Document of The World Bank FOR OFFICIAL USE ONLY MICROFICHE COPY Report No. 10626-PAN Type: (PCR) ReportNo. 10626 WISE, G. / X31679 / T9 003/ OEDD2 PROGRAM COMPLETION REPORT PANAMA STRUCTURAL ADJUSTMENT LOAN I, TECHNICAL ASSISTANCE LOAN I AND STRUCTURAL ADJUSTMENT LOAN II (LOANS 2357, 2358 and 2708-PAN) MAY 6, 1992 Country Department TI Country Operations Division 2 Latin America and the Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. C:URRENCY EQUIVALENTS Currency Unit - Balboa (B/.) US$1 - B./1 Note: The issue of Balboas is restricted to coins. The US dollar (US$) is accepted as de facto legal tender. ACRONYMS BDA - Banco de Desarrollo Agricola (Agricultural Development Bank ) CSS - Caja de Seguro Social (Social Security Agency) GOP - Government of Panama IMA - Instituto de Mercadeo Agropecuario (Agricultural Marketing Institute ) OED - Operations Evaluation Department PCR - Program Completion Report SAL - Structural Adjustment Loan SECAL - Sectoral Adjustment Loan TAL - Technical Assistance Loan FISCAL YEAR January 1 - December 31 THE WORLD BANK FOR OMCL4L USE ONLY Washington, D.C. 20433 U.S.A. Of Difedfflto-CeAI .-tm Evauati"m May 6, 1992 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Program Completion Report on Panama - Structural Adjustment Loan I, Technical Assistance Loan I and Structural Adiustment Loan II (Loans 2357, 2358 and 2768-PAN) Attached, for information, is a copy of a report entitled "Program Completion Report on Panama - Structural Adjustment Loan I, Technical Assistance Loan I and Structural Adjustment Loan II (Loans 2357, 2358 and 2768-PAN)" prepared by the Latin America and the Caribbean Regional Office. No audit of this project has been made by the Operations Evaluation Department at this time. Attachment This document has a restricted distribution and may b used by recipients only In the performance of their official duties. Its contents may not otherwise disclosed without World Bank authorization. FOR OMCIAL USE ONLY PROG0AM COPLEUTON REPORT STRUCTURAL ADJUSTMENT LOAN I. TECHNICAL ASSISTANCE LOAN I AND STRUCTURAL ADJUST1ENT LOAN II (LOANS 2357, 2358 AND 2768-PAN) TABLE OF CONTENTS PREFACE .................................l EVALUATION SUMHIARY .... . . . . . . . . . . . . . . . . . . . . . lll PART It PROGRAM REVIEW FROME THE BANKOS PEERSPECTIVE . . . . . . . . . I IlTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . 1 II. THE MACROECONOMIC FRANEWORa . . .. ......... 2 III* SAL I . . . . . . . * . . * * * * * * * * * * * * * * a * 3 A. Loan Preparation..................... 3 B. The Adjustment Program 5 . . . . . . . . * . . . . . . 5 Public Sector Effiien ncy............... 5 Industrial Policy and Trade Liberalization . . . . . . . 6 AgriculturalPolicy ..a..................... 7 C. Implementation and Results . . . ... . . . . . . . . .. .. 8 D. Compliance with Conditionality for Second Tranche Release . . . . . ............... 9 IV*SL 1.S #*#o IIoe 10 A. The Period Between SAL I and SAL . . .* 10 B. The Adjustment Program . . . . . . ......... . . . 12 Public Sector Effiency e................ 12 Industrial and Trade Policy .. .... . 13 EmploymentPolicy .... . . . . ................. . 14 Agricultural Policy a................. 14 Conditions for Second Trench. Release . . . . . . . . 14 C. Implementation and Rosults.... .... . 15 of thieir official duties. Its contents may not otherwis be disclosed without World Bank authorization. TABLE OF CONTENTS (cont'd.) A. ntroduction . . . . . . . . . . . . . . . . . . . . . . . 17 B. Description of the Studies . . . . . . . . . . . . . . . 17 Studies in the Agricultural Sectc . . . . . . . . . . 17 Effective Protection in the IndustriaL Sector . . . . . 17 Social Security and Health. . . . . .. .. . . . . . . 18 Multimodal transport study of the Panama City - Colon Corridor io ....................a.... 18 C. Implementation and Results .. . o o . . . . o .o . . . .o . . 18 VI. RELATIONSHIP WITH THE GOVERNMENT'S SHORT-TERM STABILIZATION PROGRAM AND THE STAND-BY AGREEMENT WITH THE IMF . . . . . . 19 VII EVALUATION OF THE SALs AND THE TAL AND THE ROLE OF THE BANK R o * . . . * o . . . . o . . . . . * . . 20 A. Design of the Program .................. 20 3. Front Loading . . o . . 9 . . . . . . . . . . . . . . 22 C. Sustainability . . . . . . * . * . * * * * * . 22 D. The Rolo of the Bank . . o . . . * . . . . . . * * * * 23 E. Impact of the Program . o o . . . . . . . . . . . . o . . 24 VIII. CONCLUSIONS . . . . . . . . . . . . . . . . . . . . 9 . . . . 24 A. Accomplishments of ae SALs . . . . . . . . . a . . . . e 24 B. Causes of Failure . . . a . . . . . . . . . * * * * 9 25 C. Key Issues for Possible Future Operations . 9 . . . * . . 26 PART Ilt PROGRAM REVIEW FROM THE BORROWER'S PERSPECTIVE . . . . . . 26 PART III: STATISTICAL INFORMATION ................. 27 Basic Data Sheet - Structural Adjustment Loan I (Loan 2357) . . . 27 Basic Data Sheet - Technical Assistance Loan (Loan 2358) . . . . . 29 Basic Data Sheet - Structural Adjustment Loan II (Loan 2768) . . . 31 ANNEXES 1: Table A.1 - Panama, Domestic Economic Indicators . . . . . . . . 33 Table A.2 - Panama, External Indicators . . . . . . . . . . . . . 34 Table A.3 - Panama, Consolidated Non-Financial Public Sector . . 35 2: The TAL Studies: Main Conclusions and Results . . . . . . . . . 37 3: Matrix of Tranche Release Conditions and Actual Actions Taken . . 45 4: The Period Between SAL I and SAL II . . . . . . . . . . . . . . . 55 ATTACHMENT Letter Received from the Government of Panama (original and translation) . . . .*. .*59 - i.- PROGRAI C0i2LETION REPORT PANAMA STRUCTURAL ADJUSTMENT LOAN I. TECHNICAL ASSISTANCE LOAN I AND SJRUCTURAL ADJUSTMENT LOAN II (LOANS 2357, 2358 AND 2768-PAN) PREFACE This is the Program Completion Report (PCR) for Structural Adjustment Loans (SAL) I and il (Loans 2357 and 2768 PAN), and Technical Assistance Loan (TAL, Loan 2356-PAN). SAL I and the associated TAL were approved by the Board on November 13, 1983; SAL II on December 11, 1986. SAL I of US$60.2 million was fully disbursed, SAL II of US$100 million was not. Its second tranche of US$50 million was canceled on December 14, 1987, at the Government's request. The US$5 million TAL was canceled on July 18, 1989, with an undisbursed balance of US$0.5 million. The PCR was prepared by the Country Operations Division 2, Country Department II, of the Latin American and the Caribbean Regional Office (Preface, Evaluation Summary, Parts I and III). This PCR was sent to the Government of Panama, but the Government has declined to comment (see Letter in httachment). Preparation of this PCR was based, inter alia, on reports prepared by the borrower, the most recent Country Economic Memorandum and additional data, the President's Reports, loan documents, project files, and discussions with Bank staff and Panamanian officials. - lit - PROGRAM COHPlETION MRPORT STRUCTURAL ADJUSTMENT LOAN I. ITECHNICAL ASSISTANCE LOAN I AND STRUCTURAL ADJUSTMENT LOAN II (LOANS 2357, 2358 AND 2768-PAN) EVALU4TION SUMMARY Back¸,zound 1. The Panamanian economy wes at a crossroads by the early 1980.. The existing policy and institutional framework were no longer adequate to sustain growth; unemployment was high and increasing; the public sector, which had prwiided 802 of all new jobs created during the 1970a, had become so burdened with external debt that no further expansion was possible; and the previously dynamic service sector, accounting for 702 of GDP, was slowing down markedly. 2. In 1982, the economy entered into a fiscal crisis and an economic recession. In an attempt to compensate for sluggish private activity, the public sector grossly exceeded targets established under the prevailing IMF Standby Arrangement. At the same time, the economic and financial crisis in Latin America took its toll on Panama's service sector, which is strongly oriented towards the Region. After August 1982, a new government took a series of corrective measures to deal with this crisis. A new Standby Arrangeuent with the IMF was successfully negotiated during the first half of 1983. At the same time the authorities sought Bank support for a SAL. Obi ectives 3. The structural adjustment program supported by SAL I, the TAL and SAL II was aimed at inducing additional sources of growth by increasing public sector efficiency and reducing protection on agriculture, industry and labor. The Government's program was based on a reduction of public sector deficits combined with an intended depreciation of the real exchange rate (to improve the balance of payments), through reforms in the labor code and decreasing protection on importables, mainly wage-goods. In a country like Panama, where the U.S. dollar is used as domestic currency, any adjustment to the real exchange rate can only be produced through changes in real prices and not through the adjustment of the nominal exchange rate. 4. Under SAL I, given the financial constraints on the public sector, the main aim of the Government was to increase public savings. The main actions in this area includeds (i) the closure or sale of several public entities; (ii) reform of public sector housing policy; and (iiI) improved public *ector debt management. In the industrial sector the actions to be taken by the Government included: (i) conversion of most quantitative trade restrictions into tariffs; (ii) establishment of a lower maximum and higher minimum import tariff levels; (iii) cabinet approval of draft Industrial Incentives Legislation; (iv) abolishing some domestic price controls; and (v) Improving export incentives. In the agricultural sector, the specific actions - iv - were: (i) reducing price supports aaid subsidies to inefficient producers; (ii) separating policies aimed at improving the social welfare of the rural poor from production policies; (iii) revising the role of public institutions in agriculture; and (iv) reducing and eventually eliminating subsidies for state- owned agricultural corporationr and enterprises. 5. A Techn:ical Assistance Loan (TAL) for US$5 million accompanied SAL I and financed technical assistance and studies of further public sector reforms, including major actuarial studies for the social security programs, studies on industrial protection, agrie-Atural pricing policy and management studies of key agricultural institutions and enterprises. It aimed at providing the Government with the .ecessary information and analysis for decision making in priority sectors in support of its structural adjustment program. 6. SAL II was intended to deepen the reforms started in SAL I. The program included policy char.ges in the public, industrial and agricultural sectors and in labor market regulations. The main issues to be addressed in the public cector were: (i) reform of public enterprises; (ii) reduction of pjublic employment; (iii) preparation of a public investment program for 1986- 1987 consistent with the priorities of the development strategy; and (iv) re- form of the social security system. With regard to the industrial sector, the main reforms included in the program weres (i) eliminating all but 20 import quotas; (ii) the substitution of the discriminatory industrial incentives system witin a simple industrial registry; (iii) implementation of a program for import tariifs to converge to the established minimum and maximum levels and lower average tariff protection; and (iv) according greater emphasis to ad valorem tariffs. For the agricultural sector, the specific measures included in the program were: (i) reform of the agricultural incentives legislation; (ii) revise the role of public institutions in agriculture; and (iii) liberal- ize agricultural trade and pricing policy. Imnlementation and Results 7. Compliance with SAL I conditions was satisfactory. Thz Government was successful in meeting most of its objectives: abolition of many import quotas, closure of a major sugar mill, stricter control over public expendi- tures and in setting the agenda for the reform process. Second tranche conditions were mainly plans and the approval by the Cabinet of two draft lavs. However, even though they appeared to be simple, compliance was slow, mainly due to political changes and elections. The second tranche was finally disbursed in June, 1984. Following disbursement, many actions were reversed (see para. 48). This slowed significantly the preparation of SAL II. During 1985, the Bank and the GOP could not agree on how to reverse the backsliding after SAL I second tranche release nor on the content of a Letter of Develop- ment Policy. 8. Very few of the recommendations of the studies included in the TAL were implemented, possibly because most were finished when the GOP appeared no longer committed to the program. However, several studies (i.e. Effective Protection, Trade and Pricing policies, Actuarial study of the Pension System) were very useful for the policy dialogue between the GOP and the Bank, during the design of SAL II. -v - 9. Early in 1986, the Bank and the GOP finally agreed on a number of conditions that should be fulfilled before each stage in the processing of SAL II. The key breakthrough was the agreement on the content of three laws, reforming the Industrial Incentives law, the Agricultural Incentives law and the Labor Code. These 'lavs were the main accomplishment of SAL II, and their evaluation is therefore of greal importance to judge the results of the loan. Overall, the concent of the laws appears to be unsatisfactory. The effective protection rates that would be in effect after five years, according to the new Industrial Incentives law, appear too high to have had an effect on the structure of production. The reforms of the Labor Code did not attack tb distortions. Finally, though the Agricultural Incentives Law appeared tc a good, the creation of the goods specific Commissions, proposed by the Government of Panama (GOP), proved to be a mistake. These Commissions informally set quotas and prices in their respective markets, in opposition to SAL 11 conditionality. 10. After the approval of the laws, the compliance with the other conditions was reluctant and slow, specially due to the opposition of the Minister of Agriculture. After appraisal, the Bank decided to increase the amount of the loan arguing that the program had been strengthened by the addition of a Social Security component. It in debatable if the final program was in effect stronger than the original one, especially given the final content of the three laws. 11. The GOP could not comply with the condition for Board presentation of Cabinet approval of the draft law for Social Security reform, because of intense opposition from the Government's political party. This condition was finally waived. The decision to go ahead with the loan in such circumstances, i.e. with strong opposition within the ruling party and the Cabinet to the most important components of the second tranche (changes in agricultural prices, sale of agricultural enterprises and social security reforms), implied the acceptance of high risks of non-compliance. The Bank seemed to be confident that the same slow and reluctant but in the end mostly effective compliance that had occurred in 1986 would repeat itself. In this case, compliance was possible due to the strongly negative financial consequences of a delay in SAL II (see Anaex 4, para. 18). A very high percentage of the 1986 external financing was due in the last quarter of the year, and was all tied to the approval of SAL II. The Bank seemingly was counting on the same effect being pruduced by the need for the second tranche. In this train of thought, the political problems that arose in June 1987 and led the GOP to choso to stop servicing the external debt and to disregard second tranche conditionality, were unpredictable. However, there is a second way to look at the events. The compliance with the 1986 conditions was due not only to the GOP's need for financing, but also to the fact that the Bank accepted at least three times to soften its position. The first occurred when negotiating the content of the three laws. The second when concluding appraisal. The third before Board presentation. Given this track record, the GOP may have thought that the conditions for the second tranche release were negotiable. This could explain why, by June 1987, the GOP had complied with so few of the second tranche release conditions. Faced with a strong stance by the Bank on the content of the Social Security law, the GOP was unable to deliver (see Annex 4). 12. Eight months after the approval of SAL II it was clear that the Government would be unable to comply with all of the conditions for second - vi - tranche release (see paras. 65 to 70). There were also some important reversals in first tranche conditionality, especially in the agricultural sector where some price controls vere formally reinstated and the Inatituto de Mercadso Agropecuario (IMA) started to intervene again in imports and prices (see paras. 71 to 74). The second tranche %as finally canceled on December 14, 1987. In summary, SAL II, both because of problems in design and the lack of commitment of the GOP, failed to accomplish its major objectives. Sustainability 13. Most of the substantive measures regarding quotas and price controls were rapidly reversed ir 1988. It could be argued that this was the corse- quence of the Government's lack of commitment to the execution of the program, in the context of a strategy that did not produce sufficient incentives for sustainability (see para. 106). At several key instances in the preparation of SAL II, however, the Bank made concessions to the GOP that may have weakened its negotiating position (e.g. on the trade liberalization component and on the draft law for Social Security reform) and impact. Findinas and Lessons Learned 14. By-and-large, the main objectives of the adjustment program supported by the two SALs were not met or sustained. The objectives were: i) to increase the efficiency and reduce the size of the public sector; and ii) to change the incentives in agriculture and industry from import substitution to export promotion. Apart from the quita successfu' privatization and closure program, the size of the public sector was rot reduced (see para. 112). The industrial and agricultural sectors continued to produce predominantly for import substitution, as the industry component implied only a mild reduction in protection and the Government of Panama did not comply with the condition- ality for the agricultural component. Particularly under SAL II, the measures taken fell short of what was expected at the time the loans were made. 15. Even though the areas targeted for reform under the program were important, the structure of the specific reform program was inappropriate for the realization o.f the main objectives of the strategy (see para. 101). For example, the program did not address in depth two of the key problems of Panama: the Labor Code and the oligopc'istic characteristics of most markets, due to the continuing high level of pj.:otection. 16. The Government of Panama was committed to the program during the preparation and approval of SAL I. This led to a very successful start of the operation. But the GOP's commitment started to waiver after the resignation of the President in early 1984. Nonetheless, SAL I was completed with satisfactory results. The Government of Panama asked for SAL II as part of a package to cover the country's financial gap but it was reluctant to commit itself to the needed reforms. The lack of conviction led to a substantial lack of transparency and very little national dialogue cn the reforms to be implemented and their meaning. This in itself would have made them difficult to implement, no matter how relevant and well articulated the program had been. The Bank was aware of the GOP's lack of conviction over the need of the reforms. To face this lack of commitment, the Bank followed a strategy that consisted of heavily front-loading the program so that the execution of these conditions would be the test of the GOP's commitment. But this strategy was - 'vii - undermined by conce3sions at key instances. As front-loading is an imperfect substitute for commitment, due to the fact that policy changes can be reversed, it needs to be backed by a strategy that lends credibility to the actions that would follow any reversal (i.e. a reduction or discontinuation of the Bank * lending program). In this context, concessions such as the acceptance of a very weak trade reform, the increase of the loan amount during negotiations when the program had not been made significantly stronger, and the waiver of a key condition for Board presentation, possibly reduced such credibility and therefore did not help create incentives for sustainability. 17. The TAL studies were generally of gcod quality and were fin7-shed in time. Soriie studies (e.g. effective protection, actuarial studies ot Serial security) were very useful for the preparation of SAL II, but others were disregarded, as they were concentrated in the most controversial areas, as agriculture (trade and pricing policies in agriculture, agricultural institu- tions) and social security. Others, in turn would have bV3n considered if the lending program had been continued (e.g. health). 18. For future operations, the most important lessons are: a) When SALs are a key part of a financing package from external resources, the Bank may be faced with pressure to go ahead, both by the country and the donors. In this case, it becomes important that the more difficult conditions should be resolved before appraisal and/or negotiations. Once negotiations take place, Board presenta- tion conditions should preferably not be key conditions within the overall program, as pressure to go ahead is likely to mount at later stages. b) The idea of structural adjustment as a process, assisted by a sequence of loans is acceptable. However, the adjustment program should address the more important issues at an early stage, unless there is a compelling reason not to do so. It is not helpful to address only the relatively easy issues with the first credit, assuming that more substantial issues will be addressed in follow-up operations. c) While the Bank should be flexible, within reasonable limits, regarding the content of % loan, at the design stage a careful and realistic assessment sh -Ld be made to establish a minimum core policy component from which the Bank should not deviate substan- tially. This is essential for the Bank to maintain credibility with respect to the client country and the donors. d) In the design of a program, once an area is identified as vital to the adjustment process, the associated reform covered under the credit should be sufficiently penetrating. It is not helpful to retain a condition that does not go far enough to affect the actual reform. e) If the Bank doubts that the country owns the program, the strategy of frontloading has to be safeguarded by incentives to comply. These can be provided by the risk of foregoing the subsequent loans in the program. For this strategy to succeed, the Bank should design the - viil - program as a series o,f small loans or tranche the loan adequately art then do everything possible to m=intaln the credibility in the actions that will follow non-compliance. f) Above all, it bears mentioning that there is no substitute for a committed government to ensure proper design and successful imple- mentation of a program. PROGRAM COMPLETION REPORT STRUCTURAL ADJUSTMENT LOAN I. TECHNICAL ASSISTANCE LOAN I AND STRUCTURAL ADJUSTMENT LOAN II (LOANS 2357, 2358 AND 2768-PAN) PART I: PROGRAM REVIEW FROM THE BANK'S PERSPECTIVE I. INTRODUCTION Identity Name s Structural Adjustment Loans I and II Loan :4o.: 2357-PAN and 2768-PAN Region s Latin America and the Caribbean Country t Panama Sector s Non-Project Lending Name s Technical Assistance ?'roject Loan No.: 2358-PAN Region s Latin America and the Caribbean Country t Panama Sector s Technical Assistance 1. This Program CompletLon Report (PCR) covers the Structural Adjustment Loans (SAL) I (Loan 2357-PAN) and II (Loan 2768-PAN) and the Technical Assistance Loan (TAL, Loan 2358-PAN) extended to Panama. SAL I, approved by the Board on November 13, 1983, for $60.2 million, was fully disbursed. SAL II, approved by the Board on December 11, 1986, for $100 million, was canceled on December 14, 1987 at the request of the government, before the release of a second tranche of $50 million. The TAL, also approved by the Board on November 13, 1983, for $5 million, was canceled on July 18, 1989 with an undisbursed balance of $500,438.25. 2. The report iu organized Ln the following way: in Section II, a macro- economic outlook of the Panamanian economy at the time the loans were made and implvmented is presented, to provide a framework for the discussion of the specific loans (Section III sn SAL I, Section IV on SAL II and Section V on the TAL). In Section VI, the role of the INF and the debt negotiation. with the commercial banks are analyzed; Section VII discusses the design of the Loan and the role of the Bank. Finally, the main conclusions are outlined ln Sec- tion VIII. -2- It. THE MACROECONOMIC FRANEWORK 3. In 1982, Panama was one of the most advanced developing countries eligible for Bank lending./ Moreover, the country had a very unusual structure of production, with the services sector accounting for almost 70% of GDP. Most foreign exchange earnings were also based on services, stimulated by the country's locational advantage, favorable legislation and the use of the Us dollar as its domestic currency. The last element is one of the most notable characteristics of Panama's economy and a key issue in designing an appropriate program for reforms. 4. The economy of Panama showed a much higher average rate of growth during the 1960s, when GDP grew at an annual rate of 8%, than during the 19709 (4.5%), and the 1980s (2.8% through 1987). These aggregates hide very different sectoral behavior which are relevant to the understanding of Panama's situation prior to the loans: i) the services sector (including the oil pipeline, Colon free zone, and the Canal) had been growing at a much faster rate than the goods sector; ii) the public sector was growing at a faster rate than the private sector; and iii) capital intensity was increasing at the same time as the unemployment rate was increasing. 5. Agriculture and industry achieved higher average annual rates of growth during the 1960s (5.3% and 10.9% respectively) than during the 1970s (2.2% and 3.4%). During the period 1980 through 1987, agriculture grew at 3% per annum while the industrial sector was almost stagnant. 6. During the 1970s, the public sector share in GDP and in employment increased vis-a-vis the 1960s. In the early 1980s, this suggested the need for a program designed to overcome the dependence on public sector growth, due to the impossibility of financing such a strategy in the post-1982 world, and to provide new sources of growth. 7. The capital intensity of the economy had increased sharply during the 19709 leading to low employment generation, with employment growing at 2.2% per year as compared to 3.5% in the 1960s. In the private sector this was mainly the outcome of a system of incentives which, on the one hand, increased the cost of labor (labor code modifications of the early 1970s) and, on the other, provided incentives to capital intensive techniques through generous tax exonerations under the prevailing industrial investment legislation. Urban unemployment had already become a grave economic and social problem in the early 19809. If it had not been for the expansion of public education, the reduction of the m; imum age of retirement and the great expansion of public employment, all unsustainable in the new international economic environment, the unemployment rate would have reached 20% in 1983 (double the actual rate). 8. It has been estimated that the once and for all effect of the labor code modification on total labor costs was an increase in the cost of labor of )/ With a per capita income of US$2120, only Mexico, Portugal, Algeria, Uruguay and Yugoslavia had a higher per capita income. 2J See S2ecial Recort on Metronolitan Unemolov ent in Panama, Report No. 3833-PAN (July 1982). - 3 - between 30% and 60%.! The principal changes were related to employment security after two year. on the job; compensation for unjustified firing (8% of total remuneration); a seniority bonus scheme (2% of total remuneration paid after 10 years of work) collective agreements, mandatory if requested by the union; and contributions to trade unions to be paid by the worker independently of being unionized. 9. The consolidated non-financial public sector deficit recorded a strong increase in 1982 in the ratio of the deficit to GDP to 11%, doubling the figures for 1980-81. This large deficit affected Panama's creditworthiness at a time when commercial banks were revising their policy towards all Latin American countries, making programs with the IMF and the Bank a sine amno for further commercial credits. 10. The deterioration of public finances was clearly due to the strong expansion in government services during the 1970s as well as the effect of servicing higher foreign debt payments. A program was needed which would combine a real depreciation of the exchange rate with a reduction in fiscal deficits, together with changes geared to induce investments in the medium term in activities more in line with the comparative advantage of Panama. 11. A real exchange depreciation in a country which can not devalue requires changes in domestic costs of non-tradeables. There were two main sources of cost increases: the higher cost of labor and the structure of protection on tradeables. The former resulted from the labor code, the latter from different instruments used to protect the domestic production of foods, clothing and other importable products, mostly wage goods. Export incentives (CATs), intended to introduce some neutrality in the protective system, were reducing the bias against exports only to a small degree. III. SAL I A. Loan Preparation 12. In 1982, the economy entered into a fiscal crisis and a recession. In an attempt to compensate for sluggish private activity, the public sector grossly exceeded targets established under the prevailing IMF Standby Arrangement. At the same time, the economic and financial crisis in Latin America took its toll on Panama's service sector, which is strongly oriented towards the Region. Beginning August 1982, a new government took a series of corrective measures to deal with this crisis. The economic team led by the Finance Minister, the President and the Commander of the Natlonal Guard all agreed with the need for structural adjustment. 13. The Government began to formulate a program of structural adjustment in late 1982 and early 1983. At that time the authorities sought Bank support in the form of a SAL. The principal objective was the creation of new growth opportunities by reorienting the economy towards production for export. Thie required major improvements in the efficiency of both the public and private 3/ Spinanger, D., (1986), nSpeaking up about the labor code - a survey of employed and unemployed in Panama", Kiel Working Papers, No. 263. -4- sectors: the first through a reduction in its scope an(d institutional reformsp and the latter through changes in the incentive system. 14. An Identification Mission visited Panama in February 1983. In March, the Government announced the closure of Felipillo sugar mill (the largest and most inefficient of the Complejo Azucarero La VLctoria owned by the public sector), a reduction in the support price for ricb of 8%, liberaliration of beef exports and the freeing of potato prices. This was the beginnit;i of a series of measures that were agreed between the Government and the Bank and were taken before Board presentation of SAL I. The attitude that permeated the discussions with the Government was that, given the political cost involved in many of the reforms, the loan had to be heavily front-loaded. In May 1983, the Loan Committee approved appraisal of a SAL. At that time, it was agreed not to include a reform of the Labor Code. 15. In June 1983, the commercial banks agreed to lend $278 million to Panama, the Bank appraised SAL I and the Fund approved a Stand-by Arrangement through December 31, 1984 (see paras. 89 and 91). 16. In September 1983, the Commander of the National Guard resigned and was replaced by General Manuel Noriega. Changes were also made in the Cabinet, including the replacement of the Finance Minister. At the timec the President confirmed to the Bank the Government's continued commitment to the adjustment program. 17. After the GOP had complied with all conditions for negotiations (removal of import quotas, lifting of restrictions on coffee exports, ending price controls on expensive cuts of meat and establishing a date for enforcing the Grade B milk price), the Region requested and received authorization from the Loan Committee for negotiations which were held in September 1983. At the Loan Committee meeting, the substance of the conditions proposed for the release of the second tranche was questioned, since the conditionality consisted primarily of statements of purposes, timetables and preparation of draft laws. The Region responded that much had been accomplished before Board presentation. These actions are summarized in the policy matrix in Annex 3, including the measures requested in connection with SAL I, the timing of actions planned or actually undertaken by Board presentation and subsequent developments. 18. SAL I was approved by the Executive Directors on November 15, 1983 and became effective on December 13, 1983. The first tranche of $40.2 million was disbursed on December 29, 1983. An accompanying TAL of $S million was also approved by the Executive Directors on November 15, 1983 designed to help the authorities in the formulation of further policy measures.11 g/ See Sectlon V. -5- B. The Adiustment Proaram,5' 19. The program focused on three main areas: improving public sector efficiency, reorienting the incentive structure of the industrial sector, and increasing productivity and output in the agricultural sector. The program's objectives were to increase exports (traditional and non-traditional) and productivity, by reducing policy distortions such as: high agricultural and industrial domestic prices; heavy state intervention in domestic markets; a large and inefficient public sector; and the labor legislation which increased costs. Public Sector Efficiency 20. Given the financial constraints on the public sector, the authorities realized the need for major reforms in this area. The main aim of the Government was to increase public savings. The principal actions included: (i) closure of several public sector enterprises; (ii) a coherent investment program for the period 1983-1985 consistent with the priorities of the new economic program; (iii) reform of public sector housing policy; (iv) studies of the health and social security systems; (v) effective management of state- owned assets, especially those assets located in the former Canal Zone; (vi) reform of the Customs administration; and (vii) improved public sector debt management. 21. Although in 1982 the consolidated accounts of the 45 public sector enterorises and decentralized agencies showed a surplus, some of them required large subsidies. Most of the subsidies and transfers had gone to cover losses of public entities in housing, development finance and the agricultural sector. The Government intended to eliminate these subsidies over a period of five years by selling, restructuring or shutting down some of these enterprises. With these measures the Government expected to eventually reduce the cost of the services provided by these enterpriser to consumers. For first tranche release, the GOP had closed the Felipillo sugar mill and the State banana corporation and sold a hotel. The program included as further steps, the sale of Contadora Panama and the restructuring of the National airline. 22. Due to the heavy debt service obligations and the limited availability of foreign financing, the Government intende;. to sharply reduce Public sector investment from an average of 13% of GDP between 1976 and 1982 to about 7% by the mid-1980s. Social sector investment was to be reduced, especially in public housina. To achieve these goals, the Government intended to increase control over the approval of new projects and the execution of the budget. The public housing policy reforms are detailed in Annex 3, Section I1I.4. 23. Until 1982, the Social Security Aaencv had been generating cash savings despite being mismanaged and involved in inappropriate investment, including the promotion of housing construction projects which had resulted in major losses. As a condition for first tranche release, the Social Security Agency was to be prevented from engagiinj in further promotion of housing j/ The actions taken as conditions for first tranche and second tranche release are detailed in Annex 3. - 6 - construction. Two studies under the TAL would propose a reform program for the Social Security System and the integrated system of health. 24. Under the Canal Treaty of 1979, considerable assets of the prevlouc Canal gone reverted to PanamanLan control: three ports, two unused airports, a large amount of housing, a trans-isthmian railway and a substantial amount of land. Due to inadequate legLslation, some of these assets had been underutilized. New legislation was prepared and presented to Congress ln March 1983, to allow for land in the old Canal Zone to be leased or sold. In addition, the Government intended to finance a study to reform the Customs administration to Lmprove revenue collection. The reforms were to be completed by end 1984. Industrial Policy and Trade LiberalizatLon 25. The new development strategy sought new growth and employment opportunities in the accelerated production of goods for export. Important reforms were needed to transform the previously inw&rd-looking and over- regulated goods sector into an internationally competitive sector. The specific issues which needed to be addreased by the Government included: (i) conversion of quantitative restrictions into tariffs; (ii) establishment of revised maximum and minimum tariff levels and reduction of the average tariff level; (iii) preparation of a new Industrial Incentives Law; (iv) re- moval of price controls; (v) simplification of export incentives; and (vi) flexible interpretation of the labor legislation. 26. As part of the structural adjustment program, the authorities planned to reform trade nolicies. Import quotas were to be gradually eliminated as an instrument of protection and substituted by tariffs. By October 15, 1983 the Government had eliminated around 50% of the import quotas (out of a total of 289 items) and the Government would present a timetable for the removal of the remaining quotas by May 1984.. Import quotas applied to products of an especially sensitive nature wopre expected to take longer to remove. Studies would be undertaken under the TAL to determine the appropriate level of tariff protection to replace these quotas. In view of the results of the studies, new levels of maximum and minimum tariffs would be announced, and included in the draft Industrial Incentives Law to be approved by the 'Qbinet by end-May 1984. The effective rate of protection under the new maximum ariff was to be lower than the rate of protection under the quota system, except for a few agro- industrles that were to receive tpec'.al treatment. The new minimum tariff level was to be applied to some industrial inputs that had previously had very low tariffs. This measure was to help reduce effective protection for the production of final goods while increaeing it for intermediate inputs. The Government also announced that new activities would be afforded a 125% effective protection the first year, falling later to 100%, equivalent to an ad valorem tariff between 33% and 40%. It was agreed that the Government would not apply tariff protection ln excess of 100% ad valorem, except after consultation with the Bank.W 27. An important iesue to be addressed in this sector was the LndustrLal incentives leoislation. Under Law No. 413 of December 1970, firms could sign 6/ See Annex 3, Sectlon II. what were called "Contracts with the Nation", allowing them exemptions from income tax and import duties, reduced rates of taxation and/or tax credit certificates when undertaking an investment project. These contracts were signed on a company-by-company basis and the benefits were granted in a discretionary manner, essentially reflecting the negotiating power of the investor. New legislation was to be prepared to give equal incentives to all firms, and a draft would have to be approved by the Cabinet by May 1984. In the meantime, no new contracts would be signed and the maximum term for renewals would be reduced from ten to five years. 28. Further reforms were planned to stimulate private investor confidence. Price controls on basic foods and other products such as clothing were to be lifted, except those which were applied on politically sensitive items. Moreover, these price controls would become redundant once the corresponding import quotas were abolished. 29. With regard to export incentives, redeemable tax certificates (CATs) had been introduced in 1974 for non-traditional export goods. Due to their potential importance as an instrument to compensate in compensating exporters for the high cost of some inputs, the authorities were going to simplify the process for obtaining CATs, by May 1984. 30. To further reduce costs in the manufacturing sector, labor market riaidities had to be reduced. The Government was accompanying these measures with a study of labor legislation, financed by USAID, to determine to which extent job creation had been discouraged by the Labor Code and to prepare recommendations for its reform. Furthermore, a Legal commission was estab- lished to modify labor code interpretation. Acricultural Policy 31. During the 1970s, the agricultural sector had been characterized by low productivity and low growth. During that period, large amounts of public resources were invested in agriculture, but part of them were allocated to activities with low rates of return including activities oriented towards the "asentamientos" or agrarian reform settlements formed on the expropriated land in the reform of 1969-1973. In addition, agricultural policy had emphasized import-substitution since the asentamientos mainly produced for the domestic market. The new development strategy of the program aimed at reversing this low growth trend and achieving higher output, lower cost of basic foodstuffs and expansion of exports. The specific actions to accomplish chese goals were: (i) reducing and eventually eliminating subsidies for state-owned agricultural corporations and enterprises; (Li) revising the role of public institutions in agriculture; (iii) eliminate import and export restrictionsl (iv) reducing price supports to inefficient producers; and (v) removing price controls. 32. During the late seventies and early eighties, the state intervened heavily in this sector participating directly in agricultural Troduction, in marketing and in the promotion of credit through the Agricultural Development Bank (BDA). In early 1983, a review of the directly productive state onterpr4eeo had disclosed the large amount of subsidies that they had required. Major reforms were subsequently undertaken to reduce those subsidies.11 BDA had also faced serious losses due to the large amounts of lending to the agrarian reform settlements. To reduce operating losses, the interest rate subsidy was cut. These measures were consistent with the financial constraints of the public sector and with the overall goal of the program for allocating resources more efficiently. 33. Agricultural trade and pricing had, for many years, been subject to restrictions and controls which were reflected in the Agricultural Incentives Law (Law No. 19 of October 1982). This legal framework had permitted and encouraged quantitative restrictions on food imports as well as exports, price controls on the basket of basic goods, and support prices on agricultural products. Consequently, resources had been misallocated and productivity had been low. A law consistent with the new direction of agricultural policy was to be prepared and presented to the Cablnet by May 1984. The new policy goal was to reorient the sector towards the production of those agricultural goods in which Panama had a comparative advantage, such as cattle raising, tropical export crops, selected vegetable and fruit crops and forestry, and to the promotion of those exports. These objectives were to be achieved through a reduction of the state's role in marketing and a greater reliance on market forces. As part of the new acricultural trade policy, the authorities had. removed export quotas on beef and coffee to promote the production of these goods for exports. A reduction in orice suyoorts for rice and other basic products was also carried out and was expected to decrease losses of the Agricultural Marketing Institute (IMA) caused by buying the overproduction of rice. As part of the program, the Government would reduce several support prices by March 1985 and free prices for most horticultural products by October 1984. 34. The key actions that had been taken prior to Board presentation were the reform and closure of several public entities, the removal of price controls on several goods and the elimination of most import quotas. As described above, and as can be easily noted in the matrix presented in Annex 3, the program constituted a front loaded SAL. For second tranche release, however, several measures remained to be taken. By end-May 1984, the Government was to: (i) prepare a time-table for lifting the remaining QRs; (ii) fix maximum and minimum tariff rates; (iii) prepare draft legislation for replacing the existing industrial and agricultural incentive laws which had to be approved by the Cabinet; (iv) prepare a detailed public sector investment budget for 1984, compatible with the agreed Investment Program and with the priorities of the Structural Adjustment Program; (v) ensure that the State- owned cement company, Cemento Bayano, not extend existing pricing arrangements for the commercialization of cement beyond their termination date; and (vi) make satisfactory progress in the studies financed under the TAL. C. Implementation and Results 35. In February 1984, the IMF Board approved of Panama's performance in 1983 under the Stand-by (see para.. 90). Bank supervision missions reviewed the public sector's financial performance for 1983 and found a remarkable improvement in public expenditure control. 7/ See Annex 3, Seccion 1.2. 36. On February 13, 1984, shortly after the disbursement of the flrst tranche of the SAL, the President resigned from office because of opposltion by the military to hli candldacy in the Nay elections. A Bank mission was ln Panama at the time and returned satisfied wlth the commitment of the new Presldent and the new Cabinet to the SAL program. However, some political analysts believe that the views of the new preeldent, ideologically opposed to the measures agreed with the Bank, affected negatlvely the $mplementat'on of the SAL conditions, slowlng the compliance with the legally blnding conditlons and dilregarding some of the non-legally blnding conditions. 37. In general, the early months of 1984 were a difflcult period for Panama because of the Presidential election campaign scheduled for May 6 of that year. For some weeks before the ilection, government operations came to a standstill. However, soon afterwards, the Government was able to concentrate again on economic matters and all conditLons for the release of the second tranche were met, as described in the following paragraphs. A factor that contributed to getting the economic program back on track was that the commercial banks had tied the disbursements of their own refinancing credit for 1983 and 1984 to satisfactory progress under SAL I and the IMF Stand-by. ComDliance with Conditionality for Second Tranche Release 38. The New Draft Incentives Laws. On June 21, 1984 the Cabinet approved drafts for the revision of the Agricultural and Industrial Incentives Laws. The proposals represented major improvements over previous legislation and important steps in the promotion of exports. Studies of industrial protection and agricultural pricing which had been flnanced under the TAL provided important inputs in the preparation of these drafts. 39. Within the Industrial Incentives B$il, a significant reform was the proposal to eliminate disc: etionary indlvidual Contracts with the Nation as the vehicle for providing incentives and its replacement by a method which would treat all firms on an equal basis. To stimulate exports and engender competitiveness, the draft included reforms in the rate of protection to industries and treated new and existing ones differently. For new industries, initial nominal protection would be set at no more than 30% which would be reduced to 25% after 3 years. For existing industries, initial nominal protection rates would vary between 10% and 80% but these would be reduced by 20% yearly to a final level of no more than 30%. For new industries, the draft encouraged exports by providing full import duty exonerations as well as exonerations from all other taxes. 40. The reforms of the draft Agricultural IncentLves Law concentrated on eliminating the previous objectLve of self-sufficiency and encouraging the production of goods ln which Panama had a comparative advantage. Price controls on agrlcultural equipment and inputs would be lifted and annual targets for import substitution would be eliminated. 41. Durlng the superviseon misso0n of June, the President-elect indlcated his interest in presenting these drafts to the Legislative Assembly by October 1984. However, the bills were not submitted to the LegLelatLve Assembly and were never made public. No reform of any kind was taken until the next round of the SAL process in March 1986 (see para. 49). - 10 - 42. Trade REform. A number of related trade reforms were included among the conditions for second tranche release due to their importance in the process of trade liberalization. The Government prepared a timetable for the elimination of the remaining quantitative restrictions, excluding quotas on 12 sensitive agricultural items. The actions covered by the timetable were to be completed b* March 1985. Parallel to this program was the lifting of price controls on producto previously subject to quotas. Progress was init_'ally slow; official -regulations lifting quantitative restrictions on the designated products were not published and the Price Regulation Office continued to publish price ceilings. However, to be able to meet the conditions necessary for the release of the second tranche, the authorities directed the Price Regulation Office to lift all price controls on the products for which the quotas had already been removed. The Government also established as a goal a 10% minimum tariff. 43. IThe B4vano Cement Comgany (Cemento Bavanol. The Government ended the pricing arrangement in the cement industry between the state owned-plant and the only private cement company operating in Panama.Y The remaining two conditions (satisfactory 1984 investment budget and satisfactory progress in the TAL studies) were also complied with. 44. The second tranche was released on June 30, 1984. Some of the agreed upon measures which were expected by second tranche release, but were not legally binding (i.e. a part of the overall program, but not tranche release conditions), such as the simplification of export incentives (CATs), had not been implemented. However, Bank staff were then very optimistic on the outcome of the program due to the commitment expressed by the future President, a former regional vice president of the Dank. Nevertheless, following the release of the second tranche, progress under the program slowed down and many measures were not fully carried out, -ncluding the removal of the remaining quotas and of price controls, the reduction of support prices and the enactment of the proposed IndustrLal and Agricultural Incentives Laws. The legislation on incentives, which were supposed to reach Congress by the end of 1984, was not even made public. Also, several new Contracts with the Nation were approved (see para. 48). IV. SAL II A. The Period Between SAL I and SAL II 45. Initially, the Bank moved rapidly to prepare SAL II. Bank staff were aware that thie needed to be a more demanding and therefore more difficult operation than SAL I, as it would cut deeper into the interests of powerful interest groups and require the approval by the Assembly of certain laws. Therefore, the Bank planned to front-load the program, disbursing against actions taken and not against promises of future measures. Appraisal of SAL II was programmed for January 1985. Thie original schedule could not be kept due 8/ However, a proposed cut in the cement price in July 1984 was not imple- mented. - 11 - tot (i) backtracking on conditions of SAL It and ($i) disagreements on the content of the SAL II program. This situation lasted until early 1986.V 46. During January and February 1986, there were intense negotiations on the content of a new Letter of Development Policy and the draft. of the three laws (industrial incentives, agricultural incentives and labor code reform) required by the Bank as a condition for going forward with SAL II (the approval by Congress of the incentive laws by end 1984 was a condition of SAL I). Disagreement continued on the industrial incentive law and on the exact nature of the policy changes in agriculture. A key breakthrough occurred in late February 1986 when the Bank accepted a limited reform of the industrial incentive law. At the same time, the Panamanian authorities proposed to undertake several measures for social security reform, an issue which had not been previously included in the policy matrix. Ultimately, the Industrial Incentive Law had an adequate time horizon, but in substance there was no major trade liberalization.W 47. In March 1986, the proposed reforms in industrial incentive, agricultural and labor code legislation were approved by the Congress. At the same time, an Aide Memoire between the Bank and the Panamanian authorities established a timetable of monitorable actions that would be required for processing the proposed SAL II. The compliance with this timetable was not smooth. Actions were seldom taken by the specified date. The Aide Memoire was renegotiated in May 1986, when appraisal was concludad. It was then recom- mended to increase the size of the loan, due to agreement on a reform of the Social Security System. The justification for such an increase, however, appears weak. Implementation of the agreed actions continued to be slow, especially in the agricultural sector were the minister was uncooperative. Board presentation was delayed due to Cabinet disagreements with respect to the reform of the Social Security System. Finally, the Bank waived the condition of Cabinet approval of a Social Security Reform draft law.WJ' 48. In April 1986, a Bank mission visited Panama to begin the preparation of a PCR for SAL I1.2 It found that compliance with SAL I conditions was 9/ See Annex 4 Part A for an account of these differences and the main events of 1985. 10/ The initial position of the Bank was to uphold the trade reform described in the 1984 draft: to lower import tariffs to 30% maximum (and 10% minimum) in five years. The GOP had proposed to lower import tariffs to 65% maxi$um over a 10 year period with three years of grace. Finally, it was agreed to reduce tariffs to 60% (with excep- tions) over a five year period; the minimum import tariff would be 3%. 11/ The events summarized in this paragraph are described in more detail in Annex 4, Part B. The Bank's reaction towards the difficulties in the implementation of the conditions appear to be important in explaining the difficulties encountered after SAL II was approved (see para. 106). 2/ The fi.ndings of this misston form the basis of the "Actions Taken" column for SAL I, in Annex 3. - 12 - mixed by then. Several actions scheduled to be completed after second tranche release (e.g. removal of export controls on fish meal and coffee, sale of the Hotel Contadora) had not been taken as expected, while a substantial number of new Contracts with the Nation had been approved after October 1984 in spite of the commitment to approve only renewals. As regards the measures taken before second tranche release of SAL I, it was found that administrative actions had partly or fully negated some of the reforms involved (e.g. some import quotas). Practically all of these were tackled in SAL 1I, except for the new Contracts with the Nation, that remained in effect. The Bank accepted the argument of the GOP that it could not legally repeal these contracts. 49. SAL II (for $100 million) was finally approved on December 11, 1986. The second tranche (of $50 Million) due in March 1987 was canceled in December 1987 at the Government's request (see para. 75). 50. Panama's economic situation at the time of loan approval was not good. The economy had not grown in 1983-84, as several autonomous elements adversely affected the growth in services; and the completion of the first stage of the La Fortuna hydroelectric dam and the oil pipeline, and the reduction in the housing program (as a result of a SAL I agreement) reduced construction activity. The Government had concluded in July 1985 a Stand-by Arrangement through 1987, with a fiscal deficit target in 1986 of 1.2% of GDP. In late 1985 an agreement had been reached to reschedule amortization owed to commercial banks for 1986 and 1987. In September 1986, the Paris Club also agreed to reschedule half of maturities due to its members. The outcome of those financial postponements and new credits was that the share of inter- national organizations in official foreign debt rose from 14% in 1980 to 23% in 1985. By the end of 1986, the stock of debt represented over 70% of GDP and debt service required over 30% of government revenue. Around $2100 million was owed to commercial banks (55% to U.S. banks); of the remainder (approx- imately $1400 million), 70% was owed to multilateral agencies. B. The Adiustment ProaramW 51. The program included reforms in the public, the industrial and the agricultural sectors, and in labor market regulation. Public Sector Efficiency 52. The main issues to be addressed in this sector were: (i) closure or sale of several public enterprises; (ii) reduction of public employment; (iii) preparation of a public investment program for the period 1986-1987 consistent with the priorities of the development strategy; and (iv) reform of the social security system. 53. To increase public savings the Government intended to continue restructuring agencies, and closing or divesting those state enterprises that had required large amounts of subsidies. By Board presentation, the Seed Company (ENASEM) and Azuero (or Las Cabras) Sugar Mill had been closed and two other enterprises hal been sold. Two additional enterprises from a list of 12/ A summary of the actions taken and those agreed for second tranche release can be found in Annex 3. - 13 - three had to be sold by Aprll 1987. These measures were going to cause some public employees to be lald off. In addltlon to the closLng and dlvestltures, the authorities expected to reduce the nublic sector labor force by 2% ln 1986. Consequently, wage related publlc expendltures would be decreased. DespLte being a polltlcally difficult issue, thlo was essentLal because wage-related expendltures represented a large share of public expendltures, and other areas of public expendlture had already been heavily cut durlng the SAL I program. 54. Durlng 1984 and 1985, the Soclal Security Agency had facod near-term liquLdLty problems which had malnly resulted from the fallure of the Government to pay lts contributlons and lnterest obllgatlons ln cash, the defLiLt of some of lts speclal penslon programs, and poor admLnistratLon. Furthermore, studles flnanced by the TAL had revealed serious medlum-term structural problems ln the penslon program: first, demographic trends toward an older population; second, generous penslon paymencs; and thlrd, extremely low optlonal ages of retlrement wlth full benefits. Although polltlcally sensltlve, reformlng the Social Securlty Agency was essential to lmprove the medlum-term finances of the public sector and to reduce rLsLng wage taxes due to larger contributlons. In thle respect, glven the country's relatlvely hlgh wage structure and lnabillty to l.ncrease wage competLtLveness through adjustments ln the exchange rate, lt was lmportant to remove excess costs related to labor. For second tranche release the GOP was to reform the Pension Law and the Leyes EspecLales (the special regime for publlc employees) and to reduce the work force of the Social SecurLty Agency. Industrial and Trade Policy 55. The main reforms lncluded ln the program were: (i) eliminatlng all but 20 import quotas; (li) the substitutlon of Contracts wlth the Natlon wlth a simple industrlal regLstry; (LLL) establlshment of mlnimum and maximum tariff levels; and (iv) accordlng greater emphasLs to ad valorem tarlffs. Many of these reforms were embodled under the new Industrlal Incentives Law whlch was passed ln March, 1986 and substltuted Law No. 413 of December 1970. 56. Under the new Industrial Incentlves Law, Contracts with the Natlon signed on a company-by-company basis were abollshed and substltuted by an Industrial Registry which allowed equal Lnvestment incentLves for all flrms. Furthermore, the Law establlshed new maxlmum and mlnlmum tarlff levels. The new maxlmum tarlff level of 60% established was double the 30% maximum under the SAL I program. Tarlffs on exlstlng Lndustries would decrease over a flve year perlod to an ad valorem tariff of no more than 60% of import LIF costs, except for a group of products whi:h, for reasons of natlonal lnterest, would remaln at 90% at the end of the perlod. Tarlff protection for new products :ould not be hlgher than 20%, except 30% for lndustrial goods of agrlcultural origin. Finally, flscal lncentlves were larger for fLrms located in speclflc geographlcal areas. 57. The authorlties lntended to contlnue the process of converting quantLtatLve restrLctLons lnto tarLffs lnltlated during the SAL I perlod and lnterrupted as the more polltlcally entrenched quotas were reached; only 20 quotas concentrated on agricultural products were to be left ln place by June 30, 1986. - 14 - Emilovment Policy 58. Panama's Labor Code, enacted in 1972 and amended in 1976 and 1981, had introduced rigidities in the labor market restraining employment creation and segmenting the market. Under the provisions of the Code dismissing personnel became costly as did any measures rewarding productivity. In March 1986, amendments to the Labor Code were approved by the legislature. The first change introduced was to expand the definition of small enterprises; such enterprises were exempted from the clauses of the Code regarding dismissal. Other changes concerned overtime, piecework to allow the establishment of productivity pay schemes and the administration of the Code to reduce abuses. Aaricultural Policy 59. The specific measures included in the program were: (i) to reform agricultural legislation; (ii) to revise the role of public institutions in agriculture; and (iii) to liberalize agricultural trade and pricing policy. 60. Along with the Industrial Incentives Law, an Agricultural Incentives Law had been passed in March, 1986, replacing Law No. 19 of October 5, 1982. The new piece of legislation gave greater emphasis to efficiency and com- parative advantage and removed mandated quantitative goals of self-sufficiency. The Governmc,nt planned to accompany these reforms with appropriate institu- tional actions and changes in pricing policy. Some of these policy changes concerned the Agricultural Marketing Institute (IMA) which was to discontinue its previous marketing activities and restrict itself to warehousing, and providing price and market information. The Government intended to be less involved in Pricing Policv and to place greater reliance on the interplay of market forces. Support prices, as well as import quotas, were to be removed with the exception of a few products. The quotas were to be replaced by tariffs and reduced in three equal steps to new maximum tariff levels. Controlled prices on consumor goods were also to be lifted. These measures were expected to reorient price signals to items where Panama has a comparative advantage. Furthermore, the removal of support prices was also to result in savings tc) the treasury; domestic prices had been partly supported through direct subsidies and had become a fiscal drain. Additional sources of fiscal drain in this sector were to be eliminated by closing or divesting inefficient public sector activities (para. 55). Condltions for Second Tranche Release 61. The specific actions to be completed before the second tranche release were that the Government would have: (i) completed its program to reduce the public sector work force by 2%; (Li) taken all necessary measures to strengthen the administrative capabilities of the Social Security Agency (Caja de Seguro Social); (iii) provided evidence that the disability, old age and survivor pension programs had been reformed in manner consistent with an actuarially sound financial basis and that the special pension program of government workers had been amended (Leyes Especiales); (iv) reduced tariff rates applicable to the importation of agricultural products; (v) divested from publlc ownership three of the following enterprisess Citricos de Chiriqui, Aeroperlas S.A., Hotel Contadora, and Ingenio el Alanje; (vi) completed the reorganization of the Instituto de Mercado Agropecuario (IMA); and (vii) - 15 - provided zatisfactory evidence that the Government's external financing for 1987 could be met. C. Implementation and Results 62. Progress in compliance of the Government with SAL II conditionality declined considerably over time, and from early 1987 on the Government was unable to take any significant economic measures. 63. In May 1987, staff who reviewed the agricultural sector conditionality were extremely critical of Panama's compliance in this area. The schedule for tariff reduction had not been announced, commodity specific "Comisiones Nacionales" were monitoring prices and establishing quotas in violation of SAL I and SAL II agreements, and there were even attempts by a group within the ruling party to repeal the agricultural law. In summary, very little of what the Bank had asked in agricultural policy was in fact being done. The mission finally agreed with the GOP on a schedule of tariff reductions for rice, maize, onions and beans in the 1987-1989 period. These reductions were a second tranche release condition. 64. In June 1987, several key events took place. General Noriega was accused of drug trafficking, planning political assassinations and other political crimes. These charges led to the first civil disturbances in Panama since 1964. The worsening fiscal crisis forced the GOP to suspend principal and interest payments on foreign debt owed to governments and principal payments to commercial banks. 65. By end July 1987, Panama had only complied with three of the seven second tranche release conditions. It hads (i) strengthened the administra- tion of the Social Security Agency; (ii) reduced agricultural tariffsl and (iii) completed the reorganization of INA. By mid-August there had been no progress and some reversals, especially in the agricultural sector where some price controls were formally reinstated and IMA started to intervene in imports and prices again. The following paragraphs discuss compliance with the second tranche release conditions in more detail. 66. Public Sector Work Force. Different statistics give contradictory information with respect to this condition, but the figures supplied by Pireccion de Estadistica v Censo indicated that, instead of declining, the public sector work force increased between 1986 and 1987, especially within the Central Government. 67. Social Security Reforms. Various measures were carried out to strengthen the CCS administration including a reduction in its work force and in the losses of the health care program and the Complementary Fund (that finances higher pensions for retired public employees). However, the reforms of Leyes Especiales and the Social Security Pension scheme were not imple- mented. 68. Privatization Prooram. The Government was able to sell Hotel Contadora and Aeroperlas. In addition, either the El Alanjo sugar mill or Citricoe de Chiriqui were to be sold prior to the second tranche. However, at the end of 1987, both entities remained under government operation. In the - 16 - case of El Alanje sugar mill, output was being dumped in world markets at a lose. 69. Flscal Performance. Having an acceptable flnancial plan ln place for 1987 was a conditlon for the disbureement of the second tranche. However, the 1987 budget was formulated ln a manner Lnconsistent with available external financing. Actual external financing was about $150 million below the initially expected level, due to Panama's inability to conclude a new stand-by arrangement wlth the IMF, failure to meet second tranche release conditlons, and lts consequent lnabillty to obtain new money from commerclal banks. In addltlon, publlc savings performance was poorer than ln 1986 as a result of a rise in recurrent expenditures while revenues were steady. The lack of flnanclal resources resulted in the Government cutting investment severely and in late 1987 starting to incur arrears wlth international creditors. 70. Acricultural Sector. The GOP complled with the two conditions for the sector, in part because the Bank was prepared to accept to change the schedule for tariff reduction in agriculture, postponlng lt beyond the span of influence of the loan but asking for a formal announcement of the timetable, and accepted a minor change in the operatlon of IMA as sufficient. A waiver was never formally requested because the other conditions were not complled with. 71. Maintenance of First Tranche Conditions. Along with the monitoring of the second tranche conditions, the Bank followed progress on the actions supported by the firat tranche. The findings were that actions had been taken as planned, with some reversals in the area of agricultural policy. 72. In manufacturing, the implementation of the Industrlal Incentlves Law proceeded smoothly wlth flrms joining the new registry; some firms renounced their Contracts with the Nation. The second of the flve tarlff cuts to be applied to existing products was implemented. Progress had been achieved towards a more unlform tariff system. 73. In agriculture, several measures were undertaken during 1987 that reversed the actions supported by the firat tranche. The Comisiones Nacionales established under the Law in March, 1986 as commodity-specific committees for research and the provislon of advlce and consultatlon had been informally controlling imports of agricultural products through dlfferent mochanlsms lncludlng animal and plant regulatlons. Although IMA stopped its function of setting producer prices as the program had planned, the Comisiones Nacionales de facto established support prices. These actions contradLeted the objectLves of both SAL I and II ln the area of agriculture. 74. Furthermore, after the liberalization of consumer prices, a system of price controls operated initlally for some products. In July-August of 1987, formal controls were relnstated by the Price Control Office (ORP) on several items such as onions, chLcken, eggs and fish. New products were brought under price control during the remaining part of the year. 75. A mission in the fleld in August 1987 concluded that the Bank should be prepared to cancel the balance of the loan, as it appeared impossible that the GOP would comply with second tranche conditions. By the end of August, the Minleter of Plannlng and Economic Policy had confirmed that there was no chance of compllance wlth SAL II condLtionalLty. The Bank then suggested to the - 17 - Minister that Panama should request the cancellation of the loan before its closing date. In the meantime, Panama incurred arrears in its payments to the Bank and disburuementa on operations in the country were suspended in November 1987. On Deceaber 14, 1987 the GOP asked for cancellation of the second tranche of $?dL II; the Bank agreed, making it effective as of the date of r-uest. The loan's closing date was December 31, 1987. V. THE TAL A. Introduction 76. A Technical Assistance Loan (TAL) for US$5 million accompanied SAL I and financed technical assistance and studies to support further public sector reforms. It aimed at providing the Government with the necessary information and analysis for decision making in priority sectors in support of its structural adjustment program. 77. The project included the following studies and technical assistance activities: (i) analysis of trade and price polici*s in the agricultural sector; (ii) strengthening of agricultural institutions, including training; (iii) actuarial, financial, administrative and managerial studies of the Social Security Agency and technical assistance to strengthen it, including staff training; (iv) evaluation of the level of effective protection in the industrial sector; (v) study of the health system; and (vi) multi-modal transport study of Panama City-Colon Corridor. B. Description of the Studies Studies in the Aaricultural Sector 78. The studies were to be carried out in two areas: (i) price and trade policies; and (ii) the state institutions in the agricultural sector. The studies aimed at developing specific and detailed recommendations to enable the Government to reshape the two areas in accordance with the medium term strategy laid down in the structural adjustment program. 79. The trade and price policies study was to specifically review the cost effectiveness and benefits of the current price policies for several products, and analyze their trade regime. The study was to provide advice to the Government on modifying the Agricultural Incentive Law. 80. Technical assistance related to public institutions was to be in two phases. In phase one, there would be a study to review the present role of the principal institutions and to suggest changes to adjust them to the new policy. Phase two was to consist of direct technical assistance to implement the agreed recommendations of phase one. Effective Protection in the Industrial Sector 81. The replacement of quotas by ad-valorem tariffs required much technical work to judge the appropriate level of the initial tariff. This study was to assist the Government in that task. Its findings would also assist the Government in the revision of the Industrial Incentives Law. - 18 - Social Security and Health 82. Among the public entities, the Social Security Agency (CSS) was the most important in financial terms. The study was to provide a comprehensive diagnosis of the projected situation of the social security system and would recommend alternative ways for compliance. it was to include recommendations on the appropriate legal framework and on management and financial procedures. The pension system study was to concentrate on an actuarial evaluation and on the analysis of the appropriateness of the legal requirements to receive a pension. Finally, the health sector study was to focus on the policies and strategies of the sector; the availability of health services; and the institutional arrangements between the CSS and the Ministry of Health. Multimodal Transport Study of the Panama City - Colon Corridor 83. The objective of the study was to determine the most economic use of the trans-isthmian transport alternatives between Panama City and Colon, and to make recommendations as to the appropriate transport policy and transport investments for the Corridor. C. Imclementation and Results 84. Implementation went smoothly and the stulies were of good quality and generally helpful to the Government and for the design of SAL II. A summary of the studies, their main conclusions and actions taken with regard to recommen- dations are presented in Annex 2. 85. On December 12, 1986, the GOP asked, and the Bank agreed, to extend the closing date from December 31, 1986, to December 31, 1987. On November 25, 19S7, the GOP asked again for an extension, from December 31, 1987, to December 31, 1988. Given the arrears that Panama accumulated with the Bank, disbursements were suspended on June 30, 1988. The Loan was finally canceled on July 18, 1989, with an undisbursed balance of US$0.5 million. 86. There existed what the GOP called phase II of the TAL, in which funds not used in Loan 1878-PAN (Colon Urban Development) were transferred to the TAL unit. Several studies were undertaken with these funds, but they have not been analyzed as they were funded by the technical assistance component of another loan. What is relevant to the TAL is that it was charged the expenses of administering a further US$l million in studies. 87. A thorough assessment of the relevance of the studies would require information that I,s not available. Several (i.e. effective protection, trade and pricing policies, actuarial study of the pension system) were useful for the policy dialogue and the design of SAL II. However, very few of the recommendations of the studies were implemented (see Annex 2). In part, this was due to the lack of commitment of the GOP to the reforms in the agricultural sector and the social security system. In part, it was due to the end in 1987 to the lending program. - 19 - VI. RELATIONSHIP WITH THE GOVERNMENT'S SHORT-TERM STABILIZATION PROGRAM AND THE STAND-BY AMRANGEMENT WITH THE IMF 88. Along with the development of the structural adjustment program in 1983, the Panamanian Govenment prepared a fiscal stabilization program. The main aim of the program was to lower the public sector deficit from the level of 11% of GDP reached in 1982. 89. A number of revenue and expenditure measures were taken to achieve these goals. The extent to which current expenditures could be reduced was limited by large interest payments obligations and by commitments made in 1982 for wage and salary increases. Consequently, investment had to bear the burden of the stabilization program. To support this program, the IMF approved in July, 1983 a Stand-by Arrangement of 150 SDR (about US$173 million) of which one-third was to be disbursed in 1983 and the remainder in 1984. The main conditions attached to the Stand-by were public sector deficits of no more than 6% in 1983 and 5.5% in 1984. In addition, there was to be no net increase in commercial foreign debt. 90. Although the program targets of 1983 were met and the public sector deficit declined to 5.7% of GDP, fiscal performance In 1984 weakened. Revenues declined, reflecting weak economic activity during 1983-1984 while current expenditures were higher than planned partly due to a large increase in spending on goods and services by the Central Government. To be able to compensate for the low level of savings performance, public investment was again reduced, below it. initially programmed levels. During this period, the good performance of public entities to control spending was notable. 91. The Government also initiated negotiations with the commercial banks to refinance the large amount of amortization obligations falling due in 1983 and 1984, but encountered difficulties due to the commercial banks' concerns over their exposure in Latin America. As a result of its 1983-1984 stabiliza- tion and structural adjustment programs, the Government was finally able to obtain a refinancing of US$278 million signed in September, 1983. Panama also received funds from other multilateral and bilateral agencies, including IDB and USAID, and was able to complete the financial package needed to meet the projected public sector deficits in 1983 and 1984. 92. The second stabilization program included a series of revenue and expenditure measures to achieve a public sector deficit of 3.5% of GDP in 1985 and 2.6% in 1986. The main revenue measures were broadening of the income tax base, change in the import duty valuation base from f.o.b. to c.i.f., and increases in fees and indirect taxes. With respect to current expendltures, control of public sector entities' spending was to continue. A wage freeze was to be implemented for most public sector officials and a reduction of 5000 positions of the Government was to be undertaken in 1985. The overall public sector deficit was to be financed from external sources and there was to be no net recourse to National Bank credit, since its liquidity position was becoming tight. The IMF approved on July 15, 1985 a 21-month Stand-by Arrangement to support this program for an amount of SDR 90 million. 93. In late 1985, Panama was able to conclude negotiations with commercial banks on the rescheduling of amortization falling due in 1985 and 1986 for an - 20 - amount of US$579 million and with a new money package of US$60 million. Part of these new credits from the commercial banks (US$42 million) and an additional US$40 million from the USAID Economic Support Fund were to be disbursed in 1985 conditioned on progress made in negotiating SAL II. Since the Government was not able to sustain its economic reform program and SAL II negotiations were not completed in 1985, a short-fall in external financing arose resulting in the use of net credit from the National Bank and a further curtailing of the investment program. The public sector deficit amounted only to 1.7% of GDP. The public sector work force increased during 1985 and 1986; and there was an overall increase in the real wage of the public sector for both years, especially for 1985. 94. Early in 1986, the Government reacted to the financial crisis and reembarked on its program of structural reforms. The financial stabilization program was renewed; a new target for the public sector deficit was set at 1.2% of GDP and investment was to be kept at the low levels of 1985 around 3.8% of GDP. The IMF and the Bank collaborated closely with the Government in the preparation of both programs, especially in the area of public investment. Performance under the IMF stand-by was satisfactory during 1986. 95. In both stabilization programs, adjustment in public sector finances largely came from cuts in investment and, by the second program, public investment had reached levels barely above the required investment to replace the depreciation of capital stock. Parallel to the public investment adjustment, public sector real wages had been increasing since 1982. If stronger efforts would have been made to control expenditures on wages and salaries, current expenditures could have largely been decreased releasing resources for public investment. VIZ. EVALUATION OF THE SALs AND THE TAL. AND THE ROLE OF THE BANK A. p6sign of the Proaram 96. Approaching the Bank in 1982 to formulate a SAL program, the Panamanian authorities clearly understood the depth and nature of the adjustments which needed to be undertaken. Moreover, they recognized the intensity of the political furor the proposed measures would likely engender and were prepared to face those problems. These appreciations were reflected in the design of the SAL program agreed upon with the Bank, the comprehensive nature of the areas where actions were to be undertaken, and in the timing established for those measures, in particular the extent of front-loading. 97. An inventory of the proposed reforms under the program is provided in Annex 3. This list shows that the areas scheduled for reform in the program were important. This remains the case even if one excludes the conditions that were not met, leading to the cancellation of the second tranche of SAL I'. The overall action plan for the structural adjustment program backed by the SALe, was a good one. There are, however, important questions about the appropriate- ness of the design of the specific reform program contained in the SALs. 98. What is suspect is the effectiveness of the specific changes that were finally agreed on, particularly their potential contribution to the realization - 21 - of the main objectives of the strategy. For example, was the timing of tariff reductions adequate and the ultimate goal of 60% maximum tariff (with exceptions at 90%) low enough to produce the desired resource reallocation from import substitution to export activities? With hindsight, this ultimate goal was too high. Was the agreed list with maximum tariffs of 90%, including food products and construction materials inconsistent with the goals of the program, i.s. to reduce the prices of wage goods? Even if one accepts the idea of having a limited number of goods exempted from the general process, the particular selection of goods appear inconsistent with the program. Finally, the Labor Code had been identified as a major issue but was only marginally reformed. 99. Given the nature of the Panamanian economy, reforms of the incentive system (cum labor code) needed to receive more weight, since its importance in real appreciation of the exchange rate is larger compared to a conventional economy where monetization of fiscal deficits has a greater impact on appreciation. Even though the importance of reforms of the labor code as well as the system of incentives (agriculture and industry) suggested the need for front loading these key conditions in SAL II, the legislation passed was not fully adequate. The Labor Code, as is argued in the 1985 CEM, needs to be reformed as a whole, and not marginally. In agriculture, Law 2 changed al ture the philosophy with which the public sector intervened, but de facto things continued to be handled as they had been before. The industrial sector tariff regime created by the 1986 law was inadequate to fulfill the goal of gearing the manufacturing sector towards export promotion and away from import substitution. The final dispersion (from 3% to 60%) was too large and the discrimination against new industries (with a maximum tariff of 20% or 30%) contributed to a further distortion. The paragraphs that follow discuss the reasons put forward to justify the design of the loans, in particular of SAL II. 100. Bank staff recognized that the maximum tariffs were too high but viewed i.e measure as the beginning of a trade liberalization program that would continue later with the structural adjustment program. The Panamanian structural adjustment process originally had been seen by the staff in the context of the Bank's experience with other countries (in particular Turkey), which involved a series of SALs. At that time, it was not considered possible to achieve more on trade reform under one operation. Furthermore, the proposed social security reform that was introduced in the program when it was realized that the trade liberalization component would not be as strong as desired, was deemed important. 101. Moreover, Bank staff accepted that the political costs of going further would have been too high for the GOP. It is true that the political capital lost in the approval of the three laws was substantial. A two week general strike followed the announcement of the laws, at the end of which the laws were approved by Congress, apparently under heavy pressure from the Defense Forces. For some political analysts, the date of approval of the three laws marked a significant date for Panama, the date on which the government decided to abandon the Torrijos legacy. The approval of the laws appears to have represented a significant departure from the attitude followed previously by the GOP. Therefore, it is impossible to judge if this was an opportunity to be grabbed or if the Bank should have pushed further for more substantive reforms. - 22 - 102. The reforms agreed under SAL I and especially under SAL II, can be viewed either by the political costs that they entailed or the progress towards achieving the objectives of the structural adjustment program. Though the political costs were substantial, progress was modest. One could consider that the GOP was making a great effort towards complying with the program if one judges this effort by the political costs they faced. To some extent, it appears that Bank staff were doing this when assessing the GOP performance and commitment. However, if the maximum political costs a Government is willing to face is attained with measures that fall below an acceptable threshold of substantive reform, then the country may not be ready to receive a structural adjustment loan. In the judgement of this issue the perceived commitment of the Government should play an important part. One could argue that it is reasonable to back a strongly committed Government in an unambitious loan with great political costs, as a step in a long run effort but, in this case, the Bank had doubts on the Government's commitment (see paras. 106 and 107). B. Front Loadina 103. Front loading was a particularly important element in the design of SAL I and the extent of those arrangements was cited by the staff as the main reason for the relatively limited conditionality for rel,'ose of the second tranche (paras. 17 and 34). The practice was seen as reducing the possibility that governments would be charged with submitting to external pressures in undertaking reform, a charge which could often crystallize opposition to those measures. It would appear that the early measures adopted under SAL I, drafted in large part by the economic team in consultation with the Bank, did not face organized oppo,Lt,on. 104. By tte t.me of preparation of SAL II, the situation had changed markedly. The viewpoint of the GOP economic team was clearly dlfferent from the previous team's and Bank staff had doubts about the Government's commitment to the reform process. Under these circumstances, front loading was seen as an indispensable means of ensuring the Government's commitment. Since the approval of SAL II was essential to complete the financial package for 1986, the Government did comply with the agreed upon measures prior to Board presentation, permitting loan approval in 1986 (see Annex 4, para. 17). C. Sustainubilitv 105. An important issue concerns the sustainability of the reforms which were adopted. As noted in the earlier discussion, a number of measures taken in connection with SAL I were subsequently reversed prior to the preparation of SAL II and reinstating those measures was one of the concerns in negotiating SAL II. In fact, by 1988, after the cancellation of the balance of SAL II, most of the substantive measures regarding quotas and price controls which were targeted under the SAL process had been reversed. This was not a problem of the design of the loan but the consequence of dealing with a Government which was experiencing basic political instability and was both unable and unwilling to formulate a viable economic program. 106. Faced with doubts on the degree of commitment of the GOP, the Bank chose to front-load the program. The strategy failed in the long run, an policies were reversed. Two alternative strategies to deal with doubts on government commitment, and to promote sustainability are briefly considered. - 23 - First, if the SAL program is viewed as part of a process, the Government would have an incentive to comply as otherwise the SAL process would be stopped.U But the issue is the credibility of whether the Bank will be acting in this manner. In the case of Panama, conserving its credibility may not always have been the Bank's main concern. The Bank accepted an increase in the proposed SAL II loan amount, in the context of rather reluctant compliance under SAL I and of a program that, overall, does not seem to be significantly stronger than the original one (Annex 4, para. 12). The Bank subsequently waived what was considered a key condition for Board presentation (the presentation of a draft Social Security law to Congress, see Annex 4 para. 18). The second strategy would be to shift from SALs to smaller SECALs. The shift from SALs to SECALs would increase the number of instances in which compliance and commitment is judged before going ahead with the program. The cradibility in the enforcement of the Bank's conditionality is crucial to both. 107. One of the important lessons of these loans is the need to reflect on the issues of Government commitment and the Bank's possible strategy when faced with doubts about it. In conversations with Bank staff, it was clear that in SAL II it was difficult to gauge the Government's ultimate commitment to the reform process, especially because there was a division within the Government over economic policy. Though the above alternative strategies could be useful, the evidence suggests that, in the absence of strong government commitment, it is extremely difficult to design and implement successful policy-based operations, either for SALs or SECALs. D. The Role of the Bank 108. Given the closely shared views of the authorities responsible for the preparation of SAL I and of the Bank staff working on the operation, the processing of the loan moved rapidly and smoothly, once the formal request from the Government was received. Moreover, Bank staff inputs were only some one- half of the average prevailing among the earlier SALs.W Much of the details of the program was elaborated by the Panamanian staff under the general guidance of the Bank. 109. The situation for SAL II was very different. The difficulties in getting agreement with the Panamanian officials on the necessary measures and on proper implementation is reflected in the substantial increase in staff inputs required for this operation. Considerable staff time was spent in working out details of proposed actions and on follow-up, given the ambivalence prevailing within the Government. Though the follow-up effort was intense, there appears to have been some weaknesses. As is clear from the preparation of SAL II, missions were often surprised by developments in the country once they arrived in Panama. One possible explanation is that staff relied too much 14/ Stopping the SAL program does not necessarily mean severing relations with the country. In those instances where reform faces, for the moment at least, insurmountable barriers, the Bank can maintain a core lending program focusing on social sectors where the macroeconomic distortions are not likely to affect the social rates of return of such projects. ~j/ See OED report, No. 6409, dated September 24, 1986. - 24 - on official sources to gather information on government actions and apparent policy changes. E. Impact of the Program 110. During the 1983-87 period the economy continued to follow most of the trends identified beforehand (see paras. 5 to 13). The rate of growth of the economy continued to decline, in line with the rest of the region. Services continued to grow at a faster rate than goods production. There was a deep recession in the industry and construction sectors in 1983-84, that can only partly be attributed to the program's changes to the housing policy. Government consumption continued to grow at a faster rate than the economy as a whole. Public investment, however, decreased by over seven points of GDP. Private investment also declined. The trend towards reducing the openness of the economy, measured as the ratio of the sum of exports and imports (including services) to GDP, also continued. This ratio decreased from 84.8 in 1982 to 63.4 in 1987 (see Annex 1, Table A.2). Both in the size of the public sector, and in the degree of openness of the economy, there is little evidence that the program had a significant impact, though it was intended to. This lack of impact of the structural reform component, at least during the 1983-87 period, is probably due to the design of the program (see above). However, the stabilization component was successful, as both the current account and the public sector deficits were reduced by 1987 to one tenth of the 1982 levels. VIII. CONCLUSIONS A. AccomDlishments of the SALs Ill. The fundamental objectives of the SALs were: (i) to increase the efficiency and reduce the size of the public sector; and (ii) to change the incentives in agriculture and industry from import substitution to export promotion. Neither of these objectives was fully met. 112. While there was successful privatization and closing of public enterprises, overall the size of the public sector grew. By the end of 1987, current expenditure continued at the same level as a percentage of GDP, as when the program started. Furthermore, the number of employees in the central government increased by an annual average of 4.6% between 1983 and 1987. Controlling the size of the public sector was a condition of both SALs and a reduction of the number of employees in the public sector of 2% was a specific condition of SAL II. Regarding the reduction of budgetary deficits, which were integral components of the conditions for IMF Stand-by, all of the reductions were due to declining public investment. The appropriateness of the budget strategy actually pursued was called into question several times by the Bank in its discussions with the IMF. As regards measures to shift incentives, those that were taken (e.g. the industrial incentive law) were insufficient and many were reversed, either officially or unofficially through administrative discretion (see paras. 48 and 73). 113. By early 1988, the measures taken fell considerably short of what was expected at the time the loans were made. SAL I was successful in meeting its immediate objectives: abolition of a large number of import quotas, closure - 25 - of a major sugar mill, stricter control over public expenditures and in setting the agenda for the reform process. However, the release of the second tranche was followed, by a period of backsliding. SAL II was considerably delayed due to this backtracking and disagreements on the content of the SAL II program. This situation lasted until early 1986, when agreement was reached on the content of three key laws. In substance, these laws were not strong enough to attain the objectives of trade liberalization and labor market flexibility (see para. 90). Overall, SAL I1 was successful in finishing some of the processes started by SAL I, but was too weak in several key areas. Most of the actions included in the second tranche were not taken, and many of the first tranche conditions, especially concerning agriculture, were reversed. 114. With respect to the TAL, implementation went very smoothly and the studies in general were of good quality. Several studies (i.e. on effective protection, trade and pricing policies, and the actuarial study of the pension system) were very useful for the policy dialogue and the design of SAL II. However, very few of the recommendations of the other studies were implemented. B. causes of Failure 115. In sum, the SAL program, and in particular SAL II, was not very successful. What were the factors that contributed to the lack of success? Was the key issue that the program was incorrectly designed? Or was it just a problem of Government commitment? Could this lack of commitment have been detected before the loan was designed? If this is the case, what should the Bank have done? 116. A plausible answer to these questions is that there were flaws in the design (see paras. 98 and 99), but the program could be seen as initiating a process which, if deepened, could address the fundamental problems. The key issue is that the GOP was not committed to the program, especially under SAL II. Bank staff were aware that the GOP authorittes saw the SAL primarily as the means to cover the budgetary deficit and as absolutely essential to complete the external financial package, and that they were not sufficiently convinced of the need for structural reforms. Nonetheless, the Bank went ahead with the loan. The lack of an appropriate strategy to deal with this lack of commitment then became a problem. Given the doubts about commitment, the decision to go ahead relied on the leverage the Bank had to withhold the disbursement of the second tranche. This strategy, however, requires credibility that the Bank would take such action, which in the case of Panama, the Government seemed to doubt (see para. 106). This undermined the possi- bility of effectively using this leverage, as the GOP thought that it was possible to change the second tranche conditionality in case of non-compliance. This impression could have been based on the mild-trade liberalization reform accepted by the Bank; on the fact that the Bank accepted to increase the size of the loan, a decision that did not appear warranted by the increased substance of the program; and finally, because the Bank waived the condition of Cabinet approval of a Social Security Reform draft law before Board presentation (see Annex 4, paras. 12 and 18). The decision to go ahead without sufficient safeguards with the loan, given the doubts about government commitment and the fact that second tranche conditions were concentrated in the areas were most difficulties were being encountered and expected (social security and agriculture), appears to have been questionable. Staff at the time thought the GOP had complied with several conditions during 1986 and the - 26 - condition of approving the draft by the Cablnet should not be used to stop the loan at such a late stage, especially given the importance it had for the Government's 1986 financlal program. Furthermore, faced with those doubts on the degree of commitment of the GOP, the Bank, to mLnimize uncertainty, had chosen to front-load the program. But the strategy failed, as policies were later reversed. The strategies followed to cope with the doubts about commltment appear to have been Lnadequate, and the question remains if lt is possible to design successful policy-based operations when the Government is not committed to the program. C. Key Issues for Possible Future Onerations 117. The SAL process described above ended with an unfinished agenda that remains relevant. The major items on the policy agenda are: (i) reform of the Labor code; (Li) trade reform; (iii) efficiency of the public sector- especLally public utilities; and (iv) health and social security reforms. Among these the following can be considered priorities: 1) Pursue to their conclusion the reforms initiated under SAL I. This means abolishing import quotas and prLic controls, reducing tariffs and reforming social securLty; and 2) reform public utilities, which would have been the central objective of a possible third structural adjustment loan, had SAL II ended successfully. These isoues are being addressed under an Economic Recovery Credit which is at an advanced state of preparation. PART II: PROGRAM REVIEW FROM THE BORROWER'S PERSPECT1VM The Borrower declined to comment (see Attachment) - 27 - PART m: STATISTICAL IORMA STRUCIURAL ADJUSTMENT LOAN I (LOAN 2357-PAN) BASIC DATA $HEE'M Amounts (USS millioon) LOAN POSMON OuManding Origial Disburd Canceled Rooai As of 2/29/ Loan 2357-PA 60.2 60.2 0.00 24.85 35.35 K:EY Plt](RAM DATAQ Onlinal Loan DatActual or Restimatd LIitiating Memorandum 05/09183 05/09/82 LJtter of Development Policy 08/30/83 08/30/83 Negotiations 09/30/83 09/30/83 Board Approval 11/15/83 11/15/83 Loan/Credit Agreement 11/23/83 11/23/83 Effectiveness 12/13/83 12/13/83 Loan/Credit Closing 12/31/84 12/31/84 Actual Completion 06/30/84 06/30/84 CUMULATIVE LOAN DISBURSEMENT Planned 60.2 Actual 60.2 Actual as % of Planned 100.0 Date of Final Disbursement: July 30, 1984 STAP INPUT (Manweeks) FY83 FY84 EI8 PY8 E21 EX2 1 EOAL Preparation 7.5 - - - - - 7.5 Appraisal 12.1 23.1 - - - - 35.2 Negotiations - 6.8 - - - - 6.8 Supervision _2. M2 0.8 8. 2,2 2 Sub-Total 19.6 42.2 2.2 0.8 8.1 2.3 75.2 - 28 - MIS$1ND Month/ No. of No. of Staff Date of Yea Wrmek Weeks P oR Preparation Feb. 1983 2 3 6 n.d. Appraisal June 1983 2 9 18 07/22/83 Supervision I Feb. 1984 3 9 27 03/14/84 Supervision II June 1984 1 3 3 06/21/84 Completion April 1986 1 2 2 04/11/86 FOLLOW-ON ADJUSTMENT OPERATIONS Operation: Strctural Adjustment Loan H Loan No.: 2768-PAN Amount: US$100.0 million Board Date: December 11, 1986 Operation: Economic Recovety Loan No.: 3438-PAN Amount: US$120.0 million Board Date: Febnray 20, 1992 -29- TECHNICAL A UBOA (LOAN 2358-PAN) Amkounts (US$ milion) LOA Chigbw DiSuuo CAuHxpd RUMMg A f z9 Loan 2358-PAN 5.0 4.5 0.5 1.92 2.58 BX 1RCQB DATA Oneins Low Date.cudo g:WU Initiating Memorandum 0/09/83 05/09/83 Laer of Developntn Policy 08/30/83 08/30/83 Negotiations 09/30/83 09/30/83 Board Apprval 11/15/83 11/15/83 Loan/Cnedit Agreement 11/23/83 11/23/83 Effectiveness 12/13/83 12/13/83 Loan/Credit Closing IV31/86 06/30/89 Actual Completon 06/30/89 06/30/89 CUMUATIV LOA IBUSMN EM EM E EM ElM E8 Paned 1.5 4.1 S.0 5.0 S.0 5.0 Actu 2.07 2.98 3.76 4.16 4.16 4.S Acud as % of Planned 138.0 72.7 7S.2 83.2 83.2 90.0 Date of Findl Disbursement: July 11, 1D88 STAPP NPU ElMEM ElM ElM ElM ElM ElM E12L Preparation 1.1 - - - - - - - 1.1 Appraisl 2.9 7.4 - - - - - - - 10.3 Negotiaons - 3.8 - - - - - - - 3.8 Supervision - 10.0 14.1 9.2 0.2 5.3 0.9 3.6 - 43.3 Other -. . _x _ 0. Q.1 . OA Sub-Totd 4.0 21.2 14.1 9.2 0.5 5.8 0.9 3.6 0.4 59.7 - 30 - MISSION DATA Mouth/ No. of No. of Staff Dateof . Year Weeks EWeU Reom Pftparon Appraisal June 1983 2 8 16 07/20/83 Supervision I Feb. 1984 3 9 27 03/14/84 Superviion I June 1984 1 5 S 07/09/84 Supervision m Aug. 1984 1 3 3 08/28/84 Supervision IV Dec. 1984 1 3 3 01/31/8$ Supervision V March 1985 2 1 2 03/19/85 Supervision VI Oct. 1985 1 1 1 10/16/85 Supervision VII April 1986 1 2 2 05/08/86 FOLLOW-ON OPERATIONS None -31 - SitRUCTwURAL ADJUSMIRNT LOAN n (LOAN 2768-PAN) BASIC DAT SH3L Amounts (USS million) LQAN POSMTON Oustning (diul Di&uo CB ncold BMW Asof 229/92 Lon 2768-PA 100.0 49.83 50.!7 8.25 41.58 KEY PROGRAM DATA Original LUan Dates 1 or R _U Initiating Memorandum 05/31185 05/31/85 Letter of Development Policy 08/12/86 08/1V86 Negotiations 09108186 09/08/86 Board Approval 12/11/86 1VII/86 Loan/Credit Agreement 12/12/86 12/12/86 Effectiveness 12/12/86 12/12/86 Loan/Credit Closing 12/31/87 12/31/87 Actual Completion 12/31/87 12131/87 CUMULTIVEANSUSElN Planned 100.0 Actual 49.8 Acul as % of Planned 49.8 Date of Final Disbursement: December 17, 1986 (Manweeks) FY8 EM EY87 ElM EY8 EI2R P9 E9 TO L Prepaation 19.0 39.5 - - - - - - 58.S Appraisal - 21.0 13.8 - - - - - 34.8 Negotiations - - 40.3 * * * * * 40.3 Supervision _ _ 1. OA 104 1 44 45 Sub-Total 19.0 60.5 65.4 6.4 0.6 10.4 12.5 4.4 179.2 - 32 - ISSION A Montb/ No. of No. of Staff Dte of -Yis Wooks pierons Weeks Repor Prepmidon OcL 1984 2 3 6 11/05/84 Appmil I June 1985 2 2 4 06/24/85 Past Appaisl I April 1986 2 6 12 05/13/86 Past Appraal H May 1986 1 3 3 05/29/86 Past Appniul m July 1986 1 4 4 08/05/86 Supersion I Jan. 1987 2 3 6 02/09/87 Suvdision I March 1987 2 6 12 05/04/87 Supervision m Dec. 1987 1 3 3 12/31/87 FOLL,OW-ON &U?BSMENT OPERATIlONS Opeation: Economic Rocovery Loan No.: 3438-PAN Amount: US$120.0 million Boatd Date: February 20, 1992 - 33 - Anninx 1 Page 1 of 3 TMSLE A.1I PANAMA. QoNESIC EWIONIC INDICATORS BROSS DOMESTIC PRODUCT 17T 1819 1919 1926 1918 2008 2076 2124 1764 (Miltiom of U.S. dollars at 1970 prices) iGRICULTUtE & MINING 177 192 193 194 197 206 202 217 200 riculture 174 18 189 191 194 204 199 214 198 ning 3 4 4 3 3 2 3 3 2 INDUSTRY & CONSTRUCTION 306 304 339 283 264267 278 282 182 ndustry 182 176 1S0 177 176 179 183 190 146 onstruction 124 128 159 106 BB aS 92 92 36 ;ERVICES 1263 1323 1387 1449 1457 1535 1596 1625 1402 ectricfty,ges,mater 54 56 59 65 64 69 73 78 76 amer,e rsrn.,hotels 256 253 251 239 240 251 255 244 183 ansport,eCounication 372 394 430 496 480 513 525 547 501 IL pipeline activfty 19 21 43 166 138 157 138 148 123 oLon freene 83 84 71 51 55 64 SO aS 75 anamucana comis_Icon 176 1S8 205 175 175 177 186 1S8 193 ther 94 101 111 104 112 115 121 123 110 nancmil IntermdiationCl) 96 06 111 91 94 99 109 108 83 ousing(2) 131 137 142 146 149 154 161 168 164 overnmnt servIc s 201 223 232 241 248 259 265 272 264 ither scrvfces(3) 172 180 202 214 228 235 250 252 184 aport taxes 2S 28 28 33 33 36 42 40 1S ess:lqauted bkIn n serv. 47 54 68 76 79 81 84 86 68 SHMRE() -.--.--G--- - ---- GROAN RATES (X) --------------------- GROSS DOMESTIC PRODUCT 100.0 4.2 5.5 0.3 -0.3 4.7 3.4 2.3 -16 AGRICULTURE & NINING 10.1 8.5 0.5 0.5 1.5 4.6 -1.9 7.4 7.8 INDUSTRY & CONSTRUCTION 17.5 -0.6 11.5 .16 -6.7 1.1 4.1 1.4 -35 SERVICES 72.3 4.8 4.8 4.5 5.5 5.4 4.0 1.8 -13 Of which: AutonomousC4) 15.9 -5.4 8.9 19.7 -3.7 8.2 1.5 5.0 -7.8 GROSS DOMESTIC INVESTMENT 27.7 30.1 2.7 21.4 16.7 15.4 16.7 17.5 7.4 Wernt of currant GDP) lubtic sector 10.6 910 10.7 8.2 6.9 4.8 4.1 3.4 1.8 -ivate sector 17.1 21.1 17.0 13.2 9.8 10.6 12.6 14.1 5.7 SOUCE: Offico of the Coqptroller General: (1) includes: banking, other financial Institutlons and Inurance- (2) includes: real estate and house property; (3) Include: services to firm community services, nd personat services; (1) Includes: It pipetinr activity, Colon free zone, and Panama canal commislan. - 34 - Annm 1 Page 2 of 3 PAL*A, EXTIRNML FCMaaIC Ii.ICaTCua (tdilimu of U.S dallara} im m im i m & mzm CURRENT ACOU -322 -360 -40 -2 -136 -141 23 -16 302 GOODS & SERVICES -336 -391 -451 -247 -248 -250 -72 -81 217 Trad belane -816 -974 -1000 -927 -905 -938 *789 -798 -432 Exports, Fab m 287 322 305 286 28 359 367 Petrolte trad -191 -217 -243 -24 -173 -186 -113 -112 -71 lWorts, Fab -918 -1044 -108t -988 -1018 -1040 -1036 -1054 -666 FreIght,nrurance -124 -138 -53 114 58 79 II 15 48 Tranportat10n 331 355 392 350 333 361 373 383 392 Trawt 115 110 93 101 121 152 122 96 80 Instnt In_om -283 -2V -350 -324 -294 -358 -326 -320 -394 of whAchfintest pui f db -248 -27 -344 -282 -310 -322 -320 -300 -354 overnnt n..e. -10 -10 -12 -14 -6 -11 -12 -4 4 Other sovecas 451 52 487 453 438 465 549 545 518 Colon fre tona 215 254 220 142 148 187 229 248 232 Rest of thbeorld 23 27 267 310 290 279 321 297 287 UNREWITED TRbIF. 14 31 46 * 112 109 95 65 85 Privats tr.nfore -52 -48 -55 -60 -32 -31 -27 -49 27 Publtc trwnfors 67 79 101 104 144 140 122 114 112 CAPITALACCMET 40 400 367 122 66 -171 -425 -3 -1215 Offealt capital 223 205 510 302 116 -211 -288 -55 -1113 Other official bw1 trctfon -1 -40 1 -87 Private captal -182 Z5 -144 -94 -50 -11 -73 51 -102 ERRORS & INIMOS -43 40 82 -3 332 -18 -460 -800 VALUATIN ADJUSTENT 5 3 -2 -1 FINUUCING 73 32 357 480 1713 Bnfng systm 3 73 -200 -10 453 264 Reschiuing 232 367 Arrrs 27 1449 PERCENT OF CP Exports of UGPS ".5 43.2 40. 38.5 35.0 34.9 35.8 33.9 36.8 lWorts of US 4*7.7 47.8 44.0 3.8 34.0 32.7 30.9 29.4 23.3 Current account -9.0 -9.3 -9.5 -4.6 -3.0 -2.7 .4 -.3 6.7 MMRC: Internetf0nal Nntary Fred. - 35 - Annha1 Page 3 of 3 TABLE A.3 OII-IagNNIN ALJ sLIC SECTO mi"at af U.S. domteri) Ms l91S1I 198 84 M98 15e 1 M , REVENUE AND GRANTS 100O 1170 1265 1386 1425 1532 1592 1653 1053 -enera goverrment f f 3 1106 1223 1315 1261 1387 1423 1503 940 -tral goveruent 6ao m 838 863 859 962 1006 1057 569 ocfal security agercy 219 267 319 332 312 345 351 386 336 ecentraLizad agncie 55 64 67 121 90 80 66 60 35 -1-ting balance of pubLfc enterpr m43 62 41 70 134 125 163 150 113 Grans 2 1 30 20 6 EXPENDITURE 1202 1385 1727 1650 1699 1624 1638 1695 1S55 urrent exediture of erwrtl boverlm_nt 691 10:14 1208 1243 1334 1382 1393 1495 1473 entral governmnt 610 685 829 814 898 883 896 90 962 ocfaltescurfty _aecy 197 236 267 313 334 393 405 449 426 ecentraiizod ncie 4 93 113 116 101 106 90 96 86 apital expedit" ci) 311 371 518 407 365 242 26 200 S1 :-:SOLIDATED PUBLIC ECTOR SURPLUS -194 -215 -462 -265 -274 -93 -47 -43 -501 atnce of nrnconsotidted pubLic ector 13 7 -2 17 8 13 25 3 28 PUBLIC SECTOR SULPUJ -181 -206 -464 -247 -266 -80 -22 -40 -473 Statfstical discr pancy 5 4 tRANCING xternal (Net) 228 62 36 143 97 25 76 -32 9 rrears 5 460 ational Bank -41 131 31 109 175 55 -54 71 -1 thor -6 1S 3 -5 -7 PERCENT OF GDP Publfc setor rev nu end grants 28.3 30.2 29.6 31.7 31 2 31.3 31.1 31.1 23.3 Gnorat gov. reveVA 27.1 28.5 28.6 30.1 27.6 28.3 27.8 28.3 20.8 Operating baltnce of public enterprises 1.2 1.6 .9 1.6 2.9 2.5 3.2 2.8 2.5 ubItf sector expenditure 35.6 35.7 40.4 37.8 37.2 33.1 32.0 31.9 34.4 urrent expenditure of enerol governamnt 25.0 26.1 28.2 28.4 29.2 28.2 27.2 28.2 32.6 apitet expendfture 8.7 9.6 12.1 9.3 8.0 4.9 4.6 3.8 1.8 Zlic sector surpLtu -.5 -5.4 -10.8 -5.7 -5.8 -1.6 -.4 -.8 -10.5 SOURCE: Internatfonal Nmnwtry Fund.(IItncludu net Lending. - 37 - Ann-x 2 Page 1 of 7 Th- TAL Studies: Main Conclusions and Results 1. Effective Protection (Center for Development Technology) In March 1984, the Center for Development Technology was hired. The final report was presented in June, 1984. The objective was to estimate the effective protectlon of the most difficult cases where an equivalent nominal tariff had to be established in substitution of quotas. It concentrated on textiles and clothing. It found that in general the effective protection was low, due to the existence of muggling. In the coment industry and other materials usod in construction, it found a very hlgh dogree of protection. The firm also recomuended not to increase the minimum tariff, but this was not accepted by the Bank. 2. Trade and Prigino Policies in Acricultura (University of Minnesota) In February 1984, the Department of Agricultural Economics of the Universlty of Minnesota was hired to do the study. The team was lead by Bdward Schuh. The final report was dellvered in September 1984. The study included rice, beef, onions, potatoes, etc. and concluded that the level of protection to agricultural products was too high, around 100% above the international price. The implicit pricing policy was to keep real prices unchanged, independent of changes in productivity levels, price of inputs or prices in the international market. Furthermore, this real level was too high. Pricing policies promoted import substitution, in particular in rice and corn. This policy discriminated against the beef industry, a potential exporter. It also lncreases the prico of wage-goods in favor of large producers, having a regressive impact on the distribution of incoe. The study recommended that the large subsidies and import substitutLon policies in products like rlce and maize should be terminated in a period of two to three years. It recoammended the end of the heavy state interv ntlon in the market, speclally through IMA and Zndema. The high price of some agricultural inputs (like fertilizer) should be dLminished. Som subsLdLes to agricultural exports were recommended. 3. Public Entities in the Aaricultural Sector (Management Analysis Center- MAC) The idea was to assist the public entities to adjust to the new economic policy in the sector, that meant more promotion of exports, less import substitutlon and less state intervention. The main conclusions reached by the study was that the exlsting instltutions were not complylng with their stated objectives. For example, ENDZMA was created to leas, sophisticated agricultural machinery to small and medium size farms. In reality, 40% of its activities were in construction and most of its machlnery was leased to another state flrm, the sugar complex La Victoria. INA was created to keep the prices of food low but in effect was achieving exactly the opposlte. The final report made speclfic recommendatlons on several publLc entities3 - 38 - Annex 2 Page 2 of 7 L) Corporaclon Azuearera La Vlctorla- a) close the most inefficient mllls (Asuero)g b) sell assets not related to sugar productLon; c) reduce admlnistrative staff d) reduce the prlce paid for sugar cane. L1) Banco de Desarrollo AgropecuarLo Should be merged to Banco Naelonal de Panama LLL) ENDENA (Empresa Naclonal de MaquLnarlas)i should privatlzed lv) INA (InstLtuto de Mercadeo AgropecuarLo)s Should stop all dlrect lnterventlon ln agrlcultural markets, sell all lts LnventorLes and privatLze its storage facliltles. It would remain as a diffusLon agency. v) CltrLeos de ChirLquLi should be prlvatized. vi) COBANA (CorporacLon Bananera Naclonal)t should be prlvatLzed viL) ENASER (Empresa Naclonal de Smllla)s transfer to IDIAP the research tasks and privatize the marketing section. viii) ISA (InstLtuo de Seguro AgropecuarLo)s Several changes were rca mmoended ln its way of operating to Lmprove the servLesa lt was provLdlng. In practice lt had ben reduced to insurLng the crops that were flnanced through the State Bank (BDA) and lts polley menu lacked flexlblilty. lx) Asentamlento:s had been receiving a dliproportlonate portlon of government credit and assLstance, evn though they constituted only 4.3% of the total number of producers and therefore many of them were not being developed as self sustaining enterprLses. The study reommended to liquidate all non viable asentamientos, and to reduce monetary assistance and lncrease technlcal assistance. What was done: CALV:Azuero was prlvatized, but none of the other recommandations wer Irplomnted. BDA: sme Lmprovement in services, but the transfer to SHP was not accepted by the Government. I1A: lt retreated from intervening in the acquisition, sale and storage of goods, but was not performing lts new role of provider of Lnformation and assLstance. - 39 - Annex 2 Page 3 of 7 ENASEM: was shut, transferring the research area to ZDZAP and the marketing to the private sector. ENDEHZA was privatized, then broke, and the Governmnt seized lts ausets. 4. Proaram to Improve tho Aoricultural Institutions of Panama: Phaso IX MAC (Management AnalyLsi Center) Thli study recommended the precLoe steps to implement the recommendations of the prevlous phase. For example, it recommcnded the new price to be paLd for sugar cane by CALV; lt designed a program to reduce adminLstrative staff; it LdentLfLed and valued assets not related to productlon of sugar, etc. It developed a system of Lnformatlon that could be used by management to continuously evaluate the performance of the *nterprises in the sector. The practLcal consequences of these studies were* the GOP dl.aarded the idea of manufacturing alcohol from sugar cane; convinced government offlcials of the need to sell Azuero sugar mill; other recommendatLons were not implemented 5. SocLal Security and Health Thli was the component were there was more mplementatlon problems. The consultant fLrm that was hired to perform the adminlitrative and managerial study of the Caja de Seguro Soclal (CSS) failed completely, to a point that the contract was flnally canceled. Another consultant flrm that performed an audit of the Caja and recommended changes in the accounting system and that did a very good job, found no receptivity in the Caja to $mplement its recommendations. These studLes were anyway helpful, but the most helpful were the actuarial studles that servd as a basLs to recommend changes ln the logislative framework. The consultants made detailed recoumendatLon on how to modify the reglme. They were not implemented. L) Actuarlal study of the pensions program This study was executed by Robert Ke$ffer, under the direction of Peter Thull-n. The study recommnded to eliminato the early retlrement age, to Lncroase the minimum age for retirement, to reduce the percentage of the salary that is given as penaLon, to modlfy the formula to estimate the salary on which the pension is estimated, etc. - 40 - Annex2 Pago 4 of 7 LL) Study of the adminLitration of tha CBS a) Investmnts b) ComputLng system c) Management Informatlon System Berger Internatlonal was hired for these studies. The flrm had diffLcultlis ln performlng lts study am three dlff-rent admlnLstratLons alternated in the CBS, and each redlrected their work. The fLrst two studies were completed, but the thlrd had to be suspended and the contract wlth the flrm was canceled. The studlis were not consLdered satlifactory. lll) Study of unlt costs ln the Health sector Thli study encountered many obstacles, specially in determinLng its scope once lt was known that there was not enough rellable lnformation to est4mate unlt costs. The consultant flrm developed a method that could be used to determine unlt costs, which started to be implemented. The study was started ln March, 1984 and fLnished ln September 1984. It flnally dld not achLive lts orlglnal objectLves, as the method to determLne unlt costs was not fully implmented. 6. Trannoort in the Panaq City-Colon Corridor (PRC EnglneerLng) The study was asslgned to PlannLng Research EngLneorlng CorporatLon (PRC). The prlnclpal objectLve of the study was to evaluate the future of the raLlroad in the context of alternatLve transport methods, and the convenience of dLcontLnaing the servLce. The most lmportant development from thli study was that lt establshed the vlablilty of "Centro puerto" a port that would functlon as an lnternatlonal center that would concentrate and dlitrlbute contaLners. RegardLng the raLlroad, the recommendatlons were to abolLsh the passenger servlce and concentrate on cargo. Extenslve recommundatLons were made on the admLaLstratLon and effLcLency of the rallroad. Regardlng the translt hlghway, lt was recommended to wlden lt ln the neLghborhood of Panama Clty and Colon. If the ldea of Centropuerto was developed, then Panama would not face any restrLetions ln port capaclty for the next 20 years. The TAL program also fLnanced a study on the lmprovements needed to the Port of Balboa, that was demanded by the Port Authorlty to justLfy decLsLons taken ln the context of a Bank loan for reforms to the Port. - 41 - hAnnex Page 5 of 7 7 o Cattlo and Reef Marketina ln Panam (MAC) The study was directed at glving advlie on the way to improve the meat-packing industry and the marketlng system to improve the comparatlve advantage that according to the consultants, Panama had in the production of beef. The study made specific recommendations in the followlng areas: -Classification system of the quallty of cattle and beef; -Classification oystem of beef in butcher's shops; -Ninimum sanitary provisions at meat-packing plants; -Marketing of cattlel and -Better use of by-products. S. *rban Transgort in Panama Citv The study had the following objectives to develop a five year plan on the subject of Urban Transport, including: -Analysis of the institutional framework; -Improvements to the road system and traffic flows; -Analysis of Public Transportation -Analysis of the system of road maintenance. All these areas were covered very satisfactorily, and recommendations were made about alternative plans of action in the different areas. - 42 - Annex 2 Page 6 of 7 5.4 SumarV gf Data for thg Stud1es CONULTIlG DATE DATE UUALITY OF STUD ml COS BTalm FINISHED TNE STUDIES Trade and prielng Univ. of Hnimasota *7S8.6 02/15/84 06/08/84 Good Agricultural sector MAC 3624,000 03/19/84 10/31/84 Good sector institutions Phase 1. Phas 2 MAC *956.000 01/8S 12/86 Good Effective CDT S113.820 01/30/4 05/31/84 Good protection Health sector WCHP S29474 03/12/84 09/30/84 Acceptable Audit nd Financial A. Grant £ Co. $425.416 04/02/84 09/10/84 Good aaLysis of soial security. Adelnistration of L.Berger 436.19? 04/84 Actuarial Apart from CSS nd actuariat International Inc. (08/27/85) the actuarfal situation Inform_tfon stulfes. the Technology work was (01/01/86); unsatisfactory, Investment and the contract (01/16/86) was canceled Trarnport PkC SZ54.612 04/84 12/85 Good 9Iebo Port PRC 84.820 01/21/8S 04/85 Good Cattle and beef PAC $130,000 01/01/87 06/30/87 Acceptable mrketing Urban tr nsport Israeli Institute S221.800 04/87 02/88 Good in Pana C ty Trainfng $2f966 Equipment 8142613 Adelnfetration of $481,680 the project Bank fens 12,449 Total $4,263,M% Expected Staff Maadc. Costs End Timetablo _-onths .t 1. Trad nd price polfcy fn agriculture 6 4 rinths 2. Agricultural public inatitutfons: 2a. Phs one 54 Nov. 84 2b. Phm two 78 UnloAn 3. Effective Protection 12 Aprfl U4 4. Socafl Securfty: 4a. Ffnancial nlysis (ctuarial) 36 December 84 4b. Adafnistration 72 December 84 S. NH 1th study 24 Deceer 64 6. Transport study 16 August 64 - 43 - Page 7 of 7 1. Trade sad price policy In "egculttur.9 2. AgriCultural pLhlt 1isttutions: 2S. Phase on 650,000 624,000 2b. Phao two 940,000 956,000 3. Ef fetive Protection 188,000 114,000 4. siatl Surity: 4X. Finoneiul ultyss (atusralt) 432,000 425,000 4b. Administration 864.000 436,000 (CANCELED) S. Health study 288,000 298,000 6. Trport stu&f 96.000 356.000 Subtotal 3:450,000 3:288,000 Othwr studies 758,000 _anent 72,000 Equipmnt 135,000 Training 150,000 Contin nwein 440,000 Subtotal 1:555,000 FPANtl SAL I NATRIX OF TUANCHE RELEASE COUDIT1ONS AH ACTUAL ACT IOS TAKEN Action Already Taken Sector *nd Polcv Issur By Board Presentation Staem To B Tae n Actions Tskw4' t. AGIOJLTURAa AH RURAL 1. Pricing regulation nd marketing. (a) Export restrictions. eaf export restriction lifted, Export restriction an fish mel *nd -Bf rtrictiomn were lifted. Newch 1963. cacao to be lifted by October 1964. The restrictions for fish I l nd cacao wre not tifted. -Restrictions on coffee we nut -Restrictions on coffee eports Lifted In practice. lifted by September 1963. (b) Pricing. -Producer support price of rice Substantial reduction in suport -Price of rice mas rejiced reduced. Ices for rice, corn. nd soridwu to *iohtly in 41V3. No substential cam nrc by Narch 1965. r deition by 4/35 in ny of the other goode. -Potato price freed. Prices for potatoes, tomtoe, onion -Potato price ware freed In nd other horticultural produet to 1963. Th price for thr others d be freed, by October 194. gooe wuere not freed. -Nl5k cltmifled ccording to grades Enforement of price for grde up -Information is *biguou . and appropxiat price set. milk by Decobr 31, 1963. -Grading system for meat -Domestic prices mwre freed but estableh ed. domestic prices of sseepently, th controls wae expensive cuts of mest f-sed, reirnstated. Septedber 1983. (e) arket intervention wd ank fI Mnced (wuder the T?L) pricing The scudy as completed. repuletion. study to be completed by th secnd half of 1961 to indicate a proorem of r ductions In state nte rvention In aoriculture *d of Institutional reform, keeping with new dbelop ent strategy. 1/Text preceded by a - correspond to comments to the column Actiong Already Taken. Text following a "/2 correqponds to comments to the column Steos to be Taken. Sector wi Polticy low Action AtreaTym Tten St Taken A&tf oneuLa 2. Institutional tform. -Fetipitto sugar mil closed. Neh -Activities at Dot state s_e -Activities at ote state ea r mills we redcd lnitfally, mills reduced, btreh M. b ilasinin w ty mr wvida fn el. -Stat ceem uprnetin glosed, "Mn. -subedies, to stae devlo-en Sbsdies Mere Itoppe by 19 coporatfon etiminsted in 193la I; excmpt for aeVane. -Redaction of Agricultural -The special sub idy VW Deelopme nt lank intert rate elisinat d. Th FE I was cut in *ubJdy. 196. Further Institutifnrl reform to Study urs c_ pleted. smelt re ults of bank f* Iced s etor study to be c p4ted by mid-1964. Policy ain to be adkressd Include: creatfon of an effective agriculture polcy coordfnrtion cpablJty; adainate mnagement infoort tion for better Institution l eontrol; reduction of the States role fndirectly production ctivities; furthsr strentthening of Agrfcultural Develop ent Enk; redution of stat interest in m_rketing and eliminstion of an staot mrketin menApolies; rajicing iholesale and retail price controls; and strngthen capbilities of r erch institutions. -All Agricultual D lopment Draft legfslotion for ne agriculture -M. irnsred credit s dom. San credits c d by crop Incentives l approved by Cabirnt /Agriculture incentIvs l_m fnranc. ed-Nay 1951. appro v n i y 195. s ctor *nd Policy issues Action Already Taken Stms To Re Taken It. URBAN IUSTRIAL AMD TRADE POLICIES 1. Articulation and -Under the coordination of the -New Industrial policy was isplemmntation of an Ministry of Plming and Econormc established. amqppriate Industrial Policy, a new Indatrial pollcy wa developsent strategy. established In late 1982 Incorporating a strategy based on expansion of export orfented, labor intensive activitfes. 2. Export Promotion. -National Iovtstment Councif -NIC as established, as wll *s established n October 1982 to an office for export promotfon. prmote foreign investment and provid. Inve tors with one-stop agency In deafirn with local burmeracy. -Export incentives provided in the Sioplificatfon of CAT and their Link -A change was attempted but, de form of redemeble tax certifieates to factory etployment by Mty 1984. to conflicts, t was not (CAT). 1eptemented. -Flexible Interpretations of tabor -Done. code In the cae of specific, export-oriented inistries, late 1962 early 1983. 3. Protective Structure. -Cabinet decree established policy Timetable for removal of remfning -Decree was estabtihed. /The objective of elimination of OR's quotas to be agreed by end Nay 1984. timetable as set but It was not signed by the President In 1983. iplemented. -133 quotas removed by october 15, -The quotas were rerd 1983. -Mximua term of Individuml -Maxi lengths of contracts contracts betvmen the Govermu ent and were reduced although loopholes the private firm rediced from 10 to rendered the action ineffective. 5 years, Mreh 1983. Industrfal wnd coercial policy The studies were completed but studfes. finaneed by 1 I AID I nd did not nwaer the cperational the World *nk financed technical problem. Instead, a rule of assstance on effective protection to thub of a mxui of 1O0X ad- be completed by end Nay 1984. Thee valorem tariff, plus will assist the Goverrment in ce pensation of up to SOX for determining initfal level of tarfff using expensive dbemstic ifnpts protection with kinch to replace was implemented. quotas Wmtn reasonable eb tlastes are unal tlable. II Sector nd Poltcv Issue Action Already Taken Stes To Be Taken Actions 3. Protective Structure (cnt.) -Pubiic mowicement in Narch 1963 that new industries will not be offered ny form of quota protection. -Nazium tariff protection for new Draft legislation for new industrial -Maximu. tariffs for nrw industries initially IM5X of local Incentives law approved by the inihstries uere not sat. /mm value added reduced after one year Cabinet by end of Nay 1984. legisLation u s drafted 3/84. to 100X. March 193. Mazism and minimua tariffs to be This was included In the draft defined, nd timetable reaching a of the IndLstrial Incentives laws unfform tarIff reedy by end of Le. Nay 1964. 4. Prfee Controls. -25 industrial price controls Goverment mill disowntle price -Price controls were eliminated. removed Septeaber 163. controls on indLstrial proidcts following removal of quota. S. Labor Legislation. -Legal cofission established to Study financed by AID to be coepleted -A study was dor. modify labor code interpretation, by mid-1964 followed by modification in labor code after elections. JII. PUILIC SECTOR EFFICIENCY 1. Financial Stabilization. -Increase irport tariffs and crude -Done. 4 petroleu ipport taxes. -Substantial redoctions in capital With the financial assiestnce of the -Under an INF standby. an current public sector INF. sajor export reforms are to be expenditures were reduced /No expnitures in C83. made in the Customs Administration informtion. including eventual application of B7N. The reform are to be coepleted by end 1984. -Strict cash liaits on all -Initially done, but the system expenditures established and later broke-doem. monitored by Economic Cabinet. -Directorate of Public Credit -Done. established in Ninistry of PIaming to coordinate commercial borrowing by all pLulic s, tor agencies. 2. PubtIc Investmnt Progrm. -Detailed iswestmn' budget for 83 -Done. althoush the Fortuna- includes mjor red ,ns and Changuinola road project was deferral of non-priority projects. outside the budget. -Draft program for 1984 and 1985 Detalled investment budget for 1984 Done. I reviewed by Bank, July 1983. and draft 85 program to be ready for so review by the Bank in March, 1984. Sector ad Polic Issue Action Alread Taken Steps To Be Tken ACTIONS TAL 3. Reform and Restructuring of -MaJor finanmial review of all Disposal of ta Contador Panam. -A financial review was Pubilc Entities. pubtic setor entities coopleted finished./ La Contadora not February 1983. sold. -Sale of a mejor loss-making hotel, -Sold. Jinwaty 1983. -Some agricultural entities elosed; See 1.2. above. see ftem 1.2 above. Restructuring of National airline. It was proposed but not carried out. Ending of pricing scheme arrwnged The pricing arrangement v between piblic nd private cement en id. However, the iSplicit compnfes, May 1984. agreement to rear nge ounership did not take plce. Reduction In domestic cement prices, There ware no reduction In July 1984. prices. -Rent controls freed on all now -Rent controls were ended. housing projects carrying a monthly unft rent of $00 or *ore, March 1983. -Rationalization of National -Done. Nortgage Bank including lncreased interest rates for mortgag _ nd no further independent access to coairofatl bank credit, late 1962. -Social security agency formally -Done. undertook in October 1963 not to engae In further direct housing financing. 4. Pubifc Sector Nousing. -From January 1953 socil security Done. ftads used a secondary mortgge financing at attractive rates of fnterest. -Interest rates sutaidy for sciaL Done. seourity nortge ended October 198. 5. Ffnancial Instftutions. -Reform and restructurng of Audit of current portfolfo completed An audit was done. davelopmnt finance corporation by June 15, 1983. OFINA Initiated. Institutions Issued to dissolve or auction off those parts of the portfolio which hawe beciome a fisct burden. Itew managmeent has been appointed wd process of prfvatfzation initiated. sctom end l t1w l1u Actlon Alreamv ta am to J knCTIg TAE S. Finclal Inotltutiom (cont.) Comltmwts frc the privats setor CItW t (mln) ware for purhse of shre 1n but te ceede the 1/4 eqty restructur1ng CFIM to be obtained tlfit. The problm mm never by e of Nh 16. solved; COFIt as closed. mudr of OFIlU staff to be Infh_tion not oavilable. uastantially rAeuad by frcds 31, 1964. 6. C l Zoe Lne and Assets. -Legfstatifn to facilitate lesfng -A lta allowing lesirg was or selling of land and Passed but it no t followed Infr tructure In the old Cwnal Zone upon. esnted In Cmurwes in Nerch 1963. Study of trin lsthumen trunport Done. corridor coqpleted by Juty 1954. 7. Nemlth end SWciel S curity. -Finarncil reforms to housing -Done department of ocial security agency coWleted Deceober 1962. Study of Integrated system of health Done. care to be initiated by end 1963 and coqpleted by end of 1964. finsncale* neaeril end actuarfal The finwncial and actuaralo study to Socalt Security ag. to be studies ware dbne/ The 0 Initfated by Jinuery 1964. mm"rll and study - canceled. S c: President Report for tranch relea conditi on, sack-to-Office r port of Aprit 1966 PCR mssion or Actf ao Taken. P SAL ItI *CM *CTIO TAIE LacIer uw P.1w Cm Action Altu Tm toLB Taken 1. ntC SK_ 1. Ctlase of uetitift. (a) E sl d comay). *kssr1 femtim tanore to _. is'm.. -Cl_oe of meciel OF stimm -it no towr oPerates in bs u1 dispomao at sts. ab mkset. b) rEI cIafatua -Drft nal resolutien to Cabint. -After ftited divestitto to bchinery Poet). EF_ s - Nts rasived by MA do sold am of ths se. Tns ret wN to KlL. Cc) Awaro Sitr Pill. -Nill clsed ud Cdbnst ei -Sold in fctober, 196 to dispoa of masst. -Fiast dispoa of a. -Dors. U 2. Sivotmnt of Entitie. -Solo of an of thlols entepises. Ci) Citricos de ChiriqA. (i) Ibt Sold. CiM AllptrlS. Asses sold. (I ) Sold. CiMi) lotol Cmedora. Intention announed. iiM) Sdod. Civ) Aamii swao sIlt. (Cv) Mot Sold. 3.1. by April 1, 18 of two Iot do. tintl enerprises en the list. 3. PiMic Sewtor Work force. Two perent rhejtien of tl ltor Den (P-nmnsm ion souce) but for iwiau 1986. iu ccordin to Sank fiutiq. VTJet precede by a - correspond to comments to the column Actions Already Taken. Text following a /' corresponds to the column Steve to be Taken. |tarCt mid Po-ley 13mm Actfin Alreadiw Takon 3. ToDgo Taken Aci1m Tau 4. SociaL Security Fundo. -n) Tronsfer Les" s Epeciatls to Ci) Enmctent of ne Penslon bw, -No att2t We mab to ofoth natiamu budget; mnc; the pumice progsrem of the (a) ReIductin of early Socwl Security Aorcy or the retir ment penslon and greditl pecial prosrU, for patic elimination of ewrly retir eant; VatON. (b) new s*cto of pensIon rights; (c) tongr aeraging period for pension base; (Cd) Inflation adjutnt of pensions; te) maintarnwce of cepitalizatfon lenl. -Cif) Initiate measures to imp1ove (if) Iuction of CSS wok force; -Amnistrative off icincy was administratlve offifciency; InCrsd Therem wasnly a modest redction In CSS wk force. -Cfii) Cabinet approval of draft lw Ciii) Reform of Les Especoales. -lot dos *(This rer_nmet wee overnins pnion *chem_; wived). -(iv) Undmrstuing on reform of -Not done. L;yss Especles.e. S. Financil stabilization. -Put fn pltce in accebptc Satisfactory coqpliane with Not done; 1987 [oISet - stabilization progrm stabilfzotion progrm. incnstent with tho externa financin. This led to exceselve d tic borrowIng from the 1W. 6. Pubtic Imost_mnt Progrm -Agreement with Bain preliminary Satisfactory financial plan. -Not don; 1987 baicket not 196 ilent prog. constet with finncing. 11 DIU3RIAL AM TRWDE POLICIES 1. Indstrial Incentive Lw. -New lw passed, March 1966, -Complied. The secord cut In includring: (a) discontiewetifn of tariffst wam ipamtentd novner contracts with the nation; (b) 196t. maximu tariff protection of 20X for ne indtrial prodct, 30X for now agroIndwstrial prducts; Cc) reductIon of existing protection; Cd) 3k minimu tariff. Reductfon of existing taiff, AugAt 1, 1986, a the first of 5 equa cuts to a maximu of 602 t90X for a few exceptional products). o w Sector nd Plicv Issue Action Alreadv Taken Stems To Be Taken ctlem Ta 2. General incentives and protective -All but 20 import quotas removed -Dcne. struct4re. before June 30 1986. 3. Tariff administration. -BTE system and CIF tariff base -CIF was adopted. There is no adopted. information rega rding the BTN system. -Specific duties to be supplemented There uas a shift to ad-valor._ with ad-valor.. duties for all tariffs, although high meximwi comodities; no specific duties to levels were set for new be raised. products. 111. LABO POLICIES. t. Labor Code. -Law passed farch 1986, modifying -Complied. the Code to: Ci) permit piecework; (ii) encourage reuards for productivity; (iii) rationalize overtime provisions for smll export nd agro-based firms; Civ) remove subcontracting from the scope of the Code. Improvements in the administration of the Labor code, including quicker deisions, appeals. etc. IV.AGRICULTURE P R L DEELoPNENT. 1. Agricultural Incentives -New law passed, march 1986. (1) -Complied. but commissions Legislation. replacing self-sufficiency aim with created by law control prices the pursuit of comparative and quantities. advantage; Cii) abolishing import substitution targets; Cifi) abolishing automatic quantitative restrictions on agricultural imports. 2. Producer Prices and Import -End of support prices for rice, Reduction of import duties on rice, -Ended support prices de lure: Tariffs. onions beans and salt. maize, onios, and beans. de facto. comnissiones enage prices. / Import duties were -Import quotas and rice, maize, End of support price for nmize. -Import quotas were lifted, de onions, and beans lifted and lure, but de facto they were not replaced with equivalent tariffs. done./ Price supports for maize were not eliminated. :f Sie.od FPoli la. Action Atrasi Take Stm To Be Take kAitmoM nT 3. Cemmrr pries. -Ending of price controlt on 20 -Price controls mse rmowd in c tagries of foode. 1956, but mm (5) we reintated In 1951. -Ending of price controls on four -Not don. further itm. 4. Plc Sector Role. -A_ouncment of en to INA crop Erd of A cropplptnu system. -Announcemnt u1 mdsjIDA purdcang, including l.. esd . -Arnucmnt of ich redced role Revision of INA's dchrter. -Announcoment s mde.j The for IM. dcaer wrs not revised. -sale of riee en part of sat Sale of rmlning sat lnventories. incentives. sgur: Presidnt Report for tr.ehe relee conditions, loon documnts for Actions Taken. Ln IIF - 55 - Annex 4 Page 1 of 4 The Period Between SAL I and SAL II A. Initial Disaareements and the Events of 1985 1. The original schedule for the preparation of SAL II could not be kept, as an Identification Mission for SAL II undertaken in October 1984 reported that Panamat (i) was not complying with IMF targets for 1984; (ii) had been approving Contracts with the Nation in violation of SAL I; and (iii) was unwilling to submit for legislative approval the draft Industrial Incentive Law as had been approved by the Cabinet earlier in June 1984. Given the very difficult fiscal situation that Panama would face in 1985-86 due to debt service obligations, not meeting the IMF targets, and ending 1984 with a higher deficit (by about 1 of GDP) than programmed, were very troubling developments. 2. In March 1985, the Minister of Planning and Economic Policy, Mr. Ricaurte Vasquez, asked the Bank for a second structural adjustment loan of $150 million in CY85. Panama needed a Stand-by with the Fund to obtain funds from the US Government, and it faced a financial gap of $150 million in 1985. The Bank said it would be possible to disburse before the end of 1985 if it received by end April 1985, a satisfactory draft Letter of Development Policy (LDP) and if by then the GOP had a two year Stand-by Arrangement with the Fund. 3. During the discussion of the LDP between Bank staff and the Panamanian authorities, there were many disagreements particularly on the timing and content of the three laws (labor code reform, industrial incentives and agricultural incentives legislation) that were required am part of the loan. The draft LDP that the Cabinet finally approved on May 9, 1985, did not satisfy the Bank, and there were concerns on the weakness of the Government and its capacity to deliver. Nevertheless, the Bank went ahead to appraise the loan. 4. On June 7, 1985, the Loan committee authorized appraisal and recommendeds a) clearing up the areas of non-compliance under SAL I before presentation to the Board; b) strengthening trade liberalization; and c) reversing a recently approved increase in public sector wages. The issue of the degree of the Government's commitment to the program would be assessed at appraisal. The Committee also expressed concern on the delay in signing a new Stand-by Agreement with the Fund, due to disagreements on the 1985 budget. The Committee established the size of the loan at $60 million, but agreed to consider increasing it to $80 million if the three laws (labor, industry and agriculture) were approved before Board presentation. on industrial policy the appraisal mission should insist that the draft of June 1984 should be the text to go to Congress. 5. The appraisal mission returned in July 1985 without having completed appraisal. The key problem was the industrial law. The mission expressed several points of concern: the Government was weak, had made no public declaration of its economic policy, and had exercised no firm action in - 56 - Anneg 4 Page 2 of 4 implementing the adjustment program of which SAL I was part. Furthermore, the mission confirmed the previous impression that the Government's request for a SAL was driven mainly by the public sector's financial crisis. 6. On July 15, 1985, the IMF approved a 21 month Stand-by through March 1987. This agreement kept alive consideration of SAL II, but a mission in August arrived at the conclusion that there could be no SAL II in 1985, due to the difficulties in agreeing on a satisfactory LDP. As a consequence, the GOP faced severe financial problems since $21 million from the commercial banks and $40 million from USAID were connected to the SAL II process. Furthermore, it would be very hard for Panama to comply with the IMF agreement, unless it reduced government expenditure drastically. The GOP finally did this by cutting the investment program by a third. 7. By mid-1985, Bank staff was beginning to be skeptical of Panama's future and the possibilities for reform. This was due to the enormous public debt and the attempts to use the IMF to refinance commercial debt. It also reflected growing disillusionment with the administration. 8. President Barletta resigned in late September 1985. At the time, staff attributed his removal in part to disagreements among the Panamanian authorities on economic policy arising from the publication of both the draft LDP for the Bank and the IMF Letter of Intent, though recognizing that the main reasons were political in nature. This meant that there was strong opposition within the ruling party to a LDP that the Bank thought did not go far enough. 9. In December 1985 the commercial banks inquired about the status of SAL II. The Dank responded that it considered the draft LDP no longer operative and that appraisal was dormant. As a consequence, the commercial banks did not disburse the $21 million but decided to extend the deadline for disbursement to March 31, 1986. In the opinion of Bank staff, the strong stand taken by the Bank on this issue, against pressure from several quarters, finally convinced the Panamanians that they had to put together an acceptable policy proposal to prevent a financial crisis. B. Implementation of the Agreed Actions for Processino SAL II 10. In order to proceed with appraisal of SAL II, it had been agreed that the following measures had to be taken before April 1, 1986: (i) closure of three public entities; (Li) replacing quotas with tariffs for 20 products; and (iii) removal of price controls for beef. Two of these had in fact been SAL I conditions. None of these actions were taken by the specified date and, moreover, the IMF Stand-by was delayed. As a consequence, the appraisal mission wae postponed. 11. one week later, after some progress was reported, the mission went ahead even though cwo of the three public entities had not been closed. The mission returned without having completed appraisal. The mission found that the situation was much worse than what had been conveyed to the Bank. NgM of - 57 - Annex 4 Page 3 of 4 the closings had been undertaken, as the Minister of Agriculture opposed thrm (the three were agricultural entities). In violation of a previous agreement, the Government had increased pensions by B20 per month. This also violated the agreement with the Fund. Several other measures were behind schedule or had been implemented only in part. The mission wrote a supplemental Aide Memoire (supplemental to the earlier Aide Memoire), but the Government was unable to agree on it. The major change in this supplemental Aide Memoire was that it included an explicit timetable to pass a Social Security Law by end-1986. on its return, the mission reported: "The Government remains under severe pressure of time to reach an agreement with the Bank." This was due to the connections between Bank, Fund and commercial banks' timetables. The experience of the mission pointed yet again the difficulty of implementing a SAL program in Panama. "This program will require constant monitoring on an almost daily basis or it will prob&bly slide irretrievably behind schedule." 12. At the end of May 1986, a second appraisal mission returned with a subscantial change in tone. The Bank and the GOP had agreed on a Supplemental Aide Memoire. In it, the Bank agreed to a change in the policy toward INA (the agricultural marketing agency) which would be reformed rather than closed and a rescheduling of the three closures, while the GOP agreed to eliminate quotas and price controls in the agricultural sector, and to a timetable for the social security reform. The report concluded appraisal "with the judgement that the program of reform is substantial, economically sound and worthy of support." Staff still, however, recorded some reservations on the Government's ability to implement the reforms. Nevertheless, there was a recommendation to increase the size of the SAL to $105-115 million, given the agreement on Social Security reforms. 13. By June 15, 1986, Panama had to comply with seven conditions: (i) close Las Cabras sugar mill; (ii) change the role of the Instituto de Mercadeo Agropecuario (INA), from controlling prices to providing information; (iii) end price controls for food; (iv) eliminate beef export quotas; (v) remove 35 of the remaining 55 import quotas; (vi) provide the final list of 18 goods that will be protected by the maximum import tariff of 90%; and (vii) provide a plan for reducing the public workforce by 3,000 persons in 1986. On June 19, 1986 only two of the seven conditions had been met, in part because the agricultural minister remained unconvinced and uncooperative. The documentation received by the IMF was considered uneatiseactory and the IMF staff withdrew the program from the Board. The commercial banks once again extended their deadline, to August 31, 1986. 14. By the end of June, Panama had ccmplied with the June 1986 actions. This included the acceptance by the Bank of the postponement for the second time of the closure of Las Cabras sugar mill, now to August 1, 1986. At the same time, the IMF received satisfactory documentation and the program would go to the Board in early July 1986. The August 1 deadline for the closure of Las Cabras was met, though problems continued with the agricultural sector, where the minister continued to be uncooperative. - 58 - Annex 4 Page 4 of 4 15. on September 2, 1986 the Loan Committee approved negotiations for a SAL of $100 million. Concern was expressed during the discussion about the implication of the 60% maximum import tariff and the 3% minimum, recommending more action either in terms of levels or in accelerating the decline. Furthermore, the mild effect of such a reduction in the context of 570 new Contracts with the Nation approved since early 1984 was noted. 16. There were four conditions for Board Presentation: (i) Cabinet approval of a Social Security Reform draft law; (ii) agreement on a reform of the Leyes Especiales (covering workers in the public sector); (iii) removal of price controls on four goods; and (iv) divestitune of ENDEMA (a public sector agricultural equipment enterprise). 17. By the end of September 1986, only the last two had been complied with. Cabinet approval of the reform of the Social Security System looked improbable, given the political situation. By the end of October 1986 it was clear that the principal political party opposed the reform of the system, and without that support there was no way the reform would be approved. i8. Finally on December 3, President Delvalle sent a letter in which he promised to approve a reform of the Social Security System, but stated that he needed more time to discuss it. On the basis of this letter, the Bank waived this condition for Board presentation, and the latter was set for December 11. This waiver seems to be an important decision in the SAL II process. The Bank seemed pressed to deliver SAL II. Of the US$135 million financing gap that Panama faced for 1986, transfers of US$114 million were scheduled for the fourth quarter and all were tied to SAL II. If the Loan had not been approved, the IMF agreerant would not have been complied with, Panama would have lost the commercial bank money, and the country would have faced a terrible financial aituation. One would have expected that the GOP, facing these perepectives, would have complied more smoothly with the conditions for processing the loan. The Bank could have considered this a signal of the GOP's degree of commitment te the program. Attachment - 59 - Republic of Panama Panama, February 6, 1992 I________________________________ :oJUTCPE/N/019/92 Ministry of Planning and Economic Policy Minister's Office Mr. Marko Voljc Division Chief The World Bank Washington, D.C. 20433 Dear Mr. Voljcs With reference to the preliminary PCR draft for SAL I and II and TAL loans to the Republic of Panama, document which I received from you on November 5, 1992 during my visit to Washington, I would like to observe the following: 1. I consider that the report is extremely negative for Panama since it indicates that Panama did not comply with a large number of obligations agreed with the World Bank and does not underline the fact this was due to the irresponsible behavior of the governments which were in power before December 20, 1989. 2. We are not aware of the details and reasons that caused the non- compliance mentioned in the referred document and, therefore, cannot provide any opinion with regard to what has been expressed in the World Bank's internal document. 3 I consider that Panama and its present Government have shown seriousness and correctness in the handling of their international relations and, particularly, with the World Bank. I therefore would consider fair to incorporate an attachment to the report providing an account of the events following December 20, 1989. 4. I believe that an adequate account of our efforts, which have led to the clearance of arrears and the presentation of a new loan to the Board of Directors of the World Bank, can preclude any distorted image of Panama which does not fit the current reality. Very truly yours, (signed) Guillermo A. Ford H. Minister - 60 - II 1 ASacfi4/ Panama. 6 de febrero de 1992 UTCPE/N/019/92 Senor . Marko Volic Division Chief Banco Mundial Washington, D.C. Estimado Senor VoVIC: Con referencis al Oorrador preliasinar del informe de cumplimiento do los pr6stamos SAL I v [I y TAL a la Rep4blica de Panaem, documento que usted tuvo a bien entregarme el 5 de noviembre de 1991 degrante mi visita a Wash;n9ton. me es qrato expresarle lo siqu lite: 1. gstimo qua el Informe as sumamente negativo con respecto a la Repoblica de Panam&, par cuanto indica que nuestro pa£s, como tal, incumpli6 un sinn4mero ce obligaciones pectadas con el Banco Mundial y no destaca el hecho Conereto de que fueron los Gobierno. que rigieron los destinos de nuestro pais hasta el 20 dct diciembre de 1909 los cuales, de manora irresponsable. actuaron en la forma expresada. 2. oescor~ocemos los intimidados de los incumplimiontos planteados an el documento en reforancia, raz6n par la cual no puedo apinar especiftcamente con relaci6n a lo exprwsado en el documento interno del Banco Mundial. 3. Estimo que el actual Gobierno do la Rept;blica de PenamA y el pais, han demostrado corrtccian en el maneJo de sus relaciones internacionales y concretamonte ante el Banco Mundial, par lo quo seria Justo que el Informe a qua me he reforido so completara por medio de un anexo que relate los eventos posteriores at -.0 de dciembro de 1989. 4. Considero, que de 'tu presentarse adecuedamente los esfucrzos de nuestro pdis, los cuales harn pormitido cancelar los etrasos y permitirm tllevar una nuova operaci6n al Directoria del Banco Munctal, 5o podria presenter una Imagen distorsionada y no ajustada a la realidad actual de nuostro pais. sin otca povtirilar, me as gratn suscrLbirme. muy atentement&. _ , H~~1inistro I/