Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P-7286-ZA

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A PROPOSED CREDIT

IN THE AMOUNT EQUIVALENT TO SDR 122.7 MILLION

TO THE

REPUBLIC OF ZAMBIA

FOR A

PUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT

December 30, 1998

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit: Zambia Kwacha (K)US$ 1=2,33 7.95

FISCAL YEARJanuary 1 to December 31

ABBREVIATIONS AND ACRONYMSAAC Anglo-American CorporationBOZ Bank of ZambiaBW Bonded WarehouseCOMESA Common Market for Eastern and Southern AfricaCPI Consumer Price InflationDDB Duty DrawbackERC Economic Recovery CreditERIPTA Economic Recovery and Investment Promotion Technical Assistance CreditESAC Economic and Social Adjustment CreditESAF Enhanced Structural Adjustment FacilityHIPC Highly Indebted Poor CountriesIDA International Development AssociationIDF Import Declaration FeeIMF International Monetary FundMCDSS Ministry of Community Development and Social ServicesMMD Movement for Multiparty DemocracyMOU Memorandum of UnderstandingMUB Manufacturing-under-EBondNFNC National Food and Nutrition CommissionNGO Non-Governmental OrganizationPER Public Expenditure ReviewPFP Policy Framework PaperPIRC Privatization and Industrial Reform CreditsPSRP Public Sector Reform ProgramPWAS Public Welfare Assistance SchemeSAF Structural Adjustment FacilitySIP Sector Investment ProgramSPA Special Program of AssistanceUNDP United Nations Development ProgramZCCM Zambia Consolidated Copper MinesZPA Zambia Privatization Agency

Vice President: Callisto E. MadavoCountry Director: Phyllis PomerantzSector Manager: Ataman AksoyTask Team Leader: Sudhir Shetty

FOR OFFICIAL USE ONLYZAMBL4

PUBLIC SECTOR REFORMAND EXPORTPROMOTION CREDIT

Table of Contents

L. THE ECONOMY ...................................... 1

A. BACKGROUND ..................................... IB. RECENT DEVELOPMENTS AND PROSPECTS ..................................... 2

II. ZAMBIA'SADJUSTMENT PROGRAM ..................................... 4

A. MACROECONOMIC MANAGEMENT ..................................... 5B. PRIVATIZITIONANDPARASTATALMANAGEMENT ..................................... 6C. IMPROVINGPUBLICSERVICES ..................................... 8D. FOSTERING PRIVATESECTOR GROWTH ..................................... 9E. MEDIUM TERMPROSPECTSAND FINANCING PLAN ...................................... I.I

IM. THE PROPOSED CREDIT .................................. 11

A. SUPPORTING ZCCM PRIVATIZATION ............................ 12B. PUBLIC SERVICE REFORM ............................ 13C. INVESTMENTAND EXPORT PROMOTION .......................................... 1... 14D. SOCIAL SERVICES ............................... 15E. POVERTYIMPACT .............................. I 6F. ENVIRONMENTAL IMPACT ............................... 17G. SPECIFIC AGREEMENTS ............................... 17H. IMPLEMENTA TiON ARRANGEMENTS ............................ .. 18. IMPLEMENTA TION ASSISTANCE .............................. 1 8

J. COFINANCING .............................. 1 9K. PROGRAM BENEFITS ANDRISKS ..............................R. 19

IV. BANKOPERATIONS .............................. 19

V. COLLABORATION WITH IMF .............................. 21

VI. RECOMMENDA TION .............................. 22

A .NNEXES .............................. 23

A. SOCIAL INDICATORS OF DEVELOPMENTB. KEY ECONOMIC INDICATORSC. EXTERNAL FINANCING REQUIREMENTSD. STATUS OF BANK GROUP OPERATIONSE. EVOLUTION OF POLICY REFORM AGREEMENTSF. ZAMBIA AT A GLANCEG. MATRIX OF POLICY AGREEMENTSH. PERFORMANCE INDICATORS1. LETrER OF DEVELOPMENT POLICY

This operation was prepared by a team consisting of Sudhir Shetty (Principal Economist and TaskManager, AFTM I); Emile Sawaya (Principal Private Sector Specialist, AFTPI); Charles Husband (SeniorFinancial Analyst, EMTIE); Harry Gamett (Senior Public Management Specialist, AFT12); John Todd(Principal Economist, SRMSG); Hinh Dinh (Principal Economist, AFTM I), Aberra Zerabruk (SeniorCounsel, LEGAF); Said Al-Habsy (Senior Counsel, LEGAF), Steve Gaginis (Disbursement Officer,LOAAF), Ligia Murphy (Senior Task Team Assistant, AFTM 1) and Kendall Schaefer (Research Analyst,AFTMI)

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

ZAMBIA

PUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT

SUMMARY

Borrower: Republic of Zambia

Executing Agency: Ministry of Finance

Amount and Terms: SDR 122.7 million (US$170 million equivalent) on standardIDA terms with 40 years maturity.

Description: The proposed adjustment Credit would support Zambia'seconomic reform program, which aims at reducing thewidespread poverty by promoting broadly-shared, privatesector-led growth and improving the delivery of vital socialservices. In particular, the proposed Credit would supportmeasures that would: (a) facilitate completion of theprivatization of the copper parastatal, ZCCM, by assisting in itslabor reduction program; (b) improve the performance of thepublic service by reforming pay and employment practices andimproving management controls; (c) promote privateinvestment, particularly in export-oriented activity, byimproving access to imported inputs and streamlininginvestment approvals and, (d) strengthen the delivery of socialservices by monitoring budget allocations to key socialexpenditure categories and supporting key policy reforms.

Benefits: The main benefits of this Credit will be faster economicgrowth, employment creation, and poverty reduction arisingfrom a more efficient and effective public sector (ZCCMprivatization and public service reforms), a more competitiveprivate sector and fewer barriers to investment (ZCCMprivatization and trade and investment reforms), mitigation ofthe adverse impacts of ZCCM privatization (support to itslabor reduction program), and more effective social servicedelivery and safety net provisions (monitoring of budgetallocations and social service policy reforms). These changeswould benefit all groups in the population, including thepoorest. They would also provide the basis for sustainingmacroeconomic stability and the expansion and diversificationof exports. Consequently, Zambia's prospects for sustainablemedium-term growth would be enhanced.

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Risks: There are two broad categories of risk. First, it is possible thatthe Government's reform program could falter due to policyreversal, the impact of major external shocks, or a continuingshortfall in external donor support due to either economic orgovernance related concerns. The commitment of theGovernment to economic reforms has been steadfast even inthe face of adverse external conditions, including the recentcollapse in copper prices. Completion of the privatization ofZCCM, and efforts to expand non-mining exports would alsohelp withstand the effects of adverse external shocks. TheGovernment has committed to continuing the dialogue withdonors on governance-related issues, and developments in thisarea will be closely monitored. The second set of risks relateto the reforms supported by this Credit. The risk that the saleof the remaining core ZCCM assets could be delayed beyondmid-1999 is mitigated by the detailed agreemnents that havebeen reached. And, the risk that the agenda and timetable forpublic service reforms could pose political problems ismitigated by the Government's continuing consultations withall major stakeholders during program formulation andimplementation as well as its reliance on continued supportfrom the Bank and other external partners.

Disbursement: The proposed Credit will be disbursed through the Bank ofZambia. Disbursement will be in three tranches. The firsttranche (US$65 million) will be released at effectiveness. Thefloating tranche (US$40 million) will be released when thespecific conditions related to public service reform aresatisfied. The second tranche (US$65 million) will bedisbursed when the specific conditions associated with itsrelease are met, which is expected to be around May 1999.

Project ID Number: ZM-PA-35641

INTERNATIONAL DEVELOPMENTASSOCIA TIONREPORTAND RECOMMENDATION OF THE PRESIDENT

TO THE EXECUTIVE DIRECTORSONA PROPOSED

PUBLIC SECTOR REFORMAND EXPORTPROMOTION CREDITTO THE REPUBLIC OF ZAMBIA

1. I submit for your approval the following report and recommendation on aproposed development credit to the Republic of Zambia for SDR 122.7 million (US$170million equivalent) in support of its economic reform program. The Credit would be onstandard IDA terms, with an amortization period of 40 years, including a grace period of10 years.

2. The proposed Public Sector Reform Export Promotion Credit (PSREP) would bethe seventh structural adjustment credit to Zambia since the clearance of its arrears to theBank in March 1991. Zambia continues to face very large external financing needs dueto its high debt service requirements and the steep decline in the price of its principalexport--copper. In recognition of this need and of the accomplishments of Zambia'seconomic reform program, the international community provided exceptional levels ofbalance of payments support between 1991 and 1997. The objective of this Credit is tocontinue IDA's support of Zambia's program of economic reform, which aims to reducethe widespread poverty in Zambia through measures aimed at promoting broadly-shared,private sector-led growth and improving the delivery of vital social services. Inparticular, the proposed Credit would support measures to: (a) facilitate completion ofthe privatization of the copper parastatal, ZCCM, by assisting in its labor reductionprogram; (b) improve the performance of the public service by reforming pay andemployment practices and strengthening management controls; (c) promote privateinvestment, particularly in export-oriented activity, by improving access to importedinputs and streamlining the investment approval process; and (d) strengthen the deliveryof social services by monitoring budget allocations to key social expenditure categoriesand supporting the implementation of selected policy reforms.

I. THE ECONOMY

A. BACKGROUND

3. From Independence in 1964 through the 1980s, Zambia relied on a developmentstrategy that emphasized central planning, public ownership, and foreign borrowing. Theeconomy's performance was also adversely affected throughout this period by the heavydependence on copper, despite its falling real price and declining production as a result ofinsufficient investment. Zambia undertook several partial economic reform programsduring the 1980s, but these had little lasting effect (except to increase the national debt).When elections were called in late- 1991, Zambia was suffering from a large external debtoverhang (over US$7 billion), an inefficient and highly protected parastatal sector that

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dominated the economy, continued dependence on copper, steadily declining per capitaincome (half its 1975 level), and an unwillingness on the part of its government to holdthe course on difficult but necessary policy reforms. The election of the opposition party,the Movement for Multiparty Democracy (MMD), was seen as an overwhelmingendorsement of its economic reform program. Its objectives were to restore internal andexternal balance, to reduce public sector involvement in business activity, and to focusgovernment efforts on establishing the enabling environment for the private sector and onproviding the necessary infrastructure and social services.

4. Zambia's overall economic policy performance has been good since the reformprogram was initiated in 1991. In particular, the pace of liberalization and decontrol hasbeen impressive. Prices were decontrolled and subsidies eliminated; the exchange rateand interest rates are now market determined; quantitative restrictions on imports havebeen eliminated; and, import tariffs have been reduced and their structure simplified.Parastatal monopolies have ended, crop marketing has been liberalized, and an ambitiousprivatization program has made impressive progress. Not everything has gone smoothly,however. It took several years for the high rates of inflation to be brought down, andmacroeconomic stability, including consistently low inflation rates, is still to be fullyachieved. Structural reforms also remain incomplete, particularly where institutionalchanges are required, as with public service reform. And, the investment and outputresponse to these reforms has been muted by high real interest rates, continueddeterioration in the performance of the copper mines, a series of droughts, and aidshortfalls. Although growth resumed in 1996 and 1997, the delay in privatizing thecopper mines, the fall in world copper prices, and the continued suspension of bilateralbalance of payments support have tested the Government's commitment to the reformprogram and its ability to keep the program on track in 1998. Despite these challenges,understandings have been reached at the staff level with the IMF on a policy program tobe supported by a three-year ESAF arrangement for 1999-2001.

B. RECENTDEVELOPMENTS AND PROSPECTS

5. The Government's economic reform program has remained on course since thesecond half of 1996 despite much lower external assistance than anticipated. Bilateraldonors initially suspended balance of payments assistance in June 1996, largely inresponse to concerns about the proposed conduct of presidential elections later that year.This hiatus extended into 1997 and 1998 in response to continued concerns aboutpolitical governance. In 1998, multilateral balance of payments support was also held updue to the delays in privatizing ZCCM. Consequently, external program support, whichwas only US$141 million in 1996 (less than half the original estimate), was even lower in1997 (US$120 million), and was negligible in 1998.

6. Despite the drop in external assistance, economic performance was encouragingin 1997, and by the end of the year, it looked like Zambia was well placed to movebeyond stabilization to deepening the structural reforms needed to accelerate growth.Although GDP growth slowed to 3.5 percent (from 6.5 percent in 1996), due to a poormaize harvest and a fall in metals production, it was the first time since 1989 that GDP

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had grown in consecutive years. Non-metal exports continued their impressive growth --about 30 percent in 1997 and over 25 percent p.a. since 1994. And, inflation continued todecline, with the twelve-month CPI inflation rate falling from 35 percent at end-1996 toless than 19 percent at end- 1997. The tight fiscal and monetary policy stance that wasmaintained during much of 1997 contributed to this reduction in inflation. The overallcentral government deficit (on a cash basis) was reduced to about 1.9 percent of GDP(from 2.5 percent of GDP in 1996), while a domestic budget surplus (on a cash basis, andexcluding grants, external interest payments and foreign-financed capital expenditures) ofabout 1.2 percent of GDP was registered. Tight financial policies also helped curbimports, and despite the fall in copper prices in the second half of 1997, the trade deficitfell. But, the current account deficit widened to 5.5 percent of GDP (from 3.6 percent in1996) due to a fall in net transfers and a deterioration in the services account.

7. However, a combination of adverse shocks -- internal and external -- has slowedthe economy and worsened external and internal imbalances during the past year. Copperprices have fallen by almost 25 percent since mid-1997, while ZCCM's operational andfinancial problems and the delay in completing its privatization have reduced copperproduction and exports. This decline in the copper mining sector has hurt other sectors ofthe economy, and combined with the weather-related decline in maize production, GDPis estimated to have contracted in 1998 by about 2 percent. The fall in foreign exchangeearnings from copper exports (of over 27 percent) has been exacerbated by the fall innon-traditional exports. Combined with the lack of balance of payments support, thesefactors have resulted in the Kwacha depreciating in nominal terms by over 50 percent in1998, while official foreign exchange reserves fell from about 2 months of imports atend- 1 997 to less than 2 weeks of imports by end-November 1998. The current accountdeficit (after transfers) worsened to over 9 percent of GDP. Meanwhile, average annualinflation rose to almost 30 percent by end-November 1998. Although efforts were madeto maintain a tight fiscal stance in 1998, the lack of balance of payment support meantthat the domestic fiscal balance and the overall central government deficit deteriorated in1998. The decline in confidence in the Kwacha since late- 1997 has been reflected in therapid growth of foreign currency deposits as a share of broad money while the easing ofmonetary policy in late-1997 also led to an expansion of credit growth.

8. Progress on structural reform has been most substantial in recent years onprivatization and trade policy. By December 1998, almost 80 percent of the 280 non-mining public enterprises slated for divestiture had been privatized or liquidated. Theprivatization of the publicly-owned copper company, ZCCM, suffered a setback in mid-1998 when an international consortium withdrew from negotiations on the sale of thelargest asset package, but this process has moved ahead with an agreement in Decemberto sell these assets to other buyers. With the trade policy reforms since 1995, includingthe elimination of the 5 percent Import Declaration Fee in July 1998, Zambia now has atrade regime that is one of the most outward oriented in the sub-region.

9. The incidence of poverty in Zambia remains high, reflecting the collapse of thecopper industry and the residual effects of the economic mismanagement of the 1970sand 1980s. In 1991, about 70 percent of all Zambians were living in poverty with 58percent of the population lacking sufficient income even to meet basic nutritional needs.

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Recent data show a slight decrease in poverty. After increasing to about 74 percent in1993, poverty incidence fell to about 69 percent in 1996 with decreases in rural and urbanpoverty between 1991 and 1996. The depth and severity of poverty also declined duringthis period. Rural poverty still remains more widespread and more severe than urbanpoverty. Most social indicators mirror the high incidence of poverty. Infant mortality,adult illiteracy and malnutrition all remain extremely high and the prevalence ofHIV/AIDS has exacerbated the situation.

10. Zambia's medium-term prospects have to be assessed in light of its resources aswell as the policy challenges that remain. Its advantages include ample arable land andrainfall, abundant raw materials, and a liberalized policy environment. Acceleratinggrowth will require policies aimed at ensuring macroeconomic stabilization, completingthe privatization process, especially of ZCCM, improving infrastructure, and enhancingthe quality and coverage of public services. However, even with a supportive policyenvironment and consistent donor support, the legacies of over two decades of economicmismanagement and the current unfavorable external environment mean that GDP isprojected to grow at only about 4.5 percent per year in 1999-2001. Sustained economicgrowth and poverty reduction will come about only with steady policies and consistentaction over a number of years combined with accelerated debt relief.

HI. ZAMBIA 'SADJUSTMENTPROGRAM

11. Zambia's economic reform program aims to achieve a significant and sustainedimprovement in the living standards of the population through broadly-shared, privatesector-led growth. Attaining this goal, in turn, will depend on achieving and maintaininga stable macroeconomic environment, improving the climate for private investmentthrough liberalizing markets, privatizing commercial enterprises, investing in humancapital and physical infrastructure, and making progress toward long-term externalviability.

12. Zambia has successfully implemented many aspects of its reform program,particularly in the areas of liberalization and privatization. The emphasis has now shiftedfrom instituting "stroke of the pen" policy measures to undertaking the more complicatedagenda of institutional strengthening and program implementation. On macroeconomicmanagement, the focus is shifting to improving budgetary management, enhancingmonetary control, and strengthening the financial system, building on support fromprevious IDA adjustment operations. Many sectoral reforms are being supported byinvestment projects as described in Section IV below, and in several key sectors these arealso being supported under sector investment programs (SIPs). SIPs are underimplementation for the health, agriculture and roads sectors, a Power SectorRehabilitation Prograrn will begin implementation shortly, and a SIP is under preparationfor basic education.

13. The current reform program builds on these accomplishments. The status of theeconomic reform program, along with future actions, is summarized below under four

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general headings: macroeconomic management; privatization and parastatalmanagement; improving public services; and, fostering private sector growth.

A. MACROECONOMICMANAGEMENT

14. The domestic fiscal balance has improved steadily from a deficit of 4.2 percentof GDP in 1993 to a surplus of about 0.6 percent of GDP in 1998'. In the same period,the overall (cash) deficit of the central government, excluding grants, has fallen from 13.6percent of GDP to about 9 percent of GDP. While this improvement is commendable,particularly in the light of the difficult circumstances in 1998, several aspects of fiscaladjustment still need to be addressed. Tax revenues have fallen from 19.8 percent ofGDP in 1994 to 17 percent in 1998 and a number of tax exemptions, which were grantedin 1998 but later revoked, further threatened the revenue base. The significantcompression in non-wage expenditures, particularly domestically-financed publicinvestment, since 1994 points to the need to reduce the size of the public sector andcontain the wage bill. Finally, fiscal management performance has fluctuated widelyduring the adjustment period, prolonging the time taken to reduce inflation.

15. The Governnent's fiscal targets for 1999-2001 are to maintain a domestic budgetsurplus of, on average, about 1.3 percent of GDP and to reduce the overall deficit tobelow 1 percent of GDP (including grants) by 2001, from almost 4 percent in 1998.Strengthening tax administration and public expenditure management will be key toachieving these objectives and to strengthening overall fiscal management. Taxadministration will need to improve to increase effective tax yields, particularly withrespect to income and corporate taxes. The public expenditure management system willneed to be strengthened by improving the linkages between the cash budget andcommitted expenditures, thereby avoiding the build-up of new domestic arrears.

16. On revenue, the challenge over the medium term is to continue the restructuringof the tax system while increasing its ratio to GDP. The government will build on theprogress recently made in restructuring the tax system, which will involve a further shiftof the incidence of taxation toward consumption and away from international trade.Given the limited scope to raise tax rates further, the bulk of revenue improvements willneed to be found in the strengthening of tax administration and elimination ofexemptions.

17. To be sustainable, reductions in expenditures will need to be accompanied byrestructuring to safeguard priority spending on social sectors and infrastructureinvestments. A specific area where budgetary savings need to be achieved is in thepublic service wage bill. The reduction in the size of the public service (even with someincreases in wage levels) will allow the government to reduce the wage bill to about 25percent of total domestic non-interest expenditures in 2001 from about 38 percent in1996-98. In addition, the reduction in the stock of domestic debt and declining interest

Defined as the difference between revenues, excluding grants, and expenditures, excluding externalinterest and foreign-financed capital.

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rates will lead to a drop in interest payments of about 0.75 percentage points of GDPbetween 1998 and 2001. Both of these will create room for the needed increases indomestically-financed public investment and social expenditures. Public investment isprojected to increase to 7.4 percent of GDP by 2001 (from 6.1 percent in 1998) in thecontext of a medium-term public investment program.

18. Following the setbacks in restoring macroeconomic stability in 1998, the keyobjectives for monetary policy will be to assist in regaining control over inflation andrebuilding external reserves. To this end, the monetary policy stance will be tightened in1999 by controlling the growth of net domestic assets of the banking system. To allowsufficient growth in private-sector credit, the increase in the government's claims on thebanking system will be regulated. The Bank of Zambia also intends to intensify its use ofopen market operations while maintaining positive real interest rates on Treasury bills.

19. Reflecting growing concerns over the financial weakness of the commercialbanking sector, the priority in the financial sector will be strengthening prudentialoversight of the banking system. Several banks have closed in recent years, while othershave failed to meet the increased minimum capital requirements. Decisive actions to dealwith the weak institutions and to strengthen banking supervision in the Bank of Zambiawill be required to ensure that the banking sector can support the projected increase inprivate sector economic activity.

20. With import restrictions reduced and foreign exchange controls removed (withsupport from previous adjustment operations), the focus in the external sector is shiftingto establishing a viable long-term balance of payments position. This requiresdeveloping the capacity to withstand external shocks due to adverse weather and fallingcopper prices, as well as reducing Zambia's dependence on copper receipts and donorassistance by strengthening non-metal exports. Building external reserves will be a keyelement of this strategy along with the maintenance of a market-determined exchangerate. Bank of Zambia operations in the exchange market will be aimed at achieving thedesired accumulation of reserves and smoothing short-term fluctuations in the exchangerate. Reserves will not be used to defend the exchange rate if it appears out of line withmarket fundamentals and the longer-term goal of external viability, but policies will beadjusted if exchange rate developments jeopardize the inflation objective or reduce theprofitability of the tradable goods sector.

B. PRIVATIZATIONAND PARASTA TAL MANAGEMENT

21. The privatization program is well advanced in Zambia. At the outset of theprogram, the government enacted a sound legal framework and established a semi-autonomous privatization agency, the Zambia Privatization Agency (ZPA). Significantprogress has been made in implementing the privatization program, which started in 1993with a list of 138 companies to be privatized, and has increased in late 1998 to a portfolioof about 280 entities. Of these, 223 entities have been privatized or liquidated. Theprogram will now focus on completing the sale of the remaining assets of ZambiaConsolidated Copper Mining Ltd. (ZCCM), the copper mining parastatal, privatization of

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the utilities, and on increasing private sector involvement in the provision ofinfrastructure services.

22. By far the single most important privatization transaction that has been attemptedso far is that of ZCCM. When the current government came to power in 1991, ZCCMwas facing deep-rooted operational, managerial and financial problems, includingundermaintained plant and equipment; aging technology; declining identified ore reserves(despite an abundant resource base); low productivity; declining profitability; excessivedebt; conflicting commercial and social objectives; and surplus labor. The company'slabor complement was about 57,000, and the annual productivity level was 6.8 tons ofcopper per employee, low by world standards. The management appointed by the newGovernment attempted to improve ZCCM's performance, but failed, and in 1995, theGovernment decided to privatize ZCCM in order to mobilize the capital, technology andmanagement needed to restore the company and the copper mining sector to financial andoperational health.

23. To accomplish this, the Government and the minority shareholders (mainly AngloAmerican Corporation - AAC), on the recommendation of the international investmentbankers (financed under IDA's Economic Recovery and Investment Promotion TechnicalAssistance Credit (ERIPTA), approved in FY96), adopted a two-stage Privatization Planfor ZCCM. During the first stage, ZCCM would dispose of majority interests in itsmining assets by unbundling the latter and offering them for sale to qualified privateinvestors. In the second stage after the disposal of these packages, the residual ZCCMwould become an investment holding company that would collect outstandingreceivables, settle all outstanding liabilities, oversee the Government's minority interestin the privatized companies, and implement a program to reduce the residual labor forcefrom about 7,400 people (eighteen percent of ZCCM's current labor force) to about 30 bymid-1999. Subsequently, the Government's shares in "ZCCM Investment Holding"would be sold through public flotations to the Zambian public and other investors.

24. The first stage of this plan is well under way. The company's operations havebeen split into packages. Two of the packages (Konkola North Mine Development areaand Konkola Deep Mining Project) were subject to direct negotiations with majorinternational mining companies. Bids were called for the other packages by end-February 1997, and the investor response was favorable. Konkola North was sold to aSouth African mining company, and due diligence work and negotiations for KonkolaDeep was undertaken by AAC under the provisions of a Memorandum of Understanding(MOU) with ZCCM/Government. Several of the publicly offered packages and othermajor assets have been sold (LuanshyalBaluba Mine, Kansanshi Mine, the PowerDivision, Chibuluma Mine, Chambishi acid and cobalt plants, and the Precious MetalsPlant). Negotiations for the sale of the other major packages are at an advanced stage andMemoranda of Understanding have been signed with two prospective buyers. TheGovernment currently is aiming to transfer the remaining assets currently undernegotiation by the end of the first quarter of 1999. In the transactions concluded so far,the new owners have undertaken to take over the existing labor force and to honor allexisting terms and conditions of service. Any labor reduction programs will thereafter beimplemented at their discretion and cost. The investors negotiating for the remaining

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assets are reluctant to take over all the workers. Thus, the remaining employees, alongwith commercial obligations and short term loans not assumed by the new owners andresidual assets, will remain with "ZCCM Investment Holding."

25. The cost of the residual labor force redundancy program is now estimated atUS$65 million. The amount per person appears to be high because the compensationbeing paid is a terminal benefit, which is tantamount to a lump-sum pension that ispayable to all departing employees, including retirees, and because a large proportion ofthe workers being retrenched are long-time ZCCM employees. The costs of thisredundancy program go well beyond the financial capability of"ZCCM InvestmentHolding" in the short- to medium-term. However, a successful labor reduction programwould help ensure the completion of ZCCM's privatization and enhance productivity inthe sector, while reducing the scope for potential distress and social up]heaval on theCopperbelt during the transitional period. In an effort to minimize the costs of severanceand to encourage preference for continued employment in the privatized operations,ZCCM will: (a) actively promote the skills and services which are found in theCorporate Head Office, the Operations Center and the remaining core assets to the newowners prior to transfer of assets; (b) market the self-contained functions, such asResearch and Development, Industrial Relations, and Central Winding and MaterialsTesting; (c) sell company-owned houses to employees; and, (d) enforce thereimbursement to ZCCM of severance benefits by those who are subsequently re-employed in existing operations by the new owners.

C. IMPROVINGPUBLICSERVICES

26. The effectiveness of public services in Zambia has declined significantly over thepast 10 years. The basic problems are similar to those faced in many other countries.First, there are too many employees relative to current requirements; second, personnelcosts take too great a percentage of limited resources (almost 30 percent of domesticrevenues), thereby crowding out expenditure on essential supplies and capital spending.Third, salary scales have been compressed, resulting in wages at senior levels too low toattract and retain good quality staff. Finally, management and organizational proceduresare outmoded so that the existing manpower is not used efficiently, and the public servicehas become generally unresponsive to the country's development needs.

27. In 1993, the Government launched a Public Service Reform Program (PSRP)with a view to improving the quality of public services. Some progress has been made inrestructuring ministries to relate their organization more closely to their functions, to hiveoff non-core functions, and to identify surplus positions. Although new plans have beenapproved for most ministries and departments and some staff appointed to the newpositions, implementation continues to be hampered by the high cost of involuntaryretrenchment of surplus civil servants.

28. A revised PSRP was adopted in September 1997, which aimed at substantiallyreducing non-military public service employment, decompressing public-sector salarieswhile simplifying pay scales and consolidating allowances, introducing new personnelpolicies and procedures, including actuarially sound pension arrangements, strengthening

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the system for controlling the public payroll, and developing improved performancemanagement systems. The program would institute a full census of civil servants toidentify "ghost workers", use a combination of voluntary and involuntary separationpackages for those tenured civil servants identified as surplus, and implementstrengthened procedures for personnel management and a new program of performance-based management. Some of the savings from reducing the wage bill by cutting publicemployment would be allocated over the ensuing three years to decompress salary levelswith larger increases at the higher and middle levels. Donor contributions are expected tomeet a substantial share of costs of retrenchment.

29. Improved delivery of public services also involves reforms at the sectoral level indelivery mechanisms. In the health sector, those reforms are supported by a SectorInvestment Program (SIP) involving multiple donors, and center around decentralizationof decision-making and responsibility for service delivery to levels of government closerto those being served. For a number of years now, funding for health services has beenallocated as block grants to the district level. Similar systems are being developed inbasic education. These reforms are expected to increase efficiency and responsiveness tobeneficiary needs.

30. Of particular importance in the social sectors, reforms are currently underway inthe areas of nutrition and public welfare. Over the past year, an extensive study of theNational Food and Nutrition Council (NFNC) was undertaken, and the Government hasdeveloped an agenda for reform including redirecting the functions of NFNC to be moreof a catalyst than a service provider, and providing it with adequate resources. ThePublic Welfare Assistance Scheme (PWAS) is intended to help the poorest of the poordeal with short-term disasters, to pay for health and school fees, and to assist thechronically poor, such as widows, orphans, the aged and the handicapped. In the past, ithas suffered from design weaknesses, limited administrative capacity and low budgetallocations. The Governrnent has recently revamped the scheme, devising new eligibilitycriteria and developing new operational guidelines. The Ministry of CommunityDevelopment and Social Services (MCDSS) has developed a pilot scheme to test therevamped PWAS and will launch the new scheme over four years. An eligibility criteriamatrix has been developed, and implementation guidelines have been developed and fieldtested. Critical to the success of this revised program will be adequate funding. AboutK. 2.8 billion has been budgeted in 1999 for welfare transfer payments. A NationalPoverty Reduction Unit has also been established in MCDSS to coordinate theimplementation of the Govermment's Poverty Reduction Plan.

D. FOSTERING PRIVATE SECTOR GROWTH

31. Zambia's trade and investment policies have undergone substantial reform sincethe adoption of an outward-looking and market-oriented growth strategy in 1991. Thesereforms have helped to improve the climate for private investment and to enhance theattractiveness of export-oriented production. Decontrol of prices, elimination ofsubsidies, privatization of public enterprises, and removal of restrictions on private-sectoractivity have all contributed to improving the business environment. The availability offoreign exchange at the market-determined exchange rate, the elimination of quantitative

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import restrictions, and rationalization of the tariff structure with consolidation of tariffbands and reductions in nominal tariffs have been of particular importance in reducingthe anti-export bias of the trade regime. Meanwhile, until late-1997, tariff revenues weremaintained by limiting the availability of tariff exemptions to clearly identified groups orproducts while extending tariff coverage to most government imports.

32. Tariff reforms since 1996 have enhanced the attractiveness of export production.Nominal tariffs were lowered, particularly for raw materials and capital goods, and thenegative protection faced by many domestic businesses using imported raw materials wasreduced or eliminated. The maximum tariff rate was reduced from over 100 percent in1994 to 30 percent in 1997 (including the 5 percent Import Declaration Fee) while theaverage import-weighted tariff rate fell from 20.6 percent in 1994 to 11.4 percent in1996, and the standard deviation fell from 12.6 percent to 9.9 percent over the sameperiod. The process of lowering tariffs continued in 1998 with the elimination in July ofthe Import Declaration Fee (IDF), which had been assessed since late-1995 at 5 percentof the import value as a temporary measure to compensate for the revenue losses due tothe first round of tariff reductions. While these tariff reductions have clearly increasedthe profitability of export production, as reflected in the rapid growth of non-metalexports (27 percent per year in value terms between 1994 and 1997), it is difficult to bemore precise about the exact contribution of these changes to export production since thechanges are recent and precise data on cost structures and effective protection rates arenot available.2

33. In order to sustain the response of exports and private investment, continuedmacroeconomic stability, strengthening of the financial sector, and improvements inphysical infrastructure will be essential in the medium term. Complementary policy andinstitutional reforms are also needed in two main areas. First, to ensure that exportershave access to their imported inputs at world prices, the existing schemes--the dutydrawback (DDB) scheme, which refunds import duties to eligible exporters, and themanufacturing-under-bond (MUB) scheme, which exempts designated exporters fromimport duties--need to be improved. Despite past attempts to improve their functioning,both schemes have continued to suffer from implementation problems, and neitherscheme has had a perceptible impact on the profitability of export production. Theproblems with the DDB have been that the availability of funding for the provision ofduty refunds is inadequate and unreliable, while the procedures and documentation forclaiming refunds are time-consuming and cumbersome. The MUB had suffered from notbeing focused on exporters because it was not distinguished clearly from the BondedWarehouse (BW) scheme, which is available to all importers.

34. Second, the institutional basis for export and investment promotion needs to bestrengthened by streamlining the investment approval process, including that related toland acquisition, and reducing the number of often-overlapping consultative private andpublic sector institutions. At the same time, wide-ranging investment incentives in theform of fiscal exemptions need to be avoided.

2 The fall in non-metal exports in 1998 is likely to be an aberration on account of the recession and theaccumulation of arrears to businesses throughout the country by ZCCM.

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E. MEDIUM TERMPROSPECTSAND FINANCING PLAN

35. Among the most challenging aspects of Zambia's economic reform program is toestablish a viable and self-reliant balance of payments that is compatible with Zambiameeting its external obligations and achieving steady economic growth. This isparticularly difficult because of the weakening of copper prices with little expectation ofsignificant recovery in the medium term. At the same time, Zambia's external debt ofalmost twice its GDP (nearly half of which is multilateral) implies that substantial debtservice payments will be required even with successful negotiations with creditors. Thus,even with success in expanding non-metal exports and limiting the growth in the demandfor imports, even modest levels of economic growth will mean an increase in the currentaccount deficit during the coming decade. Zambia is a severely indebted low incomecountry and, therefore, eligible to benefit from the HIPC initiative. Once a new ESAFarrangement is agreed with the IMF and the necessary technical work is completedduring 1999, Zambia's case could be reviewed by the Bank and Fund Boards, providedoverall program performance continues to be satisfactory.

36. With the suspension of bilateral balance of payments assistance in June 1996, alarger share of Zambia's financing needs in 1996 and 1997 was met from foreign directinvestment and private capital flows, including privatization proceeds. Balance ofpayments support in 1997 was about $120 million, mostly in the form of IDA Credits.External financing requirements for 1998 were discussed at the Consultative GroupMeeting in May 1998. Although about US$235 million was pledged as program support,it did not materialize due to delays in completing ZCCM privatization. In 1999, theexternal financing requirement (excluding foreign-financed capital expenditure) isestimated at about US$640 million. Of this amount, about US$190 million is expected tocome from multilateral sources (including IDA), about US$360 million is expected totake the form of private capital inflows and new Paris Club debt relief, with theremainder coming from bilateral donors. It is expected that the next Consultative GroupMeeting will be scheduled for the first half of 1999, following IMF approval of a newthree-year ESAF.

III. THE PROPOSED CREDIT

37. The proposed Credit would be the seventh adjustment operation for Zambia in thepast eight years. Zambia's economic reform program is well advanced, and the emphasisis now on consolidating past reforms and improving their implementation. The centraltheme of the proposed operation is on improving the performance of the public sector indelivering key social services and in supporting private sector activity. To this end, itexplicitly supports important actions in four critical areas of Zambia's adjustmentprogram described above-ZCCM privatization, public service reform, export andinvestment promotion, and investment in social sectors. These areas are consistent withthe priorities of the Bank program in Zambia as described in the most recent CountryAssistance Strategy reviewed by the Bank Board in July 1996. Many of the actions to besupported under the proposed operation will be complemented by specific activities beingimplemented under ongoing or new investment operations. Technical assistance and

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other activities relating to the privatization of ZCCM have received ongoing support fromthe Mining TA and ERIPTA Credits. Public service reforms already being supported bythe Financial and Legal Management Upgrading Project will be built upon in a proposedfollow-up operation to build public sector capacity. To support the private sector, theEnterprise Development Credit provides credit and matching grants for projectdevelopment, while the ongoing Agriculture Sector Investment Project provides a RuralInvestment Fund. Complementary infrastructure is being funded under multi-donor roadsand power programs. Improved delivery of social services is being supported under theHealth SIP and the Social Recovery Project and will be supported by a Basic EducationSIP under preparation.

A. SUPPORTING ZCCM PRI VA TIZA TION

38. The assistance under the Credit aims to facilitate the completion of theprivatization of ZCCM and improve the productivity of the copper industry by reducingthe labor component of overheads and centralized technical services, and by mitigatingthe social cost of adjustment. The ZCCM redundancy program will be completed byabout June 1999. Government funds for this purpose will be lent to ZCCM oncommercial terms. The estimated cost of the program is US$65 million, net of theobligations assumed by the new owners in respect of divisional personnel. Of the totalcost, US$58 million would be for payments to departing workers and US$7 million forretraining and outplacement assistance programs, comprising financial counseling, jobsearch seminars, and skills bridging programs. The Government and ZCCM will agree toa redundancy plan acceptable to IDA based on a draft plan that was agreed atnegotiations, which includes mechanisms for identifying those who would receivepayments and the terms of those payments. A loan agreement will be signed between theGovernment and ZCCM for onlending the proceeds of the Credit to cover the costs of theredundancy program. An audit without qualification by an independent auditor thatcertifies that ZCCM has implemented the redundancy plan as agreed with IDA would bea condition for release of the Second Tranche.

39. As ZCCM sells more of its mining/core and non-core assets, it will be left with aportfolio of assets that consists mainly of investments in mining companies for which theorganizational structure of a mining concern, such as ZCCM's current organization, is notsuitable. The residual ZCCM will be a company that has different objectives andfunctions, and will have significantly different organizational and staffing requirements.Specifically, it will have to emphasize the monitoring of investments and follow-up onthe commitments of the buyers of its assets under the development and other agreements.It will also need far fewer staff (about 30) whose qualifications are by and large differentfrom those employed by ZCCM, the mining company. The change in the objectives,functions, and organizational structure will require ZCCM to revise its Articles ofAssociation, shareholder agreements, administrative rules, and terms and conditions ofservice. During Negotiations, IDA agreed with Government and ZCCM: (a) on a"ZCCM Reorganization Plan,"; and (b) that ZCCM will seek the approval of the agreed"ZCCM Reorganization Plan" by the ZCCM Board of Directors. A certified copy of theBoard's approval resolution will be provided to IDA, and satisfactory progress in

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implementing this Plan is a condition for release of the Second Tranche. The transfer tothe new owners of ownership and control of the remaining core ZCCM assets for whichMOUs and/or sales agreements have been reached and decisions concerning the futurestatus of any major ZCCM assets that are unsold will also be conditions for release of theSecond Tranche.

B. PUBLIC SER vICE REFORM

40. To achieve sustainable improvements in the performance of the public service, thegovernment recognizes that it must address the key issues of overstaffing, low andcompressed pay scales, and inadequate management controls. In September 1997,therefore, it adopted a revised PSRP to address these problems decisively andcomprehensively by aiming to: reduce nonmilitary public employment substantially byend-1999; decompress public sector salaries to bring pay levels and structures more inline with those in the private sector while simplifying pay scales and consolidatingallowances; introduce new personnel policies, procedures, and practices, includingactuarially sound pension arrangements, as the basis for a new employment contractbetween the government and the public service; strengthen the systems for controlling thepublic payroll; and, develop improved performance management systems.

41. Since the adoption of the revised PSRP, some progress has been made towardsthese goals. A detailed action and implementation plan for the program was prepared andapproved by the Cabinet in April 1998. A full-time Director General was appointed inearly-1998 to oversee the implementation of the program, in consultation with a SteeringCommittee of senior officials from various ministries. To ensure enforcement of tighterestablishment controls, a hiring freeze was instituted in August 1997. Initial reductionsin the public payroll have been made in 1998 with the retrenchment of over 15,500classified employees (who are not eligible for the separation packages under the PensionsAct), of whom about 12,300 have been paid their terminal benefits, averaging about K.4.5 million each. The terminal benefits for the remaining 3200 will be paid by early-1999. Staffing reviews have been initiated for the ministries that account for the bulk ofcivil service employment.

42. However, the original phasing of the program, as spelt out in the action plan thatwas finalized in April 1998 has been modified. These changes in the implementation andphasing of actions on PSRP reflect the deterioration in the economic situation during1998 as well as delays in moving ahead in some areas due, in part, to unclear delineationof responsibilities and inadequate coordination among the key agencies responsible foraction. Specifically, the pace of retrenchment of pensionable civil servants will now beconsiderably slower than was originally envisioned, while the implementation ofimproved management controls with regard to the payroll, establishment controls,performance management, and the ministerial staffing reviews and restructurings will becompleted later than was anticipated in the action plan. The pace of retrenchingpensionable civil servants has been slowed because of a poor response to the voluntaryseverance package announced in February 1998, in part, due to the worsening economicsituation.

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43. To agree on the details of this rephasing of actions on PSRP, managementarrangements for the program will be finalized and implemented in early-l 999.Following this, a revised action and implementation plan for PSRP will be prepared, andwill include clearly-assigned responsibilities for time-bound actions and targets in areassuch as retrenchments, pay and pension policies, establishment and payroll controls,ministerial restructuring, performance monitoring, and the mitigation of the social impactof retrenchments. It is expected that this action plan will be finalized and approved byCabinet so that its implementation begins by June 1999. An important issue to beaddressed in revising the action plan is the evaluation of various options for retrenchingpensionable civil servants in an affordable manner. As the condition for release of thefloating Tranche, the Government will agree with IDA on this action and implementationplan for PSRP and begin its implementation.

44. Since successful public service reform is a long-tern process, the action plan forPSRP will necessarily stretch beyond the implementation period of this operation.Continued support from the Bank and other donors to the implementation of the actionplan will likely be provided under the framework of an Adaptable Program Credit aimedat building public sector capacity, which is currently under preparation. The IDA Creditwould finance retrenchments as needed, depending on support from other donors, as wellas the necessary technical assistance to implement the reforms in such areas as publicservice pay and employment, and performance management frameworks.

C. INVESTMENTAND EXPORTPROMOTION

45. The reforms supported under this Credit relating to export promotion would buildon the trade and tax measures implemented since 1991, and would aim at accelerating thesupply response by: (i) ensuring that exporters have access to their imported inputs atworld prices by improving the workings of the DDB and MUB schemes, therebycompensating for the residual anti-export bias of the tariff regime; (ii) reducing tariffsfurther; and (iii) improving the institutional basis for investment and export promotion.

46. Making the DDB and MUB schemes work better remains important because,despite the recent reduction in tariffs, the average rate on intermediate inputs is still over9 percent, while less than a tenth of the value of intermediate goods imports now receiveexemptions, compared to 43 percent of the value of capital goods imports. Hence, tariffson intermediate inputs continue to have an appreciable impact on production costs formany promising export products. To address the problems with the working of the DDBand MUB schemes, changes aim at providing exporters with access to duty-free inputsquickly and transparently while ensuring that they can be administered and controlledeasily by the Zambia Revenue Authority. Therefore, the funding mechanism for theDDB has been revamped to ensure adequate and timely financing for refunds, and thenecessary documentation and procedures will be simplified. In particular, the duty refundmechanism, including procedures for verifying exports, builds on that already in place forVAT refunds. The MUB has been redefined so that it focuses directly on exporters andthe provision of duty-free imports to them has been linked to the revamped DDB scheme.

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47. As a condition of Board Presentation, several changes in the design andfunctioning of the DDB and MUB schemes were announced and their implementationbegun in April 1998. These changes included: (a) for the DDB, introducing proceduresfor computing the duty drawback based on coefficients that link duty paid to exportvalues; adopting the standard export documentation currently used for VAT refunds;improving the mechanism for funding duty drawbacks; and, drawing up a code ofconduct for applying procedures, which includes tracking the elapsed time for payment ofduty refunds; and (b) for the MUB, streamlining procedures and documentation along thelines for the DDB. As a condition of Second Tranche release, it would be verified thatboth schemes are being implemented satisfactorily, in terms of agreed criteria includingthe timeliness of processing of duty refunds and the implementation of simplifiedprocessing and documentation for the schemes.

48. In facilitating and supporting private investment, the process of investmentapprovals needs to be clarified and streamlined. With the reduction of fiscal incentives asa tool of investment promotion, the role of the Investment Center is now that of afacilitator, especially for foreign investors. However, the investment approval processstill involves the need to deal with multiple agencies, and can be both confusing andtime-consuming. Streamlining the investment approval process by clarifying the role andauthority of the Investment Center is, therefore, a priority. Some measures forstreamlining the investment approval process have been implemented, includingbroadening the composition of the Committee that considers Investment Certificateapplications and establishment of an independent consultancy company, which hasprivate-sector representation on its Board, to provide services to potential investors.Additional actions are being considered by the Government to streamline the investmentpromotion process. These proposals would be included in an action plan to beimplemented beyond the period of this Credit; and on which the Government will agreewith IDA as a condition of Second Tranche release.

D. SOCIAL SERVICES

49. Although some progress has been made in recent years, the delivery of socialservices in Zambia continues to be constrained by inadequate policies, shrinking financialresources and poor institutional mechanisms. Under this Credit, budget allocations to thesocial sectors would be agreed and monitored. In addition, two administrative reformswould be included. Improving nutritional status is a cross-sectoral issue that could bringsignificant benefits to a large share of the Zambia population at a relatively small cost.Under the previous ESAC II operation, a study of the Government's efforts to addressnutritional problems and especially the role of the National Food and NutritionCommission was carried out and some policy recommendations adopted. Applying theresults of that study and developing in more detail the policies and institutionalframework to deal effectively with nutrition issues will be a focus of the government'sefforts. Specifically, the Letter of Development Policy reflects the Government'scommitment to begin implementation of these policies during the period covered by thisCredit. The second area is to improve the effectiveness of the safety net so as to assistthe poor by mitigating the transition costs of adjustment. The Public Welfare Assistance

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Scheme (PWAS) is the Government's main vehicle for meeting the needs of the poorest,but its effectiveness has been limited in the past. PWAS has been reformed andstrengthened, and implementation of these reforms and the provision of adequatesufficient funding for the revamped program will be supported by this Credit.Specifically, the Letter of Development Policy includes the Government's commitmentto initiate implementation of the revamped PWAS during the PSREP period.

50. Under agreements reached in previous adjustment operations, the share of thediscretionary budget going to the social sectors has increased from 28 percent in 1993 to33.7 percent in 1995 and 34.6 percent in 1996. In 1997 and 1998, over 36 percent wasallocated to these budget categories although agreement on this figure was not acondition under an IDA Credit. Under this Credit, the Government will again maintain aminimum percentage (about 36 percent) of the total discretionary budget (i.e. excludingdebt service, donor funded development expenditures, and other statutorily requiredexpenditures) for allocations to and expenditures in the agreed social sector categories inthe 1999 Budget.

51. In previous operations, there has also been agreement on a subset of items thatwould be specifically protected from budget cuts. These items, which totaled 6 percentof the budget in ESAC II, were felt to be the highest priority in achieving sector goals andthe most sensitive to expenditure shortfalls. Under this Credit, there is an agreement,reflected in the Letter of Development Policy on protecting the budgeted amounts for keynon-personnel spending components in health, education, and public welfare, includingthe level of transfers to the Public Welfare Assistance Scheme. However, for simplicityof monitoring, only a few key categories would be monitored. The budget shares and themechanisms for monitoring actual expenditures have been agreed as a condition of BoardPresentation. Satisfactory implementation of the agreement on social sector spending asreflected in actual disbursements at the time of program review in 1999 would be acondition of Second Tranche release.

E. POVERTYIMPACT

52. The proposed Credit will improve the economic prospects of the poor in Zambiaby supporting the Government's efforts to stay the course on policy reforms, thusincreasing the prospects for sustainable economic growth and increased investment inZambia's human resources. Economic growth should expand real income andemployment opportunities. Further improvements in the trade regime should expandopportunities for non-mining exports, which analysis has shown to be more labor-intensive than the import substitution industrialization efforts of the 1970s. Of particularimportance to the poor will be the efforts to maintain social spending. The long-termefforts to eradicate poverty can only be successful if the Government is able to increasethe investment in Zambia's human resources for all population groups. This should alsobe strengthened by specific commitments supported under this Credit to improve budgetallocations to the social services and to strengthen the administrative arrangements in theareas of nutrition and public welfare. Of possible concern in terms of its short-termimpact on incomes will be the thousands of redundancies contemplated in both the publicservice and ZCCM. Severance benefits averaging several years of pay are to be paid to

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these employees, but it will also be necessary to offer services and training to ease thetransition to the private sector, and careful follow-up monitoring will be needed toidentify and remedy any significant problems that these redundancies might create.

F. ENVIRONMENTAL IMPACT

53. Addressing the issues related to the environment has been a vital part of Zambia'seconomic reform program. The Government was one of the first to complete a NationalEnvironmental Action Plan, and an IDA-supported Environmental Support Program iscurrently being implemented to strengthen the institutions that carry out Zambia'senvironmental program and to increase the cooperation between the public and privatesectors in this critical area. In addition, the Government has recently issued revisedenvironmental regulations for the mining sector, and a new environmental department inthe Ministry of Mines has been established. These should ensure that future mininginvestment take place with due regard to environmental considerations. The proposedCredit does not have an environmental focus, but it should have an overall positive effectby strengthening the capacity of the public sector to enforce environmental legislation.

G. SPECIFICAGREEMENTS

54. The specific conditions for release of the Second Tranche and the floatingTranche are summarized below. The maintenance of a satisfactory macroeconomicenvironment will be necessary to release both tranches.

55. The proposed specific conditions for Second Tranche Release are:

(a) Satisfactory audit of ZCCM's implementation of agreed redundancy plan;

(b) Satisfactory progress in implementing the ZCCM reorganization plan;

(c) Transfer of ownership and control of remaining core ZCCM assets forwhich memoranda of understanding and/or sales agreements have beenreached;

(d) Satisfactory operation of revamped DDB and MUB schemes;

(e) Agreement with IDA on an action plan to streamline investmentpromotion; and,

(f) Actual spending in the first quarter of 1999 consistent with agreed socialspending targets.

56. The proposed specific condition for release of the floating tranche is:

(a) Agreement with IDA on a revised action and implementation plan forPSRP, which is approved by Cabinet, and its initial implementation interms of arrangements for managing the program, strengthening

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management controls, and restructuring ministries (including thenecessary retrenchments).

H. IMPLEMENTATIONARRANGEMENTS

57. The proposed Credit of US$170 million will assist Zarnbia in meeting its externalfinancing requirements in 1999 and will facilitate the retrenchment of redundantemployees of ZCCM to enable its privatization and conversion to efficient operation.The Credit will be disbursed through the Bank of Zambia with US$65 million available ateffectiveness, US$40 million tied to a floating Tranche with a specific condition relatingonly to the public service reform program, and the remaining US$65 million tied to thesecond tranche with specific conditions in the three other areas, namely, ZCCMprivatization, export and investment promotion, and social services. Simplifieddisbursement procedures under adjustment credits will apply. The Borrower will open anaccount in the Central Bank. Upon IDA notification of tranche release for each tranche,proceeds of the Credit will be deposited by IDA in this account at the request of theBorrower. If after deposits in this account, the proceeds of the Credit are used forineligible purposes (to finance items imported from non-member countries, or goods orservices in the standard negative list), IDA will require the borrower to either (a) returnthat amount to the account for use for eligible purposes; or (b) refund the amount directlyto IDA, in which case IDA will cancel an equivalent undisbursed amount of the Credit.Although routine audit of the account will not be required, IDA reserves the right torequire it. As has been the case with previous adjustment operations, the Ministry ofFinance will be responsible for the overall implementation and monitoring of reformssupported by the PSREP Credit. This will involve continuing the monitoring andimplementation unit already established, and revising its terms of reference accordingly.

I. IMPLEMENTA TIONASSISTANCE

58. Administrative capacity remains a constraint on the Government's ability toachieve the objectives of its economic recovery program. The Bank has been assistingthe Government's efforts to upgrade this capacity while recognizing that the direction ofthis program must remain firmly in Zambian hands. Several IDA-assisted projects aredirected primarily at capacity building, including the Financial and Legal ManagementUpgrading Project (which includes administrative strengthening of public procurement),the Privatization and Industrial Reform Technical Assistance Project, the recently-completed Transport Engineering Project and the Economic Recovery and InvestmentPromotion Technical Assistance Project. All investment projects have major componentsaddressing capacity issues, particularly the sector investment operations in health,agriculture and roads (and under preparation in basic education). Use has also been madeof the Institutional Development Fund in building capacity in advance of projectinvestments. Considerable technical assistance is being provided in the public sectormanagement area by other donors and by the UNDP, and a possible follow-up capacitybuilding operation by the Bank is under consideration.

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J. COFINANCING

59. At this stage, the African Development Bank has expressed an interest in parallelcofinancing. Indications are that bilateral donors will make their own arrangements forproviding balance of payments support.

K. PROGRAMBENEFITSAND RISKS

60. The primary benefit of this Credit will be the advancement of policy reforms inthe critical areas of ZCCM privatization, public service reform, export and investmentpromotion, and social service delivery. These reforms should help sustainmacroeconomic stability, accelerate economic growth and increase employment whileimproving the delivery of social services. The measures related to ZCCM privatizationand investment promotion should enhance the prospects for medium-term growth whilethe protection of social sector expenditures should increase Zambia's prospects forsustainable growth in the longer term.

61. There are two broad categories of risk. The first is that the Government's reformprogram as a whole could falter. This could result from major policy reversals and/or theimpact of major external shocks, including a continuing shortfall in external donorsupport because of either economic or governance-related concerns. The commitment ofthis Government to economic reform has remained steadfast in the past seven years.Many of the measures supported under this Credit and previous adjustment operationshave strengthened the capacity of the Zambian economy to withstand external shocks,including the collapse in copper prices during the past year. Dialogue with donors ongovernance-related issues, pledged by the Government at the last Consultative GroupMeeting, continues to be needed and is of high priority. The second source of risk forthis Credit concerns the possibility that the specific reforms supported under it are notundertaken. While it is possible that the sale of the remaining core ZCCM assets couldbe delayed beyond 1999, this risk is mitigated by the detailed agreements that have beenreached between the Government, ZCCM and the prospective buyers for the purchase ofthe bulk of these assets. On public service reform, there is a risk that the agenda andtimetable for reforms could pose political problems. To mitigate this risk, theGovernment will continue consultations with all major stakeholders during theformulation of its action plan and implementation of the program, and rely on continuedsupport from the Bank and other external partners.

IV. BANK OPERA4TIONS

62. The Bank's 1994 Poverty Assessment prepared with significant donor andGovernment involvement, provides a focus for Zambia's development objectives andframes the priorities of the Bank's assistance strategy for Zambia. The Bank is pursuinga three-pronged strategy to assist the Government in implementing an action plan forreducing poverty in Zambia: creating a stable macroeconomic enviromnent favorable togrowth; promoting private sector development and greater public sector efficiency; and,targeting assistance to poor and vulnerable groups. Under the first prong of this strategy,

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Zambia has achieved some notable successes, and on balance, seems to have emergedfrom the most difficult first stages of its economic transition. Yet Zambia's high debtburden and limited prospects for copper exports in the short term mean that continuedreform and balance of payments support will be needed for the next decade if economicgrowth is to be achieved. Under the second prong, past reforms have resulted in theeconomy being now among the most open and private-sector oriented in Africa. IDA issupporting activities through specific investment projects and sector investmentoperations (SIPs) to improve the efficiency of service delivery as well as helping toincrease the private sector's role in the economy through continued support for theprivatization program and through new initiatives aimed at providing enterprises with theinformation, technology, and term finance to adapt to the new business environment. Inaddition, IDA is assisting the Government to arrest environmental deterioration and toput in place an effective environmental management system in Zambia.

63. To help target assistance to poor and vulnerable groups (the third prong of thestrategy), stabilization and budget reform measures supported by IDA adjustment lendinginclude protection of core social expenditures. Similarly, the Bank's investment lendingemphasizes supporting community-based development initiatives, integrating growth andpoverty reducing activities better within sectors, improving the delivery of services to thepoor, and linking poverty reducing activities across sectors.

64. The Bank's program in Zambia includes adjustment lending, investment lending,economic and sector work, and aid coordination. Bank adjustment operations each yearhave been aimed at strengthening macroeconomic stabilization and market liberalization,supporting privatization and parastatal reform, reducing structural constraints on thedelivery of social services, strengthening the social safety net, and promoting publicsector reform. In addition, IDA is supporting thirteen investment operations inagriculture, health, roads, power, urban water and sanitation, environmental protection,private sector development and social recovery, and in technical assistance in mining, thepetroleum sector, privatization and financial and legal reforn. The Bank is now shiftingits investment lending towards SIPs, whose aim is to increase public efficiency byavoiding the overlap, inconsistency, and administrative overload associated with a largenumber of separate donor-funded projects within each sector. As umbrella operations inwhich the Government takes the lead, SIPs are expected to promote dynamic growth bothbroadly, through improving the efficiency of service delivery within the sector, and in atargeted way, by financing pilot projects with a more immediate impact on the poor.They also provide long-terrn capacity building within the sector. SIPs have beenapproved in health (1994), agriculture (1995), roads and power (1998). Future IDAinvestment operations will consist predominantly of similar operations in basic educationand vocational education, a public sector capacity building project and a small number ofnarrowly targeted operations to achieve needed short-term gains. Preparation of a newCAS, involving a series of consultations with the Government and other stakeholders, isunderway and will be presented to the Executive Directors early in FY00.

65. The Bank's economic and sector work will include broader studies to providesome of the analytical underpinning for the economic reforms. Recent examples of suchwork are the Policy Framework Papers (PFPs), the Public Expenditure Reviews (PERs),

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the Growth Prospects paper, and a Fiscal Management Review. In addition, the PovertyAssessment has provided additional insights into the extent and determinants of povertyin Zambia, explored the impact of the reform program on the poor, and recommendedfurther reformns and targeted investment programs. As Zambia is one of the most heavilyindebted of the low income countries, considerable attention will continue to be paid toanalyzing the country's prospects for further debt relief, and Zambia is one of thecountries highlighted in the joint Bank-Fund study on Debt Sustainability for HeavilyIndebted Poor Countries. Further work on Zambia's eligibility for HIPC will take placein 1999. Aid coordination will continue to figure prominently in the Bank's strategy.This includes: supporting the aid coordination that takes place in Lusaka under theleadership of the Government; chairing the Consultative Group; providing countryconsultations on Zambia in Special Program of Assistance for Africa (SPA) meetings;and, maintaining frequent informal contacts with Zambia's principal bilateral partners.

V. COLLABORATION WITH IMF

66. The programs of the Bank and Fund in Zambia have been closely coordinatedsince assistance to Zambia resumed in 1991. Balance of payments needs are jointlyagreed among the Bank, the Fund, and the Government as part of the PFP andConsultative Group processes. Bank proposals on trade, taxation, spending allocations,privatization, public service reform and related structural policy benchmarks arecoordinated with the Fund's fiscal targets, while the Fund's macroeconomic benchmarksare developed in close consultation with the Bank. The Fourth Policy Framework Paperwas approved by the Bank and Fund Boards in December 1995, and a new PFP for 1999-2001 is being finalized. Zambia successfully completed its Rights AccumulationProgram in December 1995, and the Fund Board approved a three year SAF/ESAFprogram, the mid-term review of which was concluded in February 1997. An IMF teamhas reached understandings with the Government on a policy program for 1999,including the macroeconomic framework, to be supported by a three-year ESAFarrangement. These understandings are reflected in the draft PFP.

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VI. RECOMMENDATION

67. I am satisfied that the proposed Credit would comply with the Articles ofAgreement of the Association, and I recommend that the Executive Directors approve it.

James D. WolfensohnPresidentby: Sven Sandstrom

Washington, D.C.December 30, 1998

Attachments

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ANNEXES

A. SOCIAL INDICATORS OF DEVELOPMENT

B. KEY ECONOMIC INDICATORS

C. EXTERNAL FINANCING REQUIREMENTS

D. STATUS OF BANK GROUP OPERATIONS

E. EVOLUTION OF POLICY REFORM AGREEMENTS

F. ZAMBIA AT A GLANCE

G. MATRIX OF POLICY AGREEMENTS

H. PERFORMANCE INDICATORS

1. LETTER OF DEVELOPMENT POLICY

- 24 - Annex APage I of I

Zambia Social IndicatorsLatest single year Same reglonflncome group

Sub-Saharan Low-

1970-75 1980-85 1990-96 Aftica income

POPULATIONTotal poptiation, mid-year (milions) 4.8 6.7 9.2 596.4 3,236.2

Growth rate (% annual average) 2.9 3.1 2.8 2.7 1.8Urban population (% of population) 34.8 40.9 43.3 31.7 29.1Total fertility rate (births per woman) 6.9 6.7 5.8 5.6 3.2

POVERTY(% of population)National headcount index 86.0

Urban headcount indexRural headcount index

INCOMEGNP per capita (US$) 600 360 360 490 490Consumer price index (1987=100) 44 31,534 266 275Food price index (1987=100) 46 40,020

INCOMEICONSUMPTION DISTRIBUTION(% of income or consumption)Lowest quintile 3.9Highest quinble 50.4

SOCIAL INDICATORSPublic expenditure

Heafth (% of GDP) 2.4 1.5Education (% of GNP) 4.7 2.6 5.3 3.6Social security and welfare (% of GDP) 0.2 0.5 0.7

Net primary school enrollment rate(% of age gmup)

Total 77 77Male 81 78Female 73 76

Access to safe water(% of populaion)

Total 42 48 43 45 76Urban 86 70 64 63 80Rural 16 32 27 34 72

Immunizaton rate(% under 12 months)

Measles 49 78 56 80DPT 58 76 55 81

Child malnutrition (% under 5 years) 24 27 29Life expectancy at birth(years)

Total 47 46 44 52 63Male 46 45 44 51 62Female 49 48 45 54 64

Mortalitylnfhnt(perthousandlivebiths) 100 103 112 91 68UnderS(perthousandlivebirths) 181 149 202 147 94Adult (15-69)

Male (per 1,W00 population) 546 482 534 448 231Femal (per 1,000 population) 460 413 494 376 206

Maternal (per 1 00,000 live births) 230

World Development Indicators 1998 CD-ROM, World Bank

- 25 - Annex BPage 1 of3

Zambia - Key Economic Indicators

Actual Estimate ProjectedIndicator 1994 1995 1996 1997 1998 1999 2000 2001 2002

National accounts(as % GDP at currentmarket prices)

Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0Agriculture8 13.5 16.2 15.4 16.3 15.7 15.8 15.9 15.9 15.9

Industry8 34.7 31.6 30.4 30.4 29.9 31.0 31.3 31.6 31.7

Services' 38.9 39.7 41.4 41.0 43.7 41.8 41.3 40.8 40.7

Total Consumption 90.7 91.9 91.3 90.7 93.3 93.4 93.1 91.9 91.2Gross domestic fixed 13.3 13.6 14.5 13.1 15.2 15.5 16.0 16.3 16.5investment

Government investment 7.0 7.0 5.9 5.2 6.4 6.8 7.4 7.4 7.4Private investment 6.5 6.9 9.0 9.3 9.8 9.7 9.6 9.9 10.1

(includes increase instocks)

Exports (GNFb)V 35.1 37.6 33.8 31.7 28.5 30.4 31.9 32.8 33.2imports (GNFS) 39.3 43.4 39.9 37.0 38.1 40.3 42.0 42.0 42.0

Gross domestic savings 9.3 8.1 8.7 9.3 6.7 6.6 6.9 8.1 8.8Gross national savings' 1.7 0.6 2.0 3.3 0.4 -0.4 0.1 1.5 2.2

Memorandum itemsGross domestic product 3347 3498 3298 3875 3356 3504 3757 4051 4364(US$ million at currentprices)Grossnationalproductper 340.0 330.0 350.0 380.0 320.0 330.0 330.0 350.0 370.0capita (US$, Atlas method)

Real annual growth rates(%, calculated from 1994prices)Gross domestic product at -3.4% -2.3% 6.5% 3.4% -2.0% 3.0% 4.5% 5.0% 5.0%market pricesGross Domestic Income -0.6% 0.4% 2.6% 5.4% -5.2% 2.3% 4.5% 5.3% 5.4%

Real annual per capitagrowth rtes (%, calculatedfrom 1994 prices)

Gross domestic product at -6.1% -4.9% 3.8% 0.9% -4.3% 0.7% 2.3% 2.9% 2.9%market pricesTotal consumption -6.9% -1.5% -0.6% -0.1% -5.3% 0.0% 1.9% 1.6% 2.5%Private consumption -6.0% -1.0% 1.6% 0.1% -5.3% 1.1% 0.4% 1.5% 2.7%

(Continued)

- 26 - Annex BPage 2 of 3

Zambia - Key Economic Indicators(Continued)

Actual Estimate ProjectedIndicator 1994 1995 1996 1997 1998 1999 2000 2001 2002

Balance of Payments(USSm)

Exports(GNFSb 1174.7 1316.0 1113.0 1230.2 955.8 1065.0 1199.1 1330.2 1450.8Merchandise FOB 1067.3 1186.0 993.0 1119.1 845.8 951.6 1074.8 1192.3 1285.3

Imports(GNFS)b 1317.0 1518.0 1316.0 1432.4 1277.5 1413.1 1579.5 1700.1 1831.0MerchandiseFOB 1003.0 1194.0 1055.0 1056.0 1004.8 1102.6 1251.2 1357.6 1471.7

Resource balance -142.3 -202.0 -203.0 -202.2 -321.6 -348.1 -380.4 -369.9 -380.1Net current trnsfers -19.0 -20.0 -17.0 -16.0 -16.8 -17.6 -18.5 -19.4 -20A(including official currenttransfers)Current account balance -59.7 -146.2 -122.0 -239.5 -308.9 -368.7 -417.0 -395.6 418.4(after official capital grants)

Net private foreign direct 40.0 97.0 117.0 125.4 163.5 170.0 200.0 220.0 242.0investmentLong-term loans (net) .. .. .. .. .. ..

Official 87.1 116.6 86.0 87.0 74.1 176.7 -12.3 60.2 76.2Private

Other capital (net, including .. .. .. .. .. ..

errors and omissions)

Change in reservesd -155.0 -2.0 -52.0 -25.0 185.3 -1112 -84.6 -121.5 -190.4

Memorandum itemsResource balance (% of -4.2% -5.8% -6.2% -5.2% -9.6% -9.9% -10.1% -9.1% -8.7%GDP at current marketprices)Real annual growh rates(1994 prices)Merchandise exports 1.8% 4.9% -0.1% 12.2% -10.3% 11.1% 9.4% 7.8% 4.6%(FOB)

Primary -2.7% -10.4% 4.2% 7.2% .. ..

Manufactures -98.9% 22.6% 18.3% 4.4% 4.0% 10.0% 15.0% 14.0% 14.0%Merchandise imports 1.9% 10.1% -7.6% 5.5% -10.0% 8.0% 10.3% 5.8% 5.8%(CIF)

Public finance(as /o of GDP at current

market prices)Currentrevenues 20.1 19.9 20.6 19.8 18.1 18.9 19.3 19.4 19.4Current expenditures 27.9 24.2 18.5 18.4 18.2 16.2 18.0 17.8 18.6

(Continued)

- 27 - Annex BPage 3 of 3

Zambia - Key Economic Indicators(Continued)

Actual Estimate ProjectedIndicator 1994 1995 1996 1997 1998 1999 2000 2001 2002

Current account surplus (+j -7.8 4.4 2.1 1.4 -0.1 2.7 1.3 1.6 0.8or deficit (-)

Capital expenditure 4.0 5.1 8.7 7.5 9.0 10.7 10.0 10.2 10.1Foreign financing 9.4 9.3 8.4 8.9 9.7 12.1 6.4 8.4 8.0

Monetary indicatorsM2/GDP(atcurrentmarket 15.5 18.0 18.3 17.4 17.5 17.9 18.2 18.2 18.2prices)Growth of M2(%) 74.8 55.3 34.4 24.0 21.5 25.8 19.2 13.4 13.4

Price indices( 1994 =100)Merchandiseexportprice 114.1 133.3 111.7 112.1 94.5 95.6 98.8 101.7 104.8indexMerchandiseimportprice 124.5 134.7 128.8 122.2 129.2 131.3 135.0 138.5 141.9indexMerchandise terms of trade 91.6 98.9 86.7 91.7 73.1 72.9 73.2 73.4 73.9indexReal exchange rate 169.2 162.0 169.5 203.0 220.7 ..

(US$/LCU);Real interest ratesConsumer price index 53.6% 34.2% 46.3% 24.8% 27.8% 20.8% 12.1% 7.7% 7.6%(% growth rate)GDP deflator 56.6% 36.9% 24.3% 25.9% 23.2% 20.0% 12.0% 8.0% 8.0%(% growth rate)

a. GDP components are estimated at factor cost.b. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Data refer to central government.f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

-28 - Annex CPage 1 of I

Extemal Financing Requirements

Millions of US$

1996 1997 1998 1999 2000

Exports of Goods and NFS 1113 1230 956 1065 1199Imports of Goods and NFS 1316 1432 1277 1413 1579Other Current Account excl. interest payments -25 -40 -20 -52 -51

Current Account Balance excl.Grants and Interest Payments -228 -243 -341 -400 -432

Debt Service Before New Rescheduling 453 413 338 457 485

Gross Financing Requirements 681 656 680 857 917

Changes in Net Reserves" -52 -25 185 -111 -85Debt Relief and Other 2 107 130 -82 0 0

Financing Requirements after Debt Relief 626 551 577 968 1001

Identified Financing 627 550 599 779 681Official Grants 304 198 222 223 217Official Loan Disbursements ' 206 227 191 386 264Direct investment 117 125 164 170 200

Financing Gap -1 0 0 189 320

Memo item:IMF Purchase 0 14 0 13 27IMF Re-purchases 0 0 0 0 0

1/ Includes IMF purchases and re-purchases.2/ Includes payments of arrears, debt relief, short term, portfolio investment and errors and omissions.3/ Excludes use of IMF resources.

Status of Bank Group Operations in ZambiaOperations Portfolio

Difference Betweenexpected

Original Amount in US$ Millions and actual Last PSRFiscal disbursements a/ Supervision Rating b/

Project ID Year Borrower PurposeIBRD rDA Cancel. Undisb. Orig Frm Rev'd Dev Obj Imp Prog

Number of Closed Projects: 56

Active ProjectsZM-PE-3251 1992 GOVERNMENT PIRC TECHNICAL ASSIS 0.00 10.00 0.00 .94 .59 0.00 S SZM-PE-3221 1993 GOVT MKTG. & PROCESS. 0.00 33.00 0.00 13.05 11.00 0.00 S SZM-PE-3258 1994 GOVT OF ZAMBIA FINANCIAL & LEGAL MA 0.00 18.00 0.00 5.92 4.35 4.72 S SZM-PE-3252 1994 GOVT PETROLEUM REHAB 0.00 30.00 0.00 25.38 19.94 2.04 S UZM-PE-3241 1995 GOZ URBAN RESTRCT &WATER 0.00 33.00 0.00 16.29 .16 -2.13 S SZM-PE-3239 1995 GOVT HEALTH SECTOR 0.00 56.00 0.00 34.99 28.37 0.00 S SZM-PE-3210 1995 GOVT SOCIAL RECOVERY II 0.00 30.00 0.00 5.90 4.49 0.00 S SZM-PE-3218 1995 GOVT. AGRICULTURE SECTOR 1 0.00 60.00 0.00 36.32 23.61 0.00 S UZM-PE-40642 1996 ERIPTA 0.00 23.00 0.00 8.28 4.47 0.00 5 SZM-PE-44324 1997 REPUBLIC OF ZAMBIA ENTERPRISE DEVELPMNT 0.00 45.00 0.00 41.87 9.78 0.00 S sZM-PE-3253 1997 GOVT OF ZAMBIA ENVIRONMENT 0.00 12.80 0.00 12.27 2.06 0.00 S SZM-PE-35076 1998 POWER REHAB 0.00 75.00 0.00 76.38 8.90 0.00 S SZM-PE-3236 1998 GOVT NATIONAL ROAD 0.00 70.00 0.00 68.81 2.81 0.00 S S

Total 0.00 495.80 0.00 346.40 120.53 4.63

Active Projects Closed Projects TotalTotal Disbursed (IBRD and IDA): 140.50 2,017.22 2,157.72

of which has been repaid: 0.00 564.68 564.68Total now held by IBRD and IDA: 495.80 1,403.08 1,898.88Amount sold : 0.00 28.58 28.58

Of which repaid : 0.00 28.58 28.58Total Undisbursed : 346.40 1.49 347.89

a. Intended disbursements to date minus actual disbursements to date as projected at appraisal.b. 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.

Note:Disbursement data is updated at the end of the first week of the month.

0 >(O x

-30 - Annex D

Page 2 of 2

ZambiaSTATEMENT OF IFC's

Committed and Disbursed PortfolioAs of 30-Nov-98

(In US Dollar Millions)

Committed DisbursedIFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic1972/73 Bata Shoe ZA 0.00 .22 0.00 0.00 0.00 .22 0.00 0.001980/84 Kafue Textile 2.78 0.00 0.00 0.00 2.78 0.00 0.00 0.001983/91 ZHP 2.73 0.00 0.00 13.59 2.73 0.00 0.00 13.591994 AEF Big Five Car .52 0.00 0.00 0.00 .52 0.00 0.00 0.001995 AEF Kaila Lodge .14 0.00 0.00 0.00 .14 0.00 0.00 0.001997 AEF JY Estates .89 0.00 0.00 0.00 .89 0.00 0.00 0.001997 AEF Pentire .67 0.00 0.00 0.00 .67 0.00 0.00 0.001997 Finance Bank 4.50 0.00 0.00 0.00 2.00 0.00 0.00 0.001997 IMDHZ 0.00 .50 0.00 0.00 0.00 .50 0.00 0.001998 AEF Amaka Cotton 1.30 0.00 0.00 0.00 1.30 0.00 0.00 0.001998 Nicozam 0.00 .30 0.00 0.00 0.00 0.00 0.00 0.00

Total Portfolio: 13.53 1.02 0.00 13.59 11.03 .72 0.00 13.59

Approvals Pending Commitment

Loan Equity Quasi Partic1998 AEF DRILLTECH .20 0.00 .15 0.001999 AEF MPELEMBE .70 0.00 .30 0.001998 AEF PREMIER LAP. 0.00 0.00 .65 0.001997 AEF ZAMBIA COFF. 1.30 0.00 0.00 0.001997 SAFARI INTL. 2.00 .75 0.00 0.001999 ZAMCELL 4.50 .60 0.00 0.00

Total Pending Commitment: 8.70 1.35 1.10 0.00

ZAMBIA

Evolution of Policy Reform Agreements

A. MACROERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED(3/91) (6/92) (6/93) (3/94) (7/95)

General fiscal and General fiscal and General fiscal and General fiscal and General fiscal and General fiscal and Primary fiscal balance changed from a deficit ofmonetary perfomance monetary performance monetary performance monetary performance monetary performance monetary performance 7 percent of GDP in 1991 to about I percent ofwith specific limit on net surplus in 1996banking credit

Annual inflation reduced from over 100 percentIn 1991-1994 to 26 percent in November 1998

Harmonize sales tax on Time-bound action plan Introduce VAT Zambia Revenue Authority has increased taximports and domestic for VAT; collection performance;products Ensure parastatal VAT introduced July 1995Reform business dividends paid directlytaxation and broaden tax to Govemmentbases

Redirect budget to Continue redirection of Redirect budget to social Social sector share of budget increased from 28social sectors and within public spending from sectors and within those in 1993 to over 36 percent in 1996 and 1997.those to certain priority low-priority areas to to certain prioritycategories, e.g., drugs social services categories, e.g., drugs andand primary education primary education

Increase nominal Interest rates completely decontrolled in 1993;interest rates Treasury Bill auction established in 1993

Improve budget Prepare guidelines for Cash budget eliminates excess of domesticmanagement operation of the Cash spending over revenues;procedures to avoid Budget;arrears and unplanned System for monitoring arrears introducedspending Adopt and distribute

procedures and guidelinesfor Zambia NationalTender Board;

Establish time boundplan for publicprocurement, coveringcomputerization, recordkeeping, training,administrativestrengthening andextemal monitoring

Phase out maize Eliminate maize and Maize and fertilizer subsidies eliminatedsubsidies fertilizer subsidies

0

B. TRADEERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED(3/91) (6/92) (6/93) (3/94) (7/95)

Achieve market Exchange rate determined by market forcesclearing exchange ratein second-windowforex marketExpand OGL to all but All quantitative restrictions on imports removeda small negative list other than those for health, safety and

environmental resourcesRemove export bans Eliminate remaining All export bans removed except for(except for ivory, oil, export ban on maize environmental reasonsmaize, and fertilizer)Compress tariffrates Reduce top tarifffrom More tariff reduction Provide relief from Adopt a tariff structure Highest tariffrate reduced from 100 to 25

1000/o to 50%; adopt and compression transitional anomalies in with a maximum rate of percent, and number oftariff bonds reduced to 4strategy for further the tariff structure 25%. Many raw materialstariffreduction would be free of tariffs, Mechanism for relief from tariff anomalies

Introduction of VAT capital goods would bc adopted in 1994will automatically lower charged 5%, intermediateprotection by goods 15% and final goods Most raw materials subject to zero tariffseliminating 'up-lift" 25%factor Transparency and simplicity oftariffstructure

Eliminate most tariff improved with the elimination of mostexemptions, including for exemptions in 1996Govemment purchases,and no introduction of newexemptions; qualifyingNGOs to be given refundsor vouchers for customsduties

Simplify and liberalize Implementation of changes in the design of theduty drawback system duty drawback scheme initiated in April 1998

.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~)T

C. PRIVATE SECTORERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED

(3/9 1) (6/92) (6/93) (3/94) (7/95)Reform Investment Evaluate effectiveness Investment Act of 1991 replaced with new Act

Law; prepare of reformed Investment in 1993;

investment guidelines; Act and Investment Investment Center reorganized

streamline operations of Center Investment Guidelines issued in 1995

Investment Center Measures to streamline investment approvalsl____________________ _____________________ implemented in 1997

Liberalize licensing Prepare action plan for Licensing requirements reviewed and

for small-scale SSE deregulation simplified for new businesses

enterpriseDevelop action plan for Create legal basis for Implement 1995 Land Act Market for leasehold land liberalized and

land market market in leasehold including the Land regularized in 1995land and facilitate Tribunal and the Landsubdivision of land Development Fund;and property The Ministry of Lands to

establish a baselineperformance assessment ofits leaseholds grants;

Informal urban settlementsto be regularized

Increase budget Road Maintenance Fund established, funded

allocation for road by excise tax on fuelmaintenance _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

National Housing Policy National Housing Policy issued in 1995

Amend Employment, andIndustrial and LaborRelations Acts

Begin liberalization Marketing of all crops liberalized in 1992

of maize marketing _ _ _ _ _-__i_es_for_ __g_

Decontrol fertilizer All prices for agricultural products and inputsdecontrolled

Begin reducing Eliminate consumer Consumer subsidies ended in 1993

consumer maize maize subsidysubsidy

Adopt new mining sector Mining policy statement approved by Cabinetpolicy to encourage private in 1995sector investment;Adopt new legal, fiscal andenvironmental New legal, environmental, and fiscalframeworks; frameworks for mining adopted in 1995Strengthen capacity ofMinistry of Mines to Training and reorganization plan prepared ID

oversee new legal, fiscal under mining sector technical assistance oaand environmentalframeworks O C

D. FINANCIAL SECTORERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED(3/91) (6/92) (6/93) (3/94) (7/95)

Reform Securities Law Foreign Exchange transactions liberalized,and exchange rate market determined;Eliminated all interventions in creditallocations and interest rates;BOZ introduced Treasury Bills weekly

Establish stock auctions;exchange and adopt Reduced high reserve and liquiditycapital market requirements for commercial banks;regulations Changed Banking and Financial Services

Law to place all financial institutions underAmend Bank of BOZ supervision;Zambia Act to Issued BOZ regulations for banks;strengthen prudential Developed a Stock Exchange andregulations of banks established a Securities Exchange

commission to regulate itEnd public Reform business Adopt business Implement simplified Reform insurance industry Opened the insurance industry to privatemonopoly on legislation legislation procedures of 1993 policies and laws companies; new insurance law adoptedinsurance industry Investment Act (including pension-fund

management companies)and set up new regulatoryand supervisory agency _

Prepare action plans Adopt policy framework Adopted new policy and strategy for termfor DBZ, Eximbank and strategy for provision finance in 1995and Lima Bank of term finance to private

sector; Decvelopment Bank of Zambia has ceasedRestructure DBZ as apex new lending since 1997bank and create collectionagency for DBZ loan Apex established to on-lend external fundsportfolio; to private sector through commercial banksPrivatize or close downEximbank and Lima Bank; Stopped budget allocations to agriculturalReform rural credit and credit institutions in 1995reorient Govemment-owned credit institutions Eximbank and LIMA Bank in liquidation

J I

E. CIVIL SERVICE REFORMERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED

(3/91) (6/92) (6/93) (3/94) (7/95)Eliminate "ghost Eliminate surplus civil Improve retention Maintain adequate Approved use of in-kind benefits for

workers" by physical service staff and "ghost incentives for high information system severance payments in 1994

survey workers" level staff with reliable data onnumber and

Identify staffing Retrench 10,000 workers Reduce up-front cash deployment of Nearly all workers now paid by check

needs in line and develop deeper costs of severance teachersministries restructuring program; benefits Launched a public sector reform

include compensation program; about 15,000 public

measures employees retrenched since 1997;restructuring plans for 14 ministries

_ _ ~~~~~~~~~~~approved

F. PRIVATIZATIONAnnounce Adopt overall Update Privatization Begin sale of state- Adopted Privatization Act in 1992

privatization policy privatization plan/strategy Program owned firmsand develop Established Zambia Privatization

modalities Enact Privatization Law Agency (ZPA) in 1992

Offer at least 6 Complete sale of at least Offer for sale 60 Offered for sale 280 entities;

parastatals for sale 10 companies; and offer companies;for sale companies Reach point of sale Completed sale or liquidated 223

accounting for 10 percent for 20 companies; entities by December 1998

of total turnover of Complete sale orcompanies in program liquidate at least 15

companies;Offer for sale additional Offer for sale a total10 parastatals of 60 companies

Recruit all key ZPA ZPA operational since 1992staff

Establish PTF set-up in 1993Privatization Trust PTF received shares in Chilanga

: ________________ ____________________ Fund (PTF) Cement in 1995

Study options to Study completed; privatization underprivatize ZCCM wayComplete assessment Initial impact assessment completedof impact ofprivatization onspecific target groups First_stage

Adopt and begin implementing plans First stage of the two-stageto privatize and restructure ZCCM privatization plan, which splitAdopt plans to develop Konkola Deep ZCCM's operations into packages, isproject on urgent basis in joint-venture almost complete. Two packages werewith private sector in manner resulting subject to direct negotiations of whichin majority private-sector ownership one has been sold. The otherand management packages were offered publicly, and

several of these and other major assets t have been sold. Negotiations for the Ofour largest remaining packages areadvanced and these are expected to besold in early-1999.

G. PARASTATALS MANAGEMENTERC PIRC PIRC II ESAC ERIP ESAC 11 RESULTS ACHIEVED(3/91) (6/92) (6/93) (3/94) (7/95) _ _ _-mbia_ __-_ys

Complete studies of Adoption of acceptable Zambia Airways liquidated in 1994Zambia Airways, Post financial plan for Zambiaand Telecoms, and Airways Telecoms separated from Post andZambia Railways commercialized in 1995

Grant autonomy to all UBZ closed in 1995other parastatalsZIMCO to be ZIMCO closed in 1995. Directorate ofrestructured and sub- State Enterprises set up under Ministry ofholding companies FinanceabolishedEstablish autonomy of Study long-tern Utilities given authority to set their priceskey parastatal utilities regulatory based on agreed mechanismsand establish transitional arrangement forregulatory system, utilitiesincluding price

I adjustment mechanisms I

H. SOCIAL SECTORSERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED(3/91) (6/92) (6/93) (3/94) (7/95)

Implementation schedule Develop improved socialfor Social Action action program andProgram begin implementationIncrease budget Meet minimum budget Meet minimum budget Maintain a social Overall budget allocations improvedallocation for education and spending targets for and spending targets for sector budget of at

key social services in key social services in least 35 percent in Social sector share of budget increased1994 1995 1996 from 28 in 1993 to over 36 percent in

1996 and 1997

Expand role of NGOs in Formulate a policy on Sector strategies adoptedsocial services delivery collaboration with Decentralization of service delivery begun

NGOsDecentralize delivery ofhealth and educationservicesAdopt comprehensive Water sector policy adopted in 1994water sector policy

Prepare an EducationSector strategy

Formulate a nationaldrug procurementpolicy

I. SOCIAL SECURITYERC PIRC PIRC 11 ESAC ERIP ESAC 11 RESULTS ACHIEVED(3/9 1) (6/92) (6/93) (3/94) (7/95)

Reform Social New Social Security Act Passed bySecurity/Pension Fund Parliament.System

Adopt action plan to Adopted refonn strategy by NSSRISCcover unfunded liabilities based on joint Bank/lLO study in 1995of existing statutorypension funds Draft legislation under preparation

Repeal 22-years-of-service compulsoryretirement law andmodify benefit formulaeand early retirementconditions

Adopt action plan toimprove administrationand operations of Zambia Approved Cabinet Memorandum onNational Provident Fund Social Security Reform in 1995

riQ

- 38 -Annex F

Zambia at a glance Page Iof 2

Sub-POVERTY and SOCIAL Saharan Low-

Zambia Africa Income Devtopmnt dlamond'1997Population, mid-year (flYJkos) 9.4 614 2.048 Life expectancyGNP per capita (Atfas method, USS) 380 500 350GNP (Atlas method, USS$ bons) 3.6 309 722

Avrage annual growth, 19914J7

Population (X) 2.7 2.7 2.1 G

Laborforce(s) 2.8 2.6 2.3 GNP Gmrssper . primary

Most recent estimate (latest year available, 1991.97) capita enrollment

Poverty (X opopulaton below naflonal poverty ne) 86Urban population (% of total Population) 44 32 28Life expectancy at birth (years) 43 52 59Infant mortality (per 1,000 lAS bArhs) 113 90 78Child malnutrition (% of dukfen under5) 29 27 .. Access to safe waterAccess to safe water (X ofpopulatfon) 43 44 71Illiteracy (% ofpopulaon age 15+) 22 43 47 ZambiaGross primary enrofment odshoo-age populafion) 89 75 91

Male 92 82 100 Lowincorme groupFemale 86 67 81

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1976 1986 1996 1997Economic ratios

GOP (USS olidons) 2.7 1.7 3.3 3.9Gross domestic investment/GDP 31.5 23.8 14.9 14.5 TradeExports of goods and serviceslGDP 43.3 42.2 33.8 31.7Gross domestic savingsGDP 36.4 22.1 8.7 9.3Gross national savingstGDP 27.0 1.3 2.0 3.3

Current account balance/GDP -4.5 -22.5 -12.9 -11.3 .oxlstiInterest payrments/GDP 2.5 4.2 2.2 1.5 Dongs ;InvestmnentTotal debt/GDP 69.2 345.2 217.8 174.4 avingsTotal debt service/exports 16.1 50.9 21.7 21.6Present value of debt/GDP ..Present value of debt/exports .. I..b..n..

Indebtedness197646 198747 1996 1997 199842

(average annual growth)GDP 0.2 0.8 6.5 3.4 4.4 ZambiaGNP per capita 4.1 -0.9 4.8 1.4 2.3 Low-income groupExportsofgoodsandservices -4.2 1.8 4.8 14.6 8.4

STRUCTURE of the ECONOMY1976 1986 1996 1997 Growth ratesofoutputandlnvesb.nt ()

(% of GDP) eo

Agriculture 15.5 13.6 17.7 18.6Industry 44.3 49.4 34.9 34.6 40..

Manufactufing 15.7 25.2 13.5 13.5 20

Services 40.2 37.0 47.5 46.7

Pdvate consumption 38.4 51.0 78.8 79.4 -20 9

General govemnent consumption 25.2 26.9 12.5 11.3 -GD1 *-GDPImports of goods and servlces 38.4 43.9 39.9 37.0

197646 198747 1996 1997 Growth rates of exports and Imports (%)(average annual growt) e

Agrtcufture 0.9 -4.5 -0.6 -5.1 .Industry -0.9 -2.8 0.2 8.7 40

Manufactudng 1.2 -9.9 5.5 7I 20Servines 0.2 6.9 152 3.2

0

Pdvate consumption 0.0 0.4 4.2 2.6 -20 s 2 o46 97General govemment consumption -1.3 -9.3 -10.5 0.7Gross donmstic invtment -9.9 9.0 9.6 25.4 -40Imports of goods and servces -6.9 -1.6 -3.6 19.2 - Expofs -e--importsGross national product -1.0 2.0 7.6 3.9

Note: 1997 data are prliminary edimetes.

The diamonds show four key indiators in the country Qn bokld oompared with its inome-group average. If dala are nissing. the dibmond wiNbe Incomplete.

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Page 2 of 2

Zambia

PRICES and GOVERNMENT RNANCE

1976 1986 1996 1997 inflation %)Domestfc ptrcest(% change) 2.Consumer prces 18.8 51.8 46.3 24.8 150Implicik GDP deflator 15.2 82.0 24.3 25.9 _ _ _ _ _ _ _

Govermrent finance o.(% of GOP, kcAiades curmnt grants)Current revenue .. 23.4 20.6 19.8 92 93 94 9f 9s 97Current budget balance .. -22.3 2.1 1.4 - GDPderfator 0 CPIOverall surphis/deficit .. -28.2 46.7 -6.2

TRADE

(UiS$ ,nitik,s) 1976 1986 1996 1997 Export and Inport levels (USS nmions)

Total expols (fob) 1,029 698 993 1,119 1,400Copper .. 572 567 623 1.200Z'inc . 49 187 185 1.0Manufactures *- 168 180 c _ I_ ri-1

Total impots (cit) 668 580 1.055 1,056 coo am 111111Food .. 17 25 12 40DlIIlFuel and energy 72 51 87 2_

91 92 93 94 ff sc 97Export pdoe index (19958100) .. 67 84 84Import price index (1995.100) 38 68 96 91 cExports DtmporlsTerms of trade (1995.100) .. 99 S8 93

BALANCE of PAYMENTS

(US$ Sditions- 1976 1986 1996 1997 Currnt account balance to GDP ratio (%

Exportsofgoodsandservlces 1,112 748 1,113 1,230 0 --- -

Imports of goods and services 979 778 1,316 1,432 1911 92 93 1 1 sResource balance 133 -29 -203 -202 -4

Net income -147 -307 -206 -219 -10 .11Net current transfers . .. -17 -16

Current account balance -125 -375 -426 -438

Financing iRems (nat) 72 -77 478 463 -20Changes in net reserves 53 452 -52 -25 -25

Memo:Reserves induding gold (USSnltiions) 115 71 211 238Conversion rate (DEC, !ocMUSS) 0.7 7.8 1,20a7 1,333.8

EXTERNAL DEBT and RESOURCE FLOWS1976 1986 1996 1997

(USS nl'J5s) Compositon of total debt, 1997 (USS mnillons)Total debt outstanding and disbursed 1,898 5,745 7,181 6,758

IBRD 254 460 105 62 G G.62IDA 0 190 1,406 1,493 F: 155 |

Total debt service 180 386 246 282IBRD 19 60 58 40IDA 0 2 12 14

Composlion of net resource NlovaOfficial grants 124 276 378 E 2,8t4Official credioms 129 197 86 87 C: 1,138Ptivate credItors 35 127 -25 9Foreign ded investment .. 0 58 70Portfolio equity .. .. .. .. D:672

Wodrd Bank programCommitments 45 70 125 187 A - laRD E - BlatealDisbursements 74 114 181 169 B-IDA D-Otrmutwilatwal F-PrivatePrncipal repayments 4 27 50 38 C-IMF 0- Shoat-ternNeltlooto 70 87 131 131 1Interet paymenbt 1S 34 20 16Net Iransfeam 5 53 111 115

Development Ecocnomis 1218198

PSREP MATRIX OF POLICY AGREEMENTS

AREA AND OBJECTIVE BOARD PRESENTATION SECOND TRANCHE FLOATING TRANCIIEZCCM PRIVATIZATION - Facilitate * Agreement reached on draft ZCCM * Satisfactory audit of ZCCM'simplementation by assisting with ZCCM redundancy plan implementation of agreedlabor reduction program. * Agreement reached on ZCCM redundancy plan

reorganization plan for which * Satisfactory progress inapproval will be sought from ZCCM implementing ZCCMBoard reorganization plan

* Transfer of ownership andcontrol for remaining ZCCMassets

PUBLIC SERVICE REFORM - * Action Plan on PSRP adopted by * Agreement on revised action andImprove efficiency by streamlining Cabinet covering public sector pay, implementation plan for PSRP,staff, aligning salaries, and improving employment levels, and which is approved by Cabinet,management. management procedures and and its initial implementation

proposals for conducting civilservice census and private sector 0pay survey

* Progress in implementing PSRPaction plan, particularly in reducingpayroll and tightening establishmentcontrols

PRIVATE SECTOR GROWTH - * Changes to enhance DDB and MUB * Satisfactory operation of DDBImprove investment climate and schemes announced and and MUB schemesincentives, especially for exports. implementation begun * Agreement on an action plan to

* IDF eliminated streamline investment promotion* Measures for streamlining the

investment promotion processpublicized and underimplementation

SOCIAL SERVICES - Improve * Agreement reached on funding * Actual spending in 1999, at timedelivery of social services levels for social services in 1999 of program review, on social

and on a plan for monitoring actual services consistent withexpenditures agreement

>Ix

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ZAMBIAPUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT

Performance Indicators

Several indicators of economic and social performance will be used to assess the impactof this operation. These relate to economic outcomes expected as a result of policychanges, rather than the agreed policy and institutional changes themselves. They will bereviewed during supervision and after the operation has been completed and there hasbeen time for the changes to have had an effect, typically two to five years after theclosing date. These assessments will inevitably entail a large degree of judgment, as it isvery difficult to trace causality between actions taken under the proposed operation andthese performance outcomes. Moreover, performance indicators do not substitute for in-depth assessments and analyses of overall economic performance over time.

The following variables will be monitored as part of this effort to assess performance:

A. Macroeconomic Management

* government revenue and expenditure as a share of GDP

* external reserves

* inflation

* external debt and debt service relative to GDP

* domestic savings and investment relative to GDP.

B. Public Sector Management

* perceived quality of public services as indicated by beneficiary assessmentsand private sector business climate surveys

C. Fostering Private Sector Growth

* growth of non-traditional exports

* copper and cobalt production and exports

* number of public sector companies offered for sale and sold and/or liquidated

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* direct foreign investment, in general and in copper and cobalt mining, inparticular.

D. Investing in Human Resources and Other Social Services

* school participation rates by age, sex and geographic distribution

* school achievement (as measured by pass rates)

* infant and child mortality rates

* nutrition indicators, especially of children

43 - Annex IPage I of 13

29th December, 1998

Mr. Callisto MadavoVice President, Africa RegionWorld BankWashington, DCUSA

RE: PUBLIC SECTOR REFORM AND EXPORT PROMOTION CREDIT:

LETTER OF DEVELOPMENT POLICY

I. INTRODUCTION

1. The Govemment has negotiated a new Enhanced Structural Adjustment Facilitywith the International Monetary Fund (IMF) covering the period 1999-2001.Concurrently, a new Policy Framework Paper 1999-2001 (PFP), which outlines theGovernment's main economic objectives and the accompanying strategies, has beenformulated in collaboration with the staff of the World Bank and the IMF and has beenadopted by the cabinet.

2. The main macroeconomic objectives for the period 1999-2001 are to lay the basisfor sustained economic growth of 4Y/2 percent per year, further reduction in inflation and astrengthening of the external payments position. The ultimate objectives of these policieswill be to reduce the incidence of poverty in Zambia from the current estimate of 70percent to 50 percent by the year 2004.

3. During the programme period, the Government will continue with its stabilisationefforts through prudential fiscal and monetary policies. These policies will becomplemented by structural and institutional reforms, of which the most fundamentalones relate to the privatisation programme, public service reform, export promotion andstrengthening of the banking sector. Other reforms and measures that will beimplemented are measures to improve the framework for energy pricing, provision ofgrowth-enabling infrastructure, rural development and targeted poverty reduction andalleviation programmes.

4. The purpose of this Letter is to inform you about policy reforms in these areas ofreform and adjustment. We are seeking IDA assistance to support these reforms throughthe Public Sector Reform and Export Promotion Credit (PSREP)

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II. RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS

5. Since the end of 1991, far-reaching policy reforms have been implemented.These include:

* the decontrol of agricultural prices and the liberalisation of maize marketing;* substantial progress on a comprehensive parastatal reform and privatisation

programme;* the decontrol of commodity prices and interest rates;* the removal of exchange controls;* the liberalisation of the financial sector, in particular the banking and insurance

sub-sectors; and,* the dismantling of quantitative restrictions on imports and exports, as well as the

reduction of the level and dispersion of customs tariffs.

6. These reforms, coupled with efforts to pursue stable financial policies, havestarted to improve the economic outlook. The domestic budget balance, which was oneof the chief destabilising factors, was reduced and subsequently turned positive in 1995.In 1996 and 1997, the overall cash balance was maintained at 1.2 percent of GDP. Thefiscal policy stance combined with tight moretary policies contributed to a steady declinein the level and rate of inflation, falling from over 100 percent in 1991 to about 18percent by the end of 1997. Similarly, the exchange rate and interest rates were alsostabilised during the period. Economic growth, however, has been uneven due partly toadverse weather conditions, and the weaknesses in the performance of the mining sector.Between 1991 and 1995, the economy declined by an average of 1 percent annually.Consequently, real per capita Gross Domestic product (GDP) declined by 13 percentduring the period. Economic activity recovered significantly in 1996 and 1997, with realGDP expanding by 6.5 percent and 3.5 percent, respectively.

7. As a result of adverse weather conditions, the sharp decline in copper exports andcopper prices, and the weakening financial position of ZCCM, real GDP contracted by anestimated 2 percent in 1998. Inflation increased from the beginning of 1998 to 26 percent,reflecting mainly increases in domestic food prices and pass through effect of thedepreciation of the Kwacha since late 1997. In addition, due to the delay in donor supportfor balance of payments, the budget experienced cost overruns mainly on public serviceretrenchment and arrears. As a result, the targeted domestic budget surplus of 1.9 percentof GDP was not realised and the foreign exchange reserves were depleted.

III. OBJECTIVES OF POLICY 1999-2001

8. The Government medium term programme aims at achieving macro-economicstability, accelerating economic growth through investment and exports, and reducingpoverty. These objectives are consistent with the Government's long term vision of theZambian economy as one with a rapidly growing private sector operating in acompetitive and stable economic environment, with the public sector focusing on theprovision of support services and enforcement of laws and regulations. To this end, wepropose to take measures in three areas: (1) stabilisation measures to establish and

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maintain internal and extemal balance; (2) structural adjustment measures to strengthenthe basis for a market based and outward oriented economy; and (3) social-sector policiesaimed at poverty reduction and human resource development.

9. The objectives for the 1999-2001 period are to achieve economic growth of about5 percent on average per year while reducing the rate of inflation from 26 percent in 1998to 15 percent in 1999 and further down to 4 percent by 2001. To bolster our ability torespond to external shocks, gross official reserves will increase to 1.2 months importcover in 1999 and rise further to 2.2 months import cover by 2001. The external currentaccount deficit is expected to widen from 7 percent of GDP in 1998 to 8.3 percent ofGDP in 2001, largely on account of foreign investment in the copper sector, which willbe financed from private capital inflows. Government's role will be centred on theprovision of infrastructure, the maintenance of a favourable policy environment forachieving high growth rates in mining, agriculture, tourism and manufacturing, and the moreeffective delivery of social and other support services.

10. The annual growth projections over the 1999-2001 period are based on an annualincrease in copper production of 6 percent, agricultural output growth of some 51/2percent, and an increase of non-traditional exports of 15 percent annually. Thecompletion of the privatisation process will enable an increase in manufacturing outputby 5 percent per year. These growth prospects are underpinned by an expected increasein gross investment, from 17 percent of GDP in 1998 to 20 percent in 2001. The increaseis to come from private investment in the mining sector, export agriculture,manufacturing and tourism, while public investment is expected to rise from 6.1 percentof GDP in 1998 to 7.4 percent of GDP by 2001. The increase in investment is expected tobe financed by the inflow of foreign private capital and rising public savings. Privatedomestic savings are expected to remain constant at 3.8 percent of GDP over the 1999-2001 period.

11. Zambia's heavy external public debt burden will require continued reliance on debtrelief and concessional balance of payments assistance for the foreseeable future. Wehope to qualify for assistance under the Heavily Indebted Poor Countries (HIPC)Initiative, as it is not expected that the external debt burden can be reduced to sustainablelevels without such supplementary debt relief. The Government recognises that continuedassistance from Paris Club creditors and the qualification for the HIPC Initiative willdepend on a strong track record under IMF and World Bank-supported programmes inthe coming years.

IV. STABILISATION MEASURES

Fiscal Policies

12. Key fiscal targets for 1999-2001 are to bring the overall fiscal deficit of(including grants) to below 1 percent of GDP by 2001 and to generate domestic budgetsurpluses of some 1.3 percent of GDP, which would create the necessary room for theexpansion of private sector activity. The fiscal stance will also allow the Zambia toreduce over the medium-term its dependence on external assistance as a source of budget

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financing. The principal key to achieving fiscal objectives will lie in the strengthening cftax administration and public expenditure management system. Tax administration willbe improved to increase effective tax yields, particularly with respect to income andcorporate taxes. The public expenditure management system will be strengthened toavoid domestic arrears and ensure the proper execution of the budget.

13. The revenue-GDP ratio is programmed to increase by I1/2 percentage points overthe medium-term. The Government will build on the progress already made inrestructuring the tax system, which will involve a further shift of the incidence of taxationtowards domestic sources away from international trade. Given the limited scope forraising tax rates, the bulk of domestic revenue improvements will be found in a moreefficient tax administration. The performance of the Value Added Tax system will beimproved by further reducing fraud, while the current one rate structure will bemaintained. In addition, the company income tax rate structure will be reviewed with aview to its unification. Efforts to combat smuggling and customs frauds will beintensified by strengthening customs administration and intensifying co-operation withcustoms officials in neighbouring countries.

14. The Government recognises that public expenditures need to be restructured tosafeguard priority spending in the social sectors and infrastructure development. Aspecific area to be addressed is the public service wage bill. The reduction in the size ofthe public service will allow the Government to reduce wage payments in percent of totaldomestic non-interest expenditures from 34 percent in 1998 to 25 percent in 2001, whiledecompressing and maintaining the wage bill relative to GDP at 5 percent in 1999. Thereduction in the stock of domestic debt and declining interest rates will lead to a drop ininterest payments of almost 3/4 percentage points of GDP between 1999 and 2001. Lowerwage and interest payments in relation to GDP will create room for the needed increasesin domestically financed capital investment and social expenditures. Between 1998 and2001, domestically financed public investment is projected to increase by almost 2percentage points to 3 Y2percent of GDP. This increase will be realised in the context of amedium term Public Investment Programme that identifies the priority infrastructureprojects in support of the development of the agriculture and agro industrial production,tourism and exports, as well as through an improved delivery of social services.

Monetary and Exchange Rate Policies

15. Monetary and credit policies will play a crucial role in reducing the rate ofinflation. A strong anti-inflationary policy will require improvements in the effectivenessof monetary policy, including the broadening of instruments. In this context, the Bank ofZambia (BOZ) will intensify the use open market operations and reduce the reliance oncash and liquidity reserve requirements as instruments of credit control. An enhancementof confidence in the internal and external value of the Kwacha will also help the BoZdevelop a market for medium and long term Government bonds. This will widen theavailable options for open market operations and reduce the sensitivity of theGovernment budget to short term fluctuations in interest rates. In addition, thesupervisory and inspection functions of the BoZ will continue to be strengthened in orderto ensure public confidence in the banking system.

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16. The exchange rate of the Kwacha is market determined, and the BOZ intends tocontinue its policy of refraining from interventions in the foreign exchange market thatgo against the underlying market trends. The authorities will closely monitor conditionsin the exchange market and price and exchange rate developments in major tradingpartner countries and will adjust policies if exchange rate developments jeopardiseinflation objectives or the profitability of Zambia's tradable goods sector.

V. STRUCTURAL ADJUSTMENT MEASURES

Privatisation

ZCCM

17. In the mining sector, the key challenge is to complete the privatisation of ZCCM,thereby mobilising the capital, technology and management needed to develop new orebodies and restore the sector to financial health. To accomplish this, a two-stagePrivatisation Plan has been adopted. During the first stage, ZCCM is disposing of itsmajority interests to private investors. In the second stage, the residual ZCCM willcollect outstanding receivables, settle short-term liabilities, manage ZCCM's long termliabilities and its minority interest in the privatised companies, and oversee a programmeto reduce the residual labour force from about 7,400 people (25 percent of ZCCM'scurrent labour force) to about 30 over the first half of 1999. The structure of the holdingcompany has been designed and approved by the ZCCM board as part of a transformationplan, which will be in place by March 1999. Government shares in the residual ZCCMwill then be sold through public flotations to the Zambian public and other investors.

18. The first stage of this plan is close to completion. As of end-December, 1998,Memorandum of Understandings on the sale of all publicly-offered ZCCM assetpackages has been finalised, including the Nchanga and Nkana Divisions, the largest ofthe units. The new owners have undertaken to take over most of the existing labour forceand to honour existing terms and conditions of service. Government has aimed tofacilitate the privatisation of ZCCM by improving productivity through the reduction ofthe labour component of overheads and centralised technical services and by minimisingthe social cost of adjustment. In addition, all self-contained non-mining assets of ZCCMhave been offered to the public through management buyouts or public auctions. TheSchedule for completion of the sales transactions is:

* January 1999: Anglo-American relinquish Mufulira smelter andsigning of sales agreement for Mufulira

* February 1999: Transfer of Mufulira Mining Assets to new owners* February 1999: Signing of Sales agreement for remaining mining assets* March 1999: Transfer of remaining assets to new owners* March 1999: Completion of sale of non-mining assets

19. The labour reduction programme will be implemented over the period January1999-March 2000 and will in part be financed out of the proceeds of the PSREP Credit to

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Government which will be on-lent to ZCCM. The estimated cost of the programme is US$67 million. Government and ZCCM have developed a redundancy plan which has beenapproved by the ZCCM Board and includes, mechanisms for identifying those to receivepayment, the terms of those payments, and the on-lending agreement betweenGovernment and ZCCM.

20. To minimise potential abuses of the redundancy programme and encouragepreference for continued employment in the privatised operations, ZCCM will:

* actively promote the skills and services which are found in the Corporate HeadOffice, the Operations Centre and the operating mines prior to hand-over to the newowners;

* consult with the new owners to ensure that those workers that are needed by the latterare not inadvertently retrenched; and

* agree with the new owners that the redundancy compensation will be paid back toZCCM by the new owners, if the retrenched worker is re-employed by the newowners within a two-year period of the date of transfer of ownership.

Non-ZCCM Parastatals

21. Privatisation of state owned enterprises is a key element of Government's effortsto raise efficiency and bolster economic growth. Since 1992, significant progress hasbeen made in the implementation of the privatisation programme. As of December 1998,223 state enterprises were privatised out of Zambia Privatisation Agency's (ZPA) totalworking portfolio of 280. Among the assets sold, seven are ZCCM assets. Other majorcompanies still in negotiations are Zambia Forest and Forestry Industries Limited,Nitrogen Chemicals Limited, Kafue Textiles Limited and Ndola Lime Limited.

22. Over the medium term ZPA will focus on the large utility companies, parastatalsin the petroleum and transport sectors, and financial institutions. The Government intendsto offer a minority shareholding and management rights in the telecommunicationcompany (ZAMTEL) and intends to study options for the commercialisation of theelectricity company (ZESCO). The parastatals in the petroleum sector (INDENI refineryand ZNOC) have been added to ZPA's portfolio. As regards, the transport sector, theGovernment has entered into a management contract for Zambia Railways and MulobeziLine, and intends to put out for tender the granting of concessions with regard to therailway system. The Zambian and Tanzanian privatisation agencies have starteddiscussions on options for private sector participation in the commonly owned TAZARArailway and TAZAMA pipeline. Management rights on the operations of the NationalAirports Corporation in Livingstone, Ndola and Mfuwe will be tendered as well. TheGovernment also intends to hand over the remaining parastatals in the communicationsector, notably ZAMPOST, to ZPA. Substantial progress is planned on the privatisationof financial institutions. In this regard, ZPA has been requested to explore options fordivestiture of Zambia National Commercial Bank, the National Savings and Credit Bankand Zambia State Insurance Corporation.

-49 - Annex IPage 7 of 13

23. Pending their privatisation, the energy sector companies will remain free ofpolitical interference in their pricing policies and management decisions and will notreceive public subventions. Government has established regulatory arrangements for theutilities. Our objective is that utility prices provide an adequate return on capital andfacilitate a sound level of performance and investment, while the utilities are makingmaximum efforts to improve their efficiency and do not exploit their monopoly positions.

The Public Service Reform Programme (PSRP).

24. The cost effectiveness of the public service has declined significantly over thepast 10 years. Personnel costs take 32 percent of domestic fiscal resources and crowd outexpenditure on essential supplies and capital spending. As wage levels and paydifferentials have been compressed, it has become difficult to attract and retain skilledpersonnel. Moreover, even the available manpower is not used efficiently because ofinappropriate management and organisational structures. Consequently, the public servicehas become generally unresponsive to the country's needs.

25. In 1993, a Public Service Reform Programme (PSRP) was initiated, with the goalof strengthening the effectiveness, efficiency and quality of services delivered by thepublic service. This was to be achieved by, amongst other things, restructuring ministriesand provinces, introducing Performance Management and Human Resource ManagementSystems and decentralising certain functions to district level. A core objective was also toreduce spending on personal emoluments (PEs) by reducing public servant numbers, soimproving the ratio of Recurrent Departmental Charges to PEs. On September 1 1997, arevised PSRP was adopted that targeted a reduction in public sector workers from136,984 as at June 1997 to 80,000 by the end of 1999. The new PSRP also included thedecompression of salaries so as to improve remuneration for the higher/skilled grades.

26. Substantial progress has been made during 1998. 15,524 casual employees havebeen approved for separation, with 12,375 (80 percent) having been paid their benefits(amounting to K 57.45 billion) by end October 1998. This class of employee nowaccounts for about 12 percent of the civil service compared with around 22 percent inmid 1997. Further by 31 October 1998, 2,059 civil servants on permanent andpensionable terms have submitted applications for voluntary separation, 939 (45.6percent) of whom are administrative staff and 172 (8.4 percent) secretarial. The hiringfreeze is firmly in place. New hires are allowed only in critical skills required by GRZ,i.e. doctors, lawyers and police. In other skills, new recruitment has been allowed toreplace those that have died, resigned or retired. All new hires are approved by theSteering Committee. During the first half of 1998, 3,863 civil servants were lost throughnatural attrition, while 2,400 new hires were recorded, resulting in a net loss of 1,463.

27. During 1998, other activities that have been carried out are:

* The ongoing exercise on identifying and eliminating "ghost" employees from thepayroll, which continues to receive special attention by the Government. During1998, the payroll has been decentralised to ministries and provinces. This has led

-50 - Annex IPage 8 of 13

to a further reduction in numbers on the payroll as controlling officers are nowbetter placed to verify those being paid than the centralised salaries section in theMinistry of Finance and Economic Development.

* Cabinet has approved the re-structuring plans for 12 ministries and 4 institutions,resulting in abolition of 8,068 posts. Out of this figure, a total of 4,733 posts willbe realised through the proposed hiving-off of some Government departments andfunctions with actual abolition of post contributing 3,335

* In addition, three other institutions - the Vice President's Office, PSMD andCabinet Office have also had their restructuring plans approved by Cabinet. Allthe remaining ministries restructuring plans will be submitted by the end ofDecember 1998. The Performance Management Package has been introduced intofour of the already restructured Ministries and institutions (Agriculture, LocalGovernment, PSMD and Environment) and will be introduced into otherrestructured institutions throughout 1999.

* Cabinet decisions have been taken to commercialise 4 institutions, (the NationalInstitute for Public Administration, the Registrar of Companies, Patents, TradeMarks & Business Names and the National Parks & Wildlife Department and theTechnical Education & Vocational Training Authority). The commercialisation ofthese will remove 3,754 persons from the civil service. A further two institutionsrecommended for commercialisation are awaiting Cabinet approval, while threehave been recommended to Cabinet for privatisation. Two institutions arerecommended for abolition and another has been recommended ifor merger.

* The decentralisation of payroll management has already been referred to above.As of November 1998, there are 46 payroll centres. A second leveldecentralisation of payrolls, applicable to large ministries with geographicallydispersed staff, will be implemented in 1999. Under the reformed payroll system,each person on the payroll must be identified with a post in the establishmentregister and a job title before payment is processed.

* An analysis of the composition of the civil service has been carried out. Followingthe retrenchments and natural attrition that have taken place during 1998, the sizeof the civil service has dropped to 117,166 persons by end October 1998. Of thisnumber, 66,939 (55.1 percent) has been in service for 10 years or less.

* The largest group of civil servants (46,395 or 39.6 percent) are those in theES/TES scales i.e. primary and secondary school teachers (excluding untrainedteachers) or technical education lecturers, with another 523 being schoolheads/inspectors or education officers. Police and prison service officers accountfor another 15,733 (13.4 percent), while medical personnel account for a further11,803 (10.1 percent). Technical officers, employed in the fields of agriculture,forestry, infrastructure construction and water supplies number 6,103 (5.2

Annex I- 51 - Page 9 of 13

percent). These critical areas account for 80,557 Civil Servants, which is alreadyabove the PSRP target of 80,000.

* Of those remaining, the bulk (l9,124 or 16.3 percent) are in the GAS/GMS scalesand include untrained teachers (over a third), accounts and administrativepersonnel. The next biggest group is the rump of classified employees who nownumber 14,271 (12.2 percent) having been more than halved in number during1998 through the retrenchment programme. The remaining civil servants arelawyers and other graduates, judges, magistrates, local courts officers andpermanent secretaries.

* The drafting of the Decentralisation Policy was completed and the draft policywas submitted for consideration by the Social Restructuring and Developmentcommittee of Cabinet in August 1998. The policy was approved in principle andis now being amended in light of the Committee's decisions, before presentationto the full Cabinet. The policy will entail further reduction in the establishments atprovincial and line ministry levels, with the devolution of functions to districts.However, this may require creation of some posts at the district levels tostrengthen the capacity of service delivery.

28. It is clear from the above that the 80,000 target by the end of 1999 is not realisticor feasible. Further widespread/across the board retrenchments would seriouslyundermine, if not destroy, the public sector's ability to deliver public services like health,education and law and order and to maintain publicly owned socio-economicinfrastructure. The government is currently carrying out more detailed work to determinethe optimal size of the civil service in the medium term.

29. Nonetheless, an additional 7,000 Civil Servants will be removed from the payrollin 1999 through retirement, natural attrition, and the hiving off of public institutions. Tokeep the reform momentum going, detailed management arrangement for PSRP will beimplemented in early 1999 along with a timetable for completing the preparation of arevised action plan for PSRP. This plan will include clearly assigned responsibilities fortime bound actions in areas such as retrenchment, pay and pension policies, establishmentof payroll controls, ministerial restructuring, performance monitoring, and the mitigationof the social impacts of retrenchments. It is expected that the implementation of thisaction plan will begin by mid-1999. In addition, a new Civil Service remunerationstructure will be introduced after the substantial completion of retrenchment, which willaddress, inter alia, the problem of compression in pay scales.

Investment and Export Promotion

30. The Government is committed to maintaining the liberal trade and exchangeregime, and to continuing trade liberalisation as part of the Cross-Border Initiative (CBI).The trade weighted average rate of import taxation has been reduced to below 15 percent,and the tariff schedule consists of three non-zero rates with a maximum of 25 percent.Over the medium term the Government aims to reduce the weighted average import taxto 10 percent. To this effect, the maximum rate will be reduced to 20 percent in 2001.

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31. Decontrol of prices, elimination of subsidies, privatisation of public enterprises,and removal of restrictions on private sector activities have all helped to improve thebusiness climate and profitability of export oriented production. In particular, tariffreduction and consolidation, and the elimination of foreign exchange controls and importrestrictions have reduced the anti-export bias of the trade regime. To build on theseachievements and sustain the supply response, the Government has undertaken thefollowing reforms:

* To ensure that exporters have access to imported inputs at world prices, the DutyDrawback Scheme (DDS - which refunds import duties to eligible exporters) and theManufacturing Under Bond scheme (MUB - which exempt designated exportersfrom import duties) have been improved, as described in SI No. 48 of 27 March 1998,and workshops to publicise the new procedures have been held.

* Measures to streamline the investment approval process, including broadening thecomposition of the Committee that considers Investment Certificate applications andthe establishment of a consultancy company to provide services to potential investorswith a Board of Directors that includes private sector representation, have been taken.

* To improve the process of consultation between government and the private sector oneconomic policies, the joint private-public Zambia Industrial Partnership Council(ZIPC) has been established. The Council is intended to be the main consultativebody and has broad representation from the private sector as well as the Government.

* Eliminated the Import Declaration Fee as of July 1, 1998.

32. The Government intends to follow these measures up as follows:

* Undertake, jointly with IDA by mid-1999, an evaluation of the working of therevamped DDB and MUB schemes focusing in particular on the timeliness ofprocessing of duty refunds and responding to new exporters who wish to use theschemes, and, the implementation of the simplified procedures and documentation forthe schemes

* Consider additional actions to streamline the investment promotion process, includingsteps needed to access infrastructure services and options for revamping and mergingconcerned agencies. Before any proposals are submitted to Cabinet for approval,these will be discussed with IDA to ensure that they are consistent with earlieragreements and measures in these areas, with a view to agreeing on an action plan tobe implemented beyond the period covered by this Credit

• Monitor experience with ZIPC as a consultative mechanism between the Governmentand the private sector

* Ensure that trade missions/offices abroad are effective in investment and exportpromotion by posting experienced trade attaches to key markets

- 53- Annex IPage II of 13

Sector Policies

Agriculture Reforms

33. The primary objective of agricultural policies is to promote more efficient smallholder agricultural production, with the view to increasing agricultural output and export.The Governrment's aim is to reduce the bottlenecks on the supply side, notably throughimproved roads, increased access of farmers to new production and harvest technologies,and wider access to financing. The Government will also emphasise the role of theprivate sector, and from 1999/2000 refrain from intervening in the marketing ofagricultural products and input supply, except in the context of officially declaredemergencies and specifically targeted poverty reduction schemes. An important vehiclefor the co-ordination of agricultural policies is the Agricultural Sector InvestmentProgramme (ASIP), which combines donor support into one programme.

Tourism

34. The slow development of Zambia's tourism sector has been due largely to limitedinfrastructure and unsatisfactory management of the parastatal lodges. Several recentdevelopments have affected the sector positively. These include the establishment of anumber of private airlines and the leasing to the private sector of government lodges. Inorder to facilitate private sector investment in the tourism sector the Government willundertake appropriate investments in supporting infrastructure. The Zambia Wildlife Actwas passed by Parliament and will come into effect on S't January 2000 and the Tourismand Hospitality Bill is being processed. These measures are expected to contribute to areduction in wildlife poaching and ensure an increase in tourism.

Transport

35. In order to develop an efficient transport network, the Government aims to adopta national transport policy by mid-1999. A significant ingredient of the plan is a majorten-year road transport investment programme (ROADSIP), which was launched in 1997to improve and rehabilitate the road network and to eliminate the maintenance backlog.The programme aims to increase the proportion of main roads in good condition to 45

36. Due to poor infrastructure, coupled with past poor management, traffic handledby ZR declined by 66 percent from 1990 to 1996. The shift in traffic to road has beencostly in terms of damage to the roads. The rehabilitation of railway transportation willassist in the reduction of road maintenance costs. Consequently, ZR has started a trackrehabilitation programme. In addition, Government aims at private operation andmanagement of ZR possibly through a concessioning arrangement.

Energy

37. In the electricity sector, the Government's main priorities are to attain financialviability of ZESCO, restructuring it for commercialisation, facilitate private sectorinvestment in generation and transmission, and improving the management of the Rural

- 54 -Annex I

Page 12 of 13

Electrification Fund. In line with the understanding with the World Bank under theElectric Power Rehabilitation Project, ZESCO's accounts for its generation, transmissionand distribution has been separated. In addition, a new hydro power and transmissionpolicy has been articulated in order to promote private sector involvement in the sector.

VI. POVERTY REDUCTION

38. The widespread poverty in Zambia is a key concern, which can only be tackled bysustained growth in per capita income. Government intends to follow the strategiescontained in the National Poverty Reduction Plan. These strategies include, amongstothers, investment in human resources by providing more adequate and reliable socialservices and improving social safety nets, which will contribute to Zaimbia's long termprospects for growth and enhance the quality of life for its citizens.

39. The Government's strategy for improving the delivery of social services includesimproving the policy and institutional framework, maintaining public expenditures tospecific social sector categories, and improving the effectiveness of social safety netprogrammes.

40. Improving education and training and reversing recent declines in coverage andquality will be central to the success of the economic reform programme. Government isembarking on an integrated Basic Education Subsector Investment Programme (BESSIP)with the aim of increasing enrolment in primary and secondary education and improvingthe quality of education as measured by student learning achievements and otherindicators. Government plans to increase the number of trained teachers with a view toeliminating the use of untrained teachers over the medium-term.

41. To improve the quality of health care, Government is reforming the deliverysystem, encouraging private sector provision, and implementing cost sharing. TheGovernment will continue implementing the medium term strategy, adopted in 1995under the Health Sector Reform Programme, which focuses on extending the provision ofan essential package of primary health care services to all Zambians. Family planning andAIDS prevention programmes will be part of the basic package of services under thehealth programme.

42. Allocation for social sector spending has been maintained at about 36 percent ofthe discretionary domestic budget of 1998. As detailed in the Annex to this Letter thisallocation will be maintained in 1999. In addition, spending on the seven specific budgetcategories of non-personnel spending on health, education and social welfare shown inthe Annex will also be maintained.

43. The Public Welfare Assistance Scheme (PWAS), which is the main social safetynet programme for the poorest, has been revamped both in terms of its eligibility criteriaand operational guidelines. The new PWAS is intended to become more communitybased over the coming years. Meanwhile, the Public Welfare Assistance ManagementUnit and a National Poverty Reduction Unit have been established in the Ministry ofCommunity Development and Social Services to manage PWAS and co-ordinate the

Annex IPage 13 of 13

implementation of the Poverty Reduction Plan, respectively. To improve the nutritionalstatus of the population, the Govenmment has adopted recommendations based on therecent study of nutritional problems and the role of the National Food and NutritionCommission (NFNC). An expanded Board of Directors for the NFNC was appointed inJanuary, 1998. A policy document will be presented to Cabinet by July, 1999, whichwould provide the context for new institutional arrangements for implementingnutritional programmes and the basis for reviewing the legislation in this area.

VII. PROGRAMME IMPLEMENTATION AND MONITORING

44. The Economic Recovery Programme imposes formidable challenges forsuccessful implementation. For these reasons, and due to the need to co-ordinate themultiple policy initiatives among ministries and agencies of Government, management ofthe programme has been entrusted to a Technical Committee of Permanent Secretaries tobe chaired by the Secretary to the Treasury.

VIII. CONCLUDING REMARKS

45. The PSREP Credit will help meet Zambia's external financing needs for1998/1999, support macro-economic reform further and reduce poverty. IDA's assistanceis also essential to help us mobilise contributions from other donors.

Yours sincerely,

(SIGNED)

EDITH Z. NAWAKWI, MPMINISTER OF FINANCE AND ECONOMIC DEVELOPMENT

- 56 -

Annex APage I of 2

Social Sector Spending in 1999

The 1999 Budget reflects Government's continuing commitment to enhancing social servicedelivery systems and poverty alleviation by maintaining the share of core social sectorexpenditures in the health, education and water & sanitation sectors and for social safety netoperations, at over 36 percent of the discretionary domestic budget.

The actual budget figures and percentages for these social sectors and safety net programmes areattached to this appendix.

The discretionary domestic budget is total tax revenues less domestic debt service costs,(including the domestic surplus used to reduce government's domestic indebtedness), thecontingency reserve and the provisions made for (a) paying the domestic arrears carried forwardfrom 1998, (b) a civil service pay award in 1999 and (c) awards made against Government in thecourts of law.

The sectoral allocations are specified as percentages of the total discretionary domestic budget toallow Government to adjust the absolute expenditures depending on fluctuations in revenues anddomestic expenditures during budget implementation in 1999.

In addition, allocations to seven specific social sector programmes are specified and will bemonitored during 1999. These are: -

Programme Budget Code

1. The Social Recovery Programme 37/1/5/2/0272. The National Social Safety Net Committee 44/1/3/1/0023. Water and Sanitation O&M grants to councils 29/6/3/1/0014. Market Rehabilitation and Maintenance 29/6/3/1/0045. Poverty Alleviation 45/1/3/1/0056. The Public Welfare Assistance Scheme 45/2/3/1/0227. The Drought Relief Fund 2/1/3/1/003

Monitoring Social Sector Releases

Releases to these core social sectors and safety net programmes will be monitored using a sub-programme of Budget Office's "Funding" programme.

The releases monitoring report will be produced monthly and will be available by the 1 5th of thefollowing month.

-57- Annex APage 2 of 2

Kwacha Percent

Total Expenditure on the basis of which share Is computed . 1.033,000,000,000 100.00%

Total Expenditure for the year 2,120,187,335,280 205.25%LessForeign Project Financing (inc. foreign financed RDCs and Pes) 558.187,335,280 54.04%Domestic Debt (inc. surplus of K 107 bn) 177,000,000,000 17.13%Foreign Debt Service 102,000,000,000 9.87%Wage Adjustment 75,000,000.000 7.26%Contingency Reserve 147,000,000,000 14.23%Compensations and Awards 5,000,000,000 0.48%1998 Arrears 23,000,000,000 2.23%

Sub-total 1,087,187,335,280 105.25%

Sectoral Expenditures 372,844,124,442 36.09%

Health 140,839,014,293 13.63%

Recurrent and Capital expenditure of the MoH (46) 136,868,996,774 13.25%o/w PEs 33,714,968,938.00Defence Medical Services (77105) 3,970,017,519 0.38%o0w PEs

Less: Foreign capex (46) - 0.00%

Education and Training 193,247,024,788 18.71%

Recurrent and Capital expenditure of the MoE (80) 235,049,404,299 22.75%o/w PEs 100,303,290,248.00Recurrent and Capital expenditure of the MSTVT (65) 32.052,407,147 3.10%olw PEs 3,929,628.381.00

Less: Foreign capex (80) 61,667,800,000 5.97%Foreign capex (65) 12.186,986,658 1.18%

Social Safety Net 12,493,815,100 1.21%

Grants and capex (45) 9.323,974,338 0.90%olw Poverty Alleviation (4511/311/005) 1,050,434,000

PWAS (4512/3/11022) 2,802,614,000Provincial Community Development (9-/40) 1,468,037,892 0.14%o/w PEs 1.214,809.693.00Provincial Social Welfare (9-/24) 471,063,353 0.05%olw PEs 318,719,022.00Provincial Cultural Services (91/25) 150,739,517 0.01%olw PEs 70,770.476.00Social Action Programme (371115/2/026) - 0.00%Social Recovery Project (37/1/512/027) 16,798,000,000 1.63%National Social Safety Net Committee (44/113/1/002) 200,000,000 0.02%

Less: Foreign capex (45) - 0.00%Foreign capex (37/1/5/2/027) 15,918,000,000 1.54%Foreign capex (45/215/21012) - 0.00%Foreign capex (37/1/5/2/030) - 0.00%

Water and Sanitation 21,264,270,261 2.06%

M oLG H 12,014,000,000 1.16%

Loans & Investments (20) net of non water projects 39,400,000,000 3.81%Less: Foreign capex (20) net of non water projects 32,386,000,000 3.14%

Water and Sanitation O&M grants to councils (29/6/3/1/001) 4,000,000,000 0.39%Market Rehabilitation and Mainrenance (29/6/3/1/004) 1,000,000,000 0.10%

M EWD 9,250,270,261 0.90%

Recurrent & Capex of the Dept. of Water Affairs (13/3) 29,254,681,937 2.83%otw PEs 419,301,278.00Provincial Water Affairs (9/19) 1,642,324,333 0.16%o0w PEs 911,701,313.00

Less: Foreign capex (13/3) 21.646,738.009 2.10%

urougnt KelT b,UUU,UUUUUU U.457

Drought Relief Fund (2/1/3/1/003) 5.000,000,000 0.48%

140,U83,189,349.00 PE eenment 13.64%