Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 10405

PROGRAM PERFORMANCE AUDIT REPORT

MADAGASCAR

INDUSTRIAL ASSISTANCE PROJECT(IDA CREDIT 1541-MAC AND

SFA CREDIT A-7-MAG)

FEBRUARY 27, 1992

MICROFICHE COPY

Report No. 10405-MAG Type: (PPR)NAMISATO, / X31678 / T9 105/ OEDD2

Operations Evaluation Department

This document has a restricted distribution and may be used by recipients only in the performance o"

their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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ABBRVIATIONS

BNI Bankin'Ny Indostria (National Bank of Industry)

ISAC Industrial Sector Adjustment Credit

ITPAC Industrial and Trade Policy Adjustment Credit

HIEK Ministry of Industry, Energy and Mines

OGL Open General Licence

PIP Public Investment Program

PSAC Public Sector Adjustment Credit

RIL Liberalized Import Regime

SFA Special Facility for Sub-Saharan Africa

SILI Liberalized Import System

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington, D.C. 20433U.5A

Office of Directo-GeneralOpeatms Evaluatkn

February 27. 1992

MENORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Program Performance Audit Report on Madagascar -Industrial Assistance Project (IDA Credit 1541-MAG

and SFA Credit A-7-MAG)

Attached, for information, is a copy of a report entitled "ProgramPerformance Audit Report on Madagascar - Industrial Assistance Project (IDACredit 1541-MAG and SFA Credit A-7-MAG)" prepared by the Operations EvaluationDepartment.

Attachment

This document has a restricted distributioki and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

PROGRAM PERFORMANCE AUDIT REPORT

MADAGASCAR

INDUSTRIAL ASSISTANCE PROJECT(IDA Credit 1541-MAG and

SFA Credit A-7-MAG)

TABLE OF CONTENTS

Page No.

PROJECT PERFORMANCE AUDIT REPORT

PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iBASIC DATA SHEET . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1EVALUATION SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . v

I. BACKGROUND....................... . . . 1

A. Historical Background of the Malagasy Economy.... . ..1B. Evolution and Features of the Industzial Sector . . . . . 3

II. CONCEPT AND DESIGN OF THE ISAC. . ........... . . . . 6

A. Industry Constraints at the Time of the ISAC. .... . . 6B. The New Industrial Development Strategy..... . . . . . 9C. Objectives, Policy Instruments, and Conditionality . . . 10

III. IMPLEMENTATION EXPERIENCE AND OUTCOME. ......... . .. 12

A. Policy Package.............. ..... . .. 13(1) Price Liberalization...... ..... . . . .. 13(2) Public Investment Program (PIP) Reform..... . .. 14(3) Import Liberalization and Export Promotion . . . . . 15(4) Private Sector Encouragement. ....... . . . .. 17

B. BNI Investment Component . . .............. 18C. Technical Assistance Component..... .... . . . .. 20

IV. ASSESSMENT OF OUTCOME WITHIN THE OVERALL ADJUSTMENT PROGRAM . . 20

A. Assessment of Outcome . . . . . . . . . . . . . . . . . . 20B. Impact on Macroeconomic Performance (1985-1989) . . . . . 26C. Supply Response . . . . . . . . . . . . . . . . . . . . . 26

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

Table of Contents (cont'd)

Page No.

V. CREDIT DESIGN, UTILIZATION. AND SUPERVISION. ... . . . . .. 28

A. Design Evaluation . . . . . . . . . . . . . . . . . . . . 28(1) Gradualism: The Governance Dimension and Social

Considerations . . . . . . . . . . . . . . . . . . . 28(2) Sequencing of Reforms . . . . . . . . . . . . . . . 30(3) Conditionality Issues . . . . . . . . . . . . . . . 31

B. Disbursements . . . . . . . . . . . . . . . . . . . . . . 32C. Supervision . . . . . . . . . . . . . . . . . . . . . . . 33

VI. SUSTAINABILITY OF THE ADJUSTMENT EFFORT........ . . .. 34

A. Economic Performance and Sustainability Assessment . . . 34B. Social and Political Issues. ........ . . . . . .. 34

VII. CONCLUSIONS AND LESSONS OF EXPERIENCE......... . . .. 36

A. Summary Assessment . . . . . . . . . . . . . . . . . . . 36B. Lessons of Experience . . . . . . . . . . . . . . . . . . 36

ANNEXES

I. KEY ECONOMIC INDICATORS: 1980-1990. ........ . . . . .. 39II. MATRIX: GOVERNMENT PROGRAM FOR INDUSTRIAL SECTOR.... . . .. 40

PROJECT COMPLETION REPORT

A. INTRODUCTION.............. ...... . . . .. 45

B. BACKGROUND............... ...... . . . .. 45

C. PROJECT PREPARATION AND APPRAISAL...... .... . . . .. 46

D. INSTITUTIONAL PERFORMANCE.......... .... . . . .. 48

Price Liberalization . . . . . . . . . . . . . . . . . . . . . 48Public Investment Program . . . . . . . . . . . . . . . . . . 48Export Promotion . . . . . . . . . . . . . . . . . . . . . . . 49Import Liberalization . . . . . . . . . . . . . . . . . . .49Investment Code . . . . . . . . . . . . . . . . . . . . . . . 49Rehabilitation Component . . . . . . . . . . . . . . . . . . . 50Technical Assistance . . . . . . . . . . . . . . . . . . . . . 50

E. MONITORING AND IMPLEMENTATION......... .... . . .. 50

Table of Contents (cont'd)

Page No.

F. DISBURSEMENTS................ ..... . .. 51

G. CONCLUSIONS AND LESSONS LEARNED....... .... . . .. 51

PART I I

A. COMMENTS ON THE WORLD BANK'S PROJECT COMPLETION REPORT . . . . 53

B. REPORT PREPARED BY THE BORROWER AND EXECUTING AGENCIES . . . . 54

1. Comments by the Ministry of Economy and Plan . . . . . . 542. Comments by the Ministry of Industry, Energy and Mining . 553. Comments by the National Bank of Industry (BNI) . . . . . 57

PROGRAM PERFORMANCE AVDIT REPORT

MADAGASCAR

INDUSTRIAL ASSISTANCE PROJECT(IDA Credit 1541-MAG and

SFA Credit A-7-MAG)

PREFACE

1. This is the Program Performance Audit Report (PPAR) on the IndustrialSector Adjustment Credit (ISAC) to Madagascar, involving IDA Credit 1541-MAG andSpecial African Facility Credit (SFA) A-7-MAG. The IDA Cred"t, in the amount ofSDR 40.2 million, was approved in January 15, 1985 and *-< t disbursement wason Septembcr 22, 1986; the Credit was closed on Septembe. 1990, three yearsbehind schedule. The Special African Facility Credit, i ne amount of SDR 18.9million, was approved on December 6, 1985 on an absence of objection basis. Lastdisbursement and closing dates are the same as for the IDA Crcdit.

2. The PPAR was prepared by the Operations Evaluation Department (OED) andthe Program Completion Report (PCR) was prepared by the Industry and EnergyOperations Division of the South Central and Indian Ocean Department of theAfrica Region. The PPAR is based on the attached PCR, the President's Report,the loan documents, economic and sector reports, loan and country files,President's Reports of follow-up credits, the latest CEM Report No. 9101,"Madagascar - Beyond Stabilization to Sustainable Growth," and Report No.7784,"Madagascar - Adjustment in the Industrial Sector and an Agenda for FurtherReforms." OED staff interviewed present and former Bank who had been associatedwith the ISAC or with economic work in Madagascar.

3. A mission was scheduled to visit the country but had to be canceledowing to civil disorders. Therefore, some of thp PPAR conclusions, particularlythose dealing with sustainability, may have to be reconfirmed later. OED expectsto conduct a field visit in connection with the forthcoming audit of ITPAC(Credit Nos. 1834-MAG and A-32-MAG).

4. The PCR provides a good account and assessment of the programexperience with regard to preparation and appraisal; institutional performance;achievements of the reforms; credit monitoring and implementation; disbursementissues; and draws lessons from the experience. The PPAR discusses trends in theMalagasy economy and the evolution of industrial policy; summarizes the statusquo ante and the critical constraints in the industrial sector that led to ISACevaluates the implementation record of agreed upon actions, includingcompl,.entary actions undertaken with the support of follow up credits; assessesthe outcome and the impact of the program on macroeconomic performance andindustrial supply response within the framework of the overall adjustment effortof the Malagasy Government; assesses the quality of the design and policy packageand che supervision effort; analyzes disbursement delays; determines key factorsinfluencing the effectiveness and sustainability of the policy reforms; and drawslessons from the program experience.

5. The draft PPAR was sent to the Borrower for comments but none werereceived.

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PROGRAM PERFORMANCE AUDIT REPORT

MADAGASCARINDUSTRIAL ASSISTANCE PROJECT

(IDA Credit 1541-MAG andSFA Credit A-7-MAG)

BASIC DATA SHEETAmounts (SDR million)

As of April 30, 1991

Oriqnal Disbured canceled Repaid OutstandIngIDA 15414AG 40.20 40.19 0.01 0.00 40.19SFA A-7MAG 18.90 '8.00 0.00 0.00 18.90TOTAL 59.06 59.06 0.01 0.00 59.08

Original Credit Dates Actual or Re-etmatedkiteing Memorandum 29 July 1983 29 July 1963Lar of Development Policy 30 Nov 1984 30 Nov 1984Negonlloe Nov 1984 Nov 19OBoard Approval 15 Jan 1985 15 Jan 1985Sgrature 22 Mar 1985 DA: 13 Dec 1986 SFA 22 Mar 198 IDA: 13 Dec 198 SFACarit Eeomiveness Mar 1986 28 Aug 1985 IDA; 3 Mar 198 SFA2nd Trano Rlosse Jan 198 22 Sep 1S9Credit Closing 30 Sep 98 30 Sep 1990

CUULATIVE CREDIT DISBURSEMENT

FY85 FYa6 FY87 FYe8 FY89 FY90 FY91IDA 1541AAG Planned 5.33 32.86 39.80 40.20 40.20 40.20 40.20

Acual 0.00 14.24 23.12 30.97 38.42 40.16 40.19SFA A-7MAG Planned 0.00 10.40 16.00 18-90 18.90 18.90 18.90

Actual 0.00 3.54 14.27 16.51 18.82 18.90 18.90Total Planned 5.33 43.26 55.50 59.10 59.10 59.10 59.10

Actual 0.00 17.77 37.39 47.48 55.25 59.08 59.06

AdualTotalsa%PlannedTotal 0.00 41.0 67.0 80.0 93. 99. 99.0

MISSION DATA

No. of No. of Siir Dab ofMonthlYear Wees Paort Weeks Report

Preparation 1983 3 3 9 29 JL 1983AppraibulJPosAppraisal Jan*Feb 1984 4 4 16 25 Apr 1964Supervwsin NA NA 3 50 MIsNComplsion NA NA NA NA

FOLLOW-ON ADJUSTMENT OPERATIONS

MADAGASCAR- Indufby and Trade Adjustment Credit (Credits 1844MAG and A.32-MAG) approved an June 30, 197 Inthe amount of usse3 mi"n.

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PROCRAM PERFORMANCE AUDIT REPORT

HADAGA%SCA

INDUSTRIAL ASSISTANCE PROJECT(IDA C^adit 1541-MAG and

SFA Credit A-7-MAG)

EVALUATION SUMMARY

Introduction

1. This is the audit of the Indus- began fully only in 1987 and was sup-trial Sector Adjustment Credit (ISAC) ported by IMF Stand-by loans and Worldto Madagascar, involving IDA Credit Bank operations in the agricultural,1541-MAG in the amount of SDR 40.2 trade, and public sectors (paras.million, approved in January 15, 1985 1.03-07).and the Special African Facility Cred-it (SFA) A-7-MAG in the amount of SDR PbJectives18.9 million, approved on December 6,1985. 3. The purpose of ISAC was to sup-

port the Government's strategy of2. Madagascar, with a population of bringing about meaningful policy chan-approximately 11.5 million and a per ges in the industrial sector designedcapita income of US$230 in 1989, is to increase its efficiency and produc-among the 12 poorest countries in the tivity, while beginning the process ofworld. After facing a sharp economic establishing an environment conduciverecession in 1980-1982, the Government to efficient import substitution andbegan in 1983 the implementation of export production. These policy chan-economic reforms. Macroeconomic bal- ges would constitute important firstances improved and there was a modest steps towards promoting the efficien-recovery in growth; during the 1983- cy, openness, and export-orientation1987 period GDP grew at an average of of the Malagasy industrial sector so1.4 percent per year, still below that it could increasingly contributepopulation growth (para. 1.01). Even to the country's balance of paymentsthough the stabilization effort that and to the growth of employment ardbegan in 1982 served to restore inter- output (para. 2.04).nal and external equilibria, structur-al problems remained in place. In 4. The credit supported policy1984, the Government began emphasizing reforms designed to increase the effi-the underlying supply-side constraints ciency and productivity of the indus-faced by the economy. The authorities trial sector, and the capacity utili-started implementing structural ad- zation of selected efficient industri-justment measures, including the first al enterprises so as to enable them tozteps toward a general liberalization produce goods for the domestic marketof most economic activities with ac- and for export. The credit providedtions such as those taken under the foreign exchange for imports of inputsISAC. In practice, however, the ad- and spare parts, rehabilitation equip-justment program's implementation ment, and technical assistance. The

- vi -

reform package consisted of (para. Support Project (EMSAP-1989), the2.06): Financial Sector and Private Enter

prise Credit (1990), and the Environ-(1) price liberalization, ment Program (1990) (paras. 2.04 and(2) public investment program (PIP) 4.01-04). The implementation record

refoim, for the various measures included in(a) import liberalization, the ISAC and the outcome of ISAC with-(4) export promotion, in the overall adjustment program are(5) private sector encouragement. described in detail in paras. 3.03-

3.22 and are summn&rized below:IMplementation Experience and Outcome

7. Between 1983 and 1989, in the5. The original credit effective- context of the overall adjustmentness date was March 1985, but formal effort, the Malagasy Government suc-effectiveness was delayed to August ceeded in re oving most price con-1985 since more time was needed to trols. In the industrial sector, theawait the actual hiring of ti': consul- price liberalization effort supportedtants for the preparation of the ex- by ISAC, was completed in 1989 throughport action program. Second tranche reforms implemented under ITPAC.disbursement was postponed from Janu- Currently, only prices of products andary 1986 to September 1986 owing to services provided by state monopoliesdelays in the preparation of the ex- are still controlled (paras. 3.04-05port promotion program. Because of and 4.05).major problems with the investmentcomponent managed by BNI, credit clos- 8. While under ISAC a small numbering was delayed by three years. The of import prohibitions were removedclosing date was originally set for and replaced by tariffs and a fewSeptember 30, 1987, but was extended export-promoting measures were imple-first to September 30, 1988, then to mented, substantial distortions re-March 30, 1989. Eventually the credit mained in the trade regime and a gen-was closed on September 30, 1990 (pa- eral anti-export bias of trade andra. 3.01). macroeconomic policy still existed.

Thus, particularly in the exchange and6. It would not be appropriate to trade area. ISAC provided oply theassess results and draw lessons for groundwork while ITPAC and PSAC set inISAC individually. ISAC was only motion a far-reaching program to re-intended to pave the way in the direc- form the instruments of trade Rolicv.tion of adjustment as a first steptoward a more comprehensive reform 9. On the import side, in Januaryprocess. It was followed by the Agri- 1988, the Malagasy Government elimi-cultural Sector Adjustment Credit nated almost all non-tariff barriers(ASAC-1986), the Industrial and Trade on imports (except for 94 items, whichPolicy Adjustment Credit (ITPAC-1987), were health and security-related andthe Public Sector Adjustment Credit were reduced to 77 in March 1989).(PSAC-1988), and a planned Private All tariff exemptions were eliminatedSector Environment Adjustment Credit and nominal and effective Rrotection(PRIVAC) which is scheduled to be was lowered. In January 1988 specif-negotiated when the political situa- ic tariffs were substituted by Ition in Midagascar stabilizes. Fol- valore ones (paras. 3.09 and 4.07).low-up credits were complemented bynon-adjustment operations such as the 10. On the exRort side. the liber-Economic Management and Social Action alization orocess began in 1986-1987

- vii -

and accelerated during 19., and by Major IssuelSeptember 1988, except for vanilla,all administrative export requirements 13. Conditionality was manageablewere reduced to a single customs' and appropriate to the objectivesdeclaration (paras. 3.10-13 and 4.08). pursued by ISAC. However, there wereIn order to further advance export two important 4ifferences in the waypromotion and to complement import two second tranche conditions wereliberalization actions, the Government stated in the irowident's Report andacted also on the exchange rate policy the legal conditions. First, whilefront and by 1989, the real effective the President's Report stated theexchange rate was approximately 40 second tranche condition as "decontrolpercent of its 1982 -- ye (paras. ^.14 of all industrial prices", the Devel-and 4.09). The cor- c7on of the FMG opment Credit Agreement specifiedovervaluation crea , x che conditions "free ex-factoXy prices." This gavefcr an overhaul of the foreign ex- the Government an option to maintainchange re,ime and by July 1988 the controls on profit margins (para.Government widened the foreign ex- 3.04). Clearly, the spirit of thechange policy reforms with the intro- condition was not met. Second, whileduction of a full-fledged Geaeral the President's Report asked for theLicense System (OGL) through which iMRlementation of a satisfactory ex-unlimited foreign exchange became port incentive system, the legal con-available at the prevailing exchav e dition specified only the need torate for imports of goods by any eco- adoRt a program of actions to promotenomic agent (para. 4.10). exports (para. 5.07).

11. While ISAC was successful in 14. SDR 5 million of the credit wasimproving the quality of the projects to be lent to the BNI for the financ-included in the 1985 and 1986 indus- ing of investment (rehat'.litation)trial PIP, in cutting the size of the projects through sub-loans to invest-program, and improving MIEM's project ment enteLprises. The BNI componentappraisal capabilities, a more compre- was the least successful and BNI'shensive effort to rationalize the untenable financial situation was theoverall national public investment main reason behind implementationprogram and to pay increased attention delays and three year delay in creditto efficiency and the social aspects closing (paras. 3.18-21). At the timeof adjustment was pursued under ASAC, of ISAC serious constraints on finan-ITPAC. and PSAC. cial intermediation existed, of which

the staff were not aware (para.2,02).12. In the area of private sector Problems and delays in the implemen-encouragement, even though an invest- tation of the BN1 component of thement code prepared under ISAC rep- credit and credit shortages consti-resented a subsuantial departure from tuting a key constraint to economicpast negative attitudes towards the recovery, were caused by financialprivate sector and foreign investment, sector liquidity problems linked toit was not timely and flexible enough the need for public enterprise reform.to keep up with the changing economic The situation of the commercial banks'environment. Thus,in December 1989. portfolios, particularly of BNI, be-to attract private domestic and for- came known only during ISAC's imple-eian investment, the Government adopt- mentation thanks to effective supervi-ed-a newpinvestment code. sion. The financial health of the

- viii -

banking sector continued worsening up additional analytical work and gatherto 1987, when JTPAC and PS&C began additional information and experienceaddressing both financial sector and to develop a more comprehensive ad-public enterprise issues which had jusement program.been left out of ISAC (paras. 4.14-15). 16. The suRervision Lffort was Ade-

guAte. Supervision was imaginative15. A general design issue deals and understanding, and findings ofwith the appropriateness of a phased ISAC supervision missions were instru-sectoral approach as opposed to an un- mental in identifying outstandi%gfront comprehensive adiustment opera- issues and thus helpful in designingtion. The gent3is of the ISAC as a subsequent operations. However, therefirst step on the road of adjustment, were deficiencies in the loan files,and its limited scope, derived from including a missing Implementati.ntwo considerations linked to the Summary (Form 590). Moreover, all 590Malagasy's authorities political and forms were issued at least two monthssocial constraints at the time. after the end of the supervision mis-First, even though the socialist Gov- sion involved. Probably due to theseernment was committed to reform in deficiencies, the PCR does not containprinciple, it was not at the time details on the supervision effort.convinced of the "necessity or desir- According to a recent OED study on SALability of a comprehensive reform supervision and monitoring, deficien-program." Bank staff hoped that suc- cies in historical records appear tocessful implementation of ISAC would be a common problem which hampers theconvince the Government to implement a maintenance of the Bank's institution-more vigorous reform package. Even al memory and thorough ex post evalua-though at the time of -SAC preparation tions of the operations concerned.governance issues were not yet explic- Finally, updates on the iMRlementatioitly considered, the governance dimen- of the TA coMonent were not adeguate.sion did affect both the design ofISAC and economic performance under ustainabilitythe overall program. The Malagasygovernment in 1985 was not prepared to 17. The maintenance of macroeconomicrisk implementing a comprehensive SAL stability and continued politi.1type operation. However, the Govern- commitment and popular support for thement felt secure enough to undertake reform process are the key determi-ISAC which was a first step in the nants of the sustainability of adjust-reform process but already contained ment measures. Economic nerformancemeasures which might have been unpopu- in the near future will be closelylar. Second, the country's economic tied to political economy consider-team was also attempting to strike a ations; recent political developmentsbalance in the pace of policy reforms and the fragility of the current re-in order to improve efficiency in the gime have pushed the governance issueindustrial sector without causin, to the forefront of any assessment ofsevere economic dislocation and possi- sustainability of the Malagasy adjust-ble social unrest. In conclusion, the ment effort (para. 6.01).phased approach was appropriate to thecircumstances. First, positive re- 18. Notwithstanding political up-sults under ISAC stimulated heavals, the political commitment to agovernment's confidence and commitment continued adjustment effort seems toto the reform process. Second, it remain strong in 1991. On the econom-permitted Bank staff to carry out ic front both sides are in agre-ment

- ix -

on the need to continue liberalizing ation with close monitoring of creditthe economy and eliminating remaining policies and domestic savings perfor-structural constraints to growth with mance. On the political side, commit-equity. In conclusion, if the politi- ment to reforms must continue to ex-cal situation does not interfere with ist, whichever political group remainseconomic processes, all the elements in power (para. 7.02).for sustained growth are in place andan optimistic assessment of the sus- 21. Th- review of the experiencetainability of the overall adjustment with the ISAC offers instructive les-effort is possible (paras. 6.02-05). sons and suggestions which may provide

useful insight for future Bank opera-Conclusions and Lessons of Exserience tions:

19. ISAC was essentially preparatory 0 In 1985 the Government was notto the more comprehensive reforms ready yet to implement a broad-basedimplemented in follow-up sector opera- structural adjustment effort. Thus,tions. ISAC was on the whole wel policy-based sector specific lendingdesigned as a preparatory loan and the was used by the Bank as vehicle toGovernment participated in the devel- open dialogue with the authorities.opment of the conceptual framework of The phased approach was successful inISAC as well as of the following sec- leading to full-fledged adjustmenttoral loans. Given the political beginning in 1987 thanks to thetnvironment at the time -- with a Government's commitment to the reformsocialist regime skeptical of market process and to the appropriateness,mechanisms and a full-fledged liberal- timeliness, and, effectiveness ofization of the economy, and fearful of follow up operations. A hased sec-the political and social consequences toral androach might be necessary andof a full blown adjustment effort -- aRRropriate when a Governgent is notthe preparation of phased sectoral ready for an u front comrehensiveloans as opposed to the implementation adustment oReration. since the pro-of an up front adjustment loan was the cess itself creates a olicy dialogueappropriate choice (para. 7.01). which leads to refors

20. Overall the adjustment effort 0 During ISAC design there wasimplemented by the Malagasy Government awareness by Bank staff of the Gove-has been impressive and it is general- rnment's political constraints, whichly perceived as one of the success led to the design of a successfulstories within Africa. However, the sequencing of sector adjustment opera-sustainability of the adjustment pro- tions, through an intense policy dia-cess will depend on macroeconomic as logue aimed at building a consensus.well a political developments. On The success of Madaascar's adustmintthe macroeconomic area, certain condi- effort shows that. even under a so-tions must be maintained for the stru- cialist regime. olic reforms can bectural reforms to have a lasting im- successful and sustained when thepact. Prospects for medium-term via- design ofthe rogram is internalizedbility would be enhanced by a more and there is tolitical will, consensusaggressive exchange rate policy per- and commitment on the efart of themitting the continuation of export authorities.diversification; by further importliberalization to enable a sustained lA nosteriori it is clear that arise in imports to maintain the recov- more complete analysis of the finan-ery; by improving financial intermedi- cial sector at the time of ISAC's

design would

at - and not t(mentation - on 1BNI as the implemrehabilitation ccit. Thus, theintermedi onlvzed in more dreform measuresincluded in ISAC.

* The Malagaswitnessed an e:with the IMF aneStand-bys and sespecially on exHowever, it appeiwere slow in keeexchange rate aan exchange ralliberalization e:by Bank operatiot

* Even thoueffort was ade

PROGRAM PERFORMANCE AUDIT REPORT

MADAGASCAR

INDUSTRIAL ASSISTANCE PROJECT(IDA Credit 1541-MAG and

SFA Credit A-7-MAG)

I. BACKGROUND

A. Historical Background of the Malagasy Economy

1.01 Madagascar, with a population of approximately 11.5 million and a percapita income of US$230 in 1989,11 is among the 12 poorest countries in theworld. Agriculture accounts for about one third of GDP, industry accounts for13 percent of GDP. The main staple is rice. Coffee, vanilla, and cloves are themain traditional exports, accounting for approximately 50 percent of exportearnings. In the period from independence (1960) to 1972 Madagascar experienceda modest average GDP growth rate of approximately 2.7 percent per year. In the1970-78 period real GDP grew on average only by 0.6 percent per annum and, givenan average population growth rate of 2.8 percent per annum, by 1978 GDP percapita was almost 20 percent below the 1970 level. A sharp deteriorationfollowed in 1980-1982, with a 9.7 drop in GDP in 1981. After 1983, with thebeginning of the implementation of economic reforms, macroeconomic balancesimproved and there was a modest recovery in growth. During the 1983-1987 periodGDP grew at an average of 1.4 percent per year, still below popri1ation growth.Adjustment efforts began in 1985 with the Industrial Sector Assistance Project(ISAC) under review. The tirst large-scale macroeconomic adjustment program waslaunched beginning in 1987 and was supported by IMF Stand-by loans and World Bankoperations in the agricultural, trade, and public sectors.

1.02 Given recent political developments in Madagascar, it is important toprovide a brief summary of political history since independence. Madagascarexperienced a peaceful transition to democracy when - after De Gaulle's returnto power in 1958 - the Malagasy population voted in a referendum to become anautonomous republic within the French post-colonial system. In 1960 PhilibertTsirabnana was elected the first Malagasy president and remained in power until1972, when as a result of the deteriorating economic situation and massive anti-governmental demonstrations, Tsirabnana resigned handing power to his armycommander, General Gabriel Ramantsoa. The new president pursued a closerelationship with Eastern Bloc countries and after several failed coup attemptsrelinquished power in 1975 to Colonel Richard Ratsimandrava, who was murderedsoon thereafter. Later that year Didier Ratsiraka, the foreign minister and navycommander, took power and still remains the head of Government to this date.Political developments in the summer of 1991 in Madagascar have shown thefragility of President Ratsiraka's position and the growing populardissatisfaction with the current administration.

11 World Bank Atlas methodology.

- 2 -

1.03 As emphasized by a recent Bank study, development policies followed

from independence to 1983 led to the stagnation of agriculture, in "an attempt

to shift to accelerated, mainly domestic market-based, industrialization, and

expansionary macroeconomic policies."- This strategy resulted in escalating

fiscal imbalances and unsustainable current account deficits in the balance of

payments after 1977-1978. In particular, economic policies pursued after the

1972 military coup account for Madagascar persistent difficulties since the late1970s. The Government which took office in 1972 emphasized state control of theeconomy: inward-looking policies aimed at achieving self-sufficiency in industryand agriculture were implemented, most of the larger private companies werenationalized, interventionist practices characterized by price controls andadministrative regulations were adopted, and direct or indirect state control

over the greater part of agricultural marketing was established. The Governmentwhich came to power in 1975 escalated, broadened, and codified such policies.

GDP declined and Madagascar went from being a country self-sufficient in food tobeing an importer of rice, its main staple.

1.04 While through 1977 fiscal and balance of payments policies remained

cautious, and public external debt was kept at a low level, ' beginning in 1978,in the face of stagnating economic activity, the Government tried to diversify

the economy and accelerate development through a large expansion in public sectorinvestment. The higher rate of public investment was financed through externalborrowing and money creation. The volume of domestic capital formation increasedby 74 percent in 1979. By 1980 it was about 60 percent above the average levelof the 1975-1978 period; the share of gross domestic investment - mostly public -to GDP rose from 9 percent in 1978 to 15 percent in the 1979-1980 period.According to a Bank report "many of the projects selected were economically andfinancially non-viable; they therefore made little contribution to GDP, exports,or debt servicing capacity." 1

1.05 A dramatic deterioration in the balance of payments and the fiscalaccounts ensued. Imports increased by almost 40 percent (in volume terms) in

1979 and with sluggish exports and deteriorating terms of trade, the external

resource gap increased from about 5 percent of GDP in 1978 to approximately 16

percent in 1979 and 1980, while the exchange rate was becoming increasinglyovervalued. The level of imports largely exceeded Madagascar's financingpossibilities and, by 1980, arrears on external payments began accumulating and

imports started decreasing. Since a high proportion of investments wereundertaken within the public sector, the overall budget deficit rose fromapproximately 4 percent of GDP in 1978 to double digits in 1980-81. Inflation

1i Report No. 7784-MAG, Madagascar - Adjustment in the Industrial Sector and an

Agenda for Further Reforms (Report 7784), October 29, 1990, para. 15.

1t PR No. P-4488-MAG, Industry and Trade Policy Adjustment Program (ITPAC-PR),

June 5, 1987, para. 1.04.

1 Ibid., para. 1.05.

-3-

rose to 30 percent per year in 1 98 1 -1982.11 The Government, moreover, wasincreasingly relying on external resources for budget deficit financing aostlyborrowing from commercial non-concessionary sources. Debt-service obligationsrose from about 4 percent of export earnings in 1978 to over 70 percent in 1982.By 1982, real per capita GDP had fallen by an estimated 28 percent from its 1973level.

1.06 In 1982, the Government began implementing a set of reforms, supportedby IMF stand-by agreements, aimed at achieving stabilization by restrainingaggregate demand. Madagascar's stabilization efforts included tax-increasingmeasures, expenditure c ts and an improved expenditure control system, bankcredit ceilings to reduce inflationary pressures, increases in prices of publicenterprises' goods and services, a sharp reduction in imports, and mostimportantly, specific actions on the exchange rate and consumer subsidies. TheMalagasy Franc (FMG) had remained fixed at 50 FMG per French franc until 1982,even though Madagascar had left the French franc zone in 1973. In 1982, the FMGwas devalued and pegged to a trade-weighted basket of currencies. Beginning in1983 a flexible exchange rate policy was adopted and the quarterly rate wasadjusted in line with domestic inflation, thus achieving a substantial realdepreciation of the FMG. The nominal price of rice distributed through officialchannels more than doubled and consumer subsidies on imported rice wereeliminated. As a result of the stabilization measures implemented the Governmentdeficit was reduced from 15 percent of GDP in 1980 to 7 percent in 1982 and 5.4in 1983. The resource gap was also cut down from over 16 percenit of GDP in 1980to 9 percent in 1982 and 7 percent in 1983. Fiscal and monetary tighteningcontributed to reducing annual average inflation from over 30 percent in both1981 and 1982, to 19 percent in 1983 (See table in Annex 1).

1.07 Even though the stabilization effort began in 1982 was quite successfulin restoring internal and external equilibria, structural problems remained inplace. In 1984, the Government began emphasizing the underlying supply-sideconstraints faced by the economy. The authorities started implementingstructural adjustment measures, including the first steps toward a generalliberalization of most economic activities with actions such as those taken underthe ISAC. In practice, however, the adjustment program's implementation beganfully only in 1987.6i

B. Evolution and Features of the Industrial Sector

1.08 As indicated earlier, after independence the Malagasy authoritiessought to diversify the structure of national production through theencouragement of industry. Their objective was to reduce the country'svulnerability to adverse fluctuations in agricultural commodity pricesaccompanied with the belief that industry would promote faster economic growth

11 Report No. 5454-MAG, Madagascar - Current Economic Situation and Prospects,October 25, 1984, paras. 5-7.

i Report No. 9101-MAG, "Madagascar - Beyond Stabilization to SustainableGrowth", June 1991 (CEM 1991): para 21.

-4-

and increased employment opportunities. Three main themes emerged inMadagascar's industrial policy:

* The reliance on an import substitution strategy to achieve rapidgrowth in manufacturing output. The main policy instrument wasprotection of domestic production from external competition.Originally, protection mechanisms were tariffs and import taxes.In the late 1970s, the Government began imposing importprohibitions, strict import licensing, and foreign exchangerationing;

* A widespread nationalization of economic activity after 1972. Atthe time of their establishment, during the 1960s, most largemanufacturing firms were owned by foreign private investors.Medium and small enterprises were mostly owned by localentrepreneurs. Beginning in 1972, however, banks, insurancecompanies, and large trading concerns were nationalized and theGovernment took over the marketing of key agricultural products.Throughout the 1970s the Government increased its involvement inthe manufacturing sector; at first, by taking over foreign ownedfirms, later the Government brought under its control a large partof domesticall owned industry through nationalization or equityparticipation.- In 1982, out of a total of 362 industrialenterprises, 40 were entirely state owned. The Government had amajority interest in other 17 firms and a minority holding of atleast 33 percent in another 14. These included most large scaleoperations; medium and small-scale firms remained mainly in privatehands. Enterprises in which the Government had an interest of morethan 50 percent accounted for an estimated 65 percent of sectoraloutput and a similar share of employment. Another 15 percent ofoutput was contributed by firms in which the Government had asubstantial minority interest;$'

* The adoption by the Government of an interventionist attitudetowards the economy. This trend was characterized by theintensification and expansion of central regulation and acorresponding reduction in the role of market forces in allocatingresources, e.g., price controls were generalized and exchangecontrols were tightened.

1.09 As a result of these policies, the Malagasy manufacturing sectorevolved with the following features:

* Strong dependence on imported inputs and spare parts and, as aconsequence. vulnerability to foreign exchange shortages: thisdependence resulted from low production of intermediate goods dueto weak inter-industry linkages. The high protection levels

i PR, paras. 28-30.

' Ibid., para.30.

- 5 -

enjoyed by producers of consumer goods, and exemptions from tariffsand import taxes on investment and intermediate goods, discouragedthe use of and/or investment in domestically produced inputs. IT,1983, imports of intermediate goods (excluding petroleum) accountedfor 25 percent of total imports, by 1986 intermediate goodsrepresented over 30 percent of total imports (Annex 1).

* High protection levels and administrative allocation of foreignexchange: traditionally custom duties and import taxes constitutedthe main vehicles of protectionist policy. In the early 1980s, dueto worsening foreign exchange shortages, imports began to besubject to increasingly tight import prohibitions. This period wasalso characterized by quotas and administrative allocation offoreign exchange.

* Low level of diversification: the two most important sub-sectors,food processing and textiles, accounted for more than 50 percent ofmanufacturing value added; beverages, cigarettes, garments, andleather goods accounted for an additional 20 percent ofmanufacturing value added. Other sub-sectors included householdchemicals, construction materials, petroleum refining, andintermediate goods such as metal and paper products;

* Heavy emphasis on the production of consumer goods: developmentsin the manufacturing sector were related to the import-substitutingstrategy implemented by the Malagasy authorities during the 1971s;thus, under a high level of protection from foreign competition,the domestic manufacturing sector became the supplier of many finalconsumer goods. Of 33 major products manufactured in Madagascar,22 were consumer goods (food and tobacco products, garments andfootwear) and simple household chemicals (soap, matches, batteriesand candles), five were petroleum products, and only six wereintermediate goods (pulp, paper, metal sheets, cement, nails andpaints);!/

* Low levels of manufacturing exports: manufacturing exports -consisting mostly of sugar and molasses, cotton fabrics, essentialoils, canned meat, and garments - accounted in 1983 for 15 percentof total exports and only 5 percent of manufacturing output; in1986 manufactured exports represented only 13 percent of totalexports, from a peak of 20 percent in 1975;

* Inefficient production: as stressed by a 1986 Bank Report, a strongindication of the inefficiency of the sector was given by thefinding that for 32 of 80 firms analyzed in 1985 (accounting forapproximately 70 percent of industrial value added) the value oftradeable inputs (excluding capital) exceeded the value of outputproduced by the firm, both calculated at border prices. Thus,

gi Ibid., para. 23.

- 6 -

these firms used up more foreign exchange than they ei-her saved

(by import substitution) or generated (by exporting)." 01

1.10 Industry, which accounted for around 4 percent of GDP in 1960, reached

approximately 15 percent of GDP in 1970 and, on average, remained at that level

throughout the 1970s. Between 1970 and 1979 industry's growth rate fluctuated

widely, and on average industry grew by only 0.8 per annum in real terms.

Industry declined every year during the 1980-1982 period, with a sharp fall (22.5percent) in 1981. Thus, during the first half of the 1980s, the share of

industry in GDP declined from 14.3 percent in 1980 to around 11 percent in 1984

and 1985 (Table in Annex 1). The Malagasy manufacturing sector accounted for

approximately two thirds of the industrial value added (excluding construction);

according to a 1982 survey there were at the time 362 manufacturing enterprises,of which 100 accounted for 80 percent of output.

II. CONCEPT AND DESIGN OF THE ISAC

A. Industry Constraints at the Time of the ISAC

2.01 As discussed in chapter I industrial production fell by 22.5 percent

in 1981 and 14.4 percent in 1982. The 1980-1982 drop in manufacturing productionresulted from the fact that, after 1979, the emergence of a severe foreignexchange constraint (i.e., lack of imported inputs) and the deterioratingeconomic situation (i.e., lack of domestic demand) forced a great number of

companies to slow down or stop production. These events brought to the surface

the structural inefficiencies of the sector, showing that development following

past industrial policies was unsustainable.

2.02 The diagnosis of the Malagasy industrial sector in 1984, when the ISAC

was designed, focused on the following priority issues:

* Heavy under-utilization owing to (a) acute shortages ofdomestically supplied agricultural raw materials and (b) lack ofimported inputs and spare parts due to foreign exchange shortages

and administrative allocation of foreign exchange. Between 1979

and 1982 imports of raw materials and spare parts dropped byapproximately 40 percent in real terms. Imports of capitalequipment were tied to on-going investment projects and external

financing arrangements and could not be quickly reduced, and

imports of food, particularly rice, actually increased thus, the

most affected by the cuts were imports of raw materials, spare

Loi ITPAC-PR, para. 2.08.

1 Ibid., para. 2.02.

-7-

parts, and non-food consumer goods. L21 Average capacityutilization in a number of firms, accounting for approximatelythree-quarters of manufacturing value added, dropped from about 75percent in 1979 to 57 percent in 1981 and to 47 percent in1982.-i Moreover, there were substantial falls in the output ofsome basic consumption goods; soap and matches production fell bymore than 50 percent, candles and corrugated metal sheets by over30 percent;1

* Import restrictions. Industry in Madagascar was highly protectedthrough custom duties, import taxes, import prohibitions, andadministrative allocation of foreign exchange. Import duties hadbeen generally low and uniform with only four rates (0, 5, 10, and15 percent), while import taxes had been relatively high and hadvaried over a wide range up to 100-150 percent. In several cases,finished industrial products had the same or even lower duty ratesthan raw materials and/or intermediate goods used as inputs.Import taxes were relatively high and varied over a wide range ofup to 150 percent. Import taxes were generally low on rawmaterials, higher on intermediate goods, and in the upper range formost finished products. On balance, then, average tariffprotection (including all taxes and duties) was, in the mid-1980s,at 112 percent for consumer goods, 37 percent for intermediategoods, and 34 percent for 40 capital goods,- not taking intoaccount the impact of import prohibitions. At the time of the ISAC(i.e., 1984) all imports - except those needed by manufacturers toproduce exports - were subject to import restrictions and wereclassified in two categories: (1) those which were prohibited, and(2) those subject to a detailed annual licensing program. Eventhough at the time of ISAC design no effective protection estimateswere availabl1, this system of import controls and quantitativerestrictions, combined with the existing structure of import taxes,granted a hiFh level of effective protection to import substitutionindustries;

* Price controls. Even though price controls had existed inMadagascar since the 1960s, their use was intensified andgeneralized in the late 1970s in an attempt to control the pricingbehavior of protected local industry. In the early 1980s, controlswere extended to all industrial goods to defuse inflationary

i Report No. 5154-MAG, Madagascar - Current Eccnomic Situation and Prospects,October 25, 1984, paras. 10, 31.

.i PR, para. 21.

Li Ibid., para. 30.

i Ibid., para.45 and ITPAC-PR, para.2.04.

Li Ibid., paras. 45-46.

- 8 -

pressures and guard against the possibility of excessive priceincreases in the absence of competitive markets. Any priceincrease had to be authorized by the Government on the basis ofcost plus a set margin for each sub-srsctor; authorizations weregiven approximately one month after the application. The systemwas complex, it aggravated shortages and distortions, impededindustrial efficiency, discouraged output increases, and in somecases had affected the financial health of manufacturing firms.L'Moreover, Government attempts to hold selling prices below market-clearing levels had a negative impact on both the agricultural andindustrial sectors and led to increased imports at a time ofbalance of payments crisis. Finally, price controls, togetherwith the fall in demand, made it increasingly difficult to pass on

rising costs due to low capacity utilization, despite the fact thatmost enterprises were enjoying a high level of protection fromforeign competition

* Ineffective public investment program in industry (PIP). Poorproject selection was a major problem particularly after the 1978-1980 investment boom. A number of large scale investmentoperations (e.g., Zeren urea plant, Mamisoa vegetable oil factory,oil-palm refinery, and several tanneries) were undertaken withouta careful assessment of their feasibility or likely returns. At

the time of ISAC appraisal, out of 21 industrial projects underexecution, 16 had been inadequately prepared, were likely to facesignificant technical and financial problems, and their viabilitywas doubtful;

* Export incentives and regulations. Up to 1982-1983 Governmentpolicies were repressing rather than encouraging exports due to theseriously overvalued exchange rate and the implementation of anarray of procedural impediments. Export incentives available underan ordinance enacted in 1973 had never become operational for lackof specific legislation required for its implementation. Moreover,the regulatory side of the ordinance had restricted freedom ofexporting, e.g., each exporter had to hold an exporter's card andeach export shipment had to be authorized;

* Investment incentives limitations. The Investment Code enacted in1973 had a series of limitations: (1) lacked precision and was opento widely different interpretations; eligibility criteria werevague and the nature and extent of benefits were decided upon bythe Government without apparent consistency; (2) several of themain incentives were made redundant by other Government regulation,

U Ibid., paras. 47 and 54.

Report No. 5996-MAG, The Democratic Republic of Madagascar Country Economic

Memorandum, March 18, 1986, Appendix B, para. 32.

.1 PR, para 33.

-9-

e.g., high protection through import taxes made some investmentsprofitable even without tax relief, meaning that the Governmentmight have been unnecessarily forgoing fiscal revenues; (3) gavegreater advantages to new credits as opposed to investments forexpansion, rehabilitation, or modernization; (4) included generousaccelerated depreciation provisions, and easy access to tax-freeimported equipment, favoring capital intensive techniques, whichwas not consistent with the employment-generation objectives ofthe Government,Li and

* Constraints on financial intermediation and public enterprises'issues. Madagascar's financial system comprised the Central Bankof Madagascar, three national commercial banks specialized bysectorU - of which the State was the sole shareholder, a postalchecking system, two insurance companies, and an investment fund.The financial situation of the three commercial banks was untenableand their portfolios were in need of major write-offs. This wasmainly a consequence of their funding of public enterprises whichhad fallen into serious financial difficulties and had been able tosurvive thanks to credit from the three state banks (crowding outthe private sector). By 1985 the Government controlled 167companies. The majority of these enterprises received Governmentsubsidies and suffered from managerial, technical, and financialproblems. After the 1983 stabilization program sharply reducedsubsidies, the banking system kept these enterprises alive at thecost of building up a very high percentage of non-performingloans. 22

B. The New Industrial Development Strategy

2.03 Even though stabilization efforts initiated in 1981-1982 wererelatively successful in restoring internal and external equilibria, underlyingstructural problems remained in place. Moreover, given the fiscal adjustmentalready achieved in 1982 and 1983, the Government felt that further budgetreductions were likely to be slower and their balance of payments impact smaller.Therefore, starting in 1984, the Government, with the support of a fourth IMF

stand-by arrangement, emphasized the liberalization of pricing and marketingarrangements in agriculture to improve production and export performance. At thetime, the Government also recognized that "the revitalization of inustry on anefficient basis would make an important contribution to overall economicrecovery."Li The Government's strategy for achieving these industrial policy

-' Ibid., paras. 48-49.

1- The National Bank for Industry (BNI), the National Bank for Agriculture (BTM),and the National Bank for Trade (BFV), created and nationalized in 1977 as aresult of the consolidation of the existing commercial and development banks.

L CEM 1991, paras. 68-69 and 84.

Ul PR, para. 52.

1 10 -

objectives involved the adoption of actions in three policy areas: (1) raise thelevel of capacity utilization of the sector to promote production of consumergoods and exports; (2) undertake initiatives aimed at improving efficiency andresource allocation in the public sector; and, (3) provide foreign exchange toefficient enterprises to import inputs necessary for a higher level of industrialproduction.

C. Objectives. Policy Instruments, and Conditionality

2.04 The purpose of ISAC was to support the Government's strategy ofbringing about meaningful policy changes in the industrial sector designed toincrease its efficiency and productivity, while beginning the process ofestablishing an environment conducive to efficient import substitution and exportproduction. These policy changes would constitute important first steps towardspromoting the efficieticy: openness, and export-orientation of the Malagasyindustrial sector so tI.; Zt could increasingly contribute to the country'sbalance of payments are -t the growth of employment and output.L4 ISAC wasthe first in a series )f sequenced sector adjustment operations. It was followedby the Agricultural Sector Adjustment Credit (ASAC-1986), the Industrial andTrade Policy Adjustment Credit (ITPAC-1987), the Public Sector Adjustment Credit(PSAC-1988), and a forthcoming Private Sector Environment Adjustment Credit(PRIVAC) which is scheduled to be negotiated when the political situation inMadagascar stabilizes. Follow-up credits were complemented by non-adjustmentoperations such as the Economic Management and Social Action Support Project(EMSAP-1989), the Financial Sector and Private Enterprise Credit (1990), and theEnvironment Program (1990).

2.05 The ISAC was jointly financed by IDA (SDR 40.2 million) and asupplemental credit from the Special Facility for Sub-Saharan Africa (SFA) (SDR18.5 million). The credit supported policy reforms designed to increase theefficiency and productivity of the industrial sector, and the capacityutilization of selected efficient industrial enterprises so as to enable them toproduce goods for the domestic market and for export. The Credit providedforeign exchange for imports of inputs and spare parts, rehabilitation equipment,and technical assistance.

2.06 The reform package consisted of: (a) price liberalization, intended tomake the Malagasy economy more responsive to market forces so as to increase itsefficiency, dynamism, and productivity through the progressive elimination ofprice controls on most industrial goods; (b) public investment program (PIP)refor, to rationalize the PIP process through the establishment of criteria forproject selection and the strengthening of project appraisal capability; (c)import liberalization, to improve industrial efficiency through greatercompetition from abroad and to encourage exports by eliminating importprohibitions on 20 percent of products; (d) export promotion, to increase theoutward-orientation of the Malagasy economy and as a way to break out of theforeign exchange constraint holding back the recovery and long-term developmentof the industrial sector through the adoption of measures designed to stimulateexports, including the elimination of all export taxes, and (e) private sector

1i Ibid., para. 77.

- 11 -

encouragement, to foster an active role of the private sector in themanufacturing sector through the elaboration of a new investment code.

2.07 Concerning exchange rate management, there was close collaboration withthe IMF. In the early 1980s, the overvaluation of the Malagasy franc requiredestablishmen4. of strict exchange controls, quantitative barriers to imports, andadministrative allocation of foreign exchange. Beginning in April 1982 - dateuntil which it was pegged to the French franc - the FMG became pegged to trade-weighted baiket of currencies and devalued several times. In 1984 the Governmentadopted a flexible exchange rate policy wh ih led, by 1986, to a 58 percentnominal depreciation and to a 29 percent depreciation in real effectiveterms.L1 Thus, at the time of ISAC design, overvaluation did not appear to bea major issue since the real exchange rate stood at approximately the same levelas in 1978, a Tear judged by Bank staff as one of reasonable external balance forthe country.- However, Bank staff acknowledged that given the 1985 terms oftrade deterioration and increasing debt service ratios, further real devaluationsmight be required. At the time of ISAC an exchange rate management strategy for1984-1985 was developed by the Government, with the help of IMF staff callingfor a depreciation of the FMG at a pace equal to domestic inflation. 27

2.08 The credits provided foreign exchange (SDR 33.5 million from the IDAcredit and all of the SFA credit) to efficient industrial enterprises for rawmaterials and spare parts imports to increase their capacity utilization andpromote the production of exports and consumer goods. The project included aninvestment component (SDR 5 million) for the financing of equipment for therehabilitation of sejected enterprises to be channeled through the National bankfor Industry (BNI). The Credit also included a technical assistance component(TA) (SDR 1.5 million) which provided technical support to the Ministry ofIndustry, Energy and Mining (MIEM). The TA component would provide technicalsupport for many of the policy reforms the Malagasy authorities were planningto introduce in later years. The TA component would achieve the followingobjectives: (1) improve data collection, processing, and analysis at the MIEM;(2) reinforce the Ministry's capability to analyze investment projects; (3)prepare an action program for export promotion and import liberalization andreinforce the MIEM's capability to analyze and formulate policies in the area oftrade and incentives; and, (4) assist the Ministry in upgrading and refurbishingan existing building to serve as its headquarters.

2.09 The proceeds for importation of inputs would be disbursed in twotranches conditional on sat? Zactory implementation of the following actionsunder ISAC, while disburseme. -s under the rehabilitation and technical assistancecomponents were linked only to progress in the implementation of these twoprograms.

L GEM 1991, para. 36.

EU PR, para. 18.

L7 Idem.

- 12 -

(1) Actions to be taken before the release of the first tranche(credit effectiveness):

(a) Remove import prohibitions on five percent of the goodswhose importation is currently prohibited and make foreignexchange available for their importation;

(b) Agree % the size and content of the 1985 Public InvestmentProgram in Industry;

(c) Hire consultants for the preparation of the export promotioand import liberalization action programs;

(d) Eliminate export taxes for all manufactured goods andexonerate exporters of manufactured goods from all indirectaxes on raw materials and spare parts used as inputs oexport productio.t.

(2) Actions to be taken before the release of the second tranche:

(a) Decontrol prices of all industrial goods with the exceptioof 31 products (i.e., 30 percent of value added);

(b) Agreement on the size and composition of the 1986 IndustriaPIP;

(c) Apply EPI system to all exporters of manufactured goods;

(d) Implement a satisfactory export incentive system;

(e) Submit the new investment code to the National Assemblyfollwing consultation with the Bank;

(f) Remove import prohibitions on a further 15 percent of thegoods whose importation is currently prohibited and makeforeign exchange available for their importation.

A policy matrix of the ISAC to Madagascar is presented in Annex II. The matrixlists issues to be addressed in all the areas of the reform package, describesthe measures which were to be taken under the ISAC, and the implementation recordof such measures.

III. IMPLEMENTATION EXPERIENCE AND OUTCOME

3.01 The original credit effectiveness date was March 1985, but formaleffectiveness was delayed to August 1985 since more time was needed to await theactual hiring of the consultants for the preparation of the export action program(para 3.12). Second tranche disbursement was postponed from January 1986 toSeptember 1986 owing to delays in the preparation of the export promotion

- 13 -

program. Because of major problems with the investment component managed by BNI(paras. 3.18-21), credit closing was delayed by three years. The closing datewas originally set for September 30, 1987, but was extended first to September30, 1988, then to March 30, 1989. Eventually the credit was closed on September30, 1990.

3.02 This section discusses the implementation experience of the variouscomponents of the credit and provides a preliminary assessment of outcome of theISAC policy package in itself. Chapter IV provides a more comprehensiveassessment of performance in the areas included in ISAC within the overalladjustment program of the Malagasy Government.

A. Policy Package

(1) Price Liberalization

3.03 The Government had agreed to free prices of manufactured goodsrepresanting 70 percent of value added in manufacturing before the release of thesecono tranche of the ISAC. At the time of Board presentation the Government hadalready freed prices of goods representing 35 percent of manufacturing valueadded. By July 1986 an additional 35 percent of ex-factory prices of goods hadbeen decontrolled, leaving only the prices of 31 industrial products(approximately 30 percent of manufacturing value added) under control. BySeptember 1986, the Government had further reduced the number of goods underprice control to ten, representing less than 15 percent of manufacturing valueadded."

3.04 Notwithstanding the apparent successful implementation of priceliberalization measures under ISAC, in reality, until late 1987, the Governmentfreed only ex-factory prices. However, it continued to control retail prices and

profit margins,- adding a fixed margin to costs. This system tended todefeat, at least in part, the purpose of the liberalization effort. Thesecontrols were maintained with the aim of curbing inflationary pressures resultingfrom the protection of monopolistic local industry existing in the import-substitution environment."

3.05 Since the implementation of ISAC, significant piogress has been madein price liberalization. By late 1986, the number of goods under price controlwas further reduced to ten. In 1987, all profit margin controls were eliminatedby the Government as one of ITPAC's effectiveness conditions, even though maximumprice guidelines remained on all but 16 goods. All profit margins controls wereeliminated between 1987 and 1989. Eventually, in February 1989, all price

Li Memo September 18, 1986, para. 6.

!i Regarding this issue, while the President's Report stated the second tranche

condition as "decontrol of all industrial prices", the Development CreditAgreement specified "free ex-factory prices". The implications of thisdifference are discussed in Chapter V, para. 5.07.

Lt Draft ITPAC-PCR, para.23.

- 14 -

controls were removed and a free market system was achieved for the productionand sale of all goods (para. 4.05).11

(2) Public Investment Program (PIP) Reform

3.06 A Public Investment program (PIP) in industry consisting only ofprojects whose viability had been established was agreed for 1985 and 1986. Thesize of the PIPs was reduced as compared to the unsustainable levels of previousyears and the quality of the projects was improved. For 1985 the Ministry ofIndustry (MIEN) had initially p:oposed an industrial PIP of US$37 million, ofwhich 80 percent would be for rehabilitation and 20 percent for completingongoing projects. Eventually, by applying the principle of including onlyprojects of established financial, economic, and technical viability, a US$10.6million PIP was agreed upon, of which 40 percent would fund the completion ofseven ongoing projects and the remaining 60 percent would be used to rehabilitatesix existing public sector enterprises. The realized PIP for 1985 was US$8.2million. The authorities also agreed to consult with the Bank before starting

any new industrial project for which total investment was in excess of US$4million. For 1986 the MIEN proposed an industrial PIP of US$47 million. Oncemore, by applying the principle of including only projects of demonstratedfinancial, economic, and technical viability, a PIP amounting to US$17.8 millionwas agreed upon, of which 70 percent would be used to rehabilitate existingpublic sector enterprises.

3.07 At the time of the 1984-1985 PIP review sixteen on-going projects wereconsidered economically dubious and specialized consultants carried out PPFfinanced studies to establish their viability. The most important conclusionsof these studies were that the Zeren urea plant project - the single mostimportant industrial public investment in Madagascar - and the Mamisoa vegetableoil factory were determined to be economically and financially non-viable. Bankstaff recommended the Government not to commence operations with Zeren andMamisoa, since they could only be operated at a loss. At first, the Governmentchallenged the consultants' findings but eventually agreed on the need to searchfor the best alternative, including liquidation, moth-balling, or some recoveryof the investment cost.32

3.08 Under ISAC, the quality of the projects included in the 1985 and 1986industrial PIP improved, the size of the program decreased, and MIEM's projectappraisal capabilities also improved. The average annual PIP for the 1984-1986period averaged US$14 million per year, below the unsustainable levels ofapproximately US$80 million a year since 1979.1 The dropping of severalprojects of dubious viability alleviated the public sector's demand for bankcredit, diminishing the crowding out of the private sector.- The role of the

1" CEM 1991, para. 93 and Draft ITPAC-PCR, para. 23.

2t Memo April 9, 1985, para. 6.

1 ITPAC-PR, para. 3.09.

2t PCR, para. 18.

- 15 -

TA component in achieving these improvements remains unclear due to lack ofdetails in supervision reports on TA's implementation. Nevertheless, missionreports' acknowledged that neither at the level of sectoral planning nor atthe level of national investment coordination had there been significant progressin project selection and the preparation of PIPs. Clearly a more comprehensiveeffort to rationalize the public investment efiort and to focus on the efficiencyand social aspects of adjustment was needed. Follow-up actions supported byITPAC and PSAC attempted to address this issue during the 1987-1990 period.

(3) Import Liberalization and Export Promotion

3.09 Concerning imports, under ISAC, the Malagasy Government removedprohibitions on the importation of basic necessities and goods that were producedby local monopolies representing 20 percent of the number of prohibited goods.Before effectiveness, 7 of the 146 categories of prohibited goods becameimportable and import licenses together with US$1 million in foreign exchangewere made available. These goods included edible oils and fats, soap, candles,writing paper and toilet paper and represented about 5 percent of the list ofprohibited goods.' An additional 15 percent reduction was implemented beforethe release of the second tranche. In addition, a study on effective protectionlevels in Madagascar was completed under the technical assistance component ofthe ISAC (see para. 18).

3.10 Concerning export promotion, beginning in 1982 with the devaluation ofthe FMG the Government began implementing policies geared toward the gradualelimination of the existing anti-export bias. The authorities began allowingmanufacturers to import goods needed for the production of exports and a schemeknown as the EPI account (export, parts, inputs) - whereby exporters were assuredaccess to part of their net export receipts to pay for their spare parts andinputs used in the production of exports - was established for specific firmsbeginning in March 1983. During ISAC preparation the Malagasy authoritiesstarted streamlining export procedures by automatically renewing exporters' cards(which had acted as an export license), by permitting manufacturers to export arange of goods rather than only specific items, and dropping, for all exporterswith a previous export record, Government clearance prior to eachconsignment. 7 Export promotion measures supported by the ISAC included (a)the elimination of export taxes applicable to all manufactured products and theexoneration of exporters of manufactured goods from all indirect taxes on rawmaterials and spare parts used in the production of exports and (b) thepreparation and implementation of an action program to promote exports, includingthe extension of the EPI system to all exporters of manufactured goods.

3.11 Export taxes applicable to all manufactured products and to a numberof agricultural products were suppressed by the 1985 Finance Law. However,ambiguities remained concerning the exoneration of exporters of manufactured

Li Memo April 9, 1985, para. 8.

3 Memo, April 9, 1985, para. 9.

L PR, para. 61.

- 16 -

goods from all indirect taxes on raw materials and spare parts used in theproduction of exports. The first supervision mission (March 18-25, 1985)ascertained that laws enabling exporters to be exempted from the two indirecttaxes applicable to inputs - the TUT1i and the TCI191 - already existed withinthe Tax Code ("Code g6n6ral des imp6ts"). Evidence was produced by theGovernment indicating that some of the exemptions included in the Tax Code wereeffectively applied (e.g. TUT tax credit). But in other cases exporters did notappear to have benefitted from exemptions, such as the tax on inputs of exportedproducts not normally subject to the TCI - as in the case of wood products -which could be exempted on the basis of individual Ministerial Decisions. Bankstaff assessed that this could be explained by a lack of knowledge of therelevant legislation among exporters and difficulties in dealing with thebureaucratic aspects of obtaining the exemption decision. Similarly, because ofpractical difficulties in identifying which spare parts were used in exportproduction and in what proportions, spare parts had not been exempted fromindirect taxes. Nevertheless, Bank staff concluded that since the necessary lawsalready existed and the remaining difficulties referred only to their effectiveapplication this condition of effectiveness could be considered as being met.The mission, however, recommended that implementation issues be addressed in theoverall context of the preparation of the action program for exportpromotion.40

3.12 The EPI foreign exchange retention facility was extended to allexporters of manufactured goods covering all their foreign exchange needs for theproduction of export goods. The preparation and implementation of an actionprogram to promote exports, however, ran into several delays. During the March1985 supervision mission, Bank staff determined that ever though consultants hadbeen invited to present proposals for the export promotion program, formaleffectiveness had to await the actual hiring of the consultants for thepreparation of the program," which had been delayed due to changes within theMIEM. At the time of the following supervision mission (June 23-July 10, 1986)the MIEM expressed its intention of implementing certain export promotionmeasures recommended by a draft export promotion study -such as the extension ofthe EPI to all manufacturing exports, the application of a uniform retention rateof 35 percent, the removal of a limit on the maximum absolute amount of foreignexchange that an exporter could retain, and the creation of a national commissionfor exports - but had not yet developed a comprehensive and detailed system topromote exports.- Moreover, Bank staff felt that the Government was notgiving enough priority to the need to further depreciate the FMG, even though theIMF was monitoring the evolution of the exchange rate. The adoption of theaction program was delayed due to the fact that the Government had not yet

Le "Taxe Unique sur le Transactions"

at "Taxe de Consommation Int6rieure"

L Memo, April 9, 1985, para. 12-13.

i Memo, April 5, 1985, para. 2.

L1 Memo April 11, 1986, para.14.

- 17 -

received the final version of the consultant's report as well as to the lack ofinter-ministerial consensus on the proposed measures.3 1

3.13 Eventually, in August 1986, the Government introduced an exportpromotion program that guaranteed exporters the necessary foreign exchange fortheir imported inputs and simplified exporting administrative procedures. Morespecifically the program: (a) guaranteed the foreign exchange required for spareparts and material inputs to all economic agents for the part of their expectedexport output, provided that the export output exceeded 20 percent of overallturnover per year; (b) guaranteed producers exporting 50 percent or more of theiroutput foreign exchange for their entire production, including the part that wassold in the domestic market; (c) exempted the latter two categories of exportersfrom a 10 percent fee levied on all other economic agents requesting foreignexchange; (d) abolished the requirement that the value of exports reach a minimumamount and that export prices be approved; set up an inter-ministerial committee(Industry and Commerce) to oversee the simplification of export procedures andto generate ideas for further encouragement to exporters.!

3.14 Within the context of IMF Stand-by agreements, the Government also tookactions pertaining to the exchange rate regime. On August 1986 the FMG wasdevalued by 20 percent in foreign currency terms against the basket of currenciesto which it was pegged. The Government also agreed under the sixth IMF Stand-byto continue a policy of quarterly exchange rate adjustment based on the evolutionof domestic inflation. 5'

3.15 As discussed in the PCR, even though these actions represented a stepin the right direction, in 1987 major structural issues relating to the Malagasyexchange and trade policy remained to be addressed. Outstanding issues included:import prohibitions and a cumbersome licensing system, high and dispersed levelsof effective protection, foreign exchange shortages and the maintenance offoreign exchange controls, and a limited export response given persistingdistortions in the overall incentives' structure.6 A more comprehensive andfar reaching effort to address trade and exchange regime issues and tariff reformwere pursued under ITPAC and would also be supported under the coming PRIVAC.

(4) Private Sector Encouragement

3.16 With the objective of resuming a more active role of the private sectorin the industrial sector a new Investment Code, satisfactory to IDA, was approvedby the National Assembly before the release of the second tranche of the ISAC.The code constituted an improvement over the previous code by providingadditional guarantees against nationalization, by allowing the repatriation ofdividends and profits, and by reducing special treatment for particular classes

13 Telex, April 29, 1986.

j Memo, October 6, 1986, para. 3.

i Memo, September 18, 1986, para. 3.

i' PCR, paras. 19-20.

- 18 -

of investors.- Investments for new enterprises as well as for capacityexpansion were eligible to receive benefits under the Code, which included tworegimes, the "priority agreement" and the small and medium scale nationalenterprise". The "priority agreement" would apply to all "large" investments fora period between four and seven years. It granted a total exemption from importduties on capital goods; a profit tax holiday during the first years of theagreement, progressively phased out during the last three years; repatriation ofdividends to non resident foreign owners, and guarantee of a stable tax regimeduring the length of the agreement. The "small and medium scale nationalenterprise" regime would apply to the enterprises which were not large enough toqualify to the previous regime. Those enterprises, however, had to have amajority Malagasy owned capital and a management under the control of Malagasypeople to be eligible to this regime, which could not in any case exceed fiveyears. It granted the same benefits as the previous one with the exception ofthe repatriation of profits. Finally, a "partnership" regime was also createdfor those private entities wishing to undertake a project jointly with the State.The benefits under this regime were to be decided on a case by case basis.L81

3.17 By early September 1987 - when a supervision mission visited Madagascar- while the Investment's Code applicability decree had been promulgated by theNational Assembly (before the release of the second tranche), the Code had notbeen published or enacted yet. For the Investment Code to become a non-discretionary law with transparent applicability, the publication of the adoptedimplementing decree was required. The applicability decree was eventuallypublished in the Official Gazette only on September 21, 19871f and was enactedonly in May 1988. By then the code had been rendered obsolete by the changingeconomic environment and a new, more open investment code was promulgated underPSAC in December 1989 partly as a result of the continuing policy dialoguebetween the Government and the Bank.So

B. BNI Investment Component

3.18 SDR 5 million of the credit was to be lent to the BNI for the fInancingof investment (rehabilitation) projects through sub-loans to investmententerprises. Sub-loans were restricted to investment projects with a total costnot exceeding US$ 500,000. According to the PCR!i "the BNI component was theleast successful, due mainly to the unfavorable investment climate and BNI'sslowness in processing applications for sub-loans and its parlous financialsituation.-' Particularly at the beginning of implementation process, projects

i Ibid., para. 21.

M Memo, April 9, 1985, para. 15.

Mi Memo,October 7, 1987, para. 21.

Lt PCR, para. 5.

Li Ibid., para v.

1-t Ibid., para. 22.

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proposed by BNI were more expansion than truly rehabilitation and this resultedin implementation delays. Nonetheless, BNI's financial situation was the mainreason behind implementation delays.

3.19 Bank staff became aware of BNI's untenable financial position onlyduring a July 1985 mission, when staff realized that BNI was having seriousliquidity problems. By the time the next supervision mission visited Madagascar,in February 1986, "BNI's portfolio situation in general remained obscure ... theyear end 1985 financial data (balance sheet and income statement) was not yetavailable, BNI's management was also quite reluctant to disseminate much otherinformation to the supervision mission."Lu Moreover, the mission realized thatexisting rehabilitation projects were not coordinated by BNI, as they weresupposed to be, but were instead carried out by the Government. Studies torehabilitate certain enterprises apparently existed but were not made availableto the Bank mission and at the end of the mission it remained unclear who wasactually in charge of coordinating these rehabilitation programs.L'

3.20 At the end of the February supervision mission Bank staff agreed withthe authorities that among other, (a) an auditor would finalize an on-goingportfolio update by April 1986, and (b) BNI would hire an international auditfirm by April 1986 to carry out the audit of the 1985 financial accounts,including a comprehensive review of BNI's accounting systems and procedures. IfBNI did not comply with these and other steps agreed during the mission to clearup BNI's portfolio situation and the terms and status of rehabilitation projects,no extension of the commitment deadline would be considered.25 During theJune-July, 1986 supervision BNI's financial situation remained difficult: anumber of large public sector enterprises were contributing to the steadydeterioration of BNI's portfolio; the non-performing portion of the portfolioincreased by 32 percent during 1985 and by mid-1986 represented about half ofBNI's total portfolio. BNI still did not prepare a budget, projections, or asound pipeline of sub-projects. Nevertheless, BNI's component cow,iitment datewas extended and ISAC's closing date which was originally set foi 'ptember 30,1987 was also extended to September 30, 1988.- By July 1988, and despite astart at rehabilitating selected public sector enterprises which were responsiblefor most of BNI's difficulties, half of BNI's portfolio was still not performing.

3.21 During supervision missions it became clear that the steps taken underISAC would be by far insufficient to reintroduce efficiency and viability to BNIand that further action would need to be pursued within a financial sectoroperation since BNI problems were common to the other two commercial banks andcould not be solved within the context of ISAC alone.

2 Memo, April 11, 1986 para. 18 and 23.

2 Ibid., para. 25.

25' Ibid., para. 30.

2U Memo June 8, 1987, para. 3.

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C. Technical Assistance Component

3.22 SDR 1.5 million had been allocated to the MIEM to (a) reinforce itsdata collection, analysis, and evaluation of Investment projects; (b) prepare anaction program for export-promotion and a study of Madagascar's import system;and, (c) rehabilitate and upgrade a building to serve as MIEM headquarters. Adata bank for the MIEM was created and the MIEM building was rehabilitated. Thetrade regime study undertaken under the TA component provided estimates ofeffective protection levels and dispersion which were used as groundwork for thedesign of ITPAC. The study concluded that in 1986-1987 tariffs were providinga high and uneven pattern of effective protection. The average effectiveprotection, granted by tariffs, for 68 representative products was about 160percent while specific tariffs varied between -5 percent and over 1,000percent.- Nonetheless, effective protection levels were underestimated sincethe did not take into account import prohibitions and exchange controls.Additional details on the TA component's implementation are unavailable due tolack of detailed supervision of the TA effort.

IV. ASSESSMENT OF OUTCOME WITHIN THE OVERALL ADJUSTMENT PROGRAMLi

A. Assessment of Outcome

9'4.01 As emphasized by the PCR,- it would not be appropriate to assessresults and draw lessons for ISAC individually. ISAC was only intended to pavethe way in the direction of adjustment as a first step toward a morecomprehensive reform process and was followed relatively quickly by otheradjustment operations.L- In fact, the process leading to ISAC "served as auseful vehicle between the Government and the Bank Group on a number of far-reaching policy changes affecting a varibty of macro and industrial sectorissues."6 Acknowledging the limitations of ISAC as a preparatory credit andrecognizing that its outcome must necessarily be assessed within the frameworkof the overall Malagasy adjustment effort, ISAC results will be evaluatedaccording to two criteria: (a) whether the stated objective of the ISAC wasa-'iieved and (b) whether priority issues in the industrial sector, discussed inChapter II, were indeed addressed either by ISAC or by subsequent operations.

4.02 The stated objective of the ISAC was to support the Government'sstrategy of bringing about meaningful policy changes in the industrial sector

1U ITPAC-PR, para. 3.20.

1t This chapter draws on CEM 1991, PRIVAC-PR, and Report No. 7784.

L PCR, para. 10.

i Ibid., para. 29.

t PR, para. 77.

- 21 -

designed to increase its efficiency and productivity, while beginning the processof establishing an environment conducive to efficient import substitution andexport production (para. 2.04). These policy changes would constitute importantfirst steps towards promoting the efficiency, openness, and export-orientationof the Malagasy industrial sector so that it could increasingly contribute to thecountry's balance of payments and to the growth of employment and output.L1

4.03 ISAC did indeed provide the impetus and groundwork for theimplementation of follow-up credits, which taken as a whole represent a fairlycomprehensive adjustment effort. After the implementation of the ISAC majoroutstanding issues still remained to be addressed by follow-up operations,including high and uneven protection, exchange rate overvaluation, foreignexchange controls, public enterprises' issues, credit policy (including a reviewof savings mobilization, interest rate structure, and credit allocation),rehabilitation of portfolios of all three banks, establishment of sound write-offprocedures, assessment of type of financial services needed, establishment ofbank supervisory entities. Therefore, ISAC was followed by a subsequentoperation in the industrial sector, the Industry and Trade Policy AdjustmentProgram (ITPAC - Credits 1834-MAG and A-32-MAII) in FY87, separate adjustmentoperations in agriculture (ASAC, Credits 1691-MAG and A-16-MAG) in FY86, in thepublic sector (PSAC, Credit 1941-MAG) in FY88, and a proposed private sectorenvironment adjustment credit (PRIVAC) which is scheduled to be negotiated inlate 1991. The adjustment effort was complemented by non-adjustment operationsin the social sector with the support of the Economic Management and SocialA tion Support Project (EMSAP, Credit 2125-MAG) in FY89, in the financial system( 2EX, Credit 2104-MAG) and in the environment (Credit 2125-MAG) in FY90.Notwithstanding the follow-up effort, the appropriateness of the decision takenby the Bank to disaggregate structural adjustment lending into a series ofsubsequent sector operations, rather than on a comprehensive SAL, is an issuelinked to the design of the credit and is discussed in Chapter V.

4.04 Beginning with ISAC and continuing in earnest in 1987, the MalagasyGovernment embarked on a process of general liberalization of most economicactivities. With respect to the industrial sector, the adjustment processfocused on:

(1) abolition of controls on prices as well as on industrial andcommercial profit margins;

(2) elimination of import prohibitions and quantitative restrictionsfor protective purposes;

(3) adoption of a market-determined foreign exchange allocationregime;

(4) simplification of the administrative exporting procedures;

Lt Ibid., para. 77.

Li Report 7784, para. 12.

- 22 -

(5) the rationalization of the overall PIP process; and,

(6) the stimulus of private domestic and foreign investment.

In addition, an active and more competitive exchange rate management policy waspursued throughout the adjustment period with the collaboration of the IMF, whichbeginning in 1980 supported the Government's stabilization effort with severalStand-by arrangements and special facilities.

4.05 Between 1983 and 1989, in the context of the overall adjustment effort,the Malagasy Government succeeded in removing virtually all price control.Price liberalization began with reforms in the agricultural sector freeing theproducer price of rice in 1983 and the consumer price of rice in 1985. Between1986 and 1988 the Government liberalized the prices of all agriculturalcommodities with the exception of vanilla, cotton, sugarcane, and tobacco. Roadtransport tariffs were also freed in 1985. In the industrial sector, the priceliberalization effort supported by ISAC, was completed in 1989 through reformsimplemented under ITPAC (paras. 3.04-05). Currently, only prices of products andservices provided by state monopolies are still controlled.- For naturalmonopolies and telecommunication services the Government has agreed with the Bankon a new pricing system based on the long term marginal cost of the services.The liberalization of vanilla, air transport, and petroleum will be pursued underthe proposed PRIVAC. 'According to World Bank reports, the inflationary impactof price liberalization has been limited because market prices already reflectedscarcity premia and because the price liberalization coincided with devaluations,tariff reductions, and the removal of quantitative restrictions.65

4.06 While under ISAC a small number of import prohibitions were removed andreplaced by tariffs and a few export-promoting measures were implemented,substantial distortions remained in the trade regime and a general anti-exportbias of trade and macroeconomic policy still existed. Thus, particularly in theexchange and trade area. ISAC provided only the groundwork while ITPAC and PSACset in motion a far-reaching program to reform the instruments of tradeRolicy.-L6

4.07 On the import side, in January 1988, the Malagasy Government eliminatedalmost all non-tariff barriers on imports (except for 94 items, which were healthand security-related and were reduced to 77 in March 1989). The authoritiesinstituted a temporary 30 percent surcharge on some previously prohibited importsto ease adjustment in the sectors concerned, primarily textiles and meat. Thesurcharge was reduced to 10 percent in 1989 and was then eliminated in January1990. All tariff exemptions were eliminated and nominal and effective protectionwas lowered. A program of tariff rationalization was introduced in January 1988,

si CEM 1991 para. 93, PRIVAC-PR, para.54, and Report 7748, para. 79.

L CEM 1991, para 93. and Report No. 7784, para. 80.

S1 Additional details and an in-depth analysis of the outcome and outstandingissues of the reform process in the industrial sector are provided in Report7784.

- 23 -

when specific tariffs were substituted by ad valorem ones and tariff categorieswere reduced from 69 (ranging from 0 to 1,000) to 21, ranging from 5 to 110. In1990, the number of rates was further reduced to 14 ranging from 5 to 80 percent.In January 1991 the Government adopted a new tariff schedule ranging from 5 to60 percent, and in 1992, supported by PRIVAC, the Government has expressed theintention of reducing the number of tariff rates to 5, ranging from 10 to 50percent. The overall (un-weighted) mean tariff rate dropped from 46 percent in1988 and 41.5 in 1989 to 32 percent in 1990 and is programmed to further decreaseto about 29 percent in 1991. The standard deviation of the tariff schedule alsodecreased form 28.6 9ercent in 1988 to 20 percent in 1990, and is expected to be17 percent in 1991.1- The 1989-1991 tariff reforms significantly contributedto the reduction of the dispersion of the tariff distribution, eliminatingcascading to a very large extent. Even in the absence of an effective protectionstudy, clearly the tariff reduction has significantly contributed to bring downeffective protection rates.

4.08 On the export side. the liberalization process began in 1986-1987 andaccelerated during 1988.1' In 1986-1987, supported by ISAC and ITPAC, priorauthorization to export, prior export price controls, minimum value requirementsand trial periods for exporters were abolished, aid exporters' cards were issuedmore freely. However, until the implementation o. PSAC, the existence of tightadministrative controls limited the effectiveness of these liberalizationmeasures. In January 1988, under PSAC, the state stabilization fund's monopolyon exports of coffee, pepper, and cloves was abolished. Exporters' cards andexport declaration requirements were eliminated. In September 1988, theGovernment published a new export law enabling exporters to freely export theirproducts, except for vanilla, at prices negotiated directly by exporters andimporters. All mandatory quality controls and certifications of exportable goodsby the authorities were abolished. In addition, under ISAC export taxes had beenabolished on all but three traditional export products (coffee, vanilla, andcloves) and in 1990 the implicit multiple levies on coffee and cloves exportswere merged into single explicit variable ad valorem taxes.- Thus, except forvanilla, all administrative export requirements were reduced to a single customs'declaration.

4.09 In order to further advance export promotion and to complement importliberalization actions, the Government acted also on the exchange rate policyfront.- During 1983-1986 the nominal effective exchange rate depreciated bya cumulative 60 percent, corresponding to approximately 30 percent in real terms.Notwithstanding these devaluations, at the time of ITPAC prparation (i.e., early1987), significant excess demand for foreign exchange persisted and the parallelmarket rate was about 50 percent higher (in foreign currency terms) than the

LU CEM 1991 para. 39, Draft PRIVAC-PR, para. 42 and draft ITPAC-PCR, para. 22.

Lt GEM 1991, para. 40.

Lt Ibid., para. 58.

LGEM 1991, para. 37.

- 24-

official rate.ZL; By end-1987 the authorities further devalued the FMG by acumulative 43 percent in nominal trade-weighted foreign currency terms. In 1988the FMG was further depreciated by a total 26 percent. Thus, by 1989. the realeffective exchange rate was approximately 40 percent of its 1982 level (Table inAnnex 1).4' On January 10, 1991 - as an up front action for PRIVAC - and toimprove the country's deteriorated external balances, the Government devalued theFMG by 13 percent. To avoid future real appreciations of the FMG the authoritieshave indicated their intention to implement periodic corrections of the exchangerate in line with the inflation rate differential between Madagascar and itsmajor trading partners.

4.10 The correction of the FMG overvaluation created the conditions for anoverhaul of the foreign exchange regime. In January 1987, supported byITPAC, the Government took a first step toward the implementation of a foreignexchange allocation system that did not discriminate between activities and endusers. The import liberalization phase of the ITPAC introduced and developed amarket-based system of foreign exchange allocation, the Liberalized Import Regime(LIR). In July 1988 the Government widened the foreign exchange policy reformswith the introduction of a full-fledged General License System (OGL) throughwhich unlimited foreign exchange became available at the prevailing exchangerate for imports of goods by any economic agent. In February 1991 - duringdiscussions on the PRIVAC-supported reform program - the Government also expandedautomatic access to foreign exchange for invisibles. Further actions to be takenunder PRIVAC would attempt to increase the flexibility and automaticity of theOGL system and address other limitations of the system.L

4.11 In conclusion, the 1970s and 1980s strong anti-export bias of the traderegime has been being dismantled, particularly after the cumulative devaluationsand the replacement of import licensing with progressively reduced tariffs. Tofurther promote exports, the Government has recently implemented further actions:in December 1989 the authorities promulgated a free-trade zone law offeringgenerous fiscal incentives. Moreover, under the proposed PRIVAC, to complementreforms of the foreign exchange system (para. 4.10) ani uhe investment (para.4.13) and free-trade zone legislation, the Government has irIcated its intentionto publish and disseminate clear administrative guidelines for exporters tobenefit from the existing mechanisms (temporary admission, drawback and bondedwarehouse) allowing tax-free access to imported inputs.!S_

4.12 While ISAC was successful in improving the quality of the projectsincluded in the 1985 and 1986 industrial PIP, cutting the size of the program,and improving MIEM's project appraisal capabilities, a more comprehensive effort

Lt ITPAC-PR, para. 3.13.

Lt Ibid., para. 10.

Zt CEM 1991, para. 38.

1t Ibid., para. 37-41.

2i Draft PPIVAC-PR, para. 45.

- 25 -

to rationalize the overall national oublic investment program and to payincrsed attention to efficiency and the social aspects of adJustment waspursued under ASAC. ITPAC. and PSAC. Under ASAC an agreement was reached on the1986 agricultural PIP. Under ITPAC, the overall PIP's preparation, control, andsupervision was improved and agreement was reached on the 1987 and 1988 nationalPIP. Agreement on the 1989 and 1990 PIP was reached during the review of theITPAC and PSAC implementation progress. The technical assistance and materialrequirements to support the budgetary reform process were financed through theEMSAP. Under PSAC, PIP's monitoring and programming was further improved withthe implementation in 1989 of the first annual investment budget in the contextof a three-year rolling PIP comprising all sources of financing with theobjective of integrating project selection into comprehensive three-year publicexpenditure programs. Since then the authorities have prepared successive three-year rolling PIPs and PEPs for the health, education, transport and mining,energy and industry sectors. The draft PRIVAC aims at further improving theprogramming and monitoring of public expenditures, by seeking agreement on the1992-94 and 1993-95 PIPs, PEPs, and the 1992 and 1993 budgets.

4.13 In the area of private sector encouragement, even though the investmentcode prepared under ISAC represented a substantial departure from pastnegative attitudes towards the private sector and foreign investment, it was nottimely and flexible enough to keep up with the changing economic environment.Thus, in December 1989. to attract private domestic and foreign investment, theGovernment adopted a new investment code. Under PRIVAC the Government hasindicated its intention to adopt the implementation decree for the new investmentcode, which is to be published before negotiations.L1

4.14 At the time of ISAC serious constraints on financial intermediationexisted (para 2,02). Problems and delays in the implementation of the BNIcomponent of the credit (paras. 3.18-21), and credit shortages constituting a keyconstraint to economic recovery, were caused by financial sector liquidityproblems linked to the need for public enterprise reform. Unfortunately, thesituation of the commercial banks' portfolios, particularly of BNI, became knownonly during ISAC's implementation thanks to effective supervision. The financialsituation of the three commercial banks was untenable and their portfolios werein need of major write-offs, mainly reflecting substantial non-performing loansto non-viable public enterprises which had been able to survive only thanks tocredit from the three state banks. The banking system kept these enterprisesalive at the cost of building up a high percentage of non-performing loans andseriously limiting its capacity to meet the financial intermediation needs of aliberalizing economy.

4.15 The financial health of the banking sector continued worsening up to1987, when ITPAC and PSAC began addressing both the financial sector and publicenterprise issues which had been left out of ISAC. On the public enterprisefront,1.1 between 1988 and end-1990, dissolution or divestiture actions wereinitiated for 71 out of 167 public enterprises and fully completed for 34 of

Li Ibid., paras. 46-48.

L' CEM 1991, paras. 68-75.

- 26 -

them; restructuring plans were formulated for the six largest agricultural andcommercial parastatals; the textile industry is currently going from almostentirely state owned to fully privatized. On the financial side, a ceiling oncredit to the public enterprises was included in IMF programs. As a result ofthese measures, the share of public enterprises in commercial banks' creditdecreased from 54 percent in 1983 to less than one third in 1990. The twocredits also supported, during 1988-1989, the authorities' successfulimplementation of a major clean-up of the commercial banks' portfolios.- InMay 1988, a comprehensive new banking law was enacted which terminated the Statemonopoly and opened the domestic banking system to foreign capital. BNI has beenprivatized and the capital of another state bank has been opened to foreigninvestors for a 25 percent minority participation. In addition, PRIVAC wouldsupport further reforms aiming at increasing the efficiency and effectiveness offinancial intermediation.Li

B. Impact on Macroeconomic Performance (1985-1989)

4.16 Even though the first large-scale macroeconomic adjustment program waslaunched in 1987, the Malagasy Government, throughout the 1980s, implementedseveral IMF and World Bank-supported stabilization and adjustment programs, whichcontributed to reducing domestic and external financial imbalances. After1984, the fiscal deficit levelled off at approximately 3.5 - 4.0 percent of GDP,and by the end of 1987 fiscal accounts had been restored to the situationexisting prior to the 1978-79 investment boom. Monetary creation slowed down,and by 1989 inflation had decreased to 10 percent, compared to a peak of over 30percent in 1981 and 1982. The external current account deficit (including netofficial transfers) dropped to 5 percent of GDP, from a peak of 14 percent of GDPin 1980. The exports to GDP ratio increased from 8.8 percent in 1983 to 13percent in 1989. Gross reserves reached a peak of 7.7 months of imports from asituation of almost no reserves at the beginning of the 1980s, and importsexpanded for the first time since 1980.

C. SuRply ResponseL1

4.17 In 1985-1986, under ISAC, limited reforms were implemented. During1987-1988, with ITPAC and PSAC, reforms began in earnest. After a transitionperiod - when the exchange rate was still overvalued and a full-fledged importliberalization effort had not yet begun - the overall economy began respondingto the adjustment effort in mid-1988. The mobilization and use of domesticresources improved and there was an increase in capacity utilization, leading toa real GDP growth rate averaging 3.8 per year during 1988-1989, compared todpproximately zero growth on average between 1980 an, 1987 (see Table in Annex

Lt CEM 1991, paras. 84-88.

1' Ibid., paras. 62-65.

Lt GEM 1991, paras. 27 and 31-33.

L Ibid., paras. 28-30.

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1 for details on macroeconomic indicators). During 1988 and 1989 real GDP percapita growth was also positive, after a dismal record throughout the 1980s.

4.18 The initial reaction of industrial production to the implementation ofreforms was limited. Industrial output grew on average by approximately 4percent during 1986-1987, and by only 2 and 1 percent in 1988 and 1989,respectively. However, in 1990 industrial sector growth accelerated to over 6percent and private industrial sector confidence improved. Between 1987 and1990, industrial capacity utilization rose to 60 percent on average, as comparedto earlier rates averaging 45 percent. The garment sub-sector was particularlyimpressive, with its capacity utilization raising from 50 percent in 1986 to 85percent in 1988. Since short-term increases in capacity utilization are drivenby export demand, 1987-1990 increases were primarily the result of the increasingprofitability of exports as a result of several devaluations beginning in 1987and of the plentiful availability of foreign exchange with the adoption of LIRand later of the OGL allocation system.

4.19 However, according to Bank assessments of the adjustment effort,

"the most impressive change in the economy induced by thetrade and price liberalization has been the increasedoutward orientation of the historically import-substitutingindustrial sector. The successful macroeconomicstabilization and, in particular, the devaluations and theliberalization of the import and export procedures havestimulated private sector development in the garment andknitwear and the food processing industries.,i2

Export of manufactures increased from 13 percent of total exports in 1986 toapproximately 23 and 25.5 percent of total exports in 1988 and 1989,respectively. July 1990 discussions with the private sector - conducted duringthe preparation of Report 7784 - confirmed a widespread supply response to theliberalization measures, exemplified by an intensification of firm entry in laborintensive activities, an observable increase in the number of takeovers and,substantial restructuring in industrial activities that existed prior to theliberalization.

Ui report 7784, paras. 96-100.

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V. CREDIT DESIGN. UTILIZATION. AND SUPERVISION

A. Design Evaluation

(1) Gradualism; The Governance Dimension and Social Considerations

5.01 The theoretical underpinnings for ISAC were jointly established by theMalagasy Government and the Bank, in close cooperation and coordination with theIMF. The Government of Madagascar, fearing the economic, political, and socialimplications of the up front implementation of a comprehensive adjustmentprogram, requested IDA's support for a sequenced approach, of which ISAC wouldbe the first step. ISAC was on the whole well designed as a preparatory loanand, as stressed by the PCR,8' the reforms adopted under ISAC were steps in theright direction even though further reforms were needed in order to generate asignificant supply response.

5.02 A general design issue deals with the appropriatenees of a phasedsectoral approach as opposed to an up front comprehensive adjustment operation.While ISAC was indeed followed by subsequent operations (para. 4.03) theappropriateness of the decision taken by the Bank to disaggregate structuraladjustment lending into a series of subsequent sector operations, rather than ona comprehensive SAL should be commented upon. The genesis of the ISAC as a firststep on the road of adjustment, and its limited scope, derived from twoconsiderations linked to the Malagasy's authorities political and socialconstraints at the time.

5.03 First, as stressed by the PCR,14 even though the socialist Governmentwas committed to reform in principle, it was not at the time convinced of the"necessity or desirability of a comprehensive reform program." ISAC, therefore,was seen from the beginning as a the first step on the path to reform andattempted to:

"strike a balance between the need for far-reaching reformsand the Government's fear of the unknown by starting theadjustment process with a program that was significantenough to lay the foundations for recovery and theresumption of growth and at the same time not too farreaching as to fail to command reasonable consensus."L5

Bank staff hoped that successful implementation of ISAC would convince theGovernment to implement a more vigorous reform package. Eventually, the overalladjustment program - supported by several IMF stand-by loans - consisted ofseveral sector loans. Even though at the time of ISAC preparation governanceissue were not yet explicitly considered, the governance dimension did affect

i PCR, para. iii.

_i Ibid., para. 8.

5i Ibid., para. 8.

- 29 -

both the design of ISAC and economic performance under the overall program.L6The Malagasy Government in 1985 was not prepared to risk implementing acomprehensive SAL type operation. The Government, however, felt strong enoughto undertake ISAC which was a first step in the reform process but alreadycontained measures which might have been unpopular. The overall adjustmentprogram was designed jointly by the Malagasy authorities and Bank staff notwithout difficulty given the skepticism and distrust of the socialist regime overmarket mechanisms. There was an effort by the authorities at building aconsensus on liberalization measures, which was particularly difficult within asocialist economy with a socialist Constitution.

5.04 Second, the country's economic team was also attempting to strike abalance in the pace of policy reforms in order to improve efficiency in theindustrial sector without causing severe economic dislocation and possible socialunrest. Notwithstanding Madagascar's outstanding social issues, there is noevidence of a social impact analysis at the time of ISAC design, while both ITPACand PSAC do discuss possible social implications of their implementation.However, this credit was considered from the beginning as a first step towardseliminating distortions in the economy, thus enabling growth with equity. It wasanticipated that the social dimensions of adjustment would be the focus ofsubsequent IDA credits.

5.05 In conclusion, as stressed by the PCR,L- the phased approach wasappropriate to the circumstances:

"First, it allowed government confidence and commitment inthe reform process to be slowly built up. Both theGovernment and important interest groups were at bestskeptical of the need and desirability for adjustment at thetime the process was begun, and at worst they were activelyopposed. Positive experience under ISAC allowed thesepolitical obstacles to be gradually overcome. Second, itgave time for additional analytical work to be carried outand information and experience to be built up within theBank, thus allowing a more comprehensive program to bedeveloped. This latter factor was particularly important inlight of the limited experience, at the time the project wasfirst being planned, with this type of adjustmentoperations.

The danger with such an approach is that 'adjustmentfatigue' might set in, and commitment to further reformwould lag. This does not appear to have happened in thiscase. There was some limited backtracking on tariff reformsand delays in the public enterprise privatization process

i Nooter, R.H. and R.A. Stacy, Progress on Adjustment in Sub-Saharan Africa:Implications for Future Lending Strategies, October 15, 1990, IBRD internaldraft: paras. 37-40.

Li PCR, paras. 30-33.

- 30 -

during implementation of ITPAC, but the program was soon setback on track.

The other significant drawback of the gradualist approach isthat the funds could go to firms (including public sectorfirms) still operating in a highly distorted environment.This problem was partidularly acute for the investmentcomponent of the Credit, but also applied to the generalimports component. Doubts were expressed by the loancommittee that the funds would be used efficiently withimportant distortions remaining. The BATA subloan, forexample, was used for equipment which later provedinappropriate in the liberalized regime. In a sense, theBNI's slowness in processing applications proved to be ablessing in disguise, since subprojects which wereeventually approved were conceived by their promoters andimplemented under the more liberalized system establishedunder ITPAC. These subprojects seem to have been reasonablyefficient. The complicated tests to ensure 'adequate valueadded' and 'additionality' are another example of theproblems caused by the partial approach. They were,however, useful to illustrate the need for a transparentnon-administrative resource allocation system and, in anycase, they were short-lived."

(2) Sequencing of Reforms

5.06 The issue of sequencing is closely related to the choice of a phasedapproach to adjustment. The PCR/ raises the issue of whether the adjustmentprocess should have started with a more rigorous foreign trade reform first,followed later by domestic reform. Such an approach, however, was not deemedpolitically feasible at the time. Moreover, even though external competitionpolicies are generally introduced prior to internal competition, this is notnecessarily a dogma. In fact, as stressed by a recent OED study on trade policyreform,L9

"the effectiveness of trade reform is strengthened when itis accompanied by internal competition policies inindustrial, financial and other sectors. It not onlyimproves the economy's flexibility to respond to externalcompetition but it also prevents domestic regulatorypolicies from eventually being used as anti-trade devices."

5.07 Given the close link between financial intermediation and industrialsector reforms, a second set of sequencing issues relate to the need for a promptanalysis of the status of the financial system and to the timing of financial

t Ibid., para. 34.

' Report No.9527, World Bank Support for Trade Policy Reform, April 22, 1991,paras. 4.62-4.65.

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sector reforms. The industrial restructuring process can succeed only ifadequate financial resources, supplied by an efficient financial intermediationsystem, are available at reasonable cost. When the financial system is in deepdistress and when most banks in the system have large non-performing portfolios,financial sector reforms should be tackled in parallel to other industrial sectorreforms, since further lending through unsound financial intermediaries wouldonly worsen the problem.2' During ISAC preparation no detailed analysis of thefinancial sector situation was performed. At the time of the President's ReportBank's staff assessment of BNI financial situation was that "overall, BNI'sportfolio is of acceptable quality ... the financial position of BNI issound.11l Only during supervision did Bank staff become aware of financialsector issues.

5.08 In discussions with the Region it became clear that at the time of ISACpreparation Bank staff accepted BNI numbers at face value and that the loanclassification available at the time led to the optimistic conclusions presentedin the President's Report. BNI's real financial situation became clear only whenloans were later reclassified enterprise by enterprise. Nonetheless, the lackof financial sector work in the design phase was made up by effective supervisionand financial sector follow-up measures taken under ITPAC and PSAC.

5.09 Even though foreign exchange controls were in place at the time of ISACthe freeing-up of foreign exchange allocation was not pursed until after 1987under ITPAC. Tnis was explained by the strong skepticism of the socialistGovernment towards market mechanisms, especially in such a delicate area, at thetime of ISAC design.

(3) Conditionality Issues

5.10 Finally, conditionality was manageable and appropriate to theobjectives pursued by ISAC. However, there were two important differences in theway two second tranche conditions were stated in the President's Report and thelegal conditions. First, while the President's Report stated the second tranchecondition as "decontrol of all industrial prices," the Development CreditAgreement specified "free ex-factory prices."L' The Region acknowledges that

the Presiaeit's Report was not specific enough since at the time of ISAC designBank staff had not focused on the differences between various price controls.This gave an opportunity to the Government to maintain controls on profit margins(para. 3.04). Clearly, the spirit of the condition was not met. Second, whilethe President's Report asked for the implementationI of a satisfactory export

qoQ' Lieberman, I. Industrial Restructuring, Policy and Practice, , Policy and

Research Series, No.9, Industry and Energy Department, 1990: 21.

_' PR, Annex IV, paras. 14 and 17.

2i PR, para. 95.

2t Development Credit Agreement, Schedule 4.

2i PR, para. 95.

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incentive system, the legal condition specified only the need to adoDt!- aprogram of actions to promote exports. Moreover, the Investment Code was notflexible enough to keep up with the changing economic environment (para. 3.17).Finally, the condition calling for the exemption of indirect export taxes wasredundant since the Tax Code already contained such exemptions. (para. 3.11).

B. Disbursements

5.11 The credit was jcintly financed by IDA (credit 1541-MAG, for SDR 40.2million) and a supplemental credit from the Special Facility for Sub-SaharanAfrica (SFA) (Credit A-7-MAG, for SDR 18.5 million). The proceeds forimportation of inputs would be disbursed in two tranches, while therehabilitation and technical assistance components were not tranched. Theindustrial imports component of the project - which represented 84 percent of theISAC and 100 percent of the SFA Credit, for a total of SDR 52.2 million -consisted of the provision of foreign exchange for the importation ofintermediate goods and spare parts, and materials for eligible enterprisesthrough the three commercial banks, i.e., BNI (National bank for Industry), BTM(National Bank for Agriculture), and BFN (National Bank for Trade). The list ofeligible enterprises was established on the basis of value-added eligibilitycriteria, i.e. eligible enterprises had to have a ratio of value added to thevalue of their inputs, both calculated at border price, at least equal to 50percent. Foreign exchange allocated to eligible firms from the proceeds of theCredit had to be additional to the amount that would otherwise have beenallocated without the Credit.

5.12 The quick-disbursing component of the credit was channeled through theCentral Bank, which then sold the foreign exchange to eligible enterprisesthrough the three commercial banks. In order to accelerate disbursements aSpecial Account, i.e. a revolving fund, was established at the Central Bank. Atthe beginning disbursements were slower than expected due to the six month delayin Credit effectiveness resulting from late hiring of consultants to prepare theexport program and as a result of problems associated with the use of the SpecialAccount. Disbursements began catching up when a supervision mission (February4-20, 1986) assessed that the exclusive reliance on the Special Account coupledwith the use of that account to guarantee imports instead of pay!ng for themoutright was the major cause of slower than expected disbursements. As a resultof consultations between Bank staff in charge of the project, the LoanDepartment, and the Malagasy authorities, it was decided to use Procedure V inaddition to the Special Account. Disbursements under the Special Account wouldfrom then on be made under a general and irrevocable guarantee of reimbursementissued by the Bank to a French bank chosen by the Malagasy Government.2 Thischange resulted in faster disbursements.

5.13 SDR 5 million of the credit was to be lent to the BNI for the financingof investment (rehabilitation) projects through sub-loans to investment

9i Development Credit Agreement, Schedule 4.

- Memo, April 11, 1986, para. 4.

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enterprises. Because of BNI financial problems and lack of coordination by June1986, only 20 percent of the US$5 million assigned by ISAC to this component hadbeen committed for two rehabilitation projects. The commitment date expired June30, 1986 and after some actions to address BNI portfolio situation were taken,the commitment date was extended to March 1987.27 Due to BNI's difficultiesin implementing the investment component ISAC's closing date which was originallyset for September 30, 1987, was extended to September 30, 1988. Eventually thecredit was closed in September 30, 1990 with only 53 percent of the plannedamount disbursed to the BNI component and the remaining amount reallocated to thefast-disbursing component. Finally, regarding the third component, of the SDR1.5 million that had been allocated to the MIEM for technical assistance purposesUS$ 400,000 were reallocated to the general imports component. 'Unfortunately, few details are available of the TA component performance and ofreasons of this reallocation of funds due to lack of continued supervision ofthis component.

C. Supervision

5.14 The supervision effort was adequate. Supervision was imaginative andunderstanding, and findings of ISAC supervision missions were instrumental inidentifying outstanding issues and thus helpful in designing subsequentoperations. Such as in the case of BNI financial difficulties, when Banksupervision missions acknowledged the impossibility of solving them within theframework of ISAC and recognized the necessity of taking care of such problemswithin the implementation of financial sector and public enterprise reform, whichwere later supported by both ITPAC and ISAC. There was close coordination andcooperation between the Bank and the IMF, and the parallel implementation ofstand-by Fund operations assured close monitoring of macroeconomic management,particularly exchange rate policy. Although the IMF had primary responsibilityon exchange rate management, the World Bark did follow exchange rate developmentsclosely during supervision.

5.15 However, there were deficiencies in the loan files, including a missingImplementation Summary (Form 590). Moreover, all 590 forms were issued at leasttwo months after the end of the supervision mission involved. Probably due tothese deficiencies, the PCR does not contain details on the supervision effort.According to a recent OED study on SAL supervision and monitoring,2-deficiencies in historical records appear to be a common problem which hampersthe maintenance of the Bank's institutional memory and thorough ex postevaluations of the operations concerned. Finally, updates on the implementationof the TA component were not adequate.

1 Memo June 8, 1987, para. 3.

Li PCR, para. 24.

L Report No. 9711, Effectiveness of SAL Supervision and Monitoring, June 26,1991, para. 105-106.

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VI. SUSTAINABILITY OF THE ADJUSTMENT EFFORT

6.01 The maintenance of macroeconomic stability and continued politicalcommitment and popular support for the reform process are the key determinantsof the sustainability of adjustment measures. Economic performance in the nearfuture will be closely tied to political economy considerations; recent politicaldevelopments and the fragility of the current regime have pushed the governanceissue to the forefront of any assessment of sustainability of the Malagasyadjustment effort.

A. Economic Performance and Sustainability Assessment

6.02 Macroeconomic developments in 1990, while confirming the upward trendof the real sector, demonstrated also the impact of exogenous factor on theMalaga&y economy and raised the issue of financial sustainability.0i In 1990,real GDP grew by 3.5 percent atimulated by strong growth in manufacturingactivities and in trade ard tourism related services, notwithstanding a poorperformance of the agricultural sector due to adverse weather conditions. Realper capita GDP growth was positive for the third consecutiv' year. Othereconomic indicators, however, did not fare as well. A severe foreign exchangeliquidity crisis - which brought down reserves to less that two months ofimports, their lowest level since 1985 - was precipitated by a series of factors.Imports increased by 45 percent (in nominal US dollar terms) due to theappreciation of the real effective exchange rate and an excessive expansion ofcredit provided by the only remaining fully state-owned commercial bank. Theimpact of the rise in imports on external accounts was magnified by a 6 percentdecline in merchandise export earnings, due to deteriorating terms of trade forcoffee, cloves, and vanilla. These events were magnified by a substantialshortfall in balance of payments support owing to delays in the implementationof policy reforms agreed with donor agencies. As a consequence, the current-account deficit worsened from 8.8 percent of GDP in 1989 to 11.8 in 1990. Theinflation rate increased three percentage points to reach 12 percent.

6.03 The reserve position of the country has improved in the first quarterof 1991 thanks to a cumulative 20 percent devaluation of the FMG, a severetightening of credit policy since November 1990, and disbursement of balance ofpayments support. Overall, indicators for the first months of 1991, suggest thatthe 1990 financial crisis was an isolated episode and has been overcome withouta lasting negative impact on the adjustment and process and growth.1fl

B. Social and Political Issues

6.04 Recent political upheavals in Madagascar have been triggered by changesin the Constitution and in the electoral law; the opposition is seeking toachieve a more open systam and not necessarily to change economic policies. Morespecifically, riots have not been directly linked to the social costs of Bank

0i For details on developments in 1990 see CEM 1991 paras. iv and 95-101.

0 Ibid., para v.

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supported adjustment policies. Although no quantitative analysis of the socialimpact of the adjustment efforts is available, Bank staff yses show thatpolicies that since 1983 have stopped GDP decline and have pen ced positive GDPper capita growth beginning in 1987, have had different effects on the varioussegments of the population:

"For instance, rapid shifts in the urban/rural terms oftrade, together with a sharp decline in the real wages ofcivil servants, while beneficial for the bulk of theMalagasy population, have adversely affected urban dwellers,and especially the poorest among them, worsening alreadydismal living conditions. Other groups, such as publicenterprise employees, while not in absolute poverty, willalso be affected by the policy measures."i

The Economic Management and Social Action Project (EMSAP, 1988) addressed in partthese issues and other social dimensions of adjustment.

6.05 Notwithstanding political upheavals, the political commitment to acontinued adjustment effort remains strong in 1991. On the economic front bothsides are in agreement on the need to continue liberalizing the economy andeliminating remaining structural constraints to growth with equity. Thiscommitment has been demonstrated on the Government side by the policy dialog .;with Bank staff leading to the preparation of a comprehensive package of reformsunder a the proposed PRIVAC. At the same time, the opposition has expressed itsintention, if it gains control of the Executive, to proceed even faster than thecurrent regime with the adjustment effort. In conclusion, if the politicalsituation does not interfere with economic processes, all the elements forsustained growth are in place and an optimistic assessment of the sustainabilityof the overall adjustment effort seems justified. This assessment reflectslargely the result of discussions with Bank staff since the planned audit missionhad to be canceled owing to civil disorders. Therefore, this sustainabilityassessment may have to be reconfirmed during a field visit OED expects to conductin connection with the forthcoming audit of ITPAC.

Li-" EMSAP-PR, paras. 3.

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VII. CONCLUSIONS AND LESSONS OF EXPERIENCE

A. Summary Assessment

7.01 ISAC was essentially preparatory to the more comprehensive reformsimplemented in follow-up sector operations. ISAC was on the whole well designedas a preparatory loan and the Government participated in the development of theconceptual framework of ISAC as well as of the following sectoral loans. Giventhe political environment at the time - with a socialist regime skeptical ofmarket mechanisms and a full-fledged liberalization of the economy, and fearfulof the political and social consequences of a full blown adjustment effort - thepreparation of subsequent sectoral loans as opposed to the implementation of anup front adjustment loan was the appropriate choice.

7.02 Overall the adjustment effort implemented by the Malagasy Governmenthas been impressive and it is generally perceived as one of the success storieswithin Africa.1 However, the sustainability of the adjustment process willdepend on macroeconomic as well as political developments. On the macroeconomicarea, certain conditions must be maintained for the structural reforms to havea lasting impact. Prospects for medium-term viability would be enhanced by amore aggressive exchange rate policy permitting the continuation of exportdiversification; further import liberalization to enable a sustained rise inimports to maintain the recovery; stronger financial intermediation with closemonitoring of credit policies; and, improvements in domestic savings performance.On the political side, commitment to reforms must continue to exist, whicheverpolitical group remains in power.

B. Lessons of Experience

7.03 The review of the experience with the ISAC offers instructive lessonsand suggestions which may provide useful insights for future Bank operations:

(i) In 1985 the Government was not ready yet to implement a bioad-based structural adjustment effort. Thus, policy-based sectorspecific lending was used by the Bank as vehicle to opendialogue with the authorities. The phased approach wassuccessful in leading to full-fledged adjustment beginning in1987 thanks to the Government's commitment to the reform processand to the appropriateness, timeliness, and, effectiveness offollow up operations. The phased approach opened a generalpolicy dialogue with the Government and many reforms wereimplemented during the identification/preparation of projects.Not all achievements or policy actions were part of theconditionality package of the various credits. ITPAC and ISACwere fairly comprehensive programs which achieved more than

1i RaJcoomar, S., "Madagascar: Crafting Comprehensive Reforms", Finance andDevelopment, September 1991: 46-48 and Nooter, R.H. and R.A. Stacy, Progress onAdjustment in Sub-Saharan Africa: Implications for Future Lending Strategies,October 15, 1990, IBRD internal draft.

- 37 -

sectoral reforms since they both included policy conditionshaving an impact across sectors and because much wasaccomplished even before effectiveness through the ongoingpolicy dialogue and negotiations with the authorities. Thus,much more was achieved than what is shown by the conditionalityitself; they were closer to SAL operations than to SECALs.Although it has been found that in general it is more effectiveto proceed with a comprehensive up-front adjustment effort, aphased approach was appropriate and necessary in the case ofKadaga§caL. This approach was indeed suitable for a countrywhere not only the Government was not ready for a full fledgedSAL, but also because following a long interruption in Bankinvolvement in the country. the stock of economic and sectorknowledge was not considered sufficient to mount a morecomprehensive reform effort.

(ii) During ISAC design there was awareness by Bank staff of theGovernment's political constraints, which led to the design ofa successful sequencing of sector adjustment operations, throughan intense policy dialogue aimed at building a consensus. Thesuccess of Madagascar's adjustment effort shows that, even undera socialist regime. Rolicy reforms can be successful andsustained yhen the design of the program is internalized andthere is valitical will, consensus and commitment on the part ofthe authorities,

(iii) A posteriori it is clear that a more complete analysis of thefinancial sector at the time of ISAC's design would have raiseddoubts ex ante - and not too late during implementation - on theappropriateness of BNI as the implementing agency for therehabilitation component of the credit. Such analysis wouldalso have identified the issues of financial situation andefficiency of the banking system, and public enterprises as keyconstraints to be addressed up front during the adjustmentprocess. Thus, the status of financial intermediation shouldhave been analyzed in more detail even if specific reformmeasures were not necessarily included in ISAC.

(iv) The Malagasy adjustment process witnessed an effectivecooperation with the IMF and a complementarity of Stand-bys andsectoral operations, especially on exchange rate issues.However, it appears that IMF actions were slow in keeping upwith necessary exchange rate adjustments to maintain an exchangerate appropriate to the liberalization effort being suported byBank operations,

(v) Even though the supervision effort was adequate, there was alack of detailed supervision of the TA component of the ISAC. Inhybrid loans all the supervision effort seems to concentrate onthe policy package rather than the less visible TA component,Thus, hybrid loans should perhaps go to the Board as a package

- 38 -

with one loan containing the policy package and a separate onedealing with TA efforts.

(vi) Two of the second tranche conditions were spelled out in aslightly different manner in the President's Report and theCredit Agreement. Supervision missions determined theBorrower's compliance based on the fulfillment of legalconditions which appear to be diluted as compared to thePresident's Report wording. This potential issue was also foundto be common to other adjustment operations by the alreadyquoted OED supervision report,-V which recommends that sincelegal conditions are usually emphasized and better implemented.Management should ensure that the most critical actionsconstitute the legal conditions in the credit or loan agreement,

gu Report No. 9711, Effectiveness of SAL Supervision and Monitoring, June 26,1991, para. 66-69.

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ANNEX 1.MADAGASCARe RET ECONCHIC INDICATORS, 1960-1990

1980 1981 1962 1983 1984 1985 1986 1987 1968 1989 1990me.meme.m.. .sm... um........m.m.m nam.m.m.m..m.s SW...e.m.mm..m..m..m.eammgassee.National Accounts

(Growth Rates, 2)Real GDP 0.8 (9.7) (1.8) 0.9 1.7 1.1 2.0 1.2 3.4 4.1 3.5Real ODP per capita (1.9) (12.3) (4.4) (1.2) (3.5) 0.4 (3.3) (2.0) 0.2 0.9 0.5Real Industry sector (2.7) (22.5) (14.4) 1.4 13.9 1.3 3.6 4.9 1.9 0.9 6.3

(As I of Current GDP)Gross Domestic Investment 15.0 11.5 8.5 8.4 8.6 8.5 9.0 10.1 13.3 13.3 16.9Industry 14.3 12.6 11.9 12.0 11.5 11.9 11.6 12.0 11.7 11.3 11.6

Balance of Paymentes

(In Months of CIF Imports)Total Gross Reserves minus Gold 0.1 0.5 0.4 0.6 1.1 1.5 3.5 5.8 7.1 7.7 1.6

(Growth Rates, 2)Exports (fob) 10.8 (23.9) (1.4) (3.3) 8.8 (13.6) 13.0 (5.9) (9.7) 14.1 (5.3)Imports (fob) 15.3 (33.1) (11.6) (16.2) (7.0) (4.6) (1.4) (4.8) (1.0) 0.7 45.6

(In Million US Dollars)Exports (fob) 436 332 327 310 337 291 329 310 260 319 302Imports (fob) 764 511 452 378 352 336 331 315 312 314 458Trade Balance (327.4) (176.9) (124.3) (68.3) (14.8) (44.5) (1.8) (3.3) (32.3) 4.6 (156.0)Current Account Balance at (599.2) (424.7) (371.9) (307.9) (261.6) (244.1) (244.7) (256.6) (263.4) (216.6)(364.7)

(As I of Current GDP)Exports (fob) 10.8 9.2 9.3 8.8 11.5 10.2 10.1 12.1 11.5 12.9 9.8Resource Balance (16.4) (11.3) (9.4) (7.0) (4.9) (6.2) (4.7) (5.4) (6.7) (4.5) (8.7)Current Account Balance a/ (14.8) (11.8) (10.5) (8.8) (8.9) (6.5) (7.5) (10.0) (10.8) (8.8) (11.6)

(As 2 of TotA Cu Imports)Imports of intermediate goods b/ 22.0 18.3 19.5 25.0 27.2 27.8 30.2 29.8 25.8 23.9 23.7

(As % of Total Exports)Exports of manufactures 12.5 16.6 14.5 15.5 11.0 13.6 13.3 18.7 23.2 25.5 n.e.

Fiscal Accountas

(As I of Current GDP)Government Deficit (cash basis) (14.8) (12.1) (7.1) (5.4) (3.9) (3.8) (3.3) (3.5) (3.5) (4.2) (0.9)

Prices and Exchange Rates

Inflation (CPI - annual average*) 18.3 30.7 31.7 19.3 10.0 10.5 14.5 15.0 26.8 9.0 12.0Nominal Effective Exchange Rate (1980-100) cl 100.0 89.6 78.3 69.3 56.9 50.6 40.3 22.9 17.0 15.7 15.3

% change (-.depreciation) (10.4) (12.5) (11.5) (17.9) (11.1) (20.3) (43.3) (25.5) (7.6) (2.6)Real Effective Exchang* Rate (1980*100) cl 100.0 105.6 112.1 111.0 94.6 89.0 79.9 50.9 45.5 44.0 44.6

2 change (--depreciation) 5.6 6.2 (1.0) (14.8) (5.9) (10.2) (36.3) (10.6) (3.2) 1.6Terms of Trade (1960*100) 100.0 78.5 60.3 91.6 95.1 61.4 100.7 8.7 81.4 57.8 30.3

% change (0.3) (21.5) 2.3 14.3 3.6 (14.4) 23.7 (12.0) (8.2) (29.0) (13.0)

emos

GDP (Million US$) 4.042 3,595 3,526 3,511 2,939 2,857 3,239 2,565 2.443 2,472 3,097-am.me.mmmm.m..n. memen.e.mme....men..........

Sourcest IHF - International Financial Statistics TearbookWorld Bank Report No. 7784. "Madagascar - Adjustment in the Industrial Sector and ao Agenda for Further Reforms, October 19901World Bank Report No. 9101, "Hadagascar - Beyond Stabilization to Sustainable Growth, June 1991.Draft President's Report. *Private Sector Environment Adjustment Credit". August 15. 1991.

Notessal Excluding official transfers.

b/ Excluding petroleum.c/ The NEER and REEK are based on the following basket of currenciess FF 412 US$ 302; Ot 122; TEN 112; UK 62.

ANNE 11Page 1 -lof 2

THE ISAC AN THE GOVERNMENT ADJUSTMENT PROGRAH

EFFECTIVENESS SECOND TRANCHE IMPLE11ENTATION FOLLOW-POLICY AREA OBJECTIVES CONDITIONS CONDITIONS RECORD UPCREDITS

1. PRICE To make the Malagasy Prices of goods Only 31 products (repre- Met. However, ITPACLIBERALIZATION economy more responsive to representing 35% value senting aboug 302 of only ex-factory

market forces so as to added freed from control industrial value added) to prices wereincrease its efficiency, remain under price freed. Profitdynamism and productivity, control. For these margin controlsProgressive elimination of products controlled prices were maintained.price controls on most to be brought into lineindustrial goods. with world prices

11. EXPORT Increase the outward Prepare Action Program to Implement satisfactory Delayed, then ITPACPROMOTIt_ or4entation and efficiency promote exports-through, Action Program to promote Met. However,

of the Nalagasy econa,y for example, improved exports action program PSACthrough the promotion f export earnings retention was only Iexports. scheme, duty drr<wback madopted" not

system, etc. *implemented" at athe time of

Export taxes on all manu- tranche ITFACfactured goods eliminated; disbureement.exporters of manufacturedgoods exonerated from all Export earnings rt.ention NETindirect taxes on raw scheme to !e extended tomaterials and spare parts all manufacturingused in the production of exporters covering allexports--both conditions of their foreign exchangeeffectiveness needs for the production

of export goods.

II:. IMPORT Progressive import Undertake a study of the Remove prohibitions on a MET ITPACLIBERALIZATION liberalization in order to trade regime. Also, remove further 152 of goods

improve industrial Import prohibitions on 52 current prohibited PSACefficiency through greater of currently prohibitedcompetition from abroad Soods (priority to he givenand to encourage exports. to incentive and monopoly

goods) before effectiv"-ness. Foreign exchangealso to be made availableto permit actuai importa-tion of these goods.

ANNEX 11Page 2 of 2

THE ISAC AND THE GOVERNMENT ADJUSTMENT PROGRAM

EFFECTIVENESS SECOND TRANCUE IMPLEMENTATION FOLLOW-UPPOLICY AREA OBJECTIVES CONDITIONS CONDITIOVS RECORD CREDITSIV. PUBLIC Rationalize the PIP Government/IDA agreement on Government/1DA agreement MET ITPACINVESTMENT process, establish 1985 industry PIP - as on 1986 industry PIP PSACPROGRAM IN criteria for project condition of effectiveness ASACINDUSTRY selection, strengthen

project appraisal Strengthen Projectcapability Appraisal capability at

HIEH

V. PRIVATE Encourage private sector Continue program of Present new Investment MET PSACSECTOR to resume active role in involving private sector in Code, which would reflectENCOURAGEMENT the industrial sector Public Enterprises IDA comments to NationalAssembly

I

-- 43 -

PROJECT COMPLETION REPORT

MADAGASCARINDUSTRIAL SECTOR ADJUSTMENT CREDIT

(Credits 1541-MAG and A.7-MAG)

June 24, 1991

Industry and Energy Operations DivisionSouth Central and Indian Ocean Department

Africa Region

- 45 -

MADAGASCAR

INDUSTRIAL SECTOR ADJUSTMENT CREDIT(Credit 1541-HAG and A-7-14AG)

PROJECT COMPLETION REPORT

PART I

A. Introduction

1. The Inductrial Sector Adjustment Credit (ISAC, Credit 1541-MAG ofSDR 40.2 million and A-7-MAG of SDR 18.9 million)' was the first in a seriesof adjustment operations in Madagascar. It was designed to aid the MalagasyGovernment in its efforts to reverse the country's economic decline byadopting stabilization and liberalization measures.

2. ISAC's main objective was to bring about policy change- designedto increase the efficiency and productivity of the industrial sector and toboost the capacity utilization of selected industrial enterprises. ThoughISAC was a hybrid operation, the bulk of the Credit (SDR 52.6 million, or89 percent of total funds) was for a quick-disbursing component whichprovided foreign exchange for imported inputs and spare parts, while smallercomponents provided funding for enterprise rehabilitation and technicalassistance. Policy reforms supported by the project fell into five areas:(a) price liberalization; (b) export promotion; (c) import liberalization;(d) improvement of the public investment program; and (e) encouragement ofthe private sector.

3. ISAC represented a significant break with Madagascar's pastpolicies, but it was seen from the beginning as only the first step on thelong road to adjustment. The Credit has since been followed by theIndustrial and Trade Policy Adjustment Credit (ITPAC, Credit 1834-MAG andA-32-MAG) in FY87, which deepens and broadens the reform process begun underISAC by supporting a market-oriented foreign exchange allocation regime,liberalizing foreign and domestic trade by lifting quantitative restrictionsand price controls, and introducing a rationalized tariff structure.Separate adjustment operations are also being carried out in the agriculture(ASAC, Credits 1691-MAG and A-16-MAG), the public sector (PSAC, Credit1941-MAG) and the financial system (Apex I, Credit 2104-MAG).

B. Background

4. Madagascar. with a population of 10.9 million and a GDP per capitaof US$190 in 1988, is among the poorest countries in the world. Almost 90percent of the labor force is employed in the agricultural sector, whichcontributes about 40 percent of GDP. Industry accounts for only about 16percent of GDP.

1/ The formal name of the project, as stated on the loan document, was'Industrial Assistance Project.' However, the name ISAC, or its Frenchequivalent CASI, is used almost exclusively in Bank files and incorrespondence with the borrowers. It will, therefore, be used here.

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5. The persistent economic difficulties encountered by Madagascarsince the late 1970s can be traced to the economic policies pursued after1972, which entailed an unprecedented expansion of the public sector and ofgovernment intervention in the economy. Foreign firms were nationalized anda large number of new public enterprises were created. Public investwentrose particularly rapidly after 1978, when the government embarked on apolicy of massive investment. In the belief that national objectives couldbetter be met by direct allocation of resources than by market signals, apolicy of extensive intervention at all levels of the economy was initiated.A rigid and cumbersome system of price controls was instituted. Domesticfirms were given high levels of protection, initially through the tariffsystem, and subsequently through administered foreign exchange allocation,tight import licensing requirements, quantitative restrictions andprohibitions.

6. This policy environment created an unfavorable climate forindustry, discouraging private sector investment, sending incorrect signalsthat oriented economic activity towards inefficient import substitution. Italso encouraged excessive use of imported inputs, discouraged exports andpermitted inefficiencies to persist. Furthermore, to finance the higher rateof public investment, the government had to resort to borrowing abroad and toinflationary financing. This resulted in rapidly growing fiscal and currentaccount deficits that peaked in 1980 at 18 percent of GDP, while the debtservice ratio reached 72 percent in 1982. The exchange rate becameincreasingly overvalued and there was an inevitable and marked annual declinein GDP of 3.6 percent between 1980 and 1983.

7. The government initiated a program of macroeconomic stabilization,supported by the IMF, in 1982. Though progress was made towards restoringinternal and external balance, the underlying supply-side problems remained.The government, therefore, while continuing its stabilization efforts,embarked on an adjustment program in 1984.

C. Project Preparation and Appraisal

8. Initially, the project was envisioned as a second line of creditto BNI, the government-owned National Bank of Industry. Given the extent ofthe distortions in the Malagasy economy, however, a DFC-style operation wasquickly discarded. It was also decided in early 1983 not to pursue a fullstructural adjustment operation. Though committed to reform in principle,the government was not at the time convinced of the necessity or desirabilityof a comprehensive reform program. The project, therefore, aimed at strikinga balance between the need for far-reaching reforms and the government's fearof the unknown by starting the adjustment process with a program that wassignificant enough to lay the foundations for recovery and the resumption ofgrowth and at the same time not too far reaching as to fail to commandreasonable consensus.

9. The principal elements of the reform package adopted under ISACwere measures to begin the process of liberalization of domestic marketsthrough the removal of price controls. Measures to reduce administrativeconstraints to exports and to begin the process of liberalization of importswere also included. Considerable debate took place as to whether more should

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be done, especially on the reform of the foreign trade regime; but, in theabsence of a significant exchange rate adjustment, import liberalizationcould not have been realistically more extensive. Ultimately, however, amore vigorous reform program was resisted by the government. Indeed, despitethe limited reach of the policy reforms envisaged under ISAC (relative to theextent of the distortions), the possibility of internal resistance to thereforms was identified as the main risk facing the project.

10. It was stressed from the beginning that ISAC should be seen onlyas a first step in the reform process; further adjustment measures would berequired. It was hoped that successful implementation of ISAC would convincethe government to proceed with a more vigorous reform package. Funds wereincluded as part of the ISAC package for studies to identify majorconstraints to efficient industrial development, analyze the incentivessystem, and make recommendations for further policy reform. Adjustment wouldthus be phased, with successive phases building on the success of previousphases and the results of studies carried out under them.

11. ISAC sought to boost capacity utilization in industry by makingforeign exchange available for imports of inputs. It was hoped thatrelatively rapid improvements in output arising from the infusion of foreignexchange would ease the economic situation and lead to an increasedcommitment to the reform process. Increases in capacity utilization wouldalso help mitigate possible adverse employment effects of the adjustmentprocess, and provide incentive goods to stimulate increased agriculturalproduction. Reflecting its origins as a DFC-style operation, ISAC retaineda small investment component of SDR 5 million (8 percent of total funds),to be used to finance enterprise rehabilitation projects.

12. Work on the project began during 1983. Appraisal missions tookplace in January and June 1984. The Credit was approved by the Board onJanuary 15, 1985, and signed on March 22, 1985. The IDA Credit was declaredeffective on August 28, 1985; the SFA Credit on March 3, 1986. The secondtranche was released on September 22, 1986.

13. The project was jointly financed by IDA (Credit 1541-MAG, forSDR 40.2 million) and the Special Facility for Sub-Saharan Africa (CreditA-7-MAG, for SDR 18.9 million). SDR 33.7 million of the IDA Credit and allof the SFA Credit were allocated to finance industrial imports; thiscomponent was divided into two tranches of SDR 27.6 million (17.2 millionfrom IDA and 10.4 million from SFA) and of SDR 25.0 million (16.5 million and8.5 million), respectively. The balance of the IDA Credit went to the BNIfor rehabilitation projects (SDR 5 million), for TA and consultant studies(SDR 1.3 million), and for civil works (SDR 0.3 million).

14. The quick-disbursing component of the Credit was channelled throughthe Central Bank, which then sold the foreign exchange to eligibleenterprises through the commercial banks. The list of eligible enterpriseswas established on the basis of value-added eligibility criteria, calculatedat international prices (para. 25). SDR 5 million of the total Credit was tobe onlent to the National Bank for Industry (BNI) for the financing of

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rehabilitation projects. Finally, SDR 1.5 million was made available to theMinistry of Industry, Energy and Mines (MIEM), which was responsible for theimplementation of studies and technical assistance.

D. Institutional Performance

15. Policy reforms supported by the project fell into five areas:

(a) price liberalization: progressive elimination of price controls onindustrial goods representing about 70 percent of industrial valueadded, so that only 31 products would remain under price controlby second tranche release;

(b) reform of the public investment program: agreement on a program torationalize the industrial PIP;

(c) export promotion: adoption of measures designed to stimulateexports, including the elimination of all export taxes;

(d) import liberalization: elimination of import prohibitions on atotal of 20 percent of goods subject to them; and

(e) private sector encouragement: elaboration of a new investment code.

Price Liberalization

16. A rigid and cumbersome price control system had been applied to allindustrial goods since the late 1970s. It had resulted in shortages anddistortions, and had either perpetuated industrial inefficiency or inflictedfinancial hardship on enterprises. Ex-factory prices of goods representing35 percent of manufacturing value added were decontrolled prior to Boardpresentation; another 35 percent were decontrolled as a condition of secondtranche release. This left only 31 products subject to price control; anumber which was later further reduced to 10 goods, representing 15 percentof manufacturing value added. However, although administrative setting ofprices was terminated, restrictions on profit margins remained. Although inpractice these restrictions were looser than previous controls, theyprolonged a sense of control over the private sector. Controls over profitmargins were eliminated at ITPAC effectiveness in September 1987.

Public Investment Program

17. A massive and generally ill-conceived Public Investment Program(PIP) had been one of the principal causes of Madagascar's economic andfinancial crisis in the early 1980s. Under ISAC, the government was to agreewith the Bank on industrial PIPs for 1985 and 1986, stop further investmentin existing projects until their viability could be determined, and obtainthe Bank's agreement for any new projects expected to cost in excess of US$4million.

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18. Agreement on industrial PIPs of USA10.6 million and US$17.8 millionfor 1985 and 1986, respectively, was reached. This represented a vastimprovement over the unsustainable level of US$80 million attained in 1979.Perhaps equally important, the quality of projects included in the PIPsincreased considerably. Although several projects of dubious viabilityremained, the worst offenders were dropped. In addition to the reduction inwaste, these measures alleviated the public sector's demand for bank credit,thus diminishing the crowding out of the private sector. A more completeoverhaul of the public sector still remained to be accomplished, however.Work on rationalizing the management of public sector resources has continuedunder ITPAC and PSAC.

Export Promotion

19. In addition to the general anti-export bias of trade and macro-economic policy (particularly the seriously overvalued exchange rate),regulatory restrictions had contributed to discouraging exports. ISACincluded a few export-promoting measures, such as abolition of export taxesand of export licensing requirements, and creation of a foreign exchangeretention scheme for exporters. These measures were carried out as planned,but did not prove sufficient to generate an export response, given thecontinuing distortion in the overall structure of incentives.

Import Liberalization

20. During the 1970s, imports had been subject to increasingly tightimport controls and prohibitions. Under ISAC, a small number of prohibitionswere lifted, and replaced by tariffs. Imports of the goods concerned soontook place, sometimes in considerable quantities. Although this representeda step in the right direction, it was clearly meant as a relatively smallfirst step towards full liberalization of the trade regime and substantialdistortions remained. Fulfilling this expectation, a far-reaching program ofimport liberalization has since been undertaken under ITPAC.

Investment Code

21. The investment code enacted in 1973 to provide fiscal and otherincentives had lacked precision and was applied in a discretionary manner bythe government. A revised investment code taking into account the Bank'ssuggestions was presented to the National Assembly in 1985. Though this coderemained relatively hostile to private entrepreneurship, it constituted aconsiderable improvement over the previous code: additional guarantees wereprovided against nationalization; the repatriation of dividends and profitswas allowed for (though no mechanism was created to ensure this); and specialconventions for particular classes of investors were reduced, leaving only adistinction between small- and medium-scale enterprises and largeenterprises. Although the code was presented to the National Assembly ontime, the implementing decree was not enacted until Hay 1988. By then, thechanging economic environment had rendered the code obsolete. A new, moreopen, investment code was promulgated under PSAC in December 1989.

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Rehabilitation Component

22. The BNI component was the least successful, due mainly to theunfavorable investment climate and BNI's slowness in processing applicationsfor subloans and its parlous financial state. BNI had previously managed aDFC-style line of credit reasonably effectively, and was considered a soundinstitution at time of appraisal, but progress during implementation was muchslower than expected. Only SDR 0.9 million had been committed by the June30, 1986 commitment deadline. Extension of the project component was onlyagreed to following an audit of the BNI's portfolio and adoption ofacceptable action plans to rehabilitate three enterprises which togetheraccounted for about 30 percent of the non-performing portfolio (thesemeasures were pursued further under ITPAC). Restrictions on use of the fundswere relaxed several times. Even so, commitment rates remained low.Further, by limiting the use of the investment component funds torehabilitation purposes, the Credit did not encourage entry of newenterprises. Ultimately, almost half the funds allocated to this componentwere reallocated to the general industrial imports component. Undersubsequent Credits, efforts have been made to address the weakness of thedomestic banking system and to encourage entry through a less restrictiveregulatory and financial environment.

23. The success of the subloans that did get approved was mixed.Some loans, such as that to SOPEBO, an export-oriented fishing firm, was usedeffectively to help upgrade equipment needed to expand export activities.The BATA shoe factory loan, on the other hand, was used for equipment whichlater proved unsuitable for producing at competitive prices. In time, thecompany's performance, however, improved considerably.

Technical Assistance

24. The technical assistance component of the Credit included supportfor the creation of a data bank for the MIEM and funding for various s udieswhich later operations drew upon. This component generally proceededsmoothly. Some additional funds (US$400,000) were reallocated to thiscomponent from the general imports component.

E. Monitoring and Implementation

25. In addition to ensuring that policy conditionality was respected,a serious effort was made to assess the impact of the reform on the economy.Some results are summarized in Section VII and in the report cited infootnote 2, para. 30. Supervision was also required to verify that fundsprovided for imports were used appropriately. Eligibility criteria wereestablished to avoid the foreign exchange being used by inefficiententerprises. These stipulated that the only eligible firms would be thosewhose ratio of value added to the value of inputs, measured in border prices,at least equalled 50 percent. An initial list of 80 enterprises was drawn upduring negotiations. This list was subsequently expanded several times.However, several of the firms which were originally considered eligible weresubsequently found to be non-viable. This was understood from the beginningas an interim and by no means perfect system of allocating foreign exchangethat would be discontinued once a market-based system was in place. Once a

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non-discriminating foreign exchange allocation regime was established inearly .988, the eligibility list was eliminated. At this point, allremaining ISAC funds were allocated through the Open General Licence system(OGL).

26. The foreign exchange provided to eligible firms under ISAC was tobe additional to the foreign exchange that they would otherwise have beenallocated. This condition was included to avoid foreign exchange freed up byuse of ISAC funds being reallocated to ineligible, inefficient firms. Aformula was devised to determine whether this principle of additionality wasrespected. Provision of funds by the government fell somewhat short of whatwas required, but the condition was considered to have been met in view ofthe constraints in terms of overall availability of foreign exchange anduncertainties in the data. This complication was also resolved once fundsbegun to be allocated through the OGL.

F. Disbursements

27. Use of project funds was delayed by difficulties in establishingCredit withdrawal procedures. New arrangements were made during a February1986 mission, resulting in an increase in the pace of commitments anddisbursements. Delays in the release of the second tranLhe resulted in abacklog of eligible expenses accumulating. Disbursements resumed aftertranche release, but the pace remained slow. The closing date, originallyset for September 30, 1987, was extended three times, first to September 30,1988 and then to March 30, 1989. Since funds remained after the latter datehad passed, and the Credit had not been formally closed, the closing date wasonce again extended, in March 1990, to September 30, 1990.

28. Only SDR 2.7 million were ultimately disbursed under the BNIcomponent, or only 53 percent of the planned amount. Moreover, 34 percent oftotal disbursements were against a single subproject, which, because its sizeexceeded the maximum limit, was approved on an exceptional basis in 1988 (twoyears after the original commitment date for this component). The technicalassistance and public works components proceeded essentially as planned, withsome additional funds being reallocated to the TA component from the generalimports component.

G. Conclusions and Lessons Learned

29. It is difficult to assess results and draw lessons for ISACindividually, since it was only a first step in the direction of adjustmentand was followed relatively quickly by other adjustment operations. Theoverall program of adjustment, which has included also ITPAC, ASAC, PSAC, andseveral IMF stand-by loans, is however considered relatively successful inthe Sub-Saharan African context.

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30. Substantial adjustment has already taken place in the industrialsector.2 The manufacturing sector has increased its outward orientation

considerably. Almost all subsectors have experienced higher capacityutilization. Significant entry of new firms has occurred, particularly inexport-oriented activities. New export activities have been characterized bylabor-intensive production technologies. The garment subsector has beenparticularly dynamic, with a threefold increase in production and significantincreases in total employment since 1987. Much of the response has, however,been due to increases in outward orientation, so the measures adopted underITPAC probably played a more important role. Without the initial impetusprovided by ISAC, however, ITPAC may not have occurred.

31. The phased approach adopted in this sequence of operations appearsto have been well suited to the circumstances for two reasons. First, itallowed government confidence and commitment in the reform process to beslowly built up. Both the government and important interest groups were atbest skeptical of the need and desirability for adjustment at the time theprocess was begun, and at worst they were actively opposed. Positiveexperience under ISAC allowed these political obstacles to be graduallyovercome. Second, it gave time for additional analytical work to be carriedout and information and experience to be built up within the Bank, thusallowing a more comprehensive program to be developed. This latter factorwas particularly important in light of the limited experience, at the timethe project was first being planned, with this type of adjustment operations.

32. The danger with such an approach is that 'adjustment fatigue' mightset in, and commitment to further reform would lag. This does not appear tohave happened in this case. There was some limited backtracking on tariffreforms and delays in the public enterprise privatization process duringimplementation of ITPAC, but the program was soon set back on track.

33. The other significant drawback of the gradualist approach is thatthe funds could go to firms (including public sector firms) still operatingin a highly distorted environment. This problem was particularly acute forthe investment component of the Credit, but also applied to the generalimports component. Doubts were expressed by the loan committee that thefunds would be used efficiently with important distortions remaining.The BATA subloan, for example, was used for equipment which later provedinappropriate in the liberalized regime. In a sense, the BNI's slownessin processing applications proved to be a blessing in disguise, sincesubprojects which were eventually approved were conceived by their promotersand implemented under the more liberalized system established under ITPAC.These subprojects seem to have been reasonably efficient. The complicatedtests to ensure 'adequate value added' and 'additionality' are anotherexample of the problems caused by the partial approach. They were, however,useful to illustrate the need for a transparent non-administrative resourceallocation system and, in any case, they were short-lived.

2/ A detailed analysis of the adjustment process in the Halagasy industrialsector can be found in "Madagascart Adjustment in the Industrial Sectorand an Agenda for Further Reforms," Report No.7784-MAG, October 1990.

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34. An issue that is particularly acute in the context of such a phasedapproach is that of sequencing. This is because of the possibility thatremoving one distortion may not be welfare-improving if other distortionsremain. Nor is it the case that all starting points will advance the reformprocess equally. A case could be made that the adjustment process should nothave started with domestic reform, but rather with more vigorous foreigntrade reform, which might have introduced compet,-ion into the domesticmarkets more rapidly and speeded the pace of adjustment. Such an approachwas not, however, deemed politically feasible at the time.

35. An issue raised by all early sectoral operations concerns theadvisability of extending balance of payments support to a particular sectorrather than to the economy as a whole. This clearly risks directingavailable foreign exchange in ways that might not be optimal. (Now, allsector operations provide general balance of payments support.) In the caseof ISAC, this problem was alleviated--but not eliminated--by a parallelagricultural sector adjustment operation. Of course, the introduction of theOGL, towards the end of the life of ISAC, alleviated this problem fully.

36. The period during which ISAC was being formulated also saw thebeginning of a close cooperation between the Bank and the IMF in theiroperations in Madagascar. A high level of frequent communications wasdeveloped between the staff of the two institutions. This was quicklyextended to include a core team from the government. The effects of suchcooperation were not so evident on ISAC, but were critically important forITPAC, which followad closely after ISAC.

PART II

A. Comments on the World Bank's Project Completion Report

37. The Industrial Sector Adjustment Credit (ISAC, Credit 1541-MAG forSDR 40.2 million and Credit A-7-MAG for SDR 18.9 million) marked the start ofa new direction in Madagascar's economic policy. The economy badly neededthe Credit during its external and internal financial stabilization,primarily to provide the necessary foreign exchange for imported inputs to beused in production and spare parts. Although it was very difficult tosimultaneously carry out a policy to restart growth in production andreestablish internal and external balance, the Government was clearlycommitted to undertaking a series of reforms to increase the performance ofthe industrial sector. ISAC was the first step on that road.

38. With the start of the implementation of ISAC in 1985, theintroduction of the Liberalized Import Regime (RIL) about mid-1987 and of theLiberalized Import System (SILI) in July 1988, private investments were againbeing made despite certain long-term persistent structural rigidities. Basedon the 1985 Investment Code, 100 companies wera approved between 1985 and1988, of which 65Z were in the industrial sector, most of them rehabilitatedenterprises.

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39. Nevertheless, difficulties were encountered as mentioned in theBank's PCR, but the phased approach to implementing the Credit was wellsuited to a difficult economic environment in which the reforms could be onlya starting point for a market-oriented economy. The impetus generated byISAC, supplemented by other macroeconomic measures, the total liberalizationof imports and the establishment of the Investment Code of 1988, resulted ina steady growth of the production capacity of industrial enterprises.

B. Report Prepared by the Borrower and Executing Agencies

1. Comments by the Ministry of Economy and Plan

Introduction

40. The Industrial Sector Adjustment Credit (ISAC, Credit 1541-MAG forSDR 40.2 million and Credit A-7-MAG for SDR 18.9 million) was a hybrid creditthat marked the beginning of the structural adjustment process in Madagascar.The project had four components:

- quick disbursement for imports of production inputs and spareparts: 89Z

- rehabilitation of industrial enterprises: 82

- technical assistance: 3%

- public works: 1%.

The Credit was approved by the Bank's Board of Directors on January 15, 1985and became effective on August 28, 1985. The closing date was extended threetimes, ultimately being September 30, 1990.

Objectives

41. ISAC's objective was to bring new vitality co the industrialsector, which had been weakened by long-standing stru,-ural rigidities, andto bring about economic policy changes designed to ! zrease the efficiencyand eventual competitiveness of the industrial sector. The credit was ameans of increasing supply during the difficult macroeconomic stabilizationperiod necessary before the structural adjustment mentioned earlier couldbegin.

Implementation Experience

42. Based on the reports prepared by the executing agencies (MIEM, BNI,Central Bank), the project was successful. The economic policy reformssupported by the project, namely, price liberalization, export promotion,import liberalization, rationalization of the public investment program, andencouragement of the private sector, were begun but were difficult toimplement for a host of reasons:

- ISAC is the first step on the road to reform;

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- The recommended reforms could have had the major effects soughtwith a regard to supply but the conditions for implementing themeasures were not ir. place; i.e., the existence of a climatefavorable to a recovery in production;

- A macroeconomic stabilization policy could not be pursued at thesame time that supply was expected to respond. Restrictions ondemand, especially imports (RIL, SILI), although necessary, limitedthe increase in supply. The weakness of industrial developmentbrought in its wake a s,ries of operating characteristics:multiple external dependencies, particularly for capital goods,inputs and means of production, insufficiency of backward-forwardlinkages, limited absorption capacity, relatively low level oftechnical know-how.

43. The executing agencies ran into various problems, in particular:delays in the utilization of the funds, inability of the industrialenterprises to award a minimum order of US$52,000 per supplier for imports ofspare parts, and the significant exchange risks borne by the industrialenterprises. On this latter problem, although the exchange risk was borne bythe State in the subsequent APEX credit, it is not yet evident thatindustrial development is going in the desired direction.

44. In point of fact, because of the need to develop a favorableclimate for production in particular, training should ultimately create acadre of national entrepreneurs capable of promoting joint ventures withforeign investors. Thus, although the credit was not regularly and fullyutilized, this does not mean that the absorption capacity of the economy islimited.

2. Comments by the Ministry of Industry, Energy and Mining

45. Prior to the involvement of the World Bank, MIEM had alreadyestablished certain criteria for the allocation of the foreign exchangerequired by the industrial and mining enterprises for importing inputs andthe spare parts needed for their operations. Those criteria were ranked bypriority.

- First priority: Exporting enterprises

- Second priority: Enterprises manufacturing basic necessitiesand intermediate goods

- Third priority: Other enterprises.

In other words, the scarce foreign exchange were already being usedconscientiously, and the enterprises clearly understood the need for suchaction despite their initial reticence. Moreover, the list of selectedenterprises was almost identical to that consistent with priorities one andtwo above.

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46. As regards the delay in utilizing the funds for which the closingdate was extended three times:

(a) When the first tranche of Credit 1541-MAG was released, prioritywas given to the selected enterprises with import licenses butwhose foreign ex.change account transactions were blocked by theCentral Bank. Accordingly, import licenses had to be checkedpending Central Bank approval of such transactions by thoseenterprises before they could be incorporated in ISAC 1541-MAG.

(b) The required rinimum order of US$52,500 per supplier delayed thefiling of additional applications, especially for imports ofspecific parts, as US$52,500 is not a negligible amount for thesmall and medium enterprises, which had had financial difficultiesfollowing the 1981 crisis.

(c) There were delays with the replenishment of the special accountsand application procedures.

47. Utilization of ISAC (Part A) required the establishment of aspecial "Monitoring Committee," composed of representatives of BCM, BNI, BTM,BFV, MFB, MIEM and MC, who met every Wednesday.

Duties: - Assess the situation regarding:

- status of account- pending applications- disbursements situation

- Raise problems

- Identify action to be taken- Act

As a result:

- An overrun of the overall amount was avoided by establishing areserve taking into account fluctuations in SDR/US$ exchange ratesand changes in freight costs.

- The credits not used by certain selected enterprises, whichpreferred to use the SILI not subject to the fixed rate of 5r,could be reallocated to other interested and efficient entities.

- Virtually all ISAC funds were utilized.

48. Lastly, ISAC and ITPAC played an undeniably important role in thenew outward orientation (export-oriented market production). Furthermore,other credits are now under way as part -f structural adjustment: ITPAC,PSAC, APEX, etc.; ISAC's experience should be used to avoid the same errors.What our enterprises lack now is working capital to meet the constraints ofliberalization.

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3. Comments by the National Bank of Industry (BNI)

49. our comments refer to the part with which we are directly involved;i.e., the component involving the financing of rehabilitation projects, andin particular para. 22.

50. First of all, the statement that the above-mentioned componentwas the least successful, owing mainly to BNI's slowness in processingapplications for subloans, requires an explanation. In point of fact, as wealready indicated in the Project Completion Report for IDA Credit 977-MAG,the exchange risk penalizes clients and was already causing financialdifficulties for many anterprises. The persistence of that problem, togetherwith the rest of the unfavorable investment climate prevailing at the time,resulted _'A clients continuing to manifest their reluctance especially tocontract loans denominated in other currencies. It was moreover for thatreason that at the same time we were able to satisfactorily use other sourcesof funds such as the long-term refinancing facility of the Caisse Centrale deCoop6ration Economique (the main advantage of which is the fact that theenterprises do not bear the exchange risk, and under certain conditions canbe granted a relatively low preferential rate).

51. In addition, BNI alone accounted for more than 60% of that line ofcredit to be used by all local banks. The exchange risk problem, moreover,also forced Soci6td JB, one of the most prosperous firms in the country, toseek cancellation of the loan that had been accorded it under IDA Credit1541-MAG.

52. Furthermore, as regards the volume of lending under the BNIcomponent, the ultimate overall amount was SDR 3,246,925 (i.e., 65% of thefunds allocated to it) and this, after the withdrawal of Soci6td JB as wellas the rejection by IDA of the request from REFRIGEPECHE-0UEST for partialfinancing of a trawler in the amount of SDR 1,300,000, which we wereul:imately able to negotiate under the Caisse Centrale line discussed above.

53. Lastly, we would stress the measures taken by BNI to promote andsupport small and medium enterprises through the establishment of venturecapital accumulated from our earnings that enabled us to increase the fundsfor projects with firms such as RUBIS, GAMO and L'ELEVEUR, to give only a fewexamples, in the form of joint ventures, and without which those projectwould not have been able to meet the criteria for loans under IDA Credit1541-MAG, and, consequently, could never have been financed.

54. The next two tables summarize the indicators for each creditoperation financed under the BNI component of Credit 1541-MAG.

CREDIT 1541-MAG, COMPONENT B

AT JANUARY 30, 1991in SDRs

(Credits denominated in Malagasy francs)

OutstandingClient Amount granted Amount utilized Repayments balance at April Comments

(FMG) 30, 1991 (FMG)

31 - SHE 52,000.00 SDR 28,312.95 SDR 26,297,126 28,297,126 Regular repayments, good52,594,252 FMG prospects

32 - RUBIS SA 48,555.00 SDR 47,010.46 SDR 23,346,993 7 250,000 Regular repayments thanks to On95,096,993 FMG the efforts of the promoters

despite difficulties relatedto liberaiization

B3 - GAMO CI 99,210.00 SDR 86,104,48 SDR Regular repayments, good177,198,517 FMG 39,377,449 13?.921,068 prospects

B4 - FTT 8,000.00 SDR 7,961.86 SDR 6,517,234 7.775,848 Regular repayments16,293,082 FMG

121,000.00 SDR 114.939.87 SDR - 236,849,266 Project in startup phase,B5 - L'ELEVEUR 236,849,26 G good prospects

Total 328,765.00 284,278.62 SDR 96,038,802 471,993,308

Equivalent 578,032,110 PMG

CREDIT IDA 1541-MAG, COMPONENT 3

AT APRIL 30, 1991

(Credits denominated in SDRe)

Client Amount granted Amount utilized Repayments Outstanding balance Coments(SDR) (SDR) at April 30, 1991

1 - ZRAOMA 500,000 483,596.48 700,000.00 383,596.48 Normal progress2 - BATA 486,700 446,980.44 746,980.44 0 Repaid in full3 - Soci6tE JB 420,000 - - - Credit canceled4 - SF0I 420,000 417,766.67 76,360.00 341,406.67 Norwal progress5 - SAMIMAD 401,460 402,514.06 60,584.00 241,930.06 Project in startup

phase6 - SOPEBO 1,110,000 1,030,299.19 1,730,299.19 0 Repaid in full

TOTAL 3,338,160 2,781,156.84 1,714,223.63 966,935.21 1