Document of The World Bank

Report No: 26192

IMPLEMENTATION COMPLETION REPORT(PPFI-P7881; IDA-32180; IDA-32181; IDA-32182; PPFI-P7880)

ON A

CREDIT

IN THE AMOUNT OF US$ 150.5 MILLION

TO THE

REPUBLIC OF MADAGASCAR

FOR A

STRUCTURAL ADJUSTMENT CREDIT II

June 20, 2003

AFTP1Africa Region

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

(Exchange Rate Effective May 26, 2003)

Currency Unit = Malagasy Francs Mgf 6,055.93 = US$ 1.00US$ 0.000165 = Mgf 1.00

FISCAL YEARJuly 1 June 30

ABBREVIATIONS AND ACRONYMS

ACM Aviation Civile de Madagascar LCU Local Currency UnitAGOA African Growth and Opportunity Act LDP Letter of Development PolicyBTM Rural Development Bank

(Bankin’ny Tantsaha Mpamokatra)MCO Mining Cadastre Office

CAB Current Account Balance Mgf Malagasy FrancsCAS Country Assistance Strategy MoP Memorandum and Recommendations of the

PresidentCFCE Centre de Facilitation de Création d’Entreprises NFA Net Foreign AssetsCNaPS Caisse Nationale d’Assurance et de Prévoyance

SocialeOMERT Office Malagasy d’Etudes et de Régulation des

TélécommunicationsCPR Caisse de Prévoyance et de Retraite OMH Office Malgache des HydrocarburesCRCM Caisse des Retraites Civiles et Militaires OMNIS Office Militaire National des Industries StratégiquesCOMESA Common Market for Eastern and Southern Africa PAIGEP Public Sector Management and Capacity Building

ProjectCSB1 Centre de Santé de Base – niveau 1

(Primary Health Center)PASERP Programme d'Actions Sociales et Economiques dans

la Réinsertion ProfessionnelleDCA Development Credit Agreement PATESP Private Sector Development and Capacity Building

ProjectESAF Enhanced Structural Adjustment Facility PRGF Poverty Reduction Growth FacilityEU European Union PSR Project Status ReportFDHA Fonds de Développement Halieutique et Aquicole SAC Structural Adjustment CreditFDI Foreign Direct Investment SDR Special Drawing RightsGDP Gross Domestic Product SME Small- and Medium-scale EnterpriseHIPC Highly-Indebted Poor Countries SOLIMA Solitany Malagasy

(Petroleum Company)ICR Implementation Completion Report STA Secrétariat Technique à l’AjustementIATA International Air Transport Association TELMA Telecom MalagasyIDA International Development Association Tot Terms of TradeIDF Institutional Development Fund U.S. United StatesIMF International Monetary Fund US$ United States DollarINSTAT Institut National de la Statistique WDR World Development Report

Vice President: Callisto MadavoCountry Director: Hafez GhanemSector Manager: Philippe Le Houerou

Task Team Leader: ICR Task Manager:

Jesko Hentschel Luc Razafimandimby

MADAGASCARSTRUCTURAL ADJUSTMENT CREDIT II

CONTENTS

Page No.1. Project Data 12. Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 65. Major Factors Affecting Implementation and Outcome 136. Sustainability 137. Bank and Borrower Performance 148. Lessons Learned 159. Partner Comments 1610. Additional Information 16Annex 1. Key Performance Indicators/Log Frame Matrix 17Annex 2. Project Costs and Financing 18Annex 3. Economic Costs and Benefits 19Annex 4. Bank Inputs 20Annex 5. Ratings for Achievement of Objectives/Outputs of Components 22Annex 6. Ratings of Bank and Borrower Performance 23Annex 7. List of Supporting Documents 24Annex 8. Ratings of Output Components and Achievements of Objectives 25Annex 9. Comparison of Selected Macroeconomic Indicators, Projections (MoP) and Actuals (ICR)

26

Annex 10. Policy/Measure Intermediate/Output 27Annex 11. Results of the Replication of WDR Surveys 32Annex 12. Income Poverty Developments 1997 - 2001 (Headcount Index %) 35Annex 13. Output Indicators Discussed during the Review Meeting with Line Ministries and STA

36

Annex 14. Performance of the Tourism Sector 38Annex 15. Adjustment Dialogues and Timeline of Events 39Annex 16. Government's Contribution 40Annex 17. SAC II Audit 49Annex 18. Borrower comments 52

Project ID: P057378 Project Name: STRUCTURAL ADJUSTMENT CREDIT II

Team Leader: Luc Razafimandimby TL Unit: AFTP1ICR Type: Core ICR Report Date: June 27, 2003

1. Project Data

Name: STRUCTURAL ADJUSTMENT CREDIT II L/C/TF Number: PPFI-P7881; IDA-32180; IDA-32181; IDA-32182; PPFI-P7880

Country/Department: MADAGASCAR Region: Africa Regional Office

Sector/subsector: Central government administration (50%); Oil and gas (17%); Mining and other extractive (17%); Telecommunications (8%); Aviation (8%)

Theme: Macroeconomic management (P); State enterprise/bank restructuring and privatization (P); Regulation and competition policy (P); Other financial and private sector development (S); Land management (S)

KEY DATESOriginal Revised/Actual

PCD: 10/21/1998 Effective: 03/30/2000 06/30/2000Appraisal: 04/01/1999 MTR: 06/30/2000 06/30/2001Approval: 05/20/1999 Closing: 12/31/2001 12/31/2002

Borrower/Implementing Agency: GOVERNMENT/MINISTRY OF FINANCEOther Partners:

STAFF Current At AppraisalVice President: Callisto E. Madavo Callisto E. MadavoCountry Director: Hafez M. H. Ghanem Michael SarrisSector Manager: Philippe H. Le Houerou Luca BarboneTeam Leader at ICR: Jesko S. Hentschel Juan ZalduendoICR Primary Author: Luc Razafimandimby

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: S

Sustainability: L

Institutional Development Impact: SU

Bank Performance: S

Borrower Performance: S

QAG (if available) ICRQuality at Entry: S

Project at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:General Background

3.1.1 The second structural adjustment (SAC II) was approved in May 1999. The reforms under SAC II were in line with the objectives of the CAS approved in 1997 and carried out in parallel with two PRGF programs supported by the International Monetary Fund (1996/2000 – 2000/04). At the initial stage, SAC II was a two-year program but the operation was closed only in December 2002 (see Annex 15).

3.1.2 The SAC II reforms were meant to consolidate the achievements of the previous single tranche Structural Adjustment Credit (SAC I) approved by the Board of the World Bank in 1996. SAC I was geared to transforming Madagascar into an open economy and to redefining public expenditure priorities by creating an enabling business environment, promoting divestiture of public enterprises - particularly the privatization of state-owned primary banks -, and re-directing public expenditures towards the social sectors. Despite implementation problems, the policies initiated under SAC I succeeded in increasing GDP growth, foreign investment and the allocation of budgetary resources to the social sectors.

3.1.3 The program of SAC II was affected by two external shocks which required a rapid response from the Bank. First, a supplemental cyclone credit was approved by the Board in June 2000 to respond to a cyclone emergency, which had caused serious damages - notably in rural areas and in the agricultural sector - and large export shortfalls. Second, a supplemental oil credit was approved by the Board in December 2000 to help the country mitigate a strong increase in petroleum prices. Both credits provided balance of payments support to meet higher import needs. Further, the generated counterpart funds were to reduce the borrowing needs of the public sector. This ICR also includes an evaluation of the two supplemental credits.

Original Objectives

3.1.4 The original objectives of SAC II were twofold:

(i) to achieve high economic growth (above 5 %), with the public/private investment ratio declining from 1.2 in 1998 to a target of 0.9 in 2001 and the level of foreign direct investment (FDI) increasing from 0.4 % of GDP in 1998 to 1.7 % by 2001, and;

(ii)to contribute to poverty reduction.

3.1.5 To achieve these objectives, the program supported substantial reforms in the following four areas: (i) macroeconomic stabilization, to ensure that the expected expansion of the economy would take place in a stable and predictable environment and to avoid an adverse impact on the standards of living of the poor; (ii) private sector development, to provide investors with a more friendly business environment; (iii) privatization of major State-owned enterprises in key areas

1

,

to provide strong signals to foreign investors of the Government's willingness to disengage from productive activities, allowing for effective liberalization and improved sector performance. Divestiture from major state-owned enterprises, in turn, would help improve public finances and fiscal accounts (MoP Para 23), and; (iv) public finance reforms, to increase tax revenues and achieve higher and more efficient spending in the social sectors (most notably, health and education).

3.2 Revised Objective:

- 2 -

Throughout implementation, the original objectives – raising economic growth and reducing poverty – were not changed. However, the two external shocks (see 3.1.3) impacted on the operation's implementation and required an injection of foreign exchange through two supplemental credits, in order to maintain the macroeconomic targets and to keep the reform program going. In addition, the political turmoil of 2002 and the resulting economic crisis called for a restructuring of the operation in September 2002, with a modification of the conditions related to Air Madagascar's privatization as well as of some conditions related to governance aspects of financial sector reform. While the objectives (growth and poverty reduction) were maintained in the restructuring, the originally quantified targets were not attainable any more for the year 2002 due to the economic crisis. The crisis was unrelated to the operation.

3.3 Original Components:3.3.1 SAC II was a three-tranche operation and a menu-based program amounting to $US 100 million. Up-front actions to complete SAC I reforms and to lay the ground for the upcoming SAC II reforms were required prior to Board presentation (Annex 10).

3.3.2 SAC II was a broad and comprehensive program and the implementation of the reforms required a very high level of political commitment. The preparation team had anticipated that the package of structural measures would be very heavy. Accordingly, an innovative project design was selected, under which the Government could choose from a menu of reforms after completion of the effectiveness of the credit. The menu-based program meant that the Government did not have to complete specific reforms on a specific date but rather that it could use the most advanced reforms to meet the conditionalities required for disbursement of the floating second tranche. Hence, it was possible for Government to postpone the completion of remaining reforms for disbursement of the third floating tranche (Annex 10).

3.3.3 The effectiveness of the credit was linked to the privatization of the oil company SOLIMA. The menu-based program, for the release of the second and the third tranches to take place, consisted of two core and eight side conditions. Core measures consisted of the privatization in the air transport and the telecommunications sectors and side conditions concentrated on private sector development and public finance reforms. The Government had to meet one core conditions and four side conditions per tranche (Annex 10). Each privatization process was linked to the completion of the sales of the voting stock.

3.4 Revised Components:3.4.1 Waiver and Closing Date Extension (Annex 10). In December 2001, the Board approved a waiver to release the second tranche of the credit once a winner for the bidding process of TELMA was chosen and invited for negotiation (hence it stopped short of the transfer of assets). Relaxing the initial condition appeared to be justifiable for the telecommunications sector. The privatization of the petroleum sector (including asset transfers) had been completed and the necessary strong signal about the sustainability of the Government’s privatization program had been provided to the private sector. Further, the telecommunications sector had been effectively liberalized with the existence of four cellular phone providers, and by the end of 2001, sector performance improved markedly. Finally, completion of the transfer of assets was affected and delayed by clarification of land and building titles and the Bank did not want to weaken the position of the Government by requiring an actual transfer of assets as a condition for tranche disbursement. The Government was also granted a one-year extension of the operation until December 2002. Second tranche disbursement occurred in January 2002.

3.4.2 Credit Restructuring (Annex 10). In September 2002, the conditions for the release of the third tranche were restructured to account for the impact of the political crisis and a number of market developments. The restructuring of the credit was also meant to reflect the priorities of the new authorities.

- 3 -

Regarding the core measure, although a bid had been launched in February 1999, the privatization of Air Madagascar was affected, for a long time, by an unsettled claim of EXIM Bank on the airline’s largest asset - a Boeing 747 -, which delayed the privatization process significantly. In addition, while a potential winning bidder had responded to the February-1999-bid, the Government halted the process in order to elaborate a new privatization strategy and to obtain higher returns. Later on, the impact of the September 11, 2001 events on the financial situation of the major international airline companies and a sharp deterioration of Air Madagascar’s financial situation in 2002

2

reduced the possibility for Government to find suitable buyer for Air Madagascar. The Government adjusted its reform strategy accordingly. With respect to the side conditions, the new Government that took office in June 2002 placed highest importance on re-establishing public financial management and control in the aftermath of the political crisis, and on combating corruption. This prioritization was based on the results of a review of the 2001 budget expenditures, which had revealed a significant overspending and mismanagement of the president’s special funds by the previous regime ($US 25 million compared to a budgeted amount of $US 400,000 million). The new Government also put emphasis on good governance in the husbandry of natural resources after sub-national entities had issued illegal licenses in forestry and fishery sectors and as a reaction against increased illegal exploitation of precious stones during the crisis. In parallel, several of the original side conditions did not appear of highest importance in the post-crisis situation. First, with respect to the liberalization side condition, the bid for a second national telecommunications operator appeared less urgent as the sector performance had improved considerably (see Annex 13), and the planned concession of airports was postponed in light of the new reforms strategy adopted for Air Madagascar. With respect to land tenure, reforms of the Bail Emphytéotique (long term land lease) had been met, and although it was uncompleted at the time of the credit restructuring, the granting of tourist and industrial sites was advanced. The audits of the insurance companies were completed and the Government had agreed to pursue with the audits of the social security funds. Although the Government requested that the conditions be restructured to match it’s own changed priorities, it nevertheless committed itself to carry-out the entire reform agenda (including those conditions which were dropped).

3.4.3 Supplemental oil credit. The supplemental oil credit (US$ 30 million) became effective on June 25, 2001 and was fully disbursed on June 29, 2001. The counterpart funds generated by this credit were destined to reduce the specific taxes on petroleum products and/or to maintain existing rebates in order to moderate the impact of the shock on prices faced by final users.

3.4.4 Supplemental cyclone credit. The supplemental cyclone credit (US$20 million) became effective on September 20, 2000 and was fully disbursed on July 18, 2002. It aimed at: (i) providing fast disbursing foreign exchange to partially alleviate the pressing financing need in the balance of payments, and; (ii) providing counterpart funds to Government for the planned reconstruction effort, thereby reducing the borrowing needs of the public sector. The reconstruction program was meant to rehabilitate health and education facilities, physical infrastructures such as roads, bridges and irrigation, and to mitigate the urgent needs of the extremely poor. For that purpose, the Government was to: (i) collect detailed reconstruction information by district, sector and contractor; (ii) publish an information bulletin on a bi-monthly basis; (ii) regularly discuss the information bulletin with regional and national stakeholder groups, and; (iv) conduct a participatory evaluation of the reconstruction effort. The Government indicated that it would withdraw the funds in two installments of US$ 10 million, with the first withdrawal immediately after effectiveness

3

. The second disbursement occurred in July 18, 2002.

3.5 Quality at Entry:3.5.1 The quality at entry is rated as satisfactory. The rating reflects the consistency of the SAC II with the previous adjustment program and with the CAS objectives, the coherence of the operation with Bank

- 4 -

projects and other donors’ programs, and the innovative menu based approach to reforms. The risks identified in the CAS strategy were also carefully taken into account in SAC II.

3.5.2 Consistency with SAC I and the CAS. The reforms supported under SAC II built directly on SAC I achievements. This enhanced the credibility of the reforms. They addressed the objectives central to the 1997 CAS by contributing to a visible economic opening and private sector development, as well as to improved public finance and poverty reduction. These objectives still remain highly relevant today.

3.5.3 Link with World Bank Projects and Donor Coordination. SAC II reforms were designed to be complementary to several Bank projects. PAIGEP, a capacity building project with a multi-sector action plan, supported reforms in the judiciary sector and of public finances, and provided institutional support to improve economic management. For the latter component, PAIGEP’s support consisted in strengthening the Secrétariat Technique à l’Ajustement (STA) in policy supervision and the statistical institute INSTAT to enable it to produce reliable statistical data. Another Bank project, PATESP, played an important role in supervising privatization and liberalization in key sectors and included severance programs and payments as well as opportunities for local ownership. The project financed the technical team in charge of privatizing state enterprises and prepared retraining programs for retrenched staff. Finally, SAC II was in line with other donors’ programs: (i) the IMF supported macroeconomic stabilization policy with the ESAF and PRGF, and; (ii) the EU developed complementary private sector development programs, as well as budget and social programs (health and education), which enhanced the likelihood of important pay-offs.

3.5.4 Risk Assessment. The MoP spelled out very clearly and openly the risks affecting the operation (MoP para 51). A number of risk mitigating factors helped some – but not all – of these risks not to materialize. Firstly, the operation benefited from the lessons learned in SAC I implementation. Significant up-front actions and multiple tranche releases were included to avoid loosing financial leverage after disbursement. Secondly, the initial time frame of the operation was made to coincide with the electoral calendar to ensure that the reforms were implemented while political will was more likely and not hampered by election concerns. Unfortunately, the pace of reforms slowed and as a result, the presidential elections in December 2001 were in advance of the extended closing date. The political and economic fallout of the contested elections impacted significantly on the economic achievements of Madagascar in 2002. Thirdly, Bank projects supported the Government’s technical assistance needs, contributing to the reduction of the risks of resistance to the opening up of the economy (PATESP) and of weak implementation capacity (PAIGEP).

3.5.5 Design. SAC II supported a broad array of important sector reforms, which had restrained economic activity in Madagascar. In hindsight, the operation was perhaps too broad given the chosen time frame (2 years) and the possibly weak implementation capacity of the administration. Indeed, not only were the reforms technically complicated (particularly in privatization), but they also necessitated efficient, rapid actions and political courage. To a large extent, the task team attempted to address these shortcomings by allowing for flexibility (through the menu-based operation/floating tranches), by ensuring complementarities between the proposed reforms and technical assistance projects as well as other donor’s programs, and through SAC II’s coherent linkage with SAC I achievements. Questions can also be raised with respect to the design of the privatization agenda. Linking the privatization to the transfer of assets had the potential to exert pressure on Government in the delicate process of negotiation, thereby undermining the Government’s bargaining position. However, considering the experience with Government commitment to previous privatizations under SAC I (the national banks), the risk was justifiable.

1

TELMA in the telecommunication sector, SOLIMA in the oil sector, and Air Madagascar in the air transport sector.

- 5 -

2 During the crisis, Madagascar did not meet the IATA membership clearing house and tickets were not accepted

by other airlines. 3

The government has planned to withdraw the second tranche when 350 destroyed primary schools in the 10 most heavily damaged schools districts and 33 of the 82 destroyed primary health centers were rehabilitated, appropriately equipped and staffed.

4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:4.1.1 The political crisis in Madagascar in 2002 had multiple adverse economic and social effects. These developments, though entirely unrelated to SAC II reforms, had an important impact on some of the “target” outcomes of SAC II. In order to control for these distortions, the evaluation considered outputs/outcomes only until 2001. 2002 data were analyzed in terms of qualitative achievement relating to the revised conditions in the credit restructuring.

4.1.2 The operation is rated satisfactory. Already in December 2001, most of the development objective indicators had been met. SAC II succeeded in consolidating the foundations for sustained growth and poverty reduction in the medium-run.

Table 1: Improving Growth Performance (%)

1995 1996 1997 1998 1999 2000 2001 2002Real GDP growth at market prices

MOPICR

1.81.7

2.02.1

3.03.6

3.93.9

4.54.7

5.34.8

5.66.0

--12.7

4.1.3 The first objective of reaching high economic growth based on private investment, particularly on foreign direct investment, was achieved. Actual performances exceeded the defined targets. Economic growth was on an upward trend during the operation and surpassed the objective in 2001 before dropping sharply in 2002 due to the political crisis (Table 1). Private investment grew by double-digit figures between 1999 and 2001 and the public investment/private investment ratio declined from 1.14 in 1998 to 0.6 in 2001 (Table 2).

4.1.4 Reforms under SAC II contributed to the surge in private investment, particularly to that of FDIs. Visible and decisive policy changes, through the privatization process and the reforms aiming at private sector development, improved State credibility, restored investors’ confidence and encouraged investment inflows (Annex 11). FDIs increased from 0.4 % in 1998 to 2 % of GDP in 2001, largely through foreign participation in the privatization process and/or investments in the textiles and clothing sector (Table 2). More than 100,000 jobs were created in the sector with significant backward and forward spillovers to local businesses (particularly small and medium enterprises). Thanks to the liberalization of the air transport sector, the tourism sector also expanded considerably with a sharp increase in the number of visitors (from 100,000 in 1997 to 170,000 in 2001), resulting in a more-than-doubling of tourism related foreign exchange earnings and an increasing number of hotels and tourism related employment (Annex 14). Equally, estimate of investments in the petroleum sector reached the equivalent of US$ 12 million after the privatization was completed. The annual growth rates in the telecommunications sector were remarkable (11,4% in 1998; 11% in 1999, 8,6% in 2000 and 5,6% in 2001), thanks to the liberalization of the latter sector and the investments carried-out by the four cellular phone providers as well as the induced expansion of TELMA.

- 6 -

Table 2: Increase in Private Investments (% of GDP)

1996 1997 1998 1999 2000 2001 2002 (Est.)

Public Investment (1) 6.8 6.5 7.9 6.9 6.7 7.3 4.8Private Investment (2) 4.9 6.3 6.9 8.0 8.3 11.2 9.4

Ratio (1/2) 1.39 1.03 1.14 0.86 0.8 0.6 0.5Net private FDIs (in million US$) - 14 16 58 70 93 8.5Annual growth rates in the textiles and clothing sector/GDP

- - 16.5 20.2 24.8 34.7 -81.1

4.1.5 Madagascar managed to break away from its dismal growth performance of the past, and the economic contraction of 2002 was essentially circumstantial. Similarly, worsening poverty was halted and the conditions for effective poverty reduction in the medium term were put in place. The national poverty headcount rate decreased from 73 % (1997) to 71 % (1999) and 69 % (2001) but the economic expansion mostly benefited the urban population and the urban poor. Rural poverty stagnated and rural extreme poverty increased in the same time period. This is most likely largely due to the negative exogenous shocks (oil shocks, cyclones and drought in the South) which had an adverse impact on the living conditions of the rural poor (Annex 12). The relatively low poverty reduction efficiency of growth in Madagascar also suggests that growth maximizing strategies alone are not sufficient to achieve broad-based poverty reduction.

4.1.6 SAC II reforms partially smoothed-out the impact of the 2002 political and economic crisis. Due to advanced structural reforms in a number of sectors, the impact of the political crisis on public finances was mitigated, leaving room for other priority expenditures during the reconstruction period. For example, the completed privatization of SOLIMA relieved Government from financial losses in the petroleum sector due to the crisis. Reforms under SAC II had also put in place a conducive medium to longer-run framework for sustained economic performance. Improved business environment coupled with better governance, and the enforcement of effective regulatory frameworks helped improve performance in key sectors rapidly after the crisis (fishing and mining sector). Recovery in the export processing zones is ongoing but is also very likely faster than had reforms supported under the credit not taken place. Already, a number of new American and Mauritian companies have begun to invest in Madagascar’s textile sector due to the favorable post-crisis investment climate.

4.2 Outputs by components:

- 7 -

4.2.1 Macroeconomic management

Macroeconomic management is rated satisfactory (Annex 9). The actions for macroeconomic stabilization were supported by the two PRGF programs of the IMF during the operation (1996/2000)/(2001/04), which aimed to achieve consolidated fiscal deficits and low inflation. Good macroeconomic performances improved the predictability for private sector investors, helped the country achieve a good growth performance, and was a precondition for reaching the HIPC decision point in December 2000. Strong export performance, surging FDIs coupled with improved terms of trade strengthened the balance of payments and the net foreign asset position of the banking system as well as external reserves. The fiscal deficit decreased steadily from 1998 to 2000 due to increased revenues and lower than projected expenditures. Although increasing, tax revenues still fell short of targets due to weaknesses in customs administration (especially in secondary ports) and exogenous developments – lower petroleum consumption, the continuing appreciation of the exchange rate

4

and the streamlining of tariffs in line with the Cross-Border Initiative/Regional Integration (COMESA) as well as a widespread fraud in the run up of the 2001 presidential elections

5

. Moderate fiscal deficits combined with a conservative monetary policy contained inflation to a low level. Finally, the privatization of the primary state-owned bank played a key role in lowering inflationary money creation.

4.2.2. Privatization

The Government completed up-front actions prior to Board presentation. The sales protocols of BTM were signed on November 24, 1999 and the Council of Ministers approved the social compensation program. Despite delays in the privatization in the telecommunications and oil sectors (see 3.4.2), and the reformulation of Air Madagascar privatization, the existence of operational and effective regulation allowed for the opening-up of key sectors and accounted for significantly improved sector performance by 2001 (see below). In this light, and given that effective economic liberalization leading to improved sector performance was the actual goal behind the privatization agenda (see 3.1.5), the privatization component is rated satisfactory.

a) Petroleum The privatization of SOLIMA is rated satisfactory. The regulatory framework became operational in 1999, following the establishment of the regulatory body (OMH). While the bids for petroleum lots had been launched in November 1998 and the winning bidders had been notified in January/February 1999, SOLIMA’s effective privatization was considerably delayed due to a cumbersome process of clarifying asset ownership and the implementation of a new retail oil price formula. In addition, the petroleum assets to be privatized were divided into four lots (refinery, aviation, distribution and logistics), which meant that the contracts had to be signed at different dates. The delay in the privatization process exerted an undue pressure on the Government to reach the effectiveness of the credit and led to a substantial decrease of the privatization receipts

6

. Full ownership of oil and gas operations was transferred to the private sector in 2001. The distribution of petroleum products and service stations all over the country are now being managed by four private companies, two of which are major worldwide distributors. The sale of petroleum lots led to visible client benefits. Investment in the distribution network reached the equivalent of US$ 12 million (cumulative 1999 to 2001) and more than 50% of gas stations in the country now meet international standards (Annex 13). Transfer of key non-petroleum lots of SOLIMA was only partially completed and the compensation program for retrenched staff is still under way. However, the overall achievement compares favorably to these few shortcomings, which had negligible impact on the success of the operation.

- 8 -

b) Air transport Reforms in the air transport sector are rated satisfactory. A series of decrees (99-123/126/821) established the regulatory authority (ACM) and defined its role, which consists in enforcing standards and competition as well as security, in promoting competition in the sector and in ensuring the regulation of international traffic. This allowed for an effective opening up of the air transport sector: six international airline companies are now operating in Madagascar

7

. Flight frequency increased, and hence the number of tourists also rose dramatically (Annex 14). In the last semester of 2002, the Government placed Air Madagascar under private management in the form of an operating contract for two years with Lufthansa Consulting. The new strategy (conclusion of a management contract for Air Madagascar with a reputable operator), was proposed to and approved by the Board of Executive Directors through an amendment of the original Development Credit Agreement on September 26, 2002. The contract imposed obligations on the operator to improve the company’s financial and technical performance. In the last quarter of 2002, a business plan for the company in the short and the medium term was finalized and a Air Madagascar creditor’s conference has resulted in halving the company’s debt.

c) TelecommunicationsPrivatization of TELMA is rated satisfactory. The Government completed the specific prior-to-Board-presentation measures. The regulatory body (OMERT) was operational in 1997 (decree 96-034) and the sector was liberalized in 1998 with the granting of four cellular licenses

8

. Decrees governing application of the Law on the liberalization of the Telecommunications sector (99-227) were adopted in 1999. The privatization of TELMA was greatly delayed by problems concerning the legalization of land and building titles and by two other major setbacks from 2001 onwards: (i) a court case, initiated by one of the bidders (France Telecom), challenging the legal procedures of the bid, and; (ii) the political and economic crisis in 2002. Although the winning bidder was appointed in December 2001, the asset transfer contract is expected to be signed only by the end of the second semester of 2003. Nevertheless, the Telecommunication sector currently offers better services (Annex 13): the penetration rate in the sector increased from 0.27 to 1.30, and the number of lines per employee in the sector increased from 15 to 24. The fixed line waiting period was reduced from 7.5 months to 2 months and long distance calls cost decreased markedly. Hence, the original goal of improving sector performance was achieved.

4.2.3 Private Sector Development

a) Mining SectorMining sector reforms are rated satisfactory. The Government completed the up-front action required by the Bank by returning the OMNIS license to the State in 1999 (decree 99-697). In the same year, the Government also set up the Mining Cadastre Office (MCO) in charge of managing in a transparent way the granting and holding of licenses, of enforcing security of tenure of mineral property, and of disclosing information to the public. A new mining code based on the “first come, first served” allocation principle in risk areas was passed by the Assembly in March 2000 (decree 2000/170). The code details the application of bidding procedures for license applications in areas of recognized potential. The list of issued and rejected licenses is now published in a transparent manner in all MCO offices and on the MCO web site. The reforms reduced the duration of permit application to 35 days and the existing backlog of permit applications from 80% in 1999 to 15% in July 2001.

b) Fishery and Forestry sectorsFishing and forestry reforms are rated satisfactory. Up-front actions required by the Bank were completed with the adoption of a transparent, competitive and non-discretionary license delivery system before the fishing campaign of the year 2000 (decree 2000/425). Fees for licenses granted in 1999 were readjusted

- 9 -

accordingly and public revenues from fisheries increased by more than 100% between 1998 and 2000. In order to ensure sustainable exploitation of the resource, the Government froze the number of fishing licenses in Madagascar, respecting the 1998 allocation by zone and boat-type per firm. An audit of the FDHA was completed in 2001 and the recommendations were distributed among the projects under the FDHA umbrella. However, so far the Government has not taken steps to implement the recommendations included in the audit. From 2000 onwards, the Government used 80% of FDHA receipts for counterpart funds of donor funded projects in the sector. An on-going study, carried-out by the Programme National de Recherche Crevettière will determine the necessary change in the number of licenses to ensure a sustainable exploitation of the shrimp potential in Madagascar. Reforms in the fishery sector led to a diversification of fish exports with the share of shrimp in total exports decreasing from 90% (1998) to 73% (2001). Since August 10, 2002 a license allocation system similar to that of the fishery sector was adopted for the forestry sector. The Government also withdrew all illegal fishery and forestry licenses which had been issued by sub-national governments during the political crisis in 2002. Recently, to emphasize the transparency of license allocation, the Government published the names of all license holders in the forestry sector in the newspapers (Midi Madagasikara and Tribune on April 11-12, 2003).

c) Judiciary sector and Business Environment Business environment and judicial reforms are rated satisfactory. With respect to justice, a study carried-out by the Government in November 2000 contained recommendations to improve the functioning of the justice system and the caseload management. An action plan was submitted to the Bank in December 2001 and deemed satisfactory. However, implementation of the action plan has not commenced. Instead, a national forum on justice is to be organized to discuss exclusively the issue of expedited proceedings and the recommendations of this forum would form the basis for a new action plan to be implemented. Nevertheless, the Government had undertaken a number of important reforms to improve caseload management before the approval of the action plan. Measures already taken included: (i) the elimination of the proportional tax on court judgments (Law 99-032); (ii) the review and reconciliation of budget items relating to legal personnel with the actual number of positions (completed in October 2000), and; (iii) the determination of the costs of postal fees for judicial oversight. Finally, the budget allocation to the Ministry of Justice increased from Mgf 15 billion in 2000 to Mgf 20 billion in 2002 in nominal terms. Regarding the business environment reforms, an Arbitration Law to settle commercial disputes was adopted by the National Assembly in 2000 and complemented by the creation of the Centre d’Arbitrage et de Médiation (Law 98-019). Madagascar thereby met the up-front requirements for credit effectiveness. A consultative process involving the private sector resulted in an action plan and the Government has achieved substantial progress in executing the action plan to date: (i) procedures for enterprise creation are now available to the general public and published in all concerned line ministries; (ii) the Centre de Facilitation de Création des Entreprises (CFCE) was created in 1999 to provide guidelines to investors; (iii) the Centre Inter-Ministeriel du Secteur Privé was created in 2001 to avoid that repetitive information is required multiple times by various ministries and agencies. As a result, company registration now involves 4 bureaus as opposed to 10 in 1999; company registration takes 5 days and work permits are generally completed within 15 days; (iv) environmental appraisal for the concerned activities is simplified, with a clear distribution of the respective roles of the different line ministries. The procedures to be followed for environmental appraisals are now published in booklets available to the general public.

As recommended in the Annex 4 of the MoP, the resident mission team conducted a survey to assess the impact of the reforms on investors’ perception of the business environment (Annex 11). The results indicated that according to the majority of the interviewed enterprises, government actions between 1998 and 2001 had a positive impact on private sector activities and improved trust in the judiciary system.

d) Liberalization

- 10 -

After much internal discussion within Government, a law governing the fiscal regime of large mining projects above Mgf 1 trillion was finally adopted by the Ministerial Council (Law 2001-031). The law was passed by Parliament in November 2001, by the Senate on August 8 and will be followed by decrees. The envisioned reform was hence successfully completed.

4.2.4 Strengthening revenue policy

Reforms of revenue policy are rated unsatisfactory. A Technical Unit on Revenue Monitoring was created in the Ministry of Budget (decree 3096/2000) in March 31, 2000 with the support of an IDF grant from IDA. For the year 2001, an annual report was submitted to the Association in December 2001, using all available data on tax revenues at the central and decentralized levels and showing detailed trends in tax collection over the past five years. The Unit was dissolved in 2002 during the political crisis but despite resumption of the IDF grant in the last quarter of 2002, the Government has not been able to revive the unit. The targeted outputs in the MoP were not reached (Annex 13) as the difference between actual and theoretical/projected collection worsened from 107% in 1999 to 84% in 2000 and to 74% in 2001. The MoP also specified that the share of imports under the suspensive regime in total imports would decrease from 50% to 40%. The realization of this share is unknown at this point, however.

4.2.5 Monitoring progress on social spending

Reforms in social expenditures management are rated marginally satisfactory. The Government completed the up-front actions required by the Bank by changing the budget nomenclature to match Budget Law and Treasury accounting. A credit delegation for the education and health sectors designed to speed up the allocation to remote districts was effective in 2000 and a Technical Monitoring Unit of social expenditures was set up in the ministries of Health and Education from 2000 onwards. The Unit has produced three monthly monitoring reports of social expenditures starting in April 2000, distinguishing between specific budget items and functions. A tracking survey was conducted by the Government to analyze the proportion of recorded budget flows reaching primary education and health centers in 2001. The reforms have permitted to improve Government budget commitment in the education sector but not in the health sector. In hindsight, implementation did not reflect the spirit of the original objectives as these initiatives did not result in the expected corrective action plan to improve the pattern and the efficiency of the spending in the social sector. Particularly, in the education sector, no community school has received direct support as spelled out in the MoP (Annex 13).

4.2.6 Anti-corruption measures

Reforms in public financial management are rated satisfactory. The Government required ministers, senior officials and judges to issue annual declarations of their assets and that of their close relatives (decree 2002/1127). An anti-corruption task force was created (decree 2002/1128) with clearly identified terms of reference as specified in the Amendment to the Development Credit Agreement and a free telephone line is available to the general public to report acts of corruption.

- 11 -

4.2.7 Public Financial Management

As required by the restructured credit agreement, the Government took major steps to improve public financial management, especially that of the presidential Special funds: (i) a report about the use of Special funds for the year 2002 was completed and submitted to the Association on August 12, 2002; (ii) another report containing a list of measures to tighten the use of Special funds in the future was produced and submitted to the Bank on October 4, 2002, and; (iii) the Chambre des Comptes was mandated to conduct semi-annual audits of the Special funds. Finally, the ministries of Finances and Budget were merged in order to improve budget planning (decree 2002-451). Recently, a CFAA Bank mission further scrutinized and strengthened the measures to prevent overspending of the Special funds. So far the measures have been properly enforced.

4.3 Net Present Value/Economic rate of return:n.a.

4.4 Financial rate of return:n.a.

4.5 Institutional development impact:The institutional development impact of the operation is judged substantial based on improvements in the legal framework and on the creation of institutions for promoting economic development. Among these are (i) the regulatory bodies set-up to oversee competition in the liberalized sectors (telecommunications, air transport, petroleum, fishing, mining); (ii) strengthened internal control functions of central Government. Similarly, social expenditures management improved with the setting up of the technical monitoring unit. The process is being enhanced under the HIPC framework.

4.6 Supplemental credits4.6.1 Supplemental Cyclone Credit

This credit is rated unsatisfactory. Although the credit did help the Government from a macroeconomic perspective to remain on the reform course by financing an unforeseen balance-of-payments and fiscal deficit, the specific conditions, as to when this supplemental credit would be judged as satisfactory, were not met. Only a fraction of the targeted reconstruction of damaged schools and health centers were achieved and many of the reconstructed infrastructure remained not operational as teachers or nurses were missing. The latest INSTAT survey indicated that only 33 of the 82 destroyed primary health centers (CSB1) met the conditions while only 99 primary schools out of 350 were functional. Similarly, the announced participatory monitoring of the reconstruction effort did not materialize as planned and beneficiary groups met only a few times.

4.6.2 Supplemental Petroleum Credit

This credit is rated marginally satisfactory. As reported in the PSR 7, the major objective of retaining macroeconomic stability was achieved. However, during an IMF mission in the last quarter of 2002, the Government announced that counterpart funds worth half the credit amount had not been used by Government as had been intended (either for the repayment of debt of the petroleum company or to help ease the price increase for consumers). Instead, it had been used for reducing the budget deficit.

4

The real exchange rate appreciated by 10 % during 2001.5

IMF article IV in September 2002.

- 12 -

6

The initial sales price was US$ 83 millions; actual payments totaled only around US$ 35 millions.7

Air France; Air Austral; Air Mauritius; Corsair; Comores Air Service and Interair.8

As of December 1998, the four companies are Sacel, Antaris, Madacom and Intercel.

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:Several exogenous shocks impacted on the reform program. First, a strong increase in oil prices impacted on the goal of price stability. Second, the cyclones of April 2000 caused considerable damages, higher import needs and lower export receipts. Both external shocks required supplemental credits. Third, the September 11, 2001 events considerably affected Air Madagascar's prospects of finding a suitable buyer. This necessitated a restructuring of the reform condition.

5.2 Factors generally subject to government control:Firstly, the selective lack of commitment of the client hindered proper implementation of some anticipated reforms, including the reforms in social expenditures management and those of the revenue policy. Secondly, the major obstacle to implementing the program was the political and economic crisis in 2002: the country was paralyzed and no activities could take place for six months. The country experienced a reversal of progress made with respect to growth and poverty reduction. Thirdly, difficulties in clarifying assets delayed considerably the privatization process at the initial stages of the operation.

5.3 Factors generally subject to implementing agency control:see 5.2

5.4 Costs and financing:n.a.

6. Sustainability

6.1 Rationale for sustainability rating:6.1.1 The nature of the measures adopted under SAC II and the commitments of the new Government suggest that several of the most important reforms are likely to be sustainable. Reforms implemented during the operation gave impulse to important changes in the economy.

6.1.2 Madagascar has taken important steps in reforming its economy as evidenced by the disengagement of the State from key sectors, leaving more room for the private sector and ensuring better governance. Civil society is now more involved in the development process and participates actively in policy-making. Reforms of public financial management and public expenditures, particularly in the social sectors, become of paramount importance. Monitoring and control of public funds and tracking poverty-reducing public expenditures are receiving particular attention in the context of HIPC. Actions are currently taken by the Government to improve state accountability and public spending efficiency with the assistance of donors.

6.1.3 The new authorities are now carrying out important reforms, showing willingness to reform beyond their obligations under the credit restructuring of 2002. As regards liberalization, the Government recently announced the concessioning of two main airports and re-launched the granting of industrial and tourist zones. This type of policy had been extended to the railroad company and the main ports in Madagascar. These initiatives, with the progress achieved in streamlining administrative procedures and the continuing reforms in the judiciary sector, are positive signals to the private sector. They are likely to consolidate favorable conditions for sustained growth.

- 13 -

6.2 Transition arrangement to regular operations:A new assistance strategy of the Bank in the coming years will build on many of the reforms completed under SAC II and it will pay particular attention to helping Government improve financial management and fight corruption. The program will help Madagascar further reform its justice system and public financial management, particularly with respect to oversight and control.

7. Bank and Borrower Performance

Bank7.1 Lending:7.1.1 SAC II was designed by Government and the Bank during a period of growth resumption where certain reforms, commenced and focused on under CAS I, were bearing fruit, and the urgency to complete the set of first generation reforms was imminent.

7.1.2 The Bank and Government agreed that a number of actions would be necessary preceding credit effectiveness. While this requirement provided important impetus to keep the reform agenda moving, it also led to a delay in effectiveness of the operation by one year. In hindsight, it might have been more advisable to make the required (and well-selected) actions conditional for Board presentation of the credit. The Bank provided the Government with needed financial support to maintain the reform program on track despite several external shocks (supplemental credits).

7.1.3 The innovative floating tranches/menu-based program was an interesting lending instrument. It helped the Government implement the heavy package of structural measures and provided much flexibility for the disbursement of the second (floating) tranche. It had little impact on reaching third tranche disbursement, though, as – by design – the borrower was to complete the totality of reforms described in the credit agreement.

7.2 Supervision:The implementation of reforms was closely supervised by the Bank. In correctly recognizing the complexity of the operation, in maintaining constant dialogue with the borrower and in displaying a certain degree of flexibility, the Bank helped support implementation of the reforms. However, the reform program supported under this credit was large and – in comparison with other structural adjustment credits – also quite difficult. While supervision was intense and permanent (especially since the task manager was based in the field office), it invariably led to several actions being taken without appropriate follow-up from the borrower or the Bank. For example, the action plan for the judiciary sector was submitted (and therefore a disbursement condition fulfilled) but in the following, the Government did not implement the action plan (even after the crisis ended). Similarly, while the unit of revenue policy had been created (and credit conditionality fulfilled), the unit did not work in the desired way thereafter. It was dismantled during the restructuring in the Ministry of Finance after the crisis. After the completion of the disbursement conditions, supervision necessarily had to shift to remaining reforms and hence did not follow-up appropriately on the continuation of earlier reforms.

7.3 Overall Bank performance:Overall Bank performance is satisfactory. Some risks for the operation were appropriately assessed at entry and mitigated throughout implementation. The Bank showed flexibility in implementation, employing supplemental credits in the presence of external shocks and approving waiver, when necessary, to keep the – perhaps overly ambitious - reform program moving forward. Constant policy dialogue from the field office provided frequent feed-back to the borrower. Coordination with other donors was very intense and is judged good.

- 14 -

Borrower7.4 Preparation:The Government took several actions which conveyed strong messages of its willingness to transform the economy along the lines of SAC II proposed reforms. Such actions included for instance the preparation of the privatization of the three State-owned companies as early as 1998 (MoP para 27). Borrower commitment was also manifested by the request of Government, during the last phase of negotiations, to add the telecommunications company TELMA to the list of companies to be privatized under the reforms.

7.5 Government implementation performance:7.5.1 Borrower implementation performance was not homogenous across the different supported reforms. Ownership was lacking in the initial stages of air transport reform and in implementation of the agreed measures to improve social expenditure allocation and revenue collection. Here, the Government focused only on complying with the agreed actions rather than the intended spirit of the reforms. Additionally, the reconstruction strategy after the passage of the cyclones in 2000 was not implemented as agreed.

7.5.2 However, this relatively weak performance in a few areas has to be balanced against: (i) the overall achievement until 2001, given the limited time frame, the breadth of the wider reform program and the high demands imposed on the scarce and weak capacity within the public sector for leading and managing reforms; (ii) the renewed progress on the reform agenda following the political crisis in 2002; and (iii) the commitment of the new authorities to carry-out some of the initial reforms which were dropped after credit restructuring.

7.6 Implementing Agency:see 7.5

7.7 Overall Borrower performance:The Government performance was satisfactory. The rating reflects the Government’s implementation of the prior actions which conveyed message of commitment and ownership, and implementation during the operation, including Government's willingness to reform the economy beyond the agreed measures within SAC II framework.

8. Lessons Learned

8.1. Growth remains an essential and indeed central ingredient in any realistic poverty-reducing program. However, it does not necessarily lead to widespread poverty reduction and progressive distribution. Madagascar, during the time period observed, is a good example of this phenomenon. To achieve pro-poor growth requires not only a concern with accelerating economic growth, but also the existence of an efficient mechanism of service delivery for those that are bypassed by this growth. Unless the growth poles themselves reach the majority of the poor, such a mechanism is needed.

8.2 Policy based lending, coupled with floating tranches, gives flexibility to the borrower but it runs the risk of engaging the borrower in too many parallel reforms. Flexibility is necessary when the package of structural measures requires a very high level of political commitment. When the package of measures is overloaded, though, prioritization becomes difficult as well as effective monitoring of reform progress.

8.3 The Bank should not make the transfer of assets a privatization conditionality for tranche disbursement under structural adjustment loans. Linking the privatization to the transfer of assets bears the risk of exerting an undue pressure and putting the Government in a weaker bargaining position. In Madagascar, such pressure was present in the privatization of SOLIMA as a condition for first tranche release of the Second Structural Adjustment Credit. With signaling effects for

- 15 -

private investors achieved through a number of Government actions, including the privatization of the SOLIMA, the Bank consequently approved a waiver to the asset transfer condition of TELMA, the telecommunication company, linked to the second tranche disbursement. The new conditionality required Government only to invite the winning bidder to negotiate and not the actual transfer of assets.

8.4 Supplemental credits to adjustment operations that provide needed balance-of-payments support can be important tools to maintain the reform program on track. However, if they are linked to specific Government expenditure measures (as was the case with the cyclone emergency credit for Madagascar), they might not be the best financing instrument as Bank influence on reaching the stated objectives are minimal due to the nature of adjustment support. Only in cases where programmatic lending through budget support operations has a proven good record should such supplemental credits be considered.

9. Partner Comments

(a) Borrower/implementing agency:see Annex 14

(b) Cofinanciers:n.a.

(c) Other partners (NGOs/private sector):n.a.

10. Additional Information

- 16 -

Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome / Impact Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

1. Increases in foreign direct investment as a share of GDP

1.7 % of GDP (2001) 2.0 percent of GDP (2001) -- strong decline during crisis

2. Increase in private investment (with public/private investment ratio declining)

ratio 0.9 in 2001 ratio 0.6 (2001); annual priv. invest. growth 8 percent until crisis;

3. growth increases to levels above 5 % by 2001.

growth of 5% by 2001 6.0 (2001) but collapse in 2002 (-12.7)

4. Poverty reduction. not specified 69% (2001) but increase to 75 % (2002) during crisis

5. Sector objective telecom: penetration numbers increase significantly

0.90 (2001) 1.30 (2002), including mobile phones

6. Sector development objective Petroleum: investment level in distribution stations

US$1.3 million US$12 million (cumulative 1999 to 2002)

7. Sector Development Objective: Air Transport -- passenger prices

freight prices

20 % decline not achieved. Fares increased (to be confirmed in ICR)

unchanged

Output Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

1. Banking privatization completed Completed 11/24/1999

2. Privatization of all petroleum lots distribution lots: June 2000; logistics: fall 2001. Several small lots not privatized.

3. TELMA privatized Provisional adjudication: Dec 2001. Expecting final sale: last semester of 2003

4. Air Madagascar privatized (in restructuring: reformulation -- management contract entered)

May 2002: management contract with Lufthansa

5. New fishing license system in operation system operated successfully since 2000

6. New Mining Code and Large Mining Law Mining Code (2000) and Law (2002) in effect

7. Audits of social security institutions completed

not achieved. Reform replaced Sept 2002

8. Tourist and industrial zones offered to private developers

not achieved. Reform replaced Sept 2002

1 End of project

- 17 -

Annex 2. Project Costs and Financing

Not applicable

- 18 -

Annex 3. Economic Costs and Benefits

- 19 -

Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/PreparationDecember 1998 7 (1) Country Director

(1) Resident Representative (1) Sector Manager (1) Task Manager (1) Mining (1) Fisheries (1) Public Sector Reform

S S

SupervisionJuly 1999 2 (1) Task Manager

(1) EconomistS S

November 1999 3 (1) Task Manager (1) Fisheries (1) Economist

S S

March 2000 6 (1) Task Manager (2) Economists (1) Privatization (1) Procurement (1) Operations

S S

March 2001 10 (1) Team Leader (3) Privatization (1) Cyclone Reconstruction (1) Sr Counsel Lawyer

S S

06/19/2001 9 (1) Team leader (1) Public Sector Reform (2) Privatization (1) Mining (2) Cyclone Reconstruction (1) Judicial Sector Reform (1) Social Expenditures

S S

09/17/2001 4 (1) Team Leader (1) Privatization (1) Cyclone Reconstruction (1) Economist

S S

11/23/2001 6 (1) Team Leader (1) Public Sector Reform (1) Privatization (1) Cyclone Reconstruction (1) Judicial Sector Reform (1) Mining

S S

ICRDecember 2002 3 (1) Team Leader

(1) Economist (1) Consultant

S S

- 20 -

(b) Staff:

Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation N.A. 181.08Supervision 101 350.51ICR 32 45Total

- 21 -

Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

- 22 -

Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

- 23 -

Annex 7. List of Supporting Documents

1. President's Report on Madagascar - Second Structural Adjustment Project

2. President's Report on Madagascar - Second Structural Adjustment Credit Project - Supplemental Credit

3. Aide-memoires and PSRs (in project files)

4. Development Credit Agreement (Second Structural Adjustment Credit) Cr. 3218-MAG

5. IMF Article IV 1999 - 2002

- 24 -

Additional Annex 8. Ratings of output components and achievements of objectives

OBJECTIVES/ OUTPUTS Highly Satisfactory

Satisfactory MarginallySatisfactory

Unsatisfactory Highly Unsatisfactory

Macroeconomic Stabilization XPrivatization Air Madagascar (restructured) X SOLIMA X TELMA X Private Sector Development Liberalization X Mining X Judiciary sector and Business environment X Fishery-Forestry X Public Finances Monitoring progress in social expenditures X Anti-corruption measures X Strengthening revenue policy X Public Financial Management X

OBJECTIVES/ OUTPUTS Highly Satisfactory

Satisfactory MarginallySatisfactory

Unsatisfactory Highly Unsatisfactory

Supplemental Cyclone Credit XSupplemental Oil Credit X

- 25 -

Additional Annex 9. Comparison of selected Macroeconomic Indicators;

Projections (MOP) and Actuals (ICR)

Percentage of GDP 1996 1997 1998 1999 2000 2001 2002 (Est.)GDP growth MOP

ICR-

2.1-

3.7-

3.94.54.7

5.34.8

5.66.0

--12.7

Fiscal Deficit b.g10

MOPICR

-9.1

-7.7

-8.1

5.84.8

4.64.2

4.5 7.4

-8.7

Tot. gov. Revenues b.g

(Tax revenue)

MOPICRICR

-8.78.5

-9.79.4

-10.69.8

11.811.411.0

13.011.711.3

13.7 10.09.6

-7.36.9

Total gov. exp. MOPICR

-17.8

-17.4

- 18.8

17.716.2

17.715.9

18.3 17.3

-15

External CAB (excl. Net official transfers)

MOPICR

--7.9

--7.7

--7.9

-7.3-6.6

-6.8-6.5

-6.6-2.0

--5.8

Annual Inflation (year-on-year basis.)

ICR 8.3 4.8 6.4 14.4 8.7

4.8 12.0

Net domestic credit Government Economy

-1.01.3

3.36.7

20.10.4

6.33.1

2.89.2

10.56.1

9.13.0

Memorandum itemsMillions of SDRs

Exports of goods and NFS

360.6 366.7 382.6 425.9 628.5 757.9 406.0

Imports of goods and NFS 444.0 495.6 495.5 548.2 707.1 746.3 497.3

Millions of SDRsOverall Balance -76.8 19.7 - 126.6 -9.9 -82.3

21.1 11.2

Gross official reserves (Weeks of goods and NFS)

12.3 14.0 7.8 9.8 10.2 14.4 13.6

Mgf/SDR (period average)

5887.2 7013.6 7381.7 8585.8 8934.0 8385.8 8804.8

Mgf/US.Dollar(period average)

4061 5091 5441.4

6283.8 6773.3 6587.2 6696.2

ToT(YR 84=100) ($US/LCU)

171.8 158.1 143.6 150.2 157.8 161.3 -

Billions of MgfNFA 1043.4 1492.7 1091.1 1532.0 1866.9 2644.1 2651.1

10 B.g: before grants, commitment basis, excluding cost of structural reforms and excluding change in arrears.

- 26 -

Additional Annex 10. Policy/Measure Intermediate/Output

Conditions in the Original DCA Amendments to the condition in December 21,

2001

Amendments to the condition in September 24,

2002

Status of reforms

Actions prior to Board Presentation (in the MoP)

(i) To sign a sales protocol for BTM;

None None Met

(ii) To make changes in the budget nomenclature in order to match Budget Law and Treasury accounting ;

None None Met

(iii) To adopt an Arbitration Law; None None Met(iv) To publish inter-connection decree between fixed and cellular operators;

None None Met

(v) To approve a mining code, in agreeable to IDA, by the council of Ministers, precluding the state from participating in productive activities and limiting its role to promotion;

None None Met

(vi) To increase license fees by 100 percent in 1999 relative to 1998, and prepare a report on actual and potential payments per firm. To commit to the introduction of a transparent, non-discretionary, and competitive mechanism for the allocation of fishing licenses before the fishing campaign of the year 2000. To limit the number of licenses in the west coast to a total of 69 industrial and 36 artisanal, and to 6 industrial licenses in the east coast (until completion of a sustainability study), respecting the 1998 distribution of authorizations per zone and boat for each firm.

None None Met

Effectiveness

(i) to reduce the state participation in the petroleum sector to 30%;

None None Met. The petroleum sector is now operated by the private sector

(ii) with respect to SOLIMA’s non-oil operations, to conclude contractual arrangements aimed at transferring the ownership/use of the said operations to private sector entities;

None None Partially metFor some non-petroleum, no contractual arrangements were done.

- 27 -

(iii) to set up a regulatory body and a regulatory framework;

None None Met. The regulatory body (OMH) now is fully operational

(iv) to adopt a methodology to compute severance payments.

None None Met

Second Tranche

CORE CONDITIONS(i) To sell at least 34% of the voting stock of TELMA to a qualified and experienced private investor or a group of investors;

Changed: Receipt of letter inviting the winner of the bid for negotiations

None Met. Sales protocol and signing contract on track

(ii) to set up a regulatory body and a regulatory framework.

None None Met. The regulatory body is fully operational

SIDE CONDITIONS(i) Revenue Policy: to establish a Unit dedicated to monitoring of public revenue through the collection, analysis and dissemination of all relevant data pertaining to public revenues, with adequate budgetary and human resources and shall have established within the said unit a cell to be responsible for formulating medium and long-term fiscal policy under terms of reference satisfactory to the Association.

None None Not metUnder the activities of a Tax IDF project, a Technical Unit on Revenue Monitoring was created in the Ministry of Budget in March 2001. A report was transmitted to IDA on tax collection trends in September 2001. A division in the unit was responsible for formulating medium and long term fiscal policy but no activity has been reported. After the political crisis the technical unit was dissolved. No activity has been reported so far

(ii) Social sector expenditures: (a) to establish an appropriate monitoring system to capture the implementation of the Borrower’s social policies and expenditures actually incurred for primary education and basic health with respect to the specific budget items and sectoral policies specified in paragraph 24 of LDP, and; (b) to carry out a survey based on a methodology aimed at assessing the Borrower’s performance in the delivery of primary education and basic health services within its territory.

None None Partially metA timely monitoring system for the social sectors was put in place. In September 2000, INSTAT carried out a tracking survey to analyze the proportion of recorded budget flows reaching primary schools. However, actual expenditures reaching the rural schools and health posts is unsatisfactory due to the absence of corrective measures

(iii) Enabling business environment

- 28 -

(a) on the basis of the results and recommendations of its ongoing study, based on a study (Etude sur les lenteurs de la procédure judiciaire), to adopt an action plan to improve caseload management within the judicial system and achieve substantive progress in the execution of the said action plan;

None None The study was done and the action plan was approved. However, the Government did not take steps to achieve progress in the action plan. Early measures were taken by the Government in line with the action plan though.

(b) on the basis of a consultative process involving all interested parties, to adopt an action plan for the purposes of streamlining formalities and procedures required to carry out economic activities and achieve substantive progress in the execution of the said action plan;

None None Met

(iv) Mining

(a) to enact a revised Mining Code, including implementation decrees;

None None Met

(b) to adopt a new and transparent allocation of mining licenses.

None None Met

Third Tranche

CORE CONDITIONS

(i) To sell at least of 65% of the voting stock of Air Madagascar to a qualified and experienced private investor or a group of investors;

None Changed: to establish a performance-based management contract for the management and restructuring of Air Madagascar

Met. No backtracking

(ii) to set up a legal and regulatory framework aimed at promoting a business environment amicable to private sector investments, by having revised, inter alia, in form and substance satisfactory to the association, the laws and regulations;

None None Met

(iii) to establish air transport regulatory authority with functions, membership, budgetary resources and adequate staffing satisfactory to the association.

None None Met

SIDE CONDITIONS

(i) Fishing Licenses.

- 29 -

(a) to establish an appropriate system, satisfactory to the Association, to allocate shrimp fishing licenses in a non-discretionary, competitive and transparent manner;

None Clarified. A similar system was to be implemented for the forestry sector

Met. In addition, for the forestry sector, the Government published the names of al license holders and the location of their exploitation in newspapers

(b) to adjust annual shrimp fishing fees for licenses granted for the 1999 fishing campaign in accordance with the methodology adopted as a result of the revamped licensing system referred to above;

None None Met

(c) to carry out the recommendations resulting from the technical and financial audits of the FDHA.

None None Financial audit of the FDHA was done. No steps have been taken to proceed with the action plan

(ii) Liberalization

(a) Grant two airport concessions to qualified and experienced private operators under contractual arrangements satisfactory to the Association;

None Dropped The Government is carrying-out the reform

(b) invite telecommunications operators to bid for a license to provide telecommunication services within the Borrower’s territory;

None Dropped (but the Bank has reserved the right to call for a second national operator in case the winning bidder for TELMA will not carry through announced expansions of the network, especially in rural areas)

Privatization on track

(c) enact a law governing the fiscal regime of mining projects whose investment costs are estimated to exceed 1 trillion Mgf;

None None Met

(d) implement decrees required to give full effect to the law referred to in form and substance satisfactory to the Association;

None None Decree is to follow

(e) to invite airport operators to bid for the concessioning of at least two airport infrastructure within the Borrower’s territory.

None Dropped The Government is carrying out the reforms

(iii) Financial Sector Reforms. (a) to None Changed: (i) Audit of the insurance

- 30 -

carry out the financial, organizational and actuarial audits through independent consultants for the insurance companies Ny Havana and Aro, and the social security funds CNaPS, CRCM, and CPR; and (b) to adopt an action plans to improve their performance.

anti-corruptions actions (establishment of an anti-corruption task force; passage of a legislation requiring all ministers, senior officials and judges to regularly declare their assets and those of their close relatives); (ii) measures to strengthen public financial management (completion of a report on the overspending of Special funds credits in 2001; an action plan to prevent any possibility of such overspending in the future; legislation mandating regular audits of all special funds by the Chambre de Compte; a merger of the Budget and Finance ministries)

companies are completed. Audits of the social security companies were not completed. No steps have been taken so far to implement the reforms Revised conditions were all implemented. No backtracking

(iv) Land tenure:

(a) Granting of five tourism and five industrial zones and invitation to bid for the zones;

None Dropped The Government is carrying-out the reforms

(b) Introduce modifications to improve the functioning of the bail emphytéotique (long term land lease): fraction payment of registration fees to make the process less expensive,and publish a guide/procedures manual.

None Dropped A decree notified the creation of the Guichet Unique for granting of a bail emphytéotique in 1998 and payment by installments of the tax relating to the bail emphytéotique (decree 99-032) was adopted. A manual of procedures was published to clarify the allocation process and the Guichets Uniques were set up

- 31 -

Additional Annex 11. Results of the replication of WDR surveys

Methods10

A descriptive analysis and the multifactorial analysis methods (AFC: Factorial Analysis of Correspondence) were used to derive the conclusions of the surveys. The descriptive analysis gives a global description of the survey’s results while the multifactorial methods allow to obtain graphic representations, which constitute the best summary of the information in the database.

Individuals contributing to an axis are mainly those who are at the extremities. An individual's angle is on the factorial plan is null and the cos ² equals to 1. On the contrary, an orthogonal individual in each of the axes of the factorial plan will have a cos ² null. All the individuals occupying intermediate positions between these two extremities will have a cos ² between 0 and 1. The closer the cos ² to 1, the better the individual is represented by its projection on the plan. Two points are said in positive correlation if they

form an angle, of which cosine is between λ and 1 (λ = < 1) whereλ is the constant from which there is a correlation (often superior to 0.60). They are negatively correlated, should the opposite occur (cosine

between 1 and λ , λ > = -1).

§ Analytical Approach

var4

1

var40-1 0 1

-1

0

1

quest1nd

quest1squest1as

quest2nd

quest2s

quest2as

quest3ou

quest3no

quest3ne quest4ou

quest4no

quest4aa

quest5nd

quest5as

quest6ndquest6s

quest6as

quest7ou

quest7as

quest7pa

quest8pe

quest8su

quest8pa

quest9au

quest9co

quest10o

quest10p

quest10n

According to the graphic, trust in justice (question 7) and satisfaction with respect to Government’s actions in its effort to improve business environment (question 1) are positively correlated to satisfactory law enforcement (questions 4), better transparency and the predictability of laws governing business (question 5) as well as the quality of access to the information on administrative procedures (question 2).

- 32 -

Investors’ decision to invest and stay in Madagascar does not have a clear relationship with all other questions but is rather dependent of the other motives mentioned in the question 11 (concerns).

Results

QUESTIONS Abbreviation Frequency Percentage yes/no total in %

Question 1 1 Do not agree quest1nd 10 35.64 35.64 1001 Satisfactory quest1s 5 2.56 64.361 Satisfactory enough quest1as 22 58.971 Entirely Satisfactory quest1es 1 2.83

Question 2 2 Do not agree quest2nd 21 56.41 56.41 1002 Satisfactory quest2s 5 12.82 43.592 Satisfactory enough quest2as 11 28.212 Entirely Satisfactory quest2es 1 2.56

Question 3 3 Yes quest3ou 25 66.67 66.67 1003 No quest3no 6 15.82 15.823 Do not know quest3ne 7 17.51 17.51

Question 4 4 Yes quest4ou 1 2.57 35.9 1004 No quest4no 13 33.334 To improve quest4aa 24 64.1 64.1

Question 5 5 Do not agree quest5 nd 19 48.72 48.72 1005 Satisfactory quest5s 7 17.95 51.285 Satisfactory enough quest5as 6 15.825 Entirely Satisfactory quest5ees 0 05 Entirely agree quest5ea 7 17.51

Question 6 6 Do not agree quest6nd 15 38.46 38.46 1006 Satisfactory quest6s 14 37.95 61.546 Satisfactory enough quest6as 8 21.036 Entirely satisfactory quest6es 1 2.56

Question 7 7 yes quest7ou 12 30.77 51.28 1007 enough quest7as 8 20.517 Not at all quest7pa 19 48.72 48.72

Question 8 8Little quest8pe 15 38.46 38.46 1008 Enough quest8su 4 10.26 10.268 Not at all quest8pa 19 51.28 51.28

Question 9 9 No effect quest9au 8 20.82 20.82 1009 Positive effect quest9ef 12 30.46 30.469 High cost quest9co 19 48.72 48.72

Question 10 10 Yes quest10o 12 30.88 30.88 10010 Wait-and-see phase quest10p 17 43.59 43.5910 No quest10n 10 25.53 25.53

The actions of the government had a positive impact on private sector’s activities for 64 % of interviewees: (i) regarding laws governing business in Madagascar, 51 % think that they are transparent and predictable; (ii) procedures for business creation and granting of visas and work permits are flexible for 62%; (iii) 51,28% of interviewees think that laws are more transparent, predictable and clearer, and; (iv) law enforcement can be improved for 64%. These results are correlated to better investor’s confidence in justice with respect to property rights, defense of their interests and regulation of commercial disputes

- 33 -

(51 % of interviewees).

However, involvement of investors in the definition of business regulation policies is not satisfactory according to 51% of interviewees. In light of the correlation between the variables, it appears that it depends on their access to the information on (unsatisfactory for 56% of inteviewees) and frequent changes in administrative procedures (66% of interviewees).

Conclusion

Reforms in justice and business environment were successful in improving State’s credibility. They resulted in better trust of investors to the Malagasy justice and improved their perception of the business environment in Madagascar. However, effort should be put in inviting the private sector to participate in policy-making. Further, information should be systematically disclosed to the general public. State’s credibility can also be improved by giving impulse to reduced changes in the administrative procedures to carry-out business. Indeed, they are still in constant fear of policy surprise and have to cope with unexpected changes in rules and policies – which is due in a large part to little private sector involvement in the state’s decision making process. Corruption increases the cost of private sector’s activities. The results of the survey indicated that efforts achieved in the past must be sustained and deepened to improve investors’ perceptions, which themselves directly determine investment behavior.

10The surveys were launched in January 2003. Out of 183 enterprises only 43 filled out the questionnaires.

- 34 -

Additional Annex 12. Income Poverty Developments 1997-2001 (Headcount Index %)

1997 1999 2001Poverty National (MoP)

11

National Urban Rural

7573.363.276.0

74.071.352.176.7

72.069.250.074.9

Extreme Poverty National Urban Rural

63.154.065.6

61.743.267.0

61.142.566.5

11 As of 1998.

- 35 -

Additional Annex 13. Output indicators discussed during the review meeting

with line Ministries and STA

TARGETS ACTUALS 2001Privatization and Sector Liberalization

Telecommunications Penetration number increases from 0.37 in 1999 to 0.90 in 2001

1,30 for the sector (including cellular phone networks) Telma standing alone : 0,38

Number of line per employee increase from 15 in 1999 to 35 in 2001

24 (Telma)

Waiting period for fixed line declines from 7.5 months in early 1999 to 4 in 2001

Telma: 1 week on non-saturated area, otherwise might be 2 months

Cost of calls Antananarivo Paris decline by 10% between early 1999 to 2001

Full rate 11 250 Mgf/mn in 2002 vs 15 000 Mgf/mn in 1999

Air Transport Round-trip passenger ticket Antananarivo-Paris (tourist class, APEX fare) declines by 20% between early 1999 and 2001

Unmet(1999: 6,500,000 Mgf2001: 6,916,500 Mgf equivalent US$ 1,050 average exchange rate 6,587.2 in 2001

Cost of freight per pound Antananarivo Paris declines by 10% b/w early 1999 and 2001

Cost of freight did not change (-45 kg - 7,70 USD/kg); (+45kg - 5,80 USD/kg)

Cost of freight per pound between Antananarivo-Johannesburg declines by 10% b/w early 1999

Cost of freight did not change(-45kg - 1,95 USD/kg); (+45 kg 1,47 USD/kg; (+100 kg1 -26 USD/kg); (+1T 0,88 - USD/kg)

Petroleum Distribution

30% increase in investment level in the distribution network between early 1999 and 2001

Estimate of investments amounted to Mgf 77,260 billion equivalent of 12 millions USD for gas and petroleum distribution.

50% of service stations in the country meet international standards by 2001

Met

Side Conditions

- 36 -

Mining Sector Mining authorization under exploitation as a share of total authorization increases from 25 to 50%

Not available due to lack of data at the level of central Ministry of mining

Fisheries Shrimp share in sector declines from 90% to 80%

Shrimp share represented 73% of exports in 2000 and 2001

Land tenure Total number of bails issued increase 100% in Antananarivo, Antsiranana and Tolagnaro between 1999 and 2001

Overall target unmet (0 in Antsiranana)

Foreigners share in total bails issued increases from 0 to 20%

Met 58% (100% in Antananarivo with 5 out of 5 bails issued between 1999 and 2001 for foreigners; 2 out of 7 in Tolagnaro)

At least one tourism and industrial zones is being developed

Unmet

Enabling Environment

Replication of WDR surveys show greater overall satisfaction

Overall satisfactory (see annex 11).

Monitoring Progress in Social sectors

Actual recurrent non-salary expenditures for primary education and health increase from 80% in 1997 respectively to a minimum of: 90% in 1999, and 98% in 2000 for both sectors

Actual recurrent non-salary expenditures for primary education and health increase from 80% respectively to 93% and 81% in 2000

Community schools begin to receive government expenditures, and mostly for rural schools

No community school received direct support during the operation

Actual cost recovery, introduced in 1998, increased from Mgf 20 billion in 1998 to Mgf 50 billion in 1999 and 100 billion in 2000

Actual cost recovery increased up to Mgf 27 billion in 2000. Data for 2001 is not available.

Revenue Monitoring and Policies

Actual customs collection, common regime, increase from 75% to 90% of the theoretical share; the suspensive regime’s share in total imports declines from 50% to 40%

Ratio of actual/projected customs collection were 84% in 2000 and 74% in 2001; the share of suspensive regime is unknown.

Audits (Insurance companies and Social security fund)

Action program discussed and agreed with IDA based on audit recommendations

Partially met. Audits of insurance companies completed. Audits of social security funds were not completed

- 37 -

Additional Annex 14. Performance of the tourism sector

1996 1997 1998 1999 2000 2001Number of jobs 11103 11318 11655 12640 13628 14010Foreign exchange earnings (million of SDRs)

44.6 52.9 65.5 72.9 91.9 90.2

Number of visitors 82,681 100,762 121,207 138,253 160,071 170,208Hotel supply 451 482 556 644 695

- 38 -

Additional Annex 15. Adjustment Dialogues and Timeline of Events

SAC I timeline of EventsSingle Tranche release of SAC IClosing Date for SAC IICR for SAC I

AprilDecember

April

199719981999

SAC II preparationGovernment request for SAC IIBoard Approval of SAC IIEffectiveness of SAC II

MayJune

19992000

Releases of SAC II tranchesFirst tranche releaseSecond tranche releaseThird tranche release

JulyJanuaryOctober

200020022002

Project Restructuring ApprovalSupplemental Cyclone CreditSupplemental Oil CreditOne-year extension of SAC IISAC II restructuringClosing date for SAC II

JulyDecemberOctober

SeptemberDecember

20002000200120022002

Disbursement of project restructuring Supplemental Cyclone Credit 1st tranche 2nd trancheSupplemental Oil CreditSAC II restructuring

SeptemberJulyJune

October

2000200220012002

IMF programs1st PRGF arrangement2nd PRGF arrangement

November March

1996 2001

- 39 -

Additional Annex 16. Government's Contribution

- 40 -

REPOBLIKAN’I MADAGASIKARATanindrazana – Fahafahana – Fandrosoana

-------

EVALUATION OF THE SECOND STRUCTURAL ADJUSTMENT CREDITBORROWER'S EVALUATION

-------

1.- After a break in relations for a few years stemming from a change in political direction in Madagascar, the resumption of these relations by the Government with the Bretton Woods institutions took the form, in 1996, of an Enhanced Structural Adjustment Facility (ESAF) agreement with the International Monetary Fund (IMF) and the first Structural Adjustment Credit (SAC I), approved by the World Bank. The economic recovery program, supported by this assistance, allowed the country to resume and strengthen efforts to achieve the structural adjustment and macroeconomic stabilization efforts that were started in the 1980s. Despite a delay noted with respect to a number of measures, particularly in the area of the privatization of public enterprises, as a result of a busy schedule of electoral activities in 1997 and 1998, overall, the objectives of program were achieved or even surpassed, including the macroeconomic objectives. Encouraged by this success, the Government and the World Bank decided to execute a Second Structural Adjustment Credit (SAC II). Adopted in 1999, the Credit Agreement for an initial amount of US$100 million and disbursable in three tranches of US$25, 30, and 45 million, respectively, was closed on December 31, 2002. In the interim, two supplemental credit agreements were signed to complement the SAC II: a credit for US$30 million to enable the country to cope with the 2000 oil shock, and another amounting to US$20 million to rebuild the economic and social infrastructure affected by three cyclones in the northern part of the country in 2000. The purpose of this note is to provide the Government's assessment of the impact of the SAC II and its supplemental credits.

2.- Although in general terms the credit was granted to assist with the recovery of the national economy by providing balance of payments and public finance assistance, it was linked, first and foremost, to the implementation of a program that can be placed into three categories:- Macroeconomic stability: the program supported by the SAC II did not set forth specific objectives; an agreement concluded with the IMF was treated as guarantee of macroeconomic stability;- Privatization of public enterprises. This key measure provides for the privatization of a major public enterprise per tranche. The three companies identified were SOLIMA (distribution of petroleum products), Air Madagascar (airlines), and TELMA (telecommunications). These three enterprises are mentioned in Decree 97-584, which lists the enterprises to be privatized.- Eight additional measures, four of which were linked to the development of the private sector and four, to public finance. The release of the second and third tranches was contingent on execution of four of these eight measures.

However, a number of measures contained in the SAC I had to be finalized even before submission of the credit agreement to the Board of Executive Directors of the World Bank. These measures (six), had to be carried out in 1999 and included, among others, the privatization of the last public bank, the BTM, which was provided for in the SAC I, but was not finalized until 1999 because of the need for a second round of bidding caused by the withdrawal of the first successful bidder for the contract.

3.- The SAC II, as designed, was very ambitious and was supposed to serve as a catalyst for the economic and social development of the country. The three enterprises to be privatized as part of the SAC II are among the four biggest state-owned enterprises, while additional measures were supposed to increase

- 41 -

significantly the percentage of private investment and improve the public finance situation by increasing revenue (the tax rate in Madagascar is one of the lowest in Africa) and improving the management of public expenditure. Apart from underestimating the problems linked to the privatization of each company as well as the 2002 political crisis, which could not be anticipated at the time of the signing of the agreement, it must be acknowledged that execution of the entire program over a three-year period was very ambitious and very optimistic. However, as we will see below, the good results obtained in 2000 and 2001 are largely attributable to execution of the measures recommended in the SAC II.

Macroeconomic stability

4.- The policy of openness and development of the private sector supported by the reforms as part of the SAC II process has fostered the expansion of enterprises and an increase in their contribution to GDP formation. In 2001, economic growth stood at 6 percent. 2002 was an unusual year because of social and political unrest linked to electoral conflicts. At the same time, inflation slowed as a result of competition and sound management of monetary policy. Overall, criteria related to the money supply and its counterparts, in this case government net loans, were followed in virtually all cases because of the control exercised over public expenditure. There has been an upward trend in tax revenue although the objectives were not always met. Tax reform, in particular reform of the VAT, as well as strengthening of the oversight and auditing mechanism proved to be efficient, given the strong performance in the area of domestic taxes. This trend has had an effect on tax collection over the past three years. Consequently, the government deficit (commitment basis) averaged 1.8 percent of GDP between 1999 and 2001, compared to 4.7 percent in 1998. The events of 2002 had a major negative impact on public finance. Provisionally, the deficit has been estimated at 4.9 percent of GDP. However, much work remains to be done. First, the fiscal structure needs to be stabilized, inasmuch as it is the driving force behind private sector development. After this, more emphasis needs to be placed on expanding the tax base and less on increasing rates. The effectiveness of general taxes and their widespread application is thus essential. Efforts have been made in this area, in particular with respect to awareness-building among taxpayers and the preparation of manuals that target them. The integration of Madagascar into the different regional cooperation groups has led to a decline in foreign taxes. Although the entities responsible for the harmonization of regional provisions with national policy are working in this area, it is essential for capacity to be strengthened. The liberalization of exports coupled with the effects of diversification and the reduction in taxes have brought the value of exports from an average of SDR 604 million in the 1999-2001 period to 383 million in 1998. This was reflected in an improvement in the external current account balance and a significant restructuring of foreign exchange reserves representing the equivalent of 11.5 weeks of c.i.f. imports between 1999 and 2001, compared to 7.8 weeks in 1998. Privatization

5.- In light of the fact that implementation of the privatization program had been delayed and involved, until that time, only "small" companies, the World Bank suggested that the privatization of three of the biggest companies in Madagascar, namely SOLIMA, Air Madagascar, and TELMA be established as a key measure in the SAC II. It is up to the Government to indicate which company will be associated with each tranche. If, in the absolute, the privatization of these three major companies was intended to demonstrate the willingness of the Government to withdraw from the productive sector and concentrate only on its essential missions; the reality is that, aware of the Government's desire for the speedy release of the credit, potential buyers have used this "conditionality" to exert pressure: bargaining with respect to prices, demanding certain advantages, an overly restrictive social plan, threats of withdrawal, etc.

6.- In the case of SOLIMA in particular, the privatization of which was a condition linked to the first

- 42 -

tranche, it turned out that neither the Government nor the World Bank could anticipate all the problems that arose with this activity. Many conditions for privatization were not met, and a succession of company officials had failed to regularize the situation following the nationalization of a petroleum companies that were privately owned in the 1970s. Moreover, it took a long time to formulate the privatization strategy. Uncertainty in a number of areas clouded the bidding process for the four individual contracts for the distribution network. The result was protracted negotiations with the buyers selected, a situation that was compounded by the pressure indicated above. Finally, it took more than one year after notification for the contracts to be signed, a condition for release of the first tranche. Currently, despite a number of details to be finalized from a logistical standpoint and with respect to the social plan, it can be said that the privatization of SOLIMA has met the country's expectations: not only have the petroleum companies resumed distribution, they have all invested in the modernization of the network in order to make it more efficient, to the satisfaction of users. Furthermore, the petroleum bill is no longer an onerous one for the State, this being the complete responsibility of the distributors.

7.- The privatization of TELMA was the main condition for release of the second credit tranche. As was the case with the other two companies, legal problems existed, particularly with respect to land rights. However, another important issue made the privatization of TELMA a rather sensitive one: the French company France TELECOM held 34 percent of the share capital in TELMA. This fact did not, however, accord it the right of first refusal in the bidding process in which it participated. Challenges by France TELECOM as well as TELMA employees regarding award of the contract to DISTACOM delayed finalization of the privatization process. However, because it had been agreed that meeting the condition involved award of the contract (choice of the buyer), the third credit tranche was released in December 2001, just before the electoral crisis of 2002. The process was suspended during the crisis and discussions did not resume until the second half of 2002. At the moment, the privatization process still has not been completed, and TELMA continues to operate, along with three mobile telephone companies (the fourth merged with one of the three companies), under the control of the regulatory office OMERT [Office Malgache pour l’Etude et la Régulation des Télécommunications].

8.- The company identified for privatization as a condition for release of the third credit tranche was Air Madagascar. The process began smoothly under the oversight of the privatization committee, and a technical entity was chosen. However, this entity failed to cover all the aspects of the problem in its study and many important points were either overlooked or clear solutions were not offered, such as the handling of the Boeing 747, the property status of the company, etc. Furthermore, it must be recognized that resistance was coming from inside the company, a situation that was compounded by the fact that contact between the privatization institutions and the decision-making entities of the company was inadequate or even sporadic. However, while discussions were underway to finalize the privatization strategy, the international situation in the airline industry was changing. Many airlines were declaring bankruptcy all over the world and potential buyers were becoming increasingly scarce. Prospects for the privatization of Air Madagascar took a sharply negative turn after September 11 in the United States. The Government and the World Bank therefore agreed to change the condition; instead of privatizing the company, a decision was made to enter into a management contract with a company that had experience in this sector. Top officials at Air Madagascar were asked to prepare a business plan that would serve as the basis for the contract. It took a long time for this to be done, and the political crisis that developed during the first half of 2002 jeopardized adoption of the plan. Following the crisis, the President of the Madagascar decided to ask the German company Lufthansa Consulting to manage the company. The World Bank approved this provision and, as a result, the second credit tranche was released. One of the measures adopted by the new management company was to bring together all of Air Madagascar's creditors and secure from them an agreement to write off 50 percent of the debt owed to them. At the moment, the company is resuming normal operations, much to the satisfaction of its clientele, has resumed the three weekly long-haul flights,

- 43 -

and has managed, despite everything, to maintain a number of domestic flights that are described as "social" flights. The actions taken by Lufthansa Consulting have allowed the company to remain in business despite unfavorable international conditions. However, these actions need to be supplemented by an assessment of conditions facing the company when the contract ends in 2004: will it be self-supporting or will the State have to subsidize it in order to ensure its survival or with a view to its privatization?

9.- To conclude, the privatization process of public enterprises, particularly the biggest among them, is proceeding in an uneven fashion. Each company has special features that make privatization easier or more difficult. Finally, the experience acquired from the SOLIMA privatization process has had little influence on the other two companies, contrary to the expectations of World Bank experts. Institutional changes and a turnover in privatization officials are making the situation even more difficult. Lastly, at the moment the development and poverty reduction program is placing less emphasis on privatization. The process continues but the priorities are elsewhere.

Measures to support private sector development

10.- The adoption and application of the provisions of the new Mining Code was the first measure to support development of the mining sector within the SAC II. The Code was adopted in March 2000 and a Mining Registry was established. As a result of the implementation of the new system, the number of pending applications for permits was reduced and the process for the granting of permits became more transparent. In any case, this office reduced the chaos that prevailed in the sector, particularly with respect to the extraction of deposits of certain precious stones (emeralds, sapphires, etc.). Because the new Mining Code was prepared and implemented early enough, this measure was identified as a condition for the release of the second credit tranche. Later on, the Code was supplemented by the law on major mining investments (investment amounts over FMG one billion), which was intended to attract foreign investors. Although the law was approved in 2001 by the National Assembly, the events of the first half of 2002 delayed its review by the Senate. This process did not take place until August 2002. However, at the moment, this law has been applied only on a very limited basis. It should be noted that the latter is not included in the measure related to the reform of the mining sector, but instead is part of a hodge-podge measure that provides for strengthening the liberalization of the production sectors, which will not be applied in the near future.

11.- The second measure pertained to land access. We note that since 1995, foreigners have been barred from owing land. This provision was circumvented in the SAC I by means of the adoption of a long-term lease (up to 99 years), which can be transferred and secured by mortgage. However, this law has been applied on a very limited basis inasmuch as the registration amount was becoming too onerous (6 percent of the lease over 100 years corresponds to the amount paid for a six-year lease, a figure that is generally higher than the purchase price of the land). The provision was relaxed in the SAC II by making the registration fee payable in five-year installments. This has not, however, proven effective since, despite the fact that the lease can be secured by a mortgage, banks are all foreign and thus unable to become owners of land that is secured by mortgage in the event of default by their clients. Furthermore, the same situation obtains with nationals, since, although that they are owners, their foreign creditors cannot institute proceedings to acquire land that is secured by mortgage. In order to encourage private investors to invest in Madagascar, an in-depth review of this provision will be necessary. However, taking into account the fact that for the Malagasy people, land is sacred, this matter must be handled very carefully and it may even be necessary to engage in a national dialogue on the subject.

12.- Also, in the case of the land-related measure, provisions were made to reserve ten zones, five for purposes of tourism and five for industrial purposes. These zones were to be cleared in the land register

- 44 -

and made available to investors through international bidding. In the case of the industrial zones, the potential targets were the promoters, while in the tourist zone, tourist operators were targeted. The five tourist zones were identified and a call for bids was issued for the Isalo area. However, no qualified bids were received. A challenge was filed by a number of prominent local persons with respect to Nossi-be, and the matter has not yet been settled. In the case of the industrial zones, only two have been formally identified and cleared, and no bids have been solicited. In any case, the remarks made in the preceding paragraph are also valid in terms of achievement of this measure.

13.- The justice system and the business environment constitute the third measure to support private sector development. This involves the preparation and application of an action plan to make the justice system less cumbersome, to streamline procedures to enforce legal decisions, and to implement the recommendations of the Foreign Investment Advisory Service regarding the creation of enterprises in Madagascar. Insofar as the first point is concerned, an action plan was finally adopted after lengthy discussions with the World Bank aimed at release of the second SAC II tranche. In terms of the justice system, steps have been taken to streamline procedures, such as the elimination of the registration fee or meeting the costs of postal fees. Moreover, a new arbitration law was passed and an Arbitration and Mediation Center of Madagascar (CAMM) was created on the initiative of the private sector.

14.- The final measure involving the private sector pertains to the liberalization of a number of sectors: air transport, telecommunications, mines. Apart from the law on major mining investments mentioned above, the other measures, other than the concessioning of the Antalaha airport (to be verified), have not been fully executed, given the fact that they are linked to the finalization of the privatization of Air Madagascar and TELMA. As indicated, these measures are more long term in nature and the changes stemming from the 2002 crisis could also prompt the new leaders to review the content of this measure: at the moment, is it appropriate to talk about a second land line telephone company when the privatization of TELMA has not even been finalized? What is the new policy of the Government with respect to the concessioning of transportation infrastructure, particularly airport infrastructure?

Measures linked to the strengthening of public finance

15.- Tax revenue examination unit. The unit was established as part of the effort to improve the business environment, as recommended in the Foreign Investment Advisory Service (FIAS) report. Its mission is to increase tax revenue by establishing a single revenue office and extending the system to the entire island and to all taxes collected at the central and municipal levels. This measure took effect with the creation of an entity in March 2000 responsible for devising a strategy to increase tax revenue, with support from the IDA's Institutional Development Fund (IDF). This entity does not appear in the new organizational chart of the Ministry of Economy, Finance, and Budget, and the IDF grant, which was suspended during the period of the crisis, has not been reinstated. In the interim, the strategy has led to the establishment of two tax centers in Antananarivo: a tax center in Mandrosoa to collect the taxes of legal entities and another in Faravohitra to collect the taxes of individuals. It is envisioned that 63 centers will be created throughout the island, and the plan for their set up is being prepared. No particular problems have arisen with the extension of the system to cover all taxes.

16.- Social sector expenditures. Monitoring budget execution of the ministries responsible for social services (health, education) started in 1999 with the SAC II process. This process was aimed at producing appropriate solutions to the problems that were thwarting the satisfactory execution of expenditures in order to raise the level of commitments, excluding salaries, to at least 80 percent of the credit account opened. Monitoring focused on a number of specific items, excluding salaries, (611 to 613 and 621) and on investments, covering all sources of financing. The two categories of expenditure were broken down

- 45 -

into the central level and outlying levels. During the last three budget years, technical problems (disparities in the figures submitted by the entities involved in the budget process, lack of familiarity with procedures by a number of credit managers, shortage of equipment) were resolved as a result of the financial assistance provided by the European Union Bank within the framework of the PAIGEP (Public Management Institutional Support Project) and the PASA, as well as the training activities conducted by the budget overview unit. The members of the unit come from the Treasury Office, the CDE [Contrôle des Dépenses Engagées], the Budget Office, the Health Office, the Education Office, and the STA [Secrétariat technique pour l'ajustement]. Other problems, such as delayed receipt of credits, delayed appointments and turnover of managers, and difficulty in relaying information from the outlying to the central areas, have remained virtually unchanged. With the exception of 2002, one of the positive effects of the establishment of the system was the increase in the ratio of operating expense commitments, excluding salaries, to more than 90 percent of the credit account opened, at both the central and outlying levels. Commitment rates for investments averaged 45 percent of the credit account opened over the past three years. In general, in the case of investments managed at the central level, problems were encountered with insufficient counterpart funds and cumbersome procurement procedures. The present Government is therefore focusing on the reform of the oversight entities, including the drafting of new legal provisions to govern the Central Procurement Commission and government procurement procedures.

17.- Furthermore, expenditure measures covered:- Credit delegations. This activity has taken place.- Increasing and monitoring operating expenses, excluding salaries (particularly the specific articles mentioned), in conjunction with direct support for community-based schools in the area of education and effective cost recovery in the area of health. Fifty percent of this measure has been executed, given the fact that both an increase and monitoring have been achieved, without, however, there being any measures to correct approaches. Also, although recovery costs have increased, community-based schools have not received any assistance;- Bi-annual reviews to review expenses for the poor in each sector. Only one review has taken place and it was financed by the EU and carried out by INSTAT.

18.- Fishing permits: Fees paid by shrimp trawlers have always been considered very low in relation to catches (barely two percent of the value of catches compared to an average of ten percent for other countries). In addition, the system for the granting of permits was not transparent. A study was therefore conducted with a view to the introduction of a new system that was transparent, non-discretionary, and competitive. The new system that resulted from the study was implemented in 2000. The system has been so successful that not only have fees quadrupled; they are received in full before each season, thereby eliminating the delays experienced earlier. A difference of opinion remains between the Government and the Bank with respect to the granting of the latter two licenses: the Government considers them something to which the operator is entitled, based on a court decision, while the Bank holds the view that they should be granted on a discretionary basis.

19.- Financial sector reform: Auditing of insurance companies and funds. In general terms, the measures associated with the SAC II come under the heading of State withdrawal from productive activities and private sector development. Because of this, financial sector reform, which includes the auditing of insurance companies (ARO, Ny HAVANA) and funds, was merely a reflection of this policy orientation. The accounts of the two companies were audited as of December 31, 2000. The deadline established for the two companies was considered sufficient, inasmuch as the work could be completed. Audit reports were submitted to and approved by the Ministry of Finance, and contained, among other things, substantiated opinions on the regularity and accuracy of the accounts, the financial status, and the balance sheets of the two companies, as well as their organization and an assessment of their technical provisions.

- 46 -

The second phase of the reform, namely the process of divestiture of the State from the sector, was suspended because of the events of 2002, although the KPMG CORPORATE FINANCE-PROGESTION group, the auditor of Ny HAVANA, proposed a privatization scheme. However, the new Government plans to forge ahead with this process. As far as the auditing of funds is concerned, the problems are largely technical in nature. A wait-and-see attitude also exists, because of a lack of specific information on the role and responsibilities of the entities involved with the audit preparation process. Although it was agreed that the auditing of the CNAPS would be subject to prior approval of the auditing report on the Caisse de Retraite Civile et Militaire (CRCM) [Civilian and Military Retirement Fund] and the Caisse de Prévoyance de Retraite (CPR) [Retirement Provident Fund], the results of the audit of the CCM and CPR have revealed that it is not possible to audit the accounts of these funds. They have no cash flow statements and are still processing things manually, while it is recommended that IFAC standards be followed when conducting the audit. New terms of reference have been established for conducting audits of these two funds, and work in this area has not gotten beyond this point.

Supplemental credits

20.- Cyclone: It was agreed that US$20 million would be released in two tranche drawings of US$10 million each. The first would become available when the credit agreement was signed, and the second, after inspection of the work conducted, which was supposed to amount to 50 percent of the assessed damages. Two comments should be made: First, the supplemental credit was tied to the SAC II, since it was expected that the credit would be used to support public finances, with rehabilitation work being financed either through the budget or other sources and, since the SAC II was being implemented, it was therefore quicker for the Bank to include the cyclone credit in the SAC II rather than to prepare a new credit agreement. Second, the spirit of the credit was misunderstood by all the parties involved: some thought that it was intended to finance the work, others did not understand why the permanent secretariat of the CNC (National Coordination Committee for the rehabilitation work related to cyclone damage) had to supervise and approve the work; furthermore, this entity wanted to establish a very cumbersome supervision structure; the respective roles of the STA as the lead entity for the SAC II and the permanent secretariat of the CNC were not well defined; there was uncertainty regarding whether work would be directly financed by the State budget, etc. Furthermore, since work is progressing very slowly in the case of projects related to this work, the objectives were not achieved and it was not possible for the second tranche drawing of US$10 million to take place before the 2002 crisis. Following the crisis, because of the rehabilitation needs of the country, the funds were released independently of the work done to repair the damage caused by the cyclones. The weak performance was the result of the hasty linkage of two disparate objectives: the structural reform objectives of the SAC II and the physical objectives of the supplemental credit which made coordination of implementation and clarification of the roles of the parties involved difficult.

21.- Oil: Following the hike in oil prices on the international market in 2000, the Bank agreed to assist the Government to meet the higher oil bill and cushion the impact of the impact of the increase from the standpoint of the budget of consumers. A supplemental credit of US$30 million was approved for the Government, and, as was the case with the cyclone credit, it was added as an amendment to the SAC II credit agreement. When the supplemental credit took effect in June 2001, international prices had stabilized; however the credit served to cover the shortfall in taxes (TPP [tax on petroleum products] and the TVAPP [value added tax on petroleum products]) that had not been collected when international prices rose, in order to maintain the price level at the pump. Another unused portion was also earmarked for repayment of Central Bank debt owed by SOLIMA to finance petroleum-related cargo.

New conditions

- 47 -

22.- In the wake of the 2002 crisis, conditions were relaxed in order to facilitate release of the third credit tranche, given the great needs of the public treasury when the crisis ended. Although these measures were relaxed, they form the basis of economic recovery and poverty reduction, the cornerstone of government policy. Efforts are being made to combat corruption through the adoption of two decrees regarding the Superior Council on Combating Corruption and the declaration of the property of magistrates and senior government officials. Resistance is coming from some quarters; however, the credibility of a number of senior officials and the confidence of the people in their leaders make acceptance of this measure essential.

Conclusion

23.- In general terms, implementation of the measures recommended within the framework of the SAC II has been satisfactory. This process has contributed greatly to the sound macroeconomic performance recorded in 2000 and 2001. However, a number of problems, both internal and external, have been encountered with implementation. From an internal standpoint, despite the satisfaction with the measures implemented, their adoption was sometimes difficult. In the case of external partners, the difficulties stem from a perception of the actual situation in Madagascar that is not shared by nationals, a situation that sometimes makes dialogue difficult. Other difficulties encountered are linked to the disconnect between the theory that formed the basis for the measure recommended and the reality. Because of this, it was sometimes impossible to implement the measure (cf. long-term lease); another reason is excessive optimism with respect to the time needed to achieve the measure (privatization of SOLIMA).

24.- Although there has been a shift in the approach to the structural adjustment program and the poverty reduction program, a number of measures that have not been fully achieved within the framework of the SAC II should be examined in greater depth in the context of future assistance by the World Bank (Poverty Reduction Support Credit), and extensive discussions should be held on the subject of land access. Furthermore, the international situation has changed greatly since the preparation of the SAC II and a number of measures that were valid at that time no longer are. Should we be talking about the privatization of Air Madagascar after the withdrawal of Lufthansa Consulting or would it not be more prudent to conduct a detailed assessment of expected changes in the international air transport market?

25.- The success of this operation can be attributed to the work of an entire team that felt fully involved in and responsible for execution of the measures recommended in the credit agreement. This team includes both officials of the different ministries and entities involved as well as their spokespersons at the World Bank. Everyone was convinced that in this case, it was not a question of meeting the conditionalities associated with a Bank credit, but rather executing measures that were intended to foster the development of the country. However, there were also weaknesses, such as the problems mentioned earlier or those related to the adoption of measures that were not widely embraced by Malagasy officials.

- 48 -

Additional Annex 17. SAC II Audit

- 49 -

- 50 -

- 51 -

Additional Annex 18. Borrower comments

- 52 -

- 53 -

- 54 -