Document of The World Bank FOR OFFICIAL USE ONLY CP. /42e_-XŽ Report No. P-4119-ZA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE TNTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 62.2 MILLION TO THE REPUBLIC OF ZAMBIA FOR AN INDUSTRIAL REORIENTATION PROJECT AUGUST 20, 1985 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit Zambian Kwacha (K) US$ 1.00 K 2.4 K 1.00 US$ 0.4167 The Zambian Kwacha is officially valued in terms of a basket of currencies, for which the US dollar is the intervention currency. Since July 1983, the Government has followed a flexible exchange rate policy, making periodic adjustments in the official value of the Kwacha. The rates expressed above are as of May 31, 1985. The following are average annual exchange rates for recent years. 1980 US$ 1.00 = K 0.7885 1981 US$ 1.00 = K 0.8684 1982 US$ 1.00 = K 0.9282 1983 USS 1.00 = K 1.2506 1984 US$ 1.00 = K 1.7943 WEIGHTS AND MEASURES 1 Metric Ton (Tonne) = 1000 Kg. or 2,205 lbs. 1 Hectare (ha.) = 2.47 acres ABBREVIATIONS GDP = Gross Domestic Product INDECO = INDECO Limited ZCCM = Zambia Consolidated Copper Mines, Limited ZIMCO = Zambia Industrial and Mining Corporation, Ltd. FISCAL YEAR Government: January 1 - December 31 ZIMCO/INDECO: April 1 - March 31 fOR OMCIAL USE ONLY ZAMBIA INDUSTRIAL REOT PROJECT CREDIT AND PROJECT SUMMARY Borrower: Republic of Zambia Beneficiaries: Industrial sector enterprises. Amount: IDA SDR 20.1 million (US$10 million equivalent) African Special Facility SDR 42.1 million (US$42 million equivalent). Terms: Standard for IDA and the-African Facility. Project The objective of this Project is to raise capacity Descriptiont utilization and production levels of efficient industrial enterprises in Zambia in order to increase the supply of mnufactured goods for both the domestic and export markets. It would support policy and institutional reforms designed to increase the efficiency and productivity of industrial firms and to reorient the industrial sector towards greater use of domestic inputs and towards export markets. The Project would finance: a) imports of spare parts, raw materials, intermediate goods and other inputs, and (b) technical assistance, equipment and training to help improve INDECO's capacity to evaluate investment projects and improve the operation of existing public enterprises, to enhance the Bank of Zamb±a's capacity to forecast and budget foreign exchange, to establish a tariff commission in the Ministry of Finance, to prepare a program to simplify the duty drawback system, to identify areas for expansion of the sales tax base and to set up an export promotion board in the Ministry of Commerce and Industry. Terms to For the importc 'nuponent, the credit proceeds would be Beneficiaries: sold at an auctiou-det*rmined exchange rate. Funds allocated for technical assistance would be made available on a grant bqsis to INDECO and the Bank of Zambia. This docu men ha a berwed trociptiuo amd mo be euod by ocpe ony in t perior Of drw officia dohm Its crnmnts may ot oderwi be claasd wihout Wodd Bautboza - ii - Benefits: By raising capacity utilization and production levels of efficient and intcrnationally competitive industrial enterprises, the Project would help reverse the downward trend in GDP, provide increased income opportunities for the Zambian people, increase the supply of domestically-produced industrial inputs, and provide wage goods needed in rural areas to enhance the effectiveness of agricultural sector incentives. By increasing the supply of raw materials, it would help lower production costs of industrial firms. The policy and institutional reforms would encourage development of domestic resource-based industries and lower the import and capital intensity of Zambian enterprises, thereby initiating the process of industrial reorientation. This would lead to an improved allocation of resources in the industrial sector and to greater emphasis on exporting which is required in the longer term to substitute for copper exports. Risks: The main risk facing the project is the delay, or even reversal, in the implementation of the policy and industrial reforms supported by the Project, as a result of possible internal resistance to the changes. This risk is limited by: (i) the fact that the Government has already shown its commitment by implementing major components of the policy package during the last two years; (ii) the growing national consensus in Zambia that the prolonged nature and severity of the current crisis requires major change; and (iii) the expected benefits, in terms of increased output and exports, of the recent and forthcoming policy changes, together with those derived from the additional foreign exchange made available by the Credit. Furthermore, the imports component of the Credit would be disbursed in two tranches with the release of each tranche linked to satisfactory progress in the implementation of the policy and institutional improvements. Estimated Disbursement: US$Nillion IDA FY FY86 FY87 FY88 FY89 Annual 60.6 0.6 0.6 0.2 Cumulative 60.6 61.2 61.8 62.0 Appraisal Report: This is a combined President's and Appraisal Report. INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF ZAMBIA FOR AN INTuSTRIAL REORIENTAION PROJECT 1. I submit the following report and recommendation on a proposed credit to the Republic of Zambia of SDR 62.2 million (US$62 million equivalent) on standard terms to help finance an Industrial Reorientation Project. Of the total credit amount, SDR 20.1 million would be financed by IDA and SDR 42.1 million by the African Facility. Special Joint Financing of 10 million pounds sterling (about US$13 million equivalent) would be provided by the United Kingdom. PART I - THE ECONOMY 2. A Country Economic Memorandum on Zambia (Report No. 5000-ZA) was distributed to the Executive Directors on April 24, 1984. This part is based on that report's findings and on subsequent information received from the Zambian authorities. Country data sheets are attached as Annex I. 3. Zambia's economy is heavily dependent on external trade and on government activity. Imports and exports range between 30 and 40 percent of GDP. Government expenditures amount to about 35 percent of GDP, and the Government owns a majority share of mining and most manufacturing enterprises. Copper mining provides over 90 percent of foreign exchange earnings and 15 percent of gross value added. Much economic activity is dependent on expatriate technical, managerial, and administrative skills. Current Economic Situation 4. Zambia is currently in an acute stage of economic and financial crisis. Production has declined steadily for three consecutive years in most sectors due to reductions in import volumes. External trade has moved to a cash basis, because of the refusal of banks to open new letters of credit without reducing existing ones. Due in part to continued declines in the copper price, scheduled external debt service obligations amount to over 70 percent of export earnings, and debt rescheduling will be required - 2 - for the third year in a row. Disbursements of external loans have fallen sharply due to reductions in capital expenditure by both the Government and many public enterprises. As a result, a multi-faceted foreign exchange constraint now grips the country and threatens to override the positive effects of the Government's economic recovery program initiated in 1983. To avoid this, a major coordinated effort of debt restructuring, renewed financial flows and further policy measures are required to restore production and thus enable the Government's program to succeed. 5. Zambia's economic and financial problems were initiated by a sharp decline in the copper price in 1975. Zambia's terms of trade have deteriorated steadily since then, and by 1984, were 70 percent below the average for the early 1970s. In 1982, and again in 1984, copper prices reached their lowest level in real terms during the post-World War II era. Real GDP has been in a general downward trend since 1975, declining on an average by about 1.5 percent per year. With population growing by 3.1 percent per annum, real GDP per capita is 25 percent lower than in 1974. GNP per capita was estimated at US$580 in 1983, using the World Bank Atlas methodology, but is now much lower as a result of major devaluations of the Kwacha in 1983, 1984 and 1985. 6. The balance of payments has been in chronic disequilibrium since 1975, with current account deficits climbing to an average of 19 percent of GDP in 1980-82. Nevertheless, the volume of imports declined steadily and is now 50 percent below its level in 1980 and 75 percent below its level in 1974. This has resulted in an economy-wide problem of severe underutilization of capacity and, especially in the mining sector, a large backlog of maintenance and rehabilitation expenditure that has contributed directly to a declining trend in copper production and exports. In 1984, copper exports fell to their lowest level (525,000 tonnes) since Zambia's independence. The current level of imports is now inadequate to sustain copper production and to provide a critical minimum for the rest of the economy to function efficiently. The large current account deficits have also led directly to Zambia's high level of external indebtedness. At the end of 1984, Zambia's total external liabilities stood at US$4.4 billion, including drawings from the DEF (US$740 million) and US$500 million in overdue commercial payments. By comparison, exports of goods and services amounted to somewhat over US$900 million. 7. The decline in copper prices also severely affected Zambia's fiscal and monetary positions. In the past, mineral taxes provided a large share of government revenue, but they have been negligible since 1976. A new mineral export tax was introduced in 1983, however, which now contributes about 10 percent of Government's revenue. Deficit financing absorbed a large share of net domestic credit and contributed to a sharp rise in consumer prices, averaging 20 percent per annum during 1976-78 and 12 percent per annum in 1979-82. Price increases have accelerated in 1983 and 1984 to about 20 percent per annum, reflecting the decontrol of prices in December 1982 and the devaluations of the Kwacha during the past two years. - 3 - 8. There is no doubt that external factors have been an important cause of Zambia's present economic difficulties. Apart from low copper prices, other factors over which the Government has little or no control include transport difficulties in neighboring countries on which Zambia is dependent for the movement of foreign trade, and severe droughts which for three consecutive years have necessitated substantial food imports. In addition, copper mining in Zambia is past its peak, and for technical reasons, such as sinking deeper shafts and tapping less rich ore bodies, production costs are rising as ore reserves are depleted. 9. Nevertheless, inappropriate policies and shortcomings in economic management have exacerbated the economic difficulties. The main deficiencies in economic policies were that: (i) pricing and subsidy policies favored the urban consumer at the expense of the agricultural producer, depressing the latter's income and incentive to produce for the market; also, controlled industrial prices led to low profitability in the manufacturing sector and a decrease in resources available for reinvestment; (ii) tax incentives and low interest rates led to a pattern of capital-intensive investment; (iii) exchange rate and tariff policies encouraged the use of artificially cheap imported raw materials and other inputs and discouraged the use of local materials and the development of non-mineral exports. As a result, a highly capital and import-intensive productive structure was created that proved to be very vulnerable to prolonged declines in the availability of foreign exchange. Strategy for Economic Restructuring 10. Economically exploitable ore reserves are only sufficient to maintain present levels of copper production for another 15 years or so, after which production can be expected to decline sharply. In the long run, therefore, the copper industry cannot be counted on to provide the domestic and external resources required for development. In the absence of policies and programs to develop new sources of income, employment and foreign exchange, Zambia may expect a drastic fall in living standards and social well-being by the turn of the century. However, Zambia has the potential to develop alternative sources of income, employment, and exports. The greatest potential is in agriculture, where there are opportunities for import substitution (cotton, oilseeds, livestock, grains, forestry products, and fish) and for exports (beef, cotton, coffee, tobacco, groundnuts, and sugar). Once a good start is made with agricultural development, poasibilities will be created for agro-based industries. 11. For any long-term growth strategy to succeed, however, it is of the utmost importance that financial balance be restored in the economy. As the main provider of foreign exchange, the copper industry has a major role to play. Without a rehabilitated copper industry, the Government's diversification effort would fail for lack of financial resources. For this reason, in 1984, the Bank approved an Export Rehabilitation and Diversification Project which aims to increase the efficiency of the mining - 4 - industry and make it competitive again by international standards. This project was accompanied by an agreement on changes that would be needed in macro-economic and sector policies in order to restructure and diversify the rest of the economy and create the conditions for developing new sources of income, employment and exports. 12. The Government, with Bank and Fund assistance, has developed a wide-ranging package of policies and measures to bring about better economic management and a policy environment conducive to healthy economic growth and diversification. The Government's economic restructuring policies may be suimmarized as follows: - Providing a system of incentives to producers and exporters of agricultural and industrial products in which prices are responsive to market forces; - Ensuring the competitiveness of exports through an active exchange rate policy; - Using tariffs and interest rate policies to reverse past trends of import dependence and capital intensity; - Liberalizing administrative restrictions on foreign trade and the licensing of production, in order to improve the allocation of resources and to encourage investment in productive activities; - Reducing the Government's deficit and recourse to domestic bank borrowing by reducing expenditure on personnel costs, subsidies and other non-development related activities; - Improving planning and budgetary proced-ares to shift resources to productive uses and economic investments; - Allowing greater competition in the procurement and selling of food crops. T-e National Agricultural Marketing Board (NAMBOARD), the Government's agricultural marketing agency, will move towards the role of buyer and seller of last resort, using a system of floor and ceiling prices for agricultural produce and inputs, respectively; - Strengthening the technical and managerial capacity of Zambia Industrial and Mining Corporation (ZIMCO), which is the holding company of most state-controlled enterprises; - Restructuring the energy sector to bring about lesser dependence on imported oil. 13. In the past two years, the Government has made significant progress in translating the above policies into tangible action. Stand-by arrangements were agreed with the IMF in 1983 and 1984. Under these programs, the Kwacha was linked to a basket of currencies and was depreciated in a gradual manner such that it is now 60 percent lower (in foreign exchange terms) than at the end of 1982. Because the Government has been successful in holding wage increases to considerably less than rises in the cost of living, it has maintained the benefits of devaluation in real terms, which has improved the competitiveness of exports. Debt rescheduling with members of the Paris Club, commercial banks and non-OECD governments was also obtained. Further measures taken under the IMF program included increases in interest rates and tough budgetary measures (including reductions in subsidies and a cap on new government employment) aimed at reducing the Government's domestic borrowing. Under the programs, the current account deficit was reduced to 8.5 percent of GDP in each year and domestic bank borrowing by the Government to 3-4 percent of GDP in each year. 14. In terms of improving conditions for longer-term growth, the most significant of the above financial measures was no doubt the exchange rate adjustments. But other measures with significant long-term impact have been introduced as well. In December 1982, in order to allow market forces to play a more important role in the economy, the Government abolished the control of all wholesale and retail prices except for three essential commodities: wheat flour, maize flour and candles. Since then, prices for a wide range of commodities have increased, thereby helping to restrain domestic demand, while increasing the profitability of firms. Most recently, the price of wheat flour and bread was also decontrolled. Over the last three years, producer prices for most agricultural crops have been increased considerably in real terms. Together with concessionary tax rates for agricultural income and freer marketing arrangements for the livestock sector, these measures have already led to increases in the area under cultivation and in the marketed production of various crops and livestock. The Government has also improved the incentives affecting foreign trade by introducing a foreign exchange retention scheme and concessional tax rates for non-traditional exports, and by imposing a minimum tariff on many non-dutiable imports which should reduce the high rates of effective protection afforded to import-intensive industries. 15. As part of its economic recovery plans, the Government has reactivated its interaction with the Consultative Group for Zambia. In May 1984 the Government presented a three-year expenditure program along with a set of policy measures aimed to restructure the economy. The Consultative Group strongly endorsed tL. Government's new policy initiatives, as well as its expenditure program which emphasized rehabilitation of existing infrastructure, increased capacity utilization and selected investments to diversify the economy, especially in agriculture. The Group indicated that its members are prepared to increase their assistance to Zambia, although these indications have yet to materialize in new loan commitments. In addition, various members indicated that in view of Zambia's serious financial position, they are converting their assistance programs to a grant basis and are prepared to make assistance available in the form of - 6 - qu5ckly disbursing loans and grants. The Consultative Group met again in June 1985 to discuss the continued deterioration in Zambia's financial situation. It reaffirmed its support for Zambia's restructuring efforts and, in view of the current financial crisis, indicated that it would increase the amount of assistance on quickly disbursing terms. 16. The Government's efforts over the past two years represent a major reformulation of economic policies and incentives. This progress is currently in danger of being set back, however, due to insufficient foreign exchange to maintain production (and exports) and to honor external debt obligations. On one hand, the Government wishes to improve the supply of essential consumer goods and thus show some benefits from the considerable sacrifices its policies have required of the population, in particular, a rapid increase in the consumer price of maize. On the other hand, the Government must allocate considerable foreign exchange to service debt that cannot be rescheduled. 17. In facing this dilemma, the Government has opted for the bold step of adopting a foreign exchange auction system in recognition of the need for greater efficiency in the allocation of these resources. The adoption of an auction system should also help mobilize additional foreign exchange for the official market from sources both within and outside Zambia, namely from unrecorded exports and from official development agencies that would be willing to support such a significant policy change with quickly disbursing assistance. While this strategy is commendable, it risks uprooting, however, a hard-won political consensus that the economic reform program must continue. Against the hope that additional foreign exchange resources will materialize, the Government's decision to adopt an auction system is being taken with the clear expectation that higher prices will inevitably follow further depreciation of the Kwacha. It is therefore essential that additional foreign exchange resources be made available for the auction to work in order to increase production, expand the supply of basic consumer goods and minimize upward pressure on prices. Along with the auction, the Zovernment intends to introduce a wide range of supporting measures, including decontrol of interest rates, conversion of the import licensing system to one of import registration, reductions in high import tariff rates, and further measures to reduce government expenditure and borrowing from the banking system. Creditworthiness 18. Scheduled service on public and publicly guaranteed (PPG) external debt will remain at over US$400 million per annum for the next three years, or about 40 percent of export earnings at today's copper prices. Of this amount, about US$65 million per annum is due to the World Bank Group, including the IFC. (The Bank Group currently holds US$430 million, or 15 percent of Zambia's US$2.8 billion PPG debt disbursed and outstanding). In addition, about US$200 million per annum in payments is due to the IMF and another US$50-70 million per annum is due on Zambia's pipeline of commercial payment arrears and short-term borrowings. In total, then, scheduled debt service will amount to over US$700 million per annum for the next three years, and it will thus be necessary for the Government to continue its financial stabilization policies in cooperation with the DMF and to seek debt relief through further rescheduling. Even with maximum debt relief, however, Zambia will continue to owe over US$400 million per annum in debt service that cannot be rescheduled. The Government should, therefore, avoid as much as possible borrowing on commercial terms, and additional borrowing should carry sufficiently long grace periods and maturities. 19. In the longer term, the restoration of Zambia's creditworthiness depends on the vigor with which the Government continues to pursue its economic restructuring policies. The Government is well underway in adjusting its economic policies and is fully committed to take further steps towards economic reform and the restructuring of Zambia's productive industries. Assuming successful economic policies, careful financial management and adequate external assistance, Zambia could achieve a reasonable measure of export growth and diversification in ten to twelve years and reduce its overall debt service ratio to 30 percent of exports. PART II - THE MANUFACTURING SECTOR 1/ A. Sector Characteristics and Recent Performance Size and Growth of Manufacturing_ 20. Zambia's manufacturing sector contributed about US$600 million C18 percent) to GDP in 1983, and as such it is relatively large compared to other sub-Saharan African countries. The share of manufacturing in GDP is second only to Zimbabwe, and only Zimbabwe and Ivory Coast in sub-Saharan Africa have higher levels of manufacturing GDP per capita. 21. Manufacturing was the fastest growing sector of the economy in the Lirst decade after independence. From 1965 to 1974, manufacturing value added grew at 10 percent per annum in real terms while total GDP was groding at about 3.3 percent per annum. The rapid growth of manufacturing during the 1960s and early 1970s was due to: (i) growing demand for consumer goods because of growing incomes; (ii) increasing demand for relatively simvle equipment by the mining sector, mostly metal products such as boilers, metal structures and other; and (iii) Government's policy of accelerated industrialization through import substitution and I/ Zambia's industrial performance, prospects and main policy issues are analyzed in more detail in the report 'Zambia - Industrial Policy and Performance, Report No. 4436-ZA, August 6, 1984. This section reflects the findings of that report. - 8 - direct Government investment in manufacturing. The sector's growth continued at high rates until 1974 when, in response to the sharp fall in capper earnings and the resulting economic recession, output began to fall faster than GDP. Manufacturing production declined by 15 percent in real terms between 1975 and 1980: it recovered somewhat in 1981, but declined again thereafter. In 1983, the production of manufactured goods was four percent below the 1980 level, and available evidence suggests that the decline continued during 1984. Value added in manufacturing is now only about three-quarters the level of 1974. Structure of Production 22. The structure of manufacturing output was already well diversified in the mid 1970s. In 1975, food, beverages, tobacco, textiles, clothing and leather accounted for less than 40 percent of manufacturing value added whereas intermediate products and equipment (chemicals, metal products, machinery, etc.) accounted for 49 percent of the total. Since the mid-1970s, the structure of the sector has changed little (in terms of installed capacity), but output has dropped substantially in most mining-related sectors while some consumer goods have experienced small increases. Investment and Capacity Utilization 23. Investment in manufacturing rose rapidly in the late 1960s and early 1970s, quadrupling in real terms over 1965-72. More than 45 percent of the total manufacturing investment during 1965-75 was in chemicals and non- metallic mineral products. It was concentrated heavily in a few large publically owned projects, such as the fertilizer plant, oil refinery, brick factory, and cement plant expansion. One consequence of the substantial investment in larger, capital-intensive industries was a nearly doubling in the incremental capital/output ratio (ICOR) between 1966-67 and 1971-72. The high and growing capital intensity in manufacturing was also due to government policies (overvalued exchange rate, duty-free impcrts of capital goods and negative real interest rates) that encouraged the use of capital-intensive processes and the establishment of over-dimensioned plants. 24. Annual investment in manufacturing fell by half in real terms between 1975 and 1980, but installed capacity and the capital/output ratio continued to rise. Available evidence suggests that average capacity utilization has been falling steadily since the early 1970s. Capacity utilization in 1982 averaged less than 55 percent, and it has deteriorated further in 1983 and 1984 as a result of the worsening economic situation and the increasingly critical foreign exchange shortage. Currently, capacity utilization in industry is estimated to be less than 45 percent. -9- Location 25. The spatial structure of Zambia's industry is unusual in Africa because it is not concentrated in the administrative/commercial capital. Rather, about half the establishments and employment are located in cities in the Copperbelt, along the line of rail, with only around a third in Central Province, which includes Lusaka. Five of the country's nine provinces have less than 3 percent of the firms and less than one percent of industrial employment. Import Intensity and Export Performance 26. Zambian manufacturing is higvIy dependent on imported inputs and spare parts. Results of a sample of 24 firms surveyed in the Industrial Sector Report revealed that, on average, firms imported about 50 percent of their inputs. Only food, textiles and footwear industries import less than half their inputs, while metal products are the most import-intensive,with imports accounting for 81% of all Inputs. Chemicals, wood and paper products also have high import shares in total inputs. 27. Although the sector is relatively large and more advanced than that of comparable African countries, manufactured exports are small. The highest amount of manufactured exports achieved was US$3.3 million in 1974, which was greater than only 8 out of 34 African countries for which data are available. Manufactured goods made up only 1.3 percent of Zambia's exports in 1977 and 0.7 percent in 1980. They represented only 0.6 percent of gross manufacturing output in 1980. The depreciation of the Kwacha since 1983 has had a positive effect on manufactured exports, but they still remain small, accounting for only about 1 percent of overall exports. The six principal manufactured goods exports are cement, molasses, copper cable, menswear, crushed stone and lime, and explosives. Employment, Labor Productivity and Wages 28. Manufacturing employment grew at more than 11 percent per annum in the 1960s and 5.6 percent per annum during 1970-74. Thereafter, employment continued to grow, albeit at only one percent annually, despite the sharp drop in the value of manufacturing output. This was due to the public/parastatal sector, where employment was growing at an annual rate of five percent during 1975-80, more than twice the rate of growth of parastatal production. In the private sector, both employment and value added fell at about three percent annually during this period. At present, Zambia's manufacturing sector employs nearly 60,000 workers, which amounts to 16 percent of formal sector employment. 29. As a result of these trends, labor productivity in manufacturing declined steadily, at an average rate of more than four percent annually, between 1973 and 1980. Real wages in manufacturing, which rose substantially during the post-independence boom period, also followed a declining trend since 1973, falling at an average annual rate of two percent between 1975 and 1980. Wages in the formal manufacturing sector are now below the average wages in mining, transport and communications and services. - 10 - The Parastatal Sector 30. The Government's initial role in the industrial sector was to provide infrastructure and an adequate policy framework as a complement to private initiative. The Industrial Development Corporation was established by the Government to promote and help finance private investment. The rationale for public intervention in manufacturing was expanded in 1968 when a new strategy, based on the public sector taking a leading role in industrialization, was adopted. The objective was to establish industries that private enterprises were unwilling or unable to invest in because of high risks, high capital costs or low return, and industries deemed to be in the national interest because of strategic importance. It was hoped that this would accelerate the pace of industrialization and Zambianization, insure reinvestment of surpluses in Zambia, and minimize what was perceived as profiteering by foreign firms. 31. Among the measures taken to implement the new policies were regulation of the activities, size and location of private-especially foreign-enterprises, and Government acquisition of 51 percent or more of the equity of some 25 private firms in manufacturing, transport, distribution and fisheries. The Industrial Development Corporation (INDECO) was turned into a holding company to operate the nationalized enterprises, as well as those established through direct public investment. These actions, along with growing direct investment, quickly gave the parastatal sector a major role in manufacturing. By 1972, parastatal enterprises accounted for 53 percent of industrial value added and 42 percent of industrial employment. Since the early 1970s, the state's share of manufacturing has continued to expand. Manufacturing parastatals account now for 69 percent of the sector's assets, 66 percent of value added and 54 percent of employment. 32. INDECO currently has 33 subsidiary enterprises (16 wholly owned and 17 majority shareholding) and 4 associated companies, and is itself a fully-owned subsidiary of ZIMCO (the holding company that oversees all parastatal enterprises). ZIMCO's influence on INDECO is largely indirect, exercised through policy guidelines, reviews of performance and of some decisions, and interlocking boards between ZIMCO and INDECO. Manufacturing parastatals are present in every major branch of industry, except basic metals, and play a dominant role in producing consumer goods (such as mealie meal and flour, beer, cotton, textiles and sugar) and heavier industrial products, especially fabricated metal products, building materials, and a variety of both industrial and consumer chemicals. 33. The financial performance of the INDECO group of companies deteriorated steadily during the 1970s, from an average gross return on net assets of 12 percent in 1970 to sizeable losses in the last two years of the decade. The poor financial performance can be attributed partly to Government policies (e.g. price controls) and partly to the general downturn in the economy, but also to weak management, over-dimensioned - 11 - plants and excessive employment. There was a slight improvement in the early 1980s, with gross profits averaging 4 percent of net assets, but the positive overall gross profits mask widespread losses at the individual firm level. More importantly, many INDECO enterprises do not appear to be economically efficient. A preliminary review of the efficiency of INDECO firms (para. 64) suggests that over 20 percent of INDECO product lines are economically inefficient in the short run in the sense that their operating costs (excluding sunk investments) evaluated at border prices exceed their border-priced revenues, and therefore appear to have negative value added when measured at world market prices. Less than a third of the product lines appear to be efficient. The proposed Credit would assist INDECO in improving the efficiency of its operations. The Private Sector 34. While the Government of Zambia has, in practice, maintained a mixed economy, private industry has been subject to widespread administrative controls and regulations, coupled with incentives to selected firms and sectors. The private sector is particularly important in the production of basic metals, paper and printing, chemicals, textiles and food and beverages. 35. Private manufacturing firms are, with few exceptions, smaller than public sector firms and they have reacted more flexibly to the changing economic conditions. In particular, private investment has been low during the last decade, and employment has been declining. Capacity utilization has been lower in the private sector than in the parastatal companies in recent years, partly because the administrative allocation of foreign exchange favored the parastatal firms. B. The Financial Sector 36. The financial sector comprises the Bank of Zambia (BOZ), eight commercial banks, one merchant bank, one savings bank, three development finance institutions (of which one is a general purpose development bank and two are agricultural development banks), the National Building Society, the State Insurance Corporation, which has a monopoly on insurince business, and the National Provident Fund (a pension fund). Seven of the eight commercial banks and the merchant bank are either wholly or mainly foreign owned and controlled, while all the other institutions are either owned or controlled by the Government. The financial system is reasonably well developed and has operated in a satisfactory manner, except for the limitations imposed by Government on interest rates. 37. The commercial banks account for the bulk of domestic credit and domestic resource mobilization, mainly through demand and short-term deposits, and lending for equally short periods, primarily to agriculture (37 percent), manufacturing (17 percent), mining (12 percent), and commerce (11 percent). The three development finance inatitutions, namely, the Development Bank of Zambia (DBZ), the Agricultural Finance - 12 - Corporation (AFC) and the Zambia Agricultural Development Bank (ZADB) do not accept deposits. They depend for their local resources mainly on the central treasury and on borrowings from the Provident Fund, the Insurance Corporation and the commercial banks. Their foreign exchange resources are obtained from multilateral and bilateral sources such as the World Bank and KfW. Although the Building Society accepts deposits and share subscriptions, it depends substantially on the same sources of domestic resources as the development banks. Over 80 percent of the combined assets of the Insurance Corporation, the Provident Fund and the Savings Bank are invested in central Government, local authority and parastatal securities. 38. In spite of periodic increases, deposit and lending interest rates have been negative in real terms in recent years. In the last four years interest rates on overdrafts were increased from 9.5 percent to 17.5 percent, and on term loans from 10.25 percent to 17.5 percent, but they are still below the estimated inflation rate of 20 percent in 1984. Deposit rates, which used to be fixed by the BOZ on the basis of maturity, are now subject to only an overall maximum of 15.5 percent p.a. The result of the negative rates has been to limit domestic resource mobilization and to generate excess demand for credit. The Government has now decided, in the context of the introduction of the foreign exchange auction, to decontrol interest rates. 39. Tight credit control has been a feature of monetary policy in the last two years. Successive IMF programs have set limits on Government budget deficits, net credit from the banking system to the Government, BOZ lending to the Zambia Consolidated Copper Mines (ZCCM)-the Government-owned copper mining company-and overall ceilings on credit expansion. Declining Government budget deficits have reduced its need for bank credit. There are indications, however, that the deteriorating financial performance of some state agencies, such as NAMBOARD, is forcing them to rely more heavily on credit. As a consequence, all commercial banks now operate close to the credit ceilings set by BOZ. C. Past Industrial Strategy and Policies 40. Zambia's industrial development strategy during the late 1960s and the 1970s did not achieve its objective of generating sustainable economic growth. In an effort to accelerate industrialization, which was seen as the main engine of development, and to increase employment and domestic ownership in the main economic sectors, the Government embarked on a strategy characterized by: (i) Government ownership of the major industrial enterprises; (ii) major public sector investments in intermediate sectors (chemicals, fertilizers, cement) and consumer durables (e.g. automobile assembly); (iii) elimination of foreign competition through import licensing and tariffs; (iv) elimination of domestic competition through restrictive investment licensing and other regulations; and (v) almost exclusive concentration on the domestic market through import substitution. This strategy was to be supported by the revenues generated by the mining sector which provided both the domestic incomes and - 13 - demand for industrial goods, and the fiscal and foreign exchange resources necessary to pay for the imports of capital goods and inputs for the new industries. 41. While the above strategy was successful in expanding and diversi- fying ZambI 1's industrial sector, its major shortcomings were, first, the neglect the agricultural sector and, second, in the industrial sector, high capital and import intensity for new investments, excess capacity in some of the new firms, and low levels of efficiency in others, as well as the sector's total dependence on the domestic market, without any attention to exports. The main policies through which the Government pursued its past industrial strategy are reviewed below. Foreign Exchange Regime 42. Exchange Rate. Zambia's exchange rate has been significantly overvalued for a prolonged period of time. The Government pursued a fixed exchange rate policy until the end of 1982. The Kwacha underwent virtually no change in its nominal rate in the 30-year period ending in 1980, when it stood at US$1 = K 0.78. After 1974, however, Zambia experienced higher inflation than its trading partners, and the real effective exchange rate as measured by the difference in inflation in Zambia and its trading partners, appreciated by about 25 percent in US dollar terms between 1974 and 1982. 43. The over-valuation of the exchange rate during the late 1970s and early 1980s reduced the competitiveness of Zambia's tradeable goods, both domestically and abroad, and put additional pressure on an already difficult balance of payments situation. In an attempt to deal with this situation, the Government devalued the Kwacha by 20 percent in January 1983. Six months later a crawling peg exchange rate system was adopted, leading to several small and regular devaluations, which resulted in a further nominal devaluation of 40 percent through December 1984. When account is taken of the differential inflation rates between Zambia and its main trading partners,these devaluations put the real value of the Kwacha in 1984 back at the 1974 level. 44. The exchange rate realignments in 1983 and 1984 were insufficient to regain external equilibrium under present economic conditions, partly because of the decline in Zambia's terms of trade and partly because of the increased debt and arrears. Under these conditions, there continued to be a significant excess demand for foreign exchange. The large backlog of commercial payment arrears, an increasing amount of import licenses for which no foreign exchange has been available, and the evidence of a parallel market which is a multiple of the existing official rate, are a reflection of the fact that as of early 1985, the Kwacha continued to be significantly overvalued. - 14 - 45. Import and Foreign Exchange Controls. An elaborate system of import and foreign exchange controls developed over the years to protect domestic industries and maintain external equilibrium with the highly distorted exchange rates. The core of this system has been: (i) an import licensing process administered by the Ministry of Commerce and Industry; and (ii) a foreign exchange allocation process administered by the BOZ. An Inter-Ministerial Committee, including the Miuistries of Finance, Commerce and Industry, and BOZ, granted specific import licenses to individual importers or enterprises. The import license, however, did not guarantee access to foreign exchange because of the shortages and because of inadequate forecasting of foreign exchange availability. As a result, a backlog of uncovered import licenses developed over the years. Holders of import licenses have to queue at commercial banks for letters of credit to be opened, and the commercial banks have, in practice, a significant influence in the final foreign exchange allocation. In some cases, BOZ also played a direct role by granting allocations directly to firms, and instructing commercial banks to give priority to certain import license holders. 46. As the foreign exchange shortage worsened, the system of import licensing/foreign exchange allocation became the main instrument of industrial policy in Zambia. Import licenses for products competing with locally produced goods were first reduced and later virtually eliminated. At the same time, imports of. industrial inputs were allocated, on a firm by firm basis, at levels well below the demand coming from the enterprises at the overvalued exchange rate. Firms receiving a relatively large allocation were in a position to make high profits because of the lack of competition from imports and the growing shortages and rising prices in Zambia. On the other hand, firms receiving little or no foreign exchange were forced to operate at very low levels or even to stop production for some periods of time. This situation generated inequities in the treatment of individual firms, inefficient allocation of resources, and windfall profits for some firms or individuals, while making redundant most other instruments of industrial policy (including tariffs). Tariff Structure 47. The structure of import tariffs in Zambia was characterized by high tariff rates on consumer and luxury goods (up to 150 percent) and low-or zero-rates on inputs and capital goods for the domestic industry. This structure, which produces high levels of effective protection for local industries engaged in assembly or processing-type activities, was intended to encourage rapid industrialization and protect infant industries. In practice, however, the tariff structure became irrelevant because, as noted above, the system of import licensing/foreign exchange allocation eliminated foreign competition and provided absolute protection to the firms receiving foreign exchange. This is reflected in the actual structure of imports and tariff revenues. The bulk of imports have been raw materials and other inputs coming in duty-free, and the average tariff revenue collection, as a percentage of imports, has been about 6 percent (compared to 20 percent for a sample of 32 Sub-Saharan African countries - 15 - for which data is available). The low tariff revenue collections also reflected widespread exemptions and exonerations granted as incentives to local industries on their imported inputs. Price Controls 48. Price controls have been a major feature of Zambia's economy since the 1960s. During the 1970s, the Government intensified and generalized the system of price controls in an attempt to control the pricing behavior of the protected local industry anl, more recently, to protect consumers in a situation of increasing shortages. Three major categories of prices came under some form of control: farm gate prices of agricultural goods, wholesale and retail prices of "essential commodities", and prices of some products of parastatal companies. Faced with mounting fiscal costs because of subsidies, low agricultural output, and its inability to control retail prices effectively, the Government introduced, in December 1982, a major change in its pricing policy. Agricultural producer prices were raised sharply and, in a move to increase reliance on market mechanisms, the Government approved a major decontrol of wholesale and retail prices, leaving the prices of only maize meal, wheat flour and bread, and candles subject to prior government approval. In early 1985, the prices of wheat flour and bread were also decontrolled. At the same time, however, farm gate prices of agricultural commodities and the prices of agricultural inputs continue to be set by the Government, and the prices of certain products of parastatal firms are subject to review by INDECO and ZI[nCO. Investment Incentives 49. Private sector investment in manufacturing has been low since the late 1960s, first, because the Government's 1968 decision to increase its direct involvement in manufacturing-including majority participation in firms previously in the hands of the private sector-reduced private sector confidence and, later, because of declining economic activity. In 1977, the Government enacted an Industrial Development Act in an effort to attract new private investment to manufacturing. The Act was not successful, however, partly because of the increasing deterioration of the economic situation, and partly because it did not fully abandon the overall industrial strategy of granting a dominant role to Government and a subordinate role to the private sector. The Act, which was highly regulatory, did not provide any new incentives that were not generally available to all manufacturers, and access to the incentives was arbitrary. Export Incentives and Regulations 50. Manufactured exports were singled out for some additional benefits in the Industrial Development Act, but these were more than compensated by the negative impact of exchange rate overvaluation and detailed export regulations. The latter, including the requirement to obtain an export license for each export shipment, were related to the - 16 - Government objectives of preventing shortages in the local markets and of avoiding capital flight. When the need to increase exports became evident in the early 1980s, the Government established a new export incentive, allowing all non-traditional exporters to retain 50 percent of their gross earnings for importation of approved inputs. PART III - THE GOVERNMENT ADJUSTMENT PROGRAM IN INDUSTRY A. New Industrial Policies 51. An immediate objective of the Government's new industrial strategy is to raise the level of capacity utilization in the sector by providing additional foreign exchange to efficient import-substitution industries and exporters. Increased industrial production would reduce the economic and social pressures associated with the economic stabilization and adjustment process, and the growth in industrial exports would help to regain external equilibrium. In the longer term, the Government's objective is to increase the efficiency of the industrial sector and its export orientation by instituting an incentive structure and a set of policies that encourage the flow of investment resources to the more productive industrial subsectors and away from inefficient industries. In order to attain these objectives the Government is committed to pursue a less protective, more outwardoriented industrial strategy, to rely increasingly on market forces to allocate resources, and to reduce the share and increase the efficiency of the public sector in manufacturing. 52. The Government is aware that provision of the additional foreign exchange needed to alleviate shortages of imported inputs would not promote efficient industrial growth unless the controls and restrictions currently in place are removed and the policy framework changed. Consequently, it has adopted-or intends to set in place-a number of institutional and policy reform measures. These are summarized in the following paragraphs. Implementation of these measures would be supported by the proposed project. The measures are designed to improve the foreign exchange regime, reform the import regime, remove disincentives to exports, streamline and improve investment incentives, increase the efficiency of public enter- prises and improve the public sector's investment program in manufacturing. 53. Exchange Rate Realignment. A more realistic exchange rate is regarded by the Government as the cornerstone of its new development strategy and of the proposed reforms of industrial policy. The Government has now approved the introduction of an auction system for the determination of the exchange rate. The new system, which is to be initiated shortly, will be based on a weekly or bi-weekly auction of foreign exchange at which the exchange rate which would then apply to all foreign exchange transactions is determined by the marginal bid which exhausts the foreign exchange available for auction. Administrative allocation, at the auction rate, will continue for the foreign exchange requirements of the Government, ZCCM, public debt service, and for imports of crude oil, drugs, books and, when necessary, maize and fertilizer. Bids - 17 - to purchase foreign exchange through the auction are to be made through commercial banks for the private sector and parastatal enterprises, and through the Ministry of Finance for the Government sector. A Foreign Exchange Auction Committee (FEAC) will be established to administer the system. The FEAC will be served by a Secretariat, which will, inter-alia, match the successful bids with the various sources of foreign exchange being auctioned, i.e., the Government's own resources, the proceeds of this Credit, and other sources. Advisors from the Ministry of Commerce and Industry will advise the Secretariat as to the eligibility of these bids for resources from the Credit (Schedule 5, draft Development Credit Agreement and draft African Facility Credit Agreement). Since the amount that could reasonably be made available for the auction would be insufficient to meet Zambia's import needs at the current exchange rate, a sharp depreciation in the auction-determined rate is to be expected. 54. The proposed auction, the resulting depreciation of the Kwacha, and the elimination of the excess demand for foreign exchange would eliminate the potential for windfall profits derived from administrative access to foreign exchange and, more importantly, would allow industrial enterprises to have access to imported inputs and spare parts on the basis of their needs and cost competitiveness rather than their ability to deal with the committees that allocate foreign exchange. Therefore, the new system is expected to lead, in the short run, to a more efficient allocation of the scarce foreign exchange available and, possibly, to an increase in the supply of foreign exchange through the rechannelling of transactions from the parallel to the auction market. In the medium and long run, the expectation is that an increasing number of activities, beth in industry and agriculture would become internationally competitive, thus increasing the generation and savings of foreign exchange. Moreover, the Government has undertaken to adopt prudent fiscal and monetary policies, which would also help reduce imports. Initiation of the auction system would be a condition of effectiveness of the proposed credit (Section 6.01(a), draft Development Credit Agreement and draft African Facility Credit Agreement). 55. Foreign Exchange Forecasting and Budgeting. The reform of the foreign exchange regime would also include improvements in the forecasting and budgeting of foreign exchange receipts, including those to be channelled through the auction. This would be necessary to ensure that a fairly stable amount of foreign exchange is channelled through the auction, and to minimize short-term fluctuations in the aucticn rate. In connection with the proposed Credit, BOZ would strengthen the Budget Section of its Foreign Operations Department by recruiting additional qualified staff and obtaining the necessary technical assistance to transform the foreign exchange budget into an operational document. To assist Government in laying the basis for an improved foreign exchange forecasting and budgeting process and in defining long-term technical assistance needs, two staff-months of consultants' services would be financed under a PPF advance already in place. The completion of this work and implementation of a follow-up program of action would be a condition of release of the second tranche. (Schedule 4, draft Development Credit Agreement and draft African Facility Credit Agreement). - 18 - 56. Import Licensing and Prohibitions. In order to open up the eco- nomy and promote greater efficiency and diversification, the Government has undertaken to carry out, together with the reform in the foreign exchange regime, the elimination of the current import licensing system and its replacement by a simple system of registration. Elimination of the present current system of import licensing would be a condition of effectiveness of the proposed credit (Section 6.01(b), draft Development Credit Agreement and draft African Facility Credit Agreement). The specific import prohibitions used for protective purposes, which cover about 50 items, will also be eliminated along with introduction of the auction system (Section 6.01 (b),draft Development Credit Agreement and draft African Facility Credit Agreement). These major reforms would shift the full weight of trade restrictions from the import licensing system to the tariff system. 57. Import Tariffs. Recognizing the deficiencies in the tariff structure, the Government began, in October 1984, to rationalize the tariff structure by imposing a 10 percent minimum tariff on many items--mostly in- dustrial inputs--which previously were not subject to duty. Subsequent to their announcement in the Budget Address of January 25, 1985, the Govern- ment implemented the following additional changes in customs duties and in sales taxes on imports: (a) removal of certain manufacturer's rebates and duty exemptions on imports of industrial inputs; (b) introduction of duty on all items which were previously exempted by ministerial decree; (c) an increase in the rate of sales tax on imports from 12.5 percent to 15 percent; and (d) an increase in the sales tax on virtually all taxable local products and services from 10 percent to 15 percent (where the rate had not yet reached this level). 58. With the proposed changes in the foreign exchange and import li- censing systems, the importance of Zambia's tariff and indirect tax struc- ture will increase, as protection will be granted mainly through tariffs. Consequently, the Government has now taken the following further measures which will complete the necessary initial changes in the tariff scructure and complement the reform in the exchange rate regime: (i) all remaining items (about 300) which have a zero import tariff rate, except for a res- tricted list to be agreed upon by IDA and the Government, will be subject to a 10 percent minimum tariff (plus the 15 percent sales tax) with effect no later than December 31, 1985 (Schedule 4, draft Development Credit Agreement and draft African Facility Credit Agreement); (ii) the sales tax, which applies to all imports but not to all domestically produced goods, will be extended to all final local goods produced in significant amounts with effect no later than June 30, 1986 (Section 4.06, draft Development Credit Agreement and draft African Facility Credit Agreement); and (iii) high tariff rates on consumer goods will be reduced from a maximum of 150 percent to 100 percent concurrent with introduction of the auction (Section 6.01 (d), draft Development Credit Agreement and draft African Facility Credit Agreement). To prevent any potential revenue losses from these measures and to avoid overconsumption of non-essential items, additional excise taxes-to be applied equally to domestically produced and imported luxury consumer goods-may be levied if needed on those goods. - 19 - 59. The measures adopted to date constitute only the first phase in the reform of the tariff system. They are designed to: (i) reduce the dispersion of effective protection rates among products; (ii) reduce protection on domestic manufacturers by increasing the cost of imported inputs; (iii) encourage the use of local raw materials, and (iv) increase tariff revenue. As indicated in its statement of industrial and trade policy presented in Annex IV of this report, the Government has decided to establish a Tariff Commission by December 31, 1985 to prepare and carry out a comprehensive reform of the tariff structure and indirect taxes. This would be the second phase of the tariff reform. The terms of reference for the consultant to assist in establishing this Commission were agreed with IDA during negotiations. The reforms recommended by the Commission would be implemented not later than June 30, 1987. 60. Export Promotion. Given the limited prospects for copper exports, particularly beyond the year 2000, Zambia's future foreign exchange availability will depend on the development and growth of non-traditional exports. The export climate already improved during 1983 and 1984 as a result of the recent devaluations of the Kvacha and establishment of an export retention scheme. Also, the changes in the foreign exchange regime discussed above and the expected depreciation of the Kwacha would provide further encouragement to exports. Tn addition, the Government has undertaken, or will shortly undertake, the following additional measures to remove existing procedural impediments to non-traditional exports: (i) the system of export licenses has been replaced by a simple registration procedure; (ii) the existing system of duty drawbacks, which has complex administrative procedures, would be replaced no later than recember 31, 1985 by a simpler process based on average drawbacks for major groups of exports, with the averages to be revised on a periodic basis; and (iii) establishment of an autonomous export promotion board by December 31, 1985, with private sector partic- ipation, to replace the Zambian Export Promotion Council (ZEPC), a Government-run instit-ution that has not been able to provide effective support to exporters. Finally, the Government has decided to carry out feasibility studies for the establishment of an export credit insurance and export credit guarantee scheme, to facilitate the initial export operations of firms that have limited or no previous experience in export markets. The studies should be initiated not later than December 31, 1985, and a program of action would be formulated and adopted not later than December 31, 1986 to implement their recommendations (Section 4.02, draft Develop- ment Credit Agreement and draft Africar. Facility Credit Agreement). 61. Investment Incentives. The Industrial Development Act of 1977, did not succeed in its objective of encouraging private industrial investment, primarily because it did not eliminate the heavy regulatory environment for private investment, and continued to assign to the private sector a role subordih,ate to that of the Government (para. 49). The Government has now prepared a draft Investment Act that is more supportive of the private sector and provides moderate and automatic incentives in the form of income tax deductions and grants for training and R & D for enter- prises that either export, produce with high local content, are located in a rural area or are classified as small-scale enterprise. The enactment - 20 - of the act will be a condition of release of the second tranche (Schedule 4, draft Development Credit Agreement and draft African Facility Credit Agreement). It is to be a radical departure from the 1977 Act in the positiveness of its provisions for private participation. 62. Interest Rate De-Control. In order to permit interest rates to play a meaningful role in mobilizing and allocating resources and avoid the adverse effects that negative real interest rates have caused in the past the Government has decided to decontrol interest rates concurrently or shortly after the introduction of the auction. This would be a condition of release of second tranche (Schedule 4, draft Development Credit Agreement and draft African Facility Credit Agreement). 63. Public Investment Program in Industry. All public investment in manufacturing is carried out by INDECO. INDECO's limited capability to appraise projects and to assess the performance of established enterprises has resulted in many uneconomic, capital-intensive and import-dependent investments and in enterprises continuing to operate even though they were uneconomic. In the past, INDECO did not prepare time-phased investment programs but operated on the basis of a "shopping list" of projects that were then accommodated into INDECO's annual capital budgets on the basis of the availability of foreign and domestic (i.e. Government) financing. INDECO has now decided to prepare 3-year rolling investment programs and has started work on the 1985/86 to 1987/88 period (INDECO's fiscal year runs from April 1 to March 31). A preliminary review of this program indicated a high proportion of new projects for an economy with foreign exchange shortages and widespread capacity underutilization, a high cost per new job created (US$65,000), and several projects with relatively low internal financial rates of return. No economic rates of return were calculated for any of the projects. Based on these preliminary findings, INDECO's management decided to carry out a detailed appraisal, including economic feasibility analysis, of all projects in the program with total costs exceeding US$1 million. The first stage of this work, carried out by consultants financed under the PPF, was completed recently, and agreement was reached on INDECO's investment program for 1985/86. The second stage, to be financed partly under the PPF and partly under the technical assistance component of the proposed credit, would provide the basis for reaching an agreement on INDECO's investment program for 1986/87. This agreement would be a condition of release of the second tranche of the proposed Credit (Schedule 4, draft Development Credit Agreement and draft African Facility Credit Agreement). Moreover, INDECO has agreed to discontinue, by December 31, 1985, projects in the program costing more than US$1 million equivalent that although started have been found after detailed appraisal not to be economically viable (Section 4.03(c), draft Development Credit Agreement and draft African Facility Credit Agreement). 64. Economic Efficiency of INDECO Enterprises. A preliminary review of the economic efficiency of INDECO's existing enterprises was carried out. This review, which produced estimates for 70 percent of INDECO activities, suggested that a number of these activities are likely to be - 21 - uneconomic under any conditions. Also, the economic viability of some other activities is questionable. On the other hand, INDECO does engage in many activities that should be economic. Although these findings are preliminary and additional work is required to refine the estimates, they suggest the need for substantial changes in the operation of existing INDECO enterprises including, possibly, the restructuring of some enterprises and the closing down of some firms and activities. 65. In order to carry out a more complete analysis of the economic efficiency of INDECO enterprises, and to build-up INDECO's capability for project appraisal and assessment of enterprise performance, INDECO's management has agreed to: (i) establish an Economic Evaluation Unit that will apply sound economic criteria for the appraisal of investment projects and the performance of existing enterprises not later than December 31, 1985 (Section 4.03(a), draft Development Credit Agreement and draft African Facility Credit Agreement); (ii) initiate, pending the establishment of the Evaluation Unit, a review of the economic viability and operational efficiency of existing INDECO enterprises; and (iii) commence implementing such Program not later than April 1, 1986 (Section 4.04, draft Development Credit Agreement and draft African Facility Credit Agreement). The review of INDECO enterprises is underway and is being carried out with the assistance of IDA. The review will concentrate initially on the enterprises identified as probably uneconomic and will lead to the submission to IDA no later than December 31, 1985, of an action program to restructure or to phase out some enterprises as needed. 66. INDECO's management is also concerned about the shortage of key skills such as engineering and financial management/accounting for INDECO enterprises. This has led to neglect of regular and systematic monitoring of the technical and economic performance of the enterprises and has adversely affected operations. Warning signals of deteriorating situations are not in place, and the operations of enterprises have suffered. One of the sources of this problem is the INDECO firms' adherence to remuneration packages that are not competitive with the private sector. INDECO has agreed to do a study of appropriate compensation levels and other measures necessary to recruit and retain qualified staff. Terms of reference for the proposed study has been agreed and INDECO has agreed to implement an action program acceptable to IDA on renumeration anid other conditions of service of its key professiona] and technical staff, no later than April 1, 1986 (Section 4.05, draft Development Credit Agreement and draft African Facility Credit Agreement). PART IV - THE PROPOSED CREDIT A. Credit History and Rationale 67. Industrial sector work by Bank Group staff culminated in the preparation of an Industrial Sector Report which was discussed with the Government in June 1984 and distributed to the Executive Directors in - 22 - August 1984 (Report No. 4436-ZA). During this period, the dialogue between the Bank Group and the Government focused on the deteriorating performance of the manufacturing sector and the need for policy and institutional reforms. In this regard, the Government requested Bank Group financial and technical assistance to relax the foreign exchange constraint, to prepare and implement the policy and institutional changes needed to increase efficiency and capacity utilization in the short term, and to reorient industrial production towards increased exports, and greater reliance on labor and domestic inputs in the medium and long term. At the same time, the Bank Group's strategy in Zambia ccncentrated on the preparation of three sector loans, in mining, industry and agriculture, to support the Government's new development strategy. 68. The proposed project was appraised in October/November 1984 and a post-appraisal- mission visited Zambia in February 1985. Negotiations were held in Washington from July 10, 1985 to July 11, 1985 with a Zambian team headed by Mr. F.M. Siame, Senior Under Secretary, Ministry of Finance. This is a combined President's Report and Staff Appraisal Report. A credit and project summary is presented at the beginning of this report and a Supplementary Project Data Sheet is attached as Annex III. B. Previous Bank Group Support to Industry 69. The World Bank has assisted the industrial sector in Zambia through the Development Bank of Zambia (DBZ), which has received two Bank loans (1210-ZA of FY76 and 1923-ZA of FY81) of US$15 million each, and three industrial projects: the Indeni Refinery Modification Engineering (Loan 2151-ZA of FY82), Export Rehabilitation and Diversification (Loan 2391-ZA of FY84) and Maamba Coal Engineering (Credit 1333-ZA of FY83) operations. IFC has made an equity investment in the DBZ (US$544,000, No. 324-ZA) and investments in four manufacturing firms in Zambia: Century Packages, Bata Shoe Company, Nchanga Consolidated Copper Mines and Kafue Textiles. A Fertilizer Restructuring Project, to improve the efficiency of Nitrogen Chemicals of Zambia, is being processed. 70. A Project Completion Report on the first DBZ project, prepared in 1983, found that Loan 1210-ZA financed 47 subprojects with an average subloan amount of US$320,000. Two thirds of the total loan amount were concentrated in five subsectors: chemicals and plastics, textiles, food processing, paper and metal products. The second DBZ project (Loan 1923-ZA) is fully committed and 96 percent disbursed. A total of 24 subloans were approved, for an average amount of US$625,000. The loan's closing date is June 30, 1987. During the implementation of the second project, DBZ's institutional structure continued to improve, but the quality of its portfolio has deteriorated somewhat due to the worsening economic climate in Zambia. The PCR on loan 1210-ZA concluded that the general objective of the project-to help establish DBZ as a sound and viable development finance institution-had been largely met. It also pointed out, however, that the DBZ-financed subprojects were not able to achieve a significant contribution to solve the country's employment and - 23 - balance of payments problems because of Zambia's difflcult overall economic conditions and continuing problems in the country's policy framework. These findings were incorporated into the preparation of the proposed credit, which is designed to support i7portant policy changes. The policy reforms supported by the credit are expected to lead to a renewal of private industrial investment in the medium term, both in rehabilitation and in new enterprises, and future Bank Group operations in Zambia would be expected to include further resources for investment to be channelled through DBZ and, possibly, other financial institutions. C. Credit Objectives 71. The proposed project's objective is to increase industrial output in the sub-sectors and firms that can produce efficiently and to help reorient manufacturing activity towards exports and greater reliance on labor and local raw materials. The proposed project would support policy and institutional reforms in several areas where the Government has already initiated changes or where the Government and the Bank have identified the need to change existing policies. At the same time, it 'Tould provide part of the foreign exchange resources necessary to increase output and capacity utilization of the existing efficient enterprises, and would provide technical assistance to improve the performance of public manufacturing enterprises and to evaluate their investment program for 1985/86-1987/88. The Zambian Government has shown the willingness to carry out a measured, but wide ranging, policy and institutional reform program, designed to bring about the economic adjustments needed to stabilize and restore economic growth to the economy. 72. In the context of the preparation of the proposed project, the Government and the Bank Group have reached agreement on development objectives for the manufacturing sector and on the most appropriate strategy to achieve them. These understandings are reflected in the Government's statement of industrial and trade policy, presented in An-ex V of this report. The specific policy changes to be supported by the project have been the subject of extensive discussions between the Bank Group, the Government of Zambia and, where appropriate, the IMF, and have already yielded tangible results. Two major policy changes (introduction of an auction system for foreign exchange and elimination of the present system of import licensing) that would substantially increase the reliance on market mechanisms for allocating resources would take place before the proposed credit becomes effective. Other policy changes would be taken concurrent with the above or in the immediate future. The main features of the poltcy reforms supported by this project are summarized in the form of a matrix on pages 24, 25 and 26. MEY OF meiRt UJM4M FM DEMtIAL -O TDID (1 DQUaIEFAT[ I_ aswe l9Sn other .Bm In 1965 1. n!o n~etfI Obj ctive: lb establiah a Dwaluatiou In 1983 and 1984 Ebtablidsnt of aiction Tore i exdwtp relgi that (23 percnt in rea tons). sytt for focetip eF will: (1) repin extermal Oalivg peg In late 1984 and (8/85)* (pra. 53). equtliritsu (ii) allocate early 1965 (pan. 43). hp l an a of prg of foreeiio exhap efficiently; ttitm to 4qICS fo_min asd (Ii1) eraurw exportt ad hptitg of fogia and efftcient t4port _a* (pre. 5I). substitution. II.Aport am nm!q 1g llidnatitoof pcnt IqIt lltcmu roti (8/85)* Objective: lb nereme (pra. 56.) efficienry a cubrd ortentation of Zmbai Elliunatlat of all ipwt irAi&trial sector (and pedibitiau for protwctFv owerall ecwa ).pupainm (abou 50 Item) (8/85) (pail. 56).* tbtabl of 10 prwt 11nlu taritff of 10 perwt tariff en 15 puat tat on an lura mmbn of Inpits xinid tt (12/85*) (10/84) (pra. 57). (pra. 35). Eliuination of emqptoaai ad Ihda tariff rate rewd Rlather tariff rictlas and rebates of lqport dutti an frtc 150 to 100 parot (8/85) dw*ms awast14 fra Mliff 1aw.V muter of Inputs (1/85) (par. 53).* Obdhon rn datt (pana. 57). (pa 59). S4ilificatio of export fltium of 15 nabs tat to lsitrg (tration) all fizul dtic gob Wotan (Pira. 60). prod in UiwfiLcut quatitim (6/86) (pan. S). *idition of effectivet **Iition of relem. of tl tmunI -25- } s §- a ] tS f l E t i i~~~~~a 3 §~~~~1 I sXjX1 kcS~~S I._ t .5 ~ ~ g'i iIg ~~~~~~~~~i 8 ! I_Nr Takelin Other NBiutsin 1915 Dz.i 196 IV. PUblic Sector hwinut mr batrpr1s O tIetth i tncreme Initiate reviw of etuic Eatablialent of Eommc n o the t m ad efficiency In now public viability of BUM WbaluatL Udit at D1020 coaition of IMU0's tnvene t ad rattalzie enterprli with Mt (12/8S) (pas. 64). int PE- for die operatilm of e3datltg aaistare (5/85) (pjra. (A). 19ff6/87 (ar. 63). public aindtrial siterpriem. hnrm~t an the awmt ad All Innstt projects aboe eaqioltion d DI5's W$1 million faud not viabl Inveesbt pIng for 1965/86 to be diawtiml (12/85) (pan. 63). (pa. 63). Saledt to Mt action prgrm Gu , by4 Atl 1, 1986, to ph t enterprise fan! qamlmiri of aactia clely nm-vable adP pDrom to pem mt atn tbase those Wkaly to be am-Aable enterpdm wA to viAble (12/85) (per. 65). retnrture tl lDlly to be viable (pja. (6). Tpl_z,!t Actiom ktE ao _nutun f lNE= staff (4M6) (pra. 6). * Odition of effectivaa O* Odition of meleae of the seciu tranhe. - 27 - D. Project Components 73. The proposed operation will total US$62 million to which IDA will contribute US$20 million and the African Facility US$42 million. Special Joint Financing of 10 million pounds sterling (US$13 million equivalent) is expected to be provided by the United Kingdom for the project. The IDA and African Facility contributions will respectively finance the following components: African IDA Facility US$ Million US$ Million Total (i) Financing of imported spare 17.8 42.0 59.8 parts, raw materials and other productive inputs for industry; (ii) Technical assistance to 1.8 - 1.8 INDECO, the Ministry of Commerce and Industry, the Ministry of Finance, and BOZ (iii) equipment and vehicles 0.2 - 0.2 (iv) training 0.2 - 0.2 20.0 42.0 62.0 The proposed credits would be made to the Republic of Zambia. The funds allocated for the industrial imports component (US$59.8 million) would be sold by the BOZ through the foreign exchange auction system, while the funds al'located for technical assistance (US$1.8 million), equipment and vehicles (US$0.2 million) and training (US$0.2 million) would be made available on a grant basis, to INDECO and to the BOZ. Xvacha received from the sale of the credit proceeds would be remitted to the Treasury for general government purposes. Industrial Imports Component 74. The purpose of this component of US$59.8 million (about 96 percent of the credit) is to help efficient enterprises in manufacturing operate at higher levels of capacity utilization. As they bid successfully in the auction for foreign exchange, they would use the credit proceeds to import raw materials, spare parts and other inputs for their operations. Overall capacity utilization levels for industry are expected to rebound modestly, i.e., from less than 45 percent in 1984 to about 55 percent in 1986. Given the expected low ceilings on total domestic credit and on credit to the public sector, as well as the continuing foreign exchange shortage, only efficient firms with good sales performance are expected to be in a position to purchase foreign exchange. Hence, while overall - 28 - capacity utilization is expected to increase only moderately in 1986, above its low level in 1985, a different, improved distribution among subsectors and among firms is expected to emerge because of the new, market-determined exchange rate and allocation mechanism. 75. The Zambian Government presented to the Consultative Group Meeting in May 1984 estimates which showed that in order to meet domestic demand and increase capacity utilization the foreign exchange resources available would fall short of the industrial sector's requirements by about US$100 million in 1985 and by US$120 million in 1986. The estimated gaps were based on expected copper prices which were higher than those now projected for 1985 and 1986. Also, capital inflows have been less than previously expected. Against this background, Bank staff estimate that the sector's requirements for foreign exchange to achieve a modest increase in capacity utilization rates will be about US$240 million in 1985, rising to US$260 million in 1986. Allocations from the country's foreign exchange receipts have declined from over $200 million per annum in 1981-83 to an estimated US$140 million in 1984, but it is not likely that even this amount would be available in the next couple of years. Thus, the unfinanced gap is likely to approach $150 million per annum over the next two years, and the amount of the proposed two Credits of US$62.0 million, alox-g with the Special Joint Financing from the United Kingdom, would cover about 50 percent of the gap during the first year. Also, the African Development Bank has expressed interest in providing about US$30 million in support of the objectives of the project. 76. The proceeds of the industrial imports component would be added to the foreign exchange pool available for auction and would thereby make additional foreign exchange resources available to manufacturing enter- prises. While the auction would make foreign exchange available for the importation of a wide range of goods other than inputs for industry, disbursements from the proposed credit would be made only to reimburse against imports of goods for the manufacturing sector. BOZ would be responsible for the overall implementation of this component, including the submission of withdrawal requests to IDA. Technical Assistance Component 77. The second component for US$1.8 million (about 2 percent of the Credit) includes technical assistance to INDECO, BOZ and the Ministries of Finance and of Commerce and Industry. This component is of critical importance as it would provide technical support for the policy and institutional reforms to be undertaken by the Government of Zambia in the coming years, particularly in the areas of public industrial investment and public enterprises management, reform of the foreign exchange regime, tariff and tax reform and export incentives. The draft terms of reference for all tasks under this component have been prepared and were discussed and agreed during negotiations. Specifically, the main elements of the component are as follows: - 29 - Ci) 142 staff-months of consultants' services to help Improve INDECO's capacity to appraise investment projects and evaluate and improve the performance of existing enterprises. This includes 24 staff-months of short-term consultants' services--four staff-months of which are financed under the PPF-for an assessment of the economic viability of projects in INDECO's investment program for the three-year period 1985/86 to 1987/88).The total estimated cost of this component is US$1.4 million. (ii) 21 staff-months of consultants services to help BOZ improve its capacity to forecast and budget foreign exchange and provide on-the-job staff training in this area; this includes two staff-months of consultants' services provided under the PPF to begin this task. The total estimated cost of this component is US$280,000. (iii) two staff-months of consultants' services under the PPF to help the Ministry of Finance establish the tariff commission, drawing up the terms of reference and work program of the Commission, and identifying its staff requirements. In addition, three staff months would be provided to assist the Ministry of Finance to simplify the duty drawback system and to identify areas for expanding the coverage of the sales tax. The total estimated cost of this component Is US$70,000. (iv) four staff-months of consultants' services (to be provided by the International Trade Center) under the PPF to help the Ministry of Commerce and Industry establish the export promotion board. The total estimated cost of this component is US$50,000. A total of 12 staff-months of consultants' services, costing US$160,000 would be provided under a PPF now in place. Equipment and Vehicles 78. This component includes the provision of a small amount of equipment and some vehicles to assist with the establishment of INDECO's Economic Evaluation Unit. The total estimated cost of this component is US$160,000. Training 79. The Project would finance about five man-years of training to assist INDECO to strengthen the economic evaluation work. The estimated total cost of this component is US$240,000. 80. UNDP/UNIDO have expressed interest in providing US$439,000 to finance part of the program for INDECO. Assistance to INDECO's proposed Economic Evaluation Unit and the purchase of some vehicles and equipment have been suggested for UNIDO's consideration because they are discrete components and fit the amount earmarked by UNDP/UNIDO. Should the - 30 - UNIDO-executed UNDP project finance these elements of the Technical Assistance component, the correqponding amount under the credit would be reallocated to the industrial Imports component. E. Procurement and Disbursement 81. The proceeds of the US$59.8 million component for industrial imports would be disbursed in two tranches of US$40 million and US$19.8 million, respectively, and are expected to be disbursed over about an eight-month period at an average rate of about US$8 million per month. The first tranche would be available upon effectiveness. The second tranche (Schedule 4, draft Development Credit Agreement and draft African Facility Credit Agreement) would be available about six months after effectiveness, or about February 28, 1986. Disbursement of the second tranche would be conditioned on a satisfactory review of progress on the policy reform program, as described in the Government's statement of industrial and trade policies, including; (i) agreement on the size and composition of INDECO's 1986/87 investment program; (ii) adoption of a x-ew Investment Act; (iii) implementation of a program of action to imnrov' forecasting and budgeting of foreign exchange, (iv) establishment of 10 percent minimum tariff on remaining items, (v) export duty drawback simplification, and (vi) interest rate decontrol. 82. Industrial Imports Component. To facilitate disbursement and procurement under the industrial imports component, two special accounts would be established in BOZ, one for the IDA credit and one for the African Facility Credit (Schedule 6, draft Development Credit Agreement and draft African Facility Credit Agreement). After credit effectiveness, an initial deposit of US$14 million would be made by the African Facility and US$6 million by IDA to the respective special accounts. These accounts would be replenished on a regular monthly basis.With subsequent replenishments made on the basis of statements of expenditure the BOZ would certify that the credit proceeds were used for eligible expenditures. These accounts would be reolenished on a regular monthly basis. 83. The proceeds of the credit for this component would be sold to successful bidders at the auction-determined exchange rate. Enterprises can be expected to procure their materials and spare parts from the most efficient source and to minimize costs; consequently, only items costing in excess of US$2 million would be procured by procedures that include broad international tendering among suppliers. Expenditures covered by the IDA credit would be in accordance with usual IDA rules while expenditures covered by the African Facility Credit would be in accordance with the resolution establishing the Facility, i.e., for goods produced in, or services supplied from, the territories of any Part II member of IDA, Part I members of IDA who have contributed to the African Facility and any country which maintains arrangements with IDA for Special Joint Financing in accordance with the Resolution establishing the Facility. Disbursements would cover 100 percent of the foreign cost of the imported inputs and spare parts. - 31 - 84. Technical Assistance, Equipment and Vehicles, and Training Components. The selection of consultants under the technical assistance component and the terms and conditions of the consultants' employment, as well as their qualifications, would be satisfactory to IDA. Disbursement from the funds earmarked under the credit for these components (US$2.2 million) would cover 100 percent of expenditures for consultant services and training and 100 percent of the foreign cost and 75 percent of the local cost of equipment and vehicles. The procurement of equipment and vehicles would be carried out on the basis of local competitive bidding, in accordance with procedures acceptable to IDA (Schedule 3, draft Development Credit Agreement). 85. Disbursements under these components would be fully documented. However, purchases costing US$100,000 or less under the industrial imports component would be on the basis of statements of expenditure. These statements will be periodically reviewed by auditors (Section 4.01(c), draft Development Credit Agreement). 86. Accounts and Audit. The accounts to be maintained by the Bank of Zambia under the proposed credit would be audited by auditors acceptable to IDA and certified copies of the relevant audited accounts would be submitted to IDA (Section 4.01(a) and (b), draft Development Credit Agreement and draft African Facility Credit Agreement). A set of audited accounts would be submitted in time for the release of the second tranche and another at the end of disbursements. F. Benefits, Risks and Justification 87. The proposed credit, through its support of the policy and institutional changes discussed above, would help increase the efficiency of Zambia's manufacturing sector and would lead to improved allocation of resources in the economy. In addition, the increase in the availability of foreign exchange in 1985 and 1986 would allow the more cost competitive among existing industrial enterprises to operate at higher levels of capacity utilization. This impact would be expanded if, as expected, other international agencies and bilateral donors agree to provide parallel financing. The resources to be provided by the proposed credit would prevent a further fall in industrial capacity utilization, and would allow, in 1986, an average level similar to that of 1983, i.e. about 55 percent but with an improved distribution among subsectors and firms. It would also allow the maintenance of the level of employment and output in manufacturing which would otherwise fall. After 1987, the beneficial impact of the new policies, particularly the new foreign exchange regime, is expected to result in further increases in output and, most importantly, manufactured exports. Without the proposed credit and the reforms it supports, the level of capacity utilization would continue to fall, employment and output in the sector would be further reduced, and linkages to the agricultural sector would diminish. GDP would continue to decline, resulting in further hardship for the Zambian population. - 32 - 88. The proposed package of policy measures, together with the expected improvements in the efficiency of public enterprises and the rationalization of the public investment program would eliminate long-standing distortions in the economy and provide powerful incentives for the reorientation of manufacturing and other productive activities (e.g. agriculture) away from their historical inward-looking stance of producing primarily for the domestic market, and towards exporting manufactured and other goods that Zambia has not traditionally exported or has exported only in small quantities. The eliminatior of the over-valuation in the exchange rate, the liberalization of the interest rate and the withdrawal of duty exemptions on many imported capital goods and raw materials would provide incentives to increase the use of labor and domestic raw materials, and to reduce the sector's dependence on imported capital goods and inputs which require scarce foreign exchange. Within the Government's ew industrial development strategy, the improved macroeconoa..c policy environment, together with the new Investment Act, are expected to lead to increased private sector investment in efficient import-substitution, as well as export-oriented, industrial activities. Finally, the expected gradual improvements in the performance of public industrial enterprises (the INDECO Group), including INDECO's investment program, would increase the productivity of the sector. Thus, the net effect would be to turn Zambia's industrial sector into an important contributor to the solution of the country's economic problems rather than being one of the sources of the crisis as it has been in the past. 89. The aggregate impact of the project on income and welfare levels in expected to be positive. Aggregate employment levels in the economy are expected to be higher under the proposed credit than in the absence of the program, since: (i) the reforms will eliminate biases (in the exchange rate, interest rates and tariffs) which have encouraged the use of capital and discouraged the use of labor; (ii) a more productive use of resources in the economy will result in higher investment and GDP levels than otherwise; and (iii) the additional availability of foreign exchange from this credit will result in higher capacity utilization. Overall income distribution is also expected to improve under the proposed program as a result of the higher employment levels and of the change in the internal terms of trade in favor of the heretofore relatively unprotected agricultural sector. Welfare levels are therefore likely to be higher for the average Zambian and for the lower income population in particular. The main social costs are likely to include price increases as a result of the expected depreciation of the Kwacha, and an increase in unemployment in the short run for some inefficient, overprotected industries, and real wages may continue to fall in the non-tradeable goods sector, which may generate social and political pressures from segments of the urban middle-class. However, price adjustments already took place during 1983 and 1984 following the price liberalization, and the overall income and employment gains in the tradeable good sector, and in the efficient industries in general, are expected to more than compensate for the economic losses in some subsectors. - 33 - 90. Zambia's stabilization and adjustment process is now at critical crossroads, with the short-term costs and benefits already being felt, but with most of the expected long-term benefits not yet visible. In this context, the risks of the proposed credit, and of the adjustment program with which it is associated, relate to the uncertainties about the length and the severity of the current economic crisis in Zambia, and the Government's ability to withstand the social pressures that are likely to be generated against the continuation of the reforms. Several factors make taking this risk acceptable. First and most importantly, the Government has already shown, during the past two years, its commitment to the reforms and its ability to carry out the necessary measures, including some politically sensitive ones. This includes a major price liberalization, gradual successive devaluations followed by the decision to establish the auction scheme, major reductions in the public sector deficit by reducing subsidies, increases in interest rates and the recent improvements in the tariff structure. Secondly, the prolonged nature and severity of the current economic crisis has helped create a national consensus in Zambia that there is a need for change. Thirdly, the continuing progress in the policy reform process-which is already more than two years old-is expected to start 'turning the tide' in terms of spreading the benefits of the reform in the near future. In fact, the rapid growth of non-traditional exports-although from a very low base-in 1984 is already an indication that the supply response of the Zambian economy has started to produce positive results. And, last but not least, the risks of reversing the adjustment process are directly reduced by the proposed project because the relaxation of the foreign exchange constraint would allow the structural transformation of the industrial sector-and, indeed, of the overall economy-to take place at a lower short-term cost in terms of lost output and employment. Bank Group staff will closely monitor progress in execution of the measures and will use the tranching mechanism to reinforce the policy dialogue. Following the expected satisfactory completion of the proposed project, additional stages in the ongoing policy and institutional reforms would be supported through subsequent credits in the sector. PART V - BANK GROUP OPERATIONS IN ZAMBIA 9i. Since 1956, the Bank Group has made 28 loans and 14 credits to Zambia, totalling about U$780 million (net of cancellations). Two additional Bank loans were made to Zambia and Zimbabwe jointly to finance shared power facilities on the Zambezi River. Fourteen loans and six credits have financed energy, transportation, communications and rural water supply projects. Four loans and one credit for education have helped expand Zambia's secondary and higher education systems, teacher training, and commercial, agricultural and technical education systems. Two program loans have helped Zambia maintain its development program in periods of severe economic dislocation. In agriculture, forestry and fisheries, six loans and six credits have been for industrial forest plantations and wood processing, livestock, commercial crops, integrated family farming, coffee production, smallholder dairy development and fisheries development. Agricultural projects in the Eastern and Southern Provinces are assisting - 34 - smallholder farmers, and an Agricultural Rehabilitation Project is providing inputs to the sector in support of policy reforms. Other loans havb assisted Zambjia's urban development program, copper mining and, through the Development of Bank of Zambia, its manufacturing, agricultural and industrial sectors. A technical assistance credit is helping the Government improve its planning and project preparation. 92. The International Finance Corporation (IFC) has invested about US$85 million in eleven projects in Zambia since 1972. Two investments were in shoe manufacturing, two in a packaging materials plant, two in textiles, and one each in the Development Bank of Zambia, cobalt production, copper production, tourism and in food and food processing. 93. The implementation of Bank-assisted projects in Zambia has deteriorated significantly in recent years, and serious delays have been experienced in the execution of a number of these projects. There are several reasons for this, the main one being the lack of budgetary resources with which to finance local counterpart expenditures and to prefinance local expenditures which are subsequently to be reimbursed by the Bank loan. Most seriously affected have been the Bank's agricultural projects for which funds, although budgeted, have not been released to the executing agencies for several months. Other reasons for the lagging implementation of projects are ineffective project management and inadequate inter-agency coordination. The Bank-assisted agricultural projects, which require careful management and effective coordination due to their complex design, have suffered from these problems, as has the Third Highway Project. 94. The deterioration of project implementation has, as expected, substantially reduced the rate of disbursements on Bank Group loans and credits. During the first four years of the period FY77-81, the disbursement rate on loans and credits to Zambia averaged slightly over 25 percent per annum, higher than the Bankwide average of 21.2 percent, or the 21.5 percent average for the Eastern Africa Region, and well above the 22.2 percent for Tanzania, 23.4 percent for Senegal and 20.2 percent for Bolivia. In FY81, however, the rate dropped to just over 16 percent, compared with 20.7 percent Bankwide, 16.5 percent for Eastern Africa, 23.6 percent for Tanzania, 20.8 percent for Senegal and 21.2 percent for Bolivia. The rate has risen since FY81, reaching 20.1 percent in FY83, which was slightly below the average for the Eastern Africa Region (20.7 percent) and for the Bank overall (20.8 percent). To alleviate the problem, provision is being made for technical assistance in projects to strengthen implementing agencies and increased use of the Resident Mission in monitoring project execution. Revolving funds are being established under new and ongoing projects which should ease the Government's financial burden and accelerate disbursements. The Bank or IDA makes advance deposits into these funds to eliminate the need for prefinancing by the Government of local expenditures financed by the Bank/IDA. In addition, estimates of counterpart funds required and when the funds should be made available are being prepared by Bank/IDA staff well in advance of their - 35 - need to allow implementing agencies as much lead time as possible to plan for these expenditures. As of December 1983, IBRD loans disbursed and outstanding were about 12 percent of Zambia's total medium and long-term debt disbursed and outstanding. 95. The Bank Group's strategy in Zambia is to support the country's efforts to diversify and increase economic efficiency. Raising the efficiency of the mining industry through the Export Rehabilitation and Diversification loan so that the industry may contribute resources for diversification programs was the first step in carrying out this strategy. Subsequent operations, such as the recently-approved Agricultural Rehabilitation Project and the proposed project will focus on improving sector policies in agriculture and industry, which are, respectively, the sectors with the best potential for production and export growth and for employment creation. The Group's strategy also gives priic-rity to programs to increase the use of indigenous energy resources and to ratse the efficiency of transportation services. Emphasis will be given to rehabilitation and maintenance, rather than expausion, of infrastructure and Bank Group assistance is expected to include a significant proportion of quick-disbursing resources. Support in addressing the longer-term development constraints, e.g., improving economic management, education, population, health, etc., is also part of the strategy. Policy and institutional reform programs in each of the sectors, as well as on the macroeconomic level, are being agreed with the Government. PART VI - LEGAL INSTRUMENTS AND AUTHORITY 96. The draft Development Credit Agreement between the Republic of Zambia and the Association, and the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement of the Association are being distributed separately to the Executive Directors. 97. The draft African Facility Credit Agreement between the Republic of Zambia and the Association is also being distributed separately to the Executive Directors. 98. Special conditions of the project are listed in Annex III of this report. The following conditions for credit effectiveness would apply: the Government (a) would initiate the operations of the foreign exchange auction system; (b) would eliminate the present system of import licenses for all goods and participants in the auction system; (c) would eliminate all import prohibitions for protective purposes; and (d) would reduce maximum tariff rates from 150 to 100 percent. 99. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. 100. I am also satisfied that the proposed Africa Facility Credit would comply with Resolution No. IDA 85-1 adopted on May 21, 1985 by the Executive Directors of the Association. - 36 - PART VII - RECOMMENDATION 101. I recommend that the Executive Directors approve the proposed Development Credit and the African Facility Credit. A.W. Clausen President Attachments August 20, 1985 Washington, D.C. -37 ANNEXI Page 1 of 6 am" (LSU VJ4) AL on (no aim £ !As AL. U=in.a Eam iNrni im In1 1 Simla All=Aifi . ON Sla N. IVUCA & KU 1*8 TM . 6.6 75L3 75326 * usim.me.* 1.ur 401.s. cm .. .. u Ia 1169 CuaLMn W OIL Nlm Oa .. 3LO "S.o 561.5 63.9 WMAUMM,UM CtM ) 3111.0 6159.0 6290.. VM umuof (Swm a w 17.2 50.1 6. 35.0 19.0 wMUN U WA 200O Ca1 U1.0 0OP0u =0in 1i cow 33.0 VlA N 2.0 . 13n. 0.. 1.2 L. 6.3 63.1 37.6 Ml _S Uk Nh. A 7.9 10.4 15.1 121.4 470.1 0-11 us 15.0 46.1 U.3 43.1 43.5 1541 Us 52.5 51.3 49.3 51.3 33.0 ISIUDASE .4 2.5 2.3 2.7 3.3 aouM ms am t STO 2.5 2. 31 2.9 LA MUM 9.1 *. 6.2 *.1 4.4 KmRU muE (Nu 10003 49.6 49.0 30.0 47.0 40. =lull Mm (m TM) n2.4 16.7 1.0 15.0 11.3 mIlinU bI33 _ am 3.2 3.3 3.3 3.2 2.L _am w . Os MB. m m (1969-7b1.200 99.0 96.0 95.0 62.9 33.1 m Cm "aGwtzLe nAo ao *. R9b canuin (ISV fr U h) 100.0 9.0 KA1.0 9.5 U11.2 1Us _ CUI Em ) GSA 60 56.0 3.4 7?.6 or IUM anu. 3 901m 14.0 16.0 1.IC 16.3 17.6 mu (MR I-) SW ua 31.6 5.2 19.0 1I.4 12.1 LIV MUM. At KM CUM) 41.7 463 30.5 0SLO 57.3 llir o. an (.3W=.) l51.S 123.0 100.0 106.9 96.0 AiM% 20 SM lAW (DOI) .. 37.0 6 j42.4 67.2 URBA. 70.0 67.0A T 7.5 33.4 Ram .. 22.0 "6.4 35.8 45.8 TM .. W 40.0 2.9 15.9 UI .- 12.0 40.0 o37.7 3.0 N .. 1.0 40.0A 2.7 26. 109 El m iSo3U 92 304 6140.0 7670.0 J 11791.7 131.0 PM. El VMW.O SM 320.0 L. 262L0 1220.0 Jje 2,39.6 1645.0 PM. E 110h?F .m TUE 360.0 M00. 210.0 A 991.1 621.6 ION 160.0e .. 36 36.8 33.0 KUE. 470.0 24 4371.9 2311.3 U_5tI e W !L. .. .. 31.0 27.2 25.7 TOTE . 4.4 som . .n. .. .. RuE .. ..... &umam 30. o FIXONMISO TOE .. 2.6 .. .. - . TML . RUE~ . .. .... . 31o 9 Elu.a Wm m=r. T . .. ..... mEN 2.S ..... RUE~ . .. . .*... -38- ANNEX I PaRe 2 of 6 uaeaU - SOCIAL IEDOrCATORS DATA I wintm IOOTS (SlRtTD AVERAGES) NOIS (No( RM r ISTIArTE) Ib i,@L?.T NICOLE 110C5 NIDOLS Ir 19OLlb lip7db *STIIATIt? AMCA S. OF SAdARA P. AFUCA A MID CS ADJUStw CIlNOUNT RATIOS PRIA. rotTA 42.0 89.0 19.0 A 95.7 69.8 NAtE 51.0 99.0 102.0 7d 100.0 103.7 FIDALC 34.0 79.0 90.0 83.2 75.2 ScoNAtT: ToTAL 2z0 13.0 17.0 /d 17.3 *2.3 NU. 3.0 17.0 22.0 25.0 50.9 rEtAL 1.0 8.0 12.0 id 14.0 34.6 vocAToNAL CZ oF SECONOD) 27.8 3.2 2.3 /d 5.9 10.0 PUPIL-TLAOR RATIO MIDI 50.0 47.0 46.0 /d 41.1 29.7 SIWIDART 14.0 22.0 22.0 w 25.5 18.8 _- PASSUNM CASS/TROUSAD FOP 10.4 14.5 1B.7 l 20.8 17.8 RADIO CIYUS/U0OUISAD OP 4 f. 18.0 26.5 107.8 175.9 TV REcxrRISItrOSAKD POI .. 4.1 12.4 20.8 51.2 fuPAP ("UALY CGOR INeRISlT") CIRaIA tON FZn TSnauM POFULtASO 5.1 13.7 18.7 18.4 37.2 CtHU A18M. A5SuDANCZ/CAFrIA .. ..OJA 0.4 2.4 trrAL AOR maPCZ (CNOoS) 1293.0 1621.0 2168.0 7Phz CiaUcEiI) 33.3 32.6 33.0 3t.2 il.o ACwsLrEt (PcLC T) 79.0 73.0 67.0 /d 54.5 42.4 IDhSThIT (PORCsIT) 7.0 9.0 11.0 4 133 27.9 PARTICmn RATEZ CFRIfNT) TOTAL 41.2 39.0 34.6 36.8 26.2 MALI 55.3 52.9 47.5 47.1 46.2 FER AE 27.3 25.2 22.6 27.2 5.8 cozwOumc DMCTADBWF WWZO- 1.2 1.2 1.5 1.3 1.8 - - P TRC OF fIWAS INCOM ocawr s5 air guuouas 33.7 23.0 . Hszin 203 or OeUSUOLDS 58.2 6347 58.7 A LOOS? 203 or toDstiniS 5.4 3.871 3.8. LERST Afor 0o SO 13.0 10.11 1.1.A mn - - LEVEL CUS ER CPIA tSTD AU60U15S PO0 DINCK -|-tC (95S P CtXW URIS .. .. 247.0 590.7 22b.3 URAL 168.0k 275.3 134.0 £srmnnM REATi Penn tcu LtVE (U58 PE CtTA) URM .. .. 126.0 545.6 431.5 EZRA!. .. *. 85.0 . 201.1 32e.0 tS SM Pce. stl ABSOLT FOVU NT iCom LIVE. CZ) UUUS .. .. 2U.0, . . WRIt .. *. .. .. 29.0 Mr AP?LICAE.E M0 TES .a Th grop curep for each lnflcator are populatlalgtud aulthetle mans. Cver. f er SNOW the lndaestoru depnda on aval blty of data 1a is not mteforu. lb learo othamia noteed "Dsta for 1960" refer to y year hamene 1359 and 1961; "Data for 19701 human 1989a 1971; and dta for "tut Recat atls_te" humwn 1981 ad 1983. s 1977; /d 1380; t 1979; _f 1963; A 1978; Ab 19781 L 1982; .J 1973. JUNL. 1985 -39 ANNEXI _ ~~~~~~~PaRe 3 of 6- bai ii. m tis jib..urib of munbgc inm J.rW b d bu nm uin 0et s oO u.mm omd O COO 1d __W dl_h WA ,_ ARMabual mdu1 s Siimkmb ia)n pam AaIl&t ib #whme w-mbeo ivem ' in u On euym aTdz&baobI nam comprbib.bb h ~tuumambsing biD madilWwtx prdaimu fmid-ympmhaimadom; lUi 97. bW 19ummdu. Tabi-oml srfac -o copuimdn landea and iopnlad otrs per thousd of mid-yin popuhtomu 1960.1970. and 1963 data. emaelyfor aopi pagtr. market and kuhen pardm or to Gm k -AmWa nmer of daughtes a w aeu lie ra.w190 1970 and IM6 daue. wilh Iw h oranmal upenduwi period if do zpi. GNP PME CAPrrA (UiSI)-G per apt itmtm a tmcsrrent in 1960,970 mad 1963. madket pen.. calcultsd by same coavemon method as WbFU A ~ ( ) ala . Boat ArIa (196143 !ui)1963 dAta.d*a I add do-oWsm KXJUGY CGGSVWPION PMR CAbA-odayppra pbf pmuau conumpzion or commnerdal piay emer (coalad AMignite. 1v P U'5 r Vammu j- hepe petoleum. natural aSu and hydro-. nucea and geotmmerl dec- tap o amareim ati m ordhid-bd.1& agp who are pmtgor tricty) in kdlogrms of oil equivalent per capiuza 1960. IM70 and whame usbands ass prcid my form fcouetrcepion..oe 1982 data. of child-beriaemsarsegeneenlly oen- apdis5.49.altoghror some countries contracetv MP is meaured for othor BP POPULATIONV AND VITAL SrATWSFIC group. Tod Fig .h ku MU-Tmw (uh.uom) ---As of July 1. 1960.1970. FOOD AND NIRO ad 1913 date.. (fib h,upmk (pwem of ian.g-Ratio of urban to total AWKf^ INIdPFdpMjO4- )-lniesof`ws mpia aemiel peodustm of al fand qapsoedkiti. ftodumi popuhtaoecdifferent deluntions ofurban area may affect camper- iealdade anima feed and mmd for agricvWts Food coimmodis. ability of data, among couatuims 1960. 1970. and 1963 data. inhd.bpns , w, o" (e.g supc m d of samps AlI I Pi kas which anreudible and contain nutrint (e.g. coffe and ien ans Ppubrise yew w20-TIM peimetb of popultio for 2io exduded they compriss cmds. rnt amp, gib. aid meds. made for each economy separately. Startin with informaton on vegetbles hits nuts.apua n sugarcn w bumu livesoc, and toa popujatio by ae and sex fissilty ratm mortalty raes, and livesock products. Aggregae producio ofreach counay is based imntentonal migrationi the bary r 1960. them parammsmr on naional averap producer p.m wdahts 1961-ES. i970. and wan projcted at five-yea int-val on the basis of puealimd 1IM data. auumptioes until the populatioabceme statonar.-qe~up'm jc.n Siakuari y populixtire-ls amin whbich agp and sem-pai mor- ad from celd equivalen of net fodsupplie avallbkalein munty utay rate have not changed oveta lon peniod, whil age-sepcil5c per copota * day. Avilbe uple compris doumuc produc. fertility rate have smuluataouly remained at replacemen level d zion. mpo km eports anid hagmin stoc. Net supplies (ce reproductio raze - 1). In such a populaton the birth ram is exclude animal feed. snds for uwein agricbultr quanutite used in constant and equal to the death rate, the age structure is als food peooinda and losses in distrbution. Requirement wmes constant, and the growth rate is wo. The stmatioay populmaio esdtimsd by FAO basd on physiologialneds for normal activit sue was estimated on the basis of the projete charaducteris of and health consdering environmental tenerature body weights thepopltionintheyer2 andtheraeofdeci offertity ged se dtbt of popuaton dalowin 10pectf ra to relaeme leel waste at houhod level; 1961. 1970 and 192 data. P,pwdimu Momeaam;*-l the tendenc for populati growth to f S*l.u gmumlPoencneto cont6nue beyond the din that repincement-level fettalit has he percuisa p yorfood parday. Net supplyoffood isdind. adhieved that is. even after the net reproduction rat hasRce as above. Requirements for all coiu- miablimed by USDA unity. Mhe momentum ifa populatio in th yer tpi meszud b, proviefor- mime. .b of`60Sgrmsorsotalprteinper a ratio or te 1um .ai y p lt to the popubi oni day and 20 warn anima d pid pmei. ofwhic 10 gramse the year r. given fth asmmptm ia th?rtility remains at reparn sould. he anmal protin 7be atandzs.bare lovaerdhn thoe of cn eve from year t onwad. 1985 data. 75 puma of tDa prti and 23 gS or animal prot as an papwwdm DOMoky ampn do teod. propoe by FAO in dt Thid World Foo Aw a0m.-Mid-year population per squas kilomet (100 bin- SPr 16. 1970 and 1912 dat. a. tam) or total ar 190. 1974. and 1983 data. PwCa h _sk S vru AmWinEhh -Protein supply Per sqiaw. ckset>wa Lud-Computod a aboe 'or agual offood ve fhom a lan nd p singramsperda 196145. ladrony. 1960. 1970. and 1912 data. 1970 and 1977 duam PApdmd.. Are LMalrre (pircuO-.Chidrven (0-14 year). work- CUW(qr-4w ) DeerhA.(pwr Emd)--Numhe ofddeahsof ingsagO(1.65year)s). andretre (65 years and over) as pmmp childen agpd 1-4 year per xhousad childen in the sLme age of mi&y-ar popuato 1960.1970. an 19 data. gop is a iven Yar For mot deveoping contr dam deived pu Gwrh A.. (pvcwar-t umuai growth Cato of frm life tble 1960. 1970 and 1963 dat. totl mid-year pop" inor 195040. 90-70, and 197043. HLALM _ Gemr Awe cm) wm %Aual gowth ran LVR Eqrermep a fu nm)-Number of years a netborn of urban populAtion for 195040.196070. an 1970433 data, infant would live if prevaiing pazum or motality ror all people ANNEX I -40- Page 4 of 6 et tlm statf ur blt - tolmy dh -le od*ollh InIlk A ,mf * . -puwy. ad ac.iy-Toal studet -. 0110 mad 1U daa rled In pbmury mI =JM Wla div by mauqr of w mg A ( amj- lum ber fktm wmo die I do t mpedl toul. yr. 1317 I 1 0 da COIuWflm A i to S W (pm of * C Fu _pje_ cm .a.Pse n can cao wd-Nimn~ ofpilw (1._ Pmr Md wmm h UIi nmbI pij now cm ing ee tha eioght perso adm iambi- mrntom w pply t _W aNd In weim or mon, hs ivesi MA litay vehW . unmtedbi miatie _ee u5t U t hai Dl_rn P'|P am_ RSIFS p I peum -AUl types of rles.. bo hlm erip ndmuaywie) pmuinof1k tmp. gf, jdabnW to wnera pbUWc per thousad of popcn.m de In a urbr a a poUr femiu or usdpm grAj m rivsm in cwtrms and In yas w_- wi.s - r barn a home inep be OiiIiaii regisaratian of fdIo am w1 in 88 c d_ fr zicsnt a y - beins within ISabsoum at dthe ham. In fiiawd U - mm ouatmp.rb.sasmtctatmaoahdInig hosidho de ismt hav to ogmd a dimupeutl.si PKs of1 day TVRd''a (P i-TVN TVrnoa rbroodut 1biing&f h ,w fts5)j ngj i - to puei ubi per thbuin poulton clodd unlicmed TV Acm juwe. Dhqpud (per *~p~ijm)-E~4 dcei-Elin ca ul.mdi.peers he ragistraiom of TVuow wune m_ mmu-Nombe of peo (at w , M .1) byd t n di e. * * urnS dmpommi e pusemumm of dhidr repedws populmmo. PhW- ( i m ja w = a- Elaraw depol my imds t colldum end dpmsL with c: agp dmu i or"d* p_e i2tKu _WqW" dI u a without t_md 1 or hms. eces amd we.w r by wa.r- pilde pubimdlA, ad primarily to rawrdig ems! awe bom _ or tde mm or pit piim nd dsimlr aidsuoeu. Ito edd to ho admilyw if t eppeu at et fou uim a Wi. _ I _ P*pMm-ftpulmtiam divd by number or pius- CFAm Aa rmqp Cepa p Yah-emd n the timing phycidsmqulilebonesmdicalachool tuniversity level nmbr of tidck m duing te y. incudin admmo to d pw Nwd Anz p-'" dividmd by number d v i cion d mab unittL pract nude nd n _b awse nUd nn ngar plk u_ NW bs a_ai. L42 FORMC I pwMm p,d A wu. on m i-rw pvladon Tad Lbw eibonacti pam a- (tooL wug and rul divided by ter rpet ive _ nuer of udin aimed frm and unemployed bu excluing houue h hospal bedb ava i publIcaC: private, womm and WpiCIM11md t ot cu.. coSEdI popult of ad sa De ftiui ia hosptaL md rdabilimm omi. Hopib an uawbdnm venous ori ui na t am umpmb 1960, 1970 and 1983 'Jata. p ee dy d by mblat ok e piyymn Estbishments pPrO FM (peIS labor force m pu ee of twA lr ---g penipely couodlal - m m iniudet. Rra hosti. MM= - hou ,imwe kbemithadnmicaonnot pw_yeei smffsd Ap*_ (porin)-Lmbor form in rumng foy. buning by a physicin (but by a medicl iumn wu. midwife. s.) ad lin as,p of tot lbbor f;m 1960. 1970 mad 19 wi' offe in-pedai aelo dtiodn sd povde a limited maus data. of medicsl facilitieLs Iad (prwooj-Labor force in mining constucto menu- AJ per RdW Bd-Total n_wnor at diion to or fctringl dsltuicity. wat sod poa psnmtarot_ lor --isc-hrg ffro boWitas divided by the number of bedr. force; 190 1970 ad 190 dat -' I {Amp)or-wisi o" Prdpicn HOUSING oracdv*uyrwecopuo.du utaln ba ardeborfom Abi Su gf 0_o (pwsm lAuwIQ-OMA rv, e P e of taL mol ad I_ population of an a miu.d-A hobaden m ofagrorpo9individoemwhoshere resctvely 196 I nd 1963 da The mu b_ on 11.0 ivi qunns and their mam mae.. A board or lodW m or pecpsinra.sludtgsc of t popula. and may not be icude id do he utbold for itatms purposes. log time m1d. A f1W umata ue fiten maiosal mourL -begs flwir pm Bear-Wd gram; and we- Ereelk - & ioDep.wmp Ale-tat, of population under 15, and Aveap nmmber oron per ream in all urtb. nd rral. 65 and overto the working age population (toe a_d 1564). ouped conventona duw_lg rspectvely. Dwe1ip auludc non-permanent structure ad unoccupid pwts INCOM DISTRMITUION PA..M* of DWEeg M Akelokp-uel, ube. d E _d- humeq -o Twtal Dbqmi& lerw (lok * csbsai Aid)-- Convetona dwullinp with elcticity in lving quwtem as per- Accring to perentile groups of households ranked by tote' oue upg of totaL. ub and rua dweip r_upictiy. bold icme DUCATION POVERTY TARGET GROUPS AEud Ew emW Rb. The follow dntma are very approximate man . of povety - *_wy FoIA - -.u onfmb-4rM t m d leve andehuM be interpred with conaideme caution. r_le eofm*m 1 ofal ea at th prnny Ind - pernnp of _sUd Aka Jim 0y hmsm Lawd (U_,p Iapi-ber rpocv prim ecoa-ap popuadou Whl may counuime nril-Abolute poverty incom level is hat income levei coneder prmay school apto be 6-11 yua otbeg do nor The beow which a minimautridondly adequate diet plus essetial dulferencea in conty pra- in the ba and durto of school non-food requrme is not affordable we refee ik the rd pt n. For ame cosmue with unival E Ad uIes P.erry bca -- Lad (fJMlp cqkJe-w6 -duton pm wromnt may esd 100 pamm sin e e _ nowP-Runa rdative povery income levd i onethird of pupi, uc bdeow or abovd temntxys ad primry-choel avea per cai personal inome or the country. Urba kvel I age. deived from th rual evel with adjustment for higher cost of Secaedw sdod - tota. mid fo,vk-Compuzed as ah ivmng in urban ares. odyeducation req at leat our y of approved pri- Eidwad PbpIlwem 5.e A&mlm fowery acs Lard (par- Ma7neurtion; provide gel vationl or teacher tama c -,sr&= meal- Pret of population (urban ad rural a _tua for pupil uafy or 12 to 17 yer ofra comespood, wbo ar 'absolute poor. cw cour am geeraly ecluded. Vocar nd DmrsPr (Porcam faemWY)-Vccbonw in1tal- Ans and Data Diviion tons induded cL indltldu or ohr pro amwhicb opera Economic Analysi and Projectons Deprtment indedly ora departmts of mondwry iatutioe June 198S - 41 - ANNEX I Page 5 of 6 ZIA* Ei[C DIICAI1 Ebp;la'Ln 6.225 mLUn(odk9E13) QNP per Capita: MSM8 ( 193) NThML Am 1984 ZS Percet Aruml Gt Rate (2) ledAcatr MilUI. of (P 1975-6 19B1 1982 1983 1964 GD, Factor Cost 2157 84 -0.7 2.7 -2.1 -6.0 -2.0 G(P, Halet PrL 2558 100 -1.1 6.2 -2.8 -2.0 -1.3 krAltutu 377 15 0.5 82 -11.7 8.4 9.7 ri'uz 359 14 -3.0 4.7 0.0 3.0 -40 Othr Idsttyl 646 25 -0.2 5.1 -0.9 '5.1 -1.3 Servii 1176 46 0.4 6.5 -1.6 -4.3 -3.5 Cixuupcinxi 2193 86 0.0 9.3 -6.8 4.4 -1.5 Cras Tves~tt 359 14 -16.9 -11.1 -23.5 -24.2 -42 ors i ods & NES 908 35 -3.5 -128 15.7 -9.7 -60 Taporcs of CGcds & *5 902 35 -69 -16.0 -22.0 -15.6 -15 Gross xestic Savitgs 365 14 0.0 -4L2 -26.6 83.9 6.3 (DVmIENr FM= GeIna Gmernment2 Cental Goverztt (1964) (K MIn.) Z of ( K Nin.) Z of GC! Qirrent lleasprs 1,170 24.7 Qmsnt E Iituces 1,241 26.2 Qarent Sraplus -71 -1.5 Capital qwiptums 275 5.8 Exernal Finan1g 60 1.3 ,EY, CREDIr and PRIES 1975 1980 1981 1962 1963 1984 ____ (Mai i kPeriod) Dm" and Qiasli )ney 493 907 979 1309 1444 1703 Bak Ctedit to me nt 318 1355 1495 1983 3)9) 2287 Ble* Credit to Private Sector3 393 505 765 905 1033 1)2 (F kramtae of Indc 3 rs) N. aid Qasi ibwey as oMP 31.3 30.1 28.4 36.7 34.2 36.0 Wholesale Price (1966=.00)4 188.6 424.2 475.9 542.8 663.7 832.0 Amual percetage clue In: QIlesale Price radme 16.6 11.1 12.2 14.1 22.2 25.4 Bm Crdt to Govxnm 406.9 2D.8 10.3 32.7 5.8 9.0 ack Credit to Private Sector3 17.0 4.6 51.4 18.3 14.1 16.4 1 Ihmfuf rag, aetuction, electridty, gs and water. 2 Flgui do not dLffer slgnlficatly Er. -tral Qoe=ent.- 3 Twci peratatal orgizatia EIS 4 All dnticany used goods. Jim 1985 - 42 - ANNEX I Page 6 of 6 ZANDA MM PA = AND CPfl FLOW BAAUM OF PAWISM MERC xM E-OR 19r 1981 1982 1983 1984 OM'1ICu US$) ISS KIn 2 hports of 1}:ds, NES 1,129 1,067 1,aO5 908 qaper 685 83 lipots of C,oob, NES 1,633 1,410 1 043 902 Cobalt 55 7 _wrm Gup (deficdt -) -504 -343 6 sl ad Zinc 45 5 Al otbur 39 5 Factor Sewics (rut)a -218 -235 -188 -174 Total w Not Truufeu -158 -72 -0 -50 Bale an CGurtt Armt - 2650 -276 -218 EIL M. Dec. 31, 1964 (ffida Geants 26 30 42 50 Diect Foveip INem .. .. we .. .. US Mn. L40t MET Borm*g 220 258 128 134 dAbic Dcbt, mc. gaited 2,817 _gSbJUItS 407 35 T76 155 Priva Debt .. a 187 92 48 21 lbtal 0zstad & Disbssd 2,8} Not IW 367 -57 64 75 Cuindal PaYDts Arm s 53 240 -50 25 Ot I (nei.) 176 267 67 -71 ME 9V( RATI FM 1984 awe tn seres 38 -8 25 5 z t-- Icrease) cjk De.bt, ti. g _ateed 7.4 b 1O'IR -MS Item ixt-QiaranrAeed Private Debt be Total QItStaidIIg & D7sbwed 7.4 b Growsintl. 1Auecm 52 140 115 110 (Meeks of lOit) (L.7) (5.2) (5.7) (6.3) Oamit A/C Bil. as 2 GDP -21.9 -16.7 48.2 -8.2 Th/MR WMW , %krdi 31, 1985 eiLilicm MNS) RMS OF EWIE - IBD ML (jatstudfr & Dlsbrsced 337.92 43.03 1981 1$51.00 - 0.8684 IWIsbasd 108L23 139.52 1982 0.9282 Outstaling iLid. 1983 1.2506 IUdsbursed 446.15 182.55 L984 1.7943 a 8E uds artrs an inteft t ad awrtfatin rsm Ia m1xts msch,3d. b Act3ml debt welam paid antl bic and PubLeaiy Qlzaxteed debt, ewdudirg artears and W .pm yto. Sd cds debt sertw due m MGP debt rm equivalent to 46.1 tperwt of emorts of goods ad rox-fwtor servAms. ..not available June 1985 - 43 - ANNEX It Pag L of 2 STATUS OF BANK GROUP OPERATIONS IN ZAMBIA A. STATEMENT OF BAWK LOANS AND IDA CREDITS (as of March 31, 1985) Amount in US$ Million (Loss Cancellations) Loan Credir Undisbursed No. No. Year Borrower Purpose Bank IDA Loon Credit 20 Loans fully disbursed 432.06 1424 1977 Zambia Industrial Forestry 16.80 0.08 1566 798 1978 Zambia Third Highway 11.25 11.25 11.25 5.29 863 1979 Zambia Coffee Production 6.00 0.45 873 1979 Zambia Technical Assistance 5.00 1.84 1790 973 1980 Zambia Third Railway 25.00 15.00 7.35 1.84 1923 1981 Development Second Development BSank of Zambia Finance Company 15.00 0.59 2001 1981 Zambia Eastern Province Agric. Development 11.00 7.99 1193 1982 Zambia Southern Province Agric. Development 18.00 15.19 1196 1982 Zambia Smallholder Dairy Dev. 7.50 6.74 1251 1982 Zambia Fifth Education 25.00 18.01 2151 1982 Zambia Indus- trial a Mining Company Oil Refinery Mod. Eng. 5.10 4.25 2152 1982 Zambia Pet. Exploration Prom. S.60 2.90 1333 1983 Zambia _ aamba Coal Eng. 4.30 3.14 1362 1983 Zambia Rural Water Supply 10.00 9.24 SF2 1983 Zambia Rural Water Supply 6.00 4.37 1437 1984 Zambia Ind. Forestry-PhasetIl 22.40 21.48 2391 1984 Zambia Export Rehab. & Diver. 75.00 73.82 1985 Zambia Fisheries 7.10 7.10 1985 Zambia Agricultural Rehab. 25.00 25.00 1985 Zambia Fourth Railways 20.00 20.00 Total 597.81 182.55 108.23 139.52 of which has been repaid [51.66 - Total now outstanding 466.15 182.55 Amounts sold 28.58 of which has been repaid 28.58 - - Total now held by Bank/IDA 446.15 182.55 of vhich is undisbursed 108.23 139.52 __ NOTES: The status of the projects listed In Part A is described in a separate report on all Bank/IDA-financed projects in execution, which is updated twice yearly and circulated to the Executive Directors on April 30 and October 31. 1/ Credits denominated in SDRs (Credit 1193-ZA and above) are shown In US Dollar equivalents, based on the exchange rate in effect at the time of negotiations. - 44 - ANNEX 11 'Paso 2 of t B. STATE£M 0? irc INVESTMENTS (as of September 30, LO84) Investment USS Mtillion Equivalent No. Year Type of Bustnesm Loan Equity Total 216-ZA 1972 Zmbia Bata Shoe Company Limilted Shoe Manufacturtng 0.85 0.23 1.08 250-ZA 1973 Zambit Bata Shoe Shoe Manufacturing Company Limited and Tannery 1.20 - 1.20 307-ZA 1975 Century Packages Limited Packagtng Haterials 0.78 0.21 0.99 324-ZA 1976 Development Bank Developmeat Pinance of Zambia Company - 0.54 0.54 394-ZA 1978 Century Packages Limited Packaging Materials 0.10 - O.L0 483-ZA 1979 Zambia Consoli- Copper and Cobalt dated Copper Mines Production 28.00 - 28.00 527-ZA 198C Iafue Textiles of Z6mbia Limited Textiles & Pt1ers 7.60 - 7.60 600-ZA 1981 Zambia Consoli- Copper Production- dated Copper Mines 27.03 - 27.03 709-ZA 1984 Zambia Hotel Properties Ltd. Tourism 17.25 - 17.25 Total gross commitments 82.81 0.98 83.79 Less cancellations, terminations, repayment and sales 29.60 0.81 30.41 Total now held by IFC 53.21 0.17 53.38 - ~ Total undisbursed 34.82 - 34.82 NOTES: Investuent No. 743-ZA for USS2.1 million equivalent in Rpongwe Development Company Limited approved on June 12. 1984 vas signed on October 8, 1984. - 45 - ANNEX III ZAMBIA INDUSTRIAL REORIENTATION CREDIT SUPPLEMENTARY CREDIT DATA SHEET T. Timetable of Key Events (a) Identification July 1983 (b) Project Preparation June 1984 (c) Appraisal Mission November 1984 (d) Post-Appraisal Mission February 1985 (e) Negotiations July 1985 (f) Planned date of effectiveness September 1985 II. Actions to be Taken Before Credit Effectiveness (a) Initiate the operations of the foreign exchange auction system (para 53); (b) Conversion of the present system of import licensing to one of import registration (para. 56); cc) elimination of import prohibitions (para. 56); and (d) reduce maximum tariff rates from 150 to 100 percent (para. 58). III. Actions to be Taken Before the Release of the Second Tranche Make satisfactory progress in the implementation of the industrial policies described in the Government's statement of industrial and trade policies (Annex V), (para. 82), including: (a) Decontrol interest rates (para. 61); (b) Agree on the amount and composition of INDECO's investment program for 1986/87 (para. 62); (c) Enact new Investment Act (para. 60); (d) Establish minimum 10 percent tariff on remaining duty free items (para. 58); and (e) Implement program of actiou to improve foreign exchange forecasting and budgeting (pars. 55). IV. Special Feature Government statement of industrial and trade policies. - 46 - TIz6trha1 I m d M a A deaility Cmd1t 1311 MabZmt Sdwle' inzla±vse US allUim Z Xbr Ibtedals 1T1ui1ml hr Ibtedals Tad1ea1 MAPr & e w M.atwme T2bbl! Pf Ainlstin Thea 1996 tmmer31,1993 0.2 3L2 53.5 9.1 51.9 Aril 30, 196 48 0.4 484 80.3 18.2 78.2 Jme 3, 1916 59.8 0.8 60:6 100.0 36.4 97.7 1987 9ytr 30 1986 59.8 0.9 60.7 100.0 40.9 97.9 Dwmbe 31, 19 59.8 1.0 60.8 IOD.0 45.5 98.1 til 30. 19 59.8 1.2 61.0 1D0.0 54.6 98L4 Jam 3D, 1987 59.8 1.4 61.2 100.0 63.6 98.7 1998 Sptaber 30, 1987 59.8 1.6 61.4 100.0 72.7 99.0 ler 31, 197 59.8 1.8 61.6 10D.0 81.8 99.4 Aprl 30, 1998 59.8 L9 61.7 .0 86.4 99.5 Jm 3D, 198 59.8 2.0 61.8 100.0 90.9 99.7 9I or 31, 1998 59.8 2.2 62.0 100.0 1X0 100.0 b~~~~~~~~~# I: ;- %if I8~ M. ruhlb ILt FUN1Ry OCF WNARE -47 - LUSAKA ANNM V June 13, 1985 Page 1 of 10 Mr. Ideard V. K. Jaycox Vice-President Eastern and Soutbarn Africa Region World Bank WasJton D.C. U.S.A. Dear Mr. Jaycox: lutroduction 1. It bas noV been two years since my Government sent to the Bank the Mmoradum of Development Objectives and Policies, dated January 13, 1983, which contained a statement of my Government's objectives and our Intentiona as regards policy reforms. The progress made In loplementing the now policies and programs during the -first year followvig this statement, was sumarized In a more recent letter dated February 1, 1984, sent by me to the Bank. In that letter we also indicated the speclflc actions we planned to take to advance further the policy reforms enumerated in the Memorandum. The purpose of this letter Is to Inform you of additional progress that has been made on the policy front over the past year particularly in the industrial and trad policy areas, and to indicate to you the spcific actions we plan to take in the comlng months to support the proposed Industrial Be-orientation Project. 2. Considerable progress has been made (since early 1983) In carrying out the macro economic and sector reforms specified in the Mememorandum and the letter, and we continue to believe that we are moving towards a policy framework essential to bring about the desired structural changes in the Zambian economy. 3. Clearly, such remains to be done in various policy areas. Since ye recognize that the long-term prospects for copper are llimted, we expect that future economic growth will have to depend more heavily upon agriculture and a more efficient lndustrial sector. 4. In the industrial sector we have adopted, and are planning to adopt In 1985 a large number of policy actions. We see the proposed Industrial Re-orientation Project as an essential element In our strategy for decreasing Zambia's reliance upon the copper sector and launching a program to re-orient sanufacturing activity to Improve the efficlency of existing operations and the economic contribution of ne lnvestments. 5. During most of the two decades since Independence, the policy to pronote the development of manufacturing industry in Zambia was based on industrial and trade policy measures which emphasized import substitution and admlnistrative cortrols, mad relied on public sector investments to promote Industrial development. Initially this pollcy led to rapid industrial growth and to the development of a relatively large and well diversified manufacturing sector. At present, however, the sector Is experiencing low capacity utilization, declining labour productivity, -48 - ANNEX V Page 2 of 10 increasing capital intensity and high dependence upon imports in a period of foreign exchange scarcity. Recent Policy Changes 6. To set the stage for resuming efficient growth, a number of problems and policy issues needed to be addressed. The correctfve policies which started as early as 1980 met with limited success. In late 1982, however, we agreed with the Bank Group and the IMF on a new program to bring about better economic management and a more appropriate pollcy environment. Agreement was reached with the IMF on a one-year standby arrangement starting in April, 1983, and with the Paris Club to reschedule the 1983 debt. As a part of the IMF program, the Kwacha was devalued by 20% in January, 1953 and a flexible exchange rate policy was established in July 1983. 7. The Memorandum of Development Objectives and Policies mentioned above was sent to the Bank in conjunction with the Export Diversificaton Project and it formed a part of the policy dialogue between the Government and the Bank which focussed on the structural elements of our diversification program. The progress made in implementing the new policies and programs, which was summarized In the letter dated February 1, 1984, included a cumulative devaluation of the Kwacha of 62% in 1983 against the SDR, compared with inflation rates of roughly 20%, the decontrol of prices in December, 1982, which led to the realignment of producer and consumer prices and to a reduction of subsidies of about 80% in 1983; cutbacks in Government expenditure, tax increases, and a 10% limit on wage increases in the private sector, with no Increases in the public sector; and higher customs duties on some capital goods introduced in the 1984 budget. The letter indicated that further progress in policy reforms vould be made once the exchange rate and tariff policies were modified to provide additional and more appropriate incentives to non-traditional exports, and once generalized duties on intermediate goods were introduced. Also, we mentioned that the tariff base would be shifted from f.o.b. to c.i.f. in 1985 and that the Industrial Development Act of 1977 would be revised by December, 1985. 8. During 1984 my Government continued to take actions consistent with the development objectives specified in the Memorandum of Development Objectives and Policies. These objectives included production and export diversification, the reversal of past trends towards excessive consumption, lessened dependence on imports in consumption and production, lower capital intensity of production and greater economic efficiency all around. The main policy actions taken during this past year are as follows: (a) As noted earlier, we have made substantial progress in the realignment of the exchange rate. From January 1983 to December 1984 the cumulative devaluation of the Kwacha has been 118%, which amounts to about 50% in real terms. We are now following a policy of depreciating the Kwacha at about 2.5% per month, a rate which exceeds the domestic rate of inflation. - 49 - ANNEX V Page 3 of 10 (b) During 1984 we continued the decontrol of retail and wholesale prices which is now virtually complete. Malze meal and candles remain the only exceptions. (c) We have managed to maintain in 1984 the levels of fiscal deficit and of borrowing from the domestic banking system at the significantly reduced levels which we achieved during 1983. The fiscal deficit dropped from 21% of GDP in 1982 to 7Z in 1983, and borrowing from the domestic banking system from 14X of GDP-to 2%. (d) We were also successful in our policy of limiting wage increases in the public and parastatal sectors to 102 annually or less since the beginning of 1983. (e) Interest rates have been raised significantly during 1984. In May the maximum lending rate went up from 12 to 15%, and in December Interest rates were increased again by 2.5 percentage points. The maximum lending and deposit rates are now 17.5 percent and 15.5 percent, respectively. (f) In addition to the above macroeconomic reforms, many important reforms have been instituted at the sectoral level. The mining lndustryhas been streamlined and made more efficient through a merger of tiae two copper mining companies (which took place prior to 1984). This has led to a consolidation of inventories and the establishment of a s;rategic planning unit in the new company's headquarters. Also, improved incentives for attracting high quality expatriate personnel have been introduced; the company has gained automatic access to foreign exchange to finance the imports needed for mining operations; and a set of studies has been initiated to raise labour productivity, to assess the economic viability of new investments and to plan for the close of uneconomic mines. These initiatives, which were supported by the Mining Rehabilitation project, will help ensure the future financial viability of the industry. (g) In agriculture, producer prices have been increased by over 30% in real terms during the past four years, and the marginal tax rate on agricultural income has been reduced to a flat rate of 15%. Responsibility for the marketing of maize and fertilizer has been given back to NAMBOARD, with the provincial cooperative unions acting as agents of NAMBOARD. Also a major study is underway to reorient agricultural research and extension services towards the smallholder sector. Further reforms in the agricultural sector have recently been agreed with the Bank in the context of the Agricultural Rehabilitation project; these include the decontrol of wheat prices and tractor hire charges, the escablishment of a pricing methodology based on border prices which should lead eventually to the termination of panteritorial pricing, the opening up of maize marketing and fertilizer distribution to private traders, and the initiation of studies on fertilizer usage and the effic4ency of agricultural marketing agencies. - 50 - ANNEX V Page 4 of 10 (h) We have begun to implement policy reforms In the lndustrial sector. In October 1984 we Introduced a LOX minimum duty on intermediate and raw material Imports which should significantly reduce the effective rate of protection on assembly-type industries and provide a minimum rate of protectioD for domestic resource-based industries. Also, the basis for levying import duties has been changed from f.o.b. to c.i.f. This, together with the new minimum tariff, should contribute to Increased Government revenues while reducing somewhat the excess demand for foreign exchange In the economy. Furthermore, we have introduced a foreign exchange retention system for non-traditional exports and lowered the tax rate on profits derived from such exports to the same concessional rate of 15Z that applies to agriculture. Industrial Strategy 9. For the new development strategy to succeed, it is necessary that the policy reforms be continued and, in some cases, accelerated. The Government is committed to this process and has requested further financial assistance from the Bank and the Fund -- as well as from other external donors - to be able to take the necessary measures, while mdnimizing the short-term costs of the adjustment. This Is particularly important given che continuing low copper price and high debt service payments that will be posing serious constraints on Zambia's balance of payments for some years ahead. - 10. In the manufacturing sector, a major reason for the recent decline in industrial production is the shortage of imported inputs due to the reduced availability of foreign exchange. This is particularly Important for manufacturing because of the sector's high import intensity. The foreign exchange allocated to the manufaturing sector for imports of raw materials and spare parts was about USS240 million in 1983. Since then the scarcity of foreign exchange has become more acute, resulting In significantly lower levels of imported inputs and raw materials for industry. The foreign exchange available to manufacturing for their import needs during 1985 is not expected to exceed US$100 million. Therefore it is evident that we need support from the Bank and oLher donors to improve this situation. 11. Notwithstanding the importance we attach to alleviatirg shortages of imported inputs and to the need for additional foreign exchange, we recognize that unless protective controls and restrictions are removed and the policy framework changed, providing additional foreign exchange would not encourage efficient industrial growth. The policy measures to be s-tpported by the proposed project are designed to reform the import regime, which provides high and variable protection to import substituting activities, to remove disincentives to exports, to Improve the system of allocation of foreign exchange, increase the efficiency of public enterprises and improve the public investment program, and to eliminate interest rate controls. - 51 - ANNEX V Page 5 of 10 Further Policy Changes In 1985 12. We recognize also the need for further policy changes to complement the galns already achieved toWards attainlng the objective of industrial reorientation and diversification. As regards speciflc actions that are being Implemented now and that we propose to take in coming months, which have partlcular relevance for the Industrial sectcor, I would like to mention the following: 1. Foreign Exchange Regime (a) Exchange Rate Realignment. We regard a more competitive exchange rate as the cornerstone of the proposed industrial and trade policy reforms. In the context of our discusslons with the IMF regarding the exchange rate regime, we have decided to Introduce an auction system for the determination of the exchange rate and the allocation of foreign exchange. The auction may be preceded by a step devaluation. We regard a satisfactory solution to the current foreign exchange problems as the most important element of the policy changes needed to reorient the industrial sector. A reform of the foreign exchange regime will necessitate the Improvement of the foreign exchange forecacting and budgeting process. As announce-& in the Budget Address of January 25th, 1985, we will improve the system of foreign exch-uige budgeting in the Bank of Zambia. Accordingly, we Intend to Implement the following additional measures: (b) Institutional Strengthenlag. The Budget Section of the External Finance Department at the Bank of Zambia which is responsible for preparing the foreign exchange forecasts and budgets will be strengthened by recruiting additional qualified staff and specialized consultants. (c) Foreign Exchange Budget Reform. The foreign exchange budget should become an operational document and a basis for making decisions on how to allocate foreign exchange. To accomplish this changc the foreign exchange budget will become a tool of economic policy decision making and will be subject to review and approval at the ministerial level in Government prior to the start of the period that the budget covers. The budget will provide operational targets that are realistic, with particular attention being paid to the expenditure side; when a deficit is projected, the budget will include specific recommendations on how to finance the deficit. The measures at 1(b) and (c) above are already in the advanced stage of implementation. - 52 - ANNEX V Page 6 of 10 Cd) Allocatiun of foreign exchange. The shortage of foreign exchange makes lt particularly imperative that Its allocation be done efficiently. In Industry, as In other sectors such allocation has not always been done in an efficient manner, since the administrative mechanism and the sytems of protection and controls have sometimes resulted in resources being channelled to less productive uses. The auction system to be introduced will enable us to allocate foreign exchange to the efficient producers. As a crucial complementary meeasure to the auction mechanism, we will reform the import licensing system through the following measures: (i) eliminating the current system of import licensing and replacing it by a simple registration system as described below; (ii) shortening the period of validity of licences and making them non-renewable; (iiI) recalling all outstanding uncovered licences and cancelling them; (iv) reducing the licence fee from 5% to 2% of the value of the licence, and making it - non-refundable; 2. Import Duties and Sales Tax Regime As announced in the Budget Address of January 25, 1985, we have adopted the following changes in the import duties and sales tax regime in connection with the new budget: (a) Removal of certain manufacturer's rebates under Section 89 of the Customs and Excise Act. This section exempts payment of duties on imports of industrial iaputs by specific subsectors. (b) Introduction of duty on somae items where duty has hithertofore not applied. Duty now applies to some goods that were still free of duty after the Customs and Excise Amendment Acts were approved in November 1984 and March 1985, and to goods that were previously exempted under Tariff Code 100.10.00. The only exceptions wil be some agricultural inputs, which will continue to be free of duty temporarily. -53 - ANNEX V Page 7 of 10 (e) The existing rate of sales tax on Imports of 12.5Z will be raised to 15%. (d) As for local products and services which presently attract sales tax (namely all final goods manufactured in Zambia in significant amounts, except for some basic foods), we are increasing the tax from 10% to 15Z on most of those goods and services where the rate has not yet reached this level. A sales tax rate of 15% will be charged on an expanded range of products and services by December, 1987. - (e) Sales Tax on Imports: The new sales tax on imports at 15% has been in effect as of April, 1985 on all dutiable goods. In addition to the measures announced in the Budget address which have been adopted, we intend to implement the following measures relating to import duties and the sales tax regime: (f) Removal of the remaining manufacturer's rebates under Section 89 of the Customs and Excise Act by December 1985. (g, Introduction of duty on those remaining Items where duty still does not apply by April 1986, with the exception of agricultural inputs, which will continue to be free of duty temporarily. (h) When the-measures in (f) and (g) above have been instituted the 15% sales tax on imports will apply to all goods with the temporary exception of agricultural inputs. Ci) Tariff Commission: In order to prepare a comprehensive review of the protection system and prepare changes in the structure of tariffs and indirect taxes, a commission for tariff and protection reform will be created by December 31, 1985 at the latest. The terms of reference of this commission will be ready and agreed with the Bank during negotiations. One of the main measures to be worked on and implemented will be the lowering of high tariff rates. All of the above changes aim to reduce the wide dispersion and the high level of effective protection to the manufacturing sector and encourage the efficient allocation of scarce resources to industry. These measures will also reduce the fiscal deficit. 3. Other Barriers to Imports. We intend to implement the following reforms: (a) Import licensing: The existing system of import licensing will be sir.plified at the time of introducing the auction mechanism, and will be replaced with a registration system (see policy measures 1(d)); and - 54 - ANNEX V Page 8 of 10 (b) Import Prohibitions: Protection to new industries will be granted through the tariff system and through other incentives to be provided by the proposed new Investment Code for a limited period of time. Import prohibitions for protective purposes (the Control of Goods (Import and Export) (Commerce) (Import Prohibition) order, 1980) which now cover about 50 items will be replaced in two stages by appropriate tariff rates. One half of the prohibitions will be eliminated by December 1985 and the remaining half by December 1986. 4. Export Promotion. In order to help increase non-traditional exports, the following measures, which were announced in the Budget Address, are being Implemented: (a) The export licensing system will be simplified. The exact features of the new system are under elaboration by the Ministry of Commerce and Industry. (b) The export earnings retention scheme has already been improved by lengthening the retention period from 21 days to 60 days. (c) A new revolving fund for export development will be established. The institutional arrangement, operational guidelines and financial requirements have been studied by a consultant. His report is expected soon. We hope to discuss this report with the Bank, as soon as possible in order to agree on a program of action to start the operation of such a fund. (d) An autonomous export promotion body to help exporters identify new export products and markets and to promote exports will be established. This promotional body is expected to become operational by December 31, 1985. In addition to the measures announced in the Budget Address, we intend to implement the followving: (e) The existing duty drawback system will be simplified by December 31, 1985. The drawback will be based on average percentages of imported inputs for major types or groups of exports, and these averages would be revised periodically. (f) Exporters will be allowed to open interest earning foreign currency accounts at domestic banks. 5. Investment Code. The existing Industrial Development Act has had an inhibitive effect on business development, particularly by the private sector. As noted above, a draft of a new investment code has been prepared and is currently being discussed. As announced in the Budget Address we intend to adopt legislation to amend the Act. The proposed reforms of this Act currently under preparation will be adopted by December 31, 1985. - 55 - ANNEX V Page 9 of 10 6. Small-Scale Enterprises. In order to promote Suall-Scale Enterprises ye have announced in the Budget Addre.s that we will present legislation to amend the Bank of Zambia Act so as to Introduce a credit guarantee scheme for small-scale industrles. 7. Interest Rate Liberalization. As discussed before, over the past year we have raised Interest rates signlficantly. Our objectives are to allow initially for a gradual W adjustment in Interest rates in order to attain positive real rates and subsequently to free interest rates from all controls. In order to accomplish these goals we will continue to raise interest rates from time to time. We expect to lift all controls and thus achieve a completely deregulated interest rate regime by December 31, 1985. 8. Public Enterprises. In order to deal with two main problems faced by INDECO, namely: (i) the insufficient review and evaluation of existing operations and proposed new investments; and (ii) the inability of INDECO, and particularly Its subsidiaries, to recruit and retain the necessary qualified staff, we will liplement the following actions: (a) INDECO wlll adopt sound economic criteria to be applied in evaluating new investments and the performance of existing enterprises by June 30, 1985. (b) An Evaluation Unit to apply the above criteria will be set up and will engage consultants, to be financed under a Bank PPF with terms of reference and qualifications satisfactory to the Bank to undertake the following: (i) Review projects costing more than K2 million which started after July 1, 1984 or are expected to start preor to June 30, 1985 on the basis of the economic criteria referred to under (a) above; (ii) Review the economic viability of all other investment projects whose costs exceed K2 uwlion that are under study as part of INDECO's investment program for the three-year period ending in 1987/88; (iii) Investment projects that do not satisfy the agreed criteria of economic viability will either be reviewed and restructured to satisfy such cziteria or be discontinued; (iv) Review, with the help of consultants to be financed under the project, the economic viability and operational efficiency of operating INDECO subsidiaries, starting by October 1, 1985. 56- 'LN V - 56 - Age 10 of 10 (c) INDICO will implemnt a program of action beginning October 1, 1986, based on the consultants' review tot (1) Improve the performance of enterprises with potential economic viabillty; and (ii) restructure, reorganise or phase out enterprises that are not economically viable. (d) INDECO will undertake a study to determine: (i) The appropriate level of compensatf.on as well as those other measures necessary to recruit and retain quallfled staff; the terms of reference and qualifications of the study team will be discussed with the Bank by June 30, 1985; and (1i) an action program to implement the reemm endations of the study will be agreed with-the Bank by December 31, 1985. 13. This is an ambitious and far-reaching program that we have set for ourselves over the next year or so. However, we feel it is imperative to continue moving ahead with these reforms so that the structural changes required in industry can get underway. The Industrial Re-orientation Project is crucial to c_;plement this program, given the acute scarcity of foreign exdhange for industrial Inputs. 14. We look forward to the World Bank's support in this endeavour. Yours sincerely, L.LLJMJ( 1IU,NP MINISTER OF FINANCE AND NATIONAL COMMISSION FOR DEVELOPMENT PLANNING