Reuort No. 7559-TA

TanzaniaPublic Expenditure Review

(In Three Volumes) Volume 1: Executive ReportMay 22,1989

Country Operations DivisionSouthem Africa Department

FOR OFFICIAL USE ONLY

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bocument of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may not otherwisebe disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit

The Tanzanian Shilling (Tsh)

Exchange Rates

1960 - 1974 US$1 Tsh 71975 - 1981 US$1 - Tsh 8December 1983 US$1 = Tsh 12December 1985 US$l = Tsh 17June 1986 US$1 - Tsh 40December 1986 US$1 = Tsh 52December 1987 US$1 - Tsh 84December 1988 US$1 - Tsh 120April 1989 US$1 = Tsh 132

Fiscal Year

July 1 - June 30

This joint World Bank/Government of Tanzania Report is based on thefindings of a mission to Tanzania in October-November 1987. The Bankmission comprised Mike Stevens (mission chief and principal author),Guttorm Schelderup, Maria-Theresa Benito of AF6CO, and Andrew Bird, StephenLister and Ron Vogel (consultants). On the Tanzania side counterpart stafffrom the Ministry of Finance. Economic Affairs and Planning (MFEAP) wereled by Mr. Solomon Odunga and Mr. Raphael Mlolwa. A special study on thestandard costs of key Government programs was prepared by Dr. NathanielOsoro of the University of Dar-es-Salaam, and the mission also drew onvaluable contribitions from Professor Wangwe and other members of theDepartment of Economics. The initial draft of this report was discussedwith MFEAP colleagues in May - June 1988, and the final draft in March-April 1989.

FOR OMCIAL USE ONLY

EXECUTIVE REPORT

TABLE OF CONTENTS

Page No.

Summary of Main Conclusions ii

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Chapter 1 - Public ExPenditure Under Stress . . . . . . . . . . . . 3

Chapter 2 - Economic Performance and Trends in Public Expenditure . .5

Historical Perspective ........ .. .. .. .. .. .. . 5Structure of Public Finance . . . . . . . . . . . . . . . . . . . 'Macro-economic Prospects ................... . 10

Chapter 3 - Public Expenditure Strategy and Issues . . . . . . . . .13

Shy Tanzania Needs a Public Expenditure Strategy 13Medium-Term Financial Framework ..... . . . . . . . . . . . 15Balsnce Between Recurrent and Development Expenditure . . . . . 15Allocating Resources Between Sectors and Activities . . . . . . 16Public Sector Manpower, Pay and Productivity . . . . . . . . . . 17Revenue Trends and Prospects ...... . .. . . .. . . . . . 22Cost Recovery ............ .... .... .... . 24Utilization of Aid . . . . . . . . . . . . . . . . . . . . . . . 25Parastatals.. .................. .... 26Local Government ................... 28Planning and Management of Public Expenditures . . . . . . . . . 29

Chapter 4 - Sector Programs ................... . 32

Agriculture.. ................... 32Natural Resources . . . . . . . . . . . . . . . . . . . . . . . 33Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . 33Energy and Mining . . . . . . . . . . . . . . . . . . . . . . . 34Transport, Communications and Works . . . . . . . . . . . . . . 36Education . . . . . . . . . . . . . . . . . . . . . . . . . . . .37Health.. . ................ 39Housing, Water Supply and Sanitation . . . . . . . . . . . . . . 40Other Government Services ................... 41

Chapter 5 - Implementing the Public Expenditure Strategy . . . . . 43

Building Blocks of a Public Expenditure Strategy . . . . . . . . 43Scenarios for a Restructured Budget . . . . . . . . . . . . . . 46

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed withoui World Bank auithorization.

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SUW A2RY OF MAIN CONCLUSIONS

Economic Recovery Program (ERP) policies have been beneficial tothe economy as a whole, and a strong supply response is building in theprivate sector. But critical improvements in the delivery of public servicesare needed if the recovery in economic activity is not to remain predominantlyoutside formal channels, and the social costs of a decade of economic declineare to be alleviated. The manifestations of strain are easily identifieds lowpublic service pay, neglected maintenance, deficient operating funds, and highlevels of parastatal recourse to the banking system and the budget.

The PER analyses the causes of fiscal strain and identifies thetrade-offs facing policy-makers. It concludes that increased aid flows,improved domestic revenue collection efficiency and the continued growth ofoutput should provide the Government some leeway within which to address theseproblems. However, in the face of multiple pressures on the budget andTanzania's rapidly growing population, an incremental approach will not yieldthe improvements the Government desires within an acceptable timeframe. Thispoints to a more fundamental restructuring of public expenditure than hashitherto taken place. Some of the building blocks of this restructuring areIn place or under consideration, others need to be developed afresh. As seenby the PER, the main components of a public expenditure strategy for Tanzaniaare the following:

1. Continuation of current macroeconomic policies including furtherdownward adjustment of the real exchange rate, and theimplementation of reform programs in industry and agriculture.

2. Further revenue strengthening by simplifying the rate structureand broadening the tax base, and greater cost recovery throughuser charges and parastatal pricing policies.

3. Restructuring of parastatals to reduce the long-term budgetaryburden of subsidies, capital transfers and overdraft guarantees.

4. A program to strengthen local governmet finances, management andmanpower.

5. A package of reform measures to restore civil service productivitythrough retrenchment with appropriate compensation, salarydecompression, reduction in non-wage benefits, monetary payincreases, and management strengthening.

6. Measures to improve the planning and maDagemnt of publicexpenditures and to strengthen aid coordination.

7. Restructuring of the Recurrent and Developmeat Budgets, modifyingthe relative shares of ministries to better reflect recoveryprogram priorities, including social development objectives, andthe changing role of the Government and to reduce the number ofprojects in the PIP to sharpen its focus and improveimplementation.

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ABBREVIATIONS

ATC - Air Tanzania CorporationBIS - Basic Industries StrategyBOS - Bureau of StatisticsBMDP - Budget Management Development ProgramCCM - Chama cha Mapinduzi (Party, formerly TANU)CFS - Consolidated Fund ServicesCMS - Central Medical StoresCTB - Central Tender BoardDB - Development BudgetDCA - DiL torate of Civil AviationDE - Development Budget ExpenditureDEVPLAN - Planning division of MFEAP (now being transferred to State

Planning Commission)EDP - Essential Drugs ProgramEC - European CommunityERP - Economic Recovery ProgramGDP - Gross Domestic ProductIMF - International Monetary FundIPR - Investment Program ReviewIRTAC - Industrial Rehabilitation and Trade Adjustment CreditMALD - Ministry of Agriculture and Livestock DevelopmentmCW - Ministry of Communications and WorksMFEAP - Ministry of Finance, Economic Affairs and PlanningMHA - Ministry of Home AffairsMIT - Ministry of Industry and TradeMLG - Ministry of Local Government, Cooperatives and MarketingMLNRT - Ministry of Lands, Natural Resources and TourismMMLD - Ministry of Manpower and Labour DevelopmentHOD - Ministry of DefenseMOH - Ministry of Health and Social WelfareMRC - Multisector Rehabilitation CreditNHC - National Housing CorporationNMC - National Milling CorporationNTC - National Transport CorporationNUWA - National Urban Water AuthorityO&M - Operations and Maintenance ExpendituresPE - Personal EmolumentsPER - Public Expenditure ReviewPIP - Public Investment ProgramPMO - Prime Minister's OfficeRADO - Regional Agricultural Development OfficerRB - Recurrent BudgetRCER - Revenue Collection Efficiency RatioRDD - Regional Director of DevelopmentRE - Recurrent Budget ExpenditureSAP - Structural Adjustment ProgramSGR - Strategic Grain ReserveSIDA - Swedish International Development AgencySSA - Sub Saharan AfricaSTAMICO - Tanzania State Mining CorporationTAFICO - Tanzania Fisheries Corporation

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TANESCO Tanzania Electricity Supply CorporationTANZAM - Tanzania-Zambia HighwayTAZARA - Tanzania-Zambia Railways AuthorityTEC - Total Estimated CostTHA - Tanzania Harbours AuthorityTHB - Tanzania Housing BankTPDC - Tanzania Petroleum Development CorporationTRC - Tanzania Railway CorporationTRE - Total Recurrent ExpenditureTS - Total SupplyUDSM - University of Dar-es-SalaamUNDP - United Nations Development ProgramUPE - Universal Primary EducationURWS - Universal Rural Water SuppliesWFP - World Food Program

EXECUTIVE REPORT

TANZANIA PUBLIC EXPENDITURE REVIEW

INTRODUCTION

1. Since 1984185, and particularly since 1986, the year the EconomicRecovery Program (ERP) was launched, the Tanzanian economy has beendemonstrating its recovery potential. Gross Domestic Product (GDP) iscurrently estimated to be growing at between 4 and 5 percent per annum,sufficient to enable per capita income and consumption to rise. This recoveryis due to several factors. The return of favorable weather for agriculturalproductiou and increased aid flows have played a part. But the most importantstimulus has been the changes the Government has made to economic policy,which have had imparting new energy to economic agents. The most significantdevelopments in economic policy have been:

(1) Trade liberalization measures such as the Own Funds Importsscheme, export retention accounts and, more recently, the OpenGeneral Licence (OGL) facility.

(2) The gradual dismantling of administrative controls over pricesand distribution.

(3) The progressive devaluation of the Tanzanian shilling, which bychanging the structure of relative prices ha- stimulated exportsand is forcing a more efficient use of resources throughout theeconomy.

2. Also important has been the control of fiscal deficits, and thesignalling to public enterprises that increasingly they will be heldaccountable for their performance, and cannot rely on Government subsidies.

3. Unfortunately (and perhaps not unexpectedly) the recovery has alsoexposed how much the fabric of Tanzania's economy deteriorated during theyears of economic crisis in the 1970's and early 1980's. The most strikingaspect has been the constricting bottlenecks facing economic agents as theyseek to translate their energies into increased output. Farmers responding tostronger price signals have seen their efforts frustrated by inadequate cropprocessing capacity and marketing rigidities. Businesses of all types havehad to deal with a high cost yet poorly functioning transport system.Hcuseholds, on their part have had to endure deteriorating service fromcentral and local Government agencies.

4. The constraints holding back the recovery of output are chiefly foundin those parts of the economy where the public sector is predominant.Although efforts are being made to strengthen the delivery of key governmentservices, it is by no means clear that the situation is improving. Whilethere are more goods to distribute and more trucks available in which to

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transport them, compared with five years ago, the road network is in worsecondition. In most other areas, publicly provided services continue todeteriorate or otherwise operate under extreme strain.

5. Thus, the public sector, once viewed as the vanguard of development,appears now to be holding back recovery. With the right incentive structurethe private sector has demonstrated its capacity to take care of itself. Thechallenge for policymakers in the next stage of the recovery process is toaddress effectively the problems of the public sector, to lift the burden ofpoorly per{ rming state enterprises, to continue the shift from directcontrols on economic activity to indirect levers working through macroeconomicpolicy and the price system, and to raise the effectiveness of governmentprograms in those areas such as physical and social infrastructure where thestate is tte main provider.

6. This Public Expenditure Review (PER), carried out by the Bank withthe assistance of counterpart staff in the Ministry of Finance, EconomicAffairs and Planning, began on a straightforward examination of publicexpenditure patterns. Its objective was practical recommendations as to howrecurre't and investment programs could be improved. It soon became clear,however, that there was a larger issue to address - the role and performanceof the public sector in Tanzania's economic recovery. This Executive Report(and the Technical Report that accompanies it) describes the presentsituation, and analyses it. The Report has therefore been written to hulppolicymakers prepare a program of actions to address the deepseated problemsof the public sector, build on what has been started with the ERP, and, overtime, ensure the sector's contribution to economic recovery is a positive andstrong one. Some of what is recommended is already in hiand and the purpose ofthe PER is to endorse and give encouragement to the present direction ofpolicy. In soze other respects the PER goes further than present policy,suggesting that some radical approaches need to be taken.

7. In overall terms, the Report makes recommendations across a broadfront aimed, firstly, at helping the Government analyse an extremely complexset of public expenditure problems, secondly, improving the processes ofpublic expenditure management, thirdly, raising the effectiveness ofGovernment programs, fourthly, restoring the productivity, morale anddiscipline of the public service, and, fifthly, redefining, over the mediumterm, the role of the public sector in the economy, so that it supports ratherthan holds back the recovery of output.

8. The Executive Report follows the same format as the Technical Report,and summarizes the principal findings of each chapter.

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CHAPTER 1 - PUBLIC EXPENDITURE UNDER STRESS

9. Chapter 1 describes the increasing difficulties faced by theGovernment as it endeavors to meet its program objectives, and how theshortage of resources has affected its ability to perform a range offunctions. Ever since the Arusha Declaration in 1967, the public sector hashad a special prominence. Public expenditures have been seen as the principalmeans of transforming the economy. The state has played a central role inforging national identity, and in providing key economic and social services.Among the latter were many innovative programs aimed at delivering basiceducation, health care and potable water to the bulk of the population.

10. But public finances have come under increasing pressure in the pastdecade as the economy has declined in the face of external shocks anddivergent domestic policies. While the Government has been generallysuccessful in containing the budget deficit in the face of revenue weaknessand uncertainty, the capacity to carry out essential functions has beenimpaired, and the poor performance of many government agencies now constitutesa bottleneck to economic recovery.

11. This fiscal stress has manifested itself in many formss

(1) Most programs of the Government give the appearance of beingchronically underfunded, program managers receiving, typically,one third of the resources they believe they need to operateeffectively;

(2) With average salaries providing one fifth the purchasing powerof the early 1970's, most officers cannot live on their officialpay alone. Not unexpectedly, this is a major source of poormorale, weak motivation, undue emphasis on fringe benefits,absenteeism, and of growing corruption;

(3) Earlier achievements in education, health and water supplies arein danger of being lost due to insufficient recurrent funding,malfunctioning input distribution systems, broken equipment anddilapidated structures;

(4) Not only roads, but virtually all government operatedinfrastructures have deteriorated due to lack of maintenance,causing crippling bottlenecks;

(5) Project implementation delays are numerous, resulting inforegone aid disbursements and few projects making thetransition each year to effective operation;

(6) Instead of contributing to budget revenues, parastatals havedrained them;

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(7) Local Government, which is responsible for the delivery of basic

services in the social sectors, remains weak and heavily

dependent on Central Government transfers;

(8) Debt servicing has been the fastest growing component of the

Govertment budget, reducing the resources available for program

expenditures;

(9) Domestic revenue deteriorated as the tax base shrank and

collection efficiency fell. Tax receipts have become heavily

reliant on a small group of tax payers and a few excisable

products.

(10) Dependence on aid has increased, and the Recurrent Budget, in

adaition to the Development Budget, has become criticallydependent on aid flows.

12. These indicators of fiscal strain point to a serious disequilibrium

in public finances, suggesting a gap between the aspiration of policy makers

and the capacity of the public sector to translate aspiration into effective

programs. In addition, these negative factors compound each other, further

depressing the productivity of public expenditures.

CHAPTER 2 - ECONOMIC PERFORMANCE AND TRENDS IN PUBLIC EXPENDITURE

Historical Perspective

13. Chapter 2 begins by examining the evolution of Tanzania's publicexpenditures. Financial pressures as profound as those now confronting theTanzanian Government take a long time to build up. The present configurationof the budget is the result of policies, programs and economic events that goback over many years.

14. In the early years after Independence, expenditures were modest inscope and in line with revenues. Fiscal strains, however, began to appear inthe period following the Arusha Declaration, when recurrent expendituresstarted growing more rapidly than domestic revenues, and large scaleinfrastructure investments greatly expanded the Development Budget. At thesame time, the Government also expanded its social programs. Exportperformance began to weaken, and the balance of payments came under increasingpressure following the first oil price shock and a drought which obliged theGovernment to spend scarce foreign exchange on food imports. As a result ofthese developments, the Recurrent Budget moved into deficit for the first timein 1974/75.

15. The Government took a number of measures in response to the economiccrisis, including supply cuts and tax increases. The foreign exchangeposition strengthened due to increased aid receipts and the windfall gains ofthe coffee boom, following serious frost damage in Brazil in 1975. As aresult, the Recurrent Budget returned to surplus for a short period.Development expenditures rose sharply. The latter was due firstly to theBasic Industry Strategy (BIS), an industrial diversification program carriedout largely through the public sector, aimed at reducing Tanzania'svulnerability to commodity price fluctuations, and secondly, to the launchingof major primary education health care and water supply expansion programs.

16. In the last years of the decade the foundation of this expansion inprogram commitments was undercut by a series of profound external shocks: thecollapse of the East African Community, the Amin war, further oil priceincreases, the end of the coffee boom and recession in the industrializedworld. This propelled the Tanzanian economy into deep economic crisis fromwhich it is only now emerging.

17. Taking the period as a whole, the overall picture is one of the rapidaccumulation of expenditure commitments set alongside a relatively lacklusterperformance of the overall economy. Over the period 1970-1985 officialstatistics show that GDP grew at an average rate of 3.2 percent, the same asestimated population growth. Unfortunately, not only was this economicperformance insufficient to raise living standard3, it also provided too slowa growth of the revenue base for the expansion of Government expenditure

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Chcft ITANZANIA

STRUCTURE OF THE GOVERNMENT BUDGET

Expenditure Revenue/Financing(1988/89) (1988/89)

40

35.1% 351%LOffl (I 8%)

Develoownet GRl (30%)Expencliture

(84%)30

FnnW RMue (2 A)

(14.5%) Domestc_ 2Fn~~~~~~~~~~~saw s (I 5eb)

-~~~ ~26 7% rmgi%

K Feae~~~~~~~~~~~~~~~Romptnon Ro~vorn(54%) Aisance

Consobdote (6.0%)Rind

Swiespi9Xf 1 Z )

20 deft h 8 99.) De¢ebt ot GDP. LOANS CUYS GRAM20.5%

20 Interes Dute 8(3 1%)

(02%)

Grants (4 3%) oumto

& ExC"sDuties

Confractuot a anehContingenReenu

MinlsterWO LkUabllt(2.9%) (208%)

(15.9%) Peesana

(22%)

income Tax

0mW (46%)Chage(668%)

0 ReinlSLPo4(I 1%) Fes(.)

Oywah budge defcto is 8 percent ef GO.D LoA!4 and GmAmJ ar,fatrpoject revLopMEN REviNUiand QiHER POGRAM ASSISANiCE roeprsn cauntsmart funds tram balance of paotriens sJppol

WoMankS*- 44171-1

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programs, leading to a mismatch between expenditure commitments and domesticresources. This is corroborated by:

(1) public service employment data which show government employmentgrowing at roughly twice the rate (6-7 percent) of Governmentrevenues; and

(2) analysis of the recurrent costs of the development programsTanzania was implementing during the period.

18. By the criterion of matching employment expansion to GDP growth, thepublic service in 1984 appeared to be 44 percent too large relative to 1970.Similarly, the size and composition of the development program Tanzania wasattempting to carry out generated recurrent costs that would have strained theresources of an economy growing twice as fast as Tanzania's was. Bothexamples illustrate the mismatch between resources and expenditure commitmentsthat began to occur in the 1970s.

Structure of Public Finance

19. Tanzania's budget has adhered to a consistent format over the years,which greatly facilitated the work of the PER. While years of financialstringency have placed an increasing strain on public financial management, asthe Reports of the Auditor-General bear testimony, the system has proved quiterobust and financial routines have for the most part been maintained. Thecountry thus possesses a functioning framework within which to address publicexpenditures problems.

20. Analyzed in terms of their percentage share of GDP, publicexpenditure aggregates have performed as follows:

(1) Current revenues averaged about 19 percent of GDP up to 1984/85,dipped to about 16 percent in the next two years before risingagain. In 1988/89 current revenues are estimated at 21 percentof measured GDP, due principally to a more buoyant economy, taxadjustments and increased collection effort.

(2) Recurrent expenditures up to 1984/85 averaged just over 20percent of GDP, but since the ERP they have been rising, and areestimated at 27 percent in the 1988/89 budget. The main reasonfor the increase is external debt servicing, which has sharplyrisen in local currency terms, as the shilling hae beendevalued. In addition, devaluation has made more apparent thereal cost of programs with a high foreign exchange content.

(3) Development expenditures have declined, from 12 percent of GDPin the late 1970s to 4 percent in 1985/86. They have sincerecovered to nearly 9 percent in 1988/89 on an estimates basisbut this is primarily exchange rate related -- the actual

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Chart 2TANZANIA

COMPOSITION OF GOVERNMENT WDGET BY MINISTRY EXPENDITURE SHARES

Recunrent Budget Devopmwent Budget(1988/89) (4988/89)

100 _IRegons (6.6%)

(0/w Hemh2 6Y fks 0 9%) Reons (78w)

00 _ 0IW (70%) Ofthr (6.5%)

PRn¶e Minwser (2 3%) PMCtW. DOv. (1.8%)

Not Service (2.3%) Education (3.1%)

80 _ Aspeute (33%) Dde8ns& NatonaS S ce (3.4%)

Commnunications and Not Reore&Wow (46%) & rTou,lm (3.5%)

Foregn Affai (48%) H16fr (40%)70 -

lealtt (48%) Waw (55%)

P oo _ Educa (8.3S) Trade (5 7%)

inFance (7.2%)

He Affan s (89%)50 _

Locc Govt (8.3%)

Defns (11.9%)40 - Coaruncrbon

&Wdc (100%)

30 Local Govnent (15.2%)o/w Education (10.2%)

Health (37%) Energv&MiNrais (164%)

20-

10 Finance (2D.0%)Agftcutture (168%)

0 _

World onk -44171:2

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project load has not increased. In real terms developmentexpenditures have been much more sharpl7 cut than recurrentsupply votes, and are now effectively half the level of the mid1970s. However, due to the high recurrent costs it generated,the latter was unsustainable.

(4) The overall deficit rose to a peak of nearly 16 percent of GDPin 1981182, declining to below 9 percent in the following years.Since the ERP, the deficit has widened again, but this is mainlythe result of exchange rate changes on external debt servicingand development expenditure. In recent years, the bul# of thefinancing of the deficit has been derived from counterpart fundsgenerated by balance of payments support, extended in the formof grants and concessional loans. The 1988/89 budget aims atzero net credit from the banking system.

21. These ratios, however, should be interpreted with caution. Firstly,because of changes in the exchange rate which have caused the shilling valueof foreign exchange denominated flows to fluctuate greatly. Secondly, becausethe underlying estimates of GDP are subject to considerable variation,particularly in recent years with high inflation and so much activity takingplace outside official channels. Due to the difficulty of capturing suchactivity in the National Accounts, GDP may be significantly undervalued,causing the revenue and expenditure ratios to be overstated. Thirdly, donorsare increasingly disbursing their aid directly, and this is often notreflected in the Government's accounts, particularly the Development Budget.Fourthly, the distinction between recurrent and capital expenditures hasbecome blurred, with many recurrent activities supported in the guise ofdevelopment projects.

22. Frequent shifts in portfolio responsibility between ministries andbetween regional administration and local goverament complicate the analysisof changes in the sectoral composition of expenditures. This and some errorsin the published data, have caused some observers to conclude that socialprograms have been worst affected. The PER presents data on sectoralallocations, but in most areas no clear pattern between sectors emerges,indicating that the squeeze on recurrent resources nas been shared evenly. Ifanything, relative allocations to social programs have slightly improved sincethe ERP, suggesting that as far as government expenditures are concerned, thesocial costs are not those of adjustment but of the economic crisis thatpreceded it.

23. More revealing are changes among different categories of expenditure:

(1) Between Consolidated Fund Services (CFS) and Total Supply.

(2) Between Ministerial Supply and Regional Supply, the latterdeclining after the reconstitution of local government --

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largely funded by transfers from the Ministry of LocalGovernment.

(3) Within Ministerial Supply, between the categories of Grants,Contractaal & Contingent Liabilities, Personal Emoluments andOther Charges.

These and other changes can be seen in Chart 3.

24. The Government's debt service burden (the principal component ofCFS), which hes risen from 15 percent of the Recurrent Budget in 1972/73 to 36percent in 1988/89. This has exerted a powerful squeeze on Supply votes.Additional pressure on expenditure programs has come from the increasing shareof Ministerial Supply taken by Grants (transfers by Central Gover.iment tolocal government councils, parastatals and external bodies) and Contractual &Contingent Liabilities (the making good of parastatal debt guarantees andother contingencies traceable to Tanzania's economic crisis). This hasreduced the amount available for Personal Emoluments and Other Charges, thenormal means of funding departmental programs. Some of the increase in thetwo former categories is explainable in terms of Ministry of Local Governmenttransfers to councils, and pending salary awards. Much of the rest reflectsthe hitherto hidden costs of Tanzania's large and mostly inefficientparastatal sector, as debts to the banking system are transferred to theGovernment budget. Chart 1 shows in diagrammatic form the composition ofrevenues and expenditures iA 1988/89 and how the Government expects the budgetdeficit to be financed.

25. Against the background of an overall reduction in the DevelopmentBudget since 1980/81, there have been significant changes in its sectoralcomposition. Capital allocations to industry declined sharply after thepeaking of expenditures on the BIS in 1980/81, and the share of publicinvestment in agriculture has risen, reflecting, in part, a conscious effortto raise agricultural output by directly productive investment. Chart 2 showsthe breakdown by ministry of recurrent and development expenditures in1988/89.

Macro-economic Prospects

26. Currently, GDP is estimated to be growing at between 4 percent and 5percent, and the PER concludes that provided the momentum of policy reformunder the ERP is maintained, there are good prospects of maintaining and evenimproving on current performance. Agriculture is projected to grow at 4.5percent, industry at 6 percent and the services sector at 4 percent. Officialexports are projected to grow at 9 percent in volume terms. This issignificantly faster than imports, which are projected to grow at 2-3 percentin the near term, before rising to a rate similar to overall output growthover the longer term. The balance of payments for many years to come,however, is likely to remain a critical constraint, implying that Tanzania

l

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Chart 3THE CHANGING STRCIE OF THE BWDGET

COMPOSITION OF PJBUC EPNDITURE1974/75 - 4988/89

100-

80° - - -- -- -- - %%- -- -- '

so- Consoldated Fund S *^__

70- (Deb SeMckV)

Soo ~~orKtue

i40____ \_

2-

COMPOSMON OF MINISTERIAL SUPPLY1974/75-1988/89

800-

PConornent oun

40 /30- o O th'_^___

20 -- _

10- Per- EmoumenEs

0- -X t t < # X g X ~am vCDZZ W g 9 W U 8 s ~~~~~~b i i i

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will require the continuation of high levels of external aid and debtrescheduling on the most concessional terms for many years to come.

27. From the perspective of public finances, the implications of thismacroeconomic scenario are that prospects for the revenue base performingbetter than during the past decade are good. However, while this shouldimprove public finances over the long term, the process is likely to be arelatively slow one. In other words, stronger GDP growth alone will not solvethe problems of fiscal imbalance in an acceptable time frame. Assuming steadyimprovements in collection efficiency, arising from the Government's presentefforts, domestic revenues are projected to rise by about 5 percent per annumin real terms. This would permit an expansion of recurrent outlays of between3 percent and 5 percent depending on whether the Government chooses to reduceor maintain the present fiscal deficit/GDP ratio, a strategic decision thataffects the long run balance between the public and the private sectors.Given that current provision is significantly below the level needed foreffective delivery of Tanzania's existing programs, and that present salariesare by several orders of magnitude too low for a well motivated and effectivecivil service, a strategy that relies on Tanzania solving its publicexpenditure problems by economic growth alone is too slow working to beacceptable. Furthermore, Tanzania's population growth rate, close to 3percent per annum, constitutes a public expenditure time bomb which must beAefused by changes in the way many programs are financed and delivered.Urgent action is necessary that addresses the root causes of Tanzania'sproblems of public finance. The PER concludes that these are structural incharacter. In short, the public finances of Tanzania have to undergo across-the-board restructuring if the public sector is to change from being a drag onthe rest of the economy to an agent for accelerated development.

28. The rest of the PER is about how that restructuring might take place.

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CHAPTER 3 - PUBLIC EXPENDITURE STRATEGY AND ISSUES

29. Chapter 3 discusses a range of issues that are critical for thefuture management of Tanzania's public finances. It begins by stressing theneed for a public expenditure strategy.

Why Tanzania Needs a Public Expenditure Strategy

30. Public expenditures in Tanzania have been quite well controlled butthey have not been effectively planned. In part this has occurred because ofthe relatively weak links, both in the central allocation ministries and theline ministries, between planning and budgeting functions. In a morefundamental sense it is because Tanzania has not yet evolved (or has lost -for there is evidence that functioning mechanisms existed in the 19609) acapacity to set public expenditure priorities that relate realistically to theexisting and prospective availability of resources. In the past, Tanzaniademonstrated a capacity to set bold and challenging program objectives, butthese have proved unsustainable because the underlying financial analysis waseither uot done, done unrealistically or set aside by policymakers.ironically, the strong thrust to translate national objectives intoquantifiable program terms has probably exacerbated Tanzania's budgetaryproblems. When faced with insufficient resources, both planners anddepartmental managers have tried unsuccessfully to meet objectives. This hasresulted in resources being attenuated and delivery efficiency has declined;and it has delayed the reappraisal of priorities. These problems are fam5liarto Tanzanian policymakers, but the steps taken so far have been piecemeal.There is a need, increasingly recognized within the Government, to develop a

public expenditure strategy that is comprehensive and rooted in a morerealistic assessment of resources available, and enables the Government to

chart a more sustainable course in the years ahead.

31. The main elements of such a strategy are the following:

(1) A lengthening of the budget horizon through some form of mediumterm financial framework, that clarifies the resource envelopeavailable for programs, and enables the spending ministries andthe Ministry of Finance, Economic Affairs and Planning (MFEAP)to break out of the present unsatisfactory situation of ad hocadjustments and across-the-board budgetary cuts.

(2) Greater acknowledgement of the linkages between the Recurrentand Development Budgets, and a recognition that, because of thepervasive problem of operating costs, the Recurrent Budget mustbe the primary focus of public expenditure planning (as opposedto the traditional concern of economic planners with theDevelopment Budget). In the interests of fiscal transparency,the transfer of recurrent activities financed within theframework of development projects to the Recurrent Budget, and a

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more effective capturing of the costs of donor financed projectsby the Development Budget.

(3) A new approach to determining the allocation of resourcesbetween sectors and activities, concentrating resources on alimited range of core programs that are critical to recovery andcan be provided only by the public sector. That a sector (forexample, industry) is crucial to the ERP does not necessarilymean a corresponding requirement for expenditures by the publicsector. Policy changes that stimulate the private sector may bea more appropriate response.

(4) Addressing squarely the issue of public service pay, numbers,productivity, morale and discipline, by eliminating excessstaffing and payoff fraud, raising monetary pay and reducingfringe benefits, widening differentials and restoring mechanismsfor the proper management and control of a revitalized publicservice.

(5) Continuing present efforts to strengthen revenue collections,and simplifying tax and tariff structures from the perspectiveof ease of collection, revenue sufficiency and economicefficiency.

(6) Pursuing, to the maximum extent possible, consistent with socialequity and administrative feasibility, cost recovery, to enhancedomestic revenues, to share the cost of services withcommunities and to promote more efficient use of resources.

(7) Improving the effectiveness with which aid resources areutilized in the economy, through aid coordination supported by abetter integrated planning and budget system.

(8) Action to reduce, over the long term, the burden of theparastatal sector on the Govenment's budget and to increaseresource use efficiency by developing policies designed toimprove the efficiency, through competition and pricing policy,of marketing boards, utilities, banks, state-owned enterprises,and to subject to review non-commercial parastatals partly orwholly dependent on the Government budget for resources.

(9) Measures to strengthen local government, dealing with councilweakness in the areas of management, staffing, finances andservice delivery.

(10) Measures to improve the planning and management of publicexpenditure.

The main findings and recommendations of the PER under these headings are setout in the paragraphs that follow.

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2.14 In terms of public finances, the most important measures taken

under the SAP weres

(a) General cutbacks in the budget, to reduce the overall deficit.

(b) A substantial reduction in development expenditures, eliminatingmost new projects and a number of old ones.

tc) A shift of budgetary resources, especially capital, to theproductive sectors, notably agriculture.

(d) Attempts to reduce the share of defense t.zpenditures andincrease maintenance allocations.

(e) Higher taxes on beer and cigarettes and increased tax collectionefforts.

2.15 In addition, local government councils were re-established, and

cuts were made in the public service. A commission was appointed to review

the parastatal sector, following which several inefficient parastatals were

closed, managers were urged to become more efficient, and recurrentsubsidies to productive enterprises were eliminated. These steps wereimportant in that public expenditure were brought under better control, butiaany of the structural problems remained, and some were to get worse.

Evidence of a Commitments/Resources Gap

2.16 In terms of public expenditures, wh&t is most striking about the

past decade and a half is the rapid accumulation of expenditure commitmentsset alongside a relatively lacklustre performance by the overall economy,and thus government revenues. On the resources side, GDP grew at anaverage rate of 3.2 percent for the period 1970-85, the same as estimated

population growth. Government revenues' share of GDP at the end of theperiod, 16 percent, was little different from the beginning. Governmentcommitments, however, appear to have grown substantially faster, leading to

a serious imbalance with resources, and the visible mismatch betweenpresent budgetary allocations and current programs. Pay restraint, budget

cutbacks and restrictions on the release of funds averted a complete loss

of control of the fiscal aggregates, but did little to tackle policycommitments rnmning ahead of the available resources. Two different setsof data confirm this: (i) public service employment trends and (ii)analysis of the size of the Development Budget and the operations andmaintenance expenditure implications on later recurrent budgets.

2.17 Public Service Employment: The two most consistently reporteddata series of public service employment are those compiled by the Bureau

of Statistics (BOS) and those published in the Economic Surveys. (SeeTable Cl in the Statistical Appendix).

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Recurrent Budget. The Development Budget should be tailored to complement theRecurrent Budget, not vice versa, and should comprise a much smaller number ofprojects aimed at rehabilitating those activities upon which the Governmentdecides to concentrate its recurrent resources. With around 860 separateprojects, the PIP is too large to manage effectively.

36. The first step in the process of budget restructuring is to assessrealistically the true cost of present commitmevts. Specifically this meansassessing: (i) recurrent funds to make good the underfunding of existingservices and to meet built-in commitments to expand services, (ii) capitalfunds to complete viable projects already under way and to make good the pastneglect of maintenance through rehabilitation in key areas like roads wherethe failure of the public sector is holding back economic recovery, and(iii) recurrent funds required to operate and maintain viable projects oncethey have been completed.

37. This work has already been started by the Budget ManagementDevelopment Program (BMDP), located in the Treasury part of MFEAP. DEVPLANstaff (who have been engaged in the preparation of a new Five-Year Plan) aswell need to be involved together with the finance and planning staff of themain sector ministries.

Allocating Resources between Sectors and Activities

38. Some changes are needed in the way ERP priorities are currentlyreflected in budget allocations. The fact that a sector is crucial does notnecessarily mean a corresponding requirement for public expenditures. In anumber of sectors (e.g. industry, agriculture) the urgent need is to adjustthe policy framework so as to improve incentives. Without an effective policyframework additional public expenditure may be futile; with an effectiveframework additional public expenditures may not be necessary. Furthermore,even when public expenditure is required to address constraints facing asector, crucial bottlenecks (e.g; transport constraints on increasedagricultural production) may require expenditure on another sector.

39. The distinction between "productive* and "service' sectors (as foundin the ERP) can be a misleading one for budget planning. Direct governmentparticipation in the productive sector in the past has not been particularlyeffective. In the future it will be better to concentrate resources in areaswhere the Government is the main provider of services, leaving actualproduction to the private sector.

40. Choices also have to be made within sectors, for example betweendifferent levels of the state education and health systems, and the share oftotal expenditures that a sector merits will depend partly on the intra-sectoral choices that are made. In critical sectors the Government is wastingresources on the wrong activities, thus resources have to be reallocatedwithin sectors. Furthermore, to improve implementation and raise the overall

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return on government programs, resources must be concentrated on keyactivities, and second order programs eliminated.

41. In designing sector programs and making choices special attentionneeds to be paid tos (i) the recurrent costs of rehabilitation programs,which must be demonstrated to be financially sustainable; and (ii), theforeign exchange costs of programs which must be valued realistically.Tanzania's present public expenditure difficulties in part were caused by theabsence of mechanisms to estimate the recurrent costs of individual projectsand to integrate them into an overall budget framework. Hitherto, theovervalued shilling has masked the true resource cost of some programs. Wherethey can be calculated, economic rates of return may be used to determine thepriority of alternative projects, bearing in mind, however, that the pay offfrom well targetted rehabilitation investment is likely to be high. Thus newprojects must demonstrate high potential returns to merit inclusion in thePublic Investment Program.

Public Sector Manpower, Pay and Productivity

42. Revitalizing the public service is one of the most important tasksfacing the Government, and one of the most complex. Few if any of theGovernment's goals for the economy can be attained without an effective,dedicated and professional public service. Issues of pay, productivity andstaffing are central to public expenditure in Tanzania, and the process ofadjustment and recovery will not be complete until they are addressed.Fortunately, there is growing awareness in Tanzania of the need for solutionsin this area, and a number of important steps have been taken. These areendorsed by the PER, but present initiatives will need to be takenconsiderably further if a durable solution is to be found.

43. The principal findings of the PER in this area are the following:

(1) Real pay in cash terms in the public sector appears to havedeclined to about one fifth the level of the early 19709.Present levels are insufficient for most public officers'families to survive, requiring official pay to be supplementedin one form or another.

(2) At the same time differentials in monetary pay have becomecompressed. Initially thi& was to make pay scales inheritedfrom the colonial era conform with national equityconsiderations. But as inflation accelerated, the process ofchanging the level and structure of pay appears to have beendriven by economic circumstances rather than as part of adeliberate plan. The present ratio of top salaries to theminimum wage is below 6:1 before tax and about 4:1 after tax.In combination with low pay present scales offer insufficientreward for additional responsibility or skills. Some attemptshave been made to compensate for low pay and compressed

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Chart 4PUJBUC SERVICE EXPANSION AND DECUNE OF REAL PAY

GDP/GOVERNMENW EMPLOYEES 49704

300-_280

~240-

10-

8 *20 .O00' 0'

§-120- GDP/

INDEX OF AVERAGE FUBIJC SECTOR WAGES

100-

630- .. , ...

6 < ; ; a3 < o3 o g ; 40gg

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differentials by increasing fringe benefits, but generally theseare inefficient compensation mechanisms, unevenly enjoyed,costly to administer, and make the remuneration structure lessflexible and less transparent.

(3) The progressive reduction in real wages has caused the PE ratio(the ratio of Personnel Emoluments to Other Charges in ministrysupply votes) to fall to between 20 and 30 percent for mostministries. This is significantly lower than earlier years (amore normal range is 40-60 percent for government as a whole),and indicates that the burden of adjustment has fallendisproportionately on wages and salaries. Random evidencesuggests that departmental supply votes are in part being usedto compensate for low pay (in the form of travel allowances,misuse of transport and other substitution mechanisms for lowpay). Thus in ways other than direct salaries, the Governmentis paying the bill for a large public service.

(4) In tne face of declines in real pay and in supportingexpenditures, public service productivity has sharply fallen.Some of the decline is pay related, some of it due tobottlenecks in the supply of critical materials, and some of itdue to the general inadequacy of supply votes. This isparticularly noticeable for transport, critical for thesupervision of staff posted out of headquarters. Public serviceproductivity is now so low as to render many government programsmeaningless. The overriding priority for most officers is day-to-day survival for themselves and their families. This stateof affairs leaves little for the effective delivery of services.

(5) Data on public service employment show, firstly, how much thepublic sector dominates the formal labor market (77 percent in1984, of which 48 percent were government and 29 percentparastatal employees), and secondly, how the government payrollcontinued rising regardless of what was happening to the revenuebase. As Chart 4 shows, government employment becameincreasingly divergent from revenues during the decade after1975, when public service employment grew by 8.2 percent perannum compared to GDP growth of 1.4 percent. At the same timemajor changes occurred in the distribution of governmentemployment between central, regional and local tiecs. Nowadays,the majority of government employees are at the local level,where staffing levels are the responsibility of councils andestablishment control is weakest.

(6) According to the Bureau of Statistics, in 1984 total employmentin the Tanzania public service, excluding the armed forces butincluding teachers and police, was 302,000 of which about onethird worked in central government and two thirds in regionaladministration or local government. In 1985, the Government

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retrenched a number of staff and instituted an employmentfreeze, with limited exceptions. Employment continued to grow.however, and a census of the public service was carried out inApril 1988. Initial returns suggested approximately 28,000ghostworkers could be eliminated from central and localgovernment payrolls, but the validity of this figure is now indoubt, and at the time of finalizing this report a freshanalysis of census returns was being carried out.

44. Notwithstanding recent retrenchment efforts, Tanzania has reached asituation that is hard to tolerate but also hard to escape from. Theoverriding need, increasingly recognized by policymakers, is to create onceagain an effective civil service, staffed at a level that can be properly paidand supported, and which provides a realistic basis for the reestablishment ofmorale, discipline, career development and training, and effectiveestablishment management. The PER considers the necessary reform program hassix elements:

(1) Increasing real pay levels.

(2) Achieving a more effective structure of incentives by widenin'monetary pay differentials between higher and lower grades andreducing the share of total remuneration received as fringebenefits.

(3) Reducing public service employment and reinstating effectivecontrol of establishments. To create room for a meaningfulincrease in real pay and per capita supporting expenditures,budget simulations indicate that an average reduction of staffon the payroll at both central and local government levels ofabout 30 percent should be aimed at.

(4) Improving the work environment by clarifying responsibilities,eliminating overlapping functions, and by giving greaterdelegation and recognition of middle managers, so that theGovernment can progress from crisis management to administrationin depth.

(5) Affordable and fair compensation arrangements for thoseretrenched from the public service.

(6) Modifying existing but largely ineffective economy-wide incomesand employment policies, to give greater freedom in settingwages and to take private sector wages and salaries into greateraccount when setting Government scales.

45. All six are linked. Real pay cannet be increased in any meaningfulway without a substantial reduction in the size of the public service. Asalaries award that does not addresd the structure of pay will do nothing tocorrect the compression of pay levels that successive rounds of

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disproportionate pay increases have brought about, nor reduce the number ofcompensating fringe benefits and leakages caused by the diversion of budgetedoperations expenditures. Staff reductions will be shortlived without moreeffective establishment control, and real pay increases will be wasted if thenormal process of staff performance review, discipline and career developmentare not at the same time restored. As pay is improved, the potential of staffmust be more effectively harnassed. Redundancies will be politicallyunacceptable and cause social hardship if compensation arrangements are notdevised and made generally known. Finally, the national incomes policy needsto be redefined, partly because in its present formulation (which presumesgovernment wage leadership) it is unworkable and partly because a moreautonomous wage setting process is required for the parastatal and privatesectors.

46. The Government's capacity to increase real pay by revenue growthalone and without substantial budget restructuring is limited. The PER'sestimate is that at five percent revenue growth it could take over 35 years torestore average real pay of the early 1970s if nothing were done at the sametime to change the size of the public service, the structure of rewards, andthe share of the budget presently allocated to personal emoluments. A moremoderate target of, say, three or four times present levels could be adopted,but this would still take over two decades to reach, during which tmestaffing levels would have to be frozen. Only when revenue growth is combinedwith far reaching staffing reductions and changes to the structure of thebudget does it seem possible to achieve a satisfactory level of public servicepay in an acceptable timeframe. Furthermore, significant staff retrenchmentreduces the pressure on the non-PE components of departmental budgets, openingup possibilities for rebalancing PE and Other Charges allocations in a moreoptimal way. Data from the civil service census were not ready for analysisby the PER, but the number of "ghost workers" initially identified (about ninepercent of the 1984 total) while significant, falls a long way short of thereduction of numbers called for by the arithmetic of trade-offs between pay,employment and resources. The exorcism of ghost workers (once the censusresults are clarified) needs to be followed by two further stages of publicservice downsizing: (i) the elimination of overstaffing and, (ii) thereduction of government functions. Because this will involve the release of asubstantial number of government employees, compensation packages, moreeffective pension arrangements and, where feasible, training and creditschemes, will need to be devised by the Government and supported by the donorcommunity. How such staffing reductions should be carried out is beyond thescope of the PER. However, it is recognised that the process will be verydifficult. Thus, before adopting a elan of action, the Government will wantto review both the lessons from past staff reduction exercises in Tanzania andthe experience of other countries, especially in Africa, which have carriedout major civil service retrenchment, to ensure that the reductions aresustained and contribute to a leaner and more effective public service with,in time, a higher and more appropriate skill mix.

47. The actions needed to strengthen the management of the public service(both central and local government) also lie outside the scope of the PER, and

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need to be studied further. But it is clear that establishment management bythe Ministry of Manpower and Labor Development must be closely linked tofinancial planning by the Ministry of Finance, Economic Affairs and Planning,and that programs to restore career structures, schemes of service, individualperformance evaluation, personnel procedures and discipline, as once existed,need to be implemented. Also crucial is the need to strengthen the managementof line ministries, and the recommendations made in this Report to enhancedepartmental managers' responsibility and accountability within a clearerbudget framework should contribute to this goal. The structure of pay willneed to be changed, in terms of restoring differentials between grades andshifting the balance between monetary pay and benefits in kind in favour ofthe former. Some savings should result from this process which can be appliedto salaries. Training will play a role, but the view of the PER is that thedecline in the work environment and a distorted incentive structure must becorrected before more resources should be allocated in a general way totraining. Furthermore, training schemes themselves need to be reviewed in thecontext of a downsized and reoriented public service. This will requireconsolidation or termination of some programs to enable facilities to be usedmore intensively, and a shift towards inservice training. As this is done, asharper picture of the skill mix and training needs of a revitalizing publicservice will emerge and appropriate training programs and manpower plans canbe devised and implemented with donor assistance.

Revenue Trends and Prospects

48. Although the main focus of the PER is on expenditures, the reportreviews recent revenue developments and makes recommendations for theirstrengthening, some of which are currently being implemented, or discussed inother reports. Three objectives underline the recommendations: (i) removal ofeconomic distortions; (ii) greater tax buoyancy, and (iii) improvedcollection efficiency.

49. In overall terms domestic revenues have averaged 19 percent ofmeasured GDP over the decade from 1975176, but declined to 15.4 percent in1985186 before recovery to 19.6 percent in 1987/88. Concerning thecomposition of revenues, the share of import duties declined as the shillingbecame progressively overvalued, rising again after the launch of the ERP,consumption and export duties have steadily risen, while income tax receiptshave fallen in the face of high inflation and a shrinking formal sectorrevenue base. Finally, the share of other revenues such as licence fees,stamp duties and parastatal dividends has fallen to about half earlier levels.

50. Several conclusions are drawn from the PER's analysis of revenues.Firstly, whatever buoyancy exists in the Tanzanian system has come largelyfrom increases in rates, to the point where evasion incentives are high.Secondly, much of the present growth in the economy is occurring in theinformal sector and other parts of the economy that are inherently difficultto tax. Thirdly, serious collection problems have arisen due, in part, tohigh rates, too many exempted categories, and officials' low salaries.

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Fourthly, the decline in other revenues suggests scope for greater cost

recovery effort.

51. The PER commends present Government efforts to increase collections

and to improve the structure of taxes. Guidelines for revenue strengthening

ares

(1) Continuing the restructuring of import tariffs initiated in the

1988189 Budget, lowering the average tariff level, simplifying

the number of categories, and reducing the number of exemptions.

(2) Carrying out a similar simplification of sales taxes, reducing

existing rates to a limited range or even a single rate (eg 20

percent) applicable equally to imported and domestic goods.

High sales tax rates (or a special excise tax) should be

retained only for goods such as beer, spirits, tobacco and

petroleum products, which have special revenue properties.

Consideration should be given to increasing petroleum product

taxes to bring prices into line with neighboring countries,

after revising marketing margins, which appear too low and stand

in the way of the oil companies playing a larger role in

rehabiliating the distribution system.

(3) Income taxes on individuals are high relative to real salary

levels and need to be reduced, as MFEAP has been doing in recent

budgets, as Government salaries scales are increased. Company

tax should be moved progressively to a current year basis,

permitting the rate to be lowered slightly without loss of

revenue. Rules on depreciation, with particular reference to

inflation and exchange rate changes, should be revised.

(4) Other taxes and revenue should be reviewed, abolishing taxes and

fees that are difficult to collect, and adjusting upward in line

with inflation those taxes and fees that are economically or

financially relevant.

52. These changes should introduce more elasticity into the tax system,

reduce the distorting effects on the economy of high rates, and by simplifying

the structure, reduce the scope for evasion and make revenues more

collectable. Greater diversification of revenues should be aimed at.

Presently the Government is heavily reliant on a limited number of excise and

sales taxes. The PER projects that domestic revenues could rise to 23.4

percent of official GDP (the actual ratio may be lower because of output

measurement difficulties) by 1993194. Over tne longer term, the Government

will need to develop a view of the optimum level of taxation for the economy.

M24-

Cost Recovery

53. In addition to strengthening the tax system, thf Government shouldexplore, as it is doing currently, greater cost recovery. Sectors with thegreatest potential arsi education, energy, health, roads and water supplies.Opportunities for cost recovery have to be assessed on an individual sectorbasis, and can only be determined after detailed review. General issuesinvolved with coot recovery includes

(1) The need to strengthen the institutional framework as costrecovery is introduced. This affects the timing of costrecovery measures.

(2) The importance of actively involving coununities in theprovision of services, and explaining to them the basis on whichcontributions will be made, and how this will lead to improvedservice.

(3) The likelihood that capital improvements will be needed whereassets have deteriorated, before charges are introduced orraised.

(4) Mechanisms for retaining contributlons at the service deliverylevel such as revolving funds should be explored. Earmarking ofgeneral revenues for specific sectors (egg f3L revenues for roadmaintenance) should be avoided.

CS) Consideration should be given to taking some activities (andtheir staffing) outside the public sector altogether (egisecondary school expansion).

54. Important as it is, cost recovery is not applicable in allcircumstances and there are limlts on how far it can be extended. In certainsectors, such as transport, measures can (and should) bo put in placeimmediately. In others, such as education, health and water supplies, costrecovery will have to be introduced gradually, in the context of institutionalreform and rehabilitation. Given the priority placed on social equity, theGovernment will want to calibrate cost recovery charges carefully and monitorthe outcome. It should be borne in mind, however, that currently in manyareas de facto charges are being levied and that the absence of services (ortheir effective collapse) already imposes heavy social costs. Overall, theimpact of cost recovery is likely to be more significant for theoustainability and expansion of individual services than in terms of theoverall gain to Government revenues.

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Utilisation of Aid

55. Total aid flows to Tanzania are running at approximately $950 - $1000million on a gross basis. This compries about $150 - $200 million oftechnical assistance, with the remainder spiLt roughly equally between projectaid and comnodity aid/balance of payments support. Traditionally, TanzanLahas been one of the largept recipients of aid in Sub-Saharan Africa, but aidflows dipped harply in the early 1980. Many projects encounteredimplementation difficulties, and donors withheld aId pending the formulationof a more acceptable macroeconomic program. Since the launch of the ERP in1986, aid flows have risen again. Noteworthy features of donors' atd programsin Tanzania are:

(1) The high dependence of the economy on aid flows, which amountedto about 16 percent of GDP in 1987, double official exportearnings.

(2) In recent years a move away from conventlonal project aid, toprogram support, either in the form of sector programs orgeneral balance of payments support, as backing for theGovernment's program of macroeconomic policy change.

(3) The growing importance of DAC donors relative to centrallyplanned economy and OPEC donors, and the expansion of World BankIDA lending.

56. The sheer importance of ald flows to the Tanzania economy makes itimportant that these resources are utilized efficiently. Thli has thefollowing policy implications.

(l) Aid coordination, while greatly improved, remains a donor drivenprocess. Requirements for more effective aid coordination onthe Government's part area (i) linking aid coordination betterwith the planning and budgeting functions of M1EAP, so that aidcan be more effectively utilized (and not merely maximised)t and(tl) closer monitoring of existing and prospective donorprograms, dependent in part on fuller disclosure by donors ofdisbursements.

(2) Action on the Government's part to get budgets, salaries andstaffing into better balance, to avoid aid wastage and forestallpressure from donors to create special management units toinsulate projects from the constraints affecting normaldepartmental activities.

(3) Close monitoring of the balance between import support andconventional project aid. The Ple's assessment is that thepresent 50:50 balance is about right for the time being, andprovides an opportunity through the counterpart funds generatedby import support for the restructuring of public expenditures.

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Over the longer term the balance will probably shift back infavour of project aid, in view of the large rehabilitationrequirement for social and physical infrastructures, and thelikelihood that donors may be unwilling to continue balance ofpayments support indefinitely. This will have implications forthe financing of the Recurrent Budget.

(4) Non-project capital aid should be channelled progressivelythrough the Open General License facility (OGL) at the Bank ofTanzania, to promote efficient use of balance of paymentssupport and to avoid crowding out viable private and publicsector users. Donors should facilitate this by untying theircommodity aid/import support, and adapting their disbursementprocedures to the requirements of the OGL system.

(5) Capital projects should continue to be focused onrehabilitation. As ongoing projects are completed, there willbe increased opportunity to redeploy capital aid within anoverall framework of priorities guided principally by therestructuring of the Recurrent Budget.

(6) Special attention should be paid to the financial sustainabilityof projects. Donor support for recurrent costs of high returnprograms should be temporary and should be provided on theunderstanding that through a reordering of Recurrent Budgetoutlays departments will be capable of absorbing such costs inthe medium term.

(7) Medium term commercial credits should be avoided for reasons ofcost and securitization (as exemplified by the recently renewedoil import credit which is detrimental to Tanzania's coffeeearnings). Overall, the present heavy budgetary dependence onaid flows (which finance 19 percent of the Recurrent Budget and81 percent of the Development Budget) will require understandingand skillful handling by both the Government and donors.

Parastatals

57. Parastatals have a significant impact on the Government's budgetthrough the Public Investment Program (PIP), recurrent revenues and recurrentexpenditures. In recent years parastatals' share of the PIP, though it stillremains large, has been falling, their contribution to revenues has been verylow, and their call on Recurrent Budget funds has been growing. Under the ERPa process of parastatal restructuring has been gathering pace. This needs tobe managed carefully to ensure that the impact on the budget is kept to aminimum and that the process as a whole leads to more efficient use ofresources by the public sector. The implications for the main groups ofparastatals are the following:

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(1) Financial institutions have been the most profitable parastatalsbut much of this is artificial due to inadequate provision fordoubtful loans and excessive interest rate margins. Their weakloan portfolios means that most banks are insolvent. In thiscontext the work of the Financial Sector Commission is crucial.Among the changes needed ares (i) a structure of interest ratesthat encourages savings and avoids subsidizing credit; (ii)greater competition between financial institutions, and (iii) alarger share of credit available to the private sector. Interms of the Government budget, it may be impossible to avoidthe consequences of past guarantees and the need to inject fundsinto banks to restore balance sheets. Allowance should be madefor this in budget programming. However, any recapitalizationof balance sheets should be carried out in the context ofmanagement improvements, portfolio audits, and where feasibledilution of Government ownership.

(2) The main priority for utilities, which are likely to be retainedin full public ownership, is to ensure that tariffs are adjustedupward sufficient to earn a minimum return on assets underefficient operating conditions. This implies autonomy formanagers in the day-to-day running of establishments andauthority delegated to the responsible Ministry to approvetariff increases quickly on justification. For some parastatalsearlier delays in tariff adjustment, the existence of largeexternal debts and social sensitivity have complicated theadjustment process, necessitating debt write offs through theGovernment budget. In such cases it is important that a mediumterm plan for financial restructuring be agreed and adhered to,bearing in mind that the subsidy inherent in delayed tariffadjustment means less resources for other Government programs,and carries with it the risk that excess demand may distort thetiming of new investment (as could be happening in the powersector).

(3) In recent years marketing boards have been a heavy burden onboth the farmer, the banking system and the Government budget.New arrangements that should improve the financial performanceof NMC are being implemented, and a process of reform ofagricultural export marketing systems is now gathering momentum.In the short run the impact of marketing boards on the budgetwill be negative, and provision will need to be made byfinancial planners for uncovered overdrafts. (By the end of1987/88 NMC's unsecured overdraft alone was four times MALD'srecurrent budget). Minimizing the impact over the medium termrequires: (i) aggressive action to increase competition at alllevels of the agricultural marketing system; (ii) specificinterventions at the marketing board level; and, (iii) continuedadjustment of the exchange rate to sharpen farmers' incentives.

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(4) State-owned enterprises are engaged in a spectrum of efficient,inefficient and unviable activities. The most effective meansof improving th'j overall performance of the sector iss (i) arealistic macroeconomic framework; (ii), action to improve theworkings of the financial sector; %Iii), greater autonomy formanagers to operate enterrpises on a commercial basis, and,(iv), a more competitive economic environment, including awillingness to liquidate or divest failing enterprises. Theimplications for the Government's budget are the progressivetransfer (as is now happening) of investment financing needsfrom the Development Budget to development banks, selectiveintervention to rehabilitate demonstrably viable enterprises,and equity injections to restore the balance sheets ofparastatals to be retained in public ownership. Regardingdivestiture, the Government should also consider divestingitself of viable enterprises whose rationale for continuedpublic ownership is tenuous.

(5) Non-commercial parastatals, such as training establishments,research stations, and specialized institutes partly or entirelydependent on Government financing, currently account for about10 percent of total Ministerial Supply. These agencies havebeen subject to the same financial pressures as their parentministries. As the resource situation gradually improves, theseentities are likely to press for a higher share. Consequently,they should be subject to the same priority setting process asGovernment departments, reviewing staffing levels and functions,amalgamating or closing establishments when indicated.

Local Government

58. After being in abeyance for a decade, local authorities were re-established in 1983. This was accompanied by a transfer of staff from theregional tier of Government and a corresponding diminution of the latter'sresponsibilities. Urban and district councils are now responsible for aboutone fifth of discretionary public expenditure in Tanzania and employ nearlytwo thirds of all public servants, and their responsibilities include some ofthe most important basic services. Unfortunately, councils have been unableto develop a strong revenue base commensurate with these responsibilities.While there are some well run councils, management and personnel problemsabound. The PER was concerned about the local government financing gap thathas emerged and councils' administrative weakness. Pending a morecomprehensive study of local government in Tanzania, the PER reached thefollowing conclusions.

(1) Councils should be relieved of their more peripheralresponsibilities and staff, so as to concentrate on the core ofbasic services for which there is strong demand.

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(2) The Government should review its targets for the provision of

basic services, and give priority to the rehabilitation of

existing facilities and services ahead of their expansion.

(3) There should be recognition that the demands of primary

education and health care will require a growing Central

Government subvention to the councils whose own revenues cannot

be expanded adequately. (In the case of urban councils, the

government subvention may be partially or fully substituted by

payment of rates).

(4) There should be a further reallocation of resources away from

Regions in favour of councils. However, critical areas are

councils' ability to prepare and administer sound budgets, plan

programs and control staffing levels, and these urgently require

strengthening before such reallocations take place..

(5) Disparity between different regions in the ability to finance

basic services suggest that the Government should consider an

equalization element in its transfer formula.

(6) Issues of pay, staffing and productivity need, to be addressed at

local as well as central government level. Strengtheningcouncil services in the long run requires increasing real pay

levels, decompressing differentials, staffing cuts, and the re-

establishment of effective establishment control.

(7) Special emphasis should be placed on improving collection under

existing revenue measures, and mobilizing self-helpcontributions and cost recovery. This will require attention to

incentives, iustitutional capacity and delivery effectiveness.There is strong potential for making urban services self-

financing, and the constraints to this happening hould be

investigated further.

(8) Accompanying the reduction of staffing and introduction of new

pay scales must be renewed emphasis on training and management.

Planning and Management of Public Expenditure

59. Tanzania has a long established planning and budgeting system that

has continued functioning during the extended period of financial and economic

stress. Detailed budgets are prepared on time each year, there is a regular

Annual Plan, and the completion of a new Five Year Plan has been announced.

However, the emphasis given in the PER to restructuring the Recurrent Budget,

and the need to consider both current and capital allocations in a medium term

framework require some modifications to the present system. Recommendations

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in the atea of public expenditure management (which apply equally to a jointMFEAP or a separate finance ministry and national planning commission) are thefollowing:

(1) Integration of the Recurrent and Development Budget departmentsof MPEAP in a single Budget Department.

(2) Extending the Recurrent Budget planning horizon. The economicand financial staff of MFEAP should prepare indicative ceilings3-5 years ahead, beyond the present single year planninghorizon.

(3) Establish a forward pprspective for the PIP by converting theInvestment Program Review (IPR) into a rolling three year PIP,and expanding it to show previous expenditure on each project aswell as the balance of funding required to complete the project.

(4) Setting forward budget ceilings for the Development Budget tocomplement Recurrent Budget ceilings, thereby discouragingsector ministries embarking upon projects with inadequatefinance. This would also permit greater decentralization of theplanning and management of the Development Budget, and allowDEVPLAN (or Planning Commission staff) to concentrate on theoverall framework of the PIP and strategic issues ofintersectoral allocation and policy.

(5) DEVPLAN/Planning Commission staff should cease producing theAnnual Plan which duplicates the Development Budget and nolonger has operationil relevance as indirect mechanisms replacedirect mechanisms for the allocation of foreign exchange andcredit.

(6) With the cooperation of donors, better measurement of aiddisbursements and their full reflection in Government accounts.

(7) Reduction of the number of projects in the PIP (currently about860) byt (i) transferring to the Recurrent Budget domesticallyfunded projects that are primarily conduits for recurrentfunding to departments; (ii) amalgamating small projects thatare expenditure components of a larger aggregate projectactivity; (iii) closing projects which have low rates of returnor perpetuate public sector involvement in areas that should beleft to the private sector or are otherwise peripheral; (iv)elimating projects for which there is little hope of funding;and (v) constraining the addition of new projects by subjectingthem to stringent rate of return or similar evaluation criteria.A PIP of no more than a third to a half the present number ofprojects sho'ild be aimed at.

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(8) Closer cooperation between MFEAP and MMLD to develop a jointview on the size and permissible long term expansion (aftersufficient retrenchment has been carried out) of departmentalstaffing, and to issue guidelines on manpower numbers, tocomplement financial ceilings, particularly for services whichemploy large numbers and are demand driven.

(9) Re-examination of government manpower planning and the review oftraining programs and bonding systems, which impart anundesirable expansion dynamic to government payrolls.

Over t.he medium term Tanzania will need to ztrengthen its capacity for policy

analysis both in the Ministry of Finance, Planning Commission, line

ministries, and institutions such as the central bank, universities andresearch institutes. This wiil be important not just for coordination of

recovery policies but so that the basis of economic planning and prioritysetting, at present confined to a relatively small number of policy makers,

can be broadened. A review of present capacities and requirements in this

area should be considered.

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CHAPTER 4 - SECTOR PROGRAMS

60. Chapter 4 analyzes the f-overnment's main sectoral programs in thecontext of economic recovery priorities and against the background of thepublic expenditure issues discussed in Chapter 3.

Agriculture

61. Public expenditure on agriculture, forestry and fishing presents apicture of high capital expenditures accompanied by low and decliningrecurrent outlays. In the case of the principal agency, the Ministry ofAgriculture and Livestock Development (MALD), the chief recurrent budgetproblem is the general underfunding of research and extension. This is poisedto undergo major rehabilitation through two World Bank IDA projects, whichwill inevitably raise recurrent costs. MALD' s Development Budget, on theoth,r hand, is unusually large (16.8 percent of planned Development Budgetexpenditures in 1988189 compared with 3.3 percent of Recurrent Budgetexpenditure, excluding debt service). Within this amount 43 percent isallocated to parastatals, such as state farms and irrigation scheme agencies,nearly twice the amount allocated to agriculture and livestock services.Thus, MALD's share of the Development Budget shouid be reduced and its shareof the Recurrent Budget increased.

62. PER recommendations for sector expenditure priorities are:

(1) Recognition that agricultural recovery requires a shift in thecomposition of public expenditure, and a balance between directexpenditure, institutional change and new policies. There needsto be a shift in the balance between capital and recurrentexpenditures within the sector, tazgetted expenditures on othersectors, such as transport infrastructure, that are presentlyinhibiting agricultural production, and by policy andinstitutional reform, particularly marketing.

(2) The central focus of MAW's Development Budget should be therehabilitation of agricultural and livestock research andextension. But because of the recurrent intensive nature of theservices and the need to ensure sustainability, this must bedone in a phased manner and without expanding staff.

(3) PIP investment in the agricultural production parastatals shouldbe sharply reduced and terminated, and resources shifted fromthe state farming sector to support programs for smallholderagriculture.

(4) Purther investment in irrigation, particulary large scale,should not be a priority.

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63. Finally, the efficiency of the marketing system and the agriculturalmarketing boards should be improved through greater competition, so that theburden of their financial deficits does not fall on future budgets.

Natural Resources

64. The public expenditure issues of the natural resources sector are inthe first instance those of the Development Budget. Over the longer run thereare issues of conservation and the environment that need to be considered, forwhich the Recurrent Budget resources of the relevant ministries are presentlyinsufficient. The major share of Development Budget expenditure by theMinistry of Lands, Natural Resources and Tourism has been directed to thedevelopment of softwoods forests and the sawmill and wood processing industry.With a number of major projects now completing, and with the new policy ofencouraging greater private sector involvement in the sector (which the PERendorses) the level of investment should decline.

65. Against the background of falling investment requirements forforestry and fisheries enterprises there is a need to reallocate resourcesfrom supporting modern sector commercial enterprises to promoting theconservation of resources in the traditional sector. This is likely to beendorsed and given greater specificity by the environmental action program dueto be prepared in 1989. Pending the development of more detailedenvironnm.ntal strategies, public expenditure priorities are the followings

(1) The reorientation of donor support towards community forestryproiects, designed so that their recurrent costs are minimal andthey can be maintained by communities.

(2) Programs to restore the capacity of the Wildlife, Forest andFisheries departments to protect the natural resource endowment.

(3) Review of forest royalties, raising them to economic levels, andthe consideration of mechanisms for retaining royalties (and ashare of game park fees) at the local level so that communitiesparticipate in the financial benefits of conservation.

66. I;ltimately, the work of environment conservation departments islikely ta be successful only if it is supported by parallel action onagricultural research and extension, land use planning and marketing reformsthat strengthens the incentive for rural people to shift to patterns ofsettled cultivation that are environmentally sustainable in the long run.

Industry

67. In the past a large share of Tanzania's PIP (21 percent in 1980/81)has been allocated to the industrial sector. However, with the completion ofmajor projects initiated under the Basic Industries Strategy (BIS), thesector's share has fallen sharply (6 percent in 1987/88). Nevertheless, the

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industrial sector continues to be a significant user of resources. With manyinefficient and unviable enterprises, capacity underutilization and widespreadmanagement problems, the restructuring of the sector is an important ERPobjective.

68. An important task tacing the Government is to develop a consistentprocedure for evaluating and handling industrial investment. For the mostpart this should be handled outside the PIP, as the Government is now doing,through: (i) the establishment and maintenance of an appropriate macroeconomicframework; (ii), financial sector reform, particularly in respect to creditand foreign exchange allocation mechanisms; (iii), deconfinement and reductionin price controls; and (iv) shifting responsibility for financing industrialinvestment from the Development Budget directly to the banking sector. Thusthe Ministry of Industry and Trade (MIT) should concentrate its energies ondeveloping the overall policy framework and spelling out investment criteriarather than involving itself di-ectly in investment. Over the short term,however, there could be significant calls on Government resources for therestructuring of balance sheets of viable public enterprises deemed necessaryto retain under state ownership. The implication in budget terms is thereforea sharp curtailment of MIT's share of the Development Budget, whilemaintaining sufficient provision in MFEAP's share for parastatai restructuringin the short term and funding of development finance institutions over thelonger run.

Energy and Mining

69. As with industry, the principal public expenditure issues in theenergy and mining sectors relate to the PIP. In 1988/89 the Ministry ofEnergy and Mining's share of the Development Budget amounts to 16 percentcompared with less than 1 percent of the Recurrent Budget.

70. The main problem in the energy sector is Tanesco's difficultfinancial position and its inability to service external debt on-lent by theGovernment. This is principally the result of delayed tariff adjustment inthe face of the rising shilling cost of foreign exchange, and revenuecollection difficulties. Notwithstanding several tariff increases since 1986,the average tariff yield is about one third the average incremental cost ofsupplying elec.ricity, resulting in a large subsidy element in pricing, and anartificially high growth of demand. In turn this is forcing Tanesco to bringforward costly new power generation investment. But because the cost of poweris viewed as socially sensitive, the Government is concerned that the path oftariff adjustment should be a gradual one, and proposals have been worked outfor the progressive adjustment of tariffs and the restructuring of Tanesco'sbalance sheet.

71. From the perspective of public expenditure planning the followingpoints should be borne in mind:

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(1) The financial restructuring will have an impact on the budget

and must be fully allowed for in fiscal planning;

(2) The longer the adjustment period, the greater the impact on the

budget (Tanesco's current unmet debt servicing to the Government

is equivalent to over 10 percent of the Government's own debt

service payments, or more than the entire recurrent funding of

the Ministry of Health).

(3) As long as power is subsidized, demand will grow rapidly and

cause the Government to invest prematurely in additionalgenerating capacity.

72. Sizeable rehabiliation and improvement investments ($42 million) have

been identified for distribution and handling of petroleum products. To

minimize the impact on public expenditures and maximise the contribution of

the oil companies, the incentive structure for private distribution needs to

be strengthened, and a petroleum pricing study is planned. With regard to the

Kilamco project, the PER confirms the Bank's 1987 report on the project. This

emphasized the need to keep up to date calculations of the opportunity cost of

gas (a low value is crucial to the project's economic viability). It also

stressed the importance. in view of the size of the project ($480 million of

which Tanzania's share would be about $100 million), of making any final

decision to proceed in the context of competing demands for domestic and

external resources. Unless entirely new and non-fungible external resources

are secured, proceeding with Kilamco as ptesentlv formulated would mean

diverting resources from rehabilitation programs. New projects need not be

eliminated completely from the PIP, but to merit inclusion a high economic

rate of return should be expected. In the PER's judgement this should be in

excess of 20 percent.

73. The investment requirements of the mining sector appear much less

certain. Tanzania is currently rehabilitating the Ilima Coal Mine and

developing a further mine at Kiwira. Unless future power generation is to be

coal based (which may not be optimal), there is likely to be insufficient

domestic demand for these two mines, and Tanzania has no comparative advantage

as an exporter of coal, suggesting that continued public investment should be

viewed very cautiously. Government policy now is to encourage private sector

participation in the mining sector. This approach is to be welcomed, since it

holds promise of improved operating efficiency and reduced demand for

budgetary funds. As a general policy, the Government should avoid direct

investment in the mining sector, concentrate its energies on negotiating the

most favourable royalty and tax frameworks. This would permit the Ministry's

large share of the Development Budget to be somewhat reduced, although

allocations will continue to be considerable because of the capital intensive

nature of power generation investment.

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Transvort, Communications and Works

74. The transport sector now constitutes a serious bottleneck to therecovery of output. The decline in transport sector performance and thedeterioration of infrastructure over the past decade and a half is attributedtot (i) insdequate resource allocatior to the sector; and, (ii) weakInstitutional structures. Against this background, the rehabilitation ofTanzania's transport and communications infrastructure, together with therestoration of a durable maintenance capacity, constitutes one of the biggestchallenges for the ERP, and has substantial implications for publicexpenditures and donor support over the next ten years. Broad requirementsares

(1) Rehabilitation of the fixed assets, plant and equipment of thekey transport parastatals, such as Tanzania Railways Corporation(TRC), coupled with improvements in management capacity andtariff policy.

(2) Provision of substantial amounts of external capital aid andtechnical assistance to rehabilitate the road system,accompanied by: (i) reallocation within the Government's budgetin favour of maintenance activities; (ii) measures to ensure thesector is adequately covering costs (but avoiding earmarking ofrevenues); and, (iii) institutional strengthening.

75. In the case of most transport parastatals, rehabilitation programsare underway and the main requirement for the Government is to monitor thisperformance, encourage greater autonomy and accountability for managers. andensure that successive phases of rehabilitation are adequately funded withexternal aid. In the case of the road transport parastatals, full comwnercialcriteria should apply, and divestiture should be considered. With regard toAir Tanzania Corporation (ATC), fares should be doubled immediatley, thebalance sheet restructured, the route structure and staffing levels reducedand greater autonomy given to management. Routes that the Government wishesto continue subsidising for social and political reasons should be limited innumber and, if necessary, given an explicit subsidy funded out of the Ministryof Works and Communications recurrent budget, where the cost can be comparedvith other MC1 priorities, such as road maintenance.

76. Rehabilitation of Tanzania's road network, however, is only beginningfollowing a donor conference in November 1987. The overall priority for theGovernment is to see that this program moves ahead and is adequately funded byaid flows. It is also necessary to ensure that domestic resources areallocated in much greater quantities (which implies a diminution of otherspending departments' shares) to maintenance, both at the Central and LocalGovernment levels. It is estimated that the 1987/88 allocation was about onefifth of the maintenance outlay necessary to maintain the truck road network.Although allocations were increased in the 1988/89 budget, they remain

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substantially below what is needed to prevent further deterioration of the

country's road network.

77. In programming resources for the transport sector, the specific

recommendations of the PER ares

(1) The need to capitalize road maintenance costs where feasible by

designs that minimize maintenance requirements. Donors should

consider the incorporation of maintenance components in

externally funded projects pending the restructuring of the

Recurrent Budget in favour of larger maintenance allocations.

(2) Maximization of the externally funded components of projects to

free domestic funds for recurrent maintenance.

(3) Where feasible the use of private contractors for routine

maintenance.

(4) Strengthening of Local Government, so that district and urban

councils can more effectively maintain the infrastructure for

which they are responsible.

(5) Higher road user taxation to raise general revenues sufficiently

for road maintenance allocations to be increased (though not

through earmarking) and to improve revenue collection efficiency

(petroleum taxation is twice as efficient in collection as road

tolls, which should be phased out, not extended).

(6) Regulai: tariff adjustment and greater management autonomy for

transport sector parastatals.

78. It should also be noted that restoring effective road maintenance (as

with other management intensive activities Involving large numbers of staff

such as agricultural extension) is critically dependent on re-establishing

staff and management incentives through civil service refotmu. Furthermore,

implementation of such a large and ambitious transport sector rehabilitation

program requires considerable improvement to the Government's capacity to

award and manage contracts with private sector consulting firms and

contractors, specifically with regard to MCi, the Attorney-General's Chambers

and the Central Tender Board. A review of performance and procedures in this

area is indicated. Subject to these conditions being fulfilled, the PER

envisages a substantial increase in MCW's share of the Recurrent Budget and,

for the next 5-10 years, the Development Budget.

Education

79. The overriding issue in the education sector in the coming years is

how to prevent erosion of Tanzania's extensive education system in the face of

rapid population growth and demands for the expansion of post primary

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education. Analysis of total sector spending, after making due allowance forMLG transfers to councils for primary schools, suggests that, contrary to somereports, the education sector has not fared any worse than others inconditions of increasing fiscal stress. However, given competing demands fromother sectors and the fact that teachers' salaries bulk large in sectorexpenditure, the scope for significantly expanding education's share of thetotal budget (presently 18.5 percent of Recurrent Budget Total Supply andabout 5 percent of the Development Budget) over the medium term is limited.Objectives for the sector have therefore to be met within the context of onlya modestly growing resource envelope. The PEtR's recommendations for aneducation sector financing strategy that reconciles these conflicting demandsare as follows:

(1) The tradeoff between quality and quantity should be faced.Capital resources at all levels should be directed towards therehabilitation of the existing education infrastructure. Anyincrease in recurrent resoueces from revenue growth should beused to improve the funding of existing public sectorfacilities, not new activities.

(2) The main focus of Government actions to restore the educationsystem should be the primary level, for example by improving thesupply of teaching materials.

(3) To reduce pressure on the Government's budget, thediversification of Tanzania's sources of educational finance by:(i) encouraging the development of more privately or churchowned schools; (ii) introducing secondary and university tuitioncharges; (iii) more effective provision of building materials tosupport community rehabilitation efforts.

(4) Reduction of the high cost of post primary education by reducingthe proportion of boarders, re-examing staff-student ratios andchanging the curriculum.

(5) Current plans to expand Government secondary education should beshelved. Instead the Ministry of Education should increase itstechnical support for private secondary schools through theSchools Inspectorate. Likewise, plans to expand universityenrolments should also be shelved until issues of quality,relevance, and cost effectiveness are resolved.

(6) As local government is strengthened, more authority, accompaniedby management training, should be delegated to council educationstaff for the running of schools and the supervision ofteachers.

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Health

80. The Tanzanian health service, one of the first national health care

systems in SSA, is under strain, due to low staff remuneration, shortage of

drugs and other essential supplies, management and operational deficiencies in

the Central Medical Store (CMS), foreign exchange shortage, and neglected

maintenance of buildings. As a result the health service, while fundamentally

sound in structure, is no longer able to maintain earlier progress inimproving the health status of the population. Furthermore, the Tanzanian

health service now faces the additional burden of AIDS.

81. As with education, the scope for increasing the health sector's share

of budget resources (currently 11.1 percent of Recurrent Budget Total Supply

and about 5-6 percent of the Development Budget) is limited unless the shares

of other sectors can be reduced. Thus a general improvement in health sector

financing will have to come gradually, as the economy recovers and revenues

strengthen. In the meantime specific actions recommended by the PER are:

(1) Until the overall budget situation is markedly better, thereshould be no further expansion of the public health care system.

The health status of the population at large stands to lose morefrom the consequent dilution of budgeting allocations than it

would gain from the creation of additional facilities. Thehealth sector's share of the Development Budget (4 percent) ismodest, and there is a case for donor capital support targeted

mainly towards rehabilitation of district hospitals, clinics and

dispensaries, and a limited amount of targeted rehabilitation of

higher level institutions.

(2) Care should be taken to ensure that the part of the health

system run by voluntary agencies is adequately financed, byapproving new patient charges quickly, and adjusting Governmentsubventions in the light of financial realities.

(3) A review of the balance between curative and preventive servicesin the health budget should be carried out to ensure thatsufficient emphasis is given to the latter. The share of the

total recurrent health budget allocated to district hospitals(13 percent) should be increased relative to the three medicalcenters (16 percent) and the 17 regional referral hospitals, in

order to improve the cost effectiveness of curative care and

increase the capacity of district hospitals to supervise health

centers and dispensaries.

(4) Recurrent support by donors in the health sector appears highly

effective and should be continued. It is desirable, though,that recurrent cost provision takes place in a framework forrestoring full domestic funding of the running costs of thehealth system over the medium term.

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(5) Supporting action by the Government and donors to rehabilitatewater supply and sanitation schemes, and to implement nutrition,population and family planning programs.

(6) A determined effort to improve the workings of the CMS, and thedeconfinement of essential drug imports.

(7) After careful review, the introduction of user charges in publichealth facilities.

(8) Improvements in the capacity of the Ministry of Health tocollect and analyze health and nutrition data.

82. Finally, the effectiveness of the health sector depends crucially onthe strengthening of local government and the encouragement of greatercommunity participation.

Housina, Water Supply and Sanitation

83. Public expenditure problems in the housing, water supply andsanitation sectors are both recurrent and capital: current in the sense thatagencies responsible for services, if the latter are to be performedadequately, face operating expenses far in excess of current revenues; andcapital in that there is a massive backlog of neglected maintenance and catch-up expenditure, particularly in the light of rapid urban population growth.The principal elements of an urban rehabilitation strategy are:

(1) Strengthen municipal finances by updating valuation rolls,rebuilding record systems, reintroducing effective property taxcollection, and restoring accountability on the expenditureside. Further study of the const:aints facing municipalities isrequired, however, to prepare action programs and pave the wayfor greater donor support.

(2) Central Government should make clear its support for councils isconditional on progress improving revenue collection, and shouldconsider reintroducing rate payments on its own properties.

(3) Increased donor support should be sought for urban watersupplies, roads and surface water drainage, sewerage and garbagecollection systems, and shelter support in the form of sites andservice schemes and squatter upgrading (in contrast to thedirect provision of housing by the public sector). Supportshould include technical assistance to improve organization andmanagement.

84. Rural housing, water supply and sanitation problems are less pressingbecause of lower population density. The public sector's role in ruralhousing is minimal and likely to remain so. Improved rural sanitation is

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primarily a matter of public education, not direct provision, and is theresponsibility of the Ministries of Health and Local Government. Rural watersupplies, by contrast, have been the focus of Government programs, with welldefined targets and substantial investment. Many of these schemes are nolonger functioning. The PER endorses the current emphasis on rehabilitationusing simple technologies and community participation. Scope exists for costrecovery but this needs to be applied flexibly, and requires complementaryaction in areas like agricultural marketing, where institutional and policyconstraints have served to depress rural incomes.

Other Government Services

85. What might be termed Other Government Services, such as law andorder, foreign representation, and financial management and control functionscollectively account for over half of Recurrent Supply and absorb a largeproportion of government manpower. The PER did not review these sectorsindividually. However, the following suggestions are made.

(1) Other Government Services should be no less critically reviewedthan other sectors. If allocations to social services,agricultural extension and road maintenance are to besignificantly increased, much of the additional resources mustcome from Other Government Services.

(2) Staffing levels should be critically reviewed. Some of thefastest manpower growth in the past decade has occurred inDefense, Foreign Affairs and Home Affairs. The country has paidfor this expansion by spreading resources so thinly that publicservice productivity has plummetted.

(3) Devaluation has made the foreign exchange cost of the Ministryof Foreign Affairs more evident, indicating that the scale offoreign representation (30 embassies costing more than theentire recurrent vote of the Ministry of Agriculture) should becritically reviewed.

(4) The share of Defense in Total Supply has been sharply reduced inrecent years. Because of the potential for Defense to crowd outother expenditures, it is critical that these reductions aresustained, without resort to off-budget funding devices.

(5) The large increase in Ministry of Home Affairs (MHA) staffing inrecent years suggests a powerful and entrenched expansiondynamic. MEA should be a prime target for an effectiveemployment freeze, staffing review and cutbacks, accompanied byrealistic guidelines for police and prison service coverage inthe future.

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(6) Four fifths of the MFEAP's recurrent budget is transferred fromthe Ministry as subventions or contingency amounts. In partthis is a reflection of the stress Government finances arecurrently under. MFEAP's vote thus constitutes a budget withinthe budget, an accommodation point for unforeseen requirements,parastatal rescue operations, and the general shortcomings ofdepartmental expenditure estimation. Over time the volume ofthese transfers should fall, but in the short to medium termrealistic provision should be made in financial projections.Adequate provision should be made for key financial managementactivities such as the government accounts (and, for thatmatter, auditing, though part of the responsibility lies outsideMFEAP).

(7) Donors, who in the past have tended to neglect the classicalfunctions of Government should be prepared to consider priorityrehabilitation programs in this sector.

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CHAPTER 5 - IMPLEMENTING THE PUBLIC EXPENDITURE STRATEGY

86. The final chapter in the PER outlines the steps the Government might

take to implement a public expenditure strategy.

Four initial points are made:

(1) Recognition that, while designing and taking crucial initial

steps shou d be done urgently, fully implementing a public

expend_.ture strategy, which implies a major reorientation of

spending patterns and significant institutional rebuilding, wi'l

take several years.

(2) Such a strategy has many interlinked elements, and therefore the

reforms have to take place across a broad front.

(3) The process of establishing a public expenditure strategy is no

less important than the end product.

(4) The purpose of the strategy and the processes it ente&ls should

be readily comprehensible to all participants and to the Cabinet

and the Party.

Building Blocks of a Public Expenditure Strategy

87. The PER identifies seven essential steps in the formulation of a

public expenditure strategy. They are as follows.

(1) Establishment of a realistic medium term (3-5 years) framework

within which Government programs can be planned. This involves

projecting forward:

- Domestic revenues, on the assumption that GDP will grow at

about 4-5 percent per annum.

- Future aid flows, on the working assumption that donors

will maintain the real value of aid flows if appropriate

recovery policies are followed. Assumptions will also have

to be made on the breakdown of aid into project finance and

import support.

- Government debt servicing, currently 36 percent of the

Recurrent Budget.

- The adjustment of real pay and decompression of salary

scales, coupled with realistic targets for staff

retrenchment in both Central and Local Government.

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- Recurrent budget subventions to local government anddirectly funded parastatals (such as Muhumbili and UDSM) ona continuing basis and to other parastatals on a reducingcontingency basis.

- Ministerial and Regional Supply, incorporating adjustmentsin the light of ERP priorities, such as increasing therecurrent budget shares of road maintenance, agriculturalresearch and extension, and primary education and healthand decreasing the share of Other Government Services.

- Development Budget expenditure in the light of completionof old and provision for new projects and a reduction inthe number of projects in the PIP, consistent with theprojection of future capital and flows, net of importsupport, and its reorientation to support the sectorpriorities of the Recurrent budget.

- rThe overall budget deficit, consistent with theGovernment's monetary targets, and the share of totalresources it is considered appropriate for the Governmentsector to absorb.

The purpose of the medium term framework is to clarify publicexpenditure dynamics and to indicate to ministries anddepartments the resource envelope within which they mustoperate.

(2) Review of departmental programs in the light of the resourceenvelope determined through the medium term framework. Someaspects of this process have already begun. Apart from somevariation in Ministry shares and to accommodate new pay scales,this is likely to mean no significant real increase in presentlevels. Ministries should be released from formal long termtargets, and instructed to establish fresh priorities and toreexamine the means by which they are to be achieved. Thisinvolves reviewing the standard costs of programs, pr'orities,opportunities for cost recovery, the requirements of directlyfunded parastatals and the implications of new recurrent budgetpriorities for the development program. The essence of thereview is a fundamental re-examination of everything departmentsand ministries are doing, as distinguished from a scrutiny atthe margin of incremental activities.

(3) Review of staffing levels in parallel with the review ofdepartmental programs. Staffing levels need to be reducedsubstantially further than that achieved by the recent exorcismof ghost workers, by reviewing functions and r-ducing the numberof staff required to carry out functions. Each alency should berequired to prepare a staffing plan comprising (i, initial staff

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reductions and, (ii) medium term staffing levels. Ministerial

training establishments should be reviewed and their outputadjusted to the new staffing levels, and greater emphasis given

to in-service training. This process will need to be carefullyplanned, and donors should be prepared to provide technicalassistance, if requested.

(4) The preparation by ministries of sector strategy paperssummarizing expenditure priorities in the light of the programsand staffing reviews described above.

(5) Institutional strengthening, along the lines described in thePER, should be carried out in the areas of:

- aid coordination, planning and budgeting

- Government accounting systems

- establishment management

- overall economic policy management

(6) Action should be taken in the follcwing areas to support the

public expenditures strategy.

- Domestic revenue mobilization.

- Strengthening of local government.

- Parastatal reform.

- Debt management.

(7) Measures to build support for the strategy, such as

- Submitting to Cabinet for discussion by Ministers (and, in

due course by the Party) a paper assessing the current

effectiveness of ministry programs and public serviceproductivity, what is implied in terms of payrestructuring, retrenchment and priority setting, and hw

the process of restructuring is to be carried out.

- Development of proposals for ministerial resourceallocations, based on revenue projections and economic

recovery priorities, endorsed by Cabinet.

- Clear guidelines to ministries on how the review offunctions and staffing should be carried out.

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- Submission of the completed program and supporting sectorpolicy papers to Cabinet.

88. Key to the success of the process is delegation to widenparticipation. Responsibility should be shifted to ministries and departmentsto review what it is they are trying to achieve, within an unequivocal,realistic and transparent medium term budget framework. Superficially, theprocess has some similarities with the preparation of a Five Year Plan. Inpractice it is more rigorous in that it brings all activities under scrutiny,and is aimed at the restructuring of existing programs rather than theaddition of new ones.

Scenarios for a Restructured Budget

89. To illustrate what a medium term financial framework implies, the PERcalculated a budget restructuring scenario for the year 1993194. five yearshence. Key assumptions underlying these projections, which are described inAnnex V of Volume III, are:

(1) Continued GDP growth of between 4 and 5 percent per annum.

(2) Substantial restructuring of the parastatal sector between nowand 1993/94.

(3) Improved domestic revenues through tax reform, cost recovery andincreased collection efficiency.

(4) Restoration of urban council finances through the development ofproperty and other taxes, to the point where urban councils nolonger require recurrent budget transfers.

(5) A public service productivity package, comprising: a 30 percentaverage reduction in central and local government staffinglevels, a trebling of monetary pay, adjustment of income taxbands, reduction in fringe benefits and an increase insupporting expenditures per person of 50 percent.

90. The result of these projections, which should be regarded as oneselection from a range of possible outcomes, are shown in Charts 5, 6 and 7.

(1) Chart 5 shows the structure of the budget in 1993/94 under theassumption that the overall budget deficit is reduced from 8.9percent of GDP to 6.8 percent. This continues the trend ofdeficit reduction of recent years and is consistnt with themedium-term fiscal perspective of the Government's PolicyFramework Paper. Compared with 1988/89 (See Chart 1 on page 6)domestic revenues increase from 20.8 percent of measured GDP to23.4 percent, through improved import duty and income taxcollections and greater cost recovery (via a doubling of Other

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Chait STANZANIA

RESTRUC1URED BUDGET SCENARIO - 1993/94

(1993/94)40

Loom (1I8S)

DatelohEnditUfe Gats(31S.)

30 .

(1t 2%) awlg (151)

Consolidated (44%) (4s1.)

2 (12%) Debt =

(2.9%) Duties (371)

& Exctse,

(9B%)

CantsteLK DoISfltUOab#mU 1 9%) Revenue

M bnirte"l (234%)

(CS) ~~Persnl10 ' Eolaumt( s.

(4.5%)

lrcayne Tax. . _. | ~~~~~~(51S%)T

O_ Regional9 SuPtv(1 1O) _ ___ . ___

Compared wtthtt 1988/89 Budget. SOe e9¢ buylooln pottuat t Perro 6beauts DebtSmvIganoeattefvuDdeametBudef. The ercal budgt defcit (Domesic ue9s miwTote 6 pendltwe le5s Dect Ree_to) 1s6peren6Dat OhP.

WaldB|w*-441?1 4

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Taxes and Fees). On the expenditure side, Ministerial Supplyincreases from 15.9 percent of GDP to 18.9 percent due to anincrease in Personal Emoluments and Grants (mainly to districtcouncils). The substantive completion of parastatalrestructuring, however, permits Contractual and ContingentLiabilities to be reduced. External debt servicing is expectedto remain constant in foreign currency terms. Lower averageinterest costs allow internal debt servicing to be reduced.However, the last component of Consolidated Fund Services (shownin the Chart as "Other' and which comprises State House andother non-debt related statutory expenditure) rises toaccommodate higher pension payments associated vith payincreases and retrenchment. Development expenditures, theresidual in this scenario, fall as a share of GDP in order tomeet the overall budget deficit target. To match this, asubstantial amount of the counterpart revenues from balance ofpayments aid is sterilised by the Bank of Tanzania.

(2) Chart 6 shows how the composition of the Recurrent Budget mightchange. Local Government would become the ministry with thelargest program, due to increased allocations to districtcouncils. The Ministry of Finance's share would be lower, dueto the diminished need for parastatal financing, and the shareof the Ministry of Foreign Affairs would be sharply reduced,necessitating a drastic curtailment of overseas representation.Funds released would be used to augment the shares of theMinistry of Communication and Works and the Ministry ofAgriculture. Through changes in regional and local governmentallocations, consolidated sector spending on education andhealth would rise from 18.5 percent to 22.0 percent and from11.1 percent to 14.0 percent, respectively. However, theselatter increases are needed primarily for higher salaries andsupporting expenditures to adequately fund existing schools,hospitals and clinics, and do not in themselves permit anexpansion of the public education and health systems. Thelatter would require a substantial reduction in unit costs,greater cost recovery and/or a reduction in other sectors'shares.

(3) Chart 7 compares recommended Development Budget shares in1993194 with 1988/89. The main changes are the curtailment ofMALD expenditures through the termination of investments instate farms and large scale irrigation, and the concentration ofresources on rehabilitation of research and extension and othersmallholder services. Direct public investment in mining andindustry is terminated. Resources thereby released are used toexpand the rehabilitation programs of the Ministry of Works andCommunications, the Ministry of Local Government (mainly forurban programs), and the Ministries of Education and Health.

ori 1 *ni v i) i ) i J II| c

*~ ~ . ~ . . g

t~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ (.4 E.P

8~~~ 3~~~~~~~~~~~~~~~~~()ec~pO~JJ

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91. The budget scenario described above is a first attempt to translatethe analysis and recommendations of the PER into a medium term financialframework for the budget. The next step is for the Government to review theassumptions and judgements underlying the scenario and to carry out its ownframework calculations, alonb the lines described in the first part of thissection. The Government's framework may not conform exactly with the PER,but, if the desired objectives are to be attained, it would need to reflectthe direction and magnitude of change indicated by the PER. In thisconnection, four additional points are made.

(1) The Government will need to consider closely all aspects of thestaff reduction and pay adjustment strategy. A fiscallysatisfactory scenario (in appearance, not dissimilar from theforegoing) could be worked out with somewhat less rigorousretrenchment assumptions and smaller pay increases. However,the more cautiously the Government acts to curtail functions andreduce staffing levels, the greater the risk that the publicservice will remain overstaffed, underpaid and engaged in toomany activities. It would remain perpetually locked in its lowproductivity trap, and unable to maintain the country'sinfrastructure or deliver basic social services.

(2) Special attention should be paid to the scale of Governmentexpenditures in the economy. Generally speaking, the Governmentshould aim to reduce the present overall budget deficit(currently estimated at 8.9 percent of GDP) over the longer run.This is required in order to ensure sufficient resources for theprivate sector and to strike a better balance between the publicand the private sector, moving away from the heavy reliance onpublic sector intervention in the economy.

(3) A budget strategy that temporarily deviated from the trend ofdeclining fiscal deficits could be formulated. This would bepossible if, as projected, balance of payments support exceedsthe financing requirements implied by the scenario depicted inChart 5. Such a strategy could take the form of maintaining thepresent deficit/GDP ratio for a period to permit an enlargedDevelopment Budget, with the additional spending concentrated oninfrastructure rehabilitation. In such a case, the share of theMinistry of Communications and Works would be higher than the 21percent projected in Chart 7.

(4) Alternatively, it might be considered that, within the frameworkof a declining overall deficit, the share of the DevelopmentBudget might be increased and that of the Recurrent Budgetreduced. This would be a prudent scenario if the Government hadreservations about domestic revenue growth. However, for thisto work, even more vigorous action on recurrent expenditurerestructuring would be needed. Furthermore, it should berecalled that according to BOP and CG data, there is substantial

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Chat 7TANZANIA

BUDGET RESTRUCTURING: MINISTRY SHARES OF DEVELOPMENT BUDGET EXPENDITURE

Bdok ResrtV tudng After Reshuctudng(4988/89) (4988/89)

Reg_o-i (78%) RWgo (685%)

90 _ Other 0 (:S) OttW (665%)woPMcapo DOv. (1.0%)

PMOC>Cip Dev (( 8S) &-1&Trde 0.0%)

Educatian (31%) ....

80 De_ense & Natbonal & T&Xbn (3.5%)SemIIce (34%)

Lanos. Not ResourCes Firnce (5.0%)&taounn (35%)

Heat (4- Waer (55%)

70 - .

water (SSS%)Water (55%) Education (60%)

nadustwv &

60 -__ _ (5 H_ Health (7.0%)

Fioance (72%)

50 _ Agdcutur (8.0%)

Local Govt (83%)

Energy &Mierals (12.0%)

40 - Comn&WC! (¶.%)

30 LOWa GoA (14 5%)o/wU L>n ('OS%)

Minras (164%)

20 -

1 10 _& Wdcs (21.0%)i- AGrculture (16.8%)

O I _

World6af-44171 7

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underrecording of aid flows in the budget, suggesting a higheractual deficit thao currently calculated.

92. Alternative scenarios need to be judged in the larger context of theGovernment's strategy for economic recovery and how the level and compositionof public expenditures contribute to economic, social and politicalobjectives. Regarding the scale of Government expenditures, it may be notedthat reducing the deficit to 6.8 percent of GDP by 1993/94 would notnecessarily lower the share of Government expenditure in GDP. In the 1988/89Budget, total expenditure, net of debt redemption is estimated at 29.7 percentof GDP. In the scenario depicted in Chart 5, it would rise slightly to 30.2percent. With an unchanged overall deficit, it would increase to 32.3 percentof GDP.

93. Furthermore, the alternative of an unchanged budget deficit and alarger Development Budget heightens the emphasis on two existing PERrecommendations and adds a third one. They are:

(1) A program of measures to strengthen the Government's capacity(at present insufficient) to manage a much larger infrastructureprogram.

(2) The fundamental restructuring of Recurrent Budget priorities,expenditure levels and staffing.

(3) An explicit policy to reduce the relative size of theDevelopment Budget once the cycle of rehabilitation is complete.

94. For all scenarios, it would be necessary to estimate the impact ofhigher overall Government expenditures on monetary conditions. The more thatcounterpart revenues from import support are applied to Governmentexpenditures as opposed to being sterilized at the Bank of Tanzania, thetighter credit conditions will have to be for the private sector, which mightdefeat the underlying purpose of accelerated infrastructure rehabilitation.These trade-offs need to be considered and a balance struck.