Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. P7591-ZA

SUPPLEMENTAL CREDIT DOCUMENT

INTERNATIONAL DEVELOPMENT AS SOCIATION

PROPOSED SECOND SUPPLEMENTAL CREDIT OF SDR 7.3 MILLION

(US$lO.O MILLION EQUIVALENT)

TO THE REPUBLIC OF ZAMBIA

FOR THE

ECONOMIC RECOVERY AND INVESTMENT PROMOTION (TECHNICAL ASSISTANCE) PROJECT

May 20,2003

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties, I t s contents may not otherwise be disclosed without World Bank authorization.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

AA BOZ CAS

CG

CEM CIR

CPPR

CSPF ERIP

ESA ESAF ESC

GDP HIPC IBRD

ICB

IDA IMF I-PRSP

KCM

LASF MMMD

Currency Unit = Zambian Kwacha (K) US$1= K4,900 (May, 2003)

FISCAL YEAR January 1 to December 3 1

ABBREVIATIONS AND ACRONYMS

Anglo American Corporation Bank of Zambia Country Assistance

Consultative Group for Zambia Strategy

Country Economic Memorandum Country Implementation Review

Country Portfolio Performance Review,

Civil Service Pension Fund Economic Recovery and Investment Credit

Economic and Social Adjustment Credit Enhanced Structural Adjustment Facility Engineering Services Corporation

Gross Domestic Product Highly Indebted Poor Countries International Bank for Reconstruction and

International Competitive Bidding Development

International Development Association International Monetary Fund Interim Poverty Reduction Strategy Paper

Konkola Copper Mines

Local Authorities Superannuation Fund Ministry of Mines and Minerals

Development

Vice President: Country Director: Sector Director: Sector Manager: Task Team Leader:

MOLA NCB NEAP

N S S R I

PER PIRC

PRGF

PRSP RPED

SCC SEC SEED

SEP VAT ZAMEFA

ZAMTEL

ZANACO ZCCM ZESCO

ZIMCO

ZNPF ZPA

ZRA

Callisto Madavo Hartwig Schafer Praful Pate1 Demba Ba Constantine Chikosi

Ministry of Legal Affairs National Competitive Bidding National Environment Action Plan

National Social Security Reform

Public Expenditure Review Privatization and Industrial Reform Credits Poverty Reduction and Growth

Poverty Reduction Strategy Paper Regional Project for Enterprise

Systematic Client Consultation Securities Exchange Commission Support to Economic Expansion and

Strategic Equity Partner Value Added Tax Zambia Metal Fabricators

Implementation

Facility

Development

Diversification Project

Zambia Telecommunications Company Zambia National Commercial Bank Zambia Consolidated Copper Mines Zambia Electricity Supply

Zambia Industrial and Mining

Zambia National Provident Fund Zambia Privatization Agency

Corporation

Corporation

Zambia Revenue Authority

2

FOR OFFICIAL USE ONLY

THE REPUBLIC OF ZAMBIA

SUPPLEMENTAL CREDIT TO THE ECONOMIC RECOVERY AND INVESTMENT PROMOTION

(TECHNICAL ASSISTANCE) PROJECT

PROJECT SUMMARY

Borrower: Republic of Zambia

Implementing Agency: Ministry of Finance and Economic Development

Beneficiaries: Ministry of Finance and Economic Development

Poverty: Not Applicable

Amount: SDR 7.3 million (US$ 10.0 million equivalent)

Terms: Standard IDA terms with a 40-year maturity, including 10 years o f grace

Financing Plan: Government: U S $ Nil (See Schedule A)

Economic Rate for Return: Not applicable

Staff Appraisal Report: None

Maps: None

Project ID: PO827 16

There i s no Project Appraisal Document. This Memorandum i s based on the findings o f a mission during the month of March 2003 and a subsequent negotiation in May 2003. The Bank team comprised Constantine Chikosi (Task Team Leader), Charles Husband (Lead Mining Specialist), Mirey Ovadiya (Operations Officer), Judith Chilufya and Yeshi Dagne (Program Assistants).

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

INTERNATIONAL DEVELOPMENT ASSOCIATION PROPOSED SECOND SUPPLEMENTAL CREDIT TO THE REPUBLIC OF

ZAMBIA FOR THE ECONOMIC RECOVERY AND INVESTMENT PROMOTION (TECHNICAL ASSISTANCE) PROJECT

A. INTRODUCTION

1. Zambia for SDR 7.3 million ( U S $ l O million) to help the Government of Zambia respond to the crisis created by Anglo American PLC’s (AA) withdrawal from i ts purchase of Konkola Copper Mines ( K O , and complete the privatization of ZCCM by restructuring KCM and securing an alternative Strategic Equity Partner (SEP). The proposed credit will supplement the ongoing Economic Recovery and Investment Promotion Technical Assistance Project (ERIPTA) and would be on standard IDA terms, with an amortization period of 40 years, including a grace period of 10 years.

The following report proposes a second supplemental credit to the Republic of

2. The proposed second supplementary credit i s consistent with the existing Country Assistance Strategy (discussed by the Board on October 7, 1999, Document ## IDA/R99- 156/1) and with the objectives of ERIPTA to support Zambia’s economic reform program which aims to promote private sector business, downsize the parastatal sector and revitalize the mining sector particularly the copper industry. The ERIPTA Credit was approved by the Bank on June 4, 1996 for US$23 million with three components i.e. technical assistance for (i) the privatization program, (ii) the Ministry of Mines, including equipment and training and (iii) the Legislative Drafting Department. The credit was signed on July 3 1, 1996 and became effective on September 27, 1996. Unexpected difficulties and delays in the ZCCM privatization led to an increase in costs and hence to a shortage of hnds for, and delays in, the privatization of the non-mining portfolio. In September 2002, the project was extended to September 3 1, 2004 to accommodate a supplemental credit of $7.5 million that was approved by the Board on September 30*, 2002 (IDAR2002-0158) to support the privatization of non-mining parastatals. Of the combined amount of $30.5 million, $8.7 million i s undisbursed, but i s restricted, under the terms of the first supplemental, to the privatization of the non-mining parastatals.

3. The proposed supplemental credit would assist the GRZ to complete the transfer of A A ’ s interests in Konkola Copper Mines (KCM) to a new private investor and includes retroactive financing for the settlement of outstanding and pending invoices from i t s legal, financial and technical advisors amounting to US$4 million. This wil l deal with the setback caused by A A ’ s withdrawal and complete the privatization of KCM which was initiated under ERIPTA. The privatization of ZCCM remains incomplete owing to A A ’ s sudden and unexpected decision to withdraw from KCM in January 2002. The supplemental fbnds are required urgently to assist GoZ settle the additional legal, financial and technical advisory fees for services rendered in bringing this transaction to a satisfactory close.

4. previous contract under which they were selected in compliance with Bank procurement guidelines. Given the urgency o f the crisis, the other three advisors were selected using the sole source method. In assessing the eligibility of the existing contracts for IDA hnding under the ERIPTA investment operation, procurement clearance was received for GoZ’s use of the sole source method.

4

The legal advisors to the initial ZCCM privatization were retained as a follow-up to a

B. BACKGROUND: ECONOMIC RECOVERY AND INVESTMENT PROMOTION TECHNICAL ASSISTANCE PROJECT (ERIPTA)

5. implementation o f the Zambian Government’s reform program, namely the privatization of parastatals and the reform o f the legal framework governing business activity. The project aims to provide technical assistance and other support to the Government o f Zambia to implement policy, institutional and regulatory reforms that will support the economic reform program, especially the privatization o f commercial parastatals, including ZCCM, and strengthen the Ministry o f Mines and Minerals Development (MMMD), and the Ministry o f Legal Affairs (MOLA). The International Development Association (IDA) financing i s to support technical assistance in areas o f (i) ZCCM privatization, (ii) financing o f ZPA activities, (iii) strengthening MMMD; and (iv) drafting new business related laws.

Credit Objectives. The objectives o f the ERIPTA Credit were to support the

6. December 3 1, 2001, activities under three components o f the credit were completed. ZCCM privatization was completed in March 2000 with the transfer o f the remaining mining assets to KCM, a company set up, owned and managed by AA. The advisory services for ZCCM’s privatization were concluded by that time. The technical assistance to the MMMD and to the legislative drafting department o f the M O L A were also completed.

Project Implementation. B y the original closing date o f the ERIPTA project on

7. increase in costs and hence to a shortage o f f h d s for, and delays in, the privatization o f the non-mining portfolio. In September 2002, the project was extended to December 3 1 , 2004 to accommodate a supplemental credit to support the privatization o f non-mining state owned entities.

Unexpected difficulties and delays in the ZCCM privatization, however, led to an

8. in K C M in March 2000 under the Bank assisted privatization o f ZCCM, liquidate the company and pay of f i t s staff, or transfer the company to the GoZ. A A ’ s withdrawal was prompted by business reasons. GoZ’s response was to seek the Bank’s support in:

In January 2002, AA announced i t s intention to sell the majority stake it had acquired

0

0

0

i ts negotiations with AA for mutually acceptable terms o f the latter’s orderly divestment and withdrawal; ensuring KCM’s survival and that it continues in operation as a viable privately owned and managed copper producer; and mitigating the significant adverse economic and social consequences for the Zambian economy in general and the Copperbelt Region in particular, which would follow as a result o f A A ’ s withdrawal.

9. legal, financial and technical advisors were retained by GoZ to help in i ts negotiations for the terms and conditions o f AA’s divestment from KCM, arrange for interim financing for KCM, restructure K C M to eliminate its debt and enhance i t s marketability, formulate a revised low cost operational plan, prepare an information memorandum, identi@ suitable strategic equity partners (SEP), and arrange for the sale and transfer o f the company as a going concern to a competent private investor with the necessary technical capacity and financial resources.

The Bank immediately fielded an emergency team to help avert the crisis. Reputable

5

10. The process o f finding another SEP for K C M was to be completed by August 2002. However, negotiations between GoZ and AA to settle the terms o f A A ' s withdrawal proved extremely complex and protracted and were only concluded in November 2002, five months behind schedule. The negotiations delayed access to the site by both the technical advisors and potential new investors, preparations for the sale o f the assets and introduction o f an SEP which i s now estimated to be completed in June 2003. So far, the GoZ has been successful in negotiating an orderly withdrawal by AA on mutually acceptable terms, restructuring K C M and securing interim financing.

11. GoZ from i t s own resources. The GoZ, however, do not have the resources to settle the estimated net costs o f advisory services to completion o f U S $ l O . O million (including invoices now due for payment and a contingency provision o f USO.9 million and $1.7 million respectively) and have had l i t t le success in mobilizing additional resources from the donor community. The GoZ has therefore turned to the Bank for assistance in concluding this critical transaction.

The initial cost o f the advisors, amounting to US$6.6 million, was financed by the

C. RECENT ECONOMIC DEVELOPMENTS

12. (such as drought, low copper prices, unstable exchange rate, etc.) or governance/economic management issues which have reduced the impact o f i t s reform program. However, Zambia has registered some major positive developments over the last four years that could help put the country on a firm and sustainable broad based growth path. Partly as a result o f completion o f the privatization o f ZCCM at the end o f the f i rs t quarter o f 2000, real GDP growth has been positive for each successive year from 1999 to-date. The donor community in turn responded by increasing their support to the country and the Consultative Group (CG) was successfblly held, for the f i rs t time, in Zambia in July 2000. In December 2000, Zambia reached the Decision Point for the Enhanced Highly Indebted Poor Countries (HIPC) Debt Relief Initiative debt on exceptional concessionary terms. To renew i ts commitment to sustainable poverty reduction, Zambia completed the preparation o f i t s Poverty Reduction Strategy Paper (PRSP) in early 2002 that was subsequently endorsed by the Executive Boards of the International Monetary Fund and the World Bank. The second in-country CG was held in Livingstone in July 2002.

Recently Zambia experienced frequent crises arising from either external shocks

13. Yet, despite such significant external support and demonstration o f goodwill by the international community, Zambia's prospects for sustainable broad-based economic growth continues to face challenges o f unstable macroeconomic environment, weak economic management and implementation capacity. The gains in the decline o f the rate o f inflation from 30.1% at the end o f 2000 to 18.7% increased to 26.7% at the end o f 2002. The inflation for 2002 was much higher than the revised target o f 16.1% and the initial target o f 15% for the year. The severe drought experienced in the 2001/2002 farming season, which drastically reduced the harvest, the AA pullout from K C M in January 2002, the low external copper prices and the continued depreciation o f the kwacha exchange rate, among other things, contributed to both the higher than projected rate o f inflation and lower than projected rate o f GDP growth (Le., 3% GDP actual growth as opposed to projected 4%). The Government's macroeconomic targets for 2003 are to achieve 4% real GDP growth rate; end year inflation rate of 17.9%; and reduce budget deficit to 1.55% o f GDP (compared to a budget deficit o f 3.3% of GDP in 2002). The expected sources o f growth include recovery in agricultural

6

production following favorable weather, manufacturing, mining (through increased productivity and reduction in unit costs), and tourism. The Government also expects to address all the HIPC Completion Point triggers during 2003 to ensure that the country reaches the completion point by the end of the year. In addition, the Government has started to implement public expenditure management reforms such as the budget framework paper (as the basis for formulating the annual budget), preparation o f the medium term expenditure framework (MTEF), change the structure o f the budget from line budgeting to activity based budgeting (ABB), piloting and installation o f the integrated financial management information system (IFMIS), and reviewing the public finance act.

D. Rationale for the Supplemental Credit

14. Consistent with the objectives o f E€UPTA to assist the implementation o f Zambia’s economic reform under its Privatization and Economic Program; the second supplemental credit will enable GoZ to retain the legal, financial and technical advisors to assist with, and ensure continuity in, its efforts to:

0 deal with the crisis precipitated by the sudden and unexpected withdrawal o f AA from Zambia, and the potential closure o f KCM and its disastrous impact on the national economy; arrange bridging finance for KCM to develop and implement a survival operating plan while a new strategic investor i s identified; and transfer the KCM assets as a going concern to competent new investors and retain the company within the private sector.

0

0

15. objective to provide the government with continuous support to implement i ts economic reforms and complete the main privatization agenda; b) will provide the added resources necessary to address the financial crisis represented by A A ’ s divestment, ensure that KCM remains in the private sector as a going concern, and reestablish the completion o f the ZCCM privatization; and c) complies with the requirements o f OP 13.20

The proposed second supplemental a) i s in line with ERIPTA’s developmental

16. control. GoZ could not have anticipated A A ’ s strategic reversal and decision to withdraw from its investments in KCM nor could it have expected the intransigence of the parties to the subsequent divestment negotiations; difficulty in quantifying the present value of A A ’ s development, social, and environmental obligations; and the complexity o f the negotiations. The subsequent need to repeat a significant part o f the ZCCM privatization program, resolve AA’s orderly withdrawal and accommodate the inevitable delays resulted directly in additional scope o f work, advisory inputs and consequent cost over runs.

The cost overrun is due to exceptional circumstances beyond the borrower’s

17. The ERIPTA credit and the first supplemental are being implemented in compliance with the project’s covenants. All the audits reports have been received on time and are unqualified. The legal covenants under the main credit have been met and the project i s in compliance with the safeguard policies in effect at the time o f the Credit effectiveness. The proposed second supplemental credit will require that the divestment of KCM and introduction of a new SEP be implemented in compliance with the relevant revised safeguards policies.

7

18. resources available without impairing the Project’s ability to achieve its objectives. The ZCCM privatization and the attainment o f the project’s main objective was significantly disrupted by A A ’ s withdrawal from KCM, and remains incomplete until another private investor i s found to substitute for AA, which i s anticipated within the next three months. This process i s almost complete and the remaining scope i s limited to the introduction o f an SEP and transfer o f the K C M assets. There i s thus little, if any, margin to reduce the scope o f the project.

I t i s extremely difficult to reduce the scope o f the Project at this stage to fit the

19. The Government o f Zambia i s unable to finance additional costs and to obtain additional funds from other lenders on reasonable terms or in reasonable time. Close to half o f the Zambian Government’s Budget i s finded by external financing which i s already committed to various public expenditures. I t therefore lacks the resources to meet the additional advisory fees, and has had litt le success in mobilizing additional resources from the donor community.

20. The time available i s too short to process a further freestanding Bank loan. The Bank i s determined to stay the course in i t s support to GoZ, but does not at present have an adjustment operation or credit that can be mobilized in time to settle outstanding claims by the advisors and ensure the orderly completion o f this key transaction. GoZ i s faced with invoices from i t s advisors which are overdue and payable immediately. The existing supplemental finds under the ERIPTA credit are restricted to the privatization o f the remaining non-mining state-owned assets and therefore cannot be used to complete the privatization o f ZCCM. Similarly, resources from other related projects such as the Mining Municipal Services or the proposed Copperbelt Environment project, cannot be deployed for this purpose since these are directed toward essential activities in support o f K C M and the other mining companies on the Copperbelt.

22. transfer o f the KCM assets to private investors. The Government has demonstrated i t s commitment by reacting to the crisis in a positive, supportive and competent manner in orchestrating the transfer o f the assets and paying i t s counterpart contributions despite tight fiscal constraints.

The Government remains committed and supportive o f the effective and orderly

23. based on the cost overruns during the project implementation and the required finds to be financed under the proposed supplemental credit are highlighted in Table 1. Progress in implementing the privatization o f non-copper public enterprises, (under category 1, c o f the project) was significantly delayed by the high cost overruns sustained during the privatization o f ZCCM. A two year delay in concluding the privatization deal more than doubled the financial and legal advisory costs to ZCCM and incurred opportunity costs for the economy as a whole.

The original cost estimates for the main project components, the revised allocations

8

Table 1. Cost Allocations Under Adjusted ERIPTA and Second Supplemental (CR. N o P759 1 -2A.l

DCA DCA Sub- Description Adjusted First Proposed Category Category Of Approved Supplemental Second

Category Allocation Credit Supplemental (Us9 (US$) Credit

(US$)

Cat. (1)

Cat. (1)

Cat. (1) Cat. (1) Cat. (1)

Cat. (1) Cat. (1) Cat. (1) Cat. (2) Cat. (2) Cat. (3) Cat. (4)

Cat. (4) Cat. (4) Cat. (5) Cat. (6)

CS: ZCCM, Tech & Mgmt

CS: ZCCM M & E Chairman

CS: ZCCM Advisors CS: ZPA, Sta f f & Mgt Support CS: ZPA, Preparatory Advisory Services CS: ZPA, Specialized TA cs: MMMD CS: MOLA Training, MMMD Training, MOLA Goods: MMMD Operating Costs, MMMD-Mining Bureau Operating Costs, Other Operating Costs, ZCCM, M P S PPF Advance Refund Unallocated

support

support

3,000,000

575,000

7,015,000 1,292,000 492,000

500,000 2,309,000 930,000 430,240 165,000 1,468,200 253,000

708,560 138,000 2,013,000 1,711,000

650,000 5,800,000

750,000

200,000

100,000

10,000,000

Total 23,000,000 7,500,000 10,000,000

CS: Consultant Services DCA: Development Credit Agreement MMMD: Ministry o f Mines and Minerals Development MOLA: Ministry o f Legal Affairs M & E: Monitoring and Evaluation PPF: Project Preparation Facility ZCCM: Zambia Consolidated Copper Mines Limited ZPA: Zambia Privatization Agency

9

24. privatization and meet the objective o f ERPTq ensure that the assets remain in the private sector which has technology, management and financial resources to restore the mine’s viability and global competitiveness, and avoid a resumption o f state subsidization o f this important component o f the Zambian economy.

Benefits. The proposed supplemental credit aims to finally complete the ZCCM

25. Risks. While the government has reiterated i ts fill commitment to the privatization of KCM, copper production has been in long-term decline in Zambia since 1969. This trend i s attributed to the exhaustion o f the original high grade and easily accessible ores, and more importantly, to the serious lack o f re-investment by the Government in ZCCM. However, the copper industry in Zambia responded to the recent privatizations o f mines by increasing copper production in 2001. The long-term decline in the copper price i s expected to slow down to about 2 percent per annum and world demand i s expected to grow by about 2 percent annually over the next five years. Zambia’s copper industry in general and K C M in particular, currently high cost producers, are expect to benefit from efficiency gains brought about by increased copper production, reduced labor and power costs, and from an injection o f new capital.

26. SEP and could revert to GOZ and management by the state owned ZCCM Investment Holdings. The ERIPTA project wil l therefore not achieve i t s developmental objectives, as the privatization o f the parastatals were an integral part o f the original project and have not yet been completed. Also, the government has indicated i ts full commitment to the continuation o f the reform program and sustainable resolution o f the mining crisis.

In the absence o f additional funding, the K C M assets may not be transferred to a

27. Agreement Amending Development Credit Agreement wil l be the only condition o f effectiveness.

Condit ion for Effectiveness. Submission o f a satisfactory legal opinion on the

10

SCHEDULE A.

COMPONENTS

THE REPUBLIC OF ZAMBIA

Local Foreign Total

SECOND SUPPLEMENTAL CREDIT FOR THE ECONOMIC RECOVERY AND INVESTMENT PROMOTION TECHNICAL

ASSISTANCE PROJECT

1. Consultancy Services 2. Goods 3. Operation Costs Total Project Costs

ESTIMATED ADDITIONAL PROJECT COSTS AND FINANCING PLAN (US$ million)

- 10.0 10.0 - - - - - - - 10.0 10.0

Estimated Costs:

COMPONENTS Government o f Zambia IDA Total Project Costs

Local Foreign Total - - - 10.0 10.0 - 10.0 10.0

Financing Plan:

11

SCHEDULE B.

CATEGORY

2. Goods 3. Operating Costs TOTAL

1. Consulting Services

THE REPUBLIC OF ZAMBIA

AMOUNT PERCENTAGE FINANCED 10.0 100%

- - - -

10.0 100%

SECOND SUPPLEMENTAL CREDIT FOR THE ECONOMIC RECOVERY AND INVESTMENT PROMOTION TECHNICAL

ASSISTANCE PROJECT

SUMMARY OF PROPOSED PROCUREMENT ARRANGEMENTS (US$ million)

Note (i) OTHER - Consulting Services covers contract extensions for the Legal Advisors and Financial and Technical Advisors on a sole source basis.

ALLOCATION AND DISBURSEMENT OF IDA SUPPLEMENTAL CREDIT (US$ million)

ESTIMATED DISBURSEMENT SCHEDULE (US$ million)

12