Document of The World Bank FOR OFFICIAL USE ONLY Report No. 21152 - ER INTERIM SUPPORT STRATEGY FOR THE STATE OF ERITREA October 23, 2000 Macroeconomics 2 (AFTM2) Country Department 6 - Eritrea 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. GOVERNMENT FISCAL YEAR January 1 - December 31 CURRENCY EQUIVALENTS Currency Unit: Eritrean Nakfa (ERN) Official Rate: US$1.00 - ERN 9.8 (October 19, 2000) ABBREVIATIONS AND ACRONYMS ACORD Agency for Cooperation and Research in Development CARE Cooperative for Assistance Relief Everywhere CEM Country Economic Memorandum CPPR Country Portfolio Performance Review DO Development Objectives ECDF Eritrean Community Development Fund ERN Eritrean Nakfa ESW Economic and Sector Work FAO Food and Agriculture Organization GDP Gross Domestic Product GNP Gross National Product HIV/AIDS Human Immunodeficiency Virus/Acquired Immunodeficiency Syndrome HRD Human Resource Development IBRD International Bank for Reconstruction and Development IDA International Development Association IMF International Monetary Fund IP Implementation Progress I-PRSP Interim Poverty Reduction Strategy Paper NGO Non-Governmental Organization OAU Organization of African Unity OED Operations Evaluation Department OXFAM Oxford Committee for Famine Relief PER Public Expenditure Review PFDJ People's Front for Democracy and Justice PSR Project Status Report TB Tuberculosis UN United Nations UJNDP United Nations Development Program UNFPA United Nations Population Fund UNICEF United Nations Children's Fund UNMEE United Nations Mission in Ethiopia and Eritrea WHO World Health Organization Vice President Callisto Madavo Country Director Oey Astra Meesook Sector Manager Frederick Kilby FOR OFFICIAL USE ONLY INTERIM SUPPORT STRATEGY FOR THE STATE OF ERITREA Contents 1. Introduction ...............................................................1 2. Country Background ...............................................................1 3. Politics and Governance ...............................................................2 4. Developments During 1998-2000: the War with Ethiopia and Drought Create a Humanitarian Crisis ......................................3 5. Human and Economic Impact of the Conflict ......................................4 6. Government's Post-Conflict Strategy for 2000-2001 ......................................7 7. World Bank's Interim Support Strategy for Eritrea ............. ........................8 8. Donor Coordination ..................................... 11 9. Risks ..................................... 11 10. Conclusions .......................................................... 12 Annex 1: Eritrea at a Glance ......................................................... 15 Annex 2: Selected Indicators of Bank Portfolio Performance and Management .......... ........ 17 Annex 3: Status of Bank Group Operations ......................................................... 19 Annex 4: Eritrea - Key Economic Indicators .................................. ....................... 21 Annex 5: Eritrea - Key Exposure Indicators .............................. ........................... 25 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization. INTERIM SUPPORT STRATEGY FOR THE STATE OF ERITREA 1. INTRODUCTION 1. This document sets out an Interim Support Strategy for Bank assistance to Eritrea as part of a multi-donor effort to assist Eritrea in addressing its most immediate needs in the face of a serious humanitarian and economic crisis. The massive population displacement and destruction of property resulting from the last round of fighting has prompted a significant shift in new development assistance towards urgent humanitarian and reconstruction interventions. Bank assistance therefore focuses on emergency reconstruction and health. Subsequently, a Transitional Support Strategy will be prepared to elaborate on the Bank's medium-term strategic response. During the coming months, Government will also prepare an Interim Poverty Reduction Strategy Paper (I-PRSP) outlining its long-term development strategy, which will serve to underpin the Transitional Support Strategy. 2. The Board has been briefed several times on the Eritrea-Ethiopia conflict. At the most recent briefing on July 18, 2000, the Board was apprised that Eritrea and Ethiopia had signed a Cessation of Hostilities Agreement in June 2000, an important step towards ending two years of conflict which erupted in May 1998 as a border dispute. It is encouraging to note that the agreement signed in June 2000 is holding, and that the leaders of both Eritrea and Ethiopia reaffirmed their commitment to finding a lasting solution to the conflict at the recent UN-sponsored Millennium Summit in New York. At the July 18 briefing, it was agreed that the Bank would prepare an Interim Support Strategy for Eritrea to accompany the Emergency Reconstruction Credit for Board discussion. Although the situation remains fragile, Bank management feels the time is right to move forward with emergency assistance. A strong effort by the international community will support and reinforce the peace process, particularly as peace talks resume on October 23, 2000. 2. COUNTRY BACKGROUND 3. Eritrea is a coastal country of about 118 thousand square kilometers in the Horn of Africa, bordered by the Red Sea, Ethiopia, Sudan and Djibouti. It has a population of about 4 million and a gross national product of about US$200 per capita. 4. Eritrea became formally independent following an internationally supervised referendum in April 1993, two years after the Eritrean People's Liberation Front assumed control of the country following a thirty-year struggle for independence. The new Government pursued policies, strategies and investments to dismantle the dirigiste economic policies of the former regime and promote rapid, widely-shared economic growth. It limited its own role mainly to creating an enabling policy environment and 1 investing in infrastructure and strategic industries in which the private sector had neither capacity nor interest. It adopted an investment code that opened up the entire economy to private investors, and acted to rehabilitate, upgrade and expand transport, communications, power, and water supply facilities; improve the capacity of government and development institutions in health, finance, education; and restore the productive capacity of the economy, particularly in agriculture and fisheries, tourism, construction, mining and manufacturing. 5. Real progress was made in all sectors of the economy. Transport and communication services were restored and expanded. Markets for labor, capital and products started functioning more efficiently. Broad-based fiscal, monetary, and trade policy regimes aimed at maintaining macroeconomic stability, mobilizing government revenue, and facilitating efficient allocation and utilization of resources were established. 6. By early 1998 most of the transition issues had been successfully addressed, investor confidence was beginning to grow and private investment in a number of sectors was increasing. The economy was growing at an annual average rate of 7 percent, among the highest in Africa. The fiscal deficit (including grants), which had increased sharply to 22 percent of GDP in 1995, declined to 20 percent in 1996 and to 6 percent in 1997. Inflation declined from about 11 percent in 1995 to about 9 percent in 1996 and to about one percent in 1997 as the Government cut spending to build up intemational reserves to prepare for the introduction of its new currency, the Eritrean Nakfa (ERN). Foreign reserves reached over five months of imports of goods and services and income payments in 1997. 3. POLITICS AND GOVERNANCE 7. Since liberation, the country has been ruled by the Provisional Government of Eritrea, formed by the Eritrean People's Liberation Front (which changed its name to the People's Front for Democracy and Justice (PFDJ) in 1993), and led by President Isaias Afwerki. There is a National Assembly made up of the 75 members of the Central Council of the PFDJ, 60 zoba or regional representatives and 15 representatives of Eritreans living abroad. The National Assembly is not a full-time body but meets when called into session. 8. A Constitutional Commission was established in 1994. It embarked upon an elaborate process of popular consultation and drafting of a Constitution. The draft Constitution was ratified by a Constituent Assembly in May 1997. Because of the outbreak of the conflict with Ethiopia, the general elections expected to be held under the new Constitution have not yet taken place. At its thirteenth session in September 2000, the National Assembly decided to hold parliamentary elections in December 2001. The laws governing multi-party elections will be promulgated in early 2001. 9. The Govemment has demonstrated real ownership of development programs, based on Eritrean authorship of its strategy and programs. Despite the need for government officials to devote most of their time to resolving the conflict and dealing 2 with the problems it caused, Government has successfully managed to implement most of its development programs during the past two years. Another notable feature of governance in Eritrea is the Government's zero tolerance of bribery and corruption. Although Eritrea has not yet established a system for ex-ante review and approval of the annual budget by the National Assembly, there is a strong culture of financial discipline within Government. The budget for 2001 is under preparation, and will be presented to the National Assembly. 4. DEVELOPMENTS DURING 1998-2000: THE WAR WITH ETHIOPIA AND DROUGHT CREATE A HUMANITARIAN CRISIS War With Ethiopia 10. Unfortunately, Eritrea's initial promising growth was disrupted by the outbreak of a border conflict with Ethiopia in May 1998 which quickly escalated into war in several border areas. While little fighting took place from June 1998 to January 1999, Ethiopia expelled some 70,000 Eritreans or Ethiopians of Eritrean descent from its territory. In addition, civilians close to the border area were obliged to relocate because of the potential risks involved. 11. On May 12, 2000 there was a major escalation in the fighting on several fronts, resulting in Ethiopian troops advancing into the Eritrean regions of Gash Barka and Debub. This created a major humanitarian crisis, as about 750,000 people (80 percent women and children) fled their homes. This brought the total number of internally displaced people to 1.1 million. 12. On June 18, 2000, the parties signed a Cessation of Hostilities Agreement and agreed to resume talks on the basis of the existing OAU Peace Framework Agreement. The agreement calls for the withdrawal of the Ethiopian army from Eritrean territory and the deployment of a United Nations peacekeeping force along a 25 kilometer buffer zone inside Eritrea until the UN can demarcate the border. On July 31, 2000 the United Nations Security Council authorized the establishment of a UN Mission in Ethiopia and Eritrea (UNMEE). During August through October, the UN deployed liaison officers in each capital city and 100 UN military observers who will maintain contact with military headquarters in each country and the field units. On September 15, 2000, the UN Security Council authorized the deployment of a peacekeeping force of up to 4,200 personnel. It is expected that the peacekeeping mission will be fully deployed by December 2000. 13. The 36th Ordinary Session of OAU Heads of State and Government, held in Lome, July 10-12, 2000, called for Ethiopia and Eritrea to negotiate the outstanding issues to achieve lasting peace. The OAU Summit gave the President of Algeria the mandate to continue the peace negotiations. These negotiations, centering on the issues of delimitation and demarcation of the border and compensation, are expected to resume in Algiers on October 23. The Governments of Eritrea and Ethiopia are cooperating with the OAU, the UN and the President of Algeria to find a lasting solution to the conflict. 3 Drought 14. Eritrea is also suffering its worst drought in many years. There has been little or no rain for the past three years in the Anseba, Northern Red Sea and Southern Red Sea areas, which produce about 24 percent of the nation's annual grain output. The poor rains of the 1999 winter resulted in widespread crop failure. About 335,000 people require assistance in obtaining basic food supplies adding to the already overwhelming burden on the Government. Although widespread famine and disease outbreaks have not yet occurred, partly owing to government efforts to mitigate the adverse impact by supplying food and other assistance, there is a growing concern that the situation will deteriorate in the coming months. 5. HUMAN AND ECONOMIC IMPACT OF THE CONFLICT Human and Social Impacts 15. The conflict has had devastating social and economic impacts in Eritrea. Some 1.1 million people have been driven from their homes. Most left on foot, leaving all their possessions behind. The conflict has also strained the housing, educational and public service systems of the villages and towns where the internally displaced people have resettled. The natural environments of these areas are also rapidly being degraded. Overcrowding increases the risk of epidemics. It is estimated that around 170,000 people in host communities are at risk. Mendefera, Tessenay, Adi Keih and Senafe have borne the greatest burden, but all towns and cities have been affected, including Asmara. 16. According to the last rapid assessment in August 2000, about 160,000 people had been able to return to their homes in Gash Barka, Debub and Anseba, but many villages have been heavily damaged and returnees have limited resources with which to rebuild. However, returning home is not yet a safe option for most of the displaced. The Ethiopian Army still occupies large areas south of the Gash River and Upper Gash and Guluj sub-zones as well as areas close to the border where landmines pose risks to returnees. 17. Because almost all men of ages 18-40 have been called up for military service, most of the displaced people are women and children. They have been receiving minimal services such as education and health care. Many are living in the hills without shelter and sanitation and many are seeking safety in remote areas, making access by the relief agencies extremely difficult. Because of the sparseness of trees and shrubs in these areas, most people living here are exposed to extreme heat, and, since the beginning of the rainy season, to rain. Most of the country's social indicators, already below the average for Sub-Saharan Africa before the conflict, will likely deteriorate further. 4 Economic Impact 18. The main economic effects of the war on the Eritrea are: * Direct war damage. Direct war damage to roads and bridges, power and telecommunications installations, schools, clinics, water supply and sanitation facilities, factories and farms is estimated to total some US$582 million, about 90 percent of 1999 GDP. * Loss of agricultural output. The areas most affected by the war, Gash Barka and Debub, are also the nation's most agriculturally productive, responsible for about 70 percent of total grain output. The fighting and widescale displacements have prevented farmers from planting their crops. Grain output is expected to fall by 75 percent and livestock production by 30 percent in 2000 compared with 1999. This has exacerbated an already critical food shortage arising from the drought. * Loss of port revenues. Port revenues have declined by about two- thirds as a result of the loss of transshipment trade with Ethiopia. The port of Assab has been particularly hard hit, as Ethiopia was responsible for 90 percent of its business. Port revenues averaged about 8 percent of GDP and 20 percent of annual government revenues in 1995-1997. In 1998-2000 they represented only about 1 percent of GDP and 4 percent of government revenues. * Decline in private sector activity. Uncertainty arising from the war, a decline in aggregate demand and a shortage of manpower have led to sharp declines in private sector activity. Many private investments, including foreign direct investments, have been postponed. Promising planned joint ventures to develop fisheries, mineral resources and tourist facilities have also been delayed indefinitely. * Decline of exports. Exports of food and livestock, beverages, salt, other commodities, manufactured goods, and machinery and transport equipment have declined sharply because of the cessation of trade with Ethiopia. In 1997 exports of goods totaled about US$54 million, in 1998 they amounted to US$28 million and in 1999 they were only US$20 million. They are projected to remain at about US$20 million in 2000 (see Table 1). * Macroeconomic impact. Direct war damage, the mobilization of 250,000 men and women, increases in military spending, declines in private sector activity and loss of port revenues have combined 5 to depress the economy. In 1998 and 1999, Eritrea's real GDP growth rate fell to well below its 1994-97 average of 7 percent. It is likely to decline by 9.5 percent in real terms in 2000. The overall fiscal deficit (including grants) ballooned from an average of 15 percent of GDP during 1994-97 to 48 percent in 1999. It is projected to be about 40 percent of GDP in 2000 owing in part to a resumption of international aid. The increase in the deficit resulted from increased spending for national defense and a decline in revenues. Defense expenditures rose from an average of about ERN 800 million during 1995-97 (12 percent of GDP) to about ERN 1,600 million during 1998-2000 (29 percent of GDP). * Debt, inflation and international reserves. The deficit has been financed by a sharp increase in domestic and external borrowing. Total external debt is expected to reach US$281 million by the end of 2000 (about 48 percent of GDP). The ratio of the net present value of external debt to the three-year average of exports of goods and services is expected to jump from 130 percent in 1999 to 218 percent in 2000. (Present value of debt to exports rose from 38.4 percent in 1998 to 78.8 percent in 1999.) The ratio of debt service to exports of goods and services (including workers' remittances) has risen from virtually nothing in 1996 to nearly 5 percent in 2000. During 1998-2000, the money supply expanded rapidly, triggering inflationary pressures, depreciation of the national currency and depletion of foreign reserves. Inflation is expected to reach 18 percent in 2000. Gross international reserves declined from an average of three months of imports of goods and services and income payments during 1994-1997 to one month in 1999 and are estimated to fall to less than one month in 2000. Table 1: Key Economic Indicators, 1994-2000 Annual 1998 1999 Projected 1994-97 2000 Gross international reserves/imports of 3 1.4 1.0 0.6 goods and services and income payments (in months) Real GDP growth (percent) 7 3.9 0.8 -9.5 Inflation (percent change) 8 9.5 9.0 18.1 Budget deficit (including grants) as 15 32.3 47.8 40.4 percent of GDP3 Merchandise exports f.o.b. (US$ million) 74 27.9 20.1 20.1 Source: Government of Eritrea and IMF estimates, September 2000 lFigures for budget deficit in Annex I exclude grants. 6 6. GOVERNMENT'S POST-CONFLICT STRATEGY FOR 2000-2001 19. The Eritrean Government's overriding objectives following the signing of the Cessation of Hostilities Agreement are to reach a peace agreement with Ethiopia, rebuild the economy and restore social services. This will require rehabilitating infrastructure and buildings damaged by the war, assisting the displaced to reestablish their homes, farms and businesses, and restoring macroeconomic balance, among other actions. Therefore over the next year or so, the Government will focus on: Meeting immediate needs for emergency humanitarian assistance. War and drought have left about 1.7 million Eritreans with inadequate resources to meet their basic needs. The situation is likely to remain extremely difficult for the next 18-24 months, during which the country will depend on emergency food assistance. It will also rely on international donors for shelter, water and sanitation infrastructure, agricultural inputs, and education, health care and transportation services. Donors, including Italy, the United States, Denmark, the United Nations agencies (World Food Program, United Nations High Commission for Refugees, UNDP, FAO, WHO, UNFPA, and UNICEF), have supplied funds, goods and logistical assistance. International NGOs, including OXFAM, Save the Children (U.K.), Africare, ACORD, the International Committee of the Red Cross, CARE International and others, are working through the Eritrean Relief and Refugee Commission to provide water and sanitation facilities, tents and tarps, and essential food and medicines to the refugee camps. The Bank has contributed to the humanitarian effort by reallocating resources from ongoing projects for emergency drugs and other health care supplies, nutritional supplements, agricultural inputs and cooking utensils, water and sanitation needs, and transportation services. * Reconstructing infrastructure and assisting displaced people to resume their economic activities. Direct war damage to infrastructure and displacement of people has affected the country's most agriculturally productive regions, so it is imperative to reconstruct damaged roads, bridges, irrigation and other infrastructure immediately to enable farmers to obtain the inputs they need to cultivate their crops and ship them to markets. It is also critical to reconstruct facilities for power and water supply, roads, health clinics and schools. Provision must also be made for maintenance of recently completed infrastructure projects. Finally, it is essential to assist displaced people, many of whom have lost their homes and all of their possessions, to rebuild their lives. 7 Restoring a stable and supportive macroeconomic framework. Bringing fiscal, monetary and balance of payments positions back into balance is critical for restoring investor confidence and reinvigorating economic growth. Cutting government spending by demobilizing the soldiers and reintegrating them into the economy is the first step. Balance of payments support to help finance critical imports will also be needed. The Government sought assistance from the IMF in September to assess recent developments and explore policy options, and has expressed interest in accessing assistance through the IMF's facility for Emergency Assistance Related to Post-Conflict Situations. 7. WORLD BANK'S INTERIM SUPPORT STRATEGY FOR ERITREA 20. Although the Bank did not provide new lending to Eritrea during the two years of war, it remained fully engaged through nonlending activities, supervision of ongoing projects and preparation of programs that would support peace once hostilities ceased. In June 2000, the Bank restructured its existing portfolio to the extent feasible to provide assistance for immediate emergency needs. The Bank agreed to reallocate US$1.2 million from the Health Project for emergency drugs and other medical supplies; to reallocate US$3.7 million from the Eritrea Community Development Fund (ECDF) Project for emergency water and sanitation needs; and to restructure the Human Resource Development (HRD) Project to release US$20 million for emergency nutritional supplements, kitchen utensils, cooking stoves, agricultural inputs and transport services.2 In addition, as a result of loss of port traffic at Assab, the Bank had earlier restructured the Ports Project. 21. While the restructuring has been helpful in meeting some urgent needs, the magnitude of destruction and human suffering calls for a shift in Bank strategy to enable it to address the country's critical requirements. Therefore, during the coming months, the Bank is proposing to resume lending for two critical projects: emergency reconstruction and HIV/AIDS. The Bank will also work with the Government on developing a program for demobilization and, together with the IMF, a potential balance of payments support program. Decisions on other important programs will be deferred until a full Transitional Support Strategy is prepared, a process that will be carried out in close consultation with Government and other development partners. Portfolio Management 22. Six Bank-financed projects are under implementation in Eritrea. The newest is the Integrated Early Childhood Development Project approved by the Board on July 27, 2 An amendment to the Human Resource Development Credit (IDA/R2000-125) which specified the restructuring measures of the credit to provide immediate assistance for emergency needs was circulated to the Board in June 2000. At that time, the Board was also informed of the restructuring measures for the other two credits, which were fully consistent with the original development objectives of these projects and thus required no amendments to the original development credit agreements. 8 2000 which has been designed with special attention to the needs of Eritrea's most vulnerable groups and which is already effective. As of October 17, 2000 the undisbursed balance for all six projects was US$100 million. Prior to the conflict, Eritrea's project implementation performance was ranked in the top quartile among the Bank's borrowers. Even with disrupted supervision activities owing to the war, implementation of the existing portfolio has been commendable. The country team has been proactive in addressing problem projects. Implementation of the emergency activities supported with funds reallocated from ongoing projects is proceeding satisfactorily. New Lending 23. The level of the Bank's proposed lending program for the Interim Support Strategy period (FY2001) reflects the relatively strong performance of the portfolio during the past year, as well as Eritrea's history of sound economic, social, and institutional performance. World Bank lending for Eritrea during the period covered by this Interim Support Strategy and the first half of fiscal 2002 would support two projects: the Emergency Reconstruction Program (US$90 million), and the HIV/AIDS-Malaria- Tuberculosis Project (up to US$40 million). 24. Emergency Reconstruction Program. This Bank-led multi-donor program will provide about US$288 million to assist Eritrea to rapidly rebuild its physical and social infrastructure, help displaced and drought-affected people rebuild their lives and resume their economic activities, and assist the Government to procure essential imports through balance of payments support. The program has five components. The first component will support agriculture through the supply of inputs, including seeds, fertilizer, farm tools and machinery and livestock. The second will support infrastructure reconstruction and rehabilitation, including roads, bridges, power plants, schools, health clinics, water supply, and houses. The third will support private sector development through the provision of both micro credit and regular bank loans and the cleanup of the war-affected bank loan portfolio. The fourth will support social protection by providing funds for community-level health, education, access roads, water and sanitation facilities, and micro credit, among others. The fifth will provide import support based on a positive list of imports; IDA is not financing this component. IDA is providing US$90 million equivalent. The remainder is being provided by the European Union (US$50 million), Italy (US$58.7 million), Denmark (US$11.million), France (US$3 million), and the African Development Bank (US$21 million) with the balance (US$24 million) being provided by the Government.3 25. HIV/AIDS-Malaria-Tuberculosis Project. HIV/AIDS, malaria and tuberculosis are three of the most deadly infectious diseases affecting Eritreans. The Bank-financed project is based on the Government's HIV/AIDS strategy. This strategy provides an effective response to HIV/AIDS and the related health issues facing Eritreans. Between 3 3The EU has indicated that it is seeking approval for an additional Euro 35 million to complete the financing package. 9 and 4 percent of adults are estimated to be infected with HIV/AIDS.4 But given the large-scale mobilization of young adults for military service, there is considerable risk that, without well-designed and implemented programs for HIV/AIDS prevention, the disease could spread fast. Malaria is a serious problem in the Eritrea lowlands, accounting for 32 percent of outpatient illnesses and 28 percent of all hospital admissions. It contributes to early death of people infected by HIV/AIDS. Tuberculosis (TB), one of the major opportunistic infections affecting people living with HIV/AIDS, also poses a significant public health risk. It spreads readily among people living in overcrowded and unhygienic conditions. Treating TB improves the quality of life for people living with HIV/AIDS and reduces the chances of infecting people who are not HIV positive. The project will collect and analyze information on the three diseases; implement multisectoral prevention programs; strengthen diagnostic, health care and counseling services; and pilot community-driven programs. Preparation of Priority Programs for the Next Phase of the Transitional Support Strategy 26. Eritrea intends to move quickly to restore macroeconomic and fiscal balance and create the conditions for long-term growth. The Bank will provide technical assistance and prepare programs for the next phase of the transition strategy, to be implemented during 2002-04. There are two immediate priorities: demobilization and support for macroeconomic management. 27. Demobilization. The Government recognizes that demobilization is crucial to achieving macroeconomic and fiscal balance and for building confidence. Demobilization will also contribute directly towards relaxing the manpower constraints that Government and businesses face. The Government has already indicated that it would like assistance in designing and mobilizing financing for a demobilization program. It is currently putting together a team to work with the Bank and other donors in developing the program. The scope and likely cost of demobilization are not yet known. The Bank is exploring the possibility of establishing a trust fund supported by donors to fund the demobilization process. 28. Support for macroeconomic management. The Bank is working with the IMF to assess Eritrea's macroeconomic and growth prospects and help the country develop an external debt management strategy. In the context of a Fund-supported program, the Bank may also consider providing balance of payments support to complement the proposed project-based interventions. 29. Development projects. The Government is preparing an Interim Poverty Reduction Strategy Paper, which will guide our future assistance strategy. It is envisaged that, over the medium term, the Bank will resume lending for key projects which support ' In the absence of more recent sero-prevalence surveys, this 1999 Govemment figure could well be an underestimate. 10 the Government's program to restore growth and social services. However, we would need to carefully review the pipeline of projects with the Government to ensure that projects address priority needs. In addition, the implementation experience of this first phase of conflict-related emergency support will need to be considered in determining the phasing and level of our future project activity. The transition support strategy will also build on the recently completed ESW in agriculture, finance and export development, and upcoming education and health sector reviews and a PER/CEM. It is anticipated that future lending will focus on community-based development, education, and key infrastructure, such as power and roads. In parallel, a program for restarting the private sector, particularly exports, may be necessary to generate growth and employment. 30. IFC. Over the past two years, IFC has been providing technical assistance for the marble and granite industry, the Chamber of Commerce and the fisheries sector. IFC's medium-term strategy is to complement Eritrea's development of the export sector. IFC is therefore exploring investment opportunities focusing on export-oriented industries, fisheries and tourism. 8. DONOR COORDINATION 31. The Government of Eritrea has established a close working relationship with its development partners in recent years. In November 1998, it sponsored a conference with its development partners to discuss its vision and programs for the short and medium term. Building on the conference, the Government has been highly effective in coordinating donor assistance for humanitarian needs and donor support for the Emergency Reconstruction Program. The preparation of the Interim Poverty Reduction Strategy Paper will further strengthen Government's relationships with its partners. A major Government-partners meeting is being planned for early 2001, assuming substantial progress is made on the peace process. The Government plans to present its proposed fiscal 2001 budget and its medium-term strategy for recovery and development at this meeting. 9. RiSKS 32. Although the Cessation of Hostilities Agreement is holding and deployment of UN troops is on track, there is still a risk that the war will resume. However, this looks increasingly less likely as both countries are now seeking international support for reconstruction, recovery, and demobilization, all of which will reinforce progress towards peace. To further minimize risks to the Bank during this period of uncertainty, a limited program is proposed to defer longer-term commitments until a transition support strategy has been prepared. If hostilities resume, management will reassess the program. It should be noted that the reconstruction program that the Bank is proposing will contribute to the establishment of peace by helping Eritrea rebuild its economy and provide essential social services. The peace process is also supported by proposing similar programs for Ethiopia and Eritrea, encouraging both to move forward with negotiated solutions to the dispute. 11 33. Aside from the risk that the war resumes, there is the risk that Government lacks capacity to prepare and implement subprojects satisfactorily. Bank staff believe this risk is quite small. Eritrea has an excellent track record of implementing Bank projects. Prior to the conflict Eritrea was in the top performance quartile of IDA borrowers and it has continued to implement development projects throughout the war. Both the Emergency Reconstruction Program and the HIV/AIDS-Malaria-Tuberculosis Project build on successful models. Implementation of these projects will also benefit from well- coordinated donor support. To manage macroeconomic risks, the Bank is working closely with the IMF. 34. While the risks of supporting Eritrea are considerable, the risks of not responding are far greater. Without external assistance, Eritrea simply could not rebuild its economy. This could set off an even worse humanitarian crisis than already exists and heighten the level of tension in the region. By the end of the fiscal year the Bank will have a better idea of progress being made in the peace negotiations. It should also be possible to form a judgment on the level of support Eritrea may need from the international community, and have a clear view of the macroeconomic framework that will be developed as part of the Interim Poverty Reduction Strategy Paper. These considerations will guide Bank programs for the longer term. 10. CONCLUSIONS 35. Given the extremely difficult circumstances the country is facing in the aftermath of the conflict, Eritrea requires exceptional assistance for the next several years. The lending program and advisory services proposed for the period covered by the Interim Support Strategy aim to address Eritrea's most pressing needs through new lending for emergency reconstruction and a health project to address HIV/AIDS and the related burdens of malaria and tuberculosis. The Bank intends to be proactive in supporting the Government's development partner coordination efforts as part of the interim poverty reduction strategy process. 36. Following the preparation of the Government's I-PRSP and before proceeding with additional lending beyond the emergency reconstruction and HIV/AIDS projects discussed above, management will submit a Transitional Support Strategy to the Board. The report will focus on progress made towards achieving peace, steps being taken by the Government to restore macroeconomic stability, portfolio implementation, capacity constraints that Government faces, donor coordination, and the Bank's proposed strategic response. James D. Wolfensohn President By: Shengman Zhang Washington, D.C. October 23, 2000 12 ERITREA Interim Support Strategy For Eritrea Annexes Annexes: 1. Eritrea at a Glance 2. Selected Indicators of Bank Portfolio Performance and Management 3. Status of Bank Group Operations 4. Eritrea - Key Economic Indicators 5. Eritrea - Key Exposure Indicators 13 Annex 1 Page I of 2 Eritrea at a glance 10/18/00 Sub- POVERTY and SOCIAL Saharan Low- - Erito Aftica Income Development dlamond' 199S Pooulalion, mbi-vear millionsl 4.0 642 2.417 Life expectancy GNP oDr caoita (Atlas method. USS) 200 500 410 GNP (Atlas meth. US$ billons) 0.78 321 988 T Averse annual orowth. 199349 Poculation (%) 2 7 2.6 19' Labor force (%) 2.7 2.6 2.3 GNP +. Gross Nl" roentogmaf thm ow vaiabe. ooz"lper . primary Moat rec nt~ e larnstta t vear avaiable. 1S9349Si capita Pnnrnllrnmnt Povertv (% of Dooulatin below national oovertv line) Urban ooouatlon (% of total Doaulabonl 18 34 31 Life exoectancv al birth (vears) 51 50 60 Infant mortalitv (oer I.ooolive baths) 61 92 77 Child malnutrition (% of children under 5S 44 32 43 Access to safe water AcCess to imoroved water source (% of ooDulation) 7 43 64 Illiteracv (% of DoDulation ace 15+) 47 39 39 Gross Drimary enrollment (% of school-aqe oooulalonl 53 78 96 Male 59 85 102 Eritrea Low-income group Female 48 71 86 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1979 19i9 1998 1999 - - EconomIc ratlos' GoP (USS billions) .. .. 0.66 06 5 Gross domestic investment/GDP 47.2 47.3 EXoorts of aoods and serviceslGDP 18.0 10.2 Trade Gross domestic savinas/GDP -24.5 -21.3 Gross national savinos/GoP 12.2 14.9 Current account balancetGDP -35.0 -43.7 Domestic Interest cavments/GDP 0.5 0.4 S Investment Total debl/GDP 20.8 37.5 ngs Total debt servicelexoorts 0.4 0.7 Present value of debt/GOP 13 8 25.4 Present value of debt/exorl.s 38.4 78 B indebtedness 1979489 1989M99 1199 1999 1999-03 (averaoe arnnuat rowth) GDP 5.0 3.9 0.8 3,2 - Eritrea - Low-income group GNP Der capita 1.7 -5.8 -2.2 0.6 Exoorts of ooods and servces -4.8 -46.6 -35.8 26.1 STRUCTURE of the ECONOMY 1979 1989 1998 1999 GrowthofInvestmentand GOPl%l (% of GDP) GD Aariculture 16.9 16.1 17.1 Industry 33.6 27.4 29.2 10 Manufacturina 30.0 14.1 14.9 5 Services 49.5 56.5 53.7 o ___ -__> Private consumption 75.5 70.8 .5 ' 957 98 99 General aovernment consumotion 49.0 50.6 -GD GDP ImDorts of qoods and services 87.6 78.8 1979-89 1989-99 1998 1999 Growth of exports and imports (%) (averaae annual arowth) Aariculture sO Industrv 60 Manufacturina 40 Services 20 Private consumotion -20 94 95 96 97 98 General aovernment consumotion 40 Gross domestic investment ImDorts of ooods and services 12.0 1.5 -14.2 - Exports -*Imports Gross national Droduct 4.5 -3.2 0.7 Note: 1999 data are estimates. GDP components are estimated at factor cost. The diamonds show four kev indicators in the countrv tin bold) comDared with its income-arouD averaae. If data are missina. the diamond will be incomDlete. 15 Annex I Page 2 of 2 Eritrea PRICES and GOVERNMENT FINANCE 1979 1989 1998 1999 Flnatlon Domestic pnices (% change) Consumer prces 9.5 9.0 30 Implicit GDP deflator . 2.7 8.2 j20 Govemment finance 10 (% of GDP. includes current grants) o Current revenue 3458 37.0 94 95 9S 97 58 99 Current budget balance . -12.8 -13.0 - GDP deflator °CPI Overall surplus/deficit . -41.4 -54.3 TRADE (US$ mrillions) 1979 1989 1998 1999 [Export and Import levels (USS mill.) Total exports (fob) . 28 20 Sm n a. n.a. 400 Manufactures 7 Total imports (cif) . 527 495 Food . 75j Fuel and energy 6 l *_ Capital goods . 139 0 , Exoort orice index (1995=100) - ImDort Drice index (1995=100) . Exports Imports Terms of trade (1995=100) BALANCE of PAYMENTS 1979 1989 1998 1999 j (USS nxtlions) Current account balance to GOP (%) Exports of goods and services 109 66 20 Imports of goods and services .. 597 597 10 Resource balance . . -488 -532 1 Net income .. 4 6 .10 | 94 Net current transfers .. 246 244 -20T Current account balance .. -238 -282 30 t|i I Financing items (net) .. 60 302 -40 Changes in net reserves .. 179 -20 - Memo: Reserves includino aold (US$ millions) .. 73 53 Conversion rate (DEC. locallUSS) -. 7.4 8.5 EXTERNAL DEBT and RESOURCE FLOWS 1979 1989 1998 1999 r (US$ nWilions) Composition of 1999 debt (USS mill.) Total debt outstanding and disbursed -. 142 242 IBRD .. 0 0 IDA . . 37 56 Total debt service .. 1 2 IBRD . . 0 0 IDA . 0 0 E. 150 Composition of net resource flows Official grants 74 Official creditors 65 69 Private creditors ° 0 0 Foreign direct investment . . 0 Portfolio equity 0 1 World Bank program Commitments . 53 0 A - BRD E - Bilateral Disbursements 6. 8 16 B- IDA D- Other multilateral F - Pnvate Principal repayments . 0 0 ! C - IMF G - Short-term Net flows . . 6 16 Interest payments . . 0 0 Net transfers .. 6 16 Development Economics 10/18/00 16 Annex 2 Selected Indicators* of Bank Portfolio Performance and Management (as of 10/17/2000) Indicator 1998 1999 2000 2001 Portfolio Assessment Number of Projects Under Implementation a5 5 5 6 Average Implementation Period (years) b 1.1 2.1 3 2.8 Percent of Problem Projects by Number a c 0 20 40 33.3 Percent of Problem Projects by Amount ' c 0 24.2 66.4 50.4 Percent of Projects at Risk by Number ad 0 20 40 33.3 Percent of Projects at Risk by Amount d 0 24.2 66.4 50.4 Disbursement Ratio (%)e 28 12.6 15.1 23.1 Portfolio Management CPPR during the year (yes/no) No No No No Memorandum Item Since Last Five FY 80 FYs Proj Eval by OED by Number 1 1 Proj Eval by OED by Amt (US$ millions) 24.5 24.5 % of OED Projects Rated U or HU by Number 0 0 % of OED Projects Rated U or HU by Amt 0 0 a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year. 17 Status of Bank Group Operations (Eritrea Portfolio) (as of 10/17/2000) Closed I Projects Active Difference Between Proiects Last PSR Expected and Actual Supervision Rating b/ Orieinal Amount in USS Disbursements aI Millions Project ID Project Name Develovment Implementati Fiscal IBRD IDA GE Cancel. Undisb. Orig. Frm Obiectives on Proeress Year Rev'd P039264 COMMUNITY DEVELOPMENT FUND S S 1996 0 17.5 0 0 2 2.1 0 P043124 HEALTHPROJECT S S 1998 0 18.3 0 0 14.7 8.5 0.1 P050354 HUMAN RES.DEV S U 1998 0 53 0 0 30.4 3.7 0 P068463 INTEGRATED EARLY CHILDHOOD S S 2001 0 40 0 0 37.4 0.5 0 PROJECT P034154 PORTS S U 1998 0 30.3 0 0 15.2 9.9 0 P044651 ROAD ENGR. CREDIT S S 1997 0 6.3 0 0 0.8 1.1 0 TOTAL: 0 165.4 0 0 100.6 25.8 0.1 Annex 4 Page 1 of 3 Eritrea - Key Economic Indicators Actual Estimate Indicator 1995 1996 1997 1998 1999 2000 National accounts (as % GDP at current market prices) Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 10.1 8.7 8.3 14.6 15.6 15.8 Industry 20.5 24.5 26.3 24.9 26.5 26.9 Services 59.7 56.1 54.5 51.3 48.8 49.4 Total Consumption 138.6 131.0 117.4 124.5 121.3 128.0 Gross domestic fixed 19.3 29.3 40.9 47.2 47.3 53.2 investment Government investment .. .. .. Private investment .. .. (includes increase in stocks) Exports (GNFS) a/ 29.9 31.7 31.1 16.0 10.2 12.7 Imports (GNFS) 87.7 92.0 89.4 87.6 78.8 93.9 Gross domestic savings -38.6 -31.0 -17.4 -24.5 -21.3 -28.0 Gross national savings bl 2.7 8.8 35.3 12.2 14.9 19.2 Memorandum items Gross domestic product 574 631 655 681 645 586 (US$ million at current prices) Gross national product per 180 200 230 210 200 - capita (US$, Atlas method) Real annual growth rates (%, calculated from 1970 prices) Gross domestic product at 2.9% 6.8% 7.9% 3.9% 0.8% -9.5% market prices Gross Domestic Income 3.3% 9.6% 8.3% 1.4% -0.7% -9.5% Real annual per capita growth rates (%, calculated from 1970 prices) Gross domestic product at 0.3% 4.0% 4.9% 1.1% -2.0% -11.8% market prices Total consumption .. .. .. .. .. Private consumption .. .. .. .. .. (Continued) 21 Annex 4 Page 2 of 3 Eritrea - Key Economic Indicators (Continued) Actual Estimate Indicator 1995 1996 1997 1998 1999 2000 Balance of Payments (US$m) Exports (GNFS) a/ 171A4 200.1 203.3 108.7 65.6 74.7 Merchandise FOB 80.6 95.3 53.5 27.9 20.1 20.1 Imports (GNFS) a/ 447.5 567.4 589.0 596.8 597.4 492.6 Merchandise FOB 403.8 513.7 494.6 526.8 494.6 469.2 Resource balance -276.1 -367.3 -385.7 -488.1 -531.8 -417.9 Net current transfers 237.4 270.8 352.1 245.5 243.6 249.2 (including official current transfers) Current account balance 17.8 -48.9 14.4 -175.3 -204.7 -107.3 (after official capital grants) Net private foreign direct 0.0 36.7 38.7 31.7 83.0 7.8 investment Long-term loans (net) c/ 57.1 62.3 80.3 128.4 183.9 110.1 Official 7.2 6.9 33.3 65.3 69.3 79.1 Private 49.9 55.4 47.0 63.1 114.6 31.0 Other capital (net, including -133.0 -125.7 -194.1 -163.4 -42.6 -36.8 errors and omissions) Change in reserves d/ 58.1 75.6 60.7 178.6 -19.6 26.2 Memorandum items Resource balance (% of -48.1% -58.2% -58.9% -71.7% -82.4% -71.3% GDP at current market prices) Real annual growth rates (1970 prices) Merchandise exports .. .. .. (FOB) Primary Manufactures .. .. .. Merchandise imports . . .. .. (CIF) Public finance (as % of GDP at current market prices) el Current revenues 34.1 32.6 42.9 34.8 37.0 32.2 Current expenditures 55.0 44.3 30.7 47.6 50.1 57.0 (Continued) 22 Annex 4 Page 3 of 3 Eritrea - Key Economic Indicators (Continued) Actual Estimate Indicator 1995 1996 1997 1998 1999 2000 Current account surplus(+) -20.9 -11.7 12.2 -12.8 -13.0 -24.8 or deficit (-) Capital expenditure 14.2 19.0 24.2 28.6 41.3 27.5 Foreign financing 13.9 12.5 10.5 18.8 22.4 17.6 Monetary indicators M2/GDP (at current market 83.3 92.4 105.0 120.6 144.3 167.5 prices) Growth of M2 (%) 11.7 21.8 26.0 22.4 30.5 21.6 Private sector credit growth/ 3.6 -76.3 60.9 30.3 -13.4 7.9 total credit growth (%) Price indices( 1970 =100) Merchandise export price .. .. .. index Merchandise import price index Merchandise terms of trade .. .. .. index Real exchange rate 7.8 3.7 5.3 (US$/LCU) f/ Real interest rates Consumer price index 10.7% 9.3% 1.3% 9.5% 9.0% 18.1% (% growth rate) GDP deflator 11.3% 2.9% 2.7% 2.7% 8.2% 15.7% (% growth rate) Source: Government of Eritrea and IMF staff estimates. a. "GNFS" denotes "goods and nonfactor services." b. Includes net unrequited transfers excluding official capital grants. c. Includes capital grants. d. Includes use of IMF resources. e. Central government. f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation. 23 Annex 5 Eritrea - Key Exposure Indicators Actual Estimate Indicator 1995 1996 1997 1998 1999 2U00 Total debt outstanding and 39.1 47.2 76.1 141.6 242.2 281.0 disbursed (TDO) (US$m) a/ Net disbursements (US$m) a/ 8.2 7.4 28.9 65.5 106.5 38.8 Total debt service (TDS) 0.2 0.4 0.6 0.9 1.5 10.2 (US$m) a/ Debt and debt service indicators (%) TDO/XGS b/ 13.1 13.7 19.5 57.8 116.4 128.6 TDO/GDP 6.8 7.5 11.6 20.8 37.5 47.9 TDS/XGS 0.07 0.12 0.15 0.37 0.72 4.67 ConcessionalfTDO 100.0 95.6 96.1 93.4 94.7 ... IBRD exposure indicators (%) IBRD DS/public DS 0.0 0.0 0.0 0.0 0.0 0.0 Preferred creditor DS/public 100.0 .. 52.9 17.5 35.3 49.0 DS (%) IBRD DS/XGS 0.0 0.0 0.0 0.0 0.0 0.0 IBRD TDO (US$m) c/ 0.0 0.0 0.0 0.0 0.0 0.0 Of which present value of 0.0 0.0 0.0 0.0 0.0 0.0 guarantees (US$m) Share of IBRD portfolio (%) 0.0 0.0 0.0 0.0 0.0 0.0 IDA TDO (US$m) c/ 24.3 26.5 28.8 36.9 55.8 89.5 IFC (US$m) Loans 0.0 0.0 0.7 0.0 0.0 Equity and quasi-equity d/ 0.0 0.0 0.2 0.0 0.0 MIGA MIGA guarantees (US$m) 0.0 0.0 0.0 0.0 0.0 Source: Government of Eritrea and IMF staff estimates. a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short- term capital. b. "XGS" denotes exports of goods and services, including workers' remittances. c. Includes present value of guarantees. d. Includes equity and quasi-equity types of both loan and equity instruments. 25