatal reform and privatization program. 13 Loan/Credit Title Purpose Year of Status Approval 5. Privatization and To strengthen capabilities in ministries and 1992 Closed Industrial Reforn TA other responsible institutions for pararstatls reforms and privatization. Simultaneous Operation 6. Economic and To contribute to filling the identified 1994 Closed Social Adjustment external financing requirements for Zambia in 1994 and 1995 and to support reforms in areas of public sector management, developing a market for land, ending the budgetary drain of Zambia Airways, planning for value added tax, improving he duty drawback system, strengthening and decentralizing social services delivery systems and improving budget allocations to and within social sectors. Following Operations 7. ESAC II Second Enhance prospects for sustainable and 1996 Closed Economic and Social widely-shared economic growth in Zambia Adjustment Credit by supporting reforms that will make the private sector more competitive and the public sector more efficient and by providing vitally needed foreign exchange. 14 Table 3: Project Timetable Steps in Program Cycle Date Planned Date actual Identification May 1994 May 1994 Preparation August, 1994 Appraisal January, 1995 February 14, 1995 Negotiations April, 1995 April 1995 Letter of Sector Policy May, 1995 May 21, 1995 Board presentation May, 1995 July 11, 1995 Signing July, 1995 July 18, 1995 Effectiveness August, 1995 September 6, 1995 First Tranche Release August, 1995 September 6, 1995 Second Tranche Release October, 1996 August 22, 1997 Closing Date December, 1996 December 31, 1997 Table 4: Credit Disbursements (Us$ million) 1995 1996 1997 Appraisal estimate 70.0 70.0 Revised Estimates' 70.0 82.1 70.0 Actual 36.2 45.5 61.2 Actual as % of revised 51.7 55.4 87.4 estimate Date of final disbursement: 26th August, 1997 'Includes US$ 12.1 million which was an IDA supplement loan: C-29101. 15 Tables 5: Key Indicators for Project Implementation and Operation Major Activities Actions Timetable Status 1. Macroeconomic and Fiscal Policies l * Maintain macro-economic Macro program consistent Board condition Done policy framework consistent with fiscal and monetary and second with objectives of economic targets agreed with IDA and tranche release reform program IMF * Improve revenue Implement VAT Second tranche Done mobilization while reducing release reliance on trade and indirect taxes and minimizing distortions to economic incentives * Continue redirection of Total allocations for social Second tranche Done public spending from low- sectors in 1995 budget at release priority areas to infrastructure least 33% of total non- and social services. interest allocations * Improve cash-budget Improve controls over Structural Done management procedures to commitment by ministries benchmark in control spending and to avoid and provinces IMF program surprises causing recourse to deficit fnancing or undesirable changes in composition of spending Maintain cash-budget Reflected in LDP Done system * Achieve a lower average Abolish uplift factor at time Second tranche Done tariff of introduction to VAT release Reduce tariff levels further Reflected in LDP Done _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ in 1996 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 16 Major Activities Actions Timetable Status 2. Financial Sector Reform l * Govermnent to rely Government to mobilize term Reflected in LDP Done on private sector for resources from official and decisions on capital concessionary sources of funds formation and investment | Adopt new policy Government decision to Done principles, framework restructure DBZ as an apex and strategy for provision institution that mobilize funds of term fnance to private from concessionary sources and sector transfer DBZ loan portfolio to a separate collection entity Government decision to Done privatize Lima Bank and Eximbank Submit to Parliament draft DBZ Condition for Done legislation, complete the sale or Second Tranche liquidation of Eximbank and Release Lima Bank through ZPA * Reforming policies Decide on which ministry will Done. and laws for insurance be responsible for prudential Ministry of industry and pension- regulation of pension-fund Finance fund management management companies designated. companies Submit to Parliament draft Condition for Done legislation to regulate and Second Tranche supervise insurance and pension- Release fund management companies and establish necessary regulatory and supervisory agency 3. Social Security Reform l * reform social security/ pension fund system as follows: * Short term Adopt action plan for social Done security strategy reform and implementation schedule Decision to amend modified Done benefit formulae and early retirement provisions and repeal 22-years-of-service compulsory retirement law 1991. l 17 Major Activities Actions Timetable Status 3. Social Security Reform *reform social security/ pension fund system as follows: Submit to Parliament draft Condition for Done *Short term legislation on benefit formulae, Second Tranche early retirement and 22-year-of- Release service compulsory retirement or timely implementation action plan to finance resulting liabilities Adopt action plan, satisfactory Done to IDA to cover unfunded liabilities of public pension funds eMedium term Adopt action plan to reform Done administration and operations of ZNPF Submit to CLC draft legislation Board Done to establish new basic social Presentation security pension scheme and independent social security institutions Submit to Parliament legislation Condition for Done for new basic social security Second Tranche pension scheme and independent Release social security institutions 4. Mining Sector Reform and Privatization of ZCCM Revive Zambian mining Adopt new mining sector policy Done industry, particularly to encourage private investment copper mining, by attracting new private Adopt new legal, fiscal and Done investment, technology environmental frameworks and management to improve the productivity of existing operation and open up new mining areas. 18 Ma3or Activities Actions Timetable Status Strengthen capacity of Strengthen capacity of Done MMMD to oversee new Ministry of Mines to oversee legal, fiscal and new legal, fiscal and environmental environmental frameworks frameworks Privatize ZCCM Adopt and begin Condition for Done implementing plans to Second Tranche privatize and restructure Release ZCCM Submit Action Plan for ZCCM privatization Develop on urgent basis the Adopt plans to develop Board Presentation Done Konkola Deep project Konkola Deep project Government to submit a report to IDA on strategies to develop Konkola Deep project 19 Performance Indicators Macro Indicators 1992 1993 1994 1995 1996 1997(est.) GDP Growth (actual) -1.7 6.8 -8.6 -4.3 6.4 3.5 GNP per capita ( US$, Atlas 389 390 380 400 430 430 method) Total Investment/GDP 10.5 12.0 6.9 11.7 12.0 15.0 Total Domestic Savings/GDP 6.4 8.6 3.0 2.9 3.9 Current Account Balance $m -117 -88 -185 -314 -472 -390 Total Revenues and 28.5 23.9 26.9 30.8 28.0 24.0 Grants/GDP(%) Total Expenditure and net 31.0 29.4 33.7 34.8 26.4 24.4 lending/GDP(%) Budget Deficit(accrual)/GDP -2.5 -5.6 -6.8 -4.0 1.6 -0.4 CPI growth Rate 197.4 189.0 53.4 34.6 48.0 18.0 Total External Debt $bn 7.00 6.26 6.53 6.35 7.01 7.03 Exchange rate (av) ZK:$ 172.21 452.76 669.37 857.23 1,203.7 1,315 Privatization * Number of companies 52 210 271 330 assets (cumulative) * privatizations completed 15 102 165 224 * under preparations 37 108 106 106 * Privatization:Total Sales 2.7 22.4 65.5 56.5 Value (US$m) 20 Financial Indicators 1994 1995 1996 1997 Dec. Dec. Dec. Dec. 1. Share of bank credit to private 116.4 205.0 293.3 285.9 sector (ZKmillion) Year to Year change (%) 76.2 43.1 -2.5 2. Mobilization of financial resources by the reformed DBZ Mining Sector 1992 1993 1994 1995 1996 1997 2. Mining output physical - copper, 844.5 736.3 541.1 462.4 445.3 324.8 cobalt and coal (metric tons) 3. Gross Metal receipts (US$m) 1,019 905.7 965.2 1,100.7 760.9 858.5 21 Table 6: Status of Legal Covenants Credit Covenant Present2 Agreement Type Status Description of Covenant Comrnents Section Section 2.03 13 C Credit Closing date. Date was changed The closing date shall be December 31, 1996, to December 31, or such later date as the Association shall 1997. establish. The Association shall promptly notify the Borrower of such a later date. Section 3.01(c) 05 C Without limitation upon the provision of Complied with paragraph (a) of this section, the Borrower shall exchange views with the with the Association on any proposed action to be taken after the disbursement of the Credit which would have effect of materially reversing the objectives of the Program or any action taken under the Program, including any specified in Schedule 3 to this agreement. (Second Tranche release conditions) Section 3.03 (a) 09 C The Borrower shall maintain records and Compliedwith accounts for the proceeds of the credit. 3.03 (b) 09 C The Borrower shall move the accounts and Complied with records audited, and furnish a certified copy within 6 months of close of fiscal year. 3.03 (c) 09 C The Borrower shall maintain records and Complied with accounts for SOEs, have SOE records and accounts audited and submit a copy to IDA within 6 months of end of fiscal year. Schedule 1, para. 4 09 C Second Tranche Threshold Complied with Schedule 3,1 09 NC Submit to Parliament legislation to restructure Complied with DBZ, to establish regulation and supervision of insurance companies and pension funds, to restructure social security institutions and establish new basic social security system, and to put in place new mining policy. Schedule 3,2 12 C Adopt mining-related environmental Complied with regulations. Schedule 3,3 12 CD Take necessary actions to privatize or liquidate Complied with Eximbank and Lima Bank Credit Covenant Present3 2 Present status: C = complied with CD = complied with after delay CP = complied with partially NC = not complied with 22 Agreement Type Status Description of Covenant Comments Section Schedule 3,4 12 NC Implement action plan to restructure DBZ. Alternative option was applied Schedule 3,5 12 C Establish two independent agencies to regulate Complied with and supervise insurance companies and pensions funds. Schedule 3,6 02 C Adopt and implement VAT. Complied with Schedule 3,7 10 C Adopt and furnish IDA a satisfactory plan to Complied with privatize ZCCM Schedule 3,8 04 C Maintain in 1995: (a) social sector spending at Complied with 33% of total non-interest spending, and (b) share of non-personnel spending at more than 24% of social sector spending. Present status: C = complied with CD = complied with after delay CP = complied with partially NC = not complied with 23 Table 7: Bank Resources: Staff Inputs (Staff - Weeks) Stage of Project Cycle Planned Actual Through appraisal (Preparation, Pre-appraisal) n.a 110.0 Appraisal - Board (Negotiation) n.a 36.9 Board -+ Effectiveness n.a n.al Supervision 51.0 44.3 Completion 13.6 9.5 T:otal 203.2 200.7 24 Table 8: Bank Resources: Staff Missions Performance Rating Stage of Month / Number Days Specialized Staff Skills Types of Project Cycle Year of in Represented Implementation Development Problems Persons Field Status Impact Through April- 13 38 Principal Private Sector appraisal August Development Specialist, 1994 Principal Economist, Senior Economist, Principal Mineral Economist, Senior Financial Sector Specialist, Principal Financial Sector Specialist, Financial Sector Specialist, Economist Appraisal February/ 8 21 Principal Private Sector 6Board March 1995 Development Specialist, Principal Economist, Senior Economist, Economist, Principal Mineral Economist, Senior Financial Sector Specialist, Principal Financial Sector Specialist, Lawyer Board |Effectivenes July/ s September 1 -199~195 Supervision I October/ 4 17 Principal Private Sector S S Review of November Development Specialist, progress 1995 Principal Economist, made, Senior Economist, especially of Principal Mineral ZCCM Economist privatization II June/July 4 17 Principal Private Sector S S Delays in 1996 Development Specialist, preparation of Principal Economist, legislation, Senior Economist, restructuring Principal Mineral of DBZ and Economist establishment of regulatory agencies for insurance and pension funds 25 Performance Rating Stage of Month / Number Days Specialized Staff Skills Types of Project Cycle Year of in Represented Implementation Development Problems Persons Field Status Impact III September 4 17 Principal Private Sector S S Delays on 1996 Development Specialist, preparation of Principal Economist, legislation, Lawyer, Principal Mineral restructuring of Economist DBZ and establishment of regulatory agencies for insurance and pension funds IV January 5 14 Principal Private Sector S S Review of 1997 Development Specialist, progress made Lawyer, Advisor on in ZCCM Mining, Senior Mining privatization Specialist, and Consultant V April 3 14 Principal Private Sector S S Review of 1997 Development Specialist, progress made Lawyer, Advisor on on ZCCM Mining, Senior Mining privatization, Specialist, and Consultant and financial sector VI August 9 1 Principal Private Sector S S 1997 Development Specialist Completion Review of ICR Mission February 2 14 Principal Private Sector S S progress made l ICR Mission 1998 Development Specialist, on privatization Consultant of ZCCM APPENDICES ZAMBIA: ECONOMIC RECOVERY AND INVESTMENT PROMOTION (ERIP) CREDIT IMPLEMENTATION COMPLETION MISSION AIDE MEMOIRE I. Introduction 1. A World Bank mission consisting of Messrs. Emile B. Sawaya, (Principal Private Sector Development Specialist and Task Team Leader- AFTP1), John E. Strongman (Mining Advisor - IENIM) and David G. Greene (Consultant) visited Lusaka from February 23 to March 3, 1998 to begin the preparation of the Implementation Completion Report (ICR) for the ERIP (Credit No. 2764-ZA). Specifically, the mission reviewed with the Government and other stakeholders: (1) the performance of the Government and that of the other agencies involved in the implementation of the ERIP Reform Program; (2) the performance of the Bank in assisting implementation of the Program; (3) the lessons to be drawn from the implementation of the ERIP Reform Program; (4) plans for the future operation of the institutions covered by the Program, if applicable; and (5) the Government's contribution to the ICR In order to do this, the mission held discussions with key agencies in the public sector, private enterprises and interested members of the donor community. The mission's conclusions and recommendations, presented below, will be confirmed by the Bank after the mission's return to headquarters. The mission wishes to thank the Government for its cooperation and for the generous provision of time and effort. II. Summary Evaluation 2. The key elements of the ERIP Reform Program were: (1) execution of the macroeconomic program consistent with the objectives of stabilization, while strengthening the system of taxation by introducing the VAT, and protecting fiscal expenditures on critical social programs; (2) reorienting the role of Government in the financial sector in support of private investment by ending state direct lending for private investment, mobilizing term foreign exchange resources and ensuring the financial health of contractual saving institutions -- insurance companies and pension funds; (3) establishing a new national pension system; and, (4) improving the legal, fiscal and environmental framework for the mining sector, strengthening the Ministry of Mines and Minerals Development, and adopting a plan for the privatization of ZCCM. 3. The mission concludes that the objectives of the project were achieved and the impact on economic performnance has been positive. Substantial progress has been made toward macroeconomic stabilization: inflation has been reduced by improving fiscal performance, while protecting Government's support to vital social services; Government's support to private investment is reoriented and concessionary funds are being mobilized; a national basic pension system is being established; and the stage has been set for rapid, environmentally sound development of the mining sector by privatizing ZCCM, and establishing a supportive legal and institutional framework. This has been accomplished despite a generally less than favorable external environment, which, among others things, was affected by drought, volatile world copper market and sharp declines in copper prices, and the cessation of bilateral balance-of- payments support. 4. The economy has responded positively, as evidenced by lower inflation, increased GDP, rising private investment and expanding nontraditional exports. On the whole, the performance of the Government in implementing the ERIP Program was satisfactory. Although the release of the Second Tranche was delayed about a year because it took longer than expected to prepare legislation and to put in place the institutional arrangements to regulate and supervise insurance companies and pension fund management companies, and to complete the restructuring of DBZ, these tasks were eventually completed satisfactorily. The Government and other stakeholders have indicated that they consider performance of the Bank in the design and supervision of the ERIP operation to have been satisfactory. 5. Despite the progress that has been made, sustainability of the Government's economic reform program, and, indeed, future economic progress will depend critically on ensuring that sufficient concessionary balance-of-payments support is available for the implementation of the macroeconomic program. This will require: (a) addressing concerns of bilateral donors about "governance" issues; and (b) continued Government commitment to the reform process and stabilization. It requires, in addition, the expeditious conclusion of the privatization of ZCCM. This is critical to ensure rapid rehabilitation of the mining sector and to provide a clear signal to investors of Zambia's commitment to private enterprise. A determined effort is therefore required to complete negotiations for the sale of the last remaining package, ACo. III. Implementation of the ERIP Reform Program A. The Macroeconomic Program 6. The Government is committed to ensuring that macroeconomic policy and performance are consistent with the objectives of ERIP. The review by IDA staff has concluded that the progress being made in the implementation of the ERIP Program is satisfactory and that the macroeconomic policy objectives of the Program are being met. 7. Zambia has made significant progress toward economic stabilization during the period of implementation of the ERIP Program (July 1995 to December 1997). Problems of budgetary management, which had persisted, as evidenced by chronic difficulties in meeting fiscal targets in the first quarter of each year, are now being addressed. Each year the Treasury has managed to tighten fiscal controls and improve revenue performance to meet its targets. Fiscal performance has improved from year to year. The Government's cash deficits were relatively small (a surplus equivalent to 0.7% of GDP in 1995, and deficits of 2.5% in 1996 and 1.8% in 1997). In addition, domestic arrears have been reduced and relatively little domestic financing has been required. In fact, there was virtually no net domestic financing of the budget for 1995- 1997, taken as a whole. 8. The combination of relative fiscal balance and tight monetary policy has led to a deceleration of inflation. As measured by the CPI (end of period), inflation declined from 48% in 1995 to 18% in 1997. Moderating inflation has also had a favorable impact on interest rates: the official bank rate fell from 52% at end-1995 to 24% at end-1997, and the treasury bill rate fell from 42% at the end of 1995 to 13% percent at the end of 1997. Exchange rates remained fairly stable, with the market rate depreciating only 9% relative to the dollar in 1997, compared to a depreciation of almost 30% the previous year. 9. The IMF Board approved the midterm review of the first annual ESAF program under the three-year SAF/ESAF arrangement in February 1997, allowing the 1996 Paris Club Agreement to formally go into effect. Negotiations for the second-year ESAF have been concluded and its presentation to the IMF Board is awaiting evidence that the external financing gap is covered. 10. As agreed under the ERIP Program, the Value Added Tax was implemented, on schedule, in July 1995. The Revenue Authority has done an outstanding job introducing and gaining acceptance for the VAT. The VAT has been very successful, as evidenced by the fact that domestic VAT collections (VAT is also applied to imports) increased from K 108 billion in 1995 to K 184 billion in 1997 Total VAT collections in 1997, including the tax on imports, were about K 300 billion, providing almost a quarter of total tax revenues. Collections of the VAT were estimated by the Revenue Authority to be 75% greater than those that the taxes it replaced would have yielded. The introduction of the VAT also improved the tariff system as it resulted in the elimination of the 5% import surcharge, or "uplift factor." 11. The Government has also met its obligation under the ERIP to protect expenditures on vital social services. Spending in the social sectors in 1995 has been at or above the levels specified in the Letter of Development Policy. The share of total social sector spending in non- debt service budget releases was 35% (compared to the minimum target of 33%), and the share of non-personnel spending in these sectors was 25% (compared to the minimum target of 24%). Similar targets for social sector spending in 1996 were agreed under the ESAC II Program and fulfilled. B. Strengthening the Financial Sector 12. As agreed under the ERIP Program, the Government has virtually eliminated its role of direct term financier of private sector development. Under the project, it was agreed that Eximbank and Lima Bank would either be privatized or liquidated. As the financial status of these two institutions made their sale impossible, they were closed and are being wound up. The ERIP Program also provided for the Development Bank of Zambia to get out of the business of direct lending. It called for DBZ to be restructured into an apex institution responsible for mobilizing and on-lending concessionary finance to commercial banks, and for DBZ's loan portfolio to be transferred to a separate collection agency. Transferring DBZ's portfolio to a collection agency was legally problematic, necessitating the restriction of the DBZ to a collection function, and creating a new apex institution, which proved to be unacceptable to parliament. The objectives were therefore accomplished by having DBZ's board order its management to suspend lending operations and concentrate on the collection of its non-performing loans. A new apex institution, Zambia Enterprise Finance Ltd., has been established under the Companies Act to mobilize concessionary external financing to be on-lent by commercial banks to the private sector. The Managing Director of DBZ indicated that the institution was engaging in a limited amount of short term lending. This is inconsistent with the Board's decision, continues to place the full burden of servicing DBZ's borrowings on the Treasury, and is contrary to the objectives of ERIP. The Government should ensure that the staff and expenses of DBZ are reduced to a level consistent with its more limited functions and that any surplus it generates from collections be returned to the Treasury immediately. 13. Strengthening the contractual savings institutions--pension funds and insurance companies--was another important element of the ERIP Program. New Acts have been enacted by Parliament to establish clear, enforceable regulatory framneworks for insurance companies and pension funds. Until the passage of the new acts, the regulation of insurance companies and pension funds was limited and inspection infrequent--not consistent with the needs of a liberalizing economy. The new legislation was drafted in consultation with the industry. Under the legislation, all insurance companies and brokers will have to be licensed, as will all pension fund managers. A single regulatory agency, the Pensions and Insurance Authority, has been established in the Ministry of Finance. The decision to establish a single agency, rather than separate agencies for pensions and insurance seems sensible, in view of the fact that six of the country's eight insurance companies are also in the pension business. The Registrar is very well qualified, as is the recently appointed Deputy Registrar for pension funds. A process of consultation with industry executives is underway and drafting of regulations will begin soon. C. Establishing a National Pension Scheme 14. Legislation has been passed to establish a National Pension Scheme and to transform the existing Zambia National Provident Fund (ZNPF) into the agency responsible for operating the new scheme. The ILO is in the process of drafting proposals for transforming ZNPF into the administrative agency. In the meantime, several critical issues remain to be resolved: contribution rates and benefit levels and transitional arrangements for present members of ZNPF. In deciding on contribution and benefit levels under the new scheme, it should be remembered that the intention of the program is to provide minimum protective benefits at the lowest rates possible, thus leaving headroom for employer-based pension plans. D. Restructuring Mining and Promoting Private Sector Mining Investment 15. The ERIP Program supported the formulation of a legal, regulatory and institutional framework for the mining industry to promote growth of the sector and to encourage private sector development of mineral resources. Consistent with these objectives, the Government adopted a new Mining Sector Policy Statement in December 1995. The objective of which is to "ensure self-sustaining mineral-based industry and encourage private investment in exploration and development. . . ." This would be achieved by putting in place a privatization plan for ZCCM and promoting private sector investment. 16. A new Mining and Minerals Act was passed, which guarantees security of title, unrestricted access to foreign exchange, companies' right to market products, and freedom of commercial operation. It also provides for international arbitration of disputes. 17. A new mining fiscal regime, including relevant amendments to the Income Tax Act, the Customs and Excise Act and the Investment Act have been approved by Parliament. The new fiscal regime concentrates on the taxation of profits, rather than output, and is also non discretionary, and internationally competitive. 18. Under the new environmental regulations, impact assessments will be required for all new projects, and existing mining areas will have to be rehabilitated. All licensees will be required to have baseline studies, environmental engineering studies, an environmental management plan, and a plan for rehabilitation after decommissioning 19. Progress has been made in strengthening the Ministry of Mineral and Mining Development (MMMD). The new Mining Environmental Regulations will ensure that new investments are socially and environmentally sustainable. The mining title system is working well and new geological data bases and maps are being prepared. MMMD has begun to implement recommendations of the studies, including establishment of regional mine offices to assist medium and small companies, including gemstone miners. 20. The new policies have already had a positive impact. For example, the operations of the Bwana Mkubwa mine, which ceased operations in 1984, were reactivated in 1997 under private ownership. There has been an upsurge in private exploration since the passage of the new Mining Act. The number of prospecting licenses in force has risen from two to about twenty, and an estimated US$100 million has been spent on exploration in the last three years. Almost half the country is now covered by international mining companies carrying out exploration and prospecting work. New owners/investors are bringing strong financial, managerial and technical capacity to the sector. 21. A plan for the privatization of ZCCM was prepared by ZPA with the assistance of investment banking and legal advisors (N. M. Rothschild and Clifford Chance, respectively). The plan, which calls for the sale of ZCCM's assets in packages, was approved by the Boards of Directors of ZCCM and ZPA and by the Cabinet and issued in May 1996. This was a major objective of the ERIP operation and fulfilled a condition for the release of the Second Tranche of the Credit. Approval of this plan marked the beginning of the implementation phase of the privatization of ZCCM. But the ultimate objective of the operation was the actual privatization of the company. The completion of the ZCCM privatization, originally targeted for June 30, 1997 is now expected in March 1998. 22. ZPA/ZCCM entered into direct negotiations with a consortium of Anglo American and Falconbridge of Canada for the Konkola Deep project and with Avmin, Ltd., a South African mining company for Konkola North. Negotiations on the latter have been completed and negotiations on Konkola Deep are ongoing, with the conclusion likely in the second quarter of 1998. In September 1996, ZPA issued an international invitation to bid on nine packages. In response 42 prospective investors carried out their due diligence. Bids were submitted by 27 investors and opened in February 1997. Since then, five asset packages were privatized and handed over to their new owners: including awarding the concession for Konkola North, and the sale of Kansanshi Mine (Cyprus Amax), Luanshya/Baluba Mines (Binani Group, a metals trading company), Chibuluma Mine (a consortium led by Metorex, a medium South African mining company), and the Power Division. 23. The major uncompleted transaction is the sale of Package A, together with the G and L packages--now consisting of Nkana and Nchanga Divisions (accounting for 55% of ZCCM's output), the Chambishi CobaltlAcid Plant, the Chingola Refractory Ore Dumps, and some subsidiaries. This is the subject of negotiations with the Kafue Consortium, consisting of Avmin Ltd. of South Africa, Phelps Dodge of the US, Noranda Exploration of Canada, and UK Commonwealth Development Corporation. These negotiations have proven to be complex and lengthy, but the sale is now expected to be completed by the end of March 1998. 24. Despite a delay of approximately three quarters of a year resulting from a change in the leadership of the Government's negotiating team and in its strategy, the time required up until now for the implementation of the ZCCM privatization has not been excessive. All parties underestimated the complexity of the ZCCM privatization. ZCCM privatization is comparable in size and complexity to that of British Coal, the privatization of which took four years. ZCCM's sale will involve outlays of approximately a US$1 billion, including cash payments, assumption of some of ZCCM's outstanding term debt, and contractual commitments for investments over the next five years. Since the Government is not the sole shareholder of ZCCM (Anglo American owns 27.3%, and other Zambian and international private investors the balance), its listing on the Lusaka, London and New York Stock exchanges, requires that the rights of the other shareholders be protected, thus requiring additional time in preparation and notification. Moreover, there are complex issues relating to retrenchment of labor, handling of ZCCM's accumulated arrears, liability for past environmental damage, ownership of staff and worker housing, and provision of social infrastructure and municipal services that are requiring time to be adequately resolved. 25. It is in Zambia's strong interest that the privatization process be concluded rapidly, and the sale of the A, G and L packages to the Kafue consortium be finalized. ZCCM's flnancial situation is precarious. Further delay could affect its operations and its relations with its creditors. The company's performance has deteriorated to the point where it threatens to undermine both Zambia's economic recovery and the privatization of the company. Completion of the sale would allow the payment of the Company's domestic arrears and provide a boost to the economy. Inflows of foreign exchange resulting from up front payments would provide some relief for Zambia's presently critical foreign exchange reserve position. Allowing new owners to take control rapidly will accelerate the process of improving efficiency and increasing output, which is in the companies' interest as well. Finally, the completion of negotiations will provide a strong positive signal to other potential investors in mining as well as other sectors. E. Impact of the ERIP Program 26. The stabilization and liberalization of the Zambia economy is beginning to show positive results. After declining by 2.3% in 1995, real GDP increased by 6.4% in 1996 and, despite a decline in agricultural output due to relatively poor weather, by 3.5% in 1997. Growth was broad based, with all sectors other than agriculture and financial services expanding. Manufacturing value-added grew by 7.4% compared to 5.5% the previous year. Mining value-added grew by 2.4%. Gross domestic savings have increased from 7.7% of GDP in 1995 to 9.5% in 1997 and gross fixed capital formation has risen from 13.8% of GDP to 14.7% over the same period. The private sector accounted for almost all of the increase in investment. 27. The shift towards a pro-export orientation in policy is helping to make Zambia's export sector a more dynamic and significant feature of Zambia's economy. The value of non-traditional products increased in 1997 by an impressive 26%, reaching a record level of over US$300 million. These exports now account for 28 % of the total and include an expanding range of agricultural, non-metal mining, agro-industrial and engineering products. 28. The economic reform program, with the support of ERIP and its predecessor and successor adjustment operations seems, at last, to be having a positive effect on poverty. According to a Government study based on the Priority Survey in 1991 and the Living Conditions Monitoring Surveys in 1993 and 1996, the incidence of poverty, which had increased from 69.7% of the total population in 1991 to 73.8% in 1993, declined to 69.2% in 1996. Extreme poverty (consumption insufficient to meet basic daily food intake) which rose from 58.2% in 1991 to 60.6% in 1993, declined to 53.2% in 1996. F. Government Contribution to the ICR 29. As agreed with the Ministry of Finance, the Government's contribution to the ICR will be forwarded to the Bank by March 20, 1998. For the Government: For the Association /S/ /S/ Professor Benjamin Mweene Emile B. Sawaya Secretary to the Treasury Principal PSD Specialist Ministry of Finance Task Manager, ERIP World Bank March 3, 1998 Lusaka, Zambia STATUS OF ZAMBIA'S ECONOMIC REFORM PROGRAMME COMPLETION REPORT FOR THE ECONOMIC RECOVERY AND INVESTMENT PROMOTION PROJECT (ERIP) 1 By the end of 1997 Government had completed the Economic Recovery and Export Promotion (ERIP) Project. This project - for which IDA provided the equivalent of US $140 million in two tranches - had been intended to facilitate the implementation of Zambia's Economic Reform Programme (ERP) in the 1995-1997 period. The ERP was designed to address poverty in Zambia through promoting private sector-led and export-oriented economic growth and by improving the delivery of vitally-needed social services. The IDA funds were used to strengthen the foreign exchange reserve position of the Bank of Zambia and helped with the smooth financing of imports, the payment of external debt service obligations and, more generally, with the implementation of the Government's programmes for economic and social development. 2. Government believes that the objectives of the ERIP project were achieved, despite a sharp decline in copper production and prices and the near-cessation of bilateral balance-of payments support. More could have been achieved - including in poverty reduction - if during the 1995-1997 period copper production had not stagnated at 300,000 tonnes annually. Nonetheless, some evidence has become available which indicates that the ERIP project has begun to have a positive effect on poverty. 3. The record of achievement can best be summarised as follows. - macro-economic stability is being achieved: inflation dropped to 18.6 percent in 1997, down from 46 percent in 1995; interest rates fell by more than one-half since mid-1995 and are currently at about 20 percent, and in 1997 the Kwacha stabilised under free exchange market conditions; for the second year running, Government realised a domestic fiscal surplus of over I percent of GDP in 1997 which compares with a deficit of 0.3 percent of GDP in 1995; - the growth momentum of the economy has been restored: after a decline of 2.3 percent in 1995, Zambia went on a positive growth path which reached 6.4 percent in 1996, indicating that the private sector has been responding positively to the Government's adjustment policies, in 1997, a growth rate of 3.5 percent was realised, despite excessive rainfall in the beginning of 1997; - Government policies to stimulate and build partnerships with the private sector have made the private sector the engine of economic growth in Zambia, private investment now accounts for some 10 percent of GDP, up from 5.5 percent in 1991 and from 7-9 percent in 1995; - significant benefits of privatisation are being realised in the wake of robust progress with the privatisation programme; by end-February 1998, 212 parastatal companies had been privatised out of ZPA's working portfolio of 326 companies; these privatisations are having a favourable impact on production, employment, incomes and export earnings. - after several years of preparation, the privatisation of ZCCM is close to completion, which, in combination with new investment in Konkola North and Konkola Deep, will inject fresh capital, new technology and private management into the copper and cobalt sector, - Zambia's foreign trade and exchange systems have been liberalised; these reforms have helped to attract foreign private investment into agriculture, mining, tourism and industry, - exports of non-traditional products have continued to increase at double-digit growth rates, from US $ 202 million in 1995 to US $329 million in 1997. These exports now account for 28 percent of Zambia's exports as compared to 17 percent in 1995-1 - to facilitate progress with poverty reduction, the share of social sector expenditures in the Budget was raised from 33.6 percent in 1995 to 34-6 percent in 19971 - a turn-around has begun in the provision of health services, reflecting the implementation of Health Sector Programme, nine out of ten babies are now born to mothers who receive ante-natal care from a doctor, a nurse or midwife, and child vaccination coverage has become much more widespread in Zambia: nearly four out of five children aged 12 to 2' ) months have received BCG, measles and three doses of each DPT and polio vaccinations.' as a result, infant mortality has stabilised- and, - while the severity and incidence of poverty in Zambia remains high, national poverty in Zambia is on the decline., having risen from 70 percent of the population in 1991 to 74 percent in 199' ), the incidence poverty has since declined to 69 percent in 1996. and in the 1993-1996 period extreme poverty fell from 61 to 53 percent- 4. However, Government is not satisfied with these achievements. Much more could have been accomplished if during the 1995-1996 period Zambia had not been required to devote a staggering 10 percent of its Gross Domestic Product to the service of its external debt (this percentage dropped to 5 percent in 1997 reflecting welcome action by Paris Club creditors and the IMF ) and if external assistance had not declined by 30 percent in the 1995-1997 period from US $544 million in 1995 to US $388 million in 1997. TABLE:EXTERNAL ASSISTANCE, DEBT SERVICE AND PRIVATE ('CAPITAL, 1995 1996 1997 Actual Actual Estimate A. EXTERNAL ASSISTANCE 544 510 388 BOP Support 283 141 120 Project Financing and Commodity Assistance 261 369 268 B. DEBT SERVICE -377 -319 -212 Exports fob 1,186 993 1,101 Debt Service as % of Exports 32 32 19 GDP 3,467 3,307 3,923 Debt Service as % of GDP 11 10 5 5. If Zambia's heavy debt burden would have been lighter and if more external assistance had been available, - more progress could have been made with reducing poverty in Zambia. While Governnent increased the relative share of social sector expenditures in the Budget, social sector expenditures declined in real terms. This contriibuted to a drop in school attendance rates in the 1995-1997 period. This deterioration could have been avoided had more resources been available; - Zambia's economic growth rate could have been 2 to 3 percentage points higher, With the resumption of economic growth in the 1995-1997 period which Government succeeded in initiating, per capita income growth could have been positive over the past three years. As it was, per capita income came down by 1 to 2 percent during the period, and, - more progress could have been made with the rehabilitation of infrastructure which is holding back economic growth and social progress. 6. Clearly, Zambia's debt burden remains very heavy indeed. Unless it is reduced further, it still will remain a strong brake on economic growth and poverty reduction, precisely at a time when Zambia is poised for take-off in both areas. Government's policy remains focused on sound macroeconomic management, but its strategic agenda for the medium-term is anchored on a marked acceleration of economic growth and a decisive reduction in poverty. 7. Most of the decline in external assistance in the 1995-1997 period is accounted for by a reduction in bilateral balance-of-payments' support which fell from US $133 million in 1995 to US $9 million in 1997 and which almost neutralised the benefits that was obtained from debt relief granted to Zambia in the 1996-1997 period. The reduction in BOP support began in 1996 when bilateral donors introduced governance considerations into their decision-making processes concerning the provision of BOP support. Since that time, the external financing programme underlying the Economic Recovery Programme has lacked the critical elements of assured and predictable availability. This seriously affected development cooperation between Zambia and the donor coalition and weakened economic recovery and social development. The lesson for the future is that more predictable and dependable levels of external assistance are needed to assist adjusting countries in implementing their reform programmes. This may require a review of the Special Programme for Africa which no longer assures that the successful implementation of economic programmes of adjusting countries will not be held back by the lack of external assistance resources. 8. As regards the decline in copper production from 500,000 tonnes in 1994 to an average of 300,000 tonnes in the three-year period thereafter, this led Government to stress the revitalisation of the mining sector so that it could once again become one of the most important determinants of economic performance in Zambia by generating increased income, foreign exchange and employment. In cognisance of this, Government decided to privatise Zambia Consolidated Copper Mines as the most viable alternative to arresting the Ion. run and steady decline in the production of metals and shrinking metal base. This privatisation process is now close to completion. 9. In conclusion, with the help of the ERIP project, the foundations for higher growth were strengthened in the 1995-1997 period, by the liberalisation of markets, by tax, tariff and financial sector reform, and by privatising state enterprises, Those reforms are now being taken further Government has already begun to Implement a three-year programme of economic recovery for the years 1998 to 2000, For this period, Govermnent has now confidently adopted as its macroeconomic objectives the achievement of economic ,-growth on the order of 5-6 percent a year, a reduction in inflation to single-digit levels, and a further strengthening of Zambia's export sector. To achieve these objectives, Government is continuing its stabilisation efforts through tight financial policies. These are being complemented by structural reforms, specifically public service reform, further trade liberalisation and export promotion, fiuther privatisation and the provision of growth-enabling as well as social infrastructure. Government has already reached agreement with the World Bank and the IMF on its economic programme for the 1998-2000 period. As part of the recovery programme 19982000, Government is stepping up Zambia's efforts to increase savings(,s, making Government leaner and more effective and improving the efficiency of investment. Government is also stepping up investment in growth- supporting infrastructure and in education and health, 10. The successful implementation of the ERIP pr 'project has not only benefited from IDA's financial resources. Government also derived significant benefits from the high-quality economic policy and technical advice received from IDA staff. 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