Document of The World Bank Group

Report No. 28791-TUN

MEMORANDUM OF THE PRESIDENT

OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE EXECUTIVE DIRECTORS

ON A

COUNTRY ASSISTANCE STRATEGY

FOR THE REPUBLIC OF TUNISIA

June 3, 2004

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CURRENCY AND EQUIVALENTS

Unit of Currency = Tunisian Dinar (TD) 1US$ = 1.30 TD (average March 2004)

ABBREVIATIONS AND ACRONYMS

AAA Analytical and Advisory Activity IMF International Monetary Fund AAEU Association Agreement with European Union JBIC Japanese Bank for International Corporation AFD French Development Agency KfW German Development Credit Agency AfDB African Development Bank MDA Master Derivatives Agreement AIDS Acquired Immune-Deficiency Syndrome MDG Millennium Development Goals ALMP Active Labor Market Policy M&E Monitoring and Evaluation APL Adaptable Program Loan MENA Middle East and North Africa CAE Country Assistance Evaluation MFA Multi-Fiber Agreement CAS Country Assistance Strategy MCI Middle Income Countries CASAR Country Assistance Strategy Achievement Report MLT Medium and Long Term CFAA Country Financial Accountability Assessment MOU Memorandum of Understanding CITET Tunisia International Center for Environmental Technologies MTEF Medium-Term Expenditure Framework CPAR Country Procurement Assessment Review NPL Non Performing Loan CPPR Country Portfolio Performance Review NRMP Natural Resources Management Project DDO Deferred Drawdown Option OED Operations Evaluation Department DPR Development Policy Review ONAS National Sanitation Utility (Tunisia) DS Debt Service PER Public Expenditure Review EC European Commission PESW Programmatic Economic and Sector Work ECAL Economic Competitiveness Adjustment Loan PIC Public Information Center EIB European Investment Bank PPI Private Participation in Infrastructure EQIP Education Quality Improvement Project QAG Quality Assurance Group ESW Economic and Sector Work R & D Research and Development EU European Union ROSC Report on the Observance of Standards and Codes FEMIP Facility for Euro-Mediterranean Investment and Partnership SIL Sector Investment Loan FDI Foreign Direct Investment SME Small and Medium Enterprise FSAP Financial Sector Assessment Program SONEDE National Water Distribution Utility (Tunisia) FY Fiscal Year SWAP Sector Wide Approach GDP Gross Domestic Product TA Technical Assistance GEF Global Environment Facility TDO Total Debt Outstanding and Disbursed GNFS Goods and Non Factor Services UN United Nations GTZ German Agency for Technical Corporation UNDP United Nations Development Program HIV Human Immune-Deficiency Virus UNIFEM United National Development Fund for Women IACE Arab Institute of Heads of Enterprises WB World Bank IBRD International Bank for Reconstruction and Development WBI World Bank Institute ICA Investment Climate Assessment WSIP Water Sector Investment Program ICT Information and Communication Technology WSIS World Summit on Information Society IDF Institutional Development Fund WSSP Water Supply and Sewerage Project IFC International Finance Corporation WTO World Trade Organization

MANAGERS AND STAFF RESPONSIBLE FOR THIS CAS (IBRD)

Vice President Christiaan Poortman Country Director Theodore Ahlers Task Manager Cécile Fruman

ACKNOWLEDGEMENTS

The World Bank greatly appreciates the collaboration with the Tunisian government in the preparation of this CAS. The document benefited from extensive and thoughtful discussions with government representatives. The additional contributions by those who were consulted during preparation of the CAS are equally appreciated.

The preparation of this CAS has truly been a team effort, which included hands-on involvement

of the entire Tunisia country team as well as staff from other units of the World Bank Group. Many team members and other staff made substantial contributions – in participating in CAS and country team meetings and retreats, in drafting parts of this document, in providing comments and advice, in translating or reviewing translations into French – to jointly develop the strategy presented here. Although it is impossible to name them all, they are all to be thanked and congratulated for their excellent collaboration and teamwork. A special thanks goes to Aristomene Varoudakis, Lead Country Economist for Tunisia, who shared his wisdom and excellent analysis of the situation in Tunisia, Sybille Crystal, Operations Analyst, who provided invaluable support and quality inputs throughout the process, and Micheline Faucompre, Program Assistant, who demonstrated great commitment in managing the organization of team meetings and editing of the document. NOTE: While this CAS adopts a results-based format, it is not an official results-based CAS pilot.

TABLE OF CONTENTS

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EXECUTIVE SUMMARY i I. COUNTRY CONTEXT 1 A. Political and Social Context 1 B. Recent Economic Developments and Policies 4 II. NATIONAL DEVELOPMENT AGENDA AND MEDIUM-TERM PROSPECTS 8 A. Tunisia’s Tenth Economic Development Plan: Progress and Challenges Ahead 8 B. Medium-Term Macroeconomic Prospects 11 III. TUNISIA-WORLD BANK GROUP PARTNERSHIP FOR FY05-08 13 A. Review of Past Bank Performance 14 B. Key Features of CAS 18 C. Expected Outcomes of CAS and Bank Support 20 IV. VEHICLES FOR WORLD BANK GROUP PARTNERSHIP WITH TUNISIA 26 A. Bank Instruments 26 B. Outreach, Communication and Capacity Building 29 C. Development Partners 30 D. Lending Scenarios 32 V. RESULTS-BASED MONITORING AND EVALUATION: PARTNERSHIP FOR MEASURING RESULTS 34 VI. MANAGING RISKS 35 CAS ANNEXES: Annex 1: CAS Results Framework 36 Annex 2: 2000 CAS Achievement Report 44 CAS TABLES Annex A1: Tunisia At a Glance 77 Annex B2: Selected Indicators of Bank Portfolio Performance and Management 79 Annex B3: Proposed IBRD Base-Case Lending Program FY04-07 80

Annex B3: IFC and MIGA Program FY01-04 81 Annex B4: Summary of AAA Program 82 Annex B5: Social Indicators 83 Annex B6: Key Economic Indicators 84 Annex B7: Key Exposure Indicators 86 Annex B8: Operations Portfolio (IBRD/IDA/Grants) 87 Annex B8: Statement of IFC’s Held and Disbursed Portfolio 88 Annex B9: CAS Summary of Development Priorities (this annex is replaced by Annex 1- CAS Results Framework) BOXES: Box 1: Millennium Development Goals: Summary of Tunisia’s Progress 2 Box 2: Key Goals in the 10th Economic Development Plan 8 Box 3: Main Results of the 2000 CAS 16 Box 4: Areas of Support under the Employment PESW 17 Box 5: Proposed Key Analytical and Advisory Activities for Agriculture and Water 23 Box 6: The New Neighborhood Initiative – What’s at stake? 31 FIGURES: Figure 1: Headcount Poverty Index in Tunisia 1 Figure 2: Average Annual Real GDP Growth – Tunisia and Comparators 4 Figure 3: Tunisia – Inflation and External Balance 4 Figure 4: Fiscal Deficit in % GDP 6 Figure 5: Foreign Debt in % of GDP 6 Figure 6: Private Investment 7 Figure 7: Illustrative Results Framework 22 TABLES: Table 1: Base-case Scenario – Selected Macroeconomic Indicators 12 Table 2: External Financing Plan 13 Table 3: Portfolio Management Indicators 17 Table 4: Indicative Base Case Assistance Program 27

EXECUTIVE SUMMARY

i. Tunisia continues to make significant progress in economic and social development. Sustained structural reform efforts since the early 1990s, prudent macroeconomic policies, and deeper trade integration in the global economy have created an enabling environment for growth of the private sector and improved competitiveness of the economy. Growth has been resilient, even when Tunisia faced an unfavorable external environment such as in 2002, reaching 5.5 percent in 2003. This has fostered positive social achievements in health, education and social protection which place Tunisia ahead of countries at similar income levels, and in a good position to achieve the Millennium Development Goals (MDGs). In particular, poverty was sharply reduced from 8 percent of the population in 1995 to 4 percent in 2000. Tunisia has made substantial progress in closing gender gaps in education, reducing fertility and building strong legal rights and privileges for women. Tunisia has also embarked on the path of environmental sustainability thanks to a strong institutional setup and legislative framework coupled with a well designed sustainable development policy.

ii. In a context of heightened international competition, three key challenges remain to meet the goals of the 10th Economic Development Plan (2002-2006). The first and most pressing challenge is to reduce unemployment which remains high, at around 15 percent, reflecting demographic pressures and increased competition (completion of the free trade zone for manufacturers with the European Union (EU) by 2008, EU enlargement in 2004 and elimination of Multi-Fiber Agreement quotas in 2005). This will require improving the investment climate for the private sector and the quality of economic governance. The second challenge is to improve the quality, relevance and financial sustainability of the education sector and strengthen innovation systems and scientific and technological research educational system in order to establish a knowledge economy. Tunisia’s education sector faces an important challenge as a result of demographic transition (rapidly rising enrollment rates in secondary and tertiary education), at a time when it is critical to further improve learning achievements and foster better linkages between education, research and the labor market if Tunisia is to have the skills to compete in the global knowledge economy. The third challenge is to strengthen the performance of social programs while maintaining budget balances. Here too, demographic trends and transformations in the labor market due to competitive pressures pose great challenges for health, social protection, and pension systems. At the same time, non-discretionary spending introduces serious rigidity in the public expenditure system which is focused on the short-term.

iii. The World Bank’s country assistance strategy (CAS) proposes to help the Government of Tunisia in addressing these three challenges:

§ Strengthen the business environment to support the development of a more competitive, internationally integrated private sector and improve competitiveness of the Tunisian economy. Bank support will be directed to achieve six CAS outcomes which are essential to raise the rate of private sector investments: (1) improved incentives framework and increased transparency and predictability of the regulatory framework; (2) reduced transaction costs for firms, leading to increased production and exports; (3) improved delivery/efficiency of infrastructure services by public and private firms; (4) improved competitiveness of agriculture while ensuring that social and environmental concerns are properly addressed; (5) banking sector more responsive to the needs of the private sector; (6) more dynamic local public and private financial markets.

§ Enhance skills and employability of graduates and labor force in a knowledge economy. Bank

support will be devoted to help to: (1) improve quality and relevance of all levels of the education system; (2) improve financial sustainability of the education system; and (3) improve linkages

ii

between research, higher education and the market place leading to greater innovation and competitiveness of firms.

§ Improve the quality of social services through enhanced efficiency of public expenditures. Three

CAS outcomes have been identified: (1) increased budget flexibility and better fiscal mobilization to reduce public debt; (2) performance budgeting and monitoring and evaluation (M&E) operational in key line ministries; and (3) improved coverage, quality, and financial sustainability of health, social protection, and pension systems.

iv. Building on lessons learned from the past, this CAS is based on the following guiding principles: a greater focus on results and quality; strengthened partnerships and outreach; and additional flexibility in the approach and choice of instruments. The CAS results framework provides the Bank and the Government with a mechanism for monitoring progress towards achievement of CAS outcomes. Since this is the first attempt to systematically identify results and indicators, the process will be refined during CAS implementation as part of a joint learning exercise. The CAS proposes enhanced cooperation with development partners, and in particular the European Union, and a broader program of outreach. It is intended to be sufficiently flexible to respond to evolving Government priorities and needs over the implementation period. The instruments proposed to support the strategy are: analytical and advisory assistance, including programmatic economic and sector work; simplified sector investment lending and adjustment lending; extending programmatic lending such as sector-wide approaches (SWAps); IBRD guarantees and hedging products; some IFC and MIGA support; and technical assistance adapted to the needs of a middle income country (i.e. to improve debt management and to help structure an adequate portfolio of IBRD financial products and services).

v. For the CAS period FY05-08, a flexible base case program of $200 to $300 million a year on average is proposed in order to support the key development objectives of the CAS. The base case lending scenario aims to provide enough flexibility to respond to opportunities for high quality lending and help support the reforms needed for Tunisia to sustain growth. The proposed lending amounts and the attached flexibility are consistent with sound risk management in view of the expected development progress and poverty reduction and the projected improvement of IBRD exposure indicators. The base case program would include at least one policy based operation, Economic Competitiveness Adjustment Loan (ECAL) IV, focusing on private sector development and the financial sector - and possibly two. Borrowing in excess of the CAS limits could be envisaged in specific circumstances, using the Bank’s special lending instruments, to help Tunisia cope with increased financing needs due to external shocks and other unpredictable factors. A low case lending scenario – not to exceed $100 million in investment lending only - would result from difficulties in maintaining a stable macroeconomic framework or a slowdown in the pace of structural reform.

vi. The program is designed to mitigate risks that could limit the effectiveness of Bank support and to enhance monitoring and evaluation of CAS outcomes. The program could face risks related to Tunisia’s greater integration into global markets; macroeconomic and financial vulnerabilities; the lack of political will for reform or slow pace of change; and regional and country instability. Risk management measures are described for each risk area. Enhanced monitoring of CAS outcomes will contribute to mitigating risks at the project level by enabling Bank teams to respond to problems as they occur and provide quality support on a more timely basis. This will be done in partnership with the Government and other development partners, by relying on existing mechanisms for data collection, and helping to strengthen existing systems and institutions.

iii

vii. The following issues, given their importance to the proposed strategy, are suggested for Board discussion:

§ The consistency of the assistance program with Tunisia’s development challenges. § The adequacy of the core design elements of the CAS to increase the effectiveness of Bank

interventions in Tunisia, in particular the proposed results focus, the greater emphasis on partnerships and the use of programmatic support.

§ The adequacy of the proposed lending scenarios in order to provide greater flexibility in accomodating the needs of a sophisticated middle income country.

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0 2 4 6 8

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1 9 9 0 1 9 9 5 2 0 0 0 C o r e p o o r r u r a l C o r e p o o r u r b a n E c o n o m i c a l l y v u l n e r a b l e r u r a l E c o n o m i c a l l y v u l n e r a b l e u r b a n

F i g u r e 1 : H e a d c o u n t p o v e r t y i n d e x i n T un i s i a ( % o f p o p u l a t i o n )

I. COUNTRY CONTEXT

A. Political and Social Context

1. The stability which characterizes the political scene in Tunisia is likely to continue during the CAS period. As a republic with a strong central authority vested in the President, Tunisia has experienced political stability at a time when its neighborhood has been experiencing significant turmoil. Tunisia has committed itself to deeper international integration; it was the first MENA country to sign an Association Agreement with the EU (AAEU) in 1995 and continues to lead efforts to revive the five-nation Arab Maghreb Union. President Zine al-Abedine Ben Ali has been in power since 1987 and will run for a fourth five-year term of office in the fall of 2004. Past positive development outcomes have fostered a large middle class that will press for more participation in the development process, greater transparency and accountability through a strengthened role of civil society and the private sector. 2. Tunisia has made steady and rapid progress on the social development front. Health levels have consistently improved, as indicated by increasing life expectancy to 72.1 years, close to high-income country standards, and falling infant, child and maternal mortality rates. At the same time, health insurance coverage has become practically universal: the state provides free or subsidized health care to the lowest income groups, while the rest of the population are covered by one of the social insurance funds. Primary education became nearly universal and illiteracy is close to becoming eradicated among younger generations, although disparities still remain in female and male literacy rates. Although challenges remain in improving the quality and ensuring the financial sustainability of social sector policies, overall, these achievements have placed Tunisia ahead of countries at similar income levels, and in a good position to achieve the Millennium Development Goals (MDGs) (Box 1). 3. Poverty was sharply reduced in the second half of the 1990s. The core poor (those living below a poverty line reflecting a minimum consumption expenditure level) made up only 4 percent of the population in 20001, equivalent to some 400,000 people, down from about 8 percent in 1990 and in 1995. Similarly, the share of poor and economically vulnerable (those living below the upper poverty line), fell from 17 percent in 1995, to 10 percent in 2000 (Figure 1). The trends of falling poverty over the second half of the 1990s hold for both urban and rural areas and are visible in all administrative regions. Poverty reduction reflects strong per capita consumption growth between 1995 and 2000, and the weaker, but pro-poor growth, of the 1990-95 period which favored the poorer groups to a higher degree as consumption expenditures of the poorest decile of the population grew above average. Sustained growth in consumption expenditures and the strong progress on social indicators have been instrumental in bringing a significant number of people out of poverty and economic vulnerability. During the second half of the 1990s, income distribution has improved slightly as indicated by the Gini coefficient which has progressed from 0.417 in 1995 to 0.409 in 2000.

1 Based on World Bank Poverty Update Report, August 2003.

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Box 1 : Millennium Development Goals Summary of Tunisia’s Progress

Goal 1: Eradicate extreme poverty and hunger Target 1: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Target 2: Halve, between 1990 and 2015, the proportion of people who suffer from hunger.

Population below $1 a day (%) Percentage share of income or consumption held by poorest 20% Prevalence of child malnutrition (% of children under 5) Population below minimum level of dietary energy consumption (%)

1990

..

.. 10.3

..

1995 2.0 5.7 9.0 ..

2001 .. ..

4.0 ..

Goal 2: Achieve universal primary education Target 3: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.

Net primary enrollment ratio (% of relevant age group) Percentage of cohort reaching grade 5 (%) Youth literacy rate (% ages 15-24)

1990 93.5 86.6 84.1

1995 97.8 91.0 89.7

2001 99.2 93.1 93.8

Goal 3: Promote gender equality and empower women Target 4: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.

Ratio of girls to boys in primary and secondary education (%) Ratio of young literate females to males (% ages 15-24) Share of women employed in the nonagricultural sector (%) Proportion of seats held by women in national parliament (%)

1990 81.9 81.0

.. 4.0

1995 89.1 87.6

.. 7.0

2001 99.9 92.0

.. 12.0

Goal 4: Reduce child mortality Target 5: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate.

Under 5 mortality rate (per 1,000) Infant mortality ratio (per 1,000 live births) Immunization, measles (% of children under 12 months)

1990 52.0 37.3 93.0

1995 37.0 30.5 91.0

2001 27.0 21.0 92.0

Goal 5: Improve maternal health Target 6: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.

Maternal mortality ratio (modeled estimate, per 100,000 live births) Births attended by skilled health staff (% of total)

1990 ..

69.0

1995 70.0 80.5

2001 ..

89.9 Goal 6: Combat HIV/AIDS, malaria and other diseases Target 7: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Target 8: Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.

Prevalence of HIV, female (5 ages 15-24) Contraceptive prevalence rate (% of women ages 15-49) Number of children orphaned by HIV/AIDS Incidence of tuberculosis (per 100,000 people)

1990 ..

50.0 .. ..

1995 ..

60.0 .. ..

2001 .. .. ..

36.9 Goal 7: Ensure environmental sustainability Target 9: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Target 10: Halve, by 2015, the proportion of people without sustainable access to safe drinking water. Target 11: By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers.

Forest area (% of total land area) Nationally protected areas (% of total land area) GDP per unit of energy use (PPP $ per kg oil equivalent) CO2 emissions (metric tons per capita) Access to an improved water source (% of population) Access to improved sanitation (% of population)

1990 3.2 ..

5.4 1.6 75.0 76.0

1995 ..

0.3 6.6 1.8 .. ..

2001 3.3 0.3 7.5 1.8

80.0 84.0

Source: World Development Indicators database, January 2004

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4. Consolidating progress made in poverty reduction remains an important priority because economic vulnerability is important, especially in urban areas, and core poverty remains entrenched in rural areas. Fifty percent of the economically vulnerable lived in urban areas in 2000, up from 43 percent in 1990. The distribution of the core poor remained stable over time, with, in 2000, 74 percent living in rural areas, about the same as in 1990. The core poor made up 8.3 percent of rural population, a rate twice as high as the national average. A fairly high proportion of people remain clustered above, but close to, the poverty lines. A total of 40 percent of the rural population and 15 percent of people in Metropolitan areas have consumption levels that are inferior to double the lower poverty line. Tunisia’s high exposure to volatility (droughts) and external shocks (tourism, exports) may thus affect poverty outcomes in unpredictable ways. Poverty trends are not known for the 2001-2003 period in the absence of yearly surveys2, but they may have increased given the economic downturn of 2001 and 2002. 5. The Tunisian authorities continue to emphasize the role of women and girls in socio-economic development. As a result of past investment in human capital, Tunisia has made substantial progress in closing gender gaps in education, reducing fertility and building strong legal rights and privileges for women. Considerable progress was achieved in reducing female illiteracy rates (from 96 percent in 1956 to 38 percent in 2001), yet these are still slightly higher than those of men and above those of countries in Tunisia’s comparator group (20%).3 Over the last decade, female school enrollment rates have in many instances surpassed those of male enrollment rates, while in the 2000-2001 academic year, slightly more than half of all university students were women. However, rural-urban discrepancies remain, and where families face socio-economic difficulties, it is often the boy rather than the girl who will be able to go to school. Reducing rural female illiteracy has become the focus of current government literacy programs. Moreover, at both secondary and tertiary levels, women mostly enroll in traditional fields of study and are less present in the scientific and technical fields. 6. Labor force participation by women is high by regional standards, but Tunisia’s important potential to integrate women into the economy has yet to be fully realized. Women’s labor force participation has increased over the last decades to 26 percent but is below potential, and labor force participation by women with higher education has declined to 55 percent in 2001, from 58.5 percent in 1997. The relatively weak maternity leave regulations and the limited coverage provided by the child care system are likely to impede labor force participation by women. Restrictive employment termination regulations that usually protect primary workers (essentially male and more experienced workers) may also limit the demand for female workers. 7. Tunisian has also embarked on the path of environment sustainability. Tunisia has maintained during the last five years a high level of public expenditures devoted to environmental protection and natural resources management, estimated at over 1 percent of GDP, equivalent to some European countries. This has led to substantial progress in natural resource management and environmental protection as measured by the annual cost of environmental degradation which was estimated at 2.1 percent of GDP in 1999 or close to $440 million, the lowest among the MNA countries4. Despite such progress, Tunisia faces some important challenges in natural resources management (soils and water), costal protection, solid waste management and, particularly, in integrating long term environmental impacts in its sector development strategies and in engaging public consultations on environmental investments.

2 The next household budget survey is scheduled for 2005 and will constitute the basis for new poverty estimates. 3 World Bank. 2003. World Development Indicators. Tunisia’s comparator group is the lower middle income

countries which are those that have a Gross National Income per capita of more than $745 and less than $2,975. 4 World Bank, METAP. 2003. Republic of Tunisia: Cost of Environmental Degradation.

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10 15

1990 1992 1994 1996 1998 2000 2002

Current account balance (in % of GDP)

Trade balance (in % of GDP)

CPI Inflation Tunisia

Figure 3 : Tunisia--Inflation and external balance (1990-2003)

CPI Inflation, 5 fast-growing comparators

0 1 2 3 4 5 6 7 8 9

1982-1986 1987-1991 1992-1996 1997-2001 2002-2003

Tunisia MENA (excluding Tunisia) Middle Income Countries 5 High growth

Figure 2 : Average annual real GDP growth--Tunisia and comparators (in%)

B. Recent Economic Developments and Policies 8. Coordinated policy reforms and a well performing public administration have supported economic and social progress in Tunisia. First, the successful stablization of 1987 and subsequent prudent macroeconomic policies have created an enabling environment for growth of the economy and of the private sector. Second, sustained structural reform efforts since the early 1990s and deeper trade integration in the global economy have created the right conditions for increased productivity and improved competitiveness of the economy. Finally, the economic reforms were supported by a well performing public administration. According to the recent MNA Governance Report5, Tunisia scores significantly higher than the average of lower middle income countries in the world on the quality of its public administration, reflecting the capability of the administration to formulate and implement sound policies, and the respect for institutions that govern interactions between citizens and government. 9. Social progress has been underpinned by fast and sustained growth since the mid-80s. GDP grew on average by 4.3 percent annually since the initiation of structural adjustment in the mid 1980s, and growth accelerated to 5.2 percent during the Ninth Development Plan (1997-2001). Growth outpaced MENA and middle-income countries’ average since 1987, even though it was slower than in other fast growing countries6 (Figure 2). In 2002, Tunisia faced an unfavorable external environment— sluggish growth in the EU and the prolonged effect of September 11, 2001 and the Djerba bombing in 2002 on tourism and transport, leading to a drop in exports, and severe drought for a third year in a row. But the economy remained broadly resilient, with growth slowing down to 1.7 percent, from 4.9 percent in 2001. Thanks to favorable rainfall in the 2002-03 season, agricultural output recovered strongly, boosting GDP growth to 5.5 percent in 2003. However, reflecting weak domestic demand, non agricultural GDP grew by only 3.5 percent, the same pace as in 2002, below the goals set in Tunisia’s Tenth Economic Development Plan (2002-2006). 10. External and internal balances have been preserved, providing a sound framework for private sector growth. The country’s sound economic management has helped overcome several shocks, such as the Gulf war in the early 1990s, the 1997 East Asia crisis, the geopolitical uncertainties from terrorism and the Iraq war, and the droughts which regularly afflict Tunisia’s agriculture. Prudent demand management helped bring inflation down, to levels below those seen in other fast-growing countries (Figure 3). Tunisia’s current account deficit was also kept under control, at around 3 percent of GDP for most of the late 1990s. After a rise in the current account deficit during 2000-2002, due to domestic demand pressures and external shocks, the current account deficit was again reduced in 2003 and foreign exchange reserves have stabilized at the equivalent of three months of imports since early 2003.

5 World Bank. 2003. Better Governance for Development in the Middle East and North Africa: Enhancing Inclusiveness and

Accountability, MENA Development Report. Washington, D.C. 6 The five high-growth countries used in the analysis are Malaysia, South Korea, Thailand, Mauritius and Chile.

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11. Although growth has been strong, unemployment remains high, at around 15 percent, reflecting demographic pressures, the decrease in the employment intensity of growth, and increased competition. Strong labor force growth is expected in the years ahead given the demographic lag and increasing labor force participation by women. While unemployment remains the highest among those with primary schooling or less (86 percent of the unemployed), in recent years, job creation for skilled workers has slowed, so that unemployment of people with formal education has increased. The lower employment intensity of growth reflects faster labor productivity growth, which supports competitiveness and real incomes growth, but also the impact of distortions in the labor market. In the coming years, tensions in the labor market will also be intensified by the shedding of labor out of agriculture (22 percent of total employment) and traditional industries such as textile (10 percent of total employment). The completion of the free trade zone for manufactured products as part of the AAEU will raise important employment challenges for import-competing industries, while the phasing out of the multi-fiber agreement (MFA) quotas for textile and clothing by 2005 will deprive Tunisia from preferential access to EU markets for these products and expose it to increased competition from lower-cost producers. The experience of other textile exporting countries which are also facing strong international competition indicates that this situation could lead to the loss of an estimated one third of Tunisia’s employment in the textile industry, or about 100,000 employees, mostly women. Trade policies—setting the stage for a more competitive economy 12. Tunisia is making considerable progress towards greater trade openness in the context of the Association Agreement with the EU. Tunisia’s strategic move of deeper trade integration with the EU is promoting private sector development in a more competitive environment, which eventually holds the promise of enhancing efficiency and improving prospects for growth. The AAEU includes provisions for a phased establishment of a free trade zone for manufactures over a 12-year period (1996 to 2008). Implementation of the tariff dismantling schedule under the AAEU is on track with around 55 percent of the tariff reductions already in place. Tariffs have been totally dismantled for capital goods since 1996, and raw materials and intermediate goods since the year 2000. Import duties on consumer goods and imported goods that are also produced locally have been cut by about one half and one fourth respectively by the end of 2001. 13. However, despite progress in nominal tariff reduction, the trade regime remains protected, and Tunisia still lags behind in regulatory reform to open services to competition. The level and the number of schedules of Most favored nation (MFN) tariffs were reduced in 2003, but these tariffs remain high, as is their differential with respect to preferential tariffs applied to imports from the EU. Some items still remain subject to import licenses or technical specifications, particularly consumer goods that compete against locally produced equivalents manufactured by "developing" industries (e.g. textiles). Imports of several products, such as drugs, cereals, coffee, and tea, remain monopolized by state trading boards or public enterprises. Most importantly, services liberalization remains limited; while Tunisia has granted WTO commitments for tourism, financial services and communication services, market opening is proceeding slowly, and the absence of commitments in other key sectors, such as transport and distribution, is of concern. Macroeconomic policies—prudent and forward looking 14. Fiscal consolidation has progressed but a primary structural budget deficit still persists. A sizeable primary budget deficit of 2.1 percent of GDP in 1990-91 was turned into a 1.3 percent surplus by 1994 (Figure 4).

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Figure 4 : Fiscal defici t in % of GDP (excluding grants and privatization receipts)

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1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003(est) Overall Fiscal deficit Primary Fiscal Deficit

Figure 5 : Foreign debt in % of GDP

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nd

Latvia

The fiscal stance has been somewhat eased since the mid 1990s and a rapid reduction of public debt would call for creating an appropriate primary budget surplus. The fiscal stance was tightened in the 2002 and 2003 budgets, but owing to slow growth and sluggish fiscal revenues, the budget deficit (excluding privatization receipts and grants) was only marginally reduced to 3.3 per cent of GDP in 2003, from 3.8 percent in 2001, while the primary budget remained in deficit, at 0.3 percent of GDP. The 2004 budget aims at a reduction of the budget deficit to 2.7 percent of GDP. 15. Over the past two decades, Tunisia successfully controlled the public debt burden, while pursuing a prudent debt management policy. Because of the structural current account deficit and the persistent primary budget deficit, public debt hovered at around 60 percent during the 1990s (of which 38 percent foreign and 22 percent domestic debt in 2002). Tunisia’s total foreign debt (public and private) amounted to 54 percent of GDP in 2002. In recent years, the debt service ratio was brought down to a more comfortable 15 percent of exports. Tunisia is among the few emerging market borrowers that have investment grade rating, allowing borrowing at long maturities and under relatively favorable conditions. However, Tunisia’s foreign debt remains high in international comparison, especially compared to countries with a similar sovereign rating (BBB-, BBB, and BBB+) (Figure 5). A faster reduction of public debt could yield substantial benefits in terms of cost of access to international capital markets. 16. Monetary and exchange rate policies have supported macroeconomic stability, while responding to changing conditions. The monetary policy framework aims to preserve the internal and external value of the dinar, by maintaining low inflation and preserving the external balance. To rein in the growth of domestic demand, monetary policy was tightened in 2001, with the Central Bank drastically cutting its refinancing to commercial banks. The tightening of monetary policy was eventually reflected into a better alignment of credit expansion with the growth in domestic demand, and allowed an easing of monetary conditions in 2003. Targeting a constant real effective exchange rate has contributed to maintaining a good level of competitiveness and the prudent budget management has provided a necessary anchor for this exchange rate policy. In particular, exchange rate depreciation has not been substituted for fiscal and monetary adjustment to absorb the pressures from the current account. The real exchange rate rule was implemented in a more flexible manner in 2002 and 2003, as the government allowed some real exchange rate depreciation in response to increased competitive pressures from countries with exchange rates tied to a weaker dollar, and in order to support Tunisia’s ongoing trade liberalization and the preparation for a more flexible exchange regime and a more open capital account in the future. However, exchange rate devaluation has not been substituted for budgetary and monetary adjustments to absorb pressures on the current account.

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0

5

10

15

20

25

30

1970 - 74 1975 - 79 1980 - 84 1985 - 89 1990 - 94 1995 - 99

Figure 6: Private investment in % of GDP

Tunisia 5 high - growth

Policies to promote a dynamic private sector—a mixed picture 17. The Government has maintained a long standing commitment towards promoting private sector development. The Tunisian authorities have maintained a policy of generous privileges for investments in selected economic activities and for exporting by supporting the creation of “offshore” firms.7 Over the years this strategy has helped address the import substitution bias of Tunisia’s trade policy and thus contributed to promoting export-oriented growth. Measures have also been implemented to reduce the costs of doing business: registration is fast and the number of procedures reasonable, the number of customs documents has been reduced, and a new system of normalized and simplified documentation for external trade transactions has been put in place. The Government has also sponsored various funds to support bank lending to SMEs and start-ups, and has put in place a regulatory framework for the development of venture capital. 18. But compared to other high-growth countries, Tunisia suffers from a structural private investment gap. Despite solid macroeconomic fundamentals and structural reforms, Tunisia’s growth has relied more on public investment, and private investment remains compressed at around 14 percent of GDP, significantly below the investment ratios seen in fast-growing comparators (Figure 6). One reason for the low private investment ratio is the limited competitive openness of services markets and network industries, in particular ICT and transport, which keeps the cost of backbone services high, hinders competitiveness, and deprives Tunisia from significant opportunities for private investment. Still another reason is heightened uncertainty of the business environment, reflecting the surrounding risks in Tunisia’s changing economic environment. But these factors only partly explain the large private investment gap in Tunisia. 19. Weaknesses in economic governance, in particular regarding the predictability and transparency of the regulatory framework and limited market contestability, constitute an important constraint to private investment. Strong government interference in the economy and the strategy of providing generous privileges for selected sectors run the risk of locking the country into threatened activities, such as textiles and clothing, which may leave Tunisia ill-positioned in the face of stiffer international competition. Discretionary intervention by the government, low levels of public accountability, voice and participation contribute to weakening the investment climate and strengthening the hand of “insiders”, mostly in the absence of strong competitive forces.8 This contributes to reducing market contestability and discouraging risk-taking by less well-connected entrepreneurs. Examples of lack of transparency and predictability of the regulatory framework include: the process for obtaining prior authorization for private sector investments in the sectors where private investment is restricted and

7 “Offshore” enterprises refers to firms that produce solely for exportation and are granted significant tax exemptions and

financial incentives. “Onshore” enterprises are those that produce for the local market and do not benefit from the same level of exemptions.

8 According to the MENA study on Governance referred to previously, Better Governance for Development in the Middle East and North Africa: Enhancing Inclusiveness and Accountability, Tunisia scores slightly higher the MENA average but lower than the world average of lower middle income countries on public accountability, voice and participation. The index of public accountability assesses the process of selecting and replacing those in authority. It measures the quality of governance according to the inclusiveness of access to basic political and civic rights and the relative strength of external accountability mechanisms. It also captures the transparency and responsiveness of the government to its population and the degree of political accountability in the public sphere.

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for majority ownership of Tunisian firms by foreign investors; the practice of limiting the amount of VAT reimbursements to non-exporting firms (onshore sector), which are submitted to the unpredictability of tax controls; the absence of sufficient safeguards for taxpayers facing tax controls and the absence of administrative appeal processes for taxation matters; the inconsistency by which auditing rules are applied to firms which borrow significant amounts; and the absence of a legal framework on concessions which would clarify the rules of engagement for private firms participating in infrastructure investments. 20. Despite the economy’s strong fundamentals, commercial banks continue to be burdened with large non performing loans (NPLs). NPLs were reduced to about 19 percent of bank assets in 2001, from over 30 percent in 1993, but increased to above 22 percent since 2002, reflecting the exposure of banks to the tourism sector. The level of provisioning of commercial banks’ NPLs remains low, at 44 percent in 2002, reflecting heavy reliance on real estate collateral in calculating the required provisions, even though realizing real estate collateral suffers from long delays in judicial procedures. Large, under provisioned NPLs increase the cost of bank intermediation, reduce access to finance for SMEs, and create a negative perception of the Tunisian banking system.

II. NATIONAL DEVELOPMENT AGENDA AND MEDIUM-TERM PROSPECTS

A. Tunisia’s 10th Economic Development Plan: Progress and Challenges Ahead

21. Tunisia’s medium-term development agenda has been elaborated in the 10th Economic Development Plan, covering the period 2002-2006. The 10th Plan aspires to place Tunisia on a convergent path with more developed countries during the next two decades. The 10th Plan is underpinned by a development framework that highlights detailed macroeconomic and sectoral goals over the period 2002-2006 (Box 2) and envisions three main goals: § Accelerating the pace of growth, to reduce unemployment, boost incomes, and consolidate

Tunisia’s progress in the reduction of poverty; § Fostering the emergence of a knowledge economy, to take advantage of Tunisia’s valuable human

resources and facilitate integration in the global economy; § Upholding social achievements by ensuring that all social groups participate in the benefits of

economic and social development.

Box 2 : Key goals in the 10th Economic Development Plan

§ Achieving average annual growth of 5.5 percent—largely driven by growth in services, projected at 7.5 percent per year;

§ Creating 380,000 new jobs, to meet 95 percent of the expected increase in the supply of labor, and reduce unemployment to about 13 percent;

§ Promoting private investment, to raise its share in total investment to 58.5 percent by 2006 from 53 percent in 2001, by opening up still protected sectors to private initiative;

§ Promoting exports, a key underpinning of Tunisia’s growth, to achieve average annual growth of about 6 percent; § Bolstering the domestic savings ratio to 25 percent in 2006, from 23 percent in 2001, to preserve the economy’s

macroeconomic balance; § Promoting agricultural development, by 3.5 percent growth per year, while preserving natural resources; § Fostering the growth of the ICT sector, a main underpinning of competitiveness and the economy, to increase its

contribution to GDP to 7 percent in 2006, from 3.3 percent in 2001; § Reducing illiteracy to 16 percent in 2006, from 24.7 percent in 2001; § Increasing enrollment to higher education to 30 percent in 2006, from 23 percent in 2001, with the number of graduates

increasing to 55,000, from 29,000 in 2001; § Increasing the number of people covered by a social protection regime to 90 percent of the population by 2006, from

84.3 percent in 2001; § Increasing rural electrification to 95 percent in 2006, from 47 percent in 2001.

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22. Half way through the implementation of the 10th Plan, more remains to be done to achieve the projected goals. First, economic growth and job creation have not been as strong as expected and there is a need to encourage additional private investment in order to meet the targets set in the Plan. Second, important measures must be taken in order to foster the emergence of a knowledge economy, such as: modernization of ICT infrastructure and services; improvements in the quality, relevance and financial sustainability of the education sector; and increased performance of innovation systems and scientific and technological research. Finally, in order to ensure that all the population benefits from economic and social progress, many important measures need to be taken in the years ahead to improve the sustainability and quality of health services and the pension system, and the effectiveness of labor market programs and existing safety nets, while maintaining current account and budget balances. These challenges are analyzed in more detail below.

Challenge 1: Boost growth and reduce unemployment by fostering development of the private sector

23. Private firms operating in Tunisia face numerous obstacles. In addition to high government interference in private investment decisions as previously described, firms face high transaction costs for business entry, operation and exit, and costly customs procedures; inefficiencies in trade logistics and in supply chains; and high costs for infrastructure services such as telecommunications, energy and water supply due to limited administrative and financial autonomy of public utilities and limited competition in the provision of these services. Entrepreneurs operating in some sectors, such as agriculture, face multiple challenges to increase their competitiveness. In particular, there is a bias against agricultural exports created by the protection of import substitutes through tariffs and subsidies which favor the production of lower value cereals as opposed to higher value fruits and vegetables, in which Tunisia has a comparative advantage. The reduction of these tariffs and subsidies would have to be carefully managed and accompanied by social protection measures, particularly for small to medium size producers in arid and semi-arid areas, to avoid aggravating rural poverty. Greater incentives for more efficient use of the country's scarcest natural resource, water, also need to be provided in irrigated areas, while efforts are made to upgrade the quality of agricultural research and extension services throughout the country. 24. While the Government has taken important steps to strengthen the supervision of the banking system, increase provisioning and reduce the level of non performing loans in public banks, modernize the infrastructure and the regulatory framework of financial markets, private firms are still constrained in their access to finance. Access is limited by high levels of NPLs, lack of venture-capital and long-term financing, as well as weak corporate transparency and financial disclosure. Improved governance, both of domestic banks and non financial enterprises, along with better corporate transparency and financial disclosure, are at the core of the reform agenda. Actions currently being taken by the Central Bank to establish a system of internal controls in banks in order to improve their ability to measure, supervise and manage banking risks should lead to greater transparency and better governance. In this respect, creating and implementing a regime for anti-money laundering and combating the financing of terrorism is key to improve governance as well as building confidence in the banking industry and non-banking financial sector, and thus to enhancing the business climate. The 2003 law on anti-terrorism and money laundering goes in the direction of complying with the recommendations of the Financial Action Task Force on Money Laundering (FATF). In addition, a law is currently being drafted which is expected to lead to greater transparency and accuracy of financial reporting as well as better enforcement of private sector accounting and auditing standards. Actions are also planned to modernize the commercial registers. At the same time, energizing the domestic finance markets is key to promote diversification of the sources of finance for private investment, better mobilize long-term savings, reduce refinancing and currency risks for public debt, and avoid overstretching of the banking system.

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Challenge 2: Establish a Knowledge Economy by improving the quality, relevance and financial sustainability of the education sector and by strengthening innovation systems and scientific and technological research

25. Tunisia’s education sector faces a critical challenge as a result of demographic transition. Thirty-five years of declining birthrates are now resulting in a reduction in the lower basic education student population, while secondary and higher education student numbers are growing rapidly as a result of increasing completion rates. Projections covering the period 2000-2010 show that basic education student numbers will decrease by 40 percent (or 470,000 students) and secondary education student number will increase by 80 percent (or 310,000 students). Students enrolled in higher education are projected to increase from 260,000 in 2003 to 400,000 in 2010. This trend challenges the education and vocational training systems to effectively accommodate the demand growth, while increasing quality and maintaining expenditures at current levels. Indeed, Tunisia’s share of public spending on education is already high compared to other middle-income countries (27 percent of total public expenditures and 7.2 percent of GDP in 2003) and cannot be expected to increase much. This challenges the Government to reduce inefficiencies, increase autonomy of universities and other educational institutions while introducing an incentive system which rewards good performers, and roll out cost-effective solutions that would guarantee the fiscal sustainability of its ambitious reform program. 26. Learning achievements, better linkages between education and the labor market, and scientific research and innovation need to improve markedly if Tunisia is to have the skills to compete in the global knowledge economy. Recent performance in international standardized testing was poor, reinforcing concerns about the quality of education. Ensuring that all children successfully complete the two cycles of basic education remains a challenge, as the repetition and drop-out rates in upper basic education remain high (9.7 percent dropouts and 19.5 percent repetitions). Failures at the higher education level are important: repeaters represent about 20 percent of students, exam rates were about 66 percent in 2002. The increase in unemployment of the educated labor force in the 1990s suggests that the education system is not adapting the skills of the future labor force to the needs of the labor market. While investments in scientific research have increased and measures have been taken to bolster the knowledge economy, public research remains largely disconnected from private sector needs and applications, and linkages between universities, the private sector and international R&D remain weak.

Challenge 3: Strengthen the performance of social programs while maintaining budget balances

27. Demographic trends and transformations in the labor market due to competitive pressures pose great challenges for health, social protection, and pension systems. Despite significant progress, the total out-of-pocket expenditures (not counting social insurance premiums) comprises almost 50 percent of all health expenditures, burdening the poor who are likely to spend a significant proportion of their income on private health care. In addition, quality and efficiency of health care services remain a major challenge and health care costs are increasing rapidly as the population ages. Implementation of the social health insurance reform is urgent and will need to tackle the financial risk protection concerns. The government plays a central role in social protection through large public sector employment, heavy regulation of the labor market, and tight control of vocational training, active labor market programs (ALMPs) and social safety nets. Spending on ALMPs is high (1.5 percent of GDP9) and increasing, yet, targeting of these programs is not adequate. The bulk of the programs benefit the post secondary graduates, which account for only 6 percent of the unemployed, while the pool of unemployed is

9 This figure includes pre-employment training as part of the AMLPs which is consistent with international definitions..

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dominated by those with primary schooling or less (86 percent of the unemployed). Coverage of the unemployed is weak and will become increasingly an issue as some of the traditional industries lay off employees when faced by greater international competition.10 The two pension funds are in a delicate financial situation which will deteriorate further with the rising proportion of old people in the population. Currently 33 percent of the population over 60 years old are receiving pension benefits, compared to 15 percent in 1984, and this is projected to increase rapidly. To ensure the financial equilibrium of the existing system, contributions rates will need to increase substantially but high payroll tax may discourage job creation and put Tunisia at a disadvantage with respect to its competitors. In addition, there is room for improving the management of the two pension funds by clarifying mandates and accountability. 28. Non-discretionary spending introduces serious rigidity on the public expenditure system which is characterized by a short-term focus and numerous tax exemptions and preferential regimes. Large non-discretionary components, comprising wages, interest payments, and social entitlements, account for over 70 percent of total public expenditures and about 24 percent of GDP. Non-discretionary items cannot be easily trimmed in adversity without threatening social stability and/or the country’s creditworthiness. Of particular concern is the government wage bill, which, at close to 12 percent of GDP, is among the highest in MENA and is steadily rising at the expense of social transfers and interest payments. Existing rigidities in the budget limit the room for fiscal maneuver in the face of shock, with the authorities only being able to respond by cutting public investment and more generally development expenditures with a detrimental impact on growth potential and social programs which already face a series of challenges. While public spending systems, control of public funds, and the accountability arrangements for their use are already quite strong, implementation of performance-based budgeting reforms, envisioned by the Government, would call for a more supporting institutional environment, in terms of the quality of budget formulation and execution. The Tunisian tax burden is not very high by international comparison, but its distribution appears to be uneven, both between labor and capital income and across taxpayers. Serious non neutralities exist in the taxation of corporate income and in indirect taxation that undermine the fairness of the tax system, narrow the tax base, create complexities that increase the cost of tax administration, and weaken incentives for tax compliance. B. Medium-Term Macroeconomic Prospects

Base Case Scenario 29. In a base case medium-term scenario, Tunisia could witness a relatively healthy growth, despite stiffer international competition, provided that reforms to enable a new development model are stepped up. The competitive pressures which could have a negative effect on non-agricultural growth in the coming years include: the possible loss of market share in traditional export sectors because of the elimination of MFA quotas and EU enlargement, increased imports during the completion phase of the free trade zone with the EU that may displace domestic production, and the slow-down of some key sectors such as tourism. In order to mitigate these pressures, Government will need to considerably strengthen the program of structural reforms, while ensuring macroeconomic stability in the face of an uncertain external environment, strengthening the investment climate and the soundness of the banking system, and speeding up the pace of liberalization in sectors still under state control. This would allow growth to continue at an average rate of 5 percent a year, at a similar pace than in the past, but less than the 5.5 percent anticipated in the 10th Plan (Table 1). In this scenario, exports could grow steadily due to the development of new engines of growth (in particular in services and the ICT sector), although at a more moderate pace due to the existing competitive threats. Consumption would keep growing at a healthy rate, though slower than in the past, reflecting the impact of persistent unemployment on

10 World Bank. June 2003. Report No. 25456-TUN. Republic of Tunisia : Employment Strategy.

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household incomes. Improvements in the business environment could lead to a progressive increase of the investment-to-GDP ratio over the 2004-08 period.

Table 1 : Base-case scenario—Selected Macroeconomic Indicators (percentages) Actual Est. Projected

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008Growth Rates Real GDP 6.1 4.7 4.9 1.7 5.5 5.3 5.0 4.8 4.7 5.2 Real Consumption 5.4 5.3 5.3 4.0 5.8 5.8 5.0 4.7 4.3 5.2 Real Gross Domestic Investment 4.9 6.9 6.2 -6.0 1.0 4.7 5.5 5.6 6.0 6.3 Export Volume, GNFS 4.7 7.7 12.1 -2.1 4.0 6.0 6.0 5.5 5.2 5.6 Import Volume, GNFS 3.0 9.9 13.4 -2.4 2.3 6.5 6.1 5.7 5.2 6.0 GDP deflator 3.1 3.3 2.7 2.3 2.3 2.4 2.2 2.4 2.7 2.8Ratios to GDP Gross Domestic Investment 26.3 27.3 27.8 25.2 24.1 24.0 24.1 24.3 24.6 24.9 Gross Domestic Savings 24.1 23.8 23.3 21.0 20.5 20.3 20.4 20.6 20.9 21.0 Fiscal Balance (excl. grants) -3.9 -3.8 -3.8 -3.5 -3.2 -3.2 -3.1 -3.0 -2.9 -2.9 Public Debt 60.0 60.7 62.4 61.6 61.0 55.8 54.5 53.9 53.1 52.4 External Current Balance -2.2 -4.2 -4.3 -3.5 -3.2 -3.2 -3.1 -3.1 -3.0 -3.0

30. The projected growth would be insufficient to reduce unemployment. Given the relatively low elasticity of employment relative to growth observed in recent years, and assuming no growth of employment in the public sector and agriculture, the unemployment rate could increase to approximately 16.4 percent during the CAS period. On current trends in labor force growth and participation rate, reducing unemployment to 13 percent by 2008 (from 14.3 percent in 2003) would call for growth of about 6.5 percent per year. All else equal, this would require a broad reform program to significantly improve the business environment and ensure adequate financing of private investments, leading to a much stronger private investment effort equivalent to about 7 percentage points of GDP. 31. Current account pressures could intensify, while some loss of fiscal revenues is expected. The base case scenario assumes that the Government will resolutely engage in fiscal consolidation in order to offset pressures on public finances and to maintain the deficit of the current account at approximately 3 to 3.2 percent of GDP. Such action should result in reducing the budget deficit (central government only, excluding privatization receipts and grants) to under 3 percent of GDP by 2008, which would require important efforts to rationalize public expenditure and enlarge the fiscal base as tax revenue collection declines due to the final removal of tariffs on imports from the EU. This effort of budgetary consolidation would reduce the public debt to GDP ratio to approximately 52 percent.11 Inflation, as measured by the GDP deflator, is expected to increase slightly but still remain contained, due to a prudent monetary policy stance. 32. Financing needs are projected to increase and will rely on access to international markets. The base case scenario projects total financing needs of about $13 billion over the period 2004-08, about 30 percent higher than in the preceding five years, owing to high debt repayments and a constant current account deficit (Table 2). After a peak in 2003, debt service as share of GDP is also expected to decline over the projection period, freeing up resources and allowing the reserves to be maintained at an equivalent of three months of imports. The external debt to GDP ratio is expected to decline between 2003 and 2008. Financing needs would also be likely to increase if the move to a more flexible exchange rate were to require, during the transition period, a higher level of foreign exchange reserves. An increase of foreign exchange reserves would also be required in case Tunisia were to adopt a more open regime for private capital movements. The base case scenario envisages a steady inflow of foreign direct investment 11 In the absence of decisive fiscal consolidation, the budget deficit would increase to approximately 3.5 percent of GDP and

the current account deficit could rise to 4 percent of GDP by 2006 due to liberalization of imports from EU and the risk of reduced growth of exports, while the debt to GDP ratio would remain at 2003 levels.

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(FDI) resources, although the pace will critically depend upon maintaining privatization efforts and further improving the environment for doing business.

Table 2 : External Financing Plan (US$ millions) Actual Est. Projected 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008Financing Needs 2130 1955 2077 2003 2610 2507 2482 2607 2694 2372 Current Account Deficit 443 821 863 746 774 799 800 842 858 922 Debt Amortization 1034 1374 959 1108 1307 1586 1435 1641 1547 1258 Reserves Accumulation 653 -240 255 149 529 121 247 125 289 192Financing Sources 2130 1955 2077 2003 2610 2507 2482 2607 2694 2372 MLT Loans 1526 1597 1842 1874 2657 2544 2196 2030 2137 1710 Multilateral 536 419 689 563 723 669 643 647 517 420 o/w: IBRD 210 136 293 117 251 102 212 226 243 239 Official Bilateral 256 281 325 202 486 397 304 302 331 331 Private Creditors 734 897 828 1109 1447 1478 1249 1082 1289 960 Foreign Direct Investment 337 731 443 801 504 600 622 637 616 669 Capital Grants 73 3 53 76 129 106 105 104 104 104 Other Capital Flows, net 194 -376 -261 -748 -678 -743 -439 -164 -163 -111

High and Low Case Scenarios 33. External or domestic risks could cause growth to fall by one to two percentage points below the base case scenario, resulting in higher unemployment and impeding the development of social programs. Two main developments could trigger lower growth. First, a combination of unfavorable external shocks could hit the economy, with growth slowing temporarily or persistently, depending on the duration of the shocks. The economy’s resilience would partly depend on the quality of policy adjustment (as in 2002), and partly on the strength of the investment climate and the soundness of the banking system. Second, a slowdown of reform efforts, in particular a failure to strengthen the investment climate as needed in the face of stiffer competition, would create unsustainable external and budget imbalances, increase public and foreign debt, and lead to increasing unemployment and lower FDI inflows. In this context, if borrowing conditions on international capital markets were to become tight, Tunisia would face difficulties in meeting its financing needs. 34. Swift action on the reform front would result in a higher growth, leading to a reduction in unemployment. Favorable exogenous factors, such as good rainfall and strong EU growth, could boost growth beyond the base case scenario during the projection period. A resolute acceleration of structural reform efforts, with the aim of considerably strengthening the investment climate and creating more opportunities for private investment, could also lead to higher growth. Leveling the playing field in investment incentives, liberalizing all of the currently protected markets, ensuring pro-competitive regulation, and taking ambitious steps in privatization of public enterprises would lay the ground work for stronger growth. In such a high-case scenario, growth could increase by one percentage point above the base case projection.

III. TUNISIA-WORLD BANK GROUP PARTNERSHIP FOR FY05-08

35. The World Bank’s partnership with Tunisia for FY05-08 aims to support the Government of Tunisia in addressing the key challenges of the 10th Plan and beyond. To do so, the CAS relies on: lessons drawn from past Bank performance (part A); guiding principles for the CAS which build on the Bank’s comparative advantage (part B); and a results-based strategy which focuses on achieving three key strategic objectives (part C). The CAS is also supported by a strong body of analytical work prepared for Tunisia in FY02-04: Development Policy Review, Poverty Update, Employment Strategy, Private Participation in Infrastructure Study, Tourism Strategy, Report on Observance of Standards and Codes

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(ROSC) on Accounting and Auditing, Country Financial Accountability Assessment, Country Environmental Performance Analysis, Country Procurement Assessment Review, and Strategy for Public Debt Management. It also draws on the four MENA regional reports prepared in 2003 and which are all highly relevant for Tunisia (Governance, Trade, Gender and Employment), as well as the recent report on Enhancing World Bank Support to Middle-Income Countries. A. Review of Past Bank Performance

Country Assistance Evaluation

36. OED’s Country Assistance Evaluation (CAE) rates Bank support overall as satisfactory, institutional development impact as substantial, and sustainability of achievements as likely. During the OED review period (1990-2003), the Bank’s programs successfully promoted policy reforms in trade liberalization, private sector development and financial sector. Bank assistance also contributed to significant progress in the rural and social sectors. The Bank’s major contribution in the rural sector was in putting Tunisian agriculture on the path of liberalization, supporting reform measures which contributed to increasing farm incomes in remote areas, and improving resource management sustainability. With Bank support, Tunisia made impressive progress in almost all areas covered by the MDGs, already meeting some targets, and the country is likely to meet others by 2015. While IBRD funding only represents 3 percent of net receipts of external financial resources and 0.7 percent of GDP, the Bank has served as a significant catalyst for mobilizing resources, leveraging nearly US$1 on every IBRD dollar.12 OED rightly emphasizes Tunisia’s own role in this success through strong ownership and broad political consensus, a well-developed human resource base, and stable macroeconomic environment. 37. The recommendations of the CAE have been endorsed by the Country Team and reflected in the CAS. The three key recommendations of the CAE are covered under the three strategic objectives pursued by the CAS, as follows: (i) continue to support improving the environment for private sector development and enhancing competitiveness (CAS Strategic Objective 1); (ii) continue support for social sectors (Strategic Objectives 2 and 3); (iii) help strengthen rural institutions to support efficient output and input markets while maintaining social and political stability through better targeted safety nets (Strategic Objectives 1 and 3). OED also recommended to adopt a results-based approach, which was done for the CAS. In terms of activities, the CAE recommended that the Bank undertake a Rural Sector-Wide Review and a Public Expenditure Review (PER), both of which are planned in the CAS.

2000 CAS Achievement Report (see full report in Annex 2)

38. The CAS Achievement Report (CASAR) concludes that the country strategy presented a well thought out strategy in support of the national objectives spelled out in the 9th Development Plan (1997-2001). During implementation of the CAS, the country team was responsive to the new priorities which emerged from the 10th Development Plan (2002-06), particularly in support of the emphasis on employment. While the CAS covered the FY00-02 period, the Bank continued to operate in FY03 and FY04 under the same CAS as its key strategic thrusts continued to be relevant to social and economic circumstances in Tunisia. As such, the CASAR measures results for the full period that the CAS was implemented: FY00 to mid-FY04 (December 2003).

12 World Bank, OED. Tunisia Country Assistance Evaluation. Net receipt of external financial resources, average for 1996-

2001 (Table 1.5 of CAE).

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39. The 2000 CAS made a satisfactory contribution to Tunisia’s development, with steady – although at times slower than anticipated – progress demonstrated in many reform areas, albeit difficult economic circumstances during the period. However, because the 2000 CAS was not designed using a results framework, it difficult to demonstrate the full extent of the outcomes achieved. Had outcomes been made fully explicit and quantifiable and outcome data collected in a systematic fashion during CAS implementation, it would certainly have been possible to demonstrate more results than those documented in the CASAR. In many outcomes, the Bank may have been overly optimistic when estimating the time frame needed and the readiness of government for reform. The main documented results for the three CAS pillars are listed in Box 3. 40. While recognizing the developmental results of Tunisia, the CAE and the CASAR point to shortfalls which pose risks to sustaining Tunisia’s development performance. These mirror the challenges identified in Chapter 2, namely the need to promote private sector development, to reform the financial sector, and to improve the overall efficiency and fiscal sustainability of social expenditures. The CAE adds that in the rural sector, addressing issues such as land tenure, rural finance, non-farm rural development and research and extension will be important, as these are areas where past Bank assistance programs were less successful.

Program Implementation Progress 41. The Tunisia portfolio has maintained a strong performance during the past four years. Since FY00, quality of the portfolio has remained consistently high and above MENA averages. OED evaluated a sample of 11 completed projects during FY00-03 and concluded that in 91 percent of the cases, quality at entry and supervision was satisfactory, as well as the Borrower’s performance for preparation and implementation of projects. Satisfactory project outcomes and likelihood of sustainability were also rated satisfactory in 82 percent of the cases. The Quality Assurance Group (QAG) reviewed quality of supervision in 22 projects, 90 percent of which were rated satisfactory. During FY00-03, the portfolio comprised 21 projects on a yearly average, but with numerous project closings in FY03 and FY04, the number of projects in the portfolio will be brought down to 11 by end FY04. This provides a unique opportunity for this CAS to be strategic in the choice of new activities. 42. Continued close follow-up and action from project teams ensured prompt resolution of occasional project management issues, but widespread delays in implementation have led to slow disbursement in FY00-02 and repeated closing date extensions. High proactivity rates and relatively low portfolio riskiness rates are indications of the quality of the portfolio and attention of project teams to resolving issues (Table 3). In addition, no project is currently classified at risk in the Tunisia portfolio. While the disbursement ratio surpassed the Bank’s projections in FY00, it slowed down in FY01 and FY02, and only picked up again in FY03. Of the 20 projects that were planned to close during the FY00-mid FY04 period, only two closed on their original closing date: ECAL II (adjustment loan) and the Municipal Development II project (financial intermediary loan). Projects were extended anywhere from 5 to 24 months, with a few extended twice. Repeated extensions put the average age of the Tunisia portfolio above the Bank and the Region’s averages for FY00-04 (average age of 4.6 years in FY04 for Tunisia opposed to 3.9 Bank-wide and 4.3 for MNA). A Country Portfolio Performance Review (CPPR) mission in June 2003 identified the key reasons for delays in project implementation (overly ambitious project timetables, insufficient planning and project preparation, and lack of attention to identifying project-level results and indicators during the preparation phase). The CPPR proposed specific recommendations to address these issues and to ensure timely implementation of projects, many of which have already been implemented, in particular in terms of capacity building (see CASAR in Annex 2).

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Box 3: Main results of the 2000 CAS

Pillar I: Support Human Development by Consolidating Long-term Development • Progress towards universal completion of basic quality education was steady but the target for this outcome has not been

fully met. It is estimated that the persistence rate13 will increase from 42 percent in 1999 to 55 percent by 2004, a substantial increase but short of the targeted 73 percent.

• The implementation of a new health insurance program was not achieved, and the Bank did not have the right instruments to influence this result. However, the Bank’s loan to the health sector was successful in improving the quality of care, building stronger institutions, and enhancing the allocative and technical efficiency and sustainability of the public health care system.

• Good progress was made towards promoting integrated water resource management and community participation, and protecting water and the environment. Water issues are no longer addressed in isolation, but in the broader context of environmental management and rural and agricultural development, with a shift from water supply management to water demand management. Progress has been made in scaling up participatory approaches which aim to enhance responsibility of users and improve the delivery of services.

• The outcome of creating an institutional framework conducive to sustainable development of public transport in major cities - including larger private sector involvement - has not been realized. The intermediate outcome of achieving lower costs of transport has been only partially reached.

• Progress was made towards consolidating municipal and urban development, and has been most significant in improving infrastructure and municipal services. However, the consolidation of municipal finance has not been fully achieved, and, as a consequence, the financial situation of Tunisian municipalities remains weak.

Pillar II: Integration of Tunisia into EU Markets by Supporting Economic Reforms. • Progress has been made to strengthen the financial sector but the CAS outcome has not been fully achieved, mainly because

it was a broad and ambitious expectation in a three-year period; even more so considering the policy and institutional reforms needed to achieve it, and the gradual approach of the Government to the reform process.

• The ambitious CAS outcome to boost private sector investment climate and streamline the business environment has only partially been achieved. Under ECAL III, actions taken have been in the direction of improving the private investment climate but one of the CAS milestones - that investment incentives for offshore-onshore enterprises be streamlined by CAS completion - has not been met.

• The outcome to modernize and liberalize public sector agencies and improve their service coverage and cost recovery - which covered in particular the liberalization and modernization of telecommunications and water and sanitation - has not been fully achieved. Reforms for telecommunications liberalization have been substantial but more remains to be done. Water tariffs represented 96 percent of the average water cost in 2002, a good improvement compared to the 1997-99 CAS baseline of 87 percent, but short of the CAS target of 110 percent. On the sewerage side, the cost recovery ratio declined to 65 percent in 2002.

Pillar III: Modernization of institutions and technological base through new initiative • The outcome of promoting export development by trade facilitation has been mostly achieved. The institutional framework

for exports has been modernized and trade facilitation has been automated resulting in greater transparency customs transactions and enhanced export development.

• Preserving Tunisia’s cultural heritage and diversifying tourism products has been partially achieved, as actions have been taken towards the achievement of intermediate outcomes, starting with the strengthening of the heritage preservation agency’s capacity to promote its assets, find new markets, and manage cultural tourism.

13 The persistence rate is the proportion of Grade 1 students who complete Grade 9 successfully in 12 years or less (i.e.

maximum of 3 repeats in the course of the basic education cycle). The figure for 1999 refers to students who entered Grade 1 in 1989, and the figure for 2004 refers to students who entered Grade 1 in 1994 and who will complete Grade 9 anywhere from 2003 to 2007.

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43. The AAA program has been mostly demand-driven, of high quality, and has played an important role in supporting the reform process, but its dissemination has been limited. Demonstrating great maturity in planning for development and in interacting with the Bank, the Tunisian authorities have been explicit in their requests for assistance and have carefully reviewed and critiqued all documents submitted to them. Most of the recent AAA products - DPR and the PPI, Employment and Tourism Studies - have been read, discussed and endorsed at the highest levels of Government. The Tunisian authorities generally value the Bank’s analysis and ability to support recommendations with cross-country experience. The two AAA reports reviewed by QAG during the period - the financial sector assessment program and the ICT report - received a rating of highly satisfactory and satisfactory respectively. Client feedback supports the fact that the Bank’s AAA has led to actions on reform and implementation of new policies. Although the quality of AAA in Tunisia is high, one of its limitations is that it has had a restricted dissemination outside of Government. This can be explained by the nature of the documents (demand-driven, policy documents) and by limited willingness, resources and expertise to reach out to a broader audience.

Table 3: Portfolio Management Indicators Projected Targets (FY00

CAS)

Annual Performance

Projected Targets

(FY04 CAS)

Indicator

FY00 FY01 FY02 FY00 FY01 FY02 FY03 FY04* FY05 – FY08 Disbursement ratio (%) 18 18 18 23.9 18.3 15.2 27.2 22 22 Disbursement Lag ; Orig. (%)

25 20 20 32.3 25.8 29.6 36.1 25 20

% Projects At Risk 5 5 5 4.2 4.8 21.1 5.6 0 5 % Problem Projects 5 5 5 4.2 4.8 21.1 5.6 5 5 Realism Index 100 100 100 100 100 100 100 100 100

* As of December 31, 2003. 44. The MENA region has piloted one of MNA’s first Programmatic ESWs, a multi-year program for analytical work, TA and capacity building in Tunisia. Following a request from Government to provide assistance on employment, it was agreed to use a sequenced process, based on a strong participatory approach to build consensus. A program was designed with emphasis on sector work (diagnosis, reform options, policy advice) and capacity building. The first stage activity (sector work on diagnostic analysis and policy recommendations) was completed in June 2003 and the Government identified five areas for further Bank support over the next 2 to 3 years (Box 4). A Memorandum of Understanding (MOU) should be formalized by mid-2004. The benefits of the PESW are the ability to agree jointly on a work program that supports important reforms and to mobilize commitment, expertise and resources in a multi-year framework.

Box 4 : Areas of Support under the Employment PESW The five areas of potential collaboration, that are expected to be reflected in the MOU between the Government and the Bank are the following: 1. Development of macro tools to evaluate impact of different sectoral patterns of growth on employment, in connection with

Tunisia’s integration into global trade; 2. Implementation of a business environment survey with an employment module; 3. Better understanding of the characteristics and constraints of the SME in terms of employment creation; 4. Improvement of the information system at household and enterprise level and introduction of dissemination mechanisms; 5. Development of evaluation studies to assess the impact of employment programs (ALMP, and pre-employment and in-

service trainings) and review of policy options, based on international experience, to improve the social protection system for those at risk of losing their job.

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45. Given alternative sources of financing at spreads lower than IFC’s, the Corporation's role has diminished in Tunisia, while MIGA has not underwritten projects in Tunisia during the past four years. IFC's portfolio is small, standing at US$7.5 million at end-March 2004, in equity positions. Since FY02, IFC has actively worked to exit a number of equity stakes, some of which the Corporation has held for over ten years and which have performed very poorly. IFC would be interested in investments in Tunisia if the Corporation's position changes and it can play a developmental role where commercial financial institutions are not providing services. In this context, IFC’s focus in Tunisia will be on new products or sectors such as ICT and large and complex private sector infrastructure investments. On May 6, 2004, the Board of Directors approved an investment of $50 million in the Banque internationale arabe de Tunisie (BIAT), the country’s largest private commercial bank. This investment will provide innovative Tier II financing to this bank and allow it to meet growing demand from private sector clients while at the same time improving key financial ratios and specifically taking additional provisions against non-performing loans. MIGA’s activities have been limited to profiling potential investment opportunities in Tunisia through its online investment services and information portal for international corporate investors. B. Key Features of CAS

Comparative Advantage and Guiding Principles 46. The Bank’s comparative advantage in Tunisia resides in its ability to support challenging and sensitive reforms, the credibility of its advice, and the quality of its expertise and knowledge in support of innovative approaches. The instruments upon which these rely are a mix of high-quality lending and demand-driven advisory products and services which introduce comparators from other middle-income countries with relevant experience. Through its AAA, the Bank has demonstrated that it is able to support policy decisions and reforms, while encouraging the Government and key stakeholders to address sensitive but critical issues such as economic governance. The Bank’s investment lending provides additional rigor in planning, execution, evaluation and safeguards and, through AAA and TA embedded into loans and regular supervision missions, provides intense knowledge-sharing around innovative ideas and cutting-edge practices. These aspects are appreciated by our client, and often outweigh the delays incurred due to relatively complex Bank procedures. 47. Building on lessons learned from the past, this CAS is based on the following guiding principles: a greater focus on results and quality; increased programmatic selectivity; strengthened partnerships and outreach; and additional flexibility in the approach and choice of instruments. These principles will be discussed in further detail but are briefly summarized here. § Results and quality: The CAS results framework provides the Bank and the Government with a

mechanism for monitoring progress towards achievement of CAS outcomes. It allows for timely identification of issues, problem solving and decision making, as well as for documenting successes and best practices. This raises accountability for teams and should lead them to make adjustments in the program to ensure that the best quality service is delivered to the client, at all stages of lending and analytical activities.

§ Programmatic selectivity: Programmatic selectivity aims at supporting a group of actions across sectors rather than isolated one-off interventions, moving the debate from more limited sectoral objectives to broader cross-sectoral outcomes. The expected outcomes constitute organizing principles through which the Country Team can decide which activities best support core development objectives over the medium-term.

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§ Partnerships and outreach: The CAS proposes enhanced cooperation with development partners, and in particular the European Union (see section IV.C). This partnership will be one of the vehicles for increasing the Bank’s outreach efforts with civil society (see section IV. B).

§ Flexibility in approach and instruments: Tunisia is a mature client of the Bank. It has been a member in good standing since 1952 and a stable borrower. As a result, the Bank has had sustained engagement in Tunisia and has good knowledge of the development challenges. In order to remain a partner of choice for this investment grade middle income country, the Bank will show flexibility in CAS implementation to accommodate requests of support which may not have been identified in this CAS, assuming that these are areas where the Bank has a comparative advantage. The Bank will also offer a more flexible range of instruments and better tailor products and services to meet the client’s needs (see section IV.A).

Consultations

48. A limited number of consultations were organized for this CAS and contributed to identifying the expected CAS outcomes. A two-day workshop with over 50 Government officials from all key Ministries was held in December 2003. It was an opportunity to discuss and validate the key findings of the DPR which constitutes the analytical base for the CAS, and to discuss key CAS outcomes for a four-year horizon. A similar workshop was organized in March to discuss the draft CAS and collect the Government’s comments. Additional consultations were held with ten line ministries, three unions (women, workers, and agriculture and fisheries), and business leaders during a workshop organized by the Arab Institute of Heads of Enterprises (IACE). Two workshops co-organized by the Bank provided an opportunity to hear the views of stakeholders on private participation in infrastructure and environmental sustainability. 49. The consultations with the private sector validated the critical importance of improving economic governance and the business environment in order to enhance growth and employment. Representatives from the private sector illustrated, through real situations, the bottlenecks and hurdles private entrepreneurs have to overcome, namely: numerous administrative burdens; insufficient use of information technology due to high costs and ways in which electronic communications are controlled; an environment that does not foster innovation, and inadequate transparency and predictability of the business environment because rules and regulations are not perceived as applying in the same way to all actors. 50. Consultations also validated the importance of continuing to support women’s participation in the Tunisian economy and society. Although Tunisia is at the fore in terms of women’s participation in economic and political spheres, many interlocutors stressed that much still remains to be done in order for women to reap the full benefits of progress and actively contribute to economic growth. They strongly suggested that Bank projects and analytical work should continue to systematically support women’s interests.

Results Framework 51. The Results Framework for the Tunisia CAS seeks to clearly indicate intended outcomes of the Bank’s strategy, in line with the country’s priorities (see Annex 1 and Figure 7). It identifies: (i) three key strategic objectives related to long-term national development goals as articulated in the 10th Development Plan; (ii) twelve associated CAS outcomes that the Bank can directly help to realize; (iii) related indicators and intermediate outcomes (milestones) that will be monitored to measure achievement of the CAS outcomes; and (iv) the mix of Bank products and services that are intended to best contribute to these outcomes, as well as other donor interventions. The framework also articulates the explicit link

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among all the activities supported by the Bank - lending and analytical work, ongoing and proposed – since it is the combination of these that will lead to outcomes. The long-term national goals are derived from the 10th Plan. Since this is the first attempt in a CAS with Tunisia to systematically identify results and indicators, the process will be refined during CAS implementation as part of a joint learning exercise. In particular, some indicators identified in the results framework will have to be better defined. The CAS progress report in 2006 will offer an opportunity to do this as well as to adjust the Results Framework, and in particular to reflect changes in national goals coming out of the preparatory work for the 11th National Plan (2007-2011). 52. The Results Framework is ambitious, and coordinated efforts on several fronts will need to be undertaken to achieve it. The CAS assumes that the twelve CAS outcomes can be achieved if the key reforms suggested in this document are implemented, allowing Tunisia to face the important challenges of the years ahead. Tunisia’s past development experience seems to indicate that this is feasible as the country has demonstrated steady results over the years, good planning and administrative capacity, and an ability to tackle complex reforms. In addition, country ownership of the development and reform agendas is high, as is Tunisia’s capacity to mobilize and coordinate support from development partners. Furthermore, the outcomes correspond to areas where the Bank has been supporting Tunisia and has both local and global knowledge and expertise to support the achievement of these outcomes. Finally, the framework also acknowledges that other development partners will support achieving the outcomes and identifies their role. 53. The Results Framework provides strategic direction but is not a blueprint for action. In line with the recommendations of the World Bank MIC strategy14, the CAS framework is intended to be sufficiently flexible to respond to evolving Government priorities and needs over the CAS period, and leave ample scope for dialogue to appropriately design future investment and adjustment lending operations. Also, the CAS does not present a final list of Bank Group activities for the next four years as doing so would be neither feasible nor advisable given the flexibility required in being responsive to a middle-income country. Illustrative lending and AAA programs are suggested for each of the three Strategic Objectives, with more certainty for the next one or two fiscal years (Table 4).

C. Expected Outcomes of CAS and Bank Support

Strategic Objective 1: Strengthen the business environment to support the development of a more competitive, internationally integrated private sector and improve competitiveness of the Tunisian economy

54. Improved incentives system and increased transparency and predictability of the regulatory framework (CAS Outcome 1.1.). Key options to address the challenges identified above would include: progressively harmonizing corporate incentives and tax system in order to level the playing field between onshore and offshore firms; continuing liberalization of foreign investment, in particular by progressively reducing restrictions to majority capital ownership by foreign investors such as requirements for prior approvals which could be replaced by technical specifications by sector; strengthening the Competition Authority and competition regulatory framework; and upgrading the capacity of the judiciary in terms of processes, institutions and human resources to ensure a more predictable, equitable and effective enforcement of laws and regulations. Other options in terms of fiscal reform include: a comprehensive examination of tax system; harmonization of the corporate tax system to improve its neutrality and eliminate existing distortions; phasing out the “forfaitaire” tax system for self-employed and SMEs. The Bank proposes to assist the Government through analytical work and the ECAL IV and ECAL V

14 “Enhancing World Bank Support to Middle Income Countries – Revised Version”, April 20, 2004., SecM2004-0071/1.

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adjustment loans which will probably benefit from parallel financing from the EU and AfDB given successful cooperation under ECAL III. The proposed Investment Climate Assessment (ICA) would be conducted in a participatory fashion in order to strengthen Tunisia’s capacity to conduct future such surveys to assess perceptions of local and foreign investors regarding the business environment, benchmark Tunisia with other middle-income countries, and establish temporal comparisons. A Legal and Judicial Sector Assessment could be conducted as it would provide a valuable understanding of the sector as well as an identification of the potential constraints to private sector development. It could lead to technical assistance and capacity building. 55. Reduced transaction costs for firms, leading to increased production and exports (CAS Outcome 1.2.). Options to achieve this include dismantling key import monopolies; revising the Customs Code; modernizing the commercial registries; and continuing to reduce tariffs on imports outside of the EU. The Bank will support this agenda through: ECAL IV and V; the ongoing Export Development Project and the new operation under preparation; the proposed Information Society project which would support firms in harnessing ICT to improve market access; possible analytical work and lending in support of SMEs; possible ESW on trade facilitation and logistics improvements. The ICA will inform the Bank’s work and will, in particular, shed light on specific barriers that women entrepreneurs and SMEs face. In order to help achievements on this outcome, the Bank expects to work with the EC and AfDB. 56. Improved delivery/efficiency of infrastructure services by public and private firms (CAS Outcome 1.3.), enabling the growth of private sector firms, as well as benefiting Tunisian citizens by contributing to enhancing their quality of life. Through sustained engagement in infrastructure and the recent PPI study15, the Bank is in a position to support the government to: make public utilities more efficient; improve the regulatory framework; and enhance private sector participation in infrastructure. The Bank will support this agenda through ongoing projects (Transport Sector Investment I and II, Greater Tunis Sewerage, Municipal Development III); new lending (Urban Water Supply Loan in preparation, possible transport project to support reform of Tunis urban transport services); ongoing GEF project on Solar Water Heating and proposed project on Energy Efficiency; ESW on infrastructure (PPI, competition and regulation, and specific sectors such as electricity and gas, ports and airports); World Bank Institute (WBI) capacity building program on regulation of PPI; and possible World Bank Group guarantees in support of specific operations. This is an area where collaboration is expected to continue with the EC, AfDB, and could be developed with EIB. In addition, the Bank could support the implementation of the reform program suggested in the tourism strategy through a technical assistance or a sector investment loan, which would complement the ongoing Cultural Heritage project (and a possible repeater operation).

15 In order to support the objective of the 10th Plan to increase private participation in all sectors, including infrastructure, the

Government called on the Bank and EC to conduct an in-depth study on PPI, which took two years to produce following a participatory process involving key ministries, and was discussed in an open forum in December 2003. The PPI study makes horizontal and sectoral recommendations which the Government is in the process of reviewing before adopting a PPI strategy and action plan.

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Figure 7: Illustrative Results Framework

Increased budget flexibility and better fiscal mobilization to reduce public debt (3.1) Performance budgeting and M&E operational in key line ministries (3.2)

…while maintaining macro economic stability and upholding social achievements.

Objective 2: Enhance skills and employability of graduates in an increasingly knowledge-based economy

Improved incentives system and increased transparency and predictability of regulatory framework (1.1) Reduced transaction costs (1.2) Improved delivery of infrastructure services by public and private firms (1.3)

Improved coverage, quality and financial sustainability of health, and pension systems (3.3)

Improved quality and relevance of all levels of the education system (2.1) Improved financial sustainability of the education system (2.2)

Objective 1: Strengthen the business environment and improve the competitiveness of the Tunisian economy

Objective 3: Improve the quality of social services through enhanced efficiency of public expenditures

Increased sustainable growth leading to more job opportunities …

Increased competitiveness of agriculture while enhancing social and environmental sustainability (1.4) Banking sector more responsive to needs of private sector (1.5) More dynamic local public and private financial markets (1.6)

Improved linkages between research, higher education, and the marketplace (2.3)

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57. Improved competitiveness of agriculture while ensuring that social and environmental concerns are properly addressed (CAS Outcome 1.4.). This outcome targets a specific sector because this is a sector that faces important challenges in terms of competitiveness and social and environmental issues. It is also a sector that the Bank has been supporting for several decades and in which it has a strong involvement. Intermediate outcomes that the Bank could support in order to assist Tunisia to improve competitiveness of agriculture include: making regular adjustments of irrigation water tariffs to better reflect costs; reorganizing and regionalizing agricultural research to make it more responsive to farmers’ demands; and improving statistics and information to better inform production and investments choices. World Bank support for the next four years will include: ongoing and proposed portfolio of loans for agriculture and natural resource management with particular emphasis on water and land conservation (Natural Resource Management, Water Sector Investment, and proposed repeater projects, Agriculture Support Services, Northwest Mountainous and Forestry Areas Development); GEF projects (Protected Areas Management, and proposed Golfe de Gabes Marine and Coastal Resource Protection Project and Africa Stockpile Project (regional program) which will assist Tunisia in meeting the objectives of the Stockholm convention on eliminating persistent organic pollutants); strategic environmental assessments in the agriculture and tourism sectors, and one to measure impacts of climate change on natural resources management; TA and AAA on environment for harmonizing environmental impact assessment systems, mainstreaming environment in sectoral policies, and developing environmental indicators related to MDG#7; Rural Sector-Wide Review as suggested by CAE and requested by Government; and ESW/TA for water resource management (Box 5). Gender issues will continue to be given priority in all of the Bank’s lending and analytical work given the central role that women play in these sectors. For this outcome, the Bank expects to work in collaboration with the EC, AfDB, AFD, GTZ and KFW.

Box 5: Proposed Key Analytical and Advisory Activities for Agriculture and Water

To address the concern of OED and the Government that the Bank has not conducted a rural sector-wide review in 21 years, such a review is proposed during the CAS period. The review will analyze key challenges faced by the rural sector such as natural resource management and water pricing, rural unemployment and under employment, lack of safety nets for rural population, constraints faced by women, competitiveness of agriculture (product quality and standards, foreign market access - in particular EU, liberalization of food marketing), delivery of agricultural support services, and increased participation and decentralization of decision making. The review will also address challenges for which Bank support has not been as effective according to the CAE, namely access to rural finance and land consolidation and tenure security. The review will provide recommendations for future reform for the Government and for future Bank operations. Given that the Government and other partners have conducted numerous studies on water in recent years, the Bank does not propose a comprehensive water sector review but rather a mix of policy notes, TA and capacity building in order to support the Government in making necessary reforms in this area. This support will complement work conducted under Bank projects in the rural (Water Sector Investment) and urban space (Greater Tunis Sewerage, Urban Water Supply project under preparation). It will help the Government to enhance sustainability of water through: the design of effective institutions, policies and regulations (i.e. updating the Water law which dates back to 1975); better integration of rural and urban concerns (now under one same Ministry); enhanced cost recovery and efficiency of water supply and irrigation, while protecting low income users; more private participation in the sector; optimization of existing hydraulic infrastructure assets and water conservation; empowerment of water user associations; and improved water quality and reuse management. The work will require a concerted effort between Bank teams working on rural and urban water and sanitation. 58. Banking sector more responsive to the needs of the private sector (CAS Outcome 1.5.). In order to address the key constraints faced by the banking sector, the Bank will support the Government’s efforts to: set and enforce provisioning targets; strengthen the protection of creditors’ rights in bankruptcy by simplifying and improving bankruptcy procedures; improve financial information on the quality of borrowers by aligning national accounting and auditing standards with international standards; strengthen incentives for the rigorous application of high quality financial reporting and auditing standards in the

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private sector; gradually enact legislation to reach greater compliance with International Financial Reporting Standards and strengthen institutions to enforce these standards;16 reinforce the existing credit registry; and promote enhanced competition in the banking sector. These reforms would allow banks to take more risks in financing private enterprises, including small and medium enterprises, on the basis of a sound assessment of the enterprises’ business plan. World Bank support will mostly be mobilized through ECAL IV and V, coordinated with other donors supporting the financial sector (i.e. AfDB, EC and AFD), and follow-up technical support to the ROSC on Accounting and Auditing. 59. More dynamic local public and private financial markets (CAS Outcome 1.6.). Examples of areas where the Bank could support reforms over the next four years include: implementing the new law on business groups to facilitate the creation of a larger number of companies for listing on the stock exchange and to strengthen corporate transparency; passing regulations to promote development of life insurance; and improving regulation of secondary market for government securities. The actions listed above to improve corporate transparency will also support achievement of this outcome. Main Bank instruments in support of these reforms are: ECAL IV and V; an IDF grant for public debt management; the financial TA support for public debt management and local debt market development described in greater detail in section IV.A.; and study on non-banking financial sector.

Strategic Objective 2: Enhance skills and employability of graduates and labor force in a knowledge economy

60. Improved quality and relevance of all levels of the education system (CAS Outcome 2.1). The Bank is well positioned to help the Government of Tunisia achieve this outcome through its long and successful cooperation with Tunisia in the field of education (the first education loan of the Bank was for Tunisia in 1962). During the CAS period, the Bank will support the efforts of the Ministries of Education and Higher Education to roll out competency-based education to upper basic education by 2008; pilot demand-side financing; redesign the vocational training tax after analyzing the costs and benefits of the current system; and reduce obstacles for provision of in-service training by firms. Bank support could also help enhance participation of communities in the decision-making process at school level through capacity building; introduce greater financial and personnel management and pedagogic autonomy of universities and other post-secondary training institutions; and design and implement an active policy to support lifelong learning. Instruments in support of this outcome are: EQIP II (Education Quality Improvement Program) approved in March 2004 and a possible third operation in FY08; the Higher Education Project II and the third of this series which is under preparation for FY06; a proposed vocational training project (FY08); and AAA in frontier areas such as lifelong learning and the future of vocational training. This outcome will also be informed by the Employment PESW and the ICA. The Bank will ensure that the support it brings to education reinforces the achievements of Strategic Objective 1. This will be achieved by ensuring that educational programs are responsive to the needs of the private sector, and of particular sectors such as tourism and agriculture. Collaboration will continue with the EC, AfDB, AFD which are active in support of education and training. 61. Improved financial sustainability of the education system (CAS Outcome 2.2). This will be achieved through a set of measures such as: updating the tuition fees policy; increasing the share of student services outsourced; and increasing the share of educational expenditures funded from non-public

16 The ROSC on Accounting and Auditing suggests ways in which Tunisia can design and strengthen the suitable institutions

to implement and enforce principles which draw upon internationally accepted practices, including relevant portions of the European Union law, also known as the acquis communautaires.

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sources (i.e. private providers of education). Bank support to achieve this outcome will come through the same lending instruments mentioned above as well as a study of the economics of education which will rely on data collected through a public expenditure review. 62. Improved linkages between research, higher education and the market place leading to greater innovation and competitiveness of firms (CAS Outcome 2.3). This will entail reorganizing and modernizing research institutions; supporting innovation and job creation through additional technoparks; addressing obstacles and enhancing incentives for innovation and scientific research; and publishing an annual report on knowledge economy to measure results achieved and set future policy directions. The “Knowledge for Development” (K4D) program of WBI conducted in 2003 an assessment of progress made by Tunisia towards becoming a Knowledge Economy which provides a solid analytical base for future interventions. A component on innovation is also planned for the Information Society Project. In all activities, special attention will be paid to the role of women in research and to fostering specific applications which benefit women.

Strategic Objective 3: Improve the quality of social services through enhanced efficiency of public expenditures

63. Increased budget flexibility and better fiscal mobilization to reduce public debt (CAS Outcome 3.1.). The Bank has begun to work with the authorities on improving the management of public expenditures and has collaborated with the Ministry of Finance to develop a debt management strategy. The Bank is well placed to continue this assistance and support the Government during the next four years to progressively reduce the multiplicity of the VAT regimes in order to broaden the tax base and narrow the statutory tax rates, and reorganize and modernize debt management institutions by 2006. Activities in support of these reforms will be: Public Expenditure Review (PER), IDF grant for debt management, TA support for public debt management and local debt market development, and possibly analytic work on options for civil service reform and examination of tax system. The PER is of particular importance as it could help build capacity to prioritize public spending and provide the basis for measures to efficiently address social expenditures. Bank staff have developed strong expertise in the areas of budget reform and could help provide the analytical basis for assistance for other development partners. In particular, AfDB has expressed interest in supporting this effort. It is proposed that the PER be followed by a programmatic ESW in the field of public finance management to support the Government’s efforts in implementing the reform agenda. 64. Performance budgeting and M&E operational in key line ministries (CAS Outcome 3.2.). The Bank will support the Government in taking the following actions: preparation of medium-term fiscal framework setting overall macroeconomic and fiscal policy parameters for the budgets; integration of recurrent and investment budgets at all stages of budgetary cycle in order to support implementation of performance budgeting by 2008; evaluation of at least two performance budgeting pilots in line ministries; and evaluation of efficiency for at least five public investment programs. Activities in support of this outcome will be: ECAL IV and V, PER, follow-up work to the CFAA, and additional ESW and TA as needed. 65. Improved coverage, quality, and financial sustainability of health, social protection, and pension systems (CAS Outcome 3.3.). The following will contribute to achieving this outcome: (i) Health: comprehensive health insurance reform passed by 2008, improving coverage, financial risk protection, and benefit packages; actions toward better regulation of private health providers taken by 2008; enhanced information systems put in place by 2007; and pre-requisites for well-functioning private

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insurance market in place; (ii) Social Protection and Active Labor Market Policies: initial plans made to achieve better balance between economic and social needs through less direct protective measures inside the firm and more effective social protection outside the firm; (iii) Pension: strategy for reform developed by 2006 and reform program launched by 2008. Bank support to achieving this outcome will be organized around: AAA (PER with special focus on social sectors, health sector review (to be completed in FY04), employment PESW, and strategy note on pension reform); capacity building (such as on impact evaluation of training and social programs); and possible future lending (health and SME/employment loan). The Bank’s support in health and other sectors will also include awareness raising activities and policy dialogue on HIV/AIDS. Indeed, although Tunisia’s prevalence rate among the population is low (0.06% in 2001, UNAIDS data), the unreliable surveillance system could mean that serious outbreaks in certain populations could be missed. The Bank proposes to support Tunisia to ensure that it acts now to keep the prevalence rate low. In addition, gender issues are of key importance in the social areas and will be given particular attention in all Bank activities. Analytical work on gender (in particular a country gender assessment focusing on the role of women in the labor market) could be carried out.

IV. VEHICLES FOR WORLD BANK GROUP PARTNERSHIP WITH TUNISIA

A. Bank Instruments

Analytical and Advisory Services 66. The Bank will continue to invest in producing high-quality, demand-driven AAA while strengthening systems to maximize and measure impact and being proactive in putting forward critical issues that are relevant to the reform process in Tunisia. The Bank will continue to mobilize its best expertise to ensure quality and timeliness of AAA in response to Government demand, and will continue to pilot the PESW approach. It will strengthen its role as key partner in support of difficult but critical reforms by challenging the Government and other key stakeholders to think about new options for reform, take stock of support for the reforms, identify appropriate entry points and sequence interventions so that they add incremental value. As part of the monitoring of CAS outcomes (see section V), task teams will be asked to document in a more systematic fashion how a given AAA product or process contributes to reaching CAS outcomes. 67. A technical assistance program will be conducted jointly with the IMF, with the aim of assisting the Government to improve debt management and to develop the local debt market. The program will support reforms and capacity building, in coordination with the IDF grant for debt and budget management, based on diagnostic work already carried out as part of ECAL III, in cooperation with the Ministry of Finance. The program aims to improve the country’s capacity in central government debt management, in particular the development of the domestic debt market.

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Table 4: Indicative Base Case Assistance Program17 Lending Operations Amount

(in $M) AAA and trust funds

FY05 ECAL IV Information Society project

GEF projects (grants): Golfe de Gabes Energy Efficiency Africa Stockpile –(regional operation)

150 to 200 15 to 20

6.1 8.5 5

Core diagnostic and Other diagnostic Public Expenditure Review Investment Climate Assessment Country advisory and Policy notes PESW on Employment Study on non-banking financial sector Additional demand-driven policy notes

Technical assistance/Trust funds TA program on public debt management and development of local debt market (with IMF) TA for production of an annual report on knowledge economy and support on scientific research policies and innovation Trust fund for statistical capacity building IDF for Public debt management, and Women and regional development

FY06 Urban Water Supply Higher Education Reform III Natural Resource Mgmt. II Tourism

50 to 70 50 to 60 30 to 40 40 to 50

Core diagnostic and Other diagnostic Follow-up on Investment Climate Assessment Country advisory and Policy notes Rural Sector-Wide Review PESW on Employment PESW on Public finance management Dialogue on Pension reform Infrastructure / Water Notes Economics of Education Note Additional demand-driven policy notes Technical assistance/Trusts funds TA on social and environment safeguards TA on procurement and financial management certification TA support for financial market integrity Trust fund for statistical capacity building, IDF for Public debt management

FY07 ECAL V Water Sector Investment II SME/Employment

150 to 200 50 to 70 30 to 50

Core diagnostic and Other diagnostic CAS Progress Report

Country advisory and Policy notes PESW on Employment PESW on Public finance management Strategy Note on Pension reform Study on lifelong learning and vocational training Strategic environment assessments (tourism, agriculture, climate change) Additional demand-driven policy notes Trust funds IDF for Public debt management

FY08 Tunis Urban Transport Health Sector Education Quality Improvement Project III Vocational Training

for all: 200 to 300

Core diagnostic and Other diagnostic Development Policy Review Country advisory and Policy notes PESW on Public finance management PESW on Employment Follow-up support on knowledge economy and innovation Additional demand-driven policy notes

17 Given the flexibility that will be sought in the Bank program in order to respond to evolving Government priorities and

needs, this table proposes illustrative lending and AAA and is subject to change during CAS implementation. Lending amounts are indicative and are within the base case lending scenario proposed in Section IV. D. Several of the AAA products will require work over more than one fiscal year; their expected delivery date is shown here.

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Lending and Other Financial Products 68. Tunisia is a good candidate for scaling up the Bank’s interventions through further reliance on country systems. Early findings of these Country Procurement Assessment Review (CPAR), Country Financial Accountability Assessment (CFAA), and Country Environmental Performance Analysis (CEPA) indicate that Tunisia’s fiduciary and safeguard procedures are well designed and its laws and capacity are of high quality. However, improvements have to be made in how the laws and regulations are implemented, in particular in reducing delays in executing decisions (procurement), in modernizing the accounting and control systems to adapt to the emerging needs, and in improving the disclosure of environmental assessments. The CFAA indicates that Tunisia’s budget process is governed by clear rules and procedures; budget execution provides timely and reliable budget reporting; and the control framework is comprehensive. Thus, Tunisia represents a moderately low to low fiduciary risk. The good performance of the Bank’s portfolio in Tunisia also points to strong implementation capacity at the level of the ministries. This has enabled the government to successfully implement sector wide approaches in areas such as water, in particular through the Water Sector Investment Program which includes three donors (AFD, WB, AfDB) in addition to the government, produces common reporting (except for the annual audit), and relies on existing institutional arrangements. In such an environment, the Bank will increasingly move towards relying more on country institutions and procedures, strengthening the capacity as needed, and focusing less on individual transactions. 69. The Bank will extend the use of programmatic lending and SWAps during the CAS period, given Tunisia’s adequate institutional capacity to implement this type of projects. Under SWAp arrangements, Bank teams will certify country procedures in procurement, financial management and safeguards in given sectors and will design programs to strengthen country practices and capacity for greater development effectiveness. This will be carried out through technical assistance on procurement and financial management, and on social and environmental safeguards. Efforts to strengthen financial management will focus on improving reporting and controls to meet the needs of performance based budgeting being progressively implemented by Government. The European Commission is piloting a SWAp for the higher education sector, and this could open the way for other such SWAps in the future to reduce the transaction cost to both the borrower and the development partners. Adjustment lending will continue to be a key instrument to support Tunisia’s reform agenda. In addition to structural adjustment lending, the Bank will explore the possibility of using Programmatic adjustment lending for the ECAL loans in order to best support reforms that involve multi-year policy changes and institution building. 70. In order to best respond to Tunisia’s needs, the Bank will strive to simplify and reduce the cost of traditional sector investment lending. Bank teams will work with the client to design investment projects that are simple, realistic regarding the types and pace of reforms that are feasible in the medium-term, and not overloaded with sector conditionality. Teams will make the most of the Bank’s simplification agenda and the positive changes made to some of the policies, such as the eligibility of expenditures, the audit and flexible reporting policies, to reduce transactions costs and ensure that both new and repeater projects are easier and quicker to process. Bank funded projects in Tunisia will continue to be implemented through the existing government systems with no parallel systems set except for reporting and auditing. To support environmental programs in Tunisia, the Bank will continue to make available financing from the Global Environment Facility (GEF). Tunisia has successfully implemented several GEF projects, and several more are planned under the CAS.

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71. The Bank will step up its assistance to the Government to structure an adequate portfolio of IBRD financial products and services. The cooperation will focus on the potential use of existing IBRD financial products to manage Tunisia’s financial risks, in line with the government’s debt strategy. While the Government has diversified the funding sources of its program over the last few years, tapping the financial markets efficiently, IBRD borrowing has contributed to lowering the cost and risk structure of its overall funding program and has provided Tunisia with a stable and reliable source of funding. For its new IBRD loans, Tunisia has moved to the Fixed Spread Loan (FSL) with embedded risk management tools that the Government has used effectively to manage the currency, interest rate and rollover risks. In addition, Tunisia was the first country to sign a Master Derivatives Agreement (MDA) with the World Bank in March 2003. The MDA gives Tunisia access to a range of hedging products (e.g., currency swaps, interest rate swaps and interest caps and collars) linked to existing World Bank loans, as well as technical support of the World Bank’s Treasury staff. These hedging products would further enhance Tunisia’s capacity to manage the financial risks in their debt portfolio. Tunisia could also consider the use of the Deferred Drawdown Option (DDO) to manage the liquidity risk emanating from unexpected shocks.18 72. Within the agreed upon lending envelope, IBRD loans, guarantees and hedging products could be applied at two levels (country portfolio and individual projects) and two dimensions (existing portfolio and new pipeline). At the country portfolio level, well structured IBRD financial products could support Tunisia’s debt management strategy by providing means to better manage risks inherent in the portfolio of IBRD debt. This could be achieved through the use of: (i) traditional IBRD lending as needed; (ii) guarantees; and (iii) IBRD intermediation for long dated derivatives transactions. For example, the customized repayment schedule could be used to reduce the rollover/refinancing risks of the government and the use of the currency, and interest rate hedging products could help the Government manage the financial risks of their overall debt portfolio. In the case of the development of the local debt market and, potentially, the local currency swap market, Tunisia might choose to use the local currency financing of IBRD to further reduce its currency risks. At the project level, the Government will be able to use flexible features embedded in lending products along with IBRD hedging products and guarantees to maximize developmental impacts of certain programs by achieving the desired cost/risk structure of certain existing projects or structuring more adequate financing for new projects (i.e. projects with longer loan maturities, up to 25 years). B. Outreach, Communication and Capacity Building 73. This CAS puts a renewed emphasis on outreach and communication. The CAS consultations reaffirmed the importance of reaching out and listening to different voices. All stakeholders expressed great interest in interacting more with the Bank to debate development issues and have greater access to Bank reports (global, regional and national). The main vehicle for outreach efforts will be conferences and workshops on topics of relevance for Tunisia’s or the region’s social and economic development (i.e. conferences on the four MNA regional studies of 2003 and the MNA report on HIV/AIDS), ongoing consultations in the Bank’s activities, and strengthening the Public Information Center (PIC) which is housed within the library of the University of Tunis. Consultations around the CAS will continue after

18 A DDO gives IBRD borrowers of a single-tranche adjustment loan the option of deferring the loan’s disbursement for up to

three years, provided that overall program implementation and the macroeconomic framework remain adequate. Exercising the DDO gives borrowers access to long-term IBRD resources to maintain ongoing structural programs if market borrowing becomes difficult and a financing need materializes. In this way, a DDO can facilitate a more effective response by the Bank in the event that temporary market access constraints might become prolonged and a borrower might need to rely more on the IBRD than previously anticipated to meet ongoing funding needs.

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publication in order to interact with those met during the CAS process and share the Bank’s strategy with a broader audience. In addition, Bank teams working on lending and analytical work will be encouraged to identify mechanisms early on for engaging with civil society and strengthening participatory processes. Several of the Bank’s rural development programs have been successful in this respect and lessons learned should be applicable to projects in other sectors. The PIC’s impact will be increased by generating greater awareness of its services among students and other stakeholders. The Bank’s outreach efforts will be conducted jointly with local and development partners such as the European Commission Delegation in Tunis which is proactive in its outreach efforts and has expressed willingness to co-organize events with the Bank. 74. The Bank will continue to support capacity building within Bank funded projects and will capitalize on Tunisia’s role as a “hub” for capacity building within the MENA region and sub-Sahara Africa. As it is currently done within each project, the Bank will continue to support learning opportunities for key stakeholders in technical skills or on reform issues through participation in training or conferences and study tours. The Bank will also increasingly support learning efforts across projects, in areas such as M&E, impact evaluation19, and fiduciary and safeguard procedures. As a well-performing middle-income country, Tunisia has a wealth of experience to share with countries that are undertaking reforms in areas where Tunisia has been successful such as education, health, environmental protection, rural development, etc. The Bank has established partnerships with several training institutes and research organizations20, which will be called upon to play an active role in regional networks of research and training institutes supported by the Bank, and in particular by WBI which has established a hub in Marseilles, France in March 2004. In addition, the Joint Africa Institute of AfDB-WB-IMF has temporarily relocated to Tunis (from Abidjan) and will be seeking additional opportunities to work with Tunisian partners in a broad range of sectors. C. Development Partners 75. Cooperation with development partners has been close in the past years and will continue to be enhanced during this CAS period. Bank teams will continue to work with bilateral donors (AFD and GTZ, in particular), Arab funds (such as Arab Fund for Economic and Social Development), the Islamic Development Bank, and multilateral initiatives such as the Mediterranean Environmental Technical Assistance Program (METAP21). The focus of the cooperation will be on upstream collaboration on assistance strategies, joint analytical work, and - to the extent possible - greater harmonization of procedures to minimize the cost and burden of borrowing for the Tunisian government and obtain greater leverage than through traditional parallel financing. The temporary relocation of the AfDB to Tunis and the expanded role that the European institutions play in Tunisia also provide opportunities for increased cooperation. The Bank will also continue to collaborate closely with the IMF which conducts regular

19 A course on impact evaluation of training programs was successfully delivered in January 2004 in Morocco to over 80

participants from Tunisia and Morocco. This was the fruit of a close collaboration between MNA, WBI and WB’s Human Development Network, and future such events will be organized during the CAS period.

20 Such as the Tunisia International Center for Environmental Technologies (CITET), the Center of Arab Women for Training and Research (CAWTAR) which is the implementing agency for the MNA Gender and Development Network, supported by the Development Grant Facility., Institute of Development Finance of the Arab Maghreb (IFID) and IACE, individually and through regional networks such as the Mediterranean Development Forum (MDF).

21 METAP was established in 1990 to bring together 14 Mediterranean countries to cope with and reduce the effects of environmental degradation. It pools resources from EC, EIB, UNDP, and Swiss Development Cooperation. CITET hosts the METAP Environmental Impact Assessment (EIA) Regional Unit and provides EIA training and TA in setting up national EIA systems.

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monitoring missions (in the context of the Article IV of the IMF Articles of Agreement) and provides TA for monetary and exchange rate policy. 76. The proposed program of cooperation between the EC and the World Bank would seek to enhance upstream coordination, joint analytical work and project financing, and outreach. The European Commission and the World Bank are complementary institutions in Tunisia and there is great willingness among the two institutions to capitalize on each other’s comparative advantages. The EC draws its main comparative advantage from the fact that it is a key strategic partner for Tunisia given the importance of EU in economic and political relations, in particular through the AAEU. EC has a support program of euros 144 million for 2005-2006 and has increasingly decentralized its staff and decision-making (40 staff at the Delegation in Tunis). The EC values the partnership with the Bank, particularly because of the depth and quality of analysis Bank teams bring to key reform issues. Both parties have agreed to engage in dialogue during formulation of their respective country assistance strategies in order to identify opportunities for collaboration as early as possible. This would lead to greater collaboration on analytical work, possibly through pooled resources. The Bank could work with the EC to support the Government in defining and implementing its action plan for the “New Neighborhood” policy of the EU (Box 6). Joint financing is expected for ECAL IV and the higher education SWAP, while additional sectors could be identified in the next few years.

Box 6 : The New Neighborhood initiative -- what's at stake? In the context of EU enlargement in May 2004, the European Commission recently launched a comprehensive reassessment of its assistance strategy towards neighboring countries. The EU Council approved in June 2003 a foreign policy framework entitled ‘Wider Europe-Neighborhood Policy’ and a Task Force was set up within the EC. This policy framework sets out terms of engagement for the coming decade with Russia, the Western NIS22 and the Southern Mediterranean Region (SMR)23, which do not currently have a perspective of membership in the EU but will soon find themselves sharing a border with an enlarged Union.

The new policy framework aims to build a zone of political stability and shared prosperity—a ‘ring of friends’—around the Union by encouraging political, economic and social reform with the promise of deeper economic integration with the EU. More specifically, the policy framework sets out a process akin to the Accession model, whereby progress on national Action Plans and progressive liberalization would be rewarded with Neighborhood Agreements giving the neighbors a stake in the EU’s internal market. This new Policy suggests that, in return for concrete progress demonstrating shared values and effective implementation of political, economic and institutional reforms, all the neighboring countries should be offered the prospect of a stake in the EU’s internal market. This should be accompanied by further integration and liberalization to promote the free movement of persons, goods, services and capital (four freedoms).

A strategy paper will outline the broad policy lines of the initiative, including the horizontal and political elements of the EU ‘offer’ to partners. Benchmarks will be set to evaluate progress in key areas (like market economy, approximation to EU standards, etc). Progress on political reform will also be assessed, in terms of democracy, rule of law and human rights. While the details of the strategy as still being discussed, the important features are emerging: (i) financial assistance is to be more strongly focused on socio-economic reforms; (ii) new Neighborhood Agreements will improve on current Association Agreements, and; (iii) the principle of ‘differentiation’ would allow the Commission to reward fast-reformers with privileged economic integration and financial assistance and should trigger competitive liberalization among peers. 77. The European Investment Bank is stepping up its investments in Tunisia through the Euro-Mediterranean Facility for Investment and Partnership (FEMIP) program, opening up new opportunities for collaboration. The FEMIP was launched in October 2002 in order to increase EIB lending to Mediterranean countries to euros 2 billion a year and to expand areas of investment.

22 Ukraine, Moldova and Belarus. 23 The Southern Mediterranean countries are: Algeria, Egypt, Israel, Jordan, Lebanon, Libya, Morocco, Palestinian Authority,

Syria and Tunisia.

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Traditionally, EIB has invested in infrastructure and financial sector, but is now expanding investments in support of human development (health and education), private sector development, and South-South collaborative projects. For instance, EIB’s 2003 portfolio in Tunisia includes a loan of euros 110 million for the health sector and euros 150 million for a global fund to support Tunisian enterprises. EIB has expressed interest in working closely with Bank in jointly designing and financing projects, and providing coordinated support in the form of TA for implementation. This collaboration will be explored in greater depth during the CAS period in order to identify specific projects for collaboration. 78. Collaboration with the African Development Bank will be reinforced through regular contacts, upstream coordination, joint analytical work, and parallel project financing. AfDB’s temporary relocation in Tunis provides greater ease for regular contacts. Upstream coordination was initiated through discussions of early drafts of this CAS, and AfDB will solicit Bank views on its upcoming strategy paper (planned for 2005). Areas for joint analytical and project work include public expenditure review, ECAL IV, infrastructure, and rural development. D. Lending scenarios 79. For the CAS period FY05-08, a flexible base case program of $200 to $300 million a year on average is proposed in order to support the key development objectives of the CAS. The base case lending scenario aims to provide enough flexibility to respond to opportunities for high-quality lending and help support the reforms needed for Tunisia to sustain the growth levels described in the base case and high case medium-term scenarios described in Section II.B. While Tunisia still faces a number of vulnerabilities that call for further strengthening the macroeconomic fundamentals, and while outstanding IBRD and preferred creditor exposure is high, the proposed lending amounts and the attached flexibility are consistent with sound risk management in view of the expected development progress and poverty reduction and the projected improvement of IBRD exposure indicators. The program is superior to lending levels of prior years since IBRD lending to Tunisia averaged $160 million a year during the FY00-03 period, slightly below the lower limit of the base case envelope of $200 million a year. The base case program would include at least one policy based operation, ECAL IV, focusing on private sector development and the financial sector, and possibly a second one (ECAL V). The lower limit of the lending envelope aims to secure needed support to achieve the three strategic objectives of the CAS under the policy performance indicators laid out in the results matrix, while the higher limit would enable the Bank to support accelerated structural reform as described below. Under the proposed lending scenario ($200 million per year), IBRD’s exposure indicators will slightly improve, with IBRD debt to GDP declining from 7.5 percent in 2003 to 5.5 percent in 2008 and share of IBRD debt in total external debt declining from 12.7 percent in 2003 to 10.9 percent in 2008. IBRD debt service to total public debt service is also projected to decline (Annex B7). Under the upper limit of the base case scenario, IBRD debt to GDP is projected to marginally decline to 6.5 percent by 2008, while the share of IBRD debt in total external debt will only fall to 12.5 percent. 80. An acceleration of structural reforms, beyond the pace envisaged under the CAS expected outcomes, would allow an increase in the base case lending program up to an upper limit of $300 million per year. Fast disbursing loan commitments, including adjustment lending, could reach a maximum of $600 million over the whole CAS period, of which a maximum of $300 million for the first half of the period (FY05-06). Enhanced lending would facilitate the implementation of complex reforms -including the financing of the associated adjustment costs. The Bank would be watching for accelerated reforms in the following key areas: investment climate, privatization of key public enterprises such as utilities and banks, liberalization of trade regime, and reform of social security and pension. Progress in

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any of these areas, as gauged by the following policy performance indicators, would allow the Bank to move toward the upper limit of the base case, as long as the Government is undertaking the necessary fiscal consolidation effort to allow a rapid reduction of public debt and hedge more effectively against external vulnerabilities: § A radical reform of the framework of investment incentives that would level the playing field for all

firms and investors. This would entail unifying the corporate tax rate for offshore and onshore firms to a tax neutral rate, significantly below the current statutory corporate tax rate. The risk that some footloose offshore firms may chose to relocate in other countries would warrant enhanced support by the Bank.

§ Significant privatization measures, especially in public utilities still in public hands, bringing proceeds to above 1.5 percent of GDP per year.

§ An ambitious liberalization of the trade regime for non EU imports, along with a dismantling of key state import monopolies.

§ Measures to improve the flexibility of the labor market, by reducing protection inside the firm while increasing protection outside of the firm through the implementation of appropriate safety nets (including unemployment insurance).

§ Privatization of major banks and reforms aiming at strengthening the banking system by improving the provisioning of NPLs.

§ Initiation of social security and/or pension reforms. 81. Borrowing in excess of the CAS limits could be envisaged in specific circumstances by using special structural adjustment loans to help Tunisia cope with increased financing needs due to external shocks and other unpredictable factors. In the past, Tunisia has coped successfully with external shocks thanks to a sound macroeconomic framework and policy adjustment carried out in a timely manner. Support by the Bank would be conditional on maintaining a satisfactory macroeconomic framework. The Bank would coordinate with the IMF to ensure that such a framework was put in place. 82. A low case lending scenario would result from difficulties in maintaining a stable macroeconomic framework or a slowdown in the pace of structural reform . The Bank would move to a low case lending scenario in the event of significant deterioration of the main macroeconomic indicators (especially the fiscal deficit to GDP ratio, the public debt to GDP ratio, the external current account deficit to GDP ratio) compared to the base case scenario (Tables 1 and 2), which would place Tunisia in the low case medium-term scenario described in Section II.B. Another reason to move to the low case would be significant delays in simplifying investment incentives and addressing the level and provisioning of NPLs in the banking system. In this situation, the lending program would be focused on a few investment-type operations and would not exceed $100 million a year.

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V. RESULTS-BASED MONITORING AND EVALUATION: PARTNERSHIP FOR MEASURING RESULTS

83. Monitoring of the CAS will rely on existing mechanisms for data collection, M&E linked to the 10th Plan, and outcome and output indicators available in the Bank portfolio of projects and analytical services. Tunisia has made significant progress in focusing on results in the 10th Plan. In order to monitor achievements, the Bank will rely on the annual progress reports of the Plan as well as the comprehensive assessment published at midway, all of which mostly indicate achievements on inputs and deliverables, but also highlight a certain number of outputs and outcomes. Many indicators in the results matrix (Annex 1) are available at the project level because the results chain links outcomes at the project level with CAS outcomes and indicators. Monitoring of CAS outcomes will be conducted by members of the country team and rely on better data collection at the project and AAA level to demonstrate results. A harmonized system of results reporting will be developed and will create an additional incentive for project teams to manage for results. The strengthening of the M&E architecture will serve as the basis for self-assessment in the CAS Progress Report to be prepared in 2006 and the CAS Completion Report to be prepared in 2008. Future CPPRs should also be aligned with the results framework in order to deal with risks and systemic issues that might hinder achievement of the outcomes. Results of these assessments will feed into the next CAS cycle. 84. While Tunisia has good M&E capacity, the Bank will help support strengthening of existing systems and institutions. To address demand for capacity building in M&E expressed during the CPPR mission of June 2003, a first mission was conducted in January 2004. Recommendations for future support during the CAS period include: increase attention to M&E at every stage of project cycle and encourage broader participation of all stakeholders in defining results and performance indicators; adopt simplicity in project design and development objectives as this has proven to be highly correlated with achievement of intended results; shift the focus of supervision missions from control to partnership for measuring results by using a harmonized M&E framework that can be monitored by project teams and the Bank at the same time; create an M&E network of resource people. Efforts will also be conducted to improve capacity in conducting impact evaluations of programs and in using M&E information in the management of programs and projects. 85. The greatest impetus for strengthened M&E at the national level will come from progress in performance-based budgeting, relying on a medium-term expenditure framework (MTEF). The MTEF will formulate indicators against which expenditure efficiency can be evaluated over the medium term. Positive outcomes would include: allocation of resources to strategic priorities between sectors; increased commitments to predictability of both policy and funding so that ministries can plan ahead and programs can be sustained; increased incentives for efficient and effective use of funds. Tunisia has already started results-based budgeting in the higher education sector, and the University of Sfax is the first pilot.

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VI. MANAGING RISKS

86. The Bank’s program over the next four years faces country risks related to Tunisia’s greater integration into global markets, macroeconomic and financial vulnerabilities, and the lack of political will for reform or slow pace of change. Greater integration into global markets, in particular, the tariff reductions scheduled in the AAEU and loss of tax revenues on external trade, will increase exposure to volatility, enlarge the financing needs in the budget and put pressure on both current account and budget deficits. Risks also arise from “homegrown” macroeconomic vulnerabilities, which may give rise to contingent and implicit liabilities of the state.24 This two types of risks can be mitigated through the implementation of a multi-faceted reform program as described in the CAS. Given economic and political uncertainties, the Government may choose to slow down or hold back on important reforms in an effort to maintain internal stability. Yet, if lack of reforms in important areas such as improving economic governance and social protection lead to increased unemployment and reduced living conditions, social unrest could result. The Bank can play a role in mitigating this risk by continuing to demonstrate the expected benefits of the reform agenda through high-quality analytical work, and helping to build coalitions of support within Government and civil society at large. 87. The program also faces risks pertaining to regional and country instability. Regional instability in the Middle East and North Africa and increased concerns of terrorism attacks could affect Tunisia in the coming years: tourism may fail to reach the expected levels, Tunisia may lose some of its attractiveness for foreign investors, and internal security and controls may be reinforced. At the same time, internal stability may be increasingly threatened. As Tunisia faces key challenges ahead - further integration in the international economy, greater access to information as Tunisia transitions towards a knowledge economy, potentially rising unemployment - the pressure for greater democracy, accountability, and freedom of speech is likely to increase and could lead to social tensions if not accommodated. The Tunisian Government is well aware of these risks and is taking action to mitigate them. In particular, Tunisia plays an important role in international affairs to help ensure greater regional stability and continues to maintain internal stability through sound economic management, social progress, and strong security aimed at containing extremism. The Bank will monitor the political situation in the region and in the country carefully in order to be prepared to respond to changes.

James D. Wolfensohn President

By: Shenghman Zhang

Washington DC June 3, 2004

24 Possible sources include: (i) the under-provisioned, non-performing loans accumulated by the banking system, and by public

banks in particular; (ii) the unfunded liabilities of the pay-as-you-go pension system; (iii) guarantees on the foreign-currency debt issued by public enterprises; (iv) performance guarantees to private providers of infrastructure services, through Build-Operate-Transfer (BOT) or Build-Lease-Transfer (BLT) agreements, if not properly designed; (v) foreign exchange guarantees may generate fresh debt if adjustment to persistent external shocks were to partly rely on exchange rate depreciation.

- 36 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Strategic Objective 1: Strengthening the Business Environment and Improving the Competitiveness of the Tunisian Economy

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4

year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner

interventions for each strategic objective

Increased sustainable growth through greater participation of firms, in particular SMEs, in all sectors Annual growth rates of 5,5 % in 2004-2006. Private investment reaches 58,5% of total investment in 2006.

• Lagging local and foreign

investment due to high discretionary intervention by government and regulatory uncertainty, perceived lack of transparency and preferential treatment of certain firms, and weak market contestability.

• Incentives and taxation favor off-shore firms.

1.1. Improved incentives system

and increased transparency and predictability of the regulatory framework*

• As measured by annual FDI

inflows increase by 15-20% by 2006, and 50% by 2008. (baseline: $650 million average 2002-2003).

• Comprehensive examination of

tax system. • Leveling of playing field between

onshore and offshore firms through progressive harmonization of incentives and corporate tax system.

• Continued liberalization of foreign investment.

• Competition Authority and competition regulatory framework strengthened.

• Upgrading the capacity of the judiciary.

Ongoing Lending: • Export Development • Transport Sector Investment I

and II • Greater Tunis Sewerage • Municipal Development III • Cultural Heritage • Natural Resource Management • Agriculture Support Services • Water Sector Investment • NW Mountainous and Forestry

Areas Development • Protected Areas Management

(GEF) • Solar Water Heating (GEF)

Increased production and exportation of services and products by firms, especially by SMEs in higher-value added segments Annual growth rates of services of 7,5% in 2004-2006, increasing to x% by 2008. Annual growth rates of exports of goods and services of 6% in 2004-2006, increasing to x% by 2008. Reduced unemployment from 15% to 13% by 2006.

• High transaction costs for

business entry, operation and exit; high cost of customs procedures.

• Efficiencies in trade logistics and supply chain need to be enhanced in order to avoid exposing Tunisian firms to lost export opportunities.

• Exports concentrated in sectors (40% clothing) and markets (75% EU).

• Insufficient private investments in R&D, innovation, quality standards, and marketing.

1.2. Lower transaction costs • Number of procedures to start a

business reduced from 10 to 4 by 2008.

• Minimum capital requirement reduced from 352% of GDP per capita in 2002 to below 50% by 2008.

• Cost of closing business reduced from 8% of estate to 6% by 2006 and 4% by 2008.

• Customs clearance and technical controls delays reduced from an average of 8 days in 2003 to 2 days in 2008.

• Key import monopolies dismantled.

• Revised Customs Code adopted by Parliament.

• Commercial registries modernized.

• Continued reduction of tariffs on imports outside of the EU.

Ongoing AAA and TFs: • IDF on public debt management • IDF for women and regional

development Proposed Lending: • ECAL IV with EC and

AfDB(FY05), ECAL V (FY07 ) • Export Development II (end of

FY04) • SME/Employment (FY07) • Tourism TA or SIL (FY06) • Urban Water Supply (FY06) • Information Society (FY05) • Tunis Urban Transport (FY08) • Repeater projects: Natural

Resource Management (FY06), Water Sector Investment (FY07), Cultural Heritage (tentative)

* This outcome will mostly be influenced by measures taken under ECAL IV and V. Since preparation of ECAL IV only started in March 2004, the intermediate outcomes and indicators have been kept broad and will be refined during implementation of the ECAL loans. The CAS completion report will reflect these changes. This also stands true for CAS outcomes 1.5., 1.6. and 3.1.

- 37 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4

year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner

interventions for each strategic objective

Modernization of infrastructure services to increase quality and efficiency, and opening of investment to private sector Growth of ICT sector by 21% in 2004-2006 to increase its contribution to GDP by 7 percent in 2006 (up from 3.3 percent in 2001). Transport sector value added increases to an average of 5.5% per year during Plan period. Electricity average annual growth rate of 7.2% within Plan period to increase energy sector value added by an average of 4.3% per year. Increase energy efficiency and develop renewable energy sources. Increase rate of rural electrification from 91,7% in 2001 to 95% in 2006. Average growth of 4.9% of tourism industry (hotels, cafes and restaurants). Increase of hotel occupancy rate of 55% while increasing number of beds by 38,000 during the Plan period.

• Low levels of administrative and

financial autonomy of public utilities.

• Insufficient cost recovery due to tariffs not aligned with cost of service.

• “Contrats-programmes” (contracts between Government and utilities) are not sufficiently designed as output-based contracts and implementation often does not follow agreements made (i.e. financial compensation of certain public service mandates not always honored).

• Labor costs represent high share of operating expenses of public utilities.

• Lack of business mentality, “client” orientation, and feedback mechanisms in public utilities.

• Limited openness to competition in infrastructure leads to high costs of services.

• Lack of appropriate legal and regulatory framework (i.e. concession law) hinders private investment.

• Government commitment to liberalize still tentative yet tariff increases and capacity for additional public funding for these sectors are constrained.

• Tourism receipts volatile and dependant on international context. Market shares are decreasing.

• Financial and environmental sustainability of many hotel units precarious.

• Low rates of occupancy and low revenue per tourist.

• Tunisia tourism shows little product variety and low image.

1.3. Improved delivery/efficiency of infrastructure services by public and private firms Telecoms and ICT • Increase in share of ICT sector in

GDP by 2% in 2008. • Number of fixed and mobile

telephone lines as % of population reaches 60% by 2008 (up from 32% in 2003).

• 30% of population uses the internet by 2008 (up from 6% in 2003 ).

• 4,000 internet hosts are based in Tunisia by 2008 (up from 1,625 in 2003).

Transport • Container terminal of Rades

privatized by 2006 and Centre-Est airport put in concession by 2006.

• Subcontracting of urban transport services (passenger-km) of 3% by Société des transports de Tunis by 2006.

• Labor costs of Société nationale des chemins de fer tunisiens (national railways) < 50% of total operating expenses by 2006.

Energy • Increased gross investment in

energy efficiency in Tunisian industry corresponds to $20 million for 2005-2008.

• Energy saving of at least 10 ktoe per year.

Public Sector • Steps towards greater disclosure

of information on public enterprises (financial statements, audits, key performance indicators) taken.

• Government reviews tariff regulations for services not open to competition ( regulated by “contrats- programmes”) and enforces compliance with quality of service standards.

Regulatory Framework • Government establishes

benchmarking for all sectors. • Legal and regulatory framework

for private sector participation adopted for transport, electricity and telecom (concession law or other form).

• Regulatory institutions set up (energy, transport) or strengthened (telecom).

Private Sector Participation • Government adopts a strategy

and action plan for accelerating participation of the private sector in infrastructure by end 2005 and rolls out a communication strategy by 2006.

• Announcement of ICT liberalization plan.

• Establishment of a sustainable energy efficiency market for Tunisian industry.

Proposed GEF: • Golfe de Gabes (GEF) • Energy Efficiency (GEF) • Africa Stockpile (GEF) Proposed AAA, TA and TFs: • Employment PESW • ICA with focus on gender and

employment dimensions • Study on non-banking financial

sector • TA support for public debt

management and local debt market development

• TA support for financial market integrity

• ESW and TA on infrastructure (PPI, regulatory issues, sector specific support, i.e. transport); WBI capacity building program on regulation of PPI

• ESW and TA on water • Rural Sector-Wide Review • TA on social and environment

safeguards (also applies to strategic objectives 2 and 3)

• TA on procurement and financial management certification (also applies to strategic objectives 2 and 3)

• Strategic Environment Assessments

• Additional demand-driven policy notes

• Other WBI programs, activities conducted jointly with Joint Africa Institute

- 38 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4

year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner

interventions for each strategic objective

Water Supply and Sanitation • Average water tariff/average cost

increases to 110% in 2008 (2002: 98)

• Average sewerage tariff/average cost increases to 80% in 2008 (2002: 67.6)

• Unaccounted for water reduced to 18% in 2008 (2002: 20.1%)

Municipal Infrastructure • 100% of municipalities with

financial situation problems have restructuring plan contracts.

• 1 private concession project financed by 2005, 3 by 2008 in municipalities.

Tourism • Increase of tourism receipts by

tourist of 5% by 2008 (baseline: 400 TD per tourist in 2002).

• 4 million visitors on cultural sites by 2008 (up from 3 million in 2003).

Tourism • Public tourism institutions

(ONTT, AFT, cultural heritage management institution) reorganized by 2006.

• New marketing plan for tourism adopted by 2006.

Partners: EC • Operations support for

implementation of association agreement, “mise a niveau” of enterprises and industry, competitiveness, promotion of foreign investments, technical assistance for privatization, rural development, natural resource management and water management.

• Collaboration with Bank expected on ECAL IV and PPI (possible use of grants to support legal and regulatory reforms).

EIB • Portfolio of loans to private and

public enterprises ( i.e. cement and steel companies) and for infrastructure (energy, transport, water supply, solid waste, etc); lines of credit (“global loans”) to support SMEs and private firms.

• Areas of possible collaboration with WB: municipal development, tourism, water and infrastructure.

Increased competitiveness of core sectors such as agriculture while preserving natural resources Agricultural growth of 3.5% a year while preserving natural resources.

Agriculture • Agriculture facing

competitiveness challenges due to increased international competition and fast changing environment.

• Agriculture is vulnerable to environmental degradation.

• Water subsidization runs counter to the objective of increasing water tariffs and water saving devices to improve efficient use.

1.4. Increased competitiveness of agriculture while enhancing social and environmental sustainability. • Improved irrigation efficiency

from 85% in 2003 to 105% in 2008.

• (Other indicators to be proposed following the completion of the Rural Sector-Wide Review and reflected in CAS Progress Report).

• Regular adjustment of irrigation

water tariffs to better reflect costs.

• Agricultural research and extension is responsive to farmers’ production constraints and improved by 2007. (e.g. adapting crop varieties to associated climatic variability, research on irrigation techniques appropriate to each crop and region).

AfDB • Loans in financial sector, “mise a

niveau” of firms, infrastructure (transport, water supply, solid waste, electricity), rural development, water resource management; line of credit to SMEs.

• Future collaboration expected on ECAL IV.

- 39 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4

year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner

interventions for each strategic objective

• Continued subsidization of wheat maintains an incentive system that favors the cultivation of cereals, a lower value crop.

• Agricultural producers are not making the most of export opportunities with EU.

• Rural poverty and vulnerability remains high.

• Research and extension not sufficiently demand-oriented and not well translated into extendable messages.

• Land tenure and access to rural finance could be improved.

• Agriculture and fisheries statistics and information more widely used for production and investment choices and risk management.

AFD • Supports « mise a niveau » of

firms, industrial zones, urban and rural development.

• Areas of possible future collaboration: water, tourism, financial sector.

JBIC • Loans in power, water and other

infrastructure sectors. KfW and GTZ • Water resource management,

environment

Financial sector modernized and more efficient

• High levels of non-performing

loans (> 20% of assets), low provisioning (44%).

• Lack of venture capital and long term financing; insufficient access to credit for SMEs due to high collateral requirements.

1.5. Banking sector more responsive to needs of private sector * • Level of NPLs reduced from 22%

in 2002 to below 17% in 2008.

• Central Bank sets and enforces

provisioning targets by 2005. • Regulations on corporate

bankruptcy revised by 2007. • Regulation enacted to strengthen

corporate transparency (financial disclosure and auditing).

• National accounting and auditing standards aligned with international standards.

• Credit registry strengthened.

UNIFEM • Study on gender implications for

economic reform

Diversified, dynamic financial markets for government and private securities

• Issuance in primary market limited and inactive secondary market.

• Rigid monetary framework that does not allow sufficient interest rate flexibility and prevents development of active money market.

• Anemic private securities market. • Weak corporate transparency.

1.6. More dynamic local public and private financial markets * • Increase number of firms listed in

stock exchange from 42 in 2003 to 60 by 2008.

• Flexible money market interest rate created by 2007.

• Share of bond issues and increases in equity capital through the stock exchange goes from 6% of gross investment in 2002 to 10% in 2008.

• New law on business groups is implemented and facilitates creation of larger number of companies for listing on stock exchange.

• Regulations passed to promote development of life insurance.

• Improved regulation of secondary market for government securities adopted by 2007.

* see previous footnote.

- 40 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Strategic Objective 2: Enhancing Skills and Employability of Graduates and the Labor Force in a Knowledge Economy

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4 year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner

interventions for each strategic objective

Improved efficiency of education at all levels and increased employability of graduates. Enrollment in higher education increases to 30% in 2006.

• Learning achievements need to

be improved in context of knowledge economy.

• Weak link between education system and labor market resulting in high unemployment of young graduates, in particular women.

• Lifelong learning opportunities limited: insufficient adult learning and labor market training for unemployed or at-risk adults.

2.1. Improved quality and relevance of all levels of the education system • Primary completion rate

increases from 87% in 2003 to 90% by 2007.

• Secondary education completion rate 50% by 2008.

• At least 40% of university students graduate from 2-year degree programs by 2006.

• Student to computer ratio drops to 15:1 in secondary schools by 2008.

• Competency based education

rolled out to upper basic education by 2008.

• Demand side financing piloted in at least 10% of private institutions by 2007.

• Government addresses obstacles that impede in-service training development (through review of financing options for in-service training, particularly for SMEs, and reform of vocational training tax, including gender issues).

• Share of Ministry of Education operational budget allocated to activities managed at school level maintained at current levels.

Ongoing lending: • EQIP I and II • Higher education II • Agriculture Support Services Proposed Lending: • EQIP III (FY08) • Higher education III – possibly

jointly with EC as SWAP (FY06) • Vocational training (FY08) • Information Society Loan with

component on innovation (FY05) Proposed AAA and TA: • Economics of education study

linked to public expenditure review

• ICA

Improved resource mobilization to meet demographic challenges.

• Rapidly increasing numbers of

students in secondary and higher education.

• High levels of public spending on education (7.2% GDP in 2003).

• Large share of recurrent resources on salaries to the detriment of other pedagogical inputs.

2.2. Improved financial sustainability of the education system • Share of budget for non-salary

current expenses remains at least at 2.5% for primary and 6.5% for secondary.

• 50% of student services outsourced by 2008.

• Tuition fees policy updated. • Incentives designed to increase

the share of educational expenditures for non-public sources and outsource student services.

• Employment PESW • Study on lifelong learning and

vocational training • TA for production of an annual

report on knowledge economy and support on scientific research policies and promotion of innovation

• Additional demand-driven policy notes

Modernized scientific and technological Research infrastructure and more dynamic innovation capabilities. 1 % GDP spent on research by 2004 and 1.3% by 2008

• Public research insufficiently linked to private sector needs and applications.

• Weak linkages with higher education institutions and private sector.

• Low levels of spending in R&D. • Insufficient linkages with

international research and development.

2.3. Improved linkages between research, higher education and the marketplace leading to greater innovation and competitiveness of firms. • Share of students graduating with

scientific and technological qualifications increases to 42% by year 2008.

• public institutions in charge of research reorganized and modernized by year 2008.

• 4 new technoparks created leading to creation of 2,000 jobs in the private sector by year 2007.

• Completion of an audit of obstacles for innovation by 2005.

• Enhanced incentives for innovation by 2006.

Partners: EC • Supports professional training,

higher education (SWAP 2004), preparing support for secondary education. Close collaboration with World Bank.

- 41 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4 year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner

interventions for each strategic objective

• At the graduate level, female students are less visible in the scientific and technical fields.

• Employment rates among these graduates increases to 90% by year 2006 (87% currently).

• Doubling of number of start-ups by year 2008.

• Increase of 50 % of private sector investment in R&D by year 2008.

• Completion of an audit of research organizations (technical centers, public laboratories, university units) by 2006.

• Publication of a yearly report on knowledge economy and innovation by 2006.

EIB • Has expressed interest in

investing in education and training – possible collaboration with WB.

AfDB • Higher education loan ongoing.

Cooperation with WB. AFD • Vocational training support

ongoing. JBIC • Possible investments in

technoparks.

- 42 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Strategic Objective 3: Improving the Quality of Social Services through Enhanced Efficiency of Public Expenditures

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4 year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner interventions for each strategic

objective

Macro-economic balances maintained to enhance economy’s ability to manage external shocks. Savings increase by 7% a year in 2004-2006 to 25.2% of GDP in 2006. Inflation rate stays within limit of 3%. Budget deficit reduced to 2% by 2006. Current deficit reduced to 2.4% of GDP by 2006.

• Large, non-discretionary

expenses (wages, interest payments, social entitlements ) account for over 70% of total public expenditures and wage bill is growing.

• Tax system suffers from a number of exemptions and multiple preferential treatments.

• Public debt remains high.

3.1. Increased budget flexibility and better fiscal mobilization to reduce public debt* • Wage bill reduced to and kept

below 40% of total central government expenditures by 2008 (from 46% in 2003).

• Total public debt reduced to under 55% of GDP by year 2008 (from 61% in 2003).

• Interest payments reduced to 10% of total central government expenditures starting from year 2006 and kept below thereafter (from 11.5% in 2003).

• Initial plans made for reduction

of multiplicity of the VAT regimes reduced to broaden the tax base and narrow the statutory tax rates.

• Debt management institutions reorganized and modernized by 2006.

• Reduction of share of non-discretionary items in total public expenditures (from over 70% in 2002).

Ongoing Lending : none Ongoing AAA or TA: • Capacity building on impact

evaluation with WBI • Trust fund for statistical capacity

building • IDF for public debt management

and for women and regional development

Proposed lending: • ECAL IV • Health TA or SIL (FY08) • SME/Employment (FY07)

• Budgetary cycle insufficiently

integrated with medium-term economic planning exercise.

• Limited integration between recurrent and investment budgets.

• Social security funds and municipal budgets not consolidated with overall budget.

3.2. Performance budgeting and M&E operational in key line ministries • Program and performance

budgeting piloted in two large ministries by 2006 and rolled out to key line ministries by 2008.

• Medium-term fiscal framework

prepared by 2006 setting overall macroeconomic and fiscal policy parameters for the consolidated general government budget.

• Recurrent and investment budgets integrated at all stages of budgetary cycle in order to support implementation of performance budgeting by 2008.

• Evaluation of performance budgeting pilot in two ministries conducted by 2007.

• Efficiency of five public investment programs evaluated by year 2008.

Proposed AAA and TFs: • Public Expenditure Review • PESW on public finance

management • Employment PESW • Strategy Note on Pension Reform • TA support for public debt

management and local debt market development

• Additional demand-driven policy notes

* see previous footnote.

- 43 - CAS Annex 1 - TUNISIA FY05-FY08 CAS Results Matrix

Long-Term Development Agenda for Tunisia

Outcomes influenced by the CAS Program during the 4 year period

Bank Assistance

Tunisia 10th Plan Goals

Major Issues which hinder the ability to achieve the National

Goals

CAS Outcomes that the Bank

expects to influence through its interventions in 4-year period and outcome-level indicators

Intermediate outcomes to track

implementation towards expected CAS outcomes

Bank and Partner interventions for each strategic

objective

Improve living standards for all in context of changing demographics. 90% of population covered by social protection regime by 2006.

• Aging population (close to 10%

of population is over 60) leading to greater pressure on pension and health systems.

• High levels of private health expenditures (50%).

• Quality of care provided in public sector perceived to be inferior to that provided by private sector.

• Quality and efficiency of health care stands to be improved due to over-use of some institutions (university hospitals) and under-use of others (local hospitals).

• Government plays central role in social protection through close regulation of labor market.

• High amount of ALMP spending on post secondary graduates (80% of spending for 6% of the unemployed).

• Need better impact evaluation of ALMPs.

• Bulk of social protection provided by enterprises.

• Little use of user surveys or feedback mechanisms.

• Need to ensure financial sustainability of pension systems and improve coverage.

3.3. Improved coverage, quality, and financial sustainability of health, social protection and pension systems Health • Health care expenditures increase

by no more than 10% from 2004 to 2008 ( vs. 215% increase between 1987-1997).

• Share of private expenses for health care reduced from 49% in 2002 to 40% in 2008.

• 10 % of regional and university hospitals accredited by 2008 (baseline: 0).

Social Protection • Number of ALMPs is

consolidated or reduced, based on evaluation of impact and cost-effectiveness.

Pension • Reform program launched by

2008.

Health • Stakeholder support leads to

comprehensive health insurance reform passed by 2008 improving coverage, financial risk protection, and benefit packages.

• Actions toward better regulation of private health providers taken by 2008: accreditation programs in place based on transparent criteria, regulation mechanisms defined.

• Pre-requisites for well-functioning private insurance market are in place: required changes to legal and regulatory framework are known, capacity to regulate improved.

Social Protection and Active Labor Market Policies (ALMPs) • Initial plans made to achieve

better balance between economic and social needs (i.e. more efficient and effective social protection system inside and outside the firm).

Pension • Strategy for pension reform

developed by 2006.

Other Activities: • WBI program on health sector

reform Partners: • EC: Support to reform of health

insurance and employment (Agence de l’emploi).

• EIB: Loan for health sector

(infrastructure and equipment), 2003.

- 44 -

Annex 2: Tunisia 2000 CAS Achievement Report Date of CAS: April 27, 2000 Progress Reports: None required Period Covered by the CAS: July 1999-June 2002 (FY00-02) Period Covered by this Report: July 1999-December 2003 Report Completed by: Rosalia Rodriguez-Garcia, Consultant, and

Cecile Fruman, Senior Country Officer Date: January 10, 2004 Summary of Report 1. This CAS Achievement Report (CASAR) aims to assess the effectiveness of the 2000 CAS for Tunisia in bringing about the expected results and to highlight the key lessons that have been learned during this period and up to December 2003. The findings of this report have informed the new CAS. The CASAR is not a formal evaluation; it is a self-assessment tool for the Country Team and relies on an analysis of key reference documents which include the 2000 CAS, AAA reports listed in Appendix Table 4, Project Appraisal Documents, Project Supervision Reports, Implementation Completion Reports, CPPR, QAG and OED reports, and other relevant documents such as WB and UN data and reports on MDGs in Tunisia, and Tunisia’s 10th Plan.

2. This Achievement Report looks at the CAS from the perspective of the Bank’s Results Framework. The framework starts from the country’s vision and goals for national development, followed by a diagnosis of country conditions and options, and the design of the World Bank’s country strategy, based on results or outcomes to be achieved by the end of the CAS period. Because the Tunisia CAS did not identify a set of core measurable outcomes, the authors of this report have extracted the likely outcomes from the CAS document. The report assesses the results achieved under each of these outcomes by tracking the key indicators and milestones laid out in the CAS. However, the report was constrained by lack of data on indicators which made the measurement of results difficult.

3. Since 2000, Tunisia has sustained a very good economic and social performance by maintaining a stable macroeconomic framework, placing strong emphasis on social achievement and implementing gradual structural reforms. Real GDP grew at an average of 5.2 percent per year during 1997-2001 compared to 2.8 percent during 1982-86; fiscal deficits were maintained at an average of 3.2 percent; inflation was cut to an average of 2.9 percent; and poverty was reduced to 4.1 percent. This evidence also points to areas were achievements fell short of expectations. For instance, private investments reached only 53.2 percent of total investments in 2002, less than the projected 56 percent; an increase in vulnerability1 from 14 percent in 1990 to 17 percent in 1995 suggests that some structural determinants of poverty remain; and the unemployment rate of 14.3 percent in 2003 remains high considering a decade of robust growth and job creation.

1 Vulnerability is measured by the number of people having expenditures of about 30 percent above

the poverty line. The share of vulnerable in total population rose from 1.1 million people in 1990 to 1.5 million in 1995.

- 45 -

4. This report concludes that the 2000 country strategy reflected a good understanding of national challenges, was relevant to and aligned with longer-term development goals as spelled out in the 9th Development Plan, and presented a well thought out strategy to achieve assistance goals. Deliberations for the 10th Development Plan (2002-06) began during the CAS period, and the Bank was responsive to the new priorities, particularly in support of the emphasis on employment. At CAS design, it became clear to the Bank that Tunisia was facing major challenges - heightened international competition, upholding social cohesion, sustaining environmental protection, and upgrading governance - and that Tunisia’s response to these challenges would affect the sustainability of reforms. The CAS recognized the conundrum that Tunisia faced as to the appropriateness of an economic governance model that, while it had served well in the past, may not be the most dynamic and flexible model for steering the national development agenda in a fast-moving environment. It also acknowledged that strains in infrastructure, services and the banking sector, low response of private investments, and employment pressures were already being felt in the economy.

5. The assistance program has shown progress - sometimes substantial - towards achieving the CAS outcomes, but has not achieved all the outcomes. Had outcomes been better defined and collected in a systematic fashion during CAS implementation, it would have been possible to demonstrate more results than are documented in this report. The available data indicates that the instruments used to support the strategy have been appropriate overall. The analytical work has been highly demand-driven, and has provided a solid basis for policy dialogue with the Government and relevant – albeit at times too ambitious - advice on implementation of reforms. Many of the analytical pieces were effective in identifying priorities and guiding lending. New lending commitments since 2000 supported financial and private sector development (39 percent of lending volume), agriculture and rural development (25 percent), urban development and transport (21 percent), and education (15 percent). Lending instruments have remained quite traditional in their approach, relying mostly on sector investment loans, with some innovation in terms of programmatic lending (i.e. adaptable program loans for education and transport). Regarding adjustment lending, lessons can be drawn from ECAL III which covered too many areas and included too many conditionalities, at times ill-defined. Partnerships with other donors (EU, AfDB, AFD, in particular) have been good and have contributed to the achievements of many of the CAS outcomes.

I. The Tunisian Context and Longer-Term National Development Goals

6. Tunisia is a middle-income country with a population of 9.8 million (about 3.4 million or 35 percent rural), a per-capita income estimated at US$ 2,000 in 2002, and one of the fastest growing economies in the MENA region. Sound stabilization and economic adjustment policies, started in Tunisia in 1987, provided the impetus for economic growth. The success of this phase of reforms emphasizing internal liberalization gave way to the next phase emphasizing external liberalization. In 1995, the signing of a 12-year Association Agreement with the European Union (EU) for manufacturing goods exemplified Tunisia’s external liberalization policies aimed at establishing free trade. The Government’s long-standing commitment to social development resulted in marked overall improvements in living conditions, social and economic indicators, a plunge in fertility rate from 3.4 percent in 1990 to 2.1 percent by 2000, and a decline in poverty levels from 40 percent in the 1960s to 11 percent by 1985 and 4.1 percent by year 2000.

7. Tunisia became a member of the World Bank in 1958 and has engaged in a long-standing and stable relationship with the Bank. Since the initiation of economic reforms in

- 46 -

the late 1980s, the Bank has been assisting Tunisia to: i) maintain a stable macroeconomic framework; ii) improve resource allocation by gradually liberalizing prices, trade and investment controls; and iii) decrease the emphasis on the public sector to free up resources for the private sector.

8. Tunisia’s efforts to liberalize its economy in the mid-90s placed greater demands for efficiency and enhanced competitiveness, at a time when the Government was already facing tough demands: stiffer global competition on export markets offshore, and increased labor force participation demands, particularly by youth, onshore. This situation was reflected in the 9th Development Plan (1997-2001), as the goals were stated to be: (1) modernizing and gradually opening up the economy to competition while increasing employment; (2) maintaining macroeconomic stability; and (3) strengthening the social agenda (education and health, poverty reduction, upholding the equity of women) and environmental management. The logic of these priorities was that a steady reduction of fiscal deficits, a more educated and skilled manpower, higher level of employment, financial sustainability of the health and social sectors and social security system, and enhancement of environmental conservation, were critical actions to strengthen the ability of Tunisia to consolidate and expand on past gains and compete in the global markets. In implementing the liberalization reforms, the government’s overriding concern was to avert major reversals in the country’s many achievements on the social and environmental fronts. According to the 2000 CAS, Tunisia’s development objectives and priorities were consistent with its situation, and realistic and attainable given the country’s solid track record.

9. The Millennium Development Goals (MDGs) (see Box 1 of CAS) were not identified as such in the 9th Plan. However, Tunisia’s achievements in human development are impressive in promoting gender equality, reducing child mortality, and improving access to water and sanitation, and particularly, in staying on-track to meet the MDG of universal primary education by 2015, with almost all 6-year olds enrolled in first grade. By 2001, the ratio of girls to boys in primary and secondary education was 0.97 to 1. During the 1995-2001 period, prevalence of child (under 5) malnutrition and infant mortality decreased, access to water and sanitation improved and life expectancy continued to increase to industrialized countries levels. The number of people with fixed line and mobile telephones increased three-folds and those with personal computers four-fold. This evidence suggests that Tunisia has made very good progress towards many of its development goals.

10. Key findings of the Tunisia 2003 Poverty Update are worth noting as they provide insights into some of the outcomes of the national development agenda in the period roughly covered by the 2000 CAS. These include: i) poverty stagnated between 1990 and 1995 but felt markedly between 1995 and 2000, reaching 4.1 percent in 2000; ii) high and pro-poor growth provided the basis for poverty reduction between 1990 and 2000 but the slow-down in growth in 2001 and 2002 raises concerns for the sustainability of poverty reduction (although the fact that growth resumed steadily in 2003 is encouraging); iii) social indicators show that Tunisia has made progress in terms of improving overall living conditions for the poor, beyond the alleviation of extreme poverty. However, two factors indicate that poverty reduction remains an important priority: (i) the level of rural poverty remains double the national rate (rural areas comprise 74 percent of the poor but only 35 percent of residents); and (ii) a fairly high proportion of people are clustered closely above the poverty line.

- 47 -

II. Country Assistance Strategy Progress and Outcomes2

A. Methodology: Explaining outcomes, indicators and milestones

11. Although the CAS did not clearly identify outcomes or explain how results would be monitored, it did identify indicators and milestones. There were eleven indicators (“core performance indicators”) that measured primarily longer-term development goals such as poverty or infant mortality (see Tables 1 and 2). All indicators showed ambitious – but not totally unrealistic – targets for a 3-year period. Some data3 are available to indicate achievement of – or progress towards achieving – CAS shorter-term goals and contribution of the CAS to the national agenda. Needless to say changes in those indicators can not be fully attributable to the Bank’s contribution in a 3-year period. The CAS identified nine milestones (see Appendix Table 2 ), which were not quantitative in nature and combined outputs with intermediate outcomes. They represented key stepping stones towards the achievement of CAS outcomes and country goals. 4

12. Consequently, in alignment with the 9th Development Plan (1997-2001), the overarching objective of the 2000 CAS was growth and equity to help reduce poverty from 7.6 percent (1997-99) to 6.5 percent by 2002. The CAS took a broad approach to supporting poverty reduction that reflected the Bank’s view of the country’s stage of development and emerging challenges. In dialogue with the Government, it was recognized that poverty reduction, in the wake of increased competition, needed to focus on labor-intensive growth, employment, and vulnerability issues, including promotion of greater coverage by the social protection system and community-based approaches in poverty areas. As a consequence, the Bank’s assistance strategy emphasizing policy analysis and dissemination, was built upon three main pillars to support: (a) human development by consolidating Bank’s past involvement in

human resources development, natural resources management, transport, rural and municipal development, and community participation to strengthen policy formulation and management;

(b) integration of Tunisia into EU markets by supporting economic reforms to strengthen the financial system, enhance the competitiveness of the economy, liberalize public agencies, improve private sector participation in the economy, and increase employment, while also putting in safeguards against the transitional costs of adjustments, and

2 See Appendix for CAS Results Summary (Table 1), CAS Milestones (Table 2), Planned Lending

Program and Actual Deliveries (Table 3), Planned AAA Program and Actual Deliveries (Table 4) , and Co-financing in Tunisia FY00-04 (Table 6).

3 Data are collected by sector, which means that data are scattered, not always consistent among sources, and are not presented in a way that corresponds directly to the CAS priorities and outcomes. Also, the choice of indicators made at the time of CAS may not have been the most appropriate to measure outcomes (e.g. persistence rate).

4 In addition, the CAS document includes a program matrix with progress indicators. Some of these indicators show quantitative targets, while many others are qualitative in nature or refer to programmatic milestones. The appropriateness and relevancy of some of the indicators in the matrix to the Bank's shorter-term goals for the country are unclear. The confusion about indicators is compounded by the fact that there is not a systematic approach to the presentation of indicators related to the objectives and expected CAS outcomes. In the text, the CAS document identifies a three-pronged approach or pillars, while the CAS summary matrix shows 15 different areas of work not categorized by pillars.

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(c) modernization of Tunisia’s institutions and technological base by launching new initiatives of catalytic nature to strengthen export development, preserve Tunisia’s cultural heritage, and examine the development potential of the information and communication sector.

13. Outcomes for each of the three pillars are analyzed as to the main objective, the assistance instruments that supported the pillar, the achievements related to the CAS outcomes, the indicators and the CAS intermediate outcomes shown as milestones, as well as borrower’s overall performance for the pillar. An effort has been made to focus on the instruments that inform the different outcomes, rather than on each particular project or loan. It is understood that activities in any particular pillar are likely to contribute to outcomes in other pillars, that CAS activities build on each other, and that each outcome is likely to be influenced by more than one instrument and by activities in other pillars. Thus, pillars are not seen in isolation or separated from each other, but as the main arteries through which efforts and resources flow in the direction towards achieving the CAS goals. CAS results are summarized in Appendix Table 1. B. Pillar I: Support human development by consolidating long-term development

14. This pillar grouped traditional sectors of Bank’s involvement: mainly, human resources development (education), health, natural resources management (water), transport, rural development, and municipal and urban development. The overarching goal of this pillar was to support continued human development and poverty reduction by consolidating Bank’s past involvement to strengthen policy formulation and management in selected areas. This was congruent with the Government’s goal of strengthening the social agenda and environmental management, as stated in the 9th Development Plan. Table 1 below shows the indicators identified in the CAS as the Bank’s contribution to the longer-term development agenda and their values for 2000.

Table 1. Performance Indicators Identified in the 2000 CAS for Pillar I

Indicators Baseline (97-99)

Target (2002)

Outcome (Year)

• Decrease % of population below the national

poverty line Urban poor Rural poor

• Increase persistence rate to school grade 9*.

• Decrease infant mortality per 1000 live births*

• Increase access of rural population to safe water %*

7.6

6.0 (95) 15.8 (95)

42

30

54 (90)

6.5 - -

73 (04)

20

4.1 (00) 3.1 (00) 8.3 (00)

55 (04)

26 (00)

58 (00) Table notes: 1. Data in the Outcome Column is from WB’s MDGs Tunisia Country Profile, 2003, and WB Tunisia

Poverty Update, 2003. 2. The * means that these are MDGs). 3. Source for persistence rate: Ministry of Education and Training. The figure in the outcome year is an

estimate for 2004. 4. Figures between parenthesis refer to the year of the data.

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Assistance instruments

15. The instruments foreseen for this pillar stressed analytic and advisory services and sector investment loans. The AAA program in support of this pillar was carried out as planned. It included a Water Sector Study conducted during the previous CAS as well as a Social Conditions Update in 2000, which reviewed selected social policies (health, education and social insurance system), and a Poverty Update (2003, after CAS period), which analyzed recent poverty trends in Tunisia, depicted a profile of the poor, and proposed critical actions to assist the Tunisian authorities in their efforts to upgrade the poverty monitoring system. Financial support was provided through three new loans: (i) FY00 Water Sector Investment (ii) FY00 Education Quality Improvement Program, and (iii) FY01 Transport Sector Investment II. Two more loans were approved in FY03: The Northwest Mountainous and Forestry Areas Development and the Municipal Development III. In addition, there were many on-going projects in the areas of higher education, health, natural resources and municipal development. Pillar I outcomes

16. Relevant outcomes and milestones that were extracted from the CAS document for this pillar are:

Outcomes § Move towards universal completion of basic quality education (grades 1

through 9). § Complete the development and initiate the implementation of the new health

insurance program. § Promote integrated water resource management and protect water and the

environment. § Create an institutional framework conducive to sustainable development of

public transport in major cities, including larger private sector involvement. § Consolidate municipal and urban development, including municipal finance

and decentralization. Milestones § Start updating poverty analysis based on new population census. § At least satisfactory rating and sustainability of reforms under planned

Education Quality Enhancement Project. § Agreement with Government and EU to initiate implementation of health

insurance reforms. § Agree on community-based programs in the Northwest region.

Outcome: Move towards universal completion of basic quality education (grades 1 through 9).

17. The target for this outcome has not been fully met. At this point, it is estimated that the persistence rate5 will increase from 42 percent in 1999 to 55 percent by 2004, a substantial increase but short of the estimated 73 percent. However, considering the time

5 The persistence rate is the proportion of Grade 1 students who complete Grade 9 successfully in 12

years or less (i.e. maximum of 3 repeats in the course of the basic education cycle). The figure for 1999 refers to students who entered Grade 1 in 1989, and the figure for 2004 refers to students who entered Grade 1 in 1994 and who will complete Grade 9 anywhere from 2003 to 2007.

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period of the CAS, the question can be raised as to whether the target set for 2004 was overly optimistic, or whether better results could be reached with better loan performance.

18. The quality of education6 outcomes were influenced by the performance of the Education Quality Improvement Program (EQIP I, APL, FY00-05), a performance-based program that drew on international standards of quality to assess results, and contributes to the development of human resources, a key goal of the national development agenda. The design of EQIP I drew heavily on the Bank’s long experience with education, and benefited from strong implementation guidance by the Ministry of Education. Throughout the first 2-3 years, the rating of project implementation has been consistently satisfactory, as well as the progress towards development objectives. Thus, the milestone of maintaining a satisfactory rating has been reached.

19. The QAG assessment found the project’s quality at entry satisfactory. Nevertheless, the report pointed to some weaknesses and recommended that attention be paid to the cost-effectiveness of the interventions, and to policy dialogue with the Government on matters related to resources (e.g. number of teachers) and financial sustainability.7 These issues have been addressed in the economic analysis of the education sector that provides the framework for the second loan of the education APL, EQIP II, negotiated in January 2004.

Outcome: Complete the development and initiate the implementation of the new health insurance program. 20. This outcome has not been achieved. The health insurance reform has been widely debated but had not been approved by Parliament. This is a socially and technically complex issue, and more delays are expected. The expected milestone of establishing an agreement between the Government and the EU to initiate implementation of health insurance reforms has been achieved. However, because the EU funds are contingent upon Parliament approving the new law/reform, the first tranche of funds has not been disbursed. The EU funds are not for implementation of the insurance program but rather to provide budget support conditional upon the reform taking place.

21. The health insurance objective was not linked to the Health Sector loan (FY98-03) with the Ministry of Health, which focused on institutional strengthening, improving management and cost control, and the overall quality of services. The goals of this loan were relevant to the Government needs during the CAS period, congruent with the CAS focus to strengthen local institutions identified in pillar III, and have contributed to the achievement of CAS objectives. Mainly, the allocative and technical efficiency and the sustainability of the public health care system have improved alongside a reduction of government’s contributions to regional hospitals as the social security fund has taken over funding obligations, and the quality of care has improved significantly, due in part to new equipment and infrastructure, and in part to management reforms and training.

6 Another education sector project was active during the CAS: the Higher Education Support Reform

loan (FY98-03) which is due to conclude in December 2003. Results information is not conclusive. 7 See: Quality at Entry Assessment (QEA), World Bank, May 17, 2001. The QEA is an annual

exercise conducted by the Quality Assurance Group to measure the quality-at-entry of projects approved by the Bank in the previous calendar year.

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Outcome: Promote integrated water resource management and community participation, and protect water and the environment. 22. This outcome was influenced by six projects: Water Sector Investment (WSIP, FY00-06), Natural Resources Management III (NRMP, FY97-04), Northwest Mountainous Areas Development (FY94-01), Northwest Mountainous and Forestry Areas Development (FY03-09), Water Supply and Sewerage (WSSP, FY94-03), and Greater Tunis Sewerage and Water Reuse (FY97-04). The two first projects built on the agriculture sector investment loan that concluded in FY02 and the two Northwest projects on the first of the series which closed in FY90. While the WSIP focused on water as the most scarce natural resource, the NRMP focused mostly on land issues such as preventing land erosion, protecting pasture lands and promoting the productive capacity of the land. The last two projects focused on improving water and sanitation in urban settings.

23. The achievement of this outcome is progressing well. First, water issues are no longer addressed in isolation, but in the broader context of environmental management and rural and agricultural development. Second, Bank activities have supported Tunisia’s shift from water supply management to water demand management, a sound strategic move that has placed Tunisia ahead of the rest of the region in terms of water conservation; almost all water resources are managed through an integrated infrastructure that takes into account environmental concerns, and 67 percent of irrigated surfaces use water-saving equipment (2001). Third, considerable progress has been made in conserving other fragile and scare natural resources such as land and coastal areas and energy, in particular through fiscal incentives and subsidies.8

24. According to the Tunisia Poverty Update, access of population to safe water increased from 75 percent in 1990 to 80 percent in 2000, and access to improved sanitation has also increased from 76 percent in 1990 to 84 percent in 2000. When data are disaggregated for rural and urban populations, during the same period, rural access to improved water source increased from 54 percent to 58 percent and access to improved sanitation from 48 percent to 62 percent. Ratios for urban population have increased from 91 percent to 92 percent for access to improved water source and access to sanitation has remained at a high 96 percent. While it is impossible to say how much of these changes can be attributable to Bank’s contribution, the Bank’s multiple loans have had an impact. As an example, during the length of the WSSP, SONEDE (Société nationale d’exploitation et de distribution des eaux, the national water supply utility) has increased coverage in water supply by 21 percent, with more than 200,000 people in rural areas connected to the water network, and ONAS (Office national de l’assainissement, the national sewerage utility) has increased its coverage in urban sewerage by 43 percent as well as the volume of wastewater treated.

25. In addition, WSIP, NRMP, and Northwest projects have been instrumental in piloting and, subsequently, scaling up participatory approaches which aim to enhance responsibility of users and improve the delivery of services. Under the NRMP, over 100 participatory plans for integrated rural development with emphasis on conservation of natural resources have been completed; the WSIP has supported the emergence and strengthening of water user associations; while the Northwest projects have assisted in creating active forestry groups with collective interest and agricultural development groups. All of these projects have stressed the importance of female participation in the planning, execution, operations and maintenance, and monitoring and evaluation of integrated rural development activities.

8 Tunisia Country Environmental Analysis, Draft, December 2003.

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Based on these experiences, the Government has extended participation of local populations in most of its rural development programs. While more remains to be done, it is possible to conclude that the CAS outcome of promoting greater community participation has been achieved.

26. The work of the Bank and the Government in the water and natural resources is an example of a successful partnership. The AAA link with the lending program was enabling and allowed the Bank to push for reform. For instance, the Water Sector Study informed the preparation of the Water Sector Investment Project and led to the creation of the Office of Water Management (Bureau de la Planification et des Equilibres Hydrauliques). This unit has slowly begun operations, and needs to be strengthened substantially to be fully operational.

Outcome: Create an institutional framework conducive to sustainable development of public transport in major cities, including larger private sector involvement.

27. The achievement of the CAS outcome is in process, but the intermediate outcome of achieving lower costs of transport has been only partially reached. However, the following measures have already been achieved: signature of “Contrat Programmes” (multi-year framework contracts between Government and state-owned enterprises) with regional urban transport companies; completion of severance programs aiming to increase efficiency and adequate staffing of those companies; presentation to Parliament of a new Transport Law reforming the institutional organization and establishing new financing mechanisms of urban transport. The potential for achieving the outcome in the coming years is good and will be influenced by the performance of the Transport Sector Investment loans I (FY98-05) and II (FY01-06).

Outcome: Consolidate municipal and urban development, including municipal finance and decentralization.

28. This CAS outcome was supported by the Municipal Finance Development II project (FY97-03) which aimed to strengthen the institutional environment for the delivery of municipal basic services and infrastructure. Aspects of this outcome have been achieved, mainly, those related to consolidating development by improving infrastructure and municipal services. However, consolidation of municipal finance has not been fully achieved, and, as a consequence, the financial situation of Tunisian municipalities remains weak. This issue is being addressed in the follow-up loan approved in December 2002. Efforts to enhance community participation in investment decisions and maintenance of infrastructure have been considerable.

Borrower performance 29. Although not all outcomes have been fully achieved, borrower performance in this pillar has been satisfactory, reflecting a good level of institutional management capacity. Government counterparts demonstrated good ownership of the programs and sufficient administrative capacity. However, there were important delays across the board. Adoption and implementation of many reforms was slower than expected, and extensions of project closing dates were granted to the majority of projects because development objectives were not fully met by the initial closing date. This statement is also relevant to the other pillars and will be analyzed in further detail (see paragraph 74).

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C. Pillar II: Integration of Tunisia into EU markets by supporting economic reforms 30. This pillar was aligned with the Government’s 9th Development Plan’s goals of modernizing and gradually opening up the economy for competition, and maintaining macroeconomic stability. It aimed at deepening the financial sector, boosting private sector development by streamlining the business environment and facilitating private sector participation in infrastructure via concessions, further privatization of state enterprises, and job creation. Table 2 shows the indicators identified in the CAS that contributed to the national development agenda.

Table 2. Performance Indicators Identified in the 2000 CAS for Pillar II

Indicators Baselin

e (97-99)

Target (2002)

Outcome

2001

Outcome 2002

• Increase share of private sector banks in

total of bank assets %. • Increase private investment in % GDP* • Increase proceeds from privatization in

% GDP. • Decrease unemployment rate %. • Increase the labor force covered by

social insurance schemes % (pension and health).

• Average water tariff as % of average cost.

• Increase market share of unleaded gasoline %.

48

12.1 0.5

(95-98) 15.9

45

87 4

60

15.4 1.0

15

50

110

20

15.3

60

105

n/a

54

14.7 0.6

14.9

60

98

n/a

Table notes: 1. Data in the Outcome Columns for 2001 and 2002 is from WB’s MDGs Tunisia Country Profile, 2003, and WB Tunisia Poverty Update, 2003, as well as Annuaire Statistique de Tunisie and data contributed by SONEDE and ONED (water tariffs). 2. The * means that these are Millennium Development Goals (MDGs). 3. Figures between parenthesis refer to the year of the data.

Assistance instruments 31. The Bank’s strategy for this pillar relied on the provision of policy-based support on a two-year cycle through Economic Competitiveness Adjustment Loan II (ECAL II) - active at the time of CAS preparation - and ECAL III approved in FY02. Another loan, the Agricultural Support Services loan (FY01-07), aimed at developing organizational structures for producers in order to better compete in local and international markets.

32. Pillar II was also supported by a substantial set of analytical products and an extensive policy dialogue component. Not all AAA products resulted in specific loans and activities, but by and large, they all contributed to a better understanding of the Tunisian situation and timely advice to Government in order to underpin policy alternatives and strategic options in support of the national development agenda. Among the key reports were: the Social and Structural Review (2000) and the Private Sector Investment Study (2000) which underpinned the ECAL III adjustment loan and triggered the preparation of the External Sustainability Study (2000); the Agricultural Competitiveness Study (2000) and Policy Note (focusing on transitional issues, 2001) that put forward a strategy for agriculture

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liberalization with measures to mitigate adverse social effects; the Financial Sector Assessment Program (FSAP, 2001) conducted with the IMF; the Trade Strategy (2001); the Foreign Investment Advisory Service report on investment promotion (2002, part of ECAL III); and the Private Participation in Infrastructure (PPI), Employment, and External Debt Management Strategies (2003).

Pillar II outcomes 33. The following outcomes and milestones have been extracted from the CAS: Outcomes § Strengthen the financial sector. § Boost private sector investment climate and streamline the business

environment. § Modernize and liberalize public sector agencies. § Enhance the competitiveness of agricultural producers. § Increase employment opportunities. Milestones § Completion of financial sector reforms under ECAL II and agreement to

deepen reforms in selected areas. § Streamline investment incentives for offshore enterprises vs onshore9. § Agree with Government on recommendations through planned policy note on

employment. § Agree on social protection strategy to increase targeting and cost-

effectiveness of social protection system.

Outcome: Strengthen the financial sector.

34. This outcome has not been fully achieved, mainly because it is a broad and ambitious expectation in a three-year period; even more so considering the policy and institutional reforms needed to achieve it, and the gradual approach of the Government to the reform process. This outcome was informed by the 2001 FSAP and influenced by the performance of ECAL II and ECAL III. Financial sector reforms under ECAL II were achieved as planned and the Government agreed to deepen reforms in selected areas under ECAL III, thus meeting the CAS milestone.

35. At CAS design, it was expected that ECAL III, the third in a series of adjustment loans to support competitiveness of the Tunisian economy, would either (i) advance financial sector reform or (ii) support measures to enhance private sector development and participation in the provision of infrastructure, depending on the readiness of the Government. As approved in December 2001, ECAL III was an ambitious program, covering three broad sectors with the following aims: strengthening the financial sector, promoting a business environment conducive to private investments, and liberalizing the information and communication technology sector, while maintaining a stable macroeconomic framework. The first tranche of the loan ($130 million equivalent) was disbursed at approval. The loan was meant to close in June 2003 but a six-month extension was granted in order to allow more time to complete the reform program. As a result, the financial sector and investment

9 Offshore enterprises refers to firms that produce solely for exportation and are granted significant

tax exemptions and financial incentives. Onshore enterprises are those that produce for the local market and do not benefit from the same level of exemptions.

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climate tranches of €44.5 million each were disbursed, respectively, in September and December 2003.

36. The expected outcomes of the financial sector tranche of ECAL III have been met: the legal framework of the insurance sector has been modernized through revisions to the laws; reform of the automobile insurance sector was undertaken; automobile insurance tariffs were increased in an effort to ensure sustainability of the sector; and four under-capitalized insurance companies are in process of being restructured. The biggest loss-maker, El Ittihad, was restructured and a new, fully capitalized, mutual company has been established. This radical transformation has been accepted by the sector and the Government has committed itself to put in place a demanding supervision of the insurance sector.

37. However, looking to the future, many weaknesses remain in the financial sector (large share of non performing loans in commercial banks with low provisioning, anemic private securities market, limited issuance in the Government securities market, etc.) that will need to be addressed in order to achieve the broader outcome of strengthening the financial sector.10

Outcome: Boost private sector investment climate and streamline the business environment. 38. While progress has been made, this ambitious outcome has not been fully achieved. Under ECAL III, progress on boosting the private sector investment climate has been slowest and the pace of reforms uneven, but the actions taken have been in the direction of improving the private investment climate:

§ The Government prepared a study and action plan on investment promotion

and incentives but has not met one of the CAS milestones - that investment incentives for offshore-onshore enterprises be streamlined by CAS completion. The Government has expressed concerns about the negative impact on offshore investments if incentives are realigned at this time when private investment in Tunisia has been performing worse than expected. Instead, the Government proposes to create a level playing field between the offshore and onshore sectors through gradual reforms to be adopted by 2008 by which date the free trade zone with the EU will have been established.The action plan does however identify a number of measures that address other important determinants of private investment (namely transactions costs of doing business, market contestability and financing mechanisms) and constitutes a useful basis for future discussions on investment promotion and incentives in the context of the new CAS and preparation of a forthcoming operation (ECAL IV).

§ The Government adopted a Code of legal tax rights and procedures that clarifies the relationships between the tax authorities and the taxpayers.

§ Accounting standards setting forth the rules and methodologies governing the consolidation of financial statements and the treatment of corporate conglomerates have been adopted.

§ An amendment law to the Company Law has been drafted and will reinforce recent legal developments governing the accounting and auditing profession in Tunisia and further expand shareholder rights and transparency. The

10 These weaknesses are outlined in the Development Policy Review which supports the new CAS.

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amendment law, when adopted, will constitute a necessary and very positive development, in line with modem corporate law approaches.

§ One commercial bank was privatized (UIB) and one is in the process of being privatized (Banque du Sud), reducing the share of the commercial banks still in public hands to below 50 percent.

§ One condition was not met and required a waiver: the privatization of a large public enterprise. The Government selected for partial privatization (up to 35 percent) the Société Nationale de Distribution du Pétrole (SNDP), the largest distributor of petroleum products (40 percent of the market) but the process of selection of an investment bank to assist the Borrower in the privatization of SNDP was only launched in December 2003.

39. The outcome of boosting private sector investment climate was also supported by the Industry Support Institution project (FY97-04). This project aimed to put in place an efficient and market-responsive system of technical support agencies, providing assistance to the industrial sector, in particular SMEs and firms seeking to become more internationally competitive. While progress was made in restructuring existing support agencies and creating new ones which have improved their outreach and the quality of their services to firms, the project development outcomes were not met by the revised closing date (December 31, 2003) because of governance issues in the agencies which jeopardized their ability to be “efficient and market-responsive”.

Outcome: Modernize and liberalize public sector agencies and improve their service coverage and cost recovery.

40. This outcome - which covered in particular the liberalization and modernization of telecommunications and water and sanitation - has not been fully achieved. Reform of telecommunications was informed by the ICT strategy paper and supported by ECAL III. All reforms under the ECAL III tranche on telecommunications liberalization have been achieved and outcomes include: competition has been introduced in the wireless component of the telecommunications sector leading to greater access to mobile telephony, better services and lower prices; the legal and regulatory framework for ICT has been strengthened (adoption of implementation regulations for new telecommunications code and of law concerning exchanges and electronic commerce, creation of National Telecom Agency, etc.); and a telecom sector liberalization timetable has been prepared. However, the telecom tranche of ECAL III was not disbursed because the Bank did not receive the documentation required to demonstrate that the Global System for Mobile Communications license (wireless telecommunications) was tendered following a transparent and competitive process. Growth of mobile telephony has been remarkable, with close to 2 million subscribers by end 2003, an increase of 240 percent over 2002. However, Tunisia still lags behind in other key ICT sector development indicators (low number of internet servers and hosts per capita, limited access to data networks and international information systems by the general public) and international communications costs remain high. More remains to be done to liberalize telecom services.

41. In terms of service improvement of water and sanitation, SONEDE, the national water supply utility, and ONAS, the national sewerage utility, have continued improving their service delivery and internal management as reflected in high coverage levels, and continuous supply and relatively low unaccounted for water (about 21 percent, the best in the region). Two Bank projects - the WSSP (FY94-03) and the Greater Tunis Sewerage and

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Water Reuse project (FY97-05) - have been accompanying the two utilities toward improving service coverage, cost recovery and sector efficiency.

42. The average water tariff represented 96 percent of the average water cost in 2002, a good improvement compared to the 1997-99 CAS baseline of 87 percent, but short of the CAS target of 110 percent. On the sewerage side, as the demand for sewerage collection and wastewater treatment services rose, the cost recovery ratio declined to 65 percent in 2002. ONAS’s low cost recovery level has translated into the present trend of increasing Government subsidies for the sewerage sector and ONAS’s deteriorating financial position. Given the past good performance of these public utilities, the Government has been reluctant to consider broader sector reforms or a larger role for the private sector in the provision of these services. Facing the future challenges in the sector will however require greater cost recovery levels and increased efficiency of operators.

43. Modernization and institutional strengthening continued in other sectors with the Ozone Depleting Substances loan (FY94-10) and the Protected Areas Management project (FY02-09). The latter was launched in December 2002 and it is too early to assess any progress.

Outcome: Enhance the competitiveness of agricultural producers. 44. There is no hard data to determine the status of this outcome at this point, and no intermediate outcomes were identified in the CAS. This outcome would be influenced by the Agriculture Support Services project (FY01-07) implemented by the Ministry of Agriculture, which is piloting an approach to improve the institutional services provided to farmers, promote participation by producers, and facilitate information flow. The project was launched with a workshop in January 2002, but delays in procuring goods, in particular services such as technical assistance and training, and in implementing reforms have been such that the project will take longer to reach its development objectives than initially anticipated.

Outcome: Boost employment opportunities. 45. The CAS goal of decreasing unemployment from 15.9 percent in 1997-1999 to 15 percent by 2002 has been partially achieved. The unemployment rate was reduced to 14.9 percent in 2002 and 14.3 percent in 2003. However, the targets set in the 10th Plan (creation of 380,000 to 400,000 new jobs between 2002 and 2006) will not be met as the rate of job creation is insufficient to absorb a rapidly growing workforce.

46. The intermediate outcome of reaching agreement with Government on the recommendations of the Employment Strategy (2003) and a strategy to address unemployment is nearly achieved. The Employment Strategy identifies strategic actions to support the Government in reaching the 10th Development Plan goal of “meeting the job-creation challenge” by creating 400,000 new jobs between 2002 and 2006 (i.e. 80,000 per year), an increase from the 67,000 new jobs a year planned in the 9th Plan. Access to reliable data11 combined with the analytical strength of the Bank have resulted in a comprehensive report that identifies benchmarks against which to assess future performance in this area. The

11 For this study, the Government made available, for the first time, important micro-level data that

permitted a more in-depth analysis of the job situation in Tunisia. This can be seen as a measure of the trust the Government places in the Bank and a demonstration of the high value-added the Bank brings to analyzing and advising on such a difficult issue.

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report provides the Government with a tool from which to design a coherent program for the future which will include continuing World Bank support. The Bank partnership in this area will be formalized with the Government upon signing of a Memorandum of Understanding which will cover a 2 to 3-year program of activities.12

47. The Employment and Training project (FY96-03) was one of the building blocks of the Government’s strategy to reform training and employment, which succeeded in establishing the concept of how training services should be structured to respond to the needs of the private sector, while preparing adolescents and youth for employment. The strategic thrusts of vocational training include strong partnership with the private sector, a new way to operate training (i.e. enterprise-based and new model to managing training centers), and the reform of the curriculum to be competency-based. The program was financed jointly with the EU and the French Development Agency. There have also been significant outputs in this project which should pave the way for achieving CAS outcomes. For instance, under the project, 30,000 were enrolled in training centers, and 30 percent of those were in enterprise-based training, surpassing the expected 25 percent, and more than 300 enterprises have been approved for training programs. However, there is no data on how many graduates were actually (and formally) employed thanks to this program.

48. The outcome of reaching agreement on a social protection system has not been achieved. The Social Protection Policy Note planned for in the CAS was never conducted, although some components of the note were: the review of active labor policies was conducted under the Employment Strategy; an IDF grant13 was used to strengthen the technical capacities of the agency responsible for social security reforms (Centre de Recherche et des Etudes sur la Sécurité Sociale under the Ministry of Social Affairs and funded three studies on pensions (extension of coverage, reform options for pension system and development of the social security data base system). The Bank has proposed to carry out a policy note on pensions reform and is waiting for confirmation from the authorities. The review of the social safety nets did not take place. Borrower performance 49. Borrower performance in advancing economic reforms has been satisfactory but has not furthered reforms in the manner that the vision of the 9th and 10th Development Plans and the strong administrative capacity of Tunisia warrant. However, given the unusual external forces playing against Tunisia during this period, the performance of the borrower has not been wanting as Tunisia has shown a strong ability to manage the economic downturn. The Government can be commended on the way in which it adjusted policies and actions to respond to external shocks and put the country back on the path to high growth.

50. Despite that progress has been made in this pillar, there is room for substantial additional work in support of the 10th Development Plan and beyond. Policy dialogue needs to expand to include issues of public expenditure management to ensure that the Government can make informed decisions about the management and allocation of financial resources that are consistent with their own strategic priorities. Furthermore, there are lessons to be

12 The employment strategy was the first element of a new AAA product being tested in the MENA

region, the Programmatic Economic Sector Work (PESW). PESW provides a framework for knowledge-based work which is agreed upon with Governments and to which Governments actively contribute. This – still to be tested – mechanism is intended to support demand-driven, country-owned work, in a coherent program in order to produce more meaningful and lasting results than one-off activities.

13 The IDF grant closed in 2003 and was rated satisfactory.

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drawn by the way the latest adjustment loan, ECAL III, was designed. In retrospect, it seems that ECAL III - with its long list of conditions to be met - proposed a piecemeal approach to reform and therefore offered little leverage. Teams working on future adjustment operations may find it advantageous to identify and resolve critical prerequisites of reform, increase selectivity, and make explicit that institutional reform at the top level includes enabling institutional change at the lower levels.

D. Pillar III: Modernization of Tunisia’s institutions and technological base through

new initiatives 51. This pillar was in line with the national goal of achieving international market integration through increased competitiveness of the economy, liberalization of the services sector, and modernization of institutions.

Assistance instruments

52. This pillar was informed by several studies: the External Sustainability Study and Private Sector Assessment update, both of 2000, the Information and Communication Technology Strategy of 2002, and a Tourism Development Strategy in 2002-2003 which is likely to contribute to strengthening the potential for achieving the CAS outcome of sustainable cultural tourism development. In addition, an impact analysis of the trade facilitation was conducted in 2003, identifying key results and providing elements for the next CAS. The pillar outcomes were supported by two projects: the Export Development loan (FY99-05) and the Cultural Heritage Management loan (FY01-07), both planned in the CAS. A question remains as to whether these activities were “new initiatives of catalytic nature to strengthen local institutions and mobilize external finance”. Indeed, while they ventured into new areas of support and have helped support local institutions, they have not been very innovative, nor have they helped catalyze additional levels of external finance. One area that the CAS had identified for possible future support was training of judges in the context of reforms of legal and regulatory frameworks, but this did not take place.

Pillar III outcomes

53. There were no milestones identified for this pillar; rather this pillar contributes to the broader goals mentioned above. The priority CAS outcomes that could be extracted for this pillar were to: § Promote export development by trade facilitation. § Preserve Tunisia’s cultural heritage and diversify tourism products. § Support Tunisia’s quest to modernize its technological base by exploring new

niches for sector development. Outcome: Promote export development.

54. Interventions to reach this outcome included promoting public-private partnerships, facilitating trade by simplifying import-export related procedures, and improving access to pre-shipment finance, especially for SMEs. The promotion of export development is a very broad goal, and achievement of this goal has been good to the extent that trade facilitation contributes to it.

55. Through the Export Development loan (FY99-05), several trade facilitation intermediate outcomes were achieved in a significant way, mainly, the creation of market

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institutions for trade promotion and trade finance, the automation of export and import-related transactions and the simplification of trade procedures, thereby increasing the preparedness of Tunisia for trade access and response. For the first time in Tunisia, export promotion has been contracted to a private firm (instead of a traditional public sector promotion agency) and the Tunisian companies pay for export services which are market-based, demand-driven and relevant to the success of the firms. Banks have started financing pre-shipment working capital needs of emerging exporters. Mechanisms to develop local expertise to help SMEs cultivate export markets have been put in place.

56. Tunisia Trade Net, a semi-public agency, was created to develop an electronic data interface between all agencies involved in international trade procedures and to expedite trade document flows. It is now fully operational and the platform is being considered for the implementation of e-procurement services and other e-government applications, in Tunisia as well as in other countries (Cameroon for example). Automation has decreased the average time taken to clear goods once unloaded from anywhere between 8 and 18 days in mid-1990s to between 2 and 5 days, and customs clearance time has been reduced from 2-3 days to 15 minutes. Achievement of other intermediate outcomes, such as pre-shipment export finance have not yet occurred due in great part to changes in the management of the executing agency for this component.

57. Given that interventions are continuing until 2004 and are moving in the right direction, there is reason to believe that the expected CAS outcome of export development through trade facilitation will be reached. This outcome also contributes in full to the goals of Pillar II by enhancing firm competitiveness.

Outcome: Preserve Tunisia’s cultural heritage and promote diversified tourism products.

58. The diversification of tourism products is being accomplished by supporting sustainable cultural tourism development. The CAS priority outcome of cultural tourism development has not yet been reached, essentially because it is too early to measure results of the Cultural Heritage Management loan which was approved in 2001. However, actions have been taken towards the achievement of intermediate outcomes, starting with the strengthening of the heritage preservation agency’s capacity to promote its assets, find new markets, and manage cultural tourism. At this point, there is a new organizational framework; studies of the legislative framework for cultural management and national museum policies are under way; and contracts are being awarded for the design of improvements of cultural sites. Project outcomes have not been significantly affected by the down-turn in tourism due to the repercussions of the events of September 11, 2001, the war in Iraq and other events in the region.

59. The tourism strategy which was elaborated jointly with Government in the course of 2002 and 2003 provides the building blocks for achieving the priority outcome. The Tunisian Government has requested a follow-on loan to help with the implementation of the strategy.

Outcome: Support Tunisia’s quest to modernize its technological base by exploring new niches for sector development. 60. Only the information and communication technology (ICT) sector strategy contributed to this outcome. This AAA was driven by the Government’s desire to create appropriate conditions for private sector involvement, increase the contribution of this industry to economic growth and employment generation in line with the objectives of the

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10th Plan (2002-06) and the move toward a knowledge economy. The 10th Plan sets an ambitious goal for the ICT sector to increase its share of revenue in GDP from 3.3 percent in 2002 to about 8 percent in 2006 and to generate one out of every fours jobs in the ICT sector by end 2006. The Government has started implementing some of recommendations spelled out in the strategy paper, in particular the liberalization of wireless telecommunications which has contributed to increasing the share of revenue in GDP to close to 4 percent in 2003.

61. A QAG assessment of the ICT report suggests that the dialogue with the Government on this issue is by itself an achievement, and highlights the comprehensiveness of the report and the country team’s ability to capitalize on a window of opportunity opened by the Government’s request. It also cautioned about the ambitious targets that are featured in the ICT strategy paper and the need to be somewhat more modest and realistic in signaling to the Government what is likely to be achieved. Bank staff stressed that this was done and that the Government is now in the low-case scenario. The higher scenario that was also included in the ITC report was designed with the ambitious targets of the 10th National Development Plan in mind.14

Borrower performance

62. Borrower performance in this pillar has been satisfactory. Faced with increasing international competition, the Government is committed to modernize its institutions and technological base and make Tunisia a choice destination for tourists. The assistance program of lending and AAA has worked particularly well to strengthen policy dialogue and Government’s investment in the outcomes of this pillar.

III. Summary Assessment of CAS Performance

63. During the assessment period, the assistance program has shown progress, sometimes substantial progress towards the CAS outcomes, but – based on the information available – has not achieved all the outcomes (see Appendix Table 1). Nevertheless, many intermediate outcomes (milestones) have been achieved and there might be more outcomes achieved than those acknowledged in this report. There has been progress, albeit slowly, in all three pillars and across pillars.

64. The nature of the Bank’s dialogue with Tunisia has been constructive and collegial, the product of a long and mutually rewarding collaboration. The Bank has been responsive to Government demands but, by the same token, may have lost out on opportunities to push the Government to fulfill its own potential by arguing for deeper reforms in difficult areas. Bank staff believe that Tunisia’s vision and capacity could propel the country not just to do more, but to do better.

65. Institutional development impact of Bank’s assistance: Since 2000, the Bank’s assistance has helped support institutional strengthening and change at the level of government agencies. Institutions serving the private sector have been significantly transformed (i.e. creation of market institutions for trade promotion and finance), while other entities such as those dealing with primary education, water management or community/rural development have raised the bar of quality and participation; liberalization has progressed, in particular in telecommunications; services have been modernized (i.e. computerization of

14 The ICT paper proposes two scenarios (low and high) and five options for reform according to

growth targets and resources.

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trade transactions); changes in policy, regulatory and the legal environment have been significant, in particular under ECAL III. The Bank has played an important role in testing new approaches for community-based participation in the development process. From the vantage point of the achievement report, however, it is difficult to assess how far changes promoted by the CAS have penetrated the culture of national institutions or the relations between the public and private sectors.

66. Assessment and mitigation of risks: The 2000 CAS showed a good understanding of the main uncertainties affecting Tunisia. These were: (i) the dependence of foreign exchange earnings on one dominant market (the EU represents 80 percent of Tunisia’s exports), (ii) the adequacy of foreign exchange reserves in the event of significant shocks, (iii) fiscal risks from budget rigidities and contingent liabilities; (iv) vulnerability to droughts; and (v) social risks arising from the regional situation and from within the country. As stated earlier in this report, there has been an important unfavorable situation in the region for the past few years and most of the risks identified in the CAS did materialize. However, the Government performed very well in tempering the risks by maintaining internal stability and sound economic management. The Bank showed willingness to accompany the Government to help mitigate uncertainties, including by offering to increase the amount of ECAL III, but this was not done because the Government preferred other sources of funds and reductions in the budget.

67. Sustainability of CAS outcomes: The sustainability potential of CAS outcomes is high, for three reasons: (i) the CAS has been responsive to the development objectives laid out in the 9th and 10th Plans and supported the national development agenda, (ii) the level of ownership of reforms and programs is strong in Tunisia, and (iii) the Tunisian authorities have demonstrated a strong ability to weather external shocks through sound economic management, while maintaining a focus on social progress and internal stability. Tunisia exemplifies the Bank concept of “client in the driver’s seat” that takes ownership for the national planning process, for the implementation of reforms and programs, and for donor coordination.

68. A number of issues may affect sustainability of CAS outcomes. First, market trends in Europe may play against Tunisia’s competitiveness efforts. Second, geo-politics in the region may dampen tourism and trade. Third, pressure for greater democracy, freedom of speech and transparency is likely to increase and could lead to social tensions if not accommodated And, needless to say, risks may come from major changes in policy directions or the reform agenda.

69. Outreach, dissemination, and capacity building: During CAS implementation, outreach efforts were not as strong as anticipated. Seminars were organized to discuss draft AAA reports or disseminate their findings, but their audience was generally limited to Government officials, with little participation of civil society. This can be explained by the nature of certain reports (confidential policy and strategy notes) and by the Bank’s restricted access to key stakeholders outside of Government. The Bank’s limited presence in Tunisia (liaison office with one person) has also hampered its ability to reach out to a broader group of constituencies. In addition, Bank teams may have been reluctant to organize dissemination activities, working under the assumption that these would not bring much value to the process or could be ill-perceived by Government officials. Dissemination of Bank documents has been however well conducted by the Public Information Center established within the library of the University of Tunis. Capacity building activities were conducted in most projects but WBI’s role was limited, even more so as Tunisia was not selected as a WBI

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focus country in 2002 and Tunisia does not have a Global Development Learning Network center. However, WBI and other Bank units have well established relations with training and research institutes in Tunisia such as the Tunisia International Center for Environmental Technologies , the Center of Arab Women for Training and Research , the Institute of Development Finance of the Arab Maghreb and the Arab Institute of Heads of Enterprises (, individually and through regional networks such as the Mediterranean Development Forum .

IV. Bank Performance Related to the 2000 CAS

70. The country strategy made compelling arguments for a shift towards the utilization of more analytical work but did not rationalize greater selectivity in the lending or articulate the added value of AAA not only to policy dialogue but also to implementation of reforms and results. It did not elaborate either on on-going loans or analytical services – precisely the components of previous country strategies that are the most likely to provide evidence of results in the current CAS given the implementation time required by most projects. As a result, it is easier to see the new priorities and interventions but much less the incremental value of the country strategy; even though the latter comes across forcefully when explained by the country team.

A. Portfolio quality

71. Based on prior good performance of the Tunisia portfolio characterized by a low riskiness, strong ownership by the country of the projects’ objectives, and good administrative capacity to prepare and implement projects, no major changes in the portfolio management strategy were anticipated in the 2000 CAS. During CAS implementation, the lending program was delivered to a large extent according to plan, with some delays, but with only one project dropped (SME support planned for FY02) (see Appendix Table 3). Recognized by the Bank as historically one of its best portfolios, Tunisia has maintained a strong performance during the past four years. Since FY00, quality of the portfolio has remained consistently high and above MENA averages (Table 3 below). OED evaluated a sample of 11 completed projects during FY00-03 and concluded that in 91 percent of the cases, quality at entry and supervision was satisfactory, as well as the Borrower’s performance for preparation and implementation of projects. Satisfactory project outcomes and likelihood of sustainability were also rated satisfactory in 82 percent of the cases. The Quality Assurance Group (QAG) reviewed quality of supervision in twenty-two projects, 90 percent of which were rated satisfactory. Bank inputs and processes were judged satisfactory in all except for two.

Table 3: OED Evaluation Findings of Evaluated Projects (Projects exiting portfolio FY90-03)

Satisfactory Outcome (%)

Likely Sustainability (%)

Substantial Impact (%)

Country

Net Commitment

(US$M)

O/w Adjustment

(US$M) Net

Commitment O/w

Adjustment Net

Commitment O/w

Adjustment Net

Commitment O/w

Adjustment

Tunisia 2,367 967 81.8 86.5 83.8 100 41 17 MENA 15,974 5,276 71.1 72.1 52.1 56.5 35 41 Algeria 3,253 1,099 45.8 41 7.2 0 21 27 Egypt 2,025 150 83.2 100 39.5 0 34 100 Jordan 1,534 870 93.6 100 79.5 90.8 49 63 Morocco 4,736 1984 67.2 67.6 38 46 58.9 51.4 Bankwide 251,234 87,978 75.9 76.9 65.5 71.9 43 44

Note: Sustainability and institutional development impact ratings have been in use only since FY98. Source: OED, BW.

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72. Continued close follow-up and action from project teams ensured prompt resolution of occasional project management issues, as reflected in the 100 percent proactivity ratio in FY00-01 and FY03-04 (Table 4). No proactivity was recorded in FY02 since the Industry Support Institution project was still in problem status at the end of the FY. The project closed in FY04 with an unsatisfactory rating after a one-year extension of its closing date. Three more projects were downgraded to problem projects in FY02, leading to a sharp but temporary increase in terms of portfolio riskiness (21.1 percent in terms of number of projects at risk and 19.4 percent in terms of commitments at risk). The riskiness level in FY03 returned to a level close to the ones of FY00-01 (less than 5 percent in terms of number and amount). As of January 2004, no project was classified at risk in the Tunisia portfolio.

Table 4: Portfolio Management Indicators

Indicator

Projected Targets (CAS)

Actual Performance

FY00 FY01 FY02 FY00 FY01 FY02 FY03 FY04 Disbursement Ratio (%)

18

18

18

23.9

18.3

15.2

27.2

22

Disbursement Lag; Orig. (%)

25

20

20

32.3

25.8

29.6

36.1

25

% Projects At Risk

5

5

5

4.2

4.8

21.1

5.6

0

% Problem Projects

5

5

5

4.2

4.8

21.1

5.6

0

Realism Index 100 100 100 100 100 100 100 100

Proactivity Index

100

100

100

100

100

100

100

100

73. Notwithstanding the good quality of the portfolio, widespread delays in implementation have led to slow disbursement and repeated closing date extensions (Appendix Table 5). While the disbursement ratio surpassed the Bank’s projections in FY00, it slowed down in FY01 and FY02, and only picked up again in FY03. In FY04 at mid-year, the disbursement ratio was at 11 percent. Regarding extension of closing dates, of the 19 projects that were planned to close during the FY00-03 period, only two closed on their original closing date: ECAL II (adjustment loan) and Municipal Development II (financial intermediary loan). Projects were extended anywhere from 5 to 24 months, with a few extended twice. In FY04, ECAL III was extended by six months in order to give the Government additional time to complete the agreed reform program. Repeated extensions put the average age of the Tunisia portfolio above the Bank and the Region’s averages for FY00-04 (Table 5).

Table 5: Average Age of Projects in Tunisia

Fiscal Year

FY99

FY00

FY01

FY02

FY03

FY04

Bank 3.8 3.8 3.9 4.0 3.9 N/a MENA 4.0 3.8 4.1 4.2 4.2 4.3 Tunisia 3.7 4.4 4.5 4.7 4.6 4.6

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74. A Country Portfolio Performance Review (CPPR) mission in June 2003 identified the key reasons for delays in project implementation and proposed a set a recommendations to ensure timely implementation of projects: § overly ambitious project timetables: this was already identified as a cause for

concern in the previous CAS, yet was insufficiently addressed in ongoing and new operations. Bank teams continued to underestimate the time required to execute projects, given the time-consuming nature of institutional policy changes and the changing nature of projects, geared more towards supporting decentralized and participatory approaches, and innovative pilots.

§ insufficient planning and project preparation: implementation could be made more efficient through better integration of counterpart teams in project preparation which requires early staffing; better defined communication and decision-making channels; and institutional arrangements better suited to implementation challenges.

§ shortcomings in Bank support, in particular frequent changes in task management with hasty handover from former to current staff, and decrease in quality of staffing of Bank supervision teams which sometimes lack specialists who can advise Tunisian counterparts on difficult reform or implementation issues.

§ Lack of attention, in many projects, to identifying project-level results and indicators during the preparation phase. Logframes are often not developed in a participatory manner with key stakeholders and therefore not owned by project staff and beneficiaries; indicators are too numerous, difficult to monitor and not always the most relevant; staff capacity is insufficient; and M&E is perceived as a pro forma activity to satisfy requirements rather than a dynamic management tool.

75. Action has already been taken to address these issues and will continue under this CAS. During the CPPR, several training modules in procurement, disbursement, financial management, and the project cycle with focus on M&E, were offered and well attended. Further modules in M&E, results management and procurement have since been offered and other such modules will be made available in the coming years.

76. During the CAS period, the choice of lending instruments was quite conventional as most lending operations were designed as Sector Investment Loans or using instruments already tested (ECAL III as third Adjustment Loan and Municipal Development III as third Financial Intermediary Loan). Adaptable Program Loans (APL) were introduced in transport (before the CAS period, in 1998) and basic education (during the CAS period) but without great success as the instrument did not fully deliver on its promise to provide “greater flexibility in adapting project design and financing over time to meet agreed development objectives as borrower conditions and partnerships evolve over time”15 The second phase of the Transport APL was approved with a waiver as the triggers to move onto the second phase were not all met and its processing was not significantly simplified over the processing of a new operation.

15 “Adaptable Lending – New Investment Opportunities”, World Bank, August 14, 1997

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B. AAA program

77. The AAA program has played an important role in supporting the reform process during the FY00-02 period and beyond. Close to 20 sector studies, policy notes and strategic documents were produced, either as stand-alone activities to enhance knowledge and guide policy dialogue (employment and tourism strategies) or to underpin the design of projects (see Appendix Table 4). Various capacity building and policy workshops as well as technical assistance visits complemented analytical work and deepened policy dialogue.

78. The AAA program for Tunisia is mostly demand-driven. Demonstrating great maturity in planning for development and in interacting with the Bank, the Tunisian authorities have been explicit in their requests for assistance and have carefully reviewed and critiqued all documents submitted to them. Most of the recent AAA products - DPR and the PPI, Employment and Tourism Studies - have been read, discussed and endorsed at the highest levels. The Tunisian authorities generally value the Bank’s analysis and ability to support recommendations with cross-country experience, even though the Bank may be overly optimistic in its assessment of the timeframe required for reform to take place.

79. Unfortunately, there seems to be no formal mechanism to determine the impact of AAA which constitutes a significant shortcoming when trying to document their contribution to CAS outcomes. Only anecdotal information is available to document whether AAA products led to changes in policies or to effective implementation of reforms, or whether advisory services have contributed to foster achievement of expected outcomes. What is known is that because much of the AAA is demand-driven and addresses specific reform issues, it is generally not broadly disseminated outside of the realm of key policy makers. Only two AAA reports were reviewed by QAG - the financial sector assessment program and the information and communication technologies report – and received a rating of highly satisfactory and satisfactory respectively.

C. Aid coordination and country dialogue

80. Tunisia possesses strong institutional capacity for donor coordination. External finance as well as technical assistance from a variety of creditors and donors is coordinated by the Ministry of Development and International Cooperation.

81. The CAS intended that the Bank would continue cooperation with the IMF, the European Union, and other bilateral and multilateral donors to complement Tunisia’s development efforts. This has materialized through the co-financing (parallel financing) of several projects. Both the EU and the AfDB co-financed ECAL III while the AfDB also co-financed ECAL II. The French Agency for Development (AFD) co-finances the Municipal Development III project and the Global Environment Facility co-finances the Protected Areas Management project (See Appendix Table 6.) The Bank also support scaling up of approaches tested by other donors, such as a teaching methodology pilot supported by UNICEF technical assistance which EQIP I took to scale. With the IMF, the Bank has had an excellent collaboration as evidenced by frequent exchanges of information and joint work on FSAP and debt management. Finally, The UNDP houses the World Bank office in Tunis.

82. The Bank works in complementary fashion with other donors, building on each other’s comparative advantages. For instance, the Bank works closely with the EC in areas where it is strong such as trade and governance, and outreach with civil society. EC and AfDB, in turn, look to the Bank for leadership in economic reforms, recognizing the Bank’s

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strength in conducting quality analysis, influencing policy decisions, and designing and supervising policy-based lending. In designing its adjustment operations for the education and health sectors, the EC has drawn on the project objectives, triggers and indicators laid out in the Bank loans for these respective sectors. The Bank has collaborated with the AFD on studies in areas of common interest such as municipal development and finance, and tourism. The country team recognizes that strategic aid cooperation provides a powerful vehicle for examining challenging issues and influencing policy decisions in Tunisia. There is a recognition that given that the Bank’s presence in Tunisia is limited16, strategic cooperation with other donors is an key element to gathering local knowledge and contributing to the country dialogue in an meaningful way.

83. The CAS mentioned the role of the IFC in fostering private sector development, especially in promoting private sector investment in infrastructure and supporting small and medium enterprises (SMEs). However, given the costs of IFC financing, IFC has recognized that it is not an attractive lender for Tunisia, and has not made Tunisia a priority country for intervention.

V. Key Considerations for Next CAS

84. Looking to the future, the quality of the country assistance program for Tunisia can be strengthened by:

§ Enhancing the Bank’s role as key partner for reforms, by providing high

quality technical advice and adequate levels of finance in support of difficult but critical reforms. This will require working with Government and other key constituencies to take stock of support for key reforms, identify appropriate entry points, and sequence interventions so that they add incremental value.

§ Ensuring that the next CAS is outcome-driven and that data are collected to document the achievements of results.

§ Articulating the explicit link among all the activities supported by the Bank –lending and AAA, old and new. This would strengthen the incremental World Bank support to help accomplish specific and clearly defined outcomes, and ensure that the total adds up to more than the sum of its parts. This will entail designing new activities that build on ongoing or past ones and showing the linkages in the CAS.

§ Addressing the recurring problem of project extensions by having a more realistic assessment of timeframes required to implement reforms and conduct developmental activities, and by providing better support to the Tunisian authorities to manage implementation of operations once they are approved.

§ Supporting flexibility in approach and instruments: Tunisia being a mature and stable client of the Bank as well as an investment grade middle-income client, the next CAS should emphasize the need to be quick to respond to requests with quality advice and lending. The CAS should also support greater flexibility in lending instruments that rely more on Tunisian fiduciary and safeguard procedures and contribute to strengthening these.

16 The World Bank has a one-person liaison office in Tunis which conducts program coordination and

supports HQ staff in project development and supervision, AAA and policy dialogue.

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§ Ensuring that AAA, while remaining responsive to Government demands, also supports policy dialogue and reform in difficult areas. The Bank would be remiss if it does not put forward critical issues, global trends and cross-national best practices that are relevant to the reform process in Tunisia, but that the Government may not be aware of or willing to address yet. This would exemplify and strengthen the role of the Bank as a catalyst and broker of innovations and new practices, which would inform and expand the way the Government perceives its needs and options.

- 69 - Appendix Table 1: Summary Tables of the Tunisia 2000 CAS Achievement Report

Results Framework

At CAS Design

Status at Completion

Lessons Learned and

Considerations for next CAS Longer-term country development goals

9th Development Plan (1997-2001) - Modernize and gradually open

up the economy to competition. - Maintain macroeconomic

stability. - Strengthen the social agenda

and environmental management.

- Generate employment.

- GDP grew at an average of 5.2% during the 9th Plan, fell to 1.7% in 2002 but grew at 5.5% in 2003.

- Current account deficits were maintained at an average of 3.8% of GDP.

- Inflation was cut to 2.4% in 2002-2003.

- Poverty was reduced to 4% in 2000 (core poor).

- Unemployment remains high at 14.3% (2003).

- Tunisia has implemented an impressive array of reforms and has demonstrated resilience to downturns in the economy.

- But Tunisia needs to pursue liberalization of its economy in order to enhance global competitiveness and reduce unemployment.

Country issues that affect goal achievement and sustainability

- Vulnerability to drought. - Foreign exchange earnings

dependent on the EU market (80%).

- Adequacy of foreign reserves in event of significant shocks.

- Fiscal risks from budget rigidities.

- Competitive pressures resulting from market integration.

- Regional instability. - Gradualism in carrying out

reforms.

Same, plus - Heightened regional instability due

to 9-11-01 events, Djerba bombings and Iraq war.

- Less demand for Tunisian exports by EU due to down-turn in global economy.

- Increased competition in international markets.

- Continued dependence of public agencies on Government subsidies, meaning liberalization has not been fully achieved.

- Risks were well assessed in CAS and have been well managed overall by the Tunisian Government. Bank has shown willingness to help mitigate uncertainties.

- Tunisian economy has shown resilience to external challenges.

CAS outcomes and results: àContribution to national development agenda

Reduce poverty through: - Human development by

consolidating Bank’s support of social sectors.

- Integration of Tunisia in EU markets through economic reforms.

- Modernization of Tunisian institutions and technological base through new initiatives.

- Deepened policy dialogue underpinned by a substantial AAA program and continued IBRD lending.

- Poverty has been reduced considerably but remains a rural phenomenon (74% of poor is in rural areas) and vulnerability remains a concern (large numbers above but clustered close to poverty line).

- Outcome data needed to provide evidence of achievements.

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Results Framework

At CAS Design

Status at Completion

Lessons Learned and

Considerations for next CAS CAS outcomes and results: àSpecific CAS outcomes through lending and AAA

Pillar I outcomes: . Support human development by improving basic education and health services and the environmental and sustainable use of resources. Pillar II outcomes: . Support Tunisia’s competitiveness in the EU market and economic reforms by improving the financial sector and business environment for the private sector, employment and social security. Pillar III outcomes: . Support Tunisia’s quest to modernize its technological base and strengthen its institutions to promote tourism, export development, and to explore new niches for sector development.

- School persistence rates improved. - Access to safe water and sanitation

improved and integrated approach to water resource management and protection established.

- Improved efficiency of health services.

- Expanded use of community participation in rural projects.

- Financial sector reforms under

ECAL III have been conducted. - Some measures to boost private

sector development have been achieved.

- Institutional framework and legislation for the liberalization of the wireless and fixed telephone lines are in place.

- Government has agreed with overall recommendations of the policy note on employment.

- Social protection agenda in discussion (pension, safety nets, active labor market policies).

- Institutional framework for exports has been modernized; automation and facilitation of trade are promoting export development.

- Tunisia’s cultural tourism products and institutional capacity have been strengthened.

- Improvements in modernization of Tunisia’s technological base.

All pillars - Project implementation has been

good overall but closing dates of almost all projects have been extended. Attention to this issue will need to be given in next CAS in order to have more realistic appreciation of implementation requirements.

- AAA program has been of high quality and demand-driven. Efforts need to be made to strengthen monitoring and evaluation of the impact of AAA.

- Need to emphasize community participation in development and enhance outreach efforts.

- M&E needs to be strengthened in individual projects and in next CAS by improving results-based logframes, choice of indicators, data collection, and data utilization for management and supervision.

- Next CAS should show the link between national agenda, CAS goals and CAS outcomes.

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Results Framework

At CAS Design

Status at Completion

Lessons Learned and

Considerations for next CAS Bank’s performance § Quality of

assistance § Aid coordination

and country dialogue

- CAS aligned with 9th National Development Plan and responsive to 10th Plan.

- CAS supported the most complex reforms.

- CAS did not articulate on-going portfolio with new projects.

- CAS did not clearly identified outcomes.

- CAS aimed at promoting participatory approaches to development.

- Quality of assistance of past

CAS satisfactory.

- Collaboration with EU, AfDB, French Development Agency, IFC, and others.

- CAS remains relevant. - CAS consistent with evolution of

national and Bank’s agendas. - AAA supported national reform

agenda and substantive dialogue with the Government.

- Loans by and large have performed satisfactory, though with delays and extensions.

- Difficult to provide evidence of outcomes.

- OED and QAG ratings of projects

high. - 100% proactivity rate during most of

CAS period. - Slow disbursements except in FY00. - Portfolio characterized by

widespread delays and repeated closing date extensions.

- Continued close collaboration with

EU. - EU and AfDB co-financed ECAL III.

- Sustainability of CAS strong because of national ownership and CAS responsiveness to national agenda.

- Unclear whether loans have performed as well as national capacity warrants.

- Beware and avoid piecemeal approach of assistance by incorporating on-going and new lending and non-lending activities within the strategy of the next CAS.

- Need to add a results focus to

Bank’s supervision. - Next CAS needs to define more

clearly a strategic approach to aid coordination to leverage different strengths.

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Appendix Table 2: Tunisia 2000 CAS Milestones (Intermediate Outcomes) (see page 34 of CAS)

Area

Pillar I: Poverty Reduction

Intermediate Milestones - Update poverty analysis based on

new census. - Agree on community-based

program in NW region.

Status at Completion - Poverty Update done in 2003. - Loan for NW region approved in

2003.

Pillar I: Basic education and health services

- Obtain satisfactory rating of EQIP. - Agreement with Government and

EU to initiate implementation of health insurance reforms.

- Achieved. - Signed but 1st tranche not

disbursed because it is contingent upon Parliament approval of reforms.

Pillar I: Environment and sustainable use of resources

- Begin implementation of demand management of water resources under the Water Sector Investment loan.

- Achieved.

Pillar II: Financial sector and business environment for the private sector

- Completion of financial sector reforms under ECAL II and agreement to deepen reforms in selected areas.

- Streamlined investment incentives for offshore/onshore enterprises.

- Done. - Some improvements but not at the

level expected. Pillar II: Employment and social security

- Agree with Government on recommendations through planned policy note on employment.

- Agree on social protection strategy

to increase targeting and cost-effectiveness of social protection system.

- The Government has agreed with overall findings of employment study and MOU for PESW planned to be signed in Q2 of 2004.

- The social protection strategy note was partially completed. Analytical work has been conducted on active labor policies, and some on pensions, but the Government has not implemented a comprehensive reform program.

Note: The CAS milestones are shown along five areas, instead of the three CAS pillars. No milestones were specifically identified for pillar III. Activities in this pillar contribute to the overall national goal of poverty reduction and increased competitiveness of the economy.

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Appendix Table 3. Tunisia – Planned IBRD/IDA Lending Program and Actual Deliveries (FY00-04)

CAS Plans (04/27/00) Achievement Report (01/10/04)

US$(M) US$(M) FY Project IBRD IDA Status IBRD IDA

2000 Education Quality Enhancement (EQIP I) 75.0 0.0 Actual 99.0 0.0

Water Sector Investment I 100.0 0.0 Actual 103.0 0.0

Transport Sector Investment II 33.0 0.0 Forwarded to FY01 .. ..

Subtotal 208.0 0.0 Subtotal 202.0 0.0 2001 Cultural Heritage 30.0 0.0 Actual 17.0 0.0

Agricultural Support Services 35.0 0.0 Actual 21.3 0.0 ECAL III 150.0 0.0 Forwarded to FY02 .. .. Additional Actual Projects: Transport Sector Investment 37.6 0.0 Subtotal 215.0 0.0 Subtotal 75.9 0.0 2002 SME Support 50.0 0.0 Dropped 0.0 0.0

Urban Water Supply 100.0 0.0 Dropped. New project

planned for FY06 0.0 0.0 Municipal Development III 50.0 0.0 Forwarded to FY03 .. .. Additional Actual Projects: ECAL III 252.5 0.0 Subtotal 200.0 0.0 Subtotal 252.5 0.0 Total FY00-02 623.0 0.0 Total FY00-02 530.4 0.0 2003 Not covered in the CAS

Municipal Development III NW Mountainous and Forestry Areas Dev.

Subtotal

78.4

34.0 112.4

0.0

0.0 0.0

2004 Not covered in the CAS To be delivered by end of FY: Education Quality Enhancement II (EQIP II)

130.3

0.0 Total FY03-04 242.7 0.0

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Appendix Table 4: Tunisia - Planned AAA Program and Actual Deliveries (FY00-04)

CAS Plans (04/27/00) Achievement Report (01/10/04)

Fiscal Year

Product

Status (a)

2000 Social & Structural Review Actual – October 1999 Private Sector Assessment Actual – March 2000 Update of Social Conditions Actual – June 2000 Agricultural Competitiveness Study Actual – June 2000 External Sustainability Study Actual – January 2001 2001 Tenth Plan Policy Notes Not conducted Policy Note on Employment Actual – June 2003 (FY03) Financial Sector Assessment Program (with IMF) Actual Policy Note on Information Technology Actual – January 2002 (FY02)

Additional Actual Products: Agricultural Competitiveness Policy Note On Transitional Issues – July 2001

2002 Decentralization Study/Municipal Finances Actual – June 2002 Policy Note on Land Issues Actual – June 2002 Comprehensive Development Review Not conducted Social Protection Strategy Note Not conducted

Additional Actual Products: Trade Strategy

2003 Not covered in CAS Foreign Investment Advisory Service Report –

December 2002 Debt Strategy Report – May 2003 Tourism Strategy – June 2003 PPI Strategy Note – June 2003 Employment Strategy – June 2003 Environmental Strategy – June 2003 2004 Not covered in CAS Poverty Note

Development Policy Review – Nov. 2003 Higher Education Strategy ROSC Accounting and Auditing Country Financial Accountability Assessment Country Procurement Assessment Review

(to be concluded in FY05)

(a) Actual, Dropped, or Forwarded to a different FY.

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Appendix Table 5: Tunisia Analysis of Project Extensions

Approval Date

Original Closing Date

Closing Date as of begin. of

last CAS

Revised Closing Date

No. extension No. months of

ext.

Age

PROJECTS WHICH WHERE MEANT TO CLOSE DURING CAS PERIOD

PRIVATE INVESTMENT CREDIT 12/09/93 31/12/1999 06/30/00 12/31/00 2 12 7.1 SECONDARY EDUCATION 08/23/94 06/30/00 06/30/00 12/31/01 1 18 7.4 AGRIC. SECTOR INVESTMENT 11/18/93 06/30/99 12/31/00 12/31/00 1 18 7.1 SECOND FORESTRY DEVELOPMENT 05/11/93 12/31/00 12/31/00 05/31/01 1 5 8.1 HIGHER EDUCATION RESTRUCTURING 03/31/92 12/31/98 12/31/00 12/31/01 2 mini. 36 9.8 RURAL FINANCE 05/23/95 09/30/99 12/31/00 06/30/01 2 21 6.1 ECAL II 04/20/99 06/30/01 06/30/01 06/30/01 2.2 DEV.OF MTS NW REGION 12/23/93 06/30/00 06/30/01 06/30/01 1 12 7.5 ASIL 2 01/29/98 06/30/02 06/30/02 12/31/02 1 6 4.9 2ND EMPLOYMENT & TRAINING 06/13/96 06/30/02 06/30/02 06/30/03 1 12 7.0 WATER SUPPLY/ SEWERAGE 07/28/94 06/30/02 06/30/02 06/30/03 1 12 8.9

Average age: 6.9

PROJECTS WHICH WERE MEANT TO CLOSE SINCE CAS PERIOD without Adj. Op. 7.6

RURAL ROADS 01/31/95 12/31/02 12/31/02 06/30/03 1 6 8.4 HEALTH SECTOR LOAN 03/10/98 12/31/02 12/31/02 12/31/03 1 12 5.8 INDUSTRY SUPPORT INSTITUTIONS 06/13/96 12/31/02 12/31/02 12/31/03 1 12 7.6 TRANSPORT SECT INVESTMENT 06/23/98 12/31/02 12/31/02 12/31/04 1 24 6.5 HIGHER EDUC. II 03/17/98 12/31/03 12/31/03 12/31/04 1 12 6.8 NATURAL RESOURCE MANAGEMENT 05/13/97 06/30/03 06/30/03 06/30/04 1 12 7.1 MUNICIPAL DEVELOPMENT II 06/24/97 06/30/03 06/30/03 06/30/03 6.0

Average age: 6.9

PROJECT EXTENDED AFTER CAS PERIOD EXPORT DEVELOPMENT 05/20/99 03/31/04 03/31/04 09/30/2004

NEW PROJECTS APPROVED DURING CAS PERIOD WATER SECTOR INVESTMENT PROJECT 6/22/2000 6/30/2006 EDUCATION EQIP I 6/27/2000 6/30/2005 TRANSPORT SECTOR INVESTMENT 4/19/2001 6/30/2006 CULTURAL HERITAGE 6/12/2001 6/30/2007 AGRIC. SUPPORT SVCS 6/26/2001 6/30/2007 ECAL III 12/20/2001 6/30/2003 12/30/2003 1 6 NW MOUTAINOUS AND FOR. AREAS DEV. 10/31/2002 12/31/2008 MUNICIPAL DEVELOPMENT III PROJECT 12/5/2002 6/30/2008 GEF- PROTECTED AREAS MGMT. 6/27/2002 8/31/2008

GEF and MT SOLAR WATER HEATING 11/02/94 06/30/04 06/30/04 OZONE DEPLETING SUBS 06/14/94 12/31/00 12/31/03 2 24

Notes: Bold indicates a closing date extension. Only Adjustment operation (ECAL II) and Financial Intermediary loan (PDM II) not extended.

- 76 -

Appendix Table 6: Co-financing in Tunisia FY00-04

Fiscal Year 2000 2001 2002

2003 2004 Total Financier

Project

Project Co-financing Amounts

AfDB ECAL III 194.1 194.1

EC: Europeaid

ECAL III 71.9 71.9

France: AFD

Municipal Dvpt III

46.6 46.6

GEF Protected Areas Mgmt

5.3 5.3

GEF Gulf of Gabès (projected)

6.1 6.1

Foreign Multi.Inst.

Protected Areas Mgmt

0.1 0.1

Germany: KfW

Water Sector Investment

17.5

17.5

Foreign Sources

Agriculture Support Services

4.4 4.4

Total

17.5

4.4

271.4

46.6

6.1

346

M. East Lower-POVERTY and SOCIAL & North middle-

Tunisia Africa income2003Population, mid-year (millions) 9.9 306 2,408GNI per capita (Atlas method, US$) 2,210 2,240 1,400GNI (Atlas method, US$ billions) 21.9 685 3,372

Average annual growth, 1997-03

Population (%) 1.2 1.9 0.9Labor force (%) 2.4 2.8 1.2

Most recent estimate (latest year available, 1997-03)

Poverty (% of population below national poverty line) .. .. ..Urban population (% of total population) 67 58 49Life expectancy at birth (years) 73 69 69Infant mortality (per 1,000 live births) 21 44 32Child malnutrition (% of children under 5) 4 .. 9Access to an improved water source (% of population) 80 88 81Illiteracy (% of population age 15+) 26 35 13Gross primary enrollment (% of school-age population) 117 96 112 Male 120 100 113 Female 115 92 111

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1983 1993 2002 2003

GDP (US$ billions) 8.4 14.6 21.0 23.8Gross domestic investment/GDP 33.5 29.2 25.2 24.1Exports of goods and services/GDP 34.4 40.4 44.8 44.8Gross domestic savings/GDP 25.1 21.7 21.0 20.5Gross national savings/GDP 26.6 20.0 21.6 20.9

Current account balance/GDP -6.9 -8.8 -3.5 -3.2Interest payments/GDP 2.5 2.9 2.4 2.5Total debt/GDP 48.6 59.5 60.1 58.7Total debt service/exports 19.2 20.8 13.5 16.0Present value of debt/GDP .. .. 60.6 ..Present value of debt/exports .. .. 117.8 ..

1983-93 1993-03 2002 2003 2003-07(average annual growth)GDP 3.8 4.8 1.7 5.5 4.9GDP per capita 1.5 3.4 0.5 4.2 3.6Exports of goods and services 7.3 5.4 -2.1 4.0 5.7

STRUCTURE of the ECONOMY1983 1993 2002 2003

(% of GDP)Agriculture 12.4 14.7 10.3 12.5Industry 32.5 28.0 29.3 28.7 Manufacturing 14.2 17.1 18.6 18.3Services 55.1 57.3 60.4 58.8

Private consumption 57.9 62.0 62.6 65.2General government consumption 16.9 16.3 16.5 14.3Imports of goods and services 42.7 48.0 49.1 48.5

1983-93 1993-03 2002 2003(average annual growth)Agriculture 5.3 2.9 -11.0 26.0Industry 3.7 4.8 3.2 3.2 Manufacturing 1.7 5.4 1.9 3.4Services 3.4 5.2 3.6 2.9

Private consumption 2.8 4.8 3.9 5.9General government consumption 3.0 4.3 4.3 5.2Gross domestic investment 2.6 4.0 -6.0 1.0Imports of goods and services 4.1 4.9 -2.4 2.3

Note: 2003 data are preliminary estimates. Group data are for 2002.

* The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.

-77 -CAS Annex A1

Tunisia at a glance

-10

-5

0

5

10

98 99 00 01 02 03

GDI GDP

Growth of investment and GDP (%)

Tunisia

Lower-middle-income group

Development diamond*

Life expectancy

Access to improved water source

GNIpercapita

Grossprimary

enrollment

-5

0

5

10

15

98 99 00 01 02 03

Exports Imports

Growth of exports and imports (%)

Tunisia

Lower-middle-income group

Economic ratios*

Trade

Domesticsavings

Investment

Indebtedness

Tunisia

PRICES and GOVERNMENT FINANCE1983 1993 2002 2003

Domestic prices(% change)Consumer prices .. 4.1 2.8 2.6Implicit GDP deflator 12.7 4.7 2.3 2.3

Government finance(% of GDP, includes current grants)Current revenue 30.3 27.6 24.8 23.9Current budget balance 5.7 4.8 4.7 4.0Overall surplus/deficit -4.2 -2.8 -3.1 -3.0

TRADE1983 1993 2002 2003

(US$ millions)Total exports (fob) 1,860 3,746 6,857 7,686 Fuel 832 454 641 749 Agriculture 82 436 489 562 Manufactures 908 2,387 5,272 5,886Total imports (cif) 3,103 6,149 9,503 10,524 Food 434 417 653 704 Fuel and energy 347 455 886 1,015 Capital goods 795 1,515 2,236 2,432

Export price index (1995=100) .. 82 154 166Import price index (1995=100) .. 95 109 118Terms of trade (1995=100) .. 86 141 140

BALANCE of PAYMENTS1983 1993 2002 2003

(US$ millions)Exports of goods and services 2,869 5,769 9,539 10,682Imports of goods and services 3,567 6,678 10,431 11,548Resource balance -698 -909 -893 -866

Net income -267 -971 -984 -1,031Net current transfers 387 597 1,130 1,124

Current account balance -578 -1,283 -746 -774

Financing items (net) 563 1,322 895 1,303Changes in net reserves 15 -39 -149 -529

Memo:Reserves including gold (US$ millions) 574 864 2,301 2,820Conversion rate (DEC, local/US$) 0.7 1.0 1.4 1.4

EXTERNAL DEBT and RESOURCE FLOWS1983 1993 2002 2003

(US$ millions)Total debt outstanding and disbursed 4,059 8,694 12,625 13,973 IBRD 434 1,595 1,464 1,779 IDA 67 54 35 33

Total debt service 638 1,352 1,438 1,909 IBRD 65 263 233 286 IDA 1 2 2 2

Composition of net resource flows Official grants 28 103 114 .. Official creditors 238 375 42 392 Private creditors 263 -98 824 956 Foreign direct investment 184 562 795 .. Portfolio equity 0 20 6 ..

World Bank program Commitments 144 189 34 .. Disbursements 90 248 117 251 Principal repayments 32 149 156 207 Net flows 57 99 -39 44 Interest payments 34 117 79 81 Net transfers 24 -18 -118 -37

Development Economics 5/6/04

-78-

-5

-4

-3

-2

-1

097 98 99 00 01 02 03

Current account balance to GDP (%)

0

2,000

4,000

6,000

8,000

10,000

12,000

97 98 99 00 01 02 03

Exports Imports

Export and import levels (US$ mill.)

0

1

2

3

4

5

98 99 00 01 02 03

GDP deflator CPI

Inflation (%)

G: 598 A: 1,779

D: 2,626

B: 33

F: 6,083

E: 2,854

Composition of 2003 debt (US$ mill.)

A - IBRDB - IDA C - IMF

D - Other multilateralE - BilateralF - PrivateG - Short-term

- 79 -

Indicator 2001 2002 2003 2004 fPortfolio AssessmentNumber of Projects Under Implementation a 21 19 18 16Average Implementation Period (years) b 4 4.2 4 4.4Percent of Problem Projects by Number a, c 4.8 21.1 5.6 0Percent of Problem Projects by Amount a, c 3.5 19.4 2.2 0Percent of Projects at Risk by Number a, d 4.8 21.1 5.6 0Percent of Projects at Risk by Amount a, d 3.5 19.4 2.2 0Disbursement Ratio (%) e 18.3 15.2 27.2 17Portfolio ManagementCPPR during the year (yes/no) no no yes noSupervision Resources (total US$) 1572 1592 1653 1089Average Supervision (US$/project) 58 72 75 57

Memorandum Item Since FY 80 Last Five FYsProj Eval by OED by Number 87 14Proj Eval by OED by Amt (US$ millions) 3489.2 865.1% of OED Projects Rated U or HU by Number 17.2 14.3% of OED Projects Rated U or HU by Amt 14.1 18.7

a. As shown in the Annual Report on Portfolio Performance (except for current FY).b. Average age of projects in the Bank's country portfolio.c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP).d. As defined under the Portfolio Improvement Program.e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only.f. Two GEFs and one MT included. Data as of April 5, 2004.* All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year.

CAS Annex B2 - TunisiaSelected Indicators* of Bank Portfolio Performance and Management

As of 04/05/2004

- 80 -

Proposed IBRD/IDA Base-Case Lending Program a

Fiscal year Proj ID US$(M) Strategic Rewards b (H/M/L)

Implementation b Risks (H/M/L)

2004 EXPORT DEVELOPMENT II 36 H MResult 36

2005 INFORMATION SOCIETY (S) 50 H MECAL IV 150 H HResult 200

2006 HIGHER EDUCATION REFORM SUPPORT II 50 H MNATURAL RESOURCE MGMT. II 40 H MURBAN WATER SUPPLY 70 H HResult 160

2007 WATER SECTOR INVESTMENT II 50 H HEDUCATION QUALITY IMPROVEMENT III 50 H MECAL V 150 H HResult 250

RESULT 646

a. This table represents the proposed program for the next three fiscal years.

b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate

(M), or low (L)

Notes:

* A second Education Quality Improvement project has already been approved by the Board in FY04.

** Two GEFs are scheduled to be approved in FY05 (Gulf of Gabes for $6.1 million, and Energy Efficiency Program/

industrial sector for $ 8.5 million).

CAS Annex B3 - Tunisia

As of Date 04/05/2004Bank Group Program Summary

- 81 -

CAS Annex B3 (IFC & MIGA) for TunisiaIFC and MIGA Program, FY 2001-2004

As of 04/05/2004

2001 2002 2003 2004

IFC approvals (US$m) * 0 0 0 0

Sector (%)

Investment instrument(%)

MIGA guarantees (US$m) ** 0 0 0 0

* IFC data as of February 29, 2004. A BIAT II project is likely to go to the Board in Q4FY04, with an IFC exposure of $50 million.** In June 2002, MIGA issued three guarantees, totaling US$63.8 million, for a Tunisian investor (Tunisie Telecom) for its investment in a GSM project in Mauritania.

- 82 -

Product Completion FY

Cost (US$000)

Audience a. Objective b.

Recent completionsDebt Management Study FY03 117 Govt., Bank Problem-solvingTourism Strategy FY03 154 Govt., Bank Knowledge generation, Problem-solvingPPI Strategy Note FY03-04 241 Govt., Bank Knowledge generation, Problem-solvingPoverty Note FY03-04 88 Govt., Bank Knowledge generation, Problem-solvingEnvironmental Strategy FY03-04 69 Govt., Bank Knowledge generation, Public

dissemination, Problem-solvingHigher Education Strategy FY03-04 70 Govt., Bank Knowledge generation, Problem-solvingEmployment Strategy FY03-04 348 Govt., Bank Knowledge generation, Problem-solvingDevelopment Policy Review FY04 165 Govt., Bank Knowledge generation, Problem-solving

UnderwayFSAP follow-up FY04 80 Govt., Bank Knowledge generation, Problem-solvingCountry Procurement Assessment Review (CPAR)

FY04 100 Govt., Bank Knowledge generation, Problem-solving

Country Financial Accountability Assessment (CFAA)

FY04 85 Govt., Bank Knowledge generation, Problem-solving

ROSC Accounting / Auditing FY04 70 Govt., Bank Knowledge generation, Problem-solvingHealth Sector Review FY04 100 Govt., Bank Knowledge generation, Problem-solving

PlannedPublic Expenditure Review FY05 200 Govt., Bank Knowledge generation, Problem-solvingROSC Insolvency / Creditor rights FY05 100 Govt., Bank Knowledge generation, Problem-solvingInvestment Climate FY05-06 150 Govt., Bank Knowledge generation, Problem-solvingRural Sector Wide Review FY05-06 120 Govt., Bank Knowledge generation, Problem-solvingInfrastructure / Water FY05-06 150 Govt., Bank Knowledge generation, Problem-solvingEU New Neighborhood Policy FY05-06 120 Govt., Bank Knowledge generation, Problem-solvingPESW - Employment Strategy FY05-08 600 Govt., Bank Knowledge generation, Problem-solving

a. Government, donor, Bank, public dissemination.b. Knowledge generation, public debate, problem-solving.

As of 04/05/2004

CAS Annex B4 - TunisiaSummary of Non-lending Services

- 83 -

Latest single year Same region/income group

M. East Lower-& North middle-

1970-75 1980-85 1995-02 Africa income

POPULATION Total population, mid-year (millions) 5.6 7.3 9.8 306.2 2,410.7 Growth rate (% annual average for period) 1.8 2.6 1.2 1.9 1.0Urban population (% of population) 49.8 53.8 66.8 58.0 49.4Total fertility rate (births per woman) 5.9 4.3 2.1 3.2 2.1

POVERTY(% of population)National headcount index .. .. 7.6 .. .. Urban headcount index .. .. 3.6 .. .. Rural headcount index .. .. 13.9 .. ..

INCOMEGNI per capita (US$) 770 1,160 1,990 2,070.0 1,390Consumer price index (1995=100) .. 53 123 .. ..Food price index (1995=100) .. 54 111 .. ..

INCOME/CONSUMPTION DISTRIBUTIONGini index .. .. 41.7 .. ..Lowest quintile (% of income or consumption) .. .. 5.7 .. ..Highest quintile (% of income or consumption) .. .. 47.9 .. ..

SOCIAL INDICATORSPublic expenditure Health (% of GDP) .. .. 2.9 2.9 2.7 Education (% of GNI) .. .. .. 5.3 4.7 Social security and welfare (% of GDP) 4.4 3.7 6.0 .. ..Net primary school enrollment rate(% of age group) Total 76 93 99 82.2 93 Male 89 99 100 84.9 92 Female 62 87 99 79.4 93Access to an improved water source(% of population) Total .. .. 80 88.2 81 Urban .. .. 92 95.5 95 Rural .. .. 58 77.6 70Immunization rate(% under 12 months) Measles .. 65 92 92.3 85 DPT .. 70 96 92.4 84Child malnutrition (% under 5 years) 20 .. 4 .. 11Life expectancy at birth(years) Total 59 65 73 68.6 69 Male 58 64 71 67.2 67 Female 59 66 75 70.1 72Mortality Infant (per thousand live births) 104 55 21 36.7 30 Under 5 (per thousand live births) 151 76 27 53.8 37 Adult (15-59) Male (per 1,000 population) 276 232 169 192.8 212 Female (per 1,000 population) 249 214 99 143.3 131 Maternal (per 100,000 live births) .. .. 70 .. ..Births attended by skilled health staff (%) .. .. 90 .. ..

CAS Annex B5. This table was produced from the CMU LDB system. 04/20/04Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment ratios exceeding 100 indicate discrepanciesbetween the estimates of school-age population and reported enrollment data.

CAS Annex B5 - TunisiaSocial Indicators

Actual Estimate ProjectedIndicator 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

National accounts (as % of GDP)Gross domestic producta 100 100 100 100 100 100 100 100 100 100 Agriculture 13 12 12 10 12 12 11 11 11 11 Industry 28 29 29 29 29 29 29 29 29 29 Services 59 59 60 60 59 60 60 60 60 60

Total Consumption 76 76 77 79 79 80 80 79 79 79Gross domestic fixed investment 26 26 26 25 24 24 24 24 25 25 Government investment 4 4 5 4 7 7 7 6 6 6 Private investment 21 22 21 21 17 17 17 18 18 18

Exports (GNFS)b 43 44 47 45 45 45 45 45 45 45Imports (GNFS) 45 48 52 49 48 48 48 49 49 49

Gross domestic savings 24 24 23 21 21 20 20 21 21 21Gross national savingsc 24 23 24 22 21 21 21 21 22 22

Memorandum itemsGross domestic product 20,799 19,468 19,977 21,024 23,820 24,962 26,076 27,420 28,821 30,836(US$ million at current prices)GNI per capita (US$, Atlas method) 2,080 2,080 2,060 1,990 2,180 2,380 2,530 2,610 2,700 2,840

Real annual growth rates (%, calculated from 1990 prices) Gross domestic product at MP 6.1 4.7 4.9 1.7 5.5 5.3 5.0 4.8 4.7 5.2 Gross Domestic Income 6.4 4.4 4.5 1.7 5.3 5.4 5.0 4.8 4.8 5.3

Real annual per capita growth rates (%, calculated from 1990 prices) Gross domestic product at MP 4.7 3.5 3.7 0.5 4.2 4.0 3.7 3.4 3.4 3.8 Total consumption 4.0 4.1 4.1 2.8 4.5 4.5 3.7 3.3 3.0 3.8 Private consumption 4.4 4.2 4.2 2.7 4.6 4.8 3.7 3.3 3.0 3.9

Balance of Payments (US$ millions) Exports (GNFS)b 8,793 8,606 9,518 9,539 10,682 11,133 11,654 12,318 12,992 13,901 Merchandise FOB 5,873 5,840 6,606 6,857 7,686 7,941 8,236 8,656 9,076 9,640 Imports (GNFS)b 9,248 9,311 10,423 10,431 11,548 12,058 12,622 13,349 14,063 15,080 Merchandise FOB 8,015 8,093 8,997 8,980 10,061 10,501 10,995 11,635 12,259 13,149 Resource balance -455 -705 -905 -893 -866 -925 -968 -1,031 -1,071 -1,179 Net current transfers 902 825 983 1,130 1,124 1,150 1,174 1,193 1,270 1,305 Current account balance -443 -821 -863 -746 -774 -799 -800 -842 -858 -922

Net foreign direct investment 337 731 443 801 504 600 622 637 616 669 Long-term loans (net) 492 223 883 866 665 207 343 232 438 352 Other capital (net, incl. errors & ommissions) 267 -373 -208 -772 134 113 83 97 93 93 Change in reservesd -653 240 -255 -149 -529 -121 -247 -125 -289 -192

Memorandum itemsResource balance (% of GDP) -2.2 -3.6 -4.5 -4.2 -3.6 -3.7 -3.7 -3.8 -3.7 -3.8Real annual growth rates ( YR90 prices) Merchandise exports (FOB) 6.7 7.3 15.7 1.9 4.0 5.5 5.4 5.0 4.7 5.0 Merchandise imports (CIF) 5.8 6.5 13.6 -2.4 2.2 6.6 6.3 5.8 5.3 6.1

(Continued)

CAS Annex B6 - Tunisia- 84 -

Key Economic Indicators

Actual Estimate ProjectedIndicator 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Public finance (as % of GDP at market prices)e

Current revenues 23.9 24.0 24.4 24.4 23.9 23.6 23.5 23.2 23.1 23.2 Current expenditures 20.6 19.9 19.4 20.1 19.9 19.6 19.6 19.5 19.3 19.4 Current budget balance 3.3 4.1 5.0 4.3 4.0 4.0 3.9 3.7 3.8 3.8 Capital expenditure 7.2 7.9 8.7 7.8 7.3 7.2 7.0 6.7 6.7 6.8 Foreign financing 1.4 -0.2 3.8 2.3 5.9 3.9 3.6 2.3 3.1 2.3

Monetary indicators M2/GDP 51.9 54.5 55.8 55.9 56.2 56.8 56.8 56.8 56.8 56.8 Growth of M2 (%) 19.5 13.5 10.3 4.0 6.3 9.1 7.3 7.3 7.5 8.1

Price indices( YR90 =100) Merchandise export price index 129.2 119.8 117.1 119.3 128.5 125.8 123.9 124.0 124.2 125.7 Merchandise import price index 136.4 129.3 126.5 129.4 140.2 137.2 135.2 135.2 135.4 136.9 Merchandise terms of trade index 94.8 92.6 92.5 92.2 91.7 91.7 91.6 91.7 91.7 91.8 Real exchange rate (US$/LCU)f 101.5 99.7 97.4 96.2 96.2 96.2 96.2 96.2 96.2 96.2

Consumer price index (% change) 2.7 3.0 1.9 2.8 2.6 2.2 2.1 2.3 2.6 2.6 GDP deflator (% change) 3.1 3.3 2.7 2.3 2.3 2.4 2.2 2.4 2.7 2.8

a. GDP at market pricesb. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Central Government Financial Operationsf. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

(Continued)

- 85 -Key Economic Indicators

- 86 -

Actual Estimate ProjectedIndicator 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Total debt outstanding and 11,880 10,629 10,876 12,625 13,973 13,729 14,169 14,490 15,025 15,476

disbursed (TDO) (US$m)a

Net disbursements (US$m)a 529 232 1,030 866 1,348 957 760 389 590 452

Total debt service (TDS) 1,485 1,861 1,327 1,438 1,909 2,198 2,025 2,233 2,191 1,898

(US$m)a

Debt and debt service indicators (%)

TDO/XGSb 122 112 103 118 117 110 109 106 104 100 TDO/GDP 57 55 54 60 59 55 54 53 52 50 TDS/XGS 15 20 13 13 16 18 16 16 15 12 Concessional/TDO 22 24 24 23 23 24 23 22 20 18

IBRD exposure indicators (%) IBRD DS/public DS 19 13 18 17 18 16 19 17 17 25

Preferred creditor DS/public DS (%)c 49 37 44 49 42 38 42 37 37 43 IBRD DS/XGS 3 2 2 2 2 2 2 2 2 2 IBRD TDO (US$m) 1,323 1,211 1,297 1,464 1,779 1,652 1,633 1,645 1,698 1,687 IBRD TDO (% of GDP) 6 6 6 7 7 7 6 6 6 5 IBRD TDO / Total TDO 11 11 12 12 13 12 12 11 11 11 IBRD TDO / Preferred Creditor TDO 36 35 36 35 40 36 35 34 35 35 Share of IBRD portfolio (%) 1 1 1 1 1 1 1 2 2 2

IDA TDO (US$m)d 41 39 37 35 33 30 28 26 24 22

IFC (US$m) Loans

Equity and quasi-equitye

MIGA MIGA guarantees (US$m)

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short- term capital.b. "XGS" denotes exports of goods and services, including workers' remittances.c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank for International Settlements. Public creditors include Multilateral, Bilateral, Private Guaranteed, and IMF debt.d. Includes present value of guarantees.e. Includes equity and quasi-equity types of both loan and equity instruments.

CAS Annex B7 - Tunisia

Key Exposure Indicators

- 87 -

CAS Annex B8 (IFC) for Tunisia

Statement of IFC'sHeld and Disbursed Portfolio

As of 02/29/2004(In US Dollars Millions)

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

1998/00/01 BIAT 0 2.5 0 0 0 2.5 0 0

1995 Maghreb IM Bank 0 0.3 0 0 0 0.3 0 0

1986/92/98 SITEX 0 2.9 0 0 0 2.9 0 0

1998 Tuninvest 0 4.3 0 0 0 4.3 0 0

Total Portfolio: 0 10.1 0 0 0 10.1 0 0

- 88 -

Closed Projects

111

IBRD/IDA

Total Disbursed (Active) 266.4

of which has been repaid 6.6

Total Disbursed (Closed) 4,054

of which has been repaid 2,950.5

Total Disbursed (Active + Closed) 4,320.5

of which has been repaid 2,957.1

Total Undisbursed (Active) 554

Total Undisbursed (Closed) 4.3

Total Undisbursed (Active + Closed) 558.3

Active Projects

Project ID Project NameDevelopment

ObjectivesImplementation

ProgressFiscal Year IBRD IDA GRANT Cancel. Undisb. Orig. Frm Rev'd

P005591 OZONE DEPLETING SUBS S S 1994 3.8 0.5 -1.5 0.5P005589 SOLAR WATER HEATING S S 1995 7.4 0.3 0.3P005741 HIGHER EDUCATION REFORM SUPPORT I S S 1998 80 35 31 3.6P005750 AGRIC. SUPPORT SVCS S S 2001 21.33 25.3 4.7P048825 CULTURAL HERITAGE S S 2001 17 22.2 5.2P055814 EXPORT DEVELOPMENT S S 1999 35 12.2 12.2 0.4P050945 EDUCATION PAQSET I S HS 2000 99 47.9 1.4P082999 EDUCATION PAQSET II # # 2004 130.3 128.8P005731 GREATER TUNIS SEWERAGE S S 1997 60 7 23.7 33.6 6.1P046832 MUNICIPAL DEV. III S S 2003 78.39 88.2 14.6P005736 NATURAL RESOURCE MGMT S S 1997 26.5 6 8.7 6.4P072317 NW MOUNTAINOUS AND FORESTRY AREAS S S 2003 34 38 2.3P048315 PROTECTED AREAS MGMT. S S 2002 5.1 4.8 1P043700 TRANSPORT SECTOR INV S S 1998 50 11.5 13.6 -0.1P064082 TRANSPORT SECTOR INVESTMENT II S S 2001 37.6 34.6 13.2P035707 WATER SECTOR INVESTMENT PROJECT S S 2000 103 80.6 10.2

Overall result 772.1 16.3 7 559.6 150.5 16.9

a. Intented disbursements to date minus disbursements to date as projected at appraisalb. Following the FY94 Annual Review of Portfolio Performance (ARPP), a letter based system was introduced (HS= Highly Satisfactory, S = Satisfactory, U = Unsatisfactory, HU = Highly Unsatisfactory): see proposed improvements in Project and Portfolio Performance Rating Methodology (SecM94-901), August 23, 1994.

CAS Annex B8 - Tunisia

Operations Portfolio (IBRD/IDA and Grants)As of 04/05/2004

Supervision Rating

Last PSR

Original Amount in US$ Millions Disbursements a/

Difference Between

Expected and Actual